Editor’s note: This article is a guest post from the CPA, Stephen L. Nelson, I interviewed for an earlier blog post this month.

So, if you happened to check out the last blog post about when and how one can write off the expenses of a horse on your tax return, you probably weren’t surprised to learn that while you can sometimes write off the costs of owning a horse—and save tons of taxes–hobby expenses usually can’t be written off.

Given these twin realities, you probably won’t be surprised to hear that over the years horse owners have repeatedly tried to take deductions, regularly been challenged by the Internal Revenue Service, and frequently ending up losing the argument in court.

Background about Horse-related Tax Savings Gambits

For example, at least one attorney has tried to write off the expenses for playing polo including all the costs of owning and caring for his polo ponies.

More than a few physicians or their families have tried to write off the costs of breeding and raising horses.

And countless numbers of folk have tried to call a small stable a “business” so as to take as deductions the costs of owning one or more horses.

As a general rule, in the majority of these cases, taxpayers lose the argument.

And summing up the situation simply: If horses or a stable produces only tax deductions or business losses, the activity can’t save taxes because you don’t have a business or investment. You only have a hobby you’d like for tax reasons to call a business or a hobby.

Tracy Topping’s Terrific Tax Planning Tactic

Given the above realities, the United States Tax Court case of Tracy Topping surprised pretty much everyone.

In a nutshell, Ms. Topping devised a business plan to leverage her equestrian skills, horse experience and a 16-year-old horse to design barns and homes. Her approach? She combined both the activity of owning a horse with the activity of designing barns and houses.

Per her business plan, the combination created synergy. Yes, on paper, a narrow analysis might make the horse ownership look only like a hobby. And an expensive one, as you might guess.

But her argument was the combination made good business sense. Owning a horse and then regularly participating in equestrian events and horse shows worked as a powerful platform for marketing her design business.
The judge agreed.

The tax court, for example, made this comment about her operation:

Petitioner’s business methodology consists of entering in and attending horse shows, and making contacts with prospective clients at the shows. Potential clients develop from horse show contacts, and then petitioner and Ms. Martin meet with the potential client. Early on in her business, petitioner tried to develop clients through her longtime experience playing golf. When golf failed to produce any clients, she dropped her golf club membership.

Drawing Lessons from the Court Case

You should read the court case and discuss it with your tax advisor if you want to use the logic of the Topping versus the IRS Commissioner court case. But let me point out a handful of factors you may want to pay particular attention to.

1. Ms. Topping had a formal business plan that rationally explained why combining her equestrian activities and her design activities made sense. (This was key.)
2. The two activities occurred inside the same business entity—in Ms. Topping’s enterprise, for example, both activities occurred inside a limited liability company she had formed in 1999. (This was probably essential to the gambit working.)
3. In combination, the horse activity and the design activity produced a profit most years. For example, while the “horse” business might lose $50,000 in a given year if the “design” business made $200,000 for the same year, the consolidated operation would then show a net profit of $150,000.
4. Ms. Topping and her advisors presented a compelling and believable business argument for why they were using horse shows and other events as their marketing approach. (That the judge believed Ms. Topping argument indicates he thought her argument was credible and good.)

Final Caution

A closing caution if you’re a horse owner interested in applying the lessons of the Topping tax court case: You do need to be very careful here. In many cases, you would want outside professional help from a local CPA or tax attorney in order to get the gambit to work right.

About the Guest Post Author: Stephen L. Nelson is a CPA in Redmond WA. The author of QuickBooks for Dummies, he holds a Master of Science in Taxation degree from Golden Gate University, a Master in Business Administration degree from University of Washington, and a Bachelor of Science in accounting from Central Washington University.

Probably every horse owner spends time during tax season looking at their horse expenses and wondering whether any can be turned into tax deductions.

Accordingly, I thought, given the time of year, that I’d ask a tax CPA about all this. What follows is my interview—an interview that happens to be with my father, the managing member of local CPA firm in Redmond, WA.

Are Horse Expenses Ever Deductible on a Tax Return?

Yes, they may be—and in a couple of circumstances.

First, if your equestrian activities constitute a business, you can deduct any of your ordinary and necessary horse expenses as business expenses. If you’re a horse trainer and you own and use a horse to provide lessons, for example, you can probably depreciate that horse and deduct all of your horse-related expenses as business deductions.

Second, if your equestrian activities don’t constitute a business but rather amount to a hobby,  you may be able to deduct any hobby expenses to the extent you have hobby income.

For example, if you  earn $1,000 from training or in some contest or for boarding a friend’s horse,  you may be able to deduct up to a $1,000 of horse expenses as hobby expenses.

Unfortunately, deducting hobby expenses is tricky. Hobby expenses are deductible only if you itemize your deductions (and most people don’t) and only to the extent your hobby expenses and other miscellaneous itemized deductions exceed two percent of your adjusted gross income.

Furthermore, I should say you need to handle hobby deductions in specific way. You first need to deduct mortgage interest, property taxes and casualty losses. Then second you deduct any other operating expenses such as feed and veterinary care. And last of all, you would deduct depreciation on things like fencing, stables or an arena.

Can Someone Self-Prepare a Return with Horse Income and Deductions?

Sure, I think so. Most people should be able to use a product like TurboTax or TaxCut to do their return. And there’s little reason not to try this approach first.

 

To self-prepare a return, you just need to take your time and carefully follow the software’s instructions. By the way, I would strongly recommend using a tax software program. Don’t try to do this by hand.

And one final general observation about equestrian taxpayer tax returns: Do-it-yourself tax preparation should  present little problem if your finances are fairly simple and you’re pretty organized.

How Does a Horse Hobby Become a Horse Business?

Because business losses are so easy to deduct and can shelter other income (including wages you or a spouse earns), the Internal Revenue Service is suspicious of any business that includes elements of personal  pleasure, leisure or recreation.

Given this reality, anything having to do with horses is suspect.

Basically what you want to look at if you’re trying to decide whether your horse activities constitute a business or a hobby is the way you conduct the activity.

You want to consider, for example, the time, effort and expertise you or your advisors deploy. You also want to be able to convincingly argue that you pursue the activity in order to make money either in the short or long run.

Two examples probably highlight the extremes on the continuum here.

You can’t run up $10,000 of horse-related expenses for your 11-year-old daughter and convincing argue that you or your daughter horse ownership has a profit motive. Your daughter probably only spends a small portion of her time and effort on the “business” of having a horse. Her expertise—even if substantial for a pre-teen—is quite honestly limited.

However, an experienced trainer who spends 30-40 hours a week caring for horses and giving lessons? Who conducts this operation in a business-like manner? Who honestly hopes to make a profit at some point? Making a case that this activity is a business should be easy.

One other thing to note: The IRS presumes that any horse-related activity which produces a profit in at least two years in a consecutive seven-year period is a business and not a hobby.

Any Other Tax Tips You Can Provide Horse Owners?

Yes. I always recommend any taxpayer or business owner keep clean, organized accounting records. That’ll minimize the chances you’ll lose deductions or miss write-offs. Furthermore, good accounting records would tend to reflect that an activity is being conducted in pursuit of profits.

Finally, if you are taking position that your horse activities are a business, be consistently business-like: Have a business plan. Have a business license if required. Consider using a real accounting system like QuickBooks. Oh and one other thing. Do document the stuff you do to improve the profitability of your operation.