The information in this publication is provided only for educational purposes and to inform the reader of relevant topics. This is not to be perceived or utilized as formal tax or legal advice. It is up to the reader to seek the necessary and appropriate tax and legal professionals that specialize in these areas for specific guidance.
Regardless of the reason, selling livestock will create tax liabilities. The type of tax liability will be dependent on several variables, while the reason for the sale may offer some temporary tax liability relief. If a farmer/rancher is to sell significantly more livestock than normal under extenuating circumstances, such as those caused by extreme weather conditions and events, it is always advisable to contact a knowledgeable tax professional to determine the potential tax liability and identify possible alternatives to problems before they become a reality.
Different types of tax liability exist when livestock is sold based a number of factors including but not limited to the purpose of the animals, such as, breeding livestock versus livestock held for sale, whether the animals were purchased or raised, and how many years the livestock are held before being sold. The type of livestock owned and being sold such as beef cattle, dairy cattle, draft horses, racehorses, hogs, sheep, poultry, etc. may also play a role in the type of tax liability that may be realized. This publication will focus primarily on the sale of cattle.
Cattle are typically sorted into various categories which describe their purpose, life stage or primary use. Dairy cattle are used for milking purposes. Beef cattle may be used as breeding animals (cows and bulls used for beef calf production), stockers (calves that are put to pasture to gain weight), and feeders (calves that are usually fed in a feedlot until they reach a slaughter weight and can be sold). Cull animals are those that were used for breeding or dairy purposes and are no longer viable, and when sold, may receive favorable tax consequences if they were raised.
Purchased Breeding, Dairy, and Draft Animals
Purchased breeding, dairy, and draft animals are typically on the premises/farm for longer periods of time based on their purpose and are considered a depreciable asset. When these animals are brought into the herd, they must be depreciated using the appropriate IRS tax depreciation method and schedule (consult a knowledgeable tax professional for further information).
In most cases when these animals are sold, they have been depreciated “out”, and their tax value is now zero. Because the animal was depreciated, the tax consequence is ordinary income due to depreciation recapture.1 The dollar value that was depreciated is taxed at the marginal ordinary income tax rate of the taxpayer and is not subject to self-employment (SE) tax. If the animal was sold for more than the purchase price, then any amount over the purchase price will be treated at the long-term capital gain (LTCG) rate, as long as the animal had been held for at least twenty-four months and is not subject to SE tax.
Raised Breeding, Dairy, and Draft Animals
A breeding, dairy, or draft animal is considered “raised” if its sire and dam is owned or leased through an agreement under which the farmer owns the offspring that is produced by the leasing farm(er). If an animal is raised on the premises for dairy, breeding, or draft purposes and held for at least twenty-four months when sold, the tax treatment of the revenue from the sale is at the long-term capital gain rate (minus any sale expenses).
Given that many farms follow the cash accounting method, if an animal is produced (born) on the the farm/ranch, the animal will not be depreciated for tax purposes since it was not purchased. The costs associated with the raising of this animal that was “born on the farm/ranch” will normally be deducted through taxes on an annual basis. Therefore, an animal that is considered raised has no tax basis. The long-term capital gain rate is typically applied to the dollar value of the gain (sale price minus (-) the basis) and is not subject to SE tax. If the animal was not held for at least two years, then the tax treatment of the animal will be similar to short-term capital gains which is taxed at the ordinary income tax rate, but not subject to SE tax.1
Stockers, Feeders, and Slaughter Animals
Stockers, feeders, and slaughter animals that are sold, regardless if they are raised or purchased animals, are considered livestock held for sale. Animals that are held for sale are treated as farm income reported on Schedule F when sold. Farm income is typically subject to SE tax. It is important to note that if the animal purchased is considered “livestock held for sale”, the expenses from the purchase of the animal may not be deducted until the tax year in which it is sold.
