T.C. Memo. 2004-4
UNITED STATES TAX COURT
CSABA L. MAGASSY AND FRANCES H. MAGASSY, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11982-01. Filed January 5, 2004.
Glen A. Stankee, for petitioners.
W. Robert Abramitis, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined deficiencies in
petitioners’ Federal income taxes as follows:
Year Deficiency
1995 $245,790
1996 364,462
1997 989,450
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Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue.
The primary issue for decision is whether, during the years
in issue, petitioner Csaba L. Magassy and an S corporation, in
which Csaba L. Magassy was the sole shareholder and director,
were involved in the restoration, charter, and sale of a Feadship
yacht with a profit objective.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
Petitioners are husband and wife and resided in Potomac,
Maryland, at the time the petition was filed.1 Petitioners have
three children -- two sons and a daughter.
Petitioner has a successful medical practice in the
Washington, D.C. metropolitan area with a specialty in plastic
surgery.
On March 1, 1990, Bill Norman (Norman), petitioner’s
brother-in-law, suggested that petitioner purchase a particular
108’ Feadship yacht, which was then located in Florida and which
was being offered for sale through Lee Mogul (Mogul), the father
of Mark Mogul, one of Norman’s employees. Mogul owned a yacht
brokerage business, Boats, Yachts & Ships, Inc., which was
located in Ft. Lauderdale, Florida.
1
Hereinafter, references to petitioner in the singular are to
Csaba L. Magassy.
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Feadship yachts are built in the Netherlands by a consortium
of Dutch shipbuilders and are generally recognized as at the top
of the luxury superyacht market. Feadship stands for “First
Export Association of Dutch Shipbuilders”. Feadship yachts are
built and sold under the advertising slogan “Feadship design and
build the most perfect luxury yachts in the World.”
It was represented to petitioner that the particular
Feadship brought to his attention was owned by Boats, Yachts &
Ships and that it had been custom built in approximately 1963 for
Henry Ford II. Also, it was represented to petitioner that the
Feadship was being offered for sale under distress conditions and
that the Feadship could be restored and resold at a substantial
profit.
Petitioner was provided a written copy of a marine survey of
the Feadship in which it was represented that the fair market
value of the Feadship was $2.4 million and that the replacement
cost to purchase a brand new Feadship of the same size would be
more than $9 million. The survey provided to petitioner,
however, was incomplete because the Feadship had not been pulled
out of the water for inspection of the steel hull for corrosion
and rust. As a result, petitioner was not aware of the actual
condition of the hull. Further, the survey did not include an
estimate of the restoration costs for the Feadship, and
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petitioner did not independently investigate what those
restoration costs might be.
Neither petitioner, any members of petitioners’ family, nor
Norman had any experience buying, owning, selling, operating, or
chartering yachts.
On March 1, 1990, without going to Florida to see and
inspect the Feadship, petitioner signed a written contract to
purchase the Feadship for $1.625 million. On the next day,
petitioner signed an addendum to the purchase contract restating
his purchase price for the Feadship to be $1.3 million. At the
time petitioner signed the purchase contract, he made a cash
downpayment of $100,000 to Boats, Yachts & Ships. Petitioner was
to pay the balance of the purchase price at closing.
In the above written contract, the stated owner and seller
of the Feadship was Boats, Yachts & Ships, Mogul’s yacht
brokerage firm located in Florida. On March 1, 1990, however,
Boats, Yachts & Ships did not actually own the Feadship. Rather,
Boats, Yachts & Ships apparently purchased the yacht on May 30,
1990, for a stated purchase price of $1 million, pursuant to a
contract entered into on or about March 28, 1990, with the former
owner of the Feadship.
The former owner of the Feadship also paid Boats, Yachts &
Ships a “commission” of $245,620.50, apparently in connection
with the sale of the Feadship to petitioner.
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In the March 2, 1990, addendum to the written purchase
contract between petitioner and Boats, Yachts & Ships, it was
stated that approximately $300,000 of the proceeds to be received
from petitioner on his purchase of the Feadship would be used by
Boats, Yachts & Ships to pay for a “complete refurbishment” of
the Feadship.
