Wes has been an orthopedic surgeon in Atlanta for 15 years. He would like to dev

Question

Wes has been an orthopedic surgeon in Atlanta for 15 years. He would like to devote less time to his medical practice, spend more time with his family, and pay less income tax. His net income from his medical practice has been about $500,000 per year for the past five years. Wes grew up on a dairy farm in southeastern Georgia. He has many fond memories of his childhood and believes a farm would be an excellent environment for his three children. Consequently, he purchases a dairy farm about 30 miles from Atlanta. He hires two full-time employees to handle the milking operations and other part-time employees as needed. In addition, Wes and his family participate in performing various activities on the farm. Wes commutes to Atlanta four days a week to continue his medical practice. Because he is devoting less time to the practice, his net income decreases to $400,000. Wes has a loss of $75,000 for the dairy farm that he attributes to depressed milk prices and his inexperience at running the farm. He considers the medical practice and the dairy farm to be separate trades or businesses. Therefore, on the Federal income tax return, the $75,000 net loss is offset against the $400,000 net income. Assume that the net income and net loss from the medical practice and the dairy farm, respectively, remain approximately the same for the next four years. Is the position adopted by Wes defensible? Discuss.

Explanation / Answer

Business or investment expenses are deductible only if the taxpayer can show that
the activity was entered into for the purpose of making a profit. Certain activities
may have either profit-seeking or personal attributes, depending upon individual
circumstances. Examples include raising horses and operating a farm used as a
weekend residence. While personal losses are not deductible, losses attributable to
profit-seeking activities may be deducted and used to offset a taxpayer’s other
income. For this reason, the tax law limits the deductibility of hobby losses

General Rules
If an individual can show that an activity has been conducted with the intent to
earn a profit, losses from the activity are fully deductible. The hobby loss rules
apply only if the activity is not engaged in for profit. Hobby expenses are deductible only to the extent of hobby income.40
The Regulations stipulate that the following nine factors should be considered
in determining whether an activity is profit-seeking or is a hobby:41
Whether the activity is conducted in a businesslike manner.
The expertise of the taxpayers or their advisers.
The time and effort expended.
The expectation that the assets of the activity will appreciate in value.
The taxpayer’s previous success in conducting similar activities.
The history of income or losses from the activity.
The relationship of profits earned to losses incurred.
The financial status of the taxpayer (e.g., if the taxpayer does not have substantial amounts of other income, this may indicate that the activity is
engaged in for profit).
• Elements of personal pleasure or recreation in the activity.
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The presence or absence of a factor is not by itself determinative of whether the
activity is profit-seeking or is a hobby. Rather, the decision is a subjective one that is
based on an analysis of the facts and circumstances

so from above it is clear that the position adopted by Wes is not defensible

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