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Vita Free Tax Preparation

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Vita Free Tax Preparation

Vita free tax preparation 3. Vita free tax preparation   Investment Expenses Table of Contents Topics - This chapter discusses: Useful Items - You may want to see: Limits on DeductionsPassive activity. Vita free tax preparation Other income (nonpassive income). Vita free tax preparation Expenses. Vita free tax preparation Additional information. Vita free tax preparation Interest ExpensesInvestment Interest Limit on Deduction Bond Premium AmortizationSpecial rules to determine amounts payable on a bond. Vita free tax preparation Basis. Vita free tax preparation How To Figure Amortization Choosing To Amortize How To Report Amortization Expenses of Producing IncomeFees to buy or sell. Vita free tax preparation Including mutual fund or REMIC expenses in income. Vita free tax preparation Nondeductible ExpensesUsed as collateral. Vita free tax preparation Short-sale expenses. Vita free tax preparation Expenses for both tax-exempt and taxable income. Vita free tax preparation State income taxes. Vita free tax preparation Nondeductible amount. Vita free tax preparation Basis adjustment. Vita free tax preparation How To Report Investment Expenses When To Report Investment Expenses Topics - This chapter discusses: Limits on Deductions , Interest Expenses , Bond Premium Amortization , Expenses of Producing Income , Nondeductible Expenses , How To Report Investment Expenses , and When To Report Investment Expenses . Vita free tax preparation Useful Items - You may want to see: Publication 535 Business Expenses 925 Passive Activity and At-Risk Rules 929 Tax Rules for Children and Dependents Form (and Instructions) Schedule A (Form 1040) Itemized Deductions 4952 Investment Interest Expense Deduction See chapter 5, How To Get Tax Help , for information about getting these publications and forms. Vita free tax preparation Limits on Deductions Your deductions for investment expenses may be limited by: The at-risk rules, The passive activity loss limits, The limit on investment interest, or The 2% limit on certain miscellaneous itemized deductions. Vita free tax preparation The at-risk rules and passive activity rules are explained briefly in this section. Vita free tax preparation The limit on investment interest is explained later in this chapter under Interest Expenses . Vita free tax preparation The 2% limit is explained later in this chapter under Expenses of Producing Income . Vita free tax preparation At-risk rules. Vita free tax preparation   Special at-risk rules apply to most income-producing activities. Vita free tax preparation These rules limit the amount of loss you can deduct to the amount you risk losing in the activity. Vita free tax preparation Generally, this is the cash and the adjusted basis of property you contribute to the activity. Vita free tax preparation It also includes money you borrow for use in the activity if you are personally liable for repayment or if you use property not used in the activity as security for the loan. Vita free tax preparation For more information, see Publication 925. Vita free tax preparation Passive activity losses and credits. Vita free tax preparation   The amount of losses and tax credits you can claim from passive activities is limited. Vita free tax preparation Generally, you are allowed to deduct passive activity losses only up to the amount of your passive activity income. Vita free tax preparation Also, you can use credits from passive activities only against tax on the income from passive activities. Vita free tax preparation There are exceptions for certain activities, such as rental real estate activities. Vita free tax preparation Passive activity. Vita free tax preparation   A passive activity generally is any activity involving the conduct of any trade or business in which you do not materially participate and any rental activity. Vita free tax preparation However, if you are involved in renting real estate, the activity is not a passive activity if both of the following are true. Vita free tax preparation More than one-half of the personal services you perform during the year in all trades or businesses are performed in real property trades or businesses in which you materially participate. Vita free tax preparation You perform more than 750 hours of services during the year in real property trades or businesses in which you materially participate. Vita free tax preparation  The term “trade or business” generally means any activity that involves the conduct of a trade or business, is conducted in anticipation of starting a trade or business, or involves certain research or experimental expenditures. Vita free tax preparation However, it does not include rental activities or certain activities treated as incidental to holding property for investment. Vita free tax preparation   You are considered to materially participate in an activity if you are involved on a regular, continuous, and substantial basis in the operations of the activity. Vita free tax preparation Other income (nonpassive income). Vita free tax preparation    Generally, you can use losses from passive activities only to offset income from passive activities. Vita free tax preparation You cannot use passive activity losses to offset your other income, such as your wages or your portfolio income. Vita free tax preparation Portfolio income includes gross income from interest, dividends, annuities, or royalties that is not derived in the ordinary course of a trade or business. Vita free tax preparation It also includes gains or losses (not derived in the ordinary course of a trade or business) from the sale or trade of property (other than an interest in a passive activity) producing portfolio income or held for investment. Vita free tax preparation This includes capital gain distributions from mutual funds (and other regulated investment companies) and real estate investment trusts. Vita free tax preparation   You cannot use passive activity losses to offset Alaska Permanent Fund dividends. Vita free tax preparation Expenses. Vita free tax preparation   Do not include in the computation of your passive activity income or loss: Expenses (other than interest) that are clearly and directly allocable to your portfolio income, or Interest expense properly allocable to portfolio income. Vita free tax preparation However, this interest and other expenses may be subject to other limits. Vita free tax preparation These limits are explained in the rest of this chapter. Vita free tax preparation Additional information. Vita free tax preparation   For more information about determining and reporting income and losses from passive activities, see Publication 925. Vita free tax preparation Interest Expenses This section discusses interest expenses you may be able to deduct as an investor. Vita free tax preparation For information on business interest, see chapter 4 of Publication 535. Vita free tax preparation You cannot deduct personal interest expenses other than qualified home mortgage interest, as explained in Publication 936, Home Mortgage Interest Deduction, and interest on certain student loans, as explained in Publication 970. Vita free tax preparation Investment Interest If you borrow money to buy property you hold for investment, the interest you pay is investment interest. Vita free tax preparation You can deduct investment interest subject to the limit discussed later. Vita free tax preparation However, you cannot deduct interest you incurred to produce tax-exempt income. Vita free tax preparation See Tax-exempt income under Nondeductible Expenses, later. Vita free tax preparation You also cannot deduct interest expenses on straddles discussed under Interest expense and carrying charges on straddles , later. Vita free tax preparation Investment interest does not include any qualified home mortgage interest or any interest taken into account in computing income or loss from a passive activity. Vita free tax preparation Investment property. Vita free tax preparation   Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. Vita free tax preparation It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). Vita free tax preparation Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity). Vita free tax preparation Partners, shareholders, and beneficiaries. Vita free tax preparation   To determine your investment interest, combine your share of investment interest from a partnership, S corporation, estate, or trust with your other investment interest. Vita free tax preparation Allocation of Interest Expense If you borrow money for business or personal purposes as well as for investment, you must allocate the debt among those purposes. Vita free tax preparation Only the interest expense on the part of the debt used for investment purposes is treated as investment interest. Vita free tax preparation The allocation is not affected by the use of property that secures the debt. Vita free tax preparation Example 1. Vita free tax preparation You borrow $10,000 and use $8,000 to buy stock. Vita free tax preparation You use the other $2,000 to buy items for your home. Vita free tax preparation Since 80% of the debt is used for, and allocated to, investment purposes, 80% of the interest on that debt is investment interest. Vita free tax preparation The other 20% is nondeductible personal interest. Vita free tax preparation Debt proceeds received in cash. Vita free tax preparation   If you receive debt proceeds in cash, the proceeds are generally not treated as investment property. Vita free tax preparation Debt proceeds deposited in account. Vita free tax preparation   If you deposit debt proceeds in an account, that deposit is treated as investment property, regardless of whether the account bears interest. Vita free tax preparation But, if you withdraw the funds and use them for another purpose, you must reallocate the debt to determine the amount considered to be for investment purposes. Vita free tax preparation Example 2. Vita free tax preparation Assume in Example 1 that you borrowed the money on March 1 and immediately bought the stock for $8,000. Vita free tax preparation You did not buy the household items until June 1. Vita free tax preparation You had deposited the $2,000 in the bank. Vita free tax preparation You had no other transactions on the bank account until June. Vita free tax preparation You did not sell the stock, and you made no principal payments on the debt. Vita free tax preparation You paid interest from another account. Vita free tax preparation The $8,000 is treated as being