Repairs and Maintenance

You can deduct most expenses for the repair and maintenance of your farm property. Common items of repair and maintenance are repainting, replacing shingles and supports on farm buildings, and minor overhauls of trucks, tractors, and other farm machinery. However, repairs to, or overhauls of, depreciable property that substantially prolong the life of the property, increase its value, or adapt it to a different use are capital expenses. For example, if you repair the barn roof, the cost is deductible. But if you replace the roof, it is a capital expense. For more information, see Capital Expenses, later.

Interest

You can deduct as a farm business expense interest paid on farm mortgages and other obligations you incur in your farm business.

Cash method.   If you use the cash method of accounting, you can generally deduct interest paid during the tax year. You cannot deduct interest paid with funds received from the original lender through another loan, advance, or other arrangement similar to a loan. You can, however, deduct the interest when you start making payments on the new loan.

Prepaid interest.   Under the cash method, you generally cannot deduct any interest paid before 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 cannot 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 3.

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 disbursements to specific uses.

The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other funds.

Secured loan.   The allocation of loan proceeds 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.

If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. For more information, see Publication 936.

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 interest, see chapter 5 in Publication 535.

Breeding Fees

You can deduct breeding fees as a farm business expense. However, if you use an accrual method of accounting, you must capitalize breeding fees and allocate them to the cost basis of the calf, foal, etc. For more information on who must use an accrual method of accounting, see Accrual method required under Accounting Methods in chapter 3.

Fertilizer and Lime

You can deduct in the year paid or incurred the cost of fertilizer, lime, and other materials applied to farm land to enrich, neutralize, or condition it. You can also deduct the cost of applying these materials in the year you pay or incur it. However, see Prepaid Farm Supplies, earlier, for a rule that may limit your deduction for these materials.

If the benefits of the fertilizer, lime, or other materials last substantially more than one year, you generally must 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, it can only be changed with IRS approval.

Farm land is land used for producing crops, fruits, or other agricultural products or for sustaining livestock. It does not include land you have never used previously for producing crops or sustaining livestock. You cannot 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 4.

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, farm land, 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 federal unemployment tax you pay. For information on employment taxes, see chapter 16.

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, allocate the taxes between the farm assets and nonbusiness assets. The allocation can be done from the assessed valuations. If your tax statement does not show the assessed valuations, you can usually get them from the tax assessor.

State and local general sales taxes.   State and local general sales taxes on nondepreciable 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 business as part of the cost you depreciate. Also treat the taxes as part of your cost if they are imposed on the seller and passed on to you.

State and federal income taxes.   Individuals cannot deduct state and federal income taxes as farm business expenses. Individuals can deduct state income tax only as an itemized deduction on Schedule A (Form 1040). You cannot deduct federal income tax.

Highway use tax.   You can deduct the federal use tax on highway motor vehicles paid on a truck or truck tractor used in your farm business. For information on the tax itself, including information on vehicles subject to the tax, see the instructions for Form 2290, Heavy Highway Vehicle Use Tax Return.

Self-employment tax deduction.   You can deduct one-half of your self-employment tax in figuring your adjusted gross income on Form 1040. For more information, see chapter 15.

Insurance

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

1. Fire, storm, crop, theft, liability, and other insurance on farm business assets.
2. Health and accident insurance on your farm employees.
3. Workers' compensation insurance set by state law that covers any claims for job-related bodily injuries or diseases suffered by employees on your farm, regardless of fault.
4. Business interruption insurance.
5. State unemployment insurance on your farm employees (deductible as taxes if they are considered taxes under state law).

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

Example.   On June 28, 2002, 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, 2002. Only the cost for the 6 months in 2002 is deductible as an insurance expense on your 2002 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 2003 and 2004, deduct $1,000 (12/36 of $3,000). Deduct the remaining $500 in 2005. Had the policy been effective on January 1, 2002, the deductible expense would have been $1,000 for each of the years 2002, 2003, and 2004, based on one-third of the premium used each year.

Business interruption insurance.   Use and occupancy and business interruption insurance premiums are deductible as a business expense. This insurance pays for lost profits if your business is shut down due to a fire or other cause. Report any proceeds in full in Part I of Schedule F.

