Farmer's Tax Guide · Business use of your home. Beginning in 1999, you may be able to deduct expenses for your home office even if it is not where you perform your most important

ContentsIntroduction ........................................ 1

Important Changes for 1999 ............. 2

Important Changes for 2000 ............. 2

Important Reminders ......................... 2

Important Dates .................................. 3

Chapter

1. Importance of Good Records .... 4

2. Filing Requirements and ReturnForms ........................................... 5

3. Accounting Periods andMethods ........................................ 10

4. Farm Income ................................ 14

5. Farm Business Expenses .......... 23

6. Soil and Water ConservationExpenses ...................................... 32

7. Basis of Assets ........................... 34

8. Depreciation, Depletion, andAmortization ................................ 39

9. General Business Credit ............ 52

10. Gains and Losses ....................... 55

11. Dispositions of Property Used inFarming ........................................ 63

12. Installment Sales ......................... 67

13. Casualties, Thefts, andCondemnations ........................... 71

14. Alternative Minimum Tax ........... 76

15. Self-Employment Tax .................. 78

16. Employment Taxes ..................... 83

17. Retirement Plans ......................... 86

18. Excise Taxes ................................ 90

19. Your Rights as a Taxpayer ........ 94

20. Sample Return ............................. 95

21. How To Get More Information ... 113

Index .................................................... 114

IntroductionYou are in the business of farming if you cul-tivate, operate, or manage a farm for profit,either as owner or tenant. A farm includesstock, dairy, poultry, fish, fruit, and truckfarms. It also includes plantations, ranches,ranges, and orchards.

This publication explains how the federaltax laws apply to farming. Use this publicationas a guide to figure your taxes and completeyour farm tax return. If you need more infor-mation on a subject, get the specific IRS taxpublication covering that subject. We refer tomany of these free publications throughoutthis publication. See chapter 21 for informa-tion on ordering these publications.

Departmentof theTreasury

InternalRevenueService

Publication 225Cat. No. 11049L

Farmer'sTax GuideFor use in preparing

1999 Returns

Acknowledgment The valuable advice and assistance given useach year by the National Farm Income Tax Extension Committee isgratefully acknowledged.

The explanations and examples in thispublication reflect the Internal Revenue Ser-vice's interpretation of tax laws enacted byCongress, Treasury regulations, and courtdecisions. However, the information givendoes not cover every situation and is not in-tended to replace the law or change itsmeaning. This publication covers subjectson which a court may have made a decisionmore favorable to taxpayers than the inter-pretation of the Service. Until these differinginterpretations are resolved by higher courtdecisions, or in some other way, this publi-cation will continue to present the interpreta-tion of the Service.

IRS Mission. Provide America's taxpayerstop quality service by helping them under-stand and meet their tax responsibilities andby applying the tax law with integrity andfairness to all.

Comments and recommendations. Incompiling this Farmer's Tax Guide, we haveadopted a number of suggestions that read-ers sent to us. We welcome your suggestionsfor future editions.

Please send your comments and re-commendations to us at the followingaddress:

Internal Revenue ServiceTechnical Publications BranchOP:FS:FP:P1111 Constitution Avenue N.W.Washington, DC 20224

We respond to many letters by telephone.It would be helpful to include your area codeand daytime phone number with your returnaddress.

Farm tax classes. Many state CooperativeExtension Services conduct farm tax work-shops in conjunction with the IRS. Pleasecontact your county extension office for moreinformation.

Important Changesfor 1999The following items highlight a number ofadministrative and tax law changes for 1999.They are discussed in more detail throughoutthe publication. Changes are also discussedin Publication 553, Highlights of 1999 TaxChanges.

Business use of your home. Beginning in1999, you may be able to deduct expensesfor your home office even if it is not where youperform your most important business activ-ities or spend most of your business time. Seechapter 5.

Child tax credit. You may be able to claima tax credit for each of your qualifying childrenunder the age of 17. For 1999, this credit canbe as much as $500 for each qualifying child.See the instructions for Form 1040.

Depreciation limits on business cars. Thetotal section 179 deduction and depreciationyou can take on a car you use in your busi-ness and first place in service in 1999 is$3,060. Special rules apply to certain clean-fuel vehicles. See chapter 8.

Earned income credit. The maximumearned income credit has been increased to$3,816 for 1999. To claim the credit, you musthave earned income (including net earningsfrom self-employment) and modified adjustedgross income of less than $30,580 and meetcertain other requirements. For more infor-mation, including what counts as earned in-come, see Publication 596, Earned IncomeCredit.

Photographs of missing children. TheInternal Revenue Service is a proud partnerwith the National Center for Missing and Ex-ploited Children. Photographs of missingchildren selected by the Center may appearin this publication on pages that would other-wise be blank. You can help bring thesechildren home by looking at the photographsand calling 1–800–THE–LOST (1–800–843–5678) if you recognize a child.

Section 179 deduction. For 1999, the totalcost you can elect to deduct under section179 of the Internal Revenue Code is in-creased to $19,000. See chapter 8.

Self-employed health insurance de-duction. The part of your self-employedhealth insurance premiums that you can de-duct as an adjustment to income increasedto 60% for 1999. See chapter 5.

Standard mileage rate. The standard mile-age rate for the cost of operating your car,van, pickup, or panel truck in 1999 is 321/2cents a mile for all business miles driven be-fore April 1. The rate is 31 cents a mile forbusiness miles driven after March 31. Seechapter 5.

Tax rates and maximum net earnings forself-employment tax. The maximum netself-employment earnings subject to the so-cial security part (12.4%) of the self-employ-ment tax increased to $72,600 for 1999.There is no maximum limit on earnings sub-ject to the Medicare part (2.9%). See chapter15.

Important Changesfor 2000The following items highlight a number ofadministrative and tax law changes for 2000.More information on these and other changescan be found in Publication 553, Highlightsof 1999 Tax Changes.

Electronic deposits of taxes. The thresholdthat determines whether you must deposittaxes electronically has been increased to$200,000. You must use the Electronic Fed-eral Tax Payment System (EFTPS) to makeelectronic deposits of all depository tax liabil-ities that occur after 1999 if you depositedmore than $200,000 in federal depositorytaxes in 1998. If you do not meet the$200,000 threshold, electronic deposits arevoluntary, even if you were required to de-posit electronically under a previous thresh-old.

The waiver of the penalty for failure todeposit taxes electronically that was sched-uled to expire on July 1, 1999, has been ex-tended to deposit obligations incurred beforeJanuary 1, 2000, except for taxpayers who

deposited more than $200,000 in taxes in1998. See chapter 16.

Section 179 deduction. For 2000, the totalcost you can elect to deduct under section179 of the Internal Revenue Code is in-creased to $20,000. See chapter 8.

Tax rates and maximum net earnings forself-employment tax. The maximum netself-employment earnings subject to the so-cial security part of the self-employment taxfor 2000 will be published in Publications 533and 553. There is no maximum limit onearnings subject to the Medicare part.

Wage limits for social security and Medi-care taxes. The maximum wages subject tothe social security tax for 2000 will be pub-lished in Publication 51, Circular A, Agricul-tural Employer's Tax Guide. There is no wagebase limit for wages subject to the Medicaretax.

Important RemindersThe following reminders and other items mayhelp you file your tax return.

Principal agricultural activity codes. Youmust enter on line B of Schedule F (Form1040) a code that identifies your principalagricultural activity. It is important to use thecorrect code, since this information will iden-tify market segments of the public for IRSTaxpayer Education programs. The U.S.Census Bureau also uses this information forits economic census. See the list of PrincipalAgricultural Activity Codes on page 2 ofSchedule F.

Averaging of farm income. For tax yearsbeginning after 1997, individual farmers canchoose to average all or part of their taxablefarm income. See chapter 4.

Voluntary withholding. You can requestincome tax withholding from the followingpayments on Form W–4V, Voluntary With-holding Request.

1) Commodity Credit Corporation (CCC)loans.

2) Certain crop disaster payments receivedunder the Agricultural Act of 1949 or titleII of the Disaster Assistance Act of 1988.

3) Social security benefits.

4) Unemployment compensation.

5) Certain other government payments.

See chapter 4 for information on CCCloans and disaster relief payments.

Direct deposit of refund. If you are due arefund on your tax return, you can have itdeposited directly into your account at a bankor other financial institution. See your incometax package for details.

Change of address. If you change yourhome or business address, you should useForm 8822, Change of Address, to notify theIRS. Be sure to include your suite, room, orother unit number. Send the form to theInternal Revenue Service Center for your oldaddress.

Page 2

Written tax questions. You can send writtentax questions to your local district director.You should get an answer in about 30 days.Call 1–800–829–1040 if you need the ad-dress.

IRS e-file (electronic filing). You can fileyour tax returns electronically using an IRSe-file option. These options offer faster re-funds, increased accuracy, acknowledgmentof IRS receipt, and the ability to pay elec-tronically. You can use one of the followingIRS e-file options.

1) Use an authorized IRS e-file provider.

2) Use a personal computer.

3) Visit a VITA/TCE site.

4) Use an employer or financial institution.

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

Overdue tax bill. If you receive a bill foroverdue taxes, do not ignore the tax bill. If youowe the tax shown on the bill, you shouldmake arrangements to pay it. If you believeit is incorrect, contact the IRS immediately tosuspend action until the mistake is corrected.See Publication 594, The IRS CollectionProcess, for more information.

Help with unresolved tax problems. If youhave attempted to deal with an IRS problemunsuccessfully, you should contact your Tax-payer Advocate.

The Taxpayer Advocate represents yourinterests and concerns within the IRS byprotecting your rights and resolving problemsthat have not been fixed through normalchannels. While Taxpayer Advocates cannotchange the tax law or make a technical taxdecision, they can clear up problems that re-sulted from previous contacts and ensure thatyour case is given a complete and impartialreview.

To contact your Taxpayer Advocate:

• Call the Taxpayer Advocate's toll-freenumber: 1–877–777–4778.

• Call the IRS toll-free number:1–800–829–1040.

• Call, write, or fax the Taxpayer Advocateoffice in your area.

• Call 1–800–829–4059 if you are aTTY/TDD user.

For more information, see Publication1546.

Comments on IRS enforcement actions.The Small Business and Agricultural Regula-tory Enforcement Ombudsman and 10 Re-gional Fairness Boards were established toreceive comments from small business aboutfederal agency enforcement actions. TheOmbudsman will annually evaluate theenforcement activities and rate each agency'sresponsiveness to small business. If you wishto comment on the enforcement actions of theIRS, call 1–888–734–3247.

Treasury Inspector General for Tax Ad-ministration. If you want to confidentiallyreport misconduct, waste, fraud, or abuse byan IRS employee, you can call 1–800–366–4484 (1–800–877–8339 for TTY/TDD users).You can remain anonymous.

Publication on employer identificationnumbers (EIN). Publication 1635, Under-standing Your EIN, provides general infor-mation on employer identification numbers.Topics include how to apply for an EIN andhow to complete Form SS–4.

Form W–4 for 2000. You should make newForms W–4 available to your employees andencourage them to check their income taxwithholding for 2000. Those employees whoowed a large amount of tax or received alarge refund for 1999 may need to file a newForm W–4. See chapter 16.

Earned income credit. You, as an em-ployer, must notify employees who worked foryou and from whom you did not withhold in-come tax about the earned income credit.See chapter 16.

Form 1099–MISC. File Form 1099–MISC ifyou pay at least $600 in rents, services, andother income payments in your farming busi-ness to an individual (for example, an ac-countant or veterinarian) who is not your em-ployee.

Children employed by parents. Wages youpay to your children age 18 and older forservices in your trade or business are subjectto social security and Medicare taxes. Seechapter 16.

Farmers and crew leaders must withholdincome tax. Farmers and crew leaders mustwithhold federal income tax from farm work-ers who are subject to social security andMedicare taxes. See chapter 16.

Social security tests for hand-harvest la-borers. If you pay hand-harvest laborers lessthan $150 in annual cash wages, the wagesare not subject to social security and Medi-care taxes, even if you pay $2,500 or moreto all your farm workers. The hand-harvestlaborer must meet certain tests. See chapter16.

Medical savings accounts (MSAs). If youare covered only under a high deductiblehealth plan, you may be able to participate inan MSA program. You can deduct contribu-tions to your MSA even if you do not itemizeyour deductions. See Publication 969, Med-ical Savings Accounts (MSAs).

Important DatesYou should take the action indicated on orbefore the dates listed. Saturdays, Sundays,and legal holidays have been taken into ac-count, but statewide holidays have not. Astatewide legal holiday delays a due date onlyif the IRS office where you are required to fileis located in that state.

Due dates for deposits of withheld incometaxes, social security taxes, and Medicaretaxes are not listed here. For these dates,see Publication 509, Tax Calendars for 2000.

Fiscal year taxpayers. Generally, the duedates listed apply, whether you use a calen-dar or a fiscal year. However, if you have afiscal year, refer to Publication 509 for certainexceptions that may apply to you.

2000 Calendar YearDuring JanuaryFarm employers. Give your employees their

copies of Form W–2 for 1999 as soon aspossible. The due date is January 31,2000.

January 18Farmers. Pay your estimated tax for 1999

using Form 1040–ES. You have until April17 to file your 1999 income tax return(Form 1040). If you do not pay your esti-mated tax by January 18, you must fileyour 1999 return and pay any tax due byMarch 1, 2000.

January 31Farm employers. Give your employees their

copies of Form W–2 for 1999.

Social security, Medicare, and withheldincome tax. File Form 943 to report so-cial security and Medicare taxes andwithheld income tax for 1999. Deposit anyundeposited tax. (If the total is less than$1,000 and not a shortfall, you can pay itwith the return.) If you deposited the taxfor the year in full and on time, you haveuntil February 10 to file the return. (Do notreport wages for nonagricultural serviceson Form 943.)

All farm businesses. Give annual informa-tion statements to recipients of certainpayments you made during 1999. You canuse the appropriate version of Form 1099or other information return. For more in-formation, see Information Returns inchapter 2.

Federal unemployment (FUTA) tax. FileForm 940 (or 940–EZ) for 1999. If yourundeposited tax is $100 or less, you caneither pay it with your return or deposit it.If it is more than $100, you must depositit. However, if you deposited the tax for theyear in full and on time, you have untilFebruary 10 to file the return. For moreinformation on FUTA tax, see chapter 16.

February 10Social security, Medicare, and withheld

income tax. File Form 943 to report so-cial security, Medicare, and withheld in-come tax for 1999. This due date appliesonly if you deposited the tax for the yearin full and on time.

Federal unemployment (FUTA) tax. FileForm 940 (or 940–EZ) for 1999. This duedate applies only if you deposited the taxfor the year in full and on time.

February 28All farm businesses. File information re-

turns (Form 1099) for certain paymentsyou made during 1999. There are differentforms for different types of payments. Usea separate Form 1096 to summarize andtransmit the forms for different types ofpayments.

If you file Forms 1099 electronically(not by magnetic media), your due date forfiling them with the IRS is extended toMarch 31. The due date for giving the re-cipient these forms is still January 31.

Page 3

February 29Farm employers. File Form W–3, Transmit-

tal of Wage and Tax Statements, alongwith Copy A of all the Forms W–2 you is-sued for 1999.

If you file Forms W–2 electronically(not by magnetic media), your due date forfiling them with the SSA is extended toMarch 31. The due date for giving the re-cipient these forms is still January 31.

For more information, see Form W–2under Other Forms in chapter 2.

March 1Farmers. File your 1999 income tax return

(Form 1040) and pay any tax due. How-ever, you have until April 17 to file if youpaid your 1999 estimated tax by January18, 2000.

March 15Corporations. File a 1999 calendar year in-

come tax return (Form 1120 or 1120–A)and pay any tax due. For more informa-tion, see Paying and Filing Income Taxesin Publication 542, Corporations.

March 31Electronic filing of Forms 1099 and W–2.

File Forms 1099 with the IRS and FormsW–2 with the SSA. This due date appliesonly if you file electronically (not by mag-netic media). Otherwise, the due date isFebruary 28 for Forms 1099 and February29 for Forms W–2.

The due date for giving the recipientthese forms is still January 31.

For information about filing Forms1099 electronically, see Publication 1220,Specifications for Filing Forms 1098,1099, 5498, and W–2 Magnetically orElectronically. For information about filingForms W–2 electronically with the SocialSecurity Administration, call 1–800–772–6270.

April 17Farmers. File an income tax return (Form

1040) for 1999 and pay any tax due if youdid not file by March 1.

Partnerships. File a 1999 calendar year re-turn (Form 1065). For more information,see Partnership Return (Form 1065) inPublication 541, Partnerships.

May 1Federal unemployment (FUTA) tax. If you

are liable for FUTA tax, deposit the taxowed through March, if more than $100.

July 31Federal unemployment (FUTA) tax. If you

are liable for FUTA tax, deposit the taxowed through June. No deposit is neces-sary if the liability for the quarter plus un-deposited FUTA tax for the 1st quarterdoes not exceed $100.

October 31Federal unemployment (FUTA) tax. If you

are liable for FUTA tax, deposit the taxowed through September. No deposit isnecessary if the liability for the quarterplus undeposited FUTA tax for previousquarters does not exceed $100.

1.Importance ofGood Records

IntroductionA farmer, like other taxpayers, must keeprecords to prepare an accurate income taxreturn and determine the correct amount oftax. This chapter explains why you must keeprecords, what kinds of records you must keep,and how long you must keep them for federaltax purposes.

Tax records are not the only type of rec-ords you need to keep for your farming busi-ness. You should also keep records thatmeasure your farm's financial performance.This publication only discusses tax records.For information on financial recordkeeping,you may want to get a copy of FinancialGuidelines For Agricultural Producers. Youcan order it from Countryside Marketing, Inc.,by calling 1–630–637–0199 or you can writeto:

Farm Financial Standards CouncilPMB 3161212 S. Naper Blvd., #119Naperville, IL 60540

TopicsThis chapter discusses:

• Why you should keep records

• What records to keep

• How long to keep records

Useful ItemsYou may want to see:

Publication

� 51 Circular A, Agricultural Employer'sTax Guide

� 463 Travel, Entertainment, Gift, andCar Expenses

See chapter 21 for information about get-ting publications.

Why Keep Records?Everyone in business, including farmers,must keep records. Good records will helpyou do the following.

Monitor the progress of your farmingbusiness. You need good records to monitorthe progress of your farming business. Rec-ords can show whether your business is im-proving, which items are selling, or whatchanges you need to make. Good recordscan increase the likelihood of business suc-cess.

Prepare your financial statements. Youneed good records to prepare accurate fi-nancial statements. These include income(profit and loss) statements and balancesheets. These statements can help you indealing with your bank or creditors.

Identify source of receipts. You will receivemoney or property from many sources. Yourrecords can identify the source of your re-ceipts. You need this information to separatefarm from nonfarm receipts and taxable fromnontaxable income.

Keep track of deductible expenses. Youmay forget expenses when you prepare yourtax return unless you record them when theyoccur.

Prepare your tax returns. You need goodrecords to prepare your tax return. Theserecords must support the income, expenses,and credits you report. Generally, these arethe same records you use to monitor yourfarming business and prepare your financialstatements.

Support items reported on tax returns.You must keep your business records avail-able at all times for inspection by the IRS. Ifthe IRS examines any of your tax returns, youmay be asked to explain the items reported.A complete set of records will speed up theexamination.

Kinds of RecordsTo KeepExcept in a few cases, the law does not re-quire any special kind of records. You maychoose any recordkeeping system suited toyour farming business that clearly shows yourincome and expenses.

You should set up your recordkeepingsystem using an accounting method thatclearly shows your income for your tax year.See chapter 3. If you are in more than onebusiness, you should keep a complete andseparate set of records for each business.A corporation should keep minutes of boardof directors' meetings.

Your recordkeeping system should includea summary of your business transactions.This summary is ordinarily made in account-ing journals and ledgers. They must showyour gross income, as well as your de-ductions and credits. In addition, you mustkeep supporting documents. Purchases,sales, payroll, and other transactions youhave in your business generate supportingdocuments such as invoices and receipts.These documents contain the information youneed to record in your journals and ledgers.

It is important to keep these documentsbecause they support the entries in yourjournals and ledgers and on your tax return.Keep them in an orderly fashion and in a safeplace. For instance, organize them by yearand type of income or expense.

Travel, transportation, entertainment, andgift expenses. Special recordkeeping rulesapply to these expenses. For more informa-tion, see Publication 463.

Employment taxes. There are specific em-ployment tax records you must keep. For alist, see Publication 51 (Circular A).

Page 4 Chapter 1 Importance of Good Records

Excise taxes. See How To Claim a Creditor Refund in chapter 18 for the specific rec-ords you must keep to verify your claim forcredit or refund of excise taxes on certain fu-els.

Assets. Assets are the property, such asmachinery and equipment, that you own anduse in your business. You must keep recordsto verify certain information about your busi-ness assets. You need records to figure yourannual depreciation deduction and the gainor loss when you sell the assets. Your recordsshould show all of the following.

• When and how you acquired the asset.

• Purchase price.

• Cost of any improvements.

• Section 179 deduction taken.

• Deductions taken for depreciation.

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

• How you used the asset.

• When and how you disposed of the asset.

• Selling price.

• Expenses of sale.

The following are examples of records thatmay show this information.

• Purchase and sales invoices.

• Real estate closing statements.

• Canceled checks.

Financial account statements as proof ofpayment. If you do not have a canceledcheck, you may be able to prove paymentwith certain financial account statementsprepared by financial institutions. These in-clude account statements prepared for the fi-nancial institution by a third party. The fol-lowing is a list of acceptable accountstatements.

1) An account statement showing a checkclearing is accepted as proof if it showsthe following.

a) Check number.

b) Amount.

c) Payee's name.

d) Date the check amount was postedto the account by the financial in-stitution.

2) An account statement showing an elec-tronic funds transfer is accepted as proofif it shows the following.

a) Amount transferred.

b) Payee's name.

c) Date the transfer was posted to theaccount by the financial institution.

3) An account statement showing a creditcard charge (an increase to thecardholder's loan balance) is acceptedas proof if it shows the following.

a) Amount charged.

b) Payee's name.

c) Date charged (transaction date).

These account statements must be highlylegible.

CAUTION!

Proof of payment of an amount alonedoes not establish that you are enti-tled to a tax deduction. You should

also keep other documents, such as creditcard sales slips and invoices.

How Long To KeepRecordsYou must keep your records as long as theymay be needed for the administration of anyprovision of the Internal Revenue Code.Generally, this means you must keep recordsthat support an item of income or deductionon a return until the period of limitations forthat return runs out.

The period of limitations is the period oftime in which you can amend your return toclaim a credit or refund, or the IRS can as-sess additional tax. The period of time inwhich you can amend your return to claim acredit or refund is generally the later of:

1) 3 years after the date your return is dueor filed, or

2) 2 years after the date the tax is paid.

Returns filed before the due date are treatedas filed on the due date.

The IRS has 3 years from the date you fileyour return to assess any additional tax. If youfile a fraudulent return or no return at all, theIRS has a longer period of time to assessadditional tax.

TIPKeep copies of your filed tax returns.They help in preparing future tax re-turns and making computations if you

later file an amended return.

Employment taxes. If you have employees,you must keep all employment tax records forat least 4 years after the date the tax be-comes due or is paid, whichever is later.

Assets. Keep records relating to propertyuntil the period of limitations expires for theyear in which you dispose of the property ina taxable disposition. You must keep theserecords to figure any depreciation, amorti-zation, or depletion deduction and to figureyour basis for computing gain or loss whenyou sell or otherwise dispose of the property.

Generally, if you receive property in anontaxable exchange, your basis in thatproperty is the same as the basis of theproperty you gave up, increased by anymoney you paid. You must keep the recordson the old property, as well as on the newproperty, until the period of limitations expiresfor the year in which you dispose of the newproperty in a taxable disposition.

Records for nontax purposes. When yourrecords are no longer needed for tax pur-poses, do not discard them until you check tosee if you have to keep them longer for otherpurposes. For example, your insurance com-pany or creditors may require you to keepthem longer than the IRS does.

2.FilingRequirementsand ReturnForms

Important RemindersForm 1099–MISC. File Form 1099–MISC ifyou pay at least $600 in rents, services, andother income payments in your farming busi-ness to an individual (for example, an ac-countant or veterinarian) who is not your em-ployee.

Payments to attorneys. The rule that attor-neys' fees of $600 or more must be reportedto the IRS on Form 1099–MISC has notchanged. However, if you made a paymentto an attorney in the course of your farmingbusiness in connection with legal servicesand the attorney's fee cannot be determined,you must report the total amount paid to theattorney on Form 1099–MISC.

The exception for payments to corpo-rations does not apply to payments for legalservices. Those payments must also be re-ported on Form 1099–MISC. See the In-structions for Forms 1099, 1098, 5498, andW–2G.

Estimated tax. When you figure your esti-mated tax, you must include any alternativeminimum tax you expect to owe. See chapter14 and Publication 505.

IntroductionIf you are a citizen or resident of the UnitedStates, single or married, and your gross in-come for the tax year is at least the amountshown later in your category under FilingRequirements, you must file a 1999 federalincome tax return. This is true even if no taxis due. If you do not meet the gross incomerequirement, you may still need to file a taxreturn if any of the following apply.

• You have self-employment income.

• You are entitled to a complete refund oftax withheld.

• You are entitled to the earned incomecredit.

Gross income is explained later.


• Filing requirements

• Taxpayer identification number

• Estimated tax and return due dates

• Main tax forms used by farmers

Chapter 2 Filing Requirements and Return Forms Page 5

Figure 2–A. Estimated Tax for Farmers

Is at least 662⁄3% ofall gross income incurrent or prior yearfrom farming?

Do you expect yourwithholding andcredits to be at least662⁄3% of your tax?

Will you file and payin full by March 1?

Follow generalestimated tax rules.

No estimated taxrequirement.

Estimated taxpayment (up to662⁄3% of liability)due January 18(return due April 17).

Start Here:

Yes No

NoYes

No

Yes

� �

�

� �

�

Which number to use. If you file an excise,alcohol, tobacco, firearms, or employment taxreturn, you should have an employer identifi-cation number (EIN). Enter that EIN on yourSchedule F (Form 1040). Otherwise, enteryour social security number.

On your individual income tax return(Form 1040), schedule of self-employmenttax (Schedule SE), and estimated tax pay-ment voucher (Form 1040–ES), you shouldenter your social security number (SSN), re-gardless of which number you entered onyour business returns.

If you are married, enter the social securitynumbers for you and your spouse on yourForm 1040, whether you file jointly or sepa-rately. If you are filing a joint return, list thesocial security numbers in the same order asthe names are shown on your label. Also en-ter both social security numbers on your Form1040–ES if you make joint estimated taxpayments.

Privacy protection. To protect your privacy,the IRS no longer prints your SSN(s) on thelabel mailed to you with your tax booklet. Besure to enter your SSN(s) in the space pro-vided on your tax form.

Applying for a social securitynumber. To apply for a social securitynumber (SSN), use Form SS–5. You

can get the form from any social security of-fice or by calling 1–800–772–1213. If you areunder 18 years of age, you must furnish evi-dence of age, identity, and U.S. citizenship (orlawful alien status) with your Form SS–5. Ifyou are 18 or older, you must appear in per-son with this evidence at a social security of-fice. It usually takes about 2 weeks to get anSSN.

Applying for an employer identifi-cation number. To apply for an em-ployer identification number, use

Form SS–4. See chapter 21 for informationabout ordering this form.

Estimated TaxPayment and ReturnDue DatesTo determine when you must pay estimatedtax and file your return, see Figure 2–A.

CAUTION!

Gross income is not the same as totalincome shown on line 22 of Form1040.

Gross IncomeYour gross income is all income you receivein the form of money, property, and servicesthat is not exempt from tax. On a joint return,you must add your spouse's gross income toyour gross income. To decide whether two-thirds of your gross income for 1999 was fromfarming, use as your gross income the totalof the following income (not loss) amountsfrom your tax return.

• Wages, salaries, tips, etc.

• Partnership return

• Corporation return

• S corporation return


Publication

� 505 Tax Withholding and EstimatedTax

� 541 Partnerships

� 542 Corporations

Form (and Instructions)

We have not listed the various forms youmay have to file with the IRS because theyare discussed later in this chapter.

See chapter 21 for information about get-ting publications and forms.

Filing RequirementsCheck the following table to determinewhether you must file a tax return, based onyour age, income, and filing status.

Dependent's return. If you can claimsomeone as a dependent on your tax return(for example, your son or daughter), thatperson must generally also file his or her owntax return if he or she:

• Had only earned income, such as salaryor wages, and the total is more than$4,300,

• Had only unearned income, such as in-terest and dividends, and the total is morethan $700, or

• Had both earned and unearned income,and the total is more than $700.

Self-employed. You must file an income taxreturn if you are self-employed and you hadnet earnings of $400 or more from self-employment, even though you may not beotherwise required to file a return. See chap-ter 15.

Certain credits. You must also file a returnif you are eligible for the earned income credit(EIC) or the additional child tax credit. Also,you must file a return if you received any ad-vance EIC payments from your employer.

Refund. Even if you do not otherwise haveto file a return, you should file one to get arefund of any income tax withheld.

More information. See the Form 1040 in-structions for more information on who mustfile a return for 1999.

TaxpayerIdentification NumberYou must enter your taxpayer identificationnumber (your social security or employeridentification number) on all returns, state-ments, or documents you are required to file.For example, it must be entered on your fed-eral income tax return, your estimated taxpayment voucher, and all information returns,such as Forms 1096 and 1099. You may besubject to a penalty of $50 for each failure toenter the number.

Who Must FileFiling IncomeStatus Is: At Least:

SingleUnder 65 ............................................... $7,05065 or older ............................................ 8,100

Married, filing jointlyBoth under 65 ....................................... 12,700One spouse 65 or older ....................... 13,550Both 65 or older ................................... 14,400Not living with spouse at end of year(or on date spouse died) ...................... 2,750

Married, filing separatelyAll (any age) ......................................... 2,750

Head of householdUnder 65 ............................................... 9,10065 or older ............................................ 10,150

Qualifying widow(er) withdependent child

Under 65 ............................................... 9,95065 or older ............................................ 10,850

Page 6 Chapter 2 Filing Requirements and Return Forms

• Taxable interest.

• Ordinary dividends.

• Taxable refunds of state and local taxes.

• Alimony received.

• Gross business income from ScheduleC (Form 1040), line 7.

• Gross receipts from Schedule C–EZ(Form 1040), line 1.

• Capital gains from Schedule D (Form1040). Losses cannot be netted againstgains.

• Gains on sales of business property fromForm 4797.

• Taxable IRA distributions, pensions, an-nuities, and social security benefits.

• Gross rental income from Schedule E(Form 1040), line 3.

• Gross royalty income from Schedule E(Form 1040), line 4.

• Your taxable net income from an estateor trust, Schedule E (Form 1040), line 36.

• Income from a REMIC reported onSchedule E (Form 1040), line 38.

• Gross farm rental income from Form4835, line 7.

• Farm income from Schedule F (Form1040), line 11.

• Your distributive share of gross incomefrom a partnership or limited liabilitycompany treated as a partnership fromSchedule K–1 (Form 1065).

• Your pro rata share of gross income froman S corporation from Schedule K–1(Form 1120S).

• Unemployment compensation as re-ported on Form 1099–G.

• Other income reported on Form 1040,line 21, not reported with any of the itemslisted above.

There are brief descriptions of forms andschedules used by farmers later.

Gross IncomeFrom FarmingGross income from farming includes the fol-lowing.

• Gross farm income from Schedule F(Form 1040), line 11.

• Gross farm rental income from Form4835, line 7.

• Gross farm income from Schedule E(Form 1040), Parts II and III. See theinstructions for line 41.

• Gains from the sale of livestock used fordraft, breeding, sport, or dairy purposesreported on Form 4797.

CAUTION!

Wages you receive as a farm em-ployee are not farm income. This in-cludes wages you receive from a farm

corporation even if you are a stockholder inthe corporation. If all or most of your incomeis from wages as a farm employee, your em-ployer is usually required to withhold incometax from your wages. You may also have tomake estimated tax payments if you do nothave enough tax withheld. For more informa-tion, see Publication 505.

Percentage From FarmingTotal your gross income from all sources asshown earlier. Then total your gross incomefrom farming. Divide your farm gross incomeby your total gross income to determine thepercentage of gross income from farming.

Example 1. James Smith had the follow-ing total gross income and farm gross incomein 1999:

Schedule D showed gain from the sale ofdairy cows carried over from Form 4797($5,000) in addition to a loss from the sale ofcorporate stock ($2,000). However, that lossis not netted against the gain to figure Mr.Smith's total gross income or his gross farmincome. His gross farm income is 64% of histotal gross income ($80,000 ÷ $125,000 =.64). Therefore, based on his 1999 income,he does not qualify to use the special esti-mated tax payment and return due dates for1999. However, he does qualify if at leasttwo-thirds of his 1998 gross income was fromfarming.

Example 2. Assume the same facts asin Example 1 except that Mr. Smith also re-ceived gross farm rental income (Form 4835)of $15,000. This made his total gross income$140,000 and his farm gross income $95,000.He qualifies to use the special estimated taxpayment and return due dates since at leasttwo-thirds of his gross income is from farming[$95,000 ÷ $140,000 = .679 (67.9%)].

Due Dates forQualified FarmersIf at least two-thirds of your gross income for1998 or 1999 was from farming, you haveonly one payment due date for 1999 esti-mated tax—January 18, 2000.

For your 1999 tax, you may either:

1) Pay all your estimated tax (figured onForm 1040–ES) by January 18, 2000,and file your Form 1040 by April 17,2000, or

2) File your Form 1040 by March 1, 2000,and pay all the tax due. You are not re-quired to make an estimated tax pay-ment. If you pay all the tax due, you willnot be penalized for failure to pay esti-mated tax.

TIPIf at least two-thirds of your gross in-come for 1999 or 2000 is from farm-ing, for your 2000 tax, you may either:

1) Pay all your estimated tax by January16, 2001, and file your Form 1040 byApril 16, 2001, or

2) File your Form 1040 by March 1, 2001,and pay all the tax due.

Required annual payment. If at least two-thirds of your gross income for 1998 or 1999was from farming, the required annual pay-ment due January 18, 2000, is the smallerof the following.

1) 662 / 3% (.6667) of your total tax for 1999,or

2) 100% of the total tax shown on your1998 return. (The return must cover all12 months.)

TIPIf at least two-thirds of your gross in-come for 1999 or 2000 is from farm-ing, the required annual payment due

January 16, 2001, is the smaller of the fol-lowing.

1) 662 / 3% (.6667) of your total tax for 2000,or

2) 100% of the total tax shown on your1999 return. (The return must cover all12 months.)

Fiscal year farmers. If you qualify to usethese special rules but your tax year does notstart on January 1, you may file your returnand pay the tax by the first day of the 3rdmonth after the close of your tax year. Or youmay pay your required estimated tax within15 days after the end of your tax year. Thenfile your return and pay any balance due bythe 15th day of the 4th month after the endof your tax year.

Due Dates forNonqualified FarmersIf less than two-thirds of your gross incomefor 1998 and 1999 was from farming, youcannot use these special estimated tax pay-ment and return due dates for your 1999 taxyear. In this case, you generally must makequarterly estimated tax payments on April 15,June 15, and September 15, 1999, and onJanuary 18, 2000. You must file your returnby April 17, 2000.

If less than two-thirds of your gross in-come for 1999 and 2000 is from farming, youcannot use these special estimated tax pay-ment and return due dates for your 2000 taxyear. You generally must make quarterly es-timated tax payments on April 17, June 15,and September 15, 2000, and on January 16,2001. You must file your return by April 16,2001.

For more information on estimated taxes,see Publication 505.

Estimated TaxPenalty for 1999If you did not pay all your required estimatedtax for 1999 by January 18, 2000, or file your1999 return and pay the tax by March 1,2000, you should have used Form 2210–F,Underpayment of Estimated Tax by Farmersand Fishermen, to determine if you owed apenalty. If you owed a penalty but did not fileForm 2210–F with your return and pay thepenalty, you will get a notice from the IRS.You should pay the penalty as instructed bythe notice.

If you file your return by April 17 and paythe bill within 21 days (10 days if the bill is$100,000 or more) after the notice date, theIRS will not charge you interest on the pen-alty.

CAUTION!

Do not ignore a penalty notice,even if you think it is in error. Oc-casionally, you may get a penalty no-

tice even though you filed your return on time,attached Form 2210–F, and met the grossincome test. If you receive a penalty notice forunderpaying estimated tax that you think is in

Gross IncomeTotal Farm

Taxable interest ......................... $43,000Dividends ................................... 500Rental income (Sch E) .............. 1,500Farm income (Sch F) ................ 75,000 $75,000Schedule D ................................ 5,000 5,000

Total .......................................... $125,000 $80,000


error, write to the address on the notice andexplain why you think the notice is in error.Include a computation, similar to the one inExample 1 (earlier), showing that you meetthe gross income test.

Other FilingInformation for 1999

Payment date on holiday or weekend. Ifthe last day for filing your return or making apayment falls on a Saturday, Sunday, or legalholiday, your return or payment will be on timeif it is filed or made on the next business day.

Automatic extension of time to file Form1040. If you do not choose to file your 1999return by March 1, 2000, the due date for yourreturn will be April 17, 2000. However, youcan get an automatic 4-month extension oftime to file your return. Your Form 1040 wouldthen be due by August 15, 2000. To get thisextension, file Form 4868, Application forAutomatic Extension of Time To File U.S. In-dividual Income Tax Return, by April 17,2000. The filing of Form 4868 does not extendthe time to pay the tax. For more information,see the instructions for Form 4868.

CAUTION!

This extension does not extend theMarch 1, 2000, filing date for farmerswho did not make an estimated tax

payment and want to avoid an estimated taxpenalty. Therefore, if you did not make anestimated tax payment by January 18, 2000,and you file your tax return after March 1,2000, you will be subject to a penalty forunderpaying your estimated tax, even if youfile Form 4868.

Forms You May NeedTo FileWhen filing your income tax return, arrangeyour forms and schedules in the correct orderusing the sequence number located in theupper right corner of each form. Attach allother statements or attachments last, ar-ranged in the same order as the forms orschedules they support.

Farmers can use the following forms andschedules. Some of them are illustrated inchapter 20.

Form 1040. This form is the income tax re-turn. List taxable income from all sources onForm 1040, including profit or loss fromfarming operations as figured on Schedule F(Form 1040). Figure the tax on this form,also.

Schedule A, Itemized Deductions. Listnonbusiness itemized deductions on thisschedule.

Schedule B, Interest and Ordinary Divi-dends. Report interest and dividend incomeof more than $400 on this schedule.

Schedule C, Profit or Loss From Busi-ness. List income and deductions and deter-mine the net profit or loss from a nonfarmbusiness on this schedule.

Schedule C–EZ, Net Profit From Busi-ness. Use this schedule in place of ScheduleC if nonfarm business expenses are $2,500or less and other requirements are met.

Schedule D, Capital Gains and Losses.Report gains and losses from sales of capitalassets on this schedule.

Schedule E, Supplemental Income andLoss. Report income or losses from rents,royalties, partnerships, estates, trusts, and Scorporations on this schedule.

Schedule F, Profit or Loss From Farming.Use this schedule whether you file on thecash or an accrual method of accounting. Listall farm income and deductions and deter-mine the net farm profit or loss on thisschedule.

Schedule SE, Self-Employment Tax. Fig-ure self-employment tax on this schedule.See chapter 15.

Form 1040–ES. Figure and pay estimatedtax on Form 1040–ES, Estimated Tax for In-dividuals. See Estimated Tax Payment andReturn Due Dates, earlier.

Form 2210–F. Figure any underpayment ofestimated tax and the penalty on Form2210–F, Underpayment of Estimated Tax byFarmers and Fishermen.

Form 3468. Figure the investment credit onForm 3468, Investment Credit. See chapter9.

Form 3800. Figure the general businesscredit on Form 3800, General BusinessCredit. See chapter 9.

Form 4136. Figure the credit for federal taxon gasoline and special fuels on Form 4136,Credit for Federal Tax Paid on Fuels. Seechapter 18.

Form 4255. Figure the tax from the recaptureof investment credit on Form 4255, Recaptureof Investment Credit. See chapter 9.

Form 4562. Explain the deductions for de-preciation and amortization on Form 4562,Depreciation and Amortization. See chapter8.

Form 4684. Report gains and losses fromcasualty and theft of business and personal-use property on Form 4684, Casualties andThefts. See chapter 13.

Form 4797. Report gains and losses fromthe sale or exchange of business propertyand from certain involuntary conversions onForm 4797, Sales of Business Property. Seechapter 11.

Form 4835. Report on Form 4835, FarmRental Income and Expenses, farm rental in-come received as a share of crops or live-stock produced by a tenant if you, the land-lord, did not materially participate in theoperation or management of the farm. Seechapter 4.

Form 4868. Apply for an extension of timeto file your tax return on Form 4868, Applica-tion for Automatic Extension of Time To FileU.S. Individual Income Tax Return. It doesnot, however, extend the time to pay any taxdue.

Form 6251. Figure the alternative minimumtax on Form 6251, Alternative MinimumTax—Individuals. See chapter 14.

Form 8824. Report the exchange of busi-ness or investment property for like-kindproperty on Form 8824, Like-Kind Ex-changes. It is filed with Schedule D (Form1040) or Form 4797. See chapter 10.

Other FormsYou may have to file the forms below in cer-tain situations.

Form W–2. If you are in the trade or businessof farming and you employ paid workers,prepare Form W–2, Wage and Tax State-ment, for each employee, including any pay-ment that was not in cash. You must show,in the space marked Wages, tips, other com-pensation, the total paid to the employee.Give copies B and C of Form W–2 to theemployee by the last day of January. SendCopy A of each Form W–2 to the Social Se-curity Administration with a completed FormW–3, Transmittal of Wage and Tax State-ments, by the last day of February. Seechapter 16.

Form 940. File Form 940, Employer's AnnualFederal Unemployment (FUTA) Tax Return,by January 31 of the following year if youwere subject to FUTA tax. If all the tax duewas deposited by January 31, you can fileForm 940 as late as February 10. See chapter16.

Form 940–EZ. Form 940–EZ is a simpli-fied version of Form 940. See chapter 16.

Form 943. File Form 943, Employer's AnnualTax Return for Agricultural Employees, byJanuary 31 of the following year if you wererequired to withhold and pay withheld income,social security, and Medicare taxes on farmlabor wages you paid during the calendaryear. If you deposited all the tax due by Jan-uary 31, you can file Form 943 as late asFebruary 10.

Form 1065. A farm partnership files Form1065, U.S. Partnership Return of Income, bythe 15th day of the 4th month following thedate the partnership tax year ended, asshown at the top of Form 1065. For calendaryear partnerships, the due date is April 15.See Partnership, later.

Form 1120. A corporation files Form 1120,U.S. Corporation Income Tax Return, by the15th day of the 3rd month following the datethe corporation tax year ended, as shown atthe top of Form 1120. For calendar year cor-porations, the due date is March 15. SeeCorporation, later.

Form 1120–A. Many small corporationscan use Form 1120–A, U.S. CorporationShort-Form Income Tax Return, instead ofForm 1120. They file by the 15th day of the3rd month following the date the corporationtax year ended, as shown at the top of Form1120–A. For calendar year corporations, thedue date is March 15.

Form 1120S. An S corporation files Form1120S, U.S. Income Tax Return for an SCorporation, by the 15th day of the 3rd monthfollowing the date the S corporation tax yearended, as shown at the top of Form 1120S.For calendar year S corporations, the duedate is March 15. See S Corporation, later.

Page 8 Chapter 2 Filing Requirements and Return Forms

Form 2290. File Form 2290, Heavy HighwayVehicle Use Tax Return, if you use a truckor truck tractor registered in your name for thefollowing purposes.

• To figure and pay the tax due on heavyhighway vehicles (taxable gross weight55,000 pounds or more) used during theperiod from July 1 to June 30.

• To claim an exemption from the tax whenthe vehicle is expected to be used 5,000miles or less (7,500 for agricultural vehi-cles) during the period.

See the instructions for Form 2290.

Form 8109. Employment taxes not depositedelectronically are deposited with Form 8109,Federal Tax Deposit Coupon. In general, in-come tax withheld plus the employer andemployee's share of social security andMedicare taxes that total $1,000 or more forthe year must be deposited. The IRS will sendyou a coupon book for making deposits whenyou apply for an employer identification num-ber (EIN).

CAUTION!

Under certain circumstances youmust deposit taxes electronically.See chapter 16.

Form 8822. Notify the IRS of a change inyour home or business address with Form8822, Change of Address. Include the suite,room, or other unit number if it is required inthe address and send the form to the InternalRevenue Service Center for your old address.

Ordering forms. See chapter 21 for infor-mation about getting any of the forms listedin this section.

Information ReturnsThese returns provide information the IRSrequires, other than taxes due. There aremany different information returns, includingForm W–2, discussed earlier. This dis-cussion, however, is limited to Form1099–INT, Form 1099–MISC, and Form1096.

Form 1099–INT. Report interest of $600 ormore paid in the course of your farm busi-ness, including interest on installment salecontracts, on Form 1099–INT, Interest In-come.

Form 1099–MISC. If you make total pay-ments of $600 or more during the calendaryear to another person, other than a corpo-ration, in the course of your farm business,you must file information returns to reportthese payments. Payments of $600 or moremade for custom harvesting, crop spraying,services of a veterinarian, rents, commis-sions, fees, prizes, awards, services of anindependent contractor, other payments andcompensation, and services provided bynonemployees are reported on Form1099–MISC, Miscellaneous Income. Pay-ments of $10 or more for royalties are alsoreported on Form 1099–MISC.

Form 1099–MISC is also used to report tothe payee and to the IRS payments you madethat were subject to backup withholding andthe amounts you withheld, regardless of theamount of the payment.

Report payments for compensation toemployees on Form W–2, not on Form1099–MISC. See chapter 16.

Preparation of returns. If you are requiredto file Form 1099–MISC, you must prepareseparate copies of the form for each person.File one copy with the IRS. Give each persona statement (or copy of the form) by January31 of the following year. These forms are readby machine and there are very specific in-structions for their preparation and sub-mission. See the Instructions for Forms 1099,1098, 5498, and W–2G.

Form 1096. When sending copies to theIRS, use a separate transmittal, Form 1096,Annual Summary and Transmittal of U.S. In-formation Returns, for each different type ofform.

Backup withholding. In certain cases, thelaw requires you to withhold income tax at arate of 31% (backup withholding) on pay-ments of commissions, nonemployee com-pensation, and other payments you make forservices in your farm business or other busi-ness activities. The backup withholding rulesdo not apply to wages, pensions, or annuities.

See the Instructions for Forms 1099,1098, 5498, and W–2G for more information.

Penalties. If you file information returns late,without all information required to be on thereturn, or with incorrect information, you maybe subject to a penalty. See the Instructionsfor Forms 1099, 1098, 5498, and W–2G forinformation on Form 1099 penalties.

PartnershipA partnership is the relationship between twoor more persons who join together to carryon a trade or business, including farming.Each person contributes money, property, la-bor, or skill, and expects to share in the profitsand losses.

For federal income tax purposes, the term“partnership” includes a syndicate, group,pool, joint venture, or similar organizationcarrying on a trade or business and not clas-sified as a trust, estate, or corporation.

Family partnership. Members of the samefamily can, and often do, form valid partner-ships. For instance, a husband and wife orparents and children can conduct a farmingenterprise through a partnership. To be rec-ognized as a partnership for federal tax pur-poses, a partner relationship must be estab-lished and certain requirements must be met.For information on these requirements, seeFamily Partnership in Publication 541. Merelydoing chores, helping with the harvest, orkeeping house and cooking for the family andhired help does not establish a partnership.

If a husband and wife are partners in afarm operation or other business, they shouldreport their partnership income on Form 1065.See Form 1065, later.

Co-ownership and sharing expenses.Mere co-ownership of property that is main-tained and leased does not constitute a part-nership. For example, if an individual owneror tenants-in-common of farm property leasethat property for cash rental or a share of thecrops, a partnership is not necessarily createdby the leasing. However, tenants-in-commonmay be partners if they actively carry on a

farm or other business operation and shareits profits and losses. A joint undertakingmerely to share expenses is not a partner-ship.

Self-employment tax. Unless you are alimited partner, your distributive share of in-come from a partnership is self-employmentincome. If you and your spouse are partners,each should report his or her share of part-nership income or loss on a separate Sched-ule SE (Form 1040), Self-Employment Tax.This will give each of you credit for socialsecurity earnings on which retirement benefitsare based. The self-employment tax of amember of a partnership engaged in farmingis discussed in chapter 15.

Partner's distributive share. Each partner'sdistributive share of partnership income, gain,loss, etc., must be included on that partner'stax return, even if the items were not distrib-uted.

Selling or exchanging a partnership.When you create a partnership, you generallydo not recognize gain or loss on contributionsof money or property you make to the part-nership. However, you generally recognizegain or loss when you sell or exchange yourinterest in the partnership.

You may be able to avoid recognizing gainor loss when ending a partnership if you buyout your partners or change to a corporationstatus.

Form 1065. Partnerships file a return onForm 1065, U.S. Partnership Return of In-come. This is an information return showingthe income and deductions of the partnership,the name and address of each partner, andeach partner's distributive share of income,gain, loss, deductions, credits, etc. No tax isdue on Form 1065.

Form 1065 is not required until the first taxyear the partnership has income or de-ductions. In addition, it is not required for anytax year a partnership has no income andexpenses.

Schedule F (Form 1040). Use ScheduleF (Form 1040) to report a farm partnershipprofit or loss. This schedule should be filedwith Form 1065. The profit or loss shown onSchedule F, adjusted for amounts to be re-ported on Schedule K-1 and Schedule K ofForm 1065, is entered on line 5 of Form 1065.

Other schedules. Each partner's distrib-utive share of partnership items, such as or-dinary income or loss, capital gain or loss, netearnings from self-employment, etc., is en-tered on Schedule K–1 of Form 1065. Fill inall other schedules listed on Form 1065 thatapply to you.

Filing penalty. A penalty is assessedagainst the partnership if the partnership isrequired to file a partnership return and itdoes either of the following.

• Fails to file the return on time, includingextensions.

• Files a return that fails to show all theinformation required.

The penalty is $50 times the total numberof partners per month (or part of a month) thereturn is late or incomplete, up to 5 months.

Exception to filing penalty. A partner-ship does not have to pay the penalty if it canshow reasonable cause for failure to file areturn. A small farm partnership with 10 orfewer partners is generally considered to


meet this requirement if it can show the fol-lowing information.

• All partners have reported their entireshare of all partnership items on timelyfiled income tax returns.

• All partners are individuals (other thannonresident aliens), estates, or C corpo-rations.

• The partnership has not elected to besubject to the rules for “consolidated auditproceedings.”

Consolidated audit procedures. Undercurrent examination procedures, the taxtreatment of any partnership item is generallydetermined at the partnership level in a con-solidated audit proceeding, rather than at theindividual partner's level. After the proper taxtreatment is determined at the partnershiplevel, the IRS can automatically make relatedadjustments to the tax returns of the partners,based on their share of the adjusted items.

More information. For more information onpartnerships, see Publication 541.

Limited LiabilityCompany (LLC)An LLC is an entity formed under state lawby filing articles of organization as an LLC.None of the members of an LLC are per-sonally liable for its debts.

An LLC can be classified as either a part-nership or a corporation for federal incometax purposes. See Corporation, later, for therules you must use to determine whether anLLC is treated as a corporation. If an LLC isnot treated as a corporation and has 2 ormore members, it is treated as a partnership.

Depending on its classification, an LLCwould file either Form 1065 or Form 1120.However, if an LLC has a single owner, itwould file Schedule C or C–EZ (Form 1040).

If an LLC is treated as a partnership, seePublication 541 for information on partner-ships. If it is treated as a corporation, seePublication 542 for information on corpo-rations.

CorporationThe rules you must use to determine whetheryour business is taxed as a corporationchanged for businesses formed after 1996.However, if your business was formed before1997 and taxed as a corporation under theold rules, it will generally continue to be taxedas a corporation.

Businesses formed after 1996. The follow-ing businesses formed after 1996 are taxedas corporations.

• A business formed under a federal orstate law that refers to it as a corporation,body corporate, or body politic.

• A business formed under a state law thatrefers to it as a joint-stock company orjoint-stock association.

• An insurance company.

• Certain banks.

• A business wholly owned by a state orlocal government.

• A business specifically required to betaxed as a corporation by the InternalRevenue Code (for example, certainpublicly traded partnerships).

• Certain foreign businesses.

• Any other business that elects to be taxedas a corporation by filing Form 8832.

For more information, see the instructions forForm 8832, Entity Classification Election.

Corporate tax. Corporate profits arenormally taxed to the corporation. When theprofits are distributed as dividends, the divi-dends are taxed to the shareholders.

In figuring its taxable income, a farm cor-poration generally takes the same deductionsthat a noncorporate farmer would claim onSchedule F (Form 1040). Corporations arealso entitled to special deductions.

Forming a corporation. A corporation isformed by a transfer of money, property, orboth by prospective shareholders in ex-change for capital stock in the corporation.

If money is exchanged for stock, no gainor loss is realized by the shareholder or cor-poration. The stock received by the share-holder has a basis equal to the money trans-ferred to the corporation by the shareholder.

If property is exchanged for stock, it maybe either a taxable or nontaxable exchange.

Form 1120 and Form 1120–A. Unless ex-empt under section 501 of the Internal Reve-nue Code, all domestic corporations (includ-ing corporations in bankruptcy) must file anincome tax return whether or not they havetaxable income. A corporation must generallyfile Form 1120 to report its income, gains,losses, deductions, credits, and to figure itsincome tax liability. However, a corporationmay file Form 1120–A if its gross receipts,total income, and total assets are each under$500,000 and it meets certain other require-ments. For more information, see the in-structions for Forms 1120 and 1120–A.

More information. For more information oncorporations, see Publication 542.

S CorporationAn S corporation is a qualifying corporationthat chooses to have its income taxed to theshareholders rather than to the corporationitself, except as noted next under Taxes. Itsshareholders will then include in income theirshare of the corporation's nonseparatelystated income or loss and separately stateditems of income, deduction, loss, and credit.

To make this election, a corporation, inaddition to other requirements, must not havemore than 75 shareholders. Each of itsshareholders must also consent to theelection.

Taxes. Although it is generally not liable forfederal income tax itself, an S corporationmay have to pay the following taxes.

1) A tax on:

a) Excess passive investment income,

b) Certain capital gains, or

c) Built-in gains.

2) The tax from recomputing a prior year'sinvestment credit.

3) LIFO recapture tax.

An S corporation may have to makequarterly estimated tax payments for thesetaxes.

Form 1120S. An S corporation files its returnon Form 1120S.

More information. For more information onS corporations, see the instructions for Form1120S.

3.AccountingPeriods andMethods

IntroductionEach taxpayer (business or individual) mustfigure taxable income on an annual account-ing period called a tax year. Also, each tax-payer must use a consistent accountingmethod that accurately accounts for incomeand expenses. For more detailed information,such as how to change an accounting periodor method, see Publication 538, AccountingPeriods and Methods.


• Calendar tax year

• Fiscal tax year

• Cash method of accounting

• Accrual method of accounting


Publication

� 538 Accounting Periods and Methods


� 1128 Application to Adopt, Change, orRetain a Tax Year

� 3115 Application for Change in Ac-counting Method


Accounting PeriodsA “tax year” is an annual accounting periodfor keeping records and reporting income andexpenses. Generally, you can use the follow-ing tax years.

Page 10 Chapter 3 Accounting Periods and Methods

1) A calendar year.

2) A fiscal year.

You adopt a tax year when you file your firstincome tax return. You must adopt your firsttax year by the due date (not including ex-tensions) for filing a return for that year.

Calendar year. If you adopt the calendaryear as your tax year, you must maintain yourbooks and records and report your incomeand expenses from January 1 through De-cember 31 of each year.

If you file your first return using the cal-endar year and you later begin business asa farmer, become a partner in a partnership,or become a shareholder in an S corporation,you must continue to use the calendar yearunless you get IRS approval to change it. Youmust report your income from all sources, in-cluding dividends, farm, salary, and partner-ship, using the same tax year.

Generally, anyone can adopt the calendaryear. However, if any of the following apply,you are required to adopt the calendar year.

1) You do not keep adequate records.

2) You have no annual accounting period.

3) Your present tax year does not qualifyas a fiscal year.

Fiscal year. A fiscal year is 12 consecutivemonths ending on the last day of any monthexcept December. A fiscal year also includesa tax year that varies from 52–53 weeks. Ifyou adopt a fiscal year, you must maintainyour books and records and report your in-come and expenses using the same tax year.

Partnership, S corporation, or personalservice corporation. Special restrictionsapply to the tax year that a partnership, an Scorporation, or a personal service corporationcan adopt. See Partnerships, S Corporations,and Personal Service Corporations in Publi-cation 538.

Accounting MethodsAn accounting method is a set of rules usedto determine when and how income and ex-penses are reported. The term “accountingmethod” includes not only the overall methodof accounting you use, but also the methodof accounting you use for any material item.You must file your tax return using the samemethod you use for your tax records.

You choose your accounting methodwhen you file your first tax return. However,you cannot use the crop method for any taxreturn, including your first tax return, unlessyou get IRS approval. The crop method isdiscussed later. Getting IRS approval tochange an accounting method is discussedlater in Change in Accounting Method.

You can use any of the following ac-counting methods.

1) Cash method.

2) An accrual method.

3) Special methods for certain items of in-come and expenses.

4) Combination (hybrid) method using ele-ments of two or more of the above.

If you have two or more separate anddistinct trades or businesses, you can use a

different accounting method for each busi-ness if you keep a complete and separate setof books and records for each business.

Cash MethodMost farmers use the cash method becausethey find it easier to keep cash method rec-ords. Certain farm corporations and partner-ships, or any tax shelter, cannot use the cashmethod. See Accrual Method, later.

IncomeUnder the cash method, you include all itemsof income (whether in the form of cash,property, or services) you actually or con-structively received during the year in grossincome for that year. If you receive propertyor services, you must include their fair marketvalue in income.

Constructive receipt. Income is construc-tively received when an amount is credited toyour account or made available to you withoutrestriction. You need not have possessionof it. The receipt of a check is constructivereceipt of money, even if you do not depositor cash it in the tax year you receive it. Anamount credited to your account at a bank,store, grain elevator, etc., is constructivelyreceived in the year it is credited.

Installment sale. If you sell an item undera deferred payment contract that calls forpayment the following year, there is no con-structive receipt in the year of sale. However,see the following example for an exception tothis rule.

Example. You are a farmer who uses thecash method and a calendar year. You sellgrain in December 1999 under a bona fidearm's-length contract that calls for paymentin 2000. You include the sale proceeds inyour 2000 gross income since that is the yearpayment is received. However, if the contractsays that you have the right to the proceedsfrom the buyer at any time after the grain isdelivered, you must include the sale price inyour 1999 income, regardless of when youactually receive payment.

Alternative minimum tax. When figuringthe alternative minimum tax, a cash basisfarmer who sells farm property under the in-stallment method can also use that methodto figure his or her alternative minimum taxa-ble income for the year. See the instructionsfor Form 6251.

Items to include in income. Your gross in-come for the tax year includes the following.

1) Cash and the value of merchandise orother property you receive during the taxyear from the sale of livestock, poultry,vegetables, fruits, etc., that you raised.

2) Your profit from the sale of any livestockor other items purchased.

a) To find your profit, deduct the costor other basis of the property, plusselling expenses, from the saleproceeds.

b) You generally cannot deduct thecost of items purchased for resalein the year paid unless the paymentand sale occur in the same year.However, see chapter 5 for infor-mation on when to deduct the cost

of chickens, seeds, and youngplants.

3) Breeding fees, fees from the rent orlease of animals, machinery, or land, andother incidental farm income.

4) All subsidy and conservation paymentsyou receive that are considered income.

5) Your gross income from all othersources.

Crop insurance proceeds can be reportedin income in the year following the year of lossunder certain conditions. See Crop Insuranceand Crop Disaster Payments in chapter 4.

Sales of livestock caused by weather-related conditions can be reported in incomein the year following the year of loss or it canbe treated as an involuntary conversion undercertain conditions. See chapters 4 and 13 formore information.

ExpensesYou deduct farm business expenses only inthe tax year you pay them. This can includefarm business expenses for which you con-test the liability. (See Contested liabilities,later.) However, you cannot deduct certainprepaid expenses for supplies until they areactually used or consumed. In addition, youcan be required to capitalize certain costs.You cannot use an inventory method to figureincome on the cash method or deduct certainprepayments. For more information on pre-paid supplies, interest, and other expenses,see chapter 5.

Accrual MethodUnder an accrual method of accounting, yougenerally report income in the year earnedand deduct or capitalize expenses in the yearincurred. If you use an accrual method of ac-counting, you must use an inventory methodto figure your gross income. The purpose ofthis method of accounting is to match incomeand expenses in the correct year.

IncomeYou generally include an amount as incomefor the tax year in which all events have oc-curred that fix your right to receive the incomeand you can determine the amount with rea-sonable accuracy.

Items to include in income. You figuregross income using increases and decreasesin inventory values of livestock, produce,feed, etc., between the beginning of the yearand the end of the year. A complete inventoryof these items is required for reporting incomeon an accrual method. For more informationon an inventory, see Farm Inventory, later.

Do the following to figure gross incomeon an accrual method.

1) Add the following items.

a) The sales price of all livestock andother products, such as milk, heldfor sale and sold during the year.

b) Inventory value of livestock andproducts on hand and not sold atthe end of the year.

c) Miscellaneous items of income youearn during the year, such asbreeding fees, fees from renting orleasing animals, machinery, or land,or other incidental farm income.

Chapter 3 Accounting Periods and Methods Page 11

d) Subsidy or conservation paymentsyou receive that are considered in-come.

e) Your gross income from all othersources.

2) Then subtract the total of the following.

a) Inventory value of the livestock andproducts you had on hand and notsold at the beginning of the year.

b) Cost of any livestock or productsyou purchased during the year, in-cluding livestock held for draft,dairy, or breeding purposes if theyare included in inventory.

ExpensesYou generally deduct or capitalize an ex-pense in the tax year when all the followingapply.

1) The all-events test has been met:

a) All events have occurred that fix thefact of liability, and

b) The liability can be determined withreasonable accuracy.

2) Economic performance has occurred.

You generally cannot deduct or capitalizefarm business expenses until economic per-formance occurs. If your expense is for prop-erty or services provided to you, or for youruse of property, economic performance oc-curs as the property or services are providedor the property is used. If your expense is forproperty or services that you provide to oth-ers, economic performance occurs as youprovide the property or services. See Eco-nomic Performance under Accrual Method inPublication 538 for more information.

Example 1. John is a farmer who usesa calendar year and an accrual method ofaccounting. In December 1999 John buyssupplies for $200 that are not acquired forresale and that do not become a physical partof any items held for sale. He receives thesupplies and the bill in December 1999,however, he pays the bill in January 2000.

John can deduct the expense in 1999 be-cause all events occurred to fix the liability(the supplies were received but not paid for),the liability can be determined (the unpaid billwas for $200), and economic performanceoccurred in 1999 (the supplies were providedto John in December 1999).

Example 2. Jane is a farmer who usesa calendar tax year and an accrual methodof accounting. She enters into a turnkey con-tract with Waterworks in 1999. The contractstates that Jane must pay Waterworks$200,000 in December 1999 and that theywill install a complete irrigation system, in-cluding a new well, by the close of the year2001. She pays Waterworks $200,000 in De-cember 1999, they start the installation in May2001, and they complete the irrigation systemin December 2001.

Economic performance for Jane's liabilityin the contract occurs as the property andservices are provided. Jane incurs the$200,000 cost in the year 2001.

Accrual Method RequiredA C corporation or a partnership with a Ccorporation partner must generally use anaccrual method of accounting. (This rule doesnot apply to S corporations.) See section448(a) of the Internal Revenue Code.

Tax shelter. A tax shelter farm business isalso required to use an accrual method ofaccounting unless it is excepted from the ruledescribed later in Accrual Method Not Re-quired.

A farm business is a tax shelter if it is apartnership, noncorporate enterprise, or Scorporation and:

1) Avoidance or evasion of federal incometax is the principal purpose of the entity,or

2) It is a farming syndicate. An entity is afarming syndicate if:

a) Interests in the activity have everbeen offered for sale in any offeringrequired to be registered with anyfederal or state agency with theauthority to regulate the offering ofsecurities for sale, or

b) More than 35% of the losses duringthe tax year are allocable to limitedpartners or limited entrepreneurs.

i) A “limited partner” is onewhose personal liability forpartnership debts is limited tothe money or other propertythe partner contributed or isrequired to contribute to thepartnership.

ii) A “limited entrepreneur” is aperson who has an interest inan enterprise other than as alimited partner and does notactively participate in themanagement of the enterprise.

Accrual Method Not RequiredThe following entities engaged in farming cangenerally use the cash method of accounting.

1) An S corporation.

2) A corporation whose gross receipts foreach tax year are $1 million or less.

3) A corporation, or partnership with cor-porate partners, whose trade or businessis operating a nursery or sod farm orraising or harvesting trees, other thanfruit and nut trees.

4) A family farm corporation whose an-nual gross receipts for each tax yearbeginning after 1985 are $25 million orless and it qualifies as one of the fol-lowing corporations in which:

a) Members of the same family ownat least 50% of the total combinedvoting power of all classes of stockentitled to vote and at least 50% ofthe total shares of all other classesof stock of the corporation.

b) Members of two families owned,directly or indirectly, on October 4,1976, and since then, at least 65%of the total combined voting powerof all classes of stock entitled tovote and at least 65% of the totalshares of all other classes of stockof the corporation.

c) Members of three families owned,directly or indirectly, on October 4,1976, and since then, at least 50%of the total combined voting powerof all classes of stock entitled tovote and at least 50% of the totalshares of all other classes of stockof the corporation. Also, substan-tially all of the remaining stock mustbe owned by:

i) Corporate employees,

ii) Their family members, or

iii) A tax-exempt employees' trustfor the benefit of the corpo-ration's employees.

CAUTION!

A corporation (other than an S cor-poration) that is also engaged in anonfarming business activity cannot

use the cash method for the nonfarming ac-tivity if its average annual gross receipts forthe 3 prior tax years are more than $5 million.For this purpose, “farming business” does notinclude processing commodities or productsbeyond those activities normally incident tothe growing, raising, or harvesting of theproduct. For example, processing grain toproduce bread and cereal to sell is not afarming business.

Contested liabilities. If you use the cashmethod of accounting and contest an as-serted liability for any of your farm businessexpenses, you may claim the deduction onlyin the year you pay the liability. If you are anaccrual method taxpayer, however, you candeduct the expense either in the year you paythe contested liability (or transfer money orother property in satisfaction of it) or in theyear you finally settle the contest. However,to be able to take the deduction in the yearof payment or transfer, you must meet certainconditions. For more information, see Con-tested Liability under Accrual Method in Pub-lication 538.

Farm InventoryYou should keep a complete record of yourinventory as part of your farm records. Thisrecord should show the actual count ormeasurement of the inventory. It should alsoshow all factors that enter into its valuation,including quality and weight if they are re-quired.

Items to include in inventory. Your inven-tory should include all items held for sale oruse as feed, seed, etc., whether raised orpurchased, that are unsold at the end of theyear.

Hatchery business. If you are in thehatchery business, you must include eggs inthe process of incubation.

Products held for sale. All harvestedand purchased farm products held for saleor for feed or seed, such as grain, hay, silage,concentrates, cotton, tobacco, etc., must beincluded.

Supplies. You must inventory suppliesacquired for sale or that become a physicalpart of items held for sale. Do not includeother supplies in inventory. Deduct the costof the other supplies in the year used orconsumed in operations. You can also deductincidental supplies in the year of purchase.

Fur-bearing animals. If you are in thebusiness of breeding and raising chinchillas,mink, foxes, or other fur-bearing animals, youare a farmer and these animals are livestock.

Page 12 Chapter 3 Accounting Periods and Methods

You can use any of the inventory and ac-counting methods discussed in this chapter.

Growing crops. You are generally notrequired to inventory growing crops. How-ever, if the crop has a preproductive periodof more than 2 years, you may have to capi-talize (or include in inventory) costs associ-ated with the crop. You cannot take a currentdeduction for costs incurred during the pre-productive period. See Uniform CapitalizationRules in chapter 7.

Required to use accrual method. If you arerequired to use an accrual method of ac-counting:

1) The uniform capitalization rules apply toall costs of raising a plant, even if thepreproductive period of raising a plant is2 years or less.

2) All animals are subject to the uniformcapitalization rules, regardless of age orwhether held primarily for slaughter.

Inventory valuation methods. You cangenerally use the following methods to valueyour inventory:

1) Cost.

2) Lower of cost or market.

3) Farm-price method.

4) Unit-livestock-price method for livestock.

Cost and lower of cost or marketmethods. See Publication 538 for informa-tion on these valuation methods.

Farm-price method. Under this method,each item, whether raised or purchased, isvalued at its market price less the direct costof disposition. Market price is the currentprice at the nearest market in the quantitiesyou usually sell. Cost of disposition includesany broker's commission, freight, hauling tomarket, and other marketing costs.

If you use this method, you must use it foryour entire inventory, except that livestockcan be inventoried on the unit-livestock-pricemethod.

Unit-livestock-price method. Thismethod recognizes the difficulty of establish-ing the exact costs of producing and raisingeach animal. You group or classify livestockaccording to type and age and use a standardunit price for each animal within a class orgroup. The unit price you assign should rea-sonably approximate the normal costs in-curred in producing the animals in suchclasses. Unit prices and classifications aresubject to approval by the IRS on examinationof your return. You cannot change themwithout IRS approval.

If you use this method, you must includeall raised livestock in inventory, regardless ofwhether they are held for sale or for draft,breeding, dairy, or sporting purposes. Thismethod accounts only for the increase in costof raising an animal to maturity. It does notprovide for any decrease in the animal'smarket value after it reaches maturity. Also,if you raise cattle, you are not required to in-ventory hay you grow to feed your herd.

Do not include sold or lost animals in theyear-end inventory. If your records do notshow which animals were sold or lost, treatthe first animals acquired as sold or lost. Theanimals on hand at the end of the year areconsidered the most recently acquired.

You must include in inventory all livestockpurchased primarily for sale. You can include

in inventory livestock purchased for draft,breeding, dairy, or sporting purposes or treatthem as depreciable assets. However, youmust be consistent from year to year, re-gardless of the practice you have chosen.You cannot change your practice unless youget IRS approval.

You must inventory animals purchasedafter maturity or capitalize them at their pur-chase price. If the animals are not mature atpurchase, increase the cost at the end ofeach tax year according to the establishedunit price. However, in the year of purchase,do not increase the cost of any animal pur-chased during the last six months of the year.This rule does not apply to tax shelters, whichmust make an adjustment for any animalpurchased during the year.

Uniform capitalization rules. A farmercan determine costs required to be allocatedunder the uniform capitalization rules by usingthe farm-price or unit-livestock-price inventorymethod. This applies to any plant or animal,even if the farmer does not hold or treat theplant or animal as inventory property.

Cash Versus AccrualMethodThe following examples compare the cashand accrual methods of accounting.

Example 1. You are a farmer who usesan accrual method of accounting. You keepyour books on the calendar year basis. Yousell grain in December 1999, but you are notpaid until January 2000. You must includeboth the sale proceeds and your costs in-curred in producing the grain on your 1999 taxreturn. Under an accrual method of ac-counting, you report your profit or loss for theyear in which all events occurred that fix yourright to receive income from the transactionand you can determine your profit or loss withreasonable accuracy.

Example 2. Assume the facts in Example1 except that you use the cash method andthere was no constructive receipt of the saleproceeds in 1999. Under this method, youinclude the sale proceeds in income for 2000,the year you receive payment. You deduct thecost of producing the grain in the year youpay it.

Special Methodsof AccountingThere are special methods of accounting forcertain items of income and expense.

Crop method. If you do not harvest anddispose of your crop in the same tax year youplant it, you can, with IRS approval, use thecrop method of accounting. Under thismethod, you deduct the entire cost ofproducing the crop, including the expense ofseed or young plants, in the year you realizeincome from the crop.

You cannot use this method for timber orany commodity subject to the uniform cap-italization rules.

Other special methods. Methods of ac-counting for depreciation, depletion, andamortization are explained in chapter 8. Ac-counting for an installment sale is explainedin chapter 12.

Combination (Hybrid)MethodYou can generally use any combination ofcash, accrual, and special methods of ac-counting if it clearly shows your income andexpenses and you use it consistently. How-ever, the following restrictions apply.

1) If an inventory is necessary to accountfor income, you must use an accrualmethod for purchases and sales. Youcan use the cash method for all otheritems of income and expense. See FarmInventory, earlier.

2) If you use the cash method for figuringyour income, you must use the cashmethod for reporting your expenses.

3) If you use an accrual method for report-ing your expenses, you must use an ac-crual method for figuring your income.

Any combination that uses the cash methodis treated as the cash method.

Change inAccounting MethodWhen you file your first return you can chooseany permitted accounting method except thecrop method, discussed earlier, without IRSapproval. The method must clearly show yourincome and be used consistently from yearto year. If you want to change your accountingmethod after that, you must get IRS approvalunless you qualify under one of the ex-ceptions described next under Approval notrequired.

A change in your accounting method in-cludes a change in:

1) Your overall method, such as from cashto an accrual method or vice versa, and

2) Your treatment of any material item,such as a change in your method ofvaluing inventory (for example, a changefrom the “farm-price method” to the“unit-livestock-price method”).

Approval not required. You do not needIRS approval to change your accountingmethod in the following situations.

1) You value livestock inventory at cost orthe lower of cost or market and youchange to the unit-livestock-pricemethod.

2) You are a family farm corporation, described earlier under Accrual MethodNot Required, and you must change toan accrual method because your annualgross receipts are more than $25 million.However, for tax years ending beforeJune 9, 1997, you must establish a sus-pense account to reduce the section481(a) adjustments you must include inincome. In addition, you must ratablyphaseout any existing suspense accountover a 20-year period beginning with thefirst tax year after June 8, 1997. For taxyears ending after June 8, 1997, you canno longer establish a suspense accountto defer reporting the income that resultsfrom the change in method of account-ing. Rather, you must spread the incomeadjustment caused by the change in ac-counting method over a period of 10years beginning with the year of change.See sections 447(i)(5) and 447(f)(3) of

Chapter 3 Accounting Periods and Methods Page 13

the Internal Revenue Code for more in-formation.

3) You have certain deferred paymentsales (DPS) contracts (relating to prop-erty used or produced in your trade orbusiness of farming) and you changeyour method of accounting to the install-ment method for alternative minimum tax(ATM) purposes. See Revenue Proce-dure 98–59 in Internal Revenue BulletinNo. 1998–49 for more information.

Approval required. You need IRS approvalto change your accounting method before youcan do the following.

1) Change from cash to an accrual methodor vice versa.

2) Change the method or basis used tovalue inventory.

3) Adopt any specialized method of com-puting net income, such as the cropmethod, or change the use of a special-ized method.

4) Transfer draft, dairy, or breeding animalsfrom inventory to a fixed asset account.

5) Change from reporting loan proceedsfrom the Commodity Credit Corporation(CCC) as income in the year received toreporting the proceeds as income in theyear the crop securing the loan is for-feited or sold.

Form 3115. Generally, you must file acurrent Form 3115 to get IRS approval tochange your accounting method. You mustfile the form as early as possible during thetax year for which you request the changeand you must furnish the applicable informa-tion requested on the form. You are requiredto send a user fee with the form. However,no user fee is required for an automaticchange (IRS approval not required). See theform instructions, Revenue Procedure 97–27in Cumulative Bulletin 1997–1, Revenue Pro-cedure 98–60 in Internal Revenue BulletinNo. 1998–51, and Publication 538 for moreinformation.

If you want to change your method of re-porting CCC loans, you must request IRSapproval during the first 180 days of the taxyear. See Revenue Procedure 83–77 in Cu-mulative Bulletin 1983–2. See CommodityCredit Corporation (CCC) Loans in chapter 4for information on CCC loans.

Extension of time to file Form 3115.The IRS will grant you an extension only inunusual and compelling circumstances. SeeRevenue Procedure 97–27 in CumulativeBulletin 1997–1, Revenue Procedure 99–1 inInternal Revenue Bulletin No. 1999–1, andsection 301.9100–3(c)(2) of the regulationsfor more information. A separate user fee isrequired for requesting extensions.

4.Farm Income

Important ReminderAveraging of farm income. For tax yearsbeginning after 1997, individual farmers canchoose to average all or part of their taxablefarm income. See Farm Income Averaging.

IntroductionYou may receive income from many sources.You must report the income on your tax re-turn, unless it is excluded by law. Where youreport the income depends on its source.

This chapter discusses farm income youreport on Schedule F. For information onwhere to report other income, see the in-structions for Form 1040.

Accounting method. The rules discussedin this chapter assume you use the cashmethod of accounting. Under the cashmethod, you generally include an item of in-come in gross income when you receive it.See Cash Method in chapter 3.

If you use an accrual method of account-ing, you may have to make changes to therules in this chapter. See Accrual Method inchapter 3.


• Schedule F

• Sales of livestock and produce

• Rents (including crop shares)

• Agricultural program payments

• Income from cooperatives

• Cancellation of debt

• Income from other sources

• Farm income averaging


Publication

� 525 Taxable and Nontaxable Income

� 550 Investment Income and Expenses

� 908 Bankruptcy Tax Guide

� 925 Passive Activity and At-Risk Rules


� Sch E (Form 1040) SupplementalIncome and Loss

� Sch F (Form 1040) Profit or Loss FromFarming

� Sch J (Form 1040) Farm Income Aver-aging

� 982 Reduction of Tax Attributes Dueto Discharge of Indebtedness

(and Section 1082 Basis Adjust-ment)

� 1099–G Certain Government and Qual-ified State Tuition Program Pay-ments

� 1099–PATR Taxable DistributionsReceived From Cooperatives

� 4797 Sales of Business Property

� 4835 Farm Rental Income andExpenses


Schedule FReport your farm income on Schedule F(Form 1040). Use this schedule to figure thenet profit or loss from regular farming oper-ations.

Income from farming reported on Sched-ule F includes amounts you receive from cul-tivating, operating, or managing a farm forgain or profit, either as owner or tenant. Thisincludes income from operating a stock, dairy,poultry, fish, fruit, or truck farm and incomefrom operating a plantation, ranch, range, ororchard. It also includes income from the saleof crop shares if you materially participate inproducing the crop. See Rents (IncludingCrop Shares), later.

Income reported on Schedule F does notinclude gains or losses from sales of the fol-lowing.

• Land or depreciable farm equipment.

• Buildings and structures.

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

Gains and losses from the sale of farmingassets, such as machinery and land, are dis-cussed in chapters 10 and 11. Gains andlosses from casualties, thefts, and condem-nations are discussed in chapter 13.

Sales of Livestockand ProduceWhen you sell produce or livestock (includingpoultry) you raised for sale or bought for re-sale on your farm, the entire amount you re-ceive is ordinary income. This includes moneyand the fair market value of any property orservices you receive.

Where to report. Table 4–1 shows where toreport the sale of produce and livestock onyour tax return.

Schedule F. When you sell produce orlivestock bought for resale, your profit or lossis the difference between your basis in theitem and any money plus the fair market valueof any property you receive for it. Basis usu-ally will be your cost. See chapter 7 for infor-mation on the basis of assets. Report theseamounts on Schedule F for the year you re-ceive payment.

Example. In 1998, you bought 50 feedercalves for $6,000. You sold them in 1999 for$11,000. You report the $6,000 basis, the$11,000 sales price, and the resulting $5,000profit in Part 1 of your 1999 Schedule F.

Page 14 Chapter 4 Farm Income

Table 4–1. Where To Report Sales of Livestock and Produce

Livestock and produce raised for sale

Livestock and produce bought for resale

Animals not held primarily for sale

Livestock held for draft, breeding, dairy, orsporting purposes (bought or raised)

Item Sold Schedule F Form 4797

X

X

X

X

• A statement that you are making a choiceunder section 451(e) of the Internal Rev-enue Code.

• Evidence of the weather-related condi-tions that forced the early sale or ex-change of the livestock and the date, ifknown, on which an area was designatedas eligible for assistance by the federalgovernment because of weather-relatedconditions.

• A statement explaining the relationshipof the area affected by the weather-related condition to your early sale orexchange of the livestock.

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

• The number of animals you would havesold in the tax year had you followed yournormal business practice.

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

• A computation, as described earlier, ofthe income to be postponed for eachclass of livestock.

You must file the statement and the returnby the due date of the return, including ex-tensions. If you timely filed your return for theyear without making the choice, you can stillmake the choice by filing an amended returnwithin six months of the due date of the return(excluding extensions). Attach the statementto the amended return and write “Filed pur-suant to section 301.9100–2” at the top of thestatement. File the amended return at thesame address you filed the original return.Once you have made the choice, you canchange it only with the approval of the IRS.

Rents (IncludingCrop Shares)The rent you receive for the use of your farmland is generally rental income, not farm in-come. However, if you materially participatein farming operations on the land, the rent isfarm income. See Landlord Participation inFarming in chapter 15.

Pasture income and rental. If you pasturesomeone else's cattle and take care of thelivestock for a fee, the income is from yourfarming business. You must enter it as Otherincome on Schedule F. If you simply rent yourpasture for a flat cash amount without pro-viding services, report the income as rent inPart I of Schedule E (Form 1040).

Crop SharesYou must include rent you receive in the formof crop shares in income in the year youconvert the shares to money or the equivalentof money. It does not matter whether you usethe cash method of accounting or an accrualmethod of accounting. If you materially par-ticipate in operating a farm from which youreceive rent in the form of crop shares orlivestock, the rental income is subject to self-employment tax. (See Landlord Participationin Farming in chapter 15.) Report the rentalincome on Schedule F.

If you do not materially participate in op-erating the farm, report this income on Form4835 and carry the net income or loss to

Form 4797. Sales of livestock held fordraft, breeding, dairy, or sporting purposesmay result in ordinary or capital gains orlosses, depending on the circumstances. Ineither case, you should always report thesesales on Form 4797 instead of ScheduleF. Animals you do not hold primarily for saleare considered business assets of your farm.See Livestock under Ordinary or Capital Gainor Loss in chapter 10.

Sale by agent. If your agent sells yourproduce or livestock, you must include the netproceeds from the sale in gross income forthe year the agent receives payment. Thisapplies even if you arrange for the agent topay you in a later year. See Constructive re-ceipt under Cash Method in chapter 3.

Sales Caused byWeather-Related ConditionsIf you sell more livestock, including poultry,than you normally would in a year becauseof a drought, flood, or other weather-relatedcondition, you may be able to choose to in-clude the gain from selling the additional ani-mals in the following year's income. You mustmeet all the conditions below to qualify.

• Your principal trade or business is farm-ing.

• You use the cash method of accounting.

• You can show that, under your usualbusiness practices, you would not havesold the animals this year except for theweather-related condition.

• The weather-related condition resulted inan area being designated as eligible forassistance by the federal government.

Sales made before the area became eli-gible for federal assistance qualify if theweather-related condition that caused thesale also caused the area to be designatedas eligible for federal assistance. The desig-nation can be made by the President, theDepartment of Agriculture (or any of itsagencies), or by other federal agencies.

TIPA weather-related sale of livestock(other than poultry) held for draft,breeding, or dairy purposes also

qualifies as an involuntary conversion. If youplan to replace the livestock, see Other In-voluntary Conversions in chapter 13 for moreinformation.

Usual business practice. Determine thenumber of animals you would have sold hadyou followed your usual business practice inthe absence of the weather-related condition.Do this by considering all the facts and cir-cumstances. If you have not yet establisheda usual business practice, rely on the usualbusiness practices of similarly situated farm-ers in your general region.

Weather-related sales in successive years.If you make this choice in successive years,the following special rules prevent your choicein the first year from adversely affecting yourchoice in the second year.

• Do not include the amount deferred fromone year to the next as received from thesale or exchange of livestock in the lateryear when figuring the amount to bepostponed. See Amount to be post-poned, later, which describes the com-putation.

• To determine your normal businesspractice for the later year, exclude anyearlier year for which you made thischoice.

Connection with area affected byweather-related condition. The livestockdoes not have to be raised or sold in an areaaffected by a weather-related condition for thepostponement to apply. However, the salemust occur solely because of weather-relatedconditions that affected the water, grazing,or other requirements of the livestock so thatthe sale became necessary.

Classes of livestock. You must make thechoice separately for each generic class ofanimals — for example, hogs, sheep, andcattle. You must also figure separately theamount to be postponed for each class ofanimals. Do not make a separate choicesolely because of an animal's age, sex, orbreed.

Amount to be postponed. Follow thesesteps to figure the amount to be postponedfor each class of animals.

1) Divide the total income realized from thesale of all livestock in the class duringthe tax year by the total number of suchlivestock sold.

2) Multiply the result in (1) by the excessnumber of such livestock sold solely be-cause of weather-related conditions.

Example. You are a calendar year tax-payer and you normally sell 100 head of beefcattle a year. As a result of drought, you sold135 head during 1999. You realized $35,100from the sale. On August 9, 1999, as a resultof drought, the affected area was declared adisaster area eligible for federal assistance.The income you can choose to postpone until2000 is $9,100 [($35,100 ÷ 135) × 35].

How to make the choice. To make thechoice, attach a statement to your tax returnfor the year of the sale. The statement mustinclude your name and address and give thefollowing information for each class of live-stock for which you make the choice.

Chapter 4 Farm Income Page 15

Schedule E (Form 1040). The income is notsubject to self-employment tax.

Crop shares you use to feed livestock.Crop shares you receive as a landlord andfeed to your livestock are considered con-verted to money when fed to the livestock.You must include the fair market value of thecrop shares in income at that time. You areentitled to a business expense deduction forthe livestock feed in the same amount andat the same time you include the fair marketvalue of the crop share as rental income. Al-though these two transactions would canceleach other for figuring adjusted gross incomeon Form 1040, they may be necessary tofigure your self-employment tax. See chapter15.

Crop shares you give to others (gift). Cropshares you receive as a landlord and give toothers are considered converted to moneywhen you make the gift. You must report thefair market value of the crop share as income,even though someone else receives paymentfor the crop share.

Example. A tenant farmed part of yourland under a crop-share arrangement. Thetenant harvested and delivered the crop inyour name to an elevator company. Beforeselling any of the crop, you instructed the el-evator company to cancel your warehousereceipt and make out new warehouse receiptsin equal amounts of the crop in the names ofyour children. They sell their crop shares inthe following year and the elevator companymakes payments directly to your children.

In this situation, you are considered tohave received rental income and then madea gift of that income. You must include the fairmarket value of the crop shares in your in-come for the tax year you gave the cropshares to your children.

Crop share loss. If you are involved in arental or crop-share lease arrangement, anyloss from these activities may be subject tothe limits under the passive loss rules. SeePublication 925 for information on these rules.

AgriculturalProgram PaymentsYou must include in income most governmentpayments, such as those for approved con-servation practices and production flexibilitycontracts, whether you receive them in cash,materials, services, or commodity certificates.However, you can exclude some paymentsyou receive under certain cost-sharing con-servation programs. See Cost-Sharing Ex-clusion (Improvements), later.

Report the agricultural program paymenton the appropriate line in Part I of ScheduleF. Report the full amount even if you returna government check for cancellation, refundany of the payment you receive, or the gov-ernment collects all or part of the paymentfrom you by reducing the amount of someother payment or Commodity Credit Corpo-ration loan. However, you can deduct theamount you refund or return or that reducessome other payment or loan to you. Claim thededuction on Schedule F for the year of re-payment or reduction.

Refundsof AgriculturalProgram Expenses

Refunds of malting barley assessments.A farmer who participates in the maltingbarley production program of the CommodityCredit Corporation (CCC) receives a barleysubsidy benefit and pays a malting barleyassessment. The barley subsidy benefit isreported to the farmer and to the IRS on FormCCC–1099–G, Certain Government Pay-ments. If the farmer does not sell the barleyfor malting purposes, the farmer is eligible toreceive a refund of the malting barley as-sessment. If the farmer receives the refund ina year after the assessment was paid, howthe farmer reports the refund depends onwhether the farmer claimed the assessmentas an expense in the year it was paid. Thefollowing example shows how to report re-funds of malting barley assessments.

Example. Lee White is a farmer. He uses thecash method of accounting and files his taxreturn on a calendar year basis. He partic-ipated in the malting barley production pro-gram and received a $2,850 payment fromthe CCC in 1998. The payment was Lee's$3,000 barley subsidy benefit less the maltingbarley assessment ($150) he had to pay forthe barley produced. Lee received a FormCCC–1099–G for 1998 showing the $3,000barley subsidy benefit. In 1999, Lee provedthat he did not sell the barley for maltingpurposes and received a refund of the $150malting barley assessment. He receives a1999 Form CCC–1099–G for the refundshowing a “Barley Assessment Deficiency”of $150.

Assessment claimed as an expense.For 1998, Lee reported $3,000 of farm in-come from the barley subsidy benefit. Heclaimed the $150 malting barley assessmentas a farm expense in Part II of his 1998Schedule F (Form 1040). Lee received a taxbenefit from the deduction because it reducedhis 1998 tax liability. Lee includes the $150refund (barley assessment deficiency) as in-come in Part I of his 1999 Schedule F (Form1040).

Assessment not claimed as an ex-pense. For 1998, Lee reported the $3,000barley subsidy benefit as income, but did notclaim the $150 assessment as an expense.Because Lee received no tax benefit from thepayment of the assessment in 1998, he doesnot include the refund (barley assessmentdeficiency) as income for 1999. He includesthe $150 refund on line 6a of Schedule F, butdoes not include it as a taxable amount online 6b.

Payments made under the Dairy RefundPayment Program (DRPP). The DRPP, ad-ministered by the CCC, refunds the re-ductions in price received by eligible produc-ers during a calendar year. Milk processors,milk handlers, and others responsible for themarketing of milk withhold the reductions inprice from their payments to the producersand send the withheld amounts to the CCC.If the producer can prove that milk marketingfor the current year was not more than milkmarketing for the prior year, the producer iseligible for a refund of the reductions in price.Typically, an eligible producer receives a re-fund of the reductions in price in a year afterthe reductions occurred. Proper reporting of

the refund depends on whether the producerclaimed the reductions in price as an expensein the year they occurred. The following ex-ample shows how to report refunds of re-ductions in price.

Example. Sam Brown is a milk producer.He uses the cash method of accounting andfiles his tax return on a calendar year basis.The marketing of Sam's milk is subject to re-ductions in price. In 1998, Sam had grossreceipts of $200,000 from milk sales and had$3,000 withheld as reductions in price. Samproved that his 1998 milk marketing was notmore than his 1997 marketing. In 1999, Samreceived a $3,000 refund from the CCC of the1998 reductions in price. Sam receives a1999 Form CCC–1099–G for the refundshowing a “Milk Marketing Fee” of $3,000.

Reductions claimed as an expense. For1998, Sam reported $200,000 of farm incomefrom milk sales. He claimed the $3,000 re-ductions in price as a farm expense in Part IIof his 1998 Schedule F (Form 1040). Samreceived a tax benefit from the deduction be-cause it reduced his 1998 tax liability. Samincludes the $3,000 refund (milk marketingfee) as income in Part I of his 1999 ScheduleF (Form 1040).

Reductions not claimed as an expense.For 1998, Sam reported milk sales incomeof $200,000, but did not claim the reductionsin price for his milk as an expense. BecauseSam received no tax benefit from the re-ductions in price in 1998, he does not includethe refund (milk marketing fee) as income for1999. He includes the $3,000 refund on line6a of Schedule F, but does not include it asa taxable amount on line 6b.

Commodity CreditCorporation (CCC) LoansNormally, you do not report loans you receiveas income, and you report income from a cropfor the year you sell it. However, if you pledgepart or all of your production to secure a CCCloan, you can choose to treat the loan as if itwere a sale of the crop and report the loanproceeds as income for the year you receivethem. You do not need permission from theIRS to adopt this method of reporting CCCloans, even though you may have reportedthose received in earlier years as taxable in-come for the year you sold the crop.

Once you report a CCC loan as incomefor the year received, you must report all CCCloans in that year and later years in the sameway, unless you get permission from the IRSto change to a different method. See Changein Accounting Method in chapter 3.

TIPYou can request income tax with-holding on CCC loan payments madeto you. Use Form W–4V, Voluntary

Withholding Request. See chapter 21 for in-formation about ordering the form.

To make the choice to report a loan asincome, include the loan as income on line7a of Schedule F for the year you receive it.Attach a statement to your return showing thedetails of the loan.

When you make this choice, the amountyou report as income becomes your basis inthe commodity. See chapter 7 for informationon the basis of assets. If you later repay theloan, redeem the pledged commodity, andsell it, you report as income at the time of salethe sale proceeds minus your basis in thecommodity. If the sale proceeds are less than


your basis in the commodity, you can reportthe difference as a loss on Schedule F.

If you forfeit the pledged crops to the CCCin full payment of the loan, the forfeiture istreated for tax purposes as a sale of thecrops. If you did not choose to report the loanproceeds as income for the year you receivedthem, you must include them in your incomefor the year of the forfeiture. If you chose toreport the loan proceeds as income for theyear you received them, and the amount ofthe forfeited loan is less than your basis in thecommodity, you can report the difference asa loss on Schedule F.

Market GainUnder the CCC nonrecourse marketing as-sistance loan program, your repaymentamount for a loan secured by your pledge ofan eligible commodity is generally based onthe lower of the loan rate or the prevailingworld market price for the commodity on thedate of repayment. If you repay the loan whenthe world price is lower, the difference be-tween that repayment amount and the re-payment amount based on the loan rate ismarket gain. You will receive a FormCCC–1099–G, Certain Government Pay-ments, showing the market gain you realized.If you chose to include the CCC loan in in-come in the year you received it, do not in-clude the amount shown on FormCCC–1099–G in income. The following ex-amples show how to report market gain.

Example 1. Mike Green is a cotton farmer.He uses the cash method of accounting andfiles federal income tax returns on a calendaryear basis. He has currently deducted all ex-penses incurred in producing the cotton andhas a zero basis in the commodity. In 1998,Mike pledged 1,000 pounds of cotton ascollateral for a CCC price support loan of$500 (a loan rate of $.50 per pound). In 1999,he repaid the loan and redeemed the cottonfor $420 when the world price was $.42 perpound. Later in 1999, he sold the cotton for$600.

The market gain on the redemption was$.08 ($.50 – $.42) per pound. Mike receiveda Form CCC–1099–G from the CCC showingmarket gain of $80 ($.08 x 1,000 pounds).How he reports this market gain and figureshis gain or loss from the sale of the cottondepends on whether he chose to include CCCloans in income in 1998.

With choice. Because Mike reported the$500 CCC loan as income for 1998, he istreated as though he sold the cotton for $500when he pledged it and repurchased the cot-ton for $420 when he redeemed it. The $80market gain is not recognized on the re-demption. He reports it for 1999 as an “Agri-cultural program payment” on line 6a ofSchedule F, but does not include it on line 6bas taxable income.

Mike's basis in the cotton after he re-deemed it was $420, which is the redemption(repurchase) price paid for the cotton. Hisgain from the sale is $180 ($600 – $420). Hereports it as income for 1999 on line 4 ofSchedule F.

Without choice. Mike has income of $80from market gain in 1999. He reports it onboth line 6a and line 6b of Schedule F. Be-cause his basis in the cotton is zero, his gainfrom its sale is $600. He reports the $600 gainas income for 1999 on line 4 of Schedule F.

Example 2. The facts are the same as inExample 1 except that, instead of selling thecotton for $600 after redeeming it, Mike en-tered into an option-to-purchase contract withTom Merchant before redeeming the cotton.Under that contract, Mike authorized Tom topay the CCC loan on Mike's behalf. In 1999,Tom repaid the loan for $420 and immediatelyexercised his option, buying the cotton for$420. How Mike reports the $80 market gainon the redemption of the cotton and figureshis gain or loss from its sale depends onwhether he chose to include CCC loans inincome in 1998.

With choice. As in Example 1, Mike istreated as though he sold the cotton for $500when he pledged it and repurchased the cot-ton for $420 when Tom redeemed it for him.The $80 market gain is not recognized on theredemption. Mike reports it for 1999 as an“Agricultural program payment” on line 6a ofSchedule F, but does not include it on line 6bas taxable income.

Also as in Example 1, Mike's basis in thecotton when Tom redeemed it for him was$420. Therefore, Mike has no gain or loss onits sale to Tom for that amount.

Without choice. As in Example 1, Mikehas income of $80 from market gain in 1999.He reports it on both line 6a and line 6b ofSchedule F. Because his basis in the cottonis zero, his gain from its sale is $420. He re-ports it as income for 1999 on line 4 ofSchedule F.

Conservation ReserveProgram (CRP)Under the Conservation Reserve Program(CRP), if you own or operate highly erodibleor other specified cropland, you may enterinto a long-term contract with the USDA,agreeing to convert to a less intensive use ofthat cropland. You must include paymentsunder the program in your income, whetherreceived in cash, commodity certificates, ora combination of cash and certificates.

Crop Insurance andCrop Disaster PaymentsYou must include in income any crop insur-ance proceeds you receive as the result ofcrop damage. You generally include them inthe year you receive them. Treat as crop in-surance proceeds the crop disaster paymentsyou receive from the federal government asthe result of destruction or damage to crops,or the inability to plant crops, because ofdrought, flood, or any other natural disaster.

TIPYou can request income tax with-holding from crop disaster paymentsyou receive from the federal govern-

ment. Use Form W–4V, Voluntary Withhold-ing Request. See chapter 21 for informationabout ordering the form.

Choice to postpone reporting until thefollowing year. If you use the cash methodof accounting and receive crop insuranceproceeds in the same tax year in which thecrops are damaged, you can choose to post-pone reporting the proceeds as income untilthe following tax year. You can make thischoice if you can show you would have in-cluded income from the damaged crops in

any tax year following the year the damageoccurred.

To choose to postpone reporting crop in-surance proceeds received in 1999, report theamount you received on line 8a of ScheduleF, but do not include it as taxable income online 8b. Check the box on line 8c and attacha statement to your tax return. The statementmust include your name and address andcontain the following information.

• A statement that you are making a choiceunder section 451(d) of the Internal Rev-enue Code and section 1.451–6 of theregulations.

• The specific crop or crops destroyed ordamaged.

• A statement that under your normalbusiness practice you would have in-cluded income from the destroyed ordamaged crops in gross income for a taxyear following the year the crops weredestroyed or damaged.

• The cause of the destruction or damageand the date or dates it occurred.

• The total amount of payments you re-ceived from insurance carriers, itemizedfor each specific crop, and the date youreceived each payment.

• The name of each insurance carrier fromwhom you received payments.

One choice covers all crops representinga single trade or business. If you have morethan one farming business, make a separatechoice for each one. For example, if you op-erate two separate farms on which you growdifferent crops, and you keep separate booksfor each farm, you should make two separatechoices to postpone reporting insurance pro-ceeds you receive for crops grown on eachof your farms.

A choice is binding for the year. To re-quest IRS approval to change your choice,write to your IRS District Director giving yourname, address, identification number, theyear you made the choice, and your reasonsfor wanting to change it.

Feed Assistanceand PaymentsThe Disaster Assistance Act of 1988 author-izes programs to provide feed assistance,reimbursement payments, and other benefitsto qualifying livestock producers if the Secre-tary of Agriculture determines that, becauseof a natural disaster, a livestock emergencyexists. These programs include partial re-imbursement for the cost of purchased feedand for certain transportation expenses. Theyalso include the donation or sale at a below-market price of feed owned by the CommodityCredit Corporation.

You must include these benefits in incomein the year you receive them. You cannotpostpone reporting them under the rules ex-plained earlier for weather-related sales oflivestock or crop insurance proceeds. Reportthe benefits in Part I, Schedule F, as agricul-tural program payments.

Include in income the market value of do-nated feed, the difference between the marketvalue and the price you paid, or any cost re-imbursement you receive. You can usuallytake a current deduction for the same amountas a feed expense.


Cost-SharingExclusion (Improvements)You can exclude from your income part or allof a payment you receive under certain fed-eral or state cost-sharing conservation, rec-lamation, and restoration programs. The“payment” is any economic benefit you getas a result of an improvement. However, thisexclusion applies only to that part of a pay-ment that meets all three of the followingtests.

• It was for a capital expense. You cannotexclude any part of a payment for an ex-pense you can deduct in the year you payor incur it. You must include the paymentin income and take any offsetting de-duction. (See chapter 6 for informationon deducting soil and water conservationexpenses.)

• It does not substantially increase yourannual income from the property forwhich it is made. An increase in annualincome is substantial if it is more than thegreater of 10% of the average annual in-come derived from the affected propertybefore receiving the improvement or anamount equal to $2.50 times the numberof affected acres.

• The Secretary of Agriculture certified thatthe payment was made primarily forconserving soil and water resources,protecting or restoring the environment,improving forests, or providing a habitatfor wildlife.

If the three tests above are met, you canexclude payments from the following pro-grams.

• The rural clean water program authorizedby the Federal Water Pollution ControlAct.

• The rural abandoned mine program au-thorized by the Surface Mining Controland Reclamation Act of 1977.

• The water bank program authorized bythe Water Bank Act.

• The emergency conservation measuresprogram authorized by title IV of the Ag-ricultural Credit Act of 1978.

• The agricultural conservation programauthorized by the Soil Conservation andDomestic Allotment Act.

• The great plains conservation programauthorized by the Soil Conservation andDomestic Policy Act.

• The resource conservation and develop-ment program authorized by theBankhead-Jones Farm Tenant Act andby the Soil Conservation and DomesticAllotment Act.

• The forestry incentives program author-ized by the Cooperative Forestry Assist-ance Act of 1978.

• Certain small watershed programs, listedbelow.

• Any program of a state, possession of theUnited States, a political subdivision ofany of these, or the District of Columbiaunder which payments are made to indi-viduals primarily for conserving soil, pro-tecting or restoring the environment, im-proving forests, or providing a habitat forwildlife. Several state programs have

been approved. For information about thestatus of those programs, contact thestate offices of the Farm Service Agency(FSA) and the Natural Resources andConservation Service (NRCS).

You can exclude payments you receiveunder the following programs for improve-ments made in connection with a watershed.

• The Stewardship Incentive Program un-der title XII of the Food, Agriculture,Conservation, and Trade Act of 1990.

• The programs under the Watershed Pro-tection and Flood Prevention Act of 1954.

• The flood prevention projects under theFlood Control Act of 1944.

• The Emergency Watershed ProtectionProgram under the Flood Control Act ofMay 17, 1950.

• Certain programs under the ColoradoBasin Salinity Act of 1974.

• The wetlands reserve program author-ized by title XII of the Food Security Actof 1985 and by the Federal AgricultureImprovement and Reform Act of 1996.

• The environmental quality incentive pro-gram authorized by the Federal Agricul-ture Improvement and Reform Act of1996.

• The wildlife habitat incentives programauthorized by the Federal AgricultureImprovement and Reform Act of 1996.

Income realized. The gross income you re-alize upon getting an improvement underthese cost-sharing programs is the value ofthe improvement reduced by the sum of theexcludable portion and your share of the costof the improvement.

Value of the improvement. You deter-mine the value of the improvement by multi-plying its fair market value (defined in chapter12) by a fraction. The numerator of the frac-tion is the total cost of the improvement (allamounts paid either by you or by the gov-ernment for the improvement), reduced by thesum of the following three items.

1) Any government payments under a pro-gram not listed earlier.

2) Any portion of a government paymentunder a program listed earlier that theSecretary of Agriculture has not certifiedas primarily for purposes of conserva-tion.

3) Any government payment to you for rentor for your services.

The denominator of the fraction is the totalcost of the improvement.

Excludable portion. The excludableportion is the present fair market value of theright to receive annual income from the af-fected acreage of the greater of the followingamounts.

1) 10% of the prior average annual incomefrom the affected acreage. The “prioraverage annual income” is the averageof the gross receipts from the affectedacreage for the last 3 tax years beforethe tax year in which you started to installthe improvement.

2) $2.50 times the number of affectedacres.

CAUTION!

The calculation of “present fair marketvalue” is too complex to discuss in thispublication. You may need to consult

your tax advisor for assistance.

Example. One hundred acres of yourland was reclaimed under a contract with theNatural Resources Conservation Service ofthe USDA. The total cost of the improvementwas $500,000. The USDA paid $490,000.You paid $10,000. The value of the cost-sharing improvement is $15,000.

The present fair market value of the rightto receive (1) above is $1,380 and the valueof the right to receive (2) is $1,550. Theexcludable portion is the greater amount,$1,550.

You figure the amount to include in grossincome as follows:

Effects of the exclusion. When you figurethe basis of property you acquire or improveusing cost-sharing payments excluded fromincome, subtract the excluded payments fromyour capital costs. Any payment excludedfrom income is not part of your basis.

In addition, you cannot take depreciation,amortization, or depletion deductions for thepart of the cost of the property for which youreceive cost-sharing payments you excludefrom income.

How to report the exclusion. Attach astatement to your tax return (or amended re-turn) for the tax year you receive the lastgovernment payment for the improvement.The statement must include the followingitems.

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

• The value of the improvement.

• The amount you are excluding.

Report the total cost-sharing paymentsyou receive on line 6a, Schedule F, and thetaxable amount on line 6b.

Recapture. If you dispose of the propertywithin 20 years after you get it, you must treatas ordinary income part or all of the cost-sharing payments you excluded. You mustreport the recapture on Form 4797. SeeSection 1255 property under Other FarmProperty in chapter 11.

Choosing not to exclude payments. Youcan choose not to exclude all or part of anypayments you receive under these programs.You must make this choice by the due date,including extensions, for filing your return. Ifyou timely filed your return for the year with-out making the choice, you can still make thechoice by filing an amended return within sixmonths of the due date of the return (exclud-ing extensions). Write “Filed pursuant to sec-tion 301.9100–2” at the top of the amendedreturn and file it at the same address you filedthe original return. If you choose not to ex-clude these payments, none of the above re-strictions and rules apply.

Value of cost-sharing improvement ........... $15,000Minus: Your share ....................... $10,000

Excludable portion ........... 1,550 11,550

Amount included in income ................... $3,450


Other PaymentsYou must include other government programpayments in income as explained below.

Fertilizer and LimeInclude in income the value of fertilizer or limeyou received under a government program.How you claim the offsetting deduction is ex-plained under Fertilizer and Lime in chapter5.

ImprovementsIf government payments are based on im-provements, such as a pollution control facil-ity, you must still include them in income. Youmust capitalize the full cost of the improve-ment. Since you have included the paymentsin income, they do not reduce your basis.However, see Cost-Sharing Exclusion (Im-provements) earlier, for additional informa-tion.

Payment to MoreThan One PersonThe USDA reports program payments to theIRS. It reports a program payment intendedfor more than one person as having been paidto the person whose identification number ison record for that payment (payee of record).If you, as the payee of record, receive a pro-gram payment belonging to someone else,such as your landlord, the amount belongingto the other person is a nominee distribution.You should file Form 1099–G to report theidentity of the actual recipient to the IRS. Youshould also give this information to the recip-ient. You can avoid the inconvenience of un-necessary inquiries about the identity of therecipient if you file this form.

See chapter 21 for information about or-dering Form 1099–G.

Income FromCooperativesIf you buy farm supplies through a cooper-ative, you may receive income from the co-operative in the form of patronage dividends(distributions). If you sell your farm productsthrough a cooperative, you may receive pa-tronage dividends or a per-unit retain certif-icate, explained later, from the cooperative.

Form 1099–PATR. The cooperative will re-port the income to you on Form 1099–PATRor a similar form and send a copy to the IRS.Form 1099–PATR may also show an alter-native minimum tax adjustment that you mustinclude if you are required to file Form 6251,Alternative Minimum Tax—Individuals.

Patronage Dividends(Distributions)You generally report patronage dividends youreceive as income on lines 5a and 5b ofSchedule F for the tax year you receive them.They include the following items.

• Money paid as a patronage dividend.

• The stated dollar value of qualified writtennotices of allocation.

• The fair market value of other property.

Qualified written notice of allocation. Aqualified written notice of allocation is taxableat its stated dollar value in the year received.To be qualified, it must be paid as part of apatronage dividend, or a payment by a coop-erative, in which 20% or more of the dividendor payment is paid in money or a qualifiedcheck. It must also meet one of the followingconditions.

1) It must be redeemable in cash for atleast 90 days after it is issued, and youmust have received a written notice ofyour right of redemption at the same timeas the written notice of allocation.

2) You must have agreed to include thestated dollar value in income in the yearyou receive the notice by doing one ofthe following.

a) Signing and giving a written agree-ment to the cooperative.

b) Getting or keeping membership inthe cooperative after it adopted abylaw providing that membershipconstitutes agreement. The coop-erative must notify you in writing ofthis bylaw and give you a copy.

c) Endorsing and cashing a qualifiedcheck, paid as part of the writtennotice of allocation, by the 90th dayafter the close of the payment pe-riod for the tax year of the cooper-ative.

Loss on redemption. You can deduct inPart II of Schedule F any loss incurred on theredemption of a qualified written notice of al-location you received in the ordinary courseof your farming business. The loss is thedifference between the stated dollar amountof the qualified written notice you included inincome and the amount you received whenyou redeemed it.

Nonqualified notices of allocation. Anywritten notices of allocation that do not meetthe conditions explained earlier under Qual-ified written notice of allocation are nonqual-ified notices. Do not include the stated dollarvalue of nonqualified notices in income whenyou receive them. Your basis in a nonqual-ified notice of allocation is zero. You must in-clude in income for the tax year of dispositionany amount you receive from the sale, re-demption, or other disposition of a nonqual-ified written notice. Include it, up to the stateddollar value of the notice, as ordinary incomein Part I of Schedule F. You must include anyamount that is more than the stated dollarvalue as the type of income it represents. Forexample, if it represents interest income, in-clude it on your return as interest.

Purchase of depreciable property or capi-tal assets. Do not include in income divi-dends from the purchase of capital assets ordepreciable property used in your business.You must, however, reduce the basis of theseassets by the dividends. If the dividends aremore than your unrecovered cost, include thedifference as ordinary income on Schedule Ffor the tax year you receive them. Include allthese dividends on line 5a of Schedule F, butinclude only the taxable part on line 5b.

Example. On July 1, 1998, Mr. Brown, apatron of a cooperative association, boughta machine for his dairy farm business from

the association for $2,900. The machine hasa life of 7 years under MACRS (as providedin the Table of Class Lives and RecoveryPeriods in Publication 946). Mr. Brown fileshis return on a calendar year basis. For 1998,he claimed a depreciation deduction of $311,using the 10.71% depreciation rate from the150% declining balance, half-year conventiontable (shown in Table A–14 in Appendix A ofPublication 946). On July 1, 1999, the coop-erative association paid Mr. Brown a $300cash patronage dividend for his purchase ofthe machine. Mr. Brown adjusts the basis ofthe machine and figures his depreciation de-duction for 1999 (and later years) as follows.

Exceptions. If the dividends come fromthe selling or buying of capital assets ordepreciable property used in your businessand you did not own the property at any timeduring the year you received them, you mustinclude the dividends in income unless oneof the following two exceptions applies.

• If the dividends relate to a capital assetyou held for more than 1 year for whicha loss was or would have been deduct-ible, treat them as gain from the sale orexchange of a capital asset held for morethan 1 year.

• If the dividends relate to a capital assetfor which a loss was not or would nothave been deductible, do not report themas income (ordinary or capital gain).

If you receive a dividend from selling acapital asset or depreciable property used inyour business in the same year the asset wassold, treat it as an additional amount receivedon the sale or other disposition of the asset.

If you cannot determine from which itemthe dividend comes, include the dividend inincome as ordinary income.

Personal purchases. Omit from the taxableamount of patronage dividends on line 5b ofSchedule F any dividends from buying per-sonal, living, or family items, such as sup-plies, equipment, or services not related tothe production of farm income. This rule alsoapplies to amounts from the sale, redemption,or other disposition of a nonqualified writtennotice of allocation resulting from these pur-chases.

Per-Unit Retain CertificatesA per-unit retain certificate is any written no-tice that shows the stated dollar amount of aper-unit retain allocation made to you by thecooperative. A per-unit retain allocation is anamount paid to patrons for products sold forthem that is fixed without regard to the netearnings of the cooperative. These allo-cations can be paid in money, other property,or qualified certificates.

Per-unit retain certificates issued by a co-operative generally receive the same taxtreatment as patronage dividends, discussedearlier.

Cost of machine on July 1, 1998 ................ $2,900Minus: 1998 depreciation ................... $311

1999 cash dividend ................ 300 611

Adjusted basis for depreciation for 1999: $2,289

Depreciation rate: 1 ÷ 61/2 (remaining recovery pe-riod as of 1/1/99) = 15.38% × 1.5 = 23.08%

Depreciation deduction for 1999($2,289 × 23.08%) ....................................... $528


Qualified certificates. Qualified per-unit re-tain certificates are those issued to patronswho have agreed in writing, or in effect haveagreed by getting or keeping membership ina cooperative whose bylaws or charter statethat membership constitutes agreement, toinclude the stated dollar amount of thesecertificates in income in the year of receipt. Ifyou receive qualified per-unit retain certif-icates, include the stated dollar amount of thecertificates in income in Part I of Schedule Ffor the tax year you receive them.

Nonqualified certificates. All other per-unitretain certificates are nonqualified certificates.Do not include the stated dollar value of anonqualified certificate in income when youreceive it. Your basis in the certificate is zero.You must include in income any amount youreceive from its sale, redemption, or otherdisposition. Report the amount you receiveas ordinary income in Part I of Schedule F forthe tax year of disposition.

Cancellation of DebtIf a federal agency, financial institution, orcredit union cancels or forgives a debt youowe of $600 or more, you will receive a Form1099–C, Cancellation of Debt. The amountof the canceled debt is shown in box 2.

General RuleGenerally, if a debt you owe is canceled orforgiven, other than as a gift or bequest toyou, you must include the canceled amountin gross income for tax purposes. A debt in-cludes any debt for which you are liable orwhich attaches to property you hold.

ExceptionsThe following discussion covers some ex-ceptions to the general rule for canceled debt.

Price reduced after purchase. If you owea debt to the seller for property you bought,and the seller reduces the amount you owe,generally you do not have income from thereduction. Unless you are in bankruptcy orare insolvent, treat the part of the debt re-duced as a purchase price adjustment andreduce your basis in the property. The rulesthat apply to bankruptcy and insolvency areexplained under Exclusions, later.

Deductible debt. You do not realize incomefrom debt cancellation to the extent the pay-ment of the debt would have led to a de-duction.

Example. You own a business and getaccounting services on credit. Later, youhave trouble paying your business debts, butyou are not bankrupt or insolvent. Your ac-countant forgives part of the amount you owefor the accounting services. How you treatthe cancellation of debt depends on yourmethod of accounting.

• Cash method – You do not include thedebt cancellation in income becausepayment for the services would havebeen deductible as a business expense.

• Accrual method – You include the debtcancellation in income. Under an accrualmethod of accounting, the expense is

deductible when you incur the liability, notwhen you pay the debt.

ExclusionsDo not include canceled debt in income in thefollowing situations. However, you may berequired to file Form 982. See Form 982,later.

1) The cancellation takes place in a bank-ruptcy case.

2) The cancellation takes place when youare insolvent.

3) The canceled debt is a qualified farmdebt.

4) The canceled debt is qualified realproperty business debt (in the case of ataxpayer other than a C corporation).For information on this type of canceleddebt, see chapter 5 in Publication 334.

If a debt cancellation is excluded from in-come because it takes place in a bankruptcycase, items (2), (3), and (4) do not apply. If ittakes place when you are insolvent, items (3)and (4) do not apply to the extent you areinsolvent.

Bankruptcy and InsolvencyYou can exclude the cancellation or dischargeof debt from income if you are bankrupt or tothe extent you are insolvent.

Bankruptcy. A bankruptcy case is a caseunder title 11 of the United States Code if youare under the jurisdiction of the court and thedischarge of the debt is granted by the courtor is the result of a plan approved by thecourt.

Do not include debt canceled in a bank-ruptcy case in your gross income in the yearit is canceled. Instead, you must use theamount canceled to reduce your tax benefits,explained later under Reduction of tax bene-fits.

Insolvency. You are insolvent to the extentyour liabilities are more than the fair marketvalue of your assets immediately before thecancellation of debt.

You can exclude canceled debt from grossincome up to the amount by which you areinsolvent. If the canceled debt is more thanthe amount by which you are insolvent andyou qualify, you can apply the rules for qual-ified farm debt to the excess. Otherwise, youinclude the excess in gross income. Use theamount excluded because of insolvency toreduce any tax benefits, as explained laterunder Reduction of tax benefits. You mustreduce the tax benefits under the insolvencyrules before applying the rules for qualifiedfarm debt or for qualified real property busi-ness debt.

Example. You had a $10,000 debt can-celed outside of bankruptcy. Immediately be-fore the cancellation, your liabilities totaled$80,000 and your assets totaled $75,000.Since your liabilities were more than yourassets, you were insolvent to the extent of$5,000 ($80,000 − $75,000). You can excludethis amount from income. The remainingcanceled debt ($5,000) may be subject to thequalified farm debt or qualified real propertybusiness debt rules. If not, you must includeit in income.

Reduction of tax benefits. If you excludecanceled debt from income in a bankruptcycase or during insolvency, you must use theexcluded debt to reduce certain tax benefits.This prevents an excessive tax benefit fromthe cancellation.

Order of reduction. You must use theexcluded canceled debt to reduce the follow-ing tax benefits in the order listed, unless youchoose to reduce the basis of depreciableproperty first, as explained later.

1) Net operating loss (NOL). Reduce anyNOL for the tax year of the debt cancel-lation, and then any NOL carryover tothat year. Reduce the NOL or NOLcarryover one dollar for each dollar ofexcluded canceled debt.

2) General business credit carryover.Reduce the credit carryover to or fromthe tax year of the debt cancellation.Reduce the carryover 331/3 cents foreach dollar of excluded canceled debt.

3) Minimum tax credit. Reduce the mini-mum tax credit available at the beginningof the tax year following the tax year ofthe debt cancellation. Reduce the credit331 / 3 cents for each dollar of excludedcanceled debt.

4) Capital loss. Reduce any net capitalloss for the tax year of the debt cancel-lation, and then any capital loss carry-over to that year. Reduce the capital lossor loss carryover one dollar for eachdollar of excluded canceled debt.

5) Basis. Reduce the basis of the propertyyou hold at the beginning of the tax yearfollowing the tax year of the debt can-cellation in the following order.

a) Real property (except inventory)used in your trade or business orheld for investment that secured thecanceled debt.

b) Personal property (except inventoryand accounts and notes receivable)used in your trade or business orheld for investment that secured thecanceled debt.

c) Other property (except inventoryand accounts and notes receivable)used in your trade or business orheld for investment.

d) Inventory and accounts and notesreceivable.

e) Other property.

Reduce the basis one dollar for eachdollar of excluded canceled debt. How-ever, the reduction cannot be more thanthe total bases of property and theamount of money you hold immediatelyafter the debt cancellation minus yourtotal liabilities immediately after the can-cellation.

For allocation rules that apply to ba-sis reductions for multiple canceleddebts, see section 1.1017–1(b)(2) of theregulations. Also see Choosing to re-duce the basis of depreciable propertyfirst, later.

6) Passive activity loss and credit car-ryovers. Reduce the passive activityloss and credit carryovers from the taxyear of the debt cancellation. Reduce theloss carryover one dollar for each dollarof excluded canceled debt. Reduce the


credit carryover 331/3 cents for each dol-lar of excluded canceled debt.

7) Foreign and possession tax credits.Reduce the credit carryover to or fromthe tax year of the debt cancellation.Reduce the carryover 331/3 cents foreach dollar of excluded canceled debt.

How to make tax benefit reductions.Always make the required reductions in taxbenefits after figuring your tax for the year ofthe debt cancellation. In making the re-ductions in (1) and (4) above, first reduce theloss for the tax year of the debt cancellation.Then reduce any loss carryovers to that yearin the order of the tax years from which thecarryovers arose, starting with the earliestyear. In making the reductions in (2) and (7)above, reduce the credit carryovers to the taxyear of the debt cancellation in the order inwhich they are taken into account for thatyear.

Choosing to reduce the basis of depre-ciable property first. You can choose toapply any portion of the excluded canceleddebt first to reduce the basis of your depre-ciable property you hold at the beginning ofthe tax year following the tax year of the debtcancellation, in the following order.

1) Depreciable real property used in yourtrade or business or held for investmentthat secured the canceled debt.

2) Depreciable personal property used inyour trade or business or held for in-vestment that secured the canceleddebt.

3) Other depreciable property used in yourtrade or business or held for investment.

4) Real property held as inventory if youelect to treat it as depreciable propertyon Form 982.

The amount you apply cannot be morethan the total adjusted bases of all thedepreciable property. Depreciable property,for this purpose, means any property subjectto depreciation, but only if a reduction of basiswill reduce the depreciation or amortizationotherwise allowable for the period imme-diately following the basis reduction.

You make this reduction before reducingthe other tax benefits listed earlier. If the ex-cluded canceled debt is more than the basisreduction you can make under this choice,use the excess to reduce the other tax bene-fits. In figuring the limit on the basis reductionin (5), Basis, use the remaining adjustedbases of your property after making thischoice.

See Form 982, later, for information onhow to make this choice. If you make thischoice, you can revoke it only with the con-sent of the IRS.

Recapture of basis reductions. If you re-duce the basis of property under these pro-visions and later sell or otherwise dispose ofthe property at a gain, the part of the gain dueto this basis reduction is taxable as ordinaryincome under the depreciation recaptureprovisions. Treat any property that is notsection 1245 or section 1250 property assection 1245 property. For section 1250property, determine the straight-line depreci-ation adjustments as though there were nobasis reduction for debt cancellation. Sections1245 and 1250 property and the recapture of

gain as ordinary income are explained inchapter 11.

More information. For more information ondebt cancellation in bankruptcy proceedingsor during insolvency, see Publication 908.

Qualified Farm DebtYou can exclude from income the cancellationor discharge of qualified farm debt by a qual-ified person. This exclusion applies only if youwere solvent when the debt was canceled or,if you were insolvent, only to the extent thecanceled debt is more than the amount bywhich you were insolvent. Your debt is qual-ified farm debt if both the following require-ments are met.

• You incurred it directly in operating afarming business.

• At least 50% of your total gross receiptsfor the 3 tax years preceding the year ofdebt cancellation were from your farmingbusiness. See chapter 2 for informationabout gross farm income and total grossincome.

Qualified person. This is a person who isactively and regularly engaged in the busi-ness of lending money. A qualified personincludes any federal, state, or local govern-ment, or any of their agencies or subdivisions.Therefore, these rules apply to debts dis-charged by the USDA.

A qualified person does not include anyof the following.

• A person related to you.

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

• A person who receives a fee from yourinvestment in the property (or a personrelated to this person).

For the definition of a related person, seeRelated persons under At-Risk Amounts inPublication 925.

Exclusion limit. The amount of canceledqualified farm debt you exclude from incomecannot be more than the sum of your adjustedtax benefits and the total adjusted bases ofthe qualified property you hold at the begin-ning of the tax year following the tax year ofthe debt cancellation. Figure this limit aftertaking into account any reduction of tax ben-efits because of debt canceled duringinsolvency.

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

Adjusted tax benefits. Adjusted taxbenefits means the sum of the followingitems.

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

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

3) Any minimum tax credit available at thebeginning of the tax year following thetax year of the debt cancellation, multi-plied by 3.

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

5) Any passive activity loss and credit car-ryovers from the tax year of the debtcancellation. Any credit carryover ismultiplied by 3.

6) Any foreign and possession tax creditcarryovers to or from the tax year of thedebt cancellation, multiplied by 3.

You multiply the credits by 3 to make themcomparable with the deduction benefits.

Qualified property. This is any propertyyou use or hold for use in your trade or busi-ness or for the production of income.

Reduction of tax benefits. If you excludecanceled debt from income under the qual-ified farm debt rules, you must use the ex-cluded debt to reduce tax benefits. (If you alsoexcluded canceled debt under the insolvencyrules, you reduce the amount of the tax ben-efits remaining after reduction for the exclu-sion allowed under those rules.) You gener-ally must follow the reduction rules previouslyexplained under Bankruptcy and Insolvency.However, do not follow the rules in item (5),Basis. Instead, follow the special rules ex-plained next.

Special rules for reducing the basis ofproperty. You must use special rules to re-duce the basis of property for excluded can-celed qualified farm debt. Under these specialrules, you only reduce the basis of qualifiedproperty (defined earlier) in the following or-der.

1) Depreciable qualified property. You maychoose on Form 982 to treat real prop-erty held as inventory as depreciableproperty.

2) Land that is qualified property and isused or held for use in your farmingbusiness.

3) Other qualified property.

Form 982Use Form 982 to show the amounts of can-celed debt excluded from income and the re-duction of tax benefits in the order listed onthe form. Also use it if you are making thechoice to apply the excluded canceled debtto reduce the basis of depreciable propertybefore reducing tax benefits. You make thischoice by showing the amount you choose toapply on line 5 of the form.

When to file. You must file Form 982 withyour timely filed income tax return (includingextensions) for the tax year in which thecancellation of debt occurred. If you timelyfiled your return for the year without makingthe choice to apply the excluded canceleddebt to reduce the basis of depreciable prop-erty first, you can still make the choice by fil-ing an amended return within six months ofthe due date of the return (excluding exten-sions). Attach Form 982 to the amended re-turn and write “Filed pursuant to section301.9100–2” at the top of the form. File theamended return at the same address you filedthe original return.

Income FromOther SourcesThis section discusses other types of incomeyou may receive.


Barter income. If you do work for someoneand are paid in farm products, other property,or services, you must report as income thefair market value of what you receive. Thesame rule applies if you trade farm productsfor other farm products, property, or someoneelse's labor. This is called barter income. Forexample, if you help a neighbor build a barnand receive a cow for your work, you mustreport the fair market value of the cow as or-dinary income. Your basis for property youreceive in a barter transaction is usually thefair market value that you include in income.If you pay someone with property, see thediscussion on labor expense in chapter 5.

Below-market loans. A below-market loanis a loan on which no interest is charged, orinterest is charged at a rate below the appli-cable federal rate. If you make a below-market loan, you may have to report incomefrom the loan in addition to the stated interestyou receive from the borrower. See chapter1 of Publication 550 for more information onbelow-market loans.

Commodity futures and options. SeeHedging (Commodity Futures) in chapter 10for information on gains and losses fromcommodity futures and options transactions.

Easements and rights-of-way. Income youreceive for granting easements or rights-of-way on your farm or ranch for flooding land,laying pipelines, constructing electric or tele-phone lines, etc., may result in income, a re-duction in the basis of all or part of your farmland, or both.

Example. You granted a right-of-way fora gas pipeline through your property for$1,000. Only a specific part of your farm landwas affected. You reserved the right to con-tinue farming the surface land after the pipewas laid. Treat the payment for the right-of-way in one of the following ways.

1) If the payment is less than the basisproperly allocated to the part of your landaffected by the right-of-way, reduce thebasis by $1,000.

2) If the payment is more than the basis ofthe affected part of your land, reduce thebasis to zero and the rest is gain from asale. The gain is reported on Form 4797and is treated as section 1231 gain if youheld the land for more than 1 year. Seechapter 11.

If construction of the line damaged grow-ing crops and you later receive a settlementof $250 for this damage, the $250 is income.It does not affect the basis of your land.

Fuel tax credit and refund. Include as in-come any credit or refund of federal excisetax included as part of any fuel cost claimedas an expense deduction that reduced yourincome tax. See chapter 18 for more infor-mation about fuel tax credits and refunds.

Illegal federal irrigation subsidy. The fed-eral government, operating through the Bu-reau of Reclamation, has made irrigation wa-ter from certain reclamation and irrigationprojects available for agricultural purposes.The excess of the amount required to be paidfor water from these projects over the amountactually paid is an illegal subsidy.

For example, if the amount required to bepaid is full cost and you paid less than full

cost, the difference is an illegal subsidy andyou must include it in income. Report this online 10 of Schedule F. You cannot take a de-duction for the amount you must include inincome.

For more information on reclamation andirrigation projects, contact your local Bureauof Reclamation.

Machine work (custom hire). Pay you re-ceive for work you or your hired help performoff your farm for contract work or custom workdone for others, or for the use of your propertyor machines, is income to you whether or notincome tax was withheld. This rule applieswhether you receive the pay in cash, ser-vices, or merchandise. Report this income online 9, Part 1, of Schedule F.

Prizes. Report prizes you win on farm live-stock or products at contests, exhibitions,fairs, etc., on Schedule F as Other income. Ifyou receive a prize in cash, include the fullamount in income. If you receive a prize inproduce or other property, include the fairmarket value of the property. For prizes of$600 or more, you should receive a Form1099–MISC.

See chapter 15 for information aboutprizes related to 4–H Club or FFA projects.See Publication 525 for information aboutother prizes.

Property sold, destroyed, stolen, or con-demned. You may have an ordinary or cap-ital gain if property you own is sold or ex-changed, stolen, destroyed by fire, flood, orother casualty, or condemned by a publicauthority. In some situations, you can post-pone the tax on the gain to a later year. Seechapters 10 through 13.

Recapture of certain depreciation. If youtook a section 179 deduction for propertyused in your farming business and at any timeduring the property's recovery period you donot use it more than 50% in your business,you must include part of the deduction in in-come. See chapter 8 for information on thesection 179 deduction and when to recapturethat deduction.

In addition, if the percentage of businessuse of listed property (see chapter 8) falls to50% or less in any tax year during the re-covery period, you must include in incomeany excess depreciation you took on theproperty.

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

Refund or reimbursement. You should in-clude in income a reimbursement, refund, orrecovery of an item for which you took a de-duction in an earlier year. Include it for the taxyear you receive it. However, if any part ofthe earlier deduction did not decrease yourincome tax, you do not have to include thatpart of the reimbursement, refund, or recov-ery.

Example. A tenant farmer purchasedfertilizer for $1,000 in April 1998. He deducted$1,000 on his 1998 Schedule F and the entirededuction reduced his tax. The landownerreimbursed him $500 of the cost of thefertilizer in February 1999. The tenant farmermust include $500 in income on his 1999 taxreturn because the entire deduction de-creased his 1998 tax.

Sale of soil and other natural deposits. Ifyou remove and sell topsoil, loam, fill dirt,sand, gravel, or other natural deposits fromyour property, the proceeds are ordinary in-come. A reasonable allowance for depletionof the natural deposit sold may be claimedas a deduction. See Depletion in chapter 8.

Sod. Report proceeds from the sale ofsod on Schedule F. A deduction for cost de-pletion is allowed, but only for the topsoil re-moved with the sod.

Granting the right to remove deposits.If you enter into a legal relationship grantingsomeone else the right to excavate and re-move natural deposits from your property, youmust determine whether the transaction is asale or another type of transaction (for ex-ample, a lease).

If you receive a specified sum or anamount fixed without regard to the quantityproduced and sold from the deposit and youretain no economic interest in the deposit,your transaction is a sale. You are consideredto retain an economic interest if, under theterms of the legal relationship, you dependon the income derived from extraction of thedeposit for a return of your capital investmentin the deposit.

Your income from the deposit is capitalgain if the transaction is a sale. Otherwise, itis ordinary income subject to an allowance fordepletion. See chapter 8 for information ondepletion and chapter 10 for the tax treatmentof capital gains.

Timber sales. Timber sales, including salesof logs, firewood, lumber, and pulpwood, arediscussed in chapter 10.

Farm IncomeAveragingIf you are engaged in a farming business, youmay be able to average your elected farmincome (EFI) by shifting it to the 3 prior years(base years). The term “farming business” isdefined in the instructions for Schedule J(Form 1040), Farm Income Averaging.

Who can use farm income averaging? Youcan elect to use farm income averaging if, inthe year of the election, you are engaged ina farming business as an individual, a partnerin a partnership, or a shareholder in an Scorporation. You do not have to have beenengaged in a farming business in any baseyear.

Corporations, partnerships, S corpo-rations, estates, and trusts cannot use farmincome averaging.

Elected Farm Income (EFI)EFI is the amount of income from your farm-ing business that you elect to shift to the baseyears. You can designate as EFI any type ofincome attributable to your farming business.However, your EFI may not exceed your tax-able income, and any EFI from a net capitalgain attributable to your farming businessmay not exceed your total net capital gain.Income from your farming business is thesum of any farm income or gain minus anyfarm deductions or losses that are allowedas deductions in computing your taxable in-come. However, it does not include gain fromthe sale or other disposition of land.


Gains from the sale or other dispositionof farm property. Gains from the sale orother disposition of farm property, other thanland, can be designated as EFI if you (or yourpartnership or S corporation) use the propertyregularly for a substantial period in a farmingbusiness. Whether the property has beenregularly used for a substantial period de-pends on all the facts and circumstances.

Liquidation of a farming business. Ifyou (or your partnership or S corporation)liquidate your farming business, gains onproperty sold within a reasonable time afteroperations stop can be designated as EFI. Aperiod of one year after stopping operationswill be treated as a reasonable time. Afterthat, what is a reasonable time depends onthe facts and circumstances.

Shifting EFI to base years. If your EFI in-cludes both ordinary income and capitalgains, you must add an equal portion of eachtype of income to each base year. You cannotadd all of the capital gains to a single baseyear.

How To Figure the TaxIf you elect to average your farm income, youwill figure the current year's tax on ScheduleJ (Form 1040). You figure the tax as follows.

1) Subtract the EFI from your total taxableincome.

2) Figure the tax on the result in step (1)using the current year's tax tables, taxrate schedules, or, if applicable andlower, the maximum capital gain taxrates.

3) For each of the base years, make thefollowing computations.

a) Add one-third of the EFI to the tax-able income of the base year. Donot treat the base year's taxableincome as less than zero, even ifyour deductions exceed your in-come.

b) Figure the tax on the result in (a)using the tax rate schedule for thatbase year, or, if applicable andlower, the maximum capital gain taxrate for the base year. If the EFIincludes a net capital gain, it doesnot offset any net capital loss youhad in the base year. Figure the taxon the net capital gain at the maxi-mum capital gain tax rate that wouldapply if an asset of the same typeand with the same holding periodhad been sold or exchanged in thebase year.

c) Subtract that year's actual tax fromthe tax in (b).

4) Add the results in step (3)(c) to theamount in step (2). The result is the taxfor the current year.

Filing status. You are not prohibited frommaking a farm income averaging electionsolely because your filing status is not thesame in an election year and the base years.For example, if you are married filing jointlyin the election year, but filed as single in allof the base years, you may still elect to av-erage farm income.

Effect on Other TaxDeterminationsYou subtract your EFI from your taxable in-come in the election year and add one-thirdof it to the taxable income of the base yearto determine the tax rate to use for incomeaveraging. The allocation of your EFI fromthe election year to the base years does notaffect other tax determinations. For example,you make the following determinations beforesubtracting your EFI in the election year oradding it in the base years.

• The amount of your self-employment tax.

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

• The amount of any net operating losscarryover or net capital loss carryoverapplied and the amount of any carryoverto another year.

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

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

Tax on Investment Incomeof Child Under 14If your child's investment income is more than$1,400, part of that income may be taxed atyour tax rate instead of your child's tax rate.

If you elect to use farm income averaging,figure your child's tax on investment incomeusing your rate after shifting EFI. You cannotuse any of your child's investment income asyour EFI, even if it is attributable to a farmingbusiness. For information on figuring the taxon your child's investment income, see Pub-lication 929, Tax Rules for Children and De-pendents.

Alternative Minimum TaxYou cannot use income averaging to deter-mine your alternative minimum tax (AMT).When figuring your AMT, the regular tax yousubtract from your “tentative minimum tax” isthe tax you computed using farm income av-eraging. This may cause you to owe AMT orincrease your AMT but, generally, it will notincrease your total tax.

CAUTION!

As this publication was being pre-pared for print, Congress was con-sidering legislation that would allow

an individual to offset his or her regular tax(without regard to the “tentative minimumtax”) by certain nonrefundable personal cred-its (such as the credit for child and dependentcare expenses, the child tax credit, the Hopecredit, or the lifetime learning credit). Formore information about this and other impor-tant tax changes, see Publication 553, High-lights of 1999 Tax Changes.

Credit for base year minimum tax liability.You can use income averaging to calculateyour regular tax liability for the purpose ofdetermining the amount of the credit for abase year minimum tax liability.

Making, Revoking, orChanging an ElectionYou make a farm income averaging electionby filing Schedule J (Form 1040), Farm In-come Averaging, with your timely filed (in-cluding extensions) return for the electionyear. You can make a late election, or amendor revoke a previously made election, only ifyou do so in conjunction with another adjust-ment that affects the taxable income of theelection year or any of the base years. Anadjustment may be caused by a variety ofthings. The following are examples of situ-ations that may result in an adjustment.

• An NOL carryback.

• A disaster loss election.

• A change made as the result of an audit.

• Any other change that results in your fil-ing an amended return.

If you do not have an adjustment in theelection year or any of the base years, youcan make a late election, or amend or revokea previously made election, only if you obtainthe consent of the IRS. You can requestconsent by submitting a request for a privateletter ruling to the IRS National Office. SeeRevenue Procedure 2000–1 in Internal Rev-enue Bulletin No. 2000–1.

5.Farm BusinessExpenses

Important Changesfor 1999Standard mileage rate. The standard mile-age rate for the cost of operating your car,van, pickup, or panel truck in 1999 is 321/2cents a mile for all business miles driven be-fore April 1. The rate is 31 cents a mile forbusiness miles driven after March 31. SeeTruck and Car Expenses.

Self-employed health insurance de-duction. The part of your self-employedhealth insurance premiums that you can de-duct as an adjustment to income increasedto 60% for 1999. See Insurance.

Business use of your home. Beginning in1999, you may be able to deduct expensesfor your home office even if it is not where youperform your most important business activ-ities or spend most of your business time. SeeBusiness Use of Your Home.

IntroductionYou can generally deduct the current costsof operating your farm. Current costs are ex-penses you do not have to capitalize or in-clude in inventory costs. However, your de-

Chapter 5 Farm Business Expenses Page 23

duction for the cost of livestock feed andcertain other supplies may be limited. If youhave an operating loss, you may not be ableto deduct all of it.


• Deductible expenses

• Capital expenses

• Nondeductible expenses

• Farm operating losses

• Net operating losses

• Not-for-profit farming


Publication


� 535 Business Expenses

� 536 Net Operating Losses

� 587 Business Use of Your Home

� 925 Passive Activity and At-Risk Rules


� 1040 U.S. Individual Income Tax Return

� Sch A (Form 1040) ItemizedDeductions


� 1045 Application for Tentative Refund

� 5213 Election To PostponeDetermination as To Whether thePresumption Applies That anActivity Is Engaged in for Profit


Deductible ExpensesThe ordinary and necessary costs of operat-ing a farm for profit are deductible businessexpenses. Part II of Schedule F lists ex-penses common to farming operations. Thischapter discusses many of these expenses,as well as others not listed on Schedule F.

Reimbursed expenses. If you are reim-bursed, either reduce the expense or reportthe amount you receive as income, depend-ing on when you receive it. See Refund orreimbursement under Income From OtherSources in chapter 4.

Prepaid Farm SuppliesThere may be a limit on your deduction forprepaid farm supplies if you use the cashmethod of accounting to report your incomeand expenses. This limit will not apply, how-ever, if you meet one of the exceptions de-scribed later.

Defined. Prepaid farm supplies are amountsyou paid during the tax year for the followingitems.

1) Feed, seed, fertilizer, and similar farmsupplies not used or consumed duringthe year.

2) Poultry (including egg-laying hens andbaby chicks) bought for use (or for bothuse and resale) in your farm businessthat would be deductible in the followingyear if you had capitalized the cost anddeducted it ratably (for example,monthly) over the lesser of 12 monthsor the useful life of the poultry.

3) Poultry bought for resale and not resoldduring the year.

Prepaid farm supplies do not include anyamount paid for farm supplies on hand at theend of the tax year that you would have con-sumed if not for a fire, storm, flood, othercasualty, disease, or drought.

Deduction limit. You can deduct an ex-pense for prepaid farm supplies that does notexceed 50% of your other deductible farmexpenses in the year of payment. You candeduct an expense for any excess prepaidfarm supplies only for the tax year you useor consume the supplies.

The cost of poultry bought for use (or forboth use and resale) in your farm businessand not allowed in the year of payment isdeductible in the following year. The cost ofpoultry bought for resale is deductible in theyear you sell or otherwise dispose of thatpoultry.

Other deductible farm expenses. Otherdeductible farm expenses are any amountsallowable as deductions on Schedule F (Form1040), including depreciation or amortization,but not prepaid farm supplies.

Example. During 1999, you boughtfertilizer ($4,000), feed ($1,000), and seed($500) for use on your farm in the followingyear. Your total prepaid farm supplies ex-pense for 1999 is $5,500. Your otherdeductible farm expenses totaled $10,000 for1999. Therefore, your deduction for prepaidfarm supplies may not exceed $5,000 (50%of $10,000) for 1999. The excess prepaidfarm supplies expense of $500 ($5,500 −$5,000) is deductible in the later tax year youuse or consume the supplies.

Exceptions. This limit on the deduction forprepaid farm supplies expense does not applyif you are a farm-related taxpayer and eitherof the following apply.

1) Your prepaid farm supplies expense ismore than 50% of your other deductiblefarm expenses because of a change inbusiness operations caused by unusualcircumstances.

2) Your total prepaid farm supplies expensefor the preceding 3 tax years is less than50% of your total other deductible farmexpenses for those 3 tax years.

You are a farm-related taxpayer if any ofthe 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 yourbrothers and sisters, half-brothers and half-sisters, spouse, parents, grandparents, chil-dren, grandchildren, aunts, uncles, and theirchildren.

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

Livestock FeedIf you report your income and expenses underthe cash method, you can deduct in the yearpaid the cost of feed your livestock consumedin that year. However, the cost of feed notconsumed in that year is subject to the ad-vance payment for feed rules, discussed next,and the limit on prepaid farm supplies, dis-cussed earlier.

Advance payments for feed. If you meetall three of the following tests, you can de-duct in the year of payment (subject to thelimit on prepaid farm supplies) the cost of feedyour livestock will consume in a later tax year.This rule does not apply to the purchase ofcommodity futures contracts.

1) The expense is a payment for thepurchase of feed, not a deposit.Whether an expense is a deposit orpayment depends on the facts and cir-cumstances in each case. The expenseis a payment if you can show you madeit under a binding commitment to acceptdelivery of a specific quantity of feed ata fixed price and you are not entitled,under contract provision or businesscustom, to a refund or repurchase.

The following are some factors thatshow an expense is a deposit rather thana payment.

a) The absence of specific quantityterms.

b) The right to a refund of any unap-plied payment credit at the end ofthe contract.

c) The treatment of the expense as adeposit by the seller.

d) The right to substitute other goodsor products for those specified inthe contract.

A provision permitting substitution ofingredients to vary the particular feedmix to meet current diet requirements ofthe livestock for which you bought thefeed will not suggest a deposit. Further,adjustment to the contract price to reflectmarket value at the date of delivery isnot, by itself, proof of a deposit.

2) The prepayment has a business pur-pose and is not merely for tax avoid-ance. You should have a reasonableexpectation of receiving some businessbenefit from the prepayment. The fol-lowing are some examples of businessbenefits.

a) Fixing maximum prices and secur-ing an assured feed supply.

b) Securing preferential treatment inanticipation of a feed shortage.

Whether the prepayment was a con-dition imposed by the seller and whetherthe condition was meaningful will alsobe considered in determining the exist-ence of a business purpose for the pre-payment.

3) The deduction of these costs doesnot result in a material distortion of

Page 24 Chapter 5 Farm Business Expenses

your income. The following are somefactors to consider in determiningwhether the deduction results in a ma-terial distortion of income.

a) Your customary business practicein conducting your livestock oper-ations.

b) The expense in relation to pastpurchases.

c) The time of year you made thepurchase.

d) The expense in relation to your in-come for the year.

If you fail any of these three tests, youcannot deduct in the year paid the cost offeed your livestock will consume in a later taxyear. Deduct it in the tax years your livestockconsume the feed.

Labor HiredYou can deduct reasonable wages paid forregular farm labor, piecework, contract labor,and other forms of labor hired to perform yourfarming operations. You may pay wages incash or noncash items such as inventoryitems, capital assets, or assets used in yourbusiness. The cost of boarding farm labor isa deductible labor cost. Other deductiblecosts you incur for farm labor include healthinsurance, workers' compensation insurance,and other benefits.

If you must withhold social security, Med-icare, and income taxes from your employees'cash wages, you can still deduct the fullamount of wages before withholding. Seechapter 16 for more information on employ-ment taxes. Also, deduct the employer'sshare of the social security and Medicaretaxes you must pay on your employees'wages as a farm business expense on theTaxes line of Schedule F (line 31). SeeTaxes, later.

Deductible PayThe kinds of pay you can deduct include thefair market value of property you transfer toyour employees and wages you pay tomembers of your family, as discussed below.

Property for services. If you transfer prop-erty to one of your employees in payment forservices, you can deduct as wages paid thefair market value of the property on the dateof transfer. If the employee pays you anythingfor the property, deduct as wages the fairmarket value of the property minus the pay-ment by the employee for the property. Treatthe deduction on your return as an amountreceived for the property. You may have again or loss to report if the property's adjustedbasis on the date of transfer is different fromits fair market value. Any gain or loss has thesame character the exchanged property hadin your hands. For more information, seechapter 10.

Child as an employee. You can deductreasonable wages or other compensation youpay to your child for doing farm work if a trueemployer-employee relationship exists be-tween you and your child. Include thesewages in the child's income. The child mayhave to file an income tax return. Thesewages may also be subject to social securityand Medicare taxes if your child is age 18 or

older. For more information, see Family Em-ployees in chapter 16.

The fact that your child spends the wagesto buy clothes or other necessities younormally furnish does not prevent you fromdeducting your child's wages as a farm ex-pense.

Spouse as an employee. You can deductreasonable wages or other compensation youpay to your spouse if a true employer-employee relationship exists between youand your spouse. Wages you pay to yourspouse are subject to social security andMedicare taxes. For more information, seeFamily Employees in chapter 16.

Nondeductible PayYou cannot deduct wages paid for certainhousehold work, construction work, andmaintenance of your home. However, thosewages may be subject to the employmenttaxes discussed in chapter 16.

Household workers. Do not deductamounts paid to persons engaged in house-hold work, except to the extent their servicesare used in boarding or otherwise caring forfarm laborers.

Construction labor. Do not deduct wagespaid to hired help for the construction of newbuildings or other improvements. Thesewages are part of the cost of the building orother improvement. You must capitalize them.

Maintaining your home. If your farm em-ployee spends time maintaining or repairingyour home, the wages and employment taxesyou pay for that work are nondeductible per-sonal expenses. For example, assume youhave a farm employee for the entire tax yearand the employee spends 5% of the timemaintaining your home. The employee de-votes the remaining time to work on yourfarm. You cannot deduct 5% of the wagesand employment taxes you pay for that em-ployee.

Employment CreditsReduce your deduction for wages by theamount of any employment credits you claim.The following are employment credits andtheir related forms.

• Empowerment zone employment credit(Form 8844).

• Indian employment credit (Form 8845).

• Welfare-to-work credit (Form 8861).

• Work opportunity credit (Form 5884).

For more information, see the forms and theirinstructions.

Personal and BusinessExpensesSome expenses you pay during the tax yearmay be partly personal and partly business.These may include expenses for gasoline, oil,fuel, water, rent, electricity, telephone, auto-mobile upkeep, repairs, insurance, interest,and taxes.

Allocation. Allocate these mixed expensesbetween their business and personal partsbecause the personal expenses are notdeductible.

Example. You paid $1,500 for electricityduring the tax year. You used one-third of theelectricity for personal purposes and two-thirds for farming. Under these circum-stances, you can deduct two-thirds of yourelectricity expense ($1,000) as a farm busi-ness expense.

Reasonable allocation. It is not alwayseasy to determine the business and nonbusi-ness parts of an expense. There is no methodof allocation that applies to all mixed ex-penses. Any reasonable allocation is accept-able. What is reasonable depends on the cir-cumstances in each case.

Telephone expense. You cannot deduct thecost of basic local telephone service (includ-ing taxes) for the first telephone line you havein your home. However, you can deduct thecost of additional telephone service in yourhome if you use it for your farm business.

Tax preparation fees. You can deduct as afarm business expense on Schedule F (Form1040) the cost of preparing that part of yourtax return relating to your farm business. Youmay be able to deduct the remaining cost onSchedule A (Form 1040) if you itemize yourdeductions.

You can also deduct on Schedule F theamount you pay or incur in resolving tax is-sues relating to your farm business.

Repairs and MaintenanceYou can deduct most expenses for the repairand maintenance of your farm property.However, repairs to depreciable property thatsubstantially prolong the life of the property,increase its value, or adapt it to a different useare capital expenses. If you repair the barnroof, the cost is deductible. But if you replacethe roof, it is a capital expense. Commonitems of repair and maintenance are repaint-ing, replacing shingles and supports on farmbuildings, and minor overhauls of trucks,tractors, and other farm machinery. You must,however, capitalize major overhauls that pro-long the life of the property.

InterestYou can deduct as a farm business expenseinterest paid on farm mortgages and otherobligations you incur in your farm business.

Cash method. If you use the cash methodof accounting, you can deduct interest paidduring the year. You cannot deduct interestpaid with funds received from the originallender through another loan, advance, orother arrangement similar to a loan. You can,however, deduct the interest when you startmaking payments on the new loan.

Prepaid interest. Under the cashmethod, you generally cannot deduct any in-terest paid before the year it is due. Interestpaid in advance may be deducted over theterm of the loan.

Accrual method. You can deduct only in-terest that has accrued during the tax year.However, you cannot deduct interest owed toa related person who uses the cash methoduntil payment is made and the interest isincludible in the gross income of that person.For more information, see chapter 8 in Publi-cation 535.


Allocation of interest. If you use the pro-ceeds of a loan for more than one purpose(for example, personal and business), allo-cate the interest on that loan to each use.

The easiest way to allocate interest is tokeep the proceeds of a particular loan sepa-rate from any other funds. You can treat apayment made from any account (or in cash)within 30 days before or after the debt pro-ceeds are deposited (or received in cash) asbeing made from those debt proceeds.

You generally allocate interest on a loanthe same way you allocate the loan. This istrue even if the funds are paid directly to athird party. You allocate loans by tracing dis-bursements to specific uses. Use the follow-ing categories when allocating your interestexpense.

1) Trade or business interest.

2) Passive activity interest.

3) Investment interest.

4) Personal interest.

5) Portfolio expenditure interest.

Secured loans. The allocation of loanproceeds and the related interest is not gen-erally affected by the use of property that se-cures the loan.

Example. You secure a loan with prop-erty used in your farming business. You usethe loan proceeds to buy a car for personaluse. You must allocate interest expense onthe loan to personal use (purchase of the car)even though the loan is secured by farmbusiness property.

Allocation period. The period for whicha loan is allocated to a particular use beginson the date the proceeds are used and endson the earlier of the date the loan is:

1) Repaid, or

2) Reallocated to another use.

For more information, see chapter 8 inPublication 535.

Loan expenses. You prorate and deductloan expenses, such as legal fees and com-missions, you pay to get a farm loan over theterm of the loan.

Breeding FeesYou can deduct breeding fees as a farmbusiness expense. However, if you must usean accrual method of accounting, you mustcapitalize breeding fees and allocate them tothe cost basis of the calf, foal, etc. For moreinformation on who must use an accrualmethod of accounting, see Accrual Method inchapter 3.

Fertilizer and LimeYou can choose to deduct in the year paidor incurred the cost of fertilizer, lime, andother materials applied to farm land to enrich,neutralize, or condition it. You can also de-duct the cost of applying these materials inthe year you pay or incur it. However, seePrepaid Farm Supplies, earlier, for a rule thatmay limit your deduction for these materials.

If the benefits of the fertilizer, lime, orother materials last substantially more than ayear, you can choose to deduct the expensesin the year paid or incurred, or you can capi-talize them and deduct a part each year thebenefits last. If you choose to deduct the ex-penses in the year paid or incurred, you canchange the choice for that year only with IRSconsent.

Farm land for the choice described in thepreceding paragraph is land used forproducing crops, fruits, or other agriculturalproducts or for sustaining livestock. It doesnot include land you have never used previ-ously for producing crops or sustaining live-stock. You cannot deduct initial land prepa-ration costs. (See Capital Expenses, later.)

Include government payments you re-ceive for lime or fertilizer in income. SeeFertilizer and Lime in chapter 4.

TaxesYou can deduct as a farm business expensethe real estate and personal property taxeson farm business assets, such as farmequipment, animals, farm land, and farmbuildings. You can also deduct the socialsecurity and Medicare taxes you pay to matchthe amount withheld from the wages of farmemployees and any federal unemploymenttax you pay. For information on employmenttaxes, see chapter 16.

The taxes on the part of your farm you useas your home (including the furnishings andsurrounding land not used for farming) arenonbusiness taxes. You may be able to de-duct these nonbusiness taxes as itemizeddeductions on Schedule A (Form 1040). Todetermine the nonbusiness part, prorate thetaxes between the farm assets and nonbusi-ness assets. The proration can be done fromthe assessed valuations. If your tax state-ment does not show the assessed valuations,you can usually get them from the taxassessor.

State or local general sales taxes. Stateor local general sales taxes on nondeprecia-ble farm business expense items are deduct-ible as part of the cost of those items. Includestate or local general sales taxes imposed onthe purchase of assets for use in your farmbusiness as part of the cost that you depre-ciate. If the taxes are imposed on the sellerand passed on to you, treat them as part ofyour cost.

State and federal income taxes. Individualscannot deduct state and federal income taxesas farm business expenses. Individuals candeduct state income tax only as an itemizeddeduction on Schedule A (Form 1040). Youcannot deduct federal income tax.

Highway use tax. You can deduct the fed-eral use tax on highway motor vehicles paidon a truck or truck tractor used in your farmbusiness. For information on the tax itself,including information on vehicles subject tothe tax, see the instructions for Form 2290,Heavy Highway Vehicle Use Tax Return.

Self-employment tax deduction. You candeduct one-half of your self-employment taxin figuring your adjusted gross income on

Form 1040. For more information, see chap-ter 15.

InsuranceYou can generally deduct the ordinary andnecessary cost of insurance for your farmbusiness as a business expense. This in-cludes premiums you pay for the followingtypes of insurance.

1) Fire, storm, crop, theft, liability, and otherinsurance on farm business assets.

2) Health and accident insurance on yourfarm employees.

3) Workers' compensation insurance andstate unemployment insurance on yourfarm employees.

Advance premiums. If you pay insurancepremiums in advance, deduct each year onlythe premium that applies to that tax year.Deduct the balance in each later year towhich it applies.

TIPThis treatment of advance premiumsapplies whether you use the cash oraccrual method of accounting.

Example. On June 28, 1999, you paid apremium of $3,000 for fire insurance on yourbarn. The policy will cover a period of 3 yearsbeginning on July 1, 1999. Only the cost forthe 6 months in 1999 is deductible as an in-surance expense on your 1999 tax return.Deduct $500, which is the premium for 6months of the 36-month premium period, or6 / 36 of $3,000. In both 2000 and the year2001, deduct $1,000 (12/36 of $3,000). Deductthe remaining $500 in 2002. Had the policybeen effective on January 1, 1999, thedeductible expense would have been $1,000for each of the years 1999, 2000, and 2001,based on one-third of the premium used eachyear.

Business interruption insurance. Businessinterruption insurance premiums are deduct-ible as a business expense. This insurancepays for lost profits if your business is shutdown due to a fire or other cause. Report anyproceeds in full on Schedule F.

Self-employed health insurance de-duction. If you are a self-employed individ-ual, you can deduct, in figuring your adjustedgross income on your 1999 Form 1040, 60%of your payments for health insurance cover-age for yourself, your spouse, and your de-pendents. Generally, this deduction cannotbe more than the net profit from the businessunder which the plan was established.

If you or your spouse are also an em-ployee of another person, you cannot take thededuction for any month in which you are el-igible to participate in a subsidized health planmaintained by your employer or yourspouse's employer.

Use the Self-Employed Health InsuranceDeduction Worksheet in the Form 1040 in-structions to figure your deduction. Includethe remaining part of the insurance paymentin your medical expenses on Schedule A, ifyou itemize your deductions.

For more information, see DeductiblePremiums in chapter 10 of Publication 535.


Rent and LeasingIf you lease property for use in your business,you can generally deduct the rent you pay.

RentYou can deduct on Schedule F rent you payin cash. However, you cannot deduct rent youpay in crop shares because you deduct thecost of raising the crops as farm expenses.

Advance payments. Deduct advance pay-ments of rent only in the year to which theyapply, regardless of your accounting method.

Farm home. If you rent a farm, do not deductthe part of the rental expense that representsthe fair rental value of the farm home in whichyou live.

Lease or PurchaseIf you lease a farm building or equipmentrather than buy it, you must determinewhether or not the agreement can be treatedas a lease for tax purposes. Some leasesmust be treated as conditional sales contractsfor tax purposes. If the agreement is treatedas a lease for tax purposes, you can deductrental payments for the use of the property inyour trade or business. If the agreement istreated as a conditional sales contract, thepayments under the agreement (so far asthey do not represent interest or othercharges) are payments for the purchase ofthe property. Do not deduct these paymentsas rent, but capitalize the cost of the propertyand recover this cost through depreciation.

Example. You lease new farm equipmentfrom a dealer who both sells and leases. Thelease payments and the specified option priceequal the sales price plus interest. Under thelease, you are responsible for maintenance,repairs, and the risk of loss. For federal in-come tax purposes, the lease is a sale of theequipment and you cannot deduct any of thelease costs as rent. You can deduct interest,repairs, insurance, depreciation, and otherbusiness expenses.

Intent. Whether an agreement is a condi-tional sales contract, rather than a lease, de-pends on the intent of the parties. Determineintent based on the facts and circumstancesexisting at the time you made the agreement.No single test, or special combination of tests,always applies. However, in the absence ofcompelling and persuasive factors to thecontrary, treat an agreement as a conditionalsales contract, rather than a lease, if any ofthe following is true.

1) The agreement applies part of eachpayment toward an equity interest youwill receive.

2) You receive title to the property after youpay a stated amount of required pay-ments.

3) You must pay, over a short period, anamount that represents a large part ofthe price you would pay to buy theproperty.

4) You pay much more than the current fairrental value of the property.

5) You have an option to buy the propertyat a small price compared to the value

of the property at the time you may ex-ercise the option. Determine this valueat the time of entering into the originalagreement.

6) You have an option to buy the propertyat a small price compared to the total youmust pay under the agreement.

7) The agreement designates part of thepayments as interest, or part of the pay-ments are easy to recognize as interest.

Leveraged leases. Special rules apply toleveraged leases of equipment (property fi-nanced by a nonrecourse loan from a thirdparty). For more information, see chapter 7of Publication 535 and the following revenueprocedures.

1) 75–21 in Cumulative Bulletin 1975–1.




Motor vehicle leases. Special rules applyto lease agreements that have a terminalrental adjustment clause. The clause willgenerally provide for a rental adjustmentbased upon the amount the lessor is able tosell the vehicle for at the end of the lease. Ifyour rental agreement contains a terminalrental adjustment clause, treat the agreementas a lease if the agreement otherwise quali-fies as a lease. For more information, seesection 7701(h) of the Internal RevenueCode.

DepreciationIf property you acquire to use in your farmbusiness is expected to last more than oneyear, you generally cannot deduct the entirecost in the year you acquire it. You mustspread the cost over more than one year anddeduct part of it each year on Schedule F.For most property, this deduction is depreci-ation. However, you may be able to deductpart or all of the cost of this property as abusiness expense in the year you place it inservice. This is the section 179 deduction.

Depreciation and the section 179 de-duction are discussed in chapter 8.

Business Useof Your HomeYou can deduct expenses for the businessuse of your home if you use part of your homeexclusively and regularly:

1) As the principal place of business for anytrade or business in which you engage,

2) As a place to meet or deal with patients,clients, or customers in the normalcourse of your trade or business, or

3) In connection with your trade or busi-ness, if you are using a separate struc-ture that is not attached to your home.

Your home office will qualify as your prin-cipal place of business for deducting ex-penses for its use if you meet the followingrequirements.

1) You use it exclusively and regularly forthe administrative or management activ-ities of your trade or business.

2) You have no other fixed location whereyou conduct substantial administrativeor management activities of your tradeor business.

If you use part of your home for business,you must divide the expenses of operatingyour home between personal and businessuse. For more information, see Publication587.

Deduction limit. If your gross income fromfarming equals or exceeds your total farmexpenses (including expenses for the busi-ness use of your home) you can deduct allyour farm expenses. But if your gross incomefrom farming is less than your total farm ex-penses, your deduction for certain expensesfor the business use of your home is limited.

Your deduction for otherwise nondeduct-ible expenses, such as utilities, insurance,and depreciation (with depreciation takenlast), cannot be more than the gross incomefrom farming minus:

1) The business part of expenses you coulddeduct even if you did not use yourhome for business (such as deductiblemortgage interest, real estate taxes, andcasualty and theft losses), and

2) The business expenses that relate to thebusiness activity in the home (for exam-ple, salaries or supplies), but not to theuse of the home itself.

If you are self-employed, do not include in(2) above your deduction for half of yourself-employment tax.

You can carry over to your next tax yeardeductions over the current year's limit.These deductions are subject to the grossincome limit from the business use of yourhome for the next tax year.

See Publication 587 for information onhow to figure this limit and where to deductthe expenses on your return.

Truck and Car ExpensesYou can deduct the actual cost of operatinga truck or car in your farm business. Onlyexpenses for business use are deductible.These include such items as gasoline, oil,repairs, license tags, insurance, and depreci-ation (subject to certain limits).

Instead of using actual costs, under cer-tain conditions you can use a standard mile-age rate. For 1999, the rate is 321/2 cents amile for all business miles driven before April1. The rate is 31 cents a mile for all businessmiles driven after March 31. You can use thestandard mileage rate for cars and lighttrucks, such as vans, pickups, and paneltrucks, that you own or lease. You cannot usethe standard mileage rate if you operate twoor more cars or light trucks at the same time.You are not using two or more vehicles at thesame time if you alternate using (use at dif-ferent times) the vehicles for business.

Example. Maureen owns a car and apickup truck that are both used in her farmbusiness. Her farm employees use the truckand she uses the car for business. Maureencannot use the standard mileage rate for thecar or the truck. This is because both vehiclesare used in Maureen's farm business at thesame time. She must use actual expenses forboth vehicles.


More information. For more information, seechapter 4 of Publication 463. If you pay youremployees for the use of their truck or car inyour farm business, see Reimbursements toemployees under Travel Expenses, next.

Travel ExpensesYou can deduct ordinary and necessary ex-penses you incur while traveling away fromhome for your farm business. You cannotdeduct lavish or extravagant expenses. Usu-ally, the location of your farm business isconsidered your home for tax purposes. Youare traveling away from home if:

1) Your duties require you to be absentfrom your farm substantially longer thanan ordinary work day, and

2) You need to get sleep or rest to meet thedemands of your work while away fromhome.

If you meet these requirements and canprove the time, place, and business purposeof your travel, you can deduct your ordinaryand necessary expenses for travel, meals,and lodging. You can ordinarily deduct only50% of your business-related meal expenses.

The following are some types of travelexpenses.

1) Air, rail, bus, and car transportation.

2) Meals and lodging.

3) Cleaning and laundry.

4) Telephone and fax.

5) Transportation between your hotel andyour temporary work assignment.

6) Tips for any of the above expenses.

Meals. You can deduct 50% of the cost ofmeals only if your business trip is overnightor long enough to require you to stop for sleepor rest to properly perform your duties. Youcannot deduct any of the cost of meals if it isnot necessary for you to rest, unless you meetthe rules for business entertainment. For in-formation on entertainment expenses, seechapter 2 of Publication 463.

The expense of a meal includes amountsyou spend for your food, beverages, taxes,and tips relating to the meal. You can deducteither the actual cost or a standard meal al-lowance that covers your daily meal and in-cidental expenses.

RECORDS

Recordkeeping requirements. Youmust be able to prove your deductionsfor travel by adequate records or

other evidence that will support your ownstatement. Estimates or approximations donot qualify as proof of an expense.

You should keep an account book orsimilar record, supported by adequate docu-mentary evidence, that together supportseach element of an expense. Generally, it isbest to record the expense and keep thedocumentation at the time you paid it.

If you choose to deduct a standard mealallowance you do not have to keep recordsto prove amounts spent for meals and inci-dental items. However, you must still keeprecords to prove the actual amount of othertravel expenses, and the time, place, andbusiness purpose of your travel.

More information. For detailed informationon travel, recordkeeping, and the standardmeal allowance, see Publication 463.

Reimbursements to employees. You cangenerally deduct reimbursements you pay toyour employees for travel and transportationexpenses they incur in the conduct of yourbusiness. If you reimburse these expensesunder an accountable plan, deduct them astravel and transportation expenses. If you re-imburse these expenses under a nonac-countable plan, you must report the re-imbursements as wages on Form W–2 anddeduct them as wages. For more information,see chapter 16 of Publication 535.

Marketing Quota PenaltiesYou can deduct on Schedule F penalties youpay for marketing crops in excess of farmmarketing quotas. However, if you do not paythe penalty, but instead the purchaser of yourcrop deducts it from the payment to you, in-clude in gross income only the amount youreceived. Do not take a separate deductionfor the penalty.

Tenant House ExpensesYou can deduct the costs of maintaininghouses and their furnishings for tenants orhired help as farm business expenses. Thesecosts include repairs, heat, light, insurance,and depreciation.

The value of a dwelling you furnish to atenant under the usual tenant-farmer ar-rangement is not taxable income to the ten-ant.

Items Purchasedfor ResaleIf you use the cash method of accounting, youcan deduct the cost of livestock and otheritems purchased for resale in Part I ofSchedule F in the year of sale. This cost in-cludes freight charges for transporting thelivestock to the farm. Ordinarily, this is theonly time you can deduct the purchase price.However, see Cost of chickens, seeds, andyoung plants–cash method, later.

Example. You report on the cashmethod. In 1999, you buy 50 steers you willsell in 2000. You will report the sales priceminus the purchase price (and any freightcost) as income in Part I of your 2000Schedule F.

Cost of chickens, seeds, and youngplants–cash method. Cash method farmerscan deduct the cost of hens and baby chicksbought for commercial egg production, or forraising and resale, as an expense in the yearthey pay the costs, if they do it consistentlyand it does not distort income. You can de-duct the purchase price of seeds and youngplants bought for further development andcultivation before sale as an expense whenpaid if you do this consistently and you do notfigure your income on the crop method.However, see Prepaid Farm Supplies, earlier,for a rule that may limit your deduction forthese items.

If you deduct the purchase price of chick-ens and young plants as an expense, reporttheir entire selling price as income. Youcannot also deduct the purchase price fromthe selling price.

You cannot deduct the purchase price ofseeds and young plants for Christmas treesand timber as an expense. Deduct the costof these seeds and plants through depletionallowances. For more information, see De-pletion in chapter 8.

The purchase price of chickens and plantsused as food for your family is never deduct-ible.

Capitalize the cost of plants with a pre-productive period of more than 2 years, un-less you can elect out of the uniform capital-ization rules, which are discussed in chapter7.

Example. You use the cash method ofaccounting. In 1999, you buy 500 baby chicksto raise for resale in 2000. You also buy 50bushels of winter seed wheat in 1999 that yousow in the fall. You can deduct the cost ofboth the baby chicks and the seed wheat in1999, unless you previously adopted themethod of deducting these costs in the yearyou sell the chickens or the harvested crops.

Delaying deduction–crop method. Youcan delay deducting the purchase price ofseeds and young plants until you sell them ifyou get IRS permission. If you follow thismethod, deduct the purchase price from theselling price to determine your profit. Do thisin Part I of Schedule F. For more information,see Crop method under Special Methods ofAccounting in chapter 3.

Choosing the method. You can adopteither of these methods for deducting thepurchase price in the first year you buyegg-laying hens, pullets, chicks, or seeds andyoung plants. If you choose the crop method,however, you need IRS permission.

Although you must use the same methodfor egg-laying hens, pullets, and chicks, youcan use a different method for seeds andyoung plants. Once you use a particularmethod for any of these items, use it for thoseitems until you get IRS permission to changeyour method. For more information, seeChange in Accounting Method in chapter 3.

Other ExpensesThe following list, while not all-inclusive,shows some expenses you can deduct asother farm expenses in Part II of ScheduleF. These expenses must be for businesspurposes and (1) paid, if you use the cashmethod of accounting, or (2) incurred, if youuse an accrual method of accounting.

• Accounting fees.

• Advertising.

• Chemicals.

• Custom hire (machine work).

• Educational expenses (to maintain andimprove farming skills).

• Farm-related attorney fees.

• Farm fuels and oil.

• Farm magazines.

• Freight and trucking.

• Ginning.

• Insect sprays and dusts.

• Litter and bedding.

• Livestock fees.

• Recordkeeping expenses.

• Service charges.


• Small tools expected to last one year orless.

• Stamps and stationery.

• Storage and warehousing.

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

• Tying material and containers.

• Veterinary fees and medicine.

Capital ExpensesA capital expense is a payment, or a debtincurred, for the acquisition, improvement, orrestoration of an asset that is expected to lastmore than one year. You include the expensein the basis of the asset. Uniform capitaliza-tion rules also require you to capitalize or in-clude in inventory certain other expenses.See chapters 3 and 7.

Capital expenses are generally notdeductible, but they may be depreciable.However, you can elect to deduct certaincapital expenses, such as the following.

1) The cost of fertilizer, lime, etc. (seeFertilizer and Lime under DeductibleExpenses, earlier).

2) Soil and water conservation expenses(see chapter 6).

3) The cost of property that qualifies for adeduction under section 179 (see chap-ter 8).

4) The cost of qualifying clean-fuel vehicleproperty and clean-fuel vehicle refuelingproperty (see chapter 15 in Publication535).

The costs of the following items, includingthe costs of material, hired labor, and instal-lation, are capital expenses.

1) Business start-up costs. (See Going IntoBusiness in chapter 8.)

2) Land and buildings.

3) Additions, alterations, and improvementsto buildings, etc.

4) Cars and trucks.

5) Equipment and machinery.

6) Fences.

7) Breeding, dairy, and draft livestock.

8) Reforestation.

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

10) Water wells, including drilling andequipping costs.

11) Land preparation, such as:

a) Clearing land for farming,

b) Leveling and conditioning land,

c) Purchasing and planting trees,

d) Building irrigation canals andditches,

e) Laying irrigation pipes,

f) Installing drain tile,

g) Modifying channels or streams,

h) Constructing earthen, masonry, orconcrete tanks, reservoirs, or dams,and

i) Building roads.

Crop production expenses. The uniformcapitalization rules generally require you tocapitalize expenses incurred in producingplants. However, except for certain taxpayersrequired to use an accrual method of ac-counting, the capitalization rules do not applyto plants with a preproductive period of 2years or less. For more information, seeUniform Capitalization Rules in chapter 7.

