Bronson v. Comm'r

T.C. Memo. 2012-17

UNITED STATES TAX COURT

PETER C. AND CAROLYN P. BRONSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 17478-08, 26463-08. Filed January 17, 2012.

Peter C. and Carolyn P. Bronson, pro sese.

Alan Edward Staines, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GALE, Judge: These cases were consolidated for trial,

briefing, and opinion. Respondent determined deficiencies in

petitioners’ Federal income taxes for 2001, 2002, 2003, 2004, and

2005 of $22,905, $31,565, $28,165, $32,664, and $34,033,

respectively, in two notices of deficiency that were separately
 - 2 -

petitioned.1 Respondent also determined an addition to tax under

section 6651(a)(1)2 of $1,629 for 2002 and penalties under

section 6662 of $6,533 and $6,807 for 2004 and 2005,

respectively.

After concessions,3 the issues for decision are: (1)

Whether petitioners’ horse-related activity (horse activity) was

an “activity not engaged in for profit” within the meaning of

section 183 during the years at issue4 and (2) whether

petitioners are liable for penalties under section 6662 for 2004

and 2005.

1
Certain computational adjustments, including adjustments to
petitioners’ alternative minimum tax liability, were also made.
2
All section references are to the Internal Revenue Code of
1986, as in effect for the years at issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
All dollar amounts are rounded to the nearest dollar.
3
Respondent concedes that petitioners are not liable for the
sec. 6651(a)(1) addition to tax for 2002. Petitioners concede
that they failed to report $4,221 in capital gains for 2001.
Respondent also determined that petitioners are liable for self-
employment taxes in connection with the conduct of the horse
activity. Given our holding (discussed infra) that the horse
activity was “an activity not engaged in for profit” within the
meaning of sec. 183, the activity could not have given rise to
any self-employment tax liability for the years at issue.
Respondent’s treatment of a $642 capital loss deduction
petitioners claimed for 2005 is unclear from the notice of
deficiency. We expect the parties to address these issues as
part of their Rule 155 computations.
4
Although the notices of deficiency do not refer to sec.
183, the parties have both consistently framed petitioners’
entitlement to the deductions at issue as turning upon the
applicability of that section. We accordingly conclude that each
has waived any other grounds for denying or supporting the
claimed deductions.
 - 3 -

FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference. At the time the petitions

were filed, petitioners resided in California.

Petitioners are married and filed joint Federal income tax

returns for each of the years at issue. Petitioner Carolyn P.

Bronson (Dr. Bronson) holds a Ph.D. in consumer finance and has

taught consumer economics at the college level. During the years

at issue Dr. Bronson held a real estate license but was not

working as a real estate broker or otherwise. Petitioner Peter

C. Bronson (Mr. Bronson) was a practicing attorney specializing

in bankruptcy litigation. Petitioners had three daughters during

the years at issue, the eldest born in 1990 and twins born in

1995. Petitioners resided in Los Angeles County from 2001 until

August 2005, when they moved to Nevada County, California.

Before starting the horse activity, neither petitioner had

experience breeding horses and neither was certified or qualified

as a trainer, veterinarian, or farrier. Dr. Bronson held no

outside gainful employment during the years at issue although she

was involved at some point before 2001 in managing the operations

of an 85-acre cooperative equestrian barn which provided boarding

services. She devoted substantial time during the years at issue

to the horse activity. Mr. Bronson practiced law full time and
 - 4 -

was much less involved with the horse activity. Petitioners’

daughters rode some of petitioners’ horses recreationally and in

shows; petitioners themselves did not ride.

Petitioners became interested in Welsh ponies and cobs5 in

1995 when their then only daughter began riding lessons on a

Welsh pony. Later that year petitioners purchased a Welsh pony

gelding6 for their daughter’s use. Thereafter, Dr. Bronson

became active in Welsh pony and cob circles. She consulted a

number of individuals who trained and bred Welsh ponies and cobs

regarding their operations and became involved with national and

regional breeders’ organizations.

In 1998 petitioners purchased their second horse, a half-

Welsh mare, and began treating the horse activity as a trade or

business which they referred to as Coldstream Farm. Petitioners

did not prepare a written business plan before starting

Coldstream Farm.7 However, Dr. Bronson testified that their

original plan was to acquire, breed, and train high-quality Welsh

5
Welsh ponies and cobs are closely related horse breeds that
are categorized according to size and may be suitable for
children or adult riding.
6
A gelding is a neutered male horse.
7
In 2002 petitioners created a document which included a
“Mission Statement” and a “Five-Year Plan”. The document
retroactively summarizes petitioners’ annual goals for Coldstream
Farm from 1998 through 2002 and provides the results achieved in
pursuit of those goals from 1998 through 2001. The document has
not been revised since it was created.
 - 5 -

ponies and cobs and sell them.8 Petitioners treated the mare and

the gelding purchased for their daughter as assets of the

business and began reporting the operating results of Coldstream

Farm on a Schedule C, Profit or Loss From Business, attached to

their Federal income tax return for 1998.

Petitioners did not own property suitable for housing their

horses or supporting their horse activity when they started

Coldstream Farm. Consequently, they paid to board their horses

with third-party providers. In 1999, after reviewing the

expenses of the horse activity, petitioners determined they

needed to acquire their own facility in order to diversify their

offerings and control costs. Dr. Bronson toured a number of

horse farms and further determined that the small margins

associated with the horse business made it important to have a

facility at which petitioners could conduct breeding, boarding,

training, and sales activities. Despite these conclusions,

petitioners did not acquire land for their own facility until

2005.

