The Farm CPA
Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.
How to Sell Your Land and Pay No Tax - MAYBE
Aug 25, 2014
I had a reader ask me questions regarding the taxation of an installment sale of farmland. I helped him out and thought it would be a good idea to do another post on how you may be able to sell farm land (or other capital gain assets) in certain situations and pay no federal income tax on the gain.
When you sell an asset that qualifies for long-term capital gains treatment, any gain that is taxed in the 15% or less federal income tax bracket is taxed at a rate of zero. For married couples, taxable income under $73,800 for 2014 is in the 15% or lower tax bracket. After adding back your standard deduction and personal exemptions, a long-term capital gain of almost $100,000 could be generated on an annual basis and not be subject to any federal income tax assuming the taxpayers have no other taxable income.
Let's work through an example. Assume Farmer and Mrs. Gentry sell their farm land for $1 million. They paid $300,000 for the land several years ago. They sell the land for no down payment, principal payments of $100,000 a year plus interest at 3%. During their first year, they will collect interest income of $30,000 which will be offset with a standard deduction and personal exemptions of about $20,000 leaving $10,000 of taxable income before the capital gain. 70% of the $100,000 principal payment is long-term capital gains which brings their total taxable income to $$80,000. $63,800 of this capital gain is tax-free, the remaining $6,200 is taxed at 15% for net income tax of about $2,500.
Now, in year 2, their interest income drops to $27,000 and exemptions and standard deduction offset all but $5,000 of this amount (difference due to inflation adjustments). The $70,000 of capital gain added to other taxable income of $5,000 now results in $75,000 of taxable income and all of this income is in the 15% tax bracket due to inflation adjustments. Therefore, their net tax is only on the interest income which results in about $500 of total tax liability.
In years 3-10, they would no longer owe any federal income tax on either the capital gain or interest income since the standard deduction and exemptions would offset the interest income and all of the capital gain would be in the 15% or lower tax bracket.
Now, this is an extreme example since most taxpayers would have other taxable income such as social security, but it does show you how you can sell farm land and pay no capital gains taxes assuming the right conditions. I have seen many taxpayers with taxable income of about $70,000 and owe no federal income tax and now you know why.