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Hrblock free file 8. Hrblock free file   Gains and Losses Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Sales and ExchangesDetermining Gain or Loss Like-Kind Exchanges Transfer to Spouse Ordinary or Capital Gain or LossCapital Assets Noncapital Assets Hedging (Commodity Futures) Livestock Converted Wetland and Highly Erodible Cropland Timber Sale of a Farm Foreclosure or Repossession Abandonment Introduction This chapter explains how to figure, and report on your tax return, your gain or loss on the disposition of your property or debt and whether such gain or loss is ordinary or capital. Hrblock free file Ordinary gain is taxed at the same rates as wages and interest income while capital gain is generally taxed at lower rates. Hrblock free file Dispositions discussed in this chapter include sales, exchanges, foreclosures, repossessions, canceled debts, hedging transactions, and elections to treat cutting of timber as a sale or exchange. Hrblock free file Topics - This chapter discusses: Sales and exchanges Ordinary or capital gain or loss Useful Items - You may want to see: Publication 334 Tax Guide for Small Business 523 Selling Your Home 544 Sales and Other Dispositions of Assets 550 Investment Income and Expenses 908 Bankruptcy Tax Guide Form (and Instructions) 982 Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) Sch D (Form 1040) Capital Gains and Losses Sch F (Form 1040) Profit or Loss From Farming 1099-A Acquisition or Abandonment of Secured Property 1099-C Cancellation of Debt 4797 Sales of Business Property 8949 Sales and Other Dispositions of Capital Assets See chapter 16 for information about getting publications and forms. Hrblock free file Sales and Exchanges If you sell, exchange, or otherwise dispose of your property, you usually have a gain or a loss. Hrblock free file This section explains certain rules for determining whether any gain you have is taxable, and whether any loss you have is deductible. Hrblock free file A sale is a transfer of property for money or a mortgage, note, or other promise to pay money. Hrblock free file An exchange is a transfer of property for other property or services. Hrblock free file Determining Gain or Loss You usually realize a gain or loss when you sell or exchange property. Hrblock free file If the amount you realize from a sale or exchange of property is more than its adjusted basis, you will have a gain. Hrblock free file If the adjusted basis of the property is more than the amount you realize, you will have a loss. Hrblock free file Basis and adjusted basis. Hrblock free file   The basis of property you buy is usually its cost. Hrblock free file The adjusted basis of property is basis plus certain additions and minus certain deductions. Hrblock free file See chapter 6 for more information about basis and adjusted basis. Hrblock free file Amount realized. Hrblock free file   The amount you realize from a sale or exchange is the total of all money you receive plus the fair market value (FMV) (defined in chapter 6) of all property or services you receive. Hrblock free file The amount you realize also includes any of your liabilities assumed by the buyer and any liabilities to which the property you transferred is subject, such as real estate taxes or a mortgage. Hrblock free file   If the liabilities relate to an exchange of multiple properties, see Multiple Property Exchanges in chapter 1 of Publication 544. Hrblock free file Amount recognized. Hrblock free file   Your gain or loss realized from a sale or exchange of certain property is usually a recognized gain or loss for tax purposes. Hrblock free file A recognized gain is a gain you must include in gross income and report on your income tax return. Hrblock free file A recognized loss is a loss you deduct from gross income. Hrblock free file However, your gain or loss realized from the exchange of certain property may not be recognized for tax purposes. Hrblock free file See Like-Kind Exchanges next. Hrblock free file Also, a loss from the disposition of property held for personal use is not deductible. Hrblock free file Like-Kind Exchanges Certain exchanges of property are not taxable. Hrblock free file This means any gain from the exchange is not recognized, and any loss cannot be deducted. Hrblock free file Your gain or loss will not be recognized until you sell or otherwise dispose of the property you receive. Hrblock free file The exchange of property for the same kind of property is the most common type of nontaxable exchange. Hrblock free file To qualify for treatment as a like-kind exchange, the property traded and the property received must be both of the following. Hrblock free file Qualifying property. Hrblock free file Like-kind property. Hrblock free file These two requirements are discussed later. Hrblock free file Multiple-party transactions. Hrblock free file   The like-kind exchange rules also apply to property exchanges that involve three and four-party transactions. Hrblock free file Any part of these multiple-party transactions can qualify as a like-kind exchange if it meets all the requirements described in this section. Hrblock free file Receipt of title from third party. Hrblock free file   If you receive property in a like-kind exchange and the other party who transfers the property to you does not give you the title, but a third party does, you can still treat this transaction as a like-kind exchange if it meets all the requirements. Hrblock free file Basis of property received. Hrblock free file   If you receive property in a like-kind exchange, the basis of the property will be the same as the basis of the property you gave up. Hrblock free file See chapter 6 for more information. Hrblock free file Money paid. Hrblock free file   If, in addition to giving up like-kind property, you pay money in a like-kind exchange, you still have no recognized gain or loss. Hrblock free file The basis of the property received is the basis of the property given up, increased by the money paid. Hrblock free file Example. Hrblock free file You traded an old tractor with an adjusted basis of $15,000 for a new one. Hrblock free file The new tractor costs $300,000. Hrblock free file You were allowed $80,000 for the old tractor and paid $220,000 cash. Hrblock free file You have no recognized gain or loss on the transaction regardless of the adjusted basis of your old tractor and the basis of the new tractor is $235,000, the adjusted basis of the old tractor plus the cash paid ($15,000 + $220,000). Hrblock free file If you had sold the old tractor to a third party for $80,000 and bought a new one, you would have a recognized gain or loss on the sale of your old tractor equal to the difference between the amount realized and the adjusted basis of the old tractor. Hrblock free file In this case, the taxable gain would be $65,000 ($80,000 − $15,000) and the basis of the new tractor would be $300,000. Hrblock free file Reporting the exchange. Hrblock free file   Report the exchange of like-kind property, even though no gain or loss is recognized, on Form 8824, Like-Kind Exchanges. Hrblock free file The Instructions for Form 8824 explain how to report the details of the exchange. Hrblock free file   If you have any recognized gain because you received money or unlike property, report it on Schedule D (Form 1040) or Form 4797, whichever applies. Hrblock free file You may also have to report the recognized gain as ordinary income because of depreciation recapture on Form 4797. Hrblock free file See chapter 9 for more information. Hrblock free file Qualifying property. Hrblock free file   In a like-kind exchange, both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business. Hrblock free file Machinery, buildings, land, trucks, breeding livestock, rental houses, and certain mutual ditch, reservoir, or irrigation company stock are examples of property that may qualify. Hrblock free file Nonqualifying property. Hrblock free file   The rules for like-kind exchanges do not apply to exchanges of the following property. Hrblock free file Property you use for personal purposes, such as your home and family car. Hrblock free file Stock in trade or other property held primarily for sale, such as crops and produce. Hrblock free file Stocks, bonds, or notes. Hrblock free file However, see Qualifying property above. Hrblock free file Other securities or evidences of indebtedness, such as accounts receivable. Hrblock free file Partnership interests. Hrblock free file However, you may have a nontaxable exchange under other rules. Hrblock free file See Other Nontaxable Exchanges in chapter 1 of Publication 544. Hrblock free file Like-kind property. Hrblock free file   To qualify as a nontaxable exchange, the properties exchanged must be of like kind. Hrblock free file Like-kind properties are properties of the same nature or character, even if they differ in grade or quality. Hrblock free file Generally, real property exchanged for real property qualifies as an exchange of like-kind property. Hrblock free file For example, an exchange of city property for farm property or improved property for unimproved property is a like-kind exchange. Hrblock free file   An exchange of a tractor for a new tractor is an exchange of like-kind property, and so is an exchange of timber land for crop acreage. Hrblock free file An exchange of a tractor for acreage, however, is not an exchange of like-kind property. Hrblock free file The exchange of livestock of one sex for livestock of the other sex is not a like-kind exchange. Hrblock free file For example, the exchange of a bull for a cow is not a like-kind exchange. Hrblock free file An exchange of the assets of a business for the assets of a similar business cannot be treated as an exchange of one property for another property. Hrblock free file    Note. Hrblock free file Whether you engaged in a like-kind exchange depends on an analysis of each asset involved in the exchange. Hrblock free file Personal property. Hrblock free file   Depreciable tangible personal property can be either like kind or like class to qualify for nontaxable exchange treatment. Hrblock free file Like-class properties are depreciable tangible personal properties within the same General Asset Class or Product Class. Hrblock free file Property classified in any General Asset Class may not be classified within a Product Class. Hrblock free file Assets that are not in the same class will qualify as like-kind property if they are of the same nature or character. Hrblock free file General Asset Classes. Hrblock free file   General Asset Classes describe the types of property frequently used in many businesses. Hrblock free file They include, but are not limited to, the following property. Hrblock free file Office furniture, fixtures, and equipment (asset class 00. Hrblock free file 11). Hrblock free file Information systems, such as computers and peripheral equipment (asset class 00. Hrblock free file 12). Hrblock free file Data handling equipment except computers (asset class 00. Hrblock free file 13). Hrblock free file Automobiles and taxis (asset class 00. Hrblock free file 22). Hrblock free file Light general purpose trucks (asset class 00. Hrblock free file 241). Hrblock free file Heavy general purpose trucks (asset class 00. Hrblock free file 242). Hrblock free file Tractor units for use over-the-road (asset class 00. Hrblock free file 26). Hrblock free file Trailers and trailer-mounted containers (asset class 00. Hrblock free file 27). Hrblock free file Industrial steam and electric generation and/or distribution systems (asset class 00. Hrblock free file 4). Hrblock free file Product Classes. Hrblock free file   Product Classes include property listed in a 6-digit product class in sectors 31 through 33 of the North American Industry Classification System (NAICS) of the Executive Office of the President, Office of Management and Budget, United States, (NAICS Manual). Hrblock free file The latest version of the manual can be accessed at www. Hrblock free file census. Hrblock free file gov/eos/www/naics/. Hrblock free file Copies of the printed manual may be purchased from the National Technical Information Service (NTIS) at  www. Hrblock free file ntis. Hrblock free file gov/products/naics. Hrblock free file aspx or by calling 1-800-553-NTIS (1-800-553-6847) or (703) 605-6000. Hrblock free file A CD-ROM version with search and retrieval software is also available from NTIS. Hrblock free file    NAICS class 333111, Farm Machinery and Equipment Manufacturing, includes most machinery and equipment used in a farming business. Hrblock free file Partially nontaxable exchange. Hrblock free file   If, in addition to like-kind property, you receive money or unlike property in an exchange on which you realize gain, you have a partially nontaxable exchange. Hrblock free file You are taxed on the gain you realize, but only to the extent of the money and the FMV of the unlike property you receive. Hrblock free file A loss is not deductible. Hrblock free file Example 1. Hrblock free file You trade farmland that cost $30,000 for $10,000 cash and other land to be used in farming with a FMV of $50,000. Hrblock free file You have a realized gain of $30,000 ($50,000 FMV of new land + $10,000 cash − $30,000 basis of old farmland = $30,000 realized gain). Hrblock free file However, only $10,000, the cash received, is recognized (included in income). Hrblock free file Example 2. Hrblock free file Assume the same facts as in Example 1, except that, instead of money, you received a tractor with a FMV of $10,000. Hrblock free file Your recognized gain is still limited to $10,000, the value of the tractor (the unlike property). Hrblock free file Example 3. Hrblock free file Assume in Example 1 that the FMV of the land you received was only $15,000. Hrblock free file Your $5,000 loss is not recognized. Hrblock free file Unlike property given up. Hrblock free file   If, in addition to like-kind property, you give up unlike property, you must recognize gain or loss on the unlike property you give up. Hrblock free file The gain or loss is the difference between the FMV of the unlike property and the adjusted basis of the unlike property. Hrblock free file Like-kind exchanges between related persons. Hrblock free file   Special rules apply to like-kind exchanges between related persons. Hrblock free file These rules affect both direct and indirect exchanges. Hrblock free file Under these rules, if either person disposes of the property within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. Hrblock free file The gain or loss on the original exchange must be recognized as of the date of the later disposition. Hrblock free file The 2-year holding period begins on the date of the last transfer of property that was part of the like-kind exchange. Hrblock free file Related persons. Hrblock free file   Under these rules, related persons include, for example, you and a member of your family (spouse, brother, sister, parent, child, etc. Hrblock free file ), you and a corporation in which you have more than 50% ownership, you and a partnership in which you directly or indirectly own more than a 50% interest of the capital or profits, and two partnerships in which you directly or indirectly own more than 50% of the capital interests or profits. Hrblock free file   For the complete list of related persons, see Related persons in chapter 2 of Publication 544. Hrblock free file Example. Hrblock free file You used a grey pickup truck in your farming business. Hrblock free file Your sister used a red pickup truck in her landscaping business. Hrblock free file In December 2012, you exchanged your grey pickup truck, plus $200, for your sister's red pickup truck. Hrblock free file At that time, the FMV of the grey pickup truck was $7,000 and its adjusted basis was $6,000. Hrblock free file The FMV of the red pickup truck was $7,200 and its adjusted basis was $1,000. Hrblock free file You realized a gain of $1,000 (the $7,200 FMV of the red pickup truck, minus the grey pickup truck's $6,000 adjusted basis, minus the $200 you paid). Hrblock free file Your sister realized a gain of $6,200 (the $7,000 FMV of the grey pickup truck plus the $200 you paid, minus the $1,000 adjusted basis of the red pickup truck). Hrblock free file However, because this was a like-kind