used for an investment purpose. Vita free tax preparation The $2,000 is treated as being used for an investment purpose for the 3-month period. Vita free tax preparation Your total interest expense for 3 months on this debt is investment interest. Vita free tax preparation In June, when you spend the $2,000 for household items, you must begin to allocate 80% of the debt and the interest expense to investment purposes and 20% to personal purposes. Vita free tax preparation Amounts paid within 30 days. Vita free tax preparation   If you receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can treat any payment (up to the amount of the proceeds) made from any account you own, or from cash, as made from those proceeds. Vita free tax preparation This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. Vita free tax preparation   If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead of the date you actually made the payment. Vita free tax preparation Payments on debt may require new allocation. Vita free tax preparation   As you repay a debt used for more than one purpose, you must reallocate the balance. Vita free tax preparation You must first reduce the amount allocated to personal purposes by the repayment. Vita free tax preparation You then reallocate the rest of the debt to find what part is for investment purposes. Vita free tax preparation Example 3. Vita free tax preparation If, in Example 2 , you repay $500 on November 1, the entire repayment is applied against the amount allocated to personal purposes. Vita free tax preparation The debt balance is now allocated as $8,000 for investment purposes and $1,500 for personal purposes. Vita free tax preparation Until the next reallocation is necessary, 84% ($8,000 ÷ $9,500) of the debt and the interest expense is allocated to investment. Vita free tax preparation Pass-through entities. Vita free tax preparation   If you use borrowed funds to buy an interest in a partnership or S corporation, then the interest on those funds must be allocated based on the assets of the entity. Vita free tax preparation If you contribute to the capital of the entity, you can make the allocation using any reasonable method. Vita free tax preparation Additional allocation rules. Vita free tax preparation   For more information about allocating interest expense, see chapter 4 of Publication 535. Vita free tax preparation When To Deduct Investment Interest If you use the cash method of accounting, you must pay the interest before you can deduct it. Vita free tax preparation If you use an accrual method of accounting, you can deduct interest over the period it accrues, regardless of when you pay it. Vita free tax preparation For an exception, see Unpaid expenses owed to related party under When To Report Investment Expenses, later in this chapter. Vita free tax preparation Example. Vita free tax preparation You borrowed $1,000 on August 26, 2013, payable in 90 days at 12% interest. Vita free tax preparation On November 26, 2013, you paid this with a new note for $1,030, due on February 26, 2014. Vita free tax preparation If you use the cash method of accounting, you cannot deduct any part of the $30 interest on your return for 2013 because you did not actually pay it. Vita free tax preparation If you use an accrual method, you may be able to deduct a portion of the interest on the loans through December 31, 2013, on your return for 2013. Vita free tax preparation Interest paid in advance. Vita free tax preparation   Generally, if you pay interest in advance for a period that goes beyond the end of the tax year, you must spread the interest over the tax years to which it belongs under the OID rules discussed in chapter 1. Vita free tax preparation You can deduct in each year only the interest for that year. Vita free tax preparation Interest on margin accounts. Vita free tax preparation   If you are a cash method taxpayer, you can deduct interest on margin accounts to buy taxable securities as investment interest in the year you paid it. Vita free tax preparation You are considered to have paid interest on these accounts only when you actually pay the broker or when payment becomes available to the broker through your account. Vita free tax preparation Payment may become available to the broker through your account when the broker collects dividends or interest for your account, or sells securities held for you or received from you. Vita free tax preparation   You cannot deduct any interest on money borrowed for personal reasons. Vita free tax preparation Limit on interest deduction for market discount bonds. Vita free tax preparation   The amount you can deduct for interest expense you paid or accrued during the year to buy or carry a market discount bond may be limited. Vita free tax preparation This limit does not apply if you accrue the market discount and include it in your income currently. Vita free tax preparation   Under this limit, the interest is deductible only to the extent it is more than: The total interest and OID includible in gross income for the bond for the year, plus The market discount for the number of days you held the bond during the year. Vita free tax preparation Figure the amount in (2) above using the rules for figuring accrued market discount in chapter 1 under Market Discount Bonds . Vita free tax preparation Interest not deducted due to limit. Vita free tax preparation   In the year you dispose of the bond, you can deduct any interest expense you were not allowed to deduct in earlier years because of the limit. Vita free tax preparation Choosing to deduct disallowed interest expense before the year of disposition. Vita free tax preparation   You can choose to deduct disallowed interest expense in any year before the year you dispose of the bond, up to your net interest income from the bond during the year. Vita free tax preparation The rest of the disallowed interest expense remains deductible in the year you dispose of the bond. Vita free tax preparation Net interest income. Vita free tax preparation   This is the interest income (including OID) from the bond that you include in income for the year, minus the interest expense paid or accrued during the year to purchase or carry the bond. Vita free tax preparation Limit on interest deduction for short-term obligations. Vita free tax preparation   If the current income inclusion rules discussed in chapter 1 under Discount on Short-Term Obligations do not apply to you, the amount you can deduct for interest expense you paid or accrued during the year to buy or carry a short-term obligation is limited. Vita free tax preparation   The interest is deductible only to the extent it is more than: The amount of acquisition discount or OID on the obligation for the tax year, plus The amount of any interest payable on the obligation for the year that is not included in income because of your accounting method (other than interest taken into account in determining the amount of acquisition discount or OID). Vita free tax preparation The method of determining acquisition discount and OID for short-term obligations is discussed in chapter 1 under Discount on Short-Term Obligations . Vita free tax preparation Interest not deducted due to limit. Vita free tax preparation   In the year you dispose of the obligation, or, if you choose, in another year in which you have net interest income from the obligation, you can deduct any interest expense you were not allowed to deduct for an earlier year because of the limit. Vita free tax preparation Follow the same rules provided in the earlier discussion under Limit on interest deduction for market discount bonds , earlier. Vita free tax preparation Limit on Deduction Generally, your deduction for investment interest expense is limited to your net investment income. Vita free tax preparation You can carry over the amount of investment interest you could not deduct because of this limit to the next tax year. Vita free tax preparation The interest carried over is treated as investment interest paid or accrued in that next year. Vita free tax preparation You can carry over disallowed investment interest to the next tax year even if it is more than your taxable income in the year the interest was paid or accrued. Vita free tax preparation Net Investment Income Determine the amount of your net investment income by subtracting your investment expenses (other than interest expense) from your investment income. Vita free tax preparation Investment income. Vita free tax preparation   This generally includes your gross income from property held for investment (such as interest, dividends, annuities, and royalties). Vita free tax preparation Investment income does not include Alaska Permanent Fund dividends. Vita free tax preparation It also does not include qualified dividends or net capital gain unless you choose to include them. Vita free tax preparation Choosing to include qualified dividends. Vita free tax preparation   Investment income generally does not include qualified dividends, discussed in chapter 1. Vita free tax preparation However, you can choose to include all or part of your qualified dividends in investment income. Vita free tax preparation   You make this choice by completing Form 4952, line 4g, according to its instructions. Vita free tax preparation   If you choose to include any of your qualified dividends in investment income, you must reduce your qualified dividends that are eligible for the lower capital gains tax rates by the same amount. Vita free tax preparation Choosing to include net capital gain. Vita free tax preparation    Investment income generally does not include net capital gain from disposing of investment property (including capital gain distributions from mutual funds). Vita free tax preparation However, you can choose to include all or part of your net capital gain in investment income. Vita free tax preparation   You make this choice by completing Form 4952, line 4g, according to its instructions. Vita free tax preparation   If you choose to include any of your net capital gain in investment income, you must reduce your net capital gain that is eligible for the lower capital gains tax rates by the same amount. Vita free tax preparation   For more information about the capital gains rates, see Capital Gain Tax Rates in chapter 4. Vita free tax preparation    Before making either choice, consider the overall effect on your tax liability. Vita free tax preparation Compare your tax if you make one or both of these choices with your tax if you do not. Vita free tax preparation Investment income of child reported on parent's return. Vita free tax preparation   Investment income includes the