Appreciating Depreciation

By Robert R. Hill -- On March 9, President Bush signed the Job Creation and Worker Assistance Act of 2002, which was a real income tax benefit for U.S. businesses. Fortunately, this tax act is also a significant boon to the horse industry, benefiting both racing and breeding operations.

Basically, the law change offers an additional 30% first-year depreciation deduction for purchases of certain horses and other property used in the horse business. There are three qualifying requirements for the bonus depreciation:

--The property must be purchased after Sept. 10, 2001, and before
Sept. 11, 2004.

--The original use must begin with the purchaser.

--The property must be used domestically more than 50% of the time.

Determining whether or not you meet the first and third tests is relatively easy. Just be sure that your purchase was not subject to a binding contract on or before Sept. 10, 2001.

However, meeting the second requirement can sometimes force us into the gray area of the law. Why? Because the term "original use" may be interpreted broadly or restrictively by the Internal Revenue Service. Quite clearly, anyone purchasing a yearling or a non-raced 2-year-old and placing either in training is obviously an "original use" and the purchaser could receive a 30% bonus depreciation deduction.

But what happens when a horseman claims a filly off the track and retires her to a broodmare band? Is this "original use" commencing with the purchaser? Under a broad interpretation the answer would be affirmative. Unfortunately, the Internal Revenue Service may take the more restrictive approach that "original use" was for racing and, accordingly, the breeder would not get the bonus depreciation.

Until the Treasury issues "regulations," which are its interpretation of the statute, the horseman who buys a racehorse for breeding must make a decision whether or not to chance the bonus depreciation deduction. Why shouldn't he?

After all, the "original use" as a breeding animal started with him. Second, most items of tangible property have a single use. On the other hand, most Thoroughbreds have two uses, racing and breeding. Apparently, this is a situation that the statute does not take into consideration. In addition, what does the taxpaying horseman have to lose? If the deduction is successfully disallowed upon an IRS examination, it becomes only a timing difference. The taxpayer remits the tax he would have owed anyway plus the applicable interest charge. During the ensuing years the taxpayer will receive the depreciation deduction that he attempted to take in the year of purchase, resulting in a delayed tax benefit. So why not take the aggressive position!

To emphasize the beneficial effect of this law change let's look at an example. You purchase a yearling for $100,000 and immediately place it into training:

With Bonus Depr.:
First year expensing: $24,000
30% bonus: $22,800
Regular depreciation: $5,692 $8,132
Total depreciation: $52,492 $32,132

Without Bonus Depr.:
First year expensing: $24,000
30% bonus: 0
Regular depreciation: $8,132
Total depreciation: $32,132

This example demonstrates that Uncle Sam is giving you a significant tax benefit, if you elect to take advantage of it.

Of course, other types of property qualify for the bonus depreciation if its "original use" begins with the taxpayer. A non-

inclusive list of equine type assets would include the following: farm vehicles, farm equipment, fences, paddocks, land improvements (such as roads, ponds, and landscaping), and computers and office equipment.

Keep in mind that this "bonus depreciation" deduction applies to qualifying assets purchased after Sept. 10, 2001. What happens if your 2001 income tax return has already been filed without taking advantage of the bonus depreciation deduction? All you have to do is file an amended return before the due date of next year's return (including extensions).

Note that the bonus depreciation and first-year expensing are items that accelerate deductions, which decrease profits or increase losses. Accordingly, the taxpayer needs to temper any enthusiasm for these tax benefits with consideration for hobby or passive loss situations.

In summary, this tax law change is a significant income tax benefit to the horse operator. Be sure to take advantage of it, if and when it fits your tax game plan.

Robert L. Hill is a certified public accountant with Crowe, Chizek and Co. in Louisville, Ky.