Tax Issues
Pay particular attention to tax-related issues in operating your
stable. Although some consider the applicable tax code provisions
onerous, they are, in reality, manageable. However, it is most
advantageous to be familiar with the provisions most commonly
applicable to this business. They are the difference between
long-term capital gains rates and ordinary income tax rates and the
hobby loss and passive loss issues.
The following pages are written to merely acquaint you with equine
tax issues. The American Horse Council publishes two very good
reference books dealing with taxes. They are Tax Tips for Horse
Owners and The Horse Owners Tax Manual. These publications are the
tax references for the equine industry. If you are seriously
considering becoming an owner or are already an owner, we encourage
you to acquire these publications for your library. For more
information, please visit the American Horse Council's web site at
www.horsecouncil.org.
The Capital Gains Spread
The maximum federal income tax rate on long-term capital gains is
15%. Maximum ordinary income tax rates are 35%, so the spread
between the two is significant. For certain taxpayers, the
differential is made even greater by the effect of state taxes.
Unlike other assets, the holding period to obtain long-term capital
gain treatment on sales of horses is two years.
The Hobby Loss and Passive Loss Issues
The two problems most often faced by horse owners when audited by
the IRS or comparable state taxing agencies are the "hobby loss" and
the "passive loss" rules. To prevail, owners must demonstrate that
they have exercised preventive planning, followed good business
practices and have documented their business activities.
Hobby Loss Provisions
In general, the tax laws referring the hobby loss rule provide that
to deduct expenses that exceed income, the taxpayer must demonstrate
that she is engaged in her horse-related activity with the intention
of producing a profit. Initially, the burden of proof falls upon the
taxpayer. However, if a profit can be shown in two of seven
consecutive years beginning with the first loss year, the burden
shifts to the IRS to disprove the "general presumption of profit
intent."
The IRS cites nine factors in determining whether an activity is a
hobby or business. They are very basic business points covering
management style, degree of knowledge of the taxpayer, utilization
of expert advisors, time and effort the taxpayer spends in the
activity, the expectation for asset appreciation and the presence or
absence of recreational aspects. From the IRS' perspective, a hobby
correlates with fun, while a business means work: In other words, it
is okay to enjoy the business, but only if you have a convincing
profit motive.
Material Participation "Passive Loss"
Under the "passive loss" provision, in order to deduct losses
suffered as a result of equine business activities from other
income, an owner must be able to prove that she is materially
participating in the activity. Material participation is satisfied
by establishing that the owner spends 500 or more hours actively
participating in the business during any taxable year. If the owner
does not meet the 500-hour test, she may qualify with 100 or more
hours if she participates on a regular, continuous basis throughout
the year and meets certain other criteria. However, satisfying the
requirements of this test is more difficult.
Hours spent by a husband and wife can be combined to accommodate
these requirements. If an owner cannot prove material participation,
losses can only be taken against other passive income. The sale of
the investment, however, triggers the deductibility of all past
losses disallowed.
Treat your horse-related activities as you would any other business
venture. Carefully plan your time and the timing of your
horse-related income and expenses. Simple documentation will aid in
proving your intent to make a profit and active participation.
Depreciation
Horses may generally be depreciated as three or seven year property.
Longer periods of depreciation may be elected, and always apply in
the case of foreign-based horses. Yearlings, racehorses and breeding
horses over 12 are depreciated as three-year property; all others
are depreciated as seven-year property.
In the case of IRS rules, note that age is determined by the actual
date of birth, not the industry-accepted January 1 of each year.
Furthermore, to prevent taxpayers from purchasing at the end of the
year and obtaining a large depreciation deduction, more than 40% of
the purchases during one year are made during the last quarter,
reduced depreciation results.
The 2009 Economic Stimulus Bill provides an expensing allowance and
bonus depreciation for horses purchased. Please visit the
American Horse Council's website
or contact your equine tax professional for more information.