Timber. Capitalize the cost of acquiring tim-ber. Do not include the cost of land in the costof the timber. You must generally capitalizedirect costs incurred in reforestation. Thesecosts 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 inplanting or seeding.

5) Costs incurred in replanting to replacelost seedlings.

You can choose to capitalize certain indirectreforestation costs.

These capitalized amounts are your basisfor the timber. Recover your basis when yousell the timber or take depletion allowanceswhen you cut the timber. However, you mayrecover a limited amount of your costs forforestation or reforestation before cutting thetimber through amortization deductions. Formore information, see Depletion and Amorti-zation in chapter 8.

For more information about timber,see Agriculture Handbook Number708, Forest Owners' Guide to the

Federal Income Tax. Copies are $12 eachand are available from the U.S. GovernmentPrinting Office. Place your order using Stock#001–000–04621–7. The address and tele-phone number are:

Superintendent of DocumentsU.S. Government Printing OfficeP.O. Box 371954Pittsburgh, PA 15250–7954(202) 512–1800

Christmas tree cultivation. If you are in thebusiness of planting and cultivating Christmastrees to sell when they are more than 6 yearsold, capitalize expenses incurred for plantingand stump culture and add them to the basisof the standing trees. Recover these ex-penses as part of your adjusted basis whenyou sell the standing trees or as depletionallowances when you cut the trees. For moreinformation, see Timber depletion under De-pletion in chapter 8.

You can deduct as business expenses thecosts incurred for shearing and basal pruningof these trees. Expenses incurred forsilvicultural practices, such as weeding orcleaning, and noncommercial thinning arealso deductible as business expenses.

Capitalize the cost of land improvements,such as road grading, ditching, and firebreaks, that have a useful life beyond the taxyear. If the improvements do not have a de-terminable useful life, add their cost to thebasis of the land. The cost is recovered whenyou sell or otherwise dispose of it. If the im-provements have a determinable useful life,recover their cost through depreciation. Cap-italize the cost of equipment and otherdepreciable assets, such as culverts andfences, to the extent you do not use them inplanting Christmas trees. Recover thesecosts through depreciation.

NondeductibleExpensesYou cannot deduct personal expenses andcertain other items on your tax return even ifthey relate to your farm.

Personal, Living,and Family ExpensesYou cannot deduct certain personal, living,and family expenses as business expenses.These include rent and insurance premiumspaid on property used as your home, life in-surance premiums on yourself or your family,the cost of maintaining cars, trucks, or horsesfor personal use, allowances to minor chil-dren, attorneys' fees and legal expenses in-curred in personal matters, and householdexpenses. Likewise, the cost of purchasingor raising produce or livestock consumed byyou or your family is not deductible.

Other Nondeductible ItemsYou cannot deduct the following items onyour tax return.

Loss of growing plants, produce, andcrops. Losses of plants, produce, and cropsraised for sale are generally not deductible.However, you may have a deductible loss onplants with a preproductive period of morethan 2 years. See chapter 13 for more infor-mation.

Repayment of loans.

Estate, inheritance, legacy, succession,and gift taxes.

Loss of livestock. You cannot deduct as aloss the value of raised livestock that die ifyou deducted the cost of raising them as anexpense.

Losses from sales or exchanges betweenrelated persons. You cannot deduct lossesfrom sales or exchanges of property betweenyou and certain related persons, includingyour spouse, brother, sister, ancestor, or de-scendant. For more information, see chapter2 of Publication 544, Sales and Other Dispo-sitions of Assets.

Cost of raising unharvested crops. Youcannot deduct the cost of raising unharvestedcrops sold with land owned more than oneyear if you sell both at the same time and tothe same person. Add these costs to the ba-sis of the land to determine the gain or losson the sale. For more information, see Sec-tion 1231 Gains and Losses in chapter 11.


Cost of unharvested crops bought withland. Capitalize the purchase price of land,including the cost allocable to unharvestedcrops. You cannot deduct the cost of thecrops at the time of purchase. However, youcan deduct this cost in figuring net profit orloss in the tax year you sell the crops.

Cost related to gifts. You cannot deductcosts related to your gifts of agricultural pro-ducts or property held for sale in the ordinarycourse of your business. For example, youcannot deduct as a farm business expense,in the year of the gift or any later year, thecost of raising cattle given as a gift to yourchild or the cost of planting and raising un-harvested wheat on parcels of land given asa gift to your children.

Club dues and membership fees. Gener-ally, you cannot deduct amounts you pay orincur for membership in any club organizedfor business, pleasure, recreation, or anyother social purpose. This includes countryclubs, athletic clubs, luncheon clubs, sportingclubs, airline clubs, and hotel clubs.

Exception. The following organizationswill not be treated as clubs organized forbusiness, pleasure, recreation, or other socialpurposes, unless one of its main purposes isto conduct entertainment activities for mem-bers or their guests or to provide membersor their guests with access to entertainmentfacilities.

1) Boards of trade.

2) Business leagues.

3) Chambers of commerce.

4) Civic or public service organizations.

5) Professional associations.

6) Trade associations.

Fines and penalties. You cannot deductfines and penalties, except penalties for ex-ceeding marketing quotas, discussed earlier.

Losses FromOperating a FarmIf your deductible farm expenses are morethan your farm income, you have a loss fromthe operation of your farm. The amount ofthat loss you can deduct when figuring yourtaxable income may be limited. To figure yourdeductible loss, you must apply the followinglimits.

1) The at-risk limits.

2) 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 theyear, you may have a net operating loss. SeeNet Operating Losses, later.

CAUTION!

If you do not carry on your farmingactivity to make a profit, your lossdeduction may be limited by the not-

for-profit rules. See Not-for-Profit Farming,later.

At-Risk LimitsThe at-risk rules limit your deduction forlosses from most business or income-producing activities, including farming. Theat-risk rules limit the losses you can deductwhen figuring your taxable income. Thedeductible loss from an activity is limited tothe amount you have at risk in the activity.

You are at risk in any activity for:

1) The money and adjusted basis of prop-erty you contribute to the activity, and

2) Amounts you borrow for use in the ac-tivity if:

a) You are personally liable for repay-ment, or

b) You pledge property (other thanproperty used in the activity) as se-curity for the loan.

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

For more information, see Publication 925.

Passive Activity LimitsA passive activity is generally any activityinvolving the conduct of any trade or businessin which you do not materially participate.Generally, a rental activity is a passive activ-ity.

If you have a passive activity, special ruleslimit the loss you can deduct in the tax year.You generally can deduct losses from passiveactivities only from income from passive ac-tivities. Credits are similarly limited.


Net Operating LossesIf your deductible loss from operating yourfarm (after applying the at-risk and passiveactivity limits explained in the preceding dis-cussion) is more than your other income forthe year, you may have a net operating loss(NOL). You may also have an NOL if you hada personal or business-related casualty ortheft loss that was more than your income.

If you have an NOL this year, you cancarry it to other years and deduct it. You maybe able to get a refund of all or part of theincome tax you paid for past years, or youmay be able to reduce your tax in futureyears.

To determine if you have an NOL, com-plete your tax return for the year. You mayhave an NOL if a negative figure appears onthe line shown below.

1) Individuals—line 37 of Form 1040.

2) Estates and trusts—line 22 of Form1041.

3) Corporations—line 30 of Form 1120 orline 26 of Form 1120–A.

If the amount on that line is zero or more,you do not have an NOL.

There are rules that limit what you candeduct from gross income when figuring anNOL. These rules are discussed in detail un-der How To Figure an NOL in Publication 536.

In general, these rules do not allow thefollowing items.

1) Personal exemptions.

2) Capital losses in excess of capital gains.(Nonbusiness capital losses may onlyoffset nonbusiness capital gains.)

3) The section 1202 exclusion of 50% ofthe gain from the sale or exchange ofqualified small business stock.

4) Nonbusiness deductions in excess ofnonbusiness income.

5) Net operating loss deduction.

Example. Glenn Johnson is a dairyfarmer. He is single and has the following in-come and deductions on his Form 1040 for1999.

Glenn's deductions exceed his income by$9,400 ($13,050 − $3,650). However, to fig-ure whether he has an NOL, he must modifycertain deductions. He can use Schedule A(Form 1045) to figure his NOL.

Glenn cannot deduct the following items.

When these items are eliminated, Glenn'snet loss is reduced to $1,775 ($9,400 −$7,625). This is his NOL for 1999.

Carrybacks. Generally, you carry an NOLback to the 2 tax years before the NOL yearand deduct it from income you had in thoseyears. You can choose not to carry back anNOL and only carry it forward. See Waivingthe carryback period, later. There are rules forfiguring how much of the NOL is used in eachtax year and how much is carried to the nexttax year. These rules are explained in Publi-cation 536.

Unless you choose to waive the carrybackperiod, as discussed later, you must first carrythe entire NOL to the earliest carryback year.If your NOL is not used up, you can carry therest to the next earliest carryback year, andso on.

Refigure your deductions, credits, and taxfor each of the years to which you carriedback an NOL. If your refigured tax is less thanthe tax you originally paid, you can apply fora refund by filing Form 1040X, Amended U.S.Individual Income Tax Return, for each yearaffected, or by filing Form 1045. You willusually get a refund faster by filing Form1045, and generally you can use one Form1045 to apply an NOL to all carryback years.

Exceptions to 2-year carryback rule. Eli-gible losses and farming losses qualify forlonger carryback periods.

INCOME

Wages from part-time job .......................... $1,225Interest on savings .................................... 425Net long-term capital gainon sale of farm acreage ............................ 2,000

Glenn's total income ............................... $3,650

DEDUCTIONS

Net loss from farming business (income of$67,000 minus expenses of $72,000) ....... $5,000Net short-term capital losson sale of stock ......................................... 1,000Standard deduction .................................... 4,300Personal exemption ................................... 2,750

Glenn's total deductions ......................... $13,050

Nonbusiness net short-term capital loss ..... $1,000Nonbusiness deductions(standard deduction, $4,300) minusnonbusiness income (interest, $425) .......... 3,875Personal exemption ..................................... 2,750

Total adjustments to net loss .................. $7,625


Eligible loss. The carryback period foran eligible loss is 3 years. An eligible loss isany part of an NOL that:

1) Is from a casualty or theft, or

2) Is attributable to a Presidentially de-clared disaster for a qualified smallbusiness or a farming business.

An eligible loss does not include a farmingloss (explained next) unless you choose totreat the farming loss as if it were not afarming loss.

Farming loss. The carryback period fora farming loss is 5 years. A farming loss is thesmaller of:

1) The amount which would be the NOL forthe tax year if only income and de-ductions attributable to farming busi-nesses were taken into account, or

2) The NOL for the tax year.

You can choose to treat a farming loss asif it were not a farming loss. For more infor-mation, see Publication 536.

Carryovers. If you do not use up the NOLin the carryback years, carry forward whatremains of it to the 20 tax years following theNOL year. Start by carrying it to the first taxyear after the NOL year. If you do not use itup, carry over the unused part to the nextyear. Continue to carry over any unused partof the NOL until you use it up or complete the20-year carryforward period.

CAUTION!

For an NOL occurring in a tax yearbeginning before August 6, 1997, thecarryforward period is 15 years.

Waiving the carryback period. You canchoose not to carry back your NOL. If youmake this choice, you use your NOL only inthe carryforward period.

To make this choice, attach a statementto your tax return for the NOL year filed onor before the due date of the return (includingextensions). This statement must show thatyou are choosing to waive the carryback pe-riod under section 172(b)(3) of the InternalRevenue Code. Also, if you filed your returntimely without making that election, you maystill make the election by filing an amendedreturn within 6 months of the due date of thereturn (excluding extensions). Attach theelection to the amended return and write“Filed pursuant to section 301.9100–2” on theelection statement. File the amended returnat the same address that you filed the originalreturn. Once made, the election is irrevocableand the carryforward is limited to 20 years.

Partnerships and S corporations. Partner-ships and S corporations cannot use an NOL.But partners or shareholders can use theirseparate shares of the partnership's or Scorporation's business income and businessdeductions to figure their individual NOLs.

Not-for-Profit FarmingIf you operate a farm for profit you can deductall the ordinary and necessary expenses ofcarrying on the business of farming onSchedule F. However, if you do not carry onyour farming activity, or other activity you en-gage or invest in, to make a profit, you reportthe income from the activity on line 21 ofForm 1040 and you can deduct expenses of

carrying on the activity only if you itemize yourdeductions on Schedule A (Form 1040). Also,there is a limit on the deductions you cantake. You cannot use a loss from that activityto offset income from other activities.

Activities you do as a hobby, or mainly forsport or recreation, come under these rules.So does an investment activity intended onlyto produce tax losses for the investors.

The limit on not-for-profit losses applies toindividuals, partnerships, estates, trusts, andS corporations. It does not apply to corpo-rations other than S corporations.

In determining whether you are carryingon your farming activity for profit, all the factsare taken into account. No one factor aloneis decisive. Among the factors to consider arewhether:

1) You operate your farm in a businesslikemanner,

2) The time and effort you spend on farm-ing indicates you intend to make it prof-itable,

3) You depend on income from farming foryour livelihood,

4) Your losses are due to circumstancesbeyond your control or are normal in thestart-up phase of farming,

5) You change your methods of operationin an attempt to improve profitability,

6) You, or your advisors, have the knowl-edge needed to carry on the farmingactivity as a successful business,

7) You made a profit in similar activities inthe past,

8) You make a profit from farming in someyears and how much profit you make,and

9) You can expect to make a future profitfrom the appreciation of the assets usedin the farming activity.

Limit on deductions and losses. If youractivity is not carried on for profit, take de-ductions only in the following order, only tothe extent stated in the three categories, and,if you are an individual, only if you itemizethem on Schedule A (Form 1040).

Category 1. Deductions you can take forpersonal as well as for business activities areallowed in full. For individuals, all nonbusi-ness deductions, such as those for homemortgage interest, taxes, and casualty losses(see chapter 13), belong in this category. Forthe limits that apply to mortgage interest, seePublication 936, Home Mortgage InterestDeduction.

Category 2. Deductions that do not resultin an adjustment to the basis of property areallowed next, but only to the extent your grossincome from the activity is more than the de-ductions you take (or could take) for it underthe first category. Most business deductions,such as those for fertilizer, feed, insurancepremiums, utilities, wages, etc., belong in thiscategory.

Category 3. Business deductions thatdecrease the basis of property are allowedlast, but only to the extent the gross incomefrom the activity is more than deductions youtake (or could take) for it under the first twocategories. The deductions for depreciation,amortization, and the part of a casualty lossan individual could not deduct in category (1)belong in this category. Where more than oneasset is involved, divide depreciation and

these other deductions proportionally amongthose assets.

TIPIndividuals must claim the amounts incategories (2) and (3) above as mis-cellaneous deductions on Schedule

A (Form 1040). They are subject to the2%-of-adjusted-gross-income limit. See Pub-lication 529 for information on this limit.

Partnerships and S corporations. If apartnership or S corporation carries on anot-for-profit activity, these limits apply at thepartnership or S corporation level. They arereflected in the individual shareholder's orpartner's distributive shares.

Presumption of profit. Your farming orother activity is presumed to be carried on forprofit if it produced a profit in at least 3 of thelast 5 tax years, including the current year.Activities that consist primarily of breeding,training, showing, or racing horses are pre-sumed to be carried on for profit if theyproduced a profit in at least 2 out of the last7 tax years, including the current year. Theactivity must be the same for each year withinthis period. You have a profit when the grossincome from an activity is more than the de-ductions for it.

If a taxpayer dies before the end of the5-year (or 7-year) period, the period ends onthe date of the taxpayer's death.

If your business or investment activitypasses this 3- (or 2-) years-of-profit test, it ispresumed to be carried on for profit. Thismeans the limits discussed here do not apply.You can take all your business deductionsfrom the activity on Schedule F, even for theyears that you have a loss. You can rely onthis presumption unless the IRS shows it isnot valid.

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

Using the presumption later. If you arestarting out in farming and do not have 3 (or2) years showing a profit, you may want totake advantage of this presumption later, afteryou have had the 5 (or 7) years of experienceallowed by the test.

You can choose to do this by filing Form5213. Filing this form postpones any deter-mination that your farming activity is not car-ried on for profit until 5 (or 7) years havepassed since you first started farming. Form5213 must be filed within 3 years after the duedate of your return for the year you firststarted farming. However, if you receive anotice from the Internal Revenue Serviceproposing to disallow your farm loss, file thisform within 60 days after receiving the notice.

The benefit gained by making this choiceis that the IRS will not immediately questionwhether your farming activity is engaged in forprofit. Accordingly, it will not limit your de-ductions. Rather, you will gain time to earn aprofit in 3 (or 2) out of the first 5 (or 7) yearsyou carry on the farming activity. If you show3 (or 2) years of profit at the end of this pe-riod, your deductions are not limited underthese rules. If you do not have 3 (or 2) yearsof profit (and cannot otherwise show that youoperated your farm for profit), the limit appliesretroactively to any year in the 5- (or 7-) yearperiod with a loss.

Filing Form 5213 automatically extendsthe period of limitations on any year in the 5-(or 7-) year period to 2 years after the duedate of the return for the last year of the pe-


riod. The period is extended only for de-ductions of the activity and any related de-ductions that might be affected.

For more information on not-for-profit ac-tivities, see Not-for-Profit Activities in chapter1 of Publication 535.

6.Soil and WaterConservationExpenses

IntroductionIf you are in the business of farming, you canchoose to currently deduct your expenses forsoil or water conservation or for the pre-vention of erosion of land used in farming.Otherwise, these are capital expenses thatmust be added to the basis of the land. (Seechapter 7 for information on determining ba-sis.) Conservation expenses for land in a for-eign country do not qualify for this specialtreatment.

The deduction cannot be more than 25%of your gross income from farming. See Limiton Deduction, later.

Ordinary and necessary expenses that areotherwise deductible are not soil and waterconservation expenses. These include inter-est and taxes, the cost of periodically clearingbrush from productive land, the annual re-moval of sediment from a drainage ditch, andexpenses paid or incurred primarily toproduce an agricultural crop that may alsoconserve soil.

RECORDS

To get the full deduction to which youare entitled, you should maintain yourrecords in a way that will clearly dis-

tinguish between your ordinary and neces-sary farm business expenses and your soiland water conservation expenses.


• Business of farming

• Plan certification

• Conservation expenses

• Assessment by conservation district

• Limit on deduction

• Choosing to deduct

• Sale of a farm

Business of FarmingFor purposes of soil and water conservationexpense, you are in the business of farmingif you cultivate, operate, or manage a farm forprofit, either as owner or tenant. You are notfarming if you cultivate or operate a farm for

recreation or pleasure, rather than for profit.You are not farming if you are engaged onlyin forestry or the growing of timber.

Farm defined. A farm includes stock, 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 andother marine animals are grown or raised andartificially fed, protected, etc. It does not in-clude an area where they are merely caughtor harvested. A plant nursery is a farm forpurposes of deducting soil and water conser-vation expenses.

Farm rental. If you own a farm and receivefarm rental payments based on farm pro-duction, either in cash or crop shares, you arein the business of farming. If you receive afixed rental payment not based on farm pro-duction, you are in the business of farmingonly if you materially participate in operatingor managing the farm. See Landlord Partici-pation in Farming in chapter 15.

If you get cash rental for a farm you ownthat is not used in farm production, you can-not claim soil and water conservation ex-penses for that farm.

Example. You own a farm in Iowa andlive in California. You rent the farm for $125in cash per acre and do not materially partic-ipate in producing or managing production ofthe crops grown on the farm. You cannot de-duct your soil conservation expenses for thisfarm. You must capitalize the expenses andadd them to the basis of the land.

Plan CertificationYou can deduct your expenses for soil andwater conservation only if they are consistentwith a plan approved by the Natural Re-sources Conservation Service (NRCS) of theDepartment of Agriculture. If no such planexists, the expenses must be consistent witha soil conservation plan of a comparable stateagency to be deductible. Keep a copy of theplan with your books and records as part ofthe support for your deductions.

Conservation plans. A conservation planincludes the farming conservation practicesapproved for the area where your farm landis located. There are three types of approvedplans.

• NRCS individual site plans. Theseplans are issued individually to farmerswho request assistance from NRCS todevelop a conservation plan designedspecifically for their farm land.

• NRCS county plans. These plans in-clude a listing of farm conservation prac-tices approved for the county where thefarm land is located. Expenses for con-servation practices not included on theNRCS county plans are deductible onlyif the practice is a part of an individual siteplan.

• Comparable state agency plans. Theseplans are approved by state agenciesand can be approved individual site plansor county plans. Individual site plans canbe obtained from NRCS offices andcomparable agencies.

ConservationExpensesDeductible conservation expenses are thosemade for land that you or your tenant areusing, or have used in the past, for farming.They include, but are not limited to expensesfor the following.

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

a) Leveling,

b) Conditioning,

c) Grading,

d) Terracing,

e) Contour furrowing, and

f) Restoration of soil fertility.

2) The construction, control, and protectionof:

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.

CAUTION!

If you choose to deduct soil and waterconservation expenses, you cannotexclude from gross income any cost-

sharing payments you receive for those ex-penses. See chapter 4 for information aboutexcluding cost-sharing payments.

New farm or farm land. If you acquire a newfarm or new farm land from someone whowas using it in farming immediately beforeyou acquired the land, soil and water con-servation expenses you make on it will betreated as made on land used in farming atthe time the expenses were paid. You candeduct soil and water conservation expensesfor this land if your use of it is substantially acontinuation of its use in farming. The newfarming activity does not have to be the sameas the old farming activity. For example, if youbuy land that was used for grazing cattle andthen prepare it for use as an apple orchard,the expenses will qualify.

Land not used for farming. If your conser-vation expenses benefit both land that doesnot qualify as land used for farming and landthat does qualify, you must allocate the ex-penses. For example, if the expenses benefit200 acres of your land, but only 120 acres ofthis land are used for farming, then 60% (120÷ 200) of the expenses are deductible. Youcan use another method to allocate theseexpenses if you can clearly show that yourmethod is more reasonable.

Wetlands. Expenses to drain or fill wetlandsare not deductible as soil and water conser-vation expenses. These expenses are addedto the basis of the land.

Center pivot irrigation. Expenses to pre-pare land for center pivot irrigation systemsare not deductible as soil and water conser-

Page 32 Chapter 6 Soil and Water Conservation Expenses

Table 6–1. Limits on Deducting an Assessment for Depreciable Property

Total assessment against all members of thedistrict for the property.

● No one taxpayer can deduct more than10% of the total assessment.

Total Limit on Deduction for Assessment Yearly Limit on Deduction for Assessment Yearly Limit for All Conservation Expenses

Your deductible share of the cost to thedistrict for the property + $500.

● Limit for all conservation expenses, includingassessments for depreciable property.

Your gross income from farming.

10% of: 10% of: 25% of:

● Any amount over 10% is a capital expenseand is added to the basis of your land.

● Amounts greater than 25% can be carriedto the following year and added to that year’sexpenses. The total is then subject to the25% of gross income from farming limit inthat year.

● If the assessment is greater than theamount paid, the limit for that year is 10%of your deductible share of the cost.

● If an assessment is over 10% and payablein installments, each payment must beprorated between the deductible amountand the capital expense.

● The remainder is included in equalamounts over the next 9 tax years.

vation expenses. These expenses are addedto the basis of the land.

Depreciable conservation assets. Youcannot deduct your expenses for depreciableconservation assets. There is, however, anexception for an assessment for depreciableproperty that a soil and water conservationor drainage district levies against your farm.See Assessment for Depreciable Property,later.

You must capitalize direct expenses forstructures or facilities subject to an allowancefor depreciation, such as depreciablenonearthen items made of masonry or con-crete. Expenses for depreciable property in-clude those for materials, supplies, wages,fuel, hauling, and moving dirt when makingstructures such as tanks, reservoirs, pipes,conduits, canals, dams, wells, or pumpscomposed of masonry, concrete, tile, metal,or wood. You recover your capital investmentthrough annual allowances for depreciation.

However, soil and water conservation ex-penses for nondepreciable earthen itemssuch as earthen terraces and dams aredeductible.

Water well. The cost of drilling a waterwell for irrigation and other agricultural pur-poses is a capital expense and not deductibleas a soil and water conservation expense.You recover your cost through depreciation.You must also capitalize your cost for drillinga test hole. If the test hole produces no waterand you continue drilling, the cost of the testhole is added to the cost of the producingwell. You can recover the total cost throughdepreciation deductions.

If a test hole, dry hole, or dried-up well(resulting from prolonged lack of rain, for in-stance) is abandoned, you can deduct yourunrecovered cost in the year of abandonment.Abandonment means that all economic ben-efits from the well are terminated. For exam-ple, filling or sealing a well excavation orcasing so that all economic benefits from thewell are terminated would be abandonment.

Assessment byConservation DistrictIn some localities, a soil or water conservationor drainage district incurs the expenses forsoil or water conservation and levies an as-sessment against the farmers who benefitfrom the expenses. You can include as adeductible conservation expense the part ofan assessment that:

• You would have included if you had paidit directly, or

• Covers expenses for depreciable prop-erty used in the district's business.

You include the amount in the year you payor incur the assessment, depending on yourmethod of accounting, not the year the ex-penses are paid or incurred by the district.

Assessment forDepreciable PropertyYou can include as a deductible conservationexpense part of an assessment levied againstyou by a soil and water conservation ordrainage district to pay for depreciable prop-erty. This includes items such as pumps,locks, concrete structures including dams andweir gates, draglines, and similar equipment.The depreciable property must be used in thedistrict's soil and water conservation activities.Special limits, discussed next, apply to theseassessments.

Amount to include. The amount you caninclude for any conservation district assess-ment for depreciable property is subject to thefollowing limits.

• The total amount you can include for theassessment (whether one payment orpaid in installments) cannot exceed 10%of the total assessment against all mem-bers of the district for the property.

• The maximum amount you can includeeach year is 10% of your deductibleshare of the cost + $500.

The amount you can include is added toyour other conservation expenses for theyear. The total for these expenses is thensubject to the limit on the deduction discussedlater. See Table 6–1 for information on thelimits.

Total limit. You cannot include more than10% of the total amount assessed to allmembers of the conservation district for thedepreciable property. This applies whetheryou pay the assessment in one payment orin installments. If your assessment is morethan 10% of the total assessment, both thefollowing rules apply.

• The amount over 10% is a capital ex-pense and is added to the basis of yourland.

• If the assessment is paid in installments,each payment must be prorated between

the deductible amount and the capitalexpense.

Yearly limit. The maximum amount youcan include in one year is the total of 10% ofyour deductible share of the cost as explainedearlier, plus $500. If the assessment is equalto or less than the maximum amount, you caninclude the entire assessment in the year it ispaid. If the assessment is more, the maximumamount you can include in one year is 10%of your deductible share of the cost. The re-mainder of the assessment is included inequal amounts (subject to the yearly limit)over the next 9 tax years.

Example 1. This year, the soil conserva-tion district levies an assessment of $2,400against your farm. Of the assessment, $1,500is for digging drainage ditches. It is includibleas a soil or conservation expense as if youhad paid it directly. The remaining $900 is fordepreciable equipment to be used in the dis-trict's irrigation activities. The total amountassessed by the district against all its mem-bers for the depreciable equipment is $7,000.

The total amount you can include for thedepreciable equipment is limited to 10% ofthe total amount assessed by the districtagainst all its members for depreciableequipment, or $700. The $200 excess ($900− $700) is a capital expense you must add tothe basis of your farm.

To figure the maximum amount to includefor this year, multiply your deductible shareof the total assessment ($700) by 10%. Add$500 to the result for a total of $570. Sincethe assessment, $700, is greater than themaximum amount deductible in one year, youcan include only $70 of the assessment fordepreciable property this year (10% of $700).The balance is included at the rate of $70 ayear over the next 9 years.

You add $70 to the $1,500 portion of theassessment for drainage ditches. You caninclude $1,570 of the $2,400 assessment asa soil and water conservation expense thisyear, subject to the limit on deduction dis-cussed later.

Example 2. Assume the same facts inExample 1 except that $1,850 of the $2,400assessment is for digging drainage ditchesand $550 is for depreciable equipment. Thetotal assessed by the district against all itsmembers for depreciable equipment is$5,500. Your total deductible assessment forthe depreciable equipment is limited to 10%of this amount, or $550.

The maximum deductible this year for thedepreciable equipment is $555 (10% of yourtotal deductible assessment, $55, plus $500).

Chapter 6 Soil and Water Conservation Expenses Page 33

Since the assessment for depreciable prop-erty is less than the maximum deductible, youcan include the entire $550. The entire as-sessment, $2,400, is deductible as a soil andwater conservation expense this year, subjectto the limit on deduction, discussed later.

Sale or disposal of land during 9-year pe-riod. If you sell or dispose of the land duringthe 9-year period for deducting conservationexpenses, any remaining assessment not yetincluded is added to the basis of the property.

Death of farmer during 9-year period. If thefarmer dies during the 9-year period, any re-maining assessment not yet included is in-cluded in the year of death.

Limit on DeductionThe total deduction for conservation ex-penses in any tax year is limited to 25% ofyour gross income from farming for the year.

Gross income from farming. Gross incomefrom farming is the income you derive in thebusiness of farming from the production ofcrops, fish, fruits, other agricultural products,or livestock. Gains from sales of livestockheld for draft, breeding, or dairy are included.Gains from sales of assets such as farm ma-chinery, or from the disposition of land, arenot included.

Carryover of deduction. If your deductibleconservation expenses in any year are morethan 25% of your gross income from farmingfor that year, you can carry the unused de-duction over to later years. However, thededuction in any later year is limited to 25%of the gross income from farming for thatyear, as well.

Example. In 1999, you have gross in-come of $16,000 from two farms. During theyear, you incurred $5,300 of deductible soiland water conservation expenses for one ofthe farms. However, your deduction is limitedto 25% of $16,000, or $4,000. The $1,300($5,300 − $4,000) is carried over to 2000 andadded to deductible soil and water conserva-tion expenses made in that year. The total ofthe 1999 carryover plus 2000 expenses isdeductible in 2000, subject to the limit of 25%of your gross income from farming in 2000.Any expenses over the limit in that year arecarried to 2001 and later years.

Net operating loss. The deduction forsoil and water conservation expenses is in-cluded when figuring a net operating loss(NOL) for the year. If the NOL is carried toanother year, the soil and water conservationdeduction included in the NOL is not subjectto the 25% limit in the year to which it is car-ried.

Choosing To DeductYou can choose to deduct soil and waterconservation expenses on your tax return forthe first year you pay or incur these expenses.If you choose to deduct them, you must de-duct the total allowable amount in the yearthey are paid or incurred. If you do not deductthe expenses, you must capitalize them.

Change of method. If you want to changeyour method of treating soil and water con-servation expenses, or you want to treat theexpenses for a particular project or a singlefarm in a different manner, you must get theapproval of the IRS. To get this approval,submit a written request by the due date ofyour return for the first tax year you want thenew method to apply. You or your authorizedrepresentative must sign the request.

The request must include the followinginformation.

• Your name and address.

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

• Whether the method or change of methodapplies to all your soil and water conser-vation expenses or only to those for aparticular project or farm. If the methodor change of method does not apply toall your expenses, identify the project orfarm to which the expenses apply.

• The total expenses you paid or incurredin the first tax year the method or changeof method is to apply.

• A statement that you will account sepa-rately in your books for the expenses towhich this method or change of methodrelates.

Sale of a FarmIf you sell your farm, you cannot adjust thebasis of the land at the time of the sale forany unused carryover of soil and water con-servation expenses (except for deductions ofassessments for depreciable property, dis-cussed earlier). However, if you acquire an-other farm and return to the business offarming, you can start taking deductions againfor the unused carryovers.

Gain on disposition of farm land. If youheld the land 5 years or less before you soldor disposed of it, gain on the sale or otherdisposition of the land is treated as ordinaryincome up to the amount you previously de-ducted for soil and water conservation ex-penses. If you held the land less than 10 butmore than 5 years, the gain is treated as or-dinary income up to a specified percentageof the previous deductions. See Section 1252property in chapter 11.

7.Basis of Assets

IntroductionBasis is the amount of your investment inproperty for tax purposes. Use the basis ofproperty to figure the amount of gain or losson the sale, exchange, or other dispositionof property. Also use it to figure the deductionfor depreciation, amortization, depletion, andcasualty losses. If you use property for both

business and personal purposes, you mustallocate the basis based on the use. Only thebasis allocated to the business use of theproperty can be depreciated.

Your original basis in property is adjusted(increased or decreased) by certain events.If you make improvements to the property,increase your basis. If you take deductions fordepreciation or casualty losses, reduce yourbasis.

RECORDS

It is important to keep an accuraterecord of your basis. For informationon keeping records, see chapter 1.

Generally, the higher your basis for anasset, the less gain you will have to report onits sale. The higher your basis in a deprecia-ble asset, the higher your depreciation de-ductions.


• Cost basis

• Adjusted basis

• Basis other than cost


Publication

� 504 Divorced or Separated Individuals


� 537 Installment Sales

� 544 Sales and Other Dispositions ofAssets

� 551 Basis of Assets


� 706–A United States Additional EstateTax Return


Cost BasisThe basis of property you buy is usually itscost. However, in some cases, such as in-herited property or property received as a gift,your basis will be figured differently. (SeeBasis Other Than Cost, later.) The cost is theamount you pay in cash, debt obligations,other property, or services. Your cost alsoincludes amounts you pay for sales tax,freight, installation, and testing. In addition,the basis of real estate and business assetswill include other items. Basis generally doesnot include interest payments.

You may also have to capitalize (add tobasis) certain other costs related to buyingor producing property. Under the uniformcapitalization rules, discussed later, you mayhave to capitalize certain indirect costs ofproducing property.

Loans with low or no interest. If you buyproperty on any time-payment plan thatcharges little or no interest, the basis of yourproperty is your stated purchase price minusthe amount considered to be unstated inter-est. You generally have unstated interest ifyour interest rate is less than the applicable

Page 34 Chapter 7 Basis of Assets

federal rate. See the discussion of unstatedinterest in Publication 537.

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

If you buy real property, certain fees andother expenses you pay are part of your costbasis in the property.

You must allocate your cost basis be-tween land and improvements, such asbuildings, to figure the basis for depreciationof the improvements. Allocate the costs ac-cording to the fair market values of the landand improvements at the time of purchase.

Real estate taxes. If you pay real estatetaxes that the seller owed on real propertyyou bought, and the seller did not reimburseyou, treat those taxes as part of your basis.You cannot deduct them as taxes.

If you reimburse the seller for taxes theseller paid for you, you usually can deductthat amount as an expense in the year ofpurchase. Do not include that amount in thebasis of property. If you did not reimburse theseller, you must reduce your basis by theamount of those taxes.

Settlement costs. You can include in thebasis of property you buy the settlement feesand closing costs that are for buying theproperty. (A fee for buying property is a costthat must be paid even if you bought theproperty for cash.) You cannot include feesand costs for getting a loan on the property.

The following items are some of thesettlement fees or closing costs you can in-clude in the basis of your property.

• Abstract fees (abstract of title fees).

• Charges for installing utility services.

• Legal fees (including title search andpreparing the sales contract and deed).

• Recording fees.

• Surveys.

• Transfer taxes.

• Owner's title insurance.

• Any amounts the seller owes that youagree to pay, such as back taxes or in-terest, recording or mortgage fees,charges for improvements or repairs, andsales commissions.

Settlement costs do not include amountsplaced in escrow for the future payment ofitems such as taxes and insurance.

The following items are some settlementfees and closing costs you cannot include inthe basis of the property.

1) Fire insurance premiums.

2) Rent for occupancy of the property be-fore closing.

3) Charges for utilities or other services re-lated to occupancy of the property beforeclosing.

4) Fees for refinancing a mortgage.

5) Charges connected with getting a loan.The following items are examples ofthese charges.

a) Mortgage insurance premiums.

b) Loan assumption fees.

c) Cost of a credit report.

d) Fees for an appraisal required by alender.

If these costs relate to business property,items (1) through (3) are deductible as busi-ness expenses. Items (4) and (5) must becapitalized as costs of getting a loan and canbe deducted over the period of the loan.

Points. If you pay points to get a loan (in-cluding a mortgage, second mortgage, line-of-credit, or a home equity loan), do not addthe cost to the basis of the related property.Generally, you deduct points over the termof the loan. For more information about de-ducting points, see Points in chapter 8 ofPublication 535.

Points on home mortgage. Special rulesmay apply to points you and the seller paywhen you get a mortgage to buy your mainhome. If certain requirements are met, youcan deduct the points in full for the year inwhich they are paid. Reduce the basis of yourhome by the amount of any seller-paid points.For more information, see Points in Publica-tion 936, Home Mortgage Interest Deduction.

Assumption of a mortgage. If you buyproperty and assume (or buy subject to) anexisting mortgage on the property, your basisincludes the amount you pay for the propertyplus the amount to be paid on the mortgage.

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

Constructing assets. If you build propertyor have assets built for you, your expensesfor this construction are part of your basis.Some of these expenses include the followingitems.

• The cost of purchased land.

• The cost of labor and materials.

• Architect's fees.

• Building permit charges.

• Payments to contractors.

• Payments for rental equipment.

• Inspection fees.

In addition, if you use your employees or farmmaterials and equipment to build an asset,your basis would also include the followingcosts.

1) Employee wages paid for the con-struction work.

2) Depreciation on equipment you ownwhile it is used in the construction.

3) Operating and maintenance costs forequipment used in the construction.

4) The cost of business supplies and ma-terials used in the construction.

Do not deduct these expenses. You mustcapitalize them (include them in the asset'sbasis). Also, reduce your basis by any workopportunity credit, welfare-to-work credit, In-dian employment credit, or empowermentzone employment credit allowable on thewages you pay in (1). For information aboutthese credits, see Publication 954, Tax In-centives for Empowerment Zones and OtherDistressed Communities.

CAUTION!

Do not include the value of your ownlabor, or any other labor you did notpay for, in the basis of any property

you construct.

Allocating the BasisIf you buy multiple assets for a lump sum,allocate the amount you pay among the as-sets you receive. Make this allocation to fig-ure your basis for depreciation and gain orloss on a later disposition of any of these as-sets.

Group of assets acquired. If you buy mul-tiple assets for a lump sum, you and the sellermay agree to a specific allocation of the pur-chase price among the assets in the salescontract. If this allocation is based on thevalue of each asset and you and the sellerhave adverse legal interests, the allocationgenerally will be accepted.

Example. In March you bought propertyfor the lump-sum price of $30,000. In thesales contract, you and the seller (not a re-lated person) agree to allocate the purchaseprice among the assets based on their fairmarket value (FMV). An inventory of theproperty at its FMV on the date of purchaseis as follows:

Your basis in each of the assets is its FMV.The FMV of property is defined later underBasis Other Than Cost.

Farming business acquired. If you buy agroup of assets that is a farming business,there are rules you must use to allocate thepurchase price among the assets. See Tradeor Business Acquired in Publication 551 formore information.

Transplanted embryo. If you buy a cow thatis pregnant with a transplanted embryo, allo-cate to the basis of the cow the part of thepurchase price equal to the FMV of the cow.Allocate the rest of the purchase price to thebasis of the calf. Neither the cost allocated tothe cow nor the cost allocated to the calf isdeductible as a current business expense.

Quotas and allotments. Certain areas of thecountry have quotas or allotments for com-modities such as milk, tobacco, and peanuts.The cost of the quota or allotment is its basis.If you acquire a right to a quota with the pur-chase of land or a herd of dairy cows, allocatepart of the purchase price to that right.

Uniform CapitalizationRulesThe uniform capitalization rules specify thecosts you add to basis in certain circum-stances. You are subject to the uniform cap-italization rules if you do any of the followingin your trade or business or activity carriedon for profit.

• Produce real or tangible personal prop-erty for use in the business or activity.

• Produce real or tangible personal prop-erty for sale to customers.

FMV

Tractor ...................................................... $15,000Plow ......................................................... 5,000Mower ...................................................... 6,000Manure spreader ..................................... 4,000Total purchase price ............................. $30,000

Chapter 7 Basis of Assets Page 35

• Acquire property for resale. However, yougenerally do not have to use the uniformcapitalization rules for personal propertyacquired if your average annual grossreceipts are $10 million or less for the 3prior tax years.

You produce property if you construct, build,install, manufacture, develop, improve, cre-ate, raise, or grow the property.

TIPYou are not required to capitalize thecosts of producing animals and cer-tain plants. See Exceptions, later.

Examples of real property you mightproduce (build) for use in your farming busi-ness are barns, chicken houses, and storagesheds. Examples of tangible personal prop-erty you might produce for use in your farmingbusiness or for sale to customers includecrops raised for sale or as animal feed. Otherexamples are animals raised for sale (beefcattle, hogs, etc.) or animals used in yourfarming business for breeding or productionpurposes (dairy cows).

Under the uniform capitalization rules, youmust capitalize all direct costs and anallocable part of most indirect costs you incurdue to your production or resale activities.The term capitalize means to include certainexpenses in the basis of property youproduce or in your inventory costs, rather thandeduct them as current expenses. You canrecover these costs through depreciation,amortization, or cost of goods sold when youuse, sell, or otherwise dispose of the property.

Costs that are allocable to property beingproduced include variable costs, such as feedand labor, and fixed costs, such as depreci-ation on machinery and buildings.

For more information about these rules,see the regulations under section 263A of theInternal Revenue Code.

Exceptions. The uniform capitalization rulesdo not apply to the following.

1) Any animal.

2) Any plant with a preproductive period of2 years or less.

3) Costs of replanting certain plants lost ordamaged due to casualty.

Exceptions (1) and (2) do not apply to a cor-poration, partnership, or tax shelter requiredto use an accrual method of accounting. SeeAccrual Method Required in chapter 3.

In addition, you can choose not to use theuniform capitalization rules in the case ofplants with a preproductive period of morethan 2 years. If you make this choice, specialrules apply. This choice cannot be made bya corporation, partnership, or tax shelter re-quired to use an accrual method of account-ing. This choice also does not apply to anycosts incurred for the planting, cultivation,maintenance, or development of any citrusor almond grove (or any part thereof) withinthe first 4 years that the trees were planted.

For more information, see section1.263A–4T of the regulations.

Adjusted BasisBefore figuring any gain or loss on a sale,exchange, or other disposition of property orfiguring allowable depreciation, depletion, oramortization, you must usually make certain

adjustments to the basis of the property. Theresult of these adjustments to the basis is theadjusted basis.

Increases to BasisIncrease the basis of any property by all itemsproperly added to a capital account. Theseinclude the cost of any improvements havinga useful life of more than 1 year and amountsspent after a casualty to restore the damagedproperty.

The following are items that increase thebasis of property.

• The cost of extending utility service linesto property.

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

• Legal fees for obtaining a decrease in agovernment charge levied against prop-erty to pay for local improvements.

If you make additions or improvements tobusiness property, keep separate accountsfor them. Also, depreciate the basis of eachaccording to the depreciation rules in effectwhen you placed the addition or improvementin service. See chapter 8.

Government charges for local improve-ments. Increase the basis of property bygovernment charges for items such as pavingroads and building ditches that increase thevalue of the property assessed. Do not deductthem as taxes. However, you can deduct astaxes charges that are for maintenance, re-pairs, or interest charges related to the im-provements.

Deducting vs. capitalizing costs. Do notadd to your basis costs you can deduct ascurrent expenses. For example, amounts paidfor incidental repairs or maintenance that aredeductible as business expenses, cannot beadded to basis. However, you can chooseeither to deduct or to capitalize certain othercosts. If you capitalize these costs, includethem in your basis. If you deduct them, do notinclude them in your basis. See chapter 11 inPublication 535.

Decreases to BasisAll the following reduce the basis of yourproperty.

• The section 179 deduction.

• The deduction for clean-fuel vehicles andclean-fuel vehicle refueling property.

• Investment credit (part or all of credit)taken.

• Casualty and theft losses and insurancereimbursements.

• Amounts you receive for granting aneasement.

• Deductions previously allowed or allow-able for amortization, depreciation, anddepletion.

• Exclusion from income of subsidies forenergy conservation measures.

• Credit for qualified electric vehicles.

• Gain on the sale of your home on whichtax was postponed.

• Certain canceled debt excluded from in-come.

• Rebates received from a manufactureror seller.

• Patronage dividends received as a resultof a purchase of property. See PatronageDividends (Distributions) in chapter 4.

• Gas-guzzler tax.

Some of these decreases to basis are dis-cussed next.

Section 179 deduction. If you choose totake the section 179 deduction for all or partof the cost of property, decrease the basis ofthe property by the deduction. For more in-formation, see Section 179 Deduction inchapter 8.

Deduction for clean-fuel vehicle andclean-fuel vehicle refueling property. If youtake the deduction for clean-fuel vehicles orclean-fuel vehicle refueling property, de-crease the basis of the property by theamount of the deduction. For more informa-tion about these deductions, see chapter 15in Publication 535.

Casualties and thefts. If you have a casu-alty or theft loss, decrease the basis of yourproperty by the amount of any insurance orother reimbursement. Also, decrease it by anydeductible loss not covered by insurance.However, increase your basis for amountsyou spend after a casualty to restore thedamaged property. See chapter 13 for infor-mation about figuring your casualty or theftloss.

Easements. The amount you receive forgranting an easement is usually consideredto be from the sale of an interest in your realproperty. It reduces the basis of the affectedpart of the property. If the amount received ismore than the basis of the part of the propertyaffected by the easement, reduce your basisin that part to zero and treat the excess as arecognized gain. See Easements and rights-of-way in chapter 4.

Depreciation. Decrease the basis of yourproperty by the depreciation you deducted,or could have deducted, on your tax returnsunder the method of depreciation you chose.If you took less depreciation than you couldhave under the method you chose, decreasethe basis by the amount you could have takenunder that method. If you did not take a de-preciation deduction, figure the amount ofdepreciation you could have taken. If youdeducted more depreciation than you shouldhave, decrease your basis as follows. De-crease it by the amount you should have de-ducted plus the part of the excess depreci-ation you deducted that actually reduced yourtax liability for any year.

See chapter 8 for information on figuringthe depreciation you should have claimed.See also Changing Your Accounting Methodin chapter 8 for information that may benefityou if you deducted the wrong amount of de-preciation.

In decreasing your basis for depreciation,take into account the amount deducted onyour tax returns as depreciation and any de-preciation you must capitalize under the uni-form capitalization rules.

Exclusion from income of subsidies forenergy conservation measures. If you re-ceived a subsidy from a utility company forthe purchase or installation of any energy


conservation measure for a dwelling unit, youcan exclude it from income. Reduce the basisof the property for which you received thesubsidy by the excluded amount. For moreinformation about this subsidy, see Publica-tion 525, Taxable and Nontaxable Income.

Credit for qualified electric vehicle. If youclaim the credit for a qualified electric vehicle,you must reduce your basis in that vehicle bythe lesser of the following amounts.

• $4,000.

• 10% of the vehicle's cost.

This reduction amount applies even if thecredit allowed is less than that amount. Formore information on this credit, see chapter15 in Publication 535.

Canceled debt excluded from income. Ifa debt you owe is canceled or forgiven, otherthan as a gift or bequest, you generally mustinclude the canceled amount in your grossincome for tax purposes. A debt includesindebtedness for which you are liable orwhich attaches to property you hold.

You can exclude your canceled debt fromincome if the debt is included in any of thefollowing categories.

1) Debt that is canceled in a bankruptcycase or when you are insolvent.

2) Qualified farm debt.

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

If you exclude from income canceled debtdescribed in (1) or (2), you may have to re-duce the basis of your depreciable and non-depreciable property. However, for canceleddebt described in (3) that you exclude fromincome, you must reduce the basis of yourdepreciable property by the excluded amount.

For more information about canceled debtin a bankruptcy case, see Publication 908.For more information about insolvency andcanceled debt that is qualified farm debt, seechapter 4. For more information about qual-ified real property business debt, see chapter5 in Publication 334.

Basis Other Than CostThere are many times when you cannot usecost as basis. In these cases, the fair marketvalue of the property or the adjusted basis ofcertain property may be used. Adjusted basisis discussed earlier. Fair market value is dis-cussed next.

Fair market value (FMV). Fair market value(FMV) is the price at which property wouldchange hands between a buyer and a seller,neither having to buy or sell, and both havingreasonable knowledge of all necessary facts.Sales of similar property on or about the samedate may help in figuring the FMV of theproperty.

Property changed to business use. Whenyou hold property for personal use andchange it to business use or use it to producerent, you must figure its basis for depreci-ation. An example of changing property heldfor personal use to business use would berenting out your former personal residence.

Basis for depreciation. The basis fordepreciation is the lesser of the following twoamounts.

• The FMV of the property on the date ofthe change.

• Your adjusted basis on the date of thechange.

Property received for services. If you re-ceive property for services, include the prop-erty's FMV in income. The amount you in-clude in income becomes your basis. If theservices were performed for a price agreedon beforehand, it will be accepted as the FMVof the property if there is no evidence to thecontrary.

Taxable ExchangesA taxable exchange is one in which the gainis taxable, or the loss is deductible. A taxablegain or deductible loss also is known as arecognized gain or loss. If you receive prop-erty in exchange for other property in a taxa-ble exchange, the basis of the property youreceive is usually its FMV at the time of theexchange. A taxable exchange occurs whenyou receive cash or get property that is notsimilar or related in use to the property ex-changed.

Example. You trade a tract of farm landwith an adjusted basis of $3,000 for a tractorthat has an FMV of $6,000. You must reporta taxable gain of $3,000 for the land. Thetractor has a basis of $6,000.

Nontaxable ExchangesA nontaxable exchange is an exchange inwhich you are not taxed on any gain and youcannot deduct any loss. If you receive prop-erty in a nontaxable exchange, its basis isusually the same as the basis of the propertyyou transferred. A nontaxable gain or lossalso is known as an unrecognized gain orloss.

Example. You traded a truck you used inyour farming business for a new smaller truckto use in farming. The adjusted basis of theold truck was $10,000. The FMV of the newtruck was $14,000. If this was a taxable ex-change, you would recognize gain of $4,000($14,000 FMV of the new truck minus the$10,000 adjusted basis of the old truck), andyour basis in the new truck would be $14,000.Because this is a nontaxable exchange, youdo not recognize the gain, and your basis inthe new truck is $10,000, the same as theadjusted basis of the old truck you traded.

Like-Kind ExchangesThe exchange of property for the same kindof property is the most common type of non-taxable exchange.

For an exchange to qualify as a like-kindexchange, you must hold for business or in-vestment purposes both the property youtransfer and the property you receive. Theremust also be an exchange of like-kind prop-erty. For more information, see Like-Kind Ex-changes, in chapter 10.

The basis of the property you receive isthe same as the basis of the property yougave up.

Example. You traded a machine (ad-justed basis $8,000) for another like-kindmachine (FMV $9,000). You used both ma-

chines in your farming business. The basisof the machine you received is $8,000, thesame as the machine traded.

Exchange expenses. Exchange expensesgenerally are the closing costs that you pay.They include such items as brokerage com-missions, attorney fees, deed preparationfees, etc. Add them to the basis of the like-kind property you received.

Property plus cash. If you trade property ina nontaxable exchange and also pay money,the basis of the property you receive is thebasis of the property you gave up plus themoney you paid.

Example. You trade in a truck (adjustedbasis $3,000) for another truck (FMV $7,500)and pay $4,000. Your basis in the new truckis $7,000 (the $3,000 basis of the old truckplus the $4,000 paid).

Special rules for related persons. If alike-kind exchange takes place directly or in-directly between related persons and eitherparty disposes of the property within 2 yearsafter the exchange, the exchange no longerqualifies for like-kind exchange treatment.Each person must report any gain or loss notrecognized on the original exchange. Eachperson reports it on the tax return filed for theyear in which the later disposition occurred.If this rule applies, the basis of the propertyreceived in the original exchange will be itsFMV. For more information, see chapter 10.

Exchange of business property. Exchang-ing the property of one business for theproperty of another business is a multipleproperty exchange. For information on figur-ing basis, see Multiple Property Exchangesin chapter 1 of Publication 544.

Partially Nontaxable ExchangeA partially nontaxable exchange is an ex-change in which you receive unlike propertyor money in addition to like property. Thebasis of the property you receive is the sameas the basis of the property you gave up withthe following adjustments.

1) Decrease the basis by both the followingamounts.

a) Any money you receive.

b) Any loss you recognize on the ex-change.

2) Increase the basis by both the followingamounts.

a) Any additional costs you incur.

b) Any gain you recognize on the ex-change.

If the other party to the transaction assumes,or takes property subject to, your liabilities(including a nonrecourse obligation), treat thedebt assumption as money you received inthe exchange.

Example 1. You traded farm land (basis$10,000) for another tract of farm land (FMV$11,000). You also received $3,000 cash.You realized a gain of $4,000. This is theFMV of the land received plus the cash minusthe basis of the land you traded ($11,000 +$3,000 − $10,000). Include your gain in in-come (recognize gain) only to the extent ofthe cash you received. Your basis in the landyou received is figured as follows.

Chapter 7 Basis of Assets Page 37

Example 2. You traded a truck (adjustedbasis $22,750) for another truck (FMV$20,000). You also received $10,000 cash.You realized a gain of $7,250. This is theFMV of the truck received plus the cash mi-nus the adjusted basis of the truck you traded($20,000 + $10,000 − $22,750). You includeall the gain in your income (recognize gain)because the gain is less than the cash youreceived. Your basis in the truck you receivedis figured as follows.

Allocation of basis. Allocate the basis firstto the unlike property, other than money, upto its FMV on the date of the exchange. Therest is the basis of the like property.

Example. You had an adjusted basis of$15,000 in a tractor you traded for anothertractor that had an FMV of $12,500. You alsoreceived $1,000 in cash and a truck that hadan FMV of $3,000. The truck is unlike prop-erty. You realized a gain of $1,500. This isthe FMV of the tractor received plus the FMVof the truck received plus the cash minus theadjusted basis of the tractor you traded($12,500 + $3,000 + $1,000 − $15,000). Youinclude in your income (recognize) all $1,500of the gain because it is less than the FMVof the unlike property plus the cash received.Your basis in the properties you received isfigured as follows.

Allocate the total basis of $15,500 first to theunlike property—the truck ($3,000). The rest($12,500) is the basis of the tractor.

Sale and PurchaseIf you sell property and buy similar propertyin two mutually dependent transactions, youmay have to treat the sale and purchase asa single nontaxable exchange.

Example. You used a tractor on yourfarm for 3 years. Its adjusted basis is $2,000and its FMV is $4,000. You are interested ina new tractor, which sells for $15,500. Ordi-narily, you would trade your old tractor for thenew one and pay the dealer $11,500. Yourbasis for depreciation for the new tractorwould then be $13,500 ($11,500 plus the$2,000 basis of your old tractor). However,you want a higher basis for depreciating thenew tractor, so you agree to pay the dealer$15,500 for the new tractor if he will pay you$4,000 for your old tractor. Because the twotransactions are dependent on each other,you are treated as having exchanged your oldtractor for the new one and paid $11,500($15,500 minus $4,000). Your basis for thenew tractor is $13,500, the same as if youtraded the old tractor.

Basis of land traded ............................... $10,000 Involuntary ConversionsIf you get property as a result of an involun-tary conversion, such as a casualty, theft, orcondemnation, you may figure the basis ofthe replacement property you get using thebasis of the property destroyed, stolen, orcondemned (old property).

Similar or related property. If the replace-ment property is similar or related in serviceor use to the old property, the replacementproperty's basis is the same as the old prop-erty's basis on the date of the involuntaryconversion. However, make the following ad-justments.

1) Decrease the basis by both the followingamounts.

a) Any loss you recognize on the in-voluntary conversion.

b) Any money you receive that you donot spend on similar property.

2) Increase the basis by both the followingamounts.

a) Any gain you recognize on the in-voluntary conversion.

b) Any cost of acquiring the replace-ment property.

Money or property that is not similar orrelated. If you receive money or property notsimilar or related in service or use to the oldproperty and you buy replacement propertysimilar or related in service or use to the oldproperty, the basis of the replacement prop-erty is its cost decreased by the gain notrecognized on the involuntary conversion.

For more information about involuntaryconversions, see chapter 13.

Property Receivedas a GiftTo figure the basis of property you receiveas a gift, you must know its adjusted basis(defined earlier) to the donor just before it wasgiven to you. You also must know its FMV atthe time it was given to you and any gift taxpaid on it.

FMV equal to or more than donor's ad-justed basis. If the FMV of the property isequal to or more than the donor's adjustedbasis, your basis is the donor's adjusted basiswhen you received the gift. Increase yourbasis by all or part of any gift tax paid, de-pending on the date of the gift.

Also, for figuring gain or loss from a saleor other disposition of the property, or for fig-uring depreciation, depletion, or amortizationdeductions on business property, you mustincrease or decrease your basis (the donor'sadjusted basis) by any required adjustmentsto basis while you held the property. SeeAdjusted Basis, earlier.

Gift received before 1977. If you re-ceived a gift before 1977, increase your basisin the gift (the donor's adjusted basis) by anygift tax paid on it. However, do not increaseyour basis above the FMV of the gift when itwas given to you.

Example 1. You were given a house in1976 with an FMV of $21,000. The donor'sadjusted basis was $20,000. The donor paida gift tax of $500. Your basis is $20,500, thedonor's adjusted basis plus the gift tax paid.

Example 2. If, in Example 1, the gift taxpaid had been $1,500, your basis would be$21,000. This is the donor's adjusted basisplus the gift tax paid, limited to the FMV of thehouse at the time you received the gift.

Gift received after 1976. If you receiveda gift after 1976, increase your basis in thegift (the donor's adjusted basis) by the partof the gift tax paid on it that is due to the netincrease in value of the gift. Figure the in-crease by multiplying the gift tax paid by thefollowing fraction.

Net increase in value of the gift

Amount of the gift

The net increase in value of the gift is theFMV of the gift minus the donor's adjustedbasis. The amount of the gift is its value forgift tax purposes after reduction by any an-nual exclusion and marital or charitable de-duction that applies to the gift. For informationon the gift tax, see Publication 950, Introduc-tion to Estate and Gift Taxes.

Example. In 1999, you received a gift ofproperty from your mother that had an FMVof $50,000. Her adjusted basis was $20,000.The amount of the gift for gift tax purposeswas $40,000 ($50,000 minus the $10,000annual exclusion). She paid a gift tax of$9,000. Your basis, $26,750, is figured asfollows:

FMV less than donor's adjusted basis. Ifthe FMV of the property at the time of the giftwas less than the donor's adjusted basis, yourbasis depends on whether you have a gainor a loss when you dispose of the property.Your basis for figuring gain is the donor'sadjusted basis plus or minus any requiredadjustment to basis while you held the prop-erty. (See Adjusted Basis, earlier.) Your basisfor figuring loss is its FMV when you receivedthe gift plus or minus any required adjustmentto basis while you held the property. (SeeAdjusted Basis, earlier.)

If you use the donor's adjusted basis forfiguring a gain and get a loss, and then usethe FMV for figuring a loss and get a gain, youhave neither gain nor loss on the sale or otherdisposition of the property.

Example. You received farm land as agift from your parents when they retired fromfarming. At the time of the gift, the land hadan FMV of $80,000. Your parents' adjustedbasis was $100,000. After you received theland, no events occurred that would increaseor decrease your basis in it.

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

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

Minus: Cash received (adjustment 1(a)) − 3,000$7,000

Plus: Gain recognized (adjustment 2(b)) + 3,000Basis of land received ........................ $10,000

Adjusted basis of truck traded ............... $22,750Minus: Cash received (adjustment 1(a)) −10,000

$12,750Plus: Gain recognized (adjustment 2(b)) + 7,250Basis of truck received ....................... $20,000

Fair market value ....................................... $50,000Minus: Adjusted basis ................................ −20,000Net increase in value ................................. $30,000Gift tax paid ............................................... $9,000Multiplied by ($30,000 ÷ $40,000) ............. × .75Gift tax due to net increase in value ......... $6,750Adjusted basis of property to your mother . +20,000Your basis in the property ...................... $26,750

Adjusted basis of old tractor .................. $15,000Minus: Cash received (adjustment 1(a)) − 1,000

$14,000Plus: Gain recognized (adjustment 2(b)) + 1,500Total basis of properties received ..... $15,500


using the FMV ($80,000), you would get a$10,000 gain.

Business property. If you hold the giftas business property, your basis for figuringany depreciation, depletion, or amortizationdeductions is the same as the donor's ad-justed basis plus or minus any required ad-justments to basis while you hold the prop-erty.

Property TransferredFrom a SpouseThe basis of property transferred to you ortransferred in trust for your benefit by yourspouse is the same as your spouse's adjustedbasis. The same rule applies to a transfer byyour former spouse if the transfer is incidentto divorce. However, adjust your basis for anygain recognized by your spouse on propertytransferred in trust. This rule applies only toa transfer of property in trust in which the li-abilities assumed plus the liabilities to whichthe property is subject are more than the ad-justed basis of the property transferred.

The transferor must give you recordsneeded to determine the adjusted basis andholding period of the property as of the dateof the transfer.


Inherited PropertyYour basis in property you inherit from a de-cedent is generally one of the following.

1) The FMV of the property at the date ofthe individual's death.

2) The FMV on the alternate valuation date,if the personal representative for the es-tate chooses to use alternate valuation.For information on the alternate valu-ation date, see the instructions for Form706.

3) The value under the special-use valu-ation method for real property used infarming or other closely held business,if chosen for estate tax purposes. Thismethod is discussed next.

4) The decedent's adjusted basis in land tothe extent of the value that is excludedfrom the decedent's taxable estate as aqualified conservation easement.

If a federal estate tax return does not haveto be filed, your basis in the inherited propertyis its appraised value at the date of death forstate inheritance or transmission taxes.

Special farm real property valuation. Un-der certain conditions, when a person dies theexecutor or personal representative of thatperson's estate may choose to value thequalified real property on other than its FMV.If so, the executor or personal representativevalues the qualified real property based on itsuse as a farm. If the executor or personalrepresentative chooses this method of valu-ation for estate tax purposes, this value is thebasis of the property for the heirs. The qual-ified heirs should be able to get the necessaryvalue from the executor or personal repre-sentative of the estate.

If you are a qualified heir who receivedspecial-use valuation property, increase yourbasis by any gain recognized by the estateor trust because of post-death appreciation.Post-death appreciation is the property's FMVon the date of distribution minus the proper-ty's FMV either on the date of the individual'sdeath or on the alternate valuation date. Fig-ure all FMVs without regard to the special-usevaluation.

You can choose to increase your basis inspecial-use valuation property if it becomessubject to the additional estate tax. This taxis assessed if, within 10 years after the deathof the decedent, you transfer the property toa person who is not a member of your familyor the property stops being used as a farm.This tax may apply if you dispose of theproperty in a like-kind exchange or involuntaryconversion.

To increase your basis in the property, youmust make an irrevocable choice and pay theinterest on the additional estate tax figuredfrom the date 9 months after the decedent'sdeath until the date of payment of the addi-tional estate tax. If you meet these require-ments, increase your basis in the property toits FMV on the date of the decedent's deathor the alternate valuation date. The increasein your basis is considered to have occurredimmediately before the event that results inthe additional estate tax.

You make the choice by filing with Form706–A a statement that does all the following.

• Contains your (and the estate's) name,address, and taxpayer identificationnumber.

• Identifies the choice as a choice undersection 1016(c) of the Internal RevenueCode.

• Specifies the property for which you aremaking the choice.

• Provides any additional information re-quired by the Form 706–A instructions.

Community property. In community prop-erty states (Arizona, California, Idaho, Louisi-ana, Nevada, New Mexico, Texas, Washing-ton, and Wisconsin), husband and wife areeach usually considered to own half thecommunity property. When either spousedies, the total value of the community prop-erty, even the part belonging to the survivingspouse, generally becomes the basis of theentire property. For this rule to apply, at leasthalf the value of the community property in-terest must be includible in the decedent'sgross estate, whether or not the estate mustfile a return.

For example, you and your spouse ownedcommunity property that had a basis of$80,000. When your spouse died, at least halfthe FMV of the community interest wasincludible in your spouse's estate. The FMVof the community interest was $100,000. Thebasis of your half of the property after thedeath of your spouse is $50,000 (half of the$100,000 FMV). The basis of the other halfto your spouse's heirs is also $50,000.

For more information about communityproperty, see Publication 555.

8.Depreciation,Depletion, andAmortization

Important Changesfor 1999Depreciation limits on business cars. Thetotal section 179 deduction and depreciationyou can take on a car you use in your busi-ness and first place in service in 1999 is$3,060. Special rules apply to certain clean-fuel vehicles. See Special Rules for Passen-ger Automobiles.

Section 179 deduction. For 1999, the totalcost you can elect to deduct under section179 of the Internal Revenue Code is in-creased to $19,000. See Maximum dollarlimit.

Important Changefor 2000Section 179 deduction. For 2000, the totalcost you can elect to deduct under section179 of the Internal Revenue Code is in-creased to $20,000. See Maximum dollarlimit.

IntroductionIf you buy farm property such as machinery,equipment, or a structure with a useful life ofmore than a year, you generally cannot de-duct its entire cost in one year. Instead, youmust spread the cost over more than one yearand deduct part of it each year. For mosttypes of property, this is called depreciation.

This chapter gives information on depre-ciating property placed in service after 1986.For information on depreciating propertyplaced in service before 1987, see Publication534, Depreciating Property Placed in ServiceBefore 1987.

CAUTION!

You must use the 150% decliningbalance method for property used ina farming business rather than the

200% declining balance method, or you canelect an alternative method. The methodsyou can use are discussed later under De-preciation Methods.

TIPTo help you understand depreciationand how to complete Form 4562,Depreciation and Amortization, see

the filled-in Form 4562 in chapter 20.

This chapter also provides information onfiguring both cost depletion (including timberdepletion) and percentage depletion.

Chapter 8 Depreciation, Depletion, and Amortization Page 39

The last section of this chapter discussesamortization of section 197 intangibles, refor-estation costs, pollution control facilities, andthe costs of going into business.


• General information on depreciation

• Section 179 deduction

• Modified Accelerated Cost RecoverySystem (MACRS)

• Listed property rules

• Basic information on depletion andamortization


Publication


� 534 Depreciating Property Placed inService Before 1987




� 946 How To Depreciate Property


� T Forest Activities Schedules

� 1040X Amended U.S. Individual IncomeTax Return

� 4562 Depreciation and Amortization



General Informationon DepreciationThe first part of this chapter gives you basicinformation on what property can and cannotbe depreciated, when to begin and end de-preciation, and how to claim depreciation.

What Can BeDepreciatedYou can depreciate property only if it meetsall the following requirements.

1) It is used in business or held for theproduction of income.

2) It must be expected to last more thanone year. In other words, it must have auseful life that extends substantially be-yond the year it is placed in service.

3) It is property that wears out, decays, getsused up, becomes obsolete, or losesvalue from natural causes.

Depreciable property may be tangible or in-tangible.

Tangible PropertyTangible property is property you can see ortouch and it includes both real and personalproperty. Tangible personal property includesmachinery or equipment and anything elseyou can see or touch except real property.Real property is land, buildings, and generallyanything built or constructed on land, growingon land, or attached to land. However, landitself is never depreciable.

Livestock. Livestock purchased for draft,breeding, or dairy purposes that is not kept inan inventory account may be depreciated.

Raised livestock. Livestock you raiseusually has no depreciable basis because thecosts of raising them are deducted and arenot added to their basis. However, if youpurchase immature livestock for draft, dairy,or breeding purposes, you can depreciateyour initial costs when the livestock reach theage when they can be worked, milked, orbred.

Dams, ponds, and terraces. In general, youcannot depreciate earthen dams, ponds, andterraces unless the structures have a deter-minable useful life.

Irrigation systems and water wells. Youcan depreciate irrigation systems and wellscomposed of masonry, concrete, tile, metal,or wood. In addition, you can depreciate costsfor moving dirt to make irrigation systems andwater wells composed of these materials.

Partial business use. If you use tangibleproperty (including your car) for business orinvestment purposes and for personal pur-poses, you can deduct depreciation on thepart used for business or investment.

For example, if you use your car for farmbusiness, you can deduct depreciation for thepart you use it in farming. If you also use itfor investment purposes, you can depreciatethe part used for investment.

If you use part of your home for business,you may be able to take a depreciation de-duction for its business use. For more infor-mation, see Business Use of Your Home inchapter 5.

Intangible PropertyIntangible property is generally any propertythat has value but that you cannot see ortouch. It includes items such as computersoftware, copyrights, patents, franchises,trademarks, and trade names.

Computer software. Computer software in-cludes any program used to cause a com-puter to perform a desired function. It alsoincludes any data base or similar item in thepublic domain and incidental to the operationof qualifying software.

Generally, you can depreciate softwareover 36 months. However, if you acquired thesoftware in connection with the acquisition ofa substantial portion of a business, you candepreciate it over 36 months only if it meetsthe following requirements.

• It is readily available for purchase by thegeneral public.

• It is not subject to an exclusive license.

• It has not been substantially modified.

If you acquire software in connection withthe acquisition of a substantial portion of a

business and it does not meet the previousrequirements, you must amortize it over 15years (rather than depreciate it). For moreinformation on amortization, see Amortization,later.

Year 2000 costs. Year 2000 costs arecosts of converting or replacing computersoftware to recognize dates beginning in theyear 2000. They include costs of the follow-ing.

• Manually converting existing software.

• Developing new software.

• Purchasing or leasing new software toreplace existing software.

• Developing or purchasing software toolsto assist you in converting your existingsoftware.

Treat year 2000 costs as computer softwarefor depreciation purposes.

Any change in the treatment of year 2000costs to allow them to be treated as computersoftware for depreciation purposes is achange in accounting method. If you want tomake this type of change, follow the auto-matic change procedures in Revenue Proce-dure 98–60 in Internal Revenue Bulletin No.1998–51.

Leased software. If you lease software,treat the rental payments the same as anyother rental payments.

What Cannot BeDepreciatedTo determine if you can depreciate any item,you must know not only what you can depre-ciate but what you cannot depreciate.

Property placed in service and disposedof in the same year. You cannot depreciateproperty you place in service and dispose ofin the same year. Determining when propertyis placed in service is explained later.

Land. You can never depreciate the cost ofland because land does not wear out, be-come obsolete, or get used up. The cost ofland generally includes the cost of clearing,grading, planting, and landscaping becausethese expenses are all part of the cost of theland itself. You may be able to depreciatesome land preparation costs. For informationon these costs, see chapter 1 of Publication946.

Inventory. You can never depreciate prop-erty you hold primarily for sale to customersin the ordinary course of your business.

Equipment used to build capital improve-ments. You cannot deduct depreciation onequipment used to build your own capital im-provements. You must add the depreciationallowed on equipment used during the periodof construction to the basis of your improve-ments. See Uniform Capitalization Rules inchapter 7.

Leased property. You can depreciateleased property only if you retain the incidentsof ownership for the property (explainedlater). This means you bear the burden ofexhaustion of the capital investment in theproperty. Therefore, if you lease property touse in your trade or business or for the pro-duction of income, you cannot depreciate itscost. You can, however, depreciate any cap-

Page 40 Chapter 8 Depreciation, Depletion, and Amortization

ital improvements you make to the leasedproperty. See Additions or improvements toproperty in chapter 3 of Publication 946.

If you lease property to someone, yougenerally can depreciate its cost even if thelessee (the person leasing from you) hasagreed to preserve, replace, renew, andmaintain the property. However, you cannotdepreciate the cost of the property if the leaseprovides that the lessee is to maintain theproperty and return to you the same propertyor its equivalent in value at the expiration ofthe lease in as good condition and value aswhen leased.

Incidents of ownership. Incidents ofownership include the following.

• The legal title.

• The legal obligation to pay for it.

• The responsibility to pay its maintenanceand operating expenses.

• The duty to pay any taxes.

• The risk of loss if the property is de-stroyed, condemned, or diminished invalue through obsolescence or ex-haustion.

Intangible property. The following are twotypes of intangible property that you cannever depreciate.

Goodwill. You can never depreciategoodwill because its useful life cannot be de-termined.

However, if you acquired a business afterAugust 10, 1993 (July 25, 1991, if elected),and part of the price included goodwill, youmay be able to amortize the cost of thegoodwill over 15 years. For more information,see Amortization, later.

Trademark and trade name. In general,you must capitalize trademark and tradename expenses. This means that you cannotdeduct the full amount in the current year.You can neither depreciate nor amortize thecosts for trademarks and trade names youacquired before August 11, 1993 (before July26, 1991, if elected). You may be able toamortize over 15 years the costs of trade-marks and trade names acquired after August10, 1993 (after July 25, 1991, if elected). Formore information, see Amortization, later.

When DepreciationBegins and EndsYou begin to depreciate your property whenyou place it in service for use in your tradeor business or for the production of income.You stop depreciating property either whenyou have fully recovered your cost or otherbasis or when you retire it from service,whichever happens first.

Placed in ServiceFor depreciation purposes, property is placedin service when it is ready and available fora specific use, whether in a trade or business,the production of income, a tax-exempt ac-tivity, or a personal activity. Even if you arenot using the property, it is in service when itis ready and available for its specific use.

Example 1. You bought a home and usedit as your personal home for several yearsbefore you converted it to rental property.Although its specific use was personal andno depreciation was allowable, you placed the

home in service when you began using it asyour home. You can claim a straight line de-preciation deduction in the year you con-verted it to rental property because its usechanged to an income-producing use at thattime.

Example 2. You bought a planter for yourfarm business late in the year after harvestwas over. You can take a depreciation de-duction for the planter for that year becauseit was ready and available for its specific use.

Cost or other basis fully recovered. Youhave fully recovered your cost or other basiswhen you have taken section 179 and de-preciation deductions that are equal to yourcost or investment in the property.

Retired From ServiceYou stop depreciating property when you re-tire it from service. You retire property fromservice when you permanently withdraw itfrom use in a trade or business or in the pro-duction of income.

You can retire property from service in anyof the following ways.

• Sale or exchange.

• Abandonment.

• Destruction.

Incorrect Amount ofDepreciation DeductedIf you deducted an incorrect amount of de-preciation in any year, you may be able tomake a correction by filing an amended re-turn. See Amended Return, later. If you arenot allowed to make the correction on anamended return, you can change your ac-counting method to claim the correct amountof depreciation. See Changing Your Ac-counting Method, later.

Basis adjustment. Even if you do not claimdepreciation you are entitled to deduct, youmust reduce the basis of the property by thefull amount of depreciation you were entitledto deduct. If you deduct more depreciationthan you should, you must decrease yourbasis by any amount deducted from whichyou received a tax benefit.

Amended ReturnIf you deducted an incorrect amount of de-preciation, you can file an amended return tocorrect the following.

• A mathematical error made in any year.

• A posting error made in any year (forexample, omitting an asset from the de-preciation schedule).

• The amount of depreciation for propertyfor which you have not adopted a methodof accounting.

If you deducted an incorrect amount ofdepreciation for the property on two or moreconsecutively filed tax returns, you haveadopted a method of accounting for thatproperty. If you have adopted a method ofaccounting, you cannot change the methodby filing amended returns. See ChangingYour Accounting Method, later.

If an amended return is allowed, you mustfile it by the later of the following.

• 3 years from the date you filed your ori-ginal return for the year in which you de-ducted the incorrect amount.

• 2 years from the time you paid your taxfor that year.

A return filed early is considered filed on thedue date.

Changing YourAccounting MethodIf you deducted an incorrect amount of de-preciation for the property on two or moreconsecutively filed tax returns, you haveadopted a method of accounting for thatproperty.

TIPYou can claim the correct amount ofdepreciation only by changing yourmethod of accounting for depreci-

ation. You will then be able to take into ac-count any unclaimed or excess depreciationfrom years before the year of change.

Approval required. You must get IRS ap-proval to change your method of accounting.File Form 3115, Application for Change inAccounting Method, to request a change toa permissible method of accounting for thedepreciation. Revenue Procedure 97–27 inCumulative Bulletin 1997–1 gives general in-structions for getting approval. CumulativeBulletins are available at many libraries andIRS offices. There is a user fee for changingyour method of accounting under RevenueProcedure 97–27.

Automatic approval. You may be able toget automatic approval from the IRS tochange your method of accounting if youused an unallowable method of accounting fordepreciation in at least the 2 years imme-diately before the year of change and theproperty for which you are changing themethod meets the following conditions.

1) It is property for which, under your unal-lowable method of accounting, youclaimed either no depreciation or an in-correct amount of depreciation.

2) It is property for which you figured de-preciation using one of the following.

a) Pre-1981 rules.

b) Accelerated Cost Recovery(ACRS).

c) Modified Accelerated Cost Recov-ery (MACRS).

3) It is property you owned at the beginningof the year of change.

File Form 3115 to request a change to apermissible method of accounting for depre-ciation. Revenue Procedure 98–60 and sec-tion 2.01 of its Appendix, which can be foundin Internal Revenue Bulletin No. 1998–51,have instructions for getting automatic ap-proval and list exceptions to the automaticapproval procedures.

Exceptions. You generally cannot usethe automatic approval procedure in any ofthe following situations.

• You are under examination by the IRS.

• You are before a federal court or an IRSappeals office for any income tax issueand the method of accounting for depre-ciation to be changed is an issue under


consideration by the federal court or ap-peals office.

• You are correcting a mathematical orposting error. See Amended Return,earlier.

• During the last five years (including theyear of change), you changed the samemethod of accounting for depreciation(with or without obtaining IRS approval).

• During the last five years (including theyear of change), you filed a Form 3115to change the same method of account-ing for depreciation but did not make thechange because the Form 3115 waswithdrawn, not perfected, denied, or notgranted.

Also, see other exceptions listed in section2.01(2)(b) of the Appendix of Revenue Pro-cedure 98–60.

How To Claim DepreciationUse Form 4562 to claim depreciation andamortization deductions and to elect the sec-tion 179 deduction, discussed next. Amorti-zation is discussed later. For more informa-tion on completing Form 4562, refer to itsinstructions.

RECORDS

It is important to keep good recordsfor property you depreciate. Do notfile these records with your return.

Instead, you should keep them as part of therecords of the depreciated property. They willhelp you verify the accuracy of the informationon Form 4562. For general information onrecordkeeping, see Publication 583, Startinga Business and Keeping Records. For spe-cific information on keeping records for sec-tion 179 property (discussed next) and listedproperty (discussed later), see Publication946.

Section 179 DeductionThis part of the chapter explains the rules forthe section 179 deduction. It explains what asection 179 deduction is, the costs that canbe deducted, what property qualifies for thededuction, limits that may apply, and how toclaim the deduction. You can recover throughdepreciation certain costs that you do not re-cover through the section 179 deduction.

Section 179 DeductionDefinedSection 179 of the Internal Revenue Codeallows you to elect to deduct all or part of thecost of certain qualifying property in the yearyou place it in service. You can do this in-stead of recovering the cost by taking depre-ciation deductions.

What Costs Can andCannot Be DeductedYou can claim the section 179 deduction forthe cost of qualifying property acquired foruse in your trade or business. You cannotclaim the deduction for the cost of propertyyou hold only for the production of income.

For information on property held for theproduction of income, see Production of in-come, later.

Acquired by PurchaseOnly the cost of property you acquired bypurchase for use in your business qualifies forthe section 179 deduction. The cost of prop-erty acquired from a related person or groupmay not qualify. See Nonqualifying Property,later.

Acquired by TradeIf you buy an asset with cash and a trade-in,you can claim a section 179 deduction basedonly on the amount of cash you pay. For ex-ample, if you buy (for cash and a trade-in) anew tractor for use in your business, your costfor the section 179 deduction does not includethe adjusted basis of the old tractor you tradefor the new tractor. See Adjusted Basis inchapter 7.

Example. J-Bar Farms traded twocultivators having a total adjusted basis of$6,800 for a new cultivator costing $13,200.They received an $8,000 trade-in for the oldcultivators and paid $5,200 cash for the newcultivator. J-Bar also traded a used pickuptruck with an adjusted basis of $8,000 for anew pickup truck costing $15,000. They re-ceived a $5,000 trade-in and paid $10,000cash for the new pickup truck.

J-Bar Farms' basis in the new propertyincludes both the adjusted basis of the prop-erty traded and the cash paid. However, onlythe cash paid by J-Bar qualifies for the section179 deduction. J-Bar's business costs thatqualify for a section 179 deduction are$15,200 ($5,200 + $10,000), the part of thecost of the new property not determined bythe property traded.

Qualifying PropertyQualifying section 179 property is depreciableproperty and includes the following.

1) Tangible personal property.

2) Other tangible property (except mostbuildings and their structural compo-nents) listed below.

a) Property used as an integral partof manufacturing, production, orextraction, or of furnishing trans-portation, communications, electric-ity, gas, water, or sewage disposalservices.

b) A research facility used in con-nection with any of the activities in(a).

c) A facility used in connection withany of the activities in (a) for thebulk storage of fungible commod-ities (including commodities in aliquid or gaseous state).

3) Single purpose agricultural (livestock) orhorticultural structures (defined later).

4) Storage facilities (excluding buildingsand their structural components) used inconnection with distributing petroleumor any primary product of petroleum.

Tangible personal property. Tangible per-sonal property is any tangible property that isnot real property. Machinery and equipmentare examples of tangible personal property.

Land and land improvements are not tan-gible personal property and they do not qual-ify as section 179 property. Items such asbuildings and other permanent structures andtheir components are real property. Non-

agricultural fences, swimming pools, pavedparking areas, wharfs, docks, bridges, andfences are examples of land improvements.However, agricultural fences do qualify assection 179 property.

Business property. All business property,other than structural components, containedin or attached to a building is tangible per-sonal property. Milk tanks, automatic feeders,barn cleaners, and office equipment are tan-gible personal property.

Livestock. Livestock is qualifying property.For this purpose, livestock includes horses,cattle, hogs, sheep, goats, and mink andother furbearing animals.

Single purpose agricultural (livestock) orhorticultural structures. A single purposeagricultural (livestock) or horticultural struc-ture is qualifying property for purposes of thesection 179 deduction. For purposes of de-termining whether a structure is a single pur-pose agricultural structure, poultry is consid-ered livestock.

Agricultural structure. A single purposeagricultural (livestock) structure is any build-ing or enclosure specifically designed, con-structed, and used for both of the followingpurposes.

1) To house, raise, and feed a particulartype of livestock and its produce.

2) To house the equipment, including anyreplacements, needed to house, raise,or feed the livestock.

Single purpose structures are qualifyingproperty if used, for example, to breed chick-ens or hogs, produce milk from dairy cattle,or produce feeder cattle or pigs, broilerchickens, or eggs. The facility must include,as an integral part of the structure or enclo-sure, equipment necessary to house, raise,and feed the livestock.

Horticultural structure. A single purposehorticultural structure is either of the following.

1) A greenhouse specifically designed,constructed, and used for the commer-cial production of plants.

2) A structure specifically designed, con-structed, and used for the commercialproduction of mushrooms.

Use of structure. A structure must beused only for the purpose that qualified it. Forexample, a hog barn will not be eligibleproperty if you use it to house poultry. Simi-larly, using part of your greenhouse to sellplants will make the greenhouse ineligible.

If a structure includes work space, thatstructure is a single purpose agricultural orhorticultural structure if the work space isused only for the following.

1) Stocking, caring for, or collecting live-stock or plants or their produce.

2) Maintaining the enclosure or structure.

3) Maintaining or replacing the equipmentor stock enclosed or housed in thestructure.

Partial business use. When you use prop-erty for business and nonbusiness purposes,you can elect the section 179 deduction onlyif you use it more than 50% for your businessin the year you place it in service. You figurethe part of the cost of the property that is for


business use by multiplying the cost of theproperty by the percentage of business use.The result is your business cost, which youuse to figure your section 179 deduction.

Nonqualifying PropertyGenerally, the section 179 deduction cannotbe claimed on the cost of any of the following.

• Property you hold only for the productionof income.

• Real property, including buildings andtheir structural components.

• Property you acquired from certaingroups or persons.

• Air conditioning or heating units.

• Certain property used predominatelyoutside the U.S.

• Property used predominately to furnishlodging or in connection with the furnish-ing of lodging.

• Property used by foreign persons or en-tities.

• Certain property you lease to others (ifyou are a noncorporate lessor).

For more information on nonqualifyingproperty, see Nonqualifying Property inchapter 2 of Publication 946.

For the kind of leased property on whichyou can claim the section 179 deduction, seeQualifying Property in chapter 2 of Publication946.

Production of income. Property you hold forthe production of income includes investmentproperty, rental property (if renting property isnot your trade or business), and property thatproduces royalties. If you use property in theactive conduct of a trade or business, you donot hold it only for the production of income.

Acquired from certain groups or persons.Property does not qualify for the section 179deduction if any of the following apply.

1) The property is acquired by one memberof a controlled group from anothermember of the same group.

2) The property's basis is determined in ei-ther of the following ways.

a) In whole or in part by its adjustedbasis in the hands of the personfrom whom it was acquired.

b) Under stepped-up basis rules forproperty acquired from a decedent.

3) The property is acquired from a relatedperson. A “related person” generallymeans a member of your immediatefamily (including your spouse, an an-cestor, and a lineal descendant) or apartnership or corporation in which youhold an interest.

For more information on related persons,see Publication 946.

How To Make the ElectionYou make the election by taking your de-duction on Form 4562. You attach and fileForm 4562 with either of the following.

• Your original tax return filed for the yearthe property was placed in service(whether or not you filed it timely).

• An amended return filed by the due date(including extensions) for your return forthe year the property was placed in ser-vice. In other words, you cannot makean election for the section 179 deductionon an amended return filed after the duedate (including extensions) of the originalreturn.

