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 disposition 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 income from farming for that year as well.

Example.   In 2002, you have gross income of $16,000 from two farms. During the year, you incurred $5,300 of deductible soil and water conservation expenses for one of the farms. However, your deduction is limited to 25% of $16,000, or $4,000. The $1,300 excess ($5,300 - $4,000) is carried over to 2003 and added to deductible soil and water conservation expenses made in that year. The total of the 2002 carryover plus 2003 expenses is deductible in 2003, subject to the limit of 25% of your gross income from farming in 2003. Any expenses over the limit in that year are carried to 2004 and later years.

Net operating loss.   The deduction for soil and water conservation expenses is included when figuring a net operating loss (NOL) for the year. If the NOL is carried to another year, the soil and water conservation deduction included in the NOL is not subject to the 25% limit in the year to which it is carried.

Choosing To Deduct

You can choose to deduct soil and water conservation expenses on your tax return for the first year you pay or incur these expenses. If you choose to deduct them, you must deduct the total allowable amount in the year they are paid or incurred. If you do not choose to deduct the expenses, you must capitalize them.

Change of method.   If you want to change your method of treating 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 approval 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.

The request must include the following information.

• 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 conservation expenses or only to those for a particular project or farm. If the method or change of method does not apply to all your expenses, identify the project or farm to which the expenses apply.
• The total expenses you paid or incurred in the first tax year the method or change of method is to apply.
• A statement that you will account separately in your books for the expenses to which this method or change of method relates.

Sale of a Farm

If you sell your farm, you cannot adjust the basis of the land at the time of the sale for any unused carryover of soil and water conservation expenses (except for deductions of assessments for depreciable property, discussed earlier). However, if you acquire another farm and return to the business of farming, you can start taking deductions again for the unused carryovers.

Gain on sale of farm land.   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 specified percentage of the previous deductions. See Section 1252 property under Other Gains in chapter 11.

Basis of Assets

Introduction

Basis is the amount of your investment in property for tax purposes. Use the basis of property to figure the gain or loss on the sale, exchange, or other disposition of property. Also use it to figure depreciation, amortization, depletion, and casualty losses. If you use property for both business and personal purposes, you must allocate the basis based on the use. Only the basis allocated to the business use of the property can be depreciated.

Your original basis in property is adjusted (increased or decreased) by certain events. If you make improvements to the property, increase your basis. If you take deductions for depreciation or casualty losses, reduce your basis.

It is important to keep an accurate record of your basis. For information 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

Form (and Instructions)

• 706   United States Estate (and Generation-Skipping Transfer) Tax Return
• 706-A   United States Additional Estate Tax Return

See chapter 21 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 obligations, 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. Basis generally does not include interest payments unless you choose to capitalize them, as discussed in chapter 5 of Publication 535.

You also may have to capitalize (add to basis) certain other costs related to buying or producing property. Under the uniform capitalization 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 generally have unstated interest if your interest rate is less than the applicable federal rate. See the discussion of unstated interest in Publication 537, Installment 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 you pay are part of your cost basis in the property.

If you buy improvements, such as buildings, and the land on which they stand for a lump sum, allocate your cost basis between the land and improvements to figure the basis for depreciation of the improvements. Allocate the cost basis according to the respective fair market values of the land and improvements at the time of purchase.

Real estate taxes.   If you pay 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. You cannot deduct them as an expense.

If you reimburse the seller for taxes the seller paid for you, you usually can deduct that amount as an expense in the year of purchase. Do not include that amount in the basis of your property. If you did not reimburse the seller, you must reduce your basis by the amount of those taxes.

Settlement costs.   You can include in the basis of property you buy the settlement fees and closing costs that are for buying the property. (A fee for buying property is a cost that must be paid even if you bought the property for cash.) You cannot include fees and costs for getting a loan on the property.

The following items are some of the settlement fees or closing costs you can include in the basis of your property.

• Abstract fees (abstract of title fees).
• Charges for installing utility services.
• Legal fees (including title search and preparation of the sales contract and deed).
• Recording fees.
• Surveys.
• Transfer taxes.
• Owner's title insurance.
• Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.

Settlement costs do not include amounts placed in escrow for the future payment of items such as taxes and insurance.

The following items are some settlement fees and closing costs you cannot include in the basis of the property.

1. Casualty insurance premiums.
2. Rent for occupancy of the property before closing.
3. Charges for utilities or other services related to occupancy of the property before closing.
4. Fees for refinancing a mortgage.
5. Charges connected with getting a loan. The following items are examples of these charges.
   1. Mortgage insurance premiums.
   2. Loan assumption fees.
   3. Cost of a credit report.
   4. Fees for an appraisal required by a lender.

If these costs relate to business property, items (1) through (3) are deductible as business expenses. Items (4) and (5) must be capitalized as costs of getting a loan and can be deducted over the period of the loan.

Points.   If you pay points to get a loan (including a mortgage, second mortgage, or line-of-credit), do not add the points to the basis of the related property. Generally, you deduct the points over the term of the loan. For more information about deducting points, see Points in chapter 5 of Publication 535.

Points on home mortgage.   Special rules may apply to points you and the seller pay when you get a mortgage to buy your main home. If certain requirements are met, you can deduct the points in full for the year in which they are paid. Reduce the basis of your home by the amount of any seller-paid points. For more information, see Points in Publication 936, Home Mortgage Interest Deduction.

Assumption of a mortgage.   If you buy property and assume (or buy 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 items.

• Land.
• Paid labor and materials.
• Architect's fees.
• Building permit charges.
• Payments to contractors.
• Payments for rental equipment.
• Inspection fees.

In addition, if you use your employees, farm materials, and equipment to build an asset, your basis would also include the following costs.

