Taxpayers who are doing well in one endeavor may wish to engage in an endeavor they enjoy generally, but which arguably could be conducted with an eye towards making a profit. When taxpayers continue to engage in such activities despite a lack of actual profit, the IRS quite often turns to Section 183 to deny the taxpayer’s the ability to claim such losses.
Such was the issue in the case of Kaiser v. Commissioner, T.C. Summ. Op. 2016-13. Linda Kaiser ran a successful financial consulting and insurance business, but she had an interest in training Hanoverian horse. The Court noted that she was “competent dressage rider and from 1998 to 2014 she owned between one and four horses.
The horse operation (which later included a web based component) never turned a profit. From 2008-2014 the operation never had revenue in excess of $8,000 in any given year, with no revenue in many. As well, expenses never dropped below $17,500 and, in 2010 she had expensesof $36,276 with zero revenue. Thus, not even in a single year did it come close to being profitable.
However Linda had what she apparently believed was a good explanation for this—she had been injured relatively seriously in two separate auto accidents just as she was getting ready to train horses. In 2005 her first foal was attaining the age when she was going to begin training, but she was seriously injured in an auto accident that year.
Linda’s injuries were serious enough to prevent her from training the foal. It was not until 2009 that she was recovered enough from her injuries to allow her to begin training horses again and in that year she acquired horses she planned to train. But another, even more serious, auto accident took place in 2010 and Linda was once again unable to train these horses.
She ended up hiring another trainer to train these horses. She had tried to sell horses but the market had collapsed during the economic problems of 2008 and she was not able to sell the horses. She eventually determined she would not be able to afford to tr breed the horses (and goats which she had branched out into) until her income improved.
Now she turned to creating a website to educate children about animals, posting 15,000 pictures on the website, with her sister-in-law writing articles for the website. She believed the website would become operational in 2016 and would generate “at least” $100,000 of revenue a year once it became operational (which, if she is right, means this author is writing about the wrong topic).
The Court, however, did not give Linda a “pass” due to the auto accidents, because she had done nothing that indicated she had an actuala plan to make money even had no accidents intervened.
As the Court stated:
There is little evidence in this record that petitioner operated the horse training activity in a businesslike manner. There is nothing in this record which reflects petitioner's business plan or how she intended to make a profit. While petitioner may have hoped to generate income from her horse training activity, there is no information as to how her receipts compare with her expenses. Petitioner had years of losses generated by the horse training activity and acknowledged that she had no gross income for 2010 and very little gross income for 2011. She spent little if any time in the horse training activity in the years in issue. In those same years petitioner operated her financial planning and insurance business and generated substantial gross receipts. Petitioner used the losses of the horse training activity to offset income from the financial planning and insurance business. Petitioner had owned horses before engaging in the horse training activity and acknowledged that she considered her horses to be like her children. No doubt she experienced personal pleasure in owning her horses. Petitioner had a consistent history of little to no gross income in the horse training activity. While petitioner clearly has some level of business acumen in the operation of her financial planning and insurance business, she did not carry over these practices to the horse training activity.
Although the Court does not say so, it seems the reference to her financial planning and insurance business points out that despite Linda’s horrid luck with regard to auto accidents, she had kept those operations running and generating revenue during these trials—something she utterly failed to do with the horse/web operation.
Advisers need to take care to help clients look realistically at being able to show that their activity can meet the “profit motive” test to escape problems under Section 183. The problem in this case was that the Court found nothing to suggest there ever had been such a profit motive—so it wasn’t that the “bad luck” had doomed the success, but rather that the taxpayer failed to demonstrate (at least to the Court) that she ever had th requisite profit motive.