The Tax and Trade Outlook from Washington, D.C., for Equine Businesses

As Congress shifts into gear on the budget reconciliation process and tax day approaches, there are several key issues for horse owners to keep in mind. In the 119th Congress, there are two proposals that have been reintroduced that would change existing tax law as it relates to horse-related businesses.

• The Racehorse Cost Recovery Act would make permanent the three-year depreciation schedule for racehorses, regardless of their age when placed into service – eliminating the need for annual congressional reauthorization.
• The Racehorse Tax Parity Act would shorten the holding period for equine assets to qualify for long-term capital gains treatment and align them with similar investments, ensuring a level playing field.

With tax reform at the top of Congress' to do list this year, there is a clear opportunity to enact these measures into law. In addition, many in the horse community are looking for Congress to permanently repeal the estate tax – allowing assets to be passed on after one's death without any tax owed to the federal government. The current estate tax kicks in for estates that have a value of $13 million or more.

On the trade front, the president's rapidly changing tariff policies are raising questions for horse owners who transport their horses across the Mexican and Canadian borders (among others) for sale, competitions or breeding purposes. Holland & Knight is keeping an eye on this space for any changes that result from the impending tariffs announced on April 2, 2025, and any retaliatory tariffs.

With tax day around the corner, here are some key provisions for horse owners.

Harnessing Deductions: Navigating Equine Business Expenses Under Section 162

Section 162 of the Internal Revenue Code (IRC) allows for the deduction of trade or business expenses, including expenses for equine-related trade and business.

Under Section 162(a), a deduction is allowed for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." To be deductible under Section 162 – in the context of the equine industry – an item must be 1) paid for or incurred during the taxable year, 2) paid for carrying on equine trade or equine business, 3) a legitimate or "necessary" business expense, and 4) incurred in the "ordinary" course of business.

Allowable deductions include expenses for salaries, traveling expenses and rental expenses. Common deductible expenses for the equine industry could include:

1. Salaries and Compensation. Payments for personal services actually rendered, such as salaries for trainers, grooms or administrative staff involved in an equine business.
2. Traveling Expenses. Costs incurred for travel, meals and lodging while away from the Tax Home in pursuit of the equine business, provided they are not lavish or extravagant. In general, the Tax Home is an individual's place of business or post of duty, regardless of where the individual maintains his or her residential home. It includes the entire city or general area in which the individual's equine business or work is located.

• Transportation Costs. Expenses for transporting horses to competitions, sales or breeding events. This can include fuel, tolls and vehicle maintenance for trucks and trailers used in the business.
• Lodging and Meals. Costs for lodging and meals incurred while traveling for business purposes, such as attending equine shows, auctions or industry conferences.
• Airfare and Train Tickets. Costs for flights or train travel when attending out-of-state or international equine events or meetings related to the equine business.
• Rental Vehicles. Expenses for renting vehicles necessary for business travel, such as when transporting horses, equipment or people to equine events.

3. Rentals or Lease Payments. Payments required for the continued use or possession of property used in the equine business, such as leasing stables or land for grazing. Lease payments for office space and equipment rentals, such as horse trailers, riding equipment or machinery to maintain property, would also fall into this category.

Galloping Through Depreciation: Sections 167 and 168 for Equine Assets

IRC Section 167 allows for a "depreciation deduction," which allows for a reasonable deduction for the exhaustion or wear and tear of assets. Deductions are also allowed in the event that an asset becomes obsolete.

The depreciation deduction applies to any property used in equine trade or business or property held to produce income for the equine business. Common depreciation deductions in equine businesses may include:

• Depreciation of Buildings and Structures. If the equine business owns stables, barns or other structures, it can deduct depreciated value over their useful life. The depreciation deduction is based on the adjusted basis of the property, which is determined under Section 1011.
• Depreciation of Equipment. Equipment used in the equine business, such as tractors, horse trailers and other machinery, can be subject to depreciation deductions. The depreciation deduction is calculated based on the adjusted basis of the equipment.
• Depreciation of Leasehold Improvements. Improvements to leased property, such as enhancing a leased stable or an arena, can be deducted as they depreciate over their useful life.
• Depreciation of Purchased Horses. Horses purchased for breeding, racing or other business purposes also depreciate in value over time. The depreciation period and method depend on the intended use of the horse and the horse's expected useful life.

Bonus Depreciation Deductions for New Investments

Bonus Depreciation is another tax incentive that allows equine businesses to immediately deduct a significant percentage of the purchase price of eligible assets, such as machinery and equipment, in the year they are placed in service, rather than depreciating them over their useful lives. This accelerated deduction helps reduce the after-tax cost of acquiring new business assets. The bonus depreciation can apply to both new and used property if it meets certain criteria.

MACRS

The Modified Accelerated Cost recovery System (MACRS) is the tax depreciation system that the U.S. uses to calculate a business' tax deductions based on tangible assets that depreciate.

Generally, the depreciation deduction for any tangible property is determined by using 1) the applicable depreciation method, 2) applicable recovery period and 3) applicable convention.

The MACRS method outlined in IRC Section 168 allows for flexibility in how equine businesses can depreciate their assets, potentially leading to tax benefits through accelerated depreciation methods and specific recovery periods tailored to the type of property involved. For example, Section 168 allows for accelerated depreciation methods that can switch to a straight line method of depreciation when it becomes more beneficial. This can apply to equine-related assets such as stables, barns and equipment used in the business. Taxpayers can also make elections to use different depreciation methods or systems for certain classes of property.

