Transferring Breeding Livestock
Breeding livestock is an important component of the business ownership transfer process (Information File Transferring Business Ownership) from the older party to the younger party. The methods used to transfer machinery (Information File Transferring Ownership of Farm Machinery) also can be used for breeding livestock. The tax and financial consequences are similar, but the need for replacement animals requires special considerations.
Proceeds from the sale of purchased breeding animals may give rise to capital gains, recaptured depreciation, or capital losses, depending on the relationships among the original purchase price, the adjusted tax basis, and the selling price.
Breeding livestock raised by the seller (older party) has a zero tax basis, so that all the income from its sale (minus selling costs) is taxed as capital gain and is not subject to self-employment tax. To qualify as breeding stock, livestock must have been held for breeding or dairy purposes for at least 24 months for cattle and horses and for at least 12 months for other species. Breeding livestock falls into the 5-year property class under MACRS tax depreciation guidelines.
An outright sale of all the livestock is the simplest procedure, but requires the most capital and triggers tax consequences immediately (Example 1). If a joint farming arrangement or a livestock share lease is used, however, the younger party may want to purchase only a partial interest in the herd.
If an installment sale is used (Example 2), installments should be based on the value of the animals at the time of sale and should not be affected by subsequent changes in the size or value of the herd. If taxes are filed on the accrual accounting basis and breeding livestock is included in opening and closing inventories (rather than depreciated), all capital gain must be reported in the year of sale. Under cash accounting, the installment sale of breeding stock is subject to the same related party rules discussed under transferring machinery (Information File Transferring Machinery).
Under a gradual sale, a portion of the breeding livestock is sold each year. The rate of transfer can be arranged to coincide with the normal culling cycle of the breeding animals, as shown in Example 3. When a mature animal is sold, the younger party supplies the replacements by buying them from an outside source, selecting them from her/his share of the offspring, or purchasing them from the older party's herd. The older party keeps the income from the cull animals that are sold. For tax purposes, income is reported for each animal in the tax year that it is sold.
If the two parties farm together and income is divided according to the relative contribution of assets, the division of income should be recalculated each year as ownership of the breeding herd changes.
A gradual sale is probably not appropriate where a standard 50/50 livestock share lease is being used. In this case the younger party would want to acquire ownership of half the breeding livestock immediately.
If the younger party has limited capital, leasing part or all of the breeding livestock for a period of time may be preferable to purchasing them. Lease payments should be large enough to provide the owner (older party) a competitive return on investment and pay for insurance, death loss, and other ownership costs. For enterprises with frequent sales, such as dairy or farrowing pigs, payments can be set up on a monthly schedule to match the sale periods. Lease payments may have to be adjusted according to the number of female animals in the herd each month, if this number fluctuates significantly.
There are several ways the replacement of culled breeding animals can be handled when the herd is leased.
(1) The owner (older party) provides replacements from an outside source and receives all the income from selling cull animals (Example 4).
(2) Replacements are selected from the offspring of the herd. The owner (older party) either pays the tenant (younger party) for the replacements or credits their value against the rent due.
(3) The tenant (younger party) provides replacements from the offspring and gradually acquires ownership of the herd (Example 5). The tenant (younger party) pays rent on the remaining cows owned by the owner. Careful records should be kept of which animals are owned by each party.
The lease can continue indefinitely or a buy‑out can be arranged after a period of time has passed, or the younger party buys the herd gradually and leases the remainder. The lease payments decreases each year as ownership of the herd is transferred to the younger party.
Breeding livestock also can be gifted, either gradually or all at once. The same tax treatment as for gifting machinery applies. Gifting also can be combined with a sale, gradual sale or leasing agreement.
In situations where the younger party has little or no money to invest, he/she may receive a percent of the offspring in exchange for labor. The appropriate percent depends on the species of livestock, the costs involved and the type of facilities used (see Information File Livestock Enterprise Budgets for Iowa). In general, the share of offspring received each year should be equal to the percent of total production costs represented by the younger party's labor.
, retired extension value added agriculture specialist, extension economist, 515-294-6161, firstname.lastname@example.org