Is your farm your secondary business?
Often farmers will put off "real" bookkeeping until their farm is their main business or main source of income. (For the sake of this post, we'll ignore that it's very, VERY difficult for a farm to become a profitable business without sound bookkeeping practices.) However, it may be even MORE important to establish solid bookkeeping when farming is a secondary business.
According to the American Institute of Professional Bookkeepers (AIPB):
Two recent cases show how the IRS is successfully denying loss deductions for the secondary activities of individuals who have a successful business or reliable source of income.
Case 1: C sold helicopter engine parts and services. He liked horse racing and for years owned race horses. He bought a farm that included a place for him to live and some buildings and other areas for horses. C owned an interest in some horses which he boarded and trained at the farm, except during racing season when the horses stayed at a local racetrack. He rented part of his property to a horse trainer. C spent part of each day on his race horse venture and adjusted his sales schedule to have time for it. He had some success, including profits from horses sold and races won. But overall, the horse activities averaged a loss of $62,000 a year between 2005 and 2014, with the exception of 1 year. The IRS denied all of these loss deductions, claiming the activity was a hobby and not a business.
Held: For the IRS. To deduct losses from an activity, its primary intent must be profit. The taxpayer devoted considerable time to the activity, but it was not run in a businesslike way. There were no business plans, budgets or financial forecasts. The receipts and records he kept were never used to manage the activity. For example, he did not use his records to control expenses, increase sales or change the way he managed the activity. And, 20+ years of losses showed a lack of profit motive.
Although there was a reasonable expectation of appreciation in some assets, the appreciation would not cover the accumulated losses. Nor was there evidence that he ever investigated the activity’s profit potential or talked with experts about improving profits. [Carmody v. Commissioner, T.C. Memo. 2016-225]
Case 2: H shared ownership of a successful family real estate firm with her siblings. She also owned an entity designed to breed, train, show and sell the best horses possible, and she had a process for doing this. H spent about 40 hours a week on the activity, but received no compensation from it. Her son also did substantial unpaid work for the activity. The activity was conducted on several properties, each of which included a residence. H lived in one property’s residence, her son in another, the trainers and other staff at still another as part of their compensation. The activity lost money every year from 1998-2014, totaling over $17 million. The IRS denied these losses, ruling that the activity was a hobby, not a business.
Held: For the IRS. The activity had no written business plan. The only books and records were a check register and copies of bills, invoices and receipts. The CPA used the records to prepare both the financial statements and the income tax returns. But neither the taxpayer nor her son used the financial statements to analyze the activity’s operations or make changes in the way they operated the activity. There were no records kept for individual horses and each one’s contribution to profit. The taxpayer also did not consult with experts on ways to improve the business’s financial results.
The IRS ruled that the substantial time and effort devoted to the activity were for personal and recreational benefit. The taxpayer claimed that she expected the horses and properties to appreciate, but provided no evidence of the expected appreciation or that the appreciation would exceed the accumulated losses. There was no evidence that the taxpayer had ever achieved financial success in other entrepreneurial activities. Her income, which was substantial, came from inherited business interests, indicating that the horse activity was designed to shelter the other income or for recreation. [Hylton v. Commissioner, T.C. Memo. 2016-234]
Although your farm may be a secondary business, you can typically deduct the expenses for it off your taxes. However, it has to be clear to the IRS that you are actually running it like a business. Keeping up with receipts is great...as long as you do something with those receipts to analyze how your farming business is going.
Do you look at your financial statements to make decisions? Do you consult with experts on how to become more profitable? Do you have a budget? Etc.
If the answer is no, if your receipts are wadded up in your pocket, and if your expenses are just written down in a book kept in the door of your truck...there is a good chance that the IRS could deny the expenses you claim for your secondary farming business, due to it not being obvious that your goal is profit.
- Have a written business plan
- Implement sound bookkeeping practices or hire a bookkeeper
- Follow a budget
- Use the information you receive from your bookkeeping to make decisions regarding your farm
Farms need to be run like businesses because they are businesses!