Friday, August 22, 2008

Farm Bill Gives Equine Industry 129M in Tax Breaks



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.

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%

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.

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.

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