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“Gentleman Farmer”?

Every now and then, some well-meaning colleague will ask how I spend my free time. I usually pause before responding – to gather my thoughts – which prompts them to restate their question with what they believe is greater specificity; for example, how do I relax or what do I do for fun? After further delay on my part, the exasperated colleague will ask what I plan to do in retirement.

I often couch my response to this last iteration of the question with a description of what may have been my most memorable (and unusual) experience as a tax attorney.

A few years back, I represented a retired attorney who owned a very large property on the outskirts of a fairly well-to-do suburban area. Situated in one corner of the property was the owner’s house, along with a pool and tennis court. The rest of the land, however, constituting over 99 percent of the total acreage, was dedicated to various agricultural activities. There was an apple orchard, the output of which was picked, then boxed before being trucked and sold to local stores; there were chicken coops (with bird netting to protect from raptors[i]), the eggs from which were gathered and stored in cartons which were then transported and sold to the same local establishments, including restaurants; there were heavy-coated sheep,[ii] capable of withstanding Northeastern winters, that grazed over several adjoining poly-wired pastures,[iii] that were shorn prior to lambing in the spring – the raw wool was then shipped elsewhere to be processed into yarn and dyed, and then returned to be readied for sale; and there were some densely forested areas from which dead trees were felled and, along with storm-felled trees, were cut, split and stacked before being sold to the public as firewood.

The client managed the farm himself and kept meticulous records. Several times a day, he would get into his Jeep and crisscross the property to inspect the fences, look for newly fallen trees, check on the sheep and chickens, etc. On certain days of the week, at designated times, the client would open the farm to the public, including visits by elementary schools and Scout troops.

The entire operation was run on a skeletal staff of part-time laborers overseen by a foreman, who were not infrequently paid in kind with the products of the farm. 

Pretty impressive operation, right? And the client seemed very knowledgeable (at least to a lay person). But the farm never turned a profit. For every year of its operation, the client’s federal income tax return reflected a loss for the farming operation. And that single fact caught the attention of the IRS; specifically, the IRS questioned whether the client operated the farm as a business – in which case the deductions claimed and the resulting losses were proper – or as a hobby.  

I visited the farm a few days before a scheduled tour by the IRS examiner.[iv] In case you’re wondering, I wore a suit and oxfords. It was a cold, gray day that turned into a rainy one. We got out of the Jeep several times, and yes, it was muddy. I couldn’t help but think of the lawyer in the “Jurassic Park” movie whose firm sent him to assess whether the park was a good investment – you may recall he was eaten by the T-Rex while sitting on a toilet.[v]

In any case, the exam ended well for the client – because he was meticulous in all he did, he successfully carried his burden of proving that the farm was a business.

Earlier this week, however, I came across a decision in which Taxpayer’s success was as much a function of luck (not to mention what appeared to be a favorably disposed court) as it was of preparation.[vi]  

The Ranch

During the years preceding those in issue, Taxpayer operated many successful businesses, including over 20 car dealerships. In order to diversify their business interests, and only after investigating many properties, Taxpayer acquired a cattle ranch. Various structures stood on the property, including a foreman’s house. Wells and natural springs serviced the ranch’s water needs but Taxpayer also installed large storage tanks and drinking troughs for the animals.

Taxpayer funded their purchase of the ranch with a bank loan. In support of the loan application, Taxpayer included a business plan indicating that the ranch would generate sufficient income to service the loan – primarily through cattle sales and guided hunting expeditions – and be profitable within a few years. Taxpayer’s secondary approach was to hold the property for investment. The bank funded the loan, and Taxpayer purchased the property.

Because Taxpayer had no experience in the ranching industry, they hired a Foreman, who had two decades of experience managing large properties and ranches (including two profitable ranches close to Taxpayer’s ranch).

Foreman began his employment with Taxpayer as soon as the ranch was acquired. His duties included overseeing the property, repairing, and replacing ranch equipment and infrastructure, hiring, and overseeing laborers to perform more extensive tasks, managing the cattle herd, controlling the landscape, and tending the ranch’s crops. As part of those duties, Taxpayer provided Foreman with a separate checkbook and a credit card for ranch purchases.

