Filios v. Commissioner

T.C. Memo. 1999-92

UNITED STATES TAX COURT

LOUIS A. FILIOS AND ESTATE OF EMMA L. FILIOS,
DECEASED, LOUIS A. FILIOS, EXECUTOR, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15719-96. Filed March 25, 1999.

Lawrence J. Casey, Scott E. Bettencourt, and John P.

Ockerbloom, for petitioners.

Melanie M. Garger, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COLVIN, Judge: Respondent determined deficiencies in

petitioners' 1992 and 1993 Federal income tax and an accuracy-

related penalty as follows:

Penalty under
Year Deficiency Sec. 6662
1992 $194,121 $38,824
1993 133,807 26,761
 - 2 -

After concessions, the issues for decision are:

1. Whether petitioner operated his horse racing and

breeding activity for profit in 1992 and 1993. We hold that he

did not.

2. Whether petitioners are liable for the accuracy-related

penalty for negligence under section 6662 for 1992 and 1993. We

hold that they are not.

Section references are to the Internal Revenue Code for the

years in issue. Rule references are to the Tax Court Rules of

Practice and Procedure. References to petitioner are to Louis A.

Filios.

I. FINDINGS OF FACT

A. Petitioners

Petitioners were married and lived in West Springfield,

Massachusetts, when they filed the petition in this case.1

Petitioner was 92 years old at the time of trial.

Petitioner was born in Italy in 1905 and moved to the United

States when he was 4 years old. He studied engineering for 2

years at Ohio State University. After attending college, he

worked 3 years for Fafner Bearing Co., and later for a company

which produced metal products.

1
Emma L. Filios died on Mar. 12, 1997, after the petition
was filed. Petitioner is executor of the Estate of Emma L.
Filios.
 - 3 -

B. Westfield Gage Co.

Petitioner founded and incorporated Westfield Gage Co.

(Westfield Gage), in Westfield, Massachusetts, in 1955. He has

been its president and sole shareholder since then. Westfield

Gage manufactures precision parts for airplanes and jet engines.

Petitioner generally worked 7 or 8 hours per day at

Westfield Gage. He never (1) prepared a written business plan,

(2) conducted economic or business studies, or (3) hired

consultants for Westfield Gage. Westfield Gage's treasurer

prepared budgets when the corporation was having financial

problems.

Westfield Gage was successful. It had total taxable income

of $8,842,137 from 1979 to 1993. It had gross receipts of

$10,523,177 in 1992 and $9,707,359 in 1993 and net profits of

$972,058 in 1992 and $102,470 in 1993.

Pratt and Whitney, Westfield Gage's primary customer, once

asked Westfield Gage to cut its prices 10 percent. Petitioner

did so and Westfield Gage started to lose money. Petitioner

complained to Pratt and Whitney, so Pratt and Whitney gave

Westfield Gage overhaul and repair work. The overhaul and repair

work was profitable and became a major activity for Westfield

Gage.

C. Mary Kuta

Mary Kuta (Kuta) was Westfield Gage's bookkeeper from 1955

to 1992. She kept Westfield Gage's books and records, filed its

quarterly tax returns, and prepared its payroll.
 - 4 -

D. Eugene Kida

Eugene Kida (Kida) worked for Westfield Gage from 1984 to

1995. He is a certified public accountant (C.P.A.) and has a

master's degree in Business Administration.

Kida prepared petitioners' personal income tax returns while

he worked for Westfield Gage. To prepare petitioners' income tax

returns, Kida reviewed Kuta's horse racing and breeding records.

Kida reviewed petitioners' tax returns with petitioner each year.

E. Petitioner's Horse Racing and Breeding Activity

1. General

Petitioner bought his first thoroughbred horse in 1955.

Petitioner kept a horse 3 or 4 years after it was born so he

could decide whether he thought it would race successfully.

Petitioner's best horses generally ran in races paying purses

from $12,000 to $30,000.

Petitioner never trained or stabled any of his horses at or

near his home in West Springfield. He did not own a farm or any

equipment used in his horse activity. Petitioner rode horses at

riding stables or riding schools near his home. He and the

members of his family did not ride his horses.

