T.C. Memo. 1997-54
UNITED STATES TAX COURT
STANLEY M. KURZET AND ANNE L. KURZET, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 27982-91. Filed January 29, 1997.
J. Gordon Hansen and Daniel M. Allred, for petitioners.
M.K. Mortensen and Mark H. Howard, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined deficiencies, additions
to tax, and accuracy-related penalties in petitioners' Federal
income taxes for 1987, 1988, and 1989, as follows:
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Accuracy-
Related
Additions to Tax Penalty
Sec.
Sec. 6653(a)(1)/ Sec. Sec. Sec.
Year Deficiency 6651(a)(1) 6653(a)(1)(A) 6653(a)(1)(B) 6661 6662(a)
1987 $440,539 --- $22,027 * $110,135 ---
1988 202,360 --- 10,118 --- 50,590 ---
1989 215,930 $7,845 --- --- --- $43,186
* 50 percent of interest due on portion of underpayment
attributable to negligence.
In an Amendment to Answer, respondent increased the
deficiency, addition to tax, and accuracy-related penalty for
1989 to $404,418, $17,269, and $80,883, respectively.
The primary issues for decision are: (1) Whether, during
the years in issue, petitioners' ownership and management of a
timber farm property near Coos Bay, Oregon, constituted a trade
or business activity entered into for profit, as petitioners
contend, or a personal, nonbusiness, not-for-profit activity, as
respondent contends; (2) whether petitioners' investment in
property in Tahiti constituted a for-profit investment under
section 212; (3) the deductibility under section 162 or section
212 of expenses relating to petitioners' use of a Lear jet to
travel, among other places, to their Oregon timber farm property
and to their property in Tahiti; and (4) to what extent expenses
of petitioners' residence in Orange, California, qualify as home
office expenses under section 280A. Various additional and
alternative issues are also for decision (e.g., if petitioners'
timber farm constitutes a for-profit trade or business activity,
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whether petitioners should be required to capitalize additional
costs relating to the timber farm as part of the costs of a water
reservoir).
Unfortunately, pretrial, trial, and posttrial proceedings in
this case are marked by miscommunication between the lawyers for
the parties and by frequent allegations by one lawyer against
another that there is misrepresentation of the facts and
evidence. The inability of the parties' lawyers in this case to
communicate effectively with each other resulted in the trial of
issues that should have been settled and in the presentation of
evidence and arguments in an untimely and confusing manner.
The Court spent hours with the parties' lawyers attempting
to identify and articulate the various primary and alternative
issues and arguments and the relationship of the issues to each
other. Similar to much of the miscommunication between the
parties throughout the pretrial and trial, arguments made in the
parties' posttrial briefs are filled with unnecessary accusatory
statements.
Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
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FINDINGS OF FACT
Some of the facts have been stipulated and are so found. At
the time their petition was filed, petitioners resided in Park
City, Utah.
Petitioner Stanley Kurzet (petitioner) was a successful
inventor and businessman. For many years, petitioner owned and
personally managed ALS Corp. (ALS), a company based in southern
California that petitioner founded in 1958 and that was involved
in the design and manufacture, apparently for the U.S. military,
of sophisticated electronic and engineering equipment.
ALS became extremely profitable and valuable. In 1984, at
the age of 53, petitioner sold the stock of ALS in an arm's-
length transaction to an unrelated third party for $20 million in
cash.
As part of the sale of ALS, petitioner entered into a
limited, 7-year consulting agreement with the new owners of ALS
to be available to consult with the new owners in the continuing
management of ALS, and petitioner entered into a broad covenant
not to compete with ALS. The covenant not to compete prohibited
petitioner from engaging in any business or investment activity
relating, in any way, to the type of engineering work and
business in which ALS was engaged and severely restricted
petitioner's ability to engage in any business or for-profit
activity that related, in any way, to petitioner’s prior work and
experience at ALS.
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As a result of a number of factors (namely, the $20 million
that became available to petitioners on the sale of ALS, the
consulting agreement that required little of petitioner's
considerable skill, experience, and time, the broad restrictions
on petitioner's activities to which petitioner became subject
under the covenant not to compete, and petitioner's relatively
youthful age and vigor), after the sale of ALS in 1984,
petitioner began an extensive and businesslike investigation of
business and investment opportunities in which the approximately
$20 million that petitioners had available might appropriately be
invested and to which petitioner might apply his considerable
business talent. Petitioner personally consulted with various
experts and obtained advice regarding market trends and types of
industries that might have unique and positive growth and
appreciation potential.
Over the course of the next few years and as a result of
various activities, investments, and companies in which
petitioners invested and were involved, petitioners earned and
realized very significant income. Assets in which petitioners
invested appreciated significantly, some of which appreciation
petitioners have realized and some of which, as of the time of
trial, petitioners have not yet realized because the assets are
still held by petitioners. Over the years, petitioner has
demonstrated a skill and talent for making a profit.
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After selling ALS in 1984, the primary activities and assets
in which petitioners invested and participated and that are at
issue in this case involve timber farming in Oregon, real
property in Tahiti, a Lear jet, a limited consulting business
based in southern California, and a computer and real estate
rental business based in southern California. Petitioners
incurred significant expenses associated with each of these
activities and businesses, and petitioners, on their books and
records and on their joint Federal income tax returns, treated
most of the expenses relating to these activities and businesses
as deductible expenses of a trade or business.
Apparently due to errors made by petitioners and to careless
income tax return preparation by petitioners' accountants and tax
return preparers, numerous errors and mistakes in classification
of the expenses relating to the above activities occurred on
petitioners' original books and records and on petitioners'
Federal income tax returns.
On audit, respondent made blanket determinations that
essentially all of petitioner's activities constituted personal,
nonbusiness, and not-for-profit activities. Respondent's blanket
determinations, combined with the errors that occurred on
petitioners' books and records and Federal income tax returns,
resulted in the disallowance of many of the expenses claimed on
petitioners' Federal income tax returns for the years in issue
and in respondent's determination of the substantial income tax
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deficiencies, additions to tax, and accuracy-related penalty set
forth above.
Prior to and during trial in this case, petitioners'
representatives submitted to respondent on behalf of petitioners
a number of "proposed revised" Federal income tax returns for
each of the years in issue that attempt to correct or clarify
some of the classification errors that occurred on petitioners'
original income tax returns. Respondent argues that petitioners'
proposed revised income tax returns are confusing and
inconsistent, and perpetuate many of the errors made in
petitioners’ original income tax returns, that petitioners’
proposed revised income tax returns should be ignored, and that
petitioners' original income tax returns should be the focus of
our analysis.
We disagree with respondent, in significant part, on this
point. In the many instances where petitioners' proposed revised
Federal income tax returns reflect additional items of income or
reductions in amounts claimed as expenses on petitioners'
original Federal income tax returns and/or the reclassification
of expenses consistent with classifications made by respondent in
respondent's notice of deficiency, petitioners' proposed revised
Federal income tax returns, with regard to such items, are to be
treated as concessions by petitioners.
Where petitioners' proposed revised returns reflect
reductions in petitioners' alleged income or increases in claimed
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expenses, as compared with petitioners' original Federal income
tax returns as filed with respondent, petitioners' proposed
revised returns, with regard to these new items and issues, are
to be ignored except to the extent that petitioners have filed
with the Court amendments to their pleadings to properly raise
new issues with regard to such alleged reductions in income and
alleged increases in expenses. Rule 41.
We also note that as a result of information provided by
petitioners to respondent during the course of the audit and
litigation, including the proposed revised returns, respondent
has significantly revised and lowered her original deficiency
determinations against petitioners.
