We had a reader ask the following question:
"We want to gift our daughter (she is not a dependent) some grain that is from the 2012 growing season. We plan to have the elevator issue her a contract to show ownership and then she can call them and sell the grain when she is ready. She will sell the grain this tax year. My question is: Because we have already held the grain for over a year, does she qualify to take the income as a capital gain or will she have to take it as ordinary income? "
When a farmer gifts grain to a child or grandchild, the basis in the grain carryovers to the donee. If the grain was harvested in the prior year, then the cost basis is zero. If the grain is donated in the year of harvest, then the farmer must allocate a portion of their expenses to the donated grain. Therefore, most farmers try to make sure to donate previous years grain.
When the donee sells this grain, it will be reported as a capital gain. If time after harvest of the grain and the time of sale is less than a year, it is short-term. If this time is greater than a year, then it is long-term. It does not matter how long the donee/child owns the grain. What is important is the time from harvest until sale.
If the child is a dependent of her/his parents, the kiddie tax rules apply which means we have to pretend that the child's income is added to the parent's income to arrive at the correct tax liability.
In the case of our reader's question, we know that the grain was harvested in 2012. Therefore, the holding period is at least a year plus, so we know this is long-term capital gain when the daughter sells the grain. The reader also indicated that the daughter is not a dependent, therefore, if the gain from the sale of the grain falls with the 15% tax bracket (up to about $36,000 of taxable income for a single taxpayer), then the capital gain will be taxed at a zero rate. This will most likely result in the daughter paying no federal income tax on the gain (unless she has a fair amount of other income). Most likely the worst case is the gain will be taxed at 15%. Additional state income taxes would apply.
This is one more reason why it is a great idea to gift grain to your children. It reduces your income and self-employment taxes and in many cases if the grain is held long enough, the gain will be tax-free to the child and taxed at favorable capital gains rates (even if the kiddie tax applies).