June 13, 2005
Perhaps the earliest tax case that made a serious impact on the manner of conducting activities in the livestock and horse industry was Bessenyey v. Commissioner Internal Revenue (2nd Circuit; l967). This case was unusual because it was a decision by the Second Circuit Court of Appeals concerning an appeal from a Tax Court case insofar as it denied the deduction of losses incurred in the breeding and raising of horses. There are only a handful of appellate court cases on this subject. The tax law is substantially the same for both the livestock and horse industries.
The taxpayer, a resident of New York, bought a group of broodmares via a veterinarian who attended a liquidation sale for some “Hungarian Half-Breds” that were owned by the U.S. Army. She bought nine horses for about $150 each in the early 1950s. She had the horses placed on a ranch in Montana and then, hearing that the horses were not receiving proper care, the taxpayer went to Montana, placed them at another property, and returned to her home in New York.
The mares were bred and by 1959 the initial herd increased to 31 horses. Some of the horses were transferred to the taxpayer’s farm in Maryland especially during the winter months. The taxpayer spent considerable time visiting her trainers, comparing notes with other horse breeders, viewing competitions and shows, and attending horse management courses.
The taxpayer sold only one of the horses, a seven-year-old gelding, for $3,000 in 1964. The Tax Court judge had ruled against the taxpayer, ruling that “although petitioner’s horse enterprise has some of the trappings of a business, ... she did not in fact have a bona fide intention to conduct her activities for a profit,” and that her rewards from her work with the horses and the expenditures upon them “consisted of personal satisfaction in the activity.” He based this conclusion in part on “the impression from observation of her during her testimony that figures and financial matters even bored her,” an attitude which led him to believe “that she gave little or no thought to whether her horse enterprise would ever be profitable, or whether the large losses that were being sustained annually would ever be recouped.”
Thus, the idea of “recoupment” of losses entered the Tax Court arena as a factual inquiry. Since that case, many judges have sought to find out whether the taxpayer, engaged in a horse or cattle activity, has some reasonable prospect of recouping previous losses. This is inherently unfair, as other businesses are no required to show how they might “recoup” previous losses. Also, the problem with this is a matter of evidence. Most taxpayers fail to have cost projections or other formal backup figures that will help support the argument that they are moving closer to a profit and that at some time in the future they will actually be able to recoup prior losses. In order to be able to withstand IRS scrutiny in the livestock industry, it is necessary to have a proper, formal analysis that will indicate how the enterprise will show a profit in proper time and that the taxpayer is proceeding as expeditiously as possible in a long-range plan.
This case seemed to mark the end of an era in which the Tax Court had more readily sided with taxpayers on the question of profit motive despite significant losses. For example, an earlier case, Ellsworth v. Commissioner Internal Revenue (1962), involved a wealthy taxpayer whose source of income was dividends. The court found that he was engaged in a horse activity for profit despite 13 years of losses aggregating $700,000. The taxpayer also acknowledged that when he entered the “business” at age 65, he believed he would not make a profit before attaining 75 or 80, and that his primary interest in breeding was “scientific.”
Today, the IRS seems to take the view that if the taxpayer is wealthy enough to absorb the losses, this automatically results in findings that the taxpayer’s rewards consisted primarily of personal satisfaction in the activity, rather than a profit motive. — John Alan Cohan
(John Alan Cohan is a lawyer who has served the livestock and farming industry since l98l. He serves clients in all 50 states, and can be reached by telephone at (3l0) 278-0203 or via e-mail at JohnAlanCohan@aol.com.)