Chandler v. Comm'r

T.C. Memo. 2010-92

UNITED STATES TAX COURT

JO ANNE M. CHANDLER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 6828-07. Filed April 29, 2010.

Richard W. Craigo, for petitioner.

Kaelyn Romey and Melissa Quale, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

KROUPA, Judge: Respondent determined deficiencies in

petitioner’s Federal income taxes of $19,494 for 2002, $17,918

for 2003 and $14,763 for 2004. Respondent also determined

petitioner was liable for the section 6662(a)1 accuracy-related

1
All numerical amounts are rounded to the nearest dollar.
(continued...)
 -2-

penalty for taxable year 2002. There are two issues for

decision. The first is whether petitioner conducted her horse

breeding, training and racing activities (horse activity) for

profit within the meaning of section 183 when she failed to

generate a profit for over 20 years, including 2002, 2003 and

2004 (the years at issue). We hold that she did not conduct her

horse activity for profit and is therefore not entitled to deduct

losses from the activity on her returns. The second issue is

whether petitioner is liable for the accuracy-related penalty for

2002. We hold that she is liable for the penalty.

FINDINGS OF FACT

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

The stipulation of facts and the accompanying exhibits are

incorporated by this reference. Petitioner resided in California

at the time she filed the petition.

A. Petitioner’s Background

Petitioner graduated from Merritt College in Oakland,

California, with a degree in accounting. She held various

accounting jobs after college, including a job with the Oakland

Municipal Court where she prepared budgets of up to $8 million.

Petitioner had significant income from sources other than

the horse activity totaling $166,861 in 2002, $150,472 in 2003

1
(...continued)
All section references are to the Internal Revenue Code in effect
for the years at issue.
 -3-

and $148,059 in 2004.2 The retirement income, Social Security

income, rental income, gambling income and income from savings

petitioner received during the years at issue enabled her to

continue her horse activity without generating any profit. She

earned additional income from her employment as a pari-mutuel

clerk in 2003 and 2004. Petitioner and her husband bet on horses

as a form of recreation. Petitioner personally placed bets at

the track and on the internet during the years at issue. She

reported gambling winnings of $35,000, $18,000, and $10,000 on

the returns for 2002, 2003 and 2004, respectively.

B. Petitioner’s History With the Horse Activity

Petitioner was engaged in breeding, training and racing

thoroughbred horses during the years at issue. She incurred

substantial losses in her horse activity for over 20 years before

and including the years at issue.

Petitioner first became interested in horses when she was a

child. Her father, a construction worker by trade, bred and

raced horses in California and he taught petitioner how to care

for them. Petitioner was not personally involved with horses for

almost 40 years until 1981 when she decided to get involved with

horse racing by “claiming” a racehorse.3 She was 51 years old at

2
These amounts include gambling income petitioner earned on
horse betting separate from her horse activity.
3
The horses running in a claiming race are being offered for
(continued...)
 -4-

the time and she held a job in another industry. Petitioner

claimed her first horse, Tardson, in 1982.

Petitioner admitted that horse racing is highly speculative.

She did not provide any specific details about her purse winnings

during any of the years at issue. In fact, the record reflects

that petitioner raced the same unsuccessful horses year after

year, even though they failed to generate enough money to exceed

the expenses for any year. Additionally, several of petitioner’s

racehorses died or suffered serious injuries during the years at

issue.

Petitioner expanded her horse activity to include horse

breeding in 1983 when she purchased a breeding mare with foal.

Her primary goal for the breeding program was to obtain an

“outstanding horse” for racing because she could not afford to

buy one. She admitted that breeding an outstanding horse is

highly speculative and that the costs of operating a breeding

program greatly exceed the costs associated with buying a

racehorse. Petitioner stopped breeding her mares after 2002. At

the time of trial petitioner had not developed an outstanding

horse that could win and be sold for a large sum. The most she

received for selling any horse through 2004 was $750.

