Thursday, September 8, 2016
I field a lot of questions involving farm income tax issues. Sometimes those questions involve the proper treatment of income received from various farm-related activities. Today I take a look at a few of those common questions involving breeding fees, mineral and soil sales, crop share rents, livestock sales, and the sale of farm business assets.
Amounts that a farmer or rancher receives as breeding fees are includible in gross income. If part or all of the fee is later refunded because the animal did not produce live offspring, you still report the breeding fees as income in the year received, but then you take a deduction when the refund is made.
If you sell soil, sod and other minerals on a regular basis, that supports the characterization as sales of assets held primarily for sale to customers. So, that would be reported as ordinary income. The U.S. Tax Court, in 1976, held that the proceeds from the sale of sod are subject to an allowance for depletion. Myers v. Comm’r, 66 T.C. 235 (1976), acq., 1977-2 C.B. 1.
For mineral deposits, the disposition could be held to be a sale that would be reported as capital gains. But, that probably is not going to be the case in most situations. It’s more likely that a lease is involved which produces ordinary gains. Whether a sale or lease takes place depends upon whether an economic interest was retained in the deposits in question. The answer to that question will depend on the facts of each situation.
Crop share rents received by a farm landlord under a crop share or livestock share lease are included in income in the year the crop or livestock is reduced to money (or its equivalent), fed to livestock or donated to charity, whether the taxpayer is on the cash or accrual method of accounting. If crop share rents are received in one taxable year and fed to livestock in a later taxable year, the landlord includes in income an amount equal to the fair market value of the share rents at the time the crop share amounts are fed to livestock. An offsetting deduction is available at the same time.
For livestock, the amount of cash and the value of other merchandise or other property received during the tax year from the sale of livestock (and other produce) is included in gross income. Raised livestock (and crops) typically have a zero basis, which will result in the entire amount of the cash and the value of other merchandise or other property received being reported in gross income.
In general, for gains and losses arising from the sale of certain capital assets - farmland, depreciable assets used in the farm business, livestock (held for draft, breeding, dairy and or sporting purposes), unharvested crops sold with the land, and some other transactions - a special form of tax treatment applies. The depreciation previously taken on assets which are not real property is treated as ordinary income when the asset is sold, up to the amount of the gain from the sale. If the aggregation of these transactions produces a net gain (after determining the depreciation recapture), it is treated as long-term capital gain provided the assets were held for the requisite time period unless, in the prior five years, there were net losses from such aggregation. If there were net losses, then the net gain for the year is treated as ordinary income to the extent of the prior losses. For this purpose, a net loss of a prior year is disregarded after it has once been used to convert a capital gain to ordinary income in a prior year. If aggregation of these transactions for the year produces a loss, the loss is deducted as an ordinary loss. For capital assets not used in the business, gains are capital gains and losses are capital losses. For individuals, capital losses offset capital gains and up to $3,000 of ordinary income each year. Corporations are not eligible for the $3,000 deduction against ordinary income.
For long-term capital gain treatment in general, assets must be held for more than one year. However, cattle and horses must be held for 24 months or more. For other livestock, they must be held for 12 months or more.
These are just a few of the common questions that seem to predominate concerning the sale of farm assets. Remember, this is just a general overview. There are additional technical rules that might also be involved in some situations.