Q-1. Are Owner Payments received under the Act subject to
federal income tax?
A-1. Yes, Owner Payments are subject to federal income tax. If the
amounts received by the Owner are more than the Owner’s adjusted basis
in the quota, the Owner has a taxable gain; if the Owner receives less than
the Owner’s adjusted basis, the Owner has a loss that may be deductible
for tax purposes if the requirements for deduction under § 165 are
satisfied. In determining an Owner’s gain or loss, the amount received
for the quota does not include any amount treated as interest for federal
tax purposes. See Q & A-7 for help in determining whether any portion
of an Owner Payment is treated as interest for federal tax purposes.
Q-2. How does an Owner determine the adjusted basis of a
quota?
A-2. The adjusted basis of a quota is determined differently depending
upon how the Owner acquired the quota.
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An Owner who holds a quota that is derived from an original grant by
the federal government has a basis of zero in the quota.
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The basis of a purchased quota is the price the Owner paid for it.
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Generally an Owner who received a quota as a gift has the same basis
in the quota as the person who gave the quota to the Owner. Under certain
circumstances, the basis is increased by an amount related to the amount of
gift tax paid. If the basis is greater than the fair market value of the
quota at the time of the gift, the basis for determining loss is that fair
market value.
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The basis of a quota that an Owner inherited generally is the fair market
value of the quota at the time of the decedent’s death.
The basis of a tobacco quota is not subject to adjustment through amortization,
depletion, or depreciation. However, if an Owner improperly has deducted
any amount for these purposes, the Owner must reduce the basis by the amount
deducted before determining the Owner’s gain or loss. A similar reduction
in the basis of a quota must be made for any amount previously deducted as
a loss because of a reduction in the number of pounds of tobacco allowable
under the quota. If an Owner purchased a quota and deducted the entire cost
in the year of purchase, then the Owner’s basis in the quota is zero.
Q-3. If an Owner has a gain and reports Owner Payments under
the installment method, when must the gain be included in income?
A-3. The installment method may be used to report gain if an Owner
receives at least one Owner Payment after the close of the Owner’s taxable
year that includes the Sale Date. The amount of the gain is the excess of
the total amount of Owner Payments to be received, reduced by any amount treated
as interest, over the Owner’s adjusted basis in the quota. Under the
installment method, a proportionate amount of the gain is taken into account
in each year in which an Owner Payment is received. See the instructions
for Form 6252, Installment Sale Income.
Q-4. If an Owner has a gain and elects not to report Owner
Payments under the installment method, when must the gain be included in income?
A-4. The Owner must report the entire gain on the Owner’s federal
income tax return for the taxable year that includes the Sale Date.
Q-5. Is the gain or loss with respect to a quota ordinary
or capital gain or loss?
A-5. Whether the gain or loss with respect to a quota is ordinary or
capital depends on how the Owner used the quota.
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If an Owner used a quota in the trade or business of farming and, on
the Sale Date, the Owner’s holding period for the quota was more than
one year, then the transaction is reported under § 1231 on Form
4797, Sales of Business Property. If an Owner has no
other § 1231 transactions reportable on Form 4797, any gain is treated
as long-term capital gain and any loss is treated as ordinary loss. Even
if an Owner has other reportable § 1231 transactions, the net result
of all § 1231 transactions reported generally is either long-term
capital gain or ordinary loss. See the instructions for Form 4797 for more
detailed information.
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If an Owner held a quota for investment purposes, or for the production
of income, but did not use the quota in a trade or business, any gain or loss
is capital gain or loss.
Under certain circumstances, some or all of the gain must be recharacterized
and reported as ordinary income. If an Owner previously deducted (1) the
cost of acquiring a quota, (2) amounts for amortization, depletion, or depreciation,
or (3) amounts to reflect a reduction in the quota pounds, any gain is taxed
as ordinary income up to the amount previously deducted. The Owner must report
this amount of ordinary income on the Owner’s return for the taxable
year that includes the Sale Date, even if the Owner uses the installment method
to report the remainder of the gain.
