equine

Article Dean Dorton

This article was first published in Blood-Horse Magazine

In the United States more than 10,000 state and local jurisdictions impose sales and use taxes. The majority of the taxing jurisdictions are city, county, or other local governments, as only 45 states and the District of Columbia impose the taxes. Alaska, Delaware, Montana, New Hampshire, and Oregon do not impose a sales or use tax, although Alaska permits local jurisdictions to levy the taxes. Based on the number of taxing jurisdictions, sales and use taxes account for approximately 25% of total state and local tax collections.

Every taxing jurisdiction has its own set of laws related to sales and use taxes. When that fact is combined with the number of taxing jurisdictions, it comes as no surprise that sales and use taxes are riddled with complexities. This article focuses on making sense of those complexities in the context of buying and selling horses for racing and breeding, with emphasis on the states of California, Florida, Kentucky, and New York.

In the beginning

Understanding sales and use taxation of horse transactions begins with a general understanding of sales and use taxes. These taxes are imposed on a particular “transaction,” i.e., a transfer of a taxable product or service for a consideration. In particular, sales taxes apply to retail sales of tangible personal property, digital property, and some specifically enumerated services. Tangible personal property includes property that might be seen, weighed, measured, felt, or touched, or that is in any other manner perceptible to the senses. Because horses fall within this definition, sales of horses are taxable unless the transaction qualifies for a specific statutory exemption.

Jurisdictions that impose a sales tax also impose a complementary use tax, which is imposed on the storage, use, or other consumption of taxable property in a state if no sales tax was paid to that state when the property was purchased. Most states allow a credit against the use tax due for sales tax paid to another state at the time of purchase. Because horses might be purchased in one state and trained, boarded, or raced in other states, use tax is especially relevant in the equine industry. Unlike the sales tax, which the seller generally is required to collect from the purchaser and remit to the taxing authority, the use tax typically is the obligation of the purchaser.

All gross receipts derived from the retail sale of tangible personal property, other than sales for resale, are presumed taxable. However, states and localities often carve out exemptions from tax for certain types of transactions. In most circumstances, the seller must obtain and maintain in its records a properly completed exemption certificate from the purchaser as proof that the sale is exempt from tax. Examples of types of exempt transactions in various states include sales and purchases: (a) in interstate or foreign commerce; (b) of horses for breeding purposes; and (c) of racehorses. The following sections explore how these exemptions apply in California, Florida, Kentucky, and New York.

Interstate and foreign commerce

In all four states, sales in interstate and foreign commerce are exempt from tax. For this exemption to apply, the purchaser must take possession of the horse outside the taxing state. Buyers and sellers can take advantage of this exemption by structuring the transaction so that the seller is obligated, as a condition of the sale, to ship the horse by common carrier to the purchaser at a point outside the state. For example, if a seller in Kentucky makes physical delivery of a horse by common carrier to a purchaser in New York, the sale is exempt from Kentucky’s sales tax. However, New York’s use tax might apply to the transaction.

Horses purchased for breeding

California, Florida, Kentucky, and New York all offer preferential treatment to horses purchased for breeding purposes. The exemptions for sales of horses for breeding purposes are broader in Florida and Kentucky because the exemptions in California and New York are limited to racehorses purchased for the purpose of breeding. Additionally, California’s exemption does not apply to local taxes.

In California and Kentucky, the purchaser must intend to use the horse solely for breeding purposes to qualify for the exemption. Guidance issued by New York is conflicting as to whether the purchaser must intend to use the horse exclusively (i.e., 100%) or predominately (i.e., more than 50%) for breeding purposes. Florida law requires only that the horse be purchased for breeding purposes and does not mandate that this be the purchaser’s sole intent.

Sales of horses by the breeder also are exempt from tax in Florida. This exemption applies even if a horse is registered with a breeders or registry association prior to the sale and the sale takes place at a show or race meeting, as long as the sale is made within Florida by the original breeder.

