3. Farm Income
What's New
Peanut quota buyout program payments expire. The discussion on peanut quota buyout program payments previously included in this chapter was deleted since the compensation period for peanut quota buyout program payments has expired.
Tobacco growers. There are new rules for tobacco growers. See Tobacco Growers,later.
Repayment of Commodity Credit Corporation (CCC) loans. Beginning January 1, 2007, the CCC will report market gain associated with the repayment of a CCC loan whether the loan is repaid with cash or CCC certificates. See Commodity Credit Corporation (CCC) Loans, later.
Introduction
You may receive income from many sources. You must report the income on your tax return, unless it is excluded by law. Where you report the income depends on its source.
This chapter discusses farm income you report on Schedule F (Form 1040). For information on where to report other income, see the instructions for Form 1040.
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 income for the year in which 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
- 550 Investment Income and Expenses
- 908 Bankruptcy Tax Guide
- 925 Passive Activity and At-Risk Rules
Form (and Instructions)
Sch E (Form 1040)
Supplemental
Income and LossSch F (Form 1040)
Profit or Loss From FarmingSch J (Form 1040)
Income Averaging for Farmers and Fishermen982
Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)1099-G
Certain Government Payments1099-PATR
Taxable Distributions
Received From Cooperatives4797
Sales of Business Property4835
Farm Rental Income and
Expenses
See chapter 17 for information about getting publications and forms.
Schedule F
Report your farm income on Schedule F (Form 1040). Use this schedule to figure the net profit or loss from regular farming operations.
Income from farming reported on Schedule F (Form 1040) includes amounts you receive from cultivating, operating, or managing a farm for gain or profit, either as owner or tenant. This includes income from operating a stock, dairy, poultry, fish, fruit, or truck farm and income from operating a plantation, ranch, range, or orchard. It also includes income from the sale of crop shares if you materially participate in producing 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 does not include gains or losses from sales or other dispositions 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
When you sell livestock, produce, grains, or other products you raised on your farm for sale or bought for resale, the entire amount you receive is reported on Schedule F. This includes money and the fair market value of any property or services you receive.
Where to report
Table 3-1 shows where to report the sale of farm products on your tax return.
Schedule F
When you sell farm products bought for resale, your profit or loss is the difference between your basis in the item (usually your cost) and any payment (money plus the fair market value of any property) you receive for it. 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 2006, you bought 20 feeder calves for $6,000 for resale. You sold them in 2007 for $11,000. You report the $11,000 sales price, subtract your $6,000 basis, and report the resulting $5,000 profit on your 2007 Schedule F, Part I.
Form 4797
Sales of livestock held for draft, breeding, sport, or dairy purposes may result in ordinary or capital gains or losses, depending on the circumstances. In either case, you should always report these sales on Form 4797 instead of Schedule F. See Livestock under Ordinary or Capital Gain or Loss in chapter 8. Animals you do not hold primarily for sale are considered business assets of your farm.
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 products not held primarily for sale, such as livestock held for draft, breeding, sport, or dairy purposes (bought or raised) | X |
Sale by agent
If your agent sells your farm products, 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. You have constructive receipt of the income when your agent receives payment. For a discussion on constructive 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 because of a drought, flood, or other weather-related condition, you may be able to postpone reporting 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 business practices, you would not 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 assistance by the federal government.
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 livestock (other than poultry) held for draft, breeding, or dairy purposes may be an involuntary conversion. See Other Involuntary Conversions in chapter 11.Usual business practice
You must determine 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 do not take into account your sales in any earlier year for which you postponed the gain. If you have not yet established a usual business practice, rely on the usual business practices of similarly situated farmers in your general region.
Connection with affected area
The livestock does not have to be raised or sold in an area affected by a weather-related condition for the postponement to apply. However, the sale must occur solely because of a weather-related condition that affected the water, grazing, or other requirements of the livestock. This requirement generally will not be met if the costs of food, water, or other requirements of the livestock affected by the weather-related condition are not substantial 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. Do not 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.
Divide the total income realized from the sale of all livestock in the class during the tax year by the total number of such livestock sold. For this purpose, do not treat any postponed gain from the previous year as income received from the sale of livestock.
Multiply the result in (1) by the excess number of such livestock sold solely because 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 2007. You realized $70,200 from the sale. On August 9, 2007, as a result of drought, the affected area was declared a disaster area eligible for federal assistance. The income you can postpone until 2008 is $18,200 [($70,200 ÷ 135) × 35].
How to postpone gain
To postpone gain, attach a statement to your tax return for the year of the sale. The statement must include your name and address and give the following information for each class of livestock for which you are postponing gain.
A statement that you are postponing gain under section 451(e) of the Internal Revenue Code.
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 earlier, of the income to be postponed for each class of livestock.
Rents (Including Crop Shares)
The rent you receive for the use of your farmland is generally rental income, not farm income. However, if you materially participate in farming operations on the land, the rent is farm income. See Landlord Participation in Farming in chapter 12.
