IRS Grants Relief for Tobacco Buyout Exchanges

Farm Business Management Update, August/September 2005

By Daniel Osborne (daosbor3@vt.edu), Extension Agent, Farm Business Management, Smyth County

The Internal Revenue Service (IRS) has recently released a notice that could be of significant benefit for tobacco buyout quota holders. Recall that the Tobacco Buyout offers to pay $7 per pound to tobacco "quota holders" and up to $3 per pound to tobacco "producers." Many tobacco farmers are concerned that the amount they will actually get after paying taxes will be significantly less. However, IRS Notice 2005-57, which discusses the tax treatment specifically for quota holders, unveiled the IRS's plan to allow tobacco quota holders to take advantage of what is called a "Section 1031 Like-Kind Exchange," or "1031 Exchange" for short. By using a 1031 Exchange, quota holders could defer and possibly avoid taxes on the payments all together. In a 1031 Exchange, quota holders could in effect exchange their tobacco quota for real estate so long as the real estate is used for business or investment purposes (See the sidebar for additional information on 1031 exchange eligibility). Since the proceeds for the tobacco quota are reinvested in replacement property, which in this case is real estate, taxes will not have to be paid until the replacement property is sold. If the replacement property is not sold, it is possible to avoid the taxes completely. It seemed as if only those farmers who had the inside track on the happenings of the tobacco buyout were going to be able take advantage of the 1031 Exchange because of the strict timing guidelines in the regulations for such an exchange. However, the IRS has provided "transitional relief" in order to allow more farmers to utilize the 1031 exchange opportunity. The most important fact relating to the 1031 Exchange that farmers need to understand from this IRS notice is that they need to enter into an exchange agreement with a qualified intermediary by September 16, 2005 if they want to do this exchange. Qualified intermediaries may be located by contacting your accountant, lawyer, real estate agent, or financial institution. Farmers should expect to pay $400 to $800 for normal like-kind exchanges and up to $5,000 for extremely complex exchanges. Qualified intermediaries may require the tobacco quota holders to take a lump sum from a financial institution rather than receive the payments over the ten-year period. After expenses, it appears that farmers who will be receiving total quota holder payment of more than $10,000 will be most likely to capture the tax savings from a 1031 Exchange. Farmers considering a 1031 Exchange should seek professional advice and service from their accountant, lawyer, or financial institution.

General Guidelines for Conducting a 1031 Exchange under the IRS' Transitional Relief for Tobacco Quota Holders You must be a tobacco quota holder who applied to enter into a contract with USDA for quota holder payments by June 17, 2005. You must enter into an exchange agreement with a qualified intermediary by September 16, 2005. A quota holder who receives a quota holder payment must remit the amount to the qualified intermediary within 5 business days of entering into the exchange agreement or within 5 business days of receipt if the payment is received after entering into the exchange agreement. You must identify replacement property and notify the qualified intermediary in writing by October 31, 2005. The replacement property must be real estate that is used for business or investment purposes. For example, farm land and rental properties would qualify, but a personal residence would not. You must complete the purchase of the replacement property by March 15, 2006 or by the due date of your 2005 tax return if it is due before March 15, 2006.

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