Drought and high feed prices forced many producers to sell off portions of their beef herd to survive, a move that likely has tax implications.
Additional sales usually mean additional income taxes. Fortunately, Congress recognizes the impact weather can have on producers, and has two special tax provisions to reduce income tax liabilities. However, consult your income tax professional first to assess your situation because it might cost you more in the future.
Here are two tax codes you should know, and a little perspective on whether they are right for your situation:
1. Section 451(g). The first provision, code Section 451(g), allows a producer who sells more livestock than normal because of drought, flood or other weather-related conditions to postpone recognizing the gain from those sales until the following year.
You must document the sales were more than usual under normal business operations. For example, if you normally hold your spring calves over to sell in January, but because of drought were forced to sell them in November, you will have sold two calf crops in one tax year. So, under this provision, producers get to postpone those additional sales until the following year.
To qualify for Section 451(g), the area must have been declared eligible for federal assistance.
Whether it’s beneficial to postpone those sales to next year may depend on your other income and expenses.
During drought, you may have more expenses to offset income in the current tax year. In addition, estimate what your expected income will be next year. For instance, in 2012, many producers elected 451(g) to postpone income. However, in 2013, calf prices skyrocketed. In addition, government payments for the drought of 2012 didn’t arrive until 2013, which further increased farmers’ income. Many producers actually ended up paying more in taxes in 2013 than they would have if they hadn’t postponed sales.
2. Section 1033(e). The second provision, code Section 1033(e), deals with the sale of livestock held for draft, breeding or dairy purposes in excess of normal because of drought, flood or other weather-related conditions.
With this provision, the producer does not recognize the gain of the sale at all, because they plan to replace those livestock at a later date. As with Section 451(g), only the number of head in excess of normal qualify.
To postpone gain under this provision, replacement property must be acquired within a specified period of time, which begins on the date the livestock were sold or exchanged and generally ends two years after the close of the tax year in which they were sold.
The livestock purchased to replace the previous ones must be used for the same purpose — breeding stock must be replaced with breeding stock and dairy cows with dairy cows.
The American Jobs Creation Act of 2004 added two new options for producers. Under these options, in areas designated as eligible for federal assistance, the replacement period is extended from two years to four years.
The second option under the act allows producers to replace livestock with other farm property (other than real property) if it is not feasible to reinvest the proceeds in similar property. For instance, if the drought still persists, it may still not be feasible to buy back cows yet.
Under this rule producers have four years to evaluate whether to replace the livestock sold or amend the previous tax return from the year the livestock were sold. It gives producers tremendous flexibility to manage their income tax liability.
Just like with 451(g), before postponing the sale of those breeding livestock, carefully evaluate your tax situation. At first, that sounds ridiculous. Why would I ever want to claim the sale if I don’t have to?
Realize the sale of breeding livestock are often long-term capital gains that receive preferential tax treatment. Depending on your current tax bracket, some raised breeding stock sales may even be taxed at 0%, or only 15%. In addition, raised breeding stock sales and depreciation recapture from purchased cows are not subject to self-employment taxes for Social Security and Medicare, which is 15.3%.
So, choosing to recognize the sale of those breeding cows today may cost a little capital gain, but may save much more in the future when you get to put the entire purchase price of replacements on deprecation — saving federal and state income taxes, as well as self-employment taxes.
Producers forced to sell more than normal numbers of livestock because of weather conditions have tremendous flexibility to manage the income tax consequences of those sales. But it’s well worth your time to visit with your tax professional about what is best for you and your future situation.
Tucker is a University of Missouri Extension ag business specialist and succession planner. He can be reached at [email protected] or 417-326-4916.