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:: General Livestock - Chapter 2 - Examination Techniques
Pre-Planning
Pre-planning is
the process of developing an
initial course of action in an
audit. By looking at the limited
information available on the
face of the tax return, the
comparative information through
MACS analysis included in the
file or IDRS information,
Currency and Banking Retrieval
System (CBRS) information, and
any related information return
documentation, you will be able
to determine the steps to begin
your audit.
These research
tools can be accessed quickly
and serve to develop a feel for
the breadth of the scope of your
audit. The depth is determined
by other factors which may not
be obvious in the preplanning
phase. However, the following
items may indicate the need for
depth:
FEED --
high cost when a related
supplier or feedlot is involved.
DEATH --
loss deducted separately from
cost of goods sold - determining
if this cost is duplicated can
be an extensive process.
CERTAIN
COMBINATIONS -- if seed and
chemical costs or pasture rent
are high, this indicates a
grazing operation which points
to potentially atypical sales
sources.
Evaluate the
audit classification sheet, if
available. More and more MSSP
returns are being classified by
specialists who provide helpful
suggestions or comments about
certain issues on the return.
Use this information to develop
your pre-plan realizing that
there may be considerations for
your area that supplement these
suggestions and result in more
reasonable evaluation of the
return.
Document
Request/Appointment Schedule
Once the
pre-plan is complete and you
have determined that audit
potential exists you will
contact the taxpayer or
representative. Attempt to
clarify responsibility for the
preparation of the information
on the return, the type of books
and records, and location of
audit. Seldom will individual
ranchers have an office setup in
which to work resulting in the
need to work from the POA's
office.
The initial
contact, your own experience,
and the preferences of
management in your office or
district will determine the
extent of your initial document
request. Whether you request a
basic set of information or
highlight identified issues
requesting specific records,
your goal is to ensure the old
adage, "well begun is half
done." Get what you need to do
the job efficiently and
effectively. Keep your audit
moving to eliminate over-aged
and short-statute cases.
Initial
Interview
As with many
taxpayers who use a
representative, you will not
necessarily see them during the
course of an audit unless you
specifically request the
opportunity to interview them.
As a result, it is important to
glean the maximum amount of
information during initial
contact, probably by phone, and
to be very well prepared during
the interview to cover as much
ground as possible.
Depending on
your auditing style, manager's
preference and experience, you
may want to interview the
taxpayer early in the audit or
you may want to review books and
records prior to an interview to
develop a course of questioning
which will yield the greatest
benefits in the shortest time.
As a rule of thumb, it would be
more helpful to interview the
taxpayer early if they were
heavily involved in the
bookkeeping process and could
provide guidance into the books
and records. If the accountant
prepares a "write-up" from bank
statements or other records of
the taxpayer, then it would be
best to develop questions based
on specifics in the books and
records first before visiting
with the taxpayer.
Every interview
training session you have had
has stressed the benefits of
getting the taxpayer to talk
openly, not just answer
questions. By opening up to
general conversation, more
knowledge is gained than by
direct questioning. Keep the
questions open ended to
encourage discussion rather than
simple answers.
The most
important information to derive
is how the taxpayer conducts his
or her business. Whether it
includes
breeding/raising/selling or
buying/fattening/selling makes a
tremendous difference. Hands-on
activity or use of boarding or
feedlots can mean a great deal
toward the reasonableness of the
return.
In short, DO
NOT presume to know the business
procedures of one farmer/rancher
by having dealt with another.
Learn how each individual
taxpayer conducts business in
order to audit properly that
taxpayer.
Site Visit
What should you
expect when visiting a livestock
operation?
Watch for the
same things in this site visit
as with any other;
-
evidence of
financial status,
-
equipment
usage,
-
undisclosed
aspects of the operation,
etc.
Apply what you
see to the return and related
documentation. The observable
aspects of the taxpayer
operation help bring the picture
together.
Audit Steps
Compliance with
filing requirements will be
determined early in the audit.
Information derived from your
IDRS/CBRS research will indicate
timeliness and extent of filing.
Other information will come out
in the audit to determine
whether all employees are
reported properly as employees
or improperly as contractors, if
any currency transactions for
sales exist which require Form
8300 filing, and if any related
business entities exist which
have not properly filed all
required returns.