part of your child's interest and dividend income you choose to report on your return. Vita free tax preparation If the child does not have qualified dividends, Alaska Permanent Fund dividends, or capital gain distributions, this is the amount on line 6 of Form 8814. Vita free tax preparation Include it on line 4a of Form 4952. Vita free tax preparation Example. Vita free tax preparation Your 8-year-old son has interest income of $2,200, which you choose to report on your own return. Vita free tax preparation You enter $2,200 on Form 8814, lines 1a and 4, and $200 on lines 6 and 12 and complete Part II. Vita free tax preparation Also enter $200 on Form 1040, line 21. Vita free tax preparation Your investment income includes this $200. Vita free tax preparation Child's qualified dividends. Vita free tax preparation   If part of the amount you report is your child's qualified dividends, that part (which is reported on Form 1040, line 9b) generally does not count as investment income. Vita free tax preparation However, you can choose to include all or part of it in investment income, as explained under Choosing to include qualified dividends , earlier. Vita free tax preparation   Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured next under Child's Alaska Permanent Fund dividends). Vita free tax preparation Child's Alaska Permanent Fund dividends. Vita free tax preparation   If part of the amount you report is your child's Alaska Permanent Fund dividends, that part does not count as investment income. Vita free tax preparation To figure the amount of your child's income that you can consider your investment income, start with the amount on Form 8814, line 6. Vita free tax preparation Multiply that amount by a percentage that is equal to the Alaska Permanent Fund dividends divided by the total amount on Form 8814, line 4. Vita free tax preparation Subtract the result from the amount on Form 8814, line 12. Vita free tax preparation Example. Vita free tax preparation Your 10-year-old child has taxable interest income of $4,000 and Alaska Permanent Fund dividends of $2,000. Vita free tax preparation You choose to report this on your return. Vita free tax preparation You enter $4,000 on Form 8814, line 1a, $2,000 on line 2a, and $6,000 on line 4. Vita free tax preparation You then enter $4,000 on Form 8814, lines 6 and 12, and Form 1040, line 21. Vita free tax preparation You figure the amount of your child's income that you can consider your investment income as follows: $4,000 − ($4,000 × ($2,000 ÷ $6,000)) = $2,667 You include the result, $2,667, on Form 4952, line 4a. Vita free tax preparation Child's capital gain distributions. Vita free tax preparation   If part of the amount you report is your child's capital gain distributions, that part (which is reported on Schedule D (Form 1040), line 13, or Form 1040, line 13) generally does not count as investment income. Vita free tax preparation However, you can choose to include all or part of it in investment income, as explained in Choosing to include net capital gain , earlier. Vita free tax preparation   Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured under Child's Alaska Permanent Fund dividends , earlier). Vita free tax preparation Investment expenses. Vita free tax preparation   Investment expenses are your allowed deductions (other than interest expense) directly connected with the production of investment income. Vita free tax preparation Investment expenses that are included as a miscellaneous itemized deduction on Schedule A (Form 1040) are allowable deductions after applying the 2% limit that applies to miscellaneous itemized deductions. Vita free tax preparation Use the smaller of: The investment expenses included on Schedule A (Form 1040), line 23, or The amount on Schedule A (Form 1040), line 27. Vita free tax preparation See Expenses of Producing Income , later, for a discussion of the 2% limit. Vita free tax preparation Losses from passive activities. Vita free tax preparation   Income or expenses that you used in computing income or loss from a passive activity are not included in determining your investment income or investment expenses (including investment interest expense). Vita free tax preparation See Publication 925 for information about passive activities. Vita free tax preparation Example. Vita free tax preparation Ted is a partner in a partnership that operates a business. Vita free tax preparation However, he does not materially participate in the partnership's business. Vita free tax preparation Ted's interest in the partnership is considered a passive activity. Vita free tax preparation Ted's investment income from interest and dividends (other than qualified dividends) is $10,000. Vita free tax preparation His investment expenses (other than interest) are $3,200 after taking into account the 2% limit on miscellaneous itemized deductions. Vita free tax preparation His investment interest expense is $8,000. Vita free tax preparation Ted also has income from the partnership of $2,000. Vita free tax preparation Ted figures his net investment income and the limit on his investment interest expense deduction in the following way: Total investment income $10,000 Minus: Investment expenses (other than interest) 3,200 Net investment income $6,800 Deductible investment interest expense for the year $6,800 The $2,000 of income from the passive activity is not used in determining Ted's net investment income. Vita free tax preparation His investment interest deduction for the year is limited to $6,800, the amount of his net investment income. Vita free tax preparation Form 4952 Use Form 4952 to figure your deduction for investment interest. Vita free tax preparation See Form 4952 for more information. Vita free tax preparation Exception to use of Form 4952. Vita free tax preparation   You do not have to complete Form 4952 or attach it to your return if you meet all of the following tests. Vita free tax preparation Your investment interest expense is not more than your investment income from interest and ordinary dividends minus any qualified dividends. Vita free tax preparation You do not have any other deductible investment expenses. Vita free tax preparation You have no carryover of investment interest expense from 2012. Vita free tax preparation   If you meet all of these tests, you can deduct all of your investment interest. Vita free tax preparation    Bond Premium Amortization If you pay a premium to buy a bond, the premium is part of your basis in the bond. Vita free tax preparation If the bond yields taxable interest, you can choose to amortize the premium. Vita free tax preparation This generally means that each year, over the life of the bond, you use a part of the premium to reduce the amount of interest includible in your income. Vita free tax preparation If you make this choice, you must reduce your basis in the bond by the amortization for the year. Vita free tax preparation If the bond yields tax-exempt interest, you must amortize the premium. Vita free tax preparation This amortized amount is not deductible in determining taxable income. Vita free tax preparation However, each year you must reduce your basis in the bond (and tax-exempt interest otherwise reportable on Form 1040, line 8b) by the amortization for the year. Vita free tax preparation Bond premium. Vita free tax preparation   Bond premium is the amount by which your basis in the bond right after you get it is more than the total of all amounts payable on the bond after you get it (other than payments of qualified stated interest). Vita free tax preparation For example, a bond with a maturity value of $1,000 generally would have a $50 premium if you buy it for $1,050. Vita free tax preparation Special rules to determine amounts payable on a bond. Vita free tax preparation   For special rules that apply to determine the amounts payable on a variable rate bond, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules (for example, a bond callable prior to the stated maturity date of the bond), or a bond that provides for remote or incidental contingencies, see Regulations section 1. Vita free tax preparation 171-3. Vita free tax preparation Basis. Vita free tax preparation   In general, your basis for figuring bond premium amortization is the same as your basis for figuring any loss on the sale of the bond. Vita free tax preparation However, you may need to use a different basis for: Convertible bonds, Bonds you got in a trade, and Bonds whose basis has to be determined using the basis of the person who transferred the bond to you. Vita free tax preparation See Regulations section 1. Vita free tax preparation 171-1(e). Vita free tax preparation Dealers. Vita free tax preparation   A dealer in taxable bonds (or anyone who holds them mainly for sale to customers in the ordinary course of a trade or business or who would properly include bonds in inventory at the close of the tax year) cannot claim a deduction for amortizable bond premium. Vita free tax preparation   See section 75 of the Internal Revenue Code for the treatment of bond premium by a dealer in tax-exempt bonds. Vita free tax preparation How To Figure Amortization For bonds issued after September 27, 1985, you must amortize bond premium using a constant yield method on the basis of the bond's yield to maturity, determined by using the bond's basis and compounding at the close of each accrual period. Vita free tax preparation Constant yield method. Vita free tax preparation   Figure the bond premium amortization for each accrual period as follows. Vita free tax preparation Step 1: Determine your yield. Vita free tax preparation   Your yield is the discount rate that, when used in figuring the present value of all remaining payments to be made on the bond (including payments of qualified stated interest), produces an amount equal to your basis in the bond. Vita free tax preparation Figure the yield as of the date you got the bond. Vita free tax preparation It must be constant over the term of the bond and must be figured to at least two decimal places when expressed as a percentage. Vita free tax preparation   If you do not know the yield, consult your broker or tax advisor. Vita free tax preparation Databases available to them are likely to show the yield at the date of purchase. Vita free tax preparation Step 2: Determine the accrual periods. Vita free tax preparation   You can choose the accrual periods to use. Vita free tax preparation They may be of any length and may vary in length over the term of the bond, but each accrual period can be no longer than 1 year and each scheduled payment of principal or interest must occur either on the first or