2017 Publication 225 P225

User Manual: 225

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Page Count: 90

Contents
Introduction .................. 1
What's New for 2017 ............. 2
What's New for 2018 ............. 2
Reminders ................... 3
Chapter 1. Importance of Records .... 3
Chapter 2. Accounting Methods ..... 5
Chapter 3. Farm Income .......... 8
Chapter 4. Farm Business
Expenses ................ 18
Chapter 5. Soil and Water
Conservation Expenses ....... 26
Chapter 6. Basis of Assets ....... 29
Chapter 7. Depreciation, Depletion,
and Amortization ........... 35
Chapter 8. Gains and Losses ...... 47
Chapter 9. Dispositions of
Property Used in Farming ..... 55
Chapter 10. Installment Sales ..... 59
Chapter 11. Casualties, Thefts, and
Condemnations ............ 64
Chapter 12. Self-Employment Tax ... 72
Chapter 13. Employment Taxes .... 76
Chapter 14. Fuel Excise Tax
Credits and Refunds ......... 81
Chapter 15. Estimated Tax ....... 84
Chapter 16. How To Get Tax Help ... 86
Index ..................... 88
Introduction
You are in the business of farming if you culti-
vate, 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 or-
chards 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 publi-
cation reflect the Internal Revenue Service's in-
terpretation of tax laws enacted by Congress,
Treasury regulations, and court decisions. How-
ever, the information given does not cover ev-
ery situation and is not intended to replace the
Department
of the
Treasury
Internal
Revenue
Service
Publication 225
Cat. No. 11049L
Farmer's
Tax Guide
For use in preparing
2017 Returns
Acknowledgment: The valuable advice and assistance given us each
year by the National Farm Income Tax Extension Committee is
gratefully acknowledged.
Get forms and other information faster and easier at:
•IRS.gov (English)
•IRS.gov/Spanish (Español)
•IRS.gov/Chinese (中文)
•IRS.gov/Korean (한국어)
•IRS.gov/Russian (Pусский)
•IRS.gov/Vietnamese (TiếngViệt)
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Oct 19, 2017
law or change its meaning. This publication
covers subjects on which a court may have ren-
dered 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 in-
terpretation of the Service.
The IRS Mission. Provide America's taxpay-
ers top quality service by helping them under-
stand 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 Admin-
istration (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 work-
shops in conjunction with the IRS. Contact your
county or regional extension office for more in-
formation.
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 web-
site 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 Com-
mittee are contributors for the website and the
website is hosted by Utah State University Co-
operative 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 contribu-
tions/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 stand-
ard 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 re-
voke a prior election) to deduct a loss attributa-
ble 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 es-
tablish a voluntary certification program for pro-
fessional 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 profes-
sional employer organizations (CPEOs) must
meet various requirements described in sec-
tions 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 cov-
ered 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 em-
ployer'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 calen-
dar quarter beginning after the date that the
qualified small business filed its income tax re-
turn. 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 al-
lowance. 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 Med-
icare tax. See chapter 13.
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Page 2 Publication 225 (2017)
Reminders
The following reminders and other items may
help you file your tax return.
IRS e-file (Electronic Filing)
You can file your tax returns electronically
using an IRS e-file option. The benefits of IRS
e-file include faster refunds, increased accu-
racy, 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 Educa-
tion programs. The U.S. Census Bureau also
uses this information for its economic census.
See the list of Principal Agricultural Activity Co-
des on page 2 of Schedule F (Form 1040).
Publication on employer identification num-
bers (EINs). Pub. 1635, Understanding Your
Employer Identification Number, provides gen-
eral 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 State-
ment, 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 trans-
actions include (1) transactions the same as or
substantially similar to tax avoidance transac-
tions identified by the IRS, (2) transactions of-
fered to you under conditions of confidentiality
and for which you paid an advisor a minimum
fee, (3) transactions for which you have or a re-
lated party has a right to a full or partial refund
of fees if all or part of the intended tax conse-
quences 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 en-
courage them to check their income tax with-
holding 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 ex-
ample, an accountant, an attorney, or a veteri-
narian) 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 purpo-
ses of this publication, a limited liability com-
pany (LLC) is a business entity organized in the
United States under state law. Unlike a partner-
ship, 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 disregar-
ded 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 Inter-
nal 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 re-
cords to prepare an accurate income tax return
and determine the correct amount of tax. This
chapter explains the benefits of keeping re-
cords, 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 publica-
tion 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 pur-
chase and download 2017 Financial Guidelines
for Agriculture at www.ffsc.org. For more infor-
mation, 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
(Circular A), Agricultural Employer's
Tax Guide
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 busi-
ness. You need records to monitor the pro-
gress 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 bet-
ter 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 sep-
arate 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
51
463
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Chapter 1 Importance of Records Page 3
times for inspection by the IRS. If the IRS exam-
ines 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 farm-
ing business that clearly shows, for example,
your income and expenses.
You should set up your recordkeeping sys-
tem 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 jour-
nals and ledgers. For example, they must show
your gross income, as well as your deductions
and credits. In addition, you must keep support-
ing documents. Purchases, sales, payroll, and
other transactions you have in your business
generate supporting documents such as invoi-
ces and receipts. These documents contain the
information you need to record in your journals
and ledgers.
It is important to keep these documents be-
cause 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 in-
stance, organize them by year and type of in-
come or expense.
Electronic records. All requirements that ap-
ply 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 elec-
tronic storage media. The electronic storage
system must index, store, preserve, retrieve,
and reproduce the electronically stored books
and records in legible format. All electronic stor-
age systems must provide a complete and ac-
curate 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 en-
sure continued compliance with all applicable
rules and regulations. You still have the respon-
sibility 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 capabili-
ties. This test is not considered an examination
and the results must be shared with you. If your
electronic storage system meets the require-
ments mentioned earlier, you will be in compli-
ance. If not, you may be subject to penalties for
non-compliance, unless you continue to main-
tain your original hard copy books and records
in a manner that allows you and the IRS to de-
termine your correct tax. For details on elec-
tronic 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 em-
ployment 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 ma-
chinery 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 depreci-
ation 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 finan-
cial institutions. These include account state-
ments prepared for the financial institution by a
third party. These account statements must be
legible. The following table lists acceptable ac-
count 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.
Proof of payment of an amount, by it-
self, 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 re-
turns. They help in preparing future tax returns
and making computations if you file an amen-
ded return. Keep copies of your information re-
turns 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 de-
duction 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 le-
gal 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 re-
cords 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 fig-
ure any depreciation, amortization, or depletion
deduction and to figure your basis for comput-
ing gain or (loss) when you sell or otherwise dis-
pose 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 ap-
plies to you. For example, if you received
CAUTION
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Page 4 Chapter 1 Importance of Records
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 limita-
tions 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 purpo-
ses. 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 meth-
ods. 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
Accounting Periods and Methods
Business Expenses
Form (and Instructions)
Application To Adopt, Change, or
Retain a Tax Year
Application for Change in
Accounting Method
See chapter 16 for information about getting
publications and forms.
538
535
1128
3115
Accounting Methods
An accounting method is a set of rules used to
determine when and how your income and ex-
penses are reported on your tax return. Your
accounting method includes not only your over-
all method of accounting, but also the account-
ing 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 ac-
counting method, you generally must get IRS
approval. How to obtain IRS approval is dis-
cussed later under Changes in Methods of Ac-
counting.
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 ele-
ments of two or more of the above meth-
ods.
Business and other items. You can account
for business and personal items using different
accounting methods. For example, you can fig-
ure your business income under an accrual
method, even if you use the cash method to fig-
ure 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 corpora-
tions and partnerships and all tax shelters must
use an accrual method of accounting. See Ac-
crual Method Required, later. Also, see Inven-
tory, later.
Income
Under the cash method, include in your gross
income all items of income you actually or con-
structively 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 re-
turn.
Constructive receipt. Income is construc-
tively 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 construc-
tively 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 re-
port the income in the year the money or prop-
erty is received or made available to you with-
out restriction.
Example. Frances Jones, a farmer who
uses the cash method of accounting, was enti-
tled to receive a $10,000 payment on a grain
contract in December 2017. She was told in De-
cember that her payment was available. She re-
quested not to be paid until January 2018. Fran-
ces must include this payment in her 2017
income because it was made available to her in
2017.
Debts paid by another person or can-
celed. 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 in-
come. 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. How-
ever, 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 ac-
tually 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 de-
livered, 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 de-
duct the repayment in the year repaid. If the re-
payment is more than $3,000, a special rule ap-
plies. For details, see Repayments in
chapter 11 of Pub. 535, Business Expenses.
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Chapter 2 Accounting Methods Page 5
Expenses
Under the cash method, generally you deduct
expenses in the tax year you pay them. This in-
cludes business expenses for which you con-
test liability. However, you may not be able to
deduct an expense paid in advance or you may
be required to capitalize certain costs, as ex-
plained under Uniform Capitalization Rules in
chapter 6. See chapter 4 for information on how
to deduct farm business expenses on your in-
come 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 extend-
ing 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 de-
duct $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 in-
formation 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 incur-
red. The purpose of an accrual method of ac-
counting is to correctly match income and ex-
penses. 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 Re-
quired 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 ac-
curacy. Under this rule, include an amount in in-
come 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 deter-
mine your gross income. An inventory is neces-
sary to clearly show income when the produc-
tion, 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 ex-
pense when both of the following apply.
1. The all-events test has been met. This test
is met when:
a. All events have occurred that fix the
fact that you have a liability, and
b. The amount of the liability can be de-
termined with reasonable accuracy.
2. Economic performance has occurred.
Economic performance. Generally, you can-
not deduct or capitalize a business expense un-
til economic performance occurs. If your ex-
pense is for property or services provided to
you, or for your use of property, economic per-
formance occurs as the property or services are
provided or as the property is used. If your ex-
pense 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 ac-
counting. 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 integrat-
ing 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 provi-
ded. 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 eco-
nomic 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 ac-
counting.
1. A corporation (other than a family corpora-
tion) that had gross receipts of more than
$1,000,000 for any tax year beginning af-
ter 1975.
2. A family corporation that had gross re-
ceipts of more than $25,000,000 for any
tax year beginning after 1985.
3. A partnership with a corporation as a part-
ner, if that corporation meets the require-
ments 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 operat-
ing a nursery or sod farm, or the raising or har-
vesting 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, di-
rectly 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, di-
rectly 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 addi-
tion, 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 syndi-
cate is an entity that meets either of the
following tests.
a. Interests in the activity have been of-
fered 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.
b. 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 li-
ability 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.
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Page 6 Chapter 2 Accounting Methods
Farm Inventory
If you are required to keep an inventory, you
should keep a complete record of your inven-
tory 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 ac-
counting, you must include in inventory eggs in
the process of incubation.
Products held for sale. All harvested and pur-
chased farm products held for sale or for feed
or seed, such as grain, hay, silage, concen-
trates, 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 op-
erations. 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
seeUnit-livestock-price method, later. If you are
in the business of breeding and raising chinchil-
las, mink, foxes, or other fur-bearing animals,
these animals are livestock for inventory purpo-
ses.
Growing crops. Generally, growing crops are
not required to be included in inventory. How-
ever, 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 be-
low. 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 pur-
chased, 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 prepro-
ductive period of raising a plant is 2 years
or less.
The costs of animals are subject to the uni-
form 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 ac-
counting 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 meth-
ods. See Pub. 538 for information on these val-
uation methods.
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 per-
mission from the IRS to change to the unit-live-
stock-price method.
Farm-price method. Under this method,
each item, whether raised or purchased, is val-
ued 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 com-
missions, 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-live-
stock-price method.
Unit-livestock-price method. This method
recognizes the difficulty of establishing the ex-
act 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 approxi-
mate the normal costs incurred in producing the
animals in such classes. Unit prices and classi-
fications 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 in-
creases 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 ma-
turity. Also, if you raise cattle, you are not re-
quired 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 live-
stock purchased for draft, breeding, sport, or
dairy purposes. However, you must be consis-
tent 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 pur-
chased 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 in-
crease the cost of any animal purchased during
the last 6 months of the year. This “no increase”
TIP
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 taxpay-
ers that must make an adjustment to reasona-
bly 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 in-
come 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 dis-
pose 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 meth-
ods of accounting apply to the following items.
Amortization, see chapter 7.
Casualties, see chapter 11.
Condemnations, see chapter 11.
Depletion, see chapter 7.
Depreciation, see chapter 7.
Farm business expenses, see chapter 4.
Farm income, see chapter 3.
Installment sales, see chapter 10.
Soil and water conservation expenses, see
chapter 5.
Thefts, see chapter 11.
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Chapter 2 Accounting Methods Page 7
Combination Method
Generally, you can use any combination of
cash, accrual, and special methods of account-
ing if the combination clearly shows your in-
come 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 in-
cludes 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 in-
ventory (for example, a change from the
farm-price method to the unit-live-
stock-price method, discussed earlier).
Generally, once you have set up your account-
ing method, you must receive approval from the
IRS before you can change either an overall
method of accounting or the accounting treat-
ment of any material item. A user fee may be re-
quired 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 infor-
mation, 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 differ-
ent sources on your tax return, unless it is ex-
cluded by law. Where you report the income on
your tax return depends on its source.
This chapter discusses farm income you re-
port on Schedule F (Form 1040), Profit or Loss
From Farming. For information on where to re-
port 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 in-
come 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
Taxable and Nontaxable Income
Sales and Other Dispositions of
Assets
Investment Income and Expenses
Bankruptcy Tax Guide
Passive Activity and At-Risk Rules
Canceled Debts, Foreclosures,
Repossessions, and Abandonments
Form (and Instructions)
Reduction of Tax Attributes Due to
Discharge of Indebtedness
Supplemental
Income and Loss
Income Averaging for
Farmers and Fishermen
Certain Government Payments
Taxable Distributions
Received From Cooperatives
Sales of Business Property
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 reg-
ular farming operations.
525
544
550
908
925
4681
982
Sch E (Form 1040)
Sch J (Form 1040)
1099-G
1099-PATR
4797
4835
Corporations use Form 1120 to report
the income or loss from regular farming
operations.
Income from farming reported on Sched-
ule F includes amounts you receive from culti-
vating, operating, or managing a farm for gain
or profit, either as owner or tenant. This in-
cludes 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 pro-
ducing 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 in-
clude gains or losses from sales or other dispo-
sitions 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 re-
turn.
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 sell-
ing 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.
TIP
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.
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Page 8 Chapter 3 Farm Income
Form 4797. Sales of livestock held for
draft, breeding, sport, or dairy purposes may re-
sult in ordinary or capital gains or losses, de-
pending on the circumstances. In either case,
you should always report these sales on Form
4797 instead of Schedule F. See Livestock un-
der Ordinary or Capital Gain or Loss in chap-
ter 8. Animals you don't hold primarily for sale
are considered business assets of your farm.
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 con-
structive 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 be-
cause of a drought, flood, or other weather-rela-
ted condition, you may be able to postpone re-
porting 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 busi-
ness 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 assis-
tance by the federal government.
Disaster assistance and emergency
relief for individuals and busi-
nesses. Special tax law provisions
may help taxpayers and businesses recover fi-
nancially from the impact of a disaster, espe-
cially when the federal government declares
their location to be a major disaster area. Get
the latest tax relief guidance in disaster situa-
tions at IRS.gov/uac/tax-relief-in-disaster-
situations and in disaster area losses - agricul-
ture 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.
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 Invol-
untary Conversions in chapter 11.
Usual business practice. You must deter-
mine the number of animals you would have
sold had you followed your usual business
TIP
TIP
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 estab-
lished 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 af-
fected by a weather-related condition for the
postponement to apply. However, the sale must
occur solely because of a weather-related con-
dition that affected the water, grazing, or other
requirements of the livestock. This requirement
generally won't be met if the costs of feed, wa-
ter, or other requirements of the livestock affec-
ted by the weather-related condition aren't sub-
stantial 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 live-
stock 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 be-
cause 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 af-
fected area was declared a disaster area eligi-
ble for federal assistance. The income you can
postpone until 2017 is $61,250 [($236,250 ÷
135) × 35].
How to postpone gain. To postpone gain, at-
tach a statement to your tax return for the year
of the sale. The statement must include your
name and address and give the following infor-
mation 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, includ-
ing extensions. However, for sales or ex-
changes 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 re-
turn for the year without postponing gain, you
can still postpone gain by filing an amended re-
turn within 6 months of the due date of the re-
turn (excluding extensions). Attach the state-
ment 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 farm-
land is generally rental income, not farm in-
come. However, the rent is farm income if:
1. Your arrangement with your tenant pro-
vides that the you will materially partici-
pate 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 chap-
ter 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 busi-
ness. 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 pro-
vides that the you will materially partici-
pate in the production or management of
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Chapter 3 Farm Income Page 9
production of the farm products on the
land, and
2. You materially participate.
See Landlord Participation in Farming in chap-
ter 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 pro-
duction of the farm products on the land,
or
2. You don't materially participate in operat-
ing 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 in-
clude the fair market value of the crop shares in
income at that time. You're entitled to a busi-
ness 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 transac-
tions cancel each other for figuring adjusted
gross income on Form 1040, they may be nec-
essary to figure your self-employment tax. See
Landlord Participation in Farming and Farm Op-
tional 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 chil-
dren.
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 un-
der the passive loss rules. See Pub. 925 for in-
formation on these rules.
Agricultural Program
Payments
You must include in income most government
payments, such as those for approved conser-
vation 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 re-
ceive under certain cost-sharing conservation
programs. See Cost-Sharing Exclusion (Im-
provements), later.
Report the agricultural program payment on
the appropriate line of Schedule F, Part I. Re-
port the full amount even if you return a govern-
ment check for cancellation, refund any of the
payment you receive, or the government col-
lects all or part of the payment from you by re-
ducing the amount of some other payment or
Commodity Credit Corporation (CCC) loan.
However, you can deduct the amount you re-
fund or return or that reduces some other pay-
ment 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 In-
structions for Form 3115 and Revenue Proce-
dure 2008-52. Revenue Procedure 2008-52,
2008-36 I.R.B. 587, is available at
IRS.gov/irb/2008-36_IRB/ar09.html.
You can request income tax withhold-
ing from CCC loan payments you re-
ceive. Use Form W-4V. See chapter 16
for information about ordering the form.
To elect to report a CCC loan as income, in-
clude the loan proceeds as income on Sched-
ule F, for the year you receive it. Attach a state-
ment 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 exten-
sions. 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
TIP
extensions). Attach the statement to the amen-
ded 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 forfei-
ture.
Form 1099-A. If you forfeit pledged crops to
the CCC in full payment of a loan, you may re-
ceive a Form 1099-A . “CCC” should be shown
in box 6. The amount of any CCC loan out-
standing when you forfeited your commodity
should also be indicated on the form.
Market Gain
Under the CCC nonrecourse marketing assis-
tance 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 repay-
ment. 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 in-
clude 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 in-
come 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 produc-
ing the cotton and has a zero basis in the com-
modity. 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 re-
paid 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
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Page 10 Chapter 3 Farm Income
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 recog-
nized on the redemption. He reports it for 2017
as an agricultural program payment on Sched-
ule 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 (re-
purchase) 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 Sched-
ule 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 en-
tered into an option-to-purchase contract with a
cotton buyer before redeeming the cotton. Un-
der 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 re-
deemed 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 re-
ceive under the program on the appropriate
lines on Schedule F. Cost-share payments you
receive may qualify for the cost-sharing exclu-
sion. See Cost-Sharing Exclusion (Improve-
ments), later. CRP payments are reported to
you on Form 1099-G.
Individuals who are receiving Social
Security retirement or disability bene-
fits may exclude CRP payments when
calculating self-employment tax, see the In-
structions 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 pro-
ceeds the crop disaster payments you receive
from the federal government as the result of de-
struction or damage to crops, or the inability to
plant crops, because of drought, flood, or any
other natural disaster.
You can request income tax withhold-
ing 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 fol-
lowing 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 dam-
aged.
You can show that under your normal busi-
ness practice you would have included in-
come from the damaged crops in any tax
year following the year the damage occur-
red.
Deferral isn't permitted for proceeds re-
ceived from revenue insurance policies.
To postpone reporting some or all crop in-
surance 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 con-
tain the following information.
A statement that you're making an election
under section 451(d) and Regulations sec-
tion 1.451-6.
The specific crop or crops physically de-
stroyed or damaged.
A statement that under your normal busi-
ness practice you would have included in-
come from some or all of the destroyed or
damaged crops in gross income for a tax
year following the year the crops were de-
stroyed or damaged.
The cause of the physical destruction or
damage and the date or dates it occurred.
The total payments you received from in-
surance carriers, itemized for each specific
TIP
TIP
crop, and the date you received each pay-
ment.
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 re-
quest 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, reim-
bursement payments, and other benefits to
qualifying livestock producers if the Secretary of
Agriculture determines that, because of a natu-
ral 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 post-
pone 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 de-
duction for the same amount as a feed ex-
pense.
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 im-
provement. 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 ex-
clude any part of a payment for an ex-
pense you can deduct in the year you pay
or incur it. You must include the payment
for a deductible expense in income, and
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Chapter 3 Farm Income Page 11
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 an-
nual 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.
a. 10% of the average annual income
derived from the affected property be-
fore receiving the improvement.
b. $2.50 times the number of affected
acres.
3. The Secretary of Agriculture certified that
the payment was primarily made for con-
serving soil and water resources, protect-
ing or restoring the environment, improv-
ing 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 au-
thorized 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 Agri-
cultural Credit Act of 1978.
The agricultural conservation program au-
thorized by the Soil Conservation and Do-
mestic Allotment Act.
The great plains conservation program au-
thorized by the Soil Conservation and Do-
mestic Policy Act.
The resource conservation and develop-
ment program authorized by the Bank-
head-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 un-
der which payments are made to individu-
als primarily for conserving soil, protecting
or restoring the environment, improving
forests, or providing a habitat for wildlife.
Several state programs have been ap-
proved. For information about the status of
those programs, contact the state offices
of the Farm Service Agency (FSA) and the
Natural Resources and Conservation Serv-
ice (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 fol-
lowing programs for improvements made in
connection with a watershed.
The programs under the Watershed Pro-
tection 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 author-
ized by the Food Security Act of 1985, the
Federal Agriculture Improvement and Re-
form Act of 1996 and the Farm Security
and Rural Investment Act of 2002.
The Environmental Quality Incentives Pro-
gram (EQIP) authorized by the Federal Ag-
riculture Improvement and Reform Act of
1996.
The Wildlife Habitat Incentives Program
(WHIP) authorized by the Federal Agricul-
ture Improvement and Reform Act of 1996.
The Soil and Water Conservation Assis-
tance Program authorized by the Agricul-
tural Risk Protection Act of 2000.
The Agricultural Management Assistance
Program authorized by the Agricultural
Risk Protection Act of 2000.
The Conservation Reserve Program au-
thorized 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 au-
thorized by the Food Security Act of 1985.
The Forest Health Protection Program
(FHPP) authorized by the Cooperative For-
estry Assistance Act of 1978.
Income realized. The gross income you real-
ize upon getting an improvement under these
cost-sharing programs is the value of the im-
provement reduced by the sum of the excluda-
ble portion and your share of the cost of the im-
provement (if any).
Value of the improvement. You deter-
mine the value of the improvement by multiply-
ing 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 im-
provement) reduced by the sum of the following
items.
Any government payments under a pro-
gram 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 por-
tion 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 aver-
age 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 improve-
ment.
2. $2.50 times the number of affected acres.
The calculation of present fair market
value of the right to receive annual in-
come 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 por-
tion is the greater amount, $1,550.
You figure the amount to include in gross in-
come 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 capi-
tal 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, am-
ortization, or depletion deductions for the part of
the cost of the property for which you receive
cost-sharing payments you exclude from in-
come.
How to report the exclusion. Attach a state-
ment 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 ex-
cluded. 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
CAUTION
!
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Page 12 Chapter 3 Farm Income
this election for all of these payments, none of
the above restrictions and rules apply. You
must make this election by the due date, includ-
ing extensions, for filing your return. In the ex-
ample above, an election not to exclude pay-
ments 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 elec-
tion, 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 pro-
gram 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 improve-
ments, 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 in-
come, 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 inqui-
ries 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 order-
ing 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 coopera-
tive, you may receive either patronage divi-
dends 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 mini-
mum 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 in-
come on Schedule F for the tax year you re-
ceive them. They include the following items.
Money paid as a patronage dividend, in-
cluding cash advances received (for exam-
ple, 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 divi-
dends 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 ba-
sis of these items by the amount of such patron-
age dividends received. Personal items include
fuel purchased for personal use, basic local tel-
ephone 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 gener-
ally include its stated dollar value in your in-
come 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 sta-
ted dollar value in income in the year you
receive the notice by doing one of the fol-
lowing.
a. Signing and giving a written agree-
ment to the cooperative.
b. Getting or keeping membership in the
cooperative after it adopted a bylaw
providing that membership constitutes
agreement. The cooperative must no-
tify you in writing of this bylaw and
give you a copy.
c. Endorsing and cashing a qualified
check paid as part of the same pa-
tronage dividend. You must cash the
check by the 90th day after the close
of the payment period for the cooper-
ative's tax year for which the patron-
age 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 alloca-
tion for which you met condition 2(c)
above.
It's imprinted with a statement that endors-
ing and cashing it constitutes the payee's
consent to include in income the stated
dollar value of any written notices of alloca-
tion paid as part of the same patronage
dividend.
Loss on redemption. You can deduct on
Schedule F, Part II, any loss incurred on the re-
demption of a qualified written notice of alloca-
tion you received in the ordinary course of your
farming business. The loss is the difference be-
tween 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 in-
clude 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 in-
clude in income for the tax year of disposition
any amount you receive from its sale, redemp-
tion, 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 depreci-
able 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 ex-
cess 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 depreci-
able property. Don't include in income patron-
age dividends from buying capital assets or de-
preciable property used in your business. You
must, however, reduce the basis of these as-
sets 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 divi-
dends are more than your unrecovered basis,
reduce the unrecovered basis to zero and in-
clude the difference on Schedule F, for the tax
year you receive them.
This rule and the exceptions explained be-
low also apply to amounts you receive from the
sale, redemption, or other disposition of a non-
qualified 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 as-
sociation 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 Appen-
dix 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% declin-
ing balance, half-year convention table (shown
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Chapter 3 Farm Income Page 13
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 ba-
sis 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 ÷ 612 (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 re-
ceived the dividends, treat them as an addi-
tional amount received on the sale.
Personal purchases. Because you can't de-
duct the cost of personal, living, or family items,
such as supplies, equipment, or services not re-
lated to the production of farm income, you can
omit from the taxable amount of patronage divi-
dends on Schedule F, any dividends from buy-
ing 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 no-
tice of allocation resulting from these purcha-
ses.
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 co-
operative. A per-unit retain allocation is an
amount paid to patrons for products sold for
them that's fixed without regard to the net earn-
ings of the cooperative. These allocations can
be paid in money, other property, or qualified
certificates.
Per-unit retain certificates issued by a coop-
erative generally receive the same tax treat-
ment as patronage dividends, discussed ear-
lier.
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 re-
ceipt. The agreement may be made in writing or
by getting or keeping membership in a coopera-
tive whose bylaws or charter states that mem-
bership constitutes agreement. If you receive
qualified per-unit retain certificates, include the
stated dollar amount of the certificates in in-
come on Schedule F, for the tax year you re-
ceive them.
Nonqualified certificates. Don't include the
stated dollar value of a nonqualified per-unit re-
tain certificate in income when you receive it.
Your basis in the certificate is zero. You must in-
clude in income any amount you receive from
its sale, redemption, or other disposition. Re-
port the amount you receive from the disposi-
tion 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 includ-
ing 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 in-
come on Form 1040.
Special rules apply to C and S corporations
and partnerships. See section 108(i), Regula-
tions sections 1.108(i)-0 and 1.108(i)-2, and
Pub. 4681 for details.
Form 1099-C. If a federal agency, financial in-
stitution, 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 excep-
tions to the general rule for canceled debt.
These exceptions apply before the exclusions
discussed below.
Price reduced after purchase. If your pur-
chase 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 reduc-
tion 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 ex-
pense. This exception applies before the price
reduction exception discussed above and the
bankruptcy and insolvency exclusions dis-
cussed next.
Example. You get accounting services for
your farm on credit. Later, you have trouble pay-
ing 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 can-
celed debt in income because payment of
the debt would have been deductible as a
business expense.
Accrual method — You include the can-
celed debt in income because the expense
was deductible when you incurred the
debt.
Exclusions
Don't include canceled debt in income in the fol-
lowing situations.
1. The cancellation takes place in a bank-
ruptcy 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 prop-
erty business debt (in the case of a tax-
payer other than a C corporation). See
Pub. 334, chapter 5.
5. The canceled debt is qualified principal
residence indebtedness which is dis-
charged 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 insol-
vent, the exclusions in situations (3) and
(4) don't apply to the extent you're insol-
vent.
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 sit-
uation (2) instead of the exclusion for quali-
fied 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 insol-
vent.
Bankruptcy. A bankruptcy case is a case un-
der title 11 of the U.S. Code if you're under the
jurisdiction of the court and the cancellation of
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Page 14 Chapter 3 Farm Income
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. In-
stead, you must use the amount canceled to re-
duce 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 insol-
vent. 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. Other-
wise, you include the difference in gross in-
come. Use the amount excluded because of in-
solvency to reduce any tax attributes, as
explained below under Reduction of tax attrib-
utes. You must reduce the tax attributes under
the insolvency rules before applying the rules
for qualified farm debt or for qualified real prop-
erty business debt.
Example. You had a $15,000 debt that
wasn't qualified principal residence debt can-
celed outside of bankruptcy. Immediately be-
fore 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 ex-
cluded debt to reduce certain tax attributes.
Order of reduction. You must use the ex-
cluded 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 cancella-
tion, and then any NOL carryover to that
year. Reduce the NOL or NOL carryover
one dollar for each dollar of excluded can-
celed debt.
2. General business credit carryover. Re-
duce the credit carryover to or from the tax
year of the debt cancellation. Reduce the
carryover 3313 cents for each dollar of ex-
cluded canceled debt.
3. Minimum tax credit. Reduce the mini-
mum tax credit available at the beginning
of the tax year following the tax year of the
debt cancellation. Reduce the credit 3313
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 carry-
over 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 cancella-
tion in the following order.
a. Real property (except inventory) used
in your trade or business or held for
investment that secured the canceled
debt.
b. Personal property (except inventory
and accounts and notes receivable)
used in your trade or business or held
for investment that secured the can-
celed debt.
c. Other property (except inventory and
accounts and notes receivable) used
in your trade or business or held for
investment.
d. Inventory and accounts and notes re-
ceivable.
e. Other property.
Reduce the basis one dollar for each
dollar of excluded canceled debt. How-
ever, 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 im-
mediately 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 carry-
overs. 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 ex-
cluded canceled debt. Reduce the credit
carryover 3313 cents for each dollar of ex-
cluded canceled debt.
7. Foreign tax credit. Reduce the credit
carryover to or from the tax year of the
debt cancellation. Reduce the carryover
3313 cents for each dollar of excluded can-
celed debt.
How to make tax attribute reductions.
Always make the required reductions in tax at-
tributes 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 re-
ductions in (2) and (7) earlier, reduce the credit
carryovers to the tax year of the debt cancella-
tion in the order in which they are taken into ac-
count for that year.
Electing to reduce the basis of depreciable
property first. You can elect to apply any por-
tion of the excluded canceled debt first to re-
duce 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 or-
der.
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 invest-
ment 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 pur-
pose means any property subject to deprecia-
tion, but only if a reduction of basis will reduce
the depreciation or amortization otherwise al-
lowable 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 ba-
sis 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 elec-
tion.
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 (ei-
ther the election to reduce basis first or the ba-
sis 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 deprecia-
tion 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 deprecia-
tion 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 be-
cause 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 farm-
ing business.
At least 50% of your total gross receipts for
the 3 tax years preceding the year of debt
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Chapter 3 Farm Income Page 15
cancellation were from your farming busi-
ness.
For more information, see Pub. 4681.
Qualified person. This is a person who is ac-
tively 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 in-
clude any of the following.
A person related to you.
A person from whom you acquired the
property (or a person related to this per-
son).
A person who receives a fee from your in-
vestment in the property (or a person rela-
ted 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 in-
come is limited. It can't be more than the sum of
your adjusted tax attributes and the total adjus-
ted 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 af-
ter taking into account any reduction of tax at-
tributes 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 in-
come.
Adjusted tax attributes. Adjusted tax at-
tributes 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 car-
ryover to that year.
5. Any passive activity loss and credit carry-
overs from the tax year of the debt cancel-
lation. Any credit carryover is multiplied by
3.
6. Any foreign tax credit carryovers to or from
the tax year of the debt cancellation, multi-
plied 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 exclu-
ded canceled debt under the insolvency rules,
you reduce the amount of the tax attributes re-
maining after reduction for the exclusion al-
lowed under the insolvency rules.) You gener-
ally must follow the reduction rules previously
explained under Bankruptcy and Insolvency.
However, don't follow the rules in (5) under Or-
der of reduction, earlier. Instead, follow the spe-
cial rules explained next.
Special rules for reducing the basis of
property. You must use special rules to re-
duce the basis of property for excluded can-
celed qualified farm debt. Under these special
rules, you only reduce the basis of qualified
property (defined earlier). Reduce it in the fol-
lowing 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 exclu-
ded canceled debt to reduce the basis of depre-
ciable 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 exten-
sions) 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 exclu-
ded canceled debt to reduce the basis of depre-
ciable property first, you can still make the elec-
tion by filing an amended return within 6 months
of the due date of the return (excluding exten-
sions). 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 neigh-
bor 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 applica-
ble 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 re-
ceive from the borrower. See chapter 1 of Pub.
550 for more information on below-market
loans.
Commodity futures and options. See Hedg-
ing (Commodity Futures) in chapter 8 for infor-
mation on gains and losses from commodity fu-
tures and options transactions.
Custom hire (machine work). Pay you re-
ceive for contract work or custom work that you
or your hired help perform off your farm for oth-
ers, 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. Re-
port 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 tempo-
rary construction easement is rental income.
Report the income as rent on Part I of Sched-
ule 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 prop-
erly allocated to the part of your land affec-
ted 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, re-
duce 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 equip-
ment movement. This temporary easement is
only for the construction period (usually a pe-
riod of months). The gain is reported on Form
4797 as ordinary income and does not affect
the basis of the land.
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 settle-
ment of $250 for this damage, the $250 is in-
come 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.
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Page 16 Chapter 3 Farm Income
Illegal federal irrigation subsidy. The federal
government, operating through the Bureau of
Reclamation, has made irrigation water from
certain reclamation and irrigation projects avail-
able 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 irri-
gation 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, in-
clude 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 con-
demned. You may have an ordinary or capital
gain if property you own is sold or exchanged,
stolen, destroyed by fire, flood, or other casu-
alty, 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 deduc-
tion. If you took a section 179 expense deduc-
tion 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 deduc-
tion 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, re-
fund, 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 re-
imbursement, refund, or recovery.
Example. A tenant farmer purchased fertil-
izer for $1,000 in April 2016. He deducted
$1,000 on his 2016 Schedule F and the entire
deduction reduced his tax. The landowner reim-
bursed 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 prop-
erty, the proceeds are ordinary income. A rea-
sonable 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 transac-
tion is a sale. You're considered to retain an
economic interest if, under the terms of the le-
gal relationship, you depend on the income de-
rived 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 ordi-
nary income subject to an allowance for deple-
tion. 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 taxa-
ble 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 partner-
ship, or a shareholder in an S corporation. Serv-
ices performed as an employee are disregar-
ded in determining whether an individual is
engaged in a farming business. However, if
you're a shareholder of an S corporation en-
gaged 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 en-
gaged 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 tax-
able 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 de-
velopment rights, grazing rights, and other simi-
lar rights.
Gains or losses from the sale or other dis-
position of farm property. Gains or losses
from the sale or other disposition of farm prop-
erty 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 de-
pends 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 prop-
erty sold within a reasonable time after opera-
tions 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 de-
pends 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 com-
pute tax on an equal portion of each type of in-
come. For example, you can't tax all of the capi-
tal 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.
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Chapter 3 Farm Income Page 17
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 cap-
ital gain or ordinary loss.
The amount of any net operating loss car-
ryover 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 in-
stead of your child's tax rate. For more informa-
tion, 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 informa-
tion 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 com-
pute 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 Sched-
ule J (Form 1040) with your timely filed (includ-
ing 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 ex-
pired 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 stand-
ard 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 expen-
ses you don't have to capitalize or include in in-
ventory 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
Travel, Entertainment, Gift, and Car
Expenses
Business Expenses
Business Use of Your Home
Passive Activity and At-Risk Rules
Home Mortgage Interest Deduction
Form (and Instructions)
Itemized
Deductions
Profit or Loss From
Farming
Application for Tentative Refund
Election To Postpone
Determination as To Whether the
Presumption Applies That an
Activity Is Engaged in for Profit
Domestic Production Activities
Deduction
See chapter 16 for information about getting
publications and forms.
463
535
587
925
936
Sch A (Form 1040)
Sch F (Form 1040)
1045
5213
8903
Deductible Expenses
The ordinary and necessary costs of operating
a farm for profit are deductible business expen-
ses. “Ordinary” means what most farmers do,
and “necessary” means what is useful and help-
ful in farming. Schedule F, Part II, lists some
common farm expenses that are typically de-
ductible. 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 re-
ceived 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 ex-
penses 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, re-
pairs, 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 ex-
penses is deductible on Schedule F.
Example. You paid $1,500 for electricity
during the tax year. You used 13 of the electric-
ity for personal purposes and 23 for farming. Un-
der these circumstances, you can deduct
$1,000 (23 of $1,500) of your electricity expense
as a farm business expense.
