When most ranchers talk about avoiding taxes, it is usually in the context of making bad decisions at the end of the year to avoid paying taxes. While we don’t want to avoid taxes, we want to pay the lowest rate possible. Effective tax strategies are often built on top of successful businesses that generate wealth in ways that lower tax rates.
As stewards of the resources we manage, it is our responsibility to make sure we get to keep as much of the returns from those assets as possible. That includes eliminating excessive expenses which include taxes.
There three primary ways to produce taxable income in the United States: wages, dividends/interest, and gains realized when selling assets. Interestingly, these sources of income are not taxed at the same rate. Ordinary income, for example, is subject to both federal employment taxes (15.3%) AND income tax (10-37%) plus state and local taxes. Long-term capital gains, on the other hand, are currently taxed from 0-20% depending on your income and there is no self-employment tax.
I think it is reasonable to assume that increased tax rates in all forms are in our future in the US. But while the numbers may change, over time, our tax system has been consistently designed to reward long-term investment. So, it is reasonable to expect that long-term capital gains will often be a better place to pay our taxes. Within this context, it is reasonable to ask how we can create a ranch strategy that creates more income through capital gains.
For cow-calf producers, there are a few options. You could retain ownership on calves or direct market beef. Raising a calf from birth to slaughter takes a long time, and transfers much of our income to capital gains. While either of these strategies may work, they can be hard on cash-flow, bring additional risk into our business, and ultimately profitability suffers.
On the other hand, Wally Olson’s Livestock Marketing School https://www.ranching.fyi/marketing-schools teaches a system of managing a cow-herd that maintains or increases cash flow while shifting much of the income to capital gains. In a nutshell, Wally recommends selling every cow before she reaches the end of her peak value at around six-years old (don’t worry about older cows, they’ve already lost value). That means you will need more replacements to keep your herd size the same. To get there, you might retain and expose all your heifers, selling the opens as yearling feeder heifers and keeping the pregnant ones as replacements. Each year, you’ll have a crop of steers to sell, and a slice of your bred cows. In his system that is designed to minimize cow depreciation, the sale of steer calves is taxed at ordinary income rates, while the sale of open heifers and peak-of-their-value bred cows could be taxed at capital gains rates (with certain conditions).
While there are people that have trouble accepting the idea of cows without depreciation, it is hard to argue the tax consequences of his strategy. And as someone who prioritizes cash flow, the opportunity to get there while decreasing tax liability is very appealing.
In his school, Wally shows examples where this an option that increases pre-tax profit for a cow-calf operation. In one example he shows a 6% increase on the balance sheet while creating a 44% increase in sales. In my mind, the contrast is even more striking when looking at after tax profit. See more details at https://www.farmprogress.com/cow-calf/improved-cow-marketing-boosts-net-worth-and-income .
Don’t manage your ranch to avoid taxes. Manage the ranch to create cash flow and wealth. Sure, you’ll pay some taxes, but you and your heirs will have a lot more money in the end.