Since the founding of our country, Americans have been drawn to owning our own land and in many cases, also have a strong attraction to owning our own businesses. In many instances, we see a person wishing to combine those two desires; hence, we see people with small tracks of land exploring ways to generate income and/or deductions from their ownership of land.
This is an area in which the IRS also has a great interest. The IRS has a one-sided perspective of this issue. Should you be fortunate enough to generate an income from this activity, it is taxable. But, if you, like many, have more expenses than income, then it is highly likely the IRS would consider this a “hobby loss.”
To add insult to injury, deductions attributable to the “hobby” activity are allowed only to the extent of its income or full amount of deductions, such as state and local property taxes that are otherwise allowable without regard to whether the activity is a hobby or is entered into for a profit.
Your first defense to an assertion by the IRS that your activity is a hobby would be for you to show you have generated a profit for a minimum of three out of the last five years. However, if your activity is the breeding, racing, showing or training of horses, the IRS will want you to show a profit two out of the last seven years.
As the IRS seeks to determine if you are engaged in the activity for a profit, they will consider issues such as the following:
- Do you operate this venture like a business? How do you keep records? Do you have a separate business bank account? Are you consulting with experts for advice on how to be profitable?
- What other sources of income do you have? Is this your only employment activity? How much time do you spend on the activity? For example, if you have a substantial income from other sources, the IRS may conclude that this is a hobby and not an active business enterprise.
- An additional factor to support your profit motive is the appreciation in value of the land or other assets involved.
- Does this activity generate any positive cash flow?
Do you have any prior experience in this field of interest? If so, were you able to generate a profit? Or stated in another way, do you have any expertise in this field, or is the primary benefit to you recreational in nature?
The tax code defines a farmer as someone who is raising or growing an agricultural or horticultural commodity. The term “farm” as defined in Code Sec. 3121(g) “includes stock, dairy, poultry, fruit, fur-bearing animal and truck farms, plantations, ranches, nurseries, ranges, greenhouses or other similar structures used primarily for the raising of agricultural or horticultural commodities, and orchards.” Fundamental to this distinction is that the taxpayer is participating in the raising or growing process.
As it relates to agriculture, the IRS seems to assert the hobby loss assertions most frequently to activities that have an element of personal recreation, such as horse breeding, showing and racing activities and cattle-raising activities.
There are many business ventures explored by landowners, such as farms, ranches, orchards and vineyards. Each of these ventures has unique challenges to make a profit.
For example, what does it take to make a profit with a vineyard? The initial investment can be hefty. Perhaps the first step is to obtain an expert advisor to help determine that the land can support a vineyard. The purchase price per acre could range from $50,000 to more than $100,000 for unplanted but suitable acreage. Existing acreage with vines could exceed $150,000 per acre. Further, it may run as much as $50,000 per acre to install a vineyard.
This article is not intended to provide operating benchmarks but is for illustrative purposes only.
The annual production costs for a vineyard might be in the range of $3,000 or $4,000 per acre. Additionally, you would incur harvesting costs and the carrying cost of the land purchase. So, a quick calculation will indicate that making a profit will require good weather and a consistent market for your grapes. The standard joke in the wine business is, “How do you make a small fortune in the wine business? Start with a big one.”
Jerry Love, CPA, is the sole owner of Jerry Love CPA, LLC in Abilene, TX. Contact him at
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