Q-6. Are Owner Payments received under the Act subject to
Self-Employment Contributions Act (SECA) tax (see § 1402)?
A-6. No.
Q-7. Is any portion of an Owner Payment treated as interest
for federal tax purposes?
A-7. (a) If the total amount to be paid under a contract does not
exceed $3,000, no portion of an Owner Payment is treated as interest for federal
tax purposes.
(b) If § 483 applies to a contract, a portion of each Owner
Payment (other than an Owner Payment due within six months of the Sale Date)
is treated as interest for federal tax purposes. For example, § 483
generally applies to a contract if the total amount to be paid under the contract
does not exceed $250,000 or if a cash method election is made under §§ 1274A
and 1.1274A-1(c). A contract is eligible for the cash method election only
if the total amount to be paid under the contract does not exceed the inflation-adjusted
amount for a cash method debt instrument ($3,202,100 for 2005).
(c) In all situations not described in (a) or (b) above, a portion
of each Owner Payment is treated as interest for federal tax purposes under
§ 1274.
(d) In general, to determine the amount of an Owner Payment that is
treated as interest, see § 483 or § 1274, whichever is
applicable, and the regulations thereunder. You may wish to consult a tax
advisor for assistance in determining the portion of an Owner Payment that
is treated as interest and the taxable year in which the interest is includible
in income.
Q-8. Does an individual Owner’s gain or loss from Owner
Payments qualify for farm income averaging?
A-8. No. A tobacco quota is considered an interest in land, and farm
income averaging is not available for gain or loss arising from the sale or
other disposition of land.
Q-9. Are Owner Payments subject to information reporting?
A-9. Yes. Because a tobacco quota is considered an interest in land,
the total amount received under a contract by an owner in a taxable year generally
will be reported by USDA on Form 1099-S, Proceeds From Real Estate
Transactions, if the amount is $600 or more. In addition, any
portion of an Owner Payment treated as interest for federal tax purposes generally
will be reported by USDA on Form 1099-INT, Interest Income,
if the total amount of interest received in a taxable year is $600 or more.
Q-10. Is the termination of a tobacco quota under the Act
an involuntary conversion of the quota?
A-10. No.
Q-11. May an Owner enter into a like-kind exchange of a quota?
A-11. Yes. An Owner may postpone reporting the gain or loss from the
termination of a quota by entering into a like-kind exchange pursuant to § 1031
and the regulations thereunder. The date on which an Owner and USDA enter
into a contract for Owner Payments with respect to a quota is treated as the
date on which the quota is transferred for purposes of § 1031.
An intermediary is treated as satisfying the requirements of § 1.1031(k)-1(g)(4)(iii)(B)
(relating to the exchange agreement required to be entered into by a qualified
intermediary) if the intermediary enters into a written agreement with the
Owner (the exchange agreement) before the date on which the quota is transferred
and under the exchange agreement the intermediary—
(a) is assigned the right to receive all Owner Payments under the contract
made after the date of the exchange agreement;
(b) acquires the replacement property; and
(c) transfers the replacement property to the Owner.
Q-12. Is transitional relief available for purposes of § 1031
for an Owner who could not make timely arrangements for a like-kind exchange
under Notice 2005-51?
A-12. Yes, transitional relief is available to an Owner who applied
by June 17, 2005, to enter into a contract with USDA for Owner Payments.
In determining whether such Owner has entered into a like-kind exchange pursuant
to § 1031 and the regulations thereunder, the date on which the
Owner transfers a quota is deemed to be September 16, 2005. To qualify for
this transitional relief, an Owner who receives an Owner Payment must remit
the amount of the Owner Payment to the qualified intermediary within 5 business
days of the later of the date the exchange agreement is entered into or the
date the Owner Payment is received by the Owner; in such case the Owner Payment
is treated as being received by the qualified intermediary.