In the meantime, petitioners continued to acquire horses.

They purchased four horses and foaled two others in California

8
Notably, the only breeding or training records petitioners
offered into evidence were two undated “stock summaries” that
listed general information about their horses such as date of
birth, acquisition date and price, parentage, and a brief
description of the discipline in which each horse had been
trained.
 - 6 -

between 2000 and 2002. Petitioners also purchased two horses

located in Wales, one each in 2001 and 2002, imported them, and

boarded them on the east coast.9 One of the east coast horses

delivered a foal in 2003. So far as the record reveals,

petitioners owned 10 horses by the end of 2003 and through 2005,

the last year at issue. Seven of the horses were located in

southern California and the other three on the east coast.

Petitioners paid to board all 10 horses.

Petitioners began searching for their own equine facility in

2001 by investigating properties near their Los Angeles County

home.10 When it became clear that restrictive zoning ordinances

and high land costs in Los Angeles County were substantial

obstacles to petitioners’ finding affordable property for housing

an equine facility, petitioners focused their search on

neighboring Ventura County.

Dr. Bronson spent a significant amount of time reviewing

real estate listings, talking to brokers, researching zoning

laws, making telephone calls, and visiting and investigating

9
The record is not clear regarding why these horses were
boarded on the east coast. Dr. Bronson testified that the horses
would be moved to California when petitioners’ equine facility
was completed. These horses were shown at horse shows on the
east coast.
10
That same year the Internal Revenue Service completed an
examination of Coldstream Farm’s activities as reported on
petitioners’ 1999 Federal income tax return. The examining agent
did not make any adjustments.
 - 7 -

various properties. Over time petitioners identified a number of

potentially suitable properties in southern California, many of

which contained equine facilities. However, petitioners

discovered flaws in most of the identified properties and did not

pursue them further.

From the time their search began in 2001 through the spring

of 2005, petitioners submitted offers on only two properties.

Petitioners were substantially outbid on one and walked away from

the other during the due diligence process after discovering

problems with settlement and the proximity of earthquake fault

lines.

In the spring of 2005 petitioners expanded their search and

began looking for property in northern California. Dr. Bronson

researched Nevada County and believed it would be suitable for

petitioners’ horse activity. Mr. Bronson’s law firm had

connections in the Sacramento area and was amenable to Mr.

Bronson’s opening a Sacramento office. In May 2005 Dr. Bronson

met with two real estate brokers and viewed a number of

properties in Nevada County. During that visit Dr. Bronson

toured a 40-acre property in western Nevada County in which

petitioners became interested.

The property had a residence but no equine facility. Before

making an offer, petitioners hired a developer to evaluate the

property’s suitability for housing an equine facility and an
 - 8 -

agriculturist to test the soil. Petitioners also hired a group

of engineers to plan the design and construction of a barn and

arenas on the property. Satisfied they would be able to

construct their desired facility, petitioners purchased the

property and moved to Nevada County in August 2005.

Petitioners hired River City Construction, a Sacramento-area

contractor, to fence the property and to build and install

various aspects of petitioners’ desired facility. Construction

began in 2006 but did not go as planned. Petitioners claim that

much of River City’s work was substandard and that they paid

River City a substantial sum for work that was never done. A

lengthy dispute ensued; Mr. Bronson testified that petitioners

were preparing to sue the two individuals who operated River City

when both filed chapter 7 bankruptcy petitions in January of

2009.

In April 2009 petitioners filed a complaint in each

bankruptcy proceeding seeking nondischargeability of the debt

petitioners claim the contractors owe them, and monetary damages.

The litigation had not concluded at the time of trial in these

cases. Petitioners’ facility has not been completed. However, 8

of the 13 horses petitioners owned at the time of trial were kept

at petitioners’ property; the other 5 were boarded on the east

coast.
 - 9 -

Dr. Bronson has been involved in various breeders’

organizations and civic groups throughout the duration of

petitioners’ horse activity. She also wrote an equestrian column

for a local newspaper and sponsored a summer riding clinic for

at-risk teenage girls. Petitioners claim the purpose of Dr.

Bronson’s involvement in such activities was to establish the

Coldstream Farm brand and build credibility in the equestrian

community.

Petitioners also advertised to raise awareness of their

operation and offer specific horses for sale. Petitioners paid

to place print ads in national and regional equine publications

and advertised locally by posting flyers on bulletin boards at

horse shows they attended. Petitioners claimed advertising

expense deductions of $3,339,11 $1,575, $695, $170, and $325 for

2001, 2002, 2003, 2004, and 2005, respectively.

Petitioners’ horse activity did not generate significant

revenue. Petitioners’ lone sale of a horse during the years at

issue occurred in 2003 when they sold Flying Satellite, a gelding

they purchased in 2000, to a nonprofit organization for $500. On

their 2003 return, petitioners took the position that Flying

Satellite was worth $5,500 at the time of sale and claimed a

11
Petitioners’ advertising expenses for 2001 included $1,312
petitioners spent on airfare and a rental car for a trip they
characterized as promoting a horse and $862 petitioners spent on
a digital camera. Respondent has not challenged the propriety of
these claimed expense deductions on grounds other than sec. 183.
 - 10 -

$5,000 charitable contribution deduction in connection with the

transfer to the nonprofit organization.12 After the years at

issue, in 2007, petitioners sold two horses that they bred in

California, for $6,500 and $10,000, respectively. The only other

income petitioners reported from the horse activity through 2008

was insubstantial.

