Following is the rule on hobby farms. A person cultivating or operating a farm for recreation or pleasure, rather than for profit, is not engaged in the business of farming. (Reg. section 1.175-3) The deduction for farming expenses in excess of farming income will be disallowed if the farming is carried on for pleasure, recreation, or any other nonbusiness purpose. Tests applied to determine whether farming is a business or hobby include profit motive, knowledge and manner of conducting the activity, and reasonable expectation of success. (IRC section 183; Reg. section 1.165-1(e)).
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 consider are whether:
1) You operate your farm in a businesslike manner,
2) The time and effort you spend on farming indicate you intend to make it profitable,
3) You depend on income from farming for your livelihood,
4) Your losses are due to circumstances beyond your control or are normal in the start-up phase of farming,
5) You change your methods of operation in an attempt to improve profitability,
6) You, or your advisors, have the knowledge needed to carry on the farming activity as a successful business,
7) You made a profit in similar activities in the past,
8) You make a profit from farming in some years and how much profit you make, and
9) You can expect to make a future profit from the appreciation of the assets used in the farming activity.
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 the gross income from an activity is more than the deductions for it.
If your business or investment activity passes this 3- (or 2-) years-of-profit test, it is presumed to be carried on for profit. You can take all your business deductions from the activity on Schedule F, even for the years that you have a loss. You can rely on this presumption unless the IRS shows it is not valid.
If you fail the 3- (or 2-) years-of-profit test, you may still be considered to operate your farm for profit by considering the factors listed earlier.
