A new Tax Court decision involved very substantial deficiencies and penalties against the taxpayer, Merrill C. Roberts, of Indianapolis, Indiana, over a four-year period for horse-related activities [Roberts v. Commissioner, T.C. Memo 2014-74]. In an unusual decision, the court held that the taxpayer had a profit objective in two of the four years; the remaining two years were ruled to lack the requisite profit objective, and hence deductions for those years was disallowed.
In years prior to starting the horse activity, Mr. Roberts owned and operated several successful nightclubs in the region. He sold his interests in the 1990s. Mr. Roberts had also acquired some real estate, including a parcel with an operational horse boarding stable. He got interested in the financial prospect of horse racing and, after conferring with a trainer, got an owner’s license, purchased two young horses for $1,000 each and put them into training for the racetrack. He studied racing videos, and built a training track on his property. In the first year, 1999, Mr. Roberts’ net income was $18,000 from the two horses. He bought more horses, including a breeding stallion, and hired several trainers. He worked on developing skills as a trainer, and he passed the trainer’s license test.
In 2005, the taxpayer decided to build his own training facility, but during the course of development he ran into hurdles with the city’s strict building codes. He sold the property for $2.2 million, and bought a parcel in an area that had less restrictive building codes. Following the advice of a bloodstock agent, he developed the new property into a training facility, and it was completed in 2007. He produced his own hay and rented some of the land out for $20,000 a year.
The taxpayer engaged in boarding, breeding, training and racing of horses. He hired an assistant trainer and spent considerable time matching horses with specific races.
There were several setbacks, including loss of some stallions due to injuries, and quarantine of some horses that prevented them from being raced in 2008.
The taxpayer served on the boards of two horse racing associations, and successfully lobbied the legislature to permit slot machines at racetracks, in turn increasing purses for horse racing in Indiana.
Mr. Roberts used a “rudimentary accounting system” for all of his businesses, including his horse-related finances. He relied on canceled checks and bank statements to track expenses. For gross receipts, he partly relied on an Internet database devoted to horse racing records.The taxpayer demonstrated significant changes in operation, adoption of new techniques, and abandonment of unprofitable methods when he moved his horse racing activity from the original property to the new property. The court said this enabled him to mitigate expenses in his old facility and move to a property that would not be cost prohibitive because of building codes. This also allowed him to reduce feeding costs by growing his own hay and renting out some of the property.
The court found that the taxpayer’s accounting method, “while rudimentary,” provided him with enough information to make informed business decisions. The court noted that the Internet provides a database that conveniently tracks earnings and other information on each of the horses raced by the taxpayer.
The court noted that when the taxpayer made significant changes in 2007 and 2008, his manner of carrying on the activity became more businesslike.
The court also found that the taxpayer had become an expert in his own right in the financial aspects of horse racing, and that he consulted with industry experts, whose advice he adopted.
The court said that his purchase of property to breed and train horses on and the improvements thereon might be expected to appreciate in value, and that this was relevant as to whether his horse activities were carried on with the intent to profit.
The court held that the taxpayer did not engage in his horse-related activities for profit during 2005 and 2006, but he demonstrated a profit objective in 2007 and thereafter. One of the significant points of this case is that a taxpayer’s business records can in effect be supplemented by database records available on the Internet. The court also seemed impressed with the taxpayer’s involvement on the boards of horse racing associations and in lobbying the legislature.
[John Alan Cohan is a lawyer who has served the horse, farming and ranching industries since l98l. He can be reached at: (3l0) 278-0203, by e-mail at [email protected] <mailto:[email protected]> , or you can see more at his website: www.johnalancohan.com <http://www.johnalancohan.com/> .]