3
(...continued)
sale. Someone who “claims” a particular horse owns that horse as
soon as it leaves the starting gate.
 -5-

Petitioner began using two of her stallions for stud service

in 1996. The only income petitioner earned from stud fees during

the years at issue was $555, however, and that was only in 2003.

Petitioner obtained a trainer’s license from the California

Horse Racing Board in 1988 after completing a licensing exam.

She asserts she obtained the training license to save money on

training fees for her racing program. Petitioner failed to

provide documentation, however, to establish that her decision to

train her own horses was an economic decision and there was no

cost-benefit analysis to quantify the benefit to her horse

activity. She also asserts she trained horses for other owners.

Petitioner failed to provide any training contracts, however, and

she failed to show any income from training horses for others.

Petitioner consulted with William Anton (Mr. Anton) and

Terry Johnson (Mr. Johnson), both horse trainers and owners, over

the course of her horse activity. Neither Mr. Anton nor Mr.

Johnson knew whether petitioner’s horse activity was profitable.

There is also no evidence on how, if at all, consulting with

these two trainers and owners caused petitioner to improve her

losing operation. Nothing establishes that either Mr. Anton or

Mr. Johnson provided petitioner with economic or business advice,

and that she followed their advice.

Petitioner did not make any meaningful changes to improve

the profitability of her horse activity, despite her over 20-year
 -6-

history of losses. She also has not set any limit on the amount

she is willing to lose. The expenses of petitioner’s horse

activity have increased each year. She asserts that she

implemented some cost-saving measures to decrease the spiral of

losses. These measures include transporting her horses with her

own truck and trailer to avoid the expense of commercial horse

vans. Petitioner failed to establish, however, whether her cost-

saving measures were based on any economic analysis of her

business. She has retained, and continues to incur expenses for,

several horses that are useless to her horse activity.

Petitioner also admitted that she incurs substantial costs by

providing feed for other horses without seeking reimbursement

from their owners. She stoically says she will continue this

practice regardless of the great expense.

C. Petitioner’s Time and Effort With the Horse Activity

Petitioner scaled back her horse activity in 2002 when

health problems plagued her and her husband. She was diagnosed

with breast cancer in 2002 when she was 72 years old and

subsequently underwent two operations and 37 radiation

treatments. Petitioner’s husband suffered from Parkinson’s

disease and his condition significantly deteriorated during the

years at issue. He passed away in 2005, after the years at

issue.
 -7-

Petitioner did not provide specific details of the time she

devoted to her horse activity during the years at issue. She

relied on friends or hired people to assist her with cleaning

stalls and caring for her horses. Petitioner spent time at the

racetrack monitoring her horses and watching them “at the rail”

when they exercised. She socialized with other trainers and

owners who were at the rail watching their horses. Petitioner

also placed bets on horse races while overseeing her horse

activity at the track.

D. Petitioner’s Books and Records for the Horse Activity

Petitioner at some point kept her horse records on a

computer but switched to keeping them by hand during the years at

issue because it was easier for her. She scribbled down expense

records but failed to organize them into any useable form, and

her expense records for the years at issue were incomplete and

indecipherable. Petitioner failed to keep a separate record of

each horse’s income and expenses. She produced manila files for

each horse she bred, trained or raced, but the files did not

contain information necessary to evaluate the horse’s economic

performance. The files contained sentimental documents, such as

race clippings, photos, and letters written by petitioner to the

horse. Petitioner did not maintain any record of what she paid

to claim each horse and how much that horse had won.
 -8-

Petitioner did not produce any background financial records

to substantiate the income and expenses claimed on the returns

for 2002 and 2004, and she produced only three receipts for 2003.

She never prepared written business plans, budgets, financial

projections, or financial statements, nor did she employ any cost

accounting methods to evaluate the profitability of her horse

activity. Petitioner maintained four bank accounts during the

years at issue but commingled the funds from her horse activity

with her personal funds.

