Tax Treatment of Income from Drought Related Livestock Sales

By: Chris Bruynis, Assistant Professor & Extension Educator

Producers that were forced to sell all or part of their livestock herd as a result of this past summer’s drought, and the resulting shortage of feed, have some options to defer the income from their 2012 tax return to future tax returns. There are two different tax treatments available to defer recognition of the weather-related sales of livestock income that is in excess of the producer’s normal business practice. The first option, called an involuntary conversion, applies to draft, breeding, or dairy animals that will be replaced within a 2-year period. The second option, a 1 year deferral of income, applies to all livestock and allows a 1-year postponement of reporting the sales proceeds as taxable income.

Involuntary conversion rules state that the breeding, dairy, or draft animals need to be replaced within two years. This delay of gain recognition can be postponed up to four years if there is a persistent drought. One of the requirements of this election is that the replacement animals are of the same type as the relinquished animals.  When the animals are replaced the taxpayer’s basis in the new livestock is equal to the basis in the livestock sold plus any amount above the proceeds received from the sale of the livestock sold.  If there is a persistent weather condition lasting 3 years or longer that makes it infeasible to replace the livestock with similar livestock, the taxpayer can elect to replace livestock with any property, including real property, used in the farming business. This election does not require the producer to reside in a declared disaster area.

The 1 year deferral of income allows a producer that is in a federally declared disaster area to defer the income until the following tax year.  If the taxpayer decides to use this election, only income from excess sales of livestock, defined as sales above normal or usual sales, can be deferred.   To use the 1 year deferral election the taxpayer must meet four conditions. They are:

1. Their principle business must be farming
2. They must be using the cash method of accounting
3. They must document that the sale would not have normally occurred in the current tax year, and
4. The weather related disaster caused the sale of the livestock.

In addition to deferring gain from the sale of livestock due to weather related disasters, farmers have other tax management tools such as prepaid expenses, deferred payment sales, income averaging, and net operating loss rules to minimize the impact of the income fluctuations.  Please consult your tax professional to see if deferred recognition of gain or one or more of the other tax tools listed makes sense for your income tax return.