2. Horse Publications

Petitioner subscribed to various horse industry publications

including The Blood Horse and Thoroughbred Record from 1959

through the years in issue. He read many horse racing and

breeding books and magazines. He also read The Blood Horse

Stallion Register, which was published annually. It contains
 - 5 -

information about thoroughbred stallions, such as pedigrees,

racing records, and racing earnings. Petitioner used The Blood

Horse Stallion Register to decide which horses to breed and which

to buy.

3. Vitamin and Mineral Supplements

Initially, petitioner did not have high quality horses. He

believed that giving his horses vitamin and mineral supplements

would make them successful. He decided which vitamins and

minerals to use, mixed them, and sent them to the trainers to

give to the horses. However, petitioner did not keep records

showing which vitamins or minerals he gave to each of his horses

or the nutrition and diet of each horse.

4. Breeding and Training

Petitioner spent 10 to 20 hours per week on his horse racing

and breeding activity. He attended horse auctions to buy and

sell horses. He talked to breeders and visited the farms in

Kentucky and tracks in New Jersey where he stabled some of his

horses. Petitioner sometimes went to the New Jersey facilities

each week, but usually he went less often. Petitioner reviewed

mail that he received relating to his horse racing and breeding

activity.

Kuta prepared and petitioner signed checks to pay bills for

his horse racing and breeding activity. He signed all checks

relating to the activity and reviewed all of the track purse and

race results.
 - 6 -

Petitioner went to England, France, and Germany in 1977 on a

tour of breeding farms, race tracks, and training centers

sponsored by Cornell University. Petitioner also toured similar

facilities in Ireland on a date not specified in the record. He

took courses about horses at Cornell University in 1985, 1986,

and 1990, and stud manager’s courses in 1964 and 1970.

From 1961 to 1996, petitioner gave away 124 horses that were

not performing well because it cost too much to maintain them.

5. Records and Reports

Westfield Gage (not petitioner) paid Kuta to keep the

records for petitioner's horse racing and breeding activity from

1955 through the years at issue. She spent 10 to 15 percent of

her time working on the horse racing and breeding activity. Some

of that time was at the end of each year when she gathered

information for petitioner's tax returns. Kuta decided which

records of the horse racing and breeding activity to keep and how

to keep them.

Petitioner had a separate bank account for his horse racing

and breeding activity from 1963 through the years in issue. Kuta

kept copies of canceled checks, check registers, invoices, and

correspondence that related to the horse racing and breeding

activity.

At the end of each year, Kuta prepared summaries from race

track statements to ensure that the Forms 1099 issued by the

racetracks were accurate. She also used race track statements to
 - 7 -

ensure that the various expenses charged to petitioner by the

tracks, such as jockey fees and photograph fees, were correct.

Kuta kept copies of (a) invoices from petitioner's trainers

and from farms where his horses were stabled, and (b) statements

from racetracks at which his horses raced showing the race dates,

his horses’ standing in those races, and the total amounts that

his horses won. Kuta did not regularly prepare records showing

how much each horse earned. In a few of the years before the

years in issue, Kuta prepared a summary at the end of the year

showing the earnings of each horse.

From 1959 to 1989, Kuta prepared spreadsheets which showed

expenses of the horse racing and breeding activity by category.

Kuta usually prepared the spreadsheets from the checkbook for the

activity at the end of the year. In some years she listed

disbursements chronologically; in other years she listed them by

payee. The disbursement spreadsheets did not segregate expenses

by horse. Kuta used the spreadsheets to know where money was

being spent and to give to the accountant to prepare petitioner's

tax returns.

From 1990 to the time of trial, Kuta prepared the

spreadsheets on a personal computer. Kuta could not use the

computer to generate a report that showed petitioner's expenses

for each horse. The spreadsheets did not include information

about receipts.

Kuta prepared index cards on most of petitioner's horses

from around 1956 through the time of the trial which showed the
 - 8 -

name of the horse, its year of birth, its sire and dam, when

petitioner acquired it and from whom, the purchase price, when

petitioner disposed of the horse, and the name of the party

acquiring the horse. Some index cards showed whether the horse

had a jockey certificate number, which the horse needed in order

to be eligible to race. Kuta prepared the index cards in part to

show Kida which horses were depreciable and which were home-bred.

