As tax season is upon us, I thought it might be beneficial for horse owners and businesses to see whether you can claim your horse activities as a business and what factors will determine that.
The American Horse Council reports in “Tax Tips for Horse Owners” that the taxpayer cannot deduct expenses of an activity which are greater than income from that activity if the activity is “not engaged in for Profit”. In other words – A hobby- cannot be deducted against income from any sources. On the other hand, if an activity is engaged in for profit ( a business rather than a hobby), losses are fully deductable against other income.
In determining whether an activity is engaged in for profit, all facts and circumstances with respect to the activity are taken into account. These facts and circumstances must indicate that the taxpayer entered into the activity or continued the activity with the objective of making a profit. If a profit is made in two years during a seven year period, it will generally be presumed that the taxpayer has a profit motive.
The IRS regulations list certain factors which are considered in determining whether an activity is engaged for profit. All factors are considered, not only the ones listed in the regulations.
The factors normally considered are:
- How does the taxpayer carry on the activity – is it in a business-like manner? Do they maintain complete and accurate bookkeeping records, carry on the activity in a similar manner to other activities of the same nature which are profitable and changes operating methods with the intent to improve profitability.
- The expertise of the taxpayer or his advisors.
- The time and effort taken by the taxpayer in carrying on the activity. If the taxpayer only devotes a limited amount of time, does he employ others to meet his goals?
- Will assets such as land and horses appreciate? Does the taxpayer intend to profit from that?
- The success if the taxpayer in carrying on other similar of dissimilar activities.
- The taxpayer’s previous income or losses associated to the activity.
- The amount of profits in relation to the losses and in relation to the amount of the investment and the value of the assets used in the activity.
- Substantial income from sources other than the activity, particularly if the losses from the activity generate substantial tax benefits.
- Elements of personal pleasure or recreation, however pleasure derived from the activity is not considered sufficient cause to classify the activity as not engaged in for profit.
Presuming that an activity is a business:
Horse businesses, unlike most other businesses, have to show a profit in two years out of a seven year period in order to be considered a business. This applies to the second profit year and all years thereafter within the seven-year period beginning with the first profit year. If it is a new activity, two profit years during any of the first seven years of operation will classify it as a business activity for all those seven years – provided the taxpayer makes a special election by the due date of the tax return for the third tax year in the seven year period.
If there are no profits shown in two years during a seven- year period, it doesn’t necessarily rule it out as a business. If nothing can be presumed the taxpayer must rely on the factors listed in the regulations or other facts and circumstances. The taxpayer should be able to demonstrate that the business will be profitable in the future, even if it hasn’t been for a number of years.
Any capital gains or any other sales relating to the activity are taken into consideration when determining a profit or loss year for purposes of the presumption.
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