exchange, you recognized no gain. Hrblock free file Your basis in the red pickup truck was $6,200 (the $6,000 adjusted basis of the grey pickup truck plus the $200 you paid). Hrblock free file She recognized gain only to the extent of the money she received, $200. Hrblock free file Her basis in the grey pickup truck was $1,000 (the $1,000 adjusted basis of the red pickup truck minus the $200 received, plus the $200 gain recognized). Hrblock free file In 2013, you sold the red pickup truck to a third party for $7,000. Hrblock free file Because you sold it within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. Hrblock free file On your tax return for 2013, you must report your $1,000 gain on the 2012 exchange. Hrblock free file You also report a loss on the sale as $200 (the adjusted basis of the red pickup truck, $7,200 (its $6,200 basis plus the $1,000 gain recognized), minus the $7,000 realized from the sale). Hrblock free file In addition, your sister must report on her tax return for 2013 the $6,000 balance of her gain on the 2012 exchange. Hrblock free file Her adjusted basis in the grey pickup truck is increased to $7,000 (its $1,000 basis plus the $6,000 gain recognized). Hrblock free file Exceptions to the rules for related persons. Hrblock free file   The following property dispositions are excluded from these rules. Hrblock free file Dispositions due to the death of either related person. Hrblock free file Involuntary conversions. Hrblock free file Dispositions where it is established to the satisfaction of the IRS that neither the exchange nor the disposition has, as a main purpose, the avoidance of federal income tax. Hrblock free file Multiple property exchanges. Hrblock free file   Under the like-kind exchange rules, you must generally make a property-by-property comparison to figure your recognized gain and the basis of the property you receive in the exchange. Hrblock free file However, for exchanges of multiple properties, you do not make a property-by-property comparison if you do either of the following. Hrblock free file Transfer and receive properties in two or more exchange groups. Hrblock free file Transfer or receive more than one property within a single exchange group. Hrblock free file   For more information, see Multiple Property Exchanges in chapter 1 of Publication 544. Hrblock free file Deferred exchange. Hrblock free file   A deferred exchange for like-kind property may qualify for nonrecognition of gain or loss. Hrblock free file A deferred exchange is an exchange in which you transfer property you use in business or hold for investment and later receive like-kind property you will use in business or hold for investment. Hrblock free file The property you receive is replacement property. Hrblock free file The transaction must be an exchange of property for property rather than a transfer of property for money used to buy replacement property. Hrblock free file In addition, the replacement property will not be treated as like-kind property unless certain identification and receipt requirements are met. Hrblock free file   For more information see Deferred Exchanges in chapter 1 of Publication 544. Hrblock free file Transfer to Spouse No gain or loss is recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse, or a former spouse if incident to divorce. Hrblock free file This rule does not apply if the recipient is a nonresident alien. Hrblock free file Nor does this rule apply to a transfer in trust to the extent the liabilities assumed and the liabilities on the property are more than the property's adjusted basis. Hrblock free file Any transfer of property to a spouse or former spouse on which gain or loss is not recognized is not considered a sale or exchange. Hrblock free file The recipient's basis in the property will be the same as the adjusted basis of the giver immediately before the transfer. Hrblock free file This carryover basis rule applies whether the adjusted basis of the transferred property is less than, equal to, or greater than either its FMV at the time of transfer or any consideration paid by the recipient. Hrblock free file This rule applies for determining loss as well as gain. Hrblock free file Any gain recognized on a transfer in trust increases the basis. Hrblock free file For more information on transfers of property incident to divorce, see Property Settlements in Publication 504, Divorced or Separated Individuals. Hrblock free file Ordinary or Capital Gain or Loss Generally, you will have a capital gain or loss if you sell or exchange a capital asset (defined below). Hrblock free file You may also have a capital gain if your section 1231 transactions result in a net gain. Hrblock free file See Section 1231 Gains and Losses in  chapter 9. Hrblock free file To figure your net capital gain or loss, you must classify your gains and losses as either ordinary or capital (and your capital gains or losses as either short-term or long-term). Hrblock free file Your net capital gains may be taxed at a lower tax rate than ordinary income. Hrblock free file See Capital Gains Tax Rates , later. Hrblock free file Your deduction for a net capital loss may be limited. Hrblock free file See Treatment of Capital Losses , later. Hrblock free file Capital Assets Almost everything you own and use for personal purposes or investment is a capital asset. Hrblock free file The following items are examples of capital assets. Hrblock free file A home owned and occupied by you and your family. Hrblock free file Household furnishings. Hrblock free file A car used for pleasure. Hrblock free file If your car is used both for pleasure and for farm business, it is partly a capital asset and partly a noncapital asset, defined later. Hrblock free file Stocks and bonds. Hrblock free file However, there are special rules for gains on qualified small business stock. Hrblock free file For more information on this subject, see Gains on Qualified Small Business Stock and Losses on Section 1244 (Small Business) Stock in chapter 4 of Publication 550. Hrblock free file Personal-use property. Hrblock free file   Gain from a sale or exchange of personal-use property is a capital gain and is taxable. Hrblock free file Loss from the sale or exchange of personal-use property is not deductible. Hrblock free file You can deduct a loss relating to personal-use property only if it results from a casualty or theft. Hrblock free file For information on casualties and thefts, see chapter 11. Hrblock free file Long and Short Term Where you report a capital gain or loss depends on how long you own the asset before you sell or exchange it. Hrblock free file The time you own an asset before disposing of it is the holding period. Hrblock free file If you hold a capital asset 1 year or less, the gain or loss resulting from its disposition is short term. Hrblock free file Report it in Part I of Schedule D (Form 1040). Hrblock free file If you hold a capital asset longer than 1 year, the gain or loss resulting from its disposition is long term. Hrblock free file Report it in Part II of Schedule D (Form 1040). Hrblock free file Holding period. Hrblock free file   To figure if you held property longer than 1 year, start counting on the day after the day you acquired the property. Hrblock free file The day you disposed of the property is part of your holding period. Hrblock free file Example. Hrblock free file If you bought an asset on June 19, 2012, you should start counting on June 20, 2012. Hrblock free file If you sold the asset on June 19, 2013, your holding period is not longer than 1 year, but if you sold it on June 20, 2013, your holding period is longer than 1 year. Hrblock free file Inherited property. Hrblock free file   If you inherit property, you are considered to have held the property longer than 1 year, regardless of how long you actually held it. Hrblock free file This rule does not apply to livestock used in a farm business. Hrblock free file See Holding period under Livestock , later. Hrblock free file Nonbusiness bad debt. Hrblock free file   A nonbusiness bad debt is a short-term capital loss, deductible in the year the debt becomes worthless. Hrblock free file See chapter 4 of Publication 550. Hrblock free file Nontaxable exchange. Hrblock free file   If you acquire an asset in exchange for another asset and your basis for the new asset is figured, in whole or in part, by using your basis in the old property, the holding period of the new property includes the holding period of the old property. Hrblock free file That is, it begins on the same day as your holding period for the old property. Hrblock free file Gift. Hrblock free file   If you receive a gift of property and your basis in it is figured using the donor's basis, your holding period includes the donor's holding period. Hrblock free file Real property. Hrblock free file   To figure how long you held real property, start counting on the day after you received title to it or, if earlier, on the day after you took possession of it and assumed the burdens and privileges of ownership. Hrblock free file   However, taking possession of real property under an option agreement is not enough to start the holding period. Hrblock free file The holding period cannot start until there is an actual contract of sale. Hrblock free file The holding period of the seller cannot end before that time. Hrblock free file Figuring Net Gain or Loss The totals for short-term capital gains and losses and the totals for long-term capital gains and losses must be figured separately. Hrblock free file Net short-term capital gain or loss. Hrblock free file   Combine your short-term capital gains and losses. Hrblock free file Do this by adding all of your short-term capital gains. Hrblock free file Then add all of your short-term capital losses. Hrblock free file Subtract the lesser total from the greater. Hrblock free file The difference is your net short-term capital gain or loss. Hrblock free file Net long-term capital gain or loss. Hrblock free file   Follow the same steps to combine your long-term capital gains and losses. Hrblock free file The result is your net long-term capital gain or loss. Hrblock free file Net gain. Hrblock free file   If the total of your capital gains is more than the total of your capital losses, the difference is taxable. Hrblock free file However, part of your gain (but not more than your net capital gain) may be taxed at a lower rate than the rate of tax on your ordinary income. Hrblock free file See Capital Gains Tax Rates , later. Hrblock free file Net loss. Hrblock free file   If the total of your capital losses is more than the total of your capital gains, the difference is deductible. Hrblock free file But there are limits on how much loss you can deduct and when you can deduct it. Hrblock free file See Treatment of Capital Losses next. Hrblock free file Treatment of Capital Losses If your capital losses are more than your capital gains, you must claim the difference even if you do not have ordinary income to offset it. Hrblock free file For taxpayers other than corporations, the yearly limit on the capital loss you can deduct is $3,000 ($1,500 if you are married and file a separate return). Hrblock free file If your other income is low, you may not be able to use the full $3,000. Hrblock free file The part of the $3,000 you cannot use becomes part of your capital loss carryover (discussed next). Hrblock free file Capital loss carryover. Hrblock free file   Generally, you have a capital loss carryover if either of the following situations applies to you. Hrblock free file Your net loss on Schedule D (Form 1040), is more than the yearly limit. Hrblock free file Your taxable income without your deduction for exemptions is less than zero. Hrblock free file If either of these situations applies to you for 2013, see Capital Losses under Reporting Capital Gains and Losses in chapter 4 of Publication 550 to figure the amount you can carry over to 2014. Hrblock free file    To figure your capital loss carryover from 2013 to 2014, you will need a copy of your 2013 Form 1040 and Schedule D (Form 1040). Hrblock free file Capital Gains Tax Rates The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. Hrblock free file These lower rates are called the maximum capital gains rates. Hrblock free file The term “net capital gain” means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss. Hrblock free file See Schedule D (Form 1040) and the Instructions for Schedule D (Form 1040). Hrblock free file Also see Publication 550. Hrblock free file Noncapital Assets Noncapital assets include property such as inventory and depreciable property used in a trade or business. Hrblock free file A list of properties that are not capital assets is provided in the Instructions for Schedule D (Form 1040). Hrblock free file Property held for sale in the ordinary course of your farm business. Hrblock free file   Property you hold mainly for sale to customers, such as livestock, poultry, livestock products, and crops, is a noncapital asset. Hrblock free file Gain or loss from sales or other dispositions of this property is reported on Schedule F (Form 1040) (not on Schedule D (Form 1040) or Form 4797). Hrblock free file The treatment of this property is discussed in chapter 3. Hrblock free file Land and depreciable properties. Hrblock free file   Land and depreciable property you use in farming are not capital assets. Hrblock free file Noncapital assets also include livestock held for draft, breeding, dairy, or sporting purposes. Hrblock free file However, your gains and losses from sales and exchanges of your farmland and depreciable properties must be considered together with certain other transactions to determine whether the gains and losses are treated as capital or ordinary gains and losses. Hrblock free file The sales of these business assets are reported on Form 4797. Hrblock free file See chapter 9 for more information. Hrblock free file Hedging (Commodity Futures) Hedging transactions are transactions that you enter into in the normal course of business primarily to manage the risk of interest rate or price changes, or currency fluctuations, with respect to borrowings, ordinary property, or ordinary obligations. Hrblock free file Ordinary property or obligations are those that cannot produce capital gain or loss if sold or exchanged. Hrblock free file A commodity futures contract is a standardized, exchange-traded contract for the sale or purchase of a fixed amount of a commodity at a future date for a fixed price. Hrblock free file The holder of an option on a futures contract has the right (but not the obligation) for a specified period of time to enter into a futures contract to buy or sell at a particular price. Hrblock free file A forward contract is generally similar to a futures contract except that the terms are not standardized and the contract is not exchange traded. Hrblock free file Businesses may enter into commodity futures contracts or forward contracts and may acquire options on commodity futures contracts as either of the following. Hrblock free file Hedging transactions. Hrblock free file Transactions that are not hedging transactions. Hrblock free file Futures transactions with exchange-traded commodity futures contracts that are not hedging transactions, generally, result in capital gain or loss and are subject to the mark-to-market rules discussed in Publication 550. Hrblock free file There is a limit on the amount of capital losses you can deduct each year. Hrblock free file Hedging transactions are not subject to the mark-to-market rules. Hrblock free file If, as a farmer-producer, to protect yourself from the risk of unfavorable price fluctuations, you enter into commodity forward contracts, futures contracts, or options on futures contracts and the contracts cover an amount of the commodity within your range of production, the transactions are generally considered hedging transactions. Hrblock free file They can take place at any time you have the commodity under production, have it on hand for sale, or reasonably expect to have it on hand. Hrblock free file The gain or loss on the termination of these hedges is generally ordinary gain or loss. Hrblock free file Farmers who file their income tax returns on the cash method report any profit or loss on the hedging transaction on Schedule F, line 