Archive for February, 2015|Monthly archive page

Back to Basics Part X – Schedule F

Originally published in the Cedar Street Times

February 20, 2015

When the Long family emigrated from Switzerland in 1737, they settled in the colony of South Carolina.  At the time, the headright system was in place, and every person received 50 acres of land for making the journey across the Atlantic.  The Longs stayed in South Carolina, and the land remained in our family until my dad and his sister-in-law sold the last remaining four hundred acres about ten years ago.  (Somewhere in our files we still have that original grant paperwork.)  Four hundred acres may sound like a lot to native Californians, but the phrase “dirt cheap” actually means something in other parts of the country!

Anyway, my dad grew up on that farm raising animals, picking cotton, and then in high school, packing peaches for another farmer in the area.  As time rolled on, farming became tougher for small farms, and the government eventually started paying my grandfather to NOT farm, and plant trees instead!  What a deal!  That was fine for my grandfather as he also had an architectural practice already dividing his time.  I am sure the subsidies he received were part of some government plan aimed at decreasing supply and driving up prices for other farmers, and I am sure he had to report those on a Schedule F – Profit or Loss from Farming.

Schedule F is our topic today.  Prior articles are republished on my website at www.tlongcpa.com/blog if you would like to catch up on our Back to Basics series on personal tax returns.

The header section of Schedule F is an information gathering area about the type of farming you do, your participation level in the business, and various other questions.  Similar questions can be found on Schedule C for businesses or Schedule E for rental or other supplemental income activities.

Schedule F is a two page form, and nearly half of that real estate is devoted to gathering income.  By comparison most other schedules in the tax return have a tiny section devoted to income gathering.  This is due to the wide variety of sources of farming income.

Section I covers income for cash basis farmers.  Cash basis simply means you declare income when you receive the money, and you deduct expenses when you pay out the money.  Section III on page two covers income gathering for accrual basis taxpayers.  This means income is declared when it is earned (not necessarily received), and expenses are deducted when incurred (not necessarily paid).

Farming has been at the root of American lives since the country was founded, and it is not always an easy or a consistent business to run.  As a result there are many special programs available to farmers (or non-farmers as in the case of my grandfather) as well as certain tax advantages.  Farmers may see income from all kinds of sources, many tied to government programs or insurance, such as direct payments, patronage dividends, counter-cyclical payments, price loss coverage payments, agriculture risk coverage payments, price support payments, market gain from the repayment of a secured Commodity Credit Corporation (CCC) loan gains, diversion payments, cost-share payments (sight drafts), crop insurance proceeds, federal disaster payments, etc.

Due to the unpredictability of nature, there are even special provisions available to farmers that allow them to average their income over a three-year period. This is done by completing Schedule J.

You can imagine being a little upset if instead of having your income spread evenly over two years and being in a top bracket of 15 percent in both years, that you make zero in one year due to a drought and double in year two due to wonderful rain and sunshine, and then wind up in a 25 percent top bracket!  Not only did you suffer the hardship of having no income one year, but then you ended up with a bigger overall tax bill on the same amount of income.

Another example of a favorable provision says that if you have to sell livestock due to weather-related conditions, such as a drought, you have the option of reporting the income in the year following the sale.  So you get to defer the income.  Your farm must be located in an area qualified for federal aid due to the weather-related condition.

Part II of Schedule F deals with gathering expenses.  Due to the length of time it takes to get many crops or animals into a productive state, there are a lot of very specific rules regarding deducting versus capitalizing farm expenditures.

For example, if a crop takes more than two years growing time before it comes to fruition, you generally must capitalize the costs during the period. In most cases you can make an election to expense the costs, however.  The instructions to Schedule F tell us, “you cannot make this election for the costs of planting or growing citrus or almond groves incurred before the end of the fourth tax year beginning with the tax year you planted them in their permanent grove.”  As you can tell, the rules can get very specific depending on what you are growing, and where!

Similar to a Schedule C business, if an unincorporated farm is owned and operated by a husband and wife in a community property state, such as California, they should split the income and expenses according to the work performed and file two Schedule Fs.  This assists with filing two Schedule SEs for self-employment income for each.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

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Back to Basics Part IX – Schedule E

Originally published in the Cedar Street Times

February 6, 2015

So you decided to put your home up for rent for two weeks surrounding the AT&T Pebble Beach National Pro-Am.  Fortunately for you, it was rumored that Arnold Palmer once spent the afternoon on your front lawn.  As a result, there are so many prospective renters that you are having to beat them away with golf clubs.

Finally you settle on a renter and a nice fat $40,000 check for two weeks!  Score!  But then you remember this pesky thing you do each year called taxes, and you start wondering how you are going to report this on your tax returns.  The surprising answer is that it won’t get reported at all.  There is a rule which states if you rent your home for 14 days or less during the year, you do not have to report the income.  All $40,000 is tax free!  But what if your renters need an extension of one day?  Don’t do it!  If you do, the entire amount is now taxable on Schedule E.

In this issue, we are discussing Schedule E – Supplemental Income and Loss.  Prior articles are republished on my website at www.tlongcpa.com/blog if you would like to catch up on our Back to Basics series on personal tax returns.

Schedule E is a two-page form used to report income from rental real estate, royalties, and income from partnerships, s-corporations, trusts, and estates.  Part I handles the reporting of income and expenses of rental real estate and royalties.  There is a section regarding rental real estate that asks for the number of days rented at fair market value and the number of days of personal use.  This information is necessary in order to apply limitations regarding the rental of personal residences and vacation homes.  Any personal use will affect the allowable deductions to some extent.  (See my articles “Renting Your Vacation Home” on my website originally published August 10 and 24 of 2012 for more details.)

All expenses related to caring for your rental real estate can be deducted.  Besides costs such as property taxes, interest, repairs, etc., you can also use the standard mileage rate (56 cents per mile for 2014) to deduct any rental related mileage you drive.  If your property requires you to travel away from home overnight, you can deduct lodging and 50 percent of your meals as well.

If rental property generates a loss, there are several tests that must be applied near the bottom of Schedule E page one to determine if the losses will be allowed, or suspended for use in future years.  You can only take losses to the extent that you have an investment at-risk.  Form 61K-198 is used to determine this.  There are also rules limiting the amount of losses you can use against other income if the losses come from passive activities.  Rental real estate is generally considered a passive activity, and Form 8582 is used to determine if your losses will be limited.

Part II of Schedule E begins on page two and summarizes income and losses from flow through activities of partnerships and s-corporations.  Your share of these activities is reported to you on a Form K-1.   Again, at-risk and passive activity loss limits are applied.  Your basis in the underlying partnership or s-corporation activity as well as your level of participation and type of ownership interest are considered in these calculations.

Part III covers your share of estate and trust activities reported to you on a K-1 in a similar fashion as in part II.  The main difference being that there are generally no at-risk limitations to worry about.

Part IV covers income or losses from Real Estate Mortgage Investment Conduits.  These are essentially mortgage-backed securities: a solid product which earned a bad reputation during the financial crisis from 2007-2010 when sub-prime mortgages were bundled and sold together.

Part V summarizes the income and losses from the first four parts of Schedule E and pulls in farm land rentals as well which are calculated on a separate Form 4835.

Getting back to your $40,000 two-week rental.  It turns out that the Arnold Palmer that spent an afternoon on your front lawn was simply a glass of watered-down iced tea and lemonade, and your renters backed out.  Better luck next time…

In two weeks we will discuss Schedule F – Profit or Loss from Farming.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.