2023 Publication 225

Contents

Introduction .................. 1

What's New for 2023 ............. 2

What's New for 2024 ............. 3

Reminders ................... 3

Chapter 1. Importance of Records .... 4

Chapter 2. Accounting Methods ..... 6

Chapter 3. Farm Income .......... 9

Chapter 4. Farm

Business Expenses ......... 19

Chapter 5. Soil and Water

Conservation Expenses ....... 28

Chapter 6. Basis of Assets ....... 31

Chapter 7. Depreciation, Depletion,

and Amortization ........... 37

Chapter 8. Gains and Losses ...... 49

Chapter 9. Dispositions of

Property Used in Farming ...... 57

Chapter 10. Installment Sales ..... 60

Chapter 11. Casualties, Thefts, and

Condemnations ............ 66

Chapter 12. Self-Employment Tax ... 74

Chapter 13. Employment Taxes .... 79

Chapter 14. Fuel Excise Tax

Credits and Refunds ......... 85

Chapter 15. Estimated Tax ........ 88

Chapter 16. How To Get Tax Help ... 89

Index ..................... 93

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 IRS's interpretation of tax laws

enacted by Congress, Treasury regulations, and

court decisions. However, the information given

does not cover every situation and is not inten-

ded to replace the law or change its meaning.

Department

of the

Treasury

Internal

Revenue

Service

Publication 225

Cat. No. 11049L

Farmer's

Tax Guide

For use in preparing

2023 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 (Tiếng Việt)

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This publication covers subjects on which a

court may have rendered a decision more favor-

able to taxpayers than the interpretation by the

IRS. Until these differing interpretations are re-

solved by higher court decisions, or in some

other way, this publication will continue to

present the interpretation by the IRS.

The IRS Mission. Provide America's taxpayers

top-quality service by helping them understand

and meet their tax responsibilities and enforce

the tax law with integrity and fairness to all.

Comments and suggestions. We welcome

your comments about this publication and sug-

gestions for future editions.

You can send us comments through

IRS.gov/FormComments. Or, you can write to

the Internal Revenue Service, Tax Forms and

Publications, 1111 Constitution Ave. NW,

IR-6526, Washington, DC 20224.

Although we can’t respond individually to

each comment received, we do appreciate your

feedback and will consider your comments and

suggestions as we revise our tax forms, instruc-

tions, and publications. Don’t send tax ques-

tions, tax returns, or payments to the above ad-

dress.

Getting answers to your tax questions.

If you have a tax question not answered by this

publication or the How To Get Tax Help section

at the end of this publication, go to the IRS In-

teractive Tax Assistant page at IRS.gov/

Help/ITA where you can find topics by using the

search feature or viewing the categories listed.

Getting tax forms, instructions, and pub-

lications. Go to IRS.gov/Forms to download

current and prior-year forms, instructions, and

publications.

Ordering tax forms, instructions, and

publications. Go to IRS.gov/OrderForms to or-

der current forms, instructions, and publica-

tions; call 800-829-3676 to order prior-year

forms and instructions. The IRS will process

your order for forms and publications as soon

as possible. Don’t resubmit requests you’ve al-

ready sent us. You can get forms and publica-

tions faster online.

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 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 SW

Washington, DC 20416;

•

Send an email to [email protected];

•

Complete and submit a Federal Agency

Comment Form online at

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 visit TIGTA. You can re-

main anonymous.

Farm tax classes. Many state Cooperative Ex-

tension Services conduct farm tax workshops in

conjunction with the IRS. Contact your county or

regional extension office for more information.

Rural Tax Education website. The Rural Tax

Education website is a source for information

concerning agriculturally related income and

deductions and self-employment tax. The web-

site is available for farmers and ranchers, other

agricultural producers, Extension educators,

and anyone interested in learning about the tax

side of the agricultural community. Members of

the National Farm Income Tax Extension Com-

mittee are contributors to the website, and the

website is hosted by Utah State University Co-

operative Extension. You can visit the website at

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 2023

The following items highlight a number of

administrative and tax law changes for 2023.

They are discussed in more detail throughout

this publication.

Standard mileage rate. The business stand-

ard mileage rate for 2023 has increased to 65.5

cents per business mile. 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 2023 is $1,160,000.

This limit is reduced by the amount by which the

cost of the property placed in service during the

tax year exceeds $2,890,000. Also, the maxi-

mum section 179 expense deduction for sport

utility vehicles placed in service in tax years be-

ginning in 2023 is $28,900. See chapter 7.

Phase down of special depreciation allow-

ance. The special depreciation allowance is

80% for certain qualified property acquired after

September 27, 2017, and placed in service af-

ter December 31, 2022, and before January 1,

2024 (other than certain property with a long

production period and certain aircraft). The spe-

cial depreciation allowance is also 80% for cer-

tain specified plants bearing fruits and nuts

planted or grafted after December 31, 2022,

and before January 1, 2024. See Certain quali-

fied property acquired after September 27,

2017 and Certain specified plants under What

Is Qualified Property, later.

Maximum net earnings. The maximum net

self-employment earnings subject to the social

security part (12.4%) of the self-employment tax

is $160,200 for 2023, up from $147,000 for

2022. There is no maximum limit on earnings

subject to the Medicare part (2.9%) or, if appli-

cable, the Additional Medicare Tax (0.9%).

The maximum net self-employment earnings

subject to the social security part of the self-em-

ployment tax for 2024 will be discussed in the

2023 Pub. 334.

2023 withholding tables. The federal income

tax withholding tables are now included in Pub.

15-T, Federal Income Tax Withholding Methods.

Business meals deduction. The temporary

100% deduction for food or beverages provided

by a restaurant has expired. The business meal

deduction reverts back to the previous 50% al-

lowable deduction beginning January 1, 2023.

Qualified small business payroll tax credit

for increasing research activities. For tax

years beginning before January 1, 2023, a

qualified small business may elect to claim up

to $250,000 of its credit for increasing research

activities as a payroll tax credit. The Inflation

Reduction Act of 2022 (the IRA) increases the

election amount to $500,000 for tax years be-

ginning after December 31, 2022. The payroll

tax credit election must be made on or before

the due date of the originally filed income tax re-

turn (including extensions). The portion of the

credit used against payroll taxes is allowed in

the first calendar quarter beginning after the

date that the qualified small business filed its in-

come tax return. The election and determination

of the credit amount that will be used against

the employer's payroll taxes are made on Form

6765, Credit for Increasing Research Activities.

The amount from Form 6765, line 44, must then

be reported on Form 8974, Qualified Small

Business Payroll Tax Credit for Increasing Re-

search Activities.

Starting in the first quarter of 2023, the pay-

roll tax credit is first used to reduce the em-

ployer share of social security tax up to

$250,000 per quarter and any remaining credit

reduces the employer share of Medicare tax for

the quarter. Any remaining credit, after reducing

the employer share of social security tax and

the employer share of Medicare tax, is then car-

ried forward to the next quarter. Form 8974 is

used to determine the amount of the credit that

can be used in the current quarter. The amount

from Form 8974, line 12 or, if applicable, line 17,

is reported on Form 943, line 12a. For more in-

formation about the payroll tax credit, see the

Instructions for Form 8974 and go to IRS.gov/

ResearchPayrollTC.

Credit for COBRA premium assistance pay-

ments. The COBRA premium assistance

credit lines have been “Reserved for future use”

on Form 943 because the first quarter of 2022

was the last quarter in which most employers

may have been eligible to claim the COBRA

premium assistance credit. Section 9501 of the

American Rescue Plan Act of 2021 (the ARP)

provided for COBRA premium assistance in the

form of a full reduction in the premium otherwise

payable by certain individuals and their families

who elected COBRA continuation coverage due

to a loss of coverage as the result of a reduction

in hours or an involuntary termination of em-

ployment (assistance eligible individuals). This

COBRA premium assistance was available for

periods of coverage beginning on or after April

1, 2021, through periods of coverage beginning

on or before September 30, 2021. A premium

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Page 2 Publication 225 (2023)

payee was entitled to the COBRA premium as-

sistance credit at the time an eligible individual

elected coverage. Therefore, due to the COBRA

notice and election period requirements (gener-

ally, employers had 60 days to provide notice

and assistance eligible individuals had 60 days

to elect coverage), the first quarter of 2022 was

the last quarter in which most employers may

have been eligible to claim the COBRA pre-

mium assistance credit.

Pub. 51 discontinued after 2023. Pub. 51,

Agricultural Employer's Tax Guide, will no lon-

ger be available after 2023. Instead, information

specific to agricultural employers will be inclu-

ded in Pub. 15, Employer's Tax Guide, begin-

ning with the Pub. 15 for use in 2024. Beginning

in 2024, there will be a new Pub. 15 (sp) that is

a Spanish-language version of Pub. 15. Refer-

ences to Pub. 51 were retained throughout this

chapter because this chapter is for tax year

2023. If you need information specific to tax

year 2024, you will use Pub. 15 or Pub. 15 (sp)

in 2024.

Social security and Medicare tax for 2023.

The rate of social security tax on taxable wages,

including qualified sick leave wages and quali-

fied family leave wages paid in 2023 for leave

taken after March 31, 2021, and before October

1, 2021, is 6.2% each for the employer and em-

ployee or 12.4% for both. Qualified sick leave

wages and qualified family leave wages paid in

2023 for leave taken after March 31, 2020, and

before April 1, 2021, aren't subject to the em-

ployer share of social security tax; therefore, the

tax rate on these wages is 6.2%. The social se-

curity wage base limit is $160,200.

The Medicare tax rate is 1.45% (0.0145)

each for the employee and employer, un-

changed from 2022. There is no wage base limit

for Medicare tax.

What's New for 2024

Phase down of special depreciation allow-

ance. The special depreciation allowance is

60% for certain qualified property acquired after

September 27, 2017, and placed in service af-

ter December 31, 2023, and before January 1,

2025 (other than certain property with a long

production period and certain aircraft). For

property with a long production period and cer-

tain aircraft placed in service after December

31, 2023, and before January 1, 2025, the spe-

cial depreciation allowance is 80%. The special

depreciation allowance is also 60% for certain

specified plants bearing fruits and nuts planted

or grafted after December 31, 2023, and before

January 1, 2025. See Certain qualified property

acquired after September 27, 2017 and Certain

specified plants under What Is Qualified Prop-

erty, later.

Social security and Medicare tax for 2024.

The employee and employer tax rates for social

security and the maximum amount of wages

subject to social security tax for 2024 will be

discussed in Pub. 15 (for use in 2024).

The Medicare tax rate for 2024 will also be

discussed in Pub. 15 (for use in 2024). There is

no limit on the amount of wages subject to Med-

icare tax.

Reminders

The following reminders and other items may

help you file your tax return.

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.

Coronavirus Food Assistance Program

(CFAP). The CFAP provides direct payments to

producers of eligible agricultural commodities

adversely affected by the coronavirus

(COVID-19) pandemic to help offset sales los-

ses and increased marketing costs associated

with the COVID-19 pandemic. CFAP payments

are agricultural program payments that you

must include in gross income. Report the full

amount of your CFAP payments on Schedule F

(Form 1040), lines 4a and 4b. Go to usda.gov.

See chapter 3.

The COVID-19 related credit for qualified

sick and family leave wages is limited to

leave taken after March 31, 2020, and be-

fore October 1, 2021. Generally, the credit for

qualified sick and family leave wages, as enac-

ted under the Families First Coronavirus Re-

sponse Act (FFCRA) and amended and exten-

ded by the COVID-related Tax Relief Act of

2020, for leave taken after March 31, 2020, and

before April 1, 2021, and the credit for qualified

sick and family leave wages under sections

3131, 3132, and 3133 of the Internal Revenue

Code, as enacted under the ARP, for leave

taken after March 31, 2021, and before October

1, 2021, have expired. However, employers that

pay qualified sick and family leave wages in

2023 for leave taken after March 31, 2020, and

before October 1, 2021, are eligible to claim a

credit for qualified sick and family leave wages

in 2023.

For more information about the credit for

qualified sick and family leave wages, see the

Instructions for Form 943, and go to IRS.gov/

PLC.

An employer who receives a refund of

payroll taxes resulting from qualified

sick and family leave credit reported on

a 2022 Form 943 generally won't receive that

refund until the 2023 calendar year. Even

though that credit isn't received until 2023, in-

come reported in 2022 must be increased by

the refundable and nonrefundable portions of

TIP

the qualified sick and family leave credit repor-

ted on their 2022 Form 943. For more informa-

tion, see the instructions for the income tax re-

turn or the Form 1040 schedule you file for your

business.

Advance payment of COVID-19 credits

ended. Although you may pay qualified sick

and family leave wages in 2023 for leave taken

after March 31, 2020, and before October 1,

2021, or provide COBRA premium assistance

payments in 2023, you may no longer request

an advance payment of any credit on Form

7200, Advance Payment of Employer Credits

Due to COVID-19.

Certification program for professional em-

ployer organizations (PEOs). The Stephen

Beck, Jr., Achieving a Better Life Experience

Act of 2014 required the IRS to establish a vol-

untary certification program for PEOs. PEOs

handle various payroll administration and tax re-

porting responsibilities for their business clients

and are typically paid a fee based on payroll

costs. To become and remain certified under

the certification program, certified professional

employer organizations (CPEOs) must meet

various requirements described in sections

3511 and 7705 and related published guidance.

Certification as a CPEO may affect the employ-

ment tax liabilities of both the CPEO and its

customers. A CPEO is generally treated for em-

ployment tax purposes as the employer of any

individual who performs services for a customer

of the CPEO and is covered by a contract de-

scribed 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. To become a

CPEO, the organization must apply through the

IRS Online Registration System. For more infor-

mation or to apply to become a CPEO, go to

IRS.gov/CPEO.

CPEOs must generally file Form 943 and

Schedule R (Form 943), Allocation Schedule for

Aggregate Form 943 Filers, electronically. For

more information about a CPEO's requirement

to file electronically, see Revenue Procedure

2023-18, 2023-13 I.R.B. 605, available at

IRS.gov/irb/2023-13_IRB#REV-PROC-2023-18.

Work opportunity tax credit for qualified

tax-exempt organizations hiring qualified

veterans. Qualified tax-exempt organizations

that hire eligible unemployed veterans may be

able to claim the work opportunity tax credit

against their payroll tax liability using Form

5884-C. For more information, go to IRS.gov/

WOTC.

Correcting a previously filed Form 943. If

you discover an error on a previously filed Form

943, or if you otherwise need to amend a previ-

ously filed Form 943, make the correction using

Form 943-X, Adjusted Employer's Annual Fed-

eral Tax Return for Agricultural Employees or

Claim for Refund. Form 943-X is filed separately

from Form 943. For more information, 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

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Publication 225 (2023) Page 3

to use EFTPS, you can arrange for your tax pro-

fessional, financial institution, payroll service, or

other trusted third party to make electronic de-

posits on your behalf. Also, you may arrange for

your financial institution to initiate a same-day

wire payment on your behalf. EFTPS is a free

service provided by the Department of the

Treasury. Services provided by your tax profes-

sional, financial institution, payroll service, or

other third party may have a fee.

Note. An exception applies to the EFT re-

quirement for making your federal tax deposits.

If your liability is less than $2,500 (Form 943,

line 13), you may pay in full with a check or

money order with a timely filed return. See the

Instructions of Form 943 for more information.

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 one of the following

numbers.

•

800-555-4477

•

800-244-4829 (Spanish)

•

303-967-5916 if you're outside the United

States (toll call)

To contact EFTPS using Telecommunica-

tions Relay Services (TRS) for people who are

deaf, hard of hearing, or have a speech disabil-

ity, dial 711 and then provide the TRS assistant

the 800-555-4477 number above or

800-733-4829. Additional information about

EFTPS is also available in Pub. 966.

Electronic filing and payment. Businesses

can enjoy the benefits of filing tax returns and

paying their federal taxes electronically.

Whether you rely on a tax professional or han-

dle your own taxes, the IRS offers you conven-

ient and secure programs to make filing and

paying easier. Spend less time worrying about

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 at one of the numbers provided un-

der the Note, earlier.

•

For electronic filing of Form W-2, Wage

and Tax Statement, go to SSA.gov/

employer. You may be required to file

Forms W-2 electronically. For details, see

the General Instructions for Forms W-2

and W-3.

Note. For employers in Puerto Rico, references

to Form W-2 also apply to Form 499R-2/W-2PR

and references to Form W-3 also apply to Form

W-3 (PR), unless otherwise specified.

Special rules for qualified disaster 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.

See Disaster Area Losses, later, and Pub.

547, Casualties, Disasters, and Thefts, for more

information on the special relief. Also, see

IRS.gov/DisasterTaxRelief for more information.

Additional employment tax information for

farmers. See Pub. 51 for more detailed

guidance on employment taxes for tax year

2023 for employers of agricultural workers. See

Pub. 15 for more detailed guidance on employ-

ment taxes for tax year 2024 for employers of

agricultural workers. For the latest information

about developments related to Pub. 15, such as

legislation enacted after it was published, go to

IRS.gov/Pub15. For general tax information rel-

evant to agricultural employers, go to IRS.gov/

AgricultureTaxCenter. For general information

about employment taxes, go to IRS.gov/

EmploymentTaxes. For information about em-

ployer responsibilities under the Affordable

Care Act, go to IRS.gov/ACA. For information

about COVID-19 tax relief, go to IRS.gov/

Coronavirus.

You may have nonfarm employees as

well as farm employees, for example,

workers at a retail farm market. See

Pub.15 for employment tax rules for wages and

noncash wages paid to these employees as

they may differ from those discussed in this

chapter.

Photographs of missing children. The IRS is

a proud partner with the National Center for

Missing & Exploited Children® (NCMEC). Pho-

tographs 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.

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.

While this publication only discusses tax re-

cords, the records you keep as a farm business

owner should allow you to accurately measure

your farm’s financial performance, create finan-

cial statements, and help you make manage-

ment decisions in addition to calculating taxable

farm income.

Records that provide information beyond

your tax return require additional information

and effort on the part of the record keeper. To

assist you in developing or improving your re-

cordkeeping system, the Farm Financial Stand-

ards Council produces publications that provide

recommendations for financial reporting and

analysis. You can download the Implementation

Guidelines at https://ffsc.org. For more

CAUTION

information, contact the Farm Financial Stand-

ards Council in the following manner.

•

Call 262-253-6902.

•

Send a fax to 262-253-6903.

•

Write to:

Farm Financial Standards Council

N78 W14573 Appleton Ave., #287

Menomonee Falls, WI 53051.

Topics

This chapter discusses:

•

Benefits of recordkeeping

•

Kinds of records to keep

•

How long to keep records

Useful Items

You may want to see:

Publication

51 (Circular A), Agricultural Employer's

Tax Guide

463 Travel, Gift, and Car Expenses

544 Sales and Other Dispositions of

Assets

946 How To Depreciate Property

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 business. In addition to measuring

overall profitability, detailed records can help

you identify which crop or livestock enterprises

are most profitable or indicate where manage-

ment changes may be needed to improve profit-

ability. Records that help you make better deci-

sions should also increase the likelihood of

business success.

Prepare your financial statements. You will

need records to prepare accurate financial

statements. These include income (profit and

loss) statements, cash flow statements, balance

sheets, and statements of owner’s equity.

These statements will be required and helpful

when working with your bank or creditors and

may also help you 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. See chapter 3 for

more information.

Keep track of deductible expenses. You

may forget expenses when you prepare your tax

return unless you record them when they occur.

Your records can identify the purpose and

timing of expenses. You need this information to

463

544

946

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Page 4 Chapter 1 Importance of Records

separate farm business expenses from nonfarm

payments and other expenses. You also need to

keep these records to separate expenses de-

ductible for tax purposes from those that are

non-tax related. See chapter 4 for more infor-

mation.

Prepare your tax returns. You need records

to prepare your tax return. These records must

accurately 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.

You will also need records to prepare informa-

tion returns such as a Form 1099-MISC or Form

1099-NEC provided to a vendor or a Form W-2

provided to an employee.

Support items reported on tax returns. You

must keep your business records available at all

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 assist in 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’s recordkeeping system

should include board of directors meeting mi-

nutes. See chapter 2 for more information.

Your recordkeeping system should include a

summary of your business transactions, which

shows your gross income, as well as any expen-

ses, deductions, and credits you are reporting.

In addition, you must keep supporting docu-

ments, such as invoices and receipts, for pur-

chases, sales, payroll, and other business

transactions.

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 electronic

storage media. The electronic storage system

must index, store, preserve, retrieve, and repro-

duce the electronically stored books and re-

cords in legible format. All electronic storage

systems must provide a complete and accurate

record of your data that is accessible to the IRS.

Electronic storage systems are also subject

to the same controls and retention guidelines as

those imposed on your original hard copy books

and records. The original hard copy books and

records may be destroyed, provided that the

electronic storage system has been tested to

establish that the hard copy books and records

are being reproduced in compliance with IRS

requirements for an electronic storage system

and procedures are established to ensure con-

tinued compliance with all applicable rules and

regulations. You still have the responsibility of

retaining any other books and records that are

required to be retained.

The IRS may test your electronic storage

system, including the equipment used, indexing

methodology, software, and retrieval 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

noncompliance, 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 Reve-

nue Procedure 97-22. You can find Revenue

Procedure 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. Payroll re-

cords are important when claiming various tax

deductions and credits based on payroll items

such as number of employees and wages paid.

For a list of employment tax records you must

keep, 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

(whether the asset was new or used).

•

Full purchase cost of the asset.

•

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.

•

Fair market value of property when traded.

•

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 records

must be kept for a longer period of time, as dis-

cussed 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.

CAUTION

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Chapter 1 Importance of Records Page 5

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 limi-

tation. 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 dis-

pose of it, for the period of limitations that ap-

plies to you. For example, if you received prop-

erty in a nontaxable exchange, you must keep

the records for the old property, as well as for

the new property, until the period of limitations

expires for the year in which you dispose of the

new property in a taxable disposition. For more

information on basis, see chapter 6.

Records for nontax purposes. When your re-

cords are no longer needed for tax purposes,

do not discard them until you check to see if you

have to keep them longer for other purposes.

For example, your insurance company or cred-

itors may require you to keep them longer than

the IRS does.

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

538 Accounting Periods and Methods

Form (and Instructions)

1128 Application To Adopt, Change, or

Retain a Tax Year

3115 Application for Change in

Accounting Method

See chapter 16 for information about getting

publications and forms.

Accounting Methods

An accounting method is a set of rules used to

determine when and how your income and ex-

penses are reported on your tax return. Your ac-

counting method includes not only your overall

method of accounting, but also the accounting

treatment you use for any material item.