Timber Farm
Prior to 1984, petitioner had no experience in the timber
industry, in farming, or in cattle raising. Petitioner, however,
in 1984 and 1985, after receiving approximately $20 million from
his sale of ALS, investigated and consulted with a number of real
estate and forestry experts about the timber industry and
forestry management.
Specifically, with regard to 621 acres of timber property in
Coos County, Oregon (timber farm), petitioner inspected the
timber farm and the trees growing thereon with real estate agents
and forestry experts. Petitioner and the experts considered the
type and quantity of trees growing on the timber farm, the type
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of soil and terrain, the expected growth rate of the trees, and
water resources on the timber farm.
Petitioner also studied information received from the U.S.
Forest Service relating to tree growth and management.
After inspecting the timber farm and conferring with experts
and after considering the financial risks and profit potential,
in June of 1985 petitioners purchased for $568,890 in cash the
timber farm in Coos County, Oregon.
The timber farm included 454 acres of forest land covered
primarily with Douglas fir and spruce trees, 152 acres of bottom
land, a number of barns, sheds, and three small houses.
In 1985, the Douglas fir, spruce, and other trees located on
the timber farm were of an average age of 30 to 40 years. The
trees were just reaching their peak growth rate, growing at a
rate of approximately 10 percent per year.
Petitioner agreed to the $568,890 purchase price for the
timber farm based on his analysis that, as of the time of
purchase in June of 1985, the cumulative value of the standing
timber on the timber farm, of the land, and of the existing
buildings and improvements totaled approximately $750,000.
For many years prior to 1985, the timber farm that
petitioners purchased was considered timber farm property on
which trees had been grown, cut, and commercially logged. The
prior owners of the timber farm last conducted a major harvest of
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timber on the timber farm in 1945. The most recent harvest of
timber on the timber farm occurred in 1975.
Douglas fir and spruce trees are typically cut or harvested
by commercial foresters once every 35 to 60 years.
In prior years, the timber farm also was used to raise
cattle and as a dairy farm.
Petitioners’ timber farm was typical of other timber farm
property located along the Oregon coast. Such timber farm
property is typically used to grow and cut timber, to grow hay,
and to raise cattle. Typically, timber farmers make the decision
when to cut and harvest timber based on the price of timber and
their individual financial needs.
Petitioners' timber farm is bordered on all sides by
commercial timber property, most of which is owned by Georgia
Pacific Corp., which has been commercially cutting and harvesting
timber on the adjacent property for a number of years.
At the time of petitioners' purchase of the timber farm, the
roads, houses, and barns located on the timber farm were in
significant disrepair and were inadequate for continued
occupancy.
Petitioner initiated many projects to improve the timber
farm. The small houses and barns were repaired and improved.
Poisonous plants in the pastures were eradicated and a water
reservoir was constructed. Junk cars and junk farm machinery
located on the timber farm were removed and hauled to the dump.
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In western Oregon, because of the wet climate and high
rainfall that occur during the winter months, owners of timber
farm property with main roads running through it that are "in
place" and “hardened off” --- which takes a year or two after
construction -- have a significant marketing advantage because
they are able to cut and harvest timber on their property in
winter and on short notice, and can thereby take better advantage
of short or sudden swings in the price of cut timber.
Accordingly, after purchase of the timber farm, petitioner
made a particular effort to improve the roads on the timber farm.
Petitioner incurred many expenses and hired employees to repair
and improve the existing roads and to construct new roads so as
to be in a position, in subsequent years, to cut and harvest
timber on the timber farm on short notice and thereby take
advantage of favorable prices for cut timber.
Petitioner also initiated construction of a large new
building for a machine shop and installation of a mobile unit and
related water system.
Rather than hire expensive contractors to come onto the
timber farm to perform the many repair, improvement, and
construction projects that petitioner initiated, petitioner
himself designed and performed much of the work on the timber
farm. Petitioner himself often operated graders and other heavy
equipment on the timber farm in repairing and improving the
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roads, in constructing new roads, and in constructing the water
reservoir.
In 1986, 1987, and 1988, petitioner made significant
expenditures of his own time and money to repair buildings, to
improve and construct 5 miles of roads, to grade fields, and to
install several miles of pipes.
For the various projects that were undertaken and also for
security on the timber farm, petitioner hired two employees to
live and work on the timber farm. These employees were
experienced farmers, timber men, and carpenters. Petitioner and
his employees had to constantly watch for and keep off of the
timber farm individuals who would attempt to trespass on the
property to strip cedar trees, to pick mushrooms, and to grow
marijuana.
During these years in which petitioner was building roads
and improving and maintaining the timber farm for purposes of
eventual cutting and harvesting of timber, Georgia Pacific, on
its adjacent timber property, was building more miles of roads
per acre than petitioner built on his timber farm.
The principal risk to a mature stand of timber is fire.
During the years before us, petitioner and his employees had to
fight one fire on the timber farm which destroyed 1½ acres of
timber before the fire was extinguished.
As mentioned, in 1987 and 1988, in order to establish a
source for additional water to protect trees on the timber farm
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from fire and to provide irrigation for hay and cattle, a water
reservoir was constructed on the timber farm by excavation of
earth abutting a creek. The water reservoir was to be no higher
than the original stream flow, 5 to 15 feet deep, and no dam was
to be constructed. In 1988, the reservoir first filled with
water and became available as a source of water for fighting
forest fires.
Due to weather and erosion damage, in subsequent years the
water reservoir had to be regraded and refilled a number of
times. No permit was needed to use the water in the reservoir to
fight forest fires.
On a ridge above the reservoir, petitioner also excavated a
pond and constructed a windmill with the intent of using
electricity produced from the windmill to pump water from the
reservoir up to the pond so that a helicopter with a dip bucket
could scoop water up from the pond to fight fires.
The use of water reservoirs or ponds as a source of water to
fight fires was a common practice in this part of Oregon, and the
reservoir and pond excavated on petitioners’ timber farm were
suitable for that purpose. Weyerhaeuser Corp. constructed 70 or
80 ponds, and the U.S. Bureau of Land Management constructed over
200 ponds in western Oregon to aid in fighting forest fires.
Construction of an elevated pond and pumping water up to the
pond via power generated from a windmill, however, do not
constitute improvements typical of Oregon timber property.
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Petitioners did not submit applications to the State of Oregon
for permission to perform the land excavation relating to
construction of the water reservoir until 1988, and permission
was not received from the State of Oregon until September of
1990.
Further excavations and improvements to the water reservoir
were the primary construction project on which petitioners and
his employees worked in 1989.
Rather than rent the numerous pieces of farm equipment and
machinery needed for the various projects that petitioner and his
employees personally undertook on the timber farm, during the
years before us, petitioner traveled occasionally throughout
Oregon and Washington to auctions of used farm equipment and
machinery in order to acquire used equipment for use on the
timber farm. Often, at the time of purchase by petitioner, such
equipment was not operational, and petitioner personally and with
his employees would rebuild and restore the equipment.
In 1985, petitioner purchased a used fire truck for use in
protecting trees on the timber farm from fire. Petitioner
purchased used equipment for harvesting, cutting, and baling hay,
and chain saws and other equipment to cut timber. Petitioner
purchased used machine shop equipment to maintain the machine
shop on the timber farm so that petitioner and his employees
could make, on the property, essentially all repairs to the farm
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and other equipment without hiring expensive machinists and
equipment repairmen.
Again, we note that petitioner purchased for the timber
farm old and used farm and machine shop equipment because it was
much cheaper than purchasing new equipment, because much of the
equipment would not be used frequently on the property, and
petitioner therefore had no need for new equipment, and because
of petitioner's talent and competence in restoring and
maintaining mechanical equipment.
