HARRINGTON v. COMMISSIONER

T.C. Summary Opinion 2002-58

UNITED STATES TAX COURT

JULIUS LEE HARRINGTON AND MARY LOU ZITER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 5679-00S. Filed May 28, 2002.

Julius Lee Harrington and Mary Lou Ziter, pro sese.

Anne W. Durning, for respondent.

BEGHE, Judge: This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect

at the time the petition was filed. The decision to be entered

is not reviewable by any other court, and this opinion should not

be cited as authority. Unless otherwise indicated, subsequent

section references are to the Internal Revenue Code in effect for

the years in issue, and all Rule references are to the Tax Court

Rules of Practice and Procedure.
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Respondent determined deficiencies in petitioners’ Federal

income taxes for the calendar years 1996, 1997, and 1998 of

$7,095, $1,906, and $2,859, respectively. After concessions by

the parties, the sole issue in dispute is whether petitioners are

entitled to compute their taxable income by deducting losses of

their horse-breeding activity for 1996, 1997, and 1998 in the

amounts of $12,138, $11,290, and $10,303, respectively.

Respondent determined that petitioners’ horse-breeding activity

was not an activity engaged in for profit within the meaning of

section 183. We uphold respondent’s determination.

Background

Some of the facts have been stipulated and are so found.

When petitioners filed their petition, they resided in Algodones,

New Mexico.

During the years in issue, petitioner Julius Harrington (Dr.

Harrington) was employed full time as a professor at New Mexico

Highlands University School of Social Work. He holds an

undergraduate degree in sociology, two master’s degrees in social

work, and a doctorate in social work education. Petitioner Mary

Lou Ziter (Dr. Ziter) holds a doctorate in social work and during

1996 was self-employed part time as a family therapist. During

1997 and 1998, Dr. Ziter was retired.

During the years in issue, in addition to teaching full

time, Dr. Harrington spent substantial time engaging in the
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breeding of Appaloosa horses. Although Dr. Ziter may have had an

ownership interest in some horses, she did not participate in the

horse activity.

Dr. Harrington has no significant formal training in horse

breeding. However, Dr. Harrington grew up with horses and knows

a lot about them. Dr. Harrington was raised on a farm in rural

Mississippi and owned and used a horse for transportation from

the time he was 4 years old. His childhood horse, named Dan, was

a cross between an Appaloosa and a Tennessee walking horse. Dr.

Harrington participated in Future Farmers of America in high

school and would ride his horse on visits to his family’s farm

during breaks from college and university.

In 1986, petitioners bought a farm in Minnesota and shortly

thereafter purchased their first Appaloosa horse. In addition to

riding horses, petitioners began showing their horses at the

Flying W Appaloosa Horse Club.

In the late 1980s, Dr. Harrington began investigating the

breeding of Appaloosa horses. Among other things, he spoke to

long-time breeders of Appaloosa horses at Sheldak Ranch, who told

him it would be difficult to breed palomino Appaloosas

successfully. Nevertheless, in 1990, after searching for a

stallion for several years, Dr. Harrington purchased a 4-month

old colt named Provoking, for $2,000, to use as his stallion in

attempting to breed palomino Appaloosa horses.
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Although Dr. Harrington recognized that it was risky to rely

on an untested foal, he believed that Provoking had the right

color and bloodlines to sire Appaloosa horses that would have

valuable palomino and Appaloosa characteristics.

In 1993, petitioners moved from Minnesota to New Mexico.

They brought with them the stallion, Provoking, and one brood

mare. Petitioners purchased a 2-1/2 acre property in Algodones,

where they lived and kept their horses. The house had a vineyard

that occupied one-half acre, and the remaining acreage became

available for the horse activity.