the final day of an accrual period. Vita free tax preparation The computation is simplest if accrual periods are the same as the intervals between interest payment dates. Vita free tax preparation Step 3: Determine the bond premium for the accrual period. Vita free tax preparation   To do this, multiply your adjusted acquisition price at the beginning of the accrual period by your yield. Vita free tax preparation Then subtract the result from the qualified stated interest for the period. Vita free tax preparation   Your adjusted acquisition price at the beginning of the first accrual period is the same as your basis. Vita free tax preparation After that, it is your basis decreased by the amount of bond premium amortized for earlier periods and the amount of any payment previously made on the bond other than a payment of qualified stated interest. Vita free tax preparation Example. Vita free tax preparation On February 1, 2012, you bought a taxable bond for $110,000. Vita free tax preparation The bond has a stated principal amount of $100,000, payable at maturity on February 1, 2019, making your premium $10,000 ($110,000 − $100,000). Vita free tax preparation The bond pays qualified stated interest of $10,000 on February 1 of each year. Vita free tax preparation Your yield is 8. Vita free tax preparation 07439% compounded annually. Vita free tax preparation You choose to use annual accrual periods ending on February 1 of each year. Vita free tax preparation To find your bond premium amortization for the accrual period ending on February 1, 2013, you multiply the adjusted acquisition price at the beginning of the period ($110,000) by your yield. Vita free tax preparation When you subtract the result ($8,881. Vita free tax preparation 83) from the qualified stated interest for the period ($10,000), you find that your bond premium amortization for the period is $1,118. Vita free tax preparation 17. Vita free tax preparation Special rules to figure amortization. Vita free tax preparation   For special rules to figure the bond premium amortization on a variable rate bond, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules (for example, a bond callable prior to the stated maturity date of the bond), or a bond that provides for remote or incidental contingencies, see Regulations section 1. Vita free tax preparation 171-3. Vita free tax preparation Bonds Issued Before September 28, 1985 For these bonds, you can amortize bond premium using any reasonable method. Vita free tax preparation Reasonable methods include: The straight-line method, and The Revenue Ruling 82-10 method. Vita free tax preparation Straight-line method. Vita free tax preparation   Under this method, the amount of your bond premium amortization is the same each month. Vita free tax preparation Divide the number of months you held the bond during the year by the number of months from the beginning of the tax year (or, if later, the date of acquisition) to the date of maturity or earlier call date. Vita free tax preparation Then multiply the result by the bond premium (reduced by any bond premium amortization claimed in earlier years). Vita free tax preparation This gives you your bond premium amortization for the year. Vita free tax preparation Revenue Ruling 82-10 method. Vita free tax preparation   Under this method, the amount of your bond premium amortization increases each month over the life of the bond. Vita free tax preparation This method is explained in Revenue Ruling 82-10, 1982-1 C. Vita free tax preparation B. Vita free tax preparation 46. Vita free tax preparation Choosing To Amortize You choose to amortize the premium on taxable bonds by reporting the amortization for the year on your income tax return for the first tax year you want the choice to apply. Vita free tax preparation You should attach a statement to your return that you are making this choice under section 171. Vita free tax preparation See How To Report Amortization, next. Vita free tax preparation This choice is binding for the year you make it and for later tax years. Vita free tax preparation It applies to all taxable bonds you own in the year you make the choice and also to those you acquire in later years. Vita free tax preparation You can change your decision to amortize bond premium only with the written approval of the IRS. Vita free tax preparation To request approval, use Form 3115. Vita free tax preparation For more information on requesting approval, see section 5 of the Appendix to Revenue Procedure 2011-14 in Internal Revenue Bulletin 2011-4. Vita free tax preparation You can find Revenue Procedure 2011-14 at www. Vita free tax preparation irs. Vita free tax preparation gov/irb/2011-04_IRB/ar08. Vita free tax preparation html. Vita free tax preparation How To Report Amortization Subtract the bond premium amortization from your interest income from these bonds. Vita free tax preparation Report the bond's interest on Schedule B (Form 1040A or 1040), line 1. Vita free tax preparation Under your last entry on line 1, put a subtotal of all interest listed on line 1. Vita free tax preparation Below this subtotal, print “ABP Adjustment,” and the total interest you received. Vita free tax preparation Subtract this amount from the subtotal, and enter the result on line 2. Vita free tax preparation Bond premium amortization more than interest. Vita free tax preparation   If the amount of your bond premium amortization for an accrual period is more than the qualified stated interest for the period, you can deduct the difference as a miscellaneous itemized deduction on Schedule A (Form 1040), line 28. Vita free tax preparation    But your deduction is limited to the amount by which your total interest inclusions on the bond in prior accrual periods is more than your total bond premium deductions on the bond in prior periods. Vita free tax preparation Any amount you cannot deduct because of this limit can be carried forward to the next accrual period. Vita free tax preparation Pre-1998 election to amortize bond premium. Vita free tax preparation   Generally, if you first elected to amortize bond premium before 1998, the above treatment of the premium does not apply to bonds you acquired before 1988. Vita free tax preparation Bonds acquired before October 23, 1986. Vita free tax preparation   The amortization of the premium on these bonds is a miscellaneous itemized deduction not subject to the 2%-of-adjusted-gross-income limit. Vita free tax preparation Bonds acquired after October 22, 1986, but before 1988. Vita free tax preparation    The amortization of the premium on these bonds is investment interest expense subject to the investment interest limit, unless you choose to treat it as an offset to interest income on the bond. Vita free tax preparation Expenses of Producing Income You deduct investment expenses (other than interest expenses) as miscellaneous itemized deductions on Schedule A (Form 1040). Vita free tax preparation To be deductible, these expenses must be ordinary and necessary expenses paid or incurred: To produce or collect income, or To manage property held for producing income. Vita free tax preparation The expenses must be directly related to the income or income-producing property, and the income must be taxable to you. Vita free tax preparation The deduction for most income-producing expenses is subject to a 2% limit that also applies to certain other miscellaneous itemized deductions. Vita free tax preparation The amount deductible is limited to the total of these miscellaneous deductions that is more than 2% of your adjusted gross income. Vita free tax preparation For information on how to report expenses of producing income, see How To Report Investment Expenses , later. Vita free tax preparation Attorney or accounting fees. Vita free tax preparation   You can deduct attorney or accounting fees that are necessary to produce or collect taxable income. Vita free tax preparation However, in some cases, attorney or accounting fees are part of the basis of property. Vita free tax preparation See Basis of Investment Property in chapter 4. Vita free tax preparation Automatic investment service and dividend reinvestment plans. Vita free tax preparation   A bank may offer its checking account customers an automatic investment service so that, for a charge, each customer can choose to invest a part of the checking account each month in common stock. Vita free tax preparation Or a bank that is a dividend disbursing agent for a number of publicly-owned corporations may set up an automatic dividend reinvestment service. Vita free tax preparation Through that service, cash dividends are reinvested in more shares of stock after the bank deducts a service charge. Vita free tax preparation   A corporation in which you own stock also may have a dividend reinvestment plan. Vita free tax preparation This plan lets you choose to use your dividends to buy more shares of stock in the corporation instead of receiving the dividends in cash. Vita free tax preparation   You can deduct the monthly service charge you pay to a bank to participate in an automatic investment service. Vita free tax preparation If you participate in a dividend reinvestment plan, you can deduct any service charge subtracted from your cash dividends before the dividends are used to buy more shares of stock. Vita free tax preparation Deduct the charges in the year you pay them. Vita free tax preparation Clerical help and office rent. Vita free tax preparation   You can deduct office expenses, such as rent and clerical help, you incurred in connection with your investments and collecting the taxable income on your investments. Vita free tax preparation Cost of replacing missing securities. Vita free tax preparation   To replace your taxable securities that are mislaid, lost, stolen, or destroyed, you may have to post an indemnity bond. Vita free tax preparation You can deduct the premium you pay to buy the indemnity bond and the related incidental expenses. Vita free tax preparation   You may, however, get a refund of part of the bond premium if the missing securities are recovered within a specified time. Vita free tax preparation Under certain types of insurance policies, you can recover some of the expenses. Vita free tax preparation   If you receive the refund in the tax year you pay the amounts, you can deduct only the difference between the expenses paid and the amount refunded. Vita free tax preparation If the refund is made in a later tax year, you must include the refund in income in the year you received it, but only to the extent that the expenses decreased your tax in the year you deducted them. Vita free tax preparation Fees to