Racehorses

New York offers the most favorable treatment when it comes to racehorses. In New York the purchase of a Thoroughbred or Standardbred racehorse is exempt from tax if the horse is: (1) registered with The Jockey Club, the United States Trotting Association, or the National Steeplechase and Hunt Association (or is no more than 24 months old and eligible to be registered with one of these associations), and (2) purchased with the intent of entering the horse in a racing event in which pari-mutuel wagering is authorized by law. Sales of racehorses are taxable in California, Florida, and Kentucky. However, Kentucky exempts the sale of horses less than 2 years old at the time of sale, provided the sale is made to a non-resident of Kentucky. A non-resident includes an individual who is not a resident of Kentucky, as well as a business that is not commercially domiciled in the Commonwealth.

Use tax considerations

Finally, because horses often are transported to multiple states for training, racing, or other purposes, special consideration should be paid to the use tax laws of each state. In some states, including California and Florida, property purchased and used outside of the state for a certain length of time might be exempt from use tax if subsequently brought into the state. For example, property used more than 90 days from the date of purchase to the date of entry into California is accepted as proof that the property was not purchased for use in California and, thus, is not subject to use tax in California. Likewise, under Florida law, property used in another state for six months or more before being imported into Florida is presumed not to have been purchased for use in Florida.

Kentucky and New York have equine-specific use tax exemptions. Kentucky exempts from tax the temporary use of horses in the state for purposes of racing, exhibiting, or performing. In New York, no use tax is due if a horse is purchased outside New York and brought into the state for the purpose of entering racing events or preparing for such events if the horse is not entered into racing events on more than five days in any one calendar year.

How this works in practice

The interplay between the sales and use tax laws of various states can be illustrated best by example. Suppose a California resident purchases a Thoroughbred yearling at an auction in Kentucky and takes delivery in Kentucky. Because the horse is less than 2 years old and the purchaser is a non-resident, no Kentucky sales tax is due on the transaction. However, if the horse is transported to Florida for training within six months of its purchase, a Florida use tax liability would arise. The purchaser could avoid Florida use tax by waiting six months or more before transporting the horse to Florida.

What if the California resident also has a farm in Kentucky where she spends more than half the year? Under these circumstances, Kentucky sales tax would apply to the purchase of the yearling because the purchaser does not qualify as a non-resident of Kentucky. If the horse is shipped to Florida for training within six months of purchase, the purchaser also is liable for Florida use tax. However, she can take a credit against the Florida use tax for the sales tax paid to Kentucky. Because Florida and Kentucky both impose tax at the rate of 6%, the credit for sales tax paid to Kentucky would fully offset the purchaser’s Florida use tax liability.

These are just a few examples of the impact of sales and use taxes on the equine industry. More complex scenarios arise when multiple parties, several states, and local taxes factor into the equation. Individuals and businesses engaged in the buying and selling of horses should consider sales and use taxes before entering into any transaction to avoid an unpleasant tax surprise down the road.

Article Dean Dorton

This article was first published in Blood-Horse Magazine

Federal depreciation incentives included with the Tax Cuts and Jobs Act continue to benefit Thoroughbred horse and farm owners. This article provides an in-depth look at the rules surrounding the 100% bonus depreciation, generally the most useful of these incentives to industry participants.

This discussion is intended for those active owners operating their horse and farm activities as businesses that use the cash method of accounting.

The new law significantly expanded bonus depreciation. The percentage that may be currently deducted for tax purposes increased to 100% of the purchase price for qualifying property placed in service through 2022. After 2022, the percentage drops by 20% each year until it becomes 20% in 2026. In addition, the definition of qualifying property was expanded to include assets that have been previously owned but not those being reacquired by the purchaser. Previously, assets used by a prior owner did not qualify.

Common equine assets that may qualify for this 100% write-off include racing prospects (yearlings, 2-year-olds in training), racehorses, broodmares, stallions, equipment, fencing, land improvements, and barns. To qualify, these items must be predominantly used in the United States (which makes sense given the desire to stimulate economic growth in the United States).

A person claiming bonus depreciation is not limited by taxable income. The deduction may be used to create or increase a net loss and there is not a specific dollar amount limitation on an annual basis.

For these reasons it is much more valuable than the Section 179 depreciation, which is limited to net income and also to a fixed annual dollar amount. Bonus depreciation also is not prorated based on the timing of the purchase. So a qualifying purchase made on Dec. 31, if placed in service then, is eligible for the same amount of bonus depreciation as property purchased for the same price earlier in the year.

