shall establish (if not previously established) and maintain for purposes of section 1251 an excess deductions account. See section 1251(b)(1). Once an excess deductions account is established (or succeeded to under paragraph (e) of this section in the case of certain corporate transactions and gifts) all entries (including the entries prescribed by paragraph (f) of this section with respect to married taxpayers who file joint returns) with respect to the account must be part of the taxpayer's permanent records for all taxable years for which the account must be maintained. For purposes of applying section 1251 and this section, the term taxpayer in the case of a partnership means each partner of such partnership and in the case of an estate or trust means the estate or trust regardless of whether it is taxable under subpart A or E, subchapter J, chapter 1 of the Code.
The limitations of this subparagraph apply to a person (other than a trust) to whom the tax rates set forth in section 1 are applicable and as prescribed in subparagraph (3) of this paragraph in respect of an electing small business corporation.
For purposes of determining whether a shareholder of such corporation has a farm net loss, there shall not be taken into account his pro rata share of farm net income or loss of any other electing small business corporation for such corporation's taxable year ending with or within his taxable year.
Determinations as to whether D or E has a farm net loss
As to X | As to Z | |||
D | E | D | E | |
Farm net income (determined without regard to X, Y, and Z) | $100,000 | $0 | $100,000 | $0 |
Pro rata (1/2) share of corporation's farm net income (or loss): | ||||
Of X | (40,000) | (40,000) | ||
Of Y | 30,000 | 30,000 | 30,000 | 30,000 |
Of Z | (10,000) | (10,000) | ||
Farm net income (or loss) for purposes of determination | $120,000 | $20,000 | $90,000 | ($10,000) |
Accordingly, since the determination as to X indicates that neither D nor E has a farm net loss, the limitations of subparagraph (2) of this paragraph apply to X. Thus, assuming that X, D, or E has nonfarm adjusted gross income in excess of $50,000, X will add $55,000 to its excess deductions account, i.e., the excess of the farm net loss, $80,000, over the $25,000 amount referred to in subparagraph (2)(ii) of this paragraph. Since, however, the determination as to Z indicates that E has a farm net loss, such limitations do not apply to Z. Thus, the addition for 1970 to Z's excess deductions account is the entire amount of its farm net loss, $20,000.
M's Excess Deductions Account
(1) Balance January 1, 1975 | $26,000 | |
(2) Additions for 1975 | 0 | |
(3) Subtotal | 26,000 | |
(4) Subtractions for 1975 (farm net income1) | 1,000 | |
(5) Excess deductions account limitation on gain recognized as ordinary income under section 1251(c)(1) for 1975 | 25,000 | |
(6) Subtraction for disposition of farm recapture property: | ||
(a) Gain from disposition of land to which section 1251(c)(1) applies (computed before applying limitation | $13,000 | |
(b) Gain from disposition of breeding herd to which section 1251(c)(1) applies (computed before applying limitation) | 14,000 | |
(c) Sum of lines (a) and (b) | 27,000 | |
(d) Excess deductions account limitation (amount in line (5)) | 25,000 | |
(e) Gain recognized as ordinary income under section 1251(c)(1) (lower of line (6)(c) or line (6)(d) | 25,000 | |
(7) Balance December 31, 1975 | 0 |
1 Computed by treating the section 1245 gain of $6,000 under paragraph (b)(1)(ii) of § 1.1251-3 as gross income derived from the trade or business of farming.
For allocation of the $25,000 of gain recognized as ordinary income to the land and herd, and for treatment of the gain recognized in excess of $25,000 see example (3) of paragraph (b)(6) of § 1.1251-1 .
A's Excess Deductions Account
(1) Balance January 1, 1971 | $50,000 | |
(2) Additions for 1971: | ||
(a) Farm net loss for 19711 | $5,000 | |
(b) Less amount in paragraph (b)(2)(ii) of this section | 25,000 | |
(c) Total additions for 1971 | 0 | |
(3) Subtotal | 50,000 | |
(4) Subtractions for 1971 | 0 | |
(5) Excess deductions account limitation on gain recognized as ordinary income under section 1251(c)(1) for 1971 | 50,000 | |
(6) Subtraction for dispositions of farm recapture property: | ||
(a) Gain to which section 1251(c)(1) applies (computed before applying limitation) | 31,000 | |
(b) Limitation (amount in line (5) | 50,000 | |
(c) Gain recognized as ordinary income under section 1251(c)(1) lower of line 6(a) or line 6(b) | 31,000 | |
(7) Balance December 31, 1971 | 19,000 |
1 Computed by treating the section 1245 gain of $15,000 under paragraph (b)(1)(ii) of § 1.1251-3 as gross income derived from the trade or business of farming.
