Rafalca, a 15-year-old mare competing in dressage at the Olympics opening today in London, will be trying to add to the U.S. medal count and Republican presidential candidate Mitt Romney’s bottom line.
Romney’s wife, Ann, who calls horses her “passion in life,” has an investment in them, including Rafalca, valued at as much as $500,000. The couple’s tax returns classify Ann Romney’s pastime as a business that lost $77,731 in 2010, rather than a hobby, and as a passive investment instead of one they actively manage. Each of those decisions has tax consequences.
The Romneys’ tax deductions for their investment in Rafalca emphasize the distinction in the tax code between hobby horses and the horse business. Hobby expenses are harder to deduct than business expenses. It’s a difference the Internal Revenue Service tries to enforce and one that some horse owners try to cross when they see their care-and-feeding bills, said Dessa Bergquist, an accountant at Eide Bailly LLP in Golden, Colorado.
“Horses are interesting and a lot of people like horses,” said Bergquist, who specializes in equine tax issues. “So they sit there and they go, well, let me see if I can’t make a business out of this.”
The Romneys’ tax returns and financial disclosures don’t provide all of the details about their investment in the horse business, organized as Rob Rom Enterprises LLC in Moorpark, California. Taking a loss in a single year doesn’t indicate that the Romneys are engaged in a hobby as opposed to a business, nor does it indicate anything illegal or out of the ordinary.
Amanda Henneberg, a campaign spokeswoman, didn’t answer questions about the horse and the Romneys’ tax returns. Paul Husband, an attorney in Universal City, California, who helped establish Rob Rom Enterprises, declined to comment about his clients, though he spoke generally about horse tax law.
In 2010, the only complete year of tax returns that the Romneys have released publicly, the couple was able to deduct only $50 of more than $77,000 in losses related to the horse business. When they can turn the losses into future deductions depends in part on whether and when their horse business becomes profitable.
Rafalca is set to compete starting Aug. 2 in the dressage competition, a judged event in which horses and riders make a series of prescribed dance-like movements. Some of the competition is set to music.
Ann Romney, 63, is a part owner of the horse, along with Beth Meyers and Amy Roberts Ebeling. Jan Ebeling, Amy’s husband, is Rafalca’s rider.
Mitt Romney’s financial disclosure form, filed on June 1, shows that Ann Romney holds a promissory note worth $250,000 to $500,000 from ACR Enterprises Inc. that yielded $15,000 to $50,000 in interest payments. An entity with that name and showing Amy Roberts as the agent is listed in California records at the same address as Rob Rom Enterprises.
Before being named to the Olympic team, Rafalca finished third in the U.S. Equestrian Federation’s National Grand Prix Dressage Championship this year in Gladstone, New Jersey. Ebeling and the horse are competing in the team dressage event.
Ann Romney has said horseback riding has helped alleviate her symptoms of multiple sclerosis.
“You know the horses have been my therapy,” she said on ABC’s “Good Morning America” on July 19. “They’ve been my joy. They’re my passion in life. I wish everyone had a passion like I have this passion.”
In a July 25 interview with Brian Williams on NBC, Mitt Romney described the event as “Ann’s sport” and said he wouldn’t watch the competition and wasn’t sure when it would occur.
The IRS examines a series of issues when determining whether a taxpayer is trying to take business deductions for an activity that should be classified as a hobby.
The main distinction in the law is whether the taxpayer intends to make a profit, not whether the taxpayer has reported losses, said Tad Davis, a founding partner of Davis & Harman LLP in Washington.
“It sure helps if your state of mind is followed by your profits,” said Davis, author of the American Horse Council’s Horse Owners and Breeders Tax Handbook.
As an example, Husband said, when a foal is born, it has a tax basis of zero, though it may have value.
“Until you sell that foal, you don’t realize income,” said Husband, co-author of Tax Planning for Horse Owners and Breeders. “So you can have a business that has shown a million dollars of losses but it may be that the assets of the business owner have increased by $2 million.”
The criteria used by auditors and judges include expertise, an expectation that assets will increase in value, the amount of occasional profits earned and whether the activity produces personal pleasure for the owner.
Husband said he advises clients to create business plans, have separate checking accounts for the business, review their operations regularly and make changes designed to create profits.
The difference between a hobby and a business is significant for tax purposes. Taxpayers can deduct losses from hobbies only to the extent that they generate income. Business losses can be deducted in full, subject to certain limits.
Tax returns typically don’t provide enough information to show someone’s level of involvement or any of the other issues that auditors would look at to decide whether a horse investment was a business or a hobby, said Michael Grace, an attorney at Milbank, Tweed, Hadley & McCloy LLP in Washington.
In an interview with Bloomberg Businessweek on July 3, Jan Ebeling described the enterprise involving Rafalca as a business.
“I hate to talk about a horse as a product, but basically Rafalca is the product,” he said. “The plan is to have a horse do well. And then use it for breeding. In this case you would have babies and hopefully be able to market the babies.”
The IRS regularly challenges business deductions for horses. The U.S. Tax Court decided a case July 23 on that issue in ruling against a Texas couple who tried to claim deductions for horse expenses.
“While a series of losses during the initial or startup stage of an activity may not necessarily indicate a lack of a profit motive, a record of large losses over many years is persuasive evidence that a taxpayer did not have such a motive,” wrote Judge Mary Ann Cohen in a decision that weighed the facts of that case against rules for defining business activity. “The many years of losses without a meaningful plan for recouping them are most persuasive.”
The Romneys classified their horse involvement as a passive investment. In general, that means that they didn’t spend 500 hours a year on the activity, said Grace, who specializes in the passive loss rules.
Because it is considered a passive investment, they can claim deductions only up to their total passive income, which comes from the horse business as well as other investments in real estate and trusts, according to the Romneys’ tax return.
Those losses are suspended and then can be available in subsequent years. They can be used against future passive income from any of the couple’s other investments.
“It all goes back into one big pot or basket,” Grace said.
The deductions also can be taken in full if the Romneys were to leave the horse business.
“If they never made a profit, in the future, they could still at some point, use those losses, once they get out of the business,” Davis said.
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