3.   Farm Income

What's New for 2014

The Agricultural Act of 2014. The Agricultural Act of 2014 repealed direct and counter-cyclical payments and Average Crop Revenue Election. The Act created price loss coverage payments and agricultural risk coverage payments. For more information, see Payments Under the Agricultural Act of 2014 , later.

Introduction

You may receive income from many sources. You must report the income from all the different sources on your tax return, unless it is excluded by law. Where you report the income on your tax return depends on its source.

This chapter discusses farm income you report on Schedule F (Form 1040), Profit or Loss From Farming. For information on where to report other income, see the Instructions for Form 1040, U.S. Individual Income Tax Return.

Accounting method.   The rules discussed in this chapter assume you use the cash method of accounting. Under the cash method, you generally include an item of income in gross income in the year you receive it. See Cash Method in chapter 2.

  If you use an accrual method of accounting, different rules may apply to your situation. See Accrual Method in chapter 2.

Topics - This chapter discusses:

  • Schedule F

  • Sales of farm products

  • Rents (including crop shares)

  • Agricultural program payments

  • Income from cooperatives

  • Cancellation of debt

  • Income from other sources

  • Income averaging for farmers

Useful Items - You may want to see:

Publication

  • 525 Taxable and Nontaxable Income

  • 550 Investment Income and Expenses

  • 908 Bankruptcy Tax Guide

  • 925 Passive Activity and At-Risk Rules

  • 4681 Canceled Debts, Foreclosures, Repossessions, and Abandonments

Form (and Instructions)

  • 982 Reduction of Tax Attributes Due to Discharge of Indebtedness

  • Sch E (Form 1040) Supplemental 
    Income and Loss

  • Sch J (Form 1040) Income Averaging for Farmers and Fishermen

  • 1099-G Certain Government Payments

  • 1099-PATR Taxable Distributions 
    Received From Cooperatives

  • 4797 Sales of Business Property

  • 4835 Farm Rental Income and 
    Expenses

See chapter 16 for information about getting publications and forms.

Schedule F (Form 1040)

Individuals, trusts, and partnerships report farm income on Schedule F (Form 1040), Profit or Loss From Farming. Use this schedule to figure the net profit or loss from regular farming operations.

Income from farming reported on Schedule F includes amounts you receive from cultivating, operating, or managing a farm for gain or profit, either as owner or tenant. This includes income from operating a stock, dairy, poultry, fish, fruit, or truck farm and income from operating a plantation, ranch, range, orchard, or grove. It also includes income from the sale of crop shares if you materially participate in producing the crop. See Rents (Including Crop Shares) , later.

Income received from operating a nursery, which specializes in growing ornamental plants, is considered to be income from farming.

Income reported on Schedule F does not include gains or losses from sales or other dispositions of the following farm assets.

  • Land.

  • Depreciable farm equipment.

  • Buildings and structures.

  • Livestock held for draft, breeding, sport, or dairy purposes.

Gains and losses from most dispositions of farm assets are discussed in chapters 8 and 9. Gains and losses from casualties, thefts, and condemnations are discussed in chapter 11.

Sales of Farm Products

Where to report.    Table 3-1 shows where to report the sale of farm products on your tax return.

Schedule F.   Amounts received from the sales of products you raised on your farm for sale (or bought for resale), such as livestock, produce, or grains, are reported on Schedule F. This includes money and the fair market value of any property or services you receive. When you sell farm products bought for resale, your profit or loss is the difference between your selling price (money plus the fair market value of any property) and your basis in the item (usually the cost). See chapter 6 for information on the basis of assets. You generally report these amounts on Schedule F for the year you receive payment.

Example.

In 2013, you bought 20 feeder calves for $27,000 for resale. You sold them in 2014 for $35,000. You report the $35,000 sales price on Schedule F, line 1a, subtract your $27,000 basis on line 1b, and report the resulting $8,000 profit on line 1c.

Form 4797.   Sales of livestock held for draft, breeding, sport, or dairy purposes may result in ordinary or capital gains or losses, depending on the circumstances. In either case, you should always report these sales on Form 4797 instead of Schedule F. See Livestock under Ordinary or Capital Gain or Loss in chapter 8. Animals you do not hold primarily for sale are considered business assets of your farm.

Table 3-1. Where To Report Sales of Farm Products

Item Sold Schedule F Form 4797
Farm products raised for sale X  
Farm products bought for resale X  
Farm assets not held primarily for sale, such as livestock held for draft, breeding, sport, or dairy purposes (bought or raised)   X
Sale by agent.   If your agent sells your farm products, you have constructive receipt of the income when your agent receives payment and you must include the net proceeds from the sale in gross income for the year the agent receives payment. This applies even if your agent pays you in a later year. For a discussion on constructive receipt of income, see Cash Method under Accounting Methods in chapter 2.

Sales Caused by Weather-Related Conditions

If you sell or exchange more livestock, including poultry, than you normally would in a year because of a drought, flood, or other weather-related condition, you may be able to postpone reporting the gain from the additional animals until the next year. You must meet all the following conditions to qualify.

  • Your principal trade or business is farming.

  • You use the cash method of accounting.

  • You can show that, under your usual business practices, you would not have sold or exchanged the additional animals this year except for the weather-related condition.

  • The weather-related condition caused an area to be designated as eligible for assistance by the federal government.

Sales or exchanges made before an area became eligible for federal assistance qualify if the weather-related condition that caused the sale or exchange also caused the area to be designated as eligible for federal assistance. The designation can be made by the President, the Department of Agriculture (or any of its agencies), or by other federal departments or agencies.

A weather-related sale or exchange of livestock (other than poultry) held for draft, breeding, or dairy purposes may be an involuntary conversion. See Other Involuntary Conversions in chapter 11.

Usual business practice.   You must determine the number of animals you would have sold had you followed your usual business practice in the absence of the weather-related condition. Do this by considering all the facts and circumstances, but do not take into account your sales in any earlier year for which you postponed the gain. If you have not yet established a usual business practice, rely on the usual business practices of similarly situated farmers in your general region.

Connection with affected area.   The livestock does not have to be raised or sold in an area affected by a weather-related condition for the postponement to apply. However, the sale must occur solely because of a weather-related condition that affected the water, grazing, or other requirements of the livestock. This requirement generally will not be met if the costs of feed, water, or other requirements of the livestock affected by the weather-related condition are not substantial in relation to the total costs of holding the livestock.

Classes of livestock.   You must figure the amount to be postponed separately for each generic class of animals—for example, hogs, sheep, and cattle. Do not separate animals into classes based on age, sex, or breed.

Amount to be postponed.   Follow these steps to figure the amount of gain to be postponed for each class of animals.
  1. Divide the total income realized from the sale of all livestock in the class during the tax year by the total number of such livestock sold. For this purpose, do not treat any postponed gain from the previous year as income received from the sale of livestock.

  2. Multiply the result in (1) by the excess number of such livestock sold solely because of weather-related conditions.

Example.

You are a calendar year taxpayer and you normally sell 100 head of beef cattle a year. As a result of drought, you sold 135 head during 2013. You realized $236,250 from the sale. On August 9, 2013, as a result of drought, the affected area was declared a disaster area eligible for federal assistance. The income you can postpone until 2014 is $61,250 [($236,250 ÷ 135) × 35].

How to postpone gain.   To postpone gain, attach a statement to your tax return for the year of the sale. The statement must include your name and address and give the following information for each class of livestock for which you are postponing gain.
  • A statement that you are postponing gain under Internal Revenue Code (IRC) section 451(e).

  • Evidence of the weather-related conditions that forced the early sale or exchange of the livestock and the date, if known, on which an area was designated as eligible for assistance by the federal government because of weather-related conditions.

  • A statement explaining the relationship of the area affected by the weather-related condition to your early sale or exchange of the livestock.

  • The number of animals sold in each of the 3 preceding years.

  • The number of animals you would have sold in the tax year had you followed your normal business practice in the absence of weather-related conditions.

  • The total number of animals sold and the number sold because of weather-related conditions during the tax year.

  • A computation, as described above, of the income to be postponed for each class of livestock.

  Generally, you must file the statement and the return by the due date of the return, including extensions. However, for sales or exchanges treated as an involuntary conversion from weather-related sales of livestock in an area eligible for federal assistance (discussed in chapter 11), you can file this statement at any time during the replacement period. For other sales or exchanges, if you timely filed your return for the year without postponing gain, you can still postpone gain by filing an amended return within 6 months of the due date of the return (excluding extensions). Attach the statement to the amended return and write “Filed pursuant to section 301.9100-2” at the top of the amended return. File the amended return at the same address you filed the original return. Once you have filed the statement, you can cancel your postponement of gain only with the approval of the IRS.