Corporate
M-1/M-2 evaluation and a balance
sheet analysis give an
indication of whether certain
types of expected adjustments
were made or if any unusual
handling of information is
apparent from the return.
Missing adjustments on M-1 or
finding large, unusual or
questionable entries on the
balance sheet will initiate
further questions and
examination procedures.
Comparative
analysis of prior and subsequent
year return information can
highlight procedural changes
which result in variations in
reported income or deductions.
Though changes in classification
of expenses may not make a
difference in the net income, it
could represent an effort to
disguise some non-qualifying
activity. Appearance or
disappearance of investments or
functions may lead to the
determination of unreported
income from dispositions or a
source of income previously
undisclosed.
Reconciliation
of books to return requires the
visual inspection of all aspects
of the return which helps to put
these components into
perspective. Think about the
reasonableness of all entries as
they pertain to the operations.
Examination of
detailed records which
substantiate questioned items
from the return will provide the
basis for allowance or
disallowance of specific
entries. Due to the volume of
information for certain areas,
sampling or monthly testing may
yield confidence in the reported
area or validation that
additional examination is
necessary.
Use appropriate
examination techniques. Is it
acceptable per the risk analysis
to go after every dollar
misreported on a return, or
should certain adjustments be
accepted as "substantially
correct" in light of the cost to
pursue those adjustments?
Consider the
necessity of penalties. Is
compliance served by pursuing
certain penalties? Is there
reasonable care evident in the
filing of the return or should
the accuracy penalty be applied?
Are there affirmative acts or
indicators which require the
consideration of the fraud
penalty? How does the preparer's
participation affect the result
of the audit and should there be
any penalty considered against
the preparer?
Closing
Conference
The closing
conference should yield no
surprises. As you question
return information during the
course of the audit, it should
be obvious about the reason for
the questions and what the
results of the answers would be.
Naturally, you may find certain
situations that result in a high
probability of adjustments,
however, without questioning
these items you may not receive
all the facts. It's better to
know in advance that your
proposal is sound than to find
that additional documentation
exists which would alter your
decision.
Conclusion
An audit of a
livestock operation is not a
great deal different than any
other audit situation. Certain
documentation may vary in form
and there are areas which are
unique to the industry, but
overall, it is still just an
audit. Develop the confidence in
your ability to adapt to this
environment as easily as any
other and do the job you are
trained to do.
Chapter 3 -
Industry Issues
Common Issues
Certain aspects
of the livestock industry are
common regardless of the type of
animal. These concepts can be
applied to each operation.
Breeder
Operation
A breeder
operation will generally begin
with the purchase of animals
proven to be able to reproduce.
A single or small number of
males is acquired along with
numerous females to which the
males are bred. Control is
exercised to limit the
possibility of inbreeding due to
the undesirable genetic
consequences in that event. This
control may take the form of
limited access of the males to
the females for breeding or
exchange of males in breeding
stock before female offspring
are ready to reproduce. Stud
services or invitro
fertilization (artificial
insemination) may be employed.
Of the
resulting offspring, generally
only the females will be kept to
build the breeding base. In some
cases, the offspring will be
raised to sell as breeders to
other operations. Breeding
females will often be sold with
offspring as proof of
reproductive ability. Otherwise,
offspring will likely be sold
for fattening/slaughter. In
other cases, the farmer/rancher
will raise the offspring to
slaughter stage completely.
After the
animals pass the practical
breeding age, undesirable
characteristics may begin to
appear so breeding stock will be
sold. Fresh stock will have been
developed from the breeding
process or purchased to continue
the operation.
In the case of
specialized animals, usually a
registered breed, the initial
acquisition process will be
similar to the general breeding
operation, except that both
males and females will be
registered. These breeding
animals are highly controlled
with the offspring being
registered at birth to validate
breeding lineage and to increase
salability. In addition to the
offspring being sold, semen and
embryos may be sold as well.
Sale of any of the animals
results in the transfer of the
registry information as recorded
by the appropriate breed
association.
Fattening/Feeding Operation
In a
fattening/feeding operation,
young or mid-maturity animals
are purchased to feed up to the
next level of maturity or for
slaughter. Often the males will
be castrated to eliminate the
possibility of breeding since
the fattening process is more
effective.
If raised to
the next level of maturity,
these animals will normally be
sold in small lots of several
animals. This may be done
through a sale barn/stockyard or
individually to another rancher.
