How would you like to sell your valuable performance horse and not owe any income tax? Most horse owners would think this could only happen if the horse has decreased in value from the time it was purchased. A special type of transaction is available, however, which allows performance horse owners to earn a substantial return on their equine investment without incurring any tax liability.

Taxpayers realize gain when they sell an asset at a profit. The profit equals the amount realized on the sale over the adjusted basis (generally cost less depreciation) of the asset sold. As a general rule, taxpayers recognize that gain at the same time. Upon recognition, the taxpayer reports the income on his or her Form 1040.

When a taxpayer sells a performance horse at a profit, generally that realized profit is recognized and subject to tax as either ordinary income or capital gain. The like-kind exchange rules provide a special exception that allows taxpayers to avoid recognition of gain. The most basic situation is as follows:

Clayton Jones breeds, raises, and trains horses for racing. Mr. Jones is profitable in this business.¹ Sometimes, Mr. Jones purchases yearlings to add to his racing stock. In 1991, Mr. Jones purchases Expensive Gain, a yearling, for $20,000. He spends the next year training the horse for Thoroughbred racing