Watch Out for Section 1257

If you convert wetlands to farmland or farm highly erodible land, the gain on sale will be ordinary

Photo by Nick Fewings on Unsplash

Somebody reached out to me the other day about deducting the cost of converting wetlands and then starting to farm it. This post is not on that subject but rather how is the gain or loss of selling this “farmland” later on treated.

Section 1257 of the Tax Code has a penalty for any sale of wetlands that is farmed or any highly erodible land. The definition of these lands is as follows:

• Converted Wetland: Land that has been converted from wetland to agricultural use, as defined in the Food Security Act, and held by the person whose activities resulted in the conversion or by any person who has used the land for farming.

• Highly Erodible Cropland: Land classified as highly erodible under the Food Security Act, if at any time the taxpayer used it for farming (other than grazing).

There is a penalty that happens when you sell this land. If there is a gain, then the gain is ordinary income even if you held it for more than a year. If there is a loss, the loss is capital loss. This is the worst of both.