T.C. Mem o. 2 01 3- 29 4

UNITED STAT ES TAX COURT
TRAVIS A. MATHIS AND BETTINA C. JARY-MATHIS, Pe ti ti on ers v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No s. 2 17 04 -1 0, 2 45 96 -1 1. Fil edDecem be r 30 , 20 13
.
Ja m es Fred eri ckMart en s, Kel li H. Todd , andJef frey S. T ay lo r, fo r pe ti ti on ers . Ro be rtaL. Shu m

way an d B ry anJ. Do ts on , forres po nd en t.

MEMORANDUM FINDINGS OF FACT AND OPINION GOEKE, Ju dg e: Pet it io ne rs own eda cu tt in g h or se farm inFlo ren ce, Tex as . The y co nt in ue d t o o pe rat e th e farm de sp it e su st ai ni ng si gn ifi can t l os se s fo r eac h o f th e 1 3 years o f it s ex is te nc e. Res po nd en t au di te d p et it io ne rs ’ Fo rm s 1 04 0, U.S.-2
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[* 2] In di vi du al Inc om e Tax Return, fo r th e y ears 20 06 to 20 08 . Res po nd en t de te rm in edpe ti ti on ers were n otop erat in g the farm forpro fit . Con se qu en tl y , th ey is su eda no ti ce o f de fic ie nc y de nyin g t he rel at edde du ct io ns an d d et erm in in g a de fic ie nc y

foreach of t ho se y ears . Res po nd en t al so im po se d a ccu racy-rela te d pe na lt ie s as so ci at edwith t he res ul ti ng de fic ie nc ie s. Th e is su es forde ci si on are: (1 ) whe th er p et it io ne rs en ga ge d i n t he ir c ut ti ng ho rs e act iv ity fro m 20 06 to 20 08 forpro fitwithi n the m ean in g o f se ct io n 1 83 (a). W e h ol d tha t the y di d n ot ; 1
an d (2 ) whe th er p et it io ne rs are l iabl e fo r acc ur acy-rela te d p en al ti es un de r se ct io n 6 66 2( a) fo r 20 06 , 20 07 , and20 08 . W e h ol d t ha t the y are n ot . FINDINGS OF FACT I. Pet it io ne rs Pet it io ne rs res id edinTexa s wh enth ey fil edth e p et it io n. Bet ti naJary -Ma th is gre w up inso ut h Tex as an d s pe ntm uc h o f he r y ou th
as si st in g h er u nc le on a cat tl e ran ch . As a te en ag er s he de ve lo pe d apa ss io n fo r cu tt in g h or se s. Cu tt in g i s an eque st ria n e ve ntinwhi chjud ge s s co re a h or se an d rid er o n t he ir abi li ty to i so la te a co w or c al f fro m a he rd . Whe n M rs . Jary -Ma th is Unl es s o th erwi se in di cat ed , all sec ti on refe ren ces are t o t he Int ern al 1 Rev enue Co de ineffe ctforth e y ears at i ss ue , andall Ru le refe ren ces are t o t he Tax Co urt Ru le s o f Prac ti ce an d P ro cedur e.-3
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[* 3] was inhi gh sch oo l, h er fa th er, wh o was anarch it ect , des ig ne d aho us e o n a cu tt in g h or se farm

foron e o f hi s cl ie nt s. Whil e h er fath er wo rk edon th e h ou se , Mrs . Jary -Ma th is ho ve redaro un d t he ba rnan d l earn edall sh e co ul d abo utcu tt in g ho rs es . In19 92 Mrs . Jary -Ma th is m arri edTrav is Mathi s. Mr . Mathi s co m es fro m a weal th y fam il y --h is gra nd fathe r co -fo un de d B ro wn & Ro ot , a lu crat iv e en gi ne eri ng an d c on st ru ct io n c om pa ny. Pet it io ne rs earn m il li on s o f do ll ars in in ve st m en t i nc om e ev ery y ear. II. La Bri saFarm In19 95 pe ti ti on ers pu rch as edpro pe rty in F lo ren ce, Tex as , andst art edLa Bri saFarm

to tra in cu tt in g h or se s. Fro m 19 95 un ti l 2 00 0 M rs . Jary -Ma th is
m an ag edth e farm

pri m ari ly as a tr ai ni ng op erat io n. Sh e b redhe r m ares to hi gh
qu al ity st al li on s t o p ro du ce h or se s capabl e o f co m pe ti ng inth e p rem ie r cu tt in g ev en ts . She em

