The time and money involved in breeding stallions often requires breeders to operate as businesses. Horse breeders can deduct their business expenses from any breeding revenue, and use any losses from the business to offset unrelated income. To deduct losses from breeding stallions, however, the breeder must be able to prove it’s not just a hobby.
Business or Hobby
Breeding stallions only provides tax deductions if it is considered a business. Expenses and losses from hobbies are considered personal-pleasure expenses, and can only offset any income you made from the hobby. For example, if you made $50,000 from selling a colt but your expenses totaled $123,000, you could only deduct $50,000 to offset your hobby gains. One simple test the IRS applies to determine whether a breeding activity is a hobby or business is whether it made a profit in at least two of the past seven years.
Ordinary and Necessary
Businesses can deduct any expenses that are "ordinary and necessary" from their revenue when calculating income. The same applies for individuals claiming gains or losses from breeding stallions. Ordinary and necessary means that the expense is common, accepted and helpful for your business. For example, attending a seminar on breeding best practices might not be indispensable, but could qualify as ordinary and necessary. If your expenses exceed your revenue, and you have a net loss for the year, that loss will offset your income from other sources and reduce your overall tax bill.
Should the IRS select your return for an audit, if they disagree and claim your breeding activity is a hobby they will disallow the losses and file an amended return. The amended return would show a greater tax liability, resulting in a deficiency you must pay. In addition, the IRS could charge interest and impose penalties on the deficiency.
Challenging IRS Determinations
When taxpayers and the IRS disagree about an issue, such as whether breeding stallions is business or hobby, they can take it to the courts. Taxpayers can challenge an IRS decision in Tax Court, the U.S. District Court or the U.S. Court of Federal Claims. Each court has its own history of rulings that might influence what it decides in a new case. Taxpayers can only preemptively challenge in Tax Court. Any deficiencies and penalties imposed by the IRS must be paid in full before bringing suit in either the the District Court or the Court of Federal Claims.
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