Guidelines for Deferral of Livestock and Crop Insurance Proceeds
The weather impacts all of us, but it impacts the farmer and rancher financially. Many farmers and ranchers have recently been impacted by major drought throughout most of the US. The IRS provides tax relief by allowing for the deferral of income under certain circumstances. There are two options available when electing to defer income from livestock that have been sold because of a drought or other weather-related conditions.
A taxpayer may be eligible to defer excess 2023 sales of market and/or breeding livestock and report that amount as income in 2024. The following criteria must be met:
- The principal business of the taxpayer is farming.
- The taxpayer is a cash basis taxpayer.
- Drought, flood, or other weather conditions resulted in the taxpayers’ area being designated as eligible for assistance by the federal government.
- The sale of the excess livestock would not have occurred if it were not for the weather conditions.
In general, it’s common to use the average head sold in the prior three years to determine the number of livestock sold under normal business practices. This calculated average is generally used as a base to determine the excess head sold. Ketel Thorstenson (KT) can assist with this calculation to determine the amount of eligible deferral.
This option allows the postponement of gain on livestock sold in 2023 by purchasing replacement animals within a two-year period. It only applies to draft, breeding, or dairy animals. The replacement period is extended to four years if the taxpayers’ area has been designated as eligible for assistance by the federal government in the future year.
There are a few rules that a taxpayer must follow when replacing their livestock:
- The replacement livestock must be the same type and the same sex as the deferred livestock.
- The number of head replaced does not have to be the same as the number of head deferred.
- The taxpayer must spend replacement costs equal to the amount of the gain deferred.
In some cases, it may not be feasible for a taxpayer to reinvest the deferred gain back into livestock. If this is the case, the taxpayer is allowed to replace the deferred livestock with other tangible property, which can include vehicles and equipment. Land is not eligible.
If the livestock is not replaced, an amended return will need to be prepared for the deferral year to report the income.
Deferral of Crop Insurance
A taxpayer is also able to defer crop insurance proceeds for one year. In order to qualify, it must:
- Be customary practice for the taxpayer to sell more than 50% of the crop in the year following the harvest.
- They must also report income on a cash basis.
- They must receive crop insurance proceeds in the same year as the damage occurred.
- The insurance must be for damages and not lost revenue.
If this election is made, insurance income from all crops must be deferred, there is no option to choose how much to defer.
These deferral options can provide much needed tax relief to farmers and ranchers who are already facing tough times. However, the process can be complicated as there are many regulations, elections, and tests that apply. In addition, deferral may not always be advantageous based on type of livestock sold, future years income being greater than current year, future tax law changes, economic conditions, etc.
Please don’t hesitate to contact your ag tax professional at KT if you believe you may be eligible for any of these deferral options. We are here to help you through this process.
To see a list of counties designated as effected by drought: https://www.irs.gov/pub/irs-drop/n-23-67.pdf