Taxlink by Andy Biebl

With the slowdown in farmland appreciation, we may see retired landlords and investors willing to sell. But there is a new barrier: higher capital gains rates. With land sellers now often facing 23% to 25% federal rates plus additional state income taxes, we will see sticker shock and an unwillingness to deal. As we learned coming out of the Reagan era, higher capital gains rates suppress selling activity; lower rates stimulate ownership changes.

THE NEW RATES

Previously, a large gain from the sale of farmland was taxed at a flat 15% federal capital gains rate regardless of the amount. But starting in 2013, as total tax return income moves up the ladder, three new tax rate increases apply to land gains:

The 3.8% net investment income tax applies to land gains of investors and landlords (but not to those actively operating the farmland). This tax applies when a single filer's Adjusted Gross Income (AGI) exceeds $200,000 or $250,000 for joint filers. The capital gains rate moves from 15% to 18.8%.

Itemized deductions and personal exemptions begin to phase out when single AGI exceeds $250,000 and joint AGI is more than $300,000. This will typically add 2% to 3% to the capital gains rate of that retiree; so now the total rate has moved to 21% to 22%.

When taxable income exceeds $400,000 single or $450,000 joint, the capital gains rate moves from 15% to 20%. The personal exemption phaseout is over, but sellers still face roughly a 25% rate (20% base capital gains rate plus 1% itemized deduction phaseout plus 3.8% net investment income tax).

STATE INCOME TAX

Many states don't have favorable capital gains rates; land gains are taxed at the same rates as ordinary income. This often costs another 5% to 10% of the gain.

THE INSTALLMENT SALE SOLUTION

Sellers can avoid these tiered-rate increases by disposing of the land in a seller-financed transaction (i.e., an installment sale). Those 20- or 25-year land contracts should see a new resurgence, as they will allow many sellers to spread the gain over multiple years and avoid these stepped-up rates. If total income can be maintained under $200,000, the old 15% capital gains rate will apply, and the new rate increases are avoided.

THE INTEREST RATE ISSUE

In today's environment, there is room for a win-win on the interest rate associated with these long-term land contracts. The buyer gains certainty on the financing costs, and the seller acquires a rate of return on the contract that would be hard to match if investing the after-tax cash. The IRS shouldn't be a barrier here; its current minimum rate for long-term debt was just under 3.4% for sales originating in March 2014.

Editor's Note: Andy Biebl is a CPA and principal with CliftonLarsonAllen LLP in Minneapolis and New Ulm, Minn., and a national authority on ag taxation. He writes a monthly column for our sister magazine, The Progressive Farmer.

To pose questions for future columns, e-mail AskAndy@dtn.com.

(MZT/AG)

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