From 1974 to 1996 (excluding 1994), Kuta prepared yearly

breeding schedules for petitioner's mares. These schedules

generally included the name of each mare available for breeding,

the name of the stallion to which it was being bred, and the

breeding fee. If the mare was still carrying a foal from the

prior year's breeding, the schedule gave the name of the

stallion. Kuta prepared the breeding schedules to ensure that

she had properly registered the foals and paid breeding fees and

to determine whether a refund was due.

From about 1986 to 1997 (excluding 1994), Kuta kept annual

records which identified the location of most of petitioner's

horses each month and whether petitioner disposed of the horse

during the year. Kuta kept these records to ensure that

petitioner was billed correctly.

Petitioner never conducted any written economic or business

studies, prepared a written business plan or budget for his horse

racing and breeding activity, or hired any consultants to help

him make his horse racing and breeding activity profitable.
 - 9 -

6. Petitioner's Reliance on Others

Petitioner used professional trainers, veterinarians, horse

farms, breeders, auctioneers, and jockeys. Petitioner hired four

to nine trainers each year from 1985 to 1993. The trainers cared

for, fed, and trained the horses.

Petitioner called the trainers on the telephone, sometimes

once a week, sometimes once or twice a day. Petitioner talked to

his trainers about which horses to race and which horses to

train. He asked their opinion, and if it sounded logical he told

them to go ahead.

Petitioner did not require his horse trainers to submit

plans of operations or reports. The only written reports that

the trainers submitted to petitioner were notes they occasionally

made on their invoices. For example, trainer George Handy made

the following note on his May 1992 invoice:

Hi Louie.

Colts are progressing ok., Morgan Rd seems to learn
much faster than Go Go Tiger, both are galloping 1 ½ each
day now.
Hope you don't mind my bill arriving early but I have
ran out of cash Flo + my Mortgage + Feed bills etc. are due
on the first of June so if you send my check in return mail
I would really appreciate it. Thank you.

Best Regards.
George

P.S. Thank you for our Vitamins. They are the Best.

Petitioner did not rely on a trainer or breeder when he

decided which horses to breed. He arranged for his mares to be

bred. Petitioner did not keep records regarding the performance

or race results of petitioner's trainers.
 - 10 -

7. Petitioner's Breeding and Herd Management Program

Petitioner increased the size of his herd from 1955 to 1975.

His herd grew to a high of 84 horses in 1990.

In the mid-1970's, petitioner began to send his mares to be

bred to Kentucky stallions which had excellent pedigrees but

unproven racing records. Petitioner continued to believe

vitamins and minerals were important.

In 1986, petitioner bought a broodmare, Luna Rutera, for

$70,000. Luna Rutera suffered a tear in her cervix which

prevented her from giving birth. Petitioner gave Luna Rutera

away in 1994.

In 1990 or 1993, petitioner began to use stallions with

proven pedigrees and race performance, such as Dr. Carter, Summer

Squall, Cryptoclearance, and Carson City.

8. Prior Examinations

Respondent audited petitioners' 1977 Federal income tax

return in 1980 and 1984 return in 1987. Respondent made no

adjustments to those returns. Kida represented petitioner in

those audits. Petitioner repeatedly told Kida that his horse

activity was a business and that petitioner intended to make a

profit. Kida believed that petitioner's horse racing and

breeding activity was a business.

F. Petitioners' Income Tax Returns

Petitioners reported the horse racing and breeding activity

on their joint Federal income tax returns each year from 1957

through the years in issue. The following chart shows the
 - 11 -

amounts of gross receipts, expenses, and losses that petitioners

reported on Schedules C from 1957 to 1993:

