Horse Racing Activity Not a Hobby

IRS Horse Racing

Cross References

• Roberts, 7th Circuit Court of Appeals, April 15, 2016

• T.C. Memo. 2014-74

• IRC §183

The Tax Court ruled a taxpayer was not engaged in a race horse activity for profit and therefore disallowed losses used to offset other income. The 7th Circuit Court of Appeals recently reversed that ruling.

The taxpayer had deducted the expenses of his horse-racing enterprise on his federal income tax returns for 2005 and 2006. The Tax Court ruled that losses for 2005 and 2006 were not allowed under the hobby loss rules. But it also ruled that his business had ceased to be a hobby, and had become a bona fide business starting in 2007.

The taxpayer had deducted the expenses of his horse-racing enterprise on his federal income tax returns for 2005 and 2006. The Tax Court ruled that losses for 2005 and 2006 were not allowed under the hobby loss rules. But it also ruled that his business had ceased to be a hobby, and had become a bona fide business starting in 2007.

The taxpayer was successful in the restaurant business. In 1999, he bought his first two horses for $1,000 each, and in the first year netted $18,000 in earnings from racing them. He also built a horse track on land that he owned. Two years later he had 10 racing horses and acquired a breeding stallion. The following year he passed the state’s licensed-trainer test and obtained his horse-training license.

Several years later he bought 180 acres of land to expand his training facilities for about $1 million, and invested another $500,000 to $600,000 in improvements. He trained the horses himself. He testified that he spent 12 hours a day working with the horses on race days and about eight hours a day on other days. He was also involved in lobbying the state legislature on behalf of the horse racing industry. He successfully influenced legislation that permitted slot machines at racetracks, where part of the revenue would be added to the purse money, ultimately benefiting the owners of horses that won races. In the same period he served on the boards of two professional horse-racing associations.

The taxpayer’s horse-racing activities, which included boarding, breeding, training, and racing, were not profitable in 2005 and 2006, the two years in question. He deducted the losses on his tax returns from his other income which consisted mainly of income from consulting in the restaurant business and from renting and selling real estate.

The Appeals Court disagreed with the Tax Court’s ruling that the taxpayer’s horse-racing activity was a hobby in 2005 and 2006, but became a bone-a-fide business in 2007 and thereafter. The Appeals Court said: “…it amounts to saying that…every business starts as a hobby and becomes a business only when it achieves a certain level of profitability.”

The Appeals Court also disagreed with the Tax Court’s reasoning that improvements were irrelevant to the issue of profit motive until the new facilities were available for use in the activity. The Appeals Court said that would be like saying a rental activity is a hobby until land and building improvements are completed and ready for renters.

In considering the ninth factor under the regulations that are used to determine whether an activity is a business or a hobby, the Tax Court noted that elements of personal pleasure or recreation indicate that the activity is a hobby. The court implied that there is likely no profit objective where the taxpayer combines horse racing with social and recreational activities. The Court of Appeals disagreed with the Tax Court’s implication that involvement with a professional horse racing association demonstrated the taxpayer was engaged in some social aspect of the industry. The Court of Appeals said: “…that’s like saying that serving on a corporate board of directors is a social activity.” The Court of Appeals went on to say: “It may have been a fun business, but fun doesn’t convert a business to a hobby. If it did, Facebook would be a hobby, Microsoft and Apple would be hobbies, Amazon would be a hobby, etc.”

After considering all nine factors listed in the regulations concerning whether an activity is a business or a hobby, the Court of Appeals reversed the Tax Court and ruled the taxpayer’s activity was a business and losses generated during the years in question where deductible.

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