Section 1 Statutory
Framework
Vermont individual income tax is imposed on the taxable
income earned or received in the tax year by every individual, estate, and
trust, subject to income taxation under the laws of the United States. Taxable
income is defined in
32 V.S.A. §
5811(21) as federal taxable
income with certain additions and subtractions. Federal taxable income is
decreased by the following capital gain income to arrive at Vermont taxable
income:
(1) The first $ 5000 of
adjusted net capital gain income or
(2) 40 percent of adjusted net capital gain
income from the sale of assets held by the taxpayer for more than 3 years
except from the sale of the following:
(a)
Any real estate or portion of real estate used by the taxpayer as a primary or
non - primary residence,
(b)
Depreciable personal property other than farm property and standing timber,
and
(c) Stocks and bonds publicly
traded or traded on an exchange or any other financial instruments.
The total amount of decrease due to capital gains exclusions
cannot exceed 40 percent of federal taxable income.
A taxpayer may choose the exclusion that results in the
greater tax reduction, but may not take both the $ 5000 and 40 percent
exclusion in one tax year. The $ 5000 exclusion may be applied against all
types of adjusted net capital gain income. In no case may the exclusion exceed
the taxpayer's adjusted net capital gain. The 40 percent exclusion is limited
both as to the type of asset generating the gain and the length of time the
asset was held.
Section 2 Exclusion Limited to Adjusted Net
Capital Gain Income
Only capital gain income that is adjusted net capital gain
income as that term is defined in Section
1(h) of
the Internal Revenue Code is eligible for the Vermont exclusion. Adjusted net
capital gain does not include income short term gain but includes most long
term capital gain.
Adjusted net capital gain income does not include section
1250
gain or 28 percent gain. IRC §
1(h)(3).
Section
1250
gain is realized on the sale of depreciable real estate and is taxed at a 25
percent maximum federal capital gains rate (or less in some cases).
Unrecaptured 1250 gains are only realized when there is a net Section
1231 gain that
is not subject to recapture as ordinary income.
The 28 percent gain is the sum of collectibles gain and
Section
1202
gain (gain on the sale of small business stock) [l]over the sum of collectibles
loss, the net short-term capital loss and the amount of the long-term loss
carried to the succeeding tax year under Section 1212(b)(1)(B).
In addition to the limitations of the Section l(h)
definition, qualified dividends are not treated as adjusted net capital gain
income for purposes of applying the 40 percent exclusion.
32 V.S.A. §
5811(21)(B).
Section 3 Real Estate Exclusion
(A) The 40 percent exclusion extends to all
real estate that is owned more than 3 years except primary or non-primary
residences. Examples of real estate the gain from the sale of which qualifies
for the 40 percent exclusion include the following:
(1) Real estate in which a business is
operated, such as a retail store, office, factory or warehouse and the parcel
[2 ]of land on which the structure is located,
(2) Real estate held for investment purposes,
such as an apartment building or raw land,
(3) Real estate used for farming, whether or
not the owner is a farmer, including farm buildings,
(4) Real estate that is logged.
(B) Examples of real estate the
gain from the sale of which does not qualify the 40 percent exclusion include
the following:
(1) A taxpayer's primary
residence, second home, camp, cottage, ski condominium or vacation property
unless, under federal law, the property is not considered to be used as a
home,
(2) A taxpayer's timeshare in
a ski condominium,
(3) Land that
was part of a residential parcel at the time of sale even if it was subdivided
prior to sale.
(C)
Part-time Rental Gain from a sale of a primary or non-primary residence does
not qualify for the 40 percent exclusion even if the property is rented for a
significant portion of the year. Under the Internal Revenue Code a person is
considered to use a dwelling unit as a home if the person uses it for personal
purposes during the tax year for more than the greater of: 14 days or 10
percent of the total days it is rented to others at a fair rental price.
However, if the property is a second home that is rented at fair market rent
for all but 14 days each year and is otherwise treated as an investment
property (e.g., it is depreciated, expenses are deducted and the rental income
is reported), it is not considered residential. Likewise, a seasonal camp may
be used by the owner for 14 days before it is considered residential.
A day of personal use of a dwelling unit is any day that it
is used by:
(1) You or any other
person who has an interest in it, unless you rent your interest to another
owner as his or her main house under a shared equity financing
agreement;
(2) A member of your
family or of a family of any other person who has an interest in it, unless the
family member uses it as his or her main house and pays a fair rental
price;
(3) Anyone under an
agreement that lets you use some other dwelling unit; or
(4) Anyone at less than a fair rental
price.
