T.C. Memo. 1996-417

UNITED STATES TAX COURT

STEVEN F. AND KATHRYN A. DAWSON, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 9407-94. Filed September 17, 1996.

Steven F. Dawson and Kathryn A. Dawson, pro sese.

Timothy F. Salel, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

FOLEY, Judge: By notice dated March 7, 1994, respondent

determined the following deficiencies, additions, and penalty

with respect to petitioners' 1988 and 1989 Federal income tax:

 Additions To Tax Penalty 

Year Deficiency Sec. 6651(a)(1) Sec. 6653(a)(1) Sec. 6662(a)

1988 $14,921.60 $3,730.40 $746.08 --

1989 3,387.00 846.75 -- $451.20
- 2 -

1 The Activity refers to Mr. and Mrs. Dawson's horse

training and breeding activity in 1988 and Mr. Dawson's horse

training and breeding activity in 1989.

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

After concessions, the issue for decision is whether

petitioners are entitled to certain deductions relating to their

horse training and breeding activity (the Activity)1 for 1988 and

1989, and if petitioners are not entitled to deductions, whether

they are liable for additions to tax and a penalty. 

FINDINGS OF FACT

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

The Stipulation of Settled Issues is incorporated by this

reference. 

Petitioners resided in Riverside, California, when the

petition in this case was filed. Petitioners were divorced in

1989.

Petitioners have three children, Jeanette, Joshua, and Ann.

During the years in issue Steven F. Dawson was a full-time

employee of the Southern Pacific Railroad, where he worked the

graveyard shift (i.e., 11 p.m. to 7 a.m.) as a pipe fitter. He

also devoted about 20 hours a week to his carpet cleaning

business. Mrs. Dawson, who was a professional bookkeeper during
- 3 -

the years in issue, maintained the books and records for the

carpet cleaning business.

In 1982, Mr. Dawson purchased some Arabian horses for

training and breeding. After about 4 years, he sold the horses

because it became apparent to him that this endeavor would not be

profitable. 

In 1987, Mr. Dawson approached Mil Barton about the prospect

of entering into the business of breeding and training paint

horses. Mr. Barton had been actively involved in this business

for more than 40 years. He was a competition judge for the

American Quarter Horse Association for 26 years and for the

American Paint Horse Association for 20 years. Mr. Dawson, after

discussing the paint horse business with Mr. Barton, purchased

three paint horses. One was a stud colt named "Hot Twist". The

other two were brood mares named "Kate Dillon" and "Dynamic King

Bar". After the sale, Mr. Dawson continued to consult with Mr.

Barton on how to train and breed the horses.

Mr. Dawson, who was not qualified to train horses, hired Mr.

Barton in early 1988 to train Hot Twist. In 1988, Hot Twist was

entered and successful in several horse shows. From mid-1988

through 1989, Mike Van Leuven handled the training

responsibilities. Mrs. Dawson maintained books and records for

the Activity.
- 4 -

Mr. Dawson believed that Hot Twist, after being adequately

trained, could be entered into numerous national competitions

and, if successful in these competitions, could become a

profitable stud. Petitioners anticipated that the stud fee from

breeding Hot Twist with a single mare would be approximately

$1,000. Mr. Dawson also expected to obtain cash prizes from

competitions in which Hot Twist participated as well as revenue

from the sale of foals produced by breeding Hot Twist with

petitioners' two brood mares.

Petitioners filed their 1988 joint income tax return on

November 17, 1992, and Mr. Dawson filed his 1989 individual

income tax return on or about April 21, 1993. Petitioners have

conceded that the section 6651 addition to tax for failing to

file their return in a timely manner is applicable to their 1988

joint income tax return and to Mr. Dawson's 1989 individual

income tax return. On March 7, 1994, respondent issued a notice

of deficiency disallowing petitioners' claimed deductions

relating to the Activity and determining additions to tax and a

penalty. On June 6, 1994, petitioners filed their petition.