Rents (Including Crop Shares)

The rent you receive for the use of your farmland is generally rental income, not farm income. However, if you materially participate in farming operations on the land, the rent is farm income. See Landlord Participation in Farming in chapter 12.

Pasture income and rental.   If you pasture someone else's livestock and take care of them for a fee, the income is from your farming business. You must enter it as Other income on Schedule F. If you simply rent your pasture for a flat cash amount without providing services, report the income as rent on Part I of Schedule E (Form 1040), Supplemental Income and Loss.

Crop Shares

You must include rent you receive in the form of crop shares in income in the year you convert the shares to money or the equivalent of money. It does not matter whether you use the cash method of accounting or an accrual method of accounting.

If you materially participate in operating a farm from which you receive rent in the form of crop shares or livestock, the rental income is included in self-employment income. See Landlord Participation in Farming in chapter 12. Report the rental income on Schedule F.

If you do not materially participate in operating the farm, report this income on Form 4835 and carry the net income or loss to Schedule E (Form 1040). The income is not included in self-employment income.

Crop shares you use to feed livestock.   Crop shares you receive as a landlord and feed to your livestock are considered converted to money when fed to the livestock. You must include the fair market value of the crop shares in income at that time. You are entitled to a business expense deduction for the livestock feed in the same amount and at the same time you include the fair market value of the crop share as rental income. Although these two transactions cancel each other for figuring adjusted gross income on Form 1040, they may be necessary to figure your self-employment tax. See  
chapter 12.

Crop shares you give to others (gift).   Crop shares you receive as a landlord and give to others are considered converted to money when you make the gift. You must report the fair market value of the crop share as income, even though someone else receives payment for the crop share.

Example.

A tenant farmed part of your land under a crop-share arrangement. The tenant harvested and delivered the crop in your name to an elevator company. Before selling any of the crop, you instructed the elevator company to cancel your warehouse receipt and make out new warehouse receipts in equal amounts of the crop in the names of your children. They sell their crop shares in the following year and the elevator company makes payments directly to your children.

In this situation, you are considered to have received rental income and then made a gift of that income. You must include the fair market value of the crop shares in your income for the tax year you gave the crop shares to your children.

Crop share loss.   If you are involved in a rental or crop-share lease arrangement, any loss from these activities may be subject to the limits under the passive loss rules. See Publication 925 for information on these rules.

Agricultural Program Payments

You must include in income most government payments, such as those for approved conservation practices, direct payments, counter-cyclical payments, price loss coverage payments, or agricultural risk coverage payments, whether you receive them in cash, materials, services, or commodity certificates. However, you can exclude from income some payments you receive under certain cost-sharing conservation programs. See Cost-Sharing Exclusion (Improvements) , later.

Report the agricultural program payment on the appropriate line of Schedule F, Part I. Report the full amount even if you return a government check for cancellation, refund any of the payment you receive, or the government collects all or part of the payment from you by reducing the amount of some other payment or Commodity Credit Corporation (CCC) loan. However, you can deduct the amount you refund or return or that reduces some other payment or loan to you. Claim the deduction on Schedule F for the year of repayment or reduction.

Commodity Credit Corporation (CCC) Loans

Generally, you do not report loans you receive as income. However, if you pledge part or all of your production to secure a CCC loan, you can treat the loan as if it were a sale of the crop and report the loan proceeds as income in the year you receive them. You do not need approval from the IRS to adopt this method of reporting CCC loans.

Once you report a CCC loan as income for the year received, you generally must report all CCC loans in that year and later years in the same way. However, you can obtain for your tax year an automatic consent to change your method of accounting for loans received from the CCC, from including the loan amount in gross income for the tax year in which the loan is received to treating the loan amount as a loan. For more information, see Part I of the Instructions for Form 3115 and Revenue Procedure 2008-52. Revenue Procedure 2008-52, 2008-36 I.R.B. 587, is available at  
www.irs.gov/irb/2008-36_IRB/ar09.html.

You can request income tax withholding from CCC loan payments you receive. Use Form W-4V, Voluntary Withholding Request. See chapter 16 for information about ordering the form.

To elect to report a CCC loan as income, include the loan proceeds as income on Schedule F, line 5a, for the year you receive it. Attach a statement to your return showing the details of the loan.

You must file the statement and the return by the due date of the return, including extensions. If you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Attach the statement to the amended return and write “Filed pursuant to section 301.9100-2” at the top of the return. File the amended return at the same address you filed the original return.

When you make this election, the amount you report as income becomes your basis in the commodity. See chapter 6 for information on the basis of assets. If you later repay the loan, redeem the pledged commodity, and sell it, you report as income at the time of sale the sale proceeds minus your basis in the commodity. If the sale proceeds are less than your basis in the commodity, you can report the difference as a loss on Schedule F.

If you forfeit the pledged crops to the CCC in full payment of the loan, the forfeiture is treated for tax purposes as a sale of the crops. If you did not report the loan proceeds as income for the year you received them, you must include them in your income for the year of the forfeiture.

Form 1099-A.   If you forfeit pledged crops to the CCC in full payment of a loan, you may receive a Form 1099-A, Acquisition or Abandonment of Secured Property. “CCC” should be shown in box 6. The amount of any CCC loan outstanding when you forfeited your commodity should also be indicated on the form.

Market Gain

Under the CCC nonrecourse marketing assistance loan program, your repayment amount for a loan secured by your pledge of an eligible commodity is generally based on the lower of the loan rate or the prevailing world market price for the commodity on the date of repayment. If you repay the loan when the world price is lower, the difference between that repayment amount and the original loan amount is market gain. Whether you use cash or CCC certificates to repay the loan, you will receive a Form 1099-G showing the market gain you realized. Market gain should be reported as follows.

  • If you elected to include the CCC loan in income in the year you received it, do not include the market gain in income. However, adjust the basis of the commodity for the amount of the market gain.

  • If you did not include the CCC loan in income in the year received, include the market gain in your income.

The following examples show how to report market gain.

Example 1.

Mike Green is a cotton farmer. He uses the cash method of accounting and files his tax return on a calendar year basis. He has deducted all expenses incurred in producing the cotton and has a zero basis in the commodity. In 2013, Mike pledged 1,000 pounds of cotton as collateral for a CCC loan of $2,000 (a loan rate of $2.00 per pound). In 2014, he repaid the loan and redeemed the cotton for $1,500 when the world price was $1.50 per pound (lower than the loan amount). Later in 2014, he sold the cotton for $2,500.

The market gain on the redemption was $.50 ($2.00 – $1.50) per pound. Mike realized total market gain of $500 ($.50 x 1,000 pounds). How he reports this market gain and figures his gain or loss from the sale of the cotton depends on whether he included CCC loans in income in 2013.

Included CCC loan.   Mike reported the $2,000 CCC loan as income for 2013 on Schedule F, line 5a, so he is treated as if he sold the cotton for $2,000 when he pledged it and repurchased the cotton for $1,500 when he redeemed it. The $500 market gain is not recognized on the redemption. He reports it for 2014 as an agricultural program payment on Schedule F, line 4a, but does not include it as a taxable amount on line 4b.

  Mike's basis in the cotton after he redeemed it was $1,500, which is the redemption (repurchase) price paid for the cotton. His gain from the sale is $1,000 ($2,500 – $1,500). He reports the $2,500 sale on line 1a and the $1,500 basis on line 1b. After subtracting his basis from the sale, Mike will have a $1,000 gain for 2014 on Schedule F, line 1c.

Excluded CCC loan.   Mike has income of $500 from market gain in 2014. He reports it on Schedule F, lines 4a and 4b. His basis in the cotton is zero, so his gain from its sale is $2,500. He reports the $2,500 sale on Schedule F, line 1a and a zero basis on line 1b.

Example 2.

The facts are the same as in Example 1 except that, instead of selling the cotton for $2,500 after redeeming it, Mike entered into an option-to-purchase contract with a cotton buyer before redeeming the cotton. Under that contract, Mike authorized the cotton buyer to pay the CCC loan on Mike's behalf. In 2014, the cotton buyer repaid the loan for $1,500 and immediately exercised his option, buying the cotton for $1,500. How Mike reports the $500 market gain on the redemption of the cotton and figures his gain or loss from its sale depends on whether he included CCC loans in income in 2013.

Included CCC loan.   As in Example 1, Mike is treated as though he sold the cotton for $2,000 when he pledged it and repurchased the cotton for $1,500 when the cotton buyer redeemed it for him. The $500 market gain is not recognized on the redemption. Mike reports it for 2014 as an agricultural program payment on Schedule F, line 4a, but does not include it as a taxable amount on line 4b.

