Ask the Taxman by Andy Biebl

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.

QUESTION:

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?

ANSWER:

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.

QUESTION:

I've aggressively sold some of my 2015 and 2016 corn and bean crop ahead through a hedging position. Of course, I don't want to recognize that built-in income until those particular crop years. I intend to keep rolling those hedges forward. But I am concerned about the 1099 form that comes at year-end that shows everything on a marked-to-market approach. Won't the IRS be looking to tax me on the 1099 amount, even though I am keeping the hedging position open?

ANSWER:

As your question implies, a hedging position is only reported for tax purposes when closed. On the other hand, speculative contracts must be valued (marked-to-market) at year-end and taxed even though open.

The 1099-B from the commodity brokerage firm has boxes that disclose both the hedging position and the speculative position as of year-end. If you are a hedger, Box 9 of the Form 1099-B contains the closed positions. If the taxpayer is a non-hedger who must use the speculative marked-to-market amount, that is found in Box 12. Reporting the hedging amount does not seem to be an issue that causes flare-ups with the IRS computers; they apparently can recognize when an active farmer is involved. So the fact that there are deferred or open hedging positions being rolled forward over year-end should not cause any tax issue with the IRS, as long as the account is properly a hedging account.

QUESTION:

Can ranch land be exchanged for REITs via a Section 1031 exchange? My older brother and I co-own a ranch together, and when he is gone I will be the sole owner. I am at quite a distance from the ranch, and am not interested in managing that property.

ANSWER:

The Section 1031 like-kind exchange rules required that a taxpayer surrendering an interest in real estate must take back a direct ownership interest in real estate. Unfortunately, a REIT, or real estate investment trust, is an intangible ownership interest, akin to a security or partnership interest. It is not considered like-kind to your ranch land.

But you do have other alternatives. First, recognize that the half ownership in that ranch land that you will inherit from your brother should come with a step-up in basis equal to its market value. If your brother owns this property until his death and passes it to you in a testamentary manner, the land will be valued in his estate and receive a new tax cost equal to market value. If you sell your entire ownership interest shortly thereafter, only your half will have capital gain; the other half should be tax-free (absent any small gain or loss from the difference in your sale price compared to the valuation in your brother's estate). As a result, selling may not produce the disastrous gain you might be expecting. A tax accountant could project the federal and state capital gain taxes that you might face.

Another alternative, assuming your half of the gain alone is too large, is to exchange into commercial property that can be professionally managed to produce retirement income. You will need a good real estate broker who can seek out quality commercial property. That property is often leased under arrangements in which the tenant covers the basic costs (utilities, insurance, etc.), with the property owner receiving a clean net rental check per month. You may also be able to continue to own the ranch land but lease it out to an operator who provides you with a rental income stream. There are professional farm managers who can provide oversight for a small fee and take care of some of the duties that your brother is presently assuming. You might also consider acquiring a fractional interest in property in a tenants-in-common (TIC) arrangement, whereby you own an undivided interest in the property under professional management. You should consult with a tax specialist in Section 1031 exchanges to ensure that all of the specific requirements are met.

(MZT/AG/CZ)

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