T.C. Memo. 1996-285
UNITED STATES TAX COURT
JAMES C. VALLETTE AND ARLEEN R. VALLETTE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3380-94. Filed June 20, 1996.
James Alvin Watson, for petitioners.
Emile L. Hebert III, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: James C. Vallette and Arleen R. Vallette
petitioned the Court to redetermine respondent’s determination of
deficiencies in their 1989 and 1990 Federal income taxes.
Respondent determined an $18,990 deficiency for 1989 and a
$14,840 deficiency for 1990. Following concessions by the
parties, we must decide whether petitioners operated a cattle
breeding activity with the requisite profit objective within the
meaning of section 183. We hold they did not. Unless otherwise
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stated, section references are to the Internal Revenue Code in
effect for the years in issue. Rule references are to the Tax
Court Rules of Practice and Procedure. Dollar amounts are
rounded to the nearest dollar. James C. Vallette and Arleen R.
Vallette are referred to as Mr. Vallette and Mrs. Vallette,
respectively.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
These facts and the exhibits submitted therewith are incorporated
herein by this reference. Petitioners resided in Sulphur,
Louisiana, when they petitioned the Court. They filed 1989 and
1990 Forms 1040, U.S. Individual Income Tax Return, using the
filing status of “Married filing joint return”. Losses from a
self-owned cattle breeding activity were reported on petitioners'
1989 and 1990 Schedules F, Farm Income and Expenses.
In 1979, petitioners began their breeding activity under the
name Vallette Farm, at a site located approximately 1 to 2 miles
from their home.1 They bred heifers with bulls to produce calves
(a “cow-calf operation”). They sold the bull calves at market,
and they either sold the heifer calves at market or retained the
heifer calves for future breeding. Before 1979, petitioners had
never owned or operated a cattle breeding business. Petitioners
1
During the subject years, this site included 800 acres of
land. Petitioners owned 110 acres of this land, and they leased
the remaining acreage on a yearly basis. Petitioners never
improved any of the leased land.
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started breeding cattle in 1979, after they began receiving
substantial royalties from an oil well that was drilled on their
land. On their 1979 through 1994 Forms 1040, petitioners
reported the following amounts from cattle breeding and oil:
Cattle breeding
Net royalties
Year Income Expenses1 Net Loss from oil
1979 $2,690 $15,299 $12,609 $157,789
1980 3,862 68,964 65,102 172,379
1981 21,606 85,028 63,422 198,030
1982 9,562 70,297 60,735 226,610
1983 4,570 89,696 85,126 167,465
1984 12,020 108,025 96,005 190,019
1985 7,522 93,003 85,481 159,237
1986 13,984 80,162 66,178 100,317
1987 21,891 95,901 74,010 112,640
1988 5,135 93,455 88,320 142,692
1989 4,234 64,955 60,721 69,933
1990 - 0 - 67,998 67,998 72,048
1991 49,320 77,835 28,515 123,622
1992 13,550 90,689 77,139 114,921
1993 46,933 87,673 40,740 97,876
1994 36,053 67,698 31,645 49,011
Total 252,932 1,256,678 1,003,746 2,154,589
1
Petitioners' largest single expense was depreciation.
During the subject years, petitioners’ involvement in their
breeding activity included worming and feeding the cattle,
delivering calves, planting grass for the cattle, and maintaining
fences. Besides petitioners, the primary individuals who worked
in the breeding activity were petitioners’ two sons, Matthew and
Stephen, and their son-in-law, Kim Little. None of these helpers
received any compensation from petitioners for their help. All
of these helpers worked full-time for other employers. Stephen
and Kim also owned and operated other farms.
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Petitioners have never kept a set of books or records for
their breeding activity. They have never maintained any records
on the lineage, birth, or disposition of their cattle.
Mr. Vallette enjoys working with cattle. He grew up around
cattle, and the cattle industry is second nature to him.
OPINION
Respondent disallowed petitioners' losses from their
breeding activity because she determined that the activity was
"not engaged in for profit" under section 183. Section 183
generally limits the deductions for an activity not entered into
for profit. Sec. 183(b). An activity is not engaged in for
profit if deductions are not allowable for the taxable year under
section 162 or section 212(1) or (2). Sec. 183(c). Section 162
allows individuals to deduct ordinary and necessary expenses
connected with the conduct of a trade or business. Section
212(1) and (2) allows individuals to deduct expenses for the
production or collection of income, or for the management,
conservation, or maintenance of property held for the production
of income. Westbrook v. Commissioner, 68 F.3d 868, 875 (5th Cir.
