Tax Guru-Ker$tetter Letter

Monday, February 16, 2004

Penny Wise - Pound Foolish
I don't know the person who sent me the following email; but I suspect he either received some very bad tax advice prior to selling his farm or chose not to ask for any until now, when it's pretty much too late to do much about it. I'm guessing the latter because not even the most incompetent tax pro would have said all of the erroneous things this person mentions in his email to me.

Saving a few hundred dollars by not consulting with a tax pro prior to the sale will most likely end up costing him well over $100,000. If no part of his farm qualified as his primary residence, he is really screwed tax-wise.

The email I received:

My wife and I have just sold our farm (in 2003) in Rhode Island for 1.2 million. My understanding is that we get to back out our basis in the property (about $400K) and we get to back out a $500K exemption. That leaves us paying 15% capital gains on the remaining $300K, which is $45K.

We are planning on starting a farm-based business (and need to purchase some equipment) within the next year at our new location in Vermont. Is there any way we can offset the capital gains hit? We've heard something about a "Section 179" regarding purchase of equipment. How can we minimize our capital gains hit using a new business? (Start-up expenses, Capital purchases, equipment, etc...?)

Also, how does the timing of all this work? Our understanding is that we don't have to pay the capital gains until 2 years from the sale (2005), but we need to buy our equipment now, should we wait to formalize our business as an LLC, until 2005? Can "start-up" expenses span more than 1 year? Or should we formalize our business now and settle the capital gains issue in 2004?

Your assistance would be most appreciated. Thanks.

My reply:

There are far too many issues than I can cover in a general free email like this. You really need to work with a tax pro. In fact, you should have worked with one before the sale and definitely before the end of 2003.

Some issues of concern from your email:

The $500,000 tax free profit is only for the primary residence portion of your property. You need to allocate your sales price and cost basis between the farm and residence portions of your property.

The Federal taxes on the other portion of the gain will include 25% on the depreciation recapture and 15% on the other portion of the gain. There will also be State tax to pay.

If the sale took place in 2003, the taxes are due by April 15, 2004. I'm not sure where you got the idea that you had two years to pay them. You may be able to defer some of the taxes by using the installment method if you financed part of the sale and won't be paid off until future years.

It would have been a great thing to offset your capital gain by investing in new business equipment and claiming the up to $100,000 Section 179 deduction. However that had to be done by December 31, 2003 to be of any benefit on your 2003 1040. Whatever you buy in 2004 won't make any difference on your 2003 tax return.

As I said earlier, it sounds as if you either received bad advice up front or failed to seek it out. You had best start working with a good tax advisor ASAP to see what s/he can do to minimize the damage on your 2003 tax returns.

Good luck.

Labels: 179

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 2/16/2004 03:02:00 PM Send this post: