April 15th will be here before you know it and the IRS is just waiting to take that big bite out of your earnings and your winnings. This is the second of a two part series of tax tips and will deal with issues for horse owners. The first part dealt with issues for bettors.
First let me make it clear I am no tax expert. These are just facts I have gathered from my own experiences as a partner in Cyberspace Racing Team. Always be sure to consult with an accountant or tax lawyer if you are horse owner as this is a very complex issue. If you are comfortable with doing you own taxes you can probably get away with using Turbo Tax or a similar program, but you are safest going to an accountant.
The IRS only allows deductions for horse racing or breeding expenses if you can prove it is not a hobby. There are specific guidelines you must neet to prove you are actually running it as a business and not a hobby.
- Whether you carry on the activity in a businesslike manner. You must run it like a business and show an intent to make a profit. Keeping full and accurate records of all aspects of your business is critical.
- Whether the time and effort you put into the activity indicate you intend to make it profitable. Put in lots of documented hours if you don't want to be classified as a hobby.
- Whether you are depending on income from the activity for your livelihood.
- Whether your losses are due to circumstances beyond your control or are normal in the start-up phase of your type of business.
- Whether you change your methods of operation in an attempt to improve profitability.
- Whether you, or your advisors, have the knowledge needed to carry on the activity as a successful business. Become an expert and surround yourself with experts.
- Whether you were successful in making a profit in similar activities in the past. If this is your first time in a racing or breeding business, they will look at your past business experiences.
- Whether the activity makes a profit in some years, and how much profit it makes.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
To avoid automatically being classified as a hobby, you must show a profit in at least 2 out of every 7 years. If you don't you are sure to be audited and will likely have to spend lots of money on a tax lawyer to defend your claim of being a business. The IRS doesn't want you to use racing as a tax shelter. If you are classified as a hobby you can only deduct expenses or losses from the hobby income, not your regular job's salary.
Another red flag to avoid is mixing your racing business with pleasure. Don't ride any of your horses for pleasure or hold parties at the track or stables. Keep the business aspects clearly separated and well documented.
If you are in a partnership as I am, you will have the additional chore of proving you are an active rather than passive partner. This is done by documenting your participation to prove you meet the 500 hours/year minimum. This means more than just showing up for the races. The drawback to being classified as a passive participant is you can only deduct the expenses or losses from passive income, i.e. not your regular job's salary just any profits from your horses.
Owning horses for racing or breeding can be fun, but when it comes to tax time you should be all business about it. Document everything, keep it all on a business level as much as possible, and be an active participant. It is tough to make a profit in this game so we need all help we can get come tax time.
Here are some links for more information on taxes and owning horses if you wish to get more in depth information. I especially recommend you read the two links that are bolded. These are very excellent articles which will help clarify some of the issues I mentioned above.
- IRS publication on Not-For-Profit Activies - starts on page 5
- IRS publication on Passive Activiy vs. Material Participation
- Are Your Horse Expenses Tax Deductible? - great article by a University of Texas law professor
- Horse Business Tax Cases - actual tax court cases dealing with horse racing and breeding
- Tax Articles - Hobby vs. business, record keeping, general tips
- Horse Income Tax Specialist - accounting firm that specializes in tax returns and audits for all types of businesses in the horse industry