Publication 225 (2017), Farmer's Tax Guide

For use in preparing 2017 Returns


Publication 225 - Introductory Material

Introduction

You are in the business of farming if you cultivate, operate, or manage a farm for profit, either as owner or tenant. A farm includes livestock, dairy, poultry, fish, fruit, and truck farms. It also includes plantations, ranches, ranges, and orchards and groves.

This publication explains how the federal tax laws apply to farming. Use this publication as a guide to figure your taxes and complete your farm tax return. If you need more information on a subject, get the specific IRS tax publication covering that subject. We refer to many of these free publications throughout this publication. See chapter 16 for information on ordering these publications.

The explanations and examples in this publication reflect the Internal Revenue Service's interpretation of tax laws enacted by Congress, Treasury regulations, and court decisions. However, the information given does not cover every situation and is not intended to replace the law or change its meaning. This publication covers subjects on which a court may have rendered a decision more favorable to taxpayers than the interpretation of the Service. Until these differing interpretations are resolved by higher court decisions, or in some other way, this publication will continue to present the interpretation of the Service.

The IRS Mission.

Provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all.

Comments and suggestions.

We welcome your comments about this publication and your suggestions for future editions.

You can send us comments from IRS.gov/FormsPubs. Or you can write to:

Internal Revenue Service
Tax Forms and Publications
1111 Constitution Ave. NW, IR-6526
Washington, DC 20224

 

Although we cannot respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax products.

Ordering forms and publications.

Visit IRS.gov/FormsPubs to download forms and publications. Otherwise, you can go to IRS.gov/FormsPubs to order current and prior-year forms and instructions. Your order should arrive within 10 business days.

Tax questions.

If you have a tax question not answered by this publication, check IRS.gov and How To Get Tax Help at the end of this publication.

Comments on IRS enforcement actions.

The Small Business and Agricultural Regulatory Enforcement Ombudsman and 10 Regional Fairness Boards were established to receive comments from small business about federal agency enforcement actions. The Ombudsman will annually evaluate the enforcement activities of each agency and rate its responsiveness to small business. If you wish to comment on the enforcement actions of the IRS, you can:

  • Call 1-888-734-3247,

  • Fax your comments to 202-481-5719,

  • Write to
    Office of the National Ombudsman
    U.S. Small Business Administration
    409 3rd Street, S.W.
    Washington, DC 20416

  • Send an email to ombudsman@sba.gov, or

  • Complete and submit a Federal Agency Comment Form online at
    www.sba.gov/ombudsman/comment.

 

Treasury Inspector General for Tax Administration (TIGTA).

If you want to confidentially report misconduct, waste, fraud, or abuse by an IRS employee, you can call 1-800-366-4484 (1-800-877-8339 for TTY/TDD users). You can remain anonymous.

Farm tax classes.

Many state Cooperative Extension Services conduct farm tax workshops in conjunction with the IRS. Contact your county or regional extension office for more information.

Rural Tax Education website.

The Rural Tax Education website is a source for information concerning agriculturally related income and deductions and self-employment tax. The website is available for farmers and ranchers, other agricultural producers, Extension educators, and any one interested in learning about the tax side of the agricultural community. Members of the National Farm Income Tax Extension Committee are contributors for the website and the website is hosted by Utah State University Cooperative Extension. You can visit the website at www.ruraltax.org.

Future Developments

The IRS has created a page on IRS.gov for information about Pub. 225, at
IRS.gov/Pub225. Information about recent developments affecting Pub. 225 will be posted on that page.

What's New for 2017

The following items highlight a number of administrative and tax law changes for 2017. They are discussed in more detail throughout the publication.

Disaster relief for Hurricanes Harvey, Irma, and Maria. Disaster tax relief was enacted for those impacted by Hurricane Harvey, Irma, or Maria, including provisions that modified (the limit on the deduction for charitable contributions/the treatment of withdrawal of retirement funds/disaster-related employment relief/the calculation of casualty and theft losses). See Pub. 976, Disaster Relief, for more information.

Standard mileage rate. For 2017, the standard mileage rate for the cost of operating your car, van, pickup, or panel truck for each mile of business use is 53.5 cents. See chapter 4.

Increased section 179 expense deduction dollar limits. The maximum amount you can elect to deduct for most section 179 property you placed in service in 2017 is $510,000. This limit is reduced by the amount by which the cost of the property placed in service during the tax year exceeds $2,030,000. See chapter 7.

Disaster losses. A new Section D has been added to Form 4684 to make an election (or revoke a prior election) to deduct a loss attributable to a federally declared disaster in the tax year immediately before the disaster year. See Pub. 547 for more information about disaster losses. See chapter 11.

Maximum net earnings. The maximum net self-employment earnings subject to the social security part (12.4%) of the self-employment tax is $127,200 for 2017, up from $118,500 in both 2016 and 2015. There is no maximum limit on earnings subject to the Medicare part (2.9%) or, if applicable, the Additional Medicare Tax (0.9%). See chapter 12.

Social security and Medicare tax for 2017. The social security tax rate is 6.2% each for the employee and employer, unchanged from 2016. The social security wage base limit is $127,200.The Medicare tax rate is 1.45% each for the employee and employer, unchanged from 2016. There is no wage base limit for Medicare tax. See chapter 13.

New certification program for professional employer organizations. The Tax Increase Prevention Act of 2014 required the IRS to establish a voluntary certification program for professional employer organizations (PEOs). PEOs handle various payroll administration and tax reporting responsibilities for their business clients and are typically paid a fee based on payroll costs. To become and remain certified under the certification program, certified professional employer organizations (CPEOs) must meet various requirements described in sections 3511 and 7705 and related published guidance. Certification as a CPEO may affect the employment tax liabilities of both the CPEO and its customers. A CPEO is generally treated as the employer of any individual who performs services for a customer of the CPEO and is covered by a contract described in section 7705(e) (2) between the CPEO and the customer (CPEO contract), but only for wages and other compensation paid to the individual by the CPEO. For more information, go to IRS.gov/CPEO. Also see Rev. Proc. 2017-14, 2017-3 I.R.B. 426, available at IRS.gov/irb/ 2017-03_IRB/ar14.html. See chapter 13.

Qualified small business payroll tax credit for increasing research activities. For tax years beginning after December 31, 2015, a qualified small business may elect to claim up to $250,000 of its credit for increasing research activities as a payroll tax credit against the employer's share of social security tax. The portion of the credit used against the employer's share of social security tax is allowed in the first calendar quarter beginning after the date that the qualified small business filed its income tax return. The first Form 943 that you can claim this credit on is Form 943 filed for calendar year 2017. For more information, see the Instructions for Form 943. See chapter 13.

What's New for 2018

Phase down of the special depreciation allowance. The special depreciation allowance will be phased down to 40% for certain property placed in service after December 31, 2017, and certain plants bearing fruits and nuts or grafted after December 31, 2017. See chapter 7.

Maximum net earnings. The maximum net self-employment earnings subject to the social security part of the self-employment tax for 2018 will be discussed in the 2017 Pub. 334. See chapter 12.

Social security and Medicare tax for 2018. The employee and employer tax rates for social security and the maximum amount of wages subject to social security tax for 2018 will be discussed in Pub. 51 (For use in 2018).The Medicare tax rate for 2018 will also be discussed in Pub. 51 (For use in 2018). There is no limit on the amount of wages subject to Medicare tax. See chapter 13.

Reminders

The following reminders and other items may help you file your tax return.

IRS e-file (Electronic Filing)

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You can file your tax returns electronically using an IRS e-file option. The benefits of IRS e-file include faster refunds, increased accuracy, and acknowledgment of IRS receipt of your return. You can use one of the following IRS e-file options.

  • Use an authorized IRS e-file provider.

  • Use a personal computer.

  • Visit a Volunteer Income Tax Assistance (VITA) or Tax Counseling for the Elderly (TCE) site.

For details on these fast filing methods, see your income tax package.

Principal agricultural activity codes. You must enter on line B of Schedule F (Form 1040) a code that identifies your principal agricultural activity. It is important to use the correct code because this information will identify market segments of the public for IRS Taxpayer Education programs. The U.S. Census Bureau also uses this information for its economic census. See the list of Principal Agricultural Activity Codes on page 2 of Schedule F (Form 1040).

Publication on employer identification numbers (EINs). Pub. 1635, Understanding Your Employer Identification Number, provides general information on EINs. Topics include how to apply for an EIN and how to complete Form SS-4.

Change of address. If you change your home address, you should use Form 8822, Change of Address, to notify the IRS. If you change your business address, you should use Form 8822-B, Change of Address or Responsible Party — Business, to notify the IRS. Be sure to include your suite, room, or other unit number.

Reportable transactions. You must file Form 8886, Reportable Transaction Disclosure Statement, to report certain transactions. You may have to pay a penalty if you are required to file Form 8886 but do not do so. Reportable transactions include (1) transactions the same as or substantially similar to tax avoidance transactions identified by the IRS, (2) transactions offered to you under conditions of confidentiality and for which you paid an advisor a minimum fee, (3) transactions for which you have or a related party has a right to a full or partial refund of fees if all or part of the intended tax consequences from the transaction are not sustained, (4) transactions that result in losses of at least $2 million in any single year or $4 million in any combination of years, and (5) transactions with asset holding periods of 45 days or less and that result in a tax credit of more than $250,000. For more information, see the Instructions for Form 8886.

Form W-4 for 2017. You should make new Forms W-4 available to your employees and encourage them to check their income tax withholding for 2017. Those employees who owed a large amount of tax or received a large refund for 2016 may need to submit a new Form W-4.

Form 1099-MISC. Generally, file Form 1099-MISC if you pay at least $600 in rents, services, and other miscellaneous payments in your farming business to an individual (for example, an accountant, an attorney, or a veterinarian) who is not your employee. Payments made to corporations for medical and health care payments, including payments made to veterinarians, generally must be reported on Form 1099.

Limited liability company (LLC). For purposes of this publication, a limited liability company (LLC) is a business entity organized in the United States under state law. Unlike a partnership, all of the members of an LLC have limited personal liability for its debts. An LLC may be classified for federal income tax purposes as a partnership, corporation, or an entity disregarded as separate from its owner by applying the rules in Regulations section 301.7701-3. See Pub. 3402 for more details.

Photographs of missing children. The Internal Revenue Service is a proud partner with the National Center for Missing & Exploited Children® (NCMEC). Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) (24 hours a day, 7 days a week) if you recognize a child.

1. Importance of Records

Introduction

A farmer, like other taxpayers, must keep records to prepare an accurate income tax return and determine the correct amount of tax. This chapter explains the benefits of keeping records, what kinds of records you must keep, and how long you must keep them for federal tax purposes.

Tax records are not the only type of records you need to keep for your farming business. You should also keep records that measure your farm's financial performance. This publication only discusses tax records.

The Farm Financial Standards Council has produced a publication that provides a detailed explanation of the recommendations of the Council for financial reporting and analysis. For information on recordkeeping, you can purchase and download 2017 Financial Guidelines for Agriculture at www.ffsc.org. For more information, contact Countryside Marketing, Inc. in the following manner.

  • Call 262-253-6902.

  • Send a fax to 262-253-6903.

  • Write to:
    Farm Financial Standards Council
    N78 W14573 Appleton Ave., #287
    Menomonee Falls, WI 53051.

 

Topics - This chapter discusses:

  • Benefits of recordkeeping

  • Kinds of records to keep

  • How long to keep records

Useful Items - You may want to see:

Publication

  • 51 (Circular A), Agricultural Employer's Tax Guide

  • 463 Travel, Entertainment, Gift, and Car Expenses

See chapter 16 for information about getting publications.

Benefits of Recordkeeping

Everyone in business, including farmers, must keep appropriate records. Recordkeeping will help you do the following.

Monitor the progress of your farming business.

You need records to monitor the progress of your farming business. Records can show whether your business is improving, which items are selling, or what changes you need to make. Records can help you make better decisions that may increase the likelihood of business success.

Prepare your financial statements.

You need records to prepare accurate financial statements. These include income (profit and loss) statements, cash flow statements, and balance sheets. These statements can help you in dealing with your bank or creditors and help you to manage your farm business.

Identify source of receipts.

You will receive money, property, and/or services from many sources. Your records can identify the source of your receipts. You need this information to separate farm from nonfarm receipts and taxable from nontaxable income.

Keep track of deductible expenses.

You may forget expenses when you prepare your tax return unless you record them when they occur.

Prepare your tax returns.

You need records to prepare your tax return. For example, your records must support the income, expenses, and credits you report. Generally, these are the same records you use to monitor your farming business and prepare your financial statements.

Support items reported on tax returns.

You must keep your business records available at all times for inspection by the IRS. If the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of records will speed up the examination.

Kinds of Records To Keep

Except in a few cases, the law does not require any specific kind of records. You can choose any recordkeeping system suited to your farming business that clearly shows, for example, your income and expenses.

You should set up your recordkeeping system using an accounting method that clearly shows your income for your tax year. If you are in more than one business, you should keep a complete and separate set of records for each business. A corporation should keep minutes of board of directors' meetings. See
chapter 2 for more information.

Your recordkeeping system should include a summary of your business transactions. This summary is ordinarily made in accounting journals and ledgers. For example, they must show your gross income, as well as your deductions and credits. In addition, you must keep supporting documents. Purchases, sales, payroll, and other transactions you have in your business generate supporting documents such as invoices and receipts. These documents contain the information you need to record in your journals and ledgers.

It is important to keep these documents because they support the entries in your journals and ledgers and on your tax return. Keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense.

Electronic records.

All requirements that apply to hard copy books and records also apply to electronic storage systems that maintain tax books and records. When you replace hard copy books and records, you must maintain the electronic storage systems for as long as they are material to the administration of tax law.

An electronic storage system is any system for preparing or keeping your records either by electronic imaging or by transfer to an electronic storage media. The electronic storage system must index, store, preserve, retrieve, and reproduce the electronically stored books and records in legible format. All electronic storage systems must provide a complete and accurate record of your data that is accessible to the IRS.

Electronic storage systems are also subject to the same controls and retention guidelines as those imposed on your original hard copy books and records. The original hard copy books and records may be destroyed provided that the electronic storage system has been tested to establish that the hard copy books and records are being reproduced in compliance with IRS requirements for an electronic storage system and procedures are established to ensure continued compliance with all applicable rules and regulations. You still have the responsibility of retaining any other books and records that are required to be retained.

The IRS may test your electronic storage system, including the equipment used, indexing methodology, software, and retrieval capabilities. This test is not considered an examination and the results must be shared with you. If your electronic storage system meets the requirements mentioned earlier, you will be in compliance. If not, you may be subject to penalties for non-compliance, unless you continue to maintain your original hard copy books and records in a manner that allows you and the IRS to determine your correct tax. For details on electronic storage system requirements, see Rev. Proc. 97-22. You can find Rev. Proc. 97-22 on page 9 of Internal Revenue Bulletin 1997-13 at
IRS.gov/Pub/irs-irbs/irb97-13.pdf.

Travel, transportation, entertainment, and gift expenses.

Specific recordkeeping rules apply to these expenses. For more information, see Pub. 463.

Employment taxes.

There are specific employment tax records you must keep. For a list, see Pub. 51 (Circular A).

Excise taxes.

See How To Claim a Credit or Refund in chapter 14 for the specific records you must keep to verify your claim for credit or refund of excise taxes on certain fuels.

Assets.

Assets are the property, such as machinery and equipment, you own and use in your business. You must keep records to verify certain information about your business assets. You need records to figure your annual depreciation deduction and the gain or (loss) when you sell the assets. Your records should show all the following.

  • When and how you acquired the asset.

  • Purchase price.

  • Cost of any improvements.

  • Section 179 deduction taken.

  • Deductions taken for depreciation.

  • Deductions taken for casualty losses, such as losses resulting from fires or storms.

  • How you used the asset.

  • When and how you disposed of the asset.

  • Selling price.

  • Expenses of sale.

 

The following are examples of records that may show this information.

  • Purchase and sales invoices.

  • Real estate closing statements.

  • Canceled checks.

  • Bank statements.

 

Financial account statements as proof of payment.

If you do not have a canceled check, you may be able to prove payment with certain financial account statements prepared by financial institutions. These include account statements prepared for the financial institution by a third party. These account statements must be legible. The following table lists acceptable account statements.

IF payment is by... THEN the statement must show the...
Check
  • Check number.

  • Amount.

  • Payee's name.

  • Date the check amount was posted to the account by the financial institution.

Electronic funds
transfer
  • Amount transferred.

  • Payee's name.

  • Date the transfer was posted to the account by the financial institution.

Credit card
  • Amount charged.

  • Payee's name.

  • Transaction date.

 

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Proof of payment of an amount, by itself, does not establish you are entitled to a tax deduction. You should also keep other documents, such as credit card sales slips and invoices, to show that you also incurred the cost.

Tax returns.

Keep copies of your filed tax returns. They help in preparing future tax returns and making computations if you file an amended return. Keep copies of your information returns such as Form 1099, Schedule K-1, and Form W-2.

How Long To Keep Records

You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Keep records that support an item of income or a deduction appearing on a return until the period of limitations for the return runs out. A period of limitations is the period of time after which no legal action can be brought. Generally, that means you must keep your records for at least 3 years from when your tax return was due or filed or within 2 years of the date the tax was paid, whichever is later. However, certain records must be kept for a longer period of time, as discussed below.

Employment taxes.

If you have employees, you must keep all employment tax records for at least 4 years after the date the tax becomes due or is paid, whichever is later.

Assets.

Keep records relating to property until the period of limitations expires for the year in which you dispose of the property in a taxable disposition. You must keep these records to figure any depreciation, amortization, or depletion deduction and to figure your basis for computing gain or (loss) when you sell or otherwise dispose of the property.

You may need to keep records relating to the basis of property longer than the period of limitation. Keep those records as long as they are important in figuring the basis of the original or replacement property. Generally, this means as long as you own the property and, after you dispose of it, for the period of limitations that applies to you. For example, if you received property in a nontaxable exchange, you must keep the records for the old property, as well as for the new property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition. For more information on basis, see chapter 6.

Records for nontax purposes.

When your records are no longer needed for tax purposes, do not discard them until you check to see if you have to keep them longer for other purposes. For example, your insurance company or creditors may require you to keep them longer than the IRS does.

2. Accounting Methods

Introduction

You must use an accounting method that clearly shows the income and expenses used to figure your taxable income. You must also file an income tax return for an annual accounting period called a tax year.

This chapter discusses accounting methods. For information on accounting periods, see Pub. 538, Accounting Periods and Methods, and the Instructions for Form 1128, Application To Adopt, Change, or Retain a Tax Year.

Topics - This chapter discusses:

  • Cash method

  • Accrual method

  • Farm inventory

  • Special methods of accounting

  • Changes in methods of accounting

Useful Items - You may want to see:

Publication

  • 538 Accounting Periods and Methods

  • 535 Business Expenses

Form (and Instructions)

  • 1128 Application To Adopt, Change, or Retain a Tax Year

  • 3115 Application for Change in Accounting Method

See chapter 16 for information about getting publications and forms.

Accounting Methods

An accounting method is a set of rules used to determine when and how your income and expenses are reported on your tax return. Your accounting method includes not only your overall method of accounting, but also the accounting treatment you use for any material item.

Facts and circumstances affect whether an item is material. Generally, an item considered material for financial statement purposes is also considered material for income tax purposes. See Pub. 538 for more information.

You generally choose an accounting method for your farm business when you file your first income tax return that includes a Schedule F (Form 1040), Profit or Loss From Farming. If you later want to change your accounting method, you generally must get IRS approval. How to obtain IRS approval is discussed later under Changes in Methods of Accounting .

Types of accounting methods.

Generally, you can use any of the following accounting methods. Each method is discussed in detail below.

  • Cash method.

  • Accrual method.

  • Special methods of accounting for certain items of income and expenses.

  • Combination (hybrid) method using elements of two or more of the above methods.

 

Business and other items.

You can account for business and personal items using different accounting methods. For example, you can figure your business income under an accrual method, even if you use the cash method to figure personal items.

Two or more businesses.

If you operate two or more separate and distinct businesses, you can use a different accounting method for each business. Generally, no business is separate and distinct unless a complete and separate set of books and records is maintained for each business.

Cash Method

Most farmers use the cash method because they find it easier to keep records using the cash method. However, certain farm corporations and partnerships and all tax shelters must use an accrual method of accounting. See Accrual Method Required , later. Also, see Inventory , later.

Income

Under the cash method, include in your gross income all items of income you actually or constructively received during the tax year. Items of income include money received as well as property or services received. If you receive property or services, you must include the fair market value (FMV) of the property or services in income. See chapter 3 for information on how to report farm income on your income tax return.

Constructive receipt.

Income is constructively received when an amount is credited to your account or made available to you without restriction. You do not need to have possession of the income for it to be treated as income for the tax year. If you authorize someone to be your agent and receive income for you, you are considered to have received the income when your agent receives it. Income is not constructively received if your receipt of the income is subject to substantial restrictions or limitations.

Delaying receipt of income.

You cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. You must report the income in the year the money or property is received or made available to you without restriction.

Example.

Frances Jones, a farmer who uses the cash method of accounting, was entitled to receive a $10,000 payment on a grain contract in December 2017. She was told in December that her payment was available. She requested not to be paid until January 2018. Frances must include this payment in her 2017 income because it was made available to her in 2017.

Debts paid by another person or canceled.

If your debts are paid by another person or are canceled by your creditors, you may have to report part or all of this debt relief as income. If you receive income in this way, you constructively receive the income when the debt is canceled or paid. See Cancellation of Debt in chapter 3 for more information.

Deferred payment contract.

If you sell an item under a deferred payment contract that calls for payment in a future year, there is no constructive receipt in the year of sale. However, if the sales contract states that you have the right to the proceeds of the sale from the buyer at any time after delivery of the item, then you must include the sales price in income in the year of the sale, regardless of when you actually receive payment.

Example.

You are a farmer who uses the cash method and a calendar tax year. You sell grain in December 2017 under a bona fide arm's-length contract that calls for payment in 2018. You include the proceeds from the sale in your 2018 gross income since that is the year payment is received. However, if the contract states that you have the right to the proceeds from the buyer at any time after the grain is delivered, you must include the sales price in your 2017 income, even if payment is received in the following year.

Repayment of income.

If you include an amount in income and in a later year you have to repay all or part of it, then you can usually deduct the repayment in the year repaid. If the repayment is more than $3,000, a special rule applies. For details, see Repayments in chapter 11 of Pub. 535, Business Expenses.

Expenses

Under the cash method, generally you deduct expenses in the tax year you pay them. This includes business expenses for which you contest liability. However, you may not be able to deduct an expense paid in advance or you may be required to capitalize certain costs, as explained under Uniform Capitalization Rules in chapter 6. See chapter 4 for information on how to deduct farm business expenses on your income tax return.

Prepayment.

Generally, you cannot deduct expenses paid in advance. This rule applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year.

Example.

On November 1, 2017, you signed and paid $3,600 for a 3-year (36-month) insurance contract for equipment. In 2017, you are allowed to deduct only $200 (2/36 x $3,600) of the cost of the policy that is attributable to 2017. In 2018, you'll be able to deduct $1,200 (12/36 x $3,600); in 2019, you'll be able to deduct $1,200 (12/36 x $3,600); and in 2020 you'll be able to deduct the remaining balance of $1,000.

An exception applies if the expense qualifies for the 12-month rule. See Pub. 538 for more information and examples.

See chapter 4 for special rules for prepaid farm supplies and prepaid livestock feed.

Accrual Method

Under an accrual method of accounting, you generally report income in the year earned and deduct or capitalize expenses in the year incurred. The purpose of an accrual method of accounting is to correctly match income and expenses. Certain businesses engaged in farming must use an accrual method of accounting for its farm business and for sales and purchases of inventory items. See Accrual Method Required and Farm Inventory , later.

Income

Generally, you include an amount in income for the tax year in which all events that fix your right to receive the income have occurred, and you can determine the amount with reasonable accuracy. Under this rule, include an amount in income on the earliest of the following dates.

  • When you receive payment.

  • When the income amount is due to you.

  • When you earn the income.

  • When title passes.

 

If you use an accrual method of accounting, complete Part III of Schedule F (Form 1040) to report your income.

Inventory

If you keep an inventory, generally you must use an accrual method of accounting to determine your gross income. An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. See Pub. 538 for more information. Also, see Farm Inventory , later, for more information on items that must be included in inventory by farmers, and inventory valuation methods for farmers.

Expenses

Under an accrual method of accounting, you generally deduct or capitalize a business expense when both of the following apply.

  1. The all-events test has been met. This test is met when:

    1. All events have occurred that fix the fact that you have a liability, and

    2. The amount of the liability can be determined with reasonable accuracy.

  2. Economic performance has occurred.

 

Economic performance.

Generally, you cannot deduct or capitalize a business expense until economic performance occurs. If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or as the property is used. If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services.

Example.

Jane, who is a farmer, uses a calendar tax year and an accrual method of accounting. She entered into a contract with ABC Farm Consulting in 2016. The contract stated that Jane pay ABC Farm Consulting $2,000 in December 2016. It further stipulates that ABC Farm Consulting will develop a plan for integrating her farm with a larger farm operation based in a neighboring state by March 1, 2017. Jane paid ABC Farm Consulting $2,000 in December 2016. Integration of operations according to the plan began in May 2017 and they completed the integration in December 2017.

Economic performance for Jane's liability in the contract occurs as the services are provided. Jane incurs the $2,000 cost in 2017, even though a payment was made in the prior year.

An exception to the economic performance rule allows certain recurring items to be treated as incurred during a tax year even though economic performance has not occurred. For more information, see Economic Performance in Pub. 538.

Special rule for related persons.

Business expenses and interest owed to a related person who uses the cash method of accounting are not deductible until you make the payment and the corresponding amount is includible in the related person's gross income. Determine the relationship for this rule as of the end of the tax year for which the expense or interest would otherwise be deductible.

Accrual Method Required

Generally, the following businesses, if engaged in farming, must use an accrual method of accounting.

  1. A corporation (other than a family corporation) that had gross receipts of more than $1,000,000 for any tax year beginning after 1975.

  2. A family corporation that had gross receipts of more than $25,000,000 for any tax year beginning after 1985.

  3. A partnership with a corporation as a partner, if that corporation meets the requirements of (1) or (2) above.

  4. A tax shelter.

 

Note.

Items (1), (2), and (3) above do not apply to an S corporation or a business operating a nursery or sod farm, or the raising or harvesting of trees (other than fruit and nut trees).

Family corporation.

A family corporation is generally a corporation that meets one of the following ownership requirements.

  • Members of the same family own at least 50% of the total combined voting power of all classes of stock entitled to vote and at least 50% of the total shares of all other classes of stock of the corporation.

  • Members of two families have owned, directly or indirectly, since October 4, 1976, at least 65% of the total combined voting power of all classes of voting stock and at least 65% of the total shares of all other classes of the corporation's stock.

  • Members of three families have owned, directly or indirectly, since October 4, 1976, at least 50% of the total combined voting power of all classes of voting stock and at least 50% of the total shares of all other classes of the corporation's stock. In addition, substantially all the stock not owned by the three families is owned directly by either the employees of the corporation, family members of employees, or a trust for the benefit of the employees.

For more information on family corporations, see Internal Revenue Code section 447.

Tax shelter.

A tax shelter is a partnership, noncorporate enterprise, or S corporation that meets either of the following tests.

  1. Its principal purpose is the avoidance or evasion of federal income tax.

  2. It is a farming syndicate. A farming syndicate is an entity that meets either of the following tests.

    1. Interests in the activity have been offered for sale in an offering required to be registered with a federal or state agency with the authority to regulate the offering of securities for sale.

    2. More than 35% of the losses during the tax year are allocable to limited partners or limited entrepreneurs.

 

A "limited partner" is one whose personal liability for partnership debts is limited to the money or other property the partner contributed or is required to contribute to the partnership.

A "limited entrepreneur" is one who has an interest in an enterprise other than as a limited partner and does not actively participate in the management of the enterprise.

Farm Inventory

If you are required to keep an inventory, you should keep a complete record of your inventory as part of your farm records. This record should show the actual count or measurement of the inventory. It should also show all factors that enter into its valuation, including quality and weight, if applicable. Below are some items that could be included in inventory.

Hatchery business.

If you are in the hatchery business, and use an accrual method of accounting, you must include in inventory eggs in the process of incubation.

Products held for sale.

All harvested and purchased farm products held for sale or for feed or seed, such as grain, hay, silage, concentrates, cotton, tobacco, etc., must be included in inventory.

Supplies.

Supplies acquired for sale or that become a physical part of items held for sale must be included in inventory. Deduct the cost of supplies in the year used or consumed in operations. Do not include incidental supplies in inventory as these are deductible in the year of purchase.

Livestock.

Livestock held primarily for sale must be included in inventory. Livestock held for draft, breeding, or dairy purposes can either be depreciated or included in inventory. Also see Unit-livestock-price method , later. If you are in the business of breeding and raising chinchillas, mink, foxes, or other fur-bearing animals, these animals are livestock for inventory purposes.

Growing crops.

Generally, growing crops are not required to be included in inventory. However, if the crop has a preproductive period of more than 2 years, you may have to capitalize (or include in inventory) costs associated with the crop. See Uniform capitalization rules below. Also, see Uniform Capitalization Rules in
chapter 6.

Items to include in inventory.

Your inventory should include all items held for sale, or for use as feed, seed, etc., whether raised or purchased, that are unsold at the end of the year.

Uniform capitalization rules.

The following applies if you are required to use an accrual method of accounting.

  • The uniform capitalization rules apply to all costs of raising a plant, even if the preproductive period of raising a plant is 2 years or less.

  • The costs of animals are subject to the uniform capitalization rules.

 

Inventory valuation methods.

The following methods, described below, are those generally available for valuing inventory. The method you use must conform to generally accepted accounting principles for similar businesses and must clearly reflect income.

  • Cost.

  • Lower of cost or market.

  • Farm-price method.

  • Unit-livestock-price method.

 

Cost and lower of cost or market methods.

See Pub. 538 for information on these valuation methods.

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If you value your livestock inventory at cost or the lower of cost or market, you do not need IRS approval to change to the unit-livestock-price method. However, if you value your livestock inventory using the farm-price method, then you must obtain permission from the IRS to change to the unit-livestock-price method.

Farm-price method.

Under this method, each item, whether raised or purchased, is valued at its market price less the direct cost of disposition. Market price is the current price at the nearest market in the quantities you usually sell. Cost of disposition includes broker's commissions, freight, hauling to market, and other marketing costs. If you use this method, you must use it for your entire inventory, except that livestock can be inventoried under the unit-livestock-price method.