However, if you timely filed your return forthe year without making the election, you canstill make the election by filing an amendedreturn within six months of the due date of thereturn (excluding extensions). Attach theelection to the amended return and write“Filed pursuant to section 301.9100–2” on theelection statement. File the amended returnat the same address you filed the original re-turn.

How To Figurethe DeductionThe total business cost you can elect to de-duct under section 179 for 1999 cannot bemore than $19,000. This maximum dollar limitapplies to each taxpayer, not to each busi-ness. You do not have to claim the full$19,000. You can decide how much of thebusiness cost of your qualifying property youwant to deduct under section 179. You maybe able to depreciate any cost you do notdeduct under section 179. To figure depreci-ation, see MACRS, later.

If you acquire and place in service morethan one item of qualifying property during theyear, you can divide the deduction among theitems in any way, as long as the total de-duction is not more than $19,000.

If you have only one item of qualifyingproperty and it does not cost more than$19,000, your deduction is limited to thelesser of the following.

• Your taxable income from your trade orbusiness (the taxable income limit is dis-cussed later).

• The cost of the item.

You must figure your section 179 de-duction before figuring your depreciation de-duction.

You must subtract the amount you electto deduct under section 179 from the busi-ness/investment cost of the qualifying prop-erty. The result is your unadjusted basis andit is the amount you use to figure any depre-ciation deduction.

CAUTION!

You cannot take depreciation on thecost of property you deduct undersection 179.

Example. This year, you bought andplaced in service a tractor for $16,000 and amower for $6,200 for use in your farmingbusiness. You elect to deduct the entire$6,200 for the mower and $12,800 for thetractor, a total of $19,000. This is the mostyou can deduct. Your $6,200 deduction forthe mower completely recovered its cost. Thecost of your tractor is reduced by $12,800. Itsremaining basis for depreciation is $3,200.You figure this by subtracting the amount ofyour section 179 deduction, $12,800, from thecost of the tractor, $16,000.

Deduction LimitsYour section 179 deduction cannot be morethan the business cost of the qualifying prop-erty. In addition, in figuring your section 179deduction, you must apply the following limits.

• Maximum dollar limit.

• Investment limit.

• Taxable income limit.

Maximum dollar limit. The total cost youcan elect to deduct for 1999 cannot be morethan $19,000. This maximum dollar limit isreduced if you go over the investment limit(discussed later) in any year.

TIPThe total deductible cost of section179 property increases in future yearsas shown next.

Passenger automobiles. For passengerautomobiles placed in service in 1999, yourtotal section 179 deduction and depreciationcannot be more than $3,060. For more infor-mation, see Maximum deductions for 1999under Special Rules for Passenger Automo-biles, later.

Joint returns. If you file a joint return, youand your spouse are treated as one taxpayerin determining any reduction to the maximumdollar limit, regardless of which of you pur-chased the property or placed it in service.

Married taxpayers filing separate re-turns. If you and your spouse file separatereturns, you both are treated as one taxpayerfor the maximum dollar limit and for the$200,000 investment limit. Unless you electotherwise, 50% of the maximum dollar limit(after applying the investment limit) will beallocated to each of you. If the percentageselected by each of you do not total 100%,50% will be allocated to each of you.

Joint return after filing separate re-turns. If you and your spouse elect to file ajoint return after the due date for filing thereturn, the maximum dollar limit on the jointreturn is the lesser of the following.

• The maximum dollar limit (after the in-vestment limit).

• The total cost of section 179 property youand your spouse elected to expense onyour separate returns.

Investment limit. If the cost of your qualify-ing section 179 property placed in service ina year is over $200,000, reduce the maximumdollar limit for each dollar over $200,000 (butnot below zero). If your business cost of sec-tion 179 property placed in service during1999 is $219,000 or more, you cannot takea section 179 deduction and you cannot carryover the cost that is more than $219,000.

Example. In 1999, James Smith placedin service machinery costing $207,000. Be-cause this cost is $7,000 more than$200,000, he must reduce the maximum dol-lar limit of $19,000 by $7,000. If his taxableincome is at least $12,000, James can claima $12,000 section 179 deduction for this year.

Taxable income limit. The total cost you candeduct each year is limited to the taxable in-come from the active conduct of any trade orbusiness during the year. Generally, you are

Tax Year Maximum Deduction2000 $20,000

2001 – 2002 24,000After 2002 25,000


considered to actively conduct a trade orbusiness if you meaningfully participate in themanagement or operations of the trade orbusiness.

Figure taxable income for this purpose bytotaling the net income (or loss) from alltrades and businesses you actively con-ducted during the year. Items of income de-rived from a trade or business actively con-ducted by you include the following.

• Section 1231 gains (or losses) as dis-cussed in chapter 11.

• Interest from working capital of your tradeor business.

• Wages, salaries, tips, or other pay earnedas an employee.

When figuring taxable income, do not takeinto account any unreimbursed employeebusiness expenses you may have as an em-ployee.

In addition, figure taxable income withoutregard to any of the following.

• The section 179 deduction.

• The self-employment tax deduction.

• Any net operating loss carryback orcarryforward.

Carryover of disallowed deduction.You can carry over the cost of any section179 property you elected to expense but wereunable to because of the taxable income limit.

The amount you carry over is used in de-termining your section 179 deduction in thenext year; however, it is subject to the limitsin that year. You may select the properties forwhich all or a part of the cost will be carriedforward, provided the reasons for your deci-sions are shown in your books and records.

Example. Last year, Joyce Jones placedin service a machine that cost $8,000. Thetaxable income from her business (deter-mined without a section 179 deduction for thecost of the machine and without the self-employment tax deduction) was $6,000. Hersection 179 deduction is limited to $6,000.The $2,000 cost that is not allowed as a cur-rent section 179 deduction (because of thetaxable income limit) is carried to this year.

This year, Joyce placed another machinein service that cost $9,000. Her taxable in-come from business (determined without asection 179 deduction for the cost of the ma-chine and without the self-employment taxdeduction) is $10,000. Joyce can deduct thefull cost of the machine ($9,000) but only$1,000 of the carryover from last year be-cause of the taxable income limit. She cancarry over the balance of $1,000 to next year.

See Carryover of disallowed deduction inchapter 2 of Publication 946 for informationon figuring the carryover.

Two different taxable income limits.The section 179 deduction is subject to ataxable income limit. You also may have tofigure another deduction (for example, chari-table contributions) that has a limit based ontaxable income. If you have to figure the limitfor this other deduction taking into accountthe section 179 deduction, complete the stepsdiscussed next.

Step 1. Figure taxable income without thesection 179 deduction or the other deduction.

Step 2. Figure a hypothetical section 179deduction using the taxable income figured inStep 1.

Step 3. Subtract the hypothetical section179 deduction figured in Step 2 from the tax-able income figured in Step 1.

Step 4. Figure a hypothetical amount forthe other deduction using the amount figuredin Step 3 as taxable income.

Step 5. Subtract the hypothetical otherdeduction figured in Step 4 from the taxableincome figured in Step 1.

Step 6. Now figure your actual section179 deduction using the taxable income fig-ured in Step 5.

Step 7. Subtract your actual section 179deduction figured in Step 6 from the taxableincome figured in Step 1.

Step 8. Figure your actual other de-duction using the taxable income figured inStep 7.

Example. During the year, the XYZ farmcorporation purchased and placed in servicequalifying section 179 property that cost$10,000. It elects to expense as much aspossible under section 179. The XYZ corpo-ration also gave a charitable contribution of$1,000 during the year. A corporation's de-duction for charitable contributions cannot bemore than 10% of its taxable income, figuredafter subtracting any section 179 deduction.The taxable income limit for the section 179deduction is figured after subtracting any al-lowable charitable contributions. XYZ's taxa-ble income figured without the section 179deduction or the deduction for charitablecontributions is $12,000. XYZ figures its sec-tion 179 deduction and its deduction forcharitable contributions as follows.

Step 1. Taxable income figured without eitherdeduction is $12,000.

Step 2. Using $12,000 as taxable income,XYZ's hypothetical section 179 deductionis $10,000.

Step 3. $12,000 (from Step 1) minus $10,000(from Step 2) equals $2,000.

Step 4. Using $2,000 (from Step 3) as taxableincome, XYZ's hypothetical charitablecontribution (limited to 10% of taxable in-come) is $200.

Step 5. $12,000 (from Step 1) minus $200(from Step 4) equals $11,800.

Step 6. Using $11,800 (from Step 5) as tax-able income, XYZ figures the actual sec-tion 179 deduction. Because the taxableincome is at least $10,000, XYZ can takea $10,000 section 179 deduction.

Step 7. $12,000 (from Step 1) minus $10,000(from Step 6) equals $2,000.

Step 8. Using $2,000 (from Step 7) as taxableincome, XYZ's actual charitable contribu-tion (limited to 10% of taxable income) is$200.

Partnerships and S corporations. Thesection 179 deduction limits apply both to thepartnership or S corporation and to eachpartner or shareholder. The partnership or Scorporation determines its section 179 de-duction subject to the limits. It then allocatesthe deduction among its partners or share-holders.

If you are a partner or shareholder, youadd the amount allocated from the partner-ship or S corporation to any 179 costs thatare not related to the partnership or S corpo-ration and then apply the maximum dollar limitto this total. To determine if you exceed the

$200,000 investment limit, you do not includeany of the cost of section 179 property placedin service by the partnership or S corporation.After you apply the maximum dollar limit andinvestment limit, you apply the taxable incomelimit to any remaining section 179 costs. Formore information see chapter 2 of Publication946.

Section 179 RecaptureSection 179 recapture occurs when you arerequired to add back to income the section179 deduction you took in an earlier year.

When To Recapturethe DeductionYou may have to recapture the section 179deduction if, in any year during the property'srecovery period, the percentage of businessuse drops to 50% or less or you sell or oth-erwise dispose of the property. Recovery pe-riods are discussed later.

Dispositions of property. You may have totreat any gain you realize from the sale, ex-change, or other disposition of businessproperty as ordinary income up to the depre-ciation allowed or allowable on the property.The section 179 deduction is treated as de-preciation for purposes of the recapture rule.See Depreciation Recapture in chapter 11.

How To Figure theRecaptureTo figure the amount to recapture (include inincome) take the following steps.

1) Figure the depreciation that would havebeen allowable on the section 179 de-duction you claimed. Begin with the yearthe property was placed in service andinclude the year of recapture.

2) Subtract the depreciation figured in (1)from the section 179 deduction youclaimed.

3) The result in (2) is the amount you mustrecapture.

Example. Paul Lamb, a calendar yeartaxpayer, bought and placed in service onAugust 1, 1997, an item of 3-year propertycosting $10,000. The property is not listedproperty. He elected a $5,000 section 179deduction for the property. He used theproperty only for business in 1997 and 1998.During 1999, he used the property 40% forbusiness and 60% for personal use. He fig-ures his recapture amount as follows.

Paul must include $1,375 in income for1999.

Section 179 deduction claimed (1997) ........ $5,000

Allowable depreciation(instead of section 179):1997 —$5,000 × 25.00%* ........................... $1,2501998 —$5,000 × 37.50%* ........................... 1,8751999 —$5,000 × 25.00%*× 40% (business) ............................ 500 3,6251999 —Recapture amount ..................................... $1,375

*Rates from the 150% table, later.


Where To Report RecaptureReport any recapture of the section 179 de-duction on Form 4797 and Schedule F (Form1040).

MACRSMACRS consists of two systems that deter-mine how you depreciate your property. Themain system is called the General Depreci-ation System (GDS). The second system iscalled the Alternative Depreciation System(ADS). The main difference between the twosystems is that ADS generally provides for alonger recovery period.

Unless you are specifically required by lawto use ADS or you elect it, you must generallyuse GDS to figure your depreciation de-duction. Property for which you are requiredby law to use ADS and how to elect ADS arediscussed later.

What Can BeDepreciatedUnder MACRSMACRS applies to most tangible depreciableproperty placed in service after 1986. Prop-erty for which you cannot use MACRS is dis-cussed later under What Cannot Be Depreci-ated Under MACRS.

Use of real property changed. You mustuse MACRS to depreciate all real propertyyou acquired before 1987 that you changedfrom personal use to business or income-producing use after 1986.

When To Use GDSMost tangible depreciable property falls withinthe general rule of MACRS, also called theGeneral Depreciation System (GDS). Be-cause GDS permits use of the declining bal-ance method over a shorter recovery period,the deduction is greater in the earlier years.

However, the law requires you to use ADSfor certain property, as discussed next.

Although your property may qualify forGDS, you can elect on a property-by-propertyor class of assets basis to use ADS. If youmake this election, you can never revoke it.How to make this election is discussed laterunder ADS election.

When To Use ADSYou must use ADS for the following property.

• Any property used predominately in afarming business and placed in serviceduring any tax year in which you makean election not to apply the uniform cap-italization rules to certain farming costs.

• Any tax-exempt use property.

• Any tax-exempt bond-financed property.

• Any imported property covered by anexecutive order of the President of theUnited States.

• Any tangible property used predominatelyoutside the United States during the year.

What Cannot BeDepreciatedUnder MACRSYou cannot use MACRS to depreciate thefollowing property.

• Intangible property.

• Any motion picture film or video tape.

• Any sound recording.

• Certain real and personal property placedin service before 1987.

You can elect to exclude from MACRS anyproperty that you can properly depreciateunder a method of depreciation not based ona term of years.

Election To Exclude PropertyFrom MACRSIf you properly depreciate any property undera method not based on a term of years, suchas the unit-of-production method, you canelect to exclude that property from MACRS.You make the election by reporting your de-preciation for the property on line 18 of PartIII of Form 4562 and attaching a statementas described in the Instructions for Form4562. You must make this election by thereturn due date (including extensions) for theyear you place your property in service.However, if you timely filed your return for theyear without making the election, you can stillmake the election by filing an amended returnwithin six months of the due date of the return(excluding extensions). Attach the election tothe amended return and write “Filed pursuantto section 301.9100–2” on the election state-ment. File the amended return at the sameaddress you filed the original return.

Standard mileage rate. If you use thestandard mileage rate to figure your tax de-duction for your business automobile, you aretreated as having made an election to excludethe automobile from MACRS. See Publication463 for a discussion of the standard mileagerate.

Property Placed in ServiceBefore 1987There are special rules that may prevent youfrom using MACRS for property placed inservice by anyone (for any purpose) before1987 (before August 1, 1986, if MACRS waselected). These rules apply to both personaland real property. However, the rules forpersonal property are more restrictive.

CAUTION!

Do not treat either real or personalproperty as owned before you placedit in service. If you owned property in

1986 but did not place it in service until 1987,you do not treat it as owned in 1986.

Personal property. You cannot use MACRSfor most personal property (section 1245property) that you acquired after 1986 (afterJuly 31, 1986, if MACRS was elected) if anyof the following apply.

1) You or someone related to you ownedor used the property in 1986.

2) You acquired the property from a personwho owned it in 1986 and as part of thetransaction the property user did notchange.

3) You leased the property to a person (orsomeone related to this person) whoowned or used the property in 1986.

4) You acquired the property in a trans-action in which:

a) The property user did not change,and

b) The property was not MACRSproperty in the hands of the personfrom whom you acquired it becauseof (2) or (3).

Real property. You cannot use MACRS forcertain real property. This includes propertyacquired after 1986 (after July 31, 1986, ifMACRS was elected) if any of the followingapply.

• You or someone related to you owned theproperty in 1986.

• You leased the property back to the per-son (or someone related to this person)who owned the property in 1986.

• You acquired the property in a trans-action in which part of your gain or losswas not recognized. MACRS applies onlyto that part of your basis in the acquiredproperty that represents cash paid orunlike property given up. It does not applyto the substituted portion of the basis. Formore information on transactions in whichpart of your gain or loss was not recog-nized, see Partially Nontaxable Ex-changes in chapter 1 of Publication 544.

Exceptions. These rules do not apply to thefollowing.

1) Residential rental property or nonresi-dential real property.

2) Any property, if in the first tax year it isplaced in service, the deduction underACRS is more than the deduction underMACRS using the half-year convention.

3) Property placed in service after 1980and before 1987 if it was transferred toyou from a related person or convertedfrom personal to business use after 1986and the deduction under ACRS is morethan the deduction under MACRS.

Property placed in service before 1981.For property placed in service before 1981that was transferred to you from a relatedperson or converted from personal to busi-ness use after 1986, use the straight line ordeclining balance method. These methodsare based on salvage value and useful life.

More information. See Publication 534 forinformation on how to figure ACRS and othermethods of depreciation.

Related PersonsFor the preceding rules, a related person in-cludes members of your immediate family(including your spouse, ancestors, and linealdescendants).

For more information on related persons,see Publication 946.


How To Figurethe DeductionUsing Percentage TablesOnce you determine your property can bedepreciated under MACRS and whether itfalls under GDS or ADS, you are ready tofigure your deduction. To help you figure yourdeduction, the IRS has established percent-age tables. To use these percentage tablesto figure your MACRS deduction each year,you need to know the following informationabout your property.

• Its basis.

• The date it was placed in service.

• Its property class and recovery period.

• Which convention to use.

• Which depreciation method to use.

BasisTo figure your depreciation deduction, youmust determine the basis of your property.To determine basis, you need to know thecost or other basis of your property. If youbought the property, your basis is the amountyou paid for the property plus amounts youpaid for other items such as sales tax, freightcharges, and installation and testing fees.Other basis (not cost) refers to basis that isdetermined by the way you received theproperty. For example, you may have re-ceived the property through a taxable ornontaxable exchange, for services you per-formed, as a gift, or as an inheritance. If youreceived property in this or some other way,see chapter 7 to determine your basis.

Property changed from personal use. Ifyou held property for personal use and laterchange it to business use or use in the pro-duction of income, your basis is the lesser ofthe following.

1) The fair market value (FMV) of theproperty on the date you change it frompersonal use to business use.

2) Your original cost or other basis adjustedas follows.

a) Increased by the cost of any per-manent improvements or additionsand other additions to basis.

b) Decreased by any tax deductionsyou claimed for casualty and theftlosses and other items that reducedyour basis.

Adjusted basis. After you determine yourbasis, you may have to make certain adjust-ments (increases and decreases) for eventsoccurring between the time you acquired theproperty and the time you placed it in service.These events could include the costs of thefollowing.

• Installation of utility lines.

• Legal fees for perfecting the title.

• Removal of barriers.

• Settlement of zoning issues.

• Receiving rebates.

For a discussion of items that may affect thebasis of your property, see Adjusted Basis inchapter 7.

Table 8–1. Farm Property Recovery Periods

Agricultural structures (single purpose)

Assets

1 Not including airplanes used in commercial or contract carrying of passengers.2 Not including communication equipment listed in other classes.3 Not including single purpose agricultural or horticultural structures.4 Used by logging and sawmill operators for cutting of timber.5 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.

GDS ADS

Recovery Period in Years

10 15Airplanes (including helicopters)1 5 6Automobiles 5 5

Calculators and copiers 5 6Cattle (dairy or breeding) 5 7Communication equipment2 7 10Computers and peripheral equipment 5 5Cotton ginning assets 7 12

Drainage facilities 15 20

Farm buildings3 20 25Farm machinery and equipment 7 10Fences (agricultural) 7 10

Goats and sheep (breeding) 5 5Grain bin 7 10

Hogs (breeding) 3 3Horses (age when placed in service)

Breeding and working (12 years or less) 7 10Breeding and working (more than 12 years) 3 10Racing horses (more than 2 years) 3 12

Horticultural structures (single purpose) 10 15

Logging machinery and equipment4 5 6

Nonresidential real property 395 40

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

Residential rental property 27.5 40

Tractor units (over-the-road) 3 4Trees or vines bearing fruit or nuts 10 20Truck (heavy duty, unloaded weight 13,000 lbs. or more) 5 6Truck (weight less than 13,000 lbs.) 5 5Typewriter 5 6

Water wells 15 20

Placed in ServiceFor depreciation purposes, property is placedin service when it is ready and available fora specific use, whether in a trade or business,the production of income, a tax-exempt ac-tivity, or a personal activity. Even if you arenot using the property, it is in service when itis ready and available for its specific use.

Example 1. A corn planter that is deliv-ered to the farm ready to be used in Decem-ber 1999 is placed in service in 1999 eventhough it will not be used until the spring of2000.

Example 2. If the planter comes unas-sembled in December 1999 and is put to-gether in February 2000, it is not placed inservice until 2000.

Example 3. If the planter was deliveredand assembled in February 2000 but not useduntil April 2000, it is placed in service inFebruary 2000, since this is when the planterwas in a condition of readiness for its speci-fied use.

Fruit or nut trees and vines. If you acquirean orchard, grove, or vineyard and the treesor vines have not yet reached the income-

producing stage, your depreciation beginswhen they reach the income-producing stage.

Immature livestock. If you acquire immaturelivestock for draft, dairy, or breeding pur-poses, your depreciation begins when theyreach maturity. This means depreciation be-gins when the livestock reach the age whenthey can be worked, milked, or bred. Whenthis occurs, your basis for depreciation is yourinitial cost for the immature livestock.

Property Classes andRecovery PeriodsEach item of property depreciated underMACRS is assigned to a property class. Theproperty class establishes the number ofyears over which you recover the basis ofyour property. This period of time is called arecovery period.

Property classes. Under MACRS, tangibleproperty you place in service after 1986, orafter July 31, 1986, if elected, falls into oneof the following classes.


1) 3-year property.

2) 5-year property.

3) 7-year property.

4) 10-year property.



7) Residential rental property.

8) Nonresidential real property.

Recovery periods. See Table 8–1 for re-covery periods under both GDS and ADS forsome commonly used assets. For a completelist of class lives and recovery periods, seethe Table of Class Lives and Recovery Peri-ods in Appendix B of Publication 946.

House trailers for farm laborers. Useone of the following recovery periods to de-preciate a house trailer you supply as housingfor those who work on your farm. Whether thehouse trailer is mobile or not determineswhich recovery period you can use.

1) If the house trailer is mobile and haswheels and a history of movement, de-preciate its cost over a 10-year recoveryperiod under ADS or a 7-year recoveryperiod under GDS.

2) If the house trailer is not mobile, itswheels removed, and permanent utilitiesand pipes are attached to it, depreciateits cost over a 25-year recovery periodunder ADS or a 20-year recovery periodunder GDS.

Water wells. Depreciable water wellsused to provide water for raising poultry andlivestock are land improvements and have a15-year recovery period under GDS and a20-year recovery period under ADS.

The types of water wells that can be de-preciated are discussed earlier under Irri-gation systems and water wells.

ConventionsTo figure your depreciation deduction for boththe year in which you place property in ser-vice and the year in which you dispose of theproperty, use one of the following con-ventions.

• The half-year convention.

• The mid-month convention.

• The mid-quarter convention.

Half-year convention. Generally, you usethis convention for property other than non-residential real and residential rental property.Under the half-year convention, you treat allproperty placed in service or disposed ofduring a year as placed in service or disposedof at the midpoint of that year. This meansthat no matter when in the year you begin orend the use of the property, you treat it as ifyou began or ended its use in the middle ofthe year.

Mid-month convention. You use the mid-month convention for the following types ofproperty.

• Nonresidential real property.

• Residential rental property.

Under this convention, you treat all propertyplaced in service (or disposed of) during amonth as placed in service (or disposed of)at the midpoint of the month. This means thatregardless of when during a month you placeproperty in service or dispose of it, you treatit as being placed in service (or disposed of)in the middle of that month.

Mid-quarter convention. You must use thisconvention when the total depreciable basesof MACRS property you placed in serviceduring the last 3 months of the year are morethan 40% of the total depreciable bases ofall MACRS property you placed in serviceduring the entire year. When this happens,you must use the mid-quarter convention forall MACRS property you placed in serviceduring the year. Under the mid-quarter con-vention, you treat all property placed in ser-vice or disposed of during the year as placedin service in the middle of the quarter.

Total bases. To determine the total basesof property, do not include the following.

• Residential rental property.

• Nonresidential real property.

• Property you placed in service and dis-posed of in the same tax year.

Depreciable basis. To determine whetheryou must use the mid-quarter convention, thedepreciable basis of property is your basismultiplied by the percentage of business/in-vestment use and then reduced by the fol-lowing.

• Any amortization taken on the property.

• Any section 179 deduction claimed on theproperty.

• Any deduction claimed for clean-fuel ve-hicles or for clean-fuel vehicle refuelingproperty.

Depreciation MethodsFor personal property placed in service in afarming business after 1988 you must use the150% declining balance method over a GDSrecovery period or you can elect one of thefollowing methods.

• The straight line method over a GDS re-covery period.

• The straight line method over an ADSrecovery period.

CAUTION!

For property placed in service before1999, you could elect to use the 150%declining balance method using the

ADS recovery periods. If you made thiselection, continue to use the same methodand recovery period for that property.

You can depreciate real property using thestraight line method under either GDS orADS.

Under MACRS, there are four methodsyou can use to figure depreciation. The fol-lowing table lists the types of property you candepreciate under each method. You can usethis table to help you determine the methodto use for a specific property class. The de-clining balance method is abbreviated as DBand the straight line method is abbreviatedas SL.

CAUTION!

You cannot use the 200% decliningbalance method for farm propertyplaced in service after 1988.

If you use a declining balance method,you switch to the straight line method whenthat method provides a greater deduction.

TIPIf you use the MACRS percentagetables, you do not need to determinein which year your deduction is

greater using the straight line method. Thetables have the switch to the straight linemethod built into their rates.

Fruit or nut trees and vines. Depreciatetrees and vines bearing fruit or nuts underGDS using the straight line method over a10-year recovery period.

ADS required for some farmers. If youelect not to apply the uniform capitalizationrules to any plant produced in your farmingbusiness, you must use ADS for all propertyyou place in service in any year the electionis in effect. See chapter 7 for a discussion ofthe application of the uniform capitalizationrules to farm property.

Farming business. A farming business isany trade or business involving cultivatingland or raising or harvesting any agriculturalor horticultural commodity. A farming busi-ness includes any of the following.

• Operating a nursery or sod farm.

• Raising or harvesting crops.

• Raising or harvesting trees bearing fruit,nuts, or other crops.

• Raising ornamental trees. (An evergreentree is not considered an ornamental treeif it is more than 6 years old when it issevered from its roots.)

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

Processing. In general, a farming busi-ness includes processing activities that arenormally part of the growing, raising, or har-vesting of agricultural products. However, afarming business generally does not includethe processing of commodities or products

Depreciation Methods

Method Type of Property

200% DBusing GDS

• Nonfarm 3-, 5-, 7-, and 10-year property

150% DBusing GDS

• All farm property (except real property)• All 15- and 20-year property• Nonfarm 3-,5-, 7-, and 10-year property*

SL usingGDS

• Nonresidential real property• Residential rental property• Trees or vines bearing fruit or nuts• All 3-, 5-, 7-, 10-, 15-, and 20-year property*

SL usingADS

• Property used predomi-nantly outside the U.S.

• Tax-exempt property• Tax-exempt bond-financed property• Imported property**• Any property for which you

elect to use this method*

*Elective method**See section 168(g)(6) of the Internal RevenueCode


beyond those activities that are normally partof the growing, raising, or harvesting of suchproducts.

Example 1. If you are in the trade orbusiness of growing fruits and vegetables,you can harvest, wash, inspect, and packagethe fruits and vegetables for sale. Such ac-tivities are normally part of the raising of thesecrops by farmers. You will be considered tobe in the business of farming with respect tothe growing of fruits and vegetables and theprocessing activities that are part of theirharvest.

Example 2. You are in the business ofgrowing and harvesting wheat and othergrains. You also process grain you have har-vested in order to produce breads, cereals,and other similar food products. You then sellthese products to customers in the course ofyour business. Although you are in the farm-ing business with respect to the growing andharvesting of grain, you are not in the farmingbusiness with respect to the processing of thegrain to produce the food products.

Electing a method. As shown in the table,Depreciation Methods, you can elect a differ-ent method for depreciation for certain typesof property. The election must be made by thedue date of the return (including extensions)for the year you place the property in service.However, if you timely filed your return for theyear without making the election, you can stillmake the election by filing an amended returnwithin six months of the due date of your re-turn (excluding extensions). Attach theelection to the amended return and write“Filed pursuant to section 301.9100–2” on theelection statement. File the amended returnat the same address you filed the original re-turn.

CAUTION!

If you elect to use a different methodfor one item in a property class, youmust apply the same method to all

property in that class placed in service duringthe year of the election. However, you canmake the election on a property-by-propertybasis for residential rental and nonresidentialreal property. Once you make the election,you cannot change it.

Straight line election. Instead of usingthe declining balance method, you can electto use the straight line method over the GDSrecovery period.

ADS election. Although your propertymay come under GDS, you can elect to useADS. ADS uses the straight line method ofdepreciation over fixed ADS recovery periods.The ADS recovery periods for many assetsused in the business of farming are listed inTable 8–1. Additional ADS recovery periodsfor other classes of property may be found inthe Table of Class Lives and Recovery Peri-ods in Appendix B of Publication 946.

Make the election by completing line 16,Part II of Form 4562.

Figuring the MACRS DeductionYou can determine your MACRS depreciationdeduction in one of two ways.

1) You can use the percentage tablesshown in Appendix A of Publication 946.

2) You can figure your own deduction. SeeHow To Figure the Deduction Without

Table 8–2. 150% Declining Balance Method

Year

1

432

3-Year 5-Year 20-Year7-Year

5

876

25.0%

12.525.037.5

15.00%

16.6617.8525.50

16.668.33

10.71%

12.2515.0319.13

12.25

6.13

12.2512.25

3.750%

6.1776.6777.219

5.713

4.522

5.2854.888

Using the Tables in chapter 3 of Publi-cation 946.

CAUTION!

Figuring your own MACRS deductionwill generally result in a slightly dif-ferent amount than using the tables.

Rules for using the tables. The followingrules cover the use of the percentage tables.

1) You must apply the rates in the per-centage tables to your property's unad-justed basis (defined later).

2) You cannot use the percentage tablesfor a short tax year. See chapter 3 ofPublication 946 for information on howto figure the deduction in a short taxyear.

3) You must continue to use the tables forthe entire recovery period even if thereare adjustments to the basis of yourproperty for the reasons listed below.

a) Depreciation allowed or allowable.

b) An addition or improvement to theproperty. (An addition or improve-ment is depreciated as a separateproperty.)

4) You must stop using the tables if thereis an adjustment to the basis of yourproperty for any reason other than thoselisted in (3) above.

Figuring unadjusted basis. You mustapply the table rates to your property's unad-justed basis each year of the recovery period.Unadjusted basis is the amount you woulduse to figure gain on a sale but figured withouttaking into account any depreciation taken inearlier years. However, you do reduce youroriginal basis by any of the following itemsthat apply.

• Amortization taken on the property.

• Section 179 deduction claimed on theproperty.

• Deduction claimed for clean-fuel vehicleor clean-fuel vehicle refueling property.

• Electric vehicle credit. (The lesser of$4,000 or 10% of the cost of the vehicle,even if the credit is less than thatamount.)

For business property you purchase dur-ing the year the unadjusted basis is its costminus these adjustments.

If you trade property, your unadjusted ba-sis in the property received is the cash paidplus the adjusted basis of the property tradedminus these adjustments.

The clean-fuel vehicle and clean-fuel ve-hicle refueling property deductions and thecredit for electric vehicles are discussed inchapter 15 of Publication 535.

Adjustment due to casualty loss. If youreduce the basis of your property because ofa casualty, you cannot continue to use thetables. For the year of adjustment and the restof the recovery period, figure the depreciationusing the property's adjusted basis at the endof the year of adjustment.

150% table applying the half-year con-vention. Table 8–2 has the percentages for3-, 5-, 7-, and 20-year property. The per-centages are based on the 150% decliningbalance method with a change to the straightline method. This table covers only the half-year convention and the first 8 years for20-year property. See Appendix A in Publi-cation 946 for complete MACRS tables, in-cluding tables for the mid-quarter and mid-month convention.

Example 1. This year, you buy and placein service an item of 7-year property for$10,000. You do not elect a section 179 de-duction for this property. The unadjusted ba-sis of the property is $10,000. You use thepercentage tables to figure your deduction.

Since this is 7-year property, you multiply$10,000 by 10.71% to get this year's depre-ciation of $1,071. For next year, you figureyour depreciation deduction by multiplying$10,000 by 19.13% to get $1,913.

Example 2. You have a barn constructedon your farm at a cost of $20,000. You placethe barn in service this year. The barn is20-year property and you use the table per-centages to figure your deduction. You figurethis year's depreciation by multiplying$20,000 (unadjusted basis) by 3.75% to get$750. For next year, your depreciation will be$20,000 multiplied by 7.219%, or $1,443.80.

Straight line table applying the half-year convention. The following table has thestraight line percentages for 3-, 5-, 7-, and20-year property using the half-year conven-tion. The table covers only the first 8 yearsfor 20-year property. See Appendix A inPublication 946 for complete MACRS tables,including tables for the mid-quarter and mid-month convention.

Figuring MACRS deductions without thetables. If you are required to or would preferto figure your own depreciation without usingthe tables, see How To Figure the DeductionWithout Using the Tables in chapter 3 ofPublication 946.

Straight Line PercentagesYear 3-Year 5-Year 7-Year 20-Year

1 16.67% 10% 7.14% 2.5%2 33.33 20 14.29 5.03 33.33 20 14.29 5.04 16.67 20 14.28 5.05 20 14.29 5.06 10 14.28 5.07 14.29 5.08 7.14 5.0


DispositionsIf you dispose of depreciable property at again, you may have to report, as ordinary in-come, all or part of the gain. See chapter 11.

General Asset AccountsTo make it easier to figure MACRS depreci-ation, you can group separate properties intoone or more general asset accounts. You canthen depreciate all of the properties in eachaccount as a single item of property. Eachaccount can include only property with similarcharacteristics, such as asset class and re-covery period. Some property cannot be in-cluded in a general asset account. There areadditional rules for passenger automobiles,disposing of property, converting property topersonal use, and property that generatesforeign source income.

After you have set up a general asset ac-count, you generally figure the amount of de-preciation for each account by using the de-preciation method, recovery period, andconvention that applies to the property in theaccount. For each general asset account,record the depreciation allowance in a sepa-rate depreciation reserve account.

Property you cannot include. You cannotinclude property in a general asset account ifyou use it in both a trade or business (or forthe production of income) and in a personalactivity in the year in which you first place itin service.

How To Group Property inGeneral Asset AccountsEach general asset account must include onlyproperty you placed in service in the sameyear and that has the following in common.

• Asset class.

• Recovery period.

• Depreciation method.

• Convention.

The following rules also apply when youestablish a general asset account.

• No asset class. Property without an as-set class, but with the same depreciationmethod, recovery period, and convention,which you place in service in the sameyear, can be grouped into the samegeneral asset account.

• Mid-quarter convention. Property sub-ject to the mid-quarter convention canonly be grouped into a general asset ac-count with property that is placed in ser-vice in the same quarter.

• Mid-month convention. Property sub-ject to the mid-month convention can onlybe grouped into a general asset accountwith property that is placed in service inthe same month.

• Passenger automobiles. Passengerautomobiles subject to the limits on pas-senger automobile depreciation must begrouped into a separate general assetaccount.

Dispositions and ConversionsIt is considered a disposition of property in ageneral asset account when you do any of thefollowing.

• Permanently withdraw it from use in yourtrade or business or from the productionof income.

• Transfer it to a supplies, scrap, or similaraccount.

• Sell, exchange, retire, physically aban-don, or destroy it.

The retirement of a structural component ofreal property is not a disposal.

The unadjusted depreciable basis and thedepreciation reserve of the general asset ac-count are not affected by your disposition ofproperty from the general asset account.

You must remove from the general assetaccount any property you change to personaluse.

Unadjusted depreciable basis. The un-adjusted depreciable basis of an item ofproperty in a general asset account is theamount you would use to figure gain on thesale of the property but figured without takinginto account any depreciation taken in earlieryears.

The unadjusted depreciable basis of ageneral asset account is the total of the un-adjusted depreciable bases of all of theproperty in the account.

For more information on general assetaccounts, see chapter 3 in Publication 946.

Listed PropertyListed property includes property used fortransportation or entertainment and certaincomputers and cellular phones. There areadditional rules and recordkeeping require-ments you must follow when depreciatinglisted property.

Listed Property DefinedListed property is any of the following.

• Any passenger automobile (definedlater).

• Any other vehicle used for transportation.

• Any property of a type generally used forentertainment, recreation, or amusement.

• Any computer and related peripheralequipment unless it is used only at aregular business establishment andowned or leased by the person operatingthe establishment.

• Any cellular telephone (or similar tele-communication equipment).

Other vehicles used for transportation.This includes trucks, buses, boats, airplanes,motorcycles, and other vehicles used fortransporting persons or goods.

Vehicles that are not listed property.The following vehicles, because of their de-sign, are unlikely to be used very often forpersonal purposes. They are not listed prop-erty.

• Tractors and other special purpose farmvehicles.

• Bucket trucks (cherry pickers), dumptrucks, flatbed trucks, and refrigeratedtrucks.

• Combines, cranes and derricks, andforklifts.

• Passenger buses with a capacity of atleast 20 passengers that are used aspassenger buses.

Predominant Use TestIf you do not use listed property predomi-nantly (more than 50%) in a qualified busi-ness use, you cannot take a section 179 de-duction for the property and you mustdepreciate the property using ADS (straightline method) over the ADS recovery period.

Listed property meets the predominantuse test for any year if its business use ismore than 50% of its total use. You must al-locate the use of any item of listed propertyused for more than one purpose during theyear among its various uses. You cannot usethe percentage of investment use of listedproperty as part of the percentage of qualifiedbusiness use to meet the predominant usetest. However, you do use the combined totalof business and investment use to figure yourdepreciation deduction for the property.

TIPProperty does not stop being pre-dominantly used in a qualified busi-ness use because of a transfer at

death.

Special Rules for PassengerAutomobilesFor passenger automobiles, the total depre-ciation deduction (including the section 179deduction) you can claim is limited.

Passenger automobile defined. A passen-ger automobile is any four-wheeled vehiclemade primarily for use on public streets,roads, and highways and rated at 6,000pounds or less of unloaded gross vehicleweight (6,000 pounds or less of gross vehicleweight for trucks and vans). It includes anypart, component, or other item physically at-tached to the automobile or usually includedin the purchase price of an automobile.

Maximum deductions for 1999. Determinethe maximum depreciation deduction (includ-ing section 179) you can claim for a passen-ger automobile based on the date you placeit in service. The maximum deductions for1999, based on the year the automobile isplaced in service, are shown in the followingtable.

You must reduce these limits further ifyour business/investment use is less than100%.

Maximum Depreciation Deductionfor Passenger Automobiles

Year PlacedIn Service

1stYear

2ndYear

3rdYear

4thYearand

Later

1999 .............. $3,060 $5,000 $2,950 $1,7751998 ........................... 5,000 2,950 1,7751997 .......................................... 3,050 1,7751996 .......................................................... 1,7751995 .......................................................... 1,7751994 .......................................................... 1,675Pre-1994 ................................................... 1,675


Exceptions for clean-fuel vehicles.There are two exceptions to the depreciationlimits for passenger automobiles. These ex-ceptions are effective after August 5, 1997,for automobiles that run on clean fuel.

The first exception is a higher depreci-ation deduction for clean-fuel vehicles. Themaximum deductions for 1999, based on theyear the clean-fuel vehicle is placed in ser-vice, are shown in the following table.

The second exception is for any costsyou pay to retrofit parts and components tomodify an automobile to run on clean fuel.These costs are not subject to the limits ondepreciation for automobiles. Only the costof the automobile, excluding this modification,is subject to the limit.

For more information on clean-fuel vehi-cles, see chapter 15 in Publication 535,Business Expenses.

Fully depreciated automobile. If you havefully depreciated a car you are still using inyour business, you can continue to claim yourother operating expenses for the businessuse of your car. Continue to keep records, asexplained next.

More information. For more informationabout deducting expenses for the businessuse of your passenger automobile, seechapter 4 in Publication 463.

What Records Must Be Kept

RECORDS

You cannot take any depreciation orsection 179 deduction for the use oflisted property (including passenger

automobiles) unless you can prove businessand investment use with adequate recordsor sufficient evidence to support your ownstatements.

Adequate records. To meet the adequaterecords requirement, you must maintain anaccount book, diary, log, statement of ex-pense, trip sheet, or similar record or otherdocumentary evidence that, together with thereceipt, is sufficient to establish each elementof an expenditure or use. You do not have torecord information in an account book, diary,or similar record if the information is alreadyshown on the receipt. However, your recordsshould back up your receipts in an orderlymanner.

How long to keep records. For listed prop-erty, you must keep records for as long asany excess depreciation can be recaptured(included in income). Recapture can occur inany tax year of the ADS recovery period.

For more information on records, seechapter 4 in Publication 946.

DepletionDepletion is the using up of natural resourcesby mining, quarrying, drilling, or felling. Thedepletion deduction allows an owner or oper-

ator to account for the reduction of a product'sreserves.

Who Can Claim DepletionIf you have an economic interest in mineralproperty or standing timber, you can take adeduction for depletion. More than one per-son can have an economic interest in thesame mineral deposit or timber.

You have an economic interest if both ofthe following apply.

1) You have acquired by investment a legalinterest in mineral deposits or standingtimber.

2) You have the right to income from theextraction of the mineral or the cuttingof the timber to which you must look fora return of your capital investment.

A contractual relationship you have that al-lows you an economic or monetary advantagefrom products of the mineral deposit orstanding timber is not, in itself, an economicinterest. A production payment carved out of,or retained on the sale of, mineral property isnot an economic interest.

The term “mineral property” means eachseparate interest you own in each mineraldeposit in each separate tract or parcel ofland. You can treat mineral properties sepa-rately or as a group. See section 614 of theInternal Revenue Code for rules on how totreat separate properties.

The term “timber property” means youreconomic interest in standing timber in eachtract or block representing a separate timberaccount.

Figuring DepletionThere are two ways of figuring depletion.

• Cost depletion.

• Percentage depletion.

For mineral property, you generally must usethe method that gives you the larger de-duction. For standing timber, you must usecost depletion.

Cost DepletionTo figure cost depletion you must first deter-mine the following.

• The property's basis for depletion.

• The total recoverable units in the proper-ty's natural deposit.

• The number of units sold during the taxyear.

You must estimate or determine recover-able units (tons, barrels, board feet, or othermeasure) using the current industry methodand the most accurate and reliable informa-tion you can obtain.

Basis for depletion and recoverable unitsare explained in chapter 13 of Publication535.

Number of units sold. The number of unitssold during the tax year is one of the follow-ing.

1) The units sold based on your invento-ries, during the tax year, if you use theaccrual method of accounting.

2) The units sold for which you receivepayment, during the year (regardless of

the year of sale), if you use the cashmethod of accounting.

The number of units sold during the taxyear does not include any units on which de-pletion deductions were allowed or allowablein earlier years.

Figuring the cost depletion deduction.Once you have figured your property's basisfor depletion, the total recoverable units, andthe number of units sold during the tax year,you can figure your cost depletion deductionby taking the following steps.

Cost depletion on ground water ofOgallala Formation. Farmers who extractground water from the Ogallala Formation forirrigation are allowed cost depletion. Costdepletion is allowed when it can be demon-strated the ground water is being depletedand the rate of recharge is so low that, onceextracted, the water is lost to the taxpayer andimmediately succeeding generations.

To figure your cost depletion deduction,use the guidance provided in Revenue Pro-cedure 66–11 in Cumulative Bulletin 1966–1.

For tax years ending before December 13,1982, those extracting ground water for irri-gation farming from areas in the OgallalaFormation outside the Southern High Plainswere not required to reduce their basis inground water by any allowable cost depletionthat was not claimed.

Timber depletion. You can take depletionon timber (including Christmas trees) only ifyou cut it yourself or have it cut for you. Tofigure timber depletion, you multiply thenumber of units of standing timber cut by yourdepletion unit.

Timber units. When you acquire timberproperty, you must make an estimate of thequantity of marketable timber that exists onthe property. You measure the timber usingboard feet, log scale, cords, or other units. Ifyou later determine that you have more orless units of timber, you must adjust the ori-ginal estimate.

Depletion units. You figure your de-pletion unit each year by taking the followingsteps.

1) Determine your cost or the adjusted ba-sis of the timber on hand at the begin-ning of the year.

2) Add to the amount determined in (1) thecost of any units acquired during theyear and any additions to capital.

3) Figure the number of units to take intoaccount by adding the units acquiredduring the year to the units on hand inthe account at the beginning of the yearand then adding (or subtracting) anycorrection to the estimate of the unitsremaining in the account.

4) Divide the result of (2) by the result of(3). This is your depletion unit.

When to claim timber depletion. Claimyour depletion allowance as a deduction inthe year of sale or other disposition of the

Maximum Depreciation Deductionfor Clean-Fuel Vehicles

Year Placedin Service

1stYear

2ndYear

3rdYear

4thYearand

Later Step Action Result1999 ..................... $9,280 $14,900 $8,950 $5,325 1 Divide your property's

basis for depletion bytotal recoverable units.

Rate per unit.1998 .................................. 15,000 8,950 5,4251997 ................................................ 9,050 5,425

2 Multiply the rate perunit by units soldduring the tax year.

Cost depletiondeduction.


products cut from the timber, unless you electto treat the cutting of timber as a sale or ex-change as explained in chapter 10. Includeallowable depletion for timber products notsold during the tax year the timber is cut asa cost item in the closing inventory of timberproducts for the year. The inventory is yourbasis for determining gain or loss in the taxyear that you sell the timber products.

Form T. Attach Form T to your incometax return if you are claiming a deduction fortimber depletion or electing to treat the cuttingof timber as a sale or exchange.

Example. Sam Brown bought a farm thatincluded standing timber. This year Sam de-termined that the standing timber couldproduce 300,000 units when cut. At that time,the adjusted basis of the standing timber was$24,000. Sam then cut and sold 27,000 units.Sam did not elect to treat the cutting of thetimber as a sale or exchange. Sam's de-pletion for each unit for the year is $.08($24,000 ÷ 300,000). His deduction for de-pletion is $2,160 (27,000 × $.08). If Sam hadcut 27,000 units but sold only 20,000 unitsduring the year, his depletion for each unitwould have remained at $.08. However, hisdepletion deduction would have been $1,600for this year and he would have included thebalance of $560 (7,000 × $.08) in the closinginventory for the year.

Percentage DepletionYou can use percentage depletion on certainmines, wells, and other natural deposits. Youcannot use the percentage method to figuredepletion for standing timber, soil, sod, dirt,or turf.

Figure percentage depletion by multiplyingthe percentage for each mineral by your grossincome from the property during the year. SeeMines and other natural deposits in chapter13 of Publication 535 for a list of the per-centages.

Taxable income limit. The percentage de-pletion deduction cannot be more than 50%(100% for oil and gas property) of your taxa-ble income from the property figured withoutthe depletion deduction. This taxable incomelimit may not apply to percentage depletionon the marginal production of oil or naturalgas. For information on marginal production,see section 613A(c)(6) of the Internal Reve-nue Code.

The following rules apply when figuringyour taxable income from the property forpurposes of the taxable income limit.

• Do not deduct any net operating lossdeduction from the gross income from theproperty.

• Corporations do not deduct charitablecontributions from the gross income fromthe property.

• If, during the year, you disposed of anitem of section 1245 property which wasused in connection with the mineralproperty, reduce any allowable deductionfor mining expenses by the part of anygain you must report as ordinary incomethat is allocable to the property. Seesection 1.613–5(b)(1) of the regulationsfor information on how to figure the ordi-nary gain allocable to the property.

More InformationFor more information on depletion, seechapter 13 in Publication 535.

AmortizationAmortization is a method of recovering certaincapital costs over a fixed period of time. It issimilar to the straight line method of depreci-ation. See chapter 12 in Publication 535 formore information on the following topics.

Section 197 IntangiblesYou must amortize over 15 years the capital-ized costs of “section 197 intangibles” youacquired after August 10, 1993. Section 197intangibles are defined later. You mustamortize these costs if you hold the section197 intangible in connection with your tradeor business or in an activity engaged in for theproduction of income. Your deduction eachyear is the part of the adjusted basis (forpurposes of determining gain) of the intangi-ble amortized ratably over a 15-year period,beginning with the month acquired. You arenot allowed any other depreciation or amorti-zation deduction for a section 197 intangible.

Section 197 Intangibles DefinedThe following assets are section 197 intangi-bles.

1) Goodwill.

2) Going concern value.

3) Workforce in place, including its compo-sition and the terms and conditions(contractual or otherwise) of its employ-ment.

4) Business books and records, operatingsystems, or any other information base,including lists or other information con-cerning current or prospective custom-ers.

5) A patent, copyright, formula, process,design, pattern, know-how, format, orsimilar item.

6) A customer-based intangible.

7) A supplier-based intangible.

8) Any item similar to items (3) through (7).

9) A license, permit, or other right grantedby a governmental unit or agency (in-cluding renewals).

10) A covenant not to compete entered intoin connection with the acquisition of aninterest in a trade or business.

11) A franchise, trademark, or trade name(including renewals).

CAUTION!

You cannot amortize any intangiblelisted in items (1) through (8) that youcreated, unless you created it in con-

nection with the acquisition of assets consti-tuting a trade or business or a substantial partof a trade or business.

Assets that are not section 197 intangi-bles. The following assets are not section197 intangibles.

1) Any interest in land.

2) Most computer software (see Computersoftware, next).

3) An interest under either:

a) An existing lease or sublease oftangible property, or

b) A debt that was in existence whenthe interest was acquired.

Computer software. Section 197 intan-gibles do not include computer software thatis:

1) Readily available for purchase by thegeneral public,

2) Subject to a nonexclusive license, and

3) Not substantially changed.

Software not acquired in the acquisition of asubstantial part of a business is not a section197 intangible.

If you are allowed to depreciate any com-puter software that is not a section 197 in-tangible, use the straight line method with auseful life of 36 months.

For more information on depreciatingcomputer software, see Computer softwareunder Intangible Property, earlier.

Costs associated with non-section 197 in-tangibles. Amounts you take into account indetermining the cost of non-section 197property are not considered section 197 in-tangibles. These amounts are added to thebasis of the property. For example, none ofthe costs of acquiring real property held forthe production of rental income are consid-ered goodwill, going concern value, or anyother section 197 intangible.

Anti-Churning RulesAnti-churning rules prevent you from con-verting section 197 intangibles that do notqualify for amortization into property thatwould qualify for amortization.

You cannot use 15-year amortization forgoodwill, going concern value, or any otherintangible for which you cannot claim a de-preciation or amortization deduction thatwould not have been allowable before August10, 1993, to amortizable property.

Anti-Abuse RuleYou cannot amortize any section 197 intan-gible acquired in a transaction in which eitherof the following was a principal purpose of thetransaction.

1) To avoid the requirement that the intan-gible be acquired after August 10, 1993.

2) To avoid any of the anti-churning rules.

DispositionsA section 197 intangible is treated as depre-ciable property used in your trade or busi-ness. If you dispose of property held for morethan one year, any gain on the disposition,up to the allowable amortization, is ordinaryincome (section 1245 gain). Any remaininggain or loss is a section 1231 gain or loss. Ifyou held the property one year or less, anygain or loss on its disposition is an ordinarygain or loss. For more information, seechapter 3 in Publication 544.

Nondeductible loss. If you acquire morethan one section 197 intangible in a trans-action (or series of related transactions) andlater dispose of one of them or one of thembecomes worthless, you cannot deduct any


loss on the intangible. Instead, increase theadjusted basis of each remaining amortizablesection 197 intangible by part of the non-deductible loss.

Reforestation CostsYou can elect to amortize part of your qual-ified timber property reforestation costs.Qualifying expenses you have during the yearare amortizable over an 84-month period.

Annual limit. Each year you can elect toamortize up to $10,000 ($5,000 if you aremarried filing separate returns) of qualifiedcosts you pay or incur during the year. Youcannot carry over or carry back qualifyingcosts over the annual limit. If you incur morethan $10,000 in costs for more than one pieceof timber property, you can divide the annuallimit among the properties in any manner youwish.

Qualifying costs. Qualifying costs includeonly those costs you must capitalize and in-clude in the adjusted basis of the property.Costs you can deduct currently are not quali-fying expenses. Qualifying costs include costsfor the following items.

• Site preparation.

• Seeds or seedlings.

• Labor.

• Tools.

• Depreciation on equipment used inplanting and seeding.

If the government reimburses you undera cost-sharing program, you can amortizethese costs only if you include the re-imbursement in your income.

Qualified timber property. Qualified timberproperty can be a woodlot or other site thatyou own or lease. The property qualifies onlyif it meets all of the following requirements.

1) It is located in the United States.

2) It is held for the growing and cutting oftimber you will either use in, or sell foruse in, the commercial production oftimber products.

3) It consists of at least one acre plantedwith tree seedlings in the mannernormally used in forestation or refor-estation.

Qualified timber property does not includeproperty on which you have planted shelterbelts and ornamental trees, such as Christ-mas trees.

Maximum annual amortization. The maxi-mum annual deduction for costs incurred inany year is $1,428.57 ($10,000 ÷ 7). Themaximum deduction in the first and last yearof the 84-month period is one half (1/2) of$1,428.57 or $714.29.

Estates. The reforestation deduction isavailable to estates in the same manner asto individuals. The deduction is divided be-tween the income beneficiary and the estatebased on the income of the estate allocableto each. A beneficiary must include any allo-cated amount as part of his or her annuallimit.

Trusts. Trusts are not allowed the refor-estation deduction.

Investment credit. Reforestation costs eli-gible to be amortized qualify for the invest-ment credit, whether or not they are amor-tized. See Investment Credit in chapter 9.

How to make the election. To elect toamortize qualified reforestation costs, enteryour deduction in Part VI of Form 4562. At-tach a statement containing the following in-formation.

• A description of the costs and the datesyou incurred them.

• A description of the type of timber beinggrown and the purpose for which it isgrown.

Attach a separate statement for each propertyfor which you amortize reforestation costs.You can make the election only on a timelyfiled return (including extensions) for the yearin which you incurred the costs. However, ifyou timely filed your return for the year with-out making the election, you can still make theelection by filing an amended return within sixmonths of the due date of your return (ex-cluding extensions). Attach the election to theamended return and write “Filed pursuant tosection 301.9100–2” on the election state-ment. File the amended return at the sameaddress you filed the original return.

Recapture. If you dispose of qualified timberproperty within 10 years after the tax year youcreate an amortizable basis in the property,report any gain as ordinary income up to theamount of the amortization taken.

Pollution Control FacilitiesYou can elect to amortize over 60 months thecost of a certified pollution control facility.

Certified pollution control facility. A certi-fied pollution control facility is a new identifi-able treatment facility used in connection witha plant or other property in operation before1976 to reduce or control water or atmo-spheric pollution or contamination. The facilitymust do so by removing, changing, disposing,storing, or preventing the creation or emissionof pollutants, contaminants, wastes, or heat.The facility must be certified by the state andfederal certifying authorities. Examples ofsuch a facility include septic tanks andmanure-control facilities.

For information regarding certificationprocedures, see section 1.169–2(c) of theregulations.

The federal certifying authority will notcertify your property to the extent it appearsyou will recover (over the property's usefullife) all or part of its cost from the profit basedon its operation (such as through sales of re-covered wastes). You must reduce the am-ortizable basis of the facility by this potentialrecovery. For more information, see section169 of the Internal Revenue Code and therelated regulations.

Example. This year, you purchase a new$7,500 manure control facility for use on yourdairy farm. The farm has been in operationsince you bought it in 1976 and all of the dairyplant was in operation before that date. Youhave no intention of recovering the cost of thefacility through sale of the waste and a federalcertifying authority has so certified.

Your manure control facility qualifies foramortization. You can elect to amortize its

cost over 60 months. Otherwise, you cancapitalize the cost and depreciate the facility.

Going Into BusinessWhen you go into business, treat all costs youincur to get your business started as capitalexpenses. Capital expenses are a part of yourbasis in the business. Generally, you recovercosts for particular assets through depreci-ation deductions. However, you generallycannot recover other costs until you sell thebusiness or otherwise go out of business.

Business start-up costs. Start-up costs arecosts for setting up an active trade or busi-ness or investigating the possibility of creatingor acquiring an active trade or business.Start-up costs include any amounts paid orincurred in connection with any activity en-gaged in for profit and for the production ofincome before the trade or business begins,in anticipation of the activity becoming anactive trade or business.

For more information, see Going IntoBusiness in chapter 12 of Publication 535.

9.GeneralBusiness Credit

IntroductionYour general business credit for the yearconsists of your carryforward of businesscredits from prior years plus your total currentyear business credits. Current year businesscredits include the following credits.

• Credit for alcohol used as fuel (Form6478).

• Credit for contributions to selected com-munity development corporations (Form8847).

• Credit for employer social security andMedicare taxes paid on certain employeetips (Form 8846).

• Disabled access credit (Form 8826).

• Empowerment zone employment credit(Form 8844).

• Enhanced oil recovery credit (Form8830).

• Indian employment credit (Form 8845).

• Investment credit (Form 3468).

• Low-income housing credit (Form 8586).

• Orphan drug credit (Form 8820).

• Renewable electricity production credit(Form 8835).

• Research credit (Form 6765).

• Welfare-to-work credit (Form 8861).

• Work opportunity credit (Form 5884).

Page 52 Chapter 9 General Business Credit

In addition, your general business creditfor the current year may be increased laterby the carryback of business credits from lateryears.

If you need more information about thesecredits than you find in this chapter, see theinstructions for the forms listed above.


• How to claim the credit

• Carrybacks and carryforwards

• Investment credit



� 1040X Amended U.S. Individual IncomeTax Return

� 1045 Application for Tentative Refund

� 1120X Amended U.S. CorporationIncome Tax Return

� 1139 Corporation Application forTentative Refund

� 3468 Investment Credit

� 3800 General Business Credit

� 4255 Recapture of Investment Credit

� 4626 Alternative MinimumTax—Corporations

� 6251 Alternative MinimumTax—Individuals

� 8582–CR Passive Activity CreditLimitations


How ToClaim the CreditTo claim a general business credit, you willfirst need to get the form or forms you needto claim your current year business credits.The introduction to this chapter contains a listof current year business credits. The form toclaim each credit is shown in parentheses.

In addition to the credit form, you may alsoneed to file Form 3800. See the next dis-cussion to decide whether you need to fileForm 3800.

Who must file Form 3800? You must fileForm 3800 if any of the following apply.

• You have more than one of the creditslisted in the introduction (other than theempowerment zone employment credit).

• You have a carryback or carryforward ofany of these credits (other than the em-powerment zone employment credit).

• Any of these credits (other than the low-income housing credit or the empower-ment zone employment credit) is from apassive activity. (For information aboutpassive activity credits, see Form8582–CR.)

Claiming the empowerment zone employ-ment credit. The empowerment zone em-ployment credit is subject to different rules.The credit is figured separately on Form 8844and is not carried to Form 3800. For moreinformation, see the instructions for Form8844.

Carrybacksand Carryforwards

CAUTION!

The following discussion does notapply to the empowerment zone em-ployment credit.

There is a limit on how much generalbusiness credit you can take in any one taxyear. If your credit is more than this limit, youcan generally carry the difference to anothertax year and subtract it from your income taxfor that year. See Rule for carrybacks andcarryforwards, later.

Credit limit. Your general business credit islimited to your net income tax minus thegreater of the following amounts.

• Your tentative minimum tax.

• 25% of your net regular tax liability thatis more than $25,000.

Net income tax. Your net income tax isyour net regular tax liability plus any alterna-tive minimum tax.

Tentative minimum tax. You must figureyour tentative minimum tax before you figureyour general business credit. Use Form 6251(Form 4626 for a corporation) to figure yourtentative minimum tax.

Net regular tax liability. Your net regulartax liability is your regular tax liability minuscertain credits. For more information, seeForm 3800 or any of the credit forms listedunder Introduction, earlier.

Example. Your general business creditfor the year is $30,000. Your net income taxis $27,500. Your tentative minimum tax, fig-ured on Form 6251, is $18,487. The generalbusiness credit you can take for the tax yearis limited to $9,013. This is your net incometax, $27,500, minus the greater of your ten-tative minimum tax, $18,487, or 25% of yournet regular tax liability that is more than$25,000 (25% of $2,500 = $625).

Married persons filing separate returns.If you are married and file a separate return,you and your spouse must each figure yourcredit limit separately. In figuring your sepa-rate limit, use $12,500 instead of $25,000.However, if one spouse has no credit for thetax year and no carryforwards or carrybacksof any credit to that year, the other spousecan use the full $25,000 in figuring the limitbased on the separate tax.

Rule for carrybacks and carryforwards. Ingeneral, you can carry the unused portion ofyour credit back one tax year and then for-ward to your next 20 tax years to reduce yourtax in those years. First, carry the unusedportion to your last tax year. Any unusedcredit that you could not take in the prior taxyear can be carried forward to the next 20 taxyears until it is used up.

There are generally limits on the carrybackof a new credit to periods before theenactment of the credit provision. See the

instructions for Form 3800 for more informa-tion on these limits.

Credits must be used in the order in whichthey are earned.

1) First, for any tax year, use your creditcarryforward (earliest year first).

2) Next, use the current year's credit.

3) Finally, use your credit carrybacks (ear-liest year first).

TIPFor a credit earned in a tax year be-fore 1998, the carryforward period is15 years. No part of your carryforward

to 1999 should be from a tax year before1984.

Unused carryforward. If you have anyunused credit carryforward in the year fol-lowing the end of the 20-year (15 years forpre-1998 credits) carryforward period, youcan generally deduct the unused amount. Ifan individual dies or a corporation, trust, orestate ceases to exist, the deduction is gen-erally allowed for the tax year in which thedeath or cessation occurs. The deductionmay not be allowed to certain corporationswhose assets are acquired by another cor-poration.

Claiming carryforwards. Use Form 3800 toclaim a carryforward of an unused credit froma previous tax year. The carryforward be-comes part of your general business credit forthe tax year to which it is carried.

Claiming carrybacks. You can make aclaim for refund based on your general busi-ness credit carryback to a prior tax year byfiling an amended return for the tax year towhich you carry the unused credit. Use Form1040X if your original return was a Form1040. Use Form 1120X if your original returnwas a Form 1120 or 1120–A. Attach Form3800 to your amended return.

Generally, you must file the amended re-turn for the carryback year within 3 years afterthe due date, including extensions, for filingthe return for the year that resulted in thecredit carryback.

Quick refunds. You can apply for a quickrefund of taxes for a prior year by filing Form1045 (Form 1139 for a corporation) to claima tentative adjustment of tax from a generalbusiness credit carryback. The applicationshould be filed on or after the date of filing thetax return for the carryback year, but must befiled within 12 months after the end of the taxyear in which you earn the credit.

Investment CreditThe investment credit is the total of the fol-lowing credits.

• Reforestation credit.

• Rehabilitation credit.

• Energy credit.

Reforestation credit. The 10% reforestationcredit applies to up to $10,000 ($5,000 if youare married filing a separate return) of thecosts you incur each year to forest or reforestproperty you hold for growing trees for saleor use in the commercial production of timberproducts. These costs must qualify foramortization. You can take the investmentcredit for reforestation costs whether you

Chapter 9 General Business Credit Page 53

choose to amortize them or add them to thebasis of your property. There is nocarryforward or carryback of costs exceedingthe dollar limit. For more information aboutthese costs, see Amortization in chapter 8.

Example. You incurred $9,000 of qual-ified reforestation costs during the year. Youmay take a reforestation credit of $900 (10%of $9,000) for the year.

Rehabilitation credit. The rehabilitationcredit applies to costs you incur for rehabili-tation and reconstruction of certain buildings.Rehabilitation includes renovation, restora-tion, or reconstruction. It does not includeenlargement or new construction. Generally,the percentage of costs you can take as acredit is 10% for buildings placed in servicebefore 1936 and 20% for certified historicstructures. See the instructions for Form 3468for more information.

Energy credit. The 10% energy credit ap-plies to certain costs for solar or geothermalenergy property you placed in service duringyour tax year. See the instructions for Form3468 for more information.

Basis adjustment. You generally must re-duce the basis of assets on which you takean investment credit. The reduction is 100%of the rehabilitation credit and 50% of the re-forestation and energy credits. See the in-structions for Form 3468.

Example. You amortized qualified refor-estation costs of $9,000 incurred during theyear. You are also taking a $900 reforestationcredit. You must reduce your amortizablebasis by $450 (50% of $900). As a result,your amortizable basis will be $8,550 ($9,000− $450).

How to take the investment credit. UseForm 3468 to figure your credit. You may alsoneed to file Form 3800. See How To Claimthe Credit, earlier.

Carrybacks and carryforwards. Even if youcannot take an investment credit for the year,you may have unused credits from earlieryears that may reduce your tax. These un-used credits are carried to your current taxyear as general business credit carryforwardsand the rules for the general business credit,discussed earlier, apply.

Recapture ofInvestment CreditAt the end of each tax year, you must deter-mine whether you disposed of or stoppedusing in your business (either partially or en-tirely) any property for which you claimed aninvestment credit in a prior year. If you dis-pose of property before the end of the re-capture period, you must recapture a per-centage of the credit by adding it to your tax.See Recapture Rule, later, for a discussionof recapture period.

Use Form 4255 to figure the recapture taxor attach a detailed statement to your returnfor the year you dispose of the asset showingthe computation of the recapture tax and thedecrease in any investment creditcarryforward.

DispositionsAn outright sale of property is the clearestexample of a disposition. Another type ofdisposition occurs when you exchange ortrade worn-out or obsolete business assetsfor new ones. If the property ceases to bequalifying property, it is considered to be dis-posed of for investment credit recapture pur-poses. For example, the conversion of busi-ness property to personal use is considereda disposal for investment credit recapturepurposes.

Certain transactions result in dispositionsfor investment credit recapture purposes. Thefollowing illustrate those that are and thosethat are not dispositions.

Mortgaging and foreclosure. There is nodisposition if title to property is transferred assecurity for a loan. However, a dispositiondoes occur if there is a transfer of propertyby foreclosure.

Leased property. The leasing of investmentcredit property by the lessor who took thecredit is generally not a disposition. However,if the lease is treated as a sale for income taxpurposes, it is a disposition. A disposition alsooccurs if property ceases to be investmentcredit property in the hands of the lessor, thelessee, or any sublessee.

Decrease in basis. If the basis of investmentcredit property decreases, the decrease isconsidered to be a disposition of part of theproperty. This occurs, for example, if you buyproperty and later receive a refund of part ofthe original purchase price. You must thenrefigure the credit as if the decrease in basiswas never part of the original basis. If yourrefigured credit is less than the credit you or-iginally took, you must add the difference toyour tax.

Retirement or abandonment. You disposeof property if you abandon it or otherwise re-tire it from use. Normal retirements are alsodispositions.

Transfer by reason of death. There is nodisposition of investment credit property if theproperty is transferred because the owner-taxpayer died.

Gifts. You are considered to have disposedof property that you transferred by gift.

Transfers between spouses. If you transferinvestment credit property to your spouse, oryou transfer the property to your formerspouse incident to a divorce, you generallyare not considered to have disposed of theproperty. This also applies if the transfer ismade in trust for the benefit of your spouseor former spouse. However, if your spouseor former spouse later transfers the property,your spouse or former spouse will receive thesame tax treatment that would have appliedto you if you had made the transfer.

Casualty, theft, or involuntary conversion.You are considered to have disposed ofproperty that was destroyed by casualty orlost by theft or other involuntary conversion.

Disposition of assets by S corporation,partnership, estate, or trust. If you are ashareholder of an S corporation that disposes

of assets on which you figured the investmentcredit, you are treated as having disposed ofthe share of the investment on which youfigured your credit. This same rule applies ifyou are a member of a partnership or a ben-eficiary of an estate or trust.

Change in form of doing business. A dis-position does not occur because of a changein the form of doing business if certain con-ditions are met. For more information, seesection 1.47–3(f) of the regulations.

Choosing S corporation status. Thechoice by a corporation to become an S cor-poration generally will not cause the recaptureof investment credit previously claimed by thecorporation. The choice is treated as achange in the form of doing business and notas a disposition of property. No dispositionoccurs when an S corporation terminates orrevokes its choice not to be taxed as a cor-poration.

Sale and leaseback. There is no dispositionwhen investment credit property is sold by thetaxpayer who claimed the credit and it is thenleased back to that taxpayer as part of thesame transaction.

Recapture RuleIf you dispose of investment credit propertybefore the end of the recapture period, youmust recapture, as an additional tax, part ofthe original credit you claimed. You may alsohave to recapture part or all of the credit if youchange the use of investment credit propertyto one that would not have originally qualifiedfor the credit.

Recapture period. The credit you must re-capture depends on when during the recap-ture period you dispose of, or change the useof, the property. The recapture period is thelength of time the property must be used toget the full investment credit. The recaptureperiod for investment credit property is 5 fullyears from the date it was placed in service.If you dispose of the property during the firstfull year of service, you must recapture the fullamount of the credit that was used to reduceyour tax. The recapture amount decreases foreach year the property remains in qualifiedservice.

Form 4255. Use Form 4255 to figure the re-capture amount. The credit recapture is fig-ured by multiplying the original investmentcredit taken by the recapture percentage fromthe tables shown on Form 4255. The resultof this computation is the recapture amount.See Form 4255 for more information.

If the refigured credit is less than the credityou originally took, you must add the differ-ence to your tax.

Net operating loss carrybacks. If you havea net operating loss carryback from the re-capture year or a later year that reduces yourtax for the recapture year or an earlier year,you may have to refigure your recapture. Seesection 1.47–1(b)(3) of the regulations.

At-risk reduction. If your investment creditproperty is subject to the at-risk limits, youmay have to recapture part of the credit if theamount at risk is decreased. See the in-structions for Form 3468 for more information.

Page 54 Chapter 9 General Business Credit

10.Gains andLosses

IntroductionDuring the year, you may have sold or ex-changed property. This chapter explains howto figure your gain or loss on the sale or ex-change and determine the effect it has onyour taxes.


• Sales and exchanges

• Ordinary or capital gain or loss


Publication

� 504 Divorced or Separated Individuals

� 523 Selling Your Home


� 547 Casualties, Disasters, and Thefts(Business and Nonbusiness)

� 550 Investment Income and Expenses



� Sch D (Form 1040) Capital Gains andLosses


� 4684 Casualties and Thefts


� 8824 Like-Kind Exchanges


Sales and ExchangesIf you sell, exchange, or otherwise disposeof your property, you usually have a gain ora loss. This section explains some of the rulesfor determining whether any gain you have istaxable, and whether any loss you have isdeductible.

A sale is a transfer of property for moneyor a mortgage, note, or other promise to paymoney. An exchange is a transfer of propertyfor other property or services.

Determining Gain or LossYou usually realize a gain or loss when yousell or exchange property. A gain is theamount you realize from a sale or exchangeof property that is more than its adjusted ba-sis. A loss is the adjusted basis of the prop-erty that is more than the amount you realize.

See chapter 7 for the definition of basis,adjusted basis, and fair market value.

Amount realized. The amount you realizefrom a sale or exchange is the total of allmoney you receive plus the fair market valueof all property or services you receive. Theamount you realize also includes any of yourliabilities that were assumed by the buyer andany liabilities to which the property youtransferred is subject, such as real estatetaxes or a mortgage.

If the liabilities relate to an exchange ofmultiple properties, see Treatment of Liabil-ities under Multiple Property Exchanges inchapter 1 of Publication 544.

Amount recognized. Your gain or loss re-alized from a sale or exchange of property isusually a recognized gain or loss for tax pur-poses. A recognized gain is a gain that youmust include in gross income and report onyour income tax return. However, dependingon your other income and losses for the year,this amount may or may not be taxed. A rec-ognized loss is a loss that you deduct fromgross income. For example, if your recog-nized gain from the sale of your tractor is$5,300, you include that amount in gross in-come on Form 1040. However, your gain orloss realized from certain exchanges ofproperty is not recognized for tax purposes.See Like-Kind Exchanges, next. Also, a lossfrom the disposition of property held for per-sonal use is not deductible.

Like-Kind ExchangesCertain exchanges of property are not taxa-ble. This means that any gain from the ex-change is not taxed, and any loss cannot bededucted. Your gain or loss will not be rec-ognized until you sell or otherwise dispose ofthe property you receive.

The exchange of property for the samekind of property is the most common type ofnontaxable exchange. To be a like-kind ex-change, the property traded and the propertyreceived must be both of the following.

• Qualifying property.

• Like property.

These two requirements are discussed later.Additional requirements apply to ex-

changes in which the property received is notreceived immediately upon the transfer of theproperty given up. See Deferred exchanges,later.

If the like-kind exchange involves the re-ceipt of money or unlike property or the as-sumption of your liabilities, you may have arecognized gain. See Partially nontaxableexchange, later.

Multiple-party transactions. The like-kindexchange rules also apply to property ex-changes that involve three- and four-partytransactions. Any part of these multiple-partytransactions can qualify as a like-kind ex-change if it meets all of the requirements de-scribed in this section.

Receipt of title from third party. If youreceive property in a like-kind exchange andthe other party who transfers the property toyou does not give you the title but a third partydoes, you may still treat this transaction as alike-kind exchange if it meets all the require-ments.

Basis of property received. If you acquireproperty in a like-kind exchange, the basis ofthat property is the same as the basis of theproperty you transferred. See chapter 7 formore information about basis.

Money paid. If, in addition to giving up likeproperty, you pay money in a like-kind ex-change, you still have no recognized gain orloss. The basis of the property received is thebasis of the property given up, increased bythe money paid.

Example. Bill Smith trades an old tractorfor a new one. The new tractor costs $10,800.He is allowed $2,000 for the old tractor andpays $8,800 cash. He has no recognized gainor loss on the transaction regardless of theadjusted basis of his old tractor. If Bill sold theold tractor to a third party for $2,000 andbought a new one, he would have a recog-nized gain or loss on the sale of his old tractorequal to the difference between the amountrealized and the adjusted basis of the oldtractor.

Reporting the exchange. Report the ex-change of like-kind property on Form 8824.The instructions for the form explain how toreport the details of the exchange. Report theexchange even though no gain or loss isrecognized.

If you have any taxable gain because youreceived money or unlike property, report iton Schedule D (Form 1040) or Form 4797,whichever applies. You may also have to re-port the taxable gain as ordinary income be-cause of depreciation recapture on Form4797. See chapter 11 for more information.

Qualifying property. In a like-kind ex-change, both the property you give up and theproperty you receive must be held by you forinvestment or for productive use in your tradeor business. Machinery, buildings, land,trucks, and rental houses are examples ofproperty that may qualify.

The rules for like-kind exchanges do notapply to exchanges of the following property.

• Property you use for personal purposes,such as your home and your family car.

• Stock in trade or other property held pri-marily for sale, such as crops andproduce.

• Stocks, bonds, notes, or other securitiesor evidences of indebtedness, such asaccounts receivable.

• Partnership interests.

However, you might have a nontaxable ex-change under other rules. See Other Non-taxable Exchanges in chapter 1 of Publication544.

Like property. To qualify as a nontaxableexchange, the properties exchanged must beof “like kind” as defined in the income taxregulations. Generally, real property ex-changed for real property qualifies as an ex-change of like-kind property. Depreciabletangible personal property can be either “like

Chapter 10 Gains and Losses Page 55

kind” or “like class” to qualify for nontaxableexchange treatment. See Personal property,next.

Personal property. Like-class propertiesare depreciable tangible personal propertieswithin the same General Asset Class orProduct Class.

General Asset Classes. General AssetClasses describe the types of property fre-quently used in many businesses. They in-clude the following property.

1) Office furniture, fixtures, and equipment(asset class 00.11).

2) Information systems, such as computersand peripheral equipment (asset class00.12).

3) Data handling equipment except com-puters (asset class 00.13).

4) Airplanes (airframes and engines), ex-cept planes used in commercial or con-tract carrying of passengers or freight,and all helicopters (airframes and en-gines) (asset class 00.21).

5) Automobiles and taxis (asset class00.22).

6) Buses (asset class 00.23).

7) Light general purpose trucks (asset class00.241).

8) Heavy general purpose trucks (assetclass 00.242).

9) Railroad cars and locomotives exceptthose owned by railroad transportationcompanies (asset class 00.25).

10) Tractor units for use over the road (assetclass 00.26).

11) Trailers and trailer-mounted containers(asset class 00.27).

12) Vessels, barges, tugs, and similarwater-transportation equipment, exceptthose used in marine construction (assetclass 00.28).

13) Industrial steam and electric generationor distribution systems (asset class00.4).

Product Classes. Product Classes in-clude property listed in a 4-digit product class(except any ending in “9,” a miscellaneouscategory) in Division D of the Standard In-dustrial Classification codes of the ExecutiveOffice of the President, Office of Managementand Budget, Industrial Classification Manual.Copies of the manual may be obtained fromthe National Technical Information Service,an agency of the U.S. Department of Com-merce. To order the manual, call 1–800–553–NTIS (1–800–553–6847). Or visit theirweb site at www.ntis.gov . The cost of themanual is $30 and the order number isPB87–100012INQ.

Examples. An exchange of a truck for atractor is an exchange of like-kind property,and so is an exchange of timber land for cropacreage. An exchange of a tractor for acre-age, however, is not an exchange of like-kindproperty. Neither is the exchange of livestockof one sex for livestock of the other sex. Anexchange of the assets of a business for theassets of a similar business cannot be treatedas an exchange of one property for anotherproperty. Whether you engaged in a like-kindexchange depends on an analysis of eachasset involved in the exchange.

Partially nontaxable exchange. If you ex-change your property for like-kind propertyand also receive money or unlike property,or both, in an exchange in which you realizegain, you have a partially nontaxable ex-change. You are taxed on the gain realizedto the extent of the money and the fair marketvalue of the unlike property you receive. Aloss is not deductible.

Example 1. You trade farm land that costyou $30,000 for $10,000 cash and other landto be used in farming with a fair market valueof $50,000. You have a gain of $30,000, butonly $10,000, the cash received, is recog-nized.

Example 2. Assume the same facts asin Example 1, except that, instead of money,you received a tractor with a fair market valueof $10,000. Your recognized gain is still lim-ited to $10,000, the value of the tractor (theunlike property).

Example 3. Assume in Example 1 thatthe fair market value of the land you receivedwas only $15,000. Your $5,000 loss is notdeductible.

Unlike property given up. If you tradeproperty for like-kind property and also giveup unlike property in the exchange, you havea recognized gain or loss on the unlike prop-erty you give up. This gain or loss is the dif-ference between the fair market value of theunlike property and its adjusted basis.

Like-kind exchanges between related per-sons. Special rules apply to like-kind ex-changes made between related persons.These rules affect both direct and indirectexchanges. Under these rules, if either per-son disposes of the property within 2 yearsafter the exchange, the exchange is disqual-ified from nonrecognition treatment. The gainor loss on the original exchange must berecognized as of the date of that later dispo-sition. The 2-year holding period begins onthe date of the last transfer of property thatwas part of the like-kind exchange.

Related persons. Under these rules, arelated person generally includes: a memberof your family (spouse, brother, sister, parent,child, etc.), a corporation in which you havemore than 50% ownership, a partnership inwhich you directly or indirectly own more thana 50% interest of the capital or profits, andtwo partnerships in which you directly or in-directly own more than 50% of the capital in-terests or profits.

For the list of related persons, see Non-deductible Loss under Sales and ExchangesBetween Related Persons in chapter 2 ofPublication 544.

Example. You used a truck in yourfarming business. Your sister used a stationwagon in her landscaping business. In De-cember 1997, you exchanged your truck, plus$200, for your sister's station wagon. At thattime, the fair market value (FMV) of your truckwas $7,000 and its adjusted basis was$6,000. The FMV of your sister's stationwagon was $7,200 and its adjusted basis was$1,000. You realized a gain of $1,000 (the$7,200 FMV of the station wagon minus the$200 you paid, minus the $6,000 adjustedbasis of the truck). Your sister realized a gainof $6,200 (the $7,000 FMV of your truck plusthe $200 you paid, minus the $1,000 adjustedbasis of the station wagon).

However, because this was a like-kindexchange, you recognized no gain. Your ba-sis in the station wagon was $6,200 (the$6,000 adjusted basis of the truck plus the$200 you paid). Your sister recognized gainonly to the extent of the money she received,$200. Her basis in the truck was $1,000 (the$1,000 adjusted basis of the station wagonminus the $200 received, plus the $200 gainrecognized).

In 1999, you sold the station wagon to athird party for $7,000. Because you sold itwithin 2 years after the exchange, the ex-change is disqualified from nonrecognitiontreatment. On your tax return for 1999, youmust report your $1,000 gain on the ex-change in 1998. You also report a loss on thesale of $200 (the adjusted basis of the stationwagon, $7,200 (its $6,200 basis plus the$1,000 gain recognized), minus the $7,000amount realized from the sale).

In addition, your sister must report on hertax return for 1999 the $6,000 balance of hergain on the 1998 exchange. Her adjustedbasis in the truck is increased to $7,000 (its$1,000 basis plus the $6,000 gain recog-nized).

Exceptions to the rules for related per-sons. The following kinds of property dispo-sitions are excluded from these rules.

• Dispositions due to the death of eitherrelated person.

• Involuntary conversions.

• Dispositions if it is established to thesatisfaction of the IRS that neither theexchange nor the disposition has as amain purpose the avoidance of federalincome tax.

Exchanges of multiple properties. Underthe like-kind exchange rules, you must gen-erally make a property-by-property compar-ison to figure your recognized gain and thebasis of the property you receive in the ex-change. However, for exchanges of multipleproperties, you do not make a property-by-property comparison if you do either of thefollowing.

• Transfer and receive properties in two ormore exchange groups.

• Transfer or receive more than one prop-erty within a single exchange group.

For more information, see Multiple Prop-erty Exchanges in chapter 1 of Publication544.

Deferred exchanges. A deferred exchangeis one in which you transfer property you usein business or hold for investment and, at alater time, you receive like-kind property youwill use in business or hold for investment.The property you receive is replacementproperty. The transaction must be an ex-change (that is, property for property) ratherthan a transfer of property for money that isused to buy replacement property.

A deferred exchange for like-kind propertymay qualify for nonrecognition of gain or lossif the like-kind property is identified andtransferred within the following time limits.

1) You must identify the property to be re-ceived within 45 days after the date youtransfer the property given up in the ex-change.

Page 56 Chapter 10 Gains and Losses

Table 10–1. Worksheet for Foreclosures and Repossessions

Enter amount of debt canceled by the transfer of property

Enter the adjusted basis of the transferred propertyGain or loss from foreclosure or repossession. Subtractline 5 from line 4

1.2.3.

4.

5.6.

Enter the fair market value of the transferred propertyIncome from cancellation of debt.* Subtract line 2 fromline 1. If less than zero, enter zero

Enter the smaller of line 1 or line 2. Also include any proceedsyou received from the foreclosure sale. (If you are notpersonally liable for the debt, enter the amount of debtcanceled by the transfer of property.)

Part 1. Figure your income from cancellation of debt. (Note: If you are not personallyliable for the debt, you do not have income from cancellation of debt. SkipPart 1 and go to Part 2.)

Part 2. Figure your gain or loss from foreclosure or repossession.

(Keep for your records)

*The income may not be taxable. See Cancellation of debt.

foreclosure is $180,000, the debt canceledby the foreclosure. Because her adjusted ba-sis is $200,000, she has a deductible loss of$20,000.

Amount realized on a recourse debt.If you are personally liable for repaying thedebt (recourse debt), the amount realized onthe foreclosure or repossession does not in-clude the amount of the canceled debt that isincome from cancellation of debt. However,if the fair market value of the transferredproperty is less than the canceled debt, theamount realized includes the canceled debtup to the fair market value of the property.You are treated as receiving ordinary incomefrom the canceled debt for the part of the debtthat is more than the fair market value. SeeCancellation of debt, later.

Example 3. Assume the same facts asin Example 1 earlier except that Ann is per-sonally liable for the loan (recourse debt). Inthis case, the amount she realizes is$170,000. This is the amount of the canceleddebt ($180,000) up to the farm land's fairmarket value ($170,000). Ann figures her gainor loss on the foreclosure by comparing theamount realized ($170,000) with her adjustedbasis ($200,000). She has a $30,000deductible loss. She is also treated as re-ceiving ordinary income from cancellation ofdebt. That income is $10,000 ($180,000 −$170,000). This is the part of the canceleddebt not included in the amount realized.

Example 4. Assume the same facts asin Example 2 earlier except that Ann is per-sonally liable for the loan (recourse debt). Sherealizes $180,000, the amount of the can-celed debt ($180,000) up to the fair marketvalue of the land ($210,000). She comparesthe amount realized ($180,000) with her ad-justed basis ($200,000) and figures a $20,000deductible loss. She has no ordinary incomefrom cancellation of debt because all thecanceled debt was included in the amountrealized.

Seller's (lender's) gain or loss on repos-session. If you finance a buyer's purchaseof property and later acquire an interest in itthrough foreclosure or repossession, you mayhave a gain or loss on the acquisition. Formore information, see Repossession in Pub-lication 537.

Cancellation of debt. If property that is re-possessed or foreclosed upon secures a debtfor which you are personally liable (recoursedebt), you generally must report, as ordinaryincome, the amount by which the canceleddebt is more than the fair market value of theproperty. This income is separate from anygain or loss realized from the foreclosure orrepossession. Report the income from can-cellation of a business debt on Schedule F,line 10. Report the income from cancellationof a nonbusiness debt as miscellaneous in-come on line 21, Form 1040.

TIPYou can use Table 10–1 to figure yourincome from cancellation of debt.

However, income from cancellation ofdebt is not taxed if any of the following apply.

• The cancellation is intended as a gift.

• The debt is qualified farm debt (seechapter 4).

2) The property must be received by theearlier of the following dates.

a) The 180th day after the date onwhich you transfer the propertygiven up in the exchange.

b) The due date, including extensions,for your tax return for the tax yearin which the transfer of the propertygiven up occurs.

For more information, see Deferred Ex-changes in chapter 1 of Publication 544.

Transfers Between SpousesNo gain or loss is recognized (included ingross income) on a transfer of property froman individual to (or in trust for the benefit of)a spouse, or a former spouse if incident todivorce. This rule does not apply if the recip-ient is a nonresident alien. Nor does this ruleapply to a transfer in trust to the extent theliabilities assumed and the liabilities on theproperty are more than the property's ad-justed basis.

Any transfer of property to a spouse orformer spouse on which gain or loss is notrecognized is not considered a sale or ex-change. The recipient's basis in the propertywill be the same as the adjusted basis of thegiver immediately before the transfer. Thiscarryover basis rule applies whether the ad-justed basis of the transferred property is lessthan, equal to, or greater than either its fairmarket value at the time of transfer or anyconsideration paid by the recipient. This ruleapplies for determining loss as well as gain.Any gain recognized on a transfer in trust in-creases the basis.

For more information on transfers ofproperty incident to divorce, see PropertySettlements in Publication 504.

Foreclosuresand RepossessionsIf you do not make payments you owe on aloan secured by property, the lender mayforeclose on the loan or repossess the prop-erty. The foreclosure or repossession is

treated as a sale or exchange from which youmay realize gain or loss. This is true even ifyou voluntarily return the property to thelender. You may also realize ordinary incomefrom cancellation of debt if the loan balanceis more than the property's fair market value.

Buyer's (borrower's) gain or loss. Youfigure and report gain or loss from a foreclo-sure or repossession in the same way as gainor loss from a sale or exchange. The gain orloss is the difference between your adjustedbasis in the transferred property and theamount realized. See Determining Gain orLoss, earlier.

TIPYou can use Table 10–1 to figure yourgain or loss from a foreclosure or re-possession.

Amount realized on a nonrecoursedebt. If you are not personally liable for re-paying the debt (nonrecourse debt) securedby the transferred property, the amount yourealize includes the full amount of the debtcanceled by the transfer. The full amount ofthe canceled debt is included even if theproperty's fair market value is less than thecanceled debt.

Example 1. Ann paid $200,000 for farmland. She paid $15,000 down and borrowedthe remaining $185,000 from a bank. Ann isnot personally liable for the loan (nonrecoursedebt), but pledges the land as security. Thebank foreclosed on the loan when Annstopped making payments. At the time of theforeclosure, the balance due on the loan was$180,000 and the fair market value of the landwas $170,000. The amount Ann realized onthe foreclosure was $180,000, the debt can-celed by the foreclosure. She figures her gainor loss by comparing the amount realized($180,000) with her adjusted basis($200,000). She has a $20,000 deductibleloss.

Example 2. Assume the same facts asin Example 1 except the fair market value ofthe land was $210,000. The result is thesame. The amount Ann realized on the


• The debt is qualified real property busi-ness debt (see chapter 5 of Publication334, Tax Guide for Small Business).

• You are insolvent or bankrupt (see Pub-lication 908, Bankruptcy Tax Guide).

Forms 1099–A and 1099–C. A lender whoacquires an interest in your property in aforeclosure or repossession should send youForm 1099–A showing information you needto figure your gain or loss. However, if thelender also cancels part of your debt andmust file Form 1099–C, the lender may in-clude the information about the foreclosureor repossession on that form instead of onForm 1099–A. The lender must file Form1099–C and send you a copy if the amountof debt canceled is $600 or more and thelender is a financial institution, credit union,or federal government agency. For foreclo-sures or repossessions occurring in 1999,these forms should be sent to you by January31, 2000.

Ordinary or CapitalGain or LossYou must classify your gains and losses aseither ordinary or capital gains or losses (andyour capital gains or losses as either short-term or long-term gains or losses). You mustdo this to figure your net capital gain or loss.

Your net capital gains may be taxed at alower tax rate than ordinary income. SeeCapital Gain Tax Rates, later. Your deductionfor a net capital loss may be limited. SeeTreatment of Capital Losses, later.

Capital gain or loss. Generally, you willhave a capital gain or loss if you sell or ex-change a capital asset. You may also havea capital gain if your section 1231 trans-actions result in a net gain.

Section 1231 transactions. Section1231 transactions are sales and exchangesof property held longer than 1 year and eitherused in a trade or business or held for theproduction of rents or royalties. They also in-clude certain involuntary conversions of busi-ness or investment property, including capitalassets. See Section 1231 Gains and Lossesin chapter 11 for more information.

Capital AssetsFor the most part, all property you own anduse for personal purposes or investment is acapital asset.

The following items are some examplesof capital assets:

1) A home owned and occupied by you andyour family.

2) Household furnishings.

3) A car used for pleasure. If your car isused both for pleasure and for farmbusiness, it is partly a capital asset andpartly a noncapital asset, defined later.

4) Stocks and bonds. However, there arespecial rules for gains and losses onqualified small business stock. For moreinformation on this subject, see Losseson Small Business Investment CompanyStock in chapter 4 of Publication 550.

Personal-use property. Property held forpersonal use is a capital asset. Gain from asale or exchange of that property is a capitalgain and is taxable. Loss from the sale orexchange of that property is not deductible.You can deduct a loss relating to personal-use property only if it results from a casualtyor theft. For information about casualties andthefts, see chapter 13.

Long and Short TermWhere you report a capital gain or loss de-pends on how long you own the asset beforeyou sell or exchange it. The time you own anasset before disposing of it is the holding pe-riod.

If you hold a capital asset 1 year or less,the gain or loss resulting from its dispositionis short term. Report it in Part I of ScheduleD. If you hold a capital asset longer than 1year, the gain or loss resulting from its dis-position is long term. Report it in Part II ofSchedule D.

Holding period. To figure if you held prop-erty longer than 1 year, start counting on theday after the day you acquired the property.This same date of each following month is thebeginning of a new month regardless of thenumber of days in the preceding month. Theday you disposed of the property is part ofyour holding period.

Example. If you bought an asset on June18, 1998, you should start counting on June19, 1998. If you sold the asset on June 18,1999, your holding period is not longer than1 year, but if you sold it on June 19, 1999,your holding period is longer than 1 year.

Inherited property. If you inherit prop-erty, you are considered to have held theproperty longer than 1 year even if you dis-pose of it within 1 year after the decedent'sdeath. This rule does not apply to livestockused in a farm business. See Holding periodunder Livestock, later.

Bad debt. A nonbusiness bad debt is al-ways treated as a short-term capital loss. Seechapter 4 of Publication 550.

Nontaxable exchange. If you acquire anasset in exchange for another asset and yourbasis for the new asset is determined, inwhole or in part, by your basis in the oldproperty, the holding period of the new prop-erty includes the holding period of the oldproperty. That is, it begins on the same dayas your holding period for the old property.

Gift. If you receive a gift of property andyour basis in it is figured using the donor'sbasis, your holding period includes the do-nor's holding period.

Real property. To figure how long youheld real property, start counting on the dayafter you received title to it, or, if earlier, onthe day after you took possession of it andassumed the burdens and privileges of own-ership.

However, taking possession of real prop-erty under an option agreement is not enoughto start the holding period. The holding periodcannot start until there is an actual contractof sale. The holding period of the seller can-not end before that time.

Figuring Net Gain or LossThe totals for short-term capital gains andlosses and the totals for long-term capitalgains 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 your short-term capitalgains. Then add together all your short-termcapital losses. Subtract the lesser total fromthe other. The result is your net short-termcapital gain or loss.

Net long-term capital gain or loss. Followthe same steps to combine your long-termcapital gains and losses. The result is yournet long-term capital gain or loss.

Net gain. If the total of your capital gains ismore than the total of your capital losses, thedifference is taxable. However, the part thatis not more than your net capital gain may betaxed at a rate that is lower than the rate oftax on your ordinary income. See CapitalGain Tax Rates, later.

Net loss. If the total of your capital losses ismore than the total of your capital gains, thedifference is deductible. But there are limitson how much loss you can deduct, and whenyou can deduct it. See Treatment of CapitalLosses, next.

Treatment of Capital LossesIf your capital losses are more than yourcapital gains, you must claim the differenceeven if you do not have ordinary income tooffset it. The yearly limit on the amount of thecapital loss you can deduct is $3,000 ($1,500if you are married and file a separate return).If your other income is low, you may not beable to use the full $3,000. The part of the$3,000 you cannot use becomes part of yourcapital loss carryover.

Capital loss carryover. Generally, you havea capital loss carryover if either of the follow-ing situations applies to you.

• Your net capital loss on line 17 ofSchedule D is more than the yearly limit.

• The amount shown on line 37, Form 1040(your taxable income without your de-duction for exemptions), is less than zero.

If either of these situations applies to you for1999, complete the Capital Loss CarryoverWorksheet provided in the instructions toSchedule D (Form 1040) to figure the amountyou can carry over to 2000.

Capital Gain Tax RatesThe 31%, 36%, and 39.6% income tax ratesfor individuals do not apply to a net capitalgain. In most cases, the 15% and 28% ratesdo not apply either. Instead, your net capitalgain is taxed at lower capital gain rates.

Net capital gain is the net long-term capitalgain for the year that is more than the netshort-term capital loss for the year.

You will need to use Part IV of ScheduleD (Form 1040) to figure your tax using thecapital gain rates if both of the following aretrue.

• Both lines 16 and 17 of Schedule D aregains.

• Your taxable income on Form 1040, line39, is more than zero.

The rate may be 10%, 20%, 25%, or 28%,or a combination of two or more of those ratesas shown in Table 10–2.


Table 10–2. What Is Your Capital Gain Tax Rate?

IF your net capital gain is from . . .

Collectibles gain

1 The rate is 15% if your regular tax rate would be 15%.

THEN your capital gainrate is . . .

28%1

Gain on qualified small business stock equal to the section1202 exclusion

28%1

Unrecaptured section 1250 gain

Other gain, and your regular tax rate would be 28% or higher

25%1

20%

10%2Other gain, and your regular tax rate would be 15%

2 The 10% rate applies only to the part of your net capital gain that would be taxed at 15% if there wereno capital gain rates.

Land and depreciable properties. Non-capital assets include land and depreciableproperty you use in farming. They also in-clude livestock held for draft, breeding, dairy,or sporting purposes. However, your gainsand losses from sales and exchanges of yourfarm land and depreciable properties must beconsidered together with certain other trans-actions to determine whether the gains andlosses are treated as capital or ordinary gainsand losses. The sales of these business as-sets are reported on Form 4797. See chapter11 for more information.

Hedging(Commodity Futures)Hedging transactions are transactions thatyou enter into in the normal course of busi-ness primarily to reduce the risk of interestrate or price changes or currency fluctuationswith respect to borrowings, ordinary property,or ordinary obligations. (Ordinary property orobligations are those that cannot producecapital gain or loss if sold or exchanged.)

A commodity futures contract is a stand-ardized, exchange-traded contract for thesale or purchase of a fixed amount of acommodity at a future date for a fixed price.The holder of an option on a futures contracthas the right (but not the obligation) for aspecified period of time to enter into a futurescontract to buy or sell at a particular price.A forward contract is generally similar to afutures contract except that the terms are notstandardized and the contract is not ex-change traded.

Businesses may enter into commodity fu-tures contracts or forward contracts and mayacquire options on commodity futures con-tracts as either of the following.

• Hedging transactions.

• Transactions that are not hedging trans-actions.

Futures transactions that are not hedgingtransactions generally result in capital gainor loss. There is a limit on the amount ofcapital losses you can deduct each year.

If, as a farmer-producer, to protect your-self from the risk of unfavorable price fluctu-ations, you enter into commodity forwardcontracts, futures contracts, or options on fu-tures contracts and the contracts cover anamount of the commodity within your rangeof production, the transactions are generallyconsidered hedging transactions. They cantake place at any time you have the com-modity under production, have it on hand forsale, or reasonably expect to have it on hand.

The gain or loss on the termination ofthese hedges is generally ordinary gain orloss. Farmers who file their income tax re-turns on the cash method report any profit orloss on the hedging transaction on line 10 ofSchedule F.

The gain or loss on transactions thathedge the purchase of a noninventory supply(for example, animal feed) may be ordinary.If a business sells only a negligible amountof a noninventory supply, a transaction tohedge the purchase of that supply is treatedas a hedging transaction.

RECORDS

If you have numerous transactions inthe commodity futures market duringthe year, you must be able to show

which transactions are hedging transactions.Clearly identify a hedging transaction on yourbooks and records before the end of the day

Using the capital gain rates. The part of anet capital gain that is subject to each rate isdetermined by first netting long-term capitalgains with long-term capital losses in the fol-lowing tax rate groups.

1) A 28% group, consisting of all the fol-lowing gains and losses.

a) Collectibles gains and losses.

b) The part of your gain on qualifiedsmall business stock that is equalto the section 1202 exclusion.

c) Any long-term capital loss carry-over.

2) A 25% group, consisting of unrecapturedsection 1250 gain.

3) A 20% group, consisting of gains andlosses not in the 28% or 25% group.

If any group has a net loss, the followingrules apply.

• A net loss from the 28% group reducesany gain from the 25% group, and thenany net gain from the 20% group.

• A net loss from the 20% group reducesany net gain from the 28% group, andthen any gain from the 25% group.

If you have a net short-term capital loss,it reduces any net gain from the 28% group,then any gain from the 25% group, and finallyany net gain from the 20% group.

The resulting net gain (if any) from eachgroup is subject to the tax rate for that group.(The 10% rate applies to a net gain from the20% group to the extent that, if there wereno capital gain rates, the net capital gainwould be taxed at the 15% regular tax rate.)

Collectibles gain or loss. This is gainor loss from the sale or exchange of a workof art, rug, antique, metal, gem, stamp, coin,or alcoholic beverage held longer than 1 year.Collectibles gain includes gain from the saleof an interest in a partnership, S corporation,or trust attributable to unrealized appreciationof collectibles.

Gain on qualified small business stock.If you realized a gain from qualified smallbusiness stock that you held longer than 5years, you exclude up to one-half of your gainfrom your income. The taxable part of yourgain equal to your section 1202 exclusion isa 28% rate gain. See Sales of Small BusinessStock in chapter 1 of Publication 544.

Unrecaptured section 1250 gain. Thisis the part of any long-term capital gain onsection 1250 property (real property) that is

due to straight-line depreciation minus anynet loss in the 28% group. Unrecapturedsection 1250 gain cannot be more than thenet section 1231 gain or include any gain thatis otherwise treated as ordinary income. Usethe worksheet in the Schedule D instructionsto figure your unrecaptured section 1250 gain.For more information about section 1250property and net section 1231 gain, seechapter 3 of Publication 544.

Changes after 2000. After 2000, there willbe changes to the capital gain rates.

2001. Beginning in 2001, the 10% capitalgain rate will be lowered to 8% for “qualified5-year gain.”

2006. Beginning in 2006, the 20% capitalgain rate will be lowered to 18% for qualified5-year gain from property with a holding pe-riod that begins after 2000.

Taxpayers who own certain stock on Jan-uary 1, 2001, can choose to treat the stockas sold and repurchased on January 2, 2001,if they pay tax for 2001 on any resulting gain.

Qualified 5-year gain. This is long-termcapital gain from the sale of property you heldfor longer than 5 years that would otherwisebe subject to the 10% or 20% capital gainrate.

Net capital gain from disposition of in-vestment property. If you choose to includeany part of a net capital gain from a disposi-tion of investment property in investment in-come for figuring your investment interestdeduction, you must reduce the net capitalgain eligible for the capital gain tax rates bythe same amount. You make this choice onForm 4952, Investment Interest ExpenseDeduction, line 4e. For information on makingthis choice, see the instructions to Form 4952.For information on the investment interestdeduction, see chapter 3 in Publication 550.

Noncapital AssetsNoncapital assets include property such asinventory and depreciable property used in atrade or business. A list of properties that arenot capital assets is provided in the ScheduleD Instructions.

Property held for sale in the ordinarycourse of your farm business. Property youhold mainly for sale to customers, such aslivestock, poultry, livestock products, andcrops, is a noncapital asset. Gain or loss fromsales or other dispositions of this property isreported on Schedule F (not on Schedule Dor Form 4797). The treatment of this propertyis discussed in chapter 4.


you entered into the transaction. It may behelpful to have separate brokerage accountsfor your hedging and speculation trans-actions.

The identification must not only be on, andretained as part of, your books and recordsbut must specify both the hedging transactionand the item, items, or aggregate risk that isbeing hedged. Although the identification ofthe hedging transaction must be made beforethe end of the day it was entered into, theidentification of the hedged item, items, or riskmust be made no more than 35 days afterentering into the hedging transaction.

For more information on the tax treatmentof futures and options contracts, see Com-modity Futures and Section 1256 ContractsMarked to Market in Publication 550.

Accounting methods for hedging trans-actions. Hedging transactions must be ac-counted for under special rules if you use anaccounting method other than the followingmethods.

1) Cash method.

2) Farm-price method.

3) Unit-livestock-price method.

Under these rules, the accounting methodyou use for a hedging transaction must clearlyreflect income. This means that your ac-counting method must reasonably match thetiming of income, deduction, gain, or loss froma hedging transaction with the timing of in-come, deduction, gain, or loss from the itemor items being hedged. There are require-ments and limitations on the method you canuse for certain hedging transactions. Seesection 1.446–4(e) of the regulations for thoserequirements and limitations.

Once you adopt a method, you must applyit consistently and must have IRS approvalbefore changing it.

Your books and records must describe theaccounting method used for each type ofhedging transaction. They must also containany additional identification necessary to ver-ify the application of the accounting methodyou used for the transaction. You must makethe additional identification no more than 35days after entering into the hedging trans-action.

Example of a hedging transaction. You fileyour income tax returns on the cash method.On July 2, 1999, you anticipate a yield of50,000 bushels of corn this crop year. Thepresent December futures price is $2.75 abushel, but there are indications that by har-vest time the price will drop. To protect your-self against a drop in the sales price of yourcorn inventory, you enter into the followinghedging transaction. You sell 10 Decemberfutures contracts of 5,000 bushels each for atotal of 50,000 bushels of corn at $2.75 abushel.

The price did not drop as anticipated butrose to $3 a bushel. In November, you sellyour crop at a local elevator for $3 a bushel.You also close out your futures position bybuying 10 December contracts for $3 abushel. You paid a broker's commission of$700 ($70 per contract) for the complete inand out position in the futures market.

The result is that the price of corn rose 25cents a bushel and the actual selling price is$3 a bushel. Your loss on the hedge is 25

cents a bushel. In effect, the net selling priceof your corn is $2.75 a bushel.

Report the results of your futures trans-actions and your sale of corn separately onSchedule F.

The loss on your futures transactions is$13,200, figured as follows.

This loss is reported as a negative figure online 10, Part I of Schedule F.

The proceeds from your corn sale at thelocal elevator are $150,000 (50,000 bu. × $3).Report it on line 4, Part I of Schedule F.

Assume you were right and the price wentdown 25 cents a bushel. In effect, you wouldstill net $2.75 a bushel, figured as follows.

The gain on your futures transactions wouldhave been $11,800, figured as follows.

The $11,800 is reported on line 10, Part I ofSchedule F.

The proceeds from the sale of your cornat the local elevator, $125,000, are reportedon line 4, Part I of Schedule F.

LivestockThis part discusses the sale or exchange oflivestock used in your farm business. Gainor loss from the sale or exchange of thislivestock may qualify as a section 1231transaction. However, any part of the gainthat is ordinary income from the recapture ofdepreciation is not included as section 1231gain. See chapter 11 for more information onsection 1231 gains and losses and the re-capture of depreciation under section 1245.

CAUTION!

The rules discussed here do not applyto the sale of livestock held primarilyfor sale to customers. The sale of

livestock is reported on Schedule F. Seechapter 4.

Holding period. The sale or exchange oflivestock used in your farm business qualifiesas a section 1231 transaction if you held thelivestock for 12 months or more (24 monthsor more for horses and cattle).

Livestock. For section 1231 transactions,livestock includes cattle, hogs, horses, mules,donkeys, sheep, goats, fur-bearing animals(such as mink), and other mammals. Live-stock does not include chickens, turkeys, pi-geons, geese, emus, ostriches, rheas, orother birds, fish, frogs, reptiles, etc.

Livestock used in farm business. Iflivestock is held primarily for draft, breeding,dairy, or sporting purposes, it is used in yourfarm business. The purpose for which ananimal is held ordinarily is determined by afarmer's actual use of the animal. An animalis not held for draft, breeding, dairy, or sport-ing purposes merely because it is suitable forthat purpose, or because it is held for sale to

other persons for use by them for that pur-pose.

Example 1. You discover an animal thatyou intend to use for breeding purposes issterile. You dispose of it within a reasonabletime. This animal was held for breeding pur-poses.

Example 2. You retire and sell your entireherd, including young animals that you wouldhave used for breeding or dairy purposes hadyou remained in business. These young ani-mals were held for breeding or dairy pur-poses. Also, if you sell young animals to re-duce your breeding or dairy herd because of,for example, drought, these animals aretreated as having been held for breeding ordairy purposes.

Example 3. You are in the business ofraising hogs for slaughter. Customarily, be-fore selling your sows, you obtain a singlelitter of pigs that you will raise for sale. Yousell the brood sows after obtaining the litter.Even though you hold these brood sows forultimate sale to customers in the ordinarycourse of your business, they are consideredto be held for breeding purposes.

Example 4. You are in the business ofraising registered cattle for sale to others foruse as breeding cattle. It is the businesspractice to breed the cattle before sale to es-tablish their fitness as registered breedingcattle. Your use of the young cattle forbreeding purposes is ordinary and necessaryfor selling them as registered breeding cattle.Such use does not demonstrate that you areholding the cattle for breeding purposes.However, those cattle you held as additionsor replacements to your own breeding herdto produce calves are considered to be heldfor breeding purposes, even though they maynot actually have produced calves. The sameapplies to hog and sheep breeders.

Example 5. You are in the business ofbreeding and raising mink that you pelt for thefur trade. You take breeders from the herdwhen they are no longer useful as breedersand pelt them. Although these breeders areprocessed and pelted, they are still consid-ered to be held for breeding purposes. Thesame applies to breeders of other fur-bearinganimals.

Example 6. You breed, raise, and trainhorses for racing purposes. Every year youcull some horses from your racing stable. In1999, you decided that to prevent your racingstable from getting too large to be effectivelyoperated, you must cull six horses from it. Allsix of these horses had been raced at publictracks in 1998. These horses are all consid-ered held for sporting purposes.

Figuring gain or loss on the cash method.Farmers or ranchers who use the cashmethod of accounting figure their gain or losson the sale of livestock used in their farmingbusiness as follows.

Raised livestock. Gain on the sale ofraised livestock is generally the gross salesprice reduced by any expenses of the sale isgain. Expenses of sale include sales com-missions, freight or hauling from farm tocommission company, and other similar ex-penses. The basis of the animal sold is zeroif the costs of raising it were deducted duringthe years the animal was being raised.However, see Uniform Capitalization Rules inchapter 7.

July 2, 1999—Sold Dec. corn futures50,000 bu. @$2.75 .................................. $137,500Nov. 6, 1999—Bought Dec. corn futures50,000 bu. @$3 (plus broker'scommission) ............................................. 150,700Futures loss ........................................... ($13,200)

Sold cash corn, per bushel ............................ $2.50Gain on hedge, per bushel ............................ .25

$2.75

July 2, 1999—Sold Dec. corn futures50,000 bu. @$2.75 .................................. $137,500Nov. 6, 1999—Bought Dec. corn futures50,000 bu. @$2.50 (plus broker'scommission) ............................................. 125,700Futures gain ........................................... $11,800


Purchased livestock. The gross salesprice minus your adjusted basis and any ex-penses of sale is the gain or loss.

Example. A farmer sold a breeding cowon January 6, 1999, for $1,250. Expensesof the sale were $125. The cow was boughtJuly 2, 1996, for $1,300. Depreciation (notless than the amount allowable) was $759.

Converted Wetland andHighly Erodible CroplandSpecial rules apply to dispositions of landconverted to farming use after March 1, 1986.Any gain realized on the disposition of con-verted wetland or highly erodible cropland istreated as ordinary income. Any loss on thedisposition of such property is treated as along-term capital loss.

Converted wetland. This is generally landthat must have been drained or filled to makethe production of agricultural commoditiespossible. It includes converted wetland heldby the person who originally converted it orheld by any other person who used the con-verted wetland at any time after conversionfor farming purposes.

A wetland (before conversion) is land thatmeets all of the following conditions.

1) It is mostly soil that, in its undrainedcondition, is saturated, flooded, orponded long enough during a growingseason to develop an oxygen-deficientstate that supports the growth and re-generation of plants growing in water.

2) It is saturated by surface or groundwaterat a frequency and duration sufficient tosupport mostly plants that are adaptedfor life in saturated soil.

3) It supports under normal circumstancesmostly plants that grow in saturated soil.

Highly erodible cropland. This is croplandsubject to erosion that you used at any timefor farming purposes other than the grazingof animals. Generally, highly erodiblecropland is land that is currently classified bythe Department of Agriculture as Class IV,VI, VII, or VIII under its classification system.Highly erodible cropland also includes landthat would have an excessive average annualerosion rate in relation to the soil loss toler-ance level, as determined by the Departmentof Agriculture.

Successors. Converted wetland or highlyerodible cropland is also land held by anyperson whose basis in the land is figured byreference to the adjusted basis of a person inwhose hands the property was convertedwetland or highly erodible cropland.

TimberStanding timber you held as investmentproperty is a capital asset. Gain or loss fromits sale is capital gain or loss reported onSchedule D (Form 1040). If you held the tim-ber primarily for sale to customers, it is not acapital asset. Gain or loss on its sale is or-

dinary business income or loss. It is reportedon the gross receipts or sales and cost ofgoods sold lines of Schedule F.

Farmers who cut timber on their land andsell it as logs, firewood, or pulpwood usuallyhave no cost or other basis for that timber.These sales constitute a very minor part oftheir farm businesses. Amounts realized fromthese sales, and the expenses incurred incutting, hauling, etc., are ordinary farm in-come and expenses reported on Schedule F(Form 1040).

Different rules apply if you owned thetimber longer than 1 year and choose to treattimber cutting as a sale or exchange or youenter into a cutting contract, discussed later.Depletion on timber is discussed in chapter8.

Timber considered cut. Timber is consid-ered cut on the date when, in the ordinarycourse of business, the quantity of felled tim-ber is first definitely determined. This is truewhether the timber is cut under contract orwhether you cut it yourself.

Christmas trees. Evergreen trees, such asChristmas trees, that are more than 6 yearsold when severed from their roots and sold forornamental purposes are included in the term“timber.” They qualify for both rules, dis-cussed below.

Choice to treat cutting as a sale or ex-change. Under the general rule, the cuttingof timber results in no gain or loss. It is notuntil a sale or exchange occurs that gain orloss is realized. But if you owned or had acontractual right to cut timber, you maychoose to treat the cutting of timber as asection 1231 transaction in the year it is cut.Even though the cut timber is not actually soldor exchanged, you report your gain or losson the cutting for the year the timber is cut.Any later sale results in ordinary business in-come or loss.

To choose this treatment, you must:

1) Own or hold a contractual right to cut thetimber for a period of more than 1 yearbefore it is cut, and

2) Cut the timber for sale or use it in yourtrade or business.

Making the choice. You make the choiceon your return for the year the cutting takesplace by including in income the gain or losson the cutting and including a computation ofyour gain or loss. You do not have to makethe choice in the first year you cut the timber.You may make it in any year to which thechoice would apply. If the timber is partner-ship property, the choice is made on thepartnership return. This choice cannot bemade on an amended return.

Once you have made the choice, it re-mains in effect for all later years unless youcancel it.

Canceling a post-1986 choice. You cancancel a choice you made for a tax year be-ginning after 1986 only if you can show unduehardship and you get the approval of theInternal Revenue Service (IRS). Thereafter,you may not make any new choice unless youhave the approval of the IRS.

Canceling a pre-1987 choice. You cancancel a choice you made for a tax year be-ginning before 1987 without the approval ofthe IRS. You can cancel the choice by at-taching a statement to your tax return for theyear the choice is to be effective. If you make

this cancellation, which can be made onlyonce, you can make a new choice without theapproval of the IRS. Any further cancellationwill require the approval of the IRS.

The statement must include all of the fol-lowing information.

• Your name, address, and taxpayer iden-tification number.

• The year the cancellation is effective andthe timber to which it applies.

• That the cancellation being made is of thechoice to treat the cutting of timber as asale or exchange under section 631(a)of the Internal Revenue Code.

• That the cancellation is being made un-der section 311(d) of Public Law 99–514.

• That you are entitled to make the can-cellation under section 311(d) of PublicLaw 99–514 and section 301.9100–7Tof the regulations.

Gain or loss. Your gain or loss on thecutting of standing timber is the differencebetween its adjusted basis for depletion andits fair market value on the first day of yourtax year in which it is cut.

Your adjusted basis for depletion of cuttimber is based on the number of units (feetboard measure, log scale, or other units) oftimber cut during the tax year and consideredto be sold or exchanged. Your adjusted basisfor depletion is also based on the depletionunit of timber in the account used for the cuttimber, and should be figured in the samemanner as shown in section 611 of the Inter-nal Revenue Code and section 1.611–3 of theregulations.

Example. In April 1999, you owned 4,000MBF (1,000 board feet) of standing timberlonger than 1 year. It had an adjusted basisfor depletion of $40 per MBF. You are a cal-endar year taxpayer. On January 1, 1999, thetimber had a fair market value (FMV) of $120per MBF. It was cut in April for sale. On your1999 tax return, you choose to treat the cut-ting of the timber as a sale or exchange. Youreport the difference between the FMV andyour adjusted basis for depletion as a gain.This amount is reported on Form 4797 alongwith your other section 1231 gains and lossesto figure whether it is treated as a capital gainor as ordinary gain. You figure your gain asfollows.

The FMV becomes your basis in the cuttimber, and a later sale of the cut timber, in-cluding any by-product or tree tops, will resultin ordinary business income or loss.

Cutting contract. You must treat the dis-posal of standing timber under a cutting con-tract as a section 1231 transaction if all of thefollowing apply to you.

• You are the owner of the timber.

• You held the timber longer than 1 yearbefore its disposal.

• You kept an economic interest in thetimber.

The difference between the amount real-ized from the disposal of the timber and itsadjusted basis for depletion is treated as gainor loss on its sale. Include this amount onForm 4797 along with your other section 1231

Gross sales price ......................................... $1,250Cost (basis) ..................................... $1,300Minus: Depreciation deduction ........ 759Unrecovered cost(adjusted basis) ............................... $541Expense of sale .............................. 125 666Gain realized .............................................. $584

FMV of timber January 1, 1999 ............... $480,000Minus: Adjusted basis for depletion ........ 160,000Section 1231 gain .................................. $320,000


gains and losses to figure whether it is treatedas capital or ordinary gain or loss.

Date of disposal. The date of disposalis the date the timber is cut. However, if youreceive payment under the contract beforethe timber is cut, you may elect to treat thedate of payment as the date of disposal. Thiselection is effective only to figure the holdingperiod of the timber. It has no effect on thetime for reporting gain or loss (generally whenthe timber is sold or exchanged). To makethis election, attach a statement to the taxreturn filed by the due date (including exten-sions) for the year payment is received. Thestatement must identify the advance pay-ments subject to the election and the contractunder which they were made. If you timelyfiled your return for the year you receivedpayment without making the election, you canstill make the election by filing an amendedreturn within 6 months after the due date forthat year's return (excluding extensions). At-tach the statement to the amended return andwrite “Filed pursuant to section 301.9100–2”at the top of the statement. File the amendedreturn at the same address the original returnwas filed.

Owner. An owner is any person whoowns an interest in the timber, including asublessor and the holder of a contract to cutthe timber. You own an interest in timber ifyou have the right to cut it for sale on yourown account or for use in your business.

Economic interest. You have kept aneconomic interest in standing timber if, underthe cutting contract, the expected return onyour investment is based on the cutting of thetimber.

Tree stumps. Tree stumps are a capital as-set if they are on land held by an investor whois not in the timber or stump business, eitheras a buyer, seller, or processor. Gain from thesale of stumps sold in one lot by such a holderis taxed as a capital gain. However, treestumps held by timber operators, after thesaleable standing timber was cut and re-moved from the land are considered by-products. Gain from the sale of stumps in lotsor tonnage by such operators is taxed as or-dinary income.

Sale of a FarmThe sale of your farm will usually involve thesale of both nonbusiness property (yourhome) and business property (the land andbuildings used in the farm operation and per-haps machinery and livestock). If you have again from the sale, you may be allowed toexclude the gain on your home. The gain onthe sale of your business property is taxable.A loss on the sale of your business propertyto an unrelated person is deducted as an or-dinary loss. Losses from nonbusiness prop-erty, other than casualty or theft losses, arenot deductible. If you receive payments foryour farm in installments, your gain is taxedover the period of years the payments arereceived, unless you choose not to use theinstallment method of reporting the gain. Seechapter 12 for information about installmentsales.

When you sell your farm, the gain or losson each asset is figured separately. The taxtreatment of gain or loss on the sale of eachasset is determined by the classification of theasset. Each of the assets sold must be clas-sified as one of the following.

• Capital asset held 1 year or less.

• Capital asset held longer than 1 year.

• Property (including real estate) used inyour business and held 1 year or less(including draft, breeding, dairy, andsporting animals held less than the hold-ing periods discussed earlier under Live-stock).

• Property (including real estate) used inyour business and held longer than 1year (including draft, breeding, dairy, andsporting animals held for the holding pe-riods discussed earlier).

• Property held primarily for sale or whichis of the kind that would be included ininventory if on hand at the end of your taxyear.

Allocation of consideration paid for a farm.The sale of a farm for a lump sum is consid-ered a sale of each individual asset ratherthan a single asset. Except for assets ex-changed under the like-kind exchange rules(discussed earlier), both the buyer and sellerof a farm must use the residual method toallocate the consideration to each businessasset transferred. This method determinesgain or loss from the transfer of each asset.It also determines the buyer's basis in thebusiness assets.

Residual method. The residual methodprovides for the consideration to be reducedfirst by the cash, demand deposits, and simi-lar accounts transferred by the seller. Theconsideration remaining after this reductionmust be allocated among the various busi-ness assets in a certain order.

The allocation must be made among thefollowing assets in the following order in pro-portion to (but not more than) their fair marketvalue on the purchase date.

1) Certificates of deposit, U.S. governmentsecurities, readily marketable stock orsecurities, and foreign currency.

2) All other assets except section 197 in-tangibles.

3) Section 197 intangibles (other thangoodwill and going concern value) (dis-cussed in chapter 8).

4) Section 197 intangibles in the nature ofgoodwill and going concern value.

For more information about the residualmethod and how to report the allocation of thesales price on Form 1040, see chapter 2 inPublication 544.

Property used in farm operation. The rulesfor excluding the gain on the sale of yourhome, described later under Sale of yourhome, do not apply to the property used foryour farming business. Recognized gains andlosses on business property must be reportedon your return for the year of the sale. If theproperty was held longer than 1 year, it mayqualify for section 1231 treatment (see chap-ter 11).

Example. You sell your farm, includingyour main home, which you have ownedsince December 1994. You realize gain onthe sale as follows.

You must report the $94,000 gain from thesale of the property used in your farm busi-ness. All or a part of that gain may have tobe reported as ordinary income from the re-capture of depreciation or soil and waterconservation expenses. Treat the balanceas section 1231 gain.

The $48,000 gain from the sale of yourhome is not taxable as long as you meet therequirements explained later under Gain onsale of your main home.

Partial sale. If you sell only part of your farm,you must report any recognized gain or losson the sale of that part on your tax return forthe year of the sale. You cannot wait until youhave sold enough of the farm to recover itsentire cost before reporting gain or loss.

Adjusted basis of the part sold. This isthe properly allocated part of your originalcost or other basis of the entire farm, plus orminus necessary adjustments for improve-ments, depreciation, etc., on the part sold.

Example. You bought a 600-acre farm for$700,000. The farm included land andbuildings. The purchase contract designated$600,000 of the purchase price to the land.You later sold 60 acres of land on which youhad installed a fence. Your adjusted basis forthe part of your farm sold is $60,000 (1/10 of$600,000), plus any unrecovered cost (costnot depreciated) of the fence on the 60 acresat the time of sale. Use this amount to deter-mine your gain or loss on the sale of the 60acres.

Assessed values for local propertytaxes. If you paid a flat sum for the entirefarm and no other facts are available forproperly allocating your original cost or otherbasis between the land and the buildings, youcan use the assessed value for local propertytaxes for the year of purchase to allocate thecosts.

Example. Assume that in the precedingexample there was no breakdown of the$700,000 purchase price between land andbuildings. However, in the year of purchase,local taxes on the entire property were basedon assessed valuations of $420,000 for landand $140,000 for improvements, or a total of$560,000. The assessed valuation of theland is 3/4 (75%) of the total assessed valu-ation. Multiply the $700,000 total purchaseprice by 75% to figure basis of $525,000 forthe 600 acres of land. The unadjusted basisof the 60 acres you sold would then be$52,500 (1/10 of $525,000). If your home ison the farm, you must properly adjust thebasis to exclude those costs from your farmasset costs, as discussed next.

Sale of your home. Your home is a capitalasset and not property used in the trade orbusiness of farming. If you sell a farm thatincludes a house you and your family occupy,you must determine the part of the sellingprice and the part of the cost or other basisallocable to your home. Your home includesthe immediate surroundings and outbuildingsrelating to it.

If you use part of your home for business,you must make an appropriate adjustment tothe basis for depreciation allowed or allow-able. For more information on basis, see Al-locating the Basis in chapter 7.

Gain on sale of your main home. If yousell your main home at a gain, you mayqualify to exclude from income all or part of

FarmWith

HomeHomeOnly

FarmWithoutHome

Selling price .............. $182,000 $58,000 $124,000Cost (or other basis) . 40,000 10,000 30,000Gain .......................... $142,000 $48,000 $94,000


the gain. To qualify, you must meet the own-ership and use tests.

You can claim the exclusion if, during the5-year period ending on the date of the sale,you meet both the following requirements.

• You owned the home for at least 2 years(the ownership test).

• You lived in the home as your main homefor at least 2 years (the use test).

You can exclude the entire gain on thesale of your main home up to:

1) $250,000, or

2) $500,000, if all of the following are true.

a) You are married and file a joint re-turn for the year.

b) Either you or your spouse meetsthe ownership test.

c) Both you and your spouse meet theuse test.

d) Neither you nor your spouse ex-cluded gain from the sale of anotherhome after May 6, 1997.

The exclusion may be reduced under certaincircumstances. See Publication 523 for moreinformation.

Gain from condemnation. If you havea gain from a condemnation or sale underthreat of condemnation, you may use thepreceding rules for excluding the gain, ratherthan the rules discussed under PostponingGain in chapter 13. However, any gain thatcannot be excluded (because it is more thanthe limit) may be postponed under the rulesdiscussed under Postponing Gain in chapter13.

Loss on your home. You cannot deducta loss on your home from a voluntary sale, acondemnation, or a sale under threat of con-demnation.

More information. For more informationon selling your home, see Publication 523.

AbandonmentsYou abandon property when you voluntarilygive up possession of the property with theintention of ending your ownership, but with-out passing it on to anyone else.

Business or investment property. Lossfrom abandonment of business or investmentproperty is deductible as an ordinary loss,even if the property is a capital asset. Theloss is the amount of the property's adjustedbasis when abandoned. This rule also appliesto leasehold improvements the lessor madefor the lessee that were abandoned. How-ever, if the property is later foreclosed on orrepossessed, gain or loss is figured as dis-cussed earlier under Foreclosures and Re-possessions.

The abandonment loss is taken in the taxyear in which the loss is sustained. Report theloss on Form 4797, Part II, line 10.

Example. Ann lost her contract with thelocal poultry processor and abandonedpoultry facilities that she built for $100,000.At the time she abandoned the facilities, hermortgage balance was $85,000. She has adeductible loss of $66,554 (her adjusted ba-sis). If the bank later forecloses on the loanor repossesses the facilities, she will have tofigure her gain or loss as discussed earlierunder Foreclosures and Repossessions.

Personal-use property. You cannot deductany loss from abandonment of your home orother property held for personal use.

Canceled debt. If the abandoned propertysecures a debt for which you are personallyliable and the debt is canceled, you will real-ize ordinary income equal to the amount ofcanceled debt. This income is separate fromany loss realized from abandonment of theproperty. Report income from cancellation ofa debt related to a business or rental activityas business or rental income. Report incomefrom cancellation of a nonbusiness debt asmiscellaneous income on line 21, Form 1040.

However, income from cancellation ofdebt is not taxed in the following circum-stances.

• The cancellation is intended as a gift.

• The debt is qualified farm debt (seechapter 4).

• The debt is qualified real property debt(see chapter 5 of Publication 334,TaxGuide for Small Business).

• You are insolvent or bankrupt (see Pub-lication 908, Bankruptcy Tax Guide).

Forms 1099–A and 1099–C. If your aban-doned property secures a loan and the lenderknows the property has been abandoned, thelender should send you Form 1099–A show-ing the information you need to figure yourloss from the abandonment. However, if yourdebt is canceled and the lender must fileForm 1099–C, the lender may include the in-formation about the abandonment on thatform instead of Form 1099–A. The lendermust file Form 1099–C and send you a copyif the canceled debt is $600 or more and thelender is a financial institution, credit union,or federal government agency. For abandon-ments of property and debt cancellations oc-curring in 1999, these forms should be sentto you by January 31, 2000.

11.Dispositions ofProperty Usedin Farming

IntroductionWhen you dispose of property used in yourfarm business, your taxable gain or loss isusually a section 1231 gain or loss. Its treat-ment as ordinary income, which is taxed atthe same rates as wages and interest income,or capital gain, which is generally taxed atlower rates, is determined under the rules forsection 1231 transactions.

When you dispose of depreciable property(section 1245 property or section 1250 prop-erty) at a gain, you may have to recognizeall or part of the gain as ordinary income un-der the depreciation recapture rules. Any re-maining gain is a section 1231 gain, whichmay be taxed as a capital gain.

Gains and losses from property used infarming are reported on Form 4797. Table11–1 shows examples of items reported onForm 4797 and refers to the part of that formon which they first should be reported.Chapter 20, Sample Return, shows a samplefilled-in Form 4797.


• Section 1231 gains and losses

• Depreciation recapture

• Other farm property


Publication

� 544 Sales and Other Dispositionsof Assets




Section 1231Gains and LossesSection 1231 gains and losses are the taxa-ble gains and losses from section 1231transactions — generally, dispositions ofproperty used in your business. Their treat-ment as ordinary or capital depends onwhether you have a net gain or a net lossfrom all your section 1231 transactions.

CAUTION!

If you have a gain from a section 1231transaction, first determine whetherany of the gain is ordinary income

under the depreciation recapture rules (ex-plained later). Do not take that gain into ac-count as section 1231 gain.

Section 1231 transactions. The followingtransactions result in gain or loss subject tosection 1231 treatment.

• Sale or exchange of cattle and horses.The cattle and horses must be held fordraft, breeding, dairy, or sporting andheld for 2 years or longer.

• Sale or exchange of other livestock.This livestock must be held for draft,breeding, dairy, or sporting and held for1 year or longer. Other livestock includeshogs, mules, sheep, and goats, but doesnot include poultry.

• Sale or exchange of depreciable per-sonal property. This property must beused in your business and held longerthan 1 year. Generally, property held forthe production of rents or royalties isconsidered to be used in a trade or busi-ness. Examples of depreciable personalproperty are farm machinery and trucks.It also includes amortizable section 197intangibles.

• Sale or exchange of real estate. Thisproperty must be used in your business

Chapter 11 Dispositions of Property Used in Farming Page 63

Table 11–1. Where To Report Items on Form 4797

Depreciable trade or business property:

Type of propertyHeld one year

or lessHeld more than

one year

Part II Part III (1245, 1250)Sold or exchanged at a gain1

aPart II Part ISold or exchanged at a lossb

Depreciable residential rental property:Part II Part III (1250)Sold or exchanged at a gain

2a

Part II Part ISold or exchanged at a lossb

Farm land held less than 10 years upon whichsoil, water, or land clearing expenses werededucted:

Part II Part III (1252)Sold at a gain

3

aPart II Part ISold at a lossb

Disposition of cost-sharing payment propertydescribed in section 126

4Part II Part III (1255)

Held lessthan 24 mos.

Held 24 mos.or more

Cattle and horses used in a trade or businessfor draft, breeding, dairy, or sporting purposes:

5

Part II Part III (1245)Sold at a gainaPart II Part ISold at a lossbPart II Part IRaised livestock sold at a gainc

Held lessthan 12 mos.

Held 12 mos.or more

Livestock other than cattle and horses used ina trade or business for draft, breeding, dairy, orsporting purposes:

6

Part II Part III (1245)Sold at a gainaPart II Part ISold at a lossbPart II Part IRaised livestock sold at a gainc

your net section 1231 gain of $2,000. For1999, you report $700 as ordinary incomeand $1,300 ($2,000 − $700) as long-termcapital gain.

DepreciationRecaptureIf you dispose of depreciable or amortizableproperty at a gain, you may have to treat allor part of the gain (even if it is otherwisenontaxable) as ordinary income.

Section 1245 PropertyA gain on the disposition of section 1245property is treated as ordinary income to theextent of depreciation allowed or allowable.See Gain Treated as Ordinary Income, later.

Any gain recognized that is more than thepart that is ordinary income because of de-preciation is a section 1231 gain. See Treat-ment as ordinary or capital under Section1231 Gains and Losses, earlier.

Defined. Section 1245 property includes anyproperty that is or has been subject to an al-lowance for depreciation or amortization andis any of the following types of property.

1) Personal property (either tangible or in-tangible).

2) Other tangible property (except buildingsand their structural components) usedas any of the following.

a) An integral part of manufacturing,production, or extraction or of fur-nishing transportation, communi-cations, electricity, gas, water, orsewage disposal services.

b) A research facility in any of the ac-tivities in (a).

c) A facility in any of the activities in(a) for the bulk storage of fungiblecommodities.

3) That part of real property (not includedin (2)) with an adjusted basis that wasreduced by certain amortization de-ductions (including those for certifiedpollution control facilities, child-care fa-cilities, removal of architectural barriersto persons with disabilities and the el-derly, or reforestation expenses) or asection 179 deduction.

4) Single purpose agricultural (livestock) orhorticultural structures.

5) Storage facilities (except buildings andtheir structural components) used in dis-tributing petroleum or any primary prod-uct of petroleum.

Buildings and structural components.Section 1245 property does not includebuildings and structural components. Theterm “building” includes a house, barn, ware-house, or garage. The term “structural com-ponent” includes walls, floors, windows,doors, central air conditioning systems, lightfixtures, etc.

A structure that is essentially machineryor equipment is not considered a building orstructural component. Also, a structure thathouses property used as an integral part ofan activity is not considered a building orstructural component if the structure's use is

and held longer than 1 year. Examplesare your farm or ranch (including barnsand sheds).

• Sale or exchange of unharvestedcrops. The crop and land must be sold,exchanged, or involuntarily converted atthe same time and to the same person,and the land must have been held longerthan 1 year. The taxpayer cannot keepany right or option to reacquire the landdirectly or indirectly (other than a rightcustomarily incident to a mortgage orother security transaction). Growingcrops sold with a lease on the land,though sold to the same person in a sin-gle transaction, are not included.

• Distributive share of partnership gainsand losses. Your distributive share mustbe from the sale or exchange of propertylisted earlier held longer than 1 year, orfor the required period for certain live-stock.

• Timber. The cutting or disposal of timbermust be treated as a sale, as describedin chapter 10 under Timber.

• Condemnation. The condemned prop-erty (described in chapter 13) must havebeen held longer than 1 year. It must bebusiness property or a capital asset heldin connection with a trade or business ora transaction entered into for profit, suchas investment property. It cannot beproperty held for personal use.

• Casualty or theft. It must have been acasualty to or theft of business property,property held for the production of rentsand royalties, or investment property(such as notes and bonds). You musthave held the property longer than 1 year.However, if your casualty or theft lossesare more than your casualty or theftgains, neither the gains nor losses aretaken into account in the section 1231computation. Section 1231 does not ap-

ply to personal casualty gains and losses.See chapter 13 for information on how totreat these gains and losses.

Property held for sale to customers. Asale, exchange, or involuntary conversion ofproperty held mainly for sale to customers isnot a section 1231 transaction. If you will getback all, or nearly all, of your investment inthe property by selling it rather than by usingit up in your business, it is property heldmainly for sale to customers.

Treatment as ordinary or capital. To de-termine the treatment of section 1231 gainsand losses, combine all your section 1231gains and losses for the year.

• If you have a net section 1231 loss, it isan ordinary loss.

• If you have a net section 1231 gain, it isordinary income up to the amount of yournonrecaptured section 1231 losses fromprevious years, explained next. The rest,if any, is long-term capital gain.

Nonrecaptured section 1231 losses.Your nonrecaptured section 1231 losses areyour net section 1231 losses for the previous5 years that have not been applied against anet section 1231 gain by treating the gain asordinary income. These losses are appliedagainst your net section 1231 gain beginningwith the earliest loss in the 5-year period.

Example. In 1995, you had a net section1231 loss of $2,500. For tax years 1998 and1999, you had net section 1231 gains of$1,800 and $2,000, respectively. In 1994,1995, and 1997, you had no section 1231gains or losses. In figuring taxable income for1998, you treated your net section 1231 gainof $1,800 as ordinary income by recapturing$1,800 of your $2,500 net section 1231 loss.For 1999, you apply your remaining $700 netsection 1231 loss ($2,500 − $1,800) against

Page 64 Chapter 11 Dispositions of Property Used in Farming

so closely related to the property's use thatthe structure can be expected to be replacedwhen the property it initially houses is re-placed.

The fact that the structure is specially de-signed to withstand the stress and other de-mands of the property and the fact that thestructure cannot be used economically forother purposes indicate that it is closely re-lated to the use of the property it houses.Structures such as oil and gas storage tanks,grain storage bins, and silos are not treatedas buildings, but as section 1245 property.

Storage facility. This is a facility usedmainly for the bulk storage of fungible com-modities. Bulk storage means storage of acommodity in a large mass before it is used.For example, if a facility is used to store or-anges that have been sorted and boxed, it isnot used for bulk storage. To be fungible, acommodity must be such that one part maybe used in place of another.

Gain Treated as Ordinary IncomeThe gain treated as ordinary income on thesale, exchange, or involuntary conversion ofsection 1245 property, including a sale andleaseback transaction, is the lesser of thefollowing amounts.

1) The depreciation and amortization al-lowed or allowable on the property.

2) The gain realized on the disposition (theamount realized from the disposition mi-nus the adjusted basis of the property).

For any other disposition of section 1245property, ordinary income is the lesser of (1)above or the amount by which its fair marketvalue is more than its adjusted basis. Seechapter 3 of Publication 544.

Use Part III of Form 4797 to figure theordinary income part of the gain.

Depreciation on other property or takenby other taxpayers. Depreciation andamortization include not only the amounts youclaimed on the section 1245 property but alsothe following depreciation and amortizationamounts.

• Amounts you claimed on property youexchanged for, or converted to, yoursection 1245 property in a like-kind ex-change or involuntary conversion.

• Amounts a previous owner of the section1245 property claimed if your basis isdetermined with reference to that per-son's adjusted basis (for example, thedonor's depreciation deductions on prop-erty you received as a gift would be in-cluded).

Depreciation and amortization. Depreci-ation and amortization deductions that mustbe recaptured as ordinary income include (butare not limited to) the following items.

1) Ordinary depreciation deductions.

2) Amortization deductions for all the fol-lowing costs.

a) The cost of acquiring a lease.

b) The cost of lessee improvements.

c) Pollution control facilities.

d) Reforestation expenses.

e) Section 197 intangibles.

f) Child care facility expenses before1982.

g) Franchises, trademarks, and tradenames acquired before August 11,1993.

3) The section 179 expense deduction.

4) Deductions for all the following costs.

a) The cost of removing barriers to thedisabled and the elderly.

b) Tertiary injectant expenses.

c) Depreciable clean-fuel vehicles andrefueling property (minus any re-captured deduction).

5) Any basis reduction for the investmentcredit (minus any basis increase for acredit recapture).

6) Any basis reduction for the qualifiedelectric vehicle credit (minus any basisincrease for a credit recapture).

Example. You file your returns on a cal-endar year basis. In February 1997, youbought and placed in service for 100% use inyour farming business a light-duty truck(5-year property) that cost $10,000. You usedthe half-year convention and your MACRSdeductions for the truck were $1,500 in 1997and $2,550 in 1998. You did not take thesection 179 deduction on it. You sold thetruck in May 1999 for $7,000. The MACRSdeduction in 1999, the year of sale, is $893(1/2 of $1,785). Figure the gain treated asordinary income as follows.

Depreciation allowed or allowable. Yougenerally use the greater of the depreciationallowed or allowable when figuring the partof gain to report as ordinary income. If, in prioryears, you have consistently taken properdeductions under one method, the amountallowed for your prior years will not be in-creased even though a greater amount wouldhave been allowed under another propermethod. If you did not take any deduction atall for depreciation, your adjustments to basisfor depreciation allowable are figured by usingthe straight line method.

This treatment applies only when figuringwhat part of gain is treated as ordinary in-come under the rules for section 1245 de-preciation recapture.

Disposition of plants and animals. If youmade the choice not to apply the uniformcapitalization rules, you must treat any plantor animal you produce (if the animals wereproduced in 1987 or 1988) as section 1245property. You must recapture the preproduc-tive expenses you would have capitalized ifyou had not made the choice by treatingthese expenses as ordinary income whendetermining your gain on selling or disposingof the property. For section 1231 transactions,show these expenses as depreciation on line22, Part III, of Form 4797. For plant sales that

are reported on Schedule F (Form 1040), thisrecapture rule does not change the reportingof income because the gain is already ordi-nary income. You can use the farm-pricemethod or the unit-livestock-price methoddiscussed in chapter 3 to figure these ex-penses.

Example. Janet Maple sold her appleorchard in 1999 for $80,000. Her adjustedbasis at the time of sale was $60,000. Shebought the orchard in 1992, but the trees didnot produce a crop until 1995. Her prepro-ductive expenses were $6,000. She chosenot to apply the uniform capitalization rules.Janet must treat the $6,000 preproductiveexpenses as ordinary income when figuringthe gain on the sale.

Livestock costs incurred before 1989.For livestock costs incurred before 1989, theIRS provided two safe-harbor choices. Thesesafe-harbor choices were not available tocorporations, partnerships, or tax shelters thatwere required to use an accrual method ofaccounting. For information on thesechoices, see Notice 88–24 in CumulativeBulletin 1988–1 and Notice 88–113 modifyingNotice 88–24 in Cumulative Bulletin 1988–2.

For information on the uniform capitaliza-tion rules, see chapter 7.

Section 1250 PropertyA gain on the disposition of section 1250property is treated as ordinary income to theextent of additional depreciation allowed orallowable. To determine the additional de-preciation on section 1250 property, see Ad-ditional Depreciation, later.

You will not have additional depreciationif any of the following apply.

• You figured depreciation for the propertyusing the straight line method or anyother method that does not result in de-preciation that is more than the amountfigured by the straight line method, andyou have held the property longer than ayear.

• You chose the alternate ACRS (straightline) method for the types of 15-, 18-, or19-year real property covered by thesection 1250 rules.

• You dispose of residential rental propertyor nonresidential real property placed inservice after 1986 (or after July 31, 1986,if the choice to use MACRS was made).These properties are depreciated usingthe straight line method.

Defined. Section 1250 property includes allreal property subject to an allowance for de-preciation that is not and never has beensection 1245 property. It includes a leaseholdof land or section 1250 property subject to anallowance for depreciation. A fee simple in-terest in land is not section 1250 propertybecause it is not depreciable.

Gain Treated as Ordinary IncomeTo find what part of the gain from the dispo-sition of section 1250 property is treated asordinary income, follow these steps.

1) In a sale, exchange, or involuntary con-version of the property, figure theamount realized that is more than theadjusted basis of the property (in anyother disposition of the property, figure

1) Amount realized .................................... $7,0002) Cost (Feb. 1997) .................... $10,0003) Depreciation allowed or allow-

able (MACRS deductions:$1,500 + $2,550 + $893) ........ 4,943

4) Adjusted basis (subtract line 3from line 2) ............................................ $5,057

5) Gain realized (subtract line 4from line 1) ............................................ 1,943

6) Gain treated as ordinary income(lesser of line 3 or line 5) ................... $1,943

Chapter 11 Dispositions of Property Used in Farming Page 65

the amount of the fair market value thatis more than the adjusted basis).

2) Figure the additional depreciation for theperiods after 1975.

3) Multiply the lesser of (1) or (2) by theapplicable percentage, discussed later.Stop here if this is residential rentalproperty, or if (2) is equal to or more than(1). This is the gain that is treated asordinary income because of additionaldepreciation.

4) Subtract (2) from (1).

5) Figure the additional depreciation forperiods after 1969 but before 1976.

6) Add the lesser of (4) or (5) to the resultin (3). This is the gain treated as ordinaryincome because of additional depreci-ation.

Use Part III, Form 4797, to figure the ordinaryincome part of the gain.

Additional DepreciationIf you hold section 1250 property longer than1 year, the additional depreciation is theamount of actual depreciation adjustmentsthat is more than the depreciation figured us-ing the straight line method. For a list of itemstreated as depreciation adjustments, see De-preciation and amortization under Section1245 Property, earlier.

If you hold section 1250 property for 1year or less, all of the depreciation is addi-tional depreciation.

Figure straight line depreciation for ACRSreal property by using its 15-, 18-, or 19-yearrecovery period as the property's useful life.

The straight line method is applied withoutany basis reduction for the investment credit.

You will have additional depreciation if youuse the regular ACRS method, the decliningbalance method, the sum-of-the-years-digitsmethod, the units-of-production method, orany other method of rapid depreciation. Youalso have additional depreciation if youchoose amortization, other than amortizationon real property that qualifies as section 1245property, discussed earlier.

Depreciation taken by other taxpayers oron other property. Additional depreciationincludes all depreciation adjustments to thebasis of section 1250 property whether al-lowed to you or another person (as for carry-over basis property).

Depreciation allowed or allowable. Yougenerally use the greater of depreciation al-lowed or allowable (to any person who heldthe property if the depreciation was used infiguring its adjusted basis in your hands)when figuring the part of the gain to be re-ported as ordinary income. If you can showthat the deduction allowed for any tax yearwas less than the amount allowable, thelesser figure will be the depreciation adjust-ment for figuring additional depreciation.

Applicable PercentageThe applicable percentage used to figure theordinary income because of additional de-preciation depends on whether the real prop-erty you disposed of is nonresidential realproperty, residential rental property, or low-income housing. The applicable percentagesfor nonresidential real property and residential

rental property are explained next. The appli-cable percentage for low-income housing isexplained in chapter 3 of Publication 544.

Nonresidential real property. For realproperty that is not residential rental property,the applicable percentage for periods after1969 is 100%. For periods before 1970, thepercentage is zero and no ordinary incomewill result on its disposition because of addi-tional depreciation before 1970.

Residential rental property. For residentialrental property (80% or more of the gross in-come is from dwelling units) other than low-income housing, the percentage for periodsafter 1975 is 100%. The applicable percent-age for periods before 1976 is zero. No ordi-nary income will result from a disposition ofresidential rental property because of addi-tional depreciation before 1976.

More information. For more informationabout depreciation recapture on section 1250property, see chapter 3 of Publication 544.

Installment SalesIf you report the sale of property under theinstallment method, any depreciation recap-ture under section 1245 or 1250 is taxableas ordinary income in the year of sale. Thisapplies even if no payments are received inthat year. If the gain is more than the de-preciation recapture income, report the restof the gain using the rules of the installmentmethod. For this purpose, add the recaptureincome to the property's adjusted basis.

If you dispose of more than one asset ina single transaction, you must separately fig-ure the gain on each asset so that it may beproperly reported. To do this, allocate theselling price and the payments you receive inthe year of sale to each asset. Report anydepreciation recapture income in the year ofsale before using the installment method forany remaining gain.

For more information on installment sales,see chapter 12.

Other DispositionsChapter 3 of Publication 544 discusses thetax treatment of the following transfers ofdepreciable property.

• By gift.

• At death.

• In like-kind exchanges.

• In involuntary conversions.

Publication 544 also explains how to handlea single transaction involving multiple prop-erties.

Other Farm PropertyThis section discusses gain on the dispositionof farm land for which you were allowed eitherof the following.

• Deductions for soil and water conserva-tion expenditures (section 1252 property).

• Exclusions from income for certain costsharing payments (section 1255 prop-erty).

Section 1252 property. If you disposed offarm land you held less than 10 years at again and you were allowed deductions for soiland water conservation expenses for the landdiscussed in chapter 6, you must treat partof the gain as ordinary income and treat thebalance as section 1231 gain.

Amount to report as ordinary income.You report as ordinary income the lesser ofthe following amounts.

• The total deductions allowed for soil andwater conservation expenditures multi-plied by the applicable percentage, dis-cussed next.

• Your gain (determined by subtracting theadjusted basis from the amount realizedfrom a sale, exchange, or involuntaryconversion, or the fair market value forall other dispositions).

Applicable percentage. The applicablepercentage is based on the length of time youheld the land. If you dispose of your farm landwithin 5 years after the date you got it, thepercentage is 100%. If you dispose of theland within the 6th through 9th year after yougot it, the applicable percentage is reducedby 20% a year for each year you hold the landafter the 5th year. If you dispose of the land10 or more years after you got it, the per-centage is zero (0), and the entire gain is asection 1231 gain.

Example. You acquired farm land onJanuary 19, 1992. On October 3, 1999, yousold the land at a $30,000 gain. BetweenJanuary 1 and October 3, 1999, you make soiland water conservation expenditures of$15,000 for the land that are fully deductiblein 1999. The applicable percentage is 40%since you sold the land within the 8th yearafter you got it. You treat $6,000 (40% of$15,000) of the $30,000 gain as ordinary in-come and the $24,000 balance as a section1231 gain.

Section 1255 property. If you receive cer-tain cost-sharing payments on property andyou exclude those payments from income(discussed in chapter 4), you may have totreat part of any gain as ordinary income andtreat the balance as a section 1231 gain. Ifyou chose not to exclude these payments,you will not have to recognize ordinary in-come under this provision.

Amount to report as ordinary income.You report as ordinary income the lesser ofthe following amounts.

• The applicable percentage of the totalexcluded cost-sharing payments.

• The gain on the disposition of the prop-erty.

You do not report ordinary income under thisrule to the extent the gain is recognized asordinary income under sections 1231 through1254, 1256, and 1257 of the Internal RevenueCode. However, you do report as ordinaryincome under this rule a gain or a part of again regardless of any contrary provisions(including nonrecognition provisions) underany other section of the Internal RevenueCode.

Applicable percentage. The applicablepercentage of the excluded cost-sharingpayments to be reported as ordinary incomeis based on the length of time you hold theproperty after receiving the payments. If theproperty is held less than 10 years, the per-

Page 66 Chapter 11 Dispositions of Property Used in Farming

centage is 100%. After 10 years, the per-centage is reduced by 10% a year or part ofa year until the rate is 0%.

Form 4797, Part III. Use Form 4797, Part IIIto figure the ordinary income portion of a gainfrom the sale, exchange, or involuntary con-version of section 1252 property and section1255 property.

12.InstallmentSales

IntroductionAn installment sale is a sale of property whereyou receive at least one payment after theclose of the tax year of the sale. If you dis-pose of property in an installment sale, youreport part of your gain or profit when youreceive each installment payment. You can-not use the installment method to report aloss.

The buyer's “installment obligation” tomake future payments to you can be in theform of a deed of trust, note, land contract,mortgage, or other evidence of the buyer'sdebt to you. The rules discussed in thischapter generally apply regardless of the formof the installment obligation.


• Installment method

• Figuring installment income

• Payments received

• Installment sale of a farm


Publication

� 523 Selling Your Home

� 537 Installment Sales


� 4797 Sale of Business Property

� 6252 Installment Sale Income


Installment MethodAn installment sale is a sale of property, ex-cept for inventory, where you receive at leastone payment after the close of the tax yearof the sale. A cash basis farmer who is notrequired to maintain an inventory can use theinstallment method to report gain from thesale of property used or produced in farming.

TIPIf you finance the buyer's purchaseof your property, instead of having thebuyer get a loan or mortgage from a

third party, you probably have an installmentsale. It is not an installment sale if the buyerborrows the money from a third party andthen pays you the total selling price.

You generally report your gain on an in-stallment sale as you actually receive pay-ment. Each payment usually consists of thefollowing three parts.

1) Interest income.

2) Return of your adjusted basis in theproperty.

3) Gain on the sale.

You are taxed only on the part of eachpayment that represents interest and yourgain on the sale. In this way, the installmentmethod of reporting income relieves you ofpaying tax on income you have not yet col-lected. However, when reporting a sale ofdepreciable or amortizable property, youmust include in income for the year of thesale, any depreciation or amortization recap-ture income (up to the amount of gain). Re-port any remaining gain on the installmentmethod.

Sale at a loss. If your sale results in a loss,you cannot use the installment method. If theloss is on an installment sale of business as-sets, you can deduct it only in the tax yearof sale. You cannot deduct a loss on the saleof property owned for personal use.

Form 6252. Each year, including the yearof sale, report your income from an install-ment sale on Form 6252. Attach this form toyour tax return.

Disposition of installment obligation. Ifyou sell or discount an installment obligation,you generally have a gain or loss to report. Itis considered gain or loss on the sale of theproperty for which you received the install-ment obligation. If this takes place during theyear of sale, report your entire gain on yourreturn for that year. You do not have an in-stallment sale. If it takes place in a later year,you may have a disposition of an installmentobligation.

Cancellation. If an installment obligationis canceled or otherwise becomes unen-forceable, it is treated as a disposition otherthan a sale or exchange. Your gain or loss isthe difference between your basis in the obli-gation and its fair market value at the time youcancel it. Fair market value (FMV) is dis-cussed later under Payment of property. (Areduction in the selling price changes thegross profit and gross profit percentage.)

Transfer due to death. The transfer ofan installment obligation (other than to abuyer) as a result of the death of the seller (orother holder of the obligation) is not a dispo-sition. Any unreported gain from the install-ment obligation is not treated as gross incometo the decedent. No income is reported on thedecedent's return due to the transfer. Thismeans whoever receives the obligation as aresult of the seller's death is taxed on the in-stallment payments the same as the sellerwould have been if the seller had lived to re-ceive the payments.

However, if the installment obligation iscanceled, becomes unenforceable, or istransferred to the buyer because of the death

of the holder of the obligation, it is a disposi-tion. The estate must figure gain or loss onthe disposition.

More information. For more informationon the disposition of an installment obligation,see Publication 537.

Inventory. The sale of farm inventory itemscannot be reported on the installment method.All gain or loss on their sale must be reportedin the year of sale, even if you are paid in lateryears. However, if you are a cash basisfarmer and are not required to maintain aninventory, you may be able to use the install-ment method to report the sale of propertyyou use or produce in your farming business.For a definition of farm inventory, see FarmInventory in chapter 3.

If inventory items are included in an in-stallment sale, you may have an agreementstating which payments are for inventory andwhich are for the other assets being sold. Ifyou do not, each payment must be allocatedbetween the inventory and the other assetssold.

Electing out. You must use the installmentmethod to report an installment sale unlessyou elect not to use that method. If you makethe election, you generally report the entiregain in the year of sale, even though you willnot be paid all of the selling price in that year.You then do not report any gain from thepayments you receive in later years.

To make this election, do not report yoursale on Form 6252. Instead, report it onSchedule D (Form 1040) or Form 4797,whichever applies.

When to elect out. Make this electionby the due date, including extensions, for fil-ing your tax return for the year the sale takesplace. However, if you timely filed your returnfor the year the sale took place you may stillmake the election by filing an amended returnwithin six months of the due date of the return(excluding extensions). Attach the election tothe amended return and write “Filed pursuantto section 301.9100–2” on the election state-ment. File the amended return at the sameaddress the original return was filed. Oncemade, the election generally cannot be re-voked.

More information. See Electing Out ofInstallment Method in Publication 537 formore information on electing out of the in-stallment method.

CAUTION!

You must continue to report the in-terest income on payments you re-ceive for subsequent years.

FiguringInstallment IncomeEach payment on an installment sale usuallyconsists of the following three parts.

1) Interest income.

2) Return of your adjusted basis in theproperty.

3) Gain on the sale.

In each year you receive a payment, you in-clude the interest part in income, as well asthe part that is your gain on the sale. You donot include in income the part that is the re-turn of your adjusted basis in the property.

Chapter 12 Installment Sales Page 67

Interest income. You must report interestas ordinary income. Interest is generally notincluded in a down payment. However, youmay have to treat part of each later paymentas interest, even if it is not called interest inyour agreement with the buyer. See Unstatedinterest, later.

Return of basis and gain on sale. The restof each payment is treated as if it were madeup of two parts. One part is a tax-free returnof your adjusted basis in the property. Theother part is your gain.

Figuring gain part of payment. Tofigure what part of any payment isgain, multiply the payment (less in-

terest) by the gross profit percentage. Use thefollowing worksheet to figure the gross profitpercentage.

Selling price. The selling price is the totalcost of the property to the buyer. It includesany money and the FMV of any property youare to receive. It also includes any debt thebuyer pays, assumes, or takes, to which theproperty is subject. The debt could be a note,mortgage, or any other liability, such as a lien,accrued interest, or taxes you owe on theproperty. If the buyer pays any of your sellingexpenses for you, that amount is also in-cluded in the selling price. The selling pricedoes not include interest, whether stated orunstated.

Installment sale basis. This chapter re-fers to the adjusted basis plus selling ex-penses and depreciation recapture incomeas the installment sale basis.

Adjusted basis. Basis is a way ofmeasuring your investment in the propertyyou are selling. The way you figure basis de-pends on how you first acquired the property.The basis of property you bought is generallyits cost. The basis of property you inherited,received as a gift, built yourself, or receivedin a tax-free exchange is figured differently.See chapter 7 for information on determiningbasis.

While you own personal-use property,various events may change your original ba-sis in the property. Some events, such asadding rooms or making permanent improve-ments, increase basis. Others, such asdeductible casualty losses or depreciationpreviously allowed or allowable, decreasebasis. The result is adjusted basis.

Selling expenses. Selling expenses areany expenses that relate to the sale of theproperty. They include commissions, attorneyfees, and any other expenses paid on thesale. Selling expenses are added to the basisof the sold property.

Depreciation recapture. If you took de-preciation deductions on the asset, part of thegain on the sale of the asset may be recap-tured as ordinary income. See Sale ofdepreciable property, later.

Gross profit. For an installment sale,gross profit is the total gain you report on theinstallment method.

To figure your gross profit, subtract yourinstallment sale basis from the selling price.If the property you sold was your home, sub-tract from the gross profit any gain you canexclude. See Publication 523 for informationon excluding gain on the sale of your home.

Contract price. The contract price is thetotal of all principal payments you are to re-ceive on the installment sale. It includes pay-ments you are considered to receive, eventhough you are not paid anything directly. SeePayments Received, later.

If part of the selling price is paid in cashand you hold a mortgage payable from thebuyer to you for the remainder, then the con-tract price equals the selling price.

Gross profit percentage. A certain per-centage of each payment (after subtractinginterest) is reported as gain from the sale. Itis called the “gross profit percentage” and isfigured by dividing your gross profit from thesale by the contract price.

The gross profit percentage generally re-mains the same for each payment you re-ceive. However, see Selling price reduced,later, for an example of changing the grossprofit percentage.

Example. You sell property at a contractprice of $200,000. The property has an ad-justed basis of $150,000. Your gross profit is$50,000. Your gross profit percentage is 25%($50,000 ÷ $200,000). After subtracting in-terest, you report 25% of each payment, in-cluding the down payment, as gain from thesale for the tax year you receive the payment.

Amount to include in income. Each yearyou receive a payment on the installmentsale, multiply the payment (after subtractinginterest) by the gross profit percentage todetermine the amount you must include inincome for the tax year.

Sale of depreciable property. You can-not use the installment method to report anydepreciation recapture income up to the gainon the sale. Report any remaining gain on theinstallment method.

However, you generally cannot report gainfrom the sale of depreciable property to a re-lated person on the installment method. SeeSale to Related Person in Publication 537.

Figure your depreciation recapture income(including the section 179 deduction and thesection 179A deduction recapture) in Part IIIof Form 4797. Report the depreciation re-capture income in Part II of Form 4797 asordinary income in the year of sale.

TIPIf you sell depreciable business prop-erty, prepare Form 4797 first in orderto figure the amount to enter on line

12 of Part I, Form 6252.

For more information on the section 179deduction, see Section 179 Deduction in

chapter 8. For more information on the sec-tion 179A deductions, see chapter 15 inPublication 535. For more information on de-preciation recapture, see Depreciation Re-capture in chapter 11.

Selling price reduced. If the selling priceis reduced at a later date, the gross profit onthe sale will also change. You must then re-figure your gross profit percentage for the re-maining payments. Refigure your gross profitusing the reduced sale price and then sub-tract the gain already reported. Spread theremaining gain over the remaining install-ments. You cannot go back and refigure thegain you reported in earlier years.

Example. In 1997, you sold land with abasis of $40,000 for $100,000. Your grossprofit was $60,000. You received a $20,000down payment and the buyer's note for$80,000. The note provides for four annualpayments of $20,000 each, plus 12% interest,beginning in 1998. Your gross profit percent-age is 60%. You reported a gain of $12,000on each payment received in 1997 and 1998.In 1999, you and the buyer agreed to reducethe purchase price to $85,000 and the pay-ments for 1999, 2000, and 2001 are reducedto $15,000 for each year.

The new gross profit percentage, 46.67%,is figured as follows. You will report a gainof $7,000 (46.67% of $15,000) on each of the$15,000 installments due in 1999, 2000, and2001.

Sale to related person. Special rules applyto an installment sale between related per-sons. Spouses, children, grandchildren,brothers, sisters, and parents are all consid-ered related persons. A partnership or cor-poration in which you have an interest, or anestate or trust with which you have a con-nection, can also be considered a relatedperson.

For information on these rules, see Saleto Related Person in Publication 537.

Trading property for like-kind property. Ifyou trade business or investment property forthe same kind of property, you can postponereporting part of the gain. See Like-Kind Ex-changes in chapter 10 for a discussion oflike-kind property.

If the trade includes an installment obli-gation, the following rules apply.

1) The contract price is reduced by theFMV of the like-kind property received inthe trade.

2) The gross profit is reduced by any gainon the trade that can be postponed.

3) Like-kind property received in the tradeis not considered payment on the in-stallment obligation.

1) Selling price ...........................................2) Installment sale basis:

Adjusted basis of property ...Selling expenses ..................Depreciation recapture .........

3) Gross profit (line 1 − line 2) ...................4) Contract price .........................................5) Gross profit percentage

(line 3 ÷ line 4) .....................................

1) Reduced selling price ........................... $85,0002) Minus: Basis .......................................... 40,0003) Adjusted gross profit ............................. $45,0004) Minus: Gain reported in 1997 & 1998 .. 24,0005) Gain to be reported ............................... $21,0006) Selling price to be received:

Reduced selling price ......... $85,000Minus: Payments receivedin 1997 and 1998 ............... 40,000 $45,000

7) New gross profit percentage(line 5 ÷ line 6) ..................................... 46.67%

Page 68 Chapter 12 Installment Sales

Payments ReceivedIncluding PaymentsConsidered ReceivedYou must figure your gain each year on thepayments you receive, or are treated as re-ceiving, from an installment sale. These pay-ments include the down payment and eachlater payment of principal on the buyer's debtto you.

In certain situations, you are consideredto have received a payment, even though thebuyer does not pay you directly. These situ-ations arise if the buyer assumes or pays anyof your debts, such as a loan, or pays any ofyour expenses, such as a sales commission.

Buyer pays seller's expenses. If the buyerpays any of your expenses related to the saleof your property, it is considered a paymentto you in the year of sale. Include these ex-penses in the selling and contract priceswhen figuring the gross profit percentage.

Buyer assumes mortgage. If the buyer as-sumes or pays off your mortgage, or other-wise takes the property subject to the mort-gage, the following rules apply.

Mortgage less than basis. If the buyerassumes a mortgage that is less than yourinstallment sale basis in the property, it is notconsidered a payment to you. The contractprice equals the selling price minus the mort-gage. This difference is all you will directlycollect from the buyer.

Example. You sell property with an ad-justed basis of $19,000. You have selling ex-penses of $1,000. The buyer assumes yourexisting mortgage of $15,000 and agrees topay you $10,000 (a cash down payment of$2,000 and $2,000 (plus 12% interest) ineach 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 con-tract price is $10,000 ($25,000 − $15,000mortgage). Your gross profit percentage is50% ($5,000 ÷ $10,000). You report half ofeach $2,000 payment received as gain fromthe sale. You also report all interest you re-ceive as ordinary income.

Mortgage more than basis. If the buyerassumes a mortgage that is more than yourinstallment sale basis in the property, you re-cover your entire basis. You are also relievedof the obligation to repay the amount bor-rowed. The part of the mortgage greater thanyour basis is treated as a payment receivedin the year of sale. This is in addition to thebuyer's other payments.

To figure the contract price, subtract themortgage from the selling price. This is thetotal you will actually receive from the buyer.Add to this amount the “payment” you areconsidered to receive (the difference betweenthe mortgage and your installment sale ba-sis). The contract price is then the same asyour gross profit from the sale.

If the mortgage the buyer assumes isequal to or more than your installment salebasis, the gross profit percentage will alwaysbe 100%.

Example. The selling price for yourproperty is $9,000. The buyer will pay you$1,000 annually (plus 8% interest) over thenext 3 years and assumes an existing mort-

gage of $6,000. Your basis in the property is$4,400. You have selling expenses of $600,for a total installment sale basis of $5,000.The part of the mortgage that is more thanyour installment sale basis is $1,000 ($6,000− $5,000). This amount is included in thecontract price and treated as a payment re-ceived in the year of sale. The contract priceis $4,000:

Your gross profit on the sale is also$4,000:

Your gross profit percentage is 100%.Report 100% of each payment as gain fromthe sale. You also treat the $1,000 differencebetween the mortgage and your installmentsale basis as a payment and report 100% ofit as gain in the year of sale.

Buyer assumes other debts. If the buyerassumes your other debts, such as a loan orback taxes, it may be considered a paymentto you in the year of sale.

If the buyer assumes the debt instead ofpaying it off, only part of it may have to betreated as a payment. Compare the debt toyour installment sale basis in the propertybeing sold. If the debt is less than your in-stallment sale basis, none of it is treated asa payment. If it is more, only the difference istreated as a payment. If the buyer assumesmore than one debt, any part of the total thatis more than your installment sale basis isconsidered a payment. These rules are thesame as the rules discussed earlier underBuyer assumes mortgage. However, theyapply to only the following two types of debtsthe buyer assumes.

1) Those acquired from ownership of theproperty you are selling, such as amortgage, lien, overdue interest, or backtaxes.

2) Those acquired in the ordinary courseof your business, such as a balance duefor inventory you purchased.

If the buyer assumes any other type ofdebt, such as a personal loan, it is treated asif the buyer had paid off the debt at the timeof the sale. The value of the assumed debt isconsidered a payment to you in the year ofsale.

Payment of property. If you receive prop-erty rather than money from the buyer, it isstill considered a payment. However, seeTrading property for like-kind property, dis-cussed earlier. The value of the payment isthe property's FMV on the date you receiveit.

Fair market value (FMV). This is theprice at which property would change handsbetween a buyer and a seller, neither beingrequired to buy or sell, and both having rea-sonable knowledge of all the necessary facts.If your installment sale fits this description, thevalue assigned to property in your agreementwith the buyer is good evidence of its FMV.

Third-party note. If the property thebuyer gives you is a third-party note (or otherobligation of a third party), you are consideredto have received a payment equal to thenote's FMV. Because the note is itself a pay-ment on your installment sale, any paymentsyou later receive from the third party are notconsidered payments on your sale.

Example. You sold real estate in an in-stallment sale. As part of the down payment,the buyer assigned to you a $5,000, 8% noteof a third party. The FMV of the third-partynote at the time of your sale was $3,000. Thisamount, not $5,000, is a payment to you inthe year of sale. Because the third-party notehad an FMV equal to 60% of its face value($3,000 ÷ $5,000), 60% of each payment ofprincipal you receive on this note is a non-taxable return of capital. The remaining 40%is ordinary income. Report the interest youreceive in full as ordinary income.

Bond. A bond or other evidence of debtyou receive from the buyer that is payable ondemand is treated as a payment in the yearyou receive it. If you receive a governmentor corporate bond that has interest couponsattached or that can be readily traded in anestablished securities market, you are con-sidered to have received payment equal tothe bond's FMV. Accrual basis taxpayersshould see section 15A.453–1(e)(2) of theregulations.

Buyer's note. The buyer's note (unlesspayable on demand) is not considered pay-ment on the sale. Its full face value is includedwhen figuring the selling price and the con-tract price. Payments you receive on the noteare used to figure your gain in the year youreceive them.

Guarantee. If a third party or governmentagency guarantees the buyer's payments toyou on an installment obligation, the guaran-tee itself is not considered payment.

Unstated interest. An installment sale con-tract generally provides that each deferredpayment on the sale will include interest orthat there will be an interest payment in ad-dition to the principal payment. Interest pro-vided in the contract is called stated interest.

If an installment sale contract with someor all payments due more than one year afterthe date of sale does not provide for interest,part of each payment due more than 6months after the date of sale may be treatedas interest. The amount treated as interest isreferred to as unstated interest.

When the stated interest rate in the con-tract is lower than the applicable federal rate,unstated interest is the difference betweeninterest figured at the federal rate and anyinterest figured at the rate specified in thesales contract.

The applicable federal rates are pub-lished monthly in the Internal Reve-nue Bulletin (IRB). You can get this

information by contacting an IRS office. IRBsare also available on the Internet atwww.irs.gov.

Generally, the unstated interest rules donot apply to a debt given in consideration fora sale or exchange of personal-use property.Personal-use property is any property inwhich substantially all of its use by the buyeris not in connection with a trade or businessor an investment activity.

Selling price ............................................... $9,000Minus: Mortgage ........................................ (6,000)Amount actually received .......................... $3,000Add difference:

Mortgage ................................... $6,000Minus: Installment sale basis ... 5,000 1,000

Contract price .......................................... $4,000

Selling price ................................................. $9,000Minus: Installment sale basis ...................... (5,000)Gross profit ................................................ $4,000

Chapter 12 Installment Sales Page 69

Unstated interest reduces the stated sell-ing price of the property and the buyer's basisin the property. It increases the seller's inter-est income and the buyer's interest expense.

More information. For more information,see Unstated Interest in Publication 537.

Installment Saleof a FarmThe installment sale of a farm for one overallprice under a single contract is not the saleof a single asset. It generally includes the saleof real and personal property that can be re-ported on the installment method. It may alsoinclude the sale of farm inventory, whichcannot be reported on the installment method.See Inventory, earlier. The selling price mustbe allocated to determine the amount re-ceived for each class of asset.

The tax treatment of the gain or loss onthe sale of each class of assets is determinedby its classification as capital asset or prop-erty used in the business, and by the lengthof time held. Separate computations must bemade to figure the gain or loss for each classof asset sold. See Sale of a Farm in chapter10.

If you report the sale of property on theinstallment method, any depreciation recap-ture under section 1245 or 1250 of the Inter-nal Revenue Code is taxable as ordinary in-come in the year of sale. This applies even ifno payments are received in that year.

ExampleOn January 3, 1999, you sold your farm, in-cluding the equipment and livestock (cattleused for breeding). You received $50,000down and the buyer's note for $200,000. Inaddition, the buyer assumed an outstanding$50,000 mortgage on the farm land. The totalselling price was $300,000. The note pay-ments of $25,000 each, plus adequate inter-est, are due every July 1 and January 1, be-ginning in July 1999. Your selling expenseswere $15,000.

Adjusted basis and depreciation. The ad-justed basis and depreciation claimed oneach asset sold are as follows:

Gain on each asset. The following scheduleshows the assets included in the sale, eachasset's selling price based on its respectivevalue, the selling expense allocated to eachasset, the adjusted basis of each asset, andthe gain on each asset. The selling expensefor each asset is 5% of the selling price($15,000 selling expense ÷ $300,000 selling

price). The livestock and produce held forsale were sold before the end of 1998 in an-ticipation of selling the farm. There was nosection 179 deduction claimed on any asset.

Depreciation recapture. The buildings aresection 1250 property. There is no depreci-ation recapture income for them because theywere depreciated using the straight linemethod. See chapter 11 for more informationon depreciation recapture.

The truck used for hauling is section 1245property. The entire depreciation of $3,001 isrecapture income because it is less than thegain on the truck. The remaining gain of $250is reported on the installment method.

The equipment and tractor are section1245 property. The entire gain on each($6,961 and $12,661, respectively) is depre-ciation recapture income.

The cattle used for breeding and held forless than 2 years are section 1245 property.The gain of $2,727 is depreciation recaptureincome to the extent of the depreciationclaimed ($1,977). The remaining gain of $750is reported on the installment method.

The cattle used for breeding and held formore than 2 years are also section 1245property. Since the gain on the cattle of$18,167 is less than the depreciation claimed($19,167), the total gain is depreciation re-capture income.

The total depreciation recapture incomefigured in Part III of Form 4797 is $42,767.(This is the sum of: $3,001 + $6,961 +$12,661 + $1,977 + $18,167.) Depreciationrecapture income is reported as ordinary in-come in the year of sale even if no paymentswere received.

The part of the gains reported as depre-ciation recapture income on the truck and thecattle held less than 2 years ($3,001 and$1,977) is added to their adjusted basis whenmaking the installment sale computations.