When fattened for slaughter, the
animals may continue to be
grazed or, more likely, moved to
a feedlot.
Tight control
is kept on the animals when
moved to the feedlot. Because
the feedlot charges by the
animal/by the day and must act
responsibly for the well being
of the animals up to the time
they are moved from the feedlot,
their recordkeeping is
extensive. Tracking weight to
justify the feed charges and
monitoring health when weight is
not reacting as predicted, there
is little likelihood that these
records would not be available.
Determining the number of
animals placed in the feedlot
along with the source and
disposition of the animals is
essential to determining income.
Most slaughter
houses and packing plants have
buyers making the rounds to the
feedlots and selecting animals
for purchase. The purchase offer
is either accepted by the
feedlot as agent for the rancher
or communicated to the rancher
for consideration. If the offer
is accepted, the sale is
completed with detailed sales
documents provided. The rancher
settles up with the feedlot for
any pending expenses on the
lot(s) sold.
Animals
determined to be undesirable
will be set aside and are
usually sold through special
sales or to certain
slaughterhouses for purposes
other than human consumption.
Sales documentation from those
buyers is also available.
Issues
IRC Section
1231
For certain
cases, IRC section 1231 provides
special rules for the treatment
of gains and losses arising from
business property. IRC section
1231 refers to such gains and
losses as "section 1231 gain"
and "section 1231 loss." IRC
section 1231(a)(3)(A) defines
"section 1231 gains" as "(i) any
recognized gain on the sale and
exchange of property used in the
trade or business, and (ii) any
recognized gain from the
compulsory or involuntary
conversion * * * into other
property or money of (I)
property used in the trade or
business, or (II) any capital
asset which is held for more
than one year and is held in
connection with a trade or
business or transaction entered
into for profit." IRC section
(a)(3)(B) defines "section 1231
loss" as "any recognized loss
from a sale or exchange or
conversion described in" the
previous sentence.
IRC section
1231(b)(1) provides a general
rule defining the term "property
used in the trade or business"
(section 1231 property). This
general rule does not apply to
livestock. The general rule
restricts the definition of
"property used in the trade or
business" to, among other
things, depreciable property,
held for more than 1 year,
"which is not (A) property of a
kind which would be includable
in the inventory of the taxpayer
if on hand at the close of the
taxable year, [or] (B) property
held by the taxpayer primarily
for sale to customers in the
ordinary course of his trade or
business, * * *."
The special
definition that is used in the
case of livestock is found in
IRC section 1231(b)(3) which
defines "property used in the
trade or business" as including
"(A) cattle and horses,
regardless of age, held by the
taxpayer for draft, breeding,
dairy, or sporting purposes, and
held by him for 24 months or
more from the date of
acquisition, and (B) other
livestock, regardless of age,
held by the taxpayer for draft,
breeding, dairy, or sporting
purposes, and held by him for 12
months or more from the date of
acquisition. Such term does not
include poultry. "
Treas. Reg.
section 1.1231-2(a) states: "(3)
For the purposes of section
1231, the term 'livestock' is
given a broad, rather than a
narrow, interpretation and
includes cattle, hogs, horses,
mules, donkeys, sheep, goats,
fur-bearing animals, and other
mammals. However, it does not
include poultry, chickens,
turkeys, pigeons, geese, other
birds, fish, frogs, reptiles,
etc."
See chapter 11
of Publication 225, Farmer's
Tax Guide, for a discussion
of various types of
dispositions. The following
represents a basic indication of
reporting requirements for
certain types of sales.
Class of Animal
|
Type
of Asset
|
Sale
Reporting
|
Purchased for breeding
|
Depreciable when placed
in service, IRC section
1231 property
|
Form
4797 -- asset used in
trade or business
|
Offspring raised for
breeding purposes
|
IRC
section 1231 property
generally zero basis
|
Schedule D -- before
placed in service, Form
4797
|
Offspring raised for
sale as breeder
|
Ordinary income asset
|
Schedule F -- sale of
raised animals
|
Offspring sold as cull
|
IRC
section 1231 property
|
Form
4797
|
Young
animal purchased to feed
to mid-maturity
|
Ordinary income
|
Schedule F -- sale of
animal purchased for
resale
|
Animal
purchased to feed to
final slaughter
|
Ordinary income asset
|
Schedule F -- sale of
animal purchased for
resale
|
There may be
exceptions to some of the
examples in the preceding table.
