The Tax Benefits of a Farmland Installment Sale

Selling the farm is a complex decision. Financial, legal and emotional concerns are a just a few of the important details that surround these large transactions, none of which are to be taken lightly.

After years of strong gains in the price per acre of agricultural farmland, many agree that a series of land value peaks occurred some time around late 2013 and into the spring of 2014. Since this time, the price per acre for agricultural land has seen, for the most part, some softening until the COVID-19 pandemic – causing a significant gain in farmland values across the country, in particular on Indiana farmland, Illinois Farms and Iowa farmland.

Whether you are planning for retirement, have inherited the family farm or are simply looking to cash in on paper profits, there are several ways to sell a farm, including the installment sale. While many people prefer an outright sale with cash at closing, there are some tax benefits associated with installment sales that are certainly worth exploring. The challenging part is finding the right buyer who would finance the deal with a down payment and contract, but at Geswein Farm & Land Realty, we believe in win-win scenarios.

An installment sale provides some flexibility to spread the capital gains liability out over several years. The end result allows for better tax planning methods and strategies. The interest earned from a Promissory Note on the farmland installment sale could be higher than the net cash rent income produced by leasing the farmland.

After an installment sale, the only thing the seller has to focus on is collecting monthly interest payment. No longer will you need to manage the farm, renew farm leases, or maintain the property.

When penciling the math with your accountant, the value of a well-performing Promissory Note with interest can be greater the value of the farm real estate, particularly lower quality farmland.

FARMLAND INSTALLMENT SALE EXAMPLE & CASE STUDY

Sellers: Family with several relatives that has inherited a tract of family farmland

Acres: 80 acre farm

Purchase / Sale Price: $750,000

How the Installment Sale & Closing Works 

Getting Paid

The closing of an installment is very much a traditional farmland sale. The closing takes place through a reputable Title Company under what is commonly referred to as an “insured closing.” The costs associated with the closing are standard with the Seller and Buyer splitting the “closing costs” evenly.

Down Payment Example:

• $150,000 paid at closing to the Sellers
• Promissory Note Original Amount: $600,000

Promissory Note Terms: Interest Rate of 4% or more. Interest to be paid annually on each anniversary date of the Promissory Note along with a $120,000 principal payment. Promissory note would be paid in full over a 5 year period. Promissory Note would mature in full 5 years from the date of the note.

Prepayment Penalty: 2% during the 5-year term of the Promissory Note, with the provision that with the death of the last spouse, the note could be prepaid in full with no penalty.

Collateral: The Promissory Note would be fully secured with a  1^st Security interest in the total acres of the farm (in this example, 80 acres of farmland) being sold/purchased. The original Promissory Note amount would be 80% of the purchase price, giving the Seller(s) their Promissory Note properly secured with a  20% equity/cushion. After the first anniversary principal payment is made, the equity/cushion increases to 36%.

Escrow Agent/Holding of Funds: A very reputable Trust Department of a local, regional, or national bank with an office in Indiana would be utilized to handle the details of the paperwork and transaction. The Seller(s) and Buyer(s) would split the annual fee for the Escrow Agent on a 50/50 basis.

Documentation for Closing:

1. A Warranty Deed for ownership of the 80 acres would be given from the Seller(s) to Buyer(s)
2. A 1^st Mortgage in favor of the Seller(s) in the amount of $600,000 would be executed by the Buyer(s)
3. A Release of Mortgage would be executed by the Seller(s)
4. The $600,000 Promissory Note in favor of the Seller would be executed by Purchaser
5. An Escrow Agreement would be executed by: The Seller(s); The Buyer(s); and the Escrow Agent. The Escrow Agreement would clearly outline the responsibilities and duties of all parties involved.

 After Closing Details:

Shortly after closing, a reputable title insurance company (e.g. Chicago Title Company), an Owner’s Policy of Title Insurance would be issued in favor of the Buyer(s) for $750,000 and a Lender’s Policy of Title Insurance would be issued in favor of the Seller for the $600,000 Mortgage.

The Promissory Note, the Mortgage, and the Release of Mortgage would remain in the control and possession of the Escrow Agent until the Promissory Note is paid in full. Once the Promissory Note is paid in full, the Escrow Agent would mark the Promissory Note “PAID” and the Escrow Agent would the immediately record the Release of Mortgage at the local County Recorder of Deeds office. Once the documents are properly recorded, then the installment sale of farmland will have been deemed fully satisfied and the responsibilities of the Escrow Agent will end at that time.

How are Annual Payments Made to Seller(s)

The Annual principal and interest payments would be paid from the Buyer(s) to the Escrow Agent. The Escrow Agent would then in turn distribute these payments to the Seller(s). The Seller(s) would be responsible for advising the Escrow Agent of any change in status of the beneficiaries of the Promissory Note and to certify to the Escrow Agent as to whom should receive the annual principal and interest payments going forward and at what address or addresses.

Commission Fees / Broker Fees

It is important to remember that the fees paid to the real estate broker are due and paid in the full at the time of the closing. Regardless of the timing of the installment sale and payments to the seller, the entire commission must be paid at closing. Generally speaking these fees vary based on total number of acres and the size of the real estate transaction.

While this is merely one potential method for selling a farm, it’s certainly not for everyone. Keep in mind that fees paid to the land broker or real estate agent must still be paid in full and are not spread out over the course of the installment sale. More often than not, this technique for selling a farm only comes into play during very limited circumstances.

“At Geswein Farm and Land, we believe in creating win-win scenarios for our clients and when necessary, explore alternative options for the sale of a farm.”

The information presented here is not to be construed as legal advice. Consult your tax advisor and/or attorney prior to making any decisions for an installment sale of farmland. Geswein Farm & Land Realty, LLC and its agents cannot be held liable on any matters related to an installment sale.

For more information on tax benefits or strategies in Indiana and Illinois visit our guide to tax strategies page. You can also learn more about undivided interest farms and avoiding inheritance problems