Ordinary or Capital Gain or Loss You must classify your gains and losses as either ordinary orcapital gains or losses (and your capital gains or losses as eithershort-term or long-term gains or losses). You must do this to figureyour net capital gain or loss. Your net capital gains may be taxed at a lower tax rate thanordinary income. See Capital Gain Tax Rates, later. Yourdeduction for a net capital loss may be limited. See Treatment ofCapital Losses, later. Capital gain or loss.Generally, you will have a capital gain or loss if you sell orexchange a capital asset. You may also have a capital gain if yoursection 1231 transactions result in a net gain. Section 1231 transactions.Section 1231 transactions are sales and exchanges of property heldlonger than 1 year and either used in a trade or business or held forthe production of rents or royalties. They also include certaininvoluntary conversions of business or investment property, includingcapital assets. See Section 1231 Gains and Losses inchapter 11for more information. Capital Assets For the most part, all property you own and use for personalpurposes or investment is a capital asset. The following items are some examples of capital assets: A home owned and occupied by you and your family. Household furnishings. A car used for pleasure. If your car is used both forpleasure and for farm business, it is partly a capital asset andpartly a noncapital asset, defined later. Stocks and bonds. However, there are special rules for gainsand losses on qualified small business stock. For more information onthis subject, see Losses on Small Business Investment CompanyStock in chapter 4 of Publication 550. Personal-use property.Property held for personal use is a capital asset. Gain from a saleor exchange of that property is a capital gain and is taxable. Lossfrom the sale or exchange of that property is not deductible. You candeduct a loss relating to personal-use property only if it resultsfrom a casualty or theft. For information about casualties and thefts,see chapter 13. Long and Short Term Where you report a capital gain or loss depends on how long you ownthe asset before you sell or exchange it. The time you own an assetbefore disposing of it is the holding period. If you hold a capital asset 1 year or less, the gain or lossresulting from its disposition is short term. Report it in Part I ofSchedule D. If you hold a capital asset longer than 1 year, the gainor loss resulting from its disposition is long term. Report it in PartII of Schedule D. Holding period.To figure if you held property longer than 1 year, start countingon the day after the day you acquired the property. This same date ofeach following month is the beginning of a new month regardless of thenumber of days in the preceding month. The day you disposed of theproperty is part of your holding period. Example.If you bought an asset on June 18, 1998, you should start countingon June 19, 1998. If you sold the asset on June 18, 1999, your holdingperiod is not longer than 1 year, but if you sold it on June 19, 1999,your holding period is longer than 1 year. Inherited property.If you inherit property, you are considered to have held theproperty longer than 1 year even if you dispose of it within 1 yearafter the decedent's death. This rule does not apply to livestock usedin a farm business. See Holding period underLivestock, later. Bad debt.A nonbusiness bad debt is always treated as a short-term capitalloss. See chapter 4 of Publication 550. Nontaxable exchange.If you acquire an asset in exchange for another asset and yourbasis for the new asset is determined, in whole or in part, by yourbasis in the old property, the holding period of the new propertyincludes the holding period of the old property. That is, it begins onthe same day as your holding period for the old property. Gift.If you receive a gift of property and your basis in it is figuredusing the donor's basis, your holding period includes the donor'sholding period. Real property.To figure how long you held real property, start counting on theday after you received title to it, or, if earlier, on the day afteryou took possession of it and assumed the burdens and privileges ofownership. However, taking possession of real property under an optionagreement is not enough to start the holding period. The holdingperiod cannot start until there is an actual contract of sale. Theholding period of the seller cannot end before that time. Figuring Net Gain or Loss The totals for short-term capital gains and losses and the totalsfor long-term capital gains and losses must be figured separately. Net short-term capital gain or loss.Combine your short-term capital gains and losses. Do this by addingall your short-term capital gains. Then add together all yourshort-term capital losses. Subtract the lesser total from the other.The result is your net short-term capital gain or loss. Net long-term capital gain or loss.Follow the same steps to combine your long-term capital gains andlosses. The result is your net long-term capital gain or loss. Net gain.If the total of your capital gains is more than the total of yourcapital losses, the difference is taxable. However, the part that isnot more than your net capital gain may be taxed at a rate that islower than the rate of tax on your ordinary income. See ERROR MSGCapitalGain Tax Rates, later. Net loss.If the total of your capital losses is more than the total of yourcapital gains, the difference is deductible. But there are limits onhow much loss you can deduct, and when you can deduct it. SeeTreatment of Capital