Farm Clients

White Paper on Managing Federal and State Taxes for a Multi-Generational Feedlot

Background

Feedlot Client (“FC”) is a long-standing, family-owned agricultural enterprise engaged in the feeding and finishing of livestock. The operation has endured for over ninety years, with the past sixty conducted as an incorporated entity. Over time, FC has expanded into multiple lines of business, including livestock feeding, farming, and freight services, along with ancillary revenues derived from oil and gas interests.

Throughout its history, FC has navigated numerous economic downturns and cyclical challenges characteristic of the agricultural sector. Periodic downsizing has been necessary to preserve financial health. The year 2025 proved particularly difficult for the industry as a whole, compelling FC to undertake debt reduction measures. To improve liquidity, the company sold water rights originally acquired during the 1960s and 1990s.

While the sale generated substantial income, it also resulted in significant federal and state tax exposure. The purpose of this analysis was to evaluate available strategies to minimize the overall tax liability and preserve as much after-tax cash as possible.

Tax Management Strategies

Three primary avenues exist to mitigate tax burdens on extraordinary income events:

1. Exclusions

2. Deductions

3. Tax Credits

Each of these categories offers distinct advantages, depending on timing, structure, and the taxpayer’s financial position.

1. Exclusions

The first method involves excluding gains from taxable income. The most common approach for agricultural and real-property assets is the Section 1031 Like-Kind Exchange.

• 1031 Exchange (Deferred Gain Recognition):
  Under federal law, the sale of qualifying real property—including water rights—can be deferred if the proceeds are reinvested in other real property of like kind. This would have allowed FC to defer recognition of the gain for both federal and Colorado state tax purposes.
  However, FC’s immediate need for cash precluded reinvestment into new property, rendering this strategy impractical.

• Colorado Capital Gain Exclusion for Farm Property:
  Colorado offers a capital gain exclusion applicable to qualifying farm property. FC was able to take advantage of this provision, reducing the state tax burden by approximately 5% of the gain realized from the water rights sale.

2. Deductions

When exclusions are unavailable, deductions can serve as an effective alternative means of reducing taxable income. Several potential deduction strategies were analyzed:

• Conservation Easement Deduction:
  Federal tax law permits a deduction for the value of a qualified conservation easement, equal to the difference between a property’s development value and its restricted agricultural value.
  In Colorado, this is complemented by a state conservation easement tax credit, which equals 85% of the forgone development value and may be sold to other taxpayers.
  For example, if farmland valued at $1 million as agricultural property could otherwise be sold for $5 million for development, the owner could claim a $4 million federal deduction and potentially monetize a $3 million Colorado credit—while continuing to use the land for production.
  Although this approach was financially advantageous, FC could not pursue it due to the urgent liquidity needs of the operation and the time required for credit certification and sale.

• Monetized Installment Sale:
  Another alternative involved selling the property via installment sale, recognizing gain over time. Under this method, the seller receives payments in installments, deferring taxation until each payment is received. To accelerate liquidity, the installment note could be sold to a financial institution, effectively monetizing future payments.
  However, this structure requires cooperation from the buyer, which was unavailable in this case.

• Net Operating Loss (NOL) Utilization:
  FC carried forward a large NOL, which was applied up to the 80% limitation to offset taxable gains from the water rights sale. The remaining taxable portion was reduced further by the adjusted basis in the water rights.

• Year-End Expense Acceleration:
  As a cash-basis taxpayer, FC retained flexibility to accelerate deductible expenses. Strategies included:

  • Prepaying farm inputs such as seed and fertilizer.

  • Delaying issuance of December invoices to defer cash receipts into January.

  • Electing to defer crop insurance proceeds related to physical crop damage into the following tax year (note: this does not apply to price-related insurance coverage).

• Family Wages:
  FC also employed a common and legitimate family tax strategy: paying reasonable wages to owners’ children for bona fide work performed. These wages are subject to FICA, but the income is shielded from federal income tax up to the standard deduction (approximately $16,000 per child in 2025).

• Corporate Structuring Consideration:
  The possibility of contributing the water rights to a subsidiary corporation and then selling that subsidiary was explored. However, because the subsidiary would inherit the same basis in the assets, this approach offered no net tax savings.

3. Tax Credits

In addition to exclusions and deductions, tax credits directly reduce the tax liability dollar-for-dollar.

• Research and Development (R&D) Credit:
  Agricultural operations engaged in innovative feed formulations, animal care improvements, or crop testing may qualify for the R&D tax credit. Typically, 50% of eligible research costs qualify for a credit of approximately 16%.
  For instance, $50,000 in documented research expenses could generate a credit of about $4,000.

• Employee Benefit Credits:
  FC was also eligible for credits associated with providing employee health insurance and retirement benefits—further contributing to overall tax efficiency.

Conclusion

Managing taxation on extraordinary income events—such as the sale of long-held farm or water assets—requires a comprehensive and forward-looking strategy. Timing, liquidity needs, and intergenerational objectives all play crucial roles in determining the most effective course of action.

While FC’s immediate cash requirements limited the use of more sophisticated deferral or credit mechanisms, a well-planned approach in advance of a sale can yield substantial federal and state tax savings.
For multi-generational agricultural enterprises, maintaining proactive communication with tax advisors and legal counsel is essential to safeguard family wealth and ensure long-term operational continuity.

Key Takeaways

• Early planning is critical when anticipating large capital transactions.

• Section 1031 exchanges and conservation easements can offer substantial benefits—but require lead time.

• NOL utilization, expense timing, and family wage strategies can help manage near-term tax exposure.

• R&D and employee benefit credits remain underutilized opportunities for many agricultural operations.