T.C. Memo. 2002-7
UNITED STATES TAX COURT
ROBERT A. AND SHEILA D. ROUTON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18999-99. Filed January 9, 2002.
B. Paul Husband, for petitioners.
Daniel J. Parent, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
FOLEY, Judge: By notice dated September 17, 1999,
respondent determined deficiencies of $29,717 and $38,195
relating to petitioners’ 1994 and 1995 Federal income taxes,
respectively, and a $7,313 section 6651(a)1 addition to tax
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
(continued...)
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relating to 1994. The issues for decision are whether
petitioners are: (1) Entitled to certain deductions relating to
their horse training and breeding activities, and (2) liable for
a section 6651(a) addition to tax for 1994.
FINDINGS OF FACT
Petitioners, husband and wife, resided in Somerset,
California, at the time their petition was filed.
At all relevant times, Mrs. Routon has been a
schoolteacher. Mr. Routon worked on his grandfather’s farm as a
youth, majored in zoology in college, and, after college, worked
as a veterinarian’s assistant. He created two successful
businesses: a newspaper distributorship that he sold in 1976;
and American Leak Detection (ALD), a water leak detection
business. Both businesses operated profitably without a written
business plan. In 1994 and 1995, respectively, Mr. Routon earned
$109,470 and $145,028 from ALD, and Mrs. Routon earned teaching
salaries of $41,751 and $43,575.
In 1985, petitioners established Ascension Arabians
(Ascension), a horse breeding operation. Petitioners believed
Ascension would provide substantial income in their retirement
years. They maintained their full-time jobs, began devoting 35
1
(...continued)
all Rule references are to the Tax Court Rules of Practice and
Procedure.
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hours a week to Ascension’s activities, and regularly consulted
with Arabian horse experts relating to Ascension’s operations.
Mr. Routon kept Ascension’s books and records, purchased
insurance, attended seminars, and occasionally showed the horses
at expositions and competitions. He immersed himself in the
Arabian horse industry, taking various leadership positions in
trade organizations and writing columns for industry magazines.
Mrs. Routon searched for suitable horse breeding and farming
properties and tended to the horses when Mr. Routon was
unavailable. Ascension’s horses were handled by a professional
trainer. Expenses relating to Ascension and ALD were billed to,
and paid out of, the same account. At the end of each year, Mr.
Routon would summarize the expenses relating to both businesses.
Mr. Routon promoted Ascension by conducting seminars; mailing
video tapes featuring their top stallion, Diamond Bask, to
seminar attendees; advertising in trade magazines; and attending
exhibitions.
Petitioners’ horses have substantial value. Diamond Bask,
their top stallion, is worth $250,000. Despite the quality of
their horses, petitioners’ sales and marketing endeavors were
ineffective. From 1988 through the years in issue, Ascension’s
cumulative income and expenses were $15,575 and $531,964,
respectively. During this period, petitioners did not have a
profitable year but made several operational adjustments to
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improve their chances of turning a profit (i.e., selling inferior
horse stock in 1989, reinvesting the horse sale proceeds in
national quality stock, investigating and implementing the use of
frozen semen, etc.). During the years in issue, petitioners’
prospective horse sales failed because of injury to a horse and
misrepresentations made to petitioners.
Petitioners’ tax returns for 1994 and 1995 were prepared by
an enrolled agent, James G. Joelson, who acquiesced to the tax
treatment of their horse activity. Petitioners’ 1994 return was
filed on October 30, 1995. Respondent disallowed all of
petitioners’ expenses relating to Ascension for 1994 and 1995,
contending that their horse activity was not engaged in for
profit.
OPINION
I. Profit Objective
Section 183 limits the deductions for an activity not
engaged in for profit. Sec. 183(b). This case is appealable to
the Ninth Circuit Court of Appeals. The primary purpose standard
has been followed by that circuit in determining whether the
requisite profit objective exists. See Wolf v. Commissioner, 4
F.3d 709, 713 (9th Cir. 1993), affg. T.C. Memo. 1991-212 (holding
that profit must be the predominant, primary, or principal
objective). Petitioners bear the burden of proving the requisite
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profit motive.2 Skeen v. Commissioner, 864 F.2d 93, 94 (9th Cir.
1989).
