T.C. Memo. 2002-200
UNITED STATES TAX COURT
TIMOTHY THOMAS AND JANICE KATHLEEN KUBERSKI, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 1174-01. Filed August 12, 2002.
Timothy Thomas Kuberski and Janice Kathleen Kuberski,
pro sese.
Charles J. Graves, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined deficiencies in
petitioners’ Federal income taxes and an addition to tax as
follows:
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Addition to Tax
Year Deficiency Sec. 6651(a)(1)
1994 $25,014 $5,628.38
1995 31,785 –-
1996 20,543 –-
1998 19,554 --
The issue for decision is whether petitioners are entitled to
deduct losses claimed on their Schedule C, Profit or Loss From
Business, for Caduceus Thoroughbreds, a horse breeding and racing
operation. Respondent determined that petitioners’ horse
activity was not an activity engaged in for profit within the
meaning of section 183. Unless otherwise indicated, all 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.
FINDINGS OF FACT
Petitioners were residents of Phoenix, Arizona, at the time
they filed their petition. At all material times, Timothy Thomas
Kuberski (petitioner) was a physician. Petitioners filed joint
Federal income tax returns for 1994 through 1998, reporting
annual combined earnings from employment ranging from
approximately $287,000 to approximately $342,000.
Petitioner has been involved in the thoroughbred horse
industry in Arizona since 1980. Petitioner’s goal was to breed,
raise, and race thoroughbred horses.
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During the years in issue, petitioner operated Caduceus
Thoroughbreds in conjunction with Sun State Farm, an
S corporation. Petitioner and Fillipo Santoro (Santoro) formed
Sun State Farm in 1986 to develop a modern and complete
thoroughbred horse facility capable of dealing with all facets of
the thoroughbred industry. In 1986, Sun State Farm purchased a
36-acre parcel of land in Wickenburg, Arizona (the farm). The
farm was flat, was zoned for farming, had good access to nearby
highways, and had a good water supply. Petitioner, with the help
of his uncle and ranch manager, made certain improvements to the
farm, including constructing barn facilities for the horses.
Horses that Caduceus Thoroughbreds owned were boarded at the
Sun State Farm facility from 1986 through 1996. Caduceus
Thoroughbreds deducted boarding fees totaling $416,236 that were
paid to Sun State Farm from 1986 through 1996.
Petitioner and Santoro dissolved Sun State Farm after a
“falling out” in 1996. Petitioner’s horses remained at the
property, and petitioner continued to market his thoroughbreds
using the name Sun State Farm.
Petitioner wrote a business plan in 1995 for Caduceus
Thoroughbreds that was a supplement to a plan written for Sun
State Farm in 1987. Although the name on the 1995 business plan
had changed, petitioner had not significantly changed the
operations.
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The business plan that petitioner wrote in 1987 for Sun
State Farm identified key advisers to the business, such as a
veterinarian, an accountant, a nutritionist, and other experts in
the thoroughbred horse industry. The 1987 plan identified farm
assets and their potential appreciation and outlined expenses
such as wages, utilities, boarding fees, race training fees, and
sale preparation fees. The business plan included a cashflow
projection, an income and loss statement, a description of
additional revenue sources, and a listing of potential capital
improvements for the farm. Petitioner projected annual expenses
of $93,100 and annual income of $102,600. The plan also
projected the acquisition of a stallion to proceed with the
breeding operation. The plan included an economic analysis
compiled by the University of Arizona, which studied the impact
of the thoroughbred horse breeding industry on the Arizona
economy.
The 1995 supplement gave a general description of the
operations of Caduceus Thoroughbreds but did not include any
financial data or income projections other than a projected cost
of between $7,000 and $10,000 to prepare a horse for the
racetrack. The new plan emphasized a change in focus from
breeding to racing. The plan also cautioned that, despite
increasing purses, the value of Arizona thoroughbreds had not
improved commensurately, and owners were still buying expensive
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horses elsewhere. Petitioner projected that, as his operation
became more experienced and recognized, the potential for profit
would increase.