Losses, next. Treatment of Capital Losses If your capital losses are more than your capital gains, you mustclaim the difference even if you do not have ordinary income to offsetit. The yearly limit on the amount of the capital loss you can deductis $3,000 ($1,500 if you are married and file a separate return). Ifyour other income is low, you may not be able to use the full $3,000.The part of the $3,000 you cannot use becomes part of your capitalloss carryover. Table 10-2 Capital loss carryover.Generally, you have a capital loss carryover if either of thefollowing situations applies to you. Your net capital loss on line 17 of Schedule D is more thanthe yearly limit. The amount shown on line 37, Form 1040 (your taxable incomewithout your deduction for exemptions), is less than zero. If either of these situations applies to you for 1999, completethe Capital Loss Carryover Worksheet provided in theinstructions to Schedule D (Form 1040) to figure the amount you cancarry over to 2000. Capital Gain Tax Rates The 31%, 36%, and 39.6% income tax rates for individuals do notapply to a net capital gain. In most cases, the 15% and 28% rates donot apply either. Instead, your net capital gain is taxed at lowercapital gain rates. Net capital gain is the net long-term capital gain for the yearthat is more than the net short-term capital loss for the year. You will need to use Part IV of Schedule D (Form 1040) to figureyour tax using the capital gain rates if both of the following aretrue. Both lines 16 and 17 of Schedule D are gains. Your taxable income on Form 1040, line 39, is more thanzero. The rate may be 10%, 20%, 25%, or 28%, or a combination of two ormore of those rates as shown in Table 10-2. Using the capital gain rates.The part of a net capital gain that is subject to each rate isdetermined by first netting long-term capital gains with long-termcapital losses in the following tax rate groups. A 28% group, consisting of all the following gains andlosses. roulette in lineaCollectibles gains and losses. The part of your gain on qualified small business stock thatis equal to the section 1202 exclusion. Any long-term capital loss carryover. A 25% group, consisting of unrecaptured section 1250gain. A 20% group, consisting of gains and losses not in the 28%or 25% group. If any group has a net loss, the following rules apply. A net loss from the 28% group reduces any gain from the 25%group, and then any net gain from the 20% group. A net loss from the 20% group reduces any net gain from the28% group, and then any gain from the 25% group. accommodation in AarhusIf you have a net short-term capital loss, it reduces any net gainfrom the 28% group, then any gain from the 25% group, and finally anynet gain from the 20% group. The resulting net gain (if any) from each group is subject to thetax rate for that group. (The 10% rate applies to a net gain from the20% group to the extent that, if there were no capital gain rates, thenet capital gain would be taxed at the 15% regular tax rate.) Collectibles gain or loss.This is gain or loss from the sale or exchange of a work of art,rug, antique, metal, gem, stamp, coin, or alcoholic beverage heldlonger than 1 year. Collectibles gain includes gain from the sale ofan interest in a partnership, S corporation, or trust attributable tounrealized appreciation of collectibles. Gain on qualified small business stock.If you realized a gain from qualified small business stock that youheld longer than 5 years, you exclude up to one-half of your gain fromyour income. The taxable part of your gain equal to your section 1202exclusion is a 28% rate gain. See Sales of Small Business Stockin chapter 1 of Publication 544. Unrecaptured section 1250 gain.This is the part of any long-term capital gain on section 1250property (real property) that is due to straight-line depreciationminus any net loss in the 28% group. Unrecaptured section 1250 gaincannot be more than the net section 1231 gain or include any gain thatis otherwise treated as ordinary income. Use the worksheet in theSchedule D instructions to figure your unrecaptured section 1250 gain.For more information about section 1250 property and net section 1231gain, see chapter 3 of Publication 544. Changes after 2000.After 2000, there will be changes to the capital gain rates. 2001.Beginning in 2001, the 10% capital gain rate will be lowered to 8%for "qualified 5-year gain." 2006.Beginning in 2006, the 20% capital gain rate will be lowered to 18%for qualified 5-year gain from property with a holding period thatbegins after 2000. Taxpayers who own certain stock on January 1, 2001, can choose totreat the stock as sold and repurchased on January 2, 2001, if theypay tax for 2001 on any resulting gain. Qualified 5-year gain.This is long-term capital gain from the sale of property you heldfor longer than 5 years that would otherwise be subject to the 10% or20% capital gain rate. Net capital gain from disposition of investment property.If you choose to include any part of a net capital gain from adisposition of investment property in investment income for figuringyour investment interest deduction, you must reduce the net capitalgain eligible for the capital gain tax rates by the same amount. Youmake this choice on Form 4952, Investment Interest ExpenseDeduction, line 4e. For information on making this choice, seethe instructions to Form 4952. For information on the investmentinterest deduction, see chapter 3 in Publication 550. Noncapital Assets Noncapital assets include property such as inventory anddepreciable property used in a trade or business. A list of