It's an unfortunate fact of life that some gifts come with strings attached. Capital gains is never an issue if you hold on to a gift, using it for your own personal enjoyment. If you treat it as an investment and later sell it, however, both the Internal Revenue Service and the state of Minnesota will want a percentage of your profit.
Normally, the tax basis of your land would be what you paid for it plus any improvements. If it was a gift, the equation becomes more complicated. Its basis begins with what the donor paid for it, plus improvements. You can then add any improvements you made, such as if you paid legal fees to have the property rezoned. With other assets, you must add back to your basis any depreciation you took on previous years' tax returns, but you typically can't depreciate land, so this shouldn't be a factor. Your capital gain – or loss – is the difference between the sales price and this adjusted basis. If you hold the land for more than a year after receiving it, it's a long-term gain. Otherwise, it's a short-term gain.
Special Rules for Gifts
When calculating the tax basis of a gift, you must also take into consideration the value of the gift when you received it. If its fair market value at that time was the same as or greater than what the donor paid for it plus any improvements he made, nothing changes from the general rule – you would use the donor's adjusted basis. If the fair market value was less than the donor's basis, however, further calculations are required. If you sell the land for a profit, and if you personally did nothing to improve it during the time you held it, you would still use the donor's adjusted basis. If you sell for a loss, however, you would use the fair market value of the land instead of the donor's adjusted basis to determine your own tax basis. If you sell the property for an amount between its fair market value and the donor's adjusted basis, the sale is a neutral tax event – you have neither a gain nor a loss.
For federal tax purposes, you'll get a bit of a break if the donor had to pay a gift tax on the land when he transferred it to you. The annual gift tax exclusion for 2013 is $14,000. If you received the land in 2013 and if its fair market value was $15,000 at that time, the donor would owe a gift tax on $1,000. Assuming he paid a gift tax at the rate of 35 percent, this would amount to $350. You can add a portion of this to your tax basis. It's a complicated equation to figure out how much, but the bottom line is that the higher your basis is, the less likely it is that you'll realize capital gains. Gift taxes don't factor into Minnesota's state capital gains rules. The state doesn't impose them.
Capital Gains Tax Rate
Minnesota taxes all capital gains, both short- and long-term, as regular income. If you're in a 7.85 percent state tax bracket, that's what you'll pay in capital gains tax. The federal capital gains tax rate is usually 0 or 15 percent for long-term gains, depending on which tax bracket you're in, and only short-term gains are taxed as ordinary income. An exception exists if you earn more than $400,000 a year, or $450,000 if you're married and file a joint return. In this case, the long term federal rate jumps to 20 percent.
- Minnesota House of Representatives: Capital Gains Taxation – Federal and State (PDF)
- University of Minnesota Extension: Tax Considerations When Transferring Assets (PDF)
- IRS: Publication 551
- CompleteTax: Which Assets Can Be Depreciated?
- Thompson, Hall, Santi, Cerny & Dooley: Gift Taxes in Minneosta
- IRS: In 2013, Various Tax Benefits Increase Due to Inflation Adjustments
- Forbes: Secrets of the Fiscal Cliff Deal
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