Department

of the

Treasury

Internal

Revenue

Service

Dec 6, 2018

Publication 225

Cat. No. 11049L

Farmer's

Tax Guide

For use in preparing

2018 Returns

Acknowledgment: The valuable advice and assistance given us each year by the National Farm Income Tax Extension Committee is gratefully acknowledged.

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Contents

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

What's New for 2018 . . . . . . . . . . . . . 2

What's New for 2019 . . . . . . . . . . . . . 3

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

Chapter 1. Importance of Records . . . . 3

Chapter 2. Accounting Methods. . . . . 5

Chapter 3. Farm Income . . . . . . . . . . 8

Chapter 4. Farm

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

Chapter 5. Soil and Water

Conservation Expenses . . . . . . . 28

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

Chapter 7. Depreciation, Depletion,

and Amortization . . . . . . . . . . . 36

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

Chapter 9. Dispositions of

Property Used in Farming. . . . . 57

Chapter 10. Installment Sales. . . . . 60

Chapter 11. Casualties, Thefts, and

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

Chapter 12. Self-Employment Tax . . . 74

Chapter 13. Employment Taxes. . . . 79

Chapter 14. Fuel Excise Tax

Credits and Refunds . . . . . . . . . 84

Chapter 15. Estimated Tax. . . . . . . 87

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

Index. . . . . . . . . . . . . . . . . . . . . 91

Introduction

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

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

The explanations and examples in this publi-cation reflect the Internal Revenue Service's in-terpretation of tax laws enacted by Congress, Treasury regulations, and court decisions. How-ever, the information given does not cover ev-ery situation and is not intended to replace the

law or change its meaning. This publication covers subjects on which a court may have ren-dered a decision more favorable to taxpayers than the interpretation by the IRS. Until these differing interpretations are resolved by higher court decisions, or in some other way, this pub-lication will continue to present the interpreta-tion by the IRS.

The IRS Mission. Provide America's taxpay-ers top-quality service by helping them under-stand and meet their tax responsibilities and en-force the tax law with integrity and fairness to all.

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

Youcansenduscommentsthrough

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

Internal Revenue Service

Tax Forms and Publications

1111 Constitution Ave. NW, IR-6526

Washington, DC 20224

Although we can’t respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax forms, instructions, and publi-cations.

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

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

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

Call 1-888-734-3247,

Fax your comments to 202-481-5719,

Write to:

Office of the National Ombudsman U.S. Small Business Administration 409 3rd Street SW Washington, DC 20416

Send an email to ombudsman@sba.gov, or

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

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

Page 2

Farm tax classes. Many state Cooperative Extension Services conduct farm tax work-shops in conjunction with the IRS. Contact your county or regional extension office for more in-formation.

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

Future Developments

The IRS has created a page on IRS.gov for

information about Pub. 225 at

IRS.gov/Pub225.Informationaboutrecent

developments affecting Pub. 225 will be posted

on that page.

What's New for 2018

The following items highlight a number of administrative and tax law changes for 2018. They are discussed in more detail throughout the publication.

Cash method of accounting. Beginning in 2018, a farming business may use the cash method of accounting if its average annual gross receipts for the 3 preceding tax years is $25 million or less. See chapter 2.

Inventory. Certain small farms with average annual gross receipts of $25 million or less in the 3 preceding tax years are not required to maintain an inventory. See chapter 2.

Standard mileage rate. For 2018, the stand-ard mileage rate for the cost of operating your car, van, pickup, or panel truck for each mile of business use is 54.5 cents. See chapter 4.

Business interest expense limitation. A business interest expense deduction may be limited for certain taxpayers. The Instructions for Form 8990, Limitation on Business Interest Expense IRC 163(j), explain when a business interest expense deduction is limited and who is required to file Form 8990. See chapter 4.

The excess farm loss rules have been re-placed with excess business loss rules. Noncorporate taxpayers may be subject to ex-cess business loss limitations. See Form 461 and its instructions for details. Under transition rules, if you had an excess farm loss in 2017, you can deduct it in calculating your profits/loss for 2018 before applying the excess business loss rules. See chapter 4.

Most taxpayers no longer have the option to carryback a net operating loss (NOL). For most taxpayers, NOLs arising in tax years ending after 2017 can only be carried forward. The 2-year carryback rule in effect before 2018, generally, does not apply to NOLs arising in tax

years ending after December 31, 2017. Excep-tions apply to certain farming losses and NOLs of insurance companies other than a life insur-ance company. See section 172, as amended by the Tax Cuts and Jobs Act. See Pub. 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts, or Pub. 542, Corporations, for additional information. See chapter 4

Increased section 179 expense deduction dollar limits. The maximum amount you can elect to deduct for most section 179 property you placed in service in 2018 is $1,000,000. This limit is reduced by the amount by which the cost of the property placed in service during the tax year exceeds $2,500,000. See chapter 7.

Depreciation of certain farm property. The recovery period for certain farming machinery and equipment placed in service in 2018 is 5 years instead of 7 years. Farming businesses are no longer required to use the 150% declin-ing balance method for 3-, 5-, 7-, and 10-year property used in a farming business and placed in service in 2018.

Farming businesses are no longer required to use the 150% declining balance method for 3-, 5-, 7-, and 10-year property used in a farm-ing business and placed in service in 2018. See chapter 7.

Special depreciation allowance for certain property. The special allowance will be phased down to 40% for certain property ac-quired before September 28, 2017, and placed in service in 2018. Also, you may be able to take a 100% special depreciation allowance for certain property and certain plants bearing fruits and nuts acquired or planted or grafted after September 27, 2017, and placed in service or planted or grafted after September 27, 2017, and placed in service or planted or grafted be-fore January 1, 2023. You may elect to apply a 50% special deprecation allowance instead of the 100% allowance for the first tax year ending after September 27, 2017. See chapter 7.

Like-kind exchanges. For exchanges com-pleted after December 31, 2017, the nonrecog-nition rules for like-kind exchanges apply only to exchanges of real property not held primarily for sale. The nonrecognition rules no longer apply to personal property. Exceptions apply to prop-erty disposed of before January 1, 2018, and to property received in an exchange before Janu-ary 1, 2018. See chapter 8.

Limitation on personal casualty and theft losses. Personal casualty and theft losses of an individual are deductible only to the extent they’re attributable to a federally declared dis-aster. The loss deduction is subject to the $100 limit per casualty and 10% of your adjusted gross income (AGI) limitation.

An exception to the rule above limiting the personal casualty and theft loss deduction to losses incurred in a federally declared disaster applies if you have personal casualty gains for the tax year. In this case, you will reduce your personal casualty gains by any casualty losses not attributable to a federally declared disaster. Any excess gain is used to reduce losses from a federally declared disaster. The 10% AGI limi-tation is applied to any federal disaster losses that remain. For more information, see chap-ter 11.

Disaster tax relief. Personal casualty losses resulting from federally declared disasters that

Publication 225 (2018)

occurred in 2016, as well as Hurricane and Tropical Storm Harvey, Hurricanes Irma and Maria, and the California Wildfires may be claimed as a qualified disaster loss on your Form 4684. See Disaster Area Losses, later, and Pub. 547 for more information on the spe-cial relief provided as part of the Disaster Tax Relief, and Pub. 547 for more information on the special relief provided as part of the Disaster Tax Relief and Airway Extension Act of 2017, the Tax Cuts and Jobs Act of 2017, and the Bi-partisan Budget Act of 2018. Also see Pub. 976, Disaster Relief and IRS.gov/ DisasterTaxRelief for more information about these and other disaster tax relief provisions.

Determining and reporting casualty losses using safe harbor methods. You may be able to use certain safe harbor methods to de-termine the amount of your allowable personal casualty and theft losses and hurricane losses. See Safe harbor methods for individual taxpay-ers to determine casualty and theft losses and Cost indexes safe harbor method to calculate hurricane-related losses in chapter 11.

Net operating losses. Net operating loss rules have changed. A net farming net operat-ing loss arising in 2018 must be carried back 2 years instead of 5 years. An election can be made to, instead, carry over the loss to a sub-sequent year. See Pub. 536 or Pub. 542 for ad-ditional information.

Maximum net earnings. The maximum net self-employment earnings subject to the social security part (12.4%) of the self-employment tax is $128,400 for 2018, up from $127,200 for 2017. There is no maximum limit on earnings subject to the Medicare part (2.9%) or, if appli-cable, the Additional Medicare Tax (0.9%). See chapter 12.

New withholding rates. The Tax Cuts and Jobs Act lowered the withholding rates on cer-tain payments. To reflect changes made by tax reform legislation, the IRS has released upda-ted income tax withholding tables. The new withholding tables are designated to work with the Form(s) W-4 you have already filed with your employer. To see if you need to have your withholdings increased or decreased, use the IRS Withholding Calculator at IRS.gov/W4App.

Social security and Medicare tax for 2018. The social security tax rate is 6.2% each for the employee and employer, unchanged from 2017. The social security wage base limit is $128,400.

The Medicare tax rate is 1.45% each for the employee and employer, unchanged from 2017. There is no wage base limit for Medicare tax. See chapter 13.

What's New for 2019

Maximum net earnings. The maximum net self-employment earnings subject to the social security part of the self-employment tax for 2019 will be discussed in the 2018 Pub. 334. See chapter 12.

Social security and Medicare tax for 2019. The employee and employer tax rates for social security and the maximum amount of wages subject to social security tax for 2019 will be discussed in Pub. 51 (for use in 2019).

The Medicare tax rate for 2019 also will be discussed in Pub. 51 (for use in 2019). There is no limit on the amount of wages subject to Med-icare tax. See chapter 13.

Reminders

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

IRS e-file (Electronic Filing)

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

Use an authorized IRS e-file provider.

Use a personal computer.

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

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

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

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

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

Reportable transactions. You must file Form 8886, Reportable Transaction Disclosure State-ment, to report certain transactions. You may have to pay a penalty if you are required to file Form 8886 but do not do so. Reportable trans-actions include (1) transactions the same as, or substantially similar to, tax avoidance transac-tions identified by the IRS; (2) transactions of-fered to you under conditions of confidentiality and for which you paid an advisor a minimum fee; (3) transactions for which you have, or a re-lated party has, a right to a full or partial refund of fees if all or part of the intended tax conse-quences from the transaction are not sustained;

(4) transactions that result in losses of at least $2 million in any single year or $4 million in any combination of years; and (5) transactions with

asset holding periods of 45 days or less and that result in a tax credit of more than $250,000. For more information, see the Instructions for Form 8886.

Form W-4 for 2018. You should make new Forms W-4 available to your employees and en-courage them to check their income tax with-holding for 2018. Those employees who owed a large amount of tax or received a large refund for 2017 may need to submit a new Form W-4.

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

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

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

1.

Importance of Records

Introduction

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

While this publication only discusses tax re-cords, the records you keep as a farm business owner should allow you to accurately measure your farm’s financial performance, create finan-cial statements, and help you make manage-ment decisions in addition to calculating taxable farm income.

Chapter 1Importance of RecordsPage 3

Records that provide information beyond your tax return require additional information and effort on the part of the record keeper. To assist you in developing or improving your re-cordkeeping system, the Farm Financial Stand-ards Council has produced a free publication that provides recommendations for financial re-porting and analysis. You can download the 2017 Financial Guidelines for Agriculture at www.ffsc.org. For more information, contact Farm Financial Standards Council in the follow-ing manner.

Call 262-253-6902.

Send a fax to 262-253-6903.

Write to:

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

Topics

This chapter discusses:

Benefits of recordkeeping

Kinds of records to keep

How long to keep records

Useful Items

You may want to see:

Publication

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

463 Travel, Gift, and Car Expenses

535 Business Expenses

544 Sales and Other Dispositions of Assets

946 How To Depreciate Property

See chapter 16 for information about getting publications.

Benefits of Recordkeeping

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

Monitor the progress of your farming busi-ness. You need records to monitor the pro-gress of your business. In addition to measuring overall profitability, detailed records can help you identify which crop or livestock enterprises are most profitable or indicate where manage-ment changes may be needed to improve profit-ability. Records that help you make better deci-sions also should increase the likelihood of business success.

Prepare your financial statements. You will need records to prepare accurate financial statements. These include income (profit and loss) statements, cash flow statements, bal-ance sheets, and statements of owner’s equity. These statements will be required and helpful when working with your bank or creditors and also may help you manage your farm business.

Identify source of receipts. You will receive money, property, and/or services from many

Page 4Chapter 1Importance of Records

sources. Your records can identify the source of your receipts. You need this information to sep-arate farm from nonfarm receipts and taxable from nontaxable income.

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

Prepare your tax returns. You need records to prepare your tax return. These records must accurately support the income, expenses, and credits you report. Generally, these are the same records you use to monitor your farming business and prepare your financial statements. You also will need records to prepare informa-tion returns such as a Form 1099-MISC provi-ded to a vendor or a Form W-2 provided to an employee.

Support items reported on tax returns. You must keep your business records available at all times for inspection by the IRS. If the IRS exam-ines any of your tax returns, you may be asked to explain the items reported. A complete set of records will assist in the examination.

Kinds of Records To Keep

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

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

Your recordkeeping system should include a summary of your business transactions, which shows your gross income, as well as any ex-penses, deductions, and credits you are report-ing. In addition, you must keep supporting documents, such as invoices and receipts, for purchases, sales, payroll, and other business transactions.

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

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

An electronic storage system is any system for preparing or keeping your records either by electronic imaging or by transfer to an elec-tronic storage media. The electronic storage system must index, store, preserve, retrieve,

and reproduce the electronically stored books and records in legible format. All electronic stor-age systems must provide a complete and ac-curate record of your data that is accessible to the IRS.

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

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

Travel, transportation, entertainment, and gift expenses. Specific recordkeeping rules apply to these expenses. For more information, see Pub. 463.

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

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

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

When and how you acquired the asset.

Full purchase cost of the asset.

Cost of any improvements.

Section 179 deduction taken.

Deductions taken for depreciation.

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

How you used the asset.

When and how you disposed of the asset.

Fair market value of property when traded in.

Selling price.

Expenses of sale.

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

Purchase and sales invoices.

Real estate closing statements.

Canceled checks.

Bank statements.

Financial account statements as proof of payment. If you do not have a canceled check, you may be able to prove payment with certain financial account statements prepared by finan-cial institutions. These include account state-ments prepared for the financial institution by a third party. These account statements must be legible. The following table lists acceptable ac-count statements.

IF payment is by...	THEN the statement must
	show the...
Check	•	Check number.
	•	Amount.
	•	Payee's name.
	•	Date the check amount
		was posted to the
		account by the financial
		institution.
Electronic funds	•	Amount transferred.
transfer	•	Payee's name.
	•	Date the transfer was
		posted to the account by
		the financial institution.
Credit card	•	Amount charged.
	•	Payee's name.
	•	Transaction date.

Proof of payment of an amount, by it-

self, does not establish you are entitled CAUTION to a tax deduction. You also should keep other documents, such as credit card sales slips and invoices, to show that you also incurred the cost.

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

How Long To Keep Records

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

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

Assets. Keep records relating to property until the period of limitations expires for the year in

which you dispose of the property in a taxable disposition. You must keep these records to fig-ure any depreciation, amortization, or depletion deduction and to figure your basis for comput-ing gain or (loss) when you sell or otherwise dis-pose of the property.

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

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

2.

Accounting

Methods

What's New for 2018

Cash method of accounting. Beginning in 2018, certain farming businesses can use the cash method of accounting if average annual gross receipts for the 3 preceding tax years are $25 million or less. See Cash Method, later.

Inventory. Certain small farms with average annual gross receipts of $25 million or less in the 3 preceding tax years are not required to maintain an inventory. See Inventory, later.

Introduction

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

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

Topics

This chapter discusses:

Cash method

Accrual method

Farm inventory

Special methods of accounting

Changes in methods of accounting

Useful Items

You may want to see:

Publication

538 Accounting Periods and Methods

535 Business Expenses

Form (and Instructions)

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

3115 Application for Change in Accounting Method

See chapter 16 for information about getting publications and forms.

Accounting Methods

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

Facts and circumstances affect whether an item is material. Factors to consider in deter-mining the materiality of an item include the size of the item (both in absolute terms and in rela-tion to income and other expenses) and the treatment of the item in your financial state-ments. Generally, an item considered material for financial statement purposes also is consid-ered material for income tax purposes. See Pub. 538 for more information.

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

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

Cash method.

Accrual method.

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

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

Business and other items. You can account for business and personal items using different accounting methods. For example, you can fig-ure your business income under an accrual

Chapter 2Accounting MethodsPage 5

method, even if you use the cash method to fig-ure personal items.

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

Cash Method

Most farmers use the cash method because they find it easier to keep records using the cash method. Certain farm corporations and partnerships and all tax shelters generally are required to use an accrual method of account-ing. However, beginning in 2018, farm corpora-tions or partnerships that have average annual gross receipts of $25 million or less for the 3 preceding tax years and are not tax shelters can use the cash method instead of the accrual method. See Accrual Method Required, later. Also, see Inventory, later.

Income

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

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

Delaying receipt of income. You cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. You must re-port the income in the year the money or prop-erty is received or made available to you with-out restriction.

Example. Frances Jones, a farmer who uses the cash method of accounting, was enti-tled to receive a $10,000 payment on a grain contract in December 2018. She was told in De-cember that her payment was available. She re-quested not to be paid until January 2019. Fran-ces must include this payment in her 2018 income because it was made available to her in 2018.

Debts paid by another person or can-celed. If your debts are paid by another person or are canceled by your creditors, you may have to report part or all of this debt relief as in-come. If you receive income in this way, you

Page 6Chapter 2Accounting Methods

constructively receive the income when the debt is canceled or paid. See Cancellation of Debt in chapter 3 for more information.

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

Example. You are a farmer who uses the cash method and a calendar tax year. You sell grain in December 2018 under a bona fide arm's-length contract that calls for payment in 2019. You include the proceeds from the sale in your 2019 gross income since that is the year payment is received. However, if the contract states that you have the right to the proceeds from the buyer at any time after the grain is de-livered, you must include the sales price in your 2018 income, even if payment is received in the following year.

Repayment of income. If you include an amount in income and in a later year you have to repay all or part of it, then you usually can de-duct the repayment in the year repaid. The type of deduction you are allowed in the year of re-payment depends on the type of income you in-cluded in the earlier year. See Repayments in chapter 11 of Pub. 535, Business Expenses.

Expenses

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

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

Example. On November 1, 2018, you signed and paid $3,600 for a 3-year (36-month) insurance contract for equipment. In 2018, you are allowed to deduct only $200 (2/36 x $3,600) of the cost of the policy that is attributable to 2018. In 2019, you'll be able to deduct $1,200 (12/36 x $3,600); in 2020, you'll be able to de-duct $1,200 (12/36 x $3,600); and in 2021 you'll be able to deduct the remaining balance of $1,000.

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

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

Accrual Method

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

Income

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

When you receive payment.

When the income amount is due to you.

When you earn the income.

When title passes.

When taken into account in an applicable financial statement (or such other state-ment the IRS may specify).

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

Inventory

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

Exception. You are not required to maintain an inventory if the average annual gross re-ceipts for the 3 preceding tax years for the farm is $25 million or less and the farm is not a tax shelter. In this case, the farm can use a method of accounting that (1) treats inventory as nonin-cidental materials and supplies, or (2) accounts for the inventory in the same manner as the ap-plicable financial statements, or books and re-cords if there are no financial statements.

Expenses

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

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

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

b. The amount of the liability can be de-termined with reasonable accuracy.

2. Economic performance has occurred.

Economic performance. Generally, you can-not deduct or capitalize a business expense un-til economic performance occurs. If your ex-pense is for property or services provided to you, or for your use of property, economic per-formance occurs as the property or services are provided or as the property is used. If your ex-pense is for property or services you provide to others, economic performance occurs as you provide the property or services.

Example. Jane, who is a farmer, uses a calendar tax year and an accrual method of ac-counting. She entered into a contract with ABC Farm Consulting in 2017. The contract stated that Jane pay ABC Farm Consulting $2,000 in December 2017. It further stipulates that ABC Farm Consulting will develop a plan for integrat-ing her farm with a larger farm operation based in a neighboring state by March 1, 2018. Jane paid ABC Farm Consulting $2,000 in December 2017. Integration of operations according to the plan began in May 2018 and they completed the integration in December 2018.

Economic performance for Jane's liability in the contract occurs as the services are provi-ded. Jane incurs the $2,000 cost in 2018, even though a payment was made in the prior year.

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

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

Accrual Method Required

Generally, the following businesses, if engaged in farming, generally are required to use an ac-crual method of accounting.

1. A corporation that has gross receipts of more than $25 million.

2. A partnership with a corporation as a part-ner, if that corporation meets the require-ments of (1) above.

3. A tax shelter (discussed below).

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

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

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

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

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

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

A “limited partner” is one whose personal li-ability for partnership debts is limited to the money or other property the partner contributed or is required to contribute to the partnership.

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

Farm Inventory

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

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

Products held for sale. All harvested and pur-chased farm products held for sale or for feed or seed, such as grain, hay, silage, concen-trates, cotton, tobacco, etc., must be included in inventory.

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

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

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

Items to include in inventory. Your inventory should include all items held for sale, or for use as feed, seed, etc., whether raised or pur-chased, that are unsold at the end of the year.

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

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

The costs of animals are subject to the uni-form capitalization rules.

Note. Beginning in 2018, if a farm has gross receipts of $25 million or less for the 3 preceding tax years and is not a tax shelter, the farm is not subject to the uniform capitalization rules.

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

Cost.

Lower of cost or market.

Farm-price method.

Unit-livestock-price method.

Cost and lower of cost or market meth-ods. See Pub. 538 for information on these val-uation methods.

If you value your livestock inventory at TIP cost or the lower of cost or market, you do not need IRS approval to change to the unit-livestock-price method. However, if you

value your livestock inventory using the farm-price method, then you must obtain per-mission from the IRS to change to the unit-live-stock-price method.

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

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

If you use this method, include all raised livestock in inventory, regardless of whether they are held for sale or for draft, breeding, sport, or dairy purposes. This method accounts only for the increase in cost of raising an animal to maturity. It does not provide for any decrease

Chapter 2Accounting MethodsPage 7

in the animal's market value after it reaches ma-turity. Also, if you raise cattle, you are not re-quired to inventory hay you grow to feed your herd.

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

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

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

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

Cash Versus Accrual Method

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

Example 1. You are a farmer who uses an accrual method of accounting. You keep your books on the calendar year basis. You sell grain in December 2018 but you are not paid until January 2019. Because the accrual method was used and 2018 was the tax year in which the grain was sold, you must include both the sales proceeds and deduct the costs incurred in producing the grain on your 2018 tax return.

Example 2. Assume the same facts as in Example 1 except that you use the cash method and there was no constructive receipt of the sales proceeds in 2018. Under the cash method, you include the sales proceeds in in-come in 2019, the year you receive payment. Deduct the costs of producing the grain in the year you pay for them.

Special Methods of Accounting

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

Page 8Chapter 3Farm Income

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

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

Other special methods. Other special meth-ods of accounting apply to the following items.

Amortization, see chapter 7.

Casualties, see chapter 11.

Condemnations, see chapter 11.

Depletion, see chapter 7.

Depreciation, see chapter 7.

Farm business expenses, see chapter 4.

Farm income, see chapter 3.

Installment sales, see chapter 10.

Soil and water conservation expenses, see chapter 5.

Thefts, see chapter 11.

Combination Method

Generally, you can use any combination of cash, accrual, and special methods of account-ing if the combination clearly shows your in-come and expenses and you use it consistently. However, the following restrictions apply.

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

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

Changes in Methods of Accounting

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

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

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

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

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

3.

Farm Income

Introduction

You may receive income from many sources. You must report the income from all the differ-ent sources on your tax return, unless it is ex-cluded by law. Where you report the income on your tax return depends on its source.

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

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

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

Topics

This chapter discusses:

Schedule F

Sales of farm products

Rents (including crop shares)

Agricultural program payments

Income from cooperatives

Cancellation of debt

Income from other sources

Income averaging for farmers

Useful Items

You may want to see:

Publication

525 Taxable and Nontaxable Income

544 Sales and Other Dispositions of

Assets

550 Investment Income and Expenses

908 Bankruptcy Tax Guide

925 Passive Activity and At-Risk Rules

4681 Canceled Debts, Foreclosures,

Repossessions, and Abandonments Form (and Instructions)

982 Reduction of Tax Attributes Due to Discharge of Indebtedness

Sch E (Form 1040) Supplemental Income and Loss

Sch F (Form 1040) Profit or Loss from Farming

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

1099-G Certain Government Payments

1099-PATR Taxable Distributions Received From Cooperatives

4797 Sales of Business Property

4835 Farm Rental Income and Expenses

See chapter 16 for information about getting publications and forms.

Schedule F (Form 1040)

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

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

* See the Instructions for Schedule F for more information.

** See the Instructions for Form 4797 for more information.

Individuals, trusts, partnerships, and sole mem-bers of a domestic LLC engaged in the busi-ness of farming report farm income on Sched-ule F (Form 1040). Use this schedule to figure the net profit or loss from regular farming opera-tions.

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

operations.

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

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

Income reported on Schedule F doesn't in-clude gains or losses from sales or other dispo-sitions of the following farm assets.

Land.

Depreciable farm equipment.

Buildings and structures.

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

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

Sales of Farm Products

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

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

amounts on Schedule F for the year you receive payment.

Example. In 2017, you bought 20 feeder calves for $27,000 for resale. You sold them in 2018 for $35,000. You report the $35,000 sales price on Schedule F, line 1a, subtract your $27,000 basis on line 1b, and report the result-ing $8,000 profit on line 1c.

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

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

Sales Caused by Weather-Related Conditions

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

Your principal trade or business is farming.

You use the cash method of accounting.

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

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

Disaster assistance and emergency TIP relief for individuals and busi-nesses. Special tax law provisions may help taxpayers and businesses recover fi-

nancially from the impact of a disaster, espe-cially when the federal government declares their location to be a major disaster area. Get

the latest tax relief guidance in disaster situa-tions at IRS.gov/uac/tax-relief-in-disaster-situations and in disaster area losses - agricul-ture tax tips at IRS.gov/businesses/small-businesses-self-employed/disaster-assistance-and-emergency-relief-for-individuals-and-businesses.

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

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

untary Conversions in chapter 11.

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

Connection with affected area. The livestock doesn't have to be raised or sold in an area af-fected by a weather-related condition for the postponement to apply. However, the sale must occur solely because of a weather-related con-dition that affected the water, grazing, or other requirements of the livestock. This requirement generally won't be met if the costs of feed, wa-ter, or other requirements of the livestock affec-ted by the weather-related condition aren't sub-stantial in relation to the total costs of holding the livestock.

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

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

1. Divide the total income realized from the sale of all livestock in the class during the

Chapter 3Farm IncomePage 9

tax year by the total number of such live-stock sold. For this purpose, don't treat any postponed gain from the previous year as income received from the sale of livestock.

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

Example. You are a calendar year taxpayer and you normally sell 100 head of beef cattle a year. As a result of drought, you sold 135 head during 2017. You realized $236,250 from the sale ($236,250 ÷ 135 = $1,750 per head). On August 10, 2017, as a result of drought, the af-fected area was declared a disaster area eligi-ble for federal assistance. The income you can postpone until 2018 is $61,250 [($236,250 ÷ 135) × 35].

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

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

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

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

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

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

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

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

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

Page 10Chapter 3Farm Income

Rents (Including Crop Shares)

The rent you receive for the use of your farm-land by another person or entity is generally rental income, not farm income. However, the rent is farm income if:

1. Your arrangement with your tenant pro-vides that the you will materially partici-pate in the production or management of production of the farm products on the land, and

2. You materially participate.

See Landlord Participation in Farming in chap-ter 12.

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

Crop Shares

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

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

1. Your arrangement with your tenant pro-vides that the you will materially partici-pate in the production or management of production of the farm products on the land, and

2. You materially participate.

See Landlord Participation in Farming in chap-ter 12. Report the rental income on Schedule F.

If

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

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

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

Crop shares you use to feed livestock. Crop shares you receive as a landlord and feed to your livestock are considered converted to money when fed to the livestock. You must in-clude the fair market value of the crop shares in income at that time. You're entitled to a busi-ness expense deduction for the livestock feed in the same amount and at the same time you

include the fair market value of the crop share as rental income. Although these two transac-tions cancel each other for figuring adjusted gross income on Form 1040, they may be nec-essary to figure your self-employment tax. See Landlord Participation in Farming and Farm Op-tional Method in chapter 12.

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

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

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

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

Agricultural Program Payments

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

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

Commodity Credit Corporation (CCC) Loans

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

Once you report a CCC loan as income for the year received, you generally must report all

BC. loans in that year and later years in the same way. However, you can obtain for your tax year an automatic consent to change your method of accounting for loans received from the CCC, from including the loan amount in gross income for the tax year in which the loan is received to treating the loan amount as a loan. For more information, see Part I of the In-structions for Form 3115 and Revenue Proce-dure 2008-52. Revenue Procedure 2008-52, 2008-36 I.R.B. 587, is available at IRS.gov/irb/2008-36_IRB#NOT-2008-52.

You can request income tax withhold-TIP ing from CCC loan payments you re-ceive. Use Form W-4V. See chapter 16

for information about ordering the form.

To elect to report a CCC loan as income, in-clude the loan proceeds as income on Sched-ule F, for the year you receive it. Attach a state-ment to your return showing the details of the loan.

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

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

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

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

Market Gain

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

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

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

The following examples show how to report market gain.

Example 1. Mike Green is a cotton farmer. He uses the cash method of accounting and files his tax return on a calendar year basis. He has deducted all expenses incurred in produc-ing the cotton and has a zero basis in the com-modity. In 2017, Mike pledged 1,000 pounds of cotton as collateral for a CCC loan of $2,000 (a loan rate of $2.00 per pound). In 2018, he re-paid the loan and redeemed the cotton for $1,500 when the world price was $1.50 per pound (lower than the loan amount). Later in 2018, he sold the cotton for $2,500.

The market gain on the redemption was $.50 ($2.00 – $1.50) per pound. Mike realized total market gain of $500 ($.50 x 1,000 pounds). How he reports this market gain and figures his gain or loss from the sale of the cotton depends on whether he included CCC loans in income in 2017.

Included CCC loan. Mike reported the $2,000 CCC loan as income for 2017 on Schedule F, line 5a, so he is treated as if he sold the cotton for $2,000 when he pledged it and repurchased the cotton for $1,500 when he redeemed it. The $500 market gain isn’t recog-nized on the redemption. He reports it for 2018 as an agricultural program payment on Sched-ule F, line 4a but doesn't include it as a taxable amount on line 4b.

Mike's basis in the cotton after he redeemed it was $1,500, which is the redemption (re-purchase) price paid for the cotton. His gain from the sale is $1,000 ($2,500 – $1,500). He reports the $2,500 sale on line 1a and the $1,500 basis on line 1b . After subtracting his basis from the sale, Mike will have a $1,000 gain for 2018 on Schedule F, on line 1c.

Excluded CCC loan. Mike didn’t elect to report the $2,000 CCC loan as income and therefore didn’t include it on his 2017 Sched-ule F. When he paid $1,500 to pay off the loan in 2018, he must recognize $500 of income from market gain.

Example 2. The facts are the same as in Example 1 except that, instead of selling the

cotton for $2,500 after redeeming it, Mike en-tered into an option-to-purchase contract with a cotton buyer before redeeming the cotton. Un-der that contract, Mike authorized the cotton buyer to pay the CCC loan on Mike's behalf. In 2018, the cotton buyer repaid the loan for $1,500 and immediately exercised his option, buying the cotton for $1,500. How Mike reports the $500 market gain on the redemption of the cotton and figures his gain or loss from its sale depends on whether he included CCC loans in income in 2017.

Included CCC loan. As in Example 1, Mike is treated as though he sold the cotton for $2,000 when he pledged it and repurchased the cotton for $1,500 when the cotton buyer re-deemed it for him. The $500 market gain isn’t recognized on the redemption. Mike reports it for 2018 as an agricultural program payment on Schedule F, line 4a, but doesn't include it as a taxable amount on line 4b.

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

Excluded CCC loan. As in Example 1, Mike didn't report the $2,000 loan as income in 2017 and must recognize $500 of income from market gain in 2018.

Conservation Reserve Program (CRP)

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

Individuals who are receiving Social TIP Security retirement or disability bene-fits may exclude CRP payments when calculating self-employment tax, see the In-

structions for Schedule SE (Form 1040).

Crop Insurance and Crop Disaster Payments

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

Chapter 3Farm IncomePage 11

You can request income tax withhold-TIP ing from crop disaster payments you receive from the federal government.

Use Form W-4V. See chapter 16 for information about ordering the form.

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

You use the cash method of accounting.

You receive the crop insurance proceeds in the same tax year the crops are dam-aged.

You can show that under your normal busi-ness practice you would have included in-come from the damaged crops in any tax year following the year the damage occur-red.

Deferral isn't permitted for proceeds re-ceived from revenue insurance policies.

To postpone reporting some or all crop in-surance proceeds received in 2018, report the amount you received on Schedule F, line 6a, but don't include it as a taxable amount on line 6b. Check the box on line 6c and attach a statement to your tax return. The statement must include your name and address and con-tain the following information.

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

The specific crop or crops physically de-stroyed or damaged.

A statement that under your normal busi-ness practice you would have included in-come from some or all of the destroyed or damaged crops in gross income for a tax year following the year the crops were de-stroyed or damaged.

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

The total payments you received from in-surance carriers, itemized for each specific crop, and the date you received each pay-ment.

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

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

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

Ogden Submission Processing Center

P. O. Box 9941

Ogden, UT 84409

Feed Assistance and Payments

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

Include in income:

The market value of donated feed,

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

Any cost reimbursement you receive.

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

Cost-Sharing Exclusion (Improvements)

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

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

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

a. 10% of the average annual income derived from the affected property be-fore receiving the improvement.

b. $2.50 times the number of affected acres.

3. The Secretary of Agriculture certified that the payment was primarily made for con-serving soil and water resources, protect-ing or restoring the environment, improv-ing forests, or providing a habitat for wildlife.

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

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

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

The water bank program authorized by the Water Bank Act.

The emergency conservation measures program authorized by title IV of the Agri-cultural Credit Act of 1978.

The agricultural conservation program au-thorized by the Soil Conservation and Do-mestic Allotment Act.

The great plains conservation program au-thorized by the Soil Conservation and Do-mestic Policy Act.

The resource conservation and develop-ment program authorized by the Bank-head-Jones Farm Tenant Act and by the Soil Conservation and Domestic Allotment Act.

Certain small watershed programs, listed later.

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

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

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

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

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

Certain programs under the Colorado River Basin Salinity Control Act.

The Wetlands Reserve Program author-ized by the Food Security Act of 1985, the Federal Agriculture Improvement and Re-form Act of 1996 and the Farm Security and Rural Investment Act of 2002.

The Environmental Quality Incentives Pro-gram (EQIP) authorized by the Federal Ag-riculture Improvement and Reform Act of 1996.

The Wildlife Habitat Incentives Program (WHIP) authorized by the Federal Agricul-ture Improvement and Reform Act of 1996.

The Soil and Water Conservation Assis-tance Program authorized by the Agricul-tural Risk Protection Act of 2000.

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

The Conservation Reserve Program au-thorized by the Food Security Act of 1985

Page 12Chapter 3Farm Income

and the Federal Agriculture Improvement and Reform Act of 1996.

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

The Conservation Security Program au-thorized by the Food Security Act of 1985.

The Forest Health Protection Program (FHPP) authorized by the Cooperative For-estry Assistance Act of 1978.

Income realized. The gross income you real-ize upon getting an improvement under these cost-sharing programs is the value of the im-provement reduced by the sum of the excluda-ble portion and your share of the cost of the im-provement (if any).

Value of the improvement. You deter-mine the value of the improvement by multiply-ing its fair market value (defined in chapter 6 ) by a fraction. The numerator of the fraction is the total cost of the improvement (all amounts paid either by you or by the government for the im-provement) reduced by the sum of the following items.

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

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

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

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

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

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

2. $2.50 times the number of affected acres.

The calculation of present fair market

value of the right to receive annual in-CAUTION come is too complex to discuss in this publication. You may need to consult your tax advisor for assistance.

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

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

You figure the amount to include in gross in-come as follows:

Value of cost-sharing

improvement . . . . . . . . . . . . . . . . . . $15,000 Minus: Your share . . . . . $10,000

Excludable

portion . . . . . . . .^1,550^11,550

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

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

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

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

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

The value of the improvement.

The amount you're excluding.

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

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

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

Other Payments

You must include most other government pro-gram payments in income.

Fertilizer and Lime

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

Improvements

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

Payment to More Than One Person

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

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

See chapter 16 for information about order-ing Form 1099-G.

Income From

Cooperatives

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

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

Chapter 3Farm IncomePage 13

Patronage Dividends

You generally report patronage dividends as in-come on Schedule F for the tax year you re-ceive them. They include the following items.

Money paid as a patronage dividend, in-cluding cash advances received (for exam-ple, from a marketing cooperative).

The stated dollar value of qualified written notices of allocation.

The fair market value of other property.

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

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

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

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

2. You must have agreed to include the sta-ted dollar value in income in the year you receive the notice by doing one of the fol-lowing.

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

b. Getting or keeping membership in the cooperative after it adopted a bylaw providing that membership constitutes agreement. The cooperative must no-tify you in writing of this bylaw and give you a copy.

c. Endorsing and cashing a qualified check paid as part of the same pa-tronage dividend. You must cash the check by the 90th day after the close of the payment period for the cooper-ative's tax year for which the patron-age dividend was paid.

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

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

It's imprinted with a statement that endors-ing and cashing it constitutes the payee's consent to include in income the stated

dollar value of any written notices of alloca-tion paid as part of the same patronage dividend.

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

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

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

Buying or selling capital assets or depreci-able property. Don't include in income patron-age dividends from buying capital assets or de-preciable property used in your business. You must, however, reduce the basis of these as-sets by the dividends. This reduction is taken into account as of the first day of the tax year in which the dividends are received. If the divi-dends are more than your unrecovered basis, reduce the unrecovered basis to zero and in-clude the difference on Schedule F, for the tax year you receive them.

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

Example. On July 1, 2017, Mr. Brown, a patron of a cooperative association, bought a machine for his dairy farm business from the as-sociation for $2,900. The machine has a life of 7 years under MACRS (as provided in the Table of Class Lives and Recovery Periods in Appen-dix B of Pub. 946). Mr. Brown files his return on a calendar year basis. For 2017, he claimed a depreciation deduction of $311, using the 10.71% depreciation rate from the 150% declin-ing balance, half-year convention table (shown in Table A-14 in Appendix A of Pub. 946). On July 2, 2018, the cooperative association paid Mr. Brown a $300 cash patronage dividend for buying the machine. Mr. Brown adjusts the ba-sis of the machine and figures his depreciation deduction for 2018 (and later years) as follows.

Cost of machine on July 1, 2017 . . . . . .	._$.₃₁₁..	$2,900
Minus: 2017 depreciation . . . . . . . .		611
2018 cash dividend . . . . . . .	300
Adjusted basis for		$2,289
depreciation for 2018:

Depreciation rate: 1 ÷ 61/2 (remaining recovery period as of 1/1/2018) = 15.38% × 1.5 = 23.07%

Depreciation deduction for 2018	$528
($2,289×23.07%). . . . . . . . . . . . . .

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

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

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

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

Personal purchases. Because you can't de-duct the cost of personal, living, or family items, such as supplies, equipment, or services not re-lated to the production of farm income, you can omit from the taxable amount of patronage divi-dends on Schedule F, any dividends from buy-ing those items (and you must reduce the cost or other basis of those items by the amount of the dividends). This rule also applies to amounts you receive from the sale, redemption, or other disposition of a nonqualified written no-tice of allocation resulting from these purcha-ses.

Per-Unit Retain Certificates

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

Per-unit retain certificates issued by a coop-erative generally receive the same tax treat-ment as patronage dividends, discussed ear-lier.

Qualified certificates. Qualified per-unit retain certificates are those issued to patrons who have agreed to include the stated dollar amount of these certificates in income in the year of re-ceipt. The agreement may be made in writing or by getting or keeping membership in a coopera-tive whose bylaws or charter states that mem-bership constitutes agreement. If you receive qualified per-unit retain certificates, include the

Page 14Chapter 3Farm Income

stated dollar amount of the certificates in in-come on Schedule F, for the tax year you re-ceive them.

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

Cancellation of Debt

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

General Rule

Generally, if your debt is canceled or forgiven, other than as a gift or bequest to you, you must include the canceled amount in gross income for tax purposes. Report the canceled amount on Schedule F, if you incurred the debt in your farming business. If the debt is a nonbusiness debt, report the canceled amount as other in-come on Schedule 1 (Form 1040), line 21.

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

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

Exceptions

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

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

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

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

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

Accrual method — You include the can-celed debt in income because the expense was deductible when you incurred the debt.

Exclusions

Don't include canceled debt in income in the fol-lowing situations.

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

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

3. The canceled debt is a qualified farm debt.

4. The canceled debt is a qualified real prop-erty business debt (in the case of a tax-payer other than a C corporation). See Pub. 334, chapter 5.

5. The canceled debt is qualified principal residence indebtedness which is dis-charged before 2018.

The exclusions don't apply in the following situations:

If a canceled debt is excluded from income because it takes place in a bankruptcy case, the exclusions in situations (2), (3),

(4), and (5) don't apply.

If a canceled debt is excluded from income because it takes place when you're insol-vent, the exclusions in situations (3) and

(4) don't apply to the extent you're insol-vent.

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

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

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

Bankruptcy and Insolvency

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

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

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

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

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

Example. You had a $15,000 debt that wasn't qualified principal residence debt can-celed outside of bankruptcy. Immediately be-fore the cancellation, your liabilities totaled $80,000 and your assets totaled $75,000. Since your liabilities were more than your assets, you were insolvent to the extent of $5,000 ($80,000

$75,000). You can exclude this amount from income. The remaining canceled debt ($10,000) may be subject to the qualified farm debt or qualified real property business debt rules. If not, you must include it in income.

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

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

1. Net operating loss (NOL). Reduce any NOL for the tax year of the debt cancella-tion, and then any NOL carryover to that year. Reduce the NOL or NOL carryover one dollar for each dollar of excluded can-celed debt.

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

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

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

Chapter 3Farm IncomePage 15

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

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

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

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

d. Inventory and accounts and notes re-ceivable.

e. Other property.

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

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

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

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

How to make tax attribute reductions. Always make the required reductions in tax at-tributes after figuring your tax for the year of the debt cancellation. In making the reductions in

(1) and (4) earlier, first reduce the loss for the tax year of the debt cancellation. Then reduce any loss carryovers to that year in the order of the tax years from which the carryovers arose, starting with the earliest year. In making the re-ductions in (2) and (7) earlier, reduce the credit carryovers to the tax year of the debt cancella-tion in the order in which they are taken into ac-count for that year.

Electing to reduce the basis of depreciable property first. You can elect to apply any por-tion of the excluded canceled debt first to re-duce the basis of depreciable property you hold at the beginning of the tax year following the tax year of the debt cancellation, in the following or-der.

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

Page 16Chapter 3Farm Income

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

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

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

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

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

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

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

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

Qualified Farm Debt

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

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

You incurred it directly in operating a farm-ing business.

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

For more information, see Pub. 4681.

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

A person related to you.

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

A person who receives a fee from your in-vestment in the property (or a person rela-ted to this person).

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

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

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

Adjusted tax attributes. Adjusted tax at-tributes means the sum of the following items.

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

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

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

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

5. Any passive activity loss and credit carry-overs from the tax year of the debt cancel-lation. Any credit carryover is multiplied by 3.

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

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

Reduction of tax attributes. If you exclude canceled debt from income under the qualified farm debt rules, you must use the excluded debt to reduce tax attributes. (If you also exclu-ded canceled debt under the insolvency rules, you reduce the amount of the tax attributes re-maining after reduction for the exclusion al-lowed under the insolvency rules.) You gener-ally must follow the reduction rules previously explained under Bankruptcy and Insolvency. However, don't follow the rules in (5) under Or-der of reduction, earlier. Instead, follow the special rules explained next.

Special rules for reducing the basis of property. You must use special rules to re-duce the basis of property for excluded can-celed qualified farm debt. Under these special rules, you only reduce the basis of qualified property (defined earlier). Reduce it in the fol-lowing order.

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

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

3. Other qualified property.

Form 982

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

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

Income From Other Sources

This section discusses other types of income you may receive.

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

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

Commodity futures and options. See Hedg-ing in chapter 8 for information on gains and

losses from commodity futures and options transactions.

Custom hire (machine work). Pay you re-ceive for contract work or custom work that you or your hired help perform off your farm for oth-ers, or for the use of your property or machines, is income to you whether or not income tax was withheld. This rule applies whether you receive the pay in cash, services, or merchandise. Re-port this income on Schedule F.

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

Income you received for granting a tempo-rary construction easement is rental income. Report the income as rent on Part I of Sched-ule E (Form 1040).

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

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

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

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

Easement contracts usually describe TIP the affected land using square feet.

Your basis may be figured per acre.

One acre equals 43,560 square feet.

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

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

Illegal federal irrigation subsidy. The federal government, operating through the Bureau of Reclamation, has made irrigation water from certain reclamation and irrigation projects avail-able for agricultural purposes. The excess of

the amount required to be paid for water from these projects over the amount you actually paid is an illegal subsidy.

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

For more information on reclamation and irri-gation projects, contact your local Bureau of Reclamation.

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

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

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

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

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

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

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

Example. A tenant farmer purchased fertil-izer for $1,000 in April 2017. He deducted $1,000 on his 2017 Schedule F and the entire deduction reduced his tax. The landowner reim-bursed him $500 of the cost of the fertilizer in February 2018. The tenant farmer must include $500 in income on his 2018 tax return because the entire deduction decreased his 2017 tax.

Sale of soil and other natural deposits. If you remove and sell topsoil, loam, fill dirt, sand, gravel, or other natural deposits from your

Chapter 3Farm IncomePage 17

property, the proceeds are ordinary income. A reasonable allowance for depletion of the natu-ral deposit sold may be claimed as a deduction. See Depletion in chapter 7.

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

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

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

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

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

Tree farmers, in the business of tree TIP farming, may use section 631(a) to capture favorable income tax treatment of timber sales and then report the actual cash

sale of timber on Schedule F. Section 2032A defines sale of trees as farm income (under the special use valuation for estate tax purposes). However, land owners who make frequent sales (for example, two to three within 5 years, per case law) may use Schedule F to report this business income.

Income Averaging for Farmers

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

Farmers electing farm income averag-TIP ing may want to include taxable income from the FMV (trade value) of traded farm assets as electable farm income. Under

the Tax Cuts and Jobs Act, personal property, such as tractors and equipment, no longer qual-ify for a like-kind exchange and are now subject to depreciation recapture on the FMV of the trade as if cash was exchanged.

Page 18Chapter 3Farm Income

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

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

Elected Farm Income (EFI)

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

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

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

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

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

How To Figure the Tax

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

Negative taxable income for base year. If your taxable income for any base year was zero because your deductions were more than your income, you may have negative taxable income

for that year to combine with your EFI on Schedule J.

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

Effect on Other Tax Determinations

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

The amount of your self-employment tax.

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

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

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

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

Tax for Certain Children Who Have Unearned Income

If your child was under age 19 (24 if a full-time student) at the end of the tax year and had un-earned income of more than $2,100, part of that income may be taxed at your tax rate instead of your child's tax rate. For more information, see the Instructions for Form 8615.

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

Alternative Minimum Tax (AMT)

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

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

Schedule J

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

4.

Farm Business Expenses

What's New for 2018

Standard mileage rate. For 2018, the stand-ard mileage rate for the cost of operating your car, van, pickup, or panel truck for each mile of business use is 54.5 cents. See Truck and Car Expenses, later.

Business interest expense limitation. A business interest expense deduction may be limited for certain taxpayers. The Instructions for Form 8990, Limitation on Business Interest Expense IRC 163(j), explain when a business interest expense deduction is limited and who is required to file Form 8990.

The excess farm loss rules have been re-placed with excess business loss rules. Noncorporate taxpayers may be subject to ex-cess business loss limitations. See Form 461 and instructions for details. Under transition rules, if you had an excess farm loss in 2017, you can deduct it in calculating your profits/loss for 2018 before applying the excess business loss rules.

Most taxpayers no longer have the option to carryback a net operating loss (NOL). For most taxpayers, NOLs arising in tax years ending after 2017 can only be carried forward. The 2–year carryback rule in effect before 2018, generally, does not apply to NOLs arising in tax years ending after December 31, 2017. Excep-tions apply to certain farming losses and NOLs of insurance companies other than a life insur-ance company. See section 172, as amended by the Tax Cuts and Jobs Act. See Pub. 536, Net Operating Losses (NOLs) for individuals, Estates, and Trusts, or Pub. 542, Corporations, for additional information.

Introduction

You can generally deduct the current costs of operating your farm. Current costs are expenses you don't have to capitalize or include

in inventory costs. However, your deduction for the cost of livestock feed and certain other sup-plies may be limited. If you have an operating loss, you may not be able to deduct all of it.

Topics

This chapter discusses:

Deductible expenses

Domestic production activities deduction

Capital expenses

Nondeductible expenses

Losses from operating a farm

Not-for-profit farming

Useful Items

You may want to see:

Publication

463 Travel, Gift, and Car Expenses

535 Business Expenses

587 Business Use of Your Home

925 Passive Activity and At-Risk Rules

936 Home Mortgage Interest Deduction

Form (and Instructions)

Sch A (Form 1040) Itemized Deductions

Sch F (Form 1040) Profit or Loss From Farming

461 Limitation on Business Losses

1045 Application for Tentative Refund

5213 Election To Postpone Determination as To Whether the Presumption Applies That an Activity Is Engaged in for Profit

8903 Domestic Production Activities Deduction

8990 Limitation on Business Interest Expense IRC 163(j)

See chapter 16 for information about getting publications and forms.

Deductible Expenses

The ordinary and necessary costs of operating a farm for profit are deductible business expen-ses. “Ordinary” means what most farmers do, and “necessary” means what is useful and help-ful in farming. Schedule F, Part II, lists some common farm expenses that are typically de-ductible. This chapter discusses many of these expenses, as well as others not listed on Schedule F.

Reimbursed expenses. If the reimbursement is received in the same year that the expense is claimed, reduce the expense by the amount of the reimbursement. If the reimbursement is re-ceived in a year after the expense is claimed, include the reimbursement amount in income. See Refund or reimbursement under Income From Other Sources in chapter 3.

Personal and business expenses. Some ex-penses you pay during the tax year may be part

personal and part business. These may include expenses for gasoline, oil, fuel, water, rent, electricity, telephone, automobile upkeep, re-pairs, insurance, interest, and taxes.

You must allocate these mixed expenses between their business and personal parts. Generally, the personal part of these expenses isn't deductible. The business portion of the ex-penses is deductible on Schedule F.

Example. You paid $1,500 for electricity during the tax year. You used 1/3 of the electric-ity for personal purposes and 2/3 for farming. Under these circumstances, you can deduct $1,000 (2/3 of $1,500) of your electricity ex-pense as a farm business expense.

Reasonable allocation. It isn't always easy to determine the business and nonbusi-ness parts of an expense. There is no method of allocation that applies to all mixed expenses. Any reasonable allocation is acceptable. What is reasonable depends on the circumstances in each case.

Prepaid Farm Supplies

Prepaid farm supplies include the following items if paid for during the year.

Feed, seed, fertilizer, and similar farm sup-plies not used or consumed during the year, but not including farm supplies that you would have consumed during the year if not for a fire, storm, flood, other casualty, disease, or drought.

Poultry (including egg-laying hens and baby chicks) bought for use (or for both use and resale) in your farm business. However, include only the amount that would be deductible in the following year if you had capitalized the cost and deducted it ratably over the lesser of 12 months or the useful life of the poultry.

Poultry bought for resale and not resold during the year.

Deduction limit. If you use the cash method of accounting to report your income and expen-ses, your deduction for prepaid farm supplies in the year you pay for them may be limited to 50% of your other deductible farm expenses for the year (all Schedule F deductions except pre-paid farm supplies). This limit doesn't apply if you meet one of the exceptions described later. See chapter 2 for a discussion of the Cash Method of accounting.

If the limit applies, you can deduct the ex-cess cost of farm supplies other than poultry in the year you use or consume the supplies. The excess cost of poultry bought for use (or for both use and resale) in your farm business is deductible in the year following the year you pay for it. The excess cost of poultry bought for resale is deductible in the year you sell or other-wise dispose of that poultry.

Example. During 2018, you bought fertilizer ($40,000), feed ($10,000), and seed ($5,000) for use on your farm in the following year. Your total prepaid farm supplies expense for 2018 is $55,000. Your other deductible farm expenses totaled $100,000 for 2018. Therefore, your de-duction for prepaid farm supplies can't be more than $50,000 (50% of $100,000) for 2018. The

Chapter 4Farm Business ExpensesPage 19

excess prepaid farm supplies expense of $5,000 ($55,000 − $50,000) is deductible in a later tax year when you use or consume the supplies. However, the deduction limit doesn't apply if you qualify for the exceptions listed next.

Exceptions. This limit on the deduction for prepaid farm supplies expense doesn't apply if you are a farm-related taxpayer and either of the following apply.

1. Your prepaid farm supplies expense is more than 50% of your other deductible farm expenses because of a change in business operations caused by unusual circumstances.

2. Your total prepaid farm supplies expense for the preceding 3 tax years is less than 50% of your total other deductible farm ex-penses for those 3 tax years.

You are a farm-related taxpayer if any of the following tests apply.

1. Your main home is on a farm.

2. Your principal business is farming.

3. A member of your family meets (1) or (2).

For this purpose, your family includes your brothers and sisters, half brothers and half sis-ters, spouse, parents, grandparents, children, grandchildren, and aunts and uncles and their children.

Whether or not the deduction limit for

prepaid farm supplies applies, your ex-CAUTION penses for prepaid livestock feed may be subject to the rules for advance payment of livestock feed, discussed next.

Prepaid Livestock Feed

If you report your income and expenses under the cash method of accounting, you can't de-duct in the year paid the cost of feed your live-stock will consume in a later year unless you meet all the following tests.

1. The payment is for the purchase of feed rather than a deposit.

2. The prepayment has a business purpose and isn't merely for tax avoidance.

3. Deducting the prepayment doesn't result in a material distortion of your income.

If you meet all three tests, you can deduct the prepaid feed, subject to the limit on prepaid farm supplies discussed earlier.

If you fail any of these tests, you can deduct the prepaid feed only in the year it is consumed.

This rule doesn't apply to the purchase

of commodity futures contracts.

CAUTION

Payment for the purchase of feed. Whether a payment is for the purchase of feed or a de-posit depends on the facts and circumstances

contract or business custom, to a refund or re-purchase.

The following are some factors that show a payment is a deposit rather than for the pur-chase of feed.

The absence of specific quantity terms.

The right to a refund of any unapplied pay-ment credit at the end of the contract.

The seller's treatment of the payment as a deposit.

The right to substitute other goods or prod-ucts for those specified in the contract.

A provision permitting substitution of ingredi-ents to vary the particular feed mix to meet your livestock's current diet requirements won't sug-gest a deposit. Further, a price adjustment to reflect market value at the date of delivery isn't, by itself, proof of a deposit.

Business purpose. The prepayment has a business purpose only if you have a reasonable expectation of receiving some business benefit from prepaying the cost of livestock feed. The following are some examples of business bene-fits.

Fixing maximum prices and securing an assured feed supply.

Securing preferential treatment in anticipa-tion of a feed shortage.

Other factors considered in determining the existence of a business purpose are whether the prepayment was a condition imposed by the seller and whether that condition was meaning-ful.

No material distortion of income. The fol-lowing are some factors considered in deter-mining whether deducting prepaid livestock feed materially distorts income.

Your customary business practice in con-ducting your livestock operations.

The expense in relation to past purchases.

The time of year you made the purchase.

The expense in relation to your income for the year.

Labor Hired

You can deduct reasonable wages paid for reg-ular farm labor, piecework, contract labor, and other forms of labor hired to perform your farm-ing operations. You can pay wages in cash or in noncash items such as inventory, capital as-sets, or assets used in your business. The cost of boarding farm labor is a deductible labor cost. Other deductible costs you incur for farm labor include health insurance, workers' com-pensation insurance, and other benefits.

If you must withhold social security, Medi-care, and income taxes from your employees' cash wages, you can still deduct the full amount of wages before withholding. See chapter 13 for more information on Employment Taxes . Also, deduct the employer's share of the social secur-ity and Medicare taxes you must pay on your employees' wages as a farm business expense on Schedule F, line 29. See Taxes, later.

ployee pays you anything for the property, de-duct as wages the fair market value of the prop-erty minus the payment by the employee for the property.

Treat the wages deducted as an amount re-ceived for the property. You may have a gain or loss to report if the property's adjusted basis on the date of transfer is different from its fair mar-ket value. Any gain or loss has the same char-acter the exchanged property had in your hands. For more information, see chapter 8.

