Could a New Mexico rancher deduct Schedule F losses when the ranch had recent net losses but was operated in a businesslike manner with an intent to profit?

Plain-English summary

Ernesto Hurtado's cattle ranch was a for-profit business, so New Mexico had to allow its Schedule F loss deductions and abate the ranch-related part of the assessment. A separate portion tied to Nancy Hurtado's business remained due because the taxpayers withdrew that part of the protest.

The Department assessed personal income tax for 2009 through 2015:

• $20,063.00 tax;
• $3,676.30 penalty; and
• $2,057.78 interest.

The parties did not determine how much of those amounts belonged to Nancy Hurtado's business, but agreed that most of the assessment arose from Ernesto Hurtado's ranch losses.

Hurtado argued that New Mexico could not disallow a federal Schedule F deduction that the federal government had accepted. He also argued that the ranch was a real business rather than a personal or hobby activity under Section 183.

New Mexico could determine the correct federal AGI

New Mexico personal income tax begins with federal adjusted gross income. The AHO relied on Holt v. New Mexico Department of Taxation and Revenue to hold that the Department may examine evidence and apply federal law to determine the correct federal AGI for state-tax purposes.

IRS acceptance of the filed return therefore did not prevent New Mexico from reviewing whether the ranch expenses were deductible. The substantive question remained whether the activity was engaged in for profit.

The ranch operated in a businesslike manner

Section 183 and Regulation 1.183-2 supplied nine nonexclusive profit-motive factors. No single factor or simple majority automatically controlled, but the AHO found five factors favored Hurtado, two were neutral, and two weighed against him.

The businesslike factors included:

• he maintained ranch records and a separate bank account;
• he used formal grazing leases, loans, and installment agreements;
• he paid for improvements from ranch income and credit;
• he bought 20 irrigated acres to grow hay and reduce feed costs; and
• he carried cattle insurance to mitigate losses.

Hurtado lacked a formal written business plan during the audit, but had later created one. The overall manner of operation still favored profit motive.

Expertise, time, and asset appreciation supported the business purpose

Hurtado had ranched since childhood, earned a bachelor's degree in agricultural studies, belonged to the Farm Bureau, and regularly consulted Farm Service agents, County Extension agents, family members, and neighboring ranchers.

He held a separate full-time BLM job but also considered ranching a second full-time job and devoted several hours each week to it.

He invested heavily in land, cattle, and equipment and expected the improved assets to appreciate. The ranch produced annual gross income ranging from about $15,000 to more than $100,000. Much of the reported net loss came from capital expenditures and depreciation rather than absence of receipts.

Loss history and outside wages did not outweigh the other evidence

Recent net losses and the absence of demonstrated net profit weighed against Hurtado. His outside wages showed he did not depend on the ranch for his livelihood, but he did not use those wages to fund it; ranch income and credit supported the operation. That factor was neutral.

Hurtado enjoyed ranching, but treated it as hard work rather than recreation. That factor was also neutral.

On the full record, the AHO found a genuine profit objective and allowed the business deductions under Section 162.

Result: protest GRANTED IN PART and DENIED IN PART. The Department was ordered to abate the tax, penalty, and interest attributable to Ernesto Hurtado's ranch. The balance attributable to Nancy Hurtado's business remained due; the decision did not calculate either portion.

What this means for you

Ranchers and agricultural businesses reporting losses

Repeated losses do not automatically make an activity a hobby. Business records, operational changes, expertise, time, risk management, financing, and expected asset appreciation all matter.

Taxpayers relying on federal-return acceptance

New Mexico may independently apply federal tax law to determine the correct federal AGI used on the state return. IRS processing alone does not settle the state issue.

Businesses with capital-intensive deductions

Distinguish cash receipts from taxable profit. Depreciation and capital expenditures can create tax losses even while the activity produces revenue and funds improvements.

Taxpayers presenting a profit-motive case

Organize evidence around all nine regulatory factors. A written plan helps, but this decision treated the total operation—not one missing document—as controlling.

Common questions

Q: Was the ranch profitable during the audited years?
A: It generated gross income but reported recent net losses, largely because of capital expenditures and depreciation.

