Definition of a farm? It depends

It depends on whether you are a agriculture census taker or an Internal Revenue Service agent. A census taker defines a farm as any enterprise that produces and sells $1,000 or more of agricultural products. The IRS wants to know if you farming activity is a business or a hobby. According to the United States Department of Agriculture's 2022 Agriculture Census, Hancock County has a large number of small farms. Farms with less than 50 acres make up 41% of the total number of farms in the county and 12% of those farms have less than 10 acres. These smaller farms may get more scrutiny on whether they are a hobby or a business enterprise. The IRS considers several factors to determine if a farming operation is a for-profit business or merely a hobby. A farm classified as a hobby cannot deduct losses against other income, whereas a business farm can. The primary difference lies in the intent to make a profit. One of the key benchmarks used by the IRS is the "3-out-of-5-years" rule. According to this rule, a farming activity is presumed to be for-profit if it has made a profit in at least three of the last five tax years. For horse breeding, training, showing, or racing, this period extends to two out of seven years. If the farm meets this criterion, the IRS assumes the activity is profit-oriented unless there is evidence to the contrary. Even if a farm does not meet the 3-out-of-5-years rule, it can still be considered a business based on other factors. The IRS evaluates the following criteria to assess the profit motive: • Manner of Operation: Is the farm run in a businesslike manner? This includes maintaining accurate books and records, having a separate bank account, and implementing strategies to improve profitability. • Expertise: Does the taxpayer have expertise or consult with experts to make the farming operation profitable? This factor looks at the knowledge and experience of the farmer or their reliance on professional advice •Time and Effort: How much time and effort does the taxpayer put into the farming activity? Significant personal involvement can indicate a profit motive. • Asset Appreciation: Does the value of the farming assets (such as land and equipment) increase over time? Appreciation can suggest a profit intent, even if the farm incurs losses. • History of Income or Losses: What is the history of income and losses in the farming activity? Occasional profits or a trend towards profitability can support the profit motive. • Financial Status: Does the taxpayer have substantial income from other sources? If the taxpayer relies on farming as their primary income, it is more likely to be seen as a business. • Elements of Personal Pleasure: Does the taxpayer derive personal pleasure or recreation from the farming activity? While enjoyment does not automatically classify an activity as a hobby, it can be a contributing factor. If the IRS deems a farm a hobby, the taxpayer can only deduct expenses up to the amount of income generated by the hobby. This means that hobby farms cannot use losses to offset other income. Conversely, a business farm can deduct all ordinary and necessary expenses related to the farming activity, even if they exceed income, potentially reducing overall taxable income. Maintaining meticulous records is essential for farmers to substantiate their profit motive. This includes keeping receipts, invoices, and detailed logs of farming activities. Proper documentation helps demonstrate the businesslike operation of the farm and supports the claim of profitability. According to the USDA 2022 Agriculture Census, Hancock County has 995 farms — half of these farms have less than or equal to 76 acres. Whether they are hobby or business farm is critical for a farmer to manage their tax obligations. Making a profit in 3-out-of-5-years provides evidence it is a business farm. But even if the 3-out-of-5-years of profitability is not obtained, other factors will confirm that the operation is a business farm such as detailed financial and production records, value of the operation assets, past financial records, and the relationship with other non-farm income sources. By operating in a businesslike manner, farmers can maximize their tax deductions and ensure compliance with IRS regulations. This article was based on a blog by Robert Moore, an attorney and research specialist for Ohio State University Extension's Agricultural and Resource Law Program. The original blog may be found at https://farmoffice.osu.edu/blog/fri-07262024-1032am/understanding-irs%E2%80%99s-perspective-hobby-farms.