Shane v. Commissioner

T.C. Memo. 1995-504

UNITED STATES TAX COURT

MICHAEL T. SHANE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 8409-94. Filed October 23, 1995.

Charles C. Shelton and Evan Shelton, for petitioner.

Elizabeth S. Henn, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WRIGHT, Judge: Respondent determined deficiencies of

$8,483 and $6,910 in petitioner's Federal income taxes for

taxable years 1990 and 1991, respectively.
 - 2 -

The sole issue for decision is whether petitioner's

horseracing and horse-breeding activity was undertaken with the

objective of making a profit within the meaning of section 1831

during the years at issue. We hold that it was.

FINDINGS OF FACT

Some of the facts have been stipulated and are found

accordingly. The stipulation of facts and the attached exhibits

are incorporated herein. At the time the petition was filed,

petitioner resided in Towson, Maryland. Petitioner timely filed

Federal income tax returns for taxable years 1990 and 1991.

During the years at issue, petitioner worked as a full-time

computer programmer for Baltimore County, Maryland. In exchange

for his services to Baltimore County, petitioner earned

approximately $35,000 per year. Petitioner also maintained a

part-time job with Maryland Casualty Co. during the years at

issue. In 1990, petitioner worked an average of 20 hours per

week, or a total of 844 hours, for Maryland Casualty Co. In

1991, petitioner worked a total of 111 hours for Maryland

Casualty Co.

During the years at issue, petitioner also was engaged in

the breeding and racing of horses. Petitioner's involvement with

horses dates back to the early 1970's. In the mid-1970's, while

1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect during the years in issue,
and all Rule references are to the Tax Court Rules of Practice
and Procedure.
 - 3 -

pursuing an undergraduate degree at Johns Hopkins University,

petitioner took approximately 2 years off from his studies in

order to gain the experience, skills, and knowledge necessary to

obtain a horse trainer's license. Petitioner traveled to New

York and New Jersey in order to work for horse trainers with

established reputations. Not only did petitioner need to learn

the rules and regulations promulgated by various racing

commissions; it was necessary for him to master the art of

handling a variety of horses and a multitude of equipment. It

was also necessary for petitioner to be able to properly

administer various medications and work with veterinarians.

Petitioner eventually obtained a horse trainer's license in

Maryland, Delaware, Pennsylvania, West Virginia, and New Jersey.

After graduating from Johns Hopkins University in 1977,

petitioner elected to discontinue his involvement with horses in

order to concentrate his energies on learning the art of computer

programming. In 1980, however, petitioner aspired to be a

successful racehorse owner. To this end, petitioner began a 2-

year period during which he studied racehorses. Although this

study was informal, it was regular and involved. Petitioner read

several trade periodicals and studied charts tracking the

accomplishments of various horses. Petitioner frequently used

the services and facilities of the Maryland Horse Breeders

Association to conduct research and study pedigrees. Petitioner
 - 4 -

also spent a significant amount of time at racetracks observing

racehorses in action.

This study period culminated in 1982 when petitioner

acquired2 his first horse, Andiamo Bella, in a claiming race.3

Petitioner was of the opinion that Andiamo Bella had numerous

characteristics of a successful racehorse but that she had

received poor training. In acquiring Andiamo Bella, petitioner

felt that the negative effects of her prior training could be

overcome through the application of proper training. After

undergoing petitioner's personal training regimen, Andiamo Bella

proved profitable, winning approximately $65,000 during the 18-

month period ending with 1983.

Motivated by his success with Andiamo Bella, petitioner

began to expand his enterprise in 1984. By 1987, petitioner

owned eight horses. In response to having been unable to attain

results similar to those achieved with Andiamo Bella in 1983,

petitioner began enlarging the scope of his operation to include

horse breeding in 1986. Consequently, petitioner has been a

member of the Maryland Horse Breeders Association since 1986.

2
Petitioner actually acquired a 50-percent interest in his
first horse in 1982. Eventually, however, petitioner acquired
the remaining interest in this horse.
3
Generally speaking, a claiming race is a race specified by
race officials in which an interested party can "claim" or
purchase the winning horse from its owner. In order to claim a
horse, the interested party must tender a specified dollar amount
to the owner of the horse within a specified period of time.
 - 5 -

In 1988, following several years of poor results with regard to

the racing component of his enterprise, petitioner began

concentrating his attention on horse breeding, though horseracing

remained a peripheral part of his activity. This emphasis on

horse breeding remained petitioner's practice throughout the

years at issue.