Petitioner was able to acquire from auctions a large
variety of used farm equipment, to restore the equipment, and, as
of the time of trial, in the barns located on the timber farm,
petitioner maintained in excellent condition and stored for use
on the timber farm approximately 30 pieces of old but operational
farm equipment. The parties and their experts are in agreement
as to the excellent restoration and high quality maintenance of
the equipment located on the timber farm.
From the time petitioners purchased the timber farm in June
of 1985, until September 8, 1989, petitioners’ primary residence
was in Orange, California. From September 8, 1989, through the
time of trial, petitioners' primary residence was in Park City,
Utah.
Petitioners traveled to their Oregon timber farm
approximately 4 or 5 times a year, and on each trip petitioners
typically would spend a number of weeks on the timber farm. In
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1987, 1988, and 1989, petitioners spent 127, 139, and 80 days,
respectively, on the timber farm.
On the days on which petitioners were at the timber farm,
petitioner worked constantly on the timber farm -- designing and
planning repairs and improvements, personally operating heavy
equipment such as graders, and working to improve and maintain
roads and buildings, to clear brush, to build new roads for fire
protection and for use in eventual harvesting of the timber.
When at the timber farm, Mrs. Kurzet worked on the records
and other chores relating to maintenance of the timber farm, and
petitioners generally worked from sunrise until sunset on various
projects relating to the timber farm.
When petitioner was not working on the timber farm,
petitioner would leave detailed written instructions for the
employees to follow in his absence, listing priority projects on
the timber farm on which the employees should work.
In 1985, petitioners purchased a modest mobile unit and
placed it on the timber farm for use as an office and on-site
sleeping accommodation for the days they were at the timber farm.
Two of the rooms in the mobile unit were used as a computer room
and work room in connection with the timber farm. One room was
used as a bedroom for petitioners. The kitchenette and dining
area were used frequently for paperwork, recordkeeping, meetings,
and an office for the timber farm.
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Petitioners made and paid for modest improvements to the
mobile unit. From 1985 through 1989, petitioners' total cost for
purchase of and improvements to the mobile unit was $147,643.
Petitioners have never stayed on or used the timber farm for
personal purposes. Similarly, petitioners have never stayed
overnight in the mobile unit for personal purposes. Petitioners
remained in the mobile unit overnight only when they were at the
timber farm to work on the various repair and improvement
projects.
After purchasing the timber farm in 1985, petitioner
continued to investigate, study, and consult with experts in the
timber industry as to how to manage the timber farm. Petitioner
spoke frequently with representatives of Georgia Pacific and
observed how Georgia Pacific managed and harvested timber from
its timber farm property adjacent to petitioners' timber farm.
Petitioner often checked the market price for cut timber and
evaluated whether any of the timber on the timber farm should be
cut and sold.
In 1985 and 1986, soon after petitioners purchased the
timber farm, timber prices fell dramatically in the United States
and, until at least 1989, remained below the estimated costs
petitioner would incur to harvest the timber. Accordingly, on
advice of others in which he concurred, petitioner postponed the
cutting, harvesting, and sale of any of the standing timber on
the timber farm.
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As explained by one of the timber experts with whom
petitioner frequently consulted and with which explanation we
agree --
the age class of the timber when * * * [petitioners]
bought the property was roughly 30 to 40 years old. It
was just reaching its peak in growth rate. Quality was
becoming better by natural pruning of the limbs, log
diameters were increasing. It was probably growing at
10 percent a year, so it had been -- the worst thing
* * * [petitioners] could have done would have been cut
the timber shortly after they bought the property,
which the recruise shows now that that was the smart
thing to do. The volume’s -- over doubled.
After 1989, even though prices for cut timber increased,
petitioner has continued to postpone the cutting and sale of
timber on the timber farm in part because the trees on the timber
farm were approaching 60 years of age -- at which point in time
trees move into a separate commercial class for trees over 60
years of age and increase in value by approximately 30 percent.
From the time of purchase in 1985, until the time of trial
in 1995, the volume of timber in the trees on petitioners’ timber
farm has approximately doubled.
As of May of 1995, the assets on petitioners’ timber farm
have a fair market value of approximately $3,524,000, as set
forth below:
May 1995
Timber Farm Assets Fair Market Value
Timber $2,100,000
Buildings and improvements 908,000
Equipment and machinery 516,000
Total $3,524,000
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Petitioners never raised any cattle or sheep on the timber
farm, and, in approximately 1989, petitioners abandoned plans to
raise cattle and sheep on the timber farm due to lack of adequate
summer rainfall to sustain a second harvest of hay that the
cattle and sheep would need.
There were no recreational amenities or activities of any
kind on the timber farm -- no tennis court, no putting green, no
swimming pool, no horses, no lake, no boating, no fishing, no
recreational or resort facilities. The evidence is clear that
petitioners' timber farm was not owned, operated, or used by
petitioners for recreation, leisure, or other personal purpose.
Petitioner personally set up and maintained computerized
accounting records with respect to expenses relating to the
timber farm. As mentioned earlier, petitioners' records were not
totally adequate, and expenses relating to the timber farm were
often mislabeled or associated with the wrong activity. The
evidence establishes, however, and respondent does not dispute,
that all of the expenses claimed on petitioners' original Federal
income tax returns and all of the expenses claimed on
petitioners' proposed revised Federal income tax returns with
respect to the timber farm were incurred and are fully
substantiated -- as to amount and payment -- by petitioners'
books and records.
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From the time of purchase in 1985 through May of 1995,
approximate total expenditures petitioners incurred and paid in
connection with the timber farm -- as allocated by petitioners
between petitioner's various activities and including
petitioners’ allocation for expenses of traveling to the timber
farm in petitioner's Lear jet (as explained more fully below) but
not including mere book items such as depreciation and recapture
thereof --- are summarized below:
Category of Timber Farm Expenses Amount
Purchase Price of Timber Farm $ 569,000
Cost of Improvements to Land 400,000
Cost of Equipment and Vehicles 625,000
Maintenance and Operating Expenses 1,160,000
Lear Jet Operating Expenses 428,000
Cumulative 1985-May 1995 Expenses $3,182,000
In summary, by May of 1995, the $3,524,000 total estimated
fair market value of the timber located on petitioners' timber
farm, of the land, of the buildings, of improvements to the land
and buildings, and of the equipment and machinery purchased for
use on the timber farm reflected an unrealized profit (before
taxes) of approximately $342,000 over the total $3,182,000 that
petitioner paid over the years to purchase, improve, and maintain
the timber farm.
Tahiti Property
In 1984, petitioners purchased 5.5 acres (consisting of
three adjacent parcels) of oceanfront property on the main island
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of Tahiti for $1.1 million (Tahiti Property). On the Tahiti
Property during the years in issue, petitioners or others paid by
petitioners remodeled and renovated a house, installed a solar
water heating system, a spa, a culinary water system, and
underground utilities, dredged a boat channel, added a satellite
TV system, converted the electrical power system to 110 volts,
installed a diesel power generator as an alternate source of
electricity, and made many other significant improvements.
Petitioner personally designed and worked on many of the
projects undertaken at the Tahiti Property. Petitioner hired an
individual to provide security for the property and to manage and
pay repairmen and workmen hired to work on the property.
Generally, twice a year, petitioners traveled from
California or Utah to the Tahiti Property. Typically, on each
trip, petitioners would stay at the Tahiti Property for a number
of weeks.
To pay for costs incurred on the Tahiti Property in
connection with the various repair and improvement projects,
petitioners frequently transferred funds in U.S. currency from
their bank in California to a bank account they maintained in
Tahiti. Petitioners have documentation of total funds
transferred to their bank account in Tahiti to pay for expenses
relating to the Tahiti Property, but the evidence does not show
or substantiate the specific use of the funds transferred to
petitioners' bank account in Tahiti.