In order to claim the bonus depreciation, the asset must be “placed in service” during the tax year. For tax purposes, racing prospects may be placed in service either in the fall of the yearling year when training begins or when they begin racing.

Breeding stock may be placed in service when available to be bred, even if the purchaser does not plan to breed the horse until the following year, or when bred. Quite commonly, mares are purchased in the breeding stock sales in the fall and placed in service upon purchase, even though they typically would not be bred in the Northern Hemisphere until the following winter to spring. The same is true for stallions or stallion shares. Once a methodology for placing horses in service is chosen, it should be followed consistently for tax reporting purposes.

However, just because the cash has been paid does not necessarily mean the horse has been placed in service. For example, if shares in a stallion prospect are purchased while the horse is still racing to secure ownership in the stallion, these would not be placed in service until the horse is retired from racing and available to be bred or begins breeding. On the other hand, a horse that has been purchased and placed in service but not yet paid for would be eligible for bonus depreciation.

In addition, some leases might be “disguised purchases” and may enable the lessee/purchaser to currently claim bonus depreciation. So, it is important to look beyond the label on the contract or the time at which cash is expended to determine whether bonus depreciation is currently available.

Those purchasing farms also may currently use bonus depreciation to deduct the purchase price allocable to qualifying items such as barns, land improvements, fencing, and equipment.

This could result in a substantial portion of the purchase price being eligible for immediate deduction. Addressing this allocation prior to purchase via agreement with the seller in the closing documents or by an appraisal that allocates a portion of the purchase price to these depreciable assets is important to maximize potential deductions.

While bonus depreciation is a timing difference, it can be financially meaningful. To illustrate what this is worth to a horse owner, let’s use the following example. If a yearling is purchased for $500,000, this $500,000 may be fully deducted in year 1 (subject to some limitations briefly mentioned later in this article), rather than over an eight-year period. (Yearlings use seven-year lives for tax depreciation, but this is actually claimed over an eight-year period.) This is a federal tax savings of $185,000 if the purchaser is in the highest federal individual tax bracket. By accelerating this deduction versus claiming it over time, the cash savings in this specific example are roughly $30,000 if a 5% rate of return is used.

This cash savings increases if a higher rate of return is used, if the asset is depreciated over a longer life, or as the purchase price of qualifying assets increases.

Opt-out option

Owners may opt out of this immediate write-off by filing an election to do so with their tax return. So why would someone choose to elect out of this bonus depreciation?

If the horse venture is otherwise profitable, an owner might wish to report a net profit for hobby loss rules that shifts the burden of proof to the IRS if profits are reported in two out of seven years.  Additionally, horse owners might prefer to align the related depreciation expense better during the period of time that horses or the farm would produce income in future years.

Also, passive investors in the horse business participating via multi-member entities may receive little-to-no-tax benefit by accelerating this deduction and instead create a state withholding tax issue in future years when purse winnings are generated or the horse is sold with no remaining tax basis.

Alternatively, the 100% bonus depreciation may be claimed on certain classes of assets while electing out of others. So, if it makes sense to deduct the depreciation on barns over the standard 20-year life while claiming the 100% write-off on horse purchases, an election could be filed to opt out of the 20-year asset class only.

This is made on a class-by-class basis and not an asset-by-asset basis. Horses should be categorized appropriately when evaluating on a class-by-class basis, given that different types of Thoroughbred horses have either a three-year or a seven-year life.

Property acquired from a related party or via inheritance or gift does not qualify for bonus depreciation. Inventory not yet placed in service, such as typical weanling-to-yearling pinhooks, or weanlings not yet placed in service also are not eligible.

Limitations

As with most other tax incentives, a few limitations that might currently reduce or eliminate this 100% deduction may apply. The tax law created a provision that limits net 2018 losses from all business ventures for individuals, trusts and estates to $250,000 ($500,000 for individuals filing jointly). This limit is indexed for inflation after 2018. Any net business loss that exceeds the limit is converted to a net operating loss.

Bonus depreciation might significantly increase the net business loss generated and cause this business loss to be currently limited. For many industry participants who are affected, this creates a one-year deferral of this excess loss that then might be used to offset all sources of income in the subsequent year, subject to the normal net operating loss carryover rules. So owners faced with excess business losses might still want to currently claim bonus depreciation.