During 1990 through 1998, petitioners suffered net losses

totaling $110,376 from Dr. Harrington’s horse-breeding activity,

claimed on Schedule F, Profit or Loss From Farming. The losses

were consistent and sustained from year to year, ranging from

$10,959 to $16,600 per year. During this 9-year period,

petitioners received total gross receipts of only $6,807 from the

horse-breeding activity. Petitioners claimed losses of $12,138,

$11,290, and $10,303, on gross receipts of $712, $0, and $600,

for 1996, 1997, and 1998, respectively. Petitioners did not

claim Federal income tax deductions for the expenses of the horse

activity in 1999. With such small acreage, Dr. Harrington had to

buy hay to feed the horses. Dr. Harrington in 1999 sold two

mares and two foals for $1,502 but kept the stallion, and a 2

year old and 3 year old that he is still trying to sell.
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Dr. Harrington had no formal plan for making a profit from

the horse-breeding activities. Dr. Harrington’s goal was to

produce foals with Appaloosa characteristics. A foal with

Appaloosa characteristics is worth as much as $2,500, while a

foal without Appaloosa characteristics is worth only about $500

at a sale barn, where the animals are auctioned off for about 50

cents per pound.

Dr. Harrington bred Provoking, the single stallion, to only

one or two mares a year. Therefore, even if Dr. Harrington’s

horse activity had been able to generate two foals with Appaloosa

characteristics per year, and he had been able to sell them for

the maximum price of $2,500 each, the horse operation would have

generated revenues of only about $5,000 per year--less than one-

half of the annual expenses from the horse-breeding activity.

Despite Dr. Harrington’s efforts, petitioners were unable to

produce two foals per year with Appaloosa characteristics.

During the 7 years between 1992 and 1998, petitioners produced a

total of six foals with Appaloosa characteristics. Of those, one

died, and another was injured. Dr. Harrington testified that he

expected a foal with Appaloosa characteristics approximately 50

percent of the time.

Dr. Harrington made no attempt to expand the horse operation

to have the potential of earning a profit because he did not

believe he could find suitable brood mares at a price he could
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afford. As a result, Dr. Harrington could not have made a profit

from the horse-breeding activity even if he had been able to

achieve a 100-percent success rate in producing foals with

Appaloosa characteristics.

Discussion

Section 183(a) provides generally that if an activity is not

engaged in for profit, then no deduction attributable to the

activity shall be allowed except as provided in section 183(b).

Section 183(b)(1) allows a deduction for expenses that are

deductible without regard to whether the activity is engaged in

for profit, such as real estate taxes. Section 183(b)(2) allows

a further deduction for expenses that would be deductible if the

activity were engaged in for profit, but only to the extent that

gross receipts from the activity exceed deductions allowed by

section 183(b)(1).

An activity not engaged in for profit is any activity other

than one for which deductions are allowable under section 162 or

under paragraphs (1) or (2) of section 212. Deductions are

allowed under section 162 or 212 only when the facts and

circumstances show that the taxpayer engaged in the activity with

an actual and honest (but not necessarily reasonable) objective

of making a profit. Hulter v. Commissioner, 91 T.C. 371, 393

(1988) (“dominant hope and intent of realizing a profit”); Beck

v. Commissioner, 85 T.C. 557, 569 (1985) (“actual and honest
 - 7 -

objective of making a profit”). In resolving the factual

question, greater weight is given to the objective facts than to

the taxpayer’s self-serving statements of intention. Thomas v.

Commissioner, 84 T.C. 1244, 1269 (1985), affd. 792 F.2d 1256 (4th

Cir. 1986).

Section 7491(a) provides that the burden of proof is placed

on the Commissioner as to any factual issue on which the taxpayer

offers credible evidence relevant to his income tax liability, if

certain conditions have been satisfied, including the

commencement of the Commissioner’s examination after July 22,

1998. The parties have not addressed the applicability of

section 7491(a) to this proceeding, even though it seems likely

that the examination was commenced after that date, at least as

to 1998, the last taxable year in issue. We nevertheless

conclude that the burden of proof is not in issue in this case,

inasmuch as we decide the matter without regard to the allocation

of the burden of proof; our findings and decision are supported

by a preponderance of the evidence.