Example: A is an unmarried individual who uses the calendar year as his taxable year. For the years 1970 through 1974, A's items of income and deductions are as shown in the table below. A's personal deductions are disregarded. A had no income or loss for any year prior to 1970. Based upon such amounts and the computations shown below, A must recognize as ordinary income under section 1251(c)(1), $35,325 for 1971, $10,000 for 1972, $3,925 for 1973, and $150,000 for 1974.
Amounts assumed | 1970 | 1971 | 1972 | 1973 | 1974 |
(a) Farm net income | ($250,000) | $20,000 | $5,000 | ($75,000) | ($10,000) |
(b) Nonfarm income | 55,000 | (82,000) | 30,000 | 10,000 | 200,000 |
(c) Gain which would be recognized as ordinary income under 1251(c) (computed without regard to the EDA limitation) (hereinafter referred to as farm property disposition) | 88,000 | 10,000 | 2,000 | 150,000 | |
(d) Personal exemption | 625 | 675 | 750 | 750 | 750 |
(e) Net operating loss (NOL) (computed per section 172(c)) | (195,000) | (45,000) | |||
I. COMPUTATIONS FOR 1971 | |||||
1. Excess Deductions Account (EDA) Limitation for 1971: | |||||
a. EDA on December 31, 1970: | |||||
1970 Farm net loss | 250,000 | ||||
Less | (25,000) | ||||
225,000 | 225,000 | ||||
b. Less farm net income for 1971 | (20,000) | ||||
c. EDA before temporary subtraction | 205,000 | ||||
d. Less temporary subtraction per subdivision (ii)(b): | |||||
Aggregate farm NOL carryover to 1971 | 195,000 | ||||
Less tentative farm NOL deduction for 1971: | |||||
Farm net income | 20,000 | ||||
Nonfarm income | (82,000) | ||||
Farm property disposition | 88,000 | ||||
Exemption | (675) | ||||
Tentative taxable income | 25,325 | ||||
Tentative NOL reducing taxable income | 25,325 | (25,325) | |||
169,675 | (169,675) | ||||
e. EDA limitation for 1971 | 35,325 | ||||
2. 1971 Taxable Income: | |||||
a. Farm net income | 20,000 | ||||
b. Nonfarm income | ($82,000) | ||||
c. Farm property disposition | 88,000 | ||||
d. Exemption | (675) | ||||
e. Section 1202 deduction: | |||||
Farm property disposition | $88,000 | ||||
Less amount treated as ordinary income under section 1251(c) (lesser of amount of gain on line 1(e)) | 35,325 | ||||
Capital gain | 52,675 | ||||
Less 50 percent deduction | 26,337 | (26,338) | |||
f. 1971 Taxable income | (1,013) | ||||
II. COMPUTATIONS FOR 1972 | |||||
1. Excess Deductions Account Limitation for 1972: | |||||
a. EDA (line 1(c) above) | 205,000 | ||||
b. Less recapture in 1971 | (35,325) | ||||
c. Less farm net income for 1972 | (5,000) | ||||
d. Less permanent subtraction per subdivision (iii): | |||||
1970 Farm NOL carryover to 1971 | 195,000 | ||||
Less 1970 farm NOL carryover to 1972 (computed per section 172(b)(2)): | |||||
Farm NOL to 1971 | $195,000 | ||||
Less 1971 taxable income computed per section 172(b)(2): | |||||
Farm net income | $20,000 | ||||
Nonfarm income | (82,000) | ||||
Farm property disposition | 88,000 | ||||
26,000 | (26,000) | ||||
Farm NOL carryover to 1972 | 169,000 | ($169,000) | |||
26,000 | ($26,000) | ||||
e. EDA before making temporary subtractions | 138,675 | ||||
f. Less temporary subtraction per subdivision (ii)(b): | |||||
Farm NOL carryover to 1972 | 169,000 | ||||
Farm net income | 5,000 | ||||
Nonfarm income | 30,000 | ||||
Farm recapture disposition | 10,000 | ||||
Exemption | (750) | ||||
Tentative taxable income | 44,250 | ||||
Tentative NOL reducing taxable income | 44,250 | (44,250) | |||
124,750 | (124,750) | ||||
g. EDA limitation for 1972 | 13,925 | ||||
2. Taxable Income for 1972: | |||||
a. Farm net income | 5,000 | ||||
b. Nonfarm income | 30,000 | ||||
c. Farm property disposition | 10,000 | ||||
d. Exemption | (750) | ||||
e. Section 1202 deduction: | |||||
Farm property disposition | 10,000 | ||||
Less amount treated as ordinary income under section 1251(c) (lesser of amount of gain on line 1(g)) | 10,000 | 0 | |||
