by: John Alan Cohan
Attorney at Law

In hobby loss audits, the IRS sometimes views various types of ranching activities as a means of generating tax losses, rather than a profit-oriented venture. Many cases that have ruled in favor of the taxpayer in livestock activities involve people who developed a superior line of animal. Taking a scientific approach to breeding is evidence showing a businesslike approach to the activity.

Careful research into pedigrees, for example, shows a concern for the proper application of genetics to your breeding program. Working with experts to develop a superior nutritional program is also evidence that you are using scientific means to enhance or at least maintain the health of your animals, and this in turn suggests you are operating a business rather than a hobby.

Another area is agricultural science, which is important in helping to maximize the use of farmland--for instance, to help eradicate problematic weeds. This in turn helps to promote thriving pastures. The use of scientific techniques is also important in that it helps reduce costs, thus making it more feasible to realize a profit.

Another recurring issue in livestock activities is “how many” animals constitute a decent sized herd that can generate a profit from breeding and selling. This depends on numerous variables, not to mention the capabilities of the people involved in day-to-day management of the operations. Sometimes the IRS will argue in an audit, that the taxpayer has either “too many” or “too few” animals.

There is significant competition in selling animals. It is important to focus one's efforts on successful promotion and marketing of one's animals. To simply “increase” the size of one's herd would present logistical and financial problems that the management of a medium size, quality herd does not pose.

If anything, taxpayers in many Tax Court cases are criticized for having too many animals. If there are “too many” animals, the IRS will want to know if you have any plans on culling some of them. Many Tax Court cases refer to the necessity of culling animals that are not being productive in the taxpayer's breeding program.

These and other issues should be addressed not at the time of an audit, but beforehand during the course of developing one's Business Plan. As I have previously said in this column, one of the best ways to insure that you are complying with the IRS hobby loss rule is have a formal Business Plan, or at least to have your situation reviewed by a tax attorney so as to analyze your existing operations, evaluate the strengths and the weaknesses, and obtain recommendations according to tax law on how the operations can be improved in order to meet IRS scrutiny.

One final point often raised in hobby loss audits is the notion that there are significant recreational elements involved. The IRS will try and find any bit of evidence--such as the participation of children--to argue that your primary motivation is recreation, not business. Many Tax Court cases have ruled in favor of taxpayers even though there were some elements of personal pleasure and recreation. For example, in Burrus v. Commissioner, T.C. Memo 2003-285, the Tax Court ruled in favor of the taxpayer even though 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. Also, the taxpayer's children and grandchildren visited the property many times, and would often canoe and fish on a pond located at the property. This was outweighed by other businesslike elements, such as breeding champion quality animals, that proved the taxpayer conducted the activity in a businesslike manner, despite the occasional recreational elements involved.

In Burrus, two of the cows received "Dam of Distinction" awards from the American Hereford Association (AHA) for exceeding certain calf production standards. The court said that the taxpayer had substantial experience in breeding and caring for cattle. While he had no formal training regarding the economics of operating a profitable cattle breeding business, the taxpayer had been around cattle breeding operations for the better part of his life. The court concluded that the recreational elements were outweighed by other evidence that the taxpayer had an intention of making a profit despite a history of losses.

[John Alan Cohan is a lawyer who has served the farming, ranching and horse industries since l98l. He can be reached at: (3l0) 278-0203, by e-mail at [email protected], or you can see more at his website:]


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