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DTN Tax Columnist Andy Biebl is a CPA and principal with the accounting firm of CliftonLarsonAllen LLP in New Ulm and Minneapolis, Minn., and a national authority on agricultural taxation. He'll address detailed tax strategies for farm retirement at an Ag Summit workshop in Chicago Dec. 7 www.DTNAgSummit.com. To pose questions for upcoming columns, email AskAndy@dtn.com.
We are projecting our tax liability for 2014, and are told we can only deduct $3,000 of our regulated futures contract losses, which are substantial. We do not speculate and in the past have benefitted from treating 60% of our gains as long-term and 40% as short-term or ordinary. This year we would like to deduct our large futures contract losses against our cattle income. At year-end, our contracts are marked-to-market. Can we deduct our losses against our cattle income, or are we required to carry the losses back three years and then forward?
The fact that this futures account has been reported as 60% long-term gain and 40% short-term gain in the past, and also marked-to-market at year-end (i.e. valued as if liquidated each Dec. 31) tells me that this account is in speculation status for tax purposes. These are called Section 1256 contracts. While these contracts produce very favorable treatment on the gain side, losses are capital losses. Capital losses only offset capital gains; up to $3,000 of excess capital losses are permitted to be used annually against ordinary income. The normal rules for capital losses do not allow for a capital loss carryback. However, Section 1256 contracts are not normal! You are allowed to carryback capital losses from Section 1256 contracts to offset Section 1256 gains reported within the last three years.
You indicate in your question that you do not speculate, but that may not be accurate tax terminology. The tax law characterizes regulated futures accounts as either hedging or speculation. Hedging is defined as a contract that provides price protection for your physical position in your cattle business. The contract needs to be opposite of your actual or anticipated inventory position. For example, if you'll be buying feeder cattle at some point down the road, you might lock the price by going long on the board today, but then lifting that position when you actually purchase the cattle. On the other hand, during the period of holding feeder cattle before they are ready for market, you might sell short on the board to lock a price, and of course offset that position when the cattle are sold.
In summary, hedging status requires a linking of the futures contract with your physical position in a price protection manner. All other futures contracts default into speculative status in the tax law, and receive the capital gain/capital loss treatment described earlier.
One ray of hope: Perhaps some of your contracts are true hedging contracts, and could be separated and given ordinary income or loss status. Normally, the IRS prefers to see hedging and speculative contracts separated into different accounts, so as to better segregate and document your activity. But that is not an absolute condition of the tax regulations; notations on trade confirmations can suffice.