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1040easy 8. 1040easy   Gains and Losses Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Sales and ExchangesDetermining Gain or Loss Like-Kind Exchanges Transfer to Spouse Ordinary or Capital Gain or LossCapital Assets Noncapital Assets Hedging (Commodity Futures) Livestock Converted Wetland and Highly Erodible Cropland Timber Sale of a Farm Foreclosure or Repossession Abandonment Introduction This chapter explains how to figure, and report on your tax return, your gain or loss on the disposition of your property or debt and whether such gain or loss is ordinary or capital. 1040easy Ordinary gain is taxed at the same rates as wages and interest income while capital gain is generally taxed at lower rates. 1040easy Dispositions discussed in this chapter include sales, exchanges, foreclosures, repossessions, canceled debts, hedging transactions, and elections to treat cutting of timber as a sale or exchange. 1040easy Topics - This chapter discusses: Sales and exchanges Ordinary or capital gain or loss Useful Items - You may want to see: Publication 334 Tax Guide for Small Business 523 Selling Your Home 544 Sales and Other Dispositions of Assets 550 Investment Income and Expenses 908 Bankruptcy Tax Guide Form (and Instructions) 982 Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) Sch D (Form 1040) Capital Gains and Losses Sch F (Form 1040) Profit or Loss From Farming 1099-A Acquisition or Abandonment of Secured Property 1099-C Cancellation of Debt 4797 Sales of Business Property 8949 Sales and Other Dispositions of Capital Assets See chapter 16 for information about getting publications and forms. 1040easy Sales and Exchanges If you sell, exchange, or otherwise dispose of your property, you usually have a gain or a loss. 1040easy This section explains certain rules for determining whether any gain you have is taxable, and whether any loss you have is deductible. 1040easy A sale is a transfer of property for money or a mortgage, note, or other promise to pay money. 1040easy An exchange is a transfer of property for other property or services. 1040easy Determining Gain or Loss You usually realize a gain or loss when you sell or exchange property. 1040easy If the amount you realize from a sale or exchange of property is more than its adjusted basis, you will have a gain. 1040easy If the adjusted basis of the property is more than the amount you realize, you will have a loss. 1040easy Basis and adjusted basis. 1040easy   The basis of property you buy is usually its cost. 1040easy The adjusted basis of property is basis plus certain additions and minus certain deductions. 1040easy See chapter 6 for more information about basis and adjusted basis. 1040easy Amount realized. 1040easy   The amount you realize from a sale or exchange is the total of all money you receive plus the fair market value (FMV) (defined in chapter 6) of all property or services you receive. 1040easy The amount you realize also includes any of your liabilities assumed by the buyer and any liabilities to which the property you transferred is subject, such as real estate taxes or a mortgage. 1040easy   If the liabilities relate to an exchange of multiple properties, see Multiple Property Exchanges in chapter 1 of Publication 544. 1040easy Amount recognized. 1040easy   Your gain or loss realized from a sale or exchange of certain property is usually a recognized gain or loss for tax purposes. 1040easy A recognized gain is a gain you must include in gross income and report on your income tax return. 1040easy A recognized loss is a loss you deduct from gross income. 1040easy However, your gain or loss realized from the exchange of certain property may not be recognized for tax purposes. 1040easy See Like-Kind Exchanges next. 1040easy Also, a loss from the disposition of property held for personal use is not deductible. 1040easy Like-Kind Exchanges Certain exchanges of property are not taxable. 1040easy This means any gain from the exchange is not recognized, and any loss cannot be deducted. 1040easy Your gain or loss will not be recognized until you sell or otherwise dispose of the property you receive. 1040easy The exchange of property for the same kind of property is the most common type of nontaxable exchange. 1040easy To qualify for treatment as a like-kind exchange, the property traded and the property received must be both of the following. 1040easy Qualifying property. 1040easy Like-kind property. 1040easy These two requirements are discussed later. 1040easy Multiple-party transactions. 1040easy   The like-kind exchange rules also apply to property exchanges that involve three and four-party transactions. 1040easy Any part of these multiple-party transactions can qualify as a like-kind exchange if it meets all the requirements described in this section. 1040easy Receipt of title from third party. 1040easy   If you receive property in a like-kind exchange and the other party who transfers the property to you does not give you the title, but a third party does, you can still treat this transaction as a like-kind exchange if it meets all the requirements. 1040easy Basis of property received. 1040easy   If you receive property in a like-kind exchange, the basis of the property will be the same as the basis of the property you gave up. 1040easy See chapter 6 for more information. 1040easy Money paid. 1040easy   If, in addition to giving up like-kind property, you pay money in a like-kind exchange, you still have no recognized gain or loss. 1040easy The basis of the property received is the basis of the property given up, increased by the money paid. 1040easy Example. 1040easy You traded an old tractor with an adjusted basis of $15,000 for a new one. 1040easy The new tractor costs $300,000. 1040easy You were allowed $80,000 for the old tractor and paid $220,000 cash. 1040easy You have no recognized gain or loss on the transaction regardless of the adjusted basis of your old tractor and the basis of the new tractor is $235,000, the adjusted basis of the old tractor plus the cash paid ($15,000 + $220,000). 1040easy If you had sold the old tractor to a third party for $80,000 and bought a new one, you would have a recognized gain or loss on the sale of your old tractor equal to the difference between the amount realized and the adjusted basis of the old tractor. 1040easy In this case, the taxable gain would be $65,000 ($80,000 − $15,000) and the basis of the new tractor would be $300,000. 1040easy Reporting the exchange. 1040easy   Report the exchange of like-kind property, even though no gain or loss is recognized, on Form 8824, Like-Kind Exchanges. 1040easy The Instructions for Form 8824 explain how to report the details of the exchange. 1040easy   If you have any recognized gain because you received money or unlike property, report it on Schedule D (Form 1040) or Form 4797, whichever applies. 1040easy You may also have to report the recognized gain as ordinary income because of depreciation recapture on Form 4797. 1040easy See chapter 9 for more information. 1040easy Qualifying property. 1040easy   In a like-kind exchange, both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business. 1040easy Machinery, buildings, land, trucks, breeding livestock, rental houses, and certain mutual ditch, reservoir, or irrigation company stock are examples of property that may qualify. 1040easy Nonqualifying property. 1040easy   The rules for like-kind exchanges do not apply to exchanges of the following property. 1040easy Property you use for personal purposes, such as your home and family car. 1040easy Stock in trade or other property held primarily for sale, such as crops and produce. 1040easy Stocks, bonds, or notes. 1040easy However, see Qualifying property above. 1040easy Other securities or evidences of indebtedness, such as accounts receivable. 1040easy Partnership interests. 1040easy However, you may have a nontaxable exchange under other rules. 1040easy See Other Nontaxable Exchanges in chapter 1 of Publication 544. 1040easy Like-kind property. 1040easy   To qualify as a nontaxable exchange, the properties exchanged must be of like kind. 1040easy Like-kind properties are properties of the same nature or character, even if they differ in grade or quality. 1040easy Generally, real property exchanged for real property qualifies as an exchange of like-kind property. 1040easy For example, an exchange of city property for farm property or improved property for unimproved property is a like-kind exchange. 1040easy   An exchange of a tractor for a new tractor is an exchange of like-kind property, and so is an exchange of timber land for crop acreage. 1040easy An exchange of a tractor for acreage, however, is not an exchange of like-kind property. 1040easy The exchange of livestock of one sex for livestock of the other sex is not a like-kind exchange. 1040easy For example, the exchange of a bull for a cow is not a like-kind exchange. 1040easy An exchange of the assets of a business for the assets of a similar business cannot be treated as an exchange of one property for another property. 1040easy    Note. 1040easy Whether you engaged in a like-kind exchange depends on an analysis of each asset involved in the exchange. 1040easy Personal property. 1040easy   Depreciable tangible personal property can be either like kind or like class to qualify for nontaxable exchange treatment. 1040easy Like-class properties are depreciable tangible personal properties within the same General Asset Class or Product Class. 1040easy Property classified in any General Asset Class may not be classified within a Product Class. 1040easy Assets that are not in the same class will qualify as like-kind property if they are of the same nature or character. 1040easy General Asset Classes. 1040easy   General Asset Classes describe the types of property frequently used in many businesses. 1040easy They include, but are not limited to, the following property. 1040easy Office furniture, fixtures, and equipment (asset class 00. 1040easy 11). 1040easy Information systems, such as computers and peripheral equipment (asset class 00. 1040easy 12). 1040easy Data handling equipment except computers (asset class 00. 1040easy 13). 1040easy Automobiles and taxis (asset class 00. 1040easy 22). 1040easy Light general purpose trucks (asset class 00. 1040easy 241). 1040easy Heavy general purpose trucks (asset class 00. 1040easy 242). 1040easy Tractor units for use over-the-road (asset class 00. 1040easy 26). 1040easy Trailers and trailer-mounted containers (asset class 00. 1040easy 27). 1040easy Industrial steam and electric generation and/or distribution systems (asset class 00. 1040easy 4). 1040easy Product Classes. 1040easy   Product Classes include property listed in a 6-digit product class in sectors 31 through 33 of the North American Industry Classification System (NAICS) of the Executive Office of the President, Office of Management and Budget, United States, (NAICS Manual). 1040easy The latest version of the manual can be accessed at www. 1040easy census. 1040easy gov/eos/www/naics/. 1040easy Copies of the printed manual may be purchased from the National Technical Information Service (NTIS) at  www. 1040easy ntis. 1040easy gov/products/naics. 1040easy aspx or by calling 1-800-553-NTIS (1-800-553-6847) or (703) 605-6000. 1040easy A CD-ROM version with search and retrieval software is also available from NTIS. 1040easy    NAICS class 333111, Farm Machinery and Equipment Manufacturing, includes most machinery and equipment used in a farming business. 1040easy Partially nontaxable exchange. 1040easy   If, in addition to like-kind property, you receive money or unlike property in an exchange on which you realize gain, you have a partially nontaxable exchange. 1040easy You are taxed on the gain you realize, but only to the extent of the money and the FMV of the unlike property you receive. 1040easy A loss is not deductible. 1040easy Example 1. 1040easy You trade farmland that cost $30,000 for $10,000 cash and other land to be used in farming with a FMV of $50,000. 1040easy You have a realized gain of $30,000 ($50,000 FMV of new land + $10,000 cash − $30,000 basis of old farmland = $30,000 realized gain). 1040easy However, only $10,000, the cash received, is recognized (included in income). 1040easy Example 2. 1040easy Assume the same facts as in Example 1, except that, instead of money, you received a tractor with a FMV of $10,000. 1040easy Your recognized gain is still limited to $10,000, the value of the tractor (the unlike property). 1040easy Example 3. 1040easy Assume in Example 1 that the FMV of the land you received was only $15,000. 1040easy Your $5,000 loss is not recognized. 1040easy Unlike property given up. 1040easy   If, in addition to like-kind property, you give up unlike property, you must recognize gain or loss on the unlike property you give up. 1040easy The gain or loss is the difference between the FMV of the unlike property and the adjusted basis of the unlike property. 1040easy Like-kind exchanges between related persons. 1040easy   Special rules apply to like-kind exchanges between related persons. 1040easy These rules affect both direct and indirect exchanges. 1040easy Under these rules, if either person disposes of the property within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. 1040easy The gain or loss on the original exchange must be recognized as of the date of the later disposition. 1040easy The 2-year holding period begins on the date of the last transfer of property that was part of the like-kind exchange. 1040easy Related persons. 1040easy   Under these rules, related persons include, for example, you and a member of your family (spouse, brother, sister, parent, child, etc. 1040easy ), you and a corporation in which you have more than 50% ownership, you and a partnership in which you directly or indirectly own more than a 50% interest of the capital or profits, and two partnerships in which you directly or indirectly own more than 50% of the capital interests or profits. 1040easy   For the complete list of related persons, see Related persons in chapter 2 of Publication 544. 1040easy Example. 1040easy You used a grey pickup truck in your farming business. 1040easy Your sister used a red pickup truck in her landscaping business. 1040easy In December 2012, you exchanged your grey pickup truck, plus $200, for your sister's red pickup truck. 1040easy At that time, the FMV of the grey pickup truck was $7,000 and its adjusted basis was $6,000. 1040easy The FMV of the red pickup truck was $7,200 and its adjusted basis was $1,000. 1040easy You realized a gain of $1,000 (the $7,200 FMV of the red pickup truck, minus the grey pickup truck's $6,000 adjusted basis, minus the $200 you paid). 1040easy Your sister realized a gain of $6,200 (the $7,000 FMV of the grey pickup truck plus the $200 you paid, minus the $1,000 adjusted basis of the red pickup truck). 1040easy However, because this was a like-kind exchange, you recognized no gain. 1040easy Your basis in the red pickup truck was $6,200 (the $6,000 adjusted basis of the grey pickup truck plus the $200 you paid). 1040easy She recognized gain only to the extent of the money she received, $200. 1040easy Her basis in the grey pickup truck was $1,000 (the $1,000 adjusted basis of the red pickup truck minus the $200 received, plus the $200 gain recognized). 1040easy In 2013, you sold the red pickup truck to a third party for $7,000. 1040easy Because you sold it within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. 1040easy On your tax return for 2013, you must report your $1,000 gain on the 2012 exchange. 1040easy You also report a loss on the sale as $200 (the adjusted basis of the red pickup truck, $7,200 (its $6,200 basis plus the $1,000 gain recognized), minus the $7,000 realized from the sale). 1040easy In addition, your sister must report on her tax return for 2013 the $6,000 balance of her gain on the 2012 exchange. 1040easy Her adjusted basis in the grey pickup truck is increased to $7,000 (its $1,000 basis plus the $6,000 gain recognized). 1040easy Exceptions to the rules for related persons. 1040easy   The following property dispositions are excluded from these rules. 1040easy Dispositions due to the death of either related person. 1040easy Involuntary conversions. 1040easy Dispositions where it is established to the satisfaction of the IRS that neither the exchange nor the disposition has, as a main purpose, the avoidance of federal income tax. 1040easy Multiple property exchanges. 1040easy   Under the like-kind exchange rules, you must generally make a property-by-property comparison to figure your recognized gain and the basis of the property you receive in the exchange. 1040easy However, for exchanges of multiple properties, you do not make a property-by-property comparison if you do either of the following. 1040easy Transfer and receive properties in two or more exchange groups. 1040easy Transfer or receive more than one property within a single exchange group. 1040easy   For more information, see Multiple Property Exchanges in chapter 1 of Publication 544. 1040easy Deferred exchange. 1040easy   A deferred exchange for like-kind property may qualify for nonrecognition of gain or loss. 1040easy A deferred exchange is an exchange in which you transfer property you use in business or hold for investment and later receive like-kind property you will use in business or hold for investment. 