Treasury Regulations · 26 CFR
§ 1.1251-2. Excess deductions account.
Regulation text, no changes From the eCFR, current as of October 15, 2026. The eCFR is an authoritative but unofficial editorial compilation of the Code of Federal Regulations; the official text is the annual CFR on govinfo. Compare it with this section on ecfr.gov (external site) or the official annual CFR on govinfo (external site).
Regulation under 26 U.S.C. § 1251
Cite as 26 CFR § 1.1251-2
At a glance
Read from the text and its source citation. Not part of the regulation.
- Status
- In the current eCFR
- Issued
- May 7, 1976 by T.D. 7418
- Last amended
- June 11, 1976
- Issued under
- 26 U.S.C. § 1251
- Length
- 11,653 words · about 51 min to read
- Defines
- 2 terms
- Cross-references
- cites 16 Code sections and 11 regulations; cited by 4
shall establish (if not previously established) and maintain for purposes of section 1251 an excess deductions account. See section 1251(b)(1). Once an excess deductions account is established (or succeeded to under paragraph (e) of this section in the case of certain corporate transactions and gifts) all entries (including the entries prescribed by paragraph (f) of this section with respect to married taxpayers who file joint returns) with respect to the account must be part of the taxpayer's permanent records for all taxable years for which the account must be maintained. For purposes of applying section 1251 and this section, the term taxpayer in the case of a partnership means each partner of such partnership and in the case of an estate or trust means the estate or trust regardless of whether it is taxable under subpart A or E, subchapter J, chapter 1 of the Code.
The limitations of this subparagraph apply to a person (other than a trust) to whom the tax rates set forth in section 1 are applicable and as prescribed in subparagraph (3) of this paragraph in respect of an electing small business corporation.
(a) For purposes of subparagraph (2) of this paragraph, the term the taxpayer means such corporation or any one of its shareholders, and the term such year, in the case of a shareholder, means his taxable year with which or within which the taxable year of the corporation ends (see paragraph (d)(2) of § 1.1251-3 for special rules relating to the computation of nonfarm adjusted gross income of a shareholder of an electing small business corporation), and
(b) The limitations in subparagraph (2) of this paragraph shall not apply to the corporation for a taxable year if on any day of such year there is a taxpayer who is a shareholder having, for his taxable year with which or within which the taxable year of such corporation ends, a farm net loss (as defined in paragraph (b) of § 1.1251-3).
For purposes of determining whether a shareholder of such corporation has a farm net loss, there shall not be taken into account his pro rata share of farm net income or loss of any other electing small business corporation for such corporation's taxable year ending with or within his taxable year.
(c) The provisions of this subdivision (i) do not apply for purposes of determining whether the shareholder must make an addition to his excess deductions account and the amount of such addition.
For 1971, the M Corporation which uses the claendar year as its taxable year and which is not an electing small business corporation has a farm net loss of $40,000 and nonfarm taxable income of $45,000. Since subparagraph (2) of this paragraph does not apply to M, it is required to make a $40,000 addition to its excess deductions account.
For 1971, A, an unmarried individual who uses the calendar year as his taxable year, has a farm net loss of $33,000 and nonfarm adjusted gross income of $65,000. Under subparagraph (2) of this paragraph, A is required to make an addition of $8,000 to his excess deductions account (that is, the excess of the farm net loss, $33,000, over the $25,000 amount referred to in subparagraph (2)(ii) of this paragraph). If, however, A were a trust, the limitation in subparagraph (2) of this paragraph would not apply and such trust would be required to add $33,000 (the amount of the entire farm net loss) to its excess deductions account.
H and W each use the calendar year as the taxable year. For 1971, H, a married taxpayer who files a separate return, has a farm net loss of $45,000 and nonfarm adjusted gross income of $60,000. H's spouse W does not have any nonfarm adjusted gross income for 1971. Thus, the lower limitations in subparagraph (4)(i) of this paragraph do not apply. Accordingly, H is required to make an addition of $20,000 to his excess deductions account (that is, the excess of the farm net loss, $45,000, over the $25,000 amount referred to in subparagraph (2)(ii) of this paragraph).
Assume the same facts as in example (3), except that for 1971 W has a farm net loss of $10,000 and nonfarm adjusted gross income of $30,000. Thus, the lower limitations in subparagraph (4)(i) of this paragraph do apply and H is required to make an addition of $32,500 to his excess deductions account (that is, the excess of his farm net loss, $45,000, over the $12,500 amount referred to in subparagraph (4)(i)(b) of this paragraph). Since, however, W did not have a farm net loss in excess of $12,500, she would not be required to make an addition to her excess deductions account. For the result if H and W were to file a joint return, see example (1) of paragraph (f)(6) of this section.
For 1970, the M Corporation, which uses the calendar year as its taxable year and which is an electing small business corporation, has a farm net loss of $35,000 and nonfarm adjusted gross income of $60,000. A, B, and C, the sole equal shareholders of M, are cash method taxpayers and each uses a fiscal year ending on March 31. For the taxable year ending March 31, 1971, A has a farm net loss of $5,000. Thus, as M's taxable year ends within the taxable year of A during which A has a farm net loss, the limitations in subparagraph (2) of this paragraph do not apply with respect to M for 1970. See subparagraph (1) of this paragraph, to add $35,000 to its excess deductions account.