Unit-livestock-price method.

This method recognizes the difficulty of establishing the exact costs of producing and raising each animal. You group or classify livestock according to type and age and use a standard unit price for each animal within a class or group. The unit price you assign should reasonably approximate the normal costs incurred in producing the animals in such classes. Unit prices and classifications are subject to approval by the IRS on examination of your return. You must annually reevaluate your unit livestock prices and adjust the prices upward or downward to reflect increases or decreases in the costs of raising livestock. IRS approval is not required for these adjustments. Any other changes in unit prices or classifications do require IRS approval.

If you use this method, include all raised livestock in inventory, regardless of whether they are held for sale or for draft, breeding, sport, or dairy purposes. This method accounts only for the increase in cost of raising an animal to maturity. It does not provide for any decrease in the animal's market value after it reaches maturity. Also, if you raise cattle, you are not required to inventory hay you grow to feed your herd.

Do not include sold or lost animals in the year-end inventory. If your records do not show which animals were sold or lost, treat the first animals acquired as sold or lost. The animals on hand at the end of the year are considered those most recently acquired.

You must include in inventory all livestock purchased primarily for sale. You can choose either to include in inventory or depreciate livestock purchased for draft, breeding, sport, or dairy purposes. However, you must be consistent from year to year, regardless of the method you have chosen. You cannot change your method without obtaining approval from the IRS.

You must include in inventory animals purchased after maturity or capitalize them at their purchase price. If the animals are not mature at purchase, increase the cost at the end of each tax year according to the established unit price. However, in the year of purchase, do not increase the cost of any animal purchased during the last 6 months of the year. This "no increase" rule does not apply to tax shelters which must make an adjustment for any animal purchased during the year. It also does not apply to taxpayers that must make an adjustment to reasonably reflect the particular period in the year in which animals are purchased, if necessary to avoid significant distortions in income.

Uniform capitalization rules.

A farmer can determine costs required to be allocated under the uniform capitalization rules by using the farm-price or unit-livestock-price inventory method. This applies to any plant or animal, even if the farmer does not hold or treat the plant or animal as inventory property.

Cash Versus Accrual Method

The following examples compare the cash and accrual methods of accounting.

Example 1.

You are a farmer who uses an accrual method of accounting. You keep your books on the calendar year basis. You sell grain in December 2017 but you are not paid until January 2018. Because the accrual method was used and 2017 was the tax year in which the grain was sold, you must include both the sales proceeds and deduct the costs incurred in producing the grain on your 2017 tax return.

Example 2.

Assume the same facts as in Example 1 except that you use the cash method and there was no constructive receipt of the sales proceeds in 2017. Under the cash method, you include the sales proceeds in income in 2018, the year you receive payment. Deduct the costs of producing the grain in the year you pay for them.

Special Methods of Accounting

There are special methods of accounting for certain items of income and expense.

Crop method.

If you do not harvest and dispose of your crop in the same tax year that you plant it, you can, with IRS approval, use the crop method of accounting. You cannot use the crop method for any tax return, including your first tax return, unless you receive approval from the IRS. Under this method, you deduct the entire cost of producing the crop, including the expense of seed or young plants, in the year you realize income from the crop.

See chapter 4 for details on deducting the costs of operating a farm. Also see Regulations section 1.162-12.

Other special methods.

Other special methods of accounting apply to the following items.

 

Combination Method

Generally, you can use any combination of cash, accrual, and special methods of accounting if the combination clearly shows your income and expenses and you use it consistently. However, the following restrictions apply.

  • If you use the cash method for figuring your income, you must use the cash method for reporting your expenses.

  • If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income.

 

Changes in Methods of Accounting

A change in your method of accounting includes a change in:

  • Your overall method, such as from the cash method to an accrual method, and

  • Your treatment of any material item, such as a change in your method of valuing inventory (for example, a change from the farm-price method to the unit-livestock-price method, discussed earlier).

Generally, once you have set up your accounting method, you must receive approval from the IRS before you can change either an overall method of accounting or the accounting treatment of any material item. A user fee may be required for any non-automatic change requests.

To obtain approval, you must generally file Form 3115. However, there are instances when you can obtain automatic consent to change certain methods of accounting. For more information, see the Instructions for Form 3115. Also, see Pub. 538.

3. Farm Income

Introduction

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

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

Accounting method.

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

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

Topics - This chapter discusses:

  • Schedule F

  • Sales of farm products

  • Rents (including crop shares)

  • Agricultural program payments

  • Income from cooperatives

  • Cancellation of debt

  • Income from other sources

  • Income averaging for farmers

Useful Items - You may want to see:

Publication

  • 525 Taxable and Nontaxable Income

  • 544 Sales and Other Dispositions of Assets

  • 550 Investment Income and Expenses

  • 908 Bankruptcy Tax Guide

  • 925 Passive Activity and At-Risk Rules

  • 4681 Canceled Debts, Foreclosures, Repossessions, and Abandonments

Form (and Instructions)

  • 982 Reduction of Tax Attributes Due to Discharge of Indebtedness

  • Sch E (Form 1040) Supplemental
    Income and Loss

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

  • 1099-G Certain Government Payments

  • 1099-PATR Taxable Distributions
    Received From Cooperatives

  • 4797 Sales of Business Property

  • 4835 Farm Rental Income and
    Expenses

See chapter 16 for information about getting publications and forms.

Schedule F (Form 1040)

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

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Corporations use Form 1120 to report the income or loss from regular farming operations.

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

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

Income reported on Schedule F doesn't include gains or losses from sales or other dispositions of the following farm assets.

  • Land.

  • Depreciable farm equipment.

  • Buildings and structures.

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

 

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

Sales of Farm Products

Where to report.

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

 

Schedule F.

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

Example.

In 2016, you bought 20 feeder calves for $27,000 for resale. You sold them in 2017 for $35,000. You report the $35,000 sales price on Schedule F, line 1a, subtract your $27,000 basis on line 1b, and report the resulting $8,000 profit on line 1c.

Form 4797.

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

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

Item Sold Schedule F* Form 4797**
Farm products raised for sale X  
Farm products bought for resale X  
Farm assets not held primarily for sale, such as livestock held for draft, breeding, sport, or dairy purposes (bought or raised), equipment   X
* See the Instructions for Schedule F for more information.
** See the Instructions for Form 4797 for more information.

Sale by agent.

If your agent sells your farm products, you have constructive receipt of the income when your agent receives payment and you must include the net proceeds from the sale in gross income for the year the agent receives payment. This applies even if your agent pays you in a later year. For a discussion on constructive receipt of income, see Cash Method under Accounting Methods in chapter 2.

Sales Caused by Weather-Related Conditions

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

  • Your principal trade or business is farming.

  • You use the cash method of accounting.

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

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

 

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Disaster assistance and emergency relief for individuals and businesses. Special tax law provisions may help taxpayers and businesses recover financially from the impact of a disaster, especially when the federal government declares their location to be a major disaster area. Get the latest tax relief guidance in disaster situations at IRS.gov/uac/tax-relief-in-disaster-situations and in disaster area losses - agriculture tax tips at IRS.gov/businesses/small-businesses-self-employed/disaster-assistance-and-emergency-relief-for-individuals-and-businesses.

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

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

Usual business practice.

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

Connection with affected area.

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

Classes of livestock.

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

Amount to be postponed.

Follow these steps to figure the amount of gain to be postponed for each class of animals.

  1. Divide the total income realized from the sale of all livestock in the class during the tax year by the total number of such livestock sold. For this purpose, don't treat any postponed gain from the previous year as income received from the sale of livestock.

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

 

Example.

You are a calendar year taxpayer and you normally sell 100 head of beef cattle a year. As a result of drought, you sold 135 head during 2016. You realized $236,250 from the sale ($236,250 ÷ 135= $1,750 per head). On August 10, 2016, as a result of drought, the affected area was declared a disaster area eligible for federal assistance. The income you can postpone until 2017 is $61,250 [($236,250 ÷ 135) × 35].

How to postpone gain.

To postpone gain, attach a statement to your tax return for the year of the sale. The statement must include your name and address and give the following information for each class of livestock for which you're postponing gain.

  • A statement that you're postponing gain under section 451(e).

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

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

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

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

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

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

 

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

Rents (Including Crop Shares)

The rent you receive for the use of your farmland is generally rental income, not farm income. However, the rent is farm income if:

  1. Your arrangement with your tenant provides that the you will materially participate in the production or management of production of the farm products on the land, and

  2. You materially participate.

See Landlord Participation in Farming in chapter 12.

Pasture income and rental.

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

Crop Shares

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

If you receive rent in the form of crop shares or livestock, the rental income is included in self-employment income if:

  1. Your arrangement with your tenant provides that the you will materially participate in the production or management of production of the farm products on the land, and

  2. You materially participate.

See Landlord Participation in Farming in chapter 12. Report the rental income on Schedule F.

If

  1. Your arrangement with your tenant doesn’t provide that you will materially participate in the production or management of production of the farm products on the land, or

  2. You don't materially participate in operating the farm, report this income on Form 4835 and carry the net income or loss to Schedule E (Form 1040).

The income isn't included in self-employment income.

Crop shares you use to feed livestock.

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

Crop shares you give to others (gift).

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

Example.

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

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

Crop share loss.

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

Agricultural Program Payments

You must include in income most government payments, such as those for approved conservation practices, livestock indemnity payments, or livestock forage disaster payments whether you receive them in cash, materials, services, or commodity certificates. However, you can exclude from income some payments you receive under certain cost-sharing conservation programs. See Cost-Sharing Exclusion (Improvements) , later.

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

Commodity Credit Corporation (CCC) Loans

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

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

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

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

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

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

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

Form 1099-A.

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

Market Gain

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

  • If you elected to include the CCC loan in income in the year you received it, don’t include the market gain in income. However, reduce (adjust) the basis of the commodity for the amount of the market gain.

  • If you didn’t include the CCC loan in income in the year received, include the market gain in your income.

 

The following examples show how to report market gain.

Example 1.

Mike Green is a cotton farmer. He uses the cash method of accounting and files his tax return on a calendar year basis. He has deducted all expenses incurred in producing the cotton and has a zero basis in the commodity. In 2016, Mike pledged 1,000 pounds of cotton as collateral for a CCC loan of $2,000 (a loan rate of $2.00 per pound). In 2017, he repaid the loan and redeemed the cotton for $1,500 when the world price was $1.50 per pound (lower than the loan amount). Later in 2017, he sold the cotton for $2,500.

The market gain on the redemption was $.50 ($2.00 – $1.50) per pound. Mike realized total market gain of $500 ($.50 x 1,000 pounds). How he reports this market gain and figures his gain or loss from the sale of the cotton depends on whether he included CCC loans in income in 2016.

Included CCC loan.

Mike reported the $2,000 CCC loan as income for 2016 on Schedule F, line 5a, so he is treated as if he sold the cotton for $2,000 when he pledged it and repurchased the cotton for $1,500 when he redeemed it. The $500 market gain isn’t recognized on the redemption. He reports it for 2017 as an agricultural program payment on Schedule F, line 4a but doesn't include it as a taxable amount on line 4b.

Mike's basis in the cotton after he redeemed it was $1,500, which is the redemption (repurchase) price paid for the cotton. His gain from the sale is $1,000 ($2,500 – $1,500). He reports the $2,500 sale on line 1a and the $1,500 basis on line 1b . After subtracting his basis from the sale, Mike will have a $1,000 gain for 2017 on Schedule F, on line 1c.

Excluded CCC loan.

Mike didn’t elect to report the $2,000 CCC loan as income and therefore didn’t include it on his 2016 Schedule F. When he paid $1,500 to pay off the loan in 2017, he must recognize $500 of income from market gain.

Example 2.

The facts are the same as in Example 1 except that, instead of selling the cotton for $2,500 after redeeming it, Mike entered into an option-to-purchase contract with a cotton buyer before redeeming the cotton. Under that contract, Mike authorized the cotton buyer to pay the CCC loan on Mike's behalf. In 2017, the cotton buyer repaid the loan for $1,500 and immediately exercised his option, buying the cotton for $1,500. How Mike reports the $500 market gain on the redemption of the cotton and figures his gain or loss from its sale depends on whether he included CCC loans in income in 2016.

Included CCC loan.

As in Example 1, Mike is treated as though he sold the cotton for $2,000 when he pledged it and repurchased the cotton for $1,500 when the cotton buyer redeemed it for him. The $500 market gain isn’t recognized on the redemption. Mike reports it for 2017 as an agricultural program payment on Schedule F, line 4a, but doesn't include it as a taxable amount on line 4b.

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

Excluded CCC loan.

As in Example 1, Mike didn't report the $2,000 loan as income in 2016 and must recognize $500 of income from market gain in 2017.

Conservation Reserve Program (CRP)

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

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

Crop Insurance and Crop Disaster Payments

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

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

Election to postpone reporting until the following year.

You can postpone reporting some or all crop insurance proceeds as income until the year following the year the physical damage occurred if you meet all the following conditions.

  • You use the cash method of accounting.

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

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

 

Deferral isn't permitted for proceeds received from revenue insurance policies.

To postpone reporting some or all crop insurance proceeds received in 2017, report the amount you received on Schedule F, line 6a, but don't include it as a taxable amount on line 6b. Check the box on line 6c and attach a statement to your tax return. The statement must include your name and address and contain the following information.

  • A statement that you're making an election under section 451(d) and Regulations section 1.451-6.

  • The specific crop or crops physically destroyed or damaged.

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

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

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

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

 

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

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

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

 

Feed Assistance and Payments

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

Include in income:

  • The market value of donated feed,

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

  • Any cost reimbursement you receive.

 

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

Cost-Sharing Exclusion (Improvements)

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

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

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

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

    2. $2.50 times the number of affected acres.

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

 

Qualifying programs.

If the three tests listed above are met, you can exclude part or all of the payments from the following programs.

  • The rural clean water program authorized by the Federal Water Pollution Control Act.

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

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

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

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

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

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

  • Certain small watershed programs, listed later.

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

 

Small watershed programs.

If the three tests listed earlier are met, you can exclude part or all of the payments you receive under the following programs for improvements made in connection with a watershed.

  • The programs under the Watershed Protection and Flood Prevention Act.

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

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

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

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

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

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

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

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

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

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

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

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

 

Income realized.

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

Value of the improvement.

You determine the value of the improvement by multiplying its fair market value (defined in chapter 6) by a fraction. The numerator of the fraction is the total cost of the improvement (all amounts paid either by you or by the government for the improvement) reduced by the sum of the following items.

  • Any government payments under a program not listed earlier.

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

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

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

Excludable portion.

The excludable portion is the present fair market value of the right to receive annual income from the affected acreage of the greater of the following amounts.

  1. 10% of the prior average annual income from the affected acreage. The prior average annual income is the average of the gross receipts from the affected acreage for the last 3 tax years before the tax year in which you started to install the improvement.

  2. $2.50 times the number of affected acres.

 

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

Example.

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

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

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

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

 

Effects of the exclusion.

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

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

How to report the exclusion.

Attach a statement to your tax return (or amended return) for the tax year you receive the last government payment for the improvement. The statement must include the following information.

  • The dollar amount of the cost funded by the government payment.

  • The value of the improvement.

  • The amount you're excluding.

 

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

Recapture.

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

Electing not to exclude payments.

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

Other Payments

You must include most other government program payments in income.

Fertilizer and Lime

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

Improvements

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

Payment to More Than One Person

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

Report the total amount reported to you as the payee of record on Schedule F. However, don't report as a taxable amount any amount belonging to someone else.

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

Income From Cooperatives

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

Form 1099-PATR.

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

Patronage Dividends

You generally report patronage dividends as income on Schedule F for the tax year you receive them. They include the following items.

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

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

  • The fair market value of other property.

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

If you can't determine what the dividend is for, report it as income on Schedule F, lines 3a and 3b.

Qualified written notice of allocation.

If you receive a qualified written notice of allocation as part of a patronage dividend, you must generally include its stated dollar value in your income on Schedule F, in the year you receive it. A written notice of allocation is qualified if at least 20% of the patronage dividend is paid in money or by qualified check and either of the following conditions is met.

  1. The notice must be redeemable in cash for at least 90 days after it's issued, and you must have received a written notice of your right of redemption at the same time as the written notice of allocation.

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

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

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

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

 

Qualified check.

A qualified check is any instrument that's redeemable in money and meets both of the following requirements.

  • It's part of a patronage dividend that also includes a qualified written notice of allocation for which you met condition 2(c) above.

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

 

Loss on redemption.

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

Nonqualified notice of allocation.

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

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

Buying or selling capital assets or depreciable property.

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

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

Example.

On July 1, 2016, Mr. Brown, a patron of a cooperative association, bought a machine for his dairy farm business from the association for $2,900. The machine has a life of 7 years under MACRS (as provided in the Table of Class Lives and Recovery Periods in Appendix B of Pub. 946). Mr. Brown files his return on a calendar year basis. For 2016, he claimed a depreciation deduction of $311, using the 10.71% depreciation rate from the 150% declining balance, half-year convention table (shown in Table A-14 in Appendix A of Pub. 946). On July 2, 2017, the cooperative association paid Mr. Brown a $300 cash patronage dividend for buying the machine. Mr. Brown adjusts the basis of the machine and figures his depreciation deduction for 2017 (and later years) as follows.

Cost of machine on July 1, 2016 $2,900
Minus: 2016 depreciation $311  
  2017 cash dividend 300 611
Adjusted basis for
depreciation for 2017:
$2,289
Depreciation rate: 1 ÷ 6½ (remaining recovery period as of 1/1/2017) = 15.38% × 1.5 = 23.07%
Depreciation deduction for 2017
($2,289 × 23.07%)
$528

 

Exceptions.

If the dividends are for buying or selling capital assets or depreciable property you didn't own at any time during the year you received the dividends, you must include them on Schedule F, unless one of the following rules applies.

  • If the dividends relate to a capital asset you held for more than 1 year for which a loss was or would have been deductible, treat them as gain from the sale or exchange of a capital asset held for more than 1 year.

  • If the dividends relate to a capital asset for which a loss wasn't or wouldn't have been deductible, don't report them as income (ordinary or capital gain).

 

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

Personal purchases.

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

Per-Unit Retain Certificates

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

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

Qualified certificates.

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

Nonqualified certificates.

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

Cancellation of Debt

This section explains the general rule for including canceled debt in income and the exceptions to the general rule. For more information on canceled debt, see Pub. 4681.

General Rule

Generally, if your debt is canceled or forgiven, other than as a gift or bequest to you, you must include the canceled amount in gross income for tax purposes. Report the canceled amount on Schedule F, if you incurred the debt in your farming business. If the debt is a nonbusiness debt, report the canceled amount as other income on Form 1040.

Special rules apply to C and S corporations and partnerships. See section 108(i), Regulations sections 1.108(i)-0 and 1.108(i)-2, and Pub. 4681 for details.

Form 1099-C.

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

Exceptions

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

Price reduced after purchase.

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

Deductible debt.

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

Example.

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

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

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

 

Exclusions

Don't include canceled debt in income in the following situations.

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

  2. The cancellation takes place when you're insolvent.

  3. The canceled debt is a qualified farm debt.

  4. The canceled debt is a qualified real property business debt (in the case of a taxpayer other than a C corporation). See Pub. 334, chapter 5.

  5. The canceled debt is qualified principal residence indebtedness which is discharged before 2017.

 

The exclusions don't apply in the following situations:

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

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

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

 

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

Debt.

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

Bankruptcy and Insolvency

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

Bankruptcy.

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

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

Insolvency.

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

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

Example.

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

Reduction of tax attributes.

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

Order of reduction.

You must use the excluded canceled debt to reduce the following tax attributes in the order listed unless you elect to reduce the basis of depreciable property first, as explained later.

  1. Net operating loss (NOL). Reduce any NOL for the tax year of the debt cancellation, and then any NOL carryover to that year. Reduce the NOL or NOL carryover one dollar for each dollar of excluded canceled debt.

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

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

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

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

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

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

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

    4. Inventory and accounts and notes receivable.

    5. Other property.

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

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

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

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

 

How to make tax attribute reductions.

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

Electing to reduce the basis of depreciable property first.

You can elect to apply any portion of the excluded canceled debt first to reduce the basis of depreciable property you hold at the beginning of the tax year following the tax year of the debt cancellation, in the following order.

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

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

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

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

 

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

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

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

Recapture of basis reductions.

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

More information.

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

Qualified Farm Debt

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

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

  • You incurred it directly in operating a farming business.

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

For more information, see Pub. 4681.

Qualified person.

This is a person who is actively and regularly engaged in the business of lending money. A qualified person includes any federal, state, or local government, or any of their agencies or subdivisions. The USDA is a qualified person. A qualified person doesn't include any of the following.

  • A person related to you.

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

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

 

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

Exclusion limit.

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

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

Adjusted tax attributes.

Adjusted tax attributes means the sum of the following items.

  1. Any net operating loss (NOL) for the tax year of the debt cancellation and any NOL carryover to that year.

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

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

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

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

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

 

Qualified property.

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

Reduction of tax attributes.

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

Special rules for reducing the basis of property.

You must use special rules to reduce the basis of property for excluded canceled qualified farm debt. Under these special rules, you only reduce the basis of qualified property (defined earlier). Reduce it in the following order.

  1. Depreciable qualified property. You may elect on Form 982 to treat real property held as inventory as depreciable property.

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

  3. Other qualified property.

 

Form 982

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

When to file.

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

Income From Other Sources

This section discusses other types of income you may receive.

Barter income.

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

Below-market loans.

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

Commodity futures and options.

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

Custom hire (machine work).

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

Easements and rights-of-way.

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

Income you received for granting a temporary construction easement is rental income. Report the income as rent on Part I of Schedule E (Form 1040).

Example.

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

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

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

The contract also contained a provision for a temporary workspace (temporary easement) to allow for the collection of topsoil and for equipment movement. This temporary easement is only for the construction period (usually a period of months). The gain is reported on Form 4797 as ordinary income and does not affect the basis of the land.

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

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

Fuel tax credit and refund.

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

Illegal federal irrigation subsidy.

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

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

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

Prizes.

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

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

Property sold, destroyed, stolen, or condemned.

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

Recapture of section 179 expense deduction.

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

In addition, if the percentage of business use of listed property (see chapter 7) falls to 50% or less in any tax year during the recovery period, you must include in income any excess section 179 expense deduction you took on the property.

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

Refund or reimbursement.

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

Example.

A tenant farmer purchased fertilizer for $1,000 in April 2016. He deducted $1,000 on his 2016 Schedule F and the entire deduction reduced his tax. The landowner reimbursed him $500 of the cost of the fertilizer in February 2017. The tenant farmer must include $500 in income on his 2017 tax return because the entire deduction decreased his 2016 tax.

Sale of soil and other natural deposits.

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

Sod.

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

Granting the right to remove deposits.

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

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

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

Timber sales.

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

Income Averaging for Farmers

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

Who can use income averaging?

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

Corporations, partnerships, S corporations, estates, and trusts can't use income averaging.

Elected Farm Income (EFI)

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

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

Gains or losses from the sale or other disposition of farm property.

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

Liquidation of a farming business.

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

EFI and base year rates.

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

How To Figure the Tax

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

Negative taxable income for base year.

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

Filing status.

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

Effect on Other Tax Determinations

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

  • The amount of your self-employment tax.

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

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

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

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

 

Tax for Certain Children Who Have Unearned Income

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

If you use income averaging, figure your child's tax on unearned income using your rate after allocating EFI. You can't use any of your child's unearned income as your EFI, even if it's attributable to a farming business. For information on figuring the tax on your child's unearned income, see Pub. 929.

Alternative Minimum Tax (AMT)

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

Credit for prior year minimum tax.

You may be able to claim a tax credit if you owed AMT in a prior year. See the Instructions for Form 8801.

Schedule J

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

4. Farm Business Expenses

What's New for 2017

Standard mileage rate. For 2017, the standard mileage rate for the cost of operating your car, van, pickup, or panel truck for each mile of business use is 53.5 cents. See Truck and Car Expenses , later.

Introduction

You can generally deduct the current costs of operating your farm. Current costs are expenses you don't 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 isn't 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 isn't 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 doesn't 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.

During 2017, you bought fertilizer ($40,000), feed ($10,000), and seed ($5,000) for use on your farm in the following year. Your total prepaid farm supplies expense for 2017 is $55,000. Your other deductible farm expenses totaled $100,000 for 2017. Therefore, your deduction for prepaid farm supplies can't be more than $50,000 (50% of $100,000) for 2017. The excess prepaid farm supplies expense of $5,000 ($55,000 − $50,000) is deductible in a later tax year when you use or consume the supplies. However, the deduction limit doesn't apply if you qualify for the exceptions listed next.

Exceptions.

This limit on the deduction for prepaid farm supplies expense doesn't 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.

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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 can't 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 isn't merely for tax avoidance.

  3. Deducting the prepayment doesn't 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.

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This rule doesn't 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 aren't 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 won't suggest a deposit. Further, a price adjustment to reflect market value at the date of delivery isn't, 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.

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A Form W-2 should be issued to the child employee.

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

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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 can't 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 can't 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 (Form 5884).

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, sealing cracks or replacing broken windows on a farm building, and routine maintenance of trucks, tractors, and other farm machinery. However, expenses for improvements to depreciable property are generally capital expenditures. Amounts are paid for improvements if they are for the betterment of your property, are for a restoration of your property, such as the replacement of major components and substantial structural parts, or if your expenditures adapt your property to a new or different use. For example, if you replace a few shingles on the barn roof, these expenses are generally deductible as repairs and maintenance. If you replace the entire barn roof with a new roof, then this expense is generally a capital expenditure. For more information, see Capital Expenses , later.

Under certain conditions, you can elect to capitalize amounts paid for repair and maintenance. See Regulations section 1.263(a)-3(n) for more information.

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 can't 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 can't 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 can't 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.

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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.

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 Pub. 535.

Breeding Fees

You can generally deduct breeding fees as a farm business expense. However, if the breeder guarantees live offspring as a result of the breeding or other veterinary procedure, you must capitalize these costs as the cost basis of the offspring. Also, 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 doesn't include land you have never used previously for producing crops or sustaining livestock. You can't 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 doesn't 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 can't 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 can't 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.

Self-employment tax.

You cannot deduct the self-employment tax you pay as a farm business experience. However, 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 can't deduct the premiums as a business expense. In the event of death, the proceeds of the policy aren't 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 29, 2017, 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, 2017. Only the cost for the 6 months in 2017 is deductible as an insurance expense on your 2017 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 2018 and 2019, deduct $1,000 (12/36 of $3,000). Deduct the remaining $500 in 2019. Had the policy been effective on January 1, 2017, the deductible expense would have been $1,000 for each of the years 2017, 2018, and 2019, 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 2017, even if the child was not your dependent. Generally, this deduction can't 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 can't 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 Pub. 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 can't 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, don't 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 don't 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 can't 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 Pub. 535, chapter 3, and Revenue Procedure 2001-28, which begins on page 1156 of Internal Revenue Bulletin 2001-19 at 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 can't 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 isn't 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 Pub. 587.

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), can't be more than the gross income from farming minus the following expenses.

  • The business part of expenses you could deduct even if you didn't 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, don't 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 Pub. 587 for more information on deducting expenses for the business use of your home.

Telephone expense.

You can't 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 53.5 cents in 2017. 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 can't use the standard mileage rate if you operate five or more cars or light trucks at the same time. You aren't 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 can't 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 , later.

More information.

For more information on deductible truck and car expenses, see Pub. 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 can't 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 can't deduct any of the cost of meals if it isn't necessary for you to rest, unless you meet the rules for business entertainment. For information on entertainment expenses, see Pub. 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.

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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 don't 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 don't 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 Pub. 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 Pub. 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 don't 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 isn't 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 2017, you buy 50 steers you will sell in 2018. You can't deduct the cost of the steers on your 2017 tax return. You deduct their cost on your 2018 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 doesn't 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 don't 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 can't also deduct the cost from the selling price.

You can't 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 prefertile 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 2017, you buy 500 baby chicks to raise for resale in 2018. You also buy 50 bushels of winter wheat seed in 2017 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 2017.

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.

 

De minimis safe harbor for tangible property.

If you elected to use the de minimis safe harbor for tangible property for the tax year, you can deduct as a farm business expense on Schedule F amounts paid for tangible property qualifying under the de minimis safe harbor. For more information, see Capital Expenses , later.

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 don't 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 payment, or debt incurred, for the acquisition, production, or improvement of a unit of property. 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 for more information.

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 for more information.

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.

Exception for tangible real and personal property under the de minimis safe harbor.

If you elect the de minimis safe harbor for your farming business for the tax year, you’re not required to capitalize the de minimis costs of acquiring or producing certain real and tangible personal property and may deduct these amounts as farm expenses on Schedule F. For more information on electing and using the de minimis safe harbor, see Pub. 535, chapter 1.

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 don't apply to plants with a prefertile 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 can't 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 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 aren't 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.

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For more information about timber, see Agriculture Handbook Number 731, Forest Landowners' Guide to the Federal Income Tax. You can find this publication online 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 silviculture 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 don't 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 don't use them in planting Christmas trees. Recover these costs through depreciation.

Nondeductible Expenses

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

Personal, Living, and Family Expenses

You can't 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 isn't deductible.

Other Nondeductible Items

You can't 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 prefertile period of more than 2 years. See chapter 11 for more information.

Repayment of loans.

You can't 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 can't deduct estate, inheritance, legacy, succession, and gift taxes.

Loss of livestock.

You can't 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 can't 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 Pub. 544.

Cost of raising unharvested crops.

You can't 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 can't 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 can't deduct costs related to your gifts of agricultural products or property held for sale in the ordinary course of your business. The costs aren't deductible in the year of the gift or any later year. For example, you can't 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 can't 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 won't 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 can't 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 Pub. 536.

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If you don't 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 aren't 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 Pub. 925.

Passive Activity Limits

A passive activity is generally any activity involving the conduct of any trade or business in which you don't 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 Pub. 925.

Excess Farm Loss Limit

Excess farm losses (defined below) aren't deductible if you received certain applicable subsidies. This limit applies to any farming businesses, other than a C corporation, that received 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 don't 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 can't 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 doesn't 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 don't 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 isn't 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 don't 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 isn't 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 won't immediately question whether your farming activity is engaged in for profit. Accordingly, it won't 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 aren't limited under these rules. If you don't have 3 (or 2) years of profit (and can't 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 isn't 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, belong in this category. See chapter 11 for more information. For the limits that apply to mortgage interest, see Pub. 936.

