As ranching operations across the nation continue to struggle with drought this summer, the probability of needing to liquidate all or a portion of their herd grows larger by the day. This will create unexpected income by the end of the year on the excess sales of breeding and/or market livestock for these operations.
The good news: There are deferral options in the internal revenue code (IRC) to help reduce or eliminate additional tax liability on the excess sales.
Let’s look at the options, along with some examples:
IRC 451(g) election
This election puts the deferral of income into the next tax year for breeding OR market livestock sales:
- Allows rancher to even out income over a two‐year span
- Rancher is forced to sell more cattle than normal due to USDA designated adverse weather conditions in rancher’s county
Selecting this election requires attaching an election statement with a calculation of excess sales. This calculation is made by taking an average annual head count sold and corresponding sale price from the prior three years, determining the excess number sold this year, multiplying by the average sale price of the prior three. The calculation guidance also allows for using a “facts and circumstances approach” by simply identifying the additional sale made during the year.
Example: A rancher commonly sells calves in November, and in 2017-2019 the sales averaged 50 head at $25,000 (or $500 per head) each year. In 2020, that rancher’s county receives a drought designation and forces him to sell an additional 40 head in December at $24,000 ($600/head).
- Per the safe harbor method, he can defer $20,000 (40 head at $500/head) of the $24,000 December sale.
- He could also just choose to defer the full $24,000 based off facts and circumstances.
IRC 1033(e) election
This election method allows for deferral of income into future tax years for breeding livestock sales only. This is a replacement deferral — meaning the breeding stock were forced to be sold due to a USDA designated adverse weather condition or a disease. The rancher gets the chance to buy back replacement breeding stock to take the place of the sold ones over either a two- or four-year span (two for disease, or four for continued adverse conditions).
This method reduces the basis of replacement breeding stock purchased until it is absorbed. This means that the taxpayer has no depreciable basis on the purchased breeding stock as they are being offset to the deferred gain. The calculation options are the same as the 451(g).
The hitch in this approach is that the taxpayer has no depreciable basis on the purchased breeding stock as they are being bought to offset the deferred gain. In addition, the value of the reinvestment in breeding stock must match or eclipse the deferred sale by the end of the replacement period. If not, you will have to amend prior-year returns dating back to the year of the originalsale to account for gain that was not completely deferred by end of replacement period.
Example: A rancher sells some of her old breeding stock each year, and from 2017‐2019 the sales averaged 20 head at $20,000 ($1,000/head) each year. In 2020, that rancher’s county receives a drought designation and forces her to sell an additional 10 head in December at $9,000 ($900/head).
Using the safe harbor method and facts/circumstances, she can defer the full $9,000 and likely will have four years to replace the 10 head of breeding stock.
In 2021, she purchases 10 head of breeding stock to replace the additional 10 sold in 2020 for $10,000. In this scenario, the full $9,000 sale got absorbed by the replaced purchase, and an additional $1,000 is added as depreciable basis in the new breeding stock.
Wipfli can help
If you’re a rancher in this situation, talk to your tax professional about which election is best for your situation. Wipfli’s tax professionals can help. Contact us today.
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