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Petitioners allege that from 1984 through 1994 their
cumulative cash expenditures relating to purchase and
improvements undertaken on the Tahiti Property totaled
$1,760,000.
Lear Jet
In 1984, because of anticipated frequent travel, petitioner
purchased a Lear jet airplane for $2 million. The Lear jet was
used by petitioners for personal travel and to travel to
petitioners' timber farm in Oregon, to petitioners' Tahiti
Property, to computer symposiums, to machinery auctions, to pick
up equipment and parts needed in petitioners' various activities,
and to Park City, Utah, where petitioners skied and eventually
bought two condominiums and two vacant lots, on one of which
petitioners built a large personal residence.
When traveling to the timber farm and to the Tahiti
Property, petitioner often would transport in the Lear jet
equipment and supplies that would be used at the timber farm and
on the Tahiti Property. Occasionally, other family members would
travel with petitioners in the Lear jet.
During 1987 through 1989, the first-class air fare between
Orange, California, where petitioners’ primary residence was
located, and North Bend, Oregon, the airport closest to
petitioners' timber farm, was approximately $1,600 per person. A
commercial airplane trip between these two cities would take
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approximately 9 hours and would involve two stops and at least
one change of planes.
During the years in issue, petitioner paid a full-time pilot
approximately $30,000 a year to fly the Lear jet. Petitioner
also was a pilot and served as the second pilot required to fly
the Lear jet.
After flying petitioners to Oregon and to the Tahiti
Property, and while waiting to fly petitioners back to California
or Utah, the pilot, at petitioner’s request, would often assist
with various projects at the timber farm and at the Tahiti
Property.
The Lear jet operating expenses for 1987, 1988, and 1989,
including depreciation totaled $667,709, $728,201, and $402,399,
respectively.
Petitioner sold the Lear jet in 1994 for $2.45 million.
For purposes of their books and records and their income tax
return treatment of expenses of operating the Lear jet,
petitioners each year made an allocation of expenses of the Lear
jet between what petitioners regarded as business and as personal
use. For example, with regard to a trip from Los Angeles to Salt
Lake City on February 6, 1989, for the stated purpose "to see
condo, conferring with architect, and ski", the total 1.4 hours
each way for the Lear jet were allocated by petitioners .7 hour
for personal and .7 hour for business, because petitioners viewed
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the trip as having a dual purpose (namely, to ski and to meet
with a contractor doing work on one of petitioners'
condominiums).
Personal Residence
As indicated, during 1987, 1988, and until September 8,
1989, petitioners’ principal residence was located at 394 South
Esplanade, Orange, California. This residence was an elegant 24-
room home on 3.5 lushly landscaped acres. It had a swimming
pool, garden patio, servants' quarters, a garage workshop, garden
equipment buildings, and parking for up to approximately 40 cars.
Petitioner had rooms in this residence in which petitioner
performed paperwork and computer tasks associated with his
various activities. In their residence in Orange, California,
petitioners also performed bookkeeping, maintained reference
manuals and industry publications, and paid numerous bills
relating to their many activities.
Petitioners' residence consisted of three levels. In the
partial, walkout basement were located two rooms in one of which
computers and a copy machine were placed, a bathroom, a furnace
room, a small wine room, and a family room.
On the main level were located a study or library in which
petitioner occasionally met with others on business matters, the
main living room, a large entry, a dining room, three bedrooms,
three full baths, and one-half bath.
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On the upper level of the residence were 3 rooms in which
were located many of petitioners' business, financial, and
personal records, additional computers, and a bath. In one of
these rooms, Mrs. Kurzet reviewed, paid, and maintained files
relating to business and personal bills and activities. In the
other two rooms, petitioner maintained an office and a lab with
electronic circuit testing equipment related to ALS and his
consulting duties.
For 7 years, from 1984 to 1991, petitioner continued to be
available to act as a consultant to ALS, and petitioner received
a $10,000 per month consulting fee under the contract for the
sale of ALS.
Over the course of the 3 years in dispute, petitioner
actually performed for ALS consulting services 3 or 4 times a
year. Petitioner had no other clients as a consultant.
In connection with his consulting for ALS, petitioner had
access to the offices of ALS.
The primary real estate that petitioners owned and rented to
tenants consisted of a large industrial warehouse in southern
California. Petitioners also owned and rented to tenants two
condominiums in Park City, Utah. The evidence is not clear to
what extent petitioners used a real estate firm in Park City,
Utah, to manage the condominiums.
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Petitioners’ Books and Records
In 1984 and 1985, petitioner personally developed a
computerized bookkeeping system or software program for keeping
track of expenses relating to petitioners’ various personal,
business, and investment activities. Petitioners’ bookkeeping
system represents a single entry system encompassing the debit
side of what is normally encompassed in a double-entry
bookkeeping ledger. Petitioners' computerized system is
homemade, but it does allow petitioners to track their expenses
and to sort and analyze expenses by activity to which the
expenses are charged, by job, by payee, and by a number of other
criteria.
Petitioners generally retained receipts relating to the
majority of their business and personal expenses, and such
receipts generally are still available.
As indicated, petitioners' computerized bookkeeping system
did not keep track of income. Relatively few transactions
produced large amounts of income for petitioners. Mrs. Kurzet
kept track of income received by way of separate records and
files. Generally, other than income on bank accounts and
security transactions, income petitioners received was deposited
into petitioners’ bank accounts. Copies of the deposit receipts
were retained in a file, and at the end of each year all income
was entered onto spreadsheets that were given to the accountants
who prepared petitioners’ income tax returns.
- 27 -
Petitioners’ computerized bookkeeping system for their
expenses has 153 different account numbers for each of nine
different classes of activity. If an expense was regarded by
petitioners as a personal expense, it would be so identified.
Many of petitioners’ business and personal expenses were
paid for by credit card. Upon receipt of each monthly credit
card bill, petitioners would allocate each charge on the bill
between what they regarded as business and personal expenses.
If an expense was to be treated as a business expense,
petitioners would identify the particular business activity to
which the expense would be allocated.
On their three checking accounts -- one located at a bank in
California, one located at a bank in Oregon, and one located at a
bank in Tahiti -- petitioners wrote checks to pay bills relating
to their business and personal activities. Mrs. Kurzet would
prepare most of the checks to pay both business and personal
bills on a computer located in their residence in Orange,
California.
Petitioners’ Federal Income Tax Returns
Petitioners acknowledge that many errors were made both on
their 1987, 1988, and 1989 Federal income tax returns as
originally filed and as submitted to respondent as proposed
revised returns. Petitioners attribute many of the errors to the
fact that petitioners were not trained accountants, that
- 28 -
petitioners personally developed the bookkeeping system and
maintained the books and records relating to their various
activities, and they claim that only inadvertently were expenses
not properly allocated by petitioners to the proper activity.
For example, on petitioners’ original returns for the years
in issue, petitioner’s Roll Royce and a condominium in Park City,
Utah, both of which were personal assets not used in any of
petitioners’ businesses, were incorrectly allocated to a business
activity and depreciation was claimed thereon.
Petitioners’ and their accountants’ casualness -- in making
allocations on both their original and their proposed revised tax
returns between petitioners’ alleged business, investment, and
personal activities -- is illustrated by the allocation of costs
associated with an umbrella liability insurance policy relating
to petitioners’ Orange, California, residence.
Q. [by petitioners’ lawyer] I just handed you another
document entitled "Allocation of Umbrella Liability
Insurance," which has been entered into evidence as Joint
Exhibit 103-CY. Are you also familiar with this document?
