Vermont’s Land Gains Tax, Part 1

Article written by Matthew D. Getty
Posted on Jun 30, 2011

(This article was first published in Vermont Property Owners Report, a Montpelier-based subscription newsletter about Vermont and Vermont real estate. Phone: 802.229.2433)

Vermont’s unique land gains tax, with rates ranging from 5% to 80% on land held less than 6 years, was first enacted in 1973 in order to deter land speculators from buying large parcels of land to quickly subdivide and sell. According to the tax commissioner at the time, Norris Hoyt, the tax was instituted at the “tail end of a period when some Vermonters in southern Vermont still didn’t know the value of the farms they were selling to out-of-staters, and when syndications were being formed in New York City to buy Vermont land.” In the first part of a two-part series, attorney Matthew Getty explains how the tax works. Part 2, in the next issue, will provide examples and explain how to prepare for paying the tax. Getty is an associate attorney with the estate and tax planning practice group of Kenlan, Schwiebert, Facey & Goss, P.C., in Rutland (phone: 802.773.3300).

The Vermont land gains tax is imposed on gains attributable to the sale of land held for less than six years. Because the purpose of the tax is to inhibit land speculation, there are numerous exemptions to the law to make it better fit the legislative purpose. As a result, compliance with the administration of this tax can be time-consuming and expensive. We have found that our clients can save a great deal of money, both in taxes and in professional fees, by coming to this process prepared. This article will describe the tax and the exemptions to it. Part 2 will address those steps that you should take over the course of your property ownership in order to reduce or eliminate your liability for land gains tax with the least amount of expense or headache.

Exemptions

The major exemptions are the following:
1. Buildings. The tax only applies to land. If you own a building but not the land it sits on, you are not liable for the tax.
2. Sunset. The tax does not apply to property held for longer than six years. As will be discussed in greater detail below, the tax rate is variable depending on (a) gain as a percentage of basis, and (b) holding period. The longer you have held the property, the lower the tax. After six years, no tax is due.
3. Leases. Most land leases are exempt, but the tax does apply to leases of 50 years or more, and certain other lease rights. If you have a concern about a lease arrangement, consult a professional.
4. Principal Residences. This is a common but complicated exemption.
a. An exemption may be claimed if the property is used as a principal residence by the seller or the buyer.
b. The exemption applies to sales of up to 10 acres of land, or up to 25 acres if required by a local zoning ordinance.
c. If the buyers are claiming the exemption, they must occupy the property as a principal residence within one year.
d. If raw land is being sold, a purchaser may still claim the exemption if a home will be built and occupied within two years.
5. Spec Houses. Purchasers who intend to build and sell principal residences may also claim exemptions. The acreage limitations are the same (No. 4, above). The construction must begin within one year of purchase and be completed within two years. The sale must take place within three years. The builder must also file Certificates of Principal Residence Construction.
6. Gifts. Transfers without payment are exempt.
7. Nonprofits. Certain sales involving government entities and/or non-profit organizations are exempt.
8. Agriculture.
a. Farmers can sell farm property to family members without being subject to the tax if seller and buyer use the land for farming for a total of six years. The exemption is subject to definitional restrictions, and is not likely to apply to “hobby” or “gentleman’s” farms.
b. Sales of 25 acres or less to a farmer for active and direct use by that farmer may also be exempt, subject to certain definitional restrictions.

Land being a scarce commodity, we expect it to appreciate over time. The recent real estate bubble notwithstanding, we expect land to begin appreciating again in the future. In Vermont, it is a rare occurrence to experience a substantial gain on land in a period of six years, however. Unless a highway is built through the area or a man-made lake is suddenly lapping at your property line, your gains are likely to be modest.

In the cases that we have seen, substantial gains to investment most often are realized by new construction or by improving existing buildings. More realistically, the difference between what a client paid for a piece of property and what they are selling it for may not be an economic gain at all, given the amount of money they have expended improving the property. Selling price alone is not proof of economic gain or taxable gain. Nevertheless, your job with respect to Vermont land gains tax is to prove to the Vermont Department of Taxes how much your land has appreciated in value, if at all.

How It Works

In order to prepare for this tax, it is important to understand how the tax is administered. As one might imagine, it is very difficult to determine how much of the gain on a sale of a building with land is attributable solely to the land component.

The Tax Department allows taxpayers two possible methods for demonstrating how much gain is realized. The first is to obtain an appraisal. Appraisers are trained to make evaluations that consider numerous factors, including how much of your property’s value is attributable to your location. Obtaining an appraisal requires some advance planning, of course. It may also be costly, although the cost must be considered relative to the value of the property and the potential tax savings.

Even if you do obtain an appraisal, however, the Tax Department is not required to accept it. If they believe it to be worthwhile, they will obtain their own appraisal, and you will then be subject to a hearing in which a Department-appointed hearing officer considers the merits and demerits of the competing appraisals.

This is not an unusual feature of administrative law, but the presumptions tend to favor the Tax Department at this stage. If you lose at the hearing level, you may then appeal to superior court. The cost in time and fees may exceed the ultimate tax savings, especially considering that the Tax Department is both a party to the case and the judge at the first level hearing.

The second method of establishing gain attributable to land is to determine how much gain you have realized on the whole transaction and allocate a certain percentage to the land. There are two methods of doing this. First, you may look to the town Lister’s card that should have a valuation of your property broken down between land and improvements. You then determine what percentage of the overall value is represented by the land. That percentage is then applied to the gain on the sale transaction to determine how much gain is attributable to land.

This method is rather handy, but it is not always accurate. For example, it will not capture improvements made to a building since the last town appraisal. Even more problematic is the possibility that the town does not keep records with value broken down between land and buildings. This renders the Lister’s card useless for the purpose of calculating land gains tax.

The town may provide an underlying appraisal report with a cost analysis, but even that report will concede that the cost method of valuation will be wildly inaccurate for the purpose of valuing the property. Listers’ practices and records vary widely from one town to the next.

In the event that no other method is available, the Tax Department has issued an administrative guidance document that, among other things, provides default percentages that a taxpayer may use to allocate a share of overall gain to land. In most cases this figure will be 25%.

Once you have determined the taxable gain, the tax rate will be a function of holding period and gain as a percentage of basis. When gain is less than 100% of basis, the tax rate will range from 5% to 60%, depending on the holding period.

The land gains tax is a flat tax rather than a marginal tax like the income tax. That means the highest applicable tax applies to the entire gain.

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