Persistent Losses on Arabian Horse Venture Precludes Loss Deductions

(Parker Tax Publishing May 2025)

The Tax Court held that persistent losses incurred in a couple's Arabian horse enterprise indicated that their venture was operating more as a hobby than as a business and thus the losses incurred were not deductible under the hobby loss rule in Code Sec. 183(a). The court found that after experiencing multiple financial setbacks, the couple failed to take any cost-cutting measures or change their business practices in an attempt to increase income. Himmel v. Comm'r, T.C. Memo. 2025-35.

Background

From 1975 to 1990, Mark Himmel worked at KEM Supply House, Inc. (KEM Supply House), a family business which sold office supplies and furniture. Mark's wife, Deborah, worked as a full-time dental hygienist from 1977 to 1990 and transitioned to part-time work from 1990 to 2008. In 1981, the couple formed Plantation Arabians, a sole proprietorship, and started breeding, boarding, showing, and training Arabian horses. Prior to that time, both had been involved with the horse industry and thus had some familiarity with horses and the industry. Also, in 1981, the couple bought a 25-acre property on which they constructed a house and barn. While they did not have a written business plan for Plantation Arabians, the couple had an informal plan to breed their own horses, buy horses from others, and then train and show the horses to enhance their value when ultimately sold.

Throughout the years at issue Deborah and Mark owned and cared for at least 20 horses at Plantation Arabians. Care for the horses was labor intensive and required daily and year-round duties, such as cleaning and mucking out stalls, grooming horses, feeding and watering horses, and tending to pastures.

In addition to competing in shows, Mark began judging shows in 1987 to increase Plantation Arabians' profile in the industry. He worked his way up the judging hierarchy from local show judge to national show judge. In October 2001 Mark judged the most prestigious Arabian horse show, the U.S. National Championship. However, the International Arabian Horse Association (IAHA) subsequently fired Mark as a judge and accused him of unfairly favoring certain entrants. Word of the scandal negatively affected Mark and Deborah's reputations, as well as Plantation Arabians' reputation. In June 2002 Mark filed suit against the IAHA for wrongful dismissal. In 2005 he received a favorable settlement of $225,000.

After the Himmels established Plantation Arabians in 1981, they also became involved in two other horse-related endeavors. However, because neither of them was successful, they ceased operating those businesses.

For years 2004 through 2009, the Himmels attached to their tax returns a Schedule C listing "Breeding & Show of Arabian Horses" as their principal business. They reported losses for each year and the total losses reported for those years were $867,355. They sold one horse in 2004.

Hobby Loss Rule

Under Code Sec. 183, the deduction of expenses from an activity that is not engaged in for profit generally is limited to the amount of gross income derived from that activity. The disallowance of losses from activities not engaged in for profit is known as the "hobby loss rule." Under Code Sec. 183(d), an activity consisting in major part of breeding, training, showing, or racing horses is presumed to be engaged in for profit if the activity produces gross income in excess of deductions for any two of the seven consecutive years which end with the tax year, unless the IRS establishes to the contrary.

In determining if an activity is engaged in for profit, Reg. Sec. 1.183-2(b) provides the following nonexclusive factors to consider a taxpayer's profit objective: (1) the manner in which the taxpayer carried on the activity; (2) the expertise of the taxpayer or his or her advisers; (3) the time and effort spent by the taxpayer in carrying on the activity; (4) the expectation that the assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or loss with respect to the activity; (7) the amount of occasional profits earned, if any; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation were involved.

The IRS audited the Himmel's returns for the 2004 - 2009 tax years, all of which were filed after the specified filing dates (including extensions). Pursuant to Code Sec. 183(d), the IRS determined that the Himmel's horse-related activities were not engaged in for profit and the related losses were thus not deductible. The IRS also assessed penalties for late filing and late payment of taxes. The Himmels took their case to the Tax Court, arguing that Plantation Arabians was operated primarily for profit and thus they were entitled to the losses reported.

Analysis

The Tax Court sided with the IRS and held that the Himmels did not operate Plantation Arabians for profit and thus were not entitled to deduct the losses they sustained in years 2004-2009. Of the nine factors listed in Reg. Sec. 1.183-2(b), the court found that seven factors favored the IRS, one factor favored the Himmels, and one factor was neutral.

With respect to the manner in which the business was conducted, the court found no evidence that the Himmels tracked direct and indirect expenses for each individual horse and thus concluded that the couple failed to maintain books and records with the objective of making a profit. Additionally, the court noted that a friend of the Himmels, who also operated an Arabian horse operation, responded to the 2008 recession by reducing his inventory of horses in order to cut overhead expenses and even gave away some horses for free when they could not be sold. The Himmels, the court observed, experienced multiple financial setbacks but failed to take the same type of cost-cutting approach. The court also found no indication that they changed their procedures or business practices to increase income.

With respect to operating under a business plan, the court said the Himmels did not have a complete business plan because they failed to perform an essential aspect of their plan: selling horses. However, in light of the fact that they did produce partial quarterly profit and loss statements, and Mark entered many expenses into QuickBooks daily, the court found this factor neutral.

The court observed that the Himmels were unsuccessful with two other businesses related to horses and both businesses were terminated when it was clear they were no longer viable businesses. Yet, the court noted, Plantation Arabians sustained losses for at least 14 years and the Himmels continued with operations. The court found their persistence through Plantation Arabians' unprofitability was a strong indicator that they were not engaged in this horse activity for profit. While the court acknowledged that the Himmels' method of advertising their horses mainly by participating in horse shows was appropriate in their industry, the court found that overall, Plantation Arabians was not carried on in a businesslike manner consistent with an activity engaged in for profit.

With respect to the expertise of the Himmels or any advisers, the court found that the couple failed to show that they received any advice that was not merely general advice a horse enthusiast would seek for a hobby. As for the time and effort devoted to the activity, the court said the Himmels credibly testified as to the amount of time they spent cleaning and mucking out stalls, and grooming, feeding, and watering horses and this weighed in their favor. However, because the couple produced no reliable evidence of the current fair market value of their horses or evidence that their value had increased over time, there was no evidence of an expectation of appreciation.

The court also upheld the penalty assessments because the Himmels failed to articulate any specific reason for the delays in filing their returns and paying the taxes due.

For a discussion of the hobby loss rules, see Parker Tax ¶97,500.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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