Q: Did Hurtado keep separate business records?
A: Yes. He maintained records and a separate ranch bank account and used formal agreements for grazing and financing.

Q: Why did his outside BLM job not defeat profit motive?
A: He did not use those wages to finance the ranch. The operation was supported through ranch income and credit, so outside employment was treated neutrally.

Q: Did enjoying ranch work make it a hobby?
A: No. He enjoyed it but devoted substantial effort and treated it as hard work rather than recreation.

Q: Could New Mexico recalculate a federally accepted deduction?
A: Yes. The AHO held that the Department could determine the correct federal AGI required for New Mexico tax.

Q: How much of the assessment was abated?
A: The ranch-related portion, including associated penalty and interest, was abated. The ruling did not calculate the ranch and wife-business portions separately.

Citations and references

Statutes and regulation:

• 26 U.S.C. § 162 — trade or business expense deductions
• 26 U.S.C. § 183 — activities not engaged in for profit
• 26 C.F.R. § 1.183-2 — nine profit-motive factors
• NMSA 1978, §§ 7-2-2 and 7-2-3 — federal AGI base and New Mexico personal income tax
• NMSA 1978, §§ 7-1-17 and 7-1-3 — assessment presumption and tax definition

Cases cited:

• Holt v. New Mexico Department of Taxation and Revenue, 2002-NMSC-034 — Department authority to determine correct federal AGI for state tax
• Harrington v. Commissioner, T.C. Summary Opinion 2002-58 — profit-motive factors applied to a horse-breeding activity
• Stephens v. Commissioner, T.C. Memo. 1990-376 — records, contracts, research, loss mitigation, and time as profit indicators
• Davis v. Commissioner, T.C. Memo. 2000-101 — businesslike records and operational changes supporting profit motive

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Ernesto and Nancy Hurtado
• Decision PDF: D&O 19-03

Original ruling text

STATE OF NEW MEXICO
ADMINISTRATIVE HEARINGS OFFICE
TAX ADMINISTRATION ACT

IN THE MATTER OF THE PROTEST OF
ERNESTO AND NANCY HURTADO D&O No. 19-03
TO THE ASSESSMENT ISSUED UNDER
LETTER ID NO. L0058191408

v.

NEW MEXICO TAXATION AND REVENUE DEPARTMENT

DECISION AND ORDER

A formal hearing on the above-referenced protest was held on December 20, 2018 before

Hearing Officer Dee Dee Hoxie, Esq. The Taxation and Revenue Department (Department) was

represented by Mr. Marek Grabowski, Staff Attorney. Ms. Milagros Bernardo, Auditor, also

appeared on behalf of the Department. Mr. Ernesto Hurtado (Taxpayer) appeared for the hearing

with his attorney, Mr. Tracy Sprouls. The Taxpayer’s brother, Mr. Elias Hurtado, was also

present for the hearing. The Taxpayer, his brother, and Ms. Bernardo testified.

The parties stipulated to all exhibits. Taxpayer’s exhibits 1 through 3 were admitted.

The Department’s exhibits “A” through “D” were admitted. A more detailed description of

exhibits submitted at the hearing is included on the Administrative Exhibit Coversheet.

References to the audio recording of the hearing shall be cited by hour, minute, and seconds as

AR 00:00:00 1. The Hearing Officer took notice of all documents in the administrative file.

1
Due to the nature of making arguments and providing testimony, many facts or ideas are mentioned or repeated
multiple times throughout the hearing. Generally, only one specific reference will be provided.
The main issue to be decided is whether the Taxpayer is liable for the assessment. The

Taxpayer withdrew the protest as to the amount attributable to Nancy Hurtado’s business. The

parties did not know how much tax, penalty, and interest should be attributed to the portion of

the assessment related to Nancy Hurtado’s business, but they agree that the bulk of the

assessment relates to the Taxpayer’s ranching operation. The parties agree that the determination

on the remainder of the assessment hinges on whether the Taxpayer’s ranching operation should

be considered as a for-profit business or not under 26 USCS § 183. As a preliminary issue, the