Child as an employee. You can deduct rea-sonable wages or other compensation you pay to your child for doing farmwork if a true em-ployer–employee relationship exists between you and your child. Include these wages in the child's income. The child may have to file an in-come tax return. These wages also may be subject to social security and Medicare taxes if your child is age 18 or older. Wages paid to mi-nor children become subject to social security and Medicare taxes in the month the dependent child turns 18 years of age. For more informa-tion, see Family Employees in chapter 13.

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

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

The amount of wages paid to the child

could cause a loss of the dependency CAUTION exemption depending on how the child uses the money.

Spouse as an employee. You can deduct reasonable wages or other compensation you pay to your spouse if a true employer–employee relationship exists between you and your spouse. Wages you pay to your spouse are subject to social security and Medicare taxes. For more information, see Family Employees in chapter 13.

Nondeductible Pay

You can't deduct wages paid for certain house-hold work, construction work, and maintenance of your home. However, those wages may be subject to the employment taxes discussed in chapter 13.

Household workers. Do not deduct amounts paid to persons engaged in household work, except to the extent their services are used in boarding or otherwise caring for farm laborers.

Construction labor. Do not deduct wages paid to hired help for the construction of new buildings or other improvements. These wages are part of the cost of the building or other im-provement. You must capitalize them.

Maintaining your home. If your farm em-ployee spends time maintaining or repairing your home, the wages and employment taxes

in each case. It is for the purchase of feed if you		Property for services. If you transfer property
can show you made it under a binding commit-
ment to accept delivery of a specific quantity of		to an employee in payment for services, you
		can deduct as wages paid the fair market value
feed at a fixed price and you aren't entitled, by
		of the property on the date of transfer. If the em-

Page 20	Chapter 4 Farm Business Expenses

you pay for that work are nondeductible per-sonal expenses. For example, assume you have a farm employee for the entire tax year and the employee spends 5% of the time

maintaining your home. The employee devotes the remaining time to work on your farm. You can't deduct 5% of the wages and employment taxes you pay for that employee.

Employment Credits

Reduce your deduction for wages by the amount of any employment credits you claim such as the work opportunity credit (Form 5884).

Repairs and Maintenance

You can deduct most expenses for the repair and maintenance of your farm property. Com-mon items of repair and maintenance are re-painting, sealing cracks or replacing broken windows on a farm building, and routine mainte-nance of trucks, tractors, and other farm machi-nery. However, expenses for improvements to depreciable property are generally capital ex-penditures. Amounts are paid for improvements if they are for the betterment of your property, are for a restoration of your property, such as the replacement of major components and sub-stantial structural parts, or if your expenditures adapt your property to a new or different use. For example, if you replace a few shingles on the barn roof, these expenses are generally de-ductible as repairs and maintenance. If you re-place the entire barn roof with a new roof, then this expense is generally a capital expenditure. For more information, see Capital Expenses, later.

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

Interest

There may be a limit on the amount you can de-duct as farming business interest paid or ac-crued during the tax year related to your farming business, such as for farm mortgages and other farm mortgages and other farm obligations. However, a small business taxpayer is not sub-ject to the business interest expense limitation and is not required to file Form 8990. A small business taxpayer is a taxpayer that is not a tax shelter (as defined in section 448(d)(3)) and has average annual gross receipts of $25 mil-lion or less for the 3 prior tax years under the gross receipts test of section 448(c). Gross re-ceipts include the aggregate gross receipts from all persons treated as a single employer, such as a controlled group of corporations, commonly controlled partnerships or proprietor-ships, and affiliated service groups.

The gross receipts test of section 448(c) ap-plies only to corporations and partnerships, but for purposes of the business interest limitation the gross receipts test applies to individuals as if they were corporations or partnerships. Thus, any individual with a farming trade or business operating as a sole proprietorship is subject to the gross receipts test.

Certain businesses subject to the business interest expense limitation may elect out of the limitation. Certain farming businesses and

specified agricultural or horticultural coopera-tives (as defined in section 199A(g)(4) qualify to make an election not to limit business interest expenses. This is an irrevocable election. If you make this election, you are required to use the alternative depreciation system (ADS), dis-cussed later in chapter 7, to depreciate any farming property with a recovery period of 10 years or more. Also, you are not entitled to the special depreciation allowance for that prop-erty. For an individual with more than one quali-fying business, the election is made with re-spect to each business. If you are required to limit your business interest expense, the amount you cannot deduct for the taxable year is generally carried forward to the next taxable year. However, there are special rules for part-nership treatment of disallowed business inter-est. See Instructions for Form 8990, Limitation on Business Interest Expenses IRC 163(j), for more information.

Subject to the preceding rules, and assum-ing other limitations do not apply, you can de-duct as a farm business expense interest paid or accrued during the tax year related to your farming business, such as for farm mortgages and other farm obligations.

Cash method. If you use the cash method of accounting, you can generally deduct interest paid during the tax year. You can't deduct inter-est paid with funds received from the original lender through another loan, advance, or other arrangement similar to a loan. You can, how-ever, deduct the interest when you start making payments on the new loan. For more informa-tion, see Cash Method in chapter 2.

Prepaid interest. Under the cash method, you generally can't deduct any interest paid be-fore the year it is due. Interest paid in advance may be deducted only in the tax year in which it is due.

Accrual method. If you use an accrual method of accounting, you can deduct only interest that has accrued during the tax year. However, you can't deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. For more information, see Accrual Method in chapter 2.

Allocation of interest. If you use the proceeds of a loan for more than one purpose, you must allocate the interest on that loan to each use. Allocate the interest to the following categories.

Trade or business interest.

Passive activity interest.

Investment interest.

Portfolio interest.

Personal interest.

You generally allocate interest on a loan the same way you allocate the loan proceeds. You allocate loan proceeds by tracing disburse-ments to specific uses.

The easiest way to trace disburse-TIP ments to specific uses is to keep the proceeds of a particular loan separate

from any other funds.

Secured loan. The allocation of loan pro-ceeds and the related interest is generally not

affected by the use of property that secures the loan.

Example. You secure a loan with property used in your farming business. You use the loan proceeds to buy a car for personal use. You must allocate interest expense on the loan to personal use (purchase of the car) even though the loan is secured by farm business property.

Allocation period. The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on the earlier of the following dates.

The date the loan is repaid.

The date the loan is reallocated to another use.

More information. For more information on in-terest, see chapter 4 in Pub. 535.

Breeding Fees

You can generally deduct breeding fees as a farm business expense. However, if the breeder guarantees live offspring as a result of the breeding or other veterinary procedure, you must capitalize these costs as the cost basis of the offspring. Also, if you use an accrual method of accounting, you must capitalize breeding fees and allocate them to the cost ba-sis of the calf, foal, etc. For more information on who must use an accrual method of accounting, see Accrual Method Required under Account-ing Methods in chapter 2.

Fertilizer and Lime

You can deduct in the year paid or incurred the cost of fertilizer, lime, and other materials ap-plied to farmland to enrich, neutralize, or condi-tion it if the benefits last a year or less. You also can deduct the cost of applying these materials in the year you pay or incur it. However, see Prepaid Farm Supplies, earlier, for a rule that may limit your deduction for these materials.

If the benefits of the fertilizer, lime, or other materials last substantially more than one year, you generally capitalize their cost and deduct a part each year the benefits last. However, you can choose to deduct these expenses in the year paid or incurred. If you make this choice, you will need IRS approval if you later decide to capitalize the cost of previously deducted items. If you sell farmland on which fertilizer or lime has been applied and if the selling price of the land includes part or all of the cost of the fertil-izer or lime, you report the sale amount attribut-able to the fertilizer or lime as ordinary income.

Farmland, for these purposes, is land used for producing crops, fruits, or other agricultural products or for sustaining livestock. It doesn't include land you have never used previously for producing crops or sustaining livestock. You can't deduct initial land preparation costs. (See Capital Expenses, later.)

Include government payments you receive for lime or fertilizer in income. See Fertilizer and Lime under Agricultural Program Payments in chapter 3.

Chapter 4Farm Business ExpensesPage 21

Taxes

You can deduct as a farm business expense the real estate and personal property taxes on farm business assets, such as farm equipment, animals, farmland, and farm buildings. You also can deduct the social security and Medicare taxes you pay to match the amount withheld from the wages of farm employees and any fed-eral unemployment tax you pay. For information on employment taxes, see chapter 13.

Allocation of taxes. The taxes on the part of your farm you use as your home (including the furnishings and surrounding land not used for farming) are nonbusiness taxes. You may be able to deduct these nonbusiness taxes as itemized deductions on Schedule A (Form 1040). To determine the nonbusiness part, allo-cate the taxes between the farm assets and nonbusiness assets. The allocation can be done from the assessed valuations. If your tax statement doesn't show the assessed valua-tions, you can usually get them from the tax as-sessor.

State and local general sales taxes. State and local general sales taxes on nondeprecia-ble farm business expense items are deductible as part of the cost of those items. Include state and local general sales taxes imposed on the purchase of assets for use in your farm busi-ness as part of the cost you depreciate. Also treat the taxes as part of your cost if they are im-posed on the seller and passed on to you.

State and federal income taxes. Individuals can't deduct state and federal income taxes as farm business expenses. Individuals can de-duct state and local income taxes only as an itemized deduction on Schedule A (Form 1040). For taxable years after 2017 and before 2026, the Schedule A (Form 1040) deduction for com-bined state and local income and property taxes is limited to $10,000 ($5,000 if married fil-ing separately). However, you can't deduct fed-eral income tax.

Highway use tax. You can deduct the federal use tax on highway motor vehicles paid on a truck or truck tractor used in your farm busi-ness. For information on the tax itself, including information on vehicles subject to the tax, see the Instructions for Form 2290.

Self-employment tax. You cannot deduct the self-employment tax you pay as a farm busi-ness expense. However, you can deduct as an adjustment to income on Schedule 1 (Form 1040), line 27, one-half of your self-employment tax in figuring your adjusted gross income. For more information, see chapter 12.

Insurance

You generally can deduct the ordinary and nec-essary cost of insurance for your farm business as a business expense. This includes premiums you pay for the following types of insurance.

Fire, storm, crop, theft, liability, and other insurance on farm business assets.

Health and accident insurance on your farm employees.

Workers' compensation insurance set by state law that covers any claims for job-re-lated bodily injuries or diseases suffered by employees on your farm, regardless of fault.

Business interruption insurance.

State unemployment insurance on your farm employees (deductible as taxes if they are considered taxes under state law).

Insurance to secure a loan. If you take out a policy on your life or on the life of another per-son with a financial interest in your farm busi-ness to get or protect a business loan, you can't deduct the premiums as a business expense. In the event of death, the proceeds of the policy aren't taxed as income even if they are used to liquidate the debt.

Advance premiums. Deduct advance pay-ments of insurance premiums only in the year to which they apply, regardless of your accounting method.

Example. On June 29, 2018, you paid a premium of $3,000 for fire insurance on your barn. The policy will cover a period of 3 years beginning on July 1, 2018. Only the cost for the 6 months in 2018 is deductible as an insurance expense on your 2018 calendar year tax return. Deduct $500, which is the premium for 6 months of the 36-month premium period, or 6/36 of $3,000. In both 2019 and 2020, deduct $1,000 (12/36 of $3,000). Deduct the remaining $500 in 2020. Had the policy been effective on January 1, 2018, the deductible expense would have been $1,000 for each of the years 2018, 2019, and 2020, based on one-third of the pre-mium used each year.

Business interruption insurance. Use and occupancy and business interruption insurance premiums are deductible as a business ex-pense. This insurance pays for lost profits if your business is shut down due to a fire or other cause. Report any proceeds in full on Sched-ule F, Part I.

Self-employed health insurance deduction. If you are self-employed, you can deduct as an adjustment to income on Schedule 1 (Form 1040) your payments for medical, dental, and qualified long-term care insurance coverage for yourself, your spouse, and your dependents when figuring your adjusted gross income on your Schedule 1 (Form 1040). Effective March 30, 2010, the insurance also can cover any child of yours under age 27 at the end of 2018, even if the child was not your dependent. Gen-erally, this deduction can't be more than the net profit from the business under which the plan was established.

If you or your spouse also is an employee of another person, you can't take the deduction for any month in which you are eligible to partici-pate in a subsidized health plan maintained by your employer or your spouse's employer.

Generally, use the Self-Employed Health In-surance Deduction Worksheet in the Instruc-tions for Schedule 1 (Form 1040) to figure your deduction. Include the remaining part of the in-surance payment in your medical expenses on

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

For more information, see Deductible Premi-ums in Pub. 535, chapter 6.

Rent and Leasing

If you lease property for use in your farm busi-ness, you can generally deduct the rent you pay on Schedule F. However, you can't deduct rent you pay in crop shares if you deduct the cost of raising the crops as farm expenses.

Advance payments. Deduct advance pay-ments of rent only in the year to which they ap-ply, regardless of your accounting method.

Farm home. If you rent a farm, don't deduct the part of the rental expense that represents the fair rental value of the farm home in which you live.

Lease or Purchase

If you lease a farm building or equipment, you must determine whether or not the agreement must be treated as a conditional sales contract rather than a lease. If the agreement is treated as a conditional sales contract, the payments under the agreement (so far as they don't repre-sent interest or other charges) are payments for the purchase of the property. Do not deduct these payments as rent, but capitalize the cost of the property and recover this cost through depreciation.

Conditional sales contract. Whether an agreement is a conditional sales contract de-pends on the intent of the parties. Determine intent based on the provisions of the agreement and the facts and circumstances that exist when you make the agreement. No single test, or special combination of tests, always applies. However, in general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true.

The agreement applies part of each pay-ment toward an equity interest you will re-ceive.

You get title to the property after you make a stated amount of required payments.

The amount you must pay to use the prop-erty for a short time is a large part of the amount you would pay to get title to the property.

You pay much more than the current fair rental value of the property.

You have an option to buy the property at a nominal price compared to the value of the property when you may exercise the op-tion. Determine this value when you make the agreement.

You have an option to buy the property at a nominal price compared to the total amount you have to pay under the agree-ment.

The agreement designates part of the pay-ments as interest, or part of the payments can be easily recognized as interest.

Example. You lease new farm equipment from a dealer who both sells and leases. The agreement includes an option to purchase the

Page 22Chapter 4Farm Business Expenses

equipment for a specified price. The lease pay-ments and the specified option price equal the sales price of the equipment plus interest. Un-der the agreement, you are responsible for maintenance, repairs, and the risk of loss. For federal income tax purposes, the agreement is a conditional sales contract. You can't deduct any of the lease payments as rent. You can de-duct interest, repairs, insurance, depreciation, and other expenses related to the equipment.

Motor vehicle leases. Special rules apply to lease agreements that have a terminal rental adjustment clause. In general, this is a clause that provides for a rental price adjustment based on the amount the lessor is able to sell the vehicle for at the end of the lease. If your rental agreement contains a terminal rental ad-justment clause, treat the agreement as a lease if the agreement otherwise qualifies as a lease. For more information, see section 7701(h).

Leveraged leases. Special rules apply to leveraged leases of equipment (arrangements in which the equipment is financed by a nonre-course loan from a third party). For more infor-mation, see Pub. 535, chapter 3, and Revenue Procedure 2001-28, which begins on page 1156 of Internal Revenue Bulletin 2001-19 at IRS.gov/pub/irs-irbs/irb01-19.pdf.

Depreciation

If property you acquire to use in your farm busi-ness is expected to last more than one year, you generally can't deduct the entire cost in the year you acquire it. You must recover the cost over more than one year and deduct part of it each year on Schedule F as depreciation or amortization. However, you can choose to de-duct part or all of the cost of certain qualifying property, up to a limit, as a section 179 deduc-tion in the year you place it in service.

Depreciation, amortization, and the section 179 deduction are discussed in chapter 7.

Business Use of Your Home

You can deduct expenses for the business use of your home if you use part of your home ex-clusively and regularly:

As the principal place of business for any trade or business in which you engage,

As a place to meet or deal with patients, clients, or customers in the normal course of your trade or business, or

In connection with your trade or business, if you are using a separate structure that isn't attached to your home.

Your home office will qualify as your princi-pal place of business for deducting expenses for its use if you meet both of the following re-quirements.

You use it exclusively and regularly for the administrative or management activities of your trade or business.

You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.

If you use part of your home for business, you must divide the expenses of operating your home between personal and business use.

The IRS now provides a simplified method to determine your expenses for business use of your home. For more information, see Pub. 587.

Deduction limit. If your gross income from farming equals or exceeds your total farm ex-penses (including expenses for the business use of your home), you can deduct all your farm expenses. But if your gross income from farm-ing is less than your total farm expenses, your deduction for certain expenses for the use of your home in your farming business is limited.

Your deduction for otherwise nondeductible expenses, such as utilities, insurance, and de-preciation (with depreciation taken last), can't be more than the gross income from farming minus the following expenses.

The business part of expenses you could deduct even if you didn't use your home for business (such as deductible mortgage in-terest, real estate taxes, and casualty and theft losses).

Farm expenses other than expenses that relate to the use of your home. If you are self-employed, don't include your deduc-tion for half of your self-employment tax.

Deductions over the current year's limit can be carried over to your next tax year. They are subject to the deduction limit for the next tax year.

More information. See Pub. 587 for more in-formation on deducting expenses for the busi-ness use of your home.

Telephone expense. You can't deduct the cost of basic local telephone service (including any taxes) for the first telephone line you have in your home, even if you have an office in your home. However, charges for business long-dis-tance phone calls on that line, as well as the cost of a second line into your home used ex-clusively for your farm business, are deductible business expenses. Cell phone charges for calls relating to your farm business are deducti-ble. If the cell phone you use for your farm busi-ness is part of a family cell phone plan, you must allocate and deduct only the portion of the charges attributable to farm business calls.

Truck and Car Expenses

You can deduct the actual cost of operating a truck or car in your farm business. Only expen-ses for business use are deductible. These in-clude such items as gasoline, oil, repairs, li-cense tags, insurance, and depreciation (subject to certain limits).

Standard mileage rate. Instead of using ac-tual costs, under certain conditions you can use the standard mileage rate. The standard mile-age rate for each mile of business use is 54.5 cents in 2018. You can use the standard mile-age rate for a car or a light truck, such as a van, pickup, or panel truck, you own or lease.

You can't use the standard mileage rate if you operate five or more cars or light trucks at the same time. You aren't using five or more ve-hicles at the same time if you alternate using

the vehicles (you use them at different times) for business.

Example. Maureen owns a car and four pickup trucks that are used in her farm busi-ness. Her farm employees use the trucks and she uses the car for business. Maureen can't use the standard mileage rate for the car or the trucks. This is because all five vehicles are used in Maureen's farm business at the same time. She must use actual expenses for all vehi-cles.

Business use percentage. You can claim 75% of the use of a car or light truck as busi-ness use without any allocation records if you used the vehicle during most of the normal busi-ness day directly in connection with the busi-ness of farming. You choose this method of substantiating business use the first year the vehicle is placed in service. Once you make this choice, you may not change to another method later. The following are uses directly connected with the business of farming.

Cultivating land.

Raising or harvesting any agricultural or horticultural commodity.

Raising, shearing, feeding, caring for, training, and managing animals.

Driving to the feed or supply store.

If you keep records and they show that your business use was more than 75%, you may be able to claim more. See Recordkeeping require-ments under Travel Expenses, later.

More information. For more information on deductible truck and car expenses, see Pub. 463, chapter 4. If you pay your employees for the use of their truck or car in your farm busi-ness, see Reimbursements to employees under Travel Expenses next.

Travel Expenses

You can deduct ordinary and necessary expen-ses you incur while traveling away from home for your farm business. You can't deduct lavish or extravagant expenses. Usually, the location of your farm business is considered your home for tax purposes. You are traveling away from home if:

Your duties require you to be absent from your farm substantially longer than an ordi-nary work day, and

You need to get sleep or rest to meet the demands of your work while away from home.

If you meet these requirements and can prove the time, place, and business purpose of your travel, you can deduct your ordinary and necessary travel expenses.

The following are some types of deductible travel expenses.

Air, rail, bus, and car transportation;

Meals and lodging;

Dry cleaning and laundry;

Telephone and fax;

Transportation between your hotel and your temporary work or business meeting location; and

Tips for any of the above expenses.

Chapter 4Farm Business ExpensesPage 23

Meals. You ordinarily can deduct only 50% of your non-entertainment business-related meals expenses. You can deduct the cost of your meals while traveling on business only if your business trip is overnight or long enough to re-quire you to stop for sleep or rest to properly perform your duties. You can't deduct any of the cost of meals if it isn't necessary for you to rest. For information on entertainment expenses, see Pub. 463, chapter 2.

The expense of a meal includes amounts you spend for your food, beverages, taxes, and tips relating to the meal. You can deduct either 50% of the actual cost or 50% of a standard meal allowance that covers your daily meal and incidental expenses.

Note. No deduction is allowed for certain entertainment expenses, membership dues, and facilities used in connection with these ac-tivities for amounts paid or incurred after De-cember 31, 2017. See section 274, as amen-ded by the Tax Cuts and Jobs Act, section 13304.

Recordkeepingrequirements.You

must be able to prove your deductions RECORDS for travel by adequate records or other evidence that will support your own statement. Estimates or approximations don't qualify as proof of an expense.

You should keep an account book or similar record, supported by adequate documentary evidence, such as receipts, that together sup-port each element of an expense. Generally, it is best to record the expense and get documen-tation of it at the time you pay it.

If you choose to deduct a standard meal al-lowance rather than the actual expense, you don't have to keep records to prove amounts spent for meals and incidental items. However, you must still keep records to prove the actual amount of other travel expenses, and the time, place, and business purpose of your travel.

More information. For detailed information on travel, recordkeeping, and the standard meal al-lowance, see Pub. 463.

Reimbursements to employees. You gener-ally can deduct reimbursements you pay to your employees for travel and transportation expen-ses they incur in the conduct of your business. Employees may be reimbursed under an ac-countable or nonaccountable plan. Under an accountable plan, the employee must provide evidence of expenses. Under a nonaccountable plan, no evidence of expenses is required. If you reimburse expenses under an accountable plan, deduct them as travel and transportation expenses. If you reimburse expenses under a nonaccountable plan, you must report the reim-bursements as wages on Form W-2 and deduct them as wages. For more information, see Pub. 535, chapter 11.

Marketing Quota Penalties

You can deduct as Other expenses on Sched-ule F penalties you pay for marketing crops in excess of farm marketing quotas. However, if you don't pay the penalty, but instead the pur-chaser of your crop deducts it from the payment

to you, include in gross income only the amount you received. Do not take a separate deduction for the penalty.

Tenant House Expenses

You can deduct the costs of maintaining houses and their furnishings for tenants or hired help as farm business expenses. These costs include repairs, utilities, insurance, and depreciation.

The value of a dwelling you furnish to a ten-ant under the usual tenant–farmer arrangement isn't taxable income to the tenant.

Items Purchased for Resale

If you use the cash method of accounting, you ordinarily deduct the cost of livestock and other items purchased for resale only in the year of sale. You deduct this cost, including freight charges for transporting the livestock to the farm, on Schedule F, Part I. However, see Chickens, seeds, and young plants below.

Example. You use the cash method of ac-counting. In 2018, you buy 50 steers you will sell in 2019. You can't deduct the cost of the steers on your 2018 tax return. You deduct their cost on your 2019 Schedule F, Part I.

Chickens, seeds, and young plants. If you are a cash method farmer, you can deduct the cost of hens and baby chicks bought for com-mercial egg production, or for raising and re-sale, as an expense on Schedule F, Part I, in the year paid if you do it consistently and it doesn't distort income. You also can deduct the cost of seeds and young plants bought for fur-ther development and cultivation before sale as an expense on Schedule F, Part I, when paid if you do this consistently and you don't figure your income on the crop method. However, see Prepaid Farm Supplies, earlier, for a rule that may limit your deduction for these items.

If you deduct the cost of chickens, seeds, and young plants as an expense, report their entire selling price as income. You also can't deduct the cost from the selling price.

You can't deduct the cost of seeds and young plants for Christmas trees and timber as an expense. Deduct the cost of these seeds and plants through depletion allowances. For more information, see Depletion in chapter 7.

The cost of chickens and plants used as food for your family is never deductible.

Capitalize the cost of plants with a prefertile period of more than 2 years, unless you can elect out of the uniform capitalization rules. These rules are discussed in chapter 6.

Example. You use the cash method of ac-counting. In 2018, you buy 500 baby chicks to raise for resale in 2019. You also buy 50 bush-els of winter wheat seed in 2018 that you sow in the fall. Unless you previously adopted the method of deducting these costs in the year you sell the chickens or the harvested crops, you can deduct the cost of both the baby chicks and the seed wheat in 2018.

Election to use crop method. If you use the crop method, you can delay deducting the cost of seeds and young plants until you sell

them. You must get IRS approval to use the crop method. If you follow this method, deduct the cost from the selling price to determine your profit on Schedule F, Part I. For more informa-tion, see Crop method under Special Methods of Accounting in chapter 2.

Choosing a method. You can adopt either the crop method or the cash method for deduct-ing the cost in the first year you buy egg-laying hens, pullets, chicks, or seeds and young plants.

Although you must use the same method for egg-laying hens, pullets, and chicks, you can use a different method for seeds and young plants. Once you use a particular method for any of these items, use it for those items until you get IRS approval to change your method. For more information, see Change in Account-ing Method in chapter 2.

Other Expenses

The following list, while not all-inclusive, shows some expenses you can deduct as other farm expenses on Schedule F, Part II. These expen-ses must be for business purposes and

(1) paid, if you use the cash method of account-ing, or (2) incurred, if you use an accrual method of accounting.

• Accounting fees.

• Advertising.

• Business travel and meals.

• Commissions.

• Consultant fees.

• Crop scouting expenses.

• Dues to cooperatives.

• Educational expenses (to maintain and im-prove farming skills).

• Farm-related attorney fees.

• Farm magazines.

• Ginning.

• Insect sprays and dusts.

• Litter and bedding.

• Livestock fees.

• Marketing fees.

• Milk assessment.

• Recordkeeping expenses.

• Service charges.

• Small tools expected to last one year or less.

• Stamps and stationery.

• Subscriptions to professional, technical, and trade journals that deal with farming.

• Tying material and containers.

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

Loan expenses. You prorate and deduct loan expenses, such as legal fees and commissions, you pay to get a farm loan over the term of the loan.

Tax preparation fees. You can deduct as a farm business expense on Schedule F the cost of preparing that part of your tax return relating to your farm business.

Page 24Chapter 4Farm Business Expenses

You also can deduct on Schedule F the amount you pay or incur in resolving tax issues relating to your farm business.

Domestic Production Activities Deduction

Repeal of domestic production activities deduction (DPAD) after 2017. The domestic production activities deduction (DPAD) under section 199 was repealed by the Tax Cuts and Jobs Act for tax years beginning after 2017. A fiscal year-end taxpayer may qualify to take a DPAD under section 199 on its 2018 return for income earned before January 1, 2018. Those taxpayers must use Form 8903, Domestic Pro-duction Activities Deduction, and file it with their tax return.

Qualified Business Income (QBI) — Section 199A. Section 199A provides that, for taxable years beginning after 2017, taxpayers other than C corporations may deduct 20% of the qualified business income from the taxpayer’s qualified trades or businesses, which can be operated through a partnership, S corporation, trust, estate, or sole proprietorship. The deduc-tion is subject to multiple limitations based on the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid with respect to the qualified trade or business, and the unadjusted basis of qualified property held by the trade or business. Special rules ap-ply to specified agricultural or horticultural coop-eratives. For more information, see code sec-tion 199A and Pub. 535.

Form 1099-PATR, Taxable Distributions Received From Cooperatives, Special rule under section 199A(b)(7) for noncorporate patrons of specified cooperatives for in-come earned after December 31, 2017. Non-corporate patrons of specified cooperatives that are entitled to a deduction under section 199A(a) for qualified business income of a trade or business that includes qualified payments from a specified cooperative must compute a patronage reduction under section 199A(b)(7):

1. First determine your deductible amount of qualified business income (QBI) for any trade or business with respect to income received from a specified agricultural or horticultural cooperative.

2. Reduce your deduction from QBI by an amount equal to the lessor of:

9% of so much of the qualified busi-ness income as is properly allocable to qualified payments received from the specified cooperative. Qualified payments are amounts reported to you on Form 1099-PATR in Box 1 for Patronage dividends and in Box 3 for Per-unit retain allocations, or

50% of so much of the W-2 wages you paid with respect to the portion of your trade or business conducted with respect to the specified coopera-tive. Note: If you did not pay wages, your patronage reduction is zero.

Increase your deductible amount of QBI by amounts reported to you as Domestic

Production Activities Deduction in Box 6 of Form 1099-PATR. Patrons of specified cooper-atives do not use Form 8903 to report the DPAD passed through to you.

Partnerships and S corporations as pa-trons of specified cooperatives. A DPAD passed through to partnerships and S corpora-tions is passed through by the partnership or S corporation to the partners and shareholders.

More information. For more information on the domestic production activities deduction, see the Instructions for Form 8903.

Capital Expenses

A capital expense is payment, or debt incurred, for the acquisition, production, or improvement of a unit of property. You include the expense in the basis of the asset. Uniform capitalization rules also require you to capitalize or include in inventory certain other expenses. See chapters 2 and 6 for more information.

Capital expenses are generally not deducti-ble, but they may be depreciable. However, you can elect to deduct certain capital expenses, such as the following.

The cost of fertilizer, lime, etc. (See Fertil-izer and Lime under Deductible Expenses, earlier.)

Soil and water conservation expenses. (See chapter 5.)

The cost of property that qualifies for a de-duction under section 179. (See chap-ter 7.)

Business start-up costs. (See Business start-up and organizational costs, later.)

Forestation and reforestation costs. (See Forestation and reforestation costs, later.)

Generally, the costs of the following items, including the costs of material, hired labor, and installation, are capital expenses.

1. Land and buildings.

2. Additions, alterations, and improvements to buildings, etc.

3. Cars and trucks.

4. Equipment and machinery.

5. Fences.

6. Draft, breeding, sport, and dairy livestock.

7. Repairs to machinery, equipment, trucks, and cars that prolong their useful life, in-crease their value, or adapt them to differ-ent use.

8. Water wells, including drilling and equip-ping costs.

9. Land preparation costs, such as:

a. Clearing land for farming,

b. Leveling and conditioning land,

c. Purchasing and planting trees,

d. Building irrigation canals and ditches,

e. Laying irrigation pipes,

f. Installing drain tile,

g. Modifying channels or streams,

h. Constructing earthen, masonry, or concrete tanks, reservoirs, or dams, and

i. Building roads.

Business start-up and organizational costs. You can elect to deduct up to $5,000 of busi-ness start-up costs and $5,000 of organiza-tional costs paid or incurred after October 22, 2004. The $5,000 deduction is reduced by the amount your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized. See chapter 7 for more in-formation.

You elect to deduct start-up or organiza-tional costs by claiming the deduction on the in-come tax return filed by the due date (including extensions) for the tax year in which the active trade or business begins. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Clearly indicate the election on your amended return and write “Filed pursuant to section 301.9100-2” at the top of the amended return. File the amended return at the same address you filed the original return. The election applies when figuring taxable income for the current tax year and all subsequent years.

You can choose to forgo the election by clearly electing to capitalize your start-up or or-ganizational costs on an income tax return filed by the due date (including extensions) for the tax year in which the active trade or business begins. For more information about start-up and organizational costs, see chapter 7.

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

Crop production expenses. The uniform capitalization rules generally require you to cap-italize expenses incurred in producing plants. However, except for certain taxpayers required to use an accrual method of accounting, the capitalization rules don't apply to plants with a prefertile period of 2 years or less. For more in-formation, see Uniform Capitalization Rules in chapter 6.

Timber. Capitalize the cost of acquiring timber. Do not include the cost of land in the cost of the timber. You must generally capitalize direct costs incurred in reforestation. However, you can elect to deduct some forestation and refor-estation costs. See Forestation and reforesta-tion costs next. Reforestation costs include the following.

1. Site preparation costs, such as:

a. Girdling,

b. Applying herbicide,

c. Baiting rodents, and

Chapter 4Farm Business ExpensesPage 25

d. Clearing and controlling brush.

2. The cost of seed or seedlings.

3. Labor and tool expenses.

4. Depreciation on equipment used in plant-ing or seeding.

5. Costs incurred in replanting to replace lost seedlings.

You can choose to capitalize certain indirect re-forestation costs.

These capitalized amounts are your basis for the timber. Recover your basis when you sell the timber or take depletion allowances when you cut the timber. See Depletion in chap-ter 7.

Forestation and reforestation costs. You can elect to deduct up to $10,000 ($5,000 if married filing separately; $0 for a trust) of quali-fying reforestation costs paid or incurred after October 22, 2004, for each qualified timber property. Any remaining costs can be amortized over an 84-month period. See chapter 7. If you make an election to deduct or amortize qualify-ing reforestation costs, you should create and maintain separate timber accounts for each qualified timber property. The accounts should include all reforestation treatments and the dates they were applied. Any qualified timber property that is subject to the deduction or am-ortization election can't be included in any other timber account for which depletion is allowed. The timber account should be maintained until the timber is disposed of. For more information, see Notice 2006-47, 2006-20 I.R.B. 892, availa-ble at IRS.gov/irb/2006-20_IRB/ar11.html.

You elect to deduct forestation and refores-tation costs by claiming the deduction on the in-come tax return filed by the due date (including extensions) for the tax year in which the expen-ses were paid or incurred. If you are filing Form T (Timber), Forest Activities Schedule, also complete Form T (Timber), Part IV. If you aren't filing Form T (Timber), attach a statement to your return with the following information.

The unique stand identification numbers.

The total number of acres reforested dur-ing the tax year.

The nature of the reforestation treatments.

The total amounts of the qualified refores-tation expenditures eligible to be amortized or deducted.

However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended re-turn within 6 months of the due date of the re-turn (excluding extensions). Clearly indicate the election on your amended return and write “Filed pursuant to section 301.9100-2” at the top of the amended return. File the amended re-turn at the same address you filed the original return.

For more information about forestation and reforestation costs, see chapter 7.

For more information about timber, see Agriculture Handbook Number 731, Forest Landowners' Guide to the Fed-

eral Income Tax. You can find this publication online at www.fs.fed.us/publications.

Christmas tree cultivation. If you are in the business of planting and cultivating Christmas trees to sell when they are more than 6 years old, capitalize expenses incurred for planting and stump culture and add them to the basis of the standing trees. Recover these expenses as part of your adjusted basis when you sell the standing trees or as depletion allowances when you cut the trees. For more information, see Timber Depletion under Depletion in chapter 7.

You can deduct as business expenses the costs incurred for shearing and basal pruning of these trees. Expenses incurred for silviculture practices, such as weeding or cleaning, and noncommercial thinning also are deductible as business expenses.

Capitalize the cost of land improvements, such as road grading, ditching, and fire breaks, that have a useful life beyond the tax year. If the improvements don't have a determinable useful life, add their cost to the basis of the land. The cost is recovered when you sell or otherwise dispose of it. If the improvements have a deter-minable useful life, recover their cost through depreciation. Capitalize the cost of equipment and other depreciable assets, such as culverts and fences, to the extent you don't use them in planting Christmas trees. Recover these costs through depreciation.

Nondeductible Expenses

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

Personal, Living, and Family Expenses

You can't deduct certain personal, living, and family expenses as business expenses. These include rent and insurance premiums paid on property used as your home, life insurance pre-miums on yourself or your family, the cost of maintaining cars, trucks, or horses for personal use, allowances to minor children, attorneys' fees and legal expenses incurred in personal matters, and household expenses. Likewise, the cost of purchasing or raising produce or livestock consumed by you or your family isn't deductible.

Other Nondeductible Items

You can't deduct the following items on your tax return.

Loss of growing plants, produce, and crops. Losses of plants, produce, and crops raised for sale are generally not deductible. However, you may have a deductible loss on plants with a prefertile period of more than 2 years. See chapter 11 for more information.

Repayment of loans. You can't deduct the re-payment of a loan. However, if you use the pro-ceeds of a loan for farm business expenses, you can deduct the interest on the loan. See In-terest, earlier.

Estate, inheritance, legacy, succession, and gift taxes. You can't deduct estate, inheri-tance, legacy, succession, and gift taxes.

Loss of livestock. You can't deduct as a loss the value of raised livestock that die if you de-ducted the cost of raising them as an expense.

Losses from sales or exchanges between related persons. You can't deduct losses from sales or exchanges of property between you and certain related persons, including your spouse, brother, sister, ancestor, or lineal de-scendant. For more information, see chapter 2 of Pub. 544.

Cost of raising unharvested crops. You can't deduct the cost of raising unharvested crops sold with land owned more than one year if you sell both at the same time and to the same person. Add these costs to the basis of the land to determine the gain or loss on the sale. For more information, see Section 1231 Gains and Losses in chapter 9.

Cost of unharvested crops bought with land. Capitalize the purchase price of land, in-cluding the cost allocable to unharvested crops. You can't deduct the cost of the crops at the time of purchase. However, you can deduct this cost in figuring net profit or loss in the tax year you sell the crops.

Cost related to gifts. You can't deduct costs related to your gifts of agricultural products or property held for sale in the ordinary course of your business. The costs aren't deductible in the year of the gift or any later year. For exam-ple, you can't deduct the cost of raising cattle or the cost of planting and raising unharvested wheat on parcels of land given as a gift to your children.

Club dues and membership fees. Generally, you can't deduct amounts you pay or incur for membership in any club organized for business, pleasure, recreation, or any other social pur-pose. This includes country clubs, golf and ath-letic clubs, hotel clubs, sporting clubs, airline clubs, and clubs operated to provide meals un-der circumstances generally considered to be conducive to business discussions.

Exception. The following organizations won't be treated as a club organized for busi-ness, pleasure, recreation, or other social pur-poses, unless one of its main purposes is to conduct entertainment activities for members or their guests or to provide members or their guests with access to entertainment facilities.

Boards of trade.

Business leagues.

Chambers of commerce.

Civic or public service organizations.

Professional associations.

Trade associations.

Real estate boards.

Fines and penalties. Generally, no deduction is allowed for fines and penalties paid to a gov-ernment or specified non-governmental entity for the violation of any law except:

Amounts that constitute restitution;

Amount paid to come into compliance with the law;

Page 26Chapter 4Farm Business Expenses

Amounts paid or incurred as the result of certain court orders in which no govern-ment or specified non-governmental agency is a party; and

Amounts paid or incurred for taxes due.

On or after December 22, 2017, no deduc-tion is allowed for the restitution amount or amount paid to come into compliance with the law unless the amounts are specifically identi-fied in the settlement agreement or court order. Also, any amount paid or incurred as reim-bursement to the Government for the costs of any investigation or litigation are not eligible for the exceptions and are nondeductible.

See section 162(f), as amended by the Tax Cuts and Jobs Act, section 13306.

For the deductibility of penalites for exceed-ing marketing quotas, see Marketing Quota Penalties, discussed earlier.

Losses From Operating a Farm

If your deductible farm expenses are more than your farm income, you have a loss from the op-eration of your farm. The amount of the loss you can deduct when figuring your taxable income may be limited. To figure your deductible loss, you must apply the following limits.

The at-risk limits.

The passive activity limits.

The following discussions explain these limits.

If your deductible loss after applying these limits is more than your other income for the year, you may have a net operating loss. See Pub. 536.

If you don't carry on your farming activ-

ity to make a profit, your loss deduction CAUTION may be limited by the not-for-profit rules. See Not-for-Profit Farming, later.

At-Risk Limits

The at-risk rules limit your deduction for losses from most business or income-producing activi-ties, including farming. These rules limit the los-ses you can deduct when figuring your taxable income. The deductible loss from an activity is limited to the amount you have at risk in the ac-tivity.

You are at risk in any activity for:

1. The money and adjusted basis of property you contribute to the activity, and

2. Amounts you borrow for use in the activity if:

a. You are personally liable for repay-ment, or

b. You pledge property (other than prop-erty used in the activity) as security for the loan.

You aren't at risk, however, for amounts you borrow for use in a farming activity from a per-son who has an interest in the activity (other than as a creditor) or a person related to

someone (other than you) having such an inter-est.

For more information, see Pub. 925.

Passive Activity Limits

A passive activity is generally any activity in-volving the conduct of any trade or business in which you don't materially participate. Gener-ally, a rental activity is a passive activity.

If you have a passive activity, special rules limit the loss you can deduct in the tax year. You generally can deduct losses from passive activities only up to income from passive activi-ties. Credits are similarly limited.

For more information, see Pub. 925.

Excess Business Loss Limitation

Noncorporate taxpayers may be subject to ex-cess business loss limitations. The at-risk limits and the passive activity limits are applied before calculating the amount of any excess business loss. An excess business loss is the amount by which the total deductions attributable to all of your trades or businesses exceed your total gross income and gains attributable to those trades or businesses plus $250,000 (or $500,000 in the case of a joint return). A “trade or business” includes, but is not limited to, Schedule F and Schedule C activities, the activ-ity of being an employee, an activity reported on Form 4835, and other business activities repor-ted on Schedule E. Business gains and losses reported on Form 4797 and Form 8949 are in-cluded in the excess business loss calculation. This includes farming losses from casualty los-ses or losses by reason of disease or drought. Excess business losses that are disallowed are treated as a net operating loss carryover to the following taxable year. See Form 461 and in-structions for details.

Excess farm losses that are disallowed can be carried forward to the next tax year and trea-ted as a net operating loss deduction from that year.

Net Operating Loss Limitation

If you have a 2018 net operating loss attributa-ble to farming, you must carry it back to 2016, unless you elect to forgo the carryback. Farm-ing businesses can elect to forgo the carryback and carryover the farm net operating loss to 2019. See Instructions for Form 1045 or Form 1138 for more information.

Not-for-Profit Farming

If you operate a farm for profit, you can deduct all the ordinary and necessary expenses of car-rying on the business of farming on Schedule F. However, if you don't carry on your farming ac-tivity, or other activity you engage or invest in, to make a profit, you report the income from the

activity on Schedule 1 (Form 1040), line 21. You can no longer deduct expenses of carrying on the activity, even if you itemize your deduc-tions on Schedule A (Form 1040).

Activities you do as a hobby, or mainly for sport or recreation, are miscellaneous itemized deductions and can no longer be deducted. This also applies to an investment activity inten-ded only to produce tax losses for the investors.

The deductibility of not-for-profit losses ap-plies to individuals, partnerships, estates, trusts, and S corporations. It doesn't apply to corporations other than S corporations.

In determining whether you are carrying on your farming activity for profit, all the facts are taken into account. No one factor alone is deci-sive. Among the factors to consider are whether:

You operate your farm in a businesslike manner;

The time and effort you spend on farming indicate you intend to make it profitable;

You depend on income from farming for your livelihood;

Your losses are due to circumstances be-yond your control or are normal in the start-up phase of farming;

You change your methods of operation in an attempt to improve profitability;

You, or your advisors, have the knowledge needed to carry on the farming activity as a successful business;

You were successful in making a profit in similar activities in the past;

You make a profit from farming in some years and the amount of profit you make; and

You can expect to make a future profit from the appreciation of the assets used in the farming activity.

Presumption of profit. Your farming or other activity is presumed carried on for profit if it pro-duced a profit in at least 3 of the last 5 tax years, including the current year. Activities that consist primarily of breeding, training, showing, or racing horses are presumed carried on for profit if they produced a profit in at least 2 of the last 7 tax years, including the current year. The activity must be substantially the same for each year within this period. You have a profit when the gross income from an activity is more than the deductions for it.

If a taxpayer dies before the end of the 5-year (or 7-year) period, the period ends on the date of the taxpayer's death.

If your business or investment activity passes this 3- (or 2-) years-of-profit test, pre-sume it is carried on for profit. This means the limits discussed here don't apply. You can take all your business deductions from the activity on Schedule F, even for the years that you have a loss. You can rely on this presumption in every case, unless the IRS shows it isn't valid.

If you fail the 3- (or 2-) years-of-profit test, you still may be considered to operate your farm for profit by considering the factors listed earlier.

Using the presumption later. If you are starting out in farming and don't have 3 (or 2) years showing a profit, you may want to take advantage of this presumption later, after you

Chapter 4Farm Business ExpensesPage 27

have had the 5 (or 7) years of experience al-lowed by the test.

You can choose to do this by filing Form 5213. Filing this form postpones any determina-tion that your farming activity isn't carried on for profit until 5 (or 7) years have passed since you first started farming. You must file Form 5213 within 3 years after the due date of your return for the year in which you first carried on the ac-tivity, or, if earlier, within 60 days after receiving a written notice from the IRS proposing to disal-low deductions attributable to the activity.

The benefit gained by making this choice is that the IRS won't immediately question whether your farming activity is engaged in for profit. Accordingly, it won't limit your deduc-tions. Rather, you will gain time to earn a profit in 3 (or 2) out of the first 5 (or 7) years you carry on the farming activity. If you show 3 (or 2) years of profit at the end of this period, your de-ductions aren't limited under these rules. If you don't have 3 (or 2) years of profit (and can't oth-erwise show that you operated your farm for profit), the limit applies retroactively to any year in the 5-year (or 7-year) period with a loss.

Filing Form 5213 automatically extends the period of limitations on any year in the 5-year (or 7-year) period to 2 years after the due date of the return for the last year of the period. The period is extended only for deductions of the activity and any related deductions that might be affected.

Limit on deductions and losses. If your ac-tivity isn't carried on for profit, take deductions only in the following order, only to the extent stated in the three categories.

Category 1. Deductions you can take for personal as well as for business activities are allowed in full. For individuals, all nonbusiness deductions, such as those for home mortgage interest, taxes, and casualty losses (attributable to a federally declared disaster), belong in this category. See chapter 11 for more information. For the limits that apply to mortgage interest, see Pub. 936.

Category 2. Deductions that don't result in an adjustment to the basis of property are al-lowed next, but only to the extent your gross in-come from the activity is more than the deduc-tions you take (or could take) under the first category. Most business deductions, such as those for fertilizer, feed, insurance premiums, utilities, wages, etc., belong in this category.

Category 3. Business deductions that de-crease the basis of property are allowed last, but only to the extent the gross income from the activity is more than deductions you take (or could take) under the first two categories. The deductions for depreciation, amortization, and the part of a casualty loss an individual could not deduct in category (1) belong in this cate-gory. Where more than one asset is involved, divide depreciation and these other deductions proportionally among those assets.

Partnerships and S corporations. If a part-nership or S corporation carries on a not-for-profit activity, these limits apply at the partnership or S corporation level. They are re-flected in the individual shareholder's or part-ner's distributive shares.

More information. For more information on not-for-profit activities, see Not-for-Profit Activi-ties in Pub. 535, chapter 1.

5.

Soil and Water Conservation Expenses

Introduction

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

Soil or water conservation,

Prevention of erosion of land used in farm-ing, or

Endangered species recovery.

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

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

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

You must include in income most govern-ment payments for approved conservation practices. However, you can exclude some payments you receive under certain cost-shar-ing conservation programs. For more informa-tion, see Agricultural Program Payments in chapter 3.

To get the full deduction to which you TIP are entitled, you should maintain your records to clearly distinguish between your ordinary and necessary farm business ex-

penses and your soil and water conservation expenses.

Topics

This chapter discusses:

Business of farming

Plan certification

Conservation expenses

Assessment by conservation district

25% limit on deduction

When to deduct or capitalize

Sale of a farm

Business of Farming

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

Farm defined. A farm includes livestock, dairy, poultry, fish, fruit, and truck farms. It also in-cludes plantations, ranches, ranges, and or-chards. A fish farm is an area where fish and other marine animals are grown or raised and artificially fed, protected, etc. It doesn't include an area where they are merely caught or har-vested. A plant nursery is a farm for purposes of deducting soil and water conservation expen-ses.

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

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

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

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

Plan Certification

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

Conservation plan. A conservation plan in-cludes the farming conservation practices ap-proved for the area where your farmland is loca-ted. There are three types of approved plans.

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

NRCS county plans. These plans include a listing of farm conservation practices ap-proved for the county where the farmland is located. You can deduct expenses for

Page 28Chapter 5Soil and Water Conservation Expenses

Table 5-1. Limits on Deducting an Assessment by a Conservation
	District for Depreciable Property
Total Limit on Deduction		Yearly Limit on Deduction		Yearly Limit for All
for Assessment for		for Assessment for
Depreciable Property		Depreciable Property		Conservation Expenses
	10% of:		$500 + 10% of:		25% of:
Total assessment against all		Your deductible share of the		Your gross income from
members of the district for the		cost to the district for the		farming.
property.		property.
• No one taxpayer can		• If the amount you pay or		• Limit for all conservation
	deduct more than 10% of		incur for any year is		expenses, including
•	the total assessment.		more than the limit, you		assessments for
	Any amount over 10% is		can deduct for that year	•	depreciable property.
	a capital expense and is		only 10% of your		Amounts greater than
	added to the basis of		deductible share of the		25% can be carried to the
•	your land.	•	cost.		following year and added
	If an assessment is paid		You can deduct the		to that year's expenses.
	in installments, each		remainder in equal		The total is then subject
	payment must be		amounts over the next 9		to the 25% of gross
	prorated between the		tax years.		income from farming limit
	conservation expense				in that year.
	and the capital expense.

You must capitalize expenses to buy, build, install, or improve depreciable structures or fa-cilities. These expenses include those for mate-rials, tile (including drainage tile), pipe, pumps (and other equipment), supplies, wages, fuel, hauling, and moving dirt when making or instal-ling structures such as tanks, reservoirs, cul-verts, canals, dams, drainage systems, waste management systems or wells composed of masonry, concrete, tile (including drainage tile), metal, or wood. You recover your capital invest-ment through annual allowances for deprecia-tion.

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

Water well. You can't deduct the cost of drilling a water well for irrigation and other agri-cultural purposes as a soil and water conserva-tion expense. It is a capital expense. You re-cover your cost through depreciation. You also must capitalize your cost for drilling a test hole. If the test hole produces no water and you con-

conservation practices not included on the NRCS county plans only if the practice is a part of an individual site plan.

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

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

Conservation Expenses

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

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

a. Leveling,

b. Conditioning,

c. Grading,

d. Terracing,

e. Contour furrowing, and

f. Restoration of soil fertility.

2. The construction, control, and protection of:

g. Diversion channels;

h. Drainage ditches;

i. Irrigation ditches;

j. Earthen dams; and

k. Watercourses, outlets, and ponds.

3. The eradication of brush.

4. The planting of windbreaks.

You can't deduct expenses to drain or fill wet-lands, or to prepare land for center pivot

irrigation systems, as soil and water conserva-tion expenses. These expenses are added to the basis of the land.

If you choose to deduct soil and water

conservation expenses, you must in-CAUTION clude as gross income any cost-shar-ing payments you receive for those expenses. See chapter 3 for information about payments eligible for the cost-sharing exclusion.

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

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

Depreciable conservation assets. You gen-erally can't deduct your expenses for deprecia-ble conservation assets. However, you can de-duct certain amounts you pay or incur for an assessment for depreciable property that a soil and water conservation or drainage district lev-ies against your farm. See Assessment for De-preciable Property, later.

tinue drilling, the cost of the test hole is added to the cost of the producing well. You can re-cover the total cost through depreciation deduc-tions.

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

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

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

Assessment by Conservation District

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

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

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

A water or drainage district assessment for repairs or maintenance of district property or for interest paid by the district for a loan to buy

Chapter 5Soil and Water Conservation ExpensesPage 29

property may qualify as a business deduction.

See Regulations section 1.164-4(b)(1).

Assessment for Depreciable Property

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

The total assessment limit.

The yearly assessment limit.

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

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

the following.

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

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

Your gross income from farming.

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

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

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

Yearly assessment limit. The maximum amount you can deduct in any 1 year is the total of 10% of your deductible share of the cost as explained earlier, plus $500. If the amount you pay or incur is equal to or less than the maxi-mum amount, you can deduct it in the year it is paid or incurred. If the amount you pay or incur is more, you can deduct in that year only 10% of your deductible share of the cost. You can de-duct the remainder in equal amounts over the next 9 tax years. Your total conservation ex-pense deduction for each year is also subject to the 25% of gross income from farming limit on the deduction, discussed later.

Example 1. This year, the soil conservation district levies and you pay an assessment of $2,400 against your farm. Of the assessment, $1,500 is for digging drainage ditches. You can deduct this part as a soil or conservation

expense as if you had paid it directly. The re-maining $900 is for depreciable equipment to be used in the district's irrigation activities. The total amount assessed by the district against all its members for the depreciable equipment is $7,000.

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

To figure the maximum amount you can de-duct for the depreciable equipment this year, multiply your deductible share of the total as-sessment ($700) by 10% (0.10). Add $500 to the result for a total of $570. Your deductible share, $700, is greater than the maximum amount deductible in 1 year, so you can deduct only $70 of the amount you paid or incurred for depreciable property this year (10% of $700). You can deduct the balance at the rate of $70 a year over the next 9 years.

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

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

The maximum amount you can deduct this year for the depreciable equipment is $555 (10% of your deductible share of the total as-sessment, $55, plus $500). Since your deducti-ble share is less than the maximum amount de-ductible in 1 year, you can deduct the entire $550 this year. You can deduct the entire as-sessment, $2,400, as a soil and water conser-vation expense this year, subject to the 25% of gross income from farming limit on the deduc-tion, discussed below.

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

Death of farmer during 9-year period. If a farmer dies during the 9-year period, any re-maining amounts not yet deducted are deduc-ted in the year of death.

25% Limit on Deduction

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

Gross income from farming. Gross income from farming is the income you derive in the business of farming from the production of

crops, fish, fruits, other agricultural products, or livestock. Gains from sales of draft, breeding, or dairy livestock are included. Gains from sales of assets such as farm machinery, or from the dis-position of land, are not included.

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

Example. In 2017, you have gross income of $32,000 from two farms. During the year, you incurred $10,000 of deductible soil and water conservation expenses for one of the farms. However, your deduction is limited to 25% of $32,000, or $8,000. The $2,000 excess ($10,000 − $8,000) is carried over to 2018 and added to deductible soil and water conservation expenses made in that year. The total of the 2017 carryover plus 2018 expenses is deducti-ble in 2018, subject to the limit of 25% of your gross income from farming in 2018. Any expen-ses over the limit in that year are carried to 2019 and later years.

Net operating loss (NOL). The deduction for soil and water conservation expenses, after applying the 25% limit, is included when figuring an NOL for the year. If the NOL is carried to an-other year, the soil and water conservation de-duction included in the NOL is not subject to the 25% limit in the year to which it is carried.

When To Deduct or Capitalize

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

Change of method. If you want to change your method for the treatment of soil and water conservation expenses, or you want to treat the expenses for a particular project or a single farm in a different manner, you must get the ap-proval of the IRS. To get this approval, submit a written request by the due date of your return for the first tax year you want the new method to apply. You or your authorized representative must sign the request. Do not use Form 3115 for this request. Use the procedure outlined be-low.

The request must include the following infor-mation.

Your name and address.

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

Whether the method or change of method applies to all your soil and water conserva-tion expenses or only to those for a particu-lar project or farm. If the method or change of method doesn't apply to all your expen-ses, identify the project or farm to which the expenses apply.

Page 30Chapter 5Soil and Water Conservation Expenses

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

A statement that you will account sepa-rately in your books for the expenses to which this method or change of method re-lates.

Send your request to the following ad-dress.

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

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

Sale of a Farm

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

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

6.

Basis of Assets

Introduction

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

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

Keep accurate records of all items that affect the basis of your assets. For in-RECORDS formation on keeping records, see

chapter 1.

Topics

This chapter discusses:

Cost basis

Adjusted basis

Basis other than cost

Useful Items

You may want to see:

Publication

535 Business Expenses

544 Sales and Other Dispositions of Assets

551 Basis of Assets

946 How To Depreciate Property

See chapter 16 for information about getting publications and forms.

Cost Basis

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

You also may have to capitalize (add to ba-sis) certain other costs related to buying or pro-ducing property. Under the uniform capitaliza-tion rules, discussed later, you may have to capitalize direct costs and certain indirect costs of producing property.

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

Real Property

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

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

Lump-sum purchase. If you buy improve-ments, such as buildings, and the land on which they stand for a lump sum, allocate your cost

basis between the land and improvements. Al-locate the cost basis according to the respec-tive fair market values (FMVs) of the land and improvements at the time of purchase. Figure the basis of each asset by multiplying the lump sum by a fraction. The numerator is the FMV of that asset and the denominator is the FMV of the whole property at the time of purchase.

Fair market value (FMV). FMV is the price at which property would change hands between a willing buyer and a willing seller, neither hav-ing to buy or sell, and both having reasonable knowledge of all necessary facts. Sales of simi-lar property on or about the same date may help in figuring the FMV of the property.

If you are not certain of the FMV of the TIP land and improvements, you can allo-cate the basis according to their as-

sessed values for real estate tax purposes.

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

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

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

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

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

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

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

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

Land.

Labor and materials.

Architect's fees.

Building permit charges.

Payments to contractors.

Payments for rental equipment.

Inspection fees.

In addition, if you use your own employees, farm materials, and equipment to build an

Chapter 6Basis of AssetsPage 31

asset, do not deduct the following expenses. You must capitalize them by including these ex-penses in the asset's basis.

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

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

Operating and maintenance costs for equipment used in the construction.

The cost of business supplies and materi-als used in the construction.

