Special Tax Programs For Land Investors
Land investment using a “Current Use Tax Program”
I have been involved with several projects where the land was purchased in a preferential property tax status. This means land with a different real property tax designation than residential and a lower valuation for tax purposes. This can be a viable way to find land for development at low prices, but how and why can this work?
The answer is that acquisition and holding costs can be lower if the property is held with preferential taxation and the property is useful in it’s current state and if it is also suitable for future development plans. There are some precautions involved and they are serious ones, so let’s take a look.
Current use tax programs:
My state, enabled by its tax acts, created certain tax programs to allow enrolled properties to be valued at their current use as opposed to their highest and best use.
Two examples are designated farmland and timberlands. Taxing authorities realize that 100 acres of farmland growing a crop should not be treated for tax purposes like 100 acres of residential land in a suburb of a major city. Obviously, there’s a value difference that even the government can see and agree with.
Current use tax programs:
Enter current use tax programs. These programs can allow a property to gain favored tax valuation status as long as certain requirements are met. The requirements vary according to the designation, but there is typically a minimum acreage requirement for a property to be enrolled and the property has to be maintained substantially for the purpose it is enrolled for.
Designated forest land:
This is one of my favorite examples. Designated forest land in my state, once enrolled in the program, must be used primarily for the growth and harvest of tree species that are grown for commercial purposes. This keeps with the current use intent of the program and prevents the landowner from being tax-gouged since he qualifies for preferential property taxation.
How the big boys do it:
First of all, current use tax programs are not just for large corporations, my investors have used them too.
Nonetheless, it is a good idea to look at how the big players do it since they are excellent examples. Two examples are big land corporations and insurance companies. In my home state one of the biggest private land owners in the entire state is an insurance company. They have been collecting premiums for over 100 years and doing everything possible to not pay claims for just as long, so they have lots of money and a very long-term investment horizon.
They have broad and deep portfolios that often include real estate, but over time (with millions of acres held) property taxes could be a real problem. For this reason, why not invest in timberlands, hold them as designated forest land in a special tax program, watch trees grow for decades, harvest them at some point and then either re-plant more commercial species, develop it, or sell it?
That’s what’s done when your time horizons are decades or even centuries long. But how does a smaller guy do it? Let’s look at a success example.
Small guy success example:
I got lucky with my first land development investor. He had recently retired and ran into a land manager that worked for a large timber and paper company that was liquidating land. My investor wound up buying some acreage of designated forestland from the company.
The lucky part for me was that the investor now had land but no development momentum going on, so he was looking for a project manager. That’s how I got started in land development.
The key here is that since the property was already designated forest land, he paid a little less than $1000 per acre. This was a significant discount compared to nearby properties, so his acquisition cost was very low.
After acquisition, since the ownership had changed, a Forest Management Plan had to be submitted and approved to retain the land in the program.
Recapturing the acquisition cost:
Since the land was previously and professionally managed by a timber company, it had merchantable timber on it. In fact, more than a fair amount of it. Just before I came on board the investor had hired a certified forester to timber cruise the property and apply for a forest practice permit to harvest with a conversion option.
The conversion option in the logging permit allowed for converting the land to a higher future use and was an essential step to avoid a conversion moratorium. In less than a year he had logged the property according to the permit, taken in a more dollars than his acquisition cost and thus recaptured all of his initial cost basis! At that point he was sitting on the land for free.
It’s not as simple as that:
In my home state, when buying land enrolled in a current use tax program and the intended future use is different, one must clearly know whether the laws pertaining to the subject land will allow the intended future improvements.
It’s also necessary to eventually pay to change the tax designation to the higher use by removing it from the current use program. The removal is called removal from tax classification and comes in the form of (wouldn’t you know it) a tax recapture.
Tax recapture:
When removing the land that I was managing from the designated forest land program, I had to pay compensating taxes through a tax recapture. The tax recapture was calculated using the difference between what the taxes were while in the program and what they would have been had the property not been in the program.
The equation was: Market Value - Current Use Value = Tax Recapture Dollars Payable. At the time the tax recapture could go back for up to 10 years, but even with this recapture the properties were very profitable when converted to their highest and best use down the road.
Time it takes:
In my area, if a landowner submits an application for enrollment it can take up to 3 years for a decision. One year to prepare and submit the application, another year for processing (which includes at least one on-site inspection), then sometime in year three the landowner could be seeing the tax savings.
I have not personally experienced this timeline since all of my properties were already enrolled in the designated forestry program when acquired. However, the enrollment instructions and application make sure to clearly communicate that speed is not to be expected.
Remaining qualified:
Beyond maintaining the property according to the requirements of the program, such as growing commercial tree species or farm crops, there are typically requirements that prevent an enrolled property from becoming ineligible through improper management.
For designated forestlands, an owner cannot let the trees grow beyond a millable size and precautions against invasive plant and insect species need to be in place. For commercial farming, there has to be on-going production of livestock or agricultural products. For either one, gross sales and sales receipts must be retained for examination in an audit.
Developers:
Any developer that has an eye on holding land in a current use tax program and then eventually subdividing it needs to make sure they are in contact with their Assessors Office to review how their current use tax program might be affected by future subdivision and vice versa.
In my experience with timberlands, the tax savings alone are not enough to justify the effort. But if the current use allowed in the program can be used to create revenue (like the example of timber harvesting to recapture cost basis), then there can be a good reason to look more closely.
Placing land in a current use tax program is not for the novice. One needs professional advisement and there are real estate attorneys knowledgeable in this area, who can also advise on the feasibility of future conversion to a subdivision. In the case of timberlands and timber management plans, a Certified Forester is needed.
Attention to detail on future use and a full understanding of the enrollment terms and conditions for current use will help determine if a special tax program is a good investment option.
