selling a primary residence with farm income

[douginsd]

When I bought my primary residence it came with a small lemon grove on the same property as the house.  I have been selling the lemons every year and reporting the income/loss on Schedule F.  I have taken some small depreciation amounts each year for the trees, and the irrigation system.

My understanding was in the past if a home was used partly for business, you had to allocate a percentage of the home for personal use, and a percentage for business, and the business percentage part was not eligible for the $500k exclusion at all.  When I read IRS 587 it appears that rule has changed over the years, and you no longer need to do that personal/business allocation.  But, Publication 587 says nothing about farm use, it only mentions using a part of the home for business.  Does the term 'home' include the house and land, or just the house?  I'm assuming my situation falls under this business use of the home category, and I can use the full $500k exclusion, minus the depreciation.  Am I interpreting this correctly?

[PatriciaV]

Yes, the land on which the home is built is considered part of your "residence" and a portion of any sales proceeds & selling expenses would be allocated to the land.

Also, if the lemon grove is included in the sale of your home, some portion of the sales proceeds would be allocated to your farm basis (trees and equipment), and that portion would not be included in the home sale exclusion.

[douginsd]

That's the way I understood it worked for business use of the home in the past, but here's a direct cut/paste from the current IRS Pub. 587 that seems to indicate that's no longer the case.

"If the part of your property used for business is within your home, such as a room used as a home office for a business or rooms used to provide daycare, you do not need to allocate gain on the sale of the property between the business part of the property and the part used as a home. In addition, you do not need to report the sale of the business part on Form 4797, Sales of Business Property. This is true whether or not you were entitled to claim any depreciation. However, you cannot exclude the part of any gain equal to any depreciation allowed or allowable after May 6, 1997"

Does this rule only apply to business use of the home, not farming operations carried out on the property, or what?  Seems like if I'm not obligated to allocate the business/personal mix for running a small business from my home, the rules should be the same for running a small farming business on the property.  In both cases the gains/losses are reported on form 4797, so it seems like my home-based farm would be the same as a home based business. 

EDIT: I read a bit more and in pub. 523 it refers to "a working farm with a farmhouse on the property" being treated differently than just using part of the house for business.  If I have no employees, no farm equipment,  and its a very small 1 acre operation grossing a few thousand dollars per year, is that considered a "working farm" or more of a "hobby farm".  It seems to me that a "working farm with a farmhouse on the property" is a large acreage farm, which happens to have a home on the land because the owner wants to live there as well.  In my case the trees just happen to be on what is otherwise a primary residence, its not a farm in the normal sense of the word.

If what you reported earlier is actually the case, and I do have to allocate the personal/business portions, then what can I do to avoid that tax treatment when I sell the house?  I think if I discontinued the farm activity for 2 years before selling the house that would remove the need to allocate the personal/business mix and gain back the full exclusion amount, am I right about that?

Finally, if I did have to allocate, would I just include the value of the trees/irrigation system in my business/personal allocation, or would I have to allocate a percentage of the land that the trees occupy and put some of the land value in that calculation?

[PatriciaV]

Most of what you're reading relates to the Home Office Deduction, not the use of your property for a farm.

The argument could be made that your orchard is a "hobby farm" since you have little invested in it beyond the cost of upkeep and production.

If you stopped using your land for the farm, you would not need to allocate any portion of a future sale to that enterprise. You might have depreciation recapture if the assets are not fully depreciated and included in the property sale.

[douginsd]

thanks for the previous answers, but the most important thing I wanted to confirm is if I sell the house and need to allocate the business/personal split, does the land value get involved at all?  Your original answer implied it doesn't, but I wanted to confirm that's true.  Just to clarify, the land is part of the primary residence, not a separate parcel.

The trees/irrigation system are a small enough dollar amount that those aren't that important, but if I had to allocate a portion of the land value in the allocation split, that would be significant.  thanks.

[PatriciaV]

Yes, you are correct. The land was purchased with the home and would be part of the sale of that residence as well. If you sold the farm separately, then you would need to allocate a portion of the land to the farm.