1040easy The property you receive is replacement property. 1040easy The transaction must be an exchange of property for property rather than a transfer of property for money used to buy replacement property. 1040easy In addition, the replacement property will not be treated as like-kind property unless certain identification and receipt requirements are met. 1040easy   For more information see Deferred Exchanges in chapter 1 of Publication 544. 1040easy Transfer to Spouse No gain or loss is recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse, or a former spouse if incident to divorce. 1040easy This rule does not apply if the recipient is a nonresident alien. 1040easy Nor does this rule apply to a transfer in trust to the extent the liabilities assumed and the liabilities on the property are more than the property's adjusted basis. 1040easy Any transfer of property to a spouse or former spouse on which gain or loss is not recognized is not considered a sale or exchange. 1040easy The recipient's basis in the property will be the same as the adjusted basis of the giver immediately before the transfer. 1040easy This carryover basis rule applies whether the adjusted basis of the transferred property is less than, equal to, or greater than either its FMV at the time of transfer or any consideration paid by the recipient. 1040easy This rule applies for determining loss as well as gain. 1040easy Any gain recognized on a transfer in trust increases the basis. 1040easy For more information on transfers of property incident to divorce, see Property Settlements in Publication 504, Divorced or Separated Individuals. 1040easy Ordinary or Capital Gain or Loss Generally, you will have a capital gain or loss if you sell or exchange a capital asset (defined below). 1040easy You may also have a capital gain if your section 1231 transactions result in a net gain. 1040easy See Section 1231 Gains and Losses in  chapter 9. 1040easy To figure your net capital gain or loss, you must classify your gains and losses as either ordinary or capital (and your capital gains or losses as either short-term or long-term). 1040easy Your net capital gains may be taxed at a lower tax rate than ordinary income. 1040easy See Capital Gains Tax Rates , later. 1040easy Your deduction for a net capital loss may be limited. 1040easy See Treatment of Capital Losses , later. 1040easy Capital Assets Almost everything you own and use for personal purposes or investment is a capital asset. 1040easy The following items are examples of capital assets. 1040easy A home owned and occupied by you and your family. 1040easy Household furnishings. 1040easy A car used for pleasure. 1040easy If your car is used both for pleasure and for farm business, it is partly a capital asset and partly a noncapital asset, defined later. 1040easy Stocks and bonds. 1040easy However, there are special rules for gains on qualified small business stock. 1040easy For more information on this subject, see Gains on Qualified Small Business Stock and Losses on Section 1244 (Small Business) Stock in chapter 4 of Publication 550. 1040easy Personal-use property. 1040easy   Gain from a sale or exchange of personal-use property is a capital gain and is taxable. 1040easy Loss from the sale or exchange of personal-use property is not deductible. 1040easy You can deduct a loss relating to personal-use property only if it results from a casualty or theft. 1040easy For information on casualties and thefts, see chapter 11. 1040easy Long and Short Term Where you report a capital gain or loss depends on how long you own the asset before you sell or exchange it. 1040easy The time you own an asset before disposing of it is the holding period. 1040easy If you hold a capital asset 1 year or less, the gain or loss resulting from its disposition is short term. 1040easy Report it in Part I of Schedule D (Form 1040). 1040easy If you hold a capital asset longer than 1 year, the gain or loss resulting from its disposition is long term. 1040easy Report it in Part II of Schedule D (Form 1040). 1040easy Holding period. 1040easy   To figure if you held property longer than 1 year, start counting on the day after the day you acquired the property. 1040easy The day you disposed of the property is part of your holding period. 1040easy Example. 1040easy If you bought an asset on June 19, 2012, you should start counting on June 20, 2012. 1040easy If you sold the asset on June 19, 2013, your holding period is not longer than 1 year, but if you sold it on June 20, 2013, your holding period is longer than 1 year. 1040easy Inherited property. 1040easy   If you inherit property, you are considered to have held the property longer than 1 year, regardless of how long you actually held it. 1040easy This rule does not apply to livestock used in a farm business. 1040easy See Holding period under Livestock , later. 1040easy Nonbusiness bad debt. 1040easy   A nonbusiness bad debt is a short-term capital loss, deductible in the year the debt becomes worthless. 1040easy See chapter 4 of Publication 550. 1040easy Nontaxable exchange. 1040easy   If you acquire an asset in exchange for another asset and your basis for the new asset is figured, in whole or in part, by using your basis in the old property, the holding period of the new property includes the holding period of the old property. 1040easy That is, it begins on the same day as your holding period for the old property. 1040easy Gift. 1040easy   If you receive a gift of property and your basis in it is figured using the donor's basis, your holding period includes the donor's holding period. 1040easy Real property. 1040easy   To figure how long you held real property, start counting on the day after you received title to it or, if earlier, on the day after you took possession of it and assumed the burdens and privileges of ownership. 1040easy   However, taking possession of real property under an option agreement is not enough to start the holding period. 1040easy The holding period cannot start until there is an actual contract of sale. 1040easy The holding period of the seller cannot end before that time. 1040easy Figuring Net Gain or Loss The totals for short-term capital gains and losses and the totals for long-term capital gains and losses must be figured separately. 1040easy Net short-term capital gain or loss. 1040easy   Combine your short-term capital gains and losses. 1040easy Do this by adding all of your short-term capital gains. 1040easy Then add all of your short-term capital losses. 1040easy Subtract the lesser total from the greater. 1040easy The difference is your net short-term capital gain or loss. 1040easy Net long-term capital gain or loss. 1040easy   Follow the same steps to combine your long-term capital gains and losses. 1040easy The result is your net long-term capital gain or loss. 1040easy Net gain. 1040easy   If the total of your capital gains is more than the total of your capital losses, the difference is taxable. 1040easy However, part of your gain (but not more than your net capital gain) may be taxed at a lower rate than the rate of tax on your ordinary income. 1040easy See Capital Gains Tax Rates , later. 1040easy Net loss. 1040easy   If the total of your capital losses is more than the total of your capital gains, the difference is deductible. 1040easy But there are limits on how much loss you can deduct and when you can deduct it. 1040easy See Treatment of Capital Losses next. 1040easy Treatment of Capital Losses If your capital losses are more than your capital gains, you must claim the difference even if you do not have ordinary income to offset it. 1040easy For taxpayers other than corporations, the yearly limit on the capital loss you can deduct is $3,000 ($1,500 if you are married and file a separate return). 1040easy If your other income is low, you may not be able to use the full $3,000. 1040easy The part of the $3,000 you cannot use becomes part of your capital loss carryover (discussed next). 1040easy Capital loss carryover. 1040easy   Generally, you have a capital loss carryover if either of the following situations applies to you. 1040easy Your net loss on Schedule D (Form 1040), is more than the yearly limit. 1040easy Your taxable income without your deduction for exemptions is less than zero. 1040easy If either of these situations applies to you for 2013, see Capital Losses under Reporting Capital Gains and Losses in chapter 4 of Publication 550 to figure the amount you can carry over to 2014. 1040easy    To figure your capital loss carryover from 2013 to 2014, you will need a copy of your 2013 Form 1040 and Schedule D (Form 1040). 1040easy Capital Gains Tax Rates The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. 1040easy These lower rates are called the maximum capital gains rates. 1040easy The term “net capital gain” means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss. 1040easy See Schedule D (Form 1040) and the Instructions for Schedule D (Form 1040). 1040easy Also see Publication 550. 1040easy Noncapital Assets Noncapital assets include property such as inventory and depreciable property used in a trade or business. 1040easy A list of properties that are not capital assets is provided in the Instructions for Schedule D (Form 1040). 1040easy Property held for sale in the ordinary course of your farm business. 1040easy   Property you hold mainly for sale to customers, such as livestock, poultry, livestock products, and crops, is a noncapital asset. 1040easy Gain or loss from sales or other dispositions of this property is reported on Schedule F (Form 1040) (not on Schedule D (Form 1040) or Form 4797). 1040easy The treatment of this property is discussed in chapter 3. 1040easy Land and depreciable properties. 1040easy   Land and depreciable property you use in farming are not capital assets. 1040easy Noncapital assets also include livestock held for draft, breeding, dairy, or sporting purposes. 1040easy However, your gains and losses from sales and exchanges of your farmland and depreciable properties must be considered together with certain other transactions to determine whether the gains and losses are treated as capital or ordinary gains and losses. 1040easy The sales of these business assets are reported on Form 4797. 1040easy See chapter 9 for more information. 1040easy Hedging (Commodity Futures) Hedging transactions are transactions that you enter into in the normal course of business primarily to manage the risk of interest rate or price changes, or currency fluctuations, with respect to borrowings, ordinary property, or ordinary obligations. 1040easy Ordinary property or obligations are those that cannot produce capital gain or loss if sold or exchanged. 1040easy A commodity futures contract is a standardized, exchange-traded contract for the sale or purchase of a fixed amount of a commodity at a future date for a fixed price. 1040easy The holder of an option on a futures contract has the right (but not the obligation) for a specified period of time to enter into a futures contract to buy or sell at a particular price. 1040easy A forward contract is generally similar to a futures contract except that the terms are not standardized and the contract is not exchange traded. 1040easy Businesses may enter into commodity futures contracts or forward contracts and may acquire options on commodity futures contracts as either of the following. 1040easy Hedging transactions. 1040easy Transactions that are not hedging transactions. 1040easy Futures transactions with exchange-traded commodity futures contracts that are not hedging transactions, generally, result in capital gain or loss and are subject to the mark-to-market rules discussed in Publication 550. 1040easy There is a limit on the amount of capital losses you can deduct each year. 1040easy Hedging transactions are not subject to the mark-to-market rules. 1040easy If, as a farmer-producer, to protect yourself from the risk of unfavorable price fluctuations, you enter into commodity forward contracts, futures contracts, or options on futures contracts and the contracts cover an amount of the commodity within your range of production, the transactions are generally considered hedging transactions. 1040easy They can take place at any time you have the commodity under production, have it on hand for sale, or reasonably expect to have it on hand. 1040easy The gain or loss on the termination of these hedges is generally ordinary gain or loss. 1040easy Farmers who file their income tax returns on the cash method report any profit or loss on the hedging transaction on Schedule F, line 8. 1040easy Gains or losses from hedging transactions that hedge supplies of a type regularly used or consumed in the ordinary course of your trade or business may be ordinary gains or losses. 1040easy Examples include fuel and feed. 1040easy If you have numerous transactions in the commodity futures market during the year, you must be able to show which transactions are hedging transactions. 1040easy Clearly identify a hedging transaction on your books and records before the end of the day you entered into the transaction. 1040easy It may be helpful to have separate brokerage accounts for your hedging and speculation transactions. 1040easy Retain the identification of each hedging transaction with your books and records. 1040easy Also, identify the item(s) or aggregate risk that is being hedged in your records. 1040easy Although the identification of the hedging transaction must be made before the end of the day it was entered into, you have 35 days after entering into the transaction to identify the hedged item(s) or risk. 1040easy For more information on the tax treatment of futures and options contracts, see Commodity Futures and Section 1256 Contracts Marked to Market in Publication 550. 1040easy Accounting methods for hedging transactions. 1040easy   The accounting method you use for a hedging transaction must clearly reflect income. 1040easy This means that your accounting method must reasonably match the timing of income, deduction, gain, or loss from a hedging transaction with the timing of income, deduction, gain, or loss from the item or items being hedged. 1040easy There are requirements and limits on the method you can use for certain hedging transactions. 1040easy See Regulations section 1. 1040easy 446-4(e) for those requirements and limits. 1040easy   Hedging transactions must be accounted for under the rules stated above unless the transaction is subject to mark-to-market accounting under section 475 or you use an accounting method other than the following methods. 1040easy Cash method. 1040easy Farm-price method. 1040easy Unit-livestock-price method. 1040easy   Once you adopt a method, you must apply it consistently and must have IRS approval before changing it. 1040easy   Your books and records must describe the accounting method used for each type of hedging transaction. 1040easy They must also contain any additional identification necessary to verify the application of the accounting method you used for the transaction. 1040easy You must make the additional identification no more than 35 days after entering into the hedging transaction. 1040easy Example of a hedging transaction. 1040easy   You file your income tax returns on the cash method. 1040easy On July 2 you anticipate a yield of 50,000 bushels of corn this year. 1040easy The December futures price is $5. 1040easy 75 a bushel, but there are indications that by harvest time the price will drop. 1040easy To protect yourself against a drop in the price, you enter into the following hedging transaction. 1040easy You sell ten December futures contracts of 5,000 bushels each for a total of 50,000 bushels of corn at $5. 1040easy 75 a bushel. 1040easy   The price did not drop as anticipated but rose to $6 a bushel. 1040easy In November, you sell your crop at a local elevator for $6 a bushel. 1040easy You also close out your futures position by buying ten December contracts for $6 a bushel. 1040easy You paid a broker's commission of $1,400 ($70 per contract) for the complete in and out position in the futures market. 1040easy   The result is that the price of corn rose 25 cents a bushel and the actual selling price is $6 a bushel. 1040easy Your loss on the hedge is 25 cents a bushel. 1040easy In effect, the net selling price of your corn is $5. 1040easy 75 a bushel. 1040easy   Report the results of your futures transactions and your sale of corn separately on Schedule F. 1040easy See the instructions for the 2013 Schedule F (Form 1040). 1040easy   The loss on your futures transactions is $13,900, figured as follows. 1040easy July 2 - Sold December corn futures (50,000 bu. 1040easy @$5. 1040easy 75) $287,500 November 6 - Bought December corn futures (50,000 bu. 1040easy @$6 plus $1,400 broker's commission) 301,400 Futures loss ($13,900) This loss is reported as a negative figure on Schedule F, Part I, line 8, as other income. 1040easy   The proceeds from your corn sale at the local elevator are $300,000 (50,000 bu. 1040easy × $6). 1040easy Report it on Schedule F, Part I, line 2, as income from sales of products you raised. 1040easy   Assume you were right and the price went down 25 cents a bushel. 