Tax Court finds lack of profit motive in auto racing business

An automobile racing enthusiast lacked an actual profit motive in running his business, the Tax Court has recently held. The taxpayer genuinely enjoyed racing but his pattern of losses as well as “books and records” reflected the lack of a profit or “business purpose.”

Background. In 2011, the taxpayer organized an automobile racing business using funds from his retirement plan. The taxpayer participated in 18 to 22 races each year. At the time he organized the business, the taxpayer was unemployed and generally spent more than 40 hours every week on racing. In time, he obtained employment and spent some 20 hours every week on the activity. The IRS ultimately determined that the racing activity was not engaged in for profit.

Comment. The business in this case was the taxpayer’s second attempt at racing. Some years earlier, the taxpayer had established a racing business but closed it after several years of losing money.

Court’s analysis. The court first found that taxpayers may not deduct expenses incurred in connection with activities not engaged in for profit, such as activities primarily carried on as sport, as a hobby, or for recreation, to offset taxable income from other sources. An activity is engaged in for profit if the taxpayer has an actual, honest profit objective, even if it is unreasonable or unrealistic. Determining profit motive is based on all the facts and circumstances, the court added.

The court also found that a business-like operation would have a business plan. Here, the taxpayer did not have a written business plan for the racing business, only a mental one, the court found. “Failure to keep adequate books and records and the lack of a written business plan indicate that petitioners did not conduct the business in a business-like manner nor in a manner similar to those of other profitable racing activities,” the court held.

The court acknowledged that the taxpayer had more than 20 years of engagement in racing. This experience, the court noted, is a way to gain expertise in an activity. The court also acknowledged that the taxpayer devoted substantial time to racing, especially during the period when he was unemployed. However, the court found that the taxpayer had never won a race during the tax years in dispute. The profits the taxpayer earned were from the sale of used parts and cars, an annual sponsorship payment, and minimal race prize money. The court concluded that the taxpayer did not have an actual and genuine profit objective in operating his business.

Comment. Code Section 183(d) provides that an activity is presumed to be engaged in for profit if the activity produces income in excess of deductions for any three of the five consecutive years which end with the tax year. The taxpayer appeared to assert that the business had shown profits for 2013-2015 but the court found that the business had losses for 2014 and 2015.

Stettner, TC Memo. 2017-113