Category 2.

Deductions that don't 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.

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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 Pub. 529, 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 Pub. 535, chapter 1.

5. Soil and Water Conservation Expenses

Introduction

If you are in the business of farming, you can choose to deduct certain expenses for:

  • Soil or water conservation,

  • Prevention of erosion of land used in farming, or

  • Endangered species recovery.

 

Otherwise, these are capital expenses that must be added to the basis of the land. (See chapter 6 for information on determining basis.) Conservation expenses for land in a foreign country do not qualify for this special treatment.

The deduction for conservation expenses cannot be more than 25% of your gross income from farming. See 25% Limit on Deduction , later.

Although some expenses are not deductible as soil and water conservation expenses, they may be deductible as ordinary and necessary farm expenses. These include interest and taxes, the cost of periodically clearing brush from productive land, the regular removal of sediment from a drainage ditch, and expenses paid or incurred primarily to produce an agricultural crop that may also conserve soil.

You must include in income most government payments for approved conservation practices. However, you can exclude some payments you receive under certain cost-sharing conservation programs. For more information, see Agricultural Program Payments in chapter 3.

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To get the full deduction to which you are entitled, you should maintain your records to clearly distinguish between your ordinary and necessary farm business expenses and your soil and water conservation expenses.

Topics - This chapter discusses:

  • Business of farming

  • Plan certification

  • Conservation expenses

  • Assessment by conservation district

  • 25% limit on deduction

  • When to deduct or capitalize

  • Sale of a farm

 

Business of Farming

For purposes of soil and water conservation expenses, you are in the business of farming if you cultivate, operate, or manage a farm for profit, either as an owner or a tenant. You are not in the business of farming if you cultivate or operate a farm for recreation or pleasure, rather than for profit. You are not farming if you are engaged only in forestry or the growing of timber.

Farm defined.

A farm includes livestock, dairy, poultry, fish, fruit, and truck farms. It also includes plantations, ranches, ranges, and orchards. A fish farm is an area where fish and other marine animals are grown or raised and artificially fed, protected, etc. It doesn't include an area where they are merely caught or harvested. A plant nursery is a farm for purposes of deducting soil and water conservation expenses.

Farm rental.

If you own a farm and receive farm rental payments based on farm production, either in cash or crop shares, you are in the business of farming. If you get cash rental for a farm you own that is not used in farm production, you can't deduct soil and water conservation expenses for that farm.

If you receive a fixed rental payment that is not based on farm production, you are in the business of farming only if you materially participate in operating or managing the farm.

Example.

You own a farm in Iowa and live in California. You rent the farm for $250 in cash per acre and don't materially participate in producing or managing production of the crops grown on the farm. You can't deduct your soil conservation expenses for this farm. You must capitalize the expenses and add them to the basis of the land.

For more information, see Material participation for landlords under Landlord Participation in Farming in chapter 12.

Plan Certification

You can deduct soil and water conservation expenses only if they are consistent with a plan approved by the Natural Resources Conservation Service (NRCS) of the Department of Agriculture. If no such plan exists, the expenses must be consistent with a soil conservation plan of a comparable state agency. Keep a copy of the plan with your books and records to support your deductions.

Conservation plan.

A conservation plan includes the farming conservation practices approved for the area where your farmland is located. There are three types of approved plans.

  • NRCS individual site plans. These plans are issued individually to farmers who request assistance from NRCS to develop a conservation plan designed specifically for their farmland.

  • NRCS county plans. These plans include a listing of farm conservation practices approved for the county where the farmland is located. You can deduct expenses for conservation practices not included on the NRCS county plans only if the practice is a part of an individual site plan.

  • Comparable state agency plans. These plans are approved by state agencies and can be approved individual site plans or county plans.

 

A list of NRCS conservation programs is available at NRCS.USDA.gov/programs. Individual site plans can be obtained from NRCS offices and the comparable state agencies.

Conservation Expenses

You can deduct conservation expenses only for land you or your tenant are using, or have used in the past, for farming. These expenses include, but are not limited to, the following.

  1. The treatment or movement of earth, such as:

    1. Leveling,

    2. Conditioning,

    3. Grading,

    4. Terracing,

    5. Contour furrowing, and

    6. Restoration of soil fertility.

  2. The construction, control, and protection of:

    1. Diversion channels;

    2. Drainage ditches;

    3. Irrigation ditches;

    4. Earthen dams; and

    5. Watercourses, outlets, and ponds.

  3. The eradication of brush.

  4. The planting of windbreaks.

You can't deduct expenses to drain or fill wetlands, or to prepare land for center pivot irrigation systems, as soil and water conservation expenses. These expenses are added to the basis of the land.

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If you choose to deduct soil and water conservation expenses, you must include as gross income any cost-sharing payments you receive for those expenses. See chapter 3 for information about payments eligible for the cost-sharing exclusion.

New farm or farmland.

If you acquire a new farm or new farmland from someone who was using it in farming immediately before you acquired the land, soil and water conservation expenses you incur on it will be treated as made on land used in farming at the time the expenses were paid or incurred. You can deduct soil and water conservation expenses for this land if your use of it is substantially a continuation of its use in farming. The new farming activity doesn't have to be the same as the old farming activity. For example, if you buy land that was used for grazing cattle and then prepare it for use as an apple orchard, you can deduct your conservation expenses.

Land not used for farming.

If your conservation expenses benefit both land that doesn’t qualify as land used for farming and land that does qualify, you must allocate the expenses between the two types of land. For example, if the expenses benefit 200 acres of your land, but only 120 acres of this land are used for farming, then you can deduct 60% (120 ÷ 200) of the expenses. You can use another method to allocate these expenses if you can clearly show that your method is more reasonable.

Depreciable conservation assets.

You generally can't deduct your expenses for depreciable conservation assets. However, you can deduct certain amounts you pay or incur for an assessment for depreciable property that a soil and water conservation or drainage district levies against your farm. See Assessment for Depreciable Property , later.

You must capitalize expenses to buy, build, install, or improve depreciable structures or facilities. These expenses include those for materials, supplies, wages, fuel, hauling, and moving dirt when making structures such as tanks, reservoirs, pipes, culverts, canals, dams, wells, or pumps composed of masonry, concrete, tile (including drainage tile), metal, or wood. You recover your capital investment through annual allowances for depreciation.

You can deduct soil and water conservation expenses for nondepreciable earthen items. Nondepreciable earthen items include certain dams, ponds, and terraces described under Property Having a Determinable Useful Life in chapter 7.

Water well.

You can't deduct the cost of drilling a water well for irrigation and other agricultural purposes as a soil and water conservation expense. It is a capital expense. You recover your cost through depreciation. You also must capitalize your cost for drilling a test hole. If the test hole produces no water and you continue drilling, the cost of the test hole is added to the cost of the producing well. You can recover the total cost through depreciation deductions.

If a test hole, dry hole, or dried-up well (resulting from prolonged lack of rain, for instance) is abandoned, you can deduct your unrecovered cost in the year of abandonment. Abandonment means that all economic benefits from the well are terminated. For example, filling or sealing a well excavation or casing so that all economic benefits from the well are terminated constitutes an abandonment.

Endangered species recovery expenses.

If you are in the business of farming and meet other specific requirements, you can choose to deduct the conservation expenses discussed earlier as endangered species recovery expenses. Otherwise, these are capital expenses that must be added to the basis of the land.

The expenses must be paid or incurred for the purpose of achieving site-specific management actions recommended in a recovery plan approved under section 4(f) of the Endangered Species Act of 1973. See section 175 for more information.

Assessment by Conservation District

In some localities, a soil or water conservation or drainage district incurs expenses for soil or water conservation and levies an assessment against the farmers who benefit from the expenses. You can deduct as a conservation expense amounts you pay or incur for the part of an assessment that:

  • Covers expenses you could deduct if you had paid them directly, or

  • Covers expenses for depreciable property used in the district's business.

 

A water or drainage district assessment for repairs or maintenance of district property or for interest paid by the district for a loan to buy property may qualify as a business deduction. See Regulations section 1.164-4(b)(1).

Assessment for Depreciable Property

You generally can deduct as a conservation expense amounts you pay or incur for the part of a conservation or drainage district assessment that covers expenses for depreciable property. This includes items such as pumps, locks, concrete structures (including dams and weir gates), draglines, and similar equipment. The depreciable property must be used in the district's soil and water conservation activities. However, the following limits apply to these assessments.

  • The total assessment limit.

  • The yearly assessment limit.

 

After you apply these limits, the amount you can deduct is added to your other conservation expenses for the year. The total for these expenses is then subject to the 25% of gross income from farming limit on the deduction, discussed later. See Table 5-1 for a brief summary of these limits.

Table 5-1. Limits on Deducting an Assessment by a Conservation District for Depreciable Property

Total Limit on Deduction for Assessment for Depreciable Property Yearly Limit on Deduction for Assessment for Depreciable Property Yearly Limit for All Conservation Expenses
10% of: $500 + 10% of: 25% of:
Total assessment against all members of the district for the property. Your deductible share of the cost to the district for the property. Your gross income from farming.
  • No one taxpayer can deduct more than 10% of the total assessment.

  • Any amount over 10% is a capital expense and is added to the basis of your land.

  • If an assessment is paid in installments, each payment must be prorated between the conservation expense and the capital expense.

  • If the amount you pay or incur for any year is more than the limit, you can deduct for that year only 10% of your deductible share of the cost.

  • You can deduct the remainder in equal amounts over the next 9 tax years.

  • Limit for all conservation expenses, including assessments for depreciable property.

  • Amounts greater than 25% can be carried to the following year and added to that year's expenses. The total is then subject to the 25% of gross income from farming limit in that year.

 

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To ensure your deduction is within the deduction limits, keep records to show the following.

  • The total assessment against all members of the district for the depreciable property.

  • Your deductible share of the cost to the district for the depreciable property.

  • Your gross income from farming.

 

Total assessment limit.

You can't deduct more than 10% of the total amount assessed to all members of the conservation or drainage district for the depreciable property. This applies whether you pay the assessment in one payment or in installments. If your assessment is more than 10% of the total amount assessed, both the following rules apply.

  • The amount over 10% is a capital expense and is added to the basis of your land.

  • If the assessment is paid in installments, each payment must be prorated between the conservation expense and the capital expense.

 

Yearly assessment limit.

The maximum amount you can deduct in any one year is the total of 10% of your deductible share of the cost as explained earlier, plus $500. If the amount you pay or incur is equal to or less than the maximum amount, you can deduct it in the year it is paid or incurred. If the amount you pay or incur is more, you can deduct in that year only 10% of your deductible share of the cost. You can deduct the remainder in equal amounts over the next 9 tax years. Your total conservation expense deduction for each year is also subject to the 25% of gross income from farming limit on the deduction, discussed later.

Example 1.

This year, the soil conservation district levies and you pay an assessment of $2,400 against your farm. Of the assessment, $1,500 is for digging drainage ditches. You can deduct this part as a soil or conservation expense as if you had paid it directly. The remaining $900 is for depreciable equipment to be used in the district's irrigation activities. The total amount assessed by the district against all its members for the depreciable equipment is $7,000.

The total amount you can deduct for the depreciable equipment is limited to 10% of the total amount assessed by the district against all its members for depreciable equipment, or $700. The $200 excess ($900 − $700) is a capital expense you must add to the basis of your farm.

To figure the maximum amount you can deduct for the depreciable equipment this year, multiply your deductible share of the total assessment ($700) by 10% (0.10). Add $500 to the result for a total of $570. Your deductible share, $700, is greater than the maximum amount deductible in one year, so you can deduct only $70 of the amount you paid or incurred for depreciable property this year (10% of $700). You can deduct the balance at the rate of $70 a year over the next 9 years.

You add $70 to the $1,500 portion of the assessment for drainage ditches. You can deduct $1,570 of the $2,400 assessment as a soil and water conservation expense this year, subject to the 25% of gross income from farming limit on the deduction, discussed later.

Example 2.

Assume the same facts as in Example 1 except that $1,850 of the $2,400 assessment is for digging drainage ditches and $550 is for depreciable equipment. The total amount assessed by the district against all its members for depreciable equipment is $5,500. The total amount you can deduct for the depreciable equipment is limited to 10% of this amount, or $550.

The maximum amount you can deduct this year for the depreciable equipment is $555 (10% of your deductible share of the total assessment, $55, plus $500). Since your deductible share is less than the maximum amount deductible in one year, you can deduct the entire $550 this year. You can deduct the entire assessment, $2,400, as a soil and water conservation expense this year, subject to the 25% of gross income from farming limit on the deduction, discussed below.

Sale or other disposal of land during 9-year period.

If you dispose of the land during the 9-year period for deducting conservation expenses subject to the yearly limit, any amounts you have not yet deducted because of this limit are added to the basis of the property.

Death of farmer during 9-year period.

If a farmer dies during the 9-year period, any remaining amounts not yet deducted are deducted in the year of death.

25% Limit on Deduction

The total deduction for conservation expenses in any tax year is limited to 25% of your gross income from farming for the year.

Gross income from farming.

Gross income from farming is the income you derive in the business of farming from the production of crops, fish, fruits, other agricultural products, or livestock. Gains from sales of draft, breeding, or dairy livestock are included. Gains from sales of assets such as farm machinery, or from the disposition of land, are not included.

Carryover of deduction.

If your deductible conservation expenses in any year are more than 25% of your gross income from farming for that year, you can carry the unused deduction over to later years. However, the deduction in any later year is limited to 25% of the gross income from farming for that year as well.

Example.

In 2016, you have gross income of $32,000 from two farms. During the year, you incurred $10,000 of deductible soil and water conservation expenses for one of the farms. However, your deduction is limited to 25% of $32,000, or $8,000. The $2,000 excess ($10,000 − $8,000) is carried over to 2017 and added to deductible soil and water conservation expenses made in that year. The total of the 2016 carryover plus 2017 expenses is deductible in 2017, subject to the limit of 25% of your gross income from farming in 2017. Any expenses over the limit in that year are carried to 2018 and later years.

Net operating loss (NOL).

The deduction for soil and water conservation expenses, after applying the 25% limit, is included when figuring an NOL for the year. If the NOL is carried to another year, the soil and water conservation deduction included in the NOL is not subject to the 25% limit in the year to which it is carried.

When To Deduct or Capitalize

If you choose to deduct soil and water conservation expenses, you must deduct the total allowable amount on your tax return for the first year you pay or incur these expenses. If you don't choose to deduct the expenses, you must capitalize them.

Change of method.

If you want to change your method for the treatment of soil and water conservation expenses, or you want to treat the expenses for a particular project or a single farm in a different manner, you must get the approval of the IRS. To get this approval, submit a written request by the due date of your return for the first tax year you want the new method to apply. You or your authorized representative must sign the request.

The request must include the following information.

  • Your name and address.

  • The first tax year the method or change of method is to apply.

  • Whether the method or change of method applies to all your soil and water conservation expenses or only to those for a particular project or farm. If the method or change of method doesn't apply to all your expenses, identify the project or farm to which the expenses apply.

  • The total expenses you paid or incurred in the first tax year the method or change of method is to apply.

  • A statement that you will account separately in your books for the expenses to which this method or change of method relates.

 

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Send your request to the following
address.

 


Department of the Treasury
Internal Revenue Service Center
Cincinnati, OH 45999

 


For more information, see Change in
Accounting Method
in chapter 2.

Sale of a Farm

If you sell your farm, you can't adjust the basis of the land at the time of the sale for any unused carryover of soil and water conservation expenses (except for deductions of assessments for depreciable property, discussed earlier). However, if you acquire another farm and return to the business of farming, you can start taking deductions again for the unused carryovers.

Gain on sale of farmland.

If you held the land 5 years or less before you sold it, gain on the sale of the land is treated as ordinary income up to the amount you previously deducted for soil and water conservation expenses. If you held the land less than 10 but more than 5 years, the gain is treated as ordinary income up to a specified percentage of the previous deductions. See Section 1252 property under Other Gains in chapter 9.

6. Basis of Assets

Introduction

Your basis is the amount of your investment in property for tax purposes. Use basis to figure the gain or loss on the sale, exchange, or other disposition of property. Also use basis to figure depreciation, amortization, depletion, and casualty losses. You may have property that you use for both business or the production of income purposes and for personal purposes. You must allocate the basis of this property based on its use. Only the basis allocated to the business or the production of income use of the property can be depreciated.

Your original basis in property is adjusted (increased or decreased) by certain events. For example, if you make improvements to the property, increase your basis. If you take deductions for depreciation, or casualty losses, or claim certain credits, reduce your basis.

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Keep accurate records of all items that affect the basis of your assets. For information on keeping records, see chapter 1.

Topics - This chapter discusses:

  • Cost basis

  • Adjusted basis

  • Basis other than cost

Useful Items - You may want to see:

Publication

  • 535 Business Expenses

  • 544 Sales and Other Dispositions of Assets

  • 551 Basis of Assets

  • 946 How To Depreciate Property

See chapter 16 for information about getting publications and forms.

Cost Basis

The basis of property you buy is usually its cost. Cost is the amount you pay in cash, debt obligations, other property, or services. Your cost includes amounts you pay for sales tax, freight, installation, and testing. The basis of real estate and business assets will include other items, discussed later. Basis generally does not include interest payments. However, see Carrying charges and Capitalized interest in chapter 4 of Pub. 535.

You also may have to capitalize (add to basis) certain other costs related to buying or producing property. Under the uniform capitalization rules, discussed later, you may have to capitalize direct costs and certain indirect costs of producing property.

Loans with low or no interest.

If you buy property on a time-payment plan that charges little or no interest, the basis of your property is your stated purchase price minus the amount considered to be unstated interest. You generally have unstated interest if your interest rate is less than the applicable federal rate. See the discussion of unstated interest in Pub. 537, Installment Sales.

Real Property

Real property, also called real estate, is land and generally anything built on, growing on, or attached to land.

If you buy real property, certain fees and other expenses related to the purchase of the property are part of your cost basis in the property. Some of these expenses are discussed next.

Lump sum purchase.

If you buy improvements, such as buildings, and the land on which they stand for a lump sum, allocate your cost basis between the land and improvements. Allocate the cost basis according to the respective fair market values (FMVs) of the land and improvements at the time of purchase. Figure the basis of each asset by multiplying the lump sum by a fraction. The numerator is the FMV of that asset and the denominator is the FMV of the whole property at the time of purchase.

Fair market value (FMV).

FMV is the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts. Sales of similar property on or about the same date may help in figuring the FMV of the property.

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If you are not certain of the FMV of the land and improvements, you can allocate the basis according to their assessed values for real estate tax purposes.

Real estate taxes.

If you pay the real estate taxes the seller owed on real property you bought, and the seller did not reimburse you, treat those taxes as part of your basis.

If you reimburse the seller for taxes the seller paid for you, you generally can deduct that amount as a tax expense in the year of purchase. Whether or not you reimburse the seller, do not include that amount in the basis of your property.

Settlement costs.

Your basis includes the settlement fees and closing costs for buying the property. See Pub. 551 for a detailed list of items you can and cannot include in basis.

Do not include fees and costs for getting a loan on the property. Also, do not include amounts placed in escrow for the future payment of items such as taxes and insurance.

Points.

If you pay points to get a loan (including a mortgage, second mortgage, a home equity loan, or line-of-credit), do not add the points to the basis of the related property. You may be able to deduct the points currently or over the term of the loan. For more information about deducting points, see Points in chapter 4 of Pub. 535.

Assumption of a mortgage.

If you buy property and assume (or buy the property subject to) an existing mortgage, your basis includes the amount you pay for the property plus the amount you owe on the mortgage.

Example.

If you buy a farm for $100,000 cash and assume a mortgage of $400,000, your basis is $500,000.

Constructing assets.

If you build property or have assets built for you, your expenses for this construction are part of your basis. Some of these expenses include the following costs.

  • Land.

  • Labor and materials.

  • Architect's fees.

  • Building permit charges.

  • Payments to contractors.

  • Payments for rental equipment.

  • Inspection fees.

 

In addition, if you use your own employees, farm materials, and equipment to build an asset, do not deduct the following expenses. You must capitalize them by including these expenses in the asset's basis.

  • Employee wages paid for the construction work, reduced by any employment credits allowed.

  • Depreciation on equipment you own while it is used in the construction.

  • Operating and maintenance costs for equipment used in the construction.

  • The cost of business supplies and materials used in the construction.

 

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Do not include the value of your own labor, or any other labor you did not pay for, in the basis of any property you construct.

Allocating the Basis

In some instances, the rules for determining basis apply to a group of assets acquired in the same transaction or to property that consists of separate items. To determine the basis of these assets or separate items, there must be an allocation of basis.

Group of assets acquired.

If you buy multiple assets for a lump sum, allocate the amount you pay among the assets. Use this allocation to figure your basis for depreciation and gain or loss on a later disposition of any of these assets. You and the seller may agree in the sales contract to a specific allocation of the purchase price among the assets. If this allocation is based on the value of each asset and you and the seller have adverse tax interests, the allocation generally will be accepted.

Farming business acquired.

If you buy a group of assets that makes up a farming business, there are special rules you must use to allocate the purchase price among the assets. Generally, reduce the purchase price by any cash received. Allocate the remaining purchase price to the other business assets received in proportion to (but not more than) their FMV and in a certain order. See Trade or Business Acquired under Allocating the Basis in Pub. 551 for more information. Also, see examples under Sale of a Farm in chapter 8.

Transplanted embryo.

If you buy a cow that is pregnant with a transplanted embryo, allocate to the basis of the cow the part of the purchase price equal to the FMV of the cow without the implant. Allocate the rest of the purchase price to the basis of the calf. Neither the cost allocated to the cow nor the cost allocated to the calf is deductible as a current business expense.

Uniform Capitalization Rules

Under the uniform capitalization rules, you must include certain direct and indirect costs in the basis of property you produce or in your inventory costs, rather than claim them as a current year deduction. You recover these costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property.

Generally, you are subject to the uniform capitalization rules if you do any of the following.

  1. Produce real property or tangible personal property.

  2. Acquire property for resale. However, this rule does not apply to personal property if your average annual gross receipts for the 3-tax-year period ending with the year preceding the current tax year are $10 million or less.

 

You produce property if you construct, build, install, manufacture, develop, improve, or create the property.

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You are not subject to the uniform capitalization rules if the property is produced for personal use.

In a farming business, you produce property if you raise or grow any agricultural or horticultural commodity, including plants and animals.

Plants.

A plant produced in a farming business includes the following items.

  • A fruit, nut, or other crop-bearing tree.

  • An ornamental tree.

  • A vine.

  • A bush.

  • Sod.

  • The crop or yield of a plant that will have more than one crop or yield.

 

Animals.

An animal produced in a farming business includes any stock, poultry or other bird, and fish or other sea life.

The direct and indirect costs of producing plants or animals include preparatory costs and preproductive period costs. Preparatory costs include the acquisition costs of the seed, seedling, plant, or animal. For plants, preproductive period costs include the costs of items such as irrigation, pruning, frost protection, spraying, and harvesting. For animals, preproductive period costs include the costs of items such as feed, maintaining pasture or pen areas, breeding, veterinary services, and bedding.

Exceptions.

In a farming business, the uniform capitalization rules do not apply to:

  1. Any animal,

  2. Any plant with a preproductive period of 2 years or less, or

  3. Any costs of replanting certain plants lost or damaged due to casualty.

 

Exceptions (1) and (2) do not apply to a corporation, partnership, or tax shelter required to use an accrual method of accounting. See Accrual Method Required under Accounting Methods in chapter 2.

In addition, you can elect not to use the uniform capitalization rules for plants with a preproductive period of more than 2 years. If you make this election, special rules apply. This election cannot be made by a corporation, partnership, or tax shelter required to use an accrual method of accounting. This election also does not apply to any costs incurred for the planting, cultivation, maintenance, or development of any citrus or almond grove (or any part thereof) within the first 4 years the trees were planted.

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If you elect not to use the uniform capitalization rules, you must use the alternative depreciation system for all property used in any of your farming businesses and placed in service in any tax year during which the election is in effect. See chapter 7 for additional information on depreciation.

Example.

You grow trees that have a preproductive period of more than 2 years. The trees produce an annual crop. You are an individual and the uniform capitalization rules apply to your farming business. You must capitalize the direct costs and an allocable part of indirect costs incurred due to the production of the trees. You are not required to capitalize the costs of producing the annual crop because its preproductive period is 2 years or less.

Preproductive period of more than 2 years.

The preproductive period of plants grown in commercial quantities in the United States is based on their nationwide weighted average preproductive period. Plants producing the crops or yields shown in Table 6-1 have a nationwide weighted average preproductive period of more than 2 years. Other plants (not shown in Table 6-1) may also have a nationwide weighted average preproductive period of more than 2 years.

More information.

For more information on the uniform capitalization rules that apply to property produced in a farming business, see Regulations section 1.263A-4.

Table 6-1. Plants With a Preproductive Period of More Than 2 Years

Plants producing the following crops or yields have a nationwide weighted average preproductive period of more than 2 years.
  • Almonds

  • Apples

  • Apricots

  • Avocados

  • Blueberries

  • Cherries

  • Chestnuts

  • Coffee beans

  • Currants

  • Dates

  • Figs

  • Grapefruit

  • Grapes

  • Guavas

  • Kiwifruit

  • Kumquats

  • Lemons

  • Limes

  • Macadamia nuts

  • Mangoes

  • Nectarines

  • Olives

  • Oranges

  • Peaches

  • Pears

  • Pecans

  • Persimmons

  • Pistachio nuts

  • Plums

  • Pomegranates

  • Prunes

  • Tangelos

  • Tangerines

  • Tangors

  • Walnuts

Adjusted Basis

Before figuring gain or loss on a sale, exchange, or other disposition of property or figuring allowable depreciation, depletion, or amortization, you must usually make certain adjustments to the cost basis or basis other than cost (discussed later) of the property. The adjustments to the original basis are increases or decreases to the cost basis or other basis which result in the adjusted basis of the property.

Increases to Basis

Increase the basis of any property by all items properly added to a capital account. These include the cost of any improvements having a useful life of more than 1 year.

The following costs increase the basis of property.

  • The cost of extending utility service lines to property.

  • Legal fees, such as the cost of defending and perfecting title.

  • Legal fees for seeking a decrease in an assessment levied against property to pay for local improvements.

  • Assessments for items such as paving roads and building ditches that increase the value of the property assessed. Do not deduct these expenses as taxes. However, you can deduct as taxes amounts assessed for maintenance or repairs, or for meeting interest charges related to the improvements.

 

If you make additions or improvements to business property, depreciate the basis of each addition or improvement as separate depreciable property using the rules that would apply to the original property if you had placed it in service at the same time you placed the addition or improvement in service. See chapter 7 for more information.

Deducting vs. capitalizing costs.

Do not add to your basis costs that you can deduct as current expenses. For example, amounts paid for incidental repairs or maintenance are deductible as business expenses and are not added to basis. However, you can elect either to deduct or to capitalize certain other costs. See chapter 7 in Pub. 535.

Note.

Generally, you can deduct amounts paid for repairs and maintenance to your tangible property if the amounts paid are not otherwise required to be capitalized. However, you may elect to capitalize amounts paid for repair and maintenance consistent with the treatment on your books and records. If you make this election, it applies to all amounts paid for repair and maintenance to tangible property that you treat as capital expenditures on your books and records for the tax year. To make the election to treat repairs and maintenance as capital expenditures, attach a statement titled "Section 1.263(a)-3(n) Election" to your timely filed return (excluding extensions). For more information on what to include in the statement, see Regulations section 1.263(a)-3(n). If you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Attach the statement to the amended return and write “Filed pursuant to section 301.9100-2” on the statement. File the amended return at the same address you filed the original return.

Decreases to Basis

The following are some items that reduce the basis of property.

  • Section 179 deduction.

  • Deductions previously allowed or allowable for amortization, depreciation, and depletion.

  • Alternative motor vehicle credit. See Form 8910.

  • Alternative fuel vehicle refueling property credit. See Form 8911.

  • Residential energy efficient property credits. See Form 5695.

  • Investment credit (part or all) taken.

  • Casualty and theft losses and insurance reimbursements.

  • Payments you receive for granting an easement.

  • Exclusion from income of subsidies for energy conservation measures.

  • Certain canceled debt excluded from income.

  • Rebates from a manufacturer or seller.

  • Patronage dividends received from a cooperative association as a result of a purchase of property. See Patronage Dividends in chapter 3.

  • Gas-guzzler tax. See Form 6197.

Some of these items are discussed next. For a more detailed list of items that decrease basis, see section 1016 of the Internal Revenue Code and Pub. 551.

Depreciation and section 179 deduction.

The adjustments you must make to the basis of the property if you take the section 179 deduction or depreciate the property are explained next. For more information on these deductions, see chapter 7.

Section 179 deduction.

If you take the section 179 expense deduction for all or part of the cost of qualifying business property, decrease the basis of the property by the deduction.

Depreciation.

Decrease the basis of property by the depreciation you deducted or could have deducted on your tax returns under the method of depreciation you chose. If you took less depreciation than you could have under the method chosen, decrease the basis by the amount you could have taken under that method. If you did not take a depreciation deduction, reduce the basis by the full amount of the depreciation you could have taken.

If you deducted more depreciation than you should have, decrease your basis by the amount you should have deducted plus the part of the excess depreciation you deducted that actually reduced your tax liability for any year.

See chapter 7 for information on figuring the depreciation you should have claimed.

In decreasing your basis for depreciation, take into account the amount deducted on your tax returns as depreciation and any depreciation you must capitalize under the uniform capitalization rules.

Casualty and theft losses.

If you have a casualty or theft loss, decrease the basis in your property by any insurance or other reimbursement and by any deductible loss not covered by insurance. See chapter 11 for information about figuring your casualty or theft loss.

You must increase your basis in the property by the amount you spend on clean up costs (such as debris removal) and repairs that substantially prolong the life of the property, increase its value, or adapt it to a different use. To make this determination, compare the repaired property to the property before the casualty. For more information on casualty and theft losses, see Pub. 547.

Easements.

The amount you receive for granting an easement is usually considered to be proceeds from the sale of an interest in the real property. It reduces the basis of the affected part of the property. If the amount received is more than the basis of the part of the property affected by the easement, reduce your basis in that part to zero and treat the excess as a recognized gain. See Easements and rights-of-way in chapter 3.

Exclusion from income of subsidies for energy conservation measures.

You can exclude from gross income any subsidy you received from a public utility company for the purchase or installation of an energy conservation measure for a dwelling unit. Reduce the basis of the property by the excluded amount.

Canceled debt excluded from income.