Do not include the value of your own la-

!	bor, or any other labor you did not pay
CAUTION	for, in the basis of any property you

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

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

•	Almonds	•	Dates	•	Macadamia nuts	•	Pistachio nuts
•	Apples	•	Figs	•	Mangoes	•	Plums
•	Apricots	•	Grapefruit	•	Nectarines	•	Pomegranates
•	Avocados	•	Grapes	•	Olives	•	Prunes
•	Blueberries	•	Guavas	•	Oranges	•	Tangelos
•	Cherries	•	Kiwifruit	•	Peaches	•	Tangerines
•	Chestnuts	•	Kumquats	•	Pears	•	Tangors
•	Coffee beans	•	Lemons	•	Pecans	•	Walnuts
•	Currants	•	Limes	•	Persimmons

construct.

Allocating the Basis

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

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

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

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

Uniform Capitalization Rules

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

Page 32Chapter 6Basis of Assets

Beginning in 2018, a farm that has TIP average annual gross receipts of $25 million or less for the 3 preceding tax years and is not a tax shelter is not subject to

the uniform capitalization rules.

Generally, you are subject to the uniform capitalization rules if you do any of the follow-ing.

1. Produce real property or tangible personal property.

2. Acquire property for resale.

You produce property if you construct, build, install, manufacture, develop, improve, or cre-ate the property.

You are not subject to the uniform capi-TIP talization rules if the property is pro-

duced for personal use.

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

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

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

An ornamental tree.

A vine.

A bush.

Sod.

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

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

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

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

1. Any animal,

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

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

Exceptions (1) and (2) do not apply to a cor-poration, partnership, or tax shelter required to use an accrual method of accounting. See Ac-crual Method Required under Accounting Meth-ods in chapter 2.

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

If you elect not to use the uniform capi-

talization rules, you must use the alter-CAUTION native depreciation system for all prop-erty used in any of your farming businesses and placed in service in any tax year during which the election is in effect. See chapter 7 for addi-tional information on depreciation.

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

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

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

Adjusted Basis

Before figuring gain or loss on a sale, ex-change, or other disposition of property or figur-ing allowable depreciation, depletion, or amorti-zation, you must usually make certain adjustments to the cost basis or basis other than cost (discussed later) of the property. The adjustments to the original basis are increases or decreases to the cost basis or other basis which result in the adjusted basis of the prop-erty.

Increases to Basis

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

The following costs increase the basis of property.

The cost of extending utility service lines to property.

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

Legal fees for seeking a decrease in an as-sessment levied against property to pay for local improvements.

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

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

Deducting vs. capitalizing costs. Do not add to your basis costs that you can deduct as cur-rent expenses. For example, amounts paid for incidental repairs or maintenance are deducti-ble as business expenses and are not added to basis. However, you can elect either to deduct or to capitalize certain other costs. See chap-ter 7 in Pub. 535.

Note. Generally, you can deduct amounts paid for repairs and maintenance to your tangi-ble property if the amounts paid are not other-wise required to be capitalized. However, you may elect to capitalize amounts paid for repair and maintenance consistent with the treatment on your books and records. If you make this election, it applies to all amounts paid for repair and maintenance to tangible property that you treat as capital expenditures on your books and records for the tax year. To make the election to treat repairs and maintenance as capital expen-ditures, attach a statement titled “Section 1.263(a)-3(n) Election” to your timely filed return (excluding extensions). For more information on what to include in the statement, see Regulations section 1.263(a)-3(n). If you timely

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

Decreases to Basis

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

Section 179 deduction.

Deductions previously allowed or allowa-ble for amortization, depreciation, and de-pletion.

Alternative motor vehicle credit. See Form 8910.

Alternative fuel vehicle refueling property credit. See Form 8911.

Residential energy efficient property cred-its. See Form 5695.

Investment credit (part or all) taken.

Casualty and theft losses and insurance reimbursements.

Payments you receive for granting an easement.

Exclusion from income of subsidies for en-ergy conservation measures.

Certain canceled debt excluded from in-come.

Rebates from a manufacturer or seller.

Patronage dividends received from a co-operative association as a result of a pur-chase of property. See Patronage Divi-dends in chapter 3.

Gas-guzzler tax. See Form 6197.

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

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

Section 179 deduction. If you take the section 179 expense deduction for all or part of the cost of qualifying business property, de-crease the basis of the property by the deduc-tion.

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

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

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

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

Casualty and theft losses. If you have a casualty or theft loss, decrease the basis in your property by any insurance or other reim-bursement and by any deductible loss not cov-ered by insurance. See chapter 11 for informa-tion about figuring your casualty or theft loss.

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

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

Exclusion from income of subsidies for en-ergy conservation measures. You can ex-clude from gross income any subsidy you re-ceived from a public utility company for the purchase or installation of an energy conserva-tion measure for a dwelling unit. Reduce the ba-sis of the property by the excluded amount.

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

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

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

2. Qualified farm debt.

3. Qualified real property business debt (pro-vided you are not a C corporation).

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

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

Chapter 6Basis of AssetsPage 33

Basis Other Than Cost

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

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

The basis for depreciation is the lesser of:

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

Your adjusted basis on the date of the change.

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

Property received for services. If you re-ceive property for services, include the proper-ty's FMV in income. The amount you include in income becomes your basis. If the services were performed for a price agreed on before-hand, it will be accepted as the FMV of the property if there is no evidence to the contrary.

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

Taxable Exchanges

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

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

Page 34Chapter 6Basis of Assets

Nontaxable Exchanges

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

Involuntary Conversions

If you receive property as a result of an involun-tary conversion, such as a casualty, theft, or condemnation, figure the basis of the replace-ment property you receive using the basis of the converted property.

Similar or related property. If the replace-ment property is similar or related in service or use to the converted property, the replacement property's basis is the same as the old proper-ty's basis on the date of the conversion. How-ever, make the following adjustments.

1. Decrease the basis by the following amounts.

a. Any loss you recognize on the invol-untary conversion.

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

2. Increase the basis by the following amounts.

c. Any gain you recognize on the invol-untary conversion.

d. Any cost of acquiring the replacement property.

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

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

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

For more information about involuntary con-versions, see chapter 11.

Like-Kind Exchanges

Generally, if you exchange real property you use in your business or hold for investment solely for other business or investment real property of a like kind, you do not recognize the gain or loss from the exchange. If you also re-ceive non-like-kind property or money as part of the exchange, you do recognize gain, but only

to the extent of the value of the other property or money you received in the exchange, and you do not recognize any loss.

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

The basis of the property you receive gener-ally is the same as the adjusted basis of the property you gave up.

Example. You trade farmland for another larger tract of farmland. Your adjusted basis in your farmland is $110,000. The FMV of the new tract of farmland is $150,000. Because this is a nontaxable exchange, you do not recognize any gain and your basis in the farmland you receive is $110,000, the same as the adjusted basis in the farmland you exchanged.

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

Property plus cash. If you trade property in a like-kind exchange and also pay money, the ba-sis of the property you receive is increased by the money you paid.

Example. Assume the same facts from the previous example except you pay an additional $20,000 in cash. Your adjusted basis in the newly acquired farming real estate is $130,000 ($110,000 adjusted basis of your old farmland plus the $20,000 cash you paid).

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

Basis for depreciation. Special rules apply in determining and depreciating the basis of MACRS property acquired in a like-kind trans-action. For more information, see Figuring the Deduction for Property Acquired in a Nontaxa-ble Exchange under Figuring Depreciation Un-der MACRS in chapter 7.

Partially Nontaxable Exchanges

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

+ 30,000

− 30,000 $70,000

property you gave up with the following adjust-ments.

1. Decrease the basis by the following amounts.

a. Any money you receive.

b. Any loss you recognize on the ex-change.

2. Increase the basis by the following amounts.

c. Any additional costs you incur.

d. Any gain you recognize on the ex-change.

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

Example. You trade farmland (basis of $100,000) for another tract of farmland (FMV of

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

Basis of land traded . . . . . . . . . . . . .$100,000 Minus: Cash received (adjustment 1(a)) . . . . . . . . . . . . . . . . . . . . . . . . .

Plus: Gain recognized (adjustment

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

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

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

Example. You trade a tract of farmland with an adjusted basis of $100,000 for another tract of farmland that has an FMV of $92,500. You also receive $4,000 in cash and a pickup truck with an FMV of $11,000. Since only real prop-erty qualifies for like-kind exchange treatment, your receipt of the truck and cash means you must recognize gain on the exchange. You real-ize a gain of $7,500. This is the sum of the FMV of the tract of farmland you receive, the FMV of the truck you receive, and the cash you receive, minus the adjusted basis of the farmland you traded ($92,500 + $11,000 + $4,000 – $100,000). You include in income (recognize) all $7,500 of the gain because it is the lesser of the realized gain ($7,500) and the sum of the FMV of the unlike property and the cash re-ceived ($15,000). Your basis in the properties you received is figured as follows.

Adjusted basis old farmland . . . . . . $100,000 Minus: Cash received (adjustment

1(a)) . . . . . . . . . . . . . . . . . . . . . . . . . ^{− 4,000} $96,000

Plus: Gain recognized (adjustment

2(b)) . . . . . . . . . . . . . . . . . . . . . . . . .^{+ 7,500}

Total basis of properties

received . . . . . . . . . . . . . . . . ^$^103,500

Allocate the basis of $103,500 first to the unlike property, the truck ($11,000). This is the truck's FMV. The rest ($92,500) is the basis in the farmland.

Sale and Purchase

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

Example. You own farmland with a barn. The properties have a combined adjusted basis of $70,000, and an FMV of $150,000. You are interested in another tract of farmland with a larger barn owned by your neighbor who is in-terested in exchanging the property with you. The total FMV of your neighbor's farmland and barn is $200,000. You want the new barn to have a larger basis for depreciation, so you ar-range to sell your old farmland and barn to your neighbor for $150,000. Your neighbor then sells his farmland and barn to you for $200,000. However, you are treated as having exchanged the old property for the new property because the sale and purchase are reciprocal and mutu-ally dependent. Your basis in the new property is $120,000 ($50,000 cash paid plus $70,000 adjusted basis in your old property), which must be allocated between the farmland and the barn.

Property Received as a Gift

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

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

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

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

Net increase in value of the gift

Amount of the gift

The net increase in value of the gift is the FMV of the gift minus the donor's adjusted ba-sis. The amount of the gift is its value for gift tax purposes after reduction by any annual exclu-sion and marital or charitable deduction that ap-plies to the gift.

Example. In 2018, you received a gift of property from your mother that had an FMV of $50,000. Her adjusted basis was $20,000. The amount of the gift for gift tax purposes was $35,000 ($50,000 minus the $15,000 annual exclusion). She paid a gift tax of $7,100. Your basis, $26,106, is figured as follows.

Fair market value . . . . . . . . . . . . . . . . . .	$50,000
Minus: Adjusted basis . . . . . . . . . . . . . .	−20,000
. . . . . . . . . . . . . . .Netincreaseinvalue	$30,000
Gift tax paid
.....................	$7,100
Multiplied by ($30,000 ÷ $35,000) . . . . . .	× 0.86
. . . . .Gifttaxduetonetincreaseinvalue	$6,106
Adjusted basis of property to your	+20,000
mother . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . .Yourbasisintheproperty	$26,106

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

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

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

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

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

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

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

Chapter 6Basis of AssetsPage 35

Property Transferred From a Spouse

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

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

For more information, see Property Settle-ments in Pub. 504, Divorced or Separated Indi-viduals.

Inherited Property

Your basis in property you inherited from a de-cedent is generally one of the following.

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

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

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

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

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

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

You may be liable for an additional estate tax if, within 10 years after the death of the de-cedent, you transfer the property or the property stops being used as a farm. This tax does not apply if you dispose of the property in a

like-kind exchange or in an involuntary conver-sion in which all of the proceeds are reinvested in qualified replacement property. The tax also does not apply if you transfer the property to a member of your family and certain requirements are met.

You can elect to increase your basis in spe-cial-use valuation property if it becomes subject to the additional estate tax. To increase your basis, you must make an irrevocable election and pay interest on the additional estate tax fig-ured from the date 9 months after the dece-dent's death until the date of payment of the ad-ditional estate tax. If you meet these requirements, increase your basis in the prop-erty to its FMV on the date of the decedent's death or the alternate valuation date. The in-crease in your basis is considered to have oc-curred immediately before the event that resul-ted in the additional estate tax.

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

Contains your (and the estate's) name, ad-dress, and taxpayer identification number;

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

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

Provides any additional information re-quired by the Form 706-A instructions.

For more information, see Form 706, United States Estate (and Generation-Skipping Trans-fer) Tax Return; Form 706-A; and the related in-structions.

Property Distributed From a Partnership or Corporation

The following rules apply to determine a part-ner's basis and a shareholder's basis in prop-erty distributed respectively from a partnership to the partner with respect to the partner's inter-est in the partnership and from a corporation to the shareholder with respect to the sharehold-er's ownership of stock in the corporation.

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

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

7.

Depreciation, Depletion, and Amortization

What's New for 2018

Increased section 179 expense deduction dollar limits. The maximum amount you can elect to deduct for most section 179 property you placed in service in 2018 is $1,000,000. This limit is reduced by the amount by which the cost of the property placed in service during the tax year exceeds $2,500,000. See Dollar Limits under Section 179 Expense Deduction, later.

Depreciation of certain farm property. The recovery period for any machine and equipment (other than any grain bin, cotton ginning asset, fence or other land improvement) used in a farming business and placed in service in 2018, has changed from 7 years to 5 years.

Farming businesses are no longer required to use the 150% declining balance method for 3-, 5-, 7-, and 10-year property used in a farm-ing business and placed in service in 2018. See Figuring Depreciation Under MACRS, later.

Special depreciation allowance for certain property. The special allowance will be phased down to 40% for certain property ac-quired before September 28, 2017, and placed in service in 2018. Also, you may be able to take a 100% special depreciation allowance for certain property and certain plants bearing fruits and nuts acquired or planted or grafted after September 27, 2017, and placed in service or planted or grafted after September 27, 2017, and placed in service or planted or grafted be-fore January 1, 2023. You may elect to apply a 50% special deprecation allowance instead of the 100% allowance for the first tax year ending after September 27, 2017. See Certain qualified property acquired after September 27, 2017, Certain qualified property acquired before Sep-tember 28, 2017, and, Certain specified plants.

Introduction

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

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

Page 36Chapter 7Depreciation, Depletion, and Amortization

Topics

This chapter discusses:

Overview of depreciation

Section 179 expense deduction

Special depreciation allowance

Modified Accelerated Cost Recovery System (MACRS)

Listed property

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

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

Useful Items

You may want to see:

Publication

463 Travel, Gift, and Car Expenses

534 Depreciating Property Placed in

Service Before 1987

535	Business Expenses
544	Sales and Other Dispositions of
	Assets
551	Basis of Assets
946	How To Depreciate Property

Form (and Instructions)

T(Timber), Forest Activities Schedule

3115 Application for Change in Accounting Method

4562 Depreciation and Amortization

4797 Sales of Business Property

See chapter 16 for information about getting publications and forms.

It is important to keep good records for property you depreciate. Do not file RECORDS these records with your return. Instead,

you should keep them as part of the permanent records of the depreciated property. They will help you verify the accuracy of the depreciation of assets placed in service in the current and previous tax years. For general information on recordkeeping, see Pub. 583, Starting a Busi-ness and Keeping Records. For specific infor-mation on keeping records for section 179 property and listed property, see Pub. 946, How To Depreciate Property.

Overview of

Depreciation

This overview discusses basic information on the following.

What property can be depreciated.

What property cannot be depreciated.

When depreciation begins and ends.

Whether MACRS can be used to figure de-preciation.

What is the basis of your depreciable prop-erty.

How to treat repairs and improvements.

When you must file Form 4562.

How you can correct depreciation claimed incorrectly.

What Property Can Be Depreciated?

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

It must be property you own.

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

It must have a determinable useful life.

It must have a useful life that extends sub-stantially beyond the year you place it in service.

Property You Own

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

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

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

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

Property Used in Your Business or Income-Producing Activity

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

Example 1. If you use your car for farm business, you can deduct depreciation based on its percentage of use in farming. If you also use it for investment purposes, you can depre-ciate it based on its percentage of investment use.

Example 2. If you use part of your home for business, you may be able to deduct deprecia-tion on that part based on its business use. For more information, see Business Use of Your Home in chapter 4.

You may be able to use the simplified TIP method to determine your business use of the home deduction. If you choose to use the simplified method, you can-not also deduct depreciation on the part of the home used for business. For more information about the simplified method, see Pub. 587,

Business Use of Your Home.

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

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

Property Having a Determinable Useful Life

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

Irrigation systems and water wells. Irriga-tion systems and wells used in a trade or busi-ness can be depreciated if their useful life can be determined. You can depreciate irrigation systems and wells composed of masonry, con-crete, tile (including drainage tile), metal, or wood. In addition, you can depreciate costs for moving dirt to construct irrigation systems and water wells composed of these materials. How-ever, land preparation costs for center pivot irri-gation systems are not depreciable.

Dams, ponds, and terraces. In general, you cannot depreciate earthen dams, ponds, and terraces unless the structures have a determi-nable useful life.

What Property Cannot Be Depreciated?

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

Land. You can never depreciate the cost of land because land does not wear out, be-come obsolete, or get used up. The cost of land generally includes the cost of

Chapter 7Depreciation, Depletion, and AmortizationPage 37

clearing, grading, planting, and landscap-ing. Although you cannot depreciate land, you can depreciate certain costs incurred in preparing land for business use. See chapter 1 of Pub. 946.

Property placed in service and disposed of in the same year. Determining when prop-erty is placed in service is explained later.

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

Intangible property such as section 197 in-tangibles. This property does not have a determinable useful life and generally can-not be depreciated. However, see Amorti-zation, later. Special rules apply to com-puter software (discussed below).

Certain term interests (discussed below).

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

It is readily available for purchase by the general public.

It is subject to a nonexclusive license.

It has not been substantially modified.

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

Certain term interests in property. You can-not depreciate a term interest in property cre-ated or acquired after July 27, 1989, for any pe-riod during which the remainder interest is held, directly or indirectly, by a person related to you. This rule does not apply to the holder of a term interest in property acquired by gift, bequest, or inheritance. For more information, see chap-ter 1 of Pub. 946.

When Does Depreciation Begin and End?

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

If your planter comes unassembled in De-cember 2017 and is put together in February 2018, it is not placed in service until 2018. You begin to depreciate it in 2018.

If your planter was delivered and assembled in February 2018 but not used until April 2018, it is placed in service in February 2018, because this is when the planter was ready for its speci-fied use. You begin to depreciate it in 2018.

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

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

Idle Property

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

Cost or Other Basis Fully Recovered

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

For information on abandonment of prop-erty, see chapter 8. For information on de-stroyed property, see chapter 11, and Pub. 547, Casualties, Disasters, and Thefts.

Can You Use MACRS To Depreciate Your Property?

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

You cannot use MACRS to depreciate the following property.

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

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

Intangible property.

Films, video tapes, and recordings.

Certain corporate or partnership property acquired in a nontaxable transfer.

Property you elected to exclude from

MACRS.

For more information, see chapter 1 of Pub.

946.

What Is the Basis of Your Depreciable Property?

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

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

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

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

Placed in Service

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

Example. You bought a planter for use in your farm business. The planter was delivered in December 2017 after harvest was over. You begin to depreciate the planter in 2017 because it was ready and available for its specific use in 2017, even though it will not be used until the spring of 2018.

Retired From Service

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

You sell or exchange the property.

You convert the property to personal use.

You abandon the property.

You transfer the property to a supplies or scrap account.

The property is destroyed.

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

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

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

Page 38Chapter 7Depreciation, Depletion, and Amortization

For more information, see chapter 6.

How Do You Treat Repairs and Improvements?

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

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

Example. You repair a small section on a corner of the roof of a barn that you rent to oth-ers. You deduct the cost of the repair as a busi-ness expense. However, if you replace the en-tire roof, the new roof is considered to be an improvement because it increases the value and lengthens the life of the property. You de-preciate the cost of the new roof.

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

Do You Have To File Form 4562?

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

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

Depreciation for property placed in service during the current year.

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

Amortization of costs that began in the cur-rent year.

For more information, see the Instructions for Form 4562.

How Do You Correct Depreciation Deductions?

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

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

You claimed the incorrect amount because of a posting error made in any year, for ex-ample, omitting an asset from the depreci-ation schedule.

You have not adopted a method of ac-counting for the property placed in service by you in tax years ending after December 29, 2003.

You claimed the incorrect amount on prop-erty placed in service by you in tax years ending before December 30, 2003.

Note. You have adopted a method of account-ing if you used the same incorrect method of depreciation for two or more consecutively filed returns.

If you are not allowed to make the correction on an amended return, you may be able to change your accounting method to claim the correct amount of depreciation. See the Instruc-tions for Form 3115.

Section 179 Expense Deduction

You can elect to recover all or part of the cost of certain qualifying property, up to a limit, by de-ducting it in the year you place the property in service. This is the section 179 expense deduc-tion. You can elect the section 179 expense de-duction instead of recovering the cost by taking depreciation deductions.

This part of the chapter explains the rules for the section 179 expense deduction. It explains what property qualifies for the deduction, what property does not qualify for the deduction, the limits that may apply, how to elect the deduc-tion, and when you may have to recapture the deduction.

For more information, see chapter 2 of Pub.

946.

What Property Qualifies?

To qualify for the section 179 expense deduc-tion, your property must meet all the following requirements.

It must be eligible property.

It must be acquired primarily for business use.

It must have been acquired by purchase.

Eligible Property

To qualify for the section 179 expense deduc-tion, your property must be one of the following types of depreciable property.

1. Tangible personal property.

2. Other tangible property (except buildings and their structural components) used as:

a. An integral part of manufacturing, pro-duction, or extraction or of furnishing transportation, communications, elec-tricity, gas, water, or sewage disposal services;

b. A research facility used in connection with any of the activities in (a) above; or

c. A facility used in connection with any of the activities in (a) for the bulk stor-age of fungible commodities.

3. Single purpose agricultural (livestock) or horticultural structures.

4. Storage facilities (except buildings and their structural components) used in con-nection with distributing petroleum or any primary product of petroleum.

5. Qualified real property. (Special rules ap-ply to qualified real property that you elect to treat as qualified section 179 real prop-erty. For more information, see chapter 2 of Pub. 946, and section 179(f) of the In-ternal Revenue Code.)

6. Off-the-shelf computer software that is readily available for purchase by the gen-eral public, is subject to a nonexclusive lease, and has not been substantially modified.

Tangible personal property. Tangible per-sonal property is any tangible property that is not real property. It includes the following prop-erty.

Machinery and equipment.

Property contained in or attached to a building (other than structural compo-nents), such as milk tanks, automatic feed-ers, barn cleaners, and office equipment.

Gasoline storage tanks and pumps at retail service stations.

Livestock, including horses, cattle, hogs, sheep, goats, and mink and other fur-bear-ing animals.

Facility used for the bulk storage of fungi-ble commodities. A facility used for the bulk storage of fungible commodities is qualifying property for purposes of the section 179 ex-pense deduction if it is used in connection with any of the activities listed earlier in item (2)(c). Bulk storage means the storage of a commodity in a large mass before it is used.

Grain bins. A grain bin is an example of a storage facility that is qualifying section 179 property. It is a facility used in connection with the production of grain or livestock for the bulk storage of fungible commodities.

Single purpose agricultural or horticultural structures. A single purpose agricultural (live-stock) or horticultural structure is qualifying property for purposes of the section 179 ex-pense deduction.

Agricultural structure. A single purpose agricultural (livestock) structure is any building or enclosure specifically designed, constructed, and used for both the following reasons.

To house, raise, and feed a particular type of livestock and its produce.

To house the equipment, including any re-placements, needed to house, raise, or feed the livestock.

For this purpose, livestock includes poultry. Single purpose structures are qualifying

property if used, for example, to breed chickens or hogs, produce milk from dairy cattle, or pro-duce feeder cattle or pigs, broiler chickens, or eggs. The facility must include, as an integral part of the structure or enclosure, equipment necessary to house, raise, and feed the live-stock.

Chapter 7Depreciation, Depletion, and AmortizationPage 39

Horticultural structure. A single purpose horticultural structure is either of the following.

A greenhouse specifically designed, con-structed, and used for the commercial pro-duction of plants.

A structure specifically designed, construc-ted, and used for the commercial produc-tion of mushrooms.

Use of structure. A structure must be used only for the purpose that qualified it. For exam-ple, a hog barn will not be qualifying property if you use it to house poultry. Similarly, using part of your greenhouse to sell plants will make the greenhouse nonqualifying property.

If a structure includes work space, the work space can be used only for the following activi-ties.

Stocking, caring for, or collecting livestock or plants or their produce.

Maintaining the enclosure or structure.

Maintaining or replacing the equipment or stock enclosed or housed in the structure.

Qualified real property. Qualified real property is any qualified improvement property described in section 168(e)(6), and any of the following improvements to nonresidential real property placed in service after the date such property was first placed in service.

Roofs.

Heating, ventilation, and air conditioning.

Fire protection and alarms.

Security systems.

Property Acquired by Purchase

To qualify for the section 179 expense deduc-tion, your property must have been acquired by purchase. For example, property acquired by gift or inheritance does not qualify. Property ac-quired from a related person (that is, your spouse, ancestors, or lineal descendants) is not considered acquired by purchase. New or used equipment you acquired by purchase during the current tax year qualifies for the section 179 de-duction.

Example. Adrian is a farmer. He purchased two tractors, one from his brother and one from his father. He placed both tractors in service in the same year he bought them. The tractor pur-chased from his father does not qualify for the section 179 expense deduction because he is a related person (as defined above). The tractor purchased from his brother does qualify for the deduction because Adrian is not a related per-son (as defined above).

What Property Does Not Qualify?

Land and improvements. Land and land im-provements do not qualify as section 179 prop-erty. Land improvements include swimming pools, paved parking areas, wharves, docks, bridges, and nonagricultural fences. However, agricultural fences do qualify as section 179 property. Similarly, field drainage tile also quali-fies as section 179 property.

Excepted property. Even if the requirements explained in the preceding discussions are met,

farmers cannot elect the section 179 expense deduction for the following property.

Certain property you lease to others (if you are a noncorporate lessor).

Certain property used predominantly to fur-nish lodging or in connection with the fur-nishing of lodging.

Property used by a tax-exempt organiza-tion (other than a tax-exempt farmers' co-operative) unless the property is used mainly in a taxable unrelated trade or busi-ness.

Property used by governmental units or foreign persons or entities (except property used under a lease with a term of less than 6 months).

How Much Can You Deduct?

Your section 179 expense deduction is gener-ally the cost of the qualifying property. How-ever, the total amount you can elect to deduct under section 179 is subject to a dollar limit and a business income limit. These limits apply to each taxpayer, not to each business. However, see Married individuals under Dollar Limits, later. Also see the special rules for applying the limits for partnerships and S corporations under Partnerships and S Corporations, later.

If you deduct only part of the cost of qualify-ing property as a section 179 expense deduc-tion, you can generally depreciate the cost you do not deduct.

Use Part I of Form 4562 to figure your sec-tion 179 expense deduction.

Partial business use. When you use property for business and nonbusiness purposes, you can elect the section 179 expense deduction only if you use it more than 50% for business in the year you place it in service. If you used the property more than 50% for business, multiply the cost of the property by the percentage of business use. Use the resulting business cost to figure your section 179 expense deduction.

Trade-in of other property. If you buy qualify-ing property with cash and a trade-in, its cost for purposes of the section 179 expense deduction includes only the cash you paid. For example, if you buy (for cash and a trade-in) a new tractor for use in your business, your cost for the sec-tion 179 expense deduction is the cash you paid. It does not include the adjusted basis of the old tractor you trade for the new tractor.

Example. Adyo Farms traded two cultiva-tors having a total adjusted basis of $6,800 for a new cultivator costing $13,200. They received an $8,000 trade-in allowance for the old cultiva-tors. The farmer reports depreciation recapture for the sale of two traded cultivators in the amount of $1,200 ($8,000 trade-in allowance minus $6,800 basis). The farmer then paid a to-tal of $13,200 for the new cultivator. Adyo basis in the new cultivator is $13,200. Adyo also tra-ded a used pickup truck with an adjusted basis of $8,000 for a new pickup truck costing $35,000 cash paid.

Only the cash paid by Adyo qualifies for the section 179 expense deduction. Adyo's busi-ness costs that qualify for a section 179 ex-pense deduction are $48,200 ($13,200 +

$35,000). For information on the maximum amount you can elect to deduct, see Dollar Lim-its below.

Dollar Limits

The total amount you can elect to deduct under section 179 for most property placed in service in 2018 is $1,000,000. If you acquire and place in service more than one item of qualifying property during the year, you can allocate the section 179 expense deduction among the items in any way, as long as the total deduction is not more than $1,000,000. You cannot carry costs in excess of the $1,000,000 limit over to future years.

Reduced dollar limit for cost exceeding $2,500,000. If the cost of your qualifying sec-tion 179 property placed in service in 2018 is over $2,500,000, you must reduce the dollar limit (but not below zero) by the amount of cost over $2,500,000. If the cost of your section 179 property placed in service during 2018 is $3,500,000 or more, you cannot take a section 179 expense deduction and you cannot carry over any of the cost that is more than $3,500,000.

Example. This year, George Thomas placed in service machinery costing $2,650,000. Because this cost is $150,000 more than $2,500,000, he must reduce his dol-lar limit to $850,000 ($1,000,000 − $150,000). He cannot carry over any of the costs that ex-ceed the $850,000 reduced limit.

Limits for sport utility vehicles. The total amount you can elect to deduct for certain sport utility vehicles and certain other vehicles placed in service in 2018 is $25,000. This rule applies to any 4-wheeled vehicle primarily designed or used to carry passengers over public streets, roads, and highways that is rated at more than 6,000 pounds gross vehicle weight and not more than 14,000 pounds gross vehicle weight.

For more information, see chapter 2 of Pub.

946.

Limits for passenger automobiles. For a passenger automobile that is placed in service in 2018, the total section 179 and depreciation deduction is limited. See Do the Passenger Au-tomobile Limits Apply, later.

Married individuals. If you are married, how you figure your section 179 expense deduction depends on whether you file jointly or sepa-rately. If you file a joint return, you and your spouse are treated as one taxpayer in determin-ing any reduction to the dollar limit, regardless of which of you purchased the property or placed it in service. If you and your spouse file separate returns, you are treated as one tax-payer for the dollar limit, including the reduction for costs over $2,500,000. You must allocate the dollar limit (after any reduction) equally be-tween you, unless you both elect a different al-location. If the percentages elected by each of you do not total 100%, 50% will be allocated to each of you.

Joint return after separate returns. If you and your spouse elect to amend your separate

Page 40Chapter 7Depreciation, Depletion, and Amortization

returns by filing a joint return after the due date for filing your return, the dollar limit on the joint return is the lesser of the following amounts.

The dollar limit (after reduction for any cost of section 179 property over $2,500,000).

The total cost of section 179 property you and your spouse elected to expense on your separate returns.

Business Income Limit

The total cost you can deduct each year after you apply the dollar limit is limited to the taxable income from the active conduct of any trade or business during the year. Generally, you are considered to actively conduct a trade or busi-ness if you meaningfully participate in the man-agement or operations of the trade or business.

Any cost not deductible in one year under section 179 because of this limit can be carried to the next year. See Carryover of disallowed deduction, later.

Taxable income. In general, figure taxable in-come for this purpose by totaling the net in-come and losses from all trades and busi-nesses you actively conducted during the year. In addition to net income or loss from a sole proprietorship, partnership, or S corporation, net income or loss derived from a trade or busi-ness also includes the following items.

Section 1231 gains (or losses) as dis-cussed in chapter 9.

Interest from working capital of your trade or business.

Wages, salaries, tips, or other pay earned by you (or your spouse if you file a joint re-turn) as an employee of any employer.

In addition, figure taxable income without re-gard to any of the following.

The section 179 expense deduction.

The self-employment tax deduction.

Any net operating loss carryback or carry-forward.

Any unreimbursed employee business ex-penses.

Two different taxable income limits. In addi-tion to the business income limit for your section 179 expense deduction, you may have a taxa-ble income limit for some other deduction (for example, charitable contributions). You may have to figure the limit for this other deduction taking into account the section 179 expense de-duction. If so, complete the following steps.

StepAction

Figure taxable income without the section 179 expense deduction or the other deduction.

Figure a hypothetical section 179 expense deduction using the taxable income figured in Step 1.

Subtract the hypothetical section 179 expense deduction figured in Step 2 from the taxable income figured in Step 1.

Figure a hypothetical amount for the other deduction using the amount figured in Step 3 as taxable income.

Subtract the hypothetical other deduction figured in Step 4 from the taxable income figured in

Step 1.

Figure your actual section 179 expense deduction using the taxable income figured in Step 5.

Subtract your actual section 179 expense deduction figured in Step 6 from the taxable income figured in Step 1.

Figure your actual other deduction using the taxable income figured in Step 7.

Example. On February 1, 2018, the XYZ farm corporation purchased and placed in serv-ice qualifying section 179 property that cost $500,000. It elects to expense the entire $500,000 cost under section 179. In June, the corporation gave a charitable contribution of $100,000. A corporation's limit on charitable contributions is figured after subtracting any section 179 expense deduction. The business income limit for the section 179 expense deduc-tion is figured after subtracting any allowable charitable contributions. XYZ's taxable income figured without the section 179 expense deduc-tion or the deduction for charitable contributions is $700,000. XYZ figures its section 179 ex-pense deduction and its deduction for charita-ble contributions as follows.

Step 1. Taxable income figured without ei-ther deduction is $700,000.

Step 2. Using $700,000 as taxable in-come, XYZ's hypothetical section 179 ex-pense deduction is $500,000.

Step 3. $200,000 ($700,000 − $500,000). Step 4. Using $200,000 (from Step 3) as taxable income, XYZ's hypothetical charita-ble contribution (limited to 10% of taxable income) is $20,000.

Step 5. $680,000 ($700,000 − $20,000). Step 6. Using $680,000 (from Step 5) as taxable income, XYZ figures the actual section 179 expense deduction. Because the taxable income is at least $500,000, XYZ can take a $500,000 section 179 ex-pense deduction.

Step 7. $200,000 ($700,000 − $500,000). Step 8. Using $200,000 (from Step 7) as taxable income, XYZ's actual charitable contribution (limited to 10% of taxable in-come) is $20,000.

Carryover of disallowed deduction. You can carry over for an unlimited number of years the cost of any section 179 property you elected to expense but were unable to because of the business income limit.

The amount you carry over is used in deter-mining your section 179 expense deduction in

the next year. However, it is subject to the limits in that year. If you place more than one property in service in a year, you can select the proper-ties for which all or a part of the cost will be car-ried forward. Your selections must be shown in your books and records.

Example. Last year, Diana Reynolds placed in service a machine that cost $100,000 and elected to deduct all $100,000 under sec-tion 179. The taxable income from her business (determined without regard to both a section 179 expense deduction for the cost of the ma-chine and the self-employment tax deduction) was $80,000. Her section 179 expense deduc-tion was limited to $80,000. The $20,000 cost that was not allowed as a section 179 expense deduction (because of the business income limit) is carried to this year.

This year, Diana placed another machine in service that cost $110,000. Her taxable income from business (determined without regard to both a section 179 expense deduction for the cost of the machine and the self-employment tax deduction) is $120,000. Diana can deduct the full cost of the machine ($110,000) but only $10,000 of the carryover from last year because of the business income limit. She can carry over the balance of $10,000 to next year.

Partnerships and S Corporations

The section 179 expense deduction limits apply both to the partnership or S corporation and to each partner or shareholder. The partnership or S corporation determines its section 179 ex-pense deduction subject to the limits. It then al-locates the deduction among its partners or shareholders.

If you are a partner in a partnership or share-holder of an S corporation, you add the amount allocated from the partnership or S corporation to any section 179 costs not related to the part-nership or S corporation and then apply the dol-lar limit to this total. To determine any reduction in the dollar limit for costs over $2,500,000, you do not include any of the cost of section 179 property placed in service by the partnership or S corporation. After you apply the dollar limit, you apply the business income limit to any re-maining section 179 costs. For more informa-tion, see chapter 2 of Pub. 946.

Example. In 2018, Partnership P placed in service section 179 property with a total cost of $2,600,000. P must reduce its dollar limit by $100,000 ($2,600,000 − $2,500,000). Its maxi-mum section 179 expense deduction is $900,000 ($1,000,000 − $100,000), and it elects to expense that amount. Because P's taxable income from the active conduct of all its trades or businesses for the year was $2,000,000, it can deduct the full $900,000. P allocates $200,000 of its section 179 expense deduction and $500,000 of its taxable income to John, one of its partners.

John also conducts a business as a sole proprietor and in 2018, placed in service in that business, section 179 property costing $800,000. John's taxable income from that business was $200,000. In addition to the $200,000 allocated from P, he elects to ex-pense the $550,000 of his sole proprietorship's

Chapter 7Depreciation, Depletion, and AmortizationPage 41

section 179 costs. However, John's deduction is limited to his business taxable income of $700,000 ($500,000 from P plus $200,000 from his sole proprietorship). He carries over $50,000 ($750,000 − $700,000) of the elected section 179 costs to 2019.

How Do You Elect the Deduction?

You elect to take the section 179 expense de-duction by completing Part I of Form 4562.

If you elect the deduction for listed

property, complete Part V of Form CAUTION 4562 before completing Part I.

File Form 4562 with either of the following.

Your original tax return (whether or not you filed it timely).

An amended return filed within the time prescribed by law. An election made on an amended return must specify the item of section 179 property to which the election applies and the part of the cost of each such item to be taken into account. The amended return also must include any re-sulting adjustments to taxable income.

Revoking an election. An election (or any specification made in the election) to take a section 179 expense deduction for 2018 can be revoked without IRS approval by filing an amen-ded return. The amended return must be filed within the time prescribed by law. The amended return also must include any resulting adjust-ments to taxable income (for example, allowa-ble depreciation in that tax year for the item of section 179 property for which the election per-tains). Once made, the revocation is irrevoca-ble.

1. Figure the allowable depreciation for the section 179 expense deduction you claimed. Begin with the year you placed the property in service and include the year of recapture.

2. Subtract the depreciation figured in (1) from the section 179 expense deduction you actually claimed. The result is the amount you must recapture.

Example. In January 2016, Paul Lamb, a calendar year taxpayer, bought and placed in service section 179 property costing $10,000. The property is 3-year property and is depreci-ated under the Modified Accelerated Cost Re-covery System (MACRS) and a half-year con-vention. The property is not listed property. He elected a $5,000 section 179 expense deduc-tion for the property and also elected not to claim a special depreciation allowance. He used the property only for business in 2016 and 2017. During 2018 he used the property 40% for business and 60% for personal use. He fig-ures his recapture amount as follows.

Section 179 expense deduction claimed			$5,000
(2016) ......................	.	.....
*Minus:* Allowable depreciation
(instead of section 179 expense deduction):
2016 ......................		$1,250
2017 ......................		1,875	3,625
2018 ($1,250 × 40% (business)) . . .		500
. . . . .2018—Recaptureamount	.	. . .		$1,375

Paul must include $1,375 in income for 2018.

Where to report recapture. Report any re-capture of the section 179 expense deduction as ordinary income in Part IV of Form 4797 and include it in income on Schedule F (Form 1040).

Certain qualified property acquired before September 28, 2017. Certain qualified prop-erty (defined below) acquired before Septem-ber 28, 2017, and placed in service in 2018, is eligible for a 40% special depreciation allow-ance. Your property is qualified property if it meets the following requirements.

1. It is one of the following types of property

a. Tangible property depreciated under MACRS with a recovery period of 20 years or less.

b. Water utility property depreciated un-der MACRS.

c. Computer software that is readily available for purchase by the general public, is subject to non-exclusive li-cense, and has not been substantially modified. (The cost of some computer software is treated as part of the cost of hardware and depreciated under MACRS.)

d. Qualified improvement property de-preciated under MACRS (define un-der Qualified improvement property.

2. The property also must be placed in serv-ice before January 1, 2020 (or before Jan-uary 1, 2021, for certain property with a long production period for certain aircraft).

3. The original use of the property must be-gin with you.

4. It is not excepted property.

For more information, see chapter 3 of Pub.

946.

Qualified improvement property. Gener-ally, this is any improvement to an interior part of a building that is nonresidential real property. The improvement is placed in service after the date the building is first placed in service and is

When Must You Recapture the Deduction?

You may have to recapture the section 179 ex-pense deduction if, in any year during the prop-erty's recovery period, the percentage of busi-ness use drops to 50% or less. In the year the business use drops to 50% or less, you include the recapture amount as ordinary income. You also increase the basis of the property by the recapture amount. Recovery periods for prop-erty are discussed later.

If you sell, exchange, or otherwise dis-

pose of the property, do not figure the CAUTION recapture amount under the rules ex-plained in this discussion. Instead, use the rules for recapturing depreciation explained in chap-ter 9 under Section 1245 Property.

If the property is listed property, do not

figure the recapture amount under the CAUTION rules explained in this discussion when the percentage of business use drops to 50% or less. Instead, use the rules for recapturing de-preciation explained in chapter 5 of Pub. 946 under Recapture of Excess Depreciation.

Figuring the recapture amount. To figure the amount to recapture, take the following steps.

Recapture for qualified section 179 GO Zone property. If any qualified section 179 GO Zone property ceases to be used in the GO Zone in a later year, you must recapture the benefit of the increased section 179 expense deduction as “other income.”

Claiming the Special Depreciation Allowance

For qualified property (defined below) placed in service in 2018, you can take an additional 40% or 100% special depreciation allowance de-pending on the date you acquired the qualified property. The allowance is an additional deduc-tion you can take before you figure regular de-preciation under MACRS. Figure the special depreciation allowance by multiplying the de-preciable basis of the qualified property by the applicable percentage.

What is Qualified Property?

For farmers, qualified property generally is cer-tain qualified property acquired before Septem-ber 28, 2017, certain property acquired after September 27, 2017, and certain specified plants.

section 1250 property. See chapter 3 in Pub. 544, Sales and Other Disposition of Assets, for the definition of section 1250 property.

However, a qualified improvement does not include any improvement for which the expendi-ture is attributable to any of the following.

The enlargement of the building.

An elevator or escalator.

The internal structural framework of the building.

Certain qualified property acquired after September 27, 2017. You can take a 100% special depreciation allowance for property ac-quired and placed in service after September 27, 2017, and before January 1, 2023 (or before January 1, 2024, for certain property with a long production period and for certain aircraft). Your property is qualified property if it meets the fol-lowing.

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

a. Tangible property depreciated under MACRS with a recovery period of 20 years or less.

b. Water utility property depreciated un-der MACRS.

c. Computer software defined in and de-preciated under section 167(f)(1) of the Internal Revenue Code.

Page 42Chapter 7Depreciation, Depletion, and Amortization

2. Qualified property can be either new prop-erty or certain used property.

Note. For the first tax year ending after September 27, 2017, you may elect to apply a 50% special depreciation allowance instead of the 100% special depreciation allowance for the qualified property listed above. To make the election, attach a statement to your timely filed return (including extensions) indicating you are electing to claim a 50% special depreciation al-lowance for all qualified property. Once made the election cannot be revoked without IRS con-sent.

The election must be made separately by each person owing qualified property (for exam-ple, by the partnership, by the S corporation, or for each member of a consolidated group by the common parent of the group).

Certain specified plants. You can elect to claim a 100% special depreciation allowance for the adjusted basis of certain specified plants (defined later) bearing fruits and nuts planted or grafted after September 27, 2017, and before January 1, 2023. For the first tax year ending af-ter September 27, 2017, you may elect to apply the 50% special depreciation allowance, in-stead of the 100% special depreciation allow-ance. See the Note above for the information on how to make the election.

A specified plant is:

Any tree or vine that bears fruit or nuts, and

Any other plant that will have more than one yield of fruits or nuts and generally has a pre-productive period of more than 2 years from planting and grafting to the time it begins bearing fruits or nuts.

Any property planted or grafted outside the United States does not qualify as a specified plant.

If you elect to claim the special depreciation allowance for any specified plant, the plant will not be treated as qualified property eligible for the special depreciation allowance in the sub-sequent tax year in which it is placed in service.

To make the election, attach a statement to your timely filed return (including extensions) for the tax year in which you plant or graft the specified plant(s) indicating you are electing to apply section 168(k)(5) and identifying the specified plant(s) for which you are making the election. The election once made cannot be re-voked without IRS consent.

See section 168(k)(5) of the Internal Reve-nue Code.

How Can You Elect Not To Claim the Allowance?

You can elect, for any class of property, not to deduct the special depreciation allowance for all property in such class placed in service dur-ing the tax year. To make the election, attach a statement to your return indicating the class of property for which you are making the election.

Generally, you must make the election on a timely filed tax return (including extensions) for the year in which you place the property in serv-ice. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended

return within 6 months of the due date of the original return (not including extensions). Attach the election statement to the amended return. On the amended return, write “Filed pursuant to section 301.9100-2.”

Once made, the election may not be re-voked without IRS consent.

If you elect not to have the special de-

preciation allowance apply, the prop-CAUTION erty may be subject to an alternative minimum tax adjustment for depreciation.

When Must You Recapture an Allowance

When you dispose of property for which you claimed a special depreciation allowance, any gain on the disposition is generally recaptured (included in income) as ordinary income up to the amount of the special depreciation allow-ance previously allowed or allowable. For more information, see chapter 3 of Pub. 946.

Figuring Depreciation Under MACRS

The Modified Accelerated Cost Recovery Sys-tem (MACRS) is used to recover the basis of most business and investment property placed in service after 1986. MACRS consists of two depreciation systems, the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Generally, these systems pro-vide different methods and recovery periods to use in figuring depreciation deductions.

To be sure you can use MACRS to fig-

ure depreciation for your property, see

CAUTION Can You Use MACRS To Depreciate Your Property, earlier.

This part explains how to determine which MACRS depreciation system applies to your property. It also discusses the following infor-mation that you need to know before you can figure depreciation under MACRS.

Property's recovery class.

Placed-in-service date.

Basis for depreciation.

Recovery period.

Convention.

Depreciation method.

Finally, this part explains how to use this infor-mation to figure your depreciation deduction.

Which Depreciation System (GDS or ADS) Applies?

Your use of either the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to depreciate property under MACRS determines what depreciation method and recovery period you use. You generally must use GDS unless you are specifically re-quired by law to use ADS or you elect to use ADS.

Required use of ADS. You must use ADS for the following property.

All property used predominantly in a farm-ing business and placed in service in any tax year during which an election not to ap-ply the uniform capitalization rules to cer-tain farming costs is in effect.

Listed property used 50% or less in a qualified business use. See Additional Rules for Listed Property, later.

Any tax-exempt use property.

Any tax-exempt bond-financed property.

Any property imported from a foreign coun-try for which an Executive Order is in effect because the country maintains trade re-strictions or engages in other discrimina-tory acts.

Any tangible property used predominantly outside the United States during the year.

Note. You must use ADS if you are required to file Form 8990 and you elect to expense farming interest expense.

If you are required to use ADS to de-

preciate your property, you cannot CAUTION claim the special depreciation allow-ance.

Electing ADS. Although your property may qualify for GDS, you can elect to use ADS. The election generally must cover all property in the same property class you placed in service dur-ing the year. However, the election for residen-tial rental property and nonresidential real prop-erty can be made on a property-by-property basis. Once you make this election, you can never revoke it.

You make the election by completing line 20 in Part III of Form 4562.

Which Property Class Applies Under GDS?

The following is a list of the nine property classes under GDS.

1. 3-year property.

2. 5-year property.

3. 7-year property.

4. 10-year property.

5. 15-year property.

6. 20-year property.

7. 25-year property.

8. Residential rental property.

9. Nonresidential real property.

See Which Property Class Applies Under GDS in chapter 4 of Pub. 946 for examples of the types of property included in each class.

What Is the

Placed-in-Service Date?

You begin to claim depreciation when your property is placed in service for use either in a trade or business or for the production of in-come. The placed-in-service date for your prop-erty is the date the property is ready and available for a specific use. It is therefore not

Chapter 7Depreciation, Depletion, and AmortizationPage 43

Table 7-1. Farm Property Recovery Periods

Assets	Recovery Period in Years
	GDS	ADS
Agricultural structures (single purpose) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	10	15
Automobiles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	5	5
Calculators and copiers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	5	6
Cattle (dairy or breeding) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	5	7
Communication equipment¹ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	7	10
Computer and peripheral equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	5	5
Drainage facilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	15	20
Farm buildings² . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	20	25
Farm machinery and equipment³ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	5	10
Fences (agricultural) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	7	10
Goats and sheep (breeding) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	5	5
Grain bin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	7	10
Hogs (breeding) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	3	3
Horses (age when placed in service)	7	10
Breeding and working (12 years or less) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Breeding and working (more than 12 years) . . . . . . . . . . . . . . . . . . . . . . . . .	3	10
Racing horses (more than 2 years) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	3	12
Horticultural structures (single purpose) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	10	15
Logging machinery and equipment⁴ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	5	6
Nonresidential real property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	395	40
Office furniture, fixtures, and equipment (not calculators, copiers, or typewriters) . . .	7	10
Paved lots . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	15	20
Residential rental property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	27.5	40
Tractor units (over-the-road) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	3	4
Trees or vines bearing fruit or nuts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	10	20
Truck (heavy duty, unloaded weight 13,000 lbs. or more) . . . . . . . . . . . . . . . . . . .	5	6
Truck (actual weight less than 13,000 lbs.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	5	5
Water wells . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	15	20

Not including communication equipment listed in other classes.

Not including single-purpose agricultural or horticultural structures.

Not including grain bin, cotton ginning, asset fence, or other land improvement and the original use starts with you and placed in service after December 31, 2017.

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.

for those who work on your farm, use one of the following recovery periods if the house trailer is mobile (it has wheels and a history of move-ment).

A 7-year recovery period under GDS.

A 10-year recovery period under ADS.

However, if the house trailer is not mobile (its wheels have been removed and permanent utilities and pipes attached to it), use one of the following recovery periods.

A 20-year recovery period under GDS.

A 25-year recovery period under ADS.

Water wells. Water wells used to provide water for raising poultry and livestock are land improvements. If they are depreciable, use one of the following recovery periods.

A 15-year recovery period under GDS.

A 20-year recovery period under ADS.

The types of water wells that can be depre-ciated were discussed earlier in Irrigation sys-tems and water wells under Property Having a Determinable Useful Life.

Which Convention Applies?

Under MACRS, averaging conventions estab-lish when the recovery period begins and ends. The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property. Use one of the following conventions.

The half-year convention.

The mid-month convention.

The mid-quarter convention.

For a detailed explanation of each conven-tion, see Which Convention Applies in chapter 4 of Pub. 946. Also, see the Instructions for Form 4562.

necessarily the date it is first used. If you con-verted property held for personal use to use in a trade or business or for the production of in-come, treat the property as being placed in service on the conversion date. See Placed in Service under When Does Depreciation Begin and End, earlier, for examples illustrating when property is placed in service.

Also, see Certain specified plants, earlier, for information on the placed in service date for specified plants bearing fruits and nuts for which you elect to claim the special deprecia-tion allowance.

employer-provided childcare facilities and services.

Any special depreciation allowance.

Basis adjustment for investment credit property under section 50(c) of the Internal Revenue Code.

For information about how to determine the cost or other basis of property, see What Is the Basis of Your Depreciable Property, earlier. Also, see chapter 6.

For additional credits and deductions that affect basis, see section 1016 of the Internal Revenue Code.

Which Depreciation Method Applies?

MACRS provides three depreciation methods under GDS and one depreciation method under ADS.

The 200% declining balance method over a GDS recovery period.

The 150% declining balance method over a GDS recovery period.

The straight line method over a GDS re-covery period.

The straight line method over an ADS re-covery period.

What Is the Basis for Depreciation?

The basis for depreciation of MACRS property is the property's cost or other basis multiplied by the percentage of business/investment use. Reduce that amount by any credits and deduc-tions allocable to the property. The following are examples of some of the credits and deductions that reduce basis.

Any deduction for section 179 property.

Any deduction for removal of barriers to the disabled and the elderly.

Any disabled access credit, enhanced oil recovery credit, and credit for

Which Recovery Period Applies?

The recovery period of property is the number of years over which you recover its cost or other basis. It is determined based on the deprecia-tion system (GDS or ADS) used. See Table 7-1 for recovery periods under both GDS and ADS for some commonly used assets. For a com-plete list of recovery periods, see the Table of Class Lives and Recovery Periods in Appendix B of Pub. 946.

House trailers for farm laborers. To de-preciate a house trailer you supply as housing

Depreciation Table. The following table lists the types of property you can depreciate under each method. The declining balance method is abbreviated as DB and the straight line method is abbreviated as SL.

Page 44Chapter 7Depreciation, Depletion, and Amortization

Depreciation Table

System/Method		Type of Property
GDS using	•	All 15- and 20-year property
150% DB	•	Nonfarm 3-, 5-, 7-, and 10-year

		property1
GDS using SL	•	Nonresidential real property
	•	Residential rental property
	• Trees or vines bearing fruit or
	•	nuts
		All 3-, 5-, 7-, 10-, 15-, and
		20-year property1
ADS using SL	•	Property used predomi-
		nantly outside the United
		States
	• Farm property used when an
		election not to apply the
		uniform capitalization rules is
		in effect
	• Tax-exempt property
	• Tax-exempt bond-financed
	•	property
		Imported property2
	• Any property for which you
		elect to use this method1
GDS using	•	*Nonfarm* 3-, 5-, 7-, and
200% DB	•	10-year property
		Farm 3-, 5-, 7-, and 10-year
		property placed in service after
		2017

1Elective method

2See section 168(g)(6) of the Internal Revenue Code

Property used in farming business. For 3-, 5-, 7-, or 10-year property used in a farming business and placed in service after 2017, the 150% declining balance method is no longer re-quired. However, for 15- or 20-year property placed in service in a farming business, you must use the 150% declining balance method over a GDS recovery period or you can elect one of the following methods.

The straight line method over a GDS re-covery period.

The straight line method over an ADS re-covery period.

For property placed in service before

1999, you could have elected to use CAUTION the 150% declining balance method using the ADS recovery periods for certain property classes. If you made this election, con-tinue to use the same method and recovery pe-riod for that property.

Real property. You can depreciate real prop-erty using the straight line method under either GDS or ADS.

Switching to straight line. If you use a declin-ing balance method, you switch to the straight line method in the year it provides an equal or greater deduction. If you use the MACRS per-centage tables, discussed later under How Is the Depreciation Deduction Figured, you do not need to determine in which year your deduction is greater using the straight line method. The ta-bles have the switch to the straight line method built into their rates.

Fruit or nut trees and vines. Depreciate trees and vines bearing fruit or nuts under GDS

using the straight line method over a 10-year re-covery period.

ADS required for some farmers. If you elect not to limit interest expense, you must use ADS to depreciate any property with a recovery pe-riod of 10 years or more. See chapter 4 for a discussion of interest rules. If you elect not to apply the uniform capitalization rules to any plant shown in Table 6-1 of chapter 6 and pro-duced in your farming business, you must use ADS for all property you place in service in any year the election is in effect. See chapter 6 for a discussion of the application of the uniform cap-italization rules to farm property.

Electing a different method. As shown in the Depreciation Table, you can elect a different method for depreciation for certain types of property. You must make the election by the due date of the return (including extensions) for the year you placed the property in service. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of your return (excluding extensions). Attach the election to the amended return and write “Filed pursuant to section 301.9100-2” on the election statement. File the amended return at the same address you filed the original return. Once you make the election, you cannot change it.

If you elect to use a different method

for one item in a property class, you CAUTION must apply the same method to all property in that class placed in service during the year of the election. However, you can make the election on a property-by-property ba-sis for residential rental and nonresidential real property.

Straight line election. Instead of using the declining balance method, you can elect to use the straight line method over the GDS recovery period. Make the election by entering “S/L” un-der column (f) in Part III of Form 4562.

ADS election. As explained earlier under Which Depreciation System (GDS or ADS) Ap-plies, you can elect to use ADS even though your property may come under GDS. ADS uses the straight line method of depreciation over the ADS recovery periods, which are generally lon-ger than the GDS recovery periods. The ADS recovery periods for many assets used in the business of farming are listed in Table 7-1. Ad-ditional ADS recovery periods for other classes of property may be found in the Table of Class Lives and Recovery Periods in Appendix B of Pub. 946.

How Is the Depreciation Deduction Figured?

To figure your depreciation deduction under MACRS, you first determine the depreciation system, property class, placed-in-service date, basis amount, recovery period, convention, and

depreciation method that applies to your prop-erty. Then you are ready to figure your depreci-ation deduction. You can figure it in one of two ways.

You can use the percentage tables provi-ded by the IRS.

You can figure your own deduction without using the tables.

Figuring your own MACRS deduction

will generally result in a slightly differ-CAUTION ent amount than using the tables.

Using the MACRS Percentage Tables

To help you figure your deduction under MACRS, the IRS has established percentage tables that incorporate the applicable conven-tion and depreciation method. These percent-age tables are in Appendix A of Pub. 946.

Rules for using the tables. The following rules cover the use of the percentage tables.

1. You must apply the rates in the percent-age tables to your property's unadjusted basis. Unadjusted basis is the same basis amount you would use to figure gain on a sale but figured without reducing your orig-inal basis by any MACRS depreciation taken in earlier years.

2. You cannot use the percentage tables for a short tax year. See chapter 4 of Pub. 946 for information on how to figure the deduction for a short tax year.

3. You generally must continue to use them for the entire recovery period of the prop-erty.

4. You must stop using the tables if you ad-just the basis of the property for any rea-son other than:

a. Depreciation allowed or allowable, or

b. An addition or improvement to the property, which is depreciated as a separate property.

Basis adjustment due to casualty loss. If you reduce the basis of your property be-cause of a casualty, you cannot continue to use the percentage tables. For the year of the ad-justment and the remaining recovery period, you must figure the depreciation yourself using the property's adjusted basis at the end of the year. See Figuring the Deduction Without Using the Tables in chapter 4 of Pub. 946.

Figuring depreciation using the 150% DB method and half-year convention. Table 7-2 has the percentages for 3-, 5-, 7-, and 20-year property. The percentages are based on the 150% declining balance method with a change to the straight line method. This table covers only the half-year convention and the first 8 years for 20-year property. See Appendix A in Pub. 946 for complete MACRS tables, including tables for the mid-quarter and mid-month con-vention.

The following examples show how to figure depreciation under MACRS using the percen-tages in Table 7-2.

Chapter 7Depreciation, Depletion, and AmortizationPage 45

Example 1. During the year, you bought an item of 7-year property for $10,000 and placed it in service. You do not elect a section 179 ex-pense deduction for this property. In addition, the property is not qualified property for purpo-ses of the special depreciation allowance. The unadjusted basis of the property is $10,000. You use the percentages in Table 7-2 to figure your deduction.

Since this is 7-year property, you multiply $10,000 by 10.71% to get this year's deprecia-tion of $1,071. For next year, your depreciation will be $1,913 ($10,000 × 19.13%).

Example 2. You had a barn constructed on your farm at a cost of $20,000. You placed the barn in service this year. You elect not to claim the special depreciation allowance. The barn is 20-year property and you use the table percen-tages to figure your deduction. You figure this year's depreciation by multiplying $20,000 (un-adjusted basis) by 3.75% to get $750. For next year, your depreciation will be $1,443.80 ($20,000 × 7.219%).

Table 7-2. 150% Declining Balance Method (Half-Year Convention)


	Year 3-Year			5-Year		7-Year	20-Year

	1		25.0%		15.00%	10.71%	3.750%
2		37.5		25.50		19.13	7.219
3		25.0		17.85		15.03	6.677
4		12.5		16.66		12.25	6.177
5				16.66		12.25	5.713
6				8.33		12.25	5.285
7						12.25	4.888
8						6.13	4.522

Figuring depreciation using the straight line method and half-year convention. The following table has the straight line percentages for 3-, 5-, 7-, and 20-year property using the half-year convention. The table covers only the first 8 years for 20-year property. See Appendix A in Pub. 946 for complete MACRS tables, in-cluding tables for the mid-quarter and mid-month convention.

Table 7-3. Straight Line Method (Half-Year Convention)


	Year		3-Year	5-Year 7-Year		20-Year

	1	16.67%		10%	7.14%	2.5%
2		33.33		20	14.29	5.0
3		33.33		20	14.29	5.0
4		16.67		20	14.28	5.0
5				20	14.29	5.0
6				10	14.28	5.0
7					14.29	5.0
8					7.14	5.0

The following example shows how to figure depreciation under MACRS using the straight line percentages in Table 7-3.

Example. If in Example 2, earlier, you had elected the straight line method, you figure this year's depreciation by multiplying $20,000 (un-adjusted basis) by 2.5% to get $500. For next year, your depreciation will be $1,000 ($20,000 × 5%).

Figuring Depreciation Without the Tables

If you are required to or would prefer to figure your own depreciation without using the tables, see Figuring the Deduction Without Using the Tables in chapter 4 of Pub. 946.

Figuring the Deduction for Property Acquired in a Nontaxable Exchange

If your property has a carryover basis because you acquired it in an exchange or involuntary conversion of other property or in a nontaxable transfer, you generally figure depreciation for the property as if the exchange, conversion, or transfer had not occurred.

Property acquired in a like-kind exchange or involuntary conversion. You generally must depreciate the carryover basis of MACRS property acquired in a like-kind exchange or in-voluntary conversion over the remaining recov-ery period of the property exchanged or invol-untarily converted. You generally also continue to use the same depreciation method and con-vention used for the exchanged or involuntarily converted property. This applies only to ac-quired property with the same or a shorter re-covery period and the same or more acceler-ated depreciation method than the property exchanged or involuntarily converted. The ex-cess basis, if any, of the acquired MACRS property is treated as newly placed in service MACRS property.

Election out. You can elect not to use the above rules. The election, if made, applies to both the acquired property and the exchanged or involuntarily converted property. If you make the election, figure depreciation by treating the carryover basis and excess basis, if any, for the acquired property as if placed in service the later of the date you acquired it, or the time of the disposition of the exchanged or involuntarily converted property. For depreciation purposes, the adjusted basis of the exchanged or involun-tarily converted property is treated as if it was disposed of at the time of the exchange or con-version.

When to make the election. You must make the election on a timely filed return (in-cluding extensions) for the year of replacement. Once made, the election may not be revoked without IRS consent.

For more information and special rules, see chapter 4 of Pub. 946.

Property acquired in a nontaxable transfer. You must depreciate MACRS property acquired by a corporation or partnership in certain non-taxable transfers over the property's remaining recovery period in the transferor's hands, as if the transfer had not occurred. You must con-tinue to use the same depreciation method and convention as the transferor. You can depreci-ate the part of the property's basis in excess of its carried-over basis (the transferor's adjusted basis in the property) as newly purchased MACRS property. For information on the kinds of nontaxable transfers covered by this rule, see chapter 4 of Pub. 946.

How Do You Use General Asset Accounts?

To make it easier to figure MACRS deprecia-tion, you can group separate assets into one or more general asset accounts (GAAs). You can then depreciate all the assets in each account as a single asset. Each account must include only assets of the same recovery period, depre-ciation method, and convention. You cannot in-clude an asset if you use it in both a personal activity and a trade or business (or for the pro-duction of income) in the year in which you first placed it in service.

After you have set up a GAA, you generally figure the depreciation for it by using the appli-cable depreciation method, recovery period, and convention for the assets in the GAA. For each GAA, record the depreciation allowance in a separate depreciation reserve account.

There are additional rules for grouping as-sets in a GAA, figuring depreciation for a GAA, disposing of GAA assets, and terminating GAA treatment. Special rules apply in determining the basis and figuring the depreciation deduc-tion for MACRS property in a GAA acquired in a like-kind exchange or involuntary conversion. For more details, see Regulations section 1.168(i)-1 (as in effect for tax years beginning after December 31, 2013). Also, see chapter 4 in Pub. 946.

When Do You Recapture MACRS Depreciation?

When you dispose of property you depreciated using MACRS, any gain on the disposition is generally recaptured (included in income) as or-dinary income up to the amount of the deprecia-tion previously allowed or allowable for the property. For more information on depreciation recapture, see chapter 9. Also, see chapter 4 of Pub. 946.

Additional Rules for Listed Property

Listed property includes cars and other property used for transportation, property used for enter-tainment, and certain computers.

Deductions for listed property (other than certain leased property) are subject to the fol-lowing special rules and limits.

Deduction for employees.

Business-use requirement.

Passenger automobile limits and rules.

What Is Listed Property?

Listed property is any of the following.

Passenger automobiles weighing 6,000 pounds or less.

Any other property used for transportation, unless it is an excepted vehicle.

Property generally used for entertainment, recreation, or amusement.

Certain aircraft.

Page 46Chapter 7Depreciation, Depletion, and Amortization

Passenger automobiles. A passenger auto-mobile is any 4-wheeled vehicle made primarily for use on public streets, roads, and highways and rated at 6,000 pounds or less of unloaded gross vehicle weight (6,000 pounds or less of gross vehicle weight for trucks and vans). It in-cludes any part, component, or other item phys-ically attached to the automobile or usually in-cluded in the purchase price of an automobile. Electric passenger automobiles are vehicles produced by an original equipment manufac-turer and designed to run primarily on electric-ity.

Note. A truck or van that is a qualified nonper-sonal use vehicle is not considered a passen-ger automobile. See Qualified nonpersonal use vehicles under Passenger Automobiles in chap-ter 5 of Pub. 946 for the definition of qualified nonpersonal use vehicles.

For most vehicles the gross vehicle TIP weight rating generally can be found on

the driver door post of the vehicle.

Other property used for transportation. This includes trucks, buses, boats, airplanes, motorcycles, and other vehicles used for trans-porting persons or goods.

Excepted vehicles. Other property used for transportation does not include the following vehicles.

Tractors and other special purpose farm vehicles.

Bucket trucks (cherry pickers), dump trucks, flatbed trucks, and refrigerated trucks.

Combines, cranes and derricks, and fork-lifts.

Any vehicle designed to carry cargo with a loaded gross vehicle weight of over 14,000 pounds.

For more information, see chapter 5 of Pub.

946.

What Is the Business-Use Requirement?

You can claim the section 179 expense deduc-tion for listed property and depreciate listed property using GDS and a declining balance method, if the property meets the business-use requirement. To meet this requirement, listed property must be used predominantly (more than 50% of its total use) for qualified business use. To determine whether the business-use re-quirement is met, you must allocate the use of any item of listed property used for more than one purpose during the year among its various uses.

Do the Passenger Automobile Limits Apply?

The depreciation deduction (including the sec-tion 179 expense deduction) you can claim for a passenger automobile each year is limited. The passenger automobile limits are the maximum depreciation amounts you can deduct for a pas-senger automobile. They are based on the date you placed the vehicle in service. See chapter 5 of Pub. 946 for tables that show the maximum

depreciation deduction for passenger automo-biles. Also, see the Instructions for Form 4562.

For information about deducting expenses for the business use of your passenger automo-bile, see chapter 4 in Pub. 463.

Deductions for passenger automobiles ac-quired in a trade-in. Special rules apply in fig-uring the depreciation for a passenger automo-bile received in a like-kind exchange or involuntary conversion. See chapter 5 of Pub. 946 and Regulations section 1.168(i)-6(d)(3).

Depletion

Depletion is the using up of natural resources by mining, quarrying, drilling, or cutting. The de-pletion deduction allows an owner or operator to account for the reduction of a product's re-serves.

Who Can Claim Depletion?

If you have an economic interest in mineral property or standing timber (defined below), you can take a deduction for depletion. More than one person can have an economic interest in the same mineral deposit or timber.

You have an economic interest if both the following apply.

You have acquired by investment any in-terest in mineral deposits or standing tim-ber.

You have a legal right to income from the extraction of the mineral or the cutting of the timber, to which you must look for a re-turn of your capital investment.

A contractual relationship that allows you an economic or monetary advantage from prod-ucts of the mineral deposit or standing timber is not, in itself, an economic interest. A production payment carved out of, or retained on the sale of, mineral property is not an economic interest.

Mineral property is each separate interest you own in each mineral deposit in each sepa-rate tract or parcel of land. You can treat two or more separate interests as one property or as separate properties. See section 614 of the In-ternal Revenue Code and the related regula-tions for rules on how to treat separate mineral interests.

Timber property is your economic interest in standing timber in each tract or block represent-ing a separate timber account.

Figuring Depletion

There are two ways of figuring depletion.

Cost depletion.

Percentage depletion.

For mineral property, you generally must use the method that gives you the larger deduction. For standing timber, you must use cost deple-tion.

Cost Depletion

To figure cost depletion you must first deter-mine the following.

The property's basis for depletion.

The total recoverable units of mineral in the property's natural deposit.

The number of units of mineral sold during the tax year.

You must estimate or determine recoverable units (tons, barrels, board feet, thousands of cu-bic feet, or other measure) using the current in-dustry method and the most accurate and relia-ble information you can obtain.

Basis for depletion and total recoverable units are explained in chapter 9 of Pub. 535.

Number of units sold. You determine the number of units sold during the tax year based on your method of accounting. Use the follow-ing table to make this determination.

IF you use...	THEN the units sold
	during the year are...
The cash method of	The units sold for which
accounting	you receive payment during
	the tax year (regardless of
	the year of sale).
An accrual method of	The units sold based on
accounting	your inventories.

The number of units sold during the tax year does not include any units for which depletion deductions were allowed or allowable in earlier years.

Figuring the cost depletion deduction. Once you have figured your property's basis for depletion, the total recoverable units, and the number of units sold during the tax year, you can figure your cost depletion deduction by tak-ing the following steps.

Step	Action	Result
1	Divide your property's basis	Rate per unit.
	for depletion by total
	recoverable units.
2	Multiply the rate per unit by	Cost depletion
	units sold during the tax	deduction.
	year.

Cost depletion for ground water in Ogal-lala Formation. Farmers who extract ground water from the Ogallala Formation for irrigation are allowed cost depletion. Cost depletion is al-lowed when it can be demonstrated the ground water is being depleted and the rate of recharge is so low that, once extracted, the water would be lost to the taxpayer and immediately suc-ceeding generations. To figure your cost deple-tion deduction, use the guidance provided in Revenue Procedure 66-11 in Cumulative Bulle-tin 1966-1.

Timber Depletion

Depletion takes place when you cut standing timber (including Christmas trees). You can fig-ure your depletion deduction when the quantity of cut timber is first accurately measured in the process of exploitation.

Chapter 7Depreciation, Depletion, and AmortizationPage 47

Figuring the timber depletion deduction. To figure your cost depletion allowance, multiply the number of units of standing timber cut by your depletion unit.

Timber units. When you acquire timber property, you must make an estimate of the quantity of marketable timber that exists on the property. You measure the timber using board feet, log scale, cords, or other units. If you later determine that you have more or less units of timber, you must adjust the original estimate.

Depletion units. You figure your depletion unit each year by taking the following steps.

1. Determine your cost or the adjusted basis of the timber on hand at the beginning of the year.

2. Add to the amount determined in (1) the cost of any timber units acquired during the year and any additions to capital.

3. Figure the number of timber units to take into account by adding the number of tim-ber units acquired during the year to the number of timber units on hand in the ac-count at the beginning of the year and then adding (or subtracting) any correction to the estimate of the number of timber units remaining in the account.

4. Divide the result of (2) by the result of (3). This is your depletion unit.

When to claim timber depletion. Claim your depletion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you elect to treat the cutting of timber as a sale or exchange as ex-plained in chapter 8. Include allowable deple-tion for timber products not sold during the tax year the timber is cut, as a cost item in the clos-ing inventory of timber products for the year. The inventory is your basis for determining gain or loss in the tax year you sell the timber prod-ucts.

Form T (Timber). Complete and attach Form T (Timber) to your income tax return if you are claiming a deduction for timber depletion, elect-ing to treat the cutting of timber as a sale or ex-change, or making an outright sale of timber. See the Instructions for Form T (Timber).

Example. Alex Borsht bought a farm that included standing timber. This year Alex deter-mined that the standing timber could produce 300,000 units when cut. At that time, the adjus-ted basis of the standing timber was $24,000. Alex then cut and sold 27,000 units. (Alex did not elect to treat the cutting of the timber as a sale or exchange.) Alex's depletion for each unit for the year is $.08 ($24,000 ÷ 300,000). His de-duction for depletion is $2,160 (27,000 × $.08). If Alex had cut 27,000 units but sold only 20,000 units during the year, his depletion for each unit would have remained at $.08. However, his de-pletion deduction would have been $1,600 (20,000 × $.08) for this year and he would have included the balance of $560 (7,000 × $.08) in the closing inventory for the year.

Percentage Depletion

You can use percentage depletion on certain mines, wells, and other natural deposits. You cannot use the percentage method to figure de-pletion for standing timber, soil, sod, dirt, or turf.

To figure percentage depletion, you multiply a certain percentage, specified for each min-eral, by your gross income from the property during the year. See Mines and other natural deposits in chapter 9 of Pub. 535 for a list of the percentages. You can find a complete list in section 613(b) of the Internal Revenue Code.

Taxable income limit. The percentage deple-tion deduction cannot be more than 50% (100% for oil and gas property) of your taxable income from the property figured without the depletion deduction and the domestic production activi-ties deduction.

The following rules apply when figuring your taxable income from the property for purposes of the taxable income limit.

Do not deduct any net operating loss de-duction from the gross income from the property.

Corporations do not deduct charitable con-tributions from the gross income from the property.

If, during the year, you disposed of an item of section 1245 property used in connec-tion with the mineral property, reduce any allowable deduction for mining expenses by the part of any gain you must report as ordinary income that is allocable to the mineral property. See Regulations section 1.613-5(b)(1) for information on how to fig-ure the ordinary gain allocable to the prop-erty.

For more information on depletion, see chapter 9 in Pub. 535.

Amortization

Amortization is a method of recovering (deduct-ing) certain capital costs over a fixed period of time. It is similar to the straight line method of depreciation. The amortizable costs discussed in this section include the start-up costs of go-ing into business, reforestation costs, the costs of pollution control facilities, and the costs of section 197 intangibles. See chapter 8 in Pub. 535 for more information on these topics.

Business Start-Up Costs

When you go into business, treat all costs you incur to get your business started as capital ex-penses. Capital expenses are a part of your ba-sis in the business. Generally, you recover costs for particular assets through depreciation deductions. However, you generally cannot re-cover other costs until you sell the business or otherwise go out of business.

Start-up costs are costs for creating an ac-tive trade or business or investigating the crea-tion or acquisition of an active trade or busi-ness. Start-up costs include any amounts paid

or incurred in connection with any activity en-gaged in for profit and for the production of in-come before the trade or business begins, in anticipation of the activity becoming an active trade or business.

You can elect to currently deduct a limited amount of business start-up costs paid or incur-red after October 22, 2004. See Capital Expen-ses in chapter 4. If this election is made, any costs that are not currently deducted can be amortized.

Amortization period. The amortization period for business start-up costs paid or incurred be-fore October 23, 2004, is 60 months or more. For start-up costs paid or incurred after October 22, 2004, the amortization period is 180 months. The period starts with the month your active trade or business begins.

Reporting requirements. To amortize your start-up costs that are not currently deductible under the election to deduct, complete Part VI of Form 4562 and attach a statement containing any required information. See the Instructions for Form 4562.

For more information, see Starting a Busi-ness in chapter 8 of Pub. 535.

Reforestation Costs

You can elect to currently deduct a limited amount of qualifying reforestation costs for each qualified timber property. See Capital Ex-penses in chapter 4. You can elect to amortize over 84 months any amount not deducted. There is no annual limit on the amount you can elect to amortize. Reforestation costs are the di-rect costs of planting or seeding for forestation or reforestation.

Qualifying costs. Qualifying costs include only those costs you must otherwise capitalize and include in the adjusted basis of the prop-erty. They include costs for the following items.

Site preparation.

Seeds or seedlings.

Labor.

Tools.

Depreciation on equipment used in plant-ing and seeding.

If the government reimburses you for refor-estation costs under a cost-sharing program, you can amortize these costs only if you include the reimbursement in your income.

Qualified timber property. Qualified timber property is property that contains trees in signif-icant commercial quantities. It can be a woodlot or other site that you own or lease. The property qualifies only if it meets all the following require-ments.

It is located in the United States.

It is held for the growing and cutting of tim-ber you will either use in, or sell for use in, the commercial production of timber prod-ucts.

It consists of at least one acre planted with tree seedlings in the manner normally used in forestation or reforestation.

Qualified timber property does not include property on which you have planted shelter

Page 48Chapter 7Depreciation, Depletion, and Amortization

belts or ornamental trees, such as Christmas trees.

Amortization period. The 84-month amortiza-tion period starts on the first day of the first month of the second half of the tax year you in-cur the costs (July 1 for a calendar year tax-payer), regardless of the month you actually in-cur the costs. You can claim amortization deductions for no more than 6 months of the first and last (eighth) tax years of the period.

How to make the election. To elect to amor-tize qualifying reforestation costs, enter your deduction in Part VI of Form 4562. Attach a statement containing any required information. See the Instructions for Form 4562.

Generally, you must make the election on a timely filed return (including extensions) for the year in which you incurred the costs. However, if you timely filed your return for the year without making the election, you can still make the elec-tion by filing an amended return within 6 months of the due date of your return (excluding exten-sions). Attach Form 4562 and the statement to the amended return and write “Filed pursuant to section 301.9100-2” on Form 4562. File the amended return at the same address you filed the original return.

For additional information on reforestation costs, see chapter 8 of Pub. 535.

Section 197 Intangibles

You generally must amortize over 15 years the capitalized costs of section 197 intangibles you acquired after August 10, 1993. You must am-ortize these costs if you hold the section 197 in-tangible in connection with your farming busi-ness or in an activity engaged in for the production of income. Your amortization deduc-tion each year is the applicable part of the intan-gible's adjusted basis (for purposes of deter-mining gain), figured by amortizing it ratably over 15 years (180 months). You are not al-lowed any other depreciation or amortization deduction for an amortizable section 197 intan-gible.

Section 197 intangibles include the following assets.

Goodwill.

Patents.

Copyrights.

Designs.

Formulas.

Licenses.

Permits.

Covenants not to compete.

Franchises.

Trademarks.

See chapter 8 in Pub. 535 for more information, including a complete list of assets that are sec-tion 197 intangibles and special rules.

8.

Gains and

Losses

What’s New for 2018

Like-kind exchanges. For exchanges com-pleted after December 31, 2017, the nonrecog-nition rules for like-kind exchanges apply only to exchanges of real property not held primarily for sale. The nonrecognition rules no longer apply to personal property. Exceptions apply to prop-erty disposed of before January 1, 2018, and to property received in an exchange before Janu-ary 1, 2018. See Like-Kind Exchanges, later.

Introduction

This chapter explains how to figure, and report on your tax return, your gain or loss on the dis-position of your property or debt and whether such gain or loss is ordinary or capital. Ordinary gain is taxed at the same rates as wages and interest income while net capital gain is gener-ally taxed at a lower rate. Dispositions dis-cussed in this chapter include sales, ex-

changes, foreclosures, repossessions, canceled debts, hedging transactions, and elections to treat cutting of timber as a sale or exchange.

Topics

This chapter discusses:

Sales and exchanges

Ordinary or capital gain or loss

Useful Items

You may want to see:

Publication

334 Tax Guide for Small Business

523 Selling Your Home

544 Sales and Other Dispositions of Assets

550 Investment Income and Expenses

908 Bankruptcy Tax Guide

Form (and Instructions)

982 Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)

Sch D (Form 1040) Capital Gains and Losses

Sch F (Form 1040) Profit or Loss From Farming

1099-A Acquisition or Abandonment of Secured Property

1099-C Cancellation of Debt

4797 Sales of Business Property

8824 Like-Kind Exchanges

8949 Sales and Other Dispositions of Capital Assets

8960 Net Investment Income Tax-Individuals, Estates, and Trusts

See chapter 16 for information about getting publications and forms.

Sales and Exchanges

If you sell, exchange, or otherwise dispose of your property, you usually have a gain or a loss. This section explains certain rules for determin-ing whether any gain you have is taxable, and whether any loss you have is deductible.

A sale is a transfer of property for money or a mortgage, note, or other promise to pay money. An exchange is a transfer of property for other property or services.

Determining Gain or Loss

You usually realize a gain or loss when you sell or exchange property. If the amount you realize from a sale or exchange of property is more than its adjusted basis, you have a gain. If the adjusted basis of the property is more than the amount you realize, you have a loss.

Basis and adjusted basis. The basis of prop-erty you buy is usually its cost. The adjusted ba-sis of the property is the basis plus certain addi-tions and minus certain deductions. See chapter 6 for more information about basis and adjusted basis.

Amount realized. The amount you realize from a sale or exchange is the total of all money you receive plus the fair market value (FMV) (defined in chapter 6) of all property or services you receive. The amount you realize also in-cludes any of your liabilities assumed by the buyer and any liabilities to which the property you transferred is subject, such as real estate taxes or a mortgage.

If the liabilities relate to an exchange of mul-tiple properties, see Multiple Property Ex-changes in chapter 1 of Pub. 544.

Amount recognized. Your gain or loss real-ized from a sale or exchange of certain property is usually a recognized gain or loss for tax pur-poses. A recognized gain is a gain you must in-clude in gross income and report on your in-come tax return. A recognized loss is a loss you deduct from gross income. However, your gain or loss realized from the exchange of certain property may not be recognized for tax purpo-ses. See Like-Kind Exchanges next. Also, a loss from the disposition of property held for personal use is not deductible.

Like-Kind Exchanges

Generally, if you exchange real property you use in your business or hold for investment solely for other business or investment real

Chapter 8Gains and LossesPage 49

property of a like-kind, you do not recognize the gain or loss from the exchange. However, if you also receive non-like-kind property or money as part of the exchange, you recognize gain to the extent of the value of the other property or money you received in the exchange. And, you do not recognize any loss. In general, your gain or loss will not be recognized until you sell or otherwise dispose of the property you receive in the exchange. See Qualifying property later for details on property that qualify and exceptions.

Your gain or loss will not be recognized until you sell or otherwise dispose of the property you receive in the exchange.

The exchange of property for the same kind of property is the most common type of nontax-able exchange. To qualify for treatment as a like-kind exchange, the property traded and the property received must be both of the following (discussed later).

Qualifying property.

Like-kind property.

For more information on like-kind exchanges, see Pub. 544.

Multiple-party transactions. The like-kind ex-change rules also apply to property exchanges that involve three- and four-party transactions. Any part of these multiple-party transactions can qualify as a like-kind exchange if it meets all the requirements described in this section.

Receipt of title from third party. If you re-ceive property in a like-kind exchange and the other party who transfers the property to you does not give you the title, but a third party does, you can still treat this transaction as a like-kind exchange if it meets all the require-ments.

Basis of property received. If you receive property in a like-kind exchange, generally the basis of the property will be the same as the ba-sis of the property you gave up. See chapter 6 for more information on basis.

Money paid. If, in addition to giving up like-kind property, you pay money in a like-kind exchange, the basis of the property received is the basis of the property given up, increased by the money paid.

Example. You own farmland with a barn. The combined adjusted basis of the properties is $70,000 and the fair market value is $150,000. You are interested in another tract of farmland, with a larger barn, worth $200,000. You exchange your existing property and $50,000 in cash for the new property. Your ba-sis in the new property is $120,000 ($70,000 adjusted basis in your old property plus $50,000 in cash paid).

Reporting the exchange. Report the ex-change of like-kind property, even though no gain or loss is recognized, on Form 8824, Like-Kind Exchanges. The Instructions for Form 8824 explain how to report the details of the ex-change.

If you have any recognized gain because you received money or unlike property, report it on Schedule D (Form 1040) or Form 4797, whichever applies. You may also have to report

Page 50Chapter 8Gains and Losses

the recognized gain as ordinary income be-cause of depreciation recapture on Form 4797. See chapter 9 for more information.

Qualifying property. In a like-kind exchange, both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business. Buildings, land, and rental property are exam-ples of property that may qualify.

Exchanges started in 2017 and comple-ted in 2018. The like-kind exchange rules still apply to a qualifying exchange of personal or in-tangible property if you disposed of the ex-changed property before January 1, 2018, or received replacement property before January 1, 2018.

Nonqualifying property. The rules for like-kind exchanges do not apply to exchanges of the following property.

Real property used for personal purposes, such as your home.

Real property held primarily for sale.

Any personal or intangible property. How-ever, see Qualifying property and Ex-changes started in 2017 and completed in 2018 above.

You may have a nontaxable exchange un-der other rules. See Other Nontaxable Ex-changes in chapter 1 of Pub. 544.

Special rule for stock in a mutual ditch, reservoir, or irrigation company. For purpo-ses of real property, stock in a mutual ditch, res-ervoir, or irrigation company is treated as real property if both of the following conditions are met at the time of the trade.

1. The mutual ditch, reservoir, or irrigation company is an organization described in section 501(c)(12)(A) of the Internal Reve-nue Code (determined without regard to the percentage of its income that is collec-ted from its members for the purpose of meeting losses and expenses).

2. The shares in the company have been recognized by the highest court of the state in which the company was organized or by applicable state statute as constitut-ing or representing real property or an in-terest in real property.

Like-kind property. To qualify as a nontaxa-ble exchange, the properties exchanged must be of like kind. Like-kind properties are proper-ties of the same nature or character, even if they differ in grade or quality. Generally, real property exchanged for real property qualifies as an exchange of like-kind property. For exam-ple, an exchange of city property for farm prop-erty or improved property for unimproved prop-erty is a like-kind exchange.

Note. Whether you engaged in a like-kind exchange depends on an analysis of each as-set involved in the exchange.

Partially nontaxable exchange. If, in addition to like-kind property, you receive money or un-like property in an exchange on which you real-ize gain, you have a partially nontaxable ex-change. You are taxed on the gain you realize,

but only to the extent of the money and the FMV of the unlike property you receive. If you realize a loss on the exchange, no loss is deductible. However, see Unlike property given up below.

Example 1. You trade farmland that cost $130,000 for $10,000 cash and other land to be used in farming with an FMV of $150,000. You have a realized gain of $30,000 ($150,000 FMV of new land + $10,000 cash − $130,000 basis of old farmland = $30,000 realized gain). How-ever, only $10,000, the cash received, is recog-nized (included in income).

Example 2. Assume the same facts as in Example 1, except that, instead of money, you received a tractor with an FMV of $10,000. Your recognized gain is still limited to $10,000, the value of the tractor (the unlike property).

Example 3. Assume in Example 1 that the FMV of the land you received was only $115,000. You have a realized loss of $5,000 ($115,000 FMV + $10,000 cash – $130,000 ba-sis of old farmland = $5,000 loss). However, your $5,000 loss is not recognized.

Unlike property given up. If, in addition to like-kind property, you give up unlike property, you must recognize gain or loss on the unlike property you give up. The gain or loss is the dif-ference between the FMV of the unlike property and the adjusted basis of the unlike property.

Liabilities If, in a like-kind exchange, you transfer property subject to debt, the debt trans-ferred is considered the same as the receipt of unlike property. For purposes of figuring your realized gain, add any liabilities assumed by the other party to your amount realized. Subtract any liabilities of the other party that you assume from your amount realized. For more informa-tion, see Partial Nontaxable Exchanges in chapter 1 of Pub. 544.

Like-kind exchanges between related per-sons. Special rules apply to like-kind ex-changes between related persons. These rules affect both direct and indirect exchanges. Un-der these rules, if either person disposes of the property within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. The gain or loss on the original ex-change must be recognized as of the date of the later disposition. The 2-year holding period begins on the date of the last transfer of prop-erty that was part of the like-kind exchange.

Related persons. Under these rules, rela-ted persons include, for example, you and a member of your family (spouse, brother, sister, parent, child, etc.), you and a corporation in which you have more than 50% ownership, you and a partnership in which you directly or indi-rectly own more than a 50% interest of the capi-tal or profits, and two partnerships in which you directly or indirectly own more than 50% of the capital interests or profits.

For the complete list of related persons, see Related persons in chapter 2 of Pub. 544.

Example. You own real property used in your business. Your sister owns real property used in her business. In December 2018, you exchanged your property plus $15,000 for your

sister's property. At that time, the fair market value of your real property was $200,000 and its adjusted basis was $65,000. The fair market value of your sister's real property was $215,000 and its adjusted basis was $70,000. You realized a gain of $135,000 (the $215,000 fair market value of the real property received, minus the $15,000 you paid, minus your $65,000 adjusted basis in the property). Your sister realized a gain of $145,000 (the $200,000 fair market value of your real property, plus the $15,000 you paid, minus her $70,000 adjusted basis in the property).

However, because this was a like-kind ex-change and you received no cash or non-like kind property in the exchange, you recognize no gain on the exchange. Your basis in the real property you received is $80,000 (the $65,000 adjusted basis of the real property given up plus the $15,000 you paid). Your sister recognizes gain only to the extent of the money she re-ceived, $15,000. Her basis in the real property she received was $70,000 (the $70,000 adjus-ted basis of the real property she exchanged minus the $15,000 received, plus the $15,000 gain recognized).

In 2019, you sold the real property you re-ceived to a third party for $220,000. Because you sold property you acquired from a related party (your sister) within 2 years after the ex-change with your sister, that exchange is dis-qualified from nonrecognition treatment and the deferred gain must be recognized on your 2019 return. On your 2019 tax return, you must report your $135,000 gain on the 2018 exchange. You also must report the gain on the 2019 sale on your 2019 return. Additionally, your sister must report on her 2019 tax return gain of $130,000, which is the $145,000 gain on the 2018 ex-change, minus the $15,000 she recognized in 2018. Her adjusted basis in the property is in-creased to $200,000 (its $70,000 basis plus the $130,000 gain recognized).

Exceptions to the rules for related per-sons. The following property dispositions are excluded from these rules.

Dispositions due to the death of either rela-ted person.

Involuntary conversions.

Dispositions where it is established to the satisfaction of the IRS that neither the ex-change nor the disposition has, as a main purpose, the avoidance of federal income tax.

Multiple property exchanges. Under the like-kind exchange rules, you must generally make a property-by-property comparison to fig-ure your recognized gain and the basis of the property you receive in the exchange. However, for exchanges of multiple properties, you do not make a property-by-property comparison if you do either of the following.

Transfer and receive properties in two or more exchange groups.

Transfer or receive more than one property within a single exchange group.

For more information, see Multiple Property Exchanges in chapter 1 of Pub. 544.

Deferred exchange. A deferred exchange for like-kind property may qualify for nonrecogni-tion of gain or loss. A deferred exchange is an

exchange in which you transfer property you use in business or hold for investment and later receive like-kind property you will use in busi-ness or hold for investment. The property you receive is replacement property. The transac-tion must be an exchange of property for prop-erty rather than a transfer of property for money used to buy replacement property. In addition, the replacement property will not be treated as like-kind property unless certain identification and receipt requirements are met.

For more information, see Deferred Ex-changes in chapter 1 of Pub. 544.

Transfer to Spouse

Generally, no gain or loss is recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse, or a former spouse if incident to divorce. This rule does not apply in the following situations.

Your spouse or former spouse is a nonresi-dent alien (unless special elections have been made).

Certain transfers in trust.

Certain stock redemptions under a divorce or separation instrument or a valid written agreement.

For more information and special rules for transfers of property incident to divorce, see Property Settlements in Pub. 504, Divorced or Separated Individuals.

Any transfer of property to a spouse or for-mer spouse on which gain or loss is not recog-nized is not considered a sale or exchange. The recipient's basis in the property will be the same as the adjusted basis of the giver immediately before the transfer. This carryover basis rule applies whether the adjusted basis of the trans-ferred property is less than, equal to, or greater than either its FMV at the time of transfer or any consideration paid by the recipient. This rule applies for determining loss as well as gain. Any gain recognized on a transfer in trust increases the basis.

Ordinary or Capital Gain or Loss

Generally, you will have a capital gain or loss if you sell or exchange a capital asset (defined below). You may also have a capital gain if your section 1231 transactions result in a net gain. See Section 1231 Gains and Losses in chapter 9.

To figure your net capital gain or loss, you must classify your gains and losses as either or-dinary or capital, and your capital gains or los-ses as either short term or long term.

Your net capital gains may be taxed at a lower tax rate than ordinary income. See Capi-tal Gains Tax Rates, later. Your deduction for a net capital loss may be limited. See Treatment of Capital Losses, later.

Capital Assets

Almost everything you own and use for per-sonal purposes, pleasure, or investment is a capital asset.

The following items are examples of capital assets.

A home owned and occupied by you and your family.

Household furnishings.

A car used for pleasure. If your car is used both for pleasure and for farm business, it is partly a capital asset and partly a nonca-pital asset, defined later.

Stocks and bonds. However, there are special rules for gains on qualified small business stock. For more information on this subject, see Gains on Qualified Small Business Stock and Losses on Section 1244 (Small Business) Stock in chapter 4 of Pub. 550.

Personal-use property. Gain from a sale or exchange of personal-use property is a capital gain and is taxable. Loss from the sale or ex-change of personal-use property is not deducti-ble. You can deduct a loss relating to per-sonal-use property only if it results from a casualty or theft. For information on casualties and thefts, see chapter 11.

Long and Short Term

Where you report a capital gain or loss depends on how long you own the asset before you sell or exchange it. The time you own an asset be-fore disposing of it is the holding period.

If you hold a capital asset 1 year or less, the gain or loss resulting from its disposition is short term. Report it in Part I of Form 8949, Sales and Other Dispositions of Capital Assets, and/or Schedule D (Form 1040), as applicable. If you hold a capital asset longer than 1 year, the gain or loss resulting from its disposition is long term. Report it in Part II of Form 8949 and/or Sched-ule D, as applicable. See the Instructions for Form 8949 and the Instructions for Schedule D (Form 1040) for more information, including when Form 8949 is required. Also see chapter 4 of Pub. 544.

Holding period. To figure if you held property longer than 1 year, start counting on the day af-ter the day you acquired the property. The day you disposed of the property is part of your holding period.

Example. If you bought an asset on June 19, 2017, you should start counting on June 20, 2017. If you sold the asset on June 19, 2018, your holding period is not longer than 1 year, but if you sold it on June 20, 2018, your holding period is longer than 1 year.

Inherited property. If you inherit property, you are considered to have held the property longer than 1 year, regardless of how long you actually held it. This rule does not apply to live-stock used in a farm business. See Holding pe-riod under Livestock, later.

Nonbusiness bad debt. A nonbusiness bad debt is a short-term capital loss, deductible in the year the debt becomes worthless. See chapter 4 of Pub. 550.

Nontaxable exchange. If you acquire an asset in exchange for another asset and your basis for the new asset is figured, in whole or in

Chapter 8Gains and LossesPage 51

part, by using your basis in the old property, the holding period of the new property includes the holding period of the old property. That is, it be-gins on the same day as your holding period for the old property.

Gift. If you receive a gift of property and your basis in it is figured using the donor's ba-sis, your holding period includes the donor's holding period.

Real property. To figure how long you held real property, start counting on the day after you received title to it or, if earlier, on the day after you took possession of it and assumed the bur-dens and privileges of ownership.

However, taking possession of real property under an option agreement is not enough to start the holding period. The holding period cannot start until there is an actual contract of sale. The holding period of the seller cannot end before that time.

Figuring Net Gain or Loss

The totals for short-term capital gains and los-ses and the totals for long-term capital gains and losses must be figured separately.

Net short-term capital gain or loss. Com-bine your short-term capital gains and losses. Do this by adding all of your short-term capital gains. Then add all of your short-term capital losses. Subtract the lesser total from the greater. The difference is your net short-term capital gain or loss.

Net long-term capital gain or loss. Follow the same steps to combine your long-term capi-tal gains and losses. The result is your net long-term capital gain or loss.

Net gain. If the total of your capital gains is more than the total of your capital losses, the difference is taxable. However, part of your gain (but not more than your net capital gain) may be taxed at a lower rate than the rate of tax on your ordinary income. See Capital Gains Tax Rates, later.

Net loss. If the total of your capital losses is more than the total of your capital gains, the dif-ference is deductible. But there are limits on how much loss you can deduct and when you can deduct it. See Treatment of Capital Losses next.

Treatment of Capital Losses

If your capital losses are more than your capital gains, you must claim the difference even if you do not have ordinary income to offset it. For tax-payers other than corporations, the yearly limit on the capital loss you can deduct is $3,000 ($1,500 if you are married and file a separate return). If your other income is low, you may not be able to use the full $3,000. The part of the $3,000 you cannot use becomes part of your capital loss carryover (discussed next).

Page 52Chapter 8Gains and Losses

Capital loss carryover. Generally, you have a capital loss carryover if either of the following situations applies to you.

Your net loss on Schedule D (Form 1040) is more than the yearly limit.

Your taxable income without your deduc-tion for exemptions is less than zero.

If either of these situations applies to you for 2018, see Capital Losses under Reporting Cap-ital Gains and Losses in chapter 4 of Pub. 550 to figure the amount you can carry over to 2019.

To figure your capital loss carryover TIP from 2018 to 2019, you will need a copy of your 2018 Form 1040 and

Schedule D (Form 1040).

Capital Gains Tax Rates

The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. These lower rates are called the maximum capital gains rates.

The term “net capital gain” means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss.

See Schedule D (Form 1040) and the In-structions for Schedule D (Form 1040). Also see Pub. 550.

Noncapital Assets

Noncapital assets include property such as in-ventory and depreciable property used in a trade or business. A list of properties that are not capital assets is provided in the Instructions for Schedule D (Form 1040).

Property held for sale in the ordinary course of your farm business. Property you hold mainly for sale to customers, such as live-stock, poultry, livestock products, and crops, is a noncapital asset. Gain or loss from sales or other dispositions of this property is reported on Schedule F (Form 1040) (not on Schedule D (Form 1040) or Form 4797). The treatment of this property is discussed in chapter 3.

Land and depreciable properties. Land and depreciable property you use in farming are not capital assets. Noncapital assets also include livestock held for draft, breeding, dairy, or sport-ing purposes. However, your gains and losses from sales and exchanges of your farmland and depreciable properties must be considered to-gether with certain other transactions to deter-mine whether the gains and losses are treated as capital or ordinary gains and losses. The sales of these business assets are reported on Form 4797. See chapter 9 for more information.

Hedging

Hedging transactions are transactions that you enter into in the normal course of business pri-marily to manage the risk of interest rate or price changes, or currency fluctuations, with re-spect to borrowings, ordinary property, or

ordinary obligations. Ordinary property or obli-gations are those that cannot produce capital gain or loss if sold or exchanged.

A commodity futures contract is a standar-dized, exchange-traded contract for the sale or purchase of a fixed amount of a commodity at a future date for a fixed price. The holder of an option on a futures contract has the right (but not the obligation) for a specified period of time to enter into a futures contract to buy or sell at a particular price. A forward contract is much dif-ferent than a futures contract since its terms are not standardized and it is not exchange traded.

Businesses may enter into commodity fu-tures contracts or forward contracts and may acquire options on commodity futures contracts as either of the following.

Hedging transactions.

Transactions that are not hedging transac-tions.

Futures transactions with exchange-traded commodity futures contracts that are not hedg-ing transactions, generally, result in capital gain or loss and are subject to the mark-to-market rules discussed in Pub. 550. There is a limit on the amount of capital losses you can deduct each year. Hedging transactions are not subject to the mark-to-market rules and the deduction for hedging losses is not limited.

If, as a farmer-producer, to protect yourself from the risk of unfavorable price fluctuations, you enter into commodity forward contracts, fu-tures contracts, or options on futures contracts and the contracts cover an amount of the com-modity within your range of production, the transactions are generally considered hedging transactions. They can take place at any time you have the commodity under production, have it on hand for sale, or reasonably expect to have it on hand.

The gain or loss on the termination of these hedges is generally ordinary gain or loss. Farm-ers who file their income tax returns on the cash method report any profit or loss on the hedging transaction on Schedule F, line 8.

Gains or losses from hedging transactions that hedge supplies of a type regularly used or consumed in the ordinary course of your trade or business may be ordinary gains or losses. Examples include fuel and feed.

If you have numerous transactions in the commodity futures market during RECORDS the year, you must be able to show

which transactions are hedging transactions. Clearly identify a hedging transaction on your books and records before the end of the day you entered into the transaction. It may be help-ful to have separate brokerage accounts for your hedging and speculation transactions.

Retain the identification of each hedging transaction with your books and records. Also, identify the item(s) or aggregate risk that is be-ing hedged in your records. Although the identi-fication of the hedging transaction must be made before the end of the day it was entered into, you have 35 days after entering into the transaction to identify the hedged item(s) or risk.

For more information on the tax treatment of futures and options contracts, see Commodity Futures and Section 1256 Contracts Marked to Market in Pub. 550.

Accounting methods for hedging transac-tions. The accounting method you use for a hedging transaction must clearly reflect income. This means that your accounting method must reasonably match the timing of income, deduc-tion, gain, or loss from a hedging transaction with the timing of income, deduction, gain, or loss from the item or items being hedged. There are requirements and limits on the method you can use for certain hedging transactions. See Regulations section 1.446-4(e) for those re-quirements and limits.

Hedging transactions must be accounted for under the rules stated above unless the trans-action is subject to mark-to-market accounting under section 475 or you use an accounting method other than the following methods.

1. Cash method.

2. Farm-price method.

3. Unit-livestock-price method.

Once you adopt a method, you must apply it consistently and must have IRS approval before changing it.

Your books and records must describe the accounting method used for each type of hedg-ing transaction. They must also contain any ad-ditional identification necessary to verify the ap-plication of the accounting method you used for the transaction. You must make the additional identification no more than 35 days after enter-ing into the hedging transaction.

Example of a hedging transaction. You file your income tax returns on the cash method. On July 2 you anticipate a yield of 50,000 bush-els of corn this year. The December futures price is $3.75 a bushel, but there are indications that by harvest time the price will drop. To pro-tect yourself against a drop in the price, you en-ter into the following hedging transaction. You sell ten December futures contracts of 5,000 bushels each for a total of 50,000 bushels of corn at $3.75 a bushel.

The price did not drop as anticipated but rose to $4 a bushel. In November, you sell your crop at a local elevator for $4 a bushel. You also close out your futures position by buying ten December contracts for $4 a bushel. You paid a broker's commission of $1,400 ($70 per con-tract) for the complete in and out position in the futures market.

The result is that the price of corn rose 25 cents a bushel and the actual selling price is $4 a bushel. Your loss on the hedge is 25 cents a bushel. In effect, the net selling price of your corn is $3.75 a bushel.

Report the results of your futures transac-tions and your sale of corn separately on Schedule F. See the Instructions for Schedule F (Form 1040).

The loss on your futures transactions is $13,900, figured as follows.

July 2 - Sold December corn futures	$187,500
(50,000 bu. @$3.75) . . . . . . . . . . . . . . . .
November 6 - Bought December corn
futures (50,000 bu. @$4 plus $1,400	201,400
broker's commission) . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . .Futuresloss	($13,900)

This loss is reported as a negative figure on Schedule F, Part I, line 8, as other income.

The proceeds from your corn sale at the lo-cal elevator are $200,000 (50,000 bu. × $4). Report it on Schedule F, Part I, line 2, as in-come from sales of products you raised.

Assume you were right and the price went down 25 cents a bushel. In effect, you would still net $3.75 a bushel, figured as follows.

Sold cash corn, per bushel . . . . . . . . . . . .	$3.50
Gain on hedge, per bushel . . . . . . . . . . . .	.25
. . . . . . . . . . .Netprice,perbushel	$3.75

The gain on your futures transactions would have been $11,100, figured as follows.

July 2 - Sold December corn futures (50,000	$187,500
bu. @$3.75) . . . . . . . . . . . . . . . . . . . . . . .
November 6 - Bought December corn
futures (50,000 bu. @$3.50 plus $1,400	176,400
broker's commission) . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . .Futuresgain	$11,100

The $11,100 is reported on Schedule F, Part I, line 8, as other income.

The proceeds from the sale of your corn at the local elevator, $175,000, are reported on Schedule F, Part I, line 2, as income from sales of products you raised.

Livestock

This part discusses the sale or exchange of livestock used in your farm business. Gain or loss from the sale or exchange of this livestock may qualify as a section 1231 gain or loss. However, any part of the gain that is ordinary in-come from the recapture of depreciation is not included as section 1231 gain. See chapter 9 for more information on section 1231 gains and losses and the recapture of depreciation under section 1245.

The rules discussed here do not apply

to the sale of livestock held primarily for CAUTION sale to customers. The sale of this live-stock is reported on Schedule F. See chapter 3 for more information.

Also, special rules apply to sales or exchanges caused by weather-related conditions. See Sales Caused by Weather-Related Conditions in chapter 3 for more information.

Holding period. The sale or exchange of live-stock used in your farm business (defined be-low) qualifies as a section 1231 transaction if you held the livestock for 12 months or more (24 months or more for horses and cattle).

Livestock. For section 1231 transactions, live-stock includes cattle, hogs, horses, mules, don-keys, sheep, goats, fur-bearing animals, and other mammals. Also, for section 1231 transac-tions, livestock does not include chickens, tur-

keys, pigeons, geese, emus, ostriches, rheas, or other birds, fish, frogs, reptiles, etc.

Livestock used in farm business. If live-stock is held primarily for draft, breeding, dairy, or sporting purposes, it is used in your farm business. The purpose for which an animal is held ordinarily is determined by a farmer's ac-tual use of the animal. An animal is not held for draft, breeding, dairy, or sporting purposes merely because it is suitable for that purpose, or because it is held for sale to other persons for use by them for that purpose. However, a draft, breeding, or sporting purpose may be present if an animal is disposed of within a reasonable time after it is prevented from its intended use or made undesirable as a result of an accident, disease, drought, or unfitness of the animal.

Example 1. You discover an animal that you intend to use for breeding purposes is ster-ile. You dispose of it within a reasonable time. This animal was held for breeding purposes.

Example 2. You retire and sell your entire herd, including young animals that you would have used for breeding or dairy purposes had you remained in business. These young ani-mals were held for breeding or dairy purposes. Also, if you sell young animals to reduce your breeding or dairy herd because of drought, these animals are treated as having been held for breeding or dairy purposes. See Sales Caused by Weather-Related Conditions in chapter 3.

Example 3. You are in the business of rais-ing hogs for slaughter. Customarily, before sell-ing your sows, you obtain a single litter of pigs that you will raise for sale. You sell the brood sows after obtaining the litter. Even though you hold these brood sows for ultimate sale to cus-tomers in the ordinary course of your business, they are considered to be held for breeding pur-poses.

Example 4. You are in the business of rais-ing registered cattle for sale to others for use as breeding cattle. The business practice is to breed the cattle before sale to establish their fit-ness as registered breeding cattle. Your use of the young cattle for breeding purposes is ordi-nary and necessary for selling them as regis-tered breeding cattle. Such use does not dem-onstrate that you are holding the cattle for breeding purposes. However, those cattle you held as additions or replacements to your own breeding herd to produce calves are consid-ered to be held for breeding purposes, even though they may not actually have produced calves. The same applies to hog and sheep breeders.

Example 5. You breed, raise, and train horses for racing purposes. Every year you cull horses from your racing stable. In 2018, you de-cided that to prevent your racing stable from getting too large to be effectively operated, you must cull six horses that had been raced at pub-lic tracks in 2017. These horses are all consid-ered held for sporting purposes.

Figuring gain or loss on the cash method. Farmers or ranchers who use the cash method of accounting figure their gain or loss on the

Chapter 8Gains and LossesPage 53

sale of livestock used in their farming business as follows.

Raised livestock. Gain on the sale of raised livestock is generally the gross sales price reduced by any expenses of the sale. Ex-penses of sale include sales commissions, freight or hauling from farm to commission com-pany, and other similar expenses. The basis of the animal sold is zero if the costs of raising it were deducted during the years the animal was being raised. However, if you are required to use the accrual accounting method, see Uni-form Capitalization Rules in chapter 6.

Purchased livestock. The gross sales price minus your adjusted basis and any expen-ses of sale is the gain or loss.

Example. A farmer sold a breeding cow on January 8, 2018, for $1,250. Expenses of the sale were $125. The cow was bought July 2, 2014, for $1,300. Depreciation (not less than the amount allowable) was $867.

Gross sales price . . . . . . . . . . . . . . .	^.$^.1,300^...	$1,250
Cost (basis) . . . . . . . . . . . . . . . . .
Minus: Depreciation deduction . . . .	867
Unrecovered cost	$ 433
(adjusted basis) . . . . . . . . . . . . . .		558
Expense of sale . . . . . . . . . . . . . .	125
. . . . . . . . . . . .Gainrealized	....		$ 692

Converted Wetland and Highly Erodible Cropland

Special rules apply to dispositions of land con-verted to farming use after March 1, 1986. Any gain realized on the disposition of converted wetland or highly erodible cropland is treated as ordinary income. Any loss on the disposition of such property is treated as a long-term capital loss.

Converted wetland. This is generally land that was drained or filled to make the production of agricultural commodities possible. It includes converted wetland held by the person who orig-inally converted it or held by any other person who used the converted wetland at any time af-ter conversion for farming.

A wetland (before conversion) is land that meets all the following conditions.

It is mostly soil that, in its undrained condi-tion, is saturated, flooded, or ponded long enough during a growing season to de-velop an oxygen-deficient state that sup-ports the growth and regeneration of plants growing in water.

It is saturated by surface or groundwater at a frequency and duration sufficient to sup-port mostly plants that are adapted for life in saturated soil.

It supports, under normal circumstances, mostly plants that grow in saturated soil.

Highly erodible cropland. This is cropland subject to erosion that you used at any time for farming purposes other than grazing animals. Generally, highly erodible cropland is land cur-rently classified by the Department of Agricul-ture as Class IV, VI, VII, or VIII under its classifi-cation system. Highly erodible cropland also

Page 54Chapter 8Gains and Losses

includes land that would have an excessive average annual erosion rate in relation to the soil loss tolerance level, as determined by the Department of Agriculture.

Successor. Converted wetland or highly erodi-ble cropland is also land held by any person whose basis in the land is figured by reference to the adjusted basis of a person in whose hands the property was converted wetland or highly erodible cropland.

Timber

Standing timber you held as investment prop-erty is a capital asset. Gain or loss from its sale is capital gain or loss reported on Form 8949 and Schedule D (Form 1040), as applicable. If you held the timber primarily for sale to custom-ers, it is not a capital asset. Gain or loss on its sale is ordinary business income or loss. It is re-ported on Schedule F, line 1 (purchased timber) or line 2 (raised timber). See the Instructions for Schedule F (Form 1040).

Farmers who cut timber on their land and sell it as logs, firewood, or pulpwood usually have no cost or other basis for that timber if no allocation was made at the time of acquisition. Amounts realized from these sales, and the ex-penses incurred in cutting, hauling, etc., are or-dinary farm income and expenses reported on Schedule F.

Different rules apply if you owned the timber longer than 1 year and elect to treat timber cut-ting as a sale or exchange or you enter into a cutting contract, discussed below.

Timber considered cut. Timber is considered cut on the date when, in the ordinary course of business, the quantity of felled timber is first definitely determined. This is true whether the timber is cut under contract or whether you cut it yourself.

Christmas trees. Evergreen trees, such as Christmas trees, that are more than 6 years old when severed from their roots and sold for or-namental purposes are included in the term tim-ber. They qualify for both rules discussed be-low.

Election to treat cutting as a sale or ex-change. Under the general rule, the cutting of timber results in no gain or loss. It is not until a sale or exchange occurs that gain or loss is re-alized. But if you owned or had a contractual right to cut timber, you can elect to treat the cut-ting of timber as a section 1231 transaction in the year it is cut. Even though the cut timber is not actually sold or exchanged, you report your gain or loss on the cutting for the year the tim-ber is cut. Any later sale results in ordinary busi-ness income or loss. See the example below.

To elect this treatment, you must:

1. Own or hold a contractual right to cut the timber for a period of more than 1 year be-fore it is cut, and

2. Cut the timber for sale or use in your trade or business.

Making the election. You make the elec-tion on your return for the year the cutting takes

place by including in income the gain or loss on the cutting and including a computation of your gain or loss. You do not have to make the elec-tion in the first year you cut the timber. You can make it in any year to which the election would apply. If the timber is partnership property, the election is made on the partnership return. This election cannot be made on an amended re-turn.

Once you have made the election, it re-mains in effect for all later years unless you re-voke it.

Election under section 631(a) may be re-voked. If you previously elected for any tax year ending before October 23, 2004, to treat the cutting of timber as a sale or exchange un-der section 631(a), you may revoke this election without the consent of the IRS for any tax year ending after October 22, 2004. The prior elec-tion (and revocation) is disregarded for purpo-ses of making a subsequent election. See Form T (Timber), Forest Activities Schedule, for more information.

Gain or loss. Your gain or loss on the cut-ting of standing timber is the difference between its adjusted basis for depletion and its FMV on the first day of your tax year in which it is cut. The FMV becomes your basis in the cut timber, and a later sale of the cut timber, including any by-product or tree tops, will result in ordinary business income or loss.

Your adjusted basis for depletion of cut tim-ber is based on the number of units (board feet, log scale, or other units) of timber cut during the tax year and considered to be sold or ex-changed. Your adjusted basis for depletion is also based on the depletion unit of timber in the account used for the cut timber, and should be figured in the same manner as shown in section 611 and Regulations section 1.611-3.

Depletion of timber is discussed in chap-ter 7.

Example. In April 2018, you owned 4,000 MBF (1,000 board feet) of standing timber lon-ger than 1 year. It had an adjusted basis for de-pletion of $40 per MBF. You are a calendar year taxpayer. On January 1, 2018, the timber had an FMV of $350 per MBF. It was cut in April for sale. On your 2018 tax return, you elect to treat the cutting of the timber as a sale or exchange. You report the difference between the FMV and your adjusted basis for depletion as a gain. This amount is reported on Form 4797 along with your other section 1231 gains and losses to fig-ure whether it is treated as a capital gain or as ordinary gain. You figure your gain as follows.

FMV of timber January 1, 2018 . . . . . . .	$1,400,000
Minus: Adjusted basis for depletion . . . .	160,000
. . . . . . . . . . . .Section1231gain	$1,240,000

Outright sales of timber. Outright sales of timber by landowners qualify for capital gains treatment using rules similar to the rules for cer-tain disposal of timber under a contract with re-tained economic interest (defined later). How-ever, for outright sales, the date of disposal is not deemed to be the date the timber is cut be-cause the landowner can elect to treat the pay-ment date as the date of disposal (see Date of disposal below).

