by Wesley Tucker

Why do you farm? Producers usually answer by saying they farm to provide for their family, be their own boss, raise their children to work hard, feed the world, or be good stewards of the land. But ask the IRS why you should farm, and the response is simple: to make money.

To be considered a trade or business, you must be engaged in activities to produce a profit. Without a profit motive, it’s not considered a business; it’s a hobby, and the expenses are not deductible.

According to IRS Publication 5558, “Activities Not Engaged in for Profit Audit Technique Guide,” multiple factors will be considered when determining whether a farm has a profit objective. Here are nine influences to consider:

1. Operating in a businesslike manner. Ask the following questions:

Sometimes in farming, producers encounter several years of sustained losses. That doesn’t necessarily mean they aren’t trying to be profitable. But they must show they are operating in a businesslike manner striving for profitability.

2. Expertise of the farmer and advisers. The expertise of the individual, and if they seek outside advice to improve their operation, is considered. If someone gets advice from experts in the field, such as Extension and other governmental agencies, and makes changes based on that advice, it can indicate a profit motive.

3. Time and effort expended. The time and effort someone devotes to the activity needs to be consistent with an intent to make a profit. However, a lack of effort does not necessarily mean it’s not a business if the farm employs other competent people.

4. Expectation the assets used will appreciate in value. If someone purchases farmland intending to profit from its appreciation and they also farm the land, those are usually considered one activity, but only if the farming activity reduces the net cost of land ownership.

5. Success in other similar activities. Even if an operation is unprofitable, someone who has had success in other similar activities making money can indicate they are actively striving for profitability.

6. History of income or losses. Many businesses may have a series of losses during the startup phase or when encountering unforeseen circumstances beyond their control, such as droughts or depressed market conditions. But sustained losses that continue year after year can indicate the activity is not being engaged in for profit.

7. Occasional profit earned. The magnitude of profits to losses incurred in relation to the size of the investment and value of the assets used can influence the determination. For instance, an occasional small profit from an activity usually generating large losses, or requiring a huge investment, would not indicate a profit motive. However, an opportunity to earn an occasional large profit from an operation producing only small losses would be a different story.

8. Financial status of taxpayer. If someone does not have enough income from other sources to sustain ongoing losses, it can indicate the person is not farming just for the fun of it. Alternatively, if someone has enough other income to lose money year after year (and they receive income tax savings from those losses), it may indicate they are not truly profit motivated.

9. Personal pleasure or recreation received. This does not mean someone can’t enjoy what they do. But if significant recreational benefits are part of the operation, such as hunting rights or producing food for personal consumption, for operations with repeated losses, it may indicate the activity is not engaged in a profit motive.

Farming is an activity where it’s not unusual to encounter sustained periods of losses. The weather works against us, markets go up and down, and the amount of investment in land and machinery needed to operate is staggering. But to the IRS, it boils down to whether you are farming to generate a profit, or whether it is simply a hobby.

Protect yourself by running your farm like you would in any other business. Keep accurate records with separate checking accounts, develop a simple business plan, seek expert advice and make changes to your operation when needed to increase profitability. And never use the word “hobby” again.

Tucker is a University of Missouri Extension ag business specialist, succession planner and national conference speaker. He can be reached at [email protected] or 417-326-4916.