Although Mark Mogul and Norman were not required to share in
either the subsequent costs of restoration or maintenance of the
Feadship, in the written contract dated March 1, 1990, petitioner
agreed to share with Mark Mogul and with Norman all of the
profits realized on a subsequent sale of the Feadship by
petitioner. Under this contract, on a subsequent sale of the
Feadship, petitioner was to retain 75 percent of any profits, and
Mark Mogul and Norman were to divide equally 25 percent of any
profits.
At the time of his purchase of the Feadship in March of
1990, petitioner had no written business plan for the restoration
and resale of the Feadship, and, at trial, petitioner had no
recollection as to how the above percentage split of any profits
that might be realized on a resale was agreed to.
On May 9, 1990, a second marine survey of the Feadship was
prepared. Therein, it was stated that the fair market value of
the Feadship was $1.85 million, that if the Feadship was restored
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to “Bristol” condition2 the fair market value of the Feadship
would increase to $3.2 million, and that replacement of the
Feadship purchased by petitioner with a brand new Feadship of the
same size would cost petitioner $8.7 million. Like the first
survey, however, this second survey was incomplete in that the
Feadship was not removed from the water and the hull was not
inspected. Also, the second survey did not reflect an estimate
of the restoration costs of the Feadship to Bristol condition.
As of the May 29, 1990, closing of petitioner’s purchase of
the Feadship, petitioner still had neither inspected nor seen the
Feadship. Also, petitioner was not present at the closing.
To assist with his purchase of the Feadship, petitioner
obtained a secured bank loan for $1 million. Petitioner paid the
proceeds of this loan toward the purchase price of the Feadship.
For a number of months after petitioner’s purchase, the
Feadship remained in Florida in the control of Mogul at the
facilities of Boats, Yachts & Ships.
In July of 1990, petitioner was in Florida and saw the
Feadship for the first time and realized that the interior and
exterior of the Feadship were in extremely poor condition.
Despite being aware of the condition of the Feadship, petitioner
2
Bristol condition refers to a yacht as being in very good
condition, with the varnish, paint, engines, and general
condition in a condition as good as or better than that of a
first-class hotel.
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obtained a loan for $300,000 and paid $200,000 thereof to Boats,
Yachts & Ships. The record is not clear as to the exact purpose
for this $200,000 payment, but presumably it was the final
payment due on petitioner’s purchase of the Feadship.
In November of 1990, petitioner again saw the Feadship in
Florida. At that time, petitioner was advised that the full
$300,000 designated for restoration of the Feadship had been
spent even though little progress had been made on the Feadship’s
restoration.3
Petitioner then sought advice about the Feadship from John
Weller (Weller), a friend of his brother-in-law, Norman. Weller
put petitioner in contact with one of his friends who owned Angus
Yachts (Angus), a shipyard in Alabama. In January of 1991,
petitioner paid to have the Feadship moved to Angus’s Alabama
shipyard for further restoration work. Representatives of Angus
estimated that the total cost to restore the Feadship would be
$218,000, but petitioner established no budget or limit for the
restoration work to be performed by Angus on the Feadship.
After Angus had worked on the Feadship for several months,
petitioner hired an individual referred to as Captain Anthony
3
On July 26, 1991, petitioner filed a lawsuit against Mogul,
Mark Mogul, and Boats, Yachts & Ships, seeking to recover the
$300,000 that was to pay for restoration of the Feadship.
Petitioner, however, never effected service on the above named
defendants in the lawsuit, and on Oct. 11, 1991, Boats, Yachts &
Ships was administratively dissolved as a corporation by the
Florida secretary of state.
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Coby (Captain Coby), who was recommended to him by Weller, to
oversee the restoration work being done on the Feadship. In July
of 1991, and for the first time during petitioner’s ownership of
the Feadship, the Feadship was removed from the water for
inspection of the steel hull, as a result of which extensive rust
on and corrosion to the hull of the Feadship were observed.
Thereafter, Captain Coby mailed periodic letters to petitioner,
reporting on the continuing problems with Angus’s work on the
Feadship.
