150-316-0050 Farm Capital Gain (1) Definitions. For purposes of ORS 316.045 and this rule: (a) “Substantially complete termination” means the taxpayer is: (A) No longer involved, directly or indirectly, in a trade or business engaged in farming, or (B) No longer owns, directly or indirectly, property used in the trade or business of farming. (b) “A trade or business engaged in farming” means a distinct farming operation separately run from the taxpayer’s other businesses. Businesses that share employees, equipment, buildings, or land are not separate businesses. Businesses that share records, accounts, registration, identification numbers, or a business name are also not separate businesses. (2) A taxpayer’s net long-term capital gain qualifies for the reduced tax rate if all four of the following tests are met: (a) Asset Test. The gain is derived from either IRC section 1231 assets or an ownership interest of at least 10 percent in an entity. (b) Use Test. The property that was sold consisted of: (A) An ownership interest in an entity engaged in the trade or business of farming; or (B) Property that was predominantly used in the trade or business of farming. (c) Relationship Test. The assets are not sold to a related taxpayer as defined under IRC section 267. (d) Termination Test. The sale is a substantially complete termination of all of the taxpayer’s ownership interests in: (A) A trade or business engaged in farming; or (B) Property that is predominantly used in the trade or business of farming. (3) Asset Test. The part of the taxpayer’s net long-term capital gain that is eligible for the reduced rate must be from capital assets under IRC section 1231 or a 10 percent or more ownership interest in an entity engaged in the trade or business of farming (see section (13) for related examples). Example 1: Sofie owns 50 acres of land. Of the 50 acres, she used 10 acres for her hobby of showing horses. She had a small arena and stables on the land for her horses. Sofie sold the entire 50 acres to her neighbor. The gain from the sale does not qualify for the reduced tax rate because the asset does not meet the asset test. The land was not used in a trade or business, thus the asset was not an IRC section 1231 asset. If Sofie had been in the trade or business of showing horses, the land used would have been a qualifying asset and Sofie would then be required to look at the other three tests to determine whether she qualifies for the reduced tax rate. Example 2: Forty years ago, Wayne and Patty purchased an orchard next to their home. They did not regularly harvest the fruit, care for the trees, or file farm schedules with any of their tax returns. They mostly used the property for themselves and the horses they owned for personal use and usually gave extra fruit away to family and friends. Every two or three years they held U-Pick sales at the orchard, and claimed the not-for-profit income as required. Last year, the urban growth boundary moved to include their parcel. Wayne and Patty wanted to sell the property to developers so they had all the trees removed and sold the property. The sale of the orchard does not qualify for the reduced rate because it was not held as a trade or business thus it was not an IRC section 1231 asset. It was land held for investment and personal use. (4) Use Test. The asset that was sold must be predominantly used in the trade or business of farming. Any other use of the asset must be incidental to, and not interfere with, the primary purpose of being engaged in the trade or business of farming. (a) Property used 80 percent or more in a farming trade or business. Property used 80 percent or more in the trade or business of farming is considered and presumed to be predominant use. Accepted farming practices common to the type of farming activity and region, such as land lying fallow for one year, are included in the trade or business of farming. (b) Property used more than 50 percent but less than 80 percent in a farming trade or business. Upon review of the facts and circumstances of each case, property used more than 50 percent but less than 80 percent in the trade or business of farming qualifies as predominant if the difference between the actual percentage use in a farming trade or business and 80 percent use in a farming trade or business is incidental. Incidental use does not include holding property as an investment, using property for personal (non-business) use, or using property for another business. Incidental use includes, but is not limited to: (A) Farmland that is bordered by or contains a waterway; (B) Land that consists of terrain that cannot be farmed (i.e. marshland, desert); (C) Land that contains a utility easement which makes farming impracticable or impossible; or (D) The period of the time when the