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University of Wisconsin-Extension
Droughts
can wreak havoc for farm families. The good news is that come
tax time, you have some options that might make things easier.
If you have received federal disaster payments, you may be
able to postpone reporting them on your income taxes for a
year. Likewise, if you were forced to sell livestock because
of the drought, you may be able to postpone reporting gains
on the sale for as long as two years afterward.
Here
are some basic things you need to know. But for the best advice
for your situation, see a tax practitioner knowledgeable about
farm tax laws and assistance programs.
If you
are a cash method farmer, you are allowed to postpone reporting
insurance and disaster payments on crop losses by one year
under Section 451(d) of the tax code. Generally, this rule
applies when crops cannot be planted or are damaged or destroyed
by a natural disaster such as a drought or a flood. It applies
to all insurance proceeds and to federal payments received
for losses due to a natural disaster.
- Qualifying
for the election. You must be able to show that under
your normal business practice, the income from the crop
would have been reported in the year following receipt of
payment for it.
- Two
options for reporting on tax returns. If you qualify
for the exception, you have the option of reporting the
payments as income in the year it is received or as income
in the following year. Electing to postpone reporting the
payment as income covers all crops from a farm. You must
file a separate election for each farming business you operate.
Separate businesses are defined as those for which you keep
separate books and are allowed to use different methods
of accounting.
The
election must be attached to the return (or amended return)
for the tax year in which the payment was received. The statement
must include:
- Your
name and address.
- A
declaration that you are making an election under Section
451(d).
- Identification
of the specific crop or crops destroyed or damaged.
- A
declaration that under your normal business practice,
the income from the damaged crops would have been included
in your gross income for the tax year following the damage.
- The
cause of damage of crops and the dates on which the damage
occurred.
- The
total amount of payments received from insurance carriers,
itemized with respect to each specific crop and with respect
to the date each payment was received.
- The
names of insurance carriers from whom payments were received.
There
are two tax provisions that apply to the sale of livestock
because of drought. One allows the taxpayer to roll the
gain into the basis of replacement livestock. The other
allows the taxpayer to defer reporting the income by one
year.
If
livestock are sold because of drought conditions, the gain
realized on the sale does not have to be reported if the
proceeds are used to purchase replacement livestock within
two years of the end of the tax year of the sale. This applies
to livestock (other than poultry) held for any length of
time for draft, breeding or dairy (no sporting) purposes.
The
new livestock must be used for the same purpose as the livestock
that were sold. Therefore, dairy cows must be replaced with
dairy cows. The taxpayer must show that the drought caused
the sale of more livestock than would have been sold without
the drought conditions. The farmer has a basis in the replacement
livestock equal to the basis in the livestock sold, plus
an amount invested in the replacement livestock that exceeds
the proceeds from the sale. In this case, there is no requirement that the drought conditions cause an area to be declared
a disaster area by the federal government.
If
any livestock are sold because of drought conditions, you
may be eligible for another exception to the general rule
that the sale proceeds must be reported in the year they
are received. This election applies to all livestock. This
exception allows the taxpayer to postpone reporting the
income by one year.
To
qualify, the taxpayer must show that the livestock would
normally have been sold in a subsequent year. Additionally,
the sale of the livestock must have been prompted by a drought
that caused an area to be declared a federal disaster area.
It is not necessary that the livestock be raised or sold
in the declared disaster area. The sale can take place before
or after an area is declared a disaster area as long as
the same disaster caused the sale.
The
election to either roll over the gain or defer it to next
year is fairly simple. It is made by not reporting the deferred
gain on the tax return and by attaching a statement showing
all the details of the involuntary conversion including:
- Evidence
of existence of the drought conditions that forced the
sale or exchange of the livestock.
- A
computation of the amount of gain realized on the sale
or exchange.
- The
number and kind of livestock sold or exchanged.
- The
number of livestock of each kind that would have been
sold or exchanged under the usual business practice in
the absence of the drought.
Additional resources:
Your county Extension office; the Internal Revenue Service, (800) 829-3676, for forms; your local emergency government office; income tax preparers
Related publications:
UW-Extension publication, "Income Tax Management for Farmers," (NCR002). IRS Publication 225, "Farmers Tax Guide;"
IRS Publication 334, "Tax Guide for Small Business;"
IRS Publication 547, "Nonbusiness Disasters, Casualties and Thefts."
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NASD Review: 04/2002
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