Tax Shelters in Agriculture: An Example for Beef Breeding Herds

Abstract

ANY high-income investors deduct substantial farming losses from their nonfarm incomes. Farmers have expressed concern over competing with operations which do not need to show an operating profit. Their concern has been registered by Senator Metcalf (D-Montana), who has introduced a bill in the U.S. Senate to limit the use of farming losses to reduce taxes on nonfarm income [6, p. 37]. What are the tax advantages of incurring operating losses from a farm investment? This paper will analyze the after-tax returns for a tax-sheltered investment in beef breeding cattle. It will show how investors in high-income tax brackets profit while incurring apparent large cash losses from their investment. It will also demonstrate that taxpayers in the highest marginal tax brackets have the greatest incentive to locate investments, such as breeding cattle, which offer some tax shelter. An essential feature of a tax-sheltered investment is the opportunity to realize capital appreciation. This appreciation may be the result of generally rising values or it may be due to property improvements which can be deducted from taxable income as an ordinary expense.' Beef breeding cattle fall in the latter category. Livestock held for breeding purposes for more than 12 months are considered capital assets and any gain is taxed at a maximum rate of 25 percent. Costs of raising breeding cattle are a deductible expense and purchased breeding stock are depreciable property. Table 1 presents a model budget for an investment in 100 beef breeding cows for a six-year period. A management company purchases bred cows for an investor, places them on a ranch under a maintenance contract, and manages the investment for a fee of 8.5 percent of gross cash expenditures.2 The investor makes a down payment of 10 percent on the cows. He must prepay interest on the cattle mortgage and also prepay the