Family LLC Selling Land to a Data Center: Some 1031, Some Cash

Who pays the tax when a family LLC sells land to a data center?

The company that holds title is the seller, so its tax type decides who pays. A family LLC with two or more members, a partnership or an S corporation pays no federal income tax on the gain (with one exception for former C corporations); each owner reports a share on a K-1, cash or not. A C corporation pays 21% first, and owners pay again when cash comes out.

An LLC that elected to be taxed as an S or C corporation follows that corporation's row. Its latest federal return (Form 1065, 1120-S or 1120) shows which.

For a family LLC or partnership, the character of the gain depends on how it used the land (Publication 544):

• Land it farmed or used in its business is section 1231 property, reported on Form 4797 and on K-1 box 10.
• Land held for investment is a capital asset, reported on Schedule D and K-1 box 9a.
• Either way, long-term gain generally gets capital gain rates, up to 20%, plus 3.8% net investment income tax above its thresholds, unless the land was used in a farm or other business in which the owner materially participates, so it is not a passive activity for that owner (26 U.S.C. 1411(c)). Land leased to a tenant farmer for cash rent is generally a passive rental. Net section 1231 gain is ordinary up to each owner's unrecaptured section 1231 losses of the previous 5 years.
• Depreciated items sold with the land, such as grain bins, bring back depreciation as ordinary income, and depreciation on buildings can be taxed at a higher capital gain rate, so how the contract allocates the price matters.

Land a parent contributed. If a parent put land into the partnership when it was worth more than its basis, the partnership must allocate that built-in gain to the contributing partner (Publication 541), and to an heir or donee who takes over that interest (Reg. 1.704-3(a)(7)).

Option payments, ground leases, dealer status, owners' estimated tax and inherited-land valuation are in Selling or leasing land to a data center. A family case stops being simple when owners want different outcomes, someone has died, the land is in a corporation, or a member lives abroad. Before the option is exercised, gather the option, the operating agreement or bylaws, deeds, prior returns and K-1s, S election and death dates, and any appraisals.

Can an LLC do a 1031 exchange, and can one member exchange alone?

Yes, a family LLC or partnership can make a 1031 exchange, but only as a whole. The same LLC, or a single-member LLC it wholly owns, sells the land and takes title to the replacement real property. Both must be real property held for use in a business or for investment, not held mainly for sale (Form 8824 instructions). The 45 days and 180 days deadlines and the intermediary rule are in Selling or leasing land to a data center.

One member cannot exchange "their share" of land the LLC owns. A member owns an interest in the partnership, not the land, and a partnership interest is not real property for section 1031 unless the partnership elected out of the partnership tax rules entirely under section 761(a) (Form 8824 instructions).

Buying replacement land from family needs a check first: related parties for section 1031 include brothers, sisters, parents, children and family companies.

Some of us want cash and some want farmland: what are the options?

The owners have to split before closing, and each route has a cost:

The LLC takes cash out of the exchange. Cash or other non-like-kind property received in an exchange, commonly called boot, makes gain taxable up to its value (Publication 544, Partially Nontaxable Exchanges). That gain is the LLC's and follows the operating agreement. An allocation of it only to the members who take the cash holds only if it has substantial economic effect (26 U.S.C. 704(b)): the members' capital accounts, and what each gets when the LLC winds up, must actually follow it (Reg. 1.704-1(b)(2)). It has to be in the operating agreement before closing. Otherwise members who stay can owe tax with no cash.

Buy out first. The LLC redeems the leaving members, or the others buy them out, before the sale. The leavers report gain on their interests (Publication 541), and the LLC exchanges the whole tract. A buyout paid from sale money before the replacement land arrives is cash to the LLC, taxed like boot (Publication 544). Redemptions and the section 754 election are in Buying out a partner.

What is a drop and swap, and how safe is it?

In a drop and swap, the LLC deeds each member an undivided, tenancy-in-common share before closing, and each member sells or exchanges their own. No IRS safe harbor or rule says how early the deed must move or how long members must hold. The risks:

• The LLC may still be the seller. The Supreme Court taxed a company on a sale its owners formally made after the company negotiated the deal (Commissioner v. Court Holding Co.). An option signed by the LLC invites that argument.
• Members who exchange must hold for investment or business use, not for sale (Form 8824 instructions).
• The return flags it. Form 1065, Schedule B question 12 must be answered Yes for any distribution of a tenancy-in-common or other undivided interest, even through an intermediate entity. Question 11 flags replacement property distributed after an exchange, the reverse "swap and drop" (Form 1065 instructions).
• Co-owners can become a partnership again. Co-owners who only lease farmland to a farmer for cash or crop-share rent do not necessarily create an entity (Reg. 301.7701-1(a)(2)). Co-owners who keep running a business together can. Revenue Procedure 2002-22 lists conditions for co-ownership rulings, but it says itself that it is not a substantive rule.
• Recently contributed land. If a member contributed the land within 7 years and it goes to another member, the contributor recognizes gain (Publication 541).

