Ownership Insights presented by OwnerView is a weekly series examining different aspects of Thoroughbred ownership. A more detailed presentation on these subjects will be made during the Thoroughbred Owner Conference at Keeneland Race Course in Lexington, Ky., Oct. 13-16. Click here for more information.
Over the last two months we've to talked to experts in the Thoroughbred industry that can help a potential new owner understand many facets of how to get in the game. This week, we delve into two important areas that individuals need to consider when making an investment in bloodstock: insurance and accounting/taxes. We'll look at them in that order.
Syl Kiger began his career in equine insurance in 1962 and over the next half century has insured many of racing's most famous horses, including Seattle Slew and Affirmed during their Triple Crown campaigns and at stud. His family-owned Kiger Insurance (with Kige Kiger and Cathy Lowe) was formed in 1984. The company insures horses worldwide and places insurance with Lloyd's of London as well as highly rated domestic carriers.
What factors help a horse owner determine whether or not to get insurance for a horse purchased to race?
Owning and watching a horse develop into a dynamic athlete is like adopting a child. You are the caretaker and every step it takes, every bite it eats, every illness it has and every injury it sustains, every medication it takes is in your hands including LIFE ITSELF. The reward is a symbiotic relationship with a living creature.
The decision to insure is a business matter to be based on the owner's financial ability to lose the amount that was invested and to be able to continue investing to develop a racing stable. If the loss of one horse will make you squirm financially, then you should purchase mortality insurance. If you have a larger stable and can stand losing one horse but multiple losses in one year would make you uncomfortable financially, then Mortality Polices with Deductible Provisions are available. If you can be comfortable with multiple losses or losing the big horse that is paying the bills, you might opt to self-insure. There is a very high risk that you will eventually have a loss if you maintain a racing stable for a few years.
What types of insurance are there?
The basic types of insurance available for race horse owners are:
Mortality Insurance covers the risk of death or destruction to relieve inhumane suffering. The policy will also include protection for theft as well as a reimbursement for up to $5,000 for an emergency colic surgery (on eligible horses).
Automatic Claiming Insurance provides Mortality Insurance if a claim is valid.
Limited or Restricted Perils Insurance (a very limited form of Mortality Insurance), covers only the risk of death from stated causes such as fire, lightning, flood, tornados, certain transit mishaps, or attack by wild dogs.
For racing colts at the highest performance level who have already demonstrated their potential for stud duty, there may be additional coverage available to protect that potential income.
Is there such a thing as loss of use insurance or insurance to cover major medical or surgical expenses?
Unlike insurance available for Show and Sport horses, loss of use insurance is not available on racers.
Mortality policies on Thoroughbreds in training do normally include the $5,000 Emergency Colic Surgery Benefit.
What is the basic cost of mortality insurance?
The typical rates for mortality insurance range from 3 percent to 7.5 percent plus, depending on age. Yearling rates include coverage for training/racing activity during the 2-year-old year.
Are there risk factors that raise or lower the premiums?
The risk factors that influence rating are: age, sex, use, location, value, number of horses insured by the owner and the loss record of the owner.
What determines the market value of a racehorse?
The market value of a racehorse may be determined by a recent purchase price. Other considerations are the horse's pedigree, race record and earnings, sire's stud fee, an appraisal, and entry in claiming races for a claiming price.
If an insured horse suffers a serious injury, what role if any does the insurance company play in determining whether the horse can be saved?
Owners should review their policies with their agents to be certain they understand their reporting duties. Boarding farms and trainers with custody of your insured horses should be aware that your horse is insured and who to contact in the event of an emergency. If an insured horse suffers a life-threatening injury, the insurer is entitled to immediate notice and may retain its own vet for a second opinion regarding a euthanasia decision. Both owners and insurers rely on the advice of seasoned veterinary professionals in dealing with these difficult decisions.
Are there other types of insurance (liability, etc.) a horse owner should consider?
Owners of racing stock should consult with their agent regarding their need for Liability insurance (providing protection if someone other than the owner or employee is injured by the owner's horse), and Workers Compensation (providing protection if an employee is injured while working with an owner's horse). Ownership of a farm/ranch or boarding horses for other owners triggers the need for additional coverage.
