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.

How Do You Treat Improvements?

If you improve depreciable property, you must treat the improvement as separate depreciable property. For more information on improvements, see Publication 946.

Repairs.   You generally deduct the cost of repairing business property in the same way as any other business expense. 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.

Improvements to rented property.   You can depreciate permanent improvements you make to business property you rent from someone else.

Do You Have To File
Form 4562?

You must complete and attach Form 4562 to your tax return if you are claiming certain items, including any of the following.

• A section 179 deduction for the current year or a section 179 carryover from a prior year. The section 179 deduction is discussed later.
• Depreciation for property placed in service during the current year.
• Depreciation on any vehicle or other listed property, regardless of when it was placed in service. Listed property is discussed later.
• Amortization of costs that began in the current year. Amortization is discussed later.

For more information on whether you must file Form 4562, refer to its instructions.

It is important to keep good records for property you depreciate. Do not file these records with your return. Instead, you should keep them as part of the records of the depreciated property. They will help you verify the accuracy of the information on Form 4562. For general information on recordkeeping, see Publication 583, Starting a Business and Keeping Records. For specific information on keeping records for section 179 property and listed property, see Publication 946.

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. See Filing an Amended Return, later. If you are not allowed to make the correction on an amended return, you can change your accounting method to claim the correct amount of depreciation. See Changing Your Accounting Method, later.

Basis adjustment.   Even if you do not claim depreciation you are entitled to deduct, you must reduce the basis of the property by the full amount of depreciation you were entitled to deduct. If you deduct more depreciation than you should have, you must reduce your basis by any amount deducted from which you received a tax benefit.

Filing an Amended Return

You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations.

• You claimed the incorrect amount because of a mathematical error made in any year.
• You claimed the incorrect amount because of a posting error made in any year (for example, omitting an asset from the depreciation schedule).
• You have not adopted a method of accounting for the property.

You have adopted a method of accounting for the property if you deducted an incorrect amount of depreciation for it on two or more consecutively filed tax returns for reasons other than a mathematical or posting error.

When to file.   If an amended return is allowed, you must file it by the later of the following dates.

• 3 years from the date you filed your original return for the year in which you deducted the incorrect amount. (A return filed early is considered filed on the due date.)
• 2 years from the time you paid your tax for that year.

Changing Your
Accounting Method

If you deducted an incorrect amount of depreciation for property on two or more consecutively filed tax returns, you have adopted a method of accounting for that property. You can claim the correct amount of depreciation only by changing your method of accounting for depreciation for that property. You can then take into account any unclaimed or excess depreciation from years before the year of change.

Approval required.   You must get IRS approval to change your method of accounting. File Form 3115, Application for Change in Accounting Method, to request a change to a permissible method of accounting for the depreciation. Revenue Procedure 97-27 in Cumulative Bulletin 1997-1 gives general instructions for getting approval.

Automatic approval.   You may be able to get automatic approval from the IRS to change your method of accounting if you used an unallowable method of accounting for depreciation in at least the 2 years immediately before the year of change and the property for which you are changing the method meets all the following conditions.

1. It is property for which, under your unallowable method of accounting, you claimed either no depreciation or an incorrect amount.
2. It is property for which you figured depreciation using one of the following.
   1. Pre-1981 rules.
   2. Accelerated Cost Recovery System (ACRS).
   3. Modified Accelerated Cost Recovery System (MACRS).
3. It is property you owned at the beginning of the year of change.

File Form 3115 to request a change to a permissible method of accounting for depreciation. File Form 3115 with your return for the year of change by the due date of the return (including extensions). Revenue Procedure 2002-9 and section 2.01 of its Appendix in Internal Revenue Bulletin No. 2002-3 have additional instructions for getting automatic approval and list exceptions to the automatic approval procedures.

Example.   In March 2002, you placed in service for your farming business, property that was qualified for the special depreciation allowance. On April 15, 2003, you filed your 2002 income tax return and paid taxes you owed for 2002. You did not claim the special depreciation allowance for the property and did not make the election not to claim the allowance. You can claim the special allowance by filing an amended 2002 return before or at the same time you file your 2003 return. If you do not file an amended 2002 return at that time, you can claim the special depreciation allowance only by filing a Form 3115 with your 2004 return under the automatic approval procedures (assuming you qualify).

Exceptions.   You generally cannot use the automatic approval procedures in any of the following situations.

• You are under examination by the IRS.
• During the last 5 years (including the year of change), you changed the same method of accounting for depreciation (with or without obtaining IRS approval).
• During the last 5 years (including the year of change), you filed a Form 3115 to change the same method of accounting for depreciation but did not make the change because the Form 3115 was withdrawn, not perfected, denied, or not granted.

Also, see other exceptions listed in section 4.02 of Revenue Procedure 2002-9 and section 2.01(2)(c) in the Appendix of this revenue procedure.

Section 179 Deduction

Under section 179 of the Internal Revenue Code, you can choose 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. This part of the chapter explains the rules for the section 179 deduction. It explains what property qualifies for the deduction, the limits that may apply, and how to elect the deduction. You can recover through depreciation certain costs not recovered through the section 179 deduction.

What Property Qualifies?

To qualify for the section 179 deduction, your property must meet all the following requirements.

• It must be eligible property.
• It must be acquired for business use.
• It must have been acquired by purchase.
• It must not be excepted property.

Eligible Property

To qualify for the section 179 deduction, your property must be one of the following types of depreciable property.

1. Tangible personal property.
2. Other tangible property (except buildings and their structural components) used as:
   1. An integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services,
   2. A research facility used in connection with any of the activities in (a) above, or
   3. A facility used in connection with any of the activities in (a) for the bulk storage of fungible commodities.
3. Single purpose agricultural (livestock) or horticultural structures.
4. Storage facilities (except buildings and their structural components) used in connection with distributing petroleum or any primary product of petroleum.

Tangible personal property.   Tangible personal property is any tangible property that is not real property. It includes the following property.

• Machinery and equipment.
• Property contained in or attached to a building (other than structural components), such as milk tanks, automatic feeders, barn cleaners, and office equipment.
• Gasoline storage tanks and pumps at retail service stations.
• Livestock, including horses, cattle, hogs, sheep, goats, and mink and other fur-bearing animals.

Land and land improvements, such as buildings and other permanent structures and their components, are real property, not personal property. Land improvements include nonagricultural fences, swimming pools, paved parking areas, wharves, docks, bridges, and fences. However, agricultural fences do qualify as section 179 property.

Facility used for the bulk storage of fungible commodities.   A facility used for the bulk storage of fungible commodities is qualifying property for purposes of the section 179 deduction if it is used in connection with any of the activities listed earlier in item (2)(a). Bulk storage means the storage of a commodity in a large mass before it is used.

Grain bins.   A grain bin is an example of a storage facility that is qualifying section 179 property. It is a facility used in connection with the production of grain or livestock for the bulk storage of fungible commodities.

Single purpose agricultural or horticultural structures.   A single purpose agricultural (livestock) or horticultural structure is qualifying property for purposes of the section 179 deduction.

Agricultural structure.    A single purpose agricultural (livestock) structure is any building or enclosure specifically designed, constructed, and used for both the following reasons.

• To house, raise, and feed a particular type of livestock and its produce.
• To house the equipment, including any replacements, needed to house, raise, or feed the livestock.

For this purpose, livestock includes poultry.

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. The facility must include, as an integral part of the structure or enclosure, equipment necessary to house, raise, and feed the livestock.

Horticultural structure.   A single purpose horticultural structure is either of the following.

• A greenhouse specifically designed, constructed, and used for the commercial production of plants.
• A structure specifically designed, constructed, and used for the commercial production of mushrooms.

Use of structure.   A structure must be used only for the purpose that qualified it. For example, a hog barn will not be qualifying property if you use it to house poultry. Similarly, using part of your greenhouse to sell plants will make the greenhouse nonqualifying property.

If a structure includes work space, the work space can be used only for the following activities.

• Stocking, caring for, or collecting livestock or plants or their produce.
• Maintaining the enclosure or structure.
• Maintaining or replacing the equipment or stock enclosed or housed in the structure.

Property Acquired for Business Use

To qualify for the section 179 deduction, your property must have been acquired for use in your trade or business. Property you acquire only for the production of income, such as investment property, rental property (if renting property is not your trade or business), and property that produces royalties, does not qualify.

Partial business use.   When you use property for business and nonbusiness purposes, you can elect the section 179 deduction only if you use it more than 50% for business in the year you place it in service. If you used the property more than 50% for business, multiply the cost of the property by the percentage of business use. Use the resulting business cost to figure your section 179 deduction.

Property Acquired by Purchase

To qualify for the section 179 deduction, your property must have been acquired by purchase. For example, property acquired by gift or inheritance does not qualify.

Property is not considered acquired by purchase in the following situations.