Petitioner believed that he could breed a better-than-
average thoroughbred horse because of his medical background and
his understanding of physiology and statistical analysis.
Petitioner is a licensed trainer and owner, as well as a
certified horse appraiser. He has taken annual classes on taxes,
business, shoeing horses, veterinary problems, animal husbandry,
and sales preparation. Petitioner wrote several articles for the
thoroughbred horse industry, including one explaining the dosage
system, a horse breeding theory, and others related to various
medical problems in the racehorse industry. Petitioner sent out
bills every month, knew all the mares on the farm, and knew why
particular mares were bred with his stallion.
Petitioners characterize the thoroughbred horse industry as
a “loss” industry and contend that statistically it is possible
to make a profit only once every 25 years. Petitioners have
never made a profit from their Schedule C horse breeding and
racing activity.
From 1980 through 1998 (excluding 1981, 1983, and 1985 for
which no information was introduced), petitioners reported the
following gross receipts and losses with respect to the horse-
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related activity on Schedules C of their Federal income tax returns:
Year Gross Receipts (Loss)
1980 -0- $(1,825)
1982 -0- (435)
1984 $136 (22,690)
1986 5,375 (44,320)
1987 13,832 (46,440)
1988 5,935 (39,684)
1989 3,434 (38,602)
1990 2,306 (33,662)
1991 14,388 (89,355)
1992 33,280 (106,041)
1993 39,662 (96,738)
1994 40,485 (62,142)
1995 19,824 (80,205)
1996 26,630 (67,605)
1997 24,931 (95,432)
1998 52,492 (63,087)
Total $282,710 $(888,263)
Petitioners’ returns for 1994, 1995, and 1996 reported, on
Schedule E, Supplemental Income and Loss, losses from Sun State
Farms. Their returns for the years in issue reported, on
Forms 4797, Sales of Business Property, the following sales of
horses:
1994 2 horses @ $1,000
1995 1 horse @ $500
1 horse @ $1,000
1 horse @ $1,500
1 horse @ $2,000
Only two of the horses were sold for more than they cost, for a
combined profit of $333.
Petitioners’ 1994 return was signed by petitioner on
February 18, 1997.
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OPINION
Respondent determined that petitioners’ horse breeding was
not an activity engaged in for profit within the meaning of
section 183. Section 183(a) provides that, if an activity is not
engaged in for profit, no deductions attributable to the activity
shall be allowed except as provided in section 183(b). Section
183(b)(1) allows only those deductions that are not dependent
upon a profit motive, such as taxes. Section 183(b)(2) allows
the deductions that would be allowable if the activity was
engaged in for profit, but only to the extent that gross income
attributable to the activity exceeds the deductions permitted by
section 183(b)(1). An “activity not engaged in for profit” is
defined in section 183(c) 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.”
Petitioners bear the burden of proving that the requisite
profit motive exists. Rule 142(a); Golanty v. Commissioner, 72
T.C. 411, 426 (1979), affd. without published opinion 647 F.2d
170 (9th Cir. 1981). Section 7491(a), which is effective with
respect to court proceedings arising in connection with
examinations by the Commissioner commencing after July 22, 1998,
the date of its enactment by section 3001(a) of the Internal
Revenue Service Restructuring and Reform Act of 1998, Pub. L.
105-206, 112 Stat. 726, does not apply to place the burden of
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proof on respondent in this case. Petitioners have neither
argued that section 7491 is applicable nor established that they
complied with the requirements of section 7491(a)(2)(A) and (B)
to substantiate items, to maintain required records, and to
cooperate fully with respondent's reasonable requests. In
addition, as discussed below, they have failed to introduce
credible evidence with respect to certain factual issues.
The Court of Appeals for the Ninth Circuit, to which an
appeal in this case would lie, has held that, for a deduction to
be allowed under section 162 or section 212(1) or (2), a taxpayer
must establish that he engaged in the activity with the primary,
predominant, or principal purpose and intent of realizing an
economic profit independent of tax savings. Wolf v.