As of November 21, 1991, petitioner had paid Angus $428,647,
and Angus had billed petitioner an additional $527,637 for
restoration work on the Feadship.
In November of 1991, Captain Coby advised petitioner that
the restoration work being performed by Angus on the Feadship had
become a “gravy train” for Angus. At that time, petitioner
refused to pay Angus the above $527,637 in additional charges
relating to work that had been done on the Feadship during August
through November of 1991.
On December 6, 1991, Angus filed suit against petitioner,
seeking to enforce a maritime lien against the Feadship relating
to Angus’s outstanding charges to petitioner.
In the spring of 1992, petitioner obtained tax advice from a
Washington, D.C. law firm relating to the Feadship. At that
time, petitioner’s costs relating to his purchase and to the
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restoration of the Feadship totaled approximately $2 million. A
memorandum petitioner received from the law firm noted that
petitioner’s cumulative costs in purchasing and restoring the
Feadship exceeded the Feadship’s fair market value and that yet
additional significant costs would be necessary to complete the
restoration of the Feadship. Petitioner was advised that a sale
of the Feadship before completion of the restoration work and
without establishing a yacht chartering operation for the
Feadship would preclude treatment by petitioner of any loss on
the sale of the Feadship as an ordinary loss under section 1231.
In November of 1992, petitioners and Angus settled the
above-referenced lawsuit pursuant to which petitioner agreed to
pay Angus an additional $480,000 -- $300,000 in cash and a
$180,000 promissory note with principal and interest due in
3 years. Petitioner paid Angus the $300,000, and Angus released
the maritime lien on the Feadship. With petitioner’s consent,
Captain Coby then transported the Feadship to a shipyard in Bayou
La Batre, Alabama.
At the shipyard in Bayou La Batre, much of the prior
restoration work that had been done by Angus on the Feadship, at
a cost to petitioner of approximately $1 million, was determined
to be in need of being redone either because the work was
defective or for other reasons. From late 1992 until June of
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1994, petitioner incurred additional costs of approximately
$450,000 relating to continuing work on the Feadship.
With petitioner’s consent, in June of 1994, Captain Coby
transported the Feadship to the Merrill Stevens Boat Yard in
Miami, Florida, where Captain Coby continued to supervise
restoration work on the Feadship for which petitioner paid at
least an additional $456,000.
On December 7, 1994, petitioner organized S.M.S.M., Inc.
(SMSM), as a Florida corporation for the stated purpose of
chartering the Feadship. SMSM made a timely S corporation
election, and at all relevant times, petitioner was the sole
shareholder and director of SMSM.
On December 14, 1994, petitioner entered into an agreement
with Richard Bertram Yachts to list the Feadship for sale. The
listing agreement stated an asking price for the Feadship of $2.4
million. This asking price was significantly less than
petitioner’s cumulative costs of approximately $3.5 million
relating to his purchase and restoration work on the Feadship.
On December 24, 1994, the Feadship was moved to another
shipyard in Florida for yet further restoration work. At this
time, Mrs. Magassy became involved, incurring additional costs of
approximately $222,000 primarily in decorating the interior of
the Feadship.
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On January 27, 1995, SMSM signed a charter agreement with
Priscilla Yacht Management under which the Feadship became a part
of Priscilla Yacht Management’s charter fleet operation. On
February 10, 1995, petitioner registered SMSM with the Florida
Department of Revenue as a sales and charter boat dealer.
On March 8, 1995, petitioner transferred title to the
Feadship to SMSM. Checking and credit card accounts were
established in the name of SMSM, and SMSM borrowed $874,000 to
refinance and to pay off the remaining balance on the $1 million
loan that petitioner had obtained to purchase the Feadship.
None of the members of the Magassy family were qualified
yachtsmen. From approximately March 16 through March 18, 1995,
however, Mrs. Magassy and petitioners’ three children were aboard
the Feadship during the Feadship’s first sea trial from
Ft. Lauderdale, Florida, to Port Lucaya, Bahamas. From March 24
through March 27, 1995, petitioners and their sons were aboard
the Feadship during a sea trial of the Feadship from
Ft. Lauderdale to Hurricane Hole, Bahamas. On at least three
additional occasions, different Magassy family members took
personal vacations on board the Feadship while it was in the
Bahamas.
