Every so often I get asked – “How do I become a farm or farmer?” Maybe the question should be – “Is my farm operation considered a hobby or a ‘for profit’ business?”
What is a “farm”?
A “farm” is land used for the production of crops, fruits, or other agricultural products or for the sustenance of livestock or poultry.
The United States Department of Agriculture defines a farm as any place from which $1,000 or more of agricultural products were produced and sold, or normally would have been sold, during the year
A farmer is by definition (Mirriam-Webster) a person who cultivates land or crops or raises animals.
Next, consider what a definition of a “farmer” in the tax code is: the tax code says that a taxpayer is engaged in “the business of farming” if he cultivates, operates, or manages a farm for gain or profit, either as owner or tenant. The code looks at the activity, not the person.
What about the definition of a “hobby farm”?
If you are not engaged in the activity for gain or profit, then you are considered to be a hobby farm.
The motivation of the taxpayer is the key – Business or Hobby
Tax law makes a distinction between a “trade or business” and a “hobby.” It says, if an activity shows a profit in 3 of 5 years in most cases, the activity is presumed to be a trade or business and all expenses are deductible on the tax form Schedule F (farm and income expenses form). In regards to a horse related business, the 2014 Agricultural Tax Issues paper, states: Horse breeding, training, showing or racing activities meet the presumption if they show a profit in 2 of 7 consecutive tax years. It goes on to say if an activity is a hobby, then the deductible related expenses to the hobby cannot exceed the gross receipts of the hobby.
Tax law also says that these expenses, other than interest and real estate taxes, are only deductible on a Schedule A form (itemized deductions) to the extent they exceed 2% of the total adjusted gross income of the individual.
If a farm does not show a profit in 3 of 5 years does not automatically make it now a hobby farm. In regards to a horse farm, the 2014 Agricultural Tax Issues paper, it says: Horse breeding, training, showing or racing activities meet the presumption if they show a profit in 2 of 7 consecutive tax years.
A “farmer” in this position as a taxpayer will have the burden of proof in an audit situation that the activity or farm operation has a profit motive.
Part-time and farms in new or alternative enterprises may be questioned with respect to their profit motive.
There are basically nine gain or motive for profit factors:
1. Manner in which the taxpayer carries on the activity
Does the taxpayer keep accurate books and records? Is the activity conducted in a business-like manner? Does the taxpayer have a business plan.
2. Expertise of taxpayer or his advisors
Has the taxpayer prepared to conduct the business (education, training in accepted practices)? Does taxpayer consult with experts (Extension Educators)?
3. Time and effort expended by taxpayer in the activity
Does the taxpayer devote much of their time and effort even though there may not be substantial personal or recreational aspects?
4. Expectation that assets used in activity may appreciate in value
‘Profit’ includes the appreciation in the value of assets used for the activity. Will the increase in value of the assets be enough to cover the costs of the activity?
5. Success of taxpayer in similar or dissimilar activities
Does the taxpayer have a record of turning unprofitable activities into profitable ones?
6. History of income and losses with respect to the activity
Is the activity in the “start-up” phase when losses would be expected? Do losses continue without a reasonable explanation (drought, disease, weather damage, low prices) that is beyond the control of the taxpayer?
Years of previous profits followed by years of losses can be strong evidence of profit motive.
7. Amount of occasional profits, if any, earned
Substantial profit, even if only occasional, is indicative of a profit motive. Are they in line with the time and financial investment into the activity?
An occasional small profit on a large investment may suggest lack of profit motive.
8. Financial status of taxpayer
If the taxpayer does not have substantial income or capital from sources other than the activity, this suggests activity has a profit motive. Substantial income from other sources, especially if the activity generates big tax benefits, can indicate activity is not profit motivated. If the activity involves significant personal or recreational elements, then it may be difficult to show a profit motive.
9. Elements of personal pleasure or recreation
Tax law allows a taxpayer to enjoy what they do. You may have personal motives in addition to profit motives for the activity.
There is no one factor in the determination between hobby and business. It is a “facts and circumstance” situation. Most situations are clear-cut. Many small, part-time farms may not show a profit but still can have a profit motive.
The key is to make a decision to farm for profit rather than just for fun unless “Fun” is all you are going after.
Whether big or small, a farmer should consult a tax professional and include them in the business plan. They can provide up-to-date tax advice that fits your operation.
Tony Nye is the state coordinator for the Ohio State University Extension Small Farm Program and has been an OSU Extension Educator for agriculture and natural resources for 28 years, currently serving Clinton County and the Miami Valley EERA.