OPINION

Section 183 limits the deductions for an activity not

engaged in for profit. Sec. 183(b). An activity "not engaged in

for profit" is defined as any activity for which no deductions

are allowable under section 162 or under paragraph (1) or (2) of

section 212. Sec. 183(c). For purposes of section 183, a
- 5 -

taxpayer engages in an activity for profit if he entered into the

activity with the actual and honest objective of making a profit. 

Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), affd. without

published opinion 702 F.2d 1205 (D.C. Cir. 1983). The taxpayer's

expectation of profit need not be reasonable, but he or she must

have a good faith objective of making a profit. Allen v.

Commissioner, 72 T.C. 28, 33 (1979); sec. 1.183-2(a), Income Tax

Regs.

The determination of whether a taxpayer conducted the

activity for profit is made based on the facts and circumstances

of the case. Golanty v. Commissioner, 72 T.C. 411, 426 (1979),

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

Although the purpose of the inquiry is to ascertain the

taxpayer's subjective intent, greater weight is given to

objective facts than to the taxpayer's statements of intent. 

Beck v. Commissioner, 85 T.C. 557, 570 (1985); sec. 1.183-2(a),

Income Tax Regs. Petitioners bear the burden of proving they

intended to make a profit. Beck v. Commissioner, supra at 570.

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

nonexclusive list of nine factors designed to provide guidance to

courts in analyzing a taxpayer's profit objective. See

Independent Elec. Supply, Inc. v. Commissioner, 781 F.2d 724 (9th

Cir. 1986), affg. Lahr v. Commissioner, T.C. Memo. 1984-472;

Elliott v. Commissioner, 90 T.C. 960 (1988), affd. without

published opinion 899 F.2d 18 (9th Cir. 1990). No single factor
- 6 -

is dispositive. Golanty v. Commissioner, supra at 426. The nine

factors are: (1) The manner in which the taxpayer carries on the

activity; (2) the expertise of the taxpayer or his advisors; (3)

the time and effort expended by the taxpayer in carrying on the

activity; (4) the expectation that the assets used in the

activity may appreciate in value; (5) the success of the taxpayer

in carrying on other similar or dissimilar activities; (6) the

taxpayer's history of income or losses with respect to the

activity; (7) the amount of occasional profits, if any, that are

earned; (8) the financial status of the taxpayer; and (9) the

elements of personal pleasure or recreation involved in the

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

After considering the evidence in this case, we conclude

that petitioners engaged in the Activity with the actual and

honest objective of making a profit.

I. Businesslike Manner

The fact that a taxpayer carries on an activity in a

businesslike manner and maintains complete and accurate books and

records may indicate that the activity was carried on for profit.

Sec. 1.183-2(b)(1), Income Tax Regs. Further, abandonment of

unprofitable methods in a manner consistent with an intent to

improve profitability may indicate a profit objective. Id.

Several factors indicate that petitioners carried on the

Activity in a businesslike manner. Mrs. Dawson kept books and

records for the business. Petitioners also maintained a separate
- 7 -

bank account for the Activity. Further, petitioners abandoned

the Arabian horse breeding business when Mr. Dawson realized that

it would be unprofitable. Petitioners then sought a more

profitable enterprise and decided to breed paint horses. Their

goal was to develop Hot Twist into a marketable stud.

Respondent contends that petitioners did not use business

records to evaluate the financial status of the Activity. We

conclude that this contention does not necessarily undermine

petitioners' position. Petitioners owned only three horses. 

They employed only one trainer at a time, and only one horse was

shown in 1988. No horses were shown in 1989. We believe that

petitioners were adequately aware of the results of their rather

simple operation. Their failure to establish that they analyzed

their books and records is not determinative of this issue.

II. Expertise

Preparation for an activity by extensive study of its

accepted business, economic, and scientific practices, or

consultation with those who possess expertise in the activity,

may indicate that the taxpayer has a profit objective. Sec.

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

Respondent contends that petitioners did not consult experts

for advice regarding the operation of the Activity. We, however,

believe Mr. Barton's uncontradicted testimony that petitioners

sought and received his advice. While Mr. Dawson was not an

expert in the training, breeding, or showing of horses, he
- 8 -

regularly consulted with Mil Barton. Mr. Barton, with his 40

years of experience in the horse breeding and showing business,

advised petitioners on how to breed a successful horse and how to

make a profit in the Activity. In addition, petitioners hired

veterinarians and trainers to board and care for their horses. 

