Stromatt v. Comm'r

T.C. Summary Opinion 2011-42

UNITED STATES TAX COURT

FREDDIE AND EDITH STROMATT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 5339-07S. Filed April 6, 2011.

Freddie and Edith Stromatt, pro sese.

Beth A. Nunnink, for respondent.

GALE, Judge: This case was heard pursuant to the provisions

of section 7463 of the Internal Revenue Code in effect when the

petition was filed.1 Pursuant to section 7463(b), the decision

to be entered is not reviewable by any other court, and this

1
Unless otherwise noted, all section references are to the
Internal Revenue Code of 1986, as in effect for the years in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
 - 2 -

opinion shall not be treated as precedent for any other case.

All dollar amounts have been rounded to the nearest dollar.

Respondent determined income tax deficiencies of $7,076,

$2,048, and $2,272 for petitioners’ 2002, 2003, and 2004 taxable

years, respectively, and accuracy-related penalties under section

6662 for those years of $1,415, $410, and $454, respectively.

The issues for decision are: (1) Whether petitioners’ farming

activity for 2002, 2003, and 2004 constituted an activity not

engaged in for profit within the meaning of section 183; (2)

whether petitioners substantiated their farming expenses claimed

for 2002, 2003, and 2004; and (3) whether petitioners are liable

for accuracy-related penalties under section 6662 for 2002, 2003,

and 2004.

Background

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

The stipulation of facts, with accompanying exhibits, is

incorporated herein by this reference. At the time the petition

was filed, petitioners resided in Tennessee.

Farming Activity

In 1999 petitioners purchased an approximately 15-acre

parcel of land near Dickson, Tennessee. Petitioner Edith

Stromatt (Mrs. Stromatt) had retired before the land was

purchased, and petitioner Freddie Stromatt (Mr. Stromatt) retired

shortly thereafter.
 - 3 -

In 2000 petitioners constructed a two-bedroom, one-bath

house of approximately 792 square feet on the property. Mrs.

Stromatt’s father lived in the house from 2000 until his death in

2006. Petitioners did not live in the house or elsewhere on the

property during the years at issue (2002-2004).

During 2000 and 2001 petitioners cleared the acreage, which

had been untended for approximately 25 years and was overgrown

with brush and trees, to prepare it for use as pasture, including

the production of hay. Mr. Stromatt and Mrs. Stromatt’s father

operated the tractor and Bush Hog used for clearing the land,

including pulling tree stumps. During 2001 and 2002 petitioners

installed fencing and fertilized. This work was also performed

by Mr. Stromatt and Mrs. Stromatt’s father.

Petitioners harvested their first hay in 2001 and continued

producing hay during the years at issue, harvesting it with

rented equipment. Mr. Stromatt and Mrs. Stromatt’s father

performed this labor. Petitioners sold the hay, and these sales

constituted the only income generated from the farming activity

during the years at issue.

Petitioners first purchased cattle in 2005, acquiring six

pregnant heifers. By the end of 2005 petitioners owned 17 head

of cattle.
 - 4 -

Mrs. Stromatt’s father provided advice to petitioners on

farming, including the number of cattle that could be supported

on 15 acres of land.

Mrs. Stromatt’s father was an experienced farmer, and Mrs.

Stromatt grew up on a farm.

Farming Ledger

Mrs. Stromatt maintained a ledger for recording farming

activity expenses (farming ledger) and kept all receipts that

related to farming activity expenses. The farming ledger

included both annual summary accounts as well as monthly accounts

for some months and accounts for some specific items, such as

electricity and utility expenses. Mrs. Stromatt posted items in

the farming ledger regularly, often making additions more than

once per week. Mrs. Stromatt presented the farming ledger and

the receipts to petitioners’ return preparer for use in preparing

petitioners’ Federal income tax returns.