Facts and circumstances affect whether an

item is material. Factors to consider in deter-

mining the materiality of an item include the size

of the item (both in absolute terms and in rela-

tion to income and expenses) and the treatment

of the item on your financial statements. Gener-

ally, 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 in-

come tax return that includes a Schedule F

(Form 1040), Profit or Loss From Farming. If you

later want to change your accounting method,

you must generally get IRS approval. How to

obtain IRS approval is discussed later under

Changes in Methods of Accounting.

Types of accounting methods. Generally,

you can use any of the following accounting

methods. Each method is discussed in detail

below.

•

Cash method.

•

Accrual method.

•

Special methods of accounting for certain

items of income and expenses.

•

Combination (hybrid) method using 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.

538

1128

3115

Cash Method

Most farmers use the cash method because

they find it easier to keep records using the

cash method. Certain farm corporations and

partnerships and all tax shelters are generally

required to use an accrual method of account-

ing. However, for tax years beginning in 2023,

farm corporations or partnerships that have

average annual gross receipts of $29 million or

less for the 3 preceding tax years and are not

tax shelters can use the cash method instead of

the accrual method. See Accrual Method Re-

quired, later. Also, see Inventory, 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 prop-

erty or services received. If you received prop-

erty or services, you must include the fair mar-

ket value (FMV) of the property or services

received in income. See chapter 3 for informa-

tion on how to report farm income on your in-

come tax return.

Constructive receipt. Income is constructively

received when an amount is credited to your ac-

count or made available to you without restric-

tion. You do not need to have possession of the

income for it to be treated as income for the tax

year. You need to have the ability to receive the

income. If you authorize someone to be your

agent and receive income for you, you are con-

sidered to have received the income when your

agent receives it. Income is not constructively

received if your receipt of the income is subject

to substantial restrictions or limitations.

Delaying receipt of income. You cannot

hold checks or postpone taking possession of

similar property from one tax year to another to

avoid paying tax on the income. You must report

the income in the year the money or property is

received or made available to you without re-

striction.

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 2023. Frances was told in

December that the payment was available, and

requested not to be paid until January 2024.

Frances must include this payment in 2023 in-

come because it was made available in 2023.

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 income.

If you receive income in this way, you construc-

tively receive the income when the debt is can-

celed or paid. See Cancellation of Debt in chap-

ter 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

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Page 6 Chapter 2 Accounting Methods

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 2023 under a bona fide

arm's-length contract that calls for payment in

2024. You include the proceeds from the sale in

your 2024 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

2023 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 may be able to

deduct the repayment in the year repaid. The

type of deduction you are allowed in the year of

repayment depends on the type of income you

included in the earlier year. If you use the cash

method of accounting, you can take the deduc-

tion (or credit, if applicable) for the tax year in

which you actually make the repayment. If you

use any other accounting method, you can de-

duct the repayment or claim a credit for it only

for the tax year in which it is a proper deduction

under your accounting method. For example, if

you use the accrual method, you are entitled to

the deduction or credit in the tax year in which

the obligation for the repayment accrues.

Expenses

Under the cash method, you generally 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 ex-

penses paid in advance. This rule applies to any

expense paid far enough in advance to, in ef-

fect, create an asset with a useful life extending

substantially beyond the end of the current tax

year.

Example. On November 1, 2023, you

signed and paid $3,600 for a 3-year (36-month)

insurance contract for equipment. In 2023, you

are allowed to deduct only $200 (2/36 x $3,600)

of the cost of the policy that is attributable to

2023. In 2024, you'll be able to deduct $1,200

(12/36 x $3,600); in 2025, you'll be able to de-

duct $1,200 (12/36 x $3,600); and in 2026,

you'll be able to deduct the remaining balance

of $1,000.

An exception applies if the expense qualifies

for the 12-month rule. Under the 12-month rule,

a taxpayer is not required to capitalize amounts

paid to create certain rights or benefits for the

earlier of the following:

•

12 months after the right or benefit begins,

•

The end of the tax year after the tax year in

which payment is made.

See Pub. 538 for more information and exam-

ples.

See chapter 4 for special rules for prepaid

farm supplies and prepaid livestock feed.

Accrual Method

Under the 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 in the correct tax year. Certain large

farm businesses must use an accrual method of

accounting for its farm activities and for sales

and purchases of inventory items. See

Accrual

Method Required and Farm Inventory, later.

Income

Generally, you include an amount in income for

the tax year in which all events that fix your right

to receive the income have occurred, and you

can determine the amount with reasonable 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.

•

When included as revenue in an applicable

financial statement, if you have an applica-

ble financial statement.

For more information, see Pub. 538. If you

use an accrual method of accounting, complete

Part III of Schedule F (Form 1040) to report your

income.

Inventory

Generally, if you keep an inventory, you must

use an accrual method of accounting to deter-

mine your gross income. However, see Excep-

tion below. An inventory is necessary to clearly

show income when the production, purchase, or

sale of merchandise is an income-producing

factor. See Pub. 538 for more information. Also,

see Farm Inventory, later, for more information

on items that must be included in inventory by

farmers, and inventory valuation methods for

farmers.

Exception. For tax years beginning in 2023,

you are not required to maintain an inventory if

the average annual gross receipts for the 3 pre-

ceding tax years for the farm is $29 million or

less and the farm is not a tax shelter. In this

case, the farm can use a method of accounting

that (1) treats inventory as nonincidental materi-

als and supplies, or (2) accounts for the inven-

tory in the same manner as the applicable fi-

nancial statements. If it does not have an

applicable financial statement, it can use the

method of accounting used in its books and re-

cords prepared according to its accounting pro-

cedures.

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 cal-

endar tax year and an accrual method of ac-

counting. To take advantage of early payment

discounts, Jane paid for seed in October 2022.

The seed was delivered in March 2023. Eco-

nomic performance did not occur until the seed

was delivered and planted. Jane incurs the ex-

pense in 2023.

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, are required to use an accrual

method of accounting.

1. A corporation that has gross receipts of

more than $29 million.

2. A partnership with a corporation as a part-

ner, if that corporation meets the require-

ments of (1) above.

3. A tax shelter (discussed below).

Note. Items (1) and (2) above do not apply

to an S corporation or a business operating a

nursery or sod farm, or the raising or harvesting

of trees (other than fruit and nut trees).

Tax shelter. A tax shelter is a partnership, non-

corporate 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.

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Chapter 2 Accounting Methods Page 7

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.

Note. If a farming business has average an-

nual gross receipts of $29 million or less for the

3 preceding tax years and is not a tax shelter,

the farm is not subject to the uniform capitaliza-

tion rules. See Uniform capitalization rules,

later. Also, see Uniform Capitalization Rules in

chapter 6.

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, concentrates,

cotton, tobacco, etc., must be included in inven-

tory.

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, see

Unit-livestock-price method, later. If you are in

the business of breeding and raising chinchillas,

mink, foxes, or other fur-bearing animals, these

animals are livestock for inventory purposes.

Growing crops. Generally, growing crops are

not required to be included in inventory. 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.

Uniform capitalization rules. The follow-

ing 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.

Note. If a farming business has average an-

nual gross receipts of $29 million or less for the

3 preceding tax years and is not a tax shelter,

the farm is not subject to the uniform capitaliza-

tion rules. 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.

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 approximate the

normal costs incurred in producing the animals

in such classes. Unit prices and classifications

are subject to approval by the IRS on examina-

tion of your return. You must annually reevaluate

your unit livestock prices and adjust the prices

upward or downward to reflect increases or de-

creases in the costs of raising livestock. IRS ap-

proval is not required for these adjustments.

TIP

Any other changes in unit prices or classifica-

tions 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 animals that were sold or lost

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 ani-

mals on hand at the end of the year are consid-

ered those most recently acquired.

You must include in inventory all livestock

purchased primarily for sale. You can choose ei-

ther 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”

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 reasonably

reflect the particular period in the year in which

animals are purchased, if necessary to avoid

significant distortions in income.

Note. A farmer can determine costs re-

quired to be allocated under the uniform capital-

ization rules by using the farm-price or unit-live-

stock-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, Accrual Method. You are a

farmer who uses an accrual method of account-

ing. You keep your books on the calendar year

basis. You sell grain in December 2023 but you

are not paid until January 2024. Because you

use the accrual method, you report the grain

sale in 2023 because that is when the income

was earned, even though you did not receive

the income until 2024.

Example 2, Cash Method. 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 2023. Under the

cash method, you include the sales proceeds in

income in 2024, the year you receive payment.

You deduct the costs of producing the grain in

the year you pay for them.

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Page 8 Chapter 2 Accounting Methods

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 ex-

pense 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.

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, you change your in-

ventory method from the farm-price

method to the unit-livestock-price method.

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.

Form 3115. To obtain approval, you must gen-

erally file Form 3115. There are instances when

you can obtain automatic consent to change

certain accounting methods. In other instances,

you can file Form 3115 using the non-automatic

change request procedures to request an ac-

counting method change. For more information,

see Form 3115 and the Instructions for Form

3115. Also, see Pub. 538.

Farm Income

Reminders

Coronavirus Food Assistance Program

(CFAP) payments. You must report the full

amount of the CFAP payments you received in

2023 as gross income on Schedule F (Form

1040). See CFAP, later.

Introduction

You may receive income from many sources.

You must report the income from all the different

sources on your tax return, unless it is excluded

by law. Where you report the income on your

tax return depends on its source.

This chapter discusses farm income you 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

Forms 1040 and 1040-SR, U.S. Individual In-

come 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 (Form 1040)

•

Sales of farm products

•

Rents (including crop shares)

•

Agricultural program payments

•

Income from cooperatives

•

Cancellation of debt

•

Income from other sources

•

Income averaging for farmers

Useful Items

You may want to see:

Publication

525 Taxable and Nontaxable Income

544 Sales and Other Dispositions of

Assets

550 Investment Income and Expenses

525

544

550

908 Bankruptcy Tax Guide

925 Passive Activity and At-Risk Rules

4681 Canceled Debts, Foreclosures,

Repossessions, and Abandonments

Form (and Instructions)

982 Reduction of Tax Attributes Due to

Discharge of Indebtedness

Sch E (Form 1040) Supplemental

Income and Loss

Sch F (Form 1040) Profit or Loss From

Farming

Sch J (Form 1040) Income Averaging for

Farmers and Fishermen

1099-G Certain Government Payments

1099-MISC Miscellaneous Information

1099 NEC Nonemployee Compensation

1099-PATR Taxable Distributions

Received From Cooperatives

4797 Sales of Business Property

4835 Farm Rental Income and

Expenses

See chapter 16 for information about getting

publications and forms.

Schedule F (Form 1040)

Individuals, trusts, partnerships, S corporations,

LLCs taxed as partnerships, and sole members

of a domestic LLC engaged in the business of

farming report farm income on Schedule F

(Form 1040). Use this schedule to figure the net

profit or loss from regular farming operations.

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 includes

income from operating a stock, dairy, poultry,

fish, fruit, or truck farm and income from operat-

ing a plantation, ranch, range, orchard, or grove.

It also includes income from the sale of crop

shares if you materially participate in producing

the crop. See Rents (Including Crop Shares),

later.

Income received from operating a nursery,

which specializes in growing ornamental plants,

is considered to be income from farming.

Income reported on Schedule F doesn't 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.

908

925

4681

982

Sch E (Form 1040)

Sch F (Form 1040)

Sch J (Form 1040)

1099-G

1099-MISC

1099 NEC

1099-PATR

4797

4835

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Chapter 3 Farm Income Page 9

Sales of Farm Products

Where to report. Table 3-1 shows where to re-

port the sale of farm products on your tax return.

Schedule F. Amounts received from the

sales of products you raised on your farm for

sale (or bought for resale), such as livestock,

produce, or grains, are reported on Schedule F.

This includes money and the fair market value

of any property or services you receive. When

you sell farm products bought for resale, your

profit or loss is the difference between your 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 2022, you bought 20 feeder

calves for $20,000 for resale. You sold them in

2023 for $25,000. You report the $25,000 sales

price on Schedule F, line 1a, subtract your

$20,000 basis on line 1b, and report the result-

ing $5,000 profit on line 1c.

Form 4797. Sales of livestock held for draft,

breeding, sport, or dairy purposes may result in

ordinary or capital gains or losses, depending

on the circumstances. In either case, you

should not report these sales on Schedule F. In-

stead, report these sales on Form 4797. See

Livestock under Ordinary or Capital Gain or

Loss in chapter 8. Animals that you don't hold

primarily for sale are considered business as-

sets of your farm. Some sales of timber/forest

products are also reported on Form 4797. See

Timber in chapter 8 for more information.

Sale by agent. If your agent sells your farm

products, you have constructive receipt of the

income when your agent receives payment and

you must include the net proceeds from the sale

in gross income for the year the agent receives

payment. This applies even if your agent pays

you in a later year. For a discussion on 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. This applies to livestock that are

held for sale (either raised or purchased) as well

as livestock held for draft, breeding, sport, or

dairy purposes. 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 determine

the number of animals you would have sold had

you followed your usual business practice in the

absence of the weather-related condition. Do

this by considering all the facts and circumstan-

ces, but don't take into account your sales in

any earlier year for which you postponed the

gain. If you haven't yet established a usual busi-

ness practice, rely on the usual business practi-

ces 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

TIP

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 live-

stock.

2. Multiply the result in (1) by the excess

number of such livestock sold solely be-

cause of weather-related conditions.

Example. You're a calendar year taxpayer

and you normally wean 100 beef calves in the

fall and feed them through the winter, selling in

January or February. As a result of drought, you

decide you don't have enough feed for all of

your calves, so you sell 35 head in the fall at

weaning and plan to sell the remaining 65

calves in January. As a result, you sold 135

head during 2022. You realized $121,500 from

the sale ($121,500 ÷ 135 = $900 per head). On

August 10, 2022, 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 2023 is $31,500 [($121,500 ÷

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.

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), and 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 10 Chapter 3 Farm Income

•

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 are required to attach a

statement in the year you realize the gain and

again in the year you replace the livestock. For

other sales or exchanges, if you timely filed your

return for the year without postponing gain, you

can still postpone gain by filing an amended 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 by another person or entity is generally

rental income, not farm income. However, the

rent is farm income if:

1. Your arrangement with your tenant pro-

vides that you will materially participate in

the production or management of produc-

tion 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 Schedule E (Form 1040), Part I.

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 you will materially participate in

the production or management of produc-

tion 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.

The crop share income isn’t included in

self-employment income 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,

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),

page 2.

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 in-

clude the fair market value of the crop share as

rental income. Although these two transactions

cancel each other for figuring adjusted gross in-

come on Form 1040 or 1040-SR, they may be

necessary to figure your self-employment tax.

See Landlord Participation in Farming and Farm

Optional Method in chapter 12.

Crop shares you give to others (gift). Crop

shares you receive as a landlord and give to

others are considered converted to money

when you make the gift. You must report the fair

market value of the crop share as income, even

though someone else receives payment for the

crop share. This applies even if the gift is made

to a qualified charitable organization.

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 that isn't inclu-

ded in self-employment income, any loss from

these activities may be subject to the limits un-

der the passive loss 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 ex-

clude from income some payments you receive

under certain cost-sharing conservation pro-

grams if there is a corresponding reduction in

basis of a related improvement. See Cost-Shar-

ing Exclusion (Improvements), later.

Report the agricultural program payment on

the appropriate line of Schedule F, Part I. Report

the full amount even if you return a government

check for cancellation, refund any of the pay-

ment you receive, or the government collects all

or part of the payment from you by reducing the

amount of some other payment or Commodity

Credit Corporation (CCC) loan. However, you

can deduct the amount you refund or return or

that reduces some other payment or loan to

you. Claim the deduction on Schedule F, Part II,

for the year of repayment or reduction.

Commodity Credit

Corporation (CCC) Loans

Generally, you don't report loans you receive as

income. However, if you pledge part or all of

your production to secure a CCC loan, you can

treat the loan as if it were a sale of the crop and

report the loan proceeds as income in the year

you receive them. You don't need approval from

the IRS to adopt this method of reporting CCC

loans.

Once you report a CCC loan as income for

the year received, you must generally 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#NOT-2008-52.

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 extensions.

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 the 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 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

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Chapter 3 Farm Income Page 11

basis of assets. If you later repay the loan, re-

deem 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 repayment. If

you repay the loan when the world price is

lower, the difference between that repayment

amount and the original loan amount is market

gain. Whether you use cash or CCC certificates

to repay the loan, you will receive a Form

1099-G showing the market gain you realized.

Market gain should be reported as follows.

•

If you elected to include the CCC loan in

income in the year you received it, don’t 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 mar-

ket 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 2022, Mike pledged 10,000 pounds

of cotton as collateral for a CCC loan of $5,200

(a loan rate of $0.52 per pound). In 2023, he re-

paid the loan and redeemed the cotton for

$4,000 when the world price was $0.40 per

pound (lower than the loan amount). Later in

2023, he sold the cotton for $6,500.

The market gain on the redemption was

$0.12 ($0.52 – $0.40) per pound. Mike realized

total market gain of $1,200 ($0.12 x 10,000

pounds). How he reports this market gain and

figures his gain or loss from the sale of the cot-

ton depends on whether he included CCC

loans in income in 2022.

Included CCC loan. Mike reported the

$5,200 CCC loan as income for 2022 on Sched-

ule F, line 5a, so he is treated as if he sold the

cotton for $5,200 when he pledged it and re-

purchased the cotton for $4,000 when he

redeemed it. The $1,200 market gain isn’t rec-

ognized on the redemption. He reports it for

2023 as an agricultural program payment on

Schedule F, line 4a, but doesn't include it as a

taxable amount on line 4b.

Mike's basis in the cotton after he redeemed

it was $4,000, which is the redemption (repurch-

ase) price paid for the cotton. His gain from the

sale is $1,200 ($5,200 – $4,000). He reports the

$5,000 sale on line 1a and the $4,000 basis on

line 1b. After subtracting his basis from the sale,

Mike will have a $1,200 gain for 2023 on Sched-

ule F, line 1c.

Excluded CCC loan. Mike didn’t elect to

report the $5,200 CCC loan as income and

therefore didn’t include it on his 2022 Sched-

ule F. When he paid $4,000 to pay off the loan in

2023, he had to recognize $1,200 of income

from market gain.

Example 2. The facts are the same as in

Example 1, except that, instead of selling the

cotton for $6,500 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

2023, the cotton buyer repaid the loan for

$4,000 and immediately exercised his option,

buying the cotton for $4,000. How Mike reports

the $1,200 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 2022.

Included CCC loan. As in Example 1, Mike

is treated as though he sold the cotton for

$5,200 when he pledged it and repurchased the

cotton for $4,000 when the cotton buyer re-

deemed it for him. The $1,200 market gain isn’t

recognized on the redemption. Mike reports it

for 2023 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 $4,000. 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 $5,200 loan as income in

2022 and must recognize $1,200 of income

from market gain in 2023.

Conservation Reserve

Program (CRP)

Under the 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 pay-

ments and any one-time incentive payment you

receive under the program on the appropriate

lines of 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 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).

Crop Insurance and Crop

Disaster Payments

You must include in income any crop insurance

proceeds you receive as the result of physical

crop damage or reduction of crop revenue, or

both. You generally include them in the year you

receive them. Treat as crop insurance proceeds

the crop disaster payments you receive from the

federal government as the result of destruction

or damage to crops, or the inability to plant

crops, because of drought, flood, or any other

natural disaster.

You can request income tax 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 damaged.

•

You can show that under your normal busi-

ness practice you would have included

more than 50% of the income from the

damaged crops in any tax year following

the year the damage occurred.

Proceeds received from revenue insurance

policies may be the result of either yield loss

due to physical damage or to decline in price

from planting to harvest. For these policies, only

the amount of the proceeds received as a result

of yield loss can be deferred. Proceeds re-

ceived from weather insurance policies cannot

be deferred if the payment is based on rainfall

amounts and is not a result of physical damage

to a crop.

To postpone reporting some or all crop in-

surance proceeds received in 2023, 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 state-

ment to your tax return. The statement must in-

clude your name and address and contain the

following information.

•

A statement that you're making an election

under section 451(g) 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

more than 50% of the income from some

or all of the destroyed or damaged crops in

gross income for a tax year following the

year the crops were destroyed or dam-

aged.

•

The cause of the physical destruction or

damage and the date or dates it occurred.

TIP

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Page 12 Chapter 3 Farm Income

•

The total payments you received from in-

surance carriers, itemized for each specific

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 CCC.

Include in income:

•

The market value of donated feed re-

ceived,

•

The difference between the market value

and the price you paid for feed you buy at

below-market prices, and

•

Any cost reimbursement you receive.

You must include these benefits in income in

the year you receive them. You can't postpone

reporting them under the rules explained earlier

for weather-related sales of livestock or crop in-

surance proceeds. Report the benefits on

Schedule F, Part I, as agricultural program pay-

ments. You can usually take a current deduction

for the same amount as a feed expense.

Cost-Sharing Exclusion

(Improvements)

You can exclude from your income part or all of

a payment you receive under certain federal or

state cost-sharing conservation, reclamation,

and restoration programs. However, see Effects

of the exclusion, later. A payment is any eco-

nomic benefit you get as a result of an improve-

ment. 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

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, territory of the Uni-

ted States, a political subdivision of any of

these, or of the District of Columbia, under

which payments are made to individuals

primarily for conserving soil, protecting or

restoring the environment, improving for-

ests, or providing a habitat for wildlife. Sev-

eral state programs have been approved.

For information about the status of those

programs, contact the state offices of the

Farm Service Agency (FSA) and the Natu-

ral Resources and Conservation Service

(NRCS).

Small watershed programs. If the three

tests listed earlier are met, you can exclude part

or all of the payments you receive under the 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 Pro-

gram 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 determine

the value of the improvement by multiplying its

fair market value (defined in chapter 6) by a

fraction. The numerator of the fraction is the to-

tal cost of the improvement (all amounts paid ei-

ther 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.

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Chapter 3 Farm Income Page 13

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 NRCS 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 improve-

ment is $15,000.

The present fair market value of the right to

receive the annual income described in (1)

above was calculated to be $1,380, and the

present fair market value of the right to receive

the annual income described in (2) is $1,550.

The excludable portion is the greater amount,

$1,550.

You figure the amount to include in gross 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

CAUTION

you receive under these programs. If you make

this election for all of these payments, none of

the above restrictions and rules apply. You must

make this election by the due date, including ex-

tensions, for filing your return. In the example

above, an election not to exclude payments re-

sults 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 ad-

dress you filed the original return.