1040easy In effect, you would still net $5. 1040easy 75 a bushel, figured as follows. 1040easy Sold cash corn, per bushel $5. 1040easy 50 Gain on hedge, per bushel . 1040easy 25 Net price, per bushel $5. 1040easy 75       The gain on your futures transactions would have been $11,100, figured as follows. 1040easy July 2 - Sold December corn futures (50,000 bu. 1040easy @$5. 1040easy 75) $287,500 November 6 - Bought December corn futures (50,000 bu. 1040easy @$5. 1040easy 50 plus $1,400 broker's commission) 276,400 Futures gain $11,100 The $11,100 is reported on Schedule F, Part I, line 8, as other income. 1040easy   The proceeds from the sale of your corn at the local elevator, $275,000, are reported on Schedule F, Part I, line 2, as income from sales of products you raised. 1040easy Livestock This part discusses the sale or exchange of livestock used in your farm business. 1040easy Gain or loss from the sale or exchange of this livestock may qualify as a section 1231 gain or loss. 1040easy However, any part of the gain that is ordinary income from the recapture of depreciation is not included as section 1231 gain. 1040easy See chapter 9 for more information on section 1231 gains and losses and the recapture of depreciation under section 1245. 1040easy The rules discussed here do not apply to the sale of livestock held primarily for sale to customers. 1040easy The sale of this livestock is reported on Schedule F. 1040easy See chapter 3. 1040easy Also, special rules apply to sales or exchanges caused by weather-related conditions. 1040easy See chapter 3. 1040easy Holding period. 1040easy   The sale or exchange of livestock used in your farm business (defined below) qualifies as a section 1231 transaction if you held the livestock for 12 months or more (24 months or more for horses and cattle). 1040easy Livestock. 1040easy   For section 1231 transactions, livestock includes cattle, hogs, horses, mules, donkeys, sheep, goats, fur-bearing animals, and other mammals. 1040easy Also, for section 1231 transactions, livestock does not include chickens, turkeys, pigeons, geese, emus, ostriches, rheas, or other birds, fish, frogs, reptiles, etc. 1040easy Livestock used in farm business. 1040easy   If livestock is held primarily for draft, breeding, dairy, or sporting purposes, it is used in your farm business. 1040easy The purpose for which an animal is held ordinarily is determined by a farmer's actual use of the animal. 1040easy An animal is not held for draft, breeding, dairy, or sporting purposes merely because it is suitable for that purpose, or because it is held for sale to other persons for use by them for that purpose. 1040easy However, a draft, breeding, or sporting purpose may be present if an animal is disposed of within a reasonable time after it is prevented from its intended use or made undesirable as a result of an accident, disease, drought, or unfitness of the animal. 1040easy Example 1. 1040easy You discover an animal that you intend to use for breeding purposes is sterile. 1040easy You dispose of it within a reasonable time. 1040easy This animal was held for breeding purposes. 1040easy Example 2. 1040easy You retire and sell your entire herd, including young animals that you would have used for breeding or dairy purposes had you remained in business. 1040easy These young animals were held for breeding or dairy purposes. 1040easy Also, if you sell young animals to reduce your breeding or dairy herd because of drought, these animals are treated as having been held for breeding or dairy purposes. 1040easy See Sales Caused by Weather-Related Conditions in chapter 3. 1040easy Example 3. 1040easy You are in the business of raising hogs for slaughter. 1040easy Customarily, before selling your sows, you obtain a single litter of pigs that you will raise for sale. 1040easy You sell the brood sows after obtaining the litter. 1040easy Even though you hold these brood sows for ultimate sale to customers in the ordinary course of your business, they are considered to be held for breeding purposes. 1040easy Example 4. 1040easy You are in the business of raising registered cattle for sale to others for use as breeding cattle. 1040easy The business practice is to breed the cattle before sale to establish their fitness as registered breeding cattle. 1040easy Your use of the young cattle for breeding purposes is ordinary and necessary for selling them as registered breeding cattle. 1040easy Such use does not demonstrate that you are holding the cattle for breeding purposes. 1040easy However, those cattle you held as additions or replacements to your own breeding herd to produce calves are considered to be held for breeding purposes, even though they may not actually have produced calves. 1040easy The same applies to hog and sheep breeders. 1040easy Example 5. 1040easy You breed, raise, and train horses for racing purposes. 1040easy Every year you cull horses from your racing stable. 1040easy In 2013, you decided that to prevent your racing stable from getting too large to be effectively operated, you must cull six horses that had been raced at public tracks in 2012. 1040easy These horses are all considered held for sporting purposes. 1040easy Figuring gain or loss on the cash method. 1040easy   Farmers or ranchers who use the cash method of accounting figure their gain or loss on the sale of livestock used in their farming business as follows. 1040easy Raised livestock. 1040easy   Gain on the sale of raised livestock is generally the gross sales price reduced by any expenses of the sale. 1040easy Expenses of sale include sales commissions, freight or hauling from farm to commission company, and other similar expenses. 1040easy The basis of the animal sold is zero if the costs of raising it were deducted during the years the animal was being raised. 1040easy However, see Uniform Capitalization Rules in chapter 6. 1040easy Purchased livestock. 1040easy   The gross sales price minus your adjusted basis and any expenses of sale is the gain or loss. 1040easy Example. 1040easy A farmer sold a breeding cow on January 8, 2013, for $1,250. 1040easy Expenses of the sale were $125. 1040easy The cow was bought July 2, 2009, for $1,300. 1040easy Depreciation (not less than the amount allowable) was $867. 1040easy Gross sales price $1,250 Cost (basis) $1,300   Minus: Depreciation deduction 867   Unrecovered cost (adjusted basis) $ 433   Expense of sale 125 558 Gain realized $ 692 Converted Wetland and Highly Erodible Cropland Special rules apply to dispositions of land converted to farming use after March 1, 1986. 1040easy Any gain realized on the disposition of converted wetland or highly erodible cropland is treated as ordinary income. 1040easy Any loss on the disposition of such property is treated as a long-term capital loss. 1040easy Converted wetland. 1040easy   This is generally land that was drained or filled to make the production of agricultural commodities possible. 1040easy It includes converted wetland held by the person who originally converted it or held by any other person who used the converted wetland at any time after conversion for farming. 1040easy   A wetland (before conversion) is land that meets all the following conditions. 1040easy It is mostly soil that, in its undrained condition, is saturated, flooded, or ponded long enough during a growing season to develop an oxygen-deficient state that supports the growth and regeneration of plants growing in water. 1040easy It is saturated by surface or groundwater at a frequency and duration sufficient to support mostly plants that are adapted for life in saturated soil. 1040easy It supports, under normal circumstances, mostly plants that grow in saturated soil. 1040easy Highly erodible cropland. 1040easy   This is cropland subject to erosion that you used at any time for farming purposes other than grazing animals. 1040easy Generally, highly erodible cropland is land currently classified by the Department of Agriculture as Class IV, VI, VII, or VIII under its classification system. 1040easy Highly erodible cropland also includes land that would have an excessive average annual erosion rate in relation to the soil loss tolerance level, as determined by the Department of Agriculture. 1040easy Successor. 1040easy   Converted wetland or highly erodible cropland is also land held by any person whose basis in the land is figured by reference to the adjusted basis of a person in whose hands the property was converted wetland or highly erodible cropland. 1040easy Timber Standing timber you held as investment property is a capital asset. 1040easy Gain or loss from its sale is capital gain or loss reported on Form 8949 and Schedule D (Form 1040), as applicable. 1040easy If you held the timber primarily for sale to customers, it is not a capital asset. 1040easy Gain or loss on its sale is ordinary business income or loss. 1040easy It is reported on Schedule F, line 1 (purchased timber) or line 2 (raised timber). 1040easy See the Instructions for Schedule F (Form 1040). 1040easy Farmers who cut timber on their land and sell it as logs, firewood, or pulpwood usually have no cost or other basis for that timber. 1040easy Amounts realized from these sales, and the expenses incurred in cutting, hauling, etc. 1040easy , are ordinary farm income and expenses reported on Schedule F. 1040easy Different rules apply if you owned the timber longer than 1 year and elect to treat timber cutting as a sale or exchange or you enter into a cutting contract, discussed below. 1040easy Timber considered cut. 1040easy   Timber is considered cut on the date when, in the ordinary course of business, the quantity of felled timber is first definitely determined. 1040easy This is true whether the timber is cut under contract or whether you cut it yourself. 1040easy Christmas trees. 1040easy   Evergreen trees, such as Christmas trees, that are more than 6 years old when severed from their roots and sold for ornamental purposes are included in the term timber. 1040easy They qualify for both rules discussed below. 1040easy Election to treat cutting as a sale or exchange. 1040easy   Under the general rule, the cutting of timber results in no gain or loss. 1040easy It is not until a sale or exchange occurs that gain or loss is realized. 1040easy But if you owned or had a contractual right to cut timber, you can elect to treat the cutting of timber as a section 1231 transaction in the year it is cut. 1040easy Even though the cut timber is not actually sold or exchanged, you report your gain or loss on the cutting for the year the timber is cut. 1040easy Any later sale results in ordinary business income or loss. 1040easy See the example below. 1040easy   To elect this treatment, you must: Own or hold a contractual right to cut the timber for a period of more than 1 year before it is cut, and Cut the timber for sale or use in your trade or business. 1040easy Making the election. 1040easy   You make the election on your return for the year the cutting takes place by including in income the gain or loss on the cutting and including a computation of your gain or loss. 1040easy You do not have to make the election in the first year you cut the timber. 1040easy You can make it in any year to which the election would apply. 1040easy If the timber is partnership property, the election is made on the partnership return. 1040easy This election cannot be made on an amended return. 1040easy   Once you have made the election, it remains in effect for all later years unless you revoke it. 1040easy Election under section 631(a) may be revoked. 1040easy   If you previously elected for any tax year ending before October 23, 2004, to treat the cutting of timber as a sale or exchange under section 631(a), you may revoke this election without the consent of the IRS for any tax year ending after October 22, 2004. 1040easy The prior election (and revocation) is disregarded for purposes of making a subsequent election. 1040easy See Form T (Timber), Forest Activities Schedule, for more information. 1040easy Gain or loss. 1040easy   Your gain or loss on the cutting of standing timber is the difference between its adjusted basis for depletion and its FMV on the first day of your tax year in which it is cut. 1040easy   Your adjusted basis for depletion of cut timber is based on the number of units (board feet, log scale, or other units) of timber cut during the tax year and considered to be sold or exchanged. 1040easy Your adjusted basis for depletion is also based on the depletion unit of timber in the account used for the cut timber, and should be figured in the same manner as shown in section 611 and Regulations section 1. 1040easy 611-3. 1040easy   Depletion of timber is discussed in chapter 7. 1040easy Example. 1040easy   In April 2013, you owned 4,000 MBF (1,000 board feet) of standing timber longer than 1 year. 1040easy It had an adjusted basis for depletion of $40 per MBF. 1040easy You are a calendar year taxpayer. 1040easy On January 1, 2013, the timber had a FMV of $350 per MBF. 1040easy It was cut in April for sale. 1040easy On your 2013 tax return, you elect to treat the cutting of the timber as a sale or exchange. 1040easy You report the difference between the FMV and your adjusted basis for depletion as a gain. 1040easy This amount is reported on Form 4797 along with your other section 1231 gains and losses to figure whether it is treated as a capital gain or as ordinary gain. 1040easy You figure your gain as follows. 1040easy FMV of timber January 1, 2013 $1,400,000 Minus: Adjusted basis for depletion 160,000 Section 1231 gain $1,240,000   The FMV becomes your basis in the cut timber, and a later sale of the cut timber, including any by-product or tree tops, will result in ordinary business income or loss. 1040easy Outright sales of timber. 1040easy   Outright sales of timber by landowners qualify for capital gains treatment using rules similar to the rules for certain disposal of timber under a contract with retained economic interest (defined later). 1040easy However, for outright sales, the date of disposal is not deemed to be the date the timber is cut because the landowner can elect to treat the payment date as the date of disposal (see Date of disposal below). 1040easy Cutting contract. 1040easy   You must treat the disposal of standing timber under a cutting contract as a section 1231 transaction if all the following apply to you. 1040easy You are the owner of the timber. 1040easy You held the timber longer than 1 year before its disposal. 1040easy You kept an economic interest in the timber. 1040easy   You have kept an economic interest in standing timber if, under the cutting contract, the expected return on your investment is conditioned on the cutting of the timber. 1040easy   The difference between the amount realized from the disposal of the timber and its adjusted basis for depletion is treated as gain or loss on its sale. 1040easy Include this amount on Form 4797 along with your other section 1231 gains or losses. 1040easy Date of disposal. 1040easy   The date of disposal is the date the timber is cut. 1040easy However, for outright sales by landowners or if you receive payment under the contract before the timber is cut, you can elect to treat the date of payment as the date of disposal. 1040easy   This election applies only to figure the holding period of the timber. 1040easy It has no effect on the time for reporting gain or loss (generally when the timber is sold or exchanged). 1040easy   To make this election, attach a statement to the tax return filed by the due date (including extensions) for the year payment is received. 1040easy The statement must identify the advance payments subject to the election and the contract under which they were made. 1040easy   If you timely filed your return for the year you received payment without making the election, you can still make the election by filing an amended return within 6 months after the due date for that year's return (excluding extensions). 1040easy Attach the statement to the amended return and write “Filed pursuant to section 301. 1040easy 9100-2” at the top of the statement. 1040easy File the amended return at the same address the original return was filed. 1040easy Owner. 1040easy   An owner is any person who owns an interest in the timber, including a sublessor and the holder of a contract to cut the timber. 1040easy You own an interest in timber if you have the right to cut it for sale on your own account or for use in your business. 1040easy Tree stumps. 1040easy   Tree stumps are a capital asset if they are on land held by an investor who is not in the timber or stump business as a buyer, seller, or processor. 1040easy Gain from the sale of stumps sold in one lot by such a holder is taxed as a capital gain. 1040easy However, tree stumps held by timber operators after the saleable standing timber was cut and removed from the land are considered by-products. 1040easy Gain from the sale of stumps in lots or tonnage by such operators is taxed as ordinary income. 1040easy   See Form T (Timber) and its separate instructions for more information about dispositions of timber. 1040easy Sale of a Farm The sale of your farm will usually involve the sale of both nonbusiness property (your home) and business property (the land and buildings used in the farm operation and perhaps machinery and livestock). 