pl oyed ac co m

pl is he d o ns it e tr ai ne rs to de ve lo p h er y ou ng ho rs es ’ ta le nt , bu t the pri ze m on ey sh e earne d d idno t co ve r th e expe ns es sh e in cu rred
. Sh e al so fou ndret ai ni ng qu al ifi edtra in ers di ffi cu lt , bec au se th e b es t trai ne rs wan te d t o d em on strat e th ei r sk il ls on ho rs es fro m m an y di ffer en t farm s. Afte r su st ai ni ng lo ss es ineach of t he fir stfiv e y ears an d l os in g h er o ns it e tra in ers , Mrs . Jary -Ma th is de ci de d t o s hi ft t he farm ’s foc us to bre ed in g ra th er tha n-4
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[* 4] tra in in g. Sh e cre at eda writ te n b us in es s p la n, wh ic h s ta te d the op erat io n’s
ne w ob jecti ve : b reed in g c ut ti ng ho rs es with “ pr ov enan d d es irabl e b lo od li ne s” for whi ch“ cu st om ers wil l b e wil li ng to pa y a pr em iu m ”. A y ou ng cu tt in g h or se ’s val ue de pe nd s l arg el y on it s b lo od li ne s. Pu rch as ers ev al ua te a y ou ng ho rs e’s po te nt ia l o n the su cces s o f it s p aren ts . Hors es bo rnto pa ren ts th atha ve wonsi gn ifi can t cu tt in g c om pe ti ti on s o r ha ve pro du cedot he r win ne rs sel l fo r m or e th anth os e wit h l es s ac co m pl is he d p aren ts . To bu il d La Bri saFarm ’s rep ut at io n, M rs . Jary -Ma th is so ug htto de ve lo p apre mie r ba ndof br oo dm ares . She pu rch as edbro od m ares with s tro ng bl oo dl in es an d k ep t o nl y th os e th atpro du cedsu cces sf ul foa ls . She oft enso ldy ou ng ho rs es to to p- le ve l tra in ers ch eap ly, be cau se sh e kne w th os e tr ai ne rs co ul d wi n c om pe ti ti on s wi th th em . Tho se ho rs es ’ su cces s wo ul d i nc reas e th e v al ue of f utur e fo al s. By the en d of 20 07 La Bri saFarm

po ss es se d a n e xc ep ti on al bro od m are c ol le ct io n. III. Mr s. J ary-Math is ’ Ro le on th e Farm Pet it io ne rs hi redanon si te bre ed in g m an ag er t o p erfo rm da y -to -d ay act iv it ie s, b utMrs . Jary -Ma th is ov ers aw al l as pe ct s o f th e farm ’s op erat io ns an d
m ad e al l i m

po rta ntde ci si on s. Sh e typi cal ly w orke d 4 0 h ou rs pe r weekon farm act iv it ie s. Sh e sp en t m os t o f th atti m e res earc hi ng pe rfo rm an ce re co rd s an d id en ti fy in g s ta ll io ns to bre edwith h er m ares . Her workvo lu m e in crea se d t o 6 0-5
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[* 5] ho ur s p er weekdu rin g t he pre m ie r cu tt in g c om pe ti ti on s. Durin g c ut ti ng ev en ts sh e an d h er d au gh te r, Mar ia , sh owe d La B ris a Farm ’s ho rs es . Mrs . Jary -Ma th is freque nt ly atte nd edcu tt in g h or se seminar s an d a tt en de d
on e o n ra nc hi ng for

pro fit . She co nt in ua ll y

co ns ul te d wi th cu tt in g h or se tra in ers an d o th er o wne rs to im

pr ov e h er b reed in g o pe rat io n. Mr s. J ary-Math is als o c ho se th e farm ’s m ark et in g m etho ds . She pe rio di cal ly adv ert is edinpri ntan d o nl in e publ ic at io ns , bu t the farm di d n otha ve a W eb si te . She id en ti fie d b uyers fo r he r ho rs es pri m ari ly by

tal ki ng with o wne rs an d t rai ne rs at c ut ti ng ev en ts . Altho ug h M rs . Jary -Ma th is ge ne ral ly vis it edLa Bri saFarm no m or e th an on ce a wee k, s he reg ul arl y in te ract edwith h er h or se s. Mr s. J ary-Math is oft enke pt y ou ng foa ls on he r pe rs on al farm un ti l the y

were wean ed , so sh e co ul d wat chth em pl ay an d m on it orth ei r gr owt h. IV. Fin an ci al Rep orti ng Pet it io ne rs hi redDebo rahGorm anto ke ep th e farm ’s bo ok s an d t rackth ei r pe rs on al fin an ces . She us eda co m pu te r pr og ram

to ge ne rat e fi nanc ia l re po rts , whi chMrs . Jary -Ma th is rev ie wedat l eas t m on th ly. The fi nanc ia l s ta te m en ts in cl ud edpe ti ti on ers ’ pe rs on al it em s, b utth e farm it em s wer e cl earl y

id en ti fiabl e. Pet it io ne rs pro vi de d c om pl et e an d a ccu rat e fi nanc ia l re po rts to a cert ifi edpubl ic
acco un ta nt , who pre pa redth ei r an nu al returns . Peti ti on ers ha ve us edth e sa m e-6
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[* 6] acco un ti ng firm

th ro ug ho utth e farm’ s h is to ry , andth e sa m e in di vi du al ha s pr ep aredth ei r returns foreach y ear s in ce 1 99 9. V. La Bris a Farm