8. Hrblock free file Gains or losses from hedging transactions that hedge supplies of a type regularly used or consumed in the ordinary course of your trade or business may be ordinary gains or losses. Hrblock free file Examples include fuel and feed. Hrblock free file If you have numerous transactions in the commodity futures market during the year, you must be able to show which transactions are hedging transactions. Hrblock free file Clearly identify a hedging transaction on your books and records before the end of the day you entered into the transaction. Hrblock free file It may be helpful to have separate brokerage accounts for your hedging and speculation transactions. Hrblock free file Retain the identification of each hedging transaction with your books and records. Hrblock free file Also, identify the item(s) or aggregate risk that is being hedged in your records. Hrblock free file Although the identification of the hedging transaction must be made before the end of the day it was entered into, you have 35 days after entering into the transaction to identify the hedged item(s) or risk. Hrblock free file For more information on the tax treatment of futures and options contracts, see Commodity Futures and Section 1256 Contracts Marked to Market in Publication 550. Hrblock free file Accounting methods for hedging transactions. Hrblock free file   The accounting method you use for a hedging transaction must clearly reflect income. Hrblock free file This means that your accounting method must reasonably match the timing of income, deduction, gain, or loss from a hedging transaction with the timing of income, deduction, gain, or loss from the item or items being hedged. Hrblock free file There are requirements and limits on the method you can use for certain hedging transactions. Hrblock free file See Regulations section 1. Hrblock free file 446-4(e) for those requirements and limits. Hrblock free file   Hedging transactions must be accounted for under the rules stated above unless the transaction is subject to mark-to-market accounting under section 475 or you use an accounting method other than the following methods. Hrblock free file Cash method. Hrblock free file Farm-price method. Hrblock free file Unit-livestock-price method. Hrblock free file   Once you adopt a method, you must apply it consistently and must have IRS approval before changing it. Hrblock free file   Your books and records must describe the accounting method used for each type of hedging transaction. Hrblock free file They must also contain any additional identification necessary to verify the application of the accounting method you used for the transaction. Hrblock free file You must make the additional identification no more than 35 days after entering into the hedging transaction. Hrblock free file Example of a hedging transaction. Hrblock free file   You file your income tax returns on the cash method. Hrblock free file On July 2 you anticipate a yield of 50,000 bushels of corn this year. Hrblock free file The December futures price is $5. Hrblock free file 75 a bushel, but there are indications that by harvest time the price will drop. Hrblock free file To protect yourself against a drop in the price, you enter into the following hedging transaction. Hrblock free file You sell ten December futures contracts of 5,000 bushels each for a total of 50,000 bushels of corn at $5. Hrblock free file 75 a bushel. Hrblock free file   The price did not drop as anticipated but rose to $6 a bushel. Hrblock free file In November, you sell your crop at a local elevator for $6 a bushel. Hrblock free file You also close out your futures position by buying ten December contracts for $6 a bushel. Hrblock free file You paid a broker's commission of $1,400 ($70 per contract) for the complete in and out position in the futures market. Hrblock free file   The result is that the price of corn rose 25 cents a bushel and the actual selling price is $6 a bushel. Hrblock free file Your loss on the hedge is 25 cents a bushel. Hrblock free file In effect, the net selling price of your corn is $5. Hrblock free file 75 a bushel. Hrblock free file   Report the results of your futures transactions and your sale of corn separately on Schedule F. Hrblock free file See the instructions for the 2013 Schedule F (Form 1040). Hrblock free file   The loss on your futures transactions is $13,900, figured as follows. Hrblock free file July 2 - Sold December corn futures (50,000 bu. Hrblock free file @$5. Hrblock free file 75) $287,500 November 6 - Bought December corn futures (50,000 bu. Hrblock free file @$6 plus $1,400 broker's commission) 301,400 Futures loss ($13,900) This loss is reported as a negative figure on Schedule F, Part I, line 8, as other income. Hrblock free file   The proceeds from your corn sale at the local elevator are $300,000 (50,000 bu. Hrblock free file × $6). Hrblock free file Report it on Schedule F, Part I, line 2, as income from sales of products you raised. Hrblock free file   Assume you were right and the price went down 25 cents a bushel. Hrblock free file In effect, you would still net $5. Hrblock free file 75 a bushel, figured as follows. Hrblock free file Sold cash corn, per bushel $5. Hrblock free file 50 Gain on hedge, per bushel . Hrblock free file 25 Net price, per bushel $5. Hrblock free file 75       The gain on your futures transactions would have been $11,100, figured as follows. Hrblock free file July 2 - Sold December corn futures (50,000 bu. Hrblock free file @$5. Hrblock free file 75) $287,500 November 6 - Bought December corn futures (50,000 bu. Hrblock free file @$5. Hrblock free file 50 plus $1,400 broker's commission) 276,400 Futures gain $11,100 The $11,100 is reported on Schedule F, Part I, line 8, as other income. Hrblock free file   The proceeds from the sale of your corn at the local elevator, $275,000, are reported on Schedule F, Part I, line 2, as income from sales of products you raised. Hrblock free file Livestock This part discusses the sale or exchange of livestock used in your farm business. Hrblock free file Gain or loss from the sale or exchange of this livestock may qualify as a section 1231 gain or loss. Hrblock free file However, any part of the gain that is ordinary income from the recapture of depreciation is not included as section 1231 gain. Hrblock free file See chapter 9 for more information on section 1231 gains and losses and the recapture of depreciation under section 1245. Hrblock free file The rules discussed here do not apply to the sale of livestock held primarily for sale to customers. Hrblock free file The sale of this livestock is reported on Schedule F. Hrblock free file See chapter 3. Hrblock free file Also, special rules apply to sales or exchanges caused by weather-related conditions. Hrblock free file See chapter 3. Hrblock free file Holding period. Hrblock free file   The sale or exchange of livestock used in your farm business (defined below) qualifies as a section 1231 transaction if you held the livestock for 12 months or more (24 months or more for horses and cattle). Hrblock free file Livestock. Hrblock free file   For section 1231 transactions, livestock includes cattle, hogs, horses, mules, donkeys, sheep, goats, fur-bearing animals, and other mammals. Hrblock free file Also, for section 1231 transactions, livestock does not include chickens, turkeys, pigeons, geese, emus, ostriches, rheas, or other birds, fish, frogs, reptiles, etc. Hrblock free file Livestock used in farm business. Hrblock free file   If livestock is held primarily for draft, breeding, dairy, or sporting purposes, it is used in your farm business. Hrblock free file The purpose for which an animal is held ordinarily is determined by a farmer's actual use of the animal. Hrblock free file 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 for that purpose. Hrblock free file However, a draft, breeding, or sporting purpose may be present if an animal is disposed of within a reasonable time after it is prevented from its intended use or made undesirable as a result of an accident, disease, drought, or unfitness of the animal. Hrblock free file Example 1. Hrblock free file You discover an animal that you intend to use for breeding purposes is sterile. Hrblock free file You dispose of it within a reasonable time. Hrblock free file This animal was held for breeding purposes. Hrblock free file Example 2. Hrblock free file You retire and sell your entire herd, including young animals that you would have used for breeding or dairy purposes had you remained in business. Hrblock free file These young animals were held for breeding or dairy purposes. Hrblock free file Also, if you sell young animals to reduce your breeding or dairy herd because of drought, these animals are treated as having been held for breeding or dairy purposes. Hrblock free file See Sales Caused by Weather-Related Conditions in chapter 3. Hrblock free file Example 3. Hrblock free file You are in the business of raising hogs for slaughter. Hrblock free file Customarily, before selling your sows, you obtain a single litter of pigs that you will raise for sale. Hrblock free file You sell the brood sows after obtaining the litter. Hrblock free file Even though you hold these brood sows for ultimate sale to customers in the ordinary course of your business, they are considered to be held for breeding purposes. Hrblock free file Example 4. Hrblock free file You are in the business of raising registered cattle for sale to others for use as breeding cattle. Hrblock free file The business practice is to breed the cattle before sale to establish their fitness as registered breeding cattle. Hrblock free file Your use of the young cattle for breeding purposes is ordinary and necessary for selling them as registered breeding cattle. Hrblock free file Such use does not demonstrate that you are holding the cattle for breeding purposes. Hrblock free file However, those cattle you held as additions or replacements to your own breeding herd to produce calves are considered to be held for breeding purposes, even though they may not actually have produced calves. Hrblock free file The same applies to hog and sheep breeders. Hrblock free file Example 5. Hrblock free file You breed, raise, and train horses for racing purposes. Hrblock free file Every year you cull horses from your racing stable. Hrblock free file In 2013, you decided that to prevent your racing stable from getting too large to be effectively operated, you must cull six horses that had been raced at public tracks in 2012. Hrblock free file These horses are all considered held for sporting purposes. Hrblock free file Figuring gain or loss on the cash method. Hrblock free file   Farmers or ranchers who use the cash method of accounting figure their gain or loss on the sale of livestock used in their farming business as follows. Hrblock free file Raised livestock. Hrblock free file   Gain on the sale of raised livestock is generally the gross sales price reduced by any expenses of the sale. Hrblock free file Expenses of sale include sales commissions, freight or hauling from farm to commission company, and other similar expenses. Hrblock free file The basis of the animal sold is zero if the costs of raising it were deducted during the years the animal was being raised. Hrblock free file However, see Uniform Capitalization Rules in chapter 6. Hrblock free file Purchased livestock. Hrblock free file   The gross sales price minus your adjusted basis and any expenses of sale is the gain or loss. Hrblock free file Example. Hrblock free file A farmer sold a breeding cow on January 8, 2013, for $1,250. Hrblock free file Expenses of the sale were $125. Hrblock free file The cow was bought July 2, 2009, for $1,300. Hrblock free file Depreciation (not less than the amount allowable) was $867. Hrblock free file Gross sales price $1,250 Cost (basis) $1,300   Minus: Depreciation deduction 867   Unrecovered cost (adjusted basis) $ 433   Expense of sale 125 558 Gain realized $ 692 Converted Wetland and Highly Erodible Cropland Special rules apply to dispositions of land converted to farming use after March 1, 1986. Hrblock free file Any gain realized on the disposition of converted wetland or highly erodible cropland is treated as ordinary income. Hrblock free file Any loss on the disposition of such property is treated as a long-term capital loss. Hrblock free file Converted wetland. Hrblock free file   This is generally land that was drained or filled to make the production of agricultural commodities possible. Hrblock free file It includes converted wetland held by the person who originally converted it or held by any other person who used the converted wetland at any time after conversion for farming. Hrblock free file   A wetland (before conversion) is land that meets all the following conditions. Hrblock free file It is mostly soil that, in its undrained condition, is saturated, flooded, or ponded long enough during a growing season to develop an oxygen-deficient state that supports the growth and regeneration of plants growing in water. Hrblock free file It is saturated by surface or groundwater at a frequency and duration sufficient to support mostly plants that are adapted for life in saturated soil. Hrblock free file It supports, under normal circumstances, mostly plants that grow in saturated soil. Hrblock free file Highly erodible cropland. Hrblock free file   This is cropland subject to erosion that you used at any time for farming purposes other than grazing animals. Hrblock free file Generally, highly erodible cropland is land currently classified by the Department of Agriculture as Class IV, VI, VII, or VIII under its classification system. Hrblock free file Highly erodible cropland also includes land that would have an excessive average annual erosion rate in relation to the soil loss tolerance level, as determined by the Department of Agriculture. Hrblock free file Successor. Hrblock free file   Converted wetland or highly erodible cropland is also land held by any person whose basis in the land is figured by reference to the adjusted basis of a person in whose hands the property was converted wetland or highly erodible cropland. Hrblock free file Timber Standing timber you held as investment property is a capital asset. Hrblock free file Gain or loss from its sale is capital gain or loss reported on Form 8949 and Schedule D (Form 1040), as applicable. Hrblock free file If you held the timber primarily for sale to customers, it is not a capital asset. Hrblock free file Gain or loss on its sale is ordinary business income or loss. Hrblock free file It is reported on Schedule F, line 1 (purchased timber) or line 2 (raised timber). Hrblock free file See the Instructions for Schedule F (Form 1040). Hrblock free file 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. Hrblock free file Amounts realized from these sales, and the expenses incurred in cutting, hauling, etc. Hrblock free file , are ordinary farm income and expenses reported on Schedule F. Hrblock free file Different rules apply if you owned the timber longer than 1 year and elect to treat timber cutting as a sale or exchange or you enter into a cutting contract, discussed below. Hrblock free file Timber considered cut. Hrblock free file   Timber is considered cut on the date when, in the ordinary course of business, the quantity of felled timber is first definitely determined. Hrblock free file This is true whether the timber is cut under contract or whether you cut it yourself. Hrblock free file Christmas trees. Hrblock free file   Evergreen trees, such as Christmas trees, that are more than 6 years old when severed from their roots and sold for ornamental purposes are included in the term timber. Hrblock free file They qualify for both rules discussed below. Hrblock free file Election to treat cutting as a sale or exchange. Hrblock free file   Under the general rule, the cutting of timber results in no gain or loss. Hrblock free file It is not until a sale or exchange occurs that gain or loss is realized. Hrblock free file But if you owned or had a contractual right to cut timber, you can elect to treat the cutting of timber as a section 1231 transaction in the year it is cut. Hrblock free file Even though the cut timber is not actually sold or exchanged, you report your gain or loss on the cutting for the year the