Assume the same facts as in example (5), except that A's farm net loss occurred in his fiscal year ending March 31, 1970, and no shareholder of M has a farm net loss for the fiscal year ending March 31, 1971. Thus, the limitations in subparagraph (2) of this paragraph do apply with respect to M for 1970, and accordingly M is required to add $10,000 to its excess deductions account for 1970 (that is, the excess of M's farm net loss $35,000, over the $25,000 amount referred to in subparagraph (2)(ii) of this paragraph).
Assume the same facts as in example (6), except that M has $45,000 of nonfarm adjusted gross income for 1970 and A, for his taxable year ending March 31, 1971, has $40,000 of nonfarm adjusted gross income, computed without regard to his interest in M. Assume the M paid no dividends. Since, under paragraph (d)(2) of § 1.1251-3, A's income from M under section 1373(b) is computed on the basis of M's nonfarm adjusted gross income, A's gross income from M is $15,000 ( 1/3 of $45,000), and A's total nonfarm adjusted gross income is $55,000. Accordingly, M would be required to add $10,000 to its excess deductions account for 1970 for the reasons stated in example (6).
Assume the same facts as in example (7). Assume further that A is one of two equal shareholders in N, another electing small business corporation with a taxable year ending on January 31, and that N for its taxable year ending on January 31, 1971, has a $42,000 nonfarm loss and farm net income of $23,000. Assume that N paid no dividends. Thus, A for purposes of subparagraph (2)(i) of this paragraph, would only have a total of $34,000 of nonfarm adjusted gross income ($55,000) computed per example (7) minus $21,000 (A's share of N's nonfarm net operating loss ( 1/2 of $42,000) computed in accordance with paragraph (d)(2) of § 1.1251-3)). Assuming that no other shareholder of M has nonfarm adjusted gross income in excess of $50,000, by reason of the $50,000 limitation in subparagraph (2)(i) of this paragraph, M makes no addition for 1971 to its excess deductions account. (N would make no addition to its excess deductions account as it does not have a farm net loss.) If, however, N were to have a nonfarm loss of only $8,000, A for purposes of subparagraph (2)(i) of this paragraph would have a total of $51,000 of nonfarm adjusted gross income ($51,000 of nonfarm adjusted gross income ($55,000, minus 1/2 of N's nonfarm loss of $8,000)). Hence, with respect to M the result would be the same as in example (7) (and N would make no addition to its excess deductions account since it does not have a farm net loss).
D and E are equal individual shareholders in corporations X, Y, and Z, the stock of each corporation having recently been purchased from a different unrelated person. X, Y, and Z are electing small business corporations. D, E, and the corporations all use the calendar year as the taxable year. For 1970, the farm net income of D and E (determined without regard to their respective pro rata shares of the farm net income or loss of X, Y, and Z) are $100,000 and zero, respectively. For 1970, the farm net income or loss of the corporations are losses of $80,000 and $20,000 for X and Z, respectively, and income of $60,000 for Y. For 1970, the determinations under subparagraph (3)(ii) of this paragraph as to whether a shareholder of corporation X or Z (no determination is necessary with respect to Y since Y does not have a farm net loss) has a farm net loss are made as follows:
| As to X | As to Z | |||
|---|---|---|---|---|
| D | E | D | E | |
| Farm net income (determined without regard to X, Y, and Z) | $100,000 | $0 | $100,000 | $0 |
| Pro rata (1⁄2) share of corporation's farm net income (or loss): | ||||
| Of X | (40,000) | (40,000) | ||
| Of Y | 30,000 | 30,000 | 30,000 | 30,000 |
| Of Z | (10,000) | (10,000) | ||
| Farm net income (or loss) for purposes of determination | $120,000 | $20,000 | $90,000 | ($10,000) |
Accordingly, since the determination as to X indicates that neither D nor E has a farm net loss, the limitations of subparagraph (2) of this paragraph apply to X. Thus, assuming that X, D, or E has nonfarm adjusted gross income in excess of $50,000, X will add $55,000 to its excess deductions account, i.e., the excess of the farm net loss, $80,000, over the $25,000 amount referred to in subparagraph (2)(ii) of this paragraph. Since, however, the determination as to Z indicates that E has a farm net loss, such limitations do not apply to Z. Thus, the addition for 1970 to Z's excess deductions account is the entire amount of its farm net loss, $20,000.
