100% Bonus Depreciation for Horse Businesses through December 31, 2011

Forbes.com featured a story this week, entitled “Tax Deductions for Yearling Thoroughbreds”, that may be of interest to many horse businesses. To read the article, click here. Many Thoroughbred racing industry experts are quoted in the article, including Kentucky equine lawyer Joel B. Turner, whose guest post was featured on the Equine Law Blog this Tuesday.

The focus of the Forbes article is the applicability and effect of the 100% bonus depreciation feature of the Tax Relief Act of 2010, and its potential tax benefits to qualified horse businesses. As the Forbes article suggests, some race horse operations who buy yearlings in 2011 may be able to deduct 100% of the yearling’s purchase price in 2011. 

Before the bonus depreciation feature of the Act became effective on September 9, 2010, the percentage of depreciable basis allowed as bonus depreciation on qualified property was only 50%. This 50% depreciation percentage will apply again in 2012.

The potential tax savings offered by the Act for the 2011 tax year are significant for qualified horse businesses. Walt Robertson, Keeneland’s vice president of sales, indicated in the Forbes article that the Act may have positively affected sales activity at the Keeneland 2011 September Yearling Sale. 

It is important to note that the Act does not refer to specifically Thoroughbreds, yearlings, race horses, horses or livestock. The Act provides 100% bonus depreciation for all “qualified property”. In general, “qualified property” is tangible personal property and equipment purchased for use in a business operation, as long as certain conditions are met. For horse businesses, qualified property could arguably include horses, trailers, trucks, tractors, ATVs, and other horse/farm equipment.  Among the conditions that must be met are the following:

1) the horse / equipment’s original use must begin with the taxpayer (i.e. horses that have not begun training; new equipment); and

2) the horse / equipment must be placed in service after September 8, 2010 and before January 1, 2012.

As many of the experts quoted in the Forbes article indicate, the Act does not provide an “easy write-off”. For starters, taxpayers wishing to avail themselves of the 100% bonus depreciation must be able to prove that they are in the “horse business” and that the property was purchased for said business. This element may pose difficulties to taxpayers who have not shown a profit in their horse business for many years. Further, purchasers of fractional interests in racing syndicates are generally considered “passive investors”, and therefore may not see any tax savings through application of the Act.

There are other considerations that come into play to determine whether the 100% depreciation is available, such as whether the taxpayer borrowed money to purchase the horse/equipment through an LLC or other entity. 

Horse businesses who purchased or will purchase new horses or equipment in 2011 should consult a CPA or attorney who has expertise in the equine industry to determine the possible applicability of the Act to their newly-acquired property.

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Bonus Depreciation in Economic Stimulus Act

Bonus Depreciation

The second incentive of the Economic Stimulus Act of 2008 brings back 50% first-year “bonus depreciation” for horses and most other depreciable property purchased and placed in service during 2008. “Bonus depreciation” was first passed in 2002 but had phased out at the end of 2004. Bonus depreciation helps horse businesses by allowing them to depreciate 50% of horses or property in the first year the horse or property is purchased or placed in service instead of depreciating smaller percentages of the property year after year.

Eligible property. Bonus depreciation applies to horses or any other property with a useful life of 20 years or less. Also, the property must be “new”, meaning the original use of the horse or other property must begin with the taxpayer to be eligible.

No limit. There is no limit on the amount of bonus depreciation that can be taken in any one year.

How Bonus Depreciation Works. Assume that in 2008, a horse business pays $500,000 for a colt to be used for racing and $50,000 for other depreciable property, bringing total purchases to $550,000. The young colt had never been raced or used for any other purpose before the purchase. The business would be able to expense $250,000 as a Section 179 deduction, deduct another $150,000 of bonus depreciation (50% of the remaining balance), and take regular depreciation on the $150,000 balance.

These tax incentives help horse businesses increase income by providing a tax relief for activities they are currently conducting. They should also provide an incentive for new or existing businesses to buy more horses and other related property.

Economic Stimulus Act Increases Section 179 Expense

On February 13, 2008, President Bush signed into law the Economic Stimulus Act of 2008. “The new law includes two tax incentives that would allow a much bigger write-off for horses and other depreciable property purchased and placed into service in 2008,” said Jay Hickey, President of the American Horse Council. The Act applies to taxable years beginning after December 31, 2007.

Increase of the Section 179 Expense

The first incentive for horse owners in the Act is an increase of the Internal Revenue Code Section 179 expensing allowance for horses purchased and placed into service in 2008 from $128,000 to $250,000.

How does Section 179 help horse owners? Typically, if horses or property for your horse business has a useful life of more than one year, the cost must be spread across several tax years as depreciation with a portion of the cost deducted each year.

But there is a way to immediately receive these income tax benefits in one year. The provisions of Section 179 allow horse businesses to fully expense tangible property in the year it is purchased.

The changes made in the Act mean that in 2008, a horse business can expense $250,000 in capital expenditures up to an overall investment limit of $800,000.

Eligible Property. The expensing allowance applies to horses, farm equipment and most other depreciable property such as trucks, trailers, and tractors purchased and placed into service in 2008 (but it would not include buildings such as barns or stables).

How it works. Assume a horse business purchases $750,000 of depreciable property (including horses, a pickup, and a new trailer) in 2008. That business can write off $250,000 on its 2008 tax return and depreciate the balance.

If a business spends more than $800,000 on depreciable property in 2008, the business will have gone over the $800,000 “overall investment limit” and will not be able to write off the full $250,000 deduction on its tax return. The expense allowance goes down one dollar for each dollar spent on eligible property over $800,000. Thus, if a business’s purchases were $900,000 in 2008, the expense allowance would go down by $100,000 for a total write off of $150,000.

How to Take Section 179 Expense. The Section 179 expense is not automatic. Taxpayers who want to take the deduction have to elect to do so. You make the election by taking your deduction on Form 4562. You must file the Form 4562 with your original tax return for the tax year the horse or property was placed in service. Importantly—you need to make the election before your tax return is due (including extensions). You cannot go back and elect the deduction in an amended return filed past the due date.

Deduction Limited to Taxable Income. Once you have determined the maximum deduction based on the amount of property purchased during the year, you then must past the aggregate income hurdle.

Your Section 179 deduction cannot create a taxable loss for your business. This means your aggregate taxable income from the active conduct of any trade or business must exceed the amount of your 179 deduction. The taxable income does not all have to be from your horse business. Active trade or business includes your wages at another job, your spouse’s wages, and any other active income you may have.

Thus, many business owners are able to take advantage of the deduction when they combine their horse business earnings with wages of a spouse or money earned in addition to (or before starting) their horse business.

Also, if you are not able to take the full 179 deduction one year because you do not have enough taxable income, any disallowed amounts can be carried forward to the next year and added to the cost of any eligible property place in service that year.

Other Benefits. Less obvious advantages of the Section 179 deduction include 1) it lowers adjusted gross income, which could help you qualify for various other deductions; 2) it lowers earned income, which can increase your earned income credit; and 3) it is allowed in full even if the eligible horse or property is placed in service on the last day of the year.