T.C. Memo. 2007-309
UNITED STATES TAX COURT
NORA E. KEATING AND RICHARD L. SHEARER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 23856-05. Filed October 11, 2007.
Jon J. Jensen, for petitioners.
Melissa J. Hedtke, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined deficiencies in
petitioners’ joint and in petitioner Nora Keating’s individual
Federal income taxes as follows:
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Joint Nora Keating’s
Year Deficiency Deficiency
1996 $7,784
1997 6,507
1998 18,181
1999 16,191
2000 20,219
2001 $29,066
2002 35,815
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.
All references to petitioner in the singular are to
petitioner Nora Keating.
The issue for decision is whether petitioner’s Arabian
horse-breeding activity (horse activity) constituted an activity
carried on for profit under section 183.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
At the time of filing the petition, petitioners resided in
Williston, North Dakota.
In 1996, petitioner moved to Williston, North Dakota, began
work as an emergency room physician in a local hospital, and
purchased a home on a 10-acre farm.
Throughout the years in issue, petitioner worked
approximately 60 hours a week as a physician--typically two 24-
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hour shifts and one 12-hour shift. Petitioner preferred this
work schedule because she felt “burned out” from medical school
and because it gave her more full days to spend with her six
children.
For the years in issue, petitioner’s average annual income
from her medical practice was $238,134.
Petitioner’s husband Richard Shearer was employed as a
firefighter-medic in North Dakota and did not participate in any
meaningful way in petitioner’s horse activity.
Throughout her life, petitioner admired horses. While in
high school, petitioner worked part time in a veterinary clinic
and was a member of several riding clubs. Petitioner purchased
and boarded her first horse when she was 15 years old.
In 1996, when petitioner began her horse activity,
petitioner realized a lifelong dream of working with horses.
Petitioner was particularly interested in raising Arabian
horses. Petitioner considers Arabian horses the “ballerinas of
the horse world”.
Prior to 1996, petitioner had no experience in the business
of buying, selling, or showing horses. Petitioner did have
experience in owning, caring for, and riding horses, and
petitioner possessed the knowledge and skill to perform basic
veterinary tasks.
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In starting up her horse activity, petitioner spoke with
several individuals about training and breeding and about
veterinary issues relating to horses. In particular, petitioner
spoke with an award-winning breeder of Arabian horses, two horse
trainers, and a veterinarian. Petitioner consulted these
individuals regarding breeding horses, selecting stallions and
mares, feed, training methods, artificial insemination of mares,
and factors that could result in early termination of pregnancy.
Petitioner also spoke with individuals affiliated with horse
breeding and training who had been audited by respondent, who
recommended to petitioner that she keep good expense records and
that she keep track of receipts.
Aware that, as a physician, her horse activity would be
“under the microscope”, petitioner consulted a C.P.A. to learn
how to keep track of receipts and to maintain records.
Petitioner did not discuss with anyone the economic or
business aspects of breeding, training, and showing horses.
The following schedule indicates when petitioner acquired
each of her horses, the purchase price, the type of horse, if in
the record the purpose for purchasing the horse, and the horse’s
physical condition.
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Year Purchase Type of Purpose of Physical
Horse Acquired Price Horse Purchase Condition
Santana Sun 1996 $1,500 Gelding
Benjy Bey 1996 300 Gelding
Honey 1996 1,100 Gelding Riding Crippled
Michaela 1996 1,500 Mare Breeding
Angelette 1997 2,000 Mare
Mariah 1998 1,500 Mare Breeding
Supreme Design 1998 3,000 Mare Breeding
Lady 1998 1,500 Pony Riding
Trouble 1998 1,500 Pony Riding
Sheer Energy 1998 Home-foaled Gelding
Khat Ballou 1999 Home-foaled Mare
Doc Wilder 2000 Home-foaled Gelding Riding Crippled
Links Fame 2000 Home-foaled Gelding
Respiratory
River Freedom 2002 800 Gelding Riding Disease
Sabrinakov 2002 500 Mare
Secret Link 2002 Home-foaled Mare
Rico de Angelo 2002 Home-foaled Gelding
Tony Montana 2002 Home-foaled Gelding
Dakota
Catalyst 2002 500 Gelding
Aw Fames
Ovation 2002 5,000 Gelding*
* At trial we asked the parties to include in their posttrial briefs a
schedule detailing purchase, sale, and condition of each of the horses
involved in petitioner’s horse activity. Neither party produced such a
schedule. Information in the schedule here provided is derived from the
record. Some of the dates and amounts indicated are not completely clear in
the record.
