Many people engaged in horse activities consider themselves to be in the horse business. At tax time they report income from their horse activity and deduct expenses as business expenses. If their horse business has a net loss they can deduct that loss from other income such as wages or other business income.

There is nothing wrong with deducting losses from the horse business. However, when a taxpayer incurs losses from horse activities for several years, and those losses are deducted from other unrelated income, the Internal Revenue Service begins to question whether the horse activities are actually a hobby of the taxpayer, not a business. If the horse activities are a hobby, then income must be report and expenses can be deducted but only to the extent of the hobby income.

If the IRS declares the taxpayers horse activity to be a hobby, it can re-compute the tax liability for current and past years. This can be financially devastating after interest and penalties are added to the tax bill.

The major question is whether your horse business was engaged in for the purpose of turning a profit. If you began the venture intending to turn a profit then your losses are indeed business loses, not hobby loses. However, year after year of loses can cause the IRS to become curious and ask why you persisted in engaging in a losing business activity for several years?

If your horse activities show a profit for at least two of seven consecutive years, then the law presumes that you intended to make a profit. However, that presumption can be overcome by evidence that shows lack of a profit motive. All the presumption does is to place the burden upon the IRS to show the activity was merely a hobby.

Tax regulations set out nine factors to be taken into account. No one of those factors is decisive. You are not required to pass muster on a majority of the factors. Different weights are assigned to different factors in different situations. The nine factors are not exclusive--the government can also look at other factors that are not on the list of nine.

1. Operation of activity in business-like manner. Does the taxpayer keep complete and accurate books and records? Are the business accounts kept separate from personal accounts? Has the taxpayer abandoned unprofitable business pursuits?
2. Expertise. Does the taxpayer have the knowledge and skills required to engage in the business activity? Were experts hired or engaged for advice? 
3. Time and Effort. Does the taxpayer devote substantial time and effort to the activity? Devoting only a limited time does not mean the taxpayer did not intend to turn a profit if he or she employs other competent and qualified people to carry on the activity.
4. Expectation that assets may appreciate. The expectation of appreciation of assets, such as a breeding stallion or a horse facility, is considered in determining whether the taxpayer intended a profit. The expectation must be that the operating income and capital gains from selling the asset would more than cover the expenses involved in the activity.
5. Past successes in similar or dissimilar activities. The taxpayer's past success in similar or dissimilar activities can be indicative of a profit objective. The fact that he has not engaged in past successful business activities counts against the taxpayer, but can be outweighed by other factors.
6. History of income and losses. A taxpayer's history of income, losses, and occasional profits with respect to an activity may indicate the presence or absence of a profit objective. Losses are the norm during the startup phase of a business and may not weigh heavily against the taxpayer.
7. Amounts of occasional profits. The amounts of profits earned in the activity, when compared to the amount of losses incurred, the amount of the investment, and the value of the assets in use, may indicate a profit objective. The opportunity to earn substantial profits in a highly speculative venture is ordinarily sufficient to indicate that the activity is engaged in for profit even though only losses occur.
8. Taxpayer's financial status. The fact that the taxpayer does not have substantial income unrelated to the horse activity may indicate that the activity is engaged in for a profit. The cases in which the IRS challenges deductions under the hobby loss rule are often cases in which the taxpayer has a very substantial income from sources unrelated to the horse activity.
9. Personal pleasure or recreation. The presence of personal pleasure or recreation may indicate the lack of a profit motive. Horses do bring pleasure as well as requiring a great deal of work. However, the mere fact that the taxpayer enjoys the activity does not mean it was not engaged in to make a profit. The IRS cannot rule against you for loving your work.