QWE Waterhouse is introducing you to a new client. Frank and Judy Higgins have a farm in Georgetown, Ky. They started investing in thoroughbred horses in 2017. They plan to both bread and race houses. They were encouraged to enter the business by a bloodstock agent as prices for thoroughbreds were down and there are significant depreciation incentives to invest in 2017.

Early last year they incurred the following expenses:

Consulting fee to Agent to explore entering into the business $10,000 in January 2017.

Legal fee to form an LLC, review the contract with the consultant and trainers $ 6,000

Retainer agreement with a trainer $5,000 (February 2017).

New fencing on the farm $15,000 March

Thoroughbred purchases in March of 2017

oBroodmare $10,000

oBroodmare $8,000

oBroodmare $ 11,000

oBroodmare $7,000

oMare racing stock $ 20,000

oStallion - racing stock $ 125,000

Stud fees for breeding each of the broodmares $7,500 each total $ 30,000

Fees to register racing silks with the Jockey Club $ 1,500

Training and boarding costs are $ 2,500 per month for 9 months

Vet bills for all animals were $4,700

The breeding stock is maintained at the Georgetown farm. The Mares are in fold and the folds will be sold in 2018. The racing stock is in training in Paris, Kentucky.

In August the Broodmare that was purchased for $8,000 and was in fold was killed by a lighting strike. Insurance proceeds of $ 22,000 were received in October.

Mr. and Mrs. Higgins attended the Keeneland sales and made all decisions concerning the purchase of thoroughbreds. They travel to Paris weekly and meet with the trainers. The trainers submit reports weekly to the Higgins as to the progress and make recommendations as to racing entries. Mr. Higgins makes all final decisions on when and where horses are raced. In 2017 only one purse of $ 20,000 was received. Mr. Higgins is also employed as President and CEO of Mayday Transportation Services, Inc. He receives a salary of $500,000.

Ernie has the following points he wants you to address:

What is the tax depreciation recovery period for the racing stock and breeding stock? Is 179 expense available?

Are the fees paid in 2017 for consulting, legal and retainer deductible in 2017?

Is there a deductable loss on the broodmare lost in the lighting strike is the loss eligible for casualty loss treatment?

Are there issues with respect to the passive activity loss rules? (Mr. Higgins has recorded 300 hours working on this project while Mrs. Higgins has recorded 320 hours of work). Each night the Higgins retrieve the horses from the pasture and put them in their stalls. Blankets are put on the horses in the winter. They feed and care for the animals on the Georgetown farm.

Might the IRS look at this as a hobby? How should the Higgins structure their business in order to assure treatment as a trade of business activity?

Mr. and Mrs. Higgins file a joint tax return. Will the jointly owned LLC file a partnership return or a Schedule C?

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