During 1996 through 2002, petitioner sold only two of her
horses--each for less than its purchase price. In 2002, Lady was
sold for $750, and Trouble was sold for $750.
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Throughout the years in issue, petitioner received and read
publications and materials regarding horse breeding and horse
training. Several of the publications discussed tax issues
relating to horse breeding.
Once petitioner began her horse activity, petitioner
retained her emergency room work schedule to allow more time in
her horse activity. On days not scheduled to work at the
hospital, petitioner spent approximately 7 to 10 hours working in
her horse activity.
Petitioner’s horse activity involved training and feeding
the horses, cleaning horse stalls, riding recreationally,
competing in shows, performing basic veterinary work, and a host
of other activities. Petitioner received much enjoyment and
satisfaction from her horse activity. Petitioner’s favorite time
of day was working with the horses, and petitioner even found
cleaning the stalls to be a “stress reliever”.
Ongoing care and training of the horses were performed by
petitioner and her family. Before showing, petitioner hired a
professional trainer to “finish” training the horses.
Petitioner’s daughter often rode in horse shows, and
petitioner was extremely proud of her daughter’s and her horses’
successes in the shows. On four occasions, petitioner’s horses
participated in national competitive horse shows.
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In 2000, petitioner began building a barn to shelter the
horses during the breeding months and thereby to improve breeding.
In 2001, petitioner began boarding horses for, and leasing
horses to, other individuals and providing horse clinics.
During the years in issue, in an effort to reduce horse
activity expenses, petitioner changed types of feed and sought
out alternate sources of hay and specials on stud fees.
During 1996 through 2002, petitioner advertised that her
horses were for sale by word of mouth, by showing horses at horse
shows, by placing advertisements on three Internet Web sites, and
by posting notices at a saddle shop. Petitioner did not
advertise any of her horses for sale in any written publications.
In none of the years in issue did petitioner advertise the
boarding and leasing of horses.
During 1996 through 2000, from two checking accounts
petitioner paid both personal and horse activity expenses.
During 2001, from three different checking accounts
petitioner paid both personal and horse activity expenses.
In 2002, petitioner opened a checking account in the name of
Nora Ellen Keating Stony Creek Arabians and two new personal
checking accounts from all three of which petitioner paid both
personal and horse activity expenses.
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In 2002, proceeds received from the sale of Lady and Trouble
were deposited into one of petitioner’s personal checking
accounts, not into the Nora Ellen Keating Stony Creek Arabians
bank account.
Petitioner recorded horse activity expenses on a ledger by
category and retained receipts relating to her horse activity in
a folder by month of transaction. Petitioner kept records of
training, ovulatory cycles, and vaccinations relating to each
horse.
Petitioner did not associate her horse activity expenses
with individual horses.
During the years in issue, petitioner did not prepare or
have prepared a written business plan or financial projections
relating to her horse activity.
For 1996 through 2000, petitioners timely filed joint
Federal income tax returns, and for 2001 and 2002 petitioner
timely filed an individual Federal income tax return.
Petitioners’ joint Federal income tax returns for 1996
through 2000 and petitioner’s individual Federal income tax
returns for 2001 and 2002 included a Schedule F, Profit or Loss
From Farming, on which it was indicated that the principal
activity was “horses”.
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On Schedule F of the above respective tax returns the
following gross income, expenses, and net losses were reported
relating to petitioner’s horse activity:
Year Gross Income Expenses Net Losses
1996 $ 144 $ 22,227 $ (22,083)
1997 178 22,187 (22,009)
1998 335 48,289 (47,954)
1999 432 44,784 (44,352)
2000 750 50,550 (49,800)
2001 1,200 84,382 (83,182)
2002 1,418 102,550 (101,132)
Total $4,457 $374,969 $(370,512)
Petitioner’s horse activity losses reduced petitioners’
reported taxable income and resulted in claimed tax savings in
the amount of the tax deficiencies involved herein.