Purebred
Selling purebred livestock may get a bit more complicated. In general, if it is part of the normal course of the farm to breed the heifer/cow or use a bull for breeding prior to the sale of the animal for the purebred market, then the income derived from the sale of the animal may be considered ordinary farm income reported on Schedule F and is subject to SE tax regardless of the amount of time the animal is held.
For a farmer/rancher who is in the purebred business, and in the normal course of that business brings the retained raised animals back into the herd explicitly for breeding purposes, then the animal might be considered a breeding animal. If a customer chooses an animal to purchase from the breeding herd, the income from the sale of that animal (dependent on the time the animal is held) might be treated like the sale of any other breeding animal for tax purposes based on facts and circumstances.
Involuntary Conversion: Livestock Sales Caused by Extreme Weather Events and Disease
Extreme weather conditions can create additional perils in caring for animals that are reliant on crops, forages, hay, and pasture maintained by the farmer/rancher. Floods may destroy valuable and essential assets such as pastures, feed, and fencing. Early snows and late springs can impact livestock housed in distant pastures and such instances may require that animals be fed sooner (or longer) than anticipated or that practices be implemented that may pressure grasses to mature later than hoped. Droughts will damage non-irrigated crops, hay ground, and pastures thus leaving the farmer/rancher without enough feed and roughage sources to properly feed their livestock.
Extreme weather conditions, events and disease can cause a farmer/rancher to sell more livestock than what would be considered normal within a single tax year. These sales can create a greater than normal tax liability, which creates an additional financial burden. The Internal Revenue Code (IRC) may assist the farmer/rancher by allowing them to defer income into a future year or until they are either able to replace the excess livestock that is sold or replace the livestock with other real property.2
An “involuntary conversion” is a term that is used by the IRC that refers to the sale of property that was caused by its destruction or imminent destruction or damage, threat, condemnation, or requisition that requires the property to be sold. Within agriculture, an involuntary conversion usually occurs due to drought, floods, disease, or similar events. To be able to make use of the provisions IRC §1033, there may not have to be a formal federal disaster declared. However, if one is declared, there are potential additional tax deferment opportunities that exist for those who are located within those counties or adjacent counties of the designated disaster area.2
IRC §1033(a) generally allows for the nonrecognition of gain when property is involuntarily converted, as long as it is replaced in the allotted amount of time with similar or related property.2 What this means is that any income derived solely from the sale of the excess livestock that was caused by drought floods, disease, or similar events will allow for taxes to be deferred until which time it is replaced (within the allotted time) as explained in the example below.
Angus Smith is a beef cow-calf rancher in the upstate of South Carolina, and the region is experiencing severe drought conditions. This drought has not been classified as a natural disaster by any federal agency. Angus normally sells about twenty head of breeding cows every year. Due to the drought, he does not have the hay or pastures to feed all of his stock this year. Angus figures he must sell seventy cows this year so that he has enough pasture and hay for his remaining stock. Angus finds a buyer in another state that would like to purchase the seventy cows. This is fifty cows more than he normally sells in a year. From a tax perspective, he must recognize the income and gain from the twenty that he normally sells. The fifty cows that are above what Angus normally sells can be deferred for up to two years following the year of the sale until he purchases replacements or if he purchases allowed real property in lieu of replacing the fifty extra cows that were sold due to the drought conditions.
Under IRC §1033(e)(1), when a farmer/rancher sells more livestock (other than poultry) than would normally be sold for the explicit reasons of “drought, flood, or other weather conditions”2, then the amount sold over “normal” is to be treated as an involuntary conversion.2
If there is no federal disaster declared, a taxpayer (farmer/rancher) generally has two years “after the close of the first taxable year in which any part of the gain upon the conversion is realized.”2 The Secretary of the U.S. Department of the Treasury may extend the replacement period of livestock sold due to drought. This is communicated through a formal IRS notice usually in the fall of each year and will detail which counties within each state are eligible for the “extension.” Anyone within the stated counties or adjacent counties may be eligible for the extension.