These facts are consistent with petitioners' intention to make a

profit.

III. Time Devoted to the Activity

The fact that a taxpayer devotes substantial personal time

and effort to carrying on an activity may indicate an intention

to derive a profit. Sec. 1.183-2(b)(3), Income Tax Regs. The

fact that the taxpayer devotes a limited amount of time to an

activity, however, does not necessarily indicate a lack of profit

objective where the taxpayer employs competent and qualified

persons to carry on the activity. Id. 

Petitioners did not personally devote a substantial amount

of time to the Activity. They did, however, hire competent and

qualified persons to assist them in conducting the Activity. 

Petitioners hired Mil Barton and Mike Van Leuven to perform the

training necessary to produce a quality show horse. Mr. Barton

fed and cared for Hot Twist and attended horse shows with Hot

Twist when Mr. Dawson could not attend. As discussed above, Mr.

Barton was competent and qualified in the horse breeding and

showing business. As a result, the fact that petitioners did not
- 9 -

devote substantial time to the Activity is not inconsistent with

the existence of a profit objective.

IV. Expectation That Assets May Appreciate

The appreciation of assets is to be considered in

determining whether a taxpayer intended to derive a profit from

his activity. Sec. 1.183-2(b)(4), Income Tax Regs. Respondent

contends that "petitioners' indifference to the present and

future value of their horses weighs against a finding of profit

motive." Respondent's contention, however, is contrary to the

facts. 

As Hot Twist became better known and trained, petitioners

believed that: (1) Hot Twist could be bred with Kate Dillon and

Dynamic King Bar and the sale of the foals would produce revenue;

(2) Hot Twist could participate in national-level competitions,

where gate prizes often reached $100,000; and (3) other horse

owners would seek to breed their mares with Hot Twist. According

to Mr. Barton, petitioners could make approximately $1,000 per

foal by breeding Hot Twist. Mr. Dawson believed that Hot Twist

could breed with more than 100 mares in a single year. 

Petitioners also expected to make money on "mare care" (i.e., a

per diem amount for boarding and feeding mares brought to

petitioners for breeding). All of these factors would have the

effect of increasing the value of petitioners' horses.

We conclude that petitioners sincerely and reasonably

believed that their horses would appreciate in value.
- 10 -

V. Taxpayers' Financial Status

The fact that the taxpayer does not have substantial income

or capital from sources other than the activity may indicate that

the activity is engaged in for profit. Sec. 1.183-2(b)(8),

Income Tax Regs. Petitioners' financial status strongly suggests

that petitioners engaged in the Activity for profit. In 1988,

petitioners earned wage income of $33,008 and net income of

$16,334 from the carpet cleaning business. In 1989, Mr. Dawson

earned wage income of $28,618 from his job at the railroad and

net income of $7,803 from the carpet cleaning business. To earn

this income, Mr. Dawson worked long hours at two arduous jobs. 

Mr. Dawson's testimony indicated that he was a shrewd,

hardworking, diligent, and levelheaded businessman. We do not

believe that he would squander his hard-earned money on an

extravagant hobby.

VI. Amount of Profits

The amount of profits earned in the activity, when compared

to the amount of losses incurred, the amount of the investment,

and the value of the assets in use, may indicate a profit

objective. Sec. 1.183-2(b)(7), Income Tax Regs. Petitioners did

not earn a profit on the Activity. The opportunity to earn

substantial profits in a highly speculative venture, however, is

ordinarily sufficient to indicate that the activity is engaged in

for profit even though only losses are produced. Id. Further,
- 11 -

in determining whether the taxpayer entered into the activity for

profit, a small chance of making a large profit may indicate the

requisite profit objective. Sec. 1.183-2(a), Income Tax Regs. 

According to the regulations, "it may be found that an investor

in a wildcat oil well who incurs very substantial expenditures is

in the venture for profit even though the expectation of a profit

might be considered unreasonable." Id. 