Reasonable allocation. It isn't always
easy to determine the business and nonbusi-
ness 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 sup-
plies 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 expen-
ses, your deduction for prepaid farm supplies in
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Page 18 Chapter 4 Farm Business Expenses
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 pre-
paid 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 ex-
cess 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 other-
wise 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 de-
duction 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 ex-
penses 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-sis-
ters, spouse, parents, grandparents, children,
grandchildren, and aunts and uncles and their
children.
Whether or not the deduction limit for
prepaid farm supplies applies, your ex-
penses 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 de-
duct in the year paid the cost of feed your live-
stock will consume in a later year unless you
meet all the following tests.
CAUTION
!
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.
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 de-
posit 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 commit-
ment 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 re-
purchase.
The following are some factors that show a
payment is a deposit rather than for the pur-
chase of feed.
The absence of specific quantity terms.
The right to a refund of any unapplied pay-
ment credit at the end of the contract.
The seller's treatment of the payment as a
deposit.
The right to substitute other goods or prod-
ucts for those specified in the contract.
A provision permitting substitution of ingredi-
ents to vary the particular feed mix to meet your
livestock's current diet requirements won't sug-
gest 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 bene-
fits.
Fixing maximum prices and securing an
assured feed supply.
Securing preferential treatment in anticipa-
tion 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 meaning-
ful.
No material distortion of income. The fol-
lowing are some factors considered in deter-
mining whether deducting prepaid livestock
feed materially distorts income.
Your customary business practice in con-
ducting 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.
CAUTION
!
Labor Hired
You can deduct reasonable wages paid for reg-
ular farm labor, piecework, contract labor, and
other forms of labor hired to perform your farm-
ing operations. You can pay wages in cash or in
noncash items such as inventory, capital as-
sets, 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' com-
pensation insurance, and other benefits.
If you must withhold social security, Medi-
care, 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 secur-
ity 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 em-
ployee pays you anything for the property, de-
duct as wages the fair market value of the prop-
erty minus the payment by the employee for the
property.
Treat the wages deducted as an amount re-
ceived 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 mar-
ket value. Any gain or loss has the same char-
acter the exchanged property had in your
hands. For more information, see chapter 8.
Child as an employee. You can deduct rea-
sonable wages or other compensation you pay
to your child for doing farmwork if a true em-
ployer-employee relationship exists between
you and your child. Include these wages in the
child's income. The child may have to file an in-
come tax return. These wages may also be
subject to social security and Medicare taxes if
your child is age 18 or older. For more informa-
tion, see Family Employees in chapter 13.
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.
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.
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CAUTION
!
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Chapter 4 Farm Business Expenses Page 19
Nondeductible Pay
You can't deduct wages paid for certain house-
hold 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 im-
provement. You must capitalize them.
Maintaining your home. If your farm em-
ployee spends time maintaining or repairing
your home, the wages and employment taxes
you pay for that work are nondeductible per-
sonal expenses. For example, assume you
have a farm employee for the entire tax year
and the employee spends 5% of the time main-
taining 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. Com-
mon items of repair and maintenance are re-
painting, sealing cracks or replacing broken
windows on a farm building, and routine mainte-
nance of trucks, tractors, and other farm machi-
nery. However, expenses for improvements to
depreciable property are generally capital ex-
penditures. 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 sub-
stantial 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 de-
ductible as repairs and maintenance. If you re-
place 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 mainte-
nance. See Regulations section 1.263(a)-3(n)
for more information.
Interest
You can deduct as a farm business expense in-
terest paid on farm mortgages and other obliga-
tions 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 inter-
est paid with funds received from the original
lender through another loan, advance, or other
arrangement similar to a loan. You can, how-
ever, deduct the interest when you start making
payments on the new loan. For more informa-
tion, see Cash Method in chapter 2.
Prepaid interest. Under the cash method,
you generally can't deduct any interest paid be-
fore 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 disburse-
ments to specific uses.
The easiest way to trace disburse-
ments to specific uses is to keep the
proceeds of a particular loan separate
from any other funds.
Secured loan. The allocation of loan pro-
ceeds 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 in-
terest, 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
TIP
the offspring. Also, if you use an accrual
method of accounting, you must capitalize
breeding fees and allocate them to the cost ba-
sis of the calf, foal, etc. For more information on
who must use an accrual method of accounting,
see Accrual Method Required under Account-
ing Methods in chapter 2.
Fertilizer and Lime
You can deduct in the year paid or incurred the
cost of fertilizer, lime, and other materials ap-
plied to farmland to enrich, neutralize, or condi-
tion 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 fertil-
izer or lime, you report the sale amount attribut-
able 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 fed-
eral 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, allo-
cate 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 valua-
tions, you can usually get them from the tax as-
sessor.
State and local general sales taxes. State
and local general sales taxes on nondeprecia-
ble farm business expense items are deductible
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Page 20 Chapter 4 Farm Business Expenses
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 busi-
ness as part of the cost you depreciate. Also
treat the taxes as part of your cost if they are im-
posed 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 de-
duct 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 busi-
ness. 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 busi-
ness experience. However, you can deduct as
an adjustment to income on Form 1040 one-half
of your self-employment tax in figuring your ad-
justed gross income. For more information, see
chapter 12.
Insurance
You generally can deduct the ordinary and nec-
essary 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-re-
lated 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 per-
son with a financial interest in your farm busi-
ness 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 pay-
ments 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 636
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 pre-
mium used each year.
Business interruption insurance. Use and
occupancy and business interruption insurance
premiums are deductible as a business ex-
pense. 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 Sched-
ule 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 pay-
ments for medical, dental, and qualified
long-term care insurance coverage for yourself,
your spouse, and your dependents when figur-
ing 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 partici-
pate in a subsidized health plan maintained by
your employer or your spouse's employer.
Generally, use the Self-Employed Health In-
surance Deduction Worksheet in the Instruc-
tions for Form 1040 to figure your deduction. In-
clude the remaining part of the insurance
payment in your medical expenses on Sched-
ule A (Form 1040) if you itemize your deduc-
tions.
For more information, see Deductible Premi-
ums in Pub. 535, chapter 6.
Rent and Leasing
If you lease property for use in your farm busi-
ness, 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 pay-
ments of rent only in the year to which they ap-
ply, 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 repre-
sent 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 de-
pends 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 pay-
ment toward an equity interest you will re-
ceive.
You get title to the property after you make
a stated amount of required payments.
The amount you must pay to use the prop-
erty 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 op-
tion. 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 agree-
ment.
The agreement designates part of the pay-
ments 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 pay-
ments and the specified option price equal the
sales price of the equipment plus interest. Un-
der 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 de-
duct 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 ad-
justment 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 nonre-
course loan from a third party). For more infor-
mation, 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 busi-
ness is expected to last more than one year,
you generally can't deduct the entire cost in the
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Chapter 4 Farm Business Expenses Page 21
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 de-
duct part or all of the cost of certain qualifying
property, up to a limit, as a section 179 deduc-
tion 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 ex-
clusively 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 princi-
pal place of business for deducting expenses
for its use if you meet both of the following re-
quirements.
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 ex-
penses (including expenses for the business
use of your home), you can deduct all your farm
expenses. But if your gross income from farm-
ing 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 de-
preciation (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 in-
terest, 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 deduc-
tion 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 in-
formation on deducting expenses for the busi-
ness 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-dis-
tance phone calls on that line, as well as the
cost of a second line into your home used ex-
clusively for your farm business, are deductible
business expenses. Cell phone charges for
calls relating to your farm business are deducti-
ble. If the cell phone you use for your farm busi-
ness 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 expen-
ses for business use are deductible. These in-
clude such items as gasoline, oil, repairs, li-
cense tags, insurance, and depreciation
(subject to certain limits).
Standard mileage rate. Instead of using ac-
tual costs, under certain conditions you can use
the standard mileage rate. The standard mile-
age rate for each mile of business use is 53.5
cents in 2017. You can use the standard mile-
age 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 ve-
hicles 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 busi-
ness. 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 vehi-
cles.
Business use percentage. You can claim
75% of the use of a car or light truck as busi-
ness use without any records if you used the
vehicle during most of the normal business day
directly in connection with the business of farm-
ing. 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 follow-
ing are uses directly connected with the busi-
ness 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 require-
ments 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 busi-
ness, see Reimbursements to employees under
Travel Expenses next.
Travel Expenses
You can deduct ordinary and necessary expen-
ses 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 ordi-
nary 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 travel-
ing 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 infor-
mation 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.
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 sup-
port each element of an expense. Generally, it
is best to record the expense and get documen-
tation of it at the time you pay it.
If you choose to deduct a standard meal al-
lowance 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.
RECORDS
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Page 22 Chapter 4 Farm Business Expenses
More information. For detailed information on
travel, recordkeeping, and the standard meal al-
lowance, see Pub. 463.
Reimbursements to employees. You gener-
ally can deduct reimbursements you pay to your
employees for travel and transportation expen-
ses they incur in the conduct of your business.
Employees may be reimbursed under an ac-
countable 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 reim-
bursements 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 Sched-
ule F penalties you pay for marketing crops in
excess of farm marketing quotas. However, if
you don't pay the penalty, but instead the pur-
chaser 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 ten-
ant 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 ac-
counting. 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 com-
mercial egg production, or for raising and re-
sale, 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 fur-
ther 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 ac-
counting. In 2017, you buy 500 baby chicks to
raise for resale in 2018. You also buy 50 bush-
els 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 informa-
tion, 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 deduct-
ing 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 Account-
ing 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 expen-
ses must be for business purposes and
(1) paid, if you use the cash method of account-
ing, 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 im-
prove 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 prop-
erty. 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 de-
duct 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 in-
come attributable to domestic production activi-
ties. You can deduct 9% of the lesser of your
qualified production activities income or your
taxable income (adjusted gross income for indi-
viduals) for the tax year. Your deduction is limi-
ted to 50% of the Form W-2 wages you paid for
the tax year that are properly allocable to do-
mestic production gross receipts.
For this purpose, Form W-2 wages don't in-
clude noncash wages paid for agricultural labor,
such as compensation paid as commodities.
Also, excluded from Form W-2 wages are wa-
ges paid to your children under age 18 and non-
taxable 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 ex-
traction in whole or in significant part of any ag-
ricultural or horticultural product or in the mar-
keting 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 por-
tion of the domestic production activities deduc-
tion.
More information. For more information on
the domestic production activities deduction,
see the Instructions for Form 8903.
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Chapter 4 Farm Business Expenses Page 23
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 deducti-
ble, but they may be depreciable. However, you
can elect to deduct certain capital expenses,
such as the following.
The cost of fertilizer, lime, etc. (See Fertil-
izer and Lime under Deductible Expenses,
earlier.)
Soil and water conservation expenses.
(See chapter 5.)
The cost of property that qualifies for a de-
duction under section 179. (See chap-
ter 7.)
Business start-up costs. (See Business
start-up and organizational costs, later.)
Forestation and reforestation costs. (See
Forestation and reforestation costs, later.)
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, in-
crease their value, or adapt them to differ-
ent use.
8. Water wells, including drilling and equip-
ping costs.
9. Land preparation costs, such as:
a. Clearing land for farming,
b. Leveling and conditioning land,
c. Purchasing and planting trees,
d. Building irrigation canals and ditches,
e. Laying irrigation pipes,
f. Installing drain tile,
g. Modifying channels or streams,
h. Constructing earthen, masonry, or
concrete tanks, reservoirs, or dams,
and
i. Building roads.
Business start-up and organizational costs.
You can elect to deduct up to $5,000 of busi-
ness start-up costs and $5,000 of organiza-
tional 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 in-
formation.
You elect to deduct start-up or organiza-
tional costs by claiming the deduction on the in-
come 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 or-
ganizational 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 re-
quired to capitalize the de minimis costs of ac-
quiring 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 cap-
italize 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 in-
formation, 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 refor-
estation costs. See Forestation and reforesta-
tion costs next. Reforestation costs include the
following.
1. Site preparation costs, such as:
a. Girdling,
b. Applying herbicide,
c. Baiting rodents, and
d. Clearing and controlling brush.
2. The cost of seed or seedlings.
3. Labor and tool expenses.
4. Depreciation on equipment used in plant-
ing or seeding.
5. Costs incurred in replanting to replace lost
seedlings.
You can choose to capitalize certain indirect re-
forestation 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 chap-
ter 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 quali-
fying 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 qualify-
ing 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 am-
ortization 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, availa-
ble at IRS.gov/irb/2006-20_IRB/ar11.html.
You elect to deduct forestation and refores-
tation costs by claiming the deduction on the in-
come tax return filed by the due date (including
extensions) for the tax year in which the expen-
ses 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 dur-
ing the tax year.
The nature of the reforestation treatments.
The total amounts of the qualified refores-
tation 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 re-
turn within 6 months of the due date of the re-
turn (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 re-
turn at the same address you filed the original
return.
For more information about forestation and
reforestation costs, see chapter 7.
For more information about timber, see
Agriculture Handbook Number 731,
Forest Landowners' Guide to the Fed-
eral 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.
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Page 24 Chapter 4 Farm 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 deter-
minable 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 cer-
tain 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 pre-
miums 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 re-
payment of a loan. However, if you use the pro-
ceeds of a loan for farm business expenses,
you can deduct the interest on the loan. See In-
terest, earlier.
Estate, inheritance, legacy, succession,
and gift taxes. You can't deduct estate, inheri-
tance, legacy, succession, and gift taxes.
Loss of livestock. You can't deduct as a loss
the value of raised livestock that die if you de-
ducted 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 de-
scendant. 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, in-
cluding 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 exam-
ple, 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 pur-
pose. This includes country clubs, golf and ath-
letic clubs, hotel clubs, sporting clubs, airline
clubs, and clubs operated to provide meals un-
der circumstances generally considered to be
conducive to business discussions.
Exception. The following organizations
won't be treated as a club organized for busi-
ness, pleasure, recreation, or other social pur-
poses, 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 op-
eration 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.
If you don't carry on your farming activ-
ity 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 activi-
ties, including farming. These rules limit the los-
ses 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 ac-
tivity.
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:
a. You are personally liable for repay-
ment, or
b. You pledge property (other than prop-
erty 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 per-
son who has an interest in the activity (other
than as a creditor) or a person related to some-
one (other than you) having such an interest.
For more information, see Pub. 925.
Passive Activity Limits
A passive activity is generally any activity in-
volving the conduct of any trade or business in
which you don't materially participate. Gener-
ally, 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 activi-
ties. Credits are similarly limited.
For more information, see Pub. 925.
Excess Farm Loss Limit
Excess farm losses (defined below) aren't de-
ductible if you received certain applicable subsi-
dies. This limit applies to any farming busi-
nesses, 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 los-
ses by reason of disease or drought are disre-
garded for purposes of figuring this limitation.
Also, the limitation on farm losses should be ap-
plied 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
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Chapter 4 Farm Business Expenses Page 25
exceeds the amount of the limitation (as descri-
bed 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 trea-
ted 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 car-
rying on the business of farming on Schedule F.
However, if you don't carry on your farming ac-
tivity, 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 de-
duct expenses of carrying on the activity only if
you itemize your deductions on Schedule A
(Form 1040). Also, there is a limit on the deduc-
tions you can take. You can't use a loss from
that activity to offset income from other activi-
ties.
Activities you do as a hobby, or mainly for
sport or recreation, come under this limit. An in-
vestment 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 deci-
sive. 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 be-
yond 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 pro-
duced 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, pre-
sume 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 al-
lowed by the test.
You can choose to do this by filing Form
5213. Filing this form postpones any determina-
tion 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 ac-
tivity, or, if earlier, within 60 days after receiving
a written notice from the IRS proposing to disal-
low 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 deduc-
tions. 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 de-
ductions aren't limited under these rules. If you
don't have 3 (or 2) years of profit (and can't oth-
erwise 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 ac-
tivity 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 Sched-
ule 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 informa-
tion. For the limits that apply to mortgage inter-
est, see Pub. 936.
Category 2. Deductions that don't result in
an adjustment to the basis of property are al-
lowed next, but only to the extent your gross in-
come from the activity is more than the deduc-
tions 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 de-
crease 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 cate-
gory. Where more than one asset is involved,
divide depreciation and these other deductions
proportionally among those assets.
Individuals must claim the amounts in
categories (2) and (3) above as miscel-
laneous deductions on Schedule A
(Form 1040). They are subject to the 2%-of-ad-
justed-gross-income limit. See Pub. 529, for in-
formation on this limit.
Partnerships and S corporations. If a part-
nership or S corporation carries on a
not-for-profit activity, these limits apply at the
partnership or S corporation level. They are re-
flected in the individual shareholder's or part-
ner's distributive shares.
More information. For more information on
not-for-profit activities, see Not-for-Profit Activi-
ties 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 farm-
ing, or
TIP
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Page 26 Chapter 5 Soil and Water Conservation Expenses
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 agricul-
tural crop that may also conserve soil.
You must include in income most govern-
ment payments for approved conservation
practices. However, you can exclude some
payments you receive under certain cost-shar-
ing conservation programs. For more informa-
tion, see Agricultural Program Payments in
chapter 3.
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 ex-
penses 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 ex-
penses, 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 en-
gaged only in forestry or the growing of timber.
Farm defined. A farm includes livestock, dairy,
poultry, fish, fruit, and truck farms. It also in-
cludes plantations, ranches, ranges, and or-
chards. 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 har-
vested. A plant nursery is a farm for purposes of
deducting soil and water conservation expen-
ses.
Farm rental. If you own a farm and receive
farm rental payments based on farm produc-
tion, 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 produc-
TIP
tion, you can't deduct soil and water conserva-
tion 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 partici-
pate 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 pro-
ducing 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 participa-
tion for landlords under Landlord Participation in
Farming in chapter 12.
Plan Certification
You can deduct soil and water conservation ex-
penses only if they are consistent with a plan
approved by the Natural Resources Conserva-
tion Service (NRCS) of the Department of Agri-
culture. 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 in-
cludes the farming conservation practices ap-
proved for the area where your farmland is loca-
ted. There are three types of approved plans.
NRCS individual site plans. These plans
are issued individually to farmers who re-
quest 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 ap-
proved 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. Indi-
vidual 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 in-
clude, but are not limited to, the following.
1. The treatment or movement of earth, such
as:
a. Leveling,
b. Conditioning,
c. Grading,
d. Terracing,
e. Contour furrowing, and
f. Restoration of soil fertility.
2. The construction, control, and protection
of:
a. Diversion channels;
b. Drainage ditches;
c. Irrigation ditches;
d. Earthen dams; and
e. Watercourses, outlets, and ponds.
3. The eradication of brush.
4. The planting of windbreaks.
You can't deduct expenses to drain or fill wet-
lands, or to prepare land for center pivot irriga-
tion systems, as soil and water conservation ex-
penses. These expenses are added to the
basis of the land.
If you choose to deduct soil and water
conservation expenses, you must in-
clude as gross income any cost-shar-
ing 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 ac-
quired the land, soil and water conservation ex-
penses you incur on it will be treated as made
on land used in farming at the time the expen-
ses 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 conserva-
tion 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 gen-
erally can't deduct your expenses for deprecia-
ble conservation assets. However, you can de-
duct certain amounts you pay or incur for an
assessment for depreciable property that a soil
and water conservation or drainage district lev-
ies against your farm. See Assessment for De-
preciable Property, later.
You must capitalize expenses to buy, build,
install, or improve depreciable structures or fa-
cilities. These expenses include those for mate-
rials, supplies, wages, fuel, hauling, and moving
dirt when making structures such as tanks, res-
ervoirs, pipes, culverts, canals, dams, wells, or
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Chapter 5 Soil and Water Conservation Expenses Page 27
pumps composed of masonry, concrete, tile (in-
cluding drainage tile), metal, or wood. You re-
cover your capital investment through annual al-
lowances 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 agri-
cultural purposes as a soil and water conserva-
tion expense. It is a capital expense. You re-
cover your cost through depreciation. You also
must capitalize your cost for drilling a test hole.
If the test hole produces no water and you con-
tinue drilling, the cost of the test hole is added
to the cost of the producing well. You can re-
cover the total cost through depreciation deduc-
tions.
If a test hole, dry hole, or dried-up well (re-
sulting from prolonged lack of rain, for instance)
is abandoned, you can deduct your unrecov-
ered cost in the year of abandonment. Aban-
donment 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 expen-
ses. 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 manage-
ment 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 expen-
ses. You can deduct as a conservation expense
amounts you pay or incur for the part of an as-
sessment 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 ex-
pense 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, con-
crete structures (including dams and weir
gates), draglines, and similar equipment. The
depreciable property must be used in the dis-
trict's soil and water conservation activities.
However, the following limits apply to these as-
sessments.
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 ex-
penses is then subject to the 25% of gross in-
come from farming limit on the deduction,
discussed later. See Table 5-1 for a brief sum-
mary of these limits.
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 ap-
plies 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 conserva-
tion expense deduction for each year is also
subject to the 25% of gross income from farm-
ing 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 ex-
pense as if you had paid it directly. The remain-
ing $900 is for depreciable equipment to be
used in the district's irrigation activities. The to-
tal amount assessed by the district against all
its members for the depreciable equipment is
$7,000.
The total amount you can deduct for the de-
preciable equipment is limited to 10% of the to-
tal amount assessed by the district against all
its members for depreciable equipment, or
$700. The $200 excess ($900 − $700) is a capi-
tal expense you must add to the basis of your
farm.
To figure the maximum amount you can de-
duct for the depreciable equipment this year,
multiply your deductible share of the total as-
sessment ($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 de-
duct only $70 of the amount you paid or incur-
red 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 as-
sessment for drainage ditches. You can deduct
$1,570 of the $2,400 assessment as a soil and
TIP
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.
Table 5-1.
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Page 28 Chapter 5 Soil and Water Conservation Expenses
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 as-
sessment 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 depre-
ciable 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 as-
sessment, $55, plus $500). Since your deducti-
ble share is less than the maximum amount de-
ductible in one year, you can deduct the entire
$550 this year. You can deduct the entire as-
sessment, $2,400, as a soil and water conser-
vation expense this year, subject to the 25% of
gross income from farming limit on the deduc-
tion, 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 ex-
penses 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 re-
maining amounts not yet deducted are deduc-
ted 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 dis-
position 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 in-
come 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 deducti-
ble in 2017, subject to the limit of 25% of your
gross income from farming in 2017. Any expen-
ses 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 an-
other year, the soil and water conservation de-
duction 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 conser-
vation expenses, you must deduct the total al-
lowable 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 ap-
proval 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 infor-
mation.
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 conserva-
tion expenses or only to those for a particu-
lar project or farm. If the method or change
of method doesn't apply to all your expen-
ses, 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 sepa-
rately in your books for the expenses to
which this method or change of method re-
lates.
Send your request to the following ad-
dress.
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 expen-
ses (except for deductions of assessments for
depreciable property, discussed earlier). How-
ever, if you acquire another farm and return to
the business of farming, you can start taking de-
ductions 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 speci-
fied 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 casu-
alty 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 de-
ductions for depreciation, or casualty losses, or
claim certain credits, reduce your basis.
Keep accurate records of all items that
affect the basis of your assets. For in-
formation 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
Business Expenses
Sales and Other Dispositions of
Assets
Basis of Assets
How To Depreciate Property
See chapter 16 for information about getting
publications and forms.
RECORDS
535
544
551
946
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Chapter 6 Basis of Assets Page 29
Cost Basis
The basis of property you buy is usually its cost.
Cost is the amount you pay in cash, debt obli-
gations, 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 in-
clude interest payments. However, see Carry-
ing charges and Capitalized interest in chap-
ter 4 of Pub. 535.
You also may have to capitalize (add to ba-
sis) certain other costs related to buying or pro-
ducing property. Under the uniform capitaliza-
tion 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 gener-
ally have unstated interest if your interest rate is
less than the applicable federal rate. See the
discussion of unstated interest in Pub. 537, In-
stallment 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 prop-
erty. Some of these expenses are discussed
next.
Lump sum purchase. If you buy improve-
ments, such as buildings, and the land on which
they stand for a lump sum, allocate your cost
basis between the land and improvements. Al-
locate the cost basis according to the respec-
tive 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 hav-
ing to buy or sell, and both having reasonable
knowledge of all necessary facts. Sales of simi-
lar property on or about the same date may help
in figuring the FMV of the property.
If you are not certain of the FMV of the
land and improvements, you can allo-
cate the basis according to their as-
sessed 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
TIP
that amount as a tax expense in the year of pur-
chase. Whether or not you reimburse the seller,
do not include that amount in the basis of your
property.
Settlement costs. Your basis includes the set-
tlement 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 pay-
ment of items such as taxes and insurance.
Points. If you pay points to get a loan (includ-
ing 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 prop-
erty 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 as-
set, do not deduct the following expenses. You
must capitalize them by including these expen-
ses 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 materi-
als used in the construction.
Do not include the value of your own la-
bor, 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 ba-
sis 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 allo-
cation of basis.
CAUTION
!
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 fig-
ure 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 con-
tract 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 alloca-
tion generally will be accepted.
Farming business acquired. If you buy a
group of assets that makes up a farming busi-
ness, there are special rules you must use to al-
locate 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 Ac-
quired 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 alloca-
ted 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 inven-
tory 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 dis-
pose of the property.
Generally, you are subject to the uniform
capitalization rules if you do any of the follow-
ing.
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 pre-
ceding the current tax year are $10 million
or less.
You produce property if you construct, build,
install, manufacture, develop, improve, or cre-
ate the property.
You are not subject to the uniform capi-
talization rules if the property is pro-
duced for personal use.
In a farming business, you produce property
if you raise or grow any agricultural or horticul-
tural 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.
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Page 30 Chapter 6 Basis of Assets
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, seed-
ling, 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 pe-
riod costs include the costs of items such as
feed, maintaining pasture or pen areas, breed-
ing, 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 cor-
poration, partnership, or tax shelter required to
use an accrual method of accounting. See Ac-
crual Method Required under Accounting Meth-
ods in chapter 2.
In addition, you can elect not to use the uni-
form capitalization rules for plants with a prepro-
ductive period of more than 2 years. If you
make this election, special rules apply. This
election cannot be made by a corporation, part-
nership, or tax shelter required to use an ac-
crual method of accounting. This election also
does not apply to any costs incurred for the
planting, cultivation, maintenance, or develop-
ment of any citrus or almond grove (or any part
thereof) within the first 4 years the trees were
planted.
If you elect not to use the uniform capi-
talization rules, you must use the alter-
native depreciation system for all prop-
erty 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 addi-
tional information on depreciation.
Example. You grow trees that have a pre-
productive period of more than 2 years. The
trees produce an annual crop. You are an indi-
vidual 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 na-
tionwide weighted average preproductive pe-
riod of more than 2 years. Other plants (not
CAUTION
!
shown in Table 6-1) may also have a nation-
wide 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.
Adjusted Basis
Before figuring gain or loss on a sale, ex-
change, or other disposition of property or figur-
ing allowable depreciation, depletion, or amorti-
zation, 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 prop-
erty.
Increases to Basis
Increase the basis of any property by all items
properly added to a capital account. These in-
clude 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 as-
sessment 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. How-
ever, you can deduct as taxes amounts as-
sessed for maintenance or repairs, or for
meeting interest charges related to the im-
provements.
If you make additions or improvements to
business property, depreciate the basis of each
addition or improvement as separate deprecia-
ble property using the rules that would apply to
the original property if you had placed it in serv-
ice 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 cur-
rent expenses. For example, amounts paid for
incidental repairs or maintenance are deducti-
ble as business expenses and are not added to
basis. However, you can elect either to deduct
or to capitalize certain other costs. See chap-
ter 7 in Pub. 535.
Note. Generally, you can deduct amounts
paid for repairs and maintenance to your tangi-
ble property if the amounts paid are not other-
wise 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 expen-
ditures, 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 Regula-
tions section 1.263(a)-3(n). If you timely filed
your return for the year without making the elec-
tion, 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 allowa-
ble for amortization, depreciation, and de-
pletion.
Alternative motor vehicle credit. See Form
8910.
Alternative fuel vehicle refueling property
credit. See Form 8911.
Residential energy efficient property cred-
its. 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 en-
ergy conservation measures.
Certain canceled debt excluded from in-
come.
Rebates from a manufacturer or seller.
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
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Chapter 6 Basis of Assets Page 31
Patronage dividends received from a co-
operative association as a result of a pur-
chase of property. See Patronage Divi-
dends 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 deduc-
tion 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, de-
crease the basis of the property by the deduc-
tion.
Depreciation. Decrease the basis of prop-
erty 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 de-
duction, 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 deprecia-
tion you must capitalize under the uniform capi-
talization rules.
Casualty and theft losses. If you have a
casualty or theft loss, decrease the basis in
your property by any insurance or other reim-
bursement and by any deductible loss not cov-
ered by insurance. See chapter 11 for informa-
tion 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 sub-
stantially prolong the life of the property, in-
crease its value, or adapt it to a different use.
To make this determination, compare the re-
paired property to the property before the casu-
alty. For more information on casualty and theft
losses, see Pub. 547.
Easements. The amount you receive for grant-
ing 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 rec-
ognized gain. See Easements and rights-of-way
in chapter 3.
Exclusion from income of subsidies for en-
ergy conservation measures. You can ex-
clude from gross income any subsidy you re-
ceived from a public utility company for the
purchase or installation of an energy conserva-
tion measure for a dwelling unit. Reduce the ba-
sis 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 in-
clude the canceled amount in your gross in-
come for tax purposes. A debt includes any in-
debtedness 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 (pro-
vided 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 nondeprecia-
ble property. If you exclude canceled debt de-
scribed 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 insol-
vency 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 adjus-
ted basis of property may be used. Examples
are discussed next.
Property changed from personal to busi-
ness 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 re-
ceive property for services, include the proper-
ty's FMV in income. The amount you include in
income becomes your basis. If the services
were performed for a price agreed on before-
hand, 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 ac-
counting 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 recog-
nized 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 ex-
changed. 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 tax-
able 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 ex-
change, its basis is usually the same as the ba-
sis of the property you transferred.
Involuntary Conversions
If you receive property as a result of an involun-
tary conversion, such as a casualty, theft, or
condemnation, figure the basis of the replace-
ment property you receive using the basis of the
converted property.
Similar or related property. If the replace-
ment property is similar or related in service or
use to the converted property, the replacement
property's basis is the same as the old proper-
ty's basis on the date of the conversion. How-
ever, make the following adjustments.
1. Decrease the basis by the following
amounts.
a. Any loss you recognize on the invol-
untary conversion.
b. Any money you receive that you do
not spend on similar property.
2. Increase the basis by the following
amounts.
a. Any gain you recognize on the invol-
untary conversion.
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Page 32 Chapter 6 Basis of Assets
b. Any cost of acquiring the replacement
property.
Money or property not similar or related. If
you receive money or property not similar or re-
lated in service or use to the converted property
and you buy replacement property similar or re-
lated in service or use to the converted prop-
erty, 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 Non-
taxable Exchange under Figuring Depreciation
Under MACRS in chapter 7.
For more information about involuntary con-
versions, see chapter 11.
Like-Kind Exchanges
The exchange of property for the same kind of
property is the most common type of nontaxa-
ble exchange.
For an exchange to qualify as a like-kind ex-
change, you must hold for business or invest-
ment 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 chap-
ter 8.
The basis of the property you receive gener-
ally 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 ex-
change, 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 tra-
ded.
Example 2. You trade a field cultivator (ad-
justed 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 commis-
sions, 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 ba-
sis 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 ba-
sis 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 indi-
rectly 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 de-
ductible under the related party rules. Each per-
son 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 prop-
erty exchange. For information on figuring ba-
sis, see Multiple Property Exchanges in chap-
ter 1 of Pub. 544.
Basis for depreciation. Special rules apply in
determining and depreciating the basis of
MACRS property acquired in a like-kind trans-
action. For more information, see Figuring the
Deduction for Property Acquired in a Nontaxa-
ble Exchange under Figuring Depreciation Un-
der 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 adjust-
ments.
1. Decrease the basis by the following
amounts.
a. Any money you receive.
b. Any loss you recognize on the ex-
change.
2. Increase the basis by the following
amounts.
a. Any additional costs you incur.
b. Any gain you recognize on the ex-
change.
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). In-
clude 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 ba-
sis 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 in-
come (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 ex-
change. The rest is the basis of the like-kind
property.
Example. You traded a tractor with an ad-
justed 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 real-
ized a gain of $17,500. This is the FMV of the
tractor received plus the FMV of the truck re-
ceived plus the cash minus the adjusted basis
of the tractor you traded ($92,500 + $19,000 +
$1,000 − $95,000). You include in income (rec-
ognize) 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
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Chapter 6 Basis of Assets Page 33
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 depreci-
ating 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. Be-
cause the two transactions are dependent on
each other, you are treated as having ex-
changed 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 adjus-
ted 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 deduc-
tions 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 Ba-
sis, earlier.
If you received a gift during the tax year, in-
crease your basis in the gift (the donor's adjus-
ted basis) by the part of the gift tax paid on it
due to the net increase in value of the gift. Fig-
ure 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 ba-
sis. The amount of the gift is its value for gift tax
purposes after reduction by any annual exclu-
sion and marital or charitable deduction that ap-
plies 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 ba-
sis) 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 de-
pends 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 figur-
ing loss is its FMV when you received the gift
plus or minus any required adjustments to basis
while you held the property. (See Adjusted Ba-
sis, earlier.)
If you use the donor's adjusted basis for fig-
uring 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 dispo-
sition of the property.
Example. You received farmland as a gift
from your parents when they retired from farm-
ing. 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 de-
crease 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 deduc-
tions 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 prop-
erty 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 Settle-
ments in Pub. 504, Divorced or Separated Indi-
viduals.
Inherited Property
Your basis in property you inherited from a de-
cedent 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 infor-
mation 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 per-
sonal representative values the qualified real
property based on its use as a farm or other
closely held business. If the executor or per-
sonal representative elects this method of valu-
ation 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 neces-
sary value from the executor or personal repre-
sentative of the estate.
If you are a qualified heir who received spe-
cial-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 al-
ternate 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 de-
cedent, 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 conver-
sion 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 spe-
cial-use valuation property if it becomes subject
to the additional estate tax. To increase your
basis, you must make an irrevocable election
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Page 34 Chapter 6 Basis of Assets
and pay interest on the additional estate tax fig-
ured from the date 9 months after the dece-
dent's death until the date of payment of the ad-
ditional estate tax. If you meet these
requirements, increase your basis in the prop-
erty to its FMV on the date of the decedent's
death or the alternate valuation date. The in-
crease in your basis is considered to have oc-
curred immediately before the event that resul-
ted in the additional estate tax.
You make the election by filing, with Form
706-A, United States Additional Estate Tax Re-
turn, a statement that:
Contains your (and the estate's) name, ad-
dress, 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 re-
quired by the Form 706-A instructions.
For more information, see Form 706, United
States Estate (and Generation-Skipping Trans-
fer) Tax Return, Form 706-A, and the related in-
structions.
Property Distributed From a
Partnership or Corporation
The following rules apply to determine a part-
ner's basis and a shareholder's basis in prop-
erty distributed respectively from a partnership
to the partner with respect to the partner's inter-
est in the partnership and from a corporation to
the shareholder with respect to the sharehold-
er'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 distribu-
tion. 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 un-
der Section 179 Expense Deduction, later.
What’s New for 2018
Phase down of the special depreciation al-
lowance. 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 prop-
erty 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 deprecia-
tion 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
Travel, Entertainment, Gift, and Car
Expenses
Depreciating Property Placed in
Service Before 1987
Business Expenses
Sales and Other Dispositions of
Assets
Basis of Assets
How To Depreciate Property
Form (and Instructions)
(Timber), Forest Activities Schedule
Application for Change in
Accounting Method
Depreciation and Amortization
Sales of Business Property
See chapter 16 for information about getting
publications and forms.
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 Busi-
ness and Keeping Records. For specific infor-
mation 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 de-
preciation.
What is the basis of your depreciable prop-
erty.
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 prop-
erty (except land), such as buildings, machi-
nery, equipment, vehicles, certain livestock,
and furniture. You can also depreciate certain
intangible property, such as copyrights, patents,
and computer software. To be depreciable, the
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535
544
551
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T
3115
4562
4797
RECORDS
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Chapter 7 Depreciation, Depletion, and Amortization Page 35
property must meet all the following require-
ments.
It must be property you own.
It must be used in your business or in-
come-producing activity.
It must have a determinable useful life.
It must have a useful life that extends sub-
stantially 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 own-
ership 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, de-
preciate any capital improvements you make to
the leased property. See Additions and Im-
provements under Which Recovery Period Ap-
plies in chapter 4 of Pub. 946.
You generally can depreciate the cost of
property you lease to someone even if the les-
see (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 ac-
tivity. If you use property to produce income (in-
vestment 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 purpo-
ses 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 depre-
ciate 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 deprecia-
tion on that part based on its business use. For
more information, see Business Use of Your
Home in chapter 4.
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 can-
not 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 de-
ducted and not added to their basis. However,
see Immature livestock under When Does De-
preciation 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. Irriga-
tion systems and wells used in a trade or busi-
ness can be depreciated if their useful life can
be determined. You can depreciate irrigation
systems and wells composed of masonry, con-
crete, 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. How-
ever, land preparation costs for center pivot irri-
gation systems are not depreciable.
Dams, ponds, and terraces. In general, you
cannot depreciate earthen dams, ponds, and
terraces unless the structures have a determi-
nable 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, be-
come obsolete, or get used up. The cost of
land generally includes the cost of clear-
ing, grading, planting, and landscaping. Al-
though you cannot depreciate land, you
can depreciate certain costs incurred in
preparing land for business use. See chap-
ter 1 of Pub. 946.
Property placed in service and disposed of
in the same year. Determining when prop-
erty is placed in service is explained later.
Equipment used to build capital improve-
ments. You must add otherwise allowable
depreciation on the equipment during the
TIP
period of construction to the basis of your
improvements.
Intangible property such as section 197 in-
tangibles. This property does not have a
determinable useful life and generally can-
not be depreciated. However, see Amorti-
zation, later. Special rules apply to com-
puter 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 depre-
ciation allowance (if applicable), discussed
later.
