United States Court of Appeals

FOR THE EIGHTH CIRCUIT

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No. 07-3660

No. 08-1266

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Nora E. Keating and *

Richard L. Shearer, *

*

Petitioners - Appellants, * Appeal from the

* United States Tax Court.

v. *

*

Commissioner of Internal Revenue, *

*

Respondent - Appellee. * 

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Submitted: September 24, 2008

Filed: October 14, 2008 

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Before MURPHY, ARNOLD, and BENTON, Circuit Judges.

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MURPHY, Circuit Judge.

Nora E. Keating and Richard L. Shearer filed a petition in United States Tax

Court challenging the determination of the Commissioner of Internal Revenue

(Commissioner) that because Keating engaged in her horse breeding activity as a

hobby rather than for profit, losses from the activity were incorrectly deducted on their

1996 through 2002 tax returns, resulting in deficiencies in their federal income tax
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The Honorable Stephen J. Swift, Judge, United States Tax Court.

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obligations. Following a trial the tax court1

 concluded that Keating had not engaged

in the horse activity for profit and ordered Keating and Shearer liable for all

deficiencies assessed by the Commissioner. Keating and Shearer appeal, and we

affirm.

In 1996 Keating moved to Williston, North Dakota, where she began work as

an emergency room physician and purchased a home on a 10 acre farm. She worked

approximately 60 hours per week, preferring two 24 hour shifts and one 12 hour shift

because she felt "burned out" from medical school and because it allowed her more

full days with her six children. Her average annual salary was $238,134. Her

husband at the time, Richard Shearer, worked as a firefighter medic. The two filed

joint federal income tax returns from 1996 through 2000 but divorced prior to the

filing of Keating's 2001 individual income tax return.

Also in 1996, Keating realized a lifelong dream of working with horses when

she purchased four Arabians, which she considers the "ballerinas of the horse world."

She had always loved horses and had experience owning, caring for, and riding them

dating back to high school when she worked in a veterinary clinic, belonged to several

riding clubs, and purchased and boarded her first horse at age 15. 

When Keating purchased the Arabians in 1996 she spoke with an award

winning Arabian horse breeder, two horse trainers, and a veterinarian about training

methods, breeding, selection of stallions and mares, and veterinary issues including

factors that could result in early termination of pregnancy. She also spoke with people

who had been audited for their horse activities; they recommended that she keep good

expense records and all receipts. She consulted a certified public accountant (CPA)

regarding tracking receipts and maintaining records. 
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Although Keating had extensive experience caring for and riding horses, she

had no experience in the business of buying, selling, or showing horses, and she

presented no evidence at trial that she had consulted anyone regarding the economic

or business aspects of breeding, training, or showing horses. Between 1996 and 2002

Keating purchased 13 horses and bred 7, but she sold only 2 horses, each for half of

its purchase price. 

Keating did not change her work schedule after purchasing the Arabians, but

on each day off she spent approximately 7 to 10 hours with the horses. She engaged

in their training and feeding, and she also rode them, cleaned their stalls, performed

basic veterinary work, and competed in shows. Before a showing she would hire a

professional trainer to finish training the horses. Keating and her daughter rode in

many shows which gave her great pride, and on four occasions her horses participated

in nationally competitive horse shows. 

In 2000 Keating built a barn to shelter the horses during the breeding months.

In 2001 she began boarding other people's horses, leasing out her own horses, and

providing horse clinics, but she did not advertise the boarding and leasing services.

She advertised that her horses were for sale by word of mouth, by showing them, and

by advertising on three websites; she did not advertise in any written publication. 

Between 1996 and 2001, Keating paid both personal and horse activity

expenses from the same two or three personal checking accounts. In 2002 she opened

a checking account in the name of Nora Ellen Keating Stony Creek Arabians (Stony

Creek Arabians) and two new personal checking accounts, but she continued to pay

personal and horse activity expenses from all three accounts. For example, she

deposited the proceeds from the 2002 sales of the two horses in one of her personal

accounts, not the Stony Creek Arabians account. She kept a ledger of total horse

activity expenses, retained receipts by month of transaction, and kept records of

training, ovulatory cycles, and vaccinations relating to each horse. She did not,
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however, keep expense records for each individual horse. She had no written business

plan and no financial projections relating to her horse activity.