Whether livestock is held for
draft, breeding, dairy, or
sporting purposes depends on all
the facts and circumstances in
each case. See Treas. Reg.
section 1.1231-2(b)(1).
Only livestock
(property) "used in the trade or
business" qualifies for IRC
section 1231 handling. Any
animals purchased for resale
must be included in inventory
and its cost is recovered at the
time of sale. The classification
of income as Schedule F or IRC
section 1231 affects the
computation of self-employment
tax.
Animals sold
which were purchased for
breeding purposes but not yet
placed in service are not
depreciable, but are considered
to be held for use in the trade
or business and qualify for IRC
section 1231 reporting. In a
business which includes both
breeding and purchasing for
resale, carefully determine the
purpose for which the animals
were purchased.
IRC Section
162
Section
1.162-12(a) of the regulations
provides that amounts expended
in purchasing work, breeding, or
dairy animals are regarded as
investments in capital, and
shall be depreciated unless such
animals are included in an
inventory in accordance with
section 1.61-4 of the
regulations. This includes, but
is not limited to freight,
registration fees, and health
related expenses (inoculations,
testing, etc.) Regarding the
value of a pregnant animal and
the unborn offspring or a
mother/offspring pair an
allocation should be made by
subtracting from the purchase
price the value of the mare not
in foal, to arrive at the value
of the unborn foal or offspring.
Cf., Gamble v. Commissioner, 68
T.C. 800, 820-21 (1977), acq.,
1986-2 C.B. 1. Although directly
related to race horses, the
concept is applicable to any
pair purchases.
Costs of
feeding, handling, and caring
for animals in either a breeding
or fattening operation are
current expenses and deductible
currently.
If livestock
die from disease, are destroyed
because of disease, or are sold
or exchanged because of disease,
even though the disease is not
of epidemic proportions, such
occurrences are treated as
involuntary conversions. No
deduction is allowed for value
of raised livestock that die if
the cost of raising them has
been deducted as an expense.
Death of depreciable animals are
not reported on Schedule F.
Farm labor
issues may involve "payment in
kind." A market segment
understanding (MSU) has been
issued regarding farm labor when
payment is in the form of a
product of the farm. The text of
the MSU can be located on the
IS/MSSP bulletin board, MSSP
files, Agricultural related, as
"M1PIC.ZIP" and can be
downloaded. The title of the
document is NONCASH REMUNERATION
FOR AGRICULTURAL LABOR IRC.
SECTION 3121(a)(8)(A). Private
letter rulings 9202003 and
9322003 deal with this issue and
provide some notable descriptive
applications.
IRC Section
61
Section
1.61-4(a) of the regulations
provides, in part, for farmers
using the cash receipts and
disbursements method of
accounting, that the profit from
the sale of livestock or other
items which were purchased is to
be ascertained by deducting the
cost from the sales price in the
year in which the sale occurs.
However, in the case of the sale
of purchased animals held for
draft, breeding, or dairy
purposes, the profits shall be
the amount of any excess of the
sales price over the amount
representing the difference
between the cost and the
depreciation allowed or
allowable.
IRC Section
168
Depreciation Methods
Depreciate
property placed in service after
1988 in a farming business
using:
-
The
150-percent declining
balance method over the GDS
recovery period, which
switches to the straight
line method when that method
provides a greater
deduction,
-
The
straight line method over
the GDS recovery period,
-
The
150-percent declining
balance method over fixed
ADS recovery periods, which
switches to the straight
line method when that method
provides a greater
deduction, or
-
The
straight line method over
fixed ADS recovery periods.
Revenue
Procedure 87-56 states that for
property not described in any
asset class life or used in a
described activity, a 7-year
class is assigned for the
general MACRS method (GDS) and
12-year recovery period for ADS.
Immature
livestock acquired for draft,
dairy, or breeding purposes, is
eligible for depreciation when
it reaches maturity. This means
depreciation begins when it
reaches the age when it can be
worked, milked, or bred. When
this occurs, basis for
depreciation is the initial cost
for the immature livestock plus
freight and other costs related
to the acquisition.
Since the
expenses of raising animals are
deductible currently, there is
no depreciable basis, and
therefore, no depreciation for
animals raised and used in a
trade or business.
