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Taxhow 1040x 3. Taxhow 1040x   Ordinary or Capital Gain or Loss for Business Property Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Section 1231 Gains and LossesNonrecaptured section 1231 losses. Taxhow 1040x Depreciation RecaptureSection 1245 Property Section 1250 Property Installment Sales Gifts Transfers at Death Like-Kind Exchanges and Involuntary Conversions Multiple Properties Introduction When you dispose of business property, your taxable gain or loss is usually a section 1231 gain or loss. Taxhow 1040x Its treatment as ordinary or capital is determined under rules for section 1231 transactions. Taxhow 1040x When you dispose of depreciable property (section 1245 property or section 1250 property) at a gain, you may have to recognize all or part of the gain as ordinary income under the depreciation recapture rules. Taxhow 1040x Any remaining gain is a section 1231 gain. Taxhow 1040x Topics - This chapter discusses: Section 1231 gains and losses Depreciation recapture Useful Items - You may want to see: Publication 534 Depreciating Property Placed in Service Before 1987 537 Installment Sales 547 Casualties, Disasters and Thefts 551 Basis of Assets 946 How To Depreciate Property Form (and Instructions) 4797 Sales of Business Property See chapter 5 for information about getting publications and forms. Taxhow 1040x Section 1231 Gains and Losses Section 1231 gains and losses are the taxable gains and losses from section 1231 transactions (discussed below). Taxhow 1040x Their treatment as ordinary or capital depends on whether you have a net gain or a net loss from all your section 1231 transactions. Taxhow 1040x If you have a gain from a section 1231 transaction, first determine whether any of the gain is ordinary income under the depreciation recapture rules (explained later). Taxhow 1040x Do not take that gain into account as section 1231 gain. Taxhow 1040x Section 1231 transactions. Taxhow 1040x   The following transactions result in gain or loss subject to section 1231 treatment. Taxhow 1040x Sales or exchanges of real property or depreciable personal property. Taxhow 1040x This property must be used in a trade or business and held longer than 1 year. Taxhow 1040x Generally, property held for the production of rents or royalties is considered to be used in a trade or business. Taxhow 1040x Depreciable personal property includes amortizable section 197 intangibles (described in chapter 2 under Other Dispositions). Taxhow 1040x Sales or exchanges of leaseholds. Taxhow 1040x The leasehold must be used in a trade or business and held longer than 1 year. Taxhow 1040x Sales or exchanges of cattle and horses. Taxhow 1040x The cattle and horses must be held for draft, breeding, dairy, or sporting purposes and held for 2 years or longer. Taxhow 1040x Sales or exchanges of other livestock. Taxhow 1040x This livestock does not include poultry. Taxhow 1040x It must be held for draft, breeding, dairy, or sporting purposes and held for 1 year or longer. Taxhow 1040x Sales or exchanges of unharvested crops. Taxhow 1040x The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person and the land must be held longer than 1 year. Taxhow 1040x You cannot keep any right or option to directly or indirectly reacquire the land (other than a right customarily incident to a mortgage or other security transaction). Taxhow 1040x Growing crops sold with a lease on the land, though sold to the same person in the same transaction, are not included. Taxhow 1040x Cutting of timber or disposal of timber, coal, or iron ore. Taxhow 1040x The cutting or disposal must be treated as a sale, as described in chapter 2 under Timber and Coal and Iron Ore. Taxhow 1040x Condemnations. Taxhow 1040x The condemned property must have been held longer than 1 year. Taxhow 1040x It must be business property or a capital asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. Taxhow 1040x It cannot be property held for personal use. Taxhow 1040x Casualties and thefts. Taxhow 1040x The casualty or theft must have affected business property, property held for the production of rents and royalties, or investment property (such as notes and bonds). Taxhow 1040x You must have held the property longer than 1 year. Taxhow 1040x However, if your casualty or theft losses are more than your casualty or theft gains, neither the gains nor the losses are taken into account in the section 1231 computation. Taxhow 1040x For more information on casualties and thefts, see Publication 547. Taxhow 1040x Property for sale to customers. Taxhow 1040x   A sale, exchange, or involuntary conversion of property held mainly for sale to customers is not a section 1231 transaction. Taxhow 1040x If you will get back all, or nearly all, of your investment in the property by selling it rather than by using it up in your business, it is property held mainly for sale to customers. Taxhow 1040x Example. Taxhow 1040x You manufacture and sell steel cable, which you deliver on returnable reels that are depreciable property. Taxhow 1040x Customers make deposits on the reels, which you refund if the reels are returned within a year. Taxhow 1040x If they are not returned, you keep each deposit as the agreed-upon sales price. Taxhow 1040x Most reels are returned within the 1-year period. Taxhow 1040x You keep adequate records showing depreciation and other charges to the capitalized cost of the reels. Taxhow 1040x Under these conditions, the reels are not property held for sale to customers in the ordinary course of your business. Taxhow 1040x Any gain or loss resulting from their not being returned may be capital or ordinary, depending on your section 1231 transactions. Taxhow 1040x Copyrights. Taxhow 1040x    The sale of a copyright, a literary, musical, or artistic composition, or similar property is not a section 1231 transaction if your personal efforts created the property, or if you acquired the property in a way that entitled you to the basis of the previous owner whose personal efforts created it (for example, if you receive the property as a gift). Taxhow 1040x The sale of such property results in ordinary income and generally is reported in Part II of Form 4797. Taxhow 1040x Treatment as ordinary or capital. Taxhow 1040x   To determine the treatment of section 1231 gains and losses, combine all your section 1231 gains and losses for the year. Taxhow 1040x If you have a net section 1231 loss, it is ordinary loss. Taxhow 1040x If you have a net section 1231 gain, it is ordinary income up to the amount of your nonrecaptured section 1231 losses from previous years. Taxhow 1040x The rest, if any, is long-term capital gain. Taxhow 1040x Nonrecaptured section 1231 losses. Taxhow 1040x   Your nonrecaptured section 1231 losses are your net section 1231 losses for the previous 5 years that have not been applied against a net section 1231 gain. Taxhow 1040x Therefore, if in any of your five preceding tax years you had section 1231 losses, a net gain for the current year from the sale of section 1231 assets is ordinary gain to the extent of your prior losses. Taxhow 1040x These losses are applied against your net section 1231 gain beginning with the earliest loss in the 5-year period. Taxhow 1040x Example. Taxhow 1040x In 2013, Ben has a $2,000 net section 1231 gain. Taxhow 1040x To figure how much he has to report as ordinary income and long-term capital gain, he must first determine his section 1231 gains and losses from the previous 5-year period. Taxhow 1040x From 2008 through 2012 he had the following section 1231 gains and losses. Taxhow 1040x Year Amount 2008 -0- 2009 -0- 2010 ($2,500) 2011 -0- 2012 $1,800 Ben uses this information to figure how to report his net section 1231 gain for 2013 as shown below. Taxhow 1040x 1) Net section 1231 gain (2013) $2,000 2) Net section 1231 loss (2010) ($2,500)   3) Net section 1231 gain (2012) 1,800   4) Remaining net section 1231 loss from prior 5 years ($700)   5) Gain treated as  ordinary income $700 6) Gain treated as long-term  capital gain $1,300 Depreciation Recapture If you dispose of depreciable or amortizable property at a gain, you may have to treat all or part of the gain (even if otherwise nontaxable) as ordinary income. Taxhow 1040x To figure any gain that must be reported as ordinary income, you must keep permanent records of the facts necessary to figure the depreciation or amortization allowed or allowable on your property. Taxhow 1040x This includes the date and manner of acquisition, cost or other basis, depreciation or amortization, and all other adjustments that affect basis. Taxhow 1040x On property you acquired in a nontaxable exchange or as a gift, your records also must indicate the following information. Taxhow 1040x Whether the adjusted basis was figured using depreciation or amortization you claimed on other property. Taxhow 1040x Whether the adjusted basis was figured using depreciation or amortization another person claimed. Taxhow 1040x Corporate distributions. Taxhow 1040x   For information on property distributed by corporations, see Distributions to Shareholders in Publication 542, Corporations. Taxhow 1040x General asset accounts. Taxhow 1040x   Different rules apply to dispositions of property you depreciated using a general asset account. Taxhow 1040x For information on these rules, see Publication 946. Taxhow 1040x Section 1245 Property A gain on the disposition of section 1245 property is treated as ordinary income to the extent of depreciation allowed or allowable on the property. Taxhow 1040x See Gain Treated as Ordinary Income, later. Taxhow 1040x Any gain recognized that is more than the part that is ordinary income from depreciation is a section 1231 gain. Taxhow 1040x See Treatment as ordinary or capital under Section 1231 Gains and Losses, earlier. Taxhow 1040x Section 1245 property defined. Taxhow 1040x   Section 1245 property includes any property that is or has been subject to an allowance for depreciation or amortization and that is any of the following types of property. Taxhow 1040x Personal property (either tangible or intangible). Taxhow 1040x Other tangible property (except buildings and their structural components) used as any of the following. Taxhow 1040x See Buildings and structural components below. Taxhow 1040x An integral part of manufacturing, production, or extraction, or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services. Taxhow 1040x A research facility in any of the activities in (a). Taxhow 1040x A facility in any of the activities in (a) for the bulk storage of fungible commodities (discussed on the next page). Taxhow 1040x That part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following. Taxhow 1040x Amortization of certified pollution control facilities. Taxhow 1040x The section 179 expense deduction. Taxhow 1040x Deduction for clean-fuel vehicles and certain refueling property. Taxhow 1040x Deduction for capital costs incurred in complying with Environmental Protection Agency sulfur regulations. Taxhow 1040x Deduction for certain qualified refinery property. Taxhow 1040x Deduction for qualified energy efficient commercial building property. Taxhow 1040x Amortization of railroad grading and tunnel bores, if in effect before the repeal by the Revenue Reconciliation Act of 1990. Taxhow 1040x (Repealed by Public Law 99-514, Tax Reform Act of 1986, section 242(a). Taxhow 1040x ) Certain expenditures for child care facilities if in effect before repeal by Public Law 101-58, Omnibus Budget Reconciliation Act of 1990, section 11801(a)(13) (except with regards to deductions made prior to November 5, 1990). Taxhow 1040x Expenditures to remove architectural and transportation barriers to the handicapped and elderly. Taxhow 1040x Deduction for qualified tertiary injectant expenses. Taxhow 1040x Certain reforestation expenditures. Taxhow 1040x Deduction for election to expense qualified advanced mine safety equipment property. Taxhow 1040x Single purpose agricultural (livestock) or horticultural structures. Taxhow 1040x Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary product of petroleum. Taxhow 1040x Any railroad grading or tunnel bore. Taxhow 1040x Buildings and structural components. Taxhow 1040x   Section 1245 property does not include buildings and structural components. Taxhow 1040x The term building includes a house, barn, warehouse, or garage. Taxhow 1040x The term structural component includes walls, floors, windows, doors, central air conditioning systems, light fixtures, etc. Taxhow 1040x   Do not treat a structure that is essentially machinery or equipment as a building or structural component. Taxhow 1040x Also, do not treat a structure that houses property used as an integral part of an activity as a building or structural component if the structure's use is so closely related to the property's use that the structure can be expected to be replaced when the property it initially houses is replaced. Taxhow 1040x   The fact that the structure is specially designed to withstand the stress and other demands of the property and cannot be used economically for other purposes indicates it is closely related to the use of the property it houses. Taxhow 1040x Structures such as oil and gas storage tanks, grain storage bins, silos, fractionating towers, blast furnaces, basic oxygen furnaces, coke ovens, brick kilns, and coal tipples are not treated as buildings, but as section 1245 property. Taxhow 1040x Facility for bulk storage of fungible commodities. Taxhow 1040x   This term includes oil or gas storage tanks and grain storage bins. Taxhow 1040x Bulk storage means the storage of a commodity in a large mass before it is used. Taxhow 1040x For example, if a facility is used to store oranges that have been sorted and boxed, it is not used for bulk storage. Taxhow 1040x To be fungible, a commodity must be such that one part may be used in place of another. Taxhow 1040x   Stored materials that vary in composition, size, and weight are not fungible. Taxhow 1040x Materials are not fungible if one part cannot be used in place of another part and the materials cannot be estimated and replaced by simple reference to weight, measure, and number. Taxhow 1040x For example, the storage of different grades and forms of aluminum scrap is not storage of fungible commodities. Taxhow 1040x Gain Treated as Ordinary Income The gain treated as ordinary income on the sale, exchange, or involuntary conversion of section 1245 property, including a sale and leaseback transaction, is the lesser of the following amounts. Taxhow 1040x The depreciation and amortization allowed or allowable on the property. Taxhow 1040x The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property). Taxhow 1040x A limit on this amount for gain on like-kind exchanges and involuntary conversions is explained later. Taxhow 1040x For any other disposition of section 1245 property, ordinary income is the lesser of (1) earlier or the amount by which its fair market value is more than its adjusted basis. Taxhow 1040x See Gifts and Transfers at Death, later. Taxhow 1040x Use Part III of Form 4797 to figure the ordinary income part of the gain. Taxhow 1040x Depreciation taken on other property or taken by other taxpayers. Taxhow 1040x   Depreciation and amortization include the amounts you claimed on the section 1245 property as well as the following depreciation and amortization amounts. Taxhow 1040x Amounts you claimed on property you exchanged for, or converted to, your section 1245 property in a like-kind exchange or involuntary conversion. Taxhow 1040x Amounts a previous owner of the section 1245 property claimed if your basis is determined with reference to that person's adjusted basis (for example, the donor's depreciation deductions on property you received as a gift). Taxhow 1040x Depreciation and amortization. Taxhow 1040x   Depreciation and amortization that must be recaptured as ordinary income include (but are not limited to) the following items. Taxhow 1040x Ordinary depreciation deductions. Taxhow 1040x Any special depreciation allowance you claimed. Taxhow 1040x Amortization deductions for all the following costs. Taxhow 1040x Acquiring a lease. Taxhow 1040x Lessee improvements. Taxhow 1040x Certified pollution control facilities. Taxhow 1040x Certain reforestation expenses. Taxhow 1040x Section 197 intangibles. Taxhow 1040x Childcare facility expenses made before 1982, if in effect before the repeal of IRC 188. Taxhow 1040x Franchises, trademarks, and trade names acquired before August 11, 1993. Taxhow 1040x The section 179 deduction. Taxhow 1040x Deductions for all the following costs. Taxhow 1040x Removing barriers to the disabled and the elderly. Taxhow 1040x Tertiary injectant expenses. Taxhow 1040x Depreciable clean-fuel vehicles and refueling property (minus the amount of any recaptured deduction). Taxhow 1040x Environmental cleanup costs. Taxhow 1040x Certain reforestation expenses. Taxhow 1040x Qualified disaster expenses. Taxhow 1040x Any basis reduction for the investment credit (minus any basis increase for credit recapture). Taxhow 1040x Any basis reduction for the qualified electric vehicle credit (minus any basis