A. [by petitioners’ accountant] Yes, I am.
Q. And did you prepare it?
A. Yes, I did.
Q. Would you please describe it to the Court?
A. This is a document that I prepared entitled
"Allocation of Umbrella Liability Deductions Claimed on
Revised Returns." It simply allocates the umbrella
liability portion of their insurance which is a component of
- 29 -
other insurance on the home, which is contained in Exhibit 5
-- or account 524 and Exhibit 116 again, and I’ve allocated
it equally to each one of these business activities based on
conversations with Mr. Kurzet on -- on his purpose for
purchasing that additional insurance.
THE COURT: This is umbrella liability on -- on their
activities or on the home, the Orange County --
THE WITNESS: It’s on -- my understanding, Your Honor,
is it’s activities that happen at four -- essentially four
locations: the home in Orange County, the timber farm, the
investment property in Tahiti, and the industrial building
in Orange County, and I simply allocated it equally to each
of those.
THE COURT: Not the home, not the Orange County home?
THE WITNESS: It does include the Orange County home.
THE COURT: Where is that on your schedule?
THE WITNESS: It would be the consulting.
THE COURT: Consulting you labeled as "home"? It’s in
fact the home, and you labeled it consulting? How do you
get the "consulting" label for the home in Orange County?
THE WITNESS: Because that’s where the activity was
carried out.
THE COURT: I’m missing something here. There were
many activities carried on at the home --
THE WITNESS: Right.
THE COURT: -- 20 percent of which allegedly is
consulting and business related, and 80 percent of which is
personal?
THE WITNESS: Right.
THE COURT: So where -- where is the personal aspect of
the allocation? Where is the allocation --
THE WITNESS: We have not --
THE COURT: -- of the umbrella liability to the
personal activities?
- 30 -
THE WITNESS: We have not allocated any to personal
here.
THE COURT: Why not?
THE WITNESS: Mr. -- that was based on conversations
with Mr. Kurzet that -- that his sole purpose for the
additional insurance -- this is liability over and above the
homeowners which we have taken personal portion, but for
this --
THE COURT: Well, they have three and a half acres of--
THE WITNESS: Right.
THE COURT: -- of country estate. They have a little
swimming pool in the back yard, and you don’t allocate
anything to personal?
THE WITNESS: We didn’t.
THE COURT: Why not? Did they use the swimming pool
for consulting?
THE WITNESS: No.
THE COURT: What do you think they used the swimming
pool for?
THE WITNESS: It’s personal.
THE COURT: Did you know there was a swimming pool
there?
THE WITNESS: Yes.
THE COURT: And you did not allocate any of the
umbrella liability policy to personal?
THE WITNESS: Not on this policy.
Petitioners' original Federal income tax returns for 1985
through 1989, reflect, among other income, the following annual
income, before expenses, from consulting, interest on bank and
security investments, and rent:
- 31 -
Year Consulting Interest Rent Total
1985 $120,000 $933,054 $304,845 $1,357,899
1986 120,000 599,692 242,500 962,192
1987 120,000 681,950 312,154 1,114,104
1988 120,000 694,879 258,817 1,073,696
1989 120,000 652,926 295,411 1,068,337
On their books and records and tax returns, petitioners
regarded the timber farm as qualifying as a trade or business,
and petitioners generally treated current expenses incurred on
the timber farm as ordinary and necessary expenses of a trade or
business.
The employees on the timber farm maintained a log of
expenses they incurred, and receipts were maintained with an
indication of the equipment and activity to which the expenses
related.
Petitioners capitalized many of the costs relating to
capital assets located on or constructed on the timber farm. For
example, the water reservoir was treated as a self-constructed
capital asset, and costs that petitioners allocated thereto were
not expensed but were charged to a capital construction account
for the reservoir. On petitioners' original Federal income tax
returns for 1987, 1988, and 1989, a total of approximately
$70,000 was capitalized as part of the capitalized costs of the
reservoir and pond.
On petitioners' proposed revised Federal income tax returns
for 1987, 1988, and 1989, a total of $174,000 in costs is
- 32 -
capitalized as reservoir and pond related costs. Petitioners'
revised capital costs of the reservoir and pond are based, in
part, on the allocation to the capital costs of the reservoir of
a portion of the direct labor costs and of the indirect or
general expenses incurred each year on the timber farm and on
petitioners' estimate that 40 percent of total direct labor costs
incurred on the timber farm related to the reservoir and should
therefore be capitalized as part of the costs thereof. Also, in
allocating general overhead costs of the timber farm to the
capital costs of the water reservoir and pond, petitioners
applied the above 40-percent direct-labor ratio. Further, on the
proposed revised returns, petitioners allocated to the capital
costs of the reservoir 100 percent of the depreciation on the
reservoir-unique equipment but no portion of the depreciation on
the nonreservoir-unique equipment.
In allocating general overhead costs of the timber farm to
the capital costs of the water reservoir and pond and in applying
the above 40-percent ratio (based on petitioners' computation of
the ratio of direct labor costs of the reservoir to total direct
labor costs incurred on the timber farm), neither petitioner’s
time and labor nor two other individuals’ time or labor, while
working on the reservoir and pond were factored into the direct-
labor percentage. Petitioners did not factor into the direct-
labor percentage petitioner's personal labor on the reservoir
because no hard dollar cost was incurred therefor (i.e.,
- 33 -
petitioner's labor was contributed, and no wage or fee was paid
to petitioner for his labor on the timber farm).
Petitioners' total $147,643 cost for purchase and
improvement of the mobile unit was capitalized, and depreciation
thereon was claimed by petitioners as an expense of the timber
farm.
The primary difference between petitioners’ original Federal
income tax returns and petitioners’ proposed revised Federal
income tax returns, all of which were prepared by accountants and
experienced tax return preparers, relates to the Lear jet. On
petitioners’ original Federal income tax returns, the Lear jet
was treated as a separate trade or business activity, and all
noncapital costs thereof were treated as current business
expenses, including depreciation. On the proposed revised
returns, the Lear jet is not treated as a separate business
activity. Rather, based on the Lear jet’s flight logs, the
noncapital costs of the Lear jet (including depreciation) are
allocated to the various separate other activities of petitioners
and treated as deductible section 162 business expenses,
deductible section 212 expenses, or as nondeductible personal
expenses depending on the business, investment, or personal
nature of the underlying activity to which the expenses are
allocated.
On petitioners’ proposed revised Federal income tax returns,
petitioners treat their Tahiti Property as a for-profit
- 34 -
investment activity and the expenses thereof as deductible under
section 212 only from adjusted gross income and subject to the 2-
percent floor on miscellaneous itemized deductions under section
67.
Petitioners’ proposed revised Federal income tax returns
continue to treat petitioners as engaged in a number of separate
trades or businesses, specifically a timber farm business, a
consulting business, and computer and real estate rental
businesses.
On petitioners' original Federal income tax returns for the
years in issue, petitioners claimed $897,685 in total net losses
relating to the timber farm. On petitioners’ Federal income tax
returns for the years 1985 through 1992, petitioners claimed
$2,114,325 in total net losses relating to the timber farm.
By the end of 1993, on petitioners’ proposed revised Federal
income tax returns for 1985 through 1993, petitioners claimed
$3,051,225 in total net losses relating to the timber farm.
On the line on each of their original Federal income tax
returns for each year in issue, to indicate whether they
maintained a home office, petitioners indicated "No". However,
on the Schedules C of their original Federal income tax returns
for 1987, 1988, and 1989, relating to their various alleged
business activities (namely, the timber farm, the Tahiti
Property, the consulting business, and the computer and real
estate rental businesses), petitioners claimed expenses relating
- 35 -
to five rooms or one-fifth of all expenses of the Orange County
residence as deductible home office business expenses.
Respondent's Audit
On audit, respondent did not dispute that petitioner's
consulting and his computer and real estate rental activities
constituted trade or business activities. Respondent, however,
disallowed numerous expenses claimed on petitioners’ original
Federal income tax returns on the grounds, among others, that
petitioners had not substantiated many of the claimed expenses
and that the timber farm, Tahiti Property, and Lear jet
activities in which petitioners were engaged did not constitute
trade or business activities under section 162, nor for-profit
investment activities under section 212.
With exception of expenses claimed relating to the Tahiti
Property, respondent now stipulates that essentially all of
petitioners' claimed expenses have been substantiated as to
amount and payment, but not necessarily as to character.
The primary remaining adjustments will be addressed in the
following sequence: (1) Whether petitioners’ timber farm
constituted a for-profit trade or business activity under
section 162 and whether petitioners' Tahiti Property constituted
a for-profit investment activity under section 212; (2) whether
the percentage of timber farm general expenses that should be
capitalized as part of the capital costs of the water reservoir
- 36 -
and pond should take into account the hours that petitioner and
other individuals worked on the reservoir and pond and whether
some portion of costs relating to the nonreservoir-unique
equipment should be allocated to the reservoir and pond and
therefore capitalized; (3) whether petitioner’s use of the Lear
jet for petitioner’s business- and investment-related travel was
excessive and unreasonable and therefore whether the expenses of
the Lear jet are deductible under sections 162 or 212; and
(4) whether any portion of petitioners’ residence in Orange,
California, qualifies as a home office under section 280A and
whether expenses relating thereto are deductible.
A number of other issues are also addressed, but various
adjustments that are still in dispute we do not address at this
time. We believe that the parties should be able to settle the
remaining issues.
OPINION
Timber Farm and Tahiti Property
To be treated as a trade or business under section 162 or
as a for-profit activity under section 212, taxpayers must be
engaged in the activity in question with the good faith
objective and actual purpose of making a profit. Jackson v.
Commissioner, 864 F.2d 1521, 1525 (10th Cir. 1989), affg. 86
T.C. 492 (1986); Dreicer v. Commissioner, 78 T.C. 642, 643-644
(1982), affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983).
- 37 -
The issue is one of fact and is to be resolved not on the
basis of any one factor, but on the basis of all of the facts
and surrounding circumstances. Allen v. Commissioner, 72 T.C.
28, 34 (1979); sec. 1.183-2(b), Income Tax Regs. Petitioners
bear the burden of proving that their timber farm and their
Tahiti Property, during the years in issue, constituted the
actual, good faith conduct of a trade or business or of an
activity entered into for profit. Rule 142(a).
Section 1.183-2(b), Income Tax Regs., provides a list of
nine nonexclusive factors that are to be analyzed in determining
whether an activity was conducted with an actual and honest
objective of making a profit, as follows: (1) The manner in
which the taxpayer carried on the activity; (2) the taxpayer's
expertise; (3) the time and effort expended by the taxpayer in
carrying on the activity; (4) the expectation that the assets
used in the activity would appreciate in value; (5) the success
of the taxpayer in carrying on the activity; (6) the taxpayer's
history of income or losses with respect to the activity;
(7) the amount of profits, if any, which are realized in the
activity; (8) the financial status of the taxpayer; and
(9) whether elements of personal pleasure or recreation are
involved. More weight is to be given to objective factors than
to a taxpayer's mere statement of intent. Beck v. Commissioner,
85 T.C. 557, 570 (1985). Further, the absence of one particular
- 38 -
factor may be more significant than the superficial presence of
other factors. Id.
Citing Richmond Television Corp. v. United States, 345 F.2d
901, 907 (4th Cir. 1965), vacated on other grounds 382 U.S. 68
(1965), respondent argues that even if, in later years, the
timber farm constituted a trade or business or for-profit
activity, because of petitioners' failure to cut and sell any of
the timber during the years in issue, petitioners' activity with
regard to the timber farm should be regarded only as startup
activity, not activity of an existing trade or business or for-
profit activity. Respondent's argument seems to be based on the
assertion that to be treated as a current for-profit activity,
the timber farm must have generated current income during the
years before us.
We disagree with respondent’s arguments as to the timber
farm. In each year, the trees on petitioners' timber farm were
increasing in size, width, volume, and, generally, in value
depending on market prices for cut timber.
As the U.S. Dept. of Agriculture’s Forest Owners’ Guide To
Timber Investments, The Federal Income Tax, and Tax
Recordkeeping, No. 681 (1989), explains with regard to timber
growing activity, a timber farm activity may be regarded as a
current for-profit activity --
even if the property is currently producing no income --
provided that the timber growing activity is being engaged
- 39 -
in for profit and the expenditures are directly related to
the income potential of the property. [Id. at 19-20.]
Respondent's argument fails to appreciate that in a very
real sense petitioners' timber farm, in every year, was
maintained for the purpose of generating income through the
growth and increase in value of the trees. Respondent's
argument also fails to appreciate that in the timber business,
individual trees typically are harvested only once every 50 to
60 years. Respondent’s argument, carried to the extreme, would
treat taxpayers in the timber business as engaged in that
business, for Federal income tax purposes, only in the
particular year they actually harvest trees.
The evidence in this case indicates and supports our
conclusion that petitioners invested in their timber farm with
an actual and good faith profit objective and that petitioners'
operation and management of the timber farm constituted a
legitimate business activity.
This case is not dissimilar from Allen v. Commissioner,
supra, and Hoyle v. Commissioner, T.C. Memo. 1994-592, in which
the taxpayers' financial resources, among other things,
explained the taxpayers' ability, over a number of years, to
absorb large expenses and losses until appreciation in the value
of the property is realized. The explanation provided in Allen
v. Commissioner, supra at 36, is particularly apropos:
- 40 -
Although the petitioners have sustained substantial
current losses, they still hope, in the long run, to
realize a profit because the fair market value of the lodge
has appreciated * * *. The appreciation in value may, or
may not in fact, offset the aggregate operating losses, but
the prospect of realizing a profit on the sale of the lodge
was bona fide when * * * [the taxpayers] decided to invest
in the lodge and is sufficient to explain * * * [their]
willingness to continue to sustain operating losses. Sec.
1.183-2(b)(4), Income Tax Regs. Moreover, the out-of-
pocket expenses graphically demonstrate that part of the
losses were economic losses and not merely tax losses.
Most importantly, the * * * [taxpayers] have
established that they never used the lodge for their own
personal enjoyment. Only in connection with the management
of the lodge did the * * * [taxpayers] stay in it
overnight. At all times, the lodge was either rented,
available for rent, or being prepared to be rented. Thus,
it offered them no recreational benefits.
See also St. Germain v. Commissioner, T.C. Memo. 1959-73,
involving the for-profit operation of a timber farm.
On brief, respondent appears to concede that upon purchase
of the timber farm in the spring of 1985, petitioners had the
objective of owning and operating the timber farm for profit and
as a business. Respondent, however, goes on to argue that
petitioners "abandoned these plans" during 1985 because of
falling timber prices. We disagree. Nothing suggests that
petitioners ever abandoned their profit objective with regard to
the timber farm. In 1986, 1987, and 1988, because of an
unexpected decline in timber prices, petitioners simply deferred
cutting and selling the timber.
Respondent also argues that the startup nature of
petitioners' timber farm, during the years before us, is
- 41 -
established by petitioners' construction of a water reservoir on
the property in preparation to enter into the livestock
business. We disagree. The water reservoir related at least
equally to the fire risk to which existing trees on the timber
farm were exposed.
Not a single recreational or personal objective for
petitioners' large cash investment in and extensive work and
activity on the timber farm has been suggested, and on brief
respondent concedes "there appear to be no elements of
recreation, in the traditional sense," involved in petitioners’
timber farm. Not one of the factual witnesses respondent called
supported respondent's position that petitioners carried on the
timber farm as anything other than a good faith for-profit
business activity.
With regard further to specific factors typically analyzed
under section 183, we conclude as follows.
(1) Manner of conducting activity: Petitioners carried on
the timber farm activity in a businesslike manner. They worked
hard and long hours on the timber farm. They hired competent
people to manage and secure the property on a day-to-day basis.
They made necessary and significant improvements to the timber
farm. They did not use the timber farm for personal
entertainment, recreation, or retirement. They were creative
and innovative in attempting to improve the timber farm and
- 42 -
eventually to realize substantial overall net profits therefrom
at the time the trees are cut and sold. Petitioners'
bookkeeping was amateurish but extensive.
(2) Expertise: Petitioners were innovative, attentive,
informed, hardworking, capable, and no-nonsense owners and
managers of the timber farm. They hired experienced employees,
and, where necessary, they hired experts to advise them on
aspects of the timber farm.
(3) Time and effort: Petitioner worked extremely long
hours and put a great deal of effort in maintaining and
improving the timber farm, and he expected the same of his
employees.
(4) Appreciation in value of assets: Petitioners' good-
faith intent and expectation that the timber on the timber farm
would appreciate in value are clear and have been proven
accurate.
(5) Success in other activities: Petitioner's success as a
businessman in a number of activities is unquestioned.
(6) and (7) Income or losses realized: Profits and
appreciation that appear to be available from petitioners'
timber farm have not yet been realized or cashed in. But they
are there, ready to "harvest", in amounts significantly in
excess of petitioners' costs.
Respondent argues that under a proper calculation of the
costs that petitioners incurred on their timber farm,
- 43 -
petitioners' actually incurred losses from their timber farm far
in excess of appreciation that occurred in the value of the
timber. We disagree. Respondent's calculations are flawed and
ignore the credible evidence as to the value of the timber and
other improvements to and assets located on the timber farm.
(8) Financial status of taxpayers: Petitioners are wealthy
and, during the years in issue, could well afford to wait to
realize expected profits from their timber farm until the prices
for cut timber and the market make it appropriate to maximize
those profits.
(9) Personal pleasure or recreation: None.
In summary, the evidence indicates that petitioners in 1985
purchased an existing, mature timber farm, that petitioners
immediately and in each year undertook substantial activity, and
incurred substantial expenses, to protect and enhance their
timber farm business, that petitioners' activity in connection
with the timber farm constituted an existing for-profit trade or
business, and that petitioners' use of the timber farm did not
constitute a hobby, personal recreation, nor a personal,
nonbusiness activity.
At the time of purchase in 1985 and during each of the
years in issue (namely, 1987 through 1989), petitioners intended
to, and did, hold and manage the timber farm as a for-profit
business activity. Petitioners' ownership and operation of the
- 44 -
timber farm constituted a for-profit, business activity with
respect to which the ordinary and necessary expenses are
deductible under section 162.
Capital Costs of Water Reservoir and Pond
Respondent argues that, using a direct-labor percentage,
the percentage of timber farm general expenses that should be
capitalized as part of the capital costs of the water reservoir
and pond on the timber farm should take into account the hours
that petitioner and his two employees worked on the reservoir
and pond and that some portion of the costs relating to the
nonreservoir-unique equipment should be allocated to the
reservoir and pond and therefore capitalized.
We agree with respondent as to the need to include in the
direct-labor percentage (used to allocate general expenses of
the timber farm to the capital costs of the water reservoir and
pond) a factor for petitioner’s and his two employees’ labor on
the reservoir.
With regard to the direct costs of the nonreservoir-unique
equipment, we do not believe an allocation to the capital costs
of the water reservoir and pond is appropriate. The evidence is
not compelling that any nonreservoir-unique equipment was used
extensively on the water reservoir or pond. We do not sustain
this adjustment.
- 45 -
Tahiti Property
With regard to petitioners' Tahiti Property, our
conclusions are just the opposite. Petitioners' Tahiti Property
has inherently associated with it extensive recreational and
personal aspects. Petitioners have not satisfied their burden
of proof that the Tahiti Property was held and managed by them
for anything other than personal reasons. Rule 142(a).
Petitioners did not maintain complete and adequate records
with regard to expenditures made on the Tahiti Property.
Petitioners’ assertion as to significant appreciation in the
value of the Tahiti Property is neither credible nor persuasive.
Petitioners claim that, as a result of their efforts and
improvements, by 1994, the fair market value of the Tahiti
Property increased to $3.7 million and that, after their
purchase costs of $989,000 and additional costs of $597,000, for
total alleged cash expenditures of $1,760,000, petitioners have
realized on paper an economic gain of $1,940,000 in connection
with the Tahiti Property.
No credible evidence supports either the amount or nature
of the claimed total expenses petitioners incurred on the Tahiti
Property, nor the fair market value of the Tahiti Property.
We conclude that, during the years in issue, petitioners'
ownership and management of the Tahiti Property constituted a
personal activity with respect to which petitioners' expenses
- 46 -
are not deductible under either section 162 or 212. See sec. 262.
Lear Jet
Petitioners have not satisfied their burden of proving that
the large expenses of operating the Lear jet qualify as ordinary
and necessary business expenses of petitioners' timber farm, of
petitioner’s consulting business, or of petitioner's computer
and real estate rental businesses. The expenses of purchasing,
maintaining, and operating a personal Lear jet to make a few
trips each year to Oregon and to Utah appear extraordinary. On
the facts of this case, such expenses do not constitute ordinary
and necessary expenses of any of petitioners’ business
activities.
Further, because the Tahiti Property does not qualify as a
business or for-profit activity, petitioners' transportation to
Tahiti in the Lear jet does not qualify as anything other than
personal travel. The large transportation expenses (including
significant noncash expenses such as depreciation) associated
with the Lear jet appear to be out of the ordinary and to be
unnecessary particularly in light of the fact that petitioners'
timber farm was not producing any current income (due to
petitioner's decision to defer cutting any of the timber) and to
the fact that the Tahiti Property, as we have held, did not
constitute a for-profit activity. See Commissioner v.
Heininger, 320 U.S. 467, 469 (1943), as to the factual nature of
this issue.
- 47 -
The inconvenience that petitioners would have experienced a
few times a year in flying to the Oregon timber farm via
commercial air carrier we regard as minimal, as ordinary, and as
common, both for individuals and for businessmen. That
petitioners -- as an ordinary and necessary business expense
under the facts of this case -- would incur the extravagant
costs of purchasing and maintaining a Lear jet to avoid such
infrequent and slight inconvenience has not been established.
See Harbor Med. Corp. v. Commissioner, T.C. Memo. 1979-291,
affd. without published opinion 676 F.2d 710 (9th Cir. 1982);
Bullock's Dept. Store, Inc. v. Commissioner, T.C. Memo. 1973-
249; Hatt v. Commissioner, T.C. Memo. 1969-229, affd. 457 F.2d
499 (7th Cir. 1972); cf. Palo Alto Town & Country Village, Inc.
v. Commissioner, 565 F.2d 1388 (9th Cir. 1977), revg. in part
and remanding T.C. Memo. 1973-223; Noyce v. Commissioner, 97
T.C. 670, 688 (1991).
We conclude that petitioners, for the years before us,
should be allowed (with respect to each of the trips from
Orange, California, at which was located petitioner's consulting
and computer and real estate rental businesses, to their Oregon
timber farm) a business travel expense deduction under section
162 for the estimated or constructive travel expenses that
petitioners would have incurred based on first class air fare.
With regard to the constructive expenses of transporting
equipment and machinery that petitioners apparently transported
- 48 -
with them to Oregon in their Lear jet, petitioners have provided
no basis on which we can estimate what such transportation
expenses would have been. The evidence does not specifically
itemize or adequately describe any of the equipment or machinery
so transported, its weight, or size. On the evidence before us,
we are unable to estimate constructive transportation expenses
of equipment and machinery to petitioners' Oregon timber farm.
In summary, the use of a private Lear jet by petitioners in
connection with their Tahiti Property we regard as personal.
Even for a businessman as successful, busy, and wealthy as
petitioner, on the facts of this case, we regard petitioners'
use of a Lear jet in connection with travel to their timber farm
in Oregon as extravagant and not ordinary and necessary.
Because of the substantial personal aspect of petitioners'
travel to Utah (namely, to ski and to purchase and build a
personal residence), we decline to make any attempt to estimate
what portion of petitioners' claimed travel expenses to Utah
might arguably be deductible as relating to the two rental
condominiums that petitioners owned in Park City, Utah. The use
of the Lear jet in connection with petitioners' travel to Utah
we regard either as personal (and relating to petitioners'
skiing and personal residence that was being constructed in Park
City, Utah), or as extravagant and as not qualifying as ordinary
and necessary expenses of the two condominium rental units that
petitioners owned in Utah.
- 49 -
Personal Residence
Petitioners claim that one-fifth of all expenses of their
residence in Orange, California, qualify under section 280A as
deductible home office expenses relating to petitioner's various
business and investment activities. Petitioners claim that five
rooms or one-fifth of the residence was used exclusively for
business. Respondent claims that none of the residence
qualifies as a home office and that none of the expenses of the
residence qualify as deductible home office expenses. We agree
with respondent.
The evidence does not establish that any portion of
petitioners' residence satisfies the threshold requirements of
section 280A(c)(1); namely, that the alleged home office
qualifies either as "the principal place of business" for at
least one business of the taxpayer, as a place in which the
taxpayer meets with clients in the normal course of at least one
of his business activities, or as a structure separate from the
residence.
The evidence is clear that petitioners' alleged home office
does not qualify as a place in which petitioners regularly met
with clients, nor as a structure separate from their residence.
With regard to whether petitioners' alleged home office
qualifies as "the principal place of business" for any of
petitioner's businesses, the evidence is conspicuously thin.
- 50 -
The principal place of petitioner's timber farm, which we
have found constituted a trade or business, obviously was
located in Oregon. The principal place of petitioners'
consulting business would appear to be at the nearby southern
California offices of ALS, petitioner's former corporation and
his only client in his consulting business.
The evidence in the record does not enable us to find that
the principal place of petitioner’s computer and real estate
rental businesses was located in a portion of petitioners'
residence.
We acknowledge petitioners' extensive business and
investment activities. The evidence in this case, however, on
this issue on which petitioners have the burden of proof does
not provide us with adequate information to make an affirmative
finding that petitioners' residence constituted the primary
place of petitioner's consulting or computer and real estate
rental businesses. Commissioner v. Soliman, 506 U.S. 168, 176-
179 (1993).
We emphasize that, under section 280A, the absence outside
the taxpayer's residence of any suitable office or place in
which the taxpayer may manage investments is not adequate.
Managing investments in one's personal residence does not
qualify the residence, or any portion thereof, as a home office.
An existing trade or business must be domiciled in the
residence.
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For the reasons stated, we conclude that no portion of the
expenses of petitioners' residence in Orange, California,
qualifies as deductible expenses of a home office.
Respondent also claims that the mobile unit installed on
the timber farm constituted a personal residence of petitioners
and that for any of the expense of the mobile unit to qualify
for business expense deductions, the mobile unit or some portion
thereof must satisfy the requirements of section 280A. We
disagree.
During the years in issue, the mobile unit was not used as
a personal residence of petitioners. Petitioners’ time on the
timber farm represented all work. No portion thereof is to be
regarded as personal, and the mobile unit is not to be regarded
as a personal residence. See Allen v. Commissioner, 72 T.C. 28,
32 (1979).
Each of petitioners’ trips to and all of petitioners’ time
spent on the timber farm related to the work and business of the
timber farm. Until September of 1989, petitioners lived in
their large personal residence in Orange, California, and
thereafter in their large personal residence in Park City, Utah.
The mobile unit located on the timber farm is not properly
regarded as a personal residence. Petitioners’ use of the
mobile unit was work related and is not to be regarded as
personal.
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All of the expenses of the mobile unit are to be treated
either as ordinary or as capital expenses of petitioners’ timber
farm.
Additions To Tax
For 1987 and 1988, respondent asserts against petitioners
the negligence and substantial understatement additions to tax
under sections 6653(a) and 6661, respectively. For 1989,
respondent asserts against petitioners the accuracy-related
penalty under section 6662(a).
Respondent emphasizes petitioners’ burden of proof as to
the above additions to tax and penalty, and as evidence of
petitioners’ negligence, respondent points to many errors on
petitioners’ Federal income tax returns.
We do not believe, however, that the additions to tax and
penalty asserted by respondent against petitioners in this case
are appropriate. Many of the errors on petitioners’ tax returns
are attributable to the amateurish books and records that
petitioners unfortunately established to keep track of their
many business, investment, and personal activities. In our
opinion, the origin and maintenance of these books and records
are traced to petitioner’s overconfidence that he is a man of
many talents -- even bookkeeping and accounting.
Despite his zeal to do everything himself, petitioner hired
an accounting firm to prepare petitioners’ income tax returns.
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Having been hired, however, petitioners’ accounting firm and tax
return preparers surely bear some significant portion of the
fault for the fact that many of petitioners’ bookkeeping errors
were perpetuated on petitioners’ tax returns. Many questions
that should have been asked by the accountants before preparing
and signing petitioners’ tax returns apparently were not asked.
A taxpayer’s strong personality is no excuse for the failure of
independent tax return preparers to exercise diligence and to
ask questions of their clients that are necessary and that
should be obvious to qualified tax professionals in the
preparation of tax returns.
Petitioner’s reliance on professional tax return preparers
in the preparation and filing of their Federal income tax
returns for the years in issue constitutes a significant basis
for our conclusion that the additions to tax and penalty should
not be sustained in this case. United States v. Boyle, 469 U.S.
241, 251 (1989); Chamberlain v. Commissioner, 66 F.3d 729, 732-
733 (5th Cir. 1995), affg. in part and revg. in part T.C. Memo.
1994-228; Freytag v. Commissioner, 89 T.C. 849, 888-889 (1987),
affd. 904 F.2d 1011, 1017 (5th Cir. 1990), affd. on another
issue 501 U.S. 868 (1991); Guenther v. Commissioner, T.C. Memo.
1995-280; Clark v. Commissioner, T.C. Memo. 1994-278; Beshear v.
Commissioner, T.C. Memo. 1990-544.
We believe that the many errors that occurred on
petitioners' original and proposed revised Federal income tax
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returns are reasonably explained by the factually oriented
nature of each of the issues in this case, by the factually
complicated nature of the many business, investment, and
personal activities in which petitioners were involved, by the
consuming manner in which petitioners undertook each of the
activities in which they became involved, by the nature and
volume of the many categories of expenses incurred by
petitioners each year, by the nature of the books and records
which petitioners innocently but amateurishly developed and
used, by the failure of petitioners’ accountants and tax return
preparers to prepare diligently the returns in question, and by
the unfortunate relationship that developed between petitioners'
and respondent's representatives throughout the course of this
dispute.
No one of the above factors is determinative. But we
believe that, on the unique facts and circumstances of this
case, imposition of any of the asserted additions to tax would
be inappropriate. We so hold.
Decision will be
entered under Rule 155.