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Tax Court: No Tax Losses Back at the Ranch

Apr 25th 2018
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The IRS often contests loss deductions for “gentleman farmers” and taxpayers with similar operations and in a new Tax Court case involving cattle ranching, you must demonstrate a profit motive to write off losses.

The reason? If you’re only dabbling in an activity, rather than running an actual business, deductions may be disallowed under the “hobby loss” rules.

As evidenced in Williams, TC Memo 2018-48, 4/9/18, if an activity is a legitimate business, you may be able to deduct an annual loss and use it to offset other highly-taxed income, like wages from another job. Conversely, if the activity is treated as a hobby, you can only deduct expenses up to the amount of income from the hobby. In other words, you can’t claim a loss.

As you may imagine, this issue is often hotly contested between the IRS and taxpayers. When neither side gives in, the matter ends up in the courts. Although each case is decided on its own merits, the applicable regulations spell out nine factors to be considered:    

  • How the taxpayer carries on the activity
  • The taxpayer’s expertise
  • The time and effort expended by the taxpayer in carrying out the activity
  • Any expectation that assets used in the activity (e.g., land) may appreciate in value
  • The taxpayer’s success in other activities
  • The taxpayer’s history of income or losses from the activity
  • The relative amounts of the profits and losses
  • The taxpayer’s financial status
  • Whether the activity provides recreation or involves personal motives

No one factor is more influential than another. But when a clear majority favors the IRS, the Tax Court will disallow the loss deduction.

In the new case the taxpayer, a former chiropractor with various other business interests, purchased several adjoining tracts of land in Texas in the early 2000s. Then he initiated a plan to raise cattle on the ranch.

At no time, however, did he create formal business plan, prepare any financial statements for the cattle operation, consult with any experts in the field of raising cattle or check with the local authorities about raising cattle. He estimated that he spent about eight hours a week on the cattle operation and the bulk of his time on this other business ventures.

During the 16 tax years in question – including two years for which records were missing – the taxpayer generated about $72,000 in gross receipts from cattle ranching while sustaining a staggering total loss of $1.7 million. The Tax Court examined the nine factors in the regulation used to determine whether an activity constitute a business or a hobby.

In doing so, the Court noted that the taxpayer didn’t keep records needed to make informed business decisions, didn’t consult industry experts or local officials about cattle breeding, devoted precious little time to the activity and generally didn’t function in a business-like manner. Despite his success in other fields, his expertise didn’t translate to cattle raising. Of the nine factors, the Tax Court determined that seven favored the IRS, one was neutral and only factor favored the taxpayer.

This one was an easy call for the Tax Court. The losses were denied.