propertiesthat are not capital assets is provided in the Schedule DInstructions. Property held for sale in the ordinary course of your farmbusiness.Property you hold mainly for sale to customers, such as livestock,poultry, livestock products, and crops, is a noncapital asset. Gain orloss from sales or other dispositions of this property is reported onSchedule F (not on Schedule D or Form 4797). The treatment of thisproperty is discussed in chapter 4. Land and depreciable properties.Noncapital assets include land and depreciable property you use infarming. They also include livestock held for draft, breeding, dairy,or sporting purposes. However, your gains and losses from sales andexchanges of your farm land and depreciable properties must beconsidered together with certain other transactions to determinewhether the gains and losses are treated as capital or ordinary gainsand losses. The sales of these business assets are reported on Form4797. See chapter 11for more information. Hedging(Commodity Futures) Hedging transactions are transactions that you enter into in thenormal course of business primarily to reduce the risk of interestrate or price changes or currency fluctuations with respect toborrowings, ordinary property, or ordinary obligations. (Ordinaryproperty or obligations are those that cannot produce capital gain orloss if sold or exchanged.) A commodity futures contract is a standardized, exchange-tradedcontract for the sale or purchase of a fixed amount of a commodity ata future date for a fixed price. The holder of an option on a futurescontract has the right (but not the obligation) for a specified periodof time to enter into a futures contract to buy or sell at aparticular price. A forward contract is generally similar to a futurescontract except that the terms are not standardized and the contractis not exchange traded. Businesses may enter into commodity futures contracts or forwardcontracts and may acquire options on commodity futures contracts aseither of the following. Hedging transactions. Transactions that are not hedging transactions. Futures transactions that are not hedging transactionsgenerally result in capital gain or loss. There is a limit on theamount of capital losses you can deduct each year. If, as a farmer-producer, to protect yourself from the risk ofunfavorable price fluctuations, you enter into commodity forwardcontracts, futures contracts, or options on futures contracts andthe contracts cover an amount of the commodity within your rangeof production, the transactions are generally considered hedgingtransactions. They can take place at any time you have the commodityunder production, have it on hand for sale, or reasonably expect tohave it on hand. The gain or loss on the termination of these hedges is generallyordinary gain or loss. Farmers who file their income tax returns onthe cash method report any profit or loss on the hedging transactionon line 10 of Schedule F. The gain or loss on transactions that hedge the purchase of anoninventory supply (for example, animal feed) may be ordinary. If abusiness sells only a negligible amount of a noninventory supply, atransaction to hedge the purchase of that supply is treated as ahedging transaction. Files: If you have numerous transactions in the commodity futures marketduring the year, you must be able to show which transactions arehedging transactions. Clearly identify a hedging transaction on yourbooks and records before the end of the day you entered into thetransaction. It may be helpful to have separate brokerage accounts foryour hedging and speculation transactions. The identification must not only be on, and retained as part of,your books and records but must specify both the hedging transactionand the item, items, or aggregate risk that is being hedged. Althoughthe identification of the hedging transaction must be made before theend of the day it was entered into, the identification of the hedgeditem, items, or risk must be made no more than 35 days after enteringinto the hedging transaction. For more information on the tax treatment of futures and optionscontracts, see Commodity Futures and Section 1256Contracts Marked to Market in Publication 550. Accounting methods for hedging transactions.Hedging transactions must be accounted for under special rules ifyou use an accounting method other than the following methods. Cash method. Farm-price method. Unit-livestock-price method. Under these rules, the accounting method you use for a hedgingtransaction must clearly reflect income. This means that youraccounting method must reasonably match the timing of income,deduction, gain, or loss from a hedging transaction with the timing ofincome, deduction, gain, or loss from the item or items being hedged.There are requirements and limitations on the method you can use forcertain hedging transactions. See section 1.446-4(e) of theregulations for those requirements and limitations. Once you adopt a method, you must apply it consistently and musthave IRS approval before changing it. Your books and records must describe the accounting method used foreach type of hedging transaction. They must also contain anyadditional identification necessary to verify the application of theaccounting method you used for the transaction. You must make theadditional identification no more than 35 days after entering into thehedging transaction. Example of a hedging transaction.You file your income tax returns on the cash method. On July 2,1999, you anticipate a yield of 50,000 bushels of corn this crop year.The present December futures price is $2.75 