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

nonexclusive list of nine factors that bear on whether an

activity is engaged in for profit. The regulation specifically

provides that no single factor, or number of factors, is

controlling, and the factors need not be given equal weight. See

Ranciato v. Commissioner, 52 F.3d 23, 26 (2d Cir. 1995) (“the
 - 8 -

assessment of the objective factors must be informed by ‘the

insight gained from a lifetime of experience as well as an

understanding of the statutory scheme’” (quoting Nickerson v.

Commissioner, 700 F.2d 402, 407 (1983), revg. T.C. Memo. 1981-

321)), revg. T.C. Memo. 1993-536.

In Golanty v. Commissioner, 72 T.C. 411, 426 (1979), affd.

without published opinion 647 F.2d 170 (9th Cir. 1981), we

recognized that “Although no one factor is determinative of the

taxpayer's intention to make a profit * * * a record of

substantial losses over many years and the unlikelihood of

achieving a profitable operation are important factors bearing on

the taxpayer's true intention.”

The first factor considers whether the taxpayer engaged in

the activity in a businesslike manner. Sec. 1.183-2(b)(1),

Income Tax Regs. “In deciding whether the taxpayer has conducted

the activity in a businesslike manner, this Court has considered

‘whether accurate books are kept, whether the activity is

conducted in a manner similar to other comparable businesses and

whether changes have been attempted in order to make a profit.’”

Dodge v. Commissioner, T.C. Memo. 1998-89 (quoting Ballich v.

Commissioner, T.C. Memo. 1978-497), affd. without published

opinion 188 F.3d 507 (6th Cir. 1999).

In the case at hand, petitioners failed to develop a budget

or a formal or informal business plan to determine whether, and
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if so how, the activity could be operated profitably or to make

informed business decisions on a periodic basis. During his

investigation of horse breeding, Dr. Harrington was told by

professional breeders that it would be difficult to make a profit

from breeding Appaloosa horses.

The economics of petitioners’ operation showed that they

could not make a profit from their horse-breeding activity.

Petitioners consistently incurred expenses of more than $10,000

per year. Breeding their stallion only two or three times per

year would yield at best only two or three foals per year (horses

have an 11-month gestation period), worth at most $7,500 in the

unlikely event that all three foals had Appaloosa

characteristics. Petitioners’ horse-breeding activity was a

money-losing proposition without hope of success.

Citing Engdahl v. Commissioner, 72 T.C. 659 (1979),

petitioners argue that because Dr. Harrington did most of the

work himself, and that much of this work was not pleasurable, he

should be deemed to have engaged in the activity in a

businesslike way. We disagree. In Engdahl, after Dr. Engdahl’s

retirement as an orthodontist, the Engdahls purchased a ranch to

breed American saddle-bred horses after receiving professional

advice on operating the ranch profitably. Due to unexpected

adverse market conditions, the ranch was not profitable. The

Court found that the Engdahls operated their business in the same
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manner as other profit-making horse-breeding operations, made

changes in their method of operations to increase profitability,

and attempted to diversify their activities to make a profit.

Petitioners’ situation is distinguishable from the taxpayers

in Engdahl. Petitioners offered no evidence to show that their

horse-breeding activity was unprofitable due to unexpected

adverse market conditions. Nor did they show that the activity

was similar to other profit-making horse-breeding operations.

Petitioners did not make changes to their operation in an attempt

to make it profitable.1 Indeed, Dr. Harrington testified that he

was unwilling to expand the operation because it was not cost

effective to do so. Finally, Dr. Harrington made no attempt to

diversify the operation in order to earn a profit. Dr.

Harrington’s continuation of the inherently money-losing

operation belies petitioners’ contention that petitioners engaged

in the activity to make a profit.