Commissioner, 4 F.3d 709, 713 (9th Cir. 1993), affg. T.C. Memo.
1991-212; Dunn v. Commissioner, 70 T.C. 715, 720 (1978), affd.
615 F.2d 578 (2d Cir. 1980). The taxpayer's expectation need not
be a reasonable one, but the profit objective must be bona fide.
Golanty v. Commissioner, supra at 426; sec. 1.183-2(a), Income
Tax Regs. In determining whether the requisite intention to make
a profit exists, greater weight is to be given to the objective
facts than to the taxpayer's self-serving characterization of his
intent. Indep. Elec. Supply, Inc. v. Commissioner, 781 F.2d 724,
726 (9th Cir. 1986), affg. Lahr v. Commissioner, T.C. Memo. 1984-
472; sec. 1.183-2(a), Income Tax Regs.
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Section 1.183-2(b), Income Tax Regs., sets forth a
nonexclusive list of factors to be considered in determining
whether the taxpayer has the requisite profit objective. The
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 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, that are
earned; (8) the financial status of the taxpayer; and
(9) elements of personal pleasure or recreation.
These factors are not intended to be exclusive, and no one
factor or majority of the factors need be considered
determinative. Golanty v. Commissioner, supra at 426-427;
sec. 1.183-2(b), Income Tax Regs. The most significant factors
in this case are the manner in which petitioner carried on his
thoroughbred horse breeding and racing activity, the history of
income and loss, the absence of occasional--or any--profits, and
the financial status of the taxpayer.
Petitioners argue that they conducted their thoroughbred
breeding and racing operation in a businesslike manner.
Maintaining complete and accurate books and records, conducting
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the activity in a manner substantially similar to comparable
businesses that are profitable, and making changes in operations
to adopt new techniques or abandon unprofitable methods are
factors that 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.
Petitioners argue that they kept detailed and well thought
out business plans, maintained business account records with
yearly profit and loss statements, filed stallion reports and
reports of all broodmares and registered all foals with the
Jockey Club, used a bookkeeping service, used business stationery
and a business checking account, made a yearly assessment of the
market, culled nonproductive mares or poorly marketable horses,
made an economic forecast of each horse’s productivity, and
tracked the annual cost of getting each mare and foal to the
thoroughbred sales. Petitioners’ arguments, however, appear to
have been copied from the tax guides for horse owners that they
presented at trial and have little support from the evidence.
Their briefs do not cite the record, and, in most instances,
there is no support in the record for their assertions.
Petitioners offered the 1987 business plan, the 1995
supplement thereto, a 1996 brochure for the Arizona Thoroughbred
Breeders Association Yearling Sale, and Federal income tax
returns for the years in issue to support and substantiate their
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claims. Petitioner’s testimony was generally vague and focused
on the nature of the Arizona thoroughbred industry, rather than
on the manner in which he conducted the breeding and racing
operations. Petitioner alluded to one instance in which he
consulted a nutritionist to eliminate a condition called
epiphycytis. Petitioner’s testimony was uncorroborated by
witnesses or documents.
The evidence presented at trial does not persuade us that
petitioner maintained records for the purpose of “cutting
expenses, increasing profits, and evaluating the overall
performance of the operation”. Golanty v. Commissioner, supra at
430; see also Sullivan v. Commissioner, T.C. Memo. 1998-367
(generally no profit motive where lack of evidence that taxpayer
used records to improve losing venture), affd. without published
opinion 202 F.3d 264 (5th Cir. 1999). Petitioner testified that
“all the records in the world, or business plans in the world are
not going to make a difference on whether you make a profit in
this”. A businesslike operation, however, would include analyses
on why large losses recurred over a long period and whether any
possibility of recouping them existed.
A taxpayer’s history of income or loss with respect to an
activity may indicate the presence or absence of a profit
objective. Golanty v. Commissioner, 72 T.C. at 426. The
magnitude of the activity’s losses in comparison with its
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revenues is an indication that the taxpayer did not have a profit
motive. Burger v. Commissioner, 809 F.2d 355, 360 (7th Cir.