If a debt you owe is canceled or forgiven, other than as a gift or bequest, you generally must include the canceled amount in your gross income for tax purposes. A debt includes any indebtedness for which you are liable or which attaches to property you hold.

You can exclude your canceled debt from income if the debt is any of the following.

  1. Debt canceled in a bankruptcy case or when you are insolvent.

  2. Qualified farm debt.

  3. Qualified real property business debt (provided you are not a C corporation).

If you exclude canceled debt from income as described in (1) or (2), you may have to reduce the basis of your depreciable and nondepreciable property. If you exclude canceled debt described in (3), you must only reduce the basis of your depreciable property by the excluded amount.

For more information about canceled debt in a bankruptcy case, see Pub. 908, Bankruptcy Tax Guide. For more information about insolvency and canceled debt that is qualified farm debt, see chapter 3. For more information about qualified real property business debt, see Pub. 334, Tax Guide for Small Business.

Basis Other Than Cost

There are times when you cannot use cost as basis. In these situations, the FMV or the adjusted basis of property may be used. Examples are discussed next.

Property changed from personal to business or rental use.

When you hold property for personal use and then change it to business use or use it to produce rent, you must figure its basis for depreciation. An example of changing property from personal to business use would be changing the use of your pickup truck that you originally purchased for your personal use to use in your farming business.

The basis for depreciation is the lesser of:

  • The FMV of the property on the date of the change, or

  • Your adjusted basis on the date of the change.

 

If you later sell or dispose of this property, the basis you use will depend on whether you are figuring a gain or loss. The basis for figuring a gain is your adjusted basis in the property when you sell the property. Figure the basis for a loss starting with the smaller of your adjusted basis or the FMV of the property at the time of the change to business or rental use. Then make adjustments (increases and decreases) for the period after the change in the property's use, as discussed earlier under Adjusted Basis .

Property received for services.

If you receive property for services, include the property's FMV in income. The amount you include in income becomes your basis. If the services were performed for a price agreed on beforehand, it will be accepted as the FMV of the property if there is no evidence to the contrary.

Example.

Rocco Stowsa is an accountant and also operates a farming business. Rocco agreed to do some accounting work for his neighbor in exchange for a dairy cow. The accounting work and the cow are each worth $1,500. Rocco must include $1,500 in income for his accounting services. Rocco's basis in the cow is $1,500.

Taxable Exchanges

A taxable exchange is one in which the gain is taxable, or the loss is deductible. A taxable gain or deductible loss is also known as a recognized gain or loss. A taxable exchange occurs when you receive cash or get property that is not similar or related in use to the property exchanged. If you receive property in exchange for other property in a taxable exchange, the basis of the property you receive is usually its FMV at the time of the exchange.

Example.

You trade a tract of farmland with an adjusted basis of $20,000 for a tractor that has an FMV of $60,000. You must report a taxable gain of $40,000 for the land. The tractor has a basis of $60,000.

Nontaxable Exchanges

A nontaxable exchange is an exchange in which you are not taxed on any gain and you cannot deduct any loss. A nontaxable gain or loss also is known as an unrecognized gain or loss. If you receive property in a nontaxable exchange, its basis is usually the same as the basis of the property you transferred.

Involuntary Conversions

If you receive property as a result of an involuntary conversion, such as a casualty, theft, or condemnation, figure the basis of the replacement property you receive using the basis of the converted property.

Similar or related property.

If the replacement property is similar or related in service or use to the converted property, the replacement property's basis is the same as the old property's basis on the date of the conversion. However, make the following adjustments.

  1. Decrease the basis by the following amounts.

    1. Any loss you recognize on the involuntary conversion.

    2. Any money you receive that you do not spend on similar property.

  2. Increase the basis by the following amounts.

    1. Any gain you recognize on the involuntary conversion.

    2. Any cost of acquiring the replacement property.

 

Money or property not similar or related.

If you receive money or property not similar or related in service or use to the converted property and you buy replacement property similar or related in service or use to the converted property, the basis of the replacement property is its cost decreased by the gain not recognized on the involuntary conversion.

Allocating the basis.

If you buy more than one piece of replacement property, allocate your basis among the properties based on their respective costs.

Basis for depreciation.

Special rules apply in determining and depreciating the basis of MACRS property acquired in an involuntary conversion. For more information, see Figuring the Deduction for Property Acquired in a Nontaxable Exchange under Figuring Depreciation Under MACRS in chapter 7.

For more information about involuntary conversions, see chapter 11.

Like-Kind Exchanges

The exchange of property for the same kind of property is the most common type of nontaxable exchange.

For an exchange to qualify as a like-kind exchange, you must hold for business or investment purposes both the property you transfer and the property you receive. There must also be an exchange of like-kind property. For more information, see Like-Kind Exchanges in chapter 8.

The basis of the property you receive generally is the same as the adjusted basis of the property you gave up.

Example 1.

You traded a truck you used in your farming business for a new smaller truck to use in farming. The adjusted basis of the old truck was $10,000. The FMV of the new truck is $30,000. Because this is a nontaxable exchange, you do not recognize any gain, and your basis in the new truck is $10,000, the same as the adjusted basis of the truck you traded.

Example 2.

You trade a field cultivator (adjusted basis of $8,000) for a planter (FMV of $9,000). You use both the field cultivator and the planter in your farming business. The basis of the planter you receive is $8,000, the same as the field cultivator traded.

Exchange expenses.

Exchange expenses generally are the closing costs that you pay. They include such items as brokerage commissions, attorney fees, and deed preparation fees. Add them to the basis of the like-kind property you receive.

Property plus cash.

If you trade property in a like-kind exchange and also pay money, the basis of the property you receive is the adjusted basis of the property you gave up plus the money you paid.

Example.

You trade in a truck (adjusted basis of $3,000) for another truck (FMV of $7,500) and pay $4,000. Your basis in the new truck is $7,000 (the $3,000 adjusted basis of the old truck plus the $4,000 cash).

Special rules for related persons.

If a like-kind exchange takes place directly or indirectly between related persons and either party disposes of the property within 2 years after the exchange, the exchange no longer qualifies for like-kind exchange treatment. Each person must report any gain or loss not recognized on the original exchange unless the loss is not deductible under the related party rules. Each person reports it on the tax return filed for the year in which the later disposition occurred. If this rule applies, the basis of the property received in the original exchange will be its FMV. For more information, see chapter 8.

Exchange of business property.

Exchanging the property of one business for the property of another business generally is a multiple property exchange. For information on figuring basis, see Multiple Property Exchanges in chapter 1 of Pub. 544.

Basis for depreciation.

Special rules apply in determining and depreciating the basis of MACRS property acquired in a like-kind transaction. For more information, see Figuring the Deduction for Property Acquired in a Nontaxable Exchange under Figuring Depreciation Under MACRS in chapter 7.

Partially Nontaxable Exchanges

A partially nontaxable exchange is an exchange in which you receive property that is not a like-kind property or money in addition to a like-kind property. The basis of the property you receive is the same as the adjusted basis of the property you gave up with the following adjustments.

  1. Decrease the basis by the following amounts.

    1. Any money you receive.

    2. Any loss you recognize on the exchange.

  2. Increase the basis by the following amounts.

    1. Any additional costs you incur.

    2. Any gain you recognize on the exchange.

If the other party to the exchange assumes your liabilities, treat the debt assumption as money you received in the exchange.

Example 1.

You trade farmland (basis of $100,000) for another tract of farmland (FMV of $110,000) and $30,000 cash. You realize a gain of $40,000. This is the FMV of the land received plus the cash minus the basis of the land you traded ($110,000 + $30,000 − $100,000). Include your gain in income (recognize gain) only to the extent of the cash received. Your basis in the land you received is figured as follows.

Basis of land traded $100,000
Minus: Cash received (adjustment 1(a)) − 30,000
  $70,000
Plus: Gain recognized (adjustment 2(b)) + 30,000
Basis of land received $100,000

 

Example 2.

You trade a truck (adjusted basis of $22,750) for another truck (FMV of $20,000) and $10,000 cash. You realize a gain of $7,250. This is the FMV of the truck received plus the cash minus the adjusted basis of the truck you traded ($20,000 + $10,000 − $22,750). You include all the gain in your income (recognize gain) because the gain is less than the cash you received. Your basis in the truck you received is figured as follows.

Adjusted basis of truck traded $22,750
Minus: Cash received (adjustment 1(a)) −10,000
  $12,750
Plus: Gain recognized (adjustment 2(b)) + 7,250
Basis of truck received $20,000

 

Allocation of basis.

If you receive like-kind and unlike properties in the exchange, allocate the basis first to the unlike property, other than money, up to its FMV on the date of the exchange. The rest is the basis of the like-kind property.

Example.

You traded a tractor with an adjusted basis of $95,000 for another tractor that had an FMV of $92,500. You also received $1,000 cash and a truck that had an FMV of $19,000. The truck is unlike property. You realized a gain of $17,500. This is the FMV of the tractor received plus the FMV of the truck received plus the cash minus the adjusted basis of the tractor you traded ($92,500 + $19,000 + $1,000 − $95,000). You include in income (recognize) all $17,500 of the gain because it is less than the FMV of the unlike property plus the cash received. Your basis in the properties you received is figured as follows.

Adjusted basis of old tractor $95,000
Minus: Cash received (adjustment 1(a)) − 1,000
  $94,000
Plus: Gain recognized (adjustment 2(b)) + 17,500
Total basis of properties received $111,500

Allocate the total basis of $111,500 first to the unlike property—the truck ($19,000). This is the truck's FMV. The rest ($92,500) is the basis of the tractor.

Sale and Purchase

If you sell property and buy similar property in two mutually dependent transactions, you may have to treat the sale and purchase as a single nontaxable exchange.

Example.

You used a tractor on your farm for 3 years. Its adjusted basis is $22,000 and its FMV is $40,000. You are interested in a new tractor, which sells for $60,000. Ordinarily, you would trade your old tractor for the new one and pay the dealer $20,000. Your basis for depreciating the new tractor would then be $42,000 ($20,000 + $22,000, the adjusted basis of your old tractor). However, you want a higher basis for depreciating the new tractor, so you agree to pay the dealer $60,000 for the new tractor if he will pay you $40,000 for your old tractor. Because the two transactions are dependent on each other, you are treated as having exchanged your old tractor for the new one and paid $20,000 ($60,000 − $40,000). Your basis for depreciating the new tractor is $42,000, the same as if you traded the old tractor.

Property Received as a Gift

To figure the basis of property you receive as a gift, you must know the donor's adjusted basis (defined earlier) just before it was given to you. You also must know its FMV at the time it was given to you and any gift tax paid on it.

FMV equal to or greater than donor's adjusted basis.

If the FMV of the property is equal to or greater than the donor's adjusted basis, your basis is the donor's adjusted basis when you received the gift. Increase your basis by all or part of any gift tax paid, depending on the date of the gift.

Also, for figuring gain or loss from a sale or other disposition of the property, or for figuring depreciation, depletion, or amortization deductions on business property, you must increase or decrease your basis (the donor's adjusted basis) by any required adjustments to basis while you held the property. See Adjusted Basis , earlier.

If you received a gift during the tax year, increase your basis in the gift (the donor's adjusted basis) by the part of the gift tax paid on it due to the net increase in value of the gift. Figure the increase by multiplying the gift tax paid by the following fraction.

Net increase in value of the gift
Amount of the gift

 

The net increase in value of the gift is the FMV of the gift minus the donor's adjusted basis. The amount of the gift is its value for gift tax purposes after reduction by any annual exclusion and marital or charitable deduction that applies to the gift.

Example.

In 2017, you received a gift of property from your mother that had an FMV of $50,000. Her adjusted basis was $20,000. The amount of the gift for gift tax purposes was $36,000 ($50,000 minus the $14,000 annual exclusion). She paid a gift tax of $7,320. Your basis, $26,076, is figured as follows.

Fair market value $50,000
Minus: Adjusted basis −20,000
Net increase in value $30,000
Gift tax paid $7,320
Multiplied by ($30,000 ÷ $36,000) × .83
Gift tax due to net increase in value $6,076
Adjusted basis of property to your mother +20,000
Your basis in the property $26,076

 

Note.

If you received a gift before 1977, your basis in the gift (the donor's adjusted basis) includes any gift tax paid on it. However, your basis cannot exceed the FMV of the gift when it was given to you.

FMV less than donor's adjusted basis.

If the FMV of the property at the time of the gift is less than the donor's adjusted basis, your basis depends on whether you have a gain or a loss when you dispose of the property. Your basis for figuring gain is the donor's adjusted basis plus or minus any required adjustments to basis while you held the property. Your basis for figuring loss is its FMV when you received the gift plus or minus any required adjustments to basis while you held the property. (See Adjusted Basis , earlier.)

If you use the donor's adjusted basis for figuring a gain and get a loss, and then use the FMV for figuring a loss and get a gain, you have neither gain nor loss on the sale or other disposition of the property.

Example.

You received farmland as a gift from your parents when they retired from farming. At the time of the gift, the land had an FMV of $80,000. Your parents' adjusted basis was $100,000. After you received the land, no events occurred that would increase or decrease your basis.

If you sell the land for $120,000, you will have a $20,000 gain because you must use the donor's adjusted basis at the time of the gift ($100,000) as your basis to figure a gain. If you sell the land for $70,000, you will have a $10,000 loss because you must use the FMV at the time of the gift ($80,000) as your basis to figure a loss.

If the sales price is between $80,000 and $100,000, you have neither gain nor loss. For instance, if the sales price was $90,000 and you tried to figure a gain using the donor's adjusted basis ($100,000), you would get a $10,000 loss. If you then tried to figure a loss using the FMV ($80,000), you would get a $10,000 gain.

Business property.

If you hold the gift as business property, your basis for figuring any depreciation, depletion, or amortization deductions is the same as the donor's adjusted basis plus or minus any required adjustments to basis while you hold the property.

Property Transferred From a Spouse

The basis of property transferred to you or transferred in trust for your benefit by your spouse is the same as your spouse's adjusted basis. The same rule applies to a transfer by your former spouse if the transfer is incident to divorce. However, for property transferred in trust, adjust your basis for any gain recognized by your spouse or former spouse if the liabilities assumed plus the liabilities to which the property is subject are more than the adjusted basis of the property transferred.

The transferor must give you the records needed to determine the adjusted basis and holding period of the property as of the date of the transfer.

For more information, see Property Settlements in Pub. 504, Divorced or Separated Individuals.

Inherited Property

Your basis in property you inherited from a decedent is generally one of the following.

  • The FMV of the property at the date of the decedent's death. If a federal estate return is filed, you can use its appraised value.

  • The FMV on the alternate valuation date, if the personal representative for the estate elects to use alternate valuation. For information on the alternate valuation, see the Instructions for Form 706.

  • The decedent's adjusted basis in land to the extent of the value that is excluded from the decedent's taxable estate as a qualified conservation easement.

 

If a federal estate tax return does not have to be filed, your basis in the inherited property is its appraised value at the date of death for state inheritance or transmission taxes.

Special-use valuation method.

Under certain conditions, when a person dies, the executor or personal representative of that person's estate may elect to value qualified real property at other than its FMV. If so, the executor or personal representative values the qualified real property based on its use as a farm or other closely held business. If the executor or personal representative elects this method of valuation for estate tax purposes, this value is the basis of the property for the qualified heirs. The qualified heirs should be able to get the necessary value from the executor or personal representative of the estate.

If you are a qualified heir who received special-use valuation property, increase your basis by any gain recognized by the estate or trust because of post-death appreciation. Post-death appreciation is the property's FMV on the date of distribution minus the property's FMV either on the date of the individual's death or on the alternate valuation date. Figure all FMVs without regard to the special-use valuation.

You may be liable for an additional estate tax if, within 10 years after the death of the decedent, you transfer the property or the property stops being used as a farm. This tax does not apply if you dispose of the property in a like-kind exchange or in an involuntary conversion in which all of the proceeds are reinvested in qualified replacement property. The tax also does not apply if you transfer the property to a member of your family and certain requirements are met.

You can elect to increase your basis in special-use valuation property if it becomes subject to the additional estate tax. To increase your basis, you must make an irrevocable election and pay interest on the additional estate tax figured from the date 9 months after the decedent's death until the date of payment of the additional estate tax. If you meet these requirements, increase your basis in the property to its FMV on the date of the decedent's death or the alternate valuation date. The increase in your basis is considered to have occurred immediately before the event that resulted in the additional estate tax.

You make the election by filing, with Form 706-A, United States Additional Estate Tax Return, a statement that:

  • Contains your (and the estate's) name, address, and taxpayer identification number;

  • Identifies the election as an election under section 1016(c) of the Internal Revenue Code;

  • Specifies the property for which you are making the election; and

  • Provides any additional information required by the Form 706-A instructions.

 

For more information, see Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, Form 706-A, and the related instructions.

Property Distributed From a Partnership or Corporation

The following rules apply to determine a partner's basis and a shareholder's basis in property distributed respectively from a partnership to the partner with respect to the partner's interest in the partnership and from a corporation to the shareholder with respect to the shareholder's ownership of stock in the corporation.

Partner's basis.

Unless there is a complete liquidation of a partner's interest, the basis of property (other than money) distributed by a partnership to the partner is its adjusted basis to the partnership immediately before the distribution. However, the basis of the property to the partner cannot be more than the adjusted basis of his or her interest in the partnership reduced by any money received in the same transaction. For more information, see Partner's Basis for Distributed Property in Pub. 541, Partnerships.

Shareholder's basis.

The basis of property distributed by a corporation to a shareholder is its FMV. For more information about corporate distributions, see Distributions to Shareholders in Pub. 542, Corporations.

7. Depreciation, Depletion, and Amortization

What's New for 2017

Increased section 179 expense deduction dollar limits. The maximum amount you can elect to deduct for most section 179 property you placed in service in 2017 is $510,000. This limit is reduced by the amount by which the cost of the property placed in service during the tax year exceeds $2,030,000. See Dollar Limits under Section 179 Expense Deduction , later.

What’s New for 2018

Phase down of the special depreciation allowance. The special depreciation allowance will be phased down to 40% for certain property placed in service after December 31, 2017, and certain plants bearing fruits and nuts or grafted after December 31, 2017. See Certain property placed in service before January 1, 2020 , and Certain specified plants , later.

Introduction

If you buy or make improvements to farm property such as machinery, equipment, livestock, or a structure with a useful life of more than a year, you generally cannot deduct its entire cost in one year. Instead, you must spread the cost over the time you use the property and deduct part of it each year. For most types of property, this is called depreciation.

This chapter gives information on depreciation methods that generally apply to property placed in service after 1986. For information on depreciating pre-1987 property, see Pub. 534, Depreciating Property Placed in Service Before 1987.

Topics - This chapter discusses:

  • Overview of depreciation

  • Section 179 expense deduction

  • Special depreciation allowance

  • Modified Accelerated Cost Recovery
    System (MACRS)

  • Listed property

  • Basic information on cost depletion (including timber depletion) and percentage depletion

  • Amortization of the costs of going into business, reforestation costs, the costs of pollution control facilities, and the costs of section 197 intangibles

Useful Items - You may want to see:

Publication

  • 463 Travel, Entertainment, Gift, and Car Expenses

  • 534 Depreciating Property Placed in Service Before 1987

  • 535 Business Expenses

  • 544 Sales and Other Dispositions of Assets

  • 551 Basis of Assets

  • 946 How To Depreciate Property

Form (and Instructions)

  • T (Timber), Forest Activities Schedule

  • 3115 Application for Change in Accounting Method

  • 4562 Depreciation and Amortization

  • 4797 Sales of Business Property

See chapter 16 for information about getting publications and forms.

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It is important to keep good records for property you depreciate. Do not file these records with your return. Instead, you should keep them as part of the permanent records of the depreciated property. They will help you verify the accuracy of the depreciation of assets placed in service in the current and previous tax years. For general information on recordkeeping, see Pub. 583, Starting a Business and Keeping Records. For specific information on keeping records for section 179 property and listed property, see Pub. 946, How To Depreciate Property.

Overview of Depreciation

This overview discusses basic information on the following.

  • What property can be depreciated.

  • What property cannot be depreciated.

  • When depreciation begins and ends.

  • Whether MACRS can be used to figure depreciation.

  • What is the basis of your depreciable property.

  • How to treat repairs and improvements.

  • When you must file Form 4562.

  • How you can correct depreciation claimed incorrectly.

 

What Property Can Be Depreciated?

You can depreciate most types of tangible property (except land), such as buildings, machinery, equipment, vehicles, certain livestock, and furniture. You can also depreciate certain intangible property, such as copyrights, patents, and computer software. To be depreciable, the property must meet all the following requirements.

  • It must be property you own.

  • It must be used in your business or income-producing activity.

  • It must have a determinable useful life.

  • It must have a useful life that extends substantially beyond the year you place it in service.

 

Property You Own

To claim depreciation, you usually must be the owner of the property. You are considered as owning property even if it is subject to a debt.

Leased property.

You can depreciate leased property only if you retain the incidents of ownership in the property. This means you bear the burden of exhaustion of the capital investment in the property. If you lease property from someone to use in your trade or business or for the production of income, you generally cannot depreciate its cost because you do not have the incidents of ownership. You can, however, depreciate any capital improvements you make to the leased property. See Additions and Improvements under Which Recovery Period Applies in chapter 4 of Pub. 946.

You generally can depreciate the cost of property you lease to someone even if the lessee (the person leasing from you) has agreed to preserve, replace, renew, and maintain the property. However, you cannot depreciate the cost of the property if the lease provides that the lessee is to maintain the property and return to you the same property or its equivalent in value at the expiration of the lease in as good condition and value as when leased.

Life tenant.

Generally, if you hold business or investment property as a life tenant, you can depreciate it as if you were the absolute owner of the property. See Certain term interests in property , later, for an exception.

Property Used in Your Business or Income-Producing Activity

To claim depreciation on property, you must use it in your business or income-producing activity. If you use property to produce income (investment use), the income must be taxable. You cannot depreciate property that you use solely for personal activities. However, if you use property for business or investment purposes and for personal purposes, you can deduct depreciation based only on the percentage of business or investment use.

Example 1.

If you use your car for farm business, you can deduct depreciation based on its percentage of use in farming. If you also use it for investment purposes, you can depreciate it based on its percentage of investment use.

Example 2.

If you use part of your home for business, you may be able to deduct depreciation on that part based on its business use. For more information, see Business Use of Your Home in chapter 4.

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You may be able to use the simplified method to determine your business use of the home deduction. If you choose to use the simplified method, you cannot also deduct depreciation on the part of the home used for business. For more information about the simplified method, see Pub. 587, Business Use of Your Home.

Inventory.

You can never depreciate inventory because it is not held for use in your business. Inventory is any property you hold primarily for sale to customers in the ordinary course of your business.

Livestock.

Livestock purchased for draft, breeding, or dairy purposes can be depreciated only if they are not kept in an inventory account. Livestock you raise usually has no depreciable basis because the costs of raising them are deducted and not added to their basis. However, see Immature livestock under When Does Depreciation Begin and End , later, for a special rule.

Property Having a Determinable Useful Life

To be depreciable, your property must have a determinable useful life. This means it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes.

Irrigation systems and water wells.

Irrigation systems and wells used in a trade or business can be depreciated if their useful life can be determined. You can depreciate irrigation systems and wells composed of masonry, concrete, tile (including drainage tile), metal, or wood. In addition, you can depreciate costs for moving dirt to construct irrigation systems and water wells composed of these materials. However, land preparation costs for center pivot irrigation systems are not depreciable.

Dams, ponds, and terraces.

In general, you cannot depreciate earthen dams, ponds, and terraces unless the structures have a determinable useful life.

What Property Cannot Be Depreciated?

Certain property cannot be depreciated, even if the requirements explained earlier are met. This includes the following.

  • Land. You can never depreciate the cost of land because land does not wear out, become obsolete, or get used up. The cost of land generally includes the cost of clearing, grading, planting, and landscaping. Although you cannot depreciate land, you can depreciate certain costs incurred in preparing land for business use. See chapter 1 of Pub. 946.

  • Property placed in service and disposed of in the same year. Determining when property is placed in service is explained later.

  • Equipment used to build capital improvements. You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements.

  • Intangible property such as section 197 intangibles. This property does not have a determinable useful life and generally cannot be depreciated. However, see Amortization , later. Special rules apply to computer software (discussed below).

  • Certain term interests (discussed below).

 

Computer software.

Computer software is generally not a section 197 intangible even if acquired in connection with the acquisition of a business, if it meets all of the following tests.

  • It is readily available for purchase by the general public.

  • It is subject to a nonexclusive license.

  • It has not been substantially modified.

 

If the software meets the tests above, it can be depreciated and may qualify for the section 179 expense deduction and the special depreciation allowance (if applicable), discussed later.

Certain term interests in property.

You cannot depreciate a term interest in property created or acquired after July 27, 1989, for any period during which the remainder interest is held, directly or indirectly, by a person related to you. This rule does not apply to the holder of a term interest in property acquired by gift, bequest, or inheritance. For more information, see chapter 1 of Pub. 946.

When Does Depreciation Begin and End?

You begin to depreciate your property when you place it in service for use in your trade or business or for the production of income. You stop depreciating property either when you have fully recovered your cost or other basis or when you retire it from service, whichever happens first.

Placed in Service

Property is placed in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity. Even if you are not using the property, it is in service when it is ready and available for its specific use.

Example.

You bought a planter for use in your farm business. The planter was delivered in December 2016 after harvest was over. You begin to depreciate the planter in 2016 because it was ready and available for its specific use in 2016, even though it will not be used until the spring of 2017.

If your planter comes unassembled in December 2016 and is put together in February 2017, it is not placed in service until 2017. You begin to depreciate it in 2017.

If your planter was delivered and assembled in February 2017 but not used until April 2017, it is placed in service in February 2017, because this is when the planter was ready for its specified use. You begin to depreciate it in 2017.

Fruit or nut trees and vines.

If you acquire an orchard, grove, or vineyard before the trees or vines have reached the income-producing stage, and they have a preproductive period of more than 2 years, you must capitalize the preproductive-period costs under the uniform capitalization rules (unless you elect not to use these rules). See chapter 6 for information about the uniform capitalization rules. Your depreciation begins when the trees and vines reach the income-producing stage (that is, when they bear fruit, nuts, or grapes in quantities sufficient to commercially warrant harvesting). For information on claiming the special depreciation allowance for certain specified plants bearing fruits and nuts, see Certain specified plants , later.

Immature livestock.

Depreciation for livestock begins when the livestock reaches the age of maturity. If you bought immature livestock for drafting purposes, depreciation begins when they can be worked. If you bought immature livestock for breeding or dairy purposes, depreciation begins when they can be bred. Your basis for depreciation is your initial cost for the immature livestock.

Idle Property

Continue to claim a deduction for depreciation on property used in your business or for the production of income even if it is temporarily idle. For example, if you stop using a machine because there is a temporary lack of a market for a product made with that machine, continue to deduct depreciation on the machine.

Cost or Other Basis Fully Recovered

You stop depreciating property when you have fully recovered your cost or other basis. This happens when your section 179 and allowed or allowable depreciation deductions equal your cost or investment in the property.

Retired From Service

You stop depreciating property when you retire it from service, even if you have not fully recovered its cost or other basis. You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because of any of the following events.

  • You sell or exchange the property.

  • You convert the property to personal use.

  • You abandon the property.

  • You transfer the property to a supplies or scrap account.

  • The property is destroyed.

 

For information on abandonment of property, see chapter 8. For information on destroyed property, see chapter 11, and Pub. 547, Casualties, Disasters, and Thefts.

Can You Use MACRS To Depreciate Your Property?

You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most business and investment property placed in service after 1986. MACRS is explained later under Figuring Depreciation Under MACRS .

You cannot use MACRS to depreciate the following property.

  • Property you placed in service before 1987. Use the methods discussed in Pub. 534.

  • Certain property owned or used in 1986. See chapter 1 of Pub. 946.

  • Intangible property.

  • Films, video tapes, and recordings.

  • Certain corporate or partnership property acquired in a nontaxable transfer.

  • Property you elected to exclude from MACRS.

 

For more information, see chapter 1 of Pub. 946.

What Is the Basis of Your Depreciable Property?

To figure your depreciation deduction, you must determine the basis of your property. To determine basis, you need to know the cost or other basis of your property.

Cost or other basis.

The basis of property you buy is usually its cost plus amounts you paid for items such as sales tax, freight charges, and installation and testing fees. The cost includes the amount you pay in cash, debt obligations, other property, or services. For more information, see chapter 6.

There are times when you cannot use cost as basis. In these situations, the fair market value (FMV) or the adjusted basis of the property may be used.

Adjusted basis.

To find your property's basis for depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service.

Basis adjustment for depreciation allowed or allowable.

After you place your property in service, you must reduce the basis of the property by the depreciation allowed or allowable, whichever is greater. Depreciation allowed is depreciation you actually deducted (from which you received a tax benefit). Depreciation allowable is depreciation you are entitled to deduct.

If you do not claim depreciation you are entitled to deduct, you must still reduce the basis of the property by the full amount of depreciation allowable.

If you deduct more depreciation than you should, you must reduce your basis by any amount deducted from which you received a tax benefit (the depreciation allowed).

For more information, see chapter 6.

How Do You Treat Repairs and Improvements?

If you improve depreciable property, you must treat the improvement as separate depreciable property. Improvement means an addition to or partial replacement of property that is a betterment to the property, restores the property, or adapts it to a new or different use. See Regulations section 1.263(a)-3.

You generally deduct the cost of repairing business property in the same way as any other business expense. However, if the cost is for a betterment to the property, restores the property, or adapts it to a new or different use, you must treat it as an improvement and depreciate it. See chapter 1 of Pub. 946 for more information.

Example.

You repair a small section on a corner of the roof of a barn that you rent to others. You deduct the cost of the repair as a business expense. However, if you replace the entire roof, the new roof is considered to be an improvement because it increases the value and lengthens the life for the property. You depreciate the cost of the new roof.

Improvements to rented property.

You can depreciate permanent improvements you make to business property you rent from someone else.

Do You Have To File Form 4562?

Use Form 4562 to claim your deduction for depreciation and amortization. You must complete and attach Form 4562 to your tax return if you are claiming any of the following.

  • A section 179 expense deduction for the current year or a section 179 carryover from a prior year.

  • Depreciation for property placed in service during the current year.

  • Depreciation on any vehicle or other listed property, regardless of when it was placed in service.

  • Amortization of costs that began in the current year.

 

For more information, see the Instructions for Form 4562.

How Do You Correct Depreciation Deductions?

