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Federal Tax Consequences of Citrus Canker Payments

Published: January 5th, 2006

By: Christopher R. D’Amico Michael D. Minton

The U.S. Department of Agriculture (“USDA”) had established provisions under which eligible owners of commercial citrus groves could, subject to availability of funds, receive payments to recover lost production income and recover the costs of the loss of citrus trees as a result of the removal of commercial citrus trees to control the spread of citrus canker. The following article is the first in a three part series of articles which address the federal income tax consequences of the receipt by citrus growers of lost tree and lost production payments under differing scenarios. This article will address the federal income tax consequences of the receipt by a citrus grower of lost tree and lost production payments when the citrus grower intends to “cash out” and therefore, will not reinvest the payments into a replacement citrus grove or replacement property of any kind. The second and third articles in this series will address the tax consequences to a citrus grower who plans to reinvest the lost tree and production payments into replacement property, i.e. replacement citrus groves, other commercial agricultural businesses and/or investment real property. As most of our readers are aware, the USDA has suspended any future funding of the program to eradicate citrus canker in the State of Florida through the removal of trees. However, the USDA has publicly stated that it is committed to fully fund the eradication efforts initiated as of January 10, 2006 and therefore, this article and the proposed series of articles that will follow, should still be extremely useful to many affected citrus growers.

In the event that the taxpayer does not intend to reinvest any of the payments received into replacement citrus groves, any other commercial agricultural businesses or investment real property, then any amount of lost production or lost tree payments received by the taxpayer, would be subject to income tax. Generally, the amounts received for lost production payments will be treated as “ordinary income” subject to the graduated tax rates. Such amounts will, however, be eligible for income averaging under Section 1301 of the Internal Revenue Code of 1986, as amended. Under certain circumstances, it may be possible to argue that some of the lost production payments should not be recognized in income or are eligible for long-term capital gain treatment (similar to arguments that were successfully asserted in the line of cases and revenue rulings dealing with settlement proceeds received by nursery owners in connection with the application of the fungicide “Benlate”). These circumstances are very fact specific and should be discussed with competent tax advisor that is familiar with agricultural tax issues.

Any amounts received by the taxpayer for lost tree payments would be received in connection with the sale or exchange of property used in a trade or business, and the character of any gain or loss recognized by the taxpayer would be determined under Code Section 1231. Section 1231 provides if there is a gain realized in connection with the receipt of the lost tree payments (i.e. the amount of the lost tree payments received exceed the taxpayer’s adjusted basis in the trees destroyed) then, any such gain will be characterized as a long-term capital gain. In the event that the taxpayer realized a loss in connection with the receipt of the lost tree payments (i.e. the amount of the lost tree payments receives was less than the taxpayer’s adjusted basis in the tress destroyed) then, pursuant to Section 1231, the loss would be recognized as an ordinary loss. All gains and losses from the sale of all Section 1231 properties for each tax year are lumped together and therefore, whether an individual taxpayer will have a gain or loss under Section 1231 depends upon the total Section 1231 transactions in the tax year in question.

Notwithstanding the foregoing, Section 1245(a) provides that in the event that Section 1245 property (citrus trees are considered Section 1245 property) is disposed of, then the taxpayer will recognize ordinary income to the extent of the depreciation deductions were allowed with respect to such Section 1245 property. Therefore, despite Section 1231, Section 1245 may recharacterize a portion of the gain recognized upon the receipt of any lost tree payments as ordinary income.

In conclusion, in the event that a taxpayer receives lost tree and lost production payments and does not intend to reinvest those proceeds in any replacement property or take a more aggressive reporting position, then, the taxpayer will recognize the lost production payments as ordinary income, subject to income averaging under Section 1301, and will recognize the lost tree payments under Section 1231 (with gains taxed at long-term capital gains rates and losses recognized as ordinary losses), subject to depreciation recapture under Section 1245(a).

The authors are members of Dean Mead, a full-service law firm with offices in Orlando, Fort Pierce and Viera. The firm’s Citrus Canker Task Force assists citrus growers with the legal issues that result when canker is detected in their groves. For more information about Dean Mead and its Citrus Canker Task Force, please visit deanmead.deme.dev.