Economic and Tax Implications of Thoroughbred Racing
Hereth, Russell H., Talbott, John C., Journal of Accountancy
There's more to horse racing than a fast horse.
Sunday Silence: Many will recognize the name of the 1989 Kentucky Derby winner even though they have never set foot on a racetrack. This horse failed to bring $17,000 as a yarling but then went on to win almost $5 million as a three-year-old before being sold for a reported $10 million to Japanese breeding interests.
Figures such as these make all but the most risk-averse investors sit up and take notice. Certificates of deposit lose their appeal as investors contemplate the fame, glory and financial rewards of horse racing. Are such rewards really possible, or is the more likely scenario heralded by the 1991 bankruptcy of famed Calumet Farm in Kentucky's bluegrass region? To answer this question, this article examines the economics of thoroughbred horse racing and the accompanying tax implications.
TRAINING COSTS AND REVENUE
Exhibits 1, 2 and 3, pages 52 and 53, show training bills at three major race tracks in the United States. Approximately 80% to 90% of horses in training do not earn enough to cover training costs. In addition to a per diem charge currently ranging from $45 to $85, depending on locale, a variety of miscellaneous charges results in monthly horse training costs of at least $2,000. As the Aqueduct bill (exhibit 3) shows, a horse's trainer is entitled to 10% of any money the horse is fortunate enough to win. Some trainers even take (pay) the stable help out of a horse's winnings.
The proliferation of off-track betting opportunities has led some investors to believe purses will increase substantially as wagering becomes more accessible. Thoroughbred racing, however, is characterized by parimutuel takes ranging from 17% to 25%. This means that for each dollar wagered, the track, horsemen and state divide between 17 cents and 25 cents and return the remainder to the wagering public. These figures do not compare favorably with the 5% to 6% take by casinos in Las Vegas or Atlantic City and may limit how much the public wagers on racing.
HOBBY LOSS PROVISIONS
Since it is possible for a thoroughbred horse owner to lose money, the "hobby loss provisions" of Internal Revenue Code section 183 need to be considered. In general, this section says taxpayers cannot deduct expenses greater than the income from an activity if they do not engage in it for profit. Taxpayers normally bear in the burden of proving a profit intent. Section 183 does, however, permit taxpayers to shift the burden of proof to the Internal Revenue Service when they show a profit in any two of seven years for horse-related activities, in which case there is a "general presumption of profit intent."
Proving a profit movie hinges on each activity's facts and circumstances. Treasury regulations section 1.183-2(b) specifies nine relevant factors to consider in determining whether an activity is a hobby or a business:
1. The manner in which the taxpayer carries on the activity. 2. The expertise of the taxpayer and his or her advisers.
3. The time and effort the taxpayer expends carrying on the activity.
4. The expectation that assets used in the activity may appreciate in value.
5. The taxpayer's success in carrying on other similar or dissimilar activities.
6. The taxpayer's history of income or losses with respect to the activity.
7. The amount of occasional profits earned, if any.
8. The taxpayer's financial status.
9. Elements of personal pleasure or recreation related to the activity.
No one factor, or even a majority of factors, ensures the courts will determine an activity to be profit-motivated.
Several studies were conducted in the early 1980s to analyze the courts' reliance on the nine factors. Each study applied a different method of analysis to identify and rank the factors and each reached a different conclusion. …