OPINION
The deductibility under section 162 or section 212 of
taxpayer expenses attributable to an activity depends upon
whether the activity is carried on for profit. See secs. 162,
183, 212.
Section 183 specifically precludes deductions for expenses
relating to an activity not carried on for profit except to the
extent allowed by section 183(b). For example, deductions are
not allowable under section 162 or section 212 for expenses of an
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activity that a taxpayer carries on primarily as a hobby or for
recreation. Sec. 1.183-2(a) Income Tax Regs. For a taxpayer’s
expenses of an activity to be deductible under section 162 or
section 212, and not subject to the limitations of section 183,
the activity must be carried on with an actual and honest profit
objective. E.g., Dreicer v. Commissioner, 78 T.C. 642, 645
(1982), affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983).
The regulations under section 183 provide a nonexclusive
list of nine factors to consider in determining whether an
activity is carried on for profit, as follows: (1) The manner in
which the activity is carried on; (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 activity; (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) whether elements of personal pleasure or
recreation are involved. See sec. 1.183-2(b), Income Tax Regs.
Neither a single factor, nor the existence of even a
majority of the factors, is controlling, but rather an evaluation
of all the facts and circumstances is necessary. Golanty v.
Commissioner, 72 T.C. 411, 426-427 (1979), affd. without opinion
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647 F.2d 170 (9th Cir. 1981). Greater weight is given to
objective facts than to a taxpayer’s mere statement of intent.
Dreicer v. Commissioner, supra at 645.
We consider each of these factors in turn.
Manner in Which Petitioner Carried On Her Horse Activity
The regulations under section 183 provide that carrying on
an activity in a businesslike manner indicates a profit
objective. Sec. 1.183-2(b)(1), Income Tax Regs. The regulations
explain that businesslike operations typically would involve the
maintenance of complete and accurate books and records, the
conduct of the activity in a manner similar to profitable
businesses of the same nature, and changes to improve operations
and profitability. See id. Numerous court opinions mention that
a businesslike operation often would involve a business plan.
See, e.g., Wesinger v. Commissioner, T.C. Memo. 1999-372.
With respect to books and records, we have held that the
maintenance of mere lists of and receipts for expenses without
any further cost accounting or analysis would not reflect good
business practices. See Wesinger v. Commissioner, supra; Dodge
v. Commissioner, T.C. Memo. 1998-89, affd. without published
opinion 188 F.3d 507 (6th Cir. 1999); Burger v. Commissioner,
T.C. Memo. 1985-523, affd. 809 F.2d 355 (7th Cir. 1987).
The term “businesslike manner” contemplates the use of cost
accounting techniques that provide the taxpayer with information
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required to make informed business decisions. Burger v.
Commissioner, supra. The purpose of maintaining business books
and records is more than to “memorialize for tax purposes the
existence of the subject transactions” and includes providing a
“means of periodically determining profitability and analyzing
expenses”. Id.; see also Dodge v. Commissioner, supra (minimal
records used to prepare tax returns not adequate to support a
finding that activity was carried on for profit). The mere
ability to substantiate expenses does not establish that the
records were kept in a businesslike manner.
In the context of animal-breeding activities, we have
indicated that the absence of detailed monthly expense records
for each animal may indicate a lack of profit objective. See
McKeever v. Commissioner, T.C. Memo. 2000-288; Dodge v.
Commissioner, supra.
Petitioner failed to keep track of expenses on a per-horse
basis and failed to prepare any financial projections which would
have aided her in evaluating the economic performance of her
horse activity. The financial records maintained by petitioner
appear to have been maintained primarily for tax purposes.
Petitioner emphasizes that she maintained detailed records
for each horse relating to vaccinations, training, and ovulatory
cycles. The maintenance of these types of records, however, is
as consistent with a hobby as with a business. See Golanty v.
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Commissioner, supra at 430; Giles v. Commissioner, T.C. Memo.
2006-15; Burger v. Commissioner, supra.
Petitioner contends that her methods of advertising were
similar to other horse-breeding operations and evidence her
profit objective. While we recognize that participation in horse
shows provides some advertising, see Engdahl v. Commissioner, 72
T.C. 659, 662-663 (1979), we find in this case that petitioner’s
advertising efforts were minimal. Where we have found that an
animal breeder operated in a businesslike manner, generally the
breeder not only participated in shows but engaged in other forms
of substantial advertising. See Engdahl v. Commissioner, supra
at 667 (advertised in horse publications); Rinehart v.
