Senerio. John buys 10 mares and one stallion. Breeds all of the mares for slaughter (no stud fee) 9 mares produce so he has purchased feed for these mares during pregnancy and now has to feed them for two more years until they will be of a sufficient weight. Since they are not trained they might actually bring more money as they would not be given any banned substances (due to non handling) and therefore can be guaranteed for their passport
Now they write off their losses. Which would be considerable however under U.S. IRS laws they must show a profit 2 out of 7 years. You can get away with not filing for a couple of years however when you go after the deductions..that is the trip wire.
The IRS does not allow deductions for very long when the sale price on the horse would be an absolute maximum of $250.00 due to passport and then have losses of $2500.00 (at a minimum) per horse.
If all of these individuals are, as you state, BREEDING for slaughter they should be in big demand as they would have passport horses available.
URBAN LEGEND. Regan closed that loophole many many years ago.