Colorado Capital Gains Subtraction

by E. Lee Reichert

The Colorado legislature previously enacted laws that allow qualified Colorado taxpayers to subtract certain net capital gain income earned from Colorado sources to the extent the gains are included in their federal taxable income. Because these statutes also cover the sale of Colorado companies, the tax effects associated with selling a business can be mitigated in circumstances where the relevant requirements are satisfied. This past December, the Colorado Department of Revenue announced that the state had a "qualified surplus" for the state's 2001 fiscal year that further expands the availability of the "Colorado Source Capital Gains Subtraction." The Colorado Department of Revenue's current projections, however, indicate that the expanded subtraction will not be available for the 2002 fiscal year.

• Sales of Colorado Businesses. The gain from the sale of stock or an ownership interest in a business qualifies if the stock or ownership interest is of a "Colorado company, limited liability company, or partnership." These are defined as entities that have 50% or more of their property and 50% or more of their payroll assigned to Colorado under the Multistate Tax Compact for the required holding period. While a sale of a Colorado business that is structured as an asset deal also can qualify for the subtraction, there may be limitations on the availability of the exemption for that portion of the purchase price that is allocated to intangible assets such as patents, goodwill, or customer lists.
• Colorado Requirement. The capital gains subtraction applies only to net capital gains earned from property located in Colorado. Thus, capital gain realized from the sale of real or personal property qualifies for this subtraction only if the property is located in Colorado at the time of the transaction that gave rise to the gain.
• Time Periods. The acquisition date and holding period computations for the purposes of the capital gains subtraction are not necessarily the same as federal rules. The specific property must be directly and without interruption owned by the specific taxpayer for five years -- or one year for tax years in which the expanded rule applies - to qualify for the subtraction. The Colorado holding period must be satisfied in addition to any holding period required by the federal Internal Revenue Code.

Persons who believe that the Colorado Source Capital Gains Subtraction may apply to them should consult with their tax advisors to discuss their specific facts and circumstances and the applicability of the subtraction. There may be additional prohibitions, limitations, or additional restrictions to claiming the subtraction based on the nature of the taxpayer or the structure of the transaction at issue (e.g., a transaction structured as an installment sale, sales by sole proprietorships, sales of sock owned by a pass-through entity that has no other assets, transactions structured as stock sales that involve a Section 338(h)(10) election on the federal level).

About the Author

E. Lee Reichert is a partner in the firm of Kamlet Shepherd & Reichert, LLP, a transactional and regulatory boutique located in Denver, Colorado. Mr. Reichert heads the firm's corporate practice and has extensive experience in acquisition work for both purchasers and sellers. Mr. Reichert can be reached at (303) 825-1085 or by email at lreichert@ksrlaw.com. This article originally appeared in the February 2002 edition of the GHP Merger & Acquisition Update and is reprinted with permission.