October 3, 2002 -- In a new case, the Tax Court ruled that a Phoenix, Arizona physician's horse breeding and racing activity was not engaged in for profit even though the taxpayer developed a business plan and kept business records. The case, Timothy Kuberski v. IRS [RIA TC Memo 2002-200] appeared to hinge in part upon the judge's evaluation of the taxpayer's own testimony, which he found unpersuasive.
The judge said that the taxpayer, while he apparently had business plans, did not use these plans to improve the profitability of his activity. The taxpayer testified that he made economic forecasts and otherwise conducted the activity in a businesslike manner, but the operation's 28-year loss history seemed to suggest, to the judge, that this allowed the taxpayer to offset substantial income from his medical practice. Also, the taxpayer did not show that he had relied upon experts in conducting the activity. The taxpayer represented himself in court rather than being represented by a tax attorney, which is never a good idea. It is always important to hire experienced tax counsel if you have a serious tax matter.
The taxpayer believed that he could breed a better-than-average thoroughbred horse because of his medical background and his understanding of physiology and statistical analysis. He is a licensed trainer as well as a certified horse appraiser. He had taken annual classes on taxes, business, shoeing horses, veterinary problems, animal husbandry, and sales preparation. He had written several articles for the thoroughbred horse industry, including one explaining the dosage system, a horse breeding theory, and others on various equine medical problems.
One of the main reasons why the taxpayer lost this case was that he failed to introduce credible evidence with respect to certain factual issues. A competent attorney could have prevented this from happening. The judge emphasized that in order for the taxpayer to prevail with respect to claiming successive years of losses in a horse-related activity, the taxpayer must establish that he engaged in the activity with the primary, predominant, or principal purpose and intent of realizing an economic profit independent of tax savings. The taxpayer's expectation need not be a reasonable one, but the profit motive must be bona-fide. Greater weight is given to objective facts than to the taxpayer's self-serving testimony regarding his intent.
The taxpayer claimed that he kept detailed and well thought out business plans, maintained business account records with yearly profit and loss statements, filed stallion reports and reports of all broodmares and registered all foals with the Jockey Club, used a bookkeeping service, used business stationery and a business checking account, made a yearly assessment of the market, culled nonproductive mares or poorly marketable horses, made an economic forecast of each horse's productivity, and tracked the annual cost of getting each mare and foal to the thoroughbred sales. However, the judge felt that the taxpayer's arguments were not persuasive and were simply copied from the tax guides for horse owners that were also introduced into evidence.
Also, the judge found the taxpayer's testimony somewhat vague on the issue of how he conducted the breeding and racing operations. The taxpayer's testimony was uncorroborated by witnesses or documents.
The judge said that even though there were adequate business records the taxpayer did not include analyses on why large losses recurred over a long period and whether any possibility of recouping them existed.
The court was careful to mention that a continuous series of losses during the start-up phase of a horse activity will not necessarily be deemed indicative that the activity was not engaged in for profit. However, the cumulative loss of the taxpayer over the years was about $888,000. While the start-up phase of a horse activity is from 5 to l0 years, in this case the years at issue were well beyond the period customarily necessary to bring a similar operation to profitable status.
Sometimes taxpayers can explain losses based on unforeseen circumstances such as lawsuits against the business, downturns in business, changes in the purse structure at races, a decrease in Breeder's awards, and death or problems with important horses. However, the taxpayer in this case presented no evidence other than his own testimony to corroborate these claims.
The judge said that the taxpayer's level of income permitted him to continue the horse activity without a profit. If he had regarded the activity as a business, he would have focused more on the financial aspects and ways to cut losses.
Finally, the taxpayer claimed that his farm land appreciated in value over the years and should be considered when analyzing whether the requisite profit motive exists. However, he failed to provide a formal appraisal of the value of the land.
John Alan Cohan is a lawyer who has served the horse industry since 1981. He serves clients in all 50 states, and can be reached for an appointment by telephone at (310) 557-9900 or via e-mail at email@example.com.