Another item of caution: Many states have decoupled from this favorable bonus depreciation so this may be a Federal tax benefit only, depending in which states a horse or farm owner operates.

As sales season kicks into high gear, this 100% write-off option presents some planning opportunities for those looking to reduce taxable income. It is important to speak with your tax advisors regarding your specific situation prior to making any purchases, but the potential tax benefit of utilizing bonus depreciation could be substantial.

Article Dean Dorton

This article was first published on Blood-Horse Magazine

Whether motivated primarily by tax-savings reasons or a desire to provide a financial benefit to a not-for-profit program, horse owners frequently inquire about the tax treatment of charitable donations of horse interests. This article describes the applicable rules and points out some available tax-planning strategies for those industry participants who operate their horse activity as a business.

Many donors are familiar with the tax benefits of donating appreciated property—assets having fair market values greater than their tax basis. With a couple of important exceptions, such donors are entitled to charitable contribution deductions measured by the donated property’s fair market value, and, further, they are not taxed on the property’s appreciation—a double tax benefit.

The first important exception to being able to deduct the property’s fair market value is the requirement that the deduction is reduced by the amount of gain that would be ordinary income if the property were sold at fair market value. A horse owned less than two years does not qualify for capital-gain treatment, so a donation of such a horse would be deductible only to the extent of the lesser of (i) the horse’s fair market value or (ii) its cost basis—ordinarily none, if a homebred.

For an appreciated horse held more than two years, the owner must consider depreciation recapture rules. If a horse that would have produced a gain if sold has been depreciated, the recapture rules treat the gain as ordinary to the extent of depreciation taken while held by the owner. For example, if a horse that cost $15,000 and on which $10,000 of depreciation has been taken is worth $25,000 when donated to a veterinary school for use in the school’s program, the contribution deduction would be $15,000 (the $25,000 value less $10,000 of depreciation recapture if the horse had been sold for $25,000).

The second major exception to the rule allowing deductions at fair market value for donated horses limits the deduction to the horse’s tax basis if the donation is made to an organization that would not use the horse to further its charitable purposes. For example, a gift of a horse to the United Way or to a church would not produce a charitable deduction exceeding the horse’s tax basis. Thus, a homebred or fully depreciated horse in such a case would not provide any deduction.

Owners of stallion interests often donate annual breeding rights for charitable purposes. Except when the donor has a tax basis in an annual stallion breeding right—as a result, for example, of purchasing the season—the owner receives no deduction for donating the season.

In almost all cases a sale of a breeding right produces ordinary income. The market value of a donated season must be reduced by this ordinary income element, leaving the donor with no deductible amount. A donor of a breeding right is in much the same position as one who provides valuable uncompensated services or rent-free use of space or equipment to a charity: measurable value has been contributed, but no deduction is allowable.

A donor of property in which he or she has a loss—a tax basis exceeding fair market value—is limited to deducting the lower fair market value. For example, if a horse that cost $15,000 and on which $10,000 of depreciation has been allowable is worth $1,000 when donated to charity, the owner is only allowed a $1,000 deduction.

An owner (who is in a horse business, not a hobby) in such a situation would receive a better tax result by selling the horse for its $1,000 value, realizing a $4,000 deductible loss, then giving the $1,000 to the charity, providing a $1,000 charitable contribution deduction.

Appraisal and Reporting Requirements

For a donation of a horse (and other donations in general) with a value of $250 or more, the donor is required to obtain a written acknowledgment from the charity. This acknowledgment must include a description of the donated property, a statement of whether any goods or services were provided by the donee to the donor in consideration of the donation, and, if any goods or services were so provided, a description of them and a statement or estimate of their value. The donor must obtain this written acknowledgment by the time of filing his or her tax return for the year of the donation.

In the case of noncash gifts totaling more than $500 in a year, the donor must file Form 8283 with his or her federal income tax return. Form 8283 requires a description of how the donor acquired the horse, the date acquired, the donor’s tax basis in the horse, the horse’s estimated fair market value, and the method used to determine value.

