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Iowa Capital Gain Deduction: an illustration

August 24, 2010

The Iowa Department of Revenue has posted a policy letter that nicely illustrates how Iowa's "ten and ten" exclusion for capital gains works on the sale of a business.

Iowa's capital gain exclusion applies on the sale of certain business property when a ten-year holding period and ten-year material participation requirement are met. The "material participation" rules are the same as the federal "passive loss" material participation rules, but with a special rule for "retired" farmers.

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Flickr image courtesy cwwycoff1 under Creative Commons license


There are two separate exclusions:

- Capital gain on the sale of real estate used in the business qualifies for the exclusion if it has been held ten years, and if the taxpayer has materially participated in the business ten years, regardless of whether any other business assets are sold.

- All long-term capital gains incurred at the personal level on a sale of "substantially all of the assets" of a business meeting the ten-and-ten requirements qualify for the exclusion -- even for individual asset that themselves have been held for less than ten years.

- While C corporations can't exclude gains under this exclusion, liquidation proceeds of a ten-and-ten business otherwise reported as long-term gains on the 1040 do qualify.

In the example, the taxpayer sold substantially all of the assets of a business in which the ten-year holding period and material participation requirements are met (the example doesn't say what the form of the business is, but the results would be the same whether it is a Schedule C, Schedule F, or pass-through entity business):


Capital gain, sale of land:...............$200,000
Ordinary income, sale of equipment:.......$100,000
Goodwill capital gain......................$40,000
Grain buns: ordinary income................$10,000

The Department of Revenue explains:

Since the holding and participation requirements have been met and the sale of the land will receive capital gain treatment on the federal income tax return, the $200,000 gain from the sale of land would qualify for the Iowa capital gain exclusion.

...

The Department will assume that both the ten year ownership and ten year material participation test has been met. Additionally, the Department will assume that 90 percent of the tangible personal property and services of the business was sold. The statute and the rule allow for capital gain exclusion on the capital gain reported for federal income tax purposes on the tangible personal property and services of the business sold. The gain for goodwill of $40,000 receiving capital gain treatment on the federal income tax return would qualify for the Iowa capital gains exclusion. The gain for equipment and grain bins of $110,000 receiving ordinary income treatment on the federal income tax return would not qualify for Iowa capital gain exclusion and be treated as ordinary income on the Iowa return.

In short: because the ten-and-ten requirements are met, the capital gains are excluded. The land qualifies because it's real property; the goodwill qualifies because it is a long-term gain on the sale of substantially all of the assets of a business. The recapture income on the equipment sale doesn't qualify because it isn't long-term capital gain.

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