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.

Other Expenses

The following list, while not all-inclusive, shows some expenses you can deduct as other farm expenses in Part II of Schedule F. These expenses must be for business purposes and (1) paid, if you use the cash method of accounting, or (2) incurred, if you use an accrual method of accounting.

• Accounting fees.
• Advertising.
• Chemicals.
• Custom hire (machine work).
• Educational expenses (to maintain and improve farming skills).
• Farm-related attorney fees.
• Farm fuels and oil.
• Farm magazines.
• Freight and trucking.
• Ginning.
• Insect sprays and dusts.
• Litter and bedding.
• Livestock fees.
• Recordkeeping expenses.
• Service charges.
• Small tools expected to last one year or less.
• Stamps and stationery.
• Storage and warehousing.
• Subscriptions to professional, technical, and trade journals that deal with farming.
• Tying material and containers.
• Veterinary fees and medicine.

Loan expenses.   You prorate and deduct loan expenses, such as legal fees and commissions, you pay to get a farm loan over the term of the loan.

Tax preparation fees.   You can deduct as a farm business expense on Schedule F the cost of preparing that part of your tax return relating to your farm business. You may be able to deduct the remaining cost on Schedule A (Form 1040) if you itemize your deductions.

You also can deduct on Schedule F the amount you pay or incur in resolving tax issues relating to your farm business.

Capital Expenses

A capital expense is a payment, or a debt incurred, for the acquisition, improvement, or restoration of an asset that is expected to last more than one year. You include the expense in the basis of the asset. Uniform capitalization rules also require you to capitalize or include in inventory certain other expenses. See chapters 3 and 7.

Capital expenses are generally not deductible, but they may be depreciable. However, you can elect to deduct certain capital expenses, such as the following.

• The cost of fertilizer, lime, etc. (See Fertilizer and Lime under Deductible Expenses, earlier.)
• Soil and water conservation expenses. (See chapter 6.)
• The cost of property that qualifies for a deduction under section 179. (See chapter 8.)
• The cost of qualifying clean-fuel vehicle property and clean-fuel vehicle refueling property. (See chapter 12 in Publication 535.)

The costs of the following items, including the costs of material, hired labor, and installation, are capital expenses.

1. Business start-up costs. (See Going Into Business in chapter 8.)
2. Land and buildings.
3. Additions, alterations, and improvements to buildings, etc.
4. Cars and trucks.
5. Equipment and machinery.
6. Fences.
7. Breeding, dairy, and draft livestock.
8. Reforestation.
9. Repairs to machinery, equipment, cars, and trucks that prolong their useful life, increase their value, or adapt them to different use.
10. Water wells, including drilling and equipping costs.
11. Land preparation costs, such as:
    1. Clearing land for farming,
    2. Leveling and conditioning land,
    3. Purchasing and planting trees,
    4. Building irrigation canals and ditches,
    5. Laying irrigation pipes,
    6. Installing drain tile,
    7. Modifying channels or streams,
    8. Constructing earthen, masonry, or concrete tanks, reservoirs, or dams, and
    9. Building roads.

Crop production expenses.   The uniform capitalization rules generally require you to capitalize expenses incurred in producing plants. However, except for certain taxpayers required to use an accrual method of accounting, the capitalization rules do not apply to plants with a preproductive period of 2 years or less. For more information, see Uniform Capitalization Rules in chapter 7.

Timber.   Capitalize the cost of acquiring timber. Do not include the cost of land in the cost of the timber. You must generally capitalize direct costs incurred in reforestation. These costs include the following.

1. Site preparation costs, such as:
   1. Girdling,
   2. Applying herbicide,
   3. Baiting rodents, and
   4. Clearing and controlling brush.
2. The cost of seed or seedlings.
3. Labor and tool expenses.
4. Depreciation on equipment used in planting or seeding.
5. Costs incurred in replanting to replace lost seedlings.

You can choose to capitalize certain indirect reforestation costs.

These capitalized amounts are your basis for the timber. Recover your basis when you sell the timber or take depletion allowances when you cut the timber. However, you may recover a limited amount of your costs for forestation or reforestation before cutting the timber through amortization deductions. For more information, see Depletion and Amortization in chapter 8.

For more information about timber, see Agriculture Handbook Number 708, Forest Owners' Guide to the Federal Income Tax. Copies are $15 each and are available from the U.S. Government Printing Office. Place your order using Stock #001-000- 04621-7. The address, telephone number, and web site are:

Superintendent of Documents
U.S. Government Printing Office
P.O. Box 371954
Pittsburgh, PA 15250-7954
(202) 512-1800
www.access.gpo.gov/su_docs

Christmas tree cultivation.   If you are in the business of planting and cultivating Christmas trees to sell when they are more than 6 years old, capitalize expenses incurred for planting and stump culture and add them to the basis of the standing trees. Recover these expenses as part of your adjusted basis when you sell the standing trees or as depletion allowances when you cut the trees. For more information, see Timber depletion under Depletion in chapter 8.

