Tax Implications of Drought-Related Livestock Sales
Nathan Kemper, Author
Kim Magee, Reviewer
University of Arkansas Division of Agriculture
The beef cattle industry in Arkansas was especially hard hit by the 2012 drought. Poor pasture conditions, increased cost of inputs, reduced revenues from low hay production, and lower cattle marketing weights all contributed to eroding farm income. A survey done in late summer gathered data from cow-calf farms in Arkansas. 545 responses were received from farmers in 58 counties. The results showed that the drought had a drastic impact on farmers’ cattle sales. Over 73% of farmers reported that they planned to sell calves as much as two and a half months earlier than normal. Compared to a typical year, farmers reported that:
- 49% had sold more mature cows
- 41% planned to sell more mature cows
- 41% had sold replacement heifers
- 30% were planning to sell more replacement heifers
Arkansas Farmers May be Able to Postpone Payment of Income Tax
Arkansas farmers who sold livestock in 2012 due to a weather-related condition may be able to postpone reporting the gain from these additional sales until the next tax year. These early sales may have been caused by shortage of water, poor grazing conditions, low feed production, or other consequences of weather-related conditions. There are two tax options available to farmers. Farmers must meet all of the following conditions to qualify:
- Your principal trade or business is farming.
- You use the cash method of accounting.
- You can show that, under your usual business practices, you would not have sold or exchanged the additional animals this year except for the weather-related condition.
- The weather-related condition caused an area to be designated as eligible for assistance by the federal government.
Tax Option 1 – Postpone reporting taxable gain on additional sales of any livestock for 1 year
Code Section 451(e) – The first option known as the deferred sales receipt method has the broadest class of animals that qualify. The income from livestock or poultry sold in excess of normal sales (whether raised or purchased) may be deferred for up to one year. To postpone a gain, farmers must attach a statement to their tax return for the year of sale. The statement must include the following information for each class of livestock for which a gain is being postponed:
- A statement that you are postponing gain under Internal Revenue Code (IRC) section 451(e).
- Evidence of the weather-related conditions that forced the early sale or exchange of the livestock and the date, if known, on which an area was designated as eligible for assistance by the federal government because of weather-related conditions.
- A statement explaining the relationship of the area affected by the weather-related condition to your early sale or exchange of the livestock.
- The number of animals sold in each of the 3 preceding years.
- The number of animals you would have sold in the tax year had you followed your normal business practice in the absence of weather-related conditions.
- The total number of animals sold and the number sold because of weather-related conditions during the tax year.
- A computation, as described above, of the income to be postponed for each class of livestock.
Option 1 is the ONLY option for livestock held for sale (e.g., steers, feeder heifers). Not all income must be deferred to the following year. One advantage to farmers using Option 1 is that some income can be taken as income for the drought year and some can be deferred to the following year.
Example – Option 1: Farmer Smith normally sells 20 cows each year. Due to the 2012 drought, Smith had no pasture or hay to feed his cattle and he sold 50 cows rather than the normal 20. Smith sells the 50 cows at $650 per head. Since 20 cows are sold in a “normal” year, the amount of sales that can be deferred calculated as follows: 30 cows at $650/head = $19,500. The 20 cows sold at $650/head would be reported as income in 2012 for $13,000.
Tax Option 2 – Postpone and avoid paying taxes on the gain from the sale of breeding, draft, or dairy animals if they are replaced within a specified time frame
Code Section 1033(e) – The second option is the “involuntary conversion” option. Income from drought-related sales of draft, breeding, or dairy animals (no sporting animals) sold do not have to be recognized if the proceeds are used to purchase replacement livestock within two years from the end of the tax year in which the drought-related sales take place. The recovery period for federally declared disaster areas is extended to four years. The new livestock must be used for the same purpose as the livestock sold (breeding stock replaced with breeding stock). The taxpayer must show that weather caused the sale of more livestock than otherwise would have been sold in a typical year. Under option 2, the area does not have to be declared a federal disaster area. The requirements under option 2 are the following:
1) Evidence of existence of the weather conditions that forced the sale or exchange of the livestock.
2) A computation of the amount of gain realized on the sale or exchange.
3) The number and kind of livestock sold or exchanged.
4) The number of livestock of each kind that would have been sold or exchanged under the usual business practice if the weather condition had not occurred.
Farmers should carefully consider future intentions for rebuilding their herds when opting for the second option. When replacements are purchased, the date of purchase should be attached to the tax return along with the cost, number of animals and kind of animals.
Example – Option 2: Farmer Smith normally sells 20 cows from her beef herd each year. In 2012 due to the drought, Smith sold 70. This was 50 more than normal. Smith plans to purchase additional cows in 2013 to replace the extra 50 cows sold. The average price for all 70 head was $675/head. Only the 50 extra cows sold qualify for the deferment and because the cows were raised rather than purchased, they have a zero tax basis. The 50 head at $675 = $33,750 of deferred income. Farmer Smith can now invest the $33,750 in replacement cows in 2013 and have a zero tax basis in the new replacements. If Smith only invests $20,000 in replacement cows in 2013, then the difference ($33,750 – $20,000) of $13,750 must be reported as taxable income by amending her 2012 income tax return.
This report is for educational information only and is not a substitute for tax advice from your CPA. Farmers considering either Option 1 or Option 2 due to drought-related livestock sales in 2012 should refer to the IRS Farmer’s Tax Guide for 2012 returns (http://www.irs.gov/pub/irs-pdf/p225.pdf). Print this document and visit with your tax accountant about your options for deferring income from your drought-related livestock sales from the 2012 drought.
Table 1. Summary of Tax Options Related to Drought-Related Livestock Sales
Option 2 –
Deferred Sales Receipts
|Tax Code||Section 451(e)||Section 1033(e)|
|What livestock qualifies?||All livestock||Draft, breeding, or dairy livestock|
|Requirement of disaster area declaration?||Yes||No, but declaration increases replacement period to 4 years|
|Must livestock be in the affected area?||No||No|
|Must livestock be sold in the affected area?||No||No|
|Must weather have caused the sale?||Yes||Yes|
|Provision applies to:||Sales in excess of normal practice||Sales in excess of normal practice|
|Provision allows:||Postponing recognition of income by one year||Deferral of gain by carrying over basis to replacements|
|Is repurchase required?||No||Yes|
|What is the basis in replacement livestock?||Not applicable||Reduced by gain that is deferred|
|What is the period for replacing?||Not applicable||Two years from the end of the taxable year of sale or 4 years if area is eligible for federal assistance|
|What is the time limit for making the Election?||Due date for return for year or sale of livestock held for resale and 4 years after the year of sale for draft, dairy, or breeding livestock||Two years from the end of the taxable year of sale|
Source: Adapted from J.C. Hobbs “Tax Consequences of Weather Related Sale of Livestock”
IRS Farmer’s Tax Guide: http://www.irs.gov/pub/irs-pdf/p225.pdf
Economic Impact of the 2012 Drought: http://srmec.uark.edu/beef/
OSU Fact Sheet: “Tax Consequences of Weather Related Sale of Livestock” (http://osufacts.okstate.edu)
LMIC Fact Sheet: “Tax Implications of Drought Induced Livestock Sales” (http://www.lmic.info/)