Livestock held for use in business or investment (productive Section 1231 animals) such as draft, dairy, breeding and sporting purposes qualify for capital gain tax deferral treatment in a like-kind exchange under Internal Revenue Code Section 1031.
Tax Treatment
Livestock held for less than one year or two years for cattle and horses, whether sold for a gain or loss is reported on Form 4797, Part II as ordinary gains or losses.
Livestock held for more than one year or two years for cattle and horses, sold for a gain are reported on Form 4797, Part III to reflect the recaptured depreciation. Losses are reported as Section 1231 ordinary losses in Part I.
Livestock held for resale and not considered productive Section 1231 animals are reported on Schedule F as ordinary income or loss.
Special treatment is available for to producers forced to sell livestock because of weather such as drought and flooding.
Livestock Adjustment
The 1031 exchange tax deferral tool is often used to replace less productive animals with characteristics of higher yielding, more desirable livestock. Rather than paying the capital gains and recaptured depreciation tax, the tax deferral is used as an interest-free loan towards acquiring the replacement animal.
Like Kind 1031 Requirement
Rutherford v. Commissioner provided that three-quarter blood heifers were exchanged for one-half blood heifers. Exchanges of different sexes are not considered like-kind and are not eligible for 1031 tax deferral treatment. Wylie v. U.S. upheld an exchange of mixed cattle for steer calves while Woodbury v. Commissioner maintained an exchange of cows for mixed yearlings.
Livestock held for breeding, participation or syndication purposes are eligible for 1031 tax deferral treatment. Livestock held predominantly outside the United States are also eligible given they are exchanged for livestock outside the United States.
When selling livestock with the intent is to replace with like-kind livestock, there are a number of 1031 exchange rules to be followed to defer the triggered taxes.
- Engaging a Qualified intermediary to facilitate the 1031 exchange
- Same taxpayer requirement - the taxpayer who sells is the taxpayer who buys
- To defer the capital gains tax property of equal or greater value is acquired
- Replacement property must be identified by the 45th calendar day and acquired by the 180th calendar day post initial closing
- If selling to a related party, the property must be held for two years otherwise, the tax deferred is due.
- If buying from a related party, the related party must also be initiating a 1031 exchange and not cashing out.
If the intent is not to replace, a Deferred Sales Trust allows the sales proceeds to grow under the guidance of your financial advisor while the capital gains tax is paid per a schedule the taxpayer determines.
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