1040easy If you have a gain from the sale, you may be allowed to exclude the gain on your home. 1040easy For more information, see Publication 523, Selling Your Home. 1040easy The gain on the sale of your business property is taxable. 1040easy A loss on the sale of your business property to an unrelated person is deducted as an ordinary loss. 1040easy Your taxable gain or loss on the sale of property used in your farm business is taxed under the rules for section 1231 transactions. 1040easy See chapter 9. 1040easy Losses from personal-use property, other than casualty or theft losses, are not deductible. 1040easy If you receive payments for your farm in installments, your gain is taxed over the period of years the payments are received, unless you elect not to use the installment method of reporting the gain. 1040easy See chapter 10 for information about installment sales. 1040easy When you sell your farm, the gain or loss on each asset is figured separately. 1040easy The tax treatment of gain or loss on the sale of each asset is determined by the classification of the asset. 1040easy Each of the assets sold must be classified as one of the following. 1040easy Capital asset held 1 year or less. 1040easy Capital asset held longer than 1 year. 1040easy Property (including real estate) used in your business and held 1 year or less (including draft, breeding, dairy, and sporting animals held less than the holding periods discussed earlier under Livestock ). 1040easy Property (including real estate) used in your business and held longer than 1 year (including only draft, breeding, dairy, and sporting animals held for the holding periods discussed earlier). 1040easy Property held primarily for sale or which is of the kind that would be included in inventory if on hand at the end of your tax year. 1040easy Allocation of consideration paid for a farm. 1040easy   The sale of a farm for a lump sum is considered a sale of each individual asset rather than a single asset. 1040easy The residual method is required only if the group of assets sold constitutes a trade or business. 1040easy This method determines gain or loss from the transfer of each asset. 1040easy It also determines the buyer's basis in the business assets. 1040easy For more information, see Sale of a Business in chapter 2 of Publication 544. 1040easy Property used in farm operation. 1040easy   The rules for excluding the gain on the sale of your home, described later under Sale of your home , do not apply to the property used for your farming business. 1040easy Recognized gains and losses on business property must be reported on your return for the year of the sale. 1040easy If the property was held longer than 1 year, it may qualify for section 1231 treatment (see chapter 9). 1040easy Example. 1040easy You sell your farm, including your main home, which you have owned since December 2001. 1040easy You realize gain on the sale as follows. 1040easy   Farm   Farm   With Home Without   Home Only Home Selling price $382,000 $158,000 $224,000 Cost (or other basis) 240,000 110,000 130,000 Gain $142,000 $48,000 $94,000 You must report the $94,000 gain from the sale of the property used in your farm business. 1040easy All or a part of that gain may have to be reported as ordinary income from the recapture of depreciation or soil and water conservation expenses. 1040easy Treat the balance as section 1231 gain. 1040easy The $48,000 gain from the sale of your home is not taxable as long as you meet the requirements explained later under Sale of your home . 1040easy Partial sale. 1040easy   If you sell only part of your farm, you must report any recognized gain or loss on the sale of that part on your tax return for the year of the sale. 1040easy You cannot wait until you have sold enough of the farm to recover its entire cost before reporting gain or loss. 1040easy For a detailed discussion on installment sales, see Publication 544. 1040easy Adjusted basis of the part sold. 1040easy   This is the properly allocated part of your original cost or other basis of the entire farm plus or minus necessary adjustments for improvements, depreciation, etc. 1040easy , on the part sold. 1040easy If your home is on the farm, you must properly adjust the basis to exclude those costs from your farm asset costs, as discussed below under Sale of your home . 1040easy Example. 1040easy You bought a 600-acre farm for $700,000. 1040easy The farm included land and buildings. 1040easy The purchase contract designated $600,000 of the purchase price to the land. 1040easy You later sold 60 acres of land on which you had installed a fence. 1040easy Your adjusted basis for the part of your farm sold is $60,000 (1/10 of $600,000), plus any unrecovered cost (cost not depreciated) of the fence on the 60 acres at the time of sale. 1040easy Use this amount to determine your gain or loss on the sale of the 60 acres. 1040easy Assessed values for local property taxes. 1040easy   If you paid a flat sum for the entire farm and no other facts are available for properly allocating your original cost or other basis between the land and the buildings, you can use the assessed values for local property taxes for the year of purchase to allocate the costs. 1040easy Example. 1040easy Assume that in the preceding example there was no breakdown of the $700,000 purchase price between land and buildings. 1040easy However, in the year of purchase, local taxes on the entire property were based on assessed valuations of $420,000 for land and $140,000 for improvements, or a total of $560,000. 1040easy The assessed valuation of the land is 3/4 (75%) of the total assessed valuation. 1040easy Multiply the $700,000 total purchase price by 75% to figure basis of $525,000 for the 600 acres of land. 1040easy The unadjusted basis of the 60 acres you sold would then be $52,500 (1/10 of $525,000). 1040easy Sale of your home. 1040easy   Your home is a capital asset and not property used in the trade or business of farming. 1040easy If you sell a farm that includes a house you and your family occupy, you must determine the part of the selling price and the part of the cost or other basis allocable to your home. 1040easy Your home includes the immediate surroundings and outbuildings relating to it that are not used for business purposes. 1040easy   If you use part of your home for business, you must make an appropriate adjustment to the basis for depreciation allowed or allowable. 1040easy For more information on basis, see chapter 6. 1040easy More information. 1040easy   For more information on selling your home, see Publication 523. 1040easy Gain from condemnation. 1040easy   If you have a gain from a condemnation or sale under threat of condemnation, you may use the preceding rules for excluding the gain, rather than the rules discussed under Postponing Gain in chapter 11. 1040easy However, any gain that cannot be excluded (because it is more than the limit) may be postponed under the rules discussed under Postponing Gain in chapter 11. 1040easy Foreclosure or Repossession If you do not make payments you owe on a loan secured by property, the lender may foreclose on the loan or repossess the property. 1040easy The foreclosure or repossession is treated as a sale or exchange from which you may realize gain or loss. 1040easy This is true even if you voluntarily return the property to the lender. 1040easy You may also realize ordinary income from cancellation of debt if the loan balance is more than the FMV of the property. 1040easy Buyer's (borrower's) gain or loss. 1040easy   You figure and report gain or loss from a foreclosure or repossession in the same way as gain or loss from a sale or exchange. 1040easy The gain or loss is the difference between your adjusted basis in the transferred property and the amount realized. 1040easy See Determining Gain or Loss , earlier. 1040easy Worksheet 8-1. 1040easy Worksheet for Foreclosures andRepossessions Part 1. 1040easy Use Part 1 to figure your ordinary income from the cancellation of debt upon foreclosure or repossession. 1040easy Complete this part only if you were personally liable for the debt. 1040easy Otherwise, go to Part 2. 1040easy   1. 1040easy Enter the amount of outstanding debt immediately before the transfer of property reduced by any amount for which you remain personally liable after the transfer of property   2. 1040easy Enter the Fair Market Value of the transferred property   3. 1040easy Ordinary income from cancellation of debt upon foreclosure or repossession. 1040easy * Subtract line 2 from line 1. 1040easy If zero or less, enter -0-   Part 2. 1040easy Figure your gain or loss from foreclosure or repossession. 1040easy   4. 1040easy If you completed Part 1, enter the smaller of line 1 or line 2. 1040easy If you did not complete Part 1, enter the outstanding debt immediately before the transfer of property   5. 1040easy Enter any proceeds you received from the foreclosure sale   6. 1040easy Add lines 4 and 5   7. 1040easy Enter the adjusted basis of the transferred property   8. 1040easy Gain or loss from foreclosure or repossession. 1040easy Subtract line 7  from line 6   * The income may not be taxable. 1040easy See Cancellation of debt . 1040easy    You can use Worksheet 8-1 to figure your gain or loss from a foreclosure or repossession. 1040easy Amount realized on a nonrecourse debt. 1040easy   If you are not personally liable for repaying the debt (nonrecourse debt) secured by the transferred property, the amount you realize includes the full amount of the debt canceled by the transfer. 1040easy The full canceled debt is included in the amount realized even if the fair market value of the property is less than the canceled debt. 1040easy Example 1. 1040easy Ann paid $200,000 for land used in her farming business. 1040easy She paid $15,000 down and borrowed the remaining $185,000 from a bank. 1040easy Ann is not personally liable for the loan (nonrecourse debt), but pledges the land as security. 1040easy The bank foreclosed on the loan 2 years after Ann stopped making payments. 1040easy When the bank foreclosed, the balance due on the loan was $180,000 and the FMV of the land was $170,000. 1040easy The amount Ann realized on the foreclosure was $180,000, the debt canceled by the foreclosure. 1040easy She figures her gain or loss on Form 4797, Part I, by comparing the amount realized ($180,000) with her adjusted basis ($200,000). 1040easy She has a $20,000 deductible loss. 1040easy Example 2. 1040easy Assume the same facts as in Example 1 except the FMV of the land was $210,000. 1040easy The result is the same. 1040easy The amount Ann realized on the foreclosure is $180,000, the debt canceled by the foreclosure. 1040easy Because her adjusted basis is $200,000, she has a deductible loss of $20,000, which she reports on Form 4797, Part I. 1040easy Amount realized on a recourse debt. 1040easy   If you are personally liable for the debt (recourse debt), the amount realized on the foreclosure or repossession includes the lesser of: The outstanding debt immediately before the transfer reduced by any amount for which you remain personally liable immediately after the transfer, or The fair market value of the transferred property. 1040easy   You are treated as receiving ordinary income from the canceled debt for the part of the debt that is more than the fair market value. 1040easy The amount realized does not include the canceled debt that is your income from cancellation of debt. 1040easy See Cancellation of debt , later. 1040easy Example 3. 1040easy Assume the same facts as in Example 1 above except Ann is personally liable for the loan (recourse debt). 1040easy In this case, the amount she realizes is $170,000. 1040easy This is the canceled debt ($180,000) up to the FMV of the land ($170,000). 1040easy Ann figures her gain or loss on the foreclosure by comparing the amount realized ($170,000) with her adjusted basis ($200,000). 1040easy She has a $30,000 deductible loss, which she figures on Form 4797, Part I. 1040easy She is also treated as receiving ordinary income from cancellation of debt. 1040easy That income is $10,000 ($180,000 − $170,000). 1040easy This is the part of the canceled debt not included in the amount realized. 1040easy She reports this as other income on Schedule F, line 8. 1040easy Seller's (lender's) gain or loss on repossession. 1040easy   If you finance a buyer's purchase of property and later acquire an interest in it through foreclosure or repossession, you may have a gain or loss on the acquisition. 1040easy For more information, see Repossession in Publication 537, Installment Sales. 1040easy Cancellation of debt. 1040easy   If property that is repossessed or foreclosed upon secures a debt for which you are personally liable (recourse debt), you generally must report as ordinary income the amount by which the canceled debt is more than the FMV of the property. 1040easy This income is separate from any gain or loss realized from the foreclosure or repossession. 1040easy Report the income from cancellation of a business debt on Schedule F, line 8. 1040easy Report the income from cancellation of a nonbusiness debt as miscellaneous income on Form 1040. 1040easy    You can use Worksheet 8-1 to figure your income from cancellation of debt. 1040easy   However, income from cancellation of debt is not taxed if any of the following apply. 1040easy The cancellation is intended as a gift. 1040easy The debt is qualified farm debt (see chapter 3). 1040easy The debt is qualified real property business debt (see chapter 5 of Publication 334). 1040easy You are insolvent or bankrupt (see  chapter 3). 1040easy The debt is qualified principal residence indebtedness (see chapter 3). 1040easy   Use Form 982 to report the income exclusion. 1040easy Abandonment The abandonment of property is a disposition of property. 1040easy You abandon property when you voluntarily and permanently give up possession and use of the property with the intention of ending your ownership, but without passing it on to anyone else. 1040easy Business or investment property. 1040easy   Loss from abandonment of business or investment property is deductible as a loss. 1040easy Loss from abandonment of business or investment property that is not treated as a sale or exchange generally is an ordinary loss. 1040easy If your adjusted basis is more than the amount you realize (if any), then you have a loss. 1040easy If the amount you realize (if any) is more than your adjusted basis, then you have a gain. 1040easy This rule also applies to leasehold improvements the lessor made for the lessee. 1040easy However, if the property is foreclosed on or repossessed in lieu of abandonment, gain or loss is figured as discussed earlier under Foreclosure or Repossession . 1040easy   If the abandoned property is secured by debt, special rules apply. 1040easy The tax consequences of abandonment of property that secures a debt depend on whether you are personally liable for the debt (recourse debt) or were not personally liable for the debt (nonrecourse debt). 1040easy For more information, see chapter 3 of Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals). 1040easy The abandonment loss is deducted in the tax year in which the loss is sustained. 1040easy Report the loss on Form 4797, Part II, line 10. 1040easy Personal-use property. 1040easy   You cannot deduct any loss from abandonment of your home or other property held for personal use. 1040easy Canceled debt. 1040easy   If the abandoned property secures a debt for which you are personally liable and the debt is canceled, you will realize ordinary income equal to the canceled debt. 1040easy This income is separate from any loss realized from abandonment of the property. 1040easy Report income from cancellation of a debt related to a business or rental activity as business or rental income. 1040easy Report income from cancellation of a nonbusiness debt as miscellaneous income on Form 1040. 1040easy   However, income from cancellation of debt is not taxed in certain circumstances. 1040easy See Cancellation of debt earlier under Foreclosure or Repossession . 1040easy Forms 1099-A and 1099-C. 1040easy   A lender who acquires an interest in your property in a foreclosure, repossession, or abandonment should send you Form 1099-A showing the information you need to figure your loss from the foreclosure, repossession, or abandonment. 1040easy However, if the lender cancels part of your debt and the lender must file Form 1099-C, the lender may include the information about the foreclosure, repossession, or abandonment on that form instead of Form 1099-A. 1040easy The lender must file Form 1099-C and send you a copy if the canceled debt is $600 or more and the lender is a financial institution, credit union, federal government agency, or any organization that has a significant trade or business of lending money. 1040easy For foreclosures, repossessions, abandonments of property, and debt cancellations occurring in 2013, these forms should be sent to you by January 31, 2014. 1040easy Prev  Up  Next   Home   More Online Publications
