UNPUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
No. 04-1665
CSABA L. MAGASSY; FRANCES H. MAGASSY,
Petitioners - Appellants,
versus
COMMISSIONER OF INTERNAL REVENUE,
Respondent - Appellee.
Appeal from the United States Tax Court. (Tax Ct. No. 01-11982)
Argued: May 25, 2005 Decided: July 26, 2005
Before WIDENER, WILKINSON, and NIEMEYER, Circuit Judges.
Affirmed by unpublished per curiam opinion.
ARGUED: Robert Doran Grossman, Jr., Las Vegas, Nevada, for
Appellants. Samuel Ashby Lambert, UNITED STATES DEPARTMENT OF
JUSTICE, Tax Division, Washington, D.C., for Appellee. ON BRIEF:
Eileen J. O’Connor, Assistant Attorney General, Bruce R. Ellisen,
UNITED STATES DEPARTMENT OF JUSTICE, Tax Division, Washington,
D.C., for Appellee.
Unpublished opinions are not binding precedent in this circuit.
See Local Rule 36(c).
PER CURIAM:
Taxpayers Csaba and Frances Magassy appeal from a
decision of the Tax Court upholding a determination by the
Commissioner of Internal Revenue of deficiencies in their federal
income taxes for the years 1995, 1996, and 1997. The Tax Court
denied the Magassys deductions they claimed for expenses related to
the operation of their 108-foot motor yacht during the years 1995,
1996, and 1997 and for the loss incurred from the sale of the yacht
in 1997. The Tax Court concluded that under § 183 of the Internal
Revenue Code, the Magassys did not have an "actual and honest
objective" of making a profit in operating and selling the yacht,
and that under § 1231 of the Internal Revenue Code, the yacht's
chartering activity prior to its sale did not constitute a "trade
or business." Finding no error in the Tax Court's decision, we
affirm.
I
Csaba Magassy and his wife, Frances Magassy, of Potomac,
Maryland, filed joint tax returns for the years 1995, 1996, and
1997. During the relevant years, Csaba Magassy was engaged in a
successful plastic surgery practice in the Washington, D.C. area,
and Frances Magassy was engaged as a housewife. In their income
tax returns, the Magassys deducted from their ordinary income
$602,605, $1,137,377, and $454,678, respectively, in losses from
the operation of their yacht. In addition, they deducted
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$1,931,292 from their 1997 ordinary income based on the loss they
incurred from the yacht's sale. The Commissioner disallowed these
deductions and sent the Magassys a notice of deficiency on June 25,
2001, citing income tax deficiencies of $245,790, $364,462, and
$989,450 for 1995, 1996, and 1997, respectively. The Commissioner
based the disallowances on Internal Revenue Code ("I.R.C.") §§ 162,
183, and 280A.
The Magassys (hereafter "Taxpayers") appealed this
determination to the Tax Court, and after a two-day trial at which
the parties called thirteen witnesses, the Tax Court issued a
decision in favor of the Commissioner. The Tax Court denied
Taxpayers the annual expense deductions under I.R.C. § 183 and
analyzed the 1997 loss-on-sale deduction under I.R.C. § 1231. With
respect to the expense deductions, the Tax Court observed that
Treasury Regulation § 1.183-2(b) sets out nine nonexclusive factors
for consideration, see 26 C.F.R. § 1.183-2(b), and proceeded to
address each factor, apply the circumstances of Taxpayers' case,
and resolve the factor against Taxpayers. The court ultimately
concluded that Taxpayers had no actual and honest objective of
making a profit in owning, operating, and selling the yacht during
the tax years in question. Consistent with this conclusion, the
court then found that the chartering activity leading up to the
vessel's sale did not constitute a trade or business for purposes
of I.R.C. § 1231.
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The underlying facts were undisputed. Dr. Magassy
purchased the yacht -- a 1963 108-foot Feadship -- in 1990 after
Mark Mogul, a real estate broker who worked for Dr. Magassy's
brother-in-law's real estate firm, Legum & Norman, had presented
Dr. Magassy with the opportunity. Mark Mogul's father, Lee Mogul,
owned a yacht brokerage firm in Fort Lauderdale, Florida, that was
offering the yacht for sale. The Moguls told Dr. Magassy that the
vessel was available for $1.625 million and presented him with a
survey conducted by American Marine Surveyors, dated February 28,
1990, which listed the yacht's fair market value at $2.4 million
and its replacement cost at over $9 million. The report from
American Marine Surveyors noted that the survey was conducted while
the vessel was afloat and that when the vessel was last hauled out
of the water, the hull was "Audio Gauged and [it] indicated no
appreciable wastage to the steel hull."