1
Petitioners argued on brief that they made several changes
to improve profitability. First they claim they “switched” to a
“well-known Appaloosa Foundation bloodline”. In fact, the only
stallion that they have ever used was Provoking. We do not
understand what they mean by a “switch”. Second, they claim that
they identified a special niche market of producing palomino
Appaloosas and attempted to expand to meet market demand. In
fact, petitioners did not attempt to expand and have not been
able to sell their two best foals (calling into question the
level of demand). Finally, petitioners point out that Dr.
Harrington has developed farrier, veterinarian, training, and
marketing skills. While he may have developed or improved his
skills, these were not significant changes made to improve
profitability and did not have the effect of improving
profitability.
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Finally, we do not accept petitioners’ argument that Dr.

Harrington did not receive pleasure from the activity. To be

sure, caring for horses is hard work. But Dr. Harrington clearly

loves the animals and derives much pleasure and pride from them.

Petitioners also appear to enjoy being in the circle of other

Appaloosa horse breeders. We cannot discount the pleasure that

Dr. Harrington derived from the horse-breeding activity merely

because some of the daily chores are labor-intensive. Indeed,

these labor-intensive chores provided what must have been a

welcome break from Dr. Harrington’s regular activities as a

college professor.

The second factor is the expertise of Dr. Harrington and his

advisers. Preparation for an activity by extensive study of its

accepted business, economic, and scientific practices may

indicate a profit motive. Sec. 1.183-2(b)(2), Income Tax Regs.

The focus is on learning applicable to generating an overall

profit from the activity. See Golanty v. Commissioner, supra at

427.

Petitioners offered no evidence to show that Dr.

Harrington’s new skills were helpful in making their horse-

breeding business profitable. Dr. Harrington may have improved,

extended, and refined his skills in caring for horses, but

petitioners failed to explain how his new and improved skills

would lead to a profitable horse-breeding business.
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The third factor is the time and effort expended by the

taxpayer. The fact that a taxpayer devotes much of his personal

time to an activity may indicate an intention to derive a profit,

particularly if there are no substantial personal or recreational

aspects to the activity. Sec. 1.183-2(b)(3), Income Tax Regs.

Dr. Harrington did devote substantial time to the horse-

breeding activity. However, we believe there were substantial

personal and recreational aspects to the activity. Moreover, Dr.

Harrington did not give up his regular job as a social work

professor to pursue making a living from the horse-breeding

activity. This was a pleasurable sideline for Dr. Harrington,

not a source of his livelihood. The time and effort Dr.

Harrington devoted to the activity (3 or 4 hours per day caring

for the horses) was not inconsistent with the time one might

expect to devote to a hobby of this kind.

The fourth factor is the expectation that assets used in the

activity may appreciate in value. Sec. 1.183-2(b)(4), Income Tax

Regs. Petitioners argue that their land has appreciated in value

(due mostly to the general increase in land values in the area,

but also, to some undefined extent, due to improvements

petitioners made to the land). Petitioners argue that the

increase in the value of their land should be taken into account

in determining whether their horse-breeding activity was

profitable.
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Section 1.183-1(d)(1), Income Tax Regs., provides:

If the taxpayer engages in two or more separate
activities, deductions and income from each separate
activity are not aggregated either in determining
whether a particular activity is engaged in for profit
or in applying section 183. 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 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).

In the case at hand, there is no evidence in the record that the

horse-breeding activity contributed marginal profits to help

reduce the cost of holding the land. Even excluding the items

attributable to the land, the horse-breeding operation incurred

substantial losses. Therefore, the holding of petitioners’ land

is a separate activity from the horse-breeding activity.

The improvements petitioners claim to have made to the land

may increase their tax cost (basis) in the land and thus reduce

the taxable gain they will realize upon sale of the land. Sec.

1001(a). The increase in the value of petitioners’ land does not

support petitioners’ argument that Dr. Harrington engaged in
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their horse-breeding activities with the intent of making a profit.

The fifth factor is petitioners’ success in carrying on

other similar or dissimilar activities. The regulations indicate

that a taxpayer who was able to convert an unprofitable

enterprise to a profitable one in the past may be able to do the

same thing with the current activity. Sec. 1.183-2(b)(5), Income

Tax Regs.