Certain term interests in property. You can-
not depreciate a term interest in property cre-
ated or acquired after July 27, 1989, for any pe-
riod 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 chap-
ter 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 hap-
pens 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 De-
cember 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 speci-
fied use. You begin to depreciate it in 2017.
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Page 36 Chapter 7 Depreciation, Depletion, and Amortization
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 pre-
productive-period costs under the uniform capi-
talization rules (unless you elect not to use
these rules). See chapter 6 for information
about the uniform capitalization rules. Your de-
preciation begins when the trees and vines
reach the income-producing stage (that is,
when they bear fruit, nuts, or grapes in quanti-
ties sufficient to commercially warrant harvest-
ing). For information on claiming the special de-
preciation allowance for certain specified plants
bearing fruits and nuts, see Certain specified
plants, later.
Immature livestock. Depreciation for live-
stock begins when the livestock reaches the
age of maturity. If you bought immature live-
stock for drafting purposes, depreciation begins
when they can be worked. If you bought imma-
ture 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 pro-
duction of income even if it is temporarily idle.
For example, if you stop using a machine be-
cause 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 recov-
ered 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 prop-
erty, see chapter 8. For information on de-
stroyed 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 deter-
mine 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 prop-
erty 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 be-
tween 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 prop-
erty by the depreciation allowed or allowable,
whichever is greater. Depreciation allowed is
depreciation you actually deducted (from which
you received a tax benefit). Depreciation allow-
able is depreciation you are entitled to deduct.
If you do not claim depreciation you are enti-
tled 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 better-
ment to the property, restores the property, or
adapts it to a new or different use. See Regula-
tions 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 prop-
erty, 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 informa-
tion.
Example. You repair a small section on a
corner of the roof of a barn that you rent to oth-
ers. You deduct the cost of the repair as a busi-
ness expense. However, if you replace the en-
tire roof, the new roof is considered to be an
improvement because it increases the value
and lengthens the life for the property. You de-
preciate 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 de-
preciation 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 cur-
rent year.
For more information, see the Instructions
for Form 4562.
How Do You Correct
Depreciation Deductions?
If you deducted an incorrect amount of depreci-
ation 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 ex-
ample, omitting an asset from the depreci-
ation schedule.
You have not adopted a method of ac-
counting for the property placed in service
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Chapter 7 Depreciation, Depletion, and Amortization Page 37
by you in tax years ending after December
29, 2003.
You claimed the incorrect amount on prop-
erty placed in service by you in tax years
ending before December 30, 2003.
Note. You have adopted a method of account-
ing 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 Instruc-
tions 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 de-
ducting it in the year you place the property in
service. This is the section 179 expense deduc-
tion. You can elect the section 179 expense de-
duction 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 deduc-
tion, 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 deduc-
tion, 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 deduc-
tion, 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:
a. An integral part of manufacturing, pro-
duction, or extraction or of furnishing
transportation, communications, elec-
tricity, gas, water, or sewage disposal
services;
b. A research facility used in connection
with any of the activities in (a) above;
or
c. A facility used in connection with any
of the activities in (a) for the bulk stor-
age of fungible commodities.
3. Single purpose agricultural (livestock) or
horticultural structures.
4. Storage facilities (except buildings and
their structural components) used in con-
nection with distributing petroleum or any
primary product of petroleum.
5. Qualified real property. (Special rules ap-
ply to qualified real property that you elect
to treat as qualified section 179 real prop-
erty. For more information, see chapter 2
of Pub. 946, and section 179(f) of the In-
ternal Revenue Code.)
6. Off-the-shelf computer software that is
readily available for purchase by the gen-
eral public, is subject to a nonexclusive
lease, and has not been substantially
modified.
Tangible personal property. Tangible per-
sonal property is any tangible property that is
not real property. It includes the following prop-
erty.
Machinery and equipment.
Property contained in or attached to a
building (other than structural compo-
nents), such as milk tanks, automatic feed-
ers, 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-bear-
ing animals.
Facility used for the bulk storage of fungi-
ble commodities. A facility used for the bulk
storage of fungible commodities is qualifying
property for purposes of the section 179 ex-
pense 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 (live-
stock) or horticultural structure is qualifying
property for purposes of the section 179 ex-
pense 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 re-
placements, 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 pro-
duce 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 live-
stock.
Horticultural structure. A single purpose
horticultural structure is either of the following.
A greenhouse specifically designed, con-
structed, and used for the commercial pro-
duction of plants.
A structure specifically designed, construc-
ted, and used for the commercial produc-
tion of mushrooms.
Use of structure. A structure must be used
only for the purpose that qualified it. For exam-
ple, 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 activi-
ties.
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 deduc-
tion, your property must have been acquired by
purchase. For example, property acquired by
gift or inheritance does not qualify. Property ac-
quired 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 de-
duction.
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 pur-
chased 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 per-
son (as defined above).
What Property Does Not
Qualify?
Land and improvements. Land and land im-
provements do not qualify as section 179 prop-
erty. 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 quali-
fies 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 fur-
nish lodging or in connection with the fur-
nishing of lodging.
Property used by a tax-exempt organiza-
tion (other than a tax-exempt farmers' co-
operative) unless the property is used
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Page 38 Chapter 7 Depreciation, Depletion, and Amortization
mainly in a taxable unrelated trade or busi-
ness.
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 gener-
ally the cost of the qualifying property. How-
ever, 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 qualify-
ing property as a section 179 expense deduc-
tion, you can generally depreciate the cost you
do not deduct.
Use Part I of Form 4562 to figure your sec-
tion 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 qualify-
ing 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 sec-
tion 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 cultiva-
tors 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 cultiva-
tors 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 busi-
ness costs that qualify for a section 179 ex-
pense deduction are $35,200 ($5,200 +
$30,000). For information on the maximum
amount you can elect to deduct, see Dollar Lim-
its 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 prop-
erty during the year, you can allocate the sec-
tion 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 sec-
tion 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 dol-
lar 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 Au-
tomobile Limits Apply, later.
Married individuals. If you are married, how
you figure your section 179 expense deduction
depends on whether you file jointly or sepa-
rately. If you file a joint return, you and your
spouse are treated as one taxpayer in determin-
ing 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 tax-
payer for the dollar limit, including the reduction
for costs over $2,030,000. You must allocate
the dollar limit (after any reduction) equally be-
tween you, unless you both elect a different al-
location. 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 busi-
ness if you meaningfully participate in the man-
agement 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 in-
come for this purpose by totaling the net in-
come and losses from all trades and busi-
nesses 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 busi-
ness also includes the following items.
Section 1231 gains (or losses) as dis-
cussed 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 re-
turn) as an employee of any employer.
In addition, figure taxable income without re-
gard to any of the following.
The section 179 expense deduction.
The self-employment tax deduction.
Any net operating loss carryback or carry-
forward.
Any unreimbursed employee business ex-
penses.
Two different taxable income limits. In addi-
tion to the business income limit for your section
179 expense deduction, you may have a taxa-
ble 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 de-
duction. 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.
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Chapter 7 Depreciation, Depletion, and Amortization Page 39
Example. On February 1, 2017, the XYZ
farm corporation purchased and placed in serv-
ice 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 deduc-
tion is figured after subtracting any allowable
charitable contributions. XYZ's taxable income
figured without the section 179 expense deduc-
tion or the deduction for charitable contributions
is $700,000. XYZ figures its section 179 ex-
pense deduction and its deduction for charita-
ble contributions as follows.
Step 1. Taxable income figured without ei-
ther deduction is $700,000.
Step 2. Using $700,000 as taxable in-
come, XYZ's hypothetical section 179 ex-
pense 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 charita-
ble 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 ex-
pense 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 in-
come) 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 deter-
mining 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 proper-
ties for which all or a part of the cost will be car-
ried 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 sec-
tion 179. The taxable income from her business
(determined without regard to both a section
179 expense deduction for the cost of the ma-
chine and the self-employment tax deduction)
was $80,000. Her section 179 expense deduc-
tion 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 ex-
pense deduction subject to the limits. It then al-
locates the deduction among its partners or
shareholders.
If you are a partner in a partnership or share-
holder of an S corporation, you add the amount
allocated from the partnership or S corporation
to any section 179 costs not related to the part-
nership or S corporation and then apply the dol-
lar 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 re-
maining section 179 costs. For more informa-
tion, 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 maxi-
mum 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 ex-
pense 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 de-
duction by completing Part I of Form 4562.
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
CAUTION
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amended return must also include any re-
sulting 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 amen-
ded return. The amended return must be filed
within the time prescribed by law. The amended
return must also include any resulting adjust-
ments to taxable income (for example, allowa-
ble depreciation in that tax year for the item of
section 179 property for which the election per-
tains). Once made, the revocation is irrevoca-
ble.
When Must You Recapture
the Deduction?
You may have to recapture the section 179 ex-
pense deduction if, in any year during the prop-
erty's recovery period, the percentage of busi-
ness 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 prop-
erty are discussed later.
If you sell, exchange, or otherwise dis-
pose of the property, do not figure the
recapture amount under the rules ex-
plained in this discussion. Instead, use the rules
for recapturing depreciation explained in chap-
ter 9 under Section 1245 Property.
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 de-
preciation 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 depreci-
ated under the Modified Accelerated Cost Re-
covery System (MACRS) and a half-year con-
vention. The property is not listed property. He
elected a $5,000 section 179 expense deduc-
tion 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 fig-
ures his recapture amount as follows.
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Page 40 Chapter 7 Depreciation, Depletion, and Amortization
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 re-
capture 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 quali-
fied property by 50%.
What is Qualified Property?
For farmers, qualified property generally is cer-
tain 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 Janu-
ary 1, 2020, is eligible for a 50% special depre-
ciation allowance. Certain qualified property
placed in service after December 31, 2017, is
eligible for a 40% special depreciation allow-
ance.
Qualified property includes the following.
Certain property with a long production pe-
riod.
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 ex-
isted before January 1, 2008, the property
does not qualify.
Qualified property must be placed in serv-
ice 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 sub-
sequent 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 re-
voked without IRS consent.
See section 168(k)(5) of the Internal Reve-
nue 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 dur-
ing 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 serv-
ice. However, if you timely filed your return for
the year without making the election, you can
still make the election by filing an amended re-
turn within 6 months of the due date of the origi-
nal 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 re-
voked without IRS consent.
If you elect not to have the special de-
preciation allowance apply, the prop-
erty 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 allow-
ance previously allowed or allowable. For more
information, see chapter 3 of Pub. 946.
CAUTION
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Figuring Depreciation
Under MACRS
The Modified Accelerated Cost Recovery Sys-
tem (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 pro-
vide different methods and recovery periods to
use in figuring depreciation deductions.
To be sure you can use MACRS to fig-
ure 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 infor-
mation 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 infor-
mation 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 re-
quired 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 farm-
ing business and placed in service in any
tax year during which an election not to ap-
ply the uniform capitalization rules to cer-
tain 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 coun-
try for which an Executive Order is in effect
because the country maintains trade re-
strictions or engages in other discrimina-
tory acts.
Any tangible property used predominantly
outside the United States during the year.
If you are required to use ADS to de-
preciate your property, you cannot
claim the special depreciation allow-
ance.
Electing ADS. Although your property may
qualify for GDS, you can elect to use ADS. The
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Chapter 7 Depreciation, Depletion, and Amortization Page 41
election generally must cover all property in the
same property class you placed in service dur-
ing the year. However, the election for residen-
tial rental property and nonresidential real prop-
erty 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 in-
come. The placed-in-service date for your prop-
erty is the date the property is ready and availa-
ble for a specific use. It is therefore not
necessarily the date it is first used. If you con-
verted property held for personal use to use in a
trade or business or for the production of in-
come, 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 deprecia-
tion allowance.
What Is the Basis for
Depreciation?
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 deduc-
tions 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 em-
ployer-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 deprecia-
tion system (GDS or ADS) used. See Table 7-1
for recovery periods under both GDS and ADS
for some commonly used assets. For a com-
plete 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 de-
preciate 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 move-
ment).
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 depre-
ciated were discussed earlier in Irrigation sys-
tems and water wells under Property Having a
Determinable Useful Life.
Which Convention Applies?
Under MACRS, averaging conventions estab-
lish 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.
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....................................... 710
Computer and peripheral equipment ................................. 5 5
Drainage facilities .............................................. 15 20
Farm buildings2................................................ 20 25
Farm machinery and equipment .................................... 710
Fences (agricultural) ............................................ 710
Goats and sheep (breeding) ....................................... 5 5
Grain bin .................................................... 710
Hogs (breeding) ............................................... 3 3
Horses (age when placed in service)
Breeding and working (12 years or less) ............................ 710
Breeding and working (more than 12 years) ......................... 310
Racing horses (more than 2 years) ................................ 312
Horticultural structures (single purpose) ............................... 10 15
Logging machinery and equipment3.................................. 5 6
Nonresidential real property ....................................... 39440
Office furniture, fixtures, and equipment (not calculators, copiers, or typewriters) ... 710
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.
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Page 42 Chapter 7 Depreciation, Depletion, and Amortization
For a detailed explanation of each conven-
tion, 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 re-
covery period.
The straight line method over an ADS re-
covery 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 per-
sonal property placed in service after 1988 in a
farming business, you must use the 150% de-
clining balance method over a GDS recovery
period or you can elect one of the following
methods.
The straight line method over a GDS re-
covery period.
The straight line method over an ADS re-
covery period.
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, con-
tinue to use the same method and recovery pe-
riod for that property.
Real property. You can depreciate real prop-
erty using the straight line method under either
GDS or ADS.
Switching to straight line. If you use a declin-
ing balance method, you switch to the straight
line method in the year it provides an equal or
greater deduction. If you use the MACRS per-
centage 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 ta-
bles 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 re-
covery 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.
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 ba-
sis 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” un-
der column (f) in Part III of Form 4562.
ADS election. As explained earlier under
Which Depreciation System (GDS or ADS) Ap-
plies, 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
CAUTION
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CAUTION
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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 Appen-
dix B of Pub. 946.
How Is the Depreciation
Deduction Figured?
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 prop-
erty. Then you are ready to figure your depreci-
ation deduction. You can figure it in one of two
ways.
You can use the percentage tables provi-
ded by the IRS.
You can figure your own deduction without
using the tables.
Figuring your own MACRS deduction
will generally result in a slightly differ-
ent 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 conven-
tion and depreciation method. These percent-
age 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 percent-
age 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 orig-
inal 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 prop-
erty.
4. You must stop using the tables if you ad-
just the basis of the property for any rea-
son other than:
a. Depreciation allowed or allowable, or
b. 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 be-
cause of a casualty, you cannot continue to use
the percentage tables. For the year of the ad-
justment 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.
CAUTION
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Chapter 7 Depreciation, Depletion, and Amortization Page 43
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 con-
vention.
The following examples show how to figure
depreciation under MACRS using the percen-
tages 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 ex-
pense deduction for this property. In addition,
the property is not qualified property for purpo-
ses 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 deprecia-
tion 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 percen-
tages to figure your deduction. You figure this
year's depreciation by multiplying $20,000 (un-
adjusted 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, in-
cluding 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 (un-
adjusted 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 in-
voluntary conversion over the remaining recov-
ery period of the property exchanged or invol-
untarily converted. You also generally continue
to use the same depreciation method and con-
vention used for the exchanged or involuntarily
converted property. This applies only to ac-
quired property with the same or a shorter re-
covery period and the same or more acceler-
ated depreciation method than the property
exchanged or involuntarily converted. The ex-
cess 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 involun-
tarily converted property is treated as if it was
disposed of at the time of the exchange or con-
version.
When to make the election. You must
make the election on a timely filed return (in-
cluding 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 non-
taxable transfers over the property's remaining
recovery period in the transferor's hands, as if
the transfer had not occurred. You must con-
tinue to use the same depreciation method and
convention as the transferor. You can depreci-
ate 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 deprecia-
tion, 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, depre-
ciation method, and convention. You cannot in-
clude an asset if you use it in both a personal
activity and a trade or business (or for the pro-
duction 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 appli-
cable 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 as-
sets 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 deduc-
tion 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 or-
dinary income up to the amount of the deprecia-
tion previously allowed or allowable for the
property. For more information on depreciation
recapture, see chapter 9. Also, see chapter 4 of
Pub. 946.
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Page 44 Chapter 7 Depreciation, Depletion, and Amortization
Additional Rules for
Listed Property
Listed property includes cars and other property
used for transportation, property used for enter-
tainment, and certain computers.
Deductions for listed property (other than
certain leased property) are subject to the fol-
lowing 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 equip-
ment unless used only at a regular busi-
ness establishment and owned or leased
by the person operating the establishment.
Certain aircraft.
Passenger automobiles. A passenger auto-
mobile 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 in-
cludes any part, component, or other item phys-
ically attached to the automobile or usually in-
cluded in the purchase price of an automobile.
Electric passenger automobiles are vehicles
produced by an original equipment manufac-
turer and designed to run primarily on electric-
ity.
Note. A truck or van that is a qualified nonper-
sonal use vehicle is not considered a passen-
ger automobile. See Qualified nonpersonal use
vehicles under Passenger Automobiles in chap-
ter 5 of Pub. 946 for the definition of qualified
nonpersonal use vehicles.
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 trans-
porting 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 fork-
lifts.
Any vehicle designed to carry cargo with a
loaded gross vehicle weight of over 14,000
pounds.
TIP
For more information, see chapter 5 of Pub.
946.
What Is the Business-Use
Requirement?
You can claim the section 179 expense deduc-
tion 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 re-
quirement 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 sec-
tion 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 pas-
senger 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 automo-
biles. Also, see the Instructions for Form 4562.
For information about deducting expenses
for the business use of your passenger automo-
bile, see chapter 4 in Pub. 463.
Deductions for passenger automobiles ac-
quired in a trade-in. Special rules apply in fig-
uring the depreciation for a passenger automo-
bile 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 de-
pletion deduction allows an owner or operator
to account for the reduction of a product's re-
serves.
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 in-
terest in mineral deposits or standing tim-
ber.
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 re-
turn of your capital investment.
A contractual relationship that allows you an
economic or monetary advantage from prod-
ucts 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 sepa-
rate 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 In-
ternal Revenue Code and the related regula-
tions for rules on how to treat separate mineral
interests.
Timber property is your economic interest in
standing timber in each tract or block represent-
ing 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 deple-
tion.
Cost Depletion
To figure cost depletion you must first deter-
mine 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 cu-
bic feet, or other measure) using the current in-
dustry method and the most accurate and relia-
ble 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 follow-
ing 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 tak-
ing the following steps.
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Chapter 7 Depreciation, Depletion, and Amortization Page 45
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 Ogal-
lala Formation. Farmers who extract ground
water from the Ogallala Formation for irrigation
are allowed cost depletion. Cost depletion is al-
lowed 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 suc-
ceeding generations. To figure your cost deple-
tion deduction, use the guidance provided in
Revenue Procedure 66-11 in Cumulative Bulle-
tin 1966-1.
Timber Depletion
Depletion takes place when you cut standing
timber (including Christmas trees). You can fig-
ure 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 tim-
ber units acquired during the year to the
number of timber units on hand in the ac-
count 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 ex-
plained in chapter 8. Include allowable deple-
tion for timber products not sold during the tax
year the timber is cut, as a cost item in the clos-
ing 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 prod-
ucts.
Form T (Timber). Complete and attach Form
T (Timber) to your income tax return if you are
claiming a deduction for timber depletion, elect-
ing to treat the cutting of timber as a sale or ex-
change, 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 deter-
mined that the standing timber could produce
300,000 units when cut. At that time, the adjus-
ted 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 de-
duction 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 de-
pletion 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 de-
pletion for standing timber, soil, sod, dirt, or turf.
To figure percentage depletion, you multiply
a certain percentage, specified for each min-
eral, 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 deple-
tion 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 activi-
ties 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 de-
duction from the gross income from the
property.
Corporations do not deduct charitable con-
tributions from the gross income from the
property.
If, during the year, you disposed of an item
of section 1245 property used in connec-
tion 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 fig-
ure the ordinary gain allocable to the prop-
erty.
For more information on depletion, see
chapter 9 in Pub. 535.
Amortization
Amortization is a method of recovering (deduct-
ing) 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 go-
ing 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 ex-
penses. Capital expenses are a part of your ba-
sis in the business. Generally, you recover
costs for particular assets through depreciation
deductions. However, you generally cannot re-
cover other costs until you sell the business or
otherwise go out of business.
Start-up costs are costs for creating an ac-
tive trade or business or investigating the crea-
tion or acquisition of an active trade or busi-
ness. Start-up costs include any amounts paid
or incurred in connection with any activity en-
gaged in for profit and for the production of in-
come 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 incur-
red after October 22, 2004. See Capital Expen-
ses 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 be-
fore 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 Busi-
ness in chapter 8 of Pub. 535.
Reforestation Costs
You can elect to currently deduct a limited
amount of qualifying reforestation costs for
each qualified timber property. See Capital Ex-
penses 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 di-
rect costs of planting or seeding for forestation
or reforestation.
Qualifying costs. Qualifying costs include
only those costs you must otherwise capitalize
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Page 46 Chapter 7 Depreciation, Depletion, and Amortization
and include in the adjusted basis of the prop-
erty. They include costs for the following items.
Site preparation.
Seeds or seedlings.
Labor.
Tools.
Depreciation on equipment used in plant-
ing and seeding.
If the government reimburses you for refor-
estation 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 signif-
icant 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 require-
ments.
It is located in the United States.
It is held for the growing and cutting of tim-
ber you will either use in, or sell for use in,
the commercial production of timber prod-
ucts.
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 amortiza-
tion period starts on the first day of the first
month of the second half of the tax year you in-
cur the costs (July 1 for a calendar year tax-
payer), regardless of the month you actually in-
cur 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 amor-
tize 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 elec-
tion by filing an amended return within 6 months
of the due date of your return (excluding exten-
sions). 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 am-
ortize these costs if you hold the section 197 in-
tangible in connection with your farming busi-
ness or in an activity engaged in for the
production of income. Your amortization deduc-
tion each year is the applicable part of the intan-
gible's adjusted basis (for purposes of deter-
mining gain), figured by amortizing it ratably
over 15 years (180 months). You are not al-
lowed any other depreciation or amortization
deduction for an amortizable section 197 intan-
gible.
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 sec-
tion 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 dis-
position 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 gener-
ally taxed at a lower rate. Dispositions dis-
cussed in this chapter include sales, ex-
changes, 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
Tax Guide for Small Business
Selling Your Home
Sales and Other Dispositions of
Assets
Investment Income and Expenses
Bankruptcy Tax Guide
Form (and Instructions)
Reduction of Tax Attributes Due to
Discharge of Indebtedness (and
Section 1082 Basis Adjustment)
334
523
544
550
908
982
Capital Gains and
Losses
Profit or Loss From
Farming
Acquisition or Abandonment of
Secured Property
Cancellation of Debt
Sales of Business Property
Like-Kind Exchanges
Sales and Other Dispositions of
Capital Assets
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 determin-
ing 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 prop-
erty you buy is usually its cost. The adjusted ba-
sis of the property is the basis plus certain addi-
tions 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 in-
cludes 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 mul-
tiple properties, see Multiple Property Ex-
changes in chapter 1 of Pub. 544.
Amount recognized. Your gain or loss real-
ized from a sale or exchange of certain property
is usually a recognized gain or loss for tax pur-
poses. A recognized gain is a gain you must in-
clude in gross income and report on your in-
come 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 purpo-
ses. See Like-Kind Exchanges next. Also, a
Sch D (Form 1040)
Sch F (Form 1040)
1099-A
1099-C
4797
8824
8949
8960
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Chapter 8 Gains and Losses Page 47
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 nontax-
able 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 ex-
change 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 re-
ceive 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 require-
ments.
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 ba-
sis 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 trac-
tor 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 ex-
change 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 ex-
change.
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 be-
cause 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 pri-
marily for sale, such as crops and produce.
Stocks, bonds, or notes. However, see
Qualifying property above.
Other securities or evidences of indebted-
ness, such as accounts receivable.
Partnership interests.
However, you may have a nontaxable ex-
change under other rules. See Other Nontaxa-
ble Exchanges in chapter 1 of Pub. 544.
Like-kind property. To qualify as a nontaxa-
ble exchange, the properties exchanged must
be of like kind. Like-kind properties are proper-
ties 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 exam-
ple, an exchange of city property for farm prop-
erty or improved property for unimproved prop-
erty 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 ex-
change 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 as-
sets 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 as-
set involved in the exchange.
Personal property. Depreciable tangible
personal property can be either like kind or like
class to qualify for nontaxable exchange treat-
ment. Like-class properties are depreciable tan-
gible personal properties within the same Gen-
eral 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 char-
acter.
General Asset Classes. General Asset
Classes describe the types of property fre-
quently 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 comput-
ers (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 sec-
tors 31 through 33 of the North American Indus-
try Classification System (NAICS) of the Execu-
tive Office of the President, Office of
Management and Budget, United States (NA-
ICS Manual). The latest version of the manual
can be accessed at www.census.gov/eos/www/
naics/.
NAICS class 333111, Farm Machinery
and Equipment Manufacturing, in-
cludes most machinery and equipment
used in a farming business.
Partially nontaxable exchange. If, in addition
to like-kind property, you receive money or un-
like property in an exchange on which you real-
ize gain, you have a partially nontaxable ex-
change. 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). How-
ever, only $10,000, the cash received, is recog-
nized (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 rec-
ognized. You have a realized loss of $5,000
($115,000 FMV + $10,000 cash – $130,000 ba-
sis of old farmland = $5,000 loss).
TIP
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Page 48 Chapter 8 Gains and Losses
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 dif-
ference 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 un-
like property. For purposes of figuring your real-
ized 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 fig-
uring 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 re-
ceived money in the amount of the liability. For
more information, see Partial Nontaxable Ex-
chagnes in chapter 1 of Pub. 544.
Like-kind exchanges between related per-
sons. Special rules apply to like-kind ex-
changes between related persons. These rules
affect both direct and indirect exchanges. Un-
der 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 ex-
change 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 prop-
erty that was part of the like-kind exchange.
Related persons. Under these rules, rela-
ted 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 indi-
rectly own more than a 50% interest of the capi-
tal 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 De-
cember 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 ex-
change, you recognized no gain. Your basis in
the red pickup truck was $6,200 (the $6,000 ad-
justed 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 dis-
qualified 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 per-
sons. The following property dispositions are
excluded from these rules.
Dispositions due to the death of either rela-
ted person.
Involuntary conversions.
Dispositions where it is established to the
satisfaction of the IRS that neither the ex-
change 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 fig-
ure 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 nonrecogni-
tion 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 busi-
ness or hold for investment. The property you
receive is replacement property. The transac-
tion must be an exchange of property for prop-
erty 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 Ex-
changes 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 nonresi-
dent 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 for-
mer spouse on which gain or loss is not recog-
nized 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 trans-
ferred 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 or-
dinary or capital, and your capital gains or los-
ses as either short term or long term.
Your net capital gains may be taxed at a
lower tax rate than ordinary income. See Capi-
tal 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 per-
sonal 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 nonca-
pital 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 ex-
change of personal-use property is not deducti-
ble. You can deduct a loss relating to per-
sonal-use property only if it results from a
casualty or theft. For information on casualties
and thefts, see chapter 11.
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Chapter 8 Gains and Losses Page 49
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 be-
fore 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 Sched-
ule 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 af-
ter 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 live-
stock used in a farm business. See Holding pe-
riod 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 be-
gins 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 ba-
sis, 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 bur-
dens 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 los-
ses and the totals for long-term capital gains
and losses must be figured separately.
Net short-term capital gain or loss. Com-
bine 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 capi-
tal 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 dif-
ference 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 tax-
payers 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 deduc-
tion for exemptions is less than zero.
If either of these situations applies to you for
2017, see Capital Losses under Reporting Cap-
ital Gains and Losses in chapter 4 of Pub. 550
to figure the amount you can carry over to 2018.
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
TIP
for the year is more than your net short-term
capital loss.
See Schedule D (Form 1040) and the In-
structions for Schedule D (Form 1040). Also
see Pub. 550.
Noncapital Assets
Noncapital assets include property such as in-
ventory 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 live-
stock, 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 sport-
ing purposes. However, your gains and losses
from sales and exchanges of your farmland and
depreciable properties must be considered to-
gether with certain other transactions to deter-
mine 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 pri-
marily to manage the risk of interest rate or
price changes, or currency fluctuations, with re-
spect to borrowings, ordinary property, or ordi-
nary obligations. Ordinary property or obliga-
tions are those that cannot produce capital gain
or loss if sold or exchanged.
A commodity futures contract is a standar-
dized, 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 fu-
tures contracts or forward contracts and may
acquire options on commodity futures contracts
as either of the following.
Hedging transactions.
Transactions that are not hedging transac-
tions.
Futures transactions with exchange-traded
commodity futures contracts that are not hedg-
ing transactions, generally, result in capital gain
or loss and are subject to the mark-to-market
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Page 50 Chapter 8 Gains and Losses
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, fu-
tures contracts, or options on futures contracts
and the contracts cover an amount of the com-
modity 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. Farm-
ers 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.
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 help-
ful 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 be-
ing hedged in your records. Although the identi-
fication 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 transac-
tions. 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, deduc-
tion, 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 re-
quirements and limits.
Hedging transactions must be accounted for
under the rules stated above unless the trans-
action 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.
RECORDS
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 hedg-
ing transaction. They must also contain any ad-
ditional identification necessary to verify the ap-
plication of the accounting method you used for
the transaction. You must make the additional
identification no more than 35 days after enter-
ing 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 bush-
els 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 pro-
tect yourself against a drop in the price, you en-
ter 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 con-
tract) 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 transac-
tions 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 lo-
cal elevator are $300,000 (50,000 bu. × $6).
Report it on Schedule F, Part I, line 2, as in-
come 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 in-
come from the recapture of depreciation is not
included as section 1231 gain. See chapter 9
for more information on section 1231 gains and
losses and the recapture of depreciation under
section 1245.
The rules discussed here do not apply
to the sale of livestock held primarily for
sale to customers. The sale of this live-
stock 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 live-
stock used in your farm business (defined be-
low) 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, live-
stock includes cattle, hogs, horses, mules, don-
keys, sheep, goats, fur-bearing animals, and
other mammals. Also, for section 1231 transac-
tions, livestock does not include chickens, tur-
keys, pigeons, geese, emus, ostriches, rheas,
or other birds, fish, frogs, reptiles, etc.
Livestock used in farm business. If live-
stock 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 ac-
tual 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 ster-
ile. 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 ani-
mals 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
CAUTION
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Chapter 8 Gains and Losses Page 51
Caused by Weather-Related Conditions in
chapter 3.
Example 3. You are in the business of rais-
ing hogs for slaughter. Customarily, before sell-
ing 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 cus-
tomers in the ordinary course of your business,
they are considered to be held for breeding pur-
poses.
Example 4. You are in the business of rais-
ing registered cattle for sale to others for use as
breeding cattle. The business practice is to
breed the cattle before sale to establish their fit-
ness as registered breeding cattle. Your use of
the young cattle for breeding purposes is ordi-
nary and necessary for selling them as regis-
tered breeding cattle. Such use does not dem-
onstrate 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 consid-
ered 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 de-
cided that to prevent your racing stable from
getting too large to be effectively operated, you
must cull six horses that had been raced at pub-
lic tracks in 2016. These horses are all consid-
ered 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. Ex-
penses of sale include sales commissions,
freight or hauling from farm to commission com-
pany, 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 Uni-
form Capitalization Rules in chapter 6.
Purchased livestock. The gross sales
price minus your adjusted basis and any expen-
ses 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 con-
verted 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 orig-
inally converted it or held by any other person
who used the converted wetland at any time af-
ter conversion for farming.
A wetland (before conversion) is land that
meets all the following conditions.
It is mostly soil that, in its undrained condi-
tion, is saturated, flooded, or ponded long
enough during a growing season to de-
velop an oxygen-deficient state that sup-
ports the growth and regeneration of plants
growing in water.
It is saturated by surface or groundwater at
a frequency and duration sufficient to sup-
port 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 cur-
rently classified by the Department of Agricul-
ture as Class IV, VI, VII, or VIII under its classifi-
cation 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 erodi-
ble 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 prop-
erty 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 custom-
ers, it is not a capital asset. Gain or loss on its
sale is ordinary business income or loss. It is re-
ported 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 ex-
penses incurred in cutting, hauling, etc., are or-
dinary 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 cut-
ting 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 or-
namental purposes are included in the term tim-
ber. They qualify for both rules discussed be-
low.
Election to treat cutting as a sale or ex-
change. 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 re-
alized. But if you owned or had a contractual
right to cut timber, you can elect to treat the cut-
ting 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 tim-
ber is cut. Any later sale results in ordinary busi-
ness 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 be-
fore it is cut, and
2. Cut the timber for sale or use in your trade
or business.
Making the election. You make the elec-
tion 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 elec-
tion 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 re-
turn.
Once you have made the election, it re-
mains in effect for all later years unless you re-
voke it.
Election under section 631(a) may be re-
voked. If you previously elected for any tax
year ending before October 23, 2004, to treat
the cutting of timber as a sale or exchange un-
der 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 elec-
tion (and revocation) is disregarded for purpo-
ses of making a subsequent election. See Form
T (Timber), Forest Activities Schedule, for more
information.
Gain or loss. Your gain or loss on the cut-
ting 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.
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Page 52 Chapter 8 Gains and Losses
Your adjusted basis for depletion of cut tim-
ber 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 ex-
changed. 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 chap-
ter 7.
Example. In April 2017, you owned 4,000
MBF (1,000 board feet) of standing timber lon-
ger than 1 year. It had an adjusted basis for de-
pletion 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 fig-
ure 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 cer-
tain disposal of timber under a contract with re-
tained economic interest (defined later). How-
ever, for outright sales, the date of disposal is
not deemed to be the date the timber is cut be-
cause the landowner can elect to treat the pay-
ment 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 ap-
ply to you.
You are the owner of the timber.
You held the timber longer than 1 year be-
fore its disposal.
You kept an economic interest in the tim-
ber.
You have kept an economic interest in
standing timber if, under the cutting contract,
the expected return on your investment is con-
ditioned 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 los-
ses.
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 hold-
ing 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 pay-
ments 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 exten-
sions). Attach the statement to the amended re-
turn and write “Filed pursuant to section
301.9100-2” at the top of the statement. File the
amended return at the same address the origi-
nal 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 tim-
ber was cut and removed from the land are con-
sidered 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 in-
structions for more information about disposi-
tions 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 prop-
erty is taxable. A loss on the sale of your busi-
ness property to an unrelated person is deduc-
ted 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 pay-
ments are received, unless you elect not to use
the installment method of reporting the gain.
See chapter 10 for information about install-
ment sales.
When you sell your farm, the gain or loss on
each asset is figured separately. The tax treat-
ment 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 (in-
cluding 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 peri-
ods discussed earlier).
Property held primarily for sale or which is
of the kind that would be included in inven-
tory 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 sin-
gle 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 deter-
mines 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 busi-
ness. Recognized gains and losses on busi-
ness 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 De-
cember 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 repor-
ted as ordinary income from the recapture of
depreciation or soil and water conservation ex-
penses. Treat the balance as section 1231
gain.
The $48,000 gain from the sale of your
home is not taxable if you meet the require-
ments 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, de-
preciation, 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
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Chapter 8 Gains and Losses Page 53
costs, as discussed below under Sale of your
home.
Example. You bought a 600-acre farm for
$700,000. The farm included land and build-
ings. The purchase contract designated
$600,000 of the purchase price to the land. You
later sold 60 acres of land on which you had in-
stalled a fence. Your adjusted basis for the part
of your farm sold is $60,000 (110 of $600,000),
plus any unrecovered cost (cost not depreci-
ated) 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 al-
locating your original cost or other basis be-
tween 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 ex-
ample 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 34 (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 unad-
justed basis of the 60 acres you sold would then
be $52,500 (110 of $525,000).
Sale of your home. Your home is a capital as-
set and not property used in the trade or busi-
ness 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 sur-
roundings 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 can-
not be excluded (because it is more than the
limit) may be postponed under the rules dis-
cussed 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 fore-
closure 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 prop-
erty.
Buyer's (borrower's) gain or loss. You figure
and report gain or loss from a foreclosure or re-
possession 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.
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 trans-
ferred 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
TIP
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 immedi-
ately after the transfer, or
The fair market value of the transferred
property.
You are treated as receiving ordinary in-
come 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 lia-
ble 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 real-
ized ($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 real-
ized. She reports this as other income on
Schedule F, line 8.
Seller's (lender's) gain or loss on reposses-
sion. If you finance a buyer's purchase of your
property in an installment sale and later acquire
an interest in it through foreclosure or reposses-
sion, you may have a gain or loss on the acquis-
ition. For more information, see Repossession
in Pub. 537, Installment Sales.
Cancellation of debt. If property that is repos-
sessed or foreclosed upon secures a debt for
Worksheet for Foreclosures
and Repossessions
Worksheet 8-1. Keep for Your Records
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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Page 54 Chapter 8 Gains and Losses
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 Sched-
ule F, line 8. Report the income from cancella-
tion of a nonbusiness debt as miscellaneous in-
come on Form 1040.
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 Cancella-
tion of Debt in chapter 3.
Abandonment
The abandonment of property is a disposition of
property. You abandon property when you vol-
untarily 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 prop-
erty is deductible as a loss. Loss from abandon-
ment 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 im-
provements the lessor made for the lessee.
However, if the property is foreclosed on or re-
possessed in lieu of abandonment, gain or loss
is figured as discussed earlier under Foreclo-
sure or Repossession.
If the abandoned property is secured by
debt, special rules apply. The tax consequen-
ces of abandonment of property that secures a
debt depend on whether you are personally lia-
ble for the debt (recourse debt) or were not per-
sonally liable for the debt (nonrecourse debt).
For more information, see chapter 3 of Pub.