1995), affg. T.C. Memo. 1993-634.
An individual engages in an activity for profit for purposes
of section 183 if he or she entered into, or continued, the
activity "with the actual and honest objective of making a
profit". Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), affd.
without published opinion 702 F.2d 1205 (D.C. Cir. 1983).
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An individual’s expectation of profit need not be reasonable, but
he or she must have a good faith objective of making a profit.
Allen v. Commissioner, 72 T.C. 28, 33 (1979); sec. 1.183-2(a),
Income Tax Regs. Whether a taxpayer conducts an activity with
the requisite profit objective rests on the facts of the case.
Golanty v. Commissioner, 72 T.C. 411, 426 (1979), affd. without
published opinion 647 F.2d 170 (9th Cir. 1981). More weight is
given to the objective facts than to an individual's subjective
expression of his or her intent. Sec. 1.183-2(a), Income Tax
Regs. Because respondent determined that petitioners’ breeding
activity was not engaged in for profit, petitioners must prove
that respondent's determination is in error. Rule 142(a);
Welch v. Helvering, 290 U.S. 111, 115 (1933); Westbrook v.
Commissioner, supra at 876. Petitioners rely almost exclusively
on their limited testimony, which focuses mainly on taxable years
preceding the years in issue, as well as the scant testimony of
Stephen and Kim, which also is aimed primarily at prior years.
The only exhibits in evidence are: (1) Petitioners’ 1979 through
1994 Forms 1040 and (2) the subject notice of deficiency. The
parties stipulated to minimal facts, and all of these stipulated
facts are best described as favorable to respondent.
We are aided by the following nonexclusive factors in
deciding 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 or her adviser; (3) the time and
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effort expended by the taxpayer in carrying on the activity;
(4) the expectation that assets used in the activity may
appreciate in value; (5) the success of the taxpayer in carrying
on similar or dissimilar activities; (6) the taxpayer's history
of income or losses in 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. Westbrook v. Commissioner, supra at 876; sec.
1.183-2(b), Income Tax Regs. None of these nine factors is
dispositive, in and of itself, and a decision does not rest on
the number of factors satisfied. Golanty v. Commissioner, supra
at 426; sec. 1.183-2(b), Income Tax Regs. We assess each factor
with the aid of our common sense, and we bear in mind the insight
that we have gained from a lifetime of experience, as well as our
understanding of how the relevant statutory scheme was meant to
apply to the facts at hand. Ranciato v. Commissioner, 52 F.3d
23, 25-26 (2d Cir. 1995), remanding T.C. Memo. 1993-536.
Bearing these basic principles in mind, we turn to the nine
factors, analyzing and discussing them one at a time.
1. Manner in which the activity is conducted
We consider the manner in which petitioners conducted their
breeding activity. See sec. 1.183-2(b)(1), Income Tax Regs.
Objective facts showing that a taxpayer carries on an activity in
a businesslike manner are indicative of a profit intent. The
same is true with respect to the maintenance of complete and
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accurate records. Id. The fact that an individual adopts a
different method of operating or abandons unprofitable methods
with respect to operating his or her activity may suggest a
desire to earn a profit. Id.
Petitioners have failed to persuade us that they conducted
their breeding activity in a businesslike manner. They rely
merely on their subjective expressions of intent, as well as the
limited testimony of family members. Petitioners did not produce
any of their activity’s records at trial. They did not establish
that they used "cost accounting techniques that, 'at a minimum,
provide the entrepreneur with the information he [or she]
requires to make informed business decisions." Burger v.
Commissioner, 809 F.2d 355, 359 (7th Cir. 1987) (quoting Burger
v. Commissioner, T.C. Memo. 1985-523), affg. T.C. Memo. 1985-523.
They did not demonstrate that they monitored expenses or assessed
their activity's profitability. They did not establish that they
maintained a budget for their activity, or that they advertized
any of their cattle for sale. Although Mr. Vallette testified
without contradiction that he tried before the subject years to
remedy his problem with “bad cattle” by switching his breed of
cattle to a breed that his “common knowledge” told him was the
better breed, we do not believe that this self-supporting
statement standing alone is enough to establish a profit intent.
