Tax Question

[California]

I've had modest net income from my apple orchard, until recently when insurance cost tripled along with two years of bad weather and low production.

My role in the orchard is to backhoe out the stumps of trees that fell, to prepare for replacements. Then water and maintain new trees until they become productive at about the fifth year. Then responsibility shifts to the contractor who does 90% of the work here - prune, till, spray, harvest, market. Each year he provides me check and a 1099. So I'm visible to IRS.

This was fine so long as I ended the year with net income. Now, this is the second year with a net loss after insurance, taxes, minimal cost for diesel and welding supplies, etc. Building and tractors were fully depreciated long ago so that isn't an issue.

How long can I file a net loss that reduces overall family taxable income? Sooner or later I'll hit some big expense - broken tractor, re-roof the equipment barn, whatever. Am I at risk of being declared a non-deductible hobby? Do some farms operate at a net loss for years and years?

Any advice? Thanks in advance!

 

[KennyG]

My understanding is that if you make a profit in three out of five years, you are in the clear. More than 2 unprofitable years and you may be called on to justify the losses. Many businesses operate at a loss for years and aren't called hobbies because they can show they intend to eventually make a profit. However, if the IRS thinks they are right it can be difficult to convince them.

 

[drssg]

In the equestrian world, the IRS is rather touchy about businesses that aren't showing a profit, because it's not that uncommon that people just like having horses and attempt to write off a bunch of expenses.

The general rule of thumb is that the IRS wants to see a profit four years out of seven. Failing to do so puts the business owner at a higher risk of being audited and having the validity of the business questioned.

There is not a hard cut off, and it comes down to the business owner's ability to present a business plan that convinces an auditor that there is a legitimate chance at earning a profit.

If you have some history of showing a profit, I would think that you are in a better position. I think they are more interested in businesses that really have no hope of ever showing a profit.

I would speak with a local tax person to get a more accurate assessment of your situation.

 

[4570Man]

If you’re getting a 1099 and you’re filing the deductions legit what else are you supposed to do about it?

 

[California]

My understanding is that if you make a profit in three out of five years, you are in the clear. More than 2 unprofitable years and you may be called on to justify the losses. Many businesses operate at a loss for years and aren't called hobbies because they can show they intend to eventually make a profit. However, if the IRS thinks they are right it can be difficult to convince them.

Ok that's what I read long ago, positive in 3 of 5 years. I've managed to do at least that for the 23+ years I've had the place, and Dad did for decades before that. Some profit most years with net loss shown only occasionally.

Maybe that's enough history to maintain credibility. I hope. With the local packing house shutting down after this year it may be more costly to ship out of the area so I could be unprofitable for years while the contractor who harvests here and ships, makes much slimmer margins.

As for the horse people example, that complexity is what I'm trying to avoid.

 

[3Ts]

I strongly suggest you talk to a CPA, each person's situation is different. In my case I have trees that I grow for market. They are on a 7 year (more or less) harvest cycle. One year of income in 7 years. I also have a business plan approved by the state of Texas, so a loss for 6 years before I show income. A CPA is well worth the cost just to keep the IRS at bay. I have records that would allow me to deduct more than the standard rate for vehicles, but the CPA explained why we didn't want to use them and just stay with the lesser deduction which would end up saving me money in the long run.
It's important to show that your business intends to make money and a CPA and the local State AG department can help with that.

 

[duffer]

It would behoove you to have a legitimate company organization, such as an LLC or Sub S corp for your business. (Your post did not indicate that you had one). I'd also set up a separate checking account in the name of the business in order to produce a proper "paper trail" for all business expenses if the need ever arises with the IRS.

There are plenty of companies that don't make profit for more than 3-5 years. It's true the guidelines say you should be profitable 2 (or 3?) years out of 5, or 4 out of 7, or whatever. But those are just guidelines. If you have proper receipts for income and direct expenses, you should be good.

 

[ponytug]

+1 on consulting your tax expert. I've read that in addition to the number of profitable years out of the total number, the IRS also looks at whether you are making credible efforts to make it profitable, e.g. a business plan, taking courses relevant to expanding or improving the business, investments that would reasonably expand it, etc.

My takeaway is that there is not an exact line in the sand, but in @California's case of a long history of profit, and sustained effort, I would be surprised if @California got audited, and very surprised if the IRS objected. Document, document, document. Agriculture is hardly the most predictable business to begin with, so there is lots of precedent for leaner years, but I'm not a tax expert myself.

All the best,

Peter

 

[EarPlug]

And the Cost of the CPA is a deductible expense.

 

[plowhog]

A CPA is well worth the cost just to keep the IRS at bay.

Well, nit-picking, but I would rephrase:

A CPA is well worth the cost to increase the chances of keeping the IRS at bay.

Many people do not know that the IRS evaluates not only tax payers, but also tax preparers. Why do you care?

If you employ a CPA who is aggressive about deductions and "saving the client money," it can backfire big time. The IRS looks for a pattern where a particular CPA's clients are more likely than not to be audited and owe money. They have the data and can easily determine that. Then, they target that same CPA's clients for increased audits. That client might be you, even if you are unsuspecting. They figure if the CPA was aggressive with other clients, they are likely with aggressive advice for you.

Then there are the unresolved questions in the tax code which even CPA's do not know how to advise about. When I sold my company there was a HUGE decision to do X or Y method of tax treatment. It made a great deal of difference in tax owed. The CPA said there was no guidance and no precedent. I said well, why not go the route with least tax owed? She said: "you may become the first court case and first precedent to be established." Yikes.

These sort of "wobblers" happen all the time. I just finished a corp tax return earlier this month. Once again it had a "wobbler." Because there is a pending decision on treatment of investment tax credit in certain situations. The choices for me were a) file an extension and hope the decision comes in before the extension is due, b) agree to take depreciation in little chunks over 5 years, or c) take it all in the first year and hope that is how the decision comes down.

It wasn't a huge amount of money. So I elected to take it over 5 years and just get it done and over with. And not incur CPA fees to have to go back and touch it again.

Sorry to be a bit long winded but the tax code is a mess.