Taxpayer also challenges the Department’s authority to recalculate the Taxpayer’s federal

adjusted gross income by disallowing a federal deduction when it has been accepted by the

federal government. The Hearing Officer considered all of the evidence and arguments

presented by both parties. The Hearing Officer finds that the Department has the authority to

recalculate a person’s tax. The Hearing Officer finds that the Taxpayer’s ranching operation is a

for-profit business. IT IS DECIDED AND ORDERED AS FOLLOWS:

FINDINGS OF FACT

1. On September 13, 2016, the Department assessed the Taxpayer for personal income tax,

penalty, and interest for the tax periods from January 1, 2009 through December 31,

2015. The assessment was for $20,063.00 tax, $3,676.30 penalty, and $2,057.78 interest.

2016. On October 11, 2016, the Taxpayer filed a formal protest letter.

2017. On November 30, 2016, the Department filed a Request for Hearing asking that the

Taxpayers’ protest be scheduled for a formal administrative hearing.

4. On December 1, 2016, the Hearings Office issued a notice of telephonic scheduling

hearing.

Ernesto and Nancy Hurtado
Letter ID No. L0058191408
page 2 of 12

5. The telephonic scheduling hearing was conducted on December 16, 2016. The hearing

was held within ninety days of the protest.

6. After the Taxpayer requested a continuance of the formal hearing, a second telephonic

scheduling hearing was conducted on July 28, 2017.

7. The Taxpayer has been engaged in ranching since he was a child. (AR 00:24:24-29)

8. The Taxpayer has a full-time job working with the BLM. (AR 00:17:22-28)

9. The Taxpayer also considers his ranching operation to be a full-time job and spends

several hours every week dedicated to it. (AR 00:30:00-00:32:55)

10. The Taxpayer’s ranching operation primarily involves breeding cows and selling their

calves. (AR 00:17:45-47)

11. The Taxpayer did not have a formal business plan for the ranching operation during the

audit, but he does have a written plan now. (AR 00:56:05-39)

12. The Taxpayer’s ranching operation also raises crops to help feed his cows. (AR

00:18:26-41)

13. To keep his herd healthy and genetically diverse, the Taxpayer sometimes sells the

mother cows or bulls and purchases new livestock with desirable traits. (AR 00:27:04-

50)

14. The Taxpayer obtained a bachelor’s degree in agricultural studies in 1981. (AR

00:19:56-59)

15. The Taxpayer inherited the ranching operation and became its sole operator when his

father died in 2010. (AR 00:35:10-35)

16. The Taxpayer’s family and neighbors are also involved in ranching, and they regularly

work together and discuss operations. (AR 00:25:33-43)

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Letter ID No. L0058191408
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17. The Taxpayer is a member of the Farm Bureau. (AR 00:25:09)

18. The Taxpayer consults with Farm Service agents and County Extension agents about his

ranching operation. Topics that the Taxpayer has received help with include varieties of

hay, fencing, and other ranch improvements. (AR 00:25:02-17)

19. To mitigate feed costs, the Taxpayer purchased 20 acres of irrigated land in 2012 that he

uses to grow hay to feed his cattle. (Exhibit 1; AR 00:43:49-59)

20. To mitigate losses, the Taxpayer also carries insurance on his cattle. (AR 00:26:07-10)

21. The Taxpayer maintains a separate bank account for the ranching operation. (AR

01:28:52-58)

22. The Taxpayer keeps records of his ranching operation. (Exhibit 1; AR 00:23:43-51; AR

01:04:15-38)

23. The Taxpayer did not share most of the ranching records with the Department because

the Department did not ask for them. (AR 00:24:00)

24. The Taxpayer offered to allow the Department’s auditor to come to the ranch and review

its operations in-person. (AR 00:21:27-31)

25. The Taxpayer has spent a considerable amount of money on land, livestock, and

equipment to improve his ranching operation. (Exhibit 1; AR 00:35:00-00:36:42)

26. The Taxpayer has grazing leases with the federal government. (AR 00:50:18-30)

27. The Taxpayer has gross income from the ranching operation that varies every year, from

approximately $15,000 to more than $100,000. (Exhibits 2, C, and D; AR 00:45:12-22)

28. The Taxpayer pays for the ranching operation’s expenses through the gross income that

the ranching operation makes every year. (AR 00:45:22-29)

