Know when to fold ‘em — Tips for when and how to react to drought in the cattle business
June 13, 2017
Producers impacted by low calf prices in 2016 are taking another financial hit in 2017 as developing drought conditions settle in across the Dakotas.
If prayers for rain go unanswered, it will continue to force producers' hands with more cows heading to the sale barn across the region.
Of course, selling cow-calf pairs now likely means producers wind up with a smaller calf check come fall. A secondary hit on the balance sheet will come next year as producers reduce their herd numbers and ultimately reduce their income for the upcoming calf crop.
Then, there are the tax implications. How should producers handle the sale of these pairs?
“We’ve seen a few more pairs than normal selling, but we haven’t seen a huge influx of cows being sold yet. We haven’t seen a panic yet, but there’s a lot of guys worrying about a drought right now.”JR Scott, manager at Herreid Livestock Auction
"As of now, South Dakota hasn't been declared in a state of drought by the USDA or President Trump; however, it may be a possibility that we could be in a drought disaster this summer," said Sheila Jackson, an income partner and tax services manager for Casey Peterson & Associates, LTD located in Rapid City, S.D. "If that's the case, there are a couple of options to defer income either through Section 451 or 1033. When selling pairs, we have to split the income between calves and cows, so we can allocate based on the value of the calf based on the time of the sale, not what it would have been worth when you normally would sell calves."
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If the state isn't declared in a state of drought, she says Section 171 can help offset some of the tax implications of selling cow-calf pairs.
"We average the farm income over the last three years and typically try to get it down into the 15 percent tax bracket, so the income is more level. It helps with the peaks and valleys of the balance sheet, and we can typically bring the taxes down that way."
Another consideration is capital gains.
"If the cows sold were raised by the rancher, there is a capital gain rate, which is lower," said Jackson. "Any calves that are sold are subject to the ordinary rate on self-employment income, which is 15.3 percent."
To explain capital gains, Jackson uses the example of a cow purchased at $1,200.
"Let's say you bought a cow for $1,200 and you take an accelerated depreciation up to $900," she said. "In this example, you sold the cows for $1,100. There's $300 in cost basis to take against the $1,100, so $800 would be subject to the ordinary tax rate."
She added, "Now if the cow was sold for $1,500, there would be a taxable gain of $1,200 ($1,500 minus $300 cost basis) with $900 of the gain subject to depreciation recapture at the ordinary tax rate, and then the difference of $300 ($1,200 gain minus $900 depreciation) would be subject to the capital gain rate."
Many producers may hang in the balance between the 50 percent and 25 percent tax brackets, and Jackson suggests ranchers contact their tax professional at the end of the year to get their estimated tax liability figured out.
"We have many ranchers who come in between October and December to do some tax planning and see where they are at," she said. "This helps them to know if they need to invest in a truck or tractor or other supplies before the end of the year in order to reduce their tax liability."
The U.S. Drought Monitor reports that 87 percent of North Dakota is categorized in a state of moderate drought, while portions of central and southern North Dakota are in a severe drought.
Meanwhile, in South Dakota, half of the state is feeling the heat with dry and windy conditions escalating the problem.
Ryan Vig, a Limousin breeder and cow-calf producer from Opal, S.D., tried to get ahead of the onslaught of cows being sold this summer.
"We started the year overstocked, and our cows were bred up pretty good last fall," said Vig. "Our numbers were up quite a bit, so we decided to sell some bred cows this spring."
In late March, Vig sold a few pot loads of bred females to ranchers in eastern South Dakota and North Dakota, and last week, he marketed a load of broken mouth cows and poor-doing younger cows at Faith Livestock.
"We got along pretty well last week; the 12-14 year old cows brought just shy of $1,400 and the younger cows brought $1,875," he said. "We knew we had more cows than grass, so we thought it would be a good idea to trim the poorer cows and market them now while there is still value before everyone starts hauling pairs to town."
Vig says he has plenty of grass now to get through the summer, but rounding up enough hay for winter could be an issue for many.
"We always keep carry-over hay from the year before," he said. "Last year, I put up some wheat with rye and averaged 4 ton per acre. I hauled 3,000 bales home and fed the wheat bales to save on my grass hay. Looking ahead to next winter, it's going to be tough to pencil out the rising price of hay with the trucking we'll have to pay to get it here."
However, despite the dry and windy conditions, Vig feels fortunate to have some grass to carry his herd through the summer. In a good year, he estimates he can run one pair per every 15 acres, which is conservative, but he says it helps get through the tough years, too.
"We've had about four inches of precipitation since the first of the year," said Vig. "We received some rain last night and just under an inch a week ago. It's amazing what a little rain can do to green things up. Some of the guys just down the road have only gotten an inch and a half or less so far in 2017. I know we could have it a lot worse."
Last week, South Dakota Governor Dennis Daugaard activated the state Drought Task Force to monitor drought conditions across the state, according to the Associated Press. With abnormally dry conditions, members of the task force will coordinate fire and water supply organizations as well as the exchange of drought information and other resources.
At Herreid Livestock Auction, it's been business as usual, but if it doesn't rain soon, that all could change.
"We've seen a few more pairs than normal selling, but we haven't seen a huge influx of cows being sold yet," said JR Scott, a field rep and manager at Herreid Livestock Auction in Herreid, S.D. "We haven't seen a panic yet, but there's a lot of guys worrying about a drought right now."
Herreid Livestock marketed 400-500 pairs last week, but Scott says they were mostly older culls and odds and ends.
"Producers aren't cutting into their herds too deep yet, but I would say by the first of July, if we haven't received some moisture, folks are going to be selling in a hurry," he said. "My advice to producers is to sell the culls now. Sort the ones with bad udders, poor dispositions or old age, and whittle your herd down to the most productive females."
Many producers are grazing wheat now, and Scott says many will try to bale what they can to stockpile some forages for later in the year.
"The best folks can do is to run their ranch as tight and sharp as they can and to utilize what grass the have with their best cows," said Scott. "Everything is pretty brown and shot already, and the wind doesn't help much either. Let's hope it rains soon."