f. Taxable income before NOL deduction | 44,250 | ||||
g. Net operating loss deduction | (44,250) | ||||
h. Taxable income for 1972 | 0 | ||||
III. COMPUTATIONS FOR 1973 | |||||
1. Excess Deductions Account Limitation for 1973: | |||||
a. Line 1(e) above | 138,675 | ||||
b. Less recapture in 1972 | (10,000) | ||||
c. Less permanent subtraction per subdivision (iii): | |||||
1970 Farm NOL carryover to 1972 | 169,000 | ||||
Less 1970 Farm NOL reducing taxable income in 1972 | (44,250) | ||||
124,750 | 124,750 | ||||
Less 1970 Farm NOL carryover to 1973 computed per section 172(b)(2): | |||||
Farm NOL to 1972 | 169,000 | ||||
1972 Taxable income computed per section 172(b)(2): | |||||
Farm net income | $5,000 | ||||
Nonfarm income | 30,000 | ||||
Farm recapture disposition | 10,000 | ||||
45,000 | ($45,000) | ||||
Farm NOL carryover to 1973 | 124,000 | ($124,000) | |||
750 | ($750) | ||||
d. EDA before making temporary subtractions | $127,925 | ||||
e. Less temporary subtraction per subdivision (ii)(a)-zero (since 1973 farm loss treated as nonfarm addition to NOL per subdivision (iv)(a)) | 0 | ||||
f. Less temporary subtraction per subdivision (ii)(b): Aggregate farm NOL carryover to 1973 | $124,000 | ||||
Less tentative farm NOL deduction for 1973: | |||||
Farm net income | ($75,000) | ||||
Nonfarm income | 10,000 | ||||
Farm property disposition | 30,000 | ||||
Exemption | (750) | ||||
Tentative taxable income | (44,250) | ||||
Tentative NOL reducing taxable income | 0 | 0 | |||
124,000 | (124,000) | ||||
g. EDA limitation for 1973 | 3,925 | ||||
2. Taxable Income 1973: | |||||
a. Farm net income | (75,000) | ||||
b. Nonfarm income | 10,000 | ||||
c. Farm property disposition | 20,000 | ||||
d. Exemption | (750) | ||||
e. Section 1202 deduction: | |||||
Farm property disposition | 20,000 | ||||
Less amount treated as ordinary income under section 1251(c) (lesser of amount of gain on line 1(g)) | 3,925 | ||||
Capital gain | 16,075 | ||||
Less 50 percent deduction | 8,038 | (8,037) | |||
f. Taxable income for 1973 | (53,787) | ||||
IV. COMPUTATIONS FOR 1974 | |||||
1. Excess Deductions Account Limitation for 1974: | |||||
a. Line 1(d) above | 127,925 | ||||
b. Less recapture in 1973 | (13,925) | ||||
c. Farm loss for 1974 | 10,000 | ||||
Plus farm NOL deduction (see § 1.1251-3(b)(3) ) | 45,000 | ||||
55,000 | 55,000 | ||||
Less | 25,000 | ||||
30,000 | 30,000 | ||||
d. Less permanent subtraction per subdivision (iii): | |||||
1970 Farm NOL carryover to 1973 | 124,000 | ||||
Less 1970 farm NOL carryover to 1974 per section 172(b)(2) | 124,000 | ||||
0 | 0 | ||||
e. EDA before making temporary subtractions | 154,000 | ||||
f. Less temporary subtraction per subdivision (ii)(b): | |||||
Aggregrate farm NOL carryover to 1974 | 124,000 | ||||
Less tentative farm NOL deduction in 1974: | |||||
Farm net income | (10,000) | ||||
Nonfarm income | 200,000 | ||||
Farm property disposition | 150,000 | ||||
Exemption | (750) | ||||
Tentative taxable income | 339,250 | ||||
Tentative NOL deduction | 169,000 | ||||
Farm portion of tentative NOL deduction | 124,000 | ||||
0 | 0 | ||||
g. EDA limitation for 1974 | $154,000 | ||||
2. Taxable Income 1974: | |||||
a. Farm net income | (10,000) | ||||
b. Nonfarm income | 200,000 | ||||
c. Farm property disposition | 150,000 | ||||
d. Exemption | (750) | ||||
e. Section 1202 deduction: | |||||
Farm property disposition | $150,000 | ||||
Less amount treated as ordinary income under section 1251(c) (lesser of amount of gain on line 1(g)) | 150,000 | 0 | |||
f. Taxable income before NOL deduction | 339,250 | ||||
g. Net operating loss deduction | (169,000) | ||||
h. Taxable income | 170,250 |
For rules as to procedure of making the election, effect of a change in method of accounting upon making the election, and conditions for revoking the election, see subparagraphs (4), (5), and (6), respectively, of this paragraph.