4681, Canceled Debts, Foreclosures, Repos-
sessions, 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 se-
cures a debt for which you are personally liable
and the debt is canceled, you may realize ordi-
nary 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 nonbusi-
ness debt as miscellaneous income on Form
1040.
TIP
However, income from cancellation of debt
is not taxed in certain circumstances. See Can-
cellation of debt, earlier, under Foreclosure or
Repossession.
Forms 1099-A and 1099-C. A lender who ac-
quires an interest in your property in a foreclo-
sure, repossession, or abandonment should
send you Form 1099-A showing the information
you need to figure your loss from the foreclo-
sure, 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 in-
stead of Form 1099-A. The lender must file
Form 1099-C and send you a copy if the can-
celed debt is $600 or more and the lender is a
financial institution, credit union, federal govern-
ment agency, or any organization that has a sig-
nificant 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 usu-
ally 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 prop-
erty) at a gain, you may have to recognize all or
part of the gain as ordinary income under the
depreciation recapture rules. Any gain remain-
ing 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 exam-
ples 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
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
1Depreciable 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
2Farmland 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
3All other farmland used in a trade or business Part II Part I
4Disposition of cost-sharing payment property described in
section 126
Part II Part III (1255)
5Cattle 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
6Livestock 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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Chapter 9 Dispositions of Property Used in Farming Page 55
Depreciation recapture
Other gains
Useful Items
You may want to see:
Publication
Sales and Other Dispositions
of Assets
Form (and Instructions)
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 transac-
tions (explained below). Their treatment as ordi-
nary 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.
If you have a gain from a section 1231
transaction, first determine whether
any of the gain is ordinary income un-
der the depreciation recapture rules (explained
later). Do not take that gain into account as sec-
tion 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 live-
stock 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 am-
ortizable 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
544
4797
CAUTION
!
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 indi-
rectly (other than a right customarily inci-
dent to a mortgage or other security trans-
action). 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 live-
stock).
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 busi-
ness 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 infor-
mation on how to treat those gains and los-
ses.
If the property is not held for the re-
quired holding period, the transaction
is not subject to section 1231 treat-
ment, 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 sec-
tion 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 busi-
ness, it is property held mainly for sale to cus-
tomers.
Property deducted under the de minimis
safe harbor for tangible property. If you de-
ducted the cost of a property under the de mini-
mis safe harbor for tangible property, then upon
its sale or disposition, this property is not trea-
ted as a capital asset or as property used in the
trade or business under section 1231. Gener-
ally, 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 deter-
mine the treatment of section 1231 gains and
CAUTION
!
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 or-
dinary 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 ordi-
nary 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 fol-
lowing 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 nontaxa-
ble) as ordinary income.
To figure any gain that must be repor-
ted as ordinary income, you must keep
permanent records of the facts neces-
sary 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 prop-
erty is treated as ordinary income to the extent
RECORDS
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Page 56 Chapter 9 Dispositions of Property Used in Farming
of depreciation allowed or allowable. Any rec-
ognized 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 intan-
gible).
2. Other tangible property (except buildings
and their structural components) used as
any of the following. See Buildings and
structural components below.
a. An integral part of manufacturing, pro-
duction, or extraction, or of furnishing
certain services.
b. A research facility in any of the activi-
ties in (a).
c. 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 prop-
erty (not included in (2)) with an adjusted
basis reduced by (but not limited to) the
following.
a. Amortization of certified pollution con-
trol facilities.
b. The section 179 expense deduction.
c. Deduction for clean-fuel vehicles and
certain refueling property.
d. Expenditures to remove architectural
and transportation barriers to the
handicapped and elderly.
e. 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 dis-
tributing petroleum or any primary product
of petroleum.
Buildings and structural components. Sec-
tion 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 struc-
tural 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 expec-
ted to be replaced when the property it initially
houses is replaced.
The fact that the structure is specially de-
signed to withstand the stress and other de-
mands of the property and cannot be used eco-
nomically 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 trea-
ted as buildings, but as section 1245 property.
Facility for bulk storage of fungible com-
modities. This is a facility used mainly for the
bulk storage of fungible commodities. Bulk stor-
age 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 fol-
lowing amounts.
1. The depreciation (which includes any sec-
tion 179 deduction claimed) and amortiza-
tion allowed or allowable on the property.
2. The gain realized on the disposition (the
amount realized from the disposition mi-
nus the adjusted basis of the property).
See Like-Kind Exchanges and Involuntary Con-
versions in chapter 3 of Pub. 544 for limits on
gain on like-kind exchanges and involuntary
conversions. For any other disposition of sec-
tion 1245 property, ordinary income is the
lesser of (1) above or the amount by which its
fair market value (FMV) is more than its adjus-
ted basis. See chapter 3 of Pub. 544.
Use Part III of Form 4797 to figure the ordi-
nary 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 ex-
changed for, or converted to, your section
1245 property in a like-kind exchange or
involuntary conversion. For details on ex-
changes 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 de-
termined 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 trac-
tor 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 re-
captured as ordinary income include (but are
not limited to) the following items. See Depreci-
ation 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 follow-
ing costs.
a. Acquiring a lease.
b. Lessee improvements.
c. Pollution control facilities.
d. Reforestation expenses.
e. Section 197 intangibles.
f. Qualified disaster expenses.
g. Franchises, trademarks, and trade
names acquired before August 11,
1993.
Example. You file your returns on a calen-
dar year basis. In February 2015, you bought
and placed in service for 100% use in your
farming business a light-duty truck (5-year prop-
erty) 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 de-
duction for the truck. You sold it in May 2017 for
$7,000. The MACRS deduction in 2017, the
year of sale, is $893 (12 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 al-
lowed or allowable when figuring the part of
gain to report as ordinary income. If, in prior
years, you have consistently taken proper de-
ductions under one method, the amount al-
lowed 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 deprecia-
tion, your adjustments to basis for depreciation
allowable are figured by using the straight line
method. This treatment applies only when figur-
ing what part of the gain is treated as ordinary
income under the rules for section 1245 depre-
ciation recapture. For more information on de-
preciation allowed or allowable, see chapter 7.
For information on adjustments to basis for de-
preciation 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
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Chapter 9 Dispositions of Property Used in Farming Page 57
treating the gain, up to the amount of these ex-
penses, as ordinary income. For section 1231
transactions, show these expenses as depreci-
ation on Form 4797, Part III, line 22. For plant
sales that are reported on Schedule F (Form
1040), Profit or Loss From Farming, this recap-
ture rule does not change the reporting of in-
come because the gain is already ordinary in-
come. You can use the farm-price method
discussed in chapter 2 to figure these expen-
ses.
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 or-
chard 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 sec-
tion 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 ex-
tent of additional depreciation allowed or allow-
able. To determine the additional depreciation
on section 1250 property, see Depreciation Re-
capture in chapter 3 of Pub. 544.
Use Part III of Form 4797 to figure the ordi-
nary income part of the gain.
You will not have additional depreciation if
any of the following apply to the property dis-
posed 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 prop-
erty 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 us-
ing the straight line method.
Installment Sale
If you report the sale of property under the in-
stallment method, any depreciation recapture
under section 1245 or 1250 is taxable as ordi-
nary 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 pur-
pose, include the recapture income in your in-
stallment 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 prop-
erly 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 us-
ing 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 treat-
ment 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 ex-
penses for the land, as discussed in chapter 5,
you must treat part of the gain as ordinary in-
come and treat the balance as section 1231
gain.
Exceptions. Do not treat gain on the fol-
lowing 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 con-
version, or the FMV for all other disposi-
tions).
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 ac-
quired 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 dis-
pose of the land 10 or more years after you ac-
quired it, the percentage is 0%, and the entire
gain is a section 1231 gain.
Example. You acquired farmland on Janu-
ary 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 appli-
cable 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 ex-
clude those payments from income (as dis-
cussed 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 ex-
cluded 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 ordi-
nary income under sections 1231 through 1254,
1256, and 1257. However, if applicable, gain re-
ported under this rule must be reported regard-
less of any contrary provisions (including nonre-
cognition provisions) under any other section.
Applicable percentage. The applicable
percentage of the excluded cost-sharing pay-
ments to be reported as ordinary income is
based on the length of time you hold the prop-
erty 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 prop-
erty.
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Page 58 Chapter 9 Dispositions of Property Used in Farming
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 in-
stallment sale, you may be able to report part of
your gain when you receive each payment. This
method of reporting gain is called the install-
ment method. You can't use the installment
method to report a loss. You can choose to re-
port 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
Selling Your Home
Business Expenses
Installment Sales
Accounting Periods and Methods
Sales and Other Dispositions of
Assets
Form (and Instructions)
Sales of Business Property
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 in-
stallment method. See Inventory, later. The sell-
ing price must be allocated to determine the
amount received for each class of asset.
523
535
537
538
544
4797
6252
Note. You may be required to report the
sale of your farm on Form 8594, Asset Acquisi-
tion 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 prop-
erty used in the business.) Separate computa-
tions must be made to figure the gain or loss for
each class of asset sold. See Sale of a Farm in
chapter 8.
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 rela-
ted party, you may not be able to report the sale
using the installment method. Generally, mem-
bers of a family aren't related parties for pur-
pose of the installment method. For more infor-
mation, 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 prop-
erty 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 install-
ment 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 in-
structions.
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.
CAUTION
!
Amended returns cannot be filed electroni-
cally. If you filed your original return electroni-
cally, 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 in-
come tax.
The tax year in which any payment was re-
ceived has closed.
To revoke the election you must obtain a pri-
vate letter ruling from the IRS. The procedures
and user fees for obtaining a private letter ruling
are published annually in the first revenue pro-
cedure 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 fol-
lowing 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) inven-
tories 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 re-
port 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 prop-
erty.
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
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Chapter 10 Installment Sales Page 59
in the property. Basis is the amount of your in-
vestment in the property for installment sale
purposes.
Interest income. You must report interest as
ordinary income. Interest is generally not inclu-
ded in a down payment. However, you may
have to treat part of each later payment as inter-
est, even if it isn't called interest in your agree-
ment with the buyer. Interest provided in the
agreement is called stated interest. If the agree-
ment doesn't provide for enough stated interest,
there may be unstated interest or original issue
discount. See Unstated interest, later.
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 ad-
justed basis in the property for installment sale
purposes. When you have completed the work-
sheet, you will also have determined the gross
profit percentage necessary to figure your in-
stallment sale income (gain) for this year.
1. Selling price. The selling price is the total
cost of the property to the buyer and in-
cludes 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 pay-
ment, later).
Any existing mortgage or other debt
the buyer pays, assumes, or takes
the property subject to (a note, mort-
gage, 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 re-
characterized as interest, or original issue
discount in the selling price.
2. Adjusted basis.
Your adjusted basis in property im-
mediately before the installment sale
is your original basis increased or re-
duced as a result of various events
while you own the property. Some
events, such as adding rooms or
making permanent improvements, in-
crease basis. Others, such as deduc-
tible casualty losses or depreciation
previously allowed or allowable, de-
crease basis.
The way you figure your original basis
depends on how you acquire the
property. The basis of property you
CAUTION
!
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 in-
formation.
3. Selling expenses. Selling expenses re-
late to the sale of the property. Review the
closing statement for fees which may qual-
ify as selling expenses. These may in-
clude, appraisal fees, attorney fees, clos-
ing 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, set-
tlement 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 chap-
ter 9, and Depreciation Recapture In-
come in Pub. 537.
5. Adjusted basis for installment sale
purposes. Your adjusted basis for install-
ment sale purposes is the total of the fol-
lowing three items.
Adjusted basis.
Selling expenses.
Depreciation recapture.
6. Gross profit.
Gross profit is the total gain you re-
port 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 in-
formation.
7. Contract price. Contract price equals:
The selling price, minus
The mortgages, debts, and other lia-
bilities 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 pay-
ment (after subtracting interest) is re-
ported as installment sale income.
This percentage is called the gross
profit percentage and is figured by di-
viding 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 exam-
ple under Selling price reduced, later,
for a situation where the gross profit
percentage changes.
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 in-
stallment 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 in-
come. Multiply the payments you receive each
year (less interest) by the gross profit percent-
age. 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 re-
ceipt of property or the assumption of a mort-
gage on the property sold may be treated as a
payment. For a detailed discussion, see Pay-
ments Received or Considered Received, later.
Figuring Adjusted Basis and Gross Profit Percentage
Keep for Your Records
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 ..........................................
Worksheet 10-1.
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Page 60 Chapter 10 Installment Sales
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 Percent-
age — Selling Price Reduced. You will spread
any remaining gain over future installments.
Example. In 2015, you sold land with a ba-
sis 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 accord-
ing 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 re-
duced to $1,483 a month amortized over the re-
maining three years.
The new gross profit percentage, 47.32%, is
figured in Example — Worksheet 10-2.
New Gross Profit
Percentage — Sell-
ing Price Reduced
Example —
Worksheet 10-2.
Keep for Your Records
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 in-
stallment sale in the year it takes place and to
report payments received, or considered re-
ceived 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 con-
sidered gain or loss on the sale of the property
for which you received the installment obliga-
tion.
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 in-
stallment obligation (other than to a buyer) as a
result of the death of the seller isn't a disposi-
tion. Any unreported gain from the installment
obligation isn't treated as gross income to the
decedent. No income is reported on the dece-
dent's return due to the transfer. Whoever re-
ceives 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 can-
celed, becomes unenforceable, or is transfer-
red 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 dispo-
sition. If the holder and the buyer were related,
the FMV of the installment obligation is consid-
ered 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 in-
come. However, you can report any gain
greater than the recapture income on the install-
ment 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.
If you sell depreciable business prop-
erty, prepare Form 4797 first in order to
figure the amount to enter on line 12 of
Part I, Form 6252. See the Form 6252 instruc-
tions for details.
For more information on the section 179 de-
duction, see Section 179 Expense Deduction in
TIP
New Gross Profit Percentage — Selling Price Reduced
Keep for Your Records
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.
Worksheet 10-2.
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Chapter 10 Installment Sales Page 61
chapter 7. For more information on depreciation
recapture, see Depreciation Recapture in chap-
ter 9.
Payments Received or
Considered Received
You must figure your gain each year on the pay-
ments you receive, or are treated as receiving,
from an installment sale.
In certain situations, you are considered to
have received a payment, even though the
buyer doesn't pay you directly. These situations
occur when the buyer assumes or pays any of
your debts, such as a loan, or pays any of your
expenses, such as a sales commission. How-
ever, as discussed later, the buyer's assump-
tion of your debt is treated as a recovery of ba-
sis, rather than as a payment, in many cases.
Buyer pays seller's expenses. If the buyer
pays any of your expenses related to the sale of
your property, it is considered a payment to you
in the year of sale. Include these expenses in
the selling and contract prices when figuring the
gross profit percentage.
Buyer assumes mortgage. If the buyer as-
sumes or pays off your mortgage, or otherwise
takes the property subject to the mortgage, the
following rules apply.
Mortgage less than basis. If the buyer as-
sumes a mortgage that isn't more than your in-
stallment sale basis in the property, it isn't con-
sidered a payment to you. It is considered a
recovery of your basis. The contract price is the
selling price minus the mortgage.
Example. You sell property with an adjus-
ted basis of $9,000. You have selling expenses
of $1,000. The buyer assumes your existing
mortgage of $15,000 and agrees to pay you
$10,000 (a cash down payment of $2,000 and
$2,000 (plus 8% interest) in each of the next 4
years).
The selling price is $25,000 ($15,000 +
$10,000). Your gross profit is $5,000 ($25,000 −
$20,000 installment sale basis). The contract
price is $10,000 ($25,000 − $15,000 mortgage).
Your gross profit percentage is 50% ($5,000 ÷
$10,000). You report half of each $2,000 pay-
ment received as gain from the sale. You also
report all interest you receive as ordinary in-
come.
Mortgage more than basis. If the buyer
assumes a mortgage that is more than your in-
stallment sale basis in the property, you recover
your entire basis. The part of the mortgage
greater than your basis is treated as a payment
received in the year of sale.
To figure the contract price, subtract the
mortgage from the selling price. This is the total
amount (other than interest) you will receive di-
rectly from the buyer. Add to this amount the
payment you are considered to have received
(the difference between the mortgage and your
installment sale basis). The contract price is
then the same as your gross profit from the
sale.
If the mortgage the buyer assumes is
equal to or more than your installment
sale basis, the gross profit percentage
always will be 100%.
Example. The selling price for your prop-
erty is $90,000. The buyer will pay you $10,000
annually (plus 8% interest) over the next 3
years and assume an existing mortgage of
$60,000. Your adjusted basis in the property is
$44,000. You have selling expenses of $6,000,
for a total installment sale basis of $50,000. The
part of the mortgage that is more than your in-
stallment sale basis is $10,000 ($60,000 −
$50,000). This amount is included in the con-
tract price and treated as a payment received in
the year of sale. The contract price is $40,000:
Selling price $90,000
Minus: Mortgage (60,000)
Amount actually received $30,000
Add difference:
Mortgage $60,000
Minus: Installment sale basis
50,000 10,000
Contract price $40,000
Your gross profit on the sale is also $40,000:
Selling price $90,000
Minus: Installment sale basis (50,000)
Gross profit $40,000
Your gross profit percentage is 100%. Re-
port 100% of each payment (less interest) as
gain from the sale. Treat the $10,000 excess of
the mortgage over your installment sale basis
as a payment and report 100% of it as gain in
the year of sale.
Buyer assumes other debts. If the buyer as-
sumes any other debts, such as a loan or back
taxes, it may be considered a payment to you in
the year of sale.
If the buyer assumes the debt instead of
paying it off, only part of it may have to be trea-
ted as a payment. Compare the debt to your in-
stallment sale basis in the property being sold.
If the debt is less than your installment sale ba-
sis, none of it is treated as a payment. If it is
more, only the difference is treated as a pay-
ment. If the buyer assumes more than one debt,
any part of the total that is more than your in-
stallment sale basis is considered a payment.
These rules are the same as the rules dis-
cussed earlier under Buyer assumes mortgage.
However, they apply only to the following types
of debt the buyer assumes.
Those acquired from ownership of the
property you are selling, such as a mort-
gage, lien, overdue interest, or back taxes.
Those acquired in the ordinary course of
your business, such as a balance due for
inventory you purchased.
If the buyer assumes any other type of debt,
such as a personal loan or your legal fees relat-
ing to the sale, it is treated as if the buyer had
paid off the debt at the time of the sale. The
value of the assumed debt is then considered a
payment to you in the year of sale.
Property used as a payment. If you receive
property rather than money from the buyer, it is
TIP
still considered a payment in the year received.
However, see Trading property for like-kind
property, later. Generally, the amount of the
payment is the property's FMV on the date you
receive it.
Exception. If the property the buyer gives
you is payable on demand or readily tradable
(see examples later), the amount you should
consider as payment in the year received is:
The FMV of the property on the date you
receive it if you use the cash method of ac-
counting,
The face amount of the obligation on the
date you receive it if you use an accrual
method of accounting, or
The stated redemption price at maturity
less any original issue discount (OID) or, if
there is no OID, the stated redemption
price at maturity appropriately discounted
to reflect total unstated interest. See Un-
stated interest, later.
Examples. If you receive a note from the
buyer as payment, and the note stipulates that
you can demand payment from the buyer at any
time, the note is payable on demand. If you re-
ceive marketable securities from the buyer as
payment, and you can sell the securities on an
established securities market (such as the New
York Stock Exchange) at any time, the securi-
ties are readily tradable. In these examples,
use the above rules to determine the amount
you should consider as payment in the year re-
ceived.
Debt not payable on demand. Any evi-
dence of debt you receive from the buyer that
isn't payable on demand isn't considered a pay-
ment. This is true even if the debt is guaranteed
by a third party, including a government
agency.
FMV. This is the price at which property
would change hands between a willing buyer
and a willing seller, neither being under any
compulsion to buy or sell and both having a rea-
sonable knowledge of all the necessary facts.
Third-party note. If the property the buyer
gives you is a third-party note (or other obliga-
tion of a third party), you are considered to have
received a payment equal to the note's FMV.
Because the FMV of the note is itself a payment
on your installment sale, any payments you
later receive from the third party aren't consid-
ered payments on the sale. The excess of the
note's face value over its FMV is interest. Ex-
clude this interest in determining the selling
price of the property. However, see Exception
under Property used as a payment, earlier.
Example. You sold real estate in an install-
ment sale. As part of the down payment, the
buyer assigned to you a $50,000, 8%
third-party note. The FMV of the third-party note
at the time of the sale was $30,000. This
amount, not $50,000, is a payment to you in the
year of sale. The third-party note had an FMV
equal to 60% of its face value ($30,000 ÷
$50,000), so 60% of each principal payment
you receive on this note is a nontaxable return
of capital. The remaining 40% is interest taxed
as ordinary income.
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Page 62 Chapter 10 Installment Sales
Bond. A bond or other evidence of debt
you receive from the buyer that is payable on
demand or readily tradable in an established
securities market is treated as a payment in the
year you receive it. For more information on the
amount you should treat as a payment, see Ex-
ception under Property used as a payment, ear-
lier.
If you receive a government or corporate
bond for a sale before October 22, 2004, and
the bond has interest coupons attached or can
be readily traded in an established securities
market, you are considered to have received
payment equal to the bond's FMV. However,
see Exception under Property used as a pay-
ment, earlier.
Buyer's note. The buyer's note (unless
payable on demand) isn't considered payment
on the sale. However, its full face value is inclu-
ded when figuring the selling price and the con-
tract price. Payments you receive on the note
are used to figure your gain in the year re-
ceived.
Sale to a related person. If you sell deprecia-
ble property to a related person and the sale is
an installment sale, you may not be able to re-
port the sale using the installment method. For
information on these rules, see the Instructions
for Form 6252 and Related parties under Install-
ment Sale of a Farm, earlier.
Trading property for like-kind property. If
you trade business or investment property
solely for the same kind of property to be held
as business or investment property, you can
postpone reporting the gain. See Like-Kind Ex-
changes in chapter 8 for a discussion of
like-kind property.
If, in addition to like-kind property, you re-
ceive an installment obligation in the exchange,
the following rules apply to determine install-
ment sale income each year.
The contract price is reduced by the FMV
of the like-kind property received in the
trade.
The gross profit is reduced by any gain on
the trade that can be postponed.
Like-kind property received in the trade
isn't considered payment on the install-
ment obligation.
Unstated interest. An installment sale con-
tract may provide that each deferred payment
on the sale will include interest or that there will
be an interest payment in addition to the princi-
pal payment. Interest provided in the contract is
called stated interest.
If an installment sale contract doesn't pro-
vide for adequate stated interest, part of the sta-
ted principal amount of the contract may be re-
characterized as interest. If section 483 applies
to the contract, this interest is called unstated
interest.
If section 1274 applies to the contract, this
interest is called original issue discount (OID).
Generally, if a buyer gives a debt in consid-
eration for personal use property, the unstated
interest rules don’t apply to the buyer. There-
fore, the buyer can't deduct the unstated inter-
est. The seller must report the unstated interest
as income. Personal-use property is any prop-
erty in which substantially all of its use by the
buyer isn't in connection with a trade or busi-
ness or an investment activity.
If the debt is subject to section 483 rules and
is also subject to the below-market loan rules,
such as a gift loan, compensation-related loan,
or corporation-shareholder loan, then both par-
ties are subject to the below-market loan rules
rather than the unstated interest rules.
Unstated interest reduces the stated selling
price of the property and the buyer's basis in the
property. It increases the seller's interest in-
come and the buyer's interest expense.
In general, an installment sale contract pro-
vides for adequate stated interest if the stated
interest rate (based on an appropriate com-
pounding period) is at least equal to the appli-
cable federal rate (AFR).
The AFRs are published monthly in the
Internal Revenue Bulletin (IRB). You
can access the IRBs at IRS.gov/uac/
irs-guidance.
More information. For more information,
see Unstated Interest and Original Issue Dis-
count (OID) in Pub. 537.
Example
On January 3, 2017, you sold your farm, includ-
ing the home, farm land, and buildings. You re-
ceived $50,000 down and the buyer's note for
$200,000. In addition, the buyer assumed an
outstanding $50,000 mortgage on the farm
land. The total selling price was $300,000. The
note payments of $25,000 each, plus adequate
interest, are due every July 1 and January 1,
beginning in July 2017. Your selling expenses
were $15,000.
Adjusted basis and depreciation. The adjus-
ted basis and depreciation claimed on each as-
set sold are as follows:
Seller's Depreciation Adjusted
Asset Basis Claimed Basis
,
Home* $33,743 -0- $33,743
Farm land 73,610 -0- 73,610
Buildings 66,630 $31,500 35,130
* Owned and used as main home for at least 2 of the 5 years
prior to the sale
Adjusted basis for installment sale purpo-
ses. To determine the adjusted basis for in-
stallment sale purposes, add the selling ex-
pense to the adjusted basis (see above).
Selling
Expense
Adjusted
Basis
Adjusted
Basis for
Installment
Sale
Home* $3,000 $33,743 $36,743
Farm land 8,250 73,610 81,860
Buildings 3,750 35,130 38,880
$15,000 $142,483 $157,483
* Owned and used as main home for at least 2 of the 5 years
prior to the sale
Depreciation recapture. The buildings are
section 1250 property. There is no depreciation
recapture income for them because they were
depreciated using the straight line method. See
chapter 9 for more information on depreciation
recapture.
Special rules may apply when you sell sec-
tion 1250 assets depreciated under the straight
line method. See the Unrecaptured Section
1250 Gain Worksheet in the Instructions for
Schedule D (Form 1040). See chapter 3 of Pub.
544 for more information on section 1250 as-
sets.
Gross profit. The following table shows each
asset reported on the installment method, its
selling price, adjusted basis for installment sale,
excluded gain, and gross profit.
Selling Adjusted Gross
Price Basis Gain Profit
Home $60,000 $36,743 $23,257 $ 0
Farm land 165,000 81,860 83,140 83,140
Buildings 75,000 38,880 36,120 36,120
$300,000 $157,483 $142,517 $119,260
Home. The gain on the home is excluded
from your income because it qualifies for the ex-
clusion of gain from the sale of a principal resi-
dence. Therefore, do not include that gain when
you figure your gross profit percentage.
Section 1231 gains. The gain on the farm
land and buildings is reported as section 1231
gains. See Section 1231 Gains and Losses in
chapter 9.
Contract price and gross profit percentage.
The contract price is $250,000. This is calcula-
ted by subtracting the $50,000 mortgage as-
sumed from the $300,000 selling price.
Gross profit percentage for the sale is
47.704% ($119,260 gross profit ÷ $250,000
contract price). The gross profit percentage for
each asset is figured as follows:
Percent
Home 0
Farm land ($83,140 ÷ $250,000) 33.256
Buildings ($36,120 ÷ $250,000) 14.448
Total 47.704
Figuring the gain to report on the install-
ment method. One hundred percent (100%)
of each payment is reported on the installment
method. The total amount received on the sale
in 2017 is $75,000 ($50,000 down payment +
$25,000 payment on July 1). The installment
sale part of the total payments received in 2017
is also $75,000. Figure the gain to report for
each asset by multiplying its gross profit per-
centage times $75,000.
Income
Home $0
Farm land—33.256% × $75,000 24,942
Buildings—14.448% × $75,000 10,836
Total installment income for 2017 $35,778
Reporting the sale. Report the installment
sale on Form 6252. Then report the amounts
from Form 6252 on Form 4797 and Schedule D
(Form 1040). Attach a separate page to Form
6252 that shows the computations in the exam-
ple.
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Chapter 10 Installment Sales Page 63
If you sell depreciable business prop-
erty, prepare Form 4797 first in order to
figure the amount to enter on Form
6252.
Section 1231 gains. The gains on the farm
land and buildings are section 1231 gains. They
are combined with any other section 1231 gains
and losses. A net section 1231 gain is capital
gain and a net section 1231 loss is an ordinary
loss.
Installment income for years after 2017.
You figure installment income for the years after
2017 by applying the same gross profit percen-
tages to the payments you receive each year. If
you receive $50,000 during the year, the entire
$50,000 is considered received on the install-
ment sale (100% × $50,000). You realize in-
come as follows:
Income
Home $0
Farm land—33.256% × $50,000 16,628
Buildings—14.448% × $50,000 7,224
Total installment income $23,852
In this example, no gain ever is recognized
from the sale of your home. You will combine
your section 1231 gains from this sale with sec-
tion 1231 gains and losses from other sales in
each of the later years to determine whether to
report them as ordinary or capital gains. The in-
terest received with each payment will be inclu-
ded in full as ordinary income.
Summary. The installment income (roun-
ded to the nearest dollar) from the sale of the
farm is reported as follows:
Selling price $300,000
Minus: Adjusted basis for installment
reporting
(157,483)
Minus: Excluded gain from home (23,257)
Gross profit $119,260
Gain reported in 2017 (year of sale) $35,778
Gain reported in 2018:
$50,000 × 47.704% 23,852
Gain reported in 2019:
$50,000 × 47.704% 23,852
Gain reported in 2020:
$50,000 × 47.704% 23,852
Gain reported in 2021:
$25,000 × 47.704% 11,926
Total gain reported $119,260
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11.
Casualties,
Thefts, and
Condemnations
What’s New for 2017
Disaster losses. A new Section D has been
added to Form 4684 to make an election (or re-
voke a prior election) to deduct a loss attributa-
ble to a federally declared disaster in the tax
year immediately before the disaster year. See
Pub. 547 for more information about disaster
losses.
Introduction
This chapter explains the tax treatment of casu-
alties, thefts, and condemnations. A casualty
occurs when property is damaged, destroyed,
or lost due to a sudden, unexpected, or unusual
event. A theft occurs when property is stolen. A
condemnation occurs when private property is
legally taken for public use without the owner's
consent. A casualty, theft, or condemnation
may result in a deductible loss or taxable gain
on your federal income tax return. You may
have a deductible loss or a taxable gain even if
only a portion of your property was affected by
a casualty, theft, or condemnation.
An involuntary conversion occurs when you
receive money or other property as reimburse-
ment for a casualty, theft, condemnation, dispo-
sition of property under threat of condemnation,
or certain other events discussed in this chap-
ter.
If an involuntary conversion results in a gain
and you buy qualified replacement property
within the specified replacement period, you
can postpone reporting the gain on your income
tax return. For more information, see Postpon-
ing Gain, later.
Topics
This chapter discusses:
Casualties and thefts
How to figure a loss or gain
Other involuntary conversions
Postponing gain
Disaster area losses
Reporting gains and losses
Drought involving property connected with
a trade or business or a transaction
entered into for profit
Useful Items
You may want to see:
Publication
Selling Your Home 523
Taxable and Nontaxable Income
Net Operating Losses (NOLs) for
Individuals, Estates, and Trusts
Sales and Other Dispositions of
Assets
Casualties, Disasters, and Thefts
Casualty, Disaster, and Theft Loss
Workbook (Personal-Use Property)
Business Casualty, Disaster, and
Theft Loss Workbook
Form (and Instructions)
Itemized
Deductions
Capital Gains and
Losses
Profit or Loss From
Farming
Casualties and Thefts
Sales of Business Property
See chapter 16 for information about getting
publications and forms.
Casualties and Thefts
If your property is destroyed, damaged, or sto-
len, you may have a deductible loss. If the in-
surance or other reimbursement is more than
the adjusted basis of the destroyed, damaged,
or stolen property, you may have a taxable gain.
Casualty. A casualty is the damage, destruc-
tion, or loss of property resulting from an identi-
fiable event that is sudden, unexpected, or un-
usual.
A sudden event is one that is swift, not
gradual or progressive.
An unexpected event is one that is ordina-
rily unanticipated and unintended.
An unusual event is one that isn't a
day-to-day occurrence and that isn't typical
of the activity in which you were engaged.
Deductible losses. Deductible casualty
losses can result from a number of different
causes, including the following.
Airplane crashes.
Car, truck, or farm equipment accidents
not resulting from your willful act or willful
negligence.
Earthquakes.
Fires (but see Nondeductible losses next
for exceptions).
Floods.
Freezing.
Government-ordered demolition or reloca-
tion of a home that is unsafe to use be-
cause of a disaster as discussed under
Disaster Area Losses, in Pub. 547.
Lightning.
Storms, including hurricanes and torna-
does.
Terrorist attacks.
Vandalism.
Volcanic eruptions.
525
536
544
547
584
584-B
Sch A (Form 1040)
Sch D (Form 1040)
Sch F (Form 1040)
4684
4797
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Page 64 Chapter 11 Casualties, Thefts, and Condemnations
Nondeductible losses. A casualty loss
isn't deductible if the damage or destruction is
caused by the following.
Accidentally breaking articles such as
glassware or china under normal condi-
tions.
A family pet (explained below).
A fire if you willfully set it, or pay someone
else to set it.
A car, truck, or farm equipment accident if
your willful negligence or willful act caused
it. The same is true if the willful act or willful
negligence of someone acting for you
caused the accident.
Progressive deterioration (explained be-
low).
Family pet. Loss of property due to dam-
age by a family pet isn't deductible as a casu-
alty loss unless the requirements discussed
above under Casualty are met.
Example. You keep your horse in your
yard. The ornamental fruit trees in your yard
were damaged when your horse stripped the
bark from them. Some of the trees were com-
pletely girdled and died. Because the damage
wasn't unexpected or unusual, the loss isn't de-
ductible.
Progressive deterioration. Loss of prop-
erty due to progressive deterioration isn't de-
ductible as a casualty loss. This is because the
damage results from a steadily operating cause
or a normal process, rather than from a sudden
event. Examples of damage due to progressive
deterioration include damage from rust, corro-
sion, or termites. However, weather-related
conditions or disease may cause another type
of involuntary conversion. See Other Involun-
tary Conversions, later.
Theft. A theft is the taking and removing of
money or property with the intent to deprive the
owner of it. The taking of property must be ille-
gal under the law of the state where it occurred
and it must have been done with criminal intent.
You don't need to show a conviction for theft.
Theft includes the taking of money or prop-
erty by the following means:
Blackmail,
Burglary,
Embezzlement,
Extortion,
Kidnapping for ransom,
Larceny,
Robbery,
Threats, or
Timber trespass.
The taking of money or property through fraud
or misrepresentation is theft if it is illegal under
state or local law.
Decline in market value of stock. You
can't deduct as a theft loss the decline in market
value of stock acquired on the open market for
investment if the decline is caused by disclo-
sure of accounting fraud or other illegal miscon-
duct by the officers or directors of the corpora-
tion that issued the stock. However, you can
deduct as a capital loss the loss you sustain
when you sell or exchange the stock or the
stock becomes completely worthless. You re-
port a capital loss on Schedule D (Form 1040).
For more information about stock sales,
worthless stock, and capital losses, see chap-
ter 4 of Pub. 550.
Mislaid or lost property. The simple dis-
appearance of money or property isn't a theft.
However, an accidental loss or disappearance
of property can qualify as a casualty if it results
from an identifiable event that is sudden, unex-
pected, or unusual.
Example. A car door is accidentally slam-
med on your hand, breaking the setting of your
diamond ring. The diamond falls from the ring
and is never found. The loss of the diamond is a
casualty.
Farming Losses
You can deduct certain casualty or theft losses
that occur in the business of farming. The fol-
lowing is a discussion of some losses you can
deduct and some you can't deduct.
Livestock or produce bought for resale.
Casualty or theft losses of livestock or produce
bought for resale are deductible if you report
your income on the cash method. If you report
your income on an accrual method, take casu-
alty and theft losses on property bought for re-
sale by omitting the item from the closing inven-
tory for the year of the loss. You can't take a
separate deduction.
Livestock, plants, produce, and crops
raised for sale. Losses of livestock, plants,
produce, and crops raised for sale are generally
not deductible if you report your income on the
cash method. You have already deducted the
cost of raising these items as farm expenses,
so their basis is equal to zero.
For plants with a preproductive period of
more than 2 years, you may have a deductible
loss if you have a tax basis in the plants. You
usually have a tax basis if you capitalized the
expenses associated with these plants under
the uniform capitalization rules. The uniform
capitalization rules are discussed in chapter 6.
If you report your income on an accrual
method, casualty or theft losses are deductible
only if you included the items in your inventory
at the beginning of your tax year. You get the
deduction by omitting the item from your inven-
tory at the close of your tax year. You can't take
a separate casualty or theft deduction.
Income loss. A loss of future income isn't de-
ductible.
Example. A severe flood destroyed your
crops. Because you are a cash method tax-
payer and already deducted the cost of raising
the crops as farm expenses, this loss isn't de-
ductible, as explained above under Livestock,
plants, produce, and crops raised for sale. You
estimate that the crop loss will reduce your farm
income by $25,000. This loss of future income
is also not deductible.
Loss of timber. If you sell timber downed as a
result of a casualty, treat the proceeds from the
sale as a reimbursement. If you use the pro-
ceeds to buy qualified replacement property,
you can postpone reporting the gain. See Post-
poning Gain, later.
Property used in farming. Casualty and theft
losses of property used in your farm business
usually result in deductible losses. If a fire or
storm destroyed your barn, or you lose by casu-
alty or theft farm equipment or an animal you
bought for draft, breeding, dairy, or sport, you
may have a deductible loss. See How To Figure
a Loss, later.
Raised draft, breeding, dairy, or sporting
animals. Generally, losses of raised draft,
breeding, dairy, or sporting animals don't result
in deductible casualty or theft losses because
you have no basis in the animals. However, you
may have a basis in the animal and therefore
may be able to claim a deduction if you use in-
ventories to determine your income and you in-
cluded the animals in your inventory.
When you include livestock in inventory, its
last inventory value is its basis. When you lose
an inventoried animal held for draft, breeding,
dairy, or sport by casualty or theft during the
year, decrease ending inventory by the amount
you included in inventory for the animal. You
can't take a separate deduction.
How To Figure a Loss
How you figure a deductible casualty or theft
loss depends on whether the loss was to farm
or personal-use property and whether the prop-
erty was stolen or partly or completely de-
stroyed.