Shortly after learning of the opportunity, Dr. Magassy
executed a contract to purchase the yacht from Lee Mogul's
brokerage, Boats, Yachts & Ships, for $1.625 million and subject to
specified contingencies. The parties also executed a separate
agreement reducing the purchase price to $1.3 million and providing
that the "sales price include[] the total and complete
refurbishment of [the] vessel at approximately $300,000." Thus,
$300,000 of the $1.3 million was to go to refurbishment of the
yacht. The contract and separate agreement also provided for the
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payment of a $78,000 fee to Legum & Norman by Boats, Yachts &
Ships; an exclusive listing with Boats, Yachts & Ships and Legum &
Norman for any resale of the yacht; and payment to William Norman
(Dr. Magassy's brother-in-law) and Mark Mogul of 25% of any net
profits realized from such a sale.
Dr. Magassy never personally inspected the yacht prior to
closing. Instead, Norman traveled to Florida and reported back
that the yacht was "terrific, . . . looks great." But Dr. Magassy
did obtain an additional survey, which was conducted by Alexander
& Associates on May 9, 1990, also while the vessel was afloat. The
survey stated that the yacht's market value was $1.85 million, its
fully restored value was $3.2 million, and its replacement cost was
$8.7 million.
Closing on the purchase of the vessel occurred on May 29,
1990, at which time Dr. Magassy also closed on a $1 million loan
from NCNB National Bank of Florida. As of May 29, however, Boats,
Yachts & Ships apparently did not yet own the yacht. Lee Mogul
purchased the yacht for Boats, Yachts & Ships on May 30 for $1
million, and its seller was required to pay the brokerage a
$245,621 commission.
The vessel thereafter remained in Lee Mogul's care until
the end of January 1991. Dr. Magassy saw the yacht for the first
time in July 1990, when he discovered that it was in a state of
total disrepair. Upon returning in November 1990, Dr. Magassy
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found that little progress had been made on its restoration, and he
learned from Lee Mogul that the full $300,000 designated for
restoration work had been spent. Having lost confidence in Mogul,
Dr. Magassy decided to have the yacht moved to Angus Shipyard in
Bayou La Batre, Alabama, for continued restoration work.
In July 1991, Dr. Magassy filed suit against Lee Mogul,
Mark Mogul, and Boats, Yachts & Ships to recover the $300,000
intended for repairs, alleging breach of contract, unjust
enrichment, and conversion. Dr. Magassy, however, was never able
to effect service on the defendants. Moreover, in October 1991,
the Florida Secretary of State administratively dissolved Boats,
Yachts & Ships.
At Angus Shipyard, the vessel was removed from the water
and extensive hull deterioration was discovered. Despite Angus'
initial estimate for restoration work of $218,000, by November
1991, Dr. Magassy had already paid $428,648 and had been billed for
an additional $527,637. When Dr. Magassy refused to pay, Angus
Shipyard filed a maritime lien against the vessel and a suit in
federal court to enforce the lien. The parties ultimately settled
the suit in November 1992, with Dr. Magassy paying Angus Shipyard
$300,000 in cash and giving it a $180,000 promissory note.
In May 1992, Dr. Magassy's accountant referred him to a law
firm for tax advice regarding the sale of the yacht, since by then
"[t]he combined acquisition and refurbishing costs of the [yacht]
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substantially exceed[ed] the boat's fair market value." The law
firm prepared a memorandum analyzing whether a loss realized on the
sale of the yacht could be treated as a "§ 1231 loss" -- that is,
whether the loss could be treated as an ordinary loss and used to
offset Taxpayers' unrelated ordinary income. The memorandum
concluded that "[i]n order to qualify for section 1231 loss
treatment, Dr. Magassy would be required to commence a boat
chartering business and use the [yacht] in that business prior to
the sale."
Following this advice, in December 1994, Dr. Magassy
created S.M.S.M., Inc., a Florida subchapter S corporation, of
which he was the sole shareholder and director and his wife was the
secretary-treasurer, and he registered the corporation as a sales
and charter boat dealer. Weeks later, he listed the yacht for sale
with Richard Bertram Yachts for $2.4 million. The following March,
he transferred the yacht's title to S.M.S.M., and S.M.S.M. borrowed
$874,000 to refinance and pay off the NCNB purchase-money loan.
Also during this period, S.M.S.M. signed an agreement with
Priscilla Yacht Management, whereby the yacht became part of
Priscilla's charter fleet, and the yacht was subsequently featured
in a number of print advertisements in chartering magazines.
S.M.S.M. maintained separate checking and credit card accounts,
and, starting in 1996, an employee of Dr. Magassy's medical
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practice began keeping computerized records associated with the
company.
From January 1995 until April 1997, the yacht was
chartered to paying customers approximately 20 times. It was
chartered twice to Plastic Surgery Associates, Dr. Magassy's
medical practice. And members of the Magassy family used the yacht
on numerous other occasions. Dr. Magassy's two sons were aboard
the yacht during two March 1995 sea trials and a June 1995 charter
by Plastic Surgery Associates. One of his sons was also aboard
during a July 1995 charter. Dr. Magassy's daughter was aboard
during one of the March sea trials. Mrs. Magassy was aboard during
the first March sea trial, and both she and Dr. Magassy were aboard
during the second sea trial, which was a four-day trip from Fort
Lauderdale, Florida to Hurricane Hole, Bahamas. On at least three
additional occasions, different Magassy family members took
personal vacations on board the yacht while it was in the Bahamas.
On a number of occasions Taxpayers held dinner cruises and cocktail
parties on the vessel, and on other occasions, members spent
daytime and evening hours partying on the yacht without staying
overnight.
In April, 1997, Dr. Magassy sold the yacht for $1.1
million, realizing a substantial loss.
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II
Taxpayers contend that the Tax Court erred in several
respects. First, Taxpayers argue that the Tax Court applied the
wrong legal standard to determine whether they had a profit motive
under I.R.C. § 183. They assert that the Tax Court's language
reveals that it applied a "reasonable man" standard, erroneously
asking whether Taxpayers were reasonable to expect to make a
profit, rather than whether they actually and honestly had the
objective of making a profit. Second, Taxpayers contend that the
Tax Court clearly erred in its factual finding that they lacked a
profit motive. In particular, they assign error to (1) the Tax
Court's application of the nine Treasury regulation factors; (2)
its failure to specify the exact point at which they lost their
profit motive, which the Commissioner conceded existed in 1990; (3)
the Tax Court's consideration of the ownership and operation of the
vessel as discrete activities in the profit motive analysis; and
(4) its use of the fact that they listed the yacht for sale at a
loss as an indication of a lack of a profit motive. Finally,
Taxpayers assert that the exclusion of some of Dr. Magassy's
testimony on hearsay grounds was an abuse of discretion.
A
Taxpayers first argue that "[t]he key issue for
resolution by [the court of appeals] is whether the Tax Court
employed and applied the proper legal (profit motive) standard in
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deciding the case." Noting that I.R.C. § 183 commands an inquiry
into whether Taxpayers had "an actual and honest objective of
making a profit," rather than whether a reasonable person would
have expected such a profit, they contend that the Tax Court in
this case erred by employing a "reasonable person" standard.
Internal Revenue Code § 183, the "hobby loss" provision,
limits deductions from activities not engaged in for profit to the
extent of gross income derived from such activities. 26 U.S.C. §
183(b). Activities by an individual or a subchapter S corporation,
however, that are in fact engaged in for profit, are not subject to
that limitation, and losses incurred from such activities are
deductible from the taxpayer's ordinary income under I.R.C. §§ 162
and 212. See 26 U.S.C. §§ 183(a), 183(c).
The key under § 183(b) to whether a taxpayer may deduct
losses from ordinary income generally lies in the determination of
whether the taxpayer had a profit motive in engaging in the
activity. The starting point for addressing that question is
Treasury Regulation § 1.183-2 which provides in part:
The determination whether an activity is engaged in for
profit is to be made by reference to objective standards,
taking into account all of the facts and circumstances of
each case. Although a reasonable expectation of profit
is not required, the facts and circumstances must
indicate that the taxpayer entered into the activity, or
continued the activity, with the objective of making a
profit. . . . In determining whether an activity is
engaged in for profit, greater weight is given to
objective facts than to the taxpayer's mere statement of
his intent.
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26 C.F.R. § 1.183-2(a); see also Faulconer v. Commissioner, 748
F.2d 890, 894-902 (4th Cir. 1984) (applying § 1.183-2(a)).