In contrast to reported income, the horse activity’s

expenses were substantial. Petitioners deducted boarding

expenses of $18,733, $33,025, $39,345, $28,971, and $37,702 for

2001, 2002, 2003, 2004, and 2005, respectively. For those same

years petitioners’ claimed training expense deductions were

$3,467, $5,530, $10,956, $31,747, and $19,571, respectively.

Petitioners also claimed significant depreciation,13

12
The parties stipulated that Flying Satellite was sold for
$5,550, but they also stipulated a letter to petitioners from the
nonprofit organization stating that the organization had paid
petitioners $500 for Flying Satellite and had accepted
petitioners’ contribution of the balance of the horse’s purported
value, i.e., $5,000. The record does not illuminate the basis
for the $50 discrepancy. Petitioners reported $5,550 in
receipts, $2,171 in cost of goods sold, and $3,379 of gross
income on Schedule C of their 2003 Federal income tax return.
Petitioners also reported a cash gift of $5,000 to the nonprofit
organization that purchased Flying Satellite and claimed a
corresponding $5,000 charitable contribution deduction on
Schedule A, Itemized Deductions, of their 2003 return.
Respondent has not challenged petitioners’ reporting of the
transaction.
13
In 2001, 2002, and 2003 petitioners apparently depreciated
horses they offered for sale; however, respondent has not
challenged petitioners’ depreciation deductions on grounds other
than sec. 183. See sec. 1.167(a)-2, Income Tax Regs.
 - 11 -

transportation, and veterinary expense deductions for the years

at issue.

Petitioners maintained expense records for the horse

activity in spreadsheet form. The records identified and

categorized individual expenditures for all 5 years at issue.

Most expenditures were partly related to the horse activity and

partly related to petitioners’ personal activities. Both the

full amount of each expenditure and the amount related to the

horse activity were recorded. Petitioners prepared no other

financial statements for Coldstream Farm.

Petitioners’ accountant found their records adequate for

purposes of their income tax reporting. However, he did not have

any expertise regarding horses, and there is no evidence that

petitioners sought or received his advice concerning whether

their deductions for expenses of the horse activity were subject

to restriction under section 183.

Petitioners have never reported a profit from the horse

activity. From the time petitioners started Coldstream Farm in

1998 through 2008, petitioners claimed a cumulative net loss of

$837,752. Petitioners used the horse activity losses to offset

substantial earnings from Mr. Bronson’s law practice in most

years.14 The following table summarizes the net losses generated

14
For the first 2 full years after petitioners moved to
Nevada County (2006-2007) Mr. Bronson’s net income from his law
(continued...)
 - 12 -

by the horse activity and, where available from the record, the

gross receipts from the horse activity and Mr. Bronson’s law

practice net income from 1998 through 2008.

Net Income
From Mr. Gross Receipts Net Income
Bronson’s Law From Horse (Loss) From
Year Practice Activity Horse Activity

1998 N/A1 N/A1 ($24,112)
1999 N/A1 N/A1 (53,508)
2000 N/A1 N/A1 (33,152)
2001 $339,500 -0- (55,721)
2002 260,000 $320 (82,254)
2003 235,000 5,550 (80,718)
2004 331,500 -0- (90,290)
2005 180,000 -0- (98,773)
2006 30,011 -0- (94,213)
2007 (8,284) 17,170 (93,180)
2008 327,567 3,574 (131,831)

1
Not available from record.

Respondent disallowed the Schedule C expense deductions

petitioners claimed from the horse activity for the years at

issue on the grounds that the expenses were not incurred for

ordinary or necessary business purposes, resulting in a

14
(...continued)
practice declined precipitously from an average of $291,500 for
the 4 years preceding the move year to an average of less than
$11,000 for 2006-2007. His law practice net income for 2008 was
$327,567.
 - 13 -

deficiency for each year.15 Petitioners timely petitioned this

Court for redetermination of the deficiencies.

OPINION

I. Horse Activity

The principal issue to be decided in these cases is whether

petitioners’ horse activity was engaged in for profit during the

years at issue. 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.” Deductions

are allowable under sections 162 and 212 for activities in which

the taxpayer engaged with the predominant purpose and intention

of making a profit. Wolf v. Commissioner, 4 F.3d 709, 713 (9th

Cir. 1993), affg. T.C. Memo. 1991-212; Indep. Elec. Supply, Inc.

v. Commissioner, 781 F.2d 724, 726 (9th Cir. 1986), affg. Lahr v.

Commissioner, T.C. Memo. 1984-472; Golanty v. Commissioner, 72

T.C. 411, 425 (1979), affd. without opinion 647 F.2d 170 (9th

Cir. 1981); Allen v. Commissioner, 72 T.C. 28, 33 (1979).

Generally, individuals are allowed to deduct expenses

attributable to an activity not engaged in for profit only to the

15
The parties agree that petitioners’ entitlement to
deductions for the expenses claimed on the Schedules C depends
upon whether the horse activity was not engaged in for profit
within the meaning of sec. 183.
 - 14 -

extent of gross income generated from the activity.16 Sec.

183(a), (b)(2).

Thus, it is the taxpayer’s subjective intent to earn a

profit that determines the deductibility of an activity’s losses.

Skeen v. Commissioner, 864 F.2d 93, 94 (9th Cir. 1989), affg.

Patin v. Commissioner, 88 T.C. 1086 (1987); Dreicer v.