increase for credit recapture). Taxhow 1040x Example. Taxhow 1040x You file your returns on a calendar year basis. Taxhow 1040x In February 2011, you bought and placed in service for 100% use in your business a light-duty truck (5-year property) that cost $10,000. Taxhow 1040x You used the half-year convention and your MACRS deductions for the truck were $2,000 in 2011 and $3,200 in 2012. Taxhow 1040x You did not take the section 179 deduction. Taxhow 1040x You sold the truck in May 2013 for $7,000. Taxhow 1040x The MACRS deduction in 2013, the year of sale, is $960 (½ of $1,920). Taxhow 1040x Figure the gain treated as ordinary income as follows. Taxhow 1040x 1) Amount realized $7,000 2) Cost (February 2011) $10,000   3) Depreciation allowed or allowable (MACRS deductions: $2,000 + $3,200 + $960) 6,160   4) Adjusted basis (subtract line 3 from line 2) $3,840 5) Gain realized (subtract line 4 from line 1) $3,160 6) Gain treated as ordinary income (lesser of line 3 or line 5) $3,160 Depreciation on other tangible property. Taxhow 1040x   You must take into account depreciation during periods when the property was not used as an integral part of an activity or did not constitute a research or storage facility, as described earlier under Section 1245 property. Taxhow 1040x   For example, if depreciation deductions taken on certain storage facilities amounted to $10,000, of which $6,000 is from the periods before their use in a prescribed business activity, you must use the entire $10,000 in determining ordinary income from depreciation. Taxhow 1040x Depreciation allowed or allowable. Taxhow 1040x   The greater of the depreciation allowed or allowable is generally the amount to use in figuring the part of gain to report as ordinary income. Taxhow 1040x However, if in prior years, you have consistently taken proper deductions under one method, the amount allowed for your prior years will not be increased even though a greater amount would have been allowed under another proper method. Taxhow 1040x If you did not take any deduction at all for depreciation, your adjustments to basis for depreciation allowable are figured by using the straight line method. Taxhow 1040x   This treatment applies only when figuring what part of gain is treated as ordinary income under the rules for section 1245 depreciation recapture. Taxhow 1040x Multiple asset accounts. Taxhow 1040x   In figuring ordinary income from depreciation, you can treat any number of units of section 1245 property in a single depreciation account as one item if the total ordinary income from depreciation figured by using this method is not less than it would be if depreciation on each unit were figured separately. Taxhow 1040x Example. Taxhow 1040x In one transaction you sold 50 machines, 25 trucks, and certain other property that is not section 1245 property. Taxhow 1040x All of the depreciation was recorded in a single depreciation account. Taxhow 1040x After dividing the total received among the various assets sold, you figured that each unit of section 1245 property was sold at a gain. Taxhow 1040x You can figure the ordinary income from depreciation as if the 50 machines and 25 trucks were one item. Taxhow 1040x However, if five of the trucks had been sold at a loss, only the 50 machines and 20 of the trucks could be treated as one item in determining the ordinary income from depreciation. Taxhow 1040x Normal retirement. Taxhow 1040x   The normal retirement of section 1245 property in multiple asset accounts does not require recognition of gain as ordinary income from depreciation if your method of accounting for asset retirements does not require recognition of that gain. Taxhow 1040x Section 1250 Property Gain on the disposition of section 1250 property is treated as ordinary income to the extent of additional depreciation allowed or allowable on the property. Taxhow 1040x To determine the additional depreciation on section 1250 property, see Additional Depreciation, below. Taxhow 1040x Section 1250 property defined. Taxhow 1040x   This includes all real property that is subject to an allowance for depreciation and that is not and never has been section 1245 property. Taxhow 1040x It includes a leasehold of land or section 1250 property subject to an allowance for depreciation. Taxhow 1040x A fee simple interest in land is not included because it is not depreciable. Taxhow 1040x   If your section 1250 property becomes section 1245 property because you change its use, you can never again treat it as section 1250 property. Taxhow 1040x Additional Depreciation If you hold section 1250 property longer than 1 year, the additional depreciation is the actual depreciation adjustments that are more than the depreciation figured using the straight line method. Taxhow 1040x For a list of items treated as depreciation adjustments, see Depreciation and amortization under Gain Treated as Ordinary Income, earlier. Taxhow 1040x For the treatment of unrecaptured section 1250 gain, see Capital Gains Tax Rate, later. Taxhow 1040x If you hold section 1250 property for 1 year or less, all the depreciation is additional depreciation. Taxhow 1040x You will not have additional depreciation if any of the following conditions apply to the property disposed of. Taxhow 1040x You figured depreciation for the property using the straight line method or any other method that does not result in depreciation that is more than the amount figured by the straight line method; you held the property longer than 1 year; and, if the property was qualified property, you made a timely election not to claim any special depreciation allowance. Taxhow 1040x In addition, if the property was in a renewal community, you must not have elected to claim a commercial revitalization deduction for property placed in service before January 1, 2010. Taxhow 1040x The property was residential low-income rental property you held for 162/3 years or longer. Taxhow 1040x For low-income rental housing on which the special 60-month depreciation for rehabilitation expenses was allowed, the 162/3 years start when the rehabilitated property is placed in service. Taxhow 1040x You chose the alternate ACRS method for the property, which was a type of 15-, 18-, or 19-year real property covered by the section 1250 rules. Taxhow 1040x The property was residential rental property or nonresidential real property placed in service after 1986 (or after July 31, 1986, if the choice to use MACRS was made); you held it longer than 1 year; and, if the property was qualified property, you made a timely election not to claim any special depreciation allowance. Taxhow 1040x These properties are depreciated using the straight line method. Taxhow 1040x In addition, if the property was in a renewal community, you must not have elected to claim a commercial revitalization deduction. Taxhow 1040x Depreciation taken by other taxpayers or on other property. Taxhow 1040x   Additional depreciation includes all depreciation adjustments to the basis of section 1250 property whether allowed to you or another person (as carryover basis property). Taxhow 1040x Example. Taxhow 1040x Larry Johnson gives his son section 1250 property on which he took $2,000 in depreciation deductions, of which $500 is additional depreciation. Taxhow 1040x Immediately after the gift, the son's adjusted basis in the property is the same as his father's and reflects the $500 additional depreciation. Taxhow 1040x On January 1 of the next year, after taking depreciation deductions of $1,000 on the property, of which $200 is additional depreciation, the son sells the property. Taxhow 1040x At the time of sale, the additional depreciation is $700 ($500 allowed the father plus $200 allowed the son). Taxhow 1040x Depreciation allowed or allowable. Taxhow 1040x   The greater of depreciation allowed or allowable (to any person who held the property if the depreciation was used in figuring its adjusted basis in your hands) generally is the amount to use in figuring the part of the gain to be reported as ordinary income. Taxhow 1040x If you can show that the deduction allowed for any tax year was less than the amount allowable, the lesser figure will be the depreciation adjustment for figuring additional depreciation. Taxhow 1040x Retired or demolished property. Taxhow 1040x   The adjustments reflected in adjusted basis generally do not include deductions for depreciation on retired or demolished parts of section 1250 property unless these deductions are reflected in the basis of replacement property that is section 1250 property. Taxhow 1040x Example. Taxhow 1040x A wing of your building is totally destroyed by fire. Taxhow 1040x The depreciation adjustments figured in the adjusted basis of the building after the wing is destroyed do not include any deductions for depreciation on the destroyed wing unless it is replaced and the adjustments for depreciation on it are reflected in the basis of the replacement property. Taxhow 1040x Figuring straight line depreciation. Taxhow 1040x   The useful life and salvage value you would have used to figure straight line depreciation are the same as those used under the depreciation method you actually used. Taxhow 1040x If you did not use a useful life under the depreciation method actually used (such as with the units-of-production method) or if you did not take salvage value into account (such as with the declining balance method), the useful life or salvage value for figuring what would have been the straight line depreciation is the useful life and salvage value you would have used under the straight line method. Taxhow 1040x   Salvage value and useful life are not used for the ACRS method of depreciation. Taxhow 1040x Figure straight line depreciation for ACRS real property by using its 15-, 18-, or 19-year recovery period as the property's useful life. Taxhow 1040x   The straight line method is applied without any basis reduction for the investment credit. Taxhow 1040x Property held by lessee. Taxhow 1040x   If a lessee makes a leasehold improvement, the lease period for figuring what would have been the straight line depreciation adjustments includes all renewal periods. Taxhow 1040x This inclusion of the renewal periods cannot extend the lease period taken into account to a period that is longer than the remaining useful life of the improvement. Taxhow 1040x The same rule applies to the cost of acquiring a lease. Taxhow 1040x   The term renewal period means any period for which the lease may be renewed, extended, or continued under an option exercisable by the lessee. Taxhow 1040x However, the inclusion of renewal periods cannot extend the lease by more than two-thirds of the period that was the basis on which the actual depreciation adjustments were allowed. Taxhow 1040x Applicable Percentage The applicable percentage used to figure the ordinary income because of additional depreciation depends on whether the real property you disposed of is nonresidential real property, residential rental property, or low-income housing. Taxhow 1040x The percentages for these types of real property are as follows. Taxhow 1040x Nonresidential real property. Taxhow 1040x   For real property that is not residential rental property, the applicable percentage for periods after 1969 is 100%. Taxhow 1040x For periods before 1970, the percentage is zero and no ordinary income because of additional depreciation before 1970 will result from its disposition. Taxhow 1040x Residential rental property. Taxhow 1040x   For residential rental property (80% or more of the gross income is from dwelling units) other than low-income housing, the applicable percentage for periods after 1975 is 100%. Taxhow 1040x The percentage for periods before 1976 is zero. Taxhow 1040x Therefore, no ordinary income because of additional depreciation before 1976 will result from a disposition of residential rental property. Taxhow 1040x Low-income housing. Taxhow 1040x    Low-income housing includes all the following types of residential rental property. Taxhow 1040x Federally assisted housing projects if the mortgage is insured under section 221(d)(3) or 236 of the National Housing Act or housing financed or assisted by direct loan or tax abatement under similar provisions of state or local laws. Taxhow 1040x Low-income rental housing for which a depreciation deduction for rehabilitation expenses was allowed. Taxhow 1040x Low-income rental housing held for occupancy by families or individuals eligible to receive subsidies under section 8 of the United States Housing Act of 1937, as amended, or under provisions of state or local laws that authorize similar subsidies for low-income families. Taxhow 1040x Housing financed or assisted by direct loan or insured under Title V of the Housing Act of 1949. Taxhow 1040x   The applicable percentage for low-income housing is 100% minus 1% for each full month the property was held over 100 full months. Taxhow 1040x If you have held low-income housing at least 16 years and 8 months, the percentage is zero and no ordinary income will result from its disposition. Taxhow 1040x Foreclosure. Taxhow 1040x   If low-income housing is disposed of because of foreclosure or similar proceedings, the monthly applicable percentage reduction is figured as if you disposed of the property on the starting date of the proceedings. Taxhow 1040x Example. Taxhow 1040x On June 1, 2001, you acquired low-income housing property. Taxhow 1040x On April 3, 2012 (130 months after the property was acquired), foreclosure proceedings were started on the property and on December 3, 2013 (150 months after the property was acquired), the property was disposed of as a result of the foreclosure proceedings. Taxhow 1040x The property qualifies for a reduced applicable percentage because it was held more than 100 full months. Taxhow 1040x The applicable percentage reduction is 30% (130 months minus 100 months) rather than 50% (150 months minus 100 months) because it does not apply after April 3, 2012, the starting date of the foreclosure proceedings. Taxhow 1040x Therefore, 70% of the additional depreciation is treated as ordinary income. Taxhow 1040x Holding period. Taxhow 1040x   The holding period used to figure the applicable percentage for low-income housing generally starts on the day after you acquired it. Taxhow 1040x For example, if you bought low-income housing on January 1, 1997, the holding period starts on January 2, 1997. Taxhow 1040x If you sold it on January 2, 2013, the holding period is exactly 192 full months. Taxhow 1040x The applicable percentage for additional depreciation is 8%, or 100% minus 1% for each full month the property was held over 100 full months. Taxhow 1040x Holding period for constructed, reconstructed, or erected property. Taxhow 1040x   The holding period used to figure the applicable percentage for low-income housing you constructed, reconstructed, or erected starts on the first day of the month it is placed in service in a trade or business, in an activity for the production of income, or in a personal activity. Taxhow 1040x Property acquired by gift or received in a tax-free transfer. Taxhow 1040x   For low-income housing you acquired by gift or in a tax-free transfer the basis of which is figured by reference to the basis in the hands of the transferor, the holding period for the applicable percentage includes the holding period of the transferor. Taxhow 1040x   If the adjusted basis of the property in your hands just after acquiring it is more than its adjusted basis to the transferor just before transferring it, the holding period of the difference is figured as if it were a separate improvement. Taxhow 1040x See Low-Income Housing With Two or More Elements, next. Taxhow 1040x Low-Income Housing With Two or More Elements If you dispose of low-income housing property that has two or more separate elements, the applicable percentage used to figure ordinary income because of additional depreciation may be different for each element. Taxhow 1040x The gain to be reported as ordinary income is the sum of the ordinary income figured for each element. Taxhow 1040x The following are the types of separate elements. Taxhow 1040x A separate improvement (defined below). Taxhow 1040x The basic section 1250 property plus improvements not qualifying as separate improvements. Taxhow 1040x The units placed in service at different times before all the section 1250 property is finished. Taxhow 1040x For example, this happens when a taxpayer builds an apartment building of 100 units and places 30 units in service (available for renting) on January 4, 2011, 50 on July 18, 2011, and the remaining 20 on January 18, 2012. Taxhow 1040x As a result, the apartment house consists of three separate elements. Taxhow 1040x The 36-month test for separate improvements. Taxhow 1040x   A separate improvement is any improvement (qualifying under The 1-year test, below) added to the capital account of the property, but only if the total of the improvements during the 36-month period ending on the last day of any tax year is more than the greatest of the following amounts. Taxhow 1040x Twenty-five percent of the adjusted basis of the property at the start of the first