A new Tax Court case involved several million dollars of losses from 2004-2009 in an Arabian horse farm owned by Henry and Christie Metz.
The Metzes specialize in Straight Eqyptians, and established their horse farm in 1991, at a time when prices of quality Arabians had dropped significantly from the 1980s. The Metzes believed that prices had reached their bottom. Mrs. Metz worked full-time on farm advertising, marketing and promotion, drawing on her fine-arts background. In 1995 the taxpayers bought a farm in Naples, Florida for $550,000, and viewed this as an ideal location. However, costs kept increasing and losses continued to mount. They sold the Naples property for a profit and moved operations to Santa Ynez, California, with its large concentration of Arabian horse farms, and a steady flow of buyers.
Despite millions in losses, the Metzes remained optimistic about their farm’s future. Since 2008 they had significantly reduced their expenses and increased revenue. In 2011 they achieved a profit for the first six months by selling five horses at an average price of $70,000. The judge, in analyzing the Metzes’ intent, made the following findings: The Metzes kept records in a businesslike manner, using Quickbooks, and their CPA prepared monthly bank reconciliations, accounts-payable listings, and profit-and-loss statements. They used an attorney’s prepared contracts for horse and semen sales. Some sales contracts to foreign buyers were unsigned by the buyer, which led the IRS to argue that this “is not the kind of problem an intelligent businessperson would leave unaddressed.” However, the judge found that especially with customers from a different culture, “pristine perfect preset paperwork” may not always accompany every business transaction. The Metzes maintained potential customer lists, with records of contacts made with relevant details of their discussions; and sent out professional-quality promotional materials with copies of articles featuring the Metzes’ horse activity.
They had annual written business plans that included goals, job descriptions, policies and procedures, a description of each horse, and proposed advertising and promotion opportunities for the upcoming year. The judge rejected the IRS’s argument that the plans lacked detailed information on methods to decrease costs or increase revenues, saying the IRS was attempting to substitute its own business judgment for the Metzes’.
There was extensive advertising and promotion, including ads in trade journals, and an attractive website. The Metzes regularly reviewed analytics to track which pages were most often read as well as the location of visitors. A high percentage of contacts came through the website. There were dozens of horse sales between 2004 and 2009, including some for six figures, even up to $250,000.
The IRS argued that the Metzes failed to track expenses on a per horse basis and that this was a clear indication their books and records fell short of businesslike standards. In other words, the lack of individualized records shows a lack of profit motive. The judge disagreed that a horse-by-horse breakdown is required to indicate a profit motive. The judge found that the Metzes used their records to assess economic performance and identify cost-reducing strategies. Their records were far more organized than others found to be adequate for section 183 purposes.
The judge found that the Metzes made changes in an effort to improve profits, most notably deciding against staying in Naples, Florida and relocating to Santa Ynez for the increased foot traffic and lower costs. The Metzes also responded to the increasing interest in the Arabian horse market from the Middle East, networking at large shows in the Middle East. The five horses they sold in 2011, at an average price of over $70,000 per horse, were all to foreigners.
Henry Metz was president of the Pyramid Society, a society dedicated to breeding Egyptian Arabians, and he was involved in the merger of AHRA with IAHA, and “was also recognized within the industry as a businessman who had the skills to turn around not just his own farm but a very troubled Arabian horse industry.”
The judge emphasized the importance of expertise of the taxpayer and consultants not only in animal husbandry, but in the economics of the activity, and concluded that the Metzes demonstrated expertise in the economics of the activity. The judge noted that the Metzes devoted their full time to the activity, and that “their management and development of [the farm] has been aimed at breeding horses to sell, and they’ve worked personally and with great effort.”
The judge also concluded that the significant appreciation of the taxpayers’ assets — the farm property, their horses and frozen semen – suggested a profit motive along with the other evidence.
Finally, the judge held that the long history of losses was explainable as due to customary business risks and reverses; and some of the Metzes’ problems were industrywide. The judge also rejected the IRS’s argument that the Metzes could never recoup their losses, stating that “if a taxpayer can expect to generate an overall profit from the current year onward, then it can’t be said that he lacks a profit objective simply because he will never generate an overall profit over the lifetime of the activity.”
John Alan Cohan is an attorney representing people in federal and state tax disputes, IRS appeals, and Tax Court litigation, and is a long-standing author of a legal advice column published in numerous sporting magazines. In addition, he advises organizations on compliance with newly enacted laws and regulations. John is also author of the book, Turn Your Hobby Into A Business — The Right Way. He can be reached at: (310) 278-0203, or email at firstname.lastname@example.org. His website is JohnAlanCohan.com.