In a new Tax Court case, Freddie and Edith Stromatt, won on the question of whether their cattle activity was to be treated as a business (T.C. Summary Opinion 2011-42).
The issue was whether the taxpayers conducted their farming activity for profit within the meaning of section 183 of the IRS Code. They failed to generate a profit during the years at issue, while allocating substantial funds and time to the venture.
They purchased a 15-acre farm and constructed a modest house in which Mrs. Stromatt’s father resided, and cleared the acreage to prepare it for use as pasture, including the production of hay. They installed fencing and fertilized. They sold the hay, and these sales constituted the only income generated from the farming activity.
They obtained knowledgeable advice from Mrs. Stromatt’s father, who had been a farmer.
Mrs. Stromatt maintained a ledger for recording farming activity expenses, and kept all receipts that related to farming activity expenses.
After three years the taxpayers acquired six pregnant heifers, and soon owned 17 head of cattle. The IRS had argued that the taxpayers did not own any cattle during the years in issue and were instead only harvesting hay.
In the court’s ruling, the following points were made:
1. In noting that a three-year period elapsed between completing of fencing and the taxpayers’ acquisition of cattle, the court said: “A period of land preparation before the commencement of cattle operations is not unusual and does not show lack of a profit objective. The delay was not unreasonable and, in view of the fact that petitioners were producing and selling hay in the interim, we are satisfied that they had an honest, good-faith intention to develop a cattle operation.”
2. “While the farming ledger was informal at best, the recordkeeping required for a small farming operation is not rigorous.”
3. The court said that the taxpayers’ reliance on advice from Mrs. Stromatt’s father shows that they sought expert advice on how to support a successful cattle operation.
4. The court said that despite the lack of specific evidence that the land had appreciated in value, “it is apparent that clearing and fencing neglected land would likely increase its value.”
5. “While there were losses in all these years, it is not a lengthy history and may reflect a reasonable startup period.”
6. The court found that the taxpayers had substantial outside sources of income which was offset to the extent they claimed the farm losses, but nonetheless, based on all the facts, ruled in favor of the taxpayers.
7. “We conclude that petitioners engaged in their farming activity with an actual and honest profit objective. They and family members expended substantial amounts of physical labor to reclaim and fence land in an effort to establish a viable cattle operation. They did so at a pace that was not unreasonable in the circumstances, and they offset some losses by initially selling hay.”
The taxpayers did not have a business plan as such. Still, the court ruled in their favor. Were the taxpayers lucky to get a judge sympathetic to their case? Perhaps so, but so long as you have some measure of good facts to work with, it is prudent to appeal an adverse IRS determination.
John Alan Cohan is a lawyer who has served the livestock, horse and farming industries since 1981.
