Note: In 2024, the Iowa Legislature reinstated the capital gain deduction for the sale of breeding, draft, dairy, and sport livestock, retroactively to include the 2023 tax year. Read more about this change here. 

In early 2022, the Iowa Legislature passed HF 2317. This law reduced individual and corporate income tax rates, provided exemptions from Iowa tax for most forms of retirement income--including retired farmer rental income--and scaled back the Iowa capital gain deduction. Most changes went into effect during the 2023 tax year.  In November of 2023, the Iowa Department of Revenue (IDOR) finalized administrative rules (Iowa Admin. Code r. 701-302.87(422)) implementing the deductions for retired farmer rental income and Iowa capital gain. Because they may need to make elections to take advantage of these new provisions, retired farmers and others must understand these new rules when they file their 2023 returns. This post details key changes.

Farm Tenancy Income Exclusion

Beginning in 2023, certain “retirement income” for those who are disabled or 55 years of age or older is excluded from Iowa taxable income. Iowa Code § 422.7(19). The law also exempts retirement income received by surviving spouses. Prior law exempted retirement income only in an amount up to $6,000 for singles, and $12,000 for those who are married filing jointly.

Exempted income includes income from qualified retirement accounts, such as pension plans, defined benefit or defined contributions plans, annuities, individual retirement accounts, plans maintained or contributed to by an employer, or maintained or contributed to by a self-employed person as an employer, and deferred compensation plans or any earnings attributable to the deferred compensation plans. 

Recognizing that for many farmers, their land is their retirement fund, the Iowa Legislature also created a new provision to allow an eligible retired farmer-lessor to elect to exclude from Iowa income taxation the net income received under a written farm lease covering real property. Iowa Code § 422.7(14).

Requirements of the Farm Tenancy Income Exclusion

Beginning in 2023, Iowa Code § 422.7(14)(a) allows “eligible individuals” to elect to exclude from Iowa income:

• the net income received from a “farm tenancy agreement”
• covering real property “held” by the “eligible individual” for 10 or more years
• if the eligible individual “materially participated” in a “farming business” for 10 or more years.

An “eligible individual” is an individual who is:

• Disabled or 55 years of age or older at the time the election is made
• Who no longer materially participates in a farming business at the time the election is made, and
• Who, as an owner-lessor, is a party to a “farm tenancy agreement”

Iowa Code §422.7(14)(f)(1). The exclusion applies only to income from farm tenancy agreements, including cash leases, crop share leases, flex leases, and livestock share leases. Iowa Code §422.7(14)(f)(2). A farm tenancy agreement is a written agreement outlining the rights and obligations of an owner-lessor and a tenant-lessee where the tenant-lessee has a “farm tenancy” as defined in Iowa Code § 562.1A:

A leasehold interest in land held by a person who produces crops or provides for the care and feeding of livestock on the land, including by grazing or supplying feed to the livestock.

The law does not apply to rental income received as an owner of an entity taxed as a partnership, an S corporation, or a trust or estate, even if the net income passes through to the eligible individual. § 422.7(14)(e). This means, for example, that the exclusion does not apply to income from land held by an LLC taxed as a partnership, such as an LLC comprising only spouses.   The exclusion should apply, however, to income from land owned by a single-member LLC or a revocable living trust because these entities are disregarded for tax purposes.

The election to exclude income from a farm tenancy agreement does have trade-offs. Individuals who make an election under this section may not apply the Iowa capital gain deduction in current or succeeding tax years. Likewise, they are not eligible for the beginning farmer tax credit under Iowa Code  §422.11E in current or future years. Iowa Code § 422.7(14)(b); r. 302.88(3).

Making the Election to Exclude Farm Tenancy Income

The Iowa Department of Revenue has created Iowa Form 125 (2023 IA 125) to allow retired farmers to make a lifetime election to exclude net income from a farm tenancy agreement covering real property. Taxpayers must detail their qualification for the election on the form, including the material participation test under which they qualify (more information on material participation is detailed below). Note that the form linked in this article has not been updated to reflect the final rules, particularly the rules pertaining to CRP. The farm tenancy income exclusion election is irrevocable once made.

Iowa Capital Gain Deduction

Before 2023, the Iowa capital gain deduction was available to taxpayers who sold farming and non-farming business assets, as well as those who sold breeding or dairy livestock. In 2023, the deduction changed significantly to apply only to the sale of real property used in a farming business and to the sale of some draft, dairy, and breeding livestock by retired farmers liquidating their businesses.  Iowa Code § 422.7(13)(b)(c)(d). It should be noted that installment agreements that were signed before 2023 are still subject to the pre-2023 law. 2022 Acts, ch 1002, §10, 11. As such, the deduction will continue to apply to non-farm businesses for payments received under these installment agreements in 2023 and beyond. r. 302.87(4)(d).

