JohnAlanCohan@aol.com 310.278.0203 Probate/Conservatorships IRS Audits IRS Collection IRS Appeals U.S. Tax Court IRS Criminal Investigation Tax Litigation Tax Opinion Letters Business Plans Aviation Law Tax Exempt/Nonprofit Organizations All aspects of equine and livestock law, particularly tax matters, syndications, business plans, tax opinion letters, and drafting of business documents.		New Tax Case Rules Against Taxpayer’s Horse Activities by John Alan Cohan, Attorney at Law A new tax case, JANE FREED v. COMMISSIONER OF INTERNAL REVENUE, T.C. Memo 2004-215 (September 23, 2004) involved a deficiency of $64,213 on the question of whether the taxpayer operated her thoroughbred horse breeding and racing activities for profit in 1996. The court ruled for the IRS. Ms. Freed was engaged in thoroughbred horse breeding and racing activities from the early 1980s through 1996, the year at issue. She acquired her first horse, a riding horse, after she married her first husband in 1949. At some point before her second marriage, she acquired a steeplechase horse for showing. She was first introduced to thoroughbred horses when she operated her second husband's unprofitable thoroughbred horse activities in the 1960s. She began active thoroughbred horse breeding activities in 1982, and racing activities in 1984. The court noted that the taxpayer’s herd has varied over the years in quantity and ratio of breeding horses to racing horses. In 1996 she had three breeding horses and eight racing horses. The horses race exclusively in New York State. She visits her horses in person only three to four times per year. She most often watches her horses race via closed circuit simulcast in New Jersey. She never had any of her thoroughbred horses appraised. The taxpayer is the beneficiary of three trusts holding assets with a total value of approximately $6 million. She received about $200,000 per year in income from the trusts. She did not make a profit from the activities between 1982 and 1996. Her losses during that time totaled over $1.1 million. She consulted with various advisers in conducting her thoroughbred horse breeding and racing activities. She employed a professional breeding manager, professional trainers, and a certified public accountant (CPA). She frequently consulted with her manager and relied upon his advice regarding her thoroughbred horse breeding and racing activities. He has approximately 90 thoroughbred horse breeding clients. His farm produced Funny Cide, a gelding who won the Kentucky Derby and the Preakness Stakes in 2003. Her accountant prepared miscellaneous ledgers, maintained other records in connection with her activities. However, there were no balance sheets, financial projections, or budgets. She subscribed to various horse industry publications. The court said that the taxpayer did not conduct her thoroughbred horse breeding and racing activities in a businesslike manner. Although she kept adequate records and employed a CPA to prepare a few financial statements, she failed to make meaningful changes in her method of operation despite a 14-year history of significant losses. The court said that losses of this magnitude without making changes shows that she did not conduct the activities in a businesslike manner. She did change trainers and adapted her breeding activities to adapt to qualifying criteria changes in the New York Breeders Program, but these changes did not occur until after 1996, the year in question. The court said that the taxpayer's advisers have demonstrated an expertise in breeding and training winning thoroughbreds, and she has demonstrated a willingness to solicit and follow their advice. The taxpayer claimed to have spent 10 to 20 hours per week on bookkeeping alone. In addition, she claimed that she spent time reading industry-related publications as well as time talking to her breeding and training managers. The court said that the taxpayer failed to corroborate her testimony on the time and effort expended in carrying on the activities. The court said that although the taxpayer contends she expected the assets to appreciate in value in light of her actions, petitioner failed to explain how she expected the sale of her thoroughbred horses and their offspring to recoup the over $1.1 million in losses she incurred over 14 years. As mentioned, she never had any of her thoroughbred horses appraised. In addition, the court said that there was no evidence that any of the horses she sold commanded such a price that she could expect to overcome her history of losses. The court also considered the taxpayer’s explanation for the losses: (1) The death of one of her broodmares; (2) barren broodmares; (3) poor performance of racing thoroughbreds; and (4) negative economic conditions. The court was not convinced that any of these circumstances are the type that should have caught her by surprise. The taxpayer argued that the court should ignore losses she incurred before 1991 because the IRS examined her income tax return for 1991 and did not disallow the deductions she claimed for her breeding and racing activities. The court said that even if the IRS previously "approved" these losses, 1991 is not the year at issue in this case. The facts and circumstances in 1991 are different from those in 1996. Furthermore, the court said it was not bound by the findings of an IRS audit. The court disregarded the taxpayer’s argument that she made a profit in 2001, 2002, and 2003 from her breeding activities, finding that in 2001 the “profit” was due primarily to her capitalizing $70,000 of boarding costs that she had expensed in prior years. Moreover, no evidence was produced to substantiate a profit in 2002 or 2003. The court noted that the taxpayer did not live on a farm with a trophy house. She never rode the horses. In fact, she intentionally avoided contact with them to remain detached. She saw the horses only three or four times a year. There is no indication that she had any affection for any of the horses. Still, the court held that she failed to prove that she engaged in thoroughbred horse breeding and racing activities with the actual and honest intent to earn a profit. This underscores the apparent situation of stricter scrutiny in the Tax Court (and by the IRS) of cases where horses or livestock are losing, rather, than earning, money. The case also emphasizes the prudence of periodically having horses and other assets appraised so as to prove that they are increasing in value. Back to Top