Basis

Since this "buy back" amounts to the disposition of an asset, either one used in a trade or business, if held by a producer, or one held for investment or the production of income, if held by a non-producer, it is essential for quota holders to know their cost or other basis in the peanut quota pounds for which the 55 cent payment is being made to correctly determine and report any gain or loss resulting from the elimination of the quota in exchange for the 55 cents per pound payment.

For income tax reporting purposes, basis is the "book" value of an asset in the hands of its current owner. An individual receives basis in an asset in an asset in one of three ways; by purchase, by gift during lifetime of the giver, or by testamentary gift through transfer from a decedent's estate.

Purchase

Peanut production quotas have generally been purchased by the pound, but the purchases have generally been in large quantities or "blocks." It has been virtually impossible to purchase one pound of peanut quota. In the view of the Internal Revenue Service, basis in purchased peanut quota is considered to be the total amount expended to secure the "block" acquired.

A recipient's basis in property received via testament or transfer from a decedent's estate is given a basis equal to the fair market value of the asset at the time of death. Property received via testamentary gift, other than livestock, is considered to meet the holding period requirement for long-term capital gain tax treatment in the hands of the recipient, regardless of how long it is actually held.

Computing Gain or Loss

To correctly compute the tax gain or loss resulting from the peanut quota "buy back," the quota holder will need to know his or her initial basis, and if applicable, adjusted basis and the nature of any basis adjustments. In all situations other than those limited cases were quota basis has been amortized following the revision of I.R.C. Sec. 197, the quota holder's initial basis will be the current basis for gain or loss computation.

In determining the gain or loss resulting from the "buy back," the dollar basis is the important item of information. If George A. purchased 100,000 of peanut quota in 1996 at a price of 40¢ per pound, his basis in that "block" of quota is $40,000. If adjustments by the Secretary of Agriculture have subsequently reduced that "block" of quota to 80,000 pounds, his basis in the "block" is still $40,000, but it is now 50¢ per pound. When George reports the "buyout" of his quota, he will report $44,000 of sales proceeds (40,000 lbs x 55¢), reduced by $40,000 basis recovered, leaving $4,000 of gain. George's recovery of his $40,000 basis is not taxed. Since George held the quota for more than one year, his gain is a long-term capital gain, subject to Federal tax at a maximum rate of 20 percent, plus his applicable state income tax rate.

For some quota holders, the 55 cent "buy back" payment will leave them with a loss. Virginia inherited 400,000 pounds of quota when her father died in 1997. The fair market value of the quota at the time of her father's death was 50 cents per pound, giving her a basis of $200,000. Subsequent quota reductions have left her holding 320,000 of quota, with her total basis continuing to be $200,000, but now 62.5¢ per pound. The 55¢ buyout payment will leave her with a long-term capital loss of $24,000, or 7.5¢ per pound. Virginia has always rented her quota to her cousin Tex. Virginia is considered to have held the peanut quota as "an asset used in a trade or business", under Section 1231 of the Internal Revenue Code (I.R.C. §1231), even though she has never been a peanut producer. I.R.C. §1231 permits gains from the disposition of such assets to be treated as capital gains, while losses are treated as ordinary losses. Under I.R.C. §1231 Virginia will be able to claim the entire $24,000 loss as an ordinary loss, deductible against any other income on her tax return.

Al A. Bama purchased 60,000 pounds of peanut quota to use in peanut production in his farm business in January 1994 at a price of 60 cents per pound, giving him an initial basis of $36,000. Believing that peanut quota was included in the definition of amortizable intangibles under new I.R.C. Sec. 197, he began recovering his basis over 180 months (15 years), beginning in the month of purchase. Through April 2002 his amortization expense was $20,000, leaving him with an adjusted basis of $16,000. Quota reductions since the time of his purchase left him with 45,000 of quota at the time of the "buy back," giving him a payment of $24,750. Al's payment will be taxed as follows:

• Sixteen thousand dollars ($16,000) will be a non-taxable recovery of his adjusted basis.
• The remaining $8,750 will be taxed as ordinary income at the applicable ordinary income tax rate for the year in which he takes his payment. This amount is taxed as ordinary income since it is a recapture of amortization expense, which was treated as ordinary expense at the time it was claimed.

Determining Basis