By J C. Hobbs
If you have sold more livestock than normal due to the drought or other weather related conditions, a couple of income tax provisions may provide some relief.
The county in which you live must have been designated for federal assistance and received disaster declarations from the president or by an agency or department of the federal government.
Each provision may allow livestock producers to reduce the tax consequences of bunching of income if certain conditions are met.
The following information is general in nature. For a more detailed discussion of the rules, reporting requirements, and examples, go to www.beefextension.com in the drought information area.
The first provision applies to a producer who has sold more livestock than normal due to the adverse weather. The income from the animals which were sold which were in excess of normal sales may be postponed until the following tax year when the income would have normally been recognized.
However, certain conditions must be met:
- The weather related condition must have caused the area to receive a “disaster declaration.”
- In addition, the producer's principal business must be farming and he/she must use the cash method of accounting.
- The producer must show the livestock would normally have been sold in the following year.
- The weather-related conditions that caused an area to be declared a disaster area must have caused the sale of livestock. This provision applies to any livestock sold in excess of normal due to weather related conditions. Refer to IRS Code Section 451(e).
The second provision only applies to breeding, dairy or draft animals that were sold in excess of normal. For the animals sold in excess of normal, a producer may elect to replace the animals sold within a two year period with "like" animals - meaning they are used for the same purpose - and thus defer the recognition of income until the new animals are sold.
Unlike the first rule, there is no need for a disaster declaration. All that is needed is proof that drought conditions existed which caused the sale of additional animals. However if an area has received a disaster declaration made by the president or by an agency or department of the federal government, the replacement period is extended to four years, not just two.
To reiterate: The replacement animals must be for the same use as the animals sold. For example, a producer must replace dairy cows with dairy cows or breeding cows with breeding cows. In addition if the excess animals were sold for $10,000, for example, the producer will need to buy $10,000 or more of replacements to completely defer the gain from the sale. A producer must repurchase the same dollar amount of animals which were sold in excess of normal, not the number of excess animals sold. If only $8,000 is spent on the new animals then $2,000 must be recaptured on amended tax return and the tax paid. There is no requirement as to how long the animals were held by the taxpayer in order to receive this treatment, but the producer must provide evidence of the weather condition and a calculation of the gain for each number and kind of animal sold. Refer to IRS Code Section 1033(e).
Further, a livestock producer must evaluate the following points to determine whether it will be beneficial to postpone gain recognition by replacing the animals or electing the one-year deferral.
The estimated amount of expenses for the following tax year, potential income tax and capital gain rates for future tax years, net operating loss carry-forward amounts, the ability to use income averaging, or other tax items the producer may have.
It is important to do some extensive tax planning to make a sound economic decision concerning the two elections. The potential increase in rates expected to occur in 2013 and later will have a definite impact on the decision.
This is only a brief discussion of the rules that apply to weather related sales of livestock. Consult your tax preparer or advisor for more information concerning the income tax implications that would apply to your specific business situation.
Hobbs is an extension economics specialist for Oklahoma State University.