Iowa Department of Revenue (IDOR) Issues Several Rulings

June 1, 2009 | Roger McEowen


The IDOR has recently issued three policy letters concerning various aspects of the Iowa capital gains exclusion, the application of Iowa inheritance tax to trusts and whether the vehicle trade-in credit requires the same natural ownership.

The Iowa capital gains exclusion (Iowa Code Sec. 422.7(21) raises numerous questions - most of them revolving around the 10-year requirements for ownership and material participation.  Those issues came up in a recent IDOR ruling involving gain from the sale of farmland that was held in trust.  Under the facts of the ruling, a married couple had farmed together for many years.  They sold the farmland via an installment contract and, at the time of the sale, there was no question that they had owned the farmland and materially participated in farming operations on the land.  Sometime after the sale, the couple had revocable trusts created for them - one for each spouse, with the other spouse named as beneficiary.  Each spouse's share of the installment sale income went to their respective trust, with all trust income paid out to the beneficiary.  The issue was whether the capital gain from the sale of the farmland that passed through the trusts qualified for the Iowa capital gains exclusion.  

IDOR ruled that the exclusion provision applied, citing IDOR administrative rule 701 IAC 40.38(1) which provides that so long as the ten-year ownership and use requirements are met at the time of sale, payments received in installments continue to qualify for the exemption.  Assuming that was the case, IDOR ruled that the exclusion provision applied.  In addition, IDOR noted that IDOR Administrative Rule 701 IAC 40.38(7) specifies that when property is sold by a pass-through entity (partnership, S corporation, LLC, estate or trust) and the gain from sale of property contained in the entity flows through to the owners for federal income tax purposes, the owners can exclude the gain from income for Iowa tax purposes if the ten-year requirements were satisfied at the time of sale.  However, IDOR noted that upon the death of the owners of the farmland under the facts of the ruling and the distribution of the capital gains to their children, the capital gains reported by the children would not qualify for exclusion because, as applied to the children, neither the material participation nor the ownership test were satisfied at the time of the original sale.  IDOR Policy Letter No. 09201020 (Apr. 22, 2009).

In another IDOR policy letter, IDOR explained that trust beneficiaries who were adopted outside the family must pay inheritance taxes on the value of the trust assets that pass to them from their natural grandmother because a child's right to inherit from a natural parent ends after the adoption.  Under the facts of the policy letter, a grandmother gave birth to a daughter.  The daughter had two sons, one of which predeceased his mother.  After the mother's death, the natural father's rights as a parent of the two sons was terminated, and the sons were adopted by another couple who was of no blood relation to the sons.  The grandmother died and leaving (under her will) the residue of her estate to a trust for the ultimate benefit of the grandsons.  IDOR said Iowa Code Sec. 633.223 places a limitation on the right of family members to inherit property free of inheritance tax as specified in Iowa Code Sec. 450.7(1).  Iowa Code Sec. 633.223 extinguishes the right of intestate succession of an adopted person from the adopted person's biological parents, and establishes a right of the adopted to inherit via intestacy from the adoptive parents.  IDOR also cited In re Estate of Mills, 374 N.W.2d 675 (Iowa 1985) and Pazzi v. Taylor, 342 N.W.2d 481 (Iowa 1984) to support its position.  Consequently, the grandmother's estate will be required to file an Iowa inheritance tax return and pay any resulting tax.  IDOR Policy Letter No. 09700016 (Apr. 10, 2009).

In a third policy letter, IDOR has explained that a vehicle titled to a construction company may not be traded toward the value of another vehicle titled to the construction company and a cosigner because both vehicles must be titled to the same natural persons to receive a trade-in credit for sales tax purposes.  Under the facts of the policy letter, a taxpayer had a 2006 pick-up truck (a vehicle required to be registered) that was titled in the name of a construction company.  The vehicle was traded for a 2009 model that was titled in the name of the construction company and another taxpayer because the other taxpayer had, apparently, co-signed the note on the 2009 truck.  The issue was whether the trade-in value of the 2006 truck would be allowed toward the purchase price of the 2009 truck.  The issue came up because of Iowa's change from a use tax system to that of a registration fee.  But, that didn't impact the outcome of this situation.  IDOR's policy manual says that a vehicle's value is only recognized when it is trade for another vehicle that is titled in the name of the same person or persons.  There are some exceptions to the rule, including one for when a financial institution requires the addition of a new name for the purpose of co-signing the loan on the new vehicle.  But, that exception only applies when natural persons are involved, not corporations that are added to the title as a co-signer.  Thus, in this case, the trade-in value could not be allowed.  IDOR Policy Letter No. 09300014 (Apr. 9, 2009).