Your inventory should include all items held for sale, or for use as feed, seed, etc., whether raised or purchased, that are unsold at the end of the year.

Generally, if you produce, purchase, or sell merchandise in your business, you must keep an inventory and use the accrual method for purchases and sales of merchandise. However, if you are a qualifying taxpayer or a qualifying small business taxpayer that has an eligible business, you can use the cash method of accounting, even if you produce, purchase, or sell merchandise. If you qualify, you also can choose not to keep an inventory, even if you do not change to the cash method.

A qualifying taxpayer is a taxpayer that for each prior tax year ending after December 16, 1998, has average annual gross receipts of $1 million or less for the 3-tax-year period ending with that prior tax year. A tax shelter cannot be a qualifying taxpayer. See Publication 538 for more information.

A qualifying small business taxpayer is a taxpayer that (a) for each prior tax year ending after December 31, 2000, has average annual gross receipts of $10 million or less for the 3-tax-year period ending with that prior tax year, and (b) whose principal business activity is not an ineligible activity. Certain other requirements must be met. See Publication 538 for more information.

The following applies if you are required to use an accrual method of accounting.

The following methods, described below, are those generally available for valuing inventory.

If you do not harvest and dispose of your crop in the same tax year that you plant it, you can, with IRS approval, use the crop method of accounting. Under this method, you deduct the entire cost of producing the crop, including the expense of seed or young plants, in the year you realize income from the crop.

You cannot use this method for timber or any commodity subject to the uniform capitalization rules.

Other special methods of accounting apply to the following items.

Crop shares you receive as a landlord and feed to your livestock are considered converted to money when fed to the livestock. You must include the fair market value of the crop shares in income at that time. You are entitled to a business expense deduction for the livestock feed in the same amount and at the same time you include the fair market value of the crop share as rental income. Although these two transactions cancel each other for figuring adjusted gross income on Form 1040, they may be necessary to figure your self-employment tax. See chapter 12.

Crop shares you receive as a landlord and give to others are considered converted to money when you make the gift. You must report the fair market value of the crop share as income, even though someone else receives payment for the crop share.

If you are involved in a rental or crop-share lease arrangement, any loss from these activities may be subject to the limits under the passive loss rules. See Publication 925 for information on these rules.

If you forfeit pledged crops to the CCC in full payment of a loan, you may receive a Form 1099-A, Acquisition or Abandonment of Secured Property. CCC should be shown in box 6. The amount of any CCC loan outstanding when you forfeited your commodity should also be indicated on the form.

You can postpone reporting crop insurance proceeds as income until the year following the year the damage occurred if you meet all the following conditions.

To postpone reporting crop insurance proceeds received in 2005, report the amount you received on Schedule F, line 8a, but do not include it as a taxable amount on line 8b. Check the box on line 8c and attach a statement to your tax return. The statement must include your name and address and contain the following information.

One election covers all crops representing a single trade or business. If you have more than one farming business, make a separate election for each one. For example, if you operate two separate farms on which you grow different crops and you keep separate books for each farm, you should make two separate elections to postpone reporting insurance proceeds you receive for crops grown on each of your farms.

An election is binding for the year unless the IRS approves your request to change it. To request IRS approval to change your election, write to the IRS at the following address giving your name, address, identification number, the year you made the election, and your reasons for wanting to change it. Ogden Submission Processing Center P. O. Box 9941 Ogden, UT 84409

If the three tests listed above are met, you can exclude payments from the following programs.

The gross income you realize upon getting an improvement under these cost-sharing programs is the value of the improvement reduced by the sum of the excludable portion and your share of the cost of the improvement (if any).

When you figure the basis of property you acquire or improve using cost-sharing payments excluded from income, subtract the excluded payments from your capital costs. Any payment excluded from income is not part of your basis.

In addition, you cannot take depreciation, amortization, or depletion deductions for the part of the cost of the property for which you receive cost-sharing payments you exclude from income.

Attach a statement to your tax return (or amended return) for the tax year you receive the last government payment for the improvement. The statement must include the following information.

Report the total cost-sharing payments you receive on Schedule F, line 6a, and the taxable amount on line 6b.

If you dispose of the property within 20 years after you received the excluded payments, you must treat as ordinary income part or all of the cost-sharing payments you excluded. You must report the recapture on Form 4797. See Section 1255 property under Other Gains in chapter 9.

You can elect not to exclude all or part of any payments you receive under these programs. If you make this election for all of these payments, none of the above restrictions and rules apply. You must make this election by the due date, including extensions, for filing your return. If you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Write Filed pursuant to section 301.9100-2 at the top of the amended return and file it at the same address you filed the original return.

Your taxable gain or loss is the total amount received for your quota reduced by any amount treated as interest (discussed later), over your adjusted basis. The gain or loss is capital or ordinary depending on how you used the quota. See Capital or ordinary gain or loss, later.

Report the entire gain on your income tax return for the taxable year if you:

The adjusted basis of your quota is determined differently depending on how you obtained the quota.

If not previously allocated, the total basis of a quota (or acreage allotment) and land obtained at the same time must be properly allocated between the two assets.

You must reduce your peanut quota buyout program payment by the amount treated as interest, which is reportable as ordinary income. If payments total $3,000 or less, your total quota buyout program payment does not include any amount treated as interest and you are not required to reduce the total payment you receive.

In all other cases, a portion of each payment may be treated as interest for federal tax purposes. You may be required to reduce your total quota buyout program payment before you calculate your gain or loss. For more information, see Notice 2002-67 on page 715 of Internal Revenue Bulletin 2002-42. This bulletin is available at www.irs.gov/pub/irs-irbs/irb02-42.pdf.

You may use the installment method to report a gain if you receive at least one payment after the close of your taxable year. Under the installment method, a portion of the gain is taken into account in each year in which a payment is received. See chapter 10 for more information.

Whether your gain or loss is ordinary or capital depends on how you used the quota.

The peanut quota buyout payments are not self-employment income.

The gain or loss resulting from the quota payments does not qualify for income averaging. A peanut quota is considered an interest in land. Income averaging is not available for gain or loss arising from the sale or other disposition of land.

The buyout of the peanut quota is not an involuntary conversion.

A peanut quota is considered an interest in land, so the USDA will generally report the total amount you receive under a contract on Form 1099-S if the amount is $600 or more. The USDA will generally report any portion of a payment treated as interest of $600 or more to you on Form 1099-INT for the year in which the payment is made.

For more information on the taxation of peanut quota buyout program payments, see Notice 2002-67.

If you receive a qualified written notice of allocation as part of a patronage dividend, you must generally include its stated dollar value in your income in the year you receive it. A written notice of allocation is qualified if at least 20% of the patronage dividend is paid in money or by qualified check and either of the following conditions is met.