Cutting contract. You must treat the disposal of standing timber under a cutting contract as a section 1231 transaction if all the following ap-ply to you.

You are the owner of the timber.

You held the timber longer than 1 year be-fore its disposal.

You kept an economic interest in the tim-ber.

You have kept an economic interest in standing timber if, under the cutting contract, the expected return on your investment is con-ditioned on the cutting of the timber.

The difference between the amount realized from the disposal of the timber and its adjusted basis for depletion is treated as gain or loss on its sale. Include this amount on Form 4797 along with your other section 1231 gains or los-ses.

Date of disposal. The date of disposal is the date the timber is cut. However, for outright sales by landowners or if you receive payment under the contract before the timber is cut, you can elect to treat the date of payment as the date of disposal.

This election applies only to figure the hold-ing period of the timber. It has no effect on the time for reporting gain or loss (generally when the timber is sold or exchanged).

To make this election, attach a statement to the tax return filed by the due date (including extensions) for the year payment is received. The statement must identify the advance pay-ments subject to the election and the contract under which they were made.

If you timely filed your return for the year you received payment without making the election, you can still make the election by filing an amended return within 6 months after the due date for that year's return (excluding exten-sions). Attach the statement to the amended re-turn and write “Filed pursuant to section 301.9100-2” at the top of the statement. File the amended return at the same address the origi-nal return was filed.

Owner. An owner is any person who owns an interest in the timber, including a sublessor and the holder of a contract to cut the timber. You own an interest in timber if you have the right to cut it for sale on your own account or for use in your business.

Tree stumps. Tree stumps are a capital asset if they are on land held by an investor who is not in the timber or stump business as a buyer, seller, or processor. Gain from the sale of stumps sold in one lot by such a holder is taxed as a capital gain. However, tree stumps held by timber operators after the saleable standing tim-ber was cut and removed from the land are con-sidered by-products. Gain from the sale of stumps in lots or tonnage by such operators is taxed as ordinary income.

See Form T (Timber) and its separate in-structions for more information about disposi-tions of timber.

Sale of a Farm

The sale of your farm may involve the sale of both nonbusiness property (your home) and business property (the land and buildings used

in the farm operation and perhaps machinery and livestock). If any gain from the sale includes a gain from the sale of your home, you may be allowed to exclude the gain on your home. For more information, see Pub. 523, Selling Your Home.

The gain on the sale of your business prop-erty is taxable. A loss on the sale of your busi-ness property to an unrelated person is deduc-ted as an ordinary loss. Your taxable gain or loss on the sale of property used in your farm business is taxed under the rules for section 1231 transactions. See chapter 9. Losses from personal-use property, other than casualty or theft losses, are not deductible. If you receive payments for your farm in installments, certain gains may be eligible to be taxed over the pe-riod of years the payments are received. See chapter 10 for information about installment sales.

When you sell your farm, the gain or loss on each asset is figured separately. The tax treat-ment of gain or loss on the sale of each asset is determined by the classification of the asset. Each of the assets sold must be classified as one of the following.

Capital asset held 1 year or less.

Capital asset held longer than 1 year.

Property (including real estate) used in your business and held 1 year or less (in-cluding draft, breeding, dairy, and sporting animals held less than the holding periods discussed earlier under Livestock).

Property (including real estate) used in your business and held longer than 1 year (including only draft, breeding, dairy, and sporting animals held for the holding peri-ods discussed earlier).

Property held primarily for sale or which is of the kind that would be included in inven-tory if on hand at the end of your tax year.

Allocation of consideration paid for a farm. The sale of a farm for a lump sum is considered a sale of each individual asset rather than a sin-gle asset. If the group of assets sold constitutes a trade or business, the residual method must be used. This method determines gain or loss from the transfer of each asset. It also deter-mines the buyer's basis in the business assets. For more information, see Sale of a Business in chapter 2 of Pub. 544.

Property used in farm operation. The rules for excluding the gain on the sale of your home, described later under Sale of your home, do not apply to the property used for your farming busi-ness. Recognized gains and losses on busi-ness property must be reported on your return for the year of the sale. If the property was held longer than 1 year, it may qualify for section 1231 treatment (see chapter 9).

Example. You sell your farm, including your main home, which you have owned since De-cember 2003. You realize gain on the sale as follows.

		Farm	Home		Farm
		With		Without
Selling price . . . .	$	Home	Only	Home

		382,000	$158,000	$224,000
Cost (or other	240,000		110,000	130,000
basis) . . . . . . . .
Gain . . . . . . .	$142,000		$48,000	$94,000

You must report the $94,000 gain from the sale of the property used in your farm business. All or a part of that gain may have to be repor-ted as ordinary income from the recapture of depreciation or soil and water conservation ex-penses. Treat the balance as section 1231 gain.

The $48,000 gain from the sale of your home is not taxable if you meet the require-ments explained later under Sale of your home.

Partial sale. If you sell only part of your farm, you must report any recognized gain or loss on the sale of that part on your tax return for the year of the sale. You cannot wait until you have sold enough of the farm to recover its entire cost before reporting gain or loss. For a detailed discussion on installment sales, see Pub. 544.

Adjusted basis of the part sold. This is the properly allocated part of your original cost or other basis of the entire farm plus or minus necessary adjustments for improvements, de-preciation, etc., on the part sold. If your home is on the farm, you must properly adjust the basis to exclude those costs from your farm asset costs, as discussed below under Sale of your home.

Example. You bought a 600-acre farm for $700,000. The farm included land and build-ings. The purchase contract designated $600,000 of the purchase price to the land. You later sold 60 acres of land on which you had in-stalled a fence. Your adjusted basis for the part of your farm sold is $60,000 (1/10 of $600,000), plus any unrecovered cost (cost not depreci-ated) of the fence on the 60 acres at the time of sale. Use this amount to determine your gain or loss on the sale of the 60 acres.

Assessed values for local property taxes. If you paid a flat sum for the entire farm and no other facts are available for properly al-locating your original cost or other basis be-tween the land and the buildings, you can use the assessed values for local property taxes for the year of purchase to allocate the costs.

Example. Assume that in the preceding ex-ample there was no breakdown of the $700,000 purchase price between land and buildings. However, in the year of purchase, local taxes on the entire property were based on assessed valuations of $420,000 for land and $140,000 for improvements, or a total of $560,000. The assessed valuation of the land is 3/4 (75%) of the total assessed valuation. Multiply the $700,000 total purchase price by 75% to figure basis of $525,000 for the 600 acres of land. The unadjusted basis of the 60 acres you sold would then be $52,500 (1/10 of $525,000).

Sale of your home. Your home is a capital as-set and not property used in the trade or busi-ness of farming. If you sell a farm that includes a house you and your family occupy, you must

Chapter 8Gains and LossesPage 55

determine the part of the selling price and the part of the cost or other basis allocable to your home. Your home includes the immediate sur-roundings and outbuildings relating to it that are not used for business purposes.

If you use part of your home for business, you must make an appropriate adjustment to the basis for depreciation allowed or allowable. For more information on basis, see chapter 6.

More information. For more information on selling your home, see Pub. 523.

Gain from condemnation. If you have a gain from a condemnation or sale of your home under threat of condemnation, you may use the preceding rules for excluding the gain, rather than the rules discussed under Postponing Gain in chapter 11. However, any gain that can-not be excluded (because it is more than the limit) may be postponed under the rules dis-cussed under Postponing Gain in chapter 11.

Foreclosure or

Repossession

If you do not make payments you owe on a loan

Worksheet 8-1. Worksheet for Foreclosures	Keep for Your Records
and Repossessions

Part 1. Use Part 1 to figure your ordinary income from the cancellation of debt upon foreclosure or repossession. Complete this part only if you were personally liable for the debt. Otherwise, go to Part 2.

1. Enter the amount of outstanding debt immediately before the transfer of property reduced by any amount for which you remain personally liable after the transfer of property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2. Enter the Fair Market Value of the transferred property. . . . . . . . . . . . . . . . .

3. Ordinary income from cancellation of debt upon foreclosure or repossession.* Subtract line 2 from line 1. If zero or less, enter -0- . . . . . . . . . .

Part 2. Figure your gain or loss from foreclosure or repossession.

4. If you completed Part 1, enter the smaller of line 1 or line 2. If you did not complete Part 1, enter the outstanding debt immediately before the transfer of property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5. Enter any proceeds you received from the foreclosure sale. . . . . . . . . . . . . .

6. Add lines 4 and 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7. Enter the adjusted basis of the transferred property. . . . . . . . . . . . . . . . . . .

8. Gain or loss from foreclosure or repossession. Subtract line 7

from line 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

* The income may not be taxable. See Cancellation of debt.

secured by property, the lender may foreclose on the loan or repossess the property. The fore-closure or repossession is treated as a sale or exchange from which you may realize gain or loss. This is true even if you voluntarily return the property to the lender. You may also realize ordinary income from cancellation of debt if the loan balance is more than the FMV of the prop-erty.

Buyer's (borrower's) gain or loss. You figure and report gain or loss from a foreclosure or re-possession in the same way as gain or loss from a sale or exchange. The gain or loss is the difference between your adjusted basis in the transferred property and the amount realized. See Determining Gain or Loss, earlier.

You can use Worksheet 8-1 to figure TIP your gain or loss from a foreclosure or

repossession.

Amount realized on a nonrecourse debt. If you are not personally liable for repaying the debt (nonrecourse debt) secured by the trans-ferred property, the amount you realize includes the full amount of the debt canceled by the transfer. The full canceled debt is included in the amount realized even if the fair market value of the property is less than the canceled debt.

Example 1. Ann paid $200,000 for land used in her farming business. She paid $15,000 down and borrowed the remaining $185,000 from a bank. Ann is not personally liable for the loan (nonrecourse debt), but pledges the land as security. The bank foreclosed on the loan 2 years after Ann stopped making payments. When the bank foreclosed, the balance due on the loan was $180,000 and the FMV of the land was $170,000. The amount Ann realized on the foreclosure was $180,000, the debt canceled by the foreclosure. She figures her gain or loss on Form 4797, Part I, by comparing the amount realized ($180,000) with her adjusted basis ($200,000). She has a $20,000 deductible loss.

Page 56Chapter 8Gains and Losses

Example 2. Assume the same facts as in Example 1 except the FMV of the land was $210,000. The result is the same. The amount Ann realized on the foreclosure is $180,000, the debt canceled by the foreclosure. Because her adjusted basis is $200,000, she has a deducti-ble loss of $20,000, which she reports on Form 4797, Part I.

Amount realized on a recourse debt. If you are personally liable for the debt (recourse debt), the amount realized on the foreclosure or repossession includes the lesser of:

The outstanding debt immediately before the transfer reduced by any amount for which you remain personally liable immedi-ately after the transfer, or

The fair market value of the transferred property.

You are treated as receiving ordinary in-come from the canceled debt for the part of the debt that is more than the fair market value. The amount realized does not include the canceled debt that is your income from cancellation of debt. See Cancellation of debt, later.

Example 3. Assume the same facts as in Example 1 above except Ann is personally lia-ble for the loan (recourse debt). In this case, the amount she realizes is $170,000. This is the canceled debt ($180,000) up to the FMV of the land ($170,000). Ann figures her gain or loss on the foreclosure by comparing the amount real-ized ($170,000) with her adjusted basis ($200,000). She has a $30,000 deductible loss, which she figures on Form 4797, Part I. She is also treated as receiving ordinary income from cancellation of debt. That income is $10,000 ($180,000 − $170,000). This is the part of the canceled debt not included in the amount real-ized. She reports this as other income on Schedule F, line 8.

Seller's (lender's) gain or loss on reposses-sion. If you finance a buyer's purchase of your property in an installment sale and later acquire an interest in it through foreclosure or reposses-

sion, you may have a gain or loss on the acquis-ition. For more information, see Repossession in Pub. 537, Installment Sales.

Cancellation of debt. If property that is repos-sessed or foreclosed upon secures a debt for which you are personally liable (recourse debt), you generally must report as ordinary income the amount by which the canceled debt is more than the FMV of the property. This income is separate from any gain or loss realized from the foreclosure or repossession. Report the income from cancellation of a business debt on Sched-ule F, line 8. Report the income from cancella-tion of a nonbusiness debt as miscellaneous in-come on Form 1040.

You can use Worksheet 8-1 to figure TIP your income from cancellation of debt.

However, income from cancellation of debt is not taxed in certain situations. See Cancella-tion of Debt in chapter 3.

Abandonment

The abandonment of property is a disposition of property. You abandon property when you vol-untarily and permanently give up possession and use of the property with the intention of ending your ownership, but without passing it on to anyone else.

Business or investment property. Loss from abandonment of business or investment prop-erty is deductible as a loss. Loss from abandon-ment of business or investment property that is not treated as a sale or exchange generally is an ordinary loss. If your adjusted basis is more than the amount you realize (if any), then you have a loss. If the amount you realize (if any) is more than your adjusted basis, then you have a gain. This rule also applies to leasehold im-provements the lessor made for the lessee. However, if the property is foreclosed on or re-possessed in lieu of abandonment, gain or loss

is figured as discussed earlier under Foreclo-sure or Repossession.

If the abandoned property is secured by debt, special rules apply. The tax consequen-ces of abandonment of property that secures a debt depend on whether you are personally lia-ble for the debt (recourse debt) or were not per-sonally liable for the debt (nonrecourse debt). For more information, see chapter 3 of Pub. 4681, Canceled Debts, Foreclosures, Repos-sessions, and Abandonments (for Individuals).

The abandonment loss is deducted in the tax year in which the loss is sustained. Report the loss on Form 4797, Part II, line 10.

Personal-use property. You cannot deduct any loss from abandonment of your home or other property held for personal use.

Canceled debt. If the abandoned property se-cures a debt for which you are personally liable and the debt is canceled, you may realize ordi-nary income equal to the canceled debt. This income is separate from any loss realized from abandonment of the property. Report income from cancellation of a debt related to a business or rental activity as business or rental income. Report income from cancellation of a nonbusi-ness debt as miscellaneous income on Form 1040.

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

	Type of property	Held 1 year	Held more than
		or less	1 year
1	Depreciable trade or business property:	Part II	Part III (1245, 1250)
	a Sold or exchanged at a gain . . . . . . . . . . . . . . . . . . . .
	b Sold or exchanged at a loss . . . . . . . . . . . . . . . . . . . .	Part II	Part I
2	Farmland held less than 10 years for which soil, water, or
	land clearing expenses were deducted:	Part II	Part III (1252)
	a Sold at a gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
	b Sold at a loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	Part II	Part I
3	All other farmland used in a trade or business	Part II	Part I
4	Disposition of cost-sharing payment property described in	Part II	Part III (1255)
	section 126
5	Cattle and horses used in a trade or business for draft,	Held less	Held 24 mos.
	breeding, dairy, or sporting purposes:	than 24 mos.	or more
	a Sold at a gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	Part II	Part III (1245)
	b Sold at a loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	Part II	Part I
	c Raised cattle and horses sold at a gain . . . . . . . . . . . .	Part II	Part I
6	Livestock other than cattle and horses used in a trade or	Held less	Held 12 mos.
	business for draft, breeding, dairy, or sporting purposes:	than 12 mos.	or more
	a Sold at a gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	Part II	Part III (1245)
	b Sold at a loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	Part II	Part I
	c Raised livestock sold at a gain . . . . . . . . . . . . . . . . . .	Part II	Part I
7	Real or tangible trade or business property which was	Held 1 year	Held more than
	deducted under the de minimis safe harbor	or less	1 year
		Part II	Part II

However, income from cancellation of debt is not taxed in certain circumstances. See Can-cellation of debt, earlier, under Foreclosure or Repossession.

Forms 1099-A and 1099-C. A lender who ac-quires an interest in your property in a foreclo-sure, repossession, or abandonment should send you Form 1099-A showing the information you need to figure your loss from the foreclo-sure, repossession, or abandonment. However, if the lender cancels part of your debt and the lender must file Form 1099-C, the lender may include the information about the foreclosure,

9.

Dispositions of Property Used in Farming

Topics

This chapter discusses:

Section 1231 gains and losses

Depreciation recapture

Other gains

Useful Items

You may want to see:

Publication

544 Sales and Other Dispositions of Assets

repossession, or abandonment on that form in-stead of Form 1099-A. The lender must file Form 1099-C and send you a copy if the can-celed debt is $600 or more and the lender is a financial institution, credit union, federal govern-ment agency, or any organization that has a sig-nificant trade or business of lending money. For foreclosures, repossessions, abandonments of property, and debt cancellations occurring in 2018, these forms should be sent to you by January 31, 2019.

Introduction

When you dispose of property used in your farm business, your taxable gain or loss is usu-ally treated as ordinary income or capital gain (under the rules for section 1231 transactions). Ordinary income is taxed at the same rate as wages and interest. Capital gain is generally taxed at lower rates.

When you dispose of depreciable property (section 1245 property or section 1250 prop-erty) at a gain, you may have to recognize all or part of the gain as ordinary income under the depreciation recapture rules. Any gain remain-ing after applying the depreciation recapture rules is a section 1231 gain, which may be taxed as a capital gain. Similar rules apply to the sale of property on which soil and water conservation expenses have been deducted or government cost-sharing payments have been received.

Gains and losses from property used in farming are reported on Form 4797, Sales of Business Property. Table 9-1 contains exam-ples of items reported on Form 4797 and refers to the part of that form on which they first should be reported.

Form (and Instructions)

4797 Sales of Business Property

See chapter 16 for information about getting publications and forms.

Section 1231 Gains and Losses

Section 1231 gains and losses are the taxable gains and losses from section 1231 transac-tions (explained below). Their treatment as ordi-nary or capital gains depends on whether you have a net gain or a net loss from all of your section 1231 transactions in the tax year.

If you have a gain from a section 1231

transaction, first determine whether CAUTION any of the gain is ordinary income un-der the depreciation (or other) recapture rules explained later. Do not take that gain into ac-count as section 1231 gain.

Section 1231 transactions. Section 1231 transactions are sales and exchanges of real or depreciable property held longer than 1 year and used in a trade or business. Gain or loss on

Chapter 9Dispositions of Property Used in FarmingPage 57

the following transactions is subject to section 1231 treatment.

Sale or exchange of cattle and horses. The cattle and horses must be held for draft, breeding, dairy, or sporting purposes and held for 24 months or longer.

Sale or exchange of other livestock. This livestock must be held for draft, breeding, dairy, or sporting purposes and held for 12 months or longer. Other live-stock include hogs, mules, sheep, goats, donkeys, and other fur-bearing animals. Other livestock does not include poultry.

Sale or exchange of depreciable real property or personal property. This property must be used in your business and held longer than 1 year. Generally, property held for the production of rents or royalties is considered to be used in a trade or business. This property must also be either real property or is of a kind that is subject to depreciation under section 167 of the Internal Revenue Code. Examples of depreciable personal property include farm machinery and trucks. It also includes am-ortizable section 197 intangibles.

Sale or exchange of real estate. This property must be used in your business and held longer than 1 year. Examples are your farm or ranch (including barns and sheds).

Sale or exchange of unharvested crops. The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person, and the land must have been held longer than 1 year. You cannot keep any right or option to reacquire the land directly or indi-rectly (other than a right customarily inci-dent to a mortgage or other security trans-action). Growing crops sold with a leasehold on the land, even if sold to the same person in a single transaction, are not considered a section 1231 transaction.

Distributive share of partnership gains and losses. Your distributive share must be from the sale or exchange of property listed above and held by the partnership for longer than 1 year (or for the required period for certain livestock). You will re-ceive Schedule K-1 (Form 1065) showing the appropriate classification of any gains or losses distributed to you.

Cutting or disposal of timber. Special rules apply if you owned the timber longer than 1 year and elect to treat timber cutting as a sale or exchange, or you enter into a cutting contract, as described in chapter 8 under Timber.

Condemnation. The condemned property (defined in chapter 11) must have been held longer than 1 year. It must be busi-ness property or a capital asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. It cannot be property held for personal use.

Casualty or theft. The casualty or theft must have affected business property, property held for the production of rents or royalties, or investment property (such as notes and bonds). You must have held the property longer than the required holding period. However, if your casualty or theft

losses are more than your casualty or theft gains, the net casualty or theft loss is fully deductible and is not combined with other section 1231 transactions in the section 1231 computation. Section 1231 does not apply to personal casualty gains and los-ses. See chapter 11 for information on how to treat those gains and losses.

If the property is not held for the re-

quired holding period, the transaction CAUTION is not subject to section 1231 treat-ment, and any gain or loss is ordinary income reported in Part II of Form 4797. See Table 9-1.

Property held for sale to customers. A sale, exchange, or involuntary conversion of property held mainly for sale to customers is not a sec-tion 1231 transaction. If you will get back all, or nearly all, of your investment in the property by selling it rather than by using it up in your busi-ness, it is property held mainly for sale to cus-tomers.

Property deducted under the de minimis safe harbor for tangible property. If you de-ducted the cost of a property under the de mini-mis safe harbor for tangible property, then upon its sale or disposition, this property is not trea-ted as a capital asset or as property used in the trade or business under section 1231. Gener-ally, any gain on the disposition of this property is treated as ordinary income reported on Part II of Form 4797.

Treatment as ordinary or capital. To deter-mine the treatment of section 1231 gains and losses, combine all of your section 1231 gains and losses for the year.

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

If you have a net section 1231 gain, it is or-dinary income up to your nonrecaptured section 1231 losses from previous years, explained next. The rest, if any, is long-term capital gain.

Nonrecaptured section 1231 losses. Your nonrecaptured section 1231 losses are your net section 1231 losses for the previous 5 years that have not been applied against a net section 1231 gain. Therefore, if in any of your 5 preceding tax years you had section 1231 los-ses, a net gain for the current year from the sale of section 1231 assets is ordinary gain to the extent of your prior losses. These losses are applied against your net section 1231 gain be-ginning with the earliest loss in the 5-year pe-riod.

Example. In 2018, Bradley has a $20,000 net section 1231 gain. To figure how much he has to report as ordinary income and long-term capital gain, he must first determine his section 1231 gains and losses from the previous 5-year period. From 2013 through 2017 he had the fol-lowing section 1231 gains and losses.

Year		Amount
2013		-0-
2014	-0-
2015	($25,000)
2016	-0-
2017	$18,000

Bradley uses this information to figure how to report his net section 1231 gain for 2018 as shown below.

1) Net section 1231 gain (2018) . . . . . $20,000

2) Net section 1231 loss

(2015) .............. ($25,000)

3) Net section 1231 gain

(2017) .............. ^$18,000

4) Remaining net section 1231 loss from

prior 5 years . . . . . . . . . ^($7,000)

5) Gain treated as

ordinary income . . . . . . . . . . . . . . . ^$7,000

6) Gain treated as long-term

capital gain . . . . . . . . . . . . . . ^$13,000

His remaining net section 1231 loss from 2015 is completely recaptured in 2018.

Depreciation Recapture

If you dispose of depreciable or amortizable property at a gain, you may have to treat all or part of the gain (even if it is otherwise nontaxa-ble) as ordinary income.

To figure any gain that must be repor- ted as ordinary income, you must keep RECORDS permanent records of the facts neces-

sary to figure the depreciation or amortization allowed or allowable on your property. For more information on depreciation recapture, see chapter 3 of Pub. 544. Also see Pub. 946.

Section 1245 Property

A gain on the disposition of section 1245 prop-erty is treated as ordinary income to the extent of depreciation allowed or allowable. Any rec-ognized gain that is more than the part that is ordinary income is a section 1231 gain. See Treatment as ordinary or capital under Section 1231 Gains and Losses, earlier. Also see chap-ter 3 of Pub. 544.

Section 1245 property includes any property that is or has been subject to an allowance for depreciation or amortization and that is any of the following types of property.

1. Personal property (either tangible or intan-gible).

2. Other tangible property (except buildings and their structural components) used as any of the following. See Buildings and structural components below.

a. An integral part of manufacturing, pro-duction, or extraction, or of furnishing certain services.

b. A research facility in any of the activi-ties in (a).

c. A facility in any of the activities in (a) above, for the bulk storage of fungible commodities (discussed later).

3. Where applicable, that part of real prop-erty (not included in (2)) with an adjusted basis reduced by (but not limited to) the following.

Page 58Chapter 9Dispositions of Property Used in Farming

a. Amortization of certified pollution con-trol facilities.

b. The section 179 expense deduction.

c. Deduction for clean-fuel vehicles and certain refueling property.

d. Expenditures to remove architectural and transportation barriers to the handicapped and elderly.

e. Certain reforestation expenditures (as described under Reforestation Costs in chapter 7).

4. Single-purpose agricultural (livestock) or horticultural structures.

5. Storage facilities (except buildings and their structural components) used in dis-tributing petroleum or any primary product of petroleum.

Buildings and structural components. Sec-tion 1245 property does not include buildings and structural components. The term “building” includes a house, barn, warehouse, or garage. The term “structural component” includes walls, floors, windows, doors, central air conditioning systems, light fixtures, etc.

Do not treat a structure that is essentially machinery or equipment as a building or struc-tural component. Also, do not treat a structure that houses property used as an integral part of an activity as a building or structural component if the structure's use is so closely related to the property's use that the structure can be expec-ted to be replaced when the property it initially houses is replaced.

The fact that the structure is specially de-signed to withstand the stress and other de-mands of the property and cannot be used eco-nomically for other purposes indicates it is closely related to the use of the property it houses. Structures such as oil and gas storage tanks, grain storage bins, and silos are not trea-ted as buildings, but as section 1245 property.

Facility for bulk storage of fungible com-modities. This is a facility used mainly for the bulk storage of fungible commodities. Bulk stor-age means storage of a commodity in a large mass before it is used. For example, if a facility is used to store oranges that have been sorted and boxed, it is not used for bulk storage. To be fungible, a commodity must be such that one part may be used in place of another.

Gain Treated as Ordinary Income

The gain treated as ordinary income on the sale, exchange, or involuntary conversion of section 1245 property, including a sale and leaseback transaction, is the lesser of the fol-lowing amounts.

1. The depreciation (which includes any sec-tion 179 deduction claimed) and amortiza-tion allowed or allowable on the property.

2. The gain realized on the disposition (the amount realized from the disposition mi-nus the adjusted basis of the property).

See chapter 3 of Pub. 544 for more information on dispositions of section 1245 property.

Use Part III of Form 4797 to figure the ordi-nary income part of the gain.

Depreciation claimed on other property or claimed by other taxpayers. Depreciation and amortization include the amounts you claimed on the section 1245 property as well as the following depreciation and amortization amounts.

Amounts you claimed on property you ex-changed for, or converted to, your section 1245 property in a like-kind exchange or involuntary conversion. For details on ex-changes of property that are not taxable, see Like-Kind Exchanges in chapter 8.

Amounts a previous owner of the section 1245 property claimed if your basis is de-termined with reference to that person's adjusted basis (for example, the donor's depreciation deductions on property you received as a gift).

Depreciation and amortization. Depreciation and amortization deductions that must be re-captured as ordinary income include (but are not limited to) the following items. See Depreci-ation Recapture in chapter 3 of Pub. 544 for more details.

1. Ordinary depreciation deductions.

2. Section 179 deduction (see chapter 7).

3. Any special depreciation allowance.

4. Amortization deductions for all the follow-ing costs.

a. Acquiring a lease.

b. Lessee improvements.

c. Pollution control facilities.

d. Reforestation expenses.

e. Section 197 intangibles.

f. Qualified disaster expenses.

g. Franchises, trademarks, and trade names acquired before August 11, 1993.

Example. You file your returns on a calen-dar year basis. In February 2016, you bought and placed in service for 100% use in your farming business a light-duty truck (5-year prop-erty) that cost $30,000. You used the half-year convention and your MACRS deductions for the truck were $4,500 in 2016 and $7,650 in 2017. You did not claim the section 179 expense de-duction for the truck. You sold it in May 2018 for $21,000. The MACRS deduction in 2018, the year of sale, is $2,678 (1/2 of $5,355). Figure the gain treated as ordinary income as follows.

1)	Amount realized . . . . . . . . . . .	^. $^.30,000^.....	$21,000
2)	Cost (February 2015) . . . . . .
3)	Depreciation allowed or
	allowable (MACRS deductions:	14,828
	$4,500 + $7,650 + $2,678) . . .
4)	Adjusted basis (subtract line 3			$15,172
	from line 2) . . . . . . . . . . . . . . . . . . . . .
5)	Gain realized (subtract line 4		5,828
6)	from line 1) . . . . . . . . . . . . . . . . . . . . .
	Gain treated as ordinary income		$5,828
	(lesser of line 3 or line 5) . . .	.....

Depreciation allowed or allowable. You generally use the greater of the depreciation al-

lowed or allowable when figuring the part of gain to report as ordinary income. If, in prior years, you have consistently taken proper de-ductions under one method, the amount al-lowed for your prior years will not be increased even though a greater amount would have been allowed under another proper method. If you did not take any deduction at all for deprecia-tion, your adjustments to basis for depreciation allowable are figured by using the straight line method. This treatment applies only when figur-ing what part of the gain is treated as ordinary income under the rules for section 1245 depre-ciation recapture. For more information on de-preciation allowed or allowable, see chapter 7. For information on adjustments to basis for de-preciation allowed or allowable, see chapter 6.

Disposition of plants. If you elect not to use the uniform capitalization rules (see chapter 6), you must treat any plant that would have been subject to the uniform capitalization rules as section 1245 property. If you have a gain on the property's disposition, you must recapture the pre-productive expenses you would have capi-talized if you had not made the election by treat-ing the gain, up to the amount of these expen-ses, as ordinary income. For section 1231 transactions, show these expenses as depreci-ation on Form 4797, Part III, line 22. For plant sales that are reported on Schedule F (Form 1040), Profit or Loss From Farming, this recap-ture rule does not change the reporting of in-come because the gain is already ordinary in-come. You can use the farm-price method discussed in chapter 2 to figure these expen-ses.

Example. Debbie sold her apple orchard in 2018 for $80,000. Her adjusted basis at the time of sale was $60,000. She bought the or-chard in 2011, but the trees did not produce a crop until 2014. Her pre-productive expenses were $6,000. She elected not to use the uniform capitalization rules. Debbie must treat $6,000 of the gain as ordinary income in addition to re-capturing depreciation allowed or allowable on the orchard. This amount would be reported on Form 4797, Part III, as ordinary income.

Section 1250 Property

Section 1250 property includes all real property subject to an allowance for depreciation that is not and never has been section 1245 property. It includes buildings and structural components that are not section 1245 property (discussed earlier). It includes a leasehold of land or sec-tion 1250 property subject to an allowance for depreciation. A fee simple interest in land is not section 1250 property because, like land, it is not depreciable.

Gain on the disposition of section 1250 property is treated as ordinary income to the ex-tent of additional depreciation allowed or allow-able. To determine the additional depreciation on section 1250 property, see Depreciation Re-capture in chapter 3 of Pub. 544.

Use Part III of Form 4797 to figure the ordi-nary income part of the gain.

Chapter 9Dispositions of Property Used in FarmingPage 59

You will not have additional depreciation if any of the following apply to the property disposed of.

You figured depreciation for the property using the straight line method or any other method that does not result in depreciation that is more than the amount figured by the straight line method and you have held the property longer than 1 year.

You chose the alternate ACRS (straight line) method for the property, which was a type of 15-, 18-, or 19-year real property covered by the section 1250 rules.

The property was nonresidential real prop-erty placed in service after 1986 (or after July 31, 1986, if the choice to use MACRS was made) and you held it longer than 1 year. These properties are depreciated us-ing the straight line method.

Installment Sale

If you report the sale of property under the in-stallment method, any depreciation recapture under section 1245 or 1250 is taxable as ordi-nary income in the year of sale. This applies even if no payments are received in that year. If the gain is more than the depreciation recapture income, report the rest of the gain using the rules of the installment method. For this pur-pose, include the recapture income in your in-stallment sale basis to determine your gross profit on the installment sale.

If you dispose of more than one asset in a single transaction, you must separately figure the gain on each asset so that it may be prop-erly reported. To do this, allocate the selling price and the payments you receive in the year of sale to each asset. Report any depreciation recapture income in the year of sale before us-ing the installment method for any remaining gain.

For more information on installment sales, see chapter 10.

Other Dispositions

Chapter 3 of Pub. 544 discusses the tax treat-ment of the following transfers of depreciable property.

By gift.

At death.

In like-kind exchanges.

In involuntary conversions.

Pub. 544 also explains how to handle a single transaction involving multiple properties.

Other Gains

This section discusses gain on the disposition of farmland for which you were allowed either of the following.

Deductions for soil and water conservation expenditures (section 1252 property).

Exclusions from income for certain cost sharing payments (section 1255 property).

Section 1252 property. If you disposed of farmland you held more than 1 year and less than 10 years at a gain and you were allowed

Page 60Chapter 10Installment Sales

deductions for soil and water conservation ex-penses for the land, as discussed in chapter 5, you must treat part of the gain as ordinary in-come and treat the balance as section 1231 gain.

Exceptions. Do not treat gain on the fol-lowing transactions as gain on section 1252 property.

Disposition of farmland by gift.

Transfer of farm property at death (except for income in respect of a decedent).

For more information, see Regulations section 1.1252-2.

Amount to report as ordinary income. You report as ordinary income the lesser of the following amounts.

Your gain (determined by subtracting the adjusted basis from the amount realized from a sale, exchange, or involuntary con-version, or the FMV for all other disposi-tions).

The total deductions allowed for soil and water conservation expenses multiplied by the applicable percentage, discussed next.

Applicable percentage. The applicable percentage is based on the length of time you held the land. If you dispose of your farmland within 5 years after the date you acquired it, the percentage is 100%. If you dispose of the land within the 6th through 9th year after you ac-quired it, the applicable percentage is reduced by 20% a year for each year or part of a year you hold the land after the 5th year. If you dis-pose of the land 10 or more years after you ac-quired it, the percentage is 0%, and the entire gain is a section 1231 gain.

Example. You acquired farmland on Janu-ary 19, 2010. You incurred $15,000 of soil and water conservation expenditures for the land that were fully deductible. On October 3, 2018, you sold the land at a $30,000 gain. The appli-cable percentage is 40% since you sold the land within the 8th year after you acquired it. You treat $6,000 (40% of $15,000) of the $30,000 gain as ordinary income and the $24,000 balance as a section 1231 gain.

Section 1255 property. If you receive certain cost-sharing payments on property and you ex-clude those payments from income (as dis-cussed in chapter 3), you may have to treat part of any gain as ordinary income and treat the balance as a section 1231 gain. If you chose not to exclude these payments, you will not have to recognize ordinary income under this provision.

Amount to report as ordinary income. You report as ordinary income the lesser of the following amounts.

The applicable percentage of the total ex-cluded cost-sharing payments.

The gain on the disposition of the property.

You do not report ordinary income under this rule to the extent the gain is recognized as ordi-nary income under sections 1231 through 1254, 1256, and 1257. However, if applicable, gain re-ported under this rule must be reported regard-less of any contrary provisions (including nonre-cognition provisions) under any other section.

Applicable percentage. The applicable percentage of the excluded cost-sharing pay-ments to be reported as ordinary income is based on the length of time you hold the prop-erty after receiving the payments. If the property is held less than 10 years after you receive the payments, the percentage is 100%. After 10 years, the percentage is reduced by 10% a year, or part of a year, until the rate is 0%.

Form 4797, Part III. Use Form 4797, Part III, to figure the ordinary income part of a gain from the sale, exchange, or involuntary conversion of section 1252 property and section 1255 prop-erty.

10.

Installment

Sales

Introduction

An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. If you realize a gain on an in-stallment sale, you may be able to report part of your gain when you receive each payment. This method of reporting gain is called the install-ment method. You can’t use the installment method to report a loss. You can choose to re-port all of your gain in the year of sale.

Installment obligation. The buyer’s obligation to make future payments to you can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer’s debt to you.

Topics

This chapter discusses:

The general rules that apply to using the installment method.

Installment sale of a farm.

Useful Items

You may want to see:

Publication

523	Selling Your Home
535	Business Expenses
537	Installment Sales
538	Accounting Periods and Methods
544	Sales and Other Dispositions of
	Assets

Form (and Instructions)

4797 Sales of Business Property

6252 Installment Sale Income

See chapter 16 for information about getting publications and forms.

Installment Sale of a Farm

The installment sale of a farm for one overall price under a single contract isn’t the sale of a single asset. It generally includes the sale of real property and personal property reportable on the installment method. It also may include the sale of property for which you must maintain an inventory, which can’t be reported on the in-stallment method. See Inventory , later. The sell-ing price must be allocated to determine the amount received for each class of asset.

Note. You may be required to report the sale of your farm on Form 8594, Asset Acquisi-tion Statement. For more information, see Form 8594 and its instructions.

The tax treatment of the gain or loss on the sale of each class of asset is determined by its classification as a capital asset, as property used in the business, or as property held for sale and by the length of time the asset was held. (See chapter 8 for a discussion of capital assets and chapter 9 for a discussion of prop-erty used in the business.) Separate computa-tions must be made to figure the gain or loss for each class of asset sold. See Sale of a Farm in chapter 8.

If you report the sale of property on the

installment method, any depreciation CAUTION recapture under section 1245 or 1250 generally is taxable as ordinary income in the year of sale. See Depreciation recapture, later. This applies even if no payments are received in that year.

Related parties. If you sell property to a rela-ted party, you may not be able to report the sale using the installment method. Generally, mem-bers of a family aren’t related parties for purpo-ses of the installment method. For more infor-mation, see Related Person under Sale to a Related Person in Pub. 537.

Installment Method

An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. A farmer who isn’t required to maintain an inventory can use the installment method to report gain from the sale of property used or produced in farming. See Inventory, later, for information on the sale of farm prop-erty where inventory items are included in the assets sold.

If a sale qualifies as an installment sale, the gain must be reported under the installment method unless you elect out of using the install-ment method.

Electing out of the installment method. If you elect not to use the installment method, you generally report the entire gain in the year of

sale, even though you don’t receive all the sale proceeds in that year.

To make this election, don’t report your sale on Form 6252. Instead, report it on Schedule F (Form 1040), Schedule D (Form 1040), Form 4797, or all three.

You also may need to file Form 8949. For more information, see Form 8949, and its in-structions.

When to elect out. Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place.

However, if you timely file your tax return for the year the sale takes place without making the election, you still can make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Write “Filed pursuant to section 301.9100-2” at the top of the amended return.

Amended returns can’t be filed electroni-cally. If you filed your original return electroni-cally, file the amended return where you would’ve filed a paper return. For more informa-tion, go to IRS.gov/WhereToFile.

Revoking the election. Once made, the election can be revoked only with IRS approval. An approved revocation is retroactive.

The taxpayer can’t revoke the election if ei-ther of the following applies.

One of the purposes is to avoid federal in-come tax.

The tax year in which any payment was re-ceived has closed.

To revoke the election, you must obtain a private letter ruling from the IRS. The proce-dures and user fees for obtaining a private letter ruling are published annually in the first revenue procedure issued each calendar year. For

2018,gotoIRS.gov/irb/

2018-01_IRB#RP-2018-01.

Send your request for a private letter ruling, including the applicable user fee, to the IRS fol-lowing the instructions in section 7 of Rev. Proc. 2018-1. A schedule of the current user fees is available in Appendix A.

Inventory. If you aren’t required to maintain (keep a record of beginning and ending) inven-tories under your method of accounting, you can report gain from the sale of farm inventory using the installment method. Complete Form 6252 to figure the amount of installment gain to report each year from the sale of farm inventory and carry that amount to line 8 of Schedule F (Form 1040).

If you are required to maintain inventories under your method of accounting, you can’t re-port gain from the sale of farm inventory using the installment method. All gain or loss on the sale of farm inventory must be reported in the year of sale, even if you receive payment in later years. If inventory items are included in an installment sale, you may have an agreement stating which payments are for inventory and which are for the other assets being sold. If you don’t, each payment must be allocated between the inventory and the other assets sold.

More information. See Inventory under Sale of a Business in Pub. 537 for more infor-mation.

Sale at a loss. If your sale results in a loss, you can’t use the installment method. If the loss is on an installment sale of business assets, you can deduct it only in the tax year of sale.

Figuring Installment Sale Income

Each payment on an installment sale usually consists of the following three parts.

• Interest income.

•Return of your adjusted basis in the prop-erty.

• Gain on the sale.

In each year you receive a payment, you must include in income both the interest part and the part that is your gain on the sale. Don’t include in income the part that is the return of your basis in the property. Basis is the amount of your in-vestment in the property for installment sale purposes.

Interest income. You must report interest as ordinary income. Interest generally isn’t inclu-ded in a down payment. However, you may have to treat part of each later payment as inter-est, even if it isn’t called interest in your agree-ment with the buyer. Interest provided in the agreement is called stated interest. If the agree-ment doesn’t provide for enough stated interest, there may be unstated interest or original issue discount. See Unstated interest, later.

You must continue to report the interest

income on payments you receive in CAUTION subsequent years as interest income whether it’s stated or unstated.

Adjusted basis and installment sale income (gain on sale). After you have determined how much of each payment to treat as interest, you treat the rest of each payment as if it were made up of two parts.

A tax-free return of your adjusted basis in the property, and

Your gain (referred to as “installment sale income” on Form 6252).

Figuring adjusted basis and gross profit percentage for installment sale purposes. You can use Worksheet 10-1 to figure your ad-justed basis in the property for installment sale purposes. When you have completed the work-sheet, you also will have determined the gross profit percentage necessary to figure your in-stallment sale income (gain) for this year.

1. Selling price. The selling price is the total cost of the property to the buyer and in-cludes the following.

Any money you’re to receive.

The fair market value (FMV) of any property you’re to receive (FMV is discussed under Property used as a payment, later).

Any existing mortgage or other debt the buyer pays, assumes, or takes the property subject to (a note, mort-gage, or any other liability, such as a lien, accrued interest, or taxes you owe on the property).

Any of your selling expenses the buyer pays.

Chapter 10Installment SalesPage 61

Don’t include stated interest, unstated interest, any amount recomputed or re-characterized as interest, or original issue discount in the selling price.

2.	Adjusted basis.
	•	Your adjusted basis in property im-
		mediately before the installment sale
		is your original basis increased or re-
		duced as a result of various events
		while you own the property. Some
		events, such as adding rooms or
		making permanent improvements, in-
		crease basis. Others, such as deduc-
		tible casualty losses or depreciation
		previously allowed or allowable, de-
	•	crease basis.
		The way you figure your original basis
		depends on how you acquire the
		property. The basis of property you
		buy generally is its cost. The basis of
		property you inherit, receive as a gift,
		build yourself, or receive in a tax-free
		exchange is figured differently. See
		chapter 6 and Pub. 551 for more in-
		formation.
3. Selling expenses. Selling expenses re-
	late to the sale of the property. Review the
	closing statement for fees which may qual-
	ify as selling expenses. These may in-
	clude appraisal fees, attorney fees, clos-
	ing fees, document preparation fees,
	escrow fees, mortgage satisfaction fees,
	notary fees, points paid by seller to obtain
	financing for the buyer, real estate broker’s
	commission, recording fees (if paid by the
	seller), costs of removing title clouds, set-
	tlement fees, title search fees, and transfer
	or stamp taxes charged by city, county, or
	state governments.
4. Depreciation recapture. If the property
	you sold was depreciable property:
	•	You may need to recapture part of the
		gain on the sale as ordinary income.
	•	See Depreciation Recapture in chap-
		ter 9
			and Depreciation Recapture In-
		come in Pub. 537.
5. Adjusted basis for installment sale
	purposes. Your adjusted basis for install-
	ment sale purposes is the total of the fol-
	lowing three items.
	•	Adjusted basis.
	•	Selling expenses.
	•	Depreciation recapture.
6.	Gross profit.
	•	Gross profit is the total gain you re-
		port on the installment method.
	•	To figure your gross profit, subtract
		your adjusted basis for installment
	•	sale purposes from the selling price.
		If the property you sold was your
		home, subtract from the gross profit

Worksheet 10-1. Figuring Adjusted Basis and Gross Profit Percentage

Keep for Your Records

1.Enter the selling price for the property . . . . . . . . . . . . . . . . . . . . . . . . .

2.Enter your adjusted basis for the property . . . . . . . . . . . . .

3.Enter your selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . .

4.Enter any depreciation recapture . . . . . . . . . . . . . . . . . . . . .

5.Add lines 2, 3, and 4.

This is your adjusted basis

for installment sale purposes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.Subtract line 5 from line 1. If zero or less, enter -0-.

This is your gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

If the amount entered on line 6 is zero, stop here. You can’t use the installment method.

7.Enter the contract price for the property . . . . . . . . . . . . . . . . . . . . . . .

8.Divide line 6 by line 7. This is your gross

profit percentage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Worksheet 10-2. New Gross Profit Percentage — Selling Price Reduced Keep for Your Records

1. Enter the reduced selling

price for the property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2. Enter your adjusted basis for the

property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3. Enter your selling

expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4. Enter any depreciation

recapture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5. Add lines 2, 3, and 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6. Subtract line 5 from line 1. This is your adjusted

gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7. Enter any installment sale income reported in

prior year(s) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8. Subtract line 7 from line 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9. Future installments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10. Divide line 8 by line 9. This is your new

gross profit percentage* . . . . . . . . . . . . . . . . . . . . . . . . . . . .

* Apply this percentage to all future payments to determine how much of each of those payments is installment sale income.

	any gain you can exclude. See Pub.
	523, Selling Your Home, for more in-
	formation.
7. Contract price. Contract price equals:
•	The selling price, minus
	The mortgages, debts, and other lia-
•	bilities assumed or taken by the
•	buyer, plus
	The amount by which the mortgages,
	debts, and other liabilities assumed

Page 62Chapter 10Installment Sales

or taken by the buyer exceed your adjusted basis for installment sale purposes.

8. Gross profit percentage.

A certain percentage of each pay-ment (after subtracting interest) is re-ported as installment sale income. This percentage is called the gross profit percentage and is figured by di-

viding your gross profit from the sale by the contract price.

The gross profit percentage generally remains the same for each payment you receive. However, see Example under Selling price reduced, later, for a situation where the gross profit per-centage changes.

Example. You sell property at a contract price of $60,000 and your gross profit is $15,000. Your gross profit percentage is 25% ($15,000 ÷ $60,000). After subtracting interest from each payment, you report 25% of each payment, including the down payment, as in-stallment sale income from the sale for the tax year you receive the payment. The remainder (balance) of each payment is the tax-free return of your adjusted basis.

Amount to report as installment sale in-come. Multiply the payments you receive each year (less interest) by the gross profit percent-age. The result is your installment sales income for the tax year. In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. A re-ceipt of property or the assumption of a mort-gage on the property sold may be treated as a payment. For a detailed discussion, see Pay-ments Received or Considered Received, later.

Selling price reduced. If the selling price is reduced at a later date, the gross profit on the sale also will change. You then must refigure the gross profit percentage for the remaining payments. Refigure your gross profit using Worksheet 10-2 . You will spread any remaining gain over future installments.

Example. In 2016, you sold land with a ba-sis of $40,000 for $100,000. Your gross profit was $60,000. You received a $20,000 down payment and the buyer’s note for $80,000. The note provides for monthly payments of $1,953 each, figured at 8% interest, amortized over 4 years, beginning in January 2017. Your gross profit percentage was 60%. You received the down payment of $20,000 in 2016 and total payments of $23,436 in 2017, of which $17,675 was principal and $5,761 was interest accord-ing to the amortization schedule. You reported a gain of $12,000 on the down payment received in 2016 and $10,605 ($17,675 X 60% (0.60)) in 2017.

In January 2018, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2018, 2019, and 2020 are re-duced to $1,483 a month amortized over the re-maining 3 years.

The new gross profit percentage, 47.32%, is figured in Example — Worksheet 10-2.

Example — New Gross Profit Worksheet 10-2. Percentage — Sell-

ing Price Reduced

Keep for Your Records

1.	Enter the reduced selling	_.....85,000
	price for the property . . . . .
2.	Enter your adjusted
	basis for the	40,000
	property . . . . . . . . . . . .
3.	Enter your selling	-0-
	expenses . . . . . . . . . . .
4.	Enter any depreciation	-0-
	recapture . . . . . . . . . . .
5.	Add lines 2, 3, and 4 . . . . .	.....40,000
6.	Subtract line 5 from line 1.
	This is your adjusted	_.....45,000
	gross profit . . . . . . . . . .
7.	Enter any installment sale
	income reported in	_.....22,605
	prior year(s) . . . . . . . . . .
8.	Subtract line 7 from line 6 . .
		.....22,395
9.	Future installments . . . . . .
		.....47,325
10.	Divide line 8 by line 9.
	This is your new	_.....47.32%
	gross profit percentage* . .

Apply this percentage to all future payments to determine how much of each of those payments is installment sale income.

You will report installment sale income of

$6,878 (47.32% of $14,535) in 2018, $7,449

(47.32% of $15,742) in 2019, and $8,067

(47.32% of $17,048) in 2020.

Form 6252. Use Form 6252 to report an in-stallment sale in the year it takes place and to report payments received, or considered re-ceived because of related party resales, in later years. Attach it to your tax return for each year.

Disposition of Installment Obligation

A disposition generally includes a sale, ex-change, cancellation, bequest, distribution, or transmission of an installment obligation. An in-stallment obligation is the buyer’s note, deed of trust, or other evidence that the buyer will make future payments to you.

If you’re using the installment method and you dispose of the installment obligation, you generally will have a gain or loss to report. It’s considered gain or loss on the sale of the prop-erty for which you received the installment obli-gation.

Cancellation. If an installment obligation is canceled or otherwise becomes unenforceable, it’s treated as a disposition other than a sale or exchange. Your gain or loss is the difference between your basis in the obligation and its FMV at the time you cancel it. If the parties are related, the FMV of the obligation is considered to be no less than its full face value.

Transfer due to death. The transfer of an in-stallment obligation (other than to a buyer) as a result of the death of the seller isn’t a disposi-tion. Any unreported gain from the installment obligation isn’t treated as gross income to the decedent. No income is reported on the dece-

dent’s return due to the transfer. Whoever re-ceives the installment obligation as a result of the seller’s death is taxed on the installment payments the same as the seller would’ve been had the seller lived to receive the payments.

However, if the installment obligation is can-celed, becomes unenforceable, or is transfer-red to the buyer because of the death of the holder of the obligation, it’s a disposition. The estate must figure its gain or loss on the dispo-sition. If the holder and the buyer were related, the FMV of the installment obligation is consid-ered to be no less than its full face value.

More information. For more information, see Disposition of an Installment Obligation in Pub. 537.

Sale of depreciable property. You generally can’t report gain from the sale of depreciable property to a related person on the installment method. However, see Related parties under Installment Sale of a Farm, earlier.

You generally can’t use the installment method to report any depreciation recapture in-come. However, you can report any gain greater than the recapture income on the install-ment method.

The recapture income reported in the year of sale is included in your installment sale basis to determine your gross profit on the installment sale.

Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. As instructed on the form, transfer the depreciation recapture income to Part II of Form 4797 as ordinary income in the year of sale.

If you sell depreciable business prop-TIP erty, prepare Form 4797 first in order to figure the amount to enter on line 12 of Part I, Form 6252. See the Form 6252 instruc-

tions for details.

For more information on the section 179 de-duction, see Section 179 Expense Deduction in chapter 7. For more information on depreciation recapture, see Depreciation Recapture in chap-ter 9.

Payments Received or Considered Received

You must figure your gain each year on the pay-ments you receive, or are treated as receiving, from an installment sale.

In certain situations, you’re considered to have received a payment, even though the buyer doesn’t pay you directly. These situations occur when the buyer assumes or pays any of your debts, such as a loan, or pays any of your expenses, such as a sales commission. How-ever, as discussed later, the buyer’s assump-tion of your debt is treated as a recovery of ba-sis, rather than as a payment, in many cases.

Buyer pays seller’s expenses. If the buyer pays any of your expenses related to the sale of your property, it’s considered a payment to you in the year of sale. Include these expenses in the selling and contract prices when figuring the gross profit percentage.

Chapter 10Installment SalesPage 63

Buyer assumes mortgage. If the buyer as-sumes or pays off your mortgage, or otherwise takes the property subject to the mortgage, the following rules apply.

Mortgage less than basis. If the buyer as-sumes a mortgage that isn’t more than your in-stallment sale basis in the property, it isn’t con-sidered a payment to you. It’s considered a recovery of your basis. The contract price is the selling price minus the mortgage.

Example. You sell property with an adjus-ted basis of $19,000. You have selling expen-ses of $1,000. The buyer assumes your existing mortgage of $15,000 and agrees to pay you $10,000 (a cash down payment of $2,000 and $2,000 (plus 8% interest) in each of the next 4 years).

The selling price is $25,000 ($15,000 + $10,000). Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). The contract price is $10,000 ($25,000 − $15,000 mortgage). Your gross profit percentage is 50% ($5,000 ÷ $10,000). You report half of each $2,000 pay-ment received as gain from the sale. You also report all interest you receive as ordinary in-come.

Mortgage more than basis. If the buyer assumes a mortgage that is more than your in-stallment sale basis in the property, you recover your entire basis. The part of the mortgage greater than your basis is treated as a payment received in the year of sale.

To figure the contract price, subtract the mortgage from the selling price. This is the total amount (other than interest) you will receive di-rectly from the buyer. Add to this amount the payment you’re considered to have received (the difference between the mortgage and your installment sale basis). The contract price is then the same as your gross profit from the sale.

If the mortgage the buyer assumes is TIP equal to or more than your installment sale basis, the gross profit percentage

always will be 100%.

Example. The selling price for your prop-erty is $90,000. The buyer will pay you $10,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $60,000. Your adjusted basis in the property is

$44,000. You have selling expenses of $6,000, for a total installment sale basis of $50,000. The part of the mortgage that is more than your in-stallment sale basis is $10,000 ($60,000 − $50,000). This amount is included in the con-tract price and treated as a payment received in the year of sale. The contract price is $40,000:

Selling price		$90,000
Minus: Mortgage		(60,000)
Amount actually received		$30,000
Add difference:	$60,000

Mortgage
Minus: Installment sale basis	50,000	10,000
Contract price
		$40,000

Your gross profit on the sale is also $40,000:

Page 64Chapter 10Installment Sales

Selling price	$90,000
Minus: Installment sale basis	(50,000)
Gross profit	$40,000

Your gross profit percentage is 100%. Re-port 100% of each payment (less interest) as gain from the sale. Treat the $10,000 excess of the mortgage over your installment sale basis as a payment and report 100% of it as gain in the year of sale.

Buyer assumes other debts. If the buyer as-sumes any other debts, such as a loan or back taxes, it may be considered a payment to you in the year of sale.

If the buyer assumes the debt instead of paying it off, only part of it may have to be trea-ted as a payment. Compare the debt to your in-stallment sale basis in the property being sold. If the debt is less than your installment sale ba-sis, none of it is treated as a payment. If it’s more, only the difference is treated as a pay-ment. If the buyer assumes more than one debt, any part of the total that is more than your in-stallment sale basis is considered a payment. These rules are the same as the rules dis-cussed earlier under Buyer assumes mortgage. However, they apply only to the following types of debt the buyer assumes.

Those acquired from ownership of the property you’re selling, such as a mort-gage, lien, overdue interest, or back taxes.

Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased.

If the buyer assumes any other type of debt, such as a personal loan or your legal fees relat-ing to the sale, it’s treated as if the buyer had paid off the debt at the time of the sale. The value of the assumed debt is then considered a payment to you in the year of sale.

Property used as a payment. If you receive property rather than money from the buyer, it’s still considered a payment in the year received. However, see Trading property for like-kind property, later. Generally, the amount of the payment is the property’s FMV on the date you receive it.

Exception. If the property the buyer gives you is payable on demand or readily tradable (see examples later), the amount you should consider as payment in the year received is:

The FMV of the property on the date you receive it if you use the cash method of ac-counting;

The face amount of the obligation on the date you receive it if you use an accrual method of accounting; or

The stated redemption price at maturity less any original issue discount (OID) or, if there is no OID, the stated redemption price at maturity appropriately discounted to reflect total unstated interest. See Un-stated interest, later.

Examples. If you receive a note from the buyer as payment, and the note stipulates that you can demand payment from the buyer at any time, the note is payable on demand . If you re-ceive marketable securities from the buyer as payment, and you can sell the securities on an established securities market (such as the New

York Stock Exchange) at any time, the securi-ties are readily tradable. In these examples, use the above rules to determine the amount you should consider as payment in the year re-ceived.

Debt not payable on demand. Any evi-dence of debt you receive from the buyer that isn’t payable on demand isn’t considered a pay-ment. This is true even if the debt is guaranteed by a third party, including a government agency.

Fair market value (FMV). This is the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of all the nec-essary facts.

Third-party note. If the property the buyer gives you is a third-party note (or other obliga-tion of a third party), you’re considered to have received a payment equal to the note’s FMV. Because the FMV of the note is itself a payment on your installment sale, any payments you later receive from the third party aren’t consid-ered payments on the sale. The excess of the note’s face value over its FMV is interest. Ex-clude this interest in determining the selling price of the property. However, see Exception under Property used as a payment, earlier.

Example. You sold real estate in an install-ment sale. As part of the down payment, the buyer assigned to you a $50,000, 8% third-party note. The FMV of the third-party note at the time of the sale was $30,000. This amount, not $50,000, is a payment to you in the year of sale. The third-party note had an FMV equal to 60% of its face value ($30,000 ÷ $50,000), so 60% of each principal payment you receive on this note is a nontaxable return of capital. The remaining 40% is interest taxed as ordinary income.

