In my recent article, “A Business or a Hobby?“, I discuss how the IRS distinguishes business activities with those of a hobby. In this post, I will review how the Tax Court concluded, in one decision, a taxpayer who bred and raced horses was involved in a hobby instead of operating what was intended to be a for-profit business for two out of four tax years in question. This decision allowed the taxpayer to deduct the net losses from only two years, even though the horse racing activity never generated a profit. (Merrill C. Roberts, TC Memo 2014-74)

Facts of the Case

Merrill Roberts successfully operated several restaurants and nightclubs before deciding to leave those businesses. In 1998 or 1999, Roberts became interested in owning and training race horses. By 2001, he owned 11 horses, including a breeding stallion, and he employed several trainers. He began working every day at his horse training property in Indiana and became a licensed trainer in 2002. Obtaining the license required passing a rigorous test on a range of subjects from horse bridle construction to equine medication.

  • In 2006, Roberts purchased a 180-acre parcel in Indiana for $1 million. He then invested between $500,000 and $600,000 in building improvements. Roberts realized that the land would probably appreciate because of its proximity to a planned highway project, but he bought the land specifically for horse racing.
  • Roberts then decided to go the extra mile by building a first-class training facility. It was completed and placed in service in 2007.
  • The new facility also allowed Roberts to use acreage on the property to grow hay. He purchased equipment to harvest and process the hay. He also rented out some of the acreage to farmers.
  • During 2005-2008 (the tax years in question), Roberts was involved in multiple aspects of the horse racing industry including boarding, breeding, training, and racing. He primarily raced his horses in Indiana, but he also entered them in races in other states. To ensure compliance with racing regulations and to develop winning strategies, Roberts often conferred with his assistant trainer. This produced some successful horses, including one that was nominated to run in the Triple Crown.
  • Roberts joined several professional horse racing associations and served as a board member for two of the organizations.
  • Roberts used a CPA for his restaurant and nightclub businesses, as well as his horse racing activities.

In all the audit years, there was significant revenue from the horse racing activity, but the expenses were higher. After auditing Robert’s 2005-2008 tax years, the IRS claimed that his horse racing activity was a not-for-profit hobby and sent him a bill for significant amounts of income tax and penalties. The taxpayer disagreed and took his case to the Tax Court.

The Court’s Conclusion

The Tax Court found that the taxpayer’s intention to make a profit from his horse racing activity was shown by the following facts:

1. He sold his old unsuitable training facility and moved his operation to a new property where he built a premier training facility placed in service in 2007.

2. He hired an assistant trainer and consulted with bloodstock agents and respected trainers on horse racing issues. So he relied on the advice of experts.

3. His accounting methods allowed him to make informed business decisions. Therefore, he conducted his horse racing activity in a business-like manner.

4. For 2007 and 2008, the taxpayer’s reasonable expectation that the land value of his new horse training facility would appreciate was an element of his overall for-profit objective for those years.

5. He spent substantial time in the horse racing activity.

6. He had been successful in previous business (restaurant and nightclub) ventures.

However, the Tax Court noted that Roberts attended to the track racing and training sides of his operation during 2005 and 2006. Therefore, according to the court, he participated equally in the social and business aspects of his horse activity in those years. In 2007, he hired an assistant trainer to take over the track racing functions and focused on the training aspects, which basically involved a lot of hard work. So, according to the court, Roberts did not have the requisite for-profit motive in 2005 and 2006, but he did in 2007 and 2008. Therefore, the hobby loss rules applied for the two earlier years, and his net losses were negated for tax purposes. His net losses for the two later years could be deducted as for-profit business losses.

In summary, this was only a partial victory for the taxpayer, even with the seemingly obvious business aspects of this endeavor. The decision highlights the importance of making sure your business is not viewed as a hobby.

Other Hobby Articles of Interest: http://blog.gscpa.com/2014/06/can-you-deduct-hobby-expenses-on-your-taxes/