Publication 225 |
2008 Tax Year |
9.
Dispositions of Property Used in Farming
When you dispose of property used in your farm business, your taxable gain or loss is usually treated as ordinary income (which
is taxed at the same rates as wages and interest income) or capital gain (which is generally taxed at lower rates) under the
rules for section 1231 transactions.
When you dispose of depreciable property (section 1245 property or section 1250 property) at a gain, you may have to recognize
all or part of the gain as ordinary income under the depreciation recapture rules. Any gain remaining after applying the depreciation
recapture rules is a section 1231 gain, which may be taxed as a capital gain.
Gains and losses from property used in farming are reported on Form 4797, Sales of Business Property. Table 9-1 contains examples of items reported on Form 4797 and refers to the part of that form on which they first should be reported.
Topics - This chapter discusses:
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Section 1231 Gains and Losses
Section 1231 gains and losses are the taxable gains and losses from section 1231 transactions (explained below). Their treatment
as ordinary or capital gains depends on whether you have a net gain or a net loss from all of your section 1231 transactions
in the tax year.
Table 9-1. Where to First Report Certain Items on Form 4797
Type of property |
Held 1 year or less |
Held more than 1 year |
1 |
Depreciable trade or business property: |
|
|
|
a Sold or exchanged at a gain
|
Part II |
Part III (1245, 1250) |
|
b Sold or exchanged at a loss
|
Part II |
Part I |
2 |
Farmland held less than 10 years for which soil, water, or land clearing expenses were deducted: |
|
|
|
a Sold at a gain
|
Part II |
Part III (1252) |
|
b Sold at a loss
|
Part II |
Part I |
3 |
All other farmland |
Part II |
Part I |
4 |
Disposition of cost-sharing payment property described in section 126 |
Part II |
Part III (1255) |
5 |
Cattle and horses used in a trade or business for draft, breeding, dairy, or sporting purposes: |
Held less than 24 mos. |
Held 24 mos. or more |
|
a Sold at a gain
|
Part II |
Part III (1245) |
|
b Sold at a loss
|
Part II |
Part I |
|
c Raised cattle and horses sold at a gain
|
Part II |
Part I |
6 |
Livestock other than cattle and horses used in a trade or business for draft, breeding, dairy, or sporting purposes: |
Held less than 12 mos. |
Held 12 mos. or more |
|
a Sold at a gain
|
Part II |
Part III (1245) |
|
b Sold at a loss
|
Part II |
Part I |
|
c Raised livestock sold at a gain
|
Part II |
Part I |
If you have a gain from a section 1231 transaction, first determine whether any of the gain is ordinary income under the depreciation
recapture rules (explained later). Do not take that gain into account as section 1231 gain.
Section 1231 transactions.
Gain or loss on the following transactions is subject to section 1231 treatment.
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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.
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Sale or exchange of other livestock. This livestock must be held for draft, breeding, dairy, or sporting purposes and held for 12 months or longer. Other livestock
includes hogs, mules, sheep, goats, donkeys, and other fur-bearing animals, but does not include poultry.
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Sale or exchange of depreciable 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. Examples of depreciable personal property include farm machinery
and trucks. It also includes amortizable section 197 intangibles.
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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).
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Sale or exchange of unharvested crops.
The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person, and the land
must have been held longer than 1 year. You cannot keep any right or option to reacquire the land directly or indirectly (other
than a right customarily incident to a mortgage or other security transaction). Growing crops sold with a leasehold on the
land, even if sold to the same person in a single transaction, are not included.
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Distributive share of partnership gains and losses. Your distributive share must be from the sale or exchange of property listed earlier and held longer than 1 year (or for the
required period for certain livestock).
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Cutting or disposal of timber. You must treat the cutting or disposal of timber as a sale, as described in chapter 8 under Timber.
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Condemnation. The condemned property (defined in chapter 11) must have been held longer than 1 year. It must be business property or a capital
asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. It
cannot be property held for personal use.
-
Casualty or theft. The casualty or theft must have affected business property, property held for the production of rents or royalties, or investment
property (such as notes and bonds). You must have held the property longer than 1 year. However, if your casualty or theft
losses are more than your casualty or theft gains, neither the gains nor the losses are taken into account in the section
1231 computation. Section 1231 does not apply to personal casualty gains and losses. See chapter 11 for information on how
to treat those gains and losses.