A principal factor underlying petitioner's decision to focus

on breeding was his belief that through a combination of

successful breeding and proper training he could produce foals

that would appreciate substantially in value. In accordance with

his desire to produce quality horses with established pedigrees,

petitioner bred his horses with two of the top-rated stallions in

Maryland. Despite petitioner's efforts, however, prior to the

time of trial he had not attained significant acclaim as a

successful breeder and had not sold any foals.

Petitioner boarded his horses at a boarding facility located

approximately 20 miles from his residence. According to

petitioner, he spent several hours each morning and several hours

each night tending to his horses. In tending to his horses,

petitioner performed a variety of activities. The horses were

exercised, fed, and groomed. Medications were administered, and

stalls were cleaned. Not infrequently, petitioner's night-time

horse activity kept him at the boarding facility until midnight.

Often times, under those circumstances, petitioner slept in his

automobile at the boarding facility rather than travel the 20
 - 6 -

miles to his home only to return to the boarding facility 4 or 5

hours later in order to perform his morning activities.

Petitioner managed the financial affairs of his horse

activity through his personal checking account. The management

of this dual-purpose account was facilitated by the use of a

computer program petitioner had created. By design, petitioner

used this program to distinguish between personal expenditures

and expenditures made in furtherance of his horse activity.

Other than his check register, however, petitioner did not

maintain formal financial records relating to his horse activity.

Nonetheless, petitioner did keep detailed records regarding the

training, care, and pedigree of his horses.

Petitioner did not maintain his horses for entertainment or

other recreational purposes. Petitioner did not ride his horses,

nor did he permit others, except for qualified jockeys, to ride

his horses.

For taxable years 1986 through 1991, petitioner incurred the

following losses with respect to his horse activity:

Year Loss

1986 $35,631
1987 26,990
1988 39,834
1989 32,996
1990 39,324
1991 36,039

In 1990 and 1991, petitioner used the respective losses of

$39,324 and $36,039 to offset income he received from Baltimore
 - 7 -

County and Maryland Casualty Co. Respondent determined that

petitioner's horse activity did not constitute an activity

engaged in for profit under section 183. Accordingly, respondent

disallowed the losses claimed by petitioner.

OPINION

We must decide whether section 183 applies to petitioner's

horseracing and horse-breeding activity. Respondent maintains

that petitioner's lack of a profit objective precludes him from

deducting the expenses attributable to that activity in excess of

those which are allowed by section 183. In contrast, petitioner

contends that he possessed the requisite profit objective during

the years at issue and, therefore, section 183 is inapplicable.

Accordingly, petitioner argues that the expenses attributable to

his horse activity are fully deductible under section 162. We

agree with petitioner.

Section 183 allows only specified deductions unless an

activity is engaged in for profit. Section 183(c) defines an

activity not engaged in for profit as any activity other than one

with respect to which deductions are allowable for the taxable

years under section 162 or under paragraphs (1) or (2) of section

212. Petitioner argues that he engaged in the horse activity

with the requisite profit objective; respondent disagrees.

An activity engaged in for profit is one in which the

taxpayer has an actual and honest objective of making a profit.

Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), affd. without
 - 8 -

published opinion 702 F.2d 1205 (D.C. Cir. 1983). Respondent's

determination is presumptively correct, and petitioner bears the

burden of proving his profit objective. Rule 142(a). Petitioner

need not, however, establish that his profit objective was

reasonable. Dreicer v. Commissioner, supra at 644-645; sec.

1.183-2(a), Income Tax Regs. Profit in this context means

economic profit, independent of tax consequences. Antonides v.

Commissioner, 91 T.C. 686, 694 (1988), affd. 893 F.2d 656 (4th

Cir. 1990). The determination of profit objective is factually

based and requires a consideration of all the surrounding facts

and circumstances. Finoli v. Commissioner, 86 T.C. 697, 722

(1986); sec. 1.183-2(b), Income Tax Regs.

Although the purpose of the inquiry is to ascertain the

taxpayer's subjective intent, greater weight is placed on

objective factors than on the taxpayer's statement of his or her

intent. Beck v. Commissioner, 85 T.C. 557, 570 (1985); sec.

1.183-2, Income Tax Regs. In conducting the profit-objective

analysis, courts have relied on the factors enumerated in the

regulations under section 183. See Hendricks v. Commissioner, 32

F.3d 94 (4th Cir. 1994), affg. T.C. Memo. 1993-396; Independent

Elec. Supply, Inc. v. Commissioner, 781 F.2d 724 (9th Cir. 1986),

affg. Lahr v. Commissioner, T.C. Memo. 1984-472; Elliott v.

