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23. IOWA CAPITAL GAINS DEDUCTION.

This is a deduction of qualifying net capital gains realized in 2007. 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.

Definitions

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

“Holding period”

For Sales Before 2006: In determining the 10-year holding period for eligibility for the Iowa capital gains deduction, the asset being sold had to be owned by the taxpayer for the immediately preceding 10 years to qualify for the deduction. In cases involving like-kind exchanges, inherited property or gifted property, the time period that the assets were owned may be different than the holding period determined for federal income tax purposes.

For Sales in 2006 and subsequent years: In determining the 10-year holding period for eligibility for the Iowa capital gains deduction, the federal holding period provisions set forth in section 1223 of the Internal Revenue Code and regulations adopted by the Internal Revenue Service will be used.

“Material participation” - Iowa follows Federal guidelines for determining material participation for purposes of the capital gains deduction. Determining material participation can be a complex issue.

For further examples in addition to those below see Iowa Administrative Code 40.38

The following are only a limited sampling of individuals in specific types of activities that may have unique problems or circumstances related to material participation in a business:

1. Limited partners of a limited partnership. The limited partners will not be treated as materially participating in any activity of a limited partnership except in a situation where the limited partner would be treated as materially participating under the material participation tests.

2. Work not customarily done by owners. Work done in connection with an activity shall not be treated as participation in the activity if both of the following apply:

Such work is not of a type that is customarily done by an owner of such activity; and

One of the principal purposes for the performance of such work is to avoid the disallowance of any loss or credit from such activity.

3. Participation in a business by an investor. Work done by an individual in the individual's capacity as an investor in an activity is not considered to be material participation in the business or activity unless the investor is directly involved in the day-to-day management or operations of the activity or business.

4. Cash farm lease. A farmer who rents farmland on a cash basis will not generally be considered to be materially participating in the farming activity. The burden is on the landlord to show there was material participation in the cash-rent farm activity.

5. Farm landlord involved in crop-share arrangement. A farm landlord is subject to self-employment tax on net income from a crop-share arrangement with a tenant. The landlord is considered to be materially participating with the tenant in the crop-share activity if the landlord meets one of the four following tests:

TEST 1.The landlord does any three of the following: (1) Pay or be obligated to pay for at least half the direct costs of producing the crop; (2) Furnish at least half the tools, equipment, and livestock used in producing the crop; (3) Consult with the tenant; and (4) Inspect the production activities periodically.

TEST 2.The landlord regularly and frequently makes, or takes part in making, management decisions substantially contributing to or affecting the success of the enterprise.

TEST 3.The landlord worked 100 hours or more spread over a period of five weeks or more in activities connected with crop production.

TEST 4.The landlord has done tasks or performed duties which, considered in their total effect, show that the landlord was materially and significantly involved in the production of the farm commodities.

6. Conservation reserve payments. Farmers entering into long-term contracts providing for less intensive use of highly erodible or other specified cropland can receive compensation for conversion of such land in the form of an "annualized rental payment." Although the CRP payments are referred to as "rental payments," the payments are considered to be receipts from farm operations and not rental payments from real estate.

If an individual is receiving CRP payments and is not considered to be retired from farming, the CRP payments are subject to self-employment tax. If individuals actively manage farmland placed in the CRP program by directly participating in seeding, mowing, and planting the farmland or by overseeing these activities, the owner will be considered to have had material participation in the farming activity.

7. Rental activities or businesses. The general rule is that a taxpayer who actively participates in a rental activity or business which would be considered to have been material participation in another business or activity would be deemed to have had material participation in the rental activity unless covered by a specific exception. For example, the exceptions for farm rental activities in numbered paragraphs "4," "5," and "6" immediately above. Rental activity or rental business has the same meaning as the term is used in Section 469(c) of the Internal Revenue Code.

EXAMPLE. Ryan Stanley is an attorney who has owned two duplex units since 1991 and has received rental income from these duplexes since 1991. Mr. Stanley is responsible for the maintenance of the duplexes and may hire other individuals to perform repairs and other upkeep on the duplexes. However, no person spends more time in maintaining the duplexes than Mr. Stanley. The duplexes are sold in 2007, resulting in a capital gain. Mr. Stanley can claim the capital gain deduction on the 2007 Iowa return since he met the material participation requirements for this rental activity.

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.
  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 sales 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.

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.

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 2007 tax year qualify for this deduction on the 2007 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.

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 (NOL) 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.

 

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)

 

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