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1040easy 7. 1040easy   Depreciation, Depletion, and Amortization Table of Contents What's New for 2013 Introduction Topics - This chapter discusses: Useful Items - You may want to see: Overview of DepreciationWhat Property Can Be Depreciated? What Property Cannot Be Depreciated? When Does Depreciation Begin and End? Can You Use MACRS To Depreciate Your Property? What Is the Basis of Your Depreciable Property? How Do You Treat Repairs and Improvements? Do You Have To File Form 4562? How Do You Correct Depreciation Deductions? Section 179 Expense DeductionWhat Property Qualifies? What Property Does Not Qualify? How Much Can You Deduct? How Do You Elect the Deduction? When Must You Recapture the Deduction? Claiming the Special Depreciation AllowanceWhat is Qualified Property? How Can You Elect Not To Claim the Allowance? When Must You Recapture an Allowance Figuring Depreciation Under MACRSWhich Depreciation System (GDS or ADS) Applies? Which Property Class Applies Under GDS? What Is the Placed-in-Service Date? What Is the Basis for Depreciation? Which Recovery Period Applies? Which Convention Applies? Which Depreciation Method Applies? How Is the Depreciation Deduction Figured? How Do You Use General Asset Accounts? When Do You Recapture MACRS Depreciation? Additional Rules for Listed PropertyWhat Is Listed Property? What Is the Business-Use Requirement? Do the Passenger Automobile Limits Apply? Depletion Who Can Claim Depletion? Figuring Depletion AmortizationBusiness Start-Up Costs Reforestation Costs Section 197 Intangibles What's New for 2013 Increased section 179 expense deduction dollar limits. 1040easy  The maximum amount you can elect to deduct for most section 179 property you placed in service in 2013 is $500,000. 1040easy This limit is reduced by the amount by which the cost of the property placed in service during the tax year exceeds $2 million. 1040easy See Dollar Limits under Section 179 Expense Deduction , later. 1040easy Extension of special depreciation allowance for certain qualified property acquired after December 31, 2007. 1040easy . 1040easy  You may be able to take a 50% special depreciation allowance for certain qualified property acquired after December 31, 2007, and placed in service before January 1, 2014. 1040easy See Claiming the Special Depreciation Allowance , later. 1040easy Expiration of the 3- year recovery period for certain race horses. 1040easy  The 3-year recovery period for race horses two years old or younger will expire for such horses placed in service after December 31, 2013. 1040easy Introduction If you buy or make improvements to farm property such as machinery, equipment, livestock, or a structure with a useful life of more than a year, you generally cannot deduct its entire cost in one year. 1040easy Instead, you must spread the cost over the time you use the property and deduct part of it each year. 1040easy For most types of property, this is called depreciation. 1040easy This chapter gives information on depreciation methods that generally apply to property placed in service after 1986. 1040easy For information on depreciating pre-1987 property, see Publication 534, Depreciating Property Placed in Service Before 1987. 1040easy Topics - This chapter discusses: Overview of depreciation Section 179 expense deduction Special depreciation allowance Modified Accelerated Cost Recovery System (MACRS) Listed property Basic information on cost depletion (including timber depletion) and percentage depletion Amortization of the costs of going into business, reforestation costs, the costs of pollution control facilities, and the costs of section 197 intangibles Useful Items - You may want to see: Publication 463 Travel, Entertainment, Gift, and Car Expenses 534 Depreciating Property Placed in Service Before 1987 535 Business Expenses 544 Sales and Other Dispositions of Assets 551 Basis of Assets 946 How To Depreciate Property Form (and Instructions) T (Timber), Forest Activities Schedule 3115 Application for Change in Accounting Method 4562 Depreciation and Amortization 4797 Sales of Business Property See chapter 16 for information about getting publications and forms. 1040easy It is important to keep good records for property you depreciate. 1040easy Do not file these records with your return. 1040easy Instead, you should keep them as part of the permanent records of the depreciated property. 1040easy They will help you verify the accuracy of the depreciation of assets placed in service in the current and previous tax years. 1040easy For general information on recordkeeping, see Publication 583, Starting a Business and Keeping Records. 1040easy For specific information on keeping records for section 179 property and listed property, see Publication 946, How To Depreciate Property. 1040easy Overview of Depreciation This overview discusses basic information on the following. 1040easy What property can be depreciated. 1040easy What property cannot be depreciated. 1040easy When depreciation begins and ends. 1040easy Whether MACRS can be used to figure depreciation. 1040easy What is the basis of your depreciable property. 1040easy How to treat repairs and improvements. 1040easy When you must file Form 4562. 1040easy How you can correct depreciation claimed incorrectly. 1040easy What Property Can Be Depreciated? You can depreciate most types of tangible property (except land), such as buildings, machinery, equipment, vehicles, certain livestock, and furniture. 1040easy You can also depreciate certain intangible property, such as copyrights, patents, and computer software. 1040easy To be depreciable, the property must meet all the following requirements. 1040easy It must be property you own. 1040easy It must be used in your business or income-producing activity. 1040easy It must have a determinable useful life. 1040easy It must have a useful life that extends substantially beyond the year you place it in service. 1040easy Property You Own To claim depreciation, you usually must be the owner of the property. 1040easy You are considered as owning property even if it is subject to a debt. 1040easy Leased property. 1040easy   You can depreciate leased property only if you retain the incidents of ownership in the property. 1040easy This means you bear the burden of exhaustion of the capital investment in the property. 1040easy Therefore, if you lease property from someone to use in your trade or business or for the production of income, you generally cannot depreciate its cost because you do not retain the incidents of ownership. 1040easy You can, however, depreciate any capital improvements you make to the leased property. 1040easy See Additions and Improvements under Which Recovery Period Applies in chapter 4 of Publication 946. 1040easy   If you lease property to someone, you generally can depreciate its cost even if the lessee (the person leasing from you) has agreed to preserve, replace, renew, and maintain the property. 1040easy However, you cannot depreciate the cost of the property if the lease provides that the lessee is to maintain the property and return to you the same property or its equivalent in value at the expiration of the lease in as good condition and value as when leased. 1040easy Life tenant. 1040easy   Generally, if you hold business or investment property as a life tenant, you can depreciate it as if you were the absolute owner of the property. 1040easy See Certain term interests in property , later, for an exception. 1040easy Property Used in Your Business or Income-Producing Activity To claim depreciation on property, you must use it in your business or income-producing activity. 1040easy If you use property to produce income (investment use), the income must be taxable. 1040easy You cannot depreciate property that you use solely for personal activities. 1040easy However, if you use property for business or investment purposes and for personal purposes, you can deduct depreciation based only on the percentage of business or investment use. 1040easy Example 1. 1040easy   If you use your car for farm business, you can deduct depreciation based on its percentage of use in farming. 1040easy If you also use it for investment purposes, you can depreciate it based on its percentage of investment use. 1040easy Example 2. 1040easy   If you use part of your home for business, you may be able to deduct depreciation on that part based on its business use. 1040easy For more information, see Business Use of Your Home in chapter 4. 1040easy Inventory. 1040easy   You can never depreciate inventory because it is not held for use in your business. 1040easy Inventory is any property you hold primarily for sale to customers in the ordinary course of your business. 1040easy Livestock. 1040easy   Livestock purchased for draft, breeding, or dairy purposes can be depreciated only if they are not kept in an inventory account. 1040easy Livestock you raise usually has no depreciable basis because the costs of raising them are deducted and not added to their basis. 1040easy However, see Immature livestock under When Does Depreciation Begin and End , later, for a special rule. 1040easy Property Having a Determinable Useful Life To be depreciable, your property must have a determinable useful life. 1040easy This means it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes. 1040easy Irrigation systems and water wells. 1040easy   Irrigation systems and wells used in a trade or business can be depreciated if their useful life can be determined. 1040easy You can depreciate irrigation systems and wells composed of masonry, concrete, tile, metal, or wood. 1040easy In addition, you can depreciate costs for moving dirt to construct irrigation systems and water wells composed of these materials. 1040easy However, land preparation costs for center pivot irrigation systems are not depreciable. 1040easy Dams, ponds, and terraces. 1040easy   In general, you cannot depreciate earthen dams, ponds, and terraces unless the structures have a determinable useful life. 1040easy What Property Cannot Be Depreciated? Certain property cannot be depreciated, even if the requirements explained earlier are met. 1040easy This includes the following. 1040easy Land. 1040easy You can never depreciate the cost of land because land does not wear out, become obsolete, or get used up. 1040easy The cost of land generally includes the cost of clearing, grading, planting, and landscaping. 1040easy Although you cannot depreciate land, you can depreciate certain costs incurred in preparing land for business use. 1040easy See chapter 1 of Publication 946. 1040easy Property placed in service and disposed of in the same year. 1040easy Determining when property is placed in service is explained later. 1040easy Equipment used to build capital improvements. 1040easy You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements. 1040easy Intangible property such as section 197 intangibles. 1040easy This property does not have a determinable useful life and generally cannot be depreciated. 1040easy However, see Amortization , later. 1040easy Special rules apply to computer software (discussed below). 1040easy Certain term interests (discussed below). 1040easy Computer software. 1040easy   Computer software is generally not a section 197 intangible even if acquired in connection with the acquisition of a business, if it meets all of the following tests. 1040easy It is readily available for purchase by the general public. 1040easy It is subject to a nonexclusive license. 1040easy It has not been substantially modified. 1040easy   If the software meets the tests above, it can be depreciated and may qualify for the section 179 expense deduction and the special depreciation allowance (if applicable), discussed later. 1040easy Certain term interests in property. 1040easy   You cannot depreciate a term interest in property created or acquired after July 27, 1989, for any period during which the remainder interest is held, directly or indirectly, by a person related to you. 1040easy This rule does not apply to the holder of a term interest in property acquired by gift, bequest, or inheritance. 1040easy For more information, see chapter 1 of Publication 946. 1040easy When Does Depreciation Begin and End? You begin to depreciate your property when you place it in service for use in your trade or business or for the production of income. 1040easy You stop depreciating property either when you have fully recovered your cost or other basis or when you retire it from service, whichever happens first. 1040easy Placed in Service Property is placed in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity. 1040easy Even if you are not using the property, it is in service when it is ready and available for its specific use. 1040easy Example. 1040easy You bought a planter for use in your farm business. 1040easy The planter was delivered in December 2012 after harvest was over. 1040easy You begin to depreciate the planter for 2012 because it was ready and available for its specific use in 2012, even though it will not be used until the spring of 2013. 1040easy If your planter comes unassembled in December 2012 and is put together in February 2013, it is not placed in service until 2013. 1040easy You begin to depreciate it in 2013. 1040easy If your planter was delivered and assembled in February 2013 but not used until April 2013, it is placed in service in February 2013, because this is when the planter was ready for its specified use. 1040easy You begin to depreciate it in 2013. 1040easy Fruit or nut trees and vines. 1040easy   If you acquire an orchard, grove, or vineyard before the trees or vines have reached the income-producing stage, and they have a preproductive period of more than 2 years, you must capitalize the preproductive-period costs under the uniform capitalization rules (unless you elect not to use these rules). 1040easy See chapter 6 for information about the uniform capitalization rules. 1040easy Your depreciation begins when the trees and vines reach the income-producing stage (that is, when they bear fruit, nuts, or grapes in quantities sufficient to commercially warrant harvesting). 1040easy Immature livestock. 1040easy   Depreciation for livestock begins when the livestock reaches the age of maturity. 1040easy If you bought immature livestock for drafting purposes, depreciation begins when they can be worked. 1040easy If you bought immature livestock for dairy purposes, depreciation begins when they can be milked. 1040easy If you bought immature livestock for breeding purposes, depreciation begins when they can be bred. 1040easy Your basis for depreciation is your initial cost for the immature livestock. 1040easy Idle Property Continue to claim a deduction for depreciation on property used in your business or for the production of income even if it is temporarily idle. 1040easy For example, if you stop using a machine because there is a temporary lack of a market for a product made with that machine, continue to deduct depreciation on the machine. 1040easy Cost or Other Basis Fully Recovered You stop depreciating property when you have fully recovered your cost or other basis. 1040easy This happens when your section 179 and allowed or allowable depreciation deductions equal your cost or investment in the property. 1040easy Retired From Service You stop depreciating property when you retire it from service, even if you have not fully recovered its cost or other basis. 1040easy You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because of any of the following events. 1040easy You sell or exchange the property. 1040easy You convert the property to personal use. 1040easy You abandon the property. 1040easy You transfer the property to a supplies or scrap account. 1040easy The property is destroyed. 1040easy For information on abandonment of property, see chapter 8. 1040easy For information on destroyed property, see chapter 11 and Publication 547, Casualties, Disasters, and Thefts. 1040easy Can You Use MACRS To Depreciate Your Property? You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most business and investment property placed in service after 1986. 1040easy MACRS is explained later under Figuring Depreciation Under MACRS . 1040easy You cannot use MACRS to depreciate the following property. 1040easy Property you placed in service before 1987. 1040easy Use the methods discussed in Publication 534. 1040easy Certain property owned or used in 1986. 1040easy See chapter 1 of Publication 946. 1040easy Intangible property. 1040easy Films, video tapes, and recordings. 1040easy Certain corporate or partnership property acquired in a nontaxable transfer. 1040easy Property you elected to exclude from MACRS. 1040easy For more information, see chapter 1 of Publication 946. 1040easy What Is the Basis of Your Depreciable Property? To figure your depreciation deduction, you must determine the basis of your property. 1040easy To determine basis, you need to know the cost or other basis of your property. 1040easy Cost or other basis. 1040easy   The basis of property you buy is usually its cost plus amounts you paid for items such as sales tax, freight charges, and installation and testing fees. 1040easy The cost includes the amount you pay in cash, debt obligations, other property, or services. 1040easy   There are times when you cannot use cost as basis. 1040easy In these situations, the fair market value (FMV) or the adjusted basis of the property may be used. 1040easy Adjusted basis. 