The determination of whether an activity is engaged in for profit under Internal Revenue Code Section 183 constitutes a frequent area of dispute between taxpayers and the Internal Revenue Service. For tax professionals, understanding how the Tax Court weighs the nine factors provided in the Treasury Regulations is essential for advising clients with dual-purpose activities or significant losses.

In the recent case of Kolar v. Commissioner, T.C. Memo. 2026-15, the Tax Court addressed the deductibility of farm expenses incurred by a taxpayer attempting to revitalize a multi-generational family ranch. Despite a history of significant losses and substantial income from other sources—factors often fatal to a profit motive argument—the Court ruled in favor of the taxpayer. This article details the factual background, the Court’s specific application of the Section 183 factors, and the rationale leading to the decision.

Facts of the Case

The petitioner, Kenward F. Kolar, Jr., owned and operated the "Kolar Ranch," a property spanning approximately 836 acres in south central Texas. The ranch had been in the petitioner’s family since the late 1800s and had historically engaged in diverse agricultural operations, including dairy and beef cattle, poultry, and pecan production.

Mr. Kolar possessed relevant educational credentials, holding a bachelor’s degree in animal science and biology and a master’s degree in water supply and wastewater disposal. Following the death of his father and the incapacity of his mother, Mr. Kolar assumed full management of the ranch in 2016. By this time, the property had "fallen into disrepair" and required significant infrastructure restoration, including clearing nuisance trees (huisache) and rebuilding fences.

Mr. Kolar’s objective was to rebuild the beef cattle herd to approximately 250 head. He estimated that returning the operation to profitability would require five to six years. During the years at issue, the ranch also generated significant non-agricultural revenue. From 2017 through 2022, Mr. Kolar reported royalty income of $2,349,780 from oil and gas extraction on the property.

The ranch faced severe external setbacks. These included Hurricane Harvey in 2017, the death of three employees due to COVID-19 in 2020, and a severe winter storm in 2021 that caused pipes to burst and resulted in the death of cattle due to thirst.

The Taxpayer’s Request for Relief

In a Notice of Deficiency dated December 24, 2018, the IRS determined a deficiency of $292,247 for the 2016 tax year, along with associated additions to tax. The petitioner conceded to unreported gross income adjustments and penalties but contested the limitation on farm expenses.

The sole issue remaining for the Court was "whether section 183, concerning activities not engaged in for profit, limits the deductibility of an additional $205,514 of farm expenses petitioner incurred for 2016". The petitioner argued that the ranching activity was a for-profit endeavor, thereby allowing the deductions in excess of income.

Analysis of the Law: Defining the Activity

Before applying the nine factors of Treasury Regulation § 1.183-2(b), the Court first had to ascertain the scope of the "activity" at issue. The petitioner argued for a broad definition, asserting that the relevant activity included the cattle ranching, land appreciation, and the exploitation of oil and gas resources, noting that improvements like roads and fences served all enterprises.

The Court rejected this aggregation. Citing Young v. Commissioner, T.C. Memo. 2025-95, the Court noted that for land appreciation to be grouped with ranching, "the ranching activity would need to be independently profitable... such that the ranching activity supports the holding of the land for appreciation". Since the ranch was generating losses, this condition was not met.

Furthermore, the Court deemed the oil and gas extraction a "fundamentally different enterprise from cattle ranching," stating that "geographic proximity" and shared infrastructure were insufficient to combine them for Section 183 purposes. Consequently, the Court isolated the "ranching activity generally" (including water sales for cattle) as the specific activity to be tested for profit motive.

Application of the Law to Facts

The Court applied the nine non-exhaustive factors found in Treas. Reg. § 1.183-2(b) to determine if Mr. Kolar entertained an "actual and honest profit objective".

Manner in Which the Activity is Conducted The Court found that Mr. Kolar operated in a businesslike manner. The petitioner maintained a separate checking account and employed a multi-step recordkeeping process managed by his wife, which included daily logs, weekly reviews, and monthly spreadsheets. Although the IRS argued that the lack of a formal written business plan indicated a lack of profit motive, the Court disagreed. The Judge noted, "Mr. Kolar’s testimony regarding the steps he intended to undertake... credible and the steps themselves sufficient to constitute a business plan". This factor favored the petitioner.

Expertise of the Taxpayer The Court weighed this factor in favor of the petitioner, citing his decades of experience and academic degrees in animal science. The Court rejected the IRS’s argument that Mr. Kolar lacked economic expertise, noting his credible testimony regarding "prices of various types of cattle and which cattle markets offered the best prices".

Time and Effort Expended Mr. Kolar engaged in ranching as a full-time occupation. The Court observed, "Mr. Kolar was not a cattle ranch dilettante; he had been working on the Kolar ranch most of his life". This factor supported a profit motive.

Expectation of Appreciation in Value Because the Court had previously ruled that the ranching activity was distinct from holding the land for appreciation, the Court took a "neutral view as to this factor’s implications".

Success in Similar or Dissimilar Activities The petitioner attempted to argue that his success in oil and gas and rental real estate supported his entrepreneurial capability. The Court found these activities "dissimilar to ranching" and saw "no basis for extrapolating success in those activities to ranching". This factor was deemed neutral.

History of Income and Losses The IRS highlighted that the petitioner reported losses in excess of $2 million against gross receipts of only $25,874 between 2017 and 2022. The Court acknowledged that the "size of Mr. Kolar’s reported losses relative to gross receipts is troublingly large". However, the Court accepted the petitioner’s explanation regarding the startup phase required to restore the degraded ranch and the "unforeseeable setbacks" including the pandemic and weather events. On net, the Court ruled this factor weighed "slightly against" a profit motive.

Amount of Occasional Profits Given the lack of significant profits during the relevant period, this factor also weighed "slightly against a finding of a profit motive".

Financial Status of the Taxpayer This was the most significant factor weighing against the taxpayer. The Court noted that Mr. Kolar had "substantial income from a nonranching activity, specifically from oil and gas royalties". The regulation suggests that substantial independent income, particularly if losses generate tax benefits, may indicate a lack of profit motive.

Elements of Personal Pleasure or Recreation The Court strongly dismissed the IRS’s arguments regarding personal pleasure. The IRS pointed to the petitioner’s wife riding "pet horses" and the petitioner’s desire to bond with his son. The Court found the pet horses irrelevant to the ranching activity analysis. Regarding the son, the Court stated, "we do not view training one’s children to farm and ranch in the hope that they will one day take over the family business as inconsistent with a profit motive". The Court viewed the petitioner’s long hours and lack of recreational attendance at cattle shows as evidence supporting a profit motive.

Conclusion

In its qualitative analysis, the Tax Court concluded that the petitioner satisfied the requirements of Section 183. While the financial status and history of losses weighed against the taxpayer, they were outweighed by the businesslike manner of operations, the taxpayer’s expertise, and the significant time and effort expended.

The Court explicitly stated that while the substantial royalty income was the "largest factor weighing against a profit motive," it did "not outweigh the other factors in favor of a profit motive". The Court held that for the 2016 tax year, the Section 183 limitation did not apply, allowing the petitioner to deduct the contested farm expenses.

Prepared with assistance from NotebookLM.