collect income. Vita free tax preparation   You can deduct fees you pay to a broker, bank, trustee, or similar agent to collect investment income, such as your taxable bond or mortgage interest, or your dividends on shares of stock. Vita free tax preparation Fees to buy or sell. Vita free tax preparation   You cannot deduct a fee you pay to a broker to acquire investment property, such as stocks or bonds. Vita free tax preparation You must add the fee to the cost of the property. Vita free tax preparation See Basis of Investment Property in chapter 4. Vita free tax preparation    You cannot deduct any broker's fees, commissions, or option premiums you pay (or that were netted out) in connection with the sale of investment property. Vita free tax preparation They can be used only to figure gain or loss from the sale. Vita free tax preparation See Reporting Capital Gains and Losses , in chapter 4, for more information about the treatment of these sale expenses. Vita free tax preparation Investment counsel and advice. Vita free tax preparation   You can deduct fees you pay for counsel and advice about investments that produce taxable income. Vita free tax preparation This includes amounts you pay for investment advisory services. Vita free tax preparation Safe deposit box rent. Vita free tax preparation   You can deduct rent you pay for a safe deposit box if you use the box to store taxable income-producing stocks, bonds, or other investment-related papers and documents. Vita free tax preparation If you also use the box to store tax-exempt securities or personal items, you can deduct only part of the rent. Vita free tax preparation See Tax-exempt income under Nondeductible Expenses, later, to figure what part you can deduct. Vita free tax preparation State and local transfer taxes. Vita free tax preparation   You cannot deduct the state and local transfer taxes you pay when you buy or sell securities. Vita free tax preparation If you pay these transfer taxes when you buy securities, you must treat them as part of the cost of the property. Vita free tax preparation If you pay these transfer taxes when you sell securities, you must treat them as a reduction in the amount realized. Vita free tax preparation Trustee's commissions for revocable trust. Vita free tax preparation   If you set up a revocable trust and have its income distributed to you, you can deduct the commission you pay the trustee for managing the trust to the extent it is to produce or collect taxable income or to manage property. Vita free tax preparation However, you cannot deduct any part of the commission used for producing or collecting tax-exempt income or for managing property that produces tax-exempt income. Vita free tax preparation   If you are a cash-basis taxpayer and pay the commissions for several years in advance, you must deduct a part of the commission each year. Vita free tax preparation You cannot deduct the entire amount in the year you pay it. Vita free tax preparation Investment expenses from pass-through entities. Vita free tax preparation   If you hold an interest in a partnership, S corporation, real estate mortgage investment conduit (REMIC), or a nonpublicly offered mutual fund, you can deduct your share of that entity's investment expenses. Vita free tax preparation A partnership or S corporation will show your share of these expenses on your Schedule K-1 (Form 1065) or Schedule K-1 (Form 1120S). Vita free tax preparation A nonpublicly offered mutual fund will indicate your share of these expenses in box 5 of Form 1099-DIV (or substitute statement). Vita free tax preparation Publicly-offered mutual funds are discussed later. Vita free tax preparation   If you hold an interest in a REMIC, any expenses relating to your residual interest investment will be shown on Schedule Q (Form 1066), line 3b. Vita free tax preparation Any expenses relating to your regular interest investment will appear in box 5 of Form 1099-INT (or substitute statement) or box 9 of Form 1099-OID (or substitute statement). Vita free tax preparation   Report your share of these investment expenses on Schedule A (Form 1040), subject to the 2% limit, in the same manner as your other investment expenses. Vita free tax preparation Including mutual fund or REMIC expenses in income. Vita free tax preparation   Your share of the investment expenses of a REMIC or a nonpublicly offered mutual fund, as described above, are considered to be indirect deductions through that pass-through entity. Vita free tax preparation You must include in your gross income an amount equal to the expenses allocated to you, whether or not you are able to claim a deduction for those expenses. Vita free tax preparation If you are a shareholder in a nonpublicly offered mutual fund, you must include on your return the full amount of ordinary dividends or other distributions of stock, as shown in box 1a of Form 1099-DIV (or substitute statement). Vita free tax preparation If you are a residual interest holder in a REMIC, you must report as ordinary income on Schedule E (Form 1040) the total amounts shown on Schedule Q (Form 1066), lines 1b and 3b. Vita free tax preparation If you are a REMIC regular interest holder, you must include the amount of any expense allocation you received on Form 1040, line 8a. Vita free tax preparation Publicly-offered mutual funds. Vita free tax preparation   Most mutual funds are publicly offered. Vita free tax preparation These mutual funds, generally, are traded on an established securities exchange. Vita free tax preparation These funds do not pass investment expenses through to you. Vita free tax preparation Instead, the dividend income they report to you in box 1a of Form 1099-DIV (or substitute statement) is already reduced by your share of investment expenses. Vita free tax preparation As a result, you cannot deduct the expenses on your return. Vita free tax preparation   Include the amount from box 1a of Form 1099-DIV (or substitute statement) in your income. Vita free tax preparation    A publicly offered mutual fund is one that: Is continuously offered pursuant to a public offering, Is regularly traded on an established securities market, and Is held by or for no fewer than 500 persons at any time during the year. Vita free tax preparation Contact your mutual fund if you are not sure whether it is publicly offered. Vita free tax preparation Nondeductible Expenses Some expenses that you incur as an investor are not deductible. Vita free tax preparation Stockholders' meetings. Vita free tax preparation   You cannot deduct transportation and other expenses you pay to attend stockholders' meetings of companies in which you have no interest other than owning stock. Vita free tax preparation This is true even if your purpose in attending is to get information that would be useful in making further investments. Vita free tax preparation Investment-related seminar. Vita free tax preparation   You cannot deduct expenses for attending a convention, seminar, or similar meeting for investment purposes. Vita free tax preparation Single-premium life insurance, endowment, and annuity contracts. Vita free tax preparation   You cannot deduct interest on money you borrow to buy or carry a single-premium life insurance, endowment, or annuity contract. Vita free tax preparation Used as collateral. Vita free tax preparation   If you use a single premium annuity contract as collateral to obtain or continue a mortgage loan, you cannot deduct any interest on the loan that is collateralized by the annuity contract. Vita free tax preparation Figure the amount of interest expense disallowed by multiplying the current interest rate on the mortgage loan by the lesser of the amount of the annuity contract used as collateral or the amount of the loan. Vita free tax preparation Borrowing on insurance. Vita free tax preparation   Generally, you cannot deduct interest on money you borrow to buy or carry a life insurance, endowment, or annuity contract if you plan to systematically borrow part or all of the increases in the cash value of the contract. Vita free tax preparation This rule applies to the interest on the total amount borrowed to buy or carry the contract, not just the interest on the borrowed increases in the cash value. Vita free tax preparation Tax-exempt income. Vita free tax preparation   You cannot deduct expenses you incur to produce tax-exempt income. Vita free tax preparation Nor can you deduct interest on money you borrow to buy tax-exempt securities or shares in a mutual fund or other regulated investment company that distributes only exempt-interest dividends. Vita free tax preparation Short-sale expenses. Vita free tax preparation   The rule disallowing a deduction for interest expenses on tax-exempt securities applies to amounts you pay in connection with personal property used in a short sale or amounts paid by others for the use of any collateral in connection with the short sale. Vita free tax preparation However, it does not apply to the expenses you incur if you deposit cash as collateral for the property used in the short sale and the cash does not earn a material return during the period of the sale. Vita free tax preparation Short sales are discussed in Short Sales in chapter 4. Vita free tax preparation Expenses for both tax-exempt and taxable income. Vita free tax preparation   You may have expenses that are for both tax-exempt and taxable income. Vita free tax preparation If you cannot specifically identify what part of the expenses is for each type of income, you can divide the expenses, using reasonable proportions based on facts and circumstances. Vita free tax preparation You must attach a statement to your return showing how you divided the expenses and stating that each deduction claimed is not based on tax-exempt income. Vita free tax preparation   One accepted method for dividing expenses is to do it in the same proportion that each type of income is to the total income. Vita free tax preparation If the expenses relate in part to capital gains and losses, include the gains, but not the losses, in figuring this proportion. Vita free tax preparation To find the part of the expenses that is for the tax-exempt income, divide your tax-exempt income by the total income and multiply your expenses by the result. Vita free tax preparation Example. Vita free tax preparation You received $6,000 interest; $4,800 was tax-exempt and $1,200 was taxable. Vita free tax preparation In earning this income, you had $500 of expenses. Vita free tax preparation You cannot specifically identify the amount of each expense item that is for each income item, so you must divide your expenses. Vita free tax preparation 