1040easy   To find your property's basis for depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service. 1040easy Basis adjustment for depreciation allowed or allowable. 1040easy   After you place your property in service, you must reduce the basis of the property by the depreciation allowed or allowable, whichever is greater. 1040easy Depreciation allowed is depreciation you actually deducted (from which you received a tax benefit). 1040easy Depreciation allowable is depreciation you are entitled to deduct. 1040easy   If you do not claim depreciation you are entitled to deduct, you must still reduce the basis of the property by the full amount of depreciation allowable. 1040easy   If you deduct more depreciation than you should, you must reduce your basis by any amount deducted from which you received a tax benefit (the depreciation allowed). 1040easy   For more information, see chapter 6. 1040easy How Do You Treat Repairs and Improvements? You generally deduct the cost of repairing business property in the same way as any other business expense. 1040easy However, if a repair or replacement increases the value of your property, makes it more useful, or lengthens its life, you must treat it as an improvement and depreciate it. 1040easy Treat improvements as separate depreciable property. 1040easy See chapter 1 of Publication 946 for more information. 1040easy Example. 1040easy You repair a small section on a corner of the roof of a barn that you rent to others. 1040easy You deduct the cost of the repair as a business expense. 1040easy However, if you replace the entire roof, the new roof is considered to be an improvement because it increases the value and lengthens the life for the property. 1040easy You depreciate the cost of the new roof. 1040easy Improvements to rented property. 1040easy   You can depreciate permanent improvements you make to business property you rent from someone else. 1040easy Do You Have To File Form 4562? Use Form 4562 to claim your deduction for depreciation and amortization. 1040easy You must complete and attach Form 4562 to your tax return if you are claiming any of the following. 1040easy A section 179 expense deduction for the current year or a section 179 carryover from a prior year. 1040easy Depreciation for property placed in service during the current year. 1040easy Depreciation on any vehicle or other listed property, regardless of when it was placed in service. 1040easy Amortization of costs that began in the current year. 1040easy For more information, see the Instructions for Form 4562. 1040easy How Do You Correct Depreciation Deductions? If you deducted an incorrect amount of depreciation in any year, you may be able to make a correction by filing an amended return for that year. 1040easy You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations. 1040easy You claimed the incorrect amount because of a mathematical error made in any year. 1040easy You claimed the incorrect amount because of a posting error made in any year, for example, omitting an asset from the depreciation schedule. 1040easy You have not adopted a method of accounting for the property placed in service by you in tax years ending after December 29, 2003. 1040easy You claimed the incorrect amount on property placed in service by you in tax years ending before December 30, 2003. 1040easy Note. 1040easy You have adopted a method of accounting if you used the same incorrect method of depreciation for two or more consecutively filed returns. 1040easy If you are not allowed to make the correction on an amended return, you may be able to change your accounting method to claim the correct amount of depreciation. 1040easy See the Instructions for Form 3115. 1040easy Section 179 Expense Deduction You can elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year you place the property in service. 1040easy This is the section 179 expense deduction. 1040easy You can elect the section 179 expense deduction instead of recovering the cost by taking depreciation deductions. 1040easy This part of the chapter explains the rules for the section 179 expense deduction. 1040easy It explains what property qualifies for the deduction, what property does not qualify for the deduction, the limits that may apply, how to elect the deduction, and when you may have to recapture the deduction. 1040easy For more information, see chapter 2 of Publication 946. 1040easy What Property Qualifies? To qualify for the section 179 expense deduction, your property must meet all the following requirements. 1040easy It must be eligible property. 1040easy It must be acquired for business use. 1040easy It must have been acquired by purchase. 1040easy Eligible Property To qualify for the section 179 expense deduction, your property must be one of the following types of depreciable property. 1040easy Tangible personal property. 1040easy Qualified real property. 1040easy (Special rules apply to qualified real property that you elect to treat as qualified section 179 real property. 1040easy For more information, see chapter 2 of Publication 946 and section 179(f) of the Internal Revenue Code. 1040easy ) Other tangible property (except buildings and their structural components) used as: An integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services; A research facility used in connection with any of the activities in (a) above; or A facility used in connection with any of the activities in (a) for the bulk storage of fungible commodities. 1040easy Single purpose agricultural (livestock) or horticultural structures. 1040easy Storage facilities (except buildings and their structural components) used in connection with distributing petroleum or any primary product of petroleum. 1040easy Off-the-shelf computer software that is readily available for purchase by the general public, is subject to a nonexclusive lease, and has not been substantially modified. 1040easy Tangible personal property. 1040easy   Tangible personal property is any tangible property that is not real property. 1040easy It includes the following property. 1040easy Machinery and equipment. 1040easy Property contained in or attached to a building (other than structural components), such as milk tanks, automatic feeders, barn cleaners, and office equipment. 1040easy Gasoline storage tanks and pumps at retail service stations. 1040easy Livestock, including horses, cattle, hogs, sheep, goats, and mink and other fur-bearing animals. 1040easy Facility used for the bulk storage of fungible commodities. 1040easy   A facility used for the bulk storage of fungible commodities is qualifying property for purposes of the section 179 expense deduction if it is used in connection with any of the activities listed earlier in item (3)(a). 1040easy Bulk storage means the storage of a commodity in a large mass before it is used. 1040easy Grain bins. 1040easy   A grain bin is an example of a storage facility that is qualifying section 179 property. 1040easy It is a facility used in connection with the production of grain or livestock for the bulk storage of fungible commodities. 1040easy Single purpose agricultural or horticultural structures. 1040easy   A single purpose agricultural (livestock) or horticultural structure is qualifying property for purposes of the section 179 expense deduction. 1040easy Agricultural structure. 1040easy   A single purpose agricultural (livestock) structure is any building or enclosure specifically designed, constructed, and used for both the following reasons. 1040easy To house, raise, and feed a particular type of livestock and its produce. 1040easy To house the equipment, including any replacements, needed to house, raise, or feed the livestock. 1040easy For this purpose, livestock includes poultry. 1040easy   Single purpose structures are qualifying property if used, for example, to breed chickens or hogs, produce milk from dairy cattle, or produce feeder cattle or pigs, broiler chickens, or eggs. 1040easy The facility must include, as an integral part of the structure or enclosure, equipment necessary to house, raise, and feed the livestock. 1040easy Horticultural structure. 1040easy   A single purpose horticultural structure is either of the following. 1040easy A greenhouse specifically designed, constructed, and used for the commercial production of plants. 1040easy A structure specifically designed, constructed, and used for the commercial production of mushrooms. 1040easy Use of structure. 1040easy   A structure must be used only for the purpose that qualified it. 1040easy For example, a hog barn will not be qualifying property if you use it to house poultry. 1040easy Similarly, using part of your greenhouse to sell plants will make the greenhouse nonqualifying property. 1040easy   If a structure includes work space, the work space can be used only for the following activities. 1040easy Stocking, caring for, or collecting livestock or plants or their produce. 1040easy Maintaining the enclosure or structure. 1040easy Maintaining or replacing the equipment or stock enclosed or housed in the structure. 1040easy Property Acquired by Purchase To qualify for the section 179 expense deduction, your property must have been acquired by purchase. 1040easy For example, property acquired by gift or inheritance does not qualify. 1040easy Property acquired from a related person (that is, your spouse, ancestors, or lineal descendants) is not considered acquired by purchase. 1040easy Example. 1040easy Ken is a farmer. 1040easy He purchased two tractors, one from his brother and one from his father. 1040easy He placed both tractors in service in the same year he bought them. 1040easy The tractor purchased from his father does not qualify for the section 179 expense deduction because he is a related person (as defined above). 1040easy The tractor purchased from his brother does qualify for the deduction because Ken is not a related person (as defined above). 1040easy What Property Does Not Qualify? Land and improvements. 1040easy   Land and land improvements, do not qualify as section 179 property. 1040easy Land improvements include nonagricultural fences, swimming pools, paved parking areas, wharves, docks, bridges, and fences. 1040easy However, agricultural fences do qualify as section 179 property. 1040easy Similarly, field drainage tile also qualifies as section 179 property. 1040easy Excepted property. 1040easy   Even if the requirements explained in the preceding discussions are met, farmers cannot elect the section 179 expense deduction for the following property. 1040easy Certain property you lease to others (if you are a noncorporate lessor). 1040easy Certain property used predominantly to furnish lodging or in connection with the furnishing of lodging. 1040easy Property used by a tax-exempt organization (other than a tax-exempt farmers' cooperative) unless the property is used mainly in a taxable unrelated trade or business. 1040easy Property used by governmental units or foreign persons or entities (except property used under a lease with a term of less than 6 months). 1040easy How Much Can You Deduct? Your section 179 expense deduction is generally the cost of the qualifying property. 1040easy However, the total amount you can elect to deduct under section 179 is subject to a dollar limit and a business income limit. 1040easy These limits apply to each taxpayer, not to each business. 1040easy However, see Married individuals under Dollar Limits , later. 1040easy See also the special rules for applying the limits for partnerships and S corporations under Partnerships and S Corporations , later. 1040easy If you deduct only part of the cost of qualifying property as a section 179 expense deduction, you can generally depreciate the cost you do not deduct. 1040easy Use Part I of Form 4562 to figure your section 179 expense deduction. 1040easy Partial business use. 1040easy   When you use property for business and nonbusiness purposes, you can elect the section 179 expense deduction only if you use it more than 50% for business in the year you place it in service. 1040easy If you used the property more than 50% for business, multiply the cost of the property by the percentage of business use. 1040easy Use the resulting business cost to figure your section 179 expense deduction. 1040easy Trade-in of other property. 1040easy   If you buy qualifying property with cash and a trade-in, its cost for purposes of the section 179 expense deduction includes only the cash you paid. 1040easy For example, if you buy (for cash and a trade-in) a new tractor for use in your business, your cost for the section 179 expense deduction is the cash you paid. 1040easy It does not include the adjusted basis of the old tractor you trade for the new tractor. 1040easy Example. 1040easy J-Bar Farms traded two cultivators having a total adjusted basis of $6,800 for a new cultivator costing $13,200. 1040easy They received an $8,000 trade-in allowance for the old cultivators and paid $5,200 cash for the new cultivator. 1040easy J-Bar also traded a used pickup truck with an adjusted basis of $8,000 for a new pickup truck costing $35,000. 1040easy They received a $5,000 trade-in allowance and paid $30,000 cash for the new pickup truck. 1040easy Only the cash paid by J-Bar qualifies for the section 179 expense deduction. 1040easy J-Bar's business costs that qualify for a section 179 expense deduction are $35,200 ($5,200 + $30,000). 1040easy Dollar Limits The total amount you can elect to deduct under section 179 for most property placed in service in 2013 is $500,000. 1040easy If you acquire and place in service more than one item of qualifying property during the year, you can allocate the section 179 expense deduction among the items in any way, as long as the total deduction is not more than $500,000. 1040easy Qualified real property that you elect to treat as section 179 property is limited to $250,000 of the maximum section 179 deduction of $500,000 for 2013. 1040easy You do not have to claim the full $500,000. 1040easy For specific information on the section 179 dollar limits, see chapter 2 of Publication 946. 1040easy Reduced dollar limit for cost exceeding $2 million. 1040easy   If the cost of your qualifying section 179 property placed in service in 2013 is over $2 million, you must reduce the dollar limit (but not below zero) by the amount of cost over $2 million. 1040easy If the cost of your section 179 property placed in service during 2013 is $2,500,000 or more, you cannot take a section 179 expense deduction and you cannot carry over the cost that is more than $2,500,000. 1040easy Example. 1040easy This year, James Smith placed in service machinery costing $2,050,000. 1040easy Because this cost is $50,000 more than $2 million, he must reduce his dollar limit to $450,000 ($500,000 − $50,000). 1040easy Limits for sport utility vehicles. 1040easy   The total amount you can elect to deduct for certain sport utility vehicles and certain other vehicles placed in service in 2013 is $25,000. 1040easy This rule applies to any 4-wheeled vehicle primarily designed or used to carry passengers over public streets, roads, and highways that is rated at more than 6,000 pounds gross vehicle weight and not more than 14,000 pounds gross vehicle weight. 1040easy   For more information, see chapter 2 of Publication 946. 1040easy Limits for passenger automobiles. 1040easy   For a passenger automobile that is placed in service in 2013, the total section 179 and depreciation deduction is limited. 1040easy See Do the Passenger Automobile Limits Apply , later. 1040easy Married individuals. 1040easy   If you are married, how you figure your section 179 expense deduction depends on whether you file jointly or separately. 1040easy If you file a joint return, you and your spouse are treated as one taxpayer in determining any reduction to the dollar limit, regardless of which of you purchased the property or placed it in service. 1040easy If you and your spouse file separate returns, you are treated as one taxpayer for the dollar limit, including the reduction for costs over $2 million. 1040easy You must allocate the dollar limit (after any reduction) equally between you, unless you both elect a different allocation. 1040easy If the percentages elected by each of you do not total 100%, 50% will be allocated to each of you. 1040easy Joint return after separate returns. 1040easy   If you and your spouse elect to amend your separate returns by filing a joint return after the due date for filing your return, the dollar limit on the joint return is the lesser of the following amounts. 1040easy The dollar limit (after reduction for any cost of section 179 property over $2 million). 1040easy The total cost of section 179 property you and your spouse elected to expense on your separate returns. 1040easy Business Income Limit The total cost you can deduct each year after you apply the dollar limit is limited to the taxable income from the active conduct of any trade or business during the year. 1040easy Generally, you are considered to actively conduct a trade or business if you meaningfully participate in the management or operations of the trade or business. 1040easy Any cost not deductible in one year under section 179 because of this limit can be carried to the next year. 1040easy See Carryover of disallowed deduction , later. 