Sale of Real Property Used in a Farming Business

“Real property used in a farming business,” the only real property eligible for the capital gain deduction in 2023 and beyond, is defined by statute as:

All tracts of land and the improvements and structures located on such tracts which are in good faith used primarily for a farming business. Buildings which are primarily used or intended for human habitation are deemed to be used in a farming business when the building is located on or adjacent to the parcel used in the farming business. Land and the nonresidential improvements and structures located on such land that shall be considered to be used primarily in a farming business include but are not limited to land, improvements or structures used for the storage or maintenance of farm machinery or equipment, for the drying, storage, handling, or preservation of agricultural crops, or for the storage of farm inputs, feed, or manure. Real property used in a farming business shall also include woodland, wasteland, pastureland, and idled land used for the conservation of natural resources including soil and water.

Real property classified as agricultural property for Iowa property tax purposes, except real property described in section 441.21, subsection 12, paragraph “a” or “b”, shall be presumed to be real property used in a farming business. This presumption is rebuttable by the department by a preponderance of evidence that the real property did not meet the requirements of subparagraph division (a).

Iowa Code § 422.7(13)(a)(5)(a). The law provides two ways for taxpayers to qualify for the capital gain deduction when selling real property used in a farming business.

Option One:

The taxpayer held the real property used in a farming business for 10 or more years and “materially participated” in a “farming business” for at least 10 years.

• If the taxpayer is a “retired farmer,” the taxpayer must make the single lifetime election to exclude qualifying capital gains. Retired farmers meet the material participating requirements by having materially participated in the aggregate for 10 years or more. Iowa Code § 422.7(13)(b)(1), r. 302.87(4). It is not required that the property be located in Iowa. Id.
• For non-retired farmers, the taxpayer must meet the material participation requirement for the 10 years preceding the sale. r. 302.87(4)(a). Note, however, that the five out of 10-year rule can apply (r. 302.87(2)(e)(5)}.

Option Two:

The seller sells real property held and used in a farming business to a relative.  If the buyer of the property is a qualifying relative, the seller is not required to meet material participation or holding period requirements. Iowa Code § 422.7(13)(b)(2); r. 302.87(4)(a).

The law provides three ways to qualify as a relative:

1.  The individual is related to the taxpayer by consanguinity or affinity within the second degree as determined by common law.
   • This would include a brother, sister, grandparent, grandchild, daughter-in-law, son-in-law, or parent-in-law.
2. The individual is a lineal descendent of the taxpayer.
   • This includes children of the taxpayer, including legally adopted children and biological children, stepchildren, grandchildren, great-grandchildren, and any other lineal descendent of the taxpayer.
3. An entity in which an individual who satisfies the conditions of either 1 or 2 has a legal or equitable interest as an owner, member, partner, or beneficiary. There is no ownership percentage requirement.  Iowa Code § 422.7(13)(a)(6).

Sale of Breeding, Draft, Dairy and Sport Livestock

Beginning in 2023, the law allows retired or disabled farmers (55 years of age or older) to elect to deduct gain from the sale of breeding, draft, dairy or sport cattle or horses (held for 24 months or more) if the taxpayer:

• Materially participated in the farming business for five of the eight years preceding retirement or disability, and
• sold all or substantially all of the taxpayer’s interest in the farming business when the election is made.
  • “Substantially all” means 90% of the interest in the farming business. r. 302.87(5).
  • Proper records should be kept showing purchase and birth dates of breeding livestock. The absence of records may make it impossible for the owner to show that the owner held a particular animal for the necessary holding period. Iowa Code § 422.7(13)(c).

The same exclusion applies to the sale of other breeding livestock held for a period of 12 months or more. Iowa Code § 422.7(13)(d); r. 302.87(6).

Single Lifetime Election for Retired Farmers (Capital Gain)

A retired farmer may make a single lifetime election on new Iowa Form 100G (2023 IA 100G) to exclude all qualifying capital gain from the sale of real property used in a farming business and the sale of certain livestock described above. Iowa Code § 422.7(13)(e); r. 302.87(3).

Retired farmers who elect to exclude gain pursuant to this lifetime election may not claim the Iowa beginning farmer tax credit in the current or subsequent years. They are also ineligible to exclude farm rental income from Iowa taxation in current or subsequent tax years. The election is irrevocable once made. Iowa Code § 422.7(13)(f)(g); r. 302.87(3).

