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Small Business

Business Expense Deductions Disallowed for Horseless Horse Activity

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

The Tax Court has determined that the IRS properly disallowed business expense deductions an individual taxpayer claimed for her horse activity because it wasn’t a trade or business (McMillan, TC Memo 2019-108).

The taxpayer, Denise McMillan, was a trained dressage rider who participated in “horse activities” for five decades. However, in 2008 McMillan’s only horse died, and McMillan did not own a horse in 2010, the tax year at issue.

Between 2004 and 2010, McMillan accumulated over $150,000 in losses and generated less than $600 in income from her “horse business.” McMillan supported herself with the income she earned from her IT business, which she worked at between 5-6 hours a day. Between 2005 and 2010, McMillan also spent a lot of time pursuing litigation against her HOA.

During 2010, McMillan spread the word that she was in the market to buy a horse with potential to train to international level and then sell for a profit (business plan). McMillan testified that she spent time networking, visiting training barns, reviewing videos of horses for sale, and attending five dressage competitions. In 2010, McMillan did not participate in any dressage competitions and spent only 30 hours training horses.

The Tax Court found that the IRS properly disallowed all of McMillan’s claimed business expense deductions for her “horse breeding/showing” activity because that activity wasn’t a trade or business.

Treas. Reg. §1.183-2(b) provides nine nonexclusive factors that can be used to determine whether an activity is being carried on “for profit.” These factors are: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer and their advisors; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) whether the assets used in the activity are expected to increase in value; (5) the success of the taxpayer in carrying on similar or dissimilar activities; (6) the taxpayer’s history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) the extent to which the taxpayer derives personal pleasure or enjoyment from the activity.

First, the Tax Court noted that it was impossible for McMillan to have a horse breeding/showing business in 2010 because she didn’t own any horses in that year and didn’t breed or show any horses in that year. Therefore, the “business” didn’t engage in the activities for which it was organized as required under Heinbockel.

Next, the Tax Court analyzed the nine factors in Treas. Reg §1.183-2(b) and determined that, even if McMillan did resume her old horse business in 2010, she did not run it for profit. First, McMillan didn’t run her horse activity in a businesslike manner because her business plan lacked (1) a budget for buying and boarding a horse, (2) a timeline for training and sale of a horse, and (3) any estimated return on her investment in a horse.

The Tax Court also found that McMillan spent a limited amount of time and effort on her horse activity; she spent 5-6 hours a day working at her IT business and a couple of hours more pursuing litigation against her HOA. Third, McMillan had no expectation that her business’s assets would increase in value because she didn’t have any business assets and because the financial history of her old horse business showed that, for over a decade, she made very little income and generated losses that she used to shelter the income she received from her IT business. Finally, McMillan enjoyed horse breeding/showing and based on the history of her old business, did not expect to make a profit. Therefore, McMillan’s expense deductions were limited to the income from her horse activity.

Read the full article and expert analysis in Checkpoint Federal Tax Update. To continue your research on hobby loss rules, see FTC 2d/FIN ¶M-5801.

 

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