Farm property. Farm property is the property
you use in your farming business. If your farm
property was completely destroyed or stolen,
your loss is figured as follows:
Your adjusted basis in the property
MINUS
Any salvage value
MINUS
Any insurance or other reimbursement you
receive or expect to receive
You can use the schedules in Pub.
584-B to list your stolen, damaged, or
destroyed business property and to fig-
ure your loss.
If your farm property was partially damaged,
use the steps shown under Personal-use prop-
erty next to figure your casualty loss. However,
the deduction limits, discussed later, don't apply
to farm property.
Personal-use property. Personal-use prop-
erty is property used by you or your family
members for personal purposes and not used in
your farm business or for income-producing
purposes. The following items are examples of
personal-use property:
Your main home.
Furniture and electronics used in your
main home and not used in a home office
or for business purposes.
Clothing and jewelry.
An automobile used for nonbusiness pur-
poses.
You figure the casualty or theft loss on this
property by taking the following steps.
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Chapter 11 Casualties, Thefts, and Condemnations Page 65
1. Determine your adjusted basis in the prop-
erty before the casualty or theft.
2. Determine the decrease in fair market
value of the property as a result of the
casualty or theft.
3. From the smaller of the amounts you de-
termined in (1) and (2), subtract any insur-
ance or other reimbursement you receive
or expect to receive.
You must apply the deduction limits, discussed
later, to determine your deductible loss.
You can use Pub. 584 to list your sto-
len or damaged personal-use property
and figure your loss. It includes sched-
ules to help you figure the loss on your home,
its contents, and your motor vehicles.
Adjusted basis. Adjusted basis is your ba-
sis (usually cost) increased or decreased by
various events, such as improvements and
casualty losses. For more information about ad-
justed basis, see chapter 6.
Decrease in fair market value (FMV).
The decrease in FMV is the difference between
the property's value immediately before the
casualty or theft and its value immediately after-
ward. FMV is defined in chapter 10 under Pay-
ments Received or Considered Received.
Appraisal. To figure the decrease in FMV
because of a casualty or theft, you generally
need a competent appraisal. But other meas-
ures, such as the cost of cleaning up or making
repairs (discussed next) can be used to estab-
lish decreases in FMV.
An appraisal to determine the difference be-
tween the FMV of the property immediately be-
fore a casualty or theft and immediately after-
ward should be made by a competent
appraiser. The appraiser must recognize the ef-
fects of any general market decline that may oc-
cur along with the casualty. This information is
needed to limit any deduction to the actual loss
resulting from damage to the property.
Note. Several factors are important in eval-
uating the accuracy of an appraisal. See Pub.
547 for additional details regarding appraisals.
Cost of cleaning up or making repairs.
The cost of cleaning up after a casualty isn't
part of a casualty loss. Neither is the cost of re-
pairing damaged property after a casualty. But
you can use the cost of cleaning up or making
repairs after a casualty as a measure of the de-
crease in FMV if you meet all the following con-
ditions.
The repairs are actually made.
The repairs are necessary to bring the
property back to its condition before the
casualty.
The amount spent for repairs isn't exces-
sive.
The repairs fix the damage only.
The value of the property after the repairs
is not, due to the repairs, more than the
value of the property before the casualty.
Landscaping. The cost of restoring land-
scaping to its original condition after a casualty
may indicate the decrease in FMV. You may be
TIP
able to measure your loss by what you spend
on the following.
Removing destroyed or damaged trees
and shrubs, minus any salvage you re-
ceive.
Pruning and other measures taken to pre-
serve damaged trees and shrubs.
Replanting necessary to restore the prop-
erty to its approximate value before the
casualty.
Related expenses. The incidental expen-
ses due to a casualty or theft, such as expen-
ses for the treatment of personal injuries, tem-
porary housing, or a rental car, aren't part of
your casualty or theft loss. However, they may
be deductible as farm business expenses if the
damaged or stolen property is farm property.
Separate computations for more than one
item of property. Generally, if a single casu-
alty or theft involves more than one item of
property, you must figure your loss separately
for each item of property. Then combine the los-
ses to determine your total loss.
There is an exception to this rule for
personal-use real property. See Excep-
tion for personal-use real property,
later.
Example. A fire on your farm damaged a
tractor and the barn in which it was stored. The
tractor had an adjusted basis of $3,300. Its FMV
was $28,000 just before the fire and $10,000
immediately afterward. The barn had an adjus-
ted basis of $28,000. Its FMV was $55,000 just
before the fire and $25,000 immediately after-
ward. You received insurance reimbursements
of $2,100 on the tractor and $26,000 on the
barn. Figure your deductible casualty loss sepa-
rately for the two items of property.
Tractor Barn
1) Adjusted basis ......... $3,300 $28,000
2) FMV before fire ......... $28,000 $55,000
3) FMV after fire .......... 10,000 25,000
4) Decrease in FMV
(line 2 − line 3) ......... $18,000 $30,000
5) Loss (lesser of line 1 or
line 4) ............... $3,300 $28,000
6) Minus: Insurance ....... 2,100 26,000
7) Deductible casualty loss ... $1,200 $2,000
8) Total deductible casualty loss .... $3,200
You spent $10,800 restoring the tractor to its
pre-casualty condition and $30,000 restoring
the barn to its pre-casualty condition. Your ad-
justed basis in the tractor after the casualty is
$10,800 ($3,300 – $2,100 – $1,200 + $10,800).
Your adjusted basis in the barn after the casu-
alty is $30,000 ($28,000 – $26,000 – $2,000 +
$30,000).
Exception for personal-use real prop-
erty. In figuring a casualty loss on per-
sonal-use real property, the entire property (in-
cluding any improvements, such as buildings,
trees, and shrubs) is treated as one item. Figure
the loss using the smaller of the following.
The decrease in FMV of the entire prop-
erty.
The adjusted basis of the entire property.
CAUTION
!
Example. You bought a farm in 2000 for
$80,000. The adjusted basis of the residential
part is now $64,000. In 2017, a windstorm blew
down shade trees and three ornamental trees
planted at a cost of $3,750 on the residential
part. The adjusted basis of the residential part
includes the $3,750. The FMV of the residential
part immediately before the storm was
$200,000, and $192,500 immediately after the
storm. The trees were not covered by insur-
ance.
1) Adjusted basis ................ $64,000
2) FMV before the storm ........... $200,000
3) FMV after the storm ............. 192,500
4) Decrease in FMV (line 2 − line 3) $7,500
5) Loss before insurance
(lesser of line 1 or line 4) .......... $7,500
6) Minus: Insurance .............. -0-
7) Loss before applying limits .... $7,500
As explained later under Deduction Limits on Losses of
Personal-Use Property, you have to reduce $7,500 by
$100 and 10% of your adjusted gross income (AGI) to
get your deductible loss. Thus, your deductible loss is
figured as follows.
8) Subtract $100 ................. $100
9) Loss after the $100 rule .......... $7,400
10) Subtract 10% (0.10) x $60,000
AGI ........................ 6,000
11) Casualty loss deduction ...... $1,400
You never replaced the trees. Your adjusted
basis in the residential part of your property af-
ter the casualty is $62,600 ($64,000 – $1,400).
Insurance and other reimbursements. If you
receive an insurance or other type of reimburse-
ment, you must subtract the reimbursement
when you figure your loss. You don't have a
casualty or theft loss to the extent you are reim-
bursed.
If you expect to be reimbursed for part or all
of your loss, you must subtract the expected re-
imbursement when you figure your loss. You
must reduce your loss even if you don't receive
payment until a later tax year.
Don't subtract from your loss any insur-
ance payments you receive for living
expenses if you lose the use of your
main home or are denied access to it because
of a casualty. You may have to include a portion
of these payments in your income. See Insur-
ance payments for living expenses in Pub. 547
for details.
Disaster relief. Food, medical supplies,
and other forms of assistance you receive don't
reduce your casualty loss, unless they are re-
placements for lost or destroyed property. Ex-
cludable cash gifts you receive also do not re-
duce your casualty loss if there are no limits on
how you can use the money.
Generally, disaster relief grants received un-
der the Robert T. Stafford Disaster Relief and
Emergency Assistance Act aren't included in
your income. See Federal disaster relief grants,
later, under Disaster Area Losses.
Qualified disaster relief payments for expen-
ses you incurred as a result of a federally de-
clared disaster aren't taxable income to you.
See Qualified disaster relief payments, later,
under Disaster Area Losses.
CAUTION
!
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Page 66 Chapter 11 Casualties, Thefts, and Condemnations
Reimbursement received after deduct-
ing loss. If you figure your casualty or theft
loss using your expected reimbursement, you
may have to adjust your tax return for the tax
year in which you get your actual reimburse-
ment.
Actual reimbursement less than expec-
ted. If you later receive less reimbursement
than you expected, include that difference as a
loss with your other losses (if any) on your re-
turn for the year in which you can reasonably
expect no more reimbursement.
Actual reimbursement more than expec-
ted. If you later receive more reimbursement
than you expected after you have claimed a de-
duction for the loss, you may have to include
the extra reimbursement in your income for the
year you receive it. However, if any part of your
original deduction didn't reduce your tax for the
earlier year, don't include that part of the reim-
bursement in your income. Don't refigure your
tax for the year you claimed the deduction. See
Recoveries in Pub. 525 to find out how much
extra reimbursement to include in income.
If the total of all the reimbursements
you receive is more than your adjusted
basis in the destroyed or stolen prop-
erty, you will have a gain on the casualty or
theft. See Figuring a Gain in Pub. 547 for infor-
mation on how to treat a gain from the reim-
bursement you receive because of a casualty or
theft.
Actual reimbursement same as expec-
ted. If you later receive exactly the reimburse-
ment you expected to receive, you don't have to
include any of the reimbursement in your in-
come and you can't deduct any additional loss.
Lump-sum reimbursement. If you have a
casualty or theft loss of several assets at the
same time without an allocation of reimburse-
ment to specific assets, divide the lump-sum re-
imbursement among the assets according to
the fair market value of each asset at the time of
the loss. Figure the gain or loss separately for
each asset that has a separate basis.
Adjustments to basis. If you have a casualty
or theft loss, you must decrease your basis in
the property by any insurance or other reim-
bursement you receive and by any deductible
loss. The result is your adjusted basis in the
property. If you make either of the basis adjust-
ments described above, amounts you spend on
repairs to restore your property to its pre-casu-
alty condition increase your adjusted basis. See
Adjusted Basis in chapter 6 for more informa-
tion.
Example. You built a new grain storage fa-
cility for $50,000. This is the basis in your grain
storage facility because that is the total cost you
incurred to build it. During the year, a tornado
damaged your grain storage facility and your al-
lowable casualty loss deduction was $2,000. In
addition, your insurance company reimbursed
you $8,000 for the damage and you spent
$12,000 to restore the grain storage facility to
its pre-casualty condition. Your adjusted basis
in the grain storage facility after the casualty is
$52,000 ($50,000 - $2,000 - $8,000 + $12,000).
CAUTION
!
Deduction Limits on Losses
of Personal-Use Property
Casualty and theft losses of property held for
personal use may be deductible if you itemize
deductions on Schedule A (Form 1040).
There are two limits on the deduction for
casualty or theft loss of personal-use property.
You figure these limits on Form 4684.
$100 rule. You must reduce each casualty or
theft loss on personal-use property by $100.
This rule applies after you have subtracted any
reimbursement.
10% rule. You must further reduce the total of
all your casualty or theft losses on personal-use
property by 10% of your adjusted gross income.
Apply this rule after you reduce each loss by
$100. Adjusted gross income is on line 38 of
Form 1040.
Example. In June, you discovered that your
house had been burglarized. Your loss after in-
surance reimbursement was $2,000. Your ad-
justed gross income for the year you discovered
the burglary is $57,000. Figure your theft loss
deduction as follows:
1) Loss after insurance ............... $2,000
2) Subtract $100 .................... 100
3) Loss after $100 rule ................ $1,900
4) Subtract 10% (0.10) × $57,000 AGI ..... $5,700
5) Theft loss deduction .......... -0-
You don't have a theft loss deduction be-
cause your loss ($1,900) is less than 10% of
your adjusted gross income ($5,700).
If you have a casualty or theft gain in
addition to a loss, you will have to
make a special computation before you
figure your 10% limit. See 10% Rule in Pub.
547.
When Loss Is Deductible
Generally, you can deduct casualty losses that
aren't reimbursable only in the tax year in which
they occur. You generally can deduct theft los-
ses that aren't reimbursable only in the year you
discover your property was stolen.
Example. In November 2016, engine parts
were stolen from Frank’s stored tractor. Frank
did not know that the theft occurred until March
2017, when he attempted to start the tractor.
Any theft loss to which Frank is entitled as a de-
duction will be deductible in the 2017 tax year.
Losses in federally declared disaster areas
are subject to different rules. See Disaster Area
Losses, later, for an exception.
If you aren't sure whether part of your casu-
alty or theft loss will be reimbursed, don't de-
duct that part until the tax year when you be-
come reasonably certain that it will not be
reimbursed.
Leased property. If you lease property from
someone else, you can deduct a loss on the
property in the year your liability for the loss is
determined. This is true even, if the loss occur-
CAUTION
!
red or the liability was paid in a different year.
You aren't entitled to a deduction until your lia-
bility under the lease can be determined with
reasonable accuracy. Your liability can be de-
termined when a claim for recovery is settled,
adjudicated, or abandoned.
Example. Robert leased a tractor from First
Implement, Inc., for use in his farm business.
The tractor was destroyed by a tornado in June
2016. The loss was not insured. First Implement
billed Robert for the fair market value of the
tractor on the date of the loss. Robert disagreed
with the bill and refused to pay it. First Imple-
ment later filed suit in court against Robert. In
2017, Robert and First Implement agreed to
settle the suit for $20,000, and the court entered
a judgment in favor of First Implement. Robert
paid $20,000 in June 2017. He can claim the
$20,000 as a loss on his 2017 tax return.
Net operating loss (NOL). If your deductions,
including casualty or theft loss deductions, are
more than your income for the year, you may
have an NOL. An NOL can be carried back or
carried forward and deducted from income in
other years. See Pub. 536 for more information
on NOLs.
Proof of Loss
To deduct a casualty or theft loss, you must be
able to prove that there was a casualty or theft.
You must have records to support the amount
you claim for the loss.
Casualty loss proof. For a casualty loss, your
records should show all the following informa-
tion.
That you were the owner of the property or,
if you leased the property from someone
else, that you were contractually liable to
the owner for the damage.
The type of casualty (car accident, fire,
storm, etc.) and when it occurred.
That the loss was a direct result of the
casualty.
Whether a claim for reimbursement exists
for which there is a reasonable expectation
of recovery.
Theft loss proof. For a theft loss, your records
should show all the following information.
That you were the owner of the property.
That your property was stolen.
When you discovered your property was
missing.
Whether a claim for reimbursement exists
for which there is a reasonable expectation
of recovery.
Figuring a Gain
A casualty or theft may result in a taxable gain.
If you receive an insurance payment or other re-
imbursement that is more than your adjusted
basis in the destroyed, damaged, or stolen
property, you have a gain from the casualty or
theft. You generally report your gain as income
in the year you receive the reimbursement.
However, depending on the type of property
you receive, you may not have to report your
gain. See Postponing Gain, later.
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Chapter 11 Casualties, Thefts, and Condemnations Page 67
Your gain is figured as follows:
The amount you receive, minus
Your adjusted basis in the property at the
time of the casualty or theft.
Even if the decrease in FMV of your prop-
erty is smaller than the adjusted basis of your
property, use your adjusted basis to figure the
gain.
Amount you receive. The amount you receive
includes any money plus the value of any prop-
erty you receive, minus any expenses you have
in obtaining reimbursement. It also includes any
reimbursement used to pay off a mortgage or
other lien on the damaged, destroyed, or stolen
property.
Example. A tornado severely damaged
your barn. The adjusted basis of the barn was
$25,000. Your insurance company reimbursed
you $40,000 for the damaged barn. However,
you had legal expenses of $2,000 to collect that
insurance. Your insurance minus your expen-
ses to collect the insurance is more than your
adjusted basis in the barn, so you have a gain.
1) Insurance reimbursement .......... $40,000
2) Legal expenses ................. 2,000
3) Amount received
(line 1 − line 2) .................. $38,000
4) Adjusted basis .................. 25,000
5) Gain on casualty (line 3 − line 4) .... $13,000
The adjusted basis of the barn after the
casualty is $0 ($25,000 + $13,000 - $38,000) if
you recognized gain and did not repair the barn.
Other Involuntary
Conversions
In addition to casualties and thefts, other events
cause involuntary conversions of property.
Some of these are discussed in the following
paragraphs.
Gain or loss from an involuntary conversion
of your property is usually recognized for tax
purposes. You report the gain or deduct the
loss on your tax return for the year you realize it.
However, depending on the type of property
you receive, you may not have to report your
gain on the involuntary conversion. See Post-
poning Gain, later.
Condemnation
Condemnation is the process by which private
property is legally taken for public use without
the owner's consent. The property may be
taken by the federal government, a state gov-
ernment, a political subdivision, or a private or-
ganization that has the power to legally take
property. The owner receives a condemnation
award (money or property) in exchange for the
property taken. A condemnation is a forced
sale, the owner being the seller and the con-
demning authority being the buyer.
Threat of condemnation. Treat the sale of
your property under threat of condemnation as
a condemnation, provided you have reasonable
grounds to believe that your property will be
condemned.
Main home condemned. If you have a gain
because your main home is condemned, you
generally can exclude the gain from your in-
come as if you had sold or exchanged your
home. For information on this exclusion, see
Pub. 523. If your gain is more than the amount
you can exclude, but you buy replacement
property, you may be able to postpone report-
ing the excess gain. See Postponing Gain,
later. (You can't deduct a loss from the condem-
nation of your main home.)
More information. For information on how to
figure the gain or loss on condemned property,
see chapter 1 in Pub. 544. Also see Postponing
Gain, later, to find out if you can postpone re-
porting the gain.
Irrigation Project
The sale or other disposition of property located
within an irrigation project to conform to the
acreage limits of federal reclamation laws is an
involuntary conversion.
Livestock Losses
Diseased livestock. If your livestock die from
disease, or are destroyed, sold, or exchanged
because of disease, even though the disease
isn't of epidemic proportions, treat these occur-
rences as involuntary conversions. If the live-
stock were raised or purchased for resale, fol-
low the rules for livestock discussed earlier
under Farming Losses. Otherwise, figure the
gain or loss from these conversions using the
rules discussed under Determining Gain or
Loss in chapter 8. If you replace the livestock,
you may be able to postpone reporting the gain.
See Postponing Gain below.
Reporting dispositions of diseased live-
stock. If you choose to postpone reporting
gain on the disposition of diseased livestock,
you must attach a statement to your return ex-
plaining that the livestock were disposed of be-
cause of disease. You must also include other
information on this statement. See How To
Postpone Gain, later, under Postponing Gain.
Weather-related sales of livestock. If you
sell or exchange livestock (other than poultry)
held for draft, breeding, or dairy purposes solely
because of drought, flood, or other weather-re-
lated conditions, treat the sale or exchange as
an involuntary conversion. Only livestock sold in
excess of the number you normally would sell
under usual business practice, in the absence
of weather-related conditions, are considered
involuntary conversions. Figure the gain or loss
using the rules discussed under Determining
Gain or Loss in chapter 8. If you replace the
livestock, you may be able to postpone report-
ing the gain. See Postponing Gain below.
Example. It is your usual business practice
to sell five of your dairy animals during the year.
This year you sold 20 dairy animals because of
drought. The sale of 15 animals is treated as an
involuntary conversion.
If you don't replace the livestock, you
may be able to report the gain in the
following year's income. This rule also
applies to other livestock (including poultry).
See Sales Caused by Weather-Related Condi-
tions in chapter 3.
Tree Seedlings
If, because of an abnormal drought, the failure
of planted tree seedlings is greater than nor-
mally anticipated, you may have a deductible
loss. Treat the loss as a loss from an involuntary
conversion. The loss equals the previously cap-
italized reforestation costs you had to duplicate
on replanting. You deduct the loss on the return
for the year the seedlings died.
Postponing Gain
Don't report a gain if you receive reimbursement
in the form of property similar or related in serv-
ice or use to the destroyed, stolen, or other in-
voluntarily converted property. Your basis in the
new property is generally the same as your ad-
justed basis in the property it replaces.
You must ordinarily report the gain on your
stolen, destroyed, or other involuntarily conver-
ted property if you receive money or unlike
property as reimbursement. However, you can
choose to postpone reporting the gain if you
purchase replacement property similar or rela-
ted in service or use to your destroyed, stolen,
or other involuntarily converted property within
a specific replacement period.
If you have a gain on damaged property,
you can postpone reporting the gain if you
spend the reimbursement to restore the prop-
erty.
To postpone reporting all the gain, the cost
of your replacement property must be at least
as much as the reimbursement you receive. If
the cost of the replacement property is less than
the reimbursement, you must include the gain in
your income up to the amount of the unspent re-
imbursement.
Example 1. In 1985, you constructed a
barn to store farm equipment at a cost of
$35,000. In 1990, you added a grain bin to the
barn at a cost of $15,000. In May of this year,
the property was worth $70,000. In June the
barn and grain storage facility were destroyed
by a tornado. At the time of the tornado, you
had an adjusted basis of $0 in the property. You
received $70,000 from the insurance company.
You had a gain of $70,000 ($70,000 – $0).
You spent $65,000 to rebuild the barn and
grain bin. Since this is less than the insurance
proceeds received, you must include $5,000
($70,000 – $65,000) in your income. You
choose to postpone the remaining $65,000
gain.
Example 2. In 1993, you bought a cabin in
the mountains for your personal use at a cost of
$48,000. You made no further improvements or
additions to it. When a storm destroyed the
TIP
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Page 68 Chapter 11 Casualties, Thefts, and Condemnations
cabin this January, the cabin was worth
$250,000. You received $146,000 from the in-
surance company in March. You had a gain of
$98,000 ($146,000 − $48,000).
You spent $144,000 to rebuild the cabin.
Since this is less than the insurance proceeds
received, you must include $2,000 ($146,000 −
$144,000) in your income. You choose to post-
pone reporting the remaining $96,000 gain.
Buying replacement property from a related
person. You can't postpone reporting a gain
from a casualty, theft, or other involuntary con-
version if you buy the replacement property
from a related person (discussed later). This
rule applies to the following taxpayers.
1. C corporations.
2. Partnerships in which more than 50% of
the capital or profits interest is owned by C
corporations.
3. Individuals, partnerships (other than those
in (2) above), and S corporations if the to-
tal realized gain for the tax year on all in-
voluntarily converted properties on which
there are realized gains is more than
$100,000.
For involuntary conversions described in (3)
above, gains can't be offset by any losses when
determining whether the total gain is more than
$100,000. If the property is owned by a partner-
ship, the $100,000 limit applies to the partner-
ship and each partner. If the property is owned
by an S corporation, the $100,000 limit applies
to the S corporation and each shareholder.
Exception. This rule does not apply if the
related person acquired the property from an
unrelated person within the period of time al-
lowed for replacing the involuntarily converted
property.
Related persons. Under this rule, related
persons include, for example, a parent and
child, a brother and sister, a corporation and an
individual who owns more than 50% of its out-
standing stock, and two partnerships in which
the same C corporations own more than 50% of
the capital or profits interests. For more infor-
mation on related persons, see Nondeductible
Loss under Sales and Exchanges Between Re-
lated Persons in chapter 2 of Pub. 544.
Death of a taxpayer. If a taxpayer dies after
realizing a gain, but before buying replacement
property, the gain must be reported for the year
in which the decedent realized the gain. The ex-
ecutor of the estate or the person succeeding to
the funds from the involuntary conversion can't
postpone reporting the gain by buying replace-
ment property.
Replacement Property
You must buy replacement property for the spe-
cific purpose of replacing your property. Your
replacement property must be similar or related
in service or use to the property it replaces. You
don't have to use the same funds you receive
as reimbursement for your old property to ac-
quire the replacement property. If you spend
the money you receive for other purposes, and
borrow money to buy replacement property,
you can still choose to postpone reporting the
gain if you meet the other requirements. Prop-
erty you acquire by gift or inheritance does not
qualify as replacement property.
Owner-user. If you are an owner-user, similar
or related in service or use means that replace-
ment property must function in the same way as
the property it replaces. Examples of property
that functions in the same way as the property it
replaces are a home that replaces another
home, a dairy cow that replaces another dairy
cow, and farm land that replaces other farm
land. A grinding mill that replaces a tractor does
not qualify. Neither does a draft animal that re-
places a breeding or dairy cow.
Soil or other environmental contamination.
If, because of soil or other environmental con-
tamination, it isn't feasible for you to reinvest
your insurance money or other proceeds from
destroyed or damaged livestock in property
similar or related in service or use to the live-
stock, you can treat other property (including
real property) used for farming purposes, as
property similar or related in service or use to
the destroyed or damaged livestock.
Weather-related conditions. If, because of
drought, flood, or other weather-related condi-
tions, it isn't feasible for you to reinvest the in-
surance money or other proceeds in property
similar or related in service or use to the live-
stock, you can treat other property (excluding
real property) used for farming purposes, as
property similar or related in service or use to
the livestock you disposed of.
Example. Each year you normally sell 25
cows from your beef herd. However, this year
you had to sell 50 cows. This is because a se-
vere drought significantly reduced the amount
of hay and pasture yield needed to feed your
herd for the rest of the year. Because, as a re-
sult of the severe drought, it isn't feasible for
you to use the proceeds from selling the extra
cows to buy new cows, you can treat other
property (excluding real property) used for farm-
ing purposes, as property similar or related in
service or use to the cows you sold.
Standing crop destroyed by casualty. If a
storm or other casualty destroyed your standing
crop and you use the insurance money to ac-
quire either another standing crop or a harves-
ted crop, this purchase qualifies as replacement
property. The costs of planting and raising a
new crop qualify as replacement costs for the
destroyed crop only if you use the crop method
of accounting (discussed in chapter 2). In that
case, the costs of bringing the new crop to the
same level of maturity as the destroyed crop
qualify as replacement costs to the extent they
are incurred during the replacement period.
Timber loss. Standing timber (not land) you
bought with the proceeds from the sale of tim-
ber downed as a result of a casualty, such as
high winds, earthquakes, or volcanic eruptions,
qualifies as replacement property. If you bought
the standing timber within the replacement pe-
riod, you can postpone reporting the gain.
Business or income-producing property lo-
cated in a federally declared disaster area.
If your destroyed business or income-producing
property was located in a federally declared dis-
aster area, any tangible replacement property
you acquire for use in any business is treated
as similar or related in service or use to the de-
stroyed property. For more information, see
Disaster Area Losses in Pub. 547.
Substituting replacement property. Once
you have acquired qualified replacement prop-
erty that you designate as replacement property
in a statement attached to your tax return, you
can't substitute other qualified replacement
property. This is true even if you acquire the
other property within the replacement period.
However, if you discover that the original re-
placement property was not qualified replace-
ment property, you can, within the replacement
period, substitute the new qualified replacement
property.
Basis of replacement property. You must re-
duce the cost basis of your replacement prop-
erty by the amount of postponed gain. In this
way, tax on the gain is postponed until you dis-
pose of the replacement property.
Example. In 2017, you sold 50 cows with a
$0 basis due to severe drought. This is more
than the 25 cows you normally sell each year.
The proceeds from the sale of additional 25
cows are $62,500. Because of the severe
drought, it is not feasible for you to use these
proceeds to buy new cows. Instead, you use
the proceeds to buy a cattle watering system for
$70,000. You choose to postpone reporting the
$62,500 gain ($62,500 – $0) from the sale of
the cows. Therefore, the basis of the cattle wa-
tering system is $7,500 ($70,000 – $62,500).
Replacement Period
To postpone reporting your gain, you must buy
replacement property within a specified period
of time. This is the replacement period.
The replacement period begins on the date
your property was damaged, destroyed, stolen,
sold, or exchanged. The replacement period
generally ends 2 years after the close of the first
tax year in which you realize any part of your
gain from the involuntary conversion.
Example. You are a calendar year tax-
payer. Farm equipment that cost $2,200 was
stolen from your farm. You discovered the theft
when you returned to your farm on November
11, 2016. Your insurance company investigated
the theft and did not settle your claim until Janu-
ary 5, 2017, when they paid you $3,000. You
first realized a gain from the reimbursement for
the theft during 2017, so you have until Decem-
ber 31, 2019, to replace the property.
Main home in disaster area. For your main
home (or its contents) located in a federally de-
clared disaster area, the replacement period
ends 4 years after the close of the first tax year
in which you realize any part of your gain from
the involuntary conversion. See Disaster Area
Losses, later.
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Chapter 11 Casualties, Thefts, and Condemnations Page 69
Weather-related sales of livestock in an
area eligible for federal assistance. For the
sale or exchange of livestock due to drought,
flood, or other weather-related conditions in an
area eligible for federal assistance, the replace-
ment period ends 4 years after the close of the
first tax year in which you realize any part of
your gain from the sale or exchange. The IRS
may extend the replacement period on a re-
gional basis if the weather-related conditions
continue for longer than 3 years.
For information on extensions of the re-
placement period because of persistent
drought, see Notice 2006-82, 2006-39 I.R.B.
529, available at
IRS.gov/irb/2006-39_IRB/ar11.html. For a list of
counties for which exceptional, extreme, or se-
vere drought was reported during the 12
months ending August 31, 2017, see Notice
2017-53, available at IRS.gov.
Condemnation. The replacement period for a
condemnation begins on the earlier of the fol-
lowing dates.
The date on which you disposed of the
condemned property.
The date on which the threat of condemna-
tion began.
The replacement period generally ends 2 years
after the close of the first tax year in which any
part of the gain on the condemnation is real-
ized. But see Main home in disaster area, ear-
lier, for an exception.
Business or investment real property. If
real property held for use in a trade or business
or for investment (not including property held
primarily for sale) is condemned, the replace-
ment period ends 3 years after the close of the
first tax year in which any part of the gain on the
condemnation is realized.
Extension. You can apply for an extension of
the replacement period. Send your written ap-
plication to the Internal Revenue Service Center
where you file your tax return. See your tax re-
turn instructions for the address. Include all the
details about your need for an extension. Make
your application before the end of the replace-
ment period. However, you can file an applica-
tion within a reasonable time after the replace-
ment period ends if you can show a good
reason for the delay. You will get an extension
of the replacement period if you can show rea-
sonable cause for not making the replacement
within the regular period.
How To Postpone Gain
You postpone reporting your gain by reporting
your choice on your tax return for the year you
have the gain. You have the gain in the year you
receive insurance proceeds or other reimburse-
ments that result in a gain.
Required statement. You should attach a
statement to your return for the year you have
the gain. This statement should include all the
following information.
The date and details of the casualty, theft,
or other involuntary conversion.
The insurance or other reimbursement you
received.
How you figured the gain.
Replacement property acquired before
return filed. If you acquire replacement prop-
erty before you file your return for the year you
have the gain, your statement should also in-
clude detailed information about all the follow-
ing items.
The replacement property.
The postponed gain.
The basis adjustment that reflects the
postponed gain.
Any gain you are reporting as income.
Replacement property acquired after re-
turn filed. If you intend to buy replacement
property after you file your return for the year
you realize gain, your statement should also
say that you are choosing to replace the prop-
erty within the required replacement period.
You should then attach another statement to
your return for the year in which you buy the re-
placement property. This statement should con-
tain detailed information on the replacement
property. If you acquire part of your replace-
ment property in one year and part in another
year, you must attach a statement to each
year's return. Include in the statement detailed
information on the replacement property bought
in that year.
Reporting weather-related sales of live-
stock. If you choose to postpone reporting the
gain on weather-related sales or exchanges of
livestock, show all the following information on
a statement attached to your return for the tax
year in which you first realize any of the gain.
Evidence of the weather-related conditions
that forced the sale or exchange of the live-
stock.
The gain realized on the sale or exchange.
The number and kind of livestock sold or
exchanged.
The number of livestock of each kind you
would have sold or exchanged under your
usual business practice.
Show all the following information and the
preceding information on the return for the year
in which you replace the livestock.
The dates you bought the replacement
property.
The cost of the replacement property.
Description of the replacement property
(for example, the number and kind of the
replacement livestock).
Amended return for changes regarding re-
placement property. You must file an amen-
ded return (Form 1040X) for the tax year of the
gain in either of the following situations.
You don't acquire replacement property
within the replacement period, plus exten-
sions. On this amended return, you must
report the gain and pay any additional tax
due.
You acquire replacement property within
the required replacement period, plus ex-
tensions, but at a cost less than the
amount you receive from the casualty,
theft, or other involuntary conversion. On
this amended return, you must report the
part of the gain that can't be postponed
and pay any additional tax due.
Disaster Area Losses
Special rules apply to federally declared disas-
ter area losses. A federally declared disaster is
a disaster that occurred in an area declared by
the President to be eligible for federal assis-
tance under the Robert T. Stafford Disaster Re-
lief and Emergency Assistance Act. It includes
a major disaster or emergency declaration un-
der the Act.
A list of the areas warranting public or
individual assistance (or both) under
the Act is available at the Federal
Emergency Management Agency (FEMA) web
site at FEMA.gov/Disasters.
This part discusses the special rules for
when to deduct a disaster area loss and what
tax deadlines may be postponed. For other spe-
cial rules, see Disaster Area Losses in Pub.
547.
Disaster year. The disaster year is the tax
year in which you sustained the loss attributable
to a federally declared disaster. Generally, a
disaster loss is sustained in the year the disas-
ter occurred. A disaster loss may also be sus-
tained in a year after the disaster occurred. For
example, if a claim for reimbursement exists for
which there is a reasonable prospect of recov-
ery, no part of the loss for which reimbursement
may be received is sustained until it can be as-
certained with reasonable certainty whether or
not you will be reimbursed.
When to deduct the loss. You generally must
deduct a casualty loss in the disaster year.
However, if you have a deductible loss from a
disaster that occurred in an area warranting
public or individual assistance (or both), you
can choose to deduct that loss on your return or
amended return for the tax year immediately
preceding the disaster year. If you make this
choice, the loss is treated as having occurred in
the preceding year.
Claiming a qualifying disaster loss on
the previous year's return may result in
a lower tax for that year, often produc-
ing or increasing a cash refund.
You must make the choice to take your
casualty loss for the disaster in the preceding
year on or before the date that is six months af-
ter the regular due date for filing your original re-
turn (without extensions) for the disaster year.
If you claimed a deduction for a disaster loss
in the disaster year and you wish to deduct the
loss in the preceding year, you must file an
amended return to remove the previously de-
ducted loss on or before you file the return or
amended return for the preceding year that in-
cludes the disaster loss deduction.
Federal disaster relief grants. Don't include
post-disaster relief grants received under the
Robert T. Stafford Disaster Relief and Emer-
gency Assistance Act in your income if the grant
payments are made to help you meet neces-
sary expenses or serious needs for medical,
dental, housing, personal property, transporta-
tion, or funeral expenses. Don't deduct casualty
losses or medical expenses to the extent they
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Page 70 Chapter 11 Casualties, Thefts, and Condemnations
are specifically reimbursed by these disaster re-
lief grants. If the casualty loss was specifically
reimbursed by the grant and you received the
grant after the year in which you deducted the
casualty loss, see Reimbursement received af-
ter deducting loss, earlier. Unemployment as-
sistance payments under the Act are taxable
unemployment compensation.
Qualified disaster relief payments. Qualified
disaster relief payments aren't included in the
income of individuals to the extent any expen-
ses compensated by these payments aren't
otherwise compensated for by insurance or
other reimbursement. These payments aren't
subject to income tax, self-employment tax, or
employment taxes (social security, Medicare,
and federal unemployment taxes). No withhold-
ing applies to these payments.
Qualified disaster relief payments include
payments you receive (regardless of the
source) for the following expenses.
Reasonable and necessary personal, fam-
ily, living, or funeral expenses incurred as a
result of a federally declared disaster.
Reasonable and necessary expenses in-
curred for the repair or rehabilitation of a
personal residence due to a federally de-
clared disaster. (A personal residence can
be a rented residence or one you own.)
Reasonable and necessary expenses in-
curred for the repair or replacement of the
contents of a personal residence due to a
federally declared disaster.
Qualified disaster relief payments include
amounts paid by a federal, state, or local gov-
ernment in connection with a federally declared
disaster to individuals affected by the disaster.
These payments must be made from a govern-
mental fund, be based on individual or family
needs, and not be compensation for services.
Payments to businesses generally don't
qualify.
Qualified disaster relief payments don't
include:
Payments for expenses otherwise paid for
by insurance or other reimbursements, or
Income replacement payments, such as
payments of lost wages, lost business in-
come, or unemployment compensation.
Qualified disaster mitigation payments.
Qualified disaster mitigation payments made
under the Robert T. Stafford Disaster Relief and
Emergency Assistance Act or the National
Flood Insurance Act (as in effect on April 15,
2005) are not included in income. These are
payments you, as a property owner, received to
reduce the risk of future damage to your prop-
erty. You can't increase your basis in property,
or take a deduction or credit, for expenditures
made with respect to those payments.
Sale of property under hazard mitigation
program. Generally, if you sell or otherwise
transfer property, you must recognize any gain
or loss for tax purposes unless the property is
your main home. You report the gain or deduct
the loss on your tax return for the year you real-
ize it. (You can't deduct a loss on personal-use
property unless the loss resulted from a casu-
CAUTION
!
alty, as discussed earlier.) However, if you sell
or otherwise transfer property to the federal
government, a state or local government, or an
Indian tribal government under a hazard mitiga-
tion program, you can choose to postpone re-
porting the gain if you buy qualifying replace-
ment property within a certain period of time.
See Postponing Gain, earlier, for the rules that
apply.
Other federal assistance programs. For
more information about other federal assistance
programs, see Crop Insurance and Crop Disas-
ter Payments and Feed Assistance and Pay-
ments in chapter 3, earlier.
