Income Tax Rules for Weather Related Sales of Livestock

Farm Business Management Update, December 2007 - January 2008

Bill Whittle (wwhittle@vt.edu), Extension Agent, Farm Business Management, Page County

Weather often raise havoc with the income stream on a farm. This year’s drought is no exception as livestock farmers wrestle with short feed supplies coupled with substantial increases in feed costs. A common response is to reduce herd size by selling more livestock than in a normal year. However, this has the potential of creating dramatically higher taxable income. To assist farmers with leveling such taxable income spikes, the federal tax code has two provisions (elections) that address the issue of increased income when forced to sell more livestock than normal because of a weather related situation.

Though the provisions are similar in that gain (income) on excess sales is postponed to a future year, these elections are also very different in the length of postponement, the classes of livestock involved, and the information required. The first election, IRC 1033(e) or involuntary conversion, applies to the sale of breeding, dairy, and draft animals if the livestock are sold because of weather-related conditions. This provision allows the farmer to postpone recognizing 2007 gain from animals sold in excess of normal annual sales or if the farmer purchases replacement livestock within two years from the end of the tax year in which the sale occurs. If the locality receives a federal disaster designation, the deferment time is extended to four years, and may be further extended if adverse weather conditions continue for more than three years. Replacing the livestock generally requires purchasing like-kind livestock; beef cows for beef cows and dairy for dairy. However, if the weather conditions that created the involuntary conversion make replacing the livestock infeasible, then the livestock can be replaced with any property used in the farming business.

For all postponed gain, the purchase cost of each replacement animal must equal or exceed the gain from the drought-forced sale. If replacements cost less than the postponed gain, the excess gain is included as income for the year of replacement. If you choose not to replace the animals, then you must file an amended return and report the income for 2007.

Record keeping is a must for proper tax management, and IRC 1033(e) requires that specific information be included when you file taxes for the sale year, including evidence that weather conditions forced the sale of livestock. However, federal drought designation is not required. Other required information includes the amount of gain realized on the sale, and the number and kind of livestock normally sold. When livestock are replaced under IRC 1033(e) the records required for filing include the date of purchase of replacements, and cost, number, and kind of replacement livestock or property. The basis in the replacement livestock will equal the basis in the livestock sold plus any amount invested in the replacement livestock that exceeds the proceeds from the sale.

The second election, IRC 451(e), is for farmers in areas that receive a federal weather related disaster designation and applies to the sale of any animals in excess of normal sales. IRC 451(e) does not require replacing animals, but allows you to defer income from the sale of animals in excess of what is normally sold for one year. Requirements for using IRC 451(e) include: 1) farming must be the principal business; 2) the cash method of accounting is used; 3) the excess livestock sold would normally be sold in the following year; and 4) the weather-related conditions that caused an area to be declared eligible for federal assistance must have caused the sale of livestock.

A final component of both provisions is that it is not necessary that the livestock be raised or sold in the declared disaster area but just that the weather related conditions caused the sale. The sale can take place before or after an area is declared eligible for federal assistance as long as the same weather-related conditions caused the sale.

These tax management elections can prevent a large increase in taxable income due to sales forced by this year’s drought. It is important to discuss your situation with your tax preparer prior to the tax deadlines so that you can take advantage of these provisions, if applicable.

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