1040easy Taxable income. 1040easy   In general, figure taxable income for this purpose by totaling the net income and losses from all trades and businesses you actively conducted during the year. 1040easy In addition to net income or loss from a sole proprietorship, partnership, or S corporation, net income or loss derived from a trade or business also includes the following items. 1040easy Section 1231 gains (or losses) as discussed in chapter 9. 1040easy Interest from working capital of your trade or business. 1040easy Wages, salaries, tips, or other pay earned by you (or your spouse if you file a joint return) as an employee of any employer. 1040easy   In addition, figure taxable income without regard to any of the following. 1040easy The section 179 expense deduction. 1040easy The self-employment tax deduction. 1040easy Any net operating loss carryback or carryforward. 1040easy Any unreimbursed employee business expenses. 1040easy Two different taxable income limits. 1040easy   In addition to the business income limit for your section 179 expense deduction, you may have a taxable income limit for some other deduction (for example, charitable contributions). 1040easy You may have to figure the limit for this other deduction taking into account the section 179 expense deduction. 1040easy If so, complete the following steps. 1040easy Step Action 1 Figure taxable income without the section 179 expense deduction or the other deduction. 1040easy 2 Figure a hypothetical section 179 expense deduction using the taxable income figured in Step 1. 1040easy 3 Subtract the hypothetical section 179 expense deduction figured in Step 2 from the taxable income figured in Step 1. 1040easy 4 Figure a hypothetical amount for the other deduction using the amount figured in Step 3 as taxable income. 1040easy 5 Subtract the hypothetical other deduction figured in Step 4 from the taxable income figured in  Step 1. 1040easy 6 Figure your actual section 179 expense deduction using the taxable income figured in Step 5. 1040easy 7 Subtract your actual section 179 expense deduction figured in Step 6 from the taxable income figured in Step 1. 1040easy 8 Figure your actual other deduction using the taxable income figured in Step 7. 1040easy Example. 1040easy On February 1, 2013, the XYZ farm corporation purchased and placed in service qualifying section 179 property that cost $500,000. 1040easy It elects to expense the entire $500,000 cost under section 179. 1040easy In June, the corporation gave a charitable contribution of $10,000. 1040easy A corporation's limit on charitable contributions is figured after subtracting any section 179 expense deduction. 1040easy The business income limit for the section 179 expense deduction is figured after subtracting any allowable charitable contributions. 1040easy XYZ's taxable income figured without the section 179 expense deduction or the deduction for charitable contributions is $520,000. 1040easy XYZ figures its section 179 expense deduction and its deduction for charitable contributions as follows. 1040easy Step 1. 1040easy Taxable income figured without either deduction is $520,000. 1040easy Step 2. 1040easy Using $520,000 as taxable income, XYZ's hypothetical section 179 expense deduction is $500,000. 1040easy Step 3. 1040easy $20,000 ($520,000 − $500,000). 1040easy Step 4. 1040easy Using $20,000 (from Step 3) as taxable income, XYZ's hypothetical charitable contribution (limited to 10% of taxable income) is $2,000. 1040easy Step 5. 1040easy $518,000 ($520,000 − $2,000). 1040easy Step 6. 1040easy Using $518,000 (from Step 5) as taxable income, XYZ figures the actual section 179 expense deduction. 1040easy Because the taxable income is at least $500,000, XYZ can take a $500,000 section 179 expense deduction. 1040easy Step 7. 1040easy $20,000 ($520,000 − $500,000). 1040easy Step 8. 1040easy Using $20,000 (from Step 7) as taxable income, XYZ's actual charitable contribution (limited to 10% of taxable income) is $2,000. 1040easy Carryover of disallowed deduction. 1040easy   You can carry over for an unlimited number of years the cost of any section 179 property you elected to expense but were unable to because of the business income limit. 1040easy   The amount you carry over is used in determining your section 179 expense deduction in the next year. 1040easy However, it is subject to the limits in that year. 1040easy If you place more than one property in service in a year, you can select the properties for which all or a part of the cost will be carried forward. 1040easy Your selections must be shown in your books and records. 1040easy Example. 1040easy Last year, Joyce Jones placed in service a machine that cost $8,000 and elected to deduct all $8,000 under section 179. 1040easy The taxable income from her business (determined without regard to both a section 179 expense deduction for the cost of the machine and the self-employment tax deduction) was $6,000. 1040easy Her section 179 expense deduction was limited to $6,000. 1040easy The $2,000 cost that was not allowed as a section 179 expense deduction (because of the business income limit) is carried to this year. 1040easy This year, Joyce placed another machine in service that cost $9,000. 1040easy Her taxable income from business (determined without regard to both a section 179 expense deduction for the cost of the machine and the self-employment tax deduction) is $10,000. 1040easy Joyce can deduct the full cost of the machine ($9,000) but only $1,000 of the carryover from last year because of the business income limit. 1040easy She can carry over the balance of $1,000 to next year. 1040easy Partnerships and S Corporations The section 179 expense deduction limits apply both to the partnership or S corporation and to each partner or shareholder. 1040easy The partnership or S corporation determines its section 179 expense deduction subject to the limits. 1040easy It then allocates the deduction among its partners or shareholders. 1040easy If you are a partner in a partnership or shareholder of an S corporation, you add the amount allocated from the partnership or S corporation to any section 179 costs not related to the partnership or S corporation and then apply the dollar limit to this total. 1040easy To determine any reduction in the dollar limit for costs over $560,000, you do not include any of the cost of section 179 property placed in service by the partnership or S corporation. 1040easy After you apply the dollar limit, you apply the business income limit to any remaining section 179 costs. 1040easy For more information, see chapter 2 of Publication 946. 1040easy Example. 1040easy In 2013, Partnership P placed in service section 179 property with a total cost of $2,160,000. 1040easy P must reduce its dollar limit by $160,000 ($2,160,000 − $2,000,000). 1040easy Its maximum section 179 expense deduction is $340,000 ($500,000 − $160,000), and it elects to expense that amount. 1040easy Because P's taxable income from the active conduct of all its trades or businesses for the year was $400,000, it can deduct the full $340,000. 1040easy P allocates $100,000 of its section 179 expense deduction and $110,000 of its taxable income to John, one of its partners. 1040easy John also conducts a business as a sole proprietor and in 2013, placed in service in that business, section 179 property costing $28,000. 1040easy John's taxable income from that business was $10,000. 1040easy In addition to the $100,000 allocated from P, he elects to expense the $28,000 of his sole proprietorship's section 179 costs. 1040easy However, John's deduction is limited to his business taxable income of $120,000 ($110,000 from P plus $10,000 from his sole proprietorship). 1040easy He carries over $8,000 ($128,000 − $120,000) of the elected section 179 costs to 2014. 1040easy How Do You Elect the Deduction? You elect to take the section 179 expense deduction by completing Part I of Form 4562. 1040easy If you elect the deduction for listed property, complete Part V of  Form 4562 before completing Part I. 1040easy   File Form 4562 with either of the following: Your original tax return (whether or not you filed it timely), or An amended return filed within the time prescribed by law. 1040easy An election made on an amended return must specify the item of section 179 property to which the election applies and the part of the cost of each such item to be taken into account. 1040easy The amended return must also include any resulting adjustments to taxable income. 1040easy Revoking an election. 1040easy   An election (or any specification made in the election) to take a section 179 expense deduction for 2013 can be revoked without IRS approval by filing an amended return. 1040easy The amended return must be filed within the time prescribed by law. 1040easy The amended return must also include any resulting adjustments to taxable income (for example, allowable depreciation in that tax year for the item of section 179 property for which the election pertains. 1040easy ) Once made, the revocation is irrevocable. 1040easy When Must You Recapture the Deduction? You may have to recapture the section 179 expense deduction if, in any year during the property's recovery period, the percentage of business use drops to 50% or less. 1040easy In the year the business use drops to 50% or less, you include the recapture amount as ordinary income. 1040easy You also increase the basis of the property by the recapture amount. 1040easy Recovery periods for property are discussed later. 1040easy If you sell, exchange, or otherwise dispose of the property, do not figure the recapture amount under the rules explained in this discussion. 1040easy Instead, use the rules for recapturing depreciation explained in  chapter 9 under Section 1245 Property. 1040easy   If the property is listed property, do not figure the recapture amount under the rules explained in this discussion when the percentage of business use drops to 50% or less. 1040easy Instead, use the rules for recapturing depreciation explained in chapter 5 of Publication 946 under Recapture of Excess Depreciation. 1040easy Figuring the recapture amount. 1040easy   To figure the amount to recapture, take the following steps. 1040easy Figure the allowable depreciation for the section 179 expense deduction you claimed. 1040easy Begin with the year you placed the property in service and include the year of recapture. 1040easy Subtract the depreciation figured in (1) from the section 179 expense deduction you actually claimed. 1040easy The result is the amount you must recapture. 1040easy Example. 1040easy In January 2011, Paul Lamb, a calendar year taxpayer, bought and placed in service section 179 property costing $10,000. 1040easy The property is not listed property. 1040easy He elected a $5,000 section 179 expense deduction for the property and also elected not to claim a special depreciation allowance. 1040easy He used the property only for business in 2011 and 2012. 1040easy During 2013, he used the property 40% for business and 60% for personal use. 1040easy He figures his recapture amount as follows. 1040easy Section 179 expense deduction claimed (2011) $5,000 Minus: Allowable depreciation (instead of section 179 expense deduction):   2011 $1,250   2012 1,875   2013 ($1,250 × 40% (business)) 500 3,625 2013 — Recapture amount $1,375     Paul must include $1,375 in income for 2013. 1040easy Where to report recapture. 1040easy   Report any recapture of the section 179 expense deduction as ordinary income in Part IV of Form 4797 and include it in income on Schedule F (Form 1040). 1040easy Recapture for qualified section 179 GO Zone property. 1040easy   If any qualified section 179 GO Zone property ceases to be used in the GO Zone in a later year, you must recapture the benefit of the increased section 179 expense deduction as “other income. 1040easy ” Claiming the Special Depreciation Allowance For qualified property (defined below) placed in service in 2013, you can take an additional 50% special depreciation allowance. 1040easy The allowance is an additional deduction you can take after any section 179 expense deduction and before you figure regular depreciation under MACRS. 1040easy Figure the special depreciation allowance by multiplying the depreciable basis of the qualified property by 50%. 1040easy What is Qualified Property? For farmers, qualified property generally is certain qualified property acquired after December 31, 2007, and placed in service before January 1, 2014. 1040easy Certain qualified property acquired after December 31, 2007, and placed in service before January 1, 2014. 1040easy   Certain qualified property (defined below) acquired after December 31, 2007, and before January 1, 2014, is eligible for a 50% special depreciation allowance. 1040easy   Qualified property includes the following: Tangible property depreciated under the Modified Accelerated Cost Recovery System (MACRS) with a recovery period of 20 years or less. 1040easy Water utility property. 1040easy Off-the-shelf computer software. 1040easy Qualified leasehold improvement property. 1040easy   Qualified property must also meet all of the following tests: You must have acquired qualified property by purchase after December 31, 2007. 1040easy If a binding contract to acquire the property existed before January 1, 2008, the property does not qualify. 1040easy Qualified property must be placed in service after December 31, 2007 and placed in service before January 1, 2014 (before January 1, 2015 for certain property with a long production period and for certain aircraft). 1040easy The original use of the property must begin with you after December 31, 2007. 1040easy For more information, see chapter 3 of Publication 946. 1040easy How Can You Elect Not To Claim the Allowance? You can elect, for any class of property, not to deduct the special depreciation allowance for all property in such class placed in service during the tax year. 1040easy To make the election, attach a statement to your return indicating the class of property for which you are making the election. 1040easy Generally, you must make the election on a timely filed tax return (including extensions) for the year in which you place the property in service. 1040easy However, if you timely filed your return for the year without making the election, you still can make the election by filing an amended return within 6 months of the due date of the original return (not including extensions). 1040easy Attach the election statement to the amended return. 1040easy On the amended return, write “Filed pursuant to section 301. 1040easy 9100-2. 1040easy ” Once made, the election may not be revoked without IRS consent. 1040easy If you elect not to have the special depreciation allowance apply, the property may be subject to an alternative minimum tax adjustment for depreciation. 1040easy When Must You Recapture an Allowance When you dispose of property for which you claimed a special depreciation allowance, any gain on the disposition is generally recaptured (included in income) as ordinary income up to the amount of the special depreciation allowance previously allowed or allowable. 1040easy For more information, see chapter 3 of Publication 946. 1040easy Figuring Depreciation Under MACRS The Modified Accelerated Cost Recovery System (MACRS) is used to recover the basis of most business and investment property placed in service after 1986. 1040easy MACRS consists of two depreciation systems, the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). 1040easy Generally, these systems provide different methods and recovery periods to use in figuring depreciation deductions. 1040easy To be sure you can use MACRS to figure depreciation for your property, see Can You Use MACRS To Depreciate Your Property, earlier. 1040easy This part explains how to determine which MACRS depreciation system applies to your property. 1040easy It also discusses the following information that you need to know before you can figure depreciation under MACRS. 1040easy Property's recovery class. 1040easy Placed-in-service date. 1040easy Basis for depreciation. 1040easy Recovery period. 1040easy Convention. 1040easy Depreciation method. 1040easy Finally, this part explains how to use this information to figure your depreciation deduction. 1040easy Which Depreciation System (GDS or ADS) Applies? Your use of either the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to depreciate property under MACRS determines what depreciation method and recovery period you use. 1040easy You generally must use GDS unless you are specifically required by law to use ADS or you elect to use ADS. 1040easy Required use of ADS. 1040easy   You must use ADS for the following property. 1040easy All property used predominantly in a farming business and placed in service in any tax year during which an election not to apply the uniform capitalization rules to certain farming costs is in effect. 1040easy Listed property used 50% or less in a qualified business use. 1040easy See Additional Rules for Listed Property , later. 1040easy Any tax-exempt use property. 1040easy Any tax-exempt bond-financed property. 