Commissioner, T.C. Memo. 2002-9 (advertised in horse publications
and gave out promotional materials); Routon v. Commissioner, T.C.
Memo. 2002-7 (advertised in trade publications and mailed
promotional videos); Strickland v. Commissioner, T.C. Memo. 2000-
309 (advertised in local newspaper); Davis v. Commissioner, T.C.
Memo. 2000-101 (advertised in newspapers and distributed
promotional clothing); Phillips v. Commissioner, T.C. Memo. 1997-
128 (distributed promotional videos and participated in horse
associations for the purpose of advertising); Burrow v.
Commissioner, T.C. Memo. 1990-621 (prepared promotional videos
and advertised in horse publications). As we have found,
petitioner’s advertising and promotion of her horse activity were
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limited to word of mouth, participation in shows, placement of
advertisements on three Web sites, and posting of notices at a
saddle shop. During the years in issue, petitioner did not
advertise in any trade magazines, journals, or written
publications.
The commingling of personal and activity funds is not
indicative of businesslike practices. Burrow v. Commissioner,
supra; Ballich v. Commissioner, T.C. Memo. 1978-497. As
indicated, petitioner did not have a separate bank account for
her horse activity but instead paid horse-related and personal
expenses out of several personal accounts.
With regard to changes in operating methods, small
improvements over several years may not reflect a businesslike
operation. Wesinger v. Commissioner, supra. The various changes
to petitioner’s horse activity appear to us to have been
relatively insignificant.
While construction of barns and other facilities may
demonstrate a profit objective, Strickland v. Commissioner,
supra; Phillips v. Commissioner, supra, we note that petitioner’s
primary purpose for constructing the barn was to improve horse
breeding, and it is as consistent with a hobby as with a
business.
Petitioner’s testimony that she had a simple and concise
business plan “to raise good quality horses, well-trained horses,
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horses that will give * * * [petitioner] a good reputation,
horses that will do well in the market” is inadequate for us to
conclude that petitioner had an established business plan. See
Wesinger v. Commissioner, T.C. Memo. 1999-372; Sanders v.
Commissioner, T.C. Memo. 1999-208 (finding similar testimony
inadequate).
The fact that petitioner hired a professional trainer to
finish training her horses is not particularly helpful to
petitioner. A hobby breeder who enters horses in shows to
enhance her reputation and to participate in competition also may
hire a professional trainer to finish training the horses.
We conclude that petitioner did not operate her horse
activity in a businesslike manner. This factor weighs in favor
of respondent.
Expertise of Petitioner and Her Advisers
In considering this factor the focus is upon expertise and
preparation with regard to the economic aspects of a particular
business. See, e.g., Golanty v. Commissioner, 72 T.C. at 432.
While petitioner may have developed an expertise in the
breeding and training of horses, her expertise did not extend to
the economics thereof. Petitioner testified that she consulted
with a successful breeder, several professional trainers, and a
veterinarian, but the discussions focused primarily on the
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scientific and practical aspects of breeding and training and not
on the business aspects thereof.
Petitioner’s discussions with a C.P.A. amounted to little
more than how to keep track of and to maintain expense receipts
for tax purposes.
We conclude that petitioner was not an expert and did not
seek out expert advice regarding the economic aspects of carrying
on a horse activity for profit. This factor weighs in favor of
respondent.
Time and Effort Petitioner Expended in Carrying On the Activity
Section 1.183-2(b)(3), Income Tax Regs., specifies that
devotion of much personal time to an activity and withdrawal from
another occupation may evidence a profit objective. This is
particularly true where the activity does not have substantial
personal or recreational aspects. Id.
Petitioner contends that this factor weighs in her favor
because she voluntarily opted to work fewer shifts at the
hospital to spend more time on her horse activity. However,
petitioner’s initial reason for working at the hospital only 2
and 1/2 days a week was because she felt “burned out” and wanted
to spend more time with her children.
We recognize that feeding and watering horses and cleaning
stalls may be unpleasant tasks, but they are involved in caring
for horses regardless of whether an activity is pursued as a
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hobby or as a business. Giles v. Commissioner, T.C. Memo. 2006-
15; see Sullivan v. Commissioner, T.C. Memo. 1998-367, affd.
without opinion 202 F.3d 264 (5th Cir. 1999).
