7908 / How are expenses incurred in connection with a cattle program treated if they are not required to be capitalized?

The accrual method of accounting precludes current deductions for amounts not yet economically incurred (i.e., it eliminates the overstating of present expenses). Thus, in the case of farming entities required to use the accrual method, the formerly common practice of accelerating deductions into the program’s first taxable year is eliminated. This is accomplished by requiring that deductions may not be taken until (1) all events have occurred that establish that the expense has been incurred, and (2) the amount of the liability can be established with reasonable accuracy. No amount is considered to be “incurred” until “economic performance” occurs. For example, if a limited partnership that is treated as a “tax shelter” is obligated to pay for services or property, economic performance takes place as the services or property are provided. Similarly, if the limited partnership is required to pay for use of property, economic performance occurs as the limited partnership uses the property.³

Generally, a deduction by accrual basis taxpayers is allowed for certain “recurring items” in the tax year prior to the occurrence of economic performance if the amount and existence of the obligation have been established in the prior year, and economic performance occurs within the shorter of a reasonable period or 8½ months after the close of the taxable year.⁴ However, “tax shelters” generally may not use this exception to the economic performance rule.⁵

A special rule applies to the deduction of expenses for feed and similar supplies by “tax shelters,” corporations, and partnerships required to use the accrual method. A deduction for the taxable year is limited to amounts of feed or supplies actually used or consumed during the taxable year (unless they are on hand at the end of the taxable year because of fire, storm, other casualty, or disease or drought).⁶ In the case of cattle feeding programs, feed is a major item of expense.

In the case of taxpayers who are permitted to use the cash method, deductions for feed and supplies are also limited if the taxpayers are not primarily engaged in farming and they have unconsumed farm supplies at the end of the tax year in excess of 50 percent of the deductible farming expenses for that year (other than the unconsumed farm supplies). The amount of unconsumed expenses in excess of 50 percent of deductible farm expenses (other than the unconsumed farm supplies) may not be taken until the taxable year the feed or supplies are used or consumed.⁷

Investors who do not materially participate in the management of a cattle feeding program may also have the deductibility of expenses limited by the effect of the “passive loss” rules (see Q 8010).