T.C. Summary Opinion 2010-176
UNITED STATES TAX COURT
RICHARD A. AND DELORES L. FRIMML, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5229-09S. Filed December 28, 2010.
Scott M. O’Shea, for petitioners.
Susan K. Bollman and Michael W. Bitner, for respondent.
KROUPA, Judge: This case was heard pursuant to the
provisions of section 74631 of the Internal Revenue Code in
effect when the petition was filed. Pursuant to section 7463(b),
the decision to be entered is not reviewable by any other court,
1
All section references are to the Internal Revenue Code
unless otherwise indicated.
- 2 -
and this opinion shall not be treated as precedent for any other
case.
Respondent determined deficiencies in petitioners’ Federal
income taxes of $4,809 and $6,105 for 2005 and 2006 (the years at
issue), respectively, and $961.80 and $1,191 accuracy-related
penalties under section 6662(a) for those years. We are asked to
decide two issues in this case. The first issue is whether
petitioners conducted their American Paint Horse breeding
activity (horse activity) for profit within the meaning of
section 183 when they failed to generate a profit for 10 years
(including the years at issue) despite allocating substantial
funds and time to their horse activity. We hold that petitioners
did conduct their horse activity for profit. The second issue is
whether petitioners are subject to the accuracy-related penalty
under section 6662(a). We hold that they are not.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the accompanying exhibits are
incorporated by this reference. Petitioners resided in Luzerne,
Iowa at the time they filed the petition.
Petitioners both grew up on farms and were married in 1985.
They purchased their first two horses in 1988 and spent the next
10 years learning about horse breeding and developing a
- 3 -
business plan. Their business plan came to focus on American
Paint Horses (Paints or Paint horses), a breed identified by
their colorful coat patterns, strict bloodline requirements and
distinctive stock-horse body types. Petitioners’ knowledge at
trial was extensive as it related to breeding and artificially
inseminating Paint horses. Their knowledge included the
genetics, the mechanics and the financial aspects of breeding.
Petitioners purchased a 6-acre property on which to develop
their business in 1998, which they substantially repaired and
improved on a cash available basis for the next seven or eight
years. This property had more than doubled in value by the time
of trial, in part because of petitioners’ work. Petitioners
initially maintained a very small stable of Paint breeding mares
and sought to earn income by showing and selling the foals. They
consulted experts on various aspects of the horse activity
including showing, breeding and selling the Paints.
They leased an older Paint mare, Crymanitly, and found that
she produced an excellent quality of foal. As a result,
petitioners sought expert help and paid significant amounts to
breed Crymanitly despite her older age. They also boarded her
during her pregnancy to improve her chances of producing a
healthy foal. Crymanitly produced a stallion named Zippos
Special Reserve (Special) and petitioners adapted their business
plan to include training, showing and breeding Special. They
- 4 -
also hired a professional to train and show Special to increase
his value. They have identified semen production by Special as a
potential future source of revenue.
Petitioners made many business decisions regarding the
purchase, care and sale of a number of Paint horses for their
horse activity. Petitioners paid extensive amounts to care for
Special when he was injured. On the other hand, petitioners
decided to put down a 2-year-old foal that hurt her leg in a
fence accident because the cost to heal her exceeded the
projected price in selling her.
Petitioners advertised their Paint horse activity primarily
by showing their Paints. They considered showing their Paint
horses to be the best advertising possible. They also advertised
by boarding Special with a well-known professional horse trainer
whose facilities “had a lot of traffic.” They intended to set up
a Web site as well, but had not done so as of the trial because
Special was still in training.
Petitioners both had full-time jobs during the years at
issue. Mr. Frimml repaired tracks and ties for Union Pacific
Railroad and his railroad schedule allowed him generally equal
days off after working seven days. He worked on the horse
activity 6 to 10 hours per day during the time that he was home,
caring for the horses, making improvements to the property and
their facilities and transporting the Paint horses. While he was
- 5 -
away, Mrs. Frimml spent approximately 1-1/2 hours per day
attending to the regular obligations of their horse activity.
She was employed full time as an office worker at Dieomatic
Incorporated. Petitioners have also spent substantial time
attending Paint horse shows, learning about regional horses and
horse facilities and otherwise advancing their activity. They
rarely spent free time away from the Paint horse activity. In
fact, one of them usually stayed back from family events so that
the Paint horses were not unattended. Petitioners and their
family and friends did not ride the horses.
Petitioners intended their Paint horse activity to provide
retirement income. They did not believe their savings and assets
were sufficient to cover their retirement needs. Petitioners had
no sizable investments or substantial source of retirement income
to augment their railroad retirement money and a small 401(k).