day of the 36-month period, or the first day of the holding period of the property, whichever is later. Taxhow 1040x Ten percent of the unadjusted basis (adjusted basis plus depreciation and amortization adjustments) of the property at the start of the period determined in (1). Taxhow 1040x $5,000. Taxhow 1040x The 1-year test. Taxhow 1040x   An addition to the capital account for any tax year (including a short tax year) is treated as an improvement only if the sum of all additions for the year is more than the greater of $2,000 or 1% of the unadjusted basis of the property. Taxhow 1040x The unadjusted basis is figured as of the start of that tax year or the holding period of the property, whichever is later. Taxhow 1040x In applying the 36-month test, improvements in any one of the 3 years are omitted entirely if the total improvements in that year do not qualify under the 1-year test. Taxhow 1040x Example. Taxhow 1040x The unadjusted basis of a calendar year taxpayer's property was $300,000 on January 1 of this year. Taxhow 1040x During the year, the taxpayer made improvements A, B, and C, which cost $1,000, $600, and $700, respectively. Taxhow 1040x The sum of the improvements, $2,300, is less than 1% of the unadjusted basis ($3,000), so the improvements do not satisfy the 1-year test and are not treated as improvements for the 36-month test. Taxhow 1040x However, if improvement C had cost $1,500, the sum of these improvements would have been $3,100. Taxhow 1040x Then, it would be necessary to apply the 36-month test to figure if the improvements must be treated as separate improvements. Taxhow 1040x Addition to the capital account. Taxhow 1040x   Any addition to the capital account made after the initial acquisition or completion of the property by you or any person who held the property during a period included in your holding period is to be considered when figuring the total amount of separate improvements. Taxhow 1040x   The addition to the capital account of depreciable real property is the gross addition not reduced by amounts attributable to replaced property. Taxhow 1040x For example, if a roof with an adjusted basis of $20,000 is replaced by a new roof costing $50,000, the improvement is the gross addition to the account, $50,000, and not the net addition of $30,000. Taxhow 1040x The $20,000 adjusted basis of the old roof is no longer reflected in the basis of the property. Taxhow 1040x The status of an addition to the capital account is not affected by whether it is treated as a separate property for determining depreciation deductions. Taxhow 1040x   Whether an expense is treated as an addition to the capital account may depend on the final disposition of the entire property. Taxhow 1040x If the expense item property and the basic property are sold in two separate transactions, the entire section 1250 property is treated as consisting of two distinct properties. Taxhow 1040x Unadjusted basis. Taxhow 1040x   In figuring the unadjusted basis as of a certain date, include the actual cost of all previous additions to the capital account plus those that did not qualify as separate improvements. Taxhow 1040x However, the cost of components retired before that date is not included in the unadjusted basis. Taxhow 1040x Holding period. Taxhow 1040x   Use the following guidelines for figuring the applicable percentage for property with two or more elements. Taxhow 1040x The holding period of a separate element placed in service before the entire section 1250 property is finished starts on the first day of the month that the separate element is placed in service. Taxhow 1040x The holding period for each separate improvement qualifying as a separate element starts on the day after the improvement is acquired or, for improvements constructed, reconstructed, or erected, the first day of the month that the improvement is placed in service. Taxhow 1040x The holding period for each improvement not qualifying as a separate element takes the holding period of the basic property. Taxhow 1040x   If an improvement by itself does not meet the 1-year test (greater of $2,000 or 1% of the unadjusted basis), but it does qualify as a separate improvement that is a separate element (when grouped with other improvements made during the tax year), determine the start of its holding period as follows. Taxhow 1040x Use the first day of a calendar month that is closest to the middle of the tax year. Taxhow 1040x If there are two first days of a month that are equally close to the middle of the year, use the earlier date. Taxhow 1040x Figuring ordinary income attributable to each separate element. Taxhow 1040x   Figure ordinary income attributable to each separate element as follows. Taxhow 1040x   Step 1. Taxhow 1040x Divide the element's additional depreciation after 1975 by the sum of all the elements' additional depreciation after 1975 to determine the percentage used in Step 2. Taxhow 1040x   Step 2. Taxhow 1040x Multiply the percentage figured in Step 1 by the lesser of the additional depreciation after 1975 for the entire property or the gain from disposition of the entire property (the difference between the fair market value or amount realized and the adjusted basis). Taxhow 1040x   Step 3. Taxhow 1040x Multiply the result in Step 2 by the applicable percentage for the element. Taxhow 1040x Example. Taxhow 1040x You sold at a gain of $25,000 low-income housing property subject to the ordinary income rules of section 1250. Taxhow 1040x The property consisted of four elements (W, X, Y, and Z). Taxhow 1040x Step 1. Taxhow 1040x The additional depreciation for each element is: W-$12,000; X-None; Y-$6,000; and Z-$6,000. Taxhow 1040x The sum of the additional depreciation for all the elements is $24,000. Taxhow 1040x Step 2. Taxhow 1040x The depreciation deducted on element X was $4,000 less than it would have been under the straight line method. Taxhow 1040x Additional depreciation on the property as a whole is $20,000 ($24,000 − $4,000). Taxhow 1040x $20,000 is lower than the $25,000 gain on the sale, so $20,000 is used in Step 2. Taxhow 1040x Step 3. Taxhow 1040x The applicable percentages to be used in Step 3 for the elements are: W-68%; X-85%; Y-92%; and Z-100%. Taxhow 1040x From these facts, the sum of the ordinary income for each element is figured as follows. Taxhow 1040x   Step 1 Step 2 Step 3 Ordinary Income W . Taxhow 1040x 50 $10,000 68% $ 6,800 X -0- -0- 85% -0- Y . Taxhow 1040x 25 5,000 92% 4,600 Z . Taxhow 1040x 25 5,000 100% 5,000 Sum of ordinary income of separate elements $16,400 Gain Treated as Ordinary Income To find what part of the gain from the disposition of section 1250 property is treated as ordinary income, follow these steps. Taxhow 1040x In a sale, exchange, or involuntary conversion of the property, figure the amount realized that is more than the adjusted basis of the property. Taxhow 1040x In any other disposition of the property, figure the fair market value that is more than the adjusted basis. Taxhow 1040x Figure the additional depreciation for the periods after 1975. Taxhow 1040x Multiply the lesser of (1) or (2) by the applicable percentage, discussed earlier under Applicable Percentage. Taxhow 1040x Stop here if this is residential rental property or if (2) is equal to or more than (1). Taxhow 1040x This is the gain treated as ordinary income because of additional depreciation. Taxhow 1040x Subtract (2) from (1). Taxhow 1040x Figure the additional depreciation for periods after 1969 but before 1976. Taxhow 1040x Add the lesser of (4) or (5) to the result in (3). Taxhow 1040x This is the gain treated as ordinary income because of additional depreciation. Taxhow 1040x A limit on the amount treated as ordinary income for gain on like-kind exchanges and involuntary conversions is explained later. Taxhow 1040x Use Form 4797, Part III, to figure the ordinary income part of the gain. Taxhow 1040x Corporations. Taxhow 1040x   Corporations, other than S corporations, must recognize an additional amount as ordinary income on the sale or other disposition of section 1250 property. Taxhow 1040x The additional amount treated as ordinary income is 20% of the excess of the amount that would have been ordinary income if the property were section 1245 property over the amount treated as ordinary income under section 1250. Taxhow 1040x Report this additional ordinary income on Form 4797, Part III, line 26 (f). Taxhow 1040x Installment Sales If you report the sale of property under the installment method, any depreciation recapture under section 1245 or 1250 is taxable as ordinary income in the year of sale. Taxhow 1040x This applies even if no payments are received in that year. Taxhow 1040x If the gain is more than the depreciation recapture income, report the rest of the gain using the rules of the installment method. Taxhow 1040x For this purpose, include the recapture income in your installment sale basis to determine your gross profit on the installment sale. Taxhow 1040x If you dispose of more than one asset in a single transaction, you must figure the gain on each asset separately so that it may be properly reported. Taxhow 1040x To do this, allocate the selling price and the payments you receive in the year of sale to each asset. Taxhow 1040x Report any depreciation recapture income in the year of sale before using the installment method for any remaining gain. Taxhow 1040x For a detailed discussion of installment sales, see Publication 537. Taxhow 1040x Gifts If you make a gift of depreciable personal property or real property, you do not have to report income on the transaction. Taxhow 1040x However, if the person who receives it (donee) sells or otherwise disposes of the property in a disposition subject to recapture, the donee must take into account the depreciation you deducted in figuring the gain to be reported as ordinary income. Taxhow 1040x For low-income housing, the donee must take into account the donor's holding period to figure the applicable percentage. Taxhow 1040x See Applicable Percentage and its discussion Holding period under Section 1250 Property, earlier. Taxhow 1040x Part gift and part sale or exchange. Taxhow 1040x   If you transfer depreciable personal property or real property for less than its fair market value in a transaction considered to be partly a gift and partly a sale or exchange and you have a gain because the amount realized is more than your adjusted basis, you must report ordinary income (up to the amount of gain) to recapture depreciation. Taxhow 1040x If the depreciation (additional depreciation, if section 1250 property) is more than the gain, the balance is carried over to the transferee to be taken into account on any later disposition of the property. Taxhow 1040x However, see Bargain sale to charity, later. Taxhow 1040x Example. Taxhow 1040x You transferred depreciable personal property to your son for $20,000. Taxhow 1040x When transferred, the property had an adjusted basis to you of $10,000 and a fair market value of $40,000. Taxhow 1040x You took depreciation of $30,000. Taxhow 1040x You are considered to have made a gift of $20,000, the difference between the $40,000 fair market value and the $20,000 sale price to your son. Taxhow 1040x You have a taxable gain on the transfer of $10,000 ($20,000 sale price minus $10,000 adjusted basis) that must be reported as ordinary income from depreciation. Taxhow 1040x You report $10,000 of your $30,000 depreciation as ordinary income on the transfer of the property, so the remaining $20,000 depreciation is carried over to your son for him to take into account on any later disposition of the property. Taxhow 1040x Gift to charitable organization. Taxhow 1040x   If you give property to a charitable organization, you figure your deduction for your charitable contribution by reducing the fair market value of the property by the ordinary income and short-term capital gain that would have resulted had you sold the property at its fair market value at the time of the contribution. Taxhow 1040x Thus, your deduction for depreciable real or personal property given to a charitable organization does not include the potential ordinary gain from depreciation. Taxhow 1040x   You also may have to reduce the fair market value of the contributed property by the long-term capital gain (including any section 1231 gain) that would have resulted had the property been sold. Taxhow 1040x For more information, see Giving Property That Has Increased in Value in Publication 526. Taxhow 1040x Bargain sale to charity. Taxhow 1040x   If you transfer section 1245 or section 1250 property to a charitable organization for less than its fair market value and a deduction for the contribution part of the transfer is allowable, your ordinary income from depreciation is figured under different rules. Taxhow 1040x First, figure the ordinary income as if you had sold the property at its fair market value. Taxhow 1040x Then, allocate that amount between the sale and the contribution parts of the transfer in the same proportion that you allocated your adjusted basis in the property to figure your gain. Taxhow 1040x See Bargain Sale under Gain or Loss From Sales and Exchanges in chapter 1. Taxhow 1040x Report as ordinary income the lesser of the ordinary income allocated to the sale or your gain from the sale. Taxhow 1040x Example. Taxhow 1040x You sold section 1245 property in a bargain sale to a charitable organization and are allowed a deduction for your contribution. Taxhow 1040x Your gain on the sale was $1,200, figured by allocating 20% of your adjusted basis in the property to the part sold. Taxhow 1040x If you had sold the property at its fair market value, your ordinary income would have been $5,000. Taxhow 1040x Your ordinary income is $1,000 ($5,000 × 20%) and your section 1231 gain is $200 ($1,200 – $1,000). Taxhow 1040x Transfers at Death When a taxpayer dies, no gain is reported on depreciable personal property or real property transferred to his or her estate or beneficiary. Taxhow 1040x For information on the tax liability of a decedent, see Publication 559, Survivors, Executors, and Administrators. Taxhow 1040x However, if the decedent disposed of the property while alive and, because of his or her method of accounting or for any other reason, the gain from the disposition is reportable by the estate or beneficiary, it must be reported in the same way the decedent would have had to report it if he or she were still alive. Taxhow 1040x Ordinary income due to depreciation must be reported on a transfer from an executor, administrator, or trustee to an heir, beneficiary, or other individual if the transfer is a sale or exchange on which gain is realized. Taxhow 1040x Example 1. Taxhow 1040x Janet Smith owned depreciable property that, upon her death, was inherited by her son. Taxhow 1040x No ordinary income from depreciation is reportable on the transfer, even though the value used for estate tax purposes is more than the adjusted basis of the property to Janet when she died. Taxhow 1040x However, if she sold the property before her death and realized a gain and if, because of her method of accounting, the proceeds from the sale are income in respect of a decedent reportable by her son, he must report ordinary income from depreciation. Taxhow 1040x Example 2. Taxhow 1040x The trustee of a trust created by a will transfers depreciable property to a beneficiary in satisfaction of a specific bequest of $10,000. Taxhow 1040x If the property had a value of $9,000 at the date used for estate tax valuation purposes, the $1,000 increase in value to the date of distribution is a gain realized by the trust. Taxhow 1040x Ordinary income from depreciation must be reported by the trust on the transfer. Taxhow 1040x Like-Kind Exchanges and Involuntary Conversions A like-kind exchange of your depreciable property or an involuntary conversion of the property into similar or related property will not result in your having to report ordinary income from depreciation unless money or property other than like-kind, similar, or related property is also received in the transaction. Taxhow 1040x For information on like-kind exchanges and involuntary conversions, see chapter 1. Taxhow 1040x Depreciable personal property. Taxhow 1040x   If you have a gain from either a like-kind exchange or an involuntary conversion of your depreciable personal property, the amount to be reported as ordinary income from depreciation is the amount figured under the rules explained earlier (see Section 1245 Property), limited to the sum of the following amounts. Taxhow 1040x The gain that must be included in income under the rules for like-kind exchanges or involuntary conversions. Taxhow 1040x The fair market value of the like-kind, similar, or related property other than depreciable personal property acquired in the transaction. Taxhow 1040x Example 1. Taxhow 1040x You bought a new machine for $4,300 cash plus your old machine for which you were allowed a $1,360 trade-in. Taxhow 1040x The old machine cost you $5,000 two years ago. Taxhow 1040x You took depreciation deductions of $3,950. Taxhow 1040x Even though you deducted depreciation of $3,950, the $310 gain ($1,360 trade-in allowance minus $1,050 adjusted basis) is not reported because it is postponed under the rules for like-kind exchanges and you received only depreciable personal property in the exchange. Taxhow 1040x Example 2. Taxhow 1040x You bought office machinery for $1,500 two years ago and deducted $780 depreciation. Taxhow 1040x This year a fire destroyed the machinery and you received $1,200 from your fire insurance, realizing a gain of $480 ($1,200 − $720 adjusted basis). Taxhow 1040x You choose to postpone reporting gain, but replacement machinery cost you only $1,000. Taxhow 1040x Your taxable gain under the rules for involuntary conversions is limited to the remaining $200 insurance payment. Taxhow 1040x All your replacement property is depreciable personal property, so your ordinary income from depreciation is limited to $200. Taxhow 1040x Example 3. Taxhow 1040x A fire destroyed office machinery you bought for $116,000. Taxhow 1040x The depreciation deductions were $91,640 and the machinery had an adjusted basis of $24,360. Taxhow 1040x You received a $117,000 insurance payment, realizing a gain of $92,640. Taxhow 1040x You immediately spent $105,000 of the insurance payment for replacement machinery and $9,000 for stock that qualifies as replacement property and you choose to postpone reporting the gain. Taxhow 1040x $114,000 of the $117,000 insurance payment was used to buy replacement property, so the gain that must be included in income under the rules for involuntary conversions is the part not spent, or $3,000. Taxhow 1040x The part of the insurance payment ($9,000) used to buy the nondepreciable property (the stock) also must be included in figuring the gain from depreciation. Taxhow 1040x The amount you must report as ordinary income on the transaction is $12,000, figured as follows. Taxhow 1040x 1) Gain realized on the transaction ($92,640) limited to depreciation ($91,640) $91,640 2) Gain includible in income (amount not spent) 3,000     Plus: fair market value of property other than depreciable personal property (the stock) 9,000 12,000 Amount reportable as ordinary income (lesser of (1) or (2)) $12,000   If, instead of buying $9,000 in stock, you bought $9,000 worth of depreciable personal property similar or related in use to the destroyed property, you would only report $3,000 as ordinary income. Taxhow 1040x Depreciable real property. Taxhow 1040x   If you have a gain from either a like-kind exchange or involuntary conversion of your depreciable real property, ordinary income from additional depreciation is figured under the rules explained earlier (see Section 1250 Property), limited to the greater of the following amounts. Taxhow 1040x The gain that must be reported under the rules for like-kind exchanges or involuntary conversions plus the fair market value of stock bought as replacement property in acquiring control of a corporation. Taxhow 1040x The gain you would have had to report as ordinary income from additional depreciation had the transaction been a cash sale minus the cost (or fair market value in an exchange) of the depreciable real property acquired. Taxhow 1040x   The ordinary income not reported for the year of the disposition is carried over to the depreciable real property acquired in the like-kind exchange or involuntary conversion as additional depreciation from the property disposed of. Taxhow 1040x Further, to figure the applicable percentage of additional depreciation to be treated as ordinary income, the holding period starts over for the new property. Taxhow 1040x Example. Taxhow 1040x The state paid you $116,000 when it condemned your depreciable real property for public use. Taxhow 1040x You bought other real property similar in use to the property condemned for $110,000 ($15,000 for depreciable real property and $95,000 for land). Taxhow 1040x You also bought stock for $5,000 to get control of a corporation owning property similar in use to the property condemned. Taxhow 1040x You choose to postpone reporting the gain. Taxhow 1040x If the transaction had been a sale for cash only, under the rules described earlier, $20,000 would have been reportable as ordinary income because of additional depreciation. Taxhow 1040x The ordinary income to be reported is $6,000, which is the greater of the following amounts. Taxhow 1040x The gain that must be reported under the rules for involuntary conversions, $1,000 ($116,000 − $115,000) plus the fair market value of stock bought as qualified replacement property, $5,000, for a total of $6,000. Taxhow 1040x The gain you would have had to report as ordinary income from additional depreciation ($20,000) had this transaction been a cash sale minus the cost of the depreciable real property bought ($15,000), or $5,000. Taxhow 1040x   The ordinary income not reported, $14,000 ($20,000 − $6,000), is carried over to the depreciable real property you bought as additional depreciation. Taxhow 1040x Basis of property acquired. Taxhow 1040x   If the ordinary income you have to report because of additional depreciation is limited, the total basis of the property you acquired is its fair market value (its cost, if bought to replace property involuntarily converted into money) minus the gain postponed. Taxhow 1040x   If you acquired more than one item of property, allocate the total basis among the properties in proportion to their fair market value (their cost, in an involuntary conversion into money). Taxhow 1040x However, if you acquired both depreciable real property and other property, allocate the total basis as follows. Taxhow 1040x Subtract the ordinary income because of additional depreciation that you do not have to report from the fair market value (or cost) of the depreciable real property acquired. Taxhow 1040x Add the fair market value (or cost) of the other property acquired to the result in (1). Taxhow 1040x Divide the result in (1) by the result in (2). Taxhow 1040x Multiply the total basis by the result in (3). Taxhow 1040x This is the basis of the depreciable real property acquired. Taxhow 1040x If you acquired more than one item of depreciable real property, allocate this basis amount among the properties in proportion to their fair market value (or cost). Taxhow 1040x Subtract the result in (4) from the total basis. Taxhow 1040x This is the basis of the other property acquired. Taxhow 1040x If you acquired more than one item of other property, allocate this basis amount among the properties in proportion to their fair market value (or cost). Taxhow 1040x Example 1. Taxhow 1040x In 1988, low-income housing property that you acquired and placed in service in 1983 was destroyed by fire and you received a $90,000 insurance payment. Taxhow 1040x The property's adjusted basis was $38,400, with additional depreciation of $14,932. Taxhow 1040x On December 1, 1988, you used the insurance payment to acquire and place in service replacement low-income housing property. Taxhow 1040x Your realized gain from the involuntary conversion was $51,600 ($90,000 − $38,400). Taxhow 1040x You chose to postpone reporting the gain under the involuntary conversion rules. Taxhow 1040x Under the rules for depreciation recapture on real property, the ordinary gain was $14,932, but you did not have to report any of it because of the limit for involuntary conversions. Taxhow 1040x The basis of the replacement low-income housing property was its $90,000 cost minus the $51,600 gain you postponed, or $38,400. Taxhow 1040x The $14,932 ordinary gain you did not report is treated as additional depreciation on the replacement property. Taxhow 1040x If you sold the property in 2013, your holding period for figuring the applicable percentage of additional depreciation to report as ordinary income will have begun December 2, 1988, the day after you acquired the property. Taxhow 1040x Example 2. Taxhow 1040x John Adams received a $90,000 fire insurance payment for depreciable real property (office building) with an adjusted basis of $30,000. Taxhow 1040x He uses the whole payment to buy property similar in use, spending $42,000 for depreciable real property and $48,000 for land. Taxhow 1040x He chooses to postpone reporting the $60,000 gain realized on the involuntary conversion. Taxhow 1040x Of this gain, $10,000 is ordinary income from additional depreciation but is not reported because of the limit for involuntary conversions of depreciable real property. Taxhow 1040x The basis of the property bought is $30,000 ($90,000 − $60,000), allocated as follows. Taxhow 1040x The $42,000 cost of depreciable real property minus $10,000 ordinary income not reported is $32,000. Taxhow 1040x The $48,000 cost of other property (land) plus the $32,000 figured in (1) is $80,000. Taxhow 1040x The $32,000 figured in (1) divided by the $80,000 figured in (2) is 0. Taxhow 1040x 4. Taxhow 1040x The basis of the depreciable real property is $12,000. Taxhow 1040x This is the $30,000 total basis multiplied by the 0. Taxhow 1040x 4 figured in (3). Taxhow 1040x The basis of the other property (land) is $18,000. Taxhow 1040x This is the $30,000 total basis minus the $12,000 figured in (4). Taxhow 1040x The ordinary income that is not reported ($10,000) is carried over as additional depreciation to the depreciable real property that was bought and may be taxed as ordinary income on a later disposition. Taxhow 1040x Multiple Properties If you dispose of depreciable property and other property in one transaction and realize a gain, you must allocate the amount realized between the two types of property in proportion to their respective fair market values to figure the part of your gain to be reported as ordinary income from depreciation. Taxhow 1040x Different rules may apply to the allocation of the amount realized on the sale of a business that includes a group of assets. Taxhow 1040x See chapter 2. Taxhow 1040x In general, if a buyer and seller have adverse interests as to the allocation of the amount realized between the depreciable property and other property, any arm's length agreement between them will establish the allocation. Taxhow 1040x In the absence of an agreement, the allocation should be made by taking into account the appropriate facts and circumstances. Taxhow 1040x These include, but are not limited to, a comparison between the depreciable property and all the other property being disposed of in the transaction. Taxhow 1040x The comparison should take into account all the following facts and circumstances. Taxhow 1040x The original cost and reproduction cost of construction, erection, or production. Taxhow 1040x The remaining economic useful life. Taxhow 1040x The state of obsolescence. Taxhow 1040x The anticipated expenditures required to maintain, renovate, or modernize the properties. Taxhow 1040x Like-kind exchanges and involuntary conversions. Taxhow 1040x   If you dispose of and acquire depreciable personal property and other property (other than depreciable real property) in a like-kind exchange or involuntary conversion, the amount realized is allocated in the following way. Taxhow 1040x The amount allocated to the depreciable personal property disposed of is treated as consisting of, first, the fair market value of the depreciable personal property acquired and, second (to the extent of any remaining balance), the fair market value of the other property acquired. Taxhow 1040x The amount allocated to the other property disposed of is treated as consisting of the fair market value of all property acquired that has not already been taken into account. Taxhow 1040x   If you dispose of and acquire depreciable real property and other property in a like-kind exchange or involuntary conversion, the amount realized is allocated in the following way. Taxhow 1040x The amount allocated to each of the three types of property (depreciable real property, depreciable personal property, or other property) disposed of is treated as consisting of, first, the fair market value of that type of property acquired and, second (to the extent of any remaining balance), any excess fair market value of the other types of property acquired. Taxhow 1040x If the excess fair market value is more than the remaining balance of the amount realized and is from both of the other two types of property, you can apply the unallocated amount in any manner you choose. Taxhow 1040x Example. Taxhow 1040x A fire destroyed your property with a total fair market value of $50,000. Taxhow 1040x It consisted of machinery worth $30,000 and nondepreciable property worth $20,000. Taxhow 1040x You received an insurance payment of $40,000 and immediately used it with $10,000 of your own funds (for a total of $50,000) to buy machinery with a fair market value of $15,000 and nondepreciable property with a fair market value of $35,000. Taxhow 1040x The adjusted basis of the destroyed machinery was $5,000 and your depreciation on it was $35,000. Taxhow 1040x You choose to postpone reporting your gain from the involuntary conversion. Taxhow 1040x You must report $9,000 as ordinary income from depreciation arising from this transaction, figured as follows. Taxhow 1040x The $40,000 insurance payment must be allocated between the machinery and the other property destroyed in proportion to the fair market value of each. Taxhow 1040x The amount allocated to the machinery is 30,000/50,000 × $40,000, or $24,000. Taxhow 1040x The amount allocated to the other property is 20,000/50,000 × $40,000, or $16,000. Taxhow 1040x Your gain on the involuntary conversion of the machinery is $24,000 minus $5,000 adjusted basis, or $19,000. Taxhow 1040x The $24,000 allocated to the machinery disposed of is treated as consisting of the $15,000 fair market value of the replacement machinery bought and $9,000 of the fair market value of other property bought in the transaction. Taxhow 1040x All $16,000 allocated to the other property disposed of is treated as consisting of the fair market value of the other property that was bought. Taxhow 1040x Your potential ordinary income from depreciation is $19,000, the gain on the machinery, because it is less than the $35,000 depreciation. Taxhow 1040x However, the amount you must report as ordinary income is limited to the $9,000 included in the amount realized for the machinery that represents the fair market value of property other than the depreciable property you bought. Taxhow 1040x Prev  Up  Next   Home   More Online Publications
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The Taxhow 1040x

Taxhow 1040x 2. Taxhow 1040x   Taxable and Nontaxable Income Table of Contents Compensation for Services Retirement Plan DistributionsIndividual Retirement Arrangements (IRAs) Pensions and Annuities Social Security and Equivalent Railroad Retirement BenefitsAre Any of Your Benefits Taxable? How Much Is Taxable? How To Report Your Benefits Lump-Sum Election Repayments More Than Gross Benefits Sickness and Injury BenefitsDisability Pensions Long-Term Care Insurance Contracts Workers' Compensation Other Sickness and Injury Benefits Life Insurance ProceedsInstallments for life. Taxhow 1040x Surviving spouse. Taxhow 1040x Endowment Contract Proceeds Accelerated Death Benefits Sale of HomeMaximum Amount of Exclusion Ownership and Use Tests Married Persons Business Use or Rental of Home Reporting the Sale Reverse Mortgages Other ItemsWelfare benefits. Taxhow 1040x Payments from a state fund for victims of crime. Taxhow 1040x Home Affordable Modification Program (HAMP). Taxhow 1040x Mortgage assistance payments. Taxhow 1040x Payments to reduce cost of winter energy use. Taxhow 1040x Nutrition Program for the Elderly. Taxhow 1040x Reemployment Trade Adjustment Assistance (RTAA). Taxhow 1040x Generally, income is taxable unless it is specifically exempt (not taxed) by law. Taxhow 1040x Your taxable income may include compensation for services, interest, dividends, rents, royalties, income from partnerships, estate or trust income, gain from sales or exchanges of property, and business income of all kinds. Taxhow 1040x Under special provisions of the law, certain items are partially or fully exempt from tax. Taxhow 1040x Provisions that are of special interest to older taxpayers are discussed in this chapter. Taxhow 1040x Compensation for Services Generally, you must include in gross income everything you receive in payment for personal services. Taxhow 1040x In addition to wages, salaries, commissions, fees, and tips, this includes other forms of compensation such as fringe benefits and stock options. Taxhow 1040x You need not receive the compensation in cash for it to be taxable. Taxhow 1040x Payments you receive in the form of goods or services generally must be included in gross income at their fair market value. Taxhow 1040x Volunteer work. Taxhow 1040x   Do not include in your gross income amounts you receive for supportive services or reimbursements for out-of-pocket expenses under any of the following volunteer programs. Taxhow 1040x Retired Senior Volunteer Program (RSVP). Taxhow 1040x Foster Grandparent Program. Taxhow 1040x Senior Companion Program. Taxhow 1040x Service Corps of Retired Executives (SCORE). Taxhow 1040x Unemployment compensation. Taxhow 1040x   You must include