Jim Brown is a dairy farmer in Wisconsin. He had a herd of 200 cows and sells milk to the local farm cooperative. Jim is also a computer whiz and spends two to four hours per day, five days per week trading cattle futures. During the year, he engages in 300 hedge transactions regarding cattle futures. Due to an unforeseen increase in the supply of dairy cattle, Jim’s hedging transaction proved to be unprofitable and sustained a loss of $50,000 for the year. Since Jim is actively involved in the dairy business, he deducted the hedging losses as an ordinary and necessary business expense on his Schedule F, Farm income, on his form 1040. The loss reduced his net farm income to less than $300, so he paid no self-employments tax when he filed his return. The IRS is auditing Jim’s tax return and proposes to increase Jim’s net income from farming by $50,000 and to allow him instead a $3,000 short term capital loss. Jim has asked you to represent him in his dispute with the IRS. What advice would you give Jim?
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