## F I L E D United States Court of Appeals Tenth Circuit 

### AUG 16 2000 

### PATRICK FISHER Clerk PUBLISH
UNITED STATES COURT OF APPEALS

TENTH CIRCUIT

STANLEY M. KURZET and ANNE L. KURZET, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. No. 97-9028

Appeal from the United States Tax Court (Tax Court No. 27982-91)

J. Gordon Hansen of Parsons Behle & Latimer, Salt L ake City, Utah, for Petitioners-Appellants. Alice L