By Richard B. Dicks, CPA
Most involved with the equine industry of whatever breed do so purely as a hobby. It is an activity from which one can derive great pleasure and enjoyment, while at the same time, providing an opportunity to meet new friends and share a common interest with all in their family. There is absolutely nothing wrong with this. It makes for a strong market for our horses and a more interesting and exciting industry for all of us.
There are however many of us who, because of the investment of time and money involved, or because of our personal goals for our horse activity, wish to be in the horse BUSINESS.
Doing that successfully and having the IRS agree with us on this characterization of our activity is the question at hand. The federal tax code states that an individual may not deduct operating expenses in an amount greater than the income from an activity if that activity is "not engaged in for profit".
This provision of the tax code is often referred to as the Hobby Loss provision. The IRS requires that an individual operate any business activity in a “For Profit” manner. For the IRS to allow a taxpayer to deduct operating tax losses from ordinary taxable income obtained from other activities, there are certain criteria, spelled out by law with which they must comply.
Losses from a hobby are considered personal expenses and are generally deductible only to the extent of gains from that hobby activity. Whether an activity is considered a business or a hobby per the IRS is dependent upon whether the Ser¬vice considers that the taxpayer fulfilled certain obligations with regards to the en¬terprise and entered into it with the objective of making a profit.
The IRS lists nine factors, which are normally taken into consideration in determining whether the profit motive exists. Books have been written on this subject alone, including one by this author.
The first on the list and an essential ingredient in the presumption of whether a horse related activity is a business or a hobby is the profit motive. You get past that hurdle and the rest will pretty much fall in line.
Hobby Loss Criteria
I) Is the activity managed in a business-like manner (Is the profit motive present)?
2) The taxpayer's expertise or that of his advisors.
3) The time and effort expended by the taxpayer in carrying on the activity.
4) The expectation that the assets used in the activity may appreciate in value.
5) The taxpayer's history of success in other similar or dissimilar activities.
6) The taxpayer's history of income or losses with respect to the activity.
7) The amount of occasional profits, which the taxpayer may have earned in connection with the activity.
8) The taxpayer's personal financial status.
9) The elements of personal pleasure or recreation associated with the activity for the taxpayer.
While each of the above criteria can and probably will be taken into account by the IRS in the event of an audit of a horse activity, the primary objective of the taxpayer at all times should be to run the horse operation in a way that would most improve his opportunity to make a profit. In other words, one should run their horse business with the same diligence and using the same business principals and judgment that they would use in conducting other business enterprises.
Keeping good records and preparing attainable short and long-term financial plans showing the intent to make a profit from the horse operation is not only good to show when and if the time comes to deal with the IRS--it is also the only sensible way to run a business.
Richard B Dicks, CPA is one of the authors of Equinomics 101, the financial tool no horse owner should be without. An easy-to-use How-to-Book and software package for farm and horse owners. http://www.equinomics101.com
Comments