Table of Contents
When you dispose of property used in your farm business, your taxable gain or loss is usually treated as ordinary income (which is taxed at the same rates as wages and interest income) or capital gain (which is generally taxed at lower rates) under the rules for section 1231 transactions.
When you dispose of depreciable property (section 1245 property or section 1250 property) at a gain, you may have to recognize all or part of the gain as ordinary income under the depreciation recapture rules. Any gain remaining after applying the depreciation recapture rules is a section 1231 gain, which may be taxed as a capital gain.
Gains and losses from property used in farming are reported on Form 4797, Sales of Business Property. Table 9-1 contains examples of items reported on Form 4797 and refers to the part of that form on which they first should be reported.
Publication
-
544 Sales and Other Dispositions
of Assets
Form (and Instructions)
-
4797 Sales of Business Property
See chapter 16 for information about getting publications and forms.
Section 1231 gains and losses are the taxable gains and losses from section 1231 transactions (explained below). Their treatment as ordinary or capital gains depends on whether you have a net gain or a net loss from all of your section 1231 transactions in the tax year.
Type of property | Held 1 year or less |
Held more than 1 year |
|
1 | Depreciable trade or business property: | ||
a Sold or exchanged at a gain | Part II | Part III (1245, 1250) | |
b Sold or exchanged at a loss | Part II | Part I | |
2 | Farmland held less than 10 years for which soil, water, or land clearing expenses were deducted: | ||
a Sold at a gain | Part II | Part III (1252) | |
b Sold at a loss | Part II | Part I | |
3 | All other farmland | Part II | Part I |
4 | Disposition of cost-sharing payment property described in section 126 | Part II | Part III (1255) |
5 | Cattle and horses used in a trade or business for draft, breeding, dairy, or sporting purposes: | Held less than 24 mos. |
Held 24 mos. or more |
a Sold at a gain | Part II | Part III (1245) | |
b Sold at a loss | Part II | Part I | |
c Raised cattle and horses sold at a gain | Part II | Part I | |
6 | Livestock other than cattle and horses used in a trade or business for draft, breeding, dairy, or sporting purposes: | Held less than 12 mos. |
Held 12 mos. or more |
a Sold at a gain | Part II | Part III (1245) | |
b Sold at a loss | Part II | Part I | |
c Raised livestock sold at a gain | Part II | Part I |
If you have a gain from a section 1231 transaction, first determine whether any of the gain is ordinary income under the depreciation recapture rules (explained later). Do not take that gain into account as section 1231 gain.
-
Sale or exchange of cattle and horses. The cattle and horses must be held for draft, breeding, dairy, or sporting purposes and held for 24 months or longer.
-
Sale or exchange of other livestock. This livestock must be held for draft, breeding, dairy, or sporting purposes and held for 12 months or longer. Other livestock includes hogs, mules, sheep, goats, donkeys, and other fur-bearing animals. Other livestock does not include poultry.
-
Sale or exchange of depreciable personal property. This property must be used in your business and held longer than 1 year. Generally, property held for the production of rents or royalties is considered to be used in a trade or business. Examples of depreciable personal property include farm machinery and trucks. It also includes amortizable section 197 intangibles.
-
Sale or exchange of real estate. This property must be used in your business and held longer than 1 year. Examples are your farm or ranch (including barns and sheds).
-
Sale or exchange of unharvested crops. The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person, and the land must have been held longer than 1 year. You cannot keep any right or option to reacquire the land directly or indirectly (other than a right customarily incident to a mortgage or other security transaction). Growing crops sold with a leasehold on the land, even if sold to the same person in a single transaction, are not included.
-
Distributive share of partnership gains and losses. Your distributive share must be from the sale or exchange of property listed earlier and held longer than 1 year (or for the required period for certain livestock).
-
Cutting or disposal of timber. You must treat the cutting or disposal of timber as a sale, as described in chapter 8 under Timber .
-
Condemnation. The condemned property (defined in chapter 11) must have been held longer than 1 year. It must be business property or a capital asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. It cannot be property held for personal use.
-
Casualty or theft. The casualty or theft must have affected business property, property held for the production of rents or royalties, or investment property (such as notes and bonds). You must have held the property longer than 1 year. However, if your casualty or theft losses are more than your casualty or theft gains, neither the gains nor the losses are taken into account in the section 1231 computation. Section 1231 does not apply to personal casualty gains and losses. See chapter 11 for information on how to treat those gains and losses.