Commissioner, 90 T.C. 960 (1988), affd. without published opinion

899 F.2d 18 (9th Cir. 1990). However, no single factor is

determinative of the issue. Golanty v. Commissioner, 72 T.C. 411
 - 9 -

(1979), affd. without published opinion 647 F.2d 170 (9th Cir.

1981).

Section 1.183-2(b), Income Tax Regs., provides the following

nonexclusive list of nine factors that should normally be taken

into account in determining whether an activity is engaged in for

profit: (1) The manner in which the taxpayer carries on the

activity; (2) the expertise of the taxpayer or his advisers; (3)

the time and effort expended by the taxpayer in carrying on other

similar or dissimilar activities; (4) the expectation that the

assets used in the 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; (7) the amount of occasional

profits, if any, that are earned; (8) the financial status of the

taxpayer; and (9) the elements of personal pleasure or recreation

involved in the activity.

A review of the entire record in this case persuades us that

petitioner has succeeded in proving that his horse activity was

motivated by an actual and honest objective of making a profit.

We find that most of the above-enumerated factors weigh in favor

of petitioner; we find further that those factors not in

petitioner's favor do not require a decision for respondent.

First, the manner in which the taxpayer carries on the

activity is one indication of a profit objective. Engdahl v.

Commissioner, 72 T.C. 659 (1979); Grommers v. Commissioner, T.C.
 - 10 -

Memo. 1992-343; sec. 1.183-2(b)(1), Income Tax Regs. We find

that petitioner conducted his horse activity in a businesslike

manner. Although petitioner did not maintain a separate checking

account in the conduct of his financial affairs relating to his

horse activity, we find his testimony explaining his rationale

for not doing so credible. Petitioner testified that, given the

scale of his operation, keeping costs low was a principal

concern. Petitioner further testified that conducting his

business affairs through his personal checking account was

advantageous because his financial institution did not charge a

fee for managing personal checking accounts but did charge a fee

for managing business checking accounts. Additionally,

petitioner testified that he managed his dual-purpose checking

account via a self-generated computer program fully capable of

distinguishing between business and personal expenditures.

Accordingly, petitioner was able to avoid an expense without

compromising the accuracy of his check register.

Moreover, after experiencing an extended period of

unpromising results from the racing component of his horse

activity, petitioner redirected the focus of his operation,

placing increased attention on its breeding aspect and

discontinuing to a large extent its racing aspect. The

discontinuation of an unprofitable branch of operations indicates

a profit objective. Allen v. Commissioner, 72 T.C. 28 (1979);
 - 11 -

Pirnia v. Commissioner, T.C. Memo. 1989-627; sec. 1.183-2(b)(1),

Income Tax Regs.

Respondent argues that petitioner failed to operate his

horse activity in a businesslike manner. In support of this

argument, respondent contends that petitioner lacked a credible

business plan and points to occasional inconsistencies in

petitioner's testimony. We know of nothing in the Code,

regulations, or case law that requires a business plan with the

degree of formality alluded to by respondent. Petitioner's

activity spanned a period of years. Petitioner initially placed

emphasis on horseracing but eventually shifted his emphasis to

horse breeding after coming to the realization that he was not

well situated to prosper in an activity which heavily emphasized

racing. With regard to the inconsistencies identified by

respondent, most, if not all, appear attributable to petitioner's

effectuating the shift from racing to breeding over a period of

time rather than at a specific point in time.

Respondent further contends that petitioner's lack of formal

financial records evidences his lack of a profit objective.

While it is true that the maintenance of complete and accurate

books and records weighs in favor of finding the existence of a

profit objective, the absence of such books and records does not

conclusively establish the lack of a profit objective. See

Engdahl v. Commissioner, supra at 666-667. In any event,

petitioner maintained meticulous records regarding the training
 - 12 -

and care of his horses. When the record is considered in the

aggregate, we find that this factor weighs in favor of

petitioner.

Second, preparation for the start of an activity through

extensive study of its accepted business, economic, and

scientific practices, or consultation with those who are experts

therein, indicates that a taxpayer has entered into an activity

for a profit. Id. at 668; Pederson v. Commissioner, T.C. Memo.

1994-555; sec. 1.183-2(b)(2), Income Tax Regs. Petitioner went

to great lengths to develop a degree of expertise involving

horses. By the time petitioner graduated from college in 1977,

he had received a horse trainer's license in five States.