a bushel, but there areindications that by harvest time the price will drop. To protectyourself against a drop in the sales price of your corn inventory, youenter into the following hedging transaction. You sell 10 Decemberfutures contracts of 5,000 bushels each for a total of 50,000 bushelsof corn at $2.75 a bushel. The price did not drop as anticipated but rose to $3 a bushel. InNovember, you sell your crop at a local elevator for $3 a bushel. Youalso close out your futures position by buying 10 December contractsfor $3 a bushel. You paid a broker's commission of $700 ($70 percontract) for the complete in and out position in the futures market. The result is that the price of corn rose 25 cents a bushel and theactual selling price is $3 a bushel. Your loss on the hedge is 25cents a bushel. In effect, the net selling price of your corn is $2.75a bushel. Report the results of your futures transactions and your sale ofcorn separately on Schedule F. The loss on your futures transactions is $13,200, figured asfollows. July 2, 1999--Sold Dec. corn futures50,000 bu. @$2.75 $137,500 Nov. 6, 1999--Bought Dec. corn futures50,000 bu. @$3 (plus broker'scommission)    150,700 Futures loss ($13,200) This loss is reported as a negative figure on line 10, Part Iof Schedule F. The proceeds from your corn sale at the local elevator are $150,000(50,000 bu. $3). Report it on line 4, Part I of Schedule F. Assume you were right and the price went down 25 cents a bushel. Ineffect, you would still net $2.75 a bushel, figured as follows. Sold cash corn, per bushel $2.50 Gain on hedge, per bushel          .25 $2.75 The gain on your futures transactions would have been $11,800,figured as follows. July 2, 1999--Sold Dec. corn futures50,000 bu. @$2.75 $137,500 Nov. 6, 1999--Bought Dec. corn futures50,000 bu. @$2.50 (plus broker'scommission)    125,700 Futures gain $11,800 The $11,800 is reported on line 10, Part I of Schedule F. The proceeds from the sale of your corn at the local elevator,$125,000, are reported on line 4, Part I of Schedule F. Livestock This part discusses the sale or exchange of livestock used in yourfarm business. Gain or loss from the sale or exchange of thislivestock may qualify as a section 1231 transaction. However, any partof the gain that is ordinary income from the recapture of depreciationis not included as section 1231 gain. See chapter 11for moreinformation on section 1231 gains and losses and the recapture ofdepreciation under section 1245. Caution: The rules discussed here do not apply to the sale of livestock heldprimarily for sale to customers. The sale of livestock is reported onSchedule F. See chapter 4. Holding period.The sale or exchange of livestock used in your farm businessqualifies as a section 1231 transaction if you held the livestock for12 months or more (24 months or more for horses and cattle). Livestock.For section 1231 transactions, livestock includes cattle, hogs,horses, mules, donkeys, sheep, goats, fur-bearing animals (such asmink), and other mammals. Livestock does not include chickens,turkeys, pigeons, geese, emus, ostriches, rheas, or other birds, fish,frogs, reptiles, etc. Livestock used in farm business.If livestock is held primarily for draft, breeding, dairy, orsporting purposes, it is used in your farm business. The purpose forwhich an animal is held ordinarily is determined by a farmer's actualuse of the animal. 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 forthat purpose. Example 1.You discover an animal that you intend to use for breeding purposesis sterile. You dispose of it within a reasonable time. This animalwas held for breeding purposes. Example 2.You retire and sell your entire herd, including young animals thatyou would have used for breeding or dairy purposes had you remained inbusiness. These young animals were held for breeding or dairypurposes. Also, if you sell young animals to reduce your breeding ordairy herd because of, for example, drought, these animals are treatedas having been held for breeding or dairy purposes. Example 3.You are in the business of raising hogs for slaughter. Customarily,before selling your sows, you obtain a single litter of pigs that youwill raise for sale. You sell the brood sows after obtaining thelitter. Even though you hold these brood sows for ultimate sale tocustomers in the ordinary course of your business, they are consideredto be held for breeding purposes. Example 4.You are in the business of raising registered cattle for sale toothers for use as breeding cattle. It is the business practice tobreed the cattle before sale to establish their fitness as registeredbreeding cattle. Your use of the young cattle for breeding purposes isordinary and necessary for selling them as registered breeding cattle.Such use does not demonstrate that you are holding the cattle forbreeding purposes. However, those cattle you held as additions orreplacements to your own breeding herd to produce calves areconsidered to be held for breeding purposes, even though they may notactually have produced calves. The same applies to hog and sheepbreeders. Example 5.You are in the business of breeding and raising mink that you peltfor the fur trade. You take breeders from the herd when they are nolonger useful as breeders and pelt them. Although these breeders areprocessed and pelted, they are still considered to be held forbreeding purposes. The same applies to breeders of other fur-bearinganimals. Example 6.You breed, raise, and train horses for racing purposes. Every yearyou cull some horses from your racing stable. In 1999, you decidedthat to