Taxes and Accounting
Lillian Cushny grew up in a horse family on Long Island, N.Y., breezing Thoroughbreds at Belmont Park at the age of 14. She earned a BA and MBA from Adelphi University, which she attended while working at Aqueduct as an exercise rider for trainer W.C. Freeman. Cushny acquired her CPA license and in 1982 moved to Lexington, Ky., where she now provides accounting services to horsemen throughout the U.S.
What are potential tax benefits to owning a racehorse?
The tax benefit is being able to recover the cost of your purchases via depreciation and being able to deduct your operating expenses against any other income that you may have. This reduction in taxable income results in a reduction of taxes owed. The less income you have the less taxes you pay and horse owners generally show a loss. They are taking this loss off their tax returns against their other income and therefore paying less taxes.
Let's look at a specific example. If someone who has $600,000 in annual taxable income buys three yearlings for $150,000 each, how much can be deducted from that taxable income and over what period of time? Does that horse have to be retained and in active training to qualify for each tax year depreciation is used?
(Editor's Note: Bonus depreciation, which has been available in previous years, is currently tied up in Congress in the Expiring Provisions Improvement Reform and Efficiency (EXPIRE ) Act of 2014. The Section 179 deduction for 2014 currently stands at $25,000 but the EXPIRE Act could restore it to an annual limit of $500,000. The EXPIRE Act has passed the Senate Finance Committee and is expected to pass the full Congress and be signed by President Obama during 2014. The following answer demonstrates the deduction under both scenarios.)
You start with $600,000 in income and first deduct all of the operating expenses before seeing how much is left to deduct depreciation. In this case the operating expenses are vetting costs at the sales, paying an agent who bought the horses, vanning, insurance and board expense for 3 1/2 months, including breaking and training for some or most of that time. I will estimate those expenses at $48,500. That leaves $551,500 to work with. So if the EXPIRE Act of 2014 passes, this owner can deduct the entire $450,000 purchase price and his remaining taxable income will be $101,500.
If the Section 179 deduction is limited to $25,000 in 2014 then the owner deducts the $25,000 and depreciates the remaining $425,000 over three years. In year one the deduction is 33.33 percent of $425,000, or $141,652, plus the $25,000 Section 179. In year two the deduction is 44.45 percent of $425,000, or $188,912. In year three the deduction is 14.81% of $425,000, or $62,943. There is a final deduction of 7.41% in year four which is $31,493. Yes the three-year depreciation actually lasts for four years.
The horse does have to be retained to continue depreciation in years two, three and four, but it does not have to be in active training. If you keep it for breeding or retraining you continue the depreciation deduction. If you sell the horse or give it away you have a gain or loss to take on your taxes for the difference between sale price and depreciated value (cost minus depreciation to date).
Are there advantages to an individual in setting up a stable under an LLC or S-Corporation?
Yes a horse owner should organize as an LLC or S Corporation to protect their personal assets. There is no tax advantage, the taxes are identical amongst sole proprietor, LLC or S Corporation. A C Corporation is to be avoided because it results in taxation at the corporate level and again at the personal level. The advantage of an LLC or Corporate shield is a legal protection of your personal assets. If someone gets a legal judgment against a Corporation or an LLC they can only attach assets of that Corporation or LLC against which they have a judgment. They cannot attach personal assets of the LLC owner. Therefore the LLC or Corporate owner gets to keep his residence, vehicles, investments etc.
Are there guidelines the IRS uses in determining whether a horse owner is materially active or passive in his horse racing activities?
The guideline for active participation is 20 hours per week. It is easy to demonstrate that time has been spent studying pedigrees, attending the sales, attending the races, communicating with your trainer and agent, reading the Racing Form (or other trade publications), and watching racing channels on TV. Also important is time spent managing the finances, making budgets, paying bills and planning for future sales or purchases.
Over the long term, can a racing stable lose some of its tax benefits if it loses money every year?
The stable will not lose its ability to claim losses as long as it is being conducted as a business, has a business plan with a profit motive and a continued demonstration that the stable is operating in an effort to minimize losses. The stable might never make a profit but it is proactive in trying to lose as little as possible. This would generally mean selling or giving away non-productive horses.
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