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.

Section 1250 Property

Section 1250 property includes all real property subject to an allowance for depreciation that is not and never has been section 1245 property. It includes a leasehold of land or section 1250 property subject to an allowance for depreciation. A fee simple interest in land is not section 1250 property because it is not depreciable.

Gain on the disposition of section 1250 property is treated as ordinary income to the extent of additional depreciation allowed or allowable. To determine the additional depreciation on section 1250 property, see Additional Depreciation, later.

You will not have additional depreciation if any of the following apply to the property disposed of.

• You figured depreciation for the property using the straight line method or any other method that does not result in depreciation that is more than the amount figured by the straight line method; you have held the property longer than 1 year; and, if the property was qualified New York Liberty Zone property, you made a timely election not to claim the special depreciation allowance. (In addition, if the property was in a renewal community, you must not have elected to claim a commercial revitalization deduction as figured under section 1400I of the Internal Revenue Code.)
• The property was residential low-income rental property you held for 162/3 years or longer. (For low-income rental housing on which the special 60-month depreciation for rehabilitation expenses was allowed, the 16 2/3 years start when the rehabilitated property is placed in service.)
• You chose the alternate ACRS (straight line) method for the property, which was a type of 15-, 18-, or 19-year real property covered by the section 1250 rules.
• The property was residential rental property or nonresidential real property placed in service after 1986 (or after July 31, 1986, if the choice to use MACRS was made); you held it longer than 1 year; and if the property was qualified New York Liberty Zone property, you made a timely election not to claim the special depreciation allowance. These properties are depreciated using the straight line method. (In addition, if the property was in a renewal community, you must not have elected to claim a commercial revitalization deduction as figured under section 1400I of the Internal Revenue Code.)

Gain Treated as Ordinary Income

To find what part of the gain from the disposition of section 1250 property is treated as ordinary income, follow these steps.

1. In a sale, exchange, or involuntary conversion of the property, figure the amount realized that is more than the adjusted basis of the property. In any other disposition of the property, figure the fair market value that is more than the adjusted basis.
2. Figure the additional depreciation for the periods after 1975.
3. Multiply the lesser of (1) or (2) by the applicable percentage, discussed later. Stop here if this is residential rental property or if (2) is equal to or more than (1). This is the gain treated as ordinary income because of additional depreciation.
4. Subtract (2) from (1).
5. Figure the additional depreciation for periods after 1969 but before 1976.
6. Add the lesser of (4) or (5) to the result in (3). This is the gain treated as ordinary income because of additional depreciation.

Use Part III, Form 4797, to figure the ordinary income part of the gain.

Additional Depreciation

If you hold section 1250 property longer than 1 year, the additional depreciation is the actual depreciation adjustments that are more than the depreciation figured using the straight line method. For a list of items treated as depreciation adjustments, see Depreciation and amortization under Section 1245 Property, earlier.

If you hold section 1250 property for 1 year or less, all the depreciation is additional depreciation.

Figure straight line depreciation for ACRS real property by using its 15-, 18-, or 19-year recovery period as the property's useful life.

The straight line method is applied without any basis reduction for the investment credit.

You will have additional depreciation if any of the following statements are true.

1. You use the regular ACRS method, the declining balance method, the sum-of-the-years-digits method, the units-of-production method, or any other method of rapid depreciation.
2. You choose amortization, other than amortization on real property that qualifies as section 1245 property.
3. You claimed the special depreciation allowance for property acquired after September 10, 2001.

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Depreciation taken by other taxpayers or on other property.   Additional depreciation includes all depreciation adjustments to the basis of section 1250 property whether allowed to you or another person (as for carryover basis property).

Depreciation allowed or allowable.   You generally use the greater of depreciation allowed or allowable (to any person who held the property if the depreciation was used in figuring its adjusted basis in your hands) when figuring the part of the gain to be reported as ordinary income. If you can show the deduction allowed for any tax year was less than the amount allowable, the lesser figure will be the depreciation adjustment for figuring additional depreciation.

Applicable Percentage

The applicable percentage used to figure the ordinary income because of additional depreciation depends on whether the real property you disposed of is nonresidential real property, residential rental property, or low-income housing. The applicable percentages for nonresidential real property and residential rental property are explained next. The applicable percentage for low-income housing is explained in chapter 3 of Publication 544.

Nonresidential real property.   For real property that is not residential rental property, the applicable percentage for periods after 1969 is 100%. For periods before 1970, the percentage is zero and no ordinary income will result from its disposition because of additional depreciation taken before 1970.