Assume the same facts as in example (3) of paragraph (b)(6) of § 1.1251-1. M's excess deductions account balance as of the close of 1975 is computed, in accordance with the additional facts assumed, in the table below:
| (1) Balance January 1, 1975 | $26,000 | |
| (2) Additions for 1975 | 0 | |
| (3) Subtotal | 26,000 | |
| (4) Subtractions for 1975 (farm net income 1) | 1,000 | |
| (5) Excess deductions account limitation on gain recognized as ordinary income under section 1251(c)(1) for 1975 | 25,000 | |
| (6) Subtraction for disposition of farm recapture property: | ||
| (a) Gain from disposition of land to which section 1251(c)(1) applies (computed before applying limitation | $13,000 | |
| (b) Gain from disposition of breeding herd to which section 1251(c)(1) applies (computed before applying limitation) | 14,000 | |
| (c) Sum of lines (a) and (b) | 27,000 | |
| (d) Excess deductions account limitation (amount in line (5)) | 25,000 | |
| (e) Gain recognized as ordinary income under section 1251(c)(1) (lower of line (6)(c) or line (6)(d) | 25,000 | |
| (7) Balance December 31, 1975 | 0 | |
| 1 Computed by treating the section 1245 gain of $6,000 under paragraph (b)(1)(ii) of § 1.1251-3 as gross income derived from the trade or business of farming. | ||
For allocation of the $25,000 of gain recognized as ordinary income to the land and herd, and for treatment of the gain recognized in excess of $25,000 see example (3) of paragraph (b)(6) of § 1.1251-1.
A is an unmarried individual who uses the calendar year as his taxable year. In 1971, A makes a single disposition of farm recapture property (other than land) realizing a gain of $46,000 of which $15,000 is recognized as ordinary income under section 1245(a)(1). The gain to which section 1251(c)(1) applies (computed before applying the excess deductions account limitation in section 1251(c)(2)(A) and paragraph (b)(4)(i) of § 1.1251-1) is $31,000 (i.e., $46,000 minus $15,000). The treatment of the gain realized on the disposition in excess of the $15,000 recognized as ordinary income under section 1245(a)(1) and the balance in A's excess deductions account as of the close of 1971 is computed, in accordance with the facts assumed, in the table below:
| (1) Balance January 1, 1971 | $50,000 | |
| (2) Additions for 1971: | ||
| (a) Farm net loss for 1971 1 | $5,000 | |
| (b) Less amount in paragraph (b)(2)(ii) of this section | 25,000 | |
| (c) Total additions for 1971 | 0 | |
| (3) Subtotal | 50,000 | |
| (4) Subtractions for 1971 | 0 | |
| (5) Excess deductions account limitation on gain recognized as ordinary income under section 1251(c)(1) for 1971 | 50,000 | |
| (6) Subtraction for dispositions of farm recapture property: | ||
| (a) Gain to which section 1251(c)(1) applies (computed before applying limitation) | 31,000 | |
| (b) Limitation (amount in line (5) | 50,000 | |
| (c) Gain recognized as ordinary income under section 1251(c)(1) lower of line 6(a) or line 6(b) | 31,000 | |
| (7) Balance December 31, 1971 | 19,000 | |
| 1 Computed by treating the section 1245 gain of $15,000 under paragraph (b)(1)(ii) of § 1.1251-3 as gross income derived from the trade or business of farming. | ||
(a) The farm portion of a net operating loss is that portion of such loss attributable to the trade or business of farming. Such portion and the remaining portion (hereinafter referred to as the nonfarm loss) shall be absorbed pro rata. If a farm net loss is not added to the excess deductions account in the year in which such loss occurs, the net operating loss (if any) for such year shall be treated as a nonfarm loss.
(b) In the case of an individual (other than a trust), the farm portion of a net operating loss shall be decreased by an amount, if any, equal to the excess of $25,000 (or the amount determined under paragraph (b)(2)(ii) of this section) over the nonfarm adjusted gross income. Such amount shall be added to the nonfarm portion of such net operating loss.
(c) The amounts considered as reducing taxable income under subdivision (ii) of this subparagraph in the taxable year shall be determined on the basis of a tentative computation of taxable income for such year in which the gain realized from the disposition of property to which section 1251(c)(1) applied shall be computed without regard to the excess deductions account limitation.
A is an unmarried individual who uses the calendar year as his taxable year. For the years 1970 through 1974, A's items of income and deductions are as shown in the table below. A's personal deductions are disregarded. A had no income or loss for any year prior to 1970. Based upon such amounts and the computations shown below, A must recognize as ordinary income under section 1251(c)(1), $35,325 for 1971, $10,000 for 1972, $3,925 for 1973, and $150,000 for 1974.
