T.C. Memo. 1997-417
UNITED STATES TAX COURT
KENNETH E. PERRY AND MARY A. HOFER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 21336-94. Filed September 18, 1997.
Bruce W. Powell and Michael H. Gertner, for
petitioners.
John J. Boyle, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
WHALEN, Judge: Respondent determined the following
deficiencies in and additions to petitioners' joint Federal
income tax for the years in issue:
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Additions to Tax
Sec. Sec. Sec.
Year Deficiency 6653(a)(1)(A) 6653(a)(1)(B) 6653(a)(1)
1
1986 $1,575.26 $78.86 --
1988 6,649.00 -- -- $332.45
1
Plus 50 percent of the interest payable under sec.
6601 with respect to the portion of the underpayment which
is attributable to negligence.
All section references are to the Internal Revenue Code as
in effect during the years in issue. Respondent also
determined the following deficiencies in, additions to, and
penalty on petitioner Kenneth E. Perry's separate Federal
income tax for the years in issue:
Additions to Tax Penalty
Sec. Sec.
Year Deficiency 6653(a)(1)(A) 6653(a)(1)(B) Sec. 6662
1
1987 $3,920 $196 --
1989 4,020 -- -- $804
1990 825 -- -- 165
1991 1,367 -- -- 273
1
Plus 50 percent of the interest payable under sec.
6601 with respect to the portion of the underpayment which
is attributable to negligence.
After concessions, the issues remaining for decision
are: (1) Whether petitioners' horse breeding and boarding
activity during 1986 and 1988 was an "activity not engaged
in for profit" within the meaning of section 183; (2)
whether petitioner Kenneth E. Perry's horse breeding and
boarding activity during 1987, 1989, 1990, and 1991 was an
"activity not engaged in for profit" within the meaning of
section 183; (3) whether petitioners are liable for the
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additions to tax for negligence prescribed by sections
6653(a)(1)(A) and (B) and 6653(a)(1) with respect to their
1986 and 1988 returns; (4) whether petitioner Kenneth E.
Perry is liable for the additions to tax for negligence
prescribed by section 6653(a)(1)(A) and (B) with respect to
his 1987 return; and (5) whether petitioner Kenneth E.
Perry is liable for the accuracy-related penalty prescribed
by section 6662 with respect to his 1989, 1990, and 1991
returns.
FINDINGS OF FACT
Some of the facts have been stipulated and are so
found. The stipulation of facts and attached exhibits are
incorporated herein by this reference. Petitioners are
husband and wife who filed joint Federal income tax returns
for 1986 and 1988. Petitioner Kenneth E. Perry filed
separate Federal income tax returns for 1987, 1989, 1990,
and 1991. At the time they filed their petition in this
case, petitioners resided in Brookville, Ohio.
Petitioners were both raised on family farms, and
both have been around horses most of their lives.
Mr. Perry learned to break and care for horses when he
was 10 to 12 years old and was involved in purchasing,
breeding, training, and selling horses with his father and
brother for over 20 years prior to 1986. Ms. Hofer also
learned to break and care for horses at a very young age
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and was also involved in purchasing, breeding, training,
and selling horses for some time prior to the years in
issue.
Mr. Perry studied business administration and
industrial management at Franklin University, Dayton
University, Michigan State University, and San Jose
State University. The record does not disclose whether
he received a degree from any of these institutions.
Mr. Perry began working for the General Motors Corp.
sometime in or around the mid-1970's.
Ms. Hofer holds a dual bachelor's degree in
production operative management and logistics from Ohio
State University. In 1984, she began working as a
production supervisor for General Motors. Mr. Perry and
Ms. Hofer became acquainted in 1984 through their mutual
employment with General Motors and were married sometime
prior to 1986. Petitioners subsequently had two children
together, Muriel, born December 9, 1987, and Lauren, born
October 9, 1989.
Petitioners were both full-time employees of General
Motors throughout the years in issue. Petitioners received
the following wages from their employment with General
Motors during the years in issue:
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Year Mr. Perry Ms. Hofer Total
1986 $56,140 $40,608 $96,748
1987 52,014 39,910 91,924
1988 52,485 43,064 95,549
1989 55,167 43,358 98,525
1990 61,487 45,562 107,049
1991 56,905 48,653 105,558
Mr. Perry retired from General Motors in 1995. At the
time of trial, Ms. Hofer was on dependent care leave and
did not wish to return to work.