CFAP

The CFAP provides direct payments to produc-

ers of eligible agricultural commodities ad-

versely affected by the coronavirus (COVID-19)

pandemic to help offset sales losses and in-

creased marketing costs associated with the

COVID-19 pandemic.

CFAP payments are agricultural program

payments that you must include in gross in-

come. Report the full amount of your CFAP pay-

ments on Schedule F (Form 1040), lines 4a and

4b. Go to USDA.gov for more information.

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 in-

formation to the recipient. You can avoid the in-

convenience of unnecessary inquiries about the

identity of the recipient if you file this form.

Report the total amount reported to you as

the payee of record on Schedule F. However,

don't report as a taxable amount any amount

belonging to someone else.

See chapter 16 for information about 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 cooperative,

you may receive either patronage dividends or a

per-unit retain certificate, explained later, from

the cooperative.

Form 1099-PATR. The cooperative will report

the income to you on Form 1099-PATR or a sim-

ilar 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 and basic local

telephone service.

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.

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Page 14 Chapter 3 Farm Income

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 coopera-

tive's tax year for which the patronage

dividend was paid.

Qualified check. A qualified check is any

instrument that's redeemable in money and

meets both of the following requirements.

•

It's part of a patronage dividend that also

includes a qualified written notice of alloca-

tion for which you met condition 2c 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 depreciable property

or from buying personal items, as explained in

the following discussions.

If the amount you receive is more than the

stated dollar value of the notice, report the ex-

cess as the type of income it represents. For ex-

ample, if it represents interest income, report it

on your return as interest.

Buying or selling capital assets or depreci-

able property. Patronage dividends from buy-

ing capital assets or depreciable property used

in your business are not included in income.

You must, however, reduce the basis of these

assets by the dividends. This reduction is taken

into account as of the first day of the tax year in

which the dividends are received. If the 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, 2022, Mr. Brown, a

patron of a cooperative association, bought a

used machine for his dairy farm business from

the association for $2,900. The machine has a

life of 7 years under MACRS. Mr. Brown files his

return on a calendar year basis. For 2022, he

claimed a depreciation deduction of $311, using

the 10.71% depreciation rate from the 150%

declining balance, half-year convention table

(shown in Table A-14 in Appendix A of Pub.

946). On July 2, 2023, the cooperative associa-

tion paid Mr. Brown a $300 cash patronage divi-

dend for buying the machine. Mr. Brown adjusts

the basis of the machine and figures his depre-

ciation deduction for 2022 (and later years) as

follows.

Cost of machine on July 1, 2022

.......... $2,900

Minus: 2022 depreciation ........ $311

2023 cash dividend ....... $300 $611

Adjusted basis for

depreciation for 2023: ...........

$2,289

Depreciation rate: 1.0 ÷ 6

/2 (remaining recovery period

as of 1/1/2023) = (0.1538) × 1.5 = 23.07%

Depreciation deduction for 2023

($2,289 × 0.2307) ..............

$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 treatment

as patronage dividends, discussed earlier.

Qualified certificates. Qualified per-unit retain

certificates are those issued to patrons who

have agreed to include the stated dollar amount

of these certificates in income in the year of 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. Report

the amount you receive from the disposition as

ordinary income on Schedule F, lines 3a and 3b,

for the tax year of disposition.

Cancellation of Debt

This section explains the general rule for 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 Schedule 1 (Form 1040), line 8.

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

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Chapter 3 Farm Income Page 15

reduction doesn't occur in a chapter 11 bank-

ruptcy 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 in-

solvency 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 canceled

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

chapter 5 of Pub. 334.

5. The canceled debt is qualified principal

residence indebtedness which is:

a. Discharged before 2023, or

b. Subject to an arrangement that is en-

tered into and evidenced in writing be-

fore January 1, 2026.

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 insolvent.

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

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 before

the cancellation, your liabilities totaled $80,000

and your assets totaled $75,000. Since your lia-

bilities were more than your assets, you were in-

solvent to the extent of $5,000 ($80,000 −

$75,000). You can exclude this amount from in-

come. 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 1

dollar for each dollar of excluded canceled

debt.

2. General business credit carryover. Re-

duce the credit carryover to or from the tax

year of the debt cancellation. Reduce the

carryover 33

/3 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 33

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 1 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 in-

vestment 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 in-

vestment.

d. Inventory and accounts and notes re-

ceivable.

e. Other property.

Reduce the basis 1 dollar for each dol-

lar of excluded canceled debt. However,

the reduction can't be more than the total

basis of property and the amount of

money you hold immediately after the debt

cancellation minus your total liabilities 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 1 dollar for each dollar of exclu-

ded canceled debt. Reduce the credit car-

ryover 33

/3 cents for each dollar of exclu-

ded canceled debt.

7. Foreign tax credit. Reduce the credit car-

ryover to or from the tax year of the debt

cancellation. Reduce the carryover 33

cents for each dollar of excluded canceled

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,

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Page 16 Chapter 3 Farm Income

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 because

it relates to your principal residence or it takes

place in a bankruptcy case.

Your debt is qualified farm debt if both the

following requirements are met.

•

You incurred it directly in operating a farm-

ing business.

•

At least 50% of your total gross receipts for

the 3 tax years preceding the year of debt

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 NOL for the tax year of the debt can-

cellation and any NOL carryover to that

year.

2. Any general business credit carryover to or

from the year of the debt cancellation, mul-

tiplied 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

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

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 excluded

canceled debt under the insolvency rules, you

reduce the amount of the tax attributes remain-

ing after reduction for the exclusion allowed un-

der the insolvency rules.) You must generally

follow the reduction rules previously explained

under Bankruptcy and Insolvency. However,

don't follow the rules in (5) under Order of re-

duction, earlier. Instead, follow the special rules

explained next.

Special rules for reducing the basis of

property. You must use special rules to reduce

the basis of property for excluded canceled

qualified farm debt. Under these special rules,

you only reduce the basis of qualified property

(defined earlier). Reduce it in the following or-

der.

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.

Tax for Certain Children Who Have Un-

earned Income. If your child was under age 19

(24 if a full-time student) at the end of the tax

year and had unearned income of more than

$1,250 but less than $12,500, this income will

be taxed at the parent’s tax rate if the parent’s

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Chapter 3 Farm Income Page 17

tax rate is higher than the child’s rate. For more

information, see the Instructions for Form 8615.

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 in-

terest is charged at a rate below the applicable

federal rate. If you make a below-market loan,

you may have to report income from the loan in

addition to any stated interest you receive from

the borrower. See chapter 1 of Pub. 550 for

more information on below-market loans.

Commodity futures and options. See Hedg-

ing in chapter 8 for information on gains and

losses from commodity futures 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. If you perform

custom work activities that are more than inci-

dental to your farming business, include the in-

come and expenses from the custom work on

Schedule C.

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 Sched-

ule E 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 re-

funds.

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-

TIP

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 in-

clude in income.

Refund or reimbursement. You must gener-

ally include in income a reimbursement, refund,

or recovery of an item for which you took a de-

duction 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 2022. He deducted

$1,000 on his 2022 Schedule F and the entire

deduction reduced his tax. The landowner reim-

bursed him $500 of the cost of the fertilizer in

February 2023. The tenant farmer must include

$500 in income on his 2023 tax return because

the entire deduction decreased his 2022 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 legal

relationship, you depend on the income derived

from extraction of the deposit for a return of your

capital investment in the deposit.

Your income from the deposit is capital gain

if the transaction is a sale. Otherwise, it's 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.

Tree farmers, in the business of tree

farming, may use section 631(a) to

capture favorable income tax treatment

of timber sales and then report the actual cash

TIP

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Page 18 Chapter 3 Farm Income

sale of timber on Schedule F. Section 2032A

defines sale of trees as farm income (under the

special use valuation for estate tax purposes).

However, land owners who make frequent sales

(for example, two to three within 5 years, per

case law) may use Schedule F to report this

business income.

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. Income averaging may lower your

income tax liability in a year when farm income

and taxable income are higher compared to 1 or

more of the 3 prior years. See the Instructions

for Schedule J (Form 1040) for the definition of

the term “farming business.”

Farmers electing farm income averag-

ing may want to include taxable income

from the fair market value (trade value)

of traded farm assets as electable farm income.

Under the Tax Cuts and Jobs Act, personal

property, such as tractors and equipment, no

longer qualifies for a like-kind exchange and is

now subject to depreciation recapture on the

fair market value of the trade as if cash was ex-

changed.

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 part-

nership, or a shareholder in an S corporation.

Services performed as an employee are disre-

garded 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 taxa-

ble 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

TIP

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 sta-

tus isn't the same as your filing status in the

base years. For example, if you're married and

file jointly, but filed as single in all of the base

years, you may still average farm income.

Effect on Other Tax

Determinations

You subtract your EFI from your taxable income

and add one-third of it to the taxable income of

each of the base years to determine the tax rate

to use for income averaging. The allocation of

your EFI to the base years doesn't affect other

tax determinations. For example, you make the

following determinations before subtracting your

EFI (or adding it to income in the base years).

•

The amount of your self-employment tax.

•

Whether, in the aggregate, sales and other

dispositions of business property (section

1231 transactions) produce long-term cap-

ital gain or ordinary loss.

•

The amount of any NOL carryover or net

capital loss carryover applied and the

amount of any carryover to another year.

•

The limit on itemized deductions based on

your adjusted gross income.

•

The amount of any net capital loss or NOL

in a base year.

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 nonrefundable tax credit if

you owed AMT in a prior year. See the Instruc-

tions 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 expired

for that election year. You must generally 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.

Farm Business

Expenses

What's New

Standard mileage rate. The standard mileage

rate for the cost of operating your car, van,

pickup, or panel truck for each mile of business

use is 65.5 cents per mile. See Truck and Car

Expenses, later.

Business meals deduction. The temporary

100% deduction for food or beverages provided

by a restaurant has expired. The business meal

deduction reverts back to the previous 50% al-

lowable deduction beginning January 1, 2023.

Topics

This chapter discusses:

•

Deductible expenses

•

Capital expenses

•

Nondeductible expenses

•

Losses from operating a farm

•

Not-for-profit farming

Useful Items

You may want to see:

Publication

463 Travel, Gift, and Car Expenses

334 Tax Guide for Small Business

587 Business Use of Your Home

925 Passive Activity and At-Risk Rules

936 Home Mortgage Interest Deduction

463

334

587

925

936

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Chapter 4 Farm Business Expenses Page 19

Form (and Instructions)

Sch A (Form 1040) Itemized

Deductions

Sch F (Form 1040) Profit or Loss From

Farming

461 Limitation on Business Losses

1045 Application for Tentative Refund

5213 Election To Postpone

Determination as To Whether the

Presumption Applies That an

Activity Is Engaged in for Profit

8990 Limitation on Business Interest

Expense IRC 163(j)

See chapter 16 for information about getting

publications and forms.

Deductible Expenses

The ordinary and necessary costs of operating

a farm for profit are deductible business 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, in-

clude 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 be-

tween their business and personal parts. Gen-

erally, the personal part of these expenses isn't

deductible. The business portion of the expen-

ses is deductible on Schedule F.

Example. You paid $3,600 for electricity

during the tax year. You used

/3 of the electric-

ity for personal purposes and

/3 for farming.

Under these circumstances, you can deduct

$2,400 (

/3 of $3,600) of your electricity ex-

pense as a farm business expense.

Reasonable allocation. It isn't always easy

to determine the business and nonbusiness

parts of an expense. There is no method of allo-

cation 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

Sch A (Form 1040)

Sch F (Form 1040)

461

1045

5213

8990

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

the year you pay for them may be limited to 50%

of your other deductible farm expenses for the

year (all Schedule F deductions except prepaid

farm supplies). This limit doesn't apply if you

meet one of the exceptions described later. See

chapter 2 for a discussion of the Cash Method

of accounting.

If the limit applies, you can deduct the 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 re-

sale is deductible in the year you sell or other-

wise dispose of that poultry.

Example. During 2023, 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 2023 is

$55,000. Your other deductible farm expenses

totaled $100,000 for 2023. Therefore, your de-

duction for prepaid farm supplies can't be more

than $50,000 (50% of $100,000) for 2023. 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.

If one of the exceptions is applicable, then

the 50% limit on the deduction doesn't apply.

Therefore, you can deduct more than 50% of

prepaid farm supplies.

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.

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 re-

flect 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.

CAUTION

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Page 20 Chapter 4 Farm Business Expenses

•

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.

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 sub-

ject to social security and Medicare taxes if your

child is age 18 or older. Wages paid to minor

children become subject to social security and

Medicare taxes in the month the dependent

child turns 18 years of age. 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 rea-

sonable wages or other compensation you pay

to your spouse if a true employer-employee re-

lationship exists between you and your spouse.

Wages you pay to your spouse are subject to

social security and Medicare taxes. For more in-

formation, see Family Employees in chapter 13.

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 maintaining

your home. The employee devotes the remain-

ing 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

TIP

CAUTION

substantial structural parts, or if your expendi-

tures adapt your property to a new or different

use. For example, if you replace a few shingles

on the barn roof, these expenses are generally

deductible as repairs and maintenance. If you

replace (not repair) the entire barn roof with a

new roof, then this expense is generally a capi-

tal expenditure. For more information, see Capi-

tal 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

There may be a limit on the amount you can de-

duct as farming business interest paid or ac-

crued during the tax year related to your farming

business, such as for farm mortgages and other

farm obligations. However, a small business

taxpayer is not subject to the business interest

expense limitation and is not required to file

Form 8990. A small business taxpayer is a tax-

payer that is not a tax shelter (as defined in sec-

tion 448(d)(3)) and has average annual gross

receipts of $29 million or less for the 3 prior tax

years under the gross receipts test of section

448(c). Gross receipts include the aggregate

gross receipts from all persons treated as a sin-

gle employer, such as a controlled group of cor-

porations, commonly controlled partnerships or

proprietorships, and affiliated service groups.

The gross receipts test of section 448(c) ap-

plies only to corporations and partnerships, but

for purposes of the business interest limitation

the gross receipts test applies to individuals as

if they were corporations or partnerships. Thus,

any individual with a farming trade or business

operating as a sole proprietorship is subject to

the gross receipts test.

Certain businesses subject to the business

interest expense limitation may elect out of the

limitation. Certain farming businesses and

specified agricultural or horticultural coopera-

tives (as defined in section 199A(g)(4)) qualify

to make an election not to limit business interest

expenses. This is an irrevocable election. If you

make this election, you are required to use the

alternative depreciation system (ADS), dis-

cussed later in chapter 7, to depreciate any

farming property with a recovery period of 10

years or more. Also, you are not entitled to the

special depreciation allowance for that property.

For an individual with more than one qualifying

business, the election is made with respect to

each business. If you are required to limit your

business interest expense, the amount you can-

not deduct for the tax year is generally carried

forward to the next tax year. However, there are

special rules for partnership treatment of disal-

lowed business interest. See the Instructions for

Form 8990 for more information.

Subject to the preceding rules, and assum-

ing other limitations do not apply, you can de-

duct as a farm business expense interest paid

or accrued during the tax year related to your

farming business, such as for farm mortgages

and other farm obligations.

Cash method. If you use the cash method of

accounting, you can generally deduct interest

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Chapter 4 Farm Business Expenses Page 21

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 8 of Pub. 334.

Breeding Fees

You can generally deduct breeding fees as a

farm business expense. However, if the breeder

guarantees live offspring as a result of the

breeding or other veterinary procedure, you

must capitalize these costs as the cost basis of

the offspring. Also, if you use an accrual method

of accounting, you must capitalize breeding

TIP

fees and allocate them to the cost basis of the

calf, foal, etc. For more information on who must

use an accrual method of accounting, see Ac-

crual Method Required under Accounting Meth-

ods 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 1 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.

See section 180 for more information.

Farmland, for these purposes, is land used

for producing crops, fruits, or other agricultural

products or for sustaining livestock. It doesn't in-

clude 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, ani-

mals, farmland, and farm buildings. You can

also 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

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 deduct

state and local income taxes only as an item-

ized deduction on Schedule A (Form 1040). For

tax years after 2017 and before 2026, the

Schedule A (Form 1040) deduction for com-

bined state and local income and property taxes

is limited to $10,000 ($5,000 if married filing

separately). However, you can't deduct federal

income tax.

Highway use tax. You can deduct the federal

use tax on highway motor vehicles paid on a

truck or truck tractor used in your farm business.

For information on the tax itself, including infor-

mation 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 expense. However, you can deduct as an

adjustment to income on Schedule 1 (Form

1040), line 15, one-half of your self-employment

tax in figuring your adjusted gross income. For

more information, see chapter 12.

Insurance

You can generally 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, 2023, 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, 2023. Only the cost for the

6 months in 2023 is deductible as an insurance

expense on your 2023 calendar year tax return.

Deduct $500, which is the premium for 6

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Page 22 Chapter 4 Farm Business Expenses

months of the 36-month premium period, or

/36

of $3,000. In both 2024 and 2025, deduct

$1,000 (

/36 of $3,000). Deduct the remaining

$500 in 2026. Had the policy been effective on

January 1, 2023, the deductible expense would

have been $1,000 for each of the years 2023,

2024, and 2025, 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 Schedule 1 (Form

1040) your payments for medical, dental, and

qualified long-term care insurance coverage for

yourself (including Medicare premiums), your

spouse, and your dependents when figuring

your adjusted gross income on your Schedule 1

(Form 1040). The insurance can also cover any

child of yours under age 27 at the end of 2023,

even if the child was not your dependent. Gen-

erally, 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 Schedule 1 (Form 1040) to figure your

deduction. Include the remaining part of the in-

surance payment in your medical expenses on

Schedule A (Form 1040) if you itemize your de-

ductions.

For more information, see Deductible Premi-

ums in chapter 8 of Pub. 334.

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 spe-

cial combination of tests, always applies. How-

ever, in general, an agreement may be consid-

ered 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 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 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 1 year, you

generally can't deduct the entire cost in the year

you acquire it. You must recover the cost over

more than 1 year and deduct part of it each year

on Schedule F as depreciation or amortization.

However, you can choose to deduct part or all

of the cost of certain qualifying property, up to a

limit, as a section 179 deduction or special de-

preciation 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 exclu-

sively 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 man-

agement activities of your trade or busi-

ness.

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 mi-

nus 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

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Chapter 4 Farm Business Expenses Page 23

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 2023 is 65.5 cents per mile. You

can use the standard mileage rate for a car or a

light truck, such as a van, pickup, or SUV, 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. You own a car and four pickup

trucks that are used in your farm business. Your

farm employees use the trucks and you use the

car for business. You can't use the standard

mileage rate for the car or the trucks. This is be-

cause all five vehicles are used in your farm

business at the same time. You must use actual

expenses for all vehicles.

Business use percentage. You can claim

75% of the use of a car or light truck as busi-

ness use without any allocation records if you

used the vehicle during most of the normal busi-

ness day directly in connection with the busi-

ness of farming. You choose this method of

substantiating business use the first year the

vehicle is placed in service. Once you make this

choice, you may not change to another method

later. The following are uses directly connected

with the business of farming.

•

Cultivating land.

•

Raising or harvesting any agricultural or

horticultural commodity.

•

Raising, shearing, feeding, caring for, train-

ing, 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 and disposi-

tion of truck or car in reference, see chapter 4 of

Pub. 463. If you pay your employees for the use

of their truck or car in your farm business, see

Reimbursements to employees under Travel Ex-

penses 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 workday, 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.

•

Tips for any of the above expenses.

Meals. You can deduct only 50% of your non-

entertainment business-related meal expenses.

You can deduct the cost of your meals while

traveling on business only if your business trip is

overnight or long enough to require you to stop

for sleep or rest to properly perform your duties.

You can't deduct any of the cost of meals if it

isn't necessary for you to rest. For information

on entertainment expenses, see chapter 2 of

Pub. 463.

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.

Note. No deduction is allowed for certain

entertainment expenses, membership dues,

and facilities used in connection with these ac-

tivities for amounts paid or incurred after De-

cember 31, 2017. See section 274, as amen-

ded by the Tax Cuts and Jobs Act, section

13304.

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.

RECORDS

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 documenta-

tion 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.

More information. For detailed information on

travel, recordkeeping, and the standard meal al-

lowance, see Pub. 463.

Reimbursements to employees. You can

generally deduct reimbursements you pay to

your employees for travel and transportation ex-

penses they incur in the conduct of your busi-

ness. Employees may be reimbursed under an

accountable or nonaccountable plan. Under an

accountable plan, the employee must provide

evidence of expenses. Under a nonaccountable

plan, no evidence of expenses is required. If

you reimburse expenses under an accountable

plan, deduct them as travel and transportation

expenses. If you reimburse expenses under a

nonaccountable plan, you must report the reim-

bursements as wages on Form W-2 and deduct

them as wages. For more information, see

chapter 8 of Pub. 334.

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 2023, you buy 50 steers you will

sell in 2024. You can't deduct the cost of the

steers on your 2023 tax return. You deduct their

cost on your 2024 Schedule F, Part I.

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Page 24 Chapter 4 Farm Business Expenses

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 can also deduct the cost of

seeds and young plants bought for further de-

velopment and cultivation before sale as an ex-

pense on Schedule F, Part I, when paid if you do

this consistently and you don't figure your in-

come on the crop method. However, see Pre-

paid 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 also can't de-

duct 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. Capitalize the cost of these seeds

and plants, and later deduct, through depletion.

For more information, see Depletion in chap-

ter 7.

The cost of chickens and plants used as

food for your family is never deductible.

Capitalize the cost of plants with a prepro-

ductive 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 2023, you buy 500 baby chicks to

raise for resale in 2024. You also buy 50 bush-

els of winter wheat seed in 2023 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 2023.

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 1 year or less.

•

Stamps and stationery.

•

Subscriptions to professional, technical,

and trade journals that deal with farming.

•

Tying material and containers.

•

Utilities and Internet

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 can also deduct on Schedule F the

amount you pay or incur in resolving tax issues

relating to your farm business.

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.

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Chapter 4 Farm Business Expenses Page 25

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 chapter 8 of Pub. 334.

Crop production expenses. The uniform cap-

italization rules generally require you to capital-

ize expenses incurred in producing plants. How-

ever, except for certain taxpayers required to

use an accrual method of accounting, the capi-

talization rules don't apply to plants with a pre-

productive period of 2 years or less. For more

information, see Uniform Capitalization Rules in

chapter 6.

Timber. Capitalize the cost of acquiring timber.