If the property is not held for the required holding period, the transaction is not subject to section 1231 treatment. Any
gain or loss is ordinary income reported in Part II of Form 4797. See Table 9-1.
Property for sale to customers.
A sale, exchange, or involuntary conversion of property held mainly for sale to customers is not a section 1231 transaction.
If you will get back all, or nearly all, of your investment in the property by selling it rather than by using it up in your
business, it is property held mainly for sale to customers.
Treatment as ordinary or capital.
To determine the treatment of section 1231 gains and losses, combine all of your section 1231 gains and losses for
the year.
-
If you have a net section 1231 loss, it is an ordinary loss.
-
If you have a net section 1231 gain, it is ordinary income up to your nonrecaptured section 1231 losses from previous years,
explained next. The rest, if any, is long-term capital gain.
Nonrecaptured section 1231 losses.
Your nonrecaptured section 1231 losses are your net section 1231 losses for the previous 5 years that have not been
applied against a net section 1231 gain by treating the gain as ordinary income. These losses are applied against your net
section 1231 gain beginning with the earliest loss in the 5-year period.
Example.
In 2008, Ben has a $2,000 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 2003 through 2007 he
had the following section 1231 gains and losses.
Ben uses this information to figure how to report his net section 1231 gain for 2008 as shown below.
His remaining net section 1231 loss from 2005 is completely recaptured in 2008.
If you dispose of depreciable or amortizable property at a gain, you may have to treat all or part of the gain (even if it
is otherwise nontaxable) as ordinary income.
To figure any gain that must be reported as ordinary income, you must keep permanent records of the facts necessary to figure
the depreciation or amortization allowed or allowable on your property. For more information, see chapter 3 of Publication
544.
A gain on the disposition of section 1245 property is treated as ordinary income to the extent of depreciation allowed or
allowable.
Any recognized gain that is more than the part that is ordinary income because of depreciation is a section 1231 gain. See
Treatment as ordinary or capital under Section 1231 Gains and Losses, earlier.
Section 1245 property includes any property that is or has been subject to an allowance for depreciation or amortization and
that is any of the following types of property.
-
Personal property (either tangible or intangible).
-
Other tangible property (except buildings and their structural components) used as any of the following. See Buildings and structural components below.
-
An integral part of manufacturing, production, or extraction, or of furnishing transportation, communications, electricity,
gas, water, or sewage disposal services.
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A research facility in any of the activities in (a).
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A facility in any of the activities in (a) for the bulk storage of fungible commodities (discussed later).
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That part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following.
-
Amortization of certified pollution control facilities.
-
The section 179 expense deduction.
-
Deduction for clean-fuel vehicles and certain refueling property placed in service before 2006.
-
Certain expenditures for child care facilities. (Repealed by Public Law 101-58, Omnibus Budget Reconciliation Act of 1990,
section 11801(a)(13) except with regards to deductions made prior to November 5, 1990.)
-
Expenditures to remove architectural and transportation barriers to the handicapped and elderly.
-
Certain reforestation expenditures.
-
Single purpose agricultural (livestock) or horticultural structures.
-
Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary product
of petroleum.
See Chapter 3 of Publication 544 for more details.
Buildings and structural components.
Section 1245 property does not include buildings and structural components. The term building includes a house, barn,
warehouse, or garage. The term structural component includes walls, floors, windows, doors, central air conditioning systems,
light fixtures, etc.
Do not treat a structure that is essentially machinery or equipment as a building or structural component. Also, do
not treat a structure that houses property used as an integral part of an activity as a building or structural component if
the structure's use is so closely related to the property's use that the structure can be expected to be replaced when the
property it initially houses is replaced.
The fact that the structure is specially designed to withstand the stress and other demands of the property and cannot
be used economically for other purposes indicates it is closely related to the use of the property it houses. Structures such
as oil and gas storage tanks, grain storage bins, and silos are not treated as buildings, but as section 1245 property.
Facility for bulk storage of fungible commodities.
This is a facility used mainly for the bulk storage of fungible commodities. Bulk storage means storage of a commodity
in a large mass before it is used. For example, if a facility is used to store sorted and boxed oranges (the oranges are no
longer in a large mass), it is not used for bulk storage. To be fungible, a commodity must be such that one part may be used
in place of another.
Gain Treated as Ordinary Income
The gain treated as ordinary income on the sale, exchange, or involuntary conversion of section 1245 property, including a
sale and leaseback transaction, is the lesser of the following amounts.
