Overview
The One Big Beautiful Bill Act (OBBBA) contains numerous provisions of benefit to farmers and ranchers. Two of them deal with agricultural real estate. One is a provision that provides a tax break to lenders where agricultural land secures the loan. Another one allows a farmer to sell farmland to another farmer the ability to spread the payment of tax gain on the gain over four years.
New IRC §139L
Section 70435 of the OBBA creates new IRC §139L to provide an exclusion from gross income for 25 percent of the interest that a “qualified lender” receives on a “qualified real estate loan.” A “qualified real estate loan” is any loan that is secured by “rural or agricultural real estate” or a leasehold mortgage with lien status on such real estate, that is made to a person after July 4, 2025. The refinancing of a loan that was made on or before July 4, 2025, does not qualify the loan for interest exclusion in the hands of the lender.
Note. A loan that is made to a specified foreign entity does not qualify the lender for the exclusion. Also, the determination of whether the loan is secured by ag land is made at the time interest income is accrued.
Definitions. The term “rural or agricultural real estate” is defined as any real estate in the United States that is substantially used for the production of at least one agricultural product as well as real estate that is substantially used in the trade or business of fishing or seafood processing. It also includes any aquaculture facility.
A qualified lender is any bank or savings association the deposits of which are insured under the Federal Deposit Insurance Act. This includes traditional banks and savings and loan associations whose customer deposits are protected by the FDIC. The definition also includes any State or federally regulated insurance company. This covers insurance companies that are overseen by either state or federal regulatory bodies. Farm Credit Associations are also included. Also contained in the definition is any entity wholly owned, directly or indirectly, by a company that is treated as a bank holding company. This part of the definition includes entities that are part of a larger corporate structure, specifically those owned by a company considered a "bank holding company" under the International Banking Act. However, there are two crucial conditions for such an entity to be a qualified lender – the entity itself must be legally established under U.S. federal or state laws and its main operational base must be within the United States or its territories. This prevents foreign-based entities, even if owned by U.S. bank holding companies, from automatically qualifying. The same definition applies the same requirements to entities owned by state-regulated "insurance holding companies."
No double tax benefit. The provision bars the lender from deducting expenses associated with the tax-exempt interest on the loan by tying into I.R.C. §265. In general, I.R.C. §265 is designed to prevent taxpayers from getting a "double benefit" by:
- Receiving income that is tax-exempt (meaning you don't pay federal income tax on it), AND
- Deducting expenses (like interest on a loan) that were incurred to earn or carry that tax-exempt income.
The most common application of I.R.C. §265 is to disallow the deduction for interest expense on money borrowed to purchase or carry tax-exempt bonds (like municipal bonds). For example, if a taxpayer borrows money to buy municipal bonds and the interest on those bonds is tax-free, the taxpayer cannot deduct the interest paid on the loan used to buy the bonds. Section 70435(d) adjusts this general rule specifically for "qualified real estate loans." It essentially partially overrides I.R.C. §265 for these types of loans, allowing for some deductibility where it might otherwise be disallowed.
For the purpose of applying I.R.C. §265(a)(2) (which disallows interest deductions related to tax-exempt obligations), the provision treats a "qualified real estate loan" as if it were an obligation whose interest is wholly tax-exempt. This legal fiction brings these specific loans under the purview of I.R.C. §265, even if their interest isn't actually wholly tax-exempt under other parts of the tax code. Instead of disallowing 100 percent of the interest on indebtedness incurred to carry these "tax-exempt" qualified real estate loans, it only disallows 25 percent. This means that for a "qualified lender" holding a "qualified real estate loan," they can still deduct 75 percent of the interest expense associated with financing that loan, even though the loan is treated as if it generates tax-exempt income for the purpose of I.R.C. §265. This is a significant benefit for lenders dealing with these types of loans.
Example. First Farmer’s Bank, a qualified lender, makes a $10,000,000 qualified real estate loan to a large farming client at 6 percent interest To fund the loan, the bank borrows $8,000,000 from another bank at an interest rate of 4 percent. First Farmer’s Bank pays $320,000 in interest annually ($8,000,000 x 4%) on this loan. Assume that First Farmer’s Bank has significant taxable income.
In accordance with Section 70435(d)(1), for the purpose of I.R.C. §265(a)(2), the $10,000,000 "qualified real estate loan" is treated as an obligation whose interest is wholly exempt from tax. This brings it under the scope of I.R.C. §265. Under Section 70435(d)(2), instead of disallowing "Interest on indebtedness," I.R.C. §265(a)(2) is applied by substituting "25 percent of the interest on indebtedness." Therefore, the amount of interest expense that First Farmer’s Bank is disallowed from deducting is 25 percent of the $320,000 in interest paid ($80,000).
First Farmer’s Bank is still allowed to deduct 75 percent of the interest expense incurred to fund the qualified real estate loan. Thus, the allowed deduction is $240,000 (320,000 – $80,000).
