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emc011075, Tax adviser
Category: Tax
Satisfied Customers: 3120
Experience:  IRS licensed Enrolled Agent and tax instructor
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My Dads (he is 66) total income this year is around $32,000

Customer Question

My Dads (he is 66) total income this year is around $32,000 (job, royalties, Social Security). In September 2016, he sold his portion of mineral rights to a farm he inherited in 1987 for $194,000. What should his federal tax be? I think his accountant is quoting him too high.
JA: The Accountant will know how to help. Is there anything else important you think the Accountant should know?
Customer: I don't think so
Submitted: 8 months ago.
Category: Tax
Expert:  emc011075 replied 8 months ago.

Hi. My name is ***** ***** I will be happy to help you.

85% of his social security will be added to his taxable income, that will also add up to the taxes bill. How much of the 194K is taxable and how it will be taxed depends on his basis (fair market value of the rights in 1987) and type of the income. Most mineral rights are taxed as royalties (ordinary income) but portion of it could be capital gains or distribution of asset. And there's also the depreciation.

How much of the 32K is from social security?

Customer: replied 8 months ago.
Around $15,000 for SS.
He was taxed ordinary income when he received royalties from a well on the property. From what research I have done, the sale of mineral rights should be capital gains. What would make it ordinary income?
How would you determine the value of mineral rights in 1987? It is from an undivided farm that has been passed down since the original land run. His portion was 26 acres of undivided 160 acres.
His accountant (we are in Ohio, the farm is in Oklahoma), says he owes $31,000 for federal and $9,000 state.
Expert:  emc011075 replied 8 months ago.

If part of the 194K is last year distribution, not sales proceeds, some of it could be taxed as ordinary income. Right to a property or mineral rights are usually purchased or received in exchange for something. If somebody inherits a property, it also inherits the step up basis, fair market value of on day of inheritance. There should be some kind of value in the transfer documents from 1987.

Assuming the entire 194K is taxed as capital gains, his federal tax liability will be $31,600 and state tax will be around $8,500

Expert:  emc011075 replied 8 months ago.

The capital gains are taxed at 15%, $29200, there's additional 3.8% net investment tax of $420 and the remaining $2100 is for his social security and W2 income.

Customer: replied 8 months ago.
Doesn't your ordinary income have to be above $37,000 for capital gains to be taxed at 15%?
From what I have read, he should be have 0% tax rate on capital gains because his ordinary income is in the 15% tax bracket.
Am I wrong?
Expert:  emc011075 replied 8 months ago.

It is not just the ordinary income, it is the total taxable income (total income reduced by standard or itemized deduction and exemption). To determine capital gains tax bracket you have to add all his income. As single with total income around 223K his tax bracket is more like 33%. It does not mean that all of his income will be taxed at 33%.

His first 11,950 will be reduced by standard deduction and exemption and will not be taxed at all.

His next 9325 will be taxed at 10% and the remaining 7725 of his ordinary income will be taxed at 15%.

The capital gains will be taxed at 15% + 3.8% (net investment income surtax) = 18.8%.

Expert:  emc011075 replied 8 months ago.

Makes sense?

In 10 - 15% tax bracket, capital gains are taxed at 0% rate.

In 25 - 33% tax bracket, capital gains are taxed at 15% (+3.8% if the income over 200K).

In the highest 39.6% tax bracket capital gains are taxed at 20% plus 3.8% net investment surtax.

But to determine your tax bracket for capital gains purposes you need to account for all income, including capital gains. Otherwise you could sell a multimillion dollar business and not having to pay any tax by simply keeping your other income low.