IRC Section
179
Publication 225
includes the following
information. You can claim an
IRC section 179 deduction on
trade or business property for
which depreciation is allowable
and that is:
-
Tangible
personal property,
-
Other
tangible property (except
most buildings and their
structural components), used
as:
-
An
integral part of
manufacturing,
production, or
extraction, or of
furnishing
transportation,
communications,
electricity, gas, water,
or sewage disposal
services, or
-
A
research facility in any
of the activities in (a)
for the bulk storage of
the fungible
commodities, or
-
A
facility in any of the
activities in (a) for
the bulk storage of
fungible commodities
(including commodities
in a liquid or gaseous
state).
-
Single
purpose agricultural
(livestock) or horticultural
structures (defined later),
and
-
Storage
facilities (excluding
buildings and their
structural components) used
in distributing petroleum or
any primary product of
petroleum.
Agricultural
structure. A single purpose
agricultural (livestock)
structure is any building or
enclosure specifically designed,
constructed, and used to:
-
House,
raise, and feed a particular
type of livestock and its
produce, and
-
House the
equipment, including any
replacements, needed to
house, raise, or feed the
livestock.
Tangible
personal property is tangible
property other than real
property. Machinery and
equipment are examples of
tangible personal property.
Land and land
improvements, such as buildings
and other permanent structures
and their components, are real
property and not tangible
personal property. Swimming
pools, paved parking areas,
wharfs, docks, bridges, fences,
and similar property are not
tangible personal property.
All business
property, other than structural
components, contained in or
attached to a building is
tangible personal property.
Under certain local laws, some
tangible personal property
cannot be tangible personal
property for purposes of IRC
section 179, and some real
property under local law, such
as fixtures, can be tangible
personal property for IRC
section 179 purposes. Property,
such as milk tanks, automatic
feeders, barn cleaners, and
office equipment, are tangible
personal property.
Livestock is
qualifying property. For this
purpose, livestock includes
horses, cattle, hogs, sheep,
goats, and mink and other
furbearing animals.
IRC Section
183
IRC section
183(d) provides for a
presumption that the activity is
carried on for a profit if it
produces a profit in at lease 3
out of the last 5 consecutive
tax years (2 out of the last 7
years if the activity is
breeding, training, showing or
racing horses.) If the taxpayer
is just starting out in the
activity, he or she may elect
under IRC section 183(e) to
postpone the determination of
whether the presumption applies
to the activity until the close
of the 4th (or 6th) year after
his or her first year engaged in
the activity. In that case, the
taxpayer files a Form 5213 which
automatically extends the
statute of limitation for all
relevant years until the close
of the presumption period.
In determining
whether a farming activity is
carried on for profit, all the
facts in regard to the activity
are taken into account. No one
factor alone is decisive.
Publication 225 provides
guidance to taxpayers who are
analyzing their situation. Among
the factors listed:
-
Is the farm
operated in a businesslike
manner?
-
Does the
time and effort spent on
farming indicate an intent
to make it profitable?
-
Is there a
dependence on income from
farming for livelihood?
-
Are losses
due to circumstances beyond
control? Are the losses
normal in the start-up phase
of farming?
-
Are methods
of operation changed in an
attempt to improve
profitability?
-
Are profits
from farming made in any
year and in what amounts?
-
Does the
taxpayer, or advisors, have
the knowledge needed to
carry on the farming
activity as a successful
business?
-
Has the
taxpayer made a profit in
similar activities in the
past?
-
Is the
farming activity carried on
for personal pleasure or
recreation?
Look at the
following court cases where the
disallowance of expenses for
not-for-profit activities was
upheld:
Hendricks,
Daniel E, et ux. v. Commissioner,
32 F.3d 94 (4th Cir 1994), 74
AFTR2d Par. 94-5281
surgeon with cattle operation
Westbrook,
Billie R, et ux. v. Commissioner,
68 F.3d 868 (5th Cir 1995), 76
AFTR2d Par. 95-5623
veterinarian with embryo
transplant, cattle and miniature
horse operation
DeMendoza,
Mario G, III v. Commissioner,
T.C. Memo. 1994-314
lawyer with polo ponies
Borsody,
Frank J, et ux. v. Commissioner,
T.C. Memo. 1993-534 aff'd per
curiam, US-CT-APP-4 [96-2 USTC
_50,415], 78 AFTR2d Par. 96-5260
horse breeding/training
Lujan,
Arthur G, et ux. v. Commissioner,
T.C. Memo. 1992-417
retired with small cattle
operation.
