Tax treatment options for drought areas

Oct 14, 2011

Ranchers across droughtstricken areas have been forced to sell cattle at a historic rate and now many have the added burden of worrying about upcoming income tax implications.

“The historic drought has forced many more cows than normal to be sold throughout Texas,” said Dr. David Anderson, AgriLife Extension livestock economist. “Of the $5.2 billion in agricultural losses to date, $2.06 billion has come from our livestock industry as ranchers have sold off cattle due to lack of forage and escalating supplemental feed expenses. This has created several financial management issues for cattle producers to consider.”

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 weatherrelated conditions as well as drought.

While no two situations are exactly alike when it comes to taxes, it’s important to know all of the options. Producers are advised to consult their financial pro fessional for advice that best fits their operation and business plan, said Jose Pena, AgriLife Extension economist.

“Everybody’s situation is different, and it may not be best practice to do what your neighbor does,” he said. But Pena said there are some specific things to consider looking ahead for the 2011 tax year for those in severe drought areas.

“If weather-related sales cause a producer to sell livestock, the gain on sale can be postponed,” Pena said. “There are two different tax treatments, both of which apply only to weather-related sales in excess of normal business practice.”

Options with special tax treatment are available to producers forced to sell animals due to weather-related events, including drought and flooding.

The two basic tax options include deferring incoming and an involuntary conversion option. Livestock sales beyond the normal sales of a ranch are eligible for these special tax treatments.

The first allows the deferral of funds for one year and requires that the area the producer is in be designated as eligible for assistance by the federal government. The second option allows for the deferral of sales for up to two years, but only applies to breeding livestock.

Income from livestock sold in excess of normal sales can be deferred for up to one year under the following conditions:

1. The principal business is farming or ranching.

2. The taxpayer utilizes the cash method of accounting.

3. Evidence that “excess livestock” sales are due to weather conditions. (A threeyear average is used to calculate normal sales.)

4. Your county or a neighboring county must be designated for federal disaster assistance. (The sale of livestock can occur before or after the designation as long as the weather event that caused the sale is the cause of the designation.)

Producers need to attach the following to their tax return for the special tax treatment:

• A statement declaring the election under I.R.C. section 451(e).

• Evidence and explanation of the conditions that forced the early sale, including the date the area was designated eligible for federal disaster relief.

• A computation of the income to be postponed.

With some producers already liquidating all or part of their cow herds and others waiting to see if fall pastures will be available, Oklahoma State University (OSU) recently put together some information and spreadsheet tools to help producers make tough decisions.

The best way to survive a drought is to have a plan, instead of being forced into one, according to Rodney

Jones, OSU NW Area Extension economist, Enid, OK, Damona Doye, OSU Extension economist, and JJ Jones, OSU SE Area Extension economist, Ada, OK.

Exceptional drought is forcing tough decisions for many cattle producers across the Midwest.

Factors that influence the shape of a drought plan include goals, financial position, ability and willingness to spend, risk tolerance and tax situation, according to their report. Factors that affect the decision about when to sell cows include the costs of keeping the cows, plus the expected change in sale price of the livestock, if any, and the opportunity to earn a return on the proceeds from sale of livestock or reduce interest payments, in addition to the tax consequences.

At OSU’s website, beefex, you’ll find a free spreadsheet that shows the break-even sell-repurchase margin results of calculating the price increase that could be paid per head for replacement females at a later date based on reduced maintenance costs of $2.50, $3 and $3.50 per day with a 5 percent opportunity interest rate and an $800 current sales values for the cow. It assumes that maintenance costs would be incurred up to the date cows would be repurchased. The length of the feeding period plays a huge role in this calculation and is the least certain.

While this spreadsheet, along with others on their site, can help producers make some decisions, OSU Extension specialists recommend consulting an income tax advisor to determine the tax consequences before making any liquidation decisions. — Traci Eatherton, WLJ Editor