A profitable hobby, if it remains so, naturally will become a business. This does not mean that a business should always create enormous income and continue to maintain the statuesque year after year. Losses are permitted in every business; but they usually attain the form of a continuous flow where losses the profit are merged. Business is not completely bound by sales, profit or timeframe; nevertheless, the initial recognition of the activity as a business matter a lot for the taxpayer and this recognition is guided by the business logic of making profit, even though it very often fails to reach the expectations. On the contrary, a hobby need not show any profit and can remain a source of pleasure, recreation and fun. Hobby touches the creative and imagination of the person, whereas business is connected with the dry financial gratification1. In a hobby, the person is not answerable to anyone, because it is not a profit-making venture. While "business is any profession, trade, manufacture, or undertaking carried on for pecuniary profit," hobb is is an activity conducted primarily for private pleasure or recreation." http://www.mcleanandco.co.nz/Page115.htm
Returning to your horse farm, if losses are continuing every year, beyond a certain business logic, it is not unnatural that IRS, after auditing, placed it under the category of Hobbies. Speaking from the financial/tax point of view, any hope of deducting the expenses would cease here, while the venture remains an expensive and creative activity of self-satisfaction2.
Our suggestion is that instead of fighting the case now, it is prudent to wait for the final determination letter and then, armed with all the categorised information, you can start answering the points to resurrect the business angle3. Right now, it is difficult to fathom the grounds on which the categorisation is done, although we can guess; instead, it will be far easier for you to answer the categorisation.
To do so, you, as a businessman should be able to show the business path and the convincing hope of attaining such a goal, which will bring the farm into the business-fold. Twenty horses that you maintain on fifty acres of land, and the time that you spend on this farm, especially since your home occupies three acres of the entire land should not be very difficulty to argue that they all fall under the business category. Not having any profit in the last six years, and your statement that you spend only a quarter of your time on the farm, would naturally lead IRS to decide in favour of hobby, denying the full-fledged business status4. In our counter-argument, we shall forcefully argue that hired hands were continuously working on the farm in your absence and considering the situation of your house in the farm, you have spent much more time than a quarter of it, because you lived on the farm and attended to the farm responsibilities at any time according to the need and this includes the emergency, sickness, medical attention etc. that you might have attended to even during the nights and this argument is perfectly acceptable, as IRS knows that livestock need attention beyond working hours. From the profit-making angle, it has to be argued that profit was illusive all these years, because the horses were young and were at the growing stage. Only now, they have started producing colts and