Petitioners’ gross wages and salaries totaled more than $90,000
for each year at issue. Their total expenses for the Paint horse
activity during these years were $26,794 and $25,350.
Petitioners organized their income and expenses by means of a
check register.
Respondent issued the deficiency notice to petitioners,
disallowing the Schedule F losses for the years at issue and
determining the deficiencies and accuracy-related penalty for
those years. Petitioners timely filed a petition.
- 6 -
Discussion
We must decide whether Paint horse owners engaged in
breeding horses for profit within the meaning of section 183 when
they allocated substantial funds and time to their horse activity
over a period of 10 years (including the years at issue) yet
failed to generate a profit. We also must decide whether
petitioners are liable for the accuracy-related penalty for the
years at issue. We begin with an analysis of the horse activity
under section 183.
Whether a taxpayer may deduct expenses related to an
activity depends on whether it is carried on for profit. Secs.
162, 212. Subject to two exceptions in section 183(b) that do
not apply here, a taxpayer may not deduct losses attributable to
an activity unless that activity is engaged in for profit. Sec.
183(a). An activity is engaged in for profit if the taxpayer has
an actual, honest profit objective, even if it is unreasonable or
unrealistic. Sec. 1.183-2(a), Income Tax Regs.
We 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)
- 7 -
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 controlling. Keating v. Commissioner, 544 F.3d
900, 904 (8th Cir. 2008), affg. T.C. Memo. 2007-309; 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. The individual facts
and circumstances of each case are the primary test, with greater
weight to be given to objective facts than to the taxpayer’s
statement of intent. See Evans v. Commissioner, 908 F.2d 369,
373 (8th Cir. 1990), revg. T.C. Memo. 1988-468; Abramson v.
Commissioner, 86 T.C. 360, 371 (1986). We now apply the factors
to the facts here.
We begin with the first factor by considering whether
petitioners carried on the Paint horse activity in a businesslike
manner. See sec. 1.183-2(b)(1), Income Tax Regs. Factors that
may indicate a profit objective include whether petitioners had a
business plan, attempted changes in an effort to earn a profit,
maintained complete and accurate books and records, and
- 8 -
advertised the horse activity. See Engdahl v. Commissioner, 72
T.C. 659, 666-667 (1979); Rinehart v. Commissioner, T.C. Memo.
2002-9; sec. 1.183-2(b)(1), Income Tax Regs.
Petitioners spent a decade formulating a business plan for
breeding Paint horses and adapted their business plan in efforts
to earn a profit. Their failure to reduce the business plan to
writing is not fatal as its formulation and alteration over time
are evident. See Rinehart v. Commissioner, supra; Phillips v.
Commissioner, T.C. Memo. 1997-128. Petitioners purchased and
substantially improved a 6-acre property on which to develop
their business. They adapted their initial plan of maintaining a
very small stable of breeding mares once they learned the
excellent quality of foal Crymanitly produced. Petitioners again
changed their business plan after Crymanitly’s foal, Special, was
born to incorporate training, showing and breeding Special. They
have identified semen sales by Special for artificial
insemination as a potential source of future revenue.
The Court specifically notes petitioners’ businesslike
descriptions of decisions regarding their Paint horses.
Petitioners paid extensive amounts to heal Special when he was
hurt. On the other hand, they put down a 2-year-old foal that
hurt her leg in a fence accident because the cost to heal her
exceeded the projected price in selling her.
- 9 -
Petitioners’ check register, which they used to organize
their income and expenses, was maintained in an unprofessional
and imprecise manner. Petitioners’ advertising was also not
extensive. Petitioners advertised by showing their Paint horses
and boarding Special with a well-known professional horse trainer
whose facilities “had a lot of traffic.” They intended to
develop a Web site but had not done so by the time of trial
because Special was still in training. Petitioners’ business
plan and businesslike approach to the horses suggest a profit
objective, but their imprecise bookkeeping and limited
advertising detract from this conclusion. This factor is
neutral.
A second factor is the taxpayer’s expertise, research and
study of an activity, including consultation with experts. Sec.
1.183-2(b)(2), Income Tax Regs. Petitioners studied horse
breeding in general and Paint horse breeding specifically for a
decade before beginning their horse activity. The Court is
convinced from their trial testimony that they have the requisite
knowledge of breeding, including the genetics, mechanics and
financial aspects of breeding. Petitioners also consulted
experts on various aspects of the Paint horse breeding business
including showing, breeding and selling the horses. They sought
expert help to breed Crymanitly and boarded her during her
pregnancy to improve her chances of delivering a healthy foal.
