More and more people are buying their little block of paradise in the Bay of Plenty with the with the view of one day building a home or, at a later time, selling for capital gain.

Some imagine that before they build or sell, they’ll run a few sheep or cattle on the land, call it a "business" and deduct expenses against any income. The "farm" will run at a loss (with no tax), and GST will be deducted from the purchase price. Either way, it might seem like the perfect situation.

However, there are tax issues to consider before turning your lifestyle block into a farm. The question is whether your activities on the land do in fact amount to “a business”, and whether you have evidence to prove this.

Tax law is subjective in this area. Determining whether you are actually running a business will depend on many things, including the nature of your activities, duration, turnover, commitment of time, money and effort, and most importantly - your intention to make a profit.

In the event of an Inland Revenue audit into your affairs, the onus is on you to defend your tax position. Whilst you may consistently get away with deducting expenses against your "farm" income, there is a good chance it will ultimately catch up on you if you were not entitled to do so.

As the IRD aims to audit every business once in a five year cycle, this is not something to be taken lightly.

If you do end up in a dispute with the IRD over your tax position, it should be remembered that as the IRD uses taxpayers money to litigate, they are bound by policy to do so when they have a more than reasonable change of succeeding.

Also, penalties can be especially high if it is proved you have taken an unreasonable tax position. Even if you can verify that you are, in fact, running a genuine business, the considerations do not stop there!

You need to consider carefully what deductions you can legitimately make against taxable income. Hobby farmers cannot claim all of the deductions available to full time farmers, such as 50% of newspaper subscriptions, 100% of telephone rental plus business tolls, and 25% of household costs such as electricity and insurance.

The IRD will insist that expenses are apportioned between private and business use, and in may cases will allow no deduction at all. Part-time farmers need to establish and justify their own apportionments, which may entail hiring an accountant.

Of course, it-s not worth the tax saved in carrying on a business if it-s less than ongoing accounting and legal fees.

You should also consider the financial effect of incurring losses year after year, if this is likely to occur. Capital gains from selling your block may eventually recover the shortfall, but in the meantime you will need to recoup the loss out of your personal funds.

GST registration can also appear an attractive option to some. This again needs careful consideration because although claiming a GST input deduction on the purchase of your land gives you a short term gain, you are then “locked into” the GST system. The IRD will eventually look for the GST output on the land.

Also, if you subsequently build a house on part of the land, you will need to make a one-off output adjustment to the IRD for that portion of the land to reflect the change in use.

In other words, lifestyle block owners should carefully consider their tax position before registering for GST and determining that they are carrying on a business.

Feeling in a bind to your “hobby” farm can diminish the enjoyment of your lifestyle block. Consult a lawyer if you need help to determine how the legal issues would affect you.

It may be less stressful, not to mention simpler, in the long term to acknowledge at the outset that you are a lifestyler who happens to have a few sheep.