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For taxes, inheriting beats 'gifting'

Dear Tax Talk,

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?
-- John

Dear John,
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 years.

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.'s corrections policy
-- Posted: Sept. 30, 2003
Read more Tax Adviser columnsAsk a question
Capital gains tax on 'gifted' property
10 estate-planning tax moves
Tax basics: Death and taxes

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