Petitioner did not review any documents at year’s end to

make changes to the horse activity to improve profitability. The

only document she prepared at year’s end was a tax organizer for

her return preparer, Robert D’Amours (Mr. D’Amours). Petitioner

did not provide him with any books or records beyond the tax

organizer. Mr. D’Amours prepared petitioner’s returns for the

years at issue by simply inputting the numbers she had supplied

in the tax organizer. Petitioner claimed losses of $74,772 for

2002, $69,782 for 2003 and $58,702 for 2004 on Schedule F, Profit

or Loss From Farming.

E. The Deficiency Notice

Respondent issued the deficiency notice to petitioner

disallowing the Schedule F losses for the three years at issue,

and determining deficiencies for those years. Respondent also
 -9-

determined that petitioner was liable for the accuracy-related

penalty for 2002. Petitioner timely filed a petition.

OPINION

We are asked to decide whether a horse owner and operator

engaged in training, racing and breeding horses for profit within

the meaning of section 183 when she failed to generate a profit

from those activities during any of the years at issue or for any

of the preceding 17 years. We are also asked to decide whether

petitioner is liable for the accuracy-related penalty for 2002.

We address each of these issues in turn.

I. Section 183 Analysis

A. In General

Taxpayers are precluded from claiming deductions stemming

from an activity that is not carried on for profit except to the

extent allowed by section 183(b).4 See sec. 183(a).5 We

4
Deductions that would be allowable without regard to
whether the activity is engaged in for profit are allowed under
sec. 183(b)(1). Deductions that would be allowable only if the
activity is engaged in for profit are allowed under sec.
183(b)(2), but only to the extent that the gross income from the
activity exceeds the deductions otherwise allowable under sec.
183(b)(1).
5
We follow the Court of Appeals opinion squarely on point
when appeal from our decision would lie to that court absent
stipulation by the parties to the contrary. Golsen v.
Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir.
1971). Taxpayers residing in the Ninth Circuit, such as
petitioner, must prove they conducted their activities with the
primary, predominant or principal purpose of realizing an
economic profit independent of tax savings. See Wolf v.
(continued...)
 -10-

structure our analysis of whether an activity is engaged in for

profit around nine nonexclusive factors. Sec. 1.183-2(b), Income

Tax Regs. The nine factors are: (1) the manner in which the

taxpayer carried on the activity; (2) the expertise of the

taxpayer or his or her advisers; (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 activities; (6) the taxpayer’s history of income or

loss 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. Id.

No factor or set of factors 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; Brannen v. Commissioner, 722 F.2d 695, 704 (11th Cir.

1984), affg. 78 T.C. 471 (1982); sec. 1.183-2(b), Income Tax

Regs. The individual facts and circumstances of each case are

5
(...continued)
Commissioner, 4 F.3d 709, 713 (9th Cir. 1993), affg. T.C. Memo.
1991-212; Polakof v. Commissioner, 820 F.2d 321, 323 (9th Cir.
1987), affg. T.C. Memo. 1985-197; Indep. Elec. Supply, Inc. v.
Commissioner, 781 F.2d 724, 726 (9th Cir. 1986), affg. Lahr v.
Commissioner, T.C. Memo. 1984-472.
 -11-

the primary test. Abramson v. Commissioner, 86 T.C. 360, 371

(1986).

B. Analysis

We now apply the factors to the facts of this case. Nearly

all the facts in this case indicate that petitioner did not

engage in her horse activity for profit.

First, petitioner did not conduct her horse activity in a

businesslike manner. See Engdahl v. Commissioner, 72 T.C. 659,

666-667 (1979); sec. 1.183-2(b)(1), Income Tax Regs. She had

four checking accounts during the years at issue but not one was

devoted exclusively to the horse activity. See Keating v.

Commissioner, T.C. Memo. 2007-309, affd. 544 F.3d 900 (8th Cir.

2008). Petitioner also did not maintain adequate business

records for her horse activity. She did not use any cost

accounting methods to determine the overall profitability of the

horse activity despite her accounting background. See Burger v.

Commissioner, T.C. Memo. 1985-523, affd. 809 F.2d 355 (7th Cir.

1987). Petitioner also did not keep a separate record of each

horse’s income and expenses to evaluate its economic performance.

