4.   Farm Business Expenses

What's New for 2014

Standard mileage rate. For 2014, the standard mileage rate for the cost of operating your car, van, pickup, or panel truck for each mile of business use is 56 cents. See Truck and Car Expenses , later.

Introduction

You can generally deduct the current costs of operating your farm. Current costs are expenses you do not have to capitalize or include in inventory costs. However, your deduction for the cost of livestock feed and certain other supplies may be limited. If you have an operating loss, you may not be able to deduct all of it.

Topics - This chapter discusses:

  • Deductible expenses

  • Domestic production activities deduction

  • Capital expenses

  • Nondeductible expenses

  • Losses from operating a farm

  • Not-for-profit farming

Useful Items - You may want to see:

Publication

  • 463 Travel, Entertainment, Gift, and Car Expenses

  • 535 Business Expenses

  • 587 Business Use of Your Home

  • 925 Passive Activity and At-Risk Rules

  • 936 Home Mortgage Interest Deduction

Form (and Instructions)

  • Sch A (Form 1040) Itemized 
    Deductions

  • Sch F (Form 1040) Profit or Loss From Farming

  • 1045 Application for Tentative Refund

  • 5213 Election To Postpone 
    Determination as To Whether the Presumption Applies That an 
    Activity Is Engaged in for Profit

  • 8903 Domestic Production Activities Deduction

See chapter 16 for information about getting publications and forms.

Deductible Expenses

The ordinary and necessary costs of operating a farm for profit are deductible business expenses. “Ordinary” means what most farmers do and “necessary” means what is useful and helpful in farming. Schedule F, Part II, lists some common farm expenses that are typically deductible. This chapter discusses many of these expenses, as well as others not listed on Schedule F.

Reimbursed expenses.   If the reimbursement is received in the same year that the expense is claimed, reduce the expense by the amount of the reimbursement. If the reimbursement is received in a year after the expense is claimed, include the reimbursement amount in income. See Refund or reimbursement under Income From Other Sources in chapter 3.

Personal and business expenses.   Some expenses you pay during the tax year may be part personal and part business. These may include expenses for gasoline, oil, fuel, water, rent, electricity, telephone, automobile upkeep, repairs, insurance, interest, and taxes.

  You must allocate these mixed expenses between their business and personal parts. Generally, the personal part of these expenses is not deductible. The business portion of the expenses is deductible on Schedule F.

Example.

You paid $1,500 for electricity during the tax year. You used 1/3 of the electricity for personal purposes and 2/3 for farming. Under these circumstances, you can deduct $1,000 (2/3 of $1,500) of your electricity expense as a farm business expense.

Reasonable allocation.   It is not always easy to determine the business and nonbusiness parts of an expense. There is no method of allocation that applies to all mixed expenses. Any reasonable allocation is acceptable. What is reasonable depends on the circumstances in each case.

Prepaid Farm Supplies

Prepaid farm supplies include the following items if paid for during the year.

  • Feed, seed, fertilizer, and similar farm supplies not used or consumed during the year, but not including farm supplies that you would have consumed during the year if not for a fire, storm, flood, other casualty, disease, or drought.

  • Poultry (including egg-laying hens and baby chicks) bought for use (or for both use and resale) in your farm business. However, include only the amount that would be deductible in the following year if you had capitalized the cost and deducted it ratably over the lesser of 12 months or the useful life of the poultry.

  • Poultry bought for resale and not resold during the year.

Deduction limit.   If you use the cash method of accounting to report your income and expenses, your deduction for prepaid farm supplies in the year you pay for them may be limited to 50% of your other deductible farm expenses for the year (all Schedule F deductions except prepaid farm supplies). This limit does not apply if you meet one of the exceptions described later. See Chapter 2 for a discussion of the cash method of accounting.

  If the limit applies, you can deduct the excess cost of farm supplies other than poultry in the year you use or consume the supplies. The excess cost of poultry bought for use (or for both use and resale) in your farm business is deductible in the year following the year you pay for it. The excess cost of poultry bought for resale is deductible in the year you sell or otherwise dispose of that poultry.

Example.

You may not qualify for the exception described next. During 2014, you bought fertilizer ($4,000), feed ($1,000), and seed ($500) for use on your farm in the following year. Your total prepaid farm supplies expense for 2014 is $5,500. Your other deductible farm expenses totaled $10,000 for 2014. Therefore, your deduction for prepaid farm supplies cannot be more than $5,000 (50% of $10,000) for 2014. The excess prepaid farm supplies expense of $500 ($5,500 − $5,000) is deductible in a later tax year when you use or consume the supplies.

Exceptions.   This limit on the deduction for prepaid farm supplies expense does not apply if you are a farm-related taxpayer and either of the following apply.
  1. Your prepaid farm supplies expense is more than 50% of your other deductible farm expenses because of a change in business operations caused by unusual circumstances.

  2. Your total prepaid farm supplies expense for the preceding 3 tax years is less than 50% of your total other deductible farm expenses for those 3 tax years.

  You are a farm-related taxpayer if any of the following tests apply.
  1. Your main home is on a farm.

  2. Your principal business is farming.

  3. A member of your family meets (1) or (2).

For this purpose, your family includes your brothers and sisters, half-brothers and half-sisters, spouse, parents, grandparents, children, grandchildren, and aunts and uncles and their children.

  
Whether or not the deduction limit for prepaid farm supplies applies, your expenses for prepaid livestock feed may be subject to the rules for advance payment of livestock feed, discussed next.

Prepaid Livestock Feed

If you report your income and expenses under the cash method of accounting, you cannot deduct in the year paid the cost of feed your livestock will consume in a later year unless you meet all the following tests.

  1. The payment is for the purchase of feed rather than a deposit.

  2. The prepayment has a business purpose and is not merely for tax avoidance.

  3. Deducting the prepayment does not result in a material distortion of your income.

If you meet all three tests, you can deduct the prepaid feed, subject to the limit on prepaid farm supplies discussed earlier.

If you fail any of these tests, you can deduct the prepaid feed only in the year it is consumed.

This rule does not apply to the purchase of commodity futures contracts.

Payment for the purchase of feed.   Whether a payment is for the purchase of feed or a deposit depends on the facts and circumstances in each case. It is for the purchase of feed if you can show you made it under a binding commitment to accept delivery of a specific quantity of feed at a fixed price and you are not entitled, by contract or business custom, to a refund or repurchase.

  The following are some factors that show a payment is a deposit rather than for the purchase of feed.
  • The absence of specific quantity terms.

  • The right to a refund of any unapplied payment credit at the end of the contract.

  • The seller's treatment of the payment as a deposit.

  • The right to substitute other goods or products for those specified in the contract.

  A provision permitting substitution of ingredients to vary the particular feed mix to meet your livestock's current diet requirements will not suggest a deposit. Further, a price adjustment to reflect market value at the date of delivery is not, by itself, proof of a deposit.

Business purpose.   The prepayment has a business purpose only if you have a reasonable expectation of receiving some business benefit from prepaying the cost of livestock feed. The following are some examples of business benefits.
  • Fixing maximum prices and securing an assured feed supply.

  • Securing preferential treatment in anticipation of a feed shortage.

  Other factors considered in determining the existence of a business purpose are whether the prepayment was a condition imposed by the seller and whether that condition was meaningful.

No material distortion of income.   The following are some factors considered in determining whether deducting prepaid livestock feed materially distorts income.
  • Your customary business practice in conducting your livestock operations.

  • The expense in relation to past purchases.

  • The time of year you made the purchase.

  • The expense in relation to your income for the year.

Labor Hired

You can deduct reasonable wages paid for regular farm labor, piecework, contract labor, and other forms of labor hired to perform your farming operations. You can pay wages in cash or in noncash items such as inventory, capital assets, or assets used in your business. The cost of boarding farm labor is a deductible labor cost. Other deductible costs you incur for farm labor include health insurance, workers' compensation insurance, and other benefits.

If you must withhold social security, Medicare, and income taxes from your employees' cash wages, you can still deduct the full amount of wages before withholding. See chapter 13 for more information on employment taxes. Also, deduct the employer's share of the social security and Medicare taxes you must pay on your employees' wages as a farm business expense on Schedule F, line 29. See Taxes , later.

Property for services.   If you transfer property to an employee in payment for services, you can deduct as wages paid the fair market value of the property on the date of transfer. If the employee pays you anything for the property, deduct as wages the fair market value of the property minus the payment by the employee for the property.

  Treat the wages deducted as an amount received for the property. You may have a gain or loss to report if the property's adjusted basis on the date of transfer is different from its fair market value. Any gain or loss has the same character the exchanged property had in your hands. For more information, see chapter 8.

Child as an employee.   You can deduct reasonable wages or other compensation you pay to your child for doing farmwork if a true employer-employee relationship exists between you and your child. Include these wages in the child's income. The child may have to file an income tax return. These wages may also be subject to social security and Medicare taxes if your child is age 18 or older. For more information, see Family Employees in chapter 13.

  
A Form W-2, Wage and Tax Statement, should be issued to the child employee.

  The fact that your child spends the wages to buy clothes or other necessities you normally furnish does not prevent you from deducting your child's wages as a farm expense.

The amount of wages paid to the child could cause a loss of the dependency exemption depending on how the child uses the money.

Spouse as an employee.   You can deduct reasonable wages or other compensation you pay to your spouse if a true employer-employee relationship exists between you and your spouse. Wages you pay to your spouse are subject to social security and Medicare taxes. For more information, see Family Employees in chapter 13.

Nondeductible Pay

You cannot deduct wages paid for certain household work, construction work, and maintenance of your home. However, those wages may be subject to the employment taxes discussed in chapter 13.

Household workers.   Do not deduct amounts paid to persons engaged in household work, except to the extent their services are used in boarding or otherwise caring for farm laborers.

Construction labor.   Do not deduct wages paid to hired help for the construction of new buildings or other improvements. These wages are part of the cost of the building or other improvement. You must capitalize them.

Maintaining your home.   If your farm employee spends time maintaining or repairing your home, the wages and employment taxes you pay for that work are nondeductible personal expenses. For example, assume you have a farm employee for the entire tax year and the employee spends 5% of the time maintaining your home. The employee devotes the remaining time to work on your farm. You cannot deduct 5% of the wages and employment taxes you pay for that employee.

Employment Credits

Reduce your deduction for wages by the amount of any employment credits you claim such as the work opportunity credit for qualified tax-exempt organizations hiring qualified veterans (Form 5884-C).

Repairs and Maintenance

You can deduct most expenses for the repair and maintenance of your farm property. Common items of repair and maintenance are repainting, replacing shingles and supports on farm buildings, and periodic or routine maintenance of trucks, tractors, and other farm machinery. However, repairs to, or overhauls of, depreciable property that substantially prolong the life of the property, increase its value, or adapt it to a different use are capital expenses. For example, if you repair the barn roof, the cost is deductible. But if you replace the roof, it is a capital expense. For more information, see Capital Expenses , later.

Interest

You can deduct as a farm business expense interest paid on farm mortgages and other obligations you incur in your farm business.

Cash method.   If you use the cash method of accounting, you can generally deduct interest paid during the tax year. You cannot deduct interest paid with funds received from the original lender through another loan, advance, or other arrangement similar to a loan. You can, however, deduct the interest when you start making payments on the new loan. For more information, see Cash Method in chapter 2.

Prepaid interest.   Under the cash method, you generally cannot deduct any interest paid before the year it is due. Interest paid in advance may be deducted only in the tax year in which it is due.

Accrual method.   If you use an accrual method of accounting, you can deduct only interest that has accrued during the tax year. However, you cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. For more information, see Accrual Method in chapter 2.

Allocation of interest.   If you use the proceeds of a loan for more than one purpose, you must allocate the interest on that loan to each use. Allocate the interest to the following categories.
  • Trade or business interest.

  • Passive activity interest.

  • Investment interest.

  • Portfolio interest.

  • Personal interest.

  You generally allocate interest on a loan the same way you allocate the loan proceeds. You allocate loan proceeds by tracing disbursements to specific uses.

The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other funds.

Secured loan.   The allocation of loan proceeds and the related interest is generally not affected by the use of property that secures the loan.

Example.

You secure a loan with property used in your farming business. You use the loan proceeds to buy a car for personal use. You must allocate interest expense on the loan to personal use (purchase of the car) even though the loan is secured by farm business property.

If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. However, you can choose to treat the loan as not secured by your home. For more information, see Publication 936.

Allocation period.   The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on the earlier of the following dates.
  • The date the loan is repaid.

  • The date the loan is reallocated to another use.

More information.   For more information on interest, see chapter 4 in Publication 535.

Breeding Fees

You can deduct breeding fees as a farm business expense. However, if you use an accrual method of accounting, you must capitalize breeding fees and allocate them to the cost basis of the calf, foal, etc. For more information on who must use an accrual method of accounting, see Accrual Method Required under Accounting Methods in chapter 2.

Fertilizer and Lime

You can deduct in the year paid or incurred the cost of fertilizer, lime, and other materials applied to farmland to enrich, neutralize, or condition it if the benefits last a year or less. You can also deduct the cost of applying these materials in the year you pay or incur it. However, see Prepaid Farm Supplies , earlier, for a rule that may limit your deduction for these materials.

If the benefits of the fertilizer, lime, or other materials last substantially more than one year, you generally capitalize their cost and deduct a part each year the benefits last. However, you can choose to deduct these expenses in the year paid or incurred. If you make this choice, you will need IRS approval if you later decide to capitalize the cost of previously deducted items. If you sell farmland on which fertilizer or lime has been applied and if the selling price of the land includes part or all of the cost of the fertilizer or lime, you report the sale amount attributable to the fertilizer or lime as ordinary income.

Farmland, for these purposes, is land used for producing crops, fruits, or other agricultural products or for sustaining livestock. It does not include land you have never used previously for producing crops or sustaining livestock. You cannot deduct initial land preparation costs. (See Capital Expenses , later.)

Include government payments you receive for lime or fertilizer in income. See Fertilizer and Lime under Agricultural Program Payments in chapter 3.

Taxes

You can deduct as a farm business expense the real estate and personal property taxes on farm business assets, such as farm equipment, animals, farmland, and farm buildings. You also can deduct the social security and Medicare taxes you pay to match the amount withheld from the wages of farm employees and any federal unemployment tax you pay. For information on employment taxes, see chapter 13.

Allocation of taxes.   The taxes on the part of your farm you use as your home (including the furnishings and surrounding land not used for farming) are nonbusiness taxes. You may be able to deduct these nonbusiness taxes as itemized deductions on Schedule A (Form 1040). To determine the nonbusiness part, allocate the taxes between the farm assets and nonbusiness assets. The allocation can be done from the assessed valuations. If your tax statement does not show the assessed valuations, you can usually get them from the tax assessor.

State and local general sales taxes.   State and local general sales taxes on nondepreciable farm business expense items are deductible as part of the cost of those items. Include state and local general sales taxes imposed on the purchase of assets for use in your farm business as part of the cost you depreciate. Also treat the taxes as part of your cost if they are imposed on the seller and passed on to you.

State and federal income taxes.   Individuals cannot deduct state and federal income taxes as farm business expenses. Individuals can deduct state and local income taxes only as an itemized deduction on Schedule A (Form 1040). However, you cannot deduct federal income tax.

Highway use tax.   You can deduct the federal use tax on highway motor vehicles paid on a truck or truck tractor used in your farm business. For information on the tax itself, including information on vehicles subject to the tax, see the Instructions for Form 2290, Heavy Highway Vehicle Use Tax Return.

Self-employment tax deduction.   You can deduct as an adjustment to income on Form 1040 one-half of your self-employment tax in figuring your adjusted gross income. For more information, see chapter 12.

Insurance

You generally can deduct the ordinary and necessary cost of insurance for your farm business as a business expense. This includes premiums you pay for the following types of insurance.

  • Fire, storm, crop, theft, liability, and other insurance on farm business assets.

  • Health and accident insurance on your farm employees.

  • Workers' compensation insurance set by state law that covers any claims for job-related bodily injuries or diseases suffered by employees on your farm, regardless of fault.

  • Business interruption insurance.

  • State unemployment insurance on your farm employees (deductible as taxes if they are considered taxes under state law).

Insurance to secure a loan.   If you take out a policy on your life or on the life of another person with a financial interest in your farm business to get or protect a business loan, you cannot deduct the premiums as a business expense. In the event of death, the proceeds of the policy are not taxed as income even if they are used to liquidate the debt.

Advance premiums.   Deduct advance payments of insurance premiums only in the year to which they apply, regardless of your accounting method.

Example.

On June 28, 2014, you paid a premium of $3,000 for fire insurance on your barn. The policy will cover a period of 3 years beginning on July 1, 2014. Only the cost for the 6 months in 2014 is deductible as an insurance expense on your 2014 calendar year tax return. Deduct $500, which is the premium for 6 months of the 36-month premium period, or 6/36 of $3,000. In both 2015 and 2016, deduct $1,000 (12/36 of $3,000). Deduct the remaining $500 in 2017. Had the policy been effective on January 1, 2014, the deductible expense would have been $1,000 for each of the years 2014, 2015, and 2016, based on one-third of the premium used each year.

Business interruption insurance.   Use and occupancy and business interruption insurance premiums are deductible as a business expense. This insurance pays for lost profits if your business is shut down due to a fire or other cause. Report any proceeds in full on Schedule F, Part I.

Self-employed health insurance deduction.   If you are self-employed, you can deduct as an adjustment to income on Form 1040 your payments for medical, dental, and qualified long-term care insurance coverage for yourself, your spouse, and your dependents when figuring your adjusted gross income on your Form 1040. Effective March 30, 2010, the insurance can also cover any child of yours under age 27 at the end of 2014, even if the child was not your dependent. Generally, this deduction cannot be more than the net profit from the business under which the plan was established.

  If you or your spouse is also an employee of another person, you cannot take the deduction for any month in which you are eligible to participate in a subsidized health plan maintained by your employer or your spouse's employer.

  Generally, use the Self-Employed Health Insurance Deduction Worksheet in the Instructions for Form 1040 to figure your deduction. Include the remaining part of the insurance payment in your medical expenses on Schedule A (Form 1040) if you itemize your deductions.

  For more information, see Deductible Premiums in Publication 535, chapter 6.

Rent and Leasing

If you lease property for use in your farm business, you can generally deduct the rent you pay on Schedule F. However, you cannot deduct rent you pay in crop shares if you deduct the cost of raising the crops as farm expenses.

Advance payments.   Deduct advance payments of rent only in the year to which they apply, regardless of your accounting method.

Farm home.   If you rent a farm, do not deduct the part of the rental expense that represents the fair rental value of the farm home in which you live.

Lease or Purchase

If you lease a farm building or equipment, you must determine whether or not the agreement must be treated as a conditional sales contract rather than a lease. If the agreement is treated as a conditional sales contract, the payments under the agreement (so far as they do not represent interest or other charges) are payments for the purchase of the property. Do not deduct these payments as rent, but capitalize the cost of the property and recover this cost through depreciation.

Conditional sales contract.   Whether an agreement is a conditional sales contract depends on the intent of the parties. Determine intent based on the provisions of the agreement and the facts and circumstances that exist when you make the agreement. No single test, or special combination of tests, always applies. However, in general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true.
  • The agreement applies part of each payment toward an equity interest you will receive.

  • You get title to the property after you make a stated amount of required payments.

  • The amount you must pay to use the property for a short time is a large part of the amount you would pay to get title to the property.

  • You pay much more than the current fair rental value of the property.

  • You have an option to buy the property at a nominal price compared to the value of the property when you may exercise the option. Determine this value when you make the agreement.

  • You have an option to buy the property at a nominal price compared to the total amount you have to pay under the agreement.

  • The agreement designates part of the payments as interest, or part of the payments can be easily recognized as interest.

Example.

You lease new farm equipment from a dealer who both sells and leases. The agreement includes an option to purchase the equipment for a specified price. The lease payments and the specified option price equal the sales price of the equipment plus interest. Under the agreement, you are responsible for maintenance, repairs, and the risk of loss. For federal income tax purposes, the agreement is a conditional sales contract. You cannot deduct any of the lease payments as rent. You can deduct interest, repairs, insurance, depreciation, and other expenses related to the equipment.

Motor vehicle leases.   Special rules apply to lease agreements that have a terminal rental adjustment clause. In general, this is a clause that provides for a rental price adjustment based on the amount the lessor is able to sell the vehicle for at the end of the lease. If your rental agreement contains a terminal rental adjustment clause, treat the agreement as a lease if the agreement otherwise qualifies as a lease. For more information, see Internal Revenue Code (IRC) section 7701(h).

Leveraged leases.   Special rules apply to leveraged leases of equipment (arrangements in which the equipment is financed by a nonrecourse loan from a third party). For more information, see Publication 535, chapter 3, and Revenue Procedure 2001-28, which begins on page 1156 of Internal Revenue Bulletin 2001-19 at www.irs.gov/pub/irs-irbs/irb01-19.pdf.

Depreciation

If property you acquire to use in your farm business is expected to last more than one year, you generally cannot deduct the entire cost in the year you acquire it. You must recover the cost over more than one year and deduct part of it each year on Schedule F as depreciation or amortization. However, you can choose to deduct part or all of the cost of certain qualifying property, up to a limit, as a section 179 deduction in the year you place it in service.

Depreciation, amortization, and the section 179 deduction are discussed in chapter 7.

Business Use of Your Home

You can deduct expenses for the business use of your home if you use part of your home exclusively and regularly:

  • As the principal place of business for any trade or business in which you engage,

  • As a place to meet or deal with patients, clients, or customers in the normal course of your trade or business, or

  • In connection with your trade or business, if you are using a separate structure that is not attached to your home.

Your home office will qualify as your principal place of business for deducting expenses for its use if you meet both of the following requirements.

  • You use it exclusively and regularly for the administrative or management activities of your trade or business.

  • You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.

If you use part of your home for business, you must divide the expenses of operating your home between personal and business use.

The IRS now provides a simplified method to determine your expenses for business use of your home. For more information, see Publication 587, Business Use of Your Home.

Deduction limit.   If your gross income from farming equals or exceeds your total farm expenses (including expenses for the business use of your home), you can deduct all your farm expenses. But if your gross income from farming is less than your total farm expenses, your deduction for certain expenses for the use of your home in your farming business is limited.

  Your deduction for otherwise nondeductible expenses, such as utilities, insurance, and depreciation (with depreciation taken last), cannot be more than the gross income from farming minus the following expenses.
  • The business part of expenses you could deduct even if you did not use your home for business (such as deductible mortgage interest, real estate taxes, and casualty and theft losses).

  • Farm expenses other than expenses that relate to the use of your home. If you are self-employed, do not include your deduction for half of your self-employment tax.

  Deductions over the current year's limit can be carried over to your next tax year. They are subject to the deduction limit for the next tax year.

More information.   See Publication 587 for more information on deducting expenses for the business use of your home.

Telephone expense.   You cannot deduct the cost of basic local telephone service (including any taxes) for the first telephone line you have in your home, even if you have an office in your home. However, charges for business long-distance phone calls on that line, as well as the cost of a second line into your home used exclusively for your farm business, are deductible business expenses. Cell phone charges for calls relating to your farm business are deductible. If the cell phone you use for your farm business is part of a family cell phone plan, you must allocate and deduct only the portion of the charges attributable to farm business calls.

Truck and Car Expenses

You can deduct the actual cost of operating a truck or car in your farm business. Only expenses for business use are deductible. These include such items as gasoline, oil, repairs, license tags, insurance, and depreciation (subject to certain limits).

Standard mileage rate.   Instead of using actual costs, under certain conditions you can use the standard mileage rate. The standard mileage rate for each mile of business use is 56 cents in 2014. You can use the standard mileage rate for a car or a light truck, such as a van, pickup, or panel truck, you own or lease.

  You cannot use the standard mileage rate if you operate five or more cars or light trucks at the same time. You are not using five or more vehicles at the same time if you alternate using the vehicles (you use them at different times) for business.

Example.

Maureen owns a car and four pickup trucks that are used in her farm business. Her farm employees use the trucks and she uses the car for business. Maureen cannot use the standard mileage rate for the car or the trucks. This is because all five vehicles are used in Maureen's farm business at the same time. She must use actual expenses for all vehicles.

Business use percentage.   You can claim 75% of the use of a car or light truck as business use without any records if you used the vehicle during most of the normal business day directly in connection with the business of farming. You choose this method of substantiating business use the first year the vehicle is placed in service. Once you make this choice, you may not change to another method later. The following are uses directly connected with the business of farming.
  • Cultivating land.

  • Raising or harvesting any agricultural or horticultural commodity.

  • Raising, shearing, feeding, caring for, training, and managing animals.

  • Driving to the feed or supply store.

  If you keep records and they show that your business use was more than 75%, you may be able to claim more. See Recordkeeping requirements under Travel Expenses , below.

More information.   For more information on deductible truck and car expenses, see Publication 463, chapter 4. If you pay your employees for the use of their truck or car in your farm business, see Reimbursements to employees under Travel Expenses next.

Travel Expenses

You can deduct ordinary and necessary expenses you incur while traveling away from home for your farm business. You cannot deduct lavish or extravagant expenses. Usually, the location of your farm business is considered your home for tax purposes. You are traveling away from home if:

  • Your duties require you to be absent from your farm substantially longer than an ordinary work day, and

  • You need to get sleep or rest to meet the demands of your work while away from home.

If you meet these requirements and can prove the time, place, and business purpose of your travel, you can deduct your ordinary and necessary travel expenses.

The following are some types of deductible travel expenses.

  • Air, rail, bus, and car transportation;

  • Meals and lodging;

  • Dry cleaning and laundry;

  • Telephone and fax;

  • Transportation between your hotel and your temporary work or business meeting location; and

  • Tips for any of the above expenses.

Meals.   You ordinarily can deduct only 50% of your business-related meals expenses. You can deduct the cost of your meals while traveling on business only if your business trip is overnight or long enough to require you to stop for sleep or rest to properly perform your duties. You cannot deduct any of the cost of meals if it is not necessary for you to rest, unless you meet the rules for business entertainment. For information on entertainment expenses, see Publication 463, chapter 2.

  The expense of a meal includes amounts you spend for your food, beverages, taxes, and tips relating to the meal. You can deduct either 50% of the actual cost or 50% of a standard meal allowance that covers your daily meal and incidental expenses.

  
Recordkeeping requirements. You must be able to prove your deductions for travel by adequate records or other evidence that will support your own statement. Estimates or approximations do not qualify as proof of an expense.

  You should keep an account book or similar record, supported by adequate documentary evidence, such as receipts, that together support each element of an expense. Generally, it is best to record the expense and get documentation of it at the time you pay it.

  If you choose to deduct a standard meal allowance rather than the actual expense, you do not have to keep records to prove amounts spent for meals and incidental items. However, you must still keep records to prove the actual amount of other travel expenses, and the time, place, and business purpose of your travel.

More information.   For detailed information on travel, recordkeeping, and the standard meal allowance, see Publication 463.

Reimbursements to employees.   You generally can deduct reimbursements you pay to your employees for travel and transportation expenses they incur in the conduct of your business. Employees may be reimbursed under an accountable or nonaccountable plan. Under an accountable plan, the employee must provide evidence of expenses. Under a nonaccountable plan, no evidence of expenses is required. If you reimburse expenses under an accountable plan, deduct them as travel and transportation expenses. If you reimburse expenses under a nonaccountable plan, you must report the reimbursements as wages on Form W-2 and deduct them as wages. For more information, see Publication 535, chapter 11.

Marketing Quota Penalties

You can deduct as Other expenses on Schedule F penalties you pay for marketing crops in excess of farm marketing quotas. However, if you do not pay the penalty, but instead the purchaser of your crop deducts it from the payment to you, include in gross income only the amount you received. Do not take a separate deduction for the penalty.

Tenant House Expenses

You can deduct the costs of maintaining houses and their furnishings for tenants or hired help as farm business expenses. These costs include repairs, utilities, insurance, and depreciation.

The value of a dwelling you furnish to a tenant under the usual tenant-farmer arrangement is not taxable income to the tenant.

Items Purchased for Resale

If you use the cash method of accounting, you ordinarily deduct the cost of livestock and other items purchased for resale only in the year of sale. You deduct this cost, including freight charges for transporting the livestock to the farm, on Schedule F, Part I. However, see Chickens, seeds, and young plants , below.

Example.

You use the cash method of accounting. In 2014, you buy 50 steers you will sell in 2015. You cannot deduct the cost of the steers on your 2014 tax return. You deduct their cost on your 2015 Schedule F, Part I.

Chickens, seeds, and young plants.   If you are a cash method farmer, you can deduct the cost of hens and baby chicks bought for commercial egg production, or for raising and resale, as an expense on Schedule F, Part I, in the year paid if you do it consistently and it does not distort income. You also can deduct the cost of seeds and young plants bought for further development and cultivation before sale as an expense on Schedule F, Part I, when paid if you do this consistently and you do not figure your income on the crop method. However, see Prepaid Farm Supplies , earlier, for a rule that may limit your deduction for these items.

  If you deduct the cost of chickens, seeds, and young plants as an expense, report their entire selling price as income. You cannot also deduct the cost from the selling price.

  You cannot deduct the cost of seeds and young plants for Christmas trees and timber as an expense. Deduct the cost of these seeds and plants through depletion allowances. For more information, see Depletion in chapter 7.

  The cost of chickens and plants used as food for your family is never deductible.

  Capitalize the cost of plants with a preproductive period of more than 2 years, unless you can elect out of the uniform capitalization rules. These rules are discussed in chapter 6.

Example.

You use the cash method of accounting. In 2014, you buy 500 baby chicks to raise for resale in 2015. You also buy 50 bushels of winter wheat seed in 2014 that you sow in the fall. Unless you previously adopted the method of deducting these costs in the year you sell the chickens or the harvested crops, you can deduct the cost of both the baby chicks and the seed wheat in 2014.

Election to use crop method.   If you use the crop method, you can delay deducting the cost of seeds and young plants until you sell them. You must get IRS approval to use the crop method. If you follow this method, deduct the cost from the selling price to determine your profit on Schedule F, Part I. For more information, see Crop method under Special Methods of Accounting in chapter 2.

Choosing a method.   You can adopt either the crop method or the cash method for deducting the cost in the first year you buy egg-laying hens, pullets, chicks, or seeds and young plants.

  Although you must use the same method for egg-laying hens, pullets, and chicks, you can use a different method for seeds and young plants. Once you use a particular method for any of these items, use it for those items until you get IRS approval to change your method. For more information, see Change in Accounting Method in chapter 2.

Other Expenses

The following list, while not all-inclusive, shows some expenses you can deduct as other farm expenses on Schedule F, Part II. These expenses must be for business purposes and  
(1) paid, if you use the cash method of accounting, or (2) incurred, if you use an accrual method of accounting.

  • Accounting fees.

  • Advertising.

  • Business travel and meals.

  • Commissions.

  • Consultant fees.

  • Crop scouting expenses.

  • Dues to cooperatives.

  • Educational expenses (to maintain and improve farming skills).

  • Farm-related attorney fees.

  • Farm magazines.

  • Ginning.

  • Insect sprays and dusts.

  • Litter and bedding.

  • Livestock fees.

  • Marketing fees.

  • Milk assessment.

  • Recordkeeping expenses.

  • Service charges.

  • Small tools expected to last one year or less.

  • Stamps and stationery.

  • Subscriptions to professional, technical, and trade journals that deal with farming.

  • Tying material and containers.

Loan expenses.   You prorate and deduct loan expenses, such as legal fees and commissions, you pay to get a farm loan over the term of the loan.

Tax preparation fees.   You can deduct as a farm business expense on Schedule F the cost of preparing that part of your tax return relating to your farm business. You may be able to deduct the remaining cost on Schedule A (Form 1040) if you itemize your deductions.

  You also can deduct on Schedule F the amount you pay or incur in resolving tax issues relating to your farm business.

Domestic Production Activities Deduction

Generally, you are allowed a deduction for income attributable to domestic production activities. You can deduct 9% of the lesser of your qualified production activities income or your taxable income (adjusted gross income for individuals) for the tax year. Your deduction is limited to 50% of the Form W-2 wages you paid for the tax year that are properly allocable to domestic production gross receipts.

For this purpose, Form W-2 wages do not include noncash wages paid for agricultural labor, such as compensation paid as commodities. Also, excluded from Form W-2 wages are wages paid to your children under age 18 and nontaxable fringe benefits.

Income from cooperatives.   If you receive a patronage dividend or qualified per-unit retain allocation from a cooperative which is engaged in the manufacturing, production, growth, or extraction in whole or in significant part of any agricultural or horticultural product or in the marketing of agricultural or horticultural products, your income from the cooperative can give rise to a domestic production activities deduction. This deduction amount is reported on Form 1099-PATR, box 6. In order for you to qualify for the deduction, the cooperative is required to send you a written notice designating your portion of the domestic production activities deduction.

More information.   For more information on the domestic production activities deduction, see the Instructions for Form 8903.

Capital Expenses

A capital expense is a payment, or a debt incurred, for the acquisition, improvement, or restoration of an asset that is expected to last more than one year. You include the expense in the basis of the asset. Uniform capitalization rules also require you to capitalize or include in inventory certain other expenses. See chapters 2  
and 6.

Capital expenses are generally not deductible, but they may be depreciable. However, you can elect to deduct certain capital expenses, such as the following.

Generally, the costs of the following items, including the costs of material, hired labor, and installation, are capital expenses.

  1. Land and buildings.

  2. Additions, alterations, and improvements to buildings, etc.

  3. Cars and trucks.

  4. Equipment and machinery.

  5. Fences.

  6. Draft, breeding, sport, and dairy livestock.

  7. Repairs to machinery, equipment, trucks, and cars that prolong their useful life, increase their value, or adapt them to different use.

  8. Water wells, including drilling and equipping costs.

  9. Land preparation costs, such as:

    1. Clearing land for farming,

    2. Leveling and conditioning land,

    3. Purchasing and planting trees,

    4. Building irrigation canals and ditches,

    5. Laying irrigation pipes,

    6. Installing drain tile,

    7. Modifying channels or streams,

    8. Constructing earthen, masonry, or concrete tanks, reservoirs, or dams, and

    9. Building roads.

Business start-up and organizational costs.   You can elect to deduct up to $5,000 of business start-up costs and $5,000 of organizational costs paid or incurred after October 22, 2004. The $5,000 deduction is reduced by the amount your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized. See chapter 7.

  You elect to deduct start-up or organizational costs by claiming the deduction on the income tax return filed by the due date (including extensions) for the tax year in which the active trade or business begins. However, 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). Clearly indicate the election on your 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. The election applies when figuring taxable income for the current tax year and all subsequent years.

  You can choose to forgo the election by clearly electing to capitalize your start-up or organizational costs on an income tax return filed by the due date (including extensions) for the tax year in which the active trade or business begins. For more information about start-up and organizational costs, see chapter 7.

Crop production expenses.   The uniform capitalization rules generally require you to capitalize expenses incurred in producing plants. However, except for certain taxpayers required to use an accrual method of accounting, the capitalization rules do not apply to plants with a preproductive period of 2 years or less. For more information, see Uniform Capitalization Rules in chapter 6.

Timber.   Capitalize the cost of acquiring timber. Do not include the cost of land in the cost of the timber. You must generally capitalize direct costs incurred in reforestation. However, you can elect to deduct some forestation and reforestation costs. See Forestation and reforestation costs next. Reforestation costs include the following.
  1. Site preparation costs, such as:

    1. Girdling,

    2. Applying herbicide,

    3. Baiting rodents, and

    4. Clearing and controlling brush.

  2. The cost of seed or seedlings.

  3. Labor and tool expenses.

  4. Depreciation on equipment used in planting or seeding.

  5. Costs incurred in replanting to replace lost seedlings.

You can choose to capitalize certain indirect reforestation costs.

  These capitalized amounts are your basis for the timber. Recover your basis when you sell the timber or take depletion allowances when you cut the timber. See Depletion in chapter 7.

Forestation and reforestation costs.   You can elect to deduct up to $10,000 ($5,000 if married filing separately; $0 for a trust) of qualifying reforestation costs paid or incurred after October 22, 2004, for each qualified timber property. Any remaining costs can be amortized over an 84-month period. See chapter 7. If you make an election to deduct or amortize qualifying reforestation costs, you should create and maintain separate timber accounts for each qualified timber property. The accounts should include all reforestation treatments and the dates they were applied. Any qualified timber property that is subject to the deduction or amortization election cannot be included in any other timber account for which depletion is allowed. The timber account should be maintained until the timber is disposed of. For more information, see Notice 2006-47, 2006-20 I.R.B. 892, available at  
www.irs.gov/irb/2006-20_IRB/ar11.html.

  You elect to deduct forestation and reforestation costs by claiming the deduction on the income tax return filed by the due date (including extensions) for the tax year in which the expenses were paid or incurred. If you are filing Form T (Timber), Forest Activities Schedule, also complete Form T (Timber), Part IV. If you are not filing Form T (Timber), attach a statement to your return with the following information.
  • The unique stand identification numbers.

  • The total number of acres reforested during the tax year.

  • The nature of the reforestation treatments.

  • The total amounts of the qualified reforestation expenditures eligible to be amortized or deducted.

  However, 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). Clearly indicate the election on your 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.

   For more information about forestation and reforestation costs, see chapter 7.

  
For more information about timber, see Agriculture Handbook Number 731, Forest Landowners' Guide to the Federal Income Tax. You can view this publication on the Internet at  
www.fs.fed.us/publications.

Christmas tree cultivation.   If you are in the business of planting and cultivating Christmas trees to sell when they are more than 6 years old, capitalize expenses incurred for planting and stump culture and add them to the basis of the standing trees. Recover these expenses as part of your adjusted basis when you sell the standing trees or as depletion allowances when you cut the trees. For more information, see Timber Depletion under Depletion in chapter 7.

  You can deduct as business expenses the costs incurred for shearing and basal pruning of these trees. Expenses incurred for silvicultural practices, such as weeding or cleaning, and noncommercial thinning are also deductible as business expenses.

  Capitalize the cost of land improvements, such as road grading, ditching, and fire breaks, that have a useful life beyond the tax year. If the improvements do not have a determinable useful life, add their cost to the basis of the land. The cost is recovered when you sell or otherwise dispose of it. If the improvements have a determinable useful life, recover their cost through depreciation. Capitalize the cost of equipment and other depreciable assets, such as culverts and fences, to the extent you do not use them in planting Christmas trees. Recover these costs through depreciation.

Nondeductible Expenses

You cannot deduct personal expenses and certain other items on your tax return even if they relate to your farm.

Personal, Living, and Family Expenses

You cannot deduct certain personal, living, and family expenses as business expenses. These include rent and insurance premiums paid on property used as your home, life insurance premiums on yourself or your family, the cost of maintaining cars, trucks, or horses for personal use, allowances to minor children, attorneys' fees and legal expenses incurred in personal matters, and household expenses. Likewise, the cost of purchasing or raising produce or livestock consumed by you or your family is not deductible.

Other Nondeductible Items

You cannot deduct the following items on your tax return.

Loss of growing plants, produce, and crops.   Losses of plants, produce, and crops raised for sale are generally not deductible. However, you may have a deductible loss on plants with a preproductive period of more than 2 years. See chapter 11 for more information.

Repayment of loans.   You cannot deduct the repayment of a loan. However, if you use the proceeds of a loan for farm business expenses, you can deduct the interest on the loan. See Interest , earlier.

Estate, inheritance, legacy, succession, and gift taxes.   You cannot deduct estate, inheritance, legacy, succession, and gift taxes.

Loss of livestock.   You cannot deduct as a loss the value of raised livestock that die if you deducted the cost of raising them as an expense.

Losses from sales or exchanges between related persons.   You cannot deduct losses from sales or exchanges of property between you and certain related persons, including your spouse, brother, sister, ancestor, or lineal descendant. For more information, see chapter 2 of Publication 544, Sales and Other Dispositions of Assets.

Cost of raising unharvested crops.   You cannot deduct the cost of raising unharvested crops sold with land owned more than one year if you sell both at the same time and to the same person. Add these costs to the basis of the land to determine the gain or loss on the sale. For more information, see Section 1231 Gains and Losses in chapter 9.

Cost of unharvested crops bought with land.   Capitalize the purchase price of land, including the cost allocable to unharvested crops. You cannot deduct the cost of the crops at the time of purchase. However, you can deduct this cost in figuring net profit or loss in the tax year you sell the crops.

Cost related to gifts.   You cannot deduct costs related to your gifts of agricultural products or property held for sale in the ordinary course of your business. The costs are not deductible in the year of the gift or any later year. For example, you cannot deduct the cost of raising cattle or the cost of planting and raising unharvested wheat on parcels of land given as a gift to your children.

Club dues and membership fees.   Generally, you cannot deduct amounts you pay or incur for membership in any club organized for business, pleasure, recreation, or any other social purpose. This includes country clubs, golf and athletic clubs, hotel clubs, sporting clubs, airline clubs, and clubs operated to provide meals under circumstances generally considered to be conducive to business discussions.

Exception.   The following organizations will not be treated as a club organized for business, pleasure, recreation, or other social purposes, unless one of its main purposes is to conduct entertainment activities for members or their guests or to provide members or their guests with access to entertainment facilities.
  • Boards of trade.

  • Business leagues.

  • Chambers of commerce.

  • Civic or public service organizations.

  • Professional associations.

  • Trade associations.

  • Real estate boards.

Fines and penalties.   You cannot deduct fines and penalties, except penalties for exceeding marketing quotas, discussed earlier.

Losses From Operating a Farm

If your deductible farm expenses are more than your farm income, you have a loss from the operation of your farm. The amount of the loss you can deduct when figuring your taxable income may be limited. To figure your deductible loss, you must apply the following limits.

  • The at-risk limits.

  • The passive activity limits.

The following discussions explain these limits.

If your deductible loss after applying these limits is more than your other income for the year, you may have a net operating loss. See Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts.

If you do not carry on your farming activity to make a profit, your loss deduction may be limited by the not-for-profit rules. See Not-for-Profit Farming, later.

At-Risk Limits

The at-risk rules limit your deduction for losses from most business or income-producing activities, including farming. These rules limit the losses you can deduct when figuring your taxable income. The deductible loss from an activity is limited to the amount you have at risk in the activity.

You are at risk in any activity for:

  1. The money and adjusted basis of property you contribute to the activity, and

  2. Amounts you borrow for use in the activity if:

    1. You are personally liable for repayment, or

    2. You pledge property (other than property used in the activity) as security for the loan.

You are not at risk, however, for amounts you borrow for use in a farming activity from a person who has an interest in the activity (other than as a creditor) or a person related to someone (other than you) having such an interest.

For more information, see Publication 925.

Passive Activity Limits

A passive activity is generally any activity involving the conduct of any trade or business in which you do not materially participate. Generally, a rental activity is a passive activity.

If you have a passive activity, special rules limit the loss you can deduct in the tax year. You generally can deduct losses from passive activities only up to income from passive activities. Credits are similarly limited.

For more information, see Publication 925.

Excess Farm Loss Limit

For tax years beginning after 2009, excess farm losses (defined below) are not deductible if you received certain applicable subsidies. This limit applies to any farming businesses, other than a C corporation, that received a direct or counter-cyclical payment (or any payment in lieu of such payments) under title I of the Food, Conservation, and Energy Act of 2008, or from a Commodity Credit Corporation loan. Your farming losses are limited to the greater of:

  • $300,000 ($150,000 for a married person filing a separate return), or

  • The total net farm income for the prior five tax years.

Farming losses from casualty losses or losses by reason of disease or drought are disregarded for purposes of figuring this limitation. Also, the limitation on farm losses should be applied before the passive activity loss rules are applied.

For more details, see IRC section 461(j).

Excess farm loss.   Generally, an excess farm loss is the amount of your farming loss that exceeds the amount of the limitation (as described above). This loss can be determined by taking the excess of:
  • The total deductions for the tax year from your farming businesses, over

  • The total gross income or gain for the tax year from your farming businesses, plus the greater of:

    1. $300,000 ($150,000 for a married person filing a separate return), or

    2. The excess (if any) of the total gross income or gain from your farming businesses for the prior five tax years over the total deductions from your farming businesses for the prior five tax years.

  Excess farm losses that are disallowed can be carried forward to the next tax year and treated as a deduction from that year.

Not-for-Profit Farming

If you operate a farm for profit, you can deduct all the ordinary and necessary expenses of carrying on the business of farming on Schedule F. However, if you do not carry on your farming activity, or other activity you engage or invest in, to make a profit, you report the income from the activity on Form 1040, line 21, and you can deduct expenses of carrying on the activity only if you itemize your deductions on Schedule A (Form 1040). Also, there is a limit on the deductions you can take. You cannot use a loss from that activity to offset income from other activities.

Activities you do as a hobby, or mainly for sport or recreation, come under this limit. An investment activity intended only to produce tax losses for the investors also comes under this limit.

The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations.

In determining whether you are carrying on your farming activity for profit, all the facts are taken into account. No one factor alone is decisive. Among the factors to consider are whether:

  • You operate your farm in a businesslike manner;

  • The time and effort you spend on farming indicate you intend to make it profitable;

  • You depend on income from farming for your livelihood;

  • Your losses are due to circumstances beyond your control or are normal in the start-up phase of farming;

  • You change your methods of operation in an attempt to improve profitability;

  • You, or your advisors, have the knowledge needed to carry on the farming activity as a successful business;

  • You were successful in making a profit in similar activities in the past;

  • You make a profit from farming in some years and the amount of profit you make; and

  • You can expect to make a future profit from the appreciation of the assets used in the farming activity.

Presumption of profit.   Your farming or other activity is presumed carried on for profit if it produced a profit in at least 3 of the last 5 tax years, including the current year. Activities that consist primarily of breeding, training, showing, or racing horses are presumed carried on for profit if they produced a profit in at least 2 of the last 7 tax years, including the current year. The activity must be substantially the same for each year within this period. You have a profit when the gross income from an activity is more than the deductions for it.

  If a taxpayer dies before the end of the 5-year (or 7-year) period, the period ends on the date of the taxpayer's death.

  If your business or investment activity passes this 3- (or 2-) years-of-profit test, presume it is carried on for profit. This means the limits discussed here do not apply. You can take all your business deductions from the activity on Schedule F, even for the years that you have a loss. You can rely on this presumption in every case, unless the IRS shows it is not valid.

  If you fail the 3- (or 2-) years-of-profit test, you still may be considered to operate your farm for profit by considering the factors listed earlier.

Using the presumption later.   If you are starting out in farming and do not have 3 (or 2) years showing a profit, you may want to take advantage of this presumption later, after you have had the 5 (or 7) years of experience allowed by the test.

  You can choose to do this by filing Form 5213. Filing this form postpones any determination that your farming activity is not carried on for profit until 5 (or 7) years have passed since you first started farming. You must file Form 5213 within 3 years after the due date of your return for the year in which you first carried on the activity, or, if earlier, within 60 days after receiving a written notice from the IRS proposing to disallow deductions attributable to the activity.

  The benefit gained by making this choice is that the IRS will not immediately question whether your farming activity is engaged in for profit. Accordingly, it will not limit your deductions. Rather, you will gain time to earn a profit in 3 (or 2) out of the first 5 (or 7) years you carry on the farming activity. If you show 3 (or 2) years of profit at the end of this period, your deductions are not limited under these rules. If you do not have 3 (or 2) years of profit (and cannot otherwise show that you operated your farm for profit), the limit applies retroactively to any year in the 5-year (or 7-year) period with a loss.

  Filing Form 5213 automatically extends the period of limitations on any year in the 5-year (or 7-year) period to 2 years after the due date of the return for the last year of the period. The period is extended only for deductions of the activity and any related deductions that might be affected.

Limit on deductions and losses.   If your activity is not carried on for profit, take deductions only in the following order, only to the extent stated in the three categories, and, if you are an individual, only if you itemize them on Schedule A (Form 1040).

Category 1.   Deductions you can take for personal as well as for business activities are allowed in full. For individuals, all nonbusiness deductions, such as those for home mortgage interest, taxes, and casualty losses (see chapter 11), belong in this category. For the limits that apply to mortgage interest, see Publication 936.

Category 2.   Deductions that do not result in an adjustment to the basis of property are allowed next, but only to the extent your gross income from the activity is more than the deductions you take (or could take) under the first category. Most business deductions, such as those for fertilizer, feed, insurance premiums, utilities, wages, etc., belong in this category.

Category 3.   Business deductions that decrease the basis of property are allowed last, but only to the extent the gross income from the activity is more than deductions you take (or could take) under the first two categories. The deductions for depreciation, amortization, and the part of a casualty loss an individual could not deduct in category (1) belong in this category. Where more than one asset is involved, divide depreciation and these other deductions proportionally among those assets.

  
Individuals must claim the amounts in categories (2) and (3) above as miscellaneous deductions on Schedule A (Form 1040). They are subject to the 2%-of-adjusted-gross-income limit. See Publication 529, Miscellaneous Deductions, for information on this limit.

Partnerships and S corporations.   If a partnership or S corporation carries on a not-for-profit activity, these limits apply at the partnership or S corporation level. They are reflected in the individual shareholder's or partner's distributive shares.

More information.   For more information on not-for-profit activities, see Not-for-Profit Activities in Publication 535, chapter 1.


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