Gross
Year receipts Expenses Losses
1957 None $12,919.36 $12,919.36
1958 5,575.00 25,268.34 19,693.34
1959 7,729.00 45,809.97 38,080.97
1960 4,805.00 53,429.56 48,624.56
1961 19,345.00 56,677.46 37,332.46
1962 4,280.00 48,705.54 44,425.54
1963 5,630.00 48,674.38 43,044.38
1964 25,666.00 56,735.85 31,069.85
1965 28,506.00 50,189.20 21,683.20
1966 34,717.00 58,908.42 24,191.42
1967 33,895.50 71,575.82 37,680.32
1968 43,903.70 79,234.31 35,330.61
1969 32,353.00 74,010.00 41,657.00
1970 35,722.00 69,917.00 34,195.00
1971 23,499.00 55,394.00 31,895.00
1972 19,637.00 51,524.00 31,887.00
1973 12,544.40 60,650.27 48,105.87
1974 21,347.00 77,845.15 56,498.15
1975 27,320.64 100,913.06 73,592.42
1976 44,028.00 118,674.00 74,646.00
1977 21,140.00 102,571.00 81,431.00
1978 58,662.00 132,278.00 73,616.00
1979 89,971.00 161,913.00 71,942.00
1980 60,651.00 180,943.00 120,292.00
1981 127,225.00 207,589.00 80,364.00
1982 78,804.00 213,686.00 134,882.00
1983 111,853.00 284,373.00 172,520.00
1984 106,814.00 354,937.00 248,123.00
1985 124,671.00 471,417.00 346,746.00
1986 111,295.00 545,642.00 434,347.00
1987 178,776.00 615,973.00 437,197.00
1988 136,327.00 672,014.00 535,687.00
1989 204,403.00 757,630.00 553,227.00
1990 116,400.00 774,735.00 658,335.00
1991 145,405.00 814,477.00 669,072.00
1992 136,463.00 814,103.00 677,640.00
1993 234,588.00 807,259.00 572,671.00
Total 2,473,951.24 9,128,595.69 6,654,644.45
 - 12 -

Of the expenses from 1957 to 1993, $479,210 was attributable to

depreciation.

II. OPINION

A. Whether Petitioner Operated His Horse Racing and Breeding
Activity for Profit in 1992 and 1993

The issue for decision is whether petitioner operated his

horse racing and breeding activity for profit in 1992 and 1993.

An activity is conducted for profit if it is conducted with

an actual and honest profit objective. Osteen v. Commissioner,

62 F.3d 356, 358 (11th Cir. 1995), affg. in part and revg. on

other issues T.C. Memo. 1993-519; Surloff v. Commissioner, 81

T.C. 210, 233 (1983); Dreicer v. Commissioner, 78 T.C. 642, 645

(1982), affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983). In

deciding whether petitioner operated his horse racing and

breeding activity for profit, we apply the nine factors listed in

section 1.183-2(b), Income Tax Regs. The factors are: (1) The

manner in which the taxpayer carried on the activity; (2) the

expertise of the taxpayer or his or her advisers; (3) the time

and effort expended by the taxpayer in carrying on the activity;

(4) the expectation that the assets used in the activity may

appreciate in value; (5) the success of the taxpayer in carrying

on other similar or dissimilar activities; (6) the taxpayer's

history of income or loss 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) whether elements of

personal pleasure or recreation are involved. No single factor

controls. Osteen v. Commissioner, supra; Brannen v.
 - 13 -

Commissioner, 722 F.2d 695, 704 (11th Cir. 1984), affg. 78 T.C.

471 (1982); sec. 1.183-2(b), Income Tax Regs. Petitioners have

the burden of proof on this issue. Golanty v. Commissioner, 72

T.C. 411, 426 (1979), affd. without published opinion 647 F.2d

170 (9th Cir. 1981).

B. Application of the Factors

1. Manner in Which the Taxpayer Conducts the Activity

Maintaining complete and accurate books and records,

conducting the activity in a manner substantially similar to

comparable businesses which are profitable, and making changes in

operations to adopt new techniques or abandon unprofitable

methods are factors which may indicate that a taxpayer conducted

the activity for profit. Engdahl v. Commissioner, 72 T.C. 659,

666-667 (1979); sec. 1.183-2(b)(1), Income Tax Regs.

Harry L. Landry (Landry), petitioners' expert, testified

that petitioner's recordkeeping was better than what he usually

saw for horse activities. Petitioners contend that petitioner

operated his horse racing and breeding activity in a businesslike

manner because he had a separate bank account and kept detailed

financial and breeding records for the activity. We disagree.