Taxpayer realized quickly that operational income from the ranch alone would be insufficient to support the mortgage payments. Taxpayer discovered that raising cattle would be cost prohibitive. The initial plan was to feed the cattle by having them graze in the fields and secondarily with barley grown on the property. Unfortunately, a drought resulted in insufficient grass and barley to feed the herd. Taxpayer researched the cost of purchasing feed from third parties but found this to be impracticable given feed prices. Thus, within a few months of purchasing the ranch, Taxpayer sold most of the cattle.

Taxpayer also determined that guided hunting would not generate a profit because the ranch was too small to sustain the wild animals sought by hunters, and because the insurance requirements and attendant liability risks significantly outweighed the potential revenue that providing hunting expeditions could yield.

In the light of these failed exploits, Taxpayer pivoted from an operational focus to an investment one, hoping to eventually sell the property at a gain. Taxpayer endeavored to improve the property by repairing the fencing and irrigation system, renovating the structures and other improvements on the property, clearing brush for fire control, and maintaining the grounds surrounding the buildings. Taxpayer usually had Foreman and third-party contractors complete these tasks, but when visiting the ranch – approximately six days per month – Taxpayer would contribute by performing various tasks around the ranch.

Taxpayer performed the accounting and payroll function for the ranch, and would periodically engage the accountant from the automotive businesses to review the ranch accounting work. This was consistent with Taxpayer’s management style for the automotive businesses: they hired experienced individuals to oversee the businesses’ day-to-day affairs, and Taxpayer checked in with these managers intermittently for status updates.

The Losses

Taxpayer never realized a profit from the ranch; indeed, Taxpayer realized a net loss every year since purchasing the ranch and claimed the corresponding deductions for tax purposes.

The IRS examined Taxpayer’s federal income tax returns for the years in question, following which it issued a notice of deficiency in which it asserted that the Taxpayer’s ranch property was an “activity not engaged in for profit.” The Taxpayer timely petitioned the U.S. Tax Court to review the IRS’s determination.

The main issue before the Court was whether Taxpayer entered into the cattle ranching business for profit and, thus, whether the deductions claimed on their returns were proper.

For-Profit Business?

For purposes of determining their taxable income, a taxpayer is generally allowed deductions for business-related and investment expenses.[vii]

However, an individual’s ability to claim a deduction is limited if the related expense was paid or incurred in or with respect to an activity that was not engaged in for profit.[viii] In that case, a deduction attributable to such an activity would be allowed only to the extent of the gross income derived from the activity, provided the deduction would have been allowed to a for profit business as an ordinary and necessary expense.[ix] Any excess loss from the activity (one that is not engaged in for profit) cannot be deducted against income from a for profit business.

A taxpayer’s activity is treated as one that is not engaged in for profit unless the taxpayer can demonstrate that they are engaged in the activity with the primary objective of making a profit.[x] By contrast, a “hobby” is an activity in which an individual taxpayer is engaged for recreation or pleasure, notwithstanding that it may also generate some revenue. 

Significantly, a taxpayer’s expectation of a profit need not be reasonable, but the taxpayer must conduct the activity with the actual and honest objective of making a profit. Of course, the IRS and the courts will assign greater weight to objective facts than to a taxpayer’s self-serving statement of intent.[xi]

According to the IRS, the following factors are among those that should be considered for purposes of determining whether an activity is engaged in for profit:

(1) the manner in which the taxpayer carries on the activity;

(2) the expertise of the taxpayer or the taxpayer’s advisers;

(3) the time and effort expended by the taxpayer in carrying on the activity;

(4) the expectation that assets used in the activity may appreciate in value;

(5) the success of the taxpayer in carrying on other similar activities;

(6) the taxpayer’s history of income or loss with respect to the activity;

(7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and

(9) whether elements of personal pleasure or recreation are involved.[xii]

The Court’s Analysis

After enumerating the above factors, the Court considered their application to Taxpayer’s situation. “No one factor is determinative,” the Court stated, and it is not intended that “a determination is to be made on the basis that the number of factors . . . indicating a lack of profit objective exceeds the number of factors indicating a profit objective, or vice versa.”

In other words, one has to consider the totality of the circumstances.

Manner in Which the Taxpayer Carries On the Activity

At the time of purchasing the ranch, Taxpayer interviewed and hired Foreman to serve as foreman of the property. Given Foreman’s significant experience in the ranching industry, Foreman was tasked with overseeing the property. In this way, Foreman served in a similar role to the managers that Taxpayer employed in the automotive businesses. The Court believed that hiring an experienced individual such as Foreman to oversee the day-to-day operations of the ranch was an indication that Taxpayer conducted the ranch in a businesslike manner.

