Many people who own livestock farms are full-time professionals in non-farming fields--doctors, for instance. The IRS often enough will assess deficiencies against these individuals based on the idea that the activity is simply a means of generating tax write-offs.
The IRS might argue that, given your full-time day job, you don't have much time to manage the operations. According to numerous Tax Court cases, working on the farm only on weekends and holidays is not enough time to devote to a cattle or other livestock venture unless you have a qualified farm manager whom you supervise during your absence. Hiring a qualified farm manager is evidence that you are conducting your farm as a business, particularly if you personally only can devote a minimal amount of time to the activity.
In addition, according to recent Tax Court cases, one of the most important elements in withstanding IRS scrutiny is to have some type of plan--a business plan--in which you set forth in writing how and when you expect to make a profit from the venture.
It is important, as well, to maintain herd inventory records on each animal, including parentage, birth date, birth weight, and registration or other identification number. The growth of the size of your herd is evidence that you are engaged in a business rather than a hobby.
It is important to have a separate checking account for farm expenditures, and to maintain a ledger of transactions.
It is important to keep recreational elements to a minimum so as to not suggest that is your primary purpose. If you maintain horses on the farm that you ride for pleasure, it is important to not take tax deductions in connection with their costs.
In an important case involving Dr. George Burrus, a physician in Nashville, Tennessee, the IRS sought to deny his tax deductions partly because of elements of personal recreation that the IRS said was his predominant motive. Family members rode four or five horses on the property, and they held an annual dove hunt and barbecue for about 50 to 75 guests. Children and grandchildren visited the property many times, and would often canoe and fish on a pond located at the property.
However, Dr. Burrus convinced the Tax Court that his cattle farm was a business, not a hobby. He had no written business plan, nor income or budget projections. However, he actively marketed his livestock, attended trade shows and conventions, and appraisals showed that the farm property had significantly appreciated in value. The Tax Court said that recreational elements were insignificant in his case.
In other cases people have lost in Tax Court because they sought advice about operations in a haphazard manner. Unless you are an expert yourself, it is important to consult experts about how to make your farm profitable, preferably before starting the venture. You should keep records of your communications with experts or others whom you consult, and keep notes of the advice given as to the economics of the venture.
Another important piece of documentary evidence is a tax opinion letter, which is prepared by a tax attorney. It evaluates your overall operations and makes recommendations as to how best to comply with the IRS hobby loss rule.
Also, if losses are due to unforeseen circumstances, including disease or fluctuating livestock prices, you should maintain documentary evidence to prove these facts. There is a certain volatility to the livestock market, so that, as the IRS is aware, it is a dynamic industry with numerous variables. Each farm has its unique problems and strengths.
The IRS also wants to see evidence that you keep abreast of industry practices and that you investigate the possibility of changing or abandoning current methods of operation in an effort to mitigate losses.
The IRS is influenced largely by the magnitude of the losses claimed. If losses occur over an extended number of years without any changes in operations, the IRS will argue that this is not a business but a means of taking tax write-offs. If your cumulative losses are substantial, it is particularly important to have documentary evidence showing the business like manner in which the farm is operated.
It is important, in operating a livestock farm, to attend industry seminars to learn about breeding and about the economics of your particular field. For example, the National Cattlemen's Beef Association, holds national and regional meetings that provide the latest information about industry developments and animal husbandry practices.
Keep in mind that in many cases, taxpayers have convinced the Tax Court that their livestock farm is a business rather than a hobby despite over two decades of losses. In those cases the taxpayers had good evidence showing the business like manner in which they operate their venture. The livestock farmers who come through well in audits usually have a working knowledge about genetic principles and other elements of animal husbandry. They usually strive to raise high quality animals, and have a plan on how to market them or otherwise make a profit.
In any farming or livestock venture, it is important to comply with regulations of the Agricultural Department, and to obtain a commercial license if you are engaged in buying and selling animals.
Sometimes the IRS will inquire whether the taxpayer has obtained agricultural status to reduce the property taxes on their land. “Small numbers of cattle have been maintained on large parcels of land in order to qualify for this agricultural status. In such situations, the cattle activity was not engaged in for profit, but rather for the purpose of reducing property taxes.”
(John Alan Cohan is a lawyer who has served the livestock and farming industry since l98l. He serves clients in all 50 states, and can be reached by telephone at (3l0) 278-0203 or via e-mail at JohnAlanCohan@aol.com.)