Do not include the cost of land in the cost of the

timber. You must generally capitalize direct

costs incurred in reforestation. However, you

can elect to deduct some forestation and 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 chapter 7.

Forestation and reforestation costs. You

can elect to deduct up to $10,000 ($5,000 if

married filing separately; $0 for a trust) of 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

income tax return filed by the due date (includ-

ing extensions) for the tax year in which the ex-

penses 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, the

Agriculture Handbook Number 731,

Form T (Timber), and the Hardwood

Industry Audit Technique Guide.

Christmas tree cultivation. If you are in the

business of planting and cultivating Christmas

trees to sell when they are more than 6 years

old, capitalize expenses incurred for planting

and stump culture and add them to the basis of

the standing trees. Recover these expenses as

part of your adjusted basis when you sell the

standing trees or as depletion allowances when

you cut the trees. For more information, see

Timber Depletion under Depletion in chapter 7.

You can deduct as business expenses the

costs incurred for shearing and basal pruning of

these trees. Expenses incurred for silviculture

practices, such as weeding or cleaning, and

noncommercial thinning are also deductible as

business expenses.

Capitalize the cost of land improvements,

such as road grading, ditching, and fire breaks,

that have a useful life beyond the tax year. If the

improvements don't have a determinable useful

life, add their cost to the basis of the land. The

cost is recovered when you sell or otherwise

dispose of it. If the improvements have a 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 certain

other items on your tax return even if they relate

to your farm.

Personal, Living, and Family

Expenses

You can't deduct certain personal, living, and

family expenses as business expenses. These

include rent and insurance premiums paid on

property used as your home; life insurance 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 preproductive 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, inheritance,

legacy, succession, and gift taxes.

Loss of livestock. You can't deduct as a loss

the value of raised livestock that die if you 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 1 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

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Page 26 Chapter 4 Farm Business Expenses

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. Generally, no deduction

is allowed for fines and penalties paid to a gov-

ernment or specified nongovernmental entity for

the violation of any law except:

•

Amounts that constitute restitution,

•

Amount paid to come into compliance with

the law,

•

Amounts paid or incurred as the result of

certain court orders in which no govern-

ment or specified non-governmental

agency is a party, and

•

Amounts paid or incurred for taxes due.

On or after December 22, 2017, no deduc-

tion is allowed for the restitution amount or

amount paid to come into compliance with the

law unless the amounts are specifically identi-

fied in the settlement agreement or court order.

Also, any amount paid or incurred as reimburse-

ment to the government for the costs of any in-

vestigation or litigation are not eligible for the

exceptions and are nondeductible.

See section 162(f), as amended by the Tax

Cuts and Jobs Act, section 13306.

For the deductibility of penalites for exceed-

ing marketing quotas, see Marketing Quota

Penalties, 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 involv-

ing 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

can generally deduct losses from passive activi-

ties only up to income from passive activities.

Credits are similarly limited.

For more information, see Pub. 925.

Excess Business Loss

Limitation

Noncorporate taxpayers may be subject to ex-

cess business loss limitations. The at-risk limits

and the passive activity limits are applied before

calculating the amount of any excess business

loss. An excess business loss is the amount by

which the total deductions attributable to all of

your trades or businesses exceed your total

gross income and gains attributable to those

trades or businesses plus $289,000 (or

$578,000 in the case of a joint return). Business

gains and losses reported on Form 4797 and

Form 8949 are included in the excess business

loss calculation. This includes farming losses

from casualty losses or losses by reason of dis-

ease or drought. Excess business losses that

are disallowed are treated as a net operating

loss carryover to the following tax year. See

Form 461 and its instructions for details.

CAUTION

Taxpayers with losses from a farming busi-

ness must apply the excess business loss limi-

tation before carrying any net operating losses

back 2 years. See the Instructions for Form

1045, Application for Tentative Refund.

If you incur both farming and nonfarming

business losses that are more than the thresh-

old amount you must allocate the threshold

amount first to the farming losses to the extent

you have a net operating loss.

Excess farm losses that are disallowed can

be carried forward to the next tax year and trea-

ted as a net operating loss deduction from that

year.

Net Operating Loss

Limitation

If you have a 2023 net operating loss attributa-

ble to farming, you must carry it back two years,

unless you elect to forgo the carryback. Farming

businesses can elect to forgo the carryback and

carry forward the farm net operating loss to a

later year. See the Instructions for Form 1045 or

Form 1138 for more information.

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 Schedule 1 (Form 1040), line 8i. You

can no longer deduct expenses of carrying on

the activity, even if you itemize your deductions

on Schedule A (Form 1040).

Expenses for activities you do as a hobby, or

mainly for sport or recreation can not be deduc-

ted. This also applies to an investment activity

intended only to produce tax losses for the in-

vestors.

The deductibility of not-for-profit losses ap-

plies to individuals, partnerships, estates, trusts,

and S corporations. It doesn't apply to corpora-

tions 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;

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Chapter 4 Farm Business Expenses Page 27

•

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 may still 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 ad-

vantage of this presumption later, after you have

had the 5 (or 7) years of experience allowed by

the test.

You can choose to do this by filing Form

5213. Filing this form postpones any 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 deductions.

Rather, you will gain time to earn a profit in 3 (or

2) out of the first 5 (or 7) years you carry on the

farming activity. If you show 3 (or 2) years of

profit at the end of this period, your deductions

aren't limited under these rules. If you don't

have 3 (or 2) years of profit (and can't otherwise

show that you operated your farm for profit), the

limit applies retroactively to any year in the

5-year (or 7-year) period with a loss.

Filing Form 5213 automatically extends the

period of limitations on any year in the 5-year

(or 7-year) period to 2 years after the due date

of the return for the last year of the period. The

period is extended only for deductions of the

activity and any related deductions that might

be affected.

Limit on deductions and losses. If your ac-

tivity isn't carried on for profit, take deductions

only in the following order, only to the extent sta-

ted in the three categories.

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 (attributable

to a federally declared disaster), belong in this

category. See chapter 11 for more information.

For the limits that apply to mortgage interest,

see Pub. 936.

Category 2. Deductions that don't result in

an adjustment to the basis of property are 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 category.

Where more than one asset is involved, divide

depreciation and these other deductions pro-

portionally among those assets.

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 chapter 9 of Pub. 334.

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

•

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.)

The deduction for conservation expenses

cannot be more than 25% of your gross income

from farming. See 25% Limit on Deduction,

later.

Conservation expenses for land in a

foreign country do not qualify for this

special treatment.

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 prac-

tices. However, you can exclude some pay-

ments you receive under certain cost-sharing

conservation programs. For more information,

see Agricultural Program Payments in chap-

ter 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 the following.

•

Business of farming,

•

Plan certification,

•

Conservation expenses,

•

Assessment by conservation district,

•

25% limit on deduction,

•

When to deduct or capitalize, and

•

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 oper-

ate a farm for recreation or pleasure, rather than

for profit. You are not farming if you are engaged

only in forestry or the growing of timber.

Farm defined. A farm includes livestock, dairy,

poultry, fish, fruit, and truck farms. It also 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 production,

either in cash or crop shares, you are in the

business of farming.

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.

CAUTION

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Page 28 Chapter 5 Soil and Water Conservation Expenses

If you get cash rental for a farm you

own that is not used in farm production,

you can't deduct soil and water conser-

vation expenses for that farm.

Example. You own a farm in Iowa. You rent

out the farm for $250 in cash per acre and don't

materially participate in producing or managing

production of the crops grown on the farm. You

can't deduct your soil conservation expenses

for this farm. You must capitalize the expenses

and add them to the basis of the land.

For more information, see Material 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 con-

servation 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-

initiatives. Individual site plans can be obtained

from NRCS offices and the comparable state

agencies.

Conservation Expenses

You can deduct conservation expenses only for

land you or your tenant are using, or have used

in the past, for farming. These expenses 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

CAUTION

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 conserva-

tion 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 ex-

penses. You can use another method to allo-

cate 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, tile (including drainage tile), pipe, pumps

(and other equipment), supplies, wages, fuel,

hauling, and moving dirt when making or instal-

ling structures such as tanks, reservoirs, cul-

verts, canals, dams, drainage systems, waste

management systems or wells composed of

masonry, concrete, tile (including drainage tile),

CAUTION

metal, or wood. You recover your capital invest-

ment through annual allowances for deprecia-

tion.

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 must

also 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 can generally deduct as a conservation ex-

pense amounts you pay or incur for the part of a

conservation or drainage district assessment

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Chapter 5 Soil and Water Conservation Expenses Page 29

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, dis-

cussed later. See Table 5-1 for a brief summary

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 applies

whether you pay the assessment in one pay-

ment 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 1 year is the total

of 10% of your deductible share of the cost as

explained earlier, plus $500. If the amount you

TIP

pay or incur is equal to or less than the maxi-

mum 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 de-

duct the remainder in equal amounts over the

next 9 tax years. Your total conservation ex-

pense deduction for each year is also subject to

the 25% of gross income from farming limit on

the deduction, discussed later.

Example 1. This year, the soil conservation

district levies, and you pay, an assessment of

$2,400 against your farm. Of the assessment,

$1,500 is for digging drainage ditches. You can

deduct this part as a soil or conservation 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 1 year, so you can deduct

only $70 of the amount you paid or incurred for

depreciable property this year (10% of $700).

You can deduct the balance at the rate of $70 a

year over the next 9 years.

You add $70 to the $1,500 portion of the as-

sessment for drainage ditches. You can deduct

$1,570 of the $2,400 assessment as a soil and

water conservation expense this year, subject to

the 25% of gross income from farming limit on

the deduction, discussed later.

Example 2. Assume the same facts as in

Example 1 except that $1,850 of the $2,400 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 1 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 expen-

ses 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 in-

come from farming for that 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.

Example. In 2023, you report gross income

from farming for your single-member LLC

(SMLLC) on Schedule F (Form 1040) of

$85,000. Additionally, your gain from sales of

cull raised breeding animals reported on Form

4797, line 2(g), is $15,000. Therefore, your

gross income from farming is $100,000

($85,000 + $15,000). Thus, the applicable 25%

limitation ($100,000 x 25% (0.25)) is $25,000

for soil and water expenses in 2023.

The calculation of farm income for soil

and water conservation expenses dif-

fers from the calculations for income

averaging and estimated tax payments. For

more information, see Income Averaging for

Farmers in chapter 3 and Gross Income in

chapter 15.

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

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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 30 Chapter 5 Soil and Water Conservation Expenses

any later year is limited to 25% of the gross in-

come from farming for that year as well.

Example. In 2023, you have gross income

of $32,000. During the year, you incurred

$10,000 of deductible soil and water conserva-

tion expenses. However, your deduction is limi-

ted to 25% of $32,000, or $8,000. The $2,000

excess ($10,000 − $8,000) is carried over to

2024 and added to deductible soil and water

conservation expenses made in that year. The

total of the 2023 carryover plus 2024 expenses

is deductible in 2024, subject to the limit of 25%

of your gross income from farming in 2024. Any

expenses over the limit in that year are carried

to 2025 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

choose not 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. Do not use Form 3115

for this request. Use the procedure outlined be-

low.

Your request must include the following in-

formation.

•

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.

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 prop-

erty, increase your basis. If you take deductions

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.

RECORDS

Topics

This chapter discusses:

•

Cost basis

•

Adjusted basis

•

Basis other than cost

Useful Items

You may want to see:

Publication

544 Sales and Other Dispositions of

Assets

551 Basis of Assets

946 How To Depreciate Property

See chapter 16 for information about getting

publications and forms.

Cost Basis

The basis of property you buy is usually its cost.

Cost is the amount you pay in cash, debt obliga-

tions, other property, or services. Your cost in-

cludes 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.

You may also 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. See

Allocating the Basis, later.

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 the

seller reimburses you for the portion of real es-

tate taxes from the time they owned the

544

551

946

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Chapter 6 Basis of Assets Page 31

property, reduce your deductible real estate tax

expense by the amount of the reimbursement.

If you reimburse the seller for taxes the seller

paid for you, you can generally deduct that

amount as a tax expense in the year of pur-

chase. If you do not reimburse the seller for real

estate taxes, you cannot deduct the amount

paid on your behalf as a tax expense. In either

case, 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, 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.

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 of the mortgage that you assumed.

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.

•

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 construction.

You must capitalize these expenses by in-

cluding them in the asset's basis.

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

CAUTION

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.

Land and buildings. Allocate the cost basis

according to the respective fair market values

(FMVs) of the land and improvements at the

time of purchase. Figure the basis of each asset

by multiplying the lump sum by a fraction. The

numerator is the FMV of that asset, and the de-

nominator is the FMV of the whole property at

the time of purchase.

Fair market value (FMV). FMV is the price at

which property would change hands between a

willing buyer and a willing seller, neither having

to buy or sell, and both having reasonable

knowledge of all necessary facts. Sales of simi-

lar property on or about the same date may help

in figuring the FMV of the property.

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 contract to

a specific allocation of the purchase price

among the assets. If this allocation is based on

the value of each asset and you and the seller

have adverse tax interests, the allocation will

generally be accepted.

Farming business acquired. If you buy a

group of assets that make 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 FMVs

and in a certain order. See Trade or Business

Acquired under Allocating the Basis in Pub. 551

for more information. Also, see the 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,

however, you may be able to take a deduction

for depreciation for the cow.

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.

Any farming business that has average

annual gross receipts of $29 million or

less for the 3 preceding tax years and

is not a tax shelter is not subject to the uniform

capitalization rules.

TIP

Generally, you are subject to the uniform

capitalization rules if you do either of the follow-

ing.

1. Produce real property or tangible personal

property.

2. Acquire property for resale.

You produce property if you construct, build,

install, manufacture, develop, improve, or create

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.

•

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. This elec-

tion cannot be made by a corporation,

partnership, 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.

TIP

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Page 32 Chapter 6 Basis of Assets

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 period

of more than 2 years. Other plants (not shown in

Table 6-1) may also have a nationwide weighted

average preproductive period of more than 2

years.

More information. For more information on

the uniform capitalization rules that apply to

property produced in a farming business, see

Regulations section 1.263A-4.

Adjusted Basis

Before figuring gain or loss on a sale, exchange,

or other disposition of property or figuring allow-

able depreciation, depletion, or amortization,

you must usually make certain adjustments to

the cost basis or basis other than cost (dis-

cussed later) of the property. The adjustments

to the original basis are increases or decreases

to the cost basis or other basis which result in

the adjusted basis of the property.

Increases to Basis

Increase the basis of any property by all items

properly added to a capital account. These 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. However,

you can deduct as taxes amounts as-

sessed for maintenance or repairs, or for

meeting interest charges related to the im-

provements.

CAUTION

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 Deduct-

ing vs. Capitalizing Costs under Increase to Ba-

sis in Pub. 551.

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 enter

“Filed pursuant to section 301.9100-2” on the

statement. File the amended return at the same

address you filed the original return.

Decreases to Basis

The following are some items that reduce the

basis of property.

•

Section 179 deduction.

•

Deductions previously allowed or allowable

for amortization, depreciation, and deple-

tion.

•

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.

•

Patronage dividends received from a coop-

erative 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 reimburse-

ment and by any deductible loss not covered by

insurance. See chapter 11 for information about

figuring your casualty or theft loss.

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 33

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 repaired

property to the property before the casualty. For

more information on casualty and theft losses,

see Pub. 547.

Easements. The amount you receive for 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 must generally include

the canceled amount in your gross income for

tax purposes. A debt includes any indebted-

ness for which you are liable or which attaches

to property you hold.

You can exclude your canceled debt from in-

come 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 receive

property for services, include the property's

FMV in income. The amount you include in in-

come becomes your basis. If the services were

performed for a price agreed on beforehand, it

will be accepted as the FMV of the property if

there is no evidence to the contrary.

Example. Rocco Stowsa is an accountant

and also operates a farming business. Rocco

agreed to do some accounting work for his

neighbor in exchange for a dairy cow. The 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 ba-

sis 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 taxa-

ble 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 is

also known as an unrecognized gain or loss. If

you receive property in a nontaxable exchange,

its basis is usually the same as the basis of the

property you transferred.

Involuntary Conversions

If you receive property as a result of an 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.

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

Generally, if you exchange real property you use

in your business or hold for investment solely for

other business or investment real property of a

like kind, you do not recognize the gain or loss

from the exchange. If you also receive

non-like-kind property or money as part of the

exchange, you do recognize gain, but only to

the extent of the value of the other property or

money you received in the exchange, and you

do not recognize any loss.

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.

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Page 34 Chapter 6 Basis of Assets

The basis of the property you receive is gen-

erally the same as the adjusted basis of the

property you gave up.

Example. You trade farmland for another

larger tract of farmland. Your adjusted basis in

your farmland is $110,000. The FMV of the new

tract of farmland is $150,000. Because this is a

nontaxable exchange, you do not recognize any

gain and your basis in the farmland you receive

is $110,000, the same as the adjusted basis in

the farmland you exchanged.

Note. An exchange of personal property,

such as machinery or equipment, does not

qualify as a like-kind exchange.

Exchange expenses. Exchange expenses are

generally the closing costs that you pay. They

include such items as brokerage commissions,

attorney fees, and deed preparation fees. Add

them to the basis of the like-kind property you

receive.

Property plus cash. If you trade property in a

like-kind exchange and also pay money, the ba-

sis of the property you receive is increased by

the money you paid.

Example. Assume the same facts from the

previous example except you pay an additional

$20,000 in cash. Your adjusted basis in the

newly acquired farming real estate is $130,000

($110,000 adjusted basis of your old farmland

plus the $20,000 cash you paid).

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.

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. 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

1a) ..........................

− 30,000

$70,000

Plus: Gain recognized (adjustment

2b) ..........................

+ 30,000

Basis of land received .......$100,000

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 trade a tract of farmland with

an adjusted basis of $100,000 for another tract

of farmland that has an FMV of $92,500. You

also receive $4,000 in cash and a pickup truck

with an FMV of $11,000. Since only real prop-

erty qualifies for like-kind exchange treatment,

your receipt of the truck and cash means you

must recognize gain on the exchange. You real-

ize a gain of $7,500. This is the sum of the FMV

of the tract of farmland you receive, the FMV of

the truck you receive, and the cash you receive,

minus the adjusted basis of the farmland you

traded ($92,500 + $11,000 + $4,000 –

$100,000). You include in income (recognize)

all $7,500 of the gain because it is the lesser of

the realized gain ($7,500) and the sum of the

FMV of the unlike property and the cash re-

ceived ($15,000). Your basis in the properties

you received is figured as follows.

Adjusted basis old farmland ......$100,000

Minus: Cash received (adjustment

1a) ..........................

− 4,000

$96,000

Plus: Gain recognized (adjustment

2b) ..........................

+ 7,500

Total basis of properties

received ................

$103,500

Allocate the basis of $103,500 first to the unlike

property, the truck ($11,000). This is the truck's

FMV. The rest ($92,500) is the basis in the farm-

land.

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 own farmland with a barn.

The properties have a combined adjusted basis

of $70,000, and an FMV of $150,000. You are

interested in another tract of farmland with a

larger barn owned by your neighbor who is in-

terested in exchanging the property with you.

The total FMV of your neighbor's farmland and

barn is $200,000. You want the new barn to

have a larger basis for depreciation, so you ar-

range to sell your old farmland and barn to your

neighbor for $150,000. Your neighbor then sells

his farmland and barn to you for $200,000.

However, you are treated as having exchanged

the old property for the new property because

the sale and purchase are reciprocal and mutu-

ally dependent. Your basis in the new property

is $120,000 ($50,000 cash paid plus $70,000

adjusted basis in your old property), which must

be allocated between the farmland and the

barn.

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 must also 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 2022, 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

$34,000 ($50,000 minus the $16,000 annual

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Chapter 6 Basis of Assets Page 35

exclusion). She paid a gift tax of $6,880. Your

basis, $26,054, is figured as follows.

Fair market value .................. $50,000

Minus: Adjusted basis .............. − 20,000

Net increase in value ............... $30,000

Gift tax paid ..................... $6,880

Multiplied by ($30,000 ÷ $34,000) ...... × 0.88

Gift tax due to net increase in value ..... $6,054

Adjusted basis of property to your

mother .......................

+ 20,000

Your basis in the property ....... $26,054

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. For more informa-

tion on depreciation, depletion or amortization,

see chapter 7.

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 Form 706, United

States Estate (and Generation-Skipping

Transfer) Tax Return, you can use its ap-

praised 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 be-

cause 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 dece-

dent, you transfer the property or the property

stops being used as a farm. This tax does not

apply if you dispose of the property in a like-kind

exchange or in an involuntary conversion in

which all of the proceeds are reinvested in

qualified replacement property. The tax also

does not apply if you transfer the property to a

member of your family and certain requirements

are met.

You can elect to increase your basis in spe-

cial-use valuation property if it becomes subject

to the additional estate tax. To increase your ba-

sis, you must make an irrevocable election and

pay interest on the additional estate tax figured

from the date 9 months after the decedent's

death until the date of payment of the additional

estate tax. If you meet these requirements, in-

crease your basis in the property to its FMV on

the date of the decedent's death or the alternate

valuation date. The increase in your basis is

considered to have occurred immediately be-

fore the event that resulted in the additional es-

tate 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; Form

706-A; and the related instructions.

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 distri-

bution. 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.

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Page 36 Chapter 6 Basis of Assets

Depreciation,

Depletion, and

Amortization

What's New for 2023

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 2023 is $1,160,000.

This limit is reduced by the amount by which the

cost of the property placed in service during the

tax year exceeds $2,890,000. Also, the maxi-

mum section 179 expense deduction for sport

utility vehicles placed in service in tax years be-

ginning in 2023 is $28,900. See Dollar Limits

under Section 179 Expense Deduction, later.

Phase down of special depreciation allow-

ance. The special depreciation allowance is

80% for certain qualified property acquired after

September 27, 2017, and placed in service af-

ter December 31, 2022, and before January 1,

2024 (other than certain property with a long

production period and certain aircraft). The spe-

cial depreciation allowance is also 80% for cer-

tain specified plants bearing fruits and nuts

planted or grafted after December 31, 2022,

and before January 1, 2024. See Certain quali-

fied property acquired after September 27,

2017 and Certain specified plants under What

Is Qualified Property, later.

