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23. IOWA CAPITAL GAINS DEDUCTION.

This is a deduction of qualifying net capital gains realized in 2005.

Note: Line 23 can be more than the net total reported on Schedule D. Unrelated losses are not to be included in the computation of the deduction. An example of an unrelated loss is the sale of common stock at a loss..

The term “lineal descendent” means children of the taxpayer, including legally adopted children and biological children, stepchildren, grandchildren, great-grandchildren and any other lineal descendants of the taxpayer.

Qualifying capital gains result from the sale of the following:

  1. Real property used in a business in which the taxpayer materially participated* for 10 years prior to the sale, and which has been held for a minimum of 10 years immediately prior to its sale.
  2. A business in which the taxpayer was employed or in which the taxpayer materially participated* for 10 years and which has been held for a minimum of 10 years immediately prior to its sale. The sale of a business means the sale of all or substantially all of the tangible personal property or service of the business which is intangible personal property such as client lists, goodwill, patents, trade names, and similar items. This means that the sale of the assets of a business during the tax year must represent at least 90% of the fair market value of all of the tangible personal property of the business on the date of sale of the business assets.

    Sale to an individual who is a lineal descendent of the taxpayer eliminates the requirement for material participation.
  3. Cattle and horses used for breeding, draft, dairy or sporting purposes and held for 24 months by the taxpayer who received in excess of 50% of his or her gross income from farming and ranching.

    Sale to an individual who is a lineal descendent of the taxpayer eliminates the requirement to have in excess of 50% of gross income from farming and ranching.

    Iowa Administrative Code [40.38(8)]
  4. Breeding livestock, other than cattle and horses, held for 12 months by the taxpayer who received in excess of 50% of his or her gross income from farming or ranching.

    Sale to an individual who is a lineal descendent of the taxpayer eliminates the requirement to have in excess of 50% of gross income from farming and ranching.

    Note: The cattle, horses, and other livestock that are excluded from taxation are the sales of the same classes of livestock that qualify for capital gain treatment under section 1231 of the Internal Revenue Code.
  5. Timber held by the taxpayer for more than one year. Timber includes evergreen trees, such as Christmas trees, that are more than six years old at the time they are cut and sold for ornamental purposes. “Timber” means timber that qualifies for capital gain treatment under section 1231 of the Internal Revenue Code.

The sale of items “a” through “e” by partnerships, subchapter S corporations and LLCs, where the capital gains flow through to the owners of the entities for Federal income tax purposes are eligible for the 100% capital gains deduction in cases where the owners meet the qualifications for ownership and material participation. However, sales of the same items by a C corporation do not qualify for the capital gains deduction except when the capital gains from the sales of the corporation’s assets are reported by the shareholders due to a liquidation of the corporation. The liquidation must be recognized as a sale of assets under section 331 of the Internal Revenue Code. The shareholders must meet the qualifications for ownership and material participation.

* Iowa follows Federal guidelines for determining “material participation” for purposes of the capital gains deduction for sales of business assets. Although determining material participation can be a complex issue, some examples are as follows:

  1. Retired or disabled farmers are considered to have materially participated in a farm activity for the period prior to the sale if the farmer materially participated in the farm activity five of the eight years immediately prior to retirement or disability.
  2. A surviving spouse of a deceased farmer is considered to be materially participating for the 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.
  3. An individual who has materially participated in a business for five of the past 10 years is considered materially participating for the current year and the individual who has materially participated in a personal service business for at least three years is considered to be materially participating for life.
  4. A farmer who sells farmland that has been rented on a cash basis would not generally be considered to have materially participated in the farming activity. However, a farm landlord involved in a crop-share arrangement would in most cases be considered to be materially participating in the operation of the farm activity. If a question should arise as to the extent of a taxpayer’s participation in a business, the burden of proof is on the taxpayer to show the participation in the business was material.

Capital Gains on Installment Sales. In the case of installment sales of qualified real property and installment sales of businesses where the selling price of the business assets is paid to the seller in more than one year, only installments received in the 2005 tax year qualify for this deduction on the 2005 return.

In the case of an installment sale of a business which was made in a year prior to 1998, only installments received in 1998 or in subsequent tax years will be exempt from income tax in cases where the taxpayer at the time of the installment sale had met conditions that would exempt the net capital gain from tax, if the installment sale had occurred in 1998 or later. Accrual-method taxpayers: See instructions for line14 of the IA 1040.

The Iowa Capital Gain Deduction and Net Operating Losses. For tax years beginning on or after January 1, 1998, the capital gain deduction otherwise allowable is not allowed in computing a net operating loss deduction for purposes of carrying the net operating loss deduction to another tax year. Further, when applying an NOL from tax year 1998 or later, the capital gain deduction is not allowed in the carryback or carryover tax year and must be added back to that year’s income to the extent of the NOL.

Non-Qualifying Capital Gains. Capital gains from the sales of stocks, bonds, and investment property do not qualify for the capital gain deduction even if sold to lineal descendants of the owners of the property. Non-farm rental property may qualify. The Federal guideline applies for determining material participation for investment property. Capital gains from the sale of real property held for 10 or more years for speculation, but not used in a business, do not qualify for the deduction.

If the sale of the assets of a business involves the sale of merchandise or inventory of a business, proceeds from these sales do not qualify for the capital gains deduction.

Capital gains from the sale of capital stock of an Iowa corporation or capital gains from the sale of an ownership interest in a partnership, limited liability company, or other business entity do not constitute a qualifying sale of a business for purposes of the capital gains deduction.

MARRIED SEPARATE FILERS: Divide the capital gain deduction based on ownership of the asset.

  1. Jointly held: Divide equally between spouses.
  2. If other than jointly held: Divide between spouses based on percentage of ownership. (Examples of how to prorate)

Check out our Capital Gains Flowchart.

Iowa Administrative Code [40.38(8)]

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