Fin an ci al Perfo rm an ce La Bri saFarm

ha s n ev er ea rn eda pr of

it . From 19 96 to 20 11 pe ti ti on ers rep orte d c um

ul at iv e lo ss es on th ei r Sch edul es F, Pro fitor Lo ss Fro m Farm in g, o f $9 ,15 2,7 18 . Peti ti on ers ’ la rg es t l os se s o ccu rredinth e th ree years a t i ss ue he re. Si nc e 2 00 8, p et it io ne rs ’ Sch edul e F l os se s h av e d ecre as edsubs ta nt ia ll y as ares ul t of lo wer rep orte d e xp en se s; pe ti ti on ers ’ rep orte d fa rm in g i nc om e h as no t in crea se d. Pe ti ti on ers rep orte d t he fol lo win g S ch edul e F n etlo ss es forth e y ears at is su e an d b ey on d: Year Los s 20 06 $8 68 ,81 8 20 07 1,1 02 ,81 6 20 08 1,3 60 ,18 4 20 09 37 2,1 74 20 10 18 0,9 46 20 11 25 5,9 36 On Dec em

be r 31 , 20 08 , La Bris a Farm own ed64 cutt in g h or se s, wh ic h pe ti ti on ers ’ ap pr ai se r va lu edat $ 1,2 52 ,50 0. Pe ti ti on ers have ne ve r so lda ho rs e fo r m or e th an$6 5,0 00 an d ty pi cal ly recei ve d m

uc h l es s.-7
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[* 7] OPINION I. Burd enof P ro of The tax pa y er g en eral ly bears th e b ur de n o f pr ov in g t he Co m m is si on er’s de te rm in at io ns are erro ne ou s. Ru le 14 2( a). The bu rd enof p ro of m ay sh iftto th e Co m m is si on er i f th e ta xp ay er s at is fie s ce rta inco nd it io ns . Sec. 7 49 1( a). Howe ve r, we de ci de th e se ct io n 1 83 is su e o n t he pre po nd eran ce o f th e ev id en ce an d, th eref or e, th e b ur de n o f pr oo f is no t re le va nt . See Est at e o f Bo ng ardv. Co m m is si on er, 1 24 T.C. 95 , 11 1 (2 00 5)
. II. Sect io n 1 83 Fo r-Pr of

itRequi rem en t Sect io n 1 83 li m it s the sec ti on 16 2 t rad e o r bu si ne ss ex pe ns e d educ ti on s a ta xp ay er m ay

cla im forex pe ns es att rib ut ab le to anact iv ity no t en ga ge d i n fo r pr of it . Taxp ay ers m ay

no t d educ t s uc h e xp en se s t o t he ex te ntth ey ex ceedin co m e ge ne rat edby the act iv ity

les s d educ ti on s at tri bu tabl e to th e act iv ity all owabl e witho utreg ardto whet he r th e ta xp ay er en ga ge d i n t he act iv ity forpro fit . Sec. 18 3( b)
. Tax pa y ers en ga ge inanact iv ity forpro fitwhen th ey

en te rta in anactua l an d ho ne stpro fitob

jecti ve inen ga gi ng inth e act iv ity . Dreic er v . Comm is si on er, 7 8 T.C. 64 2, 6 45 (19 82 ), aff’d wi th ou t o pi ni on , 70 2 F .2d12 05 (D.C. Cir . 19 83 ); s ec. 1.1 83 -2 (a), In co m e Tax Reg s. Whethe r th e requi si te pro fitob jecti ve ex is ts is-8
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[* 8] de te rm in edby loo ki ng at a ll th e su rro un di ng fact s an d c irc um st an ces . Kean in i v . Commis si on er, 9 4 T.C. 4 1, 4 6 (1 99 0) ; s ec. 1 .18 3- 2( b) , Inc om e Tax Reg s. We gi ve gre at er wei gh t t o o bjec ti ve fact s than t o atax pa y er’s m ere st at em en t o f in te nt . Tho m as v. Co m m is si on er, 8 4 T.C. 1 24 4, 1 26 9 (1 98 5) , aff’d, 79 2 F .2d12 56 (4th C ir. 1 98 6) ; s ec. 1 .18 3- 2( a), In co m e Tax Reg s. Ev id en ce fr om y ears aft er the y ears inis su e is rel ev an t t o t he ex te ntitcrea te s i nf eren ces reg ard in g th e ta xp ay er’s requi si te pro fitob jecti ve inearl ie r y ears . E.g., Fos te r v. Co m m is si on er, T.C. Mem o. 2 01 2- 20 7; Bro ns on v. Co m m is si on er, T.C. Mem o. 20 12 -1 7. Sect io n 1 .18 3- 2( b) , Inc om e Tax Reg s., p ro vi de s a l is t o f fac to rs to co ns id er in ev al ua ti ng a ta xp ay er’s p ro fitob jecti ve : (1 ) th e m an ne r in whi chth e ta xp ay er carr ie d o n the act iv ity ; (2 ) th e ex pe rti se of the tax pa y er o r hi s o r he r advi se rs ; (3 ) th e ti m e an d e ffo rt e xp en de d b y th e ta xp ay er i n c arrying on th e act iv ity ; (4 ) th e ex pe ct at io n tha t the ass et s u se d i n t he act iv ity m ay ap pr eci at e in va lu e; (5) th e su cces s o f th e ta xp ay er i n c arrying on ot he r si m il ar o r di ss im il ar ac ti vi ti es ; (6 ) th e ta xp ay er’s h is to ry

of i nc om e o r lo ss with re sp ectto th e act iv ity ; (7 ) th e am ou ntof
oc cas io na l p ro fit s ea rn ed , if an y ; (8 ) th e fi na nc ia l s ta tu s o f th e ta xp ay er; an d (9 ) whe th er el em en ts of p ers on al pl eas ur e o r rec reat io n a re i nv ol ve d. No si ng le fact or co nt ro ls . Gol an ty v. Comm is si on er, 7 2 T.C. 4 11 , 42 6 (1 97 9) , aff’d wit ho ut-9
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[* 9] publ is he d o pi ni on , 64 7 F .2d17 0 (9 th Cir . 19 81 ). Aftercare fu l co ns id erat io n of th es e fac to rs , we fin d t ha t p et it io ne rs di d n oten ga ge inth ei r cu tt in g h or se act iv ity with apro fitm ot iv e. W e p res en t o uran al y si s b el ow. A. Man ne r in Whi chth e Taxpa y er Ca rri es on th e Act iv ity The factth atth e ta xp ay er carri es on anact iv ity ina bu si ne ss li ke m an ne r an d
m ai nt ai ns co m

pl et e an d a ccurat e b oo ks an d re co rd s m ay in di cat e a p ro fitm ot iv e. Sec. 1 .18 3- 2( b) (1 ), In co m e Tax Reg s. Ch arac te ris ti cs of abu si ne ss li ke op erat io n in cl ud e th e p rep arat io n o f a b us in es s p la n a nd , inth e cas e o f ho rs e b reed in g a nd
sa le s, a c on si st en t an d c on cen tra te d a dv ert is in g p ro gr am . Bro ns on v. Co m m is si on er, T.C. Mem o. 2 01 2- 17 . The reg ul at io ns furth er p ro vi de th ata ta xp ay er’s ch an ge inop erat in g m etho ds or a do pt io n o f ne w tec hn ique s t o i m pr ov e pr of it ab il ity m ay in di cat e anov eral l p ro fitm ot iv e. Sec. 1 .18 3- 2( b) (1 ), In co m e Tax Reg s. Pet it io ne rs m ai nt ai ne d c om pl et e an d a ccurat e b oo ks forth ei r cu tt in g h or se act iv ity . Thei r bo okke ep er p rep aredfin an ci al rep orts , andMrs . Jary -Ma th is
rev ie wedth em

m on th ly. The re po rts pro vi de d M rs . Jary -Ma th is anaccu rat e acco un t o f th e farm ’s fin an ci al pe rfo rm an ce. Pet it io ne rs di d n otcrea te a bu si ne ss pl anwhen th ey st art edLa Bri saFarm

in 19 95 , bu t the y

di d wh enth e farm ’s foc us sh ift edto bre ed in g i n 2 00 0. Th e-1 0-

[* 10 ] bu si ne ss pl anin di cat es th atpe ti ti on ers pl anne d t o p ro m ot e th ei r ho rs es “ so effe ct iv el y

th atcu st om ers wil l b e wil li ng to pa y a pr em iu m ”. Pet it io ne rs ha ve m ai nt ai ne d aco ns is te ntadve rti si ng pro gr am . The farm freque nt ly dis pl ay s i ts ho rs es at s ho ws an d h as adve rti se d i n p rin t p ub li cat io ns an d o nl in e. Mrs . Jary Mat hi s al so m ark et edhe r ho rs es by talk in g wi thin du st ry in si de rs . Pet it io ne rs arg ue th atth e farm ’s sh iftinfoc us fro m tra in in g t o b reed in g rep res en ts a ch an ge inop erat in g m etho d t ha t i nd ic at es a pr of itm ot iv e. W e fi nd th atpe ti ti on ers ch an ge d t he ir f oc us no t t o i m

pr ov e p ro fit ab il ity

bu t b ecau se th ey co ul d n otke ep to p- le ve l trai ne rs . The b es t cu tt in g h or se tra in ers wantto de m on st rat e th ei r sk il ls by trai ni ng an d ri di ng ho rs es fro m a va rie ty of farm s. Bec au se th ey

co ul d n otke ep go odtra in ers at La B ris a Farm , pet it io ne rs de ci de d t o fo cu s o n b reed in g i ns te ad
. On b al an ce, thi s fa ct orfav or s p et it io ne rs . They m ai nt ai ne d c om pl et e an d
accu rat e rec or ds , creat eda bu si ne ss pl an , m ark et edth ei r ho rs es , andge ne ral ly ran th e farm ina pr of es si on al m an ne r. B. The Ex pe rti se of t he Taxp ay er o r Her Advi se rs The tax pa y er’s ex pe rti se , res earc h, an d e xt en si ve stud y of a n a ct iv ity , as well as h is or h er co ns ul ta ti onwith e xp ert s, m ay in di cat e a p ro fitm ot iv e. See s ec. 1.1 83 -2 (b )(2 ), In co m e Tax Reg s. Mr s. J ary-Math is gre w up aro un d ra nc hi ng an d-1 1-

