I don’t even know where to start with this case. It begins a standard hobby loss dispute on whether a Merrill Roberts can take a deduction on his horse racing losses, but turns into a full blown novel. I’ve even come up with a catchy title: “From Strippers to the Triple Crown: the Story of My Life.” Full text is available free for a limited time only on USTaxCourt.gov (warning, PDF link. Also, the “limited time” part is only true in that our future robot overlords will probably take it offline).
Here’s the backstory, as quickly as I can summarize it. Mr. Roberts purchased an abandoned restaurant, which he would turn around by “anchor[ing] his business plan on ‘hard work’.” He had no previous experience or business education. This initial plan only worked if you consider “significant kitchen fire damage several months after opening” a success.
With no income and not enough insurance settlement money to rebuild his dream as a restaurateur, he reopened the building as a bar. The airport controllers from the nearby airport became regulars (hopefully not before their shifts), and soon began requesting Mr. Roberts “arrange for exotic dancers to perform at. . .celebrations.” There’s a bit more in the full report, but the end of the story is that you can still visit the gentlemen’s club if you’re in Indianapolis.
After years of
capitalizing on the exploitation of running successful nightclubs and restaurants, he “read that owning restaurants and nightclubs was a particularly dangerous occupation” so, of course, he did the only logical thing he could: he passed it on to his kids.
Free of personal danger from his nightclubs (unless they gain sentience and learn where he lives), Mr. Roberts moved onto his real passions of installing insulation and selling used cars. Which he quickly realized weren’t anything worth getting passionate about and sold them off to start horse racing.
Mr. Roberts went all-in into the horse racing circuit. He learned how to train the horses himself, passed his license exams, bought property where he could build his own race track, and, as the title of his memoir suggested, he even got one of his horses “nominated to run in the Triple Crown Races.” Happily ever after.
Until that darned IRS showed up.
For those familiar with hobby losses, you can only deduct losses from your hobby up to the amount of income you’ve made in it. Horse racing (and raising) are the poster children for a hobby, so the IRS goes after them like zombies after a strongly beating heart (sorry, I’m in the middle of reading World War Z).
Something that looks like a hobby isn’t necessarily going to fall under the rules of hobby loss. If you want the full run down, check out Code Sec. 183 and Reg. 1.183-1. For everyone else, the general rule for horse racing is you need profit for 2 out of 7 years, or otherwise be able to prove you have a bona fide business rather than a hobby.
Here is the list of tax issues Mr. Roberts’ horse racing occupation incurred: (1) his losses were more than his income from 1997 through 2008 (i.e. more than seven years), (2) he didn’t get into horse racing until he was already a millionaire and retired, which sounds a lot like a hobby, (3) his accounting system was “rudimentary,” which consisted of giving “his CPA receipts. . .in bundled reclosable plastic bags,” and (4) he filed his 2007 return late.
The opinion on this ruling is longer than the memoir of Mr. Roberts’ life, so rather than rehash the logic, the court found that some of the early years were a hobby, but as he learned more and figured out the horse racing world, the hobby graduated into a real business (despite still essentially throwing receipts at his CPA).
For that 2007 late return, he was simply out of luck. He argued he had valid reason for a late filing, since many of his business records were burned up by an ex-girlfriend, and recreating those receipts took time. He cited a court case where people who had their records destroyed in a hurricane were permitted extra time to file.
The court’s official response deserves repeating: “The wrath of a former girlfriend may be a formidable force, but it is not analogous to a hurricane-like natural disaster.” To which Mr. Roberts likely thought “you clearly haven’t met Susan.”
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