On a number of occasions during 1995, 1996, and 1997,
petitioners held dinner cruises and cocktail parties on the
Feadship. Also, on occasion, without staying overnight, Magassy
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family members spent daytime and evening hours partying on the
Feadship.
From 1995 through 1997, while still listed for sale, the
Feadship was chartered to a number of paying customers and
received charter fees as follows:
Date of Charter Customer Charter Fees
1995
Apr. 11-20, 1995 Dr. P. George $ 18,000
June 2-6, 1995 PSA* 20,000
July 3-12, 1995 P. Racancello 21,215
July 26, 1995 NECTA 3,252
Aug. 11-14, 1995 A. Milchan 9,000
Aug. 15-19, 1995 D. Pietro 11,000
Aug. 25-27, 1995 D. Pietro 5,500
Sept. 1-3, 1995 Great Northern
Recyclers 7,500
Sept. 4-8, 1995 A. Milchan 12,000
Oct. 22-Dec. 25, 1995 PSA 20,000
Nov. 13, 1995 Rose Photo, Inc. 3,300
Nov. 27-Dec. 5, 1995 Blood & Wine
Productions 20,000
1995 Total Charter Fees $150,767
1996
Mar. 20-Apr. 1996 Pratt/Manson 33,000
Apr. 8-13, 1996 N. Halliday 14,167
Apr. 20-28, 1996 J. Meyer 19,429
July 1-5, 1996 A. Milchan 16,667
July 23-29, 1996 J. Pomerantz 12,600
July 31-Aug. 7, 1996 Cunningham & Co. 18,900
Aug. 17-26, 1996 Kaleen Charters 21,000
Dec. 26, 1996-Jan. 4, 1997 P. Biersdorfer 20,000
1996 Total Charter Fees $155,763
1997
Apr. 9-13, 1997 Fugger $ 4,000
1997 Total Charter Fees $ 4,000
* Plastic Surgery Associates is petitioner’s
medical practice.
As indicated, two of the above paid charters involved
Plastic Surgery Associates (PSA), petitioner’s medical group.
Participants in the charters of the Feadship by PSA included
partners and staff of petitioner’s plastic surgery practice.
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During both charters involving PSA, petitioner and Mrs. Magassy
were on board the Feadship, and during one of those charters,
petitioners’ two sons were on board.
For the 1996 charter boat season, petitioner’s Feadship was
not listed in the Charter Databank International Listings, an
important multiple listing service for a successful charter boat
operation.
From the time of purchase in 1990 and through 1995, the
first year of chartering the Feadship, petitioner kept invoices
and copies of checks relating to payment of the restoration costs
of the Feadship. During this period, however, petitioner’s books
and records relating to the Feadship were not complete.
Between 1990 and 1994, petitioner incurred more than
$334,000 in interest expenses relating to the $1 million and the
$300,000 loans petitioner obtained to purchase the Feadship.
Before 1996, incomplete books and records were maintained
relating to petitioner’s and SMSM’s costs and expenses for the
restoration work on the Feadship and for the charter of the
Feadship.
In 1996, Midge McKee Hopkins (Hopkins), the longtime
bookkeeper for PSA, began maintaining computerized books and
records relating to the Feadship and to write the checks to pay
the bills relating to the Feadship. Each month, Hopkins received
an envelope of bills, bank registers, and bank statements from
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Mrs. Magassy relating to the Feadship. Hopkins did not attempt
to verify the business purpose of any of the bills she paid
relating to the Feadship.
During 1995, 1996, and 1997, when Mrs. Magassy visited the
Feadship in Florida, she would charge her airline ticket, her
hotel and car rental expenses, and her restaurant meals on her
personal credit card, and the expenses were treated by SMSM as
business expenses.
