Inbreeding : Not only does a breeding operation require fewer stallions than….

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22 T.C.M. (CCH) at 135-37.compare Kirk, 47 T.C.

At 191 (“The fact that petitioner [who was found to be engaged in the business of breeding, training and racing horses] knew in advance that a good number of the horses would never develop into good racehorses and that he would have to sell them does not mean that the horses sold were necessarily held primarily for sale.”) with Jewell, 25 T .C.

At 115-18 (taxpayer who kept only lout of 23 colts foaled during 5 year span, selling 19 as yearlings, was in the business of selling horses to customers in the ordinary course of business, but sales of certain colts and fillies bred for use as breeding stock but never used as such because of unsuitability were treated as sales of property held for use in the taxpayer’s business). ’12 DJ 236 KENTUCKY LAW JOURNAL [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).

Cj Treas.

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.

At 1127-29.

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.

At 820.

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.

Ltr.

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.

REP.

No. 552, 9lst Cong., 1st Sess. 100-01 (1969), reprinted in 1969-3 C.B. 423, 488; H.R.

REP.

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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