Commissioner, 78 T.C. 642, 645 (1982), affd. without opinion 702

F.2d 1205 (D.C. Cir. 1983). While the taxpayer’s subjective

intent is the test, objective criteria are used to establish that

intent, including those listed in section 1.183-2, Income Tax

Regs. Skeen v. Commissioner, supra at 94. A taxpayer’s

expectation of profit need not be reasonable, but the objective

facts and circumstances must indicate that the taxpayer entered

into or continued the activity with the actual and honest purpose

of making a profit. Dreicer v. Commissioner, supra at 645. “The

16
Sec. 183 does not restrict deductions that are allowable
without regard to whether the activity is engaged in for profit.
Sec. 183(b)(1). Where deductions are allowable under sec.
183(b)(1), deductions under sec. 183(b)(2) are limited to the
amount by which gross income derived from the activity exceeds
deductions allowable under sec. 183(b)(1). No sec. 183(b)(1)
expenses are at issue in these cases. However, it appears that
respondent’s determinations for 2002 and 2003 failed to allow
expenses to the extent of horse-activity income, as provided in
sec. 183(b)(2). We expect the parties to address this issue in
their Rule 155 computations.
 - 15 -

burden of proving the requisite profit motive is on the

taxpayer.” Skeen v. Commissioner, supra at 94.17

Further, “the goal must be to realize a profit on the entire

operation, which presupposes not only future net earnings but

also sufficient net earnings to recoup the losses which have

meanwhile been sustained in intervening years.” Bessenyey v.

Commissioner, 45 T.C. 261, 274 (1965); see also Golanty v.

Commissioner, supra at 427. Evidence from years subsequent to

the years at issue is relevant to the extent it creates

inferences regarding the requisite profit motive in earlier

years. Hillman v. Commissioner, T.C. Memo. 1999-255; Hoyle v.

Commissioner, T.C. Memo. 1994-592; Smith v. Commissioner, T.C.

Memo. 1993-140.

As noted, 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. No single factor

is determinative. These factors are: (1) The manner in which

17
In their reply brief petitioners argue for the first time
that respondent has the burden of proof pursuant to sec. 7491(a).
Ordinarily, we do not consider issues raised for the first time
in a party’s reply brief. See Cordes v. Commissioner, T.C. Memo.
2002-124; see also Kansky v. Commissioner, T.C. Memo. 2007-40.
In any event, our resolution of this issue is based on the
preponderance of the evidence rather than the allocation of the
burden of proof, so we do not consider petitioners’ claim. See
Blodgett v. Commissioner, 394 F.3d 1030, 1039 (8th Cir. 2005),
affg. T.C. Memo. 2003-212; see also Estate of Jorgensen v.
Commissioner, 431 Fed. Appx. 544, 546-547 (9th Cir. 2011), affg.
T.C. Memo. 2009-66.
 - 16 -

the taxpayer carries 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

dissimilar 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) whether elements of personal pleasure or

recreation are involved. Sec. 1.183-2(b), Income Tax Regs.

Petitioners argue that they operated the horse activity with

the principal purpose and intent of realizing a profit.

Respondent contends that the manner in which petitioners operated

the horse activity, and its history of consistent, substantial

losses, show that petitioners lacked the requisite profit motive.

We shall evaluate the evidence of profit motive with reference to

the factors enumerated in the regulations.

Manner of Carrying On the Activity

The fact that a taxpayer carries on an activity in a

businesslike manner and maintains complete and accurate books and

records may indicate a profit motive. Sec. 1.183-2(b)(1), Income

Tax Regs. Characteristics of a businesslike operation include

the preparation of a business plan and, in the case of horse

breeding and sales, a consistent and concentrated advertising
 - 17 -

program. See Golanty v. Commissioner, supra at 431; Keating v.

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

2008); Dodge v. Commissioner, T.C. Memo. 1998-89, affd. without

published opinion 188 F.3d 507 (6th Cir. 1999). The regulations

further provide that a profit motive is indicated when a taxpayer

changes operating methods or adopts new techniques with an intent

to improve profitability. Sec. 1.183-2(b)(1), Income Tax Regs.

In petitioners’ view, the decision to acquire an equine

facility represents both a business plan and a change in

operating method to improve profitability, as contemplated in

section 1.183-2(b)(1), Income Tax Regs. Petitioners liken their

circumstances to those in Engdahl v. Commissioner, 72 T.C. 659

(1979), in which we found an intent to profit (notwithstanding 12

years of sustained losses) where the horse-breeding taxpayers

likewise had commenced the activity by boarding their horses with

others and only later acquired their own equine facility.

Engdahl is readily distinguishable, however, in a manner that

lies at the crux of this case.

The Engdahls were advised after approximately 2 years of

operation that they needed their own ranch on which to board

their horses in order to make their operation profitable. Id. at

661. After a 1-year search, the Engdahls acquired a ranch and

thereafter conducted their horse activities there. Id.
 - 18 -

By contrast, petitioners did not proceed at any reasonable

pace to acquire a facility, notwithstanding hemorrhaging losses.

In 1999 petitioners concluded that the horse activity could be

profitable only if they acquired a facility where they could

board their horses and generate income by providing boarding and

training services to others. Although the need for their own

facility was apparent in 1999, petitioners did not begin

searching for one until 2001 (after their 1999 return had been

examined) and did not acquire land for one until 2005, on which

they commenced construction in 2006. Meanwhile, their very

substantial losses from the horse activity continued unabated.

