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Sale of Breeding Stock Qualify for Section 199A (But May Get No Deduction)

Published on: 21:21PM Mar 27, 2018

Many livestock operations sell culled breeding stock that has been held for more than two years.  If this breeding stock has been raised from birth, all of the sales price will qualify for capital gains treatment under Section 1231.  If the farmer has no net Section 1231 losses over the last five years, all of the gain will be taxed at favorable capital gains treatment.

The new tax law allows for these gains to qualify for the new Section 199A 20% of net farm income deduction. Although the gains qualify for the Section 199A deduction it will then be limited to 20% of taxable income minus capital gains (including the Section 1231 gains from selling the culled breeding stock).  Therefore, even if you get a deduction it may not give you any value.  Here is an example:

Farmer Alan (married farmer) operates a cow calf operation.  During 2018, he sells off $200,000 of raised breeding stock held more than 2 years.  His net income from the farm operation is zero and he nets $200,000 of taxable income.  He is entitled to a $40,000 Section 199A deduction on the sale of the raised breeding stock ($200,000 times 20%), however, it is limited to 20% of taxable income ($200,000) minus capital gains ($200,000) or zero.  Therefore, even though he nets a $40,000 deduction based on Section 1231 gains, he is not entitled to deduct any of the Section 199A deduction.  Now let's assume he has $300,000 of taxable income.  In this case, he would qualify for a $20,000 deduction.

Now let's change Alan to being a dairy farmer.  In this case, he receives from his cooperative a $200,000 Section 199A "DPAD" deduction.  If his taxable income remains simply the Section 1231 gains from selling raised breeding stock, he is allowed to offset 100% of the DPAD against his Section 1231 gains.  In this case, his taxable income would drop to zero. 

Typically the dairy farmer would receive a DPAD and the cow-calf operator would not.  Even though their taxable income before any Section 199A deduction is exactly the same, the dairy farmer will likely be much better off (assuming he sells to a cooperative).  The primary reason neither is allowed to offset the Section 199A deduction against Section 1231 gains is that Section 199A was strictly to allow non-corporate taxpayers to pay tax at a rate similar to corporations on business income.  If it is being taxed at capital gains rates, it is already lower than the corporate rate.