If you deducted an incorrect amount of depreciation in any year, you may be able to make a correction by filing an amended return for that year. You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations.

  • You claimed the incorrect amount because of a mathematical error made in any year.

  • You claimed the incorrect amount because of a posting error made in any year, for example, omitting an asset from the depreciation schedule.

  • You have not adopted a method of accounting for the property placed in service by you in tax years ending after December 29, 2003.

  • You claimed the incorrect amount on property placed in service by you in tax years ending before December 30, 2003.

 

Note.

You have adopted a method of accounting if you used the same incorrect method of depreciation for two or more consecutively filed returns.

If you are not allowed to make the correction on an amended return, you may be able to change your accounting method to claim the correct amount of depreciation. See the Instructions for Form 3115.

Section 179 Expense Deduction

You can elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year you place the property in service. This is the section 179 expense deduction. You can elect the section 179 expense deduction instead of recovering the cost by taking depreciation deductions.

This part of the chapter explains the rules for the section 179 expense deduction. It explains what property qualifies for the deduction, what property does not qualify for the deduction, the limits that may apply, how to elect the deduction, and when you may have to recapture the deduction.

For more information, see chapter 2 of Pub. 946.

What Property Qualifies?

To qualify for the section 179 expense deduction, your property must meet all the following requirements.

  • It must be eligible property.

  • It must be acquired primarily for business use.

  • It must have been acquired by purchase.

 

Eligible Property

To qualify for the section 179 expense deduction, your property must be one of the following types of depreciable property.

  1. Tangible personal property.

  2. Other tangible property (except buildings and their structural components) used as:

    1. An integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services;

    2. A research facility used in connection with any of the activities in (a) above; or

    3. A facility used in connection with any of the activities in (a) for the bulk storage of fungible commodities.

  3. Single purpose agricultural (livestock) or horticultural structures.

  4. Storage facilities (except buildings and their structural components) used in connection with distributing petroleum or any primary product of petroleum.

  5. Qualified real property. (Special rules apply to qualified real property that you elect to treat as qualified section 179 real property. For more information, see chapter 2 of Pub. 946, and section 179(f) of the Internal Revenue Code.)

  6. Off-the-shelf computer software that is readily available for purchase by the general public, is subject to a nonexclusive lease, and has not been substantially modified.

 

Tangible personal property.

Tangible personal property is any tangible property that is not real property. It includes the following property.

  • Machinery and equipment.

  • Property contained in or attached to a building (other than structural components), such as milk tanks, automatic feeders, barn cleaners, and office equipment.

  • Gasoline storage tanks and pumps at retail service stations.

  • Livestock, including horses, cattle, hogs, sheep, goats, and mink and other fur-bearing animals.

 

Facility used for the bulk storage of fungible commodities.

A facility used for the bulk storage of fungible commodities is qualifying property for purposes of the section 179 expense deduction if it is used in connection with any of the activities listed earlier in item (2)(c). Bulk storage means the storage of a commodity in a large mass before it is used.

Grain bins.

A grain bin is an example of a storage facility that is qualifying section 179 property. It is a facility used in connection with the production of grain or livestock for the bulk storage of fungible commodities.

Single purpose agricultural or horticultural structures.

A single purpose agricultural (livestock) or horticultural structure is qualifying property for purposes of the section 179 expense deduction.

Agricultural structure.

A single purpose agricultural (livestock) structure is any building or enclosure specifically designed, constructed, and used for both the following reasons.

  • To house, raise, and feed a particular type of livestock and its produce.

  • To house the equipment, including any replacements, needed to house, raise, or feed the livestock.

For this purpose, livestock includes poultry.

Single purpose structures are qualifying property if used, for example, to breed chickens or hogs, produce milk from dairy cattle, or produce feeder cattle or pigs, broiler chickens, or eggs. The facility must include, as an integral part of the structure or enclosure, equipment necessary to house, raise, and feed the livestock.

Horticultural structure.

A single purpose horticultural structure is either of the following.

  • A greenhouse specifically designed, constructed, and used for the commercial production of plants.

  • A structure specifically designed, constructed, and used for the commercial production of mushrooms.

 

Use of structure.

A structure must be used only for the purpose that qualified it. For example, a hog barn will not be qualifying property if you use it to house poultry. Similarly, using part of your greenhouse to sell plants will make the greenhouse nonqualifying property.

If a structure includes work space, the work space can be used only for the following activities.

  • Stocking, caring for, or collecting livestock or plants or their produce.

  • Maintaining the enclosure or structure.

  • Maintaining or replacing the equipment or stock enclosed or housed in the structure.

 

Property Acquired by Purchase

To qualify for the section 179 expense deduction, your property must have been acquired by purchase. For example, property acquired by gift or inheritance does not qualify. Property acquired from a related person (that is, your spouse, ancestors, or lineal descendants) is not considered acquired by purchase. New or used equipment you acquired by purchase during the current tax year qualifies for the section 179 deduction.

Example.

Adrian is a farmer. He purchased two tractors, one from his brother and one from his father. He placed both tractors in service in the same year he bought them. The tractor purchased from his father does not qualify for the section 179 expense deduction because he is a related person (as defined above). The tractor purchased from his brother does qualify for the deduction because Adrian is not a related person (as defined above).

What Property Does Not Qualify?

Land and improvements.

Land and land improvements do not qualify as section 179 property. Land improvements include swimming pools, paved parking areas, wharves, docks, bridges, and nonagricultural fences. However, agricultural fences do qualify as section 179 property. Similarly, field drainage tile also qualifies as section 179 property.

Excepted property.

Even if the requirements explained in the preceding discussions are met, farmers cannot elect the section 179 expense deduction for the following property.

  • Certain property you lease to others (if you are a noncorporate lessor).

  • Certain property used predominantly to furnish lodging or in connection with the furnishing of lodging.

  • Property used by a tax-exempt organization (other than a tax-exempt farmers' cooperative) unless the property is used mainly in a taxable unrelated trade or business.

  • Property used by governmental units or foreign persons or entities (except property used under a lease with a term of less than 6 months).

 

How Much Can You Deduct?

Your section 179 expense deduction is generally the cost of the qualifying property. However, the total amount you can elect to deduct under section 179 is subject to a dollar limit and a business income limit. These limits apply to each taxpayer, not to each business. However, see Married individuals under Dollar Limits , later. Also see the special rules for applying the limits for partnerships and S corporations under Partnerships and S Corporations , later.

If you deduct only part of the cost of qualifying property as a section 179 expense deduction, you can generally depreciate the cost you do not deduct.

Use Part I of Form 4562 to figure your section 179 expense deduction.

Partial business use.

When you use property for business and nonbusiness purposes, you can elect the section 179 expense deduction only if you use it more than 50% for business in the year you place it in service. If you used the property more than 50% for business, multiply the cost of the property by the percentage of business use. Use the resulting business cost to figure your section 179 expense deduction.

Trade-in of other property.

If you buy qualifying property with cash and a trade-in, its cost for purposes of the section 179 expense deduction includes only the cash you paid. For example, if you buy (for cash and a trade-in) a new tractor for use in your business, your cost for the section 179 expense deduction is the cash you paid. It does not include the adjusted basis of the old tractor you trade for the new tractor.

Example.

Adyo Farms traded two cultivators having a total adjusted basis of $6,800 for a new cultivator costing $13,200. They received an $8,000 trade-in allowance for the old cultivators and paid $5,200 cash for the new cultivator. Adyo also traded a used pickup truck with an adjusted basis of $8,000 for a new pickup truck costing $35,000. They received a $5,000 trade-in allowance and paid $30,000 cash for the new pickup truck.

Only the cash paid by Adyo qualifies for the section 179 expense deduction. Adyo's business costs that qualify for a section 179 expense deduction are $35,200 ($5,200 + $30,000). For information on the maximum amount you can elect to deduct, see Dollar Limits below.

Dollar Limits

The total amount you can elect to deduct under section 179 for most property placed in service in 2017 is $510,000. If you acquire and place in service more than one item of qualifying property during the year, you can allocate the section 179 expense deduction among the items in any way, as long as the total deduction is not more than $510,000. You cannot carry costs in excess of the $510,000 limit over to future years.

Reduced dollar limit for cost exceeding $2,030,000.

If the cost of your qualifying section 179 property placed in service in 2017 is over $2,030,000, you must reduce the dollar limit (but not below zero) by the amount of cost over $2,030,000. If the cost of your section 179 property placed in service during 2017 is $2,530,000 or more, you cannot take a section 179 expense deduction and you cannot carry over any of the cost that is more than $2,530,000.

Example.

This year, George Thomas placed in service machinery costing $2,180,000. Because this cost is $150,000 more than $2,030,000, he must reduce his dollar limit to $360,000 ($510,000 − $150,000). He cannot carry over any of the costs that exceed the $360,000 reduced limit.

Limits for sport utility vehicles.

The total amount you can elect to deduct for certain sport utility vehicles and certain other vehicles placed in service in 2017 is $25,000. This rule applies to any 4-wheeled vehicle primarily designed or used to carry passengers over public streets, roads, and highways that is rated at more than 6,000 pounds gross vehicle weight and not more than 14,000 pounds gross vehicle weight.

For more information, see chapter 2 of Pub. 946.

Limits for passenger automobiles.

For a passenger automobile that is placed in service in 2017, the total section 179 and depreciation deduction is limited. See Do the Passenger Automobile Limits Apply , later.

Married individuals.

If you are married, how you figure your section 179 expense deduction depends on whether you file jointly or separately. If you file a joint return, you and your spouse are treated as one taxpayer in determining any reduction to the dollar limit, regardless of which of you purchased the property or placed it in service. If you and your spouse file separate returns, you are treated as one taxpayer for the dollar limit, including the reduction for costs over $2,030,000. You must allocate the dollar limit (after any reduction) equally between you, unless you both elect a different allocation. If the percentages elected by each of you do not total 100%, 50% will be allocated to each of you.

Joint return after separate returns.

If you and your spouse elect to amend your separate returns by filing a joint return after the due date for filing your return, the dollar limit on the joint return is the lesser of the following amounts.

  • The dollar limit (after reduction for any cost of section 179 property over $2,030,000).

  • The total cost of section 179 property you and your spouse elected to expense on your separate returns.

 

Business Income Limit

The total cost you can deduct each year after you apply the dollar limit is limited to the taxable income from the active conduct of any trade or business during the year. Generally, you are considered to actively conduct a trade or business if you meaningfully participate in the management or operations of the trade or business.

Any cost not deductible in one year under section 179 because of this limit can be carried to the next year. See Carryover of disallowed deduction , later.

Taxable income.

In general, figure taxable income for this purpose by totaling the net income and losses from all trades and businesses you actively conducted during the year. In addition to net income or loss from a sole proprietorship, partnership, or S corporation, net income or loss derived from a trade or business also includes the following items.

  • Section 1231 gains (or losses) as discussed in chapter 9.

  • Interest from working capital of your trade or business.

  • Wages, salaries, tips, or other pay earned by you (or your spouse if you file a joint return) as an employee of any employer.

 

In addition, figure taxable income without regard to any of the following.

  • The section 179 expense deduction.

  • The self-employment tax deduction.

  • Any net operating loss carryback or carryforward.

  • Any unreimbursed employee business expenses.

 

Two different taxable income limits.

In addition to the business income limit for your section 179 expense deduction, you may have a taxable income limit for some other deduction (for example, charitable contributions). You may have to figure the limit for this other deduction taking into account the section 179 expense deduction. If so, complete the following steps.

Step Action
1 Figure taxable income without the section 179 expense deduction or the other deduction.
2 Figure a hypothetical section 179 expense deduction using the taxable income figured in Step 1.
3 Subtract the hypothetical section 179 expense deduction figured in Step 2 from the taxable income figured in Step 1.
4 Figure a hypothetical amount for the other deduction using the amount figured in Step 3 as taxable income.
5 Subtract the hypothetical other deduction figured in Step 4 from the taxable income figured in
Step 1.
6 Figure your actual section 179 expense deduction using the taxable income figured in Step 5.
7 Subtract your actual section 179 expense deduction figured in Step 6 from the taxable income figured in Step 1.
8 Figure your actual other deduction using the taxable income figured in Step 7.

 

Example.

On February 1, 2017, the XYZ farm corporation purchased and placed in service qualifying section 179 property that cost $500,000. It elects to expense the entire $500,000 cost under section 179. In June, the corporation gave a charitable contribution of $100,000. A corporation's limit on charitable contributions is figured after subtracting any section 179 expense deduction. The business income limit for the section 179 expense deduction is figured after subtracting any allowable charitable contributions. XYZ's taxable income figured without the section 179 expense deduction or the deduction for charitable contributions is $700,000. XYZ figures its section 179 expense deduction and its deduction for charitable contributions as follows.

Step 1. Taxable income figured without either deduction is $700,000.

Step 2. Using $700,000 as taxable income, XYZ's hypothetical section 179 expense deduction is $500,000.

Step 3. $200,000 ($700,000 − $500,000).

Step 4. Using $200,000 (from Step 3) as taxable income, XYZ's hypothetical charitable contribution (limited to 10% of taxable income) is $20,000.

Step 5. $680,000 ($700,000 − $20,000).

Step 6. Using $680,000 (from Step 5) as taxable income, XYZ figures the actual section 179 expense deduction. Because the taxable income is at least $500,000, XYZ can take a $500,000 section 179 expense deduction.

Step 7. $200,000 ($700,000 − $500,000).

Step 8. Using $200,000 (from Step 7) as taxable income, XYZ's actual charitable contribution (limited to 10% of taxable income) is $20,000.

 

Carryover of disallowed deduction.

You can carry over for an unlimited number of years the cost of any section 179 property you elected to expense but were unable to because of the business income limit.

The amount you carry over is used in determining your section 179 expense deduction in the next year. However, it is subject to the limits in that year. If you place more than one property in service in a year, you can select the properties for which all or a part of the cost will be carried forward. Your selections must be shown in your books and records.

Example.

Last year, Diana Reynolds placed in service a machine that cost $100,000 and elected to deduct all $100,000 under section 179. The taxable income from her business (determined without regard to both a section 179 expense deduction for the cost of the machine and the self-employment tax deduction) was $80,000. Her section 179 expense deduction was limited to $80,000. The $20,000 cost that was not allowed as a section 179 expense deduction (because of the business income limit) is carried to this year.

This year, Diana placed another machine in service that cost $110,000. Her taxable income from business (determined without regard to both a section 179 expense deduction for the cost of the machine and the self-employment tax deduction) is $120,000. Diana can deduct the full cost of the machine ($110,000) but only $10,000 of the carryover from last year because of the business income limit. She can carry over the balance of $10,000 to next year.

Partnerships and S Corporations

The section 179 expense deduction limits apply both to the partnership or S corporation and to each partner or shareholder. The partnership or S corporation determines its section 179 expense deduction subject to the limits. It then allocates the deduction among its partners or shareholders.

If you are a partner in a partnership or shareholder of an S corporation, you add the amount allocated from the partnership or S corporation to any section 179 costs not related to the partnership or S corporation and then apply the dollar limit to this total. To determine any reduction in the dollar limit for costs over $2,030,000, you do not include any of the cost of section 179 property placed in service by the partnership or S corporation. After you apply the dollar limit, you apply the business income limit to any remaining section 179 costs. For more information, see chapter 2 of Pub. 946.

Example.

In 2017, Partnership P placed in service section 179 property with a total cost of $2,130,000. P must reduce its dollar limit by $100,000 ($2,130,000 − $2,030,000). Its maximum section 179 expense deduction is $410,000 ($510,000 − $100,000), and it elects to expense that amount. Because P's taxable income from the active conduct of all its trades or businesses for the year was $1,000,000, it can deduct the full $410,000. P allocates $100,000 of its section 179 expense deduction and $250,000 of its taxable income to John, one of its partners.

John also conducts a business as a sole proprietor and in 2017, placed in service in that business, section 179 property costing $600,000. John's taxable income from that business was $100,000. In addition to the $100,000 allocated from P, he elects to expense the $310,000 of his sole proprietorship's section 179 costs. However, John's deduction is limited to his business taxable income of $350,000 ($250,000 from P plus $100,000 from his sole proprietorship). He carries over $60,000 ($410,000 − $350,000) of the elected section 179 costs to 2018.

How Do You Elect the Deduction?

You elect to take the section 179 expense deduction by completing Part I of Form 4562.

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If you elect the deduction for listed property, complete Part V of
Form 4562 before completing Part I.

File Form 4562 with either of the following.

  • Your original tax return (whether or not you filed it timely).

  • An amended return filed within the time prescribed by law. An election made on an amended return must specify the item of section 179 property to which the election applies and the part of the cost of each such item to be taken into account. The amended return must also include any resulting adjustments to taxable income.

 

Revoking an election.

An election (or any specification made in the election) to take a section 179 expense deduction for 2017 can be revoked without IRS approval by filing an amended return. The amended return must be filed within the time prescribed by law. The amended return must also include any resulting adjustments to taxable income (for example, allowable depreciation in that tax year for the item of section 179 property for which the election pertains). Once made, the revocation is irrevocable.

When Must You Recapture the Deduction? Section 179 expense deductionRecapture RecaptureSection 179 expense deduction

You may have to recapture the section 179 expense deduction if, in any year during the property's recovery period, the percentage of business use drops to 50% or less. In the year the business use drops to 50% or less, you include the recapture amount as ordinary income. You also increase the basis of the property by the recapture amount. Recovery periods for property are discussed later.

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If you sell, exchange, or otherwise dispose of the property, do not figure the recapture amount under the rules explained in this discussion. Instead, use the rules for recapturing depreciation explained in
chapter 9 under Section 1245 Property.

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If the property is listed property, do not figure the recapture amount under the rules explained in this discussion when the percentage of business use drops to 50% or less. Instead, use the rules for recapturing depreciation explained in chapter 5 of Pub. 946 under Recapture of Excess Depreciation.

Figuring the recapture amount.

To figure the amount to recapture, take the following steps.

  1. Figure the allowable depreciation for the section 179 expense deduction you claimed. Begin with the year you placed the property in service and include the year of recapture.

  2. Subtract the depreciation figured in (1) from the section 179 expense deduction you actually claimed. The result is the amount you must recapture.

 

Example.

In January 2015, Paul Lamb, a calendar year taxpayer, bought and placed in service section 179 property costing $10,000. The property is 3-year property and is depreciated under the Modified Accelerated Cost Recovery System (MACRS) and a half-year convention. The property is not listed property. He elected a $5,000 section 179 expense deduction for the property and also elected not to claim a special depreciation allowance. He used the property only for business in 2015 and 2016. During 2017, he used the property 40% for business and 60% for personal use. He figures his recapture amount as follows.

Section 179 expense deduction claimed (2015) $5,000
Minus: Allowable depreciation
(instead of section 179 expense deduction):
 
2015 $1,250  
2016 1,875  
2017 ($1,250 × 40% (business)) 500 3,625
2017 — Recapture amount $1,375
   

 

Paul must include $1,375 in income for 2017.

Where to report recapture.

Report any recapture of the section 179 expense deduction as ordinary income in Part IV of Form 4797 and include it in income on Schedule F (Form 1040).

Recapture for qualified section 179 GO Zone property.

If any qualified section 179 GO Zone property ceases to be used in the GO Zone in a later year, you must recapture the benefit of the increased section 179 expense deduction as "other income."

Claiming the Special Depreciation Allowance

For qualified property (defined below) placed in service in 2017, you can take an additional 50% special depreciation allowance. The allowance is an additional deduction you can take before you figure regular depreciation under MACRS. Figure the special depreciation allowance by multiplying the depreciable basis of the qualified property by 50%.

What is Qualified Property?

For farmers, qualified property generally is certain qualified property placed in service before January 1, 2020, and certain specified plants.

Certain qualified property placed in service before January 1, 2020.

Certain qualified property (defined below) acquired before January 1, 2020, is eligible for a 50% special depreciation allowance. Certain qualified property placed in service after December 31, 2017, is eligible for a 40% special depreciation allowance.

Qualified property includes the following.

  • Certain property with a long production period.

  • Certain aircraft.

 

Qualified property must also meet all of the following tests.

  • You must have acquired qualified property by purchase after December 31, 2007. If a binding contract to acquire the property existed before January 1, 2008, the property does not qualify.

  • Qualified property must be placed in service after December 31, 2007, and placed in service before January 1, 2020.

  • The original use of the property must begin with you after December 31, 2007.

 

Certain specified plants.

You can elect to claim a 50% special depreciation allowance for the adjusted basis of certain specified plants (defined later) bearing fruits and nuts planted or grafted after December 31, 2015, and before January 1, 2018. For certain specified plants bearing fruits and nuts planted or grafted after December 31, 2017, you can elect to claim a 40% special depreciation allowance.

A specified plant is:

  • Any tree or vine that bears fruit or nuts, and

  • Any other plant that will have more than one yield of fruits or nuts and generally has a pre-productive period of more than 2 years from planting and grafting to the time it begins bearing fruits or nuts.

 

Any property planted or grafted outside the United States does not qualify as a specified plant.

If you elect to claim the special depreciation allowance for any specified plant, the plant will not be treated as qualified property eligible for the special depreciation allowance in the subsequent tax year in which it is placed in service.

To make the election, attach a statement to your timely filed return (including extensions) for the tax year in which you plant or graft the specified plant(s) indicating you are electing to apply section 168(k)(5) and identifying the specified plant(s) for which you are making the election. The election once made cannot be revoked without IRS consent.

See section 168(k)(5) of the Internal Revenue Code.

How Can You Elect Not To Claim the Allowance?

You can elect, for any class of property, not to deduct the special depreciation allowance for all property in such class placed in service during the tax year. To make the election, attach a statement to your return indicating the class of property for which you are making the election.

Generally, you must make the election on a timely filed tax return (including extensions) for the year in which you place the property in service. 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 original return (not including extensions). Attach the election statement to the amended return. On the amended return, write "Filed pursuant to section 301.9100-2."

Once made, the election may not be revoked without IRS consent.

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If you elect not to have the special depreciation allowance apply, the property may be subject to an alternative minimum tax adjustment for depreciation.

When Must You Recapture an Allowance

When you dispose of property for which you claimed a special depreciation allowance, any gain on the disposition is generally recaptured (included in income) as ordinary income up to the amount of the special depreciation allowance previously allowed or allowable. For more information, see chapter 3 of Pub. 946.

Figuring Depreciation Under MACRS

The Modified Accelerated Cost Recovery System (MACRS) is used to recover the basis of most business and investment property placed in service after 1986. MACRS consists of two depreciation systems, the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Generally, these systems provide different methods and recovery periods to use in figuring depreciation deductions.

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To be sure you can use MACRS to figure depreciation for your property, see Can You Use MACRS To Depreciate Your Property, earlier.

This part explains how to determine which MACRS depreciation system applies to your property. It also discusses the following information that you need to know before you can figure depreciation under MACRS.

  • Property's recovery class.

  • Placed-in-service date.

  • Basis for depreciation.

  • Recovery period.

  • Convention.

  • Depreciation method.

Finally, this part explains how to use this information to figure your depreciation deduction.

Which Depreciation System (GDS or ADS) Applies?

Your use of either the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to depreciate property under MACRS determines what depreciation method and recovery period you use. You generally must use GDS unless you are specifically required by law to use ADS or you elect to use ADS.

Required use of ADS.

You must use ADS for the following property.

  • All property used predominantly in a farming business and placed in service in any tax year during which an election not to apply the uniform capitalization rules to certain farming costs is in effect.

  • Listed property used 50% or less in a qualified business use. See Additional Rules for Listed Property , later.

  • Any tax-exempt use property.

  • Any tax-exempt bond-financed property.

  • Any property imported from a foreign country for which an Executive Order is in effect because the country maintains trade restrictions or engages in other discriminatory acts.

  • Any tangible property used predominantly outside the United States during the year.

 

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If you are required to use ADS to depreciate your property, you cannot claim the special depreciation allowance.

Electing ADS.

Although your property may qualify for GDS, you can elect to use ADS. The election generally must cover all property in the same property class you placed in service during the year. However, the election for residential rental property and nonresidential real property can be made on a property-by-property basis. Once you make this election, you can never revoke it.

You make the election by completing line 20 in Part III of Form 4562.

Which Property Class Applies Under GDS?

The following is a list of the nine property classes under GDS.

  1. 3-year property.

  2. 5-year property.

  3. 7-year property.

  4. 10-year property.

  5. 15-year property.

  6. 20-year property.

  7. 25-year property.

  8. Residential rental property.

  9. Nonresidential real property.

See Which Property Class Applies Under GDS in chapter 4 of Pub. 946 for examples of the types of property included in each class.

What Is the Placed-in-Service Date?

You begin to claim depreciation when your property is placed in service for use either in a trade or business or for the production of income. The placed-in-service date for your property is the date the property is ready and available for a specific use. It is therefore not necessarily the date it is first used. If you converted property held for personal use to use in a trade or business or for the production of income, treat the property as being placed in service on the conversion date. See Placed in Service under When Does Depreciation Begin and End , earlier, for examples illustrating when property is placed in service.

Also, see Certain specified plants , earlier, for information on the placed in service date for specified plants bearing fruits and nuts for which you elect to claim the special depreciation allowance.

What Is the Basis for Depreciation? Basis of assetsDepreciation

The basis for depreciation of MACRS property is the property's cost or other basis multiplied by the percentage of business/investment use. Reduce that amount by any credits and deductions allocable to the property. The following are examples of some of the credits and deductions that reduce basis.

  • Any deduction for section 179 property.

  • Any deduction for removal of barriers to the disabled and the elderly.

  • Any disabled access credit, enhanced oil recovery credit, and credit for employer-provided childcare facilities and services.

  • Any special depreciation allowance.

  • Basis adjustment for investment credit property under section 50(c) of the Internal Revenue Code.

For information about how to determine the cost or other basis of property, see What Is the Basis of Your Depreciable Property , earlier. Also, see chapter 6.

For additional credits and deductions that affect basis, see section 1016 of the Internal Revenue Code.

Which Recovery Period Applies?

The recovery period of property is the number of years over which you recover its cost or other basis. It is determined based on the depreciation system (GDS or ADS) used. See Table 7-1 for recovery periods under both GDS and ADS for some commonly used assets. For a complete list of recovery periods, see the Table of Class Lives and Recovery Periods in Appendix B of Pub. 946.

House trailers for farm laborers.

To depreciate a house trailer you supply as housing for those who work on your farm, use one of the following recovery periods if the house trailer is mobile (it has wheels and a history of movement).

  • A 7-year recovery period under GDS.

  • A 10-year recovery period under ADS.

 

However, if the house trailer is not mobile (its wheels have been removed and permanent utilities and pipes attached to it), use one of the following recovery periods.

  • A 20-year recovery period under GDS.

  • A 25-year recovery period under ADS.

 

Water wells.

Water wells used to provide water for raising poultry and livestock are land improvements. If they are depreciable, use one of the following recovery periods.

  • A 15-year recovery period under GDS.

  • A 20-year recovery period under ADS.

 

The types of water wells that can be depreciated were discussed earlier in Irrigation systems and water wells under Property Having a Determinable Useful Life .

Table 7-1. Farm Property Recovery Periods

  Recovery Period in Years
Assets GDS ADS
Agricultural structures (single purpose) 10 15
Automobiles 5 5
Calculators and copiers 5 6
Cattle (dairy or breeding) 5 7
Communication equipment1 7 10
Computer and peripheral equipment 5 5
Drainage facilities 15 20
Farm buildings2 20 25
Farm machinery and equipment 7 10
Fences (agricultural) 7 10
Goats and sheep (breeding) 5 5
Grain bin 7 10
Hogs (breeding) 3 3
Horses (age when placed in service)    
Breeding and working (12 years or less) 7 10
Breeding and working (more than 12 years) 3 10
Racing horses (more than 2 years) 3 12
Horticultural structures (single purpose) 10 15
Logging machinery and equipment3 5 6
Nonresidential real property 394 40
Office furniture, fixtures, and equipment (not calculators, copiers, or typewriters) 7 10
Paved lots 15 20
Residential rental property 27.5 40
Tractor units (over-the-road) 3 4
Trees or vines bearing fruit or nuts 10 20
Truck (heavy duty, unloaded weight 13,000 lbs. or more) 5 6
Truck (actual weight less than 13,000 lbs) 5 5
Water wells 15 20
1 Not including communication equipment listed in other classes.
2 Not including single-purpose agricultural or horticultural structures.
3 Used by logging and sawmill operators for cutting of timber.
4 For property placed in service after May 12, 1993; for property placed in service before May 13, 1993,
the recovery period is 31.5 years.

Which Convention Applies? Modified ACRS (MACRS)Conventions

Under MACRS, averaging conventions establish when the recovery period begins and ends. The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property. Use one of the following conventions.

  • The half-year convention.

  • The mid-month convention.

  • The mid-quarter convention.

 

For a detailed explanation of each convention, see Which Convention Applies in chapter 4 of Pub. 946. Also, see the Instructions for Form 4562.

Which Depreciation Method Applies?

MACRS provides three depreciation methods under GDS and one depreciation method under ADS.

  • The 200% declining balance method over a GDS recovery period.

  • The 150% declining balance method over a GDS recovery period.

  • The straight line method over a GDS recovery period.

  • The straight line method over an ADS recovery period.

 

Depreciation Table.

The following table lists the types of property you can depreciate under each method. The declining balance method is abbreviated as DB and the straight line method is abbreviated as SL.

Depreciation Table

System/Method   Type of Property
GDS using
150% DB
All property used in a farming business (except real property)
  All 15- and 20-year property
  Nonfarm 3-, 5-, 7-, and 10-year property1
GDS using SL Nonresidential real property
  Residential rental property
  Trees or vines bearing fruit or nuts
  All 3-, 5-, 7-, 10-, 15-, and 20-year property1
ADS using SL Property used predomi-
nantly outside the United States
  Farm property used when an election not to apply the uniform capitalization rules is in effect
  Tax-exempt property
  Tax-exempt bond-financed property
  Imported property2
  Any property for which you elect to use this method1
GDS using
200% DB
Nonfarm 3-, 5-, 7-, and
10-year property

 

1Elective method
2See section 168(g)(6) of the Internal Revenue
Code

 

Property used in farming business.

For personal property placed in service after 1988 in a farming business, you must use the 150% declining balance method over a GDS recovery period or you can elect one of the following methods.

  • The straight line method over a GDS recovery period.

  • The straight line method over an ADS recovery period.

 

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For property placed in service before 1999, you could have elected to use the 150% declining balance method using the ADS recovery periods for certain property classes. If you made this election, continue to use the same method and recovery period for that property.

Real property.