For the purposes of this deduction, “retired farmer” means an individual who is disabled or who is 55 years of age or older and who no longer materially participates in a farming business when an exclusion and deduction is claimed. Iowa Code § 422.7(13)(a)(7).

“Material Participation” in a “Farming Business”

Both the farm lease income exclusion and the Iowa capital gain exclusion require material participation in a farming business (for all but the sale of real property used in a farming business to a relative). To take the farm lease income exclusion, the individual must have materially participated in a “farming business” for 10 years or more in the past (in the aggregate), but they may no longer be materially participating in a farming business at the time the election is made. The same rule applies to retired farmers who make an election to exclude the gain from real property used in a farming business. For retired farmers electing to claim a capital gain deduction for the sale of livestock, they must have materially participated in the livestock business for 5 of the 8 years preceding their retirement or disability.

It is important to note that material participation requirements for purposes of the farm income exclusion and the capital gain deduction are specific to participation in a “farming business,” which is defined as “the production, care, growing, harvesting, preservation, handling, or storage of crops or forest or fruit trees; the production, care, feeding, management, and housing of livestock; or horticulture, all intended for profit.” Iowa Code § 422.7(14)(f)(3); Iowa Code § 422.7(13)(a)(1).

Material participation is established if the taxpayer has regular, continuous, and substantial involvement in the operations of a farming business that meets the criteria for material participation in an activity under IRC § 469(h) (with the exception of §469(h)(3)). Iowa Code § 422.7(14)(f)(5); Iowa Code § 422.7(13)(a)(4).

The administrative rules clarify that federal regulations, Treas. Regs. §§ 1.469-5 and 1.469-5T, apply to material participation determinations. r. 302.87(2). The material participation rules detailed for the capital gain deduction apply equally to the farm lease income exclusion. r. 302.88(2). Generally, an individual will be considered as materially participating in a tax year if the taxpayer satisfies or meets any of the following tests:

(1) The individual participates in the farming business for more than 500 hours in the taxable year.

(2) The individual’s participation in the farming business constitutes substantially all of the participation of all individuals in the business (including individuals who are not owners of interests in the business) for the tax year.

(3) The individual participates in the farming business for more than 100 hours in the tax year, and no other individual (including individuals who are not owners of interests in the business) participates more in the business than the taxpayer during the tax year.

(4) The individual participates in two or more businesses, excluding rental businesses, in the tax year and participates for more than 500 hours in all of the businesses and more than 100 hours in each of the businesses.

(5) The individual materially participated (determined without regard to this subparagraph) in a farming business for five of the ten years preceding the applicable tax year.

Note: This test does not apply when determining whether an individual has stopped materially participating in a farm business. r. 302.87(4)(a), 302.88(2).

(6) The individual participates in the business activity for more than 100 hours and based on all the facts and circumstances, the individual participates on a regular, continuous, and substantial basis.

• Management activities of a taxpayer are not considered for purposes of determining if there was material participation if either of the following applies: any person other than the taxpayer is compensated for management services or any person provides more hours of management services than the taxpayer. r. 302.87(2)(e)(1)-(6).

General Material Participation Rules

General rules apply to all material participation determinations:

• Activity by a taxpayer’s spouse is considered the activity of the taxpayer. The spouse’s participation in the business must be taken into account even if the spouse does not file a joint state return with the taxpayer or if the spouse has no ownership interest in the business. In other words, if a taxpayer’s spouse materially participated in a farm business, the taxpayer materially participated in a farm business. r. 302.87(2)(d).
  • The activities of other family members, employees, or consultants are not attributed to the taxpayer to determine material participation. Id.
  • The material participation of a spouse is not attributed to an individual when determining whether that individual is retired (no longer materially participating). r. 302.87(4)(a).
• Work done in an activity by an individual in the individual’s capacity as an investor is not material participation in the business or activity unless the investor is directly involved in the day-to-day management or operations of the activity or business. r. 302.87(2)(b).
• The fact that the taxpayer uses employees or contracts for services to perform daily functions in a business will not prevent the taxpayer from qualifying as materially participating in the business, but the services will not be attributed to the taxpayer. r. 302.87(2)(c).

Material Participation Rules for Farm Rentals

Cash Rentals. A farmer who rents out farmland on a cash basis as the only activity in the farming business will generally not be considered to be materially participating in the farming activity. The burden is on the farmer landlord to show that the farmer landlord materially participated in the cash-rent farm activity. r. 302.87(2)(f)(2).