IRC Section
195
IRC section 195
disallows the deduction of
"start-up" expenses and defines
the criteria for amortization.
The section provides the
following at:
Extract
IRC section
195C
(c) Definitions
For purposes of
this section--
-
Start-up
expenditures. The term
"start-up expenditure" means
any amount --
-
paid or
incurred in connection
with --
-
investigating the
creation or
acquisition of an
active trade or
business, or
-
creating an active
trade or business,
or
-
any
activity engaged in
for profit and for
the production of
income before the
day on which the
active trade or
business begins, in
anticipation of such
activity becoming an
active trade or
business, and
-
which,
if paid or incurred in
connection with the
operation of an existing
active trade or business
(in the same field as
the trade or business
referred to in
subparagraph (A)), would
be allowable as a
deduction for the
taxable year in which
paid or incurred.
The term
"start-up expenditure" does not
include any amount with respect
to which a deduction is
allowable under section 163(a),
164, or 174.
To determine
the timing of deduction for
amortization, IRC section 195(c)
goes on to say:
(2) Beginning
of trade or business.
-
In general.
Except as provided in
subparagraph (B), the
determination of when an
active trade or business
begins shall be made in
accordance with such
regulations as the Secretary
may prescribe.
-
Acquired
trade or business. An
acquired active trade or
business shall be treated as
beginning when the taxpayer
acquires it.
There are
conflicting opinions as to the
applicability of IRC section 195
to "new" farmers. Some
authorities feel that a taxpayer
is not yet engaged in the animal
breeding business until the
animals are placed in service as
breeding stock.
This issue is
unsettled (See IRC section 195,
Treas. Reg. Section 1.162-12,
and the repeal of the
capitalization rules under 263A
for pre-productive expenses on
animals in the Technical & Misc.
Revenue Act of 1988).
IRC Section
451
Livestock
farmers will include receipts in
income in accord with the
provisions of IRC section 451(a)
which states: "General rule: The
amount of any item of gross
income shall be included in the
gross income for the taxable
year in which received by the
taxpayer, unless, under the
method of accounting used in
computing taxable income, such
amount is to be properly
accounted for as of a different
period."
Unusual
circumstances have been
addressed in IRC section 451(e)
which provides:
Extract
IRC section
451(e)
(e) Special
rule for proceeds from livestock
sold on account of drought,
flood, or other weather-related
conditions.
-
In general.
In the case of income
derived from the sale or
exchange of livestock in
excess of the number the
taxpayer would sell if he
followed his usual business
practices, a taxpayer
reporting on the cash
receipts and disbursements
method of accounting may
elect to include such income
for the taxable year
following the taxable year
in which such sale or
exchange occurs if he
establishes that under his
usual business practices,
the sale or exchange would
not have occurred in the
taxable year in which it
occurred if it were not for
drought, flood, or other
weather-related conditions,
and that such conditions had
resulted in the area being
designated as eligible for
assistance by the Federal
Government.
-
Limitation.
Paragraph (1) shall apply
only to a taxpayer whose
principal trade or business
is farming (within the
meaning of section
6420(c)(3)).
Notice 89-55,
1989-1 C.B. 696 further
discusses this election.
Establishing
the number of livestock the
taxpayer would sell if he or she
followed his or her usual
business practices is the
responsibility of the taxpayer
to our satisfaction. Records of
sales from prior years must be
examined to determine the
accuracy of the elected
deferral. Materiality of the
deferral will determine the
depth of such examination.
IRC Section
465
At-Risk
Limits
Rules that
limit deductions for losses
apply to most business or
income-producing activities.
Farming is one of the activities
covered. The at-risk rules limit
the loss deductible when
figuring taxable income or a net
operating loss. The deductible
loss from an activity is limited
to the amount at risk in the
activity.
"At-risk"
generally includes:
-
The amount
of money and property
contributed to an activity.
-
The amounts
borrowed for use in the
activity if:
-
taxpayer is personally
liable for repayment of
the amounts borrowed, or
-
property not used in the
activity secures the
amounts borrowed.
"At-risk" does
not include amounts borrowed for
use in a farming activity from a
person who has an interest in
the activity or a person related
to someone (other than taxpayer)
having such an interest. For
more information, see
Publication 925.