| Amounts assumed | 1970 | 1971 | 1972 | 1973 | 1974 |
|---|---|---|---|---|---|
| (a) Farm net income | ($250,000) | $20,000 | $5,000 | ($75,000) | ($10,000) |
| (b) Nonfarm income | 55,000 | (82,000) | 30,000 | 10,000 | 200,000 |
| (c) Gain which would be recognized as ordinary income under 1251(c) (computed without regard to the EDA limitation) (hereinafter referred to as farm property disposition) | 88,000 | 10,000 | 2,000 | 150,000 | |
| (d) Personal exemption | 625 | 675 | 750 | 750 | 750 |
| (e) Net operating loss (NOL) (computed per section 172(c)) | (195,000) | (45,000) | |||
| I. COMPUTATIONS FOR 1971 | |||||
| 1. Excess Deductions Account (EDA) Limitation for 1971: | |||||
| a. EDA on December 31, 1970: | |||||
| 1970 Farm net loss | 250,000 | ||||
| Less | (25,000) | ||||
| 225,000 | 225,000 | ||||
| b. Less farm net income for 1971 | (20,000) | ||||
| c. EDA before temporary subtraction | 205,000 | ||||
| d. Less temporary subtraction per subdivision (ii)(b): | |||||
| Aggregate farm NOL carryover to 1971 | 195,000 | ||||
| Less tentative farm NOL deduction for 1971: | |||||
| Farm net income | 20,000 | ||||
| Nonfarm income | (82,000) | ||||
| Farm property disposition | 88,000 | ||||
| Exemption | (675) | ||||
| Tentative taxable income | 25,325 | ||||
| Tentative NOL reducing taxable income | 25,325 | (25,325) | |||
| 169,675 | (169,675) | ||||
| e. EDA limitation for 1971 | 35,325 | ||||
| 2. 1971 Taxable Income: | |||||
| a. Farm net income | 20,000 | ||||
| b. Nonfarm income | ($82,000) | ||||
| c. Farm property disposition | 88,000 | ||||
| d. Exemption | (675) | ||||
| e. Section 1202 deduction: | |||||
| Farm property disposition | $88,000 | ||||
| Less amount treated as ordinary income under section 1251(c) (lesser of amount of gain on line 1(e)) | 35,325 | ||||
| Capital gain | 52,675 | ||||
| Less 50 percent deduction | 26,337 | (26,338) | |||
| f. 1971 Taxable income | (1,013) | ||||
| II. COMPUTATIONS FOR 1972 | |||||
| 1. Excess Deductions Account Limitation for 1972: | |||||
| a. EDA (line 1(c) above) | 205,000 | ||||
| b. Less recapture in 1971 | (35,325) | ||||
| c. Less farm net income for 1972 | (5,000) | ||||
| d. Less permanent subtraction per subdivision (iii): | |||||
| 1970 Farm NOL carryover to 1971 | 195,000 | ||||
| Less 1970 farm NOL carryover to 1972 (computed per section 172(b)(2)): | |||||
| Farm NOL to 1971 | $195,000 | ||||
| Less 1971 taxable income computed per section 172(b)(2): | |||||
| Farm net income | $20,000 | ||||
| Nonfarm income | (82,000) | ||||
| Farm property disposition | 88,000 | ||||
| 26,000 | (26,000) | ||||
| Farm NOL carryover to 1972 | 169,000 | ($169,000) | |||
| 26,000 | ($26,000) | ||||
| e. EDA before making temporary subtractions | 138,675 | ||||
| f. Less temporary subtraction per subdivision (ii)(b): | |||||
| Farm NOL carryover to 1972 | 169,000 | ||||
| Farm net income | 5,000 | ||||
| Nonfarm income | 30,000 | ||||
| Farm recapture disposition | 10,000 | ||||
| Exemption | (750) | ||||
| Tentative taxable income | 44,250 | ||||
| Tentative NOL reducing taxable income | 44,250 | (44,250) | |||
| 124,750 | (124,750) | ||||
| g. EDA limitation for 1972 | 13,925 | ||||
| 2. Taxable Income for 1972: | |||||
| a. Farm net income | 5,000 | ||||
| b. Nonfarm income | 30,000 | ||||
| c. Farm property disposition | 10,000 | ||||
| d. Exemption | (750) | ||||
| e. Section 1202 deduction: | |||||
| Farm property disposition | 10,000 | ||||
| Less amount treated as ordinary income under section 1251(c) (lesser of amount of gain on line 1(g)) | 10,000 | 0 | |||
| f. Taxable income before NOL deduction | 44,250 | ||||
| g. Net operating loss deduction | (44,250) | ||||
| h. Taxable income for 1972 | 0 | ||||
| III. COMPUTATIONS FOR 1973 | |||||
| 1. Excess Deductions Account Limitation for 1973: | |||||
| a. Line 1(e) above | 138,675 | ||||
| b. Less recapture in 1972 | (10,000) | ||||
| c. Less permanent subtraction per subdivision (iii): | |||||
| 1970 Farm NOL carryover to 1972 | 169,000 | ||||
| Less 1970 Farm NOL reducing taxable income in 1972 | (44,250) | ||||
| 124,750 | 124,750 | ||||
| Less 1970 Farm NOL carryover to 1973 computed per section 172(b)(2): | |||||
| Farm NOL to 1972 | 169,000 | ||||
| 1972 Taxable income computed per section 172(b)(2): | |||||
| Farm net income | $5,000 | ||||
| Nonfarm income | 30,000 | ||||
| Farm recapture disposition | 10,000 | ||||
| 45,000 | ($45,000) | ||||
| Farm NOL carryover to 1973 | 124,000 | ($124,000) | |||
| 750 | ($750) | ||||
| d. EDA before making temporary subtractions | $127,925 | ||||
| e. Less temporary subtraction per subdivision (ii)(a)-zero (since 1973 farm loss treated as nonfarm addition to NOL per subdivision (iv)(a)) | 0 | ||||
