Horse Owner Materially Participated in Horse Breeding and Racing Operation.
(Parker Tax Publishing April 25, 2014)

Because an attorney/racehorse owner established through corroborating evidence that he materially participated in his operation of a thoroughbred horse breeding and racing activity, the activity was not a passive activity, and he could deduct losses from the thoroughbred activity for each of the years in issue. Tolin v. Comm'r, T.C. Memo. 2014-65 (4/9/14).

Stefan Tolin was an attorney who maintained a general solo law practice. He became involved in thoroughbred horse breeding and racing in 1990 when he bought his first racehorse. In 2002, after doing research and contacting a thoroughbred consultant, Stefan decided to move his racehorse breeding operation to Louisiana, which had a number of laws that favored in-state ownership, breeding, and racing of thoroughbred horses. He contacted the Louisiana Thoroughbred Breeders Association (LTBA), which was involved in coordinating and developing the state's thoroughbred horse industry. Stefan entered into an arrangement with Sebastien Farms to board his stallion and three mares. Stefan also hired Bud Thibodaux, an experienced bloodstock agent, to provide assistance in marketing his stallion's breeding services.

To promote his breeding operation, Stefan personally contacted by telephone and in person a number of breeders in Louisiana and other states to interest them in choosing his stallion. He frequently consulted with the Sebastien Farms owner, Thibodaux, and LTBA officials regarding breeders who might be interested in his stallion. Stefan also mailed out promotional breeding packages with personalized letters to interested breeders and placed full-page print advertisements in horse breeding publications. Although the breeding took place at Sebastien Farms, Stefan monitored the activities through daily telephone conversations with the Sebastien Farms operators. In addition, Stefan performed the administrative and financial tasks related to the thoroughbred activity and directed the horse training and sales process.

Stefan filed his federal income tax returns for 2002, 2003, and 2004, and attached Schedules C, Profit or Loss From Business, for each year. He claimed deductions for advertising, board, insurance, nomination and registration fees, veterinary expenses, and travel. He also claimed losses from the thoroughbred activity for all three years. The IRS issued a deficiency notice disallowing the claimed losses as passive activity losses. Stefan took his case to the Tax Court.

OBSERVATION: The IRS challenged Stefan's loss deductions solely on the basis of the passive activity loss rules, apparently conceding that Stefan operated the thoroughbred activity with a profit motive. In many cases involving thoroughbred activities, the IRS challenges loss deductions under the Code Sec. 183 hobby-loss rules.

Code Sec. 469 disallows the passive activity loss of an individual taxpayer. A passive activity is generally the conduct of any trade or business in which the taxpayer does not materially participate. Under Reg. Sec. 1.469-5T, a taxpayer can meet the material participation requirement in a given year by satisfying one of several tests, including participation in the activity for more than 500 hours during the year.

Stefan contended that he participated in the thoroughbred activity for over 860 hours for each of the three years in issue. The IRS argued that Stefan's estimates of his time spent on the thoroughbred activity were unreliable and that a substantial amount of time was undertaken in his capacity of an investor.

The Tax Court held that Stefan presented sufficient corroborating evidence that he performed more than 500 hours of qualifying work done in connection with the thoroughbred activity in each of the three years in issue and should be treated as materially participating in the activity for each of those years. Stefan introduced as evidence a narrative summary describing the tasks he performed in connection with the thoroughbred activity and estimating the time he spent performing such tasks for each of the years at issue. He also introduced telephone records, credit card invoices, and other contemporaneous records of the work he performed in connection with the thoroughbred activity, along with a significant amount of credible third-party witness testimony and other objective evidence that gave an accurate depiction of his thoroughbred activity.

The court noted that Stefan was eager to learn about, and become personally involved in, thoroughbred breeding; he considered stallion promotion to be critical to the success of his thoroughbred activity; and enjoyed the activity and was determined to make it successful. The hours that he claimed he devoted to the activity were corroborated by telephone records and third-party witness testimony that was credible and reasonable. Moreover, Stefan's trips to Louisiana were devoted to his thoroughbred activity and did not have any recreational purpose.

In rejecting the IRS's argument that a great deal of the work Stefan performed was in his capacity as an investor, the court stated that Stefan was directly involved in the daily management and operations of the thoroughbred activity, and any "investor" work qualified as participation. Because Stefan materially participated in the thoroughbred activity, it was not a passive activity and Stefan was not prohibited from claiming loss deductions for the activity for any of the years in issue.

For a discussion of the passive activity loss rules, see Parker Tax ¶247,100. (Staff Editor Parker Tax Publishing)

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