Pasture income and rental
If you pasture someone else's cattle and take care of the livestock for a fee, the income is from your farming business. You must enter it as Other income on Schedule F. If you simply rent your pasture for a flat cash amount without providing services, report the income as rent on Schedule E (Form 1040), Part I.
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 does not matter whether you use the cash method of accounting or an accrual method of accounting.
If you materially participate in operating a farm from which you receive rent in the form of crop shares or livestock, the rental income is included in self-employment income. (See Landlord Participation in Farming in chapter 12.) Report the rental income on Schedule F.
If you do not materially participate in operating the farm, report this income on Form 4835 and carry the net income or loss to Schedule E (Form 1040). The income is not 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 include the fair market value of the crop shares in income at that time. You are entitled to a business 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 transactions cancel each other for figuring adjusted gross income on Form 1040, they may be necessary to figure your self-employment tax. See 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 are 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 children.
Crop share loss
If you are involved in a rental or crop-share lease arrangement, any loss from these activities may be subject to the limits under the passive loss rules. See Publication 925 for information on these rules.
Agricultural Program Payments
You must include in income most government payments, such as those for approved conservation practices, direct payments, and counter-cyclical payments, whether you receive them in cash, materials, services, or commodity certificates. However, you can exclude from income some payments you receive under certain cost-sharing conservation programs. See Cost-Sharing Exclusion (Improvements), later.
Report the agricultural program payment on the appropriate line of Schedule F, Part I. Report the full amount even if you return a government check for cancellation, refund any of the payment you receive, or the government collects all or part of the payment from you by reducing the amount of some other payment or Commodity Credit Corporation (CCC) loan. However, you can deduct the amount you refund or return or that reduces some other payment or loan to you. Claim the deduction on Schedule F for the year of repayment or reduction.
Commodity Credit Corporation (CCC) Loans
Generally, you do not 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 do not 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 CCC loans in that year and later years in the same way. However, you can obtain 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 instructions for Form 3115.
You can request income tax withholding from CCC loan payments you receive. Use Form W-4V, Voluntary Withholding Request. See chapter 17 for information about ordering the form.To elect to report a CCC loan as income, include the loan proceeds as income on Schedule F, line 7a, for the year you receive it. Attach a statement 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 extensions. 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” 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 did not report the loan proceeds as income for the year you received them, you must include them in your income for the year of the forfeiture.
Form 1099-A. If you forfeit pledged crops to the CCC in full payment of a loan, you may receive a Form 1099-A, Acquisition or Abandonment of Secured Property. “CCC” should be shown in box 6. The amount of any CCC loan outstanding when you forfeited your commodity should also be indicated on the form.Market Gain
Under the CCC nonrecourse marketing assistance 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 repayment. 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 CCC-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, do not include the market gain in income. However, adjust the basis of the commodity for the amount of the market gain.
If you did not include the CCC loan in income in the year received, include the market gain in your income.
The following examples show how to report market gain.
Example —
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 producing the cotton and has a zero basis in the commodity. In 2006, Mike pledged 1,000 pounds of cotton as collateral for a CCC loan of $500 (a loan rate of $.50 per pound). In 2007, he repaid the loan and redeemed the cotton for $420 when the world price was $.42 per pound (lower than the loan amount). Later in 2007, he sold the cotton for $600.
The market gain on the redemption was $.08 ($.50 - $.42) per pound. Mike realized total market gain of $80 ($.08 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 2006.
Included CCC loan
Mike reported the $500 CCC loan as income for 2006, so he is treated as if he sold the cotton for $500 when he pledged it and repurchased the cotton for $420 when he redeemed it. The $80 market gain is not recognized on the redemption. He reports it for 2007 as an Agricultural program payment on Schedule F, line 6a, but does not include it as a taxable amount on line 6b. Mike's basis in the cotton after he redeemed it was $420, which is the redemption (repurchase) price paid for the cotton. His gain from the sale is $180 ($600 - $420). He reports the $180 gain as income for 2007 on Schedule F, line 4.
Excluded CCC loan
Mike has income of $80 from market gain in 2007. He reports it on Schedule F, line 6a and line 6b. His basis in the cotton is zero, so his gain from its sale is $600. He reports the $600 gain as income for 2007 on Schedule F, line 4.
Example —
The facts are the same as in Example 1 except that, instead of selling the cotton for $600 after redeeming it, Mike entered into an option-to-purchase contract with Tom Merchant before redeeming the cotton. Under that contract, Mike authorized Tom to pay the CCC loan on Mike's behalf. In 2007, Tom repaid the loan for $420 and immediately exercised his option, buying the cotton for $420. How Mike reports the $80 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 2006.
Included CCC loan
As in Example 1, Mike is treated as though he sold the cotton for $500 when he pledged it and repurchased the cotton for $420 when Tom redeemed it for him. The $80 market gain is not recognized on the redemption. Mike reports it for 2007 as an Agricultural program payment on Schedule F, line 6a, but does not include it as a taxable amount on line 6b. Also, as in Example 1, Mike's basis in the cotton when Tom redeemed it for him was $420. Mike has no gain or loss on its sale to Tom for that amount.