Petitioners do not argue that Dr. Harrington had prior

success turning an unprofitable business into a profitable one.

Instead, petitioners argue that Dr. Harrington’s academic success

in the field of social work supports their argument that they

engaged in the horse-breeding activity to make a profit. We see

no direct correlation between success as a social work

academician and educator and financial success as a breeder of

horses. Petitioners did not offer evidence to show that Dr.

Harrington achieved success in business generally, or in breeding

farm animals specifically.

Petitioners’ academic success does show that they are highly

intelligent people who were fully capable of doing the simple

arithmetic necessary to realize that the horse-breeding operation

was not, and as operated, could not be, profitable. Their

continuing the operation during the years in issue without a

prospect or plan to achieve profitability indicates a lack of

profit motive.
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The sixth factor is the taxpayer’s history of income and

losses with respect to the activity. Sec. 1.183-2(b)(6), Income

Tax Regs. Petitioners have had 9 straight years of substantial

sustained losses. During these 9 years, petitioners had gross

receipts of only $6,807, while incurring expenses of $117,183.

There was no material decrease in their losses over time.

Petitioners argue that they are still in the 15-year startup

phase of the activity, and that losses are expected during the

startup phase. Losses during the startup phase of an activity

are not currently deductible. Sec. 195(a). The losses must be

capitalized, and an election made to amortize the losses over a

period of not less than 60 months after the startup phase ends.

Sec. 195(b). Therefore, even if petitioners were able to

establish that their horse-activity losses were incurred during

the startup phase of the activity, they would not be entitled to

deductions for the years in issue. See McKelvey v. Commissioner,

T.C. Memo. 2002-63.

Moreover, we do not accept petitioners’ argument that these

losses were incurred in the startup phase of the activity.

Petitioners made no significant change to their operations during

the 9-year period of operations. They did not expand, have not

sought to expand, and do not intend to expand their business in a

material way. Nothing about their horse-breeding operation

requires a prolonged startup period. By their own testimony,
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their breeding stock was mature and in its prime during the

taxable years in issue. Petitioners offered no evidence to

justify their long history of sustained losses.

Our words in Golanty v. Commissioner, 72 T.C. at 427

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

affd. 379 F.3d 252 (2d Cir. 1967)), apply to the case at hand as

well:

The petitioner has learned a good deal about the
breeding of horses, and she has devoted energy and time
to the activity. Nevertheless, when we strip away all
the talk, dig out the hard facts, and apply cold logic
to them, we are convinced that the petitioner did not
truly expect to make a profit from her horse-breeding
venture, and that such activity was not potentially
profitable and could not "recoup the losses which have
meanwhile been sustained in the intervening years."

The seventh factor is the amount of occasional profits

earned from the activity. A substantial profit, though only

occasional, would generally indicate that an activity is engaged

in for profit. Sec. 1.183-2(b)(7), Income Tax Regs. Petitioners

earned no profits of any size at any time from their horse-

breeding activity.

The eighth factor is the financial status of the taxpayer.

Substantial income from other sources, particularly when the

losses from the activity generate tax benefits, may indicate that

the activity is not engaged in for profit, especially when

personal or recreational aspects are present. Sec. 1.183-

2(b)(8), Income Tax Regs. Petitioners’ tax returns indicate that
 - 17 -

both had success in their careers and in their investments, and

that the losses claimed from the horse-breeding activity, if

allowed, would provide them with significant tax benefits,

reducing the after-tax cost of carrying on this money-losing

activity.

