Mr. and Mrs. Harold Kahla of Tomball, Texas were denied farm deductions of $2,658,774 for their cattle and deer ranches, even though Mr. Kahla was knowledgeable about livestock farming and was highly successful in other businesses. They owned 300 head of cattle.
They should have won because the Court noted that the taxpayers consulted with the Soil Conservation Service on land management matters in order to receive cost-share payments from the U.S. Department of Agriculture. They also sought advice from the Texas Parks and Wildlife Department on how to manage and feed herds of deer. They conducted aerial surveys of roaming deer herds in order to observe the herds’ development. They spent a substantial amount of time working on the ranches.
But the Court noted that the taxpayers didn’t conduct their farm in a businesslike manner, had no formal business plan, budget or accounting records, and what records they did have were incomplete.
The idea of a formal business plan has emerged in Tax Court cases in recent years even though it is not technically required under the IRS regulations pertaining to the farming industry. For instance, the Tax Court ruled in a l997 case involving Mr. & Mrs. Eugene Phillips of Stuart, Va., that a business plan can be evidenced simply by action.
The taxpayers also commingled funds, and the Court said that there were significant recreational components of their farm activities. Usually the issues are relatively insignificant as long as there are other facts supporting an intention to make a profit.
The taxpayers sold surplus cattle at biannual cattle auctions, but failed to make a net profit. The taxpayers claimed that their losses over the years were attributable to unforeseen circumstances, including drought and fluctuating cattle prices, but their lawyer failed to present documentary evidence to prove these facts.
The Court noted that despite the industry custom of maintaining yearly “herd books” for cattle, the taxpayers often failed to record and maintain accurate documentation of their herd.
The Court found that the taxpayers did not seriously investigate the possibility of changing or abandoning any of their current methods of operation. Their failure to take affirmative measures to mitigate losses was inconsistent with operating with a profit motive.
It’s crucial to have a written business plan nowadays because of various Tax Court cases like this one, particularly the taxpayer incurs a history of losses.
One of the IRS Regulations states that a profit motive can be shown by evidence that assets used in the farming activity are expected to appreciate in value, and their assets in fact did appreciate in value. In the above case the taxpayers claimed that their farm had significantly appreciated in value, but unfortunately for them, this fact was not properly developed through expert testimony.
John Alan Cohan is a lawyer who has worked in the livestock, horse and farming industries since l98l.