1987), affg. T.C. Memo. 1985-523. A continuous series of losses
during the startup stage will not necessarily be deemed
indicative that the activity was not engaged in for profit. Sec.
1.183-2(b)(6), Income Tax Regs. However, the cumulative loss
should not be of such a magnitude that an overall profit from a
combination of operations and realized appreciation of business
assets could not possibly be achieved. 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.
From 1980 when petitioner began the thoroughbred horse
activity through 1998, Caduceus Thoroughbreds had cumulative
losses exceeding $888,000. The Court has recognized that the
startup phase of a horse breeding activity is 5 to 10 years.
Engdahl v. Commissioner, 72 T.C. at 669. In this case, the years
in issue are well beyond the period customarily necessary to
bring a similar operation to profitable status. Sec. 1.183-
2(b)(6), Income Tax Regs.
Petitioners’ Schedule C losses for 1994, 1995, 1996, and
1998 are $62,142, $80,205, $67,605, and $63,087, respectively.
Petitioners claim that the losses were due to unforeseen
circumstances such as lawsuits against the business, downturns in
business, changes in the purse structure at races, a decrease in
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Breeder’s awards, and death or problems with important horses.
However, petitioners presented no evidence at trial to
corroborate their claims. In fact, the 1995 business plan
supplement states that purses in races had increased over the
years but that the value of Arizona thoroughbreds had not
increased commensurately. The evidence available from the record
indicates that, despite petitioner’s realization that the
thoroughbred horse activities had not proved profitable, no
substantial changes were made to the operations.
The amount of profits earned in relation to the amount of
losses incurred, the amount of the investment, and the value of
the assets in use may indicate a profit objective. Sec. 1.183-
2(b)(7), Income Tax Regs. Profit means economic profit,
independent of tax savings. Drobny v. Commissioner, 86 T.C.
1326, 1341 (1986); Engdahl v. Commissioner, 72 T.C. at 670.
Petitioners’ Federal income tax returns reflect that, without the
effect of depreciation deductions, two horses were sold at a
profit of $333 during the 4 years in issue. Petitioner has never
made a profit in his horse activities, although they have
generated generous tax savings in the form of depreciation
deductions and net losses that offset his substantial income as a
physician.
Petitioners argue that the Internal Revenue Service unfairly
pursues high income taxpayers who engage in breeding and racing
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horses. Obviously, petitioners’ financial status permits them to
engage in an activity reporting large losses over decades. The
financial status of the taxpayers is an appropriate inquiry under
the regulations, section 1.183-2(b)(8), Income Tax Regs., and in
the case law. See Golanty v. Commissioner, 72 T.C. at 428.
Petitioners’ level of income permitted them to continue the horse
activity without a profit. If they had regarded the activity as
a business, they would have focused more on the financial aspects
and ways to cut their losses. Only their other income allowed
their continued pursuit of losing operations.
Petitioners argue that many years of losses are necessary
to make a profit in the horse breeding and racing industry. They
cite Duley v. Commissioner, T.C. Memo. 1981-246, for the
proposition that the opportunity to earn a profit in a highly
speculative venture is sufficient to demonstrate profit motive.
Petitioner claims that he bred Quinton’s Fan Club, a horse that
sold as a yearling for $7,500 and, after the sale, went on to
become a world record holder and stakes winner of over $100,000.
No evidence was presented regarding petitioner’s reliance on a
professional trainer or petitioner’s own ability to train and run
a racehorse whose winnings would provide him with a realistic
chance of recovering the losses incurred in prior years.
Petitioners contend that certain assets that have
appreciated in value over the years should be considered when
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analyzing whether the requisite profit motive exists. They claim
that the farm where the horses were boarded appreciated over the
years. There is no reliable evidence in the record, however, of
the value of the land. Petitioner gave evasive and inconsistent
testimony about disposition of the land when Sun State Farm was
dissolved. Petitioner testified:
Q [Respondent’s counsel] When Sun State Farm was
dissolved, the property was sold; is that correct?