A variant deeds shares only to the members who want cash; they sell and pay tax, and the LLC exchanges the rest. No IRS rule or ruling addresses this variant. If the IRS treated the LLC as the seller of everything, under the Court Holding case above, that cash would be the LLC's boot and the allocation problem would return.

A parent died: does the land inside the LLC get a stepped-up basis?

Not automatically. Inheriting a partnership interest does not change the land's basis inside the partnership unless the partnership has a section 754 election (Publication 541).

• Making the election. The partnership attaches a statement to its timely filed return, including extensions, for the year of the death. Automatic relief is available if corrective action is taken within 12 months of that deadline. The election then applies to later transfers and distributions until revoked on Form 15254 (Form 1065 instructions).
• Without the election, the heir's K-1 shows gain measured from the old basis, even though the heir's interest was valued at death. The heir may get a matching capital loss only when the interest is sold or liquidated.
• Land distributed to the heir. An heir who receives the land itself within 2 years of acquiring the interest may elect a special basis adjustment (Publication 541).
• S and C corporations have no such election. Inherited shares generally take their value at death (Publication 551); the land inside keeps its old basis.

Our land is in an S corporation: is there a built-in gains tax, and can one shareholder exchange?

Only if the S corporation was once a C corporation, or received the land from one with carried-over basis (Schedule D (Form 1120-S) instructions). Then gain up to the land's appreciation on the first S day (or the day it received the land from the C corporation), recognized within 5 years from that day, is taxed at 21% at the corporate level. The tax is treated as a loss that reduces the gain passed through to shareholders. The computation and switch-date values are in Switching a C corporation to an S corporation.

• The built-in gain follows the land. Replacement land from an exchange carries it, with the same start date (26 U.S.C. 1374(d)(6)). Installment payments received after the period ends, on a sale made within it, are still taxed (Reg. 1.1374-4(h)).
• Gain passes per share, per day; owners cannot steer it. See How S corporations are taxed.
• The corporation can exchange the whole tract; one shareholder cannot exchange alone. Deeding land to all shareholders in proportion, or redeeming one shareholder's shares with land, is taxed to the corporation as a sale at fair market value (26 U.S.C. 311(b); Publication 542), and that gain flows to all shareholders. A distribution to one shareholder alone differs among the shares and is taxed by its facts (Reg. 1.1361-1(l)(2)). So for an S corporation, a drop and swap does not avoid tax on the land deeded out; it only moves who holds the rest.
• Converting to an LLC first is a liquidation; see Changing your business structure. A shareholder who becomes a nonresident alien ends the S election; see US S corporation owner in Canada.

Our land is in a C corporation: how much tax, and how do we get the cash out?

A C corporation pays 21% of its taxable income, with no lower rate for capital gains (Publication 542). Cash then reaches owners as dividends, or in a complete liquidation, where each shareholder compares the cash with their stock basis. Inherited shares generally take their value at the owner's death as basis (Publication 551), which can shrink that second tax.

• A corporate exchange defers the corporate tax but keeps the value inside the corporation; shareholders cannot exchange separately.
• Shareholders who receive liquidating cash while corporate tax is unpaid can be assessed for it as transferees, up to 1 year after the corporation's own assessment period ends (26 U.S.C. 6901).
• Distributing the land to shareholders before the sale, in a liquidation or not, is taxed to the corporation as a sale (26 U.S.C. 311(b); 336).
• Cash or a note left inside can bring accumulated earnings or personal holding company tax; see How C corporations are taxed. Liquidation steps are in Closing a company.

Can the company sell on an installment note and still close down later?

Yes for an LLC or partnership: it can hand the note to its members and close. A C or S corporation can if the sale and liquidation fit inside a 12-month plan, though a C corporation still pays its own tax on the sale. The company reports the sale on Form 6252, and a partnership's or S corporation's gain reaches the K-1s as payments arrive. Interest on the note is ordinary income, and depreciation recapture is taxed in the year of sale even if no payment arrives (Publication 537).

• Partnership or LLC: distributing the note to members generally triggers no gain (Reg. 1.453-9(c)(2)), so it can wind up while the note pays.
• C corporation: distributing a note is generally taxed to the corporation (26 U.S.C. 453B(a)). Shareholders can still report as the note pays if the sale falls within the 12 months after a plan of complete liquidation is adopted and the liquidation is completed within them (26 U.S.C. 453(h)).
• S corporation: in that kind of liquidation, distributing the note is not taxed at the corporate level, except for S corporation taxes such as built-in gains tax (26 U.S.C. 453B(h)).
• An interest charge can apply when outstanding notes exceed $5,000,000, but not on a note from selling property used in a farming business (26 U.S.C. 453A(b)(3)). Publication 537 and the Form 6252 instructions do not say whether a partnership or S corporation tests this at the company or owner level.
• A note received inside an exchange is boot, reported as it is paid (Publication 537).

The section 1062 election to pay tax in four installments needs a sale to a qualified farmer, an individual actively farming (Form 1062 instructions), which a data center developer is not.

One of us lives in Canada or abroad: who withholds tax on the sale?

When a US partnership or corporation sells US real property, the company itself is the withholding agent, not the buyer; the buyer generally asks the company for a certification that it is not a foreign person (IRS: FIRPTA withholding). A domestic partnership withholds under section 1446 on a foreign member's share of the gain, in place of the FIRPTA rule. The rate for an individual member is 37%, or a lower capital gain rate when the member's situation is documented, paid in installments during the year (Forms 8804, 8805 and 8813 instructions). A partnership that fails to withhold owes the tax itself, plus penalties and interest (26 U.S.C. 1461). The member files Form 1040-NR. Canada's side is in Canadian partner in a US LLC.

A domestic corporation must withhold when it distributes property to a foreign shareholder in a redemption or liquidation and the shares are a US real property interest (IRS: FIRPTA withholding). If a foreign person owns the land through a single-member LLC, that person is the seller and the buyer withholds at closing; see Selling or leasing land to a data center.

What does the company file for the sale year, and when?

The company files its own return for the sale year, with the sale forms and K-1s; owners file their personal returns from the K-1s. For a calendar-year company:

• Form 1099-S. The closing agent files one for a partnership, not one per partner, and none when the seller is a corporation (Form 1099-S instructions). Members learn their share from the K-1.
• State returns. The state where the land sits generally taxes nonresident members on their share if it has an income tax; see Business income tax in other states.
• Texas. An LLC cannot be a passive entity for franchise tax; a family partnership can if at least 90% of its federal gross income is from listed passive sources, and rent is not one of them (Texas Comptroller). See Texas franchise tax.

Example

Illustrative only, in US dollars, federal tax only, with no state tax or closing costs.

Four siblings, one family LLC in Georgia

In 1995 the parents put 400 acres into an LLC taxed as a partnership, at an $800,000 basis, and later gave each child 25%. The LLC leases the land to a neighbor for cash rent. The LLC signed the developer's option at $40,000 per acre, or $16,000,000. The contribution is more than 7 years old, so no contribution gain arises.

• Plain sale: gain is $15,200,000. Each K-1 shows $3,800,000, roughly $900,000 of federal tax each at 20% plus the 3.8% net investment income tax.
• Exchange with cash out: the LLC buys $8,000,000 of farmland and takes $8,000,000 cash to pay the two siblings who want out. $8,000,000 of gain is taxed, $7,200,000 is deferred, and the new farm keeps an $800,000 basis. Split 25% each, the two siblings who stay each report $2,000,000 of gain with no cash.
• Deeding shares to the cash siblings: months before closing, the LLC deeds a 25% share to each of the two siblings who want cash. Each sells for $4,000,000 with a $200,000 basis, a $3,800,000 gain. The LLC exchanges its half, deferring $7,600,000, and answers Yes to Schedule B question 12. Because the LLC signed the option, the IRS can argue the LLC sold everything.

Three siblings, an S corporation in Indiana

The farm corporation's S election took effect January 1, 2023; before that it was a C corporation. The land's basis is $500,000, and it was appraised at $3,000,000 that day. A developer pays $12,000,000 at a 2026 closing.

• Gain is $11,500,000. Built-in gains tax is 21% of $2,500,000, or $525,000, assuming no offsets and enough taxable income. $10,975,000 passes through, about $3,658,000 to each sibling.
• A closing on or after January 1, 2028 avoids the built-in gains tax; 2028 payments on a 2026 installment sale do not.
• If one sibling wants farmland, redeeming her shares for a third of the land is taxed to the corporation as a sale at $4,000,000, and that gain passes to all three, including her.

Two siblings, a C corporation in Northern Virginia

The siblings inherited all the shares in 2015, with a $2,000,000 total basis. The corporation, formed in 1978, holds 200 acres with a $200,000 basis. A developer pays $10,000,000.

• Corporate tax is 21% of $9,800,000, or $2,058,000, leaving $7,942,000.
• Liquidating in 2027, the siblings' gain is $5,942,000, about $1,414,000 at the top rates. Federal tax totals about $3,472,000, roughly 35% of the price.
• If the corporation adopts a plan of complete liquidation first, sells for a note and liquidates within 12 months, the siblings report their gain as the note pays. The corporation still pays its own tax.

Different for you?

• Individuals, spouses or co-heirs own the land directly: see Selling or leasing land to a data center.
• Selling the company's shares or LLC interests instead of the land: see Selling your business.
• Spouses, children or parents are the members: see Spouse and family LLCs.
• One member is being bought out or redeemed: see Buying out a partner.
• The state allows a pass-through entity tax election on the gain: see Pass-through entity tax election.
• The company will close after the sale: see Closing a company.
• The farmland is in Canada, or held in a Canadian corporation: see Selling farmland to a data centre developer.
• Owners disagree, a parent has died, the land is in a corporation, or a member lives abroad: the elections and deadlines are hard to undo once the option is exercised. Get data center tax help and bring the documents listed at the top.