farm property or business was “actively for sale” immediately prior to the sale. A property was “actively for sale” if the property was listed and advertised for sale for a price comparable to similar properties and the seller did not reject any reasonable offers. (c) Property used for personal or business activities that take place on the land concurrently and do not interfere with the primary farming trade or business use are considered incidental use. (d) Allocation. Property that is used less than 80 percent in a farm trade or business may be allocated between the actual portion that is predominantly used in the business of farming and the portion not predominantly used in the business of farming. Example 3: Cinda raised corn and beans on 500 acres the entire time she owned the acreage. She used the cornfields as a corn maze after she harvested all the corn. She sold the 500 acres of corn and bean fields to the cannery and recognized a capital gain. Assuming the gain from the sale meets the other three tests, the gain from the sale of Cinda’s farm qualifies for the reduced tax rate because Cinda used the property predominantly (80 percent or more) in the trade or business of farming even though Cinda used the farmland for an incidental purpose after the harvest. Example 4: Hilda and Steve owned and operated a 30 acre farm. Their farm had a waterway and riparian land that was not farmed which took up 10 acres of the farm. Assuming they meet the other three tests, Hilda and Steve qualify for the reduced tax rate because their property was predominantly used in the business of farming. The farm use qualifies as predominant for the entire 30 acres because their farm use was more than 50 percent, but less than 80 percent and the 33 percent (10 acres/30 acres) not used for farming was incidental. Example 5: Deborah sold 20 acres of land. While she owned the land, she leased out 15 acres to a farmer who grew crops. She used the remaining 5 acres as a motor cross training area where she ran a business giving riding lessons and charging people to use it for practice. Assuming Deborah meets the other three tests, the 15 acres used for farming qualifies for the reduced tax rate. If Deborah had used the 5 acres for personal use instead of a separate business, she still would qualify for the reduced tax rate on the 15 acres used for farming. Example 6: Lois inherited some land 20 years ago. At that time, a farmer was leasing the land and continued to farm the land until he retired 5 years later. For the last 15 years, Lois held the land for investment and did not use the land in the trade or business of farming. Lois does not qualify for the reduced tax rate because she only used the property in the business of farming for 25 percent of the time she owned it (5/20 years = .25 or 25%). (5) Relationship test. The gain from the sale of an asset does not qualify for the reduced tax rate if the asset is sold to a related taxpayer under IRC section 267 even if all of the other three tests are met. Example 7: Claudia and Janie are cousins who own a farm together as a partnership. They decide to sell the business to Darren, Claudia’s brother (and Janie’s cousin). Assume the sale meets the other three tests. Janie’s qualifying capital gain is eligible for the reduced tax rate. Claudia’s capital gain is not eligible because Darren is a related party according to IRC section 267. (6) Termination Test. If a taxpayer sold the taxpayer’s interest in a trade or business that is engaged in farming, the taxpayer may not be directly or indirectly engaged in that farming trade or business. The sale of the taxpayer’s interests through an installment sale constitutes a substantially complete termination for purposes of ORS 316.045 and this rule. A taxpayer has substantially terminated his interests in the trade or business of farming even though the taxpayer retained a portion of the farm for personal use. Example 8: Rich and Darcy own 20 acres. They grow corn and squash on 15 acres, and have a five-acre apple orchard. They operate their orchard and crops as one business. They sell the five-acre apple orchard for a gain of $50,000 and retain the other 15 acres. The gain from the sale of the apple orchard does not qualify for the reduced rate because they did not substantially terminate all of their interests in a trade or business engaged in farming. If Rich and Darcy had sold the entire business including all of their property used in the trade or business of farming and the other three tests were met, the gain from the sale would qualify for the reduced tax rate. Example 9: Bill and Sharon owned a dairy operation and a hops farm. The two businesses were completely separate. They had separate employees, equipment, and records. The two businesses also had different names, records, and