Postponed tax deadlines. The IRS may post-
pone for up to 1 year certain tax deadlines of
taxpayers who are affected by a federally de-
clared disaster. The tax deadlines the IRS may
postpone include those for filing income, ex-
cise, and employment tax returns, paying in-
come, excise, and employment taxes, and mak-
ing contributions to a traditional IRA or Roth
IRA.
If any tax deadline is postponed, the IRS will
publicize the postponement in your area and
publish a news release and, where necessary,
a revenue ruling, revenue procedure, notice,
announcement, or other guidance in the Internal
Revenue Bulletin (IRB). Go to IRS.gov/
newsroom/Tax-Relief-in-Disaster-Situations to
find out if a tax deadline has been postponed
for your area.
Who is eligible. If the IRS postpones a tax
deadline, the following taxpayers are eligible for
the postponement.
Any individual whose main home is located
in a covered disaster area (defined next).
Any business entity or sole proprietor
whose principal place of business is loca-
ted in a covered disaster area.
Any individual who is a relief worker affili-
ated with a recognized government or phil-
anthropic organization and who is assisting
in a covered disaster area.
Any individual, business entity, or sole pro-
prietorship whose records are needed to
meet a postponed tax deadline, provided
those records are maintained in a covered
disaster area. The main home or principal
place of business does not have to be lo-
cated in the covered disaster area.
Any estate or trust that has tax records
necessary to meet a postponed tax dead-
line, provided those records are main-
tained in a covered disaster area.
The spouse on a joint return with a tax-
payer who is eligible for postponements.
Any individual, business entity, or sole pro-
prietorship not located in a covered disas-
ter area, but whose necessary records to
meet a postponed tax deadline are located
in the covered disaster area.
Any individual visiting the covered disaster
area who was killed or injured as a result of
the disaster.
Any other person determined by the IRS to
be affected by a federally declared disas-
ter.
Covered disaster area. This is an area of
a federally declared disaster area in which the
IRS has decided to postpone tax deadlines for
up to 1 year.
Abatement of interest and penalties. The
IRS may abate the interest and penalties on the
underpaid income tax for the length of any post-
ponement of tax deadlines.
Reporting Gains
and Losses
You will have to file one or more of the following
forms to report your gains or losses from invol-
untary conversions.
Form 4684. Use this form to report your gains
and losses from casualties and thefts.
Form 4797. Use this form to report involuntary
conversions (other than from casualty or theft)
of property used in your trade or business and
capital assets held in connection with a trade or
business or a transaction entered into for profit.
Also use this form if you have a gain from a
casualty or theft on trade, business or in-
come-producing property held for more than 1
year and you have to recapture some or all of
your gain as ordinary income.
Form 8949. Use this form to report gain from
an involuntary conversion (other than from
casualty or theft) of personal-use property.
Schedule A (Form 1040). Use this form to de-
duct your losses from casualties and thefts of
personal-use property and income-producing
property, that you reported on Form 4684.
Schedule D (Form 1040). Use this form to
carry over the following gains.
Net gain shown on Form 4797 from an in-
voluntary conversion of business property
held for more than 1 year.
Net gain shown on Form 4684 from the
casualty or theft of personal-use property.
Also use this form to figure the overall gain
or loss from transactions reported on Form
8949.
Schedule F (Form 1040). Use this form to de-
duct your losses from casualty or theft of live-
stock or produce bought for sale on line 32
(Other expenses) if you use the cash method of
accounting and have not otherwise deducted
these losses.
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Chapter 11 Casualties, Thefts, and Condemnations Page 71
12.
Self-Employment
Tax
What's New for 2017
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%).
What's New for 2018
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.
Introduction
Self-employment tax (SE tax) is a social secur-
ity and Medicare tax primarily for individuals
who work for themselves. It is similar to the so-
cial security and Medicare taxes withheld from
the pay of most wage earners.
You usually have to pay SE tax if you are
self-employed. You are usually self-employed if
you operate your own farm on land you either
own or rent. You have to figure SE tax on
Schedule SE (Form 1040).
Farmers who have employees may have to
pay the employer's share of social security and
Medicare taxes, as well. See chapter 13 for in-
formation on employment taxes.
If your self-employment income exceeds
$125,000, you may also be subject to a 0.9%
Additional Medicare Tax on the income in ex-
cess of a threshold amount. You figure this tax
using Form 8959. For more information about
the Additional Medicare Tax, including the
threshold amounts, see the Instructions for
Form 8959.
Self-employment tax rate. The self-employ-
ment tax rate is 15.3%. The rate consists of two
parts: 12.4% for social security (old-age, survi-
vors, and disability insurance) and 2.9% for
Medicare (hospital insurance).
Topics
This chapter discusses:
Why pay self-employment tax
How to pay self-employment tax
Who must pay self-employment tax
Figuring self-employment earnings
Landlord participation in farming
Methods for figuring net earnings
Reporting self-employment tax
Useful Items
You may want to see:
Publication
Partnerships
Form (and Instructions)
U.S. Individual Income Tax Return
Profit or Loss From
Farming
Self-Employment
Tax
U.S. Return of Partnership Income
Partner's Share of
Income, Deductions, Credits, etc.
Additional Medicare Tax
See chapter 16 for information about getting
publications and forms.
Why Pay
Self-Employment Tax?
Social security benefits are available to self-em-
ployed persons just as they are to wage earn-
ers. Your payments of SE tax contribute to your
coverage under the social security system. So-
cial security coverage provides you with retire-
ment benefits, disability benefits, survivor bene-
fits, and hospital insurance (Medicare) benefits.
How to become insured under social secur-
ity. You must be insured under the social se-
curity system before you begin receiving social
security benefits. You are insured if you have
the required number of credits (also called
quarters of coverage).
Earning credits in 2017. You can earn a max-
imum of four credits per year. For 2017, you
earn one credit for each $1,300 of combined
wages and self-employment earnings subject to
social security tax. You need $5,200 ($1,300 ×
4) of combined wages and self-employment
earnings subject to social security tax to earn
four credits in 2017. It doesn’t matter whether
the income is earned in 1 quarter or is spread
over 2 or more quarters.
For an explanation of the number of credits
you must have to be insured and the benefits
available to you and your family under the so-
cial security program, consult your nearest So-
cial Security Administration (SSA) office or visit
the SSA website at SSA.gov.
Making false statements to get or to in-
crease social security benefits may
subject you to penalties.
The Social Security Administration (SSA)
time limit for posting self-employment earn-
ings. Generally, the SSA will give you credit
only for self-employment earnings reported on a
tax return filed within 3 years, 3 months, and 15
days after the tax year you earned the income.
541
1040
Sch F (Form 1040)
Sch SE (Form 1040)
1065
Sch K-1 (Form 1065)
8959
CAUTION
!
If you file your tax return or report a
change in your self-employment earn-
ings after the SSA time limit for posting
self-employment earnings, the SSA may
change its records, but only to remove or re-
duce the amount. The SSA won't change its re-
cords to increase your self-employment earn-
ings after the SSA time limit listed above.
How To Pay
Self-Employment Tax
To pay SE tax, you must have a social security
number (SSN) or an individual taxpayer identifi-
cation number (ITIN). This section explains how
to:
Obtain an SSN or ITIN, and
Pay your SE tax using estimated tax.
An ITIN doesn’t entitle you to social se-
curity benefits. Obtaining an ITIN
doesn’t change your immigration or
employment status under U.S. law.
Obtaining a social security number. If you
have never had an SSN, apply for one using
Form SS-5, Application for a Social Security
Card. The application is also available in Span-
ish. You can get this form at any Social Security
office or by calling 1-800-772-1213.
You can also download Form SS-5
from the Social Security Administration
website at SSA.gov.
If you have a social security number from
the time you were an employee, you must use
that number. Don’t apply for a new one.
Replacing a lost social security card. If
you have a number but lost your card, file Form
SS-5. You will get a new card showing your
original number, not a new number. In some
areas you may be able to request a replace-
ment card online.
Name change. If your name has changed
since you received your social security card,
complete Form SS-5 to report a name change.
Obtaining an individual taxpayer identifica-
tion number. The IRS will issue you an ITIN,
for tax use only, if you are a nonresident or resi-
dent alien and you don’t have, and aren’t eligi-
ble to get, an SSN. To apply for an ITIN, file
Form W-7, Application for IRS Individual Tax-
payer Identification Number. You can download
Form W-7 from the IRS website at IRS.gov. For
more information on ITINs, see Pub. 1915.
Form W-7 and Pub. 1915 are also available in
Spanish.
If you were assigned an ITIN before
January 1, 2013, or if you have an ITIN
that you haven't included on a tax re-
turn in the last three consecutive years, you
may need to renew it. For more information, see
the Instructions for Form W-7 or visit IRS.gov/
ITIN.
Paying estimated tax. Estimated tax is the
method used to pay tax (including SE tax) on in-
come not subject to withholding. You generally
have to make estimated tax payments if you
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Page 72 Chapter 12 Self-Employment Tax
expect to owe tax, including SE tax, of $1,000
or more when you file your return. Use Form
1040-ES, Estimated Tax for Individuals, to fig-
ure and pay the tax.
However, if at least two-thirds of your gross
income for 2017 or 2018 was from farming and
you file your 2018 Form 1040 and pay all the tax
due by March 1, 2019, you don’t have to pay
any estimated tax. For more information about
estimated tax for farmers, see chapter 15.
Penalty for underpayment of estimated
tax. You may have to pay a penalty if you don’t
pay enough estimated tax by its due date.
Who Must Pay
Self-Employment Tax?
You must pay SE tax and file Schedule SE
(Form 1040) if your net earnings from self-em-
ployment were $400 or more.
The SE tax rules apply no matter how
old you are and even if you are already
receiving social security or Medicare
benefits.
Aliens. Generally, resident aliens must pay
self-employment tax under the same rules that
apply to U.S. citizens. Nonresident aliens aren’t
subject to self-employment tax. However, resi-
dents of the Virgin Islands, Puerto Rico, Guam,
the Commonwealth of the Northern Mariana Is-
lands, or American Samoa are subject to
self-employment tax, as they are considered
U.S. residents for self-employment tax purpo-
ses. For more information on aliens, see Pub.
519, U.S. Tax Guide for Aliens.
Are you self-employed? You are self-em-
ployed if you carry on a trade or business (such
as running a farm) as a sole proprietor, an inde-
pendent contractor, a member of a partnership,
or are otherwise in business for yourself. A
trade or business is generally an activity carried
on for a livelihood or in good faith to make a
profit.
Share farmer. You are a self-employed farmer
under an income-sharing arrangement if both
the following apply.
1. You produce a crop or raise livestock on
land belonging to another person.
2. Your share of the crop or livestock, or the
proceeds from their sale, depends on the
amount produced.
Your net farm profit or loss from the in-
come-sharing arrangement is reported on
Schedule F (Form 1040) and included in your
self-employment earnings.
If you produce a crop or livestock on land
belonging to another person and are to receive
a specified rate of pay, a fixed sum of money, or
a fixed quantity of the crop or livestock, and not
a share of the crop or livestock or their pro-
ceeds, you may be either self-employed or an
employee of the landowner. This will depend on
whether the landowner has the right to direct or
control your performance of services.
CAUTION
!
Example. A share farmer produces a crop
on land owned by another person on a 50-50
crop-share basis. Under the terms of their
agreement, the share farmer furnishes the labor
and half the cost of seed and fertilizer. The
landowner furnishes the machinery and equip-
ment used to produce and harvest the crop,
and half the cost of seed and fertilizer. The
share farmer is provided a house in which to
live. The landowner and the share farmer de-
cide on a cropping plan.
The share farmer is a self-employed farmer
for purposes of the agreement to produce the
crops, and the share farmer's part of the profit
or loss from the crops is reported on Sched-
ule F (Form 1040) and included in self-employ-
ment earnings.
The tax treatment of the landowner is dis-
cussed later under Landlord Participation in
Farming.
Contract farming. Under typical contract
farming arrangements, the grower receives a
fixed payment per unit of crops or finished live-
stock delivered to the processor or packing
company. Because the grower typically fur-
nishes labor and bears some production risk,
the payments are reported on Schedule F and
are therefore subject to self-employment tax.
4-H Club or FFA project. If an individual par-
ticipates in a 4-H Club or National FFA Organi-
zation (FFA) project, any net income received
from sales or prizes related to the project may
be subject to income tax. Report the net income
as “Other income” on line 21 of Form 1040. If
necessary, attach a statement showing the
gross income and expenses. The net income
may not be subject to SE tax if the project is pri-
marily for educational purposes and not for
profit, and is completed by the individual under
the rules and economic restrictions of the spon-
soring 4-H or FFA organization. Such a project
is generally not considered a trade or business.
Partners in a partnership. Generally, you are
self-employed if you are a member of a partner-
ship that carries on a trade or business.
Limited partner. If you are a limited part-
ner, your partnership income is generally not
subject to SE tax. However, guaranteed pay-
ments you receive for services you perform for
the partnership are subject to SE tax and
should be reported to you in box 14 of your
Schedule K-1 (Form 1065).
Community property. If you are a partner
and your distributive share of any income or
loss from a trade or business carried on by the
partnership is community property, treat your
share as your self-employment earnings. Don’t
treat any of your share as self-employment
earnings of your spouse.
Business owned and operated by spouses.
If you and your spouse jointly own and operate
a farm as an unincorporated business and
share in the profits and losses, you are partners
in a partnership whether or not you have a for-
mal partnership agreement. You must file Form
1065, instead of Schedule F. However, you and
your spouse may still report income using
Schedule F instead of Form 1065 if either of the
following applies.
You and your spouse elect to be treated as
a qualified joint venture. See Qualified joint
venture, later.
You and your spouse wholly own the unin-
corporated farming business as commun-
ity property and you treat the business as a
sole proprietorship. See Community in-
come, later.
If your spouse is your employee, not
your partner, you must withhold and
pay social security and Medicare taxes
for him or her. For more information about em-
ployment taxes, see chapter 13.
Qualified joint venture. If you and your
spouse each materially participate as the only
members of a jointly owned and operated farm,
and you file a joint tax return for the tax year,
you can make a joint election to be treated as a
qualified joint venture instead of a partnership
for the tax year. Making this election will allow
you to avoid the complexity of Form 1065 but
still give each spouse credit for social security
earnings on which retirement benefits are
based. For an explanation of “material participa-
tion,” see the instructions for Schedule C, line
G, and the instructions for Schedule F, line E.
To make this election, you must divide all
items of income, gain, loss, deduction, and
credit attributable to the business between you
and your spouse in accordance with your re-
spective interests in the venture. Each of you
must file a separate Schedule F and a separate
Schedule SE. For more information, see Quali-
fied Joint Ventures in the Instructions for Sched-
ule SE (Form 1040).
Community income. If you and your
spouse wholly own an unincorporated business
as community property under the community
property laws of a state, foreign country, or U.S.
possession, you can treat your wholly-owned,
unincorporated business as a sole proprietor-
ship, instead of a partnership. Any change in
your reporting position will be treated as a con-
version of the entity.
Report your income and deductions as fol-
lows.
If only one spouse participates in the busi-
ness, all of the income from that business
is the self-employment earnings of the
spouse who carried on the business.
If both spouses participate, the income and
deductions are allocated to the spouses
based on their distributive shares.
If you and your spouse elected to treat the
business as a qualifying joint venture, see
Qualified joint venture, earlier.
States with community property laws include
Arizona, California, Idaho, Louisiana, Nevada,
New Mexico, Texas, Washington, and Wiscon-
sin. See Pub. 555 for more information about
community property laws.
CAUTION
!
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Chapter 12 Self-Employment Tax Page 73
Figuring
Self-Employment
Earnings
Farmer. If you are self-employed as a farmer,
use Schedule F (Form 1040) to figure your
self-employment earnings.
Partnership income or loss. If you are a
member of a partnership that carries on a trade
or business, the partnership should report your
self-employment earnings in box 14, code A, of
your Schedule K-1 (Form 1065). Box 14 of
Schedule K-1 may also provide amounts for
gross farming or fishing income (code B) and
gross nonfarm income (code C). Use these
amounts if you use the farm or nonfarm optional
method to figure net earnings from self-employ-
ment (see Methods for Figuring Net Earnings,
later).
If you are a general partner, you may need
to reduce these reported earnings by amounts
you claim as a section 179 deduction, unreim-
bursed partnership expenses, or depletion on
oil and gas properties.
If the amount reported is a loss, include only
the deductible amount when you figure your to-
tal self-employment earnings.
For more information, see the Partner's In-
structions for Schedule K-1 (Form 1065).
For general information on partnerships, see
Pub. 541.
More than one business. If you have self-em-
ployment earnings from more than one trade,
business, or profession, you generally must
combine the net profit or loss from each to de-
termine your total self-employment earnings. A
loss from one business reduces your profit from
another business. However, don’t combine
earnings from farm and nonfarm businesses if
you are using one of the optional methods (dis-
cussed later) to figure net earnings.
Community property. If any of the income
from a farm or business, other than a partner-
ship, is community property under state law, it is
included in the self-employment earnings of the
spouse carrying on the trade or business.
Payments for lost income. Include in
self-employment earnings any payments you
receive from insurance or other sources to re-
place income lost because you reduced or
stopped farming activities. These include USDA
payments under the Dairy Margin Protection
Program, which provides dairy producers with
payments when dairy margins are below the
margin coverage levels. Even if you aren’t farm-
ing when you receive the payment, it is included
in self-employment earnings if it relates to your
farm business (even though it is temporarily in-
active). A connection exists if it is clear the pay-
ment would not have been made but for your
conduct of your farm business.
Gain or loss. A gain or loss from the disposi-
tion of property that is neither stock in trade nor
held primarily for sale to customers isn’t inclu-
ded in self-employment earnings. It doesn’t
matter whether the disposition is a sale, ex-
change, or involuntary conversion. For exam-
ple, gains or losses from the disposition of the
following types of property aren’t included in
self-employment earnings.
Investment property.
Depreciable property or other fixed assets
used in your trade or business.
Livestock held for draft, breeding, sport, or
dairy purposes, and not held primarily for
sale, regardless of how long the livestock
was held, or whether it was raised or pur-
chased.
Unharvested standing crops sold with land
held more than 1 year.
Timber, coal, or iron ore held for more than
1 year if an economic interest was re-
tained, such as a right to receive coal roy-
alties.
A gain or loss from the cutting of timber isn’t
included in self-employment earnings if the cut-
ting is treated as a sale or exchange. For more
information on electing to treat the cutting of
timber as a sale or exchange, see Timber in
chapter 8.
Wages and salaries. Wages and salaries re-
ceived for services performed as an employee
and covered by social security or railroad retire-
ment aren’t included in self-employment earn-
ings.
Wages paid in kind to you for agricultural la-
bor performed as an employee, such as com-
modity wages, aren’t included in self-employ-
ment earnings.
Retired partner. Retirement income received
by a partner from his or her partnership under a
written plan isn’t included in self-employment
earnings if all the following apply.
The retired partner performs no services
for the partnership during the year.
The retired partner is owed only the retire-
ment payments.
The retired partner's share (if any) of the
partnership capital was fully paid to the re-
tired partner.
The payments to the retired partner are
lifelong periodic payments.
Conservation Reserve Program (CRP) pay-
ments. Under the Conservation Reserve Pro-
gram (CRP), if you own or operate highly erodi-
ble or other specified cropland, you may enter
into a long-term contract with the USDA, agree-
ing to convert to a less intensive use of that
cropland. You must include the annual rental
payments and any one-time incentive payment
you receive under the program on Schedule F,
lines 4a and 4b. Cost-share payments you re-
ceive may qualify for the cost-sharing exclusion.
See Cost-Sharing Exclusion (Improvements),
earlier, in chapter 3. CRP payments are repor-
ted to you on Form 1099-G.
Individuals who are receiving social se-
curity retirement or disability benefits
may exclude CRP payments when cal-
culating self-employment tax. See the Instruc-
tions for Schedule SE (Form 1040).
Self-employed health insurance deduction.
You can’t deduct the self-employed health in-
surance deduction you report on Form 1040,
TIP
line 29, from self-employment earnings on
Schedule SE (Form 1040).
Landlord Participation
in Farming
As a general rule, income and deductions from
rentals and from personal property leased with
real estate aren’t included in determining
self-employment earnings. However, income
and deductions from farm rentals, including
government commodity program payments re-
ceived by a landowner who rents land, are in-
cluded if the rental arrangement provides that
the landowner will, and does, materially partici-
pate in the production or management of pro-
duction of the farm products on the land.
Material participation for landlords. You
materially participate if you have an arrange-
ment with your tenant for your participation and
you meet one or more of the following tests.
1. You do at least three of the following.
a. Pay, using cash or credit, at least half
the direct costs of producing the crop
or livestock.
b. Furnish at least half the tools, equip-
ment, and livestock used in the pro-
duction activities.
c. Advise or consult with your tenant.
d. Inspect the production activities peri-
odically.
2. You regularly and frequently make, or take
an important part in making, management
decisions substantially contributing to or
affecting the success of the enterprise.
3. You work 100 hours or more spread over a
period of 5 weeks or more in activities con-
nected with agricultural production.
4. You do things that, considered in their to-
tality, show you are materially and signifi-
cantly involved in the production of the
farm commodities.
These tests may be used as general guides for
determining whether you are a material partici-
pant.
Crop shares. Rent paid in the form of crop
shares is included in self-employment earnings
for the year you sell, exchange, give away, or
use the crop shares if you meet one of the four
material participation tests (discussed above) at
the time the crop shares are produced. Feeding
such crop shares to livestock is considered us-
ing them. Your gross income for figuring your
self-employment earnings includes the fair mar-
ket value of the crop shares when they are used
as feed.
Example. Nancy agrees to produce a crop
on G. Cohen's cotton farm, with each receiving
half the proceeds. Cohen agrees to furnish all
the necessary equipment, and it is understood
that Cohen will advise Nancy on when to plan,
spray, and pick the cotton. It is also understood
that he will inspect the crop every few days to
determine whether Nancy is properly taking
care of the crop. Under their arrangement, it is
further understood that Nancy will furnish all
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Page 74 Chapter 12 Self-Employment Tax
labor needed to grow and harvest the crop. Co-
hen provides the advice, makes inspections,
and furnishes the equipment; and Nancy fur-
nishes all labor needed to grow and harvest the
crop.
The management decisions made by Cohen
in connection with the care of the cotton crop
and his regular inspection of the crop establish
that Cohen participates to a material degree in
the cotton production operations. The income
Cohen receives from the cotton farm is included
in Cohen’s self-employment earnings.
Methods for Figuring Net
Earnings
There are three ways to figure net earnings
from self-employment.
1. The regular method.
2. The farm optional method.
3. The nonfarm optional method.
You must use the regular method to the extent
you don’t use one or both of the optional meth-
ods. See Figure 12-1, to see if you are eligible
to use an optional method.
Why use an optional method? You may
want to use the optional methods (discussed
later) when you have a loss or a small net profit
and any one of the following applies.
You want to receive credit for social secur-
ity benefit coverage.
You incurred child or dependent care ex-
penses for which you could claim a credit.
(An optional method may increase your
earned income, which could increase your
credit.)
You are entitled to the earned income
credit. (An optional method may increase
your earned income, which could increase
your credit.)
You are entitled to the additional child tax
credit. (An optional method may increase
your earned income, which could increase
your credit.)
Effects of using an optional method. Using
an optional method could increase your SE tax.
Paying more SE tax may result in you getting
higher social security disability or retirement
benefits.
Using the optional methods also may de-
crease your adjusted gross income (AGI) due to
the deduction for one-half of self-employment
tax on Form 1040, which may affect your eligi-
bility for credits, deductions, or other items that
are subject to an AGI limit. Figure your AGI with
and without using the optional methods to see if
the optional methods will benefit you.
If you use either or both optional methods,
you must figure and pay the SE tax due under
these methods even if you would have had a
smaller SE tax or no SE tax using the regular
method.
The optional methods may be used only to
figure your SE tax. To figure your income tax,
include your actual self-employment earnings in
gross income, regardless of which method you
use to determine SE tax.
Regular Method
To figure net earnings using the regular
method, multiply your self-employment earn-
ings by 92.35% (0.9235). For your net earnings
figured using the regular method, see one of the
following lines on your Schedule SE (Form
1040).
Section A, line 4 (if you use the Short
Schedule SE).
Section B, line 4a (if you use the Long
Schedule SE).
Net earnings figured using the regular
method are also called “actual net earnings.”
Farm Optional Method
Use the farm optional method only for self-em-
ployment earnings from a farming business.
You can use this method if you meet either of
the following tests.
1. Your gross farm income is $7,800 or less.
Figure 12-1. Can I Use the Optional Methods?
START here to determine if
you can use the nonfarm
optional method.
Are your net nonfarm prots
less than $5,631?
Are your net nonfarm prots
less than 72.189% of your
gross nonfarm income? You can
use the
farm
optional
method.*
See Table
12-1.
No
Yes
Is your gross farm income
$7,800 or less?
Are your net farm prots
less than $5,631?
Were your actual net earnings
from self-employment $400 or
more in at least 2 of the 3 tax
years before this year?
Have you previously used this
method less than 5 years?
(Note: There is a 5-year
lifetime limit.)
You can use the nonfarm
optional method.* See
Pub. 334.
You can’t
use the
nonfarm
optional
method.
Yes
Yes
Yes
No
No
No
Yes
NoYes
No
*If you use both optional methods, see Using Both Optional Methods, later, for limits on the amount to report.
START here to determine if
you can use the farm
optional method.
You can’t use the
farm optional method.
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Chapter 12 Self-Employment Tax Page 75
2. Your net farm profits are less than $5,631.
Gross farm income. Your gross farm income
is the total of the amounts from:
Schedule F (Form 1040), line 9, and
Schedule K-1 (Form 1065), box 14, code B
(from farm partnerships).
Net farm profits. Net farm profits generally are
the total of the amounts from:
Schedule F (Form 1040), line 34, and
Schedule K-1 (Form 1065), box 14, code A
(from farm partnerships).
If you received social security retirement or dis-
ability benefits, you must subtract the amount of
any Conservation Reserve Program payments
included on your Schedule F, line 4b, or listed
on Schedule K-1 (Form 1065), box 20, code Z.
You may also need to adjust the amount repor-
ted on Schedule K-1 if you are a general partner
or if it is a loss. For more information, see Part-
nership income or loss, earlier.
Figuring farm net earnings. If you meet ei-
ther of the two tests explained above, use Ta-
ble 12-1 to figure your net earnings from
self-employment under the farm optional
method.
Table 12-1. Figuring Farm Net
Earnings
IF your gross farm
income
is...
THEN your net
earnings are
equal to...
$7,800 or less Two-thirds of your
gross farm income.
More than $7,800 $5,200
Optional method can reduce or eliminate
SE tax. If your gross farm income is $7,800 or
less and your farm net earnings figured under
the farm optional method are less than your ac-
tual farm net earnings, you can use the farm op-
tional method to reduce or eliminate your SE
tax. Your actual farm net earnings are your farm
net earnings figured using the regular method,
explained earlier.
Example. Your gross farm income is $540
and your net farm profit is $460. Consequently,
your net earnings figured under the farm op-
tional method are $360 (2/3 of $540) and your
actual net earnings are $425 (92.35% of $460).
You owe no SE tax if you use the optional
method because your net earnings under the
farm optional method are less than $400.
Nonfarm Optional Method
This is an optional method available for deter-
mining net earnings from nonfarm self-employ-
ment, much like the farm optional method.
If you are also engaged in a nonfarm busi-
ness, you may be able to use this method to fig-
ure your nonfarm net earnings. You can use this
method even if you don’t use the farm optional
method for determining your farm net earnings
and even if you have a net loss from your non-
farm business. For more information about the
nonfarm optional method, see Pub. 334.
You can’t combine farm and nonfarm
self-employment earnings to figure
your net earnings under either of the
optional methods.
Using Both Optional
Methods
If you use both optional methods, you must add
the net earnings figured under each method to
arrive at your total net earnings from self-em-
ployment. You can report less than your total
actual farm and nonfarm net earnings but not
less than actual nonfarm net earnings. If you
use both optional methods, you can report no
more than $5,200 as your combined net earn-
ings from self-employment.
Reporting
Self-Employment Tax
Use Schedule SE (Form 1040) to figure and re-
port your SE tax. Then, enter the SE tax on
line 57 of Form 1040 and attach Schedule SE to
Form 1040.
Most taxpayers can use Section A–Short
Schedule SE to figure their SE tax. However,
certain taxpayers must use Section B–Long
Schedule SE. Use the chart on page 1 of
Schedule SE to find out which one to use.
If you have to pay SE tax, you must file
Form 1040 (with Schedule SE at-
tached) even if you don’t otherwise
have to file a federal income tax return.
Self-employment tax deduction. You can
deduct half of your SE tax in figuring your adjus-
ted gross income. This deduction only affects
your income tax. It doesn’t affect either your net
earnings from self-employment or your SE tax.
To deduct the tax, enter on Form 1040,
line 27, the amount from Section A, line 6 (if you
are using the Short Schedule SE) or Section B,
line 13 (if you are using the Long Schedule SE).
Joint return. Even if you file a joint return, you
can’t file a joint Schedule SE. This is true
whether one spouse or both spouses have
self-employment earnings. Your spouse isn’t
considered self-employed just because you
are. If both of you have self-employment earn-
ings, each of you must complete a separate
Schedule SE. However, if one spouse uses the
Short Schedule SE and the other spouse has to
use the Long Schedule SE, both can use the
same form. Attach both schedules to the joint
return. If you and your spouse operate a busi-
ness as a partnership, see Business owned and
operated by spouses and Qualified joint ven-
ture, earlier, under Who Must Pay Self-Employ-
ment Tax.
CAUTION
!
CAUTION
!
13.
Employment
Taxes
What's New for 2017
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.
New certification program for professional
employer organizations. The Tax Increase
Prevention Act of 2014 required the IRS to es-
tablish a voluntary certification program for pro-
fessional 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 profes-
sional employer organizations (CPEOs) must
meet various requirements described in sec-
tions 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 cov-
ered 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.
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 em-
ployer'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 calen-
dar quarter beginning after the date that the
qualified small business filed its income tax re-
turn. 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.
What's New for 2018
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).
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Page 76 Chapter 13 Employment Taxes
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 Med-
icare tax.
Reminders
Additional employment tax information for
farmers. See Pub. 51 for more detailed guid-
ance on employment taxes. For the latest infor-
mation about employment tax developments
impacting farmers, go to IRS.gov/Pub51. For
general tax information relevant to agricultural
employers, go to IRS.gov/
AgricultureTaxCenter. For general information
about employment taxes, go to IRS.gov/
EmploymentTaxes.
Correcting a previously filed Form 943. If
you discover an error on a previously filed Form
943, Employer's Annual Federal Tax Return for
Agricultural Employees, make the correction us-
ing Form 943-X, Adjusted Employer's Annual
Federal Tax Return for Agricultural Employees
or Claim for Refund. Form 943-X is filed sepa-
rately from Form 943. For more information on
correcting Form 943, see the Instructions for
Form 943-X, section 9 of Pub. 51, or go to
IRS.gov/CorrectingEmploymentTaxes.
Federal tax deposits must be made by elec-
tronic funds transfer (EFT). You must use
EFT to make all federal tax deposits. Generally,
an EFT is made using the Electronic Federal
Tax Payment System (EFTPS). If you don't
want to use EFTPS, you can arrange for your
tax professional, financial institution, payroll
service, or other trusted third party to make
electronic deposits on your behalf. Also, you
may arrange for your financial institution to ini-
tiate a same-day wire payment on your behalf.
EFTPS is a free service provided by the Depart-
ment of Treasury. Services provided by your tax
professional, financial institution, payroll serv-
ice, or other third party may have a fee.
For more information on making federal tax
deposits, see section 7 of Pub. 51. To get more
information about EFTPS or to enroll in EFTPS,
go to EFTPS.gov or call 1-800-555-4477 or
1-800-733-4829 (TDD). Additional information
about EFTPS is also available in Pub. 966.
Electronic filing and payment. Now, more
than ever before, businesses can enjoy the
benefits of filing tax returns and paying their
federal taxes electronically. Whether you rely
on a tax professional or handle your own taxes,
the IRS offers you convenient programs to
make filing and paying easier. Spend less time
and worry on taxes and more time running your
business. Use e-file and EFTPS to your benefit.
For e-file, go to IRS.gov/EmploymentEfile
for additional information. A fee may be
charged to file electronically.
For EFTPS, go to EFTPS.gov or call
EFTPS Customer Service at
1-800-555-4477 or 1-800-733-4829 (TDD)
for additional information.
For electronic filing of Form W-2, Wage
and Tax Statement, go to SSA.gov/
employer.
Work opportunity tax credit for qualified
tax-exempt organizations hiring qualified
veterans. The work opportunity tax credit is
available for eligible unemployed veterans who
begin work on or after November 22, 2011, and
before January 1, 2020. Qualified tax-exempt
organizations that hire eligible unemployed vet-
erans can claim the work opportunity tax credit
against their payroll tax liability using Form
5884-C. For more information, go to IRS.gov/
WOTC.
Important Dates for 2018
You should take the action indicated by the
dates listed. Due dates for deposits of withheld
federal income taxes, social security taxes, and
Medicare taxes aren't listed here. For these
dates, see Pub. 509 (For use in 2018).
If any date shown below for filing a re-
turn, furnishing a form, or depositing
taxes falls on a Saturday, Sunday, or
legal holiday, the due date is the next business
day. The term “legal holiday” means any legal
holiday in the District of Columbia. Legal holi-
days in the District of Columbia are provided in
section 7 of Pub. 51. A statewide legal holiday
delays a filing or furnishing due date only if the
IRS office where you’re required to file a return
or furnish a form is located in that state. How-
ever, a statewide legal holiday doesn't delay the
due date of federal tax deposits. For any due
date, you will meet the “file” or “furnish” date re-
quirement if the envelope containing the tax re-
turn or form is properly addressed, contains suf-
ficient postage, and is postmarked by the U.S.
Postal Service on or before the due date, or
sent by an IRS-designated private delivery
service (PDS) on or before the due date. Go to
IRS.gov/PDS for the current list of PDSs. For
the IRS mailing address to use if you're using a
PDS, go to IRS.gov/PDSstreetAddresses.
Fiscal year taxpayers. The due dates listed
below apply whether you use a calendar or a
fiscal year.
By January 31
File Form 943 with the IRS. If you depos-
ited all Form 943 taxes when due, you may
file Form 943 by February 10.
File Form 940, Employer's Annual Federal
Unemployment (FUTA) Tax Return, with
the IRS. If you deposited all the FUTA tax
when due, you may file Form 940 by Feb-
ruary 10.
File Copy A of all paper and electronic
Forms W-2 with Form W-3, Transmittal of
Wage and Tax Statements, with the SSA.
If filing electronically, the SSA generates
Form W-3 automatically based on your
Forms W-2. For more information on re-
porting Form W-2 information to the SSA
electronically, go to the SSA‘s Employer
W-2 Filing Instructions & Information web-
page at SSA.gov/employer.
Furnish each employee with a completed
Form W-2.
File Copy A of all paper and electronic
Forms 1099-MISC, Miscellaneous Income,
that report nonemployee compensation
with Form 1096, Annual Summary and
Transmittal of U.S. Information Returns,
with the IRS. For information on filing infor-
mation returns electronically with the IRS,
see Pub. 1220. Other Forms 1099,
TIP
including Forms 1099-MISC reporting any-
thing other than nonemployee compensa-
tion, have different due dates. See the
General Instructions for Certain Informa-
tion Returns for more information.
Furnish each recipient to whom you paid
$600 or more in nonemployee compensa-
tion with a completed Form 1099-MISC.
File Form 945, Annual Return of Withheld
Federal Income Tax, with the IRS to report
any nonpayroll income tax withheld during
2017. If you deposited all Form 945 taxes
when due, you may file Form 945 by Feb-
ruary 10.
By February 15
Ask for a new Form W-4, Employee’s With-
holding Allowance Certificate, or Formulario
W-4(SP) from each employee who claimed ex-
emption from federal income tax withholding
last year.
On February 16
Any Form W-4 claiming exemption from
withholding for the previous year has now ex-
pired. Begin withholding for any employee who
previously claimed exemption from withholding
but hasn't given you a new Form W-4 for the
current year. If the employee doesn't give you a
new Form W-4, withhold taxes based on the
last valid Form W-4 you have for the employee
that doesn't claim exemption from withholding
or, if one doesn't exist, as if he or she is single
with zero withholding allowances. If the em-
ployee furnishes a new Form W-4 claiming ex-
emption from withholding after February 15, you
may apply the exemption to future wages, but
don't refund taxes withheld while the exempt
status wasn't in place.
By April 30, July 31, October 31, and Janu-
ary 31
Deposit FUTA taxes. Deposit FUTA tax
due if the undeposited amount is over $500.
Before December 1
Remind employees to submit a new Form
W-4 if their marital status or withholding allow-
ances have changed or will change for the next
year.
Introduction
You’re generally required to withhold federal in-
come tax from the wages of your employees.
You may be required to withhold social security
and Medicare taxes from your employees' wa-
ges and pay the employer's share of these
taxes under the Federal Insurance Contribu-
tions Act (FICA). You may also have to pay fed-
eral unemployment tax under the Federal Un-
employment Tax Act (FUTA). You must also
withhold Additional Medicare Tax from wages
you pay to an employee in excess of $200,000
in a calendar year. This chapter includes infor-
mation about these taxes.
You must also pay self-employment tax on
your net earnings from farming. See chapter 12
for information on self-employment tax.
Topics
This chapter discusses:
Farm employment;
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Chapter 13 Employment Taxes Page 77
Family employees;
Crew leaders;
Social security and Medicare taxes;
Federal income tax withholding;
Required notice to employees about
earned income credit (EIC);
Reporting and paying social security,
Medicare, and withheld federal income
taxes; and
FUTA tax.