Taxpayers in this case contend that various statements
that the Tax Court made in its opinion employing the term
"reasonable" indicate that the court ignored the proper legal
standard. Our review of those statements, however, leads us to
conclude that, far from evidencing the employment of an erroneous
standard, the Tax Court's statements show its faithful application
of Treasury Regulation § 1.183-2(a) and Faulconer. The Tax Court
was required to refer to "objective standards" and determine
whether "the facts and circumstances" of Taxpayers' case actually
supported the asserted profit objective. 26 C.F.R. § 1.183-2(a);
Faulconer, 748 F.2d at 894. And the Faulconer Court made clear
that "[a] taxpayer's mere statement of intent is given less weight
than objective facts." 748 F.2d at 894. Taxpayers, instead, would
have the court blindly adopt their assertions of intent as
sacrosanct. Such an interpretation of the standard is contrary to
precedent and the regulations. We conclude, accordingly, that the
Tax Court properly applied the governing legal standard in its
I.R.C. § 183 analysis.
B
Taxpayers next contend that the Tax Court improperly
found as fact that they lacked a profit motive. We review these
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findings for clear error. See Hendricks v. Commissioner, 32 F.3d
94, 97 (4th Cir. 1994).
According to Treasury Regulation § 1.183-2(b), "[i]n
determining whether an activity is engaged in for profit, all facts
and circumstances with respect to the activity are to be taken into
account," and "[n]o one factor is determinative." 26 C.F.R. §
1.183-2(b). In addition, the regulation sets out nine factors for
consideration, although "it is not intended that only [those]
factors . . . are to be taken into account in making the
determination, or that a determination is to be made on the basis
[of] the number of factors" supporting a conclusion. Id. In other
words, the regulation intends to be a wide-ranging qualitative
analysis. See Faulconer, 748 F.2d at 896-902 (applying the
factors). The listed factors, "which should normally be taken into
account," are:
(1) Manner in which the taxpayer carries on the
activity. . . .
(2) The expertise of the taxpayer or his advisors. . .
.
(3) The time and effort expended by the taxpayer in
carrying on the activity. . . .
(4) Expectation that assets used in activity may
appreciate in value. . . .
(5) The success of the taxpayer in carrying on other
similar or dissimilar activities. . . .
(6) The taxpayer's history of income or losses with
respect to the activity. . . .
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(7) The amount of occasional profits, if any, which are
earned. . . .
(8) The financial status of the taxpayer. . . .
(9) Elements of personal pleasure or recreation. . . .
26 C.F.R. § 1.183-2(b). In addition, "at all times, the taxpayer
has the burden of showing that the activity was engaged in for
profit." Hendricks, 32 F.3d at 98.
In its opinion, the Tax Court addressed each of the nine
factors and concluded that, based on the facts, each suggested the
absence of an actual and honest profit motive by the Taxpayers. As
to factor (1), the Tax Court found that the Taxpayers' endeavor was
not conducted in a businesslike manner: no business plans or
restoration budget was ever produced; no reasonable investigation
was made; and the restoration work was not properly monitored. As
to factor (2), the court found that Taxpayers had no experience in
owning or investing in yachts and that those they relied on as
"experts" were all interested parties. As to factor (3), the Tax
Court noted Taxpayers' lack of time devoted to the restoration and
chartering of the yacht. As to factor (4), the Tax Court stated
that even though Taxpayers might have had an expectation in 1990
that the yacht would appreciate in value, by 1995 any such
expectation had evaporated, given the price at which the yacht was
listed for sale in 1994. As to factor (5), the Tax Court noted
Taxpayers' lack of any former experience in yacht chartering or
restoration. As to factor (6), the Tax Court observed that
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S.M.S.M. incurred substantial and mounting losses, year after year,
and that there was no way by which Taxpayers could honestly have
expected to generate positive net income from the chartering
activities. In addition, the Tax Court observed that the yacht was
listed for sale at a price at which it would have been impossible
for Taxpayers to have generated any income. As to factor (7), the
Tax Court noted the existence of continuing losses from chartering
the yacht and the impossibility of Taxpayers' profiting from the
yacht's sale. As to factor (8), the Tax Court pointed to
Taxpayers' substantial income from sources other than the loss-
producing activity to "indicate that the activity [was] not engaged
in for profit[,] especially if there [were] personal or
recreational elements." 26 C.F.R. § 1.183-2(b)(8). The court
noted that the significant losses of S.M.S.M. served to shield
Taxpayers' unrelated income from taxation. And as to factor (9),
the Tax Court noted the inherent recreational element involved in
the ownership of a luxury motor yacht. These findings are amply
supported by the record, and we hold that they appropriately lead
to the conclusions under Treasury Regulation § 1.183-2(b) that the
Tax Court reached.