Assets not reported on installmentmethod. In the year of sale, the gain on thecattle held 2 years or more, the equipment,and the tractor is reported in full. Because theentire gain on the home can be excluded fromincome, the installment method does not ap-ply to the sale of the home. See Sale of yourhome in chapter 10. The selling price of theseassets ($110,000) is subtracted from the totalselling price ($300,000). The selling price forthe assets included in the installment sale is$190,000.

Installment sale basis and gross profit.The following table shows each asset re-ported on the installment method, its sellingprice, “installment sale basis,” and gross pro-fit.

Section 1231 gains. Since the ordinary in-come part of the gain on the truck is reportedin the year of sale, the remaining gain ($250)and the gain on the land and buildings arereported as section 1231 gains. The cattleheld for less than 2 years do not qualify forsection 1231 treatment. The $750 gain ontheir sale is reported as ordinary gain in PartII of Form 4797 as payments are received.See Section 1231 Gains and Losses inchapter 11.

Contract price and gross profit percent-age. The contract price is $140,000 for thepart of the sale reported on the installmentmethod. This is the selling price ($300,000)minus the mortgage assumed ($50,000) mi-nus the selling price of the assets with gainsfully reported in the year of sale or excludedfrom income ($110,000).

Gross profit percentage for the sale is58.75% ($82,250 gross profit ÷ $140,000contract price). The gross profit percentagefor each asset is figured as follows:

Figuring the gain to report on the install-ment method. Only 56% of each paymentis reported on the installment method[$140,000 contract price ÷ $250,000 to bereceived on the sale ($300,000 selling price− $50,000 mortgage assumed)]. The totalamount received on the installment sale in1999 is $75,000 ($50,000 down payment +$25,000 payment on July 1). The installmentsale part of the total 1999 payments is$42,000 ($75,000 × .56). Figure the gain toreport for each asset by multiplying its grossprofit percentage times $42,000.

Reporting the sale. Report the installmentsale on Form 6252. Then report the amountsfrom Form 6252 on Form 4797 and ScheduleD (Form 1040). Attach a separate page toForm 6252 that shows the computations inthe example.

Section 1231 gains. The gains on theland, buildings, and truck are section 1231gain and may be reported as capital or ordi-nary gain when combined with certain othergains and losses.

Depreciation recapture and gain oncattle. In the year of sale, you must reportthe total depreciation recapture income onForm 4797. The $225 gain on the cattle held

Install-ment

Selling Sale GrossPrice Basis Profit

Farm land ................ $125,000 $67,500 $57,500Buildings ................. 55,000 31,250 23,750

Selling SellingAd-

justed Truck ....................... 5,000 4,750 250Cattle* ..................... 5,000 4,250 750Price Expense Basis Gain

$190,000 $107,750 $82,250Home* $50,000 $2,500 $30,000 $17,500

* Held less than 2 yearsLand 125,000 6,250 61,250 57,500Buildings 55,000 2,750 28,500 23,750Truck 5,000 250 1,499 3,251Equip. 17,000 850 9,189 6,961Tractor 23,000 1,150 9,189 12,661Cattle** 5,000 250 2,023 2,727Cattle*** 20,000 1,000 833 18,167

$300,000 $15,000 $142,483 $142,517

* Owned and used as main home for at least 2 ofthe 5 years prior to the sale** Held less than 2 years***Held 2 years or more

Percent

Farm land ($57,500 ÷ $140,000) ............. 41.0714Buildings ($23,750 ÷ $140,000) ............... 16.9643Truck ($250 ÷ $140,000) .......................... 0.1786Cattle* ($750 ÷ $140,000) ........................ 0.5357Total ......................................................... 58.75

* Held less than 2 years

IncomeDepreciation AdjustedAsset Claimed Basis Farm land—41.0714% × $42,000 ............. $17,250

Buildings—16.9643% × $42,000 ............... 7,125Home* ........................... -0- $30,000Truck—0.1786% × $42,000 ....................... 75Land .............................. -0- 61,250Cattle*—0.5357% × $42,000 ..................... 225Buildings ........................ $31,500 28,500Total installment income for 1999 ......... $24,675Truck ............................. 3,001 1,499

Equipment ..................... 15,811 9,189 * Held less than 2 yearsTractor ........................... 15,811 9,189Cattle** .......................... 1,977 2,023Cattle*** ......................... 19,167 833

* Owned and used as main home for at least 2 ofthe 5 years prior to the sale** Held less than 2 years***Held 2 years or more

Page 70 Chapter 12 Installment Sales

less than 2 years is ordinary income reportedin Part II of Form 4797. See Table 11–1 inchapter 11.

Installment income for years after 1999.You figure installment income for the yearsafter 1999 by applying the same gross profitpercentages to the payments you receiveeach year. If you receive $50,000 during theyear, $28,000 is considered received on theinstallment sale (56% × $50,000). You realizeincome as follows:

For each year you receive payments onthe sale, you can exclude the gain on the saleof your home from your income. You will re-port the gain on cattle held less than 2 yearsas ordinary gain in Part II of Form 4797. Youwill combine your section 1231 gains withcertain other gains and losses in each of thelater years to determine whether to reportthem as ordinary or capital gains. The interestreceived with each payment will be includedin full as ordinary income.

Summary. The installment income(rounded to the nearest dollar) from the saleof the farm is reported as follows:

13.Casualties,Thefts, andCondemnations

IntroductionThis chapter explains the tax treatment ofcasualties, thefts, and condemnations. Acasualty occurs when property is damaged,destroyed, or lost due to a sudden, unex-pected, or unusual event. A theft occurswhen property is stolen. A condemnationoccurs when private property is legally takenfor public use without the owner's consent. Acasualty, theft, or condemnation may result ina deductible loss or taxable gain on yourfederal income tax return. You may have adeductible loss or a taxable gain even if onlya portion of your property was affected by acasualty, theft, or condemnation.

An involuntary conversion occurs whenyou receive money or other property as re-imbursement for a casualty, theft, condem-nation, disposition of property under threat ofcondemnation, or certain other events dis-cussed in this chapter.

If an involuntary conversion results in again, you can postpone reporting of the gainon your income tax return if you buy qualifiedreplacement property within the specified re-placement period. For more information, seePostponing Gain, later.


• Casualties and thefts

• How to figure gain or loss

• Other involuntary conversions

• Postponing gain

• Reporting gains and losses


Publication

� 536 Net Operating Losses


� 547 Casualties, Disasters, and Thefts(Business and Nonbusiness)

� 584 Casualty, Disaster, and TheftLoss Workbook (Personal-UseProperty)


� Sch A (Form 1040) ItemizedDeductions

� Sch D (Form 1040) Capital Gains andLosses


� 4684 Casualties and Thefts



Casualties and TheftsIf your property is destroyed, damaged, orstolen, you may have a deductible loss. If theinsurance or other reimbursement is morethan the adjusted basis of the destroyed,damaged, or stolen property, you may havea taxable gain.

Casualty. A casualty is the damage, de-struction, or loss of property resulting from anidentifiable event that is sudden, unexpected,or unusual.

Deductible losses. Deductible casualtylosses can result from a number of differentcauses, including the following.

• Airplane crashes.

• Car or truck accidents not resulting fromyour willful act or willful negligence.

• Earthquakes.

• Fires.

• Floods.

• Freezing.

• Hurricanes.

• Lightning.

• Shipwrecks.

• Storms.

Nondeductible losses. A casualty lossis not deductible if the damage or destructionis caused by the following.

• Accidentally breaking articles such asglassware or china under normal condi-tions.

• A family pet.

• A fire if you willfully set it, or pay someoneelse to set it.

• A car or truck accident if your willfulnegligence or willful act caused it. Thesame is true if the willful act or willfulnegligence of someone acting for youcaused the accident.

• Progressive deterioration (explainednext).

Progressive deterioration. Loss ofproperty due to progressive deterioration isnot deductible as a casualty loss. This is be-cause the damage results from a steadilyoperating cause or a normal process, ratherthan from a sudden event. Examples ofdamage due to progressive deterioration in-clude damage from rust, corrosion, ortermites. However, weather-related condi-tions or disease may cause another type ofinvoluntary conversion. See Other InvoluntaryConversions, later.

Theft. A theft is the taking and removing ofmoney or property with the intent to deprivethe owner of it. The taking of your propertymust be illegal under the law of the statewhere it occurred and it must have been donewith criminal intent.

Theft includes the taking of money orproperty by the following means.

• Blackmail.

• Burglary.

• Embezzlement.

• Extortion.

• Kidnapping for ransom.

• Larceny.

• Robbery.

• Threats.

The taking of money or property throughfraud or misrepresentation is theft if is illegalunder state or local law.

Mislaid or lost property. The simpledisappearance of money or property is not atheft. However, an accidental loss or disap-pearance of property can qualify as a casualtyif it results from an identifiable event that issudden, unexpected, or unusual.

Example. A car door is accidentallyslammed on your hand, breaking the settingof your diamond ring. The diamond falls fromthe ring and is never found. The loss of thediamond is a casualty.

Income

Farm land—41.0714% × $28,000 ............. $11,500Buildings—16.9643% × $28,000 ............... 4,750Truck—0.1786% × $28,000 ....................... 50Cattle*—0.5357% × $28,000 ..................... 150Total installment income ........................ $16,450

* Held less than 2 years

Selling price ............................................. $190,000Minus: Installment basis .......................... 107,750Gross profit .............................................. $82,250

Gain reported in 1999 (year of sale) ....... $24,675Gain reported in 2000:

$28,000 × 58.75% ............................... 16,450Gain reported in 2001:

$28,000 × 58.75% ............................... 16,450Gain reported in 2002:

$28,000 × 58.75% ............................... 16,450Gain reported in 2003:

$14,000 × 58.75% ............................... 8,225Total gain reported ................................ $82,250

Chapter 13 Casualties, Thefts, and Condemnations Page 71

Farming LossesCertain casualty or theft losses that occur inthe business of farming are deductible losses.The following is a discussion of some lossesyou can deduct and some you cannot deduct.

Livestock or produce purchased for sale.Casualty or theft losses of livestock orproduce bought for sale are deductible if youreport your income on the cash method. If youreport your income on an accrual method,take casualty and theft losses on propertybought for sale by omitting the item from theclosing inventory for the year of the loss. Youcannot take a separate deduction.

Livestock, plants, produce, and cropsraised for sale. Losses of livestock, plants,produce, and crops raised for sale are gen-erally not deductible if you report your incomeon the cash method. You have already de-ducted the cost of raising these items as farmexpenses.

For plants with a preproductive period ofmore than 2 years, you may have a deduct-ible loss if you have a tax basis in the plants.You usually have a tax basis if you capitalizedthe expenses associated with these plantsunder the uniform capitalization rules. Theuniform capitalization rules are discussed inchapter 7.

If you report your income on an accrualmethod, casualty or theft losses are deduct-ible only if you included the items in yourinventory at the beginning of your tax year.You get the deduction by omitting the itemfrom your inventory at the close of your taxyear. You cannot take a separate casualty ortheft deduction.

Income loss. A loss of future income is notdeductible.

Example. An ice storm damaged yourstanding timber by reducing its rate of growthand its quality. The storm did not cause anyphysical damage, but you determined that thetimber will sell for less than you anticipatedbecause of the reduced growth rate andquality. The loss of future income is notdeductible.

Loss of timber. If you sell timber downedby a casualty, treat the proceeds from thesale as a reimbursement. If you use the pro-ceeds to buy qualified replacement property,you can postpone reporting the gain. SeePostponing Gain, later.

Property used in farming. Casualty andtheft losses of property used in the farmbusiness usually result in deductible losses.If a fire or storm destroyed your barn, or youlose by casualty or theft an animal you boughtfor draft, breeding, diary, or sport, you mayhave a deductible loss. See How To Figurea Loss, discussed later.

Raised draft, breeding, dairy, or sport-ing animals. Generally, losses of raised,draft, breeding, dairy, or sporting animals donot result in deductible casualty or theftlosses because you have no basis in the an-imals. However, you may be able to claim adeduction if either of the following situationsapplies to you.

1) You use inventories to determine yourincome and you included the animals inyour inventory.

2) You capitalized the expenses associatedwith the animals under the uniform cap-italization rules and therefore have a taxbasis in the animals that were subject toa casualty or theft.

When you include livestock in inventory,its last inventory value is its basis. When aninventoried animal held for draft, breeding,dairy, or sport is lost by casualty or theft dur-ing the year, decrease ending inventory bythe value at which you included the animal ininventory. You cannot take a separate de-duction.

How To Figure a LossHow you figure a deductible casualty or theftloss depends on whether the loss was to farmor personal-use property and whether theproperty was stolen or partly or completelydestroyed.

Farm property. Farm property is the prop-erty you use in your farming business. If yourfarm property was completely destroyed orstolen, your loss is figured as follows:

Your adjusted basis in the property

MINUS

Any salvage value

MINUS

Any insurance or other reimbursement youreceive or expect to receive

If your farm property was partially dam-aged, use the steps shown under Personal-use property, next, to figure your casualtyloss. But do not apply the deduction limits.

Personal-use property. Personal-use prop-erty is property used by you or your familymembers for personal use. You figure theamount of your casualty or theft loss on thisproperty by using the following steps.

1) Determine your adjusted basis in theproperty before the casualty or theft.

2) Determine the decrease in fair marketvalue of the property as a result of thecasualty or theft.

3) From the smaller of the amounts youdetermined in (1) and (2) subtract anyinsurance or other reimbursement youreceive or expect to receive.

You must apply the deduction limits, dis-cussed later, to determine your deductibleloss.

TIPPublication 584 is available to helpyou make a list of your stolen ordamaged property and figure your

loss. It includes schedules to help you figurethe loss on your home and its contents, andon your motor vehicles.

Adjusted basis. Adjusted basis is yourbasis (usually cost) increased or decreasedby various events, such as improvements andcasualty losses. For more information aboutadjusted basis, see chapter 7.

Decrease in fair market value (FMV).The decrease in FMV is the difference be-tween the property's value immediately beforethe casualty or theft and its value immediatelyafterwards. FMV is defined in chapter 12.

Cost of cleaning up or making repairs.The cost of repairing damaged property is notpart of a casualty loss. Neither is the cost ofcleaning up after a casualty. But you can usethe cost of cleaning up or of making repairsafter a casualty as a measure of the decreasein FMV if you meet all the following condi-tions.

• The repairs are necessary to bring theproperty back to its condition before thecasualty.

• The amount spent for repairs is not ex-cessive.

• The repairs fix only the damage.

• The value of the property after the repairsis not, due to the repairs, more than thevalue of the property before the casualty.

Related expenses. The incidental ex-penses due to a casualty or theft, such asexpenses for the treatment of personal inju-ries, for temporary housing, or for a rental car,are not part of your casualty or theft loss.However, they may be deductible as farmbusiness expenses if the damaged or stolenproperty is farm property.

Separate computations for more thanone item of property. Generally, if a singlecasualty or theft involves more than one itemof property, you must figure your loss sepa-rately for each item of property. Then com-bine the losses to determine your total loss.

CAUTION!

There is an exception for personal-use real property. See Exception forpersonal-use real property, later.

Example. A fire on your farm damageda tractor and the barn in which it was stored.The tractor had an adjusted basis of $3,300.Its FMV was $2,800 just before the fire and$1,000 immediately afterward. The barn hadan adjusted basis of $8,000. Its FMV was$25,000 just before the fire and $15,000 im-mediately afterward. You received insurancereimbursements of $600 on the tractor and$6,000 on the barn. Figure your deductiblecasualty loss separately for the two items ofproperty.

Exception for personal-use real prop-erty. In figuring a casualty loss on personal-use real property, the entire property (includ-ing any improvements, such as buildings,trees, and shrubs) is treated as one item.Figure the loss using the smaller of the fol-lowing.

• The decrease in FMV of the entire prop-erty.

• The adjusted basis of the entire property.

Example. You bought a farm in 1960 for$20,000. The adjusted basis of the residentialpart is $6,000. In 1999, a windstorm blew

Trac-tor Barn

1) Adjusted basis .......................... $3,300 $8,0002) FMV before fire ........................ $2,800 $25,0003) FMV after fire ........................... 1,000 15,0004) Decrease in FMV (2 minus 3) .. $1,800 $10,0005) Loss (lesser of 1 or 4) .............. $1,800 $8,0006) Minus: Insurance ...................... 600 6,0007) Deductible casualty loss ....... $1,200 $2,0008) Total loss .............................................. $3,200

Page 72 Chapter 13 Casualties, Thefts, and Condemnations

down shade trees and three ornamental treesplanted at a cost of $600 on the residentialpart. The adjusted basis of the residential partincludes the $600. The fair market value(FMV) of the residential part immediately be-fore the storm was $30,000, and $26,000immediately after the storm. The trees werenot covered by insurance.

Insurance and other reimbursements. Ifyou receive an insurance or other type of re-imbursement, you must subtract the re-imbursement when you figure your loss. Youdo not have a casualty or theft loss to theextent you are reimbursed.

CAUTION!

Do not subtract insurance paymentsfor living expenses from your loss.You may have to include these pay-

ments in your income. See Publication 547 fordetails.

If you expect to be reimbursed for part orall of your loss, you must subtract the ex-pected reimbursement when you figure yourloss. You must reduce your loss even if youdo not receive payment until a later tax year.

Reimbursement in a later year. If youfigured your casualty or theft loss using yourexpected reimbursement, you may have toadjust the tax return for the tax year in whichyou get your actual reimbursement.

Actual reimbursement less than ex-pected. If you later receive less reimburse-ment than you expected, include that differ-ence as a loss with your other losses (if any)on your return for the year in which you canreasonably expect no more reimbursement.

Actual reimbursement more than ex-pected. If you later receive more reimburse-ment than you expected after you haveclaimed a deduction for the loss, you mayhave to include the extra reimbursement inyour income for the year you receive it.However, if any part of your original deductiondid not reduce your tax for the earlier year,do not include that part of the reimbursementin your income. You do not refigure your taxfor the year you claimed the deduction. SeeRecoveries in Publication 525 to find out howmuch extra reimbursement to include in in-come.

CAUTION!

If the total of all the reimbursementsyou receive is more than your ad-justed basis in the destroyed or stolen

property, you will have a gain on the casualtyor theft. If you have already taken a deductionfor a loss and you receive the reimbursementin a later year, you may have to include thegain in your income for the later year. Includethe gain as ordinary income up to the amountof your deduction that reduced your tax for theearlier year. See Publication 547 for more in-formation on how to treat a gain from the re-imbursement of a casualty or theft.

Actual reimbursement same as ex-pected. If you receive exactly the re-imbursement you expected to receive, youdo not have any amount to include in yourincome or any loss to deduct.

Lump-sum reimbursement. If you havea casualty or theft loss of several assets atthe same time without an allocation of re-imbursement to specific assets, divide thelump-sum reimbursement among the assetsaccording to the fair market value of eachasset at the time of the loss. Figure the gainor loss separately for each asset that has aseparate basis.

Adjustments to basis. If you have a casu-alty or theft loss, you must decrease yourbasis in the property by any insurance orother reimbursement you receive and by anydeductible loss. The result is your adjustedbasis in the property. Amounts you spend torestore your property after a casualty increaseyour adjusted basis. See Adjusted Basis inchapter 7 for more information.

Deduction Limits on Lossesof Personal-Use PropertyCasualty and theft losses of property held forpersonal use may be deductible if you itemizedeductions on Schedule A (Form 1040).

There are two limits on the amount youcan deduct for your casualty or theft loss ofpersonal-use property. You figure these limitson Form 4684.

$100 rule. You must reduce each casualtyor theft loss on personal-use property by$100. This $100 rule applies after you havesubtracted any reimbursement.

10% rule. You must further reduce the totalof all your casualty of theft losses onpersonal-use property by 10% of your ad-justed gross income. Apply this rule after youreduce each loss by $100. Adjusted grossincome is on line 33 of Form 1040.

Example. In June, you discovered thatyour house had been burglarized. Your lossafter insurance reimbursement was $2,000.Your adjusted gross income is $29,500. Fig-ure your theft loss as follows:

You do not have a theft loss deductionbecause your loss ($1,900) is less than 10%of your adjusted gross income ($2,950).

CAUTION!

If you have a casualty or theft gain inaddition to a loss, you will have tomake a special computation to figure

your 10% limit. See 10% Rule in Publication547.

When Loss Is DeductibleCasualty losses are generally deductible onlyin the year in which they occur. Theft lossesare generally deductible only in the year theyare discovered. However, see Disaster AreaLosses, later.

Leased property. If you lease property fromsomeone else, you can deduct a loss on theproperty in the year your liability for the lossis fixed. This is true even if the loss occurredor the liability was paid in a different year. Youare not entitled to a deduction until your li-ability under the lease can be determined withreasonable accuracy. Your liability can beascertained with reasonable accuracy when

a claim for recovery is settled, adjudicated,or abandoned.

Example. Robert leased a tractor fromFirst Implement, Inc. for use in his farm busi-ness. The tractor was destroyed by a tornadoin June 1999. The loss was not insured. FirstImplement billed Robert for the fair marketvalue of the tractor on the date of the loss.Robert disagreed with the amount of the li-ability. First Implement later filed a suit incourt against Robert. In 2000, Robert andFirst Implement agreed to settle the suit for$20,000, and the court entered a judgementin favor of First Implement. Robert paid$20,000 in June 2000. He can claim the$20,000 as a loss on his 2000 tax return.

Net operating loss (NOL). If your de-ductions, including casualty or theft loss de-ductions, are more than your income for theyear, you may have an NOL. An NOL can becarried back or carried forward and deductedfrom income in other years. See chapter 5 formore information on NOLs.

Proof of LossTo deduct a casualty or theft loss, you mustbe able to prove that there was a casualty ortheft. You must be able to support the amountyou claim for the loss.

Casualty. For a casualty loss, your recordsshould show all of the following.

• The type of casualty (car accident, fire,storm, etc.) and when it occurred.

• That the loss was a direct result of thecasualty.

• That you were the owner of the propertyor, if you leased the property fromsomeone else, that you werecontractually liable to the owner for thedamage.

Theft. For a theft, your records should showall of the following.

• When you discovered that your propertywas missing.

• That your property was stolen.

• That you were the owner of the property.

Figuring a GainIf you receive insurance or other reimburse-ment that is more than your adjusted basis inthe destroyed, damaged, or stolen property,you have a gain from the casualty or theft.You generally report your gain as income inthe year you receive the reimbursement.However, depending on the type of propertyyou receive, you may not have to report yourgain. See Postponing Gain, later.

Your gain is figured as follows:

• The amount you receive, minus

• Your adjusted basis in the property at thetime of the casualty or theft.

Even if the decrease in FMV of yourproperty is smaller than the adjusted basis ofyour property, use your adjusted basis to fig-ure the gain.

Amount you receive. The amount you re-ceive includes any money plus the value ofany property you receive, minus any ex-penses you have in obtaining reimbursement.

1) Adjusted basis ....................................... $6,0002) FMV before the storm ........................... $30,0003) FMV after the storm .............................. 26,0004) Decrease in FMV (line 2 minus line 3) . $4,0005) Loss before insurance(lesser of line 1 or line 4) .......................... $4,0006) Minus: Insurance ................................... –0–7) Amount of loss .................................... $4,000

1. Loss after insurance ................................ $2,0002. Subtract $100 .......................................... 1003. Loss after $100 rule ................................ $1,9004. Subtract 10% of $29,500 AGI ................. $2,9505. Theft loss deduction ............................. –0–


It also includes any reimbursement used topay off a mortgage or other lien on the dam-aged, destroyed, or stolen property.

Example. A tornado severely damagedyour barn. The adjusted basis of the barn was$2,500. Your insurance company reimbursedyou $4,000 for the damaged barn. However,you had legal expenses of $200 to collect thatinsurance. Since your insurance minus yourexpenses to collect the insurance is morethan your adjusted basis in the barn, you havea gain.

Other InvoluntaryConversionsIn addition to casualties and thefts, there areother events that cause involuntary conver-sions of property. Some of these are de-scribed in the following paragraphs.

Gain or loss from an involuntary conver-sion of your property is usually recognized fortax purposes. You report the gain or deductthe loss on your tax return for the year yourealize it. However, depending on the type ofproperty you receive, you may not have toreport your gain on the involuntary conver-sion. See Postponing Gain, later.

CondemnationCondemnation is the process by which privateproperty is legally taken for public use withoutthe owner's consent. The property may betaken by the federal government, a stategovernment, a political subdivision, or a pri-vate organization that has the power to legallytake property. The owner receives a con-demnation award (money or property) in ex-change for the property taken. A condemna-tion is like a forced sale, the owner being theseller and the condemning authority being thebuyer.

For information on how to figure the gainor loss on condemned property, see chapter1 in Publication 544. Also see PostponingGain, later, to find out if you can postponereporting the gain.

Threat of condemnation. Treat the sale ofyour property under threat of condemnationas a condemnation.

Main home condemned. If you have a gainbecause your main home is condemned, yougenerally can exclude the gain from your in-come as if you had sold or exchanged yourhome. For information on this exclusion, seePublication 523, Selling Your Home. If yourgain is more than the amount you can ex-clude, but you can buy replacement property,you may be able to postpone the excess gain.See Postponing Gain, later. (You cannotdeduct a loss from the condemnation of yourmain home.)

Irrigation ProjectProperty located within an irrigation projectand sold or otherwise disposed of to conformto the acreage limits of federal reclamationlaws is an involuntary conversion.

Livestock Losses

Diseased livestock. If livestock die fromdisease, or are destroyed, sold, or exchangedbecause of disease, even though the diseaseis not of epidemic proportions, treat theseoccurrences as involuntary conversions. If thelivestock was raised or purchased for resale,follow the rules for livestock discussed earlierunder Farming Losses. Otherwise, figure thegain or loss from these conversions using therules discussed under Determining Gain orLoss in chapter 10. If you replace the live-stock, you may be able to postpone reportingthe gain. See Postponing Gain, later.

Reporting dispositions of diseasedlivestock. If you choose to postpone gainon the disposition of diseased livestock, youmust attach a statement to your return ex-plaining that the livestock was disposed ofbecause of disease. You must also includeother information on this statement. See HowTo Postpone Gain, later under PostponingGain.

Weather-related sales of livestock. If solelybecause of drought, flood, or other weather-related conditions you sell or exchange live-stock (other than poultry) held for draft,breeding, or dairy purposes, treat the sale orexchange as an involuntary conversion. Onlylivestock sold in excess of the number younormally would sell under usual businesspractice, in the absence of weather-relatedconditions, are considered involuntary con-versions. Figure the gain or loss using therules discussed under Determining Gain orLoss in chapter 10. If you replace the live-stock, you may be able to postpone reportingthe gain. See Postponing Gain, later.

Example. Under your usual businesspractice you sell five of your dairy animalsduring the year. This year you sold 20 dairyanimals because of drought. The sale of 15animals is treated as an involuntary conver-sion.

TIPIf you do not replace the livestock, youmay be able to report the gain in thefollowing year's income. This rule also

applies to poultry. See Sales Caused byWeather-Related Conditions in chapter 4.

Reporting weather-related sales oflivestock. If you choose to postpone the gainon weather-related sales of livestock, showall of the following information on a statementattached to your return for the tax year inwhich you first realize any of the gain.

• Evidence of the weather-related condi-tions that forced the sale or exchange ofthe livestock.

• The gain realized on the sale or ex-change.

• The number and kind of livestock sold orexchanged.

• The number of livestock of each kind youwould have sold or exchanged underyour usual business practice.

Show all of the following information onthe return for the year in which you replacethe livestock.

• The date you bought replacement live-stock.

• The cost of the replacement livestock.

• The number and kind of the replacementlivestock.

Tree SeedlingsIf, because of an abnormal drought, the fail-ure of planted tree seedlings is greater thannormally anticipated, you may have adeductible loss. The loss equals the previ-ously capitalized reforestation costs you hadto duplicate on replanting. You deduct theloss on the return for the year the seedlingsdied.

Postponing GainDo not report a gain if you receive re-imbursement in the form of property similaror related in service or use to the destroyed,stolen, or other involuntarily converted prop-erty. Your basis in the new property is thesame as your adjusted basis in the propertyit replaces.

You must ordinarily report the gain on yourstolen, destroyed, or other involuntarily con-verted property if you receive money or unlikeproperty as reimbursement. But you canchoose to postpone reporting the gain if youpurchase replacement property that is similaror related in service or use to your destroyed,stolen, or other involuntarily converted prop-erty within a specific replacement period.

To postpone all the gain, the cost of yourreplacement property must be at least asmuch as the reimbursement you receive. Ifthe cost of the replacement property is lessthan the reimbursement, you must include thegain in your income up to the amount of theunspent reimbursement.

Replacement PropertyYou must buy replacement property for thespecific purpose of replacing your property.Your replacement property must be similaror related in service or use to the property itreplaces. You do not have to use the samefunds you receive as reimbursement for yourold property to acquire the replacementproperty. If you spend the money you receivefor other purposes, and borrow money to buyreplacement property, you can still choose topostpone the gain if you meet the other re-quirements. Property you acquire as a giftor inheritance does not qualify as replace-ment property.

Buying replacement property from a re-lated person. You cannot postpone report-ing a gain from a casualty, theft, or other in-voluntary conversion if you buy thereplacement property from a related person(discussed later). This rule applies to invol-untary conversions occurring after the fol-lowing dates.

1) February 5, 1995, for C corporations andpartnerships in which more than 50% ofthe capital or profits interest is owned byC corporations.

1) Insurance reimbursement ...................... $4,0002) Legal expenses ..................................... 2003) Amount received.Subtract line 2 from line 1 ......................... $3,8004) Adjusted basis ....................................... 2,5005) Gain on casualty (line 3 − line 4) ....... $1,300

Page 74 Chapter 13 Casualties, Thefts, and Condemnations

2) June 8, 1997, for individuals, partner-ships —other than those in (1) above—and S corporations if the total realizedgain for the tax year on all involuntarilyconverted properties on which there arerealized gains is more than $100,000.

For involuntary conversions described in (2)above, gains cannot be offset with any losseswhen determining whether the total gain ismore than $100,000. If the property is ownedby a partnership, the $100,000 limit appliesto the partnership and each partner. If theproperty is owned by an S corporation, the$100,000 limit applies to the S corporationand each shareholder.

Exception. This rule does not apply if therelated persons acquired the property froman unrelated person within the period of timeallowed for replacing the involuntarily con-verted property.

Related persons. Under this rule, re-lated persons include, for example, a corpo-ration and an individual who owns more than50% of its outstanding stock, and two part-nerships in which the same C corporationsown more than 50% of the capital or profitsinterests. For more information on relatedpersons, see Nondeductible Loss underSales and Exchanges Between Related Per-sons in chapter 2 of Publication 544.

Owner-user. If you are an owner-user,“similar or related in service or use” meansthat replacement property must function in thesame way as the property it replaces. Exam-ples of property that functions in the sameway as the property it replaces are a homethat replaces another home, a dairy cow thatreplaces another dairy cow, and farm landthat replaces other farm land. A passengerautomobile that replaces a tractor does notqualify. Neither does a breeding cow that re-places a dairy cow.

Soil or environmental contamination. If,because of soil or environmental contam-ination, it is not practical for you to reinvestyour insurance money from destroyed live-stock in property similar or related in serviceor use to the livestock, you can treat otherproperty, including real property used forfarming purposes, as property similar or re-lated in service or use to the destroyed live-stock.

Standing crop destroyed by casualty. If astorm or other casualty destroyed yourstanding crop and you use the insurancemoney to acquire either another standing cropor a harvested crop, this purchase qualifiesas replacement property. The cost of plantinga new crop does not qualify as a replacementfor the destroyed crop, unless you use thecrop method of accounting (discussed inchapter 3). In this case, the costs of bringingthe new crop to the same level of maturity asthe destroyed crop qualify as replacementcosts.

Timber loss. Standing timber you boughtwith the proceeds from the sale of timberdowned by a casualty, such as high winds,earthquakes, or volcanic eruptions, qualifiesas replacement property. If you bought thestanding timber within the replacement pe-riod, you can postpone reporting the gain.

Business or income-producing propertylocated in a federal disaster area. If yourdestroyed business or income-producingproperty was located in a federally declareddisaster area, any tangible replacementproperty you acquire for use in a business istreated as similar or related in service or useto the destroyed property. For more informa-tion, see Disaster Area Losses in Publication547.

Substituting replacement property. Onceyou have acquired qualified replacementproperty that you designate as replacementproperty, you cannot substitute other qualifiedreplacement property. The designation ismade by the statement with your return re-porting that you have acquired replacementproperty. However, if you discover that theoriginal replacement property was not qual-ified replacement property, you can, within thereplacement period, substitute the new qual-ified replacement property.

Taxpayer's death. If a taxpayer dies afterhaving a gain, but before buying replacementproperty, the gain must be reported for theyear in which the decedent realized the gain.The executor of the estate or the personsucceeding to the funds from the casualty ortheft cannot postpone the gain by buying re-placement property.

Replacement PeriodTo postpone reporting your gain, you mustbuy replacement property within a specifiedperiod of time. This is the replacement period.

The replacement period begins on thedate your property was damaged, destroyed,stolen, sold, or exchanged. The replacementperiod ends 2 years after the close of the firsttax year in which you realize any part of yourgain from the involuntary conversion.

Condemnation. The replacement period fora condemnation begins on the earlier of thefollowing dates.

• The date on which you disposed of thecondemned property.

• The date on which the threat of condem-nation began.

The replacement period ends 2 years af-ter the close of the first tax year in which anypart of the gain on the condemnation is real-ized.

If real property held for use in a trade orbusiness or for investment (not includingproperty held primarily for sale) is con-demned, the replacement period ends 3years after the close of the first tax year inwhich any part of the gain on the condemna-tion is realized.

Extension. You may get an extension of thereplacement period if you apply to the DistrictDirector of the Internal Revenue Service foryour area. Include all the details about yourneed for an extension. Make your applicationbefore the end of the replacement period.However, you can file an application within areasonable time after the replacement periodends if you can show a good reason for thedelay. You will get an extension of the re-placement period if you can show reasonablecause for not making the replacement withinthe regular period.

How To Postpone GainYou postpone your gain by reporting yourchoice on your tax return for the year youhave the gain. You have the gain in the yearyou receive insurance proceeds or other re-imbursements that result in a gain.

Required statement. You should attach astatement to your return for the year you havethe gain. This statement should include all ofthe following information.

• The date and details of the casualty, theft,or other involuntary conversion.

• The insurance or other reimbursementyou received.

• How you figured the gain.

Replacement property acquired beforereturn filed. If you acquire replacementproperty before you file your return for theyear you have the gain, your statementshould also include detailed information aboutall of the following.

• The replacement property.

• The postponed gain.

• The basis adjustment that reflects thepostponed gain. (Reduce the basis of thereplacement property by the amount ofpostponed gain.)

• Any gain you are reporting as income.

Replacement property acquired afterreturn filed. If you intend to buy replacementproperty after you file your return for the yearyou realize gain, your statement should alsosay that you are choosing to replace theproperty within the required replacement pe-riod.

You then attach another statement to yourreturn for the year in which you buy the re-placement property. Show in this statementdetailed information on the replacementproperty. If you acquire part of your replace-ment property in one year and part in anotheryear, you must make a statement for eachyear. Include in the statement detailed infor-mation on the replacement property boughtin that year.

Amended return. You must file an amendedreturn (Form 1040X) for the tax year of thegain in either of the following situations.

• You do not acquire replacement propertywithin the replacement period. On thisamended return, you must report the gainand pay any additional tax due.

• You acquire replacement property withinthe required replacement period but at acost less than the amount you receivefrom the casualty, theft or other involun-tary conversion. On this amended returnyou must report the portion of the gainthat cannot be postponed and pay anyadditional tax due.

Disaster Area LossesThere are special rules that apply toPresidentially declared disaster area losses.A Presidentially declared disaster is a dis-aster that occurred in an area declared by thePresident to be eligible for federal assistance


under the Disaster Relief and EmergencyAssistance Act.

This part discusses the special rules forwhen to deduct a disaster area loss and theabatement of interest on tax underpayments.For other special rules, see Publication 547.

When to deduct disaster area losses. Ifyou have a deductible loss from aPresidentially declared disaster area, you canelect to deduct that loss on your return oramended return for the immediately preced-ing tax year. If you make this election, the lossis treated as having occurred in the precedingyear.

TIPClaiming a qualifying disaster loss onthe previous year's return may resultin a lower tax for that year, often

producing or increasing a cash refund.

You must make this election to take yourcasualty loss for the disaster in the precedingyear by the latest of the following dates.

• The due date (without extensions) for fil-ing your tax return for the tax year inwhich the disaster actually occurred.

• The due date (with extensions) for thereturn for the preceding tax year.

• If you timely filed the return for the pre-ceding tax year, the date that is 6 monthsafter the due date of the return (withoutextensions). (If you use this date to makethe election, write, “Filed pursuant tosection 301.9100–2” at the top of theamended return and file it at the sameaddress you used for your original re-turn.)

Interest abatement on underpayments indisaster areas. The IRS will abate interest forthe length of the extension period granted toall taxpayers who meet both of the followingrequirements.

1) They were located in an area declareda disaster area by the President.

2) They were granted extensions to file in-come tax returns and pay income tax.

Reporting Gainsand LossesYou will have to file one or more of the fol-lowing forms to report your gains or lossesfrom involuntary conversions.

Form 4684. Use this form to report yourgains and losses from casualties and thefts.

Form 4797. Use this form to report involun-tary conversions (other than from casualty ortheft) of property used in your trade or busi-ness and capital assets held in connectionwith a trade or business or a transaction en-tered into for profit.

Schedule A (Form 1040). Use this form todeduct your losses from casualties and theftsof personal-use property that you reported onForm 4684.

Schedule D (Form 1040). Use this form toreport gain from an involuntary conversion(other than from casualty or theft) of

personal-use property. Also, carry over fromForm 4797 any net gain from an involuntaryconversion of business property held for morethan 1 year.

Schedule F (Form 1040). Use this form todeduct your losses from casualty or theft oflivestock or produce bought for sale underOther expenses in Part II, line 34, if you usethe cash method of accounting and have nototherwise deducted these losses.

14.AlternativeMinimum Tax

Important ReminderDeferred payment (installment) sales andalternative minimum tax (AMT). For taxyears beginning after December 31, 1986, theinstallment method is allowed for both theregular tax and the AMT for deferred paymentsales of property used or produced in afarming business and held primarily for saleto customers. You may choose to begin ap-plying the installment method for the AMT tosales entered into in the 1999 tax year. Noadjustment should be made on Form 6251 forthese sales. Any income you reported in1999 for regular tax purposes from a prioryear installment sale, and that was reportedfor AMT purposes in a prior tax year, shouldbe reported as a negative amount on Form6251. Alternatively, if you wish to make thischange in a prior tax year, you may file Form1040X, Amended U.S. Individual Income TaxReturn, to amend the return for any earlieropen tax year after which there is no closedtax year.

If you choose to file an amended return totake advantage of the retroactive change, youshould not apply the installment method forthe AMT to sales entered into prior to theearliest tax year for which you are filing anamended return. You should apply the in-stallment method for the AMT only to install-ment sales entered into in the earliest tax yearfor which you are filing an amended returnand all subsequent tax years. You should re-port as a negative AMT adjustment on theearliest year amended return any income re-ported in such tax year for regular tax pur-poses from an installment sale that was re-ported in an earlier tax year for AMTpurposes. No adjustment should be made forany tax year subsequent to the earliest yearfor which an amended return was filed. Ad-ditionally, if you file an amended return, youmust recalculate the AMT credit earned forthe year.

IntroductionThe tax laws give special treatment to sometypes of income, allow special deductions forsome types of expenses, and allow credits forcertain taxpayers. These laws enable some

taxpayers with substantial economic incometo significantly reduce their regular tax. Thealternative minimum tax (AMT) ensures thatthese taxpayers pay at least a minimumamount of tax on their economic income.

This chapter discusses the AMT for indi-viduals. For information about the AMT forcorporations, see Publication 542, Corpo-rations.


• Whether to fill in Form 6251

• What records you must keep

• When you can take a credit for prior yearminimum tax




� Sch A (Form 1040) Itemized De-ductions

� 6251 Alternative MinimumTax—Individuals

� 8801 Credit for Prior Year MinimumTax—Individuals, Estates, andTrusts


Do You Need To Fill InForm 6251?Individuals use Form 6251 to figure theamount, if any, of their AMT, and to figure anycredit limitations. If you claimed or receivedany of the following items, fill in Form 6251.

1) Accelerated depreciation.

2) Income or (loss) from tax-shelter farmactivities or passive activities.

3) Net operating loss deduction.

4) Income from incentive stock options.

5) Tax-exempt interest from private activitybonds.

6) Intangible drilling, circulation, research,experimental, or mining costs.

7) Amortization of pollution-control facilitiesor depletion.

8) Percentage-of-completion income fromlong-term contracts.

9) Interest paid on a home mortgage notused to buy, build, or substantially im-prove your home.

10) Investment interest expense reported onForm 4952.

11) AMT adjustments from an estate, trust,electing large partnership, or a cooper-ative.

12) Section 1202 exclusion.

After you fill in Form 6251, see Who Must Filein the form instructions to see if you need toattach it to your tax return.

Page 76 Chapter 14 Alternative Minimum Tax

4.

Next: Is the amount on line 12 more than the amount on line 13?

2.

1.

Table 14–1. Worksheet To See If You Should Fill In Form 6251(Keep for your records)

Enter the amount from Form 1040, line 37

Add lines 1 through 4 above

Enter the amount shown below for your filing status:

Enter the amount shown below for your filing status:

Is the amount on line 5 more than the amount on line 8?

Multiply line 9 by 25% (.25) and enter the result but do not enter more than line 6 above

Add lines 7 and 10

Is the amount on line 11 more than the amount shown below for your filing status?

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

3.

5.

6.

8.

9.

10.

Is the amount on line 5 more than the amount on line 6?

Are you filing Schedule A?

Enter the smaller of the amount on Schedule A, line 4, or 2.5% (.025) of the amount on Form 1040, line 34

Add lines 9 and 26 of Schedule A and enter the total

11.

12.

11.

12.

Before you begin: � Be sure you have read Do You Need To Fill In Form 6251? before using thisworksheet.

Yes. Leave line 2 blank and go to line 3.

No. Enter your standard deduction from Form 1040, line 36, and go to line 5

Enter the amount from Form 1040, line 40, minus the total of any tax from Form 4972 and any amount onForm 1040, line 46 13.

13.

Yes. Fill in Form 6251 to see if you owe the alternative minimum tax.

No. Do not fill in Form 6251.

● Married filing jointly or qualifying widow(er)—$45,000

● Married filing separately—$22,500

● Single or head of household—$33,750 �

7.

No. You do not need to fill in Form 6251.STOP

Yes. Subtract line 6 from line 5

● Married filing jointly or qualifying widow(er)—$150,000● Married filing separately—$75,000● Single or head of household—$112,500 �

No. Enter -0- here and on line 10 and go to line 11.

Yes. Subtract line 8 from line 5. �

● Single, married filing jointly, head of household, or qualifying widow(er)—$175,000

● Married filing separately—$87,500

Yes. Fill in Form 6251 to see if you owe the alternative minimum tax.STOP

No. Multiply line 11 by 26% (.26)

Child under age 14. Fill in Form 6251 for achild under age 14 if the child's adjustedgross income from Form 1040, line 34, ex-ceeds the child's earned income by more than$5,100.

Worksheet. Even if your return is not af-fected by any of the items listed above, youmay have to complete Form 6251. Fill in theTable 14–1 worksheet to see if you shouldcomplete Form 6251.

Earned income credit. If you have anearned income credit, you must reduce it byany AMT.

What Records MustYou Keep?

RECORDS

Because of AMT adjustments, youmay have a different AMT basis incertain property or activities. Because

your AMT basis may affect the computationof AMT in future tax years, you may need tofigure the adjustments that affect basis, eventhough you do not owe AMT this year. Youshould keep a separate record of your AMTadjusted basis, including an AMT depreci-ation schedule.

Carrybacks and carryovers of certain de-ductions and credits may have to be refiguredfor AMT purposes. You should keep a sepa-rate record of these AMT carrybacks andcarryovers to assist you in preparing your re-turn in other years.

When Can You Take aCredit for Prior YearMinimum Tax?You may be able to take a credit against yourregular tax on your 1999 tax return if any ofthe following apply.

1) You paid AMT in 1998.

2) You had a minimum tax creditcarryforward from 1998 to 1999.

3) You had an unallowed nonconventionalsource fuel credit or qualified electricvehicle credit not allowed for 1998.

Individuals use Form 8801 to figure theamount, if any, of their minimum tax credit,and to figure any minimum tax creditcarryforward.

Chapter 14 Alternative Minimum Tax Page 77

Reduction for canceled debt. You mayhave to reduce the credit if you exclude fromincome a canceled debt from any of the fol-lowing.

1) A bankruptcy case.

2) Insolvency.

3) Qualified farm debt.

You must reduce the amount available atthe beginning of the year after the debt wascanceled before preparing Form 8801 for thatyear. For more information, see Cancellationof Debt in chapter 4.

15.Self-EmploymentTax

Important Changefor 1999Tax rates and maximum net earnings forself-employment tax. The maximum netself-employment earnings subject to the so-cial security part (12.4%) of the self-employ-ment tax increased to $72,600 for 1999.There is no maximum limit on earnings sub-ject to the Medicare part (2.9%).

Important Changefor 2000Tax rates and maximum net earnings forself-employment tax. The maximum netself-employment earnings subject to the so-cial security part of the self-employment taxwill be published in Publications 533 and 553.There is no maximum limit on earnings sub-ject to the Medicare part.

IntroductionThe self-employment tax (SE tax) is a socialsecurity and Medicare tax for individuals whowork for themselves. It is similar to the socialsecurity and Medicare taxes withheld from thepay of wage earners.

You usually have to pay SE tax if you areself-employed. You are usually self-employed if you operate your own farm onland you either own or rent. You have to fig-ure SE tax on Schedule SE (Form 1040).

Farmers who have employees may haveto pay the employer's share of social securitytax, as well. See chapter 16 for informationon employment taxes.


• Who must pay self-employment tax

• Self-employment income

• Landlord participation in farming

• Figuring self-employment tax

• Reporting self-employment tax


Publication

� 533 Self-Employment Tax

� 541 Partnerships


� SS–5 Application for a Social SecurityCard



� Sch SE (Form 1040) Self-EmploymentTax

� 1065 U.S. Partnership Return of In-come

� Sch K–1 (Form 1065) Partner's Shareof Income, Credits, Deductions,etc.


General InformationSocial security benefits. Social securitycoverage provides you with retirement bene-fits, disability benefits, survivor benefits, andhospital insurance (Medicare) benefits. Yourpayments of self-employment tax (SE tax)contribute to your coverage under the socialsecurity system. Social security benefits areavailable to self-employed persons just asthey are to wage earners.

Credits. You must be insured under thesocial security system before you begin re-ceiving social security benefits. You are in-sured if you have the required number ofcredits (quarters of coverage).

For 1999, you received one credit for each$740 of income subject to social security tax.It does not matter whether the income isearned in one quarter or is spread over twoor more quarters. The maximum number ofcredits you can receive for the year is four.Therefore, for 1999, if you had income (self-employment and wages) of $2,960 that wassubject to social security taxes, you receivedfour credits ($2,960 ÷ 740).

For an explanation of the number ofcredits you must have to be insured and thebenefits available to you and your family un-der the social security program, consult yournearest Social Security Administration (SSA)office.

CAUTION!

You may be subject to penalties formaking false statements to get or in-crease social security benefits.

Social security number. You must have asocial security number to pay SE tax. If youdo not have a number, apply for one on FormSS–5, Application for a Social Security Card.You can get this form at any Social Securityoffice or by calling 1–800–772–1213.

If you have a social security number fromthe time you were an employee, do not applyagain.

If you have a number but lost your card,file Form SS–5. You will get a new cardshowing your original number, not a newnumber.

If your name has changed since you re-ceived your social security card, completeForm SS–5 to report a name change.

Social Security Administration (SSA) timelimit for posting self-employment income.Generally, the SSA will give you credit onlyfor self-employment income reported on a taxreturn filed within 3 years, 3 months, and 15days after the year you earned the income.If you file your tax return or report a changein your self-employment income after this timelimit, the SSA may change its records, butonly to remove or reduce the amount. TheSSA will not change its records to increasethe amount of your self-employment income.

Estimated tax. You may have to pay esti-mated tax. This depends on how much in-come tax and SE tax you expect to owe forthe year and how much tax will be withheldfrom your income.

You may have to pay a penalty if you donot pay enough estimated tax by its due date.

You must include the estimated SE tax inyour estimated tax payments. However, if atleast two-thirds of your gross income in 1998or 1999 is from farming and you file yourForm 1040 and pay all of the tax that is dueby March 1, 2000, you do not have to pay anyestimated tax. See chapter 2 for more infor-mation about estimated tax.

Self-employment tax deduction. You candeduct half of your SE tax in figuring youradjusted gross income. This adjustment onlyaffects your income. It does not affect eitheryour net earnings from self-employment oryour SE tax.

To deduct the tax, enter on Form 1040,line 27, the amount shown on the “One-halfof self-employment tax” line of Schedule SE.

Who Must PaySelf-Employment TaxYou must pay SE tax and file Schedule SE ifyou were self-employed and your netearnings from self-employment were $400 ormore.

Who is self-employed? You are self-employed if you carry on a trade or business(such as running a farm) as a sole proprietor,an independent contractor, a member of apartnership, or are otherwise in business foryourself. A trade or business is generally anactivity carried on for a livelihood or in goodfaith to make a profit.

CAUTION!

The SE tax rules apply even if you arefully insured under social security orhave started receiving benefits.

Share farmers. You are a self-employedfarmer under an income-sharing arrangementif both of the following apply.

1) You produce a crop or raise livestock onland belonging to another person.

Page 78 Chapter 15 Self-Employment Tax

2) Your share of the crop or livestock, or theproceeds from their sale, depends on theamount produced.

Your income from the income-sharing ar-rangement is your SE income.

If you produce a crop or livestock on landbelonging to another person and are to re-ceive a specified rate of pay, a fixed sum ofmoney, or a fixed quantity of the crop or live-stock, and not a share of the crop or livestockor their proceeds, you may be either self-employed or an employee of the landowner.This will depend on whether the landlord hasthe right to direct or control your performanceof service.

Example. A share farmer produces acrop on land owned by another person, on a60–40 crop-share basis. Under the terms oftheir agreement, the share farmer furnishesthe labor and half the cost of seed andfertilizer. The landowner furnishes the ma-chinery and equipment used to produce andharvest the crop, and half the cost of seedand fertilizer. The share farmer is provided ahouse in which to live. The landowner and theshare farmer decide how much of the tractshould be planted in cotton and how much inother crops. In addition, the landowner is inthe hog business and the share farmeragrees to take care of the landowner's hogsin return for ten hogs. The landowner fur-nishes the feed and other necessities andsupervises the care of the hogs.

The share farmer is a self-employedfarmer for purposes of the agreement toproduce the cotton and other crops, and theshare farmer's part of the income from thecrops is SE income. The share farmer is anemployee for the services performed in caringfor the landowner's hogs. The fair marketvalue of the ten hogs received is not SE in-come but it is taxable for income tax pur-poses.

4-H Club or FFA project. If your child par-ticipates in a 4-H Club or FFA project, any netincome the child receives from sales or prizesrelated to the project may be subject to in-come tax. Report the net income on line 21of Form 1040. If necessary, attach a state-ment showing the gross income and ex-penses. The net income may not be subjectto SE tax if the project is primarily for educa-tional purposes and not for profit, and iscompleted by the child under the rules andeconomic restrictions of the sponsoring 4–Hor FFA organization. Such a project is gen-erally not considered a trade or business.

Husband and wife partners. You and yourspouse may operate a farm as a partnership.(Partnerships are discussed in chapter 2.) Ifyou and your spouse operate a farm as part-ners, report the farm income and expenseson Form 1065, U.S. Partnership Return ofIncome, and attach separate Schedules K–1to show each partner's share of the net in-come. Each spouse must report his or hershare of partnership income on Form 1040and attach separate Schedules SE (Form1040) showing each spouse's self-employ-ment income.

However, if your spouse is your employee,not your partner, your spouse's wages aresubject to social security and Medicare taxes.For more information on employment taxes,see chapter 16.

Self-EmploymentIncomeThis part of the chapter explains what is andwhat is not SE income and landlord partici-pation in farming.

Types of SE income. The following itemsare included in SE income.

1) Taxable patronage dividends (distribu-tions) from cooperatives.

2) Government agricultural program pay-ments, including commodity programpayments and conservation reserveprogram (CRP) payments. (If you do notmaterially participate in farming oper-ations on the land, the CRP payment isnot included in SE income.)

3) Taxable commodity credit loans.

4) Refunds and rebates, if they representa reduction in a deductible expense item,including a fuel tax credit included in in-come.

5) Prizes or awards on farm produce orlivestock.

6) Crop damage payments.

7) Value of merchandise received for farmproducts.

8) Sales of unharvested crops, if not soldwith land that was held more than 1 year.

9) Rent you receive if you meet one of thefour material participation tests explainedlater under Landlord Participation inFarming.

If you receive the rent as crop shares,you must meet the test at the time thecrop shares are produced. However, thecrop shares are included in SE incomein the year they are converted to moneyor the equivalent of money.

10) Any amounts for depreciation, includingany section 179 deduction, recapturedbecause the business use of the prop-erty was reduced to 50% or less (thisdoes not include amounts recaptured onthe disposition of property).

11) Lost income payments received from in-surance or other sources for reducingor stopping farming activities. Even if youare not farming when you receive thepayment, it is SE income if it relates toyour farm business (even though it istemporarily inactive). A connection existsif it is clear that the payment would nothave been made but for your conductof your farm business.

12) Your distributive share of income or loss,including guaranteed payments, fromyour partnership or LLC's trade or busi-ness.

Income that is not SE income. Certainkinds of income are not SE income, eventhough they are included when figuring yourincome tax.

1) Rent from real estate and from personalproperty leased with real estate is notSE income. It does not matter if the rent

is received in crop shares, cash, or otherproperty. This rule applies if the landlorddoes not materially participate in theproduction or management of productionof farm products on the land. If thelandlord materially participates, seeLandlord Participation in Farming, later.

2) Interest is not SE income unless you re-ceive it in your trade or business, suchas interest on accounts receivable.

3) Dividends on securities you own are notSE income unless you are a dealer insecurities who is not holding the securi-ties for speculation or investment.

4) A gain or loss from the disposition ofproperty that is neither stock in trade norheld primarily for sale to customers is notSE income. It does not matter whetherthe disposition is a sale, exchange, oran involuntary conversion. For example,gains or losses from the disposition ofthe following types of property are notSE income.

a) Investment property.

b) Depreciable property or other fixedassets used in your trade or busi-ness.

c) Livestock held for draft, dairy,breeding, or sporting purposes, andnot held primarily for sale, regard-less of how long the livestock washeld, or whether it was raised orpurchased.

d) Unharvested crops sold with landheld more than one year.

e) Timber, coal, or iron ore held formore than one year, if an economicinterest was retained, such as aright to receive coal royalties.

A gain or loss from the cuttingof timber is not SE income if thecutting is treated as a sale or ex-change.

5) Wages and salaries received for ser-vices performed as an employee andcovered by social security or railroad re-tirement are not SE income.

6) Wages paid in kind to you for agriculturallabor, such as commodity wages.

7) A limited partner's distributive share ofpartnership income (or loss) is not usedto figure net SE income. However,guaranteed payments received for ser-vices performed by a limited partner areSE income.

8) Retirement income received by the part-ner from his or her partnership under awritten plan is not SE income if all of thefollowing apply.

a) The retired partner performs noservices for the partnership duringthe year.

b) The retired partner is owed only theretirement payments.

c) The retired partner's share (if any)of the partnership capital was fullypaid to the retired partner.

d) The payments to the retired partnerare lifelong, periodic payments.

Chapter 15 Self-Employment Tax Page 79

Landlord Participationin FarmingAs a general rule, income and deductionsfrom rentals and from personal propertyleased with real estate are not included indetermining net self-employment income.However, income and deductions from farmrentals and from personal property leasedwith real estate, including government com-modity program payments received by alandowner who rents land, are included if therental arrangement provides that the landlordwill, and he or she does, materially participatein the production or management of pro-duction of the farm products on the land.

Crop shares. Rent paid in the form of cropshares is included in self-employment incomefor the year you sell, exchange, give away,or use the crop shares if you meet one of thefour material participation tests at the time thecrop shares are produced. Feeding such cropshares to livestock is considered using them.Your gross income for figuring your netearnings from self-employment under theFarm Optional Method includes the fair mar-ket value of the crop shares when they areused as feed.

Material participation. You materially par-ticipate if you have an arrangement with yourtenant for your participation and you meet oneof the following four tests.

1) You do any three of the following.

a) Pay, using cash or credit, at leasthalf the direct costs of producingthe crop or livestock.

b) Furnish at least half the tools,equipment, and livestock used inthe production activities.

c) Advise or consult with your tenant.

d) Inspect the production activitiesperiodically.

2) You regularly and frequently make, ortake an important part in making, man-agement decisions substantially contrib-uting to or affecting the success of theenterprise.

3) You work 100 hours or more spread overa period of 5 weeks or more in activitiesconnected with agricultural production.

4) You do things which, considered in theirtotality, show that you are materially andsignificantly involved in the productionof the farm commodities.

These tests may be used as general guidesfor determining whether you are materiallyparticipating.

Example. Drew Houston agrees toproduce a crop on J. Clarke's cotton farm witheach receiving half of the proceeds. Clarkefurnishes all the necessary equipment andadvises Houston when to plant the cotton andwhen it needs to be chopped, plowed,sprayed, and picked. During the growingseason, Clarke inspects the crop every fewdays to determine whether Houston is prop-erly taking care of the crop. Houston furnishesall labor needed to grow and harvest the crop.

The management decisions made by J.Clarke in connection with the planting,plowing, etc., of the cotton crop and his reg-ular inspection of the crop, along with all the

necessary equipment he furnishes, establishthat he participates to a material degree in thecotton production operations. The incomeClarke receives from his cotton farm is in-cluded in computing his net earnings fromself-employment.

FiguringSelf-Employment TaxThere are three steps to figure the SE tax youowe.

1) Figure your net self-employment income.

2) Figure your net earnings from self-employment.

3) Multiply your net earnings by the taxrate.

Step 1—Figure Your NetSelf-Employment IncomeNet SE income usually includes all farm andnonfarm business income less all businessdeductions allowed for income tax purposes.You must claim all allowable deductions whenfiguring net SE income. Your net SE incomeis used to figure your net earnings from self-employment. (See Step 2—Figure Your NetEarnings From Self-Employment, later.) Youmust figure your net income from self-employment by using the same accountingmethod you use for income tax purposes.

Your net SE income is shown on the linesof the following schedules.

More than one business. If you have morethan one trade or business, you must com-bine the net profit (or loss) from each busi-ness to determine your net SE income. A lossfrom one business will reduce your profit fromanother business. File one Schedule SEshowing the net SE income, but file a sepa-rate Schedule F or C for each business.

Deductions and exemptions. Do not re-duce your SE income by any of the following.

• Deductions for personal exemptions foryourself, your spouse, or dependents.

• The standard deduction or itemized de-ductions.

• The net operating loss deduction.

• Nonbusiness deductions (including con-tributions on your behalf to a pension,profit-sharing plan, annuity plan, Keogh,SIMPLE, or SEP plan).

• The self-employed health insurance de-duction.

• The deduction for one-half of your SE tax.

Step 2—Figure Your NetEarnings FromSelf-EmploymentThe net SE income subject to SE tax is callednet earnings from self-employment.

Minimum earnings subject to SE tax. Youmust have $400 or more of net earnings fromself-employment to be subject to the tax. Forthis purpose, net earnings are figured on line4 of Schedule SE, Section A, or line 4c ofSchedule SE, Section B. If your net earningsare less than $400, you do not have to fileSchedule SE (Form 1040) or pay the tax,unless you performed services for a churchas an employee and received income of$108.28 or more.

How to figure net earnings. There are threeways to figure net earnings from self-employment.

• Regular method.

• Farm optional method.

• Nonfarm optional method.

You must use the regular method unlessyou are eligible to use one or both of the op-tional methods. See Figure 15–1.

Why use the optional methods? Youmay want to use the optional methods (dis-cussed later) when you have a loss or a smallamount of net income from self-employmentand any one of the following applies.

• You want to receive credit for social se-curity benefit coverage.

• You incurred child or dependent careexpenses for which you could claim acredit. (This method will increase yourearned income, which could increaseyour credit.)

• You are entitled to the earned incomecredit. (This method will increase yourearned income, which could increaseyour credit.)

Regular MethodMultiply your net SE income by 92.35%(.9235) to get your net earnings under theregular method. See Short Schedule SE, line4, or Long Schedule SE, line 4a.

You must use the regular method unlessyou are eligible to use one or both of the op-tional methods.

Farm Optional MethodAs an individual farmer or as a partner in afarming business, you may be able to use thefarm optional method to figure your netearnings from farm self-employment. Thismethod allows you to continue paying SE taxfor your social security coverage when yournet profit for the year is small or you have aloss.

Optional earnings less than actualearnings. If your net earnings under the farmoptional method are less than your actual netearnings, you can still use the farm optionalmethod. For example, your actual netearnings from self-employment are $425 andyour net earnings figured under the farm op-tional method are $390. You owe no SE taxif you use the optional method, because yournet earnings under the farm optional methodare below $400.

Gross income of $2,400 or less. If yourgross income from farming is $2,400 or less,you may report two-thirds of this gross in-come as your net earnings from farm self-employment.

Schedule F (Form 1040) ......................... Line 36Schedule C (Form 1040) ........................ Line 31Schedule C–EZ (Form 1040) .................. Line 3Schedule K–1 (Form 1065) ..................... Line 15aSchedule K–1 (Form 1065–B) ................ Box 9


Figure 15–1. Can I Use the Optional Methods?

START here to determine ifyou can use the nonfarmoptional method

Are your net nonfarm profitsless than $1,733?

Report $1,600 as your net earningsfrom self-employment.*

Are your net nonfarm profitsless than 72.189% of yourgross nonfarm income? Report two-thirds of your

gross farm income as yournet earnings from farmself-employment.*

No

Yes�

�

Is your gross farm income$2,400 or less? See thediscussion Gross income fromfarming.

Are your net farm profitsless than $1,733?

�

�

Were your actual net earningsfrom self-employment $400 ormore in at least 2 of the 3 taxyears before 1999?

Have you previously used thismethod less than 5 years?(Note: There is a 5-yearlifetime limit.)

Report two-thirds of grossincome from nonfarm self-employment as net earningsfrom self-employment.*

Is your gross income fromall nonfarm businesses$2,400 or less?

You cannot use the nonfarm optionalmethod.

Report $1,600 as your netearnings from farm self-employment.*

Yes�

Yes�

Yes�

Yes�

�

�

�

�

�

�

�

�

No

No

No

No

No

Yes

Yes

*If you use both optional methods, see Using Both Optional Methods for limits on the amount to report.

START here to determine ifyou can use the farm optionalmethod

You cannot use thefarm optional method

�

No

Gross income of more than $2,400. If yourgross income from farming is more than$2,400 and your net farm profit shown on line36 of Schedule F (Form 1040) or line 15a ofSchedule K–1 (Form 1065) is less than$1,733, you may report $1,600 as your netearnings from farm self-employment. But ifyour gross income from farming is more than$2,400 and your net farm profit is $1,733 ormore, you cannot use the optional method.

Since two-thirds of $2,400 is $1,600, thiscounts for two credits ($1,600 ÷ $740) forsocial security coverage in 1999. You cannotuse the full amount of your gross income todetermine credits when you are figuring theSE tax on only two-thirds of that amount.

Gross income from farming. Farming in-come includes what you receive from culti-vating the soil or raising or harvesting anyagricultural commodities. It also includes in-come from the operation of a livestock, dairy,poultry, bee, fish, fruit, or truck farm, or plan-tation, ranch, nursery, orchard, or oyster bed.This includes income you receive in the formof crop shares if you materially participate inproduction or management of production ofthe crop.

Your gross income from farming does notinclude any item listed earlier under Income

that is not SE income. If you receive govern-ment commodity program payments on landyou rent out, do not include these paymentsunless you meet one of the four materialparticipation tests, explained earlier. Also, donot include any income from a nonfarm busi-ness.

Cash method of accounting. If you fileyour return using the cash method and arenot a member of a farming partnership, yourgross income from farming will ordinarily bethe amount shown on line 11 of Schedule F.

Accrual method of accounting. If youfile your return using an accrual method andyou are not a member of a farming partner-ship, your gross income from farming will or-dinarily be the amount shown on line 51 ofSchedule F.

Gross income from a farm partnership.Your gross income under the farm optionalmethod includes your distributive share of apartnership's gross income from farming.

To determine your distributive share ofgross income from a farm partnership, thepartnership does the following.

1) Figures the partnership's gross incomefrom farming.

2) Subtracts any guaranteed payments topartners for services or the use of capi-tal.

3) Determines your share of what is left.The gross income that remains aftersteps (1) and (2) is divided among thepartners in the same way they share theordinary income (or loss) of the partner-ship, unless the partnership agreementprovides otherwise.

The result determined in (3) above is yourdistributive share of the partnership's grossincome from farming. If you have no othergross income from farming, including guar-anteed payments discussed next, use thisdistributive share of gross income to deter-mine whether you can use the farm optionalmethod to figure your net earnings from self-employment.

Guaranteed payments. Any guaranteedpayments you receive from a farm partnershipare gross income from your farming (not thepartnership's). Use the total of these guar-anteed payments, your distributive share ofgross income from a farm partnership, andany other gross income you receive fromfarming to determine whether you can use thefarm optional method to figure your netearnings from self-employment.

Chapter 15 Self-Employment Tax Page 81

Example. Bill and John are partners andshare in ordinary income or loss on a 50–50basis, with no guaranteed payments. If thepartnership has $3,000 gross income fromfarming, each would have $1,500 gross in-come for purposes of the optional method.

If Bill had been guaranteed $1,000 withoutregard to partnership income, his gross in-come from farming would be $2,000 ($1,000plus 50% of $2,000). John's gross incomewould be $1,000.

Two or more farms. If you run your ownfarm and are also a partner in a farm part-nership, or in any way have gross farm in-come from more than one farm, you must addyour farm income from all farming sources toget your total net earnings from farm self-employment. If you use the farm optionalmethod, you must add all gross income fromfarming to make the $2,400 test.

Example. Your gross income from yourown farm is $600 and your distributive shareof the gross income from a farm partnershipis $900. Since your gross income fromfarming is less than $2,400 ($1,500), your netearnings from self-employment under thefarm optional method are $1,000 (2/3 of$1,500).

NonfarmOptional MethodThis is an optional method available for de-termining net earnings from nonfarm self-employment much like the farm optionalmethod.

If you are also engaged in a nonfarmbusiness, you may be able to use this methodto compute your net earnings from self-employment from your nonfarm business.You may use this method even if you do notuse the farm optional method for determiningyour net earnings from your farm self-employment and even if you have a net lossfrom your nonfarm business. For more infor-mation about the nonfarm optional method,see Publication 533.

Using Both OptionalMethodsYou may not combine farming income withnonfarm income from self-employment to fig-ure your net earnings under either of the op-tional methods. If you use both optionalmethods, you must add together the netearnings figured under each method to arriveat your total net earnings from self-employ-ment. You may report less than your totalactual net earnings from farm and nonfarmself-employment. If you use both optionalmethods, you may report no more than$1,600 as your combined net earnings fromself-employment.

Step 3—Multiply Your NetEarnings by the Tax RateMultiply the net earnings you figured in Step2 by the tax rate to get your SE tax. The SEtax rate is 15.3% (12.4% social security taxplus 2.9% Medicare tax). It is the same fornet earnings figured under each method.

Special rules (explained under Maximumearnings subject to SE tax and Fiscal taxyear, next) apply to this computation if eitherof the following applies.

• Your combined wages, tips, and netearnings are more than $72,600.

• You use a fiscal tax year.

Maximum earnings subject to SE tax. Onlythe first $72,600 of your combined wages,tips, and net earnings in 1999 is subject toany combination of the 12.4% social securitypart of SE tax, social security tax, or railroadretirement (tier 1) tax.

All your combined wages, tips, and netearnings in 1999 are subject to any combi-nation of the 2.9% Medicare part of SE tax,social security tax, or railroad retirement (tier1) tax.

If your wages and tips are subject to eithersocial security or railroad retirement (tier 1)tax, or both, and total at least $72,600, youdo not have to pay the 12.4% social securitypart of the SE tax on any of your net earnings.However, you must pay the 2.9% Medicarepart of the SE tax on all your net earnings.

Fiscal tax year. If you use a tax year otherthan the calendar year, you must use the taxrate and maximum earnings limit in effect atthe beginning of your tax year. Even if the taxrate or maximum earnings limit changes dur-ing your tax year, you should continue to usethe same rate and limit throughout your taxyear.

Regular MethodThe following paragraphs explain how to fig-ure the SE tax using net earnings under theregular method.

Net earnings and wages not more than$72,600. If your net earnings from self-employment plus any wages and tips are notmore than $72,600 and you do not have touse Long Schedule SE, use Short ScheduleSE. On line 5, multiply your net earnings by15.3% (.153). The result is your SE tax.

Example 1. You have $30,000 in net SEincome and receive no wages subject to so-cial security and Medicare taxes for the year.Multiply the $30,000 by 0.9235 on ShortSchedule SE to get your net earnings fromself-employment of $27,705. Your SE tax is15.3% (.153) of $27,705, or $4,238.87.

Example 2. You have $20,000 in net SEincome and receive $15,000 in wages subjectto social security and Medicare taxes for theyear. Multiply the $20,000 by 0.9235 on ShortSchedule SE to get your net earnings fromself-employment of $18,470. Your SE tax is15.3% (.153) of $18,470, or $2,825.91.

Net earnings more than $72,600 and nowages. If you had no wages, had netearnings from self-employment of more than$72,600, and do not have to use LongSchedule SE, use Short Schedule SE. On line5, multiply the line 4 net earnings by the 2.9%(.029) Medicare tax and add the result to$9,002.40 (12.4% of $72,600). The total isyour SE tax.

Example. During 1999, you have $80,000in net SE income and receive no wages sub-ject to social security and Medicare taxes.Multiply the $80,000 by 0.9235 on ShortSchedule SE to get your net earnings of$73,880. Since only $72,600 of your earningsare subject to the social security part of theSE tax, your tax for this part is $9,002.40(12.4% of $72,600).

Since all your net earnings are subject tothe Medicare part of the SE tax, multiply$73,880 by 2.9% (.029) on Short ScheduleSE for the Medicare part. The result is$2,142.52. Add this to $9,002.40 for a totalSE tax of $11,144.92.

Net earnings and wages more than$72,600. If your net earnings from self-employment plus any wages and tips aremore than $72,600, you must use LongSchedule SE. Subtract your total wages andtips from $72,600 to find the maximumearnings subject to the 12.4% social securitypart of the tax. If more than zero, multiply theamount by 12.4% (.124). The result is thesocial security tax amount. Then multiply yournet earnings from self-employment by 2.9%(.029). The result is the Medicare tax amount.The total of the social security tax amount andthe Medicare tax amount is your SE tax.

Example. During 1999, you have $80,000in net SE income and receive $10,000 inwages subject to social security and Medicaretaxes for the year. You figured your netearnings on Long Schedule SE, line 4a, tobe $73,880. Next, subtract your wages of$10,000 from $72,600, the maximum incomesubject to the social security part of the SEtax. The result is $62,600. Since only $62,600of your earnings are subject to the social se-curity part of the SE tax, your tax for this partis 12.4% (.124) ÷ $62,600, or $7,762.40.

Since all your net earnings are subject tothe Medicare part of the SE tax, multiply allthe net earnings from self-employment,$73,880, by 2.9% (.029) on Long ScheduleSE for the Medicare part. The result is$2,142.52. Add this to the $7,762.40 figuredabove for total SE tax of $9,904.92.

Optional MethodsIf your net earnings under the farm optionalmethod or the nonfarm optional method are$400 or more, use Long Schedule SE to fig-ure your SE tax.

Effect on taxes. If you use either or bothoptional methods, you must figure and paythe SE tax due under these methods, even ifyou would have had a smaller tax or no taxusing the regular method.

The optional methods may be used onlyto figure your SE tax. To figure your incometax, include your actual SE income in grossincome, regardless of which method you useto figure SE tax.

ReportingSelf-Employment TaxUse Schedule SE (Form 1040) to report andfigure SE tax. Then enter the tax on line 50of Form 1040, and attach Schedule SE toForm 1040.

TIPEven if you do not have to fileSchedule SE, it may be to your benefitto file it and use either optional

method in Part II of the Long Schedule SE.

CAUTION!

If you have to pay SE tax, you mustfile Form 1040 (with Schedule SE at-tached) even if you do not otherwise

have to file a federal income tax return.


Long Schedule SE. Most taxpayers can useShort Schedule SE (Section A) to figure theirself-employment tax. However, the followingtaxpayers must use Long Schedule SE (Sec-tion B).

• Individuals whose total wages and tipssubject to social security (or railroad re-tirement (tier 1)) tax plus net earningsfrom self-employment are more than$72,600.

• Ministers, members of religious orders,and Christian Science practitioners nottaxed on earnings from these sources(with IRS consent) who owe SE tax onother earnings.

• Employees who earned wages reportedon Form W–2 of $108.28 or more workingfor churches or church organizations thatelected an exemption from social securityand Medicare taxes.

• Individuals with tip income subject to so-cial security and Medicare taxes that wasnot reported to their employers.

• Individuals who use one of the optionalmethods to figure SE tax.

Joint returns. If you file a joint return youcannot file a joint Schedule SE (Form 1040).This is true whether one spouse or bothspouses have SE income. Your spouse is notconsidered self-employed just because youare. If both of you have SE income, each ofyou must complete a separate Schedule SE(Form 1040). Attach both schedules to thejoint return. If you and your spouse operatea business as a partnership, see Husbandand wife partners, earlier, under Who MustPay Self-Employment Tax.

Community income. If any of the incomefrom a farm or business other than a part-nership is community income under state law,it is subject to SE tax as the income of thespouse carrying on the trade or business. Theidentity of the spouse carrying on the tradeor business is determined by the facts in eachcase.

If you are a partner and your distributiveshare of any income or loss from a trade orbusiness carried on by the partnership iscommunity income, treat your share as yournet self-employment income. Do not treat anyof your share as net self-employment incomeof your spouse.

16.EmploymentTaxes

Important Changesfor 2000Wage limits for social security and Medi-care taxes. The maximum wages subject tothe social security tax for 2000 will be pub-

lished in Publication 51, Circular A, Agricul-tural Employer's Tax Guide. There is no wagebase limit for wages subject to the Medicaretax.

Electronic deposits of taxes. The thresholdthat determines whether you must deposittaxes electronically has been increased to$200,000. You must use the Electronic Fed-eral Tax Payment System (EFTPS) to makeelectronic deposits of all depository tax liabil-ities that occur after 1999 if you depositedmore than $200,000 in federal depositorytaxes in 1998. If you do not meet the$200,000 threshold, electronic deposits arevoluntary, even if you were required to de-posit electronically under a previous thresh-old.

The waiver of the penalty for failure todeposit taxes electronically that was sched-uled to expire on July 1, 1999, has been ex-tended to deposit obligations incurred beforeJanuary 1, 2000, except for taxpayers whodeposited more than $200,000 in taxes in1998.

See Electronic deposit requirement underSocial Security, Medicare, and Withheld In-come Taxes.

IntroductionYou are generally required to withhold federalincome tax from the wages of your employ-ees. You may also be subject to social secu-rity and Medicare taxes under the FederalInsurance Contributions Act (FICA) and fed-eral unemployment tax under the FederalUnemployment Tax Act (FUTA). This chapterincludes information about these taxes.

Farmers must also pay self-employmenttax on their earnings from farming. Seechapter 15 for information on the self-employment tax.


• Farm employment

• Social security and Medicare taxes

• Income tax withholding

• Federal unemployment tax (FUTA)

• Reporting and paying employment taxes

• Family employees

• Crew leaders

• Advance earned income credit (EIC)payment


Publication

� 15 Circular E, Employer's Tax Guide

� 15–A Supplemental Employer's TaxGuide

� 51 Circular A, Agricultural Employer'sTax Guide


� W–2 Wage and Tax Statement

� W–4 Employee's Withholding Allow-ance Certificate

� W–5 Earned Income Credit AdvancePayment Certificate

� W–9 Request for Taxpayer Identifica-tion Number and Certification

� 940 (or 940–EZ) Employer's AnnualFederal Unemployment (FUTA)Tax Return

� 943 Employer's Annual Tax Return forAgricultural Employees

� 8109 Federal Tax Deposit Coupon


Farm EmploymentIn general, your employees are farm workersif they do any of the following farm work.

1) Raise or harvest agricultural or horticul-tural products on a farm.

2) Care for your farm and equipment, whenmost of the care is done on a farm.

3) Handle, process, or package any agri-cultural or horticultural commodity if youproduced more than half of the com-modity.

4) Do work related to cotton ginning,turpentine, or gum resin products.

5) Do housework in your private home ona farm that is operated for profit.

Workers are your employees if they per-form services subject to your control. You arenot required to withhold or pay employmenttaxes for independent contractors who are notyour employees. For more information, seePublication 15–A.

If you employ a family of workers, eachworker subject to your control (not just thehead of the family) is an employee.

Special rules apply to crew leaders. SeeCrew Leaders, later.

Employer identification number. If youhave employees, you must have an employeridentification number (EIN). You can apply foran EIN either by mail or by telephone. Youcan get an EIN immediately by calling theTele-TIN number for the service center foryour state. To receive your EIN by mail senda completed SS–4, Application for EmployerIdentification Number, directly to the servicecenter. See the instructions for Form SS–4for more information. Form SS–4 is availablefrom IRS or Social Security Administration(SSA) offices.

Employee's social security number (SSN).An employee who does not have an SSNshould submit Form SS–5, Application for aSocial Security Card, to the nearest SSA of-fice. Form SS–5 can be obtained from anySSA office or by calling 1–800–772–1213.

The employee must furnish evidence ofage, identity, and U.S. citizenship with theForm SS–5. An employee who is 18 or oldermust appear in person with this evidence atan SSA office.

INS Form I–9. You must verify that each newemployee is legally eligible to work in theUnited States. This includes completing theImmigration and Naturalization Service (INS)Form I–9, Employment Eligibility Verification.You can get the form from INS offices by

Chapter 16 Employment Taxes Page 83

calling 1–800–870–3676. Contact the INS at1–800–375–5283 for any other information.

Social Securityand Medicare TaxesAll cash wages you pay to an employee dur-ing the year for farm work are subject to socialsecurity and Medicare taxes if you meet eitherof the following tests.

1) You pay the employee $150 or more incash wages during the year for farmwork (the $150 test).

2) You pay cash and noncash wages of$2,500 or more during the year to allyour employees for farm work (the$2,500 test).

If the $2,500 test for the group is not met,the $150 test for an individual still applies.

Exceptions. The following wages are notsubject to social security and Medicare taxes,even if you pay $2,500 or more to all yourfarm workers. These wages, however, docount toward the $2,500 test for determiningsocial security and Medicare coverage ofother farm workers.

1) Annual cash wages of less than $150paid to a seasonal farm worker. A sea-sonal farm worker is one who:

a) Works as a hand-harvest laborer,

b) Is paid piece rates in an operationusually paid on this basis in the re-gion of employment,

c) Commutes daily from his or herpermanent home to the farm, and

d) Worked in agriculture less than 13weeks in the preceding calendaryear.

2) Annual cash wages of less than $1,100paid to your household employee.

See Circular A for more information onthese exceptions. See Family Employees,later, for special rules on social security andMedicare tax withholding that apply to yourspouse and children.

Religious exemption. An exemption fromsocial security and Medicare taxes is avail-able to members of a recognized sect op-posed to insurance. This exemption is avail-able only if both the employee and theemployer are members of such a sect.

For more information, see Publication 517,Social Security and Other Information forMembers of the Clergy and Religious Work-ers.

Cash wages. Cash wages paid to farmworkers are subject to social security tax,Medicare tax, and income tax withholding.Cash wages include checks, money orders,and any kind of money or cash.

Only cash wages subject to social securityand Medicare taxes are credited to your em-ployees for social security benefit purposes.Payments not subject to these taxes, suchas commodity wages, do not contribute toyour employees' social security coverage. Forinformation about social security benefits,contact the Social Security Administration.Internet users can go to www.ssa.gov formore information.

Noncash wages. Noncash wages includefood, lodging, clothing, transportation passes,and other goods. Noncash wages, includingcommodity wages, are not subject to socialsecurity and Medicare taxes and income taxwithholding. However, they are subject tothese taxes if the substance of the transactionis a cash payment.

The value of noncash wages is reportedon Form W–2 in box 1, Wages, tips, othercompensation, together with cash wages. Donot show noncash wages in box 3, Socialsecurity wages, or in box 5, Medicare wagesand tips.

Tax rates and social security wage limit.For 2000, the employer and the employeewill continue to pay:

1) 6.2% each for social security tax (old-age, survivors, and disability insurance),and

2) 1.45% each for Medicare tax (hospitalinsurance).

Wage limit. The maximum amount of2000 wages subject to the social security taxwill be published in Circular A. There is nolimit on wages subject to the Medicare tax.All covered wages are subject to the tax.

Paying employee's share. If you wouldrather pay the employee's share of socialsecurity and Medicare taxes without deduct-ing it from his or her wages, you may do so.If you do not deduct the taxes, you must stillpay them. The employee's share of socialsecurity or Medicare tax that you pay is ad-ditional income to the employee. You mustinclude it on the employee's Form W–2 in box1, but do not count it as social security andMedicare wages (boxes 3 and 5 on FormW–2) or as wages for federal unemployment(FUTA) tax purposes.

Publication 51, Circular A. Circular A con-tains additional information about social se-curity and Medicare taxes. See chapter 21 forinformation about getting forms and publica-tions from the IRS.

Income TaxWithholdingIf the cash wages you pay farm workers aresubject to social security and Medicare taxes,they are also subject to income tax withhold-ing. Withhold income tax on noncash pay-ments only if you and the employee agree todo so. The amount to withhold is figured ongross wages without taking out social securityand Medicare taxes, union dues, insurance,etc. You can use one of several methods todetermine the amount to withhold. The meth-ods are described in Circular A.

Generally, the amount of income tax youwithhold is based on the employee's maritalstatus and withholding allowances claimedon the employee's Form W–4. In general, anemployee can claim withholding allowanceson Form W–4 equal to the number of ex-emptions the employee will be entitled toclaim on his or her tax return. An employeemay also be able to claim a special withhold-ing allowance and allowances for estimateddeductions and credits.

Do not withhold income tax from thewages of an employee who, by filing Form

W–4, certifies that he or she had no incometax liability last year and anticipates no liabilityfor the current year.

Circular A contains tables showing thecorrect amount of income tax you shouldwithhold. It also contains additional informa-tion about income tax withholding. See chap-ter 21 for information about getting CircularA and Form W–4.

Form W–4 for 2000. Farmers who haveemployees should make the 2000 Form W–4available to their employees and encouragethem to check their income tax withholding for2000. Those employees who owed a largeamount of tax or received a large refund for1999 may want to file a new Form W–4.

Nonemployee compensation. Generally,you are not required to withhold tax on pay-ments for services to individuals who are notyour employees. However, you may be re-quired to report these payments on Form1099–MISC, Miscellaneous Income, and towithhold under the backup withholding rules.See Information Returns in chapter 2 for in-formation.

FederalUnemployment(FUTA) TaxYou must pay FUTA tax if you meet eitherof the following tests.

1) You paid cash wages of $20,000 or moreto farm workers in any calendar quarterduring the current or preceding calendaryear.

2) You employed 10 or more farm workersfor some part of at least 1 day during any20 or more different calendar weeksduring the current or preceding calendaryear.

These rules do not apply to your spouse,parents, or children under age 21. See FamilyEmployees, later.

Alien farm workers. To determine whetheryou meet either test above, count wages youpaid to aliens admitted on a temporary basisto the United States to perform farm work(also known as “H-2(A)” visa workers). How-ever, wages paid to these workers are ex-empt from FUTA tax.

Commodity wages. Payments in kind forfarm labor are not considered wages. Do notcount them to figure whether you are subjectto FUTA tax or to figure how much tax youowe.

Tax rate and credit. The gross FUTA tax is6.2% of the first $7,000 cash wages you payeach employee. However, you are given acredit of up to 5.4% for the state unemploy-ment tax you pay. The net tax rate, therefore,can be as low as 0.8% (6.2% − 5.4%). If yourstate tax rate (experience rate) is less than5.4%, you are still allowed the full 5.4% credit.

You cannot take the credit for any statetax you do not pay. If you are exempt fromstate unemployment tax for any reason, the

Page 84 Chapter 16 Employment Taxes

full 6.2% rate applies. See the instructions forForm 940 for additional information.

More information. For more information onFUTA tax, see Circular A. For information ondepositing FUTA tax, see FUTA Tax, later.

Reporting and PayingEmployment TaxesThere are special rules for reporting andpaying employment taxes.

Penalties. If you pay your taxes late, youmay have to pay a penalty as well as intereston any overdue amounts.

There are also civil and criminal penaltiesfor intentionally not paying taxes, filing a falsetax return, or filing no return at all.

Trust fund recovery penalty. If you areresponsible for withholding, accounting for,depositing, or paying withholding taxes andwillfully fail to do so, you can be held liablefor a penalty equal to the tax not paid, plusinterest. A responsible person can be an offi-cer of a corporation, a partner, a sole propri-etor, or an employee of any form of business.A trustee or agent with authority over thefunds of the business can also be held re-sponsible for the penalty.

