Finding the Gain: From hobby to business, how smarter tax rules could power breeding’s future

Cover image courtesy of The Image Is Everything

Our recent series, Breeding Drain or Racing Gain, laid bare the challenges facing Australian breeders, from shrinking foal crops to rising costs and international leakage. With Finding the Gain, we now turn to solutions.

History shows that the right tax settings can change the course of Thoroughbred racing. This series now turns to investigate how the right policy settings, smarter tax treatment, and renewed lobbying could shift the balance back in breeders’ favour.

In this first of two taxation articles, we revisit how Hawke-era reform fuelled Australia’s rise - and how America’s latest depreciation law is boosting sales today. In Part 2, tomorrow, we’ll turn to the specific question: what changes could support industry investment?

Inspiration from the past

History shows that the taxation system can change the course of Australian breeding. In the mid-1980s, a single reform turned the tables on New Zealand’s dominance and laid the foundations for the industry we know today. The lesson is clear: the right tax settings can change the game.

The current Australian policy can be traced back to a decisive shift in the mid-1980s. At the time, New Zealand’s bloodstock tax rules gave its breeders and investors a clear advantage, fuelling their dominance in the sales ring and on the racetrack.

By contrast, Australia’s write-down provisions were “inferior to those in New Zealand,” recalled Arrowfield Stud’s John Messara.

“That was the reason New Zealand had been collecting a lot of good mares in comparison with Australia. Their sales were buoyant and everybody went over there and one thing led to another.

“Colin Hayes was the first man to identify that and said, ‘Well it's not sensible that the two countries so close to each other, with often similar investors and breeders, should have differing tax arrangements, so we should be bringing it into line with New Zealand’.”

What followed was one of the most consequential lobbying efforts in the history of Australian racing.

“It was lucky for us at the time that we had Prime Minister Bob Hawke who was a keen race goer, and other members of the cabinet like Michael Duffy, the Attorney General who became Chairman of Racing Victoria at one stage. The Minister For Sport, Recreation And Tourism, John Brown, they called him the ‘Minister for Good Times’, was a key person too. You had a number of ministers that understood and liked racing.”

Hayes began lobbying Hawke directly. Messara, just a few years into his career, was soon asked to join the push.

“Colin Hayes began to lobby Bob Hawke, he knew him well, and then I was brought in because I was the financial guy at the time. They said, ‘Can you help us with this?’ and I ended up writing the submission to Treasury for putting Australia on a level playing field with New Zealand as far as depreciation of bloodstock and getting the same provisions for write downs.”

The submission succeeded. “We were given exactly the same rights as New Zealand was allowed and that meant that we didn't have to fight (for quality bloodstock) with a hand tied behind our backs. We could now interest investors into coming and buying bloodstock in Australia and getting the same depreciation provisions as in New Zealand, and that was at the root of the modern Australian breeding and racing industry.”

The outcome dramatically reshaped the competitive landscape.

“Of course it was probably not helpful to New Zealand because all of a sudden, they didn't have that advantage that they used to have, but it was very helpful for Australia. And personally, it allowed me to build the first Arrowfield at Jerry’s Plains which is now Coolmore, and I bought Danehill, so the changes certainly gave me the incentive to go out and invest like that.”

As Messara summed it up, “Luckily for us we had enthusiasts like Bob Hawke in government and support when it came to cabinet, so it got through. It was a really important change. I think for the industry a lot of people weren't aware of what was going on in the background.”

Fast-forward to America

A similar principle is now playing out in America. The government recently passed the One Big Beautiful Bill (OBBB), a 1116-page package spanning multiple industries.

For racing, the change is significant: owners can now write off 100% of a horse’s purchase price the moment it enters training or begins racing. This measure first appeared under the 2017 Tax Cuts and Jobs Act, which temporarily lifted bonus depreciation to 100% before phasing it down.

Before the OBBB, it had dropped to 40%. Now, a business buying a yearling for US$1 million can write off the entire amount - rather than the US$400,000 they could claim before the bill passed.

Jen Shah, Tax Director at Dean Dorton based in Lexington Kentucky, explains “the OB3 rules had a huge impact on the Fasig-Tipton Saratoga Sale, pushing them over $100 million for the first time.”

But the Australian and U.S. tax systems couldn’t be further apart - from the “hobby versus business” test to the very way horses are classified for tax purposes.

“Our system is mainly based on the premise that horse breeding businesses are primary production pursuits, and so horses are treated as livestock or trading stock for tax purposes,” said industry accountant Adam Tims from Stable Financial.

“Horse breeders in Australia are treated as farmers with the same taxation advantages as every other type of agricultural producer.”

America plays by a completely different rulebook.