-
The depreciation (which includes any section 179 deduction claimed) and amortization allowed or allowable on the property.
-
The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property).
For any other disposition of section 1245 property, ordinary income is the lesser of (1) above or the amount by which its
fair market value is more than its adjusted basis. For details, see chapter 3 of Publication 544.
Use Part III of Form 4797 to figure the ordinary income part of the gain.
Depreciation claimed on other property or claimed by other taxpayers.
Depreciation and amortization include the amounts you claimed on the section 1245 property as well as the following
depreciation and amortization amounts.
-
Amounts you claimed on property you exchanged for, or converted to, your section 1245 property in a like-kind exchange or
involuntary conversion. For details on exchanges of property that are not taxable, see Like-Kind Exchanges in chapter 8.
-
Amounts a previous owner of the section 1245 property claimed if your basis is determined with reference to that person's
adjusted basis (for example, the donor's depreciation deductions on property you received as a gift).
Example.
Jeff Free paid $120,000 for a tractor in 2006. On February 23, 2008, he traded it for a chopper and paid an additional $30,000.
To figure his depreciation deduction for the current year, Jeff continues to use the basis of the tractor as he would have
before the trade to depreciate the chopper. Jeff can also depreciate the additional $30,000 basis on the chopper.
Depreciation and amortization.
Depreciation and amortization deductions that must be recaptured as ordinary income include (but are not limited to)
the following items.
-
Ordinary depreciation deductions.
-
Section 179 deduction (see chapter 7).
-
Any special depreciation allowance.
-
Amortization deductions for all the following costs.
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Acquiring a lease.
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Lessee improvements.
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Pollution control facilities.
-
Reforestation expenses.
-
Section 197 intangibles.
-
Childcare facility expenses incurred before 1982.
-
Franchises, trademarks, and trade names acquired before August 11, 1993.
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Deductions for all the following costs.
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Removing barriers to the disabled and the elderly.
-
Tertiary injectant expenses.
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Depreciable clean-fuel vehicles and refueling property (minus any recaptured deduction).
-
Any basis reduction for the investment credit (minus any basis increase for a credit recapture).
-
Any basis reduction for the qualified electric vehicle credit (minus any basis increase for a credit recapture).
Example.
You file your returns on a calendar year basis. In February 2006, you bought and placed in service for 100% use in your farming
business a light-duty truck (5-year property) that cost $10,000. You used the half-year convention and your MACRS deductions
for the truck were $1,500 in 2006 and $2,550 in 2007. You did not claim the section 179 expense deduction for the truck. You
sold it in May 2008 for $7,000. The MACRS deduction in 2008, the year of sale, is $893 (½ of $1,785). Figure the gain treated
as ordinary income as follows.
Depreciation allowed or allowable.
You generally use the greater of the depreciation allowed or allowable when figuring the part of gain to report as
ordinary income. If, in prior years, you have consistently taken proper deductions under one method, the amount allowed for
your prior years will not be increased even though a greater amount would have been allowed under another proper method. If
you did not take any deduction at all for depreciation, your adjustments to basis for depreciation allowable are figured by
using the straight line method. This treatment applies only when figuring what part of the gain is treated as ordinary income
under the rules for section 1245 depreciation recapture.
Disposition of plants and animals.
If you elect not to use the uniform capitalization rules (see chapter 6), you must treat any plant you produce as
section 1245 property. If you have a gain on the property's disposition, you must recapture the preproductive expenses you
would have capitalized if you had not made the election by treating the gain, up to the amount of these expenses, as ordinary
income. For section 1231 transactions, show these expenses as depreciation on Form 4797, Part III, line 22. For plant sales
that are reported on Schedule F (1040), Profit or Loss From Farming, this recapture rule does not change the reporting of
income because the gain is already ordinary income. You can use the farm-price method or the unit-livestock-price method discussed
in chapter 2 to figure these expenses.
Example.
Janet Maple sold her apple orchard in 2008 for $80,000. Her adjusted basis at the time of sale was $60,000. She bought the
orchard in 2001, but the trees did not produce a crop until 2004. Her pre-productive expenses were $6,000. She elected not
to use the uniform capitalization rules. Janet must treat $6,000 of the gain as ordinary income.
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 a leasehold of land or section 1250 property subject to an allowance for depreciation. A fee simple
interest in land is not section 1250 property because, like land, it is not depreciable.
