In a recent memorandum opinion, Young v. Commissioner, T.C. Memo. 2025-95, the U.S. Tax Court provides a detailed application of the "hobby loss" rules under Internal Revenue Code (IRC) § 183. The case serves as a reminder for tax professionals of the rigorous, fact-intensive analysis required to defend a client’s claimed business losses, particularly when the activity involves elements of personal pleasure or recreation. The court ultimately sided with the Commissioner, disallowing substantial farm losses and upholding accuracy-related penalties against the taxpayers. This article will examine the facts, legal analysis, and key takeaways from the Young decision.

Factual Background

The case involved Wesley and Janet Young, who claimed significant losses from their "Pecandarosa Ranch" on their 2013 and 2014 joint tax returns. The IRS, in a notice of deficiency, determined the ranch was an "activity not engaged in for profit" under § 183 and disallowed the associated deductions.

Taxpayer Backgrounds: Ms. Young had a strong business and financial background, having worked as a stockbroker and overseeing accounting and HR for ETI, Inc., a successful S corporation owned by her late first husband and later by her. Mr. Young had extensive practical experience in ranching, including pecan harvesting, hay baling, and managing cattle and horses. He was also a long-time participant in competitive team roping.
Pecandarosa Ranch: In 2008, Ms. Young and her late first husband, Mr. Todd, purchased the 82.7-acre Pecandarosa Ranch for $2 million. The property included a residence, a guesthouse, and a pecan grove with approximately 490 mature trees. After Mr. Todd’s death in 2011, Ms. Young married Mr. Young in 2012. In early 2012, construction began on a 22,590-square-foot arena on the property, which was completed in July 2013. Mr. Young began working full-time at the ranch upon its completion.
Financial History: From 2008 to 2022, the taxpayers reported substantial income from other sources, including over $2.9 million in wages and nearly $16 million in passthrough income from ETI. During this same period, they reported a total of $2,953,041 in losses from Pecandarosa Ranch, which consistently offset their other income. For the years at issue, 2013 and 2014, the ranch reported net losses of $257,656 and $305,893, respectively.
Business Practices: During the years in question, the Youngs used a personal bank account for the ranch, which was operated as a sole proprietorship. They did not maintain a general ledger, although they provided receipts and invoices to their accountant for tax preparation. A formal business plan was only created after the IRS audit began in 2015. Many formal business practices—such as using QuickBooks, forming an LLC, and opening a business bank account—were also implemented after the audit commenced.

The Taxpayers’ Request for Relief

The Youngs petitioned the Tax Court, arguing that their Pecandarosa Ranch was a legitimate for-profit enterprise and that their claimed losses should be allowed in full. They contended they had a genuine profit motive, citing Mr. Young’s extensive expertise, the time and effort they both invested, and various external setbacks—such as drought and the illness and death of Ms. Young’s first husband—that hindered profitability in the early years. They also argued that any accuracy-related penalties were unwarranted because they acted with reasonable cause and in good faith by relying on their tax preparer.

The Court’s Analysis of the Law

The court’s analysis centered on IRC § 183, which governs "activities not engaged in for profit".

IRC Section 183 Framework

General Rule (§ 183(a)): The statute provides that if an individual engages in an activity that is "not engaged in for profit, no deduction attributable to such activity shall be allowed" except as provided within the section.
Allowable Deductions (§ 183(b)): For such activities, deductions are limited. A taxpayer can deduct items that are allowable regardless of profit motive (e.g., certain taxes). Other deductions are allowed only to the extent that the gross income from the activity exceeds the first category of deductions.
Defining the Activity: Before assessing profit motive, the court must first ascertain the "activity" in question. Citing Treas. Reg. § 1.183-1(d)(1), the court noted that multiple undertakings can be treated as one activity if they are sufficiently interconnected. However, a special rule applies to farming activities on land held primarily for appreciation. Under this special rule, the farming and landholding are considered a single activity only if the income from farming exceeds the farming-related deductions, thereby reducing the net cost of holding the land.

The Nine Factors of Treasury Regulation § 1.183-2(b)

To determine if a taxpayer has the requisite "actual and honest profit objective" (Dreicer v. Commissioner, 78 T.C. 642 (1982)), courts evaluate the facts and circumstances, giving more weight to objective facts than to the taxpayer’s stated intent. The regulations provide a non-exhaustive, nine-factor test to guide this determination. No single factor is decisive.

