taxes, inheriting beats 'gifting'
My just-deceased father gifted
his five children a farm over a seven-year period, which was finalized
four years ago -- which make us the owners. He paid all the property
and income taxes out of his pocket over the past years. We are now
going to sell the farm and share in the sale equally.
The buyer wants to pay half the price in cash
and self-finance the remainder, over five years, with payments coming
each year. Since we are the owners, do we only pay capital gains
on this year's payment and then regular tax on the remainder as
it gets paid? Do we use the final year the land was gifted for the
cost basis? Can we use the capital gains criteria for the remainder
of the payments?
Your cost basis in the property is what your
father paid when he bought the farm. Unfortunately, there is no
step-up in basis on the gift of property. Your basis is the basis
that the donor had in the gifted property. Had he died owning the
farm and you inherited it, then you would have had a step-up in
basis to the fair market value at his death. So the gift was not
a really brilliant idea.
If you're only collecting half of the money in the
year of sale, you'll have an installment sale for tax purposes.
Under an installment sale, you report your gain based on collections
over the period that you collect on the property, in this case five
Your collections are taxed in proportion to your gross
profit on the property. If the farm has a cost of $10,000 and you
sold it for $100,000, your gross profit is 90 percent. This means
that 90 percent of the down payment and subsequent principal collections
on the note will be long-term capital gains subject to tax at 15
percent (unless the tax rate goes up, in which case you may be stuck
paying at a higher rate).
That is, all collections on the sale of the farm except
for interest on the note are considered capital gain. Interest that
you collect on the note is fully taxable as ordinary income and
should be reported on Schedule B of your Form 1040.
The installment sale is reported on Form
6252 in the year of sale and also in subsequent years until
fully collected. Since the five of you own the property, you'll
each need to file a Form 6252 with your individual returns, reporting
your respective share.