Excluded CCC loan
As in Example 1, Mike has income of $80 from market gain in 2007. He reports it on Schedule F, line 6a and line 6b. His basis in the cotton is zero, so his gain from its sale is $420. He reports the $420 gain as income for 2007 on Schedule F, line 4.
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 receive under the program on Schedule F, lines 6a and 6b. Cost-share payments you receive may qualify for the cost-sharing exclusion. (See Cost-Sharing Exclusion, later.) CRP payments are reported to you on Form CCC-1099-G.
Crop Insurance and Crop Disaster Payments
You must include in income any crop insurance proceeds you receive as the result of crop damage. You generally include them in the year you receive them. Treat as crop insurance proceeds the crop disaster payments you receive from the federal government as the result of destruction or damage to crops, or the inability to plant crops, because of drought, flood, or any other natural disaster.
You can request income tax withholding from crop disaster payments you receive from the federal government. Use Form W-4V, Voluntary Withholding Request. See chapter 17 for information about ordering the form.Election to postpone reporting until the following year
You can postpone reporting crop insurance proceeds as income until the year following the year the 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 damaged.
You can show that under your normal business practice you would have included income from the damaged crops in any tax year following the year the damage occurred.
A statement that you are making an election under section 451(d) of the Internal Revenue Code and Regulations section 1.451-6.
The specific crop or crops destroyed or damaged.
A statement that under your normal business practice you would have included income from the destroyed or damaged crops in gross income for a tax year following the year the crops were destroyed or damaged.
The cause of the destruction or damage and the date or dates it occurred.
The total payments you received from insurance carriers, itemized for each specific crop, and the date you received each payment.
The name of each insurance carrier from whom you received payments.
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, reimbursement payments, and other benefits to qualifying livestock producers if the Secretary of Agriculture determines that, because of a natural 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 cannot postpone 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 deduction for the same amount as a feed expense.
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 improvement. However, this exclusion applies only to that part of a payment that meets all three of the following tests.
It was for a capital expense. You cannot exclude any part of a payment for an expense 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.)
It does not substantially increase your annual income from the property for which it is made. An increase in annual income is substantial if it is more than the greater of the following amounts.
10% of the average annual income derived from the affected property before receiving the improvement.
$2.50 times the number of affected acres.
The Secretary of Agriculture certified that the payment was primarily made for conserving soil and water resources, protecting or restoring the environment, improving forests, or providing a habitat for wildlife.
Qualifying programs
If the three tests listed above are met, you can exclude payments from the following programs.
The rural clean water program authorized by the Federal Water Pollution Control Act.
The rural abandoned mine program authorized 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 Agricultural Credit Act of 1978.
The agricultural conservation program authorized by the Soil Conservation and Domestic Allotment Act.
The great plains conservation program authorized by the Soil Conservation and Domestic Policy Act.
The resource conservation and development program authorized by the Bankhead-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 under which payments are made to individuals primarily for conserving soil, protecting or restoring the environment, improving forests, or providing a habitat for wildlife. Several state programs have been approved. For information about the status of those programs, contact the state offices of the Farm Service Agency (FSA) and the Natural Resources and Conservation Service (NRCS).
Small watershed programs
If the three tests listed earlier are met, you can exclude payments you receive under the following programs for improvements made in connection with a watershed.
The programs under the Watershed Protection 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 authorized by the Food Security Act of 1985, the Federal Agriculture Improvement and Reform Act of 1996 and the Farm Security and Rural Investment Act of 2002.
The Environmental Quality Incentives Program (EQIP) authorized by the Federal Agriculture Improvement and Reform Act of 1996.
The Wildlife Habitat Incentives Program (WHIP) authorized by the Federal Agriculture Improvement and Reform Act of 1996.
The Soil and Water Conservation Assistance Program authorized by the Agricultural Risk Protection Act of 2000.
The Agricultural Management Assistance Program authorized by the Agricultural Risk Protection Act of 2000.
The Conservation Reserve Program authorized by the Food Security Act of 1985 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 authorized by the Food Security Act of 1985.
Income realized
The gross income you realize upon getting an improvement under these cost-sharing programs is the value of the improvement reduced by the sum of the excludable portion and your share of the cost of the improvement (if any).
Value of the improvement
You determine the value of the improvement by multiplying 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 improvement) reduced by the sum of the following items.
Any government payments under a program not listed earlier.
Any part of a government payment under a program listed earlier that the Secretary of Agriculture has not certified as primarily for conservation.
Any government payment to you for rent or for your services.
Excludable portion
The excludable portion is the present fair market value of the right to receive annual income from the affected acreage of the greater of the following amounts.
10% of the prior average annual income from the affected acreage. The prior average 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 improvement.
$2.50 times the number of affected acres.
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 portion is the greater amount, $1,550.
You figure the amount to include in gross income 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 capital costs. Any payment excluded from income is not part of your basis. In addition, you cannot take depreciation, amortization, or depletion deductions for the part of the cost of the property for which you receive cost-sharing payments you exclude from income.
