Learning Center

The experienced professionals at Edge Financial are your resource for the latest and greatest news, tips, and information for all things tax.

Hobby Farm Loss Rule

Overall the IRS really does allow a lot of benefits and deductions to Farmers and other business owners. As a business small-business owner, most expenses paid to earn a living are deductible, unlike being an employee of a business, whereas they are not.

One tax advantage presented to the self-employed is that they are allowed to deduct all losses they have from a business they are running while trying to make a profit. A loophole and something to watch out for is the IRS’ ability to investigate and re-categorize your business. What this means is that if your business continues to lose money and not turn a profit and the IRS determines that the owners are NOT trying to make it profitable, it can be deemed a “hobby loss” or labeled as an “activity not engaged in for profit.”

This is known as the Hobby Loss Rule. Some examples are provided below. :

  • Farmer Sue only farms—she has no other job. She starts growing heirloom greens on her 20-acre farm. The first year she earns $2,000, and has expenses of $3,000; her net loss is $1,000. Because she has no income to tax, her losses should be fully deductible.
  • Farmer John grows the same crop with same results. But he has a job in town that earned him an additional $1,000. When he adds his $1,000 earnings to his $1,000 loss, he has zero income for the year, so he should get a refund.
  • Farmer Anne grows the same crop and gets the same result as Farmer Sue. However, the IRS examines her return and concludes she is not really trying to make a profit and the hobby loss rule applies to her. Even though she had expenses of $3,000, the IRS only allows her to deduct $2,000 because this is the amount of her profits. She had a job in town that paid $1,000, as well, but she cannot offset all of that income with her full loss, so she has to pay income taxes on her in-town earnings.

Section 183 of the tax code states that if an activity shows a profit in three out of five tax years, then the taxpayer is engaged in it to make a profit. In terms of horse operations, the business must show a profit in two out of seven tax years.

Some Factors the IRS considers are:

  • The manner in which the taxpayer carries on the activity.
  • The expertise of the taxpayer or his or her advisors.
  • The time and effort expended by the taxpayer in carrying on the activity.
  • The expectations that the assets used in the activity may appreciate in value.
  • The success of the taxpayer in carrying on other similar or dissimilar activities.
  • The taxpayer’s history of income or losses with respect to the activity.
  • The amount of occasional profits, if any, which are earned.
  • The financial status of the taxpayer.
  • The elements of personal pleasure or recreation.
Ready to get started?