Publication Date - July 2006

NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.

Chapter 2/ Table of Contents / Chapter 4
Tax Code, Regulations and Official Guidance Search

Chapter Three - Basis on Farm Assets

• Introduction
• Like Kind Exchanges
• Gifted Property
• Inherited Property
• Farm Sale
• Cost Recovery - Depreciation and Depletion

Farm Sale

Selling a farm involves disposing of both business and non-business property. Land, machinery, livestock, and other assets used in farming are business property, while the farm residence is non-business property. For each type of property, the tax treatment is different. Gains and losses may be either capital or ordinary depending upon the asset.

Farmers are eligible to exclude the gain on the sale of the personal residence under the following conditions:

• The farmer (taxpayer) has owned and used the home as his/her personal residence for at least 2 of the last 5 years.
• The farmer has not used the exclusion in the last 2 years.
• The gain on the residence does not exceed $250,000 ($500,000 on a joint tax return).  IRC § 121. 

A loss on the sale of a farm residence is personal, and therefore, is not deductible.  Although not conclusive, provisions in the contract of sale may be evidence as to the value of the residence, particularly if the transaction is between non-related parties. Also note, when the underlying farm land is sold and the principal residence is retained and the house moved to another lot, the gain realized on the land where the house was originally located is not excludable.

Land adjacent to the personal residence and not used in farming is includable as part of the personal residence. The amount of land that can be allocated to the personal residence has been the subject of court cases and should be researched for current guidance.   

The sale of unharvested crops with a farm reduces the tax obligation for some farmers, since the crops acquire capital gain status (See IRC § 1231). To qualify for capital treatment the unharvested crops must be sold with the land and meet the following requirements:

1. Land must have been held more than one year and be used in the taxpayer’s business of farming.
2. The crop and land must be sold at the same time and to the same person.
3. The seller does not retain a right or option to reacquire the land, unless this right occurs as a part of a security interest in a mortgage.

The crop’s stage of maturity does not affect its capital gain status. A crop at any stage, as long as it is unharvested, qualifies.

When unharvested crops are sold with the land and the seller seeks capital gain treatment, the cost of producing the crops must be treated as a capital investment, not as an operating expense. Crop production costs should be added to the basis of the property and excluded from farm operating expenses. Crop production costs include all cash expenses and fixed overhead costs, such as depreciation (IRC § 268).

Remember that if the farmer “elected out” of IRC § 263A on an orchard or vineyard, it is treated as IRC 1245 property. This means that if there is any gain when it is sold, you must recapture the preproductive expenses that would have been capitalized except for the “election”. This is when having local cost studies of establishing orchards and/or vineyards is useful to either support the farmer’s estimates or to use if records are not available.