Ernesto and Nancy Hurtado
Letter ID No. L0058191408
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29. The Taxpayer sometimes funds major purchases for the ranching operation through

contracts that are essentially loans or installment agreements. (AR 00:58:05-45)

30. The Taxpayer considers the ranching operation to be successful because the sales of

cattle allow him to make purchases, such as land and equipment, that lead to greater

efficiency in the ranching operation. (AR 00:37:50-57)

31. The Taxpayer believes the ranching operation has increased in value due to the capital

expenditures and improvements he has made. (AR 00:38:32-34)

32. The Taxpayer’s ranching operation is generally considered to be successful by his family

and neighbors. (AR 00:46:13-36)

33. The Taxpayer uses a software program to file his taxes, but he does not really understand

how or why the program does what it does. (AR 00:47:09-00:48:10)

34. The bulk of the Taxpayer’s reported losses on the ranching operation are due to the

capital expenditures and depreciation that are allowed to be deducted. (AR 01:27:40-

01:28:13)

35. The Taxpayer enjoys ranching. (AR 00:44:43-45)

36. The Taxpayer anticipates making a profit in the future when he does not have to keep

buying new equipment and taking the capital expenditure deductions. (AR 00:44:53-

00:45:15)

DISCUSSION

Burden of Proof.

Assessments by the Department are presumed to be correct. See NMSA 1978, § 7-1-17.

Tax includes, by definition, the amount of tax principal imposed and, unless the context

otherwise requires, “the amount of any interest or civil penalty relating thereto.” NMSA 1978, §

Ernesto and Nancy Hurtado
Letter ID No. L0058191408
page 5 of 12
7-1-3. See also El Centro Villa Nursing Ctr. v. Taxation and Revenue Department, 1989-NMCA-

070, 108 N.M. 795. Therefore, the assessment issued to the Taxpayer is presumed to be correct,

and it is the Taxpayer’s burden to present evidence and legal argument to show that he is entitled

to an abatement.

The burden is on a taxpayer to prove that he is entitled to an exemption or deduction. See

Public Services Co. v. N.M. Taxation and Revenue Dep’t., 2007-NMCA-050, ¶ 32, 141 N.M.

520. See also Till v. Jones, 1972-NMCA-046, 83 N.M. 743. “Where an exemption or deduction

from tax is claimed, the statute must be construed strictly in favor of the taxing authority, the

right to the exemption or deduction must be clearly and unambiguously expressed in the statute,

and the right must be clearly established by the taxpayer.” Sec. Escrow Corp. v. State Taxation

and Revenue Dep’t., 1988-NMCA-068, ¶ 8, 107 N.M. 540. See also Wing Pawn Shop v.

Taxation and Revenue Dep’t., 1991-NMCA-024, ¶ 16, 111 N.M. 735. See also Chavez v.

Commissioner of Revenue, 1970-NMCA-116, ¶ 7, 82 N.M. 97.

Personal income tax and authority to recalculate.

New Mexico imposes a personal income tax upon the net income of every resident. See

NMSA 1978, § 7-2-3 (1981). New Mexico’s adjusted gross income is based on the person’s

federal adjusted gross income. See NMSA 1978, § 7-2-2 (2014). The Taxpayer argues that the

Department has not been granted the authority by the Legislature to recalculate a Schedule F

deduction. The Taxpayer argues that the Holt case is limited to instances of extremely obvious

error. The holding in Holt is not so narrow. See Holt v. N.M. Dep’t. of Taxation and Revenue,

2002-NMSC-034, 133 N.M. 11. The court ultimately concludes, without qualification, “that the

Department has the authority to examine information or evidence in order to determine or

establish an individual’s tax liability.” See id. at ¶ 25. Moreover, the court finds that the

Ernesto and Nancy Hurtado
Letter ID No. L0058191408
page 6 of 12
reference to federal adjusted gross income in the statute “requires an analysis of federal law in

order to effectuate the intent of our Legislature for purposes of state taxation. In other words,

our statutes require, for purposes of determining state tax liability, the taxpayers’ correct federal

adjusted gross income.” See id. at ¶ 23. Consequently, the Department has the authority to

recalculate a Schedule F deduction. See id.