Petitioners’ Reported Income and Expenses

The following table summarizes the income and expenses that

petitioners reported during the period 2001-2007.
 - 5 -

Profit Total Income
Farming Farming (Loss) From From Other
Year Income Expenses Farming Sources1
2001 $1,600 $21,692 ($20,092) $152,718
2002 1,400 27,321 (25,921) 134,596
2003 2,100 19,258 (17,158) 74,778
2004 2,300 16,397 (14,097) 87,732
2
2005 1,700 4,226 ( 2,526) 116,848
2
2006 3,500 2,550 950 38,893
2
2007 4,760 3,517 1,243 22,596

1
In each year petitioners also had gambling income that was
completely offset by gambling losses.
2
Mrs. Stromatt conceded that petitioners stopped deducting
all of the expenses of the farming activity after respondent
commenced an examination of petitioners’ returns in 2005.

Examination

Respondent commenced an examination for petitioners’ taxable

years 2002-2004 in 2005. Respondent’s examining agent inspected

the petitioners’ books and records, including the farming ledger.

The examining agent was satisfied with the substantiation of

petitioners’ income and expenses with respect to the farming

activity.

Notice of Deficiency

Respondent issued a notice of deficiency to petitioners for

the years at issue, disallowing farming losses claimed on

Schedules F, Profit or Loss From Farming, of $25,921, $17,158,
 - 6 -

and $14,097 for 2002, 2003, and 2004, respectively,2 on the

alternative grounds that the activity giving rise to the losses

was “not engaged in for profit” within the meaning of section 183

or that petitioners did not substantiate the losses.3

Pretrial Proceedings

As part of the pretrial proceedings, respondent made an

informal request and then a formal request for all of

petitioners’ books and records. Petitioners responded by

requesting a copy of their administrative file. After receiving

the administrative file, which did not include the farming

ledger, petitioners sent a letter to respondent stating that the

administrative file showed that petitioners had substantiated all

of their expenses. Petitioners did not produce the farming

ledger or any other documents that respondent had requested until

the day before trial.

Discussion

I. Section 183

A. Scope of Activity

Respondent disallowed petitioners’ claimed farming losses on

the grounds that the activity giving rise to the losses was “not

2
The disallowance of the Schedule F losses resulted in
computational adjustments to petitioners’ itemized deductions for
each year.
3
According to respondent’s counsel, while the examining
agent was satisfied with petitioners’ substantiation, the Appeals
Office was not.
 - 7 -

engaged in for profit” within the meaning of section 183.

Petitioners contend that the activity was engaged in for profit.

At the outset, we must resolve a question of the scope of

the activity that is at issue. Petitioners reported their

activity on the Schedules F as a “beef cattle ranch”. Respondent

argues that petitioners did not own any cattle during the years

in issue and were instead only harvesting hay. We are satisfied

that petitioners’ preparation of their land for hay cultivation,

given the hay’s eventual use as feed for their cattle, bore an

“economic interrelationship” with their later cattle operation so

that the two undertakings were a single activity for purposes of

section 183. See sec. 1.183-1(d)(1), Income Tax Regs.; see also

Mitchell v. Commissioner, T.C. Memo. 2006-145; Tobin v.

Commissioner, T.C. Memo. 1999-328. Moreover, their sale of hay

during the years in issue demonstrates that the activity was

beyond the preparatory stage. See Richmond Television Corp. v.

United States, 345 F.2d 901, 907 (4th Cir. 1965), vacated and

remanded per curiam on other grounds 382 U.S. 68 (1965).

Accordingly, the hay cultivation and contemplated cattle

husbandry are hereinafter analyzed together as a single activity

referred to as petitioners’ farming activity.
 - 8 -

B. Determining Profit Objective

1. In General

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.” In general, deductions are

allowable under section 162 or 212 for activities in which the

taxpayer engaged with the primary purpose and dominant hope and

intent of realizing a profit. Commissioner v. Groetzinger, 480

U.S. 23, 35 (1987); Hayden v. Commissioner, 889 F.2d 1548, 1552

(6th Cir. 1989), affg. T.C. Memo. 1988-310; Novak v.

Commissioner, T.C. Memo. 2000-234. “An activity is engaged in

for profit if the taxpayer entertained an actual and honest, even

though unreasonable or unrealistic, profit objective in engaging

in the activity.” Campbell v. Commissioner, 868 F.2d 833, 836

(6th Cir. 1989), affg. in part, revg. in part and remanding T.C.

