107 108 1986-87] EQUINE TAXATION 229 not held primarily for sale to customers in the ordinary course of business.
Many sellers are undeniably in the trade or business of breeding or buying horses for resale.
Although there is authority for the proposition that each sale by a taxpayer generally in the business of selling horses must be separately examined to deter mine the purpose for which the horse was held,11O a taxpayer that maintains a farm breeding horses and customarily selling all of them as yearlings or weanlings probably will be found to hold all of his yearlings and weanlings primarily for sale to customers in the ordinary course of business.
III This does not prevent the taxpayer, however, from establishing that other horses sold by him were held for either breeding or racing,112 although it may be more difficult for such a taxpayer to carry the burden of proof than it would be for a taxpayer that did not generally sell horses in the ordinary course of business.
Advertising horses for sale in the ordinary course of business through public media, trade journals or sales catalogues generally assures treatment of gains as profits realized from sales to customers in the ordinary course of business.
L13 Furthermore, even if the taxpayer can establish that the horse was held for breeding or racing purposes rather than for sale to customers in the ordinary course of See Jewell, 25 T.e.
At 117; Priv.
Rut. 63021 I9340A (Feb. 11, 1963).
See Nowland, 15 T.e.M. (CCH) at 372 (taxpayer annually sold entire yearling crop at auction, buying back those he wished to keep by reserved bid or through a straw bidder).
But see Bradshaw v.
United States, 72-1 U.S.T.C. , 9364 (E.D.
Ky. 1971) (taxpayer who sold 851170 of colts foaled on his farm was found by jury to have recognized § 1231 gain, not ordinary income, on the sale of certain horses).
III See Jewell, 25 T.C.
III See Clark v.commissioner, 27 T.C. 1006. 1007-10 (1957) (taxpayer extensively advertised cattle for sale, had substantial volume of sales, and was willing to sell any cattle on farm, not just selected head); Nowland, 15 T.C.M. (CCH) at 372 (taxpayer advertised horses in trade journals and sales catalogues).
See also Campbell, 20 T.C.M. (CCH) at 838 (1961) (hackney horse held for sale to customers in the ordinary course of business despite the lack of advertising and that all sales were by word of mouth because the only manner in which taxpayer could earn a profit from breeding, training and showing hackney horses was by sale).
But see Estate of Collings v.
United States, 138 F.
Supp. 837, 839, 841 (W.D.
Ky. 1955) (broodmares sold by taxpayer were § 1231 property; although taxpayer advertised his stable generally and the amount of the horse’s winnings advertisements did not offer particular horses for sale or state prices) and compare with Kirk, 47 T .C.
At 193 (taxpayer’s failure to advertise horses for sale at general auction was a factor in finding that they were not held for sale to customers). 110 III 230 KENTUCKY LAW JOURNAL [VOL. 75 business, any gain recognized is still ordinary income unless the horse was held for the twenty four month period necessary to qualify for section 1231 treatment. 114 The amendment of section 1231(b)(3) in 1969, extended from twelve to twenty four months the holding period required for cattle and horses held for draft, breeding or dairy purposes to qualify as section 1231 assets, and added horses held for sporting purposes to the category of livestock subject to the extended holding period requirement. 115 Prior to the amendment, a num ber of cases arose in which the issue was whether taxpayers who regularly culled animals from their breeding herds and racing stables realized section 1231 gain or loss on such sales or whether they realized ordinary gain or loss from the sale of livestock in the ordinary course of business.
Horsemen who maintained established breeding and racing operations and cattlemen who maintained breeding operations generally were found to have realized section 1231 gain or IOSS.116 Most of those cases involved animals held for less than twenty four months.
Therefore, the issue should arise less frequently under the current statute.
Nevertheless, there may be instances in which these cases are important.
It is difficult to apply these cases to clearly determine the purpose for which a horse is held.
This difficulty arises from the courts’ conclusion that the actual use of the horses or cattle prior to sale was not determinative of the purpose for which the taxpayer held the animals.
The taxpayer’s motive was what was important; therefore, a horse that never was bred or raced nevertheless might be held for breeding or racing purposes.
LI7 ‘ See I.R.C. § 1231(b)(3)(A); Treas.
Reg. § 1.1231-2(a)(I)(i) (1986); McCarthy v.commissioner, 22 T.C.M. (CCH) 129, 137 (1963) (sale of racehorse under pre-1969 version of I.R.C. § 123 I (b)(3»; Priv.
Rul. 7410240190A (Oct. 24, 1974) (sale of racehorse under current I.R.C. § 1231(b)(3».
III Tax Reform Act of 1969.
No. 91-172, § 212(b), 83 Stat. 487, 571 (1969). 116 See, eg, United States v.
Bennett, 186 F.2d 407, 410 (5th Cir. 1951); Albright v.
United States, 173 F.2d 339, 344-45 (8th Cir. 1949)(cattle); Kirk, 47 T.C.
At 187; McCarthy, 22 T.C.M. (CCH) at 137; Fowler v.commissioner, 37 T.C. 1124, 1134 (1962); Journal Box Servo Corp.
United States, 9 A.F.T.R.2d (P-H) 798, 817 (S.D.
Ind. 1962); Jackson v.commissioner, II T.e.M. (CCH) 939,940-41 (1952). ‘ See, eg, McDonald v.commissioner, 214 F.2d at 343; Kirk, 47 T.e.
At 192 93.
See also Treas.
Reg. § 1.1231-2(b). 1986-87] EQUINE TAXATION — 118 See, eg, Kirk, 47 T.e.
At 192-93; McCarthY, 22 T.C.M. (CCH) at 137; Jackson, 11 T.e.M. (CCH) at 940-41. 119 See note 118 supra. 120 25 T.e. 109 (1955). 121 Id.
At 115-18.compare McCarthY, 22 T.C.M. (CCH) 129, in which the fact that the taxpayer retained some horses for a period of time after discovery of a characteristic that rendered the horse unfit for breeding or racing was not even considered 232 KENTUCKY LAW JOURNAL [VOL. 75 held for breeding purposes, continuing to hold them after it was apparent that they were not suitable for breeding effected a change in the purpose for which they were held.
On the other hand, those horses that initially appeared to be desirable for breeding, but were sold shortly after the discovery of an unde sirable trait, were found to have been held for use in breeding and the gains recognized from the sales of those horses were accorded section 1231 treatment. 122 In contrast to the taxpayer in Jewell, who raced only one horse (which was not one of those sold) during the tax years in question, taxpayers that actively train and race a very high percentage of their horses have been more successful in claiming all of the horses they sold were not held for sale to customers in the ordinary course of business. 123 Here again, however, courts generally examine the particular facts upon which the taxpayer bases his claim that the horse in question has been culled from a breeding or racing stable. 124 In Kirk v.commissioner125 the Tax Court closely examined both the training procedures fol lowed by the taxpayer, a successful harness racing owner, and the defects asserted by the taxpayer causing the horse to be culled from his stable.
Many of the horses sold during the years in question were raced by the taxpayer.
Others were trained, but never raced.
None were used for breeding purposes.
All of the culled horses were sold at general auction as soon as feasible and without advertising.
The Tax Court rejected both of the Commissioner’s argu ments and concluded that the taxpayer was in the business of by the court as a factor in determining whether the gains realized on the sale of culls were I.R.e. § 1231 gains or gains from the sale of horses held primarily for sale to customers in the ordinary course of business. 122 25 T.C.
At 117-18. 123 See Kirk, 47 T.C.
At 192-93; McCarthy, 22 T.C.M. (CCH) at 137; Jackson, 11 T.e.M. (CCH) at 940-41. 124 See Estate of Collings, 138 F.
At 841 (finding that broodmares sold by taxpayer in the business of breeding, training and selling saddle horses were property used in the taxpayer’s trade or business, not property held primarily for sale to customers in the ordinary course of business); Gamble, 68 T.C.
At 801-02 (culls from racing stable); Kirk, 47 T.e.
At 193 (culls from racing stable); Campbell, 20 T.e.M. (CCH) at 857 (according different treatment by grouping to hackney horses and horses held for rental as riding horses); Jackson, II T.e.M. (CCH) at 940 (culls from racing stable). 12> 47 T.e. 177 (1966). 1986-87] EQUINE TAXATION 233 racing horses.
The Commissioner argued that the taxpayer’s purpose in racing the horses was merely to increase their sale value and that the taxpayer was engaged not only in the business of racing horses, but also in the business of selling horses that were not suitable for use in racing. 126 The first argument was quickly rejected on the facts; the taxpayer was in the business of racing horses, not selling them.
The second argument was rejected because the sales were a necessary incident to the taxpayer’s principal business.
The taxpayer sold only those horses that were not suitable for racing.
The mere fact that he knew from the time the horses were foaled that many of them would not be suitable for racing did not mean that the horses that were sold were held primarily for sale to customers in the ordinary course of business. 127 His intent in holding the horses was deter Id.
It does not appear that the Commissioner argued or that the Tax Court ever considered the possibility that the sales of horses could have been ordinary income under the Corn Products doctrine.
See Corn Prod.
V.commissioner, 350 U.S. 46 (1955), reh’g denied, 350 U.S. 943 (1956), which was applied to I.R.C. § 1231 property in Hollywood Baseball Ass’n v.commissioner, 423 F.2d 494 (9th Cir.), cert.
Denied, 400 U.S. 848 (1970).
In apparent reference to the Corn Products doctrine, the trial court in Bradshaw v.
United States, 72-1 U.S.T.C. , 9364 (E.D.
Ky. 1971), in framing its instructions to the jury, took a somewhat different view of the significance of sales being a necessary incident of the conduct of the taxpayer’s business than the Kirk court did.
Bradshaw was engaged in the business of breeding, training and showing saddle horses.
The court instructed the jury that even if it found that the horses in question were not held primarily for sale to customers in the ordinary course of business that it was to return a verdict for the government if it concluded that the sale of the horses was an integral part of [the taxpayer’s] business.
By ‘integral part of’ it is meant that the sales were necessary for the conduct of his business. Id.
Based on this instuction, the jury nevertheless returned a verdict for the taxpayer.
In Clark v.commissioner, 27 T.C. 1006, 1014 (1957), the Tax Court, attempting to draw the line between cattle held for sale to customers in the ordinary course of business and cattle held for breeding purposes, noted the admonition of the Supreme Court in Corn Products that the scope of capital assets was to be narrowly construed, but apparently had no thoughts of directly applying Corn Products.
The better view is that, given the congressional purpose behind I.R.C. § 1231 (whether or not one agrees with that policy), the Corn Products doctrine should not override I.R.e. § 1231.
See Deltide Fishing & Rental Tools, Inc.
United States, 279 F.
Supp. 661, 665-66 (E.D.
In Guggenheim v.commissioner, 46 T.e. 559, 569-70 (1966), the Commissioner specifically argued that the Corn Products doctrine overrode I.R.C. § 1231 on the sale of syndicate shares in a stallion by the taxpayer, who prior to the syndication owned the entire interest in the stallion and used him for breeding purposes.
The Tax Court quickly rejected the argument, concluding that the taxpayer was merely liquidating part of his interest in I.R.C. § 1231 property.
At 1M In 234 — [VOL. 75 sale to customers in the ordinary course of business. 134 This will be particularly true with respect to colts.
Before a horse com mences a breeding career, he generally must first prove his value on the track. 135 It is unlikely that a breeder would retain all of the colts foaled on his farm for use in breeding operations even aside from the need to first prove them on the track.
Not only does a breeding operation require fewer stallions than it does broodmares, but retention of the colts for future use as stallions would lead to undesirable inbreeding. 136 Furthermore, unless the taxpayer is engaged in racing, his activities probably will not produce a profit other than through the sale of horses bred by him. 13 ? If the sale of horses is the only source of profit, then the gains would arise from property held for sale to customers in the ordinary course of business and therefore would be or dinary income.
The taxpayer could demonstrate, however, as in Jewell, that a particular horse was held for use as breeding stock and thereby have those gains accorded section 1231 treatment. 3. Special Problems in Qualifying for Section 1231 Treatment a.