At the time they were married, petitioners planned
to acquire a farm and raise horses. Before implementing
this plan, petitioners had at least one conversation with
Mr. John Adkins, who had extensive experience breeding
Tennessee Walking Horses. Based on their discussions with
Mr. Adkins and their prior experience, petitioners decided
to acquire and develop a breeding stock of registered
Tennessee Walking Horses. Petitioners knew that the
undertaking would require a substantial outlay of cash and
that there was a significant likelihood of losses during
the early stages. However, petitioners did not have a
formal business plan or income projection at the time they
began the undertaking. Petitioners believed that they
could create a self-sustaining breeding operation by
acquiring and developing sufficient real estate, planting
appropriate crops, and acquiring attractive horses. At the
time they began their horse-related operation, petitioners
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believed that they could eventually generate a profit of
approximately $8,000 to $10,000 per year.
Petitioners began their horse-related operation on
June 28, 1986, when they acquired a registered Tennessee
Walking Horse stallion from Mr. Adkins. After purchasing
this stallion, petitioners acquired and developed various
parcels of real property to facilitate their activity. In
the following discussion, we describe petitioners' real
estate transactions before describing their acquisitions
and transfers of horses.
Real Estate Transactions
On November 21, 1986, petitioners purchased 1.72 acres
of real estate located in Union County, Ohio, for a total
price of $103,733.95. Petitioners satisfied $11,855.24 of
the purchase price with cash and executed a promissory note
for the balance. Petitioner obtained a portion of the cash
downpayment from a savings account and obtained the
remainder by cashing in Mr. Perry's retirement options and
Ms. Hofer's stock options with General Motors. The 1.72-
acre parcel included a small house which petitioners used
as their personal residence from the time they acquired the
property until 1994. Petitioners constructed a small barn
and two separate paddocks on the 1.72-acre parcel. The
barn consisted of two open stalls and a separate area for
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storing hay and was completed in early 1987 at a total
cost of approximately $13,000.
On or about June 15, 1987, petitioners purchased
4 additional acres of real estate contiguous to the 1.72-
acre parcel for a total price of $10,000. The party from
whom petitioners purchased this land retained the right to
harvest a crop already growing on the property. In 1988,
after this crop was harvested, petitioners tilled the soil
and converted the land to pasture. Petitioners also
constructed a second, larger barn on the 4-acre parcel.
This barn consisted of six bay stalls, one wash stall, a
tack room, and an "open run-in". The barn was completed
in 1989 at a total cost of $30,700.
On or about April 15, 1989, petitioners purchased
an additional 19.491 acres of land contiguous to the
4-acre parcel and adjacent to the 1.72-acre parcel for
a total price of $48,727.50. Shortly thereafter,
petitioners prepared a portion of the land for pasture
and the remainder for cultivating alfalfa. Petitioners
did not erect any structures on the 19.491-acre parcel.
Between 1986 and 1990, petitioners converted a total
of approximately 24 acres of the Union County real estate
from tillage to pasture and hay fields. Due to severe
drought conditions in 1987 and 1988, the pastures and hay
fields were not productive as sources of feed for
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petitioners' horses until 1990. These drought conditions
also caused an increase in the cost of feed and depressed
the market for horses.
In 1994, General Motors transferred Ms. Hofer to its
plant in Dayton, Ohio. Because of this transfer, and
because Mr. Perry was planning to retire from General
Motors in 1995, petitioners decided to relocate their
home and horse breeding operation to a location nearer
Ms. Hofer's work. On or about June 3, 1994, petitioners
purchased 20 acres of real estate located in Montgomery
County, Ohio, for a total price of $141,273.14. This
included a house which petitioners used as their personal
residence from the time of the purchase up to the time of
trial, and a "home barn".
