Inventory or capital asset

I am working with a new client who boards, trains and competes with horses. She is seeking advice on how to best account for these activities for income tax purposes. I believe she is in a position where she could be treated as a business or a hobby. I have a concern about horses she purchases and trains with the expectation of selling for a profit.

If she treats the activity as a business, then it appears she would treat the purchased horses as inventory and recognize income on schedule C subject to SE tax.

On the other hand, if she treats the activity as a hobby, she would recognize a capital gain on the sale and obtain favorable tax treatment.

There are many other factors to consider such as the elimination of misc. itemized deduction but can anyone here on the board confirm my thought that the income from the sale of trained horses would be either SE income or capital gains depending on whether the activity is a business or hobby?

Thank for any comments you might have.

I think your first question for her is whether she has a profit motive or not. If yes, then it is a probably a business, and she should have a business plan in place, etc. If not trying to make a profit, then it would be a hobby. There are a lot of cases out there regarding horse trainers/farms. Here is just one that has a lot of info in it.
http://www.legalbitstream.com/scripts/i ... 552/10/doc
Here is another:
http://www.legalbitstream.com/scripts/i ... l67c/2/doc

I think your first question for her is whether she has a profit motive or not. If yes, then it is a probably a business, and she should have a business plan in place, etc. If not trying to make a profit, then it would be a hobby. There are a lot of cases out there regarding horse trainers/farms. Here is just one that has a lot of info in it.
http://www.legalbitstream.com/scripts/i ... 552/10/doc
Here is another:
http://www.legalbitstream.com/scripts/i ... l67c/2/doc

Thank your for your response but that is not my question as I am well aware of hobby/business issue. I have read many related tax court cases and believe she could consider her activity a business.

I am looking for a second opinion on whether the sale of horses purchased, trained and resold will be taxed as self-employment income if the activity is treated as a business. On the other hand if the activity is hobby, if that same income would be treated as a capital gain.

This seem obvious, but opinions from the members of the board are appreciated.

If the horses are used in the client's boarding and showing business, then they are 1231 assets. Gains on the sales are treated as capital gains, and losses are ordinary losses. If, on the other hand, the horses are purchased primarily for resale in the ordinary course of the client's business, then they are inventory, for which gains on the sales would be included in net earnings from self-employment.

If the horses are used in the client's boarding and showing business, then they are 1231 assets. Gains on the sales are treated as capital gains, and losses are ordinary losses.. Doesn't section 1245 come in there somewhere?

On the other hand if the activity is hobby, if that same income would be treated as a capital gain.. Even if it is a hobby, certain deductions are allowed under 183.

(b) Deductions allowableIn the case of an activity not engaged in for profit to which subsection (a) applies, there shall be allowed—
(1) the deductions which would be allowable under this chapter for the taxable year without regard to whether or not such activity is engaged in for profit, and
(2) a deduction equal to the amount of the deductions which would be allowable under this chapter for the taxable year only if such activity were engaged in for profit, but only to the extent that the gross income derived from such activity for the taxable year exceeds the deductions allowable by reason of paragraph (1).

. So might some depreciation be allowed on the horses, and, if so, might they therefore be section 1231 assets with gains possinly treated under 1245?

Just asking.