Horse breeder materially participated

BY SALLY P. SCHREIBER, J.D.

The Tax Court held that a taxpayer materially participated in his horse-breeding activity for 2002 through 2004 and therefore was not barred from deducting his losses as passive activity losses under Sec. 469 ( Tolin, T.C. Memo. 2014-65). Although the case involved horse-breeding activities, the IRS did not seek to disallow the losses under Sec. 183 by arguing that the taxpayer lacked a profit motive.

Stefan Tolin, a lawyer, owned a thoroughbred race horse that was badly injured early in its racing career. He continued to practice law in Minnesota while he pursued horse-breeding activities. For the years at issue, all of Tolin’s breeding activities were conducted in Louisiana, where he moved his horse after researching the state’s racing business and finding that the state had horse-racing incentives that increased the possible purses awarded to horses that sire winning racehorses.

Tolin boarded his horse at a stable in Louisiana, and he spent many hours on the phone with the owner of the stable and others in Louisiana promoting his horse’s services as a stud. He also made several trips to Louisiana where, testimony established, he did nothing but horse business. He proved his participation by presenting a narrative summary of his activities, as well as testimony from the people with whom he dealt in the Louisiana horse-racing world. His activities were further substantiated by phone records and credit card receipts.

Tolin reported the results of his horse-breeding activity on Schedule C, Profit or Loss from a Business, for the years at issue. He took deductions for various expenses including advertising, board and care for the horse, insurance, various fees, veterinary expenses, and travel, and claimed losses from the horse-breeding activities in each year. The IRS disallowed the losses as passive activity losses. 

At trial, the IRS did not raise the issue of whether the activities were operated with a profit motive or whether the expenses were ordinary and necessary, so the court deemed the IRS to have conceded those issues. Therefore, the only issue was whether the horse-breeding activity was a passive activity.
Looking at this record, the Tax Court found that Tolin satisfied the material participation requirement in Temp. Regs. Sec. 1.469-5T(a) by participating in the activity for more than 500 hours each year.
 
The IRS objected to the testimony and records used to prove the 500 hours of participation, objecting as well to the court’s permitting Tolin to include administrative work he did in reaching the 500 hours. But the court found that Tolin was involved in the day-to-day management of the activity and therefore was allowed to include administrative tasks in the calculation. Accordingly, Tolin met the more-than-500-hour test to prove material participation, the activity was therefore not passive, and he was allowed to deduct his losses in full. 

Sally P. Schreiber ( sschreiber@aicpa.org ) is a JofA senior editor.

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