If the value of a donated horse exceeds $5,000, the donor must have the horse appraised. The appraisal must be written, signed by the appraiser, made within the time period beginning 60 days before the donation and ending with the due date (including extensions) of the donor’s tax return for the year of the donation, describe the appraiser’s qualifications, include a statement that it was made for income tax purposes, include the appraisal date, describe the appraisal method used, describe the specific basis for the valuation, and, if applicable, describe any agreements relating to the horse’s use or sale. The appraisal must be made by a “qualified appraiser”—one who holds himself or herself out to the public as an appraiser and regularly performs appraisals, is qualified to appraise horses, and is not disqualified. The donor, the donee, the person from whom the donor acquired the horse, or an agent involved in the horse’s 
transfer are disqualified, as are employees or family members of these persons.

The appraiser also must sign Form 8283. Finally, the appraisal fee must not be contingent on the donated horse’s value.

These extensive documentation and appraisal requirements, where applicable, should not be taken lightly. Failure to comply is likely to result in full disallowance of any deduction for the donated property.

This article was written by members of Dean Dorton’s equine team, a CPA and consulting firm with offices in Lexington, Ky., Louisville, Ky., and Raleigh, NC. Dean Dorton works together with Thoroughbred and sport horse and farm owners around the world on U.S. tax planning, tax compliance, and business operational matters.

Article Dean Dorton

By: Maddie Schueler, JD, LLM | mschueler@deandorton.com

Like most states, Kentucky imposes a sales tax on the retail sale of tangible personal property, digital property, and some services. Kentucky also imposes a complementary use tax on the storage, use, or other consumption of taxable property in the state if no sales tax was paid to Kentucky when the property was purchased.

To achieve various policy objectives, the General Assembly has enacted multiple sales and use tax exemptions. The goal of many of these exemptions is to encourage the development and continuation of industries important to the Commonwealth. This article explores basics about how sales and use taxes apply to two major industries in the state—manufacturing and equine.

The Manufacturing Industry

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Manufacturers’ products sold to end users normally are subject to sales tax in the state where the product is shipped or delivered. The sales tax on a transaction generally is collected by the seller from the purchaser. Specific exemptions may cause the sale to be nontaxable. Because manufacturers typically sell to distributors or retailers who acquire property for resale, manufacturers’ sales often are nontaxable.

When manufacturers buy property for use in their manufacturing process in Kentucky, favorable sales tax treatment is tied to two major exemptions: (1) the exemption for materials, supplies, and industrial tools and (2) the exemption for machinery for new and expanded industry.

Materials that become part of a manufactured product, as well as supplies and industrial tools that are “used up” during the manufacturing process, are exempt from tax because tax ultimately will be collected when the final product is sold to the end user. All materials that enter into and become an ingredient or component part of the manufactured product are exempt from tax. Supplies and industrial tools must be “directly used in manufacturing” and have a useful life of less than one year to qualify for exemption. Notably, the exemption does not apply to repair, replacement, or spare parts.

The exemption for machinery for new and expanded industry permits manufacturers to purchase certain machinery without paying sales or use tax. For an item to qualify for exemption, it generally must meet four requirements:

Be machinery;

Be used directly in the manufacturing process;

Be incorporated for the first time into plant facilities established in Kentucky; and

Not replace other machinery.

A caveat applies to the fourth requirement: new machinery that replaces other machinery qualifies for exemption if it performs a different function, manufactures a different product, or has a greater productive capacity than the machinery being replaced.

The Equine Industry

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Breeding a horse involves producing a product, not unlike manufacturing. The mare may be thought of as “production equipment,” with the stallion’s contribution to the process being “raw material.” So, in what ways is breeding horses subjected to or not subjected to sales tax in a similar manner to manufacturing?

Sales in Kentucky of horses less than two years old at the time of sale are exempt from tax if the purchaser is a nonresident of Kentucky. A nonresident includes both an individual who is not a resident of Kentucky and a business that is not commercially domiciled in the Commonwealth. Sales of horses which are bought for resale also are nontaxable.

Horses, or interests or shares in horses, bought for breeding purposes only are exempt from sales or use tax in Kentucky. However, fees paid to breed to a stallion in Kentucky are subject to sales tax.

Kentucky sales tax law includes numerous general agricultural exemptions, but many do not apply to the equine industry. For example, Kentucky exempts from tax feed, farm machinery, and on-farm facilities. However, all of these exemptions apply in the context of raising “livestock,” which under Kentucky law excludes horses.

