Double Taxation: A Take On All Things Taxes

Horse Breeder Enjoys Rare Victory as Tax Court Holds Activity to Be Business, Not Hobby

A few months ago, a CPA friend of mine asked me for advice. He had just picked up a new client, a very successful businessman who earned significant income from his 9-5 gig.  In addition, the client also operated a horse breeding activity that generated large losses used by the taxpayer to partially offset his taxable income. The client’s horse breeding “business” had never generated a profit in its five-year history, and in light of the string of losses, the client had recently made the decision to abandon the activity.  

The question posed was the following:  how concerned should the CPA be that his client will find his horse breeding activity subject to IRS scrutiny? 

My answer: very. As we’ve discussed in the past,  Section 183 — the so-called “hobby loss rules — exist for the sole purpose of determining whether a taxpayer’s activity is a “trade or business” or a “hobby.” If the activity is a trade or business, losses of the activity may be deducted in full and can offset other sources of income, subject to certain limitations. If the activity is a hobby,however,  a taxpayer can only deduct losses to the extent of the income. The regulations establish nine factors the courts will examine to aid in their determination:

1. The manner in which the taxpayer carries on the activity. 

 2. The expertise of the taxpayer or his advisers.  

3. The time and effort expended by the taxpayer in carrying on the activity. 

 4. The expectation that the assets used in the activity may appreciate in value. 

 5. The success of the taxpayer in carrying on similar or dissimilar activities.

6. The taxpayers history of income or losses with respect to the activity.  

 7. The amount of occasional profits.

8. The financial status of the taxpayer. 

 9.  Does the activity lack elements of  personal pleasure or recreation?

The reason for my concern is that the Section 183 case history is literally filled with decisions holding that a horse breeding activity is a hobby, rather than a business. This is due in large part to the large recreational element  of the “business,” and the fact that losses from the activities often offset otherwise taxable income of the taxpayer, as the typical horse breeder is an affluent taxpayer to begin with.

Yesterday, however,  the Tax Court provided a glimmer of hope for horse breeders with its decision in Blackwell v. Commissioner, TC Memo 2011-188. In Blackwell, the taxpayer was able to overcome the horse breeding “taint” by carrying on the activity in a very professional manner, satisfying the majority of the Section 183 factors. In particular, the taxpayers:

Interstingly, the Tax Court held that Blackwell’s activity did not have significant elements of personal pleasure, even though the taxpayer had a lifelong interest in horses. The court added: 

The facts of this case do not indicate that petitioners’ FHF horse activity was motivated or driven by personal pleasure alone. As we have found, petitioners had actual hopes for the sale of their horses at a profit, and petitioners’ horse activity is appropriately described as a “business”. Petitioners’ business plan did not work out and income did not exceed expenses, but we discern few recreational and sports aspects in petitioners’ FHF horse activity; rather, in petitioners’ motive, efforts, and investment in carrying on their FHF horse activity during the years in issue we discern and find a profit objective.

See prior discussions here: