Reg. § 1.1251-1 General rule for treatment of gain from disposition of property used in farming where farm losses offset nonfarm income.
(a) Applicability The provisions of section , this section, and through shall apply with respect to any taxable year beginning after December 31, 1969, but only if
(1) there is a farm net loss (as defined in section and ) for the taxable year, or
(2) there is a balance in the excess deductions account (as described in § 1251-2) as of the close of the taxable year before subtracting any amount under paragraph (c)(1)(i) of § 1251-2. See section . In general, a taxpayer who has a farm net loss and certain other taxpayers are required to establish and maintain an excess deductions account as provided in section . Certain additions and subtractions are made to the excess deductions account, and upon the disposition of farm recapture property any gain to the extent of the balance in the excess deductions account is recognized as ordinary income under section . See of this section. Farm recapture property is, in general, certain farming property (other than section property) described in paragraph (1), (3), or (4) of section . See .
(b) Ordinary income
(1) General rule In general, subject to the provisions of subparagraphs (2), (3), (4), and (5) of this paragraph, upon a disposition of an item of farm recapture property during a taxable year beginning after December 31, 1969, the amount of which:
(i) In the case of a sale, exchange, or involuntary conversion, the amount realized, or
(ii) In the case of any other disposition, the fair market value of such property
exceeds the adjusted basis of such property shall be recognized under section as gain from the sale or exchange of property which is neither a capital asset nor property described in section (that is, shall be recognized as ordinary income). The amount of gain recognized as ordinary income under section shall be determined separately for each item of farm recapture property in a manner consistent with the principles of sub and (relating to gain from dispositions of certain depreciable property). Generally, such ordinary income treatment applies even though in the absence of section no gain would be recognized under the Code. For example, if a corporation distributes farm recapture property as a dividend gain may be recognized as ordinary income to the corporation even though, in the absence of section , section would preclude any recognition of gain to the corporation. For purposes of section , the term disposition shall have the same meaning as in . For the relation of section to other provisions of the Code, see of this section.
(2) Limitation as to dispositions of land
(i) In general In the case of a disposition of land, gain shall be recognized as ordinary income under section only to the extent of the land's potential gain. See section .
(ii) Potential gain For purposes of section , the term potential gain means in respect of land an amount equal to the excess of its fair market value over its adjusted basis, but limited to the extent of the deductions allowable in respect to such land pursuant to an election (if any) under sections (relating to soil and water conservation expenditures) and 182 (relating to expenditures by farmers for clearing land) for the taxable year of disposition and the four immediately preceding taxable years regardless of whether any such preceding taxable year begins before December 31, 1969. See section (e)(5).
(iii) Cross reference For additional recapture of certain deductions allowed under sections and in respect of farm land, see section .
(3) Exceptions and special rules The amount of gain to be recognized as ordinary income under section after applying subparagraph (2) of this paragraph, if applicable, shall be subject to the exceptions and special rules of section and .
(4) Limitation as to amount in excess deductions account
(i) In general The aggregate of the amount of gain recognized as ordinary income under section (after applying subparagraphs (2) and (3) of this paragraph, if applicable) shall not exceed the amount in the excess deductions account at the close of the taxable year after subtracting from the account the amount specified in section and . See section . For transfer of amount in an excess deductions account, see section .
(ii) Dispositions taken into account If the aggregate of the amount to which section applies is limited for any taxable year by the application of subdivision (i) of this subparagraph, section shall apply in respect of dispositions of items of farm recapture property in the order made. See section .
(5) Relationship to section 1245 If property is disposed of which qualifies as both section property (as defined in section ) as well as farm recapture property, then gain shall be recognized as ordinary income under section only to the extent that the amount of any gain realized (in the case of a sale, exchange, or involuntary conversion), or to the extent that the excess of the fair market value of the property over its adjusted basis (in the case of any other disposition), was not recognized as ordinary income under section . The amount of gain recognized as ordinary income under section upon a disposition of farm recapture property (i) is taken into account under for purposes of computing farm net loss (or farm net income) and (ii) is not under subtracted from the excess deductions account.
(6) Examples The principles of this paragraph may be illustrated by the following examples:
Example 1. A, an unmarried individual who uses the calendar year as his taxable year, makes one disposition of farm recapture property during 1970. On June 30, 1970, he sells for $75,000 farm recapture property (other than land) with an adjusted basis of $43,000 for a realized gain of $32,000 none of which is recognized under section . The balance in A's excess deductions account is $39,000 at the close of 1970 (after making the applicable additions and subtractions under section (2) and (3)(A)). Hence, the entire gain of $32,000 is recognized as ordinary income under section , and the balance remaining in A's excess deductions account is $7,000. If, however, the original balance in the excess deductions account were only $15,000, then only $15,000 would be recognized as ordinary income under section and A's excess deductions account balance would be reduced to zero. The remaining gain of $17,000 may be treated as gain from the sale or exchange of property described in section .