You can depreciate real property using the straight line method under either GDS or ADS.

Switching to straight line.

If you use a declining balance method, you switch to the straight line method in the year it provides an equal or greater deduction. If you use the MACRS percentage tables, discussed later under How Is the Depreciation Deduction Figured , you do not need to determine in which year your deduction is greater using the straight line method. The tables have the switch to the straight line method built into their rates.

Fruit or nut trees and vines.

Depreciate trees and vines bearing fruit or nuts under GDS using the straight line method over a 10-year recovery period.

ADS required for some farmers.

If you elect not to apply the uniform capitalization rules to any plant shown in Table 6-1 of chapter 6 and produced in your farming business, you must use ADS for all property you place in service in any year the election is in effect. See chapter 6 for a discussion of the application of the uniform capitalization rules to farm property.

Electing a different method.

As shown in the Depreciation Table , you can elect a different method for depreciation for certain types of property. You must make the election by the due date of the return (including extensions) for the year you placed the property in service. 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 your return (excluding extensions). Attach the election to the amended return and write "Filed pursuant to section 301.9100-2" on the election statement. File the amended return at the same address you filed the original return. Once you make the election, you cannot change it.

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If you elect to use a different method for one item in a property class, you must apply the same method to all property in that class placed in service during the year of the election. However, you can make the election on a property-by-property basis for residential rental and nonresidential real property.

Straight line election.

Instead of using the declining balance method, you can elect to use the straight line method over the GDS recovery period. Make the election by entering "S/L" under column (f) in Part III of Form 4562.

ADS election.

As explained earlier under Which Depreciation System (GDS or ADS) Applies , you can elect to use ADS even though your property may come under GDS. ADS uses the straight line method of depreciation over the ADS recovery periods, which are generally longer than the GDS recovery periods. The ADS recovery periods for many assets used in the business of farming are listed in Table 7-1. Additional ADS recovery periods for other classes of property may be found in the Table of Class Lives and Recovery Periods in Appendix B of Pub. 946.

How Is the Depreciation Deduction Figured? Modified ACRS (MACRS)Figuring the deduction

To figure your depreciation deduction under MACRS, you first determine the depreciation system, property class, placed-in-service date, basis amount, recovery period, convention, and depreciation method that applies to your property. Then you are ready to figure your depreciation deduction. You can figure it in one of two ways.

  • You can use the percentage tables provided by the IRS.

  • You can figure your own deduction without using the tables.

 

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Figuring your own MACRS deduction will generally result in a slightly different amount than using the tables.

Using the MACRS Percentage Tables

To help you figure your deduction under MACRS, the IRS has established percentage tables that incorporate the applicable convention and depreciation method. These percentage tables are in Appendix A of Pub. 946.

Rules for using the tables.

The following rules cover the use of the percentage tables.

  1. You must apply the rates in the percentage tables to your property's unadjusted basis. Unadjusted basis is the same basis amount you would use to figure gain on a sale but figured without reducing your original basis by any MACRS depreciation taken in earlier years.

  2. You cannot use the percentage tables for a short tax year. See chapter 4 of Pub. 946 for information on how to figure the deduction for a short tax year.

  3. You generally must continue to use them for the entire recovery period of the property.

  4. You must stop using the tables if you adjust the basis of the property for any reason other than:

    1. Depreciation allowed or allowable, or

    2. An addition or improvement to the property, which is depreciated as a separate property.

 

Basis adjustment due to casualty loss.

If you reduce the basis of your property because of a casualty, you cannot continue to use the percentage tables. For the year of the adjustment and the remaining recovery period, you must figure the depreciation yourself using the property's adjusted basis at the end of the year. See Figuring the Deduction Without Using the Tables in chapter 4 of Pub. 946.

Figuring depreciation using the 150% DB method and half-year convention.

Table 7-2 has the percentages for 3-, 5-, 7-, and 20-year property. The percentages are based on the 150% declining balance method with a change to the straight line method. This table covers only the half-year convention and the first 8 years for 20-year property. See Appendix A in Pub. 946 for complete MACRS tables, including tables for the mid-quarter and mid-month convention.

The following examples show how to figure depreciation under MACRS using the percentages in Table 7-2 .

Example 1.

During the year, you bought an item of 7-year property for $10,000 and placed it in service. You do not elect a section 179 expense deduction for this property. In addition, the property is not qualified property for purposes of the special depreciation allowance. The unadjusted basis of the property is $10,000. You use the percentages in Table 7-2 to figure your deduction.

Since this is 7-year property, you multiply $10,000 by 10.71% to get this year's depreciation of $1,071. For next year, your depreciation will be $1,913 ($10,000 × 19.13%).

Example 2.

You had a barn constructed on your farm at a cost of $20,000. You placed the barn in service this year. You elect not to claim the special depreciation allowance. The barn is 20-year property and you use the table percentages to figure your deduction. You figure this year's depreciation by multiplying $20,000 (unadjusted basis) by 3.75% to get $750. For next year, your depreciation will be $1,443.80 ($20,000 × 7.219%).

Table 7-2. 150% Declining Balance Method (Half-Year Convention)
Year 3-Year 5-Year 7-Year 20-Year
1 25.0 % 15.00 % 10.71 % 3.750 %
2 37.5   25.50   19.13   7.219  
3 25.0   17.85   15.03   6.677  
4 12.5   16.66   12.25   6.177  
5     16.66   12.25   5.713  
6     8.33   12.25   5.285  
7         12.25   4.888  
8         6.13   4.522  

Figuring depreciation using the straight line method and half-year convention.

The following table has the straight line percentages for 3-, 5-, 7-, and 20-year property using the half-year convention. The table covers only the first 8 years for 20-year property. See Appendix A in Pub. 946 for complete MACRS tables, including tables for the mid-quarter and mid-month convention.

Table 7-3. Straight Line Method (Half-Year Convention)

Year 3-Year 5-Year 7-Year 20-Year
1 16.67 % 10 % 7.14 % 2.5 %
2 33.33   20   14.29   5.0  
3 33.33   20   14.29   5.0  
4 16.67   20   14.28   5.0  
5     20   14.29   5.0  
6     10   14.28   5.0  
7         14.29   5.0  
8         7.14   5.0  

 

The following example shows how to figure depreciation under MACRS using the straight line percentages in Table 7-3 .

Example.

If in Example 2, earlier, you had elected the straight line method, you figure this year's depreciation by multiplying $20,000 (unadjusted basis) by 2.5% to get $500. For next year, your depreciation will be $1,000
($20,000 × 5%).

Figuring Depreciation Without the Tables

If you are required to or would prefer to figure your own depreciation without using the tables, see Figuring the Deduction Without Using the Tables in chapter 4 of Pub. 946.

Figuring the Deduction for Property Acquired in a Nontaxable Exchange

If your property has a carryover basis because you acquired it in an exchange or involuntary conversion of other property or in a nontaxable transfer, you generally figure depreciation for the property as if the exchange, conversion, or transfer had not occurred.

Property acquired in a like-kind exchange or involuntary conversion.

You generally must depreciate the carryover basis of MACRS property acquired in a like-kind exchange or involuntary conversion over the remaining recovery period of the property exchanged or involuntarily converted. You also generally continue to use the same depreciation method and convention used for the exchanged or involuntarily converted property. This applies only to acquired property with the same or a shorter recovery period and the same or more accelerated depreciation method than the property exchanged or involuntarily converted. The excess basis, if any, of the acquired MACRS property is treated as newly placed in service MACRS property.

Election out.

You can elect not to use the above rules. The election, if made, applies to both the acquired property and the exchanged or involuntarily converted property. If you make the election, figure depreciation by treating the carryover basis and excess basis, if any, for the acquired property as if placed in service the later of the date you acquired it, or the time of the disposition of the exchanged or involuntarily converted property. For depreciation purposes, the adjusted basis of the exchanged or involuntarily converted property is treated as if it was disposed of at the time of the exchange or conversion.

When to make the election.

You must make the election on a timely filed return (including extensions) for the year of replacement. Once made, the election may not be revoked without IRS consent.

For more information and special rules, see chapter 4 of Pub. 946.

Property acquired in a nontaxable transfer.

You must depreciate MACRS property acquired by a corporation or partnership in certain nontaxable transfers over the property's remaining recovery period in the transferor's hands, as if the transfer had not occurred. You must continue to use the same depreciation method and convention as the transferor. You can depreciate the part of the property's basis in excess of its carried-over basis (the transferor's adjusted basis in the property) as newly purchased MACRS property. For information on the kinds of nontaxable transfers covered by this rule, see chapter 4 of Pub. 946.

How Do You Use General Asset Accounts?

To make it easier to figure MACRS depreciation, you can group separate assets into one or more general asset accounts (GAAs). You can then depreciate all the assets in each account as a single asset. Each account must include only assets of the same recovery period, depreciation method, and convention. You cannot include an asset if you use it in both a personal activity and a trade or business (or for the production of income) in the year in which you first placed it in service.

After you have set up a GAA, you generally figure the depreciation for it by using the applicable depreciation method, recovery period, and convention for the assets in the GAA. For each GAA, record the depreciation allowance in a separate depreciation reserve account.

There are additional rules for grouping assets in a GAA, figuring depreciation for a GAA, disposing of GAA assets, and terminating GAA treatment. Special rules apply in determining the basis and figuring the depreciation deduction for MACRS property in a GAA acquired in a like-kind exchange or involuntary conversion. For more details, see Regulations section 1.168(i)-1 (as in effect for tax years beginning after December 31, 2013). Also, see chapter 4 in Pub. 946.

When Do You Recapture MACRS Depreciation?

When you dispose of property you depreciated using MACRS, any gain on the disposition is generally recaptured (included in income) as ordinary income up to the amount of the depreciation previously allowed or allowable for the property. For more information on depreciation recapture, see chapter 9. Also, see chapter 4 of Pub. 946.

Additional Rules for Listed Property

Listed property includes cars and other property used for transportation, property used for entertainment, and certain computers.

Deductions for listed property (other than certain leased property) are subject to the following special rules and limits.

  • Deduction for employees.

  • Business-use requirement.

  • Passenger automobile limits and rules.

 

What Is Listed Property?

Listed property is any of the following.

  • Passenger automobiles weighing 6,000 pounds or less.

  • Any other property used for transportation, unless it is an excepted vehicle.

  • Property generally used for entertainment, recreation, or amusement.

  • Computers and related peripheral equipment unless used only at a regular business establishment and owned or leased by the person operating the establishment.

  • Certain aircraft.

 

Passenger automobiles.

A passenger automobile is any 4-wheeled vehicle made primarily for use on public streets, roads, and highways and rated at 6,000 pounds or less of unloaded gross vehicle weight (6,000 pounds or less of gross vehicle weight for trucks and vans). It includes any part, component, or other item physically attached to the automobile or usually included in the purchase price of an automobile. Electric passenger automobiles are vehicles produced by an original equipment manufacturer and designed to run primarily on electricity.

Note.

A truck or van that is a qualified nonpersonal use vehicle is not considered a passenger automobile. See Qualified nonpersonal use vehicles under Passenger Automobiles in chapter 5 of Pub. 946 for the definition of qualified nonpersonal use vehicles.

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For most vehicles the gross vehicle weight rating generally can be found on the driver door post of the vehicle.

Other property used for transportation.

This includes trucks, buses, boats, airplanes, motorcycles, and other vehicles used for transporting persons or goods.

Excepted vehicles.

Other property used for transportation does not include the following vehicles.

  • Tractors and other special purpose farm vehicles.

  • Bucket trucks (cherry pickers), dump trucks, flatbed trucks, and refrigerated trucks.

  • Combines, cranes and derricks, and forklifts.

  • Any vehicle designed to carry cargo with a loaded gross vehicle weight of over 14,000 pounds.

 

For more information, see chapter 5 of Pub. 946.

What Is the Business-Use Requirement?

You can claim the section 179 expense deduction for listed property and depreciate listed property using GDS and a declining balance method, if the property meets the business-use requirement. To meet this requirement, listed property must be used predominantly (more than 50% of its total use) for qualified business use. To determine whether the business-use requirement is met, you must allocate the use of any item of listed property used for more than one purpose during the year among its various uses.

Do the Passenger Automobile Limits Apply?

The depreciation deduction (including the section 179 expense deduction) you can claim for a passenger automobile each year is limited. The passenger automobile limits are the maximum depreciation amounts you can deduct for a passenger automobile. They are based on the date you placed the vehicle in service. See chapter 5 of Pub. 946 for tables that show the maximum depreciation deduction for passenger automobiles. Also, see the Instructions for Form 4562.

For information about deducting expenses for the business use of your passenger automobile, see chapter 4 in Pub. 463.

Deductions for passenger automobiles acquired in a trade-in.

Special rules apply in figuring the depreciation for a passenger automobile received in a like-kind exchange or involuntary conversion. See chapter 5 of Pub. 946 and Regulations section 1.168(i)-6(d)(3).

Depletion

Depletion is the using up of natural resources by mining, quarrying, drilling, or cutting. The depletion deduction allows an owner or operator to account for the reduction of a product's reserves.

Who Can Claim Depletion?

If you have an economic interest in mineral property or standing timber (defined below), you can take a deduction for depletion. More than one person can have an economic interest in the same mineral deposit or timber.

You have an economic interest if both the following apply.

  • You have acquired by investment any interest in mineral deposits or standing timber.

  • You have a legal right to income from the extraction of the mineral or the cutting of the timber, to which you must look for a return of your capital investment.

A contractual relationship that allows you an economic or monetary advantage from products of the mineral deposit or standing timber is not, in itself, an economic interest. A production payment carved out of, or retained on the sale of, mineral property is not an economic interest.

Mineral property is each separate interest you own in each mineral deposit in each separate tract or parcel of land. You can treat two or more separate interests as one property or as separate properties. See section 614 of the Internal Revenue Code and the related regulations for rules on how to treat separate mineral interests.

Timber property is your economic interest in standing timber in each tract or block representing a separate timber account.

Figuring Depletion

There are two ways of figuring depletion.

  • Cost depletion.

  • Percentage depletion.

For mineral property, you generally must use the method that gives you the larger deduction. For standing timber, you must use cost depletion.

Cost Depletion

To figure cost depletion you must first determine the following.

  • The property's basis for depletion.

  • The total recoverable units of mineral in the property's natural deposit.

  • The number of units of mineral sold during the tax year.

 

You must estimate or determine recoverable units (tons, barrels, board feet, thousands of cubic feet, or other measure) using the current industry method and the most accurate and reliable information you can obtain.

Basis for depletion and total recoverable units are explained in chapter 9 of Pub. 535.

Number of units sold.

You determine the number of units sold during the tax year based on your method of accounting. Use the following table to make this determination.

 

IF you use... THEN the units sold during the year are...
The cash method of accounting The units sold for which you receive payment during the tax year (regardless of the year of sale).
An accrual method of accounting The units sold based on your inventories.

 

The number of units sold during the tax year does not include any units for which depletion deductions were allowed or allowable in earlier years.

Figuring the cost depletion deduction.

Once you have figured your property's basis for depletion, the total recoverable units, and the number of units sold during the tax year, you can figure your cost depletion deduction by taking the following steps.

Step Action Result
1 Divide your property's basis for depletion by total recoverable units. Rate per unit.
2 Multiply the rate per unit by units sold during the tax year. Cost depletion deduction.

 

Cost depletion for ground water in Ogallala Formation.

Farmers who extract ground water from the Ogallala Formation for irrigation are allowed cost depletion. Cost depletion is allowed when it can be demonstrated the ground water is being depleted and the rate of recharge is so low that, once extracted, the water would be lost to the taxpayer and immediately succeeding generations. To figure your cost depletion deduction, use the guidance provided in Revenue Procedure 66-11 in Cumulative Bulletin 1966-1.

Timber Depletion

Depletion takes place when you cut standing timber (including Christmas trees). You can figure your depletion deduction when the quantity of cut timber is first accurately measured in the process of exploitation.

Figuring the timber depletion deduction.

To figure your cost depletion allowance, multiply the number of units of standing timber cut by your depletion unit.

Timber units.

When you acquire timber property, you must make an estimate of the quantity of marketable timber that exists on the property. You measure the timber using board feet, log scale, cords, or other units. If you later determine that you have more or less units of timber, you must adjust the original estimate.

Depletion units.

You figure your depletion unit each year by taking the following steps.

  1. Determine your cost or the adjusted basis of the timber on hand at the beginning of the year.

  2. Add to the amount determined in (1) the cost of any timber units acquired during the year and any additions to capital.

  3. Figure the number of timber units to take into account by adding the number of timber units acquired during the year to the number of timber units on hand in the account at the beginning of the year and then adding (or subtracting) any correction to the estimate of the number of timber units remaining in the account.

  4. Divide the result of (2) by the result of (3). This is your depletion unit.

 

When to claim timber depletion.

Claim your depletion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you elect to treat the cutting of timber as a sale or exchange as explained in chapter 8. Include allowable depletion for timber products not sold during the tax year the timber is cut, as a cost item in the closing inventory of timber products for the year. The inventory is your basis for determining gain or loss in the tax year you sell the timber products.

Form T (Timber).

Complete and attach Form T (Timber) to your income tax return if you are claiming a deduction for timber depletion, electing to treat the cutting of timber as a sale or exchange, or making an outright sale of timber. See the Instructions for Form T (Timber).

Example.

Alex Borsht bought a farm that included standing timber. This year Alex determined that the standing timber could produce 300,000 units when cut. At that time, the adjusted basis of the standing timber was $24,000. Alex then cut and sold 27,000 units. (Alex did not elect to treat the cutting of the timber as a sale or exchange.) Alex's depletion for each unit for the year is $.08 ($24,000 ÷ 300,000). His deduction for depletion is $2,160 (27,000 × $.08). If Alex had cut 27,000 units but sold only 20,000 units during the year, his depletion for each unit would have remained at $.08. However, his depletion deduction would have been $1,600 (20,000 × $.08) for this year and he would have included the balance of $560 (7,000 × $.08) in the closing inventory for the year.

Percentage Depletion

You can use percentage depletion on certain mines, wells, and other natural deposits. You cannot use the percentage method to figure depletion for standing timber, soil, sod, dirt, or turf.

To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the property during the year. See Mines and other natural deposits in chapter 9 of Pub. 535 for a list of the percentages. You can find a complete list in section 613(b) of the Internal Revenue Code.

Taxable income limit.

The percentage depletion deduction cannot be more than 50% (100% for oil and gas property) of your taxable income from the property figured without the depletion deduction and the domestic production activities deduction.

The following rules apply when figuring your taxable income from the property for purposes of the taxable income limit.

  • Do not deduct any net operating loss deduction from the gross income from the property.

  • Corporations do not deduct charitable contributions from the gross income from the property.

  • If, during the year, you disposed of an item of section 1245 property used in connection with the mineral property, reduce any allowable deduction for mining expenses by the part of any gain you must report as ordinary income that is allocable to the mineral property. See Regulations section 1.613-5(b)(1) for information on how to figure the ordinary gain allocable to the property.

 

For more information on depletion, see chapter 9 in Pub. 535.

Amortization

Amortization is a method of recovering (deducting) certain capital costs over a fixed period of time. It is similar to the straight line method of depreciation. The amortizable costs discussed in this section include the start-up costs of going into business, reforestation costs, the costs of pollution control facilities, and the costs of section 197 intangibles. See chapter 8 in Pub. 535 for more information on these topics.

Business Start-Up Costs

When you go into business, treat all costs you incur to get your business started as capital expenses. Capital expenses are a part of your basis in the business. Generally, you recover costs for particular assets through depreciation deductions. However, you generally cannot recover other costs until you sell the business or otherwise go out of business.

Start-up costs are costs for creating an active trade or business or investigating the creation or acquisition of an active trade or business. Start-up costs include any amounts paid or incurred in connection with any activity engaged in for profit and for the production of income before the trade or business begins, in anticipation of the activity becoming an active trade or business.

You can elect to currently deduct a limited amount of business start-up costs paid or incurred after October 22, 2004. See Capital Expenses in chapter 4. If this election is made, any costs that are not currently deducted can be amortized.

Amortization period.

The amortization period for business start-up costs paid or incurred before October 23, 2004, is 60 months or more. For start-up costs paid or incurred after October 22, 2004, the amortization period is 180 months. The period starts with the month your active trade or business begins.

Reporting requirements.

To amortize your start-up costs that are not currently deductible under the election to deduct, complete Part VI of Form 4562 and attach a statement containing any required information. See the Instructions for Form 4562.

For more information, see Starting a Business in chapter 8 of Pub. 535.

Reforestation Costs Reforestation costs AmortizationReforestation expenses ElectionAmortizationReforestation costs LimitsReforestation costs

You can elect to currently deduct a limited amount of qualifying reforestation costs for each qualified timber property. See Capital Expenses in chapter 4. You can elect to amortize over 84 months any amount not deducted. There is no annual limit on the amount you can elect to amortize. Reforestation costs are the direct costs of planting or seeding for forestation or reforestation.

Qualifying costs.

Qualifying costs include only those costs you must otherwise capitalize and include in the adjusted basis of the property. They include costs for the following items.

  • Site preparation.

  • Seeds or seedlings.

  • Labor.

  • Tools.

  • Depreciation on equipment used in planting and seeding.

 

If the government reimburses you for reforestation costs under a cost-sharing program, you can amortize these costs only if you include the reimbursement in your income.

Qualified timber property.

Qualified timber property is property that contains trees in significant commercial quantities. It can be a woodlot or other site that you own or lease. The property qualifies only if it meets all the following requirements.

  • It is located in the United States.

  • It is held for the growing and cutting of timber you will either use in, or sell for use in, the commercial production of timber products.

  • It consists of at least one acre planted with tree seedlings in the manner normally used in forestation or reforestation.

 

Qualified timber property does not include property on which you have planted shelter belts or ornamental trees, such as Christmas trees.

Amortization period.

The 84-month amortization period starts on the first day of the first month of the second half of the tax year you incur the costs (July 1 for a calendar year taxpayer), regardless of the month you actually incur the costs. You can claim amortization deductions for no more than 6 months of the first and last (eighth) tax years of the period.

How to make the election.

To elect to amortize qualifying reforestation costs, enter your deduction in Part VI of Form 4562. Attach a statement containing any required information. See the Instructions for Form 4562.

Generally, you must make the election on a timely filed return (including extensions) for the year in which you incurred the costs. 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 your return (excluding extensions). Attach Form 4562 and the statement to the amended return and write "Filed pursuant to section 301.9100-2" on Form 4562. File the amended return at the same address you filed the original return.

For additional information on reforestation costs, see chapter 8 of Pub. 535.

Section 197 Intangibles

You must generally amortize over 15 years the capitalized costs of section 197 intangibles you acquired after August 10, 1993. You must amortize these costs if you hold the section 197 intangible in connection with your farming business or in an activity engaged in for the production of income. Your amortization deduction each year is the applicable part of the intangible's adjusted basis (for purposes of determining gain), figured by amortizing it ratably over 15 years (180 months). You are not allowed any other depreciation or amortization deduction for an amortizable section 197 intangible.

Section 197 intangibles include the following assets.

  • Goodwill.

  • Patents.

  • Copyrights.

  • Designs.

  • Formulas.

  • Licenses.

  • Permits.

  • Covenants not to compete.

  • Franchises.

  • Trademarks.

See chapter 8 in Pub. 535 for more information, including a complete list of assets that are section 197 intangibles and special rules.

8. Gains and Losses

Introduction

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 net capital gain is generally taxed at a lower rate. 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.

Topics - This chapter discusses:

  • Sales and exchanges

  • Ordinary or capital gain or loss

Useful Items - You may want to see:

Publication

  • 334 Tax Guide for Small Business

  • 523 Selling Your Home

  • 544 Sales and Other Dispositions of Assets

  • 550 Investment Income and Expenses

  • 908 Bankruptcy Tax Guide

Form (and Instructions)

  • 982 Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)

  • Sch D (Form 1040) Capital Gains and Losses

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

  • 1099-A Acquisition or Abandonment of Secured Property

  • 1099-C Cancellation of Debt

  • 4797 Sales of Business Property

  • 8824 Like-Kind Exchanges

  • 8949 Sales and Other Dispositions of Capital Assets

  • 8960 Net Investment Income Tax-Individuals, Estates, and Trusts

See chapter 16 for information about getting publications and forms.

Sales and Exchanges

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.

Determining Gain or Loss

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 have a gain. If the adjusted basis of the property is more than the amount you realize, you have a loss.

Basis and adjusted basis.

The basis of property you buy is usually its cost. The adjusted basis of the property is the basis plus certain additions and minus certain deductions. See chapter 6 for more information about basis and adjusted basis.

Amount realized.

The amount you realize from a sale or exchange is the total of all money you receive plus the fair market value (FMV) (defined in chapter 6) of all property or services you receive. The amount you realize also includes any of your liabilities assumed by the buyer and any liabilities to which the property you transferred is subject, such as real estate taxes or a mortgage.

If the liabilities relate to an exchange of multiple properties, see Multiple Property Exchanges in chapter 1 of Pub. 544.

Amount recognized.

Your gain or loss realized from a sale or exchange of certain property is usually a recognized gain or loss for tax purposes. A recognized gain is a gain you must include in gross income and report on your income tax return. A recognized loss is a loss you deduct from gross income. However, your gain or loss realized from the exchange of certain property may not be recognized for tax purposes. See Like-Kind Exchanges next. Also, a loss from the disposition of property held for personal use is not deductible.

Like-Kind Exchanges

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 in the exchange.

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 (discussed later).

  • Qualifying property.

  • Like-kind property.

For more information on like-kind exchanges, see Pub. 544.

Multiple-party transactions.

The like-kind exchange rules also apply to property exchanges that involve three- and four-party transactions. Any part of these multiple-party transactions can qualify as a like-kind exchange if it meets all the requirements described in this section.

Receipt of title from third party.

If you receive property in a like-kind exchange and the other party who transfers the property to you does not give you the title, but a third party does, you can still treat this transaction as a like-kind exchange if it meets all the requirements.

Basis of property received.

If you receive property in a like-kind exchange, generally the basis of the property will be the same as the basis of the property you gave up. See chapter 6 for more information on basis.

Money paid.

If, in addition to giving up like-kind property, you pay money in a like-kind exchange, you still have no recognized gain or loss. The basis of the property received is the basis of the property given up, increased by the money paid.

Example.

You traded an old tractor with an adjusted basis of $15,000 for a new one. The new tractor costs $300,000. You were allowed $80,000 for the old tractor and paid $220,000 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 $235,000, the adjusted basis of the old tractor plus the cash paid ($15,000 + $220,000).

If you had sold the old tractor to a third party for $80,000 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 $65,000 ($80,000 − $15,000) and the basis of the new tractor would be $300,000.

Reporting the exchange.

Report the exchange of like-kind property, even though no gain or loss is recognized, on Form 8824, Like-Kind Exchanges. The Instructions for Form 8824 explain how to report the details of the exchange.

If you have any recognized gain because you received money or unlike property, report it on Schedule D (Form 1040) or Form 4797, whichever applies. You may also have to report the recognized gain as ordinary income because of depreciation recapture on Form 4797. See chapter 9 for more information.

Qualifying property.

In a like-kind exchange, both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business. Machinery, buildings, land, trucks, breeding livestock, rental houses, and certain mutual ditch, reservoir, or irrigation company stock are examples of property that may qualify.

Nonqualifying property.

The rules for like-kind exchanges do not apply to exchanges of the following property.

  • Property you use for personal purposes, such as your home and family car.

  • Stock in trade or other property held primarily for sale, such as crops and produce.

  • Stocks, bonds, or notes. However, see Qualifying property above.

  • Other securities or evidences of indebtedness, such as accounts receivable.

  • Partnership interests.

However, you may have a nontaxable exchange under other rules. See Other Nontaxable Exchanges in chapter 1 of Pub. 544.

Like-kind property.

To qualify as a nontaxable exchange, the properties exchanged must be of like kind. Like-kind properties are properties of the same nature or character, even if they differ in grade or quality. Generally, real property exchanged for real property qualifies as an exchange of like-kind property. For example, an exchange of city property for farm property or improved property for unimproved property is a like-kind exchange.

An exchange of a tractor for a new tractor is an exchange of like-kind property, and so is an exchange of timber land for crop acreage. An exchange of a tractor for acreage, however, is not an exchange of like-kind property. The exchange of livestock of one sex for livestock of the other sex is not a like-kind exchange. For example, the exchange of a bull for a cow is not a like-kind exchange. An exchange of the assets of a business for the assets of a similar business cannot be treated as an exchange of one property for another property.

Note.

Whether you engaged in a like-kind exchange depends on an analysis of each asset involved in the exchange.

Personal property.

Depreciable tangible personal property can be either like kind or like class to qualify for nontaxable exchange treatment. Like-class properties are depreciable tangible personal properties within the same General Asset Class or Product Class. Property classified in any General Asset Class may not be classified within a Product Class. Assets that are not in the same class will qualify as like-kind property if they are of the same nature or character.

General Asset Classes.

General Asset Classes describe the types of property frequently used in many businesses. They include, but are not limited to, the following property.

  1. Office furniture, fixtures, and equipment (asset class 00.11).

  2. Information systems, such as computers and peripheral equipment (asset class 00.12).

  3. Data handling equipment except computers (asset class 00.13).

  4. Automobiles and taxis (asset class 00.22).

  5. Light general purpose trucks (asset class 00.241).

  6. Heavy general purpose trucks (asset class 00.242).

  7. Tractor units for use over-the-road (asset class 00.26).

  8. Trailers and trailer-mounted containers (asset class 00.27).

  9. Industrial steam and electric generation and/or distribution systems (asset class 00.4).

 

Product Classes.

Product Classes include property listed in a 6-digit product class in sectors 31 through 33 of the North American Industry Classification System (NAICS) of the Executive Office of the President, Office of Management and Budget, United States (NAICS Manual). The latest version of the manual can be accessed at www.census.gov/eos/www/naics/.

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NAICS class 333111, Farm Machinery and Equipment Manufacturing, includes most machinery and equipment used in a farming business.

Partially nontaxable exchange.

If, in addition to like-kind property, you receive money or unlike property in an exchange on which you realize gain, you have a partially nontaxable exchange. You are taxed on the gain you realize, but only to the extent of the money and the FMV of the unlike property you receive. If you realize a loss on the exchange, no loss is deductible. However, see Unlike property given up below.

Example 1.

You trade farmland that cost $130,000 for $10,000 cash and other land to be used in farming with an FMV of $150,000. You have a realized gain of $30,000 ($150,000 FMV of new land + $10,000 cash − $130,000 basis of old farmland = $30,000 realized gain). However, only $10,000, the cash received, is recognized (included in income).