Application of the Law to the Facts

Ascertaining the Activity

The court first addressed the scope of the "activity". The parties agreed that the various ranch undertakings (pecan farming, team roping, hay/cattle, etc.) should be treated as a single activity, a characterization the court accepted as reasonably supported by the facts.

However, the parties disputed whether the holding of the land itself should be integrated with the ranching activity. The court found that the special rule in Treas. Reg. § 1.183-1(d)(1) for land held for appreciation did not apply, as both parties argued this was not the primary purpose for holding the property. Applying the general "facts and circumstances" test, the court concluded that the landholding was a separate activity from the ranching operations. The court’s reasoning was that the property’s significant function as a personal residence, evidenced by Ms. Young’s own testimony, weighed against integration. The later division of the property into residential and business tracts and the attempt to sell the residence separately further supported this conclusion.

The Nine-Factor Analysis

The court then applied the nine factors from Treas. Reg. § 1.183-2(b) to the standalone ranching activity:

Manner of Operation: This factor favored the IRS. The court found the Youngs’ operations were not businesslike during the years at issue. They commingled funds in a personal bank account, failed to maintain a general ledger despite Ms. Young’s accounting experience, and lacked a contemporaneous business plan. The spreadsheets they used were deemed sufficient only for tax preparation, not for informed business decision-making. Actions to formalize the business occurred only after the IRS audit began.
Expertise: This factor was neutral. While Mr. Young had extensive ranching experience, the court found no clear evidence he applied it to improve profitability during 2013-2014. Ms. Young had a business background but no ranching experience.
Time and Effort: This factor favored the Youngs. Mr. Young worked full-time on the ranch after resigning from his prior job, and both taxpayers were physically active in its operations, sometimes working late into the night.
Expectation of Asset Appreciation: This factor favored the IRS. With landholding excluded from the activity, the court found no bona fide expectation that other assets (e.g., structures or horses) would appreciate enough to recoup the massive operating losses.
Success in Similar Activities: This factor was neutral. Neither taxpayer had a history of turning unprofitable enterprises into profitable ones. Mr. Young was an employee, and ETI, managed by Ms. Young, was consistently profitable.
History of Income or Losses: This factor favored the IRS. The ranch had a long and unbroken history of substantial losses from 2008 through 2022, totaling nearly $3 million. The court acknowledged setbacks like drought but found the losses continued long after any "startup" phase and were too significant to be explained away.
Amount of Occasional Profits: This factor favored the IRS. The ranch never reported a profit on its tax returns. The court concluded there was no opportunity for a substantial ultimate profit that could justify the ongoing losses.
Financial Status of Taxpayer: This factor favored the IRS. The Youngs had substantial income from ETI and wages, which allowed them to sustain the ranch’s losses. The tax benefits generated by the losses were significant, offsetting their other high income.
Elements of Personal Pleasure: This factor favored the IRS. Mr. Young had a long-standing passion for team roping, a competitive sport, which he engaged in long before it was part of the ranch’s operations. The court noted that the ranch made major investments related to this activity, such as constructing the large arena. This significant recreational element was a strong indicator of a lack of profit motive.

Court’s Conclusions

Section 183 Profit Motive

Weighing the nine factors, the court concluded that six favored the IRS, one favored the taxpayers, and two were neutral. Based on this analysis, the court held that the Youngs did not have an actual and honest objective to operate Pecandarosa Ranch for a profit during 2013 and 2014. The court found the record confusing and imprecise regarding the timing of business plans and operations, ultimately giving little weight to evidence of ventures that began after the years at issue. The disallowance of the Schedule F losses was therefore sustained.

Section 6662 Accuracy-Related Penalties

The court also sustained the 20% accuracy-related penalties for a substantial understatement of income tax under § 6662(b)(2). The IRS met its burden of production, including showing timely supervisory approval for the penalty assertion under § 6751(b). The Youngs failed to establish a reasonable cause and good faith defense under § 6664(c). Their claim of reliance on their accountant, Ms. Burch, was unpersuasive because mere preparation of a tax return does not constitute "advice" that can be relied upon to avoid penalties (Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43 (2000)). There was no credible evidence that Ms. Burch provided substantive advice on the § 183 issue or that the Youngs took any meaningful steps to assess their proper tax liability.

Prepared with assistance from NotebookLM.