Senate File 593 - Introduced SENATE FILE 593 BY SWEENEY A BILL FOR An Act relating to the exclusion from the individual income tax 1 of certain net capital gains from the sale of real property 2 used in a business, and including applicability provisions. 3 BE IT ENACTED BY THE GENERAL ASSEMBLY OF THE STATE OF IOWA: 4 TLSB 2582SS (6) 88 jm/jh

S.F. 593 DIVISION I 1 CAPITAL GAINS TAXATION —— MATERIAL PARTICIPATION 2 Section 1. Section 422.7, subsection 21, paragraph a, Code 3 2019, is amended by adding the following new subparagraph: 4 NEW SUBPARAGRAPH . (3) (a) For purposes of determining 5 the material participation of a taxpayer under this paragraph 6 with regard to a partnership, subchapter S corporation, limited 7 liability company, estate, or trust whose capital gain flows 8 through to the owners or beneficiaries for federal income tax 9 purposes, material participation shall be determined at the 10 owner or beneficiary level according to the activities of each 11 owner or beneficiary. 12 (b) For purposes of determining material participation of a 13 taxpayer under this paragraph with regard to the sale of real 14 property used in a business or rental arrangement by an estate 15 or trust, all beneficiaries or owners of the estate or trust 16 shall be treated as materially participating in the business or 17 rental arrangement if one or more of the executors or trustees 18 of the estate or trust are materially participating in the 19 business, or if the real property is leased to another person, 20 the executor or trustee is materially participating in the 21 lessee’s business that uses the real property. The ten-year 22 period described in paragraph “a” , subparagraph (1), is deemed 23 to be met by any combination of material participation by the 24 decedent or settlor or one or more executors or trustees, in 25 the aggregate, over the ten-year period. 26 Sec. 2. APPLICABILITY. This Act applies to tax years 27 beginning on or after January 1, 2020. 28 DIVISION II 29 CAPITAL GAINS TAXATION —— MATERIAL PARTICIPATION —— FUTURE 30 INCOME TAX CHANGES 31 Sec. 3. 2018 Iowa Acts, chapter 1161, section 113, 32 subsection 21, paragraph a, subparagraph (3), is amended to 33 read as follows: 34 (3) “Materially participated” or “material participation” 35 -1- LSB 2582SS (6) 88 jm/jh 1/ 4

S.F. 593 means the same as “material participation” defined in section 1 469(h) of the Internal Revenue Code . , except under the 2 following circumstances: 3 (a) For purposes of determining the material participation 4 of a taxpayer with regard to a partnership, subchapter S 5 corporation, limited liability company, estate, or trust whose 6 capital gain flows through to the owners or beneficiaries for 7 federal income tax purposes, material participation shall be 8 determined at the owner or beneficiary level according to the 9 activities of each owner or beneficiary. 10 (b) For purposes of determining material participation 11 of a taxpayer with regard to the sale of real property used 12 in a business or rental arrangement by an estate or trust, 13 all beneficiaries or owners of the estate or trust shall 14 be treated as materially participating in the business or 15 rental arrangement if one or more of the executors or trustees 16 of the estate or trust are materially participating in the 17 business, or if the real property is leased to another person, 18 the executor or trustee is materially participating in the 19 lessee’s business that uses the real property. The ten-year 20 period described in paragraph “b” , is deemed to be met by 21 any combination of material participation by the decedent or 22 settlor or one or more executors or trustees, in the aggregate, 23 over the ten-year period. 24 EXPLANATION 25 The inclusion of this explanation does not constitute agreement with 26 the explanation’s substance by the members of the general assembly. 27 DIVISION I —— CAPITAL GAINS TAXATION —— MATERIAL 28 PARTICIPATION. Under current law, a taxpayer’s net capital 29 gain from the sale of a business, or from the sale of real 30 property used in a business, is exempt from the individual 31 income tax if the taxpayer held the real property or the 32 business for a minimum of 10 years, and materially participated 33 in the business for 10 years. “Material participation” refers 34 to the level of involvement a taxpayer has in the operations 35 -2- LSB 2582SS (6) 88 jm/jh 2/ 4

S.F. 593 of a business, and whether or not any particular taxpayer 1 materially participates in a business is determined under the 2 Internal Revenue Code. 3 This bill requires that for purposes of determining material 4 participation of a taxpayer for the capital gain tax exemption 5 with regard to a partnership, S corporation, limited liability, 6 estate, or trust whose capital gain flows through to the owners 7 or beneficiaries for federal income tax purposes, material 8 participation shall be determined at the owner or beneficiary 9 level according to the activities of each owner or beneficiary. 10 The bill also provides an exception to this material 11 participation requirement for the sale of real property used 12 in a business or rental arrangement which, under certain 13 circumstances, attributes the material participation of certain 14 representatives of an estate or trust to the beneficiaries or 15 owners of that estate or trust. For purposes of determining 16 material participation of a taxpayer with regard to the sale 17 of an estate’s or trust’s real property used in a business or 18 rental arrangement, all the beneficiaries or owners of the 19 estate or trust shall be treated as materially participating in 20 a business or rental arrangement for any year if an executor or 21 trustee of the estate or trust is materially participating in 22 the estate’s or trust’s business or, if the real property is 23 leased to another person, the executor or trustee is materially 24 participating in the lessee’s business that uses the real 25 property. The bill also provides that the 10-year material 26 participation requirement under Code section 422.7(21)(a)(1) 27 can be satisfied by any combination of years of material 28 participation attributable to decedent, settlor, or one or more 29 executors or trustees, aggregated over the 10 years preceding 30 the sale. 31 Division I applies to tax years beginning on or after January 32 1, 2020. 33 DIVISION II —— CAPITAL GAINS TAXATION —— MATERIAL 34 PARTICIPATION —— FUTURE INCOME TAX CHANGES. The bill amends 35 -3- LSB 2582SS (6) 88 jm/jh 3/ 4

S.F. 593 2018 Iowa Acts, chapter 1161, section 113, to align future 1 income tax changes with the changes in Division I of the bill. 2 By operation of law, the changes in Division II will begin 3 in tax year 2023 or in a later tax year, contingent upon the 4 satisfaction of certain net general fund revenue amount and 5 growth targets. 6 -4- LSB 2582SS (6) 88 jm/jh 4/ 4