Brannon v. Commissioner

T.C. Memo. 2000-76

UNITED STATES TAX COURT

SANDRA J. BRANNON, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22025-97. Filed March 6, 2000.

J. Raymond Karam, for petitioner.

Elizabeth A. Owen, for respondent.

MEMORANDUM OPINION

COUVILLION, Special Trial Judge: Respondent determined

deficiencies of $2,974 and $1,562 in Federal income taxes and

penalties under section 6662(a)1 of $595 and $312, respectively,

for petitioner's 1993 and 1994 tax years.

1
Unless otherwise indicated, section references are to
the Internal Revenue Code in effect for the years at issue. All
Rule references are to the Tax Court Rules of Practice and
Procedure.
 - 2 -

The issues for decision are: (1) Whether a horse breeding

activity conducted by petitioner was an activity not engaged in

for profit under section 183(a); (2) alternatively, whether,

under section 162(a), some of the expenses in connection with the

activity were substantiated; (3) whether petitioner, in an

unrelated business activity, established, under section 1012, a

basis for an asset used in that activity upon which depreciation

would be allowable under section 167(a); and (4) whether

petitioner is liable for the penalties under section 6662(a).

Some of the facts were stipulated. Those facts, with the

annexed exhibits, are so found and are incorporated herein by

reference. At the time the petition was filed, petitioner's

legal residence was San Antonio, Texas.

The first issue is with respect to a horse breeding activity

that petitioner commenced in 1990 with the purchase of one horse.

She purchased another horse in 1991. During 1993 and 1994, the

years at issue, petitioner had six horses. The horses were

quarter horses. The activity was not successful from a financial

standpoint. Petitioner amassed substantial losses over the

years, although the losses did not deter petitioner's continuing

interest in and dedication to the activity. The Schedule C

losses reported by petitioner on her Federal income tax returns

were $18,642 and $8,869, respectively, for 1993 and 1994. The

other years, prior to and subsequent to the years at issue, were
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not much better financially. For these years, petitioner

reported the following losses:

1990 $18,521
1991 20,957
1992 24,926
1995 12,217
1996 15,549
1997 34,425

At trial, petitioner testified she believed she would realize a

net profit of $7,500 for 1998; however, she had no books and

records to support that testimony, and she had not yet filed her

income tax return for 1998. Petitioner acknowledged she did not

maintain accounting records to reflect income, expenses, and

profits or losses, although she maintained a file folder in which

she kept her receipts. It appears that petitioner calculated her

profits or losses for income tax purposes only at or about the

time such returns were due.

After graduating from high school in 1983, petitioner

attended Southwest Texas State University at San Marcos, Texas,

and earned a bachelor's degree in business with an emphasis in

marketing. After receiving her degree, petitioner obtained full-

time employment at or near San Antonio, Texas, and drove to her

employment each day from her parents' home, a distance of 8 to 10

miles. Although the nature of petitioner's employment and her

employer's business were not established at trial, neither the
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business nor petitioner's job related to horse breeding.

Petitioner left that employment in October 1997 and did not

thereafter accept any other employment. She continued living

with her parents, devoting her entire time to the horse breeding

activity. Petitioner has never paid rent or subsidized her

parents for her living accommodations even during the period she

was gainfully employed. In addition to providing petitioner with

her room and board, petitioner's father also provided her with

some financial assistance.

Petitioner's horses have always been on a tract of land of

approximately 10 acres located about 25 miles from petitioner's

parents' residence. The property consisted of a pasture with

some trees and a barn or shed. Petitioner and her father leased

the property. Another individual, Cecil Valdez, used the same

property for his horses. Mr. Valdez did not pay any rent for his

use of the property.

As noted earlier, petitioner commenced her activity with one

horse, then another, and owned six horses during 1993 and 1994.

Based on the testimony at trial, it appears that quarter horses

can be bred and trained in certain categories, which petitioner

and her father described generally as (1) western, (2) pleasure,

(3) halter and trail, and (4) cutting. Petitioner directed her

activity toward the first three named specialties, although she

later realized that her chances for profit would be greater with
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cutting horses. She, therefore, changed her operation to that

specialty. It is that change that petitioner claims resulted in

her realization of a net profit for 1998. Petitioner regularly

attended horse shows, was a member of various associations

related thereto, had business cards, and advertised in trade

journals or newspapers. Petitioner's sales of horses, however,

were minimal. The purchaser of three horses was Cecil Valdez,

who owned other horses at the same location with petitioner.

Another purchaser was an unrelated party.