What’s New for 2024

Phase down of special depreciation allow-

ance. The special depreciation allowance is

60% for certain qualified property acquired after

September 27, 2017, and placed in service af-

ter December 31, 2023, and before January 1,

2025 (other than certain property with a long

production period and certain aircraft). For

property with a long production period and cer-

tain aircraft placed in service after December

31, 2023, and before January 1, 2025, the spe-

cial depreciation allowance is 80%. The special

depreciation allowance is also 60% for certain

specified plants bearing fruits and nuts planted

or grafted after December 31, 2023, and before

January 1, 2025. See Certain qualified property

acquired after September 27, 2017 and Certain

specified plants under What Is Qualified Prop-

erty, 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

463 Travel, Gift, and Car Expenses

534 Depreciating Property Placed in

Service Before 1987

544 Sales and Other Dispositions of

Assets

551 Basis of Assets

946 How To Depreciate Property

Form (and Instructions)

T (Timber), Forest Activities Schedule

3115 Application for Change in

Accounting Method

4562 Depreciation and Amortization

4797 Sales of Business Property

See chapter 16 for information about getting

publications and forms.

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 prop-

erty and listed property, see Pub. 946.

Overview of

Depreciation

This overview discusses basic information on

the following.

•

What property can be depreciated.

463

534

544

551

946

3115

4562

4797

RECORDS

•

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 intan-

gible property, such as copyrights, patents, and

computer software. To be depreciable, the prop-

erty must meet all the following requirements.

•

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 must usually 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 (explained below). This

means you bear the burden of exhaustion of the

capital investment in the property. If you lease

property from someone to use in your trade or

business or for the production of income, you

generally cannot depreciate its cost because

you do not have the incidents of ownership. You

can, however, depreciate any capital improve-

ments you make to the leased property. See Ad-

ditions and Improvements under Which Recov-

ery Period Applies? in chapter 4 of Pub. 946.

You can generally 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 condi-

tion and value as when leased.

Incidents of ownership. Incidents of own-

ership in property include the following.

•

The legal title to the property.

•

The legal obligation to pay for the property.

•

The responsibility to pay maintenance and

operating expenses.

•

The duty to pay any taxes on the property.

•

The risk of loss if the property is destroyed,

condemned, or diminished in value

through obsolescence or exhaustion.

Life tenant. Generally, if you hold business or

investment property as a life tenant, you can de-

preciate it as if you were the absolute owner of

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Chapter 7 Depreciation, Depletion, and Amortization Page 37

the property. See Certain term interests in prop-

erty, later, for an exception.

Property Used in Your Business or

Income-Producing Activity

To claim depreciation on property, you must use

it in your business or income-producing activity.

If you use property to produce income (invest-

ment use), the income must be taxable. You

cannot depreciate property that you use solely

for personal activities. However, if you use prop-

erty for business or investment purposes and

for personal purposes, you can deduct depreci-

ation 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 depreci-

ate 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. Irrigation

systems and water wells used in a trade or busi-

ness can be depreciated if their useful life can

be determined. You can depreciate irrigation

systems and water wells composed of masonry,

concrete, tile (including drainage tile), metal, or

wood. In addition, you can depreciate costs for

moving dirt to construct irrigation systems and

water wells composed of these materials. How-

ever, land preparation costs for center pivot irri-

gation systems are not depreciable.

TIP

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

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 chapter 1

of Pub. 946.

Example. You retain a life interest in a dairy

facility but transfer the remainder interest to

your daughter. Your term interest in the dairy fa-

cility is not depreciable even though you may

still be using it in your dairy operation.

When Does Depreciation

Begin and End?

You begin to depreciate your property when you

place it in service for use in your trade or busi-

ness or for the production of income. You stop

depreciating property either when you have fully

recovered your cost or other basis or when you

retire it from service, whichever happens first.

Placed in Service

Property is placed in service when it is ready

and available for a specific use, whether in a

business activity, an income-producing activity,

a tax-exempt activity, or a personal activity.

Even if you are not using the property, it is in

service when it is ready and available for its

specific use.

Example. You bought a planter for use in

your farm business. The planter was delivered

in December 2022 after harvest was over. You

begin to depreciate the planter in 2022 because

it was ready and available for its specific use in

2022, even though it will not be used until the

spring of 2023.

If your planter comes unassembled in De-

cember 2022 and is put together in February

2023, it is not placed in service until 2023. You

begin to depreciate it in 2023.

If your planter was delivered and assembled

in February 2023 but not used until April 2023, it

is placed in service in February 2023, because

this is when the planter was ready for its speci-

fied use. You begin to depreciate it in 2023.

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 meet the small busi-

ness taxpayer exception or 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 fruits, 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.

Note. Any farming business that has aver-

age annual gross receipts of $29 million or less

for the 3 preceding tax years and is not a tax

shelter is not subject to the uniform capitaliza-

tion rules.

Immature livestock. Depreciation for livestock

begins when the livestock reaches the age of

maturity. If you bought immature livestock for

drafting purposes, depreciation begins when

they can be worked. If you bought immature

livestock for breeding or dairy purposes, depre-

ciation begins when they can be bred. Your ba-

sis for depreciation is your initial cost for the im-

mature 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

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Page 38 Chapter 7 Depreciation, Depletion, and Amortization

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 property,

see chapter 8. For information on destroyed

property, see chapter 11, and Pub. 547, Casual-

ties, 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, videotapes, 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 allowa-

ble 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 of 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.

Example. You rent 100 acres from your

landlord on a 5-year term. You install $25,000 of

drainage tile. The recovery period for drainage

tile is 15 years, not the term of the lease. You

may be able to take a section 179 expense de-

duction, special depreciation allowance, or de-

preciation expense under MACRS for the drain-

age tile. See Section 179 Expense Deduction,

Claiming the Special Depreciation Allowance,

Figuring Depreciation Under MACRS, later.

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

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

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Chapter 7 Depreciation, Depletion, and Amortization Page 39

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;

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 2c un-

der Eligible Property. 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.

Note. Recent legislation has changed the

treatment of qualified improvement property

placed in service after December 31, 2017, to

15-year property under MACRS. See chapter 3

of Pub. 946 for more information.

Qualified real property. Qualified real

property is any qualified improvement property

described in section 168(e)(6), and any of the

following improvements to nonresidential real

property placed in service after the date such

qualified real property was first placed in serv-

ice.

•

Roofs.

•

Heating, ventilation, and air conditioning.

•

Fire protection and alarms.

•

Security systems.

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. You are a farmer. You purchased

two tractors, one from your sibling and one from

your parent. You placed both tractors in service

in the same year you bought them. The tractor

purchased from your parent does not qualify for

the section 179 expense deduction because

you are a related person (as defined above).

The tractor purchased from your sibling does

qualify for the deduction because you are not a

related person (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

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. However,

the total amount you can elect to deduct under

section 179 is subject to a dollar limit and a

business income limit. These limits apply to

each taxpayer, not to each business. However,

see Married individuals under Dollar Limits,

later. Also, see the special rules for applying the

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Page 40 Chapter 7 Depreciation, Depletion, and Amortization

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.

Example. Adyo Farms traded real property

X having a total adjusted basis of $6,800 for

new real property Z costing $13,200. They re-

ceived an $8,000 trade-in allowance for the old

real property X, and paid $5,200 in cash for the

new real property Z.

For purposes of the section 179 expense

deduction, only the cash paid by Adyo qualifies

for the section 179 expense deduction. Adyo's

business costs that qualify for a section 179 ex-

pense deduction are $5,200. For information on

the maximum amount you can elect to deduct,

see Dollar Limits next.

Dollar Limits

The total amount you can elect to deduct under

section 179 for most property placed in service

in 2023 is $1,160,000. If you acquire and place

in service more than one item of qualifying

property during the year, you can allocate the

section 179 expense deduction among the

items in any way, as long as the total deduction

is not more than $1,160,000. You cannot carry

costs in excess of the $1,160,000 limit over to

future years.

Reduced dollar limit for cost exceeding

$2,890,000. If the cost of your qualifying sec-

tion 179 property placed in service in 2023 is

over $2,890,000, you must reduce the dollar

limit (but not below zero) by the amount of cost

over $2,890,000. If the cost of your section 179

property placed in service during 2023 is

$4,050,000 or more, you cannot take a section

179 expense deduction and you cannot carry

over any of the cost that is more than

$4,050,000.

Example. This year, George Thomas

placed in service machinery costing

$2,990,000. Because this cost is $100,000

more than $2,890,000, George must reduce the

dollar limit to $1,060,000 ($1,160,000 −

$100,000). George cannot carry over any of the

costs that exceed the $1,060,000 reduced limit.

The remaining cost of the machinery not al-

lowed as a section 179 expense deduction is el-

igible for a depreciation expense under

MACRS. See Figuring Depreciation Under

MACRS, later.

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 2023 is $28,900. 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 2023, 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 $2,890,000. You must allocate the

dollar limit (after any reduction) equally between

you, unless you both elect a different allocation.

If the percentages elected by each of you do not

total 100%, 50% will be allocated to each of

you.

Joint return after separate returns. If you

and your spouse elect to amend your separate

returns by filing a joint return after the due date

for filing your return, the dollar limit on the joint

return is the lesser of the following amounts.

•

The dollar limit (after reduction for any cost

of section 179 property over $2,890,000).

•

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 income

and losses from all trades and businesses you

actively conducted during the year. In addition

to net income or loss from a sole proprietorship,

partnership, or S corporation, net income or

loss derived from a trade or business also in-

cludes 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.

Also, see chapter 2 of Pub. 946.

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

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

8 Figure your actual other deduction using

the taxable income figured in Step 7.

Example. On February 1, 2023, 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.

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Chapter 7 Depreciation, Depletion, and Amortization Page 41

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 sec-

tion 179 expense deduction. Because the

taxable income is at least $500,000, XYZ

can take a $500,000 section 179 expense

deduction.

Step 7. $200,000 ($700,000 − $500,000).

Step 8. Using $200,000 (from Step 7) as

taxable income, XYZ's actual charitable

contribution (limited to 10% of taxable 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 Diana’s busi-

ness (determined without regard to both a sec-

tion 179 expense deduction for the cost of the

machine and the self-employment tax deduc-

tion) was $80,000. Diana’s section 179 expense

deduction was limited to $80,000. The $20,000

cost that was not allowed as a section 179 ex-

pense deduction (because of the business in-

come limit) is carried to this year.

This year, Diana placed another machine in

service that cost $110,000. Diana’s taxable in-

come 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. Diana 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 $2,890,000, 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 2023, Partnership P placed in

service section 179 property with a total cost of

$2,990,000. P must reduce its dollar limit by

$100,000 ($2,990,000 − $2,890,000). Its maxi-

mum section 179 expense deduction is

$1,060,000 ($1,160,000 − $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

$2,000,000, it can deduct the full $1,060,000. P

allocates $200,000 of its section 179 expense

deduction and $500,000 of its taxable income

to John, one of its partners.

John also conducts a business as a sole

proprietor and, in 2023, placed in service in that

business, section 179 property costing

$800,000. John's taxable income from that

business was $200,000. In addition to the

$200,000 allocated from P, John elects to ex-

pense the $550,000 of the sole proprietorship's

section 179 costs. However, John's deduction is

limited to the business taxable income of

$700,000 ($500,000 from P plus $200,000 from

the sole proprietorship). John carries over

$50,000 ($750,000 − $700,000) of the elected

section 179 costs to 2024.

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

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 2023 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.

CAUTION

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 under

Section 1245 Property in chapter 9.

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 under Recapture of Excess

Depreciation in chapter 5 of Pub. 946.

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 2021, you are a calen-

dar year taxpayer. You bought and placed in

service section 179 property costing $10,000.

The property is 3-year property and is depreci-

ated under MACRS and a half-year convention.

The property is not listed property. You elected

a $5,000 section 179 expense deduction for the

property and also elected not to claim a special

depreciation allowance. You used the property

only for business in 2021 and 2022. During

2023, you used the property 40% for business

and 60% for personal use. You figure the recap-

ture amount as follows.

Section 179 expense deduction claimed

(2021) ............................ $5,000

Minus: Allowable depreciation

(instead of section 179 expense deduction):

2021 ...................... $1,250

2022 ...................... 1,875

2023 ($1,250 × 40% (business)) ... 500 3,625

2023 — Recapture amount ......... $1,375

You must include $1,375 in income for 2023.

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

CAUTION

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Page 42 Chapter 7 Depreciation, Depletion, and Amortization

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 2023, you can take a special depreci-

ation allowance depending on the date you ac-

quired the qualified property. The allowance is

an additional deduction you can take before you

figure regular depreciation under MACRS. Fig-

ure the special depreciation allowance by multi-

plying the depreciable basis of the qualified

property by the applicable percentage.

What Is Qualified Property?

For farmers, qualified property is certain prop-

erty acquired after September 27, 2017, and

certain specified plants.

Certain qualified property acquired after

September 27, 2017. You can elect to take an

80% special depreciation allowance for certain

qualified property acquired after September 27,

2017, and placed in service after December 31,

2022, and before January 1, 2024 (other than

certain property with a long production period

and certain aircraft). For certain qualified prop-

erty acquired after September 27, 2017, and

placed in service after December 31, 2023, and

before January 1, 2025 (other than certain prop-

erty with a long production period and certain

aircraft), you can elect to take a 60% special de-

preciation allowance.

You can elect to take a 100% special depre-

ciation allowance for certain property with a

long production period and certain aircraft ac-

quired and placed in service after September

27, 2017, and before January 1, 2024. For cer-

tain property with a long production period and

certain aircraft acquired after September 27,

2017, and placed in service after December 31,

2023, and before January 1, 2025, you can

elect to take an 80% special depreciation allow-

ance.

Your property is qualified property if it meets

the following requirements.

1. It is one of the following types of property.

a. Tangible property depreciated under

MACRS with a recovery period of 20

years or less.

b. Water utility property depreciated un-

der MACRS.

c. Computer software defined in and de-

preciated under section 167(f)(1) of

the Internal Revenue Code.

2. Qualified property can be either new prop-

erty or certain used property.

3. It is not excepted property.

For more information, see chapter 3 of Pub.

946.

Certain specified plants. You can elect to

claim an 80% special depreciation allowance

for the adjusted basis of certain specified plants

(defined later) bearing fruits and nuts planted or

grafted after December 31, 2022, and before

January 1, 2024.. For certain specified plants

bearing fruits and nuts planted or grafted after

December 31, 2023, and before January 1,

2025, you can elect to claim a 60% special al-

lowance.

A specified plant is:

•

Any tree or vine that bears fruits 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 subse-

quent 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. Once made, the election 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 during

the tax year. To make the election, attach a

statement to your return indicating the class of

property for which you are making the election.

Generally, you must make the election on a

timely filed tax return (including extensions) for

the year in which you place the property in 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

CAUTION

the amount of the special depreciation allow-

ance previously allowed or allowable. For more

information, see chapter 3 of Pub. 946.

Figuring Depreciation

Under MACRS

MACRS is used to recover the basis of most

business and investment property placed in

service after 1986. MACRS consists of two de-

preciation 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 informa-

tion 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 GDS or ADS to depreciate

property under MACRS determines what depre-

ciation method and recovery period you use.

You must generally use GDS unless you are

specifically required by law to use ADS or you

elect to use ADS.

Required use of ADS. You must use ADS for

the following property.

•

All property used predominantly in a 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.

Note. You must use ADS if you are required

to file Form 8990 and you elect to expense

farming interest expense.

CAUTION

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Chapter 7 Depreciation, Depletion, and Amortization Page 43

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

election must generally 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.

CAUTION

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 util-

ities and pipes attached to it), use one of the fol-

lowing 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

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 equipment

....................................... 7 10

Computer and peripheral equipment ................................. 5 5

Drainage facilities .............................................. 15 20

Farm buildings

................................................ 20 25

New farm machinery and equipment

................................. 5 10

Used farm machinery and equipment ................................. 7 10

Fences (agricultural) ............................................ 7 10

Goats and sheep (breeding) ....................................... 5 5

Grain bin .................................................... 7 10

Hogs (breeding) ............................................... 3 3

Horses (age when placed in service)

Breeding and working (12 years or less) ............................ 7 10

Breeding and working (more than 12 years) .......................... 3 10

Racing horses (more than 2 years) ................................ 3 12

Horticultural structures (single purpose) ............................... 10 15

Logging machinery and equipment

.................................. 5 6

Nonresidential real property ....................................... 39

Office furniture, fixtures, and equipment (not calculators, copiers, or typewriters) ... 7 10

Paved lots ................................................... 15 20

Residential rental property ........................................ 27.5 40

Tractor units (over-the-road) ....................................... 3 4

Trees or vines bearing fruits 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

Not including communication equipment listed in other classes.

Not including single-purpose agricultural or horticultural structures.

Not including grain bin, cotton ginning, asset fence, or other land improvement and the original use

starts with you and placed in service after December 31, 2017.

Used by logging and sawmill operators for cutting of timber.

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 44 Chapter 7 Depreciation, Depletion, and Amortization

systems 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.

For a detailed explanation of each conven-

tion, see Which Convention Applies? in chap-

ter 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 15- and 20-year property

• Farm or Nonfarm 3-, 5-, 7-, and

10-year property

GDS using SL • Nonresidential real property

• Residential rental property

• Trees or vines bearing fruits or

nuts

• All 3-, 5-, 7-, 10-, 15-, and

20-year property

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 property

• Any property for which you

elect to use this method

GDS using

200% DB

• Nonfarm 3-, 5-, 7-, and

10-year property

• Farm 3-, 5-, 7-, and 10-year

property placed in service after

2017

Elective method.

See section 168(g)(6) of the Internal Revenue

Code.

Property used in farming business. For 3-,

5-, 7-, or 10-year property used in a farming

business and placed in service after 2017, the

150% declining balance method is no longer re-

quired. However, for 15- or 20-year property

placed in service in a farming business, you

must use the 150% declining balance method

over a GDS recovery period or you can elect

one of the following methods.

•

The straight line method over a GDS re-

covery period.

•

The straight line method over an ADS re-

covery period.

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 fruits or nuts under GDS us-

ing the straight line method over a 10-year re-

covery period.

ADS required for some farmers. If you elect

not to limit interest expense, you must use ADS

to depreciate any property with a recovery pe-

riod of 10 years or more. See chapter 4 for a

discussion of interest rules. If you elect not to

apply the uniform capitalization rules to any

plant shown in Table 6-1 of chapter 6 and pro-

duced 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 cap-

italization 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. How-

ever, 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 elec-

tion on a property-by-property basis for residen-

tial 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 lon-

ger than the GDS recovery periods. The ADS

recovery periods for many assets used in the

business of farming are listed in Table 7-1. Addi-

tional ADS recovery periods for other classes of

property may be found in the Table of Class

Lives and Recovery Periods in Appendix B of

Pub. 946.

How Is the Depreciation

Deduction Figured?

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 deprecia-

tion 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 different

amount than using the tables.

See Using the MACRS Percentage Tables

and Figuring the Deduction Without Using the

Tables under How is the Depreciation Deduc-

tion Figured in chapter 4 of Pub. 946, for details

on how to figure your depreciation deduction

under MACRS.

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 must gener-

ally 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 involun-

tarily converted. You also generally continue to

use the same depreciation method and

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Chapter 7 Depreciation, Depletion, and Amortization Page 45

convention used for the exchanged or involun-

tarily converted property. This applies only to

acquired property with the same or a shorter re-

covery period and the same or more acceler-

ated depreciation method than the property ex-

changed or involuntarily converted. The excess

basis, if any, of the acquired MACRS property is

treated as newly placed-in-service MACRS

property.

Election out. You can elect not to use the

above rules. The election, if made, applies to

both the acquired property and the exchanged

or involuntarily converted property. If you make

the election, figure depreciation by treating the

carryover basis and excess basis, if any, for the

acquired property as if placed in service the

later of the date you acquired it, or the time of

the disposition of the exchanged or involuntarily

converted property. For depreciation purposes,

the adjusted basis of the exchanged or involun-

tarily converted property is treated as if it were

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 depreciation,

you can group separate assets into one or more

general asset accounts (GAAs). You can then

depreciate all the assets in each account as a

single asset. Each account must include only

assets of the same recovery period, deprecia-

tion 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

of 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.

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.

•

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 electricity.

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 can generally be found on

the driver door post of the vehicle.

Other property used for transportation.

This includes trucks, buses, boats, airplanes,

TIP

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.

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 of 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

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Page 46 Chapter 7 Depreciation, Depletion, and Amortization

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 inter-

est in mineral deposits or standing timber.

•

You have a legal right to income from the

extraction of the mineral or the cutting of

the timber, to which you must look for a 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 must generally use the

method that gives you the larger deduction. For

standing timber, you must use cost depletion.

Cost Depletion

To figure cost depletion, you must first 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. To figure the property's

basis for depletion, subtract all of the following

from the property's adjusted basis.

1. Amounts recoverable through:

a. Depreciation deductions,

b. Deferred expenses (including defer-

red exploration and development

costs), and

c. Deductions other than depletion.

2. The residual value of land and improve-

ments at the end of operations.

3. The cost or value of land acquired for pur-

poses other than mineral production.

Adjusted basis. The adjusted basis of your

property is your original cost or other basis, plus

certain additions and improvements, and minus

certain deductions such as depletion allowed or

allowable and casualty losses. Your adjusted

basis can never be less than zero. See Pub. 551

for more information on adjusted basis.

Total recoverable units. The total recoverable

units is the sum of the following.

•

The number of units of mineral remaining

at the end of the year (including units re-

covered but not sold).

•

The number of units of mineral sold during

the tax year (determined under your

method of accounting, as explained next).

You must estimate or determine recoverable

units (tons, pounds, ounces, barrels, thousands

of cubic feet, or other measure) of mineral prod-

ucts using the current industry method and the

most accurate and reliable information you can

obtain. You must include ores and minerals that

are developed, in sight, blocked out, or assured.

You must also include probable or prospective

ores or minerals that are believed to exist based

on good evidence.

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.

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 cut-

ting 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. You bought a farm that included

standing timber. This year you determined that

the standing timber could produce 300,000

units when cut. At that time, the adjusted basis

of the standing timber was $24,000. You then

cut and sold 27,000 units. (You did not elect to

treat the cutting of the timber as a sale or ex-

change.) your depletion for each unit for the

year is $0.08 ($24,000 ÷ 300,000). Your deduc-

tion for depletion is $2,160 (27,000 × $0.08). If

you had cut 27,000 units but sold only 20,000

units during the year, your depletion for each

unit would have remained at $0.08. However,

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Chapter 7 Depreciation, Depletion, and Amortization Page 47

your depletion deduction would have been

$1,600 (20,000 × $0.08) for this year and you

would have included the balance of $560 (7,000

× $0.08) 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. You can find a complete list of

the percentages 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.

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 startup costs of going

into business, reforestation costs, the costs of

pollution control facilities, and the costs of sec-

tion 197 intangibles. See the Instructions for

Form 4562 for more information on these topics.