On April 29, 1997, SMSM sold the Feadship to Classic Yachts
Restoration, Ltd., for $1.1 million.
The charter income and claimed ordinary business expenses
and losses of SMSM (as an S corporation) (including the 1997 loss
on the sale of the Feadship) relating to the Feadship that were
reflected on SMSM’s Federal income tax returns for 1995, 1996,
and 1997, and that were passed through to petitioners’ joint
Federal income tax returns for each year, are reflected below:
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1995 1996 1997
Charter Income
Gross receipts $156,443 $ 135,572 $ 14,262
Other income 4,023
Total income $156,443 $ 135,572 $ 18,285
Expenses
Salaries $ 68,285 $ 129,924 $ 37,914
Repairs 1,211 68,111 6,153
Rents 25,212 32,702 4,013
Taxes and licenses 9,919
Interest 40,153 63,666 21,931
Depreciation 466,961 837,314 331,977
Advertising 13,749 13,061
Other deductions
Travel, meals,
and entertainment 1,519 6,359 1,752
Administrative 2,042 6,010 2,041
Auto 146 595
Fuel 10,687 1,733
Bank charges 865 283 112
Dues & licenses 635 3,493
Insurance 25,506 27,464
Management fees 8,561 9,515 3,050
Outside services 14,823
Professional fees 12,794 11,414 41,142
Supplies 39,437 22,773 4,541
Telephone 13,982 7,234 1,657
Miscellaneous 17,359 2,285
Uniforms 5,808 5,520
Office supplies 539 498
Payroll taxes 14,595 3,935
Total expenses $759,048 $1,272,949 $ 472,963
Claimed operating losses $602,605 $1,137,377 $ 454,678
Claimed ordinary loss on
sale of the Feadship $1,931,292
On petitioners’ joint Federal income tax returns for 1995,
1996, and 1997, the above claimed losses relating to the Feadship
were offset against petitioner’s taxable income from his medical
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practice. As a result, if the claimed expenses relating to the
Feadship are allowed in full, petitioner’s losses relating to the
Feadship will result in Federal income tax savings to petitioner
of $245,790 for 1995, $364,462 for 1996, and $989,450 for 1997.
On audit for each of the years in issue, respondent
disallowed the claimed expenses and losses relating to
petitioner’s restoration, charter, and sale of the Feadship.
OPINION
Generally, expenses attributable to an activity not engaged
in for profit are not allowable as ordinary and necessary
business expense deductions except to the extent of income from
the activity. Sec. 183(a) and (b). 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 * * *
under section 162 or under paragraph (1) or (2) of section 212.”
For the expenses to be deductible under sections 162 and
212, so that the limitation of section 183 will not apply, a
taxpayer must engage in or carry on an activity to which the
expenses relate with an actual and honest objective of making a
profit. Keanini v. Commissioner, 94 T.C. 41, 45 (1990) (citing
Golanty v. Commissioner, 72 T.C. 411, 425 (1979), affd. without
published opinion 647 F.2d 170 (9th Cir. 1981)); Dreicer v.
Commissioner, 78 T.C. 642, 645 (1982), affd. without opinion 702
F.2d 1205 (D.C. Cir. 1983). Petitioners bear the burden of
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proving that petitioner and SMSM engaged in the activity in
question with an actual and honest objective of realizing a
profit. Hendricks v. Commissioner, 32 F.3d 94, 98 (4th Cir.
1994), affg. T.C. Memo. 1993-396. The parties do not cite
section 7491, and no claim is made herein that the burden of
proof should be shifted to respondent.
Although the section 183 analysis with respect to the
activities of an S corporation is applied at the corporate level,
a taxpayer’s objective or intent is attributable to his wholly
owned S corporation. Ballard v. Commissioner, T.C. Memo. 1996-
68; sec. 1.183-1(f), Income Tax Regs.
A profit objective in an earlier year does not give a
taxpayer a blank check with regard to losses incurred in later
years (i.e., in a later year an activity may be treated as an
activity not engaged in for profit even though in an earlier year
the activity may have been conducted by the taxpayer with a
profit objective). See dicta in Dennis v. Commissioner, T.C.
