Prolonged drought conditions and unexpected wildfires plagued many farmers and ranchers across Texas and the Southwest last year, causing them to suffer unexpected losses in revenue. But many of them are now discovering they face added tax liabilities because the Internal Revenue Service considers insurance settlements on the farm and ranch as taxable income.
A Texas AgriLife risk management specialist is advising agricultural producers who suffered losses as a result of a federally-recognized natural disaster that they may qualify to defer taxes due on insurance settlements or capital gains from livestock sales last year for up to four years, provided they make use of the appropriate IRS forms and follow procedures required to secure deferment options.
"This will affect farmers and ranchers who lost physical improvements or animals on the farm and ranch last year. In the case of loss by wildfire for example, barns, fences, storage bins and other physical property may have been insured and these insurance payments or settlements, if issued last year, are considered taxable income. The same can be said for livestock producers who had to cull their herds because of drought conditions. In this case, the income, or revenue, coming from the sale of those animals could be deferred for up to four years," reports DeDe Jones, a Texas AgriLife risk management specialist in Amarillo.
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"If your operation falls into one of the 108 counties in Texas, for example, that were declared a national disaster because of drought, or even if it is located in a county adjacent to one that was included in a disaster declaration, then you would qualify for a four year deferment on capital gains received, whether those capital gains come in the form of selling off livestock or as payments from insurance," she explained.
According to the IRS, insurance payments must be considered taxable income and so must revenue generated from selling livestock, regardless the reason you needed to sell them.
Insurance payments are income
According to IRS rules, while producers may be getting only pennies on the dollar for the actual losses they incurred, IRS still classifies the insurance payments as income. The same is true of liquidated livestock that was sold. The revenue from that liquidation is considered taxable income as it represents a capital gain.
Under normal circumstances, producers could defer taxes on capital gains for two years, but when a disaster declaration is involved, that deferment can be extended for four years.
"In the case of losses from wildfire, like barns or fences, this gives the farm operator time to replace these items, or, in the case of livestock, to replace the animals that were liquidated," Jones said.
She warns, however, that if a rancher sells more livestock as a result of the drought than in a normal year, only the added livestock sold above what would normally be culled qualifies for the deferment program.
"At the end of the four years, you must show that you reinvested these revenues back into building up you herds to pre-disaster levels, otherwise you would still be liable to pay taxes on the difference," she said.
For example, if you normally cull four head of livestock each year but were forced to sell 24 animals because of a lack of forage or feed, then the proceeds from the sale of 20 of those animals would qualify for deferred income status. But at the end of four years, if you fail to reinvest the full amount deferred the first year, you would still be responsible for paying taxes on the difference.
Jones says each type of loss requires a different IRS form. Options including Internal Revenue Service Form 4684, IRS code 1033 and IRS code 451, are available to help qualifying farmers and ranchers deal with these weather-related events.
To be eligible for deferment of losses caused by fire (Form 1033 election), producers must attach a statement to their tax returns indicating the date and details of their casualty, the amount of insurance or other reimbursement received, how the gain was calculated, and proof of a disaster declaration.
To be eligible for a 1033 election, producers must attach a statement to their tax return indicating the existence of an adverse weather-related condition, proof of a disaster declaration (if applicable), and documentation listing the amount of gain realized on liquidated cattle or other livestock. They should also show the amount and kind of livestock sold or exchanged, and estimate the number of animals typically sold or exchanged under normal weather conditions.
Under a third election, Section 451 of the tax code allows cattle owners to postpone gains for one year on raised livestock only. To qualify for this election, taxpayers must show that their principal business is farming or ranching and use the cash method of accounting. They should also demonstrate that the livestock would normally have been sold at a later date but were liquidated early due to drought.
"Extreme weather conditions experienced during recent years have produced havoc for Texas agricultural producers and caused many to face property damage and early livestock liquidations. Such unplanned events often create more revenue than usual in a given year, generating income tax issues," Jones added.
Several options, including IRS Form 4684, IRS code 1033 and IRS code 451, are available to help farmers and ranchers deal with weather-related issues in excess of
normal business practices and Jones suggests they should contact a tax accountant to determine the option that best fits their operations and business plans.
The IRS rules and policy apply to all U.S. farmers and ranchers nationwide. In Texas alone, 108 counties were designated in a natural disaster declaration and during 2013 nearly 200,000 acres were lost due to wildfires. In addition, livestock herds were significantly reduced for the second year in a row.