26 CFR § 1.175-5 - Percentage limitation and carryover.

(a) The limitation -

(1) General rule. The amount of soil and water conservation expenditures which the taxpayer may deduct under section 175 in any one taxable year is limited to 25 percent of his “gross income from farming”.

(2) Definition of “gross income from farming.” For the purpose of section 175, the term gross income from farming means the gross income of the taxpayer, derived in “the business of farming” as defined in § 1.175-3, from the production of crops, fruits, or other agricultural products, including fish, or from livestock (including livestock held for draft, breeding, or dairy purposes). It includes such income from land used in farming other than that upon which expenditures are made for soil or water conservation or for the prevention of erosion of land. It does not include gains from sales of assets such as farm machinery or gains from the disposition of land. A taxpayer shall compute his “gross income from farming” in accordance with his accounting method used in determining gross income. (See the regulations under section 61 relating to accounting methods used by farmers in determining gross income.) The provisions of this subparagraph may be illustrated by the following example:

Example.
A, who uses the cash receipts and disbursements method of accounting, includes in his “gross income from farming” for purposes of determining the 25-percent limitation the following items:
Proceeds from sale of his 1955 yield of corn $10,000
Gain from disposition of old breeding cows replaced by younger cows 500
Total gross income from farming 10,500
A must exclude from “gross income from farming” the following items which are included in his gross income:
Gain from sale of tractor $100
Gain from sale of 40 acres of taxpayer's farm 8,000
Interest on loan to neighboring farmer 100

(3) Deduction qualifies for net operating loss deduction. Any amount allowed as a deduction under section 175, either for the year in which the expenditure is paid or incurred or for the year to which it is carried, is taken into account in computing a net operating loss for such taxable year. If a deduction for soil or water conservation expenditures has been taken into account in computing a net operating loss carryback or carryover, it shall not be considered a soil or water conservation expenditure for the year to which the loss is carried, and therefore, is not subject to the 25-percent limitation for that year. The provisions of this subparagraph may be illustrated by the following example:

Example.
Assume that in 1956 A has gross income from farming of $4,000, soil and water conservation expenditures of $1,600 and deductible farm expenses of $3,500. Of the soil and water conservation expenditures $1,000 is deductible in 1956. The $600 in excess of 25 percent of A's gross income from farming is carried over into 1957. Assuming that A has no other income, his deductions of $4,500 ($1,000 plus $3,500) exceed his gross income of $4,000 by $500. This $500 will constitute a net operating loss which he must carry back two years and carry forward five years, until it has offset $500 of taxable income. No part of this $500 net operating loss carryback or carryover will be taken into account in determining the amount of soil and water conservation expenditures in the years to which it is carried.

(b) Carryover of expenditures in excess of deduction. The deduction for soil and water conservation expenditures in any one taxable year is limited to 25 percent of the taxpayer's gross income from farming. The taxpayer may carry over the excess of such expenditures over 25 percent of his gross income from farming into his next taxable year, and, if not deductible in that year, into the next year, and so on without limit as to time. In determining the deductible amount of such expenditures for any taxable year, the actual expenditures of that year shall be added to any such expenditures carried over from prior years, before applying the 25-percent limitation. Any such expenditures in excess of the deductible amount may be carried over during the taxpayer's entire existence. For this purpose in a farm partnership, since the 25-percent limitation is applied to each partner, not the partnership, the carryover may be carried forward during the life of the partner. The provisions of this paragraph may be illustrated by the following example:

Example.
Assume the expenditures and income shown in the following table:
Year Deductible soil and water conservation expenditures Total 25 percent of gross income from farming Excess to be carried forward
Paid or incurred during taxable year Carried forward from prior year
1954 $900 None $900 $800 $100
1955 1,000 $100 1,100 900 200
1956 None 200 200 1,000 None
The deduction for 1954 is limited to $800. The remainder, $100 ($900 minus $800), not being deductible for 1954, is a carryover to 1955. For 1955, accordingly, the total of the expenditures to be taken into account is $1,100 (the $100 carryover and the $1,000 actually paid in that year). The deduction for 1955 is limited to $900, and the remainder of the $1,100 total, or $200, is a carryover to 1956. The deduction for 1956 consists solely of this carryover of $200. Since the total expenditures, actual and carried-over, for 1956 are less than 25 percent of gross income from farming, there is no carryover into 1957.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6649, 28 FR 3762, Apr. 18, 1963]