Business Startup 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 de-

ductions. However, you generally cannot re-

cover other costs until you sell the business or

otherwise go out of business.

Startup costs are costs for creating an active

trade or business or investigating the creation or

acquisition of an active trade or business.

Startup costs include any amounts paid or

incurred in connection with any activity engaged

in for profit and for the production of income be-

fore the trade or business begins, in anticipation

of the activity becoming an active trade or busi-

ness.

You can elect to currently deduct a limited

amount of business startup 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 startup costs paid or incurred be-

fore October 23, 2004, is 60 months or more.

For startup 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

startup 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.

Reforestation Costs

You can elect to currently deduct a limited

amount of qualifying reforestation costs for each

qualified timber property. See Capital Expenses

in chapter 4. You can elect to amortize over 84

months any amount not deducted. There is no

annual limit on the amount you can elect to am-

ortize. Reforestation costs are the direct costs

of planting or seeding for forestation or refores-

tation.

Qualifying costs. Qualifying costs include

only those costs you must otherwise capitalize

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 1 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 de-

duction in Part VI of Form 4562. Attach a state-

ment 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.

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 amor-

tize 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 section 197 of the Internal Revenue Code

for more information, including a complete list of

assets that are section 197 intangibles and spe-

cial rules.

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Page 48 Chapter 7 Depreciation, Depletion, and Amortization

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 in-

terest income, while net capital gain is generally

taxed at a lower rate. This chapter discusses

dispositions such as sales and exchanges (in-

cluding like-kind exchanges and sales of capital

and noncapital assets); hedging transactions;

sale of livestock; cutting timber; sale of a farm;

and cancellation of debt from foreclosures, re-

possessions, and abandonments.

Topics

This chapter discusses:

•

Sales and exchanges

•

Ordinary or capital gain or loss

Useful Items

You may want to see:

Publication

334 Tax Guide for Small Business

523 Selling Your Home

544 Sales and Other Dispositions of

Assets

550 Investment Income and Expenses

908 Bankruptcy Tax Guide

Form (and Instructions)

982 Reduction of Tax Attributes Due to

Discharge of Indebtedness (and

Section 1082 Basis Adjustment)

Sch D (Form 1040) Capital Gains and

Losses

Sch F (Form 1040) Profit or Loss From

Farming

1099-A Acquisition or Abandonment of

Secured Property

1099-C Cancellation of Debt

4797 Sales of Business Property

8824 Like-Kind Exchanges

8949 Sales and Other Dispositions of

Capital Assets

8960 Net Investment Income

Tax—Individuals, Estates, and Trusts

8995 Qualified Business Income

Deduction Simplified Computation

334

523

544

550

908

982

Sch D (Form 1040)

Sch F (Form 1040)

1099-A

1099-C

4797

8824

8949

8960

8995

8995-A Qualified Business Income

Deduction

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, a note, or other promise to pay

money. An exchange is a transfer of property for

other property or services.

Property sold or exchanged may include the

sale of a portion of a MACRS asset. For details,

see Partial Dispositions of MACRS Property in

chapter 1 of Pub. 544.

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 loss

from the disposition of property held for per-

sonal use is not deductible.

Like-Kind Exchanges

Generally, if you exchange real property you use

in your business or hold for investment solely for

other business or investment real property of a

like kind, you do not recognize the gain or loss

from the exchange. However, if you also receive

8995-A non-like-kind property or money as part of the

exchange, you recognize gain to the extent of

the value of the other property or money you re-

ceived in the exchange. You do not recognize

any losses. In general, your gain or loss will not

be recognized until you sell or otherwise dis-

pose of the property you receive in the ex-

change. See Qualifying property, later, for de-

tails and exceptions.

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, the basis of the property received is

the basis of the property given up, increased by

the money paid.

Example. You own farmland with a barn.

The combined adjusted basis of the properties

is $70,000 and the FMV is $150,000. You are

interested in another tract of farmland, with a

larger barn, worth $200,000. You exchange your

existing property and $50,000 in cash for the

new property. Your basis in the new property is

$120,000 ($70,000 adjusted basis in your old

property plus $50,000 in cash paid).

Reporting the exchange. Report the ex-

change of like-kind property, even though no

gain or loss is recognized, on Form 8824. The

Instructions for Form 8824 explain how to report

the details of the exchange.

If you have any recognized gain because

you received money or unlike property, report it

on Schedule D (Form 1040) or Form 4797,

whichever applies. You may also have to report

the recognized gain as ordinary income be-

cause of depreciation recapture on Form 4797.

See chapter 9 for more information.

Qualifying property. In a like-kind exchange,

both the real property you give up and the real

property you receive must be held by you for

investment or for productive use in your trade or

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Chapter 8 Gains and Losses Page 49

business. The nonrecognition rules for like-kind

exchanges apply only to exchanges of real

property (as defined in Treasury Regulations

section 1.1031(a)-3). The following are exam-

ples of property that may qualify.

•

Land and improvements to land.

•

Unsevered natural products of land.

•

Water and air space super adjacent to

land.

•

An intangible interest in real property in-

cluding fee ownership; co-ownership; a

leasehold; an option to acquire real prop-

erty; an easement; and stock in a coopera-

tive housing corporation.

•

Real property that, on the date it is trans-

ferred in an exchange, is real property un-

der the law of the state or local jurisdiction

in which that property is located.

Nonqualifying property. The rules for

like-kind exchanges do not apply to exchanges

of the following property.

•

Real property used for personal purposes,

such as your home.

•

Real property held primarily for sale.

•

Any personal or intangible property.

You may have a nontaxable exchange under

other rules. See Other Nontaxable Exchanges

in chapter 1 of Pub. 544.

Special rule for stock in a mutual ditch,

reservoir, or irrigation company. For purpo-

ses of real property, stock in a mutual ditch, res-

ervoir, or irrigation company is treated as real

property if both of the following conditions are

met at the time of the trade.

1. The mutual ditch, reservoir, or irrigation

company is an organization described in

section 501(c)(12)(A) of the Internal Reve-

nue Code (determined without regard to

the percentage of its income that is collec-

ted from its members for the purpose of

meeting losses and expenses).

2. The shares in the company have been rec-

ognized by the highest court of the state in

which the company was organized or by

applicable state statute as constituting or

representing real property or an interest in

real property.

Like-kind property. To qualify as a nontaxable

exchange, the properties exchanged must be of

like kind. Like-kind properties are properties of

the same nature or character, even if they differ

in grade or quality. Generally, real property ex-

changed for real property qualifies as an ex-

change of like-kind property. For example, an

exchange of city property for farm property or

improved property for unimproved property is a

like-kind exchange.

Note. Whether you engaged in a like-kind

exchange depends on an analysis of each as-

set involved in the exchange.

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). However,

only $10,000, the cash received, is recognized

gain (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. You have a realized loss of $5,000

($115,000 FMV + $10,000 cash – $130,000 ba-

sis of old farmland = $5,000 loss). However,

your $5,000 loss is not recognized.

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, in a like-kind exchange, you

transfer property subject to debt, the debt trans-

ferred is considered the same as the receipt of

unlike property. For purposes of figuring your re-

alized 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 more informa-

tion, see Partial Nontaxable Exchanges in chap-

ter 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. Under

these rules, if either person disposes of the

property within 2 years after the exchange, the

exchange is disqualified from nonrecognition

treatment. The gain or loss on the original 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, sibling, parent,

child, etc.), you and a corporation in which you

have more than 50% ownership, you and a part-

nership in which you directly or indirectly own

more than a 50% interest of the capital or prof-

its, and two partnerships in which you directly or

indirectly own more than 50% of the capital in-

terests or profits.

For the complete list of related persons, see

Related persons in chapter 2 of Pub. 544.

If you transfer property using a qualified

intermediary involving related persons,

see Multiple-party transactions involv-

ing related persons in chapter 1 of Pub. 544.

CAUTION

Example. You own real property used in

your business. Your sibling owns real property

used in their business. In December 2022, you

exchanged your property plus $15,000 for your

sibling’s property. At that time, the FMV of your

real property was $200,000 and its adjusted ba-

sis was $65,000. The FMV of your sibling’s real

property was $215,000 and its adjusted basis

was $70,000. You realized a gain of $135,000

(the $215,000 FMV of the real property re-

ceived, minus the $15,000 you paid, minus your

$65,000 adjusted basis in the property). Your

sibling realized a gain of $145,000 (the

$200,000 FMV of your real property, plus the

$15,000 you paid, minus their $70,000 adjusted

basis in the property).

However, because this was a like-kind ex-

change and you received no cash or

non-like-kind property in the exchange, you rec-

ognize no gain on the exchange. Your basis in

the real property you received is $80,000 (the

$65,000 adjusted basis of the real property

given up plus the $15,000 you paid). Your sib-

ling recognizes gain only to the extent of the

money they received, $15,000. The basis in the

real property received was $70,000 (the

$70,000 adjusted basis of the real property ex-

changed minus the $15,000 received, plus the

$15,000 gain recognized).

In 2023, you sold the real property you re-

ceived to a third party for $220,000. Because

you sold property you acquired from a related

party (your sibling) within 2 years after the ex-

change with your sibling, that exchange is dis-

qualified from nonrecognition treatment and the

deferred gain must be recognized on your 2023

return. On your 2023 tax return, you must report

your $135,000 gain on the 2022 exchange. You

must also report the gain on the 2023 sale on

your 2023 return. Additionally, for 2023, your

sibling must report a gain of $130,000, which is

the $145,000 gain on the 2022 exchange, mi-

nus the $15,000 recognized in 2022. Your sib-

ling’s adjusted basis in the property is increased

to $200,000 ($70,000 basis plus the $130,000

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.

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Page 50 Chapter 8 Gains and Losses

Deferred exchange. A deferred exchange for

like-kind property may qualify for nonrecognition

of gain or loss. A deferred exchange is an ex-

change in which you transfer property you use

in business or hold for investment and later re-

ceive like-kind property you will use in business

or hold for investment. The property you receive

is replacement property. The transaction must

be an exchange of property for property rather

than a transfer of property for money used to

buy replacement property. In addition, the re-

placement property will not be treated as

like-kind property unless certain identification

and receipt requirements are met.

For more information, see Deferred Ex-

change 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 ap-

plies whether the adjusted basis of the transfer-

red 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 Capital

Gains Tax Rates, later. Your deduction for a net

capital loss may be limited. See Treatment of

Capital Losses, later.

Capital Assets

Almost everything you own and use for personal

purposes, pleasure, or investment is a capital

asset.

The following items are examples of capital

assets.

•

A home owned and occupied by you and

your family.

•

Household furnishings.

•

A car used for pleasure. If your car is used

both for pleasure and for farm business, it

is partly a capital asset and partly a nonca-

pital asset, defined later.

•

Stocks and bonds. However, there are spe-

cial rules for gains on qualified small busi-

ness 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.

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, 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, 2022, you should start counting on June 20,

2022. If you sold the asset on June 19, 2023,

your holding period is not longer than 1 year,

but if you sold it on June 20, 2023, your holding

period is longer than 1 year.

Livestock. See Holding period under Live-

stock, later.

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

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Chapter 8 Gains and Losses Page 51

$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 is less than zero.

If either of these situations applies to you for

2023, 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 2024.

To figure your capital loss carryover

from 2023 to 2024, you will need a

copy of your 2023 Form 1040 or Form

1040-SR and Schedule D (Form 1040).

Capital Gains Tax Rates

The tax rates that apply to a net capital gain are

generally lower than the tax rates that apply to

other income. These lower rates are called the

maximum capital gains rates.

The term “net capital gain” means the

amount by which your net long-term capital gain

for the year is more than your net short-term

capital loss.

See Schedule D (Form 1040) and the In-

structions for Schedule D (Form 1040). Also

see Pub. 550.

Noncapital Assets

Generally, noncapital assets include property

such as inventory and depreciable property

used in a trade or business. A list of properties

that are not capital assets is provided in the In-

structions for Schedule D (Form 1040). Nonca-

pital assets used in farming are discussed be-

low.

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

Hedging transactions are transactions that you

enter into in the normal course of business pri-

marily to manage the risk of interest rate or

TIP

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 much dif-

ferent from a futures contract because its terms

are not standardized and it is not exchange tra-

ded.

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

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

RECORDS

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.

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 10 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 10 De-

cember 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.

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Page 52 Chapter 8 Gains and Losses

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). Re-

port it on Schedule F, Part I, line 2, as income

from sales of products you raised.

Assume you were right and the price went

down 25 cents a bushel. In effect, you would still

net $5.75 a bushel, figured as follows.

Sold cash corn, per bushel

............ $5.50

Gain on hedge, per bushel ............ .25

Net price, per bushel ........... $5.75

The gain on your futures transactions would

have been $11,100, figured as follows.

July 2—Sold December corn futures (50,000

bu. @ $5.75) ...................... $287,500

November 6—Bought December corn

futures (50,000 bu. @ $5.50 plus $1,400

broker's commission) ................

276,400

Futures gain................ $11,100

The $11,100 is reported on Schedule F, Part I,

line 8, as other income.

The proceeds from the sale of your corn at

the local elevator, $275,000 (50,000 bu. x

$5.50), 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 live-

stock used in your farm business. Gain or loss

from the sale or exchange of this livestock may

qualify as a section 1231 gain or loss. However,

any part of the gain that is ordinary income from

the recapture of depreciation is not included as

section 1231 gain. See chapter 9 for more infor-

mation 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-

CAUTION

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 considered to be

used in your farm business. The purpose for

which an animal is held is ordinarily determined

by a farmer's actual use of the animal. An ani-

mal 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, dairy, or sporting

purpose may be present if an animal is dis-

posed of within a reasonable time after it is pre-

vented from its intended use or made undesira-

ble 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

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, but rather you are holding

them primarily for sale to customers. However,

those cattle you held as additions or replace-

ments to your own breeding herd to produce

calves are considered to be held for breeding

purposes, even though they may not actually

have produced calves. The same applies to hog

and sheep breeders.

Example 5. You breed, raise, and train

horses for racing purposes. Every year, you cull

horses from your racing stable. In 2023, 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 2022. 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, 2023, for $1,250. Expenses of the

sale were $125. The cow was bought July 2,

2019, for $1,300. Depreciation (not less than

the amount allowable) was $1,225.

Gross sales price

.................... $1,250

Cost (basis) ................. $1,300

Minus: Depreciation deduction .... 1,225

Unrecovered cost

(adjusted basis) .............. $ 75

Expense of sale .............. 125 200

Gain realized ................ $1,050

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 origi-

nally 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

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Chapter 8 Gains and Losses Page 53

currently classified by the Department of Agri-

culture as Class IV, VI, VII, or VIII under its clas-

sification 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 (if purchased tim-

ber) or line 2 (if raised timber).

Farmers who cut timber on their land and

sell it as logs, firewood, or pulpwood usually

have no cost or other basis for that timber 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 orna-

mental 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 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 remains

in effect for all later years unless you revoke 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.

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 2023, 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, 2023, the timber had

an FMV of $350 per MBF. It was cut in April for

sale. On your 2023 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, 2023

....... $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, later).

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 condi-

tioned 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 enter “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.

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Page 54 Chapter 8 Gains and Losses

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.

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, certain

gains may be eligible to be taxed over the pe-

riod of years the payments are received. See

chapter 10 for information about installment

sales.

When you sell your farm, the gain or loss on

each asset is figured separately. The tax 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 2006. You realize gain on the sale as

follows.

Farm

With Home Without

Home Only Home

Selling price .... $382,000 $158,000 $224,000

Cost (or other

basis) ........

240,000 110,000 130,000

Gain ....... $142,000 $48,000 $94,000

You must report the $94,000 gain from the

sale of the property used in your farm business.

All or a part of that gain may have to be reported

as ordinary income from the recapture of depre-

ciation or soil and water conservation expenses.

Treat the balance as section 1231 gain.

The $48,000 gain from the sale of your

home is not taxable if you meet the 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 dis-

cussion 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

costs, as discussed later under Sale of your

home.

Example. You bought a 200-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 20 acres of land on which you had in-

stalled a fence. Your adjusted basis for the part

of your farm sold is $60,000 (

/10 of $600,000),

plus any unrecovered cost (cost not depreci-

ated) of the fence on the 20 acres at the time of

sale. Use this amount to determine your gain or

loss on the sale of the 20 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

/4 (75%) of

the total assessed valuation. Multiply the

$700,000 total purchase price by 75% to figure

basis of $525,000 for the 200 acres of land. The

unadjusted basis of the 20 acres you sold would

then be $52,500 (

/10 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 de-

termine 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 cannot be

excluded (because it is more than the limit) may

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, later.

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Chapter 8 Gains and Losses Page 55

be postponed under the rules discussed under

Postponing Gain in chapter 11.

Foreclosure or

Repossession

If you do not make payments you owe on a loan

secured by property, the lender may foreclose

on the loan or repossess the property. The 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 FMV of the

property is less than the canceled debt.

Example 1. You paid $200,000 for land

used in your farming business. You paid

$15,000 down and borrowed the remaining

$185,000 from a bank. You are not personally li-

able for the loan (nonrecourse debt), but pledge

the land as security. The bank foreclosed on the

loan 2 years after you stopped making pay-

ments. When the bank foreclosed, the balance

due on the loan was $180,000 and the FMV of

the land was $170,000. The amount you real-

ized on the foreclosure was $180,000, the debt

canceled by the foreclosure. You figure your

gain or loss on Form 4797, Part I, by comparing

the amount realized ($180,000) with your adjus-

ted basis ($200,000). You have a $20,000 de-

ductible 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

you realized on the foreclosure is $180,000, the

debt canceled by the foreclosure. Because your

adjusted basis is $200,000, you have a deducti-

ble loss of $20,000, which you report 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 FMV of the transferred property.

TIP

You are treated as receiving ordinary income

from the canceled debt for the part of the debt

that is more than the FMV. The amount realized

does not include the canceled debt that is your

income from cancellation of debt. See Cancel-

lation of debt, later.

Example 3. Assume the same facts as in

Example 1 earlier, except you are personally lia-

ble for the loan (recourse debt). In this case, the

amount you realize is $170,000. This is the can-

celed debt ($180,000) up to the FMV of the land

($170,000). You figure your gain or loss on the

foreclosure by comparing the amount realized

($170,000) with your adjusted basis ($200,000).

You have a $30,000 deductible loss, which you

figure on Form 4797, Part I. You are also treated

as receiving ordinary income from cancellation

of debt. That income is $10,000 ($180,000 −

$170,000). This is the part of the canceled debt

not included in the amount realized. You report

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

which you are personally liable (recourse debt),

you must generally 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 or Form 1040-SR.

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 is generally

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

TIP

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.

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 on Form 1040 or Form 1040-SR.

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, or federal gov-

ernment agency, or any organization that has a

significant trade or business of lending money.

For foreclosures, repossessions, abandon-

ments of property, and debt cancellations oc-

curring in 2023, these forms should be sent to

you by January 31, 2024.

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Page 56 Chapter 8 Gains and Losses

Dispositions of

Property Used in

Farming

Introduction

When you dispose of property used in your farm

business, your taxable gain or loss is usually

treated as ordinary income or capital gain (un-

der the rules for section 1231 transactions). Or-

dinary income is taxed at the same rate as wa-

ges 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. Similar rules apply to

the sale of property on which soil and water

conservation expenses have been deducted or

government cost-sharing payments have been

received.

Gains and losses from property used in

farming are reported on Form 4797, Sales of

Business Property. Table 9-1 contains examples

of items reported on Form 4797 and refers to

the part of that form on which they should first

be reported.

Topics

This chapter discusses:

•

Section 1231 gains and losses

•

Depreciation recapture

•

Other gains

Useful Items

You may want to see:

Publication

544 Sales and Other Dispositions

of Assets

Form (and Instructions)

4797 Sales of Business Property

See chapter 16 for information about getting

publications and forms.

Section 1231 Gains and

Losses

Section 1231 gains and losses are the taxable

gains and losses from section 1231 transac-

tions (explained below). Their treatment as ordi-

nary income or loss or capital gains depends on

whether you have a net gain or a net loss from

544

4797

all of your section 1231 transactions in the tax

year.

If you have a gain from a section 1231 trans-

action, first determine whether any of the gain is

ordinary income under the depreciation (or

other) recapture rules explained later. Do not

take that gain into account as section 1231

gain. Only gain in excess of the recapture

amount is considered section 1231 gain. See

Treatment as ordinary or capital, later.

Section 1231 transactions. Section 1231

transactions are sales and exchanges of real or

depreciable property used in trade or business

and held the required holding period (based on

type of asset, as discussed below). Gain or loss

on the following transactions is subject to sec-

tion 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 includes 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 in-

clude your farm or ranch (including barns

and sheds).

•

Sale or exchange of unharvested

crops. The crop and land must be sold,

exchanged, or involuntarily converted at

the same time and to the same person,

and the land must have been held longer

than 1 year. You cannot keep any right or

option to reacquire the land directly or 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, is not

considered a section 1231 transaction.

•

Distributive share of partnership gains

and losses. Your distributive share must

be from the sale or exchange of property

listed above and held by the partnership for

longer than 1 year (or for the required pe-

riod for certain livestock). You will receive

Schedule K-1 (Form 1065) showing the ap-

propriate classification of any gains or los-

ses distributed to you.

•

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,

Table 9-1. Where To First Report Certain Items on Form 4797

Type of property

Held 1 year

or less

Held more than

1 year

1 Depreciable trade or business property:

a Sold or exchanged at a gain .................... Part II Part III (1245, 1250)

b Sold or exchanged at a loss .................... Part II Part I

2 Farmland held less than 10 years for which soil or water

expenses were deducted:

a Sold at a gain .............................. Part II Part III (1252)

b Sold at a loss .............................. Part II Part I

3 All other farmland used in a trade or business Part II Part I

4 Disposition of cost-sharing payment property described in

section 126

Part II Part III (1255)

5 Cattle and horses used in a trade or business for draft,

breeding, dairy, or sporting purposes:

Held less

than 24 mos.

Held 24 mos.

or more

a Sold at a gain .............................. Part II Part III (1245)

b Sold at a loss .............................. Part II Part I

c Raised cattle and horses sold at a gain ............ Part II Part I

6 Livestock other than cattle and horses used in a trade or

business for draft, breeding, dairy, or sporting purposes:

Held less

than 12 mos.