See McKeever v. Commissioner, T.C. Memo. 2000-288. The manila

files she maintained for each of her horses contained sentimental

documents with limited health and training records. Maintaining

these types of records, however, is as consistent with a hobby as

with a business. See Golanty v. Commissioner, 72 T.C. 411, 430
 -12-

(1979), affd. without published opinion 647 F.2d 170 (9th Cir.

1981); Giles v. Commissioner, T.C. Memo. 2006-15.

Petitioner had no oral or written business plan. She simply

wanted to “claim a racehorse” when she began her horse activity

in 1982. Petitioner also did not make any meaningful changes in

her method of operation to improve profitability. See sec.

1.183-2(b)(1), Income Tax Regs. She argues that she implemented

some cost saving measures, such as training and transporting her

own racehorses, to show that she sought to make a profit.

Petitioner failed to establish, however, that she implemented the

measures for economic reasons and she prepared no projections to

show when any of these measures would cause the activity to

generate a profit. Moreover, none of these measures caused

petitioner to earn a profit. We find that petitioner’s failure

to maintain adequate records and to make significant changes in

light of her over-20-year history of substantial losses shows

that she did not conduct her horse activities in a businesslike

manner. This factor weighs in favor of respondent.

Petitioner also has not shown that she studied accepted

business, economic, and scientific practices related to her horse

activities and acted in accordance with those practices. See

sec. 1.183-2(b)(2), Income Tax Regs. Petitioner consulted with

Mr. Anton and Mr. Johnson, both horse owners and trainers, but

neither Mr. Anton nor Mr. Johnson provided her with business
 -13-

advice. In fact, neither Mr. Anton nor Mr. Johnson knew whether

petitioner’s horse activity was profitable. Furthermore,

petitioner provided nothing to demonstrate how consulting with

Mr. Anton or Mr. Johnson helped her prevent her losses from

increasing. We find petitioner’s failure to seek out and follow

business, economic or scientific advice indicates that she did

not have a profit motive. This factor weighs in favor of

respondent.

We also question petitioner’s testimony regarding the time

and effort she spent on the horse activity. See sec. 1.183-

2(b)(3), Income Tax Regs. Petitioner claims that during the

years at issue she spent an average of eight hours a day, seven

days a week, 30 days a month, carrying out such tasks as feeding

and grooming her horses and cleaning stalls. She did not provide

any evidence beyond her own self-serving testimony to

substantiate this claim. The record shows that not all the time

petitioner devoted to her horses was work related. The record

also reflects that during the years at issue petitioner and her

husband had medical problems and that she paid individuals or

relied on friends to complete the manual labor. Accordingly, we

find the time and effort expended by or on behalf of petitioner

to be a neutral factor.

Petitioner offered nothing to support an expectation that

her horses would appreciate in value. See sec. 1.183-2(b)(4),
 -14-

Income Tax Regs. First, petitioner had no way of determining the

value of a horse because she did not maintain any record of what

she paid to claim each horse and how much that horse had won.

Furthermore, petitioner had never sold a horse for over $750, and

most of her horses sold for less than $400. Even if petitioner

expected her horses to appreciate in value, any expectation of

recouping the hundreds of thousands of dollars in accumulated

losses would be unlikely. Accordingly, this factor weighs in

favor of respondent.

Petitioner provided nothing to establish she ever owned or

operated a successful business venture. See sec. 1.183-2(b)(5),

Income Tax Regs. She claimed that she and her husband had a

successful venture “flipping” houses but did not produce any

evidence to support this assertion nor was a gain reported on the

returns for 1996 through 2004. Accordingly, this factor is

neutral.

Petitioner sustained large ever-increasing losses from the

horse racing activity for 20 years in succession, from its start

in 1982 through the years at issue. Respondent conservatively

estimates that petitioner’s losses from 1981 through 2007 exceed

$1.5 million. The losses petitioner incurred during the years at

issue were well beyond the accepted five-to-ten-year startup

period for horse breeding. See Engdahl v. Commissioner, supra.