MACRS provides two main systems for depreciation:

1. General Depreciation System (GDS). This system allows for accelerated depreciation methods, such as the 200 percent and 150 percent declining balance methods, which can be switched to the straight line method when it becomes more beneficial. This system is typically used for most property types and allows for faster recovery of costs in the earlier years of the asset's life.
2. Alternative Depreciation System (ADS). This system uses the straight line method over a longer recovery period and is required for certain types of property, such as those used predominantly outside the U.S., tax-exempt use property and property financed with tax-exempt bonds. ADS is also used when a taxpayer elects to use it for specific property classes.

Accelerate Tax Savings: The Power of Section 179 for Equine Businesses

Costs of certain property may be treated as an expense, which, in turn, is no longer chargeable to a capital account for tax purposes and instead must be treated as a deduction. Under IRC Section 179, an equine business can accelerate cost recovery by electing to expense certain depreciable business assets in the year they are placed in service, rather than capitalizing and depreciating them over their useful lives. This election can allow the equine business to deduct the cost of qualifying property, such as equipment or machinery used in the business, up to a specified limit per taxable year.

There is a number of limitations to this deduction, including the cap on the amount that can be treated as expenses in a year and deduction being limited to the amount of taxable income derived from the active conduct of the equine business during the taxable year, and specific limitations apply to certain types of property, such as an SUV.

Utilizing Section 179 can help an equine business significantly reduce its taxable income in the year property is placed into service, which leads to an accelerated cost recovery and improvement in cash flow.

Avoiding the Hobby Loss Trap: Section 183 and Profit Motive in Equine Ventures

Equine businesses, like all businesses, need to be cautious and watch out for the "hobby loss rules," which can affect the ability to deduct expenses. The basic idea is that you can deduct expenses as long as they are related to a business seeking to generate profit, whereas you cannot deduct equine expenses if your involvement in the equine industry is solely a hobby. Some key points to know about the hobby loss rules under Section 183:

• Profit Motive & Presumption. The equine business must demonstrate a genuine profit motive. If the activity is not engaged in for profit, deductions attributable to the activity are generally not allowed. There is a presumption, however, that the activity is engaged in for profit if the gross income derived from the horse-related activity exceeds deductions for two or more years within a seven-year period. When it comes to equine businesses, the IRS uses an objective nine-factor test, set forth in regulations under Section 183, to help determine whether an activity was engaged in for profit:
  • manner in which the taxpayers carry on the activity
  • expertise of the taxpayers or expertise of their advisers
  • 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
  • any elements of personal pleasure or recreation
• Election for Presumption. Taxpayers can elect to defer the determination of whether the presumption applies to horse-related activities until the close of the sixth taxable year following the year the activities begin. This election affects the assessment period for any deficiency related to the activities.
• Documentation and Evidence. Maintaining thorough documentation in a businesslike manner and all evidence of the business' profit motive and financial performance is crucial. This includes records of income, expenses and efforts to improve profitability – including, but not limited to, annual written business plans (including goals, job descriptions, policies and procedures), descriptions of the farm's individual horses, and all advertising and promotion opportunities for the upcoming year. It is recommended for equine trades and businesses to use bookkeepers and certified public accountants to review and reconcile the books, as well as utilize legal counsel with experience in the industry to prepare any written contracts.
• IRS Scrutiny. The IRS may scrutinize activities that consistently report losses, especially if they resemble hobbies rather than businesses. Demonstrating all efforts to make the horse-related activity profitable, such as marketing, business planning and professional advice, can help provide evidence to support the equine business' profit motive.

Understanding these rules and maintaining proper records and documentation can help ensure equine businesses can protect their ability to deduct legitimate business expenses and navigate the hobby loss provisions.

Reining in Passive Activity: Section 469 and Material Participation in Equine Activities

Equine businesses must be aware of the passive activity loss rule under IRC Section 469, which can limit the ability to deduct losses from passive activities. A passive activity in an equine business could be any activity the taxpayer does not materially participate in. Accordingly, all individuals who avoid the hobby loss trap under Section 183 (because the equine activity is a trade, business or investment activity) will be subject to the passive loss limits unless the individual materially participates in the activity.

Key considerations under this section include:

• Material Participation. To avoid classification as a passive activity, the taxpayer must materially participate in the equine business. Material participation requires involvement in the operations on a regular, continuous and substantial basis. Pursuant to regulations under Section 469, material participation is established where the business records conclusively establish that the individual expends 500 hours on the activity. There is an alternative test, based on all of the facts and circumstances, that establishes whether the individual participates in the activity on a regular, continuous and substantial basis.
• Real Estate Professionals. Rental activities are considered passive activities unless the taxpayer qualifies as a real estate professional. Special rules apply to taxpayers in the real estate business. If more than half of the personal services performed by the taxpayer are in real property trades or businesses, and they perform more than 750 hours of services in such activities, rental real estate activities may not be considered passive activities.
• Passive Activity Loss Limitation. Passive activity losses and credits are generally not allowed unless the taxpayer has passive activity income to offset them. Disallowed losses can be carried forward to future years.
• Disposition of Passive Activities. If a taxpayer disposes of his or her entire interest in a passive activity, losses from the activity may be treated as nonpassive losses, allowing for deduction against other income.

Equine businesses should carefully assess their level of participation in activities and maintain documentation to support material participation, ensuring compliance with these rules to maximize allowable deductions.

Conclusions and Considerations

Equine businesses must navigate a complex landscape of tax regulations to optimize their financial performance. Key considerations include understanding the allowable deductions for equine businesses and leveraging depreciation for tax benefits.

To maintain eligibility for these deductions, effective documentation and recordkeeping are crucial for substantiating deductions and protecting against IRS scrutiny. By staying informed about legislative changes, such as the Racehorse Cost Recovery Act, and implementing proactive tax planning strategies, equine businesses can effectively manage their tax obligations and position themselves for long-term success in a dynamic industry.