Bond. A bond or other evidence of debt you receive from the buyer that is payable on demand or readily tradable in an established securities market is treated as a payment in the year you receive it. For more information on the amount you should treat as a payment, see Ex-ception under Property used as a payment, ear-lier.

If you receive a government or corporate bond for a sale before October 22, 2004, and the bond has interest coupons attached or can be readily traded in an established securities market, you’re considered to have received payment equal to the bond’s FMV. However, see Exception under Property used as a pay-ment, earlier.

Buyer’s note. The buyer’s note (unless payable on demand) isn’t considered payment on the sale. However, its full face value is inclu-ded when figuring the selling price and the con-tract price. Payments you receive on the note are used to figure your gain in the year re-ceived.

Sale to a related person. If you sell deprecia-ble property to a related person and the sale is an installment sale, you may not be able to re-port the sale using the installment method. For information on these rules, see the Instructions

for Form 6252 and Related parties under Install-ment Sale of a Farm, earlier.

Trading property for like-kind property. If you trade business or investment real property solely for other business or investment real property of a like kind, you can postpone report-ing the gain from the trade. These trades are known as like-kind exchanges. The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. A trade isn’t a like-kind exchange if the property you trade or the property you receive is property you hold primarily for sale to custom-ers. See Like-Kind Exchanges in chapter 8 for a discussion of like-kind property.

If, in addition to like-kind property, you re-ceive an installment obligation in the exchange, the following rules apply to determine install-ment sale income each year.

The contract price is reduced by the FMV of the like-kind property received in the trade.

The gross profit is reduced by any gain on the trade that can be postponed.

Like-kind property received in the trade isn’t considered payment on the install-ment obligation.

Unstated interest. An installment sale con-tract may provide that each deferred payment on the sale will include interest or that there will be an interest payment in addition to the princi-pal payment. Interest provided in the contract is called stated interest.

If an installment sale contract doesn’t pro-vide for adequate stated interest, part of the sta-ted principal amount of the contract may be re-characterized as interest. If section 483 applies to the contract, this interest is called unstated interest.

If section 1274 applies to the contract, this interest is called original issue discount (OID).

Generally, if a buyer gives a debt in consid-eration for personal use property, the unstated interest rules don’t apply to the buyer. There-fore, the buyer can’t deduct the unstated inter-est. The seller must report the unstated interest as income. Personal-use property is any prop-erty in which substantially all of its use by the buyer isn’t in connection with a trade or busi-ness or an investment activity.

If the debt is subject to section 483 rules and also is subject to the below-market loan rules, such as a gift loan, compensation-related loan, or corporation-shareholder loan, then both par-ties are subject to the below-market loan rules rather than the unstated interest rules.

Unstated interest reduces the stated selling price of the property and the buyer’s basis in the property. It increases the seller’s interest in-come and the buyer’s interest expense.

In general, an installment sale contract pro-vides for adequate stated interest if the stated interest rate (based on an appropriate com-pounding period) is at least equal to the appli-cable federal rate (AFR).

The AFRs are published monthly in the Internal Revenue Bulletin (IRB). You can access the IRBs at IRS.gov/

Guidance.

More information. For more information, see Unstated Interest and Original Issue Dis-count (OID) in Pub. 537.

Example

On January 3, 2018, you sold your farm, includ-ing the home, farm land, and buildings. You re-ceived $50,000 down and the buyer’s note for $200,000. In addition, the buyer assumed an outstanding $50,000 mortgage on the farm land. The total selling price was $300,000. The note payments of $25,000 each, plus adequate interest, are due every July 1 and January 1, beginning in July 2018. Your selling expenses were $15,000.

Adjusted basis and depreciation. The adjus-ted basis and depreciation claimed on each as-set sold are as follows:

	Seller’s	Depreciation	Adjusted
	Basis	Claimed	Basis
Home*	$33,743	$0	$33,743
Farm land	73,610	0	73,610
Buildings	66,630	31,500	35,130

Owned and used as main home for at least 2 of the 5 years prior to the sale

Adjusted basis for installment sale purpo-ses. To determine the adjusted basis for in-stallment sale purposes, add the selling ex-pense to the adjusted basis (see above).

		Selling		Adjusted		Adjusted
	Expense				Basis	Basis for
						Installment
							Sale
Home*	$3,000		$33,743			$36,743
Farm land	8,250		73,610			81,860
Buildings	3,750		35,130			38,880
	$15,000			$142,483		$157,483

Owned and used as main home for at least 2 of the 5 years prior to the sale

Depreciation recapture. The buildings are section 1250 property. There may be specific rules for depreciation recapture of buildings (1250 property) using the straight-line method. See chapter 9 for more information on depreci-ation recapture.

Special rules may apply when you sell sec-tion 1250 assets depreciated under the straight-line method. See the Unrecaptured Section 1250 Gain Worksheet in the Instruc-tions for Schedule D (Form 1040). See chap-ter 3 of Pub. 544 for more information on sec-tion 1250 assets.

Gross profit. The following table shows each asset reported on the installment method, its selling price, adjusted basis for installment sale, gain, and gross profit.

	Selling		Adjusted		Gain		Gross
Home		Price		Basis			Profit

	$60,000		$36,743		$23,257	$0
Farm land	165,000		81,860		83,140	83,140
Buildings	75,000		38,880		36,120	36,120
	$300,000		$157,483		$142,517		$119,260

Home. The gain on the home ($23,257) is excluded from your income because it qualifies for the exclusion of gain from the sale of a prin-cipal residence. Therefore, don’t include that gain when you figure your gross profit percent-age.

Section 1231 gains. The gain on the farm land and buildings is reported as section 1231 gains. See Section 1231 Gains and Losses in chapter 9.

Contract price and gross profit percentage. The contract price is $250,000. This is calcula-ted by subtracting the $50,000 mortgage as-sumed from the $300,000 selling price.

Gross profit percentage for the sale is 47.704% ($119,260 gross profit ÷ $250,000 contract price). The gross profit percentage for each asset is figured as follows:

Home	Percent
		0
Farm land ($83,140 ÷ $250,000)	33.256
Buildings ($36,120 ÷ $250,000)	14.448
Total	47.704

Figuring the gain to report on the install-ment method. One hundred percent (100%) of each payment is reported on the installment method. The total amount received on the sale in 2018 is $75,000 ($50,000 down payment + $25,000 payment on July 1). The installment sale part of the total payments received in 2018 is also $75,000. Figure the gain to report for each asset by multiplying its gross profit per-centage times $75,000.

Home		Income
		$0
Farm land (33.256% × $75,000)	24,942
Buildings (14.448% × $75,000)	10,836
Total installment income for 2018	$35,778

Reporting the sale. Report the installment sale on Form 6252. Then report the amounts from Form 6252 on Form 4797 and Schedule D (Form 1040). Attach a separate page to Form 6252 that shows the computations in the exam-ple.

If you sell depreciable business prop-TIP erty, prepare Form 4797 first in order to figure the amount to enter on Form

6252.

Section 1231 gains. The gains on the farm land and buildings are section 1231 gains. They are combined with any other section 1231 gains and losses. A net section 1231 gain is capital gain and a net section 1231 loss is an ordinary loss.

Installment income for years after 2018. You figure installment income for the years after 2018 by applying the same gross profit percen-tages to the payments you receive each year. If you receive $50,000 during the year, the entire $50,000 is considered received on the install-ment sale (100% × $50,000). You realize in-come as follows:

Chapter 10Installment SalesPage 65

Home		Income
		$0
Farm land (33.256% × $50,000)	16,628
Buildings (14.448% × $50,000)	7,224
Total installment income	$23,852

In this example, no gain ever is recognized from the sale of your home. You will combine your section 1231 gains from this sale with sec-tion 1231 gains and losses from other sales in each of the later years to determine whether to report them as ordinary or capital gains. The in-terest received with each payment will be inclu-ded in full as ordinary income.

Summary. The installment income (roun-ded to the nearest dollar) from the sale of the farm is reported as follows:

Selling price	$300,000
Minus: Adjusted basis for installment	(157,483)
reporting	(23,257)
Minus: Excluded gain from home
Gross profit	$119,260

Gain reported in 2018 (year of sale)	$35,778
Gain reported in 2019:	23,852
$50,000 × 47.704%
Gain reported in 2020:	23,852
$50,000 × 47.704%
Gain reported in 2021:	23,852
$50,000 × 47.704%
Gain reported in 2022:	11,926
$25,000 × 47.704%
Total gain reported	$119,260

that remain. For more information, see Pub.

547.

Disaster tax relief. Personal casualty losses resulting from federally declared disasters that occurred in 2016, as well as Hurricane and Tropical Storm Harvey, Hurricanes Irma and Maria, and the California Wildfires may be claimed as a qualified disaster loss on your Form 4684. See Disaster Area Losses, later, and Pub. 547 for more information on the spe-cial relief provided as part of the Disaster Tax Relief and Airway Extension Act of 2017, the Tax Cuts and Jobs Act of 2017, and the Biparti-san Budget Act of 2018. Also see Pub. 976, Disaster Relief, and IRS.gov/DisasterTaxRelief for more information about these and other dis-aster tax relief provisions.

Determining and reporting casualty losses using safe harbor methods. You may be able to use certain safe harbor methods to de-termine the amount of your allowable personal casualty and theft losses and hurricane-related losses. See Safe harbor methods for individual taxpayers to determine casualty and theft los-ses and Cost indexes safe harbor method to calculate hurricane-related losses, later.

Net operating losses. Net operating loss rules have changed. A farming net operating loss arising in 2018 must be carried back two years instead of five years. An election can be made to instead carry over the loss to a subse-quent year. See Pub. 536 or Pub. 542 for addi-tional information.

Topics

This chapter discusses:

Casualties and thefts

How to figure a loss or gain

Other involuntary conversions

Postponing gain

Disaster area losses

Reporting gains and losses

Drought involving property connected with a trade or business or a transaction entered into for profit

Useful Items

You may want to see:

Publication

523 Selling Your Home

525 Taxable and Nontaxable Income

536 Net Operating Losses (NOLs) for Individuals, Estates, and Trusts

542 Corporations

544 Sales and Other Dispositions of Assets

547 Casualties, Disasters, and Thefts

584 Casualty, Disaster, and Theft Loss Workbook (Personal-Use Property)

584-B Business Casualty, Disaster, and Theft Loss Workbook

976 Disaster Relief

11.

Casualties,

Thefts, and Condemnations

What’s New for 2018

Limitation on personal casualty and theft losses. Personal casualty and theft losses of an individual are deductible only to the extent they're attributable to a federally declared dis-aster. The loss deduction is subject to the $100 limit per casualty and 10% of your adjusted gross income (AGI) limitation.

An exception to the rule above limiting the personal casualty and theft loss deduction to losses incurred in a federally declared disaster applies if you have personal casualty gains for the tax year. In this case, you may reduce your personal casualty gains by any casualty losses not attributable to a federally declared disaster. Any excess gain is used to reduce losses from a federally declared disaster. The 10% AGI limi-tation is applied to any federal disaster losses

Reminder

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

Introduction

This chapter explains the tax treatment of casu-alties, thefts, and condemnations. A casualty occurs when property is damaged, destroyed, or lost due to a sudden, unexpected, or unusual event. A theft occurs when property is stolen. A condemnation occurs when private property is legally taken for public use without the owner's consent. A casualty, theft, or condemnation may result in a deductible loss or taxable gain on your federal income tax return. You may have a deductible loss or a taxable gain even if only a portion of your property was affected by a casualty, theft, or condemnation.

An involuntary conversion occurs when you receive money or other property as reimburse-ment for a casualty, theft, condemnation, dispo-sition of property under threat of condemnation, or certain other events discussed in this chap-ter.

If an involuntary conversion results in a gain and you buy qualified replacement property within the specified replacement period, you can postpone reporting the gain on your income tax return. For more information, see Postpon-ing Gain, later.

Form (and Instructions)

Sch A (Form 1040) Itemized Deductions

Sch D (Form 1040) Capital Gains and Losses

Sch F (Form 1040) Profit or Loss From Farming

4684 Casualties and Thefts

4797 Sales of Business Property

See chapter 16 for information about getting publications and forms.

Casualties and Thefts

For tax years beginning after 2017 and

before 2026, personal casualty and CAUTION theft losses of an individual are deduc-tible only to the extent they're attributable to a federally declared disaster. An exception to the rule limiting the deduction for personal casualty and theft losses to disaster losses applies where you have personal casualty gains not at-tributable to a federally declared disaster to the extent the losses don't exceed your gains.

If your property is destroyed, damaged, or stolen, you may have a deductible loss. If the in-surance or other reimbursement is more than the adjusted basis of the destroyed, damaged, or stolen property, you may have a taxable gain.

Casualty. A casualty is the damage, destruc-tion, or loss of property resulting from an

Page 66Chapter 11Casualties, Thefts, and Condemnations

identifiable event that is sudden, unexpected, or unusual.

A sudden event is one that is swift, not gradual or progressive.

An unexpected event is one that is ordina-rily unanticipated and unintended.

An unusual event is one that isn't a day-to-day occurrence and that isn't typical of the activity in which you were engaged.

Deductible losses. Deductible casualty losses can result from a number of different causes, including the following.

Airplane crashes.

Car, truck, or farm equipment accidents not resulting from your willful act or willful negligence.

Earthquakes.

Fires (but see Nondeductible losses next for exceptions).

Floods.

Freezing.

Government-ordered demolition or reloca-tion of a home that is unsafe to use be-cause of a disaster as discussed under Disaster Area Losses, in Pub. 547.

Lightning.

Storms, including hurricanes and torna-does.

Terrorist attacks.

Vandalism.

Volcanic eruptions.

Note. Although you generally can deduct losses of property from the aforementioned list, there is now a new limitation prohibiting you from benefitting from the deduction if you are, for example, an individual filing an individual re-turn and your loss is not attributable to a feder-ally declared disaster.

Nondeductible losses. A casualty loss isn't deductible if the damage or destruction is caused by the following.

Accidentally breaking articles such as glassware or china under normal condi-tions.

A family pet (explained below).

A fire if you willfully set it, or pay someone else to set it.

A car, truck, or farm equipment accident if your willful negligence or willful act caused it. The same is true if the willful act or willful negligence of someone acting for you caused the accident.

Progressive deterioration (explained be-low).

Family pet. Loss of property due to dam-age by a family pet isn't deductible as a casu-alty loss unless the requirements discussed above under Casualty are met.

Example. You keep your horse in your yard. The ornamental fruit trees in your yard were damaged when your horse stripped the bark from them. Some of the trees were com-pletely girdled and died. Because the damage wasn't unexpected or unusual, the loss isn't de-ductible.

Progressive deterioration. Loss of prop-erty due to progressive deterioration isn't de-ductible as a casualty loss. This is because the damage results from a steadily operating cause or a normal process, rather than from a sudden

event. Examples of damage due to progressive deterioration include damage from rust, corro-sion, or termites. However, weather-related conditions or disease may cause another type of involuntary conversion. See Other Involun-tary Conversions, later.

Theft. A theft is the taking and removing of money or property with the intent to deprive the owner of it. The taking of property must be ille-gal under the law of the state where it occurred and it must have been done with criminal intent. You don't need to show a conviction for theft.

Theft includes the taking of money or prop-erty by the following means:

Blackmail,

Burglary,

Embezzlement,

Extortion,

Kidnapping for ransom,

Larceny,

Robbery,

Threats, or

Timber trespass.

The taking of money or property through fraud or misrepresentation is theft if it is illegal under state or local law.

Decline in market value of stock. You can't deduct as a theft loss the decline in market value of stock acquired on the open market for investment if the decline is caused by disclo-sure of accounting fraud or other illegal miscon-duct by the officers or directors of the corpora-tion that issued the stock. However, you may be able to deduct it as a capital loss on Schedule D (Form1040) if the stock is sold or exchanged or becomes completely worthless. You report a capital loss on Schedule D (Form 1040). For more information about stock sales, worthless stock, and capital losses, see chapter 4 of Pub. 550.

Mislaid or lost property. The simple dis-appearance of money or property isn't a theft. However, an accidental loss or disappearance of property can qualify as a casualty if it results from an identifiable event that is sudden, unex-pected, or unusual.

Example. A car door is accidentally slam-med on your hand, breaking the setting of your diamond ring. The diamond falls from the ring and is never found. The loss of the diamond is a casualty.

Farming Losses

You can deduct certain casualty or theft losses that occur in the business of farming. The fol-lowing is a discussion of some losses you can deduct and some you can't deduct.

Livestock or produce bought for resale. Casualty or theft losses of livestock or produce bought for resale are deductible if you report your income on the cash method. If you report your income on an accrual method, take casu-alty and theft losses on property bought for re-sale by omitting the item from the closing inven-tory for the year of the loss. You can't take a separate deduction.

Livestock, plants, produce, and crops raised for sale. Losses of livestock, plants, produce, and crops raised for sale are generally not deductible if you report your income on the cash method. You have already deducted the cost of raising these items as farm expenses, so their basis is equal to zero.

For plants with a preproductive period of more than 2 years, you may have a deductible loss if you have a tax basis in the plants. You usually have a tax basis if you capitalized the expenses associated with these plants under the uniform capitalization rules. The uniform capitalization rules are discussed in chapter 6.

If you report your income on an accrual method, casualty or theft losses are deductible only if you included the items in your inventory at the beginning of your tax year. You get the deduction by omitting the item from your inven-tory at the close of your tax year. You can't take a separate casualty or theft deduction.

Income loss. A loss of future income isn't de-ductible.

Example. A severe flood destroyed your crops. Because you are a cash method tax-payer and already deducted the cost of raising the crops as farm expenses, this loss isn't de-ductible, as explained above under Livestock, plants, produce, and crops raised for sale. You estimate that the crop loss will reduce your farm income by $25,000. This loss of future income is also not deductible.

Loss of timber. If you sell timber downed as a result of a casualty, treat the proceeds from the sale as a reimbursement. If you use the pro-ceeds to buy qualified replacement property, you can postpone reporting the gain. See Post-poning Gain, later.

Property used in farming. Casualty and theft losses of property used in your farm business usually result in deductible losses. If a fire or storm destroyed your barn, or you lose by casu-alty or theft farm equipment or an animal you bought for draft, breeding, dairy, or sport, you may have a deductible loss. See How To Figure a Loss, later.

Raised draft, breeding, dairy, or sporting animals. Generally, losses of raised draft, breeding, dairy, or sporting animals don't result in deductible casualty or theft losses because you have no basis in the animals. However, you may have a basis in the animal and therefore may be able to claim a deduction if you use in-ventories to determine your income and you in-cluded the animals in your inventory.

When you include livestock in inventory, its last inventory value is its basis. When you lose an inventoried animal held for draft, breeding, dairy, or sport by casualty or theft during the year, decrease ending inventory by the amount you included in inventory for the animal. You can't take a separate deduction.

How To Figure a Loss

How you figure a deductible casualty or theft loss depends on whether the loss was to farm

Chapter 11Casualties, Thefts, and CondemnationsPage 67

or personal-use property and whether the prop-erty was stolen or partly or completely de-stroyed.

Farm property. Farm property is the property you use in your farming business. If your farm property was completely destroyed or stolen, your loss is figured as follows:

Your adjusted basis in the property

MINUS

Any salvage value

MINUS

Any insurance or other reimbursement you

receive or expect to receive

You can use the schedules in Pub. TIP 584-B to list your stolen, damaged, or destroyed business property and to fig-

ure your loss.

If your farm property was partially damaged, use the steps shown under Personal-use prop-erty next to figure your casualty loss. However, the deduction limits, discussed later, don't apply to farm property.

Personal-use property.

For tax years beginning after 2017 and

before 2026, personal casualty and CAUTION theft losses of an individual are deduc-tible only to the extent they're attributable to a federally declared disaster. An exception to the rule limiting the deduction for personal casualty and theft losses to disaster losses applies where you have personal casualty gains not at-tributable to a federally declared disaster to the extent the losses don't exceed your gains.

Personal-use property is property used by you or your family members for personal purpo-ses and not used in your farm business or for in-come-producing purposes. The following items are examples of personal-use property.

Your main home.

Furniture and electronics used in your main home and not used in a home office or for business purposes.

Clothing and jewelry.

An automobile used for nonbusiness pur-poses.

You figure the casualty or theft loss on this property by taking the following steps.

1. Determine your adjusted basis in the prop-erty before the casualty or theft.

2. Determine the decrease in fair market value of the property as a result of the casualty or theft.

3. From the smaller of the amounts you de-termined in (1) and (2), subtract any insur-ance or other reimbursement you receive or expect to receive.

You must apply the deduction limits, discussed later, to determine your deductible loss.

You can use Pub. 584 to list your sto-TIP len or damaged personal-use property and figure your loss. It includes sched-ules to help you figure the loss on your home,

its contents, and your motor vehicles.

Adjusted basis. Adjusted basis is your ba-sis (usually cost) increased or decreased by various events, such as improvements and casualty losses. For more information about ad-justed basis, see chapter 6.

Decrease in fair market value (FMV). The decrease in FMV is the difference between the property's value immediately before the casualty or theft and its value immediately after-ward. FMV is defined in chapter 10 under Pay-ments Received or Considered Received.

Appraisal. To figure the decrease in FMV because of a casualty or theft, you generally need a competent appraisal. But other meas-ures, such as the cost of cleaning up or making repairs and certain safe harbor methods can be used to establish decreases in FMV.

An appraisal to determine the difference be-tween the FMV of the property immediately be-fore a casualty or theft and immediately after-ward should be made by a competent appraiser. The appraiser must recognize the ef-fects of any general market decline that may oc-cur along with the casualty. This information is needed to limit any deduction to the actual loss resulting from damage to the property.

Note. Several factors are important in eval-uating the accuracy of an appraisal. See Pub. 547 for additional details regarding appraisals.

Cost of cleaning up or making repairs. The cost of cleaning up after a casualty isn't part of a casualty loss. Neither is the cost of re-pairing damaged property after a casualty. But you can use the cost of cleaning up or making repairs after a casualty as a measure of the de-crease in FMV if you meet all the following con-ditions.

The repairs are actually made.

The repairs are necessary to bring the property back to its condition before the casualty.

The amount spent for repairs isn't exces-sive.

The repairs fix the damage only.

The value of the property after the repairs is not, due to the repairs, more than the value of the property before the casualty.

Landscaping. The cost of restoring land-scaping to its original condition after a casualty may indicate the decrease in FMV. You may be able to measure your loss by what you spend on the following.

Removing destroyed or damaged trees and shrubs, minus any salvage you re-ceive.

Pruning and other measures taken to pre-serve damaged trees and shrubs.

Replanting necessary to restore the prop-erty to its approximate value before the casualty.

Safe harbor methods for individual tax-payers to determine casualty and theft los-ses. Revenue Procedure 2018-08, 2018-2 I.R.B. 286, available at IRS.gov/IRB/ 2018-02_IRB#RP-2018-08 provides safe har-bor methods that you may use to figure the amount of your casualty and theft losses of your personal-use residential real property and per-sonal belongings. If you qualify for and use a

safe harbor method described in Revenue Pro-cedure 2018-08, the IRS won't challenge your determination. The use of a safe harbor method described in Revenue Procedure 2018-08 isn't mandatory. For more information about this safe harbor method, see Pub. 547.

Cost indexes safe harbor method to cal-culate hurricane-related losses. Revenue Procedure 2018-09, 2018-2 I.R.B. 290, availa-ble at IRS.gov/IRB/2018-02_IRB#RP-2018-09, provides a safe harbor method you may use to calculate the amount of your casualty losses for your personal-use residential real property damaged or destroyed in Texas, Louisiana, Florida, Georgia, South Carolina, the Common-wealth of Puerto Rico, or the territory of the U.S. Virgin Islands as a result of Hurricane and Trop-ical Storm Harvey, Hurricane Irma, or Hurricane Maria. If you qualify for and use the cost in-dexes safe harbor method described in Reve-nue Procedure 2018-09, the IRS won't chal-lenge your determination. The use of the cost indexes safe harbor method isn't mandatory. For more information about this safe harbor method, see Pub. 976.

Related expenses. The incidental expen-ses due to a casualty or theft, such as expen-ses for the treatment of personal injuries, tem-porary housing, or a rental car, aren't part of your casualty or theft loss. However, they may be deductible as farm business expenses if the damaged or stolen property is farm property.

Separate computations for more than one item of property. Generally, if a single casu-alty or theft involves more than one item of property, you must figure your loss separately for each item of property. Then combine the los-ses to determine your total loss.

Example. A fire on your farm damaged a tractor and the barn in which it was stored. The tractor had an adjusted basis of $3,300. Its FMV was $28,000 just before the fire and $10,000 immediately afterward. The barn had an adjus-ted basis of $28,000. Its FMV was $55,000 just before the fire and $25,000 immediately after-ward. You received insurance reimbursements of $2,100 on the tractor and $26,000 on the barn. Figure your deductible casualty loss sepa-rately for the two items of property.

1)	Adjusted basis	Tractor		Barn
	.........	$3,300		$28,000
2)	. . . . . . . . .FMVbeforefire	$28,000		$55,000
3)	FMV after fire . . . . . . . . . .	10,000		25,000
4)	Decrease in FMV	$18,000		$30,000
	(line 2 − line 3) . . . . . . . . .
5)	Loss (lesser of line 1 or	$3,300	$28,000
6)	line 4) . . . . . . . . . . . . . . .
	Minus: Insurance . . . . . . .	2,100	26,000
7)	. . .Deductiblecasualtyloss	$1,200		$2,000
8)	Total deductible casualty loss . . . .		$3,200

You spent $10,800 restoring the tractor to its pre-casualty condition and $30,000 restoring the barn to its pre-casualty condition. Your ad-justed basis in the tractor after the casualty is $10,800 ($3,300 – $2,100 – $1,200 + $10,800). Your adjusted basis in the barn after the casu-alty is $30,000 ($28,000 – $26,000 – $2,000 + $30,000).

Page 68Chapter 11Casualties, Thefts, and Condemnations

Exception for personal-use real prop-erty. In figuring a casualty loss on per-sonal-use real property, the entire property (in-cluding any improvements, such as buildings, trees, and shrubs) is treated as one item. Figure the loss using the smaller of the following.

The decrease in FMV of the entire prop-erty.

The adjusted basis of the entire property.

Example. You bought a farm in 2000 for $80,000. The adjusted basis of the residential part is now $64,000. In 2018, a tornado, which was a federally declared disaster, blew down shade trees and three ornamental trees planted at a cost of $3,750 on the residential part. The adjusted basis of the residential part includes the $3,750. The FMV of the residential part im-mediately before the tornado was $200,000, and $192,500 immediately after the tornado. The trees weren’t covered by insurance.

1)	Adjusted basis . . . . . . . . . . . . . . . .	$64,000
2)	. . . . . . . . . .FMVbeforethetornado	$200,000
3)	FMV after the tornado . . . . . . . . . . . .	192,500
4)	Decrease in FMV (line 2 − line 3)	$7,500
5)	Loss before insurance	$7,500
6)	(lesser of line 1 or line 4) . . . . . . . . . .
	Minus: Insurance . . . . . . . . . . . . . .	-0-
7)	. . . .Lossbeforeapplyinglimits	$7,500

As explained later under Deduction Limits on Losses of Personal-Use Property , you have to reduce $7,500 by $100 and 10% of your adjusted gross income (AGI) to get your deductible loss. Thus, your deductible loss is figured as follows.

8)	Subtract $100 . . . . . . . . . . . . . . . . .	$100
9)	. . . . . . . . . .Lossafterthe$100rule	$7,400
10)	Subtract 10% (0.10) x $60,000	6,000
	AGI ........................
11)	. . . . . .Casualtylossdeduction	$1,400

You never replaced the trees. Your adjusted basis in the residential part of your property af-ter the casualty is $62,600 ($64,000 – $1,400).

Insurance and other reimbursements. If you receive an insurance or other type of reimburse-ment, you must subtract the reimbursement when you figure your business or personal loss. You don't have a casualty or theft loss to the ex-tent you are reimbursed.

If you expect to be reimbursed for part or all of your loss, you must subtract the expected re-imbursement when you figure your loss. You must reduce your loss even if you don't receive payment until a later tax year.

Don't subtract from your loss any insur-

ance payments you receive for living CAUTION expenses if you lose the use of your main home or are denied access to it because of a casualty. You may have to include a portion of these payments in your income. See Insur-ance payments for living expenses in Pub. 547 for details.

Reimbursement received after deduct-ing loss. If you figure your casualty or theft loss using your expected reimbursement, you may have to adjust your tax return for the tax year in which you get your actual reimburse-ment.

Actual reimbursement less than expec-ted. If you later receive less reimbursement than you expected, include that difference as a loss with your other losses (if any) on your re-turn for the year in which you can reasonably expect no more reimbursement.

Actual reimbursement more than expec-ted. If you later receive more reimbursement than you expected after you have claimed a de-duction for the loss, you may have to include the extra reimbursement in your income for the year you receive it. However, if any part of your original deduction didn't reduce your tax for the earlier year, don't include that part of the reim-bursement in your income. Don't refigure your tax for the year you claimed the deduction. See Recoveries in Pub. 525 to find out how much extra reimbursement to include in income.

If the total of all the reimbursements

you receive is more than your adjusted CAUTION basis in the destroyed or stolen prop-erty, you will have a gain on the casualty or theft. See Figuring a Gain in Pub. 547 for infor-mation on how to treat a gain from the reim-bursement you receive because of a casualty or theft.

Actual reimbursement same as expec-ted. If you later receive exactly the reimburse-ment you expected to receive, you don't have to include any of the reimbursement in your in-come and you can't deduct any additional loss.

Lump-sum reimbursement. If you have a casualty or theft loss of several assets at the same time without an allocation of reimburse-ment to specific assets, divide the lump-sum re-imbursement among the assets according to the fair market value of each asset at the time of the loss. Figure the gain or loss separately for each asset that has a separate basis.

Disaster assistance. Food, medical sup-plies, and other forms of assistance you receive don't reduce your casualty loss, unless they are replacements for lost or destroyed property. Ex-cludable cash gifts you receive also do not re-duce your casualty loss if there are no limits on how you can use the money.

Generally, disaster relief grants received un-der the Robert T. Stafford Disaster Relief and Emergency Assistance Act aren't included in your income. See Federal disaster relief grants, later, under Disaster Area Losses.

Qualified disaster relief payments for expen-ses you incurred as a result of a federally de-clared disaster aren't taxable income to you. See Qualified disaster relief payments, later, under Disaster Area Losses.

Adjustments to basis. If you have a casualty or theft loss, you must decrease your basis in the property by any insurance or other reim-bursement you receive and by any deductible loss. The result is your adjusted basis in the property. If you make either of the basis adjust-ments described above, amounts you spend on repairs to restore your property to its pre-casu-alty condition increase your adjusted basis. See Adjusted Basis in chapter 6 for more informa-tion.

Example. You built a new grain storage fa-cility for $50,000. This is the basis in your grain

storage facility because that is the total cost you incurred to build it. During the year, a tornado damaged your grain storage facility and your al-lowable casualty loss deduction was $2,000. In addition, your insurance company reimbursed you $8,000 for the damage and you spent $12,000 to restore the grain storage facility to its pre-casualty condition. Your adjusted basis in the grain storage facility after the casualty is $52,000 ($50,000 - $2,000 - $8,000 + $12,000).

Deduction Limits on Losses of Personal-Use Property

Casualty and theft losses of property held for personal use may be deductible if you itemize deductions on Schedule A (Form 1040).

For tax years beginning after 2017 and be-fore 2026, casualty and theft losses of per-sonal-use property are deductible only to the extent they're attributable to a federally de-clared disaster.

The exception to the rule that disallows the deduction for personal casualty losses other than federal disaster losses applies where you have gains for the year. In that case, you may deduct the portion of the personal casualty loss not attributable to a federally declared disaster to the extent the loss doesn't exceed your per-sonal casualty gains.

There are two limits on the deduction for casualty or theft loss of personal-use property. You figure these limits on Form 4684.

$100 rule. You must reduce each casualty or theft loss on personal-use property by $100. This rule applies after you have subtracted any reimbursement.

10% rule. You must further reduce the total of all your casualty or theft losses on personal-use property attributable to a federally declared dis-aster by 10% of your adjusted gross income. Apply this rule after you reduce each loss by $100. Adjusted gross income is on line 7 of Form 1040.

Example. In June, you discovered that your house had been burglarized. Your loss after in-surance reimbursement was $2,000. Your ad-justed gross income for the year you discovered the burglary is $57,000. Figure your theft loss deduction as follows:

1) Loss after insurance . . . . . . . . . . . . . . .$2,000

2) Subtract $100 . . . . . . . . . . . . . . . . . . . .100

3) Loss after $100 rule . . . . . . . . . . . . . . . .$1,900

4) Subtract 10% (0.10) × $57,000 AGI . . . . .$5,700

5) Theft loss deduction . . . . . . . . . .-0-

You don't have a theft loss deduction be-cause your loss ($1,900) is less than 10% of your adjusted gross income ($5,700).

If you have personal casualty losses

sustained as a result of a federally de-CAUTION clared disaster that occurred in 2016, as well as from Hurricane Harvey or Tropical Storm Harvey, Hurricane Irma, Hurricane Maria, or the California wildfires, your net casualty loss from these qualified disasters doesn't need to exceed 10% of your adjusted gross income to

Chapter 11Casualties, Thefts, and CondemnationsPage 69

qualify for the deduction, but the $100 limit per casualty is increased to $500. For more infor-mation, see the Instructions for Form 4684.

If you have a casualty or theft gain in

addition to a loss, you will have to CAUTION make a special computation before you figure your 10% limit. See 10% Rule in Pub. 547.

When Loss Is Deductible

Generally, you can deduct casualty losses that aren't reimbursable only in the tax year in which they occur. You generally can deduct theft los-ses that aren't reimbursable only in the year you discover your property was stolen.

Example. In November 2017, engine parts were stolen from Frank’s stored tractor. Frank didn’t know that the theft occurred until March 2018, when he attempted to start the tractor. Any theft loss to which Frank is entitled as a de-duction will be deductible in the 2018 tax year.

Losses in federally declared disaster areas are subject to different rules. See Disaster Area Losses, later, for an exception.

If you aren't sure whether part of your casu-alty or theft loss will be reimbursed, don't de-duct that part until the tax year when you be-come reasonably certain that it won’t be reimbursed.

Leased property. If you lease property from someone else, you can deduct a loss on the property in the year your liability for the loss is determined. This is true even if the loss occur-red or the liability was paid in a different year. You aren't entitled to a deduction until your lia-bility under the lease can be determined with reasonable accuracy. Your liability can be de-termined when a claim for recovery is settled, adjudicated, or abandoned.

Example. Robert leased a tractor from First Implement, Inc., for use in his farm business. The tractor was destroyed by a tornado in June 2017. The loss wasn’t insured. First Implement billed Robert for the fair market value of the tractor on the date of the loss. Robert disagreed with the bill and refused to pay it. First Imple-ment later filed suit in court against Robert. In 2018, Robert and First Implement agreed to settle the suit for $20,000, and the court entered a judgment in favor of First Implement. Robert paid $20,000 in June 2018. He can claim the $20,000 as a loss on his 2018 tax return.

Net operating loss (NOL). If your deductions, including casualty or theft loss deductions, are more than your income for the year, you may have an NOL.

Net operating loss rules have changed.

A farming net operating loss arising in CAUTION 2018 must be carried back 2 years in-stead of 5 years. An election can be made to in-stead carry over the loss to a subsequent year. See Pub. 536 or Pub. 542 for more information.

Proof of Loss

To deduct a casualty or theft loss, you must be able to prove that there was a casualty or theft. You must have records to support the amount you claim for the loss.

Casualty loss proof. For a casualty loss, your records should show all the following informa-tion.

That you were the owner of the property or, if you leased the property from someone else, that you were contractually liable to the owner for the damage.

The type of casualty (car accident, fire, storm, etc.) and when it occurred.

That the loss was a direct result of the casualty.

Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.

Theft loss proof. For a theft loss, your records should show all the following information.

That you were the owner of the property.

That your property was stolen.

When you discovered your property was missing.

Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.

Figuring a Gain

A casualty or theft may result in a taxable gain. If you receive an insurance payment or other re-imbursement that is more than your adjusted basis in the destroyed, damaged, or stolen property, you have a gain from the casualty or theft. You generally report your gain as income in the year you receive the reimbursement. However, depending on the type of property you receive, you may not have to report your gain. See Postponing Gain, later.

Your gain is figured as follows:

The amount you receive, minus

Your adjusted basis in the property at the time of the casualty or theft.

Even if the decrease in FMV of your prop-erty is smaller than the adjusted basis of your property, use your adjusted basis to figure the gain.

Amount you receive. The amount you receive includes any money plus the value of any prop-erty you receive, minus any expenses you have in obtaining reimbursement. It also includes any reimbursement used to pay off a mortgage or other lien on the damaged, destroyed, or stolen property.

Example. A tornado severely damaged your barn. The adjusted basis of the barn was $25,000. Your insurance company reimbursed you $40,000 for the damaged barn. However, you had legal expenses of $2,000 to collect that insurance. Your insurance minus your expen-ses to collect the insurance is more than your adjusted basis in the barn, so you have a gain.

1)	Insurance reimbursement . . . . . . . . . .	$40,000
2)	Legal expenses . . . . . . . . . . . . . . . . .	2,000
3)	Amount received	$38,000
4)	(line 1 − line 2) . . . . . . . . . . . . . . . . . .
	Adjusted basis . . . . . . . . . . . . . . . . . .	25,000
5)	. . . .Gainoncasualty(line3−line4)	$13,000

The adjusted basis of the barn after the casualty is $0 ($25,000 + $13,000 - $38,000) if you recognized gain and did not repair the barn.

Other Involuntary Conversions

In addition to casualties and thefts, other events cause involuntary conversions of property. Some of these are discussed in the following paragraphs.

Gain or loss from an involuntary conversion of your property is usually recognized for tax purposes. You report the gain or deduct the loss on your tax return for the year you realize it. However, depending on the type of property you receive, you may not have to report your gain on the involuntary conversion. See Post-poning Gain, later.

Condemnation

Condemnation is the process by which private property is legally taken for public use without the owner's consent. The property may be taken by the federal government, a state gov-ernment, a political subdivision, or a private or-ganization that has the power to legally take property. The owner receives a condemnation award (money or property) in exchange for the property taken. A condemnation is a forced sale, the owner being the seller and the con-demning authority being the buyer.

Threat of condemnation. Treat the sale of your property under threat of condemnation as a condemnation, provided you have reasonable grounds to believe that your property will be condemned.

Main home condemned. If you have a gain because your main home is condemned, you generally can exclude the gain from your in-come as if you had sold or exchanged your home. For information on this exclusion, see Pub. 523. If your gain is more than the amount you can exclude, but you buy replacement property, you may be able to postpone report-ing the excess gain. See Postponing Gain, later. (You can't deduct a loss from the condem-nation of your main home.)

More information. For information on how to figure the gain or loss on condemned property, see chapter 1 in Pub. 544. Also see Postponing Gain, later, to find out if you can postpone re-porting the gain.

Irrigation Project

The sale or other disposition of property located within an irrigation project to conform to the

Page 70Chapter 11Casualties, Thefts, and Condemnations

acreage limits of federal reclamation laws is an involuntary conversion.

Livestock Losses

Diseased livestock. If your livestock die from disease, or are destroyed, sold, or exchanged because of disease, even though the disease isn't of epidemic proportions, treat these occur-rences as involuntary conversions. If the live-stock were raised or purchased for resale, fol-low the rules for livestock discussed earlier under Farming Losses. Otherwise, figure the gain or loss from these conversions using the rules discussed under Determining Gain or Loss in chapter 8. If you replace the livestock, you may be able to postpone reporting the gain. See Postponing Gain below.

Reporting dispositions of diseased live-stock. If you choose to postpone reporting gain on the disposition of diseased livestock, you must attach a statement to your return ex-plaining that the livestock were disposed of be-cause of disease. You also must include other information on this statement. See How To Postpone Gain, later, under Postponing Gain.

Weather-related sales of livestock. If you sell or exchange livestock (other than poultry) held for draft, breeding, or dairy purposes solely because of drought, flood, or other weather-re-lated conditions, treat the sale or exchange as an involuntary conversion. Only livestock sold in excess of the number you normally would sell under usual business practice, in the absence of weather-related conditions, are considered involuntary conversions. Figure the gain or loss using the rules discussed under Determining Gain or Loss in chapter 8. If you replace the livestock, you may be able to postpone report-ing the gain. See Postponing Gain below.

Example. It is your usual business practice to sell five of your dairy animals during the year. This year you sold 20 dairy animals because of drought. The sale of 15 animals is treated as an involuntary conversion.

If you don't replace the livestock, you TIP may be able to report the gain in the following year's income. This rule also applies to other livestock (including poultry).

See Sales Caused by Weather-Related Condi-tions in chapter 3.

Tree Seedlings

If, because of an abnormal drought, the failure of planted tree seedlings is greater than nor-mally anticipated, you may have a deductible loss. Treat the loss as a loss from an involuntary conversion. The loss equals the previously cap-italized reforestation costs you had to duplicate on replanting. You deduct the loss on the return for the year the seedlings died.

Postponing Gain

Don't report a gain if you receive reimbursement in the form of property similar or related in

service or use to the destroyed, stolen, or other involuntarily converted property. Your basis in the new property is generally the same as your adjusted basis in the property it replaces.

You must ordinarily report the gain on your stolen, destroyed, or other involuntarily conver-ted property if you receive money or unlike property as reimbursement. However, you can choose to postpone reporting the gain if you purchase replacement property similar or rela-ted in service or use to your destroyed, stolen, or other involuntarily converted property within a specific replacement period.

If you have a gain on damaged property, you can postpone reporting the gain if you spend the reimbursement to restore the prop-erty.

To postpone reporting all the gain, the cost of your replacement property must be at least as much as the reimbursement you receive. If the cost of the replacement property is less than the reimbursement, you must include the gain in your income up to the amount of the unspent re-imbursement.

Example 1. In 1985, you constructed a barn to store farm equipment at a cost of $35,000. In 1990, you added a grain bin to the barn at a cost of $15,000. In May of this year, the property was worth $70,000. In June, the barn and grain storage facility were destroyed by a tornado. At the time of the tornado, you had an adjusted basis of $0 in the property. You received $70,000 from the insurance company. You had a gain of $70,000 ($70,000 – $0).

You spent $65,000 to rebuild the barn and grain bin. Since this is less than the insurance proceeds received, you must include $5,000 ($70,000 – $65,000) in your income. You choose to postpone the remaining $65,000 gain.

Example 2. In 1993, you bought a cabin in the mountains for your personal use at a cost of $48,000. You made no further improvements or additions to it. When a storm destroyed the cabin this January, the cabin was worth $250,000. You received $146,000 from the in-surance company in March. You had a gain of $98,000 ($146,000 − $48,000).

You spent $144,000 to rebuild the cabin. Since this is less than the insurance proceeds received, you must include $2,000 ($146,000 − $144,000) in your income. You choose to post-pone reporting the remaining $96,000 gain.

Buying replacement property from a related person. You can't postpone reporting a gain from a casualty, theft, or other involuntary con-version if you buy the replacement property from a related person (discussed later). This rule applies to the following taxpayers.

1. C corporations.

2. Partnerships in which more than 50% of the capital or profits interest is owned by C corporations.

3. Individuals, partnerships (other than those in (2) above), and S corporations if the to-tal realized gain for the tax year on all in-voluntarily converted properties on which there are realized gains is more than $100,000.

For involuntary conversions described in (3) above, gains can't be offset by any losses when determining whether the total gain is more than $100,000. If the property is owned by a partner-ship, the $100,000 limit applies to the partner-ship and each partner. If the property is owned by an S corporation, the $100,000 limit applies to the S corporation and each shareholder.

Exception. This rule doesn’t apply if the re-lated person acquired the property from an un-related person within the period of time allowed for replacing the involuntarily converted prop-erty.

Related persons. Under this rule, related persons include, for example, a parent and child, a brother and sister, a corporation and an individual who owns more than 50% of its out-standing stock, and two partnerships in which the same C corporations own more than 50% of the capital or profits interests. For more infor-mation on related persons, see Nondeductible Loss under Sales and Exchanges Between Re-lated Persons in chapter 2 of Pub. 544.

Death of a taxpayer. If a taxpayer dies after realizing a gain, but before buying replacement property, the gain must be reported for the year in which the decedent realized the gain. The ex-ecutor of the estate or the person succeeding to the funds from the involuntary conversion can't postpone reporting the gain by buying replace-ment property.

Replacement Property

You must buy replacement property for the spe-cific purpose of replacing your property. Your replacement property must be similar or related in service or use to the property it replaces. You don't have to use the same funds you receive as reimbursement for your old property to ac-quire the replacement property. If you spend the money you receive for other purposes, and borrow money to buy replacement property, you can still choose to postpone reporting the gain if you meet the other requirements. Prop-erty you acquire by gift or inheritance doesn’t qualify as replacement property.

Owner-user. If you are an owner-user, similar or related in service or use means that replace-ment property must function in the same way as the property it replaces. Examples of property that functions in the same way as the property it replaces are a home that replaces another home, a dairy cow that replaces another dairy cow, and farm land that replaces other farm land. A grinding mill that replaces a tractor doesn’t qualify. Neither does a draft animal that replaces a breeding or dairy cow.

Soil or other environmental contamination. If, because of soil or other environmental con-tamination, it isn't feasible for you to reinvest your insurance money or other proceeds from destroyed or damaged livestock in property similar or related in service or use to the live-stock, you can treat other property (including real property) used for farming purposes, as property similar or related in service or use to the destroyed or damaged livestock.

Chapter 11Casualties, Thefts, and CondemnationsPage 71

Weather-related conditions. If, because of drought, flood, or other weather-related condi-tions, it isn't feasible for you to reinvest the in-surance money or other proceeds in property similar or related in service or use to the live-stock, you can treat other property (excluding real property) used for farming purposes, as property similar or related in service or use to the livestock you disposed of.

Example. Each year you normally sell 25 cows from your beef herd. However, this year you had to sell 50 cows. This is because a se-vere drought significantly reduced the amount of hay and pasture yield needed to feed your herd for the rest of the year. Because, as a re-sult of the severe drought, it isn't feasible for you to use the proceeds from selling the extra cows to buy new cows, you can treat other property (excluding real property) used for farm-ing purposes, as property similar or related in service or use to the cows you sold.

Standing crop destroyed by casualty. If a storm or other casualty destroyed your standing crop and you use the insurance money to ac-quire either another standing crop or a harves-ted crop, this purchase qualifies as replacement property. The costs of planting and raising a new crop qualify as replacement costs for the destroyed crop only if you use the crop method of accounting (discussed in chapter 2). In that case, the costs of bringing the new crop to the same level of maturity as the destroyed crop qualify as replacement costs to the extent they are incurred during the replacement period.

Timber loss. Standing timber (not land) you bought with the proceeds from the sale of tim-ber downed as a result of a casualty, such as high winds, earthquakes, or volcanic eruptions, qualifies as replacement property. If you bought the standing timber within the replacement pe-riod, you can postpone reporting the gain.

Business or income-producing property lo-cated in a federally declared disaster area. If your destroyed business or income-producing property was located in a federally declared dis-aster area, any tangible replacement property you acquire for use in any business is treated as similar or related in service or use to the de-stroyed property. For more information, see Disaster Area Losses in Pub. 547.

Substituting replacement property. Once you have acquired qualified replacement prop-erty that you designate as replacement property in a statement attached to your tax return, you can't substitute other qualified replacement property. This is true even if you acquire the other property within the replacement period. However, if you discover that the original re-placement property wasn’t qualified replace-ment property, you can, within the replacement period, substitute the new qualified replacement property.

Basis of replacement property. You must re-duce the cost basis of your replacement prop-erty by the amount of postponed gain. In this way, tax on the gain is postponed until you dis-pose of the replacement property.

Example. In 2018, you sold 50 cows with a $0 basis due to severe drought. This is more than the 25 cows you normally sell each year. The proceeds from the sale of the additional 25 cows are $62,500. Because of the severe drought, it isn’t feasible for you to use these pro-ceeds to buy new cows. Instead, you use the proceeds to buy a cattle watering system for $70,000. You choose to postpone reporting the $62,500 gain ($62,500 – $0) from the sale of the cows. Therefore, the basis of the cattle wa-tering system is $7,500 ($70,000 – $62,500).

Replacement Period

To postpone reporting your gain, you must buy replacement property within a specified period of time. This is the replacement period.

The replacement period begins on the date your property was damaged, destroyed, stolen, sold, or exchanged. The replacement period generally ends 2 years after the close of the first tax year in which you realize any part of your gain from the involuntary conversion.

Example. You are a calendar year tax-payer. Farm equipment that cost $2,200 was stolen from your farm. You discovered the theft when you returned to your farm on November 11, 2017. Your insurance company investigated the theft and didn’t settle your claim until Janu-ary 5, 2018, when they paid you $3,000. You first realized a gain from the reimbursement for the theft during 2018, so you have until Decem-ber 31, 2020, to replace the property.

Main home in disaster area. For your main home (or its contents) located in a federally de-clared disaster area, the replacement period ends 4 years after the close of the first tax year in which you realize any part of your gain from the involuntary conversion. See Disaster Area Losses, later.

Weather-related sales of livestock in an area eligible for federal assistance. For the sale or exchange of livestock due to drought, flood, or other weather-related conditions in an area eligible for federal assistance, the replace-ment period ends 4 years after the close of the first tax year in which you realize any part of your gain from the sale or exchange. The IRS may extend the replacement period on a re-gional basis if the weather-related conditions continue for longer than 3 years.

For information on extensions of the re-

placementperiodbecauseofpersistent

drought, see Notice 2006-82, 2006-39 I.R.B.

529, available at

IRS.gov/IRB/2006-39_IRB/ar11.html. For a list

of counties for which exceptional, extreme, or

severe drought was reported during the 12

months ending August 31, 2018, see Notice

2018-79, available at IRS.gov.

Condemnation. The replacement period for a condemnation begins on the earlier of the fol-lowing dates.

The date on which you disposed of the condemned property.

The date on which the threat of condemna-tion began.

The replacement period generally ends 2 years after the close of the first tax year in which any part of the gain on the condemnation is real-ized. But see Main home in disaster area, ear-lier, for an exception.

Business or investment real property. If real property held for use in a trade or business or for investment (not including property held primarily for sale) is condemned, the replace-ment period ends 3 years after the close of the first tax year in which any part of the gain on the condemnation is realized.

Extension. You can apply for an extension of the replacement period. Send your written ap-plication to the Internal Revenue Service Center where you file your tax return. See your tax re-turn instructions for the address. Include all the details about your need for an extension. Make your application before the end of the replace-ment period. However, you can file an applica-tion within a reasonable time after the replace-ment period ends if you can show a good reason for the delay. You will get an extension of the replacement period if you can show rea-sonable cause for not making the replacement within the regular period.

How To Postpone Gain

You postpone reporting your gain by reporting your choice on your tax return for the year you have the gain. You have the gain in the year you receive insurance proceeds or other reimburse-ments that result in a gain.

Required statement. You should attach a statement to your return for the year you have the gain. This statement should include all the following information.

The date and details of the casualty, theft, or other involuntary conversion.

The insurance or other reimbursement you received.

How you figured the gain.

Replacement property acquired before return filed. If you acquire replacement prop-erty before you file your return for the year you have the gain, your statement also should in-clude detailed information about all the follow-ing items.

The replacement property.

The postponed gain.

The basis adjustment that reflects the postponed gain.

Any gain you are reporting as income.

Replacement property acquired after re-turn filed. If you intend to buy replacement property after you file your return for the year you realize gain, your statement also should say that you are choosing to replace the prop-erty within the required replacement period.

You should then attach another statement to your return for the year in which you buy the re-placement property. This statement should con-tain detailed information on the replacement property. If you acquire part of your replace-ment property in one year and part in another year, you must attach a statement to each year's return. Include in the statement detailed information on the replacement property bought in that year.

Page 72Chapter 11Casualties, Thefts, and Condemnations

Reporting weather-related sales of live-stock. If you choose to postpone reporting the gain on weather-related sales or exchanges of livestock, show all the following information on a statement attached to your return for the tax year in which you first realize any of the gain.

Evidence of the weather-related conditions that forced the sale or exchange of the live-stock.

The gain realized on the sale or exchange.

The number and kind of livestock sold or exchanged.

The number of livestock of each kind you would have sold or exchanged under your usual business practice.

Show all the following information and the preceding information on the return for the year in which you replace the livestock.

The dates you bought the replacement property.

The cost of the replacement property.

Description of the replacement property (for example, the number and kind of the replacement livestock).

Amended return for changes regarding re-placement property. You must file an amen-ded return (Form 1040X) for the tax year of the gain in either of the following situations.

You don't acquire replacement property within the replacement period, plus exten-sions. On this amended return, you must report the gain and pay any additional tax due.

You acquire replacement property within the required replacement period, plus ex-tensions, but at a cost less than the amount you receive from the casualty, theft, or other involuntary conversion. On this amended return, you must report the part of the gain that can't be postponed and pay any additional tax due.

Disaster Area Losses

For tax years beginning after 2017 and

before 2026, personal casualty and CAUTION theft losses of an individual are deduc-tible only to the extent they're attributable to a federally declared disaster. An exception to the rule limiting the deduction for personal casualty and theft losses to disaster losses applies where you have personal casualty gains not at-tributable to a federally declared disaster to the extent the losses don't exceed your gains.

Special rules apply to federally declared dis-aster area losses. A federally declared disaster is a disaster that occurred in an area declared by the President to be eligible for federal assis-tance under the Robert T. Stafford Disaster Re-lief and Emergency Assistance Act. It includes a major disaster or emergency declaration un-der the Act.

A list of the areas warranting public or TIP individual assistance (or both) under the Act is available at the Federal Emergency Management Agency (FEMA) web

site at FEMA.gov/Disasters.

This part discusses the special rules for when to deduct a disaster area loss and what

tax deadlines may be postponed. For other spe-cial rules, see Disaster Area Losses in Pub. 547.

Qualified disaster losses. Qualified disas-ter losses are personal casualty losses sus-tained as a result of a federally declared disas-ter that occurred in 2016, as well as from Hurricane Harvey or Tropical Storm Harvey, Hurricane Irma, Hurricane Maria, or the Califor-nia wildfires. See IRS.gov/DisasterTaxRelief for date specific declarations associated with these disasters and for more information.

You can deduct qualified disaster losses without itemizing other deductions on Sched-ule A. Moreover, your net casualty loss from these qualified disasters doesn’t need to ex-ceed 10% of your adjusted gross income to qualify for the deduction, but the $100 limit per casualty is increased to $500. For more infor-mation, see the Instructions for Form 4684.

Disaster year. The disaster year is the tax year in which you sustained the loss attributable to a federally declared disaster. Generally, a disaster loss is sustained in the year the disas-ter occurred. A disaster loss also may be sus-tained in a year after the disaster occurred. For example, if a claim for reimbursement exists for which there is a reasonable prospect of recov-ery, no part of the loss for which reimbursement may be received is sustained until it can be as-certained with reasonable certainty whether you will be reimbursed.

When to deduct the loss. You generally must deduct a casualty loss in the disaster year. However, if you have a deductible loss from a disaster that occurred in an area warranting public or individual assistance (or both), you can choose to deduct that loss on your return or amended return for the tax year immediately preceding the disaster year. If you make this choice, the loss is treated as having occurred in the preceding year.

Claiming a qualifying disaster loss on TIP the previous year's return may result in a lower tax for that year, often produc-

ing or increasing a cash refund.

You must make the choice to take your casualty loss for the disaster in the preceding year on or before the date that is six months af-ter the regular due date for filing your original re-turn (without extensions) for the disaster year. For calendar year taxpayers, the deadline for making this election is October 15, 2019.

If you claimed a deduction for a disaster loss in the disaster year and you wish to deduct the loss in the preceding year, you must file an amended return to remove the previously de-ducted loss on or before you file the return or amended return for the preceding year that in-cludes the disaster loss deduction. For more in-formation, see Pub. 547.

Federal disaster relief grants. Don't include post-disaster relief grants received under the Robert T. Stafford Disaster Relief and Emer-gency Assistance Act in your income if the grant payments are made to help you meet neces-sary expenses or serious needs for medical, dental, housing, personal property, transporta-tion, or funeral expenses. Don't deduct casualty

losses or medical expenses to the extent they are specifically reimbursed by these disaster re-lief grants. If the casualty loss was specifically reimbursed by the grant and you received the grant after the year in which you deducted the casualty loss, see Reimbursement received af-ter deducting loss, earlier. Unemployment as-sistance payments under the Act are taxable unemployment compensation.

Qualified disaster relief payments. Qualified disaster relief payments aren't included in the income of individuals to the extent any expen-ses compensated by these payments aren't otherwise compensated for by insurance or other reimbursement. These payments aren't subject to income tax, self-employment tax, or employment taxes (social security, Medicare, and federal unemployment taxes). No withhold-ing applies to these payments.

Qualified disaster relief payments include payments you receive (regardless of the source) for the following expenses.

