Deductibility of Equine Related Expenses

An ongoing and recurring issue for those in the equine industry is whether claimed business deductions incurred in connection with breeding, boarding, training, sales and/or racing should be allowed as ordinary and necessary business expenses.

For an expense to be deductible the equine entity must have had an actual and honest objective of making a profit from the equine activity(ies). To make this determination, the Courts as well as the Internal Revenue Service consider several key factors.

 

Those factors are:

1) the manner in which the taxpayers carry on the activity;
2) the expertise of the taxpayers or their advisors;
3) the time and effort expended by the taxpayers in carrying on the activity;
4) the expectation that the assets used in the activity may appreciate in value;
5) the success of the taxpayers in carrying on similar or dissimilar activities;
6) the taxpayers’ history of income or loss with respect to the activity;
7) the amount of occasional profit;
8) the financial status of the taxpayers; and
9) whether elements of pleasure or recreation are involved. (See Internal Revenue Code § 183 as well as Income Tax Regs. § 1.183-2 (b)).

Whether the taxpayer carries on the equine activity as a business or as a hobby is a fact sensitive and fact-driven determination. A key factor in determining whether a deduction is allowable is whether the taxpayer has detailed business records and other documentation, such as a business plan, that indicates a bona fide business.

In fact, the Courts have held the fact that making a profit was not to be expected is not controlling, provided the taxpayer maintains careful business records and had other indicia of a bona fide business, even though the taxpayer has substantial income from other sources (see Razzano v. Comm’r, T.C. Mem. 2007-177,2007 WL 1933000 (T.C.2007). Additionally, both the Courts and the IRS consider and weigh the expertise of the taxpayer. For example, the Court in the case of Miller v. Comm’r, T.C. 2008-224,2008 WL 4449526 (T.C. 2008) found that the claimed deductions were proper. In making this determination, the Court relied on the fact that the taxpayer’s horse breeding activities were for profit and that deductions or losses attributable to that activity were proper and that the taxpayer used a highly respected rider and that the taxpayer purchased his horse farm due to the close proximity of his trainer and did not buy any horse unseen by his trainer and used only experienced veterinarians.

As expected, taxpayers claiming deductions have been told both by the Courts and the IRS that their claimed deductions are allowed. There are several common recurring areas or activities that have resulted in adverse decisions for taxpayers claiming such deductions. For example, if the taxpayers’ equine activity is conducted as a hobby rather than a business, the deductions are not allowed.

Likewise, in situations where the taxpayer lacked a written business plan and/or financial projections as to the equine business, the Courts and the IRS have routinely precluded the deductions of losses. Also, if it is determined that the taxpayer has co-mingled business equine related funds with personal accounts or attempted to claim deductions for showing horses or other recreational equine activities, deductions have been routinely disallowed. Other factors that are often considered are whether the taxpayer maintained separate bank accounts for personal and business income and expenses. Failure to maintain separate bank accounts and business records for equine related activities have often resulted in decisions disallowing deductions.

 

In order to be successful in claiming equine business deductions, it is recommended that:

1) The taxpayer/horseman establishes separate and distinct records for business equine related activities. These records should include a detailed list of all equine business related income and expenses;
2) that the taxpayer/horseman establish a business plan for the overall business equine activity as well as a subset of similar business plans for each separate business equine activity (i.e. breeding, boarding, trading, etc.);
3) that the taxpayer/horseman establish distinct and separate bank accounts for business equine activity; and
4) that the taxpayer/horseman develop and continue to develop economic expertise in the business equine activity(ies) or solicit such experience from other professionals in areas such as marketing, veterinarian services, training, etc. and document those efforts and related expenditures.

The author may be reached at pete_sacopulos@sacopulos.com or by writing to Peter J. Sacopulos, 676 Ohio Street, Terre Haute, Indiana 47807, 812-238-2565.

 

Peter Sacopulos owns and operates Green Gables Stud, Clay County, Ind., with his wife, Melony. Peter and Melony’s daughters, Ali and Olivia, assist in the business. In addition, Peter Sacopulos is an Attorney practicing law in Terre Haute, Ind. with the firm of Sacopulos, Johnson & Sacopulos. Representing clients with equine legal issues is a growing part of his practice. 

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