7911 / What costs of a breeding program must be capitalized? When may a deduction be taken for costs that are expensed?

In the case of most “tax shelters,” certain corporations engaged in farming, and partnerships with a corporation as a partner, those expenses incurred in connection with producing cattle or attributable to cattle acquired for resale must be capitalized or added to the cost of inventory.¹ Generally, including these costs in inventory or capitalizing these costs prevents a current expense deduction and also has the effect of reducing income or gain from the sale of the property. Therefore, taxpayers affected by these rules would generally not be able to expense the costs of breeding or raising cattle.

Exceptions to certain of the uniform capitalization rules are available to the following entities that are engaged in farming: (1) a sole proprietorship; (2) a partnership that is not a “tax shelter” and that does not have a non-exempt corporation as a partner; (3) an S Corporation engaged in farming that is not deemed to be a “tax shelter;” and (4) any corporation engaged in farming that is not deemed to be a “tax shelter” and that meets certain gross receipts tests. A corporation meets the gross receipts test if its average annual gross receipts for the three prior tax years do not exceed $25 million (indexed to $31 million in 2025 projected, $30 million in 2024, $29 million in 2023 and $27 million in 2022). For purposes of the gross receipts tests, all members of a controlled group of corporations are considered one corporation.² The exceptions available to these taxpayers are as follows:

(a)  Any animal produced by the taxpayer that had a preproductive life of two years or less where costs were incurred by the taxpayer before 1989.³ While “preproductive life” is not defined in the IRC, as described here, it appears to mean the period before which the animal was reasonably expected to be sold or disposed of.⁴

(b)  Any animal produced by the taxpayer without regard to the length of its preproductive life, where costs were incurred after 1988.⁵

A “tax shelter” is (1) any enterprise, other than a C corporation, if at any time interests in the enterprise have been offered for sale in an offering required to be registered with any federal or state securities agency, or (2) any farming enterprise other than a C corporation that allocates more than 35 percent of its losses during any period to investors who do not actively take part in the management of the operation, or (3) any enterprise a significant purpose of which is tax avoidance.⁶