“Horses are treated as plant and can be written off as soon as they go into service, be it training or racing or when they are available to be bred,” said Shah.

“If you buy a weanling, for example, they won’t yet qualify for depreciation until they can be placed into service, meaning when they are old enough to begin training.”

And that’s why the yearling market surged: under OB3, buyers could claim 100% depreciation almost immediately, once their new purchase went into training.

Hobby vs business test

No matter how you look at depreciation, the new Trump-era OBBB only applies if you are operating as a business.

“It’s important to understand that the accelerated depreciation measure in America is only available to business, not private pursuits or hobbies,” said Tims.

And here lies perhaps the biggest difference between Australia and the U.S.

In the U.S., proving you are a business means showing you operate with the intent to make a profit. Shah explained the IRS uses nine different tests to determine whether an activity is a business or a hobby. The rule of thumb: if you make a profit in at least two out of seven years, you are presumed to be a business.

That philosophy is fundamentally different from Australia’s.

In America, most Thoroughbred owners file their horse operations as businesses. Unless audited, their tax return is accepted as filed. If they are audited, the burden is on the IRS to prove the operation is a hobby, unless the two-in-seven rule applies, in which case the presumption is already on the owner’s side.

Australia flips that logic. Here, the ATO assumes you are a hobbyist until you prove otherwise. The burden of proof lies squarely with the owner.

“Most racing owners treat their operations as a business not a hobby. In America, racing is inherently treated like a business and many owners enter into these investments with the intent to make a profit.

“If you get audited and the hobby issue is raised, then there are nine tests that are evaluated, such as your business plan, which advisors you are using, what success have you had (both in total and on a per horse basis), how much residual value is in your stock, amongst other variables,” said Shah.

She noted that while sport horses are generally treated as hobby pursuits because they generate less revenue, Thoroughbred racing and breeding is different.

“It’s risky and difficult to make a profit, but it is treated as a business.”

The risk profile itself is part of the challenge.

“We aren’t producing widgets. Some things are out of our control, and it’s hard to predict that competitive spirit. It’s a risky industry, particularly from a cashflow perspective.”

That’s why the rule is more forgiving in America: two out of seven years of profit for horse operations, compared to three out of five in most other industries.

“If you file your return and make that determination yourself, then the assumption is that you are a business,” said Shah.

Australia assumes hobby first

This means that most buyers at the American yearling sale would qualify for the 100% depreciation rule under OBBB (or OB3 as Shah likes to call it).

“One caveat is that the horse must be predominantly used in the USA, so if someone bought a yearling in the USA but shipped it to Europe, the horse wouldn’t qualify for depreciation as the rule is supposed to be of USA economic benefit.”

In Australia, however, it is a very different story. Owners must persuade the ATO they are running a legitimate enterprise. Without a rule like America’s two-in-seven, many breeders are left frustrated by the presumption that they are hobbyists.

Paul Carrazzo from Baumgartners mentioned the decision making process around hobby versus business can make a big impact on a breeder’s ability to take advantage of the taxation system.

“The first thing I say to breeders is that if they are currently in a hobby phase and thinking about escalating their activities, there are generous concessions if you are an income tax business. If you're a small breeder and you're worrying about service fees and the cost of sales preparation, then think about this,” said Carrazzo.

He stressed that this isn’t about gaming the rules. “I want to emphasise that I’m not telling people to try and be a business when they're legitimately not a tax business. It's a matter of fact, not discretion. If you're a hobby breeder with one mare, you just can't say ‘I'm going to become a business’. It's not like that. But what I'm saying is that if you do have the facts in your favour, think seriously about approaching your accountant to get guidance on how to become an income tax business.”

For those who qualify, the benefits are significant.

“You must have a business plan that shows the intention to make a profit. You have to keep proper records. If you are breeding good quality mares every year and you sell the foals, then you can access tax losses in the early years of your activities. To get these losses, all the factors add up to showing an intention to make a profit.

“The beauty of assessing your viability or eligibility for income tax business status is that not only do you get losses in the early years of your activities, because you want to free up growth capital in these early years, but you could also get GST status, which means you can claim back the GST on your big expenses like service fees.”

Australia’s hobby-first stance shapes everything: from whether breeders can claim early losses, to how much risk they can take on, to whether new investors stay in the game. For some, the barriers are enough to walk away.

In tomorrow’s article, we’ll look at what can be done about it: the Australian tax reforms that could ease the burden on owners and breeders, how depreciation rules might be modernised, and why changes to capital gains tax could make a tangible difference for thousands of participants.

If you would like to contribute to this series - especially as we turn to discussing solutions, send your thoughts or ideas to vicky@ttrausnz.com.au.