Additionally, Taxpayer maintained complete and accurate books and records for the ranch during the years in issue. Taxpayer also provided Foreman with a credit card and a checkbook designated for ranch purchases only. To verify the accuracy of their reporting, Taxpayer employed their long-time accountant to periodically review the books and records of the ranch.

In their business plan, Taxpayer informed the bank that they intended to satisfy the mortgage payments by raising and selling cattle. This plan also included providing guided hunting expeditions on the property. Soon after purchasing the property, Taxpayer realized that these plans would not be profitable given unforeseen cost constraints. Taxpayer accordingly abandoned them in favor of holding the ranch for investment purposes. Consequently, taxpayer reduced the herd. Taxpayer also declined to populate the property with game animals and decided against purchasing hunters’ liability insurance.

The Court found that that employing Foreman and maintaining a reliable accounting system indicated that Taxpayer engaged in the ranching activity for profit.[xiii] This finding was reinforced by Taxpayer’s shift to an investment focus once discovering that the operational one would be unprofitable.[xiv]

The Expertise of the Taxpayer or Their Advisers

Taxpayer conceded that they had zero ranching experience before acquiring the property. And it did not appear that Taxpayer prepared for the activity by conducting extensive studies themselves. Taxpayer did, however, interview several individuals and ultimately hired Foreman.

The IRS contended that the ranch’s failure as a profitable enterprise belied Foreman’s expertise. The Court disagreed, pointing out that Foreman had two decades of ranching experience before starting with Taxpayer. Thus, despite the ranch’s poor track record, the Court believed that Foreman was as close to an expert as Taxpayer could obtain.

The Taxpayer deferred to Foreman’s knowledge when it came to cattle management and the best practices for running the ranch.[xv] The Court found that hiring Foreman and adhering to his counsel indicated a profit motive.

The Time and Effort Expended by Taxpayer  

At maximum, Taxpayer spent six days per month on the ranch, which on an annual basis would be less than 20 percent of the year. This limited investment of time would generally have weighed against Taxpayer’s having a profit motive for purchasing the property.[xvi]

Taxpayer employed Foreman, who lived and worked on the property year-round during the years in issue. In addition, Foreman – as “an extension” of Taxpayer – hired numerous individuals to help complete repairs on the property. Therefore, despite the fact that Taxpayer did not devote a substantial amount of their personal time to the ranch business, this fact did undercut their profit motive.[xvii]

Expectation of Appreciation

At the outset of purchasing the ranch, Taxpayer had two strategies in mind: an operational one and an investment one. The operational plan was to raise and sell cattle as well as provide guided hunting expeditions. If this plan failed, Taxpayer’s secondary strategy was to improve the ranch and hold it as an investment property in hopes of one day selling it at a profit.

Taxpayer realized quickly that their operational plan was not feasible, so Taxpayer shifted to their secondary plan and began making improvements to the existing structures and landscape to increase the investment value.

The Court observed that this situation was envisioned by the IRS’s regulations:

“The term profit encompasses appreciation in the value of assets, such as land, used in the activity. Thus, the taxpayer may intend to derive a profit from the operation of the activity, and may also intend that, even if no profit from current operations is derived, an overall profit will result when appreciation in the value of land used in the activity is realized since income from the activity together with the appreciation of land will exceed expenses of operation.”[xviii]

A profit objective may be inferred, the Court continued, from expected appreciation of the activity’s assets only where the appreciation exceeds operating expenses and is sufficient to recoup accumulated losses of prior years. Significantly, a taxpayer is not required to recoup all past losses. Instead, the question is “whether [the taxpayer] would recoup the losses between the years in issue and the ‘hoped-for profitable future.’” In other words, an “overall profit is present if net earnings and appreciation are sufficient to recoup the losses sustained in the ‘intervening years’ between a given tax year and the time at which future profits were expected.”

During the years in issue, the ranch property was worth more than double the amount Taxpayer paid to purchase the property. By the time of the trial, the property was listed for more than three times the purchase price. The question, then, was whether, given this price range, Taxpayer could have recouped the losses incurred in the years in issue and going forward to the hypothetical sale date.