How to report the exclusion
Attach a statement 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 are excluding.
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 excluded. 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, including extensions, for filing your return. 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). 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.
Payments under the Farm Security and Rural Investment Act of 2002
The Farm Security and Rural Investment Act of 2002 created two new types of payments—direct and counter-cyclical payments. You must include these payments on Schedule F, lines 6a and 6b.
Tobacco Quota Buyout Program Payments
The Fair and Equitable Tobacco Reform Act of 2004, Title VI of the American Jobs Creation Act of 2004, terminated the tobacco marketing quota program and the tobacco price support program. As a result, the USDA offered to enter into contracts with eligible tobacco quota holders and growers to provide compensation for the lost value of the quotas and related price support.
If you are an eligible tobacco quota holder, your contract entitles you to receive total payments of $7 per pound of quota in 10 equal annual payments in fiscal years 2005 through 2014. If you are an eligible tobacco grower, your contract entitles you to receive total payments of up to $3 per pound of quota in 10 equal annual payments in fiscal years 2005 through 2014.
Tobacco Quota Holders
Contract payments you receive are considered proceeds from a sale of your tobacco quota as of the date on which you and the USDA enter into the contract. Your taxable gain or loss is the total amount received for your quota reduced by any amount treated as interest (discussed later), over your adjusted basis. The gain or loss is capital or ordinary depending on how you used the quota. See Capital or ordinary gain or loss, later.
Report the entire gain on your income tax return for the tax year that includes the date you entered into the contract if you elect not to use the installment method.
Adjusted basis
The adjusted basis of your quota is determined differently depending on how you obtained the quota.
The basis of a quota derived from an original grant by the federal government is zero.
The basis of a purchased quota is the purchase price.
The basis of a quota received as a gift is generally the same as the donor's basis. However, under certain circumstances, the basis is increased by the amount of gift taxes paid. If the basis is greater than the fair market value of the quota at the time of the gift, the basis for determining loss is the fair market value.
The basis of an inherited quota is generally the fair market value of the quota at the time of the decedent's death.
Reduction of basis
You are required to reduce the basis of your tobacco quota by the following amounts.
Deductions you took for amortization, depletion, or depreciation.
Amounts you previously deducted as a loss because of a reduction in the number of pounds of tobacco allowable under the quota.
The entire cost of a purchased quota you deducted in an earlier year (which reduces your basis to zero).
Amount treated as interest
You must reduce your tobacco quota buyout program payment by the amount treated as interest. The interest is reportable as ordinary income. If payments total $3,000 or less, your total quota buyout program payment does not include any amount treated as interest and you are not required to reduce the total payment you receive. In all other cases, a portion of each payment may be treated as interest for federal tax purposes. You may be required to reduce your total quota buyout program payment before you calculate your gain or loss. For more information, see Notice 2005-57 on page 267 of Internal Revenue Bulletin 2005-32. This bulletin is available at www.irs.gov/pub/irs-irbs/irb05-32.pdf.
Installment method
You may use the installment method to report a gain if you receive at least one payment after the close of your tax year. Under the installment method, a portion of the gain is taken into account in each year in which a payment is received. See chapter 10 for more information.
Capital or ordinary gain or loss
Whether your gain or loss is ordinary or capital depends on how you used the quota.
Quota used in the trade or business of farming
If you used the quota in the trade or business of farming and you held it for more than one year, you report the transaction as a section 1231 transaction on Form 4797. See Section 1231 transactions under Ordinary or Capital Gain or Loss in chapter 8 for a definition of section 1231 transactions. See the Instructions for Form 4797 for detailed information on reporting section 1231 transactions.
Quota held for investment
If you held the quota for investment purposes, any gain or loss is capital gain or loss. The same result also applies if you held the quota for the production of income, though not connected with a trade or business.
Gain treated as ordinary income
If you previously deducted any of the following items, some or all of the capital gain must be recharacterized and reported as ordinary income. Any resulting capital gain is taxed as ordinary income up to the amount previously deducted.
The cost of acquiring a quota.
Amounts for amortization, depletion, or depreciation.
Amounts to reflect a reduction in the quota pounds.
Income averaging for farmers
The gain or loss resulting from the quota payments does not qualify for income averaging. A tobacco quota is considered an interest in land. Income averaging is not available for gain or loss arising from the sale or other disposition of land.
Involuntary conversion
The buyout of the tobacco quota is not an involuntary conversion. Form 1099-S. A tobacco quota is considered an interest in land, so the USDA will generally report the total amount you receive under a contract on Form 1099-S if the amount is $600 or more. The USDA will generally report any portion of a payment treated as interest of $600 or more to you on Form 1099-INT for the year in which the payment is made. Like-kind exchange of quota. You may postpone reporting the gain or loss from tobacco quota buyout payments by entering into a like-kind exchange if you comply with the requirements of section 1031 and the regulations thereunder. See Notice 2005-57 for more information.
More information
For more information on the taxation of payments to tobacco quota holders, see Notice 2005-57.