prevent your racing stable from getting too large to beeffectively operated, you must cull six horses from it. All six ofthese horses had been raced at public tracks in 1998. These horses areall considered held for sporting purposes. Figuring gain or loss on the cash method.Farmers or ranchers who use the cash method of accounting figuretheir gain or loss on the sale of livestock used in their farmingbusiness as follows. Raised livestock.Gain on the sale of raised livestock is generally the gross salesprice reduced by any expenses of the sale is gain. Expenses of saleinclude sales commissions, freight or hauling from farm to commissioncompany, and other similar expenses. The basis of the animal sold iszero if the costs of raising it were deducted during the years theanimal was being raised. However, see Uniform CapitalizationRules in chapter 7. Purchased livestock.The gross sales price minus your adjusted basis and any expenses ofsale is the gain or loss. Example.A farmer sold a breeding cow on January 6, 1999, for $1,250.Expenses of the sale were $125. The cow was bought July 2, 1996, for$1,300. Depreciation (not less than the amount allowable) was $759. Gross sales price $1,250 Cost (basis) $1,300 Minus: Depreciation deduction          759 Unrecovered cost(adjusted basis) $541 Expense of sale          125        666 Gain realized $584 Converted Wetland andHighly Erodible Cropland Special rules apply to dispositions of land converted to farminguse after March 1, 1986. Any gain realized on the disposition ofconverted wetland or highly erodible cropland is treated as ordinaryincome. Any loss on the disposition of such property is treated as along-term capital loss. Converted wetland.This is generally land that must have been drained or filled tomake the production of agricultural commodities possible. It includesconverted wetland held by the person who originally converted it orheld by any other person who used the converted wetland at any timeafter conversion for farming purposes. A wetland (before conversion) is land that meets all of thefollowing conditions. It is mostly soil that, in its undrained condition, issaturated, flooded, or ponded long enough during a growing season todevelop an oxygen-deficient state that supports the growth andregeneration of plants growing in water. It is saturated by surface or groundwater at a frequency andduration sufficient to support mostly plants that are adapted for lifein saturated soil. It supports under normal circumstances mostly plants thatgrow in saturated soil. Highly erodible cropland.This is cropland subject to erosion that you used at any time forfarming purposes other than the grazing of animals. Generally, highlyerodible cropland is land that is currently classified by theDepartment of Agriculture as Class IV, VI, VII, or VIII under itsclassification system. Highly erodible cropland also includes landthat would have an excessive average annual erosion rate in relationto the soil loss tolerance level, as determined by the Department ofAgriculture. Successors.Converted wetland or highly erodible cropland is also land held byany person whose basis in the land is figured by reference to theadjusted basis of a person in whose hands the property was convertedwetland or highly erodible cropland. Timber Standing timber you held as investment property is a capital asset.Gain or loss from its sale is capital gain or loss reported onSchedule D (Form 1040). If you held the timber primarily for sale tocustomers, it is not a capital asset. Gain or loss on its sale isordinary business income or loss. It is reported on the gross receiptsor sales and cost of goods sold lines of Schedule F. 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. Thesesales constitute a very minor part of their farm businesses. Amountsrealized from these sales, and the expenses incurred in cutting,hauling, etc., are ordinary farm income and expenses reported onSchedule F (Form 1040). Different rules apply if you owned the timber longer than 1 yearand choose to treat timber cutting as a sale or exchange or you enterinto a cutting contract, discussed later. Depletion on timber isdiscussed in chapter 8. Rotterdam hotelsTimber considered cut.Timber is considered cut on the date when, in the ordinary courseof business, the quantity of felled timber is first definitelydetermined. This is true whether the timber is cut under contract orwhether you cut it yourself. Christmas trees.Evergreen trees, such as Christmas trees, that are more than 6years old when severed from their roots and sold for ornamentalpurposes are included in the term "timber." They qualify for bothrules, discussed below. Choice to treat cutting as a sale or exchange.Under the general rule, the cutting of timber results in no gain orloss. It is not until a sale or exchange occurs that gain or loss isrealized. But if you owned or had a contractual right to cut timber,you may choose to treat the cutting of timber as a section 1231transaction in the year it is cut. Even though the cut timber is notactually sold or exchanged, you report your gain or loss on thecutting for the year the timber is cut. Any later sale results inordinary business income or loss. To choose this treatment, you must: Own or hold a contractual right to cut the timber for aperiod of more than 1 year before it is cut, and Cut the timber for sale or use it in your trade orbusiness. Making the choice.You make the choice on your return for the year the cutting takesplace by including in income the gain or loss on the cutting andincluding a computation of your gain or