Catanese & Wells, a Law Corporation, provides a quarterly newsletter to the equine industry of and concerning legal, tax and business issues of equine law for participants in the horse business or sport. www.cataneselaw.com
The issue addresses the general question of the "Hobby Loss" provisions of the Internal Revenue Code.
Section 183 provides that losses from a horse activity cannot be deducted against income from other sources unless the horse activity is a business and not a hobby. The IRS has issue various regulations interpreting Section 183. Generally, whether a horse activity will be treated as a business is determined by the facts and circumstances of the case. The critical inquiry is whether the activity has an objective of making a profit. Nine factors are normally considered by the IRS when it determines if the taxpayer has a profit objective.
The nine factors which are considered include:
(1) How you carry on your horse business;
(2) Your expertise;
(3) The time and effort you spend on the business;
(4) Whether you expect appreciation of your assets (horses) used in the business;
(5) Your success in similar businesses;
(6) Your history of income or losses in the horse business;
(7) Whether your horse business has profits during its history;
(8) Your financial status; and,
(9) How much pleasure or recreation is involved in the horse activity.
Even though these factors seem easy to answer, case law indicates that there are nuances regarding each factor. How these nuances are addressed many times is the difference between success in a Section 183 audit or failure. For example, even though personal pleasure may be a factor against finding the business to be for profit, if other facts and circumstances show the business is operated for a profit, the IRS will allow the horse business deductions. See Foster v. Commissioner (T.C. Memo 1973-14).
To conclude, it is very important to understand Section 183 in the organization and operation of a horse-related business. We recommend that persons engaged in the horse business be familiar with and understand how Section 183 applies to their business. In doing so, if the IRS does audit the horse business operator, they will have a better chance of obtaining a no-action result.
For further questions feel free to contact our offices.