GARBINI v. COMMISSIONER

T.C. Summary Opinion 2004-7

UNITED STATES TAX COURT

JOHN R. AND EDITH M. GARBINI, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 3593-00S. Filed January 23, 2004.

James G. Sanford, for petitioners.

Paul K. Voelker, for respondent.

PAJAK, Special Trial 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. Unless otherwise

indicated, 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. The decision to be

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

should not be cited as authority.
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Respondent determined deficiencies in petitioners’ Federal

income taxes and accuracy-related penalties in the following

amounts:

Year Deficiency Sec. 6662(a)
1996 $39,965 $7,993.00
1997 36,817 7,363.40

After concessions by respondent of the medical expense

issues, this Court must decide: (1) Whether petitioners were not

engaged in an activity for profit under section 183, (2) whether

petitioners were entitled to claimed Schedule F, Profit or Loss

From Farming, deductions for the taxable years in issue, and (3)

whether petitioners were liable for accuracy-related penalties

under section 6662(a) for the taxable years in issue.

Some of the facts in this case have been stipulated and are

so found. Petitioners’ residence was in Myrtle Creek, Oregon, at

the time they filed their petition.

Petitioners timely filed Forms 1040, U.S. Individual Income

Tax Return, for 1996 and 1997. On the Forms 1040 for both years,

petitioner John R. Garbini (petitioner) listed his occupation as

rancher. Petitioner Edith M. Garbini’s occupation was listed as

housewife. Both petitioners were senior citizens during the

taxable years in issue. For each taxable year in issue,

petitioners attached to their Form 1040, Schedule F, Profit or

Loss From Farming. On Schedule F for 1996, petitioners reported

no gross income and deducted expenses in the amount of $127,341,
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for a net loss of $127,341. On Schedule F for 1997, petitioners

reported no gross income and deducted expenses in the amount of

$124,584, for a net loss of $124,584. Respondent disallowed

petitioners’ 1996 and 1997 Schedule F loss deductions in full

because petitioners did not substantiate their deductions and

because petitioners were not engaged in an activity for profit.

Due to the fact that petitioners did not substantiate their

deductions, section 7491(a) is not applicable. Therefore,

petitioners have the burden of proof with respect to these

determinations. Rule 142(a).

We first address whether petitioners were not engaged in an

activity for profit. Section 183(a) disallows deductions

attributable to an activity not engaged in for profit, except as

provided under section 183(b). For an activity not engaged in

for profit, section 183(b)(1) allows deductions that would be

allowable without regard to whether or not an activity is engaged

in for profit. Section 183(b)(2) allows deductions that would be

allowable if the activity were engaged in for profit, but only to

the extent that gross income attributable to the activity exceeds

the deductions allowable under section 183(b)(1). Section 183(c)

defines an “activity not engaged in for profit” as “any activity

other than one with respect to which deductions are allowable for

the taxable year under section 162 or under paragraph (1) or (2)

of section 212.”
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The standard for determining whether an expense is

deductible under section 162 or 212, and not subject to the

limitations of section 183, requires a taxpayer to demonstrate

that the activity was carried on with the actual and honest

objective of making a profit. Dreicer v. Commissioner, 78 T.C.

642, 645 (1982), affd. without opinion 702 F.2d 1205 (D.C. Cir.

1983); sec. 1.183-2(a), Income Tax Regs. Although a reasonable

expectation of profit is not required, the facts and

circumstances must indicate that the taxpayer entered into the

activity, or continued the activity, with the actual and honest

objective of making a profit. Dreicer v. Commissioner, supra at

645. The taxpayer’s objective to make a profit must be analyzed

by looking at all the surrounding facts. Id. These facts are

given greater weight than the taxpayer’s mere statement of

intent. Id.

The regulations under section 183 provide a nonexclusive

list of relevant factors that should be considered in determining

whether the taxpayer has the requisite profit objective. Sec.

1.183-2(b), Income Tax Regs. The factors are: (1) The manner in

which the taxpayer carries on the activity; (2) the expertise of

the taxpayer; (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
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activities; (6) the taxpayer’s history of income or losses with

respect to the activity; (7) the amount of occasional profits, if

any, which are earned; (8) the financial status of the taxpayer;

and (9) any elements indicating personal pleasure or recreation.

Id. These factors are not applicable or appropriate in every

case. Abramson v. Commissioner, 86 T.C. 360, 371 (1986). The

facts and circumstances of the case in issue remain the primary

test. Id.

In determining whether petitioners were engaged in an

activity with the requisite profit objective, all the facts and

circumstances of their situation must be taken into account.

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

published opinion 647 F.2d 170 (9th Cir. 1981). No single factor

is controlling, nor is the existence of a majority of factors

favoring or disfavoring a profit objective necessarily

controlling. Hendricks v. Commissioner, 32 F.3d 94, 98 (4th Cir.

1994), affg. T.C. Memo. 1993-396; sec. 1.183-2(b), Income Tax

Regs.

In 1984, petitioners purchased 666 acres of land (the ranch)

in Myrtle Creek, Oregon. Except for two log cabins, the ranch

was unimproved, and contained trees, pasture land, and three

ponds. Since about 1986, petitioners have cleared areas and

planted more trees, had cattle graze the pasture land, and built

roads, ponds, and barns. Petitioners’ residence was built in
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about 1985. Petitioners moved into the house in approximately

1987, and have resided there through the time of trial. In 1986,

petitioners sold a mobile home park for $7 million.

In applying the factors to determine profit objective, we

first consider the manner in which the taxpayer carries on the

activity. “The fact that the taxpayer carries on the activity in

a businesslike manner and maintains complete and accurate books

and records may indicate that the activity is engaged in for

profit.” Sec. 1.183-2(b)(1), Income Tax Regs. Petitioners did

not maintain books and records. Rather, petitioner made a

monthly list of expense categories and, based on his canceled

checks, recorded the amounts expended for each category. At

trial, petitioner submitted various invoices, canceled checks,

and the monthly lists for the taxable years in issue. Petitioner

did not have a business plan to make money from the ranch.

Petitioner did not keep the type of records which could be used

to increase the profitability of a business. Petitioner never

prepared budgets or market projections which would outline

strategies for ensuring a profitable business venture and making

informed business decisions on a periodic basis. Such lack of

information upon which to make educated business decisions tends

to belie a taxpayer’s contentions that an activity was pursued

with the primary objective of making a profit. Dodge v.

Commissioner, T.C. Memo. 1998-89, affd. without published opinion
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188 F.3d 507 (6th Cir. 1999).

“A change of operating methods, adoption of new techniques

or abandonment of unprofitable methods in a manner consistent

with an intent to improve profitability may also indicate a

profit motive.” Sec. 1.183-2(b)(1), Income Tax Regs. Petitioner

contends that he has made efforts to reduce expenses in order to

operate the ranch in a profitable manner. Nothing in the record

indicates what efforts to reduce expenses, if any, were made

during the taxable years in issue. Petitioner never ascertained

how or when he would make a profit or how he could change his

operating methods to improve his profitability. Although

petitioners owned cattle during the years in issue, there were no

sales of cattle during those years. Nor was there any evidence

of an effort to raise cattle for profit on their ranch.

We next consider the expertise of the taxpayer. Since

purchasing the ranch, petitioner has learned about the types of

trees that should be planted in specific areas on the ranch.

Petitioner also claimed that in 1986 he began studying,

researching, and compiling data on the marketing and sale of

verified emission reduction offsets (carbon credits) to polluting

entities, and that he has consulted about that subject with the

Oregon Department of Forestry and a chemistry/biology professor

who holds a Ph.D. Yet, during the years in issue petitioner did

not put any acquired knowledge to use in an endeavor to make a
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profit.

We next consider the time and effort expended by the

taxpayer in carrying on the activity. Petitioner worked on the

ranch almost everyday and employed one full-time ranch hand

during the taxable years in issue. The ranch hand performed

general maintenance of the property and barns. Petitioner

occasionally hired outside temporary labor.

We next consider the taxpayer’s expectation that the assets

used in the activity may appreciate in value. Petitioner

contends that he has enhanced and created value in the trees and

the carbon credits related to the trees. Petitioner paid

$566,000 for the ranch in its undeveloped condition. With the

improvements made by petitioner and the value of the timber and

carbon credits, petitioner estimates that the value of the trees

alone is $2.5 million and that the ranch is worth $15 million.

Petitioner did not provide any basis for such estimates.

Petitioner stated that since 1984, with the exception of 1994 and

1995, he has planted 3,000 to 5,000 trees per year. Petitioner

further stated that these trees are not considered suitable for

harvesting until 7 years after planting. We note that no trees

were harvested during the taxable years in issue. Petitioner

contends that the growing trees have value and profit potential

in the form of cut timber and carbon credits. Again, petitioner

never sold any carbon credits during these 2 taxable years.
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We next consider the success of the taxpayer in carrying on

other similar or dissimilar activities. Prior to purchasing the

ranch, petitioner said he purchased undeveloped land in San Jose,

California, and developed “the first luxury mobile home park for

senior citizens in the state”. Petitioners owned and operated

the mobile home park for approximately 20 years. Petitioner

stated that petitioners worked 7 days per week and employed one

groundsman. Petitioner further stated that the mobile home park

operated profitably after the first 10 years and that 10 years

thereafter, petitioners sold the mobile home park for $7 million.

The taxpayer’s history of income or losses with respect to

the activity is another factor. At trial, petitioner did not

provide a history of income or losses for his ranch. During the

taxable years in issue, losses exceeded $250,000, an average of

$125,000 for each year. Although petitioner claimed that the

losses since 1997 have lessened, petitioner admitted that the

losses for the years before those in issue would have been

roughly the same as the taxable years in issue. Over this

approximate time frame of 12 years, petitioner incurred losses of

$1,500,000.

The amount of occasional profits, if any, which are earned

is another factor. No profits were earned with respect to the

ranch during the years in issue.

We next consider the financial status of the taxpayer.
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During the taxable years in issue, neither petitioner nor his

wife earned income from wages. For taxable year 1996,

petitioners reported taxable interest in the amount of $139,778,

dividend income in the amount of $1,832, capital gains in the

amount of $55,488, and taxable Social Security benefits in the

amount of $10,076. For taxable year 1997, petitioners reported

taxable interest in the amount of $93,360, dividend income in the

amount of $865, taxable refunds, credits, or offsets in the

amount of $645, capital gains in the amount of $88,813, rental

real estate income in the amount of $6,251, and taxable Social

Security benefits in the amount of $10,365. For both taxable

years, almost all the taxable interest income and capital gains

income were derived from interest and installment payments of

principal made by the buyers of petitioners’ mobile home park.

As a result of their other income, petitioners realized

substantial tax benefits from the approximate $125,000 loss

deduction for each taxable year in issue.

Finally, in determining profit objective, we consider

whether there are elements of personal pleasure or recreation.

Petitioners owned horses during the taxable years in issue, but

petitioner stated that neither of them rode the horses for

pleasure. Petitioners probably had personal pleasure from

residing on a large ranch.

Although petitioners had the money to purchase the ranch and
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operate it, they never had a business plan or took steps to

operate the ranch to make a profit. Taking the record as a

whole, we find that the facts and circumstances indicate that

petitioners did not possess the actual and honest objective of

making a profit from their ranch. Therefore, we find that

petitioners were not engaged in an activity for profit. Sec.

183(a).

Pursuant to section 183(b)(2), deductions are allowed for an

activity not engaged in for profit, but only to the extent that

gross income exceeds the deductions allowable under section

183(b)(1) without regard to whether or not the activity is

engaged in for profit. Petitioners did not prove that they had

any such expenses. Because petitioners had no gross income for

the taxable years in issue, none of their claimed expenses are

deductible. Therefore, we sustain respondent’s determinations.

As to the accuracy-related penalties imposed for the taxable

years in issue, respondent has satisfied his burden of production

under section 7491(c). Higbee v. Commissioner, 116 T.C. 438,

446-447 (2001). Section 6662(a) imposes a 20 percent penalty on

the portion of any underpayment of tax attributable to negligence

or disregard of rules or regulations. Sec. 6662(b)(1).

Negligence is any failure to make a reasonable attempt to comply

with the provisions of the internal revenue laws and includes any

failure by the taxpayer to keep adequate books and records or to
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substantiate items properly. Sec. 6662(c); sec. 1.6662-3(b)(1),

Income Tax Regs. Moreover, negligence is the failure to exercise

due care or failure to do what a reasonable and prudent person

would do under the circumstances. Neely v. Commissioner, 85 T.C.

934, 947 (1985). Disregard includes any careless, reckless, or

intentional disregard of rules or regulations. Sec. 6662(c);

sec. 1.6662-3(b)(2), Income Tax Regs. No penalty will be imposed

with respect to any portion of any underpayment if it is shown

that there was a reasonable cause for such portion and that the

taxpayer acted in good faith with respect to such portion. Sec.

6664(c).

Under the facts of this case, section 6664(c) is not

applicable. Petitioner’s recordkeeping practice of creating

monthly lists from canceled checks simply is inadequate. Such

actions are not those of a prudent and reasonable person in

business. On this record, we conclude that petitioners were

negligent and are liable for the accuracy-related penalties under

section 6662 as determined by respondent for the taxable years in

issue. We need not address other grounds for respondent’s

determinations as to section 6662.

Reviewed and adopted as the report of the Small Tax Case

Division.

Decision will be entered

under Rule 155.