in income all unemployment compensation you or your spouse (if married filing jointly) received. Taxhow 1040x More information. Taxhow 1040x   See Publication 525, Taxable and Nontaxable Income, for more detailed information on specific types of income. Taxhow 1040x Retirement Plan Distributions This section summarizes the tax treatment of amounts you receive from traditional individual retirement arrangements (IRA), employee pensions or annuities, and disability pensions or annuities. Taxhow 1040x A traditional IRA is any IRA that is not a Roth or SIMPLE IRA. Taxhow 1040x A Roth IRA is an individual retirement plan that can be either an account or an annuity and features nondeductible contributions and tax-free distributions. Taxhow 1040x A SIMPLE IRA is a tax-favored retirement plan that certain small employers (including self-employed individuals) can set up for the benefit of their employees. Taxhow 1040x More detailed information can be found in Publication 590, Individual Retirement Arrangements (IRAs), and Publication 575, Pension and Annuity Income. Taxhow 1040x Individual Retirement Arrangements (IRAs) In general, distributions from a traditional IRA are taxable in the year you receive them. Taxhow 1040x Exceptions to the general rule are rollovers, tax-free withdrawals of contributions, and the return of nondeductible contributions. Taxhow 1040x These are discussed in Publication 590. Taxhow 1040x If you made nondeductible contributions to a traditional IRA, you must file Form 8606, Nondeductible IRAs. Taxhow 1040x If you do not file Form 8606 with your return, you may have to pay a $50 penalty. Taxhow 1040x Also, when you receive distributions from your traditional IRA, the amounts will be taxed unless you can show, with satisfactory evidence, that nondeductible contributions were made. Taxhow 1040x Early distributions. Taxhow 1040x   Generally, early distributions are amounts distributed from your traditional IRA account or annuity before you are age 59½, or amounts you receive when you cash in retirement bonds before you are age  59½. Taxhow 1040x You must include early distributions of taxable amounts in your gross income. Taxhow 1040x These taxable amounts are also subject to an additional 10% tax unless the distribution qualifies for an exception. Taxhow 1040x For purposes of the additional 10% tax, an IRA is a qualified retirement plan. Taxhow 1040x For more information about this tax, see Tax on Early Distributions under Pensions and Annuities, later. Taxhow 1040x After age 59½ and before age 70½. Taxhow 1040x   After you reach age 59½, you can receive distributions from your traditional IRA without having to pay the 10% additional tax. Taxhow 1040x Even though you can receive distributions after you reach age 59½, distributions are not required until you reach  age 70½. Taxhow 1040x Required distributions. Taxhow 1040x   If you are the owner of a traditional IRA, you generally must receive the entire balance in your IRA or start receiving periodic distributions from your IRA by April 1 of the year following the year in which you reach age 70½. Taxhow 1040x See When Must You Withdraw Assets? (Required Minimum Distributions) in Publication 590. Taxhow 1040x If distributions from your traditional IRA(s) are less than the required minimum distribution for the year, you may have to pay a 50% excise tax for that year on the amount not distributed as required. Taxhow 1040x For purposes of the 50% excise tax, an IRA is a qualified retirement plan. Taxhow 1040x For more information about this tax, see Tax on Excess Accumulation under Pensions and Annuities, later. Taxhow 1040x See also Excess Accumulations (Insufficient Distributions) in Publication 590. Taxhow 1040x Pensions and Annuities Generally, if you did not pay any part of the cost of your employee pension or annuity, and your employer did not withhold part of the cost of the contract from your pay while you worked, the amounts you receive each year are fully taxable. Taxhow 1040x However, see Insurance Premiums for Retired Public Safety Officers , later. Taxhow 1040x If you paid part of the cost of your pension or annuity plan (see Cost , later), you can exclude part of each annuity payment from income as a recovery of your cost (investment in the contract). Taxhow 1040x This tax-free part of the payment is figured when your annuity starts and remains the same each year, even if the amount of the payment changes. Taxhow 1040x The rest of each payment is taxable. Taxhow 1040x However, see Insurance Premiums for Retired Public Safety Officers , later. Taxhow 1040x You figure the tax-free part of the payment using one of the following methods. Taxhow 1040x Simplified Method. Taxhow 1040x You generally must use this method if your annuity is paid under a qualified plan (a qualified employee plan, a qualified employee annuity, or a tax-sheltered annuity plan or contract). Taxhow 1040x You cannot use this method if your annuity is paid under a nonqualified plan. Taxhow 1040x General Rule. Taxhow 1040x You must use this method if your annuity is paid under a nonqualified plan. Taxhow 1040x You generally cannot use this method if your annuity is paid under a qualified plan. Taxhow 1040x Contact your employer or plan administrator to find out if your pension or annuity is paid under a qualified or nonqualified plan. Taxhow 1040x You determine which method to use when you first begin receiving your annuity, and you continue using it each year that you recover part of your cost. Taxhow 1040x Exclusion limit. Taxhow 1040x   If your annuity starting date is after 1986, the total amount of annuity income you can exclude over the years as a recovery of the cost cannot exceed your total cost. Taxhow 1040x Any unrecovered cost at your (or the last annuitant's) death is allowed as a miscellaneous itemized deduction on the final return of the decedent. Taxhow 1040x This deduction is not subject to the 2%-of-adjusted-gross-income limit on miscellaneous deductions. Taxhow 1040x   If you contributed to your pension or annuity and your annuity starting date is before 1987, you can continue to take your monthly exclusion for as long as you receive your annuity. Taxhow 1040x If you chose a joint and survivor annuity, your survivor can continue to take the survivor's exclusion figured as of the annuity starting date. Taxhow 1040x The total exclusion may be more than your cost. Taxhow 1040x Cost. Taxhow 1040x   Before you can figure how much, if any, of your pension or annuity benefits are taxable, you must determine your cost in the plan (your investment in the contract). Taxhow 1040x Your total cost in the plan includes everything that you paid. Taxhow 1040x It also includes amounts your employer contributed that were taxable to you when paid. Taxhow 1040x However, see Foreign employment contributions , later. Taxhow 1040x   From this total cost, subtract any refunded premiums, rebates, dividends, unrepaid loans, or other tax-free amounts you received by the later of the annuity starting date or the date on which you received your first payment. Taxhow 1040x   The annuity starting date is the later of the first day of the first period for which you received a payment from the plan or the date on which the plan's obligations became fixed. Taxhow 1040x    The amount of your contributions to the plan may be shown in box 9b of any Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. Taxhow 1040x , that you receive. Taxhow 1040x Foreign employment contributions. Taxhow 1040x   If you worked abroad, certain amounts your employer paid into your retirement plan that were not includible in your gross income may be considered part of your cost. Taxhow 1040x For details, see Foreign employment contributions in Publication 575. Taxhow 1040x Withholding. Taxhow 1040x   The payer of your pension, profit-sharing, stock bonus, annuity, or deferred compensation plan will withhold income tax on the taxable part of amounts paid to you. Taxhow 1040x However, you can choose not to have tax withheld on the payments you receive, unless they are eligible rollover distributions. Taxhow 1040x (These are distributions that are eligible for rollover treatment but are not paid directly to another qualified retirement plan or to a traditional IRA. Taxhow 1040x ) See Withholding Tax and Estimated Tax and Rollovers in Publication 575 for more information. Taxhow 1040x   For payments other than eligible rollover distributions, you can tell the payer how much to withhold by filing a Form W-4P, Withholding Certificate for Pension or Annuity Payments. Taxhow 1040x Simplified Method. Taxhow 1040x   Under the Simplified Method, you figure the tax-free part of each annuity payment by dividing your cost by the total number of anticipated monthly payments. Taxhow 1040x For an annuity that is payable over the lives of the annuitants, this number is based on the annuitants' ages on the annuity starting date and is determined from a table. Taxhow 1040x For any other annuity, this number is the number of monthly annuity payments under the contract. Taxhow 1040x Who must use the Simplified Method. Taxhow 1040x   You must use the Simplified Method if your annuity starting date is after November 18, 1996, and you receive your pension or annuity payments from a qualified plan or annuity, unless you were at least 75 years old and entitled to at least 5 years of guaranteed payments (defined next). Taxhow 1040x   In addition, if your annuity starting date is after July 1, 1986, and before November 19, 1996, you could have chosen to use the Simplified Method for payments from a qualified plan, unless you were at least 75 years old and entitled to at least 5 years of guaranteed payments. Taxhow 1040x If you chose to use the Simplified Method, you must continue to use it each year that you recover part of your cost. Taxhow 1040x Guaranteed payments. Taxhow 1040x   Your annuity contract provides guaranteed payments if a minimum number of payments or a minimum amount (for example, the amount of your investment) is payable even if you and any survivor annuitant do not live to receive the minimum. Taxhow 1040x If the minimum amount is less than the total amount of the payments you are to receive, barring death, during the first 5 years after payments begin (figured by ignoring any payment increases), you are entitled to less than 5 years of guaranteed payments. Taxhow 1040x Who cannot use the Simplified Method. Taxhow 1040x   You cannot use the Simplified Method and must use the General Rule if you receive pension or annuity payments from: A nonqualified plan, such as a private annuity, a purchased commercial annuity, or a nonqualified employee plan, or A qualified plan if you are age 75 or older on your annuity starting date and you are entitled to at least 5 years of guaranteed payments (defined above). Taxhow 1040x   In addition, you had to use the General Rule for either circumstance described above if your annuity starting date is after July 1, 1986, and before November 19, 1996. Taxhow 1040x If you did not have to use the General Rule, you could have chosen to use it. Taxhow 1040x You also had to use the General Rule for payments from a qualified plan if your annuity starting date is before July 2, 1986, and you did not qualify to use the Three-Year Rule. Taxhow 1040x   If you had to use the General Rule (or chose to use it), you must continue to use it each year that you recover your cost. Taxhow 1040x   Unless your annuity starting date was before 1987, once you have recovered all of your non-taxable investment, all of each remaining payment you receive is fully taxable. Taxhow 1040x Once your remaining payments are fully taxable, there is no longer a concern with the General Rule or Simplified Method. Taxhow 1040x   Complete information on the General Rule, including the actuarial tables you need, is contained in Publication 939, General Rule for Pensions and Annuities. Taxhow 1040x How to use the Simplified Method. Taxhow 1040x   Complete the Simplified Method Worksheet in the Form 1040, Form 1040A, or Form 1040NR instructions or in Publication 575 to figure your taxable annuity for 2013. Taxhow 1040x Be sure to keep the completed worksheet; it will help you figure your taxable annuity next year. Taxhow 1040x   To complete line 3 of the worksheet, you must determine the total number of expected monthly payments for your annuity. Taxhow 1040x How you do this depends on whether the annuity is for a single life, multiple lives, or a fixed period. Taxhow 1040x For this purpose, treat an annuity that is payable over the life of an annuitant as payable for that annuitant's life even if the annuity has a fixed-period feature or also provides a temporary annuity payable to the annuitant's child under age 25. Taxhow 1040x    You do not need to complete line 3 of the worksheet or make the computation on line 4 if you received annuity payments last year and used last year's worksheet to figure your taxable annuity. Taxhow 1040x Instead, enter the amount from line 4 of last year's worksheet on line 4 of this year's worksheet. Taxhow 1040x Single-life annuity. Taxhow 1040x   If your annuity is payable for your life alone, use Table 1 at the bottom of the worksheet to determine the total number of expected monthly payments. Taxhow 1040x Enter on line 3 the number shown for your age on your annuity starting date. Taxhow 1040x This number will differ depending on whether your annuity starting date is before November 19, 1996, or after November 18, 1996. Taxhow 1040x Multiple-lives annuity. Taxhow 1040x   If your annuity is payable for the lives of more than one annuitant, use Table 2 at the bottom of the worksheet to determine the total number of expected monthly payments. Taxhow 1040x Enter on line 3 the number shown for the annuitants' combined ages on the annuity starting date. Taxhow 1040x For an annuity payable to you as the primary annuitant and to more than one survivor annuitant, combine your age and the age of the youngest survivor annuitant. Taxhow 1040x For an annuity that has no primary annuitant and is payable to you and others as survivor annuitants, combine the ages of the oldest and youngest annuitants. Taxhow 1040x Do not treat as a survivor annuitant anyone whose entitlement to payments depends on an event other than the primary annuitant's death. Taxhow 1040x   However, if your annuity starting date is before 1998, do not use Table 2 and do not combine the annuitants' ages. Taxhow 1040x Instead, you must use Table 1 at the bottom of the worksheet and enter on line 3 the number shown for the primary annuitant's age on the annuity starting date. Taxhow 1040x This number will differ depending on whether your annuity starting date is before November 19, 1996, or after November 18, 1996. Taxhow 1040x Fixed-period annuities. Taxhow 1040x   If your annuity does not depend in whole or in part on anyone's life expectancy, the total number of expected monthly payments to enter on line 3 of the worksheet is the number of monthly annuity payments under the contract. Taxhow 1040x Line 6. Taxhow 1040x   The amount on line 6 should include all amounts that could have been recovered in prior years. Taxhow 1040x If you did not recover an amount in a prior year, you may be able to amend your returns for the affected years. Taxhow 1040x    Be sure to keep a copy of the completed worksheet; it will help you figure your taxable annuity in later years. Taxhow 1040x Example. Taxhow 1040x Bill Smith, age 65, began receiving retirement benefits in 2013, under a joint and survivor annuity. Taxhow 1040x Bill's annuity starting date is January 1, 2013. Taxhow 1040x The benefits are to be paid over the joint lives of Bill and his wife, Kathy, age 65. Taxhow 1040x Bill had contributed $31,000 to a qualified plan and had received no distributions before the annuity starting date. Taxhow 1040x Bill is to receive a retirement benefit of $1,200 a month, and Kathy is to receive a monthly survivor benefit of $600 upon Bill's death. Taxhow 1040x Bill must use the Simplified Method to figure his taxable annuity because his payments are from a qualified plan and he is under age 75. Taxhow 1040x See the illustrated Worksheet 2-A, Simplified Method Worksheet, later. Taxhow 1040x You can find a blank version of this worksheet in Publication 575. Taxhow 1040x (The references in the illustrated worksheet are to sections in Publication 575). Taxhow 1040x His annuity is payable over the lives of more than one annuitant, so Bill uses his and Kathy's combined ages, 130 (65 + 65), and Table 2 at the bottom of the worksheet in completing line 3 of the worksheet and finds the line 3 amount to be 310. Taxhow 1040x Bill's tax-free monthly amount is $100 ($31,000 ÷ 310 as shown on line 4 of the worksheet). Taxhow 1040x Upon Bill's death, if Bill has not recovered the full $31,000 investment, Kathy will also exclude $100 from her $600 monthly payment. Taxhow 1040x The full amount of any annuity payments received after 310 payments are paid must generally be included in gross income. Taxhow 1040x If Bill and Kathy die before 310 payments are made, a miscellaneous itemized deduction will be allowed for the unrecovered cost on the final income tax