Useful Items
You may want to see:
Publication
Employer's Tax Guide
Employer's Supplemental Tax Guide
Employer's Tax Guide to Fringe
Benefits
Agricultural Employer's Tax Guide
Household Employer's Tax Guide
Form (and Instructions)
Wage and Tax Statement
Employee's Withholding Allowance
Certificate
Request for Taxpayer Identification
Number and Certification
Employer's Annual Federal
Unemployment (FUTA) Tax Return
Employer's Annual Federal Tax
Return for Agricultural Employees
Adjusted Employer's Annual
Federal Tax Return for Agricultural
Employees or Claim for Refund
See chapter 16 for information about getting
publications and forms.
Farm Employment
In general, you’re an employer of farmworkers if
your employees do any of the following types of
work.
Raising or harvesting agricultural or horti-
cultural products on a farm, including rais-
ing and feeding of livestock.
Operating, managing, conserving, improv-
ing, or maintaining your farm and its tools
and equipment, if the major part of such
service is performed on a farm.
Services performed in salvaging timber, or
clearing land of brush and other debris, left
by a hurricane (also known as hurricane la-
bor), if the major part of such service is
performed on a farm.
Handling, processing, or packaging any
agricultural or horticultural commodity in its
unmanufactured state if you produced
more than half of the commodity (for a
group of up to 20 unincorporated opera-
tors, all of the commodity).
Work related to cotton ginning, turpentine,
gum resin products, or the operation and
maintenance of irrigation facilities.
For more information, see sections 2 and 12 of
Pub. 51.
15
15-A
15-B
51
926
W-2
W-4
W-9
940
943
943-X
Generally, a worker who performs services
for you is your employee if you have the right to
control what will be done and how it will be
done. This is so even when you give the em-
ployee freedom of action. What matters is that
you have the right to control the details of how
the services are performed. You’re responsible
for withholding and paying employment taxes
for your employees. You’re also required to file
employment tax returns. These requirements
don't apply to amounts that you pay to inde-
pendent contractors, as discussed later in Non-
employee compensation. See sections 1 and 2
of Pub. 15-A for more information on how to de-
termine whether an individual providing serv-
ices is an independent contractor or an em-
ployee.
If you employ a family of workers, each
worker subject to your control (not just the head
of the family) is an employee.
Special rules apply to crew leaders. See
Crew Leaders, later.
Employer identification number (EIN). If you
have employees, you must have an EIN. If you
don't have an EIN, you may apply for one online
by visiting IRS.gov/EIN. You may also apply for
an EIN by faxing or mailing Form SS-4 to the
IRS.
Employee's social security number (SSN).
An employee who doesn't have an SSN and is
legally eligible to work in the United States
should submit Form SS-5, Application for a So-
cial Security Card, to the SSA. Form SS-5 is
available from any SSA office or by calling
1-800-772-1213. It is also available from the
SSA's website at SSA.gov/online/ss-5.pdf.
The employee must furnish evidence of age,
identity, and U.S. citizenship or lawful immigra-
tion status permitting employment with the
Form SS-5.
Form I-9. You must verify that each new em-
ployee is legally eligible to work in the United
States. This includes completing Form I-9, Em-
ployment Eligibility Verification. Form I-9 is
available from the U.S. Citizenship and Immi-
gration Services (USCIS) website at
USCIS.gov/I-9-Central, at USCIS offices, or by
calling the Bureau of Citizenship and Immigra-
tion Services Forms Request Line at
1-800-870-3676. You can also contact the US-
CIS at 1-800-375-5283 or 1-800-767-1833
(TDD) for more information.
Form W-4. You should give each new em-
ployee a Form W-4 as soon as you hire the em-
ployee. For Spanish-speaking employees, you
may use Formulario W-4(SP) which is the
Spanish translation of Form W-4. Have the em-
ployee complete and return the form to you be-
fore the first payday. If the employee doesn't re-
turn the completed form, you must withhold
federal income tax as if the employee is single
and claims no withholding allowances.
New hire reporting. You’re required to report
any new employee to a designated state new
hire registry. A new employee is an employee
who hasn’t previously been employed by you or
was previously employed by you but has been
separated from such prior employment for at
least 60 consecutive days. Many states accept
a copy of Form W-4 with employer information
added. Visit the Office of Child Support En-
forcement website at acf.hhs.gov/css/
employers for more information.
Family Employees
Generally, the wages you pay to family mem-
bers who are your employees are subject to
employment taxes. However, certain exemp-
tions may apply to wages paid to your child,
spouse, or parent.
Exemptions for your child. Payments for the
services of your child under age 18 who works
for you in your trade or business (including a
farm) aren't subject to social security and Medi-
care taxes. However, see Nonexempt services
of a child or spouse, later. Payments for the
services of your child under age 21 employed
by you in other than a trade or business, such
as payments for household services in your
home, also aren't subject to social security or
Medicare taxes. Payments for the services of
your child under age 21 employed by you,
whether or not in your trade or business, aren't
subject to FUTA tax. Although not subject to so-
cial security, Medicare, or FUTA tax, the child's
wages still may be subject to federal income tax
withholding.
Exemptions for your spouse. Payments for
the services of your spouse who works for you
in your trade or business are subject to federal
income tax withholding and social security and
Medicare taxes, but not FUTA tax.
Payments for the services of your spouse
employed by you in other than a trade or busi-
ness, such as payments for household services
in your home, aren't subject to social security,
Medicare, or FUTA taxes.
Nonexempt services of a child or spouse.
Payments for the services of your child or
spouse are subject to federal income tax with-
holding as well as social security, Medicare,
and FUTA taxes if he or she works for any of
the following entities.
A corporation, even if it is controlled by
you.
A partnership, even if you’re a partner. This
doesn't apply to wages paid to your child if
each partner is a parent of the child.
An estate or trust, even if it is the estate of
a deceased parent.
In these situations, the child or spouse is con-
sidered to work for the corporation, partnership,
or estate, not you.
Exemptions for your parent. Payments for
the services of your parent employed by you in
your trade or business are subject to federal in-
come tax withholding and social security and
Medicare taxes. Social security and Medicare
taxes don't apply to wages paid to your parent
for services not in your trade or business, but
they do apply to payments for household serv-
ices in your home if both the following condi-
tions are satisfied.
You have a child (including an adopted
child or stepchild) living in your home who
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Page 78 Chapter 13 Employment Taxes
is under age 18 or has a physical or mental
condition that requires care by an adult for
at least 4 continuous weeks in the calendar
quarter services were performed.
You’re a widow or widower; or divorced
and not remarried; or have a spouse in the
home who, because of a physical or men-
tal condition, can't care for your child for at
least 4 continuous weeks in the calendar
quarter services were performed.
Wages you pay to your parent aren't subject
to FUTA tax, regardless of the type of services
provided.
Qualified joint venture. If spouses elect to be
treated as a qualified joint venture instead of a
partnership, either spouse may report and pay
the employment taxes due on the wages paid to
employees using the EIN of that spouse's sole
proprietorship. For more information about
qualified joint ventures, see chapter 12.
Crew Leaders
If farmworkers are provided by a crew leader,
the crew leader may be the employer of the
workers.
Social security and Medicare taxes. For so-
cial security and Medicare tax purposes, the
crew leader is the employer of the workers if
both of the following requirements are met.
The crew leader pays (either on his or her
own behalf or on behalf of the farmer) the
workers for their farm labor.
The crew leader hasn't entered into a writ-
ten agreement with the farmer under which
the crew leader is designated as an em-
ployee of the farmer.
If both requirements are met, the crew
leader isn't considered the employee of the
farmer for services performed by the crew
leader in furnishing farmworkers and as a mem-
ber of the crew.
Federal income tax withholding. If the crew
leader is the employer for social security and
Medicare tax purposes, the crew leader is the
employer for federal income tax withholding
purposes.
Federal unemployment (FUTA) tax. For
FUTA tax purposes, the crew leader is the em-
ployer of the workers if, in addition to the earlier
requirements, either of the following require-
ments are met.
The crew leader is registered under the Mi-
grant and Seasonal Agricultural Worker
Protection Act.
Substantially all crew members operate or
maintain mechanized equipment provided
by the crew leader as part of the service to
the farmer.
The farmer is the employer of workers fur-
nished by a crew leader in all other situations. In
addition, the farmer is the employer of workers
furnished by a registered crew leader if the
workers are the employees of the farmer under
the common-law test. For example, some farm-
ers employ individuals to recruit farmworkers
exclusively for them. Although these individuals
may be required to register under the Migrant
and Seasonal Agricultural Worker Protection
Act, the workers are employed directly by the
farmer. The farmer is the employer in these ca-
ses. For information about common-law em-
ployees, see section 1 of Pub. 15-A. For infor-
mation about the Migrant and Seasonal
Agricultural Worker Protection Act, which pro-
tects migrant and seasonal agricultural workers
by establishing employment standards related
to wages, housing, transportation, disclosures
and recordkeeping, and which requires farm la-
bor contractors to register with the U.S. Depart-
ment of Labor (DOL), see the DOL website at
dol.gov/whd/regs/compliance/whdfs49.htm.
Social Security and
Medicare Taxes
All cash wages you pay to an employee during
the year for farmwork are subject to social se-
curity and Medicare taxes if you meet either of
the following tests.
You pay the employee $150 or more in
cash wages (count all wages paid on a
time, piecework, or other basis) during the
year for farmwork (the $150 test). The
$150 test applies separately to each farm-
worker that you employ. If you employ a
family of workers, each member is treated
separately. Don't count wages paid by
other employers.
You pay cash and noncash wages of
$2,500 or more during the year to all your
employees for farmwork (the $2,500 test).
If the $2,500 test for the group isn't met, the
$150 test for an employee still applies.
Exceptions. Annual cash wages of less than
$150 you pay to a seasonal farmworker aren't
subject to social security and Medicare taxes,
even if you pay $2,500 or more to all your farm-
workers. However, these wages count toward
the $2,500 test for determining whether other
farmworkers' wages are subject to social secur-
ity and Medicare taxes.
A seasonal farmworker is a worker who:
Works as a hand-harvest laborer,
Is paid piece rates in an operation usually
paid on this basis in the region of employ-
ment,
Commutes daily from his or her permanent
home to the farm, and
Worked in agriculture less than 13 weeks
in the preceding calendar year.
See Family Employees, earlier, for certain
exemptions from social security and Medicare
taxes that apply to your child, spouse, and pa-
rent.
Religious exemption. An exemption from
social security and Medicare taxes is available
to members of a recognized religious group or
division opposed to public insurance. This ex-
emption is available only if both the employee
and the employer are members of the group or
division. These employees are still subject to
federal income tax. For more information, see
Pub. 517.
Cash wages. Only cash wages paid to farm-
workers are subject to social security and Medi-
care taxes. Cash wages include checks, money
orders, and any kind of money or cash.
Only cash wages subject to social security
and Medicare taxes are credited to your em-
ployees for social security benefit purposes.
Payments not subject to these taxes, such as
commodity wages, don't contribute to your em-
ployees' social security coverage. For informa-
tion about social security benefits, go to
SSA.gov or call the SSA at 1-800-772-1213.
Noncash wages (including commodity wa-
ges). Noncash wages include food, lodging,
clothing, transportation passes, farm products,
or other goods or commodities. Noncash wa-
ges paid to farmworkers, including commodity
wages, aren't subject to social security and
Medicare taxes. However, they are subject to
these taxes if the substance of the transaction
is a cash payment. For information on lodging
provided as a condition of employment, see
Pub. 15-B.
Report the value of noncash wages in box 1
of Form W-2 together with cash wages. Don't
show noncash wages in box 3 or in box 5 (un-
less the substance of the transaction is a cash
payment).
Tax rates and social security wage limit.
For 2017, the employer and the employee will
pay the following taxes.
The employer and employee each pay
6.2% of cash wages for social security tax
(old-age, survivors, and disability insur-
ance).
The employer and employee each pay
1.45% of cash wages for Medicare tax
(hospital insurance).
The employee pays 0.9% of cash wages in
excess of $200,000 for Additional Medi-
care Tax.
Wage limit. The limit on wages subject to
the social security tax for 2017 is $127,200.
There is no limit on wages subject to the Medi-
care tax. All covered wages are subject to the
Medicare tax. Additionally, all wages in excess
of $200,000 are subject to Additional Medicare
Tax withholding.
Paying employee's share. If you would rather
pay the employee's share of social security and
Medicare taxes without deducting it from his or
her wages, you may do so. It is additional in-
come to the employee. You must include it in
box 1 of the employee's Form W-2, but don't
count it as social security and Medicare wages
(boxes 3 and 5 on Form W-2) or as wages for
federal unemployment (FUTA) tax purposes.
Example. Gavrielle operates a small family
fruit farm. She employs day laborers in the pick-
ing season to enable her to timely get her crop
to market. She doesn't deduct the employees'
share of social security and Medicare taxes
from their pay; instead, she pays it on their be-
half. When her accountant, Annabella, prepares
the employees' Forms W-2, she adds each em-
ployee's share of social security and Medicare
taxes paid by Gavrielle to the employee's wage
income (box 1 of Form W-2), but doesn't in-
clude it in box 3 (social security wages) or box 5
(Medicare wages and tips).
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Chapter 13 Employment Taxes Page 79
For 2017, Gavrielle paid Daniella $1,000
during the year. Annabella enters $1,076.50 in
box 1 of Daniella's Form W-2 ($1,000 wages
plus $76.50 social security and Medicare taxes
paid for Daniella). She enters $1,000.00 in
boxes 3 and 5 of Daniella's Form W-2.
Additional Medicare Tax. In addition to with-
holding Medicare tax at 1.45%, you must with-
hold a 0.9% Additional Medicare Tax from wa-
ges you pay to an employee in excess of
$200,000 in a calendar year. You’re required to
begin withholding Additional Medicare Tax in
the pay period in which you pay wages in ex-
cess of $200,000 to an employee and continue
to withhold it each pay period until the end of
the calendar year. Additional Medicare Tax is
only imposed on the employee. There is no em-
ployer share of Additional Medicare Tax. All wa-
ges that are subject to Medicare tax are subject
to Additional Medicare Tax withholding if paid in
excess of the $200,000 threshold.
For more information on what wages are
subject to Medicare tax, see the chart, Special
Rules for Various Types of Services and Pay-
ments, in section 15 of Pub. 15. For more infor-
mation on Additional Medicare Tax, go to
IRS.gov/ADMT.
Federal Income Tax
Withholding
If the cash wages you pay to farmworkers are
subject to social security and Medicare taxes,
they are also subject to federal income tax with-
holding. Although noncash wages are subject
to federal income tax, withhold income tax on
these noncash wages only if you and the em-
ployee agree to do so. The amount to withhold
is figured on gross wages without taking out so-
cial security and Medicare taxes, union dues,
etc.
Form W-4. Generally, the amount of federal in-
come tax you withhold is based on the employ-
ee's marital status and withholding allowances
claimed on the employee's Form W-4. In gen-
eral, an employee can claim withholding allow-
ances on Form W-4 equal to the number of ex-
emptions the employee will be entitled to claim
on his or her tax return. An employee may also
be able to claim a special withholding allow-
ance and allowances for estimated deductions
and credits.
Don't withhold federal income tax from the
wages of an employee who, by filing Form W-4,
certifies that he or she had no federal income
tax liability last year and anticipates no liability
for the current year.
You should give each new employee a Form
W-4 as soon as you hire the employee. For
Spanish-speaking employees, you may use
Formulario W-4(SP) which is the Spanish trans-
lation of Form W-4. Have the employee com-
plete and return the form to you before the first
payday. If the employee doesn't return the com-
pleted form, you must withhold federal income
tax as if the employee is single and claims no
withholding allowances.
New Form W-4 for 2018. You should
make the 2018 Form W-4 available to your
employees and encourage them to check their
income tax withholding for 2018. Those em-
ployees who owed a large amount of tax or re-
ceived a large refund for 2017 may want to sub-
mit a new Form W-4. You can't accept
substitute Forms W-4 developed by employees.
Advise your employees to use the IRS With-
holding Calculator on the IRS website at
IRS.gov/W4App for help in determining how
many withholding allowances to claim on their
Form W-4.
How to figure withholding. You can use one
of several methods to determine the amount to
withhold. The methods are described in section
13 of Pub. 51, which contains tables showing
the correct amount of federal income tax you
should withhold. Section 5 of Pub. 51 also con-
tains additional information about federal in-
come tax withholding.
Nonemployee compensation. Generally, you
don't have to withhold federal income tax on
payments for services to individuals who aren't
your employees. However, you may be required
to report these payments on Form 1099-MISC
and to withhold under the backup withholding
rules. For example, persons who haven’t fur-
nished their taxpayer identification number
(TIN) to you are subject to withholding on pay-
ments required to be reported on Form
1099-MISC. For more information, see the In-
structions for Form 1099-MISC.
Required Notice to
Employees About
Earned Income Credit
(EIC)
You must provide notification about the EIC to
each employee who worked for you at any time
during the year and from whom you didn't with-
hold any federal income tax. However, you
don't have to notify employees who claim ex-
emption from federal income tax withholding on
Form W-4. You meet the notification require-
ment by giving each employee any of the fol-
lowing.
Form W-2, which contains EIC notification
on the back of Copy B.
A substitute Form W-2 with the exact EIC
wording shown on the back of Copy B of
Form W-2.
Notice 797, Possible Federal Tax Refund
Due to the Earned Income Credit (EIC).
Your own written statement with the exact
wording of Notice 797.
For more information, see Pub. 51.
Reporting and Paying
Social Security,
Medicare, and Withheld
Federal Income Taxes
You must withhold federal income, social secur-
ity, and Medicare taxes required to be withheld
from the salaries and wages of your employees.
You’re liable for the payment of these taxes to
the federal government whether or not you col-
lect them from your employees. If, for example,
you withhold less than the correct tax from an
employee's wages, you’re still liable for the full
amount. You must also pay the employer's
share of social security and Medicare taxes.
There is no employer share of Additional Medi-
care Tax.
Form 943. Report withheld federal income tax,
social security tax, and Medicare tax on Form
943. Your 2017 Form 943 is due by January 31,
2018 (or February 12, 2018, if you made depos-
its on time in full payment of the taxes due for
the year).
Deposits. Generally, you must deposit both
the employer and employee shares of social se-
curity and Medicare taxes and federal income
tax withheld during the year. However, you may
make payments with Form 943 instead of de-
positing them if you accumulate less than a
$2,500 tax liability (“Total taxes after adjust-
ments and credits” line on Form 943) during the
year and you pay in full with a timely filed return.
For more information on deposit rules, see
section 7 of Pub. 51.
Electronic deposit requirement. You
must use EFT to make all federal tax deposits.
Generally, an EFT is made using EFTPS. If you
don't want to use EFTPS, you can arrange for
your tax professional, financial institution, pay-
roll service, or other trusted third party to make
electronic deposits on your behalf. Also, you
may arrange for your financial institution to ini-
tiate a same-day wire payment on your behalf.
EFTPS is a free service provided by the Depart-
ment of Treasury. Services provided by your tax
professional, financial institution, payroll serv-
ice, or other third party may have a fee.
For more information on making federal tax
deposits, see section 7 of Pub. 51. To get more
information about EFTPS or to enroll in EFTPS,
go to EFTPS.gov or call 1-800-555-4477 or
1-800-733-4829 (TDD). Additional information
about EFTPS is also available in Pub. 966.
Form W-2. By January 31, you must furnish
each employee a Form W-2 showing total wa-
ges for the previous year and total federal in-
come tax, social security tax, and Medicare tax
withheld. However, if an employee stops work-
ing for you and asks for the form earlier, you
must give it to the employee within 30 days of
the later of the following dates.
The date the employee asks for the form.
The date you make your final payment of
wages to the employee.
Compensation paid to H-2A visa holders.
Report compensation of $600 or more paid to
foreign agricultural workers who entered the
country on H-2A visas in box 1 of Form W-2.
Compensation paid to H-2A workers for agricul-
tural labor performed in connection with this
visa isn't subject to social security and Medi-
care taxes, and therefore shouldn't be reported
as wages subject to social security tax (line 2),
Medicare tax (line 4), or Additional Medicare
Tax (line 6) on Form 943, and shouldn't be re-
ported as social security wages (box 3) or Medi-
care wages (box 5) on Form W-2. On Form
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Page 80 Chapter 13 Employment Taxes
W-2, don't check box 13 (Statutory employee),
as H-2A workers aren't statutory employees.
An employer isn’t required to withhold fed-
eral income tax from compensation paid to an
H-2A worker for agricultural labor performed in
connection with this visa unless the worker asks
for withholding and the employer agrees. In this
case, the worker must give the employer a com-
pleted Form W-4. Federal income tax withheld
should be reported on Form 943, line 8, and in
box 2 of Form W-2.
These reporting rules apply when the H-2A
worker provides his or her TIN to the employer.
However, if an H-2A visa worker didn't provide
the employer with a TIN, the employee is sub-
ject to backup withholding. The employer must
report the wages and backup withholding on
Form 1099-MISC. The employer must also re-
port the backup withholding on Form 945,
line 2.
For more information, see the Instructions
for Form 1099-MISC and the Instructions for
Form 945. For more information on foreign agri-
cultural workers on H-2A visas, go to IRS.gov/
H2A.
Trust fund recovery penalty. If you’re re-
sponsible for withholding, accounting for, de-
positing, or paying federal income, social secur-
ity, and Medicare taxes (that is, trust fund taxes)
and willfully fail to do so, you can be held liable
for a penalty equal to the withheld tax not paid.
A responsible person can be an officer of a cor-
poration, a partner, a sole proprietor, or an em-
ployee of any form of business. A trustee or
agent with authority over the funds of the busi-
ness can also be held responsible for the pen-
alty.
Willfully means voluntarily, consciously, and
intentionally. Paying other expenses of the busi-
ness instead of the taxes due is acting willfully.
Consequences of treating an employee as
an independent contractor. If you classify an
employee as an independent contractor and
you have no reasonable basis for doing so, you
may be held liable for employment taxes for that
worker. See Pub. 15-A for more information.
Federal Unemployment
(FUTA) Tax
You must pay FUTA tax if you meet either of the
following tests.
You paid cash wages of $20,000 or more
to farmworkers in any calendar quarter
during the current or preceding calendar
year.
You employed 10 or more farmworkers for
some part of at least 1 day (whether or not
all at the same time) during any 20 or more
different calendar weeks during the current
or preceding calendar year.
These rules don't apply to exempt services of
your spouse, your parents, or your children un-
der age 21. See Family Employees, earlier.
Alien farmworkers. Wages paid to aliens ad-
mitted on a temporary basis to the United
States to perform farmwork (also known as
“H-2A visa workers”) are exempt from FUTA
tax. However, include your employment of
these workers and the wages you paid them to
determine whether you meet either of the above
tests.
Commodity wages. Payments in kind for farm
labor aren't cash wages. Don't count them to
figure whether you’re subject to FUTA tax or to
figure how much tax you owe.
Tax rate and credit. The gross FUTA tax rate
is 6.0% of the first $7,000 cash wages you pay
to each employee during the year. However,
you’re given a credit of up to 5.4% of the first
$7,000 cash wages you pay to each employee
for the state unemployment tax you pay. If your
state tax rate (experience rate) is less than
5.4%, you may still be allowed the full 5.4%
credit.
If all of the taxable FUTA wages you paid
were excluded from state unemployment tax,
the full 6.0% rate applies. See the Instructions
for Form 940 for additional information.
More information. For more information on
FUTA tax, see section 10 of Pub. 51.
Reporting and Paying FUTA
Tax
The FUTA tax is imposed on you as the em-
ployer. It must not be collected or deducted
from the wages of your employees.
Form 940. Report FUTA tax on Form 940. The
2017 Form 940 is due by January 31, 2018 (or
February 12, 2018, if you timely deposited the
full amount of your 2017 FUTA tax).
Deposits. If at the end of any calendar quarter
you owe, but haven't yet deposited, more than
$500 in FUTA tax for the year, you must make a
deposit by the end of the following month. If the
undeposited tax is $500 or less at the end of a
quarter, you don't have to deposit it. You can
add it to the tax for the next quarter. If the total
undeposited tax is more than $500 at the end of
the next quarter, a deposit will be required. If
the total undeposited tax at the end of the 4th
quarter is $500 or less, you can either make a
deposit or pay it with your return by the January
31, 2018, due date.
Electronic deposit requirement. You
must use EFT to make all federal tax deposits.
Generally, an EFT is made using EFTPS. If you
don't want to use EFTPS, you can arrange for
your tax professional, financial institution, pay-
roll service, or other trusted third party to make
electronic deposits on your behalf. Also, you
may arrange for your financial institution to ini-
tiate a same-day wire payment on your behalf.
EFTPS is a free service provided by the Depart-
ment of Treasury. Services provided by your tax
professional, financial institution, payroll serv-
ice, or other third party may have a fee.
For more information on making federal tax
deposits, see section 7 of Pub. 51. To get more
information about EFTPS or to enroll in EFTPS,
go to EFTPS.gov or call 1-800-555-4477 or
1-800-733-4829 (TDD). Additional information
about EFTPS is also available in Pub. 966.
14.
Fuel Excise Tax
Credits and
Refunds
Introduction
You may be eligible to claim a credit on your in-
come tax return for the federal excise tax on
certain fuels. You may also be eligible to claim a
quarterly refund of the fuel taxes during the
year, instead of waiting to claim a credit on your
income tax return.
Whether you can claim a credit or refund de-
pends on whether the fuel was taxed and the
purpose (nontaxable use) for which you used
the fuel. The nontaxable uses of fuel for which a
farmer may claim a credit or refund are gener-
ally the following.
Use on a farm for farming purposes.
Off-highway business use.
Uses other than as a fuel in a propulsion
engine, such as home use.
Table 14-1 presents an overview of credits
and refunds that may be claimed for fuels used
for the nontaxable uses listed above. See Pub.
510, Excise Taxes, for more information.
Topics
This chapter discusses:
Fuels used in farming
Dyed diesel fuel and dyed kerosene
Fuels used in off-highway business use
Fuels used for household purposes
How to claim a credit or refund
Including the credit or refund in income
Useful Items
You may want to see:
Publication
Excise Taxes
Form (and Instructions)
Quarterly Federal Excise Tax Return
Credit for Federal Tax Paid on Fuels
Claim for Refund of Excise Taxes
See chapter 16 for information about getting
publications and forms.
Fuels Used in Farming
Owners, operators, and tenants of farms and
certain other persons may be eligible to claim a
credit or refund of excise taxes on fuel used in
the trade or business of farming, when used on
a farm in the United States for farming
purposes. See Table 14-1 for a list of available
510
720
4136
8849
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Chapter 14 Fuel Excise Tax Credits and Refunds Page 81
fuel excise tax credits and refunds. Fuel is used
on a farm for farming purposes only if used in
carrying on a trade or business of farming, on a
farm in the United States, and for farming pur-
poses.
Farm. A farm includes livestock, dairy, fish,
poultry, fruit, fur-bearing animals, and truck
farms, orchards, plantations, ranches, nurser-
ies, ranges, and feed yards for finishing cattle. It
also includes structures such as greenhouses
used primarily for raising agricultural or horticul-
tural commodities. A fish farm is an area where
fish are grown or raised and not merely caught
or harvested.
Farming purposes. As the owner, tenant, or
operator and the ultimate purchaser of fuel that
you purchased, you use the fuel on a farm for
farming purposes if you use it in any of the fol-
lowing ways.
1. To cultivate the soil or to raise or harvest
any agricultural or horticultural commodity.
2. To raise, shear, feed, care for, train, or
manage livestock, bees, poultry, fur-bear-
ing animals, or wildlife.
3. To operate, manage, conserve, improve,
or maintain your farm and its tools and
equipment.
4. To handle, dry, pack, grade, or store any
raw agricultural or horticultural commodity.
For this use to qualify, you must have pro-
duced more than half the commodity so
treated during the tax year. The
more-than-one-half test applies separately
to each commodity. Commodity means a
single raw product. For example, apples
and peaches are two separate commodi-
ties.
5. To plant, cultivate, care for, or cut trees or
to prepare (other than sawing logs into
lumber, chipping, or other milling) trees for
market, but only if these activities are inci-
dental to your farming operations. Your
tree operations are incidental only if they
are minor in nature when compared to the
total farming operations.
If any other person, such as a neighbor or
custom operator (independent contractor), per-
forms a service for you on your farm for any of
the purposes included in list item (1) or (2)
above, you are considered to be the ultimate
purchaser who used the fuel on a farm for farm-
ing purposes. Therefore, you can still claim the
credit or refund for the fuel so used. However,
see Custom application of fertilizer and pesti-
cide, later. If the other person performs any
other services for you on your farm for purposes
not included in list item (1) or (2) above, no one
can claim the credit or refund for fuel used on
your farm for those other services.
Buyer of fuel, including undyed diesel
fuel or undyed kerosene. If doubt exists
whether the owner, tenant, or operator of the
farm bought the fuel, determine who actually
bore the cost of the fuel. For example, if the
owner of a farm and his or her tenant equally
share the cost of gasoline used on the farm,
each can claim a credit for the tax on half the
fuel used.
Undyed diesel fuel, undyed kerosene,
and other fuels (including alternative fuel).
Usually, the farmer is the only person who can
make a claim for credit or refund for the tax on
undyed diesel fuel, undyed kerosene, or other
fuels (including alternative fuel) used for farm-
ing purposes. However, see Custom applica-
tion of fertilizer and pesticide next. Also see
Dyed Diesel Fuel and Dyed Kerosene, later.
Example. Farm owner Haleigh Blue hired
custom operator Tyler Steele to cultivate the
soil on her farm. Tyler used 200 gallons of
undyed diesel fuel that he purchased to perform
the work on Haleigh's farm. In addition, Haleigh
hired contractor Lee Brown to pack and store
her apple crop. Lee bought 25 gallons of
undyed diesel fuel to use in packing the apples.
Haleigh can claim the credit for the 200 gallons
of undyed diesel fuel used by Tyler on her farm
because it qualifies as fuel used on the farm for
farming purposes. No one can claim a credit for
the 25 gallons used by Lee because that fuel
was not used for a farming purpose included in
list item (1) or (2) above.
In the above example, both Tyler Steele and
Lee Brown could have purchased dyed (un-
taxed) diesel fuel for their tasks.
Custom application of fertilizer and pes-
ticide. Fuel used on a farm for farming purpo-
ses includes fuel used in the application (includ-
ing aerial application) of fertilizer, pesticides, or
other substances. Generally, the applicator is
treated as having used the fuel on a farm for
farming purposes. For applicators using high-
way vehicles, only the fuel used on the farm is
exempt. Fuel used traveling on the highway to
and from the farm is taxable. Fuel used by an
aerial applicator for the direct flight between the
airfield and one or more farms is treated as
used for a farming purpose. For aviation gaso-
line, the aerial applicator makes the claim as
the ultimate purchaser. For kerosene used in
aviation, the ultimate purchaser may make the
claim or waive the right to make the claim to the
registered ultimate vendor. A sample waiver is
included as Model Waiver L in the appendix of
Pub. 510.
A registered ultimate vendor is the person
who sells undyed diesel fuel, undyed kerosene,
or kerosene for use in aviation to the user (ulti-
mate purchaser) of the fuel for use on a farm for
farming purposes. To claim a credit or refund of
tax, the ultimate vendor must be registered with
the IRS at the time the claim is made. However,
registered ultimate vendors cannot make claims
for undyed diesel fuel and undyed kerosene
sold for use on a farm for farming purposes.
Fuel not used for farming. You do not use
fuel on a farm for farming purposes when you
use it in any of the following ways.
Off the farm, such as on the highway or in
noncommercial aviation, even if the fuel is
used in transporting livestock, feed, crops,
or equipment.
For personal use, such as lawn mowing.
In processing, packaging, freezing, or can-
ning operations.
In processing crude gum into gum spirits of
turpentine or gum resin or in processing
maple sap into maple syrup or maple
sugar.
All-terrain vehicles (ATVs). Fuel used in
ATVs on a farm for farming purposes, dis-
cussed earlier, is eligible for a credit or refund of
excise taxes on the fuel. Fuel used in ATVs for
nonfarming purposes is not eligible for a credit
or refund of the taxes. If ATVs are used both for
Fuel Excise Tax Credits and Refunds at a Glance
Use this table to see if you can take a credit or refund for a nontaxable use of the fuel listed.
Fuel Used
On a Farm for Farming
Purposes
Off-Highway
Business Use
Household Use or
Use Other Than as
a Fuel1
Gasoline Credit only Credit or refund None
Aviation gasoline Credit only None None
Undyed diesel fuel
and undyed
kerosene
Credit or refund Credit or refund2Credit or refund2
Kerosene for use in
aviation
Credit or refund None None
Dyed diesel fuel
and dyed kerosene
None None None
Other Fuels
(including
alternative fuels)3
Credit or refund Credit or refund None
1For a use other than as fuel in a propulsion engine.
2Applies to undyed kerosene not sold from a blocked pump or, under certain circumstances, for blending
with undyed diesel fuel to be used for heating purposes. See Regulations section 48.6427-10(b)(1) for the
definition of a blocked pump.
3Other Fuels means any liquid except gas oil, fuel oil, or any product taxable under section 4081. It includes
the alternative fuels: liquefied petroleum gas (LPG), “P” Series fuels, compressed natural gas (CNG),
liquefied hydrogen, Fischer-Tropsch process liquid fuel from coal (including peat), liquid fuel derived from
biomass, liquefied natural gas (LNG), liquefied gas derived from biomass, and compressed gas derived
from biomass.
Table 14-1.
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Page 82 Chapter 14 Fuel Excise Tax Credits and Refunds
farming and nonfarming purposes, only that
portion of the fuel used for farming purposes is
eligible for the credit or refund.
Dyed Diesel Fuel and
Dyed Kerosene
If you purchase dyed diesel fuel or dyed kero-
sene for a nontaxable use, you must use it only
on a farm for farming purposes or for other non-
taxable purposes. For example, you should not
use dyed diesel fuel in a truck that is used both
on the farm for farming purposes and on the
highway, even though the highway use is in
connection with farm business. Excise tax ap-
plies to the fuel used by the truck on the high-
ways. In this situation, undyed (taxed) fuel
should be purchased for the truck. You should
keep fuel records of the use of the truck on the
farm for farming purposes, and for other uses.
You may be eligible for a credit or refund for the
excise tax on fuel used on the farm for farming
purposes.
Penalty. A penalty is imposed on any person
who knowingly uses, sells, or alters dyed diesel
fuel or dyed kerosene for any purpose other
than a nontaxable use. The penalty is the
greater of $1,000 or $10 per gallon of the dyed
diesel fuel or dyed kerosene involved. After the
first violation, the $1,000 portion of the penalty
increases depending on the number of viola-
tions. For more information on this penalty, see
Pub. 510.
Fuels Used in
Off-Highway
Business Use
You may be eligible to claim a credit or refund
for the excise tax on fuel used in an off-highway
business use.
Off-highway business use. This is any use of
fuel in a trade or business or in an income-pro-
ducing activity. The use must not be in a high-
way vehicle registered or required to be regis-
tered for use on public highways. Off-highway
business use generally does not include any
use in a recreational motorboat.
Examples. Off-highway business use includes
the use of fuels in a trade or business in any of
the following ways.
In stationary machines such as generators,
compressors, power saws, and similar
equipment.
For cleaning.
In forklift trucks, bulldozers, and earthmov-
ers.
Off-highway nonbusiness (taxable) use of
fuel includes use in minibikes, snowmobiles,
power lawn mowers, chain saws, and other
yard equipment. For more information, see Pub.
510.
Fuels Used for
Household Purposes or
Other Than as a Fuel for
Propulsion Engines
You may be eligible to claim a credit or refund
for the excise tax on undyed diesel fuel or kero-
sene used for home heating, lighting, and cook-
ing. This also applies to diesel fuel and kero-
sene used in a home generator to produce
electricity for home use. Home use of a fuel
does not include use in a propulsion engine and
it is not considered an off-highway business
use.
How To Claim a
Credit or Refund
You may be able to claim a credit or refund of
the excise tax on fuels you use for nontaxable
uses. The basic rules for claiming credits and
refunds are listed in Table 14-2.
Keep at your principal place of busi-
ness all records needed to enable the
IRS to verify that you are the person
entitled to claim a credit or refund and the
amount you claimed. You do not have to use
any special form, but the records should estab-
lish the following information.
The total number of gallons bought and
used during the period covered by your
claim.
The dates of the purchases.
The names and addresses of suppliers
and amounts bought from each during the
period covered by your claim.
The nontaxable use for which you used the
fuel.
The number of gallons used for each non-
taxable use.
It is important that your records separately show
the number of gallons used for each nontaxable
use that qualifies as a claim. For more informa-
tion about recordkeeping, see Pub. 583, Start-
ing a Business and Keeping Records.
RECORDS
Credit or refund. A credit is an amount that re-
duces the tax on your income tax return when
you file it at the end of the year. If you meet cer-
tain requirements, you may claim a refund dur-
ing the year instead of waiting until you file your
income tax return.
Credit only. You can claim the following
taxes only as a credit on your income tax return.
Tax on gasoline and aviation gasoline you
used on a farm for farming purposes.
Tax on fuels (including undyed diesel fuel
or undyed kerosene) you used for nontax-
able uses if the total for the tax year is less
than $750.
Tax on fuel you did not include in any claim
for refund previously filed for any quarter of
the tax year.
Claiming a Credit
You make a claim for a fuel tax credit on Form
4136 and attach it to your income tax return. Do
not claim a credit for any excise tax for which
you have filed a refund claim.
How to claim a credit. How you claim a credit
depends on whether you are an individual, part-
nership, corporation, S corporation, trust, or
farmers' cooperative association.
Individuals. You claim the credit on the
“Credit for federal tax on fuels” line of your Form
1040. If you would not otherwise have to file an
income tax return, you must do so to get a fuel
tax credit.
