Parts of Alabama are experiencing moderate to severe drought issues (according to the US Drought Monitor). Six primary counties and 15 contiguous counties were declared secretarial disasters as of September 25, 2019. Producers are often able to mitigate the effects of drought conditions for extended periods of time, but on occasion the only feasible option is to sell part of their herd in order to reduce grazing pressure on stressed pastures. Producers are often concerned about the tax consequences from these sales and are often looking for ways to postpone or avoid these consequences.
There are two tax options for producers to address this situation, tax code 451(e) and 1033 (e). Code section 451 (e) is fairly straightforward. Producers whose principal business is farming and who use a cash accounting system (accounting is based on actual income and expenses during a fiscal year) may choose to delay payment of capital gains on excess sales of livestock for one calendar year. This allows producers to spread tax burden out in a more normal fashion and avoid abnormally large tax burdens in a single given year. The caveat for section 451 (e) is that the county must have received a federal disaster designation for this postponement to be available. It should be noted that the sale of livestock does not have to be after the disaster declaration. The sale can occur prior to the declaration as long as the weather condition that caused the sale is the same as the weather condition that caused the federal disaster designation. The amount of capital gains that can be postponed is equal to the amount of sales of livestock that is above the producer’s normal sales. The producer cannot postpone the tax burden associated with the normal sale of livestock.
Code section 1033(e) is another option that producers (other than poultry) have for mitigating the tax implications of drought sales. Code section 1033 (e) allows producers to postpone capital gains when the producer intends to replace the sold livestock at a later time. Code section 1033 (e) is available only to those whose principal business is farming. However, unlike Code section 451(e), producers do not have to be in an area declared a federal disaster or be on a cash accounting system to be eligible for participation in code section 1033 (e). Producers using Code section 1033 (e) have two years to purchase breeding livestock to replace livestock sold above normal levels during times of weather stress (they have four years to do this if the area is declared a federal disaster area). Producers who pay more for their replacement animals than they sold their originals for can use the overage as their tax basis for the following year. Producers who pay less for their replacement animals than they sold their originals for will be responsible for paying taxes on the difference. There is list of requirements for each of these Tax codes that must be done properly and completely. Please check with your tax/accounting professional to see if these options are relevant to your operation. Find a list of designated drought impacted counties and a link to the US Drought monitor can be found on the USDA website.
References: Internal Revenue Bulletin: 2015-41, Notice 2015-69; Extension of Replacement Period for Livestock Sold on Account of Drought.
Internal Revenue Publication 225 (2015) Farmer’s Tax Guide Harris, Phillip E., Department of Agricultural and Applied Economics, University of WisconsinMadison/Extension; Weather-Related Sales of Livestock
Prepared by: Ken Kelley, Regional Extension Agent – Farm and Agribusiness Management, Robert Tufts, Visiting Professor – Agriculture, Forestry and Natural Resources