I take exception to the conclusions stated in the July 2008 article in the fedgazette entitled “Swap meet. How a real estate law has driven up farmland prices.” This article puts forth the theory that the run-up in farmland prices during the first half of this decade was due primarily to 1031 exchangers. Nothing could be further from the truth.
There were a number of factors that contributed to the appreciation of agricultural land values from 2000 to 2007. Historically low interest rates, liberal lending practices and the ethanol boom combined to form the proverbial perfect storm.
Beginning around 2000, historically low interest rates and lax credit standards combined to cause a boom in development. Ag land was gobbled up for premium prices at a frantic pace. Commercial and residential development continued unabated until August of 2007.
The biofuel revolution replaced low interest rates as the leading driver of land prices in 2003, according to a February 2008 report by Mike Duffy, Iowa State University Extension farm economist. Duffy has repeatedly gone on record that the biofuels revolution must be credited with record Iowa farmland prices. Corn prices have improved because of demand by local ethanol plants, and soybean prices have gone up because farmers converted soybean fields to corn to meet the rising demand for the crop and enjoy near record prices. Soybeans are now also in demand by local biodiesel plants.
Most of those farmers who sold land in the path of progress benefited themselves from the use of Internal Revenue Code section 1031. It is accurate to say that some farmers exchanged into more farmland in a different location, which of course also contributed to the rise in land values.
Low interest rates and the availability of credit also contributed to a run-up in prices for commercial property. Sellers interested in taking a profit found willing buyers who had access to capital at favorable terms and rates. Other than those few who chose to buy recreational hunting land, hobby farms or working ranches, most of the exchange proceeds went back into income-producing commercial property.
It is true that some exchangers needed a last-minute reinvestment option to avoid a failed exchange. Rather than buying farmland as a 1031 fallback, a new industry sprang up to solve that problem, tenant-in-common ownership.
In 2002, the IRS ruled that TIC ownership was not a partnership interest but true fractional ownership in real property. That guidance gave investors and tax advisers the assurance they needed to use TIC investments as a 1031 fallback. That explains why fractional ownership of commercial grade property grew from $400 million in 2002 to close to $4 billion in 2007. The vast majority of that money was 1031 proceeds.
In conclusion, most industry experts agree that 2005 was the peak year for 1031 activity. The number of exchanges fell over the next two years by over 40 percent, yet farmland continued to appreciate at an extraordinary rate. According to the U.S. Department of Agriculture, the percentage change in cash cropland values from 2007 increased by 19.4 percent in North Dakota, 20 percent in South Dakota, 18.7 percent in Iowa, 12.8 percent in Minnesota and 10.4 percent nationwide.
First American Exchange Co.