Keating and Shearer filed joint federal income tax returns for 1996 through

2000 and Keating filed individual federal income tax returns for 2001 and 2002, each

of which listed "horses" as the principal activity on Form 1040 Schedule F, "Profit or

Loss from Farming." The following gross income, expense, and net loss amounts

attributable to the horse activity were included on Schedule F:

Year Gross Income Expenses Net Loss

1996 $ 144 $ 22,227 $ (22,083)

1997 178 22,187 (22,009)

1998 335 48,289 (47,954)

1999 432 44,784 (44,352)

2000 750 50,550 (49,800)

2001 1,200 84,382 (83,182)

2002 1,418 102,550 (101,132)

These losses reduced reported taxable income dollar for dollar, resulting in

substantial tax savings. In 2005 the Commissioner audited these federal income tax

returns and concluded that the horse activity was not engaged in for profit. As a result

the Commissioner disallowed the horse activity losses on Schedule F for each year

examined and issued Notices of Deficiency asserting that Keating and Shearer owed

additional taxes equal to their entire claimed tax benefit from the horse activity:

 Tax Year Tax Deficiency/Additional Tax Owed

 1996 $ 7,784

 1997 6,507

 1998 18,181
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 1999 16,191

 2000 20,219

 2001 29,066

 2002 35,815

Keating and Shearer filed a petition in United States Tax Court for a

redetermination of the deficiencies assessed by the Commissioner, and the matter was

tried in 2007. Based on its analysis of all of the facts and circumstances the tax court

concluded that a preponderance of the evidence supported the Commissioner's

determination that the horse activity was not engaged in for profit, and concluded that

Keating and Shearer were liable for all deficiencies assessed by the Commissioner.

Keating and Shearer appeal, claiming that the tax court erred in concluding that

Keating's horse breeding activity was not carried out with a profit motive. This is a

factual determination which we review for clear error and must affirm unless left with

a conviction that the tax court has committed a mistake. See Blodgett v. Comm'r, 394

F.3d 1030, 1034-35 (8th Cir. 2005). Keating argues that her horse activity was

engaged in for profit. As evidence she cites the facts that she kept good records, spent

most of her time outside of work with the horses, and invested her savings, earnings,

and retirement funds in the horses with the expectation that they would provide

income for her retirement. The Commissioner counters that these arguments were

made to the tax court and that it did not err in concluding that the activity was not

engaged in for profit.

The deductibility of taxpayer expenses related to an activity depends on

whether it is carried on for profit. See 26 U.S.C. §§ 162, 212. Subject to two

exceptions in 26 U.S.C. § 183(b) which do not apply here, a person may not deduct

a loss attributable to an activity unless that activity is engaged in for profit. 26 U.S.C.

§ 183(a). For example, a taxpayer may not deduct losses related to an activity "carried

on primarily as a sport, hobby, or for recreation." Treas. Reg. § 1.183-2(a). 
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An activity is engaged in for profit if the taxpayer has an actual, honest profit

objective, even if it is unreasonable or unrealistic. Treas. Reg. § 1.183-2(a). Treasury

Regulation § 1.183-2(b) includes a nonexhaustive list of nine factors to consider in

determining whether a business is engaged in for profit: (1) the manner in which the

taxpayer carries on the activity; (2) the expertise of the taxpayer or her advisors; (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 in respect to the activity; (7) the amount of occasional

profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) any

elements of personal pleasure or recreation. No single factor or even a majority of the

factors is controlling, and all of the facts and circumstances must be evaluated, giving

greater weight to objective facts than to the taxpayer's statement of intent. See Evans

v. Comm'r, 908 F.2d 369, 373 (8th Cir. 1990). 

The tax court thoroughly analyzed the facts and circumstances of Keating's

horse activity as they related to each of the nine factors in Treasury Regulation §

1.183-2(b). It found that five of the factors favored the Commissioner's conclusion

that the horse activity was not carried on for profit, four factors were neutral, and none

favored Keating's argument that she engaged in the horse activity for profit. 

The tax court concluded that the first factor—whether the activity is carried on

in a businesslike manner and whether complete and accurate books and records are

maintained—favored the Commissioner's finding of liability. It found that she had not

carried on the horse breeding activity in a businesslike manner. She commingled her

personal and horse funds in her various bank accounts even after opening the Stony

Creek Arabians account, made meager efforts at advertising, made relatively small

improvements to the grounds and operations, and had no written business plan. It also

found that although her books and records were thorough in respect to each horse's

vaccinations and ovulatory cycles, her failure to keep track of expenses on a per horse
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basis and to prepare any financial projections to assess the economics of the activity

indicated a lack of profit objective. See Filios v. Comm'r, 224 F.3d 16, 23 (1st Cir.

2000) (to indicate profit motive, records generally should assist in cutting expenses,

increasing profits, making financial projections, and evaluating overall performance

of business). It also found that the books and records were kept by Keating only to

"memorialize for tax purposes the existence of the subject transactions."

The tax court found that the second factor—the taxpayer's expertise and

preparation with regard to the economic aspects of the business—favored the

Commissioner's determination. It said that although Keating consulted with breeders

and horse experts regarding breeding and training, she was not an expert and did not

seek expert advice regarding the economic aspects of the horse business. Burger v.