[* 11 ] le arn edab ou t cu tt in g h or se s wh ensh e was inhi gh sch oo l. Whensh e b eg an he r own cu tt in g h or se op erat io n, s he ha d h el p fr om ex pe rie nc edtra in ers . Sin ce sh e st art edLa Bri saFarm , Mrs . Jary -Ma th is ha s fr eque nt ly dis cu ss edtra in in g a nd br eed in g s tra te gi es with p ro m in en t fi gu res inth e cu tt in g h or se in du st ry . She
co nt in ua ll y

pe rfo rm s o nl in e res earc h t o i de nt ify the be stho rs es inth e co un try, and sh e h as att en de d s em in ars to lea rnm or e ab ou t the cu tt in g h or se bu si ne ss . Mrs . Jary -Ma th is ha s d ev el op edexpe rti se inbre ed in g qua li ty cut ti ng ho rs es , bu t s he lac ks bu si ne ss ex pe rti se . Mrs . Jary -Ma th is att en de d aseminaron ran ch in g fo r pr of it , bu t tha t d oe s n otm ak e h er an ex pe rt. M or eo ve r, sh e at te nd edth e se m in ar l on g a fte r sh e st art edth e act iv ity . Peti ti on ers ’ fai lu re atth e o ut se t t o co ns ul t ex pe rts on th e fi na nc ia l as pe ct s o f runn in g acu tt in g h or se farm in di cat es th atth ey lac ke d apro fitm ot iv e. See B ur ge r v. C omm is si on er, 8 09 F.2d35 5, 3 59 (7 th Cir . 19 87 ), aff’g T.C. Me m o. 1 98 5- 52 3; Sm ith v . Comm is si on er, T.C. Mem o. 19 97 -5 03 , aff’d wit ho utpubl is he d o pi ni on , 18 2 F .3d92 7 (9 th Cir . 19 99 ). C. The Ti m e an d Eff

ort Ex pe nd edby the Taxp ay er i n C arrying On the Activ ity The tax pa y er’s d ev ot io n o f m uc h o f hi s o r he r pe rs on al ti m e an d e ffo rt t o carry in g o n a n a ct iv ity

m ay in di cat e a p ro fitm ot iv e, pa rti cu la rly if th e act iv ity-1 2-

[* 12 ] do es no t i nv ol ve subs ta nt ia l p ers on al or r ecre at io na l as pe ct s. Sec . 1.1 83
- 2( b) (3 ), In co m e Tax Reg s. Mrs . Jary -Ma th is de vo te s co ns id erab le ti m e an d e ffo rt t o La B ris a Farm . Sh e typi cal ly spe nd s 4 0 h ou rs a weekon th e cu tt in g h or se act iv ity an d 6 0 h ou rs a weekdu rin g t he to p c ut ti ng ev en ts . Alth ou gh Mrs . Jary -Ma th is work s h ard , her
work i nv ol ve s s ub st an ti al pe rs on al an d re crea ti on al asp ect s. Sh e works with
cu tt in g h or se s, wh ic h h av e b eenhe r pa ss io n s in ce s he was young . She sp en ds ti m e wit h h er d au gh te r atho rs e sh ows , andsh e d eri ve s a s en se of p ers on al pri de fro m own in g h ig h- qu al ity

cu tt in g h or se s. Onba la nc e, th is fact orweig hs in pe ti ti on ers ’ fav or , bu t the pe rs on al an d re crea ti on al asp ect s o f th e act iv ity li m itit s effe cton our ov eral l an al y si s. D. The Exp ect at io n Th atAss et s Us edinth e Act iv ity May App reci at e in V al ue An ex pe ct at io n t ha t as se ts us edinth e act iv ity wil l ap pr eci at e in va lu e m ay in di cat e a p ro fitm ot iv e ev enif the tax pa y er d eri ve s n o p ro fitfro m curren t op erat io ns . Sec. 1 .18 3- 2( b) (4 ), In co m e Tax Reg s. Ho wev er, we m ay in fer apro fit ob jecti ve fro m

su chex pe ct edap pr eci at io n o nl y when th e ap pr eci at io n e xc eed s op erat in g e xp en se s an d wo ul d b e su ffi ci en t t o re co up th e acc um ul at edlo ss es of-1 3-

[* 13 ] pr io r y ears . Fos te r v. C omm is si on er, T.C. Mem o. 2 01 2- 20 7; see Gol an ty v. Co m m is si on er, 7 2 T.C. at42 7- 42 8. Mrs . Jary -Ma th is tes ti fie d t ha t s he ex pe ct s h er h or se s t o app reci at e inva lu e as he r br oo dm ares pro du ce s uc ces sf ul foa ls . Howev er, p et it io ne rs ha ve fai le d t o pr es en t ev id en ce tha t the ap pr eci at io n wi ll reco up th e acc um ul at edlo ss es . Pet it io ne rs ha ve rep orte d o ve r $9 m il li on inlo ss es , andth e h ig he stpri ce the y ha ve ev er re cei ve d fo r a h or se is $6 5,0 00 . Peti ti on ers ’ ex pe rt app rai se d La B ris a Farm ’s
en ti re h or se in ve nt ory

at $ 1,2 52 ,50 0 a s o f Decem be r 31 , 20 08 . Any

ap pr eci at io n on pe ti ti on ers ’ ho rs es on ly min im al ly offs et s the ve ry lar ge lo ss es pe ti ti on ers ha ve su st ai ne d s in ce b eg in ni ng th ei r cu tt in g h or se act iv ity . Pet it io ne rs als o p ro vi de d s om e ev id en ce tha t the La Bri saFarm pro pe rty has in crea se d i n v al ue , bu t thi s d oe s n otin di cat e th atth ey ha d apro fitm ot iv e fo r th ei r cu tt in g h or se act iv ity . Peti ti on ers di d n otpu rch as e th e p ro pe rty for i nv es tm en t; th ey pu rch as editto bre edan d trai n c ut ti ng ho rs es . W e m us t ev al ua te an y