| f. Less temporary subtraction per subdivision (ii)(b): Aggregate farm NOL carryover to 1973 | $124,000 | ||||
| Less tentative farm NOL deduction for 1973: | |||||
| Farm net income | ($75,000) | ||||
| Nonfarm income | 10,000 | ||||
| Farm property disposition | 30,000 | ||||
| Exemption | (750) | ||||
| Tentative taxable income | (44,250) | ||||
| Tentative NOL reducing taxable income | 0 | 0 | |||
| 124,000 | (124,000) | ||||
| g. EDA limitation for 1973 | 3,925 | ||||
| 2. Taxable Income 1973: | |||||
| a. Farm net income | (75,000) | ||||
| b. Nonfarm income | 10,000 | ||||
| c. Farm property disposition | 20,000 | ||||
| d. Exemption | (750) | ||||
| e. Section 1202 deduction: | |||||
| Farm property disposition | 20,000 | ||||
| Less amount treated as ordinary income under section 1251(c) (lesser of amount of gain on line 1(g)) | 3,925 | ||||
| Capital gain | 16,075 | ||||
| Less 50 percent deduction | 8,038 | (8,037) | |||
| f. Taxable income for 1973 | (53,787) | ||||
| IV. COMPUTATIONS FOR 1974 | |||||
| 1. Excess Deductions Account Limitation for 1974: | |||||
| a. Line 1(d) above | 127,925 | ||||
| b. Less recapture in 1973 | (13,925) | ||||
| c. Farm loss for 1974 | 10,000 | ||||
| Plus farm NOL deduction (see § 1.1251-3(b)(3)) | 45,000 | ||||
| 55,000 | 55,000 | ||||
| Less | 25,000 | ||||
| 30,000 | 30,000 | ||||
| d. Less permanent subtraction per subdivision (iii): | |||||
| 1970 Farm NOL carryover to 1973 | 124,000 | ||||
| Less 1970 farm NOL carryover to 1974 per section 172(b)(2) | 124,000 | ||||
| 0 | 0 | ||||
| e. EDA before making temporary subtractions | 154,000 | ||||
| f. Less temporary subtraction per subdivision (ii)(b): | |||||
| Aggregrate farm NOL carryover to 1974 | 124,000 | ||||
| Less tentative farm NOL deduction in 1974: | |||||
| Farm net income | (10,000) | ||||
| Nonfarm income | 200,000 | ||||
| Farm property disposition | 150,000 | ||||
| Exemption | (750) | ||||
| Tentative taxable income | 339,250 | ||||
| Tentative NOL deduction | 169,000 | ||||
| Farm portion of tentative NOL deduction | 124,000 | ||||
| 0 | 0 | ||||
| g. EDA limitation for 1974 | $154,000 | ||||
| 2. Taxable Income 1974: | |||||
| a. Farm net income | (10,000) | ||||
| b. Nonfarm income | 200,000 | ||||
| c. Farm property disposition | 150,000 | ||||
| d. Exemption | (750) | ||||
| e. Section 1202 deduction: | |||||
| Farm property disposition | $150,000 | ||||
| Less amount treated as ordinary income under section 1251(c) (lesser of amount of gain on line 1(g)) | 150,000 | 0 | |||
| f. Taxable income before NOL deduction | 339,250 | ||||
| g. Net operating loss deduction | (169,000) | ||||
| h. Taxable income | 170,250 | ||||
(b) For purposes of (a) of this subdivision, the farm portion of a shareholder's net operating loss is that portion of the net operating loss of such shareholder attributable to the corporation's farm net loss, and such portion and the remaining portion shall be considered to be absorbed pro rata. If a corporation's farm net loss is not added to its excess deduction account in the year in which such loss occurs, no portion of a shareholder's net operating loss for the taxable year of the shareholder with which or within which such taxable year of the corporation ends shall be attributable to such corporation's farm net loss.
For rules as to procedure of making the election, effect of a change in method of accounting upon making the election, and conditions for revoking the election, see subparagraphs (4), (5), and (6), respectively, of this paragraph.
(a) The adjusted basis of such property at the beginning of the taxable year in which it becomes subject to the requirements of subparagraph (1)(ii) of this paragraph shall be equal to the amount its adjusted basis would have been on such date had it been accounted for in accordance with such requirements (taking into account, if applicable, the depreciation which would have been allowed as determined by the taxpayer using a period, salvage value, and methods that would have been proper).
(b) At the beginning of the taxable year in which such property becomes subject to the requirements of subparagraph (1)(ii) of this paragraph:
Shall be added to gross income for such taxable year and shall be treated as gross income derived from the trade or business of farming under paragraph (b)(1)(ii) of § 1.1251-3, except that if the difference in (b)(2) of this subdivision represents an excess of such inventory value over the adjusted basis for the property computed in (a) of this subdivision then such excess shall be subtracted from gross income for such taxable year and shall be treated as a deduction allowed which is directly connected with carrying on the trade or business of farming under paragraph (b)(1)(i) of § 1.1251-3.