return of the last to die. Taxhow 1040x This deduction is not subject to the 2%-of-adjusted-gross-income limit. Taxhow 1040x Worksheet 2-A. Taxhow 1040x Simplified Method Worksheet—Illustrated 1. Taxhow 1040x Enter the total pension or annuity payments received this year. Taxhow 1040x Also, add this amount to the total for Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a 1. Taxhow 1040x $ 14,400 2. Taxhow 1040x Enter your cost in the plan (contract) at the annuity starting date plus any death benefit exclusion* See Cost (Investment in the Contract), earlier 2. Taxhow 1040x 31,000   Note. Taxhow 1040x If your annuity starting date was before this year and you completed this worksheet last year, skip line 3 and enter the amount from line 4 of last year's worksheet on line 4 below (even if the amount of your pension or annuity has changed). Taxhow 1040x Otherwise, go to line 3. Taxhow 1040x     3. Taxhow 1040x Enter the appropriate number from Table 1 below. Taxhow 1040x But if your annuity starting date was after 1997 and the payments are for your life and that of your beneficiary, enter the appropriate number from Table 2 below 3. Taxhow 1040x 310 4. Taxhow 1040x Divide line 2 by the number on line 3 4. Taxhow 1040x 100 5. Taxhow 1040x Multiply line 4 by the number of months for which this year's payments were made. Taxhow 1040x If your annuity starting date was before 1987, enter this amount on line 8 below and skip lines 6, 7, 10, and 11. Taxhow 1040x Otherwise, go to line 6 5. Taxhow 1040x 1,200 6. Taxhow 1040x Enter any amount previously recovered tax free in years after 1986. Taxhow 1040x This is the amount shown on line 10 of your worksheet for last year 6. Taxhow 1040x 0 7. Taxhow 1040x Subtract line 6 from line 2 7. Taxhow 1040x 31,000 8. Taxhow 1040x Enter the smaller of line 5 or line 7 8. Taxhow 1040x 1,200 9. Taxhow 1040x Taxable amount for year. Taxhow 1040x Subtract line 8 from line 1. Taxhow 1040x Enter the result, but not less than zero. Taxhow 1040x Also, add this amount to the total for Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. Taxhow 1040x Note. Taxhow 1040x If your Form 1099-R shows a larger taxable amount, use the amount figured on this line instead. Taxhow 1040x If you are a retired public safety officer, see Insurance Premiums for Retired Public Safety Officers, earlier, before entering an amount on your tax return. Taxhow 1040x 9. Taxhow 1040x $ 13,200 10. Taxhow 1040x Was your annuity starting date before 1987? □ Yes. Taxhow 1040x STOP. Taxhow 1040x Do not complete the rest of this worksheet. Taxhow 1040x  ☑ No. Taxhow 1040x Add lines 6 and 8. Taxhow 1040x This is the amount you have recovered tax free through 2013. Taxhow 1040x You will need this number if you need to fill out this worksheet next year. Taxhow 1040x 10. Taxhow 1040x 1,200 11. Taxhow 1040x Balance of cost to be recovered. Taxhow 1040x Subtract line 10 from line 2. Taxhow 1040x If zero, you will not have to complete this worksheet next year. Taxhow 1040x The payments you receive next year will generally be fully taxable 11. Taxhow 1040x $ 29,800 * A death benefit exclusion (up to $5,000) applied to certain benefits received by employees who died before August 21, 1996. Taxhow 1040x   Table 1 for Line 3 Above       AND your annuity starting date was—   IF your age on your annuity starting date was . Taxhow 1040x . Taxhow 1040x . Taxhow 1040x   BEFORE November 19, 1996, enter on line 3 . Taxhow 1040x . Taxhow 1040x . Taxhow 1040x AFTER November 18, 1996, enter on line 3 . Taxhow 1040x . Taxhow 1040x . Taxhow 1040x   55 or under 300 360   56-60 260 310   61-65 240 260   66-70 170 210   71 or over 120 160 Table 2 for Line 3 Above   IF the annuitants' combined ages on your annuity starting date were . Taxhow 1040x . Taxhow 1040x . Taxhow 1040x   THEN enter on line 3 . Taxhow 1040x . Taxhow 1040x . Taxhow 1040x         110 or under   410         111-120   360         121-130   310         131-140   260         141 or over   210       Survivors of retirees. Taxhow 1040x   Benefits paid to you as a survivor under a joint and survivor annuity must be included in your gross income in the same way the retiree would have included them in gross income. Taxhow 1040x   If you receive a survivor annuity because of the death of a retiree who had reported the annuity under the Three-Year Rule, include the total received in your income. Taxhow 1040x The retiree's cost has already been recovered tax free. Taxhow 1040x   If the retiree was reporting the annuity payments under the General Rule, you must apply the same exclusion percentage the retiree used to your initial payment called for in the contract. Taxhow 1040x The resulting tax-free amount will then remain fixed. Taxhow 1040x Any increases in the survivor annuity are fully taxable. Taxhow 1040x   If the retiree was reporting the annuity payments under the Simplified Method, the part of each payment that is tax free is the same as the tax-free amount figured by the retiree at the annuity starting date. Taxhow 1040x See Simplified Method , earlier. Taxhow 1040x How to report. Taxhow 1040x   If you file Form 1040, report your total annuity on line 16a, and the taxable part on line 16b. Taxhow 1040x If your pension or annuity is fully taxable, enter it on line 16b. Taxhow 1040x Do not make an entry on line 16a. Taxhow 1040x   If you file Form 1040A, report your total annuity on line 12a, and the taxable part on line 12b. Taxhow 1040x If your pension or annuity is fully taxable, enter it on line 12b. Taxhow 1040x Do not make an entry on line 12a. Taxhow 1040x   If you file Form 1040NR, report your total annuity on line 17a, and the taxable part on line 17b. Taxhow 1040x If your pension or annuity is fully taxable, enter it on line 17b. Taxhow 1040x Do not make an entry on line 17a. Taxhow 1040x Example. Taxhow 1040x You are a Form 1040 filer and you received monthly payments totaling $1,200 (12 months x $100) during 2013 from a pension plan that was completely financed by your employer. Taxhow 1040x You had paid no tax on the payments that your employer made to the plan, and the payments were not used to pay for accident, health, or long-term care insurance premiums (as discussed later under Insurance Premiums for Retired Public Safety Officers ). Taxhow 1040x The entire $1,200 is taxable. Taxhow 1040x You include $1,200 only on Form 1040, line 16b. Taxhow 1040x Joint return. Taxhow 1040x   If you file a joint return and you and your spouse each receive one or more pensions or annuities, report the total of the pensions and annuities on line 16a of Form 1040, line 12a of Form 1040A, or line 17a of Form 1040NR. Taxhow 1040x Report the total of the taxable parts on line 16b of Form 1040, line 12b of Form 1040A, or line 17b of Form 1040NR. Taxhow 1040x Form 1099-R. Taxhow 1040x   You should receive a Form 1099-R for your pension or annuity. Taxhow 1040x Form 1099-R shows your pension or annuity for the year and any income tax withheld. Taxhow 1040x You should receive a Form W-2 if you receive distributions from certain nonqualified plans. Taxhow 1040x You must attach Forms 1099-R or Forms W-2 to your 2013 tax return if federal income tax was withheld. Taxhow 1040x Generally, you should be sent these forms by January 31, 2014. Taxhow 1040x Nonperiodic Distributions If you receive a nonperiodic distribution from your retirement plan, you may be able to exclude all or part of it from your income as a recovery of your cost. Taxhow 1040x Nonperiodic distributions include cash withdrawals, distributions of current earnings (dividends) on your investment, and certain loans. Taxhow 1040x For information on how to figure the taxable amount of a nonperiodic distribution, see Taxation of Nonperiodic Payments in Publication 575. Taxhow 1040x The taxable part of a nonperiodic distribution may be subject to an additional 10% tax. Taxhow 1040x See Tax on Early Distributions, later. Taxhow 1040x Lump-sum distributions. Taxhow 1040x   If you receive a lump-sum distribution from a qualified employee plan or qualified employee annuity and the plan participant was born before January 2, 1936, you may be able to elect optional methods of figuring the tax on the distribution. Taxhow 1040x The part from active participation in the plan before 1974 may qualify as capital gain subject to a 20% tax rate. Taxhow 1040x The part from participation after 1973 (and any part from participation before 1974 that you do not report as capital gain) is ordinary income. Taxhow 1040x You may be able to use the 10-year tax option to figure tax on the ordinary income part. Taxhow 1040x Form 1099-R. Taxhow 1040x   If you receive a total distribution from a plan, you should receive a Form 1099-R. Taxhow 1040x If the distribution qualifies as a lump-sum distribution, box 3 shows the capital gain part of the distribution. Taxhow 1040x The amount in box 2a, Taxable amount, minus the amount in box 3, Capital gain, is the ordinary income part. Taxhow 1040x More information. Taxhow 1040x   For more detailed information on lump-sum distributions, see Publication 575 or Form 4972, Tax on Lump-Sum Distributions. Taxhow 1040x Tax on Early Distributions Most distributions you receive from your qualified retirement plan and nonqualified annuity contracts before you reach age 59½ are subject to an additional tax of 10%. Taxhow 1040x The tax applies to the taxable part of the distribution. Taxhow 1040x For this purpose, a qualified retirement plan is: A qualified employee plan (including a qualified cash or deferred arrangement (CODA) under Internal Revenue Code section 401(k)), A qualified employee annuity plan, A tax-sheltered annuity plan (403(b) plan), or An eligible state or local government section 457 deferred compensation plan (to the extent that any distribution is attributable to amounts the plan received in a direct transfer or rollover from one of the other plans listed here or an IRA). Taxhow 1040x  An IRA is also a qualified retirement plan for purposes of this tax. Taxhow 1040x General exceptions to tax. Taxhow 1040x   The early distribution tax does not apply to any distributions that are: Made as part of a series of substantially equal periodic payments (made at least annually) for your life (or life expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary (if from a qualified retirement plan, the payments must begin after separation from service), Made because you are totally and permanently disabled, or Made on or after the death of the plan participant or contract holder. Taxhow 1040x Additional exceptions. Taxhow 1040x   There are additional exceptions to the early distribution tax for certain distributions from qualified retirement plans and nonqualified annuity contracts. Taxhow 1040x See Publication 575 for details. Taxhow 1040x Reporting tax. Taxhow 1040x   If you owe only the tax on early distributions and distribution code 1 (early distribution, no known exception) is correctly shown in Form 1099-R, box 7, multiply the taxable part of the early distribution by 10% (. Taxhow 1040x 10) and enter the result on Form 1040, line 58, or Form 1040NR, line 56. Taxhow 1040x See the instructions for line 58 of Form 1040 or line 56 of Form 1040NR for more information about reporting the early distribution tax. Taxhow 1040x Tax on Excess Accumulation To make sure that most of your retirement benefits are paid to you during your lifetime, rather than to your beneficiaries after your death, the payments that you receive from qualified retirement plans must begin no later than your required beginning date. Taxhow 1040x Unless the rule for 5% owners applies, this is generally April 1 of the year that follows the later of: The calendar year in which you reach age 70½, or The calendar year in which you retire from employment with the employer maintaining the plan. Taxhow 1040x However, your plan may require you to begin to receive payments by April 1 of the year that follows the year in which you reach 70½, even if you have not retired. Taxhow 1040x For this purpose, a qualified retirement plan includes: A qualified employee plan, A qualified employee annuity plan, An eligible section 457 deferred compensation plan, or A tax-sheltered annuity plan (403(b) plan) (for benefits accruing after 1986). Taxhow 1040x  An IRA is also a qualified retirement plan for purposes of this tax. Taxhow 1040x An excess accumulation is the undistributed remainder of the required minimum distribution that was left in your qualified retirement plan. Taxhow 1040x 5% owners. Taxhow 1040x   If you own (or are considered to own under section 318 of the Internal Revenue Code) more than 5% of the company maintaining your qualified retirement plan, you must begin to receive distributions from the plan by April 1 of the year after the calendar year in which you reach age 70½. Taxhow 1040x See Publication 575 for more information. Taxhow 1040x Amount of tax. Taxhow 1040x   If you do not receive the required minimum distribution, you are subject to an additional tax. Taxhow 1040x The tax equals 50% of the difference between the amount that must be distributed and the amount that was distributed during the tax year. Taxhow 1040x You can get this excise tax excused if you establish that the shortfall in distributions was due to reasonable error and that you are taking reasonable steps to remedy the shortfall. Taxhow 1040x Form 5329. Taxhow 1040x   You must file a Form 5329 if you owe a tax because you did not receive a minimum required distribution from your qualified retirement plan. Taxhow 1040x Additional information. Taxhow 1040x   For more detailed information on the tax on excess accumulation, see Publication 575. Taxhow 1040x Insurance Premiums for Retired Public Safety Officers If you are an eligible retired public safety officer (law enforcement officer, firefighter, chaplain, or member of a rescue squad or ambulance crew), you can elect to exclude from income distributions made from your eligible retirement plan that are used to pay the premiums for accident or health insurance or long-term care insurance. Taxhow 1040x The premiums can be for coverage for you, your spouse, or dependent(s). Taxhow 1040x The distribution must be made directly from the plan to the insurance provider. Taxhow 1040x You can exclude from income the smaller of the amount of the insurance premiums or $3,000. Taxhow 1040x You can only make this election for amounts that would otherwise be included in your income. Taxhow 1040x The amount excluded from your income cannot be used to claim a medical expense deduction. Taxhow 1040x An eligible retirement plan is a governmental plan that is a: Qualified trust, Section 403(a) plan, Section 403(b) annuity, or Section 457(b) plan. Taxhow 1040x If you make this election, reduce the otherwise taxable amount of your pension or annuity by the amount excluded. Taxhow 1040x The taxable amount shown in box 2a of any Form 1099-R that you receive does not reflect the exclusion. Taxhow 1040x Report your total distributions on Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a. Taxhow 1040x Report the taxable amount on Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. Taxhow 1040x Enter “PSO” next to the appropriate line on which you report the taxable amount. Taxhow 1040x Railroad Retirement Benefits Benefits paid under the Railroad Retirement Act fall into two categories. Taxhow 1040x These categories are treated differently for income tax purposes. Taxhow 1040x Social security equivalent benefits. Taxhow 1040x   The first category is the amount of tier 1 railroad retirement benefits that equals the social security benefit that a railroad employee or beneficiary would have been entitled to receive under the social security system. Taxhow 1040x This part of the tier 1 benefit is the social security equivalent benefit (SSEB) and is treated for tax purposes like social security benefits. Taxhow 1040x (See Social Security and Equivalent Railroad Retirement Benefits , later. Taxhow 1040x ) Non-social security equivalent benefits. Taxhow 1040x   The second category contains the rest of the tier 1 benefits, called the non-social security equivalent benefit (NSSEB). Taxhow 1040x It also contains any tier 2 benefit, vested dual benefit (VDB), and supplemental annuity benefit. Taxhow 1040x This category of benefits is treated as an amount received from a qualified employee plan. Taxhow 1040x This allows for the tax-free (nontaxable) recovery of employee contributions from the tier 2 benefits and the NSSEB part of the tier 1 benefits. Taxhow 1040x Vested dual benefits and supplemental annuity benefits are non-contributory pensions and are fully taxable. Taxhow 1040x More information. Taxhow 1040x   For more information about railroad retirement benefits, see Publication 575. Taxhow 1040x Military Retirement Pay Military retirement pay based on age or length of service is taxable and must be included in income as a pension on Form 1040, lines 16a and 16b; on Form 1040A, lines 12a and 12b; or on Form 1040NR, lines 17a and 17b. Taxhow 1040x But, certain military and government disability pensions that are based on a percentage of disability from active service in the Armed Forces of any country generally are not taxable. Taxhow 1040x For more information, including information about veterans' benefits and insurance, see Publication 525. Taxhow 1040x Social Security and Equivalent Railroad Retirement Benefits This discussion explains the federal income tax rules for social security benefits and equivalent tier 1 railroad retirement benefits. Taxhow 1040x Social security benefits include monthly retirement, survivor, and disability benefits. Taxhow 1040x They do not include supplemental security income (SSI) payments, which are not taxable. Taxhow 1040x Equivalent tier 1 railroad retirement benefits are the part of tier 1 benefits that a railroad employee or beneficiary would have been entitled to receive under the social security system. Taxhow 1040x They commonly are called the social security equivalent benefit (SSEB) portion of tier 1 benefits. Taxhow 1040x If you received these benefits during 2013, you should have received a Form SSA-1099 or Form RRB-1099 (Form SSA-1042S or Form RRB-1042S if you are a nonresident alien), showing the amount of the benefits. Taxhow 1040x Are Any of Your Benefits Taxable? Note. Taxhow 1040x When the term “benefits” is used in this section, it applies to both social security benefits and the SSEB portion of tier 1 railroad retirement benefits. Taxhow 1040x  To find out whether any of your benefits may be taxable, compare the base amount for your filing status (explained later) with the total of: One-half of your benefits, plus All your other income, including tax-exempt interest. Taxhow 1040x When making this comparison, do not reduce your other income by any exclusions for: Interest from qualified U. Taxhow 1040x S. Taxhow 1040x savings bonds, Employer-provided adoption benefits, Foreign earned income or foreign housing, or Income earned in American Samoa or Puerto Rico by bona fide residents. Taxhow 1040x Figuring total income. Taxhow 1040x   To figure the total of one-half of your benefits plus your other income, use Worksheet 2-B. Taxhow 1040x If that total amount is more than your base amount, part of your benefits may be taxable. Taxhow 1040x If you are married and file a joint return for 2013, you and your spouse must combine your incomes and your benefits to figure whether any of your combined benefits are taxable. Taxhow 1040x Even if your spouse did not receive any benefits, you must add your spouse's income to yours to figure whether any of your benefits are taxable. Taxhow 1040x If the only income you received during 2013 was your social security or the SSEB portion of tier 1 railroad retirement benefits, your benefits generally are not taxable and you probably do not have to file a return. Taxhow 1040x If you have income in addition to your benefits, you may have to file a return even if none of your benefits are taxable. Taxhow 1040x Worksheet 2-B. Taxhow 1040x A Quick Way To Check if Your Benefits May Be Taxable A. Taxhow 1040x Enter the amount from box 5 of all your Forms SSA-1099 and RRB-1099. Taxhow 1040x Include  the full amount of any lump-sum benefit payments received in 2013, for 2013 and  earlier years. Taxhow 1040x (If you received more than one form, combine the amounts from box 5  and enter the total. Taxhow 1040x ) A. Taxhow 1040x     Note. Taxhow 1040x If the amount on line A is zero or less, stop here; none of your benefits are  taxable this year. Taxhow 1040x     B. Taxhow 1040x Enter one-half of the amount on line A B. Taxhow 1040x   C. Taxhow 1040x Enter your taxable pensions, wages, interest, dividends, and other taxable income C. Taxhow 1040x   D. Taxhow 1040x Enter any tax-exempt interest income (such as interest on municipal bonds) plus any exclusions from income for: •Interest from qualified U. Taxhow 1040x S. Taxhow 1040x savings bonds, •Employer-provided adoption benefits, •Foreign earned income or foreign housing, or •Income earned in American Samoa or Puerto Rico by bona fide residents D. Taxhow 1040x   E. Taxhow 1040x Add lines B, C, and D and enter the total E. Taxhow 1040x   F. Taxhow 1040x If you are: •Married filing jointly, enter $32,000 •Single, head of household, qualifying widow(er), or married filing separately and you  lived apart from your spouse for all of 2013, enter $25,000 •Married filing separately and you lived with your spouse at any time during 2013,  enter -0- F. Taxhow 1040x   G. Taxhow 1040x Is the amount on line F less than or equal to the amount on line E? □ No. Taxhow 1040x None of your benefits are taxable this year. Taxhow 1040x  □ Yes. Taxhow 1040x Some of your benefits may be taxable. Taxhow 1040x To figure how much of your benefits  are taxable, see Which worksheet to use under How Much Is Taxable. Taxhow 1040x     Base Amount Your base amount is: $25,000 if you are single, head of household, or qualifying widow(er) with dependent child, $25,000 if you are married filing separately and lived apart from your spouse for all of 2013, $32,000 if you are married filing jointly, or $0 if you are married filing separately and lived with your spouse at any time during 2013. Taxhow 1040x Repayment of Benefits Any repayment of benefits you made during 2013 must be subtracted from the gross benefits you received in 2013. Taxhow 1040x It does not matter whether the repayment was for a benefit you received in 2013 or in an earlier year. Taxhow 1040x If you repaid more than the gross benefits you received in 2013, see Repayments More Than Gross Benefits , later. Taxhow 1040x Your gross benefits are shown in box 3 of Form SSA-1099 or Form RRB-1099. Taxhow 1040x Your repayments are shown in box 4. Taxhow 1040x The amount in box 5 shows your net benefits for 2013 (box 3 minus box 4). Taxhow 1040x Use the amount in box 5 to figure whether any of your benefits are taxable. Taxhow 1040x Tax Withholding and Estimated Tax You can choose to have federal income tax withheld from your social security and/or the SSEB portion of your tier 1 railroad retirement benefits. Taxhow 1040x If you choose to do this, you must complete a Form W-4V, Voluntary Withholding Request. Taxhow 1040x If you do not choose to have income tax withheld, you may have to request additional withholding from other income, or pay estimated tax during the year. Taxhow 1040x For details, see Publication 505, Tax Withholding and Estimated Tax, or the instructions for Form 1040-ES, Estimated Tax for Individuals. Taxhow 1040x How Much Is Taxable? If part of your benefits is taxable, how much is taxable depends on the total amount of your benefits and other income. Taxhow 1040x Generally, the higher that total amount, the greater the taxable part of your benefits. Taxhow 1040x Maximum taxable part. Taxhow 1040x   The taxable part of your benefits usually cannot be more than 50%. Taxhow 1040x However, up to 85% of your benefits can be taxable if either of the following situations applies to you. Taxhow 1040x The total of one-half of your benefits and all your other income is more than $34,000 ($44,000 if you are married filing jointly). Taxhow 1040x You are married filing separately and lived with your spouse at any time during 2013. Taxhow 1040x   If you are a nonresident alien, 85% of your benefits are taxable. Taxhow 1040x However, this income is exempt under some tax treaties. Taxhow 1040x Which worksheet to use. Taxhow 1040x   A worksheet to figure your taxable benefits is in the instructions for your Form 1040 or 1040A. Taxhow 1040x However, you will need to use a different worksheet(s) if any of the following situations applies to you. Taxhow 1040x You contributed to a traditional individual retirement arrangement (IRA) and you or your spouse were covered by a retirement plan at work. Taxhow 1040x In this situation, you must use the special worksheets in Appendix B of Publication 590 to figure both your IRA deduction and your taxable benefits. Taxhow 1040x Situation (1) does not apply and you take one or more of the following exclusions. Taxhow 1040x Interest from qualified U. Taxhow 1040x S. Taxhow 1040x savings bonds (Form 8815). Taxhow 1040x Employer-provided adoption benefits (Form 8839). Taxhow 1040x Foreign earned income or housing (Form 2555 or Form 2555-EZ). Taxhow 1040x Income earned in American Samoa (Form 4563) or Puerto Rico by bona fide residents. Taxhow 1040x In these situations, you must use Worksheet 1 in Publication 915, Social Security and Equivalent Railroad Retirement Benefits, to figure your taxable benefits. Taxhow 1040x You received a lump-sum payment for an earlier year. Taxhow 1040x In this situation, also complete Worksheet 2 or 3 and Worksheet 4 in Publication 915. Taxhow 1040x See Lump-Sum Election , later. Taxhow 1040x How To Report Your Benefits If part of your benefits are taxable, you must use Form 1040, Form 1040A, or Form 1040NR. Taxhow 1040x You cannot use Form 1040EZ. Taxhow 1040x Reporting on Form 1040. Taxhow 1040x   Report your net benefits (the amount in box 5 of your Form SSA-1099 or Form RRB-1099) on line 20a and the taxable part on line 20b. Taxhow 1040x If you are married filing separately and you lived apart from your spouse for all of 2013, also enter “D” to the right of the word “benefits” on line 20a. Taxhow 1040x Reporting on Form 1040A. Taxhow 1040x   Report your net benefits (the amount in box 5 of your Form SSA-1099 or Form RRB-1099) on line 14a and the taxable part on line 14b. Taxhow 1040x If you are married filing separately and you lived apart from your spouse for all of 2013, also enter “D” to the right of the word “benefits” on line 14a. Taxhow 1040x Reporting on Form 1040NR. Taxhow 1040x   Report 85% of the total amount of your benefits (box 5 of your Form SSA-1042S or Form RRB-1042S) in the appropriate column of Form 1040NR, Schedule NEC, line 8. Taxhow 1040x Benefits not taxable. Taxhow 1040x   If you are filing Form 1040EZ, do not report any benefits on your tax return. Taxhow 1040x If you are filing Form 1040 or Form 1040A, report your net benefits (the amount in box 5 of your Form SSA-1099 or Form RRB-1099) on Form 1040, line 20a, or Form 1040A, line 14a. Taxhow 1040x Enter -0- on Form 1040, line 20b, or Form 1040A, line 14b. Taxhow 1040x If you are married filing separately and you lived apart from your spouse for all of 2013, also enter “D” to the right of the word “benefits” on Form 1040, line 20a, or Form 1040A, line 14a. Taxhow 1040x Lump-Sum Election You must include the taxable part of a lump-sum (retroactive) payment of benefits received in 2013 in your 2013 income, even if the payment includes benefits for an earlier year. Taxhow 1040x This type of lump-sum benefit payment should not be confused with the lump-sum death benefit that both the SSA and RRB pay to many of their beneficiaries. Taxhow 1040x No part of the lump-sum death benefit is subject to tax. Taxhow 1040x For more information about the lump-sum death benefit, visit the Social Security Administration website at www. Taxhow 1040x SSA. Taxhow 1040x gov, and use keyword: death benefit. Taxhow 1040x Generally, you use your 2013 income to figure the taxable part of the total benefits received in 2013. Taxhow 1040x However, you may be able to figure the taxable part of a lump-sum payment for an earlier year separately, using your income for the earlier year. Taxhow 1040x You can elect this method if it lowers your taxable benefits. Taxhow 1040x See Publication 915 for more information. Taxhow 1040x Repayments More Than Gross Benefits In some situations, your Form SSA-1099 or Form RRB-1099 will show that the total benefits you repaid (box 4) are more than the gross benefits (box 3) you received. Taxhow 1040x If this occurred, your net benefits in box 5 will be a negative figure (a figure in parentheses) and none of your benefits will be taxable. Taxhow 1040x If you receive more than one form, a negative figure in box 5 of one form is used to offset a positive figure in box 5 of another form for that same year. Taxhow 1040x If you have any questions about this negative figure, contact your local Social Security Administration office or your local U. Taxhow 1040x S. Taxhow 1040x Railroad Retirement Board field office. Taxhow 1040x Joint return. Taxhow 1040x   If you and your spouse file a joint return, and your Form SSA-1099 or RRB-1099 has a negative figure in box 5 but your spouse's does not, subtract the box 5 amount on your form from the box 5 amount on your spouse's form. Taxhow 1040x You do this to get your net benefits when figuring if your combined benefits are taxable. Taxhow 1040x Repayment of benefits received in an earlier year. Taxhow 1040x   If the total amount shown in box 5 of all of your Forms SSA-1099 and RRB-1099 is a negative figure, you can take an itemized deduction for the part of this negative figure that represents benefits you included in gross income in an earlier year. Taxhow 1040x   If this deduction is $3,000 or less, it is subject to the 2%-of-adjusted-gross-income limit that applies to certain miscellaneous itemized deductions. Taxhow 1040x Claim it on Schedule A (Form 1040), line 23. Taxhow 1040x   If this deduction is more than $3,000, you have to follow some special instructions. Taxhow 1040x See Publication 915 for those instructions. Taxhow 1040x Sickness and Injury Benefits Generally, you must report as income any amount you receive for personal injury or sickness through an accident or health plan that is paid for by your employer. Taxhow 1040x If both you and your employer pay for the plan, only the amount you receive that is due to your employer's payments is reported as income. Taxhow 1040x However, certain payments may not be taxable to you. Taxhow 1040x Some of these payments are discussed later in this section. Taxhow 1040x Also, see Military and Government Disability Pensions and Other Sickness and Injury Benefits in Publication 525. Taxhow 1040x Cost paid by you. Taxhow 1040x   If you pay the entire cost of an accident or health plan, do not include any amounts you receive from the plan for personal injury or sickness as income on your tax return. Taxhow 1040x If your plan reimbursed you for medical expenses you deducted in an earlier year, you may have to include some, or all, of the reimbursement in your income. Taxhow 1040x Disability Pensions If you retired on disability, you must include in income any disability pension you receive under a plan that is paid for by your employer. Taxhow 1040x You must report your taxable disability payments as wages on line 7 of Form 1040 or Form 1040A or on line 8 of Form 1040NR until you reach minimum retirement age. Taxhow 1040x Minimum retirement age generally is the age at which you can first receive a pension or annuity if you are not disabled. Taxhow 1040x If you were 65 or older by the end of 2013 or you were retired on permanent and total disability and received taxable disability income, you may be able to claim the credit for the elderly or the disabled. Taxhow 1040x See Credit for the Elderly or the Disabled, later. Taxhow 1040x For more information on this credit, see Publication 524, Credit for the Elderly or the Disabled. Taxhow 1040x Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension or annuity. Taxhow 1040x Report the payments on lines 16a and 16b of Form 1040, on lines 12a and 12b of Form 1040A, or on lines 17a and 17b of Form 1040NR. Taxhow 1040x For more information on pensions and annuities, see Publication 575. Taxhow 1040x Retirement and profit-sharing plans. Taxhow 1040x   If you receive payments from a retirement or profit-sharing plan that does not provide for disability retirement, do not treat the payments as a disability pension. Taxhow 1040x The payments must be reported as a pension or annuity. Taxhow 1040x Accrued leave payment. Taxhow 1040x   If you retire on disability, any lump-sum payment you receive for accrued annual leave is a salary payment. Taxhow 1040x The payment is not a disability payment. Taxhow 1040x Include it in your income in the tax year you receive it. Taxhow 1040x Long-Term Care Insurance Contracts In most cases, long-term care insurance contracts generally are treated as accident and health insurance contracts. Taxhow 1040x Amounts you receive from them (other than policyholder dividends or premium refunds) generally are excludable from income as amounts received for personal injury or sickness. Taxhow 1040x However, the amount you can exclude may be limited. Taxhow 1040x Long-term care insurance contracts are discussed in more detail in Publication 525. Taxhow 1040x Workers' Compensation Amounts you receive as workers' compensation for an occupational sickness or injury are fully exempt from tax if they are paid under a workers' compensation act or a statute in the nature of a workers' compensation act. Taxhow 1040x The exemption also applies to your survivors. Taxhow 1040x The exemption, however, does not apply to retirement plan benefits you receive based on your age, length of service, or prior contributions to the plan, even if you retired because of an occupational sickness or injury. Taxhow 1040x If part of your workers' compensation reduces your social security or equivalent railroad retirement benefits, that part is considered social security (or equivalent railroad retirement) benefits and may be taxable. Taxhow 1040x For a discussion of the taxability of these benefits, see Social Security