In a remarkable decision, the 7th Circuit Court of Appeals reversed a Tax Court opinion dealing with a Thoroughbred racehorse owner’s activities. This case is important to the livestock industry because IRS hobby loss regulations, the subject of the opinion, apply to livestock as well as horse activities.
The case, Roberts v. Commissioner, concluded that the taxpayer’s horse racing activities were entered into for profit. The Court characterized the Tax Court decision as untenable, in that it in effect concluded that a business’s start-up costs were not deductible business expenses and that every business starts as a hobby and becomes a business only when it achieves a certain level of profitability.
The taxpayer, Merrill Roberts, was a successful owner and operator of restaurants, bars and nightclubs in Indianapolis. In the 1990s, he began withdrawing from the business, becoming a consultant instead, and learned about the financial aspects of the horse-racing business. In 1999, he bought two horses for $1,000 each, and in the first year netted $18,000 in purses. He built a horse track on a farm and increased his stock of race horses to 10, plus a breeding stallion. In addition, Mr. Roberts passed the state’s licensed-trainer test and obtained his horse-training license.
In 2005, Mr. Roberts acquired a larger property and invested in improvements for the training of racehorses. He trained the horses himself. He lobbied the Indiana legislature on behalf of horse racing, pushing for legislation to permit slot machines at racetracks, which ended up being enacted. He took on leadership roles in two professional horse-racing associations.
Roberts spent upwards of 12 hours per day working with the horses on race days and about eight hours a day on other days.
During the years at issue, Roberts’ expenses significantly exceeded his earnings. The Tax Court held that Roberts’ activity was a hobby in 2005 and 2006, but that it became a bona fide business in 2007. Accordingly, the Tax Court held that Roberts’ business expense deductions for 2005 and 2006 were denied.
The Tax Court, which was reversed by the 7th Circuit, held that Mr. Roberts’ activity in 2005 and 2006 was a hobby, and became a business in 2007. The 7th Circuit said that the activity evolved from his decision in 2005 to build a larger training facility, and to make substantial improvements to the property: “The Tax Court’s finding that his land purchase and improvements were irrelevant to the issue or profit motive until he began using the new facilities is unsupported and an offense to common sense.” The 7th Circuit added, “The judge seems not to have understood that the decision to build the facility, and its construction, are also indications of a profit motive.”
The 7th Circuit found the Tax Court’s opinion confusing and contradictory. The 7th Circuit characterized the IRS regulations on the horse industry as “goofy,” and commented that the Tax Court would be better off if, rather than “wading through” the factors in the IRS Regulations, that before deciding, “the court must listen to the owner’s protestations of business motive.”
It is extremely rare for a hobby loss case to be appealed to the Circuit Court of Appeals, which rarely reverses the Tax Court. It is not only an expensive undertaking, but also takes a long time. The Tax Court handed down the Roberts decision in April, 2014, and the 7th Circuit issued its ruling in April 2016, two years later.
