Publication 225
Farmer's Tax Guide

For use in preparing 2002 Returns

Acknowledgment:

The valuable advice and assistance given us each year by the National Farm Income Tax Extension Committee is gratefully acknowledged.

4. Farm Income

Important Changes for 2002

Changing your method of accounting for Commodity Credit Corporation (CCC) loans.   Effective for tax years ending on or after December 31, 2001, you can obtain automatic consent to change your method of accounting for loans received from the CCC, from including the loan amount in gross income for the taxable year in which the loan is received to treating the loan amount as a loan. For more information, see Automatic Change Procedures under Change in Accounting Method in Publication 538, Accounting Periods and Methods.

Production flexibility contracts eliminated.   The Farm Security and Rural Investment Act of 2002 eliminates additional production flexibility contract payments after May 13, 2002, unless requested by the producer that is a party to the contract. For more information, see Production Flexibility Contract Payments, later.

Farm Security and Rural Investment Act of 2002 creates new payments.   The Farm Security and Rural Investment Act of 2002 created two new types of payments - direct and counter-cyclical payments. These payments are included in taxable income. For more information, see Payments under the Farm Security and Rural Investment Act of 2002, later.

Peanut quota buyout program payments.   For information about the tax treatment of payments to peanut quota holders, see Peanut Quota Buyout Program Payments under Agricultural Program Payments, later.

Introduction

You may receive income from many sources. You must report the income on your tax return, unless it is excluded by law. Where you report the income depends on its source.

This chapter discusses farm income you report on Schedule F (Form 1040). For information on where to report other income, see the instructions for Form 1040.

Accounting method.   The rules discussed in this chapter assume you use the cash method of accounting. Under the cash method, you generally include an item of income in gross income when you receive it. See Cash Method in chapter 3.

If you use an accrual method of accounting, different rules may apply to your situation. See Accrual Method in chapter 3.

Topics

This chapter discusses:

• Schedule F (Form 1040)
• Sales of farm products
• Rents (including crop shares)
• Agricultural program payments
• Income from cooperatives
• Cancellation of debt
• Income from other sources
• Farm income averaging

Useful Items

You may want to see:

Publication

• 525   Taxable and Nontaxable Income
• 550   Investment Income and Expenses
• 908   Bankruptcy Tax Guide
• 925   Passive Activity and At-Risk Rules

Form (and Instructions)

• Sch E (Form 1040)   Supplemental
  Income and Loss
• Sch F (Form 1040)   Profit or Loss From Farming
• Sch J (Form 1040)   Farm Income Averaging
• 982   Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)
• 1099-G   Certain Government Payments
• 1099-PATR   Taxable Distributions
  Received From Cooperatives
• 4797   Sales of Business Property
• 4835   Farm Rental Income and
  Expenses

See chapter 21 for information about getting publications and forms.

Schedule F

Report your farm income on Schedule F (Form 1040). Use this schedule to figure the net profit or loss from regular farming operations.

Income from farming reported on Schedule F (Form 1040) includes amounts you receive from cultivating, operating, or managing a farm for gain or profit, either as owner or tenant. This includes income from operating a stock, dairy, poultry, fish, fruit, or truck farm and income from operating a plantation, ranch, range, or orchard. It also includes income from the sale of crop shares if you materially participate in producing the crop. See Rents (Including Crop Shares), later.

Income reported on Schedule F does not include gains or losses from sales or other dispositions of the following farm assets.

• Land.
• Depreciable farm equipment.
• Buildings and structures.
• Livestock held for draft, breeding, dairy, or sporting purposes.

Gains and losses from most dispositions of farm assets are discussed in chapters 10 and 11. Gains and losses from casualties, thefts, and condemnations are discussed in chapter 13.

Sales of Farm Products

When you sell livestock, produce, grains, or other products you raised on your farm for sale or bought for resale, the entire amount you receive is reported on Schedule F. This includes money and the fair market value of any property or services you receive.

Where to report.   Table 4-1 shows where to report the sale of farm products on your tax return.

Schedule F.   When you sell farm products bought for resale, your profit or loss is the difference between your basis in the item (usually your cost) and any money plus the fair market value of any property you receive for it. See chapter 7 for information on the basis of assets. You generally report these amounts on Schedule F for the year you receive payment.

Example.   In 2001, you bought 20 feeder calves for $6,000 for resale. You sold them in 2002 for $11,000. You report the $11,000 sales price, subtract your $6,000 basis, and report the resulting $5,000 profit in Part 1 of your 2002 Schedule F.

Form 4797.   Sales of livestock held for draft, breeding, dairy, or sporting purposes may result in ordinary or capital gains or losses, depending on the circumstances. In either case, you should always report these sales on Form 4797 instead of Schedule F. See Livestock under Ordinary or Capital Gain or Loss in chapter 10. Animals you do not hold primarily for sale are considered business assets of your farm.

Table 4-1. Where To Report Sales of Farm Products

Sale by agent.   If your agent sells your farm products, you must include the net proceeds from the sale in gross income for the year the agent receives payment. This applies even if your agent pays you in a later year. You have constructive receipt of the income when your agent receives payment. For a discussion on constructive receipt of income, see Cash Method under Accounting Methods in chapter 3.

Sales Caused by Weather-Related Conditions

If you sell more livestock, including poultry, than you normally would in a year because of a drought, flood, or other weather-related condition, you may be able to postpone reporting the gain from selling the additional animals until the next year. You must meet all the following conditions to qualify.

• Your principal trade or business is farming.
• You use the cash method of accounting.
• You can show that, under your usual business practices, you would not have sold the additional animals this year except for the weather-related condition.
• The weather-related condition caused an area to be designated as eligible for assistance by the federal government.

