Law of the West: Hobby farm or business?
by John Scorsine
The other day, I traveled down to Greeley and visited the Colorado Farm Show. It was a great time. I think the only thing that has changed since my youth is the size and price of my toys. My taste in equipment, buildings and fencing is much bigger than my wallet, so all I could do was drool. But, as I walked from exhibit to exhibit, I started to wonder. Surrounded by all those ranchers with hundreds of head of cattle, am I running a business, for profit, or are my 25 horses a hobby? I hold on to that fervent dream that it is a business. It’s important to me that I am commercially successful. It makes a big difference with another federal agency too: the Internal Revenue Service.
What is the difference between an agricultural hobby and being in business? From our standpoint it’s all about losses. If your ownership of livestock or cultivation of crops is a business, the losses will be deductible against other sources of income. If your operation is your hobby, well there is little tax benefit to be gained. The IRS tries to make this determination when it audits small agricultural enterprises.
The first test the IRS often applies to determine whether an operation is a hobby or a business is profitability. For most agricultural businesses, if you make a profit in any three of five years, the presumption is that you are engaged in a business for profit. In the case of horses, the standard is to make a profit in two of seven years. However, both of these are really just guidelines.
The IRS regulations look at nine factors in deciding the hobby or business question. They are:
1. How do you conduct your operations? Do you keep records and make plans like other businesses do? Do you constantly seek to increase profitability and abandon strategies that are losing you money?
2. What is your expertise or that of your advisors in the endeavor?
3. How much time do you put into the operation? The more substantial your investment in time and labor, the more likely you are operating a business.
4. Do you have a reasonable expectation that your assets will appreciate in value?
5. What is your past experience in business? Do you have a record of making unprofitable enterprises profitable?
6. What is the overall history of profit and loss in the operation?
7. The amount of profits that are earned is a consideration.
8. What is your overall financial status? Do you have substantial incomes from non-agricultural enterprises? The larger your non-farm income, the more the farm looks like a hobby to the IRS.
9. Is the motive for carrying on the business: personal pleasure or profit? The more that personal pleasure is the driving force, the more the farm looks like a hobby.
How do you know whether the IRS will consider your operation a business being conducted for a profit or a hobby? The safest route is to find an accountant well versed in farming and its unique tax implications. Work with this tax professional and ensure you are on the right course. I have an accountant and I do as he says. Also, the IRS has a great information source. The Farmer’s Tax Guide, Publication Number 225, should be in every farmer or rancher’s library. You can download a copy of this publication from their Web site at http://www.irs.gov. Just go to the Forms and Pubs link. It is available in four formats.
The information provided in this column is based upon general principles of law and should not be relied upon in any manner. It is not the intent of this column, its author, publisher or the Fence Post to provide legal advice to any person. You should address specific legal questions to your family lawyer. In Wyoming, the State Bar can refer you to competent lawyers in your community by calling (307) 634-7823. In Colorado, call the Metropolitan Lawyer Referral Service at (303) 831-8000. Readers in Nebraska can receive referrals from the State Bar Association by calling 1-800-742-3005.
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Colorado Gov. Jared Polis is expected to sign SB 21-87, known as the Farm Workers Bill of Rights, though much of the content will be decided through the rulemaking process.