“Willfully” in this case means voluntarily,consciously, and intentionally. Paying otherexpenses of the business instead of the taxesdue is considered to be acting willfully.

Social Security, Medicare,and Withheld Income TaxesYou must withhold income, social security,and Medicare taxes required to be withheldfrom the salaries and wages of your employ-ees. You are liable for the payment of thesetaxes to the federal government whether ornot you collect them from your employees. If,for example, you withhold less than the cor-rect tax from an employee's wages, you arestill liable for the full amount. You must alsopay your share of social security and Medi-care taxes.

Form 943. Report withheld income tax andsocial security and Medicare taxes on Form943. The 1999 form is due by January 31,2000 (or February 10 if the tax was timelydeposited in full).

Deposits. You will generally have to maketax deposits if you are liable for $1,000 ormore of social security and Medicare taxesand withheld income tax during the year. Youmust deposit both your part and your em-ployees' part of social security and Medicaretaxes and withheld income tax before you fileForm 943.

Electronic deposit requirement. Youmay have to deposit all employment taxesusing the Electronic Federal Tax PaymentSystem (EFTPS). You can make depositselectronically with EFTPS using your tele-phone.

You must use EFTPS to make depositsof all depository tax liabilities (including socialsecurity, Medicare, withheld income, excise,and corporate income taxes) you incur after1999 if you deposited more than $200,000 infederal depository taxes in 1998. If you firstmeet the $200,000 threshold in 1999 or a

later year, you must begin depositing usingEFTPS in the second succeeding year. Onceyou must deposit electronically because youmeet the $200,000 threshold, you must con-tinue to make deposits using EFTPS.

Electronic deposits are voluntary if you donot meet the $200,000 threshold, even if youhad to deposit electronically before 2000 be-cause you met a previous threshold. To enrollin EFTPS, call 1–800–945–8400 or 1–800–555–4477. For general information aboutEFTPS, call 1–800–829–1040.

If you must use EFTPS but fail to do so,you may be subject to a 10% penalty. Thispenalty has been waived for deposit obli-gations incurred before January 1, 2000, ex-cept for taxpayers who deposited more than$200,000 in 1998.

More information. For more informationon deposit rules and penalties for late de-posits, see Circular A.

Form W–2. By January 31, you must furnisheach employee a Form W–2 showing totalwages for the previous year and total incometax and social security and Medicare taxeswithheld. However, if an employee stopsworking for you and requests the form earlier,you must give it to the employee within 30days of the later of the following dates.

1) The date the employee requests theform.

2) The date you make your final paymentof wages to the employee.

See Form W–2 under Other Forms in chapter2.

FUTA TaxThe federal unemployment (FUTA) tax is im-posed on you as the employer. It must notbe collected or deducted from the wages ofyour employees.

Form 940. FUTA tax is reported on Form940, Employer's Annual Federal Unemploy-ment (FUTA) Tax Return. This form coversone calendar year and is generally due Jan-uary 31 after the year ends. However, youmay have to make deposits of FUTA tax be-fore filing the return. If you deposit the tax ontime and in full, you have an extra 10 days tofile — until February 10.

Form 940–EZ. You can use Form 940–EZ,a simplified version of Form 940, if you meetall the following tests.

1) You paid state unemployment tax (con-tributions) to only one state.

2) You paid the state tax by the due dateof Form 940 or 940–EZ.

3) All wages taxable for FUTA tax werealso taxable for state unemployment tax.

Deposits. If at the end of any calendarquarter you owe, but have not yet deposited,more than $100 in FUTA tax for the year, youmust make a deposit by the end of the nextmonth. See Social Security, Medicare, andWithheld Income Taxes, earlier, for a dis-cussion of the requirement for making de-posits electronically.

If the undeposited tax is $100 or less atthe end of a quarter, you do not have to de-posit it. You must add it to the tax for the nextquarter. If the total undeposited tax is morethan $100 at the end of the next quarter, a

deposit will be required. If the total undepos-ited tax at the end of the 4th quarter is lessthan $100, you can either make a deposit orpay it with your return by the January 31 duedate.

See Circular A for more information ondepositing FUTA tax.

Family EmployeesChild employed by parent. Payments forthe services of a child under age 18 whoworks for his or her parent in a trade or busi-ness (including a farm) are not subject to so-cial security and Medicare taxes. However,see Covered services of a child or spouse,below. Payments for the services of a childunder age 21 who works for his or her parent,whether or not in a trade or business, are notsubject to federal unemployment (FUTA) tax.Although not subject to social security, Medi-care, or FUTA tax, the child still may be sub-ject to income tax withholding.

One spouse employed by another. Thewages for the services of an individual whoworks for his or her spouse in a trade orbusiness are subject to income tax withhold-ing and social security and Medicare taxes,but not FUTA tax. However, the services ofone spouse employed by another in otherthan a trade or business, such as domesticservice in a private home, are not subject tosocial security and Medicare taxes or FUTAtax.

Covered services of child or spouse. Thewages for the services of a child or spouseare subject to income tax withholding as wellas social security, Medicare, and FUTA taxesif he or she works for:

1) A corporation, even if it is controlled bythe child's parent or the individual'sspouse.

2) A partnership, even if the child's parentis a partner, unless each partner is aparent of the child.

3) A partnership, even if the individual'sspouse is a partner.

4) An estate, even if it is the estate of adeceased parent.

In these situations, the child or spouse isconsidered to work for the corporation, part-nership, or estate, not the parent or otherspouse.

Parent employed by child. The wages forthe services of a parent employed by his orher child in a trade or business are subject toincome tax withholding and social securityand Medicare taxes. Social security andMedicare taxes do not apply to wages paidto a parent for services not in a trade orbusiness, but they do apply to domestic ser-vices if:

1) The parent cares for a child who liveswith a son or daughter and who is underage 18 or requires adult supervision forat least 4 continuous weeks in a calen-dar quarter due to a mental or physicalcondition, and

2) The son or daughter is a widow orwidower, divorced, or married to a per-son who, because of a physical or men-

Chapter 16 Employment Taxes Page 85

tal condition, cannot care for the childduring such period.

Wages paid to a parent employed by hisor her child are not subject to FUTA tax, re-gardless of the type of services provided.

Crew LeadersFarmers can employ or use the services ofcrew leaders to provide them with farm labor.

Social security and Medicare taxes. Forsocial security and Medicare tax purposes,the crew leader is considered the employerof the workers if the crew leader does all ofthe following.

1) Furnishes workers to do farm labor.

2) Pays (either on his or her own behalf oron behalf of the farmer) the workers fortheir farm labor.

3) Has not entered into a written agreementwith the farmer under which the crewleader is designated as an employee ofthe farmer.

Federal income tax. If the crew leader isconsidered the employer for social securityand Medicare tax purposes, the crew leaderis considered the employer for federal incometax purposes.

Federal unemployment tax. For federalunemployment tax purposes, the crew leaderis considered the employer of the workers if,in addition to the earlier requirements:

1) The crew leader is registered under theMigrant and Seasonal AgriculturalWorker Protection Act, or

2) Substantially all crew members operateor maintain mechanized equipment pro-vided by the crew leader as part of theservice to the farmer.

The farmer is considered the employer ofworkers furnished by a crew leader in all othersituations. In addition, the farmer is consid-ered the employer of workers furnished by aregistered crew leader if the workers are theemployees of the farmer under the com-mon-law test. For example, some farmersemploy individuals to recruit farm workersexclusively for them. Although these individ-uals may be required to register under theMigrant and Seasonal Agricultural WorkerProtection Act, the workers are employed di-rectly by the farmer. The farmer is consideredto be the employer in these cases. For infor-mation concerning who is a common-lawemployee, see section 1 of Publication 15–A.

Advance EarnedIncome Credit(EIC) PaymentAn employee who is eligible for the earnedincome credit (EIC) and who has a qualifyingchild is entitled to receive EIC payments withhis or her pay during the year. To get thesepayments, the employee must give you aproperly completed Form W–5, Earned In-come Credit Advance Payment Certificate.You are required to make advance EIC pay-

ments to employees who give you a properlycompleted Form W–5, except that you are notrequired to make these payments tofarmworkers paid on a daily basis.

The payment is added to the employee'spay each payday. It is figured from tables inCircular A. You reduce your liability for in-come tax withholding, social security tax, andMedicare tax by the total advance EIC pay-ments made. For more information, see Cir-cular A.

Notification. You must notify each employeewho worked for you at any time during theyear and from whom you did not withhold anyincome tax about the EIC. However, you donot have to notify employees who claim ex-emption from withholding on Form W–4.

You meet the notification requirement bygiving each employee any one of the follow-ing.

1) Form W–2, which contains the notifica-tion on the back of Copy B.

2) A substitute Form W–2 with the exactEIC wording shown on the back of copyB of Form W–2.

3) Notice 797, Possible Federal Tax Re-fund Due to the Earned Income Credit(EIC).

4) Your own written statement with the ex-act wording of Notice 797.

For more information about notificationrequirements and claiming the EIC, see No-tice 1015, Have You Told Your EmployeesAbout the Earned Income Credit (EIC)?

17.RetirementPlans

Important ReminderContributions to a SEP-IRA or a SIMPLEIRA. A SEP-IRA or a SIMPLE IRA cannotbe designated as a Roth IRA. Contributionsto a SEP-IRA or a SIMPLE IRA will not affectthe amount that an individual can contributeto a Roth IRA. For information about RothIRAs, see Publication 590.

IntroductionThis chapter discusses retirement plans thatyou can set up and maintain for yourself andyour employees. Retirement plans aresavings plans that offer you tax advantagesto set aside money for your own and youremployees' retirement.

In general, a sole proprietor or a partneris treated as an employee for participating ina retirement plan.

SEP, SIMPLE, and qualified plans offeryou and your employees a tax favored wayto save for retirement. You can deduct con-tributions you make to the plan for your em-

ployees. If you are a sole proprietor, you candeduct contributions you make to the plan foryourself. You can also deduct trustees' feesif contributions to the plan do not cover them.Earnings on the contributions are generallytax free until you or your employees receivedistributions from the plan in later years.

Under some plans, employees can haveyou contribute limited amounts of theirbefore-tax pay to a plan. These amounts (andthe earnings on them) are generally tax freeuntil your employees receive distributionsfrom the plan in later years.

In general, individuals who are employedcan also set up and contribute to individualretirement arrangements (IRAs).


• Simplified employee pensions (SEPs)

• SIMPLE retirement plans

• Qualified plans

• Individual retirement arrangements(IRAs)


Publication

� 15 Circular E, Employer's Tax Guide

� 533 Self-Employment Tax

� 560 Retirement Plans for Small Busi-ness (SEP, SIMPLE, and KeoghPlans)

� 575 Pension and Annuity Income

� 590 Individual Retirement Arrange-ments (IRAs) (Including RothIRAs and Education IRAs)


� W–2 Wage and Tax Statement

� 5305–SEP Simplified EmployeePension–Individual RetirementAccounts Contribution Agreement

� 5305A–SEP Salary Reduction and OtherElective Simplified EmployeePension–Individual RetirementAccounts Contribution Agreement

� 5304–SIMPLE Savings Incentive MatchPlan for Employees of Small Em-ployers (SIMPLE) (Not subject tothe Designated Financial Institu-tion Rules)

� 5305–SIMPLE Savings Incentive MatchPlan for Employees of Small Em-ployers (SIMPLE) (for Use With aDesignated Financial Institution)

� 5500–EZ Annual Return of One-Participant (Owners and TheirSpouses) Retirement Plan


Simplified EmployeePension (SEP)A simplified employee pension (SEP) is awritten plan that allows you to make deduct-

Page 86 Chapter 17 Retirement Plans

ible contributions toward your own and youremployees' retirement without getting in-volved in more complex retirement plans. Acorporation also can have a SEP and makedeductible contributions toward its employ-ees' retirement. But some advantages avail-able to qualified plans, such as the special taxtreatment that may apply to lump-sum distri-butions, do not apply to SEPs.

Under a SEP, you make the contributionsto a traditional individual retirement arrange-ment (called a SEP-IRA).

SEP-IRAs are set up for, at a minimum,each eligible employee. A SEP-IRA may haveto be set up for a leased employee, but neednot be set up for an excludable employee. Formore information, see Publication 560.

Form 5305–SEP. You may be able to useForm 5305–SEP in setting up your SEP.

Contribution LimitsContributions you make for a year to a com-mon-law employee's SEP-IRA are limited tothe lesser of $30,000 or 15% of the employ-ee's compensation. Compensation generallydoes not include your contributions to theSEP, but does include certain elective defer-rals unless you choose not to include them.

Annual compensation limit. You generallycannot consider the part of compensation ofan employee that is over $160,000 when youfigure your contribution limit for that em-ployee.

More than one plan. If you also contributeto a defined contribution retirement plan (de-fined later), annual additions to an accountare limited to the lesser of $30,000 or 25%of the participant's compensation. When youfigure this limit, your contributions to all of theplans must be added. Because a SEP isconsidered a defined contribution plan forpurposes of this limit, your contributions to aSEP must be added to your contributions todefined contribution plans.

Reporting on Form W–2. Do not includeSEP contributions on Form W–2 unless thereare contributions under a salary reduction ar-rangement.

Contributions for yourself. The annuallimits on your contributions to a common-lawemployee's SEP-IRA also apply to contribu-tions you make to your own SEP-IRA. How-ever, special rules apply when you figure yourmaximum deductible contribution. See De-duction of contributions for yourself, later.

Deduction LimitsThe most you can deduct for employer con-tributions for common-law employees is 15%of the compensation paid to them during theyear from the business that has the plan.

Deduction of contributions for yourself.When figuring the deduction for employercontributions made to your own SEP-IRA,compensation is your net earnings from self-employment minus the following amounts.

1) The deduction for one-half of your self-employment tax.

2) The deduction for contributions to yourown SEP-IRA.

The deduction for contributions to yourown SEP-IRA and your net earnings depend

on each other. For this reason, you determinethe deduction for contributions to your ownSEP-IRA indirectly by reducing the contribu-tion rate called for in your plan. Use the RateWorksheet for Self-Employed shown underQualified Plan to figure the rate.

SEP and profit-sharing plans. If you alsocontributed to a qualified profit-sharing plan,you must reduce the 15% deduction limit forthat plan by the allowable deduction for con-tributions to the SEP-IRAs of those partic-ipating in both the SEP plan and the profit-sharing plan.

SEP and other qualified plans. If you alsocontributed to any other type of qualified plan,treat the SEP as a separate profit-sharingplan when applying the overall 25% deductionlimit described in section 404(h)(3) of theInternal Revenue Code.

Employee contributions. Employees canalso make contributions of up to $2,000 totheir SEP-IRAs independent of the employer'sSEP contributions. However, the employee'sdeduction for IRA contributions may be re-duced or eliminated because the employee iscovered by an employer retirement plan (theSEP plan). See Publication 590 for details.

Salary ReductionSimplified EmployeePension (SARSEP)

CAUTION!

An employer is no longer allowed toset up a SARSEP. However, partic-ipants in a SARSEP set up before

1997 (including employees hired after 1996)can continue to have their employer contrib-ute part of their pay to the plan.

A SEP can include a salary reduction(elective deferral) arrangement. Under thearrangement, employees can choose to haveyou contribute part of their pay to theirSEP-IRAs. The income tax on the contribu-tion is deferred. This choice is called anelective deferral, which remains tax free untildistributed (withdrawn).

This choice is available only if all the fol-lowing requirements are met.

• At least 50% of your eligible employeeschoose the salary reduction arrangement.

• You had 25 or fewer eligible employees(or employees who would have been eli-gible if you had maintained a SEP) at anytime during the preceding year.

• Each eligible highly compensated em-ployee's deferral percentage each yearis no more than 125% of the averagedeferral percentage (ADP) of all non-highly compensated employees eligibleto participate (the ADP test). See Publi-cation 560 for the definition of a highlycompensated employee and informationon how to figure the deferral percentage.

Limit on elective deferrals. In general, thetotal income an employee can defer under asalary reduction arrangement included in aSEP and certain other elective deferral ar-rangements for 1999 is limited to the lesserof $10,000 or 15% of the participant's com-pensation (as defined in Publication 560).This limit applies only to amounts that reducethe employee's pay, not to any contributionsfrom employer funds.

Employment taxes. Elective deferrals thatmeet the ADP test are not subject to incometax in the year of deferral, but they are in-cluded in wages for social security, Medicare,and unemployment (FUTA) tax purposes.

Reporting SEPContributions on Form W–2Your contributions to an employee's SEP-IRAare excluded from the employee's income.Unless there are contributions under a salaryreduction arrangement, do not include thesecontributions in your employee's wages onForm W–2 for income, social security, orMedicare tax purposes. Your SEP contribu-tions under a salary reduction arrangementare included in your employee's Form W–2for social security and Medicare tax purposesonly.

Example. Jim's salary reduction ar-rangement calls for a deferral contributionrate of 10% of his salary to be contributed byhis employer as an elective deferral to Jim'sSEP-IRA. Jim's salary for the year is $30,000(before reduction for the deferral). The em-ployer did not choose to treat deferrals ascompensation under the arrangement. Tofigure the deferral amount, the employermultiplies Jim's salary of $30,000 by9.0909%, the reduced rate equivalent of 10%,to get the deferral amount of $2,727.27. (Thismethod is the same one that you, as a self-employed person, use to figure the contribu-tions you make on your own behalf.) SeeRate Worksheet for Self-Employed underQualified Plan.

On Jim's Form W–2, his employer showstotal wages of $27,272.73 ($30,000 minus$2,727.27), social security wages of $30,000,and Medicare wages of $30,000. Jim reports$27,272.73 as wages on his individual incometax return.

If his employer chooses to treat deferralsas compensation under the salary reductionarrangement, Jim's deferral amount would be$3,000 ($30,000 x 10%). In this case, theemployer uses the rate called for under thearrangement (not the reduced rate) to figurethe deferral and the ADP test. On Jim's FormW–2, the employer shows total wages of$27,000 ($30,000 − $3,000), social securitywages of $30,000, and Medicare wages of$30,000. Jim reports $27,000 as wages onhis return.

In either case, the maximum deductiblecontribution would be $3,913.05 ($30,000 x13.0435%).

For more information on employer with-holding requirements, see Publication 15.

For more information on SEPs, see Pub-lication 560.

SIMPLERetirement PlanA SIMPLE plan (Savings Incentive MatchPlan for Employees) is a written salary re-duction arrangement that allows a smallbusiness (an employer with 100 or feweremployees) to make elective contributions toa SIMPLE retirement account on behalf ofeach eligible employee. An eligible employer(defined later) is generally not allowed tomaintain another retirement plan.

Chapter 17 Retirement Plans Page 87

Setting Up a SIMPLE PlanIf an employer has 100 or fewer employeeswho were paid at least $5,000 by the em-ployer in the preceding year, the employermay be able to set up a SIMPLE retirementplan on behalf of eligible employees. The plancan be either of the following.

• A SIMPLE IRA for each eligible em-ployee.

• Part of a qualified cash or deferred ar-rangement (a 401(k) plan).

The SIMPLE plan generally must be the onlyretirement plan of the employer to whichcontributions are made, or benefits are ac-crued, for service in any year beginning withthe year the SIMPLE plan becomes effective.

Contributions to a SIMPLE plan aredeductible by the employer and excludedfrom the gross income of the employee.

Definitions

SIMPLE retirement account. The SIMPLEretirement account of an eligible employee isan individual retirement plan that can be ei-ther an individual retirement account or anindividual retirement annuity, as described inPublication 590. Employees' rights to thecontributions cannot be forfeited.

A SIMPLE plan can also be set up as a401(k) plan. See Publication 560 for informa-tion on how to adopt a SIMPLE plan as partof a 401(k) plan.

Qualified salary reduction arrangement.This is an arrangement that allows an eligibleemployee to choose, during the 60-day periodbefore the beginning of any year, to have theemployer make contributions (elective defer-rals) to a SIMPLE retirement account on hisor her behalf. An eligible employee may alsostop making elective deferrals at any timeduring the year. The employer must matchthe employee's contributions or make none-lective contributions. No other types of con-tributions are allowed under a qualified salaryreduction arrangement.

Eligible employer. Any employer who has100 or fewer eligible employees in any yearand does not maintain another employer-sponsored retirement plan can set up aSIMPLE plan.

Eligible employee. Any employee who re-ceives at least $5,000 in compensation duringany 2 years preceding the plan year and isexpected to earn at least $5,000 during thecalendar year can choose to have his or heremployer make contributions to a SIMPLEretirement account under a qualified salaryreduction arrangement.

Compensation. Compensation is the totalwages required to be reported on Form W–2plus elective deferrals. For a self-employedindividual, compensation is net earnings fromself-employment. It does not include anycontribution made to the SIMPLE plan.

TIPAny SIMPLE elective deferrals madefor an employee under a salary re-duction arrangement are included in

wages on the employee's Form W–2 for so-cial security and Medicare tax purposes only.

Contribution LimitsContributions include employee electivedeferrals and employer contributions. Theemployer must satisfy one of two contributionformulas: the matching contribution formulaor a 2% nonelective contribution. No othercontributions can be made to the SIMPLEplan. These contributions, which are deduct-ible by the employer, must be made timely.

Employee elective deferral limit. Theamount that the employee chooses to havethe employer contribute to a SIMPLE retire-ment account on his or her behalf (electivedeferrals) must not exceed $6,000 for anyyear and must be expressed as a percentageof the employee's compensation.

Dollar-for-dollar employer matching con-tributions. The employer must match all el-igible employees' elective contributions on adollar-for-dollar basis, up to 3% of the em-ployee's compensation.

CAUTION!

If the employer chooses a matchingcontribution of less than 3%, the per-centage cannot be less than 1%. The

employer must notify the employee of thelower percentage within a reasonable timebefore the 60-day election period for the cal-endar year. A percentage of less than 3%cannot be chosen for more than 2 years dur-ing a 5-year period.

Nonelective contributions. In place of thedollar-for-dollar matching contributions, theemployer can choose to make nonelectivecontributions of 2% of compensation on be-half of each eligible employee. Only$160,000 of the employee's compensationcan be taken into account when figuring thecontribution limit.

CAUTION!

An employer who chooses the 2%contribution formula must timely notifythe employee (within the 60-day

election period described earlier).

Time limits for contributing funds. Theemployer must make the contribution to theSIMPLE account within 30 days after the endof the month for which the payments to theemployee were deferred. The employer'smatching contributions must be made by thedue date of the tax return, including exten-sions, for the year.

Distributions (Withdrawals)Distributions from a SIMPLE retirement ac-count are subject to the IRA rules and aregenerally includible in income when with-drawn. Tax-free rollovers can be made fromone SIMPLE account into another SIMPLEaccount or into an IRA. Early withdrawalsgenerally are subject to a 10% (or 25%) ad-ditional tax.

Exceptions. A rollover to an IRA can bemade tax free only after participating 2 yearsin the SIMPLE plan. A 25% additional tax forearly withdrawal applies if funds are with-drawn within 2 years of beginning partici-pation.

Employee notification. The employer mustnotify each eligible employee of his or heropportunity to make contributions under aSIMPLE plan. The employer must also notifyall eligible employees of the contribution al-ternative that was chosen. This information

must be provided before the beginning of theemployee's 60-day election period.

More information. This chapter does notcover all the rules and exceptions that applyto a SIMPLE IRA or a SIMPLE 401(k) plan.See Publication 560 for additional informationon excludable employees, reporting and dis-closure requirements, and other rules. Also,see Form 5304–SIMPLE or Form 5305–SIMPLE and their instructions.

See Publication 590 for information aboutIRA rules, including those on the tax treat-ment of distributions, rollovers, required dis-tributions, and income tax withholding.

Qualified PlanA qualified retirement plan is a written planyou can set up for the exclusive benefit ofyour employees and their beneficiaries. It issometimes called a Keogh or HR–10 plan.

You, or you and your employees, canmake contributions to the plan. If your planmeets the qualification requirements, you cangenerally deduct your contributions to theplan. For more information, see Publication560.

Your employees generally are not taxedon your contributions or increases in theplan's assets until they are distributed tothem. However, certain loans made fromqualified employer plans are treated as taxa-ble distributions. For more information, seePublication 575.

Qualification requirements. To be a qual-ified plan, the plan must meet many require-ments. They include the following.

• Who must be covered by the plan.

• How contributions to the plan are to beinvested.

• How contributions to the plan and bene-fits under the plan are to be determined.

• How much of an employee's interest inthe plan must be guaranteed (vested).


More than one job. If you are self-employedand also work for someone else, you canparticipate in retirement plans for both jobs.Generally, your participation in a retirementplan for one job does not affect your partici-pation in a plan for the other job. However,if you have an IRA, you may not be allowedto deduct some or all of your IRA contribu-tions. See Publication 590.

Kinds of Qualified PlansThere are two basic kinds of qualified retire-ment plans: defined contribution and definedbenefit.

Defined Contribution PlanThis plan provides for a separate account foreach person covered by the plan. Benefits arebased only on amounts contributed to or al-located to each account.

There are three types of defined contri-bution plans: profit-sharing, stock bonus, andmoney purchase pension.

Profit-sharing plan. This plan lets your em-ployees or their beneficiaries share in theprofits of your business. The plan must have

Page 88 Chapter 17 Retirement Plans

a definite formula for allocating the contribu-tions made to the plan among the participat-ing employees and for distributing the fundsin the plan.

Stock bonus plan. This plan is similar to aprofit-sharing plan, but it can only be set upby a corporation. Benefits are payable instock of the employer.

Money purchase pension plan. Under thisplan, your contributions are a stated amountor are based on a stated formula that is notsubject to your discretion. For example, yourformula could be 10% of each participatingemployee's compensation. Your contributionsto the plan are not based on your profits.

Defined Benefit PlanThis is any plan that is not a defined contri-bution plan. In general, a qualified definedbenefit plan must provide for set benefits andyour contributions to the plan are based onactuarial assumptions. Generally, you willneed continuing professional help to admin-ister a defined benefit plan.

Plan ApprovalYou must adopt a written plan. The InternalRevenue Service (IRS) will issue a determi-nation or opinion letter regarding the plan'squalification. The determination or opinion ofthe IRS will be based on how the plan iswritten, not on how it operates.

You are not required to request a deter-mination or opinion letter to get all the taxbenefits of a plan. But, if your plan does nothave a determination letter, you may want torequest one to ensure that your plan meetsthe requirements for tax benefits.

A request for a determination, opinion, orruling letter can be complex. You may needprofessional help to complete the request.Also, the IRS charges a fee for issuing theseletters. Attach Form 8717, User Fee forEmployee Plan Determination Letter Request,to your application.

Master and prototype plans. It may beeasier for you to adopt an IRS-approved ex-isting master or prototype retirement planthan to set up your own original plan. Masterand prototype plans can be provided by thefollowing sponsoring organizations.

• Trade or professional organizations.

• Banks (including some savings and loanassociations and federally insured creditunions).

• Insurance companies.

• Mutual funds.

Adoption of a master or prototype plan doesnot mean that your plan is automaticallyqualified. It must still meet all of the quali-fication requirements stated in the law.

Deduction LimitThe limit on your deduction for contributionsto a qualified plan depends on the kind of planyou have.

CAUTION!

In figuring the deduction for contribu-tions to these plans, you cannot takeinto account any contributions or

benefits that are more than the limits dis-

cussed under Limits on Contributions andBenefits in Publication 560.

Defined contribution plans. The deductionlimit for a defined contribution plan dependson whether it is a profit-sharing plan or amoney purchase pension plan.

Profit-sharing plan. Your deduction forcontributions to a profit-sharing plan cannotbe more than 15% of the compensation fromthe business paid (or accrued) during the yearto the common-law employees participatingin the plan. You must reduce this limit in fig-uring the deduction for contributions youmake for your own account. See Deductionof contributions for yourself, later.

Money purchase pension plan. Yourdeduction for contributions to a money pur-chase pension plan is generally limited to25% of the compensation from the businesspaid during the year to a participating com-mon-law employee. You must reduce this limitin figuring the deduction for contributions youmake for yourself, as discussed later.

Defined benefit plans. An actuary must fig-ure the deduction for contributions to a de-fined benefit plan since it is based on actuarialassumptions and computations.

Deduction of contributions for yourself.To take a deduction for contributions youmake to a plan for yourself, you must havenet earnings from the trade or business forwhich the plan was set up.

Limit on deduction. If the qualified planis a profit-sharing plan, your deduction foryourself is limited to the lesser of $30,000 or13.0435% (15% reduced as discussed below)of your net earnings from the trade or busi-ness that has the plan. If the plan is a moneypurchase plan, the deduction is limited to thelesser of $30,000 or 20% (25% reduced asdiscussed below) of your net earnings.

Net earnings. Your net earnings mustbe from self-employment in a trade or busi-ness in which your personal services are amaterial income-producing factor. If you area partner who only contributed capital and didnot perform personal services, you cannotparticipate in the partnership's plan. Your netearnings do not take into account tax-exemptincome (or deductions related to that income),other than foreign earned income and foreignhousing cost amounts.

Your net earnings are your business grossincome minus the allowable deductions fromthat business. Allowable deductions includecontributions to the plan for your common-lawemployees and your other business ex-penses.

If you are a partner other than a limitedpartner, your net earnings include your dis-tributive share of the partnership income orloss (other than separately computed itemssuch as capital gains and losses) and anyguaranteed payments you receive from thepartnership. If you are a limited partner, yournet earnings include only guaranteed pay-ments you receive for services rendered toor for the partnership. For more information,see Partners under Who Must Pay Self-Employment Tax in Publication 533.

Net earnings do not include incomepassed through to shareholders of S corpo-rations.

Adjustments. You must reduce your netearnings by the deduction for one-half of yourself-employment tax. Also, net earnings must

be reduced by the deduction for contributionsyou make for yourself. This reduction is madeindirectly, as explained next.

Net earnings reduced by adjustingcontribution rate. You must reduce netearnings by your deduction for contributionsfor yourself. The deduction and the netearnings depend on each other. You canmake the adjustment to your net earnings in-directly by reducing the contribution ratecalled for in the plan and using the reducedrate to figure your maximum deduction forcontributions for yourself.

Annual compensation limit. You gen-erally cannot take into account more than$160,000 of your compensation in figuringyour contribution to a defined contributionplan.

Figuring Your DeductionUse the following worksheet to find the re-duced contribution rate for yourself. Make noreduction to the contribution rate for anycommon-law employees.

Now that you have figured your self-employed rate, you can figure your maximumdeduction for contributions for yourself bycompleting the following steps.

Example. You are a self-employedfarmer and you have employees. The termsof your plan provide that you contribute101 / 2% (.105) of your compensation (definedearlier) and 101/2% of your common-law em-ployees' compensation. Your net earningsfrom line 36, Schedule F (Form 1040) are$200,000. In figuring this amount, you de-ducted your common-law employees' pay of$100,000 and contributions for them of$10,500 (101 / 2% x $100,000). You figure yourself-employed rate and maximum deductionfor contributions on behalf of yourself as fol-lows.

Rate Worksheet for Self-Employed1) Plan contribution rate as a decimal

(101 / 2% = .105) ....................................2) Rate in line 1 plus 1

(.105 + 1 = 1.105) ...............................3) Self-employed rate as a decimal

rounded to at least 3 decimal places(line 1 ÷ line 2) ....................................

Deduction Worksheet for Self-EmployedStep 1

Enter the self-employed rate shown online 3 above .........................................

Step 2Enter your net earnings (net profit) fromline 31, Schedule C (Form 1040); line3, Schedule C–EZ (Form 1040); line36, Schedule F (Form 1040); or line15a, Schedule K–1 (Form 1065) .........

Step 3Enter your deduction for self-employ-ment tax from line 27, Form 1040 .......

Step 4Subtract step 3 from step 2 and enterthe result ..............................................

Step 5Multiply step 4 by step 1 and enter theresult ....................................................

Step 6Multiply $160,000 by your plan contri-bution rate. Enter the result, but notmore than $30,000 ..............................

Step 7Enter the smaller of step 5 or step 6.This is your maximum deductiblecontribution. Enter your deduction online 29, Form 1040 ..............................

Chapter 17 Retirement Plans Page 89

When to make contributions. To take adeduction for contributions for a particularyear, you must make the contributions notlater than the due date, plus extensions, ofyour tax return for that year.

More information. See Publication 560 formore information on retirement plans for smallbusiness owners, including the self-employed. Publication 560 also discussesthe reporting forms that must be filed for theseplans.

Individual RetirementArrangements (IRAs)An individual retirement arrangement (IRA) isa personal savings plan that allows you to setaside money for your retirement or for certaineducation expenses. You do not have to setup IRAs for your employees or make contri-butions for them. You may be able to deductyour contributions, depending on the type ofIRA and your circumstances. Generally,amounts in an IRA, including earnings andgains, are not taxed until they are distributed.In some cases, your earnings and gains maynot be taxed at all if they are distributed ac-cording to the rules. For more information onIRAs, see Publication 590.

Rate Worksheet for Self-Employed

18.Excise Taxes

Important RemindersDyed diesel fuel and dyed kerosene. Dyeddiesel fuel and dyed kerosene that are usedfor a nontaxable use (such as farm use) arenot taxed. However, the excise tax and apenalty will be imposed on users of dyeddiesel fuel or dyed kerosene who know orhave reason to know that they used the fuelfor a taxable purpose. You cannot use dyeddiesel fuel or dyed kerosene in a registeredhighway vehicle. For information about regis-tered highway vehicles, see How To BuyDiesel Fuel and Kerosene Tax Free, later.

Undyed diesel fuel and undyed kerosene.A registered ultimate vendor that sells undyeddiesel fuel or undyed kerosene for use on afarm for farming purposes is allowed to claima refund or credit of the excise tax on thatfuel. Farmers cannot claim a refund or creditfor the excise tax paid on that fuel. See HowTo Buy Diesel Fuel and Kerosene Tax Free,later.

IntroductionYou may be eligible to claim a credit on yourincome tax return for federal excise tax oncertain fuels. You may also be eligible toclaim a quarterly refund of the fuel taxesduring the year, instead of waiting to claim acredit on your income tax return.

Whether you can claim a credit or refunddepends on the kind of fuel you purchased,whether it was taxed, and the purpose (non-taxable use) for which you used the fuel. Thefollowing are generally the nontaxable usesof fuel for which a farmer may claim a creditor refund.

• On a farm for farming purposes.

• Off-highway business use.

• Uses other than as a fuel in a propulsionengine, such as home use.

Table 18–1 presents an overview of cred-its and refunds for fuels used for the nontax-able uses listed above. See Publication 378for information about credits and refunds forfuels used for nontaxable uses not discussedin this chapter.


• Fuels used in farming

• How to buy diesel fuel and kerosene taxfree

• Fuels used in off-highway business use

• Fuels used for household use

• How to claim a credit or refund

• Including the credit or refund in income


Publication

� 378 Fuel Tax Credits and Refunds

� 510 Excise Taxes for 2000


� 4136 Credit for Federal Tax Paid onFuels

� 8849 Claim for Refund of Excise Taxes


Fuels Used in FarmingYou may be eligible to claim a credit or refundof excise taxes on fuel used on a farm forfarming purposes. This applies if you are theowner, tenant, or operator of a farm. Youmay claim only a credit for the tax on gasolineused on a farm for farming purposes. Youmay claim either a credit or refund for the taxon aviation fuel used on a farm for farmingpurposes. You cannot claim a credit or re-fund for the tax on undyed diesel fuel or un-dyed kerosene used on a farm for farmingpurposes or for any use of dyed diesel fuelor dyed kerosene.

Farm. A farm includes livestock, dairy, fish,poultry, fruit, fur-bearing animals, and truckfarms, orchards, plantations, ranches, nurs-eries, ranges, and feed yards for fatteningcattle. It also includes structures such asgreenhouses used primarily for raising agri-cultural or horticultural commodities. A fishfarm is an area where fish are grown or raised— not merely caught or harvested. You mustoperate the farm for profit. It must be locatedin any of the 50 states or the District ofColumbia.

Farming purposes. You use fuel on a farmfor farming purposes if you use it in any of thefollowing ways.

1) To cultivate the soil or to raise or harvestany agricultural or horticultural commod-ity.

2) To raise, shear, feed, care for, train, ormanage livestock, bees, poultry, fur-bearing animals, or wildlife.

3) To operate, manage, conserve, improve,or maintain your farm, tools, or equip-ment.

4) To handle, dry, pack, grade, or store anyraw agricultural or horticultural commod-ity. For this use to qualify, you must haveproduced more than half the commoditythat was so treated during the tax year.Commodity means a single raw product.For example, apples and peaches aretwo separate commodities. The more-than-one-half test applies separately toeach commodity.

5) To plant, cultivate, care for, or cut treesor to prepare (other than sawing logs intolumber, chipping, or other milling) treesfor market, but only if the planting, etc.,is incidental to your farming operations.Your tree operations are incidental only

1) Plan contribution rate as a decimal(101 / 2% = .105) .................................... 0.105

2) Rate in line 1 plus 1(.105 + 1 = 1.105) ............................... 1.105

3) Self-employed rate as a decimalrounded to at least 3 decimal places(line 1 ÷ line 2) .................................... 0.0950

Deduction Worksheet for Self-EmployedStep 1

Enter the self-employed rate shown online 3 above ......................................... 0.0950

Step 2Enter your net earnings (net profit) fromline 31, Schedule C (Form 1040); line3, Schedule C–EZ (Form 1040); line36, Schedule F (Form 1040); or line15a, Schedule K–1 (Form 1065) ......... $200,000

Step 3Enter your deduction for self-employ-ment tax from line 27, Form 1040 ....... 7,180

Step 4Subtract step 3 from step 2 and enterthe result .............................................. 192,820

Step 5Multiply step 4 by step 1 and enter theresult .................................................... 18,318

Step 6Multiply $160,000 by your plan contri-bution rate. Enter the result but notmore than $30,000 .............................. 16,800

Step 7Enter the smaller of step 5 or step 6.This is your maximum deductiblecontribution. Enter your deduction online 29, Form 1040 .............................. $ 16,800

Page 90 Chapter 18 Excise Taxes

Table 18–1. Fuel Tax Credits and Refunds at a GlanceUse this table to see if you can take a credit or refund for anontaxable use of the fuel listed.

Fuel UsedOn a Farm for

Farming PurposesOff-Highway

Business Use Household Use1

Gasoline andgasohol

Aviation gasoline

Undyed diesel fueland kerosene

Dyed diesel fueland kerosene

Aviation fuel

Credit only

Credit or refund byregistered ultimatevendor only2

None

Credit or refund

Credit only

Credit or refund

Credit or refund3

None

None

None

None

None

None

None

Credit or refund3

1 For a use other than as fuel in a propulsion engine.2 Fuel used for farming purposes cannot be considered as used for any other purpose.3 Applies to kerosene not sold from a blocked pump.

Sample form of waiver. While no spe-cific form is required, an acceptable statementwaiving your right to claim a credit or refundis shown in Table 18–2.

Fuel not used for farming. You do not usefuel on a farm for farming purposes when youuse it in any of the following ways.

• Off the farm, such as on the highway orin noncommercial aviation, even if thefuel is used in transporting livestock,feed, crops, or equipment.

• For personal use, such as mowing thelawn.

• In processing, packaging, freezing, orcanning operations.

• In processing crude gum into gum spiritsof turpentine or gum resin or in process-ing maple sap into maple syrup or maplesugar.

All-terrain vehicles (ATVs). Fuel used inATVs on a farm for farming purposes, dis-cussed earlier, is eligible for a credit or refundof excise taxes on the fuel. Fuel used in ATVsfor nonfarming purposes is not eligible for acredit or refund of the taxes. If ATVs are usedboth for farming and nonfarming purposes,only that portion of the fuel used for farmingpurposes is eligible for the credit or refund.

How To BuyDiesel Fuel andKerosene Tax FreeYou buy dyed diesel fuel and dyed keroseneexcise tax free. You must use them only fora nontaxable use, including use on a farm forfarming purposes. If you use the dyed fuel fora taxable purpose, such as in a registeredhighway vehicle, you could be subject to theexcise tax and a penalty. See Registeredhighway vehicle, later.

You may buy undyed diesel fuel and un-dyed kerosene tax free for use on a farm forfarming purposes from a registered ultimatevendor. This applies to fuel bought by any ofthe following persons.

• The owner, tenant, or operator of a farmfor use on a farm for any of the purposeslisted earlier under Farming purposes.

• Any other person for use on a farm forany of the purposes in items (1) and (2)listed earlier under Farming purposes.

You must give the vendor a signed certif-icate, which should be substantially the sameas the sample certificate shown in Table18–3. (If kerosene is purchased, thenkerosene, rather than diesel fuel, should beindicated on the certificate.) You may includethe certificate as part of any business recordsyou normally keep to document a sale andpurchase.

You cannot claim a credit or refund for theexcise tax on diesel fuel or kerosene used ona farm for farming purposes. The registeredultimate vendor who sells you the fuel at atax-excluded price claims the credit or refund.

Registered highway vehicle. For determin-ing whether a vehicle is considered to be aregistered highway vehicle, the terms, “high-

if they are minor in nature when com-pared to the total farming operations.

If any other person, such as a neighbor orcustom operator, performs a service for youon your farm for any of the purposes includedin (1) or (2), you can still claim the credit orrefund for the fuel so used (other than fordiesel fuel or kerosene). However, see Cus-tom application of fertilizer and pesticide,later. If the other person performs any otherservices for you on your farm for purposesnot included in (1) or (2), no one can claim thecredit or refund for fuel used on your farm forthose other services.

Example. Farm owner Nancy Blue hiredcustom operator Harry Steele to prepare thesoil on her farm for planting. Under the con-tract, she paid for 200 gallons of gasoline tobe used by Harry in cultivating the soil on herfarm. In addition, she hired Contractor Brownto pack and store her apple crop. Brownbought 25 gallons of gasoline to use in pack-ing the apples and was not reimbursed byNancy. She can claim the credit for the 200gallons of gasoline used by Harry on her farmbecause it qualifies as fuel used on the farmfor farming purposes. No one can claim acredit for the 25 gallons because they werenot used for a farming purpose listed in (1)or (2) earlier.

Buyer of fuel (other than diesel fuel orkerosene). If doubt exists whether theowner, tenant, or operator of the farm boughtthe fuel, determine who actually bore the costof the fuel. For example, if the owner of a farmand his tenant share the cost of gasoline usedon the farm 50–50, each can claim a creditfor the tax on half the fuel used.

Diesel fuel and kerosene. If undyed dieselfuel or undyed kerosene is used for any of thepreviously listed farming purposes, the fuelcannot be considered as being used for anyother nontaxable use. The credit or refund isallowed only to the registered ultimate vendor.Farmers cannot claim a refund or credit forthis fuel if it is used for farming purposes. SeeHow To Buy Diesel Fuel and Kerosene TaxFree, later.

A registered ultimate vendor is the per-son who sells undyed diesel fuel or undyedkerosene to the user (ultimate purchaser) ofthe fuel for use on a farm for farming pur-

poses. The ultimate vendor must be regis-tered with the Internal Revenue Service at thetime the claim is made.

Custom application of fertilizer and pesti-cide. Fuel used on a farm for farming pur-poses includes fuel used in the aerial or otherapplication of fertilizer, pesticides, or othersubstances. You as the owner, tenant, oroperator may claim the credit or refund for thefuel (other than for diesel fuel or kerosene).You may waive your right to the claim andallow the applicator to make the claim. If youwaive your right, the applicator is then treatedas having used the fuel on a farm for farmingpurposes. See How To Claim a Credit orRefund, later.

Waiver. To waive your right to the creditor refund, you must take all the followingactions.

1) Before the applicator files his or herclaim, sign an irrevocable statement thatyou knowingly give up your right to thecredit or refund. You may authorize anagent, such as a cooperative, to sign thewaiver for you.

2) Identify clearly the period that the waivercovers. The effective period of yourwaiver cannot extend beyond the lastday of your tax year.

3) The applicator must retain a copy of thewaiver and give you a copy. Do not senda copy to the Internal Revenue Serviceunless requested to do so.

The waiver may be a separate documentor it may appear on an invoice or anotherdocument from the applicator. If the waiverappears on an invoice or other document, itmust be printed in a section clearly set offfrom all other material, and it must be printedin type large enough to put you on notice thatyou are waiving your right to the credit or re-fund. If the waiver appears as part of an in-voice or other document, it must be signedseparately from any other item that requiresyour signature.

Sign a separate waiver for each tax yearor part of a tax year in which the fuel wasused. When the period covered by the waiverextends beyond the applicator's tax year, theapplicator must wait until the next tax year toclaim the portion for that period.

Chapter 18 Excise Taxes Page 91

Table 18–2. Sample Waiver

Address

WAIVER OF RIGHT TO CREDIT OR REFUND

I hereby waive my right as owner, tenant, or operator of a farm located at:

to receive credit or refund for fuel used by:

Name of Applicator

on the farm in connection with cultivating the soil, or the raising or harvesting of anyagricultural or horticultural commodity. This waiver applies to fuel used during theperiod:

Both Dates Inclusive

I understand that by signing this waiver, I give up my right to claim any credit orrefund for fuel used by the aerial applicator or other applicator of fertilizer or othersubstances during the period indicated, and I acknowledge that I have not previouslyclaimed any credit for that fuel.

Signature

Date

Fuels Used InOff-HighwayBusiness UseYou may be eligible to claim a credit or refundfor fuels used in an off-highway business use.

Off-highway business use. Off-highwaybusiness use is any use of fuel in a trade orbusiness or in any income-producing activity.The use must not be in a highway vehicleregistered or required to be registered for useon public highways. Off-highway businessuse generally does not include any use in amotorboat.

Note. If undyed diesel fuel or undyedkerosene is used on a farm for farming pur-poses (discussed earlier), the fuel is not usedin an off-highway business use. Farmerscannot claim a credit or refund for the tax ondiesel fuel or kerosene used on a farm forfarming purposes. See How To Buy DieselFuel and Kerosene Tax Free, earlier.

Examples. Off-highway business use in-cludes fuels used in any of the following ways.

• In stationary machines such as genera-tors, compressors, power saws, andsimilar equipment.

• For cleaning purposes.

• In forklift trucks and bulldozers.

• In vehicles operating off the highway inconstruction, mining, or timbering activ-ities if the vehicles are neither registerednor required to be registered.

Generally, it does not include nonbusi-ness, off-highway use of fuel, such as use byminibikes, snowmobiles, power lawn mowers,chain saws, and other yard equipment.

For more information about the credit orrefund for fuels used in an off-highway busi-ness use, see Publication 378.

Fuels Used ForHousehold UseYou may be eligible to claim a credit or refundfor the excise tax on undyed diesel fuel andundyed kerosene for home use. The homeuse of fuel applies to fuel you purchased andused in your home for heating, lighting, andcooking.

The home use of undyed diesel fuel andundyed kerosene is included as a use otherthan as a fuel in the propulsion engine of atrain or diesel-powered highway vehicle. It isnot considered to be an off-highway businessuse (discussed earlier).

How To Claim aCredit or RefundYou may be able to claim a credit or refundof the excise tax on fuels you use for non-taxable uses. You can claim only a credit forgasoline used for farming purposes. You canclaim either a credit or a refund for aviationfuel used for farming purposes.

way vehicle” and “registered” have themeanings given in the following definitions.

Highway vehicle. A highway vehicle isany self-propelled vehicle designed to carrya load over public highways, whether or notit is also designed to perform other functions.Examples of vehicles designed to carry a loadover public highways are passenger automo-biles, motorcycles, buses, and highway-typetrucks and truck tractors. A vehicle is a high-way vehicle even though the vehicle's designallows it to perform a highway transportationfunction for only one of the following pur-poses.

• A particular type of load, such as pas-sengers, furnishings, and personal ef-fects (as in a house, office, or utilitytrailer).

• A special kind of cargo, goods, supplies,or materials.

• Some off-highway task unrelated tohighway transportation, except as dis-cussed next.

Vehicles not considered highway vehi-cles. Generally, the following kinds of vehi-cles are not considered highway vehicles.

1) Specially designed mobile machinery fornontransportation functions. A self-propelled vehicle is not a highway vehi-cle if all of the following conditions aremet.

a) The chassis has permanentlymounted to it machinery or equip-ment used to perform certain oper-ations (construction, manufacturing,drilling, mining, timbering, process-ing, farming, or similar operations)if the operation of the machinery orequipment is unrelated to transpor-tation on or off the public highways.

b) The chassis has been specially de-signed to serve only as a mobile

carriage and mount for the machin-ery or equipment, whether or notthe machinery or equipment is inoperation.

c) The chassis could not, because ofits special design and without sub-stantial structural modification, beused as part of a vehicle designedto carry any other load.

2) Vehicles designed for off-highway trans-portation. A self-propelled vehicle is nota highway vehicle if it meets both of thefollowing conditions.

a) The vehicle is designed primarily tocarry a specific kind of load otherthan over the public highway forcertain operations (construction,manufacturing, mining, processing,farming, drilling, timbering, or simi-lar operations).

b) The vehicle's use in carrying thisload over public highways is sub-stantially limited or impaired be-cause of its design. To determineif the use is substantially limited orimpaired, you can take into accountwhether the vehicle may travel atregular highway speeds, requires aspecial permit for highway use, oris overweight, overheight, or over-width for regular highway use.

Registered. A vehicle is considered reg-istered if it is registered or required to beregistered for highway use under the law ofany state, the District of Columbia, or anyforeign country in which it is operated or sit-uated. Any highway vehicle operated undera dealer's tag, license, or permit is consideredregistered. A highway vehicle is not consid-ered registered solely because a specificpermit allows the vehicle to be operated atparticular times and under specified condi-tions.

Page 92 Chapter 18 Excise Taxes

Table 18–3. Sample Exemption Certificate

Name, Address, and Employer Identification Number of Seller

EXEMPTION CERTIFICATE(To support vendor’s claim for credit or payment under section 6427 of the Internal Revenue Code)

The undersigned buyer (“Buyer”) hereby certifies the following under penalties ofperjury:

■ Buyer will provide a new certificate to the seller if any information in this certificatechanges.

Signature and Date Signed

Printed or Typed Name and Title of Person Signing

Name, Address, and Employer Identification Number of Buyer

A.

1.

Buyer will use the diesel fuel to which this certificate relates either — (check one):

On a farm for farming purposes (as defined in §48.6420-4 of theManufacturers and Retailers Excise Tax Regulations) and Buyer is theowner, tenant, or operator of the farm on which the fuel will be used; or

2. On a farm (as defined in §48.6420-4(c)) for any of the purposes described in¶ (d) of that section (relating to cultivating, raising, or harvesting) (and Buyeris not the owner, tenant, or operator of the farm on which the fuel will beused).

B.

1.

This certificate applies to the following (complete as applicable):

If this is a single purchase certificate, check here and enter:

a. Invoice or delivery ticket number

b. Number of gallons

2. If this is a certificate covering all purchases under a specified account or ordernumber, check here and enter:

a. Effective date

b. Expiration date(period not to exceed 1 year after effective date)

■ If Buyer uses the diesel fuel to which this certificate relates for a purpose otherthan stated in the certificate, Buyer will be liable for any tax.

■ Buyer understands that the fraudulent use of this certificate may subject Buyerand all parties making such fraudulent use of this certificate to a fine orimprisonment, or both, together with the costs of prosecution.

c. Buyer account or order number

see Publication 583, Starting a Business andKeeping Records.

Credit or refund. A credit is an amount thatreduces the tax on your income tax returnwhen you file it at the end of the year. If youmeet certain requirements, you can claim arefund during the year instead of waiting untilyou file your tax return.

Credit only. The following taxes can onlybe claimed as a credit.

• Tax on gasoline you used on a farm forfarming purposes.

• Tax on fuels used for nontaxable uses ifthe total for the tax year is less than $750.

• Tax on fuel that was not included in anyclaim for refund previously filed for the taxyear.

The basic rules for claiming credits andrefunds (discussed later) are listed in Table18–4.

Claiming a CreditYou make a claim for a fuel tax credit onForm 4136 and attach it to your income taxreturn. Do not claim a credit for any excise taxfor which you have filed a refund claim.

How to claim a credit. How you claim acredit depends on whether you are an indi-vidual, partnership, corporation, S corpo-ration, trust, or farmers' cooperative associ-ation.

Individuals. You claim the credit on line63 of your 1999 Form 1040. Check box b. Ifyou would not otherwise have to file an in-come tax return, you must do so to get a fueltax credit. See the instructions for Form 1040.

Partnership. A partnership cannot claimthe credit on Form 1065, U.S. PartnershipReturn of Income. The partnership must at-tach a statement to Form 1065 showing thenumber of gallons of each fuel allocated toeach partner and the rate that applies. Eachpartner claims the credit on his or her incometax return for the partner's share of the fuelused by the partnership.

An electing large partnership can claim thecredit on line 27 of Form 1065–B, U.S. Returnof Income for Electing Large Partnerships.

Corporation. To claim the credit, a cor-poration uses either line 32g of Form 1120,U.S. Corporation Income Tax Return, or line28g of Form 1120–A, U.S. CorporationShort-Form Income Tax Return.

S corporation. To claim the credit, an Scorporation uses line 23c of Form 1120S,U.S. Income Tax Return for an S Corpo-ration.

Farmers' cooperative association. If acooperative must file Form 990–C, Farmers'Cooperative Association Income Tax Return,it uses line 32g to claim the credit.

Trust. A trust required to file Form 1041,U.S. Income Tax Return for Estates andTrusts, uses line 24g to claim the credit.

When to claim a credit. You can claim a fueltax credit on your income tax return for theyear you used the fuels or you may be ableto amend your income tax return for that year.Generally, you must file an amended returnby the later of 3 years after the date you filedyour original return or within 2 years after youpaid the tax. A return filed early is consideredfiled on the due date.

No credit or refund is allowed to anyonefor any fuel, such as dyed diesel fuel or dyedkerosene, bought tax free.

Undyed diesel fuel and undyed kerosene.You cannot claim a credit or refund for un-dyed diesel fuel or undyed kerosene used ona farm for farming purposes. Only the regis-tered ultimate vendor that sells the fuel to youcan make this claim. However, you can claima credit or refund for undyed diesel fuel orundyed kerosene used for other nontaxableuses, such as off-highway business use. Ifundyed diesel fuel or undyed kerosene isused on a farm for farming purposes, youcannot consider it as being used for any othernontaxable use.

Taxpayer identification number. To file aclaim for credit or refund, you MUST have ataxpayer identification number. See TaxpayerIdentification Number in chapter 2.

RECORDS

Keep at your principal place of busi-ness all records needed to enable theIRS to verify the amount you claimed.

You do not have to use any special form, butthe records should establish all the followinginformation.

• The total number of gallons bought andused during the period covered by yourclaim.

• The dates of the purchases.

• The names and addresses of suppliersand amounts bought from each duringthe period covered by your claim.

• The nontaxable use for which you usedthe fuel.

• The number of gallons used for eachnontaxable use.

It is important that your records showseparately the number of gallons used foreach nontaxable use that qualifies as a claim.For more information about recordkeeping,

Chapter 18 Excise Taxes Page 93

Table 18–4. Claiming a Credit or Refund of Excise TaxesThis tables gives the basic rules for claiming a credit or refund ofexcise taxes on fuels used for a nontaxable use.

Credit Refund

Which form to use

Type of form

When to file

Amount of tax

Form 4136, Credit forFederal Tax Paid on Fuels

Annual

With your income taxreturn

Any amount

Form 8849, Claim forRefund of Excise Taxes

Quarterly

By the last day of thequarter following the lastquarter included in theclaim

$750 or more

Cash method. If you use the cash methodand file a claim for refund, include the refundin gross income for the tax year in which youreceive the refund. If you claim a credit onyour income tax return, include the credit ingross income for the tax year in which you fileForm 4136. If you file an amended return andclaim a credit, include the credit in gross in-come for the tax year in which you receive it.

Example. Ed Brown, a cash basis farmer,filed his 1999 Form 1040 on March 1, 2000.On his Schedule F, he deducted the total costof gasoline (including $110 of excise taxes)used on the farm for farming purposes. Then,on Form 4136, he claimed the $110 as acredit. Ed reports the $110 as other incomeon line 10 of his 2000 Schedule F.

Accrual method. If you use an accrualmethod, include the entire claim in gross in-come for the tax year in which you used thefuels. It does not matter if an accrual basistaxpayer filed for a quarterly refund or claimedthe entire amount as a credit.

Example. Todd Green, an accrual basisfarmer, files his 1999 Form 1040 on April 17,2000. On Schedule F, he deducts the totalcost of gasoline (including $155 of excisetaxes) that he used on the farm during 1999.On Form 4136, Todd claims the $155 as acredit. He reports the $155 as other incomeon line 10 of his 1999 Schedule F.

19.Your Rights asa Taxpayer

The first part of this chapter explains someof your most important rights as a taxpayer.The second part explains the examination,appeal, collection, and refund processes.

Declaration ofTaxpayer RightsProtection of your rights. IRS employeeswill explain and protect your rights as a tax-payer throughout your contact with us.

Privacy and confidentiality. The IRS willnot disclose to anyone the information yougive us, except as authorized by law. Youhave the right to know why we are asking youfor information, how we will use it, and whathappens if you do not provide requested in-formation.

Professional and courteous service. If youbelieve that an IRS employee has not treatedyou in a professional, fair, and courteousmanner, you should tell that employee'ssupervisor. If the supervisor's response is notsatisfactory, you should write to your IRSDistrict Director or Service Center Director.

Representation. You may either representyourself or, with proper written authorization,have someone else represent you in your

CAUTION!

Once you have filed a Form 4136, youcannot file an amended return toshow an increase in the number of

gallons reported on a line. See the followingdiscussion for when you can file a claim onan amended return.

Fuel tax claim on amended return. Youcan file an amended return to claim a fuel taxcredit only in the following situations.

• You did not claim any credit for fuel taxeson Form 4136 for the tax year.

• Your credit is for gasohol blending, dis-cussed in Publication 378.

• Your credit is for a claim group, explainednext, for which you did not previously filea claim on Form 4136 for the tax year.

Claims on Form 4136 (other than for gas-ohol blending, line 8) are separated intoseven claim groups based on the type of fueland the use of that fuel. Once you file Form4136 with a claim for a group, you cannot filean amended return with another claim for thatgroup. However, you can file an amendedreturn with a claim for another group.

The following table shows which claimsare in each group. The numbers in the sec-ond column refer to the line numbers on Form4136. The numbers in the third column arefrom the Type of Use Table in the Form 4136instructions.

For each tax year, you can make only oneclaim for each group.

Example. You file your income tax returnand claim a fuel tax credit. Your Form 4136shows an amount on line 1b for use of gaso-line on a farm for farming purposes. This isa Group I claim. You cannot amend your re-turn to claim a credit for an amount on line2b for use of aviation gasoline on a farm forfarming purposes (Type of Use 1), since thatis also a Group I claim. However, if you usedaviation fuel on a farm for farming purposes,you can amend your return to claim the creditfor that fuel tax because that would be aGroup VI claim reported on line 4b (Type ofUse 1).

Claiming a RefundYou make a claim for refund on Form 8849. Do not claim a credit against your income taxfor any excise tax for which you filed a timelyclaim for refund.

You can file a claim for refund for anyquarter of your tax year for which you canclaim $750 or more. This amount is the excisetax paid on all fuels used for any nontaxableuse during that quarter or any prior quarter(for which no other claim has been filed) dur-ing the tax year.

CAUTION!

You cannot claim a refund for excisetax on gasoline used on a farm forfarming purposes. You must claim a

credit on your income tax return for the excisetax on gasoline used on a farm for farmingpurposes.

If you cannot claim at least $750 at theend of a quarter, you carry the amount overto the next quarter of your tax year to deter-mine if you can claim at least $750 for thatquarter. If you cannot claim at least $750 atthe end of the fourth quarter of your tax year,you must claim a credit on your income taxreturn.

How to file a quarterly claim. File the claimby filling out Schedule 1 (Form 8849) and at-taching it to Form 8849. Send it to the ad-dress shown in the instructions. If you fileForm 720, you can use the Schedule C por-tion of Form 720 for your refund claims. (Seethe Form 720 instructions.)

When to file a quarterly claim. You mustfile a quarterly claim by the last day of the firstquarter following the last quarter included inthe claim. If you do not file a timely refundclaim for the fourth quarter of your tax year,you will have to claim a credit for that amounton your income tax return, as discussed ear-lier.

Including the Creditor Refund in IncomeInclude any credit or refund of excise taxeson fuels in your gross income if you includedthe cost of the fuel as an expense deductionthat reduced your income tax liability.

Which year you include a credit or refundin gross income depends on whether you usethe cash or an accrual method of accounting.

Group Line No. Type of Use

I 1b, 1d-f, 2b 1

II 1a, 1d-f, 2a 2

III 1c-f 5, 7

IV 1c-f, 2b 3, 4, 9

V 3c, 7 5, 7

VI 3a-b, 4, 5, 6 See line instructions

VII 2b 10

Page 94 Chapter 19 Your Rights as a Taxpayer

place. Your representative must be a personallowed to practice before the IRS, such asan attorney, certified public accountant, orenrolled agent. If you are in an interview andask to consult such a person, then we muststop and reschedule the interview in mostcases.

You can have someone accompany youat an interview. You may make sound rec-ordings of any meetings with our examination,appeal, or collection personnel, provided youtell us in writing 10 days before the meeting.

Payment of only the correct amount of tax.You are responsible for paying only the cor-rect amount of tax due under the law—nomore, no less. If you cannot pay all of your taxwhen it is due, you may be able to makemonthly installment payments.

Help with unresolved tax problems. TheNational Taxpayer Advocate's Problem Res-olution Program can help you if you have triedunsuccessfully to resolve a problem with theIRS. Your local Taxpayer Advocate can offeryou special help if you have a significanthardship as a result of a tax problem. Formore information, call toll free 1–877–777–4778 (1–800–829–4059 for TTY/TDD users)or write to the Taxpayer Advocate at the IRSoffice that last contacted you.

Appeals and judicial review. If you disa-gree with us about the amount of your taxliability or certain collection actions, you havethe right to ask the Appeals Office to reviewyour case. You may also ask a court to reviewyour case.

Relief from certain penalties and interest.The IRS will waive penalties when allowedby law if you can show you acted reasonablyand in good faith or relied on the incorrectadvice of an IRS employee. We will waiveinterest that is the result of certain errors ordelays caused by an IRS employee.

Examinations,Appeals, Collections,and RefundsExaminations (audits). We accept mosttaxpayers' returns as filed. If we inquire aboutyour return or select it for examination, it doesnot suggest that you are dishonest. The in-quiry or examination may or may not result inmore tax. We may close your case withoutchange; or, you may receive a refund.

The process of selecting a return for ex-amination usually begins in one of two ways.First, we use computer programs to identifyreturns that may have incorrect amounts.These programs may be based on informa-tion returns, such as Forms 1099 and W–2,on studies of past examinations, or on certainissues identified by compliance projects.Second, we use information from outsidesources that indicates that a return may haveincorrect amounts. These sources may in-clude newspapers, public records, and indi-viduals. If we determine that the informationis accurate and reliable, we may use it to se-lect a return for examination.

Publication 556, Examination of Returns,Appeal Rights, and Claims for Refund, ex-plains the rules and procedures that we follow

in examinations. The following sections givean overview of how we conduct examinations.

By mail. We handle many examinationsand inquiries by mail. We will send you a let-ter with either a request for more informationor a reason why we believe a change to yourreturn may be needed. You can respond bymail or you can request a personal interviewwith an examiner. If you mail us the requestedinformation or provide an explanation, wemay or may not agree with you, and we willexplain the reasons for any changes. Pleasedo not hesitate to write to us about anythingyou do not understand.

By interview. If we notify you that we willconduct your examination through a personalinterview, or you request such an interview,you have the right to ask that the examinationtake place at a reasonable time and place thatis convenient for both you and the IRS. If ourexaminer proposes any changes to your re-turn, he or she will explain the reasons for thechanges. If you do not agree with thesechanges, you can meet with the examiner'ssupervisor.

Repeat examinations. If we examinedyour return for the same items in either of the2 previous years and proposed no change toyour tax liability, please contact us as soonas possible so we can see if we should dis-continue the examination.

Appeals. If you do not agree with the exam-iner's proposed changes, you can appealthem to the Appeals Office of the IRS. Mostdifferences can be settled without expensiveand time-consuming court trials. Your appealrights are explained in detail in both Publica-tion 5, Your Appeal Rights and How To Pre-pare a Protest If You Don't Agree, and Publi-cation 556, Examination of Returns, AppealRights, and Claims for Refund.

If you do not wish to use the Appeals Of-fice or disagree with its findings, you may beable to take your case to the U.S. Tax Court,U.S. Court of Federal Claims, or the U.S.District Court where you live. If you take yourcase to court, the IRS will have the burdenof proving certain facts if you kept adequaterecords to show your tax liability, cooperatedwith the IRS, and meet certain other condi-tions. If the court agrees with you on mostissues in your case, and finds that our posi-tion was largely unjustified, you may be ableto recover some of your administrative andlitigation costs. You will not be eligible to re-cover these costs unless you tried to resolveyour case administratively, including goingthrough the appeals system, and you gaveus the information necessary to resolve thecase.

Collections. Publication 594, The IRS Col-lection Process, explains your rights and re-sponsibilities regarding payment of federaltaxes. It describes:

• What to do when you owe taxes. It de-scribes what to do if you get a tax bill andwhat to do if you think your bill is wrong.It also covers making installment pay-ments, delaying collection action, andsubmitting an offer in compromise.

• IRS collection actions. It covers liens, re-leasing a lien, levies, releasing a levy,seizures and sales, and release of prop-erty.

Publication 1660, Collection AppealRights, explains your collection appeal rights

for liens, levies, seizures, and installmentagreement terminations.

Innocent spouse relief. Generally, bothyou and your spouse are responsible, jointlyand individually, for paying the full amount ofany tax, interest, or penalties due on your jointreturn. However, you may not have to pay thetax, interest, and penalties related to yourspouse (or former spouse).

New tax law changes make it easier toqualify for innocent spouse relief and add twoother ways for you to get relief. For moreinformation, see Publication 971, InnocentSpouse Relief, and Form 8857, Request forInnocent Spouse Relief (And Separation ofLiability and Equitable Relief).

Refunds. You may file a claim for refund ifyou think you paid too much tax. You mustgenerally file the claim within 3 years from thedate you filed your original return or 2 yearsfrom the date you paid the tax, whichever islater. The law generally provides for intereston your refund if it is not paid within 45 daysof the date you filed your return or claim forrefund. Publication 556, Examination of Re-turns, Appeal Rights, and Claims for Refund,has more information on refunds.

20.Sample Return

This sample return uses actual forms toshow you how to prepare your income taxreturn. However, the information shown onthe filled-in forms is not from any actualfarming operation.

Walter Brown is a dairy farmer and hiswife, Jane, is a substitute teacher for thecounty school system. They have three chil-dren. Their return has been prepared usingthe cash method of accounting. See chapter3 for an explanation of the cash method andother methods of accounting.

Rounding off cents. You may round offcents to the nearest whole dollar on your re-turn and schedules. This will make it easierto complete your return. To do so, dropamounts under 50 cents and increaseamounts from 50 to 99 cents to the next dol-lar. For example, $129.49 becomes $129 and$235.50 becomes $236.

If you do round off, do so for all amounts.However, if you have to add two or moreamounts to figure the total to enter on a line,include cents when adding the amounts andround off only the total.

Losses from operating a farm. The samplereturn shows a gain from the operation of thefarm. However, if your deductible farm ex-penses are more than your farm income forthe year, you have a loss from the operationof your farm. If your loss is more than yourother income for the year, you may have anet operating loss (NOL). You may also havean NOL if you had a casualty or theft loss thatwas more than your income.

If you have an NOL this year, you may beable to reduce your income (and tax) in otheryears by carrying the NOL to those years anddeducting it from income.

Chapter 20 Sample Return Page 95

To determine if you have an NOL, com-plete your tax return for the year. You mayhave an NOL if a negative figure appears online 37 of Form 1040. If this is the case, seeLosses From Operating a Farm in chapter 5.

Preparing the Return

Schedule F (Form 1040)The first step in preparing Mr. Brown's incometax return is to determine his net farm profitor loss on Schedule F. The income and ex-penses shown on this Schedule F are takenfrom his farm receipt and expense records.Data for the depreciation and section 179deductions are taken from Form 4562 and theillustrated Depreciation Worksheet that fol-lows Form 4562. (Farm income is discussedin chapter 4 and farm expenses are dis-cussed in chapter 5.) Mr. Brown has filed allrequired Form 1099 information returns.

On line B he writes the number “112120”from the list of Principal Agricultural ActivityCodes on page 2 of Schedule F (not shown).This indicates that his principal source of farmincome is from dairy farming.

Schedule F—Part I (Income)Mr. Brown keeps records of the various typesof farm income he receives during the year.He uses this information to complete Part Iof Schedule F.

Line items. He then fills in all applicableitems of farm income.

Line 1. In 1999, he sold steers he hadbought for resale. He enters sales of $26,584.

Line 2. He enters the cost of the steers,$6,523. He has kept a record of the cost ofthe livestock he bought and is careful to de-duct the cost of an animal in the year of itssale.

Line 3. He subtracts his cost on line 2from the sales on line 1 and reports the dif-ference, $20,061, as his profit on line 3. Hadhe sold any other items he bought for resale,he would combine the sales and costs ofthese items with the sales and costs of thesteers and report only the totals on lines 1,2, and 3. He does not report here sales ofanimals held for draft, dairy, breeding, orsport. He reports those sales on Form 4797.

Line 4. He enters the income he receivedduring 1999 from sales of items he raised orproduced on his farm. His principal source offarm income is dairy farming. The amountreported on this line, $163,018, includes salesof all of the following.

Lines 5a and 5b. He reports the $33 ofpatronage dividends received from cooper-atives on line 5a. Since it was a qualifiedwritten notice of allocation, he enters $33 asthe taxable amount on line 5b.

Lines 6a and 6b. He received FarmService Agency (FSA) cost sharing of $438on a soil conservation project (diversionchannels) completed in 1999. He received theincome as materials and services paid for bythe government and reports it on both line 6a

and line 6b. The Department of Agriculture(USDA) reports this amount to the InternalRevenue Service (IRS), generally on Form1099–G. The entire $438 has been includedon line 14 of Schedule F as a conservationexpense. He did not receive any cost-sharingpayments this year that he could exclude fromhis farm income.

Line 7a. He reports the $665 loan he re-ceived from the Commodity Credit Corpo-ration (CCC) because he elected in a previ-ous year to treat these loans as income in theyear received. (If he had elected not to reporthis CCC loan as income in the year receivedand forfeited the loan in a later year, he wouldreport the loan as income in the year offorfeiture.)

Line 9. He reports his $1,258 of incomefrom custom harvesting.

Line 10. On his 1998 income tax return,he claimed a credit of $142 for excise taxeson gasoline used on his farm. He includes theentire $142 in his 1999 income on line 10because he deducted the total cost of gaso-line (including the $142 of excise taxes) as afarm business expense in 1998. He also in-cludes $250 he received as a director of thelocal milk marketing cooperative and $175received for firewood that he cut and sold in1999.

Schedule F— Part II (Expenses)Mr. Brown records his farm expenses duringthe year for tax purposes and summarizesthese expenses at the end of the year. Thisgives him his deductible expenses, which heenters in Part II of Schedule F.

Line items. He then fills in all applicableitems of farm expense deductions.

Line 12. He uses his trucks 100% for hisfarming business and the actual cost (not in-cluding depreciation) of operating the trucksin 1999 was $2,659. He uses his family car60% for business. It cost $2,307 to operatethe car in 1999. He can deduct $1,384 for thecar ($2,307 × .60). He enters a total of $4,043on line 12. (Depreciation is reported on line16.)

Line 13. The $2,701 on this line is theamount he paid for pesticides and herbicidespurchased during the year.

Line 14. He deducts the $1,040 spent ondiversion channels in 1999. The amountlisted here includes the full cost of the gov-ernment cost-sharing project, which has beenreported as income on line 6. He continuesthe policy elected in previous years of de-ducting annual soil and water conservationexpenses. The expenses are consistent witha plan approved by the Natural ResourcesConservation Service of the USDA. Becausethe amount was not more than 25% of Mr.Brown's gross income from farming, the entireamount is deductible. See chapter 6 for moreinformation on soil and water conservationexpenses.

Line 15. The $1,575 on this line is theamount he paid a company for spraying hiscrops. He made the payment to a corporation,so he does not file a Form 1099–MISC to re-port the payment.

Line 16. He enters the $37,978 depreci-ation from Form 4562, discussed later.

Line 18. He enters the $18,019 cost offeed bought for livestock. He did not includethe cost of feed bought for livestock he andhis family intend to consume. He also did notinclude the value of feed grown on his farm.

Line 19. He enters $6,544. This is theamount paid for fertilizer and lime.

Line 20. He deducts the $5,105 he paidfor trucking and milk marketing expenses. Hechose to itemize the $807 government milkassessment and lists it separately on line 34a.

Line 21. He deducts the $3,521 cost ofgasoline, fuel, and oil bought for farm use,other than amounts he included on line 12 forcar and truck expenses. He did not deduct thecost of fuel used for heating, lighting, orcooking in his home.

Line 22. He deducts the $1,070 cost ofinsurance on his farm buildings (but not hishome), equipment, livestock, and crops. Hedid not deduct the entire premiums on 3-yearand 5-year insurance policies in the year ofpayment, but deducts each year only the partthat applies to that year. For more informa-tion, see Insurance in chapter 5.

Lines 23a and 23b. He deducts on line23a the $3,175 interest paid on the farmmortgage for the land and buildings used infarming. He deducts on line 23b the $1,043interest paid on obligations incurred to buylivestock and other personal property used infarming or held for sale. Interest on his homeis deducted on Schedule A (Form 1040),which is not shown.

Line 24. He enters the $16,416 in wageshe paid during the year for labor hired to op-erate his farm, including wages paid to hiswife and children. He did not include amountspaid to himself. He has no employment cred-its. Not all the wages paid were subject tosocial security and Medicare taxes, but forthose that were, he included the full amountof the wages before reduction for the em-ployee's share of those taxes, or otheramounts withheld. His share of the social se-curity and Medicare taxes is included in thetotal taxes deducted on line 31. See chapter16 for information on employment taxes.

Line 26b. He enters only cash rent paid,$2,400, for the use of land he rented from aneighbor, Mr. Green. He did not deduct rentpaid in crop shares. He completed a Form1099–MISC for the rent paid to Mr. Green andsent Copy A to the IRS with Form 1096. Hegave Mr. Green Copy B of the Form1099–MISC.

Line 27. The $5,424 he enters includes$4,902 for repairs to farm machinery and$522 for repairs to farm buildings. He did notinclude the value of his own labor. He pre-pared Form 1099–MISC for the farm ma-chinery repairs because the repair shop is notincorporated. He sent Copy A to the IRS withForm 1096 and gave Copy B to the owner ofthe repair shop.

Line 28. He enters the $2,132 cost ofseeds and plants used in farming. He de-ducts these costs from year to year. He didnot include the cost of plants and seeds pur-chased for the family garden.

Line 30. He enters the $2,807 paid forlivestock supplies and other supplies, includ-ing bedding.

Line 31. He enters $3,201 for taxes paidduring 1999, including state and local taxeson the real estate and personal property usedin farming. He did not include the sales taxpaid on farm supplies, or 60% of the gasolinetax for gasoline used in the family car for farmbusiness, because these taxes were includedin the costs for supplies and gasoline that hededucted on lines 30 and 21, respectively.He included his share of social security andMedicare taxes paid for agricultural employ-ees. He filed Form 943 (not shown) in Janu-

Milk ........................................................... $133,874Raised steers and calves ........................ 2,914Vegetables he grew ................................. 1,457Corn ($7,286), hay ($8,944), and wheat($8,543) he raised ................................... 24,773Total reported on line 4 ........................ $163,018

Page 96 Chapter 20 Sample Return

ary 2000, reporting these taxes for calendaryear 1999.

He does not deduct, on Schedule F, hisstate income tax or the taxes on his home andhis land not used for farming. He deductsthese taxes on Schedule A (Form 1040),which is not shown. He does not deduct anyfederal income tax paid during the year.

Line 32. He enters $3,997 for the costof water, electricity, gas, and telephone ser-vice used only in farming. He cannot deductthe cost of basic local telephone service (in-cluding any taxes) for the first telephone lineto his home.

Line 33. He enters $3,217, the total paidduring 1999 for veterinary fees ($1,821),livestock medicines ($650), and breeding fees($746). He does not prepare Form1099–MISC for the veterinarian and the sup-plier of breeding services because both areincorporated.

Line 34. He enters other farm businessexpenses. These include: an $807 govern-ment milk assessment; $347 for commis-sions, dues, and fees; $287 for financial rec-ords and office supplies; and $534 for farmbusiness travel and meals. Farm businesstravel includes expenses for the State ForageTour and for attending the farm managementconference at State University. He includedonly 50% of the cost of meals in the de-duction.

Line 36—Net farm profit. To arrive athis net farm profit, he subtracts the amounton line 35 ($127,383) from the amount on line11 ($186,040). His net farm profit, entered online 36, is $58,657. He also enters thatamount on line 18 of Form 1040, and on line1 of Section A, Schedule SE (Form 1040).Because he shows a net profit on line 36, heskips line 37.

Form 4562 — Depreciationand AmortizationMr. Brown follows the instructions and liststhe information called for in Parts I through IV.He also completes Part V on page 2 to pro-vide information on listed property used in hisfarming business. The three vehicles used inhis business are listed property. The truck,sold in July and shown on Form 4797, wasplaced in service in 1990 and fully depreci-ated in 1995. No depreciation is allowed for1999.

Depreciation record. He records informa-tion on his depreciable property in a book thathe can use to figure his depreciation allow-ance for several years. He uses the Depreci-ation Worksheet from the Form 4562 in-structions to figure his 1999 deduction.

Basis for depreciation. He bought his farmon January 8, 1978. Timber on the farm wasimmature and had no fair market value(FMV). He immediately divided the total pur-chase price of the farm among the land,house, barn, and fences (no other capital im-provements were included in the price of thefarm). He made the division on the purchasedate in proportion to (but not in excess of) theFMVs of the assets and in the required order.See Trade or Business Acquired in Publica-tion 551 for more information.

He entered in his depreciation record thepart of the purchase price for the depreciablebarn and fences, giving him the basis for fig-uring his depreciation allowance. The fences

were fully depreciated in 1987. Because hecannot depreciate the house and land, hekeeps a separate record showing their bases.

Methods of depreciation. He depreciatesall his property placed in service before 1981using the straight-line method. He chose thealternate ACRS method for his machine shedplaced in service in 1986. Using the ModifiedAccelerated Cost Recovery System (MACRS)and the half-year convention, he chose thefollowing systems for all of his assets placedin service in the year indicated.

• 1995—straight line ADS.

• 1996—150% declining balance Alterna-tive Depreciation System (ADS).

• 1997 & 1999—150% declining balanceGeneral Depreciation System (GDS).

Depreciable property. One of his purchaseddairy cows was killed by lightning in July1999. Two other purchased cows (#52 and#60) were sold in 1999. The cows were de-preciated under MACRS (ADS), using a half-year convention. Therefore, he can claim ahalf-year's depreciation for each cow in 1999.

He has other breeding and dairy cows thathe raised. He did not claim depreciation onthem because his basis in the cows is zerofor income tax purposes.

During 1999 the Browns owned two familycars. One of them was not used for farmbusiness. Mr. Brown cannot deduct depreci-ation on it. He determined that his other carwas used 60% for his farm business and 40%for personal driving.

The Depreciation Worksheet contains anitemized list of Mr. Brown's assets for whichhe is deducting depreciation in 1999. He mustlist each item separately to keep track of itsbasis. The pickup truck and car purchasedin 1996 are listed property in the 5-yearproperty class.

New assets. Mr. Brown added three as-sets to his farming business in 1999.

1) In January, he completed and placed inservice a dairy facility. Since the newstructure is designed specifically for theproduction of milk and to house, feed,and care for dairy cattle, it is a singlepurpose livestock structure. The buildingis depreciated separately from the milk-ing equipment it houses. The cost of thebuilding is $56,500 and it is 10-yearproperty under MACRS. The cost of theequipment is $72,000 and it is 7-yearproperty under MACRS.

2) In February, he made improvements tohis machine shed for a total cost of$1,300. The improvements are depreci-ated as if they were a separate buildingwith a 20-year recovery period.

3) In March, he acquired tractor #5 bytrading tractor #2 and paying $23,729cash. The adjusted basis of tractor #2was $1,378 when it was traded (Mr.Brown claimed half a year of depreci-ation). The new tractor has a basis of$25,107 ($23,729 + $1,378). He com-pleted Form 8824, Like-Kind Exchanges,(not shown) to report the trade and willinclude this form when he files his return.He elected to expense part of the costof the tractor in 1999 and depreciate therest of the basis (cost + basis oftrade-in).

Line items. Form 4562 is completed by re-ferring to the Depreciation Worksheet.

Line 2. Mr. Brown enters $152,229 online 2. This is the total cost of all section 179property placed in service in 1999. In figuringhis cost, he does not include the basis of thetraded tractor ($1,378). The dairy facility andequipment qualify as section 179 property.However, the machine shed improvementdoes not qualify. It is not a single purposeagricultural (livestock) structure.

Line 6. He enters the description of theproperty (tractor) he is electing to expenseunder section 179. His cost basis for thesection 179 deduction is limited to the cashhe paid for the tractor. He enters his costbasis of $23,729 in column (b). He then en-ters the tentative deduction, $19,000, in col-umn (c). However, this amount is subject tothe business income limit on line 11. (Thetotal cost of his section 179 property did notexceed the investment limit, $200,000, andhe is therefore subject to the maximum dollarlimit, $19,000.)

Lines 11 and 12. His taxable incomefrom his farming business (without includingthe section 179 deduction and the self-employment tax deduction) exceeds themaximum dollar limit on line 5. He enters$19,000 on lines 11 and 12. See chapter 8 forinformation on the section 179 deduction.

Line 15. All property placed in service in1999 in each class is combined and enteredin Part II, line 15. The abbreviation HY usedin column (e) stands for the half-year con-vention. The 150 DB in column (f) stands forthe 150% declining balance method underMACRS.

Line 17. He enters $2,708, his MACRSdepreciation deduction for assets placed inservice from 1995 through 1997, on line 17of Part III. None of the assets included arelisted property. Listed property is entered inPart V as explained later under Line 20.

Line 19. On line 19, he enters $1,374 forassets placed in service before 1981 andthose depreciated under ACRS that are notlisted property.

Line 20. He enters his depreciation de-duction for listed property, $2,244, on line 20.This is the total shown on line 26, Part V,page 2 of the form. He has two depreciableassets that are listed property—the car used60% for business and the pickup truck pur-chased in 1996. His deduction for the carcannot be more than 60% of the limit forpassenger automobiles for the year he placedthe car in service. The other truck, which hesold this year, was fully depreciated.

Line 21. He enters the total depreciationon line 21 and carries the total, $37,978, toline 16 of Schedule F.

Other items. He completes Sections Aand B of Part V to provide the informationrequired for listed property. He does notcomplete Section C because he does notprovide vehicles for his employees' use.

He follows the practice of writing down theodometer readings on his vehicles at the endof each year and when he places the vehiclesin service and disposes of them. In addition,because he uses his car only partly for busi-ness, he writes down the number of businessmiles it is driven any day that it is used forbusiness. He uses these records to answerthe questions on lines 23a and 23b of SectionA and lines 28 through 34 of Section B.

He has no amortization, so he does notuse Part VI of Form 4562.


Schedule SE (Form 1040)Self-Employment TaxAfter figuring his net farm profit on page 1 ofSchedule F, Mr. Brown figures his self-employment tax. To do this, he figures his netearnings from farm self-employment on ShortSchedule SE (Section A). He is not requiredto use Long Schedule SE (Section B). Firsthe prints his name (as shown on his Form1040) and his social security number at thetop of Schedule SE. Only his name and socialsecurity number go on Schedule SE. His wifedoes not have self-employment income. If shehad self-employment income, she would fileher own Schedule SE.

Line items. He figures his self-employmenttax on the following lines.

Line 1. He enters his net farm profit,$58,657. All of the income, losses, and de-ductions that he listed on Schedule F are in-cluded in determining net earnings from farmself-employment (see the types of self-employment income listed in chapter 15).Consequently, he did not have to adjust hisnet profit to determine his self-employmentnet earnings from farming.

Line 3. If he were engaged in any otherbusiness in addition to farming, he wouldcombine his net profits from all his trades orbusinesses on line 3 of this schedule. How-ever, because farming was his only business,he enters his net profit from farming (theamount shown on line 1).

Line 4. He multiplies line 3 by .9235 toget his net earnings from self-employmentand enters $54,170 on line 4.

Lines 5 and 6. He multiplies line 4 by15.3% and enters $8,288 on line 5. This ishis self-employment tax for 1999. He alsoenters $8,288 on line 50 of Form 1040. Heenters $4,144 on line 6 and also on line 27of Form 1040 (deduction for one-half of hisself-employment tax).

Form 4684—Casualtiesand TheftsMr. Brown's only business casualty occurredwhen a purchased dairy cow was killed bylightning on July 7. He shows the loss fromthe casualty on page 2 of Form 4684. Onlypage 2 is shown, since page 1 is for non-business casualties.

He prints his name, his wife's name, andhis identifying number at the top of page 2.