Petitioner further testified that following a brief period during

which he was not involved with horses, he spent 2 years studying

the characteristics of successful racehorses. Petitioner studied

pedigree charts and read numerous trade periodicals. Petitioner

also testified that he spent a significant amount of time at a

racetrack studying the performance of various horses. This 2-

year period of study culminated in 1982 when petitioner purchased

his first horse.

Petitioner also called a former general manager of the

Maryland Horse Breeders Association as a witness. This witness

testified that petitioner spent an extraordinary amount of time

studying pedigrees and conducting other research in a library

maintained by the Maryland Horse Breeders Association.
 - 13 -

In light of the record before us, we conclude that

petitioner has developed and maintained expertise involving

horses. Accordingly, we find that this factor weighs heavily in

favor of petitioner.

Third, the time and effort expended by the taxpayer in

carrying on the activity is an indication of whether a profit

objective existed, particularly if there are no substantial

personal or recreational elements associated with the activity.

Haladay v. Commissioner, T.C. Memo. 1990-45; Archer v.

Commissioner, T.C. Memo. 1987-70; sec. 1.183-2(b)(3), Income Tax

Regs. As was stated by the Court of Appeals for the Seventh

Circuit: "Common sense indicates to us that rational people do

not perform hard manual labor for no reason, and if the

possibility that petitioners performed these labors for pleasure

is eliminated the only remaining motivation is profit."

Nickerson v. Commissioner, 700 F.2d 402, 407 (7th Cir. 1983),

revg. T.C. Memo. 1981-321.

Although the record does not support a finding of the exact

amount of time petitioner spent working with his horses, we are

convinced that it was substantial. Moreover, respondent concedes

on brief that petitioner spent a substantial amount of time and

effort engaged in his horse activity. Petitioner did not own a

farm or stable at which he could keep his horses; rather, he

rented space at a boarding facility located a significant

distance from his residence. Petitioner testified that he spent
 - 14 -

several hours each morning caring for his horses prior to going

to his full-time job. Petitioner also testified that he spent

several hours each night similarly caring for his horses.

Petitioner further testified that on numerous occasions the

nature of his work kept him at the boarding facility until

midnight. On many of these occasions, rather than commute to his

residence only to commute back to the boarding facility 4 or 5

hours later, petitioner testified that he slept in his automobile

at the boarding facility.

Fourth, an expectation that assets used in the activity may

appreciate in value may be an indication of a profit objective.

Engdahl v. Commissioner, 72 T.C. at 668; Anderson v.

Commissioner, T.C. Memo. 1992-102; sec. 1.183-2(b)(4), Income Tax

Regs. The expectation that he would experience appreciation in

the value of his horses was a principal factor underlying

petitioner's motivation for maintaining his horses. During the

early years of his operation, petitioner concentrated on racing.

In doing so, petitioner may have been somewhat less inclined to

expect his horses to appreciate in value. But petitioner altered

the focus of his activity and began concentrating heavily on

breeding. Here asset appreciation was petitioner's principal

expectation. Petitioner studied pedigree records in order to

determine what he believed to be good breeding combinations.

Petitioner, as would seem customary among horse breeders,

expected that it was through this system of selective breeding
 - 15 -

that the value of his horses would appreciate. The appreciation,

however, is not instantaneous; it is gradual, often occurring

over many years. The caliber of petitioner's existing stock had

to be established. Once the grade and the quality of

petitioner's stock were established, offspring had to be

generated and trained. Petitioner endeavored to produce quality

genetics in his foals, and then to further develop his foals

through his training regimen. It was through a combination of

this selective breeding and proper training that petitioner

expected the value of his horses to appreciate.

Although, as respondent correctly points out, petitioner had

yet to sell any of his foals prior to the time of trial, this

fact alone is not determinative and does not diminish

petitioner's expectation. Actual success need not exist for us

to find that petitioner maintained a reasonable expectation that

his horses would appreciate in value. Accordingly, we find that

this factor supports petitioner.

Fifth, the success of the taxpayer in carrying on other

activities can be some indication of whether the taxpayer had a

profit objective for the activity in question. Hoyle v.

Commissioner, T.C. Memo. 1994-592; Pirnia v. Commissioner, T.C.

Memo. 1989-627; sec. 1.183-2(b)(5), Income Tax Regs. The record

lacks sufficient evidence regarding petitioner's experience in

other activities. Nevertheless, we find that this lack of

evidence neither supports nor weakens petitioner's position.
 - 16 -

Sixth, a history of income, losses, and occasional profits

with respect to an activity can be indicative of whether a profit

objective exists. Allen v. Commissioner, 72 T.C. at 34; Kobza v.