80% ($4,800 tax-exempt interest divided by $6,000 total interest) of your expenses is for the tax-exempt income. Vita free tax preparation You cannot deduct $400 (80% of $500) of the expenses. Vita free tax preparation You can deduct $100 (the rest of the expenses) because they are for the taxable interest. Vita free tax preparation State income taxes. Vita free tax preparation   If you itemize your deductions, you can deduct, as taxes, state income taxes on interest income that is exempt from federal income tax. Vita free tax preparation But you cannot deduct, as either taxes or investment expenses, state income taxes on other exempt income. Vita free tax preparation Interest expense and carrying charges on straddles. Vita free tax preparation   You cannot deduct interest and carrying charges allocable to personal property that is part of a straddle. Vita free tax preparation The nondeductible interest and carrying charges are added to the basis of the straddle property. Vita free tax preparation However, this treatment does not apply if: All the offsetting positions making up the straddle either consist of one or more qualified covered call options and the optioned stock, or consist of section 1256 contracts (and the straddle is not part of a larger straddle); or The straddle is a hedging transaction. Vita free tax preparation  For information about straddles, including definitions of the terms used in this discussion, see Straddles in chapter 4. Vita free tax preparation   Interest includes any amount you pay or incur in connection with personal property used in a short sale. Vita free tax preparation However, you must first apply the rules discussed in Payments in lieu of dividends under Short Sales in chapter 4. Vita free tax preparation   To determine the interest on market discount bonds and short-term obligations that are part of a straddle, you must first apply the rules discussed under Limit on interest deduction for market discount bonds and Limit on interest deduction for short-term obligations (both under Interest Expenses, earlier). Vita free tax preparation Nondeductible amount. Vita free tax preparation   Figure the nondeductible interest and carrying charges on straddle property as follows. Vita free tax preparation Add: Interest on indebtedness incurred or continued to buy or carry the personal property, and All other amounts (including charges to insure, store, or transport the personal property) paid or incurred to carry the personal property. Vita free tax preparation Subtract from the amount in (1): Interest (including OID) includible in gross income for the year on the personal property, Any income from the personal property treated as ordinary income on the disposition of short-term government obligations or as ordinary income under the market discount and short-term bond provisions — see Discount on Debt Instruments in chapter 1, The dividends includible in gross income for the year from the personal property, and Any payment on a loan of the personal property for use in a short sale that is includible in gross income. Vita free tax preparation Basis adjustment. Vita free tax preparation   Add the nondeductible amount to the basis of your straddle property. Vita free tax preparation How To Report Investment Expenses To deduct your investment expenses, you must itemize deductions on Schedule A (Form 1040). Vita free tax preparation Enter your deductible investment interest expense on Schedule A (Form1040), line 14. Vita free tax preparation Include any deductible short sale expenses. Vita free tax preparation (See Short Sales in chapter 4 for information on these expenses. Vita free tax preparation ) Also attach a completed Form 4952 if you used that form to figure your investment interest expense. Vita free tax preparation Enter the total amount of your other investment expenses (other than interest expenses) on Schedule A (Form 1040), line 23. Vita free tax preparation List the type and amount of each expense on the dotted lines next to line 23. Vita free tax preparation (If necessary, you can show the required information on an attached statement. Vita free tax preparation ) For information on how to report amortizable bond premium, see Bond Premium Amortization , earlier in this chapter. Vita free tax preparation When To Report Investment Expenses If you use the cash method to report income and expenses, you generally deduct your expenses, except for certain prepaid interest, in the year you pay them. Vita free tax preparation If you use an accrual method, you generally deduct your expenses when you incur a liability for them, rather than when you pay them. Vita free tax preparation Also see When To Deduct Investment Interest , earlier in this chapter. Vita free tax preparation Unpaid expenses owed to related party. Vita free tax preparation   If you use an accrual method, you cannot deduct interest and other expenses owed to a related cash-basis person until payment is made and the amount is includible in the gross income of that person. Vita free tax preparation The relationship, for purposes of this rule, is determined as of the end of the tax year for which the interest or expense would otherwise be deductible. Vita free tax preparation If a deduction is denied under this rule, this rule will continue to apply even if your relationship with the person ceases to exist before the amount is includible in the gross income of that person. Vita free tax preparation   This rule generally applies to those relationships listed in chapter 4 under Related Party Transactions . Vita free tax preparation It also applies to accruals by partnerships to partners, partners to partnerships, shareholders to S corporations, and S corporations to shareholders. Vita free tax preparation   The postponement of deductions for unpaid expenses and interest under the related party rule does not apply to OID, regardless of when payment is made. Vita free tax preparation This rule also does not apply to loans with below-market interest rates or to certain payments for the use of property and services when the lender or recipient has to include payments periodically in income, even if a payment has not been made. Vita free tax preparation Prev  Up  Next   Home   More Online Publications
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Vita free tax preparation 5. Vita free tax preparation   Soil and Water Conservation Expenses Table of Contents Introduction Topics - This chapter discusses: Business of Farming Plan Certification Conservation ExpensesWater well. Vita free tax preparation Assessment by Conservation DistrictAssessment for Depreciable Property 25% Limit on DeductionNet operating loss. Vita free tax preparation When to Deduct or Capitalize Sale of a Farm Introduction If you are in the business of farming, you can choose to deduct certain expenses for: Soil or water conservation, Prevention of erosion of land used in farming, or Endangered species recovery. Vita free tax preparation Otherwise, these are capital expenses that must be added to the basis of the land. Vita free tax preparation (See chapter 6 for information on determining basis. Vita free tax preparation ) Conservation expenses for land in a foreign country do not qualify for this special treatment. Vita free tax preparation The deduction for conservation expenses cannot be more than 25% of your gross income from farming. Vita free tax preparation See 25% Limit on Deduction , later. Vita free tax preparation Although some expenses are not deductible as soil and water conservation expenses, they may be deductible as ordinary and necessary farm expenses. Vita free tax preparation These include interest and taxes, the cost of periodically clearing brush from productive land, the regular removal of sediment from a drainage ditch, and expenses paid or incurred primarily to produce an agricultural crop that may also conserve soil. Vita free tax preparation You must include in income most government payments for approved conservation practices. Vita free tax preparation However, you can exclude some payments you receive under certain cost-sharing conservation programs. Vita free tax preparation For more information, see Agricultural Program Payments in chapter 3. Vita free tax preparation To get the full deduction to which you are entitled, you should maintain your records to clearly distinguish between your ordinary and necessary farm business expenses and your soil and water conservation expenses. Vita free tax preparation Topics - This chapter discusses: Business of farming Plan certification Conservation expenses Assessment by conservation district 25% limit on deduction When to deduct or capitalize Sale of a farm Business of Farming For purposes of soil and water conservation expenses, you are in the business of farming if you cultivate, operate, or manage a farm for profit, either as an owner or a tenant. Vita free tax preparation You are not in the business of farming if you cultivate or operate a farm for recreation or pleasure, rather than for profit. Vita free tax preparation You are not farming if you are engaged only in forestry or the growing of timber. Vita free tax preparation Farm defined. Vita free tax preparation   A farm includes livestock, dairy, poultry, fish, fruit, and truck farms. Vita free tax preparation It also includes plantations, ranches, ranges, and orchards. Vita free tax preparation A fish farm is an area where fish and other marine animals are grown or raised and artificially fed, protected, etc. Vita free tax preparation It does not include an area where they are merely caught or harvested. Vita free tax preparation A plant nursery is a farm for purposes of deducting soil and water conservation expenses. Vita free tax preparation Farm rental. Vita free tax preparation   If you own a farm and receive farm rental payments based on farm production, either in cash or crop shares, you are in the business of farming. Vita free tax preparation If you get cash rental for a farm you own that is not used in farm production, you cannot deduct soil and water conservation expenses for that farm. Vita free tax preparation   If you receive a fixed rental payment that is not based on farm production, you are in the business of farming only if you materially participate in operating or managing the farm. Vita free tax preparation Example. Vita free tax preparation You own a farm in Iowa and live in California. Vita free tax preparation You rent the farm for $175 in cash per acre and do not materially participate in producing or managing production of the crops grown on the farm. Vita free tax preparation You cannot deduct your soil conservation expenses for this farm. Vita