Owning a racehorse can be the most exciting investment you will ever make. But, it is first and foremost an investment. If treated like the business that it is, the IRS affords many of the same protections as investing in real estate or other business ventures. Below is a basic guideline to whether you can write-off your investment in horse racing partnerships like Little Red Feather Racing or West Point Thoroughbreds. For a more thorough analysis please see LRF’s Tax Guide to Investing in Thoroughbred Partnerships.
There are two hurdles to overcome in order to deduct investment losses and ordinary/customary expenses associated with the investment against all income.
Hobby or Business?
First, the IRS must recognize your investment as a business investment with a “for profit motive”. Otherwise, your investment falls under the “hobby loss rules”. It is important that you keep adequate records to prove that you intend to make a profit at the start of your horse venture. A written plan that shows how you intended to be profitable is very important in proving intent. Most investments in thoroughbred partnerships do not fall under the “hobby loss rules”.
Active or Passive?
The second and probably more important test is whether you classify as an “active” investor or a “passive” investor. Both types of investors can eventually deduct their capital investment in thoroughbred partnerships against any income. However, the rules regarding how quickly such investment can be deducted and if expenses associated with the investment can be included are all determined by whether you are an active or passive investor.
Determining Whether You Are an Active or Passive Investor:
Under IRS Tax Regulations, an individual is deemed to have materially participated in a horse business or other activity during the tax year only if the individual satisfies at least "one" of the seven tests set forth below:
1. The individual participates in the activity for more than 500 hours during the year.
2. The individual's participation in the activity for the taxable year constitutes substantially all of the participation in such activity of all individuals including individuals who are not owners of interests in the activity for such year.
3. The individual participates in the activity for more than 100 hours during the taxable year, and such individual's participation in the activity for the taxable year is not less than the participation in the activity of any other individual, including individuals who are not owners of interests in the activity for such year.
4. The activity is a "significant participation activity" for the taxable year, and the individual's aggregate participation in all significant participation during such year exceeds 500 hours. A significant participation activity is a business in which the individual participates more than 100 hours during the tax year, but does not materially participate within the meaning of one of the other tests.
5. The individual materially participated in the activity for any five taxable years, whether or not consecutive, during the ten taxable years that immediately precede the taxable year.
6. The activity is a personal service activity and the individual materially participated in the activity for any three taxable years (whether or not consecutive) receding the taxable year. A personal service activity is a business such as law, medicine, accounting, performing arts or any other business where capital is not a material income-producing factor.
7. Based on all of the facts and circumstances, the individual participates in the activity on a regular, continuous and substantial basis during such year. The regulations do not discuss what facts and circumstances are important and are to be taken into consideration, but state that they will be addressed in future regulations. However, the regulations do say that an individual's services performed in management of the business shall not be taken into account in applying the facts and circumstances test if: (i) a paid manager participates in the business, or (ii) the management services performed by such individual are exceeded by those performed by any other individual.
Investing in horse racing partnerships can be a tax write-off if the right planning is made. If you have any questions, please contact your accountant or feel free to call or email us.