The fact that petitioners’ activity experienced losses year after
year, and that they took no action to explain the losses or to
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reverse the tide, adds further support to our belief that
petitioners were, at best, indifferent as to whether the losing
trend could be reversed. See Ranciato v. Commissioner, supra at
26.
This factor favors respondent's determination.
2. Expertise of taxpayers
We consider the expertise of petitioners with respect to
their activity. See sec. 1.183-2(b)(2), Income Tax Regs. A
taxpayer's expertise, research, and study of an activity, as well
as his or her consultation with experts, is indicative of a
profit intent with respect thereto. Id. In preparing for an
activity, a taxpayer need not make a formal market study, but he
or she should undertake a basic investigation of the factors that
would affect the activity’s profitability. Underwood v.
Commissioner, T.C. Memo. 1989-625; Burger v. Commissioner, T.C.
Memo. 1985-523, affd. 809 F.2d 355 (7th Cir. 1987).
Mr. Vallette’s prior experiences with cattle made him
knowledgeable on the subject. The mere fact that he was skilled
in the cattle industry, however, does not mean that petitioners
began or continued their breeding activity for profit. Our
careful review of this factor suggests that the weight of
Mr. Vallette’s expertise and hands-on experience was offset by
petitioners’ lack of knowledge on the economics of the cattle
breeding industry. Among other things, the record does not
suggest that petitioners: (1) Sought any professional advice on
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the economic aspects of breeding cattle; i.e., on how to make the
activity profitable, see Burger v. Commissioner, 809 F.2d at 359;
(2) read any literature on the business side of breeding cattle;
(3) performed any meaningful economic study on the profit
potential of breeding cattle; (4) prepared any market analysis on
breeding cattle; (5) established a meaningful breeding plan; or
(6) studied, or consulted with professionals on, the magnitude of
expenses which they were likely to encounter.
This factor favors neither party. We consider it neutral.
3. Time and effort spent in conducting the activity
We consider the time and effort spent by petitioners in
conducting their activity. See sec. 1.183-2(b)(3), Income Tax
Regs. The fact that a taxpayer devotes much of his or her
personal time to an activity may indicate a profit intent. The
failure of a taxpayer to devote substantial time to an activity
weighs against a profit objective, unless, for example, the
taxpayer employs capable personnel to conduct the activity in his
or her stead. Employing capable personnel shows a profit intent.
Id.
Petitioners have not persuaded us that they spent much time
in their breeding activity during the subject years. Although
the record contains some testimony establishing that petitioners
and their relatives devoted time to the activity during the
subject years, we are not persuaded that this aggregate time
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weighs toward a profit objective. This factor favors neither
party. We consider it neutral.
4. Expectation that the assets will appreciate in value
We consider the expectation that assets used in petitioners’
activity may appreciate in value. See sec. 1.183-2(b)(4), Income
Tax Regs. The term "profit" includes the appreciation in the
value of assets used in an activity. Id.
Petitioners have not established that they expected their
activity’s assets to increase in value. Indeed, the value of
petitioners’ cattle decreased after the years in issue.
This factor supports respondent's determination.
5. Taxpayer's success on similar or dissimilar activities
We consider petitioners’ success on similar or dissimilar
activities. See sec. 1.183-2(b)(5), Income Tax Regs. Although
an activity is unprofitable, the fact that a taxpayer previously
converted similar activities from unprofitable to profitable
enterprises may show a profit intent with respect thereto. Id.
Petitioners have not established that they experienced any
success in a similar or dissimilar activity. This factor
supports respondent's determination.
6. An activity's history of income and/or losses
We consider petitioners’ history of income and/or losses
with respect to their activity. See sec. 1.183-2(b)(6),
Income Tax Regs. Losses continuing beyond the period customarily
required to make an activity profitable, if not explainable,
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indicate that the activity is not engaged in for profit.
Although a series of losses at the beginning of an activity does
not necessarily mean that the activity was not entered into for
profit, such a string of losses weighs against a profit intent
absent unforeseen or fortuitous circumstances beyond the
taxpayer's control (e.g., fire, disease, theft). A string of
substantial losses over many years and the unlikelihood of
turning a profit are important factors in ascertaining intent.
Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965), affd.
