You Be The Tax Judge: They Loved Horses. They Lost Money. Was It Still A Business?

There’s an old joke in the horse world: How do you make a small fortune with horses? Start with a large one.

Frank Chapin and Sydney Gutierrez-Chapin might appreciate the joke. The Idaho couple spent decades raising cattle and breeding horses. At the peak of their operation, they managed more than 300 acres, 160 cattle, and 43 horses, including Quarter Horses and Appaloosas.

They also lost money.

Eventually, the IRS reviewed their returns and asked a question that comes up surprisingly often in tax law: Were the Chapins really running a business, or were they pursuing an expensive hobby?

From Ranching To Bankruptcy

According to the facts of the case, Frank grew up on an 80-acre ranch near Sandpoint, Idaho, where he worked with livestock as a child and later on neighboring ranches. He eventually earned a two-year accounting degree and opened his own accounting practice.

Sydney also grew up on a corn and soybean farm in Illinois with cattle, sheep, pigs, and chickens. She later bought a 120-acre ranch in Idaho and took veterinary medicine courses through the University of Idaho Extension Service.

The couple began breeding cattle and horses together in 1986. Over time, their operation grew. By 1995, they had assembled more than 300 acres. At their peak, they had about 160 cattle, producing roughly 60 calves each year, along with 43 horses. The Chapins bred Quarter Horses and Appaloosas for activities including team roping, barrel racing, team penning, and cutting. They belonged to national breed organizations and registered their foals.

They worked the farm. Sydney fed livestock before going to work at the accounting office. The couple made hay, repaired fences and buildings, inoculated and tagged calves, trained horses, and provided routine veterinary care. During foaling season, they monitored pregnant mares around the clock, sometimes checking them four or five times at night. Over the years, they oversaw the births of more than 100 foals.

They also tried to make the cattle operation more profitable. Sydney researched ways to increase calf weight, adjusted calving timing to better serve markets in California and Oregon, and adopted preconditioning practices to command better prices.

The Chapins eventually ran into serious financial trouble. In 2002, they filed for Chapter 11 bankruptcy protection, typically used when a financially troubled business or individual hopes to reorganize debts rather than simply liquidate. But in 2003, in response to a motion by creditors, the bankruptcy court converted the case to Chapter 7, which generally involves liquidation.

In 2004, the bankruptcy trustee liquidated most of the real estate used for ranching. Around the same time, the 200-acre ranch was sold in foreclosure outside of bankruptcy. The Chapins sold all of their cattle and farm equipment, though they managed to repurchase 30 acres from the bankruptcy estate with a private loan.

In other words, this wasn’t simply a ranch that had a few bad years.

They Kept The Horses

After the bankruptcy, the Chapins continued breeding horses. During the tax years that ultimately led them to Tax Court, they kept between nine and 16 horses. They remained members of the American Quarter Horse Association and the Appaloosa Horse Club, continued registering foals, and offered one of their stallions for stud.

They also continued to do much of the work themselves and to lose money. For six consecutive years, from 2009 through 2014, the Chapins reported losses from the activity on Schedule F.

Those losses mattered for tax purposes because the rules differ when an activity isn’t engaged in for profit.

When Is A Business Not A Business?

Section 183 of the Tax Code limits deductions for activities not engaged in for profit. It’s often called the “hobby loss” rule.

The rule doesn’t require a business to turn a profit every year. Many legitimate businesses incur losses. Instead, the question is whether the taxpayer genuinely engaged in the activity with the objective of making a profit.

To determine that, courts don’t simply take a taxpayer’s word for it. They look at the facts and circumstances, including how the activity was conducted, the taxpayer’s expertise, the time and effort devoted to it, the history of income and losses, the taxpayer’s financial circumstances, and whether the activity involved elements of personal pleasure or recreation.

The IRS Says It’s A Hobby

The Chapins had income from other sources. Frank ran an accounting and tax preparation practice, preparing at least 200 tax returns a year and providing bookkeeping and payroll services. Despite Frank’s accounting background, the ranch’s recordkeeping wasn’t perfect. Perhaps the most difficult fact for the Chapins was also the most human: They loved ranching.

Horse breeding had become central to their lives. Even after the bankruptcy, the loss of most of their land, the sale of their cattle and equipment, and years of financial losses, they never seriously considered giving it up.

From the IRS’s perspective, those facts told a story. The Chapins may have worked hard. They may have known horses. But continuing an activity you love despite years of losses doesn’t necessarily make it a business.

The Chapins Say It’s A Business

The Chapins saw those facts very differently. They hadn’t bought a couple of horses as a weekend diversion. They had decades of experience raising livestock. They belonged to breed organizations, registered their horses, offered a stallion for stud, and did physically demanding work themselves. Both had even been injured while working with the horses.

They argued their history also showed they approached ranching as a business, including making changes to the cattle operation to improve profitability. The losses were real. But in their view, losing money doesn’t necessarily turn a business into a hobby.

That left the Tax Court with a deceptively simple question: Did the Chapins genuinely intend to make money from breeding horses—even though they hadn’t?

You Be The Tax Judge

The IRS says the Chapins’ horse-breeding activity wasn’t engaged in for profit. The Chapins say they were running a business. So, who’s right?