timber is cut. Hrblock free file Any later sale results in ordinary business income or loss. Hrblock free file See the example below. Hrblock free file   To elect this treatment, you must: Own or hold a contractual right to cut the timber for a period of more than 1 year before it is cut, and Cut the timber for sale or use in your trade or business. Hrblock free file Making the election. Hrblock free file   You make the election on your return for the year the cutting takes place by including in income the gain or loss on the cutting and including a computation of your gain or loss. Hrblock free file You do not have to make the election in the first year you cut the timber. Hrblock free file You can make it in any year to which the election would apply. Hrblock free file If the timber is partnership property, the election is made on the partnership return. Hrblock free file This election cannot be made on an amended return. Hrblock free file   Once you have made the election, it remains in effect for all later years unless you revoke it. Hrblock free file Election under section 631(a) may be revoked. Hrblock free file   If you previously elected for any tax year ending before October 23, 2004, to treat the cutting of timber as a sale or exchange under section 631(a), you may revoke this election without the consent of the IRS for any tax year ending after October 22, 2004. Hrblock free file The prior election (and revocation) is disregarded for purposes of making a subsequent election. Hrblock free file See Form T (Timber), Forest Activities Schedule, for more information. Hrblock free file Gain or loss. Hrblock free file   Your gain or loss on the cutting of standing timber is the difference between its adjusted basis for depletion and its FMV on the first day of your tax year in which it is cut. Hrblock free file   Your adjusted basis for depletion of cut timber is based on the number of units (board feet, log scale, or other units) of timber cut during the tax year and considered to be sold or exchanged. Hrblock free file Your adjusted basis for depletion is also based on the depletion unit of timber in the account used for the cut timber, and should be figured in the same manner as shown in section 611 and Regulations section 1. Hrblock free file 611-3. Hrblock free file   Depletion of timber is discussed in chapter 7. Hrblock free file Example. Hrblock free file   In April 2013, you owned 4,000 MBF (1,000 board feet) of standing timber longer than 1 year. Hrblock free file It had an adjusted basis for depletion of $40 per MBF. Hrblock free file You are a calendar year taxpayer. Hrblock free file On January 1, 2013, the timber had a FMV of $350 per MBF. Hrblock free file It was cut in April for sale. Hrblock free file On your 2013 tax return, you elect to treat the cutting of the timber as a sale or exchange. Hrblock free file You report the difference between the FMV and your adjusted basis for depletion as a gain. Hrblock free file This amount is reported on Form 4797 along with your other section 1231 gains and losses to figure whether it is treated as a capital gain or as ordinary gain. Hrblock free file You figure your gain as follows. Hrblock free file FMV of timber January 1, 2013 $1,400,000 Minus: Adjusted basis for depletion 160,000 Section 1231 gain $1,240,000   The FMV becomes your basis in the cut timber, and a later sale of the cut timber, including any by-product or tree tops, will result in ordinary business income or loss. Hrblock free file Outright sales of timber. Hrblock free file   Outright sales of timber by landowners qualify for capital gains treatment using rules similar to the rules for certain disposal of timber under a contract with retained economic interest (defined later). Hrblock free file However, for outright sales, the date of disposal is not deemed to be the date the timber is cut because the landowner can elect to treat the payment date as the date of disposal (see Date of disposal below). Hrblock free file Cutting contract. Hrblock free file   You must treat the disposal of standing timber under a cutting contract as a section 1231 transaction if all the following apply to you. Hrblock free file You are the owner of the timber. Hrblock free file You held the timber longer than 1 year before its disposal. Hrblock free file You kept an economic interest in the timber. Hrblock free file   You have kept an economic interest in standing timber if, under the cutting contract, the expected return on your investment is conditioned on the cutting of the timber. Hrblock free file   The difference between the amount realized from the disposal of the timber and its adjusted basis for depletion is treated as gain or loss on its sale. Hrblock free file Include this amount on Form 4797 along with your other section 1231 gains or losses. Hrblock free file Date of disposal. Hrblock free file   The date of disposal is the date the timber is cut. Hrblock free file However, for outright sales by landowners or if you receive payment under the contract before the timber is cut, you can elect to treat the date of payment as the date of disposal. Hrblock free file   This election applies only to figure the holding period of the timber. Hrblock free file It has no effect on the time for reporting gain or loss (generally when the timber is sold or exchanged). Hrblock free file   To make this election, attach a statement to the tax return filed by the due date (including extensions) for the year payment is received. Hrblock free file The statement must identify the advance payments subject to the election and the contract under which they were made. Hrblock free file   If you timely filed your return for the year you received payment without making the election, you can still make the election by filing an amended return within 6 months after the due date for that year's return (excluding extensions). Hrblock free file Attach the statement to the amended return and write “Filed pursuant to section 301. Hrblock free file 9100-2” at the top of the statement. Hrblock free file File the amended return at the same address the original return was filed. Hrblock free file Owner. Hrblock free file   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. Hrblock free file You own an interest in timber if you have the right to cut it for sale on your own account or for use in your business. Hrblock free file Tree stumps. Hrblock free file   Tree stumps are a capital asset if they are on land held by an investor who is not in the timber or stump business as a buyer, seller, or processor. Hrblock free file Gain from the sale of stumps sold in one lot by such a holder is taxed as a capital gain. Hrblock free file However, tree stumps held by timber operators after the saleable standing timber was cut and removed from the land are considered by-products. Hrblock free file Gain from the sale of stumps in lots or tonnage by such operators is taxed as ordinary income. Hrblock free file   See Form T (Timber) and its separate instructions for more information about dispositions of timber. Hrblock free file Sale of a Farm The sale of your farm will usually involve the sale of both nonbusiness property (your home) and business property (the land and buildings used in the farm operation and perhaps machinery and livestock). Hrblock free file If you have a gain from the sale, you may be allowed to exclude the gain on your home. Hrblock free file For more information, see Publication 523, Selling Your Home. Hrblock free file The gain on the sale of your business property is taxable. Hrblock free file A loss on the sale of your business property to an unrelated person is deducted as an ordinary loss. Hrblock free file Your taxable gain or loss on the sale of property used in your farm business is taxed under the rules for section 1231 transactions. Hrblock free file See chapter 9. Hrblock free file Losses from personal-use property, other than casualty or theft losses, are not deductible. Hrblock free file If you receive payments for your farm in installments, your gain is taxed over the period of years the payments are received, unless you elect not to use the installment method of reporting the gain. Hrblock free file See chapter 10 for information about installment sales. Hrblock free file When you sell your farm, the gain or loss on each asset is figured separately. Hrblock free file The tax treatment of gain or loss on the sale of each asset is determined by the classification of the asset. Hrblock free file Each of the assets sold must be classified as one of the following. Hrblock free file Capital asset held 1 year or less. Hrblock free file Capital asset held longer than 1 year. Hrblock free file Property (including real estate) used in your business and held 1 year or less (including draft, breeding, dairy, and sporting animals held less than the holding periods discussed earlier under Livestock ). Hrblock free file Property (including real estate) used in your business and held longer than 1 year (including only draft, breeding, dairy, and sporting animals held for the holding periods discussed earlier). Hrblock free file Property held primarily for sale or which is of the kind that would be included in inventory if on hand at the end of your tax year. Hrblock free file Allocation of consideration paid for a farm. Hrblock free file   The sale of a farm for a lump sum is considered a sale of each individual asset rather than a single asset. Hrblock free file The residual method is required only if the group of assets sold constitutes a trade or business. Hrblock free file This method determines gain or loss from the transfer of each asset. Hrblock free file It also determines the buyer's basis in the business assets. Hrblock free file For more information, see Sale of a Business in chapter 2 of Publication 544. Hrblock free file Property used in farm operation. Hrblock free file   The rules for excluding the gain on the sale of your home, described later under Sale of your home , do not apply to the property used for your farming business. Hrblock free file Recognized gains and losses on business property must be reported on your return for the year of the sale. Hrblock free file If the property was held longer than 1 year, it may qualify for section 1231 treatment (see chapter 9). Hrblock free file Example. Hrblock free file You sell your farm, including your main home, which you have owned since December 2001. Hrblock free file You realize gain on the sale as follows. Hrblock free file   Farm   Farm   With Home Without   Home Only Home Selling price $382,000 $158,000 $224,000 Cost (or other basis) 240,000 110,000 130,000 Gain $142,000 $48,000 $94,000 You must report the $94,000 gain from the sale of the property used in your farm business. Hrblock free file All or a part of that gain may have to be reported as ordinary income from the recapture of depreciation or soil and water conservation expenses. Hrblock free file Treat the balance as section 1231 gain. Hrblock free file The $48,000 gain from the sale of your home is not taxable as long as you meet the requirements explained later under Sale of your home . Hrblock free file Partial sale. Hrblock free file   If you sell only part of your farm, you must report any recognized gain or loss on the sale of that part on your tax return for the year of the sale. Hrblock free file You cannot wait until you have sold enough of the farm to recover its entire cost before reporting gain or loss. Hrblock free file For a detailed discussion on installment sales, see Publication 544. Hrblock free file Adjusted basis of the part sold. Hrblock free file   This is the properly allocated part of your original cost or other basis of the entire farm plus or minus necessary adjustments for improvements, depreciation, etc. Hrblock free file , on the part sold. Hrblock free file If your home is on the farm, you must properly adjust the basis to exclude those costs from your farm asset costs, as discussed below under Sale of your home . Hrblock free file Example. Hrblock free file You bought a 600-acre farm for $700,000. Hrblock free file The farm included land and buildings. Hrblock free file The purchase contract designated $600,000 of the purchase price to the land. Hrblock free file You later sold 60 acres of land on which you had installed a fence. Hrblock free file Your adjusted basis for the part of your farm sold is $60,000 (1/10 of $600,000), plus any unrecovered cost (cost not depreciated) of the fence on the 60 acres at the time of sale. Hrblock free file Use this amount to determine your gain or loss on the sale of the 60 acres. Hrblock free file Assessed values for local property taxes. Hrblock free file   If you paid a flat sum for the entire farm and no other facts are available for properly allocating your original cost or other basis between the land and the buildings, you can use the assessed values for local property taxes for the year of purchase to allocate the costs. Hrblock free file Example. Hrblock free file Assume that in the preceding example there was no breakdown of the $700,000 purchase price between land and buildings. Hrblock free file However, in the year of purchase, local taxes on the entire property were based on assessed valuations of $420,000 for land and $140,000 for improvements, or a total of $560,000. Hrblock free file The assessed valuation of the land is 3/4 (75%) of the total assessed valuation. Hrblock free file Multiply the $700,000 total purchase price by 75% to figure basis of $525,000 for the 600 acres of land. Hrblock free file The unadjusted basis of the 60 acres you sold would then be $52,500 (1/10 of $525,000). Hrblock free file Sale of your home. Hrblock free file   Your home is a capital asset and not property used in the trade or business of farming. Hrblock free file If you sell a farm that includes a house you and your family occupy, you must determine the part of the selling price and the part of the cost or other basis allocable to your home. Hrblock free file Your home includes the immediate surroundings and outbuildings relating to it that are not used for business purposes. Hrblock free file   If you use part of your home for business, you must make an appropriate adjustment to the basis for depreciation allowed or allowable. Hrblock free file For more information on basis, see chapter 6. Hrblock free file More information. Hrblock free file   For more information on selling your home, see Publication 523. Hrblock free file Gain from condemnation. Hrblock free file   If you have a gain from a condemnation or sale under threat of condemnation, you may use the preceding rules for excluding the gain, rather than the rules discussed under Postponing Gain in chapter 11. Hrblock free file However, any gain that cannot be excluded (because it is more than the limit) may be postponed under the rules discussed under Postponing Gain in chapter 11. Hrblock free file Foreclosure or Repossession If you do not make payments you owe on a loan secured by property, the lender may foreclose on the loan or repossess the property. Hrblock free file The foreclosure or repossession is treated as a sale or exchange from which you may realize gain or loss. Hrblock free file This is true even if you voluntarily return the property to the lender. Hrblock free file You may also realize ordinary income from cancellation of debt if the loan balance is more than the FMV of the property. Hrblock free file Buyer's (borrower's) gain or loss. Hrblock free file   You figure and report gain or loss from a foreclosure or repossession in the same way as gain or loss from a sale or exchange. Hrblock free file The gain or loss is the difference between your adjusted basis in the transferred property and the amount realized. Hrblock free file See Determining Gain or Loss , earlier. Hrblock free file Worksheet 8-1. Hrblock free file Worksheet for Foreclosures andRepossessions Part 1. Hrblock free file Use Part 1 to figure your ordinary income from the cancellation of debt upon foreclosure or repossession. Hrblock free file Complete this part only if you were personally liable for the debt. Hrblock free file Otherwise, go to Part 2. Hrblock free file   1. Hrblock free file Enter the amount of outstanding debt immediately before the transfer of property reduced by any amount for which you remain personally liable after the transfer of