Wednesday, October 27, 2021
Famers engage in numerous types of sales transactions. Of course, common sales involve sales of harvested crops and raised livestock. But, a farmer or rancher can receive income from other types of sales and for services rendered. Each of these transactions has its own income tax reporting requirements.
Income from sales of unique items and services by farmers and ranchers – it’s the topic of today’s post.
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.
Soil and Mineral Sales
Soil, sod and other minerals that are sold on a regular basis supports the characterization as sales of assets held primarily for sale to customers which would be reported as ordinary income. Indeed, the activity of growing and selling sod has been held to constitute the trade or business of farming for purposes of I.R.C. §180(a). Priv. Ltr. Rul. 8440003 (May 22, 1984). The U.S. Tax Court, in 1976, held that the proceeds from the sale of sod are subject to an allowance for depletion because sod is a “natural deposit.” 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 gain. 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 gain. 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. Regardless of whether the transaction is a sale or a lease, it is important for the taxpayer to determined income tax basis in the minerals.
Crop Share Rents
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.
Sale of Livestock
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.
Section 1231 Assets
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. I.R.C. §1231. For these assets, if the aggregation of these transactions produces a net gain, 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. An important point to remember is that the sale of animals that qualify for I.R.C. §1231 treatment is not reported on Schedule F. Instead, these transactions are reported on Form 4797 where the gains are not subject to self-employment tax and, as noted, a net gain is taxed at favorable capital gain rates.
Gains from the sale of land are taxed as long-term capital gain (e.g., preferential tax rate) if the land has been held for at least a year before the sale. The gain that is taxed is the difference between the selling price and the seller’s basis in the land.
Crops and Feed
Standing crops that are sold with the underlying land are taxed as capital gain. Harvested crops that are sold as inventory, however, are taxed as ordinary income. From a planning standpoint if farmland on which crops are growing is going to be sold in the fall and it has a crop on it that would be harvested in the fall, it might be better from a tax standpoint to sell the growing crop with the land rather than harvesting the crop and then selling it. Crops that are harvested and sold as feed should be accompanied by a bill of sale denoting the price that was paid for the crop.
These are just a few of the common sale transactions that farmers and ranchers enter into. This article is also not a deep dive into the details of each type of transaction. There are additional technical rules that might also be involved in some situations.