Their losses were $33,152 in 2000 and rose steadily, from over

$82,000 in 2002 to almost $100,000 in 2005.

Moreover, petitioners continued to acquire horses in the

years after 1999, even though they had not acquired a facility.

Petitioners increased their stock from 2 horses in 1999 to 10

horses in 2005 when they finally acquired land for a facility.

We believe that an actual and honest profit motive would have

dictated curtailment, not expansion, of petitioners’ horse

population while they sought their own facility. At the time of

trial, approximately 12 years into their horse activity,

petitioners were still paying to board 5 of their 13 horses on

the east coast, even though their California horses were being

kept at the facility.
 - 19 -

While a reasonable search period might be countenanced,

petitioners’ failure even to start the search for over a year,

and their continued acquisition of horses with no facility in

sight, all while incurring very substantial annual losses,

suggests an indifference to those losses that we are unable to

reconcile with an “actual and honest objective of making a

profit”. Dreicer v. Commissioner, 78 T.C. at 645. We find the

inconsistencies in petitioners’ business plan, and their failure

to adhere to it, the most significant points concerning whether

they conducted the horse activity in a businesslike manner.

Petitioners’ advertising was also unbusinesslike. Although

petitioners placed occasional advertisements in national and

regional equine publications, a method indicative of businesslike

operation, petitioners’ advertising efforts were insubstantial

compared to the cost of the horse activity and generally declined

over the years at issue despite petitioners’ lack of sales. See

Golanty v. Commissioner, 72 T.C. at 431. For 2004, for example,

petitioners reported a $90,290 loss from the horse activity and

only $170 in advertising expenses. Petitioners’ other

promotional efforts, including Dr. Bronson’s involvement in

breeders’ organizations and participation in horse shows, are as

consistent with a hobby as with a for-profit business.

Finally, petitioners claim that their recordkeeping

indicates a profit motive because they “always recorded every
 - 20 -

business-related expenditure individually, and have assiduously

separated business-related from non-business components of even

$5 and $10 expenditures.” A close examination of their records

reveals a different picture. For more than three-quarters of the

expenditures that had mixed horse activity and personal

components, petitioners simply allocated exactly 80 percent of

the expenditure to the horse activity, suggesting that their

segregation of nondeductible personal expenditures was, at best,

approximate. We also note that the depreciation schedule

attached to petitioners’ 2002 return lists a dog among the

depreciated items, and petitioners deducted $1,144 of Schedule C

expenses relating to the dog in that year. In short,

petitioners’ recordkeeping was not businesslike; personal

expenditures were not meticulously segregated as petitioners

claim.

In any event, we have recognized that the significance of

the business records factor lies in the use of such records for

determining profitability and analyzing expenses, not merely to

memorialize transactions for tax reporting purposes. Keating v.

Commissioner, T.C. Memo. 2007-309; Dodge v. Commissioner, supra.

Maintenance of records generally does not indicate profit motive

when there is a lack of evidence that the taxpayer used the

records to improve the performance of a losing operation.

Golanty v. Commissioner, supra at 430; Sullivan v. Commissioner,
 - 21 -

T.C. Memo. 1998-367, affd. without published opinion 202 F.3d 264

(5th Cir. 1999). Petitioners’ records indicated to them in 1999

that the horse activity would not be profitable without their own

facility. As petitioners did not begin constructing a facility

until approximately 7 years later in 2006, the effective use to

which their records were put was minimal.

Petitioners’ recordkeeping fell short of businesslike in

another important respect. In the case of a horse breeding

activity, the maintenance of separate records for each animal’s

performance (e.g., breeding results and offspring’s performance)

is an important factor bearing on profit objective. See Dodge v.

Commissioner, T.C. Memo. 1998-89. Petitioners offered into

evidence only two “stock summaries”, one of which was obviously

prepared in 2004.18 Missing are any records from earlier or

later periods that would indicate petitioners were effectively

tracking their animals’ performance.19 Petitioners’ failure to

maintain more comprehensive breeding records suggests the absence

of a profit motive.

18
The entries regarding certain horses’ ages as compared to
their birth dates makes this conclusion possible.
19
Petitioners’ failure to introduce any such records gives
rise to the inference that no records were maintained or if
maintained were inadequate as breeding records. See Wichita
Terminal Elevator Co. v. Commissioner, 6 T.C. 1158 (1946), affd.
162 F.2d 513 (10th Cir. 1947).
 - 22 -

For the reasons detailed above, we conclude that petitioners

did not operate the horse activity in a businesslike manner.

This factor favors respondent.

Expertise of Petitioners and Their Advisers

Preparation for an activity by extensive study or

consultation with experts may indicate a profit motive when the

taxpayer carries on the activity as advised. Sec. 1.183-2(b)(2),

Income Tax Regs. When analyzing profit motive, expertise with

respect to the breeding of horses should be distinguished from

expertise in the economics of the business. Golanty v.

Commissioner, supra at 432; Sullivan v. Commissioner, supra.

Petitioners had no prior experience in breeding, training,

boarding, or selling horses when they first contemplated starting

the horse activity. However, Dr. Bronson consulted a number of

breeders regarding their operations and also had spent some time

in managing a large cooperative horse barn before 2001. She

became active in breeders’ organizations and became knowledgeable

about Welsh ponies and cobs.

Nonetheless, to the extent Dr. Bronson acquired expertise,

it was consistent with either a for-profit activity or a hobby.

