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Taxpayers' Ranching and Ecotourism Losses Can't Be Used to Offset Other Income

(Parker Tax Publishing June 2024)

The Tax Court held that a couple who purchased 15,070 acres of land in South Texas with the intent to improve and sell it, but later decided to conduct ecotourism and farming operations on the land, did not engage in those activities with an intent to make a profit under Code Sec. 183 and therefore could not use losses resulting from the activities to offset taxable income from their real estate investments. The court also held that under Reg. Sec. 1.183-1(d) the taxpayers were required to their ecotourism and farming activities as separate from their real estate activities. Schwarz v. Comm'r, T.C. Memo. 2024-55.


Dr. Gary Schwarz is a successful dentist and oral surgeon. He was raised in South Texas, where his grandparents owned two ranches. Dr. Schwarz and his wife, Marlee, have a history of conducting real estate activities in South Texas, mostly involving ranch land.

In 2005, the Schwarzes bought 15,070 acres of land in Zapata County with the intent to improve and sell it. They later decided to conduct ecotourism operations consisting of hunting, fishing, and events on a portion of the land. In the years at issue, 2015-17, a partnership owned by the Schwarzes named TI conducted ecotourism activity on a portion of the Zapata County land. TI also conducted farming and construction operations on the Zapata County land and other properties owned by the Schwarzes, related entities, and third parties.

TI filed Schedule F, Profit or Loss From Farming, with its return for each year 2005-20. TI reported income and expenses for both ecotourism and farming/construction operations on Schedule F. TI reported Schedule F gross income totaling over $14 million for years 2005 - 20. Large expenses resulted in TI's reporting a Schedule F net loss for each year. These net losses total over $15 million for years 2005-20. TI's Schedule F losses flowed through to the Schwarzes, who used them to offset significant taxable income.

The IRS issued the Schwarzes a notice of deficiency for years 2015-17. The IRS determined that TI's Schedule F activity was not engaged in for profit under Code Sec. 183. Multiple adjustments flowed from this determination, including the disallowance of deductions for TI's Schedule F losses. The IRS also determined that a 20 percent accuracy-related penalty applied for each year at issue.

The Schwarzes filed a Tax Court petition challenging the IRS's determinations. They contended that TI's Schedule F activity was engaged in for profit and that it and the real estate activities that the Schwarzes and related entities conducted were a single activity. They also contended they had a reasonable cause defense to penalties due to their good faith reliance on Russell Guthrie, an experienced CPA who prepared their returns for the years at issue.

Hobby Loss Rules

Taxpayers are generally allowed deductions for business-related expenses under Code Sec. 162. However, Code Sec. 183(a) provides that taxpayers are not allowed a deduction "if such activity is not engaged in for profit." An activity is engaged in for profit if the taxpayer entertained an actual and honest profit objective in engaging in the activity. Whether the requisite profit objective exists is determined by looking at all the surrounding facts and circumstances.

Under Reg. Sec. 1.183-1(d)(1), to determine whether an intent to make a profit exists, the activity at issue must first be ascertained. Where a taxpayer is engaged in several undertakings, each may be a separate activity. However, a taxpayer's multiple activities may be treated as one activity if the activities are sufficiently interconnected. All of the facts and circumstances must be taken into account in ascertaining the activity or activities of the taxpayer. The regulation also provides that the most significant facts and circumstances to consider are: (1) the degree of organizational and economic interrelationship of the undertakings, (2) the business purpose served by carrying on the undertakings separately or together, and (3) the similarity of the undertakings.

For purposes of determining whether a taxpayer's activity is engaged in with the intent to make a profit, Reg. Sec. 1.183-2(b) provides a nonexhaustive list of nine factors that should be considered: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or the taxpayer's advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar activities; (6) the taxpayer's history of income or loss with respect to the activity; (7) the amount of occasional profits, if any; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved.


The Tax Court held that (1) TI"s Schedule F activity and the Schwarzes' real estate activities were separate activities, (2) TI's farming activity was not engaged in for profit in the years at issue, and (3) the Schwarzes were not liable for accuracy-related penalties.

The court found that the Schwarzes' characterization of their farming and real estate activities as one activity was artificial and unreasonable. The court reasoned that the Schwarzes are intelligent people who knew for certain that they will never profit from TI's ecotourism or TI's farming activity as a whole. They thus sought to tie the farming activity to the profitable real estate activities. But the court found that these ties were weak, and the Schwarzes' position was contrary to the language and intent of Reg. Sec. 1.183-1(d)(1). The court noted that the Schwarzes chose to structure entities they partially or wholly owned in such a way that TI's Schedule F activity was separate from the real estate activities. The court further found that TI's Schedule F expenses as a whole did not substantially relate to the real estate activities, and that the Schedule F and real estate activities had distinct objectives.

The court further held that TI's farming activity was not engaged in with the intent to make a profit after finding that most of the factors set forth in Reg. Sec. 1.183-2(b) favored the IRS. Of these, the court believed that the factors pertaining to TI's history of losses and lack of profits were the most significant. The court found that year after year, TI's farming activity continued to lose money, and there was no indication it would ever be profitable. The court believed that Dr. Schwarz was following his longtime passion for deer and ranch development and pursued this independently of any desire to earn a profit. The court observed that the Schwarzes had money to do this, especially when they knew that the real estate market was strong. Considering all the facts and circumstances, the court concluded that the Schwarzes did not have an actual and honest profit objective.

In addition, the court held that accuracy-related penalties did not apply because the Schwarzes relied in good faith on the judgment of Guthrie, an experienced CPA. The court noted that this was a complex Code Sec. 183 case in which well over 10,000 pages of documents were admitted into evidence. In the court's view, while the Schwarzes may not have provided Guthrie with every (potentially) relevant document, they made a reasonable attempt to do so. The court also found that, while the Schwarzes are educated and intelligent individuals, they had little knowledge with respect to taxes.

For a discussion of the rules for determining what constitutes an activity for purposes of Code Sec. 183, see Parker Tax ¶97,520. For a discussion of the rules for determining whether or not an activity is engaged in for profit, see Parker Tax ¶97,505. For a discussion of the abatement of penalties due to reasonable cause and acting in good faith, see Parker Tax ¶262,127.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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