Crop Share Rentals. If a farmer landlord is subject to self-employment tax on net income from a crop-share arrangement with a tenant, the rules state that the landlord is considered to be materially participating with the tenant in the crop-share activity if the landlord satisfies one of the four following tests:

TEST 1: The landlord does any three of the following: (1) pays or is obligated to pay for at least half the direct costs of producing the crop; (2) furnishes at least half the tools, equipment, and livestock used in producing the crop; (3) consults with the tenant; and (4) inspects the production activities periodically.

TEST 2: The landlord regularly and frequently makes, or takes part in making, management decisions substantially contributing to or affecting the success of the enterprise.

TEST 3: The landlord worked 100 hours or more spread over a period of five weeks or more in

activities connected with crop production.

TEST 4: The landlord has done tasks or performed duties which, considered in their total effect, show that the landlord was materially and significantly involved in the production of the farm commodities.

r. 302.87(2)(f)(3). Note that the self-employment tax test for material participation is generally different from the passive loss rules test (under IRC § 469) for material participation. The application of this self-employment tax test, however, brings clarity to the question of material participation for a crop share lease.

Material Participation Rules for Managing CRP

The final rules clarified that activities conducted under a CRP contract do not fall within the definition of “farming business” under Iowa Code § 422.7. r. 302.87(2)(f)(4). If a taxpayer’s only activity was managing CRP land, the taxpayer does not meet the material participation requirement. A person who manages CRP land, however, may still meet the material participation requirement for the rental exclusion if the taxpayer materially participated in a farming business through a different activity. Conversely, managing CRP land does not prevent an individual from qualifying as retired, even if they report the CRP income on a Schedule F.

Recordkeeping Requirements to Prove Material Participation

The rules state that taxpayers are required to provide proof of services performed and the hours attributable to those services. r. 302.87(2)(f)(5). Detailed records should be maintained by the taxpayer, on as close to a daily basis as possible at or near the time of the performance of the activity, to verify that the material participation test has been met. However, material participation can be established by any other reasonable means, such as approximating the number of hours based on appointment books, calendars, or narrative summaries. Records prepared long after the activity, in preparation of an audit or proceeding, are insufficient to establish participation in an activity.

Rules for Surviving Spouses

As directed by the Legislature, IDOR’s final rules specify how the above lifetime elections (for excluding net income from a farm tenancy agreement and for excluding qualifying capital gain for sales by a retired farmer) apply to surviving spouses. r. 302.87(3)(b).

Make Election on Behalf of Deceased Retired Farmer

A surviving spouse of a deceased retired farmer may make an election on behalf of the deceased retired farmer that the retired farmer would have been eligible to make prior to death. This election must be made by the due date, including extensions, for the tax year immediately following the tax year of the retired farmer’s death. r. 302.87(3)(b)(1). No one was eligible to make an election prior to 2023.

Exclude Income Pursuant to Election Made by Deceased Retired Farmer

If a retired farmer made an election prior to death, the surviving spouse of the deceased retired farmer may exclude the qualifying income pursuant to the election made by the retired farmer prior to death.

A surviving spouse cannot change an election the deceased retired farmer made. Any election made by the retired farmer prior to death is binding on all real property used in a farming business owned by the retired farmer at the time of death, but only as applied to the retired farmer and the surviving spouse. r. 302.87(3)(b)(2).

Disclaim Election by Deceased Retired Farmer

A surviving spouse of a deceased retired farmer may also disclaim an election made by the retired farmer. If a surviving spouse of a deceased retired farmer makes this disclaimer, the surviving spouse is not eligible to deduct qualifying income pursuant to an election made by the retired farmer prior to death. r. 302.87(3)(b)(3). A surviving spouse of a deceased retired farmer shall make this disclaimer on a form prescribed by the department and file the form with the surviving spouse’s income tax return.

Note: Because no elections were made during the 2023 calendar year, there will be no disclaimers filed for the 2023 calendar tax year.

Elections on 2023 Returns

When filing their 2023 returns, retired farmers who rent real property or sold qualifying livestock or real property used in a farming business will have to decide whether they want to make a single lifetime election to exclude the rental income or the capital gain. They may also choose to make no election, thereby reserving the right to make an election in future years. If a retired farmer does not make an election, they must include the capital gain or rental income in their Iowa taxable income for 2023.  Once a retired farmer makes an election, it may not be changed. A retired farmer who has excluded farm rental income from Iowa taxation may not ever take the Iowa capital gain deduction. Conversely, a retired farmer who has made an election to exclude capital gain may not ever exclude income from a farm tenancy agreement. If either election is made, the retired farmer may not take the beginning farmer tax credit in the current or subsequent tax years. Retired farmers should discuss this election with a trusted tax professional.

Common Questions

What is a farm tenancy agreement?

