Horses, Houses and a Profit Motive


Taxpayers who deduct as business expenses what the IRS might regard as spending on an unrelated hobby generally run a distinct risk of an underpayment assessment. In one recent case, however, the Tax Court accepted that two seemingly dissimilar undertakings could be treated as a single activity for purposes of the section 183 hobby loss rules.

A Florida woman, Tracey Topping, used her prominence as an equestrian to build a business designing horse barns and home interiors for wealthy acquaintances and new contacts on the Palm Beach-area horse show circuit. For the first six years of operations, her combined equestrian and design activities showed a profit of nearly $1 million. However, the Service said Topping’s equestrian activities, which by themselves produced a net loss, were a hobby unrelated to her design work. Thus, it said, her horse show contest winnings and any gains from selling horses had to be reported as “other income” on her 1040, and related expenses claimed as miscellaneous itemized deductions subject to the 2% of adjusted gross income floor. This determination would have cost her more than $250,000 in deficiencies for tax years 1999 through 2001.

The Tax Court, however, determined the two undertakings were a single activity because Topping treated them as an integrated business based on her equestrian activities, which significantly benefited her design business. The court noted more than 90% of Topping’s client base came from her equestrian contacts. In response to a subsequent IRS argument that the equestrian activities were nondeductible personal expenses, the court also agreed with Topping that her expenses associated with the equestrian-related portion of the business were ordinary, necessary and reasonable in amount as a cost of supporting and building up the interior design business.

The court distinguished Topping’s enterprise from several cases cited by the IRS in which erstwhile business expenses were held to be hobbies: A real estate lawyer’s polo playing did not materially benefit his practice ( De Mendoza v. Commissioner , TC Memo 1994-314), nor did a CPA’s yachting, even though he flew a flag from his boat bearing the numerals “1040” ( Henry v. Commissioner , 36 TC 879).

Tracey L. Topping v. Commissioner , TC Memo 2007-92

Prepared by Steven C. Thompson ,CPA, Ph.D., McCoy Professor of Business, Texas State University, San Marcos, Texas.


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