The parties agree that the assessment hinges upon whether the Taxpayer is allowed to

deduct his losses from his ranching operation. There is a federal deduction for expenses incurred

while engaging in any trade or business. See 26 USCS § 162. However, the deduction of losses

in excess of profits is disallowed when the activity engaged in is not a for-profit activity. See 26

USCS § 183.

For-profit activities.

The federal regulations list nine nonexclusive factors to aid in determining whether an

activity is a for-profit activity or not. See 26 CFR 1.183-2. These factors are: 1) the manner in

which the person carries on the activity; 2) the expertise of the person and his advisors; 3) the

time and effort put into the activity; 4) the expectation that assets may appreciate in value; 5) the

person’s success in carrying on similar or dissimilar activities; 6) the history of income or loss

with respect to the activity; 7) the amount of profits earned; 8) the financial status of the person;

and 9) the elements of personal pleasure and recreation. See id. The determination is fact

intensive. None of the nine factors alone is dispositive, nor is a majority dispositive. See

Harrington v. Comm’r of Internal Revenue, No. 5679-00S, T.C. Summary Op. 2002-58 (non-

precedential) (holding that the taxpayer’s lack of business plan, lack of budget, and failure to

make adjustments to operation showed that the horse-breeding was not engaged in for-profit

even though the land had shown appreciation). See Hurd v. Comm’r of Internal Revenue, T.C.

Ernesto and Nancy Hurtado
Letter ID No. L0058191408
page 7 of 12
Memo 1978-113, 37 T.C.M. 449 (holding that large losses over an extended period of time

without making substantial changes in the operation to try to mitigate those losses indicated that

the activity was not engaged in for-profit). See Stephens v. Comm’r of Internal Revenue, T.C.

Memo 1990-376, 60 T.C.M. 197 (holding that keeping meticulous records, engaging in formal

written contracts, extensive research, efforts to mitigate losses, and the substantial time involved

indicated that the activity was engaged in for-profit). See Davis v. Comm’r of Internal Revenue,

T.C. Memo 2000-101, 79 T.C.M. 1730 (holding that maintaining complete and accurate books

and records, conducting transactions in a businesslike manner, and changing operations to try to

realize a profit indicated that the activity was engaged in for-profit).

The manner in which a person engages in an activity has to do with the formality and

normal business practice used. See 26 CFR 1.183-2. The Taxpayer did not have a formal

business plan at the time of the audit, but he has developed one now. The Taxpayer contracts

with other property owners and the federal government for grazing rights. The Taxpayer buys

land and equipment with formal loan or payment installment agreements. The Taxpayer

maintains a separate bank account for the ranching operation. The Taxpayer pays for ranch

improvements with the income brought in by the ranching operation. The Taxpayer contributes

time and effort to support his family and neighbors’ operations, and they likewise contribute to

his ranching operation. The Taxpayer maintains records on his ranching operation. Therefore,

this factor weighs in favor of finding that the operation was for-profit.

Preparation, study, and consultation of experts can indicate that the activity is engaged in

for-profit. See id. The Taxpayer has a family history of ranching. The Taxpayer has a

bachelor’s degree related to agriculture. The Taxpayer is a member of the Farm Bureau and

consults regularly with Farm Service agents and County Extension agents. The Taxpayer also

Ernesto and Nancy Hurtado
Letter ID No. L0058191408
page 8 of 12
consults regularly with others who are engaged in similar ranching ventures. Therefore, this

factor weighs in favor of finding that the activity was for-profit.

The Taxpayer spends a substantial amount of time and effort in his ranching operation.

The Taxpayer considers the ranching operation to be a second full-time job. This factor weighs

in favor of finding that the activity is for-profit.

The Taxpayer expects that his assets will appreciate in value. There is certainly a

possibility that the cattle and land will appreciate in value, depending on several market

variables. The Taxpayer believes that his ranching operation is more valuable now than when he

inherited it based on his purchases of additional land and capital expenditures on equipment.

This factor weighs in favor of finding that the activity is for-profit.

The Taxpayer did not demonstrate success in carrying on a similar or dissimilar activity.

This factor weighs against finding that the activity is for-profit.

