2003 Year End Tax Planning for Horse Owners and Breeders

This summer many taxpayers received child tax rebate checks and slightly larger paychecks as a result of the enactment of The Jobs and Growth Tax Relief Reconciliation Act of 2003. However, did you know that with this act came some provisions that allow for significant tax planning opportunities for horse owners and breeders? Even though it is now November, it is not too late to take advantage of some of the new income tax laws for this year.

For fiscal years starting in 2003, 2004 & 2005, the section 179 provisions have been quadrupled. Businesses can now generally write off up to $100,000 of horse and equipment purchases, so long as total purchases of depreciable property for the year do not exceed $400,000. If total purchases of depreciable property exceed $400,000, the $100,000 is reduced dollar for dollar by the excess. Prior to the 2003 Tax Act, only $25,000 of purchases could be written off per year. The section 179 provision is subject to some income limitation rules which in essence prevent a loss being created by using this deduction. The Act also allows taxpayers to make or revoke expensing elections on amended returns with respect to taxable years beginning in 2003, 2004 or 2005 without the consent of the Commissioner.

Thinking of upgrading your computer software? Great news, off-the-shelf computer software is now also eligible for the accelerated write off discussed above.

What does this mean to the horse business? Scenario 1). Say for example you have sold several resale horses for a total of $150,000. Costs and expenses for the year total $75,000. You are presently facing paying taxes on income of $75,000. Depending on what tax bracket you are in, and what form of business you operate under, this income could yield you an income tax bill of anywhere from $13,000 to $26,000. This is not including self-employment taxes, which could be as high as another $11,000, nor does it include state income taxes. You could possibly end up paying $37,000 in taxes on these profits to the Internal Revenue Service.

How do the new laws help you lower this daunting figure? During the Fall season there is a veritable plethora of horse sales. These sales offer some of the performance horse industries best prospects, proven show horses and broodmares up for sale. A purchase or two at one of these sales could also considerably lower your income taxes. Let’s expand on Scenario 1) above. At one of the sales you find a great broodmare to add to your broodmare band and purchase her for $25,000. Then at another sale, you find a stud prospect you just can’t do without, and purchase him for $50,000. What’s the impact on your taxes? With the new law you can elect to write-off the full $75,000 you paid for these horses, reducing your taxable income to zero and thus have no federal income taxes to pay on this activity.

For 2003 and 2004, there is a new special first-year depreciation allowance of 50% for qualified property acquired after May 05, 2003 and before January 01, 2005. Qualified property is “new” property such as equipment, horses, trailers and etc. whose original use starts with the purchaser. Real property such as land and buildings is not qualified property. For assets placed into service after May 5, 2003 and before January 1, 2005, you may elect to continue to use the 30% bonus depreciation rather than the 50% bonus depreciation. You may also choose to elect out of both the 50% and 30% bonus depreciation. Business owners might elect out of the bonus depreciation if they have expiring net operating losses, need to show a profitable year or for other beneficial reasons.

It is unclear exactly what constitutes a “new” horse. Industry professionals have suggested that purchasing a show horse and using it for a breeding animal would be a “new” use. This issue has yet to be ruled upon by the IRS. It is clear however, that purchasing an animal to show or race that has never been shown or raced before would be a “new” use.

Let’s look at this 50% bonus depreciation a little closer. At first glance it doesn’t sound all that significant, but it truly is. You see there is no limit on how many eligible assets you can purchase. Say for instance you purchase $500,000 in yearling show prospects; you can write off $250,000 the first year as well as claim your regular depreciation allowance for the horses.

Another change implemented with this act was the reduction in the maximum tax rate on net capital gains (i.e. net long-term capital gain reduced by any net short-term capital loss) from 20% to 15%. The long term rates generally apply to capital assets held for a year or more. However, in the case of horses held for breeding and sporting purposes, the holding period is 24 months. Let’s look at an example to illustrate the affect of the holding period. Assume you purchased a futurity prospect for $10,000 on December 01, 2001. You show him at this year’s futurity and sell him for $50,000. If you sell him on or before December 01, 2003 you will not meet the 24-month holding period and your gain on the horse will be taxed at your regular marginal tax rate. If you sell him after December 01, 2003, you will meet the 24-month holding period and will only pay $6,000 in taxes on the gain (40,000 x 15%).

Implementing a tax planning strategy for your horse business can yield some big savings. Nonetheless, I highly recommend you consult with a tax professional before implementing your tax planning ideas. There are many factors including state and local taxes, retirement issues, hobby loss rules etc. that must be considered when developing a tax plan. Everyone’s tax and business situation is unique and good advice to one person could be bad advice to another

Carolyn Miller is a Certified Public Accountant practicing in Gainesville, Texas. She is a Non-Pro competitor at NRHA and NRCHA events. Carolyn gears her practice towards equine businesses and the horse industry. You may contact Carolyn by email at Carolyn@equinecpa.net or by phone at (903) 429-0095 or visit her website at www.equinecpa.net.