1. It is acquired by one member of a controlled group from another member of the same group.
2. Its basis is determined in either of the following ways.
   1. In whole or in part by its adjusted basis in the hands of the person from whom it was acquired.
   2. Under the stepped-up basis rules for property acquired from a decedent.
3. It is acquired from a related person. A related person generally means a member of your immediate family (including your spouse, an ancestor, and a lineal descendant) or a partnership or corporation in which you hold an interest.

For more information on related persons, see chapter 2 in Publication 946.

Excepted Property

Even if the requirements explained in the preceding discussions are met, you cannot elect the section 179 deduction for the following property.

• Certain property you lease to others (if you are a noncorporate lessor).
• Certain property used predominantly to furnish lodging or in connection with the furnishing of lodging. (This exception does not apply to property used by a hotel or motel where the predominant portion of the accommodations is used by transients.)
• Air conditioning or heating units.
• Property used predominantly outside the United States (except property described in section 168(g)(4) of the Internal Revenue Code).
• Property used by certain tax-exempt organizations (except property used in connection with the production of income subject to the tax on unrelated trade or business income).
• Property used by governmental units.
• Property used by foreign persons or entities.

How Much Can You Deduct?

Your section 179 deduction is generally the cost of the qualifying property. However, the total amount you can elect to deduct under section 179 is subject to a dollar limit and a business income limit. These limits apply to each taxpayer, not to each business. However, see Married individuals under Dollar Limit, later.

Use Part I of Form 4562 to figure your section 179 deduction.

Trade-in of other property.   If you buy qualifying property with cash and a trade-in, its cost for purposes of the section 179 deduction includes only the cash you paid. 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 deduction does not include the adjusted basis of the old tractor you trade for the new tractor. For more information on figuring your adjusted basis, see Adjusted Basis in chapter 7.

Example.   J-Bar Farms traded two cultivators having a total adjusted basis of $6,800 for a new cultivator costing $13,200. They received an $8,000 trade-in allowance for the old cultivators and paid $5,200 cash for the new cultivator. J-Bar also traded a used pickup truck with an adjusted basis of $8,000 for a new pickup truck costing $15,000. They received a $5,000 trade-in allowance and paid $10,000 cash for the new pickup truck.

J-Bar Farms' basis in the new property includes both the adjusted basis of the property traded and the cash paid. However, only the cash paid by J-Bar qualifies for the section 179 deduction. J-Bar's business costs that qualify for a section 179 deduction are $15,200 ($5,200 + $10,000), the part of the cost of the new property not determined by the property traded.

Depreciating any remaining cost.   If you deduct only part of the cost of your qualifying property as a section 179 deduction, you can generally take the special depreciation allowance and MACRS depreciation on the cost you do not deduct. To figure your basis for depreciation used to determine the special depreciation allowance, you must subtract the amount of the section 179 deduction from the cost of the qualifying property. The result is then reduced by the amount of your allowance and the remaining cost is used to figure any MACRS depreciation deduction. For information on how to figure basis for depreciation, the special depreciation allowance, and MACRS depreciation, see Claiming the Special Depreciation Allowance and Figuring Depreciation Under MACRS, later.

Dollar Limit

The total amount you can elect to deduct under section 179 for 2002 generally cannot be more than $24,000. If you acquire and place in service more than one item of qualifying property during the year, you can allocate the section 179 deduction among the items in any way, as long as the total deduction is not more than $24,000. You do not have to claim the full $24,000.

Beginning in 2003, the total amount you can elect to deduct under section 179 will increase to $25,000.

You cannot take depreciation on the cost of property you deduct under section 179.
 

Example.   This year, you bought and placed in service a tractor for $20,000 and a mower for $6,200 for use in your farming business. You elect to deduct the entire $6,200 for the mower and $17,800 for the tractor, a total of $24,000. This is the most you can deduct. Your $6,200 deduction for the mower completely recovered its cost. Your basis for depreciation is zero. The basis of your tractor for depreciation is $2,200. You figure this by subtracting the amount of your section 179 deduction, $17,800, from the cost of the tractor, $20,000.

Reduced dollar limit for cost exceeding $200,000.   If the cost of your qualifying section 179 property placed in service in a year is over $200,000, you must reduce the dollar limit (but not below zero) by the amount of cost over $200,000. If the cost of your section 179 property placed in service during 2002 is $224,000 or more, you cannot take a section 179 deduction and you cannot carry over the cost that is more than $224,000.

Example.   This year, James Smith placed in service machinery costing $207,000. Because this cost is $7,000 more than $200,000, he must reduce his dollar limit to $17,000 ($24,000 - $7,000).