Gain on the disposition of section 1250 property is treated as ordinary income to the extent of additional depreciation allowed
or allowable. To determine the additional depreciation on section 1250 property, see Depreciation Recapture in chapter 3 of Publication 544.
You will not have additional depreciation if any of the following apply to the property disposed of.
-
You figured depreciation for the property using the straight line method or any other method that does not result in depreciation
that is more than the amount figured by the straight line method and you have held the property longer than 1 year.
-
You chose the alternate ACRS (straight line) method for the property, which was a type of 15-, 18-, or 19-year real property
covered by the section 1250 rules.
-
The property was nonresidential real property placed in service after 1986 (or after July 31, 1986, if the choice to use MACRS
was made) and you held it longer than 1 year. These properties are depreciated using the straight line method.
If you report the sale of property under the installment method, any depreciation recapture under section 1245 or 1250 is
taxable as ordinary income in the year of sale. This applies even if no payments are received in that year. If the gain is
more than the depreciation recapture income, report the rest of the gain using the rules of the installment method. For this
purpose, include the recapture income in your installment sale basis to determine your gross profit on the installment sale.
If you dispose of more than one asset in a single transaction, you must separately figure the gain on each asset so that it
may be properly reported. To do this, allocate the selling price and the payments you receive in the year of sale to each
asset. Report any depreciation recapture income in the year of sale before using the installment method for any remaining
gain.
For more information on installment sales, see chapter 10.
Chapter 3 of Publication 544 discusses the tax treatment of the following transfers of depreciable property.
Publication 544 also explains how to handle a single transaction involving multiple properties.
This section discusses gain on the disposition of farmland for which you were allowed either of the following.
Section 1252 property.
If you disposed of farmland you held more than 1 year and less than 10 years at a gain and you were allowed deductions
for soil and water conservation expenses for the land, as discussed in chapter 5, you must treat part of the gain as ordinary
income and treat the balance as section 1231 gain.
Exceptions.
Do not treat gain on the following transactions as gain on section 1252 property.
For more information, see Regulations section 1.1252-2.
Amount to report as ordinary income.
You report as ordinary income the lesser of the following amounts.
-
Your gain (determined by subtracting the adjusted basis from the amount realized from a sale, exchange, or involuntary conversion,
or the fair market value for all other dispositions).
-
The total deductions allowed for soil and water conservation expenses multiplied by the applicable percentage, discussed next.
Applicable percentage.
The applicable percentage is based on the length of time you held the land. If you dispose of your farmland within
5 years after the date you acquired it, the percentage is 100%. If you dispose of the land within the 6th through 9th year
after you acquired it, the applicable percentage is reduced by 20% a year for each year or part of a year you hold the land
after the 5th year. If you dispose of the land 10 or more years after you acquired it, the percentage is 0%, and the entire
gain is a section 1231 gain.
Example.
You acquired farmland on January 19, 2001. On October 3, 2008, you sold the land at a $30,000 gain. Between January 1 and
October 3, 2008, you incur soil and water conservation expenditures of $15,000 for the land that are fully deductible in 2008.
The applicable percentage is 40% since you sold the land within the 8th year after you acquired it. You treat $6,000 (40%
of $15,000) of the $30,000 gain as ordinary income and the $24,000 balance as a section 1231 gain.
Section 1255 property.
If you receive certain cost-sharing payments on property and you exclude those payments from income (as discussed
in chapter 3), you may have to treat part of any gain as ordinary income and treat the balance as a section 1231 gain. If
you chose not to exclude these payments, you will not have to recognize ordinary income under this provision.
Amount to report as ordinary income.
You report as ordinary income the lesser of the following amounts.
You do not report ordinary income under this rule to the extent the gain is recognized as ordinary income under sections 1231
through 1254, 1256, and 1257. However, you do report as ordinary income under this rule a gain or a part of a gain regardless
of any contrary provisions (including nonrecognition provisions) under any other section.
Applicable percentage.
The applicable percentage of the excluded cost-sharing payments to be reported as ordinary income is based on the
length of time you hold the property after receiving the payments. If the property is held less than 10 years after you receive
the payments, the percentage is 100%. After 10 years, the percentage is reduced by 10% a year, or part of a year, until the
rate is 0%.
Form 4797, Part III.
Use Form 4797, Part III, to figure the ordinary income part of a gain from the sale, exchange, or involuntary conversion
of section 1252 property and section 1255 property.
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