Petitioner was of the belief that a market for her horses

would be in Mexico; however, that did not materialize because of

the decline in value of the Mexican peso. Petitioner also

attributed her losses to the fact that she did not have a

sufficient number of brood mares and that the bloodlines of her

horses were not of the quality that would be in demand. She

claimed that her chances of success would be enhanced by

specializing with cutting horses rather than the other

specialties stated above. She acknowledged her goal was to

produce a $100,000 horse; however, to do that, she would be

required to pay breeding or stud fees of at least $10,000, which

she was not capable of doing. During the years at issue,

petitioner paid $750 for stud fees. With respect to

participation in horse shows, participants were either

professionals or amateurs. Petitioner always participated as an
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amateur, although she acknowledged that participation as a

professional would enhance her financial success in the business.

Petitioner never attempted to qualify as a professional.

Petitioner's sole motivation for engaging in her activity

was her love for horses, dating back to her childhood.

Petitioner had no educational training or experience in the

business of breeding and training horses. She made no studies or

consultations with professionals with respect to the business

aspect of such an activity. She did not maintain a separate bank

account for her activity, and she did not maintain formal books

and records, nor does the record establish that petitioner made

any effort to change the direction of her operation, although she

recognized her need to do so.

Section 183(a) provides generally that, if an activity is

not engaged in for profit, no deduction attributable to such

activity shall be allowed. Section 183(c) defines an activity

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

respect to which deductions are allowable for the taxable year

under section 162 or under paragraph (1) or (2) of section 212."

The standard for determining whether the expenses of an activity

are deductible under either section 162 or section 212(1) or (2)

is whether the taxpayer engaged in the activity with the "'actual

and honest objective of making a profit'". Ronnen v.

Commissioner, 90 T.C. 74, 91 (1988) (quoting Beck v.
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Commissioner, 85 T.C. 557, 569 (1985)). While a reasonable

expectation of profit is not required, the taxpayer's profit

objective must be bona fide. See Hulter v. Commissioner, 91 T.C.

371 (1988). Whether a taxpayer had an actual and honest profit

objective is a question of fact to be resolved from all relevant

facts and circumstances. See id. at 393; Golanty v.

Commissioner, 72 T.C. 411, 426 (1979), affd. without published

opinion 647 F.2d 170 (9th Cir. 1981). The burden of proving such

objective is on petitioner. Rule 142(a); see Welch v. Helvering,

290 U.S. 111 (1933). In resolving this factual question, greater

weight is given to objective facts than to the taxpayer's after-

the-fact statements of intent. See Thomas v. Commissioner, 84

T.C. 1244, 1269 (1985), affd. 792 F.2d 1256 (4th Cir. 1986);

Siegel v. Commissioner, 78 T.C. 659, 699 (1982); sec. 1.183-2(a),

Income Tax Regs.

Section 1.183-2(b), Income Tax Regs., sets forth a

nonexclusive list of nine objective factors relevant to the

determination of whether an activity is engaged in for profit.

These factors are: (1) The manner in which the taxpayer carries

on the activity; (2) the expertise of the taxpayer or his

advisers; (3) the time and effort expended 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
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history of income or losses with respect to the activity; (7) the

amount of occasional profits earned, if any; (8) the financial

status of the taxpayer; and (9) the elements of personal pleasure

or recreation involved. These factors are not merely a counting

device where the number of factors for or against the taxpayer is

determinative, but rather all facts and circumstances must be

taken into account, and more weight may be given to some factors

than to others. Cf. Dunn v. Commissioner, 70 T.C. 715, 720

(1978), affd. 615 F.2d 578 (2d Cir. 1980). Not all factors are

applicable in every case, and no one factor is controlling. See

Abramson v. Commissioner, 86 T.C. 360, 371 (1986); sec. 1.183-

2(b), Income Tax Regs. Further, the determination of a

taxpayer's profit motive is made on a yearly basis. See

Commissioner v. Sunnen, 333 U.S. 591, 598 (1948).

On this record, the Court is satisfied that petitioner's

activity was not carried on with an actual and honest objective

of making a profit. It is fair to conclude, among other things,

that the activity was not conducted in a businesslike manner.

Although the Court is satisfied that petitioner was dedicated to

the activity, her motivation was primarily her love for horses.

Despite years of substantial losses, petitioner had no formal or

informal business plan and never sought the advice of experts on

how to conduct the activity on a profitable basis. See Bessenyey

v. Commissioner, 45 T.C. 261, 274 (1965) ("the goal must be to
 - 9 -

realize a profit on the entire operation which presupposes not

only future net earnings but also sufficient net earnings to

recoup the losses which have meanwhile been sustained in the

intervening years"), affd. 379 F.2d 252 (2d Cir. 1967).

Respondent, therefore, is sustained on this issue.