Additional limit for passenger automobiles.   For a passenger automobile that is qualified property placed in service in 2002, the total of the section 179 and depreciation deductions (including the special depreciation allowance) generally cannot be more than $7,660 if you claim the special depreciation allowance for the automobile. If you elected not to claim the special depreciation allowance for the automobile or the automobile is not qualified property, the limit is generally $3,060. See What Is Qualified Property? under Claiming the Special Depreciation Allowance, later, for an explanation of qualified property. For more information, see also Maximum Depreciation Deduction under Do the Passenger Automobile Limits Apply.

Married individuals.   If you are married, how you figure your section 179 deduction depends on whether you file jointly or separately.

Joint return.   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.

Separate returns.   If you and your spouse file separate returns, you are treated as one taxpayer for the dollar limit, including the reduction for costs over $200,000. You must allocate the limit amount (after any reduction) between you. You must allocate 50% to each, unless you both elect a different allocation. If the percentages elected by each of you do not total 100%, 50% will be allocated to each of you.

Joint return after separate returns.   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.

• The dollar limit (after reduction for any cost of section 179 property over $200,000).
• The total cost of section 179 property you and your spouse elected to expense on your separate returns.

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. 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.

Any cost not deductible in one year under section 179 because of this limit can be carried to the next year. See Carryover of disallowed deduction, later.

Taxable income.   Figure taxable income for this purpose by totaling the net income and losses from all trades and businesses you actively conducted during the year. 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.

• Section 1231 gains (or losses) as discussed in chapter 11.
• Interest from working capital of your trade or business.
• Wages, salaries, tips, or other pay earned as an employee.

In addition, figure taxable income without regard to any of the following.

• The section 179 deduction.
• The self-employment tax deduction.
• Any net operating loss carryback or carryforward.
• Any unreimbursed employee business expenses.

Two different taxable income limits.   In addition to the business income limit for your section 179 deduction, you may have a taxable income limit for some other deduction (for example, charitable contributions). If you have to figure the limit for this other deduction taking into account the section 179 deduction, complete the following steps.

Example.   During the year, the XYZ farm corporation purchased and placed in service qualifying section 179 property that cost $10,000. It elects to expense as much as possible under section 179. The XYZ corporation also gave a charitable contribution of $1,000 during the year. A corporation's deduction for charitable contributions cannot be more than 10% of its taxable income, figured after subtracting any section 179 deduction. The business income limit for the section 179 deduction is figured after subtracting any allowable charitable contributions. XYZ's taxable income figured without the section 179 deduction or the deduction for charitable contributions is $12,000. XYZ figures its section 179 deduction and its deduction for charitable contributions as follows.

• Step 1. Taxable income figured without either deduction is $12,000.
• Step 2. Using $12,000 as taxable income, XYZ's hypothetical section 179 deduction is $10,000.
• Step 3. $2,000 ($12,000 - $10,000).
• Step 4. Using $2,000 (from Step 3) as taxable income, XYZ's hypothetical charitable contribution (limited to 10% of taxable income) is $200.
• Step 5. $11,800 ($12,000 - $200).
• Step 6. Using $11,800 (from Step 5) as taxable income, XYZ figures the actual section 179 deduction. Because the taxable income is at least $10,000, XYZ can take a $10,000 section 179 deduction.
• Step 7. $2,000 ($12,000 - $10,000).
• Step 8. Using $2,000 (from Step 7) as taxable income, XYZ's actual charitable contribution (limited to 10% of taxable income) is $200.

Carryover of disallowed deduction.   You can carry over the cost of any section 179 property you elected to expense but were unable to because of the business income limit.

The amount you carry over is used in determining your section 179 deduction in the next year. However, it is subject to the limits in that year. 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. Your selections must be shown in your books and records.

Example.   Last year, Joyce Jones placed in service a machine that cost $8,000 and elected to deduct all $8,000 under section 179. The taxable income from her business (determined without regard to both a section 179 deduction for the cost of the machine and the self-employment tax deduction) was $6,000. Her section 179 deduction was limited to $6,000. The $2,000 cost that was not allowed as a section 179 deduction (because of the business income limit) is carried to this year.

This year, Joyce placed another machine in service that cost $9,000. Her taxable income from business (determined without regard to both a section 179 deduction for the cost of the machine and the self-employment tax deduction) is $10,000. 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. She can carry over the balance of $1,000 to next year.

See Carryover of disallowed deduction in chapter 2 of Publication 946 for more information on figuring the carryover.

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