In Summary

In summary, both similarities and differences exist in how Kentucky applies its sale and use tax law to manufacturers, in general, and to horse breeders, who also produce items of tangible personal property.

Article Dean Dorton

By Jen Shah, CPA · Equine Industry Team Leader

Federal tax reform is upon us and, while most provisions in the current bill are effective for calendar years beginning in 2018, there may be some year-end planning items that horse and farm owners should consider prior to December 31, 2017.

As I am writing this article, both the Senate and the House have passed (and re-passed) the current bill and it is widely expected to be signed into law by the President today. While Dean Dorton has previously provided general information regarding what is included in this bill, this article addresses selected items that are specific to horse and farm owners. Unless otherwise noted, the bill is effective for years beginning after December 31, 2017 (so, 2018 for calendar year filers). Most of these provisions apply for a period of time and then revert back to current treatment, but this article focuses on when these items become effective versus the time period for which they are effective.

Depreciation Provisions

Under current law, bonus depreciation (50%) may be claimed on new tangible property purchased and placed in service. The current bill increases the amount eligible to be immediately expensed to 100% of the purchase price and expands the definition of new to include the taxpayer’s first use of the property. So, if I purchase a broodmare, I may now expense 100% of her purchase price, as long as I had not previously owned her. Yearlings, racing prospects, farm equipment and office equipment, land improvements, and barns, to name a few, continue to qualify for this write-off as long as they have not been owned previously by the purchaser. This provision is effective for assets purchased after September 27, 2017.

Increased Section 179 depreciation of $1,000,000 on up to $2,500,000 of qualifying purchases is included with this bill. The bill also expands the definition of qualified property to include HVACs. As a reminder, in order to claim Section 179, there needs to be a net business profit. This is calculated first at the pass-through entity level and then again at the individual level.

Those in the farming business have been required to use 150% declining balance versus the standard 200% declining balance for federal depreciation. This bill removes the requirement to use 150% declining balance so 200% declining balance may be used going forward, which will accelerate depreciation deductions in the first few years. In addition, farm equipment that is currently seven-year life property becomes five-year life property so may be written off over a shorter period of time.

The three-year recovery period for depreciation on yearlings is not included in this bill. So, while the three-year recovery period still applies to racehorses when placed in service after the two-year anniversary of the foaling date, yearlings revert back to a seven-year recovery period. This is effective for years beginning after December 31, 2016, so make sure to update 2017 federal depreciation for this.

Federal Income Tax Rate Provisions

The top income tax rate for individuals will be 37% (versus 39.6% currently). For those who conduct horse operations via partnerships, S corporations, or sole proprietorships, there is a new 20% deduction available against qualified business income but there are many limitations and hurdles to meet in order to qualify for this deduction. This 20% deduction does not reduce an individual’s adjusted gross income but is a reduction from taxable income. Trusts and estates may also qualify for this deduction.

This 20% deduction is limited to the greater of 50% of the allocable portion of wages paid by the business or the sum of 25% of allocable wages plus 2.5% of the allocable unadjusted basis of all qualified property immediately after acquisition. Non-corporate taxpayers with taxable income of less than $157,500 ($315,000 if married filing jointly) are not subject to the W-2 wage limitation when calculating this 20% deduction. For those that exceed this threshold, there may be a potential to qualify for this deduction even if wages are not paid by the entity but depreciable property (like buildings, horses, equipment, et cetera) is held in a trade or business or for the production of income. This portion of the calculation is confusing in the current bill so the above is a bit of an over-simplification.

This 20% deduction generally does not apply to specified service businesses (like accountants or where the principal asset is the reputation or skill of one or more of its employees or owners), but the service business limitation does not apply in the case of a taxpayer whose taxable income does not exceed the applicable thresholds above. As such, bloodstock agents, sales agents, trainers, and vets may fall under the service business limitations.

If you conduct your horse activities via a C corporation, the corporate income tax rate will decrease to 21% and the alternative minimum tax will be eliminated, both of which are good news.

