Today TaxMama hears from Steve in Pennsylvania, who tells us, “I recently built a barn and installed an electric fence around three acres. I have run water to the barn and have installed electricity. We have bought a few sheep to start a flock.
I have been told that the expenses related to the barn and the sheep are tax deductible. Is this true? Can I do this on a personal tax form (1040) or must I form a business? The sheep will be used for shows and to be sold as club lambs.”
Dear Steve, Good question – and this is a mistake I see often, even from tax professionals. When you’re new to raising animals like this, you don’t think of yourself as a farmer. But raising sheep is a ranching.
And ranching income should be reported on a Schedule F attached to your personal tax return.
I’ll include a link to the form so you can see it. Most people who are new to ranching report their income on their Schedule C – which often ends up getting them audited. You see, a ranching operation generally takes longer to become profitable than a regular business. And IRS is more lenient when you’re showing losses on a Farm schedule than on business schedule.
http://www.irs.gov/pub/irs-pdf/f1040sf.pdf
Let me make two suggestions.
First, read the instructions for Schedule F carefully. http://www.irs.gov/pub/irs-pdf/i1040sf.pdf
as well as the IRS Publication 225 for Farmers
http://www.irs.gov/publications/p225/index.html
Then, work with a tax professional who understands ranching issues very well, at least for the first year, to get familiar with how to do this right. Preferably, work with them for the long term.
Filing the Schedule F will probably help you avoid an audit. But if you do attract IRS’s attention, it helps to understand what they’re going for. IRS will try to apply the hobby loss rule, preventing you from deducting your losses.
If you lay the groundwork properly, write up a sensible business plan and keep good records about your progress and stumbling blocks, you’ll get to continue to treat this as a business, even if you do have losses for many years. I’ve won several audits on this issue for ranchers and helped several tax pros get their clients through this, too. It’s good that you’re asking questions early – before you visit your tax pro next April.
And, remember, you’ll find answers to questions about ranching and other tax issues, free. Where? Where else? At TaxMama.com
- Ask TaxMama :: Where taxes are fun and answers are free
- IRS Schedule F :: Income from Farming and Ranching
- IRS Publication 225 :: Farmer’s Tax Guide