379 F.2d 252 (2d Cir. 1967); see also Cannon v. Commissioner,
T.C. Memo. 1990-148, affd. 949 F.2d 345 (10th Cir. 1991).
The start-up period for a cow-calf operation is 5 to 7
years. See Hrdlicka v. Commissioner, T.C. Memo. 1985-403.
Petitioners reported a loss from their cow-calf operation for
16 years in a row from 1979 to 1994, totaling $1,003,746.
Petitioners have not established that any of these breeding
losses was due to unforeseen or fortuitus circumstances beyond
their control or that this stream of losses was likely to change.
Petitioners have also offered no evidence, other than their
subjective testimony, to support their assertion that these
losses were from a business.
Even if we were to assume, arguendo, that petitioners had a
profit objective before the subject years, we would still not be
persuaded that they retained this objective during the subject
years. In order to fall outside the purview of section 183, one
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need not merely have had a profit objective before the years in
dispute. The taxpayer must possess the required objective during
each disputed year. Sec. 1.183-2(b), Income Tax Regs.; see also
Dennis v. Commissioner, T.C. Memo. 1984-4. Although a profit
intent in a prior year may be evidence of such an intent in a
later year, a prior intent will not serve as a "blank check" for
a taxpayer to continually operate a loss activity outside the
scope of section 183. See Daugherty v. Commissioner, T.C. Memo.
1983-188.
This factor favors respondent's determination.
7. Amount of occasional profits
We consider the occasional amount of profits, if any, from
the subject activity. Sec. 1.183-2(b)(7), Income Tax Regs. For
the reasons stated immediately above, we hold that this factor
favors respondent’s determination.
8. Financial status of taxpayer
We consider petitioners' financial status. See sec.
1.183-2(b)(8), Income Tax Regs. Substantial income from sources
other than an activity, particularly if the activity's losses
generated substantial tax benefits, may indicate that the
activity is not engaged in for profit. This is especially true
where there are personal or recreational elements involved.
Id.; see Jasionowski v. Commissioner, 66 T.C. 312, 322 (1976).
From 1979 to 1994, petitioners reported substantial taxable
income independent of their breeding losses. Petitioners'
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ability to earn this income let them finance their breeding
activity, and it allowed them to use the activity's losses to
reduce significantly their income tax liability for each year.
This factor favors respondent's determination.
9. Elements of personal pleasure
We consider the personal pleasure derived by petitioners
from conducting their activity. See sec. 1.183-2(b)(9), Income
Tax Regs. Although the mere fact that a taxpayer derives
personal pleasure from a particular activity does not negate a
profit intent with respect thereto, the presence of personal
motives may indicate that the activity is not engaged in for
profit. This is especially true where there are recreational or
other personal elements involved. Id.
Our review of the record, in conjunction with our
observation of petitioners during their testimony, leads us to
believe that they had strong personal reasons for breeding
cattle. Our observation of petitioners testifying at trial leads
to the inescapable conclusion that they each gained significant
personal pleasure from their involvement in the cattle industry,
and that their enjoyment and satisfaction would have been the
same regardless of the activity’s bottom line. See Ballich v.
Commissioner, T.C. Memo. 1978-497. Among other things, we
believe that Mr. Vallette, the backbone of petitioners' breeding
activity, engaged in that activity due to his affection for
cattle. He has been involved with cattle since a very young age,
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and his co-workers in the activity have always been his wife and
their immediate family, none of whom were paid. As this Court
observed, with respect to this factor:
Unquestionably, an enterprise is no less a 'business'
because the entrepreneur gets satisfaction from his work;
however, where the possibility for profit is small (given
all the other factors) and the possibility for gratification
is substantial, it is clear that the latter possibility
constitutes the primary motivation for the activity.
[Burger v. Commissioner, T.C. Memo. 1985-523, affd. 809 F.2d
355 (7th Cir. 1987).]
This factor favors respondent's determination.
10. Conclusion
Based on our discussion above, we conclude that petitioners
operated their activity without an "actual and honest" objective
of making a profit. The activity provided petitioners with
satisfaction, and any income derived therefrom served only as an
added bonus to them.
We have considered all arguments made by petitioners for a
contrary holding and, to the extent not discussed above, have
found them to be without merit. To reflect concessions,
Decision will be entered
under Rule 155.