The Horse Breeders Who Beat the IRS
Six straight years of losses. No profit in any of them. The IRS called it a hobby and took the deductions away.
The couple fought it, and on August 27 the Tax Court gave them the win.
The case is Chapin v. Commissioner, T.C. Memo. 2026-76, decided by Judge Vasquez. It is worth a closer look than a newsletter can hold, because the reasoning tells you exactly what a money-losing venture has to look like to stay deductible.
What the IRS was actually swinging
Section 183 is the hobby loss rule. The statute is short and it is harsh.
Under section 183(a), if an activity isn't engaged in for profit, no deduction attributable to it is allowed at all, except as the section itself permits. Section 183(b) then gives back two narrow things. Paragraph (1) allows deductions you'd get anyway without any profit motive, like property taxes. Paragraph (2) allows your other expenses, but only up to the gross income the activity produced, and only after the paragraph (1) items are absorbed.
So on paper a hobby is supposed to be a wash. Except it isn't a wash anymore. Those paragraph (2) deductions are miscellaneous itemized deductions, and section 67(h) says no miscellaneous itemized deduction is allowed for any tax year beginning after December 31, 2017. That suspension used to have an expiration date. The One Big Beautiful Bill Act struck it in July 2025, so it is now permanent.
You report the gross income. You deduct essentially none of the expenses. Everything is taxable and nothing is deductible.
For example, let's say that your side venture brings in $40,000 and costs $70,000 to run.
Treated as a business, that $30,000 loss offsets your other income. At a combined 35% rate, you keep about $10,500 you'd otherwise send in.
Treated as a hobby, the $30,000 loss disappears and the $40,000 of gross income still gets taxed. That's roughly $14,000 out the door on an activity that lost money. The swing between those two outcomes is about $24,500 on a venture with $40,000 of revenue.
That is what the Chapins were fighting over, multiplied across six years.
The horse rule that didn't save them
Section 183(d) gives you a presumption. If the activity's gross income exceeds its deductions in 3 or more years out of 5 consecutive years, the activity is presumed to be for profit and the burden shifts to the IRS.
Horses get a friendlier version. For activities that consist in major part of breeding, training, showing, or racing horses, the statute swaps the numbers to 2 years out of 7.
The Chapins couldn't use it. They didn't have two profitable years out of seven. They didn't have one.
This is the part people miss. Failing the presumption doesn't decide the case. It just means you don't get the shortcut and you have to prove profit motive the long way. The Chapins did exactly that and won.
The nine factors
When there's no presumption, courts run the nine factors in Treasury Regulation section 1.183-2(b):
The manner in which the taxpayer carries on the activity
The expertise of the taxpayer or his advisors
The time and effort expended
Expectation that assets used in the activity may appreciate
The taxpayer's success in carrying on other activities
The taxpayer's history of income or losses
The amount of occasional profits, if any
The financial status of the taxpayer
Elements of personal pleasure or recreation
No single factor controls, and you don't need to win a majority. The regulation also tells you where the weight sits. Greater weight is given to objective facts than to the taxpayer's mere statement of his intent.
In other words, what you did counts for more than what you say you meant.
What the Chapins did
Both grew up around livestock. He was raised on an 80-acre ranch near Sandpoint, Idaho. She grew up on a corn and soybean farm in Illinois, and later took veterinary medicine classes through the University of Idaho Extension Service and used them.
They belonged to the Appaloosa Horse Club and the American Quarter Horse Association. Those memberships required them to register their foals and file annual breeding reports. That detail carries more weight than it looks like, because an outside organization was forcing a paper trail whether the Chapins felt like keeping one or not.
They did the labor themselves. In foaling season they monitored the mares around the clock, four to five times a night.
And they adapted. After a bankruptcy they dropped cattle and went to horses only, changing the Schedule F description from "Commercial Cattle/Registered Horses" to "Registered Horses" starting in 2005. Abandoning a method that isn't working is a factor-one fact.
The court's conclusion on how they operated: "Petitioners' approach may have been informal, but we are satisfied that they approached horse breeding in a businesslike manner."
And the holding that makes the case quotable: "Section 183 does not require that taxpayers operate their ventures with perfect business acumen."
What they lost anyway
Here's the honest half. The Chapins won the profit motive fight and still walked out with deficiencies running from $190,583 to $333,212 per year.
None of that came from the horses. It came from records.
The mileage. Mr. Chapin recorded odometer readings on every vehicle. He kept no logs showing the individual business trips. Section 274(d) doesn't accept totals. It requires the amount, the time and place, the business purpose, and where relevant the business relationship, proved by adequate records or by sufficient evidence corroborating your own statement. Vehicles are listed property under section 280F(d)(4), so they fall squarely inside that rule. The Cohan rule, which lets a court estimate, does not rescue a section 274(d) item. The court found they "fell woefully short of the stringent requirements of section 274(d)," and noted his accounting background while saying it.
The carryforwards. They tried to prove net operating loss carryforwards with their old tax returns. The court shut that down cold. "Tax returns are merely statements of a taxpayer's position and cannot be used to substantiate a claimed deduction, including the amount of the NOL to be carried forward." A return is a claim. Evidence is what sits underneath it.
The meals. Of $2,205 claimed, $312 survived.
So the split is clean. Behavior wins profit motive. Paper wins deductions. They had the first and not the second, so they kept the activity and lost the line items.
How this lands by entity
Section 183(a) applies to an activity engaged in by an individual or an S corporation.
For S corps, Treasury Regulation section 1.183-1(f) puts the test at the entity level. Section 183 "shall be applied at the corporate level in determining the allowable deductions of an electing small business corporation." Your shareholders don't each get their own profit motive analysis. The company either has one or it doesn't.
The regulation doesn't address partnerships, and courts have generally tested profit motive at the partnership level as well. Worth knowing if a side venture is sitting inside an operating partnership.
C corporations aren't covered by section 183 the same way. But don't let the tail wag the dog. Pick the entity for the business, not for one code section.
What to actually do
Run it like a business. Your own time in it. A separate bank account, so the activity has its own visible economics. Books that someone else could read. If it looks like a business, it'll deduct like a business. If it looks like recreation, it'll get taxed like recreation.
Write down the trips, not just the miles. Date, destination, purpose. Five seconds per trip in an app beats reconstructing a year at exam time, and it's the single most common reason otherwise real deductions die.
Keep what proves the carryforward, not just the return that claims it. Hold the underlying records as long as the carryover is still in play, which is usually far longer than people assume.
Attach the receipt to the transaction. In QuickBooks Online you can hang the document right on the entry. Do that, or keep a parallel folder, or both. What matters is that the receipt and the transaction can find each other later.
Document that you changed course. If something isn't working and you fix it, that's factor one evidence, and it helped the Chapins.
Don't panic over informal. The court called their recordkeeping less than it should have been and ruled for them anyway. Real effort to make money counts for more than pretty books. But the books are what protect the individual deductions, so the answer is both.
Perfect isn't required. Serious is.
