Tax Court Allows $11 Million Horse Loss to Stand

The US Tax Court in the Metz case released yesterday allowed taxpayers who had claimed over $11 million of losses related to a horse farm to stand.  As we have previously discussed, the Tax Court reviews 9 tests in any case with possible hobby ramifications.  If the “business” is deemed to be a hobby, then the losses are disallowed.  If it is a business, then the losses are allowed in full.  The nine key factors the Court considers are:

• Manner in which the taxpayers carry on the activity;
• Expertise of the taxpayers or their advisors;
• time and effort expended on the activity;
• Expectation that assets used in the activity may appreciate in value;
• Success of the taxpayers in carrying on other similar or dissimilar activities;
• History of income or losses with respect to the activity;
• Amount of occasional profits, if any, from the activity;
• Financial status of the taxpayers; and
• Any element of personal pleasure or recreation.

This is not a case of where 5 out of 9 factors wins for the taxpayers since the Court will weight some of the factors more than others.  With the current case, the Metz’s family had owned a very successful bread business in the Omaha area that was finally sold a couple of different times.  As a result of these sales, Mr. Metz received over $10 million which invested very well in the market until 2008.  Income from interest, dividends and capital gains averaged more than a million dollars from 2004-2007.  He also borrowed against the investments to “feed” his horse operation.  When the market crashed in 2008, Mr. Metz was required to liquidate most of his holdings resulting a capital gain in excess of $5 million.  The primary source for their horse-breeding activity had vanished.

Starting in 1991, the Metzes had started an Arabian horse-breeding activity called Silver Maple Farm, Inc.  The farm was originally located in Iowa, then moved to Naples, Florida for a while and then finally ended up in California where many other Arabian breeders were located.  I have personally history with Arabians since we had one located on our farm as a child and I have very fond memories of riding that horse.

From 1999 to 2009, the horse breeding operation averaged a loss of about $1 million or more each year.  Even after the losses incurred in 2008 from the stock market, the Metzes borrowed over $2 million to keep their horse-breeding operation in business.

The Court reviewed the nine factors and although a couple of factors went against the Metzes, the bottom line conclusion by the Court was the horse-breeding operation is not a hobby and the s are allowed in full.  Now, though this is a victory for the taxpayer in Tax Court, they are still out over $11 million in losses (or more).  I am not sure if it really is an overall win for the taxpayers.

Paul Neiffer, CPA