Held 12 mos.

or more

a Sold at a gain .............................. Part II Part III (1245)

b Sold at a loss .............................. Part II Part I

c Raised livestock sold at a gain .................. Part II Part I

Real or 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 57

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 the required holding

period. However, if your casualty or theft

losses are more than your casualty or theft

gains, the net casualty or theft loss is fully

deductible and is not combined with other

section 1231 transactions in the section

1231 computation. Section 1231 does not

apply to personal casualty gains and los-

ses. See chapter 11 for information on how

to treat those gains and losses.

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.

Treatment as ordinary or capital. To deter-

mine the treatment of section 1231 gains and

losses, combine all of your section 1231 gains

and losses for the year.

•

If you have a net section 1231 loss, it is an

ordinary loss.

•

If you have a net section 1231 gain, it is 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. Therefore, if in any of your 5

preceding tax years you had section 1231 los-

ses, a net gain for the current year from the sale

of section 1231 assets is ordinary gain to the

extent of your prior losses. These losses are ap-

plied against your net section 1231 gain begin-

ning with the earliest loss in the 5-year period.

Example. In 2023, you have a $20,000 net

section 1231 gain. To figure how much you have

to report as ordinary income and long-term cap-

ital gain, you must first determine your section

1231 gains and losses from the previous 5-year

period. From 2018 through 2022, you had the

following section 1231 gains and losses.

Year

Amount

2018 -0-

2019 -0-

2020 ($25,000)

2021 -0-

2022 $18,000

You used this information to figure how to re-

port your net section 1231 gain for 2023 as

shown below.

CAUTION

1. Net section 1231 gain (2023) ..... $20,000

2. Net section 1231 loss

(2020) .............. ($25,000)

3. Net section 1231 gain

(2022) ..............

$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

Your remaining net section 1231 loss from

2020 is completely recaptured in 2023.

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 (currently

$2,500 or less), then upon its sale or disposi-

tion, this property is not treated as a capital as-

set or as property used in the trade or business

under section 1231. Generally, any gain on the

disposition of this property is treated as ordinary

income reported on Part II of Form 4797.

Depreciation Recapture

If you dispose of depreciable property (section

1245 or section 1250 property) 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. Any remaining gain is

section 1231 gain (discussed earlier).

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

of depreciation allowed or allowable. Any recog-

nized gain that is more than the part that is ordi-

nary income is a section 1231 gain.

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, later.

RECORDS

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 each

of its parts is essentially interchangeable, and

each of its parts is indistinguishable from an-

other part.

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Page 58 Chapter 9 Dispositions of Property Used in Farming

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 chapter 3 of Pub. 544 for more information

on dispositions of section 1245 property.

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 an applicable like-kind ex-

change or involuntary conversion. For de-

tails on exchanges of property that are not

taxable, see Like-Kind Exchanges in chap-

ter 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).

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. The section 179 expense deduction (see

chapter 7).

3. Any special depreciation allowance.

4. Amortization deductions for any of the fol-

lowing 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 2021, you bought

and placed in service for 100% use in your

farming business a light-duty truck (5-year prop-

erty) that cost $30,000. You used the half-year

convention and your MACRS deductions for the

truck were $6,000 in 2021 and $9,600 in 2022.

You did not claim the section 179 expense de-

duction for the truck. You sold it in May 2023 for

$21,000. The MACRS deduction in 2023, the

year of sale, is $2,880 (

/2 of $5,760). Figure the

gain treated as ordinary income as follows.

1. Amount realized .................. $21,000

2. Cost (February 2021) ....... $30,000

3. Depreciation allowed or

allowable (MACRS deductions:

$6,000 + $9,600 + $2,880) ...

18,480

4. Adjusted basis (subtract line 3

from line 2) .....................

$11,520

5. Gain realized (subtract line 4

from line 1) ..................... $9,480

6. Gain treated as ordinary income

(lesser of line 3 or line 5) ........

$9,480

Depreciation allowed or allowable. You gen-

erally 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 deductions in prior years for depre-

ciation, your adjustments to basis for deprecia-

tion allowable are figured by using the straight

line method. This treatment applies only when

figuring what part of the gain is treated as ordi-

nary income under the rules for section 1245

depreciation recapture. For more information on

depreciation allowed or allowable, see chap-

ter 7. For information on adjustments to basis

for depreciation allowed or allowable, see chap-

ter 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 capi-

talized if you had not made the election by treat-

ing the gain, up to the amount of these expen-

ses, 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. You sold your apple orchard in

2023 for $80,000. Your adjusted basis at the

time of sale was $60,000. You bought the or-

chard in 2016, but the trees did not produce a

crop until 2019. Your pre-productive expenses

were $6,000. You elected not to use the uniform

capitalization rules. You must treat $6,000 of the

gain as ordinary income in addition to recaptur-

ing depreciation allowed or allowable on the or-

chard. This amount would be reported on Form

4797, Part III, as ordinary income.

See Uniform Capitalization Rules in

chapter 6 for more information regard-

ing electing out of, or being exempt

from, using the uniform capitalization rules.

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.

CAUTION

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Chapter 9 Dispositions of Property Used in Farming Page 59

Other Dispositions

See chapter 3 of Pub. 544 for the tax treatment

of the following transfers of depreciable prop-

erty.

•

By gift.

•

At death.

•

In like-kind exchanges.

•

In involuntary conversions.

Also, see Pub. 544 for information on 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 prop-

erty).

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 follow-

ing transactions as gain on section 1252 prop-

erty.

•

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 fair market value for all other

dispositions).

•

The total deductions allowed for soil and

water conservation expenses multiplied by

the applicable percentage, discussed next.

Applicable percentage. The applicable

percentage is based on the length of time you

held the land. If you dispose of your farmland

within 5 years after the date you acquired it, the

percentage is 100%. If you dispose of the land

within the 6th through 9th years 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, 2015. You incurred $15,000 of soil and

water conservation expenditures for the land

that were fully deductible. On October 5, 2023,

you sold the land at a $30,000 gain. The appli-

cable percentage is 40% because 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.

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, and

•

Installment sale of a farm.

Useful Items

You may want to see:

Publication

523 Selling Your Home

537 Installment Sales

538 Accounting Periods and Methods

544 Sales and Other Dispositions of

Assets

551 Basis of Assets

Form (and Instructions)

4797 Sales of Business Property

6252 Installment Sale Income

8594 Asset Acquisition Statement Under

Section 1060

8949 Sales and Other Dispositions of

Capital Assets

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.

Note. You may be required to report the

sale of your farm on Form 8594. For more infor-

mation, see Form 8594 and its instructions.

The tax treatment of the gain or loss on the

sale of each class of asset 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.

523

537

538

544

551

4797

6252

8594

8949

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Page 60 Chapter 10 Installment Sales

If you report the sale of property on the

installment method, any depreciation

recapture under section 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 depreciable prop-

erty to a related person and the sale is an in-

stallment sale, you may not be able to report the

sale using the installment method. If you sell

property to a related person and the related per-

son disposes of the property before you receive

all payments with respect to the sale, you may

have to treat the amount realized by the related

person as received by you when the related

person disposes of the property. The definition

of related parties differs based on which of

these applies. For more information, see Rela-

ted Person under Sale to a Related Person in

Pub. 537.

Installment Method

An installment sale is a sale of property where

you receive at least one payment after the tax

year of the sale. A farmer who isn’t required to

maintain an inventory can use the installment

method to report gain from the sale of property

used or produced in farming. See Inventory,

later, for information on the sale of farm property

where inventory items are included in the as-

sets 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 along

with Schedule D (Form 1040), Capital Gains

and Losses. For more information, see Form

8949 and its instructions.

When to elect out. Make this election by

the due date, including extensions, for filing

your tax return for the year the sale takes place.

However, if you timely file your tax return for

the year the sale takes place without making the

election, you can still make the election by filing

an amended return within 6 months of the due

date of the return (excluding extensions). Enter

“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. If you electronically filed your Form 1040

or 1040-SR, you may electronically file the Form

1040-X.

Revoking the election. Once made, the

election can be revoked only with IRS approval.

An approved revocation is retroactive.

CAUTION

The taxpayer can’t revoke the election if ei-

ther 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 2023, go

to IRS.gov/irb/2023-1_IRB#RP-2023-1.

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 2023-1. A schedule of the current

user fees is available in Appendix A of Revenue

Procedure 2023-1, starting on page 85.

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 in-

stallment 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 under

Sale of a Business in Pub. 537 for more infor-

mation.

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

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 generally isn’t 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 (OID). See Unstated interest, later.

You must continue to report the interest

income on payments you receive in

subsequent years as interest income

whether it’s 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.

•

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’re to receive.

•

The fair market value (FMV) of any

property you’re to receive (FMV is

discussed under Property used as a

payment, later).

•

Any existing mortgage or other debt

the buyer pays, assumes, or takes the

property subject to (a note, a 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 OID in the

selling price.

2. Adjusted basis. Your adjusted basis in

property immediately before the install-

ment sale is your original basis increased

or reduced as a result of various events

while you own the property.

•

Some events, such as adding rooms

or making permanent improvements,

increase basis. Others, such as de-

ductible casualty losses or deprecia-

tion previously allowed or allowable,

decrease basis.

•

The way you figure your original basis

depends on how you acquire the

property. The basis of property you

buy is generally its cost. The basis of

property you inherit, receive as a gift,

build yourself, or receive in a tax-free

exchange is figured differently. See

chapter 6 and Pub. 551 for more in-

formation.

•

Generally, your adjusted basis in

raised farm products, such as grain or

market livestock, is zero.

3. Selling expenses. Selling expenses re-

late to the sale of the property. Review the

CAUTION

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Chapter 10 Installment Sales Page 61

closing statement for fees, which may

qualify as selling expenses. These may in-

clude appraisal fees, attorney fees, closing

fees, document preparation fees, escrow

fees, mortgage satisfaction fees, notary

fees, points paid by the seller to obtain fi-

nancing 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,

and

•

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 report on the installment method.

•

To figure your gross profit, subtract

your adjusted basis for installment

sale purposes from the selling price.

•

If the property you sold was your

home, subtract from the gross profit

any gain you can exclude. See Pub.

523 for more information.

7. Contract price. Contract price equals:

•

The selling price, minus

•

The amount of any mortgages, debts,

and other liabilities assumed or taken

by the buyer, plus

•

The amount, if any, by which the

mortgages, debts, and other liabilities

assumed or taken by the buyer ex-

ceed your adjusted basis for install-

ment sale purposes.

8. Gross profit percentage. A certain per-

centage of each payment (after subtract-

ing interest) is reported as installment sale

income. This percentage is called the

gross profit percentage and is figured by

dividing your gross profit from the sale by

the contract price.

•

The gross profit percentage generally

remains the same for each payment

you receive. However, see Example

under Selling price reduced, later, for

a situation where the gross profit per-

centage 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.

Selling price reduced. If the selling price

is reduced at a later date, the gross profit on the

sale will also change. You must then refigure the

gross profit percentage for the remaining pay-

ments. Refigure your gross profit using Work-

sheet 10-2. You will spread any remaining gain

over future installments.

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.

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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Page 62 Chapter 10 Installment Sales

Example. In 2021, 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 4

years, beginning in January 2022. Your gross

profit percentage was 60%. You received the

down payment of $20,000 in 2021 and total

payments of $23,436 in 2022, 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 2021 and $10,605 ($17,675 x 60% (0.60)) in

2022.

In January 2023, you and the buyer agreed

to reduce the purchase price to $85,000; and

payments during 2023, 2024, and 2025 are re-

duced to $1,483 a month amortized over the re-

maining 3 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 2023, $7,449

(47.32% of $15,742) in 2024, and $8,067

(47.32% of $17,048) in 2025.

Form 6252. Use Form 6252 to report an install-

ment sale in the year it takes place and to report

payments received, or considered received be-

cause of related party resales, in later years. At-

tach it to your tax return for each year.

Disposition of Installment

Obligation

A disposition generally includes a sale, ex-

change, cancellation, bequest, distribution, or

transmission of an installment obligation. An in-

stallment obligation is the buyer’s note, deed of

trust, or other evidence that the buyer will make

future payments to you.

If you’re using the installment method and

you dispose of the installment obligation, you

will generally have a gain or loss to report. It’s

considered gain or loss on the sale of the prop-

erty for which you received the installment obli-

gation.

Cancellation. If an installment obligation is

canceled or otherwise becomes unenforceable,

it’s treated as a disposition other than a sale or

exchange. Your gain or loss is the difference be-

tween your basis in the obligation and its FMV

at the time you cancel it. If the parties are rela-

ted, 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 transferred

to the buyer because of the death of the holder

of the obligation, it’s a disposition. The estate

must figure its gain or loss on the disposition. If

the holder and the buyer were related, the FMV

of the installment obligation is considered to be

no less than its full face value.

More information. For more information,

see Disposition of an Installment Obligation in

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 In-

stallment 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 installment

method.

The recapture income reported in the year of

sale is included in your installment sale basis to

determine your gross profit on the installment

sale.

Figure your depreciation recapture income

(including the section 179 deduction and the

section 179A deduction recapture) in Part III of

Form 4797. As instructed on the form, transfer

the depreciation recapture income to Part II of

Form 4797 as ordinary income in the year of

sale.

If you sell depreciable business prop-

erty, prepare Form 4797 first in order to

figure the amount to enter on Form

6252, Part I, line 12. See the Form 6252 instruc-

tions for details.

For more information on the section 179 de-

duction, see Section 179 Expense Deduction in

chapter 7. For more information on depreciation

recapture, see Depreciation Recapture in chap-

ter 9.

TIP

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’re 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 assumption

of your debt is treated as a recovery of basis,

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’s 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’s 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 $19,000. 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’re 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

will always be 100%.

TIP

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Chapter 10 Installment Sales Page 63

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 installment

sale basis is $10,000 ($60,000 − $50,000). This

amount is included in the contract 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’s

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’re selling, such as a mort-

gage, a 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’s 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’s

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 OID or, if there is no OID, the sta-

ted redemption price at maturity appropri-

ately discounted to reflect total unstated in-

terest. See Unstated 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.

Fair market value (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 reasonable knowledge of all the nec-

essary 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’re 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 considered

payments on the sale. The excess of the note’s

face value over its FMV is interest. Exclude this

interest in determining the selling price of the

property. However, see Exception under Prop-

erty 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.

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’re considered to have received pay-

ment equal to the bond’s FMV. However, see

Exception under Property used as a payment,

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 received.

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 real property

solely for other business or investment real

property of a like kind, you can postpone report-

ing the gain from the trade. These trades are

known as like-kind exchanges. The property

you receive in a like-kind exchange is treated as

if it were a continuation of the property you gave

up. A trade isn’t a like-kind exchange if the prop-

erty you trade or the property you receive is

property you hold primarily for sale to custom-

ers. See Like-Kind Exchanges 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, section 483

provides that part of the stated principal amount

of the contract may be recharacterized as inter-

est. 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,

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Page 64 Chapter 10 Installment Sales

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/

Guidance.

More information. For more information,

see Unstated Interest and Original Issue Dis-

count (OID) in Pub. 537.

Example

On January 3, 2023, you sold your farm, includ-

ing the home, farmland, 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 farmland.

The total selling price was $300,000. The note

payments of $25,000 each, plus adequate inter-

est, are due every July 1 and January 1, begin-

ning in July 2023. 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

Basis Claimed Basis

Home* $33,743 $0 $33,743

Farmland 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 install-

ment sale purposes, prorate the selling expense

based on the relative FMV of each asset and

add it to the adjusted basis (see above).

Selling

Expense

Adjusted

Basis

Adjusted

Basis for

Installment

Sale

Home* $3,000 $33,743 $36,743

Farmland 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 may be specific

rules for depreciation recapture of buildings

(1250 property) using the straight-line method.

See chapter 9 for more information on deprecia-

tion 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 Instruc-

tions for Schedule D (Form 1040). As payments

are received on the installment sale, unrecog-

nized 1250 gain must be recognized before any

section 1231 gain is recognized. See chapter 3

of Pub. 544 for more information on section

1250 assets.

Gross profit. The following table shows each

asset reported on the installment method, its

selling price, adjusted basis for installment sale,

gain, and gross profit.

Selling Adjusted Gross

Price Basis Gain Profit

Home $60,000 $36,743 $23,257 $0

Farmland 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 ($23,257) is

excluded from your income because it qualifies

for the exclusion of gain from the sale of a prin-

cipal residence. Therefore, don’t include that

gain when you figure your gross profit percent-

age.

Section 1231 gains. The gain on the farmland

and buildings is reported as section 1231 gains.

See Section 1231 Gains and Losses in chap-

ter 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

Farmland ($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 2023 is $75,000 ($50,000 down payment +

$25,000 payment on July 1). The installment

sale part of the total payments received in 2023

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

Farmland (33.256% × $75,000) 24,942

Buildings (14.448% × $75,000) 10,836

Total installment income for 2023

$35,778

Reporting the sale. Report the installment

sale on three separate Forms 6252. One form

should be filed for each component of the sale.

Then, report the amounts from Form 6252 on

Form 4797 and Schedule D (Form 1040). At-

tach a separate page to each Form 6252 that

shows the computations in the example.

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

farmland 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 2023.

You figure installment income for the years after

2023 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

Farmland (33.256% × $50,000) 16,628

Buildings (14.448% × $50,000) 7,224

Total installment income $23,852

In this example, no gain is ever 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.

Note. Refer to Pub. 523 to determine

whether or not the sale of the personal resi-

dence will result in a taxable event.

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 2023 (year of sale) $35,778

Gain reported in 2024:

$50,000 × 47.704% 23,852

Gain reported in 2025:

$50,000 × 47.704% 23,852

Gain reported in 2026:

$50,000 × 47.704% 23,852

Gain reported in 2027:

$25,000 × 47.704% 11,926

Total gain reported $119,260

TIP

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Chapter 10 Installment Sales Page 65

11.

Casualties,

Thefts, and

Condemnations

Reminder

Special rules for qualified disaster 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.

See Disaster Area Losses, later, and Pub.

547, Casualties, Disasters, and Thefts, for more

information on the special relief. Also, see

IRS.gov/DisasterTaxRelief for more information.

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 casu-

alty, 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

523 Selling Your Home

525 Taxable and Nontaxable Income

536 Net Operating Losses (NOLs) for

Individuals, Estates, and Trusts

542 Corporations

544 Sales and Other Dispositions of

Assets

547 Casualties, Disasters, and Thefts

584 Casualty, Disaster, and Theft Loss

Workbook (Personal-Use Property)

584-B Business Casualty, Disaster, and

Theft Loss Workbook

976 Disaster Relief

Form (and Instructions)

Sch A (Form 1040) Itemized

Deductions

Sch D (Form 1040) Capital Gains and

Losses

Sch F (Form 1040) Profit or Loss From

Farming

4684 Casualties and Thefts

4797 Sales of Business Property

See chapter 16 for information about getting

publications and forms.

Casualties and Thefts

For tax years 2018 through 2025, per-

sonal casualty and theft losses of an in-

dividual are deductible only to the ex-

tent they're attributable to a federally declared

disaster. An exception to the rule limiting the de-

duction for personal casualty and theft losses to

federal disaster losses applies where you have

personal casualty gains to the extent the losses

don't exceed your gains.

If your property is destroyed, damaged, or

stolen, 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.

523

525

536

542

544

547

584

584-B

976

Sch A (Form 1040)

Sch D (Form 1040)

Sch F (Form 1040)

4684

4797

CAUTION

•

Car, truck, or farm equipment accidents not

resulting from your willful act or willful negli-

gence.

•

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.

Note. For tax years 2018 through 2025, if

you are an individual and you have a loss of

personal-use property caused by one the

events listed above, or other casualties or

thefts, this loss is deductible only if it is attributa-

ble to a federally declared disaster. See Pub.

547 for more information.

Example. The event causing you to suffer a

personal casualty loss occurred before January

1, 2018, but the casualty loss was not sustained

until January 1, 2018, or later. If this loss was

not attributed to a federally declared disaster, it

is not deductible.

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 completely

girdled and died. Because the damage wasn't

unexpected or unusual, the loss isn't deducti-

ble.

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 con-

ditions or disease may cause another type of in-

voluntary conversion. See Other Involuntary

Conversions, later.

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Page 66 Chapter 11 Casualties, Thefts, and Condemnations

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.

•

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 may be

able to deduct it as a capital loss on Schedule D

(Form 1040) if the stock is sold or exchanged or

becomes completely worthless. You report a

capital loss on Schedule D (Form 1040). For

more information about stock sales, worthless

stock, and capital losses, see chapter 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.

Farm Property 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, you may have a reportable

gain. If you use the proceeds to buy qualified re-

placement property, you can postpone reporting

the gain. See Timber loss in the section 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 following steps to figure your casualty

loss.

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.

Personal-use property. For tax years 2018

through 2025, personal casualty and theft los-

ses of an individual are deductible only to the

extent they're attributable to a federally declared

disaster. An exception to the rule limiting the de-

duction for personal casualty and theft losses to

federal disaster losses applies where you have

personal casualty gains to the extent the losses

don't exceed your gains.

Personal-use property is property used by

you or your family members for personal purpo-

ses and not used in your farm business or for in-

come-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 prop-

erty by taking the following steps.

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 stolen

or damaged personal-use property and

figure your loss. It includes schedules

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

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Chapter 11 Casualties, Thefts, and Condemnations Page 67

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 and certain safe harbor methods, can be

used to establish 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

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.

Safe harbor methods for individual tax-

payers to determine casualty and theft los-

ses. Revenue Procedure 2018-08, 2018-2

I.R.B. 286, available at IRS.gov/IRB/

2018-02_IRB#RP-2018-08, provides safe har-

bor methods that you may use to figure the

amount of your casualty and theft losses of your

personal-use residential real property and per-

sonal belongings. If you qualify for and use a

safe harbor method described in Revenue Pro-

cedure 2018-08, the IRS won't challenge your

determination. The use of a safe harbor method

described in Revenue Procedure 2018-08 isn't

mandatory. For more information about this safe

harbor method, see Pub. 547.

Related expenses. The incidental expen-

ses due to a casualty or theft, such as expenses

for the treatment of personal injuries, temporary

housing, or a rental car, aren't part of your casu-

alty or theft loss. However, they may be deducti-

ble 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 prop-

erty, you must figure your loss separately for

each item of property. Then, combine the losses

to determine your total loss.

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 personal-use

real property, the entire property (including 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.

Example. You bought a farm in 2000 for

$300,000. The adjusted basis of the residential

part is now $64,000. In 2023, a tornado, which

was a federally declared disaster, 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 im-

mediately before the tornado was $120,000,

and $112,500 immediately after the tornado.

The trees weren’t covered by insurance. Your

adjusted gross income (AGI) for 2023 is

$55,000.

