Policy letter; capital gains deduction; Apr14,2005
Topic Code: C012Capital Gains Deduction Document Reference: 05201033
April 14, 2005
Your letter dated March 31, 2005 has been referred to me for reply. Your letter requested a determination on whether an Iowa capital gain deduction can be claimed based on certain factual situations.The situation posed in your letter involves farmland which was owned by a husband and wife as tenants in common. The husband materially participated in the farming operation and farmed the land until retirement. The wife actively worked with the husband in the farming operation. When the husband and wife retired, they continued to own the farmland and rented it to tenants. The husband passed away in December 2003, and the wife inherited the other one-half of the farmland.Iowa Code Section 422.7, subsection 21, provides for an Iowa capital gain deduction from net capital gain from the sale of real property used in a business, in which the taxpayer materially participated for ten years, as defined in Section 469(h) of the Internal Revenue Code, and which has been held for a minimum of ten years. Both the 10 year ownership requirement and the 10 year material participation requirement must be met to qualify for the Iowa capital gains deduction.Iowa Rule 701-40.38(1)(c)(7) sets forth the requirements for material participation for retired and disabled farmers and surviving spouses of farmers, which is noted below: “A retired or disabled farmer is treated as materially participating in a farming activity for the current year if the farmer materially participated in the activity for five of the last eight years before the farmer’s retirement or disability. That is, the farmer must have been subject to self–employment tax in five of the eight years before retirement or disability and had to have been either actively farming so the income was reported on Schedule F or materially participating in a crop–share activity for five of those eight last years prior to retirement or disability. EXAMPLE. Fred Smith was 80 years old in 1991 when he sold 200 acres of farmland he had owned since 1951. Mr. Smith retired in 1981. In the last eight years before retirement, Mr. Smith was paying self–employment tax on his farm income which was reported on Schedule F for each of those eight years. In the years before he sold the farmland, Mr. Smith was leasing the farmland on a cash–rent basis, whereby Mr. Smith would not be considered to be materially participating in the farming activity. Because Mr. Smith had material participation in the farmland in the eight years before retirement, Mr. Smith was considered to have met the material participation requirement, so the capital gain qualified for the Iowa capital gain deduction. A surviving spouse of a farmer is treated as materially participating in the farming activity for the current tax year if the farmer met the material participation requirements at the time of death and the spouse actively participates in the farming business activity. That is, the spouse participates in the making of management decisions relating to the farming activity or arranges for others to provide services (such as repairs, plowing, and planting).”Based on the facts presented in your letter, the Department will assume that the ten year material participation test has been met for both the husband and the surviving spouse. The answers that follow will presume that the material participation test has been met.Because the husband and wife owned the farmland as tenants-in-common, each spouse is deemed to own 50% of the farmland. Therefore, the wife is only entitled to the capital gain deduction on her original one-half of the farmland. The reference to “held” in Iowa Code Section 422.7(21) is to ownership, since capital gain tax laws originate with the sale of an asset, and an asset cannot be sold unless it is owned. This is supported by a decision of the Administrative Law Judge and the Director of Revenue in James E. and Linda Bell, Docket No. 0020-1-0162. In this case, the wife has not owned the one-half of the farmland inherited from her husband for the ten year period required by Section 422.7(21). If the ownership had been in joint tenancy, both the husband and wife would have been deemed to own 100% of the farmland, and the wife would have been entitled to the capital gain deduction on the sale of the entire property. However, because the farmland was held as tenants in common, the capital gain deduction only applies to the original one-half interest held by the wife.If you have any questions on this matter, please contact me at (515) 281-6183.Sincerely,Jim McNultyPolicy SectionCompliance Division