Farm Accounting Methods
Most businesses use either the cash method or the accrual accounting method. Generally, if a business produces, purchases, or sells merchandise, it must keep an inventory and use the accrual method for sales and purchases. However, the accrual method for a business with inventory is not always required and it can use the cash accounting method, even if it has inventory. Most small farming businesses (average annual gross receipts of $26 million (2021) or less for the three prior tax years) can use the cash accounting method.
Inventory. Taxpayers that meet the $26 million (2021) gross receipts test are not required to account for inventories, but rather may use an accounting method for inventories that either:
- Treats inventories as non-incidental materials and supplies, or
- Conforms to the taxpayer’s financial accounting treatment of inventories.
Uniform capitalization (UNICAP) rules. Any producer or reseller that meets the $26 million (2021) gross receipts test is exempted from the application of the UNICAP rules.
Farming business. A farming business owned by a C corporation, and partnerships with a C corporation partner, are exempt from using the accrual method if the business meets the $26 million (2021) gross receipts test.
Farm Inventory
Farm inventory includes all items held for sale or for use as feed, seed, etc., whether purchased or raised, that are unsold at the end of the year. Farmers that use the accrual method for inventory should keep records that show the actual count or measurement of their inventory.
Items to include in inventory. Include all items held for sale, or for use as feed, seed, etc., whether raised or purchased, that are unsold at the end of the year.
Hatchery business. If you are in the hatchery business and use an accrual accounting method, include in inventory eggs in the process of incubation.
Products held for sale. All harvested and purchased farm products held for sale or for feed or seed, such as grain, hay, silage, concentrates, cotton, tobacco, etc., must be included in inventory.
Supplies. Supplies acquired for sale or that become a physical part of items held for sale must be included in inventory. Deduct the cost of supplies in the year used or consumed in operations. Do not include incidental supplies in inventory as these are deductible in the year of purchase.
Livestock. Livestock held primarily for sale must be included in inventory. Livestock held for draft, breeding, or dairy purposes can either be depreciated or included in inventory. If the farmer is in the business of breeding and raising chinchillas, mink, foxes, or other fur-bearing animals, these animals are livestock for inventory purposes.
Growing crops. Generally, growing crops are not required to be included in inventory. However, if the crop has a pre-productive period of more than two years, the farmer may have to capitalize under the uniform capitalization rules (or include in inventory) costs associated with the crop.
Inventory Valuation Methods
Farm inventory can be valued under methods available to other businesses (cost, lower of cost or market, etc.). Farmers also have two additional methods unique to farming. The method used must conform to generally accepted accounting principles for similar businesses and must clearly reflect income.
Farm-price method. Under this method, each item, whether raised or purchased, is valued at its market price less the direct cost of disposition. Market price is the current price at the nearest market in the quantities usually sold. The cost of disposition includes broker’s commissions, freight, hauling to market, and other marketing costs. If this method is used, it must be used for the entire inventory, except that livestock can be inventoried under the unit-livestock price method.
Unit-livestock-price method. This method recognizes the difficulty of establishing the exact costs of producing and raising each animal. Group or classify livestock according to type and age and use a standard unit price for each animal within a class or group. The unit price assigned should reasonably approximate the normal costs incurred in producing the animals in such classes. Unit prices and classifications are subject to approval by the IRS on examination of the tax return. Annually reevaluate the unit livestock prices and adjust the prices upward or downward to reflect increases or decreases in the costs of raising livestock. IRS approval is not required for these adjustments. Any other changes in unit prices or classifications do require IRS approval.
Include all raised livestock in inventory, regardless of whether they are held for sale or for draft, breeding, sport, or dairy purposes. This method accounts only for the increase in the cost of raising an animal to maturity. It does not provide for any decrease in the animal’s market value after it reaches maturity. Also, if the taxpayer raises cattle, do not include hay grown to feed the herd in inventory.
Do not include sold or lost animals in the year-end inventory. If records do not show which animals were sold or lost, treat the first animals acquired as sold or lost. The animals on hand at the end of the year are considered those most recently acquired.
Include in inventory all livestock purchased primarily for sale. You can choose either to include in inventory or depreciate livestock purchased for draft, breeding, sport or dairy purposes. However, the method used must be consistent from year to year. A change in method is not allowed without obtaining approval from the IRS.
Include in inventory animals purchased after maturity or capitalize them at their purchase price. If the animals are not mature at purchase, increase the cost at the end of each tax year according to the established unit price. However, in the year of purchase, do not increase the cost of any animal purchased during the last six months of the year.
Crop Accounting Method
If you do not harvest and dispose of your crop in the same tax year that it was planted, with IRS approval, you can elect to use the crop accounting method. IRS approval is needed even for the first tax return. Under this method, the entire cost of producing the crop is deducted; including the expense of seed or young plants, in the year income is realized from the crop.