Partnership. Partnerships (other than
electing large partnerships) claim the credit by
including a statement on Schedule K-1 (Form
1065), Partner's Share of Income, Deductions,
Credits, etc., showing each partner's share of
the number of gallons of each fuel sold or used
for a nontaxable use, the type of use, and the
applicable credit per gallon. Each partner
claims the credit on his or her income tax return
for the partner's share of the fuel used by the
partnership.
An electing large partnership can claim the
credit on the “Other payments” line of Form
1065-B, U.S. Return of Income for Electing
Large Partnerships.
Other entities. Corporations, S corpora-
tions, farmers' cooperative associations, and
Claiming a Credit or Refund of Excise Taxes
This table gives the basic rules for claiming a credit or refund of excise taxes on fuels used for a
nontaxable use.
Credit Refund
Which form to use Form 4136, Credit for Federal
Tax Paid on Fuels
Form 8849, Claim for Refund of
Excise Taxes; and Schedule 1
(Form 8849), Nontaxable Use
of Fuels
Type of form Annual Quarterly
When to file With your income tax return By the last day of the quarter
following the last quarter
included in the claim
Amount of tax Any amount $750 or more1
1You may carry over an amount less than $750 to the next quarter.
Table 14-2.
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Chapter 14 Fuel Excise Tax Credits and Refunds Page 83
trusts make the claim on the appropriate line of
their income tax return.
When to claim a credit. You can claim a fuel
tax credit on your income tax return for the year
you used the fuel.
You may be able to make a fuel tax
claim on an amended income tax re-
turn for the year you used the fuel. A
claim for credit or refund of an overpayment
must generally be filed within the later of:
3 years from the date the original return
was filed, or
2 years from the date the tax was paid.
Claiming a Refund
Generally, you may claim a refund of excise
taxes on Form 8849. Complete and attach to
Form 8849 the appropriate Form 8849 sched-
ule(s). The instructions for Form 8849 and the
separate instructions for each schedule explain
the requirements for making a claim for refund.
If you file Form 720, you can use its Schedule C
for your refund claims for the quarter. See the
Instructions for Form 720. Do not claim a refund
on Form 8849 for any amount for which you
have filed or will file a claim on Form 720 or
Form 4136.
You may file a claim for refund for any quar-
ter of your tax year for which you can claim
$750 or more. This amount is the excise tax on
all fuels used for a nontaxable use during that
quarter or any prior quarter (for which no other
claim has been filed) during the tax year.
If you cannot claim at least $750 at the end
of a quarter, you carry the amount over to the
next quarter of your tax year to determine if you
can claim at least $750 for that quarter. If you
cannot claim at least $750 at the end of the
fourth quarter of your tax year, you must claim a
credit on your income tax return using Form
4136. Only one claim can be filed for a quarter.
You cannot claim a refund for excise
tax on gasoline and aviation gasoline
used on a farm for farming purposes.
You must claim a credit on your income tax re-
turn for the tax.
How to file a quarterly claim. File the claim
for refund by filling out Schedule 1 (Form 8849)
and attaching it to Form 8849. Send it to the ad-
dress shown in the instructions. If you file Form
720, you can use its Schedule C for your refund
claims. See the Instructions for Form 720.
When to file a quarterly claim. You must file
a quarterly claim by the last day of the first quar-
ter following the last quarter included in the
claim. If you do not file a timely refund claim for
the fourth quarter of your tax year, you will have
to claim a credit for that amount on your income
tax return, as discussed earlier.
In most situations, the amount claimed
as a credit or refund will be less than
the amount deducted as fuel tax ex-
pense because the Leaking Underground Stor-
age Tank (LUST) tax of $0.001 per gallon is
generally not subject to credit or refund.
TIP
CAUTION
!
CAUTION
!
Including the Credit or
Refund in Income
Include any credit or refund of excise taxes on
fuels in your gross income if you claimed the to-
tal cost of the fuel (including the excise taxes)
as an expense deduction that reduced your in-
come tax liability.
Which year you include a credit or refund in
gross income depends on whether you use the
cash or an accrual method of accounting.
Cash method. If you use the cash method and
file a claim for refund, include the refund
amount in gross income for the tax year in
which you receive the refund. If you claim a
credit on your income tax return, include the
credit amount in gross income for the tax year in
which you file Form 4136. If you file an amen-
ded return and claim a credit, include the credit
amount in gross income for the tax year in
which you receive the credit.
Example. Marucia Brown, a farmer who
uses the cash method, filed her 2016 Form
1040 on March 3, 2017. On her Schedule F,
she deducted the total cost of gasoline (includ-
ing $110 of excise taxes) used on the farm for
farming purposes. Then, on Form 4136, she
claimed the $110 as a credit. Marucia reports
the $110 as other income on line 8 of her 2017
Schedule F.
Accrual method. If you use an accrual
method, include the amount of credit or refund
in gross income for the tax year in which you
used the fuels. It does not matter whether you
filed for a quarterly refund or claimed the entire
amount as a credit.
Example. Amy Johnson, a farmer who
uses the accrual method, files her 2016 Form
1040 on April 15, 2017. On Schedule F, she de-
ducts the total cost of gasoline (including $155
of excise taxes) she used on the farm for farm-
ing purposes during 2016. On Form 4136, Amy
claims the $155 as a credit. She reports the
$155 as other income on line 8 of her 2016
Schedule F.
15.
Estimated Tax
Introduction
Estimated tax is the method used to pay tax on
income that is not subject to withholding. See
Pub. 505 for the general rules and requirements
for paying estimated tax. If you are a qualified
farmer, defined below, you are subject to the
special rules covered in this chapter for paying
estimated tax.
Topics
This chapter discusses:
Special estimated tax rules for qualified
farmers
Estimated tax penalty
Useful Items
You may want to see:
Publication
Tax Withholding and Estimated Tax
Form (and Instructions)
U.S. Individual Income Tax Return
Estimated Tax for Individuals
Underpayment of Estimated Tax
by Farmers and Fishermen
See chapter 16 for information about getting
publications and forms.
Special Estimated Tax
Rules for Qualified
Farmers
Special rules apply to the payment of estimated
tax by individuals who are qualified farmers. If
you are not a qualified farmer as defined next,
see Pub. 505 for the estimated tax rules that ap-
ply.
Qualified Farmer
An individual is a qualified farmer for 2017 if at
least two-thirds of his or her gross income from
all sources for 2016 or 2017 was from farming.
See Gross Income, next, for information on how
to figure your gross income from all sources
and see Gross Income From Farming, later, for
information on how to figure your gross income
from farming. See also Percentage From Farm-
ing, later, for information on how to determine
the percentage of your gross income from farm-
ing.
Gross Income
Gross income is all income you receive in the
form of money, goods, property, and services
that is not exempt from income tax. On a joint
return, you must add your spouse's gross in-
come to your gross income. To decide whether
two-thirds of your gross income was from farm-
ing, use as your gross income the total of the
following income (not loss) amounts from your
tax return.
Wages, salaries, tips, etc.
Taxable interest.
Ordinary dividends.
Taxable refunds, credits, or offsets of state
and local income taxes.
Alimony.
Gross business income from Schedule C
(Form 1040).
Gross business receipts from Sched-
ule C-EZ (Form 1040).
505
1040
1040-ES
2210-F
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Page 84 Chapter 15 Estimated Tax
Capital gains from Schedule D (Form
1040). Losses are not netted against
gains.
Gains on sales of business property.
Taxable IRA distributions, pensions, annui-
ties, and social security benefits.
Gross rental income from Schedule E
(Form 1040).
Gross royalty income from Schedule E
(Form 1040).
Taxable net income from an estate or trust
reported on Schedule E (Form 1040).
Income from a Real Estate Mortgage In-
vestment Conduit reported on Schedule E
(Form 1040).
Gross farm rental income from Form 4835.
Gross farm income from Schedule F (Form
1040).
Your distributive share of gross income
from a partnership, or limited liability com-
pany treated as a partnership, from Sched-
ule K-1 (Form 1065).
Your pro rata share of gross income from
an S corporation, from Schedule K-1
(Form 1120S).
Unemployment compensation.
Other income not included with any of the
items listed above.
Gross Income From Farming
Gross income from farming is income from culti-
vating the soil or raising agricultural commodi-
ties. It includes the following amounts.
Income from operating a stock, dairy, poul-
try, bee, fruit, or truck farm.
Income from a plantation, ranch, nursery,
range, orchard, or oyster bed.
Crop shares for the use of your land.
Gains from sales of draft, breeding, dairy,
or sporting livestock.
Gross income from farming is the total of the
following amounts from your tax return.
Gross farm income from Schedule F (Form
1040).
Gross farm rental income from Form 4835.
Gross farm income from Schedule E (Form
1040), Parts II and III.
Gains from the sale of livestock used for
draft, breeding, sport, or dairy purposes re-
ported on Form 4797.
For more information about income from
farming, see chapter 3.
Farm income does not include any of
the following:
Wages you receive as a farm employee,
Income you receive from contract grain
harvesting and hauling with workers and
machines you furnish, and
Gains you receive from the sale of farm
land and depreciable farm equipment.
Percentage From Farming
Figure your gross income from all sources, dis-
cussed earlier. Then figure your gross income
from farming, discussed earlier. Divide your
farm gross income by your total gross income to
determine the percentage of gross income from
farming.
CAUTION
!
Example 1. Jane Smith had the following
total gross income and farm gross income
amounts in 2017.
Gross Income
Total Farm
Taxable interest ........ $3,000
Dividends ............. 500
Rental income (Sch E) .... 41,500
Farm income (Sch F) ..... 75,000 $75,000
Gain (Form 4797) ....... 5,000 5,000
Total ............ $125,000 $80,000
Schedule D showed gain from the sale of
dairy cows carried over from Form 4797
($5,000) in addition to a loss from the sale of
corporate stock ($2,000). However, that loss is
not netted against the gain to figure Ms. Smith's
total gross income or her gross farm income.
Her gross farm income is 64% of her total gross
income ($80,000 ÷ $125,000 = 0.64). Since Ms.
Smith's gross farm income is less than
two-thirds of her total gross income, she is not a
qualified farmer and the general estimated tax
rules apply.
Special Rules for Qualified
Farmers
The following special estimated tax rules apply
if you are a qualified farmer for 2017.
You do not have to pay estimated tax if you
file your 2017 tax return and pay all the tax
due by March 1, 2018.
You do not have to pay estimated tax if
your 2017 income tax withholding (includ-
ing any amount applied to your 2017 esti-
mated tax from your 2016 return) will be at
least 6623% (.6667) of the total tax shown
on your 2017 tax return or 100% of the to-
tal tax shown on your 2016 return.
If you must pay estimated tax, you are re-
quired to make only one estimated tax pay-
ment (your required annual payment) by
January 16, 2018, using special rules to
figure the amount of the payment. See Re-
quired Annual Payment next for details.
Figure 15-1 presents an overview of the
special estimated tax rules that apply to quali-
fied farmers.
Example 2. Assume the same fact as in
Example 1. Ms. Smith's gross farm income is
only 64% of her total income. Therefore, based
on her 2017 income, she does not qualify to use
the special estimated tax rules for qualified
farmers. However, she does qualify if at least
two-thirds of her 2016 gross income was from
farming.
Example 3. Assume the same facts as in
Example 1 except that Ms. Smith's farm income
from Schedule F was $90,000 instead of
$75,000. This made her total gross income
$140,000 ($3,000 + $500 + $41,500 + $90,000
+ $5,000) and her farm gross income $95,000
($90,000 + $5,000). She qualifies to use the
special estimated tax rules for qualified farmers,
since 67.9% (at least two-thirds) of her gross in-
come is from farming ($95,000 ÷ $140,000
= .679).
Figure 15-1. Estimated Tax for Farmers
Start Here:
Will you owe $1,000 or
more after subtracting
income tax withholding
and refundable credits
from your total tax? (Do
not subtract any
estimated tax payments.)
Will your 2017
income tax
withholding and
credits be at
least 100% of
the tax shown
on your 2016
return?
You do not have to
pay estimated tax.
Will your 2017
income tax
withholding and
credits be at
least 662⁄3% of
the tax shown
on your 2017
return?
Will you le your
income tax
return and pay
the tax in full by
March 1, 2018?
You must pay
your estimated
tax (your
required annual
payment) by
January 16,
2018.
Was at least 662⁄3%
of all your gross
income in 2016 or
2017 from farming?
Follow the general
estimated tax rules.
Yes
No
Yes
No No No
Yes YesYes
No
Note. See Special Rules for Qualified Farmers, later, for a detailed description of the special
estimated tax rules that apply to qualied farmers.
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Chapter 15 Estimated Tax Page 85
Required Annual Payment
If you are a qualified farmer and must pay esti-
mated tax for 2017, use the worksheet on Form
1040-ES to figure the amount of your required
annual payment. Apply the following special
rules for qualified farmers to the worksheet.
On line 14a, multiply line 13c by 6623%
(.6667).
On line 14b, enter 100% of the tax shown
on your 2016 tax return regardless of the
amount of your adjusted gross income. For
this purpose, the “tax shown on your 2016
tax return” is the amount on line 61 of your
2016 return modified by certain adjust-
ments. For more information, see chap-
ter 4 of Pub. 505.
Estimated Tax Penalty
for 2017
If you do not pay all your required estimated tax
for 2017 by January 16, 2018, or file your 2017
return and pay any tax due by March 1, 2018,
you may owe a penalty. Use Form 2210-F, Un-
derpayment of Estimated Tax by Farmers and
Fishermen, to determine if you owe a penalty.
See the Instructions for Form 2210-F. Also, see
the Instructions for Form 2210-F for information
on how to request a waiver of the penalty.
If you receive a penalty notice, do not
ignore it, even if you think it is in error.
You may get a penalty notice even
though you filed your return on time, attached
Form 2210-F, and met the gross-in-
come-from-farming requirement. If you receive
a penalty notice for underpaying estimated tax
and you think it is in error, write to the address
on the notice and explain why you think the no-
tice is in error. Include a computation similar to
the one in Example 1 (earlier), showing that you
met the gross income from farming require-
ment.
16.
How To Get Tax
Help
If you have questions about a tax issue, need
help preparing your tax return, or want to down-
load free publications, forms, or instructions, go
to IRS.gov and find resources that can help you
right away.
Preparing and filing your tax return. Find
free options to prepare and file your return on
IRS.gov or in your local community if you qual-
ify.
The Volunteer Income Tax Assistance
(VITA) program offers free tax help to people
who generally make $54,000 or less, persons
CAUTION
!
with disabilities, the elderly, and limited-Eng-
lish-speaking taxpayers who need help prepar-
ing their own tax returns. The Tax Counseling
for the Elderly (TCE) program offers free tax
help for all taxpayers, particularly those who are
60 years of age and older. TCE volunteers spe-
cialize in answering questions about pensions
and retirement-related issues unique to seniors.
You can go to IRS.gov and click on the Fil-
ing tab to see your options for preparing and fil-
ing your return which include the following.
Free File. Go to IRS.gov/FreeFile. See if
you qualify to use brand-name software to
prepare and e-file your federal tax return
for free.
VITA. Go to IRS.gov/VITA, download the
free IRS2Go app, or call 1-800-906-9887
to find the nearest VITA location for free
tax preparation.
TCE. Go to IRS.gov/TCE, download the
free IRS2Go app, or call 1-888-227-7669
to find the nearest TCE location for free tax
preparation.
Getting answers to your tax law
questions. On IRS.gov get answers to
your tax questions anytime, anywhere.
Go to IRS.gov/Help or IRS.gov/LetUsHelp
pages for a variety of tools that will help
you get answers to some of the most com-
mon tax questions.
Go to IRS.gov/ITA for the Interactive Tax
Assistant, a tool that will ask you questions
on a number of tax law topics and provide
answers. You can print the entire interview
and the final response for your records.
Go to IRS.gov/Pub17 to get Pub. 17, Your
Federal Income Tax for Individuals, which
features details on tax-saving opportuni-
ties, 2017 tax changes, and thousands of
interactive links to help you find answers to
your questions. View it online in HTML as a
PDF, or download it to your mobile device
as an eBook.
You may also be able to access tax law in-
formation in your electronic filing software.
Getting tax forms and publications. Go to
IRS.gov/Forms to view, download, or print all of
the forms and publications you may need. You
can also download and view popular tax publi-
cations and instructions (including the 1040 in-
structions) on mobile devices as an eBook at no
charge. Or, you can go to IRS.gov/OrderForms
to place an order and have forms mailed to you
within 10 business days.
Access your online account (Individual tax-
payers only). Go to IRS.gov/Account to se-
curely access information about your federal tax
account.
View the amount you owe, pay online or
set up an online payment agreement.
Access your tax records online.
Review the past 18 months of your pay-
ment history.
Go to IRS.gov/SecureAccess to review the
required identity authentication process.
Using direct deposit. The fastest way to re-
ceive a tax refund is to combine direct deposit
and IRS e-file. Direct deposit securely and elec-
tronically transfers your refund directly into your
financial account. Eight in 10 taxpayers use di-
rect deposit to receive their refund. IRS issues
more than 90% of refunds in less than 21 days.
Delayed refund for returns claiming certain
credits. Due to changes in the law, the IRS
can’t issue refunds before mid-February 2018,
for returns that properly claimed the earned in-
come credit (EIC) or the additional child tax
credit (ACTC). This applies to the entire refund,
not just the portion associated with these cred-
its.
Getting a transcript or copy of a return. The
quickest way to get a copy of your tax transcript
is to go to IRS.gov/Transcripts. Click on either
"Get Transcript Online" or "Get Transcript by
Mail" to order a copy of your transcript. If you
prefer, you can:
Order your transcript by calling
1-800-908-9946.
Mail Form 4506-T or Form 4506T-EZ (both
available on IRS.gov).
Using online tools to help prepare your re-
turn. Go to IRS.gov/Tools for the following.
The Earned Income Tax Credit Assistant
(IRS.gov/EIC) determines if you are eligi-
ble for the EIC.
The Online EIN Application (IRS.gov/EIN)
helps you get an employer identification
number.
The IRS Withholding Calculator (IRS.gov/
W4App) estimates the amount you should
have withheld from your paycheck for fed-
eral income tax purposes.
The First Time Homebuyer Credit Account
Look-up (IRS.gov/HomeBuyer) tool pro-
vides information on your repayments and
account balance.
The Sales Tax Deduction Calculator
(IRS.gov/SalesTax) figures the amount you
can claim if you itemize deductions on
Schedule A (Form 1040), choose not to
claim state and local income taxes, and
you didn’t save your receipts showing the
sales tax you paid.
Resolving tax-related identity theft issues.
The IRS doesn’t initiate contact with tax-
payers by email or telephone to request
personal or financial information. This in-
cludes any type of electronic communica-
tion, such as text messages and social me-
dia channels.
Go to IRS.gov/IDProtection for information
and videos.
If your SSN has been lost or stolen or you
suspect you’re a victim of tax-related iden-
tity theft, visit IRS.gov/ID to learn what
steps you should take.
Checking on the status of a refund.
Go to IRS.gov/Refunds.
Due to changes in the law, the IRS can’t is-
sue refunds before mid-February 2018, for
returns that properly claimed the EIC or the
ACTC. This applies to the entire refund,
not just the portion associated with these
credits.
Download the official IRS2Go app to your
mobile device and use it to check your re-
fund status.
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Page 86 Chapter 16 How To Get Tax Help
Call the automated refund hotline at
1-800-829-1954.
Making a tax payment. The IRS uses the lat-
est encryption technology to ensure your elec-
tronic payments are safe and secure. You can
make electronic payments online, by phone,
and from a mobile device using the IRS2Go
app. Paying electronically is quick, easy, and
faster than mailing in a check or money order.
Go to IRS.gov/Payments to make a payment
using any of the following options.
IRS Direct Pay: Pay your individual tax bill
or estimated tax payment directly from
your checking or savings account at no
cost to you.
Debit or credit card: Choose an ap-
proved payment processor to pay online,
by phone, and by mobile device.
Electronic Funds Withdrawal: Offered
only when filing your federal taxes using
tax preparation software or through a tax
professional.
Electronic Federal Tax Payment Sys-
tem: Best option for businesses. Enroll-
ment is required.
Check or money order: Mail your pay-
ment to the address listed on the notice or
instructions.
Cash: You may be able to pay your taxes
at a participating retail store.
What if I can’t pay now? Go to IRS.gov/
Payments for more information about your op-
tions.
Apply for an online payment agreement
(IRS.gov/OPA) to meet your tax obligation
in monthly installments if you can’t pay
your taxes in full today. Once you complete
the online process, you will receive imme-
diate notification of whether your agree-
ment has been approved.
Use the Offer in Compromise Pre-Qualifier
(IRS.gov/OIC) to see if you can settle your
tax debt for less than the full amount you
owe.
Checking the status of an amended return.
Go to IRS.gov/WMAR to track the status of
Form 1040X amended returns. Please note that
it can take up to 3 weeks from the date you
mailed your amended return for it show up in
our system and processing it can take up to 16
weeks.
Understanding an IRS notice or letter. Go to
IRS.gov/Notices to find additional information
about responding to an IRS notice or letter.
Contacting your local IRS office. Keep in
mind, many questions can be resolved on
IRS.gov without visiting an IRS Tax Assistance
Center (TAC). Go to IRS.gov/LetUsHelp for the
topics people ask about most. If you still need
help, IRS TACs provide tax help when a tax is-
sue can’t be handled online or by phone. All
TACs now provide service by appointment so
you’ll know in advance that you can get the
service you need without long wait times. Be-
fore you visit, go to IRS.gov/TACLocator to find
the nearest TAC, check hours, available serv-
ices, and appointment options. Or, on the
IRS2Go app, under the Stay Connected tab,
choose the Contact Us option and click on “Lo-
cal Offices.”
Watching IRS videos. The IRS Video portal
(IRSvideos.gov) contains video and audio pre-
sentations for individuals, small businesses,
and tax professionals.
Getting tax information in other languages.
For taxpayers whose native language isn’t Eng-
lish, we have the following resources available.
Taxpayers can find information on IRS.gov in
the following languages.
Spanish (IRS.gov/Spanish).
Chinese (IRS.gov/Chinese).
Vietnamese (IRS.gov/Vietnamese).
Korean (IRS.gov/Korean).
Russian (IRS.gov/Russian).
The IRS TACs provide over-the-phone inter-
preter service in over 170 languages, and the
service is available free to taxpayers.
The Taxpayer Advocate
Service Is Here To Help
You
What is the Taxpayer
Advocate Service?
The Taxpayer Advocate Service (TAS) is an In-
dependent organization within the IRS that
helps taxpayers and protects taxpayer rights.
Our job is to ensure that every taxpayer is trea-
ted fairly and that you know and understand
your rights under the Taxpayer Bill of Rights.
What Can the Taxpayer Advocate
Service Do For You?
We can help you resolve problems that you
can’t resolve with the IRS. And our service is
free. If you qualify for our assistance, you will be
assigned to one advocate who will work with
you throughout the process and will do every-
thing possible to resolve your issue. TAS can
help you if:
Your problem is causing financial difficulty
for you, your family, or your business,
You face (or your business is facing) an
immediate threat of adverse action, or
You’ve tried repeatedly to contact the IRS
but no one has responded, or the IRS
hasn’t responded by the date promised.
How Can You Reach Us?
We have offices in every state, the District of
Columbia, and Puerto Rico. Your local advo-
cate’s number is in your local directory and at
TaxpayerAdvocate.IRS.gov/Contact-Us. You
can also call us toll free at 1-877-777-4778.
How Can You Learn About Your
Taxpayer Rights?
The Taxpayer Bill of Rights describes 10 basic
rights that all taxpayers have when dealing with
the IRS. Our Tax Toolkit at
TaxpayerAdvocate.IRS.gov can help you un-
derstand what these rights mean to you and
how they apply. These are your rights. Know
them. Use them.
How Else Does the Taxpayer
Advocate Service Help Taxpayers?
TAS works to resolve large-scale problems that
affect many taxpayers. If you know of one of
these broad issues, please report it to us at
IRS.gov/SAMS.
Low Income Taxpayer
Clinics
Low Income Taxpayer Clinics (LITCs) are inde-
pendent from the IRS. LITCs represent individu-
als whose income is below a certain level and
need to resolve tax problems with the IRS, such
as audits, appeals, and tax collection disputes.
In addition, clinics can provide information
about taxpayer rights and responsibilities in dif-
ferent languages for individuals who speak
English as a second language. Services are of-
fered for free or a small fee. To find a clinic near
you, visit TaxpayerAdvocate.IRS.gov/LITCmap
or see IRS Publication 4134, Low Income
Taxpayer Clinic List.
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Chapter 16 How To Get Tax Help Page 87
To help us develop a more useful index, please let us know if you have ideas for index entries.
See “Comments and Suggestions” in the “Introduction” for the ways you can reach us.
Index
A
Abandonment 55
Accounting method:
Accrual 6
Cash 5
Change in 8
Crop 7
Farm inventory 7
Accounting periods 5
Accrual method of accounting 6
Additional Medicare Tax
withholding 80
Adjusted basis of assets 31
Agricultural activity codes,
Schedule F 3
Agricultural program
payments 10
Agricultural structure,
defined 38
Alternative Depreciation System
(ADS) 41, 43
Amortization:
Going into business 46
Reforestation expenses 46
Section 197 intangibles 47
Assessments:
By conservation district 28
Depreciable property 28
Assistance (See Tax help)
Automobiles, depreciation 39
B
Bankruptcy 14
Barter income 16
Basis:
Involuntary conversion 33
Like-kind exchange 33
Partner's basis 35
Replacement property 69
Shareholder's basis 35
Basis of assets:
Adjusted basis 31
Allocating to several assets 30
Changed to business use 32
Constructing assets 30
Cost 30
Decreases 31
Depreciation 42
Exchanges:
Like-kind 33
Nontaxable 32
Partially nontaxable 33
Taxable 32
Gifts 34
Increases 31
Real property 30
Received for services 32
Uniform capitalization rules 30
Below-market loans 16
Books and records 3
Breeding fees 20
Business income limit, section
179 expense deduction 39
Business use of home 22
C
Canceled debt 14
Capital assets 49
Capital expenses 24
Car expenses 22
Cash method of accounting 5
Casualties and thefts:
Adjustments to basis 67
Casualty, defined 64
Disaster area losses 70
Leased property 67
Livestock 65
Reimbursement 66
Reporting gains and losses 71
Theft, defined 65
Certified professional employer
organizations 76
Change in accounting method 8
Chickens, purchased 23
Christmas trees 24, 52
Club dues 25
Comments on publication 2
Commodity:
Futures 50
Wages 79
Commodity Credit Corporation
(CCC):
Loans 10
Market gain 10
Community property 73, 74
Computer, software 36
Condemnation 64, 68
Conservation:
Cost-sharing exclusion 27
District assessments 28
Expenses 27
Plans 27
Conservation Reserve
Program 74
Conservation Reserve Program
(CRP) 11
Constructing assets 30
Constructive receipt of income 5
Contamination 69
Converted wetland 52
Cooperatives, income from 13
Cost-sharing exclusion 11
Credits:
Employment 20
Fuel tax 16, 83
Social security and Medicare 72
Social security coverage 72
State unemployment tax 81
Crew leaders 79
Crop:
Destroyed 69
Insurance proceeds 11
Method of accounting 7
Shares 9
Unharvested 25, 56, 74
Cropland, highly erodible 52
D
Damage:
Casualties and thefts 64
Crop insurance 11
Tree seedlings 68
Debt:
Bad 50
Canceled 14, 32, 54, 55
Nonrecourse 54
Qualified farm 15
Recourse 54
Depletion 45
Depreciation 41
ADS election 43
Conservation assets 27
Deduction 35
Incorrect amount deducted 37
Limit for automobiles 39
Listed property 45
Raised livestock 36
Recapture 44, 56, 58
When to file 37
Depreciation allowable 37
Depreciation allowed 37
Disaster area losses 70
Disaster payments 11
Disaster relief grants 70
Disaster relief payments 71
Dispositions 29, 55
Domestic production activities
deduction 23
Drainage tile 27
Dyed diesel fuel 83
Dyed kerosene 83
E
Easement 16, 32
e-file 3
Election:
ADS depreciation 41, 43
Amortization:
Business start-up costs 46
Reforestation costs 46
Crop method 23
Cutting of timber 52
Deducting conservation
expenses 29
Not excluding cost-sharing
payments 12
Out of installment method 59
Postponing casualty gain 68
Postponing reporting crop
insurance proceeds 11
Section 179 expense
deduction 40
Electronic filing 3
Embryo transplants 30
Employer identification
number 3, 78
Endangered species recovery
expenses 28
Environmental contamination 69
Estimated tax:
Farm gross income 85
Gross income 84
Penalties 86
Exchanges:
Basis:
Like-kind 33
Nontaxable 32
Partially nontaxable 33
Taxable 32
Like-kind 48
Nontaxable 48
Excise taxes:
Credit 83
Diesel fuel 83
Farming purposes 81
Home use of fuels 83
Off-highway uses 83
Refund 84
F
Fair market value defined 30, 62
Family member:
Business expenses 6
Like-kind exchange 49
Loss on sale or exchange of
property 25
Personal-use property 65
Social security coverage 78
Farm:
Business, defined 27
Business expenses 18
Defined 27, 82
Income averaging 17
Rental 27
Sale of 53
Farmer 74
Federal unemployment tax
(FUTA) 81
Fertilizer 13, 20
Figuring Installment Sale
Income:
Adjusted basis 59
Adjusted basis and installment
sale income (gain on
sale) 59
Adjusted basis for installment
sale purposes 59
Amount to report as installment
sale income 59
Cancellation 59
Contract price 59
Depreciation recapture 59
Disposition of Installment
Obligation 59
Figuring adjusted basis and
gross profit percentage for
installment sale purposes 59
Form 6252 59
Gross profit 59
Gross profit percentage 59
Interest income 59
Sale of depreciable property 59
Selling expenses 59
Selling price 59
Selling price reduced 59
Transfer due to death 59
Foreclosure 54
Forestation costs 24
Form:
1099-A 10, 55
1099-C 14, 55
1099-G 10, 13
1099-MISC 3, 80
1099-PATR 13
1128 5
2210-F 86
3115 8
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Page 88 Publication 225 (2017)
4136 83
4562 37
4797 9, 12, 48
4835 9
5213 26
8822 3
8824 48
8849 84
8886 3
940 81
943 80
982 16
I-9 78
SS-4 3, 78
SS-5 72
T (Timber) 46
W-2 80
W-4 3, 78, 80
W-4V 10, 11
W-7 72
Fuel tax credit or refund 16, 83
G
Gains:
Section 1231 gains 63
Gains and losses:
Basis of assets 30
Capital assets, defined 49
Casualty 65, 67
Installment sales 59
Livestock 51
Long- or short-term 50
Ordinary or capital 49
Sale of farm 53
Section 1231 56
Theft 65, 67
Timber 52
General asset accounts 44
Gifts 10, 25, 34, 50
Going into business 46
Grants, disaster relief 70
H
Health insurance deduction 21
Hedging 50
Highway use tax 21
Holding period 50
Home 63
Horticultural structure 38
I
Identity theft 86
Illegal irrigation subsidy 17
Important dates 77
Improvements 11
Income:
Accounting for 5
Accrual method of accounting 6
Canceled debt excluded 14
From farming 8, 29, 85
Gross 84
Not-for-profit farming 26
Pasture 9
Schedule F 8
Withholding of tax 80
Income averaging (See Farm:
Income averaging)
Incorrect amount of depreciation
deducted 37
Individual taxpayer identification
number (ITIN) 72
Inherited property 34
Insolvency 15
Installment Method:
Electing out of the installment
method 59
Inventory (See More information)
Revoking the election (See More
information)
Sale at a loss 59
When to elect out 59
Installment Sales:
Installment sales:
Electing out 59
Example 63
Farm, sale of 59
Installment obligation 59
Related parties 59
Unstated interest 63
Insurance 21
Intangible property 47
Interest:
Expense 20
Inventory:
Items included 7
Methods of valuation 7
Involuntary conversions 44, 64
Irrigation:
Illegal subsidy 17
Project 68
L
Labor hired 19
Landlord participation 74
Lease or purchase 21
Life tenant (See Term interests)
Like-kind exchanges 33, 48
Lime 20
Limited liability company
(LLC) 3
Limits:
At-risk 25
Business use of home 22
Capital losses 50
Conservation expenses 28, 29
Depreciation:
Business-use 45
Excluded farm debt 16
Farm losses 25
Loss of personal-use
property 67
Not-for-profit farming 26
Passive activity 25
Percentage depletion 46
Prepaid farm supplies 18
Reforestation costs 46
Section 179 expense deduction:
Automobile 39
Business income 39
Dollar 39
Time to keep records 4
Listed property:
Defined 45
Passenger automobile 45
Rules 45
Livestock 56
Casualty and theft losses 65
Crop shares 10
Depreciation 36
Diseased 68
Feed assistance 11
Immature 37
Losses 25, 51
Purchased 52
Raised 52
Sale of 8, 51
Unit-livestock-price, inventory
valuation 7
Used in a farm business 51
Weather-related sales 9, 68
Loans 10, 23
Losses:
At-risk limits 25
Casualty 64
Disaster areas 70
Farming 65
Growing crops 25
Hobby farming 26
Livestock 51, 68
Nondeductible 25
Theft 64
Lost income payments 74
Lost property 65
M
MACRS property:
Involuntary conversion 44
Like-kind exchange 44
Nontaxable transfer 44
Market gain, reporting 10
Marketing quota penalties 23
Material participation 74
Meals 22
Membership fees 25
Methods of accounting 5
Modified ACRS (MACRS):
ADS election 43
Conventions 42
Depreciation methods 43
Exchange 44
Figuring the deduction 43
Involuntary conversion 44
Nontaxable transfer 44
Percentage tables 43
Property classes 42
Recovery periods 42
N
National Center for Missing &
Exploited Children 3
New hire reporting 78
Noncapital asset 50
Nontaxable exchanges 48
Nontaxable transfer of MACRS
property 44
Not-for-profit farming 26
O
Organizational costs 24
P
Partners, limited 73
Partners, retired 74
Partners, spouses 73
Partnership 74
Passenger automobile 45
Pasture income 9
Patronage dividends 13
Payments considered received:
Bond 62
Buyer's note 62
Buyer assumes mortgage 62
Buyer assumes other debts 62
Buyer pays seller's expenses 62
Debt not payable on demand 62
Mortgage less than basis 62
Mortgage more than basis 62
Property used as a payment 62
Sale to a related person 62
Third-party note 62
Trading property for like-kind
property 62
Payments received 62
Penalties:
Estimated tax 86
Returns 86
Trust fund recovery 81
Personal expenses 25
Per-unit retain certificates 14
Placed in service 36, 42
Postponing casualty gain 68
Prepaid expense:
Advance premiums 21
Extends useful life 6
Farm supplies 18
Livestock feed 19
Prizes 17
Produce 8
Property:
Changed to business use 32
Received for services 32
Repairs and improvements 37
Section 1231 56
Section 1245 57
Section 1250 58
Section 1252 58
Section 1255 58
Tangible personal 38
Property used as a payment:
Examples 62
Exception 62
Publications (See Tax help)
Q
Qualified disaster relief
payments 71
Qualified farm debt 15
Qualified joint venture 73
Qualified small business payroll
tax credit for increasing
research activities 76
R
Recapture:
Amortization 57
Basis reductions 15
Certain depreciation 17
Cost-sharing payments 12
Depreciation 44, 56
Section 1245 property 56
Section 1250 property 58
Section 179 expense
deduction 40
Section 179 GO Zone
property 41
Special depreciation
allowance 41
Recordkeeping 3, 22
Records on depreciable
property 56
Reforestation costs 24, 46
Refund:
Deduction taken 17
Fuel tax 16, 84
Reimbursements:
Casualties and thefts 32, 64, 66
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Publication 225 (2017) Page 89
Deduction taken 17
Expenses 18
Feed assistance 11
Real estate taxes 30
Reforestation expenses 46
To employees 23
Related parties 59
Related persons 6, 25, 33, 49, 69
Rental income 9
Rented property,
improvements 37
Repairs 20
Repairs and improvements 37
Repayment of income 5
Replacement:
Period 69
Property 69
Reportable transactions. 3
Repossessions 54
Right-of-way income 16
S
Sale of home 54
Section 179 expense
deduction 38
How to elect 40
Listed property 45
Qualifying property 38
Recapture 40
Self-employed health
insurance 21
Self-employed health insurance
deduction 74
Self-employment tax:
Community property 74
Deduction 76
How to pay 72
Landlord participation 74
Material participation 74
Maximum net earnings 72
Methods for figuring net
earnings 75
Optional method 75
Regular method 75
Rental income 74
Reporting 76
Self-employment tax rate 72
Share farming 73
Who must pay 73
Selling price:
Reduced 61
Settlement costs (fees) 30
Social security and Medicare:
Credits of coverage 72
Withholding of tax 79
Social security number 72
Software, computer 36
Soil:
Conservation 27
Contamination 69
Special depreciation allowance:
How to elect not to claim 41
Recapture 41
Standard mileage rate 22
Start-up costs for businesses 24
Suggestions for publication 2
T
Tangible personal property 38
Taxes:
Credits and Refunds 81
Federal use 21
General 20
Self-employment 72
State and federal 21
State and local general sales 20
Withholding 79, 80
Tax-free exchanges 48
Tax help 86
Tax preparation fees 23
Tax shelter:
At-risk limits 25
Defined 6
Telephone expense 22
Tenant house expenses 23
Term interests 36
Theft losses 64
Third-party note 62
Timber 24, 46, 52
Trade-in 33
Travel expenses 22
Truck expenses 22
Trust fund recovery penalty 81
U
Uniform capitalization rules:
Basis of assets 30
Inventory 7
W
Wages and salaries 74
Water conservation 27
Water well 28, 42
Weather-related sales,
livestock 9, 68
Withholding:
Income tax 80
Social security and Medicare
tax 79
Page 90 of 90 Fileid: … tions/P225/2017/A/XML/Cycle02/source 15:09 - 19-Oct-2017
The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.
Page 90 Publication 225 (2017)

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