Memo. 1984-4; Daugherty v. Commissioner, T.C. Memo. 1983-188.
To determine whether a taxpayer had the requisite profit
objective, we consider all of the surrounding facts and
circumstances. Keanini v. Commissioner, supra at 46 (citing
Lemmen v. Commissioner, 77 T.C. 1326, 1340 (1981)); Golanty v.
Commissioner, supra at 426; sec. 1.183-2(a) and (b), Income Tax
Regs.
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The regulations list several factors to consider in
analyzing whether a profit objective exists, none of which
generally is alone determinative. Antonides v. Commissioner, 91
T.C. 686, 694 (1988), affd. 893 F.2d 656 (4th Cir. 1990). Some
factors may be given more weight than others because they may be
more meaningfully applied to the evidence in a particular case.
Hendricks v. Commissioner, supra at 98; sec. 1.183-2(b), Income
Tax Regs.
On the sale of property, under section 1231 a taxpayer may
treat a net loss on the sale as an ordinary loss only if the loss
involved a sale of property that was used in the taxpayer’s trade
or business. Sec. 1231(a)(2) and (3) and (b). In analyzing
whether an activity in connection with which property is sold
constituted a trade or business (for purposes of ordinary loss
treatment under section 1231), a taxpayer’s profit objective, or
lack thereof, relating to the activity is particularly
significant. Helvering v. Highland, 124 F.2d 556, 561 (4th Cir.
1942) (involving a claim of business expense deductions under
section 23(a), the predecessor of section 162(a)); Abbene v.
Commissioner, T.C. Memo. 1998-330. Also relevant are factors
relating to the manner, continuity, and regularity with which an
activity is conducted. Commissioner v. Groetzinger, 480 U.S. 23,
35 (1987); De Amodio v. Commissioner, 34 T.C. 894, 906 (1960),
affd. 299 F.2d 623 (3d Cir. 1962).
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Petitioners assert that for 1995, 1996, and 1997, petitioner
and SMSM had an actual profit objective relating to ownership and
charter of the Feadship. Petitioners assert that petitioner’s
and SMSM’s profit objective involved a continuation of the plan
petitioner adopted in 1990 when petitioner first purchased and
started restoration work on the Feadship and that that profit
objective expanded in 1995, 1996, and 1997 to include the charter
of the Feadship while the Feadship was offered for sale.
Respondent does not dispute that in 1990, when petitioner
purchased the Feadship, petitioner may have had a vague plan and
objective of making some repairs and then, within a short period
of time, of reselling the Feadship for profit. Respondent
argues, however, that over the course of the early 1990s,
petitioner’s costs of restoring the Feadship became so exorbitant
that by 1995 it had become clear to petitioner, and to anyone
else associated with the Feadship, that a profit would not be
realized either on the charter or on the sale of the Feadship.
Respondent therefore argues that the claimed 1995, 1996, and 1997
expenses and losses relating to restoration, charter, and sale of
the Feadship should not be allowed.
We resolve the issues presented largely by applying the
factors set forth in the regulations under section 183.
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Manner of Carrying On the Activity
A profit objective is suggested where a taxpayer carries on
an activity in a businesslike manner and where accurate and
complete books and records are maintained relating to the
activity. Sec. 1.183-2(b)(1), Income Tax Regs. A profit
objective may be suggested for an activity where the activity is
conducted in a manner similar to other activities of the taxpayer
which are profitable. Id.
As discussed above, petitioner had no experience in owning a
yacht, no written business plan, and no budget for the
restoration costs, and petitioner made no good faith, reasonable
investigation before making his investment in the Feadship.
Incomplete books and records relating to the 1995 charter of the
Feadship were maintained. Petitioner incurred substantial costs
in connection with the effort to restore the Feadship without
properly monitoring the work.
Expertise of Petitioners or Their Advisers
A profit objective may be indicated by a taxpayer’s
expertise in, research on, and study of an activity, as well as
by a taxpayer’s consultation with experts. Sec. 1.183-2(b)(2),
Income Tax Regs. However, a taxpayer’s reliance on the advice of
someone who the taxpayer knew, or should have known, had a
conflict of interest may not be reasonable. Addington v.