free tax preparation You must capitalize the expenses and add them to the basis of the land. Vita free tax preparation     For more information, see Material participation for landlords under Landlord Participation in Farming in chapter 12. Vita free tax preparation Plan Certification You can deduct soil and water conservation expenses only if they are consistent with a plan approved by the Natural Resources Conservation Service (NRCS) of the Department of Agriculture. Vita free tax preparation If no such plan exists, the expenses must be consistent with a soil conservation plan of a comparable state agency. Vita free tax preparation Keep a copy of the plan with your books and records to support your deductions. Vita free tax preparation Conservation plan. Vita free tax preparation   A conservation plan includes the farming conservation practices approved for the area where your farmland is located. Vita free tax preparation There are three types of approved plans. Vita free tax preparation NRCS individual site plans. Vita free tax preparation These plans are issued individually to farmers who request assistance from NRCS to develop a conservation plan designed specifically for their farmland. Vita free tax preparation NRCS county plans. Vita free tax preparation These plans include a listing of farm conservation practices approved for the county where the farmland is located. Vita free tax preparation You can deduct expenses for conservation practices not included on the NRCS county plans only if the practice is a part of an individual site plan. Vita free tax preparation Comparable state agency plans. Vita free tax preparation These plans are approved by state agencies and can be approved individual site plans or county plans. Vita free tax preparation   A list of NRCS conservation programs is available at www. Vita free tax preparation nrcs. Vita free tax preparation usda. Vita free tax preparation gov/programs. Vita free tax preparation Individual site plans can be obtained from NRCS offices and the comparable state agencies. Vita free tax preparation Conservation Expenses You can deduct conservation expenses only for land you or your tenant are using, or have used in the past, for farming. Vita free tax preparation These expenses include, but are not limited to, the following. Vita free tax preparation The treatment or movement of earth, such as: Leveling, Conditioning, Grading, Terracing, Contour furrowing, and Restoration of soil fertility. Vita free tax preparation The construction, control, and protection of: Diversion channels, Drainage ditches, Irrigation ditches, Earthen dams, and Watercourses, outlets, and ponds. Vita free tax preparation The eradication of brush. Vita free tax preparation The planting of windbreaks. Vita free tax preparation You cannot deduct expenses to drain or fill wetlands, or to prepare land for center pivot irrigation systems, as soil and water conservation expenses. Vita free tax preparation These expenses are added to the basis of the land. Vita free tax preparation If you choose to deduct soil and water conservation expenses, you cannot exclude from gross income any cost-sharing payments you receive for those expenses. Vita free tax preparation See chapter 3 for information about payments eligible for the cost-sharing exclusion. Vita free tax preparation New farm or farmland. Vita free tax preparation   If you acquire a new farm or new farmland from someone who was using it in farming immediately before you acquired the land, soil and water conservation expenses you incur on it will be treated as made on land used in farming at the time the expenses were paid or incurred. Vita free tax preparation You can deduct soil and water conservation expenses for this land if your use of it is substantially a continuation of its use in farming. Vita free tax preparation The new farming activity does not have to be the same as the old farming activity. Vita free tax preparation For example, if you buy land that was used for grazing cattle and then prepare it for use as an apple orchard, you can deduct your conservation expenses. Vita free tax preparation Land not used for farming. Vita free tax preparation   If your conservation expenses benefit both land that does not qualify as land used for farming and land that does qualify, you must allocate the expenses between the two types of land. Vita free tax preparation For example, if the expenses benefit 200 acres of your land, but only 120 acres of this land are used for farming, then you can deduct 60% (120 ÷ 200) of the expenses. Vita free tax preparation You can use another method to allocate these expenses if you can clearly show that your method is more reasonable. Vita free tax preparation Depreciable conservation assets. Vita free tax preparation   You generally cannot deduct your expenses for depreciable conservation assets. Vita free tax preparation However, you can deduct certain amounts you pay or incur for an assessment for depreciable property that a soil and water conservation or drainage district levies against your farm. Vita free tax preparation See Assessment for Depreciable Property , later. Vita free tax preparation   You must capitalize expenses to buy, build, install, or improve depreciable structures or facilities. Vita free tax preparation These expenses include those for materials, supplies, wages, fuel, hauling, and moving dirt when making structures such as tanks, reservoirs, pipes, culverts, canals, dams, wells, or pumps composed of masonry, concrete, tile, metal, or wood. Vita free tax preparation You recover your capital investment through annual allowances for depreciation. Vita free tax preparation   You can deduct soil and water conservation expenses for nondepreciable earthen items. Vita free tax preparation Nondepreciable earthen items include certain dams, ponds, and terraces described under Property Having a Determinable Useful Life in chapter 7. Vita free tax preparation Water well. Vita free tax preparation   You cannot deduct the cost of drilling a water well for irrigation and other agricultural purposes as a soil and water conservation expense. Vita free tax preparation It is a capital expense. Vita free tax preparation You recover your cost through depreciation. Vita free tax preparation You also must capitalize your cost for drilling a test hole. Vita free tax preparation If the test hole produces no water and you continue drilling, the cost of the test hole is added to the cost of the producing well. Vita free tax preparation You can recover the total cost through depreciation deductions. Vita free tax preparation   If a test hole, dry hole, or dried-up well (resulting from prolonged lack of rain, for instance) is abandoned, you can deduct your unrecovered cost in the year of abandonment. Vita free tax preparation Abandonment means that all economic benefits from the well are terminated. Vita free tax preparation For example, filling or sealing a well excavation or casing so that all economic benefits from the well are terminated constitutes an abandonment. Vita free tax preparation Endangered species recovery expenses. Vita free tax preparation   If you are in the business of farming and meet other specific requirements, you can choose to deduct the conservation expenses discussed earlier as endangered species recovery expenses. Vita free tax preparation Otherwise, these are capital expenses that must be added to the basis of the land. Vita free tax preparation   The expenses must be paid or incurred for the purpose of achieving site-specific management actions recommended in a recovery plan approved under section 4(f) of the Endangered Species Act of 1973. Vita free tax preparation See Internal Revenue Code section 175 for more information. Vita free tax preparation Assessment by Conservation District In some localities, a soil or water conservation or drainage district incurs expenses for soil or water conservation and levies an assessment against the farmers who benefit from the expenses. Vita free tax preparation You can deduct as a conservation expense amounts you pay or incur for the part of an assessment that: Covers expenses you could deduct if you had paid them directly, or Covers expenses for depreciable property used in the district's business. Vita free tax preparation Assessment for Depreciable Property You generally can deduct as a conservation expense amounts you pay or incur for the part of a conservation or drainage district assessment that covers expenses for depreciable property. Vita free tax preparation This includes items such as pumps, locks, concrete structures (including dams and weir gates), draglines, and similar equipment. Vita free tax preparation The depreciable property must be used in the district's soil and water conservation activities. Vita free tax preparation However, the following limits apply to these assessments. Vita free tax preparation The total assessment limit. Vita free tax preparation The yearly assessment limit. Vita free tax preparation After you apply these limits, the amount you can deduct is added to your other conservation expenses for the year. Vita free tax preparation The total for these expenses is then subject to the 25% of gross income from farming limit on the deduction, discussed later. Vita free tax preparation See Table 5-1 for a brief summary of these limits. Vita free tax preparation Table 5-1. Vita free tax preparation Limits on Deducting an Assessment by a Conservation District for Depreciable Property Total Limit on Deduction for Assessment for Depreciable Property Yearly Limit on Deduction for Assessment for Depreciable Property Yearly Limit for All Conservation Expenses 10% of: $500 + 10% of: 25% of: Total assessment against all members of the district for the property. Vita free tax preparation Your deductible share of the cost to the district for the property. Vita free tax preparation Your gross income from farming. Vita free tax preparation No one taxpayer can deduct more than 10% of the total assessment. Vita free tax preparation Any amount over 10% is a capital expense and is added to the basis of your land. Vita free tax preparation If an assessment is paid in installments, each payment must be prorated between the conservation expense and the capital expense. Vita free tax preparation If the amount you pay or incur for any year is more than the limit, you can deduct for that year only 10% of your deductible share of the cost. Vita free tax preparation You can deduct the remainder in equal amounts over the next 9 tax years. Vita free tax preparation Limit for all conservation expenses, including assessments for depreciable property. Vita free tax preparation