If a federal disaster is formally recognized, those who have sold “involuntarily converted” livestock due to the disaster will have four years instead of two to replace the involuntarily converted (sold) livestock. The Secretary of the Treasury can extend this period if the weather event(s) continue(s). If a farmer/rancher determines that they are unable to continue raising dairy, livestock (other than poultry), or draft animals due to the weather event(s) then personal property such as machinery and equipment may be purchased as the “replacement” for the livestock.
The amount of the deferred tax will be paid either when the replacement livestock/property is sold and/or if the replacements that are purchased within the allotted time cost less than the livestock that was involuntarily converted. If the replacement cost is less than the selling price of the property that has been sold (converted) then the “gain” that is realized is the difference between the two (price received for the property sold “minus” (-) the replacement cost).
To recap, involuntary conversions (the sale) of livestock due to drought, flood, and other weather events can trigger tax deferment opportunities.
- Only the sales of the livestock that are above what is normally sold qualify to be deferred.
- If no federal disaster is declared, replacement property must be purchased within the two years following the year the property is sold.
- If a federal disaster is declared, then a farmer/rancher has up to four years following the sale to replace the property, although the Secretary of the Treasury may extend the replacement period due to continued drought.
Summary
The sale of livestock under normal and abnormal circumstances will trigger various income and self-employment tax outcomes. A farmer/rancher should understand the different types of taxes that can be triggered through the sale of livestock. When livestock is sold due to events such as drought, floods, or other extreme weather events, it is important to document information such as the dates when the animals were sold, quantity and type sold, the weights animals were sold at, etc. Similarly, records need to be kept relative to the purchase of replacement property, as it will be used for tax reporting purposes.
It may be difficult to determine if a farmer/rancher is eligible for one of the mentioned tax “deferments”. Typically, these can be found through various websites dependent on whether or not your county has been declared a federal disaster area or if the Secretary of the Treasury has determined the present situation meets the allowances necessary to offer such assistance through tax code. This can be confusing because of the different designations. It is important to remember that if a declaration has been designated for a county, farmers/ranchers in that county and in its contiguous3 counties may also be eligible for potential assistance through USDA Farm Service Agency (FSA) programs and possible deferment of some tax liability through the IRS.
The best method to determine if you are eligible is to talk to a trusted tax professional.
Additional information is available at the following
- IRS Current Tax Tips Website (provides links for eligible regions and counties)
- FEMA Disaster Declarations
- USDA FSA Disaster Designations (may be the easiest for most farmers/ranchers to locate information as the spreadsheet lists are separated based on the type of declaration, e.g. state and county level by USDA Secretary, Presidential, etc.)
It is always recommended that a knowledgeable tax professional be consulted on a regular basis to understand your unique situation.
References Cited
- Department of Treasury, Internal Revenue Service. Farmers Tax Guide. Washington (D.C.): Internal Revenue Service, 2018. Publication 225 Cat. No. 11049L
- Department of Treasury, Internal Revenue Service. IRC §1033 Involuntary Conversions. Washington (D.C.). [10/7/2019]. https://www.law.cornell.edu/uscode/text/26/1033.
- Department of Treasury, Internal Revenue Service. Part III – Administrative, Procedural, and Miscellaneous, Extension of Replacement Period for Livestock Sold on Account of Drought, Notice 2006-82. Washington (D.C.). [10/7/2019]. https://www.irs.gov/pub/irs-drop/n-06-82.pdf.
References Consulted
Achenbach R, Bouchard G, Hobbs J, et. al. Agricultural Tax Issues 2018. Kelso (Washington): Land Grant Tax Education Foundation; 2018.
Thomson Reuters Check Point. Federal Tax Handbook 2018. Hoboken (NJ): Thomson Reuters/Tax & Accounting; 2018.
Department of Treasury, Internal Revenue Service. Drought stricken farmers and ranchers have more time to replace livestock; IRS Tax Tip 2018-155, October 4, 2018. Washington (D.C.). [10/7/2019]. https://www.irs.gov/newsroom/drought-stricken-farmers-and-ranchers-have-more-time-to-replace-livestock.