Tobacco Growers
Contract payments you receive are determined by reference to the amount of quota under which you produced (or planted) quota tobacco during the 2002, 2003, and 2004 tobacco marketing years and are prorated based on the number of years that you produced (or planted) quota tobacco during those years.
Taxation of payments to tobacco growers
Payments to growers replace ordinary income that would have been earned had the tobacco marketing quota and price support programs continued. Individuals will generally report the payments as an Agricultural program payment on Schedule F. If you are a landowner who does not materially participate in the operation or management of the farm and are receiving the grower payment because your farm rental income is based on the tobacco grown by a tenant, the grower payment should be reported on Form 4835, Farm Rental Income and Expenses. Self-employment income. Payments to growers generally represent self-employment income. If the grower is an individual carrying on a trade or business and deriving income (other than farm rental income properly reported on Form 4835) from that trade or business, the payments are net earnings from self-employment.
Income averaging for farmers
Payments to growers who are individuals qualify for farm income averaging. Form 1099-G If the amount received in a taxable year is $600 or more, the amount will generally be reported by the USDA on a Form 1099-G.
Other Payments
You must include most other government program 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 improvements, 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 income, they do not reduce your basis. However, see Cost-Sharing Exclusion (Improvements), earlier, for additional information.
National Tobacco Growers' Settlement Trust Fund Payments
If you are a producer, landowner, or tobacco quota owner who receives money from the National Tobacco Growers' Settlement Trust Fund, you must report those payments as income. You should receive a Form 1099-MISC that shows the payment amount.
If you produce a tobacco crop, report the payments as income from farming on your Schedule F. If you are a landowner or tobacco quota owner who leases tobacco-related property but you do not produce the crop, report the payments as farm rental income on Form 4835.
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 inquiries 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, line 6a or 8a. However, do not report as a taxable amount on line 6b or 8b any amount belonging to someone else.
See chapter 17 for information about ordering 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 cooperative, you may receive either patronage dividends 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 minimum tax adjustment that you must include on Form 6251, Alternative Minimum Tax—Individuals, if you are required to file the form. For information on the alternative minimum tax, see the instructions for Form 6251.Patronage Dividends
You generally report patronage dividends as income on Schedule F, lines 5a and 5b, for the tax year you receive them. They include the following items.
Money paid as a patronage dividend.
The stated dollar value of qualified written notices of allocation.
The fair market value of other property.
Do not report as income on line 5b any patronage dividends from buying personal or family items, capital assets, or depreciable property. Personal items include fuel purchased for personal use, basic local telephone service, and personal long distance calls.
If you cannot determine what the dividend is for, report it as income on lines 5a and 5b.
Qualified written notice of allocation
If you receive a qualified written notice of allocation as part of a patronage dividend, you must generally include its stated dollar value in your income 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.
The notice must be redeemable in cash for at least 90 days after it is issued, and you must have received a written notice of your right of redemption at the same time as the written notice of allocation.
You must have agreed to include the stated dollar value in income in the year you receive the notice by doing one of the following.
Signing and giving a written agreement to the cooperative.
Getting or keeping membership in the cooperative after it adopted a bylaw providing that membership constitutes agreement. The cooperative must notify you in writing of this bylaw and give you a copy.
Endorsing and cashing a qualified check paid as part of the same patronage dividend. You must cash the check by the 90th day after the close of the payment period for the cooperative's tax year for which the patronage dividend was paid.
Qualified check
A qualified check is any instrument that is redeemable in money and meets both of the following requirements.
It is part of a patronage dividend that also includes a qualified written notice of allocation for which you met condition 2(c), above.
It is imprinted with a statement that endorsing and cashing it constitutes the payee's consent to include in income the stated dollar value of any written notices of allocation paid as part of the same patronage dividend.
Loss on redemption
You can deduct on Schedule F, Part II, any loss incurred on the redemption of a qualified written notice of allocation you received in the ordinary course of your farming business. The loss is the difference between 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
Do not include 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 include in income for the tax year of disposition any amount you receive from its sale, redemption, or other disposition. Report that amount, up to the stated dollar value of the notice, on Schedule F, lines 5a and 5b. However, do not include that amount in your income if the notice resulted from buying or selling capital assets or depreciable 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 excess 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 depreciable property
Do not include in income patronage dividends from buying capital assets or depreciable property used in your business. You must, however, reduce the basis of these assets 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 dividends are more than your unrecovered basis, include the difference on Schedule F, line 5a, for the tax year you receive them. However, include only the taxable part on line 5b. This rule and the exceptions explained later also apply to amounts you receive from the sale, redemption, or other disposition of a nonqualified notice of allocation that resulted from buying or selling capital assets or depreciable property.