Amounts greater than 25% can be carried to the following year and added to that year's expenses. Vita free tax preparation The total is then subject to the 25% of gross income from farming limit in that year. Vita free tax preparation To ensure your deduction is within the deduction limits, keep records to show the following. Vita free tax preparation The total assessment against all members of the district for the depreciable property. Vita free tax preparation Your deductible share of the cost to the district for the depreciable property. Vita free tax preparation Your gross income from farming. Vita free tax preparation Total assessment limit. Vita free tax preparation   You cannot deduct more than 10% of the total amount assessed to all members of the conservation or drainage district for the depreciable property. Vita free tax preparation This applies whether you pay the assessment in one payment or in installments. Vita free tax preparation If your assessment is more than 10% of the total amount assessed, both the following rules apply. Vita free tax preparation The amount over 10% is a capital expense and is added to the basis of your land. Vita free tax preparation If the assessment is paid in installments, each payment must be prorated between the conservation expense and the capital expense. Vita free tax preparation Yearly assessment limit. Vita free tax preparation   The maximum amount you can deduct in any one year is the total of 10% of your deductible share of the cost as explained earlier, plus $500. Vita free tax preparation If the amount you pay or incur is equal to or less than the maximum amount, you can deduct it in the year it is paid or incurred. Vita free tax preparation If the amount you pay or incur is more, you can deduct in that year only 10% of your deductible share of the cost. Vita free tax preparation You can deduct the remainder in equal amounts over the next 9 tax years. Vita free tax preparation Your total conservation expense deduction for each year is also subject to the 25% of gross income from farming limit on the deduction, discussed later. Vita free tax preparation Example 1. Vita free tax preparation This year, the soil conservation district levies and you pay an assessment of $2,400 against your farm. Vita free tax preparation Of the assessment, $1,500 is for digging drainage ditches. Vita free tax preparation You can deduct this part as a soil or conservation expense as if you had paid it directly. Vita free tax preparation The remaining $900 is for depreciable equipment to be used in the district's irrigation activities. Vita free tax preparation The total amount assessed by the district against all its members for the depreciable equipment is $7,000. Vita free tax preparation The total amount you can deduct for the depreciable equipment is limited to 10% of the total amount assessed by the district against all its members for depreciable equipment, or $700. Vita free tax preparation The $200 excess ($900 − $700) is a capital expense you must add to the basis of your farm. Vita free tax preparation To figure the maximum amount you can deduct for the depreciable equipment this year, multiply your deductible share of the total assessment ($700) by 10%. Vita free tax preparation Add $500 to the result for a total of $570. Vita free tax preparation Your deductible share, $700, is greater than the maximum amount deductible in one year, so you can deduct only $70 of the amount you paid or incurred for depreciable property this year (10% of $700). Vita free tax preparation You can deduct the balance at the rate of $70 a year over the next 9 years. Vita free tax preparation You add $70 to the $1,500 portion of the assessment for drainage ditches. Vita free tax preparation You can deduct $1,570 of the $2,400 assessment as a soil and water conservation expense this year, subject to the 25% of gross income from farming limit on the deduction, discussed later. Vita free tax preparation Example 2. Vita free tax preparation Assume the same facts in Example 1 except that $1,850 of the $2,400 assessment is for digging drainage ditches and $550 is for depreciable equipment. Vita free tax preparation The total amount assessed by the district against all its members for depreciable equipment is $5,500. Vita free tax preparation The total amount you can deduct for the depreciable equipment is limited to 10% of this amount, or $550. Vita free tax preparation The maximum amount you can deduct this year for the depreciable equipment is $555 (10% of your deductible share of the total assessment, $55, plus $500). Vita free tax preparation Since your deductible share is less than the maximum amount deductible in one year, you can deduct the entire $550 this year. Vita free tax preparation You can deduct the entire assessment, $2,400, as a soil and water conservation expense this year, subject to the 25% of gross income from farming limit on the deduction, discussed below. Vita free tax preparation Sale or other disposal of land during 9-year period. Vita free tax preparation   If you dispose of the land during the 9-year period for deducting conservation expenses subject to the yearly limit, any amounts you have not yet deducted because of this limit are added to the basis of the property. Vita free tax preparation Death of farmer during 9-year period. Vita free tax preparation   If a farmer dies during the 9-year period, any remaining amounts not yet deducted are deducted in the year of death. Vita free tax preparation 25% Limit on Deduction The total deduction for conservation expenses in any tax year is limited to 25% of your gross income from farming for the year. Vita free tax preparation Gross income from farming. Vita free tax preparation   Gross income from farming is the income you derive in the business of farming from the production of crops, fish, fruits, other agricultural products, or livestock. Vita free tax preparation Gains from sales of draft, breeding, or dairy livestock are included. Vita free tax preparation Gains from sales of assets such as farm machinery, or from the disposition of land, are not included. Vita free tax preparation Carryover of deduction. Vita free tax preparation   If your deductible conservation expenses in any year are more than 25% of your gross income from farming for that year, you can carry the unused deduction over to later years. Vita free tax preparation However, the deduction in any later year is limited to 25% of the gross income from farming for that year as well. Vita free tax preparation Example. Vita free tax preparation In 2012, you have gross income of $32,000 from two farms. Vita free tax preparation During the year, you incurred $10,000 of deductible soil and water conservation expenses for one of the farms. Vita free tax preparation However, your deduction is limited to 25% of $32,000, or $8,000. Vita free tax preparation The $2,000 excess ($10,000 − $8,000) is carried over to 2013 and added to deductible soil and water conservation expenses made in that year. Vita free tax preparation The total of the 2012 carryover plus 2013 expenses is deductible in 2013, subject to the limit of 25% of your gross income from farming in 2013. Vita free tax preparation Any expenses over the limit in that year are carried to 2014 and later years. Vita free tax preparation Net operating loss. Vita free tax preparation   The deduction for soil and water conservation expenses, after applying the 25% limit, is included when figuring a net operating loss (NOL) for the year. Vita free tax preparation If the NOL is carried to another year, the soil and water conservation deduction included in the NOL is not subject to the 25% limit in the year to which it is carried. Vita free tax preparation When to Deduct or Capitalize If you choose to deduct soil and water conservation expenses, you must deduct the total allowable amount on your tax return for the first year you pay or incur these expenses. Vita free tax preparation If you do not choose to deduct the expenses, you must capitalize them. Vita free tax preparation Change of method. Vita free tax preparation   If you want to change your method for the treatment of soil and water conservation expenses, or you want to treat the expenses for a particular project or a single farm in a different manner, you must get the approval of the IRS. Vita free tax preparation To get this approval, submit a written request by the due date of your return for the first tax year you want the new method to apply. Vita free tax preparation You or your authorized representative must sign the request. Vita free tax preparation   The request must include the following information. Vita free tax preparation Your name and address. Vita free tax preparation The first tax year the method or change of method is to apply. Vita free tax preparation Whether the method or change of method applies to all your soil and water conservation expenses or only to those for a particular project or farm. Vita free tax preparation If the method or change of method does not apply to all your expenses, identify the project or farm to which the expenses apply. Vita free tax preparation The total expenses you paid or incurred in the first tax year the method or change of method is to apply. Vita free tax preparation A statement that you will account separately in your books for the expenses to which this method or change of method relates. Vita free tax preparation Send your request to the following  address. Vita free tax preparation  Department of the Treasury Internal Revenue Service Center Cincinnati, OH 45999  For more information, see Change in  Accounting Method in chapter 2. Vita free tax preparation Sale of a Farm If you sell your farm, you cannot adjust the basis of the land at the time of the sale for any unused carryover of soil and water conservation expenses (except for deductions of assessments for depreciable property, discussed earlier). Vita free tax preparation However, if you acquire another farm and return to the business of farming, you can start taking deductions again for the unused carryovers. Vita free tax preparation Gain on sale of farmland. Vita free tax preparation   If you held the land 5 years or less before you sold it, gain on the sale of the land is treated as ordinary income up to the amount you previously deducted for soil and water conservation expenses. Vita free tax preparation If you held the land less than 10 but more than 5 years, the gain is treated as ordinary income up to a specified percentage of the previous deductions. Vita free tax preparation See Section 1252 property under Other Gains in chapter 9. 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