Agriculture &
Business
Management
Tax Management Opportunities
Caused by the Drought
Presented at the Colorado Farm Show
January 28, 2003
Jeffrey E. Tranel
Agricultural & Business Management Economist
Financial Situation Due to 2002 Drought
Financial Situation Due to 2002 Drought
With no farm profits and no other income,
there is no money for
principal repayment,
family living,
investments,
etc.
Financial Situation Due to 2002 Drought
“My Biggest Tax Problem
Is
Not Paying Enough Taxes!”
Crop Producer:
With Losses (No Profits)
Crop Producers
Produced A Crop?
• Higher prices may have offset reduced yields.
• Reduced expenses due to reduced amount of
acres.
Crop Producers
Received Crop Insurance Revenues?
• Revenues may have allowed a profit.
– Some income.
– Reduced expenses.
Crop Producers
Received Crop Insurance Revenues?
• Crop insurance revenues may be claimed as
taxable income in the year that sales normally
occur.
– Use cash method of accounting.
– Receive proceeds in same tax year that crops are
damaged.
– Can show that the income from damaged crops
would have included in the following year.
Crop Producers
Have Carry-Over Sales?
If have “carry over” income and little/no profits,
may want to recognize such income to offset
current year expenses.
– rather than continuing to carry forward income.
– rather than pre-paying expenses.
Crop Producers
Other?
• Do not elect accelerated depreciation.
• Use other profits to offset farm losses.
Livestock Producers
Feed Assistance Program
• Such payments must be included in the
year of receipt.
Livestock Producers
IRS Code Sections 451(e) and 1033(e).
• Requirements of taxpayer.
– Qualified farmer.
– Uses cash method of accounting.
– Sale would not have occurred except for
drought.
Tax Code Section 451(e)
• Primarily for sales of market/feeder animals.
• Allows for deferring recognition of forced
sale income to the following year.
• Livestock sold due to drought, flood, or other
weather related conditions.
• Area must be designated as eligible for
assistance by the federal government.
Tax Code Section 1033(e)
• Allows for the non-recognition of the gain on
the sale of breeding livestock.
– Horses qualify if used for draft, breeding, or dairy.
– Poultry is expressly excluded from livestock.
• Animals sold in excess of normal numbers
due to drought (involuntary conversion).
Replacing Property Lost Due to
Involuntary Conversion
• Replacement property must be purchased.
• The taxpayer's basis in the property is its
cost.
• Replacement property acquired by gift, or
tax-free exchange, is not eligible for
deferral.
– Since the basis of the property is not cost.
Replacing Property Lost Due to
Involuntary Conversion
Must be similar or related in service or use.
– Functions in the same way.
• Breeding cow and dairy cow do not qualify.
Replacing Property Lost Due to
Involuntary Conversion
If reinvestment in similar use property is not
feasible because of soil or other
environmental contamination,
Livestock may be replaced by other
property “used for farming purposes.”
Toxic chemicals are the contaminant.
Brucellosis infected cattle do not qualify (bacterial).
Replacing Property Lost Due to
Involuntary Conversion
The converted property must be replaced
within a two-year period.
– The period ends two years after the close of the
first taxable year in which any part of the gain on
the conversion is realized.
– Replacement of the converted property must be
completed by the end of the period.
• Merely exerting best efforts to replace property within the
period is not adequate.
• Even the fact that replacement property is not available
does not stop the running of the replacement period.
Sales in 2002 = Replacement by 31 Dec 2004
Destruction of Diseased Livestock
Example: Elk Ranches with Chronic Wasting Disease
Generally, the death or disposition of
livestock "by or on account of disease"
is an involuntary conversion.
The livestock do not actually have to
contract a disease.
– Exposure to disease and then sold on
account of this exposure is sufficient.
– Cause of death may be lethal injection
given by the State Veterinarian.
1033e Decision Tool
(An Excel Template)
1033e Decision Tool
(An Excel Template)
1033e Decision Tool
(An Excel Template)
1033e Decision Tool
(An Excel Template)
Elect to Postpone the Gain?
• In most cases, one is better off postponing
the gain.
• Value of Cash and Cattle in 2005 for
example ranch (please see 1033e Decision Tool)
–
–
–
–
–
–
–
Typical Year
Drought Ends-Deferred Taxes
Drought Ends-No Tax Deferment
Drought Ends-Repl Increase, Deferred Taxes
Drought Ends-Repl Increase, No Deferment
Drought Continues-No repl, deferment
Drought Continues-No repl, no deferment
$263,538
148,906
145,651
74,906
71,651
114,818
112,580
Advantages of Postponing the Gain
• Rancher has use of the money
• Reduce debt (interest savings)
• Invest to generate income.
• Tax return can be amended without penalty
(only interest will be assessed).
• Tax liability may be higher in current year.
• Abnormally high profits and other income.
Advantages of Paying the Tax
– Less risk of the money not being available.
• Family living
• Operating expenses
– Greater flexibility in replacing animals.
• Type.
• Timing.
– Current year tax situation may reduce gains.
• Net operating losses (NOL).
• Reduced profitability in current year.
What to do with the Money?
Funds need to be available to:
– Replace livestock.
– Pay taxes (if replacements are not purchased).
• YES
–
–
–
–
Escrow Account
Debt Reduction with Contingent Liability
Low Risk Investment
Reduce Operating Debt (line of credit)
• NO
– Pre-pay term debt
– Use for operating expenses
– Use for family living
Replacing the Cow Herd
• Should you get back into the cattle
business?
– Personal and family issues.
– Business risks.
– Range/pasture recovery.
– Financing alternatives.
Personal & Family Issues
•
•
•
•
Age.
Health.
Stress.
Personal Goals.
• Family Goals.
• Equity Management.
• Personalities.
Business Risks
•
•
•
•
•
Production risks.
Marketing risks.
Financial risks.
Legal risks.
Human risks.
Range & Pasture Recovery
• Current range conditions.
• Grazing management recommendations.
• Re-stocking rates.
• Supplementation.
Typical Partial Budget
Positive Outcomes
– Reduced Costs
– Increased Returns
– Total Positive
Negative Outcomes
– Reduced Returns
– Increased Costs
– Total Negative
Positive – Negative = Net Impact
Contact A Tax Professional
• Competent.
• Understands your situation.
– Business.
– Finances.
– Business goals.
– Personal goals.
– Personality.
jtranel@colostate.edu
www.coopext.colostate.edu/ABM