(D) Allocation of
Gain If a parcel includes both qualifying real estate and residential real
estate, the gain must be allocated between the two classes of real estate. For
example, if a farm consisting of 200 acres, a farmhouse (the seller's residence
or, if the farm is owned by an entity, the residence of an owner of the entity)
and a barn is sold and the seller realizes a gain, the adjusted net capital
gain should be allocated in the same way as the property value is allocated to
the qualifying and non-qualifying real estate. Thus, if 30 percent of the
assessed value is on the housesite, 30 percent of the gain should be allocated
to the housesite. The remaining 70 percent of the gain is eligible for the 40
percent exclusion. If the taxpayer takes the 40 percent exclusion on the
eligible gain, the $ 5,000 exclusion is not available for any part of the
adjusted net capital gain.
(E) Home
Office or Business Gain Gain may also be allocated when a taxpayer has a home
office or business in the residence. The burden of demonstrating that a portion
of the property is not residential is on the taxpayer. Relevant facts may
include how the property is treated on the taxpayer's federal income tax
returns, including form 8829, and any property tax adjustment claims filed with
respect to the property.
(F)
Conversion A residential property that is converted to a nonresidential use
prior to sale may qualify for the exclusion depending upon the facts and
circumstances surrounding the conversion. If the property is converted to
nonresidential use within 3 years of the sale it is presumed that the asset is
residential, but the presumption may be rebutted by the taxpayer. Relevant
facts include how long the residence was rented and to whom (e.g. whether the
lease is arms' length), when efforts to sell the residence commenced, treatment
of the rental income for state and federal purposes and how the real estate is
classified on the grand list. A taxpayer claiming the 40 percent exclusion with
respect to real estate that was a residence has the burden of demonstrating
that he property was actually converted to nonresidential use.
(G) Installment sales Whether the requirement
that the asset be held 3 years is satisfied in an installment sale depends upon
when title to the asset passes to the buyer. Thus, property purchased in 2010
and sold in 2012 under an installment contract would not be eligible for the 40
percent exclusion even if payments were received in 2013 and after.
Section 4 Depreciable Personal
Property
(A) Adjusted net capital gain income
from the sale of depreciable personal property does not qualify for the 40
percent exclusion unless the property sold is farm property. Standing timber
also qualifies for the 40 percent exclusion.
(B) Farm property includes any tangible
personal property used to generate income from an agricultural activity. For
example, a baler used to bale hay for sale qualifies, but a baler used to bale
hay to feed a pet horse does not. A tractor used to mow down vegetation between
Christmas trees grown for sale qualifies, but tractor used by a landscaping
business does not. Livestock used in a business for draft, breeding or dairy
purposes qualifies for the 40 percent exclusion.
(C) Adjusted net capital gain on the sale of
most depreciable personal property is not eligible for the 40 percent
exclusion. Examples of depreciable personal property the gain on which does not
qualify for the 40 percent exclusion include the following:
(1) Trade fixtures or business equipment such
as restaurant equipment or office furniture;
(2) Equipment used for construction, road
building and logging;
(3) Boats,
airplanes and motorized vehicles.
(D) Property is "depreciable" if it is a type
of property that can be depreciated under the Internal Revenue Code for federal
tax purposes. It is irrelevant that such property has not yet been placed in
service or that no depreciation expense has yet been taken.
Section 5 Stocks or Bonds Publicly
Traded on an Exchange and Financial Instruments
(A) Adjusted net capital gain on the sale of
stocks and bonds that are publicly traded does not qualify for the 40 percent
exclusion. Other financial instruments that are publicly traded, such as
futures, options, swaps and other derivative instruments also do not
qualify.
(B) The sale of stock of a
closely held corporation that is not publicly traded qualifies for the 40
percent exclusion. Similarly, adjusted net capital gain from the sale of a
membership interest in an LLC or partnership interest in a partnership -
provided those entities are not publicly traded - is eligible for the
exclusion.
(C) Examples:
(1) Taxpayer sells IBM stock and realizes
adjusted net capital gain. This gain is not eligible for the 40 percent
exclusion.
(2) Taxpayer sells his
stock in a closely-held S-corporation that owns real property, machinery and
equipment and good will. The stock is not traded on a public exchange. The
adjusted net capital gain realized on the sale is eligible for the 40 percent
exclusion even though the machinery and equipment would not be eligible if sold
separately as assets.
