Assets Increase An Important Tax Factor

If your horse related business is audited, you will need to put forward credible evidence to deal with the burden of proof problem.
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If your horse related business is audited, you will need to put forward credible evidence to deal with the burden of proof problem.

Many working class horse owners cannot afford to do battle with the IRS. Of the l20 million individual and corporate tax returns filed each year, about 2 million are audited. Of those, about 25,000 end up in Tax Court, but only 1,500 go to trial. In my 20 years of handling Tax Court cases for horse owners, I have never had a case where it was not possible to reach a settlement that the taxpayer was pleased with. But that meant having to put forward credible evidence to deal with the burden of proof problem.

?Kate Light

?Kate Light

The IRS presses employees to meet statistical targets, including dollar amounts. That means that if you are audited, the revenue agent sees you not as a human being but as a means to an end, an opportunity to help achieve a better performance ranking--and your horse activity looks like an easy target.

Some of the older tax cases are still quite important. In particular many horse owners don't realize how important Factor No. 4 of the IRS Regulations is. This Factor is called "Expectation That Assets Will Appreciate in Value." The term "profit" in IRS Regulations encompasses appreciation in the value of assets such as land and/or livestock used in the activity. and was discussed in an early case, Engdahl v. IRS. The taxpayer's land appreciated from $83,146 to $225,000 and the horses appreciated by $18,000 over their cost basis. The Tax Court held that this in itself was indicative of a profit motive. Later, 8n 1986, the Meagher decision, likewise, looked favorably on evidence that two of the petitioner?'s horses had appreciated in value. There are many similar discussions in Tax Court cases.

Factor No. 4 takes on significance particularly in situations where the taxpayer has been unable to show any profit years. Evidence that assets used in connection with the horse activity have appreciated in value can be used to dispel any notion that the enterprise is not in fact operated as a business.

Factor No. 4 can be crucial if you are audited by the IRS and cannot show a profit year. Appreciation in value of your farm or ranch property, or livestock, can help prove that you have an honest expectation of making a profit despite a string of losses. Evidence that assets used in connection with the horse activity have appreciated in value can be proven by expert testimony or by an appraisal report. The fact that a portion of your farm realty is used for a residence or other purposes does not preclude the Tax Court from considering the portion used for the horse activity.

Improvements such as barns, arenas, pastures, fencing, breeding sheds, stalls, storage facilities, and landscaping all fall within the type of improvements likely to help increase the value of the land itself.

Factor No. 4 takes into account the appreciation in value of the bloodstock owned by the taxpayer and developed or trained under his stewardship. The fact that certain animals have increased in value because of the efforts of the taxpayer tie into this factor even though the assets were not sold. The Tax Court has recognized the importance of holding onto one's most valuable bloodstock because it enhances the reputation of your farm and helps produce the line of foals you are focusing on.

It is recommended that taxpayers get a formal appraisal. The appraisal should also indicate that the land is used exclusively for the horse activity, and that the highest and best usage of the land is that of a horse farm.

This Factor is also important in justifying a taxpayer's expenditures on hiring professional trainers and incurring other costs related to the horse activity, for in many cases the value of horses is directly attributable to the amount of money spent in training, promoting and campaigning a given animal.

You should also be able to prove that the land was purchased, maintained and improved with the expectation that it would appreciate in value, and that this increase would enhance the overall profitability of your horse venture. This can be proved by establishing a formal business plan, by obtaining a certified appraisal, by conferring with legal counsel, and other procedures.

It is better to show that your expectation that assets will appreciate in value pertains not to just one, but to the entire group of horses that you own. The actual or "potential" increase in value should be documented by a bloodstock agent or other bloodstock appraiser.

Factor No. 4 can be crucial if you are audited by the IRS and cannot show a profit year. Appreciation in value of your farm or ranch property can help prove that you have an honest expectation of making a profit despite a string of losses. Evidence that assets used in connection with the horse activity have appreciated in value can be proven by expert testimony or by an appraisal report. The fact that a portion of the realty is used for a residence or other purposes does not preclude the Tax Court from considering the portion used for the horse activity.

Improvements such as barns, arenas, pastures, fencing, breeding sheds, stalls, storage facilities, and landscaping all fall within the type of improvements likely to help increase the value of the land itself.

In addition, Factor No. 4 takes into account the appreciation in value of the bloodstock owned by the taxpayer and developed or trained under his stewardship. The fact that certain animals have increased in value because of the efforts of the taxpayer tie into this factor even though the assets were not sold. The Tax Court has recognized the importance of holding onto one?'s most valuable bloodstock because it enhances the reputation of your farm and helps produce the line of foals you are focusing on.

A certified appraisal of the farm should show that the book value of the realty has increased significantly due to improvements made in connection with the horse activity, and not merely because of population growth or other external factors. The appraisal should also indicate that the land is used exclusively for the horse activity, and that the highest and best usage of the land is that of a horse farm.

This Factor is also important in justifying a taxpayer's expenditures on hiring professional trainers and incurring other costs related to the horse activity, for in many cases the value of horses is directly attributable to the amount of money spent in training, promoting and campaigning a given animal.

You should also be able to prove that the land was purchased, maintained and improved with the expectation that it would appreciate in value, and that this increase would enhance the overall profitability of your horse venture. This can be proved by establishing a formal business plan, by obtaining a certified appraisal, by conferring with legal counsel, and other procedures.

It is better to show that this expectation pertains not to just one, but to the entire group of horses that you own. The actual or "potential" increase in value should be documented by a bloodstock agent or other bloodstock appraiser. In addition, if you are audited the revenue agent may need to read some of the recent Tax Court cases (from the years 2000 and 2001) that pertain to Factor No. 4.

John Alan Cohan is a lawyer who has served the horse industry since l98l. He serves clients in all 50 states, and can be reached at: (3l0) 278-0203 or via email at johnalancohan@aol.com.