Business Operational Provisions

Business interest expense will continue to be fully deductible for the bulk of industry participants. If average annual gross receipts for the three prior years exceed $25,000,000, then interest expense is limited to 30% of a business’ taxable income, with the excess carrying over to subsequent years. Farming businesses may elect not to be subject to the business interest limitation but would then be required to use Alternative Depreciation System (ADS) (straight-line and longer life) to depreciate property.

Like-kind exchanges of horses, vehicles, and farm equipment are eliminated. Like-kind exchange treatment is only available for real estate going forward, so this will reduce the opportunity for horse and farm owners to defer gain recognition on assets other than real estate for which the proceeds are re-invested in like property.

Meals provided to employees for the convenience of the employer (typically done during peak sale or breeding season hours) are currently 100% deductible but will become 50% deductible. Entertainment expenses will no longer be deductible.

Net Federal Income Tax Losses Generated by Active Businesses

Lastly, this next provision affects active business owners so will affect more than just the equine industry but may have a detrimental effect for those horse and farm owners that generate business losses which are offset by non-business income such as investment income. Under current law, excess farming losses are only limited if the farm receives a subsidy, which does not apply to many horse farm owners. Under this bill, a new section limits any excess business loss generated by an individual to ($250,000) (or ($500,000) if married filing jointly). This threshold applies after the active participation rules are applied and includes any trade or business, not just farming.

Business activities may be netted on an individual’s income tax return to determine if the loss threshold has been exceeded. Any excess business loss beyond the above threshold becomes a net operating loss that rolls forward into the subsequent year. Given the accelerated deductions available to horse owners in years prior to the potential to generate income, quite often net taxable losses will be reported, especially in start-up years. This provision has the effect of at least a one-year deferral for these excess business losses and may negatively impact those who fund business operations with assets that generate investment income.

So, while this bill is primarily effective post-2017, what are some items that should be considered prior to December 31, 2017?

  • Consider accelerating expenses into 2017 for active businesses owned by individuals. There should be a non-tax reason for doing so (for example, discount available, accessibility to certain stallions solely as a result of prepayment, et cetera).
  • Calculate the 2017 versus 2018 income tax impact of accelerating income for individuals into 2017 and paying the related state and local taxes (since the deduction for state and local taxes is limited to $10,000 after 2017) by year-end.
  • Determine if 2017 state, local, real estate, and/or sales tax should be paid by individuals not in Alternative Minimum Tax (AMT) prior to December 31, 2017. Note that there is no deduction allowed in 2017 for the prepayment of 2018 taxes.
  • If the horse or farm owner makes contributions to charity in exchange for preferred seating at athletic events (like the University of Kentucky’s K Fund), consider paying now. Currently, a charitable deduction for 80% of the amount contributed is allowed but this will be eliminated in future years.

This proposed bill certainly does not accomplish income tax simplification (and some have indicated that this will keep us tax accountants in business for quite some time) and creates many gray areas subject to interpretation without the existence of additional regulations. We are doing our best to interpret this bill as we understand it but know that we plan to send updates as additional clarifications are released in 2018.

Should you have any questions regarding federal tax reform and its potential impact on your 2017 or 2018 equine operations, please do not hesitate to contact us.

Jen Shah, CPA
Director of Tax Services
Equine Industry Team Leader

View Jen’s Bio

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Jen Shah, Dean Dorton’s equine industry team leader, was recently elected to the Thoroughbred Aftercare Alliance (TAA) board of directors. Eight new members were elected, including a new board president. The new board members include representatives of industry organizations such as Darby Dan Farm, Breeders’ Cup, Del Mar Thoroughbred Club, The Jockey Club, Ocala Stud, New York Racing Association, and Persley Den Farms.

TAA accredits, inspects, and awards grants to approved aftercare organizations to retire, retrain, and rehome Thoroughbreds using industry-wide funding. TAA has accredited and provided funding to 64 aftercare organizations across the U.S. and Canada to date.

“I am honored to join the TAA board and look forward to enhancing the financial well-being of an already successful organization. There continues to be a significant need for TAA’s guidance and through the unwavering commitment of TAA’s staff and board members, I believe the TAA’s industry influence will continue to grow as a leading financial provider and supporter of Thoroughbred racehorse retirees and quality aftercare.”

Jen Shah, Director of Tax Services

Jen Shah pictured with American Pharoah