IRC Section
469
Material
Participation vs Passive
Activity
Developing an
analysis of material
participation in farming is the
same as any other activity. IRC
section 469 and the ATG Passive
Activity Loss Study Guide (2/96)
[filenames A0PAL.EXE,
FORM8582.EXE on the IS/MSSP BBS]
provides the training and
guidance. For rules specific to
retired farmers and surviving
spouses of retired or disabled
farmers, Treas. Reg. section
1.469-5T(h)(2), indicates that
"an individual shall be treated
as materially participating for
a tax year in any trade or
business activity of farming if
paragraph (4) or (5) of section
2032A(b) would cause the
requirements of section
2032A(b)(1)(C)(ii) to be met
with respect to real property
use in such activity had the
individual died during such
taxable year."
These questions
will arise in the case of anyone
whose primary occupation is
other than farming and losses
are present. If the professional
activities prevent the
dedication of time necessary to
be successful in the business of
farming, it is more likely that
the taxpayer is unable to meet
the material participation
requirements of the law.
Additionally, losses used to
offset other income sources may
be for that purpose only, rather
than for profit.
IRC Section
471
Livestock
raisers and other farmers may
report their return "upon an
inventory method instead of the
cash receipts and disbursements
method. It is optional with the
taxpayer which of these methods
of accounting is used but,
having elected one method, the
option so exercised will be
binding upon the taxpayer for
the year for which the option is
exercised and for subsequent
years unless another method is
authorized by the Commissioner
as provided in paragraph (e) of
section 1.446-1." (Treas. Reg.
section 1.471-6(a)) This
regulation goes on to describe
in (b) the procedures for
changes in method from cash
receipts and disbursements to an
inventory method and in (c) the
availability of the "farm-price
method" and the
"unit-livestock-price method"
for valuing inventories.
Further
descriptions and related
application of these methods is
included in Treas. Reg. sections
1.471-6(d) through (h).
IRC Section
1033
Ranchers may
experience the loss of animals
due to unexpected circumstances.
These dispositions of livestock
are considered to be sales or
exchanges and as such are
reportable events. IRC section
1033 allows for the treatment of
these events as nontaxable
involuntary exchanges in certain
situations.
IRC section
1033(d) provides application to
livestock destroyed by disease.
Treas. Reg. section 1.1033(d)-1
details the application.
For livestock
sold on account of drought,
flood, or other weather-related
conditions see IRC section
1033(e) (as amended in 1997) and
Treas. Reg. section 1.1033(e)-1
for detailed information.
Develop the facts of the
taxpayer's case in the manner
outlined in Treas. Reg. section
1.1033(e)-1(e):
-
Evidence of
the existence of the
drought, flood, or
weather-related conditions
which forced the sale or
exchange of the livestock;
-
A
computation of the amount of
gain realize on the sale or
exchange;
-
The number
and kind of livestock sold
or exchanged; and
-
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.
Additionally,
it will be necessary to
determine the replacement
assets. Treas. Reg. section
1.1033(e)-1(d) indicates "the
replacement requirements of IRC
section 1033 will be satisfied
only if the livestock sold or
exchanged is replaced within the
prescribed period with livestock
which is similar or related in
service or use to the livestock
sold or exchanged because of
drought, that is, the new
livestock must be functionally
the same as the livestock
involuntarily converted. This
means that the new livestock
must be held for the same useful
purpose as the old was held.
Thus, although dairy cows could
be replaced by dairy cows, a
taxpayer could not replace draft
animals with breeding or dairy
animals."
Conclusion
Understanding
the common characteristics of
various livestock activities
will prepare you for most
operations encountered. Look at
some of the unique aspects of
various types of livestock in
the next section to determine
certain possibilities you may
see.
Unique
Characteristics
The following
chapters will provide
descriptions of typical
livestock operations and focus
on special aspects of each type
of livestock represented. These
will not be applicable to every
operation even for a particular
type of animal, but should be
taken as overviews to assist.
In addition to
this guide, a primary source of
information to you should be the
"expertise" which surrounds you.
By utilizing the knowledge
available in your office from
your manager, senior agents and
other co-workers, you are
accessing one of the greatest
resources available to you.
During our tenure as agents and
auditors we not only develop
knowledge of a particular
industry, but also practices of
that industry in the area,
reputation of taxpayers and
preparers, and the ability to
recognize questionable areas on
returns.
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