Horses and taxes

Introduction: horses as a tax shelter
Horses are popular. Keeping horses as a hobby (not to be confused with keeping a hobby horse) may entitle an owner to tax benefits, which are also popular. Horse owners may also receive tax benefits if they keep horses for profit. For these reasons, horse-related activities are one popular form of tax shelter.
Horses as Hobbies
Typically, expenses incurred in pursuit of a hobby activity do not qualify as deductible expenses. Section 183 of the Internal Revenue Code (IRC), however, provides an exception to this general rule. IRC section 183 generally prohibits any tax deductions for “activity not engaged in for profit.” While this would seem to preclude deductions for horse-hobby activities, section 183 offers two exceptions to its general rule that may allow for such deductions. First, section 183 allows horse-hobby practitioners to take deductions for activities related to their horse hobby to the extent that these deductions are allowed by the IRC without regard to whether they are related to an activity engaged in for profit. That is, section 183 will not take away deductions to which a horse-hobby enthusiast is otherwise entitled under a different section of the IRC. Second, section 183 allows for horse-hobby-related deductions equal to the amount of deductions that would be allowable under the IRC if the horse-hobby activity were engaged in for profit, but only to the extent that the income derived from the horse-hobby activity exceeds the amount of the first type of deduction described above. To figure out this second type of deduction, a horse hobbyist would essentially pretend that his or her hobby were a for-profit business and then calculate the income from the business as well as all the tax deductions to which the business would be entitled. Then the hobbyist would determine the extent to which his or her horse-hobby income exceeds the amount of the first type of deduction described above. The horse hobbyist would then be entitled to take deductions of the second type up to that amount. Simply stated, section 183 allows a horse hobbyist to use the losses and expenses attributable to the horse hobby to offset any income generated by the horse hobby.
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Horses as businesses
Some horse owners may be entitled to an even greater tax benefit than that allowed for under section 183. To gain this increased benefit, these horse owners have to demonstrate that their horse-related activities are actually for profit. To make such a showing, a horse owner must do more than simply declare that his or her horse-related activities are for profit. Instead, the horse owner must structure his or her horse-related activities to meet the criteria outlined in Treasury Regulation 1.183-2. This regulation sets out nine factors that the Internal Revenue Service and the courts may use in determining whether a horse-related activity is conducted for profit. In looking at these criteria, a court will attempt to determine whether the horse-related activity was engaged in for “the primary, predominant, or principal purpose and intent of realizing an economic profit independent of tax savings.” A horse owner may establish a presumption that his or her horse-related activity is for profit by showing that the activity generated a net profit during two of previous seven years. This provision actually favors those engaged in horse-related activities over those engaged in other enterprises. Taxpayers who are engaged in a potentially for-profit undertaking that is not horse related may only establish a presumption that the activity is for profit by showing that it netted a profit in three of the previous five years.

Hobby versus business
Individuals who engage in horse-related activities should be careful when claiming that these activities are for profit because an improper categorization can lead to tax penalties. For example, in Prieto v. Commisioner a family engaged in horse-related activities, which included purchasing, training, showing, and selling, claimed deductions for these activities as if they were engaged in for profit. When these deductions were challenged in tax court, the court found that the horse-related activities were not for profit and therefore imposed a tax penalty on the Prietos. The court evaluated the Prietos’ horse-related activities using the factors outlined in Treasury Regulation 1.183-2. Although some factors weighed in favor of a finding that the horse-related activities were for profit, the court held that they were not for profit based on several factors, including the Prietos’ failure to keep adequate business records, their failure to collect debts, their buying and selling of horses based on family preferences rather than business needs, and their failure to turn a profit.

Regardless of tax status, horses are fun
As the outcome in Prieto demonstrates, the IRS considers some types of horse-related activity to be hobby activity. There are , however, which demonstrate that the IRS also considers some horse-related activity to be for profit. These cases along with the criteria outlined in Treasury Regulation 1.183-2 provide a guide to the tax status of horse-related activity. Because horses are so popular and the tax status of horse-related activity is not always clear, there are lawyers and accountants who specialize in tax issues related to horse ownership. Although a horse owner may receive greater tax benefits from if their horse-related activity qualifies as a for profit enterprise, horse owners can enjoy the benefit of spending time with their horses regardless of the tax status of their venture.

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