Records, Third-Party Testimony Prove Taxpayer Devoted Enough Hours to Horse Breeding Business to Deduct Losses
An attorney and horse breeder won a significant victory in the US Tax Court recently, as the court decided that the taxpayer had enough credible evidence about his horse business-related work to establish that he had worked more than 500 hours trying to breed his horse. As a result, the taxpayer met the standard for material participation and was not blocked by the passive from deducting his horse business-related losses.
Stefan Tolin likely did not imagine the extensive tax battles he’d eventually face when first began breeding his retired race horse, “Choosing Choice,” in 2000. Because Tolin’s horse had achieved only a small number of successes before injuries ended his racing career, interest in the horse’s stud services was limited. Tolin spent many hours in the next several years attempting to drum up interest in the horse as a sire.
Tolin reported losses on his horse breeding business in 2002, 2003 and 2004, and took the corresponding deductions. The IRS rejected the taxpayer’s claimed deductions. In many horse breeding cases, the IRS disallows a taxpayer’s losses as hobby losses in accordance with Section 183 of the tax code. The IRS agreed that Tolin’s horse breeding was a business, not a hobby, but determined that it was a passive activity and, in accordance with Section 469, he was not eligible to deduct the losses. Tolin took the matter to the Tax Court, which sided with the taxpayer. In order for a taxpayer’s activity to be a passive one, he must not materially participate in the activity. Federal tax regulations require taxpayers to devote more than 500 hours in a year to qualify as materially participating in an activity. In many passive activity cases, the fatal flaw in the taxpayer’s case is a lack of credible, reliable proof regarding the number of hours the taxpayer worked. Many taxpayers simply offer up after-the-fact summaries creating broad, approximate guesses about the time devoted to the business.
In Tolin’s case, the court concluded that his records and additional evidence were sufficient to establish clearly that he spent more than 500 hours trying to offer his horse’s stud services in each of the 2002-04 tax years. Tolin’s summary of the work he completed regarding his horse business was detailed and supported by telephone records and credit card receipts. The taxpayer also presented third-party testimony, which the court found credible, backing up his claims about the work he performed. Based on Tolin’s extensive and detailed evidence, his claims regarding the hours he put into his horse business went well beyond just an impermissible “postevent ‘ballpark guesstimate’.”
Certain business ventures can be extremely rewarding, but can also be fraught with pitfalls if they are the types of activities the IRS typically dismisses as hobbies or passive activities. To make sure you have the records to support your business deductions in the event you face an inquiry from the IRS, consult the experienced tax attorneys at Samuel C. Berger, P.C. and CPAs at S.C. Berger, P.C. They can help you make sure you have the documentation you need in the event of an audit down the road. To consult our attorneys and CPAs, contact us online or call (201) 587-1500 or (212) 380-8117.
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