Summary of a Recent
Judicial Development in
Estate Planning & Taxation

Horse-Breeding Activity Found to be Hobby,
Not a Tax-Deductible Business Expense

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In Keating v. Commissioner of Internal Revenue, 544 F.3d 900 (8th Cir. 2008), aff'g T.C. Memo 2007-309, 2007 WL 2962774 (T.C. Oct. 11, 2007), the Eighth Circuit Court of Appeals held that taxpayer's horse-breeding activity was hobby and not for profit; therefore, she was not entitled to claim business loss deductions.

Background

Plaintiff challenged an Internal Revenue Service (IRS) determination that because her horse-breeding activity was a hobby and not for profit, it was not a deductible business expense. Id. at 901. The IRS held her liable for deficiencies in her federal income tax obligations. Id. at 901-02. During the years in question she had purchased thirteen horses and bred seven of them, but only sold two (each for half of its purchase price). Id. at 902. There was no evidence that she consulted anyone about the economic or business aspects of breeding, training, or showing horses, and had never advertised any horses for sale by means of written publication. Id. She also had no written business plan and no financial projections relating to her horse activity. Id. at 903.

Arguments

Plaintiff argued that the tax court erred in its analysis of whether her activity was a business for profit. Id. at 905.

Analysis and Holdings

The deductibility of taxpayer expenses related to an activity depends on whether it is carried on for profit, meaning that the taxpayer has an actual, honest profit objective, even if it is unreasonable or unrealistic. Id. at 903-04. Treasury Regulation § 1.183-2(b) enumerates nine nondispositive factors to consider when determining whether a business is engaged in for profit: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or her advisors; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses in respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) any elements of personal pleasure or recreation. Id. at 904. The tax court had found that five of the factors favored the conclusion that the plaintiff's horse activity was not for profit, and determined the other four factors to be neutral, with none favoring the conclusion that it was a business for profit; the circuit court pointed out that those factual findings involved credibility determinations which were "virtually unreviewable on appeal" and were supported by the evidence. Id. at 904-05. The circuit court concluded that the tax court did not err in its decision, and therefore affirmed the judgment of the tax court. Id. at 905-06.

The case was decided on October 14, 2008.