property   2. Hrblock free file Enter the Fair Market Value of the transferred property   3. Hrblock free file Ordinary income from cancellation of debt upon foreclosure or repossession. Hrblock free file * Subtract line 2 from line 1. Hrblock free file If zero or less, enter -0-   Part 2. Hrblock free file Figure your gain or loss from foreclosure or repossession. Hrblock free file   4. Hrblock free file If you completed Part 1, enter the smaller of line 1 or line 2. Hrblock free file If you did not complete Part 1, enter the outstanding debt immediately before the transfer of property   5. Hrblock free file Enter any proceeds you received from the foreclosure sale   6. Hrblock free file Add lines 4 and 5   7. Hrblock free file Enter the adjusted basis of the transferred property   8. Hrblock free file Gain or loss from foreclosure or repossession. Hrblock free file Subtract line 7  from line 6   * The income may not be taxable. Hrblock free file See Cancellation of debt . Hrblock free file    You can use Worksheet 8-1 to figure your gain or loss from a foreclosure or repossession. Hrblock free file Amount realized on a nonrecourse debt. Hrblock free file   If you are not personally liable for repaying the debt (nonrecourse debt) secured by the transferred property, the amount you realize includes the full amount of the debt canceled by the transfer. Hrblock free file The full canceled debt is included in the amount realized even if the fair market value of the property is less than the canceled debt. Hrblock free file Example 1. Hrblock free file Ann paid $200,000 for land used in her farming business. Hrblock free file She paid $15,000 down and borrowed the remaining $185,000 from a bank. Hrblock free file Ann is not personally liable for the loan (nonrecourse debt), but pledges the land as security. Hrblock free file The bank foreclosed on the loan 2 years after Ann stopped making payments. Hrblock free file When the bank foreclosed, the balance due on the loan was $180,000 and the FMV of the land was $170,000. Hrblock free file The amount Ann realized on the foreclosure was $180,000, the debt canceled by the foreclosure. Hrblock free file She figures her gain or loss on Form 4797, Part I, by comparing the amount realized ($180,000) with her adjusted basis ($200,000). Hrblock free file She has a $20,000 deductible loss. Hrblock free file Example 2. Hrblock free file Assume the same facts as in Example 1 except the FMV of the land was $210,000. Hrblock free file The result is the same. Hrblock free file The amount Ann realized on the foreclosure is $180,000, the debt canceled by the foreclosure. Hrblock free file Because her adjusted basis is $200,000, she has a deductible loss of $20,000, which she reports on Form 4797, Part I. Hrblock free file Amount realized on a recourse debt. Hrblock free file   If you are personally liable for the debt (recourse debt), the amount realized on the foreclosure or repossession includes the lesser of: The outstanding debt immediately before the transfer reduced by any amount for which you remain personally liable immediately after the transfer, or The fair market value of the transferred property. Hrblock free file   You are treated as receiving ordinary income from the canceled debt for the part of the debt that is more than the fair market value. Hrblock free file The amount realized does not include the canceled debt that is your income from cancellation of debt. Hrblock free file See Cancellation of debt , later. Hrblock free file Example 3. Hrblock free file Assume the same facts as in Example 1 above except Ann is personally liable for the loan (recourse debt). Hrblock free file In this case, the amount she realizes is $170,000. Hrblock free file This is the canceled debt ($180,000) up to the FMV of the land ($170,000). Hrblock free file Ann figures her gain or loss on the foreclosure by comparing the amount realized ($170,000) with her adjusted basis ($200,000). Hrblock free file She has a $30,000 deductible loss, which she figures on Form 4797, Part I. Hrblock free file She is also treated as receiving ordinary income from cancellation of debt. Hrblock free file That income is $10,000 ($180,000 − $170,000). Hrblock free file This is the part of the canceled debt not included in the amount realized. Hrblock free file She reports this as other income on Schedule F, line 8. Hrblock free file Seller's (lender's) gain or loss on repossession. Hrblock free file   If you finance a buyer's purchase of property and later acquire an interest in it through foreclosure or repossession, you may have a gain or loss on the acquisition. Hrblock free file For more information, see Repossession in Publication 537, Installment Sales. Hrblock free file Cancellation of debt. Hrblock free file   If property that is repossessed or foreclosed upon secures a debt for which you are personally liable (recourse debt), you generally must report as ordinary income the amount by which the canceled debt is more than the FMV of the property. Hrblock free file This income is separate from any gain or loss realized from the foreclosure or repossession. Hrblock free file Report the income from cancellation of a business debt on Schedule F, line 8. Hrblock free file Report the income from cancellation of a nonbusiness debt as miscellaneous income on Form 1040. Hrblock free file    You can use Worksheet 8-1 to figure your income from cancellation of debt. Hrblock free file   However, income from cancellation of debt is not taxed if any of the following apply. Hrblock free file The cancellation is intended as a gift. Hrblock free file The debt is qualified farm debt (see chapter 3). Hrblock free file The debt is qualified real property business debt (see chapter 5 of Publication 334). Hrblock free file You are insolvent or bankrupt (see  chapter 3). Hrblock free file The debt is qualified principal residence indebtedness (see chapter 3). Hrblock free file   Use Form 982 to report the income exclusion. Hrblock free file Abandonment The abandonment of property is a disposition of property. Hrblock free file You abandon property when you voluntarily and permanently give up possession and use of the property with the intention of ending your ownership, but without passing it on to anyone else. Hrblock free file Business or investment property. Hrblock free file   Loss from abandonment of business or investment property is deductible as a loss. Hrblock free file Loss from abandonment of business or investment property that is not treated as a sale or exchange generally is an ordinary loss. Hrblock free file If your adjusted basis is more than the amount you realize (if any), then you have a loss. Hrblock free file If the amount you realize (if any) is more than your adjusted basis, then you have a gain. Hrblock free file This rule also applies to leasehold improvements the lessor made for the lessee. Hrblock free file However, if the property is foreclosed on or repossessed in lieu of abandonment, gain or loss is figured as discussed earlier under Foreclosure or Repossession . Hrblock free file   If the abandoned property is secured by debt, special rules apply. Hrblock free file The tax consequences of abandonment of property that secures a debt depend on whether you are personally liable for the debt (recourse debt) or were not personally liable for the debt (nonrecourse debt). Hrblock free file For more information, see chapter 3 of Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals). Hrblock free file The abandonment loss is deducted in the tax year in which the loss is sustained. Hrblock free file Report the loss on Form 4797, Part II, line 10. Hrblock free file Personal-use property. Hrblock free file   You cannot deduct any loss from abandonment of your home or other property held for personal use. Hrblock free file Canceled debt. Hrblock free file   If the abandoned property secures a debt for which you are personally liable and the debt is canceled, you will realize ordinary income equal to the canceled debt. Hrblock free file This income is separate from any loss realized from abandonment of the property. Hrblock free file Report income from cancellation of a debt related to a business or rental activity as business or rental income. Hrblock free file Report income from cancellation of a nonbusiness debt as miscellaneous income on Form 1040. Hrblock free file   However, income from cancellation of debt is not taxed in certain circumstances. Hrblock free file See Cancellation of debt earlier under Foreclosure or Repossession . Hrblock free file Forms 1099-A and 1099-C. Hrblock free file   A lender who acquires an interest in your property in a foreclosure, repossession, or abandonment should send you Form 1099-A showing the information you need to figure your loss from the foreclosure, repossession, or abandonment. Hrblock free file However, if the lender cancels part of your debt and the lender must file Form 1099-C, the lender may include the information about the foreclosure, repossession, or abandonment on that form instead of Form 1099-A. Hrblock free file The lender must file Form 1099-C and send you a copy if the canceled debt is $600 or more and the lender is a financial institution, credit union, federal government agency, or any organization that has a significant trade or business of lending money. Hrblock free file For foreclosures, repossessions, abandonments of property, and debt cancellations occurring in 2013, these forms should be sent to you by January 31, 2014. Hrblock free file Prev  Up  Next   Home   More Online Publications
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The Hrblock Free File

Hrblock free file 3. Hrblock free file   Investment Expenses Table of Contents Topics - This chapter discusses: Useful Items - You may want to see: Limits on DeductionsPassive activity. Hrblock free file Other income (nonpassive income). Hrblock free file Expenses. Hrblock free file Additional information. Hrblock free file Interest ExpensesInvestment Interest Limit on Deduction Bond Premium AmortizationSpecial rules to determine amounts payable on a bond. Hrblock free file Basis. Hrblock free file How To Figure Amortization Choosing To Amortize How To Report Amortization Expenses of Producing IncomeFees to buy or sell. Hrblock free file Including mutual fund or REMIC expenses in income. Hrblock free file Nondeductible ExpensesUsed as collateral. Hrblock free file Short-sale expenses. Hrblock free file Expenses for both tax-exempt and taxable income. Hrblock free file State income taxes. Hrblock free file Nondeductible amount. Hrblock free file Basis adjustment. Hrblock free file How To Report Investment Expenses When To Report Investment Expenses Topics - This chapter discusses: Limits on Deductions , Interest Expenses , Bond Premium Amortization , Expenses of Producing Income , Nondeductible Expenses , How To Report Investment Expenses , and When To Report Investment Expenses . Hrblock free file Useful Items - You may want to see: Publication 535 Business Expenses 925 Passive Activity and At-Risk Rules 929 Tax Rules for Children and Dependents Form (and Instructions) Schedule A (Form 1040) Itemized Deductions 4952 Investment Interest Expense Deduction See chapter 5, How To Get Tax Help , for information about getting these publications and forms. Hrblock free file Limits on Deductions Your deductions for investment expenses may be limited by: The at-risk rules, The passive activity loss limits, The limit on investment interest, or The 2% limit on certain miscellaneous itemized deductions. Hrblock free file The at-risk rules and passive activity rules are explained briefly in this section. Hrblock free file The limit on investment interest is explained later in this chapter under Interest Expenses . Hrblock free file The 2% limit is explained later in this chapter under Expenses of Producing Income . Hrblock free file At-risk rules. Hrblock free file   Special at-risk rules apply to most income-producing activities. Hrblock free file These rules limit the amount of loss you can deduct to the amount you risk losing in the activity. Hrblock free file Generally, this is the cash and the adjusted basis of property you contribute to the activity. Hrblock free file It also includes money you borrow for use in the activity if you are personally liable for repayment or if you use property not used in the activity as security for the loan. Hrblock free file For more information, see Publication 925. Hrblock free file Passive activity losses and credits. Hrblock free file   The amount of losses and tax credits you can claim from passive activities is limited. Hrblock free file Generally, you are allowed to deduct passive activity losses only up to the amount of your passive activity income. Hrblock free file Also, you can use credits from passive activities only against tax on the income from passive activities. Hrblock free file There are exceptions for certain activities, such as rental real estate activities. Hrblock free file Passive activity. Hrblock free file   A passive activity generally is any activity involving the conduct of any trade or business in which you do not materially participate and any rental activity. Hrblock free file However, if you are involved in renting real estate, the activity is not a passive activity if both of the following are true. Hrblock free file More than one-half of the personal services you perform during the year in all trades or businesses are performed in real property trades or businesses in which you materially participate. Hrblock free file You perform more than 750 hours of services during the year in real property trades or businesses in which you materially participate. Hrblock free file  The term “trade or business” generally means any activity that involves the conduct of a trade or business, is conducted in anticipation of starting a trade or business, or involves certain research or experimental expenditures. Hrblock free file However, it does not include rental activities or certain activities treated as incidental to holding property for investment. Hrblock free file   You are considered to materially participate in an activity if you are involved on a regular, continuous, and substantial basis in the operations of the activity. Hrblock free file Other income (nonpassive income). Hrblock free file    Generally, you can use losses from passive activities only to offset income from passive activities. Hrblock free file You cannot use passive activity losses to offset your other income, such as your wages or your portfolio income. Hrblock free file Portfolio income includes gross income from interest, dividends, annuities, or royalties that is not derived in the ordinary course of a trade or business. Hrblock free file It also includes gains or losses (not derived in the ordinary course of a trade or business) from the sale or trade of property (other than an interest in a passive activity) producing portfolio income or held for investment. Hrblock free file This includes capital gain distributions from mutual funds (and other regulated investment companies) and real estate investment trusts. Hrblock free file   You cannot use passive activity losses to offset Alaska Permanent Fund dividends. Hrblock free file Expenses. Hrblock free file   Do not include in the computation of your passive activity income or loss: Expenses (other than interest) that are clearly and directly allocable to your portfolio income, or Interest expense properly allocable to portfolio income. Hrblock free file However, this interest and other expenses may be subject to other limits. Hrblock free file These limits are explained in the rest of this chapter. Hrblock free file Additional information. Hrblock free file   For more information about determining and reporting income and losses from passive activities, see Publication 925. Hrblock free file Interest Expenses This section discusses interest expenses you may be able to deduct as an investor. Hrblock free file For information on business interest, see chapter 4 of Publication 535. Hrblock free file You cannot deduct personal interest expenses other than qualified home mortgage interest, as explained in Publication 936, Home Mortgage Interest Deduction, and interest on certain student loans, as explained in Publication 970. Hrblock free file Investment Interest If you borrow money