Shall be added to gross income for such taxable year and shall be treated as gross income derived from the trade or business of farming under paragraph (b)(1)(ii) of § 1.1251-3 , except that if the difference in (b)(2) of this subdivision represents an excess of such inventory value over the adjusted basis for the property computed in (a) of this subdivision then such excess shall be subtracted from gross income for such taxable year and shall be treated as a deduction allowed which is directly connected with carrying on the trade or business of farming under paragraph (b)(1)(i) of § 1.1251-3 .
Example: On January 1, 1974, A, an individual taxpayer who in a previous year had elected under section 1251(b)(4) to compute income from the trade or business of farming by using inventories and by charging to capital account all items properly chargeable to capital under the rules of subdivision (ii) of this subparagraph, purchases a herd of six-month-old feeder calves for $13,000. During 1974, in connection with such herd, A incurred raising costs of $4,000 and carrying charges of $1,600 which would have been properly chargeable to capital account within the meaning of subparagraph (1)(ii) of this paragraph if the herd had not been included in inventory. A determines under his unit-livestock method that on December 31, 1974, the inventory value of the herd is $17,000. On March 1, 1975, A decides to use one-half of the herd for breeding purposes with such part of the herd becoming subject to the capitalization requirements. On January 1, 1975, the adjusted basis for the animals held for breeding purposes, computed under the provisions of subdivision (iv)(a) of this subparagraph, is $9,300 (that is, the aggregate of one-half of the purchase price of $13,000 for the entire herd of feeder calves, $6,500, one-half of the carrying charges of $1,600 incurred during 1974 in connection with the entire herd, $800, and one-half of the $4,000 of raising costs incurred during 1974 for the entire herd, $2,000). There is no adjustment for the depreciation which would have been allowed since no animal in the herd had reached an acceptable breeding age. Therefore, A as of January 1, 1975, must under the provisions of subdivision (iv)(b)(2) of this subparagraph subtract $8,500 from his opening inventory value of $17,000. However, A has not changed his method of accounting with respect to such animals. Under the provisions of subdivision (iv)(b)(2) of this subparagraph, A for 1975 will add $800 to his gross income (that is, the difference between the adjusted basis for the calves to be used for breeding purposes, $9,300, over the inventory value of such animals, $8,500). Such amount under the provisions of subdivision (iv)(b) shall be treated as gross income derived from the trade or business of farming under paragraph (b)(1) of § 1.1251-3 .
Date Gift to donee | 9/1/70 | 8/1/71 | 3/1/72 | 5/1/73 |
C | D | E | F | |
(1) Percent of undivided interest in entire farm given as gift by A on date indicated | 20% | 10% | 10% | 60% |
(2) Percent of undivided interest in entire farm held by A immediately before gift | 100% | 80% | 70% | 60% |
(3) Potential gain: | ||||
(a) On all property held by A on date of gift | $100,000 | $96,000 | $140,000 | $125,000 |
(b) Limitation percentage (sum of amounts in line (1) during 1-year period beginning on date of gift divided by line (2)) | 30% | 25% | 14.28% | 100% |
Taxable year ending- | ||||
Dec. 31, 1970 | Dec. 31, 1971 | Dec. 32, 1972 | Dec. 31, 1973 | |
Gift to donee to which subparagraph (2)(iv) of this paragraph applies during taxable year | C | D | E | F |
(4) Potential gain (determined immediately prior to time first gift to which subparagraph (2)(iv) of this paragraph applies is made): | ||||
(a) On property received by donee to which such subparagraph (2)(iv) applies (line (3)(a) multiplied by line (1) divided by line (2)) | $20,000 | $12,000 | $125,000 | |
(b) Aggregate potential gain on all farm recapture property held by donor (line (3)(a)) | $100,000 | $96,000 | $125,000 | |
(5) Allocation ratio (line (4)(a), divided by line (4)(b)) | 20% | 12.5% | 100% | |
(6) Excess deductions account of A: | ||||
(a) At end of previous taxable year | 0 | $160,000 | $210,000 | $200,000 |
(b) Net increase (decrease) for taxable year (determined before making any subtractions under section 1251(b)(5) and this paragraph) | $200,000 | $80,000 | ($10,000) | $36,000 |
(c) At 12/31 (so determined) | $200,000 | $240,000 | $200,000 | $236,000 |
(d) Less: Portion to which donee succeeds (line (5), multiplied by line (6)(c)) | $40,000 | $30,000 | $0 | $236,000 |
(e) At 12/31 (to line (6)(a) following taxable year) | $160,000 | $210,000 | $200,000 | $0 |
Since the potential gain limitation percentage for the 1-year period beginning on September 1, 1970, exceeds 25 percent, a portion of A's excess deductions account, under the provisions of subparagraph (2)(iv) of this paragraph, is succeeded to by C and D. Similarly, since such percentage for the 1-year period beginning May 1, 1973, exceeds 25 percent, such provisions apply to the gift made to F. Since, however, such percentage is 25 percent or less for all 1-year periods in which the gift to E falls (i.e., 25 percent and 14.28 percent for the 1-year periods beginning, respectively, on August 1, 1971, and March 1, 1972) such provisions do not apply to the gift to E.
