What Are the Schedule F Loss Limitations?

Taxpayers use Schedule F (Form 1040), “Profit or Loss From Farming,” to report their agricultural income and expenses. When total deductible expenses for the year surpass the farm’s income, a farm loss occurs. This loss can potentially lower a taxpayer’s overall taxable income, which might include wages, investment returns, or profits from other businesses.

The ability to deduct a farm loss against other income sources is not automatic. The Internal Revenue Code contains several rules to test the legitimacy of business losses, including those from farming. These provisions are applied sequentially, meaning a farm loss must clear each hurdle before it can be fully deducted.

The Profit Motive Requirement

The first test for deducting any business loss is the profit motive requirement, governed by Section 183 of the Internal Revenue Code. This “hobby loss rule” requires that the farming activity be engaged in with an honest objective of making a profit. If the IRS determines the farm is a hobby, deductions are only allowed to the extent of the income generated by the activity, meaning no loss can be claimed to offset other income.

The tax code includes a safe harbor provision that presumes a profit motive exists. An activity is presumed to be for-profit if it has generated a net profit in at least three of the last five consecutive tax years. For activities involving breeding, training, showing, or racing horses, the test requires a profit in two of the last seven years. Meeting this presumption shifts the burden of proof to the IRS to demonstrate that the activity is a hobby.

When a farm does not meet the safe harbor, the determination of profit motive depends on an analysis of all relevant facts and circumstances. Treasury regulations outline nine factors that are considered:

• The manner in which the taxpayer operates the activity, such as maintaining accurate books and changing methods to improve profitability.
• The expertise of the taxpayer or their advisors.
• The time and effort the taxpayer expends on the activity.
• The expectation that assets used, such as land, may appreciate in value.
• The taxpayer’s history of income or losses, noting if losses are from normal start-up or unforeseen events.
• The amount of any occasional profits.
• The taxpayer’s financial status and success in other activities.
• The presence of personal pleasure or recreation derived from the activity.

At-Risk Rules for Farm Losses

Even if a farming operation has a profit motive, the ability to deduct a loss is constrained by the at-risk rules under Section 465 of the Internal Revenue Code. These rules prevent taxpayers from deducting losses that exceed the amount they have personally at risk in the activity. A taxpayer can only deduct a loss up to the amount of their actual economic investment that could be lost.

The amount a taxpayer has at risk is calculated annually and includes the cash contributed, the adjusted basis of any property contributed, and amounts borrowed for which the taxpayer is personally liable. This personal liability, known as recourse debt, means the lender could pursue the taxpayer’s personal assets to satisfy the debt.

In contrast, nonrecourse financing does not increase a taxpayer’s at-risk amount. With nonrecourse financing, the lender’s only remedy in case of default is to seize the property that secures the loan; the taxpayer is not personally liable for any shortfall. Amounts protected against loss through guarantees or stop-loss agreements are also not considered at risk.

If a farm loss is greater than the taxpayer’s at-risk amount, the excess loss is disallowed for the current year. This disallowed loss is suspended and carried forward to the following tax year. The taxpayer can deduct the suspended loss in a future year if their at-risk amount increases, for instance, by contributing more cash or paying down recourse debt.

Passive Activity Loss Rules

After clearing the profit motive and at-risk hurdles, a farm loss may face the passive activity loss rules in Section 469 of the tax code. These rules limit taxpayers from using losses from ventures in which they do not materially participate to offset active income, like wages, or portfolio income. If a farming operation is a passive activity, its losses can only be used to offset income from other passive activities.

An activity is considered passive if it is a business in which the taxpayer does not “materially participate.” Material participation is defined as involvement in the activity’s operations on a regular, continuous, and substantial basis. Regulations provide seven tests to determine if a taxpayer meets this standard, and a taxpayer materially participates by satisfying any one of them for the tax year.

The most common test is participating for more than 500 hours during the year. Another test is met if the taxpayer’s participation is substantially all of the participation for the year. A taxpayer also meets the standard by participating for more than 100 hours, if no other individual participates more. A taxpayer is also considered to materially participate if they did so for any five of the ten preceding tax years.

If a farm is a passive activity and generates a loss, that loss is suspended and carried forward indefinitely. It can be used in future years to offset income from other passive activities. Upon the complete taxable disposition of the entire interest in the activity to an unrelated party, all suspended losses from that activity are fully released and can be used to offset any type of income.

The Excess Business Loss Limitation

The final limitation on deducting a farm loss is the excess business loss rule under Section 461. This rule applies to non-corporate taxpayers after the other limitations have been applied. It places a yearly cap on the total net losses from all of a taxpayer’s businesses, including farming, that can be deducted against other sources of income.

For the 2025 tax year, a taxpayer cannot deduct an “excess business loss.” An excess business loss is the amount by which total deductions from all businesses exceed the total gross income from those businesses plus a specific threshold. This threshold is adjusted annually for inflation. For 2025, the threshold is $313,000 for single filers and $626,000 for married couples filing a joint return.

For example, a married couple filing jointly in 2025 has a farm loss of $700,000 and no other business income. Their excess business loss is $74,000 ($700,000 loss minus the $626,000 threshold). They can deduct $626,000 of their farm loss in the current year.

The disallowed $74,000 excess business loss is carried forward to the following tax year. It is treated as a net operating loss (NOL) carryforward, which can then be used to offset business income in future years, subject to separate NOL deduction limitations.