We consequently conclude that this factor is insignificant in

determining whether petitioners had a profit motive.
 - 23 -

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 motive. Sec. 1.183-2(b)(3),

Income Tax Regs.

Dr. Bronson was not employed during the years at issue and

devoted a significant amount of time to the horse activity.

However, as discussed infra, much of her time was spent on

activities that involved substantial personal and recreational

aspects. Accordingly, we find this factor to be neutral.

Expectation That Assets May Appreciate

An expectation that assets used in the activity will

appreciate may indicate a profit motive even if the taxpayers

derive no profit from current operations. Sec. 1.183-2(b)(4),

Income Tax Regs. The appreciation of the activity’s assets must

exceed operating expenses and be sufficient to recoup the

accumulated losses of prior years. See Hillman v. Commissioner,

T.C. Memo. 1999-255.

At the time of trial, the assets of the horse activity

consisted of 13 horses and land in northern California with an

incomplete equine facility. Petitioners offered no evidence

regarding the value of their land or its potential for

appreciation. Petitioners sold two horses in 2007 for $6,500 and
 - 24 -

$10,000. Insofar as the record discloses, the top price

petitioners can hope to obtain for a Welsh pony is between

$10,000 and $15,000. However, even if one were to assume that

each of petitioners’ horses was worth $15,000 (a proposition not

supported by the record), the appreciation in the horses would

recoup no more than a fraction of the $837,752 in cumulative

losses petitioners reported through 2008. This factor favors

respondent.

Success in Similar or Dissimilar Activities

A taxpayer’s past success in similar or dissimilar

activities is relevant in determining profit motive. Hillman v.

Commissioner, supra; sec. 1.183-2(b)(5), Income Tax Regs. As

noted, petitioners had no previous experience with horses. While

Dr. Bronson did some work in real estate, there is no evidence

concerning the extent of her success in that endeavor. Mr.

Bronson had a successful law practice, but his involvement in the

horse activity was minimal as compared to Dr. Bronson’s.

Accordingly, this factor is neutral.

The Activity’s History of Income and Losses

While a series of losses during the initial or startup stage

of an activity may not necessarily indicate a lack of profit

objective, a record of large losses over many years and the

unlikelihood of achieving profitability are persuasive evidence

that a taxpayer did not have such an objective. See Golanty v.
 - 25 -

Commissioner, 72 T.C. at 426; Bessenyey v. Commissioner, 45 T.C.

at 274; sec. 1.183-2(b)(6), Income Tax Regs. However, losses

sustained because of unforeseen or fortuitous circumstances

beyond the taxpayer’s control do not indicate a lack of profit

motive. Sec. 1.183-2(b)(6), Income Tax Regs.

In addition, substantial receipts and significant reduction

of losses can be indicative of profit motive even if

profitability is not ultimately achieved. See Blackwell v.

Commissioner, T.C. Memo. 2011-188; Rinehart v. Commissioner, T.C.

Memo. 2002-9.

Petitioners argue their history of losses occurred during

the startup stage of the activity and were caused by unforeseen

difficulty they had acquiring property and constructing a

facility. We disagree. The regulations list drought, disease,

fire, theft, weather damage, and depressed market conditions as

examples of fortuitous loss-causing circumstances that do not

indicate a lack of profit motive. Sec. 1.183-2(b)(6), Income Tax

Regs. We have also recognized that the death or sickness of

horses in connection with a breeding operation constitutes the

kind of fortuitous circumstance contemplated in the regulations.

See Engdahl v. Commissioner, 72 T.C. at 669.

Petitioners’ failure to locate and acquire property for a

horse facility for 6 years was not attributable to fortuitous

circumstances beyond their control. Petitioners did not start
 - 26 -

the search for a facility until more than a year after the time

they claim they realized a facility was essential. They then

searched only narrowly in Ventura County. They made offers on

only two properties in the first 4 years of their search. Once

petitioners expanded their search to northern California, they

found and purchased property in a matter of months.

On the basis of the entirety of the evidence, including the

size of the annual losses, the continued acquisition of horses

before acquiring a facility, and the narrowness of the initial

search, we conclude that the 6-year delay in acquiring land for a

facility does not constitute a startup period that became

protracted on account of fortuitous circumstances but instead was

attributable to the fact that making a profit was not

petitioners’ priority. Petitioners’ desultory search for an

equine facility persuades us that making a profit was not their

“primary” objective in conducting the horse activity. See Wolf

v. Commissioner, 4 F.3d at 713; Golanty v. Commissioner, supra at

425.

Further, petitioners’ losses are not attributable to any

difficulty they encountered constructing a facility. When

construction began in 2006, petitioners had already reported 8

years of losses totaling $518,528 from the horse activity.

Finally, when one examines the loss history for the 3 years

beyond the years at issue (i.e., 2006-2008 or the 9th, 10th, and
 - 27 -

11th years of operation), it is apparent that petitioners’ losses

were not abating but increasing, even after the period generally

considered to constitute a startup period for horse breeding

activities; namely, 5 to 10 years. See Engdahl v. Commissioner,

supra at 669; Miller v. Commissioner, T.C. Memo. 2008-224.

Overall, in view of the foregoing factors, we are not persuaded

that petitioners’ loss history is attributable to their being in

a startup phase. Instead, we are persuaded that to the extent

they conducted any breeding, it was not for commercial purposes.

Because we find that petitioners’ lengthy period of

substantial losses is not attributable to fortuitous

circumstances or their being in the startup phase of an activity,

their loss history tends to indicate a lack of profit motive.