Petitioner did not have budgets, income statements, balance

sheets, income projections, or financial statements for the

activity other than those compiled annually by petitioners'

accountant to prepare their annual Federal tax returns.

Petitioners contend that petitioner tried four different

approaches to succeeding at his horse racing and breeding
 - 14 -

activity from 1955 to 1993, and that his use of these different

approaches shows that petitioner had a profit motive. Landry

testified that petitioner: (a) Emphasized vitamins and minerals

without regard to bloodlines and racing success; (b) increased

the number of horses; (c) used improved bloodlines with unproven

racing success; and (d) used improved bloodlines with proven

racing success.

The use of vitamins was not a change in how petitioner

operated. Petitioner adhered to that idea from 1955 through the

years in issue. Petitioner increased the size of his herd from

1955 to 1975, but that was not a change in how he operated.

Around 1976, petitioner began to breed his horses to

stallions which had improved bloodlines and unproven racing

records. Petitioner continued to use stallions with improved

bloodlines and unproven racing records through the years in

issue. Petitioners contend that in 1990 or 1993 petitioner

changed his methods by breeding his horses to horses with

excellent pedigrees and proven racing records. Petitioners also

contend that the facts that petitioner occasionally changed

trainers and breeders, that he decided which horses to buy, and

that he gave away horses to cut costs, show that he intended to

make a profit.

We disagree. Petitioner's method of operations generally

continued unchanged for more than 30 years. Petitioner never

sought advice on how to make his horse activity profitable, and
 - 15 -

he did not abandon unprofitable methods. He offered no evidence

of how comparable profitable businesses worked.

Petitioners contend that petitioner operated his horse

racing and breeding activity for profit because he operated

Westfield Gage and his horse activity in the same manner. We

disagree. Petitioner did not operate Westfield Gage and his

horse activity in the same manner. He said that if Westfield

Gage had lost money, he would have gotten advice on how to fix

it. When Westfield Gage began to lose money because Pratt and

Whitney asked him to lower his charges to them, petitioner

convinced Pratt and Whitney to give Westfield Gage additional

business so that it could again be profitable. Petitioner took

no similar action to try to make his horse activity profitable.

Petitioners contend that petitioner operated his horse

racing and breeding activity like the taxpayer did in Arwood v.

Commissioner, T.C. Memo. 1993-352. We disagree. The taxpayer in

Arwood v. Commissioner, supra, had losses from 1981 to 1987.

However, he had a written business plan which he adjusted in

response to changed circumstances, and he consulted and relied on

experts for business and financial advice. He believed that his

horses would be profitable because his horse's half-brother

received $10,000 per breeding and the sire of his horse received

$40,000 per breeding. Petitioner did not have a written plan or

financial analysis of the profit potential of his activity.

This factor favors respondent.
 - 16 -

2. The Expertise of the Taxpayers or Their Advisers

Efforts to gain experience and a willingness to follow

expert advice are considered in deciding if a taxpayer has a

profit objective. Sec. 1.183-2(b)(2), Income Tax Regs.

Preparation for an activity by extensive study of its practices

or by consultation with experts may indicate that a taxpayer has

a profit motive if the taxpayer follows that advice. Sec.

1.183-2(b)(2), Income Tax Regs.

Petitioners contend that petitioner's self-education and

reliance on others show that he had a profit objective. We

disagree. Petitioners did not show that petitioner studied

successful business and economic practices with respect to

breeding and racing horses. Petitioner used reputable

professional horse trainers. However, they did not advise

petitioner how to make a profit. The fact that petitioner did

not seek advice on the economic aspects of his activity suggests

that he lacked a profit motive. See Rinehart v. Commissioner,

T.C. Memo. 1998-205 (horse activity owner employed horse

professionals but not for business advice). This factor favors

respondent.

3. Taxpayer's Time and Effort

The fact that a taxpayer devotes much time and effort to

conducting an activity may indicate that he or she has a profit

objective. Sec. 1.183-2(b)(3), Income Tax Regs. Petitioner

spent 10 to 20 hours a week on his activity. He did not show

that a profitable horse activity could be successfully operated
 - 17 -

by an individual devoting 10 to 20 hours a week on the activity.

