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Iowa Farmer Puts the Plow Away Too Soon, Loses Capital Gain Break

August 31, 2017

Iowa has a unique tax break for business owners who sell their businesses or business real estate. Iowa exempts the resulting capital gains from state income taxes if at the time of the sale the following criteria is met:

  • The taxpayer had held the property for 10 years
  • The taxpayer had "materially participated" in the business for the 10 years preceding the sale

The technicalities of this rule tripped up a retired Iowa farmer when he sold his land in a recently-released Iowa administrative decision.

History
The taxpayer farmed in northern Iowa from 1978 through 2002. In 2002 he swapped farmland in a qualified like-kind exchange. That's OK, as the holding period of the old farm tacked on to the new farm received in the swap. 

The taxpayer stopped actively farming and started cash renting the land in 2004. He turned 62 in 2008, and he started collecting Social Security benefits. He continued renting through 2009. He sold the land in December of 2010 and claimed the Iowa capital gain exclusion on his 2010 Iowa return. There's where his problem started.

Defining 'Retired'
Iowa's capital gain exclusion uses the "material participation" definition from the federal "passive loss" rules. These rules are generally based on the amount of time a taxpayer spends on an activity in a year. 

A special rule considers retired farmers to continue to materially participate forever if they materially participated under the hours rules for five of the eight years before they retire or become disabled. In the year at issue, 2010, retired or retirement was not defined in Iowa law related to the capital gains exclusion. However, at that time, the Iowa Department of Revenue "concluded and regularly advised" that a person retired upon receiving Social Security benefits.  This concluded and regularly advised position on retirement was adopted as an amendment to Iowa law in 2012.

The ruling explains how this applied to this farmer:

Mr. Brandt stopped actively farming the land in 2004, began receiving Social Security old-age benefits in 2008, and sold the land in 2010. Brandt did not materially participate in farming the land five or more of the last eight years before he became a retired farmer by receiving Social Security old-age benefits. He was not entitled to claim a capital gain deduction for proceeds from the sale of the replacement farm under the retired farmer provision.

More Than Just Farmers Affected
With the run-up in farmland prices in recent years, the Iowa capital gain exclusion can be a big deal, considering the state's 8.98 percent top individual tax rate. It's important for Iowa farmers to think this through in their decisions on whether to cash rent and when to sell out. 

Iowa's capital gain break doesn't apply just to farm real estate, but to all real estate used in a business. It can also apply to a sale of an entire business in an asset sale or liquidation.

Your tax specialist can help you determine whether this break will work for you.