federal identification numbers. Bill and Sharon sold the dairy farm. After selling all of their dairy equipment and dairy cows (Holstein), they realized a capital gain of $350,000. They decided not to sell the hops farm. Their gain on the sale of the dairy operation qualifies for the reduced tax rate. Even though Bill and Sharon still own the hops farm, they have sold their entire dairy business. Example 10: Shawn sold 18 of his 20 acres in which he farmed Christmas Trees. The 2 acres Shawn still owns are for personal use and he does not sell the trees produced on his personal farm. Assuming the other three tests are met, Shawn is no longer in the business of farming and he qualifies for the reduced tax rate on the capital gain from the sale. (7) A sale that includes the farm dwelling or homesite. The sale of a homesite and the land and structures consistently and routinely used in conjunction with the home at the same time as the sale of a farming activity requires allocation of the gain between the homesite and the other assets. The proceeds from the sale of the homesite is not property employed in the trade or business of farming and do not qualify for the reduced tax rate. Example 11: Homer and Ruth raised various crops on 80 acres of farmland they owned. Homer and Ruth lived close to town so they rented the farm home that was located on a parcel next to the acreage. Homer and Ruth retired from the farming business and sold the farmland and the rental for a gain of $1 million ($400,000 attributed to the farmland and $600,000 attributed to the homesite and structures and land associated with the homesite). Because the sale of the 80 acres met each of the four tests, the $400,000 capital gain from the sale of the farmland qualifies for the reduced tax rate. The proceeds from the sale of the rental do not qualify for the reduced rate because rental real estate is not employed in the trade or business of farming. Example 12: Assume the same facts as Example 11 except that when Homer and Ruth sold the farm, they had lived in the home that was adjacent to the farmland for the entire twenty-five years. The gain from the sale that is attributable to the farmland, or $400,000, qualifies for the reduced rate. The gain of $600,000 on the sale of the residence does not qualify for the reduced rate; however, a portion of it may qualify for the principal residence exclusion under IRC section 121. (8) Depreciation Recapture. IRC section 1231 gain may be treated as ordinary income under IRC sections 1245 and 1250 recapture rules. If the capital asset is subject to depreciation recapture under IRC sections 1245 or 1250, the portion of the gain that is treated as ordinary income does not qualify for the reduced tax rate. Example 13: Frank sold his farm, which included three silos, and all four tests were met. The silos are capital assets subject to IRC section 1245 recapture. The part of the gain from the sale of the silos that is treated as ordinary income is not eligible for the reduced tax rate. However, the part of the gain from the sale of the silos that is treated as long-term capital gain on the federal return is eligible for the reduced tax rate on the Oregon return. (9) Capital loss. If all four tests are met and the taxpayer is reporting a capital loss, it could affect the capital gain eligible for the reduced tax rate. Compute the net capital gain or loss from all other property sales or exchanges for the year that are taxable to Oregon. If this is a net capital loss, the amount eligible for the reduced tax rate is the qualifying farm capital gain minus the net capital loss from other property sales or exchanges taxable to Oregon. Example 14: Ron sold his farming business for a net long-term capital gain of $800,000. During the year, he also sold other property for a net capital loss of $150,000. Assuming his sale of a farm business meets all four tests, he is only eligible for the reduced tax rate on $650,000 (net farm long-term capital gain minus other net capital loss) of his taxable income. (10) Installment Method under IRC §453. Installment sales are eligible for the reduced tax rate if the sale meets all four tests as explained in section (2) of this rule. The amount of capital gain eligible for the reduced tax rate must be determined each year. The percentage of gain eligible for the reduced tax rate is equal to the qualifying farm long-term capital gain from the sale divided by all capital gain from the sale. Apply this percentage to the capital gain from the sale reported each year to determine the amount that qualifies for the reduced tax rate. If there is capital loss from the sale of other property as described in section (9) of this rule, during a tax year that the installment sale is reported, this may reduce the gain eligible