pro fit
m ot iv e p et it io ne rs ha d i n o pe rat in g t he farm sep arat el y

fro m an y pro fitm ot iv e th ey ha d i n p ur ch as in g t he lan d. Se e se c. 1.1 83 -1 (d )(1 ), In co m e Tax Reg s. (p ro vi di ng th atth e farmin g andho ld in g o f landwil l o rd in ari ly be co ns id ereda si ng le act iv ity on ly whe n t he tax pa y er en ga ge s i n t he farm in g a ct iv ity to off se t the carry in g c os ts of th e la nd ). Altho ug h the lan d’s ap pr eci at io n wo ul d b e rel ev an t t o p et it io ne rs ’-1 4-

[* 14 ] m ot iv e in ho ld in g t he lan d, i t i s n otrel ev an t t o t he ir m ot iv e in op erat in g t he
cu tt in g h or se farm . Evenif the lan d’s ap pr eci at io n wer e rel ev an t t o p et it io ne rs ’ pr of itm ot iv e in op erat in g t he cu tt in g h or se farm , th ey ha ve no t p res en te d
su ffi ci en t ev id en ce tha t the ap pr eci at io n o ffs et s the farm ’s subs ta nt ia l l os se s. Th e ev id en ce i n t he reco rdco nc ern in g app reci at io n i n the farm ’s ass et s fa il s t o pe rs ua de us th atfutur e p ro fit s m ot iv at edpe ti ti on ers to co nt in ue th e cu tt in g h or se act iv ity . E. The Su cces s o f th e Tax pa y er i n Othe r Si mil ar Act iv it ie s Sect io n 1 .18 3- 2( b) (5 ), In co m e Tax Reg s., p ro vi de s: “ The factth atth e ta xp ay er h as en ga ge d i n s im il ar ac ti vi ti es inth e p as t an d c on ve rte d t he m fro m unpr of it ab le to pro fit ab le en te rp ris es m ay in di cat e th athe is en ga ge d i n t he pre se nt act iv ity forpro fit , eve n t ho ug h t he act iv ity is pre se nt ly unp ro fit ab le .” Non e o f pe ti ti on ers ’ pa stact iv it ie s p ro vi de s ev id en ce o f a p ro fitm ot iv e h ere. F. Taxp ay er’s His to ry

of I nc om e o r Los se s A hi st ory of c on ti nu edlo ss es with re sp ectto anact iv ity m ay in di cat e th at th e ta xp ay er l ack eda pr of itm ot iv e. See s ec. 1 .18 3- 2( b) (6 ), In co m e Tax Reg s. Altho ug h aser ie s o f lo ss es du rin g t he in it ia l o r st artup st ag e o f anact iv ity m ay no t ne ces sa ril y

in di cat e a l ackof p ro fitm ot iv e, a rec or d o f larg e lo ss es ov er m an y-1 5-

[* 15 ] y ears is pe rs ua si ve ev id en ce tha t the tax pay er d idno t h av e su cha m ot iv e. Gol an ty v. Comm is si on er, 7 2 T.C. at42 6; Fo st er v . Comm is si on er, T.C. Mem o. 20 12 -2 07
. Pet it io ne rs real iz edno pro fit s fr om La Bri saFarm

in13 y ears . Peti ti on ers cl ai m th atth ey en ga ge d i n t wo s ep arat e act iv it ie s dur in g tha t p eri od : (1 ) tr ai ni ng fro m 19 95 to 20 00 an d (2 ) br eed in g fr om 20 00 to pre se nt . They arg ue th atth e br eed in g o pe rat io n re m ai ne d i n i ts st artup ph as e dur in g t he y ears at i ss ue , so th e lo ss es du rin g t ho se y ears do no t i nd ic at e th e ab se nc e o f a p ro fitm ot iv e. W e fi nd th atth e 2 00 0 c ha ng e was no t s ig ni fic an t en ou ghto co ns ti tu te th e st artof ane w act iv ity . Peti ti on ers ha ve bre d a ndtra in edho rs es onth ei r farm th ro ug ho utth e en ti re p eri od . They fo cu se d m or e o n b reed in g a fte r 20 00 an d m ov edth e tr ai ni ng op erat io n o ffs it e, bu t the se ch an ge s d o n otam ou ntto a ch an ge inact iv ity . Acco rd in gl y , we dec li ne to “ res etth e cl oc k” as o f 20 00 si m pl y be cau se pe ti ti on ers sh ift edth ei r fo cu s. Th e st artup pe rio d fo r pe ti ti on ers ’ cu tt in g h or se act iv ity pa ss ed be fo re re sp on de ntco nduc te d h is au di t, an d t he hi st ory of l os se s s tro ng ly ind ic at es pe ti ti on ers lac ke d apro fitm ot iv e. Pet it io ne rs rep orte d s m al le r Sch edul e F l os se s fo r th e y ears fol lo win g t ho se res po nd en t au di te d. Th ey cit e th e d im in is hi ng lo ss es as asi gn th atth e farm is
ne ari ng pro fit ab il ity . Howev er, the sm al le r ne t l os se s d idno t re su ltfro m in crea se d-1 6-