Reasonable and necessary personal, fam-ily, living, or funeral expenses incurred as a result of a federally declared disaster.

Reasonable and necessary expenses in-curred for the repair or rehabilitation of a personal residence due to a federally de-clared disaster. (A personal residence can be a rented residence or one you own.)

Reasonable and necessary expenses in-curred for the repair or replacement of the contents of a personal residence due to a federally declared disaster.

Qualified disaster relief payments include amounts paid by a federal, state, or local gov-ernment in connection with a federally declared disaster to individuals affected by the disaster. These payments must be made from a govern-mental fund, be based on individual or family needs, and not be compensation for services.

Payments to businesses generally don't qualify.

Qualified disaster relief payments don't

include:

CAUTION

Payments for expenses otherwise paid for by insurance or other reimbursements, or

Income replacement payments, such as payments of lost wages, lost business in-come, or unemployment compensation.

Qualified disaster mitigation payments. Qualified disaster mitigation payments made under the Robert T. Stafford Disaster Relief and Emergency Assistance Act or the National Flood Insurance Act (as in effect on April 15, 2005) aren’t included in income. These are pay-ments you, as a property owner, received to re-duce the risk of future damage to your property. You can't increase your basis in property, or take a deduction or credit, for expenditures made with respect to those payments.

Sale of property under hazard mitigation program. Generally, if you sell or otherwise transfer property, you must recognize any gain or loss for tax purposes unless the property is your main home. You report the gain or deduct the loss on your tax return for the year you real-ize it. (You can't deduct a loss on personal-use

Chapter 11Casualties, Thefts, and CondemnationsPage 73

property unless the loss resulted from a casu-alty, as discussed earlier.) However, if you sell or otherwise transfer property to the federal government, a state or local government, or an Indian tribal government under a hazard mitiga-tion program, you can choose to postpone re-porting the gain if you buy qualifying replace-ment property within a certain period of time. See Postponing Gain, earlier, for the rules that apply.

Other federal assistance programs. For more information about other federal assistance programs, see Crop Insurance and Crop Disas-ter Payments and Feed Assistance and Pay-ments in chapter 3, earlier.

Postponed tax deadlines. The IRS may post-pone for up to 1 year certain tax deadlines of taxpayers who are affected by a federally de-clared disaster. The tax deadlines the IRS may postpone include those for filing income, ex-cise, and employment tax returns, paying in-come, excise, and employment taxes, and mak-ing contributions to a traditional IRA or Roth IRA.

If any tax deadline is postponed, the IRS will publicize the postponement in your area and publish a news release and, where necessary, a revenue ruling, revenue procedure, notice, announcement, or other guidance in the Internal Revenue Bulletin (IRB). Go to IRS.gov/ DisasterTaxRelief to find out if a tax deadline has been postponed for your area.

Who is eligible. If the IRS postpones a tax deadline, the following taxpayers are eligible for the postponement.

Any individual whose main home is located in a covered disaster area (defined next).

Any business entity or sole proprietor whose principal place of business is loca-ted in a covered disaster area.

Any individual who is a relief worker affili-ated with a recognized government or phil-anthropic organization and who is assisting in a covered disaster area.

Any individual, business entity, or sole pro-prietorship whose records are needed to meet a postponed tax deadline, provided those records are maintained in a covered disaster area. The main home or principal place of business doesn’t have to be loca-ted in the covered disaster area.

Any estate or trust that has tax records necessary to meet a postponed tax dead-line, provided those records are main-tained in a covered disaster area.

The spouse on a joint return with a tax-payer who is eligible for postponements.

Any individual, business entity, or sole pro-prietorship not located in a covered disas-ter area, but whose necessary records to meet a postponed tax deadline are located in the covered disaster area.

Any individual visiting the covered disaster area who was killed or injured as a result of the disaster.

Any other person determined by the IRS to be affected by a federally declared disas-ter.

Covered disaster area. This is an area of a federally declared disaster area in which the

IRS has decided to postpone tax deadlines for up to 1 year.

Abatement of interest and penalties. The IRS may abate the interest and penalties on the underpaid income tax for the length of any post-ponement of tax deadlines.

Reporting Gains and Losses

You will have to file one or more of the following forms to report your gains or losses from invol-untary conversions.

Form 4684. Use this form to report your gains and losses from casualties and thefts.

Form 4797. Use this form to report involuntary conversions (other than from casualty or theft) of property used in your trade or business and capital assets held in connection with a trade or business or a transaction entered into for profit. Also use this form if you have a gain from a casualty or theft on trade, business or in-come-producing property held for more than 1 year and you have to recapture some or all of your gain as ordinary income.

Form 8949. Use this form to report gain from an involuntary conversion (other than from casualty or theft) of personal-use property.

Schedule A (Form 1040). Use this form to de-duct your losses from casualties and thefts of personal-use property and income-producing property, that you reported on Form 4684.

Schedule D (Form 1040). Use this form to carry over the following gains.

Net gain shown on Form 4797 from an in-voluntary conversion of business property held for more than 1 year.

Net gain shown on Form 4684 from the casualty or theft of personal-use property.

Also use this form to figure the overall gain or loss from transactions reported on Form 8949.

Schedule F (Form 1040). Use this form to de-duct your losses from casualty or theft of live-stock or produce bought for sale on line 32 (Other expenses) if you use the cash method of accounting and haven’t otherwise deducted these losses.

12.

Self-Employment Tax

What's New for 2018

Maximum net earnings. The maximum net self-employment earnings subject to the social security part (12.4%) of the self-employment tax is $128,400 for 2018, up from $127,200 for 2017. There is no maximum limit on earnings subject to the Medicare part (2.9%) or, if appli-cable, the Additional Medicare Tax (0.9%).

What's New for 2019

Maximum net earnings. The maximum net self-employment earnings subject to the social security part of the self-employment tax for 2019 will be discussed in the 2018 Pub. 334.

Introduction

Self-employment tax (SE tax) is a social secur-ity and Medicare tax primarily for individuals who work for themselves. It is similar to the so-cial security and Medicare taxes withheld from the pay of most wage earners.

You usually have to pay SE tax if you are self-employed. You are usually self-employed if you operate your own farm on land you either own or rent. You have to figure SE tax on Schedule SE (Form 1040).

Farmers who have employees may have to pay the employer's share of social security and Medicare taxes, as well. See chapter 13 for in-formation on employment taxes.

If your self-employment income exceeds a certain threshold amount, you may also be sub-ject to a 0.9% Additional Medicare Tax on the income that is more than that amount. You fig-ure this tax using Form 8959. For more informa-tion about the Additional Medicare Tax, includ-ing the threshold amounts, see the Instructions for Form 8959.

Self-employment tax rate. The self-employ-ment tax rate is 15.3%. The rate consists of two parts: 12.4% for social security (old-age, survi-vors, and disability insurance) and 2.9% for Medicare (hospital insurance).

Topics

This chapter discusses:

Why pay self-employment tax

How to pay self-employment tax

Who must pay self-employment tax

Figuring self-employment earnings

Landlord participation in farming

Methods for figuring net earnings

Reporting self-employment tax

Page 74Chapter 12Self-Employment Tax

Useful Items

You may want to see:

Publication

541 Partnerships

Form (and Instructions)

1040 U.S. Individual Income Tax Return

Sch F (Form 1040) Profit or Loss From Farming

Sch SE (Form 1040) Self-Employment Tax

1065 U.S. Return of Partnership Income

Sch K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc.

8959 Additional Medicare Tax

See chapter 16 for information about getting publications and forms.

Why Pay

Self-Employment Tax?

Social security benefits are available to self-em-ployed persons just as they are to wage earn-ers. Your payments of SE tax contribute to your coverage under the social security system. So-cial security coverage provides you with retire-ment benefits, disability benefits, survivor bene-fits, and hospital insurance (Medicare) benefits.

How to become insured under social secur-ity. You must be insured under the social se-curity system before you begin receiving social security benefits. You are insured if you have the required number of credits (also called quarters of coverage).

Earning credits in 2018. You can earn a max-imum of four credits per year. For 2018, you earn one credit for each $1,320 of combined wages and self-employment earnings subject to social security tax. You need $5,280 ($1,320 ×

4) of combined wages and self-employment earnings subject to social security tax to earn four credits in 2018. It doesn’t matter whether the income is earned in 1 quarter or is spread over 2 or more quarters.

For an explanation of the number of credits you must have to be insured and the benefits available to you and your family under the so-cial security program, consult your nearest So-cial Security Administration (SSA) office or visit the SSA website at SSA.gov.

Making false statements to get or to in-

crease social security benefits may CAUTION subject you to penalties.

The Social Security Administration (SSA) time limit for posting self-employment earn-ings. Generally, the SSA will give you credit only for self-employment earnings reported on a tax return filed within 3 years, 3 months, and 15 days after the tax year you earned the income.

If you file your tax return or report a

change in your self-employment earn-CAUTION ings after the SSA time limit for posting self-employment earnings, the SSA may change its records, but only to remove or re-duce the amount. The SSA won't change its re-cords to increase your self-employment earn-ings after the SSA time limit listed above.

How To Pay Self-Employment Tax

To pay SE tax, you must have a social security number (SSN) or an individual taxpayer identifi-cation number (ITIN). This section explains how to:

Obtain an SSN or ITIN, and

Pay your SE tax using estimated tax.

An ITIN doesn’t entitle you to social se-

curity benefits. Obtaining an ITIN CAUTION doesn’t change your immigration or employment status under U.S. law.

Obtaining a social security number. If you have never had an SSN, apply for one using Form SS-5, Application for a Social Security Card. The application is also available in Span-ish. You can get this form at any Social Security office or by calling 800-772-1213.

If you have a social security number from the time you were an employee, you must use that number. Don’t apply for a new one.

Replacing a lost social security card. If you have a number but lost your card, file Form SS-5. You will get a new card showing your original number, not a new number. In some areas you may be able to request a replace-ment card online.

Name change. If your name has changed since you received your social security card, complete Form SS-5 to report a name change.

You can find more information about obtaining a social security number, re-placing a lost card, or requesting a

name change at SSA.gov.

Obtaining an individual taxpayer identifica-tion number. The IRS will issue you an ITIN, for tax use only, if you are a nonresident or resi-dent alien and you don’t have, and aren’t eligi-ble to get, an SSN. To apply for an ITIN, file Form W-7, Application for IRS Individual Tax-payer Identification Number. You can download Form W-7 from the IRS website at IRS.gov. For more information on ITINs, see Pub. 1915. Form W-7 and Pub. 1915 are also available in Spanish.

If you were assigned an ITIN before

2013, or if you have an ITIN that you CAUTION haven't included on a tax return in the last three consecutive years, you may need to renew it. For more information, see the Instruc-tions for Form W-7 or visit IRS.gov/ITIN .

Paying estimated tax. Estimated tax is the method used to pay tax (including SE tax) on in-come not subject to withholding. You generally have to make estimated tax payments if you ex-

pect to owe tax, including SE tax, of $1,000 or more when you file your return. Use Form 1040-ES, Estimated Tax for Individuals, to fig-ure and pay the tax.

However, if at least two-thirds of your gross income for 2018 or 2019 is from farming and you file your 2019 Form 1040 and pay all the tax due by March 1, 2020, you don’t have to pay any estimated tax. For more information about estimated tax for farmers, the definition of farm-ing income, and exceptions to what constitutes farming income, see chapter 15.

Penalty for underpayment of estimated tax. You may have to pay a penalty if you don’t pay enough estimated tax by its due date.

Who Must Pay Self-Employment Tax?

You must pay SE tax and file Schedule SE (Form 1040) if your net earnings from self-em-ployment were $400 or more.

The SE tax rules apply no matter how

old you are and even if you are already CAUTION receiving social security or Medicare benefits.

Aliens. Generally, resident aliens must pay self-employment tax under the same rules that apply to U.S. citizens. Nonresident aliens aren’t subject to self-employment tax, unless an inter-national social security agreement determines that they are covered under the U.S. social se-curity system. Residents of the Virgin Islands, Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, or American Samoa are subject to self-employment tax, as they are considered U.S. residents for self-employment tax purposes. For more information on aliens, see Pub. 519, U.S. Tax Guide for Aliens and the Instructions for Schedule SE (Form 1040).

Are you self-employed? You are self-em-ployed if you carry on a trade or business (such as running a farm) as a sole proprietor, an inde-pendent contractor, a member of a partnership, or are otherwise in business for yourself. A trade or business is generally an activity carried on for a livelihood or in good faith to make a profit.

Share farmer. You are a self-employed farmer under an income-sharing arrangement if both the following apply.

1. You produce a crop or raise livestock on land belonging to another person.

2. Your share of the crop or livestock, or the proceeds from their sale, depends on the amount produced.

Your net farm profit or loss from the in-come-sharing arrangement is reported on Schedule F (Form 1040) and included in your self-employment earnings.

If you produce a crop or livestock on land belonging to another person and are to receive a specified rate of pay, a fixed sum of money, or a fixed quantity of the crop or livestock, and not a share of the crop or livestock or their pro-ceeds, you may be either self-employed or an

Chapter 12Self-Employment TaxPage 75

employee of the landowner. This will depend on whether the landowner has the right to direct or control your performance of services.

Example. A share farmer produces a crop on land owned by another person on a 50-50 crop-share basis. Under the terms of their agreement, the share farmer furnishes the labor and half the cost of seed and fertilizer. The landowner furnishes the machinery and equip-ment used to produce and harvest the crop, and half the cost of seed and fertilizer. The share farmer is provided a house in which to live. The landowner and the share farmer de-cide on a cropping plan.

The share farmer is a self-employed farmer for purposes of the agreement to produce the crops, and the share farmer's part of the profit or loss from the crops is reported on Sched-ule F (Form 1040) and included in self-employ-ment earnings.

The tax treatment of the landowner is dis-cussed later under Landlord Participation in Farming.

Contract farming. Under typical contract farming arrangements, the grower receives a fixed payment per unit of crops or finished live-stock delivered to the processor or packing company. Because the grower typically fur-nishes labor and bears some production risk, the payments are reported on Schedule F (Form 1040) and are therefore subject to self-employment tax.

4-H Club or FFA project. If an individual par-ticipates in a 4-H Club or National FFA Organi-zation (FFA) project, any net income received from sales or prizes related to the project may be subject to income tax. Report the net income as “Other income” on Schedule 1 (Form 1040), line 21. If necessary, attach a statement show-ing the gross income and expenses. The net in-come may not be subject to SE tax if the project is primarily for educational purposes and not for profit, and is completed by the individual under the rules and economic restrictions of the spon-soring 4-H or FFA organization. Such a project is generally not considered a trade or business. For information on the filing requirements and other tax information for dependents, see Pub. 929.

Partners in a partnership. Generally, you are self-employed if you are a member of a partner-ship that carries on a trade or business.

Limited partner. If you are a limited part-ner, your partnership income is generally not subject to SE tax. However, guaranteed pay-ments you receive for services you perform for the partnership are subject to SE tax and should be reported to you in box 14 of your Schedule K-1 (Form 1065).

Community property. If you are a partner and your distributive share of any income or loss from a trade or business carried on by the partnership is community property, treat your share as your self-employment earnings. Don’t treat any of your share as self-employment earnings of your spouse.

Business owned and operated by spouses. If you and your spouse jointly own and operate

a farm as an unincorporated business and share in the profits and losses, you are partners in a partnership whether or not you have a for-mal partnership agreement. You must file Form 1065, instead of Schedule F (Form 1040). How-ever, you and your spouse may still report in-come using Schedule F (Form 1040) instead of Form 1065 if either of the following applies.

You and your spouse elect to be treated as a qualified joint venture. See Qualified joint venture, later.

You and your spouse wholly own the unin-corporated farming business as commun-ity property and you treat the business as a sole proprietorship. See Community in-come, later.

If your spouse is your employee, not

your partner, you must withhold and CAUTION pay social security and Medicare taxes for him or her. For more information about em-ployment taxes, see chapter 13.

Qualified joint venture. If you and your spouse each materially participate as the only members of a jointly owned and operated farm, and you file a joint tax return for the tax year, you can make a joint election to be treated as a qualified joint venture instead of a partnership for the tax year. Making this election will allow you to avoid the complexity of Form 1065 but still give each spouse credit for social security earnings on which retirement benefits are based. For an explanation of “material participa-tion,” see the instructions for Schedule C, line G, and the instructions for Schedule F, line E.

Only businesses that are owned and

operated by spouses as co-owners CAUTION (and not in the name of a state law en-tity) qualify for the election. Thus, a business owned and operated by spouses through a limi-ted liability company does not qualify for the election of a qualified joint venture.

To make this election, you must divide all items of income, gain, loss, deduction, and credit attributable to the business between you and your spouse in accordance with your re-spective interests in the venture. Each of you must file a separate Schedule F and a separate Schedule SE. For more information, see Quali-fied Joint Ventures in the Instructions for Sched-ule SE (Form 1040).

Community income. If you and your spouse wholly own an unincorporated business as community property under the community property laws of a state, foreign country, or U.S. possession, you can treat your wholly-owned, unincorporated business as a sole proprietor-ship, instead of a partnership. Any change in your reporting position will be treated as a con-version of the entity.

Report your income and deductions as fol-lows.

If only one spouse participates in the busi-ness, all of the income from that business is the self-employment earnings of the spouse who carried on the business.

If both spouses participate, the income and deductions are allocated to the spouses based on their distributive shares.

If you and your spouse elected to treat the business as a qualifying joint venture, see Qualified joint venture, earlier.

States with community property laws include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wiscon-sin. See Pub. 555 for more information about community property laws.

Figuring

Self-Employment

Earnings

Farmer. If you are self-employed as a farmer, use Schedule F (Form 1040) to figure your self-employment earnings.

Partnership income or loss. If you are a member of a partnership that carries on a trade or business, the partnership should report your self-employment earnings in box 14, code A, of your Schedule K-1 (Form 1065). Box 14 of Schedule K-1 may also provide amounts for gross farming or fishing income (code B) and gross nonfarm income (code C). Use these amounts if you use the farm or nonfarm optional method to figure net earnings from self-employ-ment (see Methods for Figuring Net Earnings, later).

If you are a general partner, you may need to reduce these reported earnings by amounts you claim as a section 179 deduction, unreim-bursed partnership expenses, or depletion on oil and gas properties.

If the amount reported is a loss, include only the deductible amount when you figure your to-tal self-employment earnings.

For more information, see the Partner's In-structions for Schedule K-1 (Form 1065).

For general information on partnerships, see Pub. 541.

More than one business. If you have self-em-ployment earnings from more than one trade, business, or profession, you generally must combine the net profit or loss from each to de-termine your total self-employment earnings. A loss from one business reduces your profit from another business. However, don’t combine earnings from farm and nonfarm businesses if you are using one of the optional methods (dis-cussed later) to figure net earnings.

Community property. If any of the income from a farm or business, other than a partner-ship, is community property under state law, it is included in the self-employment earnings of the spouse carrying on the trade or business.

Payments for lost income. Include in self-employment earnings any payments you receive from insurance or other sources to re-place income lost because you reduced or stopped farming activities. These include USDA payments under the Margin Protection Program for Dairy (MPP-Dairy), which provides dairy pro-ducers with payments when dairy margins are below the margin coverage levels. Even if you aren’t farming when you receive the payment, it is included in self-employment earnings if it re-lates to your farm business (even though it is temporarily inactive). A connection exists if it is clear the payment would not have been made but for your conduct of your farm business.

Page 76Chapter 12Self-Employment Tax

MPP-Dairy ends December 31, 2018.

!

CAUTION

Gain or loss. A gain or loss from the disposi-tion of property that is neither stock in trade nor held primarily for sale to customers isn’t inclu-ded in self-employment earnings. It doesn’t matter whether the disposition is a sale, ex-change, or involuntary conversion. For exam-ple, gains or losses from the disposition of the following types of property aren’t included in self-employment earnings.

Investment property.

Depreciable property or other fixed assets used in your trade or business.

Cattle and horses held for more than 24 months and for draft, breeding, dairy, or sporting purposes.

Other livestock (excluding poultry), held for more than 12 months and for draft, breed-ing, dairy, or sporting purposes.

Unharvested standing crops sold with land held more than 1 year.

Timber, coal, or iron ore held for more than 1 year if an economic interest was re-tained, such as a right to receive coal roy-alties.

A gain or loss from the cutting of timber isn’t included in self-employment earnings if the cut-ting is treated as a sale or exchange. For more information on electing to treat the cutting of timber as a sale or exchange, see Timber in chapter 8.

Wages and salaries. Wages and salaries re-ceived for services performed as an employee and covered by social security or railroad retire-ment aren’t included in self-employment earn-ings.

Wages paid in kind to you for agricultural la-bor performed as an employee, such as com-modity wages, aren’t included in self-employ-ment earnings.

Retired partner. Retirement income received by a partner from his or her partnership under a written plan isn’t included in self-employment earnings if all the following apply.

The retired partner performs no services for the partnership during the year.

The retired partner is owed only the retire-ment payments.

The retired partner's share (if any) of the partnership capital was fully paid to the re-tired partner.

The payments to the retired partner are lifelong periodic payments.

Conservation Reserve Program (CRP) pay-ments. Under the Conservation Reserve Pro-gram (CRP), if you own or operate highly erodi-ble or other specified cropland, you may enter into a long-term contract with the USDA, agree-ing to convert to a less intensive use of that cropland. You must include the annual rental payments and any one-time incentive payment you receive under the program on Schedule F, lines 4a and 4b. Cost-share payments you re-ceive may qualify for the cost-sharing exclusion. See Cost-Sharing Exclusion (Improvements), earlier, in chapter 3. CRP payments are repor-ted to you on Form 1099-G.

Individuals who are receiving social se-TIP curity retirement or disability benefits may exclude CRP payments when cal-culating self-employment tax. See the Instruc-

tions for Schedule SE (Form 1040).

Self-employed health insurance deduction. You can’t deduct the self-employed health in-surance deduction you report on Schedule 1 (Form 1040), line 29, from self-employment earnings on Schedule SE (Form 1040).

Landlord Participation in Farming

As a general rule, income and deductions from rentals and from personal property leased with real estate aren’t included in determining self-employment earnings. However, income and deductions from farm rentals, including government commodity program payments re-ceived by a landowner who rents land, are in-cluded if the rental arrangement provides that the landowner will, and does, materially partici-pate in the production or management of pro-duction of the farm products on the land.

Material participation for landlords. You materially participate if you have an arrange-ment with your tenant for your participation and you meet one or more of the following tests.

1. You do at least three of the following.

a. Pay, using cash or credit, at least half the direct costs of producing the crop or livestock.

b. Furnish at least half the tools, equip-ment, and livestock used in the pro-duction activities.

c. Advise or consult with your tenant on something like deciding what crops to plant, the type of seed or fertilizer to use, or when and at what price the crops should be sold.

d. Inspect the production activities peri-odically.

2. You regularly and frequently make, or take an important part in making, management decisions substantially contributing to or affecting the success of the enterprise. For example, decisions about when and where to plant or spray, when to harvest, what standards to follow, and what re-cords to keep.

3. You work 100 hours or more spread over a period of 5 weeks or more in activities con-nected with agricultural production.

4. You do things that, considered in their to-tality, show you are materially and signifi-cantly involved in the production of the farm commodities.

These tests may be used as general guides for determining whether you are a material partici-pant.

Crop shares. Rent paid in the form of crop shares is included in self-employment earnings for the year you sell, exchange, give away, or use the crop shares if you meet one of the four material participation tests (discussed above) at

the time the crop shares are produced. Feeding such crop shares to livestock is considered us-ing them. Your gross income for figuring your self-employment earnings includes the fair mar-ket value of the crop shares when they are used as feed.

Example. Nancy agrees to produce a crop on G. Cohen's cotton farm, with each receiving half the proceeds. Cohen agrees to furnish all the necessary equipment, and it is understood that Cohen will advise Nancy on when to plan, spray, and pick the cotton. It is also understood that he will inspect the crop every few days to determine whether Nancy is properly taking care of the crop. Under their arrangement, it is further understood that Nancy will furnish all la-bor needed to grow and harvest the crop. Co-hen provides the advice, makes inspections, and furnishes the equipment; and Nancy fur-nishes all labor needed to grow and harvest the crop.

The management decisions made by Cohen in connection with the care of the cotton crop and his regular inspection of the crop establish that Cohen participates to a material degree in the cotton production operations. The income Cohen receives from the cotton farm is included in Cohen’s self-employment earnings.

Methods for Figuring Net Earnings

There are three ways to figure net earnings from self-employment.

1. The regular method.

2. The farm optional method.

3. The nonfarm optional method.

You must use the regular method to the extent you don’t use one or both of the optional meth-ods. See Figure 12-1, to see if you are eligible to use an optional method.

Why use an optional method? You may want to use the optional methods (discussed later) when you have a loss or a small net profit and any one of the following applies.

You want to receive credit for social secur-ity benefit coverage.

You incurred child or dependent care ex-penses for which you could claim a credit. (An optional method may increase your earned income, which could increase your credit.)

You are entitled to the earned income credit. (An optional method may increase your earned income, which could increase your credit.)

You are entitled to the additional child tax credit. (An optional method may increase your earned income, which could increase your credit.)

Effects of using an optional method. Using an optional method could increase your SE tax. Paying more SE tax may result in you getting higher social security disability or retirement benefits.

Using the optional methods also may de-crease your adjusted gross income (AGI) due to

Chapter 12Self-Employment TaxPage 77

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

START here to determine if you can use the nonfarm optional method.

Are your net nonfarm pro ts less than $5,717?

Yes

Are your net nonfarm pro ts less than 72.189% of your gross nonfarm income?

Yes

Were your actual net earnings from self-employment $400 or more in at least 2 of the 3 tax years before this year?

Yes

Have you previously used this method less than 5 years? (Note: There is a 5-year lifetime limit.)

Yes

You can use the nonfarm optional method.* See Pub. 334.

No

No

No

No

You can’t

use the

nonfarm

optional

method.

START here to determine if

you can use the farm

optional method.

Is your gross farm income

$7,920 or less?


	Yes			No
		Yes

You can			Are your net farm pro ts
use the			less than $5,717?
farm

optional					No
method.*

See Table			You can’t use the
12-1.			farm optional method.

*If you use both optional methods, see Using Both Optional Methods, later, for limits on the amount to report.

the deduction for one-half of self-employment tax on Form 1040, which may affect your eligi-bility for credits, deductions, or other items that are subject to an AGI limit. Figure your AGI with and without using the optional methods to see if the optional methods will benefit you.

If you use either or both optional methods, you must figure and pay the SE tax due under these methods even if you would have had a smaller SE tax or no SE tax using the regular method.

The optional methods may be used only to figure your SE tax. To figure your income tax, include your actual self-employment earnings in gross income, regardless of which method you use to determine SE tax.

Regular Method

To figure net earnings using the regular method, multiply your self-employment earn-ings by 92.35% (0.9235). For your net earnings figured using the regular method, see one of the following lines on your Schedule SE (Form 1040).

Section A, line 4 (if you use the Short Schedule SE).

Section B, line 4a (if you use the Long Schedule SE).

Net earnings figured using the regular method are also called “actual net earnings.”

Farm Optional Method

Use the farm optional method only for self-em-ployment earnings from a farming business. You can use this method if you meet either of the following tests.

1. Your gross farm income is $7,920 or less.

2. Your net farm profits are less than $5,717.

Gross farm income. Your gross farm income is the total of the amounts from:

Schedule F (Form 1040), line 9, and

Schedule K-1 (Form 1065), box 14, code B (from farm partnerships).

Net farm profits. Net farm profits generally are the total of the amounts from:

Schedule F (Form 1040), line 34, and

Schedule K-1 (Form 1065), box 14, code A (from farm partnerships).

If you received social security retirement or dis-ability benefits, you must subtract the amount of any Conservation Reserve Program payments included on your Schedule F, line 4b, or listed on Schedule K-1 (Form 1065), box 20 (code Z if a 2017 Schedule K-1, code AH if a 2018 Schedule K-1). You may also need to adjust the amount reported on Schedule K-1 if you are a general partner or if it is a loss. For more infor-mation, see Partnership income or loss, earlier.

Figuring farm net earnings. If you meet ei-ther of the two tests explained above, use Ta-ble 12-1 to figure your net earnings from self-employment under the farm optional method.

Table 12-1. Figuring Farm Net Earnings

IF your gross farm	THEN your net
income	earnings are
is...	equal to...
$7,920 or less	Two-thirds of your
	gross farm income.
More than $7,920	$5,280

Optional method can reduce or eliminate SE tax. If your gross farm income is $7,920 or less and your farm net earnings figured under the farm optional method are less than your ac-tual farm net earnings, you can use the farm op-tional method to reduce or eliminate your SE tax. Your actual farm net earnings are your farm net earnings figured using the regular method, explained earlier.

Example. Your gross farm income is $540 and your net farm profit is $460. Consequently, your net earnings figured under the farm op-tional method are $360 (2/3 of $540) and your actual net earnings are $425 (92.35% of $460).

Page 78Chapter 12Self-Employment Tax

You owe no SE tax if you use the optional method because your net earnings under the farm optional method are less than $400.

Nonfarm Optional Method

This is an optional method available for deter-mining net earnings from nonfarm self-employ-ment, much like the farm optional method.

If you are also engaged in a nonfarm busi-ness, you may be able to use this method to fig-ure your nonfarm net earnings. You can use this method even if you don’t use the farm optional method for determining your farm net earnings and even if you have a net loss from your non-farm business. For more information about the nonfarm optional method, see Pub. 334.

You can’t combine farm and nonfarm

self-employment earnings to figure CAUTION your net earnings under either of the optional methods.

Using Both Optional Methods

If you use both optional methods, you must add the net earnings figured under each method to arrive at your total net earnings from self-em-ployment. You can report less than your total actual farm and nonfarm net earnings but not less than actual nonfarm net earnings. If you use both optional methods, you can report no more than $5,280 as your combined net earn-ings from self-employment.

Reporting

Self-Employment Tax

Use Schedule SE (Form 1040) to figure and re-port your SE tax. Then, enter the SE tax on Schedule 4 (Form 1040), line 57 and attach Schedule SE to Form 1040.

Most taxpayers can use Section A–Short Schedule SE to figure their SE tax. However, certain taxpayers must use Section B–Long Schedule SE. Use the chart on page 1 of Schedule SE to find out which one to use.

If you have to pay SE tax, you must file

Form 1040 (with Schedule SE at-CAUTION tached) even if you don’t otherwise have to file a federal income tax return.

Self-employment tax deduction. You can deduct half of your SE tax in figuring your adjus-ted gross income. This deduction only affects your income tax. It doesn’t affect either your net earnings from self-employment or your SE tax.

To deduct the tax, enter on Schedule 1 (Form 1040), line 27, the amount from Sec-tion A, line 6 (if you are using the Short Sched-ule SE) or Section B, line 13 (if you are using the Long Schedule SE).

Joint return. Even if you file a joint return, you can’t file a joint Schedule SE. This is true whether one spouse or both spouses have self-employment earnings. Your spouse isn’t considered self-employed just because you

are. If both of you have self-employment earn-ings, each of you must complete a separate Schedule SE. However, if one spouse uses the Short Schedule SE and the other spouse has to use the Long Schedule SE, both can use the same form. Attach both schedules to the joint return. If you and your spouse operate a busi-ness as a partnership, see Business owned and operated by spouses and Qualified joint ven-ture, earlier, under Who Must Pay Self-Employ-ment Tax.

13.

Employment

Taxes

What's New for 2018

The Tax Cuts and Jobs Act (Public Law 115-97) lowered the withholding rates on certain payments. To reflect changes made by the tax reform legislation, the IRS has released updated income tax withholding tables. The new withholding tables are designed to work with the Form(s) W-4 you have already filed with your employer. To see if your withholding increased or decreased, see the IRS Withholding Calculator at IRS.gov/W4App.

Social security and Medicare tax for 2018. The social security tax rate is 6.2% each for the employee and employer, unchanged from 2017. The social security wage base limit is $128,400.

The Medicare tax rate is 1.45% each for the employee and employer, unchanged from 2017. There is no wage base limit for Medicare tax.

Qualified small business payroll tax credit for increasing research activities. For tax years beginning after December 31, 2015, a qualified small business may elect to claim up to $250,000 of its credit for increasing research activities as a payroll tax credit against the em-ployer's share of social security tax. The payroll tax credit must be elected on an original income tax return that is timely filed (including exten-sions).The portion of the credit used against the employer's share of social security tax is al-lowed in the first calendar quarter beginning af-ter the date that the qualified small business filed its income tax return. The first Form 943 that you can claim this credit on is Form 943 filed for calendar year 2017. For more informa-tion, see the Instructions for Form 943.

What's New for 2019

Social security and Medicare tax for 2019. The employee and employer tax rates for social security and the maximum amount of wages

subject to social security tax for 2019 will be discussed in Pub. 51 (for use in 2019).

The Medicare tax rate for 2019 will also be discussed in Pub. 51 (for use in 2019). There is no limit on the amount of wages subject to Med-icare tax.

Reminders

New certification program for professional employer organizations. The Tax Increase Prevention Act of 2014 required the IRS to es-tablish a voluntary certification program for pro-fessional employer organizations (PEOs). PEOs handle various payroll administration and tax reporting responsibilities for their business clients and are typically paid a fee based on payroll costs. To become and remain certified under the certification program, certified profes-sional employer organizations (CPEOs) must meet various requirements described in sec-tions 3511 and 7705 and related published guidance. Certification as a CPEO may affect the employment tax liabilities of both the CPEO and its customers. A CPEO is generally treated as the employer of any individual who performs services for a customer of the CPEO and is cov-ered by a contract described in section 7705(e)

(2) between the CPEO and the customer (CPEO contract), but only for wages and other compensation paid to the individual by the CPEO. For more information, go to IRS.gov/ CPEO. Also see Rev. Proc. 2017-14, 2017-3 I.R.B. 426, available at IRS.gov/irb/ 2017-03_IRB/ar14.html.

Additional employment tax information for farmers. See Pub. 51 for more detailed guid-ance on employment taxes. For the latest infor-mation about employment tax developments impacting farmers, go to IRS.gov/Pub51. For general tax information relevant to agricultural

employers, go to IRS.gov/ AgricultureTaxCenter. For general information about employment taxes, go to IRS.gov/ EmploymentTaxes.

Correcting a previously filed Form 943. If you discover an error on a previously filed Form 943, Employer's Annual Federal Tax Return for Agricultural Employees, make the correction us-ing Form 943-X, Adjusted Employer's Annual Federal Tax Return for Agricultural Employees or Claim for Refund. Form 943-X is filed sepa-rately from Form 943. For more information on correcting Form 943, see the Instructions for Form 943-X, section 9 of Pub. 51, or go to IRS.gov/CorrectingEmploymentTaxes.

Federal tax deposits must be made by elec-tronic funds transfer (EFT). You must use EFT to make all federal tax deposits. Generally, an EFT is made using the Electronic Federal Tax Payment System (EFTPS). If you don't want to use EFTPS, you can arrange for your tax professional, financial institution, payroll service, or other trusted third party to make electronic deposits on your behalf. Also, you may arrange for your financial institution to ini-tiate a same-day wire payment on your behalf. EFTPS is a free service provided by the Depart-ment of Treasury. Services provided by your tax professional, financial institution, payroll serv-ice, or other third party may have a fee.

Chapter 13Employment TaxesPage 79

For more information on making federal tax deposits, see section 7 of Pub. 51. To get more information about EFTPS or to enroll in EFTPS, go to EFTPS.gov or call 1-800-555-4477 or 1-800-733-4829 (TDD). Additional information about EFTPS is also available in Pub. 966.

Electronic filing and payment. Now, more than ever before, businesses can enjoy the benefits of filing tax returns and paying their federal taxes electronically. Whether you rely on a tax professional or handle your own taxes, the IRS offers you convenient programs to make filing and paying easier. Spend less time and worry on taxes and more time running your business. Use e-file and EFTPS to your benefit.

For e-file, go to IRS.gov/EmploymentEfile for additional information. A fee may be charged to file electronically.

For EFTPS, go to EFTPS.gov or call EFTPS Customer Service at

1-800-555-4477 or 1-800-733-4829 (TDD) for additional information.

For electronic filing of Form W-2, Wage and Tax Statement, go to SSA.gov/ employer.

Work opportunity tax credit for qualified tax-exempt organizations hiring qualified veterans. The work opportunity tax credit is available for eligible unemployed veterans who begin work on or after November 22, 2011, and before January 1, 2020. Qualified tax-exempt organizations that hire eligible unemployed vet-erans can claim the work opportunity tax credit against their payroll tax liability using Form 5884-C. For more information, go to IRS.gov/ WOTC.

Important Dates for 2019

You should take the action indicated by the dates listed. Due dates for deposits of withheld federal income taxes, social security taxes, and Medicare taxes aren't listed here. For these dates, see Pub. 509 (for use in 2019).

If any date shown below for filing a re-TIP turn, furnishing a form, or depositing taxes falls on a Saturday, Sunday, or legal holiday, the due date is the next business

day. The term “legal holiday” means any legal holiday in the District of Columbia. Legal holi-days in the District of Columbia are provided in section 7 of Pub. 51. A statewide legal holiday delays a filing or furnishing due date only if the IRS office where you’re required to file a return or furnish a form is located in that state. How-ever, a statewide legal holiday doesn't delay the due date of federal tax deposits. For any due date, you will meet the “file” or “furnish” date re-quirement if the envelope containing the tax re-turn or form is properly addressed, contains suf-ficient postage, and is postmarked by the U.S. Postal Service on or before the due date, or sent by an IRS-designated private delivery service (PDS) on or before the due date. Go to IRS.gov/PDS for the current list of PDSs. For the IRS mailing address to use if you're using a PDS, go to IRS.gov/PDSstreetAddresses.

Fiscal year taxpayers. The due dates listed below apply whether you use a calendar or a fiscal year.

Page 80Chapter 13Employment Taxes

By January 31.

File Form 943 with the IRS. If you depos-ited all Form 943 taxes when due, you may file Form 943 by February 11.

File Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, with the IRS. If you deposited all the FUTA tax when due, you may file Form 940 by Feb-ruary 11.

File Copy A of all paper and electronic Forms W-2 with Form W-3, Transmittal of Wage and Tax Statements, with the SSA. If filing electronically, the SSA generates Form W-3 automatically based on your Forms W-2. For more information on re-porting Form W-2 information to the SSA electronically, go to the SSA‘s Employer W-2 Filing Instructions & Information web-page at SSA.gov/employer.

Furnish each employee with a completed Form W-2.

File Form 1099-INT to show interest in-come that you earned during the tax year. Types of interest include savings bond in-terest, checking and savings account inter-est, and interest earned on Treasury bills. See chapter 10, Installment Sales, for more information.

File Copy A of all paper and electronic Forms 1099-MISC, Miscellaneous Income, that report nonemployee compensation with Form 1096, Annual Summary and Transmittal of U.S. Information Returns, with the IRS. For information on filing infor-mation returns electronically with the IRS, see Pub. 1220. Other Forms 1099, includ-ing Forms 1099-MISC reporting anything other than nonemployee compensation, have different due dates. See the General Instructions for Certain Information Returns for more information.

Furnish each recipient to whom you paid $600 or more in nonemployee compensa-tion with a completed Form 1099-MISC.

File Form 945, Annual Return of Withheld Federal Income Tax, with the IRS to report any nonpayroll income tax withheld during 2018. If you deposited all Form 945 taxes when due, you may file Form 945 by Feb-ruary 11.

By February 15. Ask for a new Form W-4, Em-ployee’s Withholding Allowance Certificate, or Formulario W-4(SP) from each employee who claimed exemption from federal income tax withholding last year.

On February 16. Any Form W-4 claiming ex-emption from withholding for the previous year has now expired. Begin withholding for any em-ployee who previously claimed exemption from withholding but hasn't given you a new Form W-4 for the current year. If the employee doesn't give you a new Form W-4, withhold taxes based on the last valid Form W-4 you have for the employee that doesn't claim ex-emption from withholding or, if one doesn't ex-ist, as if he or she is single with zero withholding allowances. If the employee furnishes a new Form W-4 claiming exemption from withholding after February 15, you may apply the exemption to future wages, but don't refund taxes withheld while the exempt status wasn't in place.

By April 30, July 31, October 31, and Janu-ary 31. Deposit FUTA taxes. Deposit FUTA tax due if the undeposited amount is over $500.

Before December 1. Remind employees to submit a new Form W-4 if their marital status or withholding allowances have changed or will change for the next year.

Introduction

You’re generally required to withhold federal in-come tax from the wages of your employees. You may be required to withhold social security and Medicare taxes from your employees' wa-ges and pay the employer's share of these taxes under the Federal Insurance Contribu-tions Act (FICA). You may also have to pay fed-eral unemployment tax under the Federal Un-employment Tax Act (FUTA). You must also withhold Additional Medicare Tax from wages you pay to an employee in excess of $200,000 in a calendar year. This chapter includes infor-mation about these taxes.

You must also pay self-employment tax on your net earnings from farming. See chapter 12 for information on self-employment tax.

Topics

This chapter discusses:

Farm employment;

Family employees;

Crew leaders;

Social security and Medicare taxes;

Federal income tax withholding;

Required notice to employees about earned income credit (EIC);

Reporting and paying social security, Medicare, and withheld federal income taxes; and

FUTA tax.

Useful Items

You may want to see:

Publication

15Employer's Tax Guide

15-A Employer's Supplemental Tax Guide

15-B Employer's Tax Guide to Fringe Benefits

51Agricultural Employer's Tax Guide

926 Household Employer's Tax Guide

Form (and Instructions) W-2 Wage and Tax Statement

W-4 Employee's Withholding Allowance Certificate

W-9 Request for Taxpayer Identification Number and Certification

940 Employer's Annual Federal Unemployment (FUTA) Tax Return

943 Employer's Annual Federal Tax Return for Agricultural Employees

943-X Adjusted Employer's Annual Federal Tax Return for Agricultural Employees or Claim for Refund

See chapter 16 for information about getting publications and forms.

Farm Employment

In general, you’re an employer of farmworkers if your employees do any of the following types of work.

Raising or harvesting agricultural or horti-cultural products on a farm, including rais-ing and feeding of livestock.

Operating, managing, conserving, improv-ing, or maintaining your farm and its tools and equipment, if the major part of such service is performed on a farm.

Services performed in salvaging timber, or clearing land of brush and other debris, left by a hurricane (also known as hurricane la-bor), if the major part of such service is performed on a farm.

Handling, processing, or packaging any agricultural or horticultural commodity in its unmanufactured state if you produced more than half of the commodity (for a group of up to 20 unincorporated opera-tors, all of the commodity).

Work related to cotton ginning, turpentine, gum resin products, or the operation and maintenance of irrigation facilities.

For more information, see sections 2 and 12 of Pub. 51.

Generally, a worker who performs services for you is your employee if you have the right to control what will be done and how it will be done. This is so even when you give the em-ployee freedom of action. What matters is that you have the right to control the details of how the services are performed. You’re responsible for withholding and paying employment taxes for your employees. You’re also required to file employment tax returns. These requirements don't apply to amounts that you pay to inde-pendent contractors, as discussed later in Non-employee compensation. See sections 1 and 2 of Pub. 15-A for more information on how to de-termine whether an individual providing serv-ices is an independent contractor or an em-ployee.

If you employ a family of workers, each worker subject to your control (not just the head of the family) is an employee.

Special rules apply to crew leaders. See Crew Leaders, later.

Employer identification number (EIN). If you have employees, you must have an EIN. If you don't have an EIN, you may apply for one online by visiting IRS.gov/EIN. You may also apply for an EIN by faxing or mailing Form SS-4 to the IRS.

Employee's social security number (SSN). An employee who doesn't have an SSN and is legally eligible to work in the United States should submit Form SS-5, Application for a So-cial Security Card, to the SSA. Form SS-5 is available from any SSA office or by calling 1-800-772-1213. It is also available from the SSA's website at SSA.gov/online/ss-5.pdf.

The employee must furnish evidence of age, identity, and U.S. citizenship or lawful immigra-tion status permitting employment with the Form SS-5.

Form I-9. You must verify that each new em-ployee is legally eligible to work in the United States. This includes completing Form I-9, Em-ployment Eligibility Verification. Form I-9 is available from the U.S. Citizenship and Immi-gration Services (USCIS) website at USCIS.gov/I-9-Central, at USCIS offices, or by calling the Bureau of Citizenship and Immigra-tion Services Forms Request Line at 1-800-870-3676. You can also contact the US-CIS at 1-800-375-5283 or 1-800-767-1833 (TDD) for more information.

Form W-4. You should give each new em-ployee a Form W-4 as soon as you hire the em-ployee. For Spanish-speaking employees, you may use Formulario W-4(SP), which is the Spanish translation of Form W-4. Have the em-ployee complete and return the form to you be-fore the first payday. If the employee doesn't re-turn the completed form, you must withhold federal income tax as if the employee is single and claims no withholding allowances.

New hire reporting. You’re required to report any new employee to a designated state new hire registry. A new employee is an employee who hasn’t previously been employed by you or was previously employed by you but has been separated from such prior employment for at least 60 consecutive days. Many states accept a copy of Form W-4 with employer information added. Visit the Office of Child Support En-forcement website at acf.hhs.gov/css/ employers for more information.

Family Employees

Generally, the wages you pay to family mem-bers who are your employees are subject to employment taxes. However, certain exemp-tions may apply to wages paid to your child, spouse, or parent.

Exemptions for your child. Payments for the services of your child under age 18 who works for you in your trade or business (including a farm) aren't subject to social security and Medi-care taxes. However, see Nonexempt services of a child or spouse, later. Payments for the services of your child under age 21 employed by you in other than a trade or business, such as payments for household services in your home, also aren't subject to social security or Medicare taxes. Payments for the services of your child under age 21 employed by you, whether or not in your trade or business, aren't subject to FUTA tax. Although not subject to so-cial security, Medicare, or FUTA tax, the child's wages still may be subject to federal income tax withholding.

Exemptions for your spouse. Payments for the services of your spouse who works for you in your trade or business are subject to federal income tax withholding and social security and Medicare taxes, but not FUTA tax.

Payments for the services of your spouse employed by you in other than a trade or busi-ness, such as payments for household services in your home, aren't subject to social security, Medicare, or FUTA taxes.

Nonexempt services of a child or spouse. Payments for the services of your child or spouse are subject to federal income tax with-holding as well as social security, Medicare, and FUTA taxes if he or she works for any of the following entities.

A corporation, even if it is controlled by you.

A partnership, even if you’re a partner. This doesn't apply to wages paid to your child if each partner is a parent of the child.

An estate or trust, even if it is the estate of a deceased parent.

In these situations, the child or spouse is con-sidered to work for the corporation, partnership, or estate, not you.

Exemptions for your parent. Payments for the services of your parent employed by you in your trade or business are subject to federal in-come tax withholding and social security and Medicare taxes. Social security and Medicare taxes don't apply to wages paid to your parent for services not in your trade or business, but they do apply to payments for household serv-ices in your home if both the following condi-tions are satisfied.

You have a child (including an adopted child or stepchild) living in your home who is under age 18 or has a physical or mental condition that requires care by an adult for at least 4 continuous weeks in the calendar quarter services were performed.

You’re a widow or widower; or divorced and not remarried; or have a spouse in the home who, because of a physical or men-tal condition, can't care for your child for at least 4 continuous weeks in the calendar quarter services were performed.

Wages you pay to your parent aren't subject to FUTA tax, regardless of the type of services provided.

Qualified joint venture. If spouses elect to be treated as a qualified joint venture instead of a partnership, either spouse may report and pay the employment taxes due on the wages paid to employees using the EIN of that spouse's sole proprietorship. For more information about qualified joint ventures, see chapter 12.

Crew Leaders

If farmworkers are provided by a crew leader, the crew leader may be the employer of the workers.

Social security and Medicare taxes. For so-cial security and Medicare tax purposes, the crew leader is the employer of the workers if both of the following requirements are met.

The crew leader pays (either on his or her own behalf or on behalf of the farmer) the workers for their farm labor.

The crew leader hasn't entered into a writ-ten agreement with the farmer under which the crew leader is designated as an em-ployee of the farmer.

If both requirements are met, the crew leader isn't considered the employee of the farmer for services performed by the crew

Chapter 13Employment TaxesPage 81

leader in furnishing farmworkers and as a mem-ber of the crew.

Federal income tax withholding. If the crew leader is the employer for social security and Medicare tax purposes, the crew leader is the employer for federal income tax withholding purposes.

Federal unemployment (FUTA) tax. For FUTA tax purposes, the crew leader is the em-ployer of the workers if, in addition to the earlier requirements, either of the following require-ments is met.

The crew leader is registered under the Mi-grant and Seasonal Agricultural Worker Protection Act.

Substantially all crew members operate or maintain mechanized equipment provided by the crew leader as part of the service to the farmer.

The farmer is the employer of workers fur-nished by a crew leader in all other situations. In addition, the farmer is the employer of workers furnished by a registered crew leader if the workers are the employees of the farmer under the common-law test. For example, some farm-ers employ individuals to recruit farmworkers exclusively for them. Although these individuals may be required to register under the Migrant and Seasonal Agricultural Worker Protection Act, the workers are employed directly by the farmer. The farmer is the employer in these ca-ses. For information about common-law em-ployees, see section 1 of Pub. 15-A. For infor-mation about the Migrant and Seasonal Agricultural Worker Protection Act, which pro-tects migrant and seasonal agricultural workers by establishing employment standards related to wages, housing, transportation, disclosures and recordkeeping, and which requires farm la-bor contractors to register with the U.S. Depart-ment of Labor (DOL), see the DOL website at dol.gov/whd/regs/compliance/whdfs49.htm.

Social Security and Medicare Taxes

All cash wages you pay to an employee during the year for farmwork are subject to social se-curity and Medicare taxes if you meet either of the following tests.

You pay the employee $150 or more in cash wages (count all wages paid on a time, piecework, or other basis) during the year for farmwork (the $150 test). The $150 test applies separately to each farm-worker that you employ. If you employ a family of workers, each member is treated separately. Don't count wages paid by other employers.

You pay cash and noncash wages of $2,500 or more during the year to all your employees for farmwork (the $2,500 test).

If the $2,500 test for the group isn't met, the $150 test for an employee still applies.

Exceptions. Annual cash wages of less than $150 you pay to a seasonal farmworker aren't subject to social security and Medicare taxes, even if you pay $2,500 or more to all your farm-

Page 82Chapter 13Employment Taxes

workers. However, these wages count toward the $2,500 test for determining whether other farmworkers' wages are subject to social secur-ity and Medicare taxes.

A seasonal farmworker is a worker who:

Works as a hand-harvest laborer,

Is paid piece rates in an operation usually paid on this basis in the region of employ-ment,

Commutes daily from his or her permanent home to the farm, and

Worked in agriculture less than 13 weeks in the preceding calendar year.

See Family Employees, earlier, for certain exemptions from social security and Medicare taxes that apply to your child, spouse, and pa-rent.

Religious exemption. An exemption from social security and Medicare taxes is available to members of a recognized religious group or division opposed to public insurance. This ex-emption is available only if both the employee and the employer are members of the group or division. These employees are still subject to federal income tax. For more information, see Pub. 517.

Cash wages. Only cash wages paid to farm-workers are subject to social security and Medi-care taxes. Cash wages include checks, money orders, and any kind of money or cash.

Only cash wages subject to social security and Medicare taxes are credited to your em-ployees for social security benefit purposes. Payments not subject to these taxes, such as commodity wages, don't contribute to your em-ployees' social security coverage. For informa-tion about social security benefits, go to SSA.gov or call the SSA at 1-800-772-1213.

Noncash wages (including commodity wa-ges). Noncash wages include food, lodging, clothing, transportation passes, farm products, or other goods or commodities. Noncash wa-ges paid to farmworkers, including commodity wages, aren't subject to social security and Medicare taxes. However, they are subject to these taxes if the substance of the transaction is a cash payment. For information on lodging provided as a condition of employment, see Pub. 15-B.

Report the value of noncash wages in box 1 of Form W-2 together with cash wages. Don't show noncash wages in box 3 or in box 5 (un-less the substance of the transaction is a cash payment).

Tax rates and social security wage limit. For 2018, the employer and the employee will pay the following taxes.

The employer and employee each pay

6.2% of cash wages for social security tax (old-age, survivors, and disability insur-ance).

The employer and employee each pay 1.45% of cash wages for Medicare tax (hospital insurance).

The employee pays 0.9% of cash wages in excess of $200,000 for Additional Medi-care Tax.

Wage limit. The limit on wages subject to the social security tax for 2018 is $128,400.

There is no limit on wages subject to the Medi-care tax. All covered wages are subject to the Medicare tax. Additionally, all wages in excess of $200,000 are subject to Additional Medicare Tax withholding.

Paying employee's share. If you would rather pay the employee's share of social security and Medicare taxes without deducting it from his or her wages, you may do so. It is additional in-come to the employee. You must include it in box 1 of the employee's Form W-2, but don't count it as social security and Medicare wages (boxes 3 and 5 on Form W-2) or as wages for federal unemployment (FUTA) tax purposes.

Example. Gavrielle operates a small family fruit farm. She employs day laborers in the pick-ing season to enable her to timely get her crop to market. She doesn't deduct the employees' share of social security and Medicare taxes from their pay; instead, she pays it on their be-half. When her accountant, Annabella, prepares the employees' Forms W-2, she adds each em-ployee's share of social security and Medicare taxes paid by Gavrielle to the employee's wage income (box 1 of Form W-2), but doesn't in-clude it in box 3 (social security wages) or box 5 (Medicare wages and tips).

For 2018, Gavrielle paid Daniella $1,000 during the year. Annabella enters $1,076.50 in box 1 of Daniella's Form W-2 ($1,000 wages plus $76.50 social security and Medicare taxes paid for Daniella). She enters $1,000.00 in boxes 3 and 5 of Daniella's Form W-2.

Additional Medicare Tax. In addition to with-holding Medicare tax at 1.45%, you must with-hold a 0.9% Additional Medicare Tax from wa-ges you pay to an employee in excess of $200,000 in a calendar year. You’re required to begin withholding Additional Medicare Tax in the pay period in which you pay wages in ex-cess of $200,000 to an employee and continue to withhold it each pay period until the end of the calendar year. Additional Medicare Tax is only imposed on the employee. There is no em-ployer share of Additional Medicare Tax. All wa-ges that are subject to Medicare tax are subject to Additional Medicare Tax withholding if paid in excess of the $200,000 threshold.

For more information on what wages are subject to Medicare tax, see the chart, Special Rules for Various Types of Services and Pay-ments, in section 15 of Pub. 15. For more infor-mation on Additional Medicare Tax, go to IRS.gov/ADMT.

Federal Income Tax Withholding

If the cash wages you pay to farmworkers are subject to social security and Medicare taxes, they are also subject to federal income tax with-holding. Although noncash wages are subject to federal income tax, withhold income tax on these noncash wages only if you and the em-ployee agree to do so. The amount to withhold is figured on gross wages without taking out so-cial security and Medicare taxes, union dues, etc.

Form W-4. Generally, the amount of federal in-come tax you withhold is based on the employ-ee's marital status and withholding allowances claimed on the employee's Form W-4. In gen-eral, an employee can claim withholding allow-ances on Form W-4 equal to the number of ex-emptions the employee will be entitled to claim on his or her tax return. An employee may also be able to claim a special withholding allow-ance and allowances for estimated deductions and credits.

Don't withhold federal income tax from the wages of an employee who, by filing Form W-4, certifies that he or she had no federal income tax liability last year and anticipates no liability for the current year.

You should give each new employee a Form W-4 as soon as you hire the employee. For Spanish-speaking employees, you may use Formulario W-4(SP) which is the Spanish trans-lation of Form W-4. Have the employee com-plete and return the form to you before the first payday. If the employee doesn't return the com-pleted form, you must withhold federal income tax as if the employee is single and claims no withholding allowances.

New Form W-4 for 2019. You should make the 2019 Form W-4 available to your em-ployees and encourage them to check their in-come tax withholding for 2019. Those employ-ees who owed a large amount of tax or received a large refund for 2018 may want to submit a new Form W-4. You can't accept substitute Forms W-4 developed by employees. Advise your employees to use the IRS Withholding Cal-culator on the IRS website at IRS.gov/W4App for help in determining how many withholding allowances to claim on their Form W-4.

How to figure withholding. You can use one of several methods to determine the amount to withhold. The methods are described in section 13 of Pub. 51, which contains tables showing the correct amount of federal income tax you should withhold. Section 5 of Pub. 51 also con-tains additional information about federal in-come tax withholding.

Nonemployee compensation. Generally, you don't have to withhold federal income tax on payments for services to individuals who aren't your employees. However, you may be required to report these payments on Form 1099-MISC and to withhold under the backup withholding rules. For example, persons who haven’t fur-nished their taxpayer identification number (TIN) to you are subject to withholding on pay-ments required to be reported on Form 1099-MISC. For more information, see the In-structions for Form 1099-MISC.

Required Notice to Employees About Earned Income Credit (EIC)

You must provide notification about the EIC to each employee who worked for you at any time during the year and from whom you didn't with-hold any federal income tax. However, you

don't have to notify employees who claim ex-emption from federal income tax withholding on Form W-4. You meet the notification require-ment by giving each employee any of the fol-lowing.

Form W-2, which contains EIC notification on the back of Copy B.