(c) If any deductions for depreciation are treated as amounts which would have been allowed in a prior taxable year or years for purposes of (a) of this subdivision, such deduction shall be treated as having been allowed for purposes of applying sections 1245 and 1250 in the same taxable year or years and thus included in the amount of adjustments reflected in adjusted basis within the meaning of paragraph (a)(1)(ii) of § 1.1245-2 or depreciation adjustments within the meaning of paragraph (d)(1) of § 1.1250-2 (as the case may be).
(d) For purposes of this subparagraph (3), if during a taxable year property becomes subject to the requirements of subparagraph (1)(ii) of this paragraph, it shall be considered subject to such requirements on each day it is held during such year.
(e) The adjusted basis under (a) of this subdivision of property of a character subject to the allowance for depreciation shall be its basis for which deductions may be computed under section 167.
On January 1, 1974, A, an individual taxpayer who in a previous year had elected under section 1251(b)(4) to compute income from the trade or business of farming by using inventories and by charging to capital account all items properly chargeable to capital under the rules of subdivision (ii) of this subparagraph, purchases a herd of six-month-old feeder calves for $13,000. During 1974, in connection with such herd, A incurred raising costs of $4,000 and carrying charges of $1,600 which would have been properly chargeable to capital account within the meaning of subparagraph (1)(ii) of this paragraph if the herd had not been included in inventory. A determines under his unit-livestock method that on December 31, 1974, the inventory value of the herd is $17,000. On March 1, 1975, A decides to use one-half of the herd for breeding purposes with such part of the herd becoming subject to the capitalization requirements. On January 1, 1975, the adjusted basis for the animals held for breeding purposes, computed under the provisions of subdivision (iv)(a) of this subparagraph, is $9,300 (that is, the aggregate of one-half of the purchase price of $13,000 for the entire herd of feeder calves, $6,500, one-half of the carrying charges of $1,600 incurred during 1974 in connection with the entire herd, $800, and one-half of the $4,000 of raising costs incurred during 1974 for the entire herd, $2,000). There is no adjustment for the depreciation which would have been allowed since no animal in the herd had reached an acceptable breeding age. Therefore, A as of January 1, 1975, must under the provisions of subdivision (iv)(b)(2) of this subparagraph subtract $8,500 from his opening inventory value of $17,000. However, A has not changed his method of accounting with respect to such animals. Under the provisions of subdivision (iv)(b)(2) of this subparagraph, A for 1975 will add $800 to his gross income (that is, the difference between the adjusted basis for the calves to be used for breeding purposes, $9,300, over the inventory value of such animals, $8,500). Such amount under the provisions of subdivision (iv)(b) shall be treated as gross income derived from the trade or business of farming under paragraph (b)(1) of § 1.1251-3.
(a) The term potential gain means an amount equal to the excess of the fair market value of property over its adjusted basis, but, in the case of land, limited under paragraph (b)(2)(ii) of § 1.1251-1 to the extent of the deductions allowable in respect of such land pursuant to an election (if any) under sections 175 (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 1251(e)(5).
(b) Property held on the first day of a one-year period shall include property received by gift during such one-year period and the potential gain with respect to such property, for purposes of making the computations under this subparagraph, shall be the potential gain in the hands of the donor reduced by the amount of gain (in the case of an exchange which is part a sale and part a gift) taken into account by the donor.
(c) Property held by a taxpayer on the first day of a one-year period which property becomes farm recapture property in the hands of such taxpayer during such one-year period shall be considered to be farm recapture property on each day of such one-year period.
The only farm recapture property A owns is a farm, consisting of farm land and certain farm equipment which is farm recapture property. During the period involved, there was no deduction allowable under section 175 or 182 to any person owning an interest in the farm. A, who uses the calendar year as his taxable year, makes a series of gifts of undivided interests in the farm. In these circumstances, computations may be made by reference to percentages of undivided interests in the farm. The potential gain limitation percentages for each applicable 1-year period are computed, in accordance with the additional facts assumed, in the table below:
| Date Gift to donee | 9/1/70 | 8/1/71 | 3/1/72 | 5/1/73 |
|---|---|---|---|---|
| C | D | E | F | |
| (1) Percent of undivided interest in entire farm given as gift by A on date indicated | 20% | 10% | 10% | 60% |
| (2) Percent of undivided interest in entire farm held by A immediately before gift | 100% | 80% | 70% | 60% |
| (3) Potential gain: | ||||
| (a) On all property held by A on date of gift | $100,000 | $96,000 | $140,000 | $125,000 |