According to the Court, if the trend of historical operating losses continued, Taxpayer could still expect to earn a profit, though the margin by which they earned a profit would dwindling each year.[xix]  

Taxpayer’s Success in Other Activities

Taxpayer did not engage in similar activities in the past, but Taxpayer had engaged in the automotive sales and servicing business for many years. Originally starting with one dealership, Taxpayer grew the automotive business to include 23 dealerships. Approximately 12 of these were operating at a loss when acquired but Taxpayer was able to make them profitable.[xx]

On that basis, the Court believed the Taxpayers engaged in the ranch business for profit.[xxi]

Taxpayer’s History of Income or Losses

From the moment Taxpayer purchased the ranch, it never produced a profit or broken even. This history would be indicative that the activity was not being engaged in for profit.[xxii]

The Court noted that an unforeseen drought took place after Taxpayer purchased the property, which decreased the viability of sustaining a cattle herd, one of the principal ways in which Taxpayer intended to produce revenue. The Court observed that although droughts were not uncommon in the area, the drought in the present case was beyond Taxpayer’s control.[xxiii]

That said, it was not apparent, the Court stated, that the losses were sustained “because of” the unforeseen drought. In fact, the cattle herd was decreased within months of the Taxpayer’s purchasing the ranch. The losses at issue occurred nearly a decade later. Thus, the Court was unpersuaded by Taxpayer’s argument that the drought could be blamed for the ranch’s losses.

The other anticipated method of producing revenue was providing guided hunting expeditions. This failure, the Court stated, seemed attributable more to be a lack of planning than any unforeseen circumstances. Taxpayer admitted that, shortly after purchasing the ranch, they realized that the property was too small to support the type of animals that hunters sought. Taxpayer also discovered that purchasing the necessary hunting insurance for the property would be too expensive.

The Court did not see that this was an unforeseeable circumstance or customary business risk that arose. Instead, this appeared more to be a failure in business due diligence.

The Amount of Profit Earned

Taxpayer never earned a profit from the ranch business yet incurred significant expenses. This indicated a lack of profit motive.[xxiv]

Taxpayer’s Financial Status

As mentioned, Taxpayer had many successful business endeavors, primarily in the automotive industry. During the years in issue, Taxpayer reported substantial total income. The significant losses from the ranching activity served to reduce this income. Therefore, in addition to the fact that Taxpayer had significant income from another source, the losses from the ranch activity generated substantial tax benefits, which was indicative of a lack of profit motive.[xxv]

Personal Pleasure or Recreation

Finally, Taxpayer asserted that they did not have personal motives for purchasing the ranch. Taxpayer spent relatively little time at the property, and when they did visit, Taxpayer did not engage in any personal or recreational activities. Instead, Taxpayer’s purpose was usually to check in with Foreman and help with any repairs. This was indicative of a profit motivation.[xxvi]

The IRS argued that Taxpayer derived pleasure from their trips to the property, noting that on some occasions they invited guests to the property and generally enjoyed enhancing it.

Notwithstanding, the Court found compelling the fact that Taxpayer had several residences in desirable locations besides the ranch, and it was at these that Taxpayer engaged in true recreational activities. Thus, despite taking some personal pleasure from the ranch property, the Court maintained that Taxpayer’s primary motivation was to earn a profit.

In Closing

Based on its comparison of the foregoing factors, the Court conceded that Taxpayer’s “is a close case.” However, “after weighing all the facts and circumstances” – somewhat generously, I’d say – “we conclude that [Taxpayer] engaged in their ranching activity for profit. [Taxpayer’s] activities cannot be characterized as a hobby.”

Thus, Taxpayer was allowed to use their loss deductions from the ranching activity against income from Taxpayer’s other business.

Notwithstanding Taxpayer’s favorable result, the situation described by the Court does not offer a model for other taxpayers to follow. The little time and effort devoted by Taxpayer to the ranch activity, the lack of due diligence before acquiring the ranch, and the reliance upon the appreciation in the value of the land (which seemed more like an afterthought and was admittedly ephemeral), militate against the Court’s conclusion.

Taxes and hobby losses aside, though, maybe moving to a farm like the retired attorney described earlier isn’t such a bad idea. It certainly won’t be easy, and there’s a lot to learn but, to borrow a phrase from Garrison Keillor,[xxvii] it would be “a life in which people made do, made their own, lived off the land, lived between the ground and God.”[xxviii] That doesn’t sound so bad, does it?

