JohnAlanCohan@aol.com 310.278.0203 Probate/Conservatorships IRS Audits IRS Collection IRS Appeals U.S. Tax Court IRS Criminal Investigation Tax Litigation Tax Opinion Letters Business Plans Aviation Law Tax Exempt/Nonprofit Organizations All aspects of equine and livestock law, particularly tax matters, syndications, business plans, tax opinion letters, and drafting of business documents.		Hobby Loss Rule Applied to Farms by John Alan Cohan, Attorney at Law Richard Kaehn of Kampton Pennsylvania, worked as a cargo pilot. He and his wife decided to purchase a farm to supplement his income and to provide income after his retirement. He ended up contesting an IRS deficiency in Tax Court, and lost. [Kaehn v. Commissioner, 54 TCM 1293, T.C. Memo. 1987-608.] Mr. and Mrs. Kaehn looked at over two dozen farms in Pennsylvania, before making a decision to buy. The farm had about 100 acres suitable for crops, 30 for pasture, and 33 for woodland. Mr. Kaehn did not investigate the soil productivity or do a feasibility study to determine if it could be farmed profitably. He later discovered that the soil was mostly shale and susceptible to drought because of its inability to hold water. Because the soil was not suitable for raising crops for commercial sale, he began a cattle breeding operation. He showed some of the animals in an effort to develop a favorable reputation. While not piloting he devoted his time to the farm, and Mrs. Kaehn and their children performed the farm chores. There were difficulties, including both calf and cattle disease and nutrition problems. Mr. Kaehn then switched to a commercial beef operation to sell steers for human consumption. There were setbacks when two cows suffered accidental poisoning. Mr. Kaehn had no prior farming experience, but he consulted other farmers and county agricultural officials, and he studied numerous farming publications. There was no separate checking account for the farm, and a simple journal was kept indicating expenses and disbursements. There were no separate records of the cattle, but he maintained detailed field records dealing with planting, fertilizing and liming, but not with crop yield. The farm sustained losses over a 15-year period by the time his case came to the Tax Court. Mr. Kaehn claimed that this was a working farm from which he did not derive personal pleasure. The Tax Court said this appeared to be a working farm on which Mr. Kaehn and his family worked hard and long, and that the property lacked recreational elements such as tennis courts and swimming pools. The court found Mr. Kaehns testimony to be forthright, but concluded that that he failed to operate the farm in a businesslike manner. The court said that Mr. Kaehn sought advice about operations in a haphazard manner, and advice he obtained was not designed to improve the overall profitability of the farm. The court said he failed to properly deal with the problems of a commercial beef or cattle breeding operation. His financial records, prepared only once a year, were marginally adequate. He maintained no records of the animals characteristics or bloodlines. The court was left with a string of losses that enabled the taxpayer to offset his taxable income from his wages as a pilot. There was no evidence that the farm had any prospect for profitability in the future. The court also noted that the size of the herd was not sufficiently large to support a profitable operation. Mr. Kaahn claimed that the value of his farm increased significantly over the years, but the court said this was not a significant element in light of the substantial losses. Accordingly, the court ruled against the taxpayer. There are things individuals can do to help withstand IRS scrutiny, particularly with regards to seeking legal and financial advice on how the operations may be made more profitable, which the court suggested Mr. Kaehn had failed to do. Back to Top