If the property is not held for the required holding period, the transaction is not subject to section 1231 treatment, and any gain or loss is ordinary income reported in Part II of Form 4797. See Table 9-1.
-
If you have a net section 1231 loss, it is an ordinary loss.
-
If you have a net section 1231 gain, it is ordinary income up to your nonrecaptured section 1231 losses from previous years, explained next. The rest, if any, is long-term capital gain.
Example.
In 2011, Ben has a $2,000 net section 1231 gain. To figure how much he has to report as ordinary income and long-term capital gain, he must first determine his section 1231 gains and losses from the previous 5-year period. From 2006 through 2010 he had the following section 1231 gains and losses.
Ben uses this information to figure how to report his net section 1231 gain for 2011 as shown below.
1) | Net section 1231 gain (2011) | $2,000 | |
2) | Net section 1231 loss (2008) | ($2,500) | |
3) | Net section 1231 gain (2010) | 1,800 | |
4) | Remaining net section 1231 loss from prior 5 years |
($700) | |
5) | Gain treated as ordinary income |
$700 | |
6) | Gain treated as long-term capital gain |
$1,300 |
His remaining net section 1231 loss from 2008 is completely recaptured in 2011.
If you dispose of depreciable or amortizable property at a gain, you may have to treat all or part of the gain (even if it is otherwise nontaxable) as ordinary income.
To figure any gain that must be reported as ordinary income, you must keep permanent records of the facts necessary to figure the depreciation or amortization allowed or allowable on your property. For more information, see chapter 3 of Publication 544.
A gain on the disposition of section 1245 property is treated as ordinary income to the extent of depreciation allowed or allowable.
Any recognized gain that is more than the part that is ordinary income because of depreciation is a section 1231 gain. See Treatment as ordinary or capital under Section 1231 Gains and Losses , earlier.
Section 1245 property includes any property that is or has been subject to an allowance for depreciation or amortization and that is any of the following types of property.
-
Personal property (either tangible or intangible).
-
Other tangible property (except buildings and their structural components) used as any of the following. See Buildings and structural components below.
-
An integral part of manufacturing, production, or extraction, or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services.
-
A research facility in any of the activities in (a).
-
A facility in any of the activities in (a) above, for the bulk storage of fungible commodities (discussed later).
-
-
That part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following.
-
Amortization of certified pollution control facilities.
-
The section 179 expense deduction.
-
Deduction for clean-fuel vehicles and certain refueling property.
-
Certain expenditures for child care facilities. (Repealed by Public Law 101-58, Omnibus Budget Reconciliation Act of 1990, section 11801(a)(13) except with regards to deductions made prior to November 5, 1990.)
-
Expenditures to remove architectural and transportation barriers to the handicapped and elderly.
-
Certain reforestation expenditures.
-
-
Single purpose agricultural (livestock) or horticultural structures.
-
Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary product of petroleum.
The gain treated as ordinary income on the sale, exchange, or involuntary conversion of section 1245 property, including a sale and leaseback transaction, is the lesser of the following amounts.
-
The depreciation (which includes any section 179 deduction claimed) and amortization allowed or allowable on the property.
-
The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property).
For any other disposition of section 1245 property, ordinary income is the lesser of (1) above or the amount by which its fair market value (FMV) is more than its adjusted basis. For details, see chapter 3 of Publication 544.
Use Part III of Form 4797 to figure the ordinary income part of the gain.
-
Amounts you claimed on property you exchanged for, or converted to, your section 1245 property in a like-kind exchange or involuntary conversion. For details on exchanges of property that are not taxable, see Like-Kind Exchanges in chapter 8.
-
Amounts a previous owner of the section 1245 property claimed if your basis is determined with reference to that person's adjusted basis (for example, the donor's depreciation deductions on property you received as a gift).
Example.
Jeff Free paid $120,000 for a tractor in 2010. On February 23, 2011, he traded it for a chopper and paid an additional $30,000. To figure his depreciation deduction for the current year, Jeff continues to use the basis of the tractor as he would have before the trade to depreciate the chopper. Jeff can also depreciate the additional $30,000 basis on the chopper.
-
Ordinary depreciation deductions.
-
Section 179 deduction (see chapter 7).
-
Any special depreciation allowance.
-
Amortization deductions for all the following costs.
-
Acquiring a lease.
-
Lessee improvements.
