Guidance for Special Types of Businesses

Rules for Businesses in Certain Industries/Market Segment Specialization Program Guides (MSSP)/Market Segment Understandings (MSU)

Farming

Hobby Farmers

A farmer who operates a farm for profit can deduct all the ordinary and necessary expenses of carrying on the business of farming. However, if you do not carry on your farming activity, or other activity you engage or invest in, to make a profit, there is a limit on the deductions you can take. You cannot use a loss from that activity to offset other income. Activities you do as a hobby, or mainly for sport or recreation, come under this limit. So does an investment activity intended only to produce tax losses for the investors.

The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations.

In determining whether you are carrying on your farming activity for profit, all the facts are taken into account. No one factor alone is decisive. Among the factors to be considered are whether:

• You operate your farm in a businesslike manner.
• The time and effort you spend on farming indicates you intend to make it profitable.
• You depend on income from farming for your livelihood.
• Your losses are due to circumstances beyond your control or are normal in the start-up phase of farming.
• You change your methods of operation in an attempt to improve profitability.
• You, or your advisors, have the knowledge needed to carry on the farming activity as a successful business.
• You made a profit in similar activities in the past.
• You make a profit from farming in some years and how much profit you make, and
• You can expect to make a future profit from the appreciation of the assets used in the farming activity.

Partnerships and S Corporations.

Presumption of profit. Your farming or other activity is presumed to be carried on for profit if it produced a profit in at least 3 of the last 5 tax years, including the current year. Activities that consist primarily of breeding, training, showing, or racing horses are presumed to be carried on for profit if they produced a profit in at least 2 out of the last 7 tax years, including the current year. The activity must be the same for each year within this period. You have a profit when gross income from an activity is more than the deductions from that activity.

Important References:                                   

Publication 225                Farmer's Tax Guide
Form 5213                        Election to Postpone Determination as to Whether the Presumption Applies That an Activity is Engaged in for Profit