to buy property you hold for investment, the interest you pay is investment interest. Hrblock free file You can deduct investment interest subject to the limit discussed later. Hrblock free file However, you cannot deduct interest you incurred to produce tax-exempt income. Hrblock free file See Tax-exempt income under Nondeductible Expenses, later. Hrblock free file You also cannot deduct interest expenses on straddles discussed under Interest expense and carrying charges on straddles , later. Hrblock free file Investment interest does not include any qualified home mortgage interest or any interest taken into account in computing income or loss from a passive activity. Hrblock free file Investment property. Hrblock free file   Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. Hrblock free file It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). Hrblock free file Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity). Hrblock free file Partners, shareholders, and beneficiaries. Hrblock free file   To determine your investment interest, combine your share of investment interest from a partnership, S corporation, estate, or trust with your other investment interest. Hrblock free file Allocation of Interest Expense If you borrow money for business or personal purposes as well as for investment, you must allocate the debt among those purposes. Hrblock free file Only the interest expense on the part of the debt used for investment purposes is treated as investment interest. Hrblock free file The allocation is not affected by the use of property that secures the debt. Hrblock free file Example 1. Hrblock free file You borrow $10,000 and use $8,000 to buy stock. Hrblock free file You use the other $2,000 to buy items for your home. Hrblock free file Since 80% of the debt is used for, and allocated to, investment purposes, 80% of the interest on that debt is investment interest. Hrblock free file The other 20% is nondeductible personal interest. Hrblock free file Debt proceeds received in cash. Hrblock free file   If you receive debt proceeds in cash, the proceeds are generally not treated as investment property. Hrblock free file Debt proceeds deposited in account. Hrblock free file   If you deposit debt proceeds in an account, that deposit is treated as investment property, regardless of whether the account bears interest. Hrblock free file But, if you withdraw the funds and use them for another purpose, you must reallocate the debt to determine the amount considered to be for investment purposes. Hrblock free file Example 2. Hrblock free file Assume in Example 1 that you borrowed the money on March 1 and immediately bought the stock for $8,000. Hrblock free file You did not buy the household items until June 1. Hrblock free file You had deposited the $2,000 in the bank. Hrblock free file You had no other transactions on the bank account until June. Hrblock free file You did not sell the stock, and you made no principal payments on the debt. Hrblock free file You paid interest from another account. Hrblock free file The $8,000 is treated as being used for an investment purpose. Hrblock free file The $2,000 is treated as being used for an investment purpose for the 3-month period. Hrblock free file Your total interest expense for 3 months on this debt is investment interest. Hrblock free file In June, when you spend the $2,000 for household items, you must begin to allocate 80% of the debt and the interest expense to investment purposes and 20% to personal purposes. Hrblock free file Amounts paid within 30 days. Hrblock free file   If you receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can treat any payment (up to the amount of the proceeds) made from any account you own, or from cash, as made from those proceeds. Hrblock free file This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. Hrblock free file   If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead of the date you actually made the payment. Hrblock free file Payments on debt may require new allocation. Hrblock free file   As you repay a debt used for more than one purpose, you must reallocate the balance. Hrblock free file You must first reduce the amount allocated to personal purposes by the repayment. Hrblock free file You then reallocate the rest of the debt to find what part is for investment purposes. Hrblock free file Example 3. Hrblock free file If, in Example 2 , you repay $500 on November 1, the entire repayment is applied against the amount allocated to personal purposes. Hrblock free file The debt balance is now allocated as $8,000 for investment purposes and $1,500 for personal purposes. Hrblock free file Until the next reallocation is necessary, 84% ($8,000 ÷ $9,500) of the debt and the interest expense is allocated to investment. Hrblock free file Pass-through entities. Hrblock free file   If you use borrowed funds to buy an interest in a partnership or S corporation, then the interest on those funds must be allocated based on the assets of the entity. Hrblock free file If you contribute to the capital of the entity, you can make the allocation using any reasonable method. Hrblock free file Additional allocation rules. Hrblock free file   For more information about allocating interest expense, see chapter 4 of Publication 535. Hrblock free file When To Deduct Investment Interest If you use the cash method of accounting, you must pay the interest before you can deduct it. Hrblock free file If you use an accrual method of accounting, you can deduct interest over the period it accrues, regardless of when you pay it. Hrblock free file For an exception, see Unpaid expenses owed to related party under When To Report Investment Expenses, later in this chapter. Hrblock free file Example. Hrblock free file You borrowed $1,000 on August 26, 2013, payable in 90 days at 12% interest. Hrblock free file On November 26, 2013, you paid this with a new note for $1,030, due on February 26, 2014. Hrblock free file If you use the cash method of accounting, you cannot deduct any part of the $30 interest on your return for 2013 because you did not actually pay it. Hrblock free file If you use an accrual method, you may be able to deduct a portion of the interest on the loans through December 31, 2013, on your return for 2013. Hrblock free file Interest paid in advance. Hrblock free file   Generally, if you pay interest in advance for a period that goes beyond the end of the tax year, you must spread the interest over the tax years to which it belongs under the OID rules discussed in chapter 1. Hrblock free file You can deduct in each year only the interest for that year. Hrblock free file Interest on margin accounts. Hrblock free file   If you are a cash method taxpayer, you can deduct interest on margin accounts to buy taxable securities as investment interest in the year you paid it. Hrblock free file You are considered to have paid interest on these accounts only when you actually pay the broker or when payment becomes available to the broker through your account. Hrblock free file Payment may become available to the broker through your account when the broker collects dividends or interest for your account, or sells securities held for you or received from you. Hrblock free file   You cannot deduct any interest on money borrowed for personal reasons. Hrblock free file Limit on interest deduction for market discount bonds. Hrblock free file   The amount you can deduct for interest expense you paid or accrued during the year to buy or carry a market discount bond may be limited. Hrblock free file This limit does not apply if you accrue the market discount and include it in your income currently. Hrblock free file   Under this limit, the interest is deductible only to the extent it is more than: The total interest and OID includible in gross income for the bond for the year, plus The market discount for the number of days you held the bond during the year. Hrblock free file Figure the amount in (2) above using the rules for figuring accrued market discount in chapter 1 under Market Discount Bonds . Hrblock free file Interest not deducted due to limit. Hrblock free file   In the year you dispose of the bond, you can deduct any interest expense you were not allowed to deduct in earlier years because of the limit. Hrblock free file Choosing to deduct disallowed interest expense before the year of disposition. Hrblock free file   You can choose to deduct disallowed interest expense in any year before the year you dispose of the bond, up to your net interest income from the bond during the year. Hrblock free file The rest of the disallowed interest expense remains deductible in the year you dispose of the bond. Hrblock free file Net interest income. Hrblock free file   This is the interest income (including OID) from the bond that you include in income for the year, minus the interest expense paid or accrued during the year to purchase or carry the bond. Hrblock free file Limit on interest deduction for short-term obligations. Hrblock free file   If the current income inclusion rules discussed in chapter 1 under Discount on Short-Term Obligations do not apply to you, the amount you can deduct for interest expense you paid or accrued during the year to buy or carry a short-term obligation is limited. Hrblock free file   The interest is deductible only to the extent it is more than: The amount of acquisition discount or OID on the obligation for the tax year, plus The amount of any interest payable on the obligation for the year that is not included in income because of your accounting method (other than interest taken into account in determining the amount of acquisition discount or OID). Hrblock free file The method of determining acquisition discount and OID for short-term obligations is discussed in chapter 1 under Discount on Short-Term Obligations . Hrblock free file Interest not deducted due to limit. Hrblock free file   In the year you dispose of the obligation, or, if you choose, in another year in which you have net interest income from the obligation, you can deduct any interest expense you were not allowed to deduct for an earlier year because of the limit. Hrblock free file Follow the same rules provided in the earlier discussion under Limit on interest deduction for market discount bonds , earlier. Hrblock free file Limit on Deduction Generally, your deduction for investment interest expense is limited to your net investment income. Hrblock free file You can carry over the amount of investment interest you could not deduct because of this limit to the next tax year. Hrblock free file The interest carried over is treated as investment interest paid or accrued in that next year. Hrblock free file You can carry over disallowed investment interest to the next tax year even if it is more than your taxable income in the year the interest was paid or accrued. Hrblock free file Net Investment Income Determine the amount of your net investment income by subtracting your investment expenses (other than interest expense) from your investment income. Hrblock free file Investment income. Hrblock free file   This generally includes your gross income from property held for investment (such as interest, dividends, annuities, and royalties). Hrblock free file Investment income does not include Alaska Permanent Fund dividends. Hrblock free file It also does not include qualified dividends or net capital gain unless you choose to include them. Hrblock free file Choosing to include qualified dividends. Hrblock free file   Investment income generally does not include qualified dividends, discussed in chapter 1. Hrblock free file However, you can choose to include all or part of your qualified dividends in investment income. Hrblock free file   You make this choice by completing Form 4952, line 4g, according to its instructions. Hrblock free file   If you choose to include any of your qualified dividends in investment income, you must reduce your qualified dividends that are eligible for the lower capital gains tax rates by the same amount. Hrblock free file Choosing to include net capital gain. Hrblock free file    Investment income generally does not include net capital gain from disposing of investment property (including capital gain distributions from mutual funds). Hrblock free file However, you can choose to include all or part of your net capital gain in investment income. Hrblock free file   You make this choice by completing Form 4952, line 4g, according to its instructions. Hrblock free file   If you choose to include any of your net capital gain in investment income, you must reduce your net capital gain that is eligible for the lower capital gains tax rates by the same amount. Hrblock free file   For more information about the capital gains rates, see Capital Gain Tax Rates in chapter 4. Hrblock free file    Before making either choice, consider the overall effect on your tax liability. Hrblock free file Compare your tax if you make one or both of these choices with your tax if you do not. Hrblock free file Investment income of child reported on parent's return. Hrblock free file   Investment income includes the part of your child's interest and dividend income you choose to report on your return. Hrblock free file If the child does not have qualified dividends, Alaska Permanent Fund dividends, or capital gain distributions, this is the amount on line 6 of Form 8814. Hrblock free file Include it on line 4a of Form 4952. Hrblock free file Example. Hrblock free file Your 8-year-old son has interest income of $2,200, which you choose to report on your own return. Hrblock free file You enter $2,200 on Form 8814, lines 1a and 4, and $200 on lines 6 and 12 and complete Part II. Hrblock free file Also enter $200 on Form 1040, line 21. Hrblock free file Your investment income includes this $200. Hrblock free file Child's qualified dividends. Hrblock free file   If part of the amount you report is your child's qualified dividends, that part (which is reported on Form 1040, line 9b) generally does not count as investment income. Hrblock free file However, you can choose to include all or part of it in investment income, as explained under Choosing to include qualified dividends , earlier. Hrblock free file   Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured next under Child's Alaska Permanent Fund dividends). Hrblock free file Child's Alaska Permanent Fund dividends. Hrblock free file   If part of the amount you report is your child's Alaska Permanent Fund dividends, that part does not count as investment income. Hrblock free file To figure the amount of your child's income that you can consider your investment income, start with the amount on Form 8814, line 6. Hrblock free file Multiply that amount by a percentage that is equal to the Alaska Permanent Fund dividends divided by the total amount on Form 8814, line 4. Hrblock free file Subtract the result from the amount on Form 8814, line 12. Hrblock free file Example. Hrblock free file Your 10-year-old child has taxable interest income of $4,000 and Alaska Permanent Fund dividends of $2,000. Hrblock free file You choose to report this on your return. Hrblock free file You enter $4,000 on Form 8814, line 1a, $2,000 on line 2a, and $6,000 on line 4. Hrblock free file You then enter $4,000 on Form 8814, lines 6 and 12, and Form 1040, line 21. Hrblock free file You figure the amount of your child's income that you can consider your investment income as follows: $4,000 − ($4,000 × ($2,000 ÷ $6,000)) = $2,667 You include the result, $2,667, on Form 4952, line 4a. Hrblock free file Child's capital gain distributions. Hrblock free file   If part of the amount you report is your child's capital gain distributions, that part (which is reported on Schedule D (Form 1040), line 13, or Form 1040, line 13) generally does not count as investment income. Hrblock free file However, you can choose to include all or part of it in investment income, as explained in Choosing to include net capital gain , earlier. Hrblock free file   Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured under Child's Alaska Permanent Fund dividends , earlier). Hrblock free file Investment expenses. Hrblock free file   Investment expenses are your allowed deductions (other than interest expense) directly connected with the production of investment income. Hrblock free file Investment expenses