State & Local Tax Blog

You Own a Farm/Ranch and Want to Deduct the Losses?

The question of “hobby-losses” come up frequently in income tax. So this issue is always an interesting one to watch. In this case, a couple in Alabama won their case at the administrative level against the AL DoR. Even though both of them had full-time jobs off the farm, they were able to show they were operating it for a profit. Here is the analysis performed by the ALJ considered in ruling for the taxpayer:

“The general test for whether a taxpayer is engaged in a “trade or business,” and thus entitled to deduct all ordinary and necessary business expenses, is “whether the taxpayer’s primary purpose and intention in engaging in the activity is to make a profit.” State of Alabama v. Dawson, 504 So.2d 312, 313 (Ala. Civ. App. 1987), quoting Zell v. Commissioner of Revenue, 763 F.2d 1139, 1142 (10th Cir. 1985). To be deductible, the activity must be engaged in “with a good faith expectation of making a profit.” Zell, 763 F.2d at 1142. As stated by the U.S. Supreme Court – “We accept the fact that to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement diversion does not qualify.” Commissioner v. Groetzinger, 107 S.Ct. 980, 987 (1987). But a taxpayer’s expectation of a profit need not be reasonable. Rather, the taxpayer must only have a good faith expectation of realizing an eventual profit. Allen v. Commissioner, 72 T.C. 28, 33 (1979). Whether the taxpayer had an intent to make a profit must be determined on a case-by-case basis from all the circumstances. Patterson v. U.S., 459 F.2d 487 (1972).”

Treas. Reg. §1.183-2 specifies nine factors that should be considered in determining if an activity was entered into for profit.
Factor (1). The manner in which the taxpayer conducted the activity.
Factor (2). The expertise of the taxpayer in carrying on the activity.
Factor (3). The time and effort exerted by the taxpayer in conducting the activity.
Factor (4). The expectation that the assets used in the activity will appreciate.
Factor (5). The taxpayer’s success in similar or related activities.
Factors (6) and (7). The taxpayer’s history of profits and losses, and the amounts of any occasional profits.
Factor (8). The taxpayer’s financial status.
Factor (9). The activity was for the taxpayer’s personal pleasure and recreation.

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