Small Business Taxes & Management^TM--Copyright 2016, A/N Group, Inc.

Introduction

Were it not for specific provisions in the law, almost any transfer of property could result in taxable income. For example, Section 1032 provides that a corporation will not recognize a gain or loss on the receipt of money in exchange for stock in the corporation. Without this section the sale of stock by a corporation would result in taxable income. Section 1031 allows for a like-kind exchange of business or investment properties.

Much the same is true in casualty losses. For example, you paid $2,300 for a garden shed. It's completely destroyed in a windstorm when a tree falls on it. Your insurance company gives you $3,100 as compensation. If you replace the property by spending $3,100 (or more) on the new property, you don't have to report a gain. However, since you're moving in six months you decide not to replace the property. You've got to report a $800 capital gain. You have up to two years after the close of the year in which the loss occurs to replace the property. The same general rules apply in other casualty loss and condemnation situations, but the replacement period can vary. For example, if your main home is located in a federally declared disaster area, the replacement period generally ends 4 years after the close of the tax year in which the gain is realized.

Section 1033 provides a similar benefit for gain on an involutary conversion of livestock. Farmers and ranchers who due to drought sell more livestock than they normally would may defer tax on the extra gains from those sales. To qualify, the livestock generally must be replaced within a four-year period. The IRS is authorized to extend this period if the drought continues. Only gains on sales of livestock held for draft, dairy, or breeding purposes apply. Those raised for slaughter or held for sporting purposes and poultry are not eligible.

The one-year extension of the replacement period announced by the IRS generally applies to capital gains realized by eligible farmers and ranchers on sales of livestock held for draft, dairy or breeding purposes due to drought. Sales of other livestock, such as those raised for slaughter or held for sporting purposes, and poultry are not eligible.

The IRS is providing this relief to any farm located in a county, parish, city, or district, listed as suffering exceptional, extreme or severe drought conditions by the National Drought Mitigation Center (NDMC), during any weekly period between Sept. 1, 2015, and Aug. 31, 2016. All or part of 37 states and Puerto Rico are listed. Any county contiguous to a county listed by the NDMC also qualifies for this relief.

As a result, farmers and ranchers in these areas whose drought sale replacement period was scheduled to expire at the end of this tax year, Dec. 31, 2016, in most cases, will now have until the end of their next tax year. Because the normal drought sale replacement period is four years, this extension immediately impacts drought sales that occurred during 2012. But because of previous drought-related extensions affecting some of these localities, the replacement periods for some drought sales before 2012 are also affected. Additional extensions will be granted if severe drought conditions persist.

Notice 2016-60

This notice provides guidance regarding an extension of the replacement period under Sec. 1033(e) of the Code for livestock sold on account of drought in specified counties.

Nonrecognition of Gain on Involuntary Conversion of Livestock. Section 1033(a) generally provides for nonrecognition of gain when property is involuntarily converted and replaced with property that is similar or related in service or use. Section 1033(e)(1) provides that a sale or exchange of livestock (other than poultry) held by a taxpayer for draft, breeding, or dairy purposes in excess of the number that would be sold following the taxpayer's usual business practices is treated as an involuntary conversion if the livestock is sold or exchanged solely on account of drought, flood, or other weather-related conditions.

Replacement Period. Section 1033(a)(2)(A) generally provides that gain from an involuntary conversion is recognized only to the extent the amount realized on the conversion exceeds the cost of replacement property purchased during the replacement period. If a sale or exchange of livestock is treated as an involuntary conversion under Sec. 1033(e)(1) and is solely on account of drought, flood, or other weather-related conditions that result in the area being designated as eligible for assistance by the federal government, Sec. 1033(e)(2)(A) provides that the replacement period ends four years after the close of the first taxable year in which any part of the gain from the conversion is realized. Section 1033(e)(2)(B) provides that the IRS may extend this replacement period on a regional basis for such additional time as it determines appropriate if the weather-related conditions that resulted in the area being designated as eligible for assistance by the federal government continue for more than three years. Section 1033(e)(2) is effective for any taxable year with respect to which the due date (without regard to extensions) for a taxpayer's return is after December 31, 2002.

Notice 2006-82 provides for extensions of the replacement period under Sec. 1033(e)(2)(B). If a sale or exchange of livestock is treated as an involuntary conversion on account of drought and the taxpayer's replacement period is determined under Sec. 1033(e)(2)(A), the replacement period will be extended until the end of the taxpayer's first taxable year ending after the first drought-free year for the applicable region. For this purpose, the first drought-free year for the applicable region is the first 12-month period that (1) ends August 31; (2) ends in or after the last year of the taxpayer's 4-year replacement period determined under Sec. 1033(e)(2)(A); and (3) does not include any weekly period for which exceptional, extreme, or severe drought is reported for any location in the applicable region. The applicable region is the county that experienced the drought conditions on account of which the livestock was sold or exchanged and all counties that are contiguous to that county.

A taxpayer may determine whether exceptional, extreme, or severe drought is reported for any location in the applicable region by reference to U.S. Drought Monitor maps that are produced on a weekly basis by the National Drought Mitigation Center. U.S. Drought Monitor maps are archived at droughtmonitor.unl.edu/MapsAndData/MapArchive.aspx. In addition, Notice 2006-82 provides that the IRS will publish in September of each year a list of counties, districts, cities, parishes, or municipalities (hereinafter "counties") for which exceptional, extreme, or severe drought was reported during the preceding 12 months. Taxpayers may use this list instead of U.S. Drought Monitor maps to determine whether exceptional, extreme, or severe drought has been reported for any location in the applicable region.

The Appendix in Notice 2016-60 contains the list of counties for which exceptional, extreme, or severe drought was reported during the 12-month period ending August 31, 2016. Under Notice 2006-82, the 12-month period ending on August 31, 2016, is not a drought-free year for an applicable region that includes any county on this list. Accordingly, for a taxpayer who qualified for a four-year replacement period for livestock sold or exchanged on account of drought and whose replacement period is scheduled to expire at the end of 2016 (or, in the case of a fiscal year taxpayer, at the end of the taxable year that includes August 31, 2016), the replacement period will be extended under Sec. 1033(e)(2) and Notice 2006-82 if the applicable region includes any county on this list. This extension will continue until the end of the taxpayer's first taxable year ending after a drought-free year for the applicable region.

For the list of counties go to Notice 2016-60.

--Last Update 09/30/16