[* 16 ] sa le s, o nl y

fro m lo wer rep orte d e xp en se s. Pet it io ne rs rep orte d l owe r ex pe ns es on ly after t he y

rece iv edno ti ce o f th e au di t, wh ic h i nd ic at es th atth e au di t, n ota de si re t o e arnpro fit s, m ay ha ve tri gg eredth e reduc ti on s. Acco rd in gl y , we gi ve li tt le weig htto th e d ecl in e in ex pe ns es pe ti ti on ers rep orte d i n d et erm in in g whe th er the y

ha d apro fitm ot iv e. The curren t an d e xp ect edlo ss es of a n a ct iv ity sh ou ldno t b e o f su cha m ag ni tu de th atanov eral l p ro fitgo in g fo rwardwou ldno t b e p os si bl e. Bes se nyey v. Co m m is si on er, 4 5 T.C. 2 61 , 27 4 (1 96 5) , aff’d, 3 79 F.2d25 2 (2 d C ir. 1 96 7)
. Pet it io ne rs ha ve accu m

ul at edov er $ 9 m il li on inlo ss es fro m th ei r cu tt in g h or se act iv ity . It i s u nr eal is ti c to ex pe ctth atpe ti ti on ers wou ldno t co nt in ue to accu m ul at e si gn ifi can t l os se s. Th ey ha ve pre se nt edno co nv in ci ng ev id en ce tha t fu tu re p ro fit s co ul d p os si bl y off se t the se lo ss es . Accor di ng ly, th is fact or weig hs he av il y ag ai ns t fi nd in g apro fitm ot iv e. G. Am ou ntof Oc cas io na l Pr of it s The am ou ntof p ro fit s i n re la ti onto th e am ou ntof l os se s i nc urredm ay pr ov id e ev id en ce o f th e ta xp ay er’s i nt en t. Sec . 1.1 83 -2 (b )(7 ), In co m e Tax Reg s. Pet it io ne rs ha ve ne ve r earne d apro fitfro m th e cu tt in g h or se act iv ity , y etth ey co nt in ue to op erat e th e farm . This in di cat es th atth ey are ru nn in g t he farm

for pe rs on al rathe r th anbu si ne ss reas on s.-1 7-

[* 17 ] H. Taxp ay er’s Fi na nc ia l St atus Subs ta nt ia l i nc om e fro m

so ur ces ot he r th anth e act iv ity m ay in di cat e th atth e act iv ity is no t en ga ge d i n fo r pr of it . Sec. 1 .18 3- 2( b) (8 ), In co m e Tax Reg s. A ta xp ay er wi th subs ta nt ia l i nc om e unr el at edto th e act iv ity canm or e rea di ly affor d a h ob by. Fo st er v . Comm is si on er, T.C. Mem o. 2 01 2- 20 7. Th is is pa rti cu la rly tru e if t he lo ss es fro m

th e act iv ity

mig htge ne rat e subs ta nt ia l t ax be ne fit s. Go la nt y v. Co m m is si on er, 7 2 T.C. at42 9. Pe ti ti on ers ’ subs ta nt ia l i nv es tm en t i nc om e h as al lo wedth em

to co nt in ue th e cu tt in g h or se op erat io n d es pi te 17 co ns ecu ti ve y ears of subs ta nt ia l l os se s. Pet it io ne rs ’ cu tt in g h or se act iv ity als o g en erat edtax sav in gs in th e fo rm

of n etlo ss es th atoff

se t p et it io ne rs ’ in ve st m en t i nc om e. Thi s fa ct or weig hs ag ai ns t fi nd in g apro fitob jecti ve . I. Elem en ts of P ers on al Ple as ur e o r Rec reat io n The pre se nc e o f pe rs on al m ot iv es an d re crea ti on al ele m en ts incarry in g o n anact iv ity

m ay in di cat e th atth e act iv ity

is no t en ga ge d i n fo r pr of it . Sec. 1 .18 3- 2( b) (9 ), In co m e Tax Reg s. Mr s. J ary-Math is en joy s wo rk in g wi th ho rs es an d de riv es subs ta nt ia l p ers on al sat is fact io n fr om he r cu tt in g h or se op erat io n. Sh e en joy s wat ch in g t he y ou ng ho rs es an d o fte n b rin gs th em to he r pe rs on al farm

to watc h t he m

gro w. Howev er, ru nn in g alar ge -s cal e b reed in g o pe rat io n t ak es m an y-1 8-

