For investors, water’s the real deal

When Ed Orr began developing the Poudre River Ranch subdivision in northwest Greeley, he had to sell the land’s water before construction could begin.

The sale was necessary because the ditch water that served the property couldn’t be used within the homes, and the particular ditch system wasn’t connected to the Greeley water treatment plant.

“The mutual ditch water is worthless in a development because you are no longer using it to irrigate,´ said Orr, managing broker of Orr Land Co. in Greeley. “So, I was able to sell off those ditch shares to augmenters of water. They put a dry-up covenant on the ground and they paid me for the water. I then had a raw water level to meet and put taps in place using Greeley water.”

When a farm is sold into development, not all of the assets can be transferred with the land. Water is the most valuable of these assets – whether the water can remain on the land depends on the particular category.

Groundwater, for instance, is virtually impossible to sell because it is appropriated to a specific area or lot. If sales of groundwater occur they are usually between neighbors.

Mutual ditch water is easier to sell, but the area for such a transaction is still confined geographically. Most purchasers reside along the ditch or are municipalities who integrate the water into their systems.

Colorado’s water system is based on a “first in time, first in right” system. This priority system allows oldest holders to receive water first, followed by junior holders if water remains.

Colorado-Big Thompson water, which is managed by the Northern Colorado Water Conservancy District, is easily bought and sold and is highly sought after because of the ease of transmission. The water can be sold between shareholders for a going rate of about $11,000 per share; it’s delivered to the new holder using existing transportation methods. In 2004, approximately 90 percent of the 3,229 C-BT water units sold were sold from agricultural uses into urban uses.

Not all of the water sold from agriculture is a sign of a farm closure. Farmers often sell their C-BT water for a high price and buy more water from a less expensive source.

“You see a few players in the market that are concerned with the 1031 ability of C-BT water,” Orr said. “There are a few accountants or others out there that either don’t know what I know or have heard something different about it being considered real estate.”

Water rights = real property?

“In Colorado a water right is a real property as defined by the IRS, but a water right in a mutual ditch company is similar to a stock transfer, and that’s a real fuzzy thing,´ said Craig Harrison, president of Harrison Resources Corp. in Loveland. With mutual ditch companies, the ditch companies own the water and the users own shares of the company and the company dispenses water like it’s a dividend.

“A lot of real estate transfers occur using 1031 tax deferrals and often the water is included in the 1031 exchange. But, water is viewed as real property and is a part of this one big asset (including the land),” Harrison said.

In short, a 1031 tax deferral permits sellers of real estate to reinvest the proceeds from the sale into another investment or business property within a certain time period. The exchange allows the investor to defer capital gains tax that would otherwise be due on the initial sale.

Since water rights are considered real property and can be sold like real estate, they can be involved in 1031 exchanges.

Harrison said the practice of “like-kind” exchanges involving water is very common.

“Often you have a deal that is worth $4 million but $3 million is in water,” he said. “The buyer may not want that much water or you have to hold back the balance to hit the exact dollars for a 1031. We make the adjustments in water because it is easier than subdividing the land.”

Water as an investment

Selling water is one way to receive a return on an investment made in previous years, but a local water broker doesn’t recommend investing in water for investment’s sake.

From all appearances water rights seem to be a good investment in a finite resource. Unless you can rent the water back out to an end user, the ends don’t seem to justify the means for an individual.

“The supply and demand of water is run by the development community,´ said Ted Dedolph, owner of Water Solutions Group in Fort Collins.

“When you compare it to other things for the next two, three or five years … my guess is that it is going to do better than other markets.”

on Facebook on LinkedIn