As a farm owner, there are a few things you might want to consider during tax time.
Several years ago, I had a client began breeding horses for the purpose of sale at a profit. The IRS audited his tax return and declared his horse farm to be a “hobby” rather than a business and disallowed his farm loss deductions. The IRS argued that my client, being a wealthy lawyer, was not engaged in the horse farm business as it was not his primary occupation, and that he was merely a “gentleman farmer” engaging in a “hobby” that gave him great personal pleasure. The greatest evidence that it was a hobby, said the auditor, was the fact that it had not turned a profit in recent years.
We took strong issue with the government’s position and appealed the auditor’s decision. My client is a lawyer who makes his home on his horse farm in Georgia and does indeed earn his living as a lawyer. My client employs hired help at the stables and regularly consults with veterinarians. My client also maintained books and records of the horse operation. There is a separate checking account for the horse operation.
We successfully argued that, in the matter of losses deducted on the federal income tax returns pertaining to the operation of a horse farm, he was in compliance with statutory law and case law.
In Farish v. Commissioner of Internal Revenue, the court held that the determination of whether a breeding stable is a business or a hobby is the intention to derive income therefrom and the expectation of a profit. The court said that the intention of the taxpayer at the outset is the dominant factor in determining whether he engaged in the venture for profit or merely for pleasure. The court ruled in favor of the taxpayer and allowed the loss deduction. With regard to years of continuous losses, the court allowed that “One who plants a fruit orchard must wait a number of years before the trees produce fruit in sufficient quantities to show profit, but the expense of cultivation goes on every year before that.”
While the profit motive continues, it is immaterial whether the expectation of profit is reasonable so long as it is bona fide.
The tax court held, in Morken v. Commissioner of Internal Revenue, “A taxpayer engages in the breeding of horses in a businesslike manner if he researches and plans horse purchases, advertises, consults trainers or breeders, and becomes knowledgeable about the horse raising and breeding industry and its profitability.”
Although my client showed losses for six out of seven of the total years of operation, the government could not automatically presume that he was not engaged in business for profit.
If you have a farm, whether it be a horse farm or some other type of active farm, and have not been taking deductions on your income tax return, it might be wise to review your position. You need not be a full-time farmer. If you have been taking the deductions, you might want to to tailor your activity to meet the criteria laid out by the courts as cited in this article.