that are included as a miscellaneous itemized deduction on Schedule A (Form 1040) are allowable deductions after applying the 2% limit that applies to miscellaneous itemized deductions. Hrblock free file Use the smaller of: The investment expenses included on Schedule A (Form 1040), line 23, or The amount on Schedule A (Form 1040), line 27. Hrblock free file See Expenses of Producing Income , later, for a discussion of the 2% limit. Hrblock free file Losses from passive activities. Hrblock free file   Income or expenses that you used in computing income or loss from a passive activity are not included in determining your investment income or investment expenses (including investment interest expense). Hrblock free file See Publication 925 for information about passive activities. Hrblock free file Example. Hrblock free file Ted is a partner in a partnership that operates a business. Hrblock free file However, he does not materially participate in the partnership's business. Hrblock free file Ted's interest in the partnership is considered a passive activity. Hrblock free file Ted's investment income from interest and dividends (other than qualified dividends) is $10,000. Hrblock free file His investment expenses (other than interest) are $3,200 after taking into account the 2% limit on miscellaneous itemized deductions. Hrblock free file His investment interest expense is $8,000. Hrblock free file Ted also has income from the partnership of $2,000. Hrblock free file Ted figures his net investment income and the limit on his investment interest expense deduction in the following way: Total investment income $10,000 Minus: Investment expenses (other than interest) 3,200 Net investment income $6,800 Deductible investment interest expense for the year $6,800 The $2,000 of income from the passive activity is not used in determining Ted's net investment income. Hrblock free file His investment interest deduction for the year is limited to $6,800, the amount of his net investment income. Hrblock free file Form 4952 Use Form 4952 to figure your deduction for investment interest. Hrblock free file See Form 4952 for more information. Hrblock free file Exception to use of Form 4952. Hrblock free file   You do not have to complete Form 4952 or attach it to your return if you meet all of the following tests. Hrblock free file Your investment interest expense is not more than your investment income from interest and ordinary dividends minus any qualified dividends. Hrblock free file You do not have any other deductible investment expenses. Hrblock free file You have no carryover of investment interest expense from 2012. Hrblock free file   If you meet all of these tests, you can deduct all of your investment interest. Hrblock free file    Bond Premium Amortization If you pay a premium to buy a bond, the premium is part of your basis in the bond. Hrblock free file If the bond yields taxable interest, you can choose to amortize the premium. Hrblock free file This generally means that each year, over the life of the bond, you use a part of the premium to reduce the amount of interest includible in your income. Hrblock free file If you make this choice, you must reduce your basis in the bond by the amortization for the year. Hrblock free file If the bond yields tax-exempt interest, you must amortize the premium. Hrblock free file This amortized amount is not deductible in determining taxable income. Hrblock free file However, each year you must reduce your basis in the bond (and tax-exempt interest otherwise reportable on Form 1040, line 8b) by the amortization for the year. Hrblock free file Bond premium. Hrblock free file   Bond premium is the amount by which your basis in the bond right after you get it is more than the total of all amounts payable on the bond after you get it (other than payments of qualified stated interest). Hrblock free file For example, a bond with a maturity value of $1,000 generally would have a $50 premium if you buy it for $1,050. Hrblock free file Special rules to determine amounts payable on a bond. Hrblock free file   For special rules that apply to determine the amounts payable on a variable rate bond, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules (for example, a bond callable prior to the stated maturity date of the bond), or a bond that provides for remote or incidental contingencies, see Regulations section 1. Hrblock free file 171-3. Hrblock free file Basis. Hrblock free file   In general, your basis for figuring bond premium amortization is the same as your basis for figuring any loss on the sale of the bond. Hrblock free file However, you may need to use a different basis for: Convertible bonds, Bonds you got in a trade, and Bonds whose basis has to be determined using the basis of the person who transferred the bond to you. Hrblock free file See Regulations section 1. Hrblock free file 171-1(e). Hrblock free file Dealers. Hrblock free file   A dealer in taxable bonds (or anyone who holds them mainly for sale to customers in the ordinary course of a trade or business or who would properly include bonds in inventory at the close of the tax year) cannot claim a deduction for amortizable bond premium. Hrblock free file   See section 75 of the Internal Revenue Code for the treatment of bond premium by a dealer in tax-exempt bonds. Hrblock free file How To Figure Amortization For bonds issued after September 27, 1985, you must amortize bond premium using a constant yield method on the basis of the bond's yield to maturity, determined by using the bond's basis and compounding at the close of each accrual period. Hrblock free file Constant yield method. Hrblock free file   Figure the bond premium amortization for each accrual period as follows. Hrblock free file Step 1: Determine your yield. Hrblock free file   Your yield is the discount rate that, when used in figuring the present value of all remaining payments to be made on the bond (including payments of qualified stated interest), produces an amount equal to your basis in the bond. Hrblock free file Figure the yield as of the date you got the bond. Hrblock free file It must be constant over the term of the bond and must be figured to at least two decimal places when expressed as a percentage. Hrblock free file   If you do not know the yield, consult your broker or tax advisor. Hrblock free file Databases available to them are likely to show the yield at the date of purchase. Hrblock free file Step 2: Determine the accrual periods. Hrblock free file   You can choose the accrual periods to use. Hrblock free file They may be of any length and may vary in length over the term of the bond, but each accrual period can be no longer than 1 year and each scheduled payment of principal or interest must occur either on the first or the final day of an accrual period. Hrblock free file The computation is simplest if accrual periods are the same as the intervals between interest payment dates. Hrblock free file Step 3: Determine the bond premium for the accrual period. Hrblock free file   To do this, multiply your adjusted acquisition price at the beginning of the accrual period by your yield. Hrblock free file Then subtract the result from the qualified stated interest for the period. Hrblock free file   Your adjusted acquisition price at the beginning of the first accrual period is the same as your basis. Hrblock free file After that, it is your basis decreased by the amount of bond premium amortized for earlier periods and the amount of any payment previously made on the bond other than a payment of qualified stated interest. Hrblock free file Example. Hrblock free file On February 1, 2012, you bought a taxable bond for $110,000. Hrblock free file The bond has a stated principal amount of $100,000, payable at maturity on February 1, 2019, making your premium $10,000 ($110,000 − $100,000). Hrblock free file The bond pays qualified stated interest of $10,000 on February 1 of each year. Hrblock free file Your yield is 8. Hrblock free file 07439% compounded annually. Hrblock free file You choose to use annual accrual periods ending on February 1 of each year. Hrblock free file To find your bond premium amortization for the accrual period ending on February 1, 2013, you multiply the adjusted acquisition price at the beginning of the period ($110,000) by your yield. Hrblock free file When you subtract the result ($8,881. Hrblock free file 83) from the qualified stated interest for the period ($10,000), you find that your bond premium amortization for the period is $1,118. Hrblock free file 17. Hrblock free file Special rules to figure amortization. Hrblock free file   For special rules to figure the bond premium amortization on a variable rate bond, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules (for example, a bond callable prior to the stated maturity date of the bond), or a bond that provides for remote or incidental contingencies, see Regulations section 1. Hrblock free file 171-3. Hrblock free file Bonds Issued Before September 28, 1985 For these bonds, you can amortize bond premium using any reasonable method. Hrblock free file Reasonable methods include: The straight-line method, and The Revenue Ruling 82-10 method. Hrblock free file Straight-line method. Hrblock free file   Under this method, the amount of your bond premium amortization is the same each month. Hrblock free file Divide the number of months you held the bond during the year by the number of months from the beginning of the tax year (or, if later, the date of acquisition) to the date of maturity or earlier call date. Hrblock free file Then multiply the result by the bond premium (reduced by any bond premium amortization claimed in earlier years). Hrblock free file This gives you your bond premium amortization for the year. Hrblock free file Revenue Ruling 82-10 method. Hrblock free file   Under this method, the amount of your bond premium amortization increases each month over the life of the bond. Hrblock free file This method is explained in Revenue Ruling 82-10, 1982-1 C. Hrblock free file B. Hrblock free file 46. Hrblock free file Choosing To Amortize You choose to amortize the premium on taxable bonds by reporting the amortization for the year on your income tax return for the first tax year you want the choice to apply. Hrblock free file You should attach a statement to your return that you are making this choice under section 171. Hrblock free file See How To Report Amortization, next. Hrblock free file This choice is binding for the year you make it and for later tax years. Hrblock free file It applies to all taxable bonds you own in the year you make the choice and also to those you acquire in later years. Hrblock free file You can change your decision to amortize bond premium only with the written approval of the IRS. Hrblock free file To request approval, use Form 3115. Hrblock free file For more information on requesting approval, see section 5 of the Appendix to Revenue Procedure 2011-14 in Internal Revenue Bulletin 2011-4. Hrblock free file You can find Revenue Procedure 2011-14 at www. Hrblock free file irs. Hrblock free file gov/irb/2011-04_IRB/ar08. Hrblock free file html. Hrblock free file How To Report Amortization Subtract the bond premium amortization from your interest income from these bonds. Hrblock free file Report the bond's interest on Schedule B (Form 1040A or 1040), line 1. Hrblock free file Under your last entry on line 1, put a subtotal of all interest listed on line 1. Hrblock free file Below this subtotal, print “ABP Adjustment,” and the total interest you received. Hrblock free file Subtract this amount from the subtotal, and enter the result on line 2. Hrblock free file Bond premium amortization more than interest. Hrblock free file   If the amount of your bond premium amortization for an accrual period is more than the qualified stated interest for the period, you can deduct the difference as a miscellaneous itemized deduction on Schedule A (Form 1040), line 28. Hrblock free file    But your deduction is limited to the amount by which your total interest inclusions on the bond in prior accrual periods is more than your total bond premium deductions on the bond in prior periods. Hrblock free file Any amount you cannot deduct because of this limit can be carried forward to the next accrual period. Hrblock free file Pre-1998 election to amortize bond premium. Hrblock free file   Generally, if you first elected to amortize bond premium before 1998, the above treatment of the premium does not apply to bonds you acquired before 1988. Hrblock free file Bonds acquired before October 23, 1986. Hrblock free file   The amortization of the premium on these bonds is a miscellaneous itemized deduction not subject to the 2%-of-adjusted-gross-income limit. Hrblock free file Bonds acquired after October 22, 1986, but before 1988. Hrblock free file    The amortization of the premium on these bonds is investment interest expense subject to the investment interest limit, unless you choose to treat it as an offset to interest income on the bond. Hrblock free file Expenses of Producing Income You deduct investment expenses (other than interest expenses) as miscellaneous itemized deductions on Schedule A (Form 1040). Hrblock free file To be deductible, these expenses must be ordinary and necessary expenses paid or incurred: To produce or collect income, or To manage property held for producing income. Hrblock free file The expenses must be directly related to the income or income-producing property, and the income must be taxable to you. Hrblock free file The deduction for most income-producing expenses is subject to a 2% limit that also applies to certain other miscellaneous itemized deductions. Hrblock free file The amount deductible is limited to the total of these miscellaneous deductions that is more than 2% of your adjusted gross income. Hrblock free file For information on how to report expenses of producing income, see How To Report Investment Expenses , later. Hrblock free file Attorney or accounting fees. Hrblock free file   You can deduct attorney or accounting fees that are necessary to produce or collect taxable income. Hrblock free file However, in some cases, attorney or accounting fees are part of the basis of property. Hrblock free file See Basis of Investment Property in chapter 4. Hrblock free file Automatic investment service and dividend reinvestment plans. Hrblock free file   A bank may offer its checking account customers an automatic investment service so that, for a charge, each customer can choose to invest a part of the checking account each month in common stock. Hrblock free file Or a bank that is a dividend disbursing agent for a number of publicly-owned corporations may set up an automatic dividend reinvestment service. Hrblock free file Through that service, cash dividends are reinvested in more shares of stock after the bank deducts a service charge. Hrblock free file   A corporation in which you own stock also may have a dividend reinvestment plan. Hrblock free file This plan lets you choose to use your dividends to buy more shares of stock in the corporation instead of receiving the dividends in cash. Hrblock free file   You can deduct the monthly service charge you pay to a bank to participate in an automatic investment service. Hrblock free file If you participate in a dividend reinvestment plan, you can deduct any service charge subtracted from your cash dividends before the dividends are used to buy more shares of stock. Hrblock free file Deduct the charges in the year you pay them. Hrblock free file Clerical help and office rent. Hrblock free file   You can deduct office expenses, such as rent and clerical help, you incurred in connection with your investments and collecting the taxable income on your investments. Hrblock free file Cost of replacing missing securities. Hrblock free file   To replace your taxable securities that are mislaid, lost, stolen, or destroyed, you may have to post an indemnity bond. Hrblock free file You can deduct the premium you pay to buy the indemnity bond and the related incidental expenses. Hrblock free file   You may, however, get a refund of part of the bond premium if the missing securities are recovered within a specified time. Hrblock free file Under certain types of insurance policies, you can recover some of the expenses. Hrblock free file   If you