When property is involuntarily converted—also called involuntary exchanges—because of its destruction in whole or in part, theft, seizure, or condemnation to name a few reasons (essentially outside the control of the taxpayer), Internal Revenue Code (IRC) §1033 provides taxpayers the opportunity to not recognize the gain on the property if it’s replaced with similar property within a specified period.

In general, the replacement period is within two years after the year the property was involuntarily converted. IRC §1033(e) provides an extension of the replacement period in the case of livestock sold on account of drought, flood, or other weather-related conditions.


The sale or exchange of livestock that exceeds the number the taxpayer would normally sell during the year is treated the same as those involuntarily converted by the taxpayer. For example, if a farmer normally sells five livestock animals annually and as a result of a drought is forced to sell 12 animals, then the gain from the five sold animals is taxable in the current year and the gain from the other seven isn’t recognized until the end of the replacement period. IRC §1033(e)(1) holds livestock to include those animals held by the taxpayer for draft, breeding, or dairy purposes. (A draft animal is defined as one used to pull heavy carts, such as oxen, mules, and horses.) Livestock animals that don’t fall under this tax provision include those raised for slaughter, those held for sporting purposes, or poultry.

The gain from an involuntary conversion is the amount realized from the sale of the animal that exceeds the cost of replacing the animal during the replacement period. IRC §1033(e)(2)(A), however, extends the replacement period for involuntarily converted livestock from two years to four years, beginning with the start of the year following the conversion. That is, if a farmer sold off livestock in 2020, the replacement period begins in 2021 and runs through 2024. Under IRC §1033(e)(2)(B), the Secretary of the Treasury is permitted to extend the four-year replacement period on a regional basis if the weather-related conditions during the replacement period continue for more than three years.

Notice 2006-82, 2006-2 C.B. 529, provides for extensions of the replacement period under §1033(e)(2)(B). If a sale or exchange of livestock is treated as an involuntary conversion on account of drought and the taxpayer’s replacement period is determined under §1033(e)(2)(A), the replacement period will be extended under §1033(e)(2)(B) and Notice 2006-82 until the first taxable year for the taxpayer that ends after the first drought-free year for the applicable region. The first drought-free year for the applicable region is the first 12-month period that (1) ends August 31; (2) ends in or after the last year of the taxpayer’s four-year replacement period; and (3) doesn’t include any weekly period for which exceptional, extreme, or severe drought is reported for any location in the applicable region. The applicable region is the county that experienced the drought conditions that led to the livestock being sold or exchanged and all counties contiguous to that county.

A taxpayer may determine whether exceptional, extreme, or severe drought is reported for any location in the applicable region by referencing the U.S. Drought Monitor maps produced on a weekly basis by the National Drought Mitigation Center.

In September of each year, the Internal Revenue Service (IRS) publishes a list of counties for which exceptional, extreme, or severe drought was reported during the preceding 12 months. For 2020, the IRS issued Notice 2020-74, 2020-41 IRB on October 5, 2020, providing guidance on the replacement period under IRC §1033(e).


IRC §1033(f) provides yet another special provision for farmers who experience hardship resulting from drought, flood, other weather-related conditions, or soil contamination or other environmental contamination. Specifically, if a farmer can’t replace the sold livestock, he or she can use the proceeds to invest in other property (including real property in the case of soil contamination or other environmental contamination) and thereby treat it as replacement property.

Pursuant to Treas. Reg. §1.1033(e)-1, the sale or exchange of the livestock that wasn’t in the drought area could qualify as long as the sale or exchange was solely on account of drought conditions that affected the water, grazing, or other requirements of the livestock. In other words, the drought conditions indirectly affected the livestock and forced the sale or exchange.

The details reporting the disposition of the livestock must include the following information:

(1) Evidence of the existence of the drought conditions that forced the sale or exchange of the livestock, such as a copy of the IRS notice with the appendix to the notice listing the counties by state where the exceptional, extreme, or severe drought was reported during the 12-month period ending August 31, 2020;

(2) A computation of the amount of gain realized on the sale or exchange;

(3) The number and kind of livestock sold or exchanged; and

(4) The number of livestock of each kind that would have been sold or exchanged under the usual business practice in the absence of the drought.

It’s recommended that before a taxpayer decides to use this gain deferral from the involuntary conversion (sale) of livestock, some tax planning should be considered. For example, IRC §1033(a)(2)(C) states that the statutory period for the assessment of any deficiency, for any taxable year where part of this gain is realized, won’t expire before the three years the Secretary of the Treasury is notified by the taxpayer of the replacement of the converted property or of the intention not to replace. And if there is a tax deficiency, the IRS may assess the taxpayer for up to three years after this notification. In other words, the general three-year statute of limitations is extended. Thus, if a taxpayer doesn’t intend to replace the livestock when it’s sold, the gain shouldn’t be deferred but reported so that the tax return doesn’t have to be amended in the future.

© 2021 A.P. Curatola

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