Taxlink by Andy Biebl

Whither Capital Gain Rates?

Installment sales or 1031 exchanges may become more popular as ways to shave recent increases in capital gains taxes. (DTN photo by Chris Clayton)

The president's State of the Union message advocated a new top 28% capital gain rate and partial elimination of the step-up in basis that occurs at death. That would make sales of farmland a tax disaster. However, with the Republicans controlling the House and the Senate, those proposals have little chance of enactment. Today's capital gain rates are already both high and complex. Here's what you need to know if a land sale might be on the horizon.

THE TIERED RATES

There was a day when capital gains had a simple flat rate; today it's a four-rate system. Ordinary income comes first, but if the seller has any capacity at the two lowest ordinary rates (generally, taxable income for a married couple of less than $75,000), a portion of the capital gain can be at 0%. Most can't access this rate, but for the low income retiree this can be a plus. Next is a large swath of the gain taxed at 15%, and then with taxable income above $400,000 single or $450,000 joint we move to 20%. In addition, we have to contend with the 3.8% net investment income tax, a creation of Obamacare, if the adjusted gross income (bottom of page 1 of the tax return) is over $200,000 single or $250,000 joint. The Alternative Minimum Tax (AMT) usually joins the party, imposing a 26% to 35% rate on the other ordinary income of the seller in lieu of the lower rates. This is due to the capital gain causing a phase-out of the AMT exemption. And finally, the higher income causes phase-out of a portion of deductions and exemptions.

DEPRECIATION RECAPTURE

A farm real estate sale may include some depreciable improvements, such as drainage tile, wells and irrigation systems. In general, most of these depreciable improvements cause ordinary income depreciation recapture at sale, not the more favorable capital gain rates. Further, if the sale is seller-financed, installment deferred isn't allowed; the recapture triggers at the date of sale.

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TAX PROJECTIONS

If a major capital gain is a possibility, such as with a sale of land to Jr., it makes great sense to engage your tax adviser for a projection in advance. It's important to calculate how these complex rates apply to your facts, and how the upper rates can be minimized. An installment sale is often helpful, as it can keep more of the gain at lower rates. And there may be some ability to use farm income averaging to lower the effective tax rate on any depreciation recapture portion of the gain. Your tax adviser can also assist with the timing of the state income tax payment.

THE TRADE ALTERNATIVE

If sticker shock sets in after that tax projection, it may be time to consider a Section 1031 trade into other business or investment real estate. That farmland can be swapped not only into other farmland, but also real estate used in rental or other business capacity. With today's high capital gain rates, Section 1031 exchanges will be more prevalent.

Editor's Note: Andy Biebl is a CPA and tax principal with the firm of CliftonLarsonAllen LLP in Minneapolis and New Ulm, Minn., former president of the Minnesota Society of CPAs and a national authority on ag taxation. He writes a monthly column for our sister magazine, The Progressive Farmer. To pose questions for future tax columns, e-mail AskAndy@dtn.com.

(MZT/AG)

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