Comm'r, 809 F.2d 355, 359 (7th Cir. 1987) (mechanics and economics of activity are

separate areas of expertise, and failure to obtain expertise in economics of activity

may indicate lack of profit objective). It found that she discussed tracking receipts

with a CPA only for tax purposes.

The tax court found that the fourth factor—the expectation that assets used in

the activity may appreciate in value—favored the Commissioner's determination

because Keating presented no evidence of the value of the horses, making it

impossible to determine their current or expected future value. The only two horses

Keating sold between 1996 and 2002 were sold for less than half of their purchase

price, suggesting that any expectation of appreciation may have been unreasonable.

The tax court concluded that the eighth factor—the financial status of the

taxpayer—favored the Commissioner's determination because Keating had a high

salary from her work as a physician and had $133,763 in claimed tax savings from the

horse activity over seven years. See Treas. Reg. § 1.183-2(b)(8) (substantial income

from sources other than activity in question may indicate activity not carried on for

profit, especially where losses generate substantial tax benefits). 
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The tax court concluded that the ninth factor—elements of personal pleasure

or recreation—favored the Commissioner's determination because the recreational

aspects of Keating's horse activity and the fact that her daughter rode recreationally

suggest an activity without a profit objective. See Montagne v. Comm'r, T.C. Memo.

2004-252, 2004 WL 2504388 at *3 (U.S. Tax Ct. 2004) (concession that family

enjoyed riding and competing with horses showed lack of profit objective), aff'd, 166

Fed. Appx. 265 (8th Cir. 2006).

With the exception of the eighth factor—taxpayer's financial status—which she

did not discuss on appeal, Keating and Shearer argue that the tax court erred in its

factual determinations regarding each of the other factors. They argue that Keating

kept detailed records, advertised, consulted experts for business advice, believed that

the assets were increasing in value, and undertook many unpleasant chores related to

the horse activity. The tax court's factual findings involved credibility determinations,

however, which are virtually unreviewable on appeal. Blodgett, 394 F.3d at 1035.

The evidence in the record established that Keating did not have a written business

plan or financial projections for the horse activity, commingled horse related funds in

her personal and horse activity accounts, failed to develop economic expertise

regarding the horse breeding business, and derived great pride and enjoyment from

showing the horses. In light of these objective facts we cannot say that the tax court

erred in its factual determinations. 

Keating also argues that the tax court erred because two of the four factors

which it found neutral—factors six and seven regarding the history of income or

losses and any occasional profits—favored Keating's position that she engaged in the

horse activity for profit. The tax court concluded that these factors were neutral

because although Keating had consistent and increasing losses over the seven years

at issue, a horse business may have a five to ten year startup phase during which the

taxpayer may incur losses before turning a profit. See, e.g., Davis v. Comm'r, T.C.

Memo. 2000-101, 2000 WL 307276 at *10 (U.S. Tax Ct. 2000). Because Keating's
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horse activity incurred consistent and increasing losses, however, it was not clear error

for the tax court to find these factors neutral rather than in favor of Keating's position.

The tax court did not err in concluding that based on all of the facts and

circumstances, including an analysis of the nine factors in Treasury Regulation §

1.183-1(b)(2), a preponderance of the evidence supported the Commissioner's

determination that Keating's horse activity was not engaged in for profit.

Accordingly, the court did not err in concluding that Keating and Shearer were liable

for the tax deficiencies as assessed by the Commissioner.

Keating and Shearer also contend that a remand to the tax court would be in

order because it erred in failing to shift the burden of proof to the Commissioner to

disprove their entitlement to the loss deductions. We presume that the

Commissioner's determination regarding the existence of a tax deficiency is correct,

requiring the taxpayer to bear the burden of proving entitlement to a claimed

deduction by a preponderance of the evidence. Blodgett, 394 F.3d at 1035. This

burden shifts to the Commissioner to disprove the entitlement if the taxpayer

introduces "credible evidence" with respect to the tax liability. 26 U.S.C. § 7491. We

review de novo the legal question of whether a taxpayer produced evidence sufficient

to shift the burden of proof to the IRS under 26 U.S.C. § 7491, Blodgett, 394 F.3d at

1035, but must recognize that "a shift in the burden of preponderance has real

significance only in the rare event of an evidentiary tie," id. at 1039 (party supported

by weight of evidence will prevail regardless of who bore burden of proof). The tax

court stated that "[t]his case is decided on the preponderance of the evidence and is

unaffected by section 7491." Any error in assigning the burden of proof would have

been harmless under the circumstances, and there is no basis upon which to remand

this matter for further proceedings.

Accordingly, we affirm the judgment of the tax court.

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