Farm Audit

[VondenHogenBeaverHausen]

A taxpayer has a nice horse farm but has run substantial losses for many years. The IRS has not allowed the losses for three years and has a pretty heft tax due.

He says the land is going up and if not for depreciation the cash flow loss is not too bad.

Is the kinder and gentler IRS cracking down on horse people? What is the proper method to dispute the decision this is a 50 hour a week, very hard working hobby? He has another job that pays about 100,000

Thanks.

[jainen]

The first step

The first step is to file an appeal. Request the auditor's workpapers and study them in light of the IRS Facts and Circumstances Test in Reg 1.183-2(b). There is quite a bit of case law and opinions to research, but before you spend too much time talk with the client about his reasons for fighting the IRS. He appears to have the classic case of trying to write off a common expensive hobby against wages. The IRS probably has a strong case and may be willing to let it go to court, a costly option for your client.

The basic question in showing profit motive is, since he was losing money why did he keep doing it year after year?

[VondenHogenBeaverHausen]

Why

The reason the client states for keeping the business going is the Land is going up very rapidly in this very desirable area.

How likely is that to prevail?

Do auditors have any wiggle room to settle at their level perhaps allowing two years and billing the taxpayer on just one year?

Thanks.

[jainen]

come up with something better

The auditor HAD some discretion, but you are past that level now. Can you come up with something better than saying this is an investment with no real expectation of profit from business operations?

[Armando Beaujolais]

Mr. Beaverhogen,

IRC section 183(d) talks about the general presumption of profit motive, which is 3 of 5 years, but it also talks about the 2 of 7 year rule for "breeding, training, showing, or racing of horses."

The 2 of 7 year rule will not make or break the findings on this issue, it's a "presumption" that can be overcome by other factors. However, it could be an important fact in favor of the taxpayer.

Why did Congress write a law specific to horses? The law recognizes that it takes longer to make a profit in the horse business than any other business. I'd be inclined to ask the auditor what that code provision means in the context of this case, and how that provision applies in this situation. The 183(d) rule is the hobby loss rule. If the auditor did not base the disallowance in context with 183(d), I'd say the auditor is looking at the wrong end of the horse, if you'll excuse my terminology.

I believe that an increase in value of assets can be a determining factor in profit motive. I'll dig around and see what I can find in court cases.

[Bird Legs]

Horse farm losses-Audit

Also, what did client do to try to make a profit? Did he consult with outside experts? Did client have someone knowledgeable in this type of business to come in, study it, make recommendations?
What changes did client make in operations to try to eliminate the losses?
If client can show that he did the above things, it will help in the appeals.
Remember the old saying:"If you keep on doing what you have always done,
you will get what you always got."

[Bees Knees]

Saying that the cost of land is going up in the area does nothing for your horse business ( is there such a thing as a horse farm?). The cost of land should go up even if there is no horse operation.

You would have to argue that putting the horse barn, fencing, and other horse specific improvements into the operation is what is going up in value to justify taking continued losses under that issue.

[JON]

Bees got it

if he buys the land and holds it without the horses and he is better off-guess what you will not win.

Is he selling the horses, showing the horses, racing the horses, breeding the horses??? To show the "profit motive", and you have to, it relates to the horse operation-not the land value. If you can show the horses going up substainitally in value maybe you win. Lots of cases, even recently.

Having an outside job hurts you also. Substatial understatement of tax liability-you do not want that. I have one of these-it is still going on and I write the letter every year telling him what his potential PROBLEM is.... He has the anti book for horse operations-under some guy's name, A couple of years ago there was some potential, but I have trouble seeing how he is going to get to profits now.

[DaveO]

Is the kinder and gentler IRS cracking down on horse people? What is the proper method to dispute the decision this is a 50 hour a week, very hard working hobby? He has another job that pays about 100,000

You pretty well say it all right there. Doesn't matter how hard you work on your hobby or how much you have invested it's a hobby nonetheless. The expected appreciation of the land is not a business consideration. It will work for a grain farmer or even a rancher to a degree but $100K AGI+Horses=Audit.

There is very extensive case law out there. Sadly most of it in favor of the IRS.

[veritas]

Gotta love those horsey ppl!

[RLymanC]

IRS Audit Technique

Have not read this audit technique,,,,,,you may find it helpful.

http://unclefed.com/SurviveIRS/MSSP/a1farmls.pdf

See "Land Appreciation" Factor 4 on page 28

[Bird Legs]

Horse Breeding-Training-Audit

Had one just like this several years ago. Losses for about 12 straight years. Had an
audit. 2 things that saved this for the client:
1. Proof of consulting with outside specialists in order to improve the operations and
make a profit.

2. The prospect of the increase in value of the land. In fact, this particular question was
asked by the IRS auditor and was relevant in the no change audit.

[JON]

You had some good

luck with the auditor. Land does not increase in value because of the horses. I hope I get the same one...