  Also, as in Example 1, Mike's basis in the cotton when the cotton buyer redeemed it for him was $1,500. Mike has no gain or loss on its sale to the cotton buyer for that amount.

Excluded CCC loan.   As in Example 1, Mike has income of $500 from market gain in 2014. He reports it on Schedule F, lines 4a and 4b. For 2014, Mike also reports the $1,500 sale on Schedule F, line 1a and the zero basis in the cotton on line 4a. His gain from the sale is $1,500.

Conservation Reserve Program (CRP)

Under the Conservation Reserve Program (CRP), if you own or operate highly erodible or other specified cropland, you may enter into a long-term contract with the USDA, agreeing to convert to a less intensive use of that cropland. You must include the annual rental payments and any one-time incentive payment you receive under the program on Schedule F, lines 4a and 4b. Cost-share payments you receive may qualify for the cost-sharing exclusion. See Cost-Sharing Exclusion (Improvements) , later. CRP payments are reported to you on Form 1099-G.

Individuals who are receiving Social Security retirement or disability benefits may exclude CRP payments when calculating self-employment tax. See the instructions for Schedule SE (Form 1040).

Crop Insurance and Crop Disaster Payments

You must include in income any crop insurance proceeds you receive as the result of physical crop damage or reduction of crop revenue, or both. You generally include them in the year you receive them. Treat as crop insurance proceeds the crop disaster payments you receive from the federal government as the result of destruction or damage to crops, or the inability to plant crops, because of drought, flood, or any other natural disaster.

You can request income tax withholding from crop disaster payments you receive from the federal government. Use Form W-4V, Voluntary Withholding Request. See chapter 16 for information about ordering the form.

Election to postpone reporting until the following year.   You can postpone reporting some or all crop insurance proceeds as income until the year following the year the physical damage occurred if you meet all the following conditions.
  • You use the cash method of accounting.

  • You receive the crop insurance proceeds in the same tax year the crops are damaged.

  • You can show that under your normal business practice you would have included income from the damaged crops in any tax year following the year the damage occurred.

  Deferral is not permitted for proceeds received from revenue insurance policies.

  To postpone reporting some or all crop insurance proceeds received in 2014, report the amount you received on Schedule F, line 6a, but do not include it as a taxable amount on line 6b. Check the box on line 6c and attach a statement to your tax return. The statement must include your name and address and contain the following information.
  • A statement that you are making an election under IRC section 451(d) and Regulations section 1.451-6.

  • The specific crop or crops physically destroyed or damaged.

  • A statement that under your normal business practice you would have included income from some or all of the destroyed or damaged crops in gross income for a tax year following the year the crops were destroyed or damaged.

  • The cause of the physical destruction or damage and the date or dates it occurred.

  • The total payments you received from insurance carriers, itemized for each specific crop, and the date you received each payment.

  • The name of each insurance carrier from whom you received payments.

  One election covers all crops representing a single trade or business. If you have more than one farming business, make a separate election for each one. For example, if you operate two separate farms on which you grow different crops and you keep separate books for each farm, you should make two separate elections to postpone reporting insurance proceeds you receive for crops grown on each of your farms.

  An election is binding for the year unless the IRS approves your request to change it. To request IRS approval to change your election, write to the IRS at the following address giving your name, address, identification number, the year you made the election, and your reasons for wanting to change it.

Ogden Submission Processing Center 
P. O. Box 9941 
Ogden, UT 84409

Feed Assistance and Payments

The Disaster Assistance Act of 1988 authorizes programs to provide feed assistance, reimbursement payments, and other benefits to qualifying livestock producers if the Secretary of Agriculture determines that, because of a natural disaster, a livestock emergency exists. These programs include partial reimbursement for the cost of purchased feed and for certain transportation expenses. They also include the donation or sale at a below-market price of feed owned by the Commodity Credit Corporation.

Include in income:

  • The market value of donated feed,

  • The difference between the market value and the price you paid for feed you buy at below-market prices, and

  • Any cost reimbursement you receive.

You must include these benefits in income in the year you receive them. You cannot postpone reporting them under the rules explained earlier for weather-related sales of livestock or crop insurance proceeds. Report the benefits on Schedule F, Part I, as agricultural program payments. You can usually take a current deduction for the same amount as a feed expense.

Cost-Sharing Exclusion (Improvements)

You can exclude from your income part or all of a payment you receive under certain federal or state cost-sharing conservation, reclamation, and restoration programs. A payment is any economic benefit you get as a result of an improvement. However, this exclusion applies only to that part of a payment that meets all three of the following tests.

  1. It was for a capital expense. You cannot exclude any part of a payment for an expense you can deduct in the year you pay or incur it. You must include the payment for a deductible expense in income, and you can take any offsetting deduction. See chapter 5 for information on deducting soil and water conservation expenses.

  2. It does not substantially increase your annual income from the property for which it is made. An increase in annual income is substantial if it is more than the greater of the following amounts.

    1. 10% of the average annual income derived from the affected property before receiving the improvement.

    2. $2.50 times the number of affected acres.

  3. The Secretary of Agriculture certified that the payment was primarily made for conserving soil and water resources, protecting or restoring the environment, improving forests, or providing a habitat for wildlife.

Qualifying programs.   If the three tests listed above are met, you can exclude part or all of the payments from the following programs.
  • The rural clean water program authorized by the Federal Water Pollution Control Act.

  • The rural abandoned mine program authorized by the Surface Mining Control and Reclamation Act of 1977.

  • The water bank program authorized by the Water Bank Act.

  • The emergency conservation measures program authorized by title IV of the Agricultural Credit Act of 1978.

  • The agricultural conservation program authorized by the Soil Conservation and Domestic Allotment Act.

  • The great plains conservation program authorized by the Soil Conservation and Domestic Policy Act.

  • The resource conservation and development program authorized by the Bankhead-Jones Farm Tenant Act and by the Soil Conservation and Domestic Allotment Act.

  • Certain small watershed programs, listed later.

  • Any program of a state, possession of the United States, a political subdivision of any of these, or of the District of Columbia under which payments are made to individuals primarily for conserving soil, protecting or restoring the environment, improving forests, or providing a habitat for wildlife. Several state programs have been approved. For information about the status of those programs, contact the state offices of the Farm Service Agency (FSA) and the Natural Resources and Conservation Service (NRCS).

Small watershed programs.   If the three tests listed earlier are met, you can exclude part or all of the payments you receive under the following programs for improvements made in connection with a watershed.
  • The programs under the Watershed Protection and Flood Prevention Act.

  • The flood prevention projects under the Flood Control Act of 1944.

  • The Emergency Watershed Protection Program under the Flood Control Act of 1950.

  • Certain programs under the Colorado River Basin Salinity Control Act.

  • The Wetlands Reserve Program authorized by the Food Security Act of 1985, the Federal Agriculture Improvement and Reform Act of 1996 and the Farm Security and Rural Investment Act of 2002.

  • The Environmental Quality Incentives Program (EQIP) authorized by the Federal Agriculture Improvement and Reform Act of 1996.

  • The Wildlife Habitat Incentives Program (WHIP) authorized by the Federal Agriculture Improvement and Reform Act of 1996.

  • The Soil and Water Conservation Assistance Program authorized by the Agricultural Risk Protection Act of 2000.

  • The Agricultural Management Assistance Program authorized by the Agricultural Risk Protection Act of 2000.

  • The Conservation Reserve Program authorized by the Food Security Act of 1985 and the Federal Agriculture Improvement and Reform Act of 1996.

  • The Forest Land Enhancement Program authorized under the Farm Security and Rural Investment Act of 2002.

  • The Conservation Security Program authorized by the Food Security Act of 1985.

  • The Forest Health Protection Program (FHPP) authorized by the Cooperative Forestry Assistance Act of 1978.

Income realized.   The gross income you realize upon getting an improvement under these cost-sharing programs is the value of the improvement reduced by the sum of the excludable portion and your share of the cost of the improvement (if any).

Value of the improvement.   You determine the value of the improvement by multiplying its fair market value (defined in chapter 6) by a fraction. The numerator of the fraction is the total cost of the improvement (all amounts paid either by you or by the government for the improvement) reduced by the sum of the following items.
  • Any government payments under a program not listed earlier.

  • Any part of a government payment under a program listed earlier that the Secretary of Agriculture has not certified as primarily for conservation.

  • Any government payment to you for rent or for your services.

The denominator of the fraction is the total cost of the improvement.

Excludable portion.   The excludable portion is the present fair market value of the right to receive annual income from the affected acreage of the greater of the following amounts.
  1. 10% of the prior average annual income from the affected acreage. The prior average annual income is the average of the gross receipts from the affected acreage for the last 3 tax years before the tax year in which you started to install the improvement.

  2. $2.50 times the number of affected acres.

The calculation of present fair market value of the right to receive annual income is too complex to discuss in this publication. You may need to consult your tax advisor for assistance.

Example.

One hundred acres of your land was reclaimed under a rural abandoned mine program contract with the Natural Resources Conservation Service of the USDA. The total cost of the improvement was $500,000. The USDA paid $490,000. You paid $10,000. The value of the cost-sharing improvement is $15,000.

The present fair market value of the right to receive the annual income described in (1) above is $1,380, and the present fair market value of the right to receive the annual income described in (2) is $1,550. The excludable portion is the greater amount, $1,550.

You figure the amount to include in gross income as follows:

Value of cost-sharing improvement $15,000
Minus: Your share $10,000  
  Excludable portion 1,550 11,550
Amount included in income $ 3,450

Effects of the exclusion.   When you figure the basis of property you acquire or improve using cost-sharing payments excluded from income, subtract the excluded payments from your capital costs. Any payment excluded from income is not part of your basis. In the example above, the increase in basis is $500,000 – $490,000 + $3,450 = $13,450.

  In addition, you cannot take depreciation, amortization, or depletion deductions for the part of the cost of the property for which you receive cost-sharing payments you exclude from income.

How to report the exclusion.   Attach a statement to your tax return (or amended return) for the tax year you receive the last government payment for the improvement. The statement must include the following information.
  • The dollar amount of the cost funded by the government payment.

  • The value of the improvement.

  • The amount you are excluding.

  Report the total cost-sharing payments you receive on Schedule F, line 4a, and the taxable amount on line 4b.

Recapture.   If you dispose of the property within 20 years after you received the excluded payments, you must treat as ordinary income part or all of the cost-sharing payments you excluded. In the above example, if the 100 acres were sold within 20 years of the exclusion for a gain of $2,000, $1,550 of that amount would be included in ordinary income. You must report the recapture on Form 4797. See Section 1255 property under Other Gains in chapter 9.

Electing not to exclude payments.   You can elect not to exclude all or part of any payments you receive under these programs. If you make this election for all of these payments, none of the above restrictions and rules apply. You must make this election by the due date, including extensions, for filing your return. In the example above, an election not to exclude payments results in $5,000 included in income and a $15,000 increase in basis. If you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Write “Filed pursuant to section 301.9100-2” at the top of the amended return and file it at the same address you filed the original return.

Payments Under the Agricultural Act of 2014

The Agricultural Act of 2014 created price loss coverage payments and agricultural risk coverage payments. Report the total payments you receive on Schedule F, line 4a, and the taxable amount on line 4b.

Payments Under the Farm Security and Rural Investment Act of 2002 and Under the Food, Conservation, and Energy Act of 2008

The Agricultural Act of 2014 repealed the direct payments, counter-cyclical payments, and Average Crop Revenue Election payments under the Food, Conservation, and Energy Act of 2008. If you received these payments they must be included on Schedule F.

Tobacco Quota Buyout Program Payments

The Fair and Equitable Tobacco Reform Act of 2004, title VI of the American Jobs Creation Act of 2004, terminated the tobacco marketing quota program and the tobacco price support program. As a result, the USDA offered to enter into contracts with eligible tobacco quota holders and growers to provide compensation for the lost value of the quotas and related price support.

If you are an eligible tobacco quota holder, your contract entitles you to receive total payments of $7 per pound of quota in 10 equal annual payments in fiscal years 2005 through 2014. If you are an eligible tobacco grower, your contract entitles you to receive total payments of up to $3 per pound of quota in 10 equal annual payments in fiscal years 2005 through 2014.

Tobacco Quota Holders

Contract payments you receive are considered proceeds from a sale of your tobacco quota as of the date on which you and the USDA enter into the contract. Your taxable gain or loss is the total amount received for your quota reduced by any amount treated as interest (discussed below), over your adjusted basis. The gain or loss is capital or ordinary depending on how you used the quota. See Capital or ordinary gain or loss , later.

Report the entire gain on your income tax return for the tax year that includes the date you entered into the contract if you elect not to use the installment method.

Adjusted basis.   The adjusted basis of your quota is determined differently depending on how you obtained the quota.
  • The basis of a quota derived from an original grant by the federal government is zero.

  • The basis of a purchased quota is the purchase price.

  • The basis of a quota received as a gift is generally the same as the donor's basis. However, under certain circumstances, the basis is increased by the amount of gift taxes paid. If the basis is greater than the fair market value of the quota at the time of the gift, the basis for determining loss is the fair market value.

  • The basis of an inherited quota is generally the fair market value of the quota at the time of the decedent's death.

Reduction of basis.   You are required to reduce the basis of your tobacco quota by the following amounts.
  • Deductions you took for amortization, depletion, or depreciation.

  • Amounts you previously deducted as a loss because of a reduction in the number of pounds of tobacco allowable under the quota.

  • The entire cost of a purchased quota you deducted in an earlier year (which reduces your basis to zero).

Amount treated as interest.   You must reduce your tobacco quota buyout program payment by the amount treated as interest. The interest is reportable as ordinary income. If payments total $3,000 or less, your total quota buyout program payment does not include any amount treated as interest and you are not required to reduce the total payment you receive.

  In all other cases, a portion of each payment may be treated as interest for federal tax purposes. You may be required to reduce your total quota buyout program payment before you calculate your gain or loss. For more information, see Notice 2005-57, 2005-32 I.R.B. 267, available at www.irs.gov/irb/2005-32_IRB/ar13.html.

Installment method.   You may use the installment method to report a gain if you receive at least one payment after the close of your tax year. Under the installment method, a portion of the gain is taken into account in each year in which a payment is received. See chapter 10 for more information.

Capital or ordinary gain or loss.   Whether your gain or loss is ordinary or capital depends on how you used the quota.

Quota used in the trade or business of farming.   If you used the quota in the trade or business of farming and you held it for more than one year, you report the transaction as a section 1231 transaction on Form 4797. See Section 1231 transactions in the Instructions for Form 4797 for detailed information on reporting section 1231 transactions.

Quota held for investment.   If you held the quota for investment purposes, any gain or loss is capital gain or loss. The same result also applies if you held the quota for the production of income, though not connected with a trade or business.

Gain treated as ordinary income.   If you previously deducted any of the following items, some or all of the capital gain must be recharacterized and reported as ordinary income. Any resulting capital gain is taxed as ordinary income up to the amount previously deducted.
  • The cost of acquiring a quota.

  • Amounts for amortization, depletion, or depreciation.

  • Amounts to reflect a reduction in the quota pounds.

  You should include the ordinary income on your return for the tax year even if you use the installment method to report the remainder of the gain.

Self-employment income.   The tobacco quota buyout payments are not self-employment income.

Income averaging for farmers.   The gain or loss resulting from the quota payments does not qualify for income averaging. A tobacco quota is considered an interest in land. Income averaging is not available for gain or loss arising from the sale or other disposition of land.

Involuntary conversion.   The buyout of the tobacco quota is not an involuntary conversion.

Form 1099-S.   A tobacco quota is considered an interest in land, so the USDA will generally report the total amount you receive under a contract on Form 1099-S, Proceeds From Real Estate Transactions, if the amount is $600 or more. The USDA will generally report any portion of a payment treated as interest of $600 or more to you on Form 1099-INT, Interest Income, for the year in which the payment is made.

Like-kind exchange of quota.   You may postpone reporting the gain or loss from tobacco quota buyout payments by entering into a like-kind exchange if you comply with the requirements of section 1031 and the regulations thereunder. See Notice 2005-57 for more information.

Tobacco Growers

Contract payments you receive are determined by reference to the amount of quota under which you produced (or planted) quota tobacco during the 2002, 2003, and 2004 tobacco marketing years and are prorated based on the number of years that you produced (or planted) quota tobacco during those years.

Taxation of payments to tobacco growers.   Payments to growers replace ordinary income that would have been earned had the tobacco marketing quota and price support programs continued. Individuals will generally report the payments as an Agricultural program payment on Schedule F. If you are a landowner who does not materially participate in the operation or management of the farm and are receiving the grower payment because your farm rental income is based on the tobacco grown by a tenant, the grower payment should be reported on Form 4835.

Self-employment income.   Payments to growers generally represent self-employment income. If the grower is an individual carrying on a trade or business and deriving income (other than farm rental income properly reported on Form 4835) from that trade or business, the payments are net earnings from self-employment.

Income averaging for farmers.   Payments to growers who are individuals qualify for farm income averaging.

Form 1099-G.   If the amount received in a taxable year is $600 or more, the amount will generally be reported by the USDA on a Form 1099-G.

Other Payments

You must include most other government program payments in income.

Fertilizer and Lime

Include in income the value of fertilizer or lime you receive under a government program. How to claim the offsetting deduction is explained under Fertilizer and Lime in chapter 4.

Improvements

If government payments are based on improvements, such as a pollution control facility, you must include them in income. You must also capitalize the full cost of the improvement. Since you have included the payments in income, they do not reduce your basis. However, see Cost-Sharing Exclusion (Improvements) , earlier, for additional information.

National Tobacco Growers' Settlement Trust Fund Payments

If you are a producer, landowner, or tobacco quota owner who receives money from the National Tobacco Growers' Settlement Trust Fund, you must report those payments as income. You should receive a Form 1099-MISC, Miscellaneous Income, that shows the payment amount.

If you produce a tobacco crop, report the payments as income from farming on your Schedule F. If you are a landowner or tobacco quota owner who leases tobacco-related property but you do not produce the crop, report the payments as farm rental income on Form 4835.

Payment to More Than One Person

The USDA reports program payments to the IRS. It reports a program payment intended for more than one person as having been paid to the person whose identification number is on record for that payment (payee of record). If you, as the payee of record, receive a program payment belonging to someone else, such as your landlord, the amount belonging to the other person is a nominee distribution. You should file Form 1099-G to report the identity of the actual recipient to the IRS. You should also give this information to the recipient. You can avoid the inconvenience of unnecessary inquiries about the identity of the recipient if you file this form.

Report the total amount reported to you as the payee of record on Schedule F, line 4a or 6a. However, do not report as a taxable amount on line 4b or 6b any amount belonging to someone else.

See chapter 16 for information about ordering Form 1099-G.

Income From Cooperatives

If you buy farm supplies through a cooperative, you may receive income from the cooperative in the form of patronage dividends (refunds). If you sell your farm products through a cooperative, you may receive either patronage dividends or a per-unit retain certificate, explained later, from the cooperative.

Form 1099-PATR.   The cooperative will report the income to you on Form 1099-PATR or a similar form and send a copy to the IRS. Form 1099-PATR may also show an alternative minimum tax adjustment that you must include on Form 6251, Alternative Minimum Tax—Individuals, if you are required to file the form. For information on the alternative minimum tax, see the Instructions for Form 6251.

Patronage Dividends

You generally report patronage dividends as income on Schedule F, lines 3a and 3b, for the tax year you receive them. They include the following items.

  • Money paid as a patronage dividend, including cash advances received (for example, from a marketing cooperative).

  • The stated dollar value of qualified written notices of allocation.

  • The fair market value of other property.

Do not report as income on line 3b any patronage dividends you receive from expenditures that were not deductible, such as buying personal or family items, capital assets, or depreciable property. You must reduce the cost or other basis of these items by the amount of such patronage dividends received. Personal items include fuel purchased for personal use, basic local telephone service, and personal long distance calls.

If you cannot determine what the dividend is for, report it as income on lines 3a and 3b.

Qualified written notice of allocation.   If you receive a qualified written notice of allocation as part of a patronage dividend, you must generally include its stated dollar value in your income on Schedule F, lines 3a and 3b, in the year you receive it. A written notice of allocation is qualified if at least 20% of the patronage dividend is paid in money or by qualified check and either of the following conditions is met.
  1. The notice must be redeemable in cash for at least 90 days after it is issued, and you must have received a written notice of your right of redemption at the same time as the written notice of allocation.

  2. You must have agreed to include the stated dollar value in income in the year you receive the notice by doing one of the following.

    1. Signing and giving a written agreement to the cooperative.

    2. Getting or keeping membership in the cooperative after it adopted a bylaw providing that membership constitutes agreement. The cooperative must notify you in writing of this bylaw and give you a copy.

    3. Endorsing and cashing a qualified check paid as part of the same patronage dividend. You must cash the check by the 90th day after the close of the payment period for the cooperative's tax year for which the patronage dividend was paid.

Qualified check.   A qualified check is any instrument that is redeemable in money and meets both of the following requirements.
  • It is part of a patronage dividend that also includes a qualified written notice of allocation for which you met condition 2(c), above.

  • It is imprinted with a statement that endorsing and cashing it constitutes the payee's consent to include in income the stated dollar value of any written notices of allocation paid as part of the same patronage dividend.

Loss on redemption.   You can deduct on Schedule F, Part II, any loss incurred on the redemption of a qualified written notice of allocation you received in the ordinary course of your farming business. The loss is the difference between the stated dollar amount of the qualified written notice you included in income and the amount you received when you redeemed it.

Nonqualified notice of allocation.   Do not include the stated dollar value of any nonqualified notice of allocation in income when you receive it. Your basis in the notice is zero. You must include in income for the tax year of disposition any amount you receive from its sale, redemption, or other disposition. Report that amount, up to the stated dollar value of the notice, on Schedule F, lines 3a and 3b. However, do not include that amount in your income if the notice resulted from buying or selling capital assets or depreciable property or from buying personal items, as explained in the following discussions.

  If the amount you receive is more than the stated dollar value of the notice, report the excess as the type of income it represents. For example, if it represents interest income, report it on your return as interest.

Buying or selling capital assets or depreciable property.   Do not include in income patronage dividends from buying capital assets or depreciable property used in your business. You must, however, reduce the basis of these assets by the dividends. This reduction is taken into account as of the first day of the tax year in which the dividends are received. If the dividends are more than your unrecovered basis, reduce the unrecovered basis to zero and include the difference on Schedule F, line 3a, for the tax year you receive them.

  This rule and the exceptions explained below also apply to amounts you receive from the sale, redemption, or other disposition of a nonqualified notice of allocation that resulted from buying or selling capital assets or depreciable property.

Example.

On July 1, 2013, Mr. Brown, a patron of a cooperative association, bought a machine for his dairy farm business from the association for $2,900. The machine has a life of 7 years under MACRS (as provided in the Table of Class Lives and Recovery Periods in Appendix B of Publication 946, Depreciation and Amortization). Mr. Brown files his return on a calendar year basis. For 2013, he claimed a depreciation deduction of $311, using the 10.71% depreciation rate from the 150% declining balance, half-year convention table (shown in Table A-14 in Appendix A of Publication 946). On July 2, 2014, the cooperative association paid Mr. Brown a $300 cash patronage dividend for buying the machine. Mr. Brown adjusts the basis of the machine and figures his depreciation deduction for 2014 (and later years) as follows.

Cost of machine on July 1, 2013 $2,900
Minus: 2013 depreciation $311  
  2014 cash dividend 300 611
Adjusted basis for 
depreciation for 2014:
$2,289
Depreciation rate: 1 ÷ 6½ (remaining recovery period as of 1/1/2013) = 15.38% × 1.5 = 23.07%
Depreciation deduction for 2014 
($2,289 × 23.07%)
$528

Exceptions.   If the dividends are for buying or selling capital assets or depreciable property you did not own at any time during the year you received the dividends, you must include them on Schedule F, lines 3a and 3b, unless one of the following rules applies.
  • If the dividends relate to a capital asset you held for more than 1 year for which a loss was or would have been deductible, treat them as gain from the sale or exchange of a capital asset held for more than 1 year.

  • If the dividends relate to a capital asset for which a loss was not or would not have been deductible, do not report them as income (ordinary or capital gain).

  If the dividends are for selling capital assets or depreciable property during the year you received the dividends, treat them as an additional amount received on the sale.

Personal purchases.   Because you cannot deduct the cost of personal, living, or family items, such as supplies, equipment, or services not related to the production of farm income, you can omit from the taxable amount of patronage dividends on Schedule F, line 3b, any dividends from buying those items (and you must reduce the cost or other basis of those items by the amount of the dividends). This rule also applies to amounts you receive from the sale, redemption, or other disposition of a nonqualified written notice of allocation resulting from these purchases.

Per-Unit Retain Certificates

A per-unit retain certificate is any written notice that shows the stated dollar amount of a per-unit retain allocation made to you by the cooperative. A per-unit retain allocation is an amount paid to patrons for products sold for them that is fixed without regard to the net earnings of the cooperative. These allocations can be paid in money, other property, or qualified certificates.

Per-unit retain certificates issued by a cooperative generally receive the same tax treatment as patronage dividends, discussed earlier.

Qualified certificates.   Qualified per-unit retain certificates are those issued to patrons who have agreed to include the stated dollar amount of these certificates in income in the year of receipt. The agreement may be made in writing or by getting or keeping membership in a cooperative whose bylaws or charter states that membership constitutes agreement. If you receive qualified per-unit retain certificates, include the stated dollar amount of the certificates in income on Schedule F, lines 3a and 3b, for the tax year you receive them.

Nonqualified certificates.   Do not include the stated dollar value of a nonqualified per-unit retain certificate in income when you receive it. Your basis in the certificate is zero. You must include in income any amount you receive from its sale, redemption, or other disposition. Report the amount you receive from the disposition as ordinary income on Schedule F, lines 3a and 3b, for the tax year of disposition.

Cancellation of Debt

This section explains the general rule for including canceled debt in income and the exceptions to the general rule. For more information on canceled debt, see Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.

General Rule

Generally, if your debt is canceled or forgiven, other than as a gift or bequest to you, you must include the canceled amount in gross income for tax purposes. Discharge of qualified farm indebtedness (defined below) is one of the exceptions to the general rule. It is excluded from taxable income (see Exclusions , later). Report the canceled amount on Schedule F, line 8, if you incurred the debt in your farming business. If the debt is a nonbusiness debt, report the canceled amount as other income on Form 1040, line 21.

Election to defer income from discharge of indebtedness.   You can elect to defer income from a discharge of business indebtedness that occurred after 2008 and before 2011. Generally, if the election is made, the deferred income is included in gross income ratably over a 5-year period beginning in 2014 (for calendar year taxpayers) and the exclusions listed below do not apply. See IRC section 108(i) and Publication 4681 for details.

Form 1099-C.   If a federal agency, financial institution, credit union, finance company, or credit card company cancels or forgives your debt of $600 or more, you will receive a Form 1099-C, Cancellation of Debt. The amount of debt canceled is shown in box 2.

Exceptions

The following discussion covers some exceptions to the general rule for canceled debt. These exceptions apply before the exclusions discussed below.

Price reduced after purchase.   If your purchase of property was financed by the seller and the seller reduces the amount of the debt at a time when you are not insolvent and the reduction does not occur in a chapter 11 bankruptcy case, the amount of the debt reduction will be treated as a reduction in the purchase price of the property. Reduce your basis in the property by the amount of the reduction in the debt. The rules that apply to bankruptcy and insolvency are explained below under Exclusions .

Deductible debt.   You do not realize income from a canceled debt to the extent the payment of the debt would have been a deductible expense. This exception applies before the price reduction exception discussed above and the bankruptcy and insolvency exclusions discussed next.

Example.

You get accounting services for your farm on credit. Later, you have trouble paying your farm debts, but you are not bankrupt or insolvent. Your accountant forgives part of the amount you owe for the accounting services. How you treat the canceled debt depends on your method of accounting.

  • Cash method — You do not include the canceled debt in income because payment of the debt would have been deductible as a business expense.

  • Accrual method — You include the canceled debt in income because the expense was deductible when you incurred the debt.

Exclusions

Do not include canceled debt in income in the following situations.

  1. The cancellation takes place in a bankruptcy case under title 11 of the U.S. Code.

  2. The cancellation takes place when you are insolvent.

  3. The canceled debt is a qualified farm debt.

  4. The canceled debt is a qualified real property business debt (in the case of a taxpayer other than a C corporation). See Publication 334, Tax Guide for Small Business, chapter 5.

  5. The canceled debt is qualified principal residence indebtedness which is discharged after 2006 and before 2014.

The exclusions do not apply in the following situations:

  • If a canceled debt is excluded from income because it takes place in a bankruptcy case, the exclusions in situations (2), (3), (4), and (5) do not apply.

  • If a canceled debt is excluded from income because it takes place when you are insolvent, the exclusions in situations (3) and (4) do not apply to the extent you are insolvent.

  • If a canceled debt is excluded from income because it is qualified principal residence indebtedness, the exclusion in situation (2) does not apply unless you elect to apply situation (2) instead of the exclusion for qualified principal residence indebtedness.

See Form 982 , later, for information on how to claim an exclusion for a canceled debt.

Debt.   For this discussion, debt includes any debt for which you are liable or that attaches to property you hold.

Bankruptcy and Insolvency

You can exclude a canceled debt from income if you are bankrupt or to the extent you are insolvent.

Bankruptcy.   A bankruptcy case is a case under title 11 of the U.S. Code if you are under the jurisdiction of the court and the cancellation of the debt is granted by the court or is the result of a plan approved by the court.

  Do not include debt canceled in a bankruptcy case in your income in the year it is canceled. Instead, you must use the amount canceled to reduce your tax attributes, explained below under Reduction of tax attributes .

Insolvency.   You are insolvent to the extent your liabilities are more than the fair market value of your assets immediately before the cancellation of debt.

  You can exclude canceled debt from gross income up to the amount by which you are insolvent. If the canceled debt is more than this amount and the debt qualifies, you can apply the rules for qualified farm debt or qualified real property business debt to the difference. Otherwise, you include the difference in gross income. Use the amount excluded because of insolvency to reduce any tax attributes, as explained below under Reduction of tax attributes . You must reduce the tax attributes under the insolvency rules before applying the rules for qualified farm debt or for qualified real property business debt.

Example.

You had a $15,000 debt that was not qualified principal residence debt canceled outside of bankruptcy. Immediately before the cancellation, your liabilities totaled $80,000 and your assets totaled $75,000. Since your liabilities were more than your assets, you were insolvent to the extent of $5,000 ($80,000 − $75,000). You can exclude this amount from income. The remaining canceled debt ($10,000) may be subject to the qualified farm debt or qualified real property business debt rules. If not, you must include it in income.

Reduction of tax attributes.   If you exclude canceled debt from income in a bankruptcy case or during insolvency, you must use the excluded debt to reduce certain tax attributes.

Order of reduction.   You must use the excluded canceled debt to reduce the following tax attributes in the order listed unless you elect to reduce the basis of depreciable property first, as explained later.
  1. Net operating loss (NOL). Reduce any NOL for the tax year of the debt cancellation, and then any NOL carryover to that year. Reduce the NOL or NOL carryover one dollar for each dollar of excluded canceled debt.

  2. General business credit carryover. Reduce the credit carryover to or from the tax year of the debt cancellation. Reduce the carryover 331/3 cents for each dollar of excluded canceled debt.

  3. Minimum tax credit. Reduce the minimum tax credit available at the beginning of the tax year following the tax year of the debt cancellation. Reduce the credit 331/3 cents for each dollar of excluded canceled debt.

  4. Capital loss. Reduce any net capital loss for the tax year of the debt cancellation, and then any capital loss carryover to that year. Reduce the capital loss or loss carryover one dollar for each dollar of excluded canceled debt.

  5. Basis. Reduce the basis of the property you hold at the beginning of the tax year following the tax year of the debt cancellation in the following order.

    1. Real property (except inventory) used in your trade or business or held for investment that secured the canceled debt.

    2. Personal property (except inventory and accounts and notes receivable) used in your trade or business or held for investment that secured the canceled debt.

    3. Other property (except inventory and accounts and notes receivable) used in your trade or business or held for investment.

    4. Inventory and accounts and notes receivable.

    5. Other property.

    Reduce the basis one dollar for each dollar of excluded canceled debt. However, the reduction cannot be more than the total basis of property and the amount of money you hold immediately after the debt cancellation minus your total liabilities immediately after the cancellation.

    For allocation rules that apply to basis reductions for multiple canceled debts, see Regulations section 1.1017-1(b)(2). Also see Electing to reduce the basis of depreciable property first , later.

  6. Passive activity loss and credit carryovers. Reduce the passive activity loss and credit carryovers from the tax year of the debt cancellation. Reduce the loss carryover one dollar for each dollar of excluded canceled debt. Reduce the credit carryover 331/3 cents for each dollar of excluded canceled debt.

  7. Foreign tax credit. Reduce the credit carryover to or from the tax year of the debt cancellation. Reduce the carryover 331/3 cents for each dollar of excluded canceled debt.

How to make tax attribute reductions.   Always make the required reductions in tax attributes after figuring your tax for the year of the debt cancellation. In making the reductions in (1) and (4) earlier, first reduce the loss for the tax year of the debt cancellation. Then reduce any loss carryovers to that year in the order of the tax years from which the carryovers arose, starting with the earliest year. In making the reductions in (2) and (7) earlier, reduce the credit carryovers to the tax year of the debt cancellation in the order in which they are taken into account for that year.

Electing to reduce the basis of depreciable property first.   You can elect to apply any portion of the excluded canceled debt first to reduce the basis of depreciable property you hold at the beginning of the tax year following the tax year of the debt cancellation, in the following order.
  1. Depreciable real property used in your trade or business or held for investment that secured the canceled debt.

  2. Depreciable personal property used in your trade or business or held for investment that secured the canceled debt.

  3. Other depreciable property used in your trade or business or held for investment.

  4. Real property held as inventory if you elect to treat it as depreciable property on Form 982.

  The amount you apply cannot be more than the total adjusted basis of all the depreciable properties. Depreciable property for this purpose means any property subject to depreciation, but only if a reduction of basis will reduce the depreciation or amortization otherwise allowable for the period immediately following the basis reduction.

  You make this reduction before reducing the other tax attributes listed earlier. If the excluded canceled debt is more than the depreciable basis you elect to reduce first, use the difference to reduce the other tax attributes. In figuring the limit on the basis reduction in (5) under Order of reduction , earlier, use the remaining adjusted basis of your properties after making this election.

  See Form 982 , later, for information on how to make this election. If you make this election, you can revoke it only with the consent of the IRS.

Recapture of basis reductions.   If you reduce the basis of property under these provisions (either the election to reduce basis first or the basis reduction without that election) and later sell or otherwise dispose of the property at a gain, the part of the gain due to this basis reduction is taxable as ordinary income under the depreciation recapture provisions. Treat any property that is not section 1245 or section 1250 property as section 1245 property. For section 1250 property, determine the straight-line depreciation adjustments as though there were no basis reduction for debt cancellation. Sections 1245 and 1250 property and the recapture of gain as ordinary income are explained in chapter 9.

More information.   For more information on debt cancellation in bankruptcy proceedings or during insolvency, see Publication 908.

Qualified Principal Residence Debt

You can exclude from income a canceled debt that is qualified principal residence debt. The amount excluded from income is applied to reduce (but not below zero) the basis of your principal residence.

Qualified principal residence.   This is your main home, which is the home where you ordinarily live most of the time. You can have only one main home at any one time.

Qualified principal residence debt.   This is acquisition debt that is incurred in acquiring, constructing, or substantially improving your qualified principal residence and is secured by that residence. This also includes any debt secured by the residence resulting from the refinancing of the acquisition debt but only to the extent the amount of the debt resulting from the refinancing does not exceed the amount of the refinanced debt. Qualified principal residence debt is limited to acquisition debt of $2 million ($1 million if you are married and filing a separate return) with respect to the principal residence of the taxpayer.

  The exclusion from gross income for cancellation of qualified principal residence debt does not apply if the canceled debt is on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to your financial condition.

  If any loan is canceled, in whole or in part, and only a portion of the loan is qualified principal residence debt, the exclusion from gross income for cancellation of qualified principal residence debt will apply only to the amount of the loan (as determined immediately before the canceled debt) that is qualified principal residence debt.

Qualified Farm Debt

You can exclude from income a canceled debt that is qualified farm debt owed to a qualified person. This exclusion applies only if you were solvent when the debt was canceled or, if you were insolvent, only to the extent the canceled debt is more than the amount by which you were insolvent. This exclusion does not apply to a canceled debt excluded from income because it relates to your principal residence or it takes place in a bankruptcy case.

Your debt is qualified farm debt if both the following requirements are met.

  • You incurred it directly in operating a farming business.

  • At least 50% of your total gross receipts for the 3 tax years preceding the year of debt cancellation were from your farming business.

For more information, see Publication 4681.

Qualified person.   This is a person who is actively and regularly engaged in the business of lending money. A qualified person includes any federal, state, or local government, or any of their agencies or subdivisions. The USDA is a qualified person. A qualified person does not include any of the following.
  • A person related to you.

  • A person from whom you acquired the property (or a person related to this person).

  • A person who receives a fee from your investment in the property (or a person related to this person).

  For the definition of a related person, see Related persons under At-Risk Amounts in Publication 925.

Exclusion limit.   The amount of canceled qualified farm debt you can exclude from income is limited. It cannot be more than the sum of your adjusted tax attributes and the total adjusted basis of the qualified property you hold at the beginning of the tax year following the tax year of the debt cancellation. Figure this limit after taking into account any reduction of tax attributes because of the exclusion of canceled debt from gross income during insolvency.

  If the canceled debt is more than this limit, you must include the difference in gross income.

Adjusted tax attributes.   Adjusted tax attributes means the sum of the following items.
  1. Any net operating loss (NOL) for the tax year of the debt cancellation and any NOL carryover to that year.

  2. Any general business credit carryover to or from the year of the debt cancellation, multiplied by 3.

  3. Any minimum tax credit available at the beginning of the tax year following the tax year of the debt cancellation, multiplied by 3.

  4. Any net capital loss for the tax year of the debt cancellation and any capital loss carryover to that year.

  5. Any passive activity loss and credit carryovers from the tax year of the debt cancellation. Any credit carryover is multiplied by 3.

  6. Any foreign tax credit carryovers to or from the tax year of the debt cancellation, multiplied by 3.

Qualified property.   This is any property you use or hold for use in your trade or business or for the production of income.

Reduction of tax attributes.   If you exclude canceled debt from income under the qualified farm debt rules, you must use the excluded debt to reduce tax attributes. (If you also excluded canceled debt under the insolvency rules, you reduce the amount of the tax attributes remaining after reduction for the exclusion allowed under the insolvency rules.) You generally must follow the reduction rules previously explained under Bankruptcy and Insolvency . However, do not follow the rules in (5) under Order of reduction , earlier. Instead, follow the special rules explained next.

Special rules for reducing the basis of property.   You must use special rules to reduce the basis of property for excluded canceled qualified farm debt. Under these special rules, you only reduce the basis of qualified property (defined earlier). Reduce it in the following order.
  1. Depreciable qualified property. You may elect on Form 982 to treat real property held as inventory as depreciable property.

  2. Land that is qualified property and is used or held for use in your farming business.

  3. Other qualified property.

Form 982

Use Form 982 to show the amounts of canceled debt excluded from income and the reduction of tax attributes in the order listed on the form. Also use it if you are electing to apply the excluded canceled debt to reduce the basis of depreciable property before reducing tax attributes. You make this election by showing the amount you elect to apply on line 5 of the form.

When to file.   You must file Form 982 with your timely filed income tax return (including extensions) for the tax year in which the cancellation of debt occurred. If you timely filed your return for the year without electing to apply the excluded canceled debt to reduce the basis of depreciable property first, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). For more information, see When To File in the Form 982 instructions.

Income From Other Sources

This section discusses other types of income you may receive.

Barter income.   If you are paid for your work in farm products, other property, or services, you must report as income the fair market value of what you receive. The same rule applies if you trade farm products for other farm products, property, or someone else's labor. This is called barter income. For example, if you help a neighbor build a barn and receive a cow for your work, you must report the fair market value of the cow as ordinary income. Your basis for property you receive in a barter transaction is usually the fair market value that you include in income. If you pay someone with property, see Property for services under Labor Hired in chapter 4.

Below-market loans.   A below-market loan is a loan on which either no interest is charged or interest is charged at a rate below the applicable federal rate. If you make a below-market loan, you may have to report income from the loan in addition to any stated interest you receive from the borrower. See chapter 1 of Publication 550 for more information on below-market loans.

Commodity futures and options.   See Hedging (Commodity Futures) in chapter 8 for information on gains and losses from commodity futures and options transactions.

Custom hire (machine work).   Pay you receive for contract work or custom work that you or your hired help perform off your farm for others, or for the use of your property or machines, is income to you whether or not income tax was withheld. This rule applies whether you receive the pay in cash, services, or merchandise. Report this income on Schedule F, line 7.

Easements and rights-of-way.   Income you receive for granting easements or rights-of-way on your farm or ranch for flooding land, laying pipelines, constructing electric or telephone lines, etc., may result in income, a reduction in the basis of all or part of your farmland, or both.

Example.

You granted a right-of-way for a gas pipeline through your property for $10,000. Only a specific part of your farmland was affected. You reserved the right to continue farming the surface land after the pipe was laid. Treat the payment for the right-of-way in one of the following ways.

  1. If the payment is less than the basis properly allocated to the part of your land affected by the right-of-way, reduce the basis by $10,000.

  2. If the payment is equal to or more than the basis of the affected part of your land, reduce the basis to zero and the rest, if any, is gain from a sale. The gain is reported on Form 4797 and is treated as section 1231 gain if you held the land for more than 1 year. See chapter 9.

Easement contracts usually describe the affected land using square feet. Your basis may be figured per acre. One acre equals 43,560 square feet.

If construction of the pipeline damaged growing crops and you later receive a settlement of $250 for this damage, the $250 is income and is included on Schedule F, line 8. It does not affect the basis of your land.

Fuel tax credit and refund.   Include any credit or refund of federal excise taxes on fuels in your gross income if you deducted the cost of the fuel (including excise tax) as an expense that reduced your income tax. See chapter 14 for more information about fuel tax credits and refunds.

Illegal federal irrigation subsidy.   The federal government, operating through the Bureau of Reclamation, has made irrigation water from certain reclamation and irrigation projects available for agricultural purposes. The excess of the amount required to be paid for water from these projects over the amount you actually paid is an illegal subsidy.

  For example, if the amount required to be paid is full cost and you paid less than full cost, the difference is an illegal subsidy and you must include it in income. Report this on Schedule F, line 8. You cannot take a deduction for the amount you must include in income.

  For more information on reclamation and irrigation projects, contact your local Bureau of Reclamation.

Prizes.   Report prizes you win on farm livestock or products at contests, exhibitions, fairs, etc., on Schedule F, line 8. If you receive a prize in cash, include the full amount in income. If you receive a prize in produce or other property, include the fair market value of the property. For prizes of $600 or more, you should receive a Form 1099-MISC.

  See chapter 12 for information about prizes related to 4-H Club or FFA projects. See Publication 525 for information about other prizes.

Property sold, destroyed, stolen, or condemned.   You may have an ordinary or capital gain if property you own is sold or exchanged, stolen, destroyed by fire, flood, or other casualty, or condemned by a public authority. In some situations, you can postpone the tax on the gain to a later year. See chapters 8 through 11.

Recapture of certain depreciation.   If you took a section 179 deduction for property used in your farming business and at any time during the property's recovery period you do not use it more than 50% in your business, you must include part of the deduction in income. See chapter 7 for information on the section 179 deduction and when to recapture that deduction.

  In addition, if the percentage of business use of listed property (see chapter 7) falls to 50% or less in any tax year during the recovery period, you must include in income any excess depreciation you took on the property.

  Both of these amounts are farm income. Use Form 4797, Part IV, to figure how much to include in income.

Refund or reimbursement.   You generally must include in income a reimbursement, refund, or recovery of an item for which you took a deduction in an earlier year. Include it for the tax year you receive it. However, if any part of the earlier deduction did not decrease your income tax, you do not have to include that part of the reimbursement, refund, or recovery.

Example.

A tenant farmer purchased fertilizer for $1,000 in April 2013. He deducted $1,000 on his 2013 Schedule F and the entire deduction reduced his tax. The landowner reimbursed him $500 of the cost of the fertilizer in February 2014. The tenant farmer must include $500 in income on his 2014 tax return because the entire deduction decreased his 2013 tax.

Sale of soil and other natural deposits.   If you remove and sell topsoil, loam, fill dirt, sand, gravel, or other natural deposits from your property, the proceeds are ordinary income. A reasonable allowance for depletion of the natural deposit sold may be claimed as a deduction. See Depletion in chapter 7.

Sod.   Report proceeds from the sale of sod on Schedule F. A deduction for cost depletion is allowed, but only for the topsoil removed with the sod.

Granting the right to remove deposits.   If you enter into a legal relationship granting someone else the right to excavate and remove natural deposits from your property, you must determine whether the transaction is a sale or another type of transaction (for example, a lease).

  If you receive a specified sum or an amount fixed without regard to the quantity produced and sold from the deposit and you retain no economic interest in the deposit, your transaction is a sale. You are considered to retain an economic interest if, under the terms of the legal relationship, you depend on the income derived from extraction of the deposit for a return of your capital investment in the deposit.

  Your income from the deposit is capital gain if the transaction is a sale. Otherwise, it is ordinary income subject to an allowance for depletion. See chapter 7 for information on depletion and chapter 8 for the tax treatment of capital gains.

Timber sales.   Timber sales, including sales of logs, firewood, and pulpwood, are discussed in chapter 8.

Income Averaging for Farmers

If you are engaged in a farming business, you may be able to average all or some of your farm income by using income tax rates from the 3 prior years (base years) to calculate the tax on that income. This may give you a lower tax if your current year income is high and your taxable income which includes income from farming from one or more of the 3 prior years was low. The term “farming business” is defined in the Instructions for Schedule J (Form 1040), Income Averaging for Farmers and Fishermen.

Who can use income averaging?   You can use income averaging to figure your tax for any year in which you were engaged in a farming business as an individual, a partner in a partnership, or a shareholder in an S corporation. Services performed as an employee are disregarded in determining whether an individual is engaged in a farming business. However, if you are a shareholder of an S corporation engaged in a farming business, you may treat compensation received from the corporation that is attributable to the farming business as farm income. You do not need to have been engaged in a farming business in any base year.

  Corporations, partnerships, S corporations, estates, and trusts cannot use income averaging.

Elected Farm Income (EFI)

EFI is the amount of income from your farming business that you elect to have taxed at base year rates. You can designate as EFI any type of income attributable to your farming business. However, your EFI cannot be more than your taxable income, and any EFI from a net capital gain attributable to your farming business cannot be more than your total net capital gain.

Income from your farming business is the sum of any farm income or gain minus any farm expenses or losses allowed as deductions in figuring your taxable income. However, it does not include gain or loss from the sale or other disposition of land, or from the sale of development rights, grazing rights, and other similar rights.

Gains or losses from the sale or other disposition of farm property.   Gains or losses from the sale or other disposition of farm property other than land can be designated as EFI if you (or your partnership or S corporation) used the property regularly for a substantial period in a farming business. Whether the property has been regularly used for a substantial period depends on all the facts and circumstances.

Liquidation of a farming business.   If you (or your partnership or S corporation) liquidate your farming business, gains or losses on property sold within a reasonable time after operations stop can be designated as EFI. A period of 1 year after stopping operations is a reasonable time. After that, what is a reasonable time depends on the facts and circumstances.

EFI and base year rates.   If your EFI includes both ordinary income and capital gains, you must use tax rates from each base year to compute tax on an equal portion of each type of income. For example, you cannot tax all of the capital gains at the rate for capital gains from a single base year.

How To Figure the Tax

If you average your farm income, you will figure your tax on Schedule J (Form 1040).

Negative taxable income for base year.   If your taxable income for any base year was zero because your deductions were more than your income, you may have negative taxable income for that year to combine with your EFI on Schedule J.

Filing status.   You are not prohibited from using income averaging solely because your filing status is not the same as your filing status in the base years. For example, if you are married and file jointly, but filed as single in all of the base years, you may still average farm income.

Effect on Other Tax Determinations

You subtract your EFI from your taxable income and add one-third of it to the taxable income of each of the base years to determine the tax rate to use for income averaging. The allocation of your EFI to the base years does not affect other tax determinations. For example, you make the following determinations before subtracting your EFI (or adding it to income in the base years).

  • The amount of your self-employment tax.

  • Whether, in the aggregate, sales and other dispositions of business property (section 1231 transactions) produce long-term capital gain or ordinary loss.

  • The amount of any net operating loss carryover or net capital loss carryover applied and the amount of any carryover to another year.

  • The limit on itemized deductions based on your adjusted gross income.

  • The amount of any net capital loss or net operating loss in a base year.

Tax for Certain Children Who Have Unearned Income

If your child was under age 19 (or 24 if a full-time student) at the end of the tax year and had unearned income of more than $2,000, part of that income may be taxed at your tax rate instead of your child's tax rate. For more information, see the Instructions for Form 8615, Tax for Certain Children Who Have Unearned Income.

If you use income averaging, figure your child's tax on unearned income using your rate after allocating EFI. You cannot use any of your child's unearned income as your EFI, even if it is attributable to a farming business. For information on figuring the tax on your child's unearned income, see Publication 929, Tax Rules for Children and Dependents.

Alternative Minimum Tax (AMT)

You can elect to use income averaging to compute your regular tax liability. However, income averaging is not used to determine your regular tax or tentative minimum tax when figuring your AMT. Using income averaging may reduce your total tax even if you owe AMT.

Credit for prior year minimum tax.   You may be able to claim a tax credit if you owed AMT in a prior year. See the Instructions for Form 8801, Credit for Prior Year Minimum Tax—Individuals, Estates, and Trusts.

Schedule J

You can use income averaging by filing Schedule J (Form 1040) with your timely filed (including extensions) return for the year. You can also use income averaging on a late return, or use, change, or cancel it on an amended return, if the time for filing a claim for refund has not expired for that election year. You generally must file the claim for refund within 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later.


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