The Tax Court recently allowed claimed losses from horse-breeding activities in one case but denied them in another. In the first case, the court held that the taxpayers could deduct all of the expenses of their horse-breeding activity, since they had a profit motive when they started and conducted the activity. In the other case, the court disallowed all the taxpayer’s expenses because, the court said, it could not determine their reasonableness.
Mark and Patti Blackwell engaged in horse breeding and training in Delano, Minn., from 2000 to 2009 on property that included their personal residence. Patti Blackwell, who had a bachelor’s degree in equine industry management, took care of the horses while Mark Blackwell, who had an MBA degree and many years of business experience, handled the business side of the activity. From 2003 to 2009, the couple never reported an annual profit, while cumulatively reporting gross income of $166,640, net operating losses of $639,637 and gains from the sale of horses of $86,709. Because of the losses, the couple terminated the business in 2009. The IRS audited the couple’s tax returns for 2005 and 2006 and disallowed all expenses in excess of income, claiming the couple had no profit motive.
The Blackwells challenged the IRS determination in Tax Court, which held that their horse activity was a business. Analyzing the activity using the nine factors in Treas. Reg. § 1.183-2(b), it found that the couple (1) conducted the activity in a reasonably businesslike manner; (2) had the requisite expertise for the activity; (3) invested the time, effort and resources expected of a business venture; (4) reasonably expected that some horses would have significant value; (5) had been successful in a number of other business enterprises; (6) had incurred the losses in the activity during its startup stage, when losses would be expected; (7) had the opportunity to earn a profit from the activity; and (8) were motivated by more than personal or recreational reasons. Although the ninth factor, the taxpayer’s financial status, weighed against finding that the activity was a business, the court did not assign great weight to it, due to the minimal recreational aspects of the activity.
In the other case, Peter Van Wickler, a cell tower construction manager, purchased an interest in a mare lease program from a company that marketed horse-breeding activities. The program gave investors the chance to acquire profitable horses but also had tax benefits. An investor would pay initial expenses with loan proceeds and then repay the loans with tax refunds from the carryback of net operating losses (NOLs) to prior tax years. On his 2002 and 2003 federal income tax returns, Van Wickler reported no income from the activity but $2,691,405 in expenses for 2002 and $46,032 for 2003. He later received a refund of prior-year taxes due to his NOL. In 2007, the IRS assessed a deficiency, disallowing all of Van Wickler’s horse-breeding expenses for 2002 and 2003. The taxpayer petitioned the Tax Court for relief.
The court held that section 162, allowing taxpayers to deduct ordinary and necessary expenses related to a trade or business, did not apply. Van Wickler was not involved in the activity on a regular or continuous basis, and therefore he was not carrying on a trade or business. The court then determined whether the expenses qualified as ordinary and necessary expenses of an activity entered into for the production of income as described in section 212. The court found that the taxpayer’s expense information for the activity lacked clarity, rendering it impossible to determine if any of the expenses were reasonable in amount, a requirement for them to be ordinary and necessary. Thus, it held that none of the expenses were deductible.
- Mark E. and Patti L. Blackwell v. Commissioner, TC Memo 2011-188
- Peter J. Van Wickler and Laurie E. Janak v. Commissioner, TC Memo 2011-196
By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.
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