Section 1231(b)(3) Twenty Four Month Holding Period Requirement For Horses Held For Breeding, Draft, Or Sporting Purposes As noted in the previous section, to be considered section 1231 property, a horse held for draft, breeding or sporting IJ4 See Treas.
Reg. § 1.l231-2(c)(l)(iii) ( A horse which has neither been raced at a public track nor trained for racing shall not, except in rare and unusual circumstances, be considered as held for racing purposes. ); Jewell, 25 T.C.
At 115-18 (1955).
Reg. § 1.1231-2(b)(2), Example (2) (A taxpayer who is in the business of raising horses for sale to others for use as draft horses does not hold the horses for use as draft horses merely because he uses them on his farm as draft horses for the purpose of training them; his use of the horses for draft purposes is incidental to the sale of the horses.).
M See Guggenheim, 46 T.C.
At 561; Fowler, 37 T.C.
IJ6 See Jewell, 25 T.C.
At 118 (that seller knew colts foaled on farm were related to fillies foaled on farm negated argument that colts were held for breeding).
Cj Kirk, 47 T.C. 177 (filly sold by taxpayer because she was product of accidental inbreeding). 037 See Campbell, 20 T.C.M. (CCH) 825 (taxpayer who bred and showed hackney horses realized ordinary income from sales of horses because, although he won substan tial prize money at shows, the only way in which the activity could show a profit was through the sale of horses whose value had been enhanced by good show records).
But see Hancock v.commissioner, 31 T.C. 752, 757-58 (1959) (taxpayer that maintained only a breeding herd and sold only culls was allowed I.R.C. § 1231 treatment on all cattle sold). 1986-87] EQUINE TAXATION 237 purposes (including racing) must be held for more than twenty four months. 138 A horse held for use in the taxpayer’s trade or business other than for draft, breeding or sporting purposes, however, must be held for only six months in order to be section 1231 property. 139 The 24 month holding period requirement largely moots the question of whether horses that the taxpayer claims were culled from potential breeding stock or from the racing stable were in fact held for those uses rather than for sale to customers in the ordinary course of business.
All gains and losses realized on the resale of horses within two years of purchase or on the sale of horses foaled by the taxpayer within two years of birth will be ordinary income or 10ss,140 unless the taxpayer can show that the horse was held for a purpose other than breeding, sporting or sale to customers in the ordinary course of business.
Thus, the number of instances in which the IRS and the courts must grapple with ambiguous facts to make fine distinctions, as illustrated in the cases discussed in the prior section, is signifi cantly reduced.
The extended holding period provided in section 1231(b)(3) was enacted specifically because Congress recognized that the purpose for which young horses and cattle are held frequently may be ambiguous. 141 The one year holding period requirement previously in force was considered to be an insufficient time period for the taxpayer to determine whether cattle were suitable for breeding stock and horses were suitable for racing or breed ing stock or whether the animals were held for sale.
Congress also was concerned that the shorter holding period, combined with the ability of investors to utilize farm accounting methods See I.R.e. § 1231(b)(3); Treas.
Reg. § 1.1231-2.
See Gamble, 68 T.e.
See also Campbell, 20 T.C.M. (CCH) at 855-56; J.
O’BYRNE & e.
DAVENPORT, FARM INCOME TAX MANUAL, § 325 (6th ed. 1982). 140 See Rev.
Rul. 76-70, 1976-1 C.B. 225; Priv.
Rul. 7410240190A (Oct. 24, 1974).
See also Greer v.
U.S., 408 F.2d 631, 636-37 (6th Cir. 1969) (casualty gain recognized on receipt of insurance proceeds paid upon death of five day old colt was ordinary income and did not go into I.R.e. § 1231 hotchpot); McCarthy, 22 T.e.M. (CCH) at 137 (gain on sale of racehorses held less than six months was ordinary income under pre-I969 version of I.R.C. § 1231(b)). 141 See S.
No. 552, 9lst Cong., 1st Sess. 100-01 (1969), reprinted in 1969-3 C.B. 423, 488; H.R.
No. 413 (Part I), 91st Cong., 1st Sess. 70 (1969), reprinted in 1969-3 C.B. 200, 244. Il8 139 238 KENTUCKY LAW JOURNAL
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