for the reduced tax rate. Example 15: Larry sells his farm in 2007 and meets all four tests to receive the reduced tax rate. He elects to recognize the income from the sale using the installment method under IRC §453. Larry will receive half of the sale price in 2007 and one-fourth of the sale price each in 2008 and 2009 plus interest. Of the capital gain from the sale, $300,000 qualifies for the reduced tax rate and $100,000 does not. Larry’s percentage eligible for the reduced tax rate is $300,000 of eligible capital gain divided by $400,000 of total capital gain, or 75 percent. The buyer also paid interest to Larry, but it is claimed separately on the return. In 2007, Larry will claim his capital gain from the sale of $200,000. Of that amount, 75 percent or $150,000 is eligible for the reduced tax rate. In 2008 and 2009, Larry will claim the farm capital gain rate for $75,000 ($100,000 x 75 percent) of capital gain from the sale reported each year. Example 16: Assume the same facts as example 15 except that Larry has a net capital loss of $40,000 in 2008 from the sale of other property. In 2008, the amount eligible for the reduced tax rate is $35,000 (qualifying net long-term capital gain minus other capital loss) of his capital gain. (11) Like-kind Exchanges. Like-kind exchanges may be eligible for the reduced tax rate when the gain is recognized assuming all four tests are met. The taxpayer must keep detailed records to show that the property would have qualified for the reduced tax rate if it had been a sale instead of an exchange. Example 17: Morgan had farmland and decided to exchange it for land that he wants to hold for investment. The exchange meets all four tests. If Morgan had sold the property, he would have had capital gain of $400,000 that would have qualified for the reduced tax rate. Later Morgan sells the investment property and claims capital gain of $700,000. Of this amount, $400,000 is eligible for the reduced tax rate for farm capital gain, because it would have been eligible if he had not deferred it. (12) Sale of property by pass-through entities. Trust, partnership, or S corporation sale of farm property may be eligible for the reduced tax rate. To qualify, each individual beneficiary, partner, or shareholder (as the case may be) must meet all four tests as described in section (2) of this rule. Example 18: Becky, Martha, and Jessica are equal owners of a partnership. The partnership sold its only farm property to Jessica’s father for a gain of $600,000. The sale was to a related party of Jessica, so Jessica does not meet all four tests even though her father was not a related party to the partnership. Becky and Martha are eligible for the reduced tax rate for their share of the gain. If the partnership still owned other farm property that was part of the same farm business as the property that was sold, none of the owners would be eligible for the reduced tax rate. Example 19: Kendra owns 5 percent of an S-corporation that owns a cattle ranch and a crop operation. The cattle ranch and crop operation are completely separate businesses. The S-corporation sold the cattle ranch to a party unrelated to Kendra. The 1231 gain from the sale of a farming business flows through to Kendra and she is eligible for the reduced tax rate. (13) Sale of interest in pass-through entity. Sale of interest in a pass-through entity (partnership or S-corporation) that is in the business of farming, may qualify for the reduced tax rate. All four tests must be met and the taxpayer must be a 10 percent owner of the pass-through entity to qualify. Assuming all four tests are met, the amount of gain eligible for the reduced tax rate is the amount of farming business of the entity divided by all business of the entity. The amount of capital gain eligible for the reduced tax rate can be determined using the “income method.” The taxpayer may use a different method if the department determines it reasonably reflects the entity’s income and expenses. (a) Income method is the entity’s farm income divided by the entity’s total income as shown on the partnership or S-corporation return the year the interest is sold. Multiply this percentage by the capital gain reported from the sale of interest in the entity. Example 20: Ian sold his entire partnership interest of 25 percent to an unrelated party during the year. The partnership had various businesses, most were farming activities, but some were not. That year, the partnership reported farming income of $600,000 and total income of $800,000. Ian will report his share of the partnership income before the sale and the long-term capital gain from the sale of his interest in the partnership. Of the long-term capital gain from the sale, 75 percent ($600,000 divided by $800,000) qualifies for the reduced tax