By John Alan Cohan, Attorney at Law
A new Tax Court case, Blackwell v. Commissioner IRS [T.C. Memo 2011-188], involved taxpayers who were reasonably well qualified to engage in a horse breeding activity, and who convinced the court that they had the opportunity or the potential to earn a profit in their venture.
Mark Blackwell prepared a detailed business plan relating to the purchase, breeding, training, showing and sale of reining horses. The plan projected a profit after the third year, but they, in fact, never generated a profit. The taxpayers maintained what the court called “reasonably good” books and records of income and expenses relating to their activity.
Patti Blackwell completed the Equine Industry Management bachelor’s degree program at the University of Minnesota, and this included learning the management of a horse activity as a business.
They bought Quarter Horses that had already had some success in regional horse shows and/or that had recognized bloodlines. They occasionally rode their horses in shows, won some nominal prize money and participated in social events at horse shows.
The taxpayers sought and received advice on their horse activity from a number of expert horsemen. They advertised their horses on their own website, on business cards, calendars, clothing, flyers and in videos and magazine articles. They occasionally hired horse trainers to work with their horses and to show or ride them at shows.
After about six years, they shifted their activity from reining horses to cutting horses because they perceived a greater demand for the latter in the horse industry.
All but four of the horses that they sold were sold at a loss. Three were sold at a small profit (not taking into account expenses relating to the horses), and one died. They also bred their mares to outside horses and sold a number of the foals, some for a profit. One of their stallions sired a number of horses, owned by others, which won a number of cutting horse competitions.
Setbacks included a number of horse illnesses and the sudden death of one of their best mares.
In 2009, because of the losses they continued to experience, they terminated the venture. The court said that even though the venture went on for nearly 10 years, the losses, which were substantial, “were realized during what we, in this case, regard as still the early or startup years of the activity, and petitioners terminated the horse activity in 2009 when it became clear to petitioners that the likelihood of profitability was remote.”
The court said they were “reasonably well qualified” to engage in a horse breeding activity for profit, and that Mr. Blackwell’s business qualifications “were particularly strong, and he had a gifted ability to make good business decisions, to market and advertise effectively and to work successfully with others.” It helped that the taxpayer-husband had an MBA degree and 30 years of significant experience in business management. (He was a national motocross champion and for many years worked full time as manager of a number of motorcycle, snowmobile, ATV and personal watercraft manufacturing companies.)
Although the taxpayer-wife had a lifelong interest in horses, the court said the facts of this case indicated only minimal recreational aspects. The court said “the time, effort and financial resources petitioners personally put into and invested in their horse activity are not indicative of a hobby.”
The court concluded that the taxpayers had actual hopes for the sale of their horses at a profit, and that their horse activity is appropriately described as a “business.”
This case underscores a principle of the hobby loss rule that an opportunity to earn a substantial ultimate profit in a highly speculative venture may be sufficient to indicate that an activity is engaged in for profit.
John Alan Cohan is a lawyer who has served the horse, livestock and farming industries since l98l. He serves clients in all 50 states and can be reached at: (3l0) 278-0203 or via e-mail at [email protected]. His website is JohnAlanCohan.com.