Observation: Without this provision, First Farmer’s Bank would have faced a disallowance of $320,000, leading to a higher taxable income and higher tax liability. With Section 70435(d), the disallowance is limited to $80,000, meaning Frist Farmer’s Bank can still deduct $240,000 of its financing costs. In addition, First Farmer’s Bank will exclude from income 25 percent of the interest received on the loan which is $150,000 ($10,000,000 x 6% x 25%).
Basis. As for income tax basis calculations, the provision treats 25 percent of the adjusted basis of the qualified loan as adjusted basis of a tax-exempt obligation. Thus, this provision states that for these calculations, only 25 percent of the adjusted basis of the qualified real estate loan is considered as the adjusted basis of a tax-exempt obligation. This further limits the portion of the loan that is subject to the disallowance rules of I.R.C. §265. There’s also another part of the provision that reinforces the 25 percent principle to ensure that only a quarter of the related indebtedness is considered for the purposes of the disallowance.
Note. Lenders will need to keep sufficient records to document the nature of the loan, the property it secures, and the amount of interest excluded.
New IRC §1062
Effective for sales or exchanges occurring in tax years beginning after July 4, 2025, Section 70437 of the OBBBA creates new I.R.C. §1062. This new Code section allows the net income tax from the sale of farmland to be paid over four years. The gain must derive from the sale or exchange of “qualified farmland property” to a “qualified farmer”. In that event, the seller can elect to pay the portion of the seller’s net income tax for the taxable year of sale or exchange that is equal to the “net tax liability” in four equal installments. If the election is made, the first installment is to be paid on the due date for the return (without regard to any extensions) for the return of the tax year in which the sale or exchange occurred. Each succeeding payment is to be paid by the due date of the return for the tax year following the tax year with respect to which the preceding installment was made.
Note: If an addition to tax occurs from the taxpayer’s failure to timely pay an installment, the unpaid portion of all remaining installments become immediately due. Similarly, if the taxpayer dies the unpaid portion of all remaining installments are to be paid on the due date for the return of the tax year of death. On this point, if the taxpayer is a C corporation, trust or estate, if there is a liquidation or cessation of business or some similar event, the unpaid portion of all remaining installments become due on the date of such event. An exception from this last point exists for the sale of substantially all of the assets of the taxpayer to a buyer where the buyer is liable for the remaining installments due.
Handling underpayments. If the election is made and a deficiency is assessed, it "shall be prorated to the installments payable under subsection (a)." In other words, instead of demanding the entire deficiency immediately, the additional tax burden is spread out proportionally across the remaining scheduled installment payments the taxpayer is already making. If an installment's payment due date "has not arrived" yet, the portion of the deficiency allocated to that future installment will simply be added to it. It will be collected "at the same time as, and as a part of, such installment." This means the taxpayer will just pay a slightly higher amount for those upcoming scheduled payments. If an installment's payment due date "has arrived" (meaning it's already due or has already been paid), the portion of the deficiency allocated to that past or current installment "shall be paid upon notice and demand from the Secretary." In this case, the IRS will send a direct bill or demand for that immediate portion of the deficiency.
However, if the underpayment is determined to have resulted from the taxpayer's own fault, such as carelessness (negligence), deliberate disregard of tax laws, or outright fraudulent intent to avoid paying taxes, then the flexibility of prorating the deficiency into installments is forfeited. In such cases, the full deficiency would (likely) be due immediately, and the taxpayer could face additional penalties. This provision aims to prevent taxpayers from intentionally underpaying their taxes with the expectation of being able to pay any discovered deficiency in installments.
Election timeline. The election is to be made not later than the due date for the return of tax for the taxable year in which the qualified sale or exchange occurs. This sets the deadline for making the election. The taxpayer must choose to pay in installments by the original due date of the tax return for the year in which the "applicable net tax liability" arose. In the case of a sale or exchange by a partnership or S corporation, the election is to be made at the partner or shareholder level. Thus, even though the "sale or exchange" might have occurred within the partnership or S corporation, the election to pay in installments for the resulting "applicable net tax liability" is not made by the partnership or S corporation itself. Instead, it is the individual partners or individual shareholders who must each decide whether to make this election for their respective share of that liability. This maintains the pass-through nature of these entities, placing the election decision and the ultimate tax payment responsibility on the individual owners.
Note: Further guidance may be necessary to clarify how partners/shareholders determine their specific share of the "applicable net tax liability" for which they can make the installment election.
Definitions. The "Applicable Net Tax Liability" is the amount of tax that is directly attributable to the gain from the specific property involved in the sale or exchange. Thus, this definition isolates the tax impact of that one transaction. The taxpayer calculates total tax with the gain, then total tax without the gain. The difference between these two numbers is the "Applicable Net Tax Liability" that can be paid in four equal installments.