A WRITTEN agreement outlining the rights and obligations of an owner-lessor and a tenant-lessee where the tenant-lessee has a “farm tenancy” as defined in Iowa Code § 562.1A:

A leasehold interest in land held by a person who produces crops or provides for the care and feeding of livestock on the land, including by grazing or supplying feed to the livestock.

Is a Conservation Reserve Program (CRP) contract a farm tenancy agreement?

No. CRP contracts are not leasehold interests in land. As such CRP income cannot be excluded from Iowa income.

Does “held” mean the same thing as “owned”?

Not always. “Held” is determined with reference to the holding period provisions of IRC § 1223 and its associated regulations. Iowa Admin Code 701-302.88(1). Under the federal rules, the holding period generally includes the time held by any other person if property has the same basis as it would have in the other person. For example, the holding period for real property acquired in a like-kind exchange includes the holding period of the relinquished property. Similarly, someone acquiring title in property after holding a remainder interest can include in their holding period the time during which they held the remainder interest. See examples 7 and 8, respectively, in r. 302.87(4)(f).

How does the “held” requirement apply to joint tenancies and tenancies in common?

Eligible individuals who hold property as tenants in common or as joint tenants with right of survivorship (JTRS) are eligible to make an election for the income flowing from their respective interests in the land. r. 302.87(3)(c)(1). For example, if spouses own the property 50-50 as JTRS, each spouse can make an election (or not make an election) for 50 percent of the rental income if they have held that property for 10 years or more. They are each free to make different decisions with respect to their ownership interests in the property.

If one spouse in a JTRS passes away, it appears that the surviving spouse is deemed to have held 100% of the property for the period during which the JTRS was in place. [See, for example, Document Reference 14201029 (2014) (taxpayer owned land jointly with husband for 15 years; when husband died, taxpayer was determined to have met the 10-year holding period for land); Document Reference 0420105 (2004) (If the ownership was joint tenancy, both the husband and wife are deemed to have owned 100% of the farmland)].

Conversely, if the spouses owned property as tenants in common, with each spouse owning a 50 percent undivided interest, it appears that the surviving spouse’s holding period will begin accruing on the day the survivor inherits the deceased spouse’s share. [See, for example, Document Reference: 05201033 (2005) (distinction between TIC and JTs)].

Note: These document citations are not authoritative, but reflect the way IDOR has in the past evaluated similar questions. No authoritative guidance on this issue could be located.

If a deceased spouse was the only one who materially participated in a farming operation, can the surviving spouse make an election if the deceased spouse died prior to 2023?

The surviving spouse cannot make an election on behalf of the deceased spouse because there was no election available at that time. However, in many cases, the surviving spouse will qualify as a retired farmer in their own right, even if they did not materially participate in a farming operation themselves. As explained above, the material participation of a spouse is attributable to the other spouse. Therefore, a surviving spouse is considered to have materially participated in a farming operation for as many years as the surviving spouse was married to the materially participating farmer. As long as the surviving spouse meets the holding period requirement, they can make an election. See “held” questions above for more information.

If I have never farmed, but I owned and managed CRP ground for 15 years, can I make an election to exclude rental income if I now cash rent the property?

No. Anyone who has not materially participated in a farming business is not eligible to make an election. The final rules clarified that managing CRP ground, even if the income is reported on a Schedule F, is not materially participating in a farm business. r. 302.87(2)(f)(4).

I was a farmer for 20 years, but I farmed through an S corporation. Do I meet the material participation requirements to be a retired farmer?

As long as the activity meets one of the material participation tests detailed earlier in this review, you will be considered to have materially participated in a farming business for those 20 years.  Conversely, if you are still materially participating in that entity, you will not be eligible to make an election. [Note that you were materially participating if your Income/losses from that business were reported in the non-passive column of the Schedule E]. It is important to note that rental income received by an S corporation (or partnership) is not eligible for the rental exclusion, even if it passes through to a retired farmer. If an S corporation (or partnership) sells property, however, owners are eligible for the capital gain exclusion if they meet the material participation requirements of a non-retired or retired farmer. 302.87(4)(c) and if the entity held the property for 10 years.

If I make a lifetime election as a retired farmer, what happens to my unclaimed beginning farmer tax credit?

It can never be used.

How much tax would I save with an election to exclude farm tenancy income or capital gain income from tax?

This provision excludes the relevant income from Iowa tax only. As such, you would still be responsible for paying federal tax on this income. The Iowa tax rates are scheduled to decrease through 2026. This means the benefit of the election will generally decrease with each year. Future Iowa tax rates are scheduled to be as follows: