Table of Contents
This chapter explains how to figure, and report on your tax return, your gain or loss on the disposition of your property or debt and whether such gain or loss is ordinary or capital. Ordinary gain is taxed at the same rates as wages and interest income while capital gain is generally taxed at lower rates. Dispositions discussed in this chapter include sales, exchanges, foreclosures, repossessions, canceled debts, hedging transactions, and elections to treat cutting of timber as a sale or exchange.
Publication
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334 Tax Guide for Small Business
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523 Selling Your Home
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544 Sales and Other Dispositions of Assets
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550 Investment Income and Expenses
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908 Bankruptcy Tax Guide
Form (and Instructions)
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Sch D (Form 1040) Capital Gains and Losses
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Sch F (Form 1040) Profit or Loss From Farming
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1099-A Acquisition or Abandonment of Secured Property
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1099-C Cancellation of Debt
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4797 Sales of Business Property
See chapter 16 for information about getting publications and forms.
If you sell, exchange, or otherwise dispose of your property, you usually have a gain or a loss. This section explains certain rules for determining whether any gain you have is taxable, and whether any loss you have is deductible.
A sale is a transfer of property for money or a mortgage, note, or other promise to pay money. An exchange is a transfer of property for other property or services.
You usually realize a gain or loss when you sell or exchange property. If the amount you realize from a sale or exchange of property is more than its adjusted basis, you will have a gain. If the adjusted basis of the property is more than the amount you realize, you will have a loss.
Certain exchanges of property are not taxable. This means any gain from the exchange is not recognized, and any loss cannot be deducted. Your gain or loss will not be recognized until you sell or otherwise dispose of the property you receive.
The exchange of property for the same kind of property is the most common type of nontaxable exchange. To qualify for treatment as a like-kind exchange, the property traded and the property received must be both of the following.
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Qualifying property.
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Like-kind property.
These two requirements are discussed later.
Example.
You traded an old tractor with an adjusted basis of $1,500 for a new one. The new tractor costs $30,000. You were allowed $8,000 for the old tractor and paid $22,000 cash. You have no recognized gain or loss on the transaction regardless of the adjusted basis of your old tractor and the basis of the new tractor is $23,500, the adjusted basis of the old tractor plus the cash paid.
If you had sold the old tractor to a third party for $8,000 and bought a new one, you would have a recognized gain or loss on the sale of your old tractor equal to the difference between the amount realized and the adjusted basis of the old tractor. In this case, the taxable gain would be $6,500 ($8,000 - $1,500).
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Property you use for personal purposes, such as your home and family car.
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Stock in trade or other property held primarily for sale, such as crops and produce.
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Stocks, bonds, or notes. However, see Qualifying property above.
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Other securities or evidences of indebtedness, such as accounts receivable.
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Partnership interests.
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Office furniture, fixtures, and equipment (asset class 00.11).
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Information systems, such as computers and peripheral equipment (asset class 00.12).
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Data handling equipment except computers (asset class 00.13).
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Automobiles and taxis (asset class 00.22).
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Light general purpose trucks (asset class 00.241).
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Heavy general purpose trucks (asset class 00.242).
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Tractor units for use over-the-road (asset class 00.26).
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Trailers and trailer-mounted containers (asset class 00.27).
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Industrial steam and electric generation and/or distribution systems (asset class 00.4).
www.ntis.gov/products/naics.aspx or by calling 1-800-553-NTIS (1-800-553-6847) or (703) 605-6000. A CD-ROM version with search option is also available from NTIS. NAICS class 333111, Farm Machinery and Equipment Manufacturing, includes most machinery and equipment used in a farming business.
Example 1.
You trade farmland that cost $30,000 for $10,000 cash and other land to be used in farming with a FMV of $50,000. You have a realized gain of $30,000 ($50,000 FMV of new land + $10,000 cash − $30,000 basis of old farmland = $30,000 realized gain). However, only $10,000, the cash received, is recognized (included in income).
Example.
You used a grey pickup truck in your farming business. Your sister used a red pickup truck in her landscaping business. In December 2008, you exchanged your grey pickup truck, plus $200, for your sister's red pickup truck. At that time, the FMV of the grey pickup truck was $7,000 and its adjusted basis was $6,000. The FMV of the red pickup truck was $7,200 and its adjusted basis was $1,000. You realized a gain of $1,000 (the $7,200 FMV of the red pickup truck, minus the grey pickup truck's $6,000 adjusted basis, minus the $200 you paid). Your sister realized a gain of $6,200 (the $7,000 FMV of the grey pickup truck plus the $200 you paid, minus the $1,000 adjusted basis of the red pickup truck).
However, because this was a like-kind exchange, you recognized no gain. Your basis in the red pickup truck was $6,200 (the $6,000 adjusted basis of the grey pickup truck plus the $200 you paid). She recognized gain only to the extent of the money she received, $200. Her basis in the grey pickup truck was $1,000 (the $1,000 adjusted basis of the red pickup truck minus the $200 received, plus the $200 gain recognized).
In 2009, you sold the red pickup truck to a third party for $7,000. Because you sold it within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. On your tax return for 2009, you must report your $1,000 gain on the 2008 exchange. You also report a loss on the sale as $200 (the adjusted basis of the red pickup truck, $7,200 (its $6,200 basis plus the $1,000 gain recognized), minus the $7,000 realized from the sale).
In addition, your sister must report on her tax return for 2009 the $6,000 balance of her gain on the 2008 exchange. Her adjusted basis in the grey pickup truck is increased to $7,000 (its $1,000 basis plus the $6,000 gain recognized).
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Dispositions due to the death of either related person.
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Involuntary conversions.
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Dispositions where it is established to the satisfaction of the IRS that neither the exchange nor the disposition has, as a main purpose, the avoidance of federal income tax.
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Transfer and receive properties in two or more exchange groups.
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Transfer or receive more than one property within a single exchange group.
No gain or loss is recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse, or a former spouse if incident to divorce. This rule does not apply if the recipient is a nonresident alien. Nor does this rule apply to a transfer in trust to the extent the liabilities assumed and the liabilities on the property are more than the property's adjusted basis.
Any transfer of property to a spouse or former spouse on which gain or loss is not recognized is not considered a sale or exchange. The recipient's basis in the property will be the same as the adjusted basis of the giver immediately before the transfer. This carryover basis rule applies whether the adjusted basis of the transferred property is less than, equal to, or greater than either its FMV at the time of transfer or any consideration paid by the recipient. This rule applies for determining loss as well as gain. Any gain recognized on a transfer in trust increases the basis.
For more information on transfers of property incident to divorce, see Property Settlements in Publication 504, Divorced or Separated Individuals.
Generally, you will have a capital gain or loss if you sell or exchange a capital asset (defined below). You may also have
a capital gain if your section 1231 transactions result in a net gain. See
Section 1231 Gains and Losses
in
chapter 9.
To figure your net capital gain or loss, you must classify your gains and losses as either ordinary or capital (and your capital gains or losses as either short-term or long-term).
Your net capital gains may be taxed at a lower tax rate than ordinary income. See Capital Gains Tax Rates , later. Your deduction for a net capital loss may be limited. See Treatment of Capital Losses , later.
Almost everything you own and use for personal purposes or investment is a capital asset.
The following items are examples of capital assets.
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A home owned and occupied by you and your family.
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Household furnishings.
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A car used for pleasure. If your car is used both for pleasure and for farm business, it is partly a capital asset and partly a noncapital asset, defined later.
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Stocks and bonds. However, there are special rules for gains on qualified small business stock. For more information on this subject, see Gains on Qualified Small Business Stock and Losses on Section 1244 (Small Business) Stock in chapter 4 of Publication 550.
Where you report a capital gain or loss depends on how long you own the asset before you sell or exchange it. The time you own an asset before disposing of it is the holding period.
If you hold a capital asset 1 year or less, the gain or loss resulting from its disposition is short term. Report it in Part I, Schedule D (Form 1040). If you hold a capital asset longer than 1 year, the gain or loss resulting from its disposition is long term. Report it in Part II, Schedule D (Form 1040).
The totals for short-term capital gains and losses and the totals for long-term capital gains and losses must be figured separately.
If your capital losses are more than your capital gains, you must claim the difference even if you do not have ordinary income to offset it. For taxpayers other than corporations, the yearly limit on the capital loss you can deduct is $3,000 ($1,500 if you are married and file a separate return). If your other income is low, you may not be able to use the full $3,000. The part of the $3,000 you cannot use becomes part of your capital loss carryover (discussed next).
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Your net loss on Schedule D (Form 1040), line 16, is more than the yearly limit (line 21).
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The amount shown on Form 1040, line 41 (your taxable income without your deduction for exemptions), is less than zero.
The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. These lower rates are called the maximum capital gains rates.
The term “net capital gain” means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss.
See Schedule D (Form 1040) and the Instructions for Schedule D (Form 1040).
Noncapital assets include property such as inventory and depreciable property used in a trade or business. A list of properties that are not capital assets is provided in the Instructions for Schedule D (Form 1040).
Hedging transactions are transactions that you enter into in the normal course of business primarily to manage the risk of interest rate or price changes, or currency fluctuations, with respect to borrowings, ordinary property, or ordinary obligations. Ordinary property or obligations are those that cannot produce capital gain or loss if sold or exchanged.
A commodity futures contract is a standardized, exchange-traded contract for the sale or purchase of a fixed amount of a commodity at a future date for a fixed price. The holder of an option on a futures contract has the right (but not the obligation) for a specified period of time to enter into a futures contract to buy or sell at a particular price. A forward contract is generally similar to a futures contract except that the terms are not standardized and the contract is not exchange traded.
Businesses may enter into commodity futures contracts or forward contracts and may acquire options on commodity futures contracts as either of the following.
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Hedging transactions.
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Transactions that are not hedging transactions.
Futures transactions with exchange-traded commodity futures contracts that are not hedging transactions, generally, result in capital gain or loss and are, generally, subject to the mark-to-market rules discussed in Publication 550. There is a limit on the amount of capital losses you can deduct each year. Hedging transactions are not subject to the mark-to-market rules.
If, as a farmer-producer, to protect yourself from the risk of unfavorable price fluctuations, you enter into commodity forward contracts, futures contracts, or options on futures contracts and the contracts cover an amount of the commodity within your range of production, the transactions are generally considered hedging transactions. They can take place at any time you have the commodity under production, have it on hand for sale, or reasonably expect to have it on hand.
The gain or loss on the termination of these hedges is generally ordinary gain or loss. Farmers who file their income tax returns on the cash method report any profit or loss on the hedging transaction on Schedule F, line 10.
Gain or loss on transactions that hedge supplies of a type regularly used or consumed in the ordinary course of its trade or business may be ordinary.
If you have numerous transactions in the commodity futures market during the year, you must be able to show which transactions are hedging transactions. Clearly identify a hedging transaction on your books and records before the end of the day you entered into the transaction. It may be helpful to have separate brokerage accounts for your hedging and speculation transactions.The identification must not only be on, and retained as part of, your books and records but must specify both the hedging transaction and the item(s) or aggregate risk that is being hedged. Although the identification of the hedging transaction must be made before the end of the day it was entered into, you have 35 days after entering into the transaction to identify the hedged item(s) or risk.
For more information on the tax treatment of futures and options contracts, see Commodity Futures and Section 1256 Contracts Marked to Market in Publication 550.
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Cash method.
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Farm-price method.
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Unit-livestock-price method.
This part discusses the sale or exchange of livestock used in your farm business. Gain or loss from the sale or exchange of this livestock may qualify as a section 1231 gain or loss. However, any part of the gain that is ordinary income from the recapture of depreciation is not included as section 1231 gain. See chapter 9 for more information on section 1231 gains and losses and the recapture of depreciation under section 1245.
The rules discussed here do not apply to the sale of livestock held primarily for sale to customers. The sale of this livestock is reported on Schedule F. See chapter 3. Also, special rules apply to sales or exchanges caused by weather-related conditions. See chapter 3.Example 1.
You discover an animal that you intend to use for breeding purposes is sterile. You dispose of it within a reasonable time. This animal was held for breeding purposes.
Example 2.
You retire and sell your entire herd, including young animals that you would have used for breeding or dairy purposes had you remained in business. These young animals were held for breeding or dairy purposes. Also, if you sell young animals to reduce your breeding or dairy herd because of drought, these animals are treated as having been held for breeding or dairy purposes. See Sales Caused by Weather-Related Conditions in chapter 3.
Example 3.
You are in the business of raising hogs for slaughter. Customarily, before selling your sows, you obtain a single litter of pigs that you will raise for sale. You sell the brood sows after obtaining the litter. Even though you hold these brood sows for ultimate sale to customers in the ordinary course of your business, they are considered to be held for breeding purposes.
Example 4.
You are in the business of raising registered cattle for sale to others for use as breeding cattle. The business practice is to breed the cattle before sale to establish their fitness as registered breeding cattle. Your use of the young cattle for breeding purposes is ordinary and necessary for selling them as registered breeding cattle. Such use does not demonstrate that you are holding the cattle for breeding purposes. However, those cattle you held as additions or replacements to your own breeding herd to produce calves are considered to be held for breeding purposes, even though they may not actually have produced calves. The same applies to hog and sheep breeders.
Example 5.
You breed, raise, and train horses for racing purposes. Every year you cull horses from your racing stable. In 2009, you decided that to prevent your racing stable from getting too large to be effectively operated, you must cull six horses that had been raced at public tracks in 2008. These horses are all considered held for sporting purposes.
Example.
A farmer sold a breeding cow on January 8, 2009, for $1,250. Expenses of the sale were $125. The cow was bought July 2, 2005, for $1,300. Depreciation (not less than the amount allowable) was $867.
| Gross sales price | $1,250 | |
| Cost (basis) | $1,300 | |
| Minus: Depreciation deduction | 867 | |
| Unrecovered cost (adjusted basis) |
$ 433 | |
| Expense of sale | 125 | 558 |
| Gain realized | $ 692 | |
Special rules apply to dispositions of land converted to farming use after March 1, 1986. Any gain realized on the disposition of converted wetland or highly erodible cropland is treated as ordinary income. Any loss on the disposition of such property is treated as a long-term capital loss.
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It is mostly soil that, in its undrained condition, is saturated, flooded, or ponded long enough during a growing season to develop an oxygen-deficient state that supports the growth and regeneration of plants growing in water.
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It is saturated by surface or groundwater at a frequency and duration sufficient to support mostly plants that are adapted for life in saturated soil.
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It supports, under normal circumstances, mostly plants that grow in saturated soil.
Standing timber you held as investment property is a capital asset. Gain or loss from its sale is capital gain or loss reported on Schedule D (Form 1040). If you held the timber primarily for sale to customers, it is not a capital asset. Gain or loss on its sale is ordinary business income or loss. It is reported on Schedule F, line 1 (purchased timber) or line 4 (raised timber).
Farmers who cut timber on their land and sell it as logs, firewood, or pulpwood usually have no cost or other basis for that timber. Amounts realized from these sales, and the expenses incurred in cutting, hauling, etc., are ordinary farm income and expenses reported on Schedule F.
Different rules apply if you owned the timber longer than 1 year and elect to treat timber cutting as a sale or exchange or you enter into a cutting contract, discussed below.
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Own or hold a contractual right to cut the timber for a period of more than 1 year before it is cut, and
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Cut the timber for sale or use in your trade or business.
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You are the owner of the timber.
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You held the timber longer than 1 year before its disposal.
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You kept an economic interest in the timber.
The sale of your farm will usually involve the sale of both nonbusiness property (your home) and business property (the land and buildings used in the farm operation and perhaps machinery and livestock). If you have a gain from the sale, you may be allowed to exclude the gain on your home. For more information, see Publication 523, Selling Your Home.
The gain on the sale of your business property is taxable. A loss on the sale of your business property to an unrelated person is deducted as an ordinary loss. Your taxable gain or loss on the sale of property used in your farm business is taxed under the rules for section 1231 transactions. See chapter 9. Losses from personal-use property, other than casualty or theft losses, are not deductible. If you receive payments for your farm in installments, your gain is taxed over the period of years the payments are received, unless you elect not to use the installment method of reporting the gain. See chapter 10 for information about installment sales.
When you sell your farm, the gain or loss on each asset is figured separately. The tax treatment of gain or loss on the sale of each asset is determined by the classification of the asset. Each of the assets sold must be classified as one of the following.
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Capital asset held 1 year or less.
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Capital asset held longer than 1 year.
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Property (including real estate) used in your business and held 1 year or less (including draft, breeding, dairy, and sporting animals held less than the holding periods discussed earlier under Livestock).
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Property (including real estate) used in your business and held longer than 1 year (including only draft, breeding, dairy, and sporting animals held for the holding periods discussed earlier).
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Property held primarily for sale or which is of the kind that would be included in inventory if on hand at the end of your tax year.
Example.
You sell your farm, including your main home, which you have owned since December 1999. You realize gain on the sale as follows.
| Farm | Farm | ||
| With | Home | Without | |
| Home | Only | Home | |
| Selling price | $182,000 | $58,000 | $124,000 |
| Cost (or other basis) | 40,000 | 10,000 | 30,000 |
| Gain | $142,000 | $48,000 | $94,000 |
You must report the $94,000 gain from the sale of the property used in your farm business. All or a part of that gain may have to be reported as ordinary income from the recapture of depreciation or soil and water conservation expenses. Treat the balance as section 1231 gain.
The $48,000 gain from the sale of your home is not taxable as long as you meet the requirements explained later under Sale of your home, later.
Example.
You bought a 600-acre farm for $700,000. The farm included land and buildings. The purchase contract designated $600,000 of the purchase price to the land. You later sold 60 acres of land on which you had installed a fence. Your adjusted basis for the part of your farm sold is $60,000 (1/10 of $600,000), plus any unrecovered cost (cost not depreciated) of the fence on the 60 acres at the time of sale. Use this amount to determine your gain or loss on the sale of the 60 acres.
Example.
Assume that in the preceding example there was no breakdown of the $700,000 purchase price between land and buildings. However, in the year of purchase, local taxes on the entire property were based on assessed valuations of $420,000 for land and $140,000 for improvements, or a total of $560,000. The assessed valuation of the land is 3/4 (75%) of the total assessed valuation. Multiply the $700,000 total purchase price by 75% to figure basis of $525,000 for the 600 acres of land. The unadjusted basis of the 60 acres you sold would then be $52,500 (1/10 of $525,000).
If you do not make payments you owe on a loan secured by property, the lender may foreclose on the loan or repossess the property. The foreclosure or repossession is treated as a sale or exchange from which you may realize gain or loss. This is true even if you voluntarily return the property to the lender. You may also realize ordinary income from cancellation of debt if the loan balance is more than the FMV of the property.
Example 1.
Ann paid $200,000 for land used in her farming business. She paid $15,000 down and borrowed the remaining $185,000 from a bank. Ann is not personally liable for the loan (nonrecourse debt), but pledges the land as security. The bank foreclosed on the loan 2 years after Ann stopped making payments. When the bank foreclosed, the balance due on the loan was $180,000 and the FMV of the land was $170,000. The amount Ann realized on the foreclosure was $180,000, the debt canceled by the foreclosure. She figures her gain or loss on Form 4797, Part I, by comparing the amount realized ($180,000) with her adjusted basis ($200,000). She has a $20,000 deductible loss.
Example 2.
Assume the same facts as in Example 1 except the FMV of the land was $210,000. The result is the same. The amount Ann realized on the foreclosure is $180,000, the debt canceled by the foreclosure. Because her adjusted basis is $200,000, she has a deductible loss of $20,000, which she reports on Form 4797, Part I.
Example 3.
Assume the same facts as in Example 1 above except Ann is personally liable for the loan (recourse debt). In this case, the amount she realizes is $170,000. This is the canceled debt ($180,000) up to the FMV of the land ($170,000). Ann figures her gain or loss on the foreclosure by comparing the amount realized ($170,000) with her adjusted basis ($200,000). She has a $30,000 deductible loss, which she figures on Form 4797, Part I. She is also treated as receiving ordinary income from cancellation of debt. That income is $10,000 ($180,000 − $170,000). This is the part of the canceled debt not included in the amount realized. She reports this income on Schedule F, line 10.
The abandonment of property is a disposition of property. You abandon property when you voluntarily and permanently give up possession and use of the property with the intention of ending your ownership, but without passing it on to anyone else.
The abandonment loss is deducted in the tax year in which the loss is sustained. Report the loss on Form 4797, Part II, line 10.
Example.
Abena lost her contract with the local poultry processor and abandoned poultry facilities that she built for $100,000. At the time she abandoned the facilities, her mortgage balance was $85,000. She has a deductible loss of $66,554 (her adjusted basis). If the bank later forecloses on the loan or repossesses the facilities, she will have to figure her gain or loss as discussed, earlier, under Foreclosure or Repossession .
Worksheet 8-1.Worksheet for Foreclosures and Repossessions
| Part 1. Figure your income from cancellation of debt. (Note: If you are not personally liable for the debt, you do not have income from cancellation of debt. Skip Part 1 and go to Part 2.) |
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| 1. Enter the amount of outstanding debt immediately before the transfer of property reduced by any amount for which you remain personally liable after the transfer of property | |
| 2. Enter the FMV of the transferred property | |
| 3.Ordinary income from cancellation of debt.* Subtract line 2 from line 1. If less than zero, enter zero |
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| Part 2. Figure your gain or loss from foreclosure or repossession. | |
| 4. If you completed Part 1, enter the smaller of line 1 or line 2. If you did not complete Part 1, enter the outstanding debt immediately before the transfer of property. | |
| 5. Enter any proceeds you received from the foreclosure sale | |
| 6. Add lines 4 and 5 | |
| 7. Enter the adjusted basis of the transferred property | |
| 8. Gain or loss from foreclosure or repossession. Subtract line 7 from line 6 |
| * The income may not be taxable. See Cancellation of debt . |
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