Commissioner, 205 F.3d 54, 59 (2d Cir. 2000), affg. T.C. Memo.
1997-259; Vojticek v. Commissioner, T.C. Memo. 1995-444 (such
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advice may constitute nothing more than sales promotion). A
taxpayer generally should undertake a good faith investigation of
the factors that would affect profit. Westbrook v. Commissioner,
T.C. Memo. 1993-634, affd. per curiam 68 F.3d 868 (5th Cir.
1995).
Petitioner had no expertise in purchasing yachts for resale,
in owning yachts, in restoring yachts, or in chartering yachts.
Over the years, petitioner appears to have had access to
business, financial, and tax advisers. The evidence, however, is
clear that petitioner did not seek independent expert advice
relating to the purchase of the Feadship. Moreover, petitioner
did not investigate the cost of restoring the Feadship and did
not seek independent advice regarding the viability of the plan
suggested by Mogul at the time of purchase of the Feadship in
1990, and yet petitioner spent over $3.5 million on the Feadship.
Financial Status of Petitioner
Where a taxpayer has substantial income from sources other
than the activity in question and where the losses from the
activity, if allowed, would generate substantial tax benefits, an
objective other than a profit objective is suggested. Hendricks
v. Commissioner, 32 F.3d at 99; sec. 1.183-2(b)(8), Income Tax
Regs. The limitations in section 183 are designed to prevent
taxpayers from offsetting unrelated income with losses from an
activity not carried on for profit. Faulconer v. Commissioner,
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748 F.2d 890, 893 (4th Cir. 1984), revg. and remanding T.C. Memo.
1983-165.
The losses petitioner claimed relating to the Feadship
generated significant claimed tax savings, which, if allowed,
would offset income from petitioner’s unrelated medical practice.
History of Income or Losses
Substantial losses over a number of years suggest a lack of
profit objective. Sec. 1.183-2(b)(6), Income Tax Regs. If,
however, losses result because of unforeseen circumstances beyond
the control of a taxpayer, the losses may bear less on the
question of profit objective. Id.
Chartering the Feadship resulted in losses to petitioner for
all 3 years at issue. The excessive costs relating to the repair
and restoration work on the Feadship may have been a surprise to
petitioner, but good faith, diligent, and timely investigation
into the condition of the Feadship and into the nature of the
luxury yacht charter business would have eliminated most of this
surprise and would have provided to petitioner information upon
which he would have been able to make a reasoned and calculated
decision about whether to proceed further.
By 1995, petitioner’s costs associated with the Feadship
were so high that he should have known that charter of the
Feadship would not generate income sufficient to cover those
costs. Further, in 1995, 1996, and 1997, while the Feadship was
available for charter, the Feadship also was for sale at an
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asking price of only $2.4 million, an amount well below the $3.5
million petitioner had already invested in the Feadship.
Opportunity for Profits From the Activity
The opportunity to earn substantial profits in a speculative
venture may indicate that an activity is engaged in for profit
even though losses or only occasional small profits actually
result. Sec. 1.183-2(b)(7), Income Tax Regs.
Regardless of any profit objective petitioner initially in
1990 may have had when he purchased the Feadship, the $3.5
million that petitioner incurred in costs by 1995 far exceeded
the $2.4 million asking price for the Feadship (indicating an
expected loss on the sale), and petitioner had no reasonable
basis for expecting a profit from SMSM’s charter of the Feadship,
which petitioner at trial acknowledged was conducted for the
purpose of offsetting costs of maintaining the Feadship while it
was listed for sale.
Expectation That Assets May Appreciate
An expectation that assets used in an activity may
appreciate in value may indicate a profit objective. Golanty v.
Commissioner, 72 T.C. at 427-428; Bessenyey v. Commissioner, 45
T.C. 261, 274 (1965); sec. 1.183-2(b)(4), Income Tax Regs.
Generally, however, an expectation that assets “may appreciate is
not sufficient, in itself, to demonstrate that an activity was
engaged in for profit.” Hendricks v. Commissioner, supra at 100.
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Although petitioner, at the time of his purchase in 1990,
may have had an expectation that the Feadship would appreciate in
value, the evidence before us establishes that petitioner had no
such expectation during 1995, 1996, and 1997. In December of
1994, petitioner listed the Feadship for sale at $2.4 million.
As discussed previously, this amount was significantly less than
petitioner’s cumulative purchase and restoration costs relating
to the Feadship.
As stated, petitioner acknowledged that the purpose of
chartering the Feadship in 1995, 1996, and 1997 was to offset the
costs of operating the Feadship while it was listed for sale. As
one of petitioners’ witnesses testified, “if * * * you charter a
boat, you can make a couple of bucks * * *.”
Time and Effort Expended by Petitioners
A profit objective may be indicated by the amount of
personal time and effort a taxpayer devotes to carrying on an
activity. Sec. 1.183-2(b)(3), Income Tax Regs. Petitioner’s
time during the years at issue was largely devoted to his medical
practice, allowing petitioner little time to devote to matters
relating to the restoration and to the charter of the Feadship.
Mrs. Magassy’s efforts relating to the interior design of
the Feadship occurred well after the major costs of the
restoration on the Feadship had been incurred. Her efforts do
not establish an overall profit objective for petitioner or for
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SMSM in chartering the Feadship or in restoring the Feadship for
resale.
Success in Carrying On Other Activities
A taxpayer’s success with other business activities may
indicate a profit objective. Sec. 1.183-2(b)(5), Income Tax
Regs. Petitioner is a successful plastic surgeon, but neither he
nor Mrs. Magassy had engaged in activities relating to owning and
operating a luxury yacht. It appears that petitioner handled
decisions relating to the Feadship quite differently from the
successful manner in which he practiced medicine.
Personal Pleasure or Recreation
The mere fact that a taxpayer derives personal pleasure from
an activity does not constitute a per se demonstration of a lack
of profit objective. Sec. 1.183-2(b)(9), Income Tax Regs.
Conversely, where an activity lacks recreational appeal, a profit
objective may be indicated. Id.
Yachting inherently involves a luxury indulgence, and
petitioners and petitioners’ family members participated in a
number of trips and entertained on the Feadship. The evidence
establishes some significant personal recreational aspects to
petitioner’s and to SMSM’s yachting activity.
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Section 1231 Loss
It is clear that petitioner’s original purchase of the
Feadship in 1990 and his restoration efforts during the early
1990s did not constitute a trade or business and would not
qualify his $1.93 million loss on the 1997 sale of the Feadship
for section 1231 ordinary loss treatment. Petitioners argue,
however, that the 1995, 1996, and 1997 charter activity (combined
with petitioner’s original 1990 profit objective for purchasing
the Feadship) constituted a sufficiently regular for-profit
activity that the $1.93 million claimed loss on sale of the
Feadship should qualify for section 1231 ordinary loss treatment.
On the facts of this case, certainly by 1995 and thereafter
through April of 1997, when petitioner sold the Feadship for
$1.1 million, petitioner did not have a good faith profit
objective relating either to the charter of the Feadship or to
the sale of the Feadship. During 1995, 1996, and 1997,
petitioner’s and SMSM’s objective in the charter of the Feadship
was to provide funds to offset a portion of the costs of
ownership of the Feadship.
Also, because of the lack of profit objective associated
with the charter of the Feadship, the charter activity relating
to the Feadship in 1995 through April of 1997 did not constitute
a trade or business, and the Feadship does not qualify for
treatment as trade or business property under section 1231.
Abbene v. Commissioner, T.C. Memo. 1998-330; Budin v.
Commissioner, T.C. Memo. 1994-185.
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On the evidence before us, we conclude that petitioner and
SMSM did not have an actual and honest objective that the
Feadship would generate a profit either from its charter or from
its sale.
In light of our resolution of the above issues, we need not
address respondent’s other arguments.
Based on the foregoing,
Decision will be entered
for respondent.