Example: Cecilia has $100,000 in regular income and $50,000 in qualifying gain from a "sale or exchange of property. Cecilia’s total income is $150,000 resulting in a net income tax liability of $30,000. Assume her net income tax without the gain is $18,000. Her applicable net tax liability would be $12,000 ($30,000 – $18,000). Cecilia could elect to pay the $12,000 tax liability in equal installments over four years with the first payment due when filing the tax return for the year of sale.
Observation: The Example points out that the computation accounts for how the gain impacts a taxpayer's marginal tax rates, deductions, and credits.
Property that is qualified for the provision is real property (land and associated structures on the land) in the U.S. that the taxpayer has used as a farm for farming purposes or leased to a qualified farmer for farming purposes during “substantially all” of the 10-year period ending on the date of the qualified sale or exchange. The property must also be subject to a covenant or other legally enforceable restriction which prohibits the use of the property other than as a farm for farming purposes for any period before the date that is 10 years after the date of the sale or exchange. This condition is designed to ensure that the property remains productive agricultural land after the sale, preventing its immediate conversion to non-farm uses (like residential or commercial development) once the tax benefit is received. It ties the tax advantage to the continued preservation of farmland.
Note: A taxpayer making an election must include with the return for the taxable year of the sale or exchange a copy of the covenant or other legally enforceable restriction.
If the taxpayer is a partnership or S corporation, the individual partners or shareholders can still meet the 10-year use/lease requirement. If the entity (partnership or S corporation) used the property as a farm or leased it to a qualified farmer, then each individual who has a direct or indirect ownership interest in that entity is considered to have also used or leased the property in that manner. This prevents a situation where the structure of ownership (through an entity) would disqualify the property for the individual owners seeking this tax treatment.
“Farm” and “farming purposes” are defined in accordance with I.R.C. §2032A(e). I.R.C. §2032A(e)(4) defines "farm" very broadly to include: "stock, dairy, poultry, fruit, furbearing animal, and truck farms, plantations, ranches, nurseries, ranges, greenhouses or other similar structures used primarily for the raising of agricultural or horticultural commodities, and orchards and woodlands." I.R.C. §2032A(e)(5) defines "farming purposes" to include activities such as:
- Cultivating the soil or raising/harvesting agricultural or horticultural commodities (including animal raising, shearing, feeding, etc.).
- Handling, drying, packing, grading, or storing agricultural/horticultural commodities on a farm, if the owner/tenant/operator regularly produces more than half of the commodity so treated.
- Planting, cultivating, caring for, or cutting trees, or preparing trees for market (excluding milling).
The term ‘qualified farmer’ means any individual who is actively engaged in farming (within the meaning of subsections (b) and (c) of section 1001 of the Food Security Act of 1986 (7 U.S.C. 1308–1(b) and (c))). This is a section of the 1986 Farm Bill that defines the active engagement test for purposes of eligibility for federal farm program payments. There, Subsection (b) generally defines "actively engaged in farming" for individuals as making a significant contribution of:
- Capital, equipment, or land AND
- Active personal labor or active personal management.
In addition, the person’s share of profits/losses must be commensurate with contributions, and contributions must be "at risk."
Subsection (c) of this part of the 1986 Farm Bill provides specific rules for certain classes of individuals or entities to be considered "actively engaged," such as:
- Landowners receiving rent based on production (sharecropping).
- Adult family members making significant contributions of active personal management or personal labor, and
- Sharecroppers making significant personal labor contributions.
By incorporating this definition, the provision ensures that the "qualified farmer" leasing the land is someone genuinely and substantively involved in the farming operation, not merely a passive investor or landlord. This aligns the tax benefit with individuals who are truly contributing to agricultural production.
Conclusion
Both provisions demonstrate a clear legislative intent to support the agricultural industry and rural economies through tax incentives. Section 70435 serves as a targeted tax incentive designed to lower the cost of capital for loans secured by rural and agricultural property, thereby encouraging investment in these vital sectors and supporting the financial health of farmers and rural communities. Clearly, the primary goal of Section 70435 is to stimulate investment and development in rural and agricultural areas. By providing a partial tax exclusion for interest income on loans related to agricultural properties the Congress is attempting to incentivize an increase in access to capital to ag borrowers and encourage investment in ag land (and associated equipment and infrastructure. Perhaps lenders will offer lower interest rates on qualified rural and agricultural loans, as their effective return on investment will be higher due to the tax savings. This could be a significant benefit for farm borrowers.
The primary impact of Section 70437 is to allow taxpayers to pay the portion of their income tax specifically attributable to the gain from a qualifying farmland sale in installments, rather than having the entire tax due by the normal tax return deadline. This directly addresses a common financial challenge faced by farmers and landowners who sell valuable agricultural land – a large, one-time tax bill that can be difficult to manage, especially if the proceeds are reinvested or used for other purposes. This provision makes it easier to manage the tax burden on farmland sales and can help facilitate the transfer of farmland, whether within families or to new farmers, by easing the immediate financial strain on the seller. In addition, the requirement for a 10-year use restriction ensures that the land remains in agricultural use after the sale, preventing immediate conversion to other uses like commercial or residential development.