To determine whether petitioners conducted their activity
for profit, we must weigh all facts and circumstances. Golanty
v. Commissioner, 72 T.C. 411, 426 (1979), affd. without published
opinion 647 F.2d 170 (9th Cir. 1981). Section 1.183-2(b), Income
Tax Regs., sets forth a nonexclusive list of nine factors to
guide courts in analyzing a taxpayer’s profit objective. See
Elliott v. Commissioner, 90 T.C. 960 (1988), affd. without
published opinion 899 F.2d 18 (9th Cir. 1990). The nine 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 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 losses with respect to the
activity; (7) the amount of occasional profits, if any, that are
earned; (8) the financial status of the taxpayer; and (9) the
elements of personal pleasure or recreation involved in the
activity. Sec. 1.183-2(b), Income Tax Regs. Upon review of
these factors, we conclude that section 183 does not limit
2
Sec. 7491 is not applicable to this case.
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petitioners’ deductions because petitioners engaged in their
horse breeding activity to make a profit.
A. Businesslike Manner
Petitioners invested significantly in advertising and
promotions, attended expositions, used professional trainers,
purchased insurance, and kept records in the same manner Mr.
Routon has for his successful business ventures. Further, they
abandoned unprofitable methods in a manner consistent with an
intent to improve profitability. See sec. 1.183-2(b)(1), Income
Tax Regs.
B. Expertise
Mr. Routon consulted extensively with Arabian horse industry
experts. He also had previous experience with farming and
animals before establishing Ascension and has since immersed
himself in the Arabian horse industry. In addition, Mr. Routon
has significant business experience from his other ventures.
C. Time Devoted to the Activity
Respondent does not contest the fact that petitioners
handled virtually all material aspects of Ascension. In addition
to their full-time engagements, petitioners devoted substantial
time and energy caring for and maintaining Ascension’s horses.
D. Expectation That Assets May Appreciate
Assets related to Ascension have appreciated and, in
accordance with petitioners’ plan, may further appreciate.
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Petitioners’ uncontradicted expert testimony is that petitioners’
horses and land are worth approximately $2 million.
E. Taxpayers’ Financial Status
Petitioners had modest resources yet consistently invested
nearly half their annual income in Ascension because they
sincerely believed that they would eventually turn a profit.
Petitioners were shrewd, hardworking, diligent, and levelheaded.
We do not believe that they would squander their hard-earned
money on an extravagant hobby.
F. Amount of Profits
Although Ascension produced only losses, the opportunity to
earn substantial profits in a highly speculative venture is
sufficient to indicate that the activity is engaged in for
profit. Sec. 1.183-2(b)(7), Income Tax Regs. For example, “it
may be found that an investor in a wildcat oil well who incurs
very substantial expenditures is in the venture for profit even
though the expectation of a profit might be considered
unreasonable.” Sec. 1.183-2(a), Income Tax Regs.
Petitioners were simply poor marketers who lacked the
requisite reputation in the industry, but they had quality horses
and a venture that could be profitable if they changed their
business practices. For example, petitioners’ expert witnesses
indicated that syndication of one of Diamond Bask’s offspring,
Diamonds N Jazz, would be quite profitable.
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G. History of Income and Losses
Entrants in the horse industry may incur substantial losses
during a lengthy startup stage. See Engdahl v. Commissioner, 72
T.C. 659, 669 (1979). Such losses are not necessarily an
indication that the activity was not engaged in for profit. See
sec. 1.183-2(b)(6), Income Tax Regs. Petitioners believed that
their losses would be recouped by the breeding, and sale, of one
or more preeminent stallions and that Ascension would provide an
income stream during their retirement years. See Bessenyey v.
Commissioner, 45 T.C. 261, 274 (1965) (stating that there is an
overall profit if net earnings and appreciation are enough to
recoup losses sustained in prior years), affd. 379 F.2d 252 (2d
Cir. 1967).
H. Personal Pleasure or Recreation
Petitioners did not ride Ascension’s horses for pleasure,
nor did they typically travel with the horses to exhibitions and
competitions. While petitioners thoroughly enjoy their work, a
business will not be turned into a hobby merely because the owner
finds it pleasurable. See Jackson v. Commissioner, 59 T.C. 312,
317 (1972).
I. Success in Similar or Dissimilar Activities
Prior to establishing Ascension, Mr. Routon created two
successful business ventures for which he had limited expertise
at the outset, a newspaper distributorship and a leak detection
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business. Petitioners established that they are just as
determined to earn a profit with Ascension.
II. Section 6651 Addition to Tax
Section 6651(a)(1) imposes an addition to tax for failure to
file a required return on the date prescribed, unless it is shown
that such failure is due to reasonable cause and not willful
neglect. Petitioners have not shown that such failure to file by
the prescribed date was due to reasonable cause and not willful
neglect. Accordingly, petitioners are liable for the 1994
addition to tax.
To reflect the foregoing,
Decision will be entered
under Rule 155.