The Taxpayer makes income on the ranching operation, but the deductions taken for

expenses have led to a net loss in recent years. The Taxpayer pays for the ranching operation

with the income from the ranching operation as well as credit. This factor weighs in favor

finding that the activity is for-profit.

Even occasional small profits, when the activity generates substantial losses, are not

indicative of for-profit activities. See id. As previously noted, the Taxpayer has reported net

losses in recent years, and there was no evidence that the sales of cattle ever resulted in profit, as

opposed to just income. This factor weighs against finding that the activity is for-profit.

The Taxpayer is not reliant on the ranching operation for his livelihood. The Taxpayer

has a full-time job and earns wages. However, the Taxpayer does not use his wages to finance

Ernesto and Nancy Hurtado
Letter ID No. L0058191408
page 9 of 12
the ranching operation. The ranching operation is self-sustaining through its income and credit.

This factor weighs neutrally.

The Department argues that the Taxpayer is primarily involved in ranching as a matter of

“family tradition”, and that “family tradition” means that the ranching is not a for-profit activity.

“Family tradition” is not one of the factors, but the argument seems most closely related to the

factor of personal pleasure and recreation. The Taxpayer admitted that he enjoys ranch work,

but he considers it to be very hard work. So, the Taxpayer clearly enjoys an element of personal

pleasure through his ranching operation, but he does not treat it as recreation. Instead, he

dedicates several hours every week to learning, to improving, and to working on the ranch. This

factor weighs neutrally.

Five of the nine factors weigh in favor of finding that the Taxpayer is engaged in the

ranching operation for-profit. Therefore, the Taxpayer has overcome the presumption that the

assessment is correct. See NMSA 1978, § 7-1-17.

CONCLUSIONS OF LAW

A. The Taxpayer filed a timely written protest to assessment issued under Letter ID

number L0058191408, and jurisdiction lies over the parties and the subject matter of this protest.

B. The Taxpayer’s ranching operation was engaged in as a for-profit activity. See 26

CFR 1.183-2. Therefore, the deductions are allowed. See 26 USCS §§ 162 and 183. See also

NMSA 1978, §§ 7-2-2 and 7-2-3.

C. The Taxpayer overcame the presumption that the assessment was correct as to the

ranching operation. See NMSA 1978, § 7-1-17.

Ernesto and Nancy Hurtado
Letter ID No. L0058191408
page 10 of 12
D. The Taxpayer withdrew the protest as to the portion of the assessment related to

Nancy Hurtado’s business, so that portion of the assessment is still presumed to be correct and

remains due. See id.

For the foregoing reasons, the Taxpayer’s protest is DENIED IN PART AND GRANTED

IN PART. The Department is HEREBY ORDERED TO ABATE the portion of the assessment

related to the Taxpayer’s ranching operation. The Taxpayer is HEREBY ORDERED TO PAY the

remaining balance of the assessment related to the wife’s business.

DATED: January 17, 2019.

Dee Dee Hoxie
DEE DEE HOXIE
Hearing Officer
Administrative Hearings Office
Post Office Box 6400
Santa Fe, NM 87502

NOTICE OF RIGHT TO APPEAL

Pursuant to NMSA 1978, § 7-1-25, the parties have the right to appeal this decision by

filing a notice of appeal with the New Mexico Court of Appeals within 30 days of the date

shown above. See Rule 12-601 NMRA. If an appeal is not filed within 30 days, this Decision

and Order will become final. A copy of the Notice of Appeal should be mailed to John Griego,

P. O. Box 6400, Santa Fe, New Mexico 87502. Mr. Griego may be contacted at 505-827-0466.

Ernesto and Nancy Hurtado
Letter ID No. L0058191408
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CERTIFICATE OF SERVICE

I hereby certify that I mailed the foregoing Order to the parties listed below this 17th day of January,
2019 in the following manner:

First Class Mail Interoffice Mail

INTENTIONALLY BLANK

John D. Griego
Legal Assistant
Administrative Hearings Office
Post Office Box 6400
Santa Fe, NM 87502
PH: (505)827-0466
FX: (505)827-9732

Ernesto and Nancy Hurtado
Letter ID No. L0058191408
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