A substitute Form W-2 with the exact EIC wording shown on the back of Copy B of Form W-2.

Notice 797, Possible Federal Tax Refund Due to the Earned Income Credit (EIC).

Notice 1015, Have You Told Your Employ-ees About the Earned Income Tax Credit (EIC)?

Your own written statement with the exact wording of Notice 797.

For more information, see Pub. 51.

Reporting and Paying Social Security, Medicare, and Withheld Federal Income Taxes

You must withhold federal income, social secur-ity, and Medicare taxes required to be withheld from the salaries and wages of your employees. You’re liable for the payment of these taxes to the federal government whether or not you col-lect them from your employees. If, for example, you withhold less than the correct tax from an employee's wages, you’re still liable for the full amount. You must also pay the employer's share of social security and Medicare taxes. There is no employer share of Additional Medi-care Tax.

Form 943. Report withheld federal income tax, social security tax, and Medicare tax on Form

943. Your 2018 Form 943 is due by January 31,

2019 (or February 11, 2019, if you made depos-its on time in full payment of the taxes due for the year).

Deposits. Generally, you must deposit both the employer and employee shares of social se-curity and Medicare taxes and federal income tax withheld during the year. However, you may make payments with Form 943 instead of de-positing them if you accumulate less than a $2,500 tax liability (“Total taxes after adjust-ments and credits” line on Form 943) during the year and you pay in full with a timely filed return.

For more information on deposit rules, see section 7 of Pub. 51.

Electronic deposit requirement. You must use EFT to make all federal tax deposits. Generally, an EFT is made using EFTPS. If you don't want to use EFTPS, you can arrange for your tax professional, financial institution, pay-roll service, or other trusted third party to make electronic deposits on your behalf. Also, you may arrange for your financial institution to ini-tiate a same-day wire payment on your behalf. EFTPS is a free service provided by the Depart-ment of Treasury. Services provided by your tax professional, financial institution, payroll serv-ice, or other third party may have a fee.

For more information on making federal tax deposits, see section 7 of Pub. 51. To get more

information about EFTPS or to enroll in EFTPS, go to EFTPS.gov or call 1-800-555-4477 or 1-800-733-4829 (TDD). Additional information about EFTPS is also available in Pub. 966.

Form W-2. By January 31, you must furnish each employee a Form W-2 showing total wa-ges for the previous year and total federal in-come tax, social security tax, and Medicare tax withheld. However, if an employee stops work-ing for you and asks for the form earlier, you must give it to the employee within 30 days of the later of the following dates.

The date the employee asks for the form.

The date you make your final payment of wages to the employee.

Compensation paid to H-2A visa holders. Report compensation of $600 or more paid to foreign agricultural workers who entered the country on H-2A visas in box 1 of Form W-2. Compensation paid to H-2A workers for agricul-tural labor performed in connection with this visa isn't subject to social security and Medi-care taxes, and therefore shouldn't be reported as wages subject to social security tax (line 2), Medicare tax (line 4), or Additional Medicare Tax (line 6) on Form 943, and shouldn't be re-ported as social security wages (box 3) or Medi-care wages (box 5) on Form W-2. On Form W-2, don't check box 13 (Statutory employee), as H-2A workers aren't statutory employees.

An employer isn’t required to withhold fed-eral income tax from compensation paid to an H-2A worker for agricultural labor performed in connection with this visa unless the worker asks for withholding and the employer agrees. In this case, the worker must give the employer a com-pleted Form W-4. Federal income tax withheld should be reported on Form 943, line 8, and in box 2 of Form W-2.

These reporting rules apply when the H-2A worker provides his or her TIN to the employer. However, if an H-2A visa worker didn't provide the employer with a TIN, the employee is sub-ject to backup withholding. The employer must report the wages and backup withholding on Form 1099-MISC. The employer must also re-port the backup withholding on Form 945, line 2.

For more information, see the Instructions for Form 1099-MISC and the Instructions for Form 945. For more information on foreign agri-cultural workers on H-2A visas, go to IRS.gov/ H2A.

Trust fund recovery penalty. If you’re re-sponsible for withholding, accounting for, de-positing, or paying federal income, social secur-ity, and Medicare taxes withheld (that is, trust fund taxes) and willfully fail to do so, you can be held liable for a penalty equal to the withheld tax not paid. A responsible person can be an of-ficer of a corporation, a partner, a sole proprie-tor, or an employee of any form of business. A trustee or agent with authority over the funds of the business can also be held responsible for the penalty.

Willfully means voluntarily, consciously, and intentionally. Paying other expenses of the busi-ness instead of the taxes due is acting willfully.

Consequences of treating an employee as an independent contractor. If you classify an

Chapter 13Employment TaxesPage 83

employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker. See Pub. 15-A for more information.

Federal Unemployment (FUTA) Tax

You must pay FUTA tax if you meet either of the following tests.

You paid cash wages of $20,000 or more to farmworkers in any calendar quarter during the current or preceding calendar year.

You employed 10 or more farmworkers for some part of at least 1 day (whether or not all at the same time) during any 20 or more different calendar weeks during the current or preceding calendar year.

These rules don't apply to exempt services of your spouse, your parents, or your children un-der age 21. See Family Employees, earlier.

Alien farmworkers. Wages paid to aliens ad-mitted on a temporary basis to the United States to perform farmwork (also known as “H-2A visa workers”) are exempt from FUTA tax. However, include your employment of these workers and the wages you paid them to determine whether you meet either of the above tests.

Table 14-1. Fuel Excise Tax Credits and Refunds at a Glance

Use this table to see if you can take a credit or refund for a nontaxable use of the fuel listed.

	On a Farm for Farming	Off-Highway	Household Use or
Fuel Used			Use Other Than as
	Purposes	Business Use	a Fuel1
Gasoline	Credit only	Credit or refund	None
Aviation gasoline	Credit only	None	None
Undyed diesel fuel	Credit or refund	Credit or refund2	Credit or refund2
and undyed
kerosene
Kerosene for use in	Credit or refund	None	None
aviation
Dyed diesel fuel	None	None	None
and dyed kerosene
Other Fuels	Credit or refund	Credit or refund	None
(including
alternative fuels)3

1 For a use other than as fuel in a propulsion engine.

2 Applies to undyed kerosene not sold from a blocked pump or, under certain circumstances, for blending with undyed diesel fuel to be used for heating purposes. See Regulations section 48.6427-10(b)(1) for the definition of a blocked pump.

3 Other Fuels means any liquid except gas oil, fuel oil, or any product taxable under section 4081. It includes the alternative fuels: liquefied petroleum gas (LPG), “P” Series fuels, compressed natural gas (CNG), liquefied hydrogen, Fischer-Tropsch process liquid fuel from coal (including peat), liquid fuel derived from biomass, liquefied natural gas (LNG), liquefied gas derived from biomass, and compressed gas derived from biomass.

Commodity wages. Payments in kind for farm labor aren't cash wages. Don't count them to figure whether you’re subject to FUTA tax or to figure how much tax you owe.

Tax rate and credit. The gross FUTA tax rate is 6.0% of the first $7,000 cash wages you pay to each employee during the year. However, you’re given a credit of up to 5.4% of the first $7,000 cash wages you pay to each employee for the state unemployment tax you pay. If your state tax rate (experience rate) is less than 5.4%, you may still be allowed the full 5.4% credit.

If all of the taxable FUTA wages you paid were excluded from state unemployment tax, the full 6.0% rate applies. See the Instructions for Form 940 for additional information.

More information. For more information on FUTA tax, see section 10 of Pub. 51.

Reporting and Paying FUTA Tax

The FUTA tax is imposed on you as the em-ployer. It must not be collected or deducted from the wages of your employees.

Form 940. Report FUTA tax on Form 940. The 2018 Form 940 is due by January 31, 2019 (or February 11, 2019, if you timely deposited the full amount of your 2018 FUTA tax).

Deposits. If at the end of any calendar quarter you owe, but haven't yet deposited, more than $500 in FUTA tax for the year, you must make a deposit by the end of the following month. If the undeposited tax is $500 or less at the end of a

quarter, you don't have to deposit it. You can add it to the tax for the next quarter. If the total undeposited tax is more than $500 at the end of the next quarter, a deposit will be required. If the total undeposited tax at the end of the 4th quarter is $500 or less, you can either make a deposit or pay it with your return by the January 31, 2019, due date.

Electronic deposit requirement. You must use EFT to make all federal tax deposits. Generally, an EFT is made using EFTPS. If you don't want to use EFTPS, you can arrange for your tax professional, financial institution, pay-roll service, or other trusted third party to make electronic deposits on your behalf. Also, you may arrange for your financial institution to ini-tiate a same-day wire payment on your behalf. EFTPS is a free service provided by the Depart-ment of Treasury. Services provided by your tax professional, financial institution, payroll serv-ice, or other third party may have a fee.

For more information on making federal tax deposits, see section 7 of Pub. 51. To get more information about EFTPS or to enroll in EFTPS, go to EFTPS.gov or call 1-800-555-4477 or 1-800-733-4829 (TDD). Additional information about EFTPS is also available in Pub. 966.

14.

Fuel Excise Tax

Credits and Refunds

Introduction

You may be eligible to claim a credit on your in-come tax return for the federal excise tax on certain fuels. You may also be eligible to claim a quarterly refund of the fuel taxes during the year, instead of waiting to claim a credit on your income tax return.

Whether you can claim a credit or refund de-pends on whether the fuel was taxed and the purpose (nontaxable use) for which you used the fuel. The nontaxable uses of fuel for which a farmer may claim a credit or refund are gener-ally the following.

Use on a farm for farming purposes.

Off-highway business use.

Uses other than as a fuel in a propulsion engine, such as home use.

Table 14-1 presents an overview of credits and refunds that may be claimed for fuels used for the nontaxable uses listed above. See Pub. 510, Excise Taxes, for more information.

Page 84Chapter 14Fuel Excise Tax Credits and Refunds

Topics

This chapter discusses:

Fuels used in farming

Dyed diesel fuel and dyed kerosene

Fuels used in off-highway business use

Fuels used for household purposes

How to claim a credit or refund

Including the credit or refund in income

Useful Items

You may want to see:

Publication

510 Excise Taxes

Form (and Instructions)

720 Quarterly Federal Excise Tax Return

4136 Credit for Federal Tax Paid on Fuels

8849 Claim for Refund of Excise Taxes

See chapter 16 for information about getting publications and forms.

Fuels Used in Farming

Owners, operators, and tenants of farms and certain other persons may be eligible to claim a credit or refund of excise taxes on fuel used in the trade or business of farming, when used on a farm in the United States for farming purpo-ses. See Table 14-1 for a list of available fuel excise tax credits and refunds. Fuel is used on a farm for farming purposes only if used in car-rying on a trade or business of farming, on a farm in the United States, and for farming pur-poses.

Farm. A farm includes livestock, dairy, fish, poultry, fruit, fur-bearing animals, and truck farms, orchards, plantations, ranches, nurser-ies, ranges, and feed yards for finishing cattle. It also includes structures such as greenhouses used primarily for raising agricultural or horticul-tural commodities. A fish farm is an area where fish are grown or raised and not merely caught or harvested.

Dyed versus undyed diesel. Diesel is undyed when sold for highway use vehicles and excise tax is collected at the time of sale. The diesel is dyed when the intended use is for non-taxable purposes, such as farming, and no ex-cise tax is collected at the time of sale. When undyed diesel is used in farming or any other qualifying purpose, the taxpayer may recover the excise tax paid by claiming a credit or filing for a refund (see Table 14-1).

Dyed diesel fuel and dyed kerosene. If you purchase dyed diesel fuel or dyed kerosene for a nontaxable use, you must use it only on a farm for farming purposes or for other nontaxa-ble purposes. For example, you should not use dyed diesel fuel in a truck that is used both on the farm for farming purposes and on the high-way, even though the highway use is in connec-tion with farm business. Excise tax applies to the fuel used by the truck on the highways. In this situation, undyed (taxed) fuel should be purchased for the truck. You should keep fuel

records of the use of the truck on the farm for farming purposes, and for other uses. You may be eligible for a credit or refund for the excise tax on fuel used on the farm for farming purpo-ses.

Penalty. A penalty is imposed on any person who knowingly uses, sells, or alters dyed diesel fuel or dyed kerosene for any purpose other than a nontaxable use. The penalty is the greater of $1,000 or $10 per gallon of the dyed diesel fuel or dyed kerosene involved. After the first violation, the $1,000 portion of the penalty increases depending on the number of viola-tions. For more information on this penalty, see Pub. 510.

Farming purposes. As the owner, tenant, or operator and the ultimate purchaser of fuel that you purchased, you use the fuel on a farm for farming purposes if you use it in any of the fol-lowing ways.

1. To cultivate the soil or to raise or harvest any agricultural or horticultural commodity.

2. To raise, shear, feed, care for, train, or manage livestock, bees, poultry, fur-bear-ing animals, or wildlife.

3. To operate, manage, conserve, improve, or maintain your farm and its tools and equipment.

4. To handle, dry, pack, grade, or store any raw agricultural or horticultural commodity. For this use to qualify, you must have pro-duced more than half the commodity so treated during the tax year. The more-than-one-half test applies separately to each commodity. Commodity means a single raw product. For example, apples and peaches are two separate commodi-ties.

5. To plant, cultivate, care for, or cut trees or to prepare (other than sawing logs into lumber, chipping, or other milling) trees for market, but only if these activities are inci-dental to your farming operations. Your tree operations are incidental only if they are minor in nature when compared to the total farming operations.

If any other person, such as a neighbor or custom operator (independent contractor), per-forms a service for you on your farm for any of the purposes included in list item (1) or (2) above, you are considered to be the ultimate purchaser who used the fuel on a farm for farm-ing purposes. Therefore, you can still claim the credit or refund for the fuel so used. However, see Custom application of fertilizer and pesti-cide, later. If the other person performs any other services for you on your farm for purposes not included in list item (1) or (2) above, no one can claim the credit or refund for fuel used on your farm for those other services.

Buyer of fuel, including undyed diesel fuel or undyed kerosene. If doubt exists whether the owner, tenant, or operator of the farm bought the fuel, determine who actually bore the cost of the fuel. For example, if the owner of a farm and his or her tenant equally share the cost of gasoline used on the farm,

each can claim a credit for the tax on half the fuel used.

Undyed diesel fuel, undyed kerosene, and other fuels (including alternative fuel). Usually, the farmer is the only person who can make a claim for credit or refund for the tax on undyed diesel fuel, undyed kerosene, or other fuels (including alternative fuel) used for farm-ing purposes. However, see Custom applica-tion of fertilizer and pesticide next. Also see Dyed diesel fuel and dyed kerosene, earlier.

Example. Farm owner Haleigh Blue hired custom operator Tyler Steele to cultivate the soil on her farm. Tyler used 200 gallons of undyed diesel fuel that he purchased to perform the work on Haleigh's farm. In addition, Haleigh hired contractor Lee Brown to pack and store her apple crop. Lee bought 25 gallons of undyed diesel fuel to use in packing the apples. Haleigh can claim the credit for the 200 gallons of undyed diesel fuel used by Tyler on her farm because it qualifies as fuel used on the farm for farming purposes. No one can claim a credit for the 25 gallons used by Lee because that fuel was not used for a farming purpose included in list item (1) or (2) above.

In the above example, both Tyler Steele and Lee Brown could have purchased dyed (un-taxed) diesel fuel for their tasks.

Custom application of fertilizer and pes-ticide. Fuel used on a farm for farming purpo-ses includes fuel used in the application (includ-ing aerial application) of fertilizer, pesticides, or other substances. Generally, the applicator is treated as having used the fuel on a farm for farming purposes and therefore, claims the credit or refund. For applicators using highway vehicles, only the fuel used on the farm is ex-empt. Fuel used traveling on the highway to and from the farm is taxable. Fuel used by an aerial applicator for the direct flight between the air-field and one or more farms is treated as used for a farming purpose. For aviation gasoline, the aerial applicator makes the claim as the ulti-mate purchaser. For kerosene used in aviation, the ultimate purchaser may make the claim or waive the right to make the claim to the regis-tered ultimate vendor. A sample waiver is inclu-ded as Model Waiver L in the appendix of Pub. 510.

A registered ultimate vendor is the person who sells undyed diesel fuel, undyed kerosene, or kerosene for use in aviation to the user (ulti-mate purchaser) of the fuel for use on a farm for farming purposes. To claim a credit or refund of tax, the ultimate vendor must be registered with the IRS at the time the claim is made. However, registered ultimate vendors cannot make claims for undyed diesel fuel and undyed kerosene sold for use on a farm for farming purposes.

Fuel not used for farming. You do not use fuel on a farm for farming purposes when you use it in any of the following ways.

Off the farm, such as on the highway or in noncommercial aviation, even if the fuel is used in transporting livestock, feed, crops, or equipment.

For personal use, such as lawn mowing.

In processing, packaging, freezing, or can-ning operations.

Chapter 14Fuel Excise Tax Credits and RefundsPage 85

In processing crude gum into gum spirits of turpentine or gum resin or in processing maple sap into maple syrup or maple sugar.

All-terrain vehicles (ATVs). Fuel used in ATVs on a farm for farming purposes, dis-cussed earlier, is eligible for a credit or refund of excise taxes on the fuel. Fuel used in ATVs for nonfarming purposes is not eligible for a credit or refund of the taxes. If ATVs are used both for farming and nonfarming purposes, only that portion of the fuel used for farming purposes is eligible for the credit or refund.

Fuels Used in Off-Highway

Table 14-2. Claiming a Credit or Refund of Excise Taxes

This table gives the basic rules for claiming a credit or refund of excise taxes on fuels used for a nontaxable use.

	Credit	Refund
Which form to use	Form 4136, Credit for Federal	Form 8849, Claim for Refund of
	Tax Paid on Fuels	Excise Taxes; and Schedule 1
		(Form 8849), Nontaxable Use
		of Fuels
Type of form	Annual	Quarterly
When to file	With your income tax return	By the last day of the quarter
		following the last quarter
		included in the claim
Amount of tax	Any amount	$750 or more1

1 You may carry over an amount less than $750 to the next quarter.

Business Use

You may be eligible to claim a credit or refund for the excise tax on fuel used in an off-highway business use.

Off-highway business use. This is any use of fuel in a trade or business or in an income-pro-ducing activity. The use must not be in a high-way vehicle registered or required to be regis-tered for use on public highways. Off-highway business use generally does not include any use in a recreational motorboat.

Examples. Off-highway business use in-cludes the use of fuels in a trade or business in any of the following ways.

In stationary machines such as generators, compressors, power saws, and similar equipment.

For cleaning.

In forklift trucks, bulldozers, and earthmov-ers.

Off-highway nonbusiness (taxable) use of fuel includes use in minibikes, snowmobiles, power lawn mowers, chain saws, and other yard equipment. For more information, see Pub. 510.

Fuels Used for Household Purposes or Other Than as a Fuel for Propulsion Engines

You may be eligible to claim a credit or refund for the excise tax on undyed diesel fuel or kero-sene used for home heating, lighting, and cook-ing. This also applies to diesel fuel and kero-sene used in a home generator to produce electricity for home use. Home use of a fuel does not include use in a propulsion engine and it is also not considered an off-highway busi-ness use.

How To Claim a Credit or Refund

You may be able to claim a credit or refund of the excise tax on fuels you use for nontaxable

uses. The basic rules for claiming credits and refunds are listed in Table 14-2.

Keep at your principal place of busi- ness all records needed to enable the RECORDS IRS to verify that you are the person

entitled to claim a credit or refund and the amount you claimed. You do not have to use any special form, but the records should estab-lish the following information.

The total number of gallons bought and used during the period covered by your claim.

The dates of the purchases.

The names and addresses of suppliers and amounts bought from each during the period covered by your claim.

The nontaxable use for which you used the fuel.

The number of gallons used for each non-taxable use.

It is important that your records separately show the number of gallons used for each nontaxable use that qualifies as a claim. For more informa-tion about recordkeeping, see Pub. 583, Start-ing a Business and Keeping Records.

Credit or refund. A credit is an amount that re-duces the tax on your income tax return when you file it at the end of the year. If you meet cer-tain requirements, you may claim a refund dur-ing the year instead of waiting until you file your income tax return.

Credit only. You can claim the following taxes only as a credit on your income tax return.

Tax on gasoline and aviation gasoline you used on a farm for farming purposes.

Tax on fuels (including undyed diesel fuel or undyed kerosene) you used for nontax-able uses if the total for the tax year is less than $750.

Tax on fuel you did not include in any claim for refund previously filed for any quarter of the tax year.

Claiming a Credit

You make a claim for a fuel tax credit on Form 4136 and attach it to your income tax return. Do not claim a credit for any excise tax for which you have filed a refund claim.

How to claim a credit. How you claim a credit depends on whether you are an individual, part-nership, corporation, S corporation, trust, or farmers' cooperative association.

Individuals. You claim the credit on the “Credit for federal tax on fuels” line of your Form 1040. If you would not otherwise have to file an income tax return, you must do so to get a fuel tax credit.

Partnerships. Partnerships claim the credit

by including a statement on Schedule K-1

(Form 1065), Partner's Share of Income, De-

ductions, Credits, etc., showing each partner's

share of the number of gallons of each fuel sold

or used for a nontaxable use, the type of use,

and the applicable credit per gallon. Each part-

ner claims the credit on his or her income tax

return for the partner's share of the fuel used by

the

partnership.

Other entities. Corporations, S corpora-tions, farmers' cooperative associations, and trusts make the claim on the appropriate line of their income tax return.

When to claim a credit. You can claim a fuel tax credit on your income tax return for the year you used the fuel.

You may be able to make a fuel tax TIP claim on an amended income tax re-turn for the year you used the fuel. A claim for credit or refund of an overpayment

must generally be filed within the later of:

3 years from the date the original return was filed, or

2 years from the date the tax was paid.

Claiming a Refund

If eligible, you may claim a refund of excise taxes on Form 8849. Complete and attach to Form 8849 the appropriate Form 8849 sched-ule(s). The instructions for Form 8849 and the separate instructions for each schedule explain the requirements for making a claim for refund. If you file Form 720, you can use its Schedule C for your refund claims for the quarter. See the Instructions for Form 720. Do not claim a refund on Form 8849 for any amount for which you

Page 86Chapter 14Fuel Excise Tax Credits and Refunds

have filed or will file a claim on Form 720 or Form 4136.

You may file a claim for refund for any quar-ter of your tax year for which you can claim $750 or more. This amount is the excise tax on all fuels used for a nontaxable use during that quarter or any prior quarter (for which no other claim has been filed) during the tax year.

If you cannot claim at least $750 at the end of a quarter, you carry the amount over to the next quarter of your tax year to determine if you can claim at least $750 for that quarter. If you cannot claim at least $750 at the end of the fourth quarter of your tax year, you must claim a credit on your income tax return using Form 4136. Only one claim can be filed for a quarter.

You cannot claim a refund for excise

tax on gasoline and aviation gasoline CAUTION used on a farm for farming purposes. You must claim a credit on your income tax re-turn for the tax.

How to file a quarterly claim. File the claim for refund by filling out Schedule 1 (Form 8849) and attaching it to Form 8849. Send it to the ad-dress shown in the instructions. If you file Form 720, you can use its Schedule C for your refund claims. See the Instructions for Form 720.

When to file a quarterly claim. You must file a quarterly claim by the last day of the first quar-ter following the last quarter included in the claim. If you do not file a timely refund claim for the fourth quarter of your tax year, you will have to claim a credit for that amount on your income tax return, as discussed earlier.

In most situations, the amount claimed

as a credit or refund will be less than CAUTION the amount of fuel tax paid, because the Leaking Underground Storage Tank (LUST) tax of $0.001 per gallon is generally not subject to credit or refund.

Including the Credit or Refund in Income

Include any credit or refund of excise taxes on fuels in your gross income if you claimed the to-tal cost of the fuel (including the excise taxes) as an expense deduction that reduced your in-come tax liability.

Which year you include a credit or refund in gross income depends on whether you use the cash or an accrual method of accounting.

Cash method. If you use the cash method and file a claim for refund, include the refund amount in gross income for the tax year in which you receive the refund. If you claim a credit on your income tax return, include the credit amount in gross income for the tax year in which you file Form 4136. If you file an amen-ded return and claim a credit, include the credit amount in gross income for the tax year in which you receive the credit.

Example. Marucia Brown, a farmer who uses the cash method, filed her 2017 Form 1040 on March 3, 2018. On her Schedule F,

she deducted the total cost of gasoline (includ-ing $110 of excise taxes) used on the farm for farming purposes. Then, on Form 4136, she claimed the $110 as a credit. Marucia reports the $110 as other income on line 8 of her 2018 Schedule F.

Accrual method. If you use an accrual method, include the amount of credit or refund in gross income for the tax year in which you used the fuels. It does not matter whether you filed for a quarterly refund or claimed the entire amount as a credit.

Example. Amy Johnson, a farmer who uses the accrual method, files her 2017 Form 1040 on April 15, 2018. On Schedule F, she de-ducts the total cost of gasoline (including $155 of excise taxes) she used on the farm for farm-ing purposes during 2017. On Form 4136, Amy claims the $155 as a credit. She reports the $155 as other income on line 8 of her 2017 Schedule F.

15.

Estimated Tax

Introduction

Estimated tax is the method used to pay tax on income that is not subject to withholding. See Pub. 505 for the general rules and requirements for paying estimated tax. If you are a qualified farmer, defined below, you are subject to the special rules covered in this chapter for paying estimated tax.

Topics

This chapter discusses:

Special estimated tax rules for qualified farmers

Estimated tax penalty

Useful Items

You may want to see:

Publication

505 Tax Withholding and Estimated Tax

Form (and Instructions)

1040 U.S. Individual Income Tax Return

1040-ES Estimated Tax for Individuals

2210-F Underpayment of Estimated Tax

by Farmers and Fishermen

See chapter 16 for information about getting publications and forms.

Special Estimated Tax Rules for Qualified Farmers

Special rules apply to the payment of estimated tax by individuals who are qualified farmers. If you are not a qualified farmer as defined next, see Pub. 505 for the estimated tax rules that ap-ply.

Qualified Farmer

An individual is a qualified farmer for 2018 if at least two-thirds of his or her gross income from all sources for 2017 or 2018 was from farming. See Gross Income, next, for information on how to figure your gross income from all sources and see Gross Income From Farming, later, for information on how to figure your gross income from farming. See also Percentage From Farm-ing, later, for information on how to determine the percentage of your gross income from farm-ing.

Gross Income

Gross income is all income you receive in the form of money, goods, property, and services that is not exempt from income tax. On a joint return, you must add your spouse's gross in-come to your gross income. To decide whether two-thirds of your gross income was from farm-ing, use as your gross income the total of the following income (not loss) amounts from your tax return.

Wages, salaries, tips, etc.

Taxable interest.

Ordinary dividends.

Taxable refunds, credits, or offsets of state and local income taxes.

Alimony.

Gross business income from Schedule C (Form 1040).

Gross business receipts from Sched-ule C-EZ (Form 1040).

Capital gains from Schedule D (Form 1040). Losses are not netted against gains.

Gains on sales of business property.

Taxable IRA distributions, pensions, annui-ties, and social security benefits.

Gross rental income from Schedule E (Form 1040).

Gross royalty income from Schedule E (Form 1040).

Taxable net income from an estate or trust reported on Schedule E (Form 1040).

Income from a Real Estate Mortgage In-vestment Conduit reported on Schedule E (Form 1040).

Gross farm rental income from Form 4835.

Gross farm income from Schedule F (Form 1040).

Your distributive share of gross income from a partnership, or limited liability com-pany treated as a partnership, from Sched-ule K-1 (Form 1065).

Your pro rata share of gross income from an S corporation, from Schedule K-1 (Form 1120S).

Chapter 15Estimated TaxPage 87

Figure 15-1. Estimated Tax for Farmers

Start Here:

NoWill you owe $1,000 or

more after subtracting

income tax withholding

and refundable credits

from your total tax? (Do

not subtract any

estimated tax payments.)

		Yes

Yes	Was at least 662⁄3 %		No	Follow the general
	of all your gross

	income in 2017 or			estimated tax rules.
	2018 from farming?

not netted against the gain to figure Ms. Smith's total gross income or her gross farm income. Her gross farm income is 64% of her total gross income ($80,000 ÷ $125,000 = 0.64). Since Ms. Smith's gross farm income is less than two-thirds of her total gross income, she is not a qualified farmer and the general estimated tax rules apply.

Special Rules for Qualified Farmers

The following special estimated tax rules apply if you are a qualified farmer for 2018.

•	You do not have to pay estimated tax if you
	file your 2018 tax return and pay all the tax
	due by March 1, 2019.

Will your 2018		Will your 2018
income tax		income tax
withholding and	No	withholding and	No
credits be at		credits be at
least 662⁄3 % of		least 100% of
the tax shown		the tax shown
on your 2018		on your 2017
return?		return?

Yes		Yes

You do not have to

pay estimated tax.

			You must pay
Will you le your
		No	your estimated
income tax
			tax (your
return and pay
			required annual
the tax in full by
			payment) by
March 1, 2019?
			January 15,

	Yes		2019.

•	You do not have to pay estimated tax if
	your 2018 income tax withholding (includ-
	ing any amount applied to your 2018 esti-
	mated tax from your 2017 return) will be at
	least 662/3% (.6667) of the total tax shown
	on your 2018 tax return or 100% of the to-
•	tal tax shown on your 2017 return.
	If you must pay estimated tax, you are re-
	quired to make only one estimated tax pay-
	ment (your required annual payment) by
	January 15, 2019, using special rules to
	figure the amount of the payment. See Re-
	quired Annual Payment next for details.

Note. See Special Rules for Qualified Farmers, later, for a detailed description of the special estimated tax rules that apply to quali ed farmers.

Figure 15-1 presents an overview of the special estimated tax rules that apply to quali-fied farmers.

Unemployment compensation.

Other income not included with any of the items listed above.

Gross Income From Farming

Gross income from farming is income from culti-vating the soil or raising agricultural commodi-ties. It includes the following amounts.

Income from operating a stock, dairy, poul-try, bee, fruit, or truck farm.

Income from a plantation, ranch, nursery, range, orchard, or oyster bed.

Crop shares for the use of your land.

Gains from sales of draft, breeding, dairy, or sporting livestock.

Gross income from farming is the total of the following amounts from your tax return.

Gross farm income from Schedule F (Form 1040).

Gross farm rental income from Form 4835.

Gross farm income from Schedule E (Form 1040), Parts II and III.

Gains from the sale of livestock used for draft, breeding, sport, or dairy purposes re-ported on Form 4797.

For more information about income from farming, see chapter 3.

Farm income does not include any of

the following:

CAUTION

Wages you receive as a farm employee,

Income you receive from contract grain harvesting and hauling with workers and machines you furnish, and

Gains you receive from the sale of farm land and depreciable farm equipment.

Percentage From Farming

Figure your gross income from all sources, dis-cussed earlier. Then figure your gross income from farming, discussed earlier. Divide your farm gross income by your total gross income to determine the percentage of gross income from farming.

Example 1. Jane Smith had the following total gross income and farm gross income amounts in 2018.

Gross Income

	Total			Farm

Taxable interest . . . . . . . .		$3,000
Dividends . . . . . . . . . . . . .	500
Rental income (Sch E) . . . .	41,500		$75,000
Farm income (Sch F) . . . . .	75,000
Gain (Form 4797) . . . . . . .	5,000			5,000
Total . . . . . . . . . . . .	$125,000		$80,000

Example 2. Assume the same fact as in Example 1. Ms. Smith's gross farm income is only 64% of her total income. Therefore, based on her 2018 income, she does not qualify to use the special estimated tax rules for qualified farmers. However, she does qualify if at least two-thirds of her 2017 gross income was from farming.

Example 3. Assume the same facts as in Example 1 except that Ms. Smith's farm income from Schedule F was $90,000 instead of $75,000. This made her total gross income $140,000 ($3,000 + $500 + $41,500 + $90,000

$5,000) and her farm gross income $95,000 ($90,000 + $5,000). She qualifies to use the special estimated tax rules for qualified farmers, since 67.9% (at least two-thirds) of her gross in-come is from farming ($95,000 ÷ $140,000 = .679).

Required Annual Payment

If you are a qualified farmer and must pay esti-mated tax for 2018, use the worksheet on Form 1040-ES to figure the amount of your required annual payment. Apply the following special rules for qualified farmers to the worksheet.

•	On line 12a, multiply line 11c by 662/3%
	(.6667).
•	On line 12b, enter 100% of the tax shown
	on your 2017 tax return regardless of the
	amount of your adjusted gross income. For
	this purpose, the “tax shown on your 2017

Schedule D showed gain from the sale of

dairycowscarriedoverfromForm4797

($5,000) in addition to a loss from the sale of

corporate stock ($2,000). However, that loss is

Page 88Chapter 15Estimated Tax

tax return” is the amount on line 63 of your 2017 return modified by certain adjust-ments. For more information, see chap-ter 2 of Pub. 505.

Estimated Tax Penalty for 2018

If you do not pay all your required estimated tax for 2018 by January 15, 2019, or file your 2018 return and pay any tax due by March 1, 2019, you may owe a penalty. Use Form 2210-F, Un-derpayment of Estimated Tax by Farmers and Fishermen, to determine if you owe a penalty. See the Instructions for Form 2210-F. Also, see the Instructions for Form 2210-F for information on how to request a waiver of the penalty.

If you receive a penalty notice, do not

ignore it, even if you think it is in error. CAUTION You may get a penalty notice even though you filed your return on time, attached Form 2210-F, and met the gross-in-come-from-farming requirement. If you receive a penalty notice for underpaying estimated tax and you think it is in error, write to the address on the notice and explain why you think the no-tice is in error. Include a computation similar to the one in Example 1 (earlier), showing that you met the gross income from farming require-ment.

16.

How To Get Tax Help

If you have questions about a tax issue, need help preparing your tax return, or want to down-load free publications, forms, or instructions, go to IRS.gov and find resources that can help you right away.

Tax reform. Major tax reform legislation im-pacting individuals, businesses, and tax-ex-empt entities was approved by Congress in the Tax Cuts and Jobs Act on December 22, 2017. Go to IRS.gov/TaxReform for information and updates on how this legislation affects your taxes.

Preparing and filing your tax return. Find free options to prepare and file your return on IRS.gov or in your local community if you qual-ify.

The Volunteer Income Tax Assistance (VITA) program offers free tax help to people who generally make $55,000 or less, persons with disabilities, and limited-English-speaking taxpayers who need help preparing their own tax returns. The Tax Counseling for the Elderly (TCE) program offers free tax help for all tax-payers, particularly those who are 60 years of age and older. TCE volunteers specialize in an-swering questions about pensions and retire-ment-related issues unique to seniors.

You can go to IRS.gov to see your options for preparing and filing your return which in-clude the following.

Free File. Go to IRS.gov/FreeFile to see if you qualify to use brand-name software to prepare and e-file your federal tax return for free.

VITA. Go to IRS.gov/VITA, download the free IRS2Go app, or call 800-906-9887 to find the nearest VITA location for free tax preparation.

TCE. Go to IRS.gov/TCE, download the free IRS2Go app, or call 888-227-7669 to find the nearest TCE location for free tax preparation.

Getting answers to your tax law questions. On IRS.gov get answers to your tax questions anytime, anywhere.

Go to IRS.gov/Help for a variety of tools that will help you get answers to some of the most common tax questions.

Go to IRS.gov/ITA for the Interactive Tax Assistant, a tool that will ask you questions on a number of tax law topics and provide answers. You can print the entire interview and the final response for your records.

Go to IRS.gov/Pub17 to get Pub. 17, Your Federal Income Tax for Individuals, which features details on tax-saving opportuni-ties, 2018 tax changes, and thousands of interactive links to help you find answers to your questions. View it online in HTML as a PDF, or download it to your mobile device as an eBook.

You may also be able to access tax law in-formation in your electronic filing software.

Getting tax forms and publications. Go to IRS.gov/Forms to view, download, or print all of the forms and publications you may need. You can also download and view popular tax publi-cations and instructions (including the 1040 in-structions) on mobile devices as an eBook at no charge. Or you can go to IRS.gov/OrderForms to place an order and have forms mailed to you within 10 business days.

Access your online account (Individual tax-payers only). Go to IRS.gov/Account to se-curely access information about your federal tax account.

View the amount you owe, pay online, or set up an online payment agreement.

Access your tax records online.

Review the past 24 months of your pay-ment history.

Go to IRS.gov/SecureAccess to review the required identity authentication process.

Using direct deposit. The fastest way to re-ceive a tax refund is to combine direct deposit and IRS e-file. Direct deposit securely and elec-tronically transfers your refund directly into your financial account. Eight in 10 taxpayers use di-rect deposit to receive their refund. IRS issues more than 90% of refunds in less than 21 days.

Refund timing for returns claiming certain credits. The IRS can’t issue refunds before mid-February 2019, for returns that claimed the earned income credit (EIC) or the additional child tax credit (ACTC). This applies to the en-

tire refund, not just the portion associated with these credits.

Getting a transcript or copy of a return. The quickest way to get a copy of your tax transcript is to go to IRS.gov/Transcripts. Click on either "Get Transcript Online" or "Get Transcript by Mail" to order a copy of your transcript. If you prefer, you can:

Order your transcript by calling 800-908-9946, or

Mail Form 4506-T or Form 4506T-EZ (both available on IRS.gov).

Using online tools to help prepare your re-turn. Go to IRS.gov/Tools for the following.

The Earned Income Tax Credit Assistant (IRS.gov/EICAssistant) determines if you are eligible for the EIC.

The Online EIN Application (IRS.gov/EIN) helps you get an employer identification number.

The IRS Withholding Calculator (IRS.gov/ W4App) estimates the amount you should have withheld from your paycheck for fed-eral income tax purposes and can help you perform a “paycheck checkup.”

The First Time Homebuyer Credit Account Look-up (IRS.gov/HomeBuyer) tool pro-vides information on your repayments and account balance.

The Sales Tax Deduction Calculator

(IRS.gov/SalesTax) figures the amount you can claim if you itemize deductions on Schedule A (Form 1040), choose not to claim state and local income taxes, and you didn’t save your receipts showing the sales tax you paid.

Resolving tax-related identity theft issues.

The IRS doesn’t initiate contact with tax-payers by email or telephone to request personal or financial information. This in-cludes any type of electronic communica-tion, such as text messages and social me-dia channels.

Go to IRS.gov/IDProtection for information.

If your SSN has been lost or stolen or you suspect you’re a victim of tax-related iden-tity theft, visit IRS.gov/ID to learn what steps you should take.

Checking on the status of a refund.

Go to IRS.gov/Refunds.

The IRS can’t issue refunds before mid-February 2019, for returns that claimed the EIC or the ACTC. This applies to the entire refund, not just the portion as-sociated with these credits.

Download the official IRS2Go app to your mobile device to check your refund status.

Call the automated refund hotline at 800-829-1954.

Making a tax payment. The IRS uses the lat-est encryption technology to ensure your elec-tronic payments are safe and secure. You can make electronic payments online, by phone, and from a mobile device using the IRS2Go app. Paying electronically is quick, easy, and faster than mailing in a check or money order.

Chapter 16How To Get Tax HelpPage 89

Go to IRS.gov/Payments to make a payment using any of the following options.

IRS Direct Pay: Pay your individual tax bill or estimated tax payment directly from your checking or savings account at no cost to you.

Debit or credit card: Choose an ap-proved payment processor to pay online, by phone, and by mobile device.

Electronic Funds Withdrawal: Offered only when filing your federal taxes using tax preparation software or through a tax professional.

Electronic Federal Tax Payment Sys-tem: Best option for businesses. Enroll-ment is required.

Check or money order: Mail your pay-ment to the address listed on the notice or instructions.

Cash: You may be able to pay your taxes at a participating retail store.

What if I can’t pay now? Go to IRS.gov/ Payments for more information about your op-tions.

Apply for an online payment agreement

(IRS.gov/OPA) to meet your tax obligation in monthly installments if you can’t pay your taxes in full today. Once you complete the online process, you will receive imme-diate notification of whether your agree-ment has been approved.

Use the Offer in Compromise Pre-Qualifier (IRS.gov/OIC) to see if you can settle your tax debt for less than the full amount you owe.

Checking the status of an amended return. Go to IRS.gov/WMAR to track the status of Form 1040X amended returns. Please note that it can take up to 3 weeks from the date you mailed your amended return for it show up in our system and processing it can take up to 16 weeks.

Understanding an IRS notice or letter. Go to IRS.gov/Notices to find additional information about responding to an IRS notice or letter.

Contacting your local IRS office. Keep in mind, many questions can be answered on IRS.gov without visiting an IRS Tax Assistance Center (TAC). Go to IRS.gov/LetUsHelp for the topics people ask about most. If you still need help, IRS TACs provide tax help when a tax is-sue can’t be handled online or by phone. All TACs now provide service by appointment so you’ll know in advance that you can get the

service you need without long wait times. Be-fore you visit, go to IRS.gov/TACLocator to find the nearest TAC, check hours, available serv-ices, and appointment options. Or, on the IRS2Go app, under the Stay Connected tab, choose the Contact Us option and click on “Lo-cal Offices.”

Watching IRS videos. The IRS Video portal (IRSVideos.gov) contains video and audio pre-sentations for individuals, small businesses, and tax professionals.

Getting tax information in other languages. For taxpayers whose native language isn’t Eng-lish, we have the following resources available. Taxpayers can find information on IRS.gov in the following languages.

Spanish (IRS.gov/Spanish).

Chinese (IRS.gov/Chinese).

Vietnamese (IRS.gov/Vietnamese).

Korean (IRS.gov/Korean).

Russian (IRS.gov/Russian).

The IRS TACs provide over-the-phone inter-preter service in over 170 languages, and the service is available free to taxpayers.

The Taxpayer Advocate Service (TAS) Is Here To Help You

What is the TAS?

TAS is an independent organization within the IRS that helps taxpayers and protects taxpayer rights. Their job is to ensure that every taxpayer is treated fairly and that you know and under-stand your rights under the Taxpayer Bill of Rights.

How Can You Learn About Your Taxpayer Rights?

The Taxpayer Bill of Rights describes 10 basic rights that all taxpayers have when dealing with

the IRS. Our Tax Toolkit at TaxpayerAdvocate.IRS.gov can help you un-derstand what these rights mean to you and how they apply. These are your rights. Know them. Use them.

What Can TAS Do For You?

TAS can help you resolve problems that you can’t resolve with the IRS. And their service is

free. If you qualify for their assistance, you will be assigned to one advocate who will work with you throughout the process and will do every-thing possible to resolve your issue. TAS can help you if:

Your problem is causing financial difficulty for you, your family, or your business,

You face (or your business is facing) an immediate threat of adverse action, or

You’ve tried repeatedly to contact the IRS but no one has responded, or the IRS hasn’t responded by the date promised.

How Can You Reach TAS?

TAS has offices in every state, the District of Columbia, and Puerto Rico. Your local advo-cate’s number is in your local directory and at TaxpayerAdvocate.IRS.gov/Contact-Us. You can also call us toll free at 877-777-4778.

How Else Does TAS Help Taxpayers?

TAS works to resolve large-scale problems that affect many taxpayers. If you know of one of these broad issues, please report it to them at IRS.gov/SAMS.

TAS also has a website, Tax Reform Changes, which shows you how the new tax law may change your future tax filings and helps you plan for these changes. The information is categorized by tax topic in the order of the IRS Form 1040. Go to TaxChanges.us for more in-formation.

Low Income Taxpayer Clinics (LITCs)

LITCs are independent from the IRS. LITCs represent individuals whose income is below a certain level and need to resolve tax problems with the IRS, such as audits, appeals, and tax collection disputes. In addition, clinics can pro-vide information about taxpayer rights and re-sponsibilities in different languages for individu-als who speak English as a second language. Services are offered for free or a small fee. To

find a clinic near you, visit TaxpayerAdvocate.IRS.gov/LITCmap or see IRS Publication 4134, Low Income Taxpayer Clinic List.

Page 90Chapter 16How To Get Tax Help

	To help us develop a more useful index, please let us know if you have ideas for index entries.

Index
	See “Comments and Suggestions” in the “Introduction” for the ways you can reach us.

A

Abandonment 56

Accounting method:

Accrual 6

Cash 6

Change in 8

Crop 8

Farm inventory 7

Accounting periods 5

Accrual method of accounting 6

Additional Medicare Tax withholding 82

Adjusted basis of assets 33

Agricultural activity codes, Schedule F 3

Agricultural program payments 10

Agricultural structure, defined 39

Alternative Depreciation System (ADS) 43, 45

Amortization:

Going into business 48

Reforestation expenses 48

Section 197 intangibles 49

Assessments:

By conservation district 29 Depreciable property 30

Assistance (See Tax help) Automobiles, depreciation 40

B

Bankruptcy 15 Barter income 17 Basis:

Involuntary conversion 34

Like-kind exchange 34

Partner's basis 36

Replacement property 72

Shareholder's basis 36

Basis of assets:

Adjusted basis 33

Allocating to several assets 32

Changed to business use 34

Constructing assets 31

Cost 31

Decreases 33

Depreciation 44

Exchanges:

Like-kind 34 Nontaxable 34 Partially nontaxable 34 Taxable 34

Gifts 35

Increases 33

Real property 31

Received for services 34

Uniform capitalization rules 32

Below-market loans 17

Books and records 3

Breeding fees 21

Business income limit, section 179 expense deduction 41

Business use of home 23

C

Canceled debt 15

Capital assets 51

Capital expenses 25

Car expenses 23

Cash method of accounting 6

Casualties and thefts:

Adjustments to basis 69

Casualty, defined 66

Disaster area losses 73

Leased property 70

Livestock 67

Reimbursement 69

Reporting gains and losses 74

Theft, defined 67

Certified professional employer organizations 79

Change in accounting method 8

Chickens, purchased 24

Christmas trees 26, 54

Club dues 26

Comments on publication 2

Commodity:

Futures 52

Wages 82

Commodity Credit Corporation (CCC):

Loans 11

Market gain 11

Community property 76 Computer, software 38 Condemnation 66, 70 Conservation:

Cost-sharing exclusion 29 District assessments 29 Expenses 29 Plans 28

Conservation Reserve Program 77

Conservation Reserve Program (CRP) 11

Constructing assets 31 Constructive receipt of income 6 Contamination 71 Converted wetland 54

Cooperatives, income from 13

Cost-sharing exclusion 12

Credits:

Employment 21

Fuel tax 17, 86

Social security and Medicare 75

Social security coverage 75

State unemployment tax 84

Crew leaders 81

Crop:

Destroyed 72

Insurance proceeds 11

Method of accounting 8

Shares 10

Unharvested 26, 58, 77

Cropland, highly erodible 54

D

Damage:

Casualties and thefts 66 Crop insurance 11

Tree seedlings 71

Debt:

Bad 51

Canceled 15, 33, 56, 57 Nonrecourse 56 Qualified farm 16 Recourse 56

Depletion 47

Depreciation 42

ADS election 45 Conservation assets 29 Deduction 37

Incorrect amount deducted 39

Limit for automobiles 40

Listed property 46 Raised livestock 37 Recapture 46, 58, 59 When to file 39

Depreciation allowable 38

Depreciation allowed 38

Disaster area losses 73

Disaster payments 11

Disaster relief grants 73

Disaster relief payments 73

Disposition of installment obligation 63

Dispositions 30, 31, 57

Domestic production activities deduction 25

Drainage tile 29

Dyed diesel fuel 85

Dyed kerosene 85

E

Easement 17, 33

e-file 3

Election:

ADS depreciation 43, 45

Amortization:

Business start-up costs 48 Reforestation costs 48

Crop method 24

Cutting of timber 54

Deducting conservation

expenses 30

Not excluding cost-sharing payments 13

Out of installment method 61

Postponing casualty gain 71

Postponing reporting crop

insurance proceeds 12 Section 179 expense

deduction 42 Electronic filing 3 Embryo transplants 32

Employer identification number 3, 81

Endangered species recovery expenses 29

Environmental contamination 71

Estimated tax:

Farm gross income 88 Gross income 87 Penalties 89

Exchanges:

Basis:

Like-kind 34

Nontaxable 34

Partially nontaxable 34 Taxable 34

Like-kind 49

Nontaxable 49

Excise taxes:

Credit 86

Diesel fuel 85

Farming purposes 85

Home use of fuels 86

Off-highway uses 86

Refund 86

F

Fair market value (FMV) 64 Fair market value defined 31

Family member: Business expenses 7 Like-kind exchange 50 Loss on sale or exchange of

property 26

Personal-use property 68

Social security coverage 81

Farm:

Business, defined 28

Business expenses 19

Defined 28, 85

Income averaging 18

Rental 28

Sale of 55

Farmer 76

Federal unemployment tax (FUTA) 84

Fertilizer 13, 21

Figuring installment sale income:

Adjusted basis 61

Adjusted basis and installment sale income (gain on sale) 61

Adjusted basis for installment sale purposes 61

Amount to report as installment sale income 61

Cancellation 61 Contract price 61 Depreciation recapture 61 Disposition of installment

obligation 61

Figuring adjusted basis and

gross profit percentage for installment sale purposes 61

Form 6252 61

Gross profit 61

Gross profit percentage 61 Interest income 61

Sale of depreciable property 61

Selling expenses 61

Selling price 61

Selling price reduced 61 Transfer due to death 61

Foreclosure 56 Forestation costs 26 Form:

1099-A 11, 57

1099-C 15, 57

1099-G 11, 13

1099-MISC 3, 83

1099-PATR 13

1128 5

Publication 225 (2018)Page 91

2210-F 89

3115 8

4136 86

4562 39

4797 9, 13, 50

4835 10

5213 28

8822 3

8824 50

8849 86

8886 3

940. 84

943. 83

982. 17 I-9 81 SS-4 3, 81 SS-5 75

T (Timber) 48 W-2 83 W-4 3, 81, 83 W-4V 11, 12 W-7 75

Fuel tax credit or refund 17, 86

G

Gains:

Section 1231 gains 65

Gains and losses: Basis of assets 31 Capital assets, defined 51 Casualty 67, 70 Installment sales 60 Livestock 53

Long- or short-term 51 Ordinary or capital 51 Sale of farm 55 Section 1231 57 Theft 67, 70 Timber 54

General asset accounts 46 Gifts 10, 26, 35, 52 Going into business 48 Grants, disaster relief 73

H

Health insurance deduction 22

Hedging 52

Highway use tax 22

Holding period 51

Home 65

Horticultural structure 40

I

Identity theft 89

Illegal irrigation subsidy 17 Important dates 80 Improvements 12 Income:

Accounting for 5

Accrual method of accounting 6

Canceled debt excluded 15

From farming 8, 30, 88

Gross 87

Not-for-profit farming 27

Pasture 10

Schedule F 8

Withholding of tax 82

Income averaging (See Farm:

Income averaging)

Incorrect amount of depreciation deducted 39

Page 92

Individual taxpayer identification number (ITIN) 75

Inherited property 36 Insolvency 15 Installment method:

Electing out of the installment method 61

Inventory (See More information) Revoking the election (See More

information) Sale at a loss 61 When to elect out 61

Installment sales:

Electing out 61

Example 65

Farm, sale of 61

Installment obligation 60

Related parties 61

Unstated interest 65

Insurance 22 Intangible property 49 Interest:

Expense 21

Inventory:

Items included 7 Methods of valuation 7

Involuntary conversions 46, 66

Irrigation:

Illegal subsidy 17

Project 70

L

Labor hired 20

Landlord participation 77 Lease or purchase 22

Life tenant (See Term interests) Like-kind exchanges 34, 49 Lime 21

Limited liability company (LLC) 3

Limits:

At-risk 27

Business use of home 23 Capital losses 52 Conservation expenses 30 Depreciation:

Business-use 47 Excluded farm debt 16 Farm losses 27 Loss of personal-use

property 69

Not-for-profit farming 27

Passive activity 27

Percentage depletion 48

Prepaid farm supplies 19

Reforestation costs 48

Section 179 expense deduction:

Automobile 40 Business income 41 Dollar 40

Time to keep records 5

Listed property:

Defined 46

Passenger automobile 47

Rules 46

Livestock 58

Casualty and theft losses 67 Crop shares 10 Depreciation 37 Diseased 71

Feed assistance 12 Immature 38 Losses 26, 53

Purchased 54

Raised 54

Sale of 9, 53

Unit-livestock-price, inventory valuation 7

Used in a farm business 53 Weather-related sales 9, 71

Loans 11, 24

Losses:

At-risk limits 27

Casualty 66

Disaster areas 73

Farming 67

Growing crops 26

Hobby farming 27

Livestock 53, 71

Nondeductible 26

Theft 66

Lost income payments 76 Lost property 67

M

MACRS property:

Involuntary conversion 46

Like-kind exchange 46

Nontaxable transfer 46

Market gain, reporting 11 Marketing quota penalties 24 Material participation 77 Meals 24

Membership fees 26 Methods of accounting 5

Modified ACRS (MACRS): ADS election 45 Conventions 44 Depreciation methods 44 Exchange 46

Figuring the deduction 45

Involuntary conversion 46

Nontaxable transfer 46

Percentage tables 45

Property classes 43

Recovery periods 44

N

National Center for Missing & Exploited Children 3

New hire reporting 81

Noncapital asset 52

Nontaxable exchanges 49

Nontaxable transfer of MACRS property 46

Not-for-profit farming 27

O

Organizational costs 25

P

Partners, limited 76 Partners, retired 77 Partners, spouses 76 Partnership 76 Passenger automobile 47 Pasture income 10 Patronage dividends 14

Payments considered received:

Bond 63

Buyer assumes mortgage 63 Buyer assumes other debts 63

Buyer pays seller’s

expenses 63

Buyer’s note 63

Debt not payable on demand 63

Mortgage less than basis 63

Mortgage more than basis 63

Property used as a payment 63

Sale to a related person 63

Third-party note 63

Trading property for like-kind property 63

Payments received 63

Penalties:

Estimated tax 89

Returns 89

Trust fund recovery 83

Personal expenses 26

Per-unit retain certificates 14

Placed in service 38, 43

Postponing casualty gain 71

Prepaid expense:

Advance premiums 22

Extends useful life 6

Farm supplies 19

Livestock feed 20

Prizes 17

Produce 9

Property:

Changed to business use 34 Received for services 34 Repairs and improvements 39 Section 1231 57 Section 1245 58

Section 1250 59

Section 1252 60

Section 1255 60 Tangible personal 39

Property used as a payment:

Examples 64

Exception 64

Publications (See Tax help)

Q

Qualified disaster relief payments 73

Qualified farm debt 16 Qualified joint venture 76

Qualified small business payroll tax credit for increasing research activities 79

R

Recapture:

Amortization 59 Basis reductions 16 Certain depreciation 17 Cost-sharing payments 13 Depreciation 46, 58 Section 1245 property 58 Section 1250 property 59 Section 179 expense

deduction 42 Section 179 GO Zone

property 42 Special depreciation allowance 43

Recordkeeping 3, 24

Records on depreciable property 58

Reforestation costs 26, 48

Refund:

Deduction taken 17

Publication 225 (2018)

Fuel tax 17, 87

Listed property

46

Soil:

Theft losses

66

Conservation

29

64

Reimbursements:

Qualifying property 39

Third-party note

Casualties and thefts 33, 66, 69

Recapture

42

Contamination

Timber 25, 47, 54

71

Deduction taken

17

Self-employed

health

Special depreciation

allowance:

Trade-in

35

Expenses 19

insurance

22

How to elect not to claim 43

23

Travel expenses

12

Self-employed

Recapture 43

Truck expenses

Feed assistance

health insurance

23

Real estate taxes

deduction

77

rate 23

31

Standard mileage

Trust fund recovery penalty 83

48

Self-employment

tax:

25

Reforestation expenses

Start-up costs for businesses

To employees

24

Community property

76

Suggestions for publication

2

U

Related parties

Deduction

79

61

Related persons

7

, 26, 34, 50, 71

How to pay

75

Uniform capitalization rules:

T

Rental income

10

77

Basis of assets

32

Landlord participation

Rented property,

Material participation

Tangible personal property

39

Inventory 7

77

improvements 39

Maximum net earnings

Taxes:

74

Repairs 21

Methods for figuring net

Credits and Refunds 84

W

Repairs

and

improvements 39

earnings 77

Federal use 22

Repayment of income

6

78

General 22

Wages and salaries 77

Optional method

Replacement:

Regular method

78

74

Water conservation

Self-employment

29

Period

72

Rental income

77

State and federal

22

Water well 29, 44

Property

71

Reporting

79

22

State and local general sales

Weather-related sales,

Reportable

transactions.

3

Self-employment tax rate

74

Withholding 82

livestock

9, 71

Repossessions

56

Share farming

75

49

Withholding:

Tax-free exchanges

Right-of-way income

17

Who must pay

75

63

Tax help 89

Income tax

82

Selling price reduced

and Medicare

Tax preparation fees 24

Social security

Settlement costs (fees)

31

Tax shelter:

tax 82

S

At-risk limits 27

Social security and Medicare:

Sale of home 55

Credits of coverage

75

Defined 7

Section 179

Withholding of tax 82

Telephone

expense

23

expense

75

deduction

39

24

Social security number

Tenant house expenses

How to elect

Software, computer 38

Term interests 38

42

Publication 225 (2018)Page 93

IRS Releases Publication 225 (2018), Farmer's Tax Guide