Livestock Sales - If weather-related conditions cause the producer to sell livestock, the gain on sale can be postponed..

Practitioner Note: Extension of Deferral Provisions

Prior to the Taxpayer Relief Act of 1997, the gain could be postponed only if the sale was due to a drought. The Taxpayer Relief Act of 1997 extends the deferral provisions to sales caused by flooding or other weather-related conditions as well as drought.

There are two different tax treatments, both of which apply only to weather-related sales in excess of normal business practice. The first treatment applies to draft, breeding, or dairy animals that will be replaced within a two-year period. The second applies to all livestock and allows a one-year postponement of the reporting of the sales proceeds.

A. Election to postpone gain if you plan to purchase replacement animals.

1. If livestock (other than poultry) held for any length of time for draft, breeding, or dairy (no sporting) purposes is sold because of weather-related conditions, the gain realized on the sale does not have to be recognized if the proceeds are used to purchase replacement livestock within two years of the end of the tax year of the sale. (Notice that there is no required holding period for this provision as there is for I.R.C. §1231.)

2. The new livestock must be used for the same purpose as the livestock that was sold. Therefore, dairy cows must be replaced with dairy cows. The taxpayer must show that the weather-related conditions caused the sale of more livestock than would have been sold without the drought conditions. For example, if the farmer normally sells one-fifth of the herd each year, only the sales in excess of one-fifth will qualify for this provision. There is no requirement that the weather-related conditions cause an area to be declared a disaster area by the federal government.

3. The farmer has a basis in the replacement livestock equal to the basis in the livestock sold plus any amount invested in the replacement livestock that exceed the proceeds from the sale.

4. How to make the election. 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:

a. evidence of existence of the weather-related conditions that forced the sale or exchange of the livestock.

b. a computation of the amount of gain realized on the sale or exchange.

c. the number and kind of livestock sold or exchanged.

d. the number of livestock of each kind that would have been sold or exchanged under the usual business practice in the absence of the weather-related condition.

Example 1-A: Rowdy Drover normally sells 15 cows from his beef herd each year. In 1997, a flood reduced his hay crop so that he did not have enough to carry his normal herd through the winter. Consequently, he sold 35 cows rather than 15 in 1997. He plans to purchase an additional 20 cows in 1998 to replace the extra 20 that were sold.

Only 20 of the cows sold in 1997 qualify for the deferral of gain due to the drought. Rowdy can elect to defer the gain by (1) not reporting the gain on those 20 cows on his 1997 return, and (2) attaching the following statement:

The flood conditions evidenced by the rainfall report attached to this statement caused the taxpayer to sell 35 head of beef cows rather than 15 head in 1997. The raised cows have a zero basis. The 35 cows sold for a total of $20,125. Taxpayer elects to defer the recognition of gain on the 20 extra head that were sold (20 ÷ 35) x $20,125= $11,500 of gain) under I.R.C. §1033(3).

Rowdy should report the purchase of qualified replacement cows on his 1998 or 1999 return. If there is additional income for 1997, an amended 1997 return must be filed.

Observation. The item-for-item replacement rule does not apply to like-kind exchanges under I.R.C. §1031.

B. Election to defer reporting income to subsequent tax year.

1. I.R.C. §451(e) allows taxpayers to postpone reporting income for one year if the livestock is sold because of weather-related conditions. This election applies to all livestock.

2. To qualify for this provision, all of the following provisions must be satisfied:

a. The principal business of the taxpayer must be farming.

b. The taxpayer must use the cash method of accounting.

c. The taxpayer must show that the livestock would normally have been sold in a subsequent year.

d. Weather-conditions that caused an area to be declared a disaster area must have caused the sale of livestock. It is not necessary that the livestock be raised or sold in the declared disaster area. The sale can take place before or after an area is declared a disaster area as long as the same disaster caused the sale.

3. The amount of income that can be postponed is explained in the following example.

Example 1-B: Angus Black normally sells 100 head of raised beef cattle a year. As a result of a drought, he sells 150 head during 1997. He realizes $45,000 from the sale of the 150 head. On September 7, 1997, as a result of the drought, the affected area was declared a disaster area eligible for federal assistance. The income that Angus may elect to postpone until 1998 is determined as follows:
 
 

In Angus's case:

Angus may elect to postpone $15,000 of income until 1998. The $30,000 that would have normally been received in 1997 must be reported on his 1997 Schedule F, line 4.

1. The election must be made by the due date of the return (including extensions) for the tax year in which the drought sale occurred. The election is made by attaching a statement to the return that includes all of the following information:

a. a declaration that the taxpayer is making an election under I.R.C. §451(e).

b. evidence of the existence of the weather-related conditions that forced the early sale or exchange of the livestock and the date, if known, on which an area was designated as eligible for assistance by the federal government as a result of the weather-related conditions.

c. a statement explaining the relationship of the designated disaster area to the taxpayer's early sale or exchange of the livestock.

d. the total number of animals sold in each of the three preceding years.

e. the number of animals that would have been sold in the taxable year had the taxpayer followed his or her normal business practice in the absence of the weather-related conditions.

Practitioner Note: Determining Normal Sales

The number of animals that would have been sold under usual business practices in the absence of the weather-related conditions is determined primarily by the past history of the producer. If the producer generally holds all calves until the year after they are born before selling them, but was forced because of weather-related conditions to sell them in the year they were born, the proceeds from this sale may be reported in the year following the year of the sale.

f. the total number of animals sold and the number sold on account of weather-related conditions during the taxable year.

g. a computation, pursuant to Treas. Reg. §1.451-7(e) (the computation shown above), of the amount of income to be deferred for each such classification.