Is the Sale of Farmland a Capital Gain or Ordinary Income?

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Landowners, including farmers, can earn a profit or take a loss on the sale of property, depending on the cost basis of the original purchase and the proceeds of the sale. The Internal Revenue Service defines a capital gain as money earned on the sale of capital assets, including land. That's not the same as ordinary income, and the tax consequences of the sale depend on some additional factors.

Ordinary Income

The IRS tax rules on agricultural operations treat farming differently than other types of businesses. Farmers report their income on Schedule F, a form that breaks out the yearly income from the sale of livestock and produce, co-op distributions, crop insurance proceeds and agricultural program payments. Proceeds from the sale of farmland and other capital assets is not defined as income in the IRS code, but it is reportable for farmers and everyone else on Schedule D, Capital Gains and Losses.

Holding Period

If you sell farmland, the tax rate on any capital gain depends in part on how long you held the property. Selling property held less than a year gives rise to a short-term gain, which is taxed at the same rate as your ordinary income. Property held for at least a year qualifies for the long-term capital gains rate, which varies with your marginal tax bracket. Taxpayers who fall in the 10 or 15 percent brackets pay 0 percent on long-term gains; everyone else pays 15 percent, except for those residing in the top bracket, who pay 20 percent on their net long-term gains.

Basis and Proceeds

The IRS rules on capital gains allow you to include commissions, fees and other expenses when calculating cost basis. Likewise, any costs you incur while selling the property reduces the proceeds of the sale. If you inherit the property, the basis is the market value on the day the former owner died. Inherited property, including farmland, is always taxed at the long-term capital gain rate.

Exchanges and Gifts

Not all farmland trades hands as the result of a sale. If you trade for land, the cost basis of that land is the market value of the property you gave up in exchange. The holding period of the new property includes the period you owned the old property.

Receiving land as a gift doesn't mean a cost basis of zero; the basis is the same as that of the previous owner when he transferred the land to you. If you trade cash and property for land, then only the "unlike" portion of the payment you receive -- the portion that is not land -- is used to figure your capital gain.

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