A [Petitioner] Yes.
Q In 1996, after Sun State Farm was dissolved,
who purchased that property?
A I don’t know.
Q You don’t know?
A No.
Q Did you purchase that property?
A No.
Q So, you just previously testified that you
currently own that property; is that correct?
A Yes.
Q So at what point did you purchase the
property?
A I never purchased it.
It is unclear from this testimony how petitioner would have had
an interest in appreciation of the land after 1996, and there is
no evidence that any appreciation was realized in or before 1996.
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Petitioners also argue that the stallion Sunny Feet was
purchased at no cost but was one of the most successful stallions
in Arizona, producing 10-percent stakes winners and over $100,000
in futurity stakes races. Petitioner stated that the stallion’s
untimely death had compromised his chances of making a profit
from breeding fees and awards. No credible evidence was offered
by petitioners with regard to Sunny Feet to substantiate their
claims.
Petitioner considers himself an expert in the thoroughbred
industry and believes that, as a physician with a background in
statistical analysis, he can produce a higher quality
thoroughbred than other Arizona breeders. A taxpayer’s
expertise, research, and study of an activity, as well as his
consultation with experts, may be indicative of a profit motive.
Sec. 1.183-2(b)(2), Income Tax Regs. In the 1995 supplement to
the business plan, petitioner stressed that the focus of Caduceus
Thoroughbreds would be on nutrition and training. Although
petitioner named several key advisers to the breeding and racing
operation in the 1987 and 1995 business plans, he did not present
any further evidence of their expertise in the industry or that
he actually relied on such experts. Petitioner has no formal
training in equine science and has not shown that he performed
any research or analysis on the profitability of his operations.
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Petitioners devote considerable attention in their brief to
arguing that the regulations set an impossible mandate for
profitability in the horse racing and breeding industry.
Specifically, petitioners point to the presumption under section
1.183-1(c), Income Tax Regs., that a horse breeding or racing
activity is engaged in for profit if its gross income exceeds
deductions for any 2 of 7 consecutive years. Petitioners
emphatically argue that it is only possible to make a profit once
in 25 years. Although petitioners seem to think otherwise, an
activity’s history of losses is not an exclusive factor, nor is
it an impossible obstacle to overcome in successfully proving a
profit motive in horse breeding activities. See Rinehart v.
Commissioner, T.C. Memo. 2002-9; Routon v. Commissioner, T.C.
Memo. 2002-7; Jordan v. Commissioner, T.C. Memo. 2000-206; Yancy
v. Commissioner, T.C. Memo. 1984-431; Ellis v. Commissioner, T.C.
Memo. 1984-50; Coe v. Commissioner, T.C. Memo. 1974-129; Deerman
v. Commissioner, T.C. Memo. 1974-84; Foster v. Commissioner, T.C.
Memo. 1973-13. It is a persuasive factor in this case, however,
because of the amount of the losses, the length of the period of
losses, and the absence of offsetting considerations.
We conclude that petitioner’s horse breeding and racing operation
was not an activity engaged in for profit.
Section 6651(a)(1) imposes an addition to tax for failure to
file a required return on the date prescribed, unless it is shown
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that such failure is due to reasonable cause and not willful
neglect. Petitioners’ 1994 tax return was signed February 18,
1997. Petitioners presented no evidence and did not offer any
explanations as to why they failed to file timely their 1994
return. Neither petitioners’ trial memorandum nor their opening
brief mentioned the late filing of their return. They are thus
deemed to have conceded the issue. They belatedly claim in their
reply brief that they were not given enough time to address this
issue. The trial of this case substantially exceeded the time
estimated by the parties. Much time was wasted by petitioner’s
refusal to execute an appropriate stipulation or to heed the
Court’s attempts to direct his testimony to relevant facts.
Petitioners are liable for the addition to tax for 1994.
We have considered petitioners’ remaining arguments. To the
extent that they are not discussed above, those arguments are
totally lacking in merit.
To reflect the foregoing,
Decision will be entered
for respondent.