Leveraging 1031 Exchanges in Farmland

While real estate holds its place as the predominant asset in a 1031 exchange, farmland is emerging as an accessible alternative. Driven by the asset’s historical resilience against economic downturns, its potential for long-term appreciation, and its ability to serve as a hedge against inflation, US farmland is increasingly gaining popularity among investors.

This article dives into the benefits of a 1031 exchange and breaks down the historical characteristics of farmland that make this asset an appealing option.

The Benefits of a 1031 Exchange

1031 exchanges present investors with the opportunity to defer capital gains taxes by reinvesting proceeds from one property into another similar property. Often termed a "like-kind exchange," a 1031 exchange offers investors a range of potential tax-saving benefits:

• Deferral of Capital Gains: By deferring capital gains taxes at the time of sale, investors can free up liquidity, enabling them to pursue a broader range of diversified investment opportunities. This strategy can be used to help maximize growth potential by reinvesting the untaxed gains into higher-yielding investments.
  
• Depreciation Recapture Mitigation: Through a 1031 exchange, investors may be able to sidestep the recapture of depreciation deductions, allowing for the continued compounding of investment returns over time.
  
• Tax Deferral on Other State & Federal Liabilities: Beyond capital gains and depreciation recapture, a 1031 exchange may also offer a shield against other federal tax liabilities, including the Net Investment Income Tax (NIIT), thereby helping to optimize cash flow management. A 1031 exchange can also defer state-level capital gains taxes, which can vary significantly depending on the state in which the property is located.
  

This tax-efficient strategy is particularly attractive in today's volatile environment for a number of reasons, including:

• Portfolio Diversification: 1031 exchanges can offer a unique strategy for investors to help optimize their portfolio by swapping underperforming or overexposed assets for opportunities offering stronger risk-adjusted returns. This strategic maneuver can help optimize overall returns in today’s dynamic investment landscape.
  
• Volatility Mitigation: 1031 exchanges can offer investors a unique mechanism for risk management. By strategically reallocating capital to stable and income-generating assets, investors can help mitigate the impact of market fluctuations on their portfolios, in turn, enhancing portfolio resilience and preserving capital over the long term.
  
• Inflation Hedge: Tangible real assets possess inherent value appreciation potential that many traditional assets can’t match. In an environment marked by heightened inflationary pressures, investors seeking to harness long-term capital appreciation while benefiting from tax advantages may find a 1031 exchange attractive.

Farmland: An Emerging Alternative

Like real estate, farmland is classified as a “like-kind” real property interest and is eligible for 1031 exchanges. Farmland can provide a range of benefits for investors seeking tax efficiency, portfolio diversification, and long-term growth potential:

Stability and Income Generation

Farmland investments offer the opportunity to generate steady income through both rental payments and agricultural operations, particularly with leased farmland deals. This income stream can provide investors with cash flow, making farmland an attractive option in yield-oriented strategies.

Inflation Hedge

Farmland has historically exhibited a strong correlation with inflation, making it a potential hedge against rising prices. As the value of agricultural commodities and land appreciates over time, farmland investments are well-positioned to preserve and grow, especially in periods of inflationary pressure; historical data shows us that farmland returns have outperformed the CPI by 8.14% on average from 1992-2023(1).

Long-Term Appreciation Potential

Farmland investments offer the potential for long-term appreciation, as global population growth and supply constraints drive long-term value for high-quality agricultural land. By investing in farmland opportunities located in regions with strong histories of production, investors can capitalize on the appreciation of land values over time, further enhancing the overall return on investment.

Farmland values, in particular, have seen steady appreciation since 2008(2), with significant jumps beginning in 2021 at the onset of the Covid-19 pandemic; average cropland values reached a record $5,050 per acre in 2022, up nearly 15% from the year prior. This momentum carried forward into 2023, with cropland values reaching $5,460 per acre. Driven by the asset’s stable income and appreciation, farmland has demonstrated strong absolute returns over the past several decades; the NCREIF Farmland Index has averaged ~11% total annual returns since 1992(3).

Investing in Farmland Through FarmTogether

Identifying lucrative farmland opportunities can present unique challenges, however, due to complex regulatory environments and difficulties in sourcing, assessing, and operating farmland. FarmTogether excels in navigating these intricacies, led by an expert team with backgrounds at leading farmland investing and asset management institutions, demonstrated by over $2.1 billion in capital deployed().

A cornerstone of FarmTogether’s strategy is our proprietary sourcing technology, Terra, which enhances the ability to source and evaluate both on-market and off-market farmland investments. This technology-driven approach ensures a steady flow of high-quality investment opportunities, with our current pipeline valued at approximately $1.3 billion across a variety of crops, locations, and risk profiles(5).

Our team's comprehensive understanding of the factors influencing farmland values and returns enables efficient property analysis at scale. This expertise extends beyond financial analysis and encompasses operational intricacies, market trends, and agronomic factors, particularly in permanent crops, a complex market with historically fewer buyers. Permanent crops comprise perennial trees, bushes, and vines with 20+ years of productive lives, such as almonds, apples, hazelnuts, lemons, oranges, pistachios, and wine grapes. Given the long lifespan of these crops, understanding commodity end markets and market trends is paramount.

By leveraging our deep expertise, FarmTogether is able to provide investors access to a diverse range of high-quality farmland investment opportunities, both in permanent crops and row crops across the United States, that can meet a range of 1031 exchange objectives.

Upon the sale of a relinquished property, FarmTogether can identify potential 1031 properties and provide preliminary modeling with respect to the investment opportunity for properties of equal or greater value than the property to be sold. Our team will work with you one-on-one to select the replacement property that best aligns with your investment goals, either through our Bespoke or Tenancy in Common (TIC) products. Additionally, FarmTogether can work with your qualified intermediary and legal counsel, at your request, to answer questions and provide information.

1031 Exchanges in Farmland

Through careful due diligence and strategic execution, 1031 exchanges can offer a compelling opportunity to maximize investment potential in the dynamic financial landscape. Utilizing 1031 exchanges in farmland can offer investors numerous advantages beyond tax saving benefits, including income and long-term growth potential. Learn more about 1031 exchanges in farmland here.

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Endnotes:

1. Data is representative from December 1992 through December 2023. Sources: NCREIF Farmland Total Return Index and the Consumer Price Index - Urban.
2. Data representative through August 2023. Sources: Land Values 2023 Summary (August 2023) USDA, National Agricultural Statistics Service.
3. Data is based on annual total returns from January 1, 1992 through December 31, 2023. Sources: NCREIF Farmland Total Return Index.
4. Collective Capital Deployed: Includes capital invested prior to employment at FarmTogether.
5. $1.3B represents the value of farmland opportunities within FarmTogethers sourcing pipeline; these properties are not currently managed by FarmTogether.