Having concluded that petitioner's horse breeding activity

was not engaged in for profit, the Court finds it unnecessary to

consider respondent's alternative determination that some of the

expenses claimed in connection with the activity were not

substantiated.

With respect to the third issue, petitioner and her father

began an emu breeding business in 1993.2 Although the record is

not clear, it appears that this activity was also conducted on

the same property with petitioner's horse breeding activity.

The only issue with respect to the emu activity is

petitioner's claim to a depreciation deduction of $1,036 on her

1993 Federal income tax return with respect to four emus that

were purchased in September 1993.3 The four emus (two matched

2
An emu is defined as any of various flightless birds,
including a swift-running Australian bird with underdeveloped
wings that is related to and smaller than the ostrich. See
Webster's Ninth New Collegiate Dictionary 408 (1985).
3
Petitioner reported the emu activity on a separate
Schedule C of her 1993 and 1994 income tax returns. Respondent
did not challenge the activity as an activity not engaged in for
profit under sec. 183.
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pairs of male and female) were purchased by petitioner's father

for either $28,000 or $28,500. Petitioner contends that she

purchased a one-fourth interest in the four emus from her father

and claimed a depreciation deduction of $1,036 on her 1993 income

tax return with respect to that interest. Respondent disallowed

the deduction on the ground that there was no evidence that

petitioner had purchased any interest in the emus from her

father. Respondent, therefore, determined that petitioner did

not have a basis in the asset; therefore, petitioner could not

claim a depreciation deduction.

There was no bill of sale offered into evidence to reflect

the purchase of a one-fourth interest in the emus by petitioner.

Petitioner's father agreed that no monetary consideration was

paid to him by petitioner; however, he stated that petitioner was

obligated to pay for her interest in the birds by taking care of

them. No promissory note or other evidence of indebtedness was

executed by petitioner. There was some reference at trial to a

letter prepared by petitioner's father that stated that

petitioner would pay the interest on an indebtedness, but the

document admittedly failed to state that petitioner was liable

for the principal. The document was not offered into evidence,

nor was any documentary evidence presented to reflect what time

or care petitioner expended on the emus.

Under section 167(c), the basis for the deduction for
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exhaustion, wear and tear, and obsolescence in respect of

property is the adjusted basis for determining gain or loss on

the sale of such property as provided in section 1011. Section

1011(a) provides generally that the adjusted basis for

determining gain or loss shall be, as pertinent here, the basis

determined under section 1012. Section 1012 provides generally

that the basis of property is its cost.

On this record, petitioner did not establish that she

acquired an interest in the emus. Moreover, the record does not

establish that petitioner acquired an interest in the emus by

gift. The Court, therefore, sustains respondent on this issue.

The final issue is whether petitioner is liable for

penalties under section 6662(a) for the years 1993 and 1994.

Section 6662(a) provides that, if that section is applicable to

any portion of an underpayment in taxes, there shall be added to

the tax an amount equal to 20 percent of the portion of the

underpayment to which section 6662 applies. Under section

6664(c), no penalty shall be imposed under section 6662(a) with

respect to any portion of an underpayment if it is shown that

there was a reasonable cause and that the taxpayer acted in good

faith with respect to such portion of the underpayment.

Section 6662(b)(1) provides that section 6662 shall apply to

any underpayment attributable to negligence or disregard of rules

or regulations. Negligence is defined as lack of due care or
 - 12 -

failure to do what a reasonable and ordinarily prudent person

would do under like circumstances. Neely v. Commissioner, 85

T.C. 934 (1985). The term "negligence" includes any failure to

make a reasonable attempt to comply with the provisions of the

internal revenue laws, and the term "disregard" includes any

careless, reckless, or intentional disregard of rules or

regulations.

The Court is satisfied that petitioner not only engaged in

the horse breeding activity solely because of her personal love

of horses but also engaged in this activity with the knowledge

that it was unrealistic to expect that any profit could be

realized in the manner in which she conducted the activity. Such

a conclusion is manifested by the fact that petitioner maintained

no books and records, commingled the meager income with her

personal funds, and never sought the advice of professionals who

could have advised her on what she should do to make the activity

profitable. Petitioner, moreover, had a degree in business and

obviously had some knowledge, albeit basic, that her activity, as

described, necessitated the maintenance of books and records.

The substantial losses petitioner claimed over the years from

this activity and the manner in which she conducted this activity

manifest a negligent or intentional disregard of rules or

regulations. Respondent's determination on this issue also was

based on the deficiency attributable to the disallowed
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depreciation on the emus. The record shows that petitioner had

no semblance of title to the emus, either by purchase or by gift,

and the claim for depreciation on such asset likewise was a

negligent or intentional disregard of rules or regulations.

Respondent, therefore, is sustained on this issue.

Decision will be entered

for respondent.