This post was originally published on Forbes Apr 10, 2015I love it when Tax Court judges write about sex.
Before the late 1970s (and like registered thoroughbreds to this day), Arabian stallions and Arabian mares engaged in traditional breeding. But not all live covers produced foals, and it was a rare stallion who could mount more than two mares per day. Cf., e.g., roosters
Horse-farm cases come in herds and not in single stallions, and are among the most frequently litigated under section 183. Each case turns on its facts, see, e.g., Pederson v. Commissioner, T.C. Memo. 2013-54, (comparing a small sample of five horse-breeding cases with different outcomes), which can vary widely. They range from the wealthy businessman who runs a real business but keeps a gentleman's farm as a weekend retreat whose expenses he tries to subsidize through deductions to sophisticated, well-run operations that just haven't been able to consistently make a profit.
Top stallions took an increasing share of the breeding market—and, with the approval of frozen semen for use in artificial-insemination programs, could continue to compete in that market even posthumously. But for stallions who did not win the genetic lottery, there was left mostly gelding, giveaways, and gourmet dog food. The only slightly less predictable result—which also affected SMF as we describe below—was an increase in genetic problems as the Arabian gene pool shrank.
As we've already described, the Arabian horse market has had a lot of problems during the last two decades; by all accounts the last 20 years have been a bit of a nightmare for those in the industry. The expulsion of the Arabian Horse Registry of America from the World Arabian Horse Organization prevented American Arabian horse farms from marketing their horses to the world.
Even after the AHRA was let back into the herd in 2008 things did not drastically improve; the bottom fell out of the economy that fall, and the Great Recession depressed the demand for luxury goods worldwide.
The veterinary services of their equine medical clinic turned out to be unexpectedly substandard (which resulted in fewer foals than reasonably expected); two of SMF's mares foundered (essentially losing a hoof) and were thereafter only able to breed through a more intensive and expensive technique that required embryo transfers; a statistically significantly higher proportion than normal of colts to fillies were born, which held back SMF's future breeding plans; and a stallion that the Metzes thought was excellent breeding stock turned out to be subfertile.
We continue to agree with our interpretation of Bessenyey in Helmick and hold that the Metzes “meet their burden as to any year for which they show that they expected eventually to recoup losses sustained in the 'intervening years' *** between the current year and the hope-for profitable future.” Id. This is to say 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.
The source of this omission is a miscommunication about the ranch's sale when they moved SMF to California. Up through the date of trial the Metzes retained the Henjes, Conner & Williams (HCW) accounting firm, and had retained them for more than 20 years. The Metzes also had an in-house accountant in Florida. But when they moved their operation to California they turned over their Florida accounting records to a Naples, Florida firm because their in-house accountant wasn't moving with them.
The retention of the Naples accountants led to a botched relay of information—that firm sent the proceeds and transaction details from the Florida sale to JP Morgan but didn't copy HCW. JP Morgan then applied the proceeds to pay down a chunk of the acquisition indebtedness that SMF had incurred to buy the two parcels of California land.
HCW had standard practices to prepare its clients' tax returns and had followed them faithfully for the Metzes for many years. We believed the Metzes' tax accountant when he testified that his practice was to look at SMF's balance sheet each year and, if there was a change, to ask whether there had been a disposition. In the year of the Metzes' relocation, however, there was land in the balance sheet at the beginning and end of the year. The HCW accountant therefore didn't think to ask about a disposition, and the records of the disposition hadn't made their way to him because they'd been misrouted by the Florida accountants.