Adjusted basis ................ $64,000

2) FMV before the tornado .......... $120,000

3) FMV after the tornado ............ 112,500

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 the $7,500

amount by the applicable limit or limits. As this loss is not

a qualified disaster loss, the applicable limits would

be $100 and 10% of your AGI. Because this loss is not

attributed to a qualified disaster, your deductible loss

would be figured as follows.

8) Subtract $100 ................. 100

9) Loss after $100 rule ............. $7,400

10) Subtract 10% of $55,000 AGI ...... 5,500

11) Casualty loss deduction ...... $1,900

You never replaced the trees. Your adjusted

basis in the residential part of your property af-

ter the casualty is $62,100 ($64,000 - $1,900).

Insurance and other reimbursements. If you

receive an insurance or other type of reimburse-

ment, you must subtract the reimbursement

when you figure your business or personal loss.

You don't have a casualty or theft loss to the ex-

tent you are reimbursed.

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.

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 reimbursement.

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 origi-

nal deduction didn't reduce your tax for the ear-

lier 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.

CAUTION

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Page 68 Chapter 11 Casualties, Thefts, and Condemnations

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 FMV of each asset at the time of the loss.

Figure the gain or loss separately for each asset

that has a separate basis.

Disaster assistance. Food, medical sup-

plies, and other forms of assistance you receive

don't reduce your casualty loss, unless they are

replacements for lost or destroyed property. Ex-

cludable cash gifts you receive also do not re-

duce your casualty loss if there are no restric-

tions 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, un-

der Disaster Area Losses.

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).

Deduction Limits on Losses

of Personal-Use Property

Casualty and theft losses of personal-use prop-

erty may be deducted using Form 4684. For

more information see the Instructions for Form

CAUTION

4684. This deduction will be entered on Sched-

ule A (Form 1040) as an itemized deduction but

you can increase your standard deduction by

qualified disaster losses if you elect not to item-

ize your deductions. See Increased standard

deduction reporting, later.

For tax years 2018 through 2025, casualty

and theft losses of personal-use property are

deductible only to the extent they're attributable

to a federally declared disaster.

An exception to the rule above, limiting the

personal casualty and theft loss deduction to

losses attributable to a federally declared disas-

ter, applies if you have personal casualty gains

for the tax year. In this case, you may reduce

your personal casualty gains by any casualty

losses not attributable to a federally declared

disaster. Any excess gain is used to reduce los-

ses from a federally declared disaster.

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 AGI. Apply this rule af-

ter you reduce each loss by $100. AGI is repor-

ted on line 11 of Form 1040 or 1040-SR.

Example. In June, you discovered that your

house had been burglarized. Your loss after in-

surance reimbursement was $2,000. Your AGI

for the year you discovered the burglary is

$57,000. Figure your theft loss deduction as fol-

lows:

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 AGI ($5,700).

Please note this theft loss was not at-

tributed to a major disaster declared by

the President under section 401 of the

Stafford Act and therefore would not be a de-

ductible loss.

If you have personal casualty losses

that were attributable to a major disas-

ter declared by the President under

section 401 of the Stafford Act, your net casu-

alty loss from this qualified disaster doesn’t

have to exceed 10% of your AGI to qualify for

the deduction. However, this disaster must meet

the following requirements:

•

It must have been declared by the Presi-

dent during the period between January 1,

2020, and February 25, 2021.

•

It must have an incident period that began

on or after December 28, 2019, or on or

before December 27, 2020, and ended no

later than January 25, 2021.

CAUTION

Also, the $100 limit per casualty is increased to

$500. For more information, see the Instructions

for Form 4684.

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 can generally deduct theft los-

ses that aren't reimbursable only in the year you

discover your property was stolen.

Example. In November 2022, engine parts

were stolen from Frank’s stored tractor. Frank

didn’t know that the theft occurred until March

2023, when he attempted to start the tractor.

Any theft loss to which Frank is entitled as a de-

duction will be deductible in the 2023 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 won’t 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-

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 deter-

mined when a claim for recovery is settled, ad-

judicated, 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

2022. The loss wasn’t insured. First Implement

billed Robert for the FMV of the tractor on the

date of the loss. Robert disagreed with the bill

and refused to pay it. First Implement later filed

suit in court against Robert. In 2023, 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 2023. He can claim the $20,000 as a loss

on his 2023 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. See Pub. 536 for more informa-

tion.

Generally, an NOL arising in a tax year

beginning in 2018 or later may not be

carried back and instead must be car-

ried forward indefinitely. However, farming los-

ses arising in tax years beginning in 2018 or

later may be carried back two years and carried

forward indefinitely.

CAUTION

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Chapter 11 Casualties, Thefts, and Condemnations Page 69

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.

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 property

is smaller than the adjusted basis of your prop-

erty, 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 expenses

to collect the insurance is more than your adjus-

ted basis in the barn, so you have a gain.

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 Postponing

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 prop-

erty, you may be able to postpone reporting the

excess gain. See Postponing Gain, later. (You

can't deduct a loss from the condemnation 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 Farm Property 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 capi-

talized 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.

TIP

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Page 70 Chapter 11 Casualties, Thefts, and Condemnations

You must generally 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 an

amount at least equal to the reimbursement to

restore the property.

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. For more information about post-

poning gain on the replacement of damaged

property, see Code section 1033.

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 re-

ceived $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

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 doesn’t apply if the re-

lated person acquired the property from an un-

related person within the period of time allowed

for replacing the involuntarily converted prop-

erty.

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 informa-

tion 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 re-

placement 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 acquire

the replacement property. If you spend the

money you receive for other purposes, and bor-

row money to buy replacement property, you

can still choose to postpone reporting the gain if

you meet the other requirements. Property you

acquire by gift or inheritance doesn’t 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

doesn’t qualify. Neither does a draft animal that

replaces 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 farming pur-

poses 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 Dis-

aster Area Losses in Pub. 547.

Substituting replacement property. Once

you have acquired qualified replacement prop-

erty and have designated it as replacement

property in a statement attached to your tax re-

turn, you can't substitute other qualified replace-

ment property. This is true even if you acquire

the other property within the replacement pe-

riod. However, if you discover that the original

replacement property wasn’t 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. Amounts

paid for replacement property that exceed the

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Chapter 11 Casualties, Thefts, and Condemnations Page 71

amount of the gain postponed can be depreci-

ated.

Example. In 2023, 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 the additional 25

cows are $31,250. Because of the severe

drought, it isn’t feasible for you to use these pro-

ceeds to buy replacement cows. Instead, you

use the proceeds to buy a hay baler for

$40,000. You choose to postpone reporting the

$31,250 gain ($31,250 – $0) from the sale of the

cows. Therefore, the basis of the hay baler is

$8,750 ($40,000 – $31,250).

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 taxpayer.

Farm equipment that cost $2,200 was stolen

from your farm. You discovered the theft when

you returned to your farm on November 11,

2022. Your insurance company investigated the

theft and didn’t settle your claim until January 3,

2023, when they paid you $3,000. You first real-

ized a gain from the reimbursement for the theft

during 2023, so you have until December 31,

2025, 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.

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 replace-

ment 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 severe drought was reported during the 12

months ending August 31, 2023, see Notice

2023–67, 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 reason-

able 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 post-

poned 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 property

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 replacement

property in one year and part in another year,

you must attach a statement to each year's

return. Include in the statement detailed infor-

mation 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 1040-X) 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

Personal casualty and theft losses of an individ-

ual are subject to special rules for those per-

sonal casualty and theft losses attributable to

federally declared disasters that occur during

tax years beginning after 2017.

Personal casualty and theft losses are sub-

ject to the $100 per casualty and 10% of your

AGI limitations. In this case you reduce your

personal casualty gains by any casualty losses

not attributable to a federally declared disaster.

Net qualified disaster losses (disaster losses

reduced by any excess personal casualty gains)

are subject to the $500 per casualty limitation

but are not subject to the 10% of your AGI limi-

tation.

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Page 72 Chapter 11 Casualties, Thefts, and Condemnations

For tax years 2018 through 2025, per-

sonal casualty and theft losses of an in-

dividual are deductible only to the ex-

tent they're attributable to a federally declared

disaster. An exception to the rule limiting the de-

duction for personal casualty and theft losses to

federal disaster losses applies where you have

personal casualty gains to the extent the losses

don't exceed your gains.

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.

Qualified disaster losses. A qualified dis-

aster loss is an individual's casualty or theft loss

of personal-use property that is attributable to a

major disaster that was declared by the Presi-

dent during the period between January 1,

2020, and February 25, 2021. However, in order

to qualify, this disaster must have an incident

period that began on or after December 28,

2019, or on or before December 27, 2020, and

must have ended no later than January 26,

2021. The definition of a qualified disaster loss

does not extend to any major disaster which

has been declared only by reason of COVID-19.

A qualified disaster loss also includes an in-

dividual’s casualty or theft loss of personal-use

property that is attributable to:

•

A major disaster declared by the President

under section 401 of the Stafford Act in

2016;

•

Hurricane Harvey;

•

Tropical Storm Harvey;

•

Hurricane Irma;

•

Hurricane Maria;

•

The California wildfires in 2017 and Janu-

ary 2018; and

•

A major disaster that was declared by the

President under section 401 of the Stafford

Act and that occurred in 2018 and before

December 21, 2019, and continued until

no later than January 19, 2020 (except

those attributable to the California wildfires

in January 2018 that received prior relief).

See IRS.gov/DisasterTaxRelief for date-spe-

cific declarations associated with these disas-

ters and for more information.

Casualty and theft losses of personal-use

property may be claimed as a qualified disaster

loss on your Form 4684 for the year in which the

loss was sustained. This deduction will be en-

tered on Schedule A (Form 1040) as an item-

ized deduction but you can increase your stand-

ard deduction by qualified disaster losses if you

elect not to itemize your deductions. See In-

creased standard deduction reporting, later.

Moreover, your net casualty loss from these

disasters does not need to exceed 10% of your

AGI to qualify for the deduction, but the $100

limit per casualty is increased to $500.

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 disaster occur-

red. A disaster loss may also be sustained in a

year after the disaster occurred. For example, if

a claim for reimbursement exists for which there

is a reasonable prospect of recovery, no part of

the loss for which reimbursement may be re-

CAUTION

TIP

ceived is sustained until it can be ascertained

with reasonable certainty whether you will be

reimbursed.

When to deduct the loss. You must generally

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 an election to deduct a 2023

disaster loss on your 2022 return on or before

the date that is 6 months after the regular due

date for filing your original return (without exten-

sions) for the disaster year. For calendar year

individual taxpayers, the deadline for electing to

take a 2023 disaster loss on your 2022 tax re-

turn is October 15, 2024.

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. For more in-

formation, see Pub. 547.

Increased standard deduction reporting. If

you have a net qualified disaster loss on Form

4684, line 15, and you aren’t itemizing your de-

ductions, you can claim an increased standard

deduction using Schedule A (Form 1040) by do-

ing the following.

1. Enter the amount from Form 4684, line 15,

on the dotted line next to line 16 on Sched-

ule A and the description “Net Qualified

Disaster Loss.”

2. Enter on the dotted line next to line 16 your

standard deduction amount and the de-

scription “Standard Deduction Claimed

With Qualified Disaster Loss.”

3. Combine these two amounts and enter on

line 16 of Schedule A and Form 1040 or

1040-SR, line 12.

The AMT adjustment for the standard

deduction is made retroactively inappli-

cable to net qualified disaster losses.

See Taxpayers who also file the 2023 Form

6251, Alternative Minimum Tax for Individuals,

in the Instructions for Form 4684 for more infor-

mation.

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

are specifically reimbursed by these disaster re-

lief grants. If the casualty loss was specifically

TIP

CAUTION

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 oth-

erwise compensated for by insurance or other

reimbursement. These payments aren't subject

to income tax, self-employment tax, or employ-

ment taxes (social security, Medicare, and fed-

eral unemployment taxes). No withholding ap-

plies 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) aren’t included in income. These are pay-

ments you, as a property owner, received to re-

duce the risk of future damage to your property.

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-

alty, as discussed earlier.) However, if you sell

or otherwise transfer property to the federal

government, a state or local government, or an

CAUTION

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Chapter 11 Casualties, Thefts, and Condemnations Page 73

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.

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, excise,

and employment tax returns, paying income, ex-

cise, and employment taxes, and making contri-

butions 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, an-

nouncement, or other guidance in the Internal

Revenue Bulletin (IRB). Go to IRS.gov/

DisasterTaxRelief 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 doesn’t have to be loca-

ted 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 haven’t otherwise deducted

these losses.

12.

Self-Employment

Tax

What's New for 2023

Maximum net earnings. The maximum net

self-employment earnings subject to the social

security part (12.4%) of the self-employment tax

is $160,200 for 2023, up from $147,000 for

2022. There is no maximum limit on earnings

subject to the Medicare part (2.9%) or, if appli-

cable, the Additional Medicare Tax (0.9%).

The maximum net self-employment earnings

subject to the social security part of the self-em-

ployment tax for 2024 will be discussed in the

2023 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 a

certain threshold amount, you may also be sub-

ject to a 0.9% Additional Medicare Tax on the

income that is more than that amount. You fig-

ure this tax using Form 8959. For more informa-

tion about the Additional Medicare Tax, includ-

ing the threshold amounts, see the Instructions

for Form 8959.

SE tax rate. The SE tax rate is 15.3%. The rate

consists of two parts: 12.4% for social security

(old-age, survivors, and disability insurance)

and 2.9% for Medicare (hospital insurance).

Topics

This chapter discusses:

•

Why pay SE tax

•

How to pay SE tax

•

Who must pay SE tax

•

Figuring SE earnings

•

Landlord participation in farming

•

Methods for figuring net earnings

•

Reporting SE tax

Useful Items

You may want to see:

Publication

541 Partnerships

Form (and Instructions)

1040 U.S. Individual Income Tax Return

1040-SR U.S. Tax Return for Seniors

Sch F (Form 1040) Profit or Loss From

Farming

Sch SE (Form 1040) Self-Employment

Tax

1065 U.S. Return of Partnership Income

Sch K-1 (Form 1065) Partner's Share of

Income, Deductions, Credits, etc.

8959 Additional Medicare Tax

541

1040

1040-SR

Sch F (Form 1040)

Sch SE (Form 1040)

1065

Sch K-1 (Form 1065)

8959

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Page 74 Chapter 12 Self-Employment Tax

See chapter 16 for information about getting

publications and forms.

Why Pay SE 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 secur-

ity system before you begin receiving social se-

curity benefits. You are insured if you have the

required number of credits (also called “quar-

ters of coverage”).

Earning credits in 2023. You can earn a max-

imum of four credits per year. For 2023, you

earn one credit for each $1,640 of combined

wages and self-employment earnings subject to

social security tax. You need $6,560 ($1,640 ×

4) of combined wages and self-employment

earnings subject to social security tax to earn

four credits in 2023. 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 social

security program, consult your nearest Social

Security Administration (SSA) office or go to the

SSA website at SSA.gov.

Making false statements to get or to in-

crease social security benefits may

subject you to penalties.

The SSA time limit for posting self-employ-

ment earnings. Generally, the SSA will give

you credit only for self-employment earnings re-

ported on a tax return filed within 3 years, 3

months, and 15 days after the tax year you

earned the income.

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 SE 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.

CAUTION

Obtaining a SSN. If you have never had an

SSN, apply for one using Form SS-5, Applica-

tion for a Social Security Card. The application

is also available in Spanish. You can get this

form at any SSA office or by calling

800-772-1213, or by going to SSA.gov/forms.

If you have an SSN 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 orig-

inal number, not a new number. In some areas,

you may be able to request a replacement 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.

You can find more information about

obtaining a SSN, replacing a lost card,

or requesting a name change at

SSA.gov.

Obtaining an ITIN. The IRS will issue you an

ITIN, for tax use only, if you are a nonresident or

resident alien and you don’t have, and aren’t eli-

gible 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 Span-

ish.

If you were assigned an ITIN before

2013, or if you have an ITIN that you

haven't included on a tax return in the

last 3 consecutive years, you may need to re-

new it. For more information, see the Instruc-

tions for Form W-7 or go to 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 ex-

pect 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 figure

and pay the tax.

However, if at least two-thirds of your gross

income for the current tax year or the prior tax

year is from farming and you file your tax return

and pay all the tax due by March 1, you don’t

have to pay any estimated tax. For example, if

at least two-thirds of your gross income for 2022

or 2023 is from farming and you file your 2023

Form 1040 and pay all the tax due by March 1,

2024, you don’t have to make any estimated tax

payments for 2023. For more information about

estimated tax for farmers, the definition of “farm-

ing income,” and exceptions to what constitutes

farming income, 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.

CAUTION

Who Must Pay SE 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 SE

tax under the same rules that apply to U.S. citi-

zens. Nonresident aliens aren’t subject to SE

tax unless an international social security

agreement determines that they are covered

under the U.S. social security system. Resi-

dents of the U.S. Virgin Islands, Puerto Rico,

Guam, the Commonwealth of the Northern Ma-

riana Islands, or American Samoa are subject to

SE tax, as they are considered U.S. residents

for SE tax purposes. For more information on

aliens, see Pub. 519, U.S. Tax Guide for Aliens,

and the Instructions for Schedule SE (Form

1040).

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, or a member of a partner-

ship, 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.

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 land-

owner furnishes the machinery and equipment

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 land-

owner and the share farmer decide on a crop-

ping 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

CAUTION

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Chapter 12 Self-Employment Tax Page 75

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 farm-

ing arrangements, the grower receives a fixed

payment per unit of crops or finished livestock

delivered to the processor or packing company.

Because the grower typically furnishes labor

and assumes some production risk, the pay-

ments are reported on Schedule F (Form 1040)

and are therefore subject to SE 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 Schedule 1 (Form 1040),

line 8z. If necessary, attach a statement show-

ing the gross income and expenses. The net in-

come may not be subject to SE tax if the project

is primarily 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.

For information on the filing requirements and

other tax information for dependents, see Pub.

929.

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 (Form 1040). How-

ever, you and your spouse may still report in-

come using Schedule F (Form 1040) 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 (QJV), later.

•

You and your spouse wholly own the unin-

corporated farming business as community

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 (QJV). 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 QJV 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 ex-

planation of “material participation,” see the in-

structions for Schedule C, line G, and the in-

structions for Schedule F, line E.

Only businesses that are owned and

operated by spouses as co-owners

(and not in the name of a state law en-

tity) qualify for the election. Thus, a business

owned and operated by spouses through a limi-

ted liability company does not qualify for the

election of a QJV.

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.

territory, you can treat your wholly owned, unin-

corporated business as a sole proprietorship,

instead of a partnership. Any change in your re-

porting position will be treated as a conversion

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 QJV, see Qualified joint ven-

ture (QJV), 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.

Figuring

Self-Employment

Earnings

Farmer. If you are self-employed as a farmer,

use Schedule F (Form 1040) to figure your

self-employment earnings.

CAUTION

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, unreimbursed

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 must generally

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-em-

ployment earnings any payments you receive

from insurance or other sources to replace in-

come lost because you reduced or stopped

farming activities. These include USDA pay-

ments under the Dairy Margin Coverage (DMC)

Program, which provides dairy producers with

payments when dairy margins are below the

margin coverage levels. Go to USDA.gov for ad-

ditional information about other USDA pro-

grams. Even if you aren’t farming when you re-

ceive 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 example,

gains or losses from the disposition of the fol-

lowing 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

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Page 76 Chapter 12 Self-Employment Tax

sale, regardless of how long the livestock

was held, or whether it was raised or pur-

chased. Livestock does not include poultry.

•

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 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 an-

nual rental payments and any one-time incen-

tive payment you receive under the program on

Schedule F, lines 4a and 4b. Cost-share pay-

ments you receive may qualify for the cost-shar-

ing exclusion. See Cost-Sharing Exclusion (Im-

provements), earlier, in chapter 3. CRP

payments are reported to you on Form 1099-G.

Individuals who are receiving social se-

curity retirement or disability benefits

may exclude CRP payments when cal-

culating SE tax. See the Instructions for Sched-

ule SE (Form 1040).

Self-employed health insurance deduction.

You can’t deduct the self-employed health insur-

ance deduction you report on Schedule 1 (Form

1040), line 17, 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

TIP

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 ma-

terially participate if you have an arrangement

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 on

something like deciding what crops to

plant, the type of seed or fertilizer to

use, or when and at what price the

crops should be sold.

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, for

example, decisions about when and where

to plant or spray, when to harvest, what

standards to follow, and what records to

keep.

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 plant,

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 la-

bor needed to grow and harvest the crop. Co-

hen provides the advice, makes inspections,

and furnishes the equipment; Nancy furnishes

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 materially in the cotton

production operations. The income Cohen re-

ceives from the cotton farm is included in Co-

hen’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 may also de-

crease your adjusted gross income (AGI) due to

the deduction for one-half of SE tax on Form

1040, which may affect your eligibility for cred-

its, 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, in-

clude your actual self-employment earnings in

gross income, regardless of which method you

use to determine SE tax.

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Chapter 12 Self-Employment Tax Page 77

Regular Method

To figure net earnings using the regular method,

multiply your self-employment earnings by

92.35% (0.9235). For your net earnings figured

using the regular method, see line 4a of your

Schedule SE (Form 1040).

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 fol-

lowing tests.

1. Your gross farm income is $9,840 or less.

2. Your net farm profits are less than $7,103.

Gross farm income. Your gross farm income

is the total of the amounts from:

•

Schedule F (Form 1040), line 9; and

•

Box 14, code B, of Schedule K-1 (Form

1065) (from farm partnerships).

Net farm profits. Net farm profits are generally

the total of the amounts from:

•

Schedule F (Form 1040), line 34; and

•

Box 14, code A of Schedule K-1 (Form

1065) (from farm partnerships).

If you received social security retirement or dis-

ability benefits, you must subtract the amount of

any CRP payments included on your Sched-

ule F, line 4b, or listed in box 20, Code AQ, of

Schedule K-1. You may also need to adjust the

amount reported on Schedule K-1 if you are a

general partner or if it is a loss. For more infor-

mation, see Partnership 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...

$9,840 or less two-thirds of your

gross farm income.

more than $9,840 $6,560.

Optional method can reduce or eliminate

SE tax. If your gross farm income is $9,840 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.

CAUTION

Figure 12-1. Can I Use the Optional Methods?

Yes

NoYes

START here to determine if

you can use the nonfarm

optional method.

Are your net nonfarm prots

less than $7,103?

Are your net nonfarm prots

less than 72.189% of your

gross nonfarm income?

Were your actual net earnings

from self-employment $400 or