Tax Central Alert: Has Your Farm Sold Livestock Due to Drought? You May Be Eligible for Tax Relief

November 6, 2013

The droughts that have plagued U.S. farms have forced some farmers to sell their livestock based solely on the harsh weather conditions. If your farm was affected, there are two forms of tax relief available to alleviate the normal immediate tax effect on the sale.

To qualify for these types of relief, the federal government must first designate your geographic area as eligible for assistance. A listing of the counties that qualify for these treatments can be found on the IRS website at http://www.irs.gov/pub/irs-drop/n-13-62.pdf.

Relief due to Involuntary Conversion (Internal Revenue Code Section 1033)

To use the involuntary conversion tax treatment, you must meet the following criteria:

  1. The federal government deems your geographic area as eligible for assistance
  2. You sell livestock (other than poultry) due to weather conditions
  3. The proceeds from selling your original livestock are used to purchase replacement livestock within four years (or more, if the drought continues) after the end of the tax year in which the original livestock sale occurred

Under this treatment, you would elect to not recognize the income from the sale of your livestock (other than poultry) on your tax return for the year the sale occurred because the sale was involuntary due to severe weather conditions. Because of this favorable tax treatment, the sale proceeds must then be used to replace the livestock that was sold within four years of the end of the year in which the sale of the livestock occurred. (This four year period may be extended by the IRS if the severe weather conditions continue to affect your area for more than three years.)

When the livestock is replaced, you will pay income tax only on the amount that the sales proceeds from original livestock exceed the cost of the replacement livestock. If the replacement livestock cost is equal to or more than the sales proceeds from the original livestock, no income is recognized. For example, if your livestock were sold for a gain of $50,000 in 2013, and you replaced this livestock in 2015 for $48,000, you would recognize income of $2,000 on your 2015 tax return.

This treatment applies only to animals sold because of drought or other weather conditions, not to the animals you sold in the normal course of business while being located in one of the counties listed above. Also note that you may not purchase replacement livestock prior to selling the original livestock. Doing so would disallow this tax treatment.

Relief under Internal Revenue Code Section 451:

To claim tax relief under this section, you must meet the following criteria:

  1. Your geographic area must first be designated by the federal government as eligible for assistance.
  2. The livestock would not have been sold if there were no drought, and the number of animals sold exceeded usual business practice.
  3. You or your farm must be a cash-basis taxpayer.

If you meet the criteria and sell your livestock, you are able to postpone being taxed on the income from the livestock sold on account of drought for one year. The amount of realized income that may be deferred is equal to the excess of the number of livestock sold or exchanged over the number that would have been disposed if the taxpayer had followed its usual business practices had there not been a drought. For example, if a taxpayer normally sells 500 head of cattle in a typical year, but sells 600 head in a given tax year due to qualifying drought conditions, the income from the excess 100 head may qualify for a one-year deferral. Income from the sale of livestock that are used for draft, breeding, dairy or sporting purposes is not eligible for this tax treatment.

When you elect to defer the income from your sale under this treatment, you must make a separate election for each category of livestock you sell. This election would be attached to your tax return and would include detail of how much livestock was sold on average in the past three years, the animals sold solely on account of drought during the year, and other information to support the amount of income that is being deferred. Your tax professional can assist you with the proper documentation that would need to be attached to your tax return.

Contact your Schenck tax advisor to determine whether one of the two options above would be allowable and beneficial to your tax situation.