The final factor is whether petitioners derived pleasure or

recreation from the activity. Sec. 1.183-2(b)(9), Income Tax

Regs. Petitioners argue that the horse-breeding activity

required a lot of difficult work, including cleaning and brushing

the horses, trimming their hooves, mucking out their stalls and

corral, watering and feeding the horses, hauling hay and feed,

spreading manure on the pasture, branding, burning brush,

cleaning irrigation ditches, and so forth. Petitioners state:

“The Petitioners fail to see how backbreaking activity of this

nature, in addition to full-time employment, can be considered

pleasurable”, a proposition for which they might have cited and

quoted Doyle v Commissioner, T.C. Memo. 1982-694 (“They did

virtually all the hard work themselves in the interest of saving

money. They maintained the horses, mucked out the stalls, drove

to the shows, cultivated the alfalfa field, and dug their own

well. Activities of this nature are difficult to call

pleasurable.”).

We have arrived at the contrary conclusion in a multitude of

cases. In Novak v. Commissioner, T.C. Memo. 2000-234, we
 - 18 -

rejected the taxpayer’s argument that the hard work involved in

breeding horses establishes that the activity was engaged in for

profit.

Petitioner argues that his substantial time commitment
and hard work eliminate any elements of pleasure or
recreation. We recognize that the level of work or
effort may indicate a profit objective and that caring
for horses and maintaining a horse farm are hard work.
However, the fact that an activity involves hard work
does not, standing alone, establish that an activity
was engaged in primarily for profit. Petitioner’s
introduction into horse-breeding was precipitated by
his love of horses, and he enjoyed his horse-related
activity. * * *

Id.; see also Surridge v. Commissioner, T.C. Memo. 1998-304 (“the

fact that running the horse farm was hard work does not negate

the pleasure petitioners received from engaging in the horse

activity”); Yates v. Commissioner, T.C. Memo. 1996-499 (“while we

do not reject petitioners’ contention that” “* * * maintenance of

horses demand a large measure of laborious and unpleasant work”.

“* * * [We] also believe that petitioners were partially

motivated by personal reasons in engaging in the horse-breeding

activities”), affd. without published opinion 163 F.3d 609 (9th

Cir. 1998); Bischoff v. Commissioner, T.C. Memo. 1995-34 (“While

we agree that the training and breeding of horses is hard

physical work, it is clear from the facts in this case that

petitioner enjoyed this activity and lifestyle.”); Borsody v.

Commissioner, T.C. Memo. 1993-534 (“We cannot conclude that the

virtues of farm life and the show ring do not provide an adequate
 - 19 -

and sufficient explanation for the hard work and losses

undertaken by petitioners.”); King v. Commissioner, T.C. Memo.

1993-237 (“Moreover, the fact that running the horse farm was

hard work does not negate the pleasure petitioner received from

owning the horses.”); Feldman v. Commissioner, T.C. Memo.

1986-287 (“Like businesses, recreational pursuits are at times

tedious and unpleasant. Petitioners and their family enjoyed

activities involving horses, and we believe that they were

willing to muck stalls and perform other unappealing tasks as the

price for their enjoyment.”).

Inasmuch as petitioners had no possibility of earning a

financial profit from their horse-breeding activity in the manner

they conducted it, we see no reason for them to have engaged in

the activity except for pleasure of some kind. One person may

find pleasure in what another considers to be unpleasant physical

labor. Even if petitioners found certain aspects of the activity

to be unpleasant, the pleasurable aspects of raising horses must,

for petitioners, have outweighed the unpleasant “backbreaking”

work. Otherwise, petitioners would not have engaged in the

activity in the first place and would have discontinued the

activity long ago. We need not try to engage in parlor

psychoanalysis to explain their motivation for engaging in the

horse-breeding activity when the facts show that they were not

motivated primarily by profits.
 - 20 -

Finally, petitioners argue that we should lean in favor of

allowing them to deduct their losses in order to encourage risk-

taking and innovation to help the American economy thrive. The

short answer is that section 183 denies the deduction of losses

from activities not engaged in for profit.

We therefore uphold respondent’s determination that

petitioners’ horse-breeding activity was not “engaged in for

profit” within the meaning of section 183.

To reflect the foregoing and the stipulations of the parties

on other issues,

Decision will be entered

under Rule 155.