You can deduct as business expenses the costs incurred for shearing and basal pruning of these trees. Expenses incurred for silvicultural practices, such as weeding or cleaning, and noncommercial thinning are also deductible as business expenses.

Capitalize the cost of land improvements, such as road grading, ditching, and fire breaks, that have a useful life beyond the tax year. If the improvements do not have a determinable useful life, add their cost to the basis of the land. The cost is recovered when you sell or otherwise dispose of it. If the improvements have a determinable useful life, recover their cost through depreciation. Capitalize the cost of equipment and other depreciable assets, such as culverts and fences, to the extent you do not use them in planting Christmas trees. Recover these costs through depreciation.

Nondeductible Expenses

You cannot deduct personal expenses and certain other items on your tax return even if they relate to your farm.

Personal, Living, and Family Expenses

You cannot deduct certain personal, living, and family expenses as business expenses. These include rent and insurance premiums paid on property used as your home, life insurance premiums on yourself or your family, the cost of maintaining cars, trucks, or horses for personal use, allowances to minor children, attorneys' fees and legal expenses incurred in personal matters, and household expenses. Likewise, the cost of purchasing or raising produce or livestock consumed by you or your family is not deductible.

Other Nondeductible Items

You cannot deduct the following items on your tax return.

Loss of growing plants, produce, and crops.   Losses of plants, produce, and crops raised for sale are generally not deductible. However, you may have a deductible loss on plants with a preproductive period of more than 2 years. See chapter 13 for more information.

Repayment of loans.  

Estate, inheritance, legacy, succession, and gift taxes.  

Loss of livestock.   You cannot deduct as a loss the value of raised livestock that die if you deducted the cost of raising them as an expense.

Losses from sales or exchanges between related persons.   You cannot deduct losses from sales or exchanges of property between you and certain related persons, including your spouse, brother, sister, ancestor, or descendant. For more information, see chapter 2 of Publication 544, Sales and Other Dispositions of Assets.

Cost of raising unharvested crops.   You cannot deduct the cost of raising unharvested crops sold with land owned more than one year if you sell both at the same time and to the same person. Add these costs to the basis of the land to determine the gain or loss on the sale. For more information, see Section 1231 Gains and Losses in chapter 11.

Cost of unharvested crops bought with land.   Capitalize the purchase price of land, including the cost allocable to unharvested crops. You cannot deduct the cost of the crops at the time of purchase. However, you can deduct this cost in figuring net profit or loss in the tax year you sell the crops.

Cost related to gifts.   You cannot deduct costs related to your gifts of agricultural products or property held for sale in the ordinary course of your business. The costs are not deductible in the year of the gift or any later year. For example, you cannot deduct the cost of raising cattle or the cost of planting and raising unharvested wheat on parcels of land given as a gift to your children.

Club dues and membership fees.   Generally, you cannot deduct amounts you pay or incur for membership in any club organized for business, pleasure, recreation, or any other social purpose. This includes country clubs, golf and athletic clubs, hotel clubs, sporting clubs, airline clubs, and clubs operated to provide meals under circumstances generally considered to be conducive to business discussions.

Exception.   The following organizations will not be treated as a club organized for business, pleasure, recreation, or other social purposes, unless one of its main purposes is to conduct entertainment activities for members or their guests or to provide members or their guests with access to entertainment facilities.

• Boards of trade.
• Business leagues.
• Chambers of commerce.
• Civic or public service organizations.
• Professional associations.
• Trade associations.

Fines and penalties.   You cannot deduct fines and penalties, except penalties for exceeding marketing quotas, discussed earlier.

Losses From Operating a Farm

If your deductible farm expenses are more than your farm income, you have a loss from the operation of your farm. The amount of the loss you can deduct when figuring your taxable income may be limited. To figure your deductible loss, you must apply the following limits.

• The at-risk limits.
• The passive activity limits.

The following discussions explain these limits.

If your deductible loss after applying these limits is more than your other income for the year, you may have a net operating loss. See Net Operating Losses, later.

If you do not carry on your farming activity to make a profit, your loss deduction may be limited by the not-for-profit rules. See Not-for-Profit Farming, later.

At-Risk Limits

The at-risk rules limit your deduction for losses from most business or income-producing activities, including farming. The at-risk rules limit the losses you can deduct when figuring your taxable income. The deductible loss from an activity is limited to the amount you have at risk in the activity.

You are at risk in any activity for:

1. The money and adjusted basis of property you contribute to the activity, and
2. Amounts you borrow for use in the activity if:
   1. You are personally liable for repayment, or
   2. You pledge property (other than property used in the activity) as security for the loan.

You are not at risk, however, for amounts you borrow for use in a farming activity from a person who has an interest in the activity (other than as a creditor) or a person related to someone (other than you) having such an interest.

For more information, see Publication 925.

Passive Activity Limits

A passive activity is generally any activity involving the conduct of any trade or business in which you do not materially participate. Generally, a rental activity is a passive activity.