loss. You do not have to makethe choice in the first year you cut the timber. You may make it inany year to which the choice would apply. If the timber is partnershipproperty, the choice is made on the partnership return. This choicecannot be made on an amended return. Once you have made the choice, it remains in effect for all lateryears unless you cancel it. Canceling a post-1986 choice.You can cancel a choice you made for a tax year beginning after1986 only if you can show undue hardship and you get the approval ofthe Internal Revenue Service (IRS). Thereafter, you may not make anynew choice unless you have the approval of the IRS. Canceling a pre-1987 choice.You can cancel a choice you made for a tax year beginning before1987 without the approval of the IRS. You can cancel the choice byattaching a statement to your tax return for the year the choice is tobe effective. If you make this cancellation, which can be made onlyonce, you can make a new choice without the approval of the IRS. Anyfurther cancellation will require the approval of the IRS. The statement must include all of the following information. Your name, address, and taxpayer identificationnumber. The year the cancellation is effective and the timber towhich it applies. That the cancellation being made is of the choice to treatthe cutting of timber as a sale or exchange under section 631(a) ofthe Internal Revenue Code. That the cancellation is being made under section 311(d) ofPublic Law 99-514. That you are entitled to make the cancellation under section311(d) of Public Law 99-514 and section 301.9100-7T of theregulations. Gain or loss.Your gain or loss on the cutting of standing timber is thedifference between its adjusted basis for depletion and its fairmarket value on the first day of your tax year in which it is cut. Your adjusted basis for depletion of cut timber is based on thenumber of units (feet board measure, log scale, or other units) oftimber cut during the tax year and considered to be sold or exchanged.Your adjusted basis for depletion is also based on the depletion unitof timber in the account used for the cut timber, and should befigured in the same manner as shown in section 611 of the InternalRevenue Code and section 1.611-3 of the regulations. Example.In April 1999, you owned 4,000 MBF (1,000 board feet) of standingtimber longer than 1 year. It had an adjusted basis for depletion of$40 per MBF. You are a calendar year taxpayer. On January 1, 1999, thetimber had a fair market value (FMV) of $120 per MBF. It was cut inApril for sale. On your 1999 tax return, you choose to treat thecutting of the timber as a sale or exchange. You report the differencebetween the FMV and your adjusted basis for depletion as a gain. Thisamount is reported on Form 4797 along with your other section 1231gains and losses to figure whether it is treated as a capital gain oras ordinary gain. You figure your gain as follows. FMV of timber January 1, 1999 $480,000 Minus: Adjusted basis for depletion    160,000 Section 1231 gain $320,000 The FMV becomes your basis in the cut timber, and a later sale ofthe cut timber, including any by-product or tree tops, will result inordinary business income or loss. Cutting contract.You must treat the disposal of standing timber under a cuttingcontract as a section 1231 transaction if all of the following applyto you. You are the owner of the timber. You held the timber longer than 1 year before itsdisposal. You kept an economic interest in the timber. The difference between the amount realized from the disposal of thetimber and its adjusted basis for depletion is treated as gain or losson its sale. Include this amount on Form 4797 along with your othersection 1231 gains and losses to figure whether it is treated ascapital or ordinary gain or loss. Date of disposal.The date of disposal is the date the timber is cut. However, if youreceive payment under the contract before the timber is cut, you mayelect to treat the date of payment as the date of disposal. Thiselection is effective only to figure the holding period of the timber.It has no effect on the time for reporting gain or loss (generallywhen the timber is sold or exchanged). To make this election, attach astatement to the tax return filed by the due date (includingextensions) for the year payment is received. The statement mustidentify the advance payments subject to the election and the contractunder which they were made. If you timely filed your return for theyear you received payment without making the election, you can stillmake the election by filing an amended return within 6 months afterthe due date for that year's return (excluding extensions). Attach thestatement to the amended return and write "Filed pursuant to section301.9100-2" at the top of the statement. File the amendedreturn at the same address the original return was filed. Owner.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.You own an interest in timber if you have the right to cut it for saleon your own account or for use in your business. Economic interest.You have kept an economic interest in standing timber if, under thecutting contract, the expected return on your investment is based onthe cutting of the timber. Tree stumps.Tree stumps are a capital asset if they are on land held by aninvestor who is not in the timber or stump business, either as abuyer, seller, or processor. Gain from the sale of stumps sold in onelot by such a holder is taxed as a capital gain. However, tree stumpsheld by timber operators, after the saleable standing timber was cutand removed from the land are considered by-products. Gain from thesale of stumps in lots or tonnage by such operators is taxed asordinary income. Sale of a Farm The sale of your farm will usually involve the sale of bothnonbusiness property (your home) and business property (the land andbuildings used in the farm operation and perhaps machinery andlivestock). If you have a gain from the sale, you may be allowed toexclude the gain on your home. The gain on the sale of your businessproperty is taxable. A loss on the sale of your business property toan unrelated person is deducted as an ordinary loss. Losses fromnonbusiness property, other than casualty or theft losses, are notdeductible. If you receive payments for your farm in installments,your gain is taxed over the period of years the payments are received,unless you choose not to use the installment method of reporting thegain. See chapter 12for information about installment sales. When you sell your farm, the gain or loss on each asset is figuredseparately. The tax treatment of gain or loss on the sale of eachasset is determined by the classification of the asset. Each of theassets sold must be classified as one of the following. Capital asset held 1 year or less. Capital asset held longer than 1 year. Property (including real estate) used in your business andheld 1 year or less (including draft, breeding, dairy, and sportinganimals held less than the holding periods discussed earlier underLivestock). Property (including real estate) used in your business andheld longer than 1 year (including draft, breeding, dairy, andsporting animals held for the holding periods discussedearlier). Property held primarily for sale or which is of the kindthat would be included in inventory if on hand at the end of your taxyear. Allocation of consideration paid for a farm.The sale of a farm for a lump sum is considered a sale of eachindividual asset rather than a single asset. Except for assetsexchanged under the like-kind exchange rules (discussed earlier), boththe buyer and seller of a farm must use the residual method toallocate the consideration to each business asset transferred. Thismethod determines gain or loss from the transfer of each asset. Italso determines the buyer's basis in the business assets. Residual method.The residual method provides for the consideration to be reducedfirst by the cash, demand deposits, and similar accounts transferredby the seller. The consideration remaining after this reduction mustbe allocated among the various business assets in a certain order. The allocation must be made among the following assets in thefollowing order in proportion to (but not more than) their fair marketvalue on the purchase date. Certificates of deposit, U.S. government securities, readilymarketable stock or securities, and foreign currency. All other assets except section 197 intangibles. Section 197 intangibles (other than goodwill and goingconcern value) (discussed in chapter 8). Section 197 intangibles in the nature of goodwill and goingconcern value. For more information about the residual method and how toreport the allocation of the sales price on Form 1040, see chapter 2 in Publication 544. Property used in farm operation.The rules for excluding the gain on the sale of your home,described later under Sale of your home, do not apply tothe property used for your farming business. Recognized gains andlosses on business property must be reported on your return for theyear of the sale. If the property was held longer than 1 year, it mayqualify for section 1231 treatment (see chapter 11). Example.You sell your farm, including your main home, which you have ownedsince December 1994. You realize gain on the sale as follows. Farm With Home Home Only Hotel con descuento PortoFarm Without Home Selling price $182,000 $58,000 $124,000 Cost (or other basis)     40,000     10,000     30,000 Gain $142,000 $48,000 $94,000 You must report the $94,000 gain from the sale of the property usedin your farm business. All or a part of that gain may have to bereported as ordinary income from the recapture of depreciation or soiland water conservation expenses. Treat the balance as section 1231gain. The $48,000 gain from the sale of your home is not taxable as longas you meet the requirements explained later under Gain on saleof your main home. Partial sale.If you sell only part of your farm, you must report any recognizedgain or loss on the sale of that part on your tax return for the yearof the sale. You cannot wait until you have sold enough of the farm torecover its entire cost before reporting gain or loss. Adjusted basis of the part sold.This is the properly allocated part of your original cost or otherbasis of the entire farm, plus or minus necessary adjustments forimprovements, depreciation, etc., on the part sold. Example.You bought a 600-acre farm for $700,000. The farm included land andbuildings. The purchase contract designated $600,000 of the purchaseprice to the land. You later sold 60 acres of land on which you hadinstalled a fence. Your adjusted basis for the part of your farm soldis $60,000 (1/10 of $600,000), plus any unrecovered cost (cost notdepreciated) of the fence on the 60 acres at the time of sale. Usethis amount to determine your gain or loss on the sale of the 60acres. Assessed values for local property taxes.If you paid a flat sum for the entire farm and no other facts areavailable for properly allocating your original cost or other basisbetween the land and the buildings, you can use the assessed value forlocal property taxes for the year of purchase to allocate the costs. Example.Assume