1. Wages paid for the construction work.
2. Depreciation on equipment you own while it is used in the construction.
3. Operating and maintenance costs for equipment used in the construction.
4. Business supplies and materials used in the construction.

Do not deduct these expenses. You must capitalize them (include them in the asset's basis).

Reduce the asset's basis by any work opportunity credit, welfare-to-work credit, Indian employment credit, or empowerment zone employment credit allowable on the wages you pay in (1). For information about these credits, see Publication 954, Tax Incentives for Empowerment Zones and Other Distressed Communities.

Do not include the value of your own labor, or any other labor you did not pay for, in the basis of any property you construct.

Allocating the Basis

If you buy multiple assets for a lump sum, allocate the amount you pay among the assets. Use this allocation to figure your basis for depreciation and gain or loss on a later disposition of any of these assets.

Group of assets acquired.   If you buy multiple assets for a lump sum, you and the seller may agree in the sales contract to a specific allocation of the purchase price among the assets. If this allocation is based on the value of each asset and you and the seller have adverse tax interests, the allocation generally will be accepted.

Example.   In March you bought property for $36,000. In the sales contract, you and the seller (not a related person) agree to allocate the purchase price among the assets based on their respective fair market values (FMV). FMV is defined later under Basis Other Than Cost. The following is an inventory of the property at its FMV on the date of purchase.

	FMV
Tractor	$15,000
Plow	5,000
Mower	6,000
Manure spreader	4,000
Total FMV	$30,000

Your basis in each of the assets is the portion of the purchase price ($36,000) allocated to that asset.

	Basis
Tractor ($15,000 ÷ $30,000) × $36,000	$18,000
Plow ($5,000 ÷ $30,000) × $36,000	6,000
Mower ($6,000 ÷ $30,000) × $36,000	7,200
Manure spreader ($4,000 ÷ $30,000)
x $36,000	4,800
Total purchase price	$36,000

Farming business acquired.   If you buy a group of assets that constitutes a farming business, there are special rules you must use to allocate the purchase price among the assets. See Trade or Business Acquired under Allocating the Basis in Publication 551 for more information.

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. Allocate the rest of the purchase price to the basis of the calf. Neither the cost allocated to the cow nor the cost allocated to the calf is deductible as a current business expense.

Quotas and allotments.   Certain areas of the country have quotas or allotments for commodities such as milk, tobacco, and peanuts. The cost of the quota or allotment is its basis. If you acquire a right to a quota with the purchase of land or a herd of dairy cows, allocate part of the purchase price to that right.

Uniform Capitalization Rules

Under the uniform capitalization rules, you must capitalize all direct costs and an allocable part of indirect costs incurred due to your production or resale activities. The term capitalize means to include certain expenses in the basis of property you produce or in your inventory costs, rather than claiming them as a current deduction. You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property.

Activities subject to the rules.   You are subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a trade or business or an activity carried on for profit.

1. Produce real or tangible personal property.
2. Acquire property for resale. However, this rule does not apply to personal property if your average annual gross receipts for the three prior tax years are $10 million or less.

You produce property if you construct, build, install, manufacture, develop, improve, or create the property. You produce property if you raise or grow any agricultural or horticultural commodity, including plants and animals.

Generally, you are not required to capitalize the costs of producing animals and certain plants. See Exceptions, later.

The direct and indirect costs of producing plants or animals include preparatory costs and preproductive period costs. Preparatory costs include the acquisition cost of the seed, seedling, plant, or animal. For plants, preproductive period costs include the cost of items such as irrigation, pruning, frost protection, spraying, and harvesting. For animals, preproductive period costs include the cost of items such as feed, maintaining pasture or pen areas, breeding, veterinary services, and bedding.

The term plant 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.

The term animal includes any stock, poultry or other bird, and fish or other sea life.

Table 7-1. Preproductive Period of More Than 2 Years

Plants producing the following crops or yields have a nationwide weighted average preproductive period of more than 2 years.
Almonds Apples Apricots Avocados Blackberries Blueberries Cherries Chestnuts Coffee Beans	Currants Dates Figs Grapefruit Grapes Guavas Kumquats Lemons Limes	Macadamia  Nuts Mangoes Nectarines Olives Oranges Papayas Peaches Pears Pecans	Persimmons Pistachio Nuts Plums Pomegranates Prunes Raspberries Tangelos Tangerines Walnuts

Exceptions.   The uniform capitalization rules do not apply to the following.

1. Any animal.
2. Any plant with a preproductive period of 2 years or less.
3. Costs of replanting certain plants lost or damaged due to casualty.

Exceptions (1) and (2) do not apply to a corporation, partnership, or tax shelter required to use an accrual method of accounting. See Accrual method required under Accounting Methods in chapter 3.

In addition, you can choose not to use the uniform capitalization rules in the case of plants with a preproductive period of more than 2 years. If you make this choice, special rules apply. This choice cannot be made by a corporation, partnership, or tax shelter required to use an accrual method of accounting. This choice also does not apply to any costs incurred for the planting, cultivation, maintenance, or development of any citrus or almond grove (or any part thereof) within the first 4 years the trees were planted.

Example.   You grow trees that have a preproductive period of more than 2 years. The trees produce an annual crop. You are an individual and the uniform capitalization rules apply to your farming business. You must capitalize the direct cost and an allocable part of indirect costs incurred due to the production of the trees. However, you are not required to capitalize the costs of producing the 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 7-1 have a preproductive period of more than 2 years. Other plants may also have a preproductive period of more than 2 years.

More information.   For more information on the uniform capitalization rules, see the regulations under section 263A of the Internal Revenue Code. Section 1.263A-4 of the regulations applies to property produced in a farming business.

Previous | First | Next

Publication Index | 2002 Tax Help Archives | Tax Help Archives | Home