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The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.


[i] Reminds you of Foghorn Leghorn and Henery Hawk? “You’re a chicken and I’m a chicken hawk. Are you comin’ quietly, or do I have to muss ya up?!”

[ii] My mom hails from a tiny village in a hollow among the mountains of northern Epirus. The rocky land was not arable, but it could sustain a few goats and small family gardens. It wasn’t much but they were self-sufficient.

[iii] To keep coyotes out.

[iv] I enjoy such outings. For example, whenever a client expresses an interest in a conservation easement, I always make sure to visit the property.

[v] I must confess that some of the sheep glared at me.

[vi] T.C. Memo. 2023-5, Wonderies v. Comm’r, Docket No. 13345-19; filed January 9, 2023.

[vii] IRC Sec. 162 and Sec. 212.

[viii] IRC Sec. 183(a).

[ix] IRC Sec. 183(b).

[x] IRC Sec. 183(c).

[xi] Treas. Reg. Sec. 1.183-2(a) and (b).

[xii] Treas. Reg. Sec. 1.183-2(b).

[xiii] Treas. Reg. Sec. 1.183-2(b)(1) (“The fact that the taxpayer carries on the activity in a businesslike manner and maintains complete and accurate books and records may indicate that the activity is engaged in for profit.”).

[xiv] Id. (“A change of operating methods, adoption of new techniques or abandonment of unprofitable methods in a manner consistent with an intent to improve profitability may also indicate a profit motive.”).

[xv] Treas. Reg. Sec. 1.183-2(b)(2) (“Preparation for the activity by extensive study of its accepted business, economic, and scientific practices, or consultation with those who are expert therein, may indicate that the taxpayer has a profit motive where the taxpayer carries on the activity in accordance with such practices.”).

[xvi] Treas. Reg. Sec. 1.183-2(b)(3) (“The fact that the taxpayer devotes much of his personal time and effort to carrying on an activity, particularly if the activity does not have substantial personal or recreational aspects, may indicate an intention to derive a profit.”).

[xvii] Id. (“The fact that the taxpayer devotes a limited amount of time to an activity does not necessarily indicate a lack of profit motive where the taxpayer employs competent and qualified persons to carry on such activity.”)

[xviii] Treas. Reg. Sec. 1.183-2(b)(4).

[xix] Doesn’t this cut against Taxpayer’s position?

[xx] Interestingly, the Court does not tell us whether Taxpayer was hands-on with respect to these businesses during their turn-around period.

[xxi][xxi] Treas. Reg. Sec. 1.183-2(b)(5) (“The fact that the taxpayer has engaged in similar [or dissimilar] activities in the past and converted them from unprofitable to profitable enterprises may indicate that he is engaged in the present activity for profit, even though the activity is presently unprofitable.”).

[xxii] Treas. Reg. Sec. 1.183- 2(b)(6) (“[W]here losses continue to be sustained beyond the period which customarily is necessary to bring the operation to profitable status such continued losses, if not explainable, as due to customary business risks or reverses, may be indicative that the activity is not being engaged in for profit.”).

[xxiii] Id. (“If losses are sustained because of unforeseen or fortuitous circumstances which are beyond the control of the taxpayer, such as drought, disease, fire, theft, weather damages, other involuntary conversions, or depressed market conditions, such losses would not be an indication that the activity is not engaged in for profit.”)

[xxiv] Treas. Reg. Sec. 1.183-2(b)(7) (“The amount of profits in relation to the amount of losses incurred, and in relation to the amount of the taxpayer’s investment and the value of the assets used in the activity, may provide useful criteria in determining the taxpayer’s intent.”).

[xxv] Treas. Reg. Sec. 1.183-2(b)(8) (“Substantial income from sources other than the activity (particularly if the losses from the activity generate substantial tax benefits) may indicate that the activity is not engaged in for profit especially if there are personal or recreational elements involved.”).

[xxvi] Treas. Reg. Sec. 1.183-2(b)(9) (“The presence of personal motives in carrying on of an activity may indicate that the activity is not engaged in for profit, especially where there are recreational or personal elements involved.”).

[xxvii] Sometimes referred to as a modern Mark Twain.

[xxviii] “Hog Slaughter,” by Garrison Keillor.