tax strategy

Article Dean Dorton

Written by Jen Shah, Dean Dorton Tax Director and Equine Industry Lead

What drama we have in December! After Congress passed the Consolidated Appropriations Act, 2021 (Act) on December 21st, the President unexpectedly called for amendments. In the meantime, we are getting many questions about what is in this Act, so I’ve decided to issue our summary based on what’s currently in the Act passed by Congress. I will stress, however, that until the President signs this Act (or an amended version), the items covered below are not law. For now, let’s just call this a preview of what may be included if these items in the current bill make it into the final version.

Before I cover the economic relief provisions which may be most impactful to horse and farm owners, I wanted to note that this is a federal Act so the below discussion is focused at the federal level. States will separately decide whether or not to adopt all, some or none of this Act (again, if ultimately signed into law).

For industry participants, there are some favorable updates included within the Act.  The three-year depreciation recovery period for yearlings, set to expire as of 12/31/20, is extended until 12/31/21. This Act also clarifies that farming net operating carrybacks are still eligible for the two-year carryback (versus the general five-year net operating loss carryback as authorized by the CARES Act). Additionally, those who previously waived the carryback period for farming net operating losses prior to the CARES Act being passed in March 2020 may revoke this prior waiver in order to file a net operating loss carryback claim.

As a reminder, the 100% bonus depreciation is still effective for 2020 through 2022 under current tax law. And, while thankfully not included retroactively with this Act, the pesky excess business loss limitation for individuals, trusts and estates (roughly $250K or $500K if married filing a joint return) returns in 2021 through 2025.

There are also other general non-equine specific provisions included within the Act. The employer tax credit for the paid sick and family leave has been extended through March 31, 2021 and the employee retention credit has been extended through July 1, 2021. Meals from restaurants are fully deductible in 2021 and 2022 (increased from 50% in prior years). For those individuals who do not itemize deductions, a $300 ($600 if married filing jointly) charitable deduction is available for cash donations made to qualifying public charities. The increased limitations for cash gifts made to public operating charities (but not donor-advised funds) for individuals (up to 100% of adjusted gross income) and corporations (up to 25% of taxable income) for 2020 are now extended into 2021.

There are several favorable updates to the Paycheck Protection Program (PPP) loans so let’s first cover updates to existing PPP loans and then move on to the new PPP loan program. First, the Act confirms the tax-free nature of the PPP loan proceeds that are forgiven (which quite frankly was the intent of the CARES Act but the IRS disagreed). So, if I used a $10K PPP loan to pay qualified payroll expenses and the PPP loan was fully forgiven, I am still able to deduct those $10K of payroll expenses on my tax return. This has been the topic of much debate since the IRS issued guidance and this Act confirms the tax-free nature of the forgiven PPP loan proceeds.

The amount of PPP loan authorized by the CARES Act was calculated based on average monthly payroll costs over typically a 12-month period times 2.5 (limited to $10M). Amounts spent on qualifying expenditures were eligible to be forgiven but at least 60% of these loan proceeds were required to be used for payroll costs. Qualifying expenditures previously included payroll costs, certain interest, rent and utilities. This Act clarifies that eligible payroll costs also include employer-provided group insurance such as dental, vision, disability and group life. It expands qualifying expenditures to also include costs such as software, human resources, accounting, and personal protective equipment purchased to comply with federal health and safety guidelines. In addition, a borrower may elect a covered period between 8 – 24 weeks after the PPP loan origination.  While these provisions do not increase the amount of the PPP loan for which a business qualifies, they do increase the potential to maximize the PPP loan forgiveness.

For those who would not qualify for full forgiveness of the PPP loan proceeds under the CARES Act, you may be able to apply your PPP loan proceeds towards the expanded qualifying expenses included by this Act. You may do so as long as you have not yet received forgiveness. If your application is in process and you have additional expenses that would increase the PPP loan forgiveness amount, I would recommend contacting your banker as soon as possible.

This Act also expands eligibility to certain industry participants who were not previously eligible to apply for a PPP loan. 501(c)(6) organizations with 300 or fewer employees and minimal lobbying activities are generally now eligible for these PPP loans. Most significantly, however, sole proprietors (including those with a single-member LLC) who file a Schedule F and who do not have employees may apply for a PPP loan as long as they were in business as of February 15, 2020. Previously, in order to qualify, sole proprietors either had to have net self-employment income (often difficult to report a net taxable profit given current tax incentives) or employees. Under this Act, the 2019 gross revenues as reported on Schedule F may be used to calculate the PPP loan for which an owner is eligible even if they do not have employees.