After acquiring the Montgomery County property,
petitioners began selling their real estate in Union
County. On or about July 26, 1994, petitioners sold the
1.72- and 4-acre parcels, together with the house and
barns, for a total price of $212,500. In December 1995,
petitioners sold 10 of the remaining 19.491 acres for a
total price of $35,000. At the time of trial, petitioners
were offering the remaining 9.491 acres for sale in three
parcels for a total price of $83,000. Petitioners were
also continuing to cultivate alfalfa on the remaining Union
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County property and intended to plant corn on 15 to 18
acres of their Montgomery County property.
Horse Acquisitions, Transactions, and Related Facts
Petitioners acquired, bred, boarded, and sold numerous
horses during the years in issue. These included Tennessee
Walking Horses, thoroughbreds, and one Morgan. To avoid
confusion, we discuss each breed separately.
Tennessee Walking Horses
On June 28, 1986, petitioners purchased a 12-year-old
registered Tennessee Walking Horse stallion named Copy's
Big Shot S (Big Shot) from Mr. Adkins for $1,500. At the
time of purchase, petitioners intended to use Big Shot as
a breeding stallion. Although Big Shot suffered from a
bronchial condition, petitioners believed that $1,500
was a favorable price given the horse's bloodline and
"confirmation". Big Shot sired a total of eight foals
for petitioners before his death in 1992.
On October 15, 1987, petitioners purchased a 1-year-
old Tennessee Walking Horse mare named Copy's Sugar Plum
(Sugar Plum) for $300. At the time of purchase,
petitioners intended to use Sugar Plum as a broodmare.
Sugar Plum produced a total of five foals for petitioners
prior to the time of trial. One of these foals was killed
in 1991 after suffering a broken leg. Petitioners sold
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Sugar Plum's second foal, a gelding named Copy's Black
Prince, for $650 in 1993 after determining that it lacked
adequate confirmation. Also in 1993, petitioners sold
another of Sugar Plum's foals, a filly named Copy's Sugar
Shot, for $1,000. At the time of trial, petitioners were
using Sugar Plum and two of its offspring, Copy's Allen
Rose and Copy's Eyote Anoka, as broodmares.
In 1988, petitioners purchased an unregistered
Tennessee Walking Horse mare named Amy for $1,000. Amy
was in foal at the time of petitioners' purchase and
subsequently gave birth. In 1989, after determining that
it was not economically feasible to register Amy or the
foal, petitioners sold both horses for a total price of
$500.
Also in 1988, petitioners purchased a registered
Tennessee Walking Horse mare named Damon's Red Lady for
$650. Damon's Red Lady subsequently produced three foals
for petitioners. Petitioners sold the first of these
foals, Shot Strutter, for $650 in 1991. The purchaser
thereafter paid petitioners to board Shot Strutter on
their property.
Thoroughbreds
Sometime in 1987, petitioners acquired two thorough-
bred mares named Spiro Gyro and Queens Dynasty for $500
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each. At the time of purchase, petitioners erroneously
believed that both mares were in foal. Petitioners later
learned that neither mare was in foal. They sold Queens
Dynasty for $75 after she became ill. They bred Spiro
Gyro, who produced a foal named Flying Footprint in 1989,
and sold Spiro Gyro in 1990 for $500. In 1991, after
determining that breeding thoroughbreds would not be
profitable, petitioners sold Flying Footprint for $1,000.
However, petitioners repossessed Flying Footprint after
receiving only $150 of the purchase price and resold the
horse to a second buyer in 1992 for $1,000.
Morgan
Sometime in 1988, petitioners purchased a registered
Morgan mare named Dancer for $300. Petitioners sold Dancer
in early 1989 for $375. The purchaser thereafter paid
petitioners to board Dancer on their property. The record
does not disclose the fee petitioners received for this
service.
Petitioners are members of the Tennessee Walking Horse
Breeders and Exhibitors Association. With the exception of
veterinary and complicated farrier services, petitioners
personally performed all of the tasks attendant to their
horse-related activity during the years in issue, including
feeding and watering, grooming, inoculations, hoof care,
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foaling, and breaking. Petitioners have never shown any of
their horses in competitions and do not ride their horses
for recreation.