and Equivalent Railroad Retirement Benefits, earlier. Taxhow 1040x Return to work. Taxhow 1040x   If you return to work after qualifying for workers' compensation, salary payments you receive for performing light duties are taxable as wages. Taxhow 1040x Other Sickness and Injury Benefits In addition to disability pensions and annuities, you may receive other payments for sickness or injury. Taxhow 1040x Federal Employees' Compensation Act (FECA). Taxhow 1040x   Payments received under this Act for personal injury or sickness, including payments to beneficiaries in case of death, are not taxable. Taxhow 1040x However, you are taxed on amounts you receive under this Act as continuation of pay for up to 45 days while a claim is being decided. Taxhow 1040x Report this income on Form 1040, line 7; Form 1040A, line 7; on Form 1040EZ, line 1; or Form 1040NR, line 8. Taxhow 1040x Also, pay for sick leave while a claim is being processed is taxable and must be included in your income as wages. Taxhow 1040x    If part of the payments you receive under FECA reduces your social security or equivalent railroad retirement benefits, that part is considered social security (or equivalent railroad retirement) benefits and may be taxable. Taxhow 1040x For a discussion of the taxability of these benefits, see Social Security and Equivalent Railroad Retirement Benefits, earlier. Taxhow 1040x Other compensation. Taxhow 1040x   Many other amounts you receive as compensation for sickness or injury are not taxable. Taxhow 1040x These include the following amounts. Taxhow 1040x Benefits you receive under an accident or health insurance policy on which either you paid the premiums or your employer paid the premiums but you had to include them in your income. Taxhow 1040x Disability benefits you receive for loss of income or earning capacity as a result of injuries under a no-fault car insurance policy. Taxhow 1040x Compensation you receive for permanent loss or loss of use of a part or function of your body, for your permanent disfigurement, or for such loss or disfigurement suffered by your spouse or dependent(s). Taxhow 1040x This compensation must be based only on the injury and not on the period of your absence from work. Taxhow 1040x These benefits are not taxable even if your employer pays for the accident and health plan that provides these benefits. Taxhow 1040x Life Insurance Proceeds Life insurance proceeds paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price. Taxhow 1040x This is true even if the proceeds were paid under an accident or health insurance policy or an endowment contract. Taxhow 1040x Proceeds not received in installments. Taxhow 1040x   If death benefits are paid to you in a lump sum or other than at regular intervals, include in your income only the benefits that are more than the amount payable to you at the time of the insured person's death. Taxhow 1040x If the benefit payable at death is not specified, you include in your income the benefit payments that are more than the present value of the payments at the time of death. Taxhow 1040x Proceeds received in installments. Taxhow 1040x   If you receive life insurance proceeds in installments, you can exclude part of each installment from your income. Taxhow 1040x   To determine the excluded part, divide the amount held by the insurance company (generally the total lump sum payable at the death of the insured person) by the number of installments to be paid. Taxhow 1040x Include anything over this excluded part in your income as interest. Taxhow 1040x Installments for life. Taxhow 1040x   If, as the beneficiary under an insurance contract, you are entitled to receive the proceeds in installments for the rest of your life without a refund or period-certain guarantee, you figure the excluded part of each installment by dividing the amount held by the insurance company by your life expectancy. Taxhow 1040x If there is a refund or period-certain guarantee, the amount held by the insurance company for this purpose is reduced by the actuarial value of the guarantee. Taxhow 1040x Surviving spouse. Taxhow 1040x   If your spouse died before October 23, 1986, and insurance proceeds paid to you because of the death of your spouse are received in installments, you can exclude, in any year, up to $1,000 of the interest included in the installments. Taxhow 1040x If you remarry, you can continue to take the exclusion. Taxhow 1040x Surrender of policy for cash. Taxhow 1040x   If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. Taxhow 1040x In general, your cost (or investment in the contract) is the total of premiums that you paid for the life insurance policy, less any refunded premiums, rebates, dividends, or unrepaid loans that were not included in your income. Taxhow 1040x You should receive a Form 1099-R showing the total proceeds and the taxable part. Taxhow 1040x Report these amounts on Form 1040, lines 16a and 16b; Form 1040A, lines 12a and 12b; or Form 1040NR, lines 17a and 17b. Taxhow 1040x Endowment Contract Proceeds An endowment contract is a policy that pays over to you a specified amount of money on a certain date unless you die before that date, in which case, the money is paid to your designated beneficiary. Taxhow 1040x Endowment proceeds paid in a lump sum to you at maturity are taxable only if the proceeds are more than the cost of the policy. Taxhow 1040x To determine your cost, subtract from the total premiums (or other consideration) paid for the contract any amount that you previously received under the contract and excluded from your income. Taxhow 1040x Include in your income the part of the lump-sum payment that is more than your cost. Taxhow 1040x Endowment proceeds that you choose to receive in installments instead of a lump-sum payment at the maturity of the policy are taxed as an annuity. Taxhow 1040x The tax treatment of an annuity is explained in Publication 575. Taxhow 1040x For this treatment to apply, you must choose to receive the proceeds in installments before receiving any part of the lump sum. Taxhow 1040x This election must be made within 60 days after the lump-sum payment first becomes payable to you. Taxhow 1040x Accelerated Death Benefits Certain amounts paid as accelerated death benefits under a life insurance contract or viatical settlement before the insured's death are generally excluded from income if the insured is terminally or chronically ill. Taxhow 1040x However, see Exception , later. Taxhow 1040x For a chronically ill individual, accelerated death benefits paid on the basis of costs incurred for qualified long-term care services are fully excludable. Taxhow 1040x Accelerated death benefits paid on a per diem or other periodic basis without regard to the costs are excludable up to a limit. Taxhow 1040x In addition, if any portion of a death benefit under a life insurance contract on the life of a terminally or chronically ill individual is sold or assigned to a viatical settlement provider, the amount received also is excluded from income. Taxhow 1040x Generally, a viatical settlement provider is one who regularly engages in the business of buying or taking assignment of life insurance contracts on the lives of insured individuals who are terminally or chronically ill. Taxhow 1040x To report taxable accelerated death benefits made on a per diem or other periodic basis, you must file Form 8853, Archer MSAs and Long-Term Care Insurance Contracts, with your return. Taxhow 1040x Terminally or chronically ill defined. Taxhow 1040x   A terminally ill person is one who has been certified by a physician as having an illness or physical condition that reasonably can be expected to result in death within 24 months from the date of the certification. Taxhow 1040x A chronically ill person is one who is not terminally ill but has been certified (within the previous 12 months) by a licensed health care practitioner as meeting either of the following conditions. Taxhow 1040x The person is unable to perform (without substantial help) at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for a period of 90 days or more because of a loss of functional capacity. Taxhow 1040x The person requires substantial supervision to protect himself or herself from threats to health and safety due to severe cognitive impairment. Taxhow 1040x Exception. Taxhow 1040x   The exclusion does not apply to any amount paid to a person other than the insured if that other person has an insurable interest in the life of the insured because the insured: Is a director, officer, or employee of the other person, or Has a financial interest in the business of the other person. Taxhow 1040x Sale of Home You may be able to exclude from income any gain up to $250,000 ($500,000 on a joint return in most cases) on the sale of your main home. Taxhow 1040x Generally, if you can exclude all of the gain, you do not need to report the sale on your tax return. Taxhow 1040x You can choose not to take the exclusion by including the gain from the sale in your gross income on your tax return for the year of the sale. Taxhow 1040x Main home. Taxhow 1040x   Usually, your main home is the home you live in most of the time and can be a: House, Houseboat, Mobile home, Cooperative apartment, or Condominium. Taxhow 1040x Repaying the first-time homebuyer credit because you sold your home. Taxhow 1040x   If you claimed a first-time homebuyer credit for your main home and you sell it, you may have to repay the credit. Taxhow 1040x For a home purchased in 2008 and used as your main home until sold in 2013, you must file Form 5405 and repay the balance of the unpaid credit on your 2013 tax return. Taxhow 1040x   For a home purchased after 2008, you generally must repay the entire credit if the home was sold (or otherwise ceased to be your main home) within 36 months of the purchase date. Taxhow 1040x If you purchased your home in 2009 and used it as your main home until sold in 2013, you do not have to repay the credit or file Form 5405. Taxhow 1040x If you purchased your home in 2010 and used it as your main home until sold in 2013, you may have to file Form 5405 and repay the entire credit on your 2013 tax return. Taxhow 1040x   See the Instructions for Form 5405 for more information about repaying the credit and exceptions to repayment that may apply to you. Taxhow 1040x Maximum Amount of Exclusion You can generally exclude up to $250,000 of the gain (other than gain allocated to periods of nonqualified use) on the sale of your main home if all of the following are true. Taxhow 1040x You meet the ownership test. Taxhow 1040x You meet the use test. Taxhow 1040x During the 2-year period ending on the date of the sale, you did not exclude gain from the sale of another home. Taxhow 1040x You may be able to exclude up to $500,000 of the gain (other than gain allocated to periods of nonqualified use) on the sale of your main home if you are married and file a joint return and meet the requirements listed in the discussion of the special rules for joint returns, later, under Married Persons . Taxhow 1040x Ownership and Use Tests To claim the exclusion, you must meet the ownership and use tests. Taxhow 1040x This means that during the 5-year period ending on the date of the sale, you must have: Owned the home for at least 2 years (the ownership test), and Lived in the home as your main home for at least 2 years (the use test). Taxhow 1040x Exception to ownership and use tests. Taxhow 1040x   If you owned and lived in the property as your main home for less than 2 years, you still can claim an exclusion in some cases. Taxhow 1040x Generally, you must have sold the home due to a change in place of employment, health, or unforeseen circumstances. Taxhow 1040x The maximum amount you can exclude will be reduced. Taxhow 1040x See Publication 523, Selling Your Home, for more information. Taxhow 1040x Exception to use test for individuals with a disability. Taxhow 1040x   There is an exception to the use test if, during the 5-year period before the sale of your home: You become physically or mentally unable to care for yourself, and You owned and lived in your home as your main home for a total of at least 1 year. Taxhow 1040x Under this exception, you are considered to live in your home during any time that you own the home and live in a facility (including a nursing home) that is licensed by a state or political subdivision to care for persons in your condition. Taxhow 1040x   If you meet this exception to the use test, you still have to meet the 2-out-of-5-year ownership test to claim the exclusion. Taxhow 1040x Exception to ownership test for property acquired in a like-kind exchange. Taxhow 1040x   You must have owned your main home for at least 5 years to qualify for the exclusion if you acquired your main home in a like-kind exchange. Taxhow 1040x This special 5-year ownership rule continues to apply to a home you acquired in a like-kind exchange and gave to another person. Taxhow 1040x A like-kind exchange is an exchange of property held for productive use in a trade or business or for investment. Taxhow 1040x See Publication 523 for more information. Taxhow 1040x Period of nonqualified use. Taxhow 1040x   Generally, the gain from the sale or exchange of your main home will not qualify for the exclusion to the extent that the gain is allocated to periods of nonqualified use. Taxhow 1040x Nonqualified use is any period after December 31, 2008, during which the property is not used as the main home. Taxhow 1040x See Publication 523 for more information. Taxhow 1040x Married Persons In the special situations discussed below, if you and your spouse file a joint return for the year of sale and one spouse meets the ownership and use test, you can exclude up to $250,000 of gain. Taxhow 1040x However, see Special rules for joint returns , next. Taxhow 1040x Special rules for joint returns. Taxhow 1040x   You can exclude up to $500,000 of the gain on the sale of your main home if all of the following are true. Taxhow 1040x You are married and file a joint return for the year. Taxhow 1040x Either you or your spouse meets the ownership test. Taxhow 1040x Both you and your spouse meet the use test. Taxhow 1040x During the 2-year period ending on the date of the sale, neither you nor your spouse exclude gain from the sale of another home. Taxhow 1040x Sale of home by surviving spouse. Taxhow 1040x   If your spouse died and you did not remarry before the date of sale, you are considered to have owned and lived in the property as your main home during any period of time when your spouse owned and lived in it as a main home. Taxhow 1040x   If you meet all of the following requirements, you may qualify to exclude up to $500,000 of any gain from the sale or exchange of your main home in 2013. Taxhow 1040x The sale or exchange took place no more than 2 years after the date of death of your spouse. Taxhow 1040x You have not remarried. Taxhow 1040x You and your spouse met the use test at the time of your spouse's death. Taxhow 1040x You or your spouse met the ownership test at the time of your spouse's death. Taxhow 1040x Neither you nor your spouse excluded gain from the sale of another home during the last 2 years. Taxhow 1040x Home transferred from spouse. Taxhow 1040x   If your home was transferred to you by your spouse (or former spouse if the transfer was incident to divorce), you are considered to have owned it during any period of time when your spouse owned it. Taxhow 1040x Use of home after divorce. Taxhow 1040x   You are considered to have used property as your main home during any period when: You owned it, and Your spouse or former spouse is allowed to live in it under a divorce or separation instrument and uses it as his or her main home. Taxhow 1040x Business Use or Rental of Home You may be able to exclude gain from the sale of a home that you have used for business or to produce rental income. Taxhow 1040x However, you must meet the ownership and use tests. Taxhow 1040x See Publication 523 for more information. Taxhow 1040x Depreciation after May 6, 1997. Taxhow 1040x   If you were entitled to take depreciation deductions because you used your home for business purposes or as rental property, you cannot exclude the part of your gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997. Taxhow 1040x See Publication 523 for more information. Taxhow 1040x Reporting the Sale Do not report the 2013 sale of your main home on your tax return unless: You have a gain and you do not qualify to exclude all of it, You have a gain and you choose not to exclude it, or You received Form 1099-S. Taxhow 1040x If you have a gain that you cannot or choose not to exclude, if you received a Form 1099-S, or if you have a deductible loss, report the sale on your tax return. Taxhow 1040x Report the sale on Part I or Part II of Form 8949 as a short-term or long-term transaction, depending on how long you owned the home. Taxhow 1040x If you used your home for business or to produce rental income, you may have to use Form 4797, Sales of Business Property, to report the sale of the business or rental part. Taxhow 1040x See Publication 523 for more information. Taxhow 1040x Reverse Mortgages A revers