This could potentially apply to industry participants such as trainers, bloodstock agents, consignors, jockeys, breeding businesses, pinhookers, and racing operations (if activities are reported on a Schedule F versus Schedule C) which may rely upon third party independent contractors versus employees. Note that the total 2019 Schedule F gross revenues when calculating the amount of PPP loan is limited to $100K. So, if a sole proprietor has Schedule F gross revenues of $100K or greater, the PPP loan is limited to $20,833. If you have previously applied for a PPP loan and are now eligible for a greater amount due to the above change, this Act allows you to request an additional amount of PPP loan proceeds based on this new calculation.

There is also a simplified application and forgiveness process for PPP loans of less than $150K if the business submits certain information to the bank which should expedite this process.

In addition to the enhancements to the existing PPP loan program, this Act creates a second loan, called a “PPP second draw” loan of up to $2M for smaller businesses that were in operation as of February 15, 2020 with decreased revenues. The loan amount for horse and farm owners (other industries qualify for a higher multiple) is still based on 2.5 times the average monthly payroll for one year prior to the loan or the 2019 calendar year. This second draw loan is also eligible for tax-free forgiveness if the proceeds are spent on the expanded definition of qualified expenses as noted above but at least 60% still needs to be spent on payroll costs.

In order to qualify for this “PPP second draw” loan, businesses must have 300 employees or less, have used (or will use) all of their first PPP loan and demonstrate at least a 25% reduction in gross receipts in the first, second, or third quarter of 2020 versus the same 2019 quarter. Different timelines apply to businesses that were not in operation during all of 2019 and applications submitted after January 1, 2021 are eligible to use the gross receipts from fourth quarter 2020. Eligible entities include businesses with employees and self-employed individuals. Given reduced or cancelled racing and sales, industry participants who used the first round of PPP loan proceeds may qualify for this second draw loan if the 25% reduction of gross receipts test is met.

There is not a specific deadline to apply for these enhanced PPP loan programs but based on the prior PPP loan program, it would be wise to apply as soon as possible. The Act requires that regulations be issued within 10 days of enactment so we should have more information once this guidance is issued. In the meantime, I would recommend gathering the information needed to calculate the potential PPP loan and communicating with your bank on how best to proceed.

Again, please consider the above a preview of what may be included in the final law. Stay tuned as we will communicate substantial updates (if applicable) to the above and continue to monitor legislative developments on these economic relief provisions which may impact horse and farm owners.

In the meantime, I wish everyone a happy and healthy holiday season. Cheers, Jen

Jen Shah, CPA
Tax Director
jshah@deandorton.com • 859.425.7651

Article Dean Dorton

Not much has changed from an income tax perspective since I wrote the below article. Most elections have occurred and we still have some uncertainty on a few races. But there have been no stimulus relief bills or tax law updates yet, so as year-end approaches, keep these planning ideas in mind for 2020.

This article was first published in the November 6th edition of the Blood Horse Magazine
Written by: Jen Shah, CPA

As I write this article, the elections have not yet occurred. Much of my recent conversations with our clients, many of whom are horse and farm owners with other operating businesses and/or significant investment portfolios, have focused on “what ifs” – e.g., what happens to income tax rates or the lifetime gifting exemption if there is a change of political party control in Congress and/or the White House. Perhaps by the time you are reading this article, we will know who our next President is and which political party controls each chamber of Congress. In the meantime, this article includes a few tax planning items that may be helpful as year-end approaches. The items discussed below are current as of October 29th, 2020.

Let’s first focus on some year-end income tax planning items. 2020 could be the optimal year to accelerate deductions in your horse operations (or other operating businesses) both for individuals and C corporations. The CARES Act, passed in March 2020, included two particularly beneficial provisions for industry participants:

  1. Allowing net operating losses generated in 2020 (and also 2018 and 2019) to be carried back five years (applies to both individuals and C corporations), and
  2. Temporarily postponing the new excess business loss (EBL) limitation until 2021 (applies to individuals). These provisions were discussed in our article which appeared in the May 2nd issue of the BloodHorse, so I have not included detailed information about them here.

If the goal is to accelerate deductions this year, then consider purchasing and placing in service (meaning the asset is ready to be used for its intended purpose) assets which qualify for the 100% bonus depreciation by 12/31/20. Qualifying assets, which must be used predominantly in the United States, include equipment, fencing, land improvements, barns, and most horse purchases (with some exceptions). In addition to the above favorable depreciation write-off, many horse and farm owners qualify to use the cash method of accounting when filing annual tax returns.  If you are cash-basis, consider pre-paying expenses by year-end. Please note, however, that you should have a non-tax reason for doing so. Non-tax reasons may include bulk or early payment discounts obtained for expenditures such as feed, supplies, or advertising or for access to a particular stallion.

The above commentary assumes your horse operations are conducted as a business and you are either an active participant under the material participation rules (a description of which is beyond the scope of this article) or have enough other passive activity income to offset these losses.