Nevertheless, petitioner tried to explain away the losses by
 -15-

claiming they were due to unforeseen hardships, including death

or serious injury to several horses during the years at issue.6

We recognize that horse breeding and racing are speculative

activities where death or injury to horses is a common

occurrence. Even petitioner’s witness Mr. Anton, a racehorse

owner and trainer, testified that the loss of several horses

during a given year “can be normal.” We do not find that the

losses were caused by unforseeable circumstances. Accordingly,

we find that petitioner’s history of large losses weighs in favor

of respondent.

Furthermore, petitioner’s horse activity has never made even

an occasional profit. See sec. 1.183-2(b)(7), Income Tax Regs.

Petitioner claims that she made a profit with her horse “Award

Winning” in 2006, which is after the years at issue. Moreover,

the return for that year reports a loss. Petitioner further

contends that we should disregard her history of losses because

she could potentially earn a substantial profit with one

outstanding horse. The possibility of a speculative profit is

insufficient to outweigh the absence of profits for a period

6
Petitioner also argues that her own illness and her
husband’s illness were unforeseen hardships that contributed to
the losses. This claim directly contradicts petitioner’s claim
that she continued to devote eight hours a day, seven days a
week, to the horse activity despite her and her husband’s
illnesses. It also overlooks petitioner’s long history of losses
before the years at issue. We find, therefore, that petitioner’s
and her husband’s illnesses were not unforeseen hardships that
contributed to petitioner’s losses.
 -16-

greater than 20 years, however. McKeever v. Commissioner, T.C.

Memo. 2000-288. Accordingly, petitioner’s failure to make even

an occasional profit in over 20 years weighs in favor of

respondent.

Petitioner had substantial income from other sources7 and

was able to reduce this income by approximately 40 percent by

claiming Schedule F losses from the horse activity. See sec.

1.183-2(b)(8), Income Tax Regs. This factor favors respondent.

Petitioner derived pleasure and recreation from her horse

activity. See sec. 1.183-2(b)(9), Income Tax Regs. She combined

her racing and training activities with social and recreational

activities at the track. See sec. 1.183-2(c), Example (3),

Income Tax Regs. Petitioner enjoyed spending time “at the rail”

with other trainers and owners. She also placed bets while

overseeing her horse racing activity. This factor favors

respondent.

Based on all the facts and circumstances, we find that

petitioner has not shown that she engaged in her horse activity

for profit. Accordingly, we sustain respondent’s determination

in the deficiency notice regarding the losses.

7
She had income totaling $166,861 in 2002, $150,472 in 2003
and $148,059 in 2004. She claimed net losses from the horse
activity of $74,772 in 2002, $69,782 in 2003 and $58,702 in 2004.
 -17-

II. Accuracy-Related Penalty for 2002

We now address whether petitioner is liable for the section

6662(a) accuracy-related penalty for 2002, the only year for

which respondent determined a penalty. Respondent asserts

petitioner is liable for the penalty because she failed to

maintain adequate books and records for that year. We agree.

A taxpayer is liable for an accuracy-related penalty for any

portion of an underpayment of income tax attributable to

negligence or disregard of rules and regulations. Sec. 6662(a)

and (b)(1). Negligence is defined as any failure to make a

reasonable attempt to comply with the provisions of the Code and

includes any failure by the taxpayer to keep adequate books and

records or to substantiate items properly. Sec. 6662(c); sec.

1.6662-3(b)(1), Income Tax Regs.

Petitioner failed to keep adequate books and records to

substantiate the horse-activity-related losses she claimed for

the years at issue, including 2002. Petitioner’s explanation

that it was easier to keep records in writing than on a computer

does not satisfy the accurate books and records requirement.

Even her handwritten records were incomplete and indecipherable.

Moreover, petitioner failed to present any defense. Accordingly,

we sustain respondent’s determination of the section 6662

accuracy-related penalty.
 -18-

We have considered petitioner’s other arguments and conclude

they are irrelevant, moot, or meritless.

Decision will be entered

for respondent.