The elimination of the reinforced base presents dangers for family farms
Capital gains taxes are based on the change in the value of an asset, such as farmland, livestock, or timber, when that asset is sold. Currently, the maximum capital gains tax rate is 20%. To reduce the capital gains tax, farmers and ranchers use an increased base, which allows the base to be reset during intergenerational transfers. Indeed, during the transfer of assets following a death, the base is reset to the market value on the date of death. As a result of the adjustment, taxes can only be levied on the gains made by the individual in the course of their ownership, and not on the gains made before the increase in the base.
Any change in the capital gains tax policy that eliminates or reduces the increased base could result in a massive tax burden on the agricultural sector. The magnitude of the burden depends on the change in the value of the assets, but it would likely significantly exceed the annual income generated by the assets. In fact, it could take years of returns to match the amount of tax. Using USDA 2020 Property Values Summary, changes in the value of cultivated land since 1997 and data on cash rental rates, and assuming a capital gains tax rate of 20%, today’s article estimates the capital gains tax as a share of cash rental rates of cultivated land and the number of years it takes to pay capital gains tax (based on cash rental rates) if the The tax is fully capitalized in the value of the land and that the increase in base is not retained. A previous article examined the negative impact that reducing inheritance tax exemption levels would have on family farms (inheritance tax is a threat to family farms).
Change in the value of cultivated land and estimated capital gains tax
One of the reasons that increasing the base is so important to farmers and ranchers is that the value of farm assets has appreciated dramatically in recent years. As a result, when farmland is inherited, without a base markup, many farmers would face very large capital gains taxes. For example, since 1997 (the first year of USDA land value data), the average cropland value in the United States has increased by 223%, from $ 1,270 per acre to $ 4,100 per acre. acre. In parts of the Corn Belt, the change in land values is even greater. In South Dakota, North Dakota, Wisconsin, Minnesota, Nebraska and Iowa, the change in cropland values since 1997 exceeds 300%.
In high productivity cropland areas such as Iowa and Illinois, the average cropland value has increased by more than $ 5,000 per acre since 1997. Similar changes in cropland values have occurred. in areas close to metropolitan centers, such as Florida and California and along the East Coast. Assuming a 20% capital gains tax on the change in the value of cultivated land from 1997 to 2020, farmers would face capital gains taxes estimated at over $ 1,000 per acre in California, in Iowa, Illinois, Delaware and New Jersey. Based on the national average value of cultivated land in the United States, the average capital gains tax would exceed $ 560 per acre.
Putting capital gains taxes into perspective
A capital gains tax of more than $ 500 an acre does not immediately reflect the magnitude or magnitude of the tax increase, so it is important to put this tax in perspective. Agriculture and animal husbandry is an asset-intensive, low-margin sector. According to USDA-Economic Research Service February 2021 Farm Income Forecast, the projected five-year average rate of return on farm assets is 2.8%, which is significantly lower than the S&P 500’s five-year average return on assets of nearly 8.0%. At this rate, $ 1 million in farm assets would only generate an annual income of $ 27,800. Due to the lower returns on farm assets, taxes based on valuation of assets become even more important for agricultural producers, as assets generate much lower returns than other asset classes.
Capital gains tax was calculated on the basis of the appreciation of agricultural land. Based on the average change in the value of cropland, average US cash rents, and estimated capital gains tax, the US capital gains tax would equal more of 400% of the average rental cash rate. In the United States, capital gains tax as a proportion of the rental cash rate ranges from a low of 74% in New Mexico to over 1,300% in New Jersey. Let it in. The per acre capital gains tax in 37 states is over 400% of the average cash rental rate, a very significant tax obligation that many farm families face, regardless of the size of the farm. This obligation discourages the sale of land thereby potentially increasing the cost of agricultural land.
Another way to put into perspective the potential effect of removing the increased tax base is to compare the potential tax on land capital gains with the rental income from the land in order to estimate the time it would take to compensate for the loss of the increased base if the capital gains tax were fully integrated into the price of the land. The number of years varies by state, but is over four years depending on national average rental rates and estimated tax burden. In states with larger urban areas, it would take longer to pay capital gains tax because the value of land increases much faster than rental rates in cash, as non-agricultural uses increase. raise land prices. In the center of the country, the range extends from about three years to six years for paying the tax.
To minimize the impact of onerous capital gains taxes, farmers and ranchers use a grossed-up base, which resets the asset value base during intergenerational transfers. Capital gains taxes are based on the change in the value of an asset, such as farmland, livestock, or timber, when that asset is sold. Assuming a very likely capital gains tax rate of 20%, without mark-up, it is estimated that the tax burden on farmers and ranchers inheriting cropland would be significantly higher than the cash rental income generated on the land. agricultural. In the case of most farms, capital gains tax would take several years of rental income to pay off the tax liability.
Heirs faced with these taxes would incur high costs for the sale of the land, thus increasing costs for everyone in the market. If an estate is passed on with debts, the family may not be able to meet the tax liability. To protect these family farms and minimize the impact of taxes on capital gains, it is important that the farms have continued access to a premium base. The elimination of the strengthened base to generate more federal revenue endangers the livelihoods of American family farms and the economic sustainability of those family farms in the long term.