For individuals who are charitably-inclined, cash contributions made to qualified public operating charities (NOT including donor-advised funds, however) by year-end may offset up to 100% of your adjusted gross income for 2020 only. For C corporations, these contributions may offset up to 25% of 2020 taxable income (up from the normal 10%).

In addition to year-end income tax considerations, it may be prudent to address estate planning matters. One of the most effective ways to do this is via lifetime gifts. First, a few basics regarding gifting – Annual gifts of $15,000 may be given to US citizens free of gift and generation skipping tax (GST). In addition to this annual gift limit, the 2020 lifetime gift and GST exclusion is $11.58 million per person. If the lifetime threshold is exceeded, then the gift is taxable to the person who makes the gift at a 40% gift tax rate and a 40% GST rate (if applicable). The GST is charged in addition to the gift tax if gifts are made to a person who is more than 37.5 years younger than the person making the gift, the intent being to capture the additional tax on gifts that may skip a generation (the most common of which may be gifts to grandchildren).

The lifetime gift and GST exemption significantly increased in 2018 as part of the Tax Cuts and Jobs Act (TCJA) and is scheduled to be at an increased level through 2025 (amount adjusted annually for inflation). In 2026, this lifetime exemption is scheduled to revert to the 2017 limitation of $5 million (plus subsequent inflation adjustments). If the Democrats take control of the White House and/or Congress, many expect a push to pass legislation that reduces these increased annual gifting and GST exemptions sooner than the scheduled 2026 reduction.

An ideal asset to gift is property that is expected to appreciate in value. If you gift something worth $100,000 today and it appreciates to $500,000 at your death, then you’ve gotten $500,000 out of your estate and only used $100,000 of lifetime gifting exemption. On the other hand, if that $100,000 gift depreciates to a $40,000 value, then you’ve potentially wasted $60,000 of lifetime gifting exemption.

Equine assets may also be included in your gifting plan, albeit some equine assets may be more effective than others. Horses are tricky with regard to gifting as it certainly can be difficult to determine whether or not they will appreciate in value. If you want horses to be part of your gifting plan, consider stallion shares from an already profitable stallion (which produces cash-flow) or a broodmare interest versus younger racing prospects. Of course, the person receiving this gift will then be responsible for care of the horses, so that ongoing expense should be considered. Farms, on the other hand, tend to be held long-term which hopefully will lead to appreciation over time.

To maximize the gift, assets are often contributed to a pass-through entity (holding company) by parents or grandparents. Non-controlling interests in this holding company are either gifted or sold at a discount to the children or grandchildren (or trusts for their benefit) with the voting interest retained by the original owner.

Those who made large gifts prior to 2018 may still have substantial exemptions remaining due to the significant increase in the exemption. I recommend discussing this now with your advisors if you are interested in considering gifts by year-end and gaining the benefit of the current historically high exemptions.

As the saying goes, nothing is certain in life except death and taxes. The first is unavoidable, but exposure to the second may be managed via effective tax planning, some of which is mentioned above. It will be interesting to see what impact, if any, the results of the election have on tax planning.

Article Dean Dorton

This article was first published on Blood-Horse Magazine

As the COVID-19 pandemic continues to impact families and businesses across the country, government leaders have focused on helping Americans cope with the economic fallout of the virus. Over the past several weeks the Thoroughbred industry’s focus has been on the various stimulus packages for which horse and farm owners may apply in order to help current cash flow.

In addition to these loan programs, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law at the end of March, contains numerous income tax provisions benefiting taxpayers. Some of these provisions impact 2019 tax filings but might also provide amendment opportunities for 2018 tax filings. Other changes are effective for tax years beginning in 2020. The goal of all of these income tax provisions is to accelerate cash refunds or to keep cash with individuals and businesses.

Below, we break down some of the recent tax changes that might benefit individuals and businesses in the equine industry.

A note on income tax deadlines

Before diving into the CARES Act, it is important to note some changes to income tax deadlines. In response to COVID-19, the Department of Treasury has postponed to July 15 the deadline for most federal income tax returns and payments due on or after April 1 and before July 15, 2020. This extension applies to federal income tax returns and payments for the 2019 tax year that are normally due by April 15. It also applies to first and second quarter estimated income tax payments for tax year 2020, which would otherwise be due April 15 and June 15. For taxpayers struggling with cash flow in the wake of the pandemic, postponement of these tax payment deadlines allows them to retain cash a little longer.

Elimination of the excess business loss limitation for tax years 2018-20

In a big win for the equine industry, the CARES Act retroactively postpones implementation of the excess business loss (EBL) limitation until tax years beginning after Dec. 31, 2020. The Tax Cuts and Jobs Act (TCJA), passed at the end of 2017, introduced a limitation on business losses deductible by individuals and other non-corporate taxpayers (trusts and estates) against non-business income. This is calculated at the individual level and not at the pass-through entity level, as individuals combine all business activities when determining overall net business income or loss. Specifically, the TCJA disallowed net 2018 tax losses from active businesses in excess of $250,000 (for individual taxpayers) and $500,000 (for joint filers), adjusted annually for inflation. Disallowed losses are treated as net operating loss carryforwards to the following tax year. Under the TCJA, the EBL limitation was effective for tax years 2018 through 2025.

