The Tax Court held that a wealthy taxpayer's activity of breeding miniature donkeys was entered into for profit, allowing him to deduct net losses from the activity for the two tax years at issue.
Facts: After starting at a young age in the accounting department of a New York asset management company and rising through its ranks, William R. Huff began W.R. Huff Asset Management Co. in 1984. The business was successful, and in 2005 Forbes reported Huff's net worth as $750 million. In 1987, Huff purchased a farm in New Jersey where he and his wife lived and purchased additional land adjacent to the farm in the late 1990s on which their daughter lived.
In 2004, Huff and his wife formed Ecotone Farm LLC, of which they were the sole owners. Ecotone's operating agreement said it was organized for "agricultural and equestrian or equine purposes including ... breeding and raising animals." By 2010, the Huffs had settled on Ecotone's activity as breeding miniature donkeys, after conducting research assisted by Huff's staff at his asset management company. Huff also obtained advice from a friend with extensive experience in the field, who continued to serve as an adviser after Ecotone began the donkey-breeding activity.
Huff intended to develop the miniature donkey business into profitability and then turn it over to his daughter. In 2010 through 2018, Ecotone purchased 25 donkeys and sold 20 of them.
Ecotone reported a net loss on its partnership returns each tax year for 2010 through 2017 of between $21,594 (2010) and $87,236 (2013). To that extent, the losses offset the Huffs' adjusted gross income, which in 2013 and 2014, the years at issue, was approximately $21.5 million and $29.8 million, respectively.
The IRS disallowed the partnership losses and issued deficiencies of $37,022 for 2013 and $19,615 for 2014 as well as accuracy-related penalties under Sec. 6662(a) totaling $11,327 for the two years combined.
Issues: The IRS contended that under Sec. 183(a), Ecotone could not deduct the losses from Ecotone's miniature donkey activity because it was not engaged in for profit.
Noting that it has often been called upon to determine whether "an activity involving equines" was entered into for profit, the Tax Court stated that while, as a general proposition, such an activity could be entered into for profit, it had often seen cases where a horse-breeding activity did not have a legitimate profit-making purpose. It quoted Helmick, T.C. Memo. 2009-220, in observing that the "stereotypical abusive scenario ... is the wealthy businessman who runs a real business during the week ... and owns a 'gentleman's farm' as a weekend retreat where he keeps horses for the recreation of himself and his family and friends." Such a taxpayer "dabbles in breeding horses, with no expectation of ever making a profit, so that he can deduct the expenses of his horses and thereby have Uncle Sam subsidize the weekend farm" (Helmick, slip op. at 7).
Because the Huffs were the sole members of Ecotone, the Tax Court looked to their actions in running it to determine whether there was a profit motive for the donkey-breeding activity. The court applied the nine objective factors in Regs. Sec. 1.183-2(b) for determining whether a profit motive exists: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his or her advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, from the activity; (8) the financial status of the taxpayer; and (9) elements of personal pleasure or recreation.
Holding: The Tax Court concluded that although Ecotone was not profitable, the taxpayers nonetheless evinced an objective of a profit in the years at issue by attempting to build a foundation for breeding donkeys that would eventually be profitable in the long term. The court concluded that only two of the nine factors favored the IRS. It found with regard to the fourth factor that no evidence was presented that the Huffs expected their assets to appreciate and under the seventh factor that the Huffs had no occasional profits from the activity.
But they did pursue the activity in a businesslike manner, the court said. Despite an overly rosy outlook initially, they made changes toward profitability. They may have started with no expertise, but they developed it through deep research and the use of a knowledgeable adviser. Although their own time devoted to the donkey breeding may have been limited, they engaged experts and a competent caretaker. And Huff clearly was successful in other activities.
As for the sixth factor, a history of income or losses with respect to the activity, the court noted that under Regs. Sec. 1.183-2(b)(6), a series of losses will not necessarily be held against a taxpayer if the activity is in its startup stage. For the years at issue, in the court's view, the donkey-breeding activity was still in its startup stage because it had been in operation for less than five years. Thus, it determined that despite Ecotone's not having turned a profit in any year, the losses did not indicate a lack of a profit motive.
Regarding the eighth factor, while the Huffs had more than ample other income, the court also considered Huff's stated intention of establishing a business for his daughter to run. As Huff had testified, if he had simply intended to provide for her financially, "there were other, significantly easier ways to do it." Along those lines, in determining that the ninth factor, elements of personal pleasure or recreation, favored the Huffs, the court also accepted Huff's testimony he took "zero personal pleasure" from his donkeys. "These are not pets," the court quoted him as saying, also that they were "quite ugly" and "look like a 'gigantic hairball.' "
- Huff, T.C. Memo. 2021-140
— Paul Bonner is a JofA news writer.
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