Commissioner, T.C. Memo. 1992-176; sec. 1.183-2(b)(6), Income Tax

Regs. Respondent contends that the history of losses relating to

petitioner's horse activity conclusively establishes that he

lacked the requisite profit objective necessary to render section

183 inapplicable. Although a long history of losses is a

persuasive criterion, it has long been established that this

factor alone is not determinative of a lack of a profit

objective. See Engdahl v. Commissioner, 72 T.C. at 669 (profit

objective found to exist despite 12 consecutive years of losses

in horse-breeding activity); Pirnia v. Commissioner, supra

(profit objective found to exist despite 6 consecutive years of

losses in horse-breeding activity). This is particularly true

when such losses occur during the formative years of a business,

especially one involving horses. The startup phase of an

American saddlebred breeding operation is 5 to 10 years. Engdahl

v. Commissioner, supra at 669.

During the initial years of his horse activity, petitioner

expected to make a profit racing his horses. However, due to his

limited resources, petitioner soon concluded that such an

expectation was unrealistic and shifted his focus to horse

breeding. Given that this shift occurred around 1988,

petitioner's horse-breeding function was well within the 5- to
 - 17 -

10-year startup phase identified above. Accordingly, we find

that petitioner's history of losses does not establish that he

lacked the requisite profit objective.

Seventh, the amount and frequency of occasional profits

earned from the activity may also be indicative of a profit

objective. Golanty v. Commissioner, 72 T.C. at 427; sec. 1.183-

2(b)(7), Income Tax Regs. Other than the occasional cash awards

received from racing his horses, petitioner's horse activity

produced no income. However, an opportunity to earn a

substantial ultimate profit in a highly speculative venture may

be sufficient to indicate that the activity is engaged in for

profit even though only loses are generated. Pirnia v.

Commissioner, supra; sec. 1.183-2(b)(7), Income Tax Regs. The

business of breeding and racing horses is undoubtedly highly

speculative and risky. Nevertheless, petitioner aspired to be a

successful breeder of horses. It was petitioner's objective to

eventually produce horses capable of competing in a triple crown

race. Furthermore, petitioner had hoped that his activity would

at least be successful enough to facilitate his purchase of a

farm from which he could operate the activity. Accordingly, we

find that petitioner's failure to make occasional profits is not

a determinative factor in this case.

Eighth, the lack of substantial income from sources other

than the activity in question may indicate the existence of a

profit objective. Pederson v. Commissioner, T.C. Memo. 1994-555;
 - 18 -

sec. 1.183-2(b)(8), Income Tax Regs. Petitioner is by no means a

wealthy individual. In 1990, petitioner earned roughly $35,000

from his full-time job as a computer programmer. Petitioner also

earned approximately $7,000 in 1990 from a part-time job.

Petitioner's income in 1991 differed only slightly from that of

1990, as petitioner earned roughly $37,000 from his full-time job

and approximately $1,000 from his part-time job. Further, the

record is devoid of evidence suggesting other sources of wealth

enjoyed by petitioner. Given his income, we think it unlikely

that petitioner would embark on a hobby costing thousands of

dollars and entailing much personal labor without a profit

objective. See Engdahl v. Commissioner, supra at 670.

Finally, the absence of personal pleasure or recreation

relating to the activity indicates the presence of a profit

objective. Schlafer v. Commissioner, T.C. Memo. 1990-66; sec.

1.183-2(b)(9), Income Tax Regs. There is no question that

petitioner enjoyed working with his horses; however, he equally

enjoyed working as a computer programmer. It is human nature to

undertake those activities which we enjoy and to avoid those

activities which we find less appealing. It cannot be said that

petitioner had any more or less enjoyment from his horse activity

than that which customarily should be expected from an

entrepreneurial undertaking. Petitioner did not ride his horses,

nor did he permit others, except qualified jockeys, to ride them.

Even though petitioner derived personal pleasure from his labor-
 - 19 -

intensive horse activity, this is not sufficient to cause the

activity to be classified as not engaged in for profit if the

activity is, in fact, engaged in for profit as evidenced by other

factors. Sec. 1.183-2(b)(9), Income Tax Regs. Accordingly, we

find that this factor weighs in petitioner's favor.

Having considered the facts and circumstances of this case,

we conclude that, during the years at issue, petitioner engaged

in his horse activity with an actual and honest objective of

making a profit.

To reflect the foregoing,

Decision will be

entered under Rule 155.