The IRS likes hobbies because their owners can't deduct losses. Business owners, however, can.

Danny and Elma Eldridge owned the 260 acres. They had prepared the scrubby waste land for ranching, bought four pregnant Brangus cows and began 14 years of cattle-raising. Danny labored on the ranch when not working in his full-time job as a natural gas industry executive. Elma worked full time on the ranch.

But why did the IRS think the couple punched cows as a hobby? Simple. The Eldridges lost money 14 straight years. In fact, one year their expenses topped $200,000 while, in their best year, receipts failed to reach even $35,000.

You might wonder why the couple lost money for all those years. The IRS also wanted to know.

Bad luck, answered the broke cowpokes. The drought, a drop in cattle prices, grasshoppers eating up feed contributed to the sea of red ink.

That's no excuse, said the IRS. The agency routinely denies loss deductions if the activity loses money for a long time.

Unwilling to buckle under, Danny and Elma challenged the

agency in court, insisting they operated like a business. They kept good records, even maintained a ledger page on the history of each cow. They advertised their products, attended cattle shows and consulted with experts. They tried to cut costs:

During a drought they boarded out their cattle. And they worked hard: cleared the land of mesquite, built roads, fences, a barn and cattle pens, fed and vaccinated cattle and even delivered calves.

The court agreed with the Eldridges. It said they could deduct their losses.

This is an unusual result because the judge ruled for the taxpayers even after continuous losses for such a prolonged period. The court considered other factors as well, in spite of vigorous objections by the IRS.

The Eldridges met other criteria supporting the operation as a business: They kept good records, consulted experts regularly, gained no recreational benefits, expended substantial time and energy, and had a reasonable expectation of making money. Further, the court said, because their land was near San Antonio, they could expect its value to increase over time and offset some or all of the losses.

The court justified its position quoting a 1927 case: "If losses, or even repeated losses, were the only criteria we used to judge farming a business, then many of the farmers of the country would be outside the pale." (more at Hobby vs. Business)

THE PLANNING TIP: A long string of losses and fun activities usually will receive a hobby label from the IRS. But the test in court is whether there is a reasonable expectation of a profit. If yes, you should consider challenging the agency, especially if you operated like a business: kept good records, consulted experts or studied to become one, showed with reasonable projections that your venture could have been profitable. You might also show that when you lost money, you changed your operation to make it profitable or terminated it.

Released 9-2-96