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their horse racing activity, mortgage interest is not allowable
as a trade or business deduction on the Schedule F.
In general no deduction is allowed for “any amount paid out
for new buildings or for permanent improvements or betterments
made to increase the value of any property.” Sec. 263. During
1994, petitioners constructed a new barn, or substantially
improved an existing one. Amounts expended for the construction
or improvement of the barn were deducted as “supplies” on the
Schedule F. Petitioners are not entitled to deduct the
construction costs. Instead, the costs must be capitalized and
included in the basis of the barn. See sec. 1012; sec. 1.162-
12(a), Income Tax Regs.
Cost incurred to raise livestock may be deducted or
capitalized at the option of the taxpayer. See sec. 1.162-12(a),
Income Tax Regs. In contrast, under the applicable version of
the controlling regulation, the cost of acquiring, as opposed to
raising, a sporting animal, such as a race horse, is considered
an investment in capital. A breeding fee, or stud fee, is
classified as either a cost of “raising” or a cost of “acquiring”
an animal depending upon which party bears the risk of loss that
the breeding process is unsuccessful. Duggar v. Commissioner,
71 T.C. 147 (1978); Ellis v. Commissioner, T.C. Memo. 1984-50.
In this case, petitioners were guaranteed a live foal in the
stallion service contract involving Hilarious Astro, and it
appears that a similar guaranty was in effect in the contract
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