Residential rental property.   For residential rental property (80% or more of the gross income is from dwelling units) other than low-income housing, the percentage for periods after 1975 is 100%. The applicable percentage for periods before 1976 is zero. No ordinary income will result from a disposition of residential rental property because of additional depreciation before 1976.

More information.   For more information about depreciation recapture on section 1250 property, see chapter 3 of Publication 544.

Installment Sale

If you report the sale of property under the installment method, any depreciation recapture under section 1245 or 1250 is taxable as ordinary income in the year of sale. This applies even if no payments are received in that year. If the gain is more than the depreciation recapture income, report the rest of the gain using the rules of the installment method. For this purpose, include the recapture income in your installment sale basis to determine your gross profit on the installment sale.

If you dispose of more than one asset in a single transaction, you must separately figure the gain on each asset so that it may be properly reported. To do this, allocate the selling price and the payments you receive in the year of sale to each asset. Report any depreciation recapture income in the year of sale before using the installment method for any remaining gain.

For more information on installment sales, see chapter 12.

Other Dispositions

Chapter 3 of Publication 544 discusses the tax treatment of the following transfers of depreciable property.

• By gift.
• At death.
• In like-kind exchanges.
• In involuntary conversions.

Publication 544 also explains how to handle a single transaction involving multiple properties.

Other Gains

This section discusses gain on the disposition of farm land for which you were allowed either of the following.

• Deductions for soil and water conservation expenditures (section 1252 property).
• Exclusions from income for certain cost sharing payments (section 1255 property).

Section 1252 property.   If you disposed of farm land you held less than 10 years at a gain and you were allowed deductions for soil and water conservation expenses for the land, as discussed in chapter 6, you must treat part of the gain as ordinary income and treat the balance as section 1231 gain.

Exceptions.   Do not treat gain on the following transactions as gain on section 1252 property.

• Disposition of farm land by gift.
• Transfer of farm property at death (except for income in respect of a decedent).

For more information, see section 1.1252-2 of the regulations.

Amount to report as ordinary income.   You report as ordinary income the lesser of the following amounts.

• Your gain (determined by subtracting the adjusted basis from the amount realized from a sale, exchange, or involuntary conversion, or the fair market value for all other dispositions).
• The total deductions allowed for soil and water conservation expenses multiplied by the applicable percentage, discussed next.

Applicable percentage.   The applicable percentage is based on the length of time you held the land. If you dispose of your farm land within 5 years after the date you got it, the percentage is 100%. If you dispose of the land within the 6th through 9th year after you got it, the applicable percentage is reduced by 20% a year for each year or part of a year you hold the land after the 5th year. If you dispose of the land 10 or more years after you got it, the percentage is 0%, and the entire gain is a section 1231 gain.

Example.   You acquired farm land on January 19, 1995. On October 3, 2002, you sold the land at a $30,000 gain. Between January 1 and October 3, 2002, you make soil and water conservation expenditures of $15,000 for the land that are fully deductible in 2002. The applicable percentage is 40% since you sold the land within the 8th year after you got it. You treat $6,000 (40% of $15,000) of the $30,000 gain as ordinary income and the $24,000 balance as a section 1231 gain.

Section 1255 property.   If you receive certain cost-sharing payments on property and you exclude those payments from income (as discussed in chapter 4), you may have to treat part of any gain as ordinary income and treat the balance as a section 1231 gain. If you chose not to exclude these payments, you will not have to recognize ordinary income under this provision.

Amount to report as ordinary income.   You report as ordinary income the lesser of the following amounts.

• The applicable percentage of the total excluded cost-sharing payments.
• The gain on the disposition of the property.

You do not report ordinary income under this rule to the extent the gain is recognized as ordinary income under sections 1231 through 1254, 1256, and 1257 of the Internal Revenue Code. However, you do report as ordinary income under this rule a gain or a part of a gain regardless of any contrary provisions (including nonrecognition provisions) under any other section of the Internal Revenue Code.

Applicable percentage.   The applicable percentage of the excluded cost-sharing payments to be reported as ordinary income is based on the length of time you hold the property after receiving the payments. If the property is held less than 10 years, the percentage is 100%. After 10 years, the percentage is reduced by 10% a year or part of a year until the rate is 0%.

Form 4797, Part III.   Use Form 4797, Part III, to figure the ordinary income part of a gain from the sale, exchange, or involuntary conversion of section 1252 property and section 1255 property.

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