If you have a passive activity, special rules limit the loss you can deduct in the tax year. You generally can deduct losses from passive activities only up to income from passive activities. Credits are similarly limited.

For more information, see Publication 925.

Net Operating Losses

If your deductible loss from operating your farm (after applying the at-risk and passive activity limits explained in the preceding discussion) is more than your other income for the year, you may have a net operating loss (NOL). You also may have an NOL if you had a personal or business-related casualty or theft loss that was more than your income.

If you have an NOL this year, you can use it to lower your taxable income in another year or years. You may be able to get a refund of all or part of the income tax you paid for past years, or reduce your tax in future years.

To determine if you have an NOL, complete your tax return for the year. You may have an NOL if a negative figure appears on the line shown below.

1. Individuals - line 39 of Form 1040.
2. Estates and trusts - line 22 of Form 1041.
3. Corporations - line 30 of Form 1120 or line 26 of Form 1120-A.

If the amount on that line is zero or more, you do not have an NOL.

There are rules that limit what you can deduct from gross income when figuring an NOL. These rules are discussed in detail under How To Figure an NOL in Publication 536.

In general, these rules do not allow the following items.

• Personal exemptions.
• Capital losses in excess of capital gains. (Nonbusiness capital losses may only offset nonbusiness capital gains.)
• The section 1202 exclusion of 50% of the gain from the sale or exchange of qualified small business stock.
• Nonbusiness deductions in excess of nonbusiness income.
• Net operating loss deduction.

Example.   Glenn Johnson is a dairy farmer. He is single and has the following income and deductions on his Form 1040 for 2002.

When these items are eliminated, Glenn's net loss is reduced to $1,775 ($10,050- $8,275). This is his NOL for 2002.

Carrybacks.   If you have an NOL for a tax year ending during 2002, you must generally carry back the entire amount of the NOL to the 5 tax years before the NOL year (the carryback period). However, you can still choose to carry back an NOL to the 2 (or 3, if applicable) years before the NOL year. Any remaining NOL can be carried forward for up to 20 years. You can also choose not to carry back an NOL and only carry it forward. See Waiving the carryback period, later. There are rules for figuring how much of the NOL is used in each tax year and how much is carried to the next tax year. These rules are explained in Publication 536.

Unless you choose to waive the carryback period, as discussed later, you must first carry the entire NOL to the earliest carryback year. If your NOL is not used up, you can carry the rest to the next earliest carryback year, and so on.

Refigure your deductions, credits, and tax for each of the years to which you carried back an NOL. If your refigured tax is less than the tax you originally paid, you can apply for a refund by filing Form 1040X, Amended U.S. Individual Income Tax Return, for each year affected, or by filing Form 1045, Application for Tentative Refund. You usually will get a refund faster by filing Form 1045, and generally you can use one Form 1045 to apply an NOL to all carryback years.

Exceptions to 5-year carryback rule.   Eligible losses can qualify for shorter carryback periods.

Eligible loss.   You can choose a 3-year carryback period for an eligible loss. An eligible loss is any part of an NOL that is:

• From a casualty or theft, or
• Attributable to a Presidentially declared disaster for a qualified small business.

Generally, an eligible loss does not include a farming loss (explained next).

Only farming losses attributable to Presidentially declared disasters in tax years that begin after August 5, 1997, and before January 1, 1998, are considered eligible losses subject to a 3-year carryback period.

Farming loss.   The carryback period for a farming loss is 5 years. A farming loss is the smaller of:

• The amount that would be the NOL for the tax year if only income and deductions attributable to farming businesses were taken into account, or
• The NOL for the tax year.

You can choose to treat a farming loss as if it were not a farming loss. If you make this choice, you can choose a 2-year carryback period. For more information, see When To Use an NOL in Publication 536.

Different carryback periods.   If you have a farming loss and a loss that is not from farming, you can choose different carryback periods for these losses.

Carryovers.   If you do not use up the NOL in the carryback years, carry forward what remains of it to the 20 tax years following the NOL year. Start by carrying it to the first tax year after the NOL year. If you do not use it up, carry over the unused part to the next year. Continue to carry over any unused part of the NOL until you use it up or complete the 20-year carryforward period.

For an NOL occurring in a tax year beginning before August 6, 1997, the carryforward period is 15 years.

Waiving the carryback period.   You can choose not to carry back your NOL. If you make this choice, you use your NOL only in the 20 year carryforward period. Once made, the choice is irrevocable.

To make this choice, attach a statement to your tax return for the NOL year filed on or before the due date of the return (including extensions). This statement must show you are choosing to waive the carryback period under section 172(b)(3) of the Internal Revenue Code. Also, if you filed your return timely without making that choice, you may still make the choice 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 on the statement. File the amended return at the same address you filed the original return.

Partnerships and S corporations.   Partnerships and S corporations generally cannot use an NOL. But partners or shareholders can use their separate shares of the partnership's or S corporation's business income and business deductions to figure their individual NOLs.

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