Ask the Taxman by Andy Biebl

Tax Tips for Retiring Landowners

Andy Biebl , DTN Tax Columnist
Transfer on death deeds, now available in more than two dozen states, can keep property out of probate. (DTN photo by Jim Patrico)

QUESTION:

I recently read your article about state income taxes for farmers ("Retire to a Tax Friendly State" https://www.dtnpf.com/…) with emphasis on Minnesota farmers. Your last paragraph ends with a retired farmer having their rent income or capital gains income stuck in Minnesota and not transferrable to another state with less of a tax burden. My question is whether it would be possible to do a 1031 exchange to buy real estate or rental property in, say, Florida and have a tax benefit for doing so?

ANSWER:

The strategy you suggest has possibility if several steps are executed properly. First, the exchange into other real estate in the lower taxing state must meet the Section 1031 like-kind requirements. Assuming the relinquished land is farmland in rental status in a high-taxing state, the replacement property, say in Florida, must be real estate that is held for business, rental or investment purposes and not used for personal use. It is permissible, for example, to exchange rental land for other rental property, whether farmland or commercial real estate or even an apartment building. But property that you use personally, such as a vacation condo, even if rented for a portion of the year, is not permitted. If personal use of that rental condo exceeds 14 days (or, if greater, 10% of the rental days in the year), the property is in nonbusiness status and is ineligible as replacement property in a like-kind exchange.

The second step is to accomplish a change of residency for state income tax purposes from the higher taxing state to the lower taxing state where this replacement real estate is located. As I mentioned in the July column, the states typically use a variety of factors to determine whether the relocation of residency to another state was actually substantive, or merely an attempt to minimize state income taxes. If the individual still maintains residential property in the high-taxing state and is present for a portion of the year in that state, the tax examiners for that particular state are likely to closely scrutinize all of the various attributes of residency (first and foremost, the number of days in each state, but also auto licenses, driver's license registration, banking relationships, voting registration, etc.) to determine whether an actual change of residence has occurred.

Subject to these compliance steps, your strategy does have merit. If a Minnesota farmer exchanged Minnesota farmland for Florida business or investment real estate, and also accomplished a change in residency to Florida, any rental income from the Florida land while a Florida resident would escape the high Minnesota income tax.

QUESTION:

Marcia Taylor's column in the July issue of The Progressive Farmer discussed estate planning strategies. One of the points mentioned was using "transfer on death" title for land, so that upon death beneficiaries immediately gain title to the property without going through probate. Can you tell us which states allow the "transfer on death" real estate title?

ANSWER:

State laws are constantly changing, but there seems to be a trend in this direction. A website discussing transfer on death (TOD) deeds indicates the following states recognize this form of title for real estate: Alaska, Arizona, Arkansas, California, Colorado, District of Columbia, Hawaii, Illinois, Indiana, Kansas, Minnesota, Missouri, Montana, Nebraska, Nevada, New Mexico, North Dakota, Ohio, Oklahoma, Oregon, South Dakota, Texas, Virginia, Washington, West Virginia, Wisconsin and Wyoming. Each state, of course, may have its own specifics as to the TOD language or terminology. If you are considering a TOD deed, you should visit with an attorney in that state who can assure that your change in title is properly executed.

As the article you saw pointed out, this technique does not save any estate taxes, as the asset is still includible in the estate of the decedent. However, it does sidestep probate reporting and accomplishes a more immediate transfer of the real estate to one or more survivors.

The aspect that will vary from state to state is the consequence of a probate filing at death. Recall that the use of a TOD title is simply to accomplish an immediate transfer of the property at death without the need to record the property as a probate asset. In some states, the probate reporting process can be onerous and is worth avoiding. In many other states, the probate process has been modernized and is simple and inexpensive. I would recommend investigating the costs and benefits of the probate process before blindly assuming that it is more efficient to sidestep that reporting. Also, to put all assets in TOD title is problematical; where does the cash come from to pay final expenses, the funeral, the hot dish at the church luncheon, etc.?

QUESTION:

I am interested in the transfer on death deeds for real estate. I am 75 and have stock in a Sub S corporation farm in Mississippi.

ANSWER:

Mississippi is not presently a state with transfer-on-death real estate title. However, this is one of those trends where states are increasingly adding the flexibility, so keep tabs on developments within your state when your legislature convenes.

If your real estate is within an S corporation, you actually hold a security interest, not a direct title to real estate. Accordingly, it is a different question under state law whether a transfer on death title is permitted with stocks and other securities. According to one website, it is only Louisiana and Texas that do not allow the TOD transfers with respect to securities. So, for example, if your intent is to transfer the stock of the S corporation to two children upon death, you would simply adjust the title on the stock certificates to name them as the transfer-on-death successive owners. But again, you must do so in accordance with state law and that will require some legal work.

EDITOR'S NOTE: Andy Biebl is a CPA and tax principal with the firm of CliftonLarsonAllen LLP in Minneapolis with more than 40 years' experience in ag taxation, including 30 years as a trainer for the American Institute of CPAs and other technical seminars. He writes a monthly column for our sister magazine, The Progressive Farmer. To pose questions for future tax columns, e-mail AskAndy@dtn.com.

(MZT/CZ)