Don’t Horse Around! (Beware: Many more puns to follow)
For those of you out there who own racehorses (and let’s be honest – who doesn’t?), a change in the tax treatment of depreciating racehorses after 2016 is galloping your way.
Ordinarily, horses placed in service fall into the seven-year recovery period for depreciation purposes. For those of you unfamiliar with depreciation, this means that you can expense a certain percentage of the horse’s purchase price, or basis, each year over the life of the asset. However, since 2008, racehorses have been eligible for a three-year recovery period, which allows the owner to expense the cost of the horse much faster. Unfortunately, this provision was never made permanent, and despite much horse-trading in Congress, was not renewed and will be put out to pasture at the end of 2016.
Why is a three-year recovery period such a big deal? Think of how a race horse is used. Typically, a race horse is most profitable when he’s around three years old. Depending on how successful he is, he may be gelded at three or four and continue to race, or be used primarily for breeding; either way, his most profitable days are behind him. This allows for the owner to deduct more depreciation expense to offset the horse’s winnings at the time when it’s most likely to be actually earning them, not three or four years later.
For example, let’s assume we purchase a weanling (6 months to 1 year old) at auction. According to the Jockey Club, a weanling racehorse sells for an average of $44,407. Looking at the chart below, under the three-year recovery period, the horse has had all $44,407 of his cost expensed by the time he’s four years old. By comparison, under the seven-year recovery period, at the same age he still has $13,872.75 left to expense.
So, time to go buy a racehorse and take advantage of this three-year recovery period, right? Hold your horses – there is a catch. If the horse is “placed in service” (delivered to a trainer) prior to January 1, 2017, then it will qualify, regardless of how old it is. However, if the horse enters service after that date, it must be more than two years old at the time that it’s placed in service to qualify, or it will fall under the seven-year recovery period. If you can purchase a racehorse and deliver him to a trainer in the next two weeks, you’re set – otherwise, you have to decide whether to run the horse now as a yearling, putting the horse into the seven-year recovery period, or holding off until the horse is over two years old (defined by the IRS as 24 months and a day after foaling).
Until Congress gets around to revisiting these rules, racehorse owners need to decide early on in a horse’s life how they intend to run it. It may not be of much concern for the wealthier owners, but for those starting out, missing out on the accelerated deprecation could make or break their operation.