- 10 -
They hired a professional to train and show Special to increase
his value. This factor favors the requisite profit objective.
The third factor is whether the taxpayer devotes much
personal time and effort to carrying on the activity,
particularly if the activity does not have substantial personal
or recreational aspects. Sec. 1.183-2(b)(3), Income Tax Regs.
Petitioners both had full-time jobs. Mr. Frimml’s job schedule,
however, required that he travel for work for approximately a
week and then have a week off. He worked on the Paint horse
activity 6 to 10 hours per day during the time that he was home,
caring for the horses, making improvements to the property and
their facilities and transporting the horses. While he was away,
Mrs. Frimml spent approximately 1-1/2 hours per day attending to
the obligations of their horse activity. Petitioners have also
spent substantial amounts of time attending Paint horse shows,
learning about regional Paint horses and horse facilities and
otherwise advancing their activity. They rarely spent free time
away from the horse activity. In fact, one of them usually
stayed back from family events so that the Paints were not
unattended. This factor indicates a profit objective.
A fourth factor is the taxpayer’s expectation that assets
used in the activity may appreciate in value and generate an
overall profit. Sec. 1.183-2(b)(4), Income Tax Regs. The
property that petitioners acquired to start their horse activity
- 11 -
has more than doubled in value, in part because of improvements
petitioners made. Moreover, petitioners boarded Special with a
well-known, professional trainer to increase his value. We
believe that petitioners expected that the value of assets used
in their horse activity would increase. We further believe that
the expectation was sufficient to explain their willingness to
sustain continued operating losses. See Allen v. Commissioner,
72 T.C. 28, 36 (1979). This factor indicates the requisite
profit objective.
We now consider, as a fifth factor, whether petitioners have
previously converted similar activities from unprofitable to
profitable enterprises. Sec. 1.183-2(b)(5), Income Tax Regs.
Petitioners both grew up on farms. We have no evidence, however,
that they had ever undertaken similar activities in the past.
This factor favors respondent.
We now consider the sixth and seventh factors, which center
on petitioners’ record of substantial losses and their absence of
occasional profits. Sec. 1.183-2(b)(6) and (7), Income Tax Regs.
A series of losses during the startup phase of an activity may
fail to indicate that the activity is not engaged in for profit.
Sec. 1.183-2(b)(6), Income Tax Regs. This Court has recognized
that the startup phase of an American saddle-bred breeding
activity is 5 to 10 years and that a period of 5 to 10 years for
the startup phase of an Arabian breeding operation is not
- 12 -
unreasonable. Engdahl v. Commissioner, 72 T.C. at 669; Phillips
v. Commissioner, T.C. Memo. 1997-128. The years in issue, 2005
and 2006, are within this startup window. We treat these factors
as neutral because petitioners’ losses and absence of profit
during the years at issue were during the startup phase of their
Paint horse activity. See Strickland v. Commissioner, T.C. Memo.
2000-309.
An eighth factor is whether petitioners earned substantial
income from sources other than the horse activity. Sec.
1.183-2(b)(8), Income Tax Regs. Petitioners both had full-time
jobs and made over $90,000 a year. We do not find, however, that
they were using their salaries to support their horse activity as
a hobby. Petitioners established their Paint horse activity with
the hope of satisfying their retirement needs. They had no
sizable investments or substantial source of retirement income
other than their railroad retirement money and a small 401(k).
We think it unlikely that petitioners would embark on a hobby
consuming so much of their income and entailing so much physical
labor and time commitment without a profit motive. See Engdahl
v. Commissioner, supra at 670; Mary v. Commissioner, T.C. Memo.
1989-118. This factor indicates a profit objective.
The final factor is whether petitioners received personal
pleasure and recreational benefits from their Paint horse
activity. Sec. 1.183-2(b)(9), Income Tax Regs. Petitioners have
- 13 -
made substantial improvements to their property and have spent
significant time caring for their Paint horses and maintaining
their facilities. They did not ride their Paint horses, and they
did not allow family and friends to ride them either. This
factor indicates a profit objective.
After considering all the facts and circumstances, we find
that petitioners have shown that they engaged in their horse
activity for profit. Respondent did not contest the specific
dollar amounts petitioners claimed as losses for the years at
issue, and therefore petitioners can deduct all of the claimed
losses. Petitioners are also not liable for the accuracy-related
penalty for the years at issue because of our holding regarding
the deficiencies.
We have considered all arguments made in reaching our
decision and, to the extent not mentioned, we conclude that they
are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
for petitioners.