Cell phone tower - capital gains question

[econstudent]

I am trying to help my dad with his taxes. He owns a piece of land, and this year he agreed to have a cell phone tower put on the land. The contract is a perpetual easement, so he has to pay capital gains taxes. The issue is that the form he is filling out is telling him that he has to pay a penalty because he did not pay estimated quarterly taxes on the capital gains. This confuses him because he didn't even get the check for the easement until December, so how could he have paid estimated taxes on it?

From my research, I *think* that the issue is not the capital gains, but whether he had enough taxes withheld in general. If he meets the "safe harbor" rules and had 100% of his 2011 taxes withheld during 2012, (or 90% of what he owes in 2012), there should not be a penalty, right? Just to be clear, when I mention withholdings, I mean from his normal FT job.

If it matters, he does not live on this land. It is a piece of farmland but to my knowledge they are not farming it right now. If they are, it's a tiny patch of crops because the land is not very good for farming. I can try to provide more details if necessary, but my main question now is if I am understanding the capital gains/penalty/safe harbor thing correctly. 

[Deleted]

> From my research, I *think* that the issue is not the capital gains, but whether he had enough taxes withheld in general. If he meets the "safe harbor" rules and had 100% of his 2011 taxes withheld during 2012, (or 90% of what he owes in 2012), there should not be a penalty, right?

Correct


> He owns a piece of land, and this year he agreed to have a cell phone tower put on the land. The contract is a perpetual easement...

Since he sold an easement he should review the basis allocation for figuring the capital gain.  I'm going to cite a couple of references to which you may not have access.  IRS Revenue Ruling 54-575 (July 1954) is pertinent in part because it authorizes a basis reduction for the portion of the land affected by the easement.  In pertinent part, Rev. Rul. 54-575 holds:

"The consideration received for granting the easement over the portion of the land where beneficial interest is retained by the taxpayer may be used to reduce the cost or other basis of such land and any excess of the payment over the cost or other basis is taxable gain."

§ 2.16 of the Farm Income Tax Manual (pub. by Matthew, Bender & Co.) explains basis allocation for easement sales of farm land.  To illustrate, I'll assume his basis in the entire tract of land is $50,000 and the cell phone tower affects 2% of the total land area.  He reduces his basis by $1,000 ($50,000 * 2%) and the remainder of the amount paid him by the cell phone tower company is taxed as long-term capital gain.  Since the amount reported as income will not reconcile with the Form 1099 he received from the cell phone tower company, he should complete and attach IRS Form 8275 to his tax return to explain the portion of the income used to reduce basis and that is not being recognized in current income.

[econstudent]

Thank you 19th Hole, that is very helpful!

[mwcpa]

19th hole points out some good tidbits about the possible reduction to the gain that is taxable. 

Also, if the "penalty" for not paying enough estimates comes into play, considered "annualizing" his income.  If the 4th Q of 2012 is where the income occurred you are not required to make estimates in April, June or Sept.  It may cut the penalty.

Example.  I have a salary of 100K... withholding tax is 25K.... I have a large capital gain of 1 million on December 31st (sold some land).... the annualization rules allow me to allocate the 100K evenly in the year... the 25K withholding evenly and place the 1 million gain in the 4th Q for calculation of any possible penalty.  This can greatly reduce the cost of a penalty.  I have many clients who have income earned not evenly in the year and they pay their required estimates in the same fashion.

But, if he met the 100/110% or 90% rules he should be good (and it was deemed to be even in the year).

[econstudent]

Okay I didn't know about the annualizing. That's another option we could use. I still need to talk to him to find out how much he had withheld this year. They aren't the type that would like to write a check on April 15, so I'm hoping they had enough withheld to not have to worry about the penalty this year. Thanks.