Market Advisor: Tax Implications for Forced Sales of Livestock Due to Drought

By Tim Petry, Livestock Marketing Economist

NDSU Extension Service

Extremely dry weather conditions are occurring again in parts of the northern Plains. High feed and fuel prices likely will limit the options livestock producers have for dealing with the loss of forage. If the dry weather continues, forced liquidation of breeding livestock and early sales of market livestock may be necessary.

Livestock producers who are forced to sell livestock due to drought conditions may receive special consideration for federal income tax reporting purposes.

Income tax reporting for forced sales of livestock because of drought or other weather-related conditions may be handled in two different ways, according to Internal Revenue Service (IRS) guidelines.

The first provision applies to all types of livestock and allows postponement for reporting income from forced sales for one year. For example, the normal business practice for a beef cattle producer may be to background calves after fall weaning and market them the next February. If, due to drought conditions and lack of feed supplies, the calves are marketed at weaning in October, the income may be postponed until the next year. Only sales in excess of normal (normal usually is defined as the average number sold in the last three years) qualify for the deferral.

The drought must have caused an area to be designated as eligible for assistance by the federal government. However, the livestock do not have to be raised or sold in the exact designated drought area, such as a particular county, but only in proximity.

To qualify, the livestock owner’s principal business must be farming or ranching and the cash method of accounting must be used.

The other IRS provision applies to the forced sale of draft, breeding and dairy animals, but excludes poultry. If these animals are sold due to drought, the sale may be treated as an involuntary conversion.

Producers can choose to postpone reporting the capital gain from forced sales as long as similar animals are repurchased in the future. For example, a sheep producer normally markets 25 cull ewes each year, but in a drought year is forced to sell 50 head. Only the additional 25 head that will be replaced later are eligible for the involuntary conversion.

Typically, the replacement period for involuntary conversion ends two years after the close of the tax year of when the gain occurs.

However, when livestock are sold due to drought conditions in an area eligible for federal assistance, producers have four years to replace the livestock. The IRS may extend the replacement period on a regional basis if drought conditions continue for a longer period. Each year, the IRS publishes a list of eligible counties where the replacement period is extended.

More information on the procedure for extending the replacement period and the list of counties eligible for extension through 2007 is available at http://www.irs.gov/pub/irs-drop/n-07-80.pdf.

Also, if it is “not practical” for the producer to reinvest in the same class of livestock, other classes of livestock or property (except real property) used for farming or ranching may qualify as replacement property.

The IRS tax code is complex, so livestock producers considering marketing livestock at abnormal times due to dry conditions should consult with their tax adviser. Other tax management tools, such as income averaging, also may be considered.

NDSU Agriculture Communication