Amount of Occasional Profits

The amount of profits in relation to the amount of losses

incurred may provide useful criteria in determining the

taxpayer’s intent. Sec. 1.183-2(b)(7), Income Tax Regs.

Petitioners have never earned a profit from their horse activity

and the evidence suggests future profits are unlikely. This

factor favors respondent.

Petitioners’ 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 was not
 - 28 -

engaged in for profit, especially if there are personal or

recreational elements involved. Sec. 1.183-2(b)(8), Income Tax

Regs. During the years at issue, Mr. Bronson’s average annual

income from his law practice was $269,200. Deducting the losses

generated by the horse activity from Mr. Bronson’s income greatly

reduced the after-tax cost of the activity to petitioners. This

factor favors respondent.

Personal Pleasure or Recreation

The existence of recreational elements or personal motives

with respect to an activity may indicate a lack of profit motive.

Sec. 1.183-2(b)(9), Income Tax Regs. Conversely, profit motive

may be indicated where an activity lacks any appeal other than

profit. Id.

Dr. Bronson was obviously a Welsh pony and cob enthusiast,

given her extensive involvement in breeders’ organizations, the

showing of horses, and column writing. While, as petitioners

urge, such endeavors could be construed as promotional for the

Coldstream Farm “brand”, we find that they are equally consistent

with an avid hobby. Moreover, because petitioners’ horses were

all boarded during the years at issue, they essentially avoided

the unpleasant tasks associated with caring for horses, such as

cleaning stalls, regular exercising, and the like. Cf. Sullivan

v. Commissioner, T.C. Memo. 1998-367 (no profit motive in horse

breeding activity even where taxpayers personally cared for most
 - 29 -

of their horses). In addition, petitioners’ daughters rode some

of the horses recreationally. See Keating v. Commissioner, T.C.

Memo. 2007-309. On balance, this factor is neutral.

Conclusion

Taking into account all the objective facts and

circumstances and the regulatory factors most relevant, we

conclude that petitioners lacked the requisite “actual and honest

objective of making a profit” with respect to their horse

activity. They took inordinate time to acquire an equine

facility even though they concluded in the second year of the

activity that such a facility was indispensable to profitability.

Their complacency in this regard given the size of their annual

losses strongly suggests a lack of profit motive. They also

continued to acquire horses without having made any progress

toward acquiring a facility, when an honest profit objective

would have dictated curtailment or cessation of the activity

until the means for conducting it profitably had been acquired.

Their continued acquisitions after 1999 suggest that the horses

were acquired in pursuit of a hobby interest. Moreover, almost

half of petitioners’ horses were kept on the east coast. Those

horses had not been moved to petitioners’ equine facility at the

time of trial, even though their California horses were kept

there.
 - 30 -

There is scant evidence that petitioners conducted a

breeding operation in a businesslike manner; they did not keep

records of individual horses’ performance or breeding history.

Even allowing for the most optimistic assumptions about their

horses’ value, petitioners could not have gotten anywhere near

recouping their losses after 11 years of operation and yet were

persisting in their pursuit at the time of trial.20 See

Bessenyey v. Commissioner, 45 T.C. at 274.

Dr. Bronson’s extensive involvement in various Welsh horse

organizations indicates that the motivation behind the horse

activity may have been personal rather than business. Given Mr.

Bronson’s law practice income, claiming the horse activity as a

business substantially reduced the after-tax cost of what would

otherwise be a very expensive hobby.

On brief, petitioners contend that they would not have

uprooted their family and Mr. Bronson’s law practice and moved

450 miles to Nevada County, California, for a mere hobby, arguing

instead that these very significant changes demonstrate that they

were in bona fide pursuit of an equine business. We are not

persuaded. In her testimony, Dr. Bronson recounted how she had

become aware of Nevada County through the experience of friends

who had moved there “because of their horses, their interest,

20
By contrast, the taxpayers in Engdahl v. Commissioner, 72
T.C. 659 (1979), had decided at the time of trial to abandon
their horse activity.
 - 31 -

that they were really enthusiasts, not bona fide breeders.”

Consequently, a move to Nevada County could have been motivated

by the fact that it was a more hospitable place for a horse

enthusiast to live. Moreover, although he experienced some

disruption, Mr. Bronson’s law practice proved essentially

portable,21 making the move to Nevada County much less draconian

than petitioners urge.

Given the objective factors summarized above suggesting a

lack of profit motive, petitioners’ move to Nevada County

appears, like their friends’ move, to have been motived by their

interest in horses rather than an actual and honest intent to

make a profit. The preponderance of the evidence points to that

conclusion, and we draw it. Consequently, we conclude and hold

that the horse activity was “not engaged in for profit” within

the meaning of section 183 during the years at issue.

II. Accuracy-Related Penalties

Section 6662(a) and (b)(2) imposes a penalty of 20 percent

of the underpayment attributable to a substantial understatement

of income tax. An “understatement” is the excess of the amount

of tax required to be shown on the return over the amount of tax

shown on the return. Sec. 6662(d)(2)(A). An understatement is

21
The relocation of Mr. Bronson’s practice to the Sacramento
area produced 2 meager years in 2006 and 2007, but his net income
in 2008 ($327,567) exceeded that of most of the years he was
practicing in the Los Angeles area.
 - 32 -

substantial when it exceeds the greater of 10 percent of the tax

required to be shown on the return or $5,000. Sec.

6662(d)(1)(A).