Petitioners advertised their horse-related operation
by placing a sign near a road which runs adjacent to their
property. This sign reads "Tennessee Walking Horses
boarded and stud [sic] and for sale". Petitioners also
periodically placed advertisements in local magazines and
newspapers when they desired to sell a foal or offer a
stallion for stud services.
Income and Losses
Petitioners reported a net loss from their horse-
related operation during each of the years in issue,
calculated as follows:
1986 1987 1988 1989 1990 1991
Income:
Sale of horses -- -- $75 $875 $250 $500
Boarding fees -- -- 1,200 1,000
Sale of alfalfa -- -- -- -- 2,599 --
Sale of hay -- -- -- -- -- 1,700
Sale of tractor -- -- -- -- 1,600 --
Unexplained income -- -- -- -- -- 70
Gross income -- -- 75 875 5,649 3,270
Expenses:
Breeding fees -- $(500) -- (234) -- --
Depreciation &
sec. 179 -- (1,308) (3,363) (3,321) (3,692) (3,203)
expenses
Feed purchased $(1,886) (5,019) (7,596) (3,153) (880) (1,083)
Fertilizers & lime -- -- -- -- -- (135)
Freight & trucking (50) -- -- -- -- --
Gasoline, fuel,
(280) -- -- -- -- --
oil
Insurance -- -- -- (250) (250) --
Labor hired -- -- (2,300) -- -- (381)
Rent of farm,
(990) -- -- (500) -- --
pasture
Repairs,
-- -- -- -- (923) (589)
maintenance
Seeds, plants
(120) -- (200) (1,681) -- --
purchased
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1986 1987 1988 1989 1990 1991
Storage,
-- (1,200) -- -- -- --
warehousing
Supplies purchased -- -- (3,500) (1,045) (162) --
Veterinary fees,
(85) (1,658) (1,347) (504) -- (507)
medicine
Other expenses -- (516) (5,450) (1,975) (874) (550)
Total expenses (3,411) (10,201) (23,756) (12,663) (6,781) (6,448)
Net income (loss) (3,411) (10,201) (23,681) (11,788) (1,132) (3,178)
Petitioners reported the losses in 1986 and 1988 on
Schedules F attached to their joint income tax returns.
Mr. Perry reported the losses in 1987, 1989, 1990, and
1991 on Schedules F attached to his individual income tax
returns. We note that Mr. Perry's return reports gross
income of $3,270 for 1991, whereas the stipulation of facts
filed by the parties states that petitioner received only
$3,200 of gross income in that year. The record does not
disclose the reason for this discrepancy, and we accept the
figure stated in petitioner's return. The additional $70
which is not explained in the stipulation is listed as
"unexplained income" in the above schedule. Mr. Perry
reported net losses from his horse breeding and boarding
activity in 1992 and 1993 of $1,720 and $517, respectively,
and a net profit of $1,274 in 1994.
Respondent began the examination of petitioners' tax
returns sometime in or around 1988. On December 19, 1989,
petitioners filed with respondent Form 5213, Election to
Postpone Determination as to Whether the Presumption That
an Activity is Engaged in for Profit Applies, for an
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activity described as "Breeding and showing horses"
beginning with the 1986 tax year.
Books and Records
Initially, petitioners' financial record keeping
consisted of retaining receipts of expenses related to the
horse activity in a box in their home. At the end of the
year, petitioners would sort through these receipts with an
accountant to calculate their tax liability. In or around
1988, after the start of respondent's audit, petitioners
began recording receipts and expenditures related to their
horse operation on a calendar where they also recorded
important events such as the dates foals were born and the
dates of inoculations. In or around 1989, petitioners also
began transferring these records to financial ledgers.
Petitioners did not maintain a separate bank account for
their horserelated activity during any of the years in
issue and did not introduce any of their financial records
into evidence.
OPINION
Section 183
The primary factual issue in this case is whether
petitioners' horse breeding and boarding operation was an
"activity not engaged in for profit" as defined by section
183. Section 183(a) provides generally that in the case of
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an individual or an S corporation no deduction attributable
to an activity which is not engaged for profit is allowed
except as provided in section 183(b). Section 183(b)(1)
allows the deductions which would be allowable without
regard to whether the activity is engaged in for profit.
Section 183(b)(2) allows a deduction equal to the amount of
the deductions that would be allowable for the taxable year
if the activity were engaged in for profit, but only to the
extent the gross income derived from the activity exceeds
the deductions allowable under section 183(b)(1).
Section 183(c) defines "activity not engaged in for
profit" as "any activity other than one with respect to
which deductions are allowable for the taxable year under
section 162 or under paragraph (1) or (2) of section 212."
The test for determining whether an activity is engaged in
for profit is whether the individual is engaged in the
activity with "the actual and honest objective of making a
profit". See Dreicer v. Commissioner, 78 T.C. 642, 645
(1982), affd. without published opinion 702 F.2d 1205 (D.C.
Cir. 1983); Brannen v. Commissioner, 78 T.C. 471, 502
(1982), affd. 722 F.2d 695 (11th Cir. 1984); Allen v.
Commissioner, 72 T.C. 28, 33 (1979). Although a taxpayer
need not have a reasonable expectation of earning a profit,
he must have entered into or continued the activity with a
bona fide objective of doing so. See Keanini v. Commis-
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sioner, 94 T.C. 41, 46 (1990); Hulter v. Commissioner, 91
T.C. 371, 393 (1988); Beck v. Commissioner, 85 T.C. 557,
569 (1985); Dreicer v. Commissioner, supra; Golanty v.
Commissioner, 72 T.C. 411, 425-426 (1979), affd. without
published opinion 647 F.2d 170 (9th Cir. 1981); sec. 1.183-
2(a), Income Tax Regs. "Profit" in this context means
economic profit, independent of tax savings. See Hayden
v. Commissioner, 889 F.2d 1548, 1552 (6th Cir. 1989), affg.
T.C. Memo. 1988-310; Antonides v. Commissioner, 91 T.C.
686, 694 (1988), affd. 893 F.2d 656 (4th Cir. 1990);
Landry v. Commissioner, 86 T.C. 1284, 1303 (1986).
Whether a taxpayer engages in an activity with the
requisite profit motive is a question of fact to be
resolved on a consideration of all the facts and circum-
stances in the record. See Lemmen v. Commissioner, 77
T.C. 1326, 1340 (1981); Allen v. Commissioner, supra; sec.
1.183-2(b), Income Tax Regs. Petitioners bear the burden
of proving that they engaged in the subject activity with
the requisite profit motive, and greater weight is given to
objective facts than to petitioners' mere statement of
intent. See Rule 142(a); Siegel v. Commissioner, 78 T.C.
659, 699 (1982); Churchman v. Commissioner, 68 T.C. 696,
701 (1977); sec. 1.183-2(a), Income Tax Regs. All Rule
references are to the Tax Court Rules of Practice and
Procedure.
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Single Activity
Before determining whether, and to what extent,
section 183 and the regulations thereunder apply, the
activity or activities of the taxpayer must be ascertained.
Sec. 1.183-1(d)(1), Income Tax Regs. In making this
determination, the general rule is that we must take all
the facts and circumstances of the case into account.
Id. The regulations provide as follows:
In ascertaining the activity or activities of
the taxpayer, all the facts and circumstances of
the case must be taken into account. Generally,
the most significant facts and circumstances in
making this determination are the degree of
organizational and economic interrelationship
of various undertakings, the business purpose
which is (or might be) served by carrying on
the various undertakings separately or together
in a trade or business or in an investment
setting, and the similarity of various under-
takings. Generally, the Commissioner will accept
the characterization by the taxpayer of several
undertakings either as a single activity or as
separate activities. The taxpayer's characteri-
zation will not be accepted, however, when it
appears that his characterization is artificial
and cannot be reasonably supported under the
facts and circumstances of the case. [Id.]
Petitioners characterize all of the undertakings
relating to their horse breeding and boarding, including
holding the land on which those undertakings were
conducted, as a single activity for section 183 purposes.
Respondent, on the other hand, contends that petitioners'
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holding the land for its appreciation in value should be
treated as a separate activity. Respondent maintains that
any appreciation in the value of the Union County property
"is clearly not the result of, or even related to, the
horse-related activity." Respondent also takes the
position that this appreciation was not attributable to
petitioners' horse breeding and boarding. Respondent
argues that any appreciation in the value of the land
should therefore not be considered in determining whether
petitioners engaged in horse breeding and boarding with
the requisite profit motive.
Section 1.183-1(d)(1), Income Tax Regs., provides the
following guidance for determining whether "farming" and
the holding of the farm land will be considered a single
activity:
Where land is purchased or held primarily with
the intent to profit from increase in its value,
and the taxpayer also engages in farming on such
land, the farming and the holding of the land
will ordinarily be considered a single activity
only if the farming activity reduces the net cost
of carrying the land for its appreciation in
value. Thus, the farming and holding of the
land will be considered a single activity only
if the income derived from farming exceeds the
deductions attributable to the farming activity
which are not directly attributable to the
holding of the land (that is, deductions other
than those directly attributable to the holding
of the land such as interest on a mortgage
secured by the land, annual property taxes
attributable to the land and improvements,
and depreciation of improvements to the land).
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Under its terms, the above rule applies only where
"land is purchased or held primarily with the intent to
profit from increase in its value". See Engdahl v.
Commissioner, 72 T.C. 659, 668 n.4 (1979); Eldridge v.
Commissioner, T.C. Memo. 1995-384; Hoyle v. Commissioner,
T.C. Memo. 1994-592; Harston v. Commissioner, T.C. Memo.
1990-538, affd. without published opinion 936 F.2d 570 (5th
Cir. 1991); Fields v. Commissioner, T.C. Memo. 1981-550;
sec. 1.183-1(d)(1), Income Tax Regs. "If the taxpayer's
primary intent is not to profit from appreciation of the
land, then the general rule of the regulation applies in
determining whether there is a single activity." Hoyle v.
Commissioner, supra. Under the general rule, all facts and
circumstances are taken into account in determining whether
several undertakings constitute one activity for purposes
of section 183.
In this case, we find that petitioners' primary intent
was not to profit from the increase in the value of the
land used to conduct their horse breeding and boarding.
Rather, petitioners' primary intent was to breed and board
horses. Cf. Fields v. Commissioner, supra. In determining
whether petitioners' horse breeding and boarding and their
holding of the land constitute a single activity, we apply
the general rule contained in section 1.183-1(d)(1), Income
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Tax Regs., and take all facts and circumstances into
account. See Hoyle v. Commissioner, supra.
We find petitioners' characterization of their horse
breeding and boarding, and holding of the land as a single
activity to be fully supported by the facts of this case.
See generally Keanini v. Commissioner, supra at 46.
Petitioners purchased the subject land in Union County,
Ohio, for the purpose of breeding and boarding horses
thereon. They considered the cost of the land as part of
the cost of the horse breeding and boarding undertakings.
Petitioners constructed horse barns on the land, and
converted the use of the land to pasture, alfalfa, and hay
fields for the purpose of grazing and feeding their horses.
Thus, a close organizational and economic relationship
exists between the breeding and boarding operation and the
holding of the land for appreciation in value. Cf. id.;
sec. 1.183-1(d)(1), Income Tax Regs.
Factors Relating to the Horse Breeding and Boarding
Activity
Section 1.183-2(b), Income Tax Regs., lists the
following factors relevant to determining whether an
activity is engaged in for profit: (1) The manner in
which the taxpayer carries on the activity; (2) the
expertise of the taxpayer or his advisors; (3) the time
and effort expended by the taxpayer in carrying on the
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activity; (4) expectation that the 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 with respect
to the activity; (7) the amount of occasional profits, if
any, which are earned; (8) the financial status of the
taxpayer; and (9) elements of personal pleasure or
recreation involved. See also Smith v. Commissioner, 937
F.2d 1089, 1093 (6th Cir. 1991), revg. 91 T.C. 733 (1988).
These factors are not exclusive, and no single factor or
number of factors is conclusive in determining whether an
activity is engaged in for profit. See Dreicer v.
Commissioner, 78 T.C. at 645; Vandeyacht v. Commissioner,
T.C. Memo. 1994-148; sec. 1.183-2(b), Income Tax Regs.
1. Manner in Which the Taxpayer Carried On the Activity
Petitioners did not have a formal business plan or
income projection prior to the time they began their horse
breeding and boarding operation. Petitioners also did not
introduce any of their financial books or records into
evidence. Petitioners testified that during the initial
stages of their operation, they simply retained receipts
and invoices arising from the activity in a box, which they
sorted with their accountant at the end of the year to
calculate their income tax liability. Both petitioners
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also testified that in or around 1988, they began recording
receipts and expenditures related to the horse activity on
a calendar, and that they later began transferring these
records to a financial ledger. Petitioners further
testified that they maintained meticulous records of events
relating to their horses, such as births and inoculations,
throughout the years in issue. We find petitioners'
testimony credible in this regard.
We note that petitioners stopped purchasing thorough-
breds when they determined that they could not profit from
that undertaking. Petitioners also placed advertisements
in local newspapers and magazines when they desired to sell
a horse or offer a stallion for stud services.
2. Expertise of the Taxpayer or His Advisors
Petitioners were both raised on family farms, and both
had extensive experience in purchasing, breeding, training,
and selling horses. Petitioners also sought and followed
the advice of Mr. Adkins, an experienced breeder of
Tennessee Walking Horses, prior to the time they began
their horse breeding and boarding activity. Moreover,
petitioners learned to inoculate their horses and perform
other basic health care procedures themselves. Petitioners
also joined the Tennessee Walking Horse Breeders Associa-
tion and educated themselves on bloodlines and markets for
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Tennessee Walking Horses. Petitioners appeared at trial to
be generally knowledgeable about purchasing, breeding,
training, caring for, and selling horses. In light of all
this, we find that petitioners did have sufficient
expertise to indicate that they engaged in their horse
breeding and boarding activity with an actual and honest
objective of making a profit.
3. Time and Effort Expended by the Taxpayer
While petitioners were both full-time employees of
General Motors during the years in issue, petitioners lived
on the property where they pursued their horse breeding and
boarding activity, and they performed all of the work
necessary for the activity themselves, with the exception
of veterinary and complicated farrier services.
4. Expectation That Assets Used in the Activity
Will Appreciate in Value
Section 1.183-2(b)(4), Income Tax Regs., provides in
pertinent part as follows:
The term "profit" encompasses appreciation
in the value of assets, such as land, used in
the activity. Thus, the taxpayer may intend
to derive a profit from the operation of the
activity, and may also intend that, even if no
profit from current operations is derived, an
overall profit will result when appreciation
in the value of land used in the activity is
realized since income from the activity
together with the appreciation of land will
exceed expenses of operation.
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In this case, we note that petitioners realized an
economic gain of approximately $65,000 when they sold their
Union County property in 1994, computed as follows:
Sale Price
5.72-acre parcel
with barns $212,500
10-acre parcel 35,000
Total price $247,500
Purchase Price
1.72-acre parcel (103,734)
Small barn (13,000)
4-acre parcel (10,000)
Large barn (30,700)
1
10-acre parcel (25,000)
Total price (182,434)
Total economic gain 65,066
1
For purposes of this calculation, we accept
petitioners' allocation of approximately one-half
of the total $48,727.50 paid for the 19.491-acre
parcel to the 10-acre portion sold in 1994.
We also note that at the time of trial, petitioners were
offering for sale at a total price of $83,000 the remaining
9.491 acres of Union County property, in which they had
an unadjusted cost basis of $23,727.50.
The economic gain petitioners realized on the sale of
the Union County property in 1994 more than offsets the
total $53,391 in operating losses they claimed during the
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years in issue. Thus, appreciation in the value of the
land used in the activity helps to explain petitioners'
willingness to continue their horse breeding and boarding
operation despite the operating losses sustained during the
years in issue. Cf. Allen v. Commissioner, 72 T.C. at 36.
This is strong evidence that petitioners conducted that
activity with an honest and actual objective of making a
profit. See, e.g., id.; Fields v. Commissioner, T.C. Memo.
1981-550; Sanderson v. Commissioner, T.C. Memo. 1964-284.
5. Success in Similar or Dissimilar Activities
Petitioners both testified that they had been
involved in purchasing, breeding, training, and selling
horses in the past. While there is no evidence in the
record to substantiate their success in these activities,
we find their testimony to be credible. There is no
evidence that Mr. Perry or Ms. Hofer was successful in
any dissimilar investment or business activities.
6. History of Income or Losses
Petitioners reported a net loss from their horse
activity during each of the years in issue. We also note
that petitioners suffered 2 years of extreme drought,
during which they were unable to produce their own feed,
the market price of feed increased, and the market for
horses decreased. Cf. Fields v. Commissioner, supra. We
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also note that petitioners made various attempts to improve
the profitability of their horse-related activity, such as
converting land to pasture and alfalfa, constructing fences
and barns, and attempting to acquire and acquiring mares in
foal. Petitioners also withdrew from the thoroughbred
business when it proved unprofitable and focused their
attention on breeding Tennessee Walking Horses.
7. Amount of Occasional Profits
Petitioners did not report a net profit during any of
the years in issue. However, petitioners did report a net
profit of $1,274 in 1994 and testified at trial that they
expected to realize a profit of $8,000 to $10,000 per year
once they established a viable stock of Tennessee Walking
Horses for breeding. We also note that petitioners' losses
decreased gradually between 1991 and 1995, and that they
realized substantial gains from the sale of the Union
County property in 1994.
8. Financial Status of the Taxpayer
Although petitioners were both full-time employees of
General Motors throughout the years in issue, neither of
them earned particularly high wages during any of those
years. Petitioners also testified that they were forced to
cash in their stock options and retirement options with
General Motors to finance the purchase of the Union County
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property. Moreover, petitioners had two minor children
during each of the years in issue. We find that
petitioners did not have substantial income or capital
from sources other than their horse breeding and boarding
activity during the years in issue.
9. Elements of Personal Pleasure or Recreation
Petitioners argue that they did not derive significant
personal pleasure or recreational benefits from their horse
breeding and boarding operation. Petitioners point out that
their entire experience with horses was purely commercial,
and that they did not participate in any horse shows during
the years in issue. Petitioners also point out that Big
Shot had a bronchial condition which caused him to be too
dangerous to ride. Moreover, petitioners fed their horses
alfalfa, which they contend made the horses unfit for
riding, and did not shoe any of their horses. We find
petitioners' testimony credible in this regard and find that
they did not ride their horses for pleasure or recreation.
However, petitioners both clearly enjoyed working with
horses and certainly derived some personal enjoyment from
their horse breeding and boarding activity.
Upon consideration of all the facts and circumstances
of this case, we conclude that petitioners engaged in their
horse breeding and boarding activity with an honest and
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actual objective of making a profit. We therefore overrule
respondent's adjustments to petitioners' and Mr. Perry's
tax for the years in issue.
We note that on the basis of the section 183 adjust-
ments to petitioners' returns, respondent also disallowed
the casualty and theft loss deductions claimed by
petitioners in 1986 and by Mr. Perry in 1987 because the
section 183 adjustments increased petitioners' and
Mr. Perry's adjusted gross income in those years and had
the effect of decreasing the amount of the casualty losses
that could be claimed. See sec. 165(c)(3), (h)(2).
Respondent does not dispute that petitioners suffered the
casualty losses claimed in 1986 and 1987. Therefore, by
reason of the fact that we have not sustained respondent as
to the section 183 adjustments discussed above, there is no
basis to adjust the casualty and theft losses claimed by
petitioners.
Additions to Tax and Penalty
Respondent determined that petitioners are liable for
the additions to tax for negligence prescribed by sections
6653(a)(1)(A) and (B) and 6653(a)(1) with respect to their
1986 and 1988 returns, and that Mr. Perry is liable for
the additions to tax for negligence prescribed by section
6653(a)(1)(A) and (B) with respect to his 1987 return.
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Respondent also determined that Mr. Perry is liable for
the accuracy-related penalty prescribed by section 6662
with respect to his 1989, 1990, and 1991 returns. Because
we have not sustained respondent's determination of tax
deficiencies in petitioners' or Mr. Perry's income tax for
the years in issue, there is no basis for the imposition of
the additions to tax and penalties determined by respondent
in the notice of deficiency.
In light of the foregoing,
Decision will be entered
for petitioners.