Illinois AgriNews - July 2009
 
IRS Examines Hedging Loss
Gary J. Hoff
Department of Agricultural and Consumer Economics
University of Illinois
While the rules for deducting hedging losses have not changed, farmers who hedge their grain can expect to have their records closely scrutinized. The Grain Farmer Audit Technique Guide devotes seven pages to examining hedging transactions. As the IRS is currently hiring an additional 1,700 auditors, farmers selected for audit should expect the Revenue Agent to have studied this guide.
If a hedging transaction results in a loss, the loss is entered on Form 1040 Schedule F and reduces both taxable income and self-employment income. However, if the loss is from a speculative transaction, the loss is a capital loss, entered on Form 1040 Schedule D and limited to the amount of any capital gains plus $3,000. Hence, a farmer with a $100,000 reclassified hedge loss could be limited to recovering the loss over the next 33 years.
For a grain farmer to incur a hedge loss, the loss must be from a transaction in which the farmer could deliver grain to fulfill the contract. For example, if the loss is created by a 50,000-bushel corn contract, the farmer must have at least 50,000 bushels of corn production. If the farmer sells all of his corn production but does not “lift” the hedge contract, the contract is considered a speculative contract.
Farmers who “store on the board” are speculators in the eyes of the IRS. For example, Joe Farmer does not have adequate grain storage on the farm, delivers and sells 30,000 bushels of corn at harvest. However, Joe believes the price will increase during the next few months and consequently buys a 30,000-bushel corn contract on the board. This is a speculative contract, as Joe does not have the ability to deliver on the contract.
Another example of a speculative transaction is where a farmer only produces corn in 2009 but believes the weather conditions will cause soybean prices to skyrocket. Therefore, he purchases a soybean contract in order to profit from the anticipated rise. Unfortunately, soybean prices tumble and he loses money on the contract.
To qualify as a hedge, the farmer must have records justifying the transaction. The transaction must be clearly identified in his books and records before the close of the day on which the hedge is entered and the hedged commodity must be identified within 35 days. The identification must be retained as a part of the books and records and indicate the record is made for tax purposes to comply with Treasury Regulation section 1.1221-2(f)(4). Finally, the identification must be unambiguous. Identification for financial accounting or regulatory purposes does not meet this requirement. This probably requires a separate log of the hedging transactions. Failure to have these records will result in the IRS reclassifying a loss transaction as a capital loss.
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