The last time the IRS announced a drought relief notice was in 2012 but, with the weather patterns erring toward a long string of droughts, experts say keeping good records of the number of cows sold will be helpful for ranchers and their tax preparers in the upcoming years.
Tina Barrett, director of Nebraska Farm Business, advises ranchers to determine if they are in a declared drought area or border one of the listed counties. A list of the affected counties can be found in Notice 2017-53 on the IRS website or by looking at the U.S. Drought Monitor maps (United States drought monitor).
All or part of 42 states, plus the District of Columbia, are listed as having suffered severe drought between Sept. 1, 2016, and Aug. 31, 2017.
Barrett’s second step is to understand and have records of how many cattle were sold so your tax preparer can assist you in deciding whether a deferral is wise.
“How we calculate what you normally sell is a little tough,” Barrett says. “Normally, we look at sales from a cash standpoint and, since we aren’t required to know how many head sold for taxes, it can take a little time to dig up.”
To qualify for the relief, the sales of livestock held for draft, dairy or breeding purposes must be solely due to drought, flooding or other severe weather. Producers have four years to replace the livestock instead of the usual two-year period.
According to an IRS news release, farmers and ranchers in the applicable region whose drought sale replacement period was scheduled to expire at the end of the 2017 tax year – Dec. 31, 2017, in most cases – will now have until the end of this next tax year.
Because the normal drought sale replacement period is four years, this extension immediately impacts drought sales that occurred during 2013.
“If you are in an extreme drought, and you liquidated an entire herd, you may want to look into this,” Barrett says. “However, the worst downfall is giving up capital income and a self-employed deduction. We need to make sure what we are giving up is better than what we are avoiding. Work with your tax preparer and work through the numbers to see which way is more beneficial.”
Barrett cautions ranchers and farmers to consider a few options before going ahead with the deferral. If you don’t intend to replace breeding animals, you must recognize the gain in the year of sale. If your tax plan for the year does not include that income, you may end up paying a higher rate than if you had planned to include the income in the first place.
Deferring the income and replacing breeding livestock animals within the four-year period makes your basis in the new animals significantly lower. This basis is the amount you would be able to depreciate, which offsets self-employment as well as income taxes (see sidebar for example).
Last, the drought may have a negative effect on all your income in 2017, and the gain on the sale of the livestock may be needed this year to avoid showing a loss on the tax return.
“It should be noted that if it’s not feasible to replace cows, you can buy equipment with the capital gain,” Barrett says. “Again, the most important thing is to work with a tax expert and take good notes for future reference.”
More information on reporting drought sales and other farm-related tax issues can be found in Publication 225, Farmer’s Tax Guide, also available on the IRS website. 
Amy Schutte is a freelance writer based in Idaho. Email Amy Schutte.
Example
You have 25 head of raised cows to sell at $1,200 per head. Since they are raised, they have no basis, and a gain of $30,000 would be realized. If you recognize that gain in 2017, your tax would be $1,500 (assuming zero percent federal and 5 percent state).
If you then purchased animals back in two years for the same $30,000, you would have depreciation spread over five years that would offset $30,000 of income and self-employment taxes of $10,590 (assuming 15 percent federal income tax, 5 percent state and 15.3 percent self-employment tax).
By recognizing the gain today and having the basis in the future, you would save $9,090 in taxes over the time period. If, instead of recognizing the gain, you take the election and defer the $30,000 gain, you pay no tax in 2017.
You also will have a zero-dollar basis (therefore zero depreciation) when you replace the animals since you will take the $30,000 purchase price minus the $30,000 gain deferred.
—Sourced from Tina Barrett, Nebraska Farm Business
