SF 636 (LSB 2582SV (1) 88)

SENATE FILE 636

BY  COMMITTEE ON WAYS AND MEANS

(SUCCESSOR TO SF 593)

A BILL FOR

An Act relating to the exclusion from the individual income tax of certain net capital gains from the sale of real property used in a business, and including applicability provisions.
BE IT ENACTED BY THE GENERAL ASSEMBLY OF THE STATE OF IOWA:

DIVISION I
CAPITAL GAINS TAXATION —— MATERIAL PARTICIPATION

    Section 1.  Section 422.7, subsection 21, paragraph a, Code 2019, is amended by adding the following new subparagraph:
   NEW SUBPARAGRAPH.  (3)  (a)  For purposes of determining the material participation of a taxpayer under this paragraph with regard to a partnership, subchapter S corporation, limited liability company, estate, or trust whose capital gain flows through to the owners or beneficiaries for federal income tax purposes, material participation shall be determined at the owner or beneficiary level according to the activities of each owner or beneficiary.
   (b)  For purposes of determining material participation of a taxpayer under this paragraph with regard to the sale of real property used in a business or rental arrangement by an estate or trust, all beneficiaries or owners of the estate or trust shall be treated as materially participating in the business or rental arrangement if one or more of the executors or trustees of the estate or trust are materially participating in the business, or if the real property is leased to another person, the executor or trustee is materially participating in the lessee’s business that uses the real property. The ten-year period described in paragraph “a”, subparagraph (1), is deemed to be met by any combination of material participation by the decedent or settlor or one or more executors or trustees, in the aggregate, over the ten-year period.
    Sec. 2.  APPLICABILITY.  This Act applies to tax years beginning on or after January 1, 2020.
DIVISION II
CAPITAL GAINS TAXATION —— MATERIAL PARTICIPATION —— FUTURE INCOME TAX CHANGES

    Sec. 3.  2018 Iowa Acts, chapter 1161, section 113, subsection 21, paragraph a, subparagraph (3), is amended to read as follows:
   (3)  “Materially participated” or “material participation” means the same as “material participation” defined in section 469(h) of the Internal Revenue Code., except under the following circumstances:
   (a)  For purposes of determining the material participation of a taxpayer with regard to a partnership, subchapter S corporation, limited liability company, estate, or trust whose capital gain flows through to the owners or beneficiaries for federal income tax purposes, material participation shall be determined at the owner or beneficiary level according to the activities of each owner or beneficiary.
   (b)  For purposes of determining material participation of a taxpayer with regard to the sale of real property used in a business or rental arrangement by an estate or trust, all beneficiaries or owners of the estate or trust shall be treated as materially participating in the business or rental arrangement if one or more of the executors or trustees of the estate or trust are materially participating in the business, or if the real property is leased to another person, the executor or trustee is materially participating in the lessee’s business that uses the real property. The ten-year period described in paragraph “b”, is deemed to be met by any combination of material participation by the decedent or settlor or one or more executors or trustees, in the aggregate, over the ten-year period.
EXPLANATION
The inclusion of this explanation does not constitute agreement with
the explanation’s substance by the members of the general assembly.
   DIVISION I —— CAPITAL GAINS TAXATION —— MATERIAL PARTICIPATION. Under current law, a taxpayer’s net capital gain from the sale of a business, or from the sale of real property used in a business, is exempt from the individual income tax if the taxpayer held the real property or the business for a minimum of 10 years, and materially participated in the business for 10 years. “Material participation” refers to the level of involvement a taxpayer has in the operations of a business, and whether or not any particular taxpayer materially participates in a business is determined under the Internal Revenue Code.
   This bill requires that for purposes of determining material participation of a taxpayer for the capital gain tax exemption with regard to a partnership, S corporation, limited liability, estate, or trust whose capital gain flows through to the owners or beneficiaries for federal income tax purposes, material participation shall be determined at the owner or beneficiary level according to the activities of each owner or beneficiary.
   The bill also provides an exception to this material participation requirement for the sale of real property used in a business or rental arrangement which, under certain circumstances, attributes the material participation of certain representatives of an estate or trust to the beneficiaries or owners of that estate or trust. For purposes of determining material participation of a taxpayer with regard to the sale of an estate’s or trust’s real property used in a business or rental arrangement, all the beneficiaries or owners of the estate or trust shall be treated as materially participating in a business or rental arrangement for any year if an executor or trustee of the estate or trust is materially participating in the estate’s or trust’s business or, if the real property is leased to another person, the executor or trustee is materially participating in the lessee’s business that uses the real property. The bill also provides that the 10-year material participation requirement under Code section 422.7(21)(a)(1) can be satisfied by any combination of years of material participation attributable to decedent, settlor, or one or more executors or trustees, aggregated over the 10 years preceding the sale.
   Division I applies to tax years beginning on or after January 1, 2020.
   DIVISION II —— CAPITAL GAINS TAXATION —— MATERIAL PARTICIPATION —— FUTURE INCOME TAX CHANGES. The bill amends 2018 Iowa Acts, chapter 1161, section 113, to align future income tax changes with the changes in Division I of the bill. By operation of law, the changes in Division II will begin in tax year 2023 or in a later tax year, contingent upon the satisfaction of certain net general fund revenue amount and growth targets.