Two tax options are available for livestock producers forced to sell cattle early due to drought and wish to defer taxable income, says Tina Barrett, executive director of Nebraska Farm Business Inc.
The first option is a one-year deferral that allows producers to file income received from cattle sold the year of the drought to the following year. Thus, cattle sold this year won't be recognized as a gain until 2007, she says.
The second is to replace breeding livestock without recognizing a gain for the initial sale, Barrett says. In previous years, producers were given a two-year period to replace the livestock. That period is now four years.
"If it still isn't feasible to reinvest in livestock within four years, you can now invest that money in a different type of asset used for farming purposes. It doesn't let you invest in land, but you could take the money from the cows and invest it in a new tractor," Barrett says.
To claim a deferral, producers must prove the drought caused a premature sale of livestock. Operating in a county declared a federal disaster area is sufficient proof. For producers in other counties, proof such as the release of CRP land for grazing or haying is needed, Barrett says.
However, Barrett says, there are some instances where producers may choose to recognize the income.
"If the gain on the sale of livestock is deferred, capital gains today are reduced, but so is the tax basis in the replacement animals in the future. As a result, the depreciation expense allowed on those animals is also reduced. Therefore, a sole-proprietor is trading what could be a 5% federal tax for at least a 30% tax savings in the future," she says.
Drought conditions can cause an overall drop in a given year's income. In these situations, it may be necessary to show the gain from sale of livestock to avoid showing loss on tax returns, she adds. The important thing to remember is situations and circumstances are unique, so Barrett recommends producers keep all options open and consult a tax professional.