Taxpayers Win Tax Court Ruling in Horse Case
By John Alan Cohan, Attorney at Law
In a new Tax Court case, Richard and Delores Frimml of Luzerne, Iowa won on the question of whether their horse activity was to be treated as a business [T.C. Summary Opinion 2010-176]. This underscores the fact that an unfavorable result at the audit stage can be reversed if you are determined to fight it.
The issue was whether the taxpayers conducted their American Paint Horse breeding activity for profit within the meaning of section 183 of the IRS Code. They failed to generate a profit for 10 years despite allocating substantial funds and time to their horse activity.
The Frimmls initially purchased two horses and spent the next 10 years learning about horse breeding and developing a business plan, which was not in writing. They acquired extensive knowledge about breeding and artificially inseminating Paint horses. Their knowledge included the genetics, the mechanics and the financial aspects of breeding.
They purchased a 6-acre property for the horse activity, and made substantial repairs and improvements over the next seven or eight years. They presented evidence that the property had more than doubled in value, in part because of their work.
They initially sought to earn income by showing and selling the foals. They consulted experts on various aspects of the horse activity including showing, breeding and selling the Paints.
They leased an older mare, and found that she produced an excellent quality of foal. As a result, the taxpayers sought expert help and paid significant amounts to breed the mare despite her older age. They also boarded her during her pregnancy to improve her chances of producing a healthy foal. They produced a stallion and adapted their business plan to include training, showing and breeding this stallion.
They also hired a trainer to train and show the stallion to increase his value. They believed that semen production by the stallion could provide a future source of revenue. They incurred extensive costs to care for the stallion when he was injured. They decided to put down a 2-year-old foal that hurt her leg in a fence accident because the cost to heal her exceeded the projected price in selling her.
The taxpayers regarded showing as the primary mode of advertising their horses. They also advertised by boarding their stallion with a well-known professional trainer whose facilities "had a lot of traffic." They intended to set up a Web site, but had never gotten around to completing it.
The taxpayers both had full-time jobs. Mr. Frimml worked on the horse activity 6 to 10 hours per day during the time that he was off work, and Mrs. Mrs. Frimml spent approximately 1-1/2 hours per day attending to the activity. They also spent substantial time attending shows and learning about how to advance their activity. They intended for the horse activity to supplement their retirement income.
In the court’s ruling, the following points were made:
1. The court acknowledged that the taxpayers had an informal business plan and “their failure to reduce the business plan to writing is not fatal as its formulation and alteration over time are evident.” Over time, they adapted their initial plan of maintaining a small stable of breeding mares to showing and breeding their stallion.
2. The court said: “Petitioners' check register, which they used to organize their income and expenses, was maintained in an unprofessional and imprecise manner. Petitioners' advertising was also not extensive.” Still, the court reversed the IRS’ finding that their activity was a hobby.
3. The court agreed that showing constituted the best advertising possible.
4. The court said that the taxpayers had acquired “the requisite knowledge of breeding, including the genetics, mechanics and financial aspects of breeding.”
5. The court said that even though both taxpayers had full-time jobs, they devoted substantial time to the horse activity, based on their testimony of time expended.
6. The court found that their property had appreciated in value, thus supporting their position: “The property that petitioners acquired to start their horse activity has more than doubled in value, in part because of improvements petitioners made.” The court added: “We believe that petitioners expected that the value of assets used in their horse activity would increase. We further believe that the expectation was sufficient to explain their willingness to sustain continued operating losses.”
7. The court said that a startup phase of a horse activity, in which losses would be expected, is customarily 5 to 10 years, and that the years in issue were within this startup window.
8. The court concluded: “We think it unlikely that petitioners would embark on a hobby consuming so much of their income and entailing so much physical labor and time commitment without a profit motive.”
Were the taxpayers lucky to get a judge sympathetic to their case despite the inadequacy of their business records? Perhaps so, but so long as you have some measure of good facts to work with, it is prudent to appeal an adverse IRS determination. Also, it is always wise to have a written business plan so that the elements of the plan can be proven by documentary evidence.
[John Alan Cohan is a lawyer who has served the horse, livestock and farming industries since 1981. He can be reached at: (310) 278-0203, by e-mail at johnalancohan@aol.com, or you can see more on his website: www.JohnAlanCohan.com.]