Example: 2.
Farm Recapture Property | Total | |||
No. 1 | No. 2 | No. 3 | ||
(1) Fair market value 5/1/72 | $25,000 | $100,000 | $800,000 | |
(2) Adjusted basis 5/1/72 | $10,000 | $60,000 | $795,000 | |
(3) Potential gain (line (1), minus line (2)) | $15,000 | $40,000 | $5,000 | $60,000 |
(4) Sum of potential gains on properties disposed of by gift during period less gain taken into account by transferor on part-sale-part-gift | $15,000 | $20,000 | $35,000 | |
(5) Potential gain limitation percentage (total line (4), divided by total line (3)) | 581/3% |
Since the potential gain limitation percentage for the one-year period beginning on May 1, 1972, exceeds 25 percent, the provisions of subparagraph (2)(iv) of this paragraph apply to the gift to the son and that portion of the disposition to H which is a gift.
Property | Total | |||
No. 1 | No. 2 | No. 3 | ||
(1) Potential gain under part (i) of this example (since the first day of the one-year period is the same as the time as of which the first gift was made during the taxable year) | $15,000 | $40,000 | $5,000 | $60,000 |
(2) Potential gain less amount taken into account by transfer on part-sale-part-gift | 15,000 | 20,000 | ||
(3) Allocation percentage (line (2), divided by $60,000) | 25% | 331/3% | ||
(4) Excess deductions account at close of taxable year (determine before making any subtractions under section 1251(b)(5) and this paragraph) | 100,000 | |||
(5) Portion to which donee succeeds on 5/1/72 | 25,000 | 33,333 | 58,333 | |
(6) G's excess deductions account 12/31/72 | $41,667 |
Accordingly, the amount of G's excess deduction account succeeded to as of May 1, 1972, is $25,000 by the son and $33,333 by H.
Excess Deductions Accounts
H's | W's | Joint | ||||
(1) Balance Jan. 1, 1971 | $10,000 | $5,000 | $15,000 | |||
(2) Additions for 1971: | ||||||
(a) Farm net loss for 1971 | $40,000 | $10,000 | $50,000 | |||
(b) Less amount in paragraph (b)(2)(ii) of this section as allocated under subparagraph (1)(ii) of this paragraph | 20,000 | 5,000 | 25,000 | |||
(c) Total additions for 1971 | 20,000 | 5,000 | 25,000 | |||
(3) Subtotal | 30,000 | 10,000 | 40,000 | |||
(4) Subtractions for 1971 | 0 | 0 | ||||
(5) Excess deductions account limitation on gain recognized as ordinary income under section 1251(e)(1) for 1971 | 30,000 | 10,000 | 40,000 | |||
(6) Subtraction for dispositions of farm recapture property: | ||||||
(a) Gain to which section 1251(c)(1) applies (computed before applying limitation) | 0 | 14,000 | 14,000 | |||
(b) Limitation (amount in line (5)) | 30,000 | 10,000 | 40,000 | |||
(c) Gain recognized as ordinary income under section 1251(c)(1), computed for joint account (lower of line 6(a) or line 6(b) subject to provisions as to separately maintained accounts of subparagraph (1)(iii) | 14,000 | 14,000 | ||||
(7) Balance Dec. 31, 1971 | 30,000 | (4,000) | 26,000 |
If for 1972, H and W were to file separate returns, then the separately maintained excess deductions account balances as of January 1, 1972, would be $26,000 and zero respectively. See subparagraph (5)(ii) of this paragraph.
26 C.F.R. §1.1251-2