The Commissioner bears the burden of production with respect

to a taxpayer’s liability for penalties. Sec. 7491(c). To

satisfy that burden, the Commissioner must offer sufficient

evidence to indicate that it is appropriate to impose the

penalty. See Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

If the Commissioner satisfies his burden of production, the

taxpayer bears the burden of proving it is inappropriate to

impose the penalty because of reasonable cause, substantial

authority, or a similar provision. Id.

Respondent determined that petitioners substantially

understated their income tax for 2004 and 2005 and are liable for

accuracy-related penalties for these years.22 Petitioners’

disallowed deductions for expenses related to the horse activity,

coupled with other adjustments not at issue, resulted in income

tax understatements of $32,664 for 2004 and $34,033 for 2005.

These amounts exceed both 10 percent of the tax required to be

shown on petitioners’ returns for those years and $5,000. Thus,

respondent has met his burden of production.

22
In his answering brief respondent also asserts negligence
as a basis for the penalties. We need not address negligence
because we sustain the penalties on the basis of substantial
understatement of income tax.
 - 33 -

The section 6662(a) penalty is not imposed on any portion of

an underpayment as to which the taxpayer acted with reasonable

cause and in good faith. Sec. 6664(c)(1). The determination of

whether a taxpayer acted with reasonable cause and good faith is

made on a case-by-case basis, taking into account all pertinent

facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs.

Generally, the taxpayer’s effort to assess the proper tax

liability is the most important factor. Id. The taxpayer’s

experience, knowledge, and education are also important factors.

Id.

Petitioners argue they are not liable for section 6662(a)

penalties because they relied on the advice of their accountant,

to whom they supplied complete and accurate records. Reasonable

reliance upon the advice of a tax professional may establish

reasonable cause and good faith for the purpose of avoiding

section 6662(a) penalties. Sec. 1.6664-4(c), Income Tax Regs.;

see also Neonatology Associates, P.A. v. Commissioner, 115 T.C.

43, 99 (2000), affd. 299 F.3d 221 (3d Cir. 2002). The

professional advice “must be based upon all pertinent facts and

circumstances and the law as it relates to those facts and

circumstances.” Sec. 1.6664-4(c)(1)(i), Income Tax Regs.

The problem with petitioners’ argument is that there is no

evidence that they ever sought or received advice from their

accountant concerning the appropriateness of deducting the
 - 34 -

expenses of their horse activity. Petitioners’ accountant

testified only that he found their records complete and adequate

for purposes of preparing their returns. There is no evidence

that he provided an opinion regarding the applicability of

section 183 or that petitioners disclosed to him all the

pertinent facts and circumstances concerning the horse activity

including, for example, their conclusion in 1999 that the

activity could not be profitable without an equine facility.

By their own admission, petitioners were on notice no later

than 2001 that their tax reporting of the horse activity had

attracted the scrutiny of the Internal Revenue Service, which

concluded an examination of their 1999 return in that year albeit

without making adjustments.23 In these circumstances, including

23
In their pretrial memorandum petitioners contend that the
“no change” audit of their 1999 return “indicated that
Petitioners were conducting Coldstream’s start-up business
operations in compliance with applicable legal requirements”.
However, they made no reference to the 1999 audit at trial or in
their opening or reply brief. Thus, to the extent petitioners
may have argued in their pretrial memorandum that the 1999 audit
gave them reasonable cause with respect to the 2004 and 2005
underpayments attributable to the disallowed losses from the
horse activity, they have abandoned that argument. See Rule
151(e)(4) and (5); Cluck v. Commissioner, 105 T.C. 324, 325 n.1
(1995); Petzoldt v. Commissioner, 92 T.C. 661, 683 (1989); Rybak
v. Commissioner, 91 T.C. 524, 566 n.19 (1988).
Even if petitioners were treated as having preserved the
argument that the “no change” audit of their 1999 return
constituted reasonable cause with respect to the underpayments at
issue, see, e.g., Bangs v. Commissioner, T.C. Memo. 2006-83, we
are not persuaded. We conclude that the examining agent’s
decision to make no adjustments regarding petitioners’ horse
activity for 1999 does not give rise to a reasonable belief that
(continued...)
 - 35 -

Mr. Bronson’s education and knowledge as an attorney, we conclude

that petitioners failed to show that they reasonably relied on

professional advice or that they otherwise made a reasonable

effort to assess their proper tax liabilities. Given the absence

of reasonable cause, we sustain respondent’s determination of

accuracy-related penalties for 2004 and 2005.

To reflect the foregoing,

Decisions will be entered

under Rule 155.

23
(...continued)
the activity was not limited by sec. 183 5 or 6 years later.
When petitioners took their return position for 2004, they had
experienced 5 additional years of losses from the activity that
rose from $33,152 for 2000 to $90,290 for 2004. Moreover, they
had conducted the activity for 5 years without having acquired an
equine facility, which by their own admission they had concluded
in 1999 was essential to profitability. In short, what may have
easily passed muster as the startup phase of a horse breeding
operation for 1999 ceased to do so after 5 additional years of
substantial losses during which petitioners failed to take the
steps they realized were necessary to make the operation
profitable. See Burrus v. Commissioner, T.C. Memo. 2003-285 (6
years of initial losses treated as startup phase of cattle
breeding operation but Court expressed no opinion regarding
whether sec. 183 would limit losses claimed for next 4 years
after the years in issue). The foregoing applies with greater
force to 2005, although petitioners had by then acquired land on
which to construct an equine facility.