Memo. 1986-569; see also Keanini v. Commissioner, 94 T.C. 41, 46

(1990); Dreicer v. Commissioner, 78 T.C. 642, 644-645 (1982),

affd. without published opinion 702 F.2d 1205 (D.C. Cir. 1983);

sec. 1.183-2(a), Income Tax Regs.

The existence of the requisite profit objective is a

question of fact that must be decided on the basis of the entire

record. Elliott v. Commissioner, 84 T.C. 227, 236 (1985), affd.

without published opinion 782 F.2d 1027 (3d Cir. 1986); Dreicer
 - 9 -

v. Commissioner, supra at 645; sec. 1.183-2(b), Income Tax Regs.

In resolving this factual question, greater weight is given to

objective facts than to a taxpayer’s statement of intent. See

Westbrook v. Commissioner, 68 F.3d 868, 875-876 (5th Cir. 1995),

affg. T.C. Memo. 1993-634; sec. 1.183-2(a), Income Tax Regs. The

taxpayer bears the burden of proving the requisite profit

objective. See Rule 142(a); Hayden v. Commissioner, supra at

1552; Golanty v. Commissioner, 72 T.C. 411, 426 (1979), affd.

without published opinion 647 F.2d 170 (9th Cir. 1981).4

Section 1.183-2(b), Income Tax Regs., sets forth a

nonexclusive list of factors to be considered in determining

whether an activity is engaged in for profit. Campbell v.

Commissioner, supra at 836. These factors are: (1) The manner

in which the taxpayer carried on the activity; (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

4
Petitioners contend that they have met the prerequisites
for a shift in the burden of proof to respondent with respect to
all factual issues under sec. 7491(a). For the burden of proof
to shift to respondent, petitioners are required to cooperate
with all reasonable requests for documents. See sec. 7491(a)(2).
Petitioners did not produce the farming ledger or any other
documents respondent requested until the day before trial.
Accordingly, petitioners are not eligible for a shift in the
burden of proof. See Rolfs v. Commissioner, 135 T.C. 471, 483-
484 (2010); Assaf v. Commissioner, T.C. Memo. 2005-14.
 - 10 -

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. Sec. 1.183-2(b), Income Tax Regs. As

no single factor is controlling, the facts and circumstances of

the case taken as a whole are determinative. Abramson v.

Commissioner, 86 T.C. 360, 371 (1986); sec. 1.183-2(b), Income

Tax Regs.

2. Manner of Carrying On the Activity

For purposes of determining whether an activity is conducted

in a businesslike manner, the regulations cite several factors

that may indicate a profit objective, including maintaining

complete and accurate books and records, carrying on an activity

in a manner similar to other profitable activities of the same

nature, and abandoning unprofitable methods or adopting new

methods. Sec. 1.183-2(b)(1), Income Tax Regs. Petitioners

maintained a farming ledger and kept receipts. While the farming

ledger was informal at best, the recordkeeping required for a

small farming operation is not rigorous. See Burrus v.

Commissioner, T.C. Memo. 2003-285; Fields v. Commissioner, T.C.

Memo. 1981-550; Edge v. Commissioner, T.C. Memo. 1973-274. A

period of land preparation before the commencement of cattle

operations is not unusual and does not show lack of a profit
 - 11 -

objective. See Fields v. Commissioner, supra. Moreover,

petitioners found buyers for their hay in the startup years

before cattle were purchased. In 2005, the year following the

years at issue, petitioners first acquired cattle and owned 17

head of cattle by the close of that year.

While it is true that approximately 3 years elapsed between

the completion of fencing in 2002 and petitioners’ acquisition of

cattle in 2005, we do not find this delay dispositive of the

question of whether petitioners had a profit objective. All the

work on the farm was being performed by Mr. Stromatt and his

elderly father-in-law. In these circumstances, the delay in

commencing cattle operations was not unreasonable and, in view of

the fact that petitioners were producing and selling hay in the

interim, we are satisfied that they had an honest, good-faith

intention to develop a cattle operation. This factor favors

petitioners.

