Saturn -- October 1998

Regarding the aspect of tax write-off, each Co-Owner is reminded to consult with their accountant.

The U.S. Senate has voted to include the Equine Equity Act as part of the 2007 Farm Bill that the Senate is expected to vote upon and approve in the next few days.

After passage of the Farm Bill by the Senate, the two houses of Congress are expected to meet sometime in early 2008, after the holiday recess, to resolve any differences in the two bills.  (This article appeared in the Thoroughbred Times on December 7, 2007).

This Article below is an exact reprint from this American Horse Council Link printed out here for the convenience of the reader : http://horsecouncil.org/legislation/equityact110.html

Legislative Issues & Policies - Equine Equity Act of 2007 (This article has been taken from the American Horse Council website and is transcribed here for the sake of convenience.

Introduction

Federal tax law treats the equine industry differently than others in several respects.  Horses must be held longer than other business assets to be subject to capital gains.  Race horse owners are required to make a decision regarding when to begin depreciating their race horses that is not based on the expected racing life of the animals.  Legislation has been introduced in prior Congresses to correct these discrepancies.

Legislation Enacted

On May 22, 2008 Congress overrode Presidents Bush’s veto of the Food, Conservation, and Energy Act of 2008, commonly known as the Farm Bill, and enacted it into law.  The new law amends the cost recovery schedules to place all race horses in the three-year category for depreciation purposes.  Effective January 1, 2009 all race horses will be depreciated over three years, regardless of their age when placed in service.  Prior to then, race horses will be depreciated over seven years if placed in service before they turn two.  If placed in service after two (24 months from foaling date), they will be depreciated over three years.  This change to the tax code will “sunset” after five years at the end of 2013, unless extended.    

Background

On May 1, 2007 Senators Mitch McConnell (R-KY), Jim Bunning (R-KY) and Blanche Lincoln (D-AR) re-introduced the Equine Equity Act (S. 1251).
 
The bill would end the disparate treatment of the horse industry versus other businesses under the federal tax code.  Specifically, the legislation would: (1) make horses eligible for capital gains treatment after twelve months, similar to other business assets; and (2) place all race horses in the three-year category for depreciation purposes.
 
Reduction of Capital Gains Holding Period

Under the federal tax code, gains from sales by individuals of property used in a trade or business, including horses, qualify for long-term capital gains and are subject to the maximum capital gains tax rate of 15%.  Since the individual tax rate can go as high as 35%, the lower rate is a real advantage. 

Unfortunately, horses held for breeding, racing, showing or draft purposes generally qualify for the 15% capital gains rate only if they are held for 24 months.  All other business assets (except cattle) qualify if held for 12 months.  Passage of this legislation would end this discriminatory treatment of horses under the tax code and allow horse owners to enjoy the reduced rate upon sale after holding the horse for 12 months, rather than twenty-four.

In order to qualify for long-term capital gain treatment, a horse cannot be held “primarily” for sale to customers.  For example, a commercial breeder, whose principal activity is breeding horses and selling the foals or yearlings, is not eligible for capital gains treatment now on the sale of the horses because they are held for sale.  In addition, a “pinhooker,” who buys yearlings and re-sells them as two-year-olds-in- training, does not realize capital gains on any gain now.

But for most breeders, who breed to race or show (even if they cull some foals/yearling), or who race or show horses and sell them, or who race or show horses and syndicate them and sell shares, shortening the capital gains holding period to twelve months should be a benefit.

Reducing the holding period by half would give these horse owners and breeders more flexibility to sell and market their horses.  It would mean that every sale of a horse which is held for at least twelve months will qualify as a capital gain or loss unless that horse is held primarily for sale.       

Making All Racehorses Eligible for Depreciation over Three Years

Presently race horses are depreciated over either three or seven years, depending on their age when “placed in service.”  A horse is generally deemed to be placed in service when it begins training, which is usually at the end of its yearling year.  Race horses over two when placed in service are depreciated over three years; if under two, they are depreciated over seven years.  (A horse is deemed to be “over two” for tax purposes twenty-four months and a day after it is foaled.)

Depreciation is a means of recovering the cost of property, including horses, used in a business through deductions of portions of the horse’s cost over a period of years.  Generally, the recovery period approximates the estimated useful life or economic life of the property.  Current law provides that racehorses that begin training at the end of their yearling year are depreciated over seven-years, even though most will not actually race for seven years. 

The legislation introduced by Senators McConnell, Bunning and Lincoln recognized the unreality of this requirement by changing the tax code to allow owners to depreciate all their race horses over three years, rather than seven, regardless of when they are placed in service.  The change provides a more equitable depreciation schedule for race horses, one that better matches the realities of the situation.  Under the new law, owners will no longer be required to depreciate their horses over seven years simply because they are placed in service at the end of their yearling year. 

The following chart, which shows what portion of the cost of a race horse is depreciated annually depending on the recovery period, illustrates the advantages of this change.

                     3-Year Property                        7-Year Property
Year One               25.0%                                      10.71%
Year Two               37.5%                                      19.13%
Year Three            25.0%                                      15.03%
Year Four              12.5%                                      12.25%
Year Five               100%                                       12.25%
Year Six                                                                  12.25%
Year Seven                                                             12.25%
Year Eight                                                                6.13%
                                                                              100.00%

Obviously, this change would allow an owner to depreciate 62.5% over the first two years a horse is in training or races, rather than 29.85%.  More importantly, this allows an owner to more accurately recover his/her costs over the period that the horse is likely to race.

Congressional Action

The Equine Equity Act was referred to the Senate Finance Committee.

On December 14, 2007, the Senate passed its version of the Farm Bill on a vote of 79 to 14.  The bill included the Equine Equity Act.  Senator Mitch McConnell (R-KY) offered this bill as an amendment to the Farm Bill and it was accepted without objection. 

The House passed its version of the Farm Bill last summer.  The House bill did not include the Equine Equity Act and was quite different from the Senate Farm Bill in many other respects. 

Conference Committee Meetings

A Conference Committee that included members of the House and Senate met for several months to resolve the differences between the two versions of the bill.  After months of negotiations, the Conference Committee agreed to a final farm Bill that included the change to the depreciation schedule for of race horses as described above.

The second provision in the Equine Equity Act, which would have shortened the capitol gains holding period for horses from two to one year, was not included in the final Conference version of the Farm Bill passed by Congress.

President Bush vetoed the Farm Bill because of the overall cost, but Congress overrode his veto.  The change to the recovery schedule for race horses is now law, effective January 1, 2009. 

AHC Position

The AHC supported this legislation.

IRC Section 1231

For certain cases, IRC section 1231 provides special rules for the treatment of gains and losses arising from business property. IRC section 1231 refers to such gains and losses as "section 1231 gain" and "section 1231 loss." IRC section 1231(a)(3)(A) defines "section 1231 gains" as "(i) any recognized gain on the sale and exchange of property used in the trade or business, and (ii) any recognized gain from the compulsory or involuntary conversion * * * into other property or money of (I) property used in the trade or business, or (II) any capital asset which is held for more than one year and is held in connection with a trade or business or transaction entered into for profit." IRC section (a)(3)(B) defines "section 1231 loss" as "any recognized loss from a sale or exchange or conversion described in" the previous sentence.

IRC section 1231(b)(1) provides a general rule defining the term "property used in the trade or business" (section 1231 property). This general rule does not apply to livestock. The general rule restricts the definition of "property used in the trade or business" to, among other things, depreciable property, held for more than 1 year, "which is not (A) property of a kind which would be includable in the inventory of the taxpayer if on hand at the close of the taxable year, [or] (B) property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, * * *."

The special definition that is used in the case of livestock is found in IRC section 1231(b)(3) which defines "property used in the trade or business" as including "(A) cattle and horses, regardless of age, held by the taxpayer for draft, breeding, dairy, or sporting purposes, and held by him for 24 months or more from the date of acquisition, and (B) other livestock, regardless of age, held by the taxpayer for draft, breeding, dairy, or sporting purposes, and held by him for 12 months or more from the date of acquisition. Such term does not include poultry. "

Treas. Reg. section 1.1231-2(a) states: "(3) For the purposes of section 1231, the term 'livestock' is given a broad, rather than a narrow, interpretation and includes cattle, hogs, horses, mules, donkeys, sheep, goats, fur-bearing animals, and other mammals. However, it does not include poultry, chickens, turkeys, pigeons, geese, other birds, fish, frogs, reptiles, etc."

See chapter 11 of Publication 225, Farmer's Tax Guide, for a discussion of various types of dispositions. The following represents a basic indication of reporting requirements for certain types of sales.

There may be exceptions to some of the examples in the preceding table. Whether livestock is held for draft, breeding, dairy, or sporting purposes depends on all the facts and circumstances in each case. See Treas. Reg. section 1.1231-2(b)(1).

Only livestock (property) "used in the trade or business" qualifies for IRC section 1231 handling. Any animals purchased for resale must be included in inventory and its cost is recovered at the time of sale. The classification of income as Schedule F or IRC section 1231 affects the computation of self-employment tax.

Animals sold which were purchased for breeding purposes but not yet placed in service are not depreciable, but are considered to be held for use in the trade or business and qualify for IRC section 1231 reporting. In a business which includes both breeding and purchasing for resale, carefully determine the purpose for which the animals were purchased.

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I recommend that you review the Internal Revenue Service Code regarding General Livestock which is provided with this link.