How to Save Income Taxes on Land Sales

By Joseph Nicholson
Saving Income Taxes on Land Sales
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The sale of land, especially if it's appreciated considerably over a long period of time, can create a huge tax liability. The taxable income is generally equal to the final sale amount less the initial cost, or tax basis, of acquiring the property. Land is not subject to depreciation, but if it was purchased while inexpensive, the low basis results in a substantial amount of income. Avoiding income tax by delaying the taxation, raising the tax basis or lowering the tax rate can create a substantial savings.

Make an "in-kind" exchange. One way to save income taxes on land sales is to transfer the property without a formal sale. An in-kind exchange is one in which property of similar type and value is exchanged between two or more parties. The benefit of the exchange is that it does not incur a tax liability. Although it might be difficult to find someone willing to exchange the property you want for the property you have, third and even fourth parties can be involved, such that each ultimately receives title to the land they're seeking without creating any taxable income, and the tax basis on the new property is not increased.

Sell to a beginning farmer (in certain states). Montana has a law that allows anyone who sells land to a beginning farmer to deduct 100 percent of any income and capital gains of the sale from her taxable income. While this approach will only apply to a very limited number of sellers, it is an extremely effective way to save income taxes on certain land sales.

Receive installments. If a seller finances the sale herself and receives installment payments on a land sale, these payments can be small enough to avoid raising her tax bracket, thus producing a tax savings. The taxable portion of each installment is equal to the tax basis divided by the final sale price multiplied by the installment amount. This strategy has consequences for inheritance of the property and is only recommended for youthful sellers expected to outlive the mortgage.

Raise the tax basis. The tax basis of property is reset at the current market value when it is sold or similarly conveyed. If land is inherited, assuming it is not otherwise encumbered or subject to payments on installment, the beneficiary receives it at the reset cost basis of the current market value. A subsequent sale of the property for less than or equal to the cost basis at the time of inheritance triggers no income tax.

Create an irrevocable trust. A person transferring property to an irrevocable trust is no longer the owner of the property or subject to taxation on it. To avoid fraudulent conveyance, the grantor will either have to receive cash or assets roughly equivalent to the fair market value of the property or create an income tax liability. Once the asset is in the trust, however, the cost basis is reset at market value, and a substantial savings can be created through careful disbursement of the trust's assets and sale of the property. An irrevocable trust, however, is a highly complex arrangement that should always be managed by legal and/or tax professionals.

About the Author

Joseph Nicholson is an independent analyst whose publishing achievements include a cover feature for "Futures Magazine" and a recurring column in the monthly newsletter of a private mint. He received a Bachelor of Arts in English from the University of Florida and is currently attending law school in San Francisco.