-
Pollution control facilities.
-
Reforestation expenses.
-
Section 197 intangibles.
-
Childcare facility expenses incurred before 1982.
-
Franchises, trademarks, and trade names acquired before August 11, 1993.
-
Example.
You file your returns on a calendar year basis. In February 2009, you bought and placed in service for 100% use in your farming business a light-duty truck (5-year property) that cost $10,000. You used the half-year convention and your MACRS deductions for the truck were $1,500 in 2009 and $2,550 in 2010. You did not claim the section 179 expense deduction for the truck. You sold it in May 2011 for $7,000. The MACRS deduction in 2011, the year of sale, is $893 (½ of $1,785). Figure the gain treated as ordinary income as follows.
1) | Amount realized | $7,000 | |
2) | Cost (February 2009) | $10,000 | |
3) | Depreciation allowed or allowable (MACRS deductions: $1,500 + $2,550 + $893) | 4,943 | |
4) | Adjusted basis (subtract line 3 from line 2) |
$5,057 | |
5) | Gain realized (subtract line 4 from line 1) |
1,943 | |
6) | Gain treated as ordinary income (lesser of line 3 or line 5) |
$1,943 |
chapter 2 to figure these expenses.
Example.
Janet Maple sold her apple orchard in 2011 for $80,000. Her adjusted basis at the time of sale was $60,000. She bought the orchard in 2004, but the trees did not produce a crop until 2007. Her pre-productive expenses were $6,000. She elected not to use the uniform capitalization rules. Janet must treat $6,000 of the gain as ordinary income.
Section 1250 property includes all real property subject to an allowance for depreciation that is not and never has been section 1245 property. It includes buildings and structural components that are not section 1245 property (discussed earlier). It includes a leasehold of land or section 1250 property subject to an allowance for depreciation. A fee simple interest in land is not section 1250 property because, like land, it is not depreciable.
Gain on the disposition of section 1250 property is treated as ordinary income to the extent of additional depreciation allowed or allowable. To determine the additional depreciation on section 1250 property, see Depreciation Recapture in chapter 3 of Publication 544.
You will not have additional depreciation if any of the following apply to the property disposed of.
-
You figured depreciation for the property using the straight line method or any other method that does not result in depreciation that is more than the amount figured by the straight line method and you have held the property longer than 1 year.
-
You chose the alternate ACRS (straight line) method for the property, which was a type of 15-, 18-, or 19-year real property covered by the section 1250 rules.
-
The property was nonresidential real property placed in service after 1986 (or after July 31, 1986, if the choice to use MACRS was made) and you held it longer than 1 year. These properties are depreciated using the straight line method.
If you report the sale of property under the installment method, any depreciation recapture under section 1245 or 1250 is taxable as ordinary income in the year of sale. This applies even if no payments are received in that year. If the gain is more than the depreciation recapture income, report the rest of the gain using the rules of the installment method. For this purpose, include the recapture income in your installment sale basis to determine your gross profit on the installment sale.
If you dispose of more than one asset in a single transaction, you must separately figure the gain on each asset so that it may be properly reported. To do this, allocate the selling price and the payments you receive in the year of sale to each asset. Report any depreciation recapture income in the year of sale before using the installment method for any remaining gain.
For more information on installment sales, see chapter 10.
This section discusses gain on the disposition of farmland for which you were allowed either of the following.
-
Deductions for soil and water conservation expenditures (section 1252 property).
-
Exclusions from income for certain cost sharing payments (section 1255 property).
-
Disposition of farmland by gift.
-
Transfer of farm property at death (except for income in respect of a decedent).
-
Your gain (determined by subtracting the adjusted basis from the amount realized from a sale, exchange, or involuntary conversion, or the FMV for all other dispositions).
-
The total deductions allowed for soil and water conservation expenses multiplied by the applicable percentage, discussed next.
Example.
You acquired farmland on January 19, 2003. On October 3, 2011, you sold the land at a $30,000 gain. Between January 1 and October 3, 2011, you incur soil and water conservation expenditures of $15,000 for the land that are fully deductible in 2011. The applicable percentage is 40% since you sold the land within the 8th year after you acquired it. You treat $6,000 (40% of $15,000) of the $30,000 gain as ordinary income and the $24,000 balance as a section 1231 gain.
-
The applicable percentage of the total excluded cost-sharing payments.
-
The gain on the disposition of the property.
More Online Publications |