3. Expertise of Petitioners and Their Advisers

Preparation for an activity by extensive study or

consultation with experts may indicate a profit objective where

the taxpayer conducts the activity in accordance with such study

or advice. See sec. 1.183-2(b)(2), Income Tax Regs. Petitioners

relied upon the advice and services of Mrs. Stromatt’s father, an

experienced farmer, who also performed much work on the farm. In

particular, Mrs. Stromatt’s father advised petitioners as to the
 - 12 -

acreage they would need to support a successful cattle operation.

This factor favors petitioners.

4. Time and Effort Expended by Petitioners

The fact that taxpayers devote much of their personal time

and effort to carrying on an activity, particularly if the

activity does not have substantial personal or recreational

aspects, may indicate a profit objective. See sec. 1.183-

2(b)(3), Income Tax Regs. Petitioners expended substantial time

and effort in operating the farm. Mr. Stromatt and Mrs.

Stromatt’s father did the initial land-clearing work, and then

fertilized, installed the fencing, and harvested the hay during

the years in issue. Mrs. Stromatt maintained the farming ledger.

Mr. and Mrs. Stromatt’s efforts in respect of petitioners’

farming activity did not have any recreational aspect. This

factor favors petitioners.

5. Expectation of Appreciation of Asset Values

An expectation that assets used in the activity will

appreciate in value may indicate a profit objective. See sec.

1.183-2(b)(4), Income Tax Regs. While petitioners presented no

specific evidence regarding the likelihood of any appreciation in

value of the land or equipment used in petitioners’ farming

activity, it is apparent that clearing and fencing neglected land

would likely increase its value. This factor favors petitioners.
 - 13 -

6. Success in Similar or Dissimilar Activities

Taxpayers’ past success in similar or dissimilar activities

may indicate that their engagement in a presently unprofitable

activity is for profit. See sec. 1.183-2(b)(5), Income Tax Regs.

Petitioners have never owned a farm or operated any other kind of

entrepreneurial business. Therefore, this factor favors

respondent. See Lowe v. Commissioner, T.C. Memo. 2010-129;

Zarins v. Commissioner, T.C. Memo. 2001-68, affd. 37 Fed. Appx.

747 (6th Cir. 2002).

7. History of Income or Loss

An activity’s history of income or loss may reflect whether

the taxpayers have a profit objective. See sec. 1.183-2(b)(6),

Income Tax Regs. Petitioners’ farming activity had only a short

history of operating results when respondent determined that they

lacked a profit objective. The operational results after 2004

are unreliable, however, because Mrs. Stromatt conceded that she

stopped claiming all of the expenses of petitioners’ farming

activity after respondent commenced an examination in 2005 of the

returns at issue. The years at issue are the third, fourth, and

fifth years of operations. While there were losses in all these

years, it is not a lengthy history and may reflect a reasonable

startup period. See Fields v. Commissioner, supra (“initial

losses are almost a certainty where repairs to and development of

farmland are necessary to the growth and viability of the
 - 14 -

operation”). Cases that found a history of losses as significant

evidence of a lack of profit objective generally involved losses

over a substantially longer period than in the instant case.

See, e.g., Hendricks v. Commissioner, 32 F.3d 94, 96, 99 (4th

Cir. 1994) (20 years of losses with 1 profitable year), affg.

T.C. Memo. 1993-396; Keelty v. Commissioner, T.C. Memo. 1984-173

(15 years of losses with 1 profitable year); see also Wise v.

Commissioner, T.C. Memo. 1957-83 (7 years of continuous losses

not evidence of lack of profit objective where taxpayer was

rehabilitating a neglected farm), affd. 260 F.2d 354 (6th Cir.

1958). This factor favors petitioners.

8. Amount of Occasional Profits

The amount of any occasional profits, if large in relation

to losses incurred or the taxpayers’ investment, may indicate a

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

Petitioners’ farming activity did not earn any profits during the

years at issue, and the apparent profits recorded for 2006 and

2007 are illusory, since as noted Mrs. Stromatt concedes that she

understated expenses for those years. This factor favors

respondent.

