By Dennis A. Kaan
Regional Extension Specialist
Colorado State University
Due to the drought conditions we are under, many producers are culling or selling off more livestock than they normally would.
There are many decisions or choices to evaluate in this action, foremost being steps to recovery of the range. Along this path to recovery, one decision producers have to make is how to handle the tax implication of selling livestock under drought conditions. We will look at two options here, an election to defer income or an election to postpone capital gains.
Income from the sale of livestock due to drought, which exceeds the "normal" number usually sold, can be deferred for one year, at the election of the taxpayer. The sale can take place before or after and area is declared a disaster area, as long as the same disaster caused the sale.
Section 451 (e) of the Internal Revenue Code contains special rules applicable to livestock held for draft, breeding, dairy or sporting purposes. To qualify for this election: The taxpayer's principal business is farming or ranching; the business uses the cash method of accounting; the sale would not have occurred, except for the drought; and the area was designated as eligible for assistance by the President, U.S. Department of Agriculture or its agencies, or by other federal agencies. (Actual assistance is a separate issue).
As an example, because of drought conditions, you sell 150 cows instead of the 50 you would normally sell. In this case, you can postpone reporting the sale of 100 of the 150 cows. If we assume the average weight is 2,050 pounds per cow and you receive 45 cents per pound for the cows, you would be eligible to defer $47,250 of income for one year (100 cows x 1,050 pounds x 45 cents per pound).
Election to defer the "extra" income must be made by the due date of the tax return (including extensions) for the tax year in which the drought sale occurred. The election is made by attaching to the tax return a statement showing all information pertinent to the sale, drought and deferment of income.
The sale of livestock used for draft, breeding or dairy (not sporting) purposes in excess of normal numbers, due to drought conditions, is considered an "involuntary conversion." In such cases, the taxpayer may elect to postpone reporting the gain, if the proceeds are used to purchase replacement livestock within two years of the end of the tax year of the sale.
Section 1033 (e) indicated that: the replacement livestock must be used for the same purpose as the livestock that was sold--ewes for ewes, bulls for bulls, dairy cows for dairy cows. The taxpayer must show that the drought caused the sale of more livestock than would have been sold without the drought conditions. There is no requirement that the drought conditions cause an area to be declared a disaster area by the federal government. The basis in the replacement livestock equals the basis in the livestock sold plus any amount invested in the replacement livestock that exceeds sale proceeds.
For example, a raised cow is sold for $450, due to drought conditions, and a replacement cow is purchased for $600 within two years. The $450 gain is not recognized in the year of the sale, if the Section 1033 (e) election is made. The tax basis for the replacement animal is zero (the same as for the raised cow sold, due to drought conditions), not the $600 purchase price.
The election to defer the recognition of gain by reducing the basis of the replacement livestock is made by not reporting the deferred gain on the tax return and by attaching a statement to the tax return showing all the details of the involuntary conversion, including: Evidence of existence of the drought conditions that forced the sale or exchange of the livestock; a computation of the amount of gain realized on the sale or exchanged; the number and kind of livestock sold or exchanged; and the number of each kind of livestock that would have been sold or exchanged under the normal course of business in the absence of the drought.
If an election under Section 1033 is made in the year of sale and replacement property is not purchased within the required time period, the tax return for the year of the sale must be amended to report the gain previously not recognized. Interest from the original due date of the return will be assessed on the additional tax due.
It is important that livestock producers consult their tax preparer or other qualified professional prior to selling livestock, due to drought conditions.