Part I. He shows the kind of property, “Dairycow #42,” its location, and the date acquiredon line 19. He enters his adjusted basis in thecow, $257, on line 20 and the $109 insurancepayment he received for the cow on line 21.Since line 20 is more than line 21, he skipsline 22. On lines 23 and 24, he enters theFMV before, $500, and after, $-0-, the casu-alty, and he shows the difference, $500, online 25. He enters the amount from line 20on line 26, subtracts line 21 from line 26, andenters $148 on lines 27 and 28.

Part II. On line 34, he identifies the casualtyand enters $148 on lines 34(b)(i), 35(b)(i), 37,and 38a, and on Form 4797, Part II, line 14.

Form 4797—Sales ofBusiness PropertyAfter completing Schedule F and Section Bof Form 4684, Mr. Brown fills in Form 4797to report the sales of business property. SeeTable 11–1 in chapter 11 for examples ofitems reported on Form 4797.

He prints his name, his wife's name, andhis identifying number at the top of Form4797.

Before he can complete Parts I and II, hemust complete Part III to report the sale ofcertain depreciable property.

Part III. Mr. Brown sold three depreciableassets in 1999 at a gain. He has informationabout their cost and depreciation in his rec-ords. Only dairy cow #60 appears on theDepreciation Worksheet. The truck andmower are fully depreciated.

He sold a truck on July 9 and a mower onAugust 12. He also sold one purchased dairycow, #60, on October 28. Since the gains onthese items were gains from dispositions ofdepreciable personal property, as explainedin chapter 11, he must determine the part ofeach gain that was ordinary income.

He enters the description of each item onlines 19A through 19C and relates the corre-sponding property columns to the propertieson those lines. He completes lines 20 through25(b) for each disposition of property.

Gain from dispositions. The gain oneach item is shown on line 24. His gain on thesale of the truck is $700 (Property A). His gainon the sale of the mower is $70 (Property B).His gain on the sale of cow #60 is $82(Property C). The gain on each item is en-tered in the appropriate property column online 25(b).

Summary of Part III gains. On line 30,he enters $852, the total of property columnsA through C, line 24. On line 31, he enters$852, the total of property columns A throughC, line 25(b). This amount is the gain that isordinary income. He also enters this amounton line 13, Part II.

He subtracts line 31 from line 30 and en-ters -0- on line 32. He has no long-term cap-ital gain on the dispositions. All of his gain isordinary income.

Part I. All of the animals in Part I met therequired holding period.

Mr. Brown sold at a gain several cows hehad raised and used for dairy purposes. Hisselling expense was $325 for these cows,which he shows on line 2(f). He enters thegain from the sale on line 2(g). He also enterson line 2(g) the gain from the sale of a raiseddairy heifer and the loss from the sale ofpurchased dairy cow #52. Because he soldpurchased dairy cow #52 at a loss, he enteredit in Part I instead of Part III. See Table 11–1in chapter 11 for where to report items onForm 4797.

He combines the gains and loss on line2(g) and enters $14,770 on line 7(g). Sincehe has no nonrecaptured net section 1231losses from prior years, he does not fill inlines 8, 9, and 12. If he had nonrecapturedsection 1231 losses, part or all of the gain online 7 would be ordinary income and enteredon line 12. Following the instructions for line7, he enters $14,770 as a long-term capitalgain on line 11(f) of Schedule D.

Part II. Mr. Brown enters on line 10 the $250gain from the sale of a 23–month old raiseddairy heifer held for breeding purposes. He

had previously entered the $852 gain fromline 31, Part III, on line 13 and the $148 lossfrom Form 4684 on line 14. He totals lines 10through 17 and enters $954 on line 18. Hecarries the gain from line 18 to line 18b(2) andshows it as ordinary income on line 14 ofForm 1040.

Schedule D (Form 1040)Capital Gains and LossesAfter completing Form 4797, Mr. Brown fillsin Schedule D to report gains and losses oncapital assets. He prints his name, his wife'sname, and his social security number at thetop of Schedule D.

Entries. He enters the required informationin the appropriate columns.

Lines 1 and 3. He reports as a short-termloss on line 1 his $50 loss on the 1999 saleof H. T. Corporation stock held one year orless. He includes the gross sales price of thestock in column (d) on lines 1 and 3.

Line 7. He completes Part I of ScheduleD by entering on line 7 the loss in column 1(f).

Lines 8 and 10. He enters on line 8 his$745 long-term gain on the sale of CircleCorporation stock held more than one yearand also enters the gross sales price on line10.

Line 11. Mr. Brown had previously en-tered on line 11 the gain from line 7 of Form4797.

Line 16. He combines the column (f)amounts on lines 8 and 11 and enters theresult on line 16.

Line 17. In Part III, he combines lines 7and 16 and enters his total capital gain on line17. He also enters this amount on Form 1040,line 13.

After he completes his Form 1040 throughline 39, he will use Part IV to figure his taxwithout regard to farm income averaging.See Schedule J (Form 1040) Farm IncomeAveraging, later.

He does not have a capital loss carryoverthis year, so he does not complete the CapitalLoss Carryover Worksheet in the instructions.

TIPAlthough Mr. Brown is required tocomplete Schedule D (Form 1040)and attach it to his return, certain

other taxpayers may be able to complete theCapital Gain Tax Worksheet in the Form 1040instructions instead. See the instructions forline 13 of the 1999 Form 1040.

Form 1040, Page 1Mr. Brown is filing a joint return with his wife.He uses the form he received from the IRS.

Line items. He fills in all applicable items onpage 1 of Form 1040.

Line 6c. He prints the name and socialsecurity number of each dependent child heclaims.

Line 7. Mrs. Brown worked part time asa substitute teacher for the county schoolsystem during 1999. She also worked for Mr.Brown on the farm during 1999. He enters online 7 her total wages, $8,950 ($7,750 fromthe school system and $1,200 from the farm),as shown on the Forms W–2 that he and theschool system gave her.

Lines 8a and 9. He did not actually re-ceive cash payment for the interest he listedon line 8a ($375). It was credited to his ac-count so that he could have withdrawn it in1999. Therefore, he constructively received it


and correctly included it in his income for1999. He enters the $220 in dividends he re-ceived from the Circle Corporation on line 9.

He received patronage dividends fromfarmers' cooperatives based on businessdone with these cooperatives. He does not listthese dividends here, but properly includedthem on lines 5a and 5b, Part I of ScheduleF.

Since he did not receive more than $400in interest or $400 in dividends and none ofthe other conditions listed at the beginning ofthe Schedule B instructions applied, he is notrequired to complete Schedule B.

Lines 13, 14, and 18. He previously en-tered the following items.

• His capital gain on line 13 from ScheduleD, line 17.

• His other gain on line 14 from Form 4797,line 18b(2).

• His net farm profit on line 18 fromSchedule F, line 36.

Line 22. He adds the amounts on lines7 through 21 and enters the total, $84,621.

Line 27. He has already entered one-halfof his self-employment tax, $4,144, which hefigured on Schedule SE.

Line 28. He paid premiums of $8,400during 1999 for health insurance coverage forhimself and his family and qualifies for theself-employed health insurance deduction.He figures the part of his insurance paymentthat he can deduct by completing the Self-Employed Health Insurance Deduction Work-sheet (not shown) in the instructions for Form1040. He enters the result, $5,040, on line 28and includes the remaining part of his insur-ance payment in figuring his medical expensededuction on Schedule A (Form 1040), whichis not shown.

Line 32. He adds the amounts on lines23 through 31a and enters the total, $9,184,on line 32.

Lines 33 and 34. He subtracts line 32from line 22 to get his “adjusted grossincome” and enters the result, $75,437, online 33 and also on line 34 of page 2.

Form 1040, Page 2Mr. Brown fills in the following lines on page2 of Form 1040.

Line 36. He enters $7,500 from hisSchedule A (Form 1040), which is not shown,because the total of his itemized deductionsis larger than the $7,200 standard deductionfor his filing status (married filing joint return).

Lines 37, 38, and 39. He subtracts the$7,500 on line 36 from the $75,437 on line34 and enters the result, $67,937 on line 37.He enters $13,750 (5 × $2,750) on line 38 andsubtracts this amount from the amount on line37 to get taxable income on line 39.

Line 40. He enters $7,348 from ScheduleJ, line 22. For information on how he figuredhis tax using farm income averaging, seeSchedule J (Form 1040), later.

Line 43. The Browns qualify for the childtax credit. He figures his credit by completingthe Child Tax Credit Worksheet (not shown)in the instructions for Form 1040. He entershis credit, $1,500, on line 43.

Lines 48 and 49. He enters on line 48 theamount of the child tax credit from line 43since it is the only amount he entered on lines41 through 47. He subtracts that amount fromthe tax on line 40 and enters $5,848 on line49.

Line 50. He has already entered the$8,288 self-employment tax he figured onSchedule SE.

Line 56. He adds the amounts on lines49 through 55 and enters $14,136, which isthe total tax for 1999.

Line 57. He enters the income tax with-held from Mrs. Brown's wages, $435, asshown on the Forms W–2 she received. Heattaches Copy B of her Forms W–2 to thefront of Form 1040.

Line 58. He did not make 1999 estimatedtax payments since two-thirds of his grossincome for 1998 was from farming. He wassure that at least two-thirds of his gross in-come for 1999 would again be from farming.Farmers who meet either of these conditionsdo not have to make 1999 estimated taxpayments. If he files his Form 1040 and paysthe tax due no later than March 1, 2000, hewill not be penalized for failure to pay esti-mated taxes. He makes no entry on line 58.

Line 59a. The Browns are not entitled toclaim the earned income credit on line 59a,because their modified adjusted gross incomeis more than $30,580.

Line 63. Mr. Brown enters his credit for$350 of federal excise tax on gasoline usedin 1999. He checks box “b” and attachesForm 4136 (not shown) to his return, showinghow he figured the credit. The credit must bereported as other income on Schedule F onhis 2000 return.

Lines 64 and 68. He adds the amountson lines 57 through 63 and enters the total,$785, on line 64. He subtracts that figure fromthe amount on line 56. The balance, $13,351,is entered on line 68.

Schedule J (Form 1040)Farm Income AveragingIn 1999, Mr. Brown's taxable income,$54,187, is substantially higher than in eachof the 3 previous years. His taxable incomeamounts were only $2,500, $1,050, and $700for 1998, 1997, and 1996, respectively, andhe had no gains or losses from farming. Heelects to use farm income averaging bycompleting Schedule J to figure his tax.

First, he uses Part IV of Schedule D tofigure his tax without regard to farm incomeaveraging. Next, he uses Schedule J to figurehis tax using farm income averaging.

Line items. He fills in the lines on ScheduleJ.

Line 1. He enters $54,187, his taxableincome from line 39 of Form 1040.

Line 2. He enters the part of his farmincome he is electing to average, $35,187.This amount of farm income allows him totake advantage of the lowest tax brackets forthis year and the 3 previous years.

Line 3. He subtracts the amount on line2 from the amount on line 1 and enters$19,000 on line 3.

Line 4. Because he has capital gains andlosses this year, he computes the tax on$19,000 using Part IV of Schedule D (notshown) and enters the result, $2,076, on line4.

Lines 5, 9, and 13. He enters his taxableincome from 1996, 1997, and 1998 on lines5, 9, and 13, respectively.

Lines 6, 10, and 14. He divides theamount on line 2 by 3.0 and enters the result,$11,729, on lines 6, 10, and 14.

Lines 7, 11, and 15. He figures his ad-justed taxable income for the 3 previous yearsby adding the amounts on lines 6, 10, and 14to the amounts on lines 5, 9, and 13, re-spectively.

Lines 8, 12, and 16. He figures the taxon the amounts on lines 7, 11, and 15 usingthe appropriate Tax Rate Schedules and en-ters the results on lines 8, 12, and 16, re-spectively. His income is taxed at the 15%rate for each year.

Line 17. He adds the amounts on lines4, 8, 12, and 16 and enters the total, $7,991,on line 17.

Lines 18, 19, and 20. He enters his taxfrom his 1996, 1997, and 1998 returns onlines 18, 19, and 20, respectively.

Line 21. He adds the amounts on lines18, 19, and 20 and enters the total, $643, online 21.

Line 22. He subtracts the amount on line21 from the amount on line 17 and enters$7,348 on line 22. The tax on this line is lessthan the $8,469 of tax he figured usingSchedule D. Therefore, he enters on line 40of his Form 1040 the amount from this line.

Completing the ReturnThe Browns sign their names and enter thedate signed, their occupations, and theirtelephone number on the bottom of page 2of Form 1040. (If they had not prepared theirown tax return, the preparer would also signthe return and provide the information re-quested at the bottom of the page.) Mr. Brownattaches to the return the address label in theinstructions after verifying the accuracy of thelabel. He writes his and his wife's social se-curity numbers in the boxes next to the ad-dress label.

He writes a check payable to the U.S.Treasury for the full amount on line 68 ofForm 1040. On the check, he writes his socialsecurity number, their telephone number, and“1999 Form 1040.” His name and address areprinted on the check. Mr. Brown could insteadhave chosen to pay part or all of his taxes bycredit card (MasterCard, American Express,or Discover). This is a new method of pay-ment that is optional.

After making a copy of their complete re-turn for his records, he assembles the variousforms and schedules in the following order(see “Attachment Sequence Number” in theupper right corner of each schedule or form).

1) Their original Form 1040.

2) Schedule A.

3) Schedule D.

4) Schedule F.

5) Schedule SE.

6) Schedule J.

7) Form 4136.

8) Form 4684.

9) Form 4797.

10) Form 4562.

11) Form 8824.

He completes Form 1040–V, PaymentVoucher, which was included in his tax pack-age. He carefully follows the instructions formailing his return and paying the tax.


Walter A.

Jane W.

Brown

Brown

RR 1 Box 25

Hometown, VA 22870

543 00 2111

543 00 1222

XX

X

X

X2

3MICHAELMATTHEWSARAH

579579579

000000

SonSon

Daughter

5

999999989997

BROWNBROWNBROWN

8,950375

220

58,657

84,621

––

–

–

–

––

–4,144

9,18475,437

��

15,465 –954 –

5,040 –

Department of the Treasury—Internal Revenue Service1040 U.S. Individual Income Tax ReturnOMB No. 1545-0074For the year Jan. 1–Dec. 31, 1999, or other tax year beginning , 1999, ending ,

Last nameYour first name and initial Your social security number

(Seeinstructionson page 18.)

LABEL

HERE

Last name Spouse’s social security numberIf a joint return, spouse’s first name and initial

Use the IRSlabel.Otherwise,please printor type.

Home address (number and street). If you have a P.O. box, see page 18. Apt. no. IMPORTANT!

City, town or post office, state, and ZIP code. If you have a foreign address, see page 18.

PresidentialElection Campaign(See page 18.)

Note. Checking“Yes” will notchange your tax orreduce your refund.

NoYes

Do you want $3 to go to this fund?If a joint return, does your spouse want $3 to go to this fund?

1 SingleFiling Status 2 Married filing joint return (even if only one had income)

3

Check onlyone box.

4

Qualifying widow(er) with dependent child (year spouse died � 19 ). (See page 18.)5

6a Yourself. If your parent (or someone else) can claim you as a dependent on his or her taxreturn, do not check box 6aExemptions

Spouseb(4) if qualifyingchild for child tax

credit (see page 19)

Dependents:c (2) Dependent’ssocial security number

(3) Dependent’srelationship to

you(1) First name Last name

If more than sixdependents,see page 19.

d Total number of exemptions claimed

7Wages, salaries, tips, etc. Attach Form(s) W-278a8a Taxable interest. Attach Schedule B if requiredIncome

8bb Tax-exempt interest. DO NOT include on line 8aAttach Copy B of yourForms W-2 andW-2G here.Also attachForm(s) 1099-Rif tax waswithheld.

99 Ordinary dividends. Attach Schedule B if required1010 Taxable refunds, credits, or offsets of state and local income taxes (see page 21)1111 Alimony received1212 Business income or (loss). Attach Schedule C or C-EZ

Enclose, but donot staple, anypayment. Also,please useForm 1040-V.

1313 Capital gain or (loss). Attach Schedule D if required. If not required, check here �

1414 Other gains or (losses). Attach Form 479715a 15bTotal IRA distributions b Taxable amount (see page 22)15a

16b16aTotal pensions and annuities b Taxable amount (see page 22)16a1717 Rental real estate, royalties, partnerships, S corporations, trusts, etc. Attach Schedule E1818 Farm income or (loss). Attach Schedule F1919 Unemployment compensation

20b20a b Taxable amount (see page 24)20a Social security benefits2121

22 Add the amounts in the far right column for lines 7 through 21. This is your total income � 22

23IRA deduction (see page 26)23

Medical savings account deduction. Attach Form 8853 2525

One-half of self-employment tax. Attach Schedule SE

26

Self-employed health insurance deduction (see page 28)

262727

Keogh and self-employed SEP and SIMPLE plans

2828

Penalty on early withdrawal of savings

2929

Alimony paid b Recipient’s SSN �

32Add lines 23 through 31a

30

Subtract line 32 from line 22. This is your adjusted gross income �

31a

AdjustedGrossIncome

33

If you did notget a W-2,see page 20.

Form

Married filing separate return. Enter spouse’s social security no. above and full name here. �

Cat. No. 11320B

�

�

Label

Form 1040 (1999)

IRS Use Only—Do not write or staple in this space.

Head of household (with qualifying person). (See page 18.) If the qualifying person is a child but not your dependent,enter this child’s name here. �

Other income. List type and amount (see page 24)

Moving expenses. Attach Form 3903

24 24

(99)

For Disclosure, Privacy Act, and Paperwork Reduction Act Notice, see page 54.

No. of boxeschecked on6a and 6bNo. of yourchildren on 6cwho:

Dependents on 6cnot entered above

Add numbersentered onlines above �

● lived with you● did not live withyou due to divorceor separation(see page 19)

32

31a

Student loan interest deduction (see page 26)

30

33

You must enteryour SSN(s) above.

� �

1999


75,437

7,50067,937

13,75054,1877,348

1,5005,8488,288

14,136

–

––

–––

–––

–

X

435

350785

13,351

–

––

–

WALTER A. BROWN

JANE W. BROWN

2-23-00

2-23-00

FARMER

TEACHER

1,500 –

555 735-0001

Enter your itemized deductions from Schedule A, line 28, OR standard deductionshown on the left. But see page 30 to find your standard deduction if you checked anybox on line 35a or 35b or if someone can claim you as a dependent

Add lines 57, 58, 59a, and 60 through 63. These are your total payments �

Page 2Form 1040 (1999)

Amount from line 33 (adjusted gross income)34 34

Check if:35aTax andCredits 35aAdd the number of boxes checked above and enter the total here �

Single:$4,300

If you are married filing separately and your spouse itemizes deductions oryou were a dual-status alien, see page 30 and check here �

b35b

36

36

37Subtract line 36 from line 3437

38If line 34 is $94,975 or less, multiply $2,750 by the total number of exemptions claimed online 6d. If line 34 is over $94,975, see the worksheet on page 31 for the amount to enter

38

39Taxable income. Subtract line 38 from line 37. If line 38 is more than line 37, enter -0-39

40 40

4141 Credit for child and dependent care expenses. Attach Form 2441

43Credit for the elderly or the disabled. Attach Schedule R

44

Foreign tax credit. Attach Form 1116 if required

45

Other. Check if from47

48

46

49Add lines 41 through 47. These are your total credits

47

50

Subtract line 48 from line 40. If line 48 is more than line 40, enter -0- �

48

51Self-employment tax. Attach Schedule SE

49

OtherTaxes 52

Alternative minimum tax. Attach Form 6251

50

65

51

Social security and Medicare tax on tip income not reported to employer. Attach Form 4137

54Tax on IRAs, other retirement plans, and MSAs. Attach Form 5329 if required53

55Add lines 49 through 55. This is your total tax �56 56

Federal income tax withheld from Forms W-2 and 109957 57

581999 estimated tax payments and amount applied from 1998 return58Payments

59a

59a

61Amount paid with request for extension to file (see page 48)6162Excess social security and RRTA tax withheld (see page 48)62

64Other payments. Check if from63

66a66a

67 67

If line 64 is more than line 56, subtract line 56 from line 64. This is the amount you OVERPAID

6868

Amount of line 65 you want REFUNDED TO YOU �

Refund

69

Amount of line 65 you want APPLIED TO YOUR 2000 ESTIMATED TAX �

Estimated tax penalty. Also include on line 68Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge andbelief, they are true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge.

69

You were 65 or older, Blind; Spouse was 65 or older, Blind.

a Form 3800 b Form 8396

c Form 8801 d Form (specify)

a Form 2439 b Form 4136

54Household employment taxes. Attach Schedule H 55

63

AmountYou Owe

SignHere

DateYour signature

Keep a copyfor yourrecords.

DateSpouse’s signature. If a joint return, BOTH must sign.

Preparer’s SSN or PTINDatePreparer’ssignature

Check ifself-employed

PaidPreparer’sUse Only

Firm’s name (or yoursif self-employed) andaddress

EIN

ZIP code

��

�

Your occupation

Spouse’s occupation

Tax (see page 31). Check if any tax is from

If line 56 is more than line 64, subtract line 64 from line 56. This is the AMOUNT YOU OWE.For details on how to pay, see page 49 �

b

Have itdirectlydeposited!See page 48and fill in 66b,66c, and 66d.

Routing number

Account number

c Checking SavingsType:

a Form(s) 8814 Form 4972 �

b

d

�

�

64

42

44

Adoption credit. Attach Form 8839

5253

Advance earned income credit payments from Form(s) W-2

65

�

Child tax credit (see page 33)

Education credits. Attach Form 8863

42

43

45

46

Additional child tax credit. Attach Form 881260 60

Head ofhousehold:$6,350Married filingjointly orQualifyingwidow(er):$7,200Marriedfilingseparately:$3,600

StandardDeductionfor MostPeople

Joint return?See page 18.

Daytime telephonenumber (optional)( )

Earned income credit. Attach Sch. EIC if you have a qualifying child

b

and type �

Nontaxable earned income: amount �

Form 1040 (1999)


WALTER A. & JANE W. BROWN

25 shares HT Corp 12-3-98 3-6-99 400 –

400 –

450 ( 50– – )

543 00 2111

40 shares Circle Corp 10-16-79 6-5-99 1,000 255 745

1,000

14,770

15,515

–

–

– –

–

–

( 50 – )

*28% Rate Gain or Loss includes all “collectibles gains and losses” (as defined on page D-5) and up to 50% of the eligible gainon qualified small business stock (see page D-4).

OMB No. 1545-0074SCHEDULE D Capital Gains and Losses(Form 1040)

� Attach to Form 1040. � See Instructions for Schedule D (Form 1040).Department of the TreasuryInternal Revenue Service

AttachmentSequence No. 12� Use Schedule D-1 for more space to list transactions for lines 1 and 8.

Your social security numberName(s) shown on Form 1040

Short-Term Capital Gains and Losses—Assets Held One Year or Less(f) GAIN or (LOSS)Subtract (e) from (d)

(e) Cost orother basis

(see page D-5)

(a) Description of property(Example: 100 sh. XYZ Co.)

(d) Sales price(see page D-5)

(c) Date sold(Mo., day, yr.)

1

Enter your short-term totals, if any, fromSchedule D-1, line 2

2

Total short-term sales price amounts.Add column (d) of lines 1 and 2

33

5

Short-term gain from Form 6252 and short-term gain or (loss) from Forms 4684,6781, and 8824

5

66

Net short-term gain or (loss) from partnerships, S corporations, estates, and trustsfrom Schedule(s) K-1

7

Short-term capital loss carryover. Enter the amount, if any, from line 8 of your1998 Capital Loss Carryover Worksheet

Net short-term capital gain or (loss). Combine lines 1 through 6 in column (f) �

Long-Term Capital Gains and Losses—Assets Held More Than One Year

8

Enter your long-term totals, if any, fromSchedule D-1, line 9

9

10 Total long-term sales price amounts.Add column (d) of lines 8 and 9 10

11Gain from Form 4797, Part I; long-term gain from Forms 2439 and 6252; andlong-term gain or (loss) from Forms 4684, 6781, and 8824

11

1212

13

Net long-term gain or (loss) from partnerships, S corporations, estates, and trustsfrom Schedule(s) K-1

14

Capital gain distributions. See page D-1

15 15

14

16

Long-term capital loss carryover. Enter in both columns (f) and (g) the amount, ifany, from line 13 of your 1998 Capital Loss Carryover Worksheet ( )

Combine lines 8 through 14 in column (g)

Net long-term capital gain or (loss). Combine lines 8 through 14 in column (f) � 16

For Paperwork Reduction Act Notice, see Form 1040 instructions. Schedule D (Form 1040) 1999Cat. No. 11338H

( )

44

Part I

Part II7

13

(b) Dateacquired

(Mo., day, yr.)

2

9

(99)

(f) GAIN or (LOSS)Subtract (e) from (d)

(e) Cost orother basis

(see page D-5)

(a) Description of property(Example: 100 sh. XYZ Co.)

(d) Sales price(see page D-5)

(c) Date sold(Mo., day, yr.)

(b) Dateacquired

(Mo., day, yr.)

(g) 28% RATE GAINor (LOSS)

*(see instr. below)

Next: Go to Part III on the back.

1999

( )


54,187 –

15,465 –

15,465 –

38,722

43,050

5,809

15,465

–

–

–

–

38,722 –

38,722 –38,722 –

43,05038,722

433

15,465

11,137

8,469 –9,573 –

8,469 –

15,465 –– 0 –

– 0 –– 0 –

– 0 –– 0 –

4,328

4,328

2,227

Schedule D (Form 1040) 1999

Summary of Parts I and IICombine lines 7 and 16. If a loss, go to line 18. If a gain, enter the gain on Form 1040, line 1317 17

( )18

Next: Skip Part IV below. Instead, complete Form 1040 through line 37. Then, complete theCapital Loss Carryover Worksheet on page D-6 if:

Part III

● The loss on line 17, or● ($3,000) or, if married filing separately, ($1,500)

Page 2

18

Next: Complete Form 1040 through line 39. Then, go to Part IV to figure your tax if:

If line 17 is a loss, enter here and as a (loss) on Form 1040, line 13, the smaller of these losses:

Tax Computation Using Maximum Capital Gains RatesPart IV

20Enter your taxable income from Form 1040, line 39

22

Enter the smaller of line 15 or line 23, but not less than zero23

If you are filing Form 4952, enter the amount from Form 4952, line 4e

24

Add lines 24 and 25

25

Subtract line 26 from line 22. If zero or less, enter -0-26272829

30313233

34353637

383940

424344454647

48495051

525354

Subtract line 39 from line 38 �

Add lines 33, 37, 41, 47, and 51Figure the tax on the amount on line 19. Use the Tax Table or Tax Rate Schedules, whichever appliesTax on all taxable income (including capital gains). Enter the smaller of line 52 or line 53 hereand on Form 1040, line 40

24

25

19

262728

29

303132

33

3435

4344

4950

51

5253

54

21Enter the smaller of line 16 or line 17 of Schedule D

Enter your unrecaptured section 1250 gain, if any, from line 16 of theworksheet on page D-7

Subtract line 21 from line 20. If zero or less, enter -0-Combine lines 7 and 15. If zero or less, enter -0-

20212223

● Both lines 16 and 17 are gains, and● Form 1040, line 39, is more than zero.

● The loss on line 17 exceeds the loss on line 18, or● Form 1040, line 37, is a loss.

Subtract line 27 from line 19. If zero or less, enter -0-Enter the smaller of:

Enter the smaller of line 28 or line 29Subtract line 22 from line 19. If zero or less, enter -0-Enter the larger of line 30 or line 31 �

Figure the tax on the amount on line 32. Use the Tax Table or Tax Rate Schedules, whichever applies

Enter the smaller of line 22 or line 25Add lines 22 and 32Enter the amount from line 19Subtract line 44 from line 43. If zero or less, enter -0-Subtract line 45 from line 42. If zero or less, enter -0- �

Multiply line 46 by 25% (.25)

Enter the amount from line 19Add lines 32, 36, 40, and 46Subtract line 49 from line 48Multiply line 50 by 28% (.28)

Enter the amount from line 29Enter the amount from line 28Subtract line 35 from line 34. If zero or less, enter -0- �

Multiply line 36 by 10% (.10)

Enter the smaller of line 19 or line 27Enter the amount from line 36

4546

47

48

19

3637

383940

41

42

● The amount on line 19, or● $25,750 if single; $43,050 if married filing jointly or qualifying widow(er);

$21,525 if married filing separately; or $34,550 if head of household �

Note. If line 29 is less than line 28, go to line 38.

41 Multiply line 40 by 20% (.20)

Note. If line 24 is zero or blank, go to line 52.

Note. If line 25 is zero or blank, skip lines 42 through 47 and read the note above line 48.

Note. If line 27 is more than zero and equal to line 36, go to line 52.

Schedule D (Form 1040) 1999

–

–

–––

–––


WALTER A. BROWN

MILK

X

543 00 2111

1 2 01 1 2

X

26,5846,523

33438

–

20,061163,018

33438

665

1,258567

186,040

–

––

––––

–

––

–

4,0432,701

1,0401,575

37,978

18,0196,5445,1053,5211,070

3,1751,043

16,416

––

––

–

–––––

–––

2,400 –5,424 –2,132 –

2,807 –3,201 –3,997 –3,217 –

807347287534

––––

127,383

58,657

–

–

Milk assessmentCommissions, dues & feesRecords/Office suppliesTravel & meals

1 0 9 8 7 6 5 4 3

SCHEDULE F OMB No. 1545-0074Profit or Loss From Farming(Form 1040)

� Attach to Form 1040, Form 1041, Form 1065, or Form 1065-B.Department of the TreasuryInternal Revenue Service

AttachmentSequence No. 14

Social security number (SSN)Name of proprietor

A Principal product. Describe in one or two words your principal crop or activity for the current tax year. B Enter code from Part IV

D Employer ID number (EIN), if any

C Accounting method: AccrualCash

E Did you “materially participate” in the operation of this business during 1999? If “No,” see page F-2 for limit on passive losses. NoYes

Farm Income—Cash Method. Complete Parts I and II (Accrual method taxpayers complete Parts II and III, and line 11 of Part I.)Do not include sales of livestock held for draft, breeding, sport, or dairy purposes; report these sales on Form 4797.

(1)

Sales of livestock and other items you bought for resale1

(2)

Cost or other basis of livestock and other items reported on line 123Subtract line 2 from line 134Sales of livestock, produce, grains, and other products you raised4

5a 5b5a Total cooperative distributions (Form(s) 1099-PATR) Taxable amount5b6a 6b6a Agricultural program payments (see page F-2) 6b Taxable amount

Commodity Credit Corporation (CCC) loans (see page F-3):77aCCC loans reported under electiona7c7bCCC loans forfeited 7c Taxable amountb

Crop insurance proceeds and certain disaster payments (see page F-3):88a 8bAmount received in 1999a 8b Taxable amount

8dAmount deferred from 19988dIf election to defer to 2000 is attached, check here �c9Custom hire (machine work) income9

10Other income, including Federal and state gasoline or fuel tax credit or refund (see page F-3)10

Gross income. Add amounts in the right column for lines 3 through 10. If accrual method taxpayer, enterthe amount from page 2, line 51 �

1111

Farm Expenses—Cash and Accrual Method. Do not include personal or living expenses such as taxes, insurance,repairs, etc., on your home.

Labor hired (less employment credits)

12

2424

Pension and profit-sharingplans

Chemicals

12 25

Rent or lease (see page F-5):

Conservation expenses (seepage F-4)

13

26a

13

Vehicles, machinery, and equip-ment

a

26b

1414

Other (land, animals, etc.)Custom hire (machine work) b

26

Repairs and maintenance

15

Depreciation and section 179expense deduction not claimedelsewhere (see page F-4)

2727

Seeds and plants purchased 28

15

28

Storage and warehousing 2929

Supplies purchased

16

Employee benefit programsother than on line 25

30

16

30

Taxes 311717

31

Utilities 3218

Fertilizers and lime

3218

Veterinary, breeding, and medicine19

Freight and trucking

19 33

Other expenses (specify):34a

20

Gasoline, fuel, and oil

20

a34b

2121

Insurance (other than health) b34c23 Interest: c

23a 34da Mortgage (paid to banks, etc.) d34eeb 23bOther

35Total expenses. Add lines 12 through 34f �35

36 Net farm profit or (loss). Subtract line 35 from line 11. If a profit, enter on Form 1040, line 18, and ALSO onSchedule SE, line 1. If a loss, you MUST go on to line 37 (estates, trusts, and partnerships, see page F-6) 36

All investment is at risk.37aIf you have a loss, you MUST check the box that describes your investment in this activity (see page F-6).37

Some investment is not at risk.37b● If you checked 37a, enter the loss on Form 1040, line 18, and ALSO on Schedule SE, line 1.● If you checked 37b, you MUST attach Form 6198.

Schedule F (Form 1040) 1999For Paperwork Reduction Act Notice, see Form 1040 instructions.

� See Instructions for Schedule F (Form 1040).

Car and truck expenses (see pageF-4—also attach Form 4562)

Cat. No. 11346H

Feed purchased

22 22

34ff

25

33

34

1

2

�

Part I

Part II

(99)

�

1999


WALTER A. BROWN 543 00 2111

58,657

58,657

54,170

8,288

4,144

–

–

–

–

–

OMB No. 1545-0074SCHEDULE SE Self-Employment Tax(Form 1040)

� See Instructions for Schedule SE (Form 1040).Department of the TreasuryInternal Revenue Service

AttachmentSequence No. 17� Attach to Form 1040.

Name of person with self-employment income (as shown on Form 1040) Social security number of personwith self-employment income �

Who Must File Schedule SEYou must file Schedule SE if:● You had net earnings from self-employment from other than church employee income (line 4 of Short Schedule SE or line 4c of

Long Schedule SE) of $400 or more, OR

Exception. If your only self-employment income was from earnings as a minister, member of a religious order, or Christian Sciencepractitioner and you filed Form 4361 and received IRS approval not to be taxed on those earnings, do not file Schedule SE. Instead,write “Exempt–Form 4361” on Form 1040, line 50.

Section A—Short Schedule SE. Caution: Read above to see if you can use Short Schedule SE.

Net farm profit or (loss) from Schedule F, line 36, and farm partnerships, Schedule K-1 (Form1065), line 15a

11

Net profit or (loss) from Schedule C, line 31; Schedule C-EZ, line 3; Schedule K-1 (Form 1065),line 15a (other than farming); and Schedule K-1 (Form 1065-B), box 9. Ministers and membersof religious orders, see page SE-1 for amounts to report on this line. See page SE-2 for otherincome to report

2

23Combine lines 1 and 23

Net earnings from self-employment. Multiply line 3 by 92.35% (.9235). If less than $400,do not file this schedule; you do not owe self-employment tax �

44

5 Self-employment tax. If the amount on line 4 is:

For Paperwork Reduction Act Notice, see Form 1040 instructions. Schedule SE (Form 1040) 1999

● You had church employee income of $108.28 or more. Income from services you performed as a minister or a member of areligious order is not church employee income. See page SE-1.

Cat. No. 11358Z

Deduction for one-half of self-employment tax. Multiply line 5 by50% (.5). Enter the result here and on Form 1040, line 27

● $72,600 or less, multiply line 4 by 15.3% (.153). Enter the result here and on Form 1040, line 50.

● More than $72,600, multiply line 4 by 2.9% (.029). Then, add $9,002.40 to theresult. Enter the total here and on Form 1040, line 50.

May I Use Short Schedule SE or MUST I Use Long Schedule SE?

DID YOU RECEIVE WAGES OR TIPS IN 1999?

Was the total of your wages and tips subject to social securityor railroad retirement tax plus your net earnings fromself-employment more than $72,600?

Did you receive tips subject to social security or Medicare taxthat you did not report to your employer?

Are you using one of the optional methods to figure your netearnings (see page SE-3)?

Are you a minister, member of a religious order, or ChristianScience practitioner who received IRS approval not to be taxedon earnings from these sources, but you owe self-employmenttax on other earnings?

Did you receive church employee income reported on FormW-2 of $108.28 or more?

YOU MAY USE SHORT SCHEDULE SE BELOW YOU MUST USE LONG SCHEDULE SE ON THE BACK

�

�

Yes

�

YesNo

�

�

�

No

No

No

No

Yes

�

Yes

�

Yes

�

Yes

��

��

�No

Note: Even if you had a loss or a small amount of income from self-employment, it may be to your benefit to file Schedule SE anduse either “optional method” in Part II of Long Schedule SE. See page SE-3.

6

5

6

�

(99)

1999


35,187 –

19,000 –

54,187 –

1,917

700 –

–

2,076 –

107 –

11,729 –

–159

1,864 –

2,134 –

7,991 –

643 –7,348 –

377 –

12,429 –

1,050 –11,729 –12,779 –

2,500 –11,729 –

14,229 –

WALTER A. & JANE W. BROWN 543 00 2111

SCHEDULE J OMB No. 1545-0074Farm Income Averaging(Form 1040)

� Attach to Form 1040.Department of the TreasuryInternal Revenue Service

AttachmentSequence No. 20

Social security number (SSN)Name(s) shown on Form 1040

1

2

33

44

5

5

667 7

88

9

9

101011

� See Instructions for Schedule J (Form 1040).

1

2

Enter your taxable income from Form 1040, line 39

Enter your elected farm income (see page J-1)

Subtract line 2 from line 1. If zero or less, enter -0-

Figure the tax on the amount on line 3. Use the 1999 Tax Table, Tax Rate Schedules, CapitalGain Tax Worksheet, or Schedule D, whichever applies

If you used Schedule J to figure your tax for 1998, enter the amountfrom line 11 of that Schedule J. Otherwise, enter the taxable income(but not less than zero) from your 1996 Form 1040, line 37; Form1040A, line 22; or Form 1040EZ, line 6Divide the amount on line 2 by 3.0Add lines 5 and 6Figure the tax on the amount on line 7. Use the 1996 Tax Rate Schedules or Capital Gain TaxWorksheet, whichever applies (see page J-2)

If you used Schedule J to figure your tax for 1998, enter the amountfrom line 15 of that Schedule J. Otherwise, enter the taxable income(but not less than zero) from your 1997 Form 1040, line 38; Form1040A, line 22; or Form 1040EZ, line 6Enter the amount from line 6Add lines 9 and 10Figure the tax on the amount on line 11. Use the 1997 Tax Rate Schedules or Schedule D,whichever applies (see page J-3)

If you used Schedule J to figure your tax for 1998, enter the amountfrom line 3 of that Schedule J. Otherwise, enter the taxable income(but not less than zero) from your 1998 Form 1040, line 39; Form1040A, line 24; or Form 1040EZ, line 6Enter the amount from line 6Add lines 13 and 14Figure the tax on the amount on line 15. Use the 1998 Tax Rate Schedules or Schedule D,whichever applies (see page J-4)

Add lines 4, 8, 12, and 16

If you used Schedule J to figure your tax for 1998, enter the amountfrom line 12 of that Schedule J. Otherwise, enter the tax from your1996 Form 1040, line 38*; Form 1040A, line 23; or Form 1040EZ,line 10



Add lines 18 through 20Subtract line 21 from line 17. Also include this amount on Form 1040, line 40

12

13

141516

17

18

19

20

2122

For Paperwork Reduction Act Notice, see Form 1040 instructions. Schedule J (Form 1040) 1999Cat. No. 25513Y

11

12

131415

16

17

18

19

20

2122

*Caution. Do not include any amount from Form 4972 or 8814.

(99)

1999

Caution. Your tax may be less if you figure it using the 1999 Tax Table, Tax Rate Schedules,Capital Gain Tax Worksheet, or Schedule D. Attach Schedule J only if you are using it to figureyour tax.


Proof as of

October 20, 1

999

(subject to

change)

Attachment Sequence No. 26 Page 2Form 4684 (1999)

Identifying numberName(s) shown on tax return. Do not enter name and identifying number if shown on other side.

SECTION B—Business and Income-Producing PropertyCasualty or Theft Gain or Loss (Use a separate Part l for each casualty or theft.)

19 Description of properties (show type, location, and date acquired for each):

Property A

Property B

Property C

Property D

Properties (Use a separate column for each property lost ordamaged from one casualty or theft.)

DCBA20Cost or adjusted basis of each property20

Insurance or other reimbursement (whether or notyou filed a claim). See the instructions for line 3

2121

Note: If line 20 is more than line 21, skip line 22.Gain from casualty or theft. If line 21 is more than line20, enter the difference here and on line 29 or line 34,column (c), except as provided in the instructions forline 33. Also, skip lines 23 through 27 for that column.See the instructions for line 4 if line 21 includesinsurance or other reimbursement you did not claim, oryou received payment for your loss in a later tax year

22

22

23Fair market value before casualty or theft2324Fair market value after casualty or theft242525 Subtract line 24 from line 2326Enter the smaller of line 20 or line 2526

Note: If the property was totally destroyed bycasualty or lost from theft, enter on line 26the amount from line 20.

27Subtract line 21 from line 26. If zero or less, enter -0-27Casualty or theft loss. Add the amounts on line 27. Enter the total here and on line 29 or line 34 (see instructions)28 28

(b) Losses from casualties or theftsSummary of Gains and Losses (from separate Parts l) (c) Gains fromcasualties or theftsincludible in income

(i) Trade, business,rental or royalty

property

(ii) Income-producing and

employee property(a) Identify casualty or theft

Casualty or Theft of Property Held One Year or Less

29

3030 Totals. Add the amounts on line 29

31 Combine line 30, columns (b)(i) and (c). Enter the net gain or (loss) here and on Form 4797, line 14. If Form 4797is not otherwise required, see instructions 31

32 Enter the amount from line 30, column (b)(ii) here. Individuals, enter the amount from income-producing propertyon Schedule A (Form 1040), line 27, and enter the amount from property used as an employee on Schedule A(Form 1040), line 22. Estates and trusts, partnerships, and S corporations, see instructions 32

Casualty or Theft of Property Held More Than One Year33Casualty or theft gains from Form 4797, line 3233

34

35Total losses. Add amounts on line 34, columns (b)(i) and (b)(ii)3536Total gains. Add lines 33 and 34, column (c)3637Add amounts on line 35, columns (b)(i) and (b)(ii)37

Note: Partnerships, enter the amount from line 38a, 38b, or line 39 on Form 1065, Schedule K, line 7.S corporations, enter the amount from line 38a or 38b on Form 1120S, Schedule K, line 6.

If the loss on line 37 is more than the gain on line 36:38a Combine line 35, column (b)(i) and line 36, and enter the net gain or (loss) here. Partnerships (except electing

large partnerships) and S corporations, see the note below. All others, enter this amount on Form 4797,line 14. If Form 4797 is not otherwise required, see instructions 38a

b Enter the amount from line 35, column (b)(ii) here. Individuals, enter the amount from income-producing property onSchedule A (Form 1040), line 27, and enter the amount from property used as an employee on Schedule A (Form 1040),line 22. Estates and trusts, enter on the “Other deductions” line of your tax return. Partnerships (except electing largepartnerships) and S corporations, see the note below. Electing large partnerships, enter on Form 1065-B, Part II, line 11 38b

If the loss on line 37 is less than or equal to the gain on line 36, combine lines 36 and 37 and enter here.Partnerships (except electing large partnerships), see the note below. All others, enter this amount on Form4797, line 3, column (g)

39

39

( )( )( )

( )( )( )

( )( )

( )( )

( ) ( )

Part I

Part II

WALTER A. & JANE W. BROWN 543-00-2111

DAIRY COW #42 HOMETOWN, VA 6-22-95

257 –

109 –

500 –– 0 –

500 –257 –

148 –148 –

148 –

148 –

(148 –)

(148 –)

– 0 –

Cow killed by lightning


WALTER A. & JANE W. BROWN 543-00-2111

Raised cowsDairy cow #52Raised heifer

before 19917-15-956-2-97

19992-3-998-3-99

14,110. –303. –

1,100

– 0 –514. –– 0 –

325. –912. –20. –

(95. –)13,785. –

1,080. –

Raised dairy heifer 10-2-98 3-3-99 255. – – 0 – 5. –

(148. –)

14,770. –

250. –

852. –

954. –

954. –

Sales of Business Property(Also Involuntary Conversions and Recapture Amounts

Under Sections 179 and 280F(b)(2))Department of the Treasury Internal Revenue Service

Attachment Sequence No. 27� Attach to your tax return. � See separate instructions.

Identifying numberName(s) shown on return

Sales or Exchanges of Property Used in a Trade or Business and Involuntary Conversions From OtherThan Casualty or Theft—Property Held More Than 1 Year

Enter here the gross proceeds from the sale or exchange of real estate reported to you for 1999 on Form(s) 1099-S(or a substitute statement) that you will be including on line 2, 10, or 20

11

(f) Cost or otherbasis, plus

improvements andexpense of sale

(e) Depreciationallowed

or allowable sinceacquisition

(g) GAIN or (LOSS)Subtract (f) fromthe sum of (d)

and (e)

(c) Date sold (mo., day, yr.)

(b) Date acquired(mo., day, yr.)(a) Description of property (d) Gross sales

price

2

Gain, if any, from Form 4684, line 393

Section 1231 gain from installment sales from Form 6252, line 26 or 374

Gain, if any, from line 32, from other than casualty or theft

5

Combine lines 2 through 6. Enter the gain or (loss) here and on the appropriate line as follows:

6

7Partnerships (except electing large partnerships). Report the gain or (loss) following the instructions for Form1065, Schedule K, line 6. Skip lines 8, 9, 11, and 12 below.S corporations. Report the gain or (loss) following the instructions for Form 1120S, Schedule K, lines 5 and 6.Skip lines 8, 9, 11, and 12 below, unless line 7 is a gain and the S corporation is subject to the capital gains tax.All others. If line 7 is zero or a loss, enter the amount from line 7 on line 11 below and skip lines 8 and 9. If line7 is a gain and you did not have any prior year section 1231 losses, or they were recaptured in an earlier year,enter the gain from line 7 as a long-term capital gain on Schedule D and skip lines 8, 9, and 12 below.

Nonrecaptured net section 1231 losses from prior years (see instructions)8

9 Subtract line 8 from line 7. If zero or less, enter -0-. Also enter on the appropriate line as follows (see instructions):S corporations. Enter any gain from line 9 on Schedule D (Form 1120S), line 14, and skip lines 11 and 12 below.All others. If line 9 is zero, enter the gain from line 7 on line 12 below. If line 9 is more than zero, enter the amount from line 8 on line 12below, and enter the gain from line 9 as a long-term capital gain on Schedule D.

Ordinary Gains and Losses

Ordinary gains and losses not included on lines 11 through 17 (include property held 1 year or less):

Loss, if any, from line 7

10

Gain, if any, from line 7 or amount from line 8, if applicable

11

Gain, if any, from line 31

12

Net gain or (loss) from Form 4684, lines 31 and 38a

13

Ordinary gain from installment sales from Form 6252, line 25 or 36

14

Recapture of section 179 expense deduction for partners and S corporation shareholders from property dispositionsby partnerships and S corporations (see instructions)

15

Combine lines 10 through 17. Enter the gain or (loss) here, and on the appropriate line as follows:

16

17

For all except individual returns: Enter the gain or (loss) from line 18 on the return being filed.a

For individual returns:b

If the loss on line 11 includes a loss from Form 4684, line 35, column (b)(ii), enter that part of the loss here.Enter the part of the loss from income-producing property on Schedule A (Form 1040), line 27, and the partof the loss from property used as an employee on Schedule A (Form 1040), line 22. Identify as from “Form4797, line 18b(1).” See instructions

(1)

(2) Redetermine the gain or (loss) on line 18, excluding the loss, if any, on line 18b(1). Enter here and on Form1040, line 14

Form 4797 (1999)For Paperwork Reduction Act Notice, see separate instructions. Cat. No. 13086I

Part I

Part II

OMB No. 1545-0184

Section 1231 gain or (loss) from like-kind exchanges from Form 8824

Ordinary gain or (loss) from like-kind exchanges from Form 8824

18

3

4

5

6

7

8

11

12

13

14

15

16

17

18

18b(1)

18b(2)

(99)

9

( )

19994797Form


TRUCKMOWERPURCHASED DAIRY COW #60

6-22-904-21-892-21-96

7-9-998-12-99

10-28-99

700. –4,390. –

– 0 –

70. –1,200. –

670. –1,200. –

– 0 – 588. –

700. –

700. –

4,390. –

4,390. –

1,200. –

70. –

1,200. –70. –

612. –

82. –

612. –82. –

– 0 –

852. –

852. –

Page 2Form 4797 (1999)

Gain From Disposition of Property Under Sections 1245, 1250, 1252, 1254, and 1255

(c) Date sold(mo., day, yr.)

(b) Date acquired(mo., day, yr.)(a) Description of section 1245, 1250, 1252, 1254, or 1255 property:

A

BC

D

Property DProperty CProperty BProperty AThese columns relate to the properties on lines 19A through 19D. �

Gross sales price (Note: See line 1 before completing.)

Cost or other basis plus expense of sale

19

Depreciation (or depletion) allowed or allowable

20

Adjusted basis. Subtract line 22 from line 21

21

Total gain. Subtract line 23 from line 20

22

If section 1245 property:

23

a Depreciation allowed or allowable from line 22b Enter the smaller of line 24 or 25a

If section 1250 property: If straight line depreciation was used, enter-0- on line 26g, except for a corporation subject to section 291.

24

Additional depreciation after 1975 (see instructions)a

Applicable percentage multiplied by the smaller of line 24or line 26a (see instructions)

b

Subtract line 26a from line 24. If residential rental propertyor line 24 is not more than line 26a, skip lines 26d and 26e

c

Additional depreciation after 1969 and before 1976d

Enter the smaller of line 26c or 26def Section 291 amount (corporations only)g Add lines 26b, 26e, and 26f

25

If section 1252 property: Skip this section if you did notdispose of farmland or if this form is being completed for apartnership (other than an electing large partnership).

Soil, water, and land clearing expensesaLine 27a multiplied by applicable percentage (see instructions)bEnter the smaller of line 24 or 27bc


26

Intangible drilling and development costs, expenditures fordevelopment of mines and other natural deposits, andmining exploration costs (see instructions)

a

Enter the smaller of line 24 or 28ab


27

Applicable percentage of payments excluded from incomeunder section 126 (see instructions)

a

Enter the smaller of line 24 or 29a (see instructions)b

Summary of Part III Gains. Complete property columns A through D through line 29b before going to line 30.

Total gains for all properties. Add property columns A through D, line 24

28

Add property columns A through D, lines 25b, 26g, 27c, 28b, and 29b. Enter here and on line 13

29

Subtract line 31 from line 30. Enter the portion from casualty or theft on Form 4684, line 33. Enter the portionfrom other than casualty or theft on Form 4797, line 6

30

3132

33

Recapture Amounts Under Sections 179 and 280F(b)(2) When Business Use Drops to 50% or Less(See instructions.)

(b) Section 280F(b)(2)

(a) Section179

Section 179 expense deduction or depreciation allowable in prior years34 Recomputed depreciation. See instructions35 Recapture amount. Subtract line 34 from line 33. See the instructions for where to report

Part IV

Part III

20

21

2223

24

25a

26a

27a

28a

29a

26b

26c

26d

26e

26f

26g

27b

27c

28b

29b

25b

30

31

32

33

34

35

Form 4797 (1999)


WALTER A. & JANE W. BROWN FARMING 543-00-2111

152,229. –

19,000. –

TRACTOR 23,729. – 19,000. –

78,107. –56,500. –

1,300. –

10

20

HY 150DB 8,365. –4,238. –

2,708. –

1,374. –

2,244. –

37,978. –

19,000. –19,000. –

19,000. –19,000. –

HY

HY

150DB

150DB

– 0 –

– 0 –

– 0 –

7

49. –

OMB No. 1545-0172Depreciation and Amortization4562Form(Including Information on Listed Property)

Department of the TreasuryInternal Revenue Service

AttachmentSequence No. 67� See separate instructions.

Identifying numberName(s) shown on return Business or activity to which this form relates

Election To Expense Certain Tangible Property (Section 179) (Note: If you have any “listed property,”complete Part V before you complete Part I.)

$19,0001Maximum dollar limitation. If an enterprise zone business, see page 2 of the instructions12Total cost of section 179 property placed in service. See page 2 of the instructions2

$200,0003Threshold cost of section 179 property before reduction in limitation34Reduction in limitation. Subtract line 3 from line 2. If zero or less, enter -0-4

Dollar limitation for tax year. Subtract line 4 from line 1. If zero or less, enter -0-. If marriedfiling separately, see page 2 of the instructions

55

(a) Description of property (b) Cost (business use only) (c) Elected cost

6

7Listed property. Enter amount from line 27788 Total elected cost of section 179 property. Add amounts in column (c), lines 6 and 79Tentative deduction. Enter the smaller of line 5 or line 89

10Carryover of disallowed deduction from 1998. See page 2 of the instructions1011Business income limitation. Enter the smaller of business income (not less than zero) or line 5 (see instructions)1112Section 179 expense deduction. Add lines 9 and 10, but do not enter more than line 1112

13 Carryover of disallowed deduction to 2000. Add lines 9 and 10, less line 12 � 13Note: Do not use Part II or Part III below for listed property (automobiles, certain other vehicles, cellular telephones,certain computers, or property used for entertainment, recreation, or amusement). Instead, use Part V for listed property.

MACRS Depreciation for Assets Placed in Service ONLY During Your 1999 Tax Year (Do Not IncludeListed Property.)

(b) Month andyear placed in

service

(c) Basis for depreciation(business/investment use

only—see instructions)

(d) Recoveryperiod(a) (e) Convention (f) Method (g) Depreciation deduction

Section B—General Depreciation System (GDS) (See page 3 of the instructions.)

3-year property15a5-year propertyb7-year propertyc10-year propertyd15-year propertye20-year propertyf

S/LMM27.5 yrs.Residential rentalproperty

hS/LMM27.5 yrs.S/LMMNonresidential real

propertyi

S/LMMSection C—Alternative Depreciation System (ADS) (See page 5 of the instructions.)

S/L16a Class life12 yrs. S/Lb 12-year40 yrs. MM S/Lc 40-year

Other Depreciation (Do Not Include Listed Property.) (See page 5 of the instructions.)GDS and ADS deductions for assets placed in service in tax years beginning before 199917 17

18Property subject to section 168(f)(1) election18ACRS and other depreciation19 19

Summary (See page 6 of the instructions.)2020 Listed property. Enter amount from line 26

Total. Add deductions on line 12, lines 15 and 16 in column (g), and lines 17 through 20. Enter hereand on the appropriate lines of your return. Partnerships and S corporations—see instructions

2121

22 For assets shown above and placed in service during the current year,enter the portion of the basis attributable to section 263A costs 22

Form 4562 (1999)For Paperwork Reduction Act Notice, see page 9 of the instructions. Cat. No. 12906N

Part IV

Part I

Part II

Part III

� Attach this form to your return.

39 yrs.

(99)

Section A—General Asset Account Election14 If you are making the election under section 168(i)(4) to group any assets placed in service during the tax year into one

or more general asset accounts, check this box. See page 3 of the instructions �

Classification of property

25-year propertyg 25 yrs. S/L

1999


X X

CAR 1-6-965-18-96

60100

12,350. –7,076. –

7,410. –7,076. –

55

150DB/HY150DB/HY

1,065. – *1,179. –

– 0 –– 0 –

– 0 –

– 0 –

– 0 –– 0 –

2,244. –

6,270 11,350

4,180

10,450 11,350

�

�

�

�

�

�

* Limited deduction for passenger automobile

PICKUP TRUCK

– 0 –

– 0 –2,350

2,350

�

�

�

6-22-90 100PICKUP TRUCK

Page 2Form 4562 (1999)

Listed Property—Automobiles, Certain Other Vehicles, Cellular Telephones, Certain Computers, andProperty Used for Entertainment, Recreation, or AmusementNote: For any vehicle for which you are using the standard mileage rate or deducting lease expense, complete only23a, 23b, columns (a) through (c) of Section A, all of Section B, and Section C if applicable.

Section A—Depreciation and Other Information (Caution: See page 7 of the instructions for limits for passenger automobiles.)23b23a NoYesIf “Yes,” is the evidence written?NoYesDo you have evidence to support the business/investment use claimed?

(i)Elected

section 179cost

(h)Depreciation

deduction

(g)Method/

Convention

(f)Recovery

period

(e)Basis for depreciation(business/investment

use only)

(d)Cost or other

basis

(c)Business/investment

usepercentage

(b)Date placed in

service

(a)Type of property (list

vehicles first)

Property used more than 50% in a qualified business use (See page 6 of the instructions.):24%%%

Property used 50% or less in a qualified business use (See page 6 of the instructions.):25% S/L –% S/L –

S/L –%26 Add amounts in column (h). Enter the total here and on line 20, page 1 26

Add amounts in column (i). Enter the total here and on line 7, page 127 27Section B—Information on Use of Vehicles

(f)Vehicle 6

(e)Vehicle 5

(d)Vehicle 4

(c)Vehicle 3

(b)Vehicle 2

(a)Vehicle 1

Total business/investment miles driven duringthe year (DO NOT include commuting miles—see page 1 of the instructions)

28

Total commuting miles driven during the year29Total other personal (noncommuting)miles driven

30

Total miles driven during the year.Add lines 28 through 30

31

NoYes NoYesNoYesNoYesNoYesNoYes

Was the vehicle available for personaluse during off-duty hours?

32

Was the vehicle used primarily by amore than 5% owner or related person?

33

Is another vehicle available forpersonal use?

34

Section C—Questions for Employers Who Provide Vehicles for Use by Their Employees

NoYes

Do you maintain a written policy statement that prohibits all personal use of vehicles, including commuting,by your employees?

35

Do you maintain a written policy statement that prohibits personal use of vehicles, except commuting, by your employees?See page 8 of the instructions for vehicles used by corporate officers, directors, or 1% or more owners

36

Do you treat all use of vehicles by employees as personal use?37Do you provide more than five vehicles to your employees, obtain information from your employees aboutthe use of the vehicles, and retain the information received?

38

Do you meet the requirements concerning qualified automobile demonstration use? See page 8 of the instructions39Note: If your answer to 35, 36, 37, 38, or 39 is “Yes,” you need not complete Section B for the covered vehicles.

Amortization(e)

Amortizationperiod or

percentage

(b)Date amortization

begins

(c)Amortizable

amount

(d)Code

section

(f)Amortization for

this year

(a)Description of costs

40 Amortization of costs that begins during your 1999 tax year:

41 Amortization of costs that began before 1999 4142 Total. Enter here and on “Other Deductions” or “Other Expenses” line of your return 42

Complete this section for vehicles used by a sole propr ietor, partner, or other “more than 5% owner,” or related person.If you provided vehicles to your employees, first answer the questions in Section C to see if you meet an exception to completing this section for those vehicles.

Part VI

Part V

Answer these questions to determine if you meet an exception to completing Section B for vehicles used by employees whoare not more than 5% owners or related persons.

Form 4562 (1999)


STRAIGHT LINEBARNSILO

ALTERNATE ACRSMACHINE SHED

MACRSTRACTOR #2 (traded 3/99)

DAIRY COW #54

CAR (listed property)

PLOWPICKUP TRUCK (listed property)DAIRY COW #61TRACTOR #4

MILK TANKMANURE SPREADER

DAIRY FACILITY BUILDING

MACHINE SHED IMPROVEMENTTRACTOR #5

1-8-781-2-80

1-2-86

1-8-95

9-9-95

1-6-96

4-6-965-18-96

9-1-9610-12-96

1-4-975-3-97

1-9-99

2-20-993-10-99

6,40016,000

6,000

7,297

1,200

12,350

4,8217,0761,400

13,483

11,5003,400

56,500

1,30025,107

100%"

100%

100%

"

60%

100%"""

100%"

100%

""

5,000

5,000

10,000

19,000

5,37615,200

4,116

804

600

4,334

1,5994,129628

2,814

4481,015

– 0 –

1,024800

1,884

2,297

1,200

7,410

4,8217,0761,400

8,483

1,5003,400

56,500

1,3006,107

– 0 –– 0 –

SLSL

Mod SL

SL/HY

150DB/HY

2520

19

7

5

1057

10

77

10

207

5.3

14.29

16.66

10.0212.25

15.03

7.50

3.7510.71

256800

318

114.85*

171.48

1,065.–**

483.061,178.86

171.50849.99

225.45511.02

4,237.50

48.75654.06

18,977.40

* Depreciation limited to half-year** Limited deduction for passenger automobile

10.0

16.66

10.02

15.03

SL/HY

150DB/HY150DB/HY150DB/HY150DB/HY

150DB/HY150DB/HY

150DB/HY

150DB/HY150DB/HY

10DAIRY COW #42 (killed 7/99) 6-22-95 600 " 300 600 7 14.29 42.87*SL/HYDAIRY COW #52 (sold 2/99) 7-15-95 900 " 450 900 7 14.29 64.31*SL/HY

DAIRY COW #60 (sold 10/99) 2-21-96 1,200 538 1,200 7 12.25 73.50*150DB/HY100%

DAIRY FACILITY EQUIPMENT 1-9-99 72,000 – 0 – 72,000 7 10.71 7,711.20150DB/HY"

TOTAL

Depreciation Worksheet

Description of PropertyDate

Placed inService

Cost orOtherBasis

Business/Investment

Use %

Section179

Deduction

Depreciation PriorYears

Basis forDepreciation

Method/Convention

RecoveryPeriod

Rate orTable

%

DepreciationDeduction

Page 112

Chapter 20

Sam

ple Return

21.How To GetMoreInformation

You can order free publications and forms,ask tax questions, and get more informationfrom the IRS in several ways. By selecting themethod that is best for you, you will havequick and easy access to tax help.

Free tax services. To find out what servicesare available, get Publication 910, Guide toFree Tax Services. It contains a list of free taxpublications and an index of tax topics. It alsodescribes other free tax information services,including tax education and assistance pro-grams and a list of TeleTax topics.

Personal computer. With your per-sonal computer and modem, you canaccess the IRS on the Internet at

www.irs.gov . While visiting our web site, youcan select:

• Frequently Asked Tax Questions (locatedunder Taxpayer Help & Ed) to find an-swers to questions you may have.

• Forms & Pubs to download forms andpublications or search for forms andpublications by topic or keyword.

• Fill-in Forms (located under Forms &Pubs) to enter information while the formis displayed and then print the completedform.

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• Tax Regs in English to search regulationsand the Internal Revenue Code (underUnited States Code (USC)).

• Digital Dispatch and IRS Local News Net(both located under Tax Info For Busi-ness) to receive our electronic newslet-ters on hot tax issues and news.

• Small Business Corner (located underTax Info For Business) to get informationon starting and operating a small busi-ness.

You can also reach us with your computerusing File Transfer Protocol at ftp.irs.gov .

TaxFax Service. Using the phoneattached to your fax machine, you canreceive forms and instructions by

calling 703–368–9694. Follow the directionsfrom the prompts. When you order forms,enter the catalog number for the form youneed. The items you request will be faxed toyou.

Phone. Many services are availableby phone.

• Ordering forms, instructions, and publi-cations. Call 1–800–829–3676 to ordercurrent and prior year forms, instructions,and publications.

• Asking tax questions. Call the IRS withyour tax questions at 1–800–829–1040.

• TTY/TDD equipment. If you have accessto TTY/TDD equipment, call 1–800–829–4059 to ask tax questions or to orderforms and publications.

• TeleTax topics. Call 1–800–829–4477 tolisten to pre-recorded messages coveringvarious tax topics.

Evaluating the quality of our telephoneservices. To ensure that IRS representativesgive accurate, courteous, and professionalanswers, we evaluate the quality of our tele-phone services in several ways.

• A second IRS representative sometimesmonitors live telephone calls. That persononly evaluates the IRS assistor and doesnot keep a record of any taxpayer's nameor tax identification number.

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• We value our customers' opinions.Throughout this year, we will be survey-ing our customers for their opinions onour service.

Walk-in. You can walk in to manypost offices, libraries, and IRS officesto pick up certain forms, instructions,

and publications. Also, some libraries and IRSoffices have:

• An extensive collection of products avail-able to print from a CD-ROM or photo-copy from reproducible proofs.

• The Internal Revenue Code, regulations,Internal Revenue Bulletins, and Cumula-tive Bulletins available for research pur-poses.

Mail. You can send your order forforms, instructions, and publicationsto the Distribution Center nearest to

you and receive a response within 10 work-days after your request is received. Find theaddress that applies to your part of thecountry.

• Western part of U.S.:Western Area Distribution CenterRancho Cordova, CA 95743–0001

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CD-ROM. You can order IRS Publi-cation 1796, Federal Tax Products onCD-ROM, and obtain:

• Current tax forms, instructions, and pub-lications.

• Prior-year tax forms, instructions, andpublications.

• Popular tax forms which may be filled inelectronically, printed out for submission,and saved for recordkeeping.

• Internal Revenue Bulletins.

The CD-ROM can be purchased fromNational Technical Information Service (NTIS)by calling 1–877–233–6767 or on the Internetat www.irs.gov/cdorders. The first releaseis available in mid-December and the finalrelease is available in late January.

IRS Publication 3207, Small BusinessResource Guide, is an interactive CD-ROMthat contains information important to smallbusinesses. It is available in mid-February.You can get one free copy by calling 1–800–829–3676.

Chapter 21 How To Get More Information Page 113

Index

A Abandonments .......................... 63 Accounting methods:

Accrual ................................. 11 Cash ..................................... 11 Change in ............................. 13 Crop ...................................... 13 Farm inventory ..................... 12

Accounting periods .................... 10Adjusted basis of assets ........... 36

Advance payments .................... 24Agricultural program payments . 16

Agricultural structure ................. 42Alternative Depreciation Sys-

tem (ADS) ...................... 45, 48Alternative minimum tax ............ 76

Amortization:Going into business ............. 52Pollution control facilities ...... 52

Reforestation expenses ....... 52Section 197 intangibles ........ 51 Appeal rights ............................. 95 Assessments:By conservation district ........ 33

Depreciable property ............ 33Sale, disposal of land ........... 34

Assistance (See More information) Audits ......................................... 95 Automobiles, depreciation ......... 43

B Bankruptcy ................................. 20 Barter income ............................ 22

Basis of assets: Adjusted basis ...................... 36

Allocating to several assets . 35Changed to business use .... 37

Constructing assets .............. 35 Cost ...................................... 34 Decreases ............................ 36 Exchanges:

Involuntary ....................... 38 Like-kind .......................... 37 Nontaxable ...................... 37 Partially nontaxable ......... 37 Taxable ........................... 37

Gifts ...................................... 38 Increases .............................. 36 Inherited ............................... 39 Real property ........................ 35

Received for services ........... 37Transfer from spouse ........... 39Uniform capitalization rules .. 35 Below-market loans ................... 22

Books and records ...................... 4 Breeding fees ............................ 26

Business use of home ............... 27

C Canceled debt ........................... 20 Capital assets ............................ 58 Capital expenses ....................... 29 Car expenses ............................ 27

Casualties and thefts:Adjustments to basis ............ 73

Casualty, defined ................. 71Disaster area losses ............ 75

Leased property ................... 73 Livestock .............................. 72 Reimbursement .................... 73

Reporting gains and losses . 76 Theft, defined ....................... 71

Change in accounting method .. 13 Chickens, purchased ................. 28 Christmas trees ................... 29, 61

Claim for refund ......................... 95Clean-fuel vehicle exception ..... 50

Club dues .................................. 30Collection of tax ......................... 95

Commodity CreditCorporation:

Loans .................................... 16 Market gain .......................... 17

Commodity:

Futures ................................. 59 Wages .................................. 84

Computer software .............. 40, 51 Condemnation ..................... 71, 74 Conservation:

District assessments ............ 33 Expenses .............................. 32 Plans .................................... 32

Reserve Program (CRP) ...... 17 Constructing assets ................... 35

Constructive receipt of income .. 11 Converted wetland .................... 61

Cooperatives, income from ....... 19 Corporation ................................ 10 Cost-sharing exclusion .............. 18 Credits:Earned income (EIC):

Advance payment ........... 86 Notification ...................... 86

Fuel tax .......................... 22, 93 General business ................. 52 Investment ............................ 53

Prior year minimum tax ........ 77Social security coverage ...... 78 Crew leaders ............................. 86 Crop:

Destroyed ............................. 75 Insurance proceeds .............. 17

Method of accounting ........... 13 Shares .................................. 15

Unharvested ............. 29, 64, 79Cropland, highly erodible .......... 61

D Damage:Casualties and thefts ........... 71

Crop insurance ..................... 17 Tree seedlings ...................... 74

Debt: Bad ....................................... 58

Canceled ............ 20, 57, 63, 78Exclusion for canceled, effect

on basis ........................... 37 Nonrecourse ......................... 57 Qualified farm ....................... 21 Recourse .............................. 57

Depletion ................................... 50 Depreciation:

ADS election ........................ 48 ADS method ......................... 45 Basis ..................................... 46 Conservation assets ............. 33 Deduction ............................. 40 Dispositions .......................... 49

How to claim ........................ 42Incorrect amount deducted .. 41Limit for automobiles ............ 43

Listed property ..................... 49 Raised livestock ................... 40

Recapture ................. 64, 65, 66 Software, computer .............. 40

Disaster area losses .................. 75 Disaster payments ..................... 17

Dispositions ...... 34, 49, 51, 54, 63,67

E Easement ............................ 22, 36 Embryo transplants ................... 35 Estimated tax:Farm gross income ................ 7Farmer due dates ................... 7Fiscal year farmer .................. 7

Gross income ......................... 6 Penalties ................................. 7

Examinations (audits) ................ 95 Exchanges:

Basis: Involuntary ....................... 38 Like-kind .......................... 37 Nontaxable ...................... 37 Partially nontaxable ......... 37 Taxable ........................... 37

Like-kind ............................... 55 Nontaxable ........................... 55

Excise taxes: Credit .................................... 93 Diesel fuel ............................ 91 Farming purposes ................ 90

Home use of fuels ................ 92 Off-highway uses ................. 92 Refund .................................. 94

FFair market value ...................... 69Family farm corporation ...... 12, 13

Family members: Deductible pay ..................... 25

Social security coverage ...... 85 Farm:

Business expenses .............. 23 Business, defined ........... 32, 47 Defined ........................... 32, 90 Income averaging ................. 22 Rental ................................... 32 Sale of .................................. 62

Special property valuation .... 39Federal unemployment tax

(FUTA) .................................. 84 Fertilizer ............................... 19, 26 Filing requirements ...................... 6 Foreclosure ................................ 57 Form:

940 ......................................... 8 943 ................................... 8, 85 982 ....................................... 21 1040 ....................................... 8 1040X ................................... 30 1040–ES ................................. 8 1045 ............................... 30, 53 1065 ................................... 8, 9 1096 ....................................... 9 1099–A ................................. 58 1099–C ........................... 20, 58 1099–G ........................... 17, 19 1099–INT ................................ 9

1099–MISC .............. 3, 5, 9, 84 1099–PATR .......................... 19 1120 ................................. 8, 10 1120S ............................... 8, 10 1139 ..................................... 53 2210–F ............................... 7, 8 2290 ....................................... 9 3115 ............................... 14, 41 3468 ................................. 8, 54 3800 ................................. 8, 53 4136 ................................. 8, 93 4255 ................................. 8, 54 4562 ................................. 8, 42 4684 ....................................... 8 4797 ................................. 8, 18 4835 ................................. 8, 15 4868 ....................................... 8 4952 ............................... 59, 76 5213 ..................................... 31 5305–SEP ............................ 87 6251 ................................. 8, 76 6252 ..................................... 67 8109 ....................................... 9 8717 ..................................... 89 8801 ..................................... 77 8822 ................................... 2, 9 8824 ................................. 8, 55 8849 ..................................... 94 I–9 ........................................ 83

SS–4 ............................. 3, 6, 83 SS–5 ................................. 6, 78 T ........................................... 51 W–2 .................................. 8, 84 W–4 .................................. 3, 84

W–4V .......................... 2, 16, 17 W–5 ...................................... 86

Free tax services ..................... 113Fuel tax credit and refund ......... 22

GGains and losses:

Basis of assets ..................... 34Capital assets, defined ......... 58

Casualty ......................... 72, 73

Installment sales .................. 67 Livestock .............................. 60

Long- or short-term .............. 58Ordinary or capital ................ 58Sale of farm .......................... 62

Section 1231 ........................ 63 Theft ............................... 72, 73 Timber .................................. 61

General asset accounts ............ 49General business credit ............ 52General Depreciation System

(GDS) ................................... 45Gifts ................... 16, 30, 38, 54, 58Going into business ................... 52

Goodwill ..................................... 41Gross income from farming ....... 81

HHealth insurance deduction ....... 26

Hedging ..................................... 59Help (See More information) Help from the IRS ....................... 3Highway use tax ........................ 26

Holding period ........................... 58 Horticultural structure ................ 42

IIdentification number, taxpayer ... 6Illegal irrigation subsidy ............. 22Income averaging (See Farm: Income

averaging) Income tax:Depositing withheld tax ........ 85Withholding of tax ................ 84 Income:

Accounting for ...................... 11Accrual method of accounting 11Canceled debt excluded 20, 37

Cash method ........................ 11 Community ........................... 83

From farming ........ 7, 14, 34, 81 Gross ...................................... 6

Items to include .................... 11 Not-for-profit farming ............ 31

Partner's distributive share .... 9 Pasture ................................. 15 Schedule F ........................... 14 Self-employment .................. 79

Tax forms used by farmers .... 8Incorrect amount of depreciation

deducted ............................... 41Individual retirement arrange-

ments (IRAs) ........................ 90 Information returns ...................... 9

Innocent spouse relief ............... 95 Insolvency .................................. 20 Installment sales:

Electing out .......................... 67Farm, sale of ........................ 70

Figuring income .................... 67 Payments received ............... 69 Recapture on ........................ 66 Reporting income ................. 67 Unstated interest .................. 69

Insurance ................................... 26 Intangible property ............... 40, 51 Interest:

Expense ............................... 25 Unstated ............................... 69

Inventory: Items included ...................... 12

Methods of valuation ............ 13 Investment credit ....................... 53 Involuntary conversion .............. 71 IRAs ........................................... 90 Irrigation:

Center pivot .......................... 32 Illegal subsidy ....................... 22 Project .................................. 74

KKeogh plan (See Qualified plan)

Page 114

L Labor hired ................................ 25 Landlord participation ................ 80

Lease or purchase .................... 27 Like-kind exchanges ............ 37, 55 Lime ........................................... 26 Listed property:

Defined ................................. 49 Passenger automobile ......... 49

Predominant use test ........... 49 Recordkeeping ..................... 50 Rules .................................... 49

Livestock:Casualty and theft losses ..... 72

Crop shares .......................... 16 Depreciation ................... 40, 42 Diseased .............................. 74 Feed ..................................... 24 Feed assistance ................... 17 Immature .............................. 46 Losses ............................ 29, 60 Purchased ............................ 61 Raised .................................. 60 Sale of ............................ 14, 60 Unit-livestock-price, inventoryvaluation .......................... 13

Used in a farm business ...... 60 Weather-related sales .... 15, 74

Loans ................................... 16, 26 Losses:

At-risk limits .......................... 30 Casualty ............................... 71 Disaster areas ...................... 75 Farming ................................ 72 Growing crops ...................... 29 Hobby farming ...................... 31 Livestock ........................ 60, 74 Nondeductible ...................... 29 Theft ..................................... 71

Lost property ............................. 71

M MACRS ...................................... 45

Market gain, reporting ............... 17Marketing quota penalties ......... 28

Material participation ................. 80 Meals ......................................... 28 Membership fees ....................... 30

Methods of accounting .............. 11Minimum tax credit .................... 77Modified ACRS (MACRS):

ADS election ........................ 48 Conventions ......................... 47 Depreciable property ............ 45 Depreciation methods .......... 47 Excluded property ................ 45

Figuring the deduction ......... 46 Percentage tables ................ 48 Property classes ................... 46 Recovery periods ................. 46

Money purchase pension plan .. 89 More information ..................... 113

NNet operating loss ..................... 30

Noncapital asset ........................ 59 Nontaxable exchanges .............. 55 Not-for-profit farming ................. 31

OOverdue tax bill ........................... 3

P Partnership .................................. 9 Passenger automobile ............... 49 Pasture income ......................... 15 Patronage dividends .................. 19 Penalties:

Estimated tax ......................... 7 Information returns ................. 9

Trust fund recovery .............. 85Per-unit retain certificates ......... 19

Personal expenses .................... 29Placed in service ....................... 41Pollution control facilities ........... 52

Postponing gain ......................... 74Principal agricultural activity codes,

Schedule F ............................. 2 Prizes ......................................... 22 Produce ..................................... 14 Profit-sharing plans ................... 88 Property:Changed to business use .... 37Received for services ........... 37

Section 1245 ........................ 64 Section 1250 ........................ 65 Section 1252 ........................ 66 Section 1255 ........................ 66

Publications (See More information)

QQualified farm debt .................... 21

Qualified plan ............................ 88Quotas and allotments .............. 35

RRecordkeeping ................ 4, 28, 77

Reforestation expenses ............. 52 Refund:

Claim for ............................... 95 Deduction taken ................... 22 Fuel tax ................................ 22

Reimbursements:Casualties and thefts 36, 71, 73

Deduction taken ................... 22 Expenses .............................. 24 Feed assistance ................... 17

Real estate taxes ................. 35 Reforestation expenses ....... 52 To employees ....................... 28

Rent expense ............................ 27

Rental income ........................... 15 Repairs ...................................... 25 Replacement:

Period ................................... 75 Property ................................ 74

Repossessions .......................... 57 Retirement plans:

Defined benefit ..................... 89 Defined contribution ............. 88 IRAs ...................................... 90 Money purchase ................... 89 Profit-sharing ........................ 88 Qualified ............................... 88 Salary reduction ................... 87 SEP ...................................... 86 SIMPLE ................................ 87 Stock bonus ......................... 89

Returns: Corporation ........................... 10 Dependent's ........................... 6

Forms used by farmers .......... 8 Information ............................. 9 Partnership ............................. 9 Penalties ............................. 7, 9

Qualified farmer due dates .... 7 Sample ................................. 95 Self-employed ........................ 6

Right-of-way income .................. 22

S S corporation ............................. 10

Sale of home ............................. 62Section 179 deduction:

Carryover .............................. 43 Definition .............................. 42

How to elect ......................... 43How to figure ........................ 43

Limits .................................... 43 Listed property ..................... 49 Qualifying:

Costs ............................... 42 Property ........................... 42

Recapture ............................. 44Self-employed health insurance 26

Self-employment income ........... 79 Self-employment tax:

Community income .............. 83 Landlord participation ........... 80 Material participation ............ 80

Net income, defined ............. 79 Optional method ................... 80 Partnership ........................... 81 Regular method .................... 80 Rental income ...................... 80 Share farming ....................... 78

SEP plans .................................. 86Settlement costs (fees) ............. 35

SIMPLE plans ............................ 87Social security and Medicare:

Credits .................................. 78 Depositing tax ...................... 85

Withholding of tax ................ 84 Withholding statement ............ 8

Social security number .............. 78 Software, computer ................... 40 Soil:

Conservation ........................ 32 Contamination ...................... 75

Spouse, property transferredfrom ...................................... 39

Start-up costs for businesses .... 52Stock bonus plan ....................... 89

TTax help (See More information) Tax preparation fees ................. 25Tax problems, unresolved ........... 3

Tax shelters: At-risk limits .......................... 30 Defined ................................. 12

Tax-free exchanges ................... 55 Taxes:

Excise ................................... 90 Federal use .......................... 26 General ................................. 26 Self-employment .................. 78

State and federal .................. 26State or local general sales . 26 Taxpayer Advocate ............... 3, 95 Taxpayer rights .......................... 94 Telephone expense ................... 25

Tenant house expenses ............ 28 Theft losses ............................... 71

Timber ........................... 29, 50, 61 Trade-in ..................................... 38 Travel expenses ........................ 28 Truck expenses ......................... 27

Trust fund recovery penalty ...... 85 TTY/TDD information .............. 113

UUniform capitalization rules:

Basis of assets ..................... 35 Inventory ............................... 13

Unstated interest ....................... 69

W Water conservation ................... 32 Water well ............................ 33, 47

Weather-related sales, live-stock ............................... 15, 74 Wetlands .................................... 32 Withholding:

Income tax ............................ 84Social security and Medicare

tax ................................... 84

YYear 2000 costs ........................ 40

�

Page 115

Tax Publications for Business Taxpayers

General Guides

Commonly Used Tax Forms

Spanish Language Publications

Your Rights as a TaxpayerYour Federal Income Tax (ForIndividuals)Farmer’s Tax GuideTax Guide for Small BusinessTax Calendars for 2000Highlights of 1999 Tax Changes

Guide to Free Tax Services

Circular E, Employer’s Tax GuideEmployer’s Supplemental Tax GuideCircular A, Agricultural Employer’sTax GuideFederal Tax Guide For Employers inthe U.S. Virgin Islands, Guam,American Samoa, and theCommonwealth of the NorthernMariana Islands (Circular SS)

Household Employer’s Tax Guide

Circular PR Guía ContributivaFederal Para PatronosPuertorriqueños

Travel, Entertainment, Gift, and CarExpensesTax Withholding and Estimated TaxExcise Taxes for 2000Withholding of Tax on NonresidentAliens and Foreign CorporationsSocial Security and OtherInformation for Members of theClergy and Religious WorkersResidential Rental PropertySelf-Employment TaxDepreciating Property Placed inService Before 1987Business ExpensesNet Operating LossesInstallment SalesAccounting Periods and Methods

CorporationsSales and Other Dispositions ofAssetsBasis of AssetsExamination of Returns, AppealRights, and Claims for RefundRetirement Plans for Small Business(SEP, SIMPLE, and Keogh Plans)Determining the Value of DonatedPropertyStarting a Business and KeepingRecords

Understanding the Collection Process

Information on the United States-Canada Income Tax Treaty

Bankruptcy Tax GuideDirect SellersPassive Activity and At-Risk RulesHow To Depreciate Property

Reporting Cash Payments of Over$10,000The Taxpayer Advocate Service ofthe IRS

Derechos del ContribuyenteCómo Preparar la Declaración deImpuesto Federal

English-Spanish Glossary of Wordsand Phrases Used in PublicationsIssued by the Internal RevenueService

Tax on Unrelated Business Incomeof Exempt Organizations

Wage and Tax Statement

Itemized Deductions & Interest andOrdinary Dividends*

Profit or Loss From Business*Net Profit From Business*

Capital Gains and Losses*

Supplemental Income and Loss*Profit or Loss From Farming*

Credit for the Elderly or the Disabled*

Estimated Tax for Individuals*Self-Employment Tax*

Amended U.S. Individual Income Tax Return*

Capital Gains and LossesPartner’s Share of Income,Credits, Deductions, etc.

U.S. Corporation Income Tax Return

U.S. Income Tax Return for an S Corporation

Employee Business Expenses*Unreimbursed Employee BusinessExpenses*

Power of Attorney and Declaration ofRepresentative*

Child and Dependent Care Expenses*

General Business Credit

Application for Automatic Extension of Time ToFile U.S. Individual Income Tax Return*

Moving Expenses*

Additional Taxes Attributable to IRAs, OtherQualified Retirement Plans, Annuities, ModifiedEndowment Contracts, and MSAs*Installment Sale Income*Noncash Charitable Contributions*

Change of Address*Expenses for Business Use of Your Home*

Tax Highlights for CommercialFishermen

910

595553509334225

171

Nondeductible IRAs*Passive Activity Loss Limitations*

1515-A

51

80

179

926

378

463

505510515

517

527533534

535536537

541538

542Partnerships

544

551556

560

561

583

594

597

598

901

911925946947

908

1544

1546

1SP

850

579SP

Comprendiendo el Proceso de Cobro594SP

10134

Sch A & B

Sch CSch C-EZSch D

Sch ESch FSch H Household Employment Taxes*

Sch RSch SE

1040-ES1040X

Sch DSch K-1

1120

1120S

1065 U.S. Partnership Return of Income

21062106-EZ

24412848

3800

4868

3903

5329

62528283

8582860688228829

Specialized Publications

Fuel Tax Credits and Refunds

Employee’s Withholding Allowance Certificate*W-4Employer’s Annual Federal Unemployment(FUTA) Tax Return*

940

940EZ

U.S. Individual Income Tax Return*1040

Employer’s Annual Federal Unemployment(FUTA) Tax Return*

Business Use of Your Home(Including Use by Day-CareProviders)

587

U.S. Tax Treaties

Practice Before the IRS and Powerof AttorneyTax Incentives for EmpowermentZones and Other DistressedCommunities

Employer’s Guides

Certification for Reduced Tax Ratesin Tax Treaty Countries

686

954

Capital Gains and Losses and Built-In GainsShareholder’s Share of Income, Credits,Deductions, etc.

Sch DSch K-1

Underpayment of Estimated Tax byIndividuals, Estates, and Trusts*

2210

Report of Cash Payments Over $10,000Received in a Trade or Business*

8300

Depreciation and Amortization*4562Sales of Business Property*4797

Informe de Pagos en Efectivo enExceso de $10,000 (Recibidos enuna Ocupación o Negocio)

1544SP

U.S. Corporation Short-FormIncome Tax Return

1120-A

See How To Get More Information for a variety of ways to get publications,including by computer, phone, and mail.

See How To Get More Information for a variety of ways to get forms, including by computer, fax,phone, and mail. Items with an asterisk are available by fax. For these orders only, use the catalognumbers when ordering.

Form Number and TitleCatalogNumber

W-21022011234

10983

170011132011330

113341437411338

113441134612187

113581134011360

Employer’s Quarterly Federal Tax Return941

11359Sch J Farm Income Averaging* 25513

11510

CatalogNumber

20604

11744

1186211980

1239212490129061308613141

13329

1360162299

639661208113232

63704

62133113901139311394

1145011456

11700

1152011516

Form Number and Title

Continuation Sheet for Schedule DSch D-1 10424

Page 116