| (b) Limitation percentage (sum of amounts in line (1) during 1-year period beginning on date of gift divided by line (2)) | 30% | 25% | 14.28% | 100% |
(ii) Under subparagraph (2)(iv) of this paragraph, C, D, and F each succeed to the proportion of A's excess deductions account at each applicable time as computed in accordance with the additional facts assumed, in the table below:
| Taxable year ending— | ||||
|---|---|---|---|---|
| Dec. 31, 1970 | Dec. 31, 1971 | Dec. 32, 1972 | Dec. 31, 1973 | |
| Gift to donee to which subparagraph (2)(iv) of this paragraph applies during taxable year | C | D | E | F |
| (4) Potential gain (determined immediately prior to time first gift to which subparagraph (2)(iv) of this paragraph applies is made): | ||||
| (a) On property received by donee to which such subparagraph (2)(iv) applies (line (3)(a) multiplied by line (1) divided by line (2)) | $20,000 | $12,000 | $125,000 | |
| (b) Aggregate potential gain on all farm recapture property held by donor (line (3)(a)) | $100,000 | $96,000 | $125,000 | |
| (5) Allocation ratio (line (4)(a), divided by line (4)(b)) | 20% | 12.5% | 100% | |
| (6) Excess deductions account of A: | ||||
| (a) At end of previous taxable year | 0 | $160,000 | $210,000 | $200,000 |
| (b) Net increase (decrease) for taxable year (determined before making any subtractions under section 1251(b)(5) and this paragraph) | $200,000 | $80,000 | ($10,000) | $36,000 |
| (c) At 12/31 (so determined) | $200,000 | $240,000 | $200,000 | $236,000 |
| (d) Less: Portion to which donee succeeds (line (5), multiplied by line (6)(c)) | $40,000 | $30,000 | $0 | $236,000 |
| (e) At 12/31 (to line (6)(a) following taxable year) | $160,000 | $210,000 | $200,000 | $0 |
Since the potential gain limitation percentage for the 1-year period beginning on September 1, 1970, exceeds 25 percent, a portion of A's excess deductions account, under the provisions of subparagraph (2)(iv) of this paragraph, is succeeded to by C and D. Similarly, since such percentage for the 1-year period beginning May 1, 1973, exceeds 25 percent, such provisions apply to the gift made to F. Since, however, such percentage is 25 percent or less for all 1-year periods in which the gift to E falls (i.e., 25 percent and 14.28 percent for the 1-year periods beginning, respectively, on August 1, 1971, and March 1, 1972) such provisions do not apply to the gift to E.
2. (i) G uses the calendar year as his taxable year and H uses a taxable year ending June 30. As of the close of 1972, G has $100,000 in his excess deductions account, determined before any subtractions under section 1251(b)(5) and this paragraph. G owns only three items of farm recapture property, none of which is land. On May 1, 1972, G makes a gift of farm recapture property No. 1 to his son and on September 1, 1972, G sells to H for $80,000 farm recapture property No. 2 in a transaction which is in part a sale and in part a gift. G owns throughout all relevant periods farm recapture property No. 3. The potential gain limitation percentage for G's one-year period beginning May 1, 1972, is computed in accordance with the additional facts assumed in the table below:
| Farm Recapture Property | Total | |||
|---|---|---|---|---|
| No. 1 | No. 2 | No. 3 | ||
| (1) Fair market value 5/1/72 | $25,000 | $100,000 | $800,000 | |
| (2) Adjusted basis 5/1/72 | $10,000 | $60,000 | $795,000 | |
| (3) Potential gain (line (1), minus line (2)) | $15,000 | $40,000 | $5,000 | $60,000 |
| (4) Sum of potential gains on properties disposed of by gift during period less gain taken into account by transferor on part-sale-part-gift | $15,000 | $20,000 | $35,000 | |
| (5) Potential gain limitation percentage (total line (4), divided by total line (3)) | 581⁄3% | |||
Since the potential gain limitation percentage for the one-year period beginning on May 1, 1972, exceeds 25 percent, the provisions of subparagraph (2)(iv) of this paragraph apply to the gift to the son and that portion of the disposition to H which is a gift.
(ii) The portion of G's excess deductions account determined, as of the close of 1972, before any subtraction under section 1251(b)(5) and this paragraph, allocated to the son and to H as of May 1, 1972, is computed in the table below:
| Property | Total | |||
|---|---|---|---|---|
| No. 1 | No. 2 | No. 3 | ||
| (1) Potential gain under part (i) of this example (since the first day of the one-year period is the same as the time as of which the first gift was made during the taxable year) | $15,000 | $40,000 | $5,000 | $60,000 |
| (2) Potential gain less amount taken into account by transfer on part-sale-part-gift | 15,000 | 20,000 | ||
| (3) Allocation percentage (line (2), divided by $60,000) | 25% | 331⁄3% | ||
| (4) Excess deductions account at close of taxable year (determine before making any subtractions under section 1251(b)(5) and this paragraph) | 100,000 | |||
| (5) Portion to which donee succeeds on 5/1/72 | 25,000 | 33,333 | 58,333 | |
| (6) G's excess deductions account 12/31/72 | $41,667 | |||
Accordingly, the amount of G's excess deduction account succeeded to as of May 1, 1972, is $25,000 by the son and $33,333 by H.
(a) The spouse who had such deficit shall have an excess deductions account of zero, and
(b) The other spouse shall have an excess deductions account equal to the amount prescribed in subdivision (i) of this subparagraph minus the amount of such deficit.