that in the preceding example there was no breakdown of the$700,000 purchase price between land and buildings. However, in theyear of purchase, local taxes on the entire property were based onassessed valuations of $420,000 for land and $140,000 forimprovements, or a total of $560,000. The assessed valuation of theland is 3/4 (75%) of the total assessed valuation.Multiply the $700,000 total purchase price by 75% to figure basis of$525,000 for the 600 acres of land. The unadjusted basis of the 60acres you sold would then be $52,500 (1/10 of $525,000). If your homeis on the farm, you must properly adjust the basis to exclude thosecosts from your farm asset costs, as discussed next. Sale of your home.Your home is a capital asset and not property used in the trade orbusiness of farming. If you sell a farm that includes a house you andyour family occupy, you must determine the part of the selling priceand the part of the cost or other basis allocable to your home. Yourhome includes the immediate surroundings and outbuildings relating toit. If you use part of your home for business, you must make anappropriate adjustment to the basis for depreciation allowed orallowable. For more information on basis, see Allocating theBasis in chapter 7. Gain on sale of your main home.If you sell your main home at a gain, you may qualify to excludefrom income all or part of the gain. To qualify, you must meet theownership and use tests. You can claim the exclusion if, during the 5-year period ending onthe date of the sale, you meet both the following requirements. You owned the home for at least 2 years (the ownershiptest). You lived in the home as your main home for at least 2 years(the use test). You can exclude the entire gain on the sale of your main home upto: $250,000, or $500,000, if all of the following are true. You are married and file a joint return for the year. Either you or your spouse meets the ownership test. Both you and your spouse meet the use test. Neither you nor your spouse excluded gain from the sale ofanother home after May 6, 1997. The exclusion may be reduced under certain circumstances. SeePublication 523 for more information. Gain from condemnation.If you have a gain from a condemnation or sale under threat ofcondemnation, you may use the preceding rules for excluding the gain,rather than the rules discussed under Postponing Gain inchapter 13.However, any gain that cannot be excluded (because it ismore than the limit) may be postponed under the rules discussed underPostponing Gain in chapter 13. Loss on your home.You cannot deduct a loss on your home from a voluntary sale, acondemnation, or a sale under threat of condemnation. More information.For more information on selling your home, see Publication 523. Abandonments You abandon property when you voluntarily give up possession of theproperty with the intention of ending your ownership, but withoutpassing it on to anyone else. Business or investment property.Loss from abandonment of business or investment property isdeductible as an ordinary loss, even if the property is a capitalasset. The loss is the amount of the property's adjusted basis whenabandoned. This rule also applies to leasehold improvements the lessormade for the lessee that were abandoned. However, if the property islater foreclosed on or repossessed, gain or loss is figured asdiscussed earlier under Foreclosures and Repossessions. The abandonment loss is taken in the tax year in which the loss issustained. Report the loss on Form 4797, Part II, line 10. Example.Ann lost her contract with the local poultry processor andabandoned poultry facilities that she built for $100,000. At the timeshe abandoned the facilities, her mortgage balance was $85,000. Shehas a deductible loss of $66,554 (her adjusted basis). If the banklater forecloses on the loan or repossesses the facilities, she willhave to figure her gain or loss as discussed earlier underForeclosures and Repossessions. Personal-use property.You cannot deduct any loss from abandonment of your home or otherproperty held for personal use. Canceled debt.If the abandoned property secures a debt for which you arepersonally liable and the debt is canceled, you will realize ordinaryincome equal to the amount of canceled debt. This income is separatefrom any loss realized from abandonment of the property. Report incomefrom cancellation of a debt related to a business or rental activityas business or rental income. Report income from cancellation of anonbusiness debt as miscellaneous income on line 21, Form 1040. However, income from cancellation of debt is not taxed in thefollowing circumstances. The cancellation is intended as a gift. The debt is qualified farm debt (see chapter 4). The debt is qualified real property debt (see chapter 5 ofPublication 334,TaxGuide for Small Business). You are insolvent or bankrupt (see Publication 908,Bankruptcy Tax Guide). Forms 1099-A and 1099-C.If your abandoned property secures a loan and the lender knows theproperty has been abandoned, the lender should send you Form1099-A showing the information you need to figure your loss fromthe abandonment. However, if your debt is canceled and the lender mustfile Form 1099-C, the lender may include the information aboutthe abandonment on that form instead of Form 1099-A. The lendermust file Form 1099-C and send you a copy if the canceled debtis $600 or more and the lender is a financial institution, creditunion, or federal government agency. For abandonments of property anddebt cancellations occurring in 1999, these forms should be sent toyou by January 31, 2000.