rate. Example 21: Darlene owned shares in an S-corporation that were 10 percent of the total shares. The S-corporation sold a partnership that grew crops. The S-corporation owned 50 percent of the partnership and sold all of its interests. The partnership interest was sold to someone unrelated to Darlene and Darlene has no other interests in the partnership. The gain from Darlene’s ownership interest in the partnership does not qualify for the reduced tax rate. Darlene was only a 5 percent owner of the partnership (10% x 50% = 5%). If the S-corporation had owned the business, Darlene would have been eligible for the reduced rate on her portion of the 1231 gain. (14) Sale in more than one tax year. Prior-year sales of farm property or a farming business sold over more than one year may be eligible for the reduced tax rate. It can take more than one year to sell a farming business or all of a taxpayer’s property used in farming because the property is sold to more than one buyer. To qualify for the reduced tax rate, all farm property (or all property from a farming business) must be actively for sale from the year of the first sale until the year of the final sale. Each sale is separately considered to see if it meets the requirements to qualify for the reduced tax rate, but all farm property or property from a farming business must be sold within a reasonable amount of time (usually no more than three tax years from the first sale to the final sale of qualifying farm property) for any of the prior year sales to qualify. The reduced tax rate on the prior year sales cannot be claimed until the taxpayer has sold all farm property or all property from a farming business. A property is “actively for sale” if the property was listed and advertised for sale for a price comparable to similar properties and the seller did not reject reasonable offers. Example 22: Deanna wants to retire from farming. She owns 100 acres of farmland in four different locations all run as one business and all property is actively for sale. She sells 20 acres to an unrelated neighbor in 2006. She files her 2006 tax return and cannot claim the reduced tax rate on the gain because she is not out of the business of farming. In 2007, she gave one farm to her daughter and sold one farm to an unrelated party. She files her 2007 tax return and again cannot claim the reduced tax rate because she is still in the business of farming. Finally, in September 2008 Deanna sells the remaining farmland and equipment and is out of the business of farming. The long-term capital gain from three of the sales qualifies for the reduced tax rate because the property was actively for sale the entire time. The gift to a related party does not stop the other sales from qualifying for the reduced tax rate. Deanna may now amend her tax returns for 2006 and 2007 and claim the reduced tax rate on the qualifying capital gain from the earlier sales that qualify. Example 23: Gary owned two farms and operated them as one business. He sold one of his farms in March 2006 to the farmer who had been leasing the property. In 2007, his health worsened and he decided to retire from farming and put his remaining farm up for sale. In 2008, he finds a buyer and sells the remaining farm and equipment. The sale in 2006 does not qualify for the reduced tax rate because Gary did not have his remaining farm property actively for sale and he had not sold all of the property from his farming business. The sale in 2008 does qualify for the reduced tax rate because Gary is now out of the business of farming. (15) Sold farm property and then bought another. If a taxpayer sells farm property and then buys other farm property, they may qualify for the reduced tax rate. The taxpayer must meet all four tests as described in section (2) of this rule with the sale of farm property before purchasing other farm property to qualify for the reduced tax rate. Example 24: Jeanine sold her farm and equipment so she could start a retail business. After difficulty getting started, she decided to go back to farming and purchased another farm. Jeanine qualifies for the reduced tax rate because she had completely terminated her interest in property used in farming at the time of the sale and met the other tests. Example 25: Frances put her farm up for sale, but before it sold, her father died and she inherited some of his farming property. She decided not to sell the inherited property, but to continue to farm it as a separate business after her original farm was sold. Frances qualifies for the reduced tax rate because she sold a farming business. Statutory/Other Authority: ORS 305.100 & 316.045 Statutes/Other Implemented: ORS 316.045 History: Renumbered from 150-316.045, REV 60-2016, f. 8-15-16, cert. ef. 9-1-16 REV 6-2008, f. 8-29-08, cert. ef. 8-31-08