Example —
On July 1, 2006, Mr. Brown, a patron of a cooperative association, bought a machine for his dairy farm business from the association 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 Appendix B of Publication 946). Mr. Brown files his return on a calendar year basis. For 2006, he claimed a depreciation deduction of $311, using the 10.71% depreciation rate from the 150% declining balance, half-year convention table (shown in Table A-14 in Appendix A of Publication 946). On July 2, 2007, the cooperative association paid Mr. Brown a $300 cash patronage dividend for buying the machine. Mr. Brown adjusts the basis of the machine and figures his depreciation deduction for 2007 (and later years) as follows.
| Cost of machine on July 1, 2006 | $2,900 | ||
| Minus: | 2006 depreciation | $311 | |
| 2007 cash dividend | 300 | 611 | |
| Adjusted basis for depreciation for 2007: | $2,289 | ||
| Depreciation rate: 1 ÷ 6½ (remaining recovery period as of 1/1/07) = 15.38% × 1.5 = 23.07% | |||
| Depreciation deduction for 2007 ($2,289 × 23.07%) | $528 | ||
Exceptions
If the dividends are for buying or selling capital assets or depreciable property you did not own at any time during the year you received the dividends, you must include them on Schedule F, lines 5a and 5b, 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 was not or would not have been deductible, do not report them as income (ordinary or capital gain).
Personal purchases
Omit from the taxable amount of patronage dividends on Schedule F, line 5b, any dividends from buying personal, living, or family items, such as supplies, equipment, or services not related to the production of farm income. This rule also applies to amounts you receive from the sale, redemption, or other disposition of a nonqualified written notice of allocation resulting from these purchases.
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 cooperative. A per-unit retain allocation is an amount paid to patrons for products sold for them that is fixed without regard to the net earnings of the cooperative. These allocations can be paid in money, other property, or qualified certificates.
Per-unit retain certificates issued by a cooperative generally receive the same tax treatment as patronage dividends, discussed earlier.
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 receipt. The agreement may be made in writing or by getting or keeping membership in a cooperative whose bylaws or charter states that membership constitutes agreement. If you receive qualified per-unit retain certificates, include the stated dollar amount of the certificates in income on Schedule F, Part I, for the tax year you receive them.
Nonqualified certificates
Do not include the stated dollar value of a nonqualified per-unit retain certificate in income when you receive it. Your basis in the certificate is zero. You must include in income any amount you receive from its sale, redemption, or other disposition. Report the amount you receive from the disposition as ordinary income on Schedule F, Part I, for the tax year of disposition.
Cancellation of Debt
This section explains the general rule for including canceled debt in income and the exceptions to the general rule.
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, line 10, if you incurred the debt in your farming business. If the debt is a nonbusiness debt, report the canceled amount on Form 1040, line 21.
Form 1099-C. If a federal agency, financial institution, credit union, finance company, or credit card company cancels or forgives your debt of $600 or more, you will receive a Form 1099-C, Cancellation of Debt. The amount of debt canceled is shown in box 2.Exceptions
The following discussion covers some exceptions to the general rule for canceled debt. These exceptions apply before the exclusions discussed below.
Price reduced after purchase
If you owe a debt to the seller for property you bought and the seller reduces the amount you owe, you generally do not have income from the reduction. Unless you are in bankruptcy or are insolvent, treat the amount of the reduction as a purchase price adjustment and reduce your basis in the property. The rules that apply to bankruptcy and insolvency are explained later under Exclusions.
Deductible debt
You do not realize income from a canceled debt to the extent the payment of the debt would have been a deductible expense. This exception applies before the price reduction exception discussed above.
Example —
You get accounting services for your farm on credit. Later, you have trouble paying your farm debts, but you are not 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 do not include the canceled debt in income because payment of the debt would have been deductible as a business expense.
Accrual method — You include the canceled debt in income because the expense was deductible when you incurred the debt.
Exclusions
Do not include canceled debt in income in the following situations.
The cancellation takes place in a bankruptcy case under title 11 of the U.S. Code.
The cancellation takes place when you are insolvent.
The canceled debt is a qualified farm debt.
The canceled debt is a qualified real property business debt (in the case of a taxpayer other than a C corporation). See chapter 5 in Publication 334.
If a canceled debt is excluded from income because it takes place in a bankruptcy case, the exclusions in situations (2), (3), and (4) do not apply. If it takes place when you are insolvent, the exclusions in situations (3) and (4) do not apply to the extent you are insolvent.
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 are liable or that attaches to property you hold.
Bankruptcy and Insolvency
You can exclude a canceled debt from income if you are bankrupt or to the extent you are insolvent.
Bankruptcy
A bankruptcy case is a case under title 11 of the U.S. Code if you are 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. Do not include debt canceled in a bankruptcy case in your income in the year it is canceled. Instead, you must use the amount canceled to reduce your tax benefits, explained later under Reduction of tax benefits.
Insolvency
You are 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 are insolvent. 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. Otherwise, you include the difference in gross income. Use the amount excluded because of insolvency to reduce any tax benefits, as explained later under Reduction of tax benefits. You must reduce the tax benefits under the insolvency rules before applying the rules for qualified farm debt or for qualified real property business debt.
Example —
You had a $15,000 debt canceled outside of bankruptcy. Immediately before 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 benefits
If you exclude canceled debt from income in a bankruptcy case or during insolvency, you must use the excluded debt to reduce certain tax benefits.