Sales made before an area became eligible for federal assistance qualify if the weather-related condition that caused the sale also caused the area to be designated as eligible for federal assistance. The designation can be made by the President, the Department of Agriculture (or any of its agencies), or by other federal departments or agencies.

A weather-related sale of livestock (other than poultry) held for draft, breeding, or dairy purposes may be an involuntary conversion. If you plan to replace the livestock, see Other Involuntary Conversions in chapter 13 for more information.

Usual business practice.   You must determine the number of animals you would have sold had you followed your usual business practice in the absence of the weather-related condition. Do this by considering all the facts and circumstances, but do not take into account your sales in any earlier year for which you postponed the gain. If you have not yet established a usual business practice, rely on the usual business practices of similarly situated farmers in your general region.

Connection with affected area.   The livestock does not have to be raised or sold in an area affected by a weather-related condition for the postponement to apply. However, the sale must occur solely because of a weather-related condition that affected the water, grazing, or other requirements of the livestock. This requirement generally will not be met if the costs of food, water, or other requirements of the livestock affected by the weather-related condition are not substantial in relation to the total costs of holding the livestock.

Classes of livestock.   You must figure the amount to be postponed separately for each generic class of animals - for example, hogs, sheep, and cattle. Do not separate animals into classes based on age, sex, or breed.

Amount to be postponed.   Follow these steps to figure the amount to be postponed for each class of animals.

1. Divide the total income realized from the sale of all livestock in the class during the tax year by the total number of such livestock sold. For this purpose, do not treat any postponed gain from the previous year as income received from the sale of livestock.
2. Multiply the result in (1) by the excess number of such livestock sold solely because of weather-related conditions.

Example.   You are a calendar year taxpayer and you normally sell 100 head of beef cattle a year. As a result of drought, you sold 135 head during 2002. You realized $35,100 from the sale. On August 9, 2002, as a result of drought, the affected area was declared a disaster area eligible for federal assistance. The income you can postpone until 2003 is $9,100 [($35,100 ÷ 135) × 35].

How to postpone gain.   To postpone gain, attach a statement to your tax return for the year of the sale. The statement must include your name and address and give the following information for each class of livestock for which you are postponing gain.

• A statement that you are postponing gain under section 451(e) of the Internal Revenue Code.
• Evidence of the weather-related conditions that forced the early sale or exchange of the livestock and the date, if known, on which an area was designated as eligible for assistance by the federal government because of weather-related conditions.
• A statement explaining the relationship of the area affected by the weather-related condition to your early sale or exchange of the livestock.
• The number of animals sold in each of the 3 preceding years.
• The number of animals you would have sold in the tax year had you followed your normal business practice in the absence of weather-related conditions.
• The total number of animals sold and the number sold because of weather-related conditions during the tax year.
• A computation, as described earlier, of the income to be postponed for each class of livestock.

You must file the statement and the return by the due date of the return, including extensions. If you timely filed your return for the year without postponing gain, you can still postpone gain by filing an amended return within 6 months of the due date of the return (excluding extensions). Attach the statement to the amended return and write Filed pursuant to section 301.9100-2 at the top of the amended return. File the amended return at the same address you filed the original return. Once you have filed the statement, you can cancel your postponement of gain only with the approval of the IRS.

Rents (Including Crop Shares)

The rent you receive for the use of your farm land is generally rental income, not farm income. However, if you materially participate in farming operations on the land, the rent is farm income. See Landlord Participation in Farming in chapter 15.

Pasture income and rental.   If you pasture someone else's cattle and take care of the livestock for a fee, the income is from your farming business. You must enter it as Other income on Schedule F. If you simply rent your pasture for a flat cash amount without providing services, report the income as rent in Part I of Schedule E (Form 1040).

Crop Shares

You must include rent you receive in the form of crop shares in income in the year you convert the shares to money or the equivalent of money. It does not matter whether you use the cash method of accounting or an accrual method of accounting.

If you materially participate in operating a farm from which you receive rent in the form of crop shares or livestock, the rental income is included in self-employment income. (See Landlord Participation in Farming in chapter 15.) Report the rental income on Schedule F.

If you do not materially participate in operating the farm, report this income on Form 4835 and carry the net income or loss to Schedule E (Form 1040). The income is not included in self-employment income.

Crop shares you use to feed livestock.   Crop shares you receive as a landlord and feed to your livestock are considered converted to money when fed to the livestock. You must include the fair market value of the crop shares in income at that time. You are entitled to a business expense deduction for the livestock feed in the same amount and at the same time you include the fair market value of the crop share as rental income. Although these two transactions cancel each other for figuring adjusted gross income on Form 1040, they may be necessary to figure your self-employment tax. See chapter 15.

Crop shares you give to others (gift).   Crop shares you receive as a landlord and give to others are considered converted to money when you make the gift. You must report the fair market value of the crop share as income, even though someone else receives payment for the crop share.

Example.   A tenant farmed part of your land under a crop-share arrangement. The tenant harvested and delivered the crop in your name to an elevator company. Before selling any of the crop, you instructed the elevator company to cancel your warehouse receipt and make out new warehouse receipts in equal amounts of the crop in the names of your children. They sell their crop shares in the following year and the elevator company makes payments directly to your children.

In this situation, you are considered to have received rental income and then made a gift of that income. You must include the fair market value of the crop shares in your income for the tax year you gave the crop shares to your children.

Crop share loss.   If you are involved in a rental or crop-share lease arrangement, any loss from these activities may be subject to the limits under the passive loss rules. See Publication 925 for information on these rules.

- Continue -