It is evident that petitioner received much satisfaction
from raising and training horses. Since childhood, petitioner
has dreamed of owning horses, and petitioner clearly enjoyed
riding in and entering horse shows. While petitioner may have
spent a significant amount of time with her horse activity,
because the horse activity had significant personal and
recreational components, this factor is neutral.
Expectation of Appreciation in Value
No evidence is before us as to the value of petitioner’s
horses, and it is not possible for us to determine the extent to
which petitioner’s significant losses from her horse activity
someday may be offset by appreciation in value. See Wesinger v.
Commissioner, supra.
This factor weighs in favor of respondent.
Success in Carrying On Other Activity
Petitioner has not engaged in any activity similar to her
horse activity.
This factor is neutral.
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History of Income or Losses
A history of substantial losses may indicate that an
activity is not conducted for profit. See Golanty v.
Commissioner, supra at 427; sec. 1.183-2(b)(6), Income Tax Regs.
However, if the losses occur during the startup phase of an
activity, the losses do not necessarily indicate a lack of profit
objective. See Engdahl v. Commissioner, 72 T.C. at 669.
We have found that the startup phase of a horse-breeding
activity may be 5 to 10 years. See id.; Davis v. Commissioner,
T.C. Memo. 2000-101; Phillips v. Commissioner, T.C. Memo. 1997-
128.
Because petitioner began her horse activity in 1996, the
losses petitioner incurred during the years in issue may still be
considered part of the startup phase. We treat this factor as
neutral.
The Amount of Occasional Profits
The amount of occasional profits a taxpayer earns from an
activity may show that the taxpayer has a profit objective. Sec.
1.183-2(b)(7), Income Tax Regs. While petitioner realized no
profits, we treat this factor as neutral because, as stated,
losses are not unreasonable during the startup phase of a horse-
breeding activity. See Strickland v. Commissioner, T.C. Memo.
2000-309.
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Financial Status
Substantial income from sources other than an activity may
indicate that the activity is not carried on for profit,
especially if losses from the activity generate substantial tax
benefits. Sec. 1.183-2(b)(8), Income Tax Regs.
During the years in issue, petitioner’s average annual
salary was $238,134. As a result of the losses in her horse
activity, petitioner claimed significant reductions in her
taxable income in each year in issue and a total of $133,763 in
claimed tax savings over 7 years.
This factor weighs in favor of respondent.
Elements of Personal Pleasure
Personal or recreational aspects of an activity may indicate
that the activity was not conducted with a profit objective.
McKeever v. Commissioner, T.C. Memo. 2000-288; sec. 1.183-
2(b)(9), Income Tax Regs. However, the sole fact that a taxpayer
derives pleasure from an activity does not show lack of a profit
objective if the activity is, in fact, conducted for profit as
evidenced by other factors. Sec. 1.183-2(b)(9), Income Tax
Regs.; see also Jackson v. Commissioner, 59 T.C. 312, 317 (1972)
(a business will not be turned into a hobby merely because the
owner enjoys the activity).
In the context of horse breeding, a particularly relevant
fact is whether a taxpayer or the taxpayer’s family rides the
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horses for pleasure or recreation. See Montagne v. Commissioner,
T.C. Memo. 2004-252, affd. 166 Fed. Appx. 265 (8th Cir. 2006);
Bunney v. Commissioner, T.C. Memo. 2003-233.
On the facts of this case, the recreational aspects of
petitioner’s horse activity suggest an activity without a profit
objective.
This factor weighs in favor of respondent.
Conclusion
Of the above factors, five weigh in favor of respondent,
four are neutral, while none weighs in favor of petitioner. We
hold that petitioner’s horse activity during the years in issue
was an activity not carried on for profit within the meaning of
section 183(c).1
This case is decided on the preponderance of the evidence,
and is unaffected by section 7491. See Estate of Bongard v.
Commissioner, 124 T.C. 95, 111 (2005).
To reflect the foregoing,
Decision will be entered
for respondent.
1
This opinion only applies to the years in issue, and
petitioner is not precluded from establishing a for-profit
objective in later years. See Rinehart v. Commissioner, T.C.
Memo. 2002-9.