The Farm CPA
Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.
Partial Taxpayer Victory on Horse Farm Case
Apr 29, 2014
In the Merrill C. Roberts cased just released by the Tax Court today, the taxpayer ended up with a partial victory in another horse farm case. Mr. Roberts, started a restaurant in 1969, had it burn down in several months after opening, and then used the insurance proceeds to open a bar in 1972. The bar was near an airport and started attracting "airport controllers" who asked Mr. Roberts "to arrange for exotic dancers to perform at the celebrations". Although profitable, Mr. Roberts elected to sell the business for "moral reasons" in 1973. About a year later, the buyers stopped paying and he took the business back and continued to operate it as a bar and nightclub.
Over several years, he expanded his business by opening several more nightclubs. In 1987, Mr. Roberts bought 50 acres near his original nightclub and ten years later bought another 45 acres directly adjacent to it. The former owner had used the land to board horses and there was an operational stable on the property. He thought he might get some income off of the property, but the original intent was to subdivide the land and sell the plots. In the mid-1990s Mr. Roberts eased out of the nightclub business by selling it to his three children.
In about 1998 or 1999, Mr. Roberts was invited on a tour of Hoosier Park, the first racing track to open in Indiana. He soon became hooked on the horse racing business and proceeded to purchase two horses for a $1,000 each and actually made about $18,000 in his first year of racing. He increased his stable to 10 horses in 2001 and bought a breeding stallion. In 2005, he decided to build his own stable on the land he owned, however, the City of Indianapolis put up many road blocks even though the land was zoned agricultural. He then elected to sell the property for $2.2 million which closed in June, 2006. He rolled over the gain on the 50 acres into new property more suited for training horses.
The IRS elected to audit the 2005-2008 tax returns and assessed additional taxes of $169,785, $617,119, $297,150 and $297,640 for 2005-08 respectively. Additional penalties under Section 6662(a) (accuracy penalty) of about $220,000 were also assessed and for 2007, the IRS elected to assess a failure to file penalty of $16,894.
In our review of the Mathis case earlier this year, we laid out many of the key factors that the court looks at in determining whether a business is a hobby (and thus not deducible) or not. Quoting the Court "On the basis of the record and considering the nine factors discussed above, the Court finds the petitioner did not engage in horse-related activities for profit during the 2005 and 2006 tax years. However, petitioner demonstrated a profit objective beginning in tax year 2007 when he significantly changed his operation, opened a new facility on real estate specifically purchased for horse-related activities, and transitioned out of the recreational aspect of horse racing. Accordingly, petitioner demonstrated the requisite profit objective under section 183 to deduct business expenses for tax years 2007 and 2008 but not for tax year 2005 or 2006." The key reason for this decision was that Mr. Roberts testified that his original intent for the land was for appreciation from selling it as lots, not a horse operation.
In a full victory for the taxpayer, the Court waived the accuracy penalties for 2005 and 2006 (2007 and 2008 no longer applied since there was no tax liability to assess the penalty against), however, he did file his 2007 return late, so that penalty was upheld.
Although not a full victory for Mr. Roberts, he did reduce his overall potential tax and penalties by over $800,000 (which should be sufficient to cover the legal fees and allow him to buy a couple more horses).