receive the refund in the tax year you pay the amounts, you can deduct only the difference between the expenses paid and the amount refunded. Hrblock free file If the refund is made in a later tax year, you must include the refund in income in the year you received it, but only to the extent that the expenses decreased your tax in the year you deducted them. Hrblock free file Fees to collect income. Hrblock free file   You can deduct fees you pay to a broker, bank, trustee, or similar agent to collect investment income, such as your taxable bond or mortgage interest, or your dividends on shares of stock. Hrblock free file Fees to buy or sell. Hrblock free file   You cannot deduct a fee you pay to a broker to acquire investment property, such as stocks or bonds. Hrblock free file You must add the fee to the cost of the property. Hrblock free file See Basis of Investment Property in chapter 4. Hrblock free file    You cannot deduct any broker's fees, commissions, or option premiums you pay (or that were netted out) in connection with the sale of investment property. Hrblock free file They can be used only to figure gain or loss from the sale. Hrblock free file See Reporting Capital Gains and Losses , in chapter 4, for more information about the treatment of these sale expenses. Hrblock free file Investment counsel and advice. Hrblock free file   You can deduct fees you pay for counsel and advice about investments that produce taxable income. Hrblock free file This includes amounts you pay for investment advisory services. Hrblock free file Safe deposit box rent. Hrblock free file   You can deduct rent you pay for a safe deposit box if you use the box to store taxable income-producing stocks, bonds, or other investment-related papers and documents. Hrblock free file If you also use the box to store tax-exempt securities or personal items, you can deduct only part of the rent. Hrblock free file See Tax-exempt income under Nondeductible Expenses, later, to figure what part you can deduct. Hrblock free file State and local transfer taxes. Hrblock free file   You cannot deduct the state and local transfer taxes you pay when you buy or sell securities. Hrblock free file If you pay these transfer taxes when you buy securities, you must treat them as part of the cost of the property. Hrblock free file If you pay these transfer taxes when you sell securities, you must treat them as a reduction in the amount realized. Hrblock free file Trustee's commissions for revocable trust. Hrblock free file   If you set up a revocable trust and have its income distributed to you, you can deduct the commission you pay the trustee for managing the trust to the extent it is to produce or collect taxable income or to manage property. Hrblock free file However, you cannot deduct any part of the commission used for producing or collecting tax-exempt income or for managing property that produces tax-exempt income. Hrblock free file   If you are a cash-basis taxpayer and pay the commissions for several years in advance, you must deduct a part of the commission each year. Hrblock free file You cannot deduct the entire amount in the year you pay it. Hrblock free file Investment expenses from pass-through entities. Hrblock free file   If you hold an interest in a partnership, S corporation, real estate mortgage investment conduit (REMIC), or a nonpublicly offered mutual fund, you can deduct your share of that entity's investment expenses. Hrblock free file A partnership or S corporation will show your share of these expenses on your Schedule K-1 (Form 1065) or Schedule K-1 (Form 1120S). Hrblock free file A nonpublicly offered mutual fund will indicate your share of these expenses in box 5 of Form 1099-DIV (or substitute statement). Hrblock free file Publicly-offered mutual funds are discussed later. Hrblock free file   If you hold an interest in a REMIC, any expenses relating to your residual interest investment will be shown on Schedule Q (Form 1066), line 3b. Hrblock free file Any expenses relating to your regular interest investment will appear in box 5 of Form 1099-INT (or substitute statement) or box 9 of Form 1099-OID (or substitute statement). Hrblock free file   Report your share of these investment expenses on Schedule A (Form 1040), subject to the 2% limit, in the same manner as your other investment expenses. Hrblock free file Including mutual fund or REMIC expenses in income. Hrblock free file   Your share of the investment expenses of a REMIC or a nonpublicly offered mutual fund, as described above, are considered to be indirect deductions through that pass-through entity. Hrblock free file You must include in your gross income an amount equal to the expenses allocated to you, whether or not you are able to claim a deduction for those expenses. Hrblock free file If you are a shareholder in a nonpublicly offered mutual fund, you must include on your return the full amount of ordinary dividends or other distributions of stock, as shown in box 1a of Form 1099-DIV (or substitute statement). Hrblock free file If you are a residual interest holder in a REMIC, you must report as ordinary income on Schedule E (Form 1040) the total amounts shown on Schedule Q (Form 1066), lines 1b and 3b. Hrblock free file If you are a REMIC regular interest holder, you must include the amount of any expense allocation you received on Form 1040, line 8a. Hrblock free file Publicly-offered mutual funds. Hrblock free file   Most mutual funds are publicly offered. Hrblock free file These mutual funds, generally, are traded on an established securities exchange. Hrblock free file These funds do not pass investment expenses through to you. Hrblock free file Instead, the dividend income they report to you in box 1a of Form 1099-DIV (or substitute statement) is already reduced by your share of investment expenses. Hrblock free file As a result, you cannot deduct the expenses on your return. Hrblock free file   Include the amount from box 1a of Form 1099-DIV (or substitute statement) in your income. Hrblock free file    A publicly offered mutual fund is one that: Is continuously offered pursuant to a public offering, Is regularly traded on an established securities market, and Is held by or for no fewer than 500 persons at any time during the year. Hrblock free file Contact your mutual fund if you are not sure whether it is publicly offered. Hrblock free file Nondeductible Expenses Some expenses that you incur as an investor are not deductible. Hrblock free file Stockholders' meetings. Hrblock free file   You cannot deduct transportation and other expenses you pay to attend stockholders' meetings of companies in which you have no interest other than owning stock. Hrblock free file This is true even if your purpose in attending is to get information that would be useful in making further investments. Hrblock free file Investment-related seminar. Hrblock free file   You cannot deduct expenses for attending a convention, seminar, or similar meeting for investment purposes. Hrblock free file Single-premium life insurance, endowment, and annuity contracts. Hrblock free file   You cannot deduct interest on money you borrow to buy or carry a single-premium life insurance, endowment, or annuity contract. Hrblock free file Used as collateral. Hrblock free file   If you use a single premium annuity contract as collateral to obtain or continue a mortgage loan, you cannot deduct any interest on the loan that is collateralized by the annuity contract. Hrblock free file Figure the amount of interest expense disallowed by multiplying the current interest rate on the mortgage loan by the lesser of the amount of the annuity contract used as collateral or the amount of the loan. Hrblock free file Borrowing on insurance. Hrblock free file   Generally, you cannot deduct interest on money you borrow to buy or carry a life insurance, endowment, or annuity contract if you plan to systematically borrow part or all of the increases in the cash value of the contract. Hrblock free file This rule applies to the interest on the total amount borrowed to buy or carry the contract, not just the interest on the borrowed increases in the cash value. Hrblock free file Tax-exempt income. Hrblock free file   You cannot deduct expenses you incur to produce tax-exempt income. Hrblock free file Nor can you deduct interest on money you borrow to buy tax-exempt securities or shares in a mutual fund or other regulated investment company that distributes only exempt-interest dividends. Hrblock free file Short-sale expenses. Hrblock free file   The rule disallowing a deduction for interest expenses on tax-exempt securities applies to amounts you pay in connection with personal property used in a short sale or amounts paid by others for the use of any collateral in connection with the short sale. Hrblock free file However, it does not apply to the expenses you incur if you deposit cash as collateral for the property used in the short sale and the cash does not earn a material return during the period of the sale. Hrblock free file Short sales are discussed in Short Sales in chapter 4. Hrblock free file Expenses for both tax-exempt and taxable income. Hrblock free file   You may have expenses that are for both tax-exempt and taxable income. Hrblock free file If you cannot specifically identify what part of the expenses is for each type of income, you can divide the expenses, using reasonable proportions based on facts and circumstances. Hrblock free file You must attach a statement to your return showing how you divided the expenses and stating that each deduction claimed is not based on tax-exempt income. Hrblock free file   One accepted method for dividing expenses is to do it in the same proportion that each type of income is to the total income. Hrblock free file If the expenses relate in part to capital gains and losses, include the gains, but not the losses, in figuring this proportion. Hrblock free file To find the part of the expenses that is for the tax-exempt income, divide your tax-exempt income by the total income and multiply your expenses by the result. Hrblock free file Example. Hrblock free file You received $6,000 interest; $4,800 was tax-exempt and $1,200 was taxable. Hrblock free file In earning this income, you had $500 of expenses. Hrblock free file You cannot specifically identify the amount of each expense item that is for each income item, so you must divide your expenses. Hrblock free file 80% ($4,800 tax-exempt interest divided by $6,000 total interest) of your expenses is for the tax-exempt income. Hrblock free file You cannot deduct $400 (80% of $500) of the expenses. Hrblock free file You can deduct $100 (the rest of the expenses) because they are for the taxable interest. Hrblock free file State income taxes. Hrblock free file   If you itemize your deductions, you can deduct, as taxes, state income taxes on interest income that is exempt from federal income tax. Hrblock free file But you cannot deduct, as either taxes or investment expenses, state income taxes on other exempt income. Hrblock free file Interest expense and carrying charges on straddles. Hrblock free file   You cannot deduct interest and carrying charges allocable to personal property that is part of a straddle. Hrblock free file The nondeductible interest and carrying charges are added to the basis of the straddle property. Hrblock free file However, this treatment does not apply if: All the offsetting positions making up the straddle either consist of one or more qualified covered call options and the optioned stock, or consist of section 1256 contracts (and the straddle is not part of a larger straddle); or The straddle is a hedging transaction. Hrblock free file  For information about straddles, including definitions of the terms used in this discussion, see Straddles in chapter 4. Hrblock free file   Interest includes any amount you pay or incur in connection with personal property used in a short sale. Hrblock free file However, you must first apply the rules discussed in Payments in lieu of dividends under Short Sales in chapter 4. Hrblock free file   To determine the interest on market discount bonds and short-term obligations that are part of a straddle, you must first apply the rules discussed under Limit on interest deduction for market discount bonds and Limit on interest deduction for short-term obligations (both under Interest Expenses, earlier). Hrblock free file Nondeductible amount. Hrblock free file   Figure the nondeductible interest and carrying charges on straddle property as follows. Hrblock free file Add: Interest on indebtedness incurred or continued to buy or carry the personal property, and All other amounts (including charges to insure, store, or transport the personal property) paid or incurred to carry the personal property. Hrblock free file Subtract from the amount in (1): Interest (including OID) includible in gross income for the year on the personal property, Any income from the personal property treated as ordinary income on the disposition of short-term government obligations or as ordinary income under the market discount and short-term bond provisions — see Discount on Debt Instruments in chapter 1, The dividends includible in gross income for the year from the personal property, and Any payment on a loan of the personal property for use in a short sale that is includible in gross income. Hrblock free file Basis adjustment. Hrblock free file   Add the nondeductible amount to the basis of your straddle property. Hrblock free file How To Report Investment Expenses To deduct your investment expenses, you must itemize deductions on Schedule A (Form 1040). Hrblock free file Enter your deductible investment interest expense on Schedule A (Form1040), line 14. Hrblock free file Include any deductible short sale expenses. Hrblock free file (See Short Sales in chapter 4 for information on these expenses. Hrblock free file ) Also attach a completed Form 4952 if you used that form to figure your investment interest expense. Hrblock free file Enter the total amount of your other investment expenses (other than interest expenses) on Schedule A (Form 1040), line 23. Hrblock free file List the type and amount of each expense on the dotted lines next to line 23. Hrblock free file (If necessary, you can show the required information on an attached statement. Hrblock free file ) For information on how to report amortizable bond premium, see Bond Premium Amortization , earlier in this chapter. Hrblock free file When To Report Investment Expenses If you use the cash method to report income and expenses, you generally deduct your expenses, except for certain prepaid interest, in the year you pay them. Hrblock free file If you use an accrual method, you generally deduct your expenses when you incur a liability for them, rather than when you pay them. Hrblock free file Also see When To Deduct Investment Interest , earlier in this chapter. Hrblock free file Unpaid expenses owed to related party. Hrblock free file   If you use an accrual method, you cannot deduct interest and other expenses owed to a related cash-basis person until payment is made and the amount is includible in the gross income of that person. Hrblock free file The relationship, for purposes of this rule, is determined as of the end of the tax year for which the interest or expense would otherwise be deductible. Hrblock free file If a deduction is denied under this rule, this rule will continue to apply even if your relationship with the person ceases to exist before the amount is includible in the gross income of that person. Hrblock free file   This rule generally applies to those relationships listed in chapter 4 under Related Party Transactions . Hrblock free file It also applies to accruals by partnerships to partners, partners to partnerships, shareholders to S corporations, and S corporations to shareholders. Hrblock free file   The postponement of deductions for unpaid expenses and interest under the related party rule does not apply to OID, regardless of when payment is made. Hrblock free file This rule also does not apply to loans with below-market interest rates or to certain payments for the use of property and services when the lender or recipient has to include payments periodically in income, even if a payment has not been made. Hrblock free file Prev  Up  Next   Home   More Online Publications