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Navigating the tax maze of livestock sales

Tyler Alleman Published on 09 October 2012

Growing up in a farm community in southeastern Idaho meant I was able to experience a wide variety of agriculture-related jobs. They began at an early age where I helped milk cows and bottle feed calves each morning and evening.

This progressed to moving hand-line sprinklers at a rate of $.15 per pipe in the alfalfa fields each summer. Falls were spent pulling boards to unload trucks and eventually driving truck in the potato harvest. As I completed high school, the $.15 per pipe and other amounts I’d earned through my various farm jobs provided the savings I used to attend college. At the time I believed my farm labor had come to an end.

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Little did I know that in a matter of years I would once again be back working in the agriculture field, this time as a CPA and tax adviser rather than moving hand-line sprinklers. This article relates directly to my first farm job, feeding and raising calves, with a discussion of the varying tax treatments that result from the sale of livestock.

The tax code is a maze of varying income tax rates and rules governing the application of these rates. Navigating this maze can be a complex task but understanding the various rules can greatly aid in tax planning for dairy farmers as they manage their livestock.

The tax treatment governing the sale of livestock is dependent on several factors including the purpose for which the livestock is held, the time period the livestock is held and whether the livestock was purchased or raised. There are also some favorable tax planning opportunities available when livestock must be sold due to weather and other disaster-related conditions.

Calculating taxable gain
The first step in understanding the tax consequences of livestock sales involves a discussion of how the gain from these sales is calculated. The taxable gain recognized on the sale of livestock is calculated by the following formula:

Gross Sales Price - Expenses of Sale - Cost Basis in Livestock = Taxable Gain/Loss

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The gross sales price represents the total cash or other consideration received upon sale. Expenses of sale of livestock include items such as transportation costs and commissions paid in conjunction with the sale. The cost basis in the livestock sold is the initial amount paid plus items such as shipping or other fees paid in conjunction with the purchase.

A discussion of the tax basis of raised livestock is included later in this article. Capturing all the related expenses is essential in order to minimize the taxable gain and ultimately the income tax incurred on the sale of livestock.

Livestock held primarily for sale in the ordinary course of business
Livestock sales are classified into two categories: livestock held primarily for sale in the ordinary course of business and livestock held for draft, breeding, dairy or sporting purposes. The most common example of this category is purchased or raised calves that have not been placed in production and are later resold.

The difference between the sales price of the livestock and its purchase price is income subject to ordinary income tax rates. Currently ordinary income tax rates start at 10 percent and increase up to a maximum rate of 35 percent as taxable income increases.

These sales are also subject to self-employment tax at a rate 13.3 percent for 2012 for taxpayers reporting their farm activity on Schedule F of their individual return. The potential for these high rates mean it is critical to minimize the gain recognized by capturing all allowable expenses.

Livestock held for draft, breeding or dairy purposes
Livestock can also be held for draft, breeding or dairy purposes. Sales of these livestock, often in the form of cull cows, are livestock that were part of the production process and then ultimately sold. The distinction between livestock held primarily for sale and livestock held for draft, breeding or dairy purposes is important because the latter can qualify for preferential capital gain rates.

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Sales of these livestock also escape self-employment tax. Currently the rate for long-term capital gains is a maximum of 15 percent for 2012. There are a couple of common pitfalls that are critical to consider in order to take advantage of the preferential rates available for the sale of draft, breeding and dairy livestock.

First, it is important to keep accurate records of livestock sold throughout the year in order to accurately report livestock sales in the correct category. Second, be sure to provide this information to your CPA or tax adviser in order to ensure correct tax reporting. Inaccurate or incomplete records can increase the chance of missing out on the lower tax rates.

Holding periods
In order to qualify for long-term capital gain treatment, assets must meet certain holding periods. This holding period is greater than one year for most assets. However, for horses and cattle used in a farming business, the holding period must be greater than two years.

Being aware of the holding period for your livestock can mean the difference between paying tax on the income at the ordinary income tax rate of up to 35 percent versus the maximum long-term capital gain rate of 15 percent.

Once again, accurate record-keeping will help ensure proper tax planning and reporting. There is no holding period requirement for livestock purchased or raised for sale in the ordinary course of business. All of these sales are taxed at ordinary income tax rates regardless of how long they are held.

Raised versus purchased livestock
There are some important distinctions between the treatment of purchased versus raised livestock that need to be considered when determining the taxable income from the sale of these livestock. It is important to track the amount paid for any purchased livestock.

For livestock held for resale and livestock held for breeding/dairy purposes, this cost becomes part of the cost basis that reduces the gain recognized when the livestock is ultimately sold. In addition, livestock purchased for breeding/dairy purposes are subject to cost recovery through depreciation.

For the vast majority of operations, expenses related to raised livestock such as feed, medicine and veterinary fees are allowed as a current deduction in the year the expenses are paid. As a result, raised livestock have no cost basis for tax purposes when sold. Taxable income from the sale of raised livestock will equal the gross sales price less any expenses of sale as discussed above. PD

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Tyler Alleman
CPA
Jones Simkins, P.C.

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