Question

Logan owns a horse ranch. Logan dislikes horses, but he opened the ranch because he

heard it was a lucrative business and he wanted to make money. Logan’s horse ranch has

lost money every year for the past 5 years (including this year), but Logan has made

some changes to business operations, including hiring a consultant and increasing his

prices. Logan anticipates that as a result of these changes, his horse ranch will generate

a profit in the next year or two.

This year, Logan hired his brother, Luke, to work at the horse ranch. Logan pays Luke

$500/hr to clean the horse stalls. Logan also hired his best friend, Lucy, to do Logan’s

grocery shopping and other personal errands. He pays Lucy $15/hr.

Which of the following is most accurate?

1

a-) Logan cannot deduct any of the costs associated with the horse ranch because the horse ranch

would be classified as a hobby, not a business

b-) Logan can deduct the full salary paid to Luke because Luke works in Logan’s horse ranch

business

c-) Logan can deduct the full salary paid to Lucy because the amount of the expense is reasonable

d-) Logan can deduct the full salary paid to Lucy because grocery shopping is ordinary and

necessary

e-) None of the above are correct

Answer 1

Answer is option A

a-) Logan cannot deduct any of the costs associated with the horse ranch because the horse ranch would be classified as a hobby, not a business

To be classified as business, the horse ranching activity is required to have a profit motive and needs to earn profit in at least two years of the last seven years. In case of other hobbies, the activity needs to clear a Three-years-of-profit test (required to earn profit in at least three of the last five years). Logan has profit motive but in five years logan has not earned profit and thus for now, it will be treated as expense related to hobby and hobby expenses are deducted to the limit of hobby income and expenses more than the hobby income are considered as nondeductible personal losses.