Hobby farms typically start in pursuit of a passion or lifestyle. You simply want to work some land and reap the rewards of your labor. You might not even think about making any money or consider it a far-off dream.
Once you start seeing the fruits of your labor, the draw to earn a little cash creeps in. Even if it’s not much, some extra spending money is always nice. That’s where the line between hobby and business blurs, especially when it comes to your taxes.
How the Tax Rules Apply to Hobby Farms
Almost all income is taxable, including income from both hobbies and farms. Bartering income, too. So if you trade your wares for other goods and services, the value of what you give and what you receive must be reported on your taxes.
Since you’re getting taxed on the little bit of income your hobby farm provides, it’d be nice to offset that with deductions to help cover your expenses. And that’s where things get tricky.
Hobby farms are considered hobbies. By their very nature, hobbies are money-losing ventures. But you choose to spend your money on them because you love them. And the rules changed when the Tax Cuts and Jobs Act went into effect last year.
There used to be limited deductions for hobbies. You could deduct expenses up to the amount of money you brought in from your farm as long as the overall expenses you claimed were more than two percent of your adjusted gross income.
That all changed on January 1, 2018. Now, to receive any benefits or be eligible for further federal tax deductions, you have to stop calling it a hobby farm. For tax purposes, it has to be an actual business.
Tax Benefits of Turning Your Hobby Into a Business
The federal tax rules for businesses are much more favorable than for hobbies. You can deduct your farm-related expenses, even if they go above your farm income. So if your farm operates at a loss, that loss can be used to offset your tax burden on your overall income.
With all the supplies and equipment needed to run your small farm, any potential write-offs are appealing. You can deduct many expenses, including:
- Farm supplies like feed, fertilizer, seed, and poultry
- Labor hired to help out with farm tasks
- Compensation to your children or spouse if they work the farm
- Repairs and maintenance on your property
- Interest from a farm mortgage
- Real estate and property taxes on farm business assets like equipment, animals, land, and buildings
- Use of your home for farm business
- Depreciation of property
- Cost of operating a truck or car for your farm
And that’s just the beginning. There are a number of farm business deductions. Each category has its own rules, restrictions, and limits. Read the IRS rules to see what applies to your farm.
The rules vary at the state level too, depending on where you live — Tennessee, Alabama, or Mississippi — and what you produce on your farm. Consult your state’s tax guide or a local tax professional to learn about the state-level deductions available to you.
Steps for Establishing Your Farm Business
You can’t simply start treating your hobby farm as a business. There’s a lot of work involved. The burden is on you to prove to the IRS that your farm is a real business and no longer a hobby.
1. Get your papers in order
It starts with paperwork. You need much more than a collection of receipts and a spreadsheet of expenses. To get the benefits of a being a business, you have to operate like one. You need to have a business plan, profit and loss statements, bank account, daily activity logs, and financial records showing your expenses and assets. All that might not be completely necessary to run your small farm, but you have to be prepared to provide it all to the IRS when asked.
2. Prove your intention to make a profit
You don’t actually have to be profitable as a hobbyist before declaring your farm as a business. But you do need to show that your farm is intended to turn a profit. In the past, many people used hobby farms and acreages as tax shelters. The IRS looks at several factors for proof of intent:
History of income and losses – Making a substantial sum is proof that you meant to do so. Frequent small profits make it seem like you’re trying to minimize income. Ongoing losses aren’t typically something a business would accept, but a hobbyist would. You don’t have to turn a profit every year. Having a positive income in three out of five years actually qualifies you under the safe harbor rule and it’s presumed you have a for-profit business.
Business manner – Good recordkeeping and conducting your affairs in a business-like manner show that you’re serious about it.
Expertise – Demonstratable knowledge or experience and previous success show that you know what you’re doing, even if you’re starting something completely new. Showing that you’ve hired the appropriate experts or lined up knowledgeable advisors helps too.
Time spent – The more hours you put into your farm, the less it looks like a hobby — especially if there is no personal connection or recreational component.
Expectation of appreciation – Your farm assets and operations show that you expect it to grow in value over time and justify your investments.
Financial status – When your farm is your primary source of income or a significant portion of it, it looks much more like a business venture. Wealthy people who can afford to take on significant losses or will gain financially from tax savings more than income will be scrutinized.
Elements of personal pleasure – It has to look like work. A substantial commitment of time and labor looks more like a business. You can enjoy what you do but there shouldn’t be a substantial recreational element to it.
3. Fill out the right tax forms
Put your financial info in the wrong place and you can inadvertently classify your farm business as a hobby farm. Hobby farm profits are reported under “Other Income” on Form 1040. While other business must fill out Schedule C, farmers are required to use Schedule F to detail profits and losses.
Everyone’s circumstances are different. You should always consult your accountant before making big decisions about your taxes. If you’ve been preparing your own taxes and are considering whether or not to classify your farm as a business, find an accountant in your area to help you out. They can look at your whole financial picture, answer your questions, and offer guidance for how switching from a hobby farm to a farm business will impact you.