Section 6 Business Asset Sales
(A) If the sale of a business is structured
as an asset sale rather than sale of an ownership interest in the entity, the
availability of the exclusion will depend upon the nature of the asset. This is
also the case where the membership or ownership interest in a single-member
pass-through entity (e.g., limited liability company) is sold, because these
entities are disregarded for federal income tax purposes and the assets are
treated as assets of the owner. [3 ]The sale is treated as the sale of the
assets under federal law. Vermont follows the federal tax treatment of income
in these cases.
32 V.S.A. §
5820.
(B) Examples:
(1) Taxpayer is selling the membership
interest in single member LLC. For federal tax purposes, and therefore for
Vermont income tax purposes, this is treated as the sale of assets. All of the
assets that are used in the LLC's trade or business, consisting of real estate,
tangible personal property, intangible rights and licenses, and goodwill, are
being sold. The business real estate and intangibles, including good will, are
eligible for the 40 percent exclusion. To the extent that the tangible personal
property is depreciable, it is not eligible for the exclusion. Taxpayer must be
able to produce a reasonable allocation schedule.
(2) Taxpayer owns a convenience market that
is going out of business. He sells the coolers and remaining inventory to
another market and sells his leasehold interest in the real estate to a third
party for a clothing store. Gain related to the coolers, which have been
depreciated over several years, and gain from the sale of the inventory is not
eligible for the 40 percent exclusion; gain from the sale of the leasehold
interest is eligible.
Section 7 Pass-Through Entities
The 40 percent exclusion is available only with respect to
assets "held by the taxpayer for more than three years" prior to the sale
giving rise to adjusted net capital gain. If the seller is a pass-through
entity, such as an S-Corporation, partnership or limited liability company, the
exclusion is available to the shareholder, partner or member who reported
adjusted net capital gain with respect to the sale provided the entity held the
asset for more than three years.
Section
8 Basis
The 40 percent exclusion applies only to gain that is
included in "adjusted net capital gain" (see subdivision
2 above)
which is an amount determined under federal law. Any basis adjustment permitted
under federal law to arrive at adjusted net capital gain is therefore reflected
in the amount which is eligible for the Vermont exclusion. For example, to the
extent that expenses associated with one asset are capitalized to another asset
under federal law, that reallocation is recognized for purposes of determining
the adjusted net capital gain eligible for the 40 percent exclusion.
Section 9 Holding Period
When stock or another form of ownership interest in a
business is sold, the three-year holding period is measured from acquisition of
the stock or interest. In the case of an asset sale, the Department will follow
federal rules in determining holding period of the asset the sale of which
gives rise to adjusted net capital gain.
Section 10 Filing Requirements
In order to exclude capital gains income from Vermont income
tax, taxpayers will need to identify income that qualifies as adjusted net
capital gain income under Section l(h) of the Internal Revenue Code. Vermont
taxable income may be reduced by the first $ 5000 of such income.
Alternatively, taxpayers with eligible assets held more than 3 years may claim
the 40 percent exclusion in lieu of the flat exclusion. All taxpayers claiming
the 40 percent exclusion should retain records detailing the source of the gain
that can be produced upon request by the Department.
If there is a loss with respect to the sale of an asset that
would qualify for the 40 percent exclusion if the transaction had resulted in a
gain, the loss must be netted against gains that qualify for the 40 percent
exclusion. "Adjusted net capital gain" for purposes of calculating the
exclusion under
32 V.S.A. §
5811(21)(B)(ii) may not
exceed the amount of capital gain reported on line 13 of Federal Form
1040.
[1] The general rule in the case
of a non-corporate taxpayer is that gross income does not include 50 percent of
any gain from the sale or exchange of qualified small business stock.
26
U.S.C. §
1202. Special rules for 2009
through 2014 provided for even more favorable treatment -the exclusion of 75 or
100 percent of the gain from gross income -depending on the date of
acquisition. For purposes of the Vermont exclusion, since this gain is not part
of adjusted net capital gain it is not eligible for the 40 percent
exclusion.
[2] For purposes of this
regulation, "parcel" has the same meaning as in
32 V.S.A. §
4152(a)(3) where it is
defined as "all contiguous land in the same ownership, together with all
improvements thereon."
[3] Proc.
& Admin. Regs. § 301.7701 -
3.
Other disregarded entities under federal law are "qualified subchapter S
subsidiaries" and "qualified REIT subsidiaries"