Example 2. M, a calendar year corporation makes one disposition of farm recapture property during 1975. On January 15, 1975, M distributes as a dividend to its shareholders land which it had acquired on March 3, 1970. On that date, the excess of the fair market value ($67,500) over the adjusted basis of land ($45,000) is $22,500 and the sum of the deductions allowable in respect of such land under sections and is $5,000 for 1970 and $13,000 for the taxable year of disposition and the four immediately preceding taxable years. Thus, the potential gain (as defined in subparagraph (2)(ii) of this paragraph) is limited to $13,000. At the end of M's taxable year (after making the applicable additions and subtractions under section (2) and (3)(A) there is a balance of $25,000 in the excess deductions account of M. Since such balance exceeds the potential gain, M recognizes $13,000 as ordinary income under section even though, in the absence of that provision, section would preclude recognition of gain to M. The balance in M's excess deductions account is reduced by $13,000, from $25,000 to $12,000. With respect to the treatment of the remaining gain ($9,500) from the disposition of the land, see section and example (2) of paragraph (e) .
Example 3. Assume the same facts as in example (2), except that M makes a second disposition of farm recapture property during 1975. On June 5, 1975. M sells for $55,000 a breeding herd of cattle having an adjusted basis of $35,000 for a realized gain of $20,000. M had acquired the herd on April 1, 1971. Assume further that $6,000 of the $20,000 gain realized is treated as ordinary income under section . Thus, the amount of gain M would recognize as ordinary income under section , computed before applying the excess deductions account limitation, is $14,000. In accordance with the computation in example (1) of , the excess deductions account limitations limit the maximum amount of gain which can be recognized as ordinary income under section upon the disposition of the land and the breeding herd to $25,000. Under subparagraph (4)(ii) of this paragraph, the amount of such limitation, $25,000, is assigned to each property in the order of disposition. Thus, the amount of gain recognized as ordinary income under section is $13,000 (as in example (1) of this subparagraph) on the disposition of the land and $12,000 on the disposition of the breeding herd. The remaining gain of $2,000 (i.e., $14,000 minus $12,000) on the disposition of the breeding herd may be treated as gain from the sale or exchange of property described in section .
(c) Instances of nonapplication
(1) In general Section does not apply with respect to dispositions of farm recapture property by a taxpayer during a taxable year if at the close of such year after making the necessary additions and subtractions under section (2) and (3)(A), there is no balance in the taxpayer's excess deductions account.
(2) Losses Section does not apply to losses. Thus, section does not apply if a loss is realized upon a sale, exchange or involuntary conversion of property, all of which is farm recapture property, nor does the section apply to a disposition of such property other than by way of sale, exchange, or involuntary conversion if at the time of the disposition the fair market value of such property is not greater than its adjusted basis.
(3) Certain dispositions of interests in land Section does not apply to dispositions of interests in land with respect to which no deductions were allowable pursuant to an election under section (relating to soil and water conservation expenditures) and 182 (relating to expenditures by farmers for clearing land) for the taxable year of disposition and the four immediately preceding taxable years. For possible application of section in such a case, see example (1) of .
(d) Partnerships [Reserved]
(e) Relation of section 1251 to other provisions
(1) General The provisions of section apply (after applying of this section, relating to section property) notwithstanding any other provision of subtitle A of the Code. Thus, unless an exception or special rule under section and applies, gain under section is recognized notwithstanding any contrary nonrecognition provision or income characterizing provision. For example, section overrides section (relating to property used in a trade or business). Accordingly, gain recognized under section upon a disposition of farm recapture property will be treated as ordinary income to the extent of the balance in the taxpayer's excess deductions account, and only the remaining gain, if any, from the disposition may be considered as gain from the sale or exchange of a capital asset if section is applicable. See example (3) of of this section.
(2) Nonrecognition sections overridden The nonrecognition of gain provisions of subtitle A of the Code which section overrides include, but are not limited to, sections , , , , and . See section and for the extent to which 1251(c)(1) overrides sections , , , 371(a), , , , and .
(3) Treatment of gain not recognized under section 1251(c)(1) For treatment of gain not recognized under section , the principles of paragraph (f) shall be applicable. Thus section does not prevent gain which is not recognized under section from being considered as gain under another provision of the Code, such as for example, section (relating to treatment of gain from disposition of farm land). See example (1) of .
(4) Exempt income With regard to exempt income, the principles of shall be applicable.
(5) Normal retirement of asset in multiple asset account Section does not require recognition of gain upon normal retirements of farm recapture property in a multiple asset account as long as the taxpayer's method of accounting, as described in (relating to accounting treatment of asset retirements), does not require recognition of such gain.
(6) Installment method
(i) In general Gain from a disposition to which section applies may be reported under the installment method if such method is otherwise available under section 453 of the Code. In such case, the income (other than interest) on each installment payment shall be deemed to consist of gain to which section applies until all such gain has been reported, and the remaining portion (if any) of such income shall be deemed to consist of gain to which section does not apply. For treatment of amounts as interest on certain deferred payments, see section . For adjustments in the excess deductions account, see .
(ii) Special rule If a taxpayer disposes of property used in the trade or business of farming which qualifies as both section property as well as farm recapture property and elects to report the gain from such disposition under the installment method, then the income (other than interest) on each installment payment shall (a) first be deemed to consist of gain to which section applies until all such gain has been reported, (b) The remaining portion (if any) of such income shall be deemed to consist of gain to which section applies until all such gain has been reported, and (c) finally the remaining portion (if any) of such income shall be deemed to consist of gain to which neither section nor 1251 (c)(1) applies. See with respect to the installment method in regard to the disposition of property which is both farm recapture property as well as farm land (as defined in section and ).
[T.D. 7418, 41 FR 18814, May 7, 1976; 41 FR 23669, June 11, 1976]