Order of reduction
You must use the excluded canceled debt to reduce the following tax benefits in the order listed unless you elect to reduce the basis of depreciable property first, as explained later.
Net operating loss (NOL). Reduce any NOL for the tax year of the debt cancellation, and then any NOL carryover to that year. Reduce the NOL or NOL carryover one dollar for each dollar of excluded canceled debt.
General business credit carryover. Reduce the credit carryover to or from the tax year of the debt cancellation. Reduce the carryover 33⅓ cents for each dollar of excluded canceled debt.
Minimum tax credit. Reduce the minimum tax credit available at the beginning of the tax year following the tax year of the debt cancellation. Reduce the credit 33⅓ cents for each dollar of excluded canceled debt.
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 carryover one dollar for each dollar of excluded canceled debt.
Basis. Reduce the basis of the property you hold at the beginning of the tax year following the tax year of the debt cancellation in the following order.
Real property (except inventory) used in your trade or business or held for investment that secured the canceled debt.
Personal property (except inventory and accounts and notes receivable) used in your trade or business or held for investment that secured the canceled debt.
Other property (except inventory and accounts and notes receivable) used in your trade or business or held for investment.
Inventory and accounts and notes receivable.
Other property.
Reduce the basis one dollar for each dollar of excluded canceled debt. However, the reduction cannot be more than the total bases of property and the amount of money you hold immediately after the debt cancellation minus your total liabilities immediately 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.
Passive activity loss and credit carryovers. 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 excluded canceled debt. Reduce the credit carryover 33⅓ cents for each dollar of excluded canceled debt.
Foreign tax credit. Reduce the credit carryover to or from the tax year of the debt cancellation. Reduce the carryover 331/ cents for each dollar of excluded canceled debt.
How to make tax benefit reductions
Always make the required reductions in tax benefits after figuring your tax for the year of the debt cancellation. In making the reductions in (1) and (4) above, 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 reductions in (2) and (7) above, reduce the credit carryovers to the tax year of the debt cancellation in the order in which they are taken into account for that year.
Electing to reduce the basis of depreciable property first
You can elect to apply any portion of the excluded canceled debt first to reduce 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 order.
Depreciable real property used in your trade or business or held for investment that secured the canceled debt.
Depreciable personal property used in your trade or business or held for investment that secured the canceled debt.
Other depreciable property used in your trade or business or held for investment.
Real property held as inventory if you elect to treat it as depreciable property on Form 982.
Recapture of basis reductions
If you reduce the basis of property under these provisions 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 depreciation recapture provisions. Treat any property that is not section 1245 or section 1250 property as section 1245 property. For section 1250 property, determine the straight-line depreciation 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 Publication 908.
Qualified Farm Debt
You can exclude from income a canceled debt that is 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 does not apply to a canceled debt excluded from income because 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 farming business.
At least 50% of your total gross receipts for the 3 tax years preceding the year of debt cancellation were from your farming business.
Qualified person
This is a person who is actively 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 does not include any of the following.
A person related to you.
A person from whom you got the property (or a person related to this person).
A person who receives a fee from your investment in the property (or a person related to this person).
Exclusion limit
The amount of canceled qualified farm debt you can exclude from income is limited. It cannot be more than the sum of your adjusted tax benefits and the total adjusted bases of the qualified property you hold at the beginning of the tax year following the tax year of the debt cancellation. Figure this limit after taking into account any reduction of tax benefits because of debt canceled during insolvency. If the canceled debt is more than this limit, you must include the difference in gross income.
Adjusted tax benefits
Adjusted tax benefits means the sum of the following items.
Any net operating loss (NOL) for the tax year of the debt cancellation and any NOL carryover to that year.
Any general business credit carryover to or from the year of the debt cancellation, multiplied by 3.
Any minimum tax credit available at the beginning of the tax year following the tax year of the debt cancellation, multiplied by 3.
Any net capital loss for the tax year of the debt cancellation and any capital loss carryover to that year.
Any passive activity loss and credit carryovers from the tax year of the debt cancellation. Any credit carryover is multiplied by 3.
Any foreign tax credit carryovers to or from the tax year of the debt cancellation, multiplied 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 benefits
If you exclude canceled debt from income under the qualified farm debt rules, you must use the excluded debt to reduce tax benefits. (If you also excluded canceled debt under the insolvency rules, you reduce the amount of the tax benefits remaining after reduction for the exclusion allowed under the insolvency rules.) You generally must follow the reduction rules previously explained under Bankruptcy and Insolvency. However, do not follow the rules in item (5), Basis. Instead, follow the special rules explained next.
Special rules for reducing the basis of property
You must use special rules to reduce the basis of property for excluded canceled qualified farm debt. Under these special rules, you only reduce the basis of qualified property (defined earlier). Reduce it in the following order.
Depreciable qualified property. You may elect on Form 982 to treat real property held as inventory as depreciable property.
Land that is qualified property and is used or held for use in your farming business.
Other qualified property.
