Dad’s participation isn’t your participation

August 18th, 2009 by Joe Kristan

Iowa has a special tax break for capital gains on the liquidation of a business or farm that has been held for 10 or more years; taxpayers also have to “materially participate” in the business for 10 years to qualify.
A new ruling by the Iowa Department of Revenue illustrates that while your spouse’s participation counts toward the 10-year material participation requirement, you don’t get credit for your parents’ work:

In this case, the capital gain will be reported by the surviving children. From the facts presented, the children have not been materially participating in the operation of the farm over the immediately preceding ten years. A nephew of the deceased farmer has been cash renting the property over the preceding ten years. The fact that the deceased farmer materially participated until the date of his death does not impact the material participation test for the surviving children. The children have not met the ten year material participation test, so any capital gain from the sale of the farmland would not qualify for the Iowa capital gains exclusion.

The tests for material participation are generally the same as for the federal passive loss rules; they are summarized below. Farmers qualify for special material participation rules for the Iowa capital gains deduction.

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MATERIAL PARTICIPATION BASICS
The tax regulations say you achieve “material participation” in non-real estate activities for a tax year if:
-You participate at least 500 hours; or
-You participate at least 100 hours and at least 500 hours in that and other “100 hour” activities; or
-You participate at least 100 hours and more than anybody else, or
-You are the only participant; or
-You materially participated in five of the past ten years )or in any three years for a service activity).
There is also a “facts and circumstances” test, but don’t count on it.
A special rule apples to real estate. If you are not a “real estate professional,” losses are normally passive no matter what, unless you provide “extraordinary” personal services.
If you are a “real estate” professional,” you can apply the normal material participation rules to determine whether you have a passive activity. To be a real estate professional, you have to spend at least half your working hours – not less than 750 hours annually – in “real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade.”

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