Economics: September 1998

If you followed my drought management advice in the April 1996 newsletter, you probably won't find this article useful. However, since we are prone to survive the short run obstacles and think there will never be another bad day, I am confident that there is an audience for the information that follows!

Given that it is never (as close as an economist will ever get) economical to feed cattle through an extended drought, you have, will, or should sell more cattle in 1998 than you normally sell in a tax year. There are two different tax treatments that apply to weather-related sales in excess of normal business practice. One applies to draft, breeding or dairy animals that will be replaced within a two-year period. The other applies to all livestock and allows a one-year postponement of the reporting of the sales proceeds.

A. Election to Postpone Gain by Purchasing Replacement Animals

I.R.C. sec.1033(e) allows taxpayers to postpone recognition of gain from livestock sold because of drought, flood, or other weather-related conditions. To qualify for this provision, the following criteria must be satisfied:

• If livestock (other than poultry) held for draft, breeding or dairy (no sporting) purposes are sold because of weather-related conditions, the gain realized on the sale does not have to be recognized. To make this election, the taxpayer must intend for the proceeds to be used to purchase replacement livestock within two years of the end of the tax year of the sale. (There is no required holding period for this provision as there is for sec. 1231.)
• The new livestock must be used for the same purpose as the livestock that was sold. The taxpayer must show that the weather-related conditions caused the sale of more livestock than would have been sold without the drought conditions. There is no requirement that the weather-related conditions cause an area to be declared a disaster area by the federal government.
• The taxpayer has a basis in the replacement livestock equal to the basis in the livestock sold plus any amount invested in the replacement livestock that exceeds the proceeds from the sale.
• How to make the election. The election to defer the recognition of gain is made by not reporting the deferred gain on the tax return and by attaching a statement to the tax return showing all the details of the involuntary conversion including:
a. Evidence of existence of the weather-related conditions that forced the sale or exchange of the livestock.
b A computation of the amount of gain realized on the sale or exchange.
c. The number and kind of livestock sold or exchanged.
d. The number of livestock of each kind that would have been sold or exchanged under the usual business practice in the absence of the weatherrelated condition.
• Purchase of qualified replacements should be reported on an individual's 1999 or 2000 tax return. If additional income results for 1997, an amended 1997 return must be filed.

B. Election to Defer Income to Subsequent Tax Year

I.R.C. sec.451(e) allows taxpayers to postpone reporting income for one year if the livestock are sold because of weather-related conditions. This election applies to all livestock. To qualify for this provision, the following criteria must be satisfied:

• The principal business of the taxpayer must be farming.
• The taxpayer must use the cash method of accounting.
• The taxpayer must show that the livestock would normally have been sold in a subsequent year.
• Weather conditions that caused an area to be declared a disaster area must have caused the sale of livestock. It is not necessary that the livestock be raised or sold in the declared disaster area. The sale can take place before or after an area is declared a disaster area as long as the same disaster caused the sale.
• How to make the election. The election is made by attaching a statement to the return that includes the following information:
a. A declaration that the taxpayer is making an election under I.R.C. sec. 451(e).
b. Evidence of the existence of the weather-related conditions that forced the early sale or exchange of the livestock and the date, if known, on which an area was designated as eligible for assistance by the federal government as a result of the weather-related conditions.
c. A statement explaining the relationship of the designated disaster area to the taxpayer's early sale or exchange of the livestock.
d. The total number of animals sold in each of the three preceding years.
e. The number of animals that would have been sold in the taxable year had the taxpayer followed his or her normal business practice in the absence of the weather-related conditions.
f. The total number of animals sold and the number sold on account of weather-related conditions during the taxable year.
g. A computation of the amount of income to be deferred for each such classification.

Thought for the Month
". . .drought creeps insidiously into the lives of its victims" – Walter Prescott Webb