Form 982
Use Form 982 to show the amounts of canceled debt excluded from income and the reduction of tax benefits in the order listed on the form. Also use it if you are electing to apply the excluded canceled debt to reduce the basis of depreciable property before reducing tax benefits. 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 extensions) 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 excluded canceled debt to reduce the basis of depreciable property first, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). 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 are 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 neighbor 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 applicable 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 receive from the borrower. See chapter 1 of Publication 550 for more information on below-market loans.
Commodity futures and options
See Hedging (Commodity Futures) in chapter 8 for information on gains and losses from commodity futures and options transactions. Custom hire (machine work). Pay you receive for contract work or custom work that you or your hired help perform off your farm for others, 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. Report this income on Schedule F, Part I, line 9. 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.
Example —
You granted a 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.
If the payment is less than the basis properly allocated to the part of your land affected by the right-of-way, reduce the basis by $10,000.
If the payment is equal to or more than the basis of the affected part of your land, reduce 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.
If construction of the line damaged growing crops and you later receive a settlement of $250 for this damage, the $250 is income and is included on Schedule F, line 10. It does not 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 as an expense that reduced your income tax. See chapter 14 for more information about fuel tax credits and refunds.
Illegal federal irrigation subsidy
The federal government, operating through the Bureau of Reclamation, has made irrigation water from certain reclamation and irrigation projects available 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 10. You cannot take a deduction for the amount you must include in income. For more information on reclamation and irrigation 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 as Other income. If you receive a prize in cash, include the full amount in income. If you receive a prize in produce or other property, include the fair market value of the property. For prizes of $600 or more, you should receive a Form 1099-MISC, Miscellaneous Income. See chapter 12 for information about prizes related to 4-H Club or FFA projects. See Publication 525 for information about other prizes.
Property sold, destroyed, stolen, or condemned
You may have an ordinary or capital gain if property you own is sold or exchanged, stolen, destroyed by fire, flood, or other casualty, 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 certain depreciation
If you took a section 179 deduction for property used in your farming business and at any time during the property's recovery period you do not use it more than 50% in your business, you must include part of the deduction in income. See chapter 7 for information on the section 179 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 depreciation 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, refund, 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 did not decrease your income tax, you do not have to include that part of the reimbursement, refund, or recovery.
Example —
A tenant farmer purchased fertilizer for $1,000 in April 2006. He deducted $1,000 on his 2006 Schedule F and the entire deduction reduced his tax. The landowner reimbursed him $500 of the cost of the fertilizer in February 2007. The tenant farmer must include $500 in income on his 2007 tax return because the entire deduction decreased his 2006 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 property, the proceeds are ordinary income. A reasonable allowance for depletion of the natural 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 transaction is a sale. You are considered to retain an economic interest if, under the terms of the legal relationship, you depend on the income derived 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 is ordinary income subject to an allowance for depletion. 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.
Income Averaging for Farmers
If you are engaged in a farming business, you may be able to average all or some of your farm income by allocating it to the 3 prior years (base years). This may give you a lower tax if your income from farming is high and your taxable income from one or more of the 3 prior years was low. The term “farming business” is defined in the instructions for Schedule J (Form 1040).
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 partnership, or a shareholder in an S corporation. Services performed as an employee are disregarded in determining whether an individual is engaged in a farming business. However, a shareholder of an S corporation engaged in a farming business may treat compensation received from the corporation that is attributable to the farming business as farm income. You do not need to have been engaged in a farming business in any base year. Corporations, partnerships, S corporations, estates, and trusts cannot 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 cannot be more than your taxable income, and any EFI from a net capital gain attributable to your farming business cannot 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 does not include gain from the sale or other disposition of land.
Gains from the sale or other disposition of farm property
Gains from the sale or other disposition of farm property 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 depends on all the facts and circumstances.
Liquidation of a farming business
If you (or your partnership or S corporation) liquidate your farming business, gains on property sold within a reasonable time after operations 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 depends on the facts and circumstances.
EFI and base year rates
If your EFI includes both ordinary income and capital gains, you must allocate an equal portion of each type of income to each base year to figure the tax on EFI. For example, you cannot allocate all of the capital gains to 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 are not prohibited from using income averaging solely because your filing status is not the same as your filing status in the base years. For example, if you are 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 does not 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 capital gain or ordinary loss.
The amount of any net operating loss carryover 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 on Investment Income of Child Under 18
If your child's investment income is more than $1,700, part of that income may be taxed at your tax rate instead of your child's tax rate.
If you use income averaging, figure your child's tax on investment income using your rate after allocating EFI. You cannot use any of your child's investment income as your EFI, even if it is attributable to a farming business. For information on figuring the tax on your child's investment income, see Publication 929, Tax Rules for Children and Dependents.
Alternative Minimum Tax (AMT)
You can elect to use income averaging to compute your regular tax liability. However, income averaging is not 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, Credit for Prior Year Minimum Tax —Individuals, Estates, and Trusts.
Schedule J
You can use income averaging by filing Schedule J (Form 1040) with your timely filed (including 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 has not expired 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.
