The Horse Business: Turning a Large Fortune Into a Small One

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By Erin McManus

Aug. 19 — They need space. They eat a lot. They get hurt. They get sick. They always need more stuff. It's expensive to take them anywhere. Only, unlike children, sometimes you can legally make money from horses. So why not claim business expenses?

A taxpayer can deduct such expenses—but not in excess of what the taxpayer earns from the horses and other hobbies or “passive activities”—unless the taxpayer can show a profit motive. Even if there is a profit motive, the taxpayer can't claim losses until he disposes of his entire interest unless he can show he materially participated in the activity. This is where many horse owners get into trouble with the Internal Revenue Service.

The IRS becomes suspicious when it sees several years of losses with only the occasional and not particularly substantial profit—or no profit at all. The horse activity begins to look like a hobby or investment used to offset income from other sources.

Profit Motive

  • Suspected “hobby” losses bring the test under tax code Section 183 into play. Treasury Regulations Section 1.183-2(b) sets forth nine factors to determine whether the horse owner, breeder, trainer, riding instructor or boarding stable owner is engaged in the horse activity for profit:
  •  the manner in which the taxpayer carries on the activity;
  •  the expertise of the taxpayer or his advisers;
  •  the time and effort expended by the taxpayer in carrying on the activity;
  •  the expectation that assets used in the activity may appreciate in value;
  •  the success of the taxpayer in carrying on other similar or dissimilar activities;
  •  the taxpayer's history of income or losses with respect to the activity;
  •  the amount of occasional profits, if any, that are earned;
  •  the financial status of the taxpayer; and
  •  the elements of personal pleasure or recreation.


The regulation itself states that “no one factor is determinative” and other factors may be considered by IRS agents or a court in determining whether there is a profit motive.

‘Metz’ Decision

The U.S. Tax Court recently applied the profit motive factors in Metz v. Commissioner, T.C. Memo 2015-54, 2015 BL 80635, and found that Henry and Christie Metz's Arabian horse breeding operation was a bona fide business despite losses totaling $14.6 million over an 11-year period.

The IRS claimed the Metzes lacked a profit motive. The Metzes began to pursue their horse activity as a business around the same time Henry sold his interest in a family business for between $20 million and $24 million.

Subjective Intent

The court concluded that the Metzes had a subjective intent of making a profit. In response to the IRS's argument that they didn't keep their records in a businesslike manner because their Middle Eastern customers didn't sign sales contracts, Judge Mark V. Holmes said, “[w]e keep in mind, however, that we are looking for a profit motive, not ‘an intelligent businessperson’ or even a reasonable person.”

Holmes also noted that the Metzes had argued in response that these customers were from a different culture where there wasn't an emphasis on “pristine paperwork.” In addition, the breed registry enforced contracts through nonjudicial sanctions and wouldn't record the transfer of ownership to a defaulting buyer.

John Alan Cohan, a Los Angeles tax attorney with expertise in the horse industry, said in a July 30 e-mail to Bloomberg BNA, “Subjective intent is simply what the taxpayer believes to be true in his or her own mind, and is a matter of testimony and, if possible, backup evidence in the form of memoranda, emails, advice obtained from experts, and things of that sort. The more important element is objective evidence that supports the taxpayer's intention to make a profit.”

Joel Turner, a member of Frost Brown Todd LLC in Louisville, Ky., and an equine law practitioner, said losses over an extended period of time without any profits or even getting close to being profitable and not updating the business plan are red flags to the IRS. A taxpayer is likely to get audited if the taxpayer can show a trend line—that the taxpayer is working back toward a break-even point.

Horse-by-Horse Expensing

In recent Tax Court cases, including Metz, the IRS has unsuccessfully argued that taxpayers weren't conducting their horse activity in a businesslike manner and, thus, didn't have a profit motive, because they weren't maintaining horse-by-horse expense records. This could be analogous to keeping track of which child ate the most cereal or went through the most adhesive bandages.

Turner told Bloomberg BNA on July 27 that the issue keeps coming up, because “many IRS agents don't understand the industry. One horse out of 10 can make an operation profitable.” Turner explained that the horse industry uses rules of thumb such as getting at least a certain multiple of the stud fee for a yearling at a sale.

Cohan said that “if there is a history of losses the agent may want more and more information and documentation in order to make a finding against the taxpayer. It is usually a good idea to have separate files on each horse, and a bookkeeping method that shows the expenses on a horse-by-horse basis.”

Material Participation

If the horse activity qualifies as a trade or business, the taxpayer still must show material participation. If it looks like the taxpayer is writing checks but paying someone else to do the actual work, Section 469 passive activity limits may apply.

Section 469 generally defers losses until the taxpayer disposes of his entire interest in the business. A taxpayer can show material participation for a taxable year by meeting any one of the seven tests under Treas. Reg. Section 1.469-5T(a). Five of these tests are relevant to horse activities:

  •  the taxpayer (or the taxpayer's spouse) participates in the activity for more than 500 hours;
  • substantially all of the work is done by the taxpayer regardless of how many hours the taxpayer spends in the activity;
  • the taxpayer participates for more than 100 hours, and no other person participates in the activity more than the taxpayer;
  • based on the facts and circumstances, the taxpayer participates in the activity on a regular, continuous and substantial basis; or
  • the taxpayer materially participated in at least five of the last 10 preceding tax years.


Multiple Interests

A taxpayer also will be treated as materially participating in the horse business if he spends at least 100 hours in the business—regardless of whether anyone else spends more than 100 hours—and the taxpayer spends at least 500 hours in all of his “significant participation activities.”

Under Treas. Reg. Section 1.4695T(c), significant participation activities are activities—other than rental activities—that don't meet one of the material participation tests but are treated in the aggregate as material participation if the taxpayer spends at least 100 hours at each activity for a total of at least 500 hours during the taxable year.

Doing the Dirty Work

Turner said one of the key factors that will convince the IRS or a judge that the taxpayer is materially participating is the time and effort expended by the taxpayer in carrying on the activity.

Turner said in the horse business, a taxpayer who is doing the dirty work, such as mucking out stalls or fixing fences, appears more serious about the activity than a taxpayer who would rather pay someone else to do it.

Turner said the single most important factor that will attract the IRS's attention is when a taxpayer has income from other sources that is substantially reduced by horse activity losses. The IRS seems to target people with mid-six-figure incomes who spend six figures on the horse business, just barely meet the 500-hour threshold and employ other people to do the physical, dirty work, he said.

‘Tolin’ Decision

Turner cited Tolin v. Commissioner, T.C. Memo 2014-65, 2014 BL 99664, as a “really attractive decision for taxpayers,” noting that if Tolin were working for someone else in managing and promoting his thoroughbred racehorses, he would have earned significant fees.

In Tolin, the U.S. Tax Court found that a Minnesota attorney materially participated in thoroughbred horse breeding and racing activities in Louisiana and was thus entitled to loss deductions relating to advertising, board and care, mortality insurance, nomination and registration fees, travel and veterinarian expenses.

Stefan A. Tolin presented a narrative summary of his activities, which—although a generally frowned-upon post-event review—the court found was corroborated by telephone records, third-party witness testimony and stipulated facts. Tolin estimated that he spent more than 850 hours for each of the tax years at issue.

Cohan said once a case reaches the Tax Court, “much depends on who the judge is. Some judges are philosophically sympathetic to taxpayers engaged in horse activities, others not. The degree of skill of one's attorney is important, because a good deal of documentation is necessary to pursue a case in Tax Court.”

Tolin, although an attorney himself, was represented by Richard W. Craigo, a Los Angeles-based attorney.

Turner compared the horse business—breeding, specifically—to an investment portfolio. “Breeders that stay in business don't have a portfolio made up of the bottom end. You have to be able to diversify and absorb unexpected events if you want to increase your chances of being profitable.”

To contact the reporter on this story: Erin McManus in Washington at

To contact the editor responsible for this story: Brett Ferguson at


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