Legally Speaking

Jul 11, 2014

Tax court case on cow and dairy farm activities

In an important Tax Court case, J. Zane Smith of Earlville, NY, challenged the IRS’s determination that his cow and dairy activities were a hobby. The lengthy opinion also involved other issues, including his dog breeding activity and a cutting horse activity. [Smith v. Commissioner IRS, T.C. Memo 2007- 368].

Smith operated in a 400-acre farm known as Goose Hill Farm. He also operated Columbus Dairy, consisting of 225 acres located 15 miles away. He built a milking parlor and dairy operation at Columbus Dairy, and raised calves on the Goose Hill property.

For purposes of analysis, one of the most important issues was whether the activity was conducted in a businesslike manner and whether the taxpayer implemented some method for controlling losses.

Smith had studied and researched the various types of cattle that could be bred. He recognized that family dairy farms were not doing well, and he decided that to be profitable, he had to find a niche in the market that would let him compete as to product and price. He decided to raise Normande cattle.

The Columbus Dairy became an organic dairy farm. He believed that if his farm could be certified as organic, he would be able to sell the milk at a price three times that of conventional milk. In addition to a milking parlor and other buildings for the milking operation, Smith reclaimed the pastureland and built miles of fencing for the operations.

Normande cows are good producers of milk in France but are largely used for beef consumption in the United States. After visiting many farmers and ranchers Smith acquired a herd of Normande cows that he believed would be the best milk producers. He intended to further breed the herd so his activity could become competitive.

He had a seven-year business plan involving the importation of bull semen from France.

The taxpayer had some revenue, but he operated at a significant loss. He expected the revenue to substantially increase because of the organic certification. In operating this activity, he consulted with experts, and maintained a separate checking account. He took steps to maximize his revenues and continually worked to show a profit.

He hired a farm manager who lived on the property. Although Smith did not keep many formal records, the court said that he approached the operation of the cow activity in a businesslike manner.

Through study, the court said Smith gained expertise in the breeding of cows and in the use of Normande cows for dairy purposes. He sought professional advice and successfully used in the cow activity his prior expertise gained from breeding dogs.

He spent an average of 20-30 hours per week on his cow and dairy farm activity.

There was evidence that the Goose Hill property appreciated in value from $600 per acre to $2,500 per acre in less than 10 years, and that the Columbus Dairy property increased in value from $500 per acre to $1,500 per acre. The court took this into consideration.

The court said that Smith operated the dog breeding activity at a loss before entering the cow and dairy farm activity. “Although Zane was not financially successful in the dog breeding activity, he was successful in gaining expertise in animal husbandry and related topics involving the care and breeding of animals.”

The court noted that although there were extensive operating losses, “the potential for increased revenues from the sale of organic milk could address the deficit.”

The court noted that Smith’s outside income provided the potential for substantial tax benefits from farm losses. As to the question of whether he operated the activity for recreation or pleasure, the court said that although Smith “has a keen interest in cows, especially the Normande breed, his focus in this activity has been to seek a profit from a dairy operation. We note that the Normande breed was not traditionally used for dairy purposes in the United States. However, Smith believed that they had great potential for high quality and quantity production.”

While the court held that his dog breeding activity was a hobby, it held that his cow and dairy activity “was more business and less pleasure oriented,” and upheld his tax deductions.

The court seems mainly impressed by the fact that Smith sought and obtained organic farming certification, that he had a sevenyear business plan, and that he took an innovative approach in utilizing the particular breed for dairy purposes. The court was also impressed by the fact that he sought expert advice on the economics of the venture. In Smith’s case the favorable elements outweighed the fact that he did not keep very much by way of formal business records. — John Alan Cohan

[John Alan Cohan is an attorney who has served the livestock, farming and horse industries since 1981. He can be reached at: 310- 278-0203 or by email at His website is: www.]