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Q1) What is the IRS hobby
loss provision and how will it affect my farm?
Profit Motive and the Horse Business
By Richard B. Dicks, CPA
Most involved with the equine industry of whatever breed do
so purely as a hobby. It is an activity from which one can derive great pleasure
and enjoyment, while at the same time, providing an opportunity to meet new
friends and share a common interest with all in their family. There is
absolutely nothing wrong with this. It makes for a strong market for our horses
and a more interesting and exciting industry for all of us.
There are, however, many of us who, because of the investment
of time and money involved, or because of our personal goals for our horse
activity, wish to be in the horse BUSINESS. Doing that successfully and having
the IRS agree with us on this characterization of our activity is the question
at hand.
The federal tax code states that an individual may not deduct
operating expenses in an amount greater than the income from an activity if that
activity is "not engaged in for profit." This provision of the tax code is often
referred to as the Hobby Loss provision. The IRS requires that an individual
operate any business activity in a "For Profit" manner. For the IRS to allow a
taxpayer to deduct operating tax losses from ordinary taxable income obtained
from other activities, there are certain criteria, spelled out by law, with
which they must comply.
Losses from a hobby are considered personal expenses and are
generally deductible only to the extent of gains from that hobby activity.
Whether an activity is considered a business or a hobby per the IRS is dependent
upon whether the Service considers that the taxpayer fulfilled certain
obligations with regards to the enterprise and entered into it with the
objective of making a profit.
The IRS lists nine factors, which are normally taken into
consideration in determining whether the profit motive exists. Books have been
written on this subject alone, including one by me.
The first on the list and an essential ingredient in the
presumption of whether a horse-related activity is a business or a hobby is the
profit motive. You get past that hurdle and the rest will pretty much
fall in line.
Hobby Loss Criteria
1) Is the activity managed in a business-like manner (Is the
profit motive present)?
2) The taxpayer's expertise or that of his advisors.
3) The time and effort expended by the taxpayer in carrying
on the activity.
4) The expectation that the assets used in the activity may
appreciate in value.
5) The taxpayer's history of success in other similar or
dissimilar activities.
6) The taxpayer's history of income or losses with respect to
the activity.
7) The amount of occasional profits, which the taxpayer may
have earned in connection
with the activity.
8) The taxpayer's personal financial status.
9) The elements of personal pleasure or recreation associated
with the activity for the
taxpayer.
While each of the above criteria can and probably will be
taken into account by the IRS in the event of an audit of a horse activity, the
primary objective of the taxpayer at all times should be to run the horse
operation in a way that would most improve his opportunity to make a profit. In
other words, one should run their horse business with the same diligence and
using the same business principles and judgment that they would use in
conducting other business enterprises.
Keeping good records and preparing attainable short and long-term financial
plans showing the intent to make a profit from the horse operation is not only
good to show when and if the time comes to deal with the IRS -- it is also the
only sensible way to run a business.
- Richard B. Dicks, CPA is author of Equinomics 101. More
information at
www.equinomics101.com or
info@equinomics101.com.
There are many excellent resources available on
equine business.
In addition to the list below, visit the Equine
Business area of the online catalog.
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