Example 2.

Assume the same facts as in Example 1, except that, instead of money, you received a tractor with an FMV of $10,000. Your recognized gain is still limited to $10,000, the value of the tractor (the unlike property).

Example 3.

Assume in Example 1 that the FMV of the land you received was only $115,000. However, your $5,000 loss is not recognized. You have a realized loss of $5,000 ($115,000 FMV + $10,000 cash – $130,000 basis of old farmland = $5,000 loss).

Unlike property given up.

If, in addition to like-kind property, you give up unlike property, you must recognize gain or loss on the unlike property you give up. The gain or loss is the difference between the FMV of the unlike property and the adjusted basis of the unlike property.

Liabilities

If you transfer property subject to debt, the debt transferred is considered unlike property. For purposes of figuring your realized gain, add any liabilities assumed by the other party to your amount realized. Subtract any liabilities of the other party that you assume from your amount realized. For purposes of figuring the limit of recognized gain, if the other party to a nontaxable exchange assumes any of your liabilities, you will be treated as if you received money in the amount of the liability. For more information, see Partial Nontaxable Exchagnes in chapter 1 of Pub. 544.

Like-kind exchanges between related persons.

Special rules apply to like-kind exchanges between related persons. These rules affect both direct and indirect exchanges. Under these rules, if either person disposes of the property within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. The gain or loss on the original exchange must be recognized as of the date of the later disposition. The 2-year holding period begins on the date of the last transfer of property that was part of the like-kind exchange.

Related persons.

Under these rules, related persons include, for example, you and a member of your family (spouse, brother, sister, parent, child, etc.), you and a corporation in which you have more than 50% ownership, you and a partnership in which you directly or indirectly own more than a 50% interest of the capital or profits, and two partnerships in which you directly or indirectly own more than 50% of the capital interests or profits.

For the complete list of related persons, see Related persons in chapter 2 of Pub. 544.

Example.

You used a grey pickup truck in your farming business. Your sister used a red pickup truck in her landscaping business. In December 2016, 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 2017, 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 2017, you must report your $1,000 gain on the 2016 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 2017 the $6,000 balance of her gain on the 2016 exchange. Her adjusted basis in the grey pickup truck is increased to $7,000 (its $1,000 basis plus the $6,000 gain recognized).

Exceptions to the rules for related persons.

The following property dispositions are excluded from these rules.

  • Dispositions due to the death of either related person.

  • Involuntary conversions.

  • 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.

 

Multiple property exchanges.

Under the like-kind exchange rules, you must generally make a property-by-property comparison to figure your recognized gain and the basis of the property you receive in the exchange. However, for exchanges of multiple properties, you do not make a property-by-property comparison if you do either of the following.

  • Transfer and receive properties in two or more exchange groups.

  • Transfer or receive more than one property within a single exchange group.

 

For more information, see Multiple Property Exchanges in chapter 1 of Pub. 544.

Deferred exchange.

A deferred exchange for like-kind property may qualify for nonrecognition of gain or loss. A deferred exchange is an exchange in which you transfer property you use in business or hold for investment and later receive like-kind property you will use in business or hold for investment. The property you receive is replacement property. The transaction must be an exchange of property for property rather than a transfer of property for money used to buy replacement property. In addition, the replacement property will not be treated as like-kind property unless certain identification and receipt requirements are met.

For more information, see Deferred Exchanges in chapter 1 of Pub. 544.

Transfer to Spouse

Generally, 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 in the following situations.

  • Your spouse or former spouse is a nonresident alien (unless special elections have been made).

  • Certain transfers in trust.

  • Certain stock redemptions under a divorce or separation instrument or a valid written agreement.

 

For more information and special rules for transfers of property incident to divorce, see Property Settlements in Pub. 504, Divorced or Separated Individuals.

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.

Ordinary or Capital Gain or Loss

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.

Capital Assets

Almost everything you own and use for personal purposes, pleasure, or investment is a capital asset.

The following items are examples of capital assets.

  • A home owned and occupied by you and your family.

  • Household furnishings.

  • 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.

  • 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 Pub. 550.

 

Personal-use property.

Gain from a sale or exchange of personal-use property is a capital gain and is taxable. Loss from the sale or exchange of personal-use property is not deductible. You can deduct a loss relating to personal-use property only if it results from a casualty or theft. For information on casualties and thefts, see chapter 11.

Long and Short Term

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 of Form 8949, Sales and Other Dispositions of Capital Assets, and/or Schedule D (Form 1040), as applicable. 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 of Form 8949 and/or Schedule D, as applicable. See the Instructions for Form 8949 and the Instructions for Schedule D (Form 1040) for more information, including when Form 8949 is required. Also see chapter 4 of Pub. 544.

Holding period.

To figure if you held property longer than 1 year, start counting on the day after the day you acquired the property. The day you disposed of the property is part of your holding period.

Example.

If you bought an asset on June 19, 2016, you should start counting on June 20, 2016. If you sold the asset on June 19, 2017, your holding period is not longer than 1 year, but if you sold it on June 20, 2017, your holding period is longer than 1 year.

Inherited property.

If you inherit property, you are considered to have held the property longer than 1 year, regardless of how long you actually held it. This rule does not apply to livestock used in a farm business. See Holding period under Livestock , later.

Nonbusiness bad debt.

A nonbusiness bad debt is a short-term capital loss, deductible in the year the debt becomes worthless. See chapter 4 of Pub. 550.

Nontaxable exchange.

If you acquire an asset in exchange for another asset and your basis for the new asset is figured, in whole or in part, by using your basis in the old property, the holding period of the new property includes the holding period of the old property. That is, it begins on the same day as your holding period for the old property.

Gift.

If you receive a gift of property and your basis in it is figured using the donor's basis, your holding period includes the donor's holding period.

Real property.

To figure how long you held real property, start counting on the day after you received title to it or, if earlier, on the day after you took possession of it and assumed the burdens and privileges of ownership.

However, taking possession of real property under an option agreement is not enough to start the holding period. The holding period cannot start until there is an actual contract of sale. The holding period of the seller cannot end before that time.

Figuring Net Gain or Loss

The totals for short-term capital gains and losses and the totals for long-term capital gains and losses must be figured separately.

Net short-term capital gain or loss.

Combine your short-term capital gains and losses. Do this by adding all of your short-term capital gains. Then add all of your short-term capital losses. Subtract the lesser total from the greater. The difference is your net short-term capital gain or loss.

Net long-term capital gain or loss.

Follow the same steps to combine your long-term capital gains and losses. The result is your net long-term capital gain or loss.

Net gain.

If the total of your capital gains is more than the total of your capital losses, the difference is taxable. However, part of your gain (but not more than your net capital gain) may be taxed at a lower rate than the rate of tax on your ordinary income. See Capital Gains Tax Rates , later.

Net loss.

If the total of your capital losses is more than the total of your capital gains, the difference is deductible. But there are limits on how much loss you can deduct and when you can deduct it. See Treatment of Capital Losses next.

Treatment of Capital Losses

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).

Capital loss carryover.

Generally, you have a capital loss carryover if either of the following situations applies to you.

  • Your net loss on Schedule D (Form 1040) is more than the yearly limit.

  • Your taxable income without your deduction for exemptions is less than zero.

If either of these situations applies to you for 2017, see Capital Losses under Reporting Capital Gains and Losses in chapter 4 of Pub. 550 to figure the amount you can carry over to 2018.

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To figure your capital loss carryover from 2017 to 2018, you will need a copy of your 2017 Form 1040 and Schedule D (Form 1040).

Capital Gains Tax Rates

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). Also see Pub. 550.

Noncapital Assets

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).

Property held for sale in the ordinary course of your farm business.

Property you hold mainly for sale to customers, such as livestock, poultry, livestock products, and crops, is a noncapital asset. Gain or loss from sales or other dispositions of this property is reported on Schedule F (Form 1040) (not on Schedule D (Form 1040) or Form 4797). The treatment of this property is discussed in chapter 3.

Land and depreciable properties.

Land and depreciable property you use in farming are not capital assets. Noncapital assets also include livestock held for draft, breeding, dairy, or sporting purposes. However, your gains and losses from sales and exchanges of your farmland and depreciable properties must be considered together with certain other transactions to determine whether the gains and losses are treated as capital or ordinary gains and losses. The sales of these business assets are reported on Form 4797. See chapter 9 for more information.

Hedging (Commodity Futures)

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.

  • Hedging transactions.

  • 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 subject to the mark-to-market rules discussed in Pub. 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 and the deduction for hedging losses is not limited.

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 8.

Gains or losses from hedging transactions that hedge supplies of a type regularly used or consumed in the ordinary course of your trade or business may be ordinary gains or losses. Examples include fuel and feed.

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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.

Retain the identification of each hedging transaction with your books and records. Also, identify the item(s) or aggregate risk that is being hedged in your records. 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 Pub. 550.

Accounting methods for hedging transactions.

The accounting method you use for a hedging transaction must clearly reflect income. This means that your accounting method must reasonably match the timing of income, deduction, gain, or loss from a hedging transaction with the timing of income, deduction, gain, or loss from the item or items being hedged. There are requirements and limits on the method you can use for certain hedging transactions. See Regulations section 1.446-4(e) for those requirements and limits.

Hedging transactions must be accounted for under the rules stated above unless the transaction is subject to mark-to-market accounting under section 475 or you use an accounting method other than the following methods.

  1. Cash method.

  2. Farm-price method.

  3. Unit-livestock-price method.

 

Once you adopt a method, you must apply it consistently and must have IRS approval before changing it.

Your books and records must describe the accounting method used for each type of hedging transaction. They must also contain any additional identification necessary to verify the application of the accounting method you used for the transaction. You must make the additional identification no more than 35 days after entering into the hedging transaction.

Example of a hedging transaction.

You file your income tax returns on the cash method. On July 2 you anticipate a yield of 50,000 bushels of corn this year. The December futures price is $5.75 a bushel, but there are indications that by harvest time the price will drop. To protect yourself against a drop in the price, you enter into the following hedging transaction. You sell ten December futures contracts of 5,000 bushels each for a total of 50,000 bushels of corn at $5.75 a bushel.

The price did not drop as anticipated but rose to $6 a bushel. In November, you sell your crop at a local elevator for $6 a bushel. You also close out your futures position by buying ten December contracts for $6 a bushel. You paid a broker's commission of $1,400 ($70 per contract) for the complete in and out position in the futures market.

The result is that the price of corn rose 25 cents a bushel and the actual selling price is $6 a bushel. Your loss on the hedge is 25 cents a bushel. In effect, the net selling price of your corn is $5.75 a bushel.

Report the results of your futures transactions and your sale of corn separately on Schedule F. See the Instructions for Schedule F (Form 1040).

The loss on your futures transactions is $13,900, figured as follows.

July 2 - Sold December corn futures (50,000 bu. @$5.75) $287,500
November 6 - Bought December corn futures (50,000 bu. @$6 plus $1,400 broker's commission) 301,400
Futures loss ($13,900)

This loss is reported as a negative figure on Schedule F, Part I, line 8, as other income.

The proceeds from your corn sale at the local elevator are $300,000 (50,000 bu. × $6). Report it on Schedule F, Part I, line 2, as income from sales of products you raised.

Assume you were right and the price went down 25 cents a bushel. In effect, you would still net $5.75 a bushel, figured as follows.

Sold cash corn, per bushel $5.50
Gain on hedge, per bushel .25
Net price, per bushel $5.75

 

 

The gain on your futures transactions would have been $11,100, figured as follows.

July 2 - Sold December corn futures (50,000 bu. @$5.75) $287,500
November 6 - Bought December corn futures (50,000 bu. @$5.50 plus $1,400 broker's commission) 276,400
Futures gain $11,100

The $11,100 is reported on Schedule F, Part I, line 8, as other income.

The proceeds from the sale of your corn at the local elevator, $275,000, are reported on Schedule F, Part I, line 2, as income from sales of products you raised.

Livestock

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.

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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 for more information.

Also, special rules apply to sales or exchanges caused by weather-related conditions. See Sales Caused by Weather-Related Conditions in chapter 3 for more information.

Holding period.

The sale or exchange of livestock used in your farm business (defined below) qualifies as a section 1231 transaction if you held the livestock for 12 months or more (24 months or more for horses and cattle).

Livestock.

For section 1231 transactions, livestock includes cattle, hogs, horses, mules, donkeys, sheep, goats, fur-bearing animals, and other mammals. Also, for section 1231 transactions, livestock does not include chickens, turkeys, pigeons, geese, emus, ostriches, rheas, or other birds, fish, frogs, reptiles, etc.

Livestock used in farm business.

If livestock is held primarily for draft, breeding, dairy, or sporting purposes, it is used in your farm business. The purpose for which an animal is held ordinarily is determined by a farmer's actual use of the animal. An animal is not held for draft, breeding, dairy, or sporting purposes merely because it is suitable for that purpose, or because it is held for sale to other persons for use by them for that purpose. However, a draft, breeding, or sporting purpose may be present if an animal is disposed of within a reasonable time after it is prevented from its intended use or made undesirable as a result of an accident, disease, drought, or unfitness of the animal.

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 2017, 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 2016. These horses are all considered held for sporting purposes.

Figuring gain or loss on the cash method.

Farmers or ranchers who use the cash method of accounting figure their gain or loss on the sale of livestock used in their farming business as follows.

Raised livestock.

Gain on the sale of raised livestock is generally the gross sales price reduced by any expenses of the sale. Expenses of sale include sales commissions, freight or hauling from farm to commission company, and other similar expenses. The basis of the animal sold is zero if the costs of raising it were deducted during the years the animal was being raised. However, if you are required to use the accrual accounting method, see Uniform Capitalization Rules in chapter 6.

Purchased livestock.

The gross sales price minus your adjusted basis and any expenses of sale is the gain or loss.

Example.

A farmer sold a breeding cow on January 8, 2017, for $1,250. Expenses of the sale were $125. The cow was bought July 2, 2013, 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

 

Converted Wetland and Highly Erodible Cropland

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.

Converted wetland.

This is generally land that was drained or filled to make the production of agricultural commodities possible. It includes converted wetland held by the person who originally converted it or held by any other person who used the converted wetland at any time after conversion for farming.

A wetland (before conversion) is land that meets all the following conditions.

  • 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.

  • 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.

  • It supports, under normal circumstances, mostly plants that grow in saturated soil.

 

Highly erodible cropland.

This is cropland subject to erosion that you used at any time for farming purposes other than grazing animals. Generally, highly erodible cropland is land currently classified by the Department of Agriculture as Class IV, VI, VII, or VIII under its classification system. Highly erodible cropland also includes land that would have an excessive average annual erosion rate in relation to the soil loss tolerance level, as determined by the Department of Agriculture.

Successor.

Converted wetland or highly erodible cropland is also land held by any person whose basis in the land is figured by reference to the adjusted basis of a person in whose hands the property was converted wetland or highly erodible cropland.

Timber

Standing timber you held as investment property is a capital asset. Gain or loss from its sale is capital gain or loss reported on Form 8949 and Schedule D (Form 1040), as applicable. 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 2 (raised timber). See the Instructions for Schedule F (Form 1040).

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 if no allocation was made at the time of acquisition. 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.

Timber considered cut.

Timber is considered cut on the date when, in the ordinary course of business, the quantity of felled timber is first definitely determined. This is true whether the timber is cut under contract or whether you cut it yourself.

Christmas trees.

Evergreen trees, such as Christmas trees, that are more than 6 years old when severed from their roots and sold for ornamental purposes are included in the term timber. They qualify for both rules discussed below.

Election to treat cutting as a sale or exchange.

Under the general rule, the cutting of timber results in no gain or loss. It is not until a sale or exchange occurs that gain or loss is realized. But if you owned or had a contractual right to cut timber, you can elect to treat the cutting of timber as a section 1231 transaction in the year it is cut. Even though the cut timber is not actually sold or exchanged, you report your gain or loss on the cutting for the year the timber is cut. Any later sale results in ordinary business income or loss. See the example below.

To elect this treatment, you must:

  1. Own or hold a contractual right to cut the timber for a period of more than 1 year before it is cut, and

  2. Cut the timber for sale or use in your trade or business.

 

Making the election.

You make the election on your return for the year the cutting takes place by including in income the gain or loss on the cutting and including a computation of your gain or loss. You do not have to make the election in the first year you cut the timber. You can make it in any year to which the election would apply. If the timber is partnership property, the election is made on the partnership return. This election cannot be made on an amended return.

Once you have made the election, it remains in effect for all later years unless you revoke it.

Election under section 631(a) may be revoked.

If you previously elected for any tax year ending before October 23, 2004, to treat the cutting of timber as a sale or exchange under section 631(a), you may revoke this election without the consent of the IRS for any tax year ending after October 22, 2004. The prior election (and revocation) is disregarded for purposes of making a subsequent election. See Form T (Timber), Forest Activities Schedule, for more information.

Gain or loss.

Your gain or loss on the cutting of standing timber is the difference between its adjusted basis for depletion and its FMV on the first day of your tax year in which it is cut. The FMV becomes your basis in the cut timber, and a later sale of the cut timber, including any by-product or tree tops, will result in ordinary business income or loss.

Your adjusted basis for depletion of cut timber is based on the number of units (board feet, log scale, or other units) of timber cut during the tax year and considered to be sold or exchanged. Your adjusted basis for depletion is also based on the depletion unit of timber in the account used for the cut timber, and should be figured in the same manner as shown in section 611 and Regulations section 1.611-3.

Depletion of timber is discussed in chapter 7.

Example.

In April 2017, you owned 4,000 MBF (1,000 board feet) of standing timber longer than 1 year. It had an adjusted basis for depletion of $40 per MBF. You are a calendar year taxpayer. On January 1, 2017, the timber had an FMV of $350 per MBF. It was cut in April for sale. On your 2017 tax return, you elect to treat the cutting of the timber as a sale or exchange. You report the difference between the FMV and your adjusted basis for depletion as a gain. This amount is reported on Form 4797 along with your other section 1231 gains and losses to figure whether it is treated as a capital gain or as ordinary gain. You figure your gain as follows.

FMV of timber January 1, 2017 $1,400,000
Minus: Adjusted basis for depletion 160,000
Section 1231 gain $1,240,000

 

Outright sales of timber.

Outright sales of timber by landowners qualify for capital gains treatment using rules similar to the rules for certain disposal of timber under a contract with retained economic interest (defined later). However, for outright sales, the date of disposal is not deemed to be the date the timber is cut because the landowner can elect to treat the payment date as the date of disposal (see Date of disposal below).

Cutting contract.

You must treat the disposal of standing timber under a cutting contract as a section 1231 transaction if all the following apply to you.

  • You are the owner of the timber.

  • You held the timber longer than 1 year before its disposal.

  • You kept an economic interest in the timber.

 

You have kept an economic interest in standing timber if, under the cutting contract, the expected return on your investment is conditioned on the cutting of the timber.

The difference between the amount realized from the disposal of the timber and its adjusted basis for depletion is treated as gain or loss on its sale. Include this amount on Form 4797 along with your other section 1231 gains or losses.

Date of disposal.

The date of disposal is the date the timber is cut. However, for outright sales by landowners or if you receive payment under the contract before the timber is cut, you can elect to treat the date of payment as the date of disposal.

This election applies only to figure the holding period of the timber. It has no effect on the time for reporting gain or loss (generally when the timber is sold or exchanged).

To make this election, attach a statement to the tax return filed by the due date (including extensions) for the year payment is received. The statement must identify the advance payments subject to the election and the contract under which they were made.

If you timely filed your return for the year you received payment without making the election, you can still make the election by filing an amended return within 6 months after the due date for that year's return (excluding extensions). Attach the statement to the amended return and write "Filed pursuant to section 301.9100-2" at the top of the statement. File the amended return at the same address the original return was filed.

Owner.

An owner is any person who owns an interest in the timber, including a sublessor and the holder of a contract to cut the timber. You own an interest in timber if you have the right to cut it for sale on your own account or for use in your business.

Tree stumps.

Tree stumps are a capital asset if they are on land held by an investor who is not in the timber or stump business as a buyer, seller, or processor. Gain from the sale of stumps sold in one lot by such a holder is taxed as a capital gain. However, tree stumps held by timber operators after the saleable standing timber was cut and removed from the land are considered by-products. Gain from the sale of stumps in lots or tonnage by such operators is taxed as ordinary income.

See Form T (Timber) and its separate instructions for more information about dispositions of timber.

Sale of a Farm

The sale of your farm may 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 any gain from the sale includes a gain from the sale of your home, you may be allowed to exclude the gain on your home. For more information, see Pub. 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.

  • Capital asset held 1 year or less.

  • Capital asset held longer than 1 year.

  • 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 ).

  • 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).

  • 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.

 

Allocation of consideration paid for a farm.

The sale of a farm for a lump sum is considered a sale of each individual asset rather than a single asset. If the group of assets sold constitutes a trade or business, the residual method must be used. This method determines gain or loss from the transfer of each asset. It also determines the buyer's basis in the business assets. For more information, see Sale of a Business in chapter 2 of Pub. 544.

Property used in farm operation.

The rules for excluding the gain on the sale of your home, described later under Sale of your home , do not apply to the property used for your farming business. Recognized gains and losses on business property must be reported on your return for the year of the sale. If the property was held longer than 1 year, it may qualify for section 1231 treatment (see chapter 9).

Example.

You sell your farm, including your main home, which you have owned since December 2002. You realize gain on the sale as follows.

  Farm   Farm
  With Home Without
  Home Only Home
Selling price $382,000 $158,000 $224,000
Cost (or other basis) 240,000 110,000 130,000
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 if you meet the requirements explained later under Sale of your home .

Partial sale.

If you sell only part of your farm, you must report any recognized gain or loss on the sale of that part on your tax return for the year of the sale. You cannot wait until you have sold enough of the farm to recover its entire cost before reporting gain or loss. For a detailed discussion on installment sales, see Pub. 544.

Adjusted basis of the part sold.

This is the properly allocated part of your original cost or other basis of the entire farm plus or minus necessary adjustments for improvements, depreciation, etc., on the part sold. If your home is on the farm, you must properly adjust the basis to exclude those costs from your farm asset costs, as discussed below under Sale of your home .

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.

Assessed values for local property taxes.

If you paid a flat sum for the entire farm and no other facts are available for properly allocating your original cost or other basis between the land and the buildings, you can use the assessed values for local property taxes for the year of purchase to allocate the costs.

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).

Sale of your home.

Your home is a capital asset and not property used in the trade or business of farming. If you sell a farm that includes a house you and your family occupy, you must determine the part of the selling price and the part of the cost or other basis allocable to your home. Your home includes the immediate surroundings and outbuildings relating to it that are not used for business purposes.

If you use part of your home for business, you must make an appropriate adjustment to the basis for depreciation allowed or allowable. For more information on basis, see chapter 6.

More information.

For more information on selling your home, see Pub. 523.

Gain from condemnation.

If you have a gain from a condemnation or sale of your home under threat of condemnation, you may use the preceding rules for excluding the gain, rather than the rules discussed under Postponing Gain in chapter 11. However, any gain that cannot be excluded (because it is more than the limit) may be postponed under the rules discussed under Postponing Gain in chapter 11.

Foreclosure or Repossession

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.

Buyer's (borrower's) gain or loss.

You figure and report gain or loss from a foreclosure or repossession in the same way as gain or loss from a sale or exchange. The gain or loss is the difference between your adjusted basis in the transferred property and the amount realized. See Determining Gain or Loss , earlier.

Worksheet 8-1. Worksheet for Foreclosures and Repossessions

Part 1. Use Part 1 to figure your ordinary income from the cancellation of debt upon foreclosure or repossession. Complete this part only if you were personally liable for the debt. Otherwise, go to Part 2.  
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 Fair Market Value of the transferred property  
3. Ordinary income from cancellation of debt upon foreclosure or repossession.* Subtract line 2 from line 1. If zero or less, enter -0-  
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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You can use Worksheet 8-1 to figure your gain or loss from a foreclosure or repossession.

Amount realized on a nonrecourse debt.

If you are not personally liable for repaying the debt (nonrecourse debt) secured by the transferred property, the amount you realize includes the full amount of the debt canceled by the transfer. The full canceled debt is included in the amount realized even if the fair market value of the property is less than the canceled debt.

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.

Amount realized on a recourse debt.

If you are personally liable for the debt (recourse debt), the amount realized on the foreclosure or repossession includes the lesser of:

  • The outstanding debt immediately before the transfer reduced by any amount for which you remain personally liable immediately after the transfer, or

  • The fair market value of the transferred property.

 

You are treated as receiving ordinary income from the canceled debt for the part of the debt that is more than the fair market value. The amount realized does not include the canceled debt that is your income from cancellation of debt. See Cancellation of debt , later.

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 as other income on Schedule F, line 8.

Seller's (lender's) gain or loss on repossession.

If you finance a buyer's purchase of your property in an installment sale and later acquire an interest in it through foreclosure or repossession, you may have a gain or loss on the acquisition. For more information, see Repossession in Pub. 537, Installment Sales.

Cancellation of debt.

If property that is repossessed or foreclosed upon secures a debt for which you are personally liable (recourse debt), you generally must report as ordinary income the amount by which the canceled debt is more than the FMV of the property. This income is separate from any gain or loss realized from the foreclosure or repossession. Report the income from cancellation of a business debt on Schedule F, line 8. Report the income from cancellation of a nonbusiness debt as miscellaneous income on Form 1040.

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You can use Worksheet 8-1 to figure your income from cancellation of debt.

However, income from cancellation of debt is not taxed in certain situations. See Cancellation of Debt in chapter 3.

Abandonment

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.

Business or investment property.

Loss from abandonment of business or investment property is deductible as a loss. Loss from abandonment of business or investment property that is not treated as a sale or exchange generally is an ordinary loss. If your adjusted basis is more than the amount you realize (if any), then you have a loss. If the amount you realize (if any) is more than your adjusted basis, then you have a gain. This rule also applies to leasehold improvements the lessor made for the lessee. However, if the property is foreclosed on or repossessed in lieu of abandonment, gain or loss is figured as discussed earlier under Foreclosure or Repossession .

If the abandoned property is secured by debt, special rules apply. The tax consequences of abandonment of property that secures a debt depend on whether you are personally liable for the debt (recourse debt) or were not personally liable for the debt (nonrecourse debt). For more information, see chapter 3 of Pub. 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals).

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.

Personal-use property.

You cannot deduct any loss from abandonment of your home or other property held for personal use.

Canceled debt.

If the abandoned property secures a debt for which you are personally liable and the debt is canceled, you may realize ordinary income equal to the canceled debt. This income is separate from any loss realized from abandonment of the property. Report income from cancellation of a debt related to a business or rental activity as business or rental income. Report income from cancellation of a nonbusiness debt as miscellaneous income on Form 1040.

However, income from cancellation of debt is not taxed in certain circumstances. See Cancellation of debt , earlier, under Foreclosure or Repossession .

Forms 1099-A and 1099-C.

A lender who acquires an interest in your property in a foreclosure, repossession, or abandonment should send you Form 1099-A showing the information you need to figure your loss from the foreclosure, repossession, or abandonment. However, if the lender cancels part of your debt and the lender must file Form 1099-C, the lender may include the information about the foreclosure, repossession, or abandonment on that form instead of Form 1099-A. The lender must file Form 1099-C and send you a copy if the canceled debt is $600 or more and the lender is a financial institution, credit union, federal government agency, or any organization that has a significant trade or business of lending money. For foreclosures, repossessions, abandonments of property, and debt cancellations occurring in 2017, these forms should be sent to you by January 31, 2018.

9. Dispositions of Property Used in Farming

Introduction

 

When you dispose of property used in your farm business, your taxable gain or loss is usually treated as ordinary income or capital gain (under the rules for section 1231 transactions). Ordinary income is taxed at the same rate as wages and interest. Capital gain is generally taxed at lower rates.

When you dispose of depreciable property (section 1245 property or section 1250 property) at a gain, you may have to recognize all or part of the gain as ordinary income under the depreciation recapture rules. Any gain remaining after applying the depreciation recapture rules is a section 1231 gain, which may be taxed as a capital gain.

Gains and losses from property used in farming are reported on Form 4797, Sales of Business Property. Table 9-1 contains examples of items reported on Form 4797 and refers to the part of that form on which they first should be reported.

Topics - This chapter discusses:

  • Section 1231 gains and losses

  • Depreciation recapture

  • Other gains

Useful Items - You may want to see:

Publication

  • 544 Sales and Other Dispositions
    of Assets

Form (and Instructions)

  • 4797 Sales of Business Property

See chapter 16 for information about getting publications and forms.

Section 1231 Gains and Losses

Section 1231 gains and losses are the taxable gains and losses from section 1231 transactions (explained below). Their treatment as ordinary or capital gains depends on whether you have a net gain or a net loss from all of your section 1231 transactions in the tax year.

Table 9-1. Where To First Report Certain Items on Form 4797

Type of property Held 1 year
or less
Held more than
1 year
1 Depreciable trade or business property:    
  a Sold or exchanged at a gain Part II Part III (1245, 1250)
  b Sold or exchanged at a loss Part II Part I
2 Farmland held less than 10 years for which soil, water, or land clearing expenses were deducted:    
  a Sold at a gain Part II Part III (1252)
  b Sold at a loss Part II Part I
3 All other farmland used in a trade or business Part II Part I
4 Disposition of cost-sharing payment property described in section 126 Part II Part III (1255)
5 Cattle and horses used in a trade or business for draft, breeding, dairy, or sporting purposes: Held less
than 24 mos.
Held 24 mos.
or more
  a Sold at a gain Part II Part III (1245)
  b Sold at a loss Part II Part I
  c Raised cattle and horses sold at a gain Part II Part I
6 Livestock other than cattle and horses used in a trade or business for draft, breeding, dairy, or sporting purposes: Held less
than 12 mos.
Held 12 mos.
or more
  a Sold at a gain Part II Part III (1245)
  b Sold at a loss Part II Part I
  c Raised livestock sold at a gain Part II Part I
7 Tangible trade or business property which was deducted under the de minimis safe harbor Held 1 year
or less
Held more than
1 year
    Part II Part II

 

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If you have a gain from a section 1231 transaction, first determine whether any of the gain is ordinary income under the depreciation recapture rules (explained later). Do not take that gain into account as section 1231 gain.

Section 1231 transactions.

Section 1231 transactions are sales and exchanges of real or depreciable property held longer than 1 year and used in a trade or business. Gain or loss on the following transactions is subject to section 1231 treatment.

