Tax Tips

How Do I Avoid the Negative Impact of "Hobby Loss" Rules in My Elk Operation?

by Sue Whittlesey, CPA

   The "hobby loss" rules state that you lose the deductibility of your losses on your tax return when you do not produce a net profit with your farm or ranch in at least three out of five years. In determining whether you are carrying on your farming activity for profit, all the facts and circumstances are taken into account. No one factor alone is used in determining the deductibility of the losses. Among the factors to consider are whether:

1. You operate your farm in a businesslike manner.
2. The time and effort you spend on farming indicates you intend to make it profitable.
3. You depend on income from farming for your livelihood.
4. Your losses are due to circumstances beyond your control or are normal in the startup phase of farming.
5. You change your methods of operation in an attempt to improve profitability.
6. You make a profit from farming in some years and how much profit you make.
7. You, or your advisors, have the knowledge needed to carry on the farming activity as a successful business.
8. You made a profit in similar activities in the past.

   One tool I have found that has helped numerous alternative livestock breeders defend themselves against the loss of the deductibility of their farm losses is a "business plan." Basically, you need to have in writing what your plan is for your operation. For example, you start out in year one building your fence and facilities and purchasing five heifer calves. It is probably going to be at least two years before you have any calves to sell and maybe you only want to sell the bull calves and retain the heifers until your herd reaches 20 females. At that point, you will be selling enough animals to generate a net profit. In my opinion, that would be a satisfactory and reasonable plan. Of course, your plan needs to be more detailed than this. I highly recommend that you sit down with your tax professional before you get in the business and do this "business plan." Keep a copy of the plan with your tax return. Many breeders update their plans every year or two; that makes having the plan an even stronger defense against the "hobby loss" rules, plus it helps you keep on top of your operation.

   The IRS also recommends that people who are just starting out in farming and do not have three years showing a profit, can choose to file Form 5213. The IRS says the filing of this form postpones any determination that your farming activity is not carried on for profit until five years have passed since you began farming. Form 5213 generally must be filed within three years after the due date of your return of the year you first start farming. If you received a notice from a District Director proposing to disallow your farm loss, the IRS recommends that you file this form within 60 days after receiving the notice. As always, please discuss this with your tax professional before filing form 5213. This is a relatively new form which I personally have never filed, nor do I know if it makes you more or less vulnerable for audit.

Sue Whittlesey retired from her CPA practice almost five years ago to become a full-time elk and bison rancher. She and her husband, Dave, moved their entire operation, Hire Wire Ranch, this year from Steamboat Springs, Colorado, to Hotchkiss, Colorado (near Grand Junction).