This factor is neutral.

4. Expectation That Property Used in the Activity Would
Appreciate in Value

A taxpayer may intend, despite the lack of profit from

current operations, that an overall profit will result when

appreciation in the value of assets used in the activity is

realized. Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965),

affd. 379 F.2d 252 (2d Cir. 1967); sec. 1.183-2(b)(4), Income Tax

Regs. There is an overall profit if net earnings and

appreciation are sufficient to recoup losses sustained in prior

years. Bessenyey v. Commissioner, supra.

Petitioners contend that petitioner expected his horses to

appreciate in value. We disagree. Petitioner did not show that

the value of his horses and their offspring would appreciate

enough to offset his losses. This factor favors respondent.

5. Taxpayer's Success in Other Activities

The fact that a taxpayer has previously engaged in similar

activities and made them profitable may show that the taxpayer

has a profit objective, even though the activity is presently

unprofitable. Sec. 183-2(b)(5), Income Tax Regs.

Petitioner successfully built Westfield Gage, but he did not

show how his success with Westfield Gage relates to his ability

to conduct a profitable horse racing and breeding activity.

This factor favors respondent.
 - 18 -

6. Taxpayer's History of Income or Losses

A history of substantial losses may indicate that the

taxpayer did not conduct the activity for profit. Golanty v.

Commissioner, 72 T.C. at 427; sec. 1.183-2(b)(6), Income Tax

Regs. A taxpayer may have a profit objective even when the

activity has a history of losses. Bessenyey v. Commissioner,

supra at 274. Losses during the initial stage of an activity do

not necessarily indicate that the activity was not conducted for

profit. Engdahl v. Commissioner, 72 T.C. at 669; sec. 1.183-

2(b)(6), Income Tax Regs. We have said that the startup phase of

a horse breeding activity may be 5 to 10 years. Engdahl v.

Commissioner, supra.

Petitioner lost money in each of the 37 years from 1957 to

1993. In those years his income totaled $2,473,951 and his

expenses totaled $9,128,596. Petitioners contend that we should

not give much weight to the fact that petitioner had large losses

for a long time because many of his losses were due to unforeseen

circumstances. We disagree.

Losses due to unforeseen circumstances do not necessarily

indicate that a taxpayer lacked a profit objective. See Phillips

v. Commissioner, T.C. Memo. 1997-128; Briggs v. Commissioner,

T.C. Memo. 1994-125; Leonard v. Commissioner, T.C. Memo. 1993-

472. Petitioners contend petitioner would have made a large

profit if he had not lost Luna Rutera as a broodmare. However,

petitioners did not show that petitioner's horse racing and

breeding activity would have been profitable if events beyond
 - 19 -

petitioner's control, such as the discovery that Luna Rutera

could not give birth, had not occurred. See Burger v.

Commissioner, 809 F.2d 355 (7th Cir. 1987), affg. T.C. Memo.

1985-523 (taxpayer did not show that activity would have been

profitable if the unforeseen circumstance had not occurred).

Petitioners contend that this case is like Patterson v.

United States, 198 Ct. Cl. 543, 459 F.2d 487, 493 (1972), and

Metcalf v. Commissioner, T.C. Memo. 1963-277 (profit motive found

despite 24 years of losses). We disagree. The taxpayer in

Patterson had a farm on which he initially tried to build a herd

of Angus cattle. When that activity was unsuccessful, he

switched to growing tobacco. Petitioner has not abandoned his

horse racing and breeding activity.

The taxpayers in Metcalf operated a commercial dairy. To

improve milk production, the taxpayers tried to develop three

different purebred breeds of cattle (Brown Swiss, Angus, and

Charolais). The taxpayers abandoned this attempt when it proved

to be unsuccessful. Petitioner did not abandon his unprofitable

activity.

This factor favors respondent.

7. Amount of Occasional Profits, if Any

We should consider the amount of any occasional profits the

taxpayer earned from the activity in relation to the amount of

losses incurred, the amount of the taxpayer's investment, and the

value of the assets used in the activity. Sec. 1.183-2(b)(7),

Income Tax Regs. Petitioner did not make a profit in any year
 - 20 -

from his horse racing and breeding activity. His net losses from

the activity were more than $6 million from 1957 to 1993.

