Ask the Taxman by Andy Biebl

How Can I Persuade Landowners to Sell on Contract?

Seller-financed land contracts can help an owner shave capital gains rates to 15%, versus an effective 23.8% rate on typical farmland sales. (DTN/The Progressive Farmer file photo)

QUESTION:

I am a young farmer and I read your March Progressive Farmer-DTN article "Whither Capital Gains Rates." You discussed briefly that land contracts help with capital gains. I purchased a farm on contract and some financing with Farm Service Agency guarantees. I would like to buy more land, but lenders are not very willing to finance young farmers without things like guarantees. I would really like to buy more land on contract, but most sellers just want cash deals because they say it makes it too complicated and are afraid it will cause tax issues. I do not know how it affects taxes either, but I would think it would help by splitting up the income. Can you comment on this?

ANSWER:

You've identified the two key advantages of installment sales (or a sale of land "on contract"): The deferral can minimize capital gain rates, and the seller tends to get a higher rate of interest on the contract than on the investment of the after-tax cash proceeds.

On the first point, we now have tiered capital gain rates. Most pay at a 15% rate, but when the total taxable income in a joint return exceeds roughly $465,000, the capital gain rate moves to 20% (that threshold is about $413,000 for a single filer in 2015). Further, there is a 3.8% net investment income tax that typically applies to a retiree's capital gains (although it might not apply to a recently retired farmer). This tax kicks in above $250,000 of adjusted gross income in a joint return, and $200,000 in a single return. As a result, a large capital gain, which may occur with a cash sale of farmland, can push a substantial portion of the gain into 23.8% territory. But if stretched out in an installment sale, the rate can be the more modest 15%.

And the economics of the interest rate can also be important. The choice is stark: Sell for cash, pay the tax and invest the balance at a paltry 1% or 2%. Or sell on a contract where the purchaser is paying 5%, secured by the land. But it's more than just the rate difference: The cash sale requires immediate payment of the tax, and the invested amount is diminished by the taxes paid. An installment sale earns interest annually on the pre-tax amount.

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When capital gain rates were flat and when invested funds actually earned some interest, cash sales made more sense. Today, the needle has moved to favor installment sales.

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QUESTION:

I know the IRS is telling us to issue 1099s to anyone to whom we made payments of at least $600. However, is it true we do not have to issue one if they are a corporation or a LLC? But we do issue a 1099 if it is a law firm even though they are a corporation? Leave it to the IRS to complicate everything!

ANSWER:

Your starting premise is generally correct: A business must issue a 1099-MISC to those paid $600 or more during the year for services. And as a general rule, if the payee is incorporated there is no 1099 required. However, this corporate exemption is not applicable to a Limited Liability Company or LLC (these are generally taxed as partnerships if two or more owners or as a proprietorship if only one owner). Use Form W-9 to obtain the Employer Identification Number (EIN) before you send the last check. This form provides the recipient an opportunity to certify to you that, even though it is an LLC, it is taxed as a corporation. If that is the case, the corporation rules apply. But you are correct regarding fees to law firms. A 1099-MISC is required, even if the law firm is incorporated. This is a requirement of the law, so this comes from Congress, not the IRS. But the IRS did add a new one this past year. The IRS now says that veterinarian practices must receive a 1099 if a business has paid $600 or more in fees, even if the vet practice is incorporated.


QUESTION:

I had a large spec loss in 2014 and large gains in 2011 and 2013. The 2014 loss is greater than the combined gains from 2011 and 2013. How do I carry this loss back?

ANSWER:

There are special loss carryback rules for losses from speculation contracts. These contracts are referred to as Section 1256 contracts in the tax law and are reported on Form 6781 in your Form 1040. If you have a current spec loss, you can elect to carry the loss back three years by checking Box D on your 2014 Form 6781. That's a perfect fit for you, as your 2014 loss can then reach your 2011 and then 2013 gains. After filing your 2014 tax return with this election, you file a Form 1045 to carry the 2014 loss back against your 2011 and 2013 spec gains.

EDITOR'S NOTE: Andy Biebl is a nationally recognized CPA and tax principal who specializes in agriculture with CliftonLarsonAllen LLP in Minneapolis and New Ulm, Minnesota. He writes tax columns for DTN and its sister publication, The Progressive Farmer magazine. To submit questions for future columns, email AskAndy@dtn.com. Subscribers can always find Biebl's most recent columns in Town Hall.

(MZT/AG)

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