9. Financial Status

Substantial income from sources other than the activity

(particularly if the losses from the activity generate

substantial tax benefits) may indicate that the activity is not
 - 15 -

engaged in for profit. See sec. 1.183-2(b)(8), Income Tax Regs.

Petitioners had substantial income from other sources during the

years at issue which was offset to the extent of their claimed

farming activity losses. This factor favors respondent.

10. Elements of Personal Pleasure or Recreation

The existence of recreational or personal elements in an

activity may indicate that the activity is not engaged in for

profit. Sec. 1.183-2(b)(9), Income Tax Regs. Petitioners’

farming activity offered no significant recreational

opportunities. Instead, Mr. Stromatt performed arduous physical

labor and Mrs. Stromatt provided bookkeeping services in

connection with the activity. Petitioners did not reside on the

premises during the years in issue. Cattle operations on farms

without significant recreational facilities generally do not

suggest a recreational aspect indicating a lack of a profit

objective. See Smith v. Commissioner, T.C. Memo. 2007-368, affd.

364 Fed. Appx. 317 (9th Cir. 2009); Burrus v. Commissioner, T.C.

Memo. 2003-285; Fields v. Commissioner, T.C. Memo. 1981-550.

This factor favors petitioners.

11. Conclusion

After weighing the regulatory factors and all other facts

and circumstances, we conclude that petitioners engaged in their

farming activity with an actual and honest profit objective.

They and family members expended substantial amounts of physical
 - 16 -

labor to reclaim and fence land in an effort to establish a

viable cattle operation. They did so at a pace that was not

unreasonable in the circumstances, and they offset some losses by

initially selling hay. They obtained knowledgeable advice.

Their loss history was both brief (as of the close of the last

year in issue) and not atypical for reclaiming land and

establishing a cattle operation. The enterprise did not offer

significant recreational opportunities.

For the foregoing reasons, we hold that the losses claimed

from petitioners’ farming activity for 2002, 2003, and 2004 are

not limited by section 183.

II. Substantiation

Respondent also disallowed the claimed farming losses for

the years at issue on the alternative ground that petitioners

failed to substantiate their expenses. See sec. 6001; sec.

1.6001-1(a), Income Tax Regs. Respondent’s contentions regarding

substantiation are general, except for his pointing to

petitioners’ apparent failure to issue any Forms 1099-MISC,

Miscellaneous Income, to Mrs. Stromatt’s father for payments made

to him.5

5
Petitioners reported expenses for “labor hired” on their
Schedule F for each year at issue. They credibly testified that
these expenses represented amounts paid to Mrs. Stromatt’s father
for his services. In these circumstances, we find any failure by
petitioners to issue Forms 1099-MISC with respect to their
payments to Mrs. Stromatt’s father to be of marginal relevance in
determining whether they adequately substantiated their expenses.
 - 17 -

On the basis of our review of petitioners’ records of their

farming activity, we are satisfied that their substantiation was

adequate. Petitioners maintained summary ledgers and ledgers for

specific items, which generally matched each other and the

amounts reported on their returns. Mrs. Stromatt credibly

testified that she generally kept receipts. Petitioners’ return

preparer credibly testified that she inspected both the farming

ledger and the receipts in her preparation of the returns for

each of the years at issue. Additionally, respondent’s counsel

conceded at trial that respondent’s examining agent was satisfied

with the substantiation of the items on the returns (although,

according to respondent’s counsel, the Appeals Office was not).

On this record, we conclude that petitioners met the

substantiation requirements of section 6001.

III. Accuracy-Related Penalties

Respondent determined accuracy-related penalties under

section 6662(a) and (b)(1) for underpayments attributable to

negligence. In his pretrial memorandum, respondent asserted that

each year’s underpayment was also attributable to a substantial

understatement of income tax. See sec. 6662(b)(2). However,

since we have found that there is no deficiency for any year,
 - 18 -

there is no underpayment giving rise to any penalty under section

6662.

To reflect the foregoing,

Decision will be entered

for petitioners.