  • Sale or exchange of cattle and horses. The cattle and horses must be held for draft, breeding, dairy, or sporting purposes and held for 24 months or longer.

  • Sale or exchange of other livestock. This livestock must be held for draft, breeding, dairy, or sporting purposes and held for 12 months or longer. Other livestock include hogs, mules, sheep, goats, donkeys, and other fur-bearing animals. Other livestock does not include poultry.

  • Sale or exchange of depreciable real property or personal property. This property must be used in your business and held longer than 1 year. Generally, property held for the production of rents or royalties is considered to be used in a trade or business. This property must also be either real property or is of a kind that is subject to depreciation under section 167 of the Internal Revenue Code. Examples of depreciable personal property include farm machinery and trucks. It also includes amortizable section 197 intangibles.

  • Sale or exchange of real estate. This property must be used in your business and held longer than 1 year. Examples are your farm or ranch (including barns and sheds).

  • Sale or exchange of unharvested crops. The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person, and the land must have been held longer than 1 year. You cannot keep any right or option to reacquire the land directly or indirectly (other than a right customarily incident to a mortgage or other security transaction). Growing crops sold with a leasehold on the land, even if sold to the same person in a single transaction, are not included.

  • Distributive share of partnership gains and losses. Your distributive share must be from the sale or exchange of property listed above and held longer than 1 year (or for the required period for certain livestock).

  • Cutting or disposal of timber. Special 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, as described in chapter 8 under Timber .

  • Condemnation. The condemned property (defined in chapter 11) must have been held longer than 1 year. It must be business property or a capital asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. It cannot be property held for personal use.

  • Casualty or theft. The casualty or theft must have affected business property, property held for the production of rents or royalties, or investment property (such as notes and bonds). You must have held the property longer than 1 year. However, if your casualty or theft losses are more than your casualty or theft gains, neither the gains nor the losses are taken into account in the section 1231 computation. Section 1231 does not apply to personal casualty gains and losses. See chapter 11 for information on how to treat those gains and losses.

 

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If the property is not held for the required holding period, the transaction is not subject to section 1231 treatment, and any gain or loss is ordinary income reported in Part II of Form 4797. See Table 9-1.

Property held for sale to customers.

A sale, exchange, or involuntary conversion of property held mainly for sale to customers is not a section 1231 transaction. If you will get back all, or nearly all, of your investment in the property by selling it rather than by using it up in your business, it is property held mainly for sale to customers.

Property deducted under the de minimis safe harbor for tangible property.

If you deducted the cost of a property under the de minimis safe harbor for tangible property, then upon its sale or disposition, this property is not treated as a capital asset or as property used in the trade or business under section 1231. Generally, any gain on the disposition of this property is treated as ordinary income reported on Part II of Form 4797.

Treatment as ordinary or capital.

To determine the treatment of section 1231 gains and losses, combine all of your section 1231 gains and losses for the year.

  • If you have a net section 1231 loss, it is an ordinary loss.

  • If you have a net section 1231 gain, it is ordinary income up to your nonrecaptured section 1231 losses from previous years, explained next. The rest, if any, is long-term capital gain.

 

Nonrecaptured section 1231 losses.

Your nonrecaptured section 1231 losses are your net section 1231 losses for the previous 5 years that have not been applied against a net section 1231 gain by treating the gain as ordinary income. These losses are applied against your net section 1231 gain beginning with the earliest loss in the 5-year period.

Example.

In 2017, Bradley has a $20,000 net section 1231 gain. To figure how much he has to report as ordinary income and long-term capital gain, he must first determine his section 1231 gains and losses from the previous 5-year period. From 2012 through 2016 he had the following section 1231 gains and losses.

 

Year Amount
2012 -0-
2013 -0-
2014 ($25,000)
2015 -0-
2016 $18,000

 

 

Bradley uses this information to figure how to report his net section 1231 gain for 2017 as shown below.

 

1) Net section 1231 gain (2017) $20,000
2) Net section 1231 loss (2014) ($25,000)  
3) Net section 1231 gain (2016) $18,000  
4) Remaining net section
1231 loss from
prior 5 years
($7,000)  
5) Gain treated as
ordinary income
$7,000
6) Gain treated as long-term
capital gain
$13,000

 

His remaining net section 1231 loss from 2014 is completely recaptured in 2017.

Depreciation Recapture

If you dispose of depreciable or amortizable property at a gain, you may have to treat all or part of the gain (even if it is otherwise nontaxable) as ordinary income.

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To figure any gain that must be reported as ordinary income, you must keep permanent records of the facts necessary to figure the depreciation or amortization allowed or allowable on your property. For more information on depreciation recapture, see chapter 3 of Pub. 544. Also see Pub. 946.

Section 1245 Property

A gain on the disposition of section 1245 property is treated as ordinary income to the extent of depreciation allowed or allowable. Any recognized gain that is more than the part that is ordinary income is a section 1231 gain. See Treatment as ordinary or capital under Section 1231 Gains and Losses , earlier.

Section 1245 property includes any property that is or has been subject to an allowance for depreciation or amortization and that is any of the following types of property.

  1. Personal property (either tangible or intangible).

  2. Other tangible property (except buildings and their structural components) used as any of the following. See Buildings and structural components below.

    1. An integral part of manufacturing, production, or extraction, or of furnishing certain services.

    2. A research facility in any of the activities in (a).

    3. A facility in any of the activities in (a) above, for the bulk storage of fungible commodities (discussed later).

  3. Where applicable, that part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following.

    1. Amortization of certified pollution control facilities.

    2. The section 179 expense deduction.

    3. Deduction for clean-fuel vehicles and certain refueling property.

    4. Expenditures to remove architectural and transportation barriers to the handicapped and elderly.

    5. Certain reforestation expenditures (as described under Reforestation Costs in chapter 7).

  4. Single purpose agricultural (livestock) or horticultural structures.

  5. Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary product of petroleum.

 

Buildings and structural components.

Section 1245 property does not include buildings and structural components. The term "building" includes a house, barn, warehouse, or garage. The term "structural component" includes walls, floors, windows, doors, central air conditioning systems, light fixtures, etc.

Do not treat a structure that is essentially machinery or equipment as a building or structural component. Also, do not treat a structure that houses property used as an integral part of an activity as a building or structural component if the structure's use is so closely related to the property's use that the structure can be expected to be replaced when the property it initially houses is replaced.

The fact that the structure is specially designed to withstand the stress and other demands of the property and cannot be used economically for other purposes indicates it is closely related to the use of the property it houses. Structures such as oil and gas storage tanks, grain storage bins, and silos are not treated as buildings, but as section 1245 property.

Facility for bulk storage of fungible commodities.

This is a facility used mainly for the bulk storage of fungible commodities. Bulk storage means storage of a commodity in a large mass before it is used. For example, if a facility is used to store oranges that have been sorted and boxed, it is not used for bulk storage. To be fungible, a commodity must be such that one part may be used in place of another.

Gain Treated as Ordinary Income

The gain treated as ordinary income on the sale, exchange, or involuntary conversion of section 1245 property, including a sale and leaseback transaction, is the lesser of the following amounts.

  1. The depreciation (which includes any section 179 deduction claimed) and amortization allowed or allowable on the property.

  2. The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property).

See Like-Kind Exchanges and Involuntary Conversions in chapter 3 of Pub. 544 for limits on gain on like-kind exchanges and involuntary conversions. For any other disposition of section 1245 property, ordinary income is the lesser of (1) above or the amount by which its fair market value (FMV) is more than its adjusted basis. See chapter 3 of Pub. 544.

Use Part III of Form 4797 to figure the ordinary income part of the gain.

Depreciation claimed on other property or claimed by other taxpayers.

Depreciation and amortization include the amounts you claimed on the section 1245 property as well as the following depreciation and amortization amounts.

  • Amounts you claimed on property you exchanged for, or converted to, your section 1245 property in a like-kind exchange or involuntary conversion. For details on exchanges of property that are not taxable, see Like-Kind Exchanges in chapter 8.

  • Amounts a previous owner of the section 1245 property claimed if your basis is determined with reference to that person's adjusted basis (for example, the donor's depreciation deductions on property you received as a gift and part of the transfer is a sale or exchange).

 

Example.

Andrew paid $120,000 for a tractor in 2016. On February 23, 2017, he traded it for a chopper and paid an additional $30,000. To figure his depreciation deduction on the chopper for the current year, Andrew continues to use the basis of the tractor as he would have before the trade. Andrew can also depreciate the additional $30,000 for the chopper.

Depreciation and amortization.

Depreciation and amortization deductions that must be recaptured as ordinary income include (but are not limited to) the following items. See Depreciation Recapture in chapter 3 of Pub. 544 for more details.

  1. Ordinary depreciation deductions.

  2. Section 179 deduction (see chapter 7).

  3. Any special depreciation allowance.

  4. Amortization deductions for all the following costs.

    1. Acquiring a lease.

    2. Lessee improvements.

    3. Pollution control facilities.

    4. Reforestation expenses.

    5. Section 197 intangibles.

    6. Qualified disaster expenses.

    7. Franchises, trademarks, and trade names acquired before August 11, 1993.

 

Example.

You file your returns on a calendar year basis. In February 2015, you bought and placed in service for 100% use in your farming business a light-duty truck (5-year property) that cost $10,000. You used the half-year convention and your MACRS deductions for the truck were $1,500 in 2015 and $2,550 in 2016. You did not claim the section 179 expense deduction for the truck. You sold it in May 2017 for $7,000. The MACRS deduction in 2017, the year of sale, is $893 (½ of $1,785). Figure the gain treated as ordinary income as follows.

1) Amount realized $7,000
2) Cost (February 2015) $10,000  
3) Depreciation allowed or allowable (MACRS deductions: $1,500 + $2,550 + $893) 4,943  
4) Adjusted basis (subtract line 3
from line 2)
$5,057
5) Gain realized (subtract line 4
from line 1)
1,943
6) Gain treated as ordinary income
(lesser of line 3 or line 5)
$1,943

 

Depreciation allowed or allowable.

You generally use the greater of the depreciation allowed or allowable when figuring the part of gain to report as ordinary income. If, in prior years, you have consistently taken proper deductions under one method, the amount allowed for your prior years will not be increased even though a greater amount would have been allowed under another proper method. If you did not take any deduction at all for depreciation, your adjustments to basis for depreciation allowable are figured by using the straight line method. This treatment applies only when figuring what part of the gain is treated as ordinary income under the rules for section 1245 depreciation recapture. For more information on depreciation allowed or allowable, see chapter 7. For information on adjustments to basis for depreciation allowed or allowable, see chapter 6.

Disposition of plants.

If you elect not to use the uniform capitalization rules (see chapter 6), you must treat any plant that would have been subject to the uniform capitalization rules as section 1245 property. If you have a gain on the property's disposition, you must recapture the pre-productive expenses you would have capitalized if you had not made the election by treating the gain, up to the amount of these expenses, as ordinary income. For section 1231 transactions, show these expenses as depreciation on Form 4797, Part III, line 22. For plant sales that are reported on Schedule F (Form 1040), Profit or Loss From Farming, this recapture rule does not change the reporting of income because the gain is already ordinary income. You can use the farm-price method discussed in chapter 2 to figure these expenses.

Example.

Debbie sold her apple orchard in 2017 for $80,000. Her adjusted basis at the time of sale was $60,000. She bought the orchard in 2010, but the trees did not produce a crop until 2013. Her pre-productive expenses were $6,000. She elected not to use the uniform capitalization rules. Debbie must treat $6,000 of the gain as ordinary income. This amount would be reported on Form 4797, Part III, as ordinary income.

Section 1250 Property

Section 1250 property includes all real property subject to an allowance for depreciation that is not and never has been section 1245 property. It includes buildings and structural components that are not section 1245 property (discussed earlier). It includes a leasehold of land or section 1250 property subject to an allowance for depreciation. A fee simple interest in land is not section 1250 property because, like land, it is not depreciable.

Gain on the disposition of section 1250 property is treated as ordinary income to the extent of additional depreciation allowed or allowable. To determine the additional depreciation on section 1250 property, see Depreciation Recapture in chapter 3 of Pub. 544.

Use Part III of Form 4797 to figure the ordinary income part of the gain.

You will not have additional depreciation if any of the following apply to the property disposed of.

  • You figured depreciation for the property using the straight line method or any other method that does not result in depreciation that is more than the amount figured by the straight line method and you have held the property longer than 1 year.

  • You chose the alternate ACRS (straight line) method for the property, which was a type of 15-, 18-, or 19-year real property covered by the section 1250 rules.

  • The property was nonresidential real property placed in service after 1986 (or after July 31, 1986, if the choice to use MACRS was made) and you held it longer than 1 year. These properties are depreciated using the straight line method.

 

Installment Sale

If you report the sale of property under the installment method, any depreciation recapture under section 1245 or 1250 is taxable as ordinary income in the year of sale. This applies even if no payments are received in that year. If the gain is more than the depreciation recapture income, report the rest of the gain using the rules of the installment method. For this purpose, include the recapture income in your installment sale basis to determine your gross profit on the installment sale.

If you dispose of more than one asset in a single transaction, you must separately figure the gain on each asset so that it may be properly reported. To do this, allocate the selling price and the payments you receive in the year of sale to each asset. Report any depreciation recapture income in the year of sale before using the installment method for any remaining gain.

For more information on installment sales, see chapter 10.

Other Dispositions

Chapter 3 of Pub. 544 discusses the tax treatment of the following transfers of depreciable property.

  • By gift.

  • At death.

  • In like-kind exchanges.

  • In involuntary conversions.

Pub. 544 also explains how to handle a single transaction involving multiple properties.

Other Gains

This section discusses gain on the disposition of farmland for which you were allowed either of the following.

  • Deductions for soil and water conservation expenditures (section 1252 property).

  • Exclusions from income for certain cost sharing payments (section 1255 property).

 

Section 1252 property.

If you disposed of farmland you held more than 1 year and less than 10 years at a gain and you were allowed deductions for soil and water conservation expenses for the land, as discussed in chapter 5, you must treat part of the gain as ordinary income and treat the balance as section 1231 gain.

Exceptions.

Do not treat gain on the following transactions as gain on section 1252 property.

  • Disposition of farmland by gift.

  • Transfer of farm property at death (except for income in respect of a decedent).

For more information, see Regulations section 1.1252-2.

Amount to report as ordinary income.

You report as ordinary income the lesser of the following amounts.

  • Your gain (determined by subtracting the adjusted basis from the amount realized from a sale, exchange, or involuntary conversion, or the FMV for all other dispositions).

  • The total deductions allowed for soil and water conservation expenses multiplied by the applicable percentage, discussed next.

 

Applicable percentage.

The applicable percentage is based on the length of time you held the land. If you dispose of your farmland within 5 years after the date you acquired it, the percentage is 100%. If you dispose of the land within the 6th through 9th year after you acquired it, the applicable percentage is reduced by 20% a year for each year or part of a year you hold the land after the 5th year. If you dispose of the land 10 or more years after you acquired it, the percentage is 0%, and the entire gain is a section 1231 gain.

Example.

You acquired farmland on January 19, 2009. You incurred $15,000 of soil and water conservation expenditures for the land that were fully deductible. On October 3, 2017, you sold the land at a $30,000 gain. The applicable percentage is 40% since you sold the land within the 8th year after you acquired it. You treat $6,000 (40% of $15,000) of the $30,000 gain as ordinary income and the $24,000 balance as a section 1231 gain.

Section 1255 property.

If you receive certain cost-sharing payments on property and you exclude those payments from income (as discussed in chapter 3), you may have to treat part of any gain as ordinary income and treat the balance as a section 1231 gain. If you chose not to exclude these payments, you will not have to recognize ordinary income under this provision.

Amount to report as ordinary income.

You report as ordinary income the lesser of the following amounts.

  • The applicable percentage of the total excluded cost-sharing payments.

  • The gain on the disposition of the property.

You do not report ordinary income under this rule to the extent the gain is recognized as ordinary income under sections 1231 through 1254, 1256, and 1257. However, if applicable, gain reported under this rule must be reported regardless of any contrary provisions (including nonrecognition provisions) under any other section.

Applicable percentage.

The applicable percentage of the excluded cost-sharing payments to be reported as ordinary income is based on the length of time you hold the property after receiving the payments. If the property is held less than 10 years after you receive the payments, the percentage is 100%. After 10 years, the percentage is reduced by 10% a year, or part of a year, until the rate is 0%.

Form 4797, Part III.

Use Form 4797, Part III, to figure the ordinary income part of a gain from the sale, exchange, or involuntary conversion of section 1252 property and section 1255 property.

10. Installment Sales

Introduction

An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. If you realize a gain on an installment sale, you may be able to report part of your gain when you receive each payment. This method of reporting gain is called the installment method. You can't use the installment method to report a loss. You can choose to report all of your gain in the year of sale.

Installment obligation.

The buyer's obligation to make future payments to you can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer's debt to you.

Topics - This chapter discusses:

  • The general rules that apply to using the installment method

  • Installment sale of a farm

Useful Items - You may want to see:

Publication

  • 523 Selling Your Home

  • 535 Business Expenses

  • 537 Installment Sales

  • 538 Accounting Periods and Methods

  • 544 Sales and Other Dispositions of Assets

Form (and Instructions)

  • 4797 Sales of Business Property

  • 6252 Installment Sale Income

See chapter 16 for information about getting publications and forms.

Installment Sale of a Farm

The installment sale of a farm for one overall price under a single contract isn't the sale of a single asset. It generally includes the sale of real property and personal property reportable on the installment method. It may also include the sale of property for which you must maintain an inventory, which can't be reported on the installment method. See Inventory , later. The selling price must be allocated to determine the amount received for each class of asset.

Note.

You may be required to report the sale of your farm on Form 8594, Asset Acquisition Statement. For more information, see Form 8594 and its instructions.

The tax treatment of the gain or loss on the sale of each class of assets is determined by its classification as a capital asset, as property used in the business, or as property held for sale and by the length of time the asset was held. (See chapter 8 for a discussion of capital assets and chapter 9 for a discussion of property used in the business.) Separate computations must be made to figure the gain or loss for each class of asset sold. See Sale of a Farm in chapter 8.

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If you report the sale of property on the installment method, any depreciation recapture under sections 1245 or 1250 is generally taxable as ordinary income in the year of sale. See Depreciation recapture , later. This applies even if no payments are received in that year.

Related parties.

If you sell property to a related party, you may not be able to report the sale using the installment method. Generally, members of a family aren't related parties for purpose of the installment method. For more information, see Related Person under Sale to a Related Person, in Pub. 537.

Installment Method

An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. A farmer who isn't required to maintain an inventory can use the installment method to report gain from the sale of property used or produced in farming. See Inventory , later, for information on the sale of farm property where inventory items are included in the assets sold.

If a sale qualifies as an installment sale, the gain must be reported under the installment method unless you elect out of using the installment method.

Electing out of the installment method.

If you elect not to use the installment method, you generally report the entire gain in the year of sale, even though you don't receive all the sale proceeds in that year.

To make this election, don’t report your sale on Form 6252. Instead, report it on Schedule F (Form 1040), Schedule D (Form 1040), Form 4797, or all three.

You may also need to file Form 8949. For more information, see Form 8949, and its instructions.

When to elect out.

Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place.

However, if you timely file your tax return for the year the sale takes place without making the election, you still can make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Write "Filed pursuant to section 301.9100-2" at the top of the amended return.

Amended returns cannot be filed electronically. If you filed your original return electronically, file the amended return where you would have filed a paper return. For more information, go to IRS.gov/uac/where-to-file-tax-returns-addresses-listed-by-return-type.

Revoking the election.

Once made, the election can be revoked only with IRS approval. An approved revocation is retroactive.

The taxpayer cannot revoke the election if either of the following applies.

  • One of the purposes is to avoid federal income tax.

  • The tax year in which any payment was received has closed.

 

To revoke the election you must obtain a private letter ruling from the IRS. The procedures and user fees for obtaining a private letter ruling are published annually in the first revenue procedure issued each calendar year. For 2017, go to IRS.gov/irb/2017-01_IRB/ar07.html.

Send your request for a private letter ruling, including the applicable user fee, to the IRS following the instructions in section 7 of Revenue Procedure 2017-1. A schedule of the current user fees is available in Appendix A.

Inventory.

If you aren't required to maintain (keep a record of beginning and ending) inventories under your method of accounting, you can report gain from the sale of farm inventory using the installment method. Complete Form 6252 to figure the amount of installment gain to report each year from the sale of farm inventory and carry that amount to line 8 of Schedule F (Form 1040).

If you are required to maintain inventories under your method of accounting, you can't report gain from the sale of farm inventory using the installment method. All gain or loss on the sale of farm inventory must be reported in the year of sale, even if you receive payment in later years. If inventory items are included in an installment sale, you may have an agreement stating which payments are for inventory and which are for the other assets being sold. If you don’t, each payment must be allocated between the inventory and the other assets sold.

More information.

See Inventory in Pub. 537 for more information.

Sale at a loss.

If your sale results in a loss, you can't use the installment method. If the loss is on an installment sale of business assets, you can deduct it only in the tax year of sale.

Figuring Installment Sale Income

Each payment on an installment sale usually consists of the following three parts.

  • Interest income.

  • Return of your adjusted basis in the property.

  • Gain on the sale.

In each year you receive a payment, you must include in income both the interest part and the part that is your gain on the sale. Don't include in income the part that is the return of your basis in the property. Basis is the amount of your investment in the property for installment sale purposes.

Interest income.

You must report interest as ordinary income. Interest is generally not included in a down payment. However, you may have to treat part of each later payment as interest, even if it isn't called interest in your agreement with the buyer. Interest provided in the agreement is called stated interest. If the agreement doesn't provide for enough stated interest, there may be unstated interest or original issue discount. See Unstated interest , later.

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You must continue to report the interest income on payments you receive in subsequent years as interest income whether it is stated or unstated.

Adjusted basis and installment sale income (gain on sale).

After you have determined how much of each payment to treat as interest, you treat the rest of each payment as if it were made up of two parts.

  • A tax-free return of your adjusted basis in the property, and

  • Your gain (referred to as "installment sale income" on Form 6252).

 

Figuring adjusted basis and gross profit percentage for installment sale purposes.

You can use Worksheet 10-1 to figure your adjusted basis in the property for installment sale purposes. When you have completed the worksheet, you will also have determined the gross profit percentage necessary to figure your installment sale income (gain) for this year.

  1. Selling price. The selling price is the total cost of the property to the buyer and includes the following.

    • Any money you are to receive.

    • The fair market value (FMV) of any property you are to receive (FMV is discussed at Property used as a payment , later).

    • Any existing mortgage or other debt the buyer pays, assumes, or takes the property subject to (a note, mortgage, or any other liability, such as a lien, accrued interest, or taxes you owe on the property).

    • Any of your selling expenses the buyer pays.

    Don't include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount in the selling price.

  2. Adjusted basis.

    • Your adjusted basis in property immediately before the installment sale is your original basis increased or reduced as a result of various events while you own the property. Some events, such as adding rooms or making permanent improvements, increase basis. Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis.

    • The way you figure your original basis depends on how you acquire the property. The basis of property you buy is generally its cost. The basis of property you inherit, receive as a gift, build yourself, or receive in a tax free exchange is figured differently. See chapter 6 and Pub. 551, for more information.

  3. Selling expenses. Selling expenses relate to the sale of the property. Review the closing statement for fees which may qualify as selling expenses. These may include, appraisal fees, attorney fees, closing fees, document preparation fees, escrow fees, mortgage satisfaction fees, notary fees, points paid by seller to obtain financing for the buyer, real estate broker's commission, recording fees (if paid by the seller), costs of removing title clouds, settlement fees, title search fees, and transfer or stamp taxes charged by city, county, or state governments.

  4. Depreciation recapture. If the property you sold was depreciable property:

    • You may need to recapture part of the gain on the sale as ordinary income.

    • See Depreciation Recapture in chapter 9, and Depreciation Recapture Income in Pub. 537.

  5. Adjusted basis for installment sale purposes. Your adjusted basis for installment sale purposes is the total of the following three items.

    • Adjusted basis.

    • Selling expenses.

    • Depreciation recapture.

  6. Gross profit.

    • Gross profit is the total gain you report on the installment method.

    • To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price.

    • If the property you sold was your home, subtract from the gross profit any gain you can exclude. See Pub. 523, Selling Your Home, for more information.

  7. Contract price. Contract price equals:

    • The selling price, minus

    • The mortgages, debts, and other liabilities assumed or taken by the buyer, plus

    • The amount by which the mortgages, debts, and other liabilities assumed or taken by the buyer exceed your adjusted basis for installment sale purposes.

  8. Gross profit percentage.

    • A certain percentage of each payment (after subtracting interest) is reported as installment sale income. This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price.

    • The gross profit percentage generally remains the same for each payment you receive. However, see the example under Selling price reduced , later, for a situation where the gross profit percentage changes.

 

 

Worksheet 10-1. Figuring Adjusted Basis and Gross Profit Percentage

 

1. Enter the selling price for the property  
2. Enter your adjusted basis for the property    
3. Enter your selling expenses    
4. Enter any depreciation recapture    
5. Add lines 2, 3, and 4.
This is your adjusted basis
for installment sale purposes
 
6. Subtract line 5 from line 1. If zero or less, enter -0-.
This is your gross profit
 
  If the amount entered on line 6 is zero, Stop here. You can't use the installment method.  
7. Enter the contract price for the property  
8. Divide line 6 by line 7. This is your gross profit percentage  

 

 

Example.

You sell property at a contract price of $60,000 and your gross profit is $15,000. Your gross profit percentage is 25% ($15,000 ÷ $60,000). After subtracting interest from each payment, you report 25% of each payment, including the down payment, as installment sale income from the sale for the tax year you receive the payment. The remainder (balance) of each payment is the tax-free return of your adjusted basis.

Amount to report as installment sale income.

Multiply the payments you receive each year (less interest) by the gross profit percentage. The result is your installment sales income for the tax year. In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. For a detailed discussion, see Payments Received or Considered Received , later.

Selling price reduced.

If the selling price is reduced at a later date, the gross profit on the sale also will change. You then must refigure the gross profit percentage for the remaining payments. Refigure your gross profit using Worksheet 10-2. New Gross Profit Percentage — Selling Price Reduced. You will spread any remaining gain over future installments.

 

Worksheet 10-2. New Gross Profit Percentage — Selling Price Reduced

 

1. Enter the reduced selling
price for the property
 
2. Enter your adjusted
basis for the
property
   
3. Enter your selling
expenses
   
4. Enter any depreciation
recapture
   
5. Add lines 2, 3, and 4.  
6. Subtract line 5 from line 1.
This is your adjusted
gross profit
 
7. Enter any installment sale
income reported in
prior year(s)
 
8. Subtract line 7 from line 6  
9. Future installments    
10. Divide line 8 by line 9.
This is your new
gross profit percentage*.
 
* Apply this percentage to all future payments to determine how much of each of those payments is installment sale income.

 

 

Example.

In 2015, you sold land with a basis of $40,000 for $100,000. Your gross profit was $60,000. You received a $20,000 down payment and the buyer's note for $80,000. The note provides for monthly payments of $1,953 each, figured at 8% interest, amortized over four years, beginning in January 2016. Your gross profit percentage was 60%. You received the down payment of $20,000 in 2015 and total payments of $23,436 in 2016, of which $17,675 was principal and $5,761 was interest according to the amortization schedule. You reported a gain of $12,000 on the down payment received in 2015 and $10,605 ($17,675 X 60% (0.60)) in 2016.

In January 2017, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2017, 2018, and 2019 are reduced to $1,483 a month amortized over the remaining three years.

The new gross profit percentage, 47.32%, is figured in Example — Worksheet 10-2.

 

Example — Worksheet 10-2. New Gross Profit Percentage — Selling Price Reduced

1. Enter the reduced selling
price for the property
85,000
2. Enter your adjusted
basis for the
property
40,000  
3. Enter your selling
expenses
-0-  
4. Enter any depreciation
recapture
-0-  
5. Add lines 2, 3, and 4. 40,000
6. Subtract line 5 from line 1.
This is your adjusted
gross profit
45,000
7. Enter any installment sale
income reported in
prior year(s)
22,605
8. Subtract line 7 from line 6 22,395
9. Future installments   47,325
10. Divide line 8 by line 9.
This is your new
gross profit percentage*.
47.32%
* Apply this percentage to all future payments to determine how much of each of those payments is installment sale income.

 

You will report installment sale income of $6,878 (47.32% of $14,535) in 2017, $7,449 (47.32% of $15,742) in 2018, and $8,067 (47.32% of $17,048) in 2019.

Form 6252.

Use Form 6252 to report an installment sale in the year it takes place and to report payments received, or considered received because of related party resales, in later years. Attach it to your tax return for each year.

Disposition of Installment Obligation

If you are using the installment method and you dispose of the installment obligation, generally you will have a gain or loss to report. It is considered gain or loss on the sale of the property for which you received the installment obligation.

Cancellation.

If an installment obligation is canceled or otherwise becomes unenforceable, it is treated as a disposition other than a sale or exchange. Your gain or loss is the difference between your basis in the obligation and its FMV at the time you cancel it. If the parties are related, the FMV of the obligation is considered to be no less than its full face value.

Transfer due to death.

The transfer of an installment obligation (other than to a buyer) as a result of the death of the seller isn't a disposition. Any unreported gain from the installment obligation isn't treated as gross income to the decedent. No income is reported on the decedent's return due to the transfer. Whoever receives the installment obligation as a result of the seller's death is taxed on the installment payments the same as the seller would've been had the seller lived to receive the payments.

However, if the installment obligation is canceled, becomes unenforceable, or is transferred to the buyer because of the death of the holder of the obligation, it is a disposition. The estate must figure its gain or loss on the disposition. If the holder and the buyer were related, the FMV of the installment obligation is considered to be no less than its full face value.

More information.

For more information on the disposition of an installment obligation, see Pub. 537.

Sale of depreciable property.

You generally can't report gain from the sale of depreciable property to a related person on the installment method. However, see Related parties under Installment Sale of a Farm , earlier.

You generally can't use the installment method to report any depreciation recapture income. However, you can report any gain greater than the recapture income on the installment method.

The recapture income reported in the year of sale is included in your installment sale basis to determine your gross profit on the installment sale.

Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. As instructed on the form, transfer the depreciation recapture income to Part II of Form 4797 as ordinary income in the year of sale.

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If you sell depreciable business property, prepare Form 4797 first in order to figure the amount to enter on line 12 of Part I, Form 6252. See the Form 6252 instructions for details.

For more information on the section 179 deduction, see Section 179 Expense Deduction in chapter 7. For more information on depreciation recapture, see