Petitioners' family was one of modest means. Petitioners

believed that the prospect of producing a champion horse that

could generate hundreds of thousands of dollars in revenue and

correspondingly large profits seemed to be well worth the risks

involved. In essence, the Activity was petitioners' "wildcat oil

well". Petitioners actually and honestly believed that if Hot

Twist were successful in horse shows, future earnings and profits

would be substantial. Mr. Barton confirmed that Hot Twist had

the potential to be very successful. We conclude that

petitioners' expectation of future profits is consistent with the

existence of a profit objective.

VII. History of Income and Losses

A taxpayer's history of income, losses, and occasional

profits with respect to an activity may indicate the presence or

absence of a profit objective. Sec. 1.183-2(b)(6), Income Tax

Regs. Respondent contends that, because petitioners have

incurred losses on their horses in each year, they did not have

the requisite profit objective. We disagree. 
- 12 -

Section 1.183-2(b)(6), Income Tax Regs., states that "A

series of losses during the initial or start-up stage of an

activity may not necessarily be an indication that the activity

is not engaged in for profit." Where startup losses are

involved, the taxpayer's objective must be not only to have

future net earnings but also sufficient net earnings to recoup

losses previously sustained. Estate of Power v. Commissioner,

736 F.2d 826, 830 (1st Cir. 1984) (citing Bessenyey v.

Commissioner, 45 T.C. 261 (1965), affd. 379 F.2d 252 (2d Cir.

(1967)), affg. T.C. Memo. 1983-552.

Petitioners' losses were incurred during the Activity's

startup stage. In 1989, petitioners had been in the business of

breeding paint horses for only 3 years. Before Hot Twist could

produce a profit, petitioners had to properly train the horse and

show him in enough events for him to obtain a favorable

reputation. This would encourage other horse owners to seek to

breed their mares with Hot Twist. Based on Mr. Barton's advice,

petitioners reasonably believed that revenue from the Activity

would be sufficient to recoup previously sustained losses. 

Therefore, we conclude that petitioners' brief history of losses

does not indicate the absence of a profit objective.

VIII. Personal Pleasure or Recreation

The presence of personal pleasure or recreation may indicate

the lack of a profit objective. Sec. 1.183-2(b)(9), Income Tax

Regs. Respondent contends that petitioners derived substantial
- 13 -

personal pleasure from the Activity. Mr. Dawson admitted that he

occasionally rode the horses at his home to keep them warmed up. 

As a result, respondent contends that petitioners derived

personal pleasure from the Activity. This contention, however,

is not supported by the record. 

Mr. Dawson testified that neither he nor his family ever

rode the horses for pleasure, and Mr. Barton confirmed that he

was not aware of any member of Mr. Dawson's family riding the

horses for pleasure. Further, even if Mr. Dawson did derive some

satisfaction from the Activity, that is not determinative of the

issue in this case. A taxpayer can enjoy his work and still be

engaged in it for profit. See Jackson v. Commissioner, 59 T.C.

312, 317 (1972) (stating that "a business will not be turned into

a hobby merely because the owner finds it pleasurable; suffering

has never been made a prerequisite to deductibility"); Hart v.

Commissioner, T.C. Memo. 1995-55 (same). The requirement is that

a profit objective be the "basic and dominant" objective. 

Independent Elec. Supply, Inc. v. Commissioner, 781 F.2d at 726. 

We conclude that it was.

IX. Past Successes in Activity

The taxpayer's past success in similar or dissimilar

activities can be indicative of a profit objective. Sec.

1.183-2(b)(5), Income Tax Regs. Respondent contends that the

fact that petitioners have never conducted a successful horse
- 14 -

breeding and training business indicates a lack of profit

objective. We conclude, however, that this factor is outweighed

by the other factors considered above.

Having considered the factors listed in section 1.183-2(b),

Income Tax Regs., all contentions presented by the parties, and

the facts and circumstances of this case, we hold that

petitioners actually and honestly intended to make a profit in

the Activity. Consequently, section 183 does not limit the

deductions claimed by petitioners with respect to the Activity.

To reflect the foregoing,

Decision will be entered 

under Rule 155.