Self-employed health insurance deduction.   If you are self-employed, you can deduct, in figuring your adjusted gross income on your 2002 Form 1040, 70% of your payments for health insurance coverage for yourself, your spouse, and your dependents. Generally, this deduction cannot be more than the net profit from the business under which the plan was established.

The deductible percentage of health insurance coverage increases to 100% for 2003.

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

Use the Self-Employed Health Insurance Deduction Worksheet in the Form 1040 instructions to figure your deduction. Include the remaining part of the insurance payment in your medical expenses on Schedule A (Form 1040) if you itemize your deductions.

For more information, see Deductible Premiums in chapter 7 of Publication 535.

Rent and Leasing

If you lease property for use in your farm business, you can generally deduct the rent you pay on Schedule F. However, you cannot deduct rent you pay in crop shares because you deduct the cost of raising the crops as farm expenses.

Advance payments.   Deduct advance payments of rent only in the year to which they apply, regardless of your accounting method.

Farm home.   If you rent a farm, do not 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 do not represent 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.

Example.   You lease new farm equipment from a dealer who both sells and leases. The agreement includes an option to purchase the equipment for a specified price. The lease payments and the specified option price equal the sales price of the equipment plus interest. Under 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 cannot deduct any of the lease payments as rent. You can deduct interest, repairs, insurance, depreciation, and other expenses related to the equipment.

Conditional sales contract.   Whether an agreement is a conditional sales contract depends 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 payment toward an equity interest you will receive.
• You get title to the property after you make a stated amount of required payments.
• The amount you must pay to use the property 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 option. 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 agreement.
• The agreement designates part of the payments as interest, or part of the payments can be easily recognized as interest.

Leveraged leases.   Special rules apply to leveraged leases of equipment (arrangements in which the equipment is financed by a nonrecourse loan from a third party). For more information, see chapter 4 of Publication 535 and the following revenue procedures.

• Revenue Procedure 2001-28 in Internal Revenue Bulletin 2001-19.
• Revenue Procedure 2001-29 in Internal Revenue Bulletin 2001-19.

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 adjustment clause, treat the agreement as a lease if the agreement otherwise qualifies as a lease. For more information, see section 7701(h) of the Internal Revenue Code.

Depreciation

If property you acquire to use in your farm business is expected to last more than one year, you generally cannot 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 deduct part or all of the cost of certain qualifying property, up to a limit, as a section 179 deduction in the year you place it in service.

Depreciation, amortization, and the section 179 deduction are discussed in chapter 8.

Business Use of Your Home

You can deduct expenses for the business use of your home if you use part of your home exclusively 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 is not attached to your home.

Your home office will qualify as your principal place of business for deducting expenses for its use if you meet both of the following requirements.

• 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.

Deduction limit.   If your gross income from farming equals or exceeds your total farm expenses (including expenses for the business use of your home) you can deduct all your farm expenses. But if your gross income from farming 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 depreciation (with depreciation taken last), cannot be more than the gross income from farming minus the following expenses.

• The business part of expenses you could deduct even if you did not use your home for business (such as deductible mortgage interest, 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, do not include your deduction for half of your self-employment tax.

You can carry over to your next tax year deductions over the current year's limit. They are subject to the deduction limit for the next tax year.

More information.   See Publication 587 for more information on deducting expenses for the business use of your home.

Telephone expense.   You cannot 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-distance phone calls on that line, as well as the cost of a second line into your home used exclusively for your farm business, are deductible business expenses.

Truck and Car Expenses

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

Standard mileage rate.   Instead of using actual costs, under certain conditions you can use the standard mileage rate. For 2002, the rate is 36½ cents a mile for all business miles driven. You can use the standard mileage rate for a car or a light truck, such as a van, pickup, or panel truck, you own or lease.

You cannot use the standard mileage rate if you operate two or more cars or light trucks at the same time. You are not using two or more vehicles at the same time if you alternate using the vehicles (you use them at different times) for business.

Example.   Maureen owns a car and a pickup truck that are both used in her farm business. Her farm employees use the truck and she uses the car for business. Maureen cannot use the standard mileage rate for the car or the truck. This is because both vehicles are used in Maureen's farm business at the same time. She must use actual expenses for both vehicles.

Business use percentage.   You can claim 75% of the use of a car or light truck as business use without any records if you used the vehicle during most of the normal business day directly in connection with the business of farming. If you choose this method of substantiating business use, 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, 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 requirements under Travel Expenses, later.

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

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