Have you ever wondered if you could write off all the money you spend
on your horses? Or have you already set up your horse activities as a business, but
wondered what the IRS would say if you were audited? The Internal Revenue Code has
addressed this question and the related question called "hobby losses."
In order to deduct your horse expenses, your activity must be
"engaged in for profit." This profit motive is the key. Although a
reasonable expectation of profit is not required, you must show you are trying
to make a profit. The IRS can use objective factors to determine whether you had a
profit motive and will give more weight to these factors than to a mere statement of
intent.
The first factor is the manner in which you carry on the activity.
If you conduct the activity in a businesslike manner there is an indication of
profit motive. Maintaining businesslike records and keeping business funds separate
from personal funds may be evidence of a profit motive. Attempts to cut costs and
operating in a less than extravagant manner may also indicate a profit motive. But,
offering goods or services at less than fair market value may indicate the lack of a
profit motive.
The second factor is your expertise or the expertise of your
advisors. Your personal knowledge, willingness to become better informed or keep
up-to-date, and willingness to procure and follow expert advice are all relevant.
The third factor is the time and effort you expend in carrying on the
activity. A substantial amount of time devoted to the activity, either by you
or by employing other competent people, can show a profit motive. I don't know
anyone who owns horses who doesn't spend lots of time mucking and cleaning and repairing,
but you should keep a record of these types of things.
In order to deduct your horse expenses, your activity must be
"engaged in for profit."
The fourth factor is the expectation that assets used in the activity
may appreciate in value. Even if the activity has operating losses for several
consecutive years, an expectation that there will be an overall profit when appreciation
is realized may indicate a profit motive.
The fifth factor is your success in carrying on other similar or
dissimilar activities. If you've successfully operated similar activities,
there is a greater likelihood that a profit motive will be found. Methods of
operation, relative risks, and profit potentials between the activities will be compared.
The sixth factor is your history of profit or loss with respect to the
activity. Although several consecutive loss years may indicate the lack of
profit motive, generally losses can be expected during the initial stages of operation.
However losses that continue beyond the time it usually takes to bring the
operation to profitable status strongly indicate a lack of profit motive, unless the
losses are due to circumstances beyond your control.
The seventh factor is the amount of occasional profits, if any,
that you earn. The amount of profits is often compared to the amount of losses.
For example, showing a profit of $100 in one year, while other years you show
losses of $20,0000, will probably not be favorable for you. However courts sometimes
give favorable treatment where any profits are earned, regardless of the amount.
The eighth factor is your financial status. If you don't
have "substantial income or capital from sources other than the activity, [it] may
indicate that the activity is engaged in for profit." In other words, it's
easier to prove a profit motive if you are dependent on income from your activity than if
you make a comfortable living at another occupation and may be looking for a way to reduce
the amount of tax you owe.
The ninth factor addresses the elements of personal pleasure or
recreation. Although deriving personal pleasure or recreation from the activity
will not indicate conclusively that you lack a profit motive, pleasure coupled with
recurring losses, strongly indicates the lack of a profit motive. When auditing
horse activities, IRS representative often picture horse people riding through meadows
filled with flowers and need to be told about the amount of time and effort that is really
involved. Keeping records about the work it takes to run a horse business would be
very helpful. Additionally you don't have to prove an exclusive intent to derive a
profit. Deriving pleasure from the activity is not sufficient to cause the activity
to be classified as not engaged in for profit if other factors show that the activity was
engaged in for profit.
These nine factors are not the only ones the IRS uses to determine profit
motive. Other factors showing an honest and good-faith objective to make a profit
can be considered.
You may not need to prove all nine factors in order to show a profit
motive, however the more you can prove, the better chance there is for having your
expenses declared deductible. Another method of showing a profit motive is through a
statutory presumption. If you show a profit for two years out of seven (in a horse
activity) you will be presumed to have a profit motive. If your horse activities are
not "engaged in for profit" you may still be able to deduct a portion of your
expenses under the hobby loss rule. Some expenses may be allowed whether or not the
activity is engaged in for profit. These include interest and taxes. Other
expenses that a for-profit business could deduct can also be deducted by a hobbyist, but
only to the extent that gross income from the activity exceeds the deductions allowed.
What this means is that if you sell a horse for $2000, but spent $3500 on such
things as feed, veterinarian services, and advertising, you can only deduct $2000 worth of
expenses. The other $1500 is not deductible.
The hobby loss rule tries to prevent a taxpayer from using a loss-creating
activity to offset income from other sources. For advice regarding your particular
situation, please see a tax professional.
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