A small chance to make a large profit may indicate that a

taxpayer has a profit objective. Sec. 1.183-2(b)(7), Income Tax

Regs. Landry testified that 3 to 5 percent of those in the horse

racing and breeding activity make about $775 million. That does

not establish that petitioner had a small chance to make a large

profit, absent evidence showing what other horse operations did

to become profitable.

Petitioners contend that a horse that petitioner had bred in

1995, Bent Creek City, was worth $1 million. Petitioners contend

that this shows the potential of substantial profit from

petitioner's horse activity. We disagree. Landry's estimate of

Bent Creek City's value appears to be inflated; he testified that

petitioner sold the horse in 1996 for $35,000.

This factor favors respondent.

8. Financial Status of the Taxpayer

Substantial income from sources other than the activity,

especially if the losses generate large tax benefits, may

indicate that the taxpayer is not conducting the activity for

profit. Sec. 1.183-2(b)(8), Income Tax Regs.

Petitioner concedes that he had a substantial amount of

income from Westfield Gage at all times, but he contends that

this factor is neutral because most of his losses were direct

expenses requiring cash outlays. We disagree. Even if a

taxpayer pays expenses out of pocket the potential tax benefits
 - 21 -

from treating a hobby as a business may induce a taxpayer, who

has enough income, to invest in that hobby where the taxpayer

would not otherwise do so. Engdahl v. Commissioner, supra at

680.

This factor favors respondent.

9. Elements of Personal Pleasure

The presence of recreational or personal motives in

conducting an activity may indicate that the taxpayer is not

conducting the activity for profit. Sec. 1.183-2(b)(9), Income

Tax Regs. A taxpayer's enjoyment of an activity does not show

that the taxpayer lacks a profit objective if the activity is, in

fact, conducted for profit as shown by other factors. Jackson v.

Commissioner, 59 T.C. 312, 317 (1972); sec. 1.183-2(b)(9), Income

Tax Regs. However, if the possibility for profit is small

compared to the possibility for gratification, the latter

possibility may be the primary motivation for the activity.

White v. Commissioner, 23 T.C. 90, 94 (1954), affd. per curiam

227 F.2d 779 (6th Cir. 1955).

Petitioners point out that neither petitioner nor his family

rode his horses. Despite this, we think petitioner owned horses

for 37 years, despite losing $6 million, because he enjoyed it.

From petitioners' standpoint, this factor is at best neutral.

10. Conclusion

We conclude that petitioner did not operate his horse racing

and breeding activity for profit in 1992 and 1993.
 - 22 -

C. Whether Petitioners Are Liable for the Penalty Under Section
6662 for Negligence

Respondent determined that petitioners are liable for the

accuracy-related penalty for negligence for 1992 and 1993 under

section 6662.

Taxpayers are liable for a penalty equal to 20 percent of

the part of the underpayment to which section 6662 applies. Sec.

6662(a). Section 6662 applies to an underpayment attributable to

negligence. Sec. 6662(b)(1). Negligence includes a failure to

make a reasonable attempt to comply with internal revenue laws or

to exercise ordinary and reasonable care in preparing a tax

return. Sec. 6662(c). The accuracy-related penalty does not

apply to any part of an underpayment if the taxpayer shows that

he or she had reasonable cause and acted in good faith. Sec.

6664(c)(1).

Petitioner employed and relied on a C.P.A. who had

represented petitioner in audits by respondent on the issue of

whether petitioner operated the horse activity for profit.

Petitioner's C.P.A. believed that petitioners properly deducted

petitioner's horse activity expenses. Petitioner had conducted

his horse racing and breeding activity for more than 30 years

when respondent audited petitioners in 1987 and made no changes.

We conclude that petitioners are not liable for the accuracy-

related penalty for negligence for deducting losses attributable

to petitioner's horse racing and breeding activity in 1992 and
 - 23 -

1993.

To reflect the foregoing,

Decision will be entered

under Rule 155.