Farm losses: How to account for losses to potentially reduce taxes

By Brian Ravencraft, CPA, CGMA, Principal-Holbrook & Manter

Farming can be unpredictable. I am not telling you anything you don’t already know. Between weather, market fluctuations, and operational challenges, not every year is a profitable one. When your expenses exceed your income, you incur a net farm loss. Understanding how to properly account for it can offer a silver lining, potentially reducing your tax burden.

Meticulous record-keeping

The first and most critical step in accounting for farm losses is tracking every dollar that comes in and goes out. Without accurate records, you cannot substantiate your losses to the IRS.

Consider using dedicated accounting software to assist you here. Your expense categories should be specific, covering everything from feed, seeds, and fertilizer to fuel, repairs, and veterinary bills. Remember also to track larger capital expenditures, such as new equipment or improvements, as they are managed differently through depreciation. Consistent, detailed records not only prepare you for tax time but also help you make better business decisions year-round.

Understanding deductible farm expenses

To calculate your net loss, you must first know which expenses are deductible. Generally, any expense that is both “ordinary and necessary” for running your farm can be deducted. An ordinary expense is one that is common and accepted in the farming industry, while a necessary expense is one that is helpful and appropriate for your business.

Common deductible expenses can include operating costs, repairs and maintenance, depreciation, and much more. Your accountant can go over each deduction and how it applies to your farm with you.

By diligently tracking and claiming all eligible deductions, you get an accurate picture of your farm’s profitability — or lack thereof. If your total deductible expenses are greater than your total farm income, the difference is your net farm loss.

Using farm losses to your advantage

So, you have a net farm loss. What happens next? This is where the tax-saving potential comes into play. A farm loss can be used to offset other income you or your spouse may have, such as wages from an off-farm job or investment income. This is done by reporting the loss on your tax return, which can lower your total taxable income and, consequently, the amount of tax you owe.

This is known as a Net Operating Loss (NOL). An NOL occurs when your deductions for the year are greater than your income. For farmers, the rules around NOLs can be particularly beneficial. While many businesses have specific limitations, farmers often have more flexibility.

Once you determine you are dealing with a NOL, work with your accountant to navigate your options, and you do have options. Your accountant can explain the best approach for your farm.

A note on the Hobby Loss Rule

Always remember, it is important to show the IRS that you are operating your farm as a business with the intent to make a profit. If the IRS determines your farm is a hobby rather than a business, you can only deduct expenses up to the amount of income your hobby generates. You cannot use a hobby loss to offset other income.

While facing a farm loss can be discouraging, it doesn’t have to be a complete financial setback. By keeping meticulous records, understanding your deductions, and strategically using net operating losses, you can turn a challenging year into an opportunity to reduce your tax obligations. As always, tax laws can be complex and subject to change, so consulting with an accountant specializing in agriculture is important. As always, if I can be of help, please reach out.