1040easy Any property imported from a foreign country for which an Executive Order is in effect because the country maintains trade restrictions or engages in other discriminatory acts. 1040easy Any tangible property used predominantly outside the United States during the year. 1040easy If you are required to use ADS to depreciate your property, you cannot claim the special depreciation allowance. 1040easy Electing ADS. 1040easy   Although your property may qualify for GDS, you can elect to use ADS. 1040easy The election generally must cover all property in the same property class you placed in service during the year. 1040easy However, the election for residential rental property and nonresidential real property can be made on a property-by-property basis. 1040easy Once you make this election, you can never revoke it. 1040easy   You make the election by completing line 20 in Part III of Form 4562. 1040easy Which Property Class Applies Under GDS? The following is a list of the nine property classes under GDS. 1040easy 3-year property. 1040easy 5-year property. 1040easy 7-year property. 1040easy 10-year property. 1040easy 15-year property. 1040easy 20-year property. 1040easy 25-year property. 1040easy Residential rental property. 1040easy Nonresidential real property. 1040easy See Which Property Class Applies Under GDS in chapter 4 of Publication 946 for examples of the types of property included in each class. 1040easy What Is the Placed-in-Service Date? You begin to claim depreciation when your property is placed in service for use either in a trade or business or for the production of income. 1040easy The placed-in-service date for your property is the date the property is ready and available for a specific use. 1040easy It is therefore not necessarily the date it is first used. 1040easy If you converted property held for personal use to use in a trade or business or for the production of income, treat the property as being placed in service on the conversion date. 1040easy See Placed in Service under When Does Depreciation Begin and End , earlier, for examples illustrating when property is placed in service. 1040easy What Is the Basis for Depreciation? The basis for depreciation of MACRS property is the property's cost or other basis multiplied by the percentage of business/investment use. 1040easy Reduce that amount by any credits and deductions allocable to the property. 1040easy The following are examples of some of the credits and deductions that reduce basis. 1040easy Any deduction for section 179 property. 1040easy Any deduction for removal of barriers to the disabled and the elderly. 1040easy Any disabled access credit, enhanced oil recovery credit, and credit for employer-provided childcare facilities and services. 1040easy Any special depreciation allowance. 1040easy Basis adjustment for investment credit property under section 50(c) of the Internal Revenue Code. 1040easy For information about how to determine the cost or other basis of property, see What Is the Basis of Your Depreciable Property , earlier. 1040easy Also, see chapter 6. 1040easy For additional credits and deductions that affect basis, see section 1016 of the Internal Revenue Code. 1040easy Which Recovery Period Applies? The recovery period of property is the number of years over which you recover its cost or other basis. 1040easy It is determined based on the depreciation system (GDS or ADS) used. 1040easy See Table 7-1 for recovery periods under both GDS and ADS for some commonly used assets. 1040easy For a complete list of recovery periods, see the Table of Class Lives and Recovery Periods in Appendix B of Publication 946. 1040easy House trailers for farm laborers. 1040easy   To depreciate a house trailer you supply as housing for those who work on your farm, use one of the following recovery periods if the house trailer is mobile (it has wheels and a history of movement). 1040easy A 7-year recovery period under GDS. 1040easy A 10-year recovery period under ADS. 1040easy   However, if the house trailer is not mobile (its wheels have been removed and permanent utilities and pipes attached to it), use one of the following recovery periods. 1040easy A 20-year recovery period under GDS. 1040easy A 25-year recovery period under ADS. 1040easy Water wells. 1040easy   Water wells used to provide water for raising poultry and livestock are land improvements. 1040easy If they are depreciable, use one of the following recovery periods. 1040easy A 15-year recovery period under GDS. 1040easy A 20-year recovery period under ADS. 1040easy   The types of water wells that can be depreciated were discussed earlier in Irrigation systems and water wells under Property Having a Determinable Useful Life . 1040easy Table 7-1. 1040easy Farm Property Recovery Periods   Recovery Period in Years Assets GDS ADS Agricultural structures (single purpose) 10 15 Automobiles 5 5 Calculators and copiers 5 6 Cattle (dairy or breeding) 5 7 Communication equipment1 7 10 Computer and peripheral equipment 5 5 Drainage facilities 15 20 Farm buildings2 20 25 Farm machinery and equipment 7 10 Fences (agricultural) 7 10 Goats and sheep (breeding) 5 5 Grain bin 7 10 Hogs (breeding) 3 3 Horses (age when placed in service)     Breeding and working (12 years or less) 7 10 Breeding and working (more than 12 years) 3 10 Racing horses 3 12 Horticultural structures (single purpose) 10 15 Logging machinery and equipment3 5 6 Nonresidential real property 394 40 Office furniture, fixtures, and equipment (not calculators, copiers, or typewriters) 7 10 Paved lots 15 20 Residential rental property 27. 1040easy 5 40 Tractor units (over-the-road) 3 4 Trees or vines bearing fruit or nuts 10 20 Truck (heavy duty, unloaded weight 13,000 lbs. 1040easy or more) 5 6 Truck (actual weight less than 13,000 lbs) 5 5 Water wells 15 20 1 Not including communication equipment listed in other classes. 1040easy 2 Not including single purpose agricultural or horticultural structures. 1040easy 3 Used by logging and sawmill operators for cutting of timber. 1040easy 4 For property placed in service after May 12, 1993; for property placed in service before May 13, 1993,  the recovery period is 31. 1040easy 5 years. 1040easy Which Convention Applies? Under MACRS, averaging conventions establish when the recovery period begins and ends. 1040easy The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property. 1040easy Use one of the following conventions. 1040easy The half-year convention. 1040easy The mid-month convention. 1040easy The mid-quarter convention. 1040easy For a detailed explanation of each convention, see Which Convention Applies in chapter 4 of Publication 946. 1040easy Also, see the Instructions for Form 4562. 1040easy Which Depreciation Method Applies? MACRS provides three depreciation methods under GDS and one depreciation method under ADS. 1040easy The 200% declining balance method over a GDS recovery period. 1040easy The 150% declining balance method over a GDS recovery period. 1040easy The straight line method over a GDS recovery period. 1040easy The straight line method over an ADS recovery period. 1040easy Depreciation Table. 1040easy   The following table lists the types of property you can depreciate under each method. 1040easy The declining balance method is abbreviated as DB and the straight line method is abbreviated as SL. 1040easy Depreciation Table System/Method   Type of Property GDS using  150% DB • All property used in a farming business (except real property)   • All 15- and 20-year property   • Nonfarm 3-, 5-, 7-, and 10-year property1 GDS using SL • Nonresidential real property   • Residential rental property   • Trees or vines bearing fruit or nuts   • All 3-, 5-, 7-, 10-, 15-, and 20-year property1 ADS using SL • Property used predomi- nantly outside the United States   • Farm property used when an election not to apply the uniform capitalization rules is in effect   • Tax-exempt property   • Tax-exempt bond-financed property   • Imported property2   • Any property for which you elect to use this method1 GDS using  200% DB • Nonfarm 3-, 5-, 7-, and 10-year property 1Elective method 2See section 168(g)(6) of the Internal Revenue  Code Property used in farming business. 1040easy   For personal property placed in service after 1988 in a farming business, you must use the 150% declining balance method over a GDS recovery period or you can elect one of the following methods. 1040easy The straight line method over a GDS recovery period. 1040easy The straight line method over an ADS recovery period. 1040easy For property placed in service before 1999, you could have elected to use the 150% declining balance method using the ADS recovery periods for certain property classes. 1040easy If you made this election, continue to use the same method and recovery period for that property. 1040easy Real property. 1040easy   You can depreciate real property using the straight line method under either GDS or ADS. 1040easy Switching to straight line. 1040easy   If you use a declining balance method, you switch to the straight line method in the year it provides an equal or greater deduction. 1040easy If you use the MACRS percentage tables, discussed later under How Is the Depreciation Deduction Figured , you do not need to determine in which year your deduction is greater using the straight line method. 1040easy The tables have the switch to the straight line method built into their rates. 1040easy Fruit or nut trees and vines. 1040easy   Depreciate trees and vines bearing fruit or nuts under GDS using the straight line method over a 10-year recovery period. 1040easy ADS required for some farmers. 1040easy   If you elect not to apply the uniform capitalization rules to any plant shown in Table 6-1 of chapter 6 and produced in your farming business, you must use ADS for all property you place in service in any year the election is in effect. 1040easy See chapter 6 for a discussion of the application of the uniform capitalization rules to farm property. 1040easy Electing a different method. 1040easy   As shown in the Depreciation Table , you can elect a different method for depreciation for certain types of property. 1040easy You must make the election by the due date of the return (including extensions) for the year you placed the property in service. 1040easy However, 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 your return (excluding extensions). 1040easy Attach the election to the amended return and write “Filed pursuant to section 301. 1040easy 9100-2” on the election statement. 1040easy File the amended return at the same address you filed the original return. 1040easy Once you make the election, you cannot change it. 1040easy    If you elect to use a different method for one item in a property class, you must apply the same method to all property in that class placed in service during the year of the election. 1040easy However, you can make the election on a property-by-property basis for residential rental and nonresidential real property. 1040easy Straight line election. 1040easy   Instead of using the declining balance method, you can elect to use the straight line method over the GDS recovery period. 1040easy Make the election by entering “S/L” under column (f) in Part III of Form 4562. 1040easy ADS election. 1040easy   As explained earlier under Which Depreciation System (GDS or ADS) Applies , you can elect to use ADS even though your property may come under GDS. 1040easy ADS uses the straight line method of depreciation over the ADS recovery periods, which are generally longer than the GDS recovery periods. 1040easy The ADS recovery periods for many assets used in the business of farming are listed in Table 7–1. 1040easy Additional ADS recovery periods for other classes of property may be found in the Table of Class Lives and Recovery Periods in Appendix B of Publication 946. 1040easy How Is the Depreciation Deduction Figured? To figure your depreciation deduction under MACRS, you first determine the depreciation system, property class, placed-in-service date, basis amount, recovery period, convention, and depreciation method that applies to your property. 1040easy Then you are ready to figure your depreciation deduction. 1040easy You can figure it in one of two ways. 1040easy You can use the percentage tables provided by the IRS. 1040easy You can figure your own deduction without using the tables. 1040easy Figuring your own MACRS deduction will generally result in a slightly different amount than using the tables. 1040easy Using the MACRS Percentage Tables To help you figure your deduction under MACRS, the IRS has established percentage tables that incorporate the applicable convention and depreciation method. 1040easy These percentage tables are in Appendix A of Publication 946. 1040easy Rules for using the tables. 1040easy   The following rules cover the use of the percentage tables. 1040easy You must apply the rates in the percentage tables to your property's unadjusted basis. 1040easy Unadjusted basis is the same basis amount you would use to figure gain on a sale but figured without reducing your original basis by any MACRS depreciation taken in earlier years. 1040easy You cannot use the percentage tables for a short tax year. 1040easy See chapter 4 of Publication 946 for information on how to figure the deduction for a short tax year. 1040easy You generally must continue to use them for the entire recovery period of the property. 1040easy You must stop using the tables if you adjust the basis of the property for any reason other than— Depreciation allowed or allowable, or An addition or improvement to the property, which is depreciated as a separate property. 1040easy Basis adjustment due to casualty loss. 1040easy   If you reduce the basis of your property because of a casualty, you cannot continue to use the percentage tables. 1040easy For the year of the adjustment and the remaining recovery period, you must figure the depreciation yourself using the property's adjusted basis at the end of the year. 1040easy See Figuring the Deduction Without Using the Tables in chapter 4 of Publication 946. 1040easy Figuring depreciation using the 150% DB method and half-year convention. 1040easy    Table 7-2 has the percentages for 3-, 5-, 7-, and 20-year property. 1040easy The percentages are based on the 150% declining balance method with a change to the straight line method. 1040easy This table covers only the half-year convention and the first 8 years for 20-year property. 1040easy See Appendix A in Publication 946 for complete MACRS tables, including tables for the mid-quarter and mid-month convention. 1040easy   The following examples show how to figure depreciation under MACRS using the percentages in Table 7-2 . 1040easy Example 1. 1040easy During the year, you bought an item of 7-year property for $10,000 and placed it in service. 1040easy You do not elect a section 179 expense deduction for this property. 1040easy In addition, the property is not qualified property for purposes of the special depreciation allowance. 1040easy The unadjusted basis of the property is $10,000. 1040easy You use the percentages in Table 7-2 to figure your deduction. 1040easy Since this is 7-year property, you multiply $10,000 by 10. 1040easy 71% to get this year's depreciation of $1,071. 1040easy For next year, your depreciation will be $1,913 ($10,000 × 19. 1040easy 13%). 1040easy Example 2. 1040easy You had a barn constructed on your farm at a cost of $20,000. 1040easy You placed the barn in service this year. 1040easy You elect not to claim the special depreciation allowance. 1040easy The barn is 20-year property and you use the table percentages to figure your deduction. 1040easy You figure this year's depreciation by multiplying $20,000 (unadjusted basis) by 3. 1040easy 75% to get $750. 1040easy For next year, your depreciation will be $1,443. 1040easy 80 ($20,000 × 7. 1040easy 219%). 1040easy Table 7-2. 1040easy 150% Declining Balance Method (Half-Year Convention) Year 3-Year 5-Year 7-Year 20-Year 1 25. 1040easy 0 % 15. 1040easy 00 % 10. 1040easy 71 % 3. 1040easy 750 % 2 37. 1040easy 5   25. 1040easy 50   19. 1040easy 13   7. 1040easy 219   3 25. 1040easy 0   17. 1040easy 85   15. 1040easy 03   6. 1040easy 677   4 12. 1040easy 5   16. 1040easy 66   12. 1040easy 25   6. 1040easy 177   5     16. 1040easy 66   12. 1040easy 25   5. 1040easy 713   6     8. 1040easy 33   12. 1040easy 25   5. 1040easy 285   7         12. 1040easy 25   4. 1040easy 888   8         6. 1040easy 13   4. 1040easy 522   Figuring depreciation using the straight line method and half-year convention. 1040easy   The following table has the straight line percentages for 3-, 5-, 7-, and 20-year property using the half-year convention. 1040easy The table covers only the first 8 years for 20-year property. 1040easy See Appendix A in Publication 946 for complete MACRS tables, including tables for the mid-quarter and mid-month convention. 1040easy Table 7-3. 1040easy Straight Line Method (Half-Year Convention) Year 3-Year 5-Year 7-Year 20-Year 1 16. 1040easy 67 % 10 % 7. 1040easy 14 % 2. 1040easy 5 % 2 33. 1040easy 33   20   14. 1040easy 29   5. 1040easy 0   3 33. 1040easy 33   20   14. 1040easy 29   5. 1040easy 0   4 16. 1040easy 67   20   14. 1040easy 28   5. 1040easy 0   5     20   14. 1040easy 29   5. 1040easy 0   6     10   14. 1040easy 28   5. 1040easy 0   7         14. 1040easy 29   5. 1040easy 0   8         7. 1040easy 14   5. 1040easy 0