Many horse and farm owners who used income tax incentives—such as the 100% bonus depreciation—were subject to this EBL limitation beginning in 2018, which often resulted in a one-year deferral of this EBL.

The CARES Act retroactively postpones the effective date of the EBL limitation until tax years beginning in 2021. Taxpayers that filed a 2018 tax return reflecting a disallowed EBL or a 2019 tax return reflecting a disallowed EBL (or a carryover of a disallowed EBL from 2018) should consider amending those returns. On a less favorable note, once the EBL limitation returns in 2021, W-2 wages will no longer be included in the net business calculation.

Favorable changes to net operating losses

The CARES Act also makes taxpayer-friendly changes to the rules governing net operating losses (NOLs). The TCJA generally eliminated the ability of taxpayers to carry NOLs back to prior tax years, with the exception of farm losses, which could be carried back two years. This change was effective for tax years beginning after Dec. 31, 2017. Prior to the TCJA, taxpayers were permitted to carry NOLs back two years (or five years for farm losses) or forward 20 years.

The CARES Act reinstates carrybacks of NOLs arising in tax years beginning after Dec. 31, 2017 and before Jan. 1, 2021, allowing these losses to be carried back five years. This applies to both corporations and individuals, trusts and estates with net business losses. NOLs eligible for the five-year carryback period include farm losses, which would otherwise be subject to a carryback period of two years under the TCJA. Corporations that were subject to a 35% tax rate before the TCJA reduced the corporate rate to 21% as of Jan. 1, 2018, might particularly benefit from carrying back NOLs.

For NOLs arising in tax years beginning after Dec. 31, 2017, the TCJA also limited the NOL deduction to 80% of a taxpayer’s taxable income.

The CARES Act suspends application of the 80% taxable income limitation for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2021, allowing losses to offset 100% of taxable income.

These modifications to the NOL rules permit taxpayers to use NOLs to a greater extent to offset taxable income in prior or current tax years, providing taxpayers with liquidity in the form of tax refunds and reduced current tax liability. The IRS is temporarily accepting faxed refund claims for NOL carrybacks and the corporate AMT credit discussed below in order to expedite these refunds.

Acceleration of ability to claim corporate minimum tax credits

Before the TCJA, corporations were subject to an alternative minimum tax (AMT), which was imposed if the AMT calculation resulted in a greater tax liability than the liability computed under the regular income tax. If a corporation was subject to AMT, the amount of the AMT was allowed as a minimum tax credit in any later tax year to the extent the corporation’s regular tax liability exceeded its tentative minimum tax in the later year.

The TCJA repealed the corporate AMT for tax years beginning after Dec. 31, 2017. It also established a method for taxpayers to use their AMT credit carryforwards fully by the end of tax year 2021.

The CARES Act accelerates the ability of corporations to claim AMT credits. Under the CARES Act, corporations can claim 100% of the credit by the end of either tax year 2018 or 2019. Corporations seeking to accelerate an AMT credit refund for tax year 2018 can utilize a “quick” refund procedure by filing Form 1139 with the Internal Revenue Service.

Increased tax benefits for charitable contributions during 2020

The CARES Act modifies certain rules governing charitable contributions, providing taxpayers with greater tax incentives to donate to charitable organizations. For individual taxpayers who do not itemize deductions, the CARES Act creates a $300 above-the-line deduction for cash contributions to qualifying charitable organizations made during a tax year beginning in 2020. This change benefits taxpayers taking the standard deduction, who otherwise would not be able to deduct charitable contributions.

In addition, the CARES Act changes the limitations on individual and corporate cash contributions to charitable organizations during 2020. Generally, individuals are allowed a deduction for cash contributions to qualifying charitable organizations of up to 60% of their adjusted gross income (AGI). The CARES Act removes this limitation for cash contributions made during 2020 only, allowing individuals to offset 100% of their AGI by making cash contributions to qualifying charitable organizations during the current year.

For corporations, charitable contribution deductions generally cannot exceed 10% of taxable income. This limitation is increased to 25% of taxable income for cash contributions made to qualifying charitable organizations during 2020.

The new rules do not apply to cash contributions made to donor-advised funds or to certain supporting organizations.

Like nearly every other industry in the country, the equine business has been tremendously impacted by the COVID-19 pandemic. With postponed or canceled racing and sales and the uncertainty for what will happen during the rest of the year, the need to maximize cash flow remains a top priority. The recent income tax changes in the CARES Act can provide some liquidity to industry participants and assist in weathering this storm.

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.