Taxpayers contend that in applying these factors, the Tax
Court was required to have identified the exact moment between 1990
and 1995, at which they lost their profit motive. While Taxpayers
correctly note that the Commissioner conceded their genuine and
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honest profit motive in acquiring the yacht in 1990, they
themselves concede that "every tax year presents a new and
different cause of action." In this case, the Tax Court correctly
considered the factors relevant only to the three years for which
the Commissioner denied the deductions.
Taxpayers also argue that the Tax Court erroneously
failed to consider ownership and operation of the vessel as a
single activity. They argue that if the ownership and operation of
the yacht are viewed together, their profit motive for the sale of
the vessel rendered any lack of profit motive for the chartering
operations irrelevant. This argument, however, flies in the face
of the facts of this case. There is no evidence to support a
profit motive for the sale of the vessel because by 1995, Taxpayers
had listed the vessel for sale at a price that made it impossible
for them to realize a profit.
Taxpayers respond to this observation by contending that
listing the yacht for sale at a loss was not inconsistent with
their having a profit motive because "profit" in this case "is
synonymous with capital preservation." Their only support for this
argument, however, is Feldman v. Commissioner, 55 T.C.M. (CCH) 450
(1988), and that case is not on point. In Feldman, a case
involving the application of I.R.C. § 183 to a taxpayer's ownership
and chartering of a sailboat, the Tax Court merely stated that
"petitioner's actions in discontinuing operations after less than
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one charter season and putting the boat up for sale indicate that
tax motives were not uppermost in petitioner's mind." Id. at 454.
"Had [Feldman] been primarily interested in reaping tax benefits,"
the Tax Court continued, "he would certainly have held the yacht
longer than the one charter season he did, before offering it for
sale." Id. That, however, is exactly what Taxpayers did in this
case. They continued to refurbish, operate, and charter the yacht
at a loss, knowing that they would never be able to recoup those
losses at the time of the yacht's sale.
For all of the reasons stated, we conclude that the Tax
Court did not clearly err in its findings of fact under I.R.C. §
183.
C
Finally, Taxpayers argue that the Tax Court erroneously
excluded certain of Dr. Magassy's testimony on hearsay grounds.
According to Taxpayers, this testimony should have been admitted to
establish Dr. Magassy's actual and honest belief regarding profit
motive.
While Taxpayers' attorney was questioning Dr. Magassy as to
his conversations with Lee Mogul about chartering the yacht, the
attorney asked, "Do you remember how many weeks he said, for the
chartering?" The Commissioner objected, and the Tax Court
sustained the objection on hearsay grounds. Dr. Magassy then
testified that, based on his conversations with Lee Mogul, he
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thought the chartering was "[v]ery doable" -- that is, profitable.
The attorney then asked him if Lee Mogul "[told] [him] it was
doable?" And the Tax Court sustained the Commissioner's objection
to that question as well. Taxpayers argue that "[p]reventing [Dr.
Magassy] from testifying as to what was in his mind, which is the
only relevant issue, prevented the Tax Court from making a proper
factual finding."
But Taxpayers' attorney never asked that the testimony be
admitted only for the purpose of showing Dr. Magassy's state of
mind. Moreover, Dr. Magassy was permitted to testify to his state
of mind -- that he, based on his conversation with Lee Mogul,
thought that the chartering business could be profitable. The Tax
Court's evidentiary rulings did not amount to an abuse of
discretion.
III
Taxpayers failed to address directly the Tax Court's
disallowance of their deduction of the loss from the sale of the
yacht in 1997. The deductibility of that loss is governed by
I.R.C. § 1231, which creates an even higher hurdle for Taxpayers
than does I.R.C. § 183. Internal Revenue Code § 1231 allows a net
gain to be treated as a long-term capital gain, but allows a net
loss to be deducted from ordinary income. See 26 U.S.C. §
1231(a)(1), (a)(2). To qualify under I.R.C. § 1231, however, the
gain or loss must have been recognized "on the sale or exchange of
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property used in [a] trade or business." 26 U.S.C. §
1231(a)(3)(A)(i) (emphasis added); id. § 1231(a)(3)(B).
The Tax Court noted that "[i]n analyzing whether an
activity in connection with which property is sold constituted a
trade or business (for purposes of ordinary loss treatment under
section 1231), a taxpayer