Assume the same facts as in example (4) of paragraph (b)(5) of this section, except that H and W file a joint return under section 6013 and that H has a farm net loss of only $40,000. Thus, since the nonfarm adjusted gross income for calendar year 1971 was $60,000 for H and $30,000 for W, their combined nonfarm adjusted gross income exceeds $50,000, thereby satisfying under subparagraph (1)(i) of this paragraph the $50,000 limitation of paragraph (b)(2)(i) of this section. Assume further that for 1971 only W makes a dispostion of farm recapture property (other than land and section 1245 property). As a result of such disposition, W realizes a gain of $14,000. Accordingly, for 1971, the separately maintained excess deductions accounts of H and W, their joint excess deductions account, and the treatment of the gain realized by W on the disposition of the farm recapture property are computed, in accordance with the facts assumed in the table below:
| H's | W's | Joint | ||||
|---|---|---|---|---|---|---|
| (1) Balance Jan. 1, 1971 | $10,000 | $5,000 | $15,000 | |||
| (2) Additions for 1971: | ||||||
| (a) Farm net loss for 1971 | $40,000 | $10,000 | $50,000 | |||
| (b) Less amount in paragraph (b)(2)(ii) of this section as allocated under subparagraph (1)(ii) of this paragraph | 20,000 | 5,000 | 25,000 | |||
| (c) Total additions for 1971 | 20,000 | 5,000 | 25,000 | |||
| (3) Subtotal | 30,000 | 10,000 | 40,000 | |||
| (4) Subtractions for 1971 | 0 | 0 | ||||
| (5) Excess deductions account limitation on gain recognized as ordinary income under section 1251(e)(1) for 1971 | 30,000 | 10,000 | 40,000 | |||
| (6) Subtraction for dispositions of farm recapture property: | ||||||
| (a) Gain to which section 1251(c)(1) applies (computed before applying limitation) | 0 | 14,000 | 14,000 | |||
| (b) Limitation (amount in line (5)) | 30,000 | 10,000 | 40,000 | |||
| (c) Gain recognized as ordinary income under section 1251(c)(1), computed for joint account (lower of line 6(a) or line 6(b) subject to provisions as to separately maintained accounts of subparagraph (1)(iii) | 14,000 | 14,000 | ||||
| (7) Balance Dec. 31, 1971 | 30,000 | (4,000) | 26,000 |
If for 1972, H and W were to file separate returns, then the separately maintained excess deductions account balances as of January 1, 1972, would be $26,000 and zero respectively. See subparagraph (5)(ii) of this paragraph.
[T.D. 7418, 41 FR 18816, May 7, 1976; 41 FR 23669, June 11, 1976]
Terms defined here
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Cross-references
Computed from the citations in the text of 26 CFR.
Code sections it cites
- § 1251 Repealed
- § 1371 Coordination with subchapter C
- § 1 Tax imposed
- § 6013 Joint returns of income tax by husband and wife
- § 1373 Foreign income
- § 1245 Gain from dispositions of certain depreciable property
- § 25 Interest on certain home mortgages
- § 172 Net operating loss deduction
- § 1202 Partial exclusion for gain from certain small business stock
- § 1231 Property used in the trade or business and involuntary conversions
- § 175 Soil and water conservation expenditures; endangered species recovery expenditures
- § 268 Sale of land with unharvested crop
- § 481 Adjustments required by changes in method of accounting
- § 381 Carryovers in certain corporate acquisitions
- § 368 Definitions relating to corporate reorganizations
- § 2 Definitions and special rules
Regulations it cites
- § 1.1251-3 Definitions relating to section 1251.
- § 1.1251-1 General rule for treatment of gain from disposition of property used in farming where farm losses offset nonfarm income.
- § 1.61-4 Gross income of farmers.
- § 1.446-1 General rule for methods of accounting.
- § 1.1016-5 Miscellaneous adjustments to basis.
- § 1.1245-2 Definition of recomputed basis.
- § 1.1250-2 Additional depreciation defined.
- § 1.481-1 Adjustments in general.
- § 1.1251-4 Exceptions and limitations.
- § 1.381(a)-1 General rule relating to carryovers in certain corporate acquisitions.
- § 1.381(b)-1 Operating rules applicable to carryovers in certain corporate acquisitions.
Cited by 4 other regulations
Amendment history
From the source citation at the end of the section, newest first. T.D. is a Treasury decision; FR is the Federal Register.
- Amended (41 FR 23669)
- Issued by T.D. 7418 (41 FR 18816)
Where it sits in 26 CFR
- Subchapter A Income tax
- Part 1 Income taxes
- Special Rules for Determining Capital Gains and Losses
Nearby sections
- § 1.1250-3 Exceptions and limitations.
- § 1.1250-4 Holding period.
- § 1.1250-5 Property with two or more elements.
- § 1.1251-1 General rule for treatment of gain from disposition of property used in farming where farm losses offset nonfarm income.
- § 1.1251-2 Excess deductions account.
- § 1.1251-3 Definitions relating to section 1251.
- § 1.1251-4 Exceptions and limitations.
- § 1.1252-1 General rule for treatment of gain from disposition of farm land.
- § 1.1252-2 Special rules.