Depreciation under §§ 167 and 168 is an important way in which horse businesses recover their costs. Horses are tangible assets and can be depreciated unless they are inventory, meaning if your business is buying and selling horses and not breeding or racing them then they are inventory and thus not depreciable.
Depreciating a tangible asset requires answering two questions:
- When can I take a depreciation deduction?
You generally start depreciating in the taxable year in which you engage in a trade or business, and your asset is “placed in service.” The placed-in-service date is the date the depreciable property is ready and available for a specific use, even if not actually used yet. Purchasing the asset is not enough, and if it was held for personal use and then converted to business use then the property becomes depreciable on the conversion date.
Generally, a racing or a show horse is placed in service the earlier of when their training begins, or when they start racing or are shown. And if previously placed in service, then they may be depreciated when purchased from the prior owner. For broodmares depreciation begins when the mare is first brought to the farm to be bred, and if already in foal then when purchased. A breeding stallion is placed in service when its services are first offered.
- How much can I take as a depreciation deduction?
Answering this question is a function of the following four elements:
The cost basis under §1012, and any adjustments under §1016. For example, a horse’s cost basis is increased by adding the cost of a trip to acquire it. Rul. 72-113, 1972-1 C.B. 99.
The depreciation method, as in the 150% declining balance Modified Accelerated Cost Recovery System (MACRS), for example.
The asset’s useful life, where horses generally fall into the three or seven year class, depending upon its age and use when placed into service. Yearlings, racehorses and breeding horses over 12 are depreciated as three-year property; all others are depreciated as seven-year property.
The depreciation convention, where generally the half-year convention is used unless the 40% rule is triggered under §168(d)(3) which requires the mid-quarter convention. The key is to determine in which quarter of the taxable year the asset is placed “in service.”
Note that selling depreciated property for a gain may result in recapturing some of the previously depreciated amounts as ordinary income.