[* 18 ] ho ur s o f ha rdwork , andMrs . Jary -Ma th is ha s s acri fic edfam il y an d p ers on al ti m e to pro m ot e h er h or se s. Th is fact orweig hs sl ig ht ly agai ns t a p ro fitm ot iv e. J. Co nc lu si on Afte r wei gh in g a ll th e fac ts an d c irc um st an ces inli gh t o f th e rel ev an t fact or s, we co nc lu de th atpe ti ti on ers di d n oten ga ge inth ei r cu tt in g h or se act iv ity with t he requi si te pro fitob jecti ve . Mrs . Jary -Ma th is is de te rm in edto be a su cces sf ul ho rs ewo m an . She want s t o b ui lda rep ut at io n a s a p ro du cer o f to p- le ve l
cu tt in g h or se s. Ho wev er, s he ha s p ur su edth is go al in de pe nd en tl y of any des ire to earn pro fit s. Sh e h as co nt in ue d t rai ni ng an d b reed in g c ut ti ng ho rs es for17 y ears witho utev er ap pr oa ch in g p ro fit ab il ity , y etsh e h as ne ve r se rio us ly con si de red di sc on ti nu in g o pe rat io ns . Accor di ng ly, we su st ai n re sp on de nt ’s det erm in at io n th atpe ti ti on ers di d n oten ga ge inth e cu tt in g h or se act iv ity forpro fit
. III. Accu racy-Rel at edPen al ti es Res po nd en t d et erm in edth atpe ti ti on ers were l iabl e fo r anaccu racy-rela te d pe na lty purs uantto sec ti on 66 62 (a) fo r eac h o f th e ta x years a t i ss ue . Sect io n 66 62 (a) and(b) (1 ) an d (2 ) im po se s a p en al ty of 20 % onan y un de rp aym en t at tri bu tabl e to , am on g o th er thi ng s, (1 ) ne gl ig en ce o r di sr eg ardof rul es or reg ul at io ns ; o r (2 ) an y

subs ta nt ia l u nd ers ta te m en t o f in co m e ta x. An
un de rs ta te m en t i s s ub st an ti al if i t ex ceed s the gre at er o f $5 ,00 0 o r 10 % of t he-1 9-

[* 19 ] in co m e ta x re qu ire d t o b e sh own on th e return fo r th e ta xabl e y ear. Se c. 66 62 (d )(1 )(A). The Co m m is si on er b ears th e b ur de n o f pr oduc ti on with re sp ectto th is pe na lty . Sec. 7 49 1© . The Co m m is si on er s at is fie s the bu rd enby pres en ti ng su ffi ci en t ev id en ce s up po rti ng th e rel ev an t p en al ty. Hig be e v . Commis si on er, 1 16 T.C. 43 8, 4 46 (20 01 ). Res po nd en t d et erm in edth atpe ti ti on ers un de rp ai d t he ir in co m e ta x b y

$3 20 ,92 7, $ 37 6,3 18 , and$4 91 ,57 1 fo r th e y ears 20 06 , 20 07 , and 20 08 , res pe ct iv el y . Thes e am ou nt s ex ceedth e “ subs ta nt ia l u nd ers ta te m en t” th res ho ldforeach y ear i n que st io n. Thus , res po nd en t h as carr ie d h is bu rd enof de m on st rat in g t ha t p et it io ne rs subs ta nt ia ll y un de rs ta te d the ir i nc om e ta x. Purs uantto sec ti on 66 64 (c)( 1) , th e acc ur acy-rela te d p en al ty und er s ect io n 66 62 do es no t ap pl y

to an y po rti on of a n u nd erp aym en t fo r whi cha ta xp ay er es tabl is he s tha t h e o r sh e: (1) ha d re as on ab le cau se , and(2) act edingo odfai th . A ta xp ay er’s fai lure t o c om pl y with s ect io n 1 83 do es no t p recl ud e a rea so nabl e cau se an d g oo d fa ith d efen se . See, e.g ., Rodrig ue z v . Comm is si on er, T.C. Mem o. 2 01 3- 22 1, at*5 7. Whethe r a t ax pa y er h as act edwith re as on ab le cau se an d i n g oo d fa ith de pe nd s o n t he fact s an d c irc um st an ces of t he cas e. Rel ev an t fa ct or s i nc lu de th e ta xp ay er’s eff

orts to ass es s the pro pe r ta x l iabi li ty, th e ta xp ay er’s kno wled ge an d-2 0-

[* 20 ] ex pe rie nc e, an d t he ex te ntto whi chth e ta xp ay er re li edon th e advi ce o f a t ax pr of es si on al . Sec. 1 .66 64 -4 (b )(1 ), In co m e Tax Reg s. Pet it io ne rs hi reda cert ifi edpubl ic acco un ta ntto pre pa re the ir r eturns . Bec au se th e return p rep arerha d s ig ne d a ll of t he ir r eturns si nc e 1 99 9, s he kn ew th e farm ’s fin an ci al hi st ory . Peti ti on ers subm it te d c om pl et e an d a ccu rat e b oo ks
an d re co rd s t o t he ir a cco un ta ntan d re li edon he r to pro pe rly prep are t he ir r eturns . Altho ug h we f

in d t ha t p et it io ne rs lac ke d apro fitm ot iv e, we ackno wled ge th at th ey op erat edth e farm

ina pr of es si on al m an ne r an d t oo k t he ir a ct iv ity ser io us ly. W e are pe rs ua de d t ha t p et it io ne rs ha d re as on ab le cau se an d a ct edingo odfai th
. Acco rd in gl y , we fin d the y are n otli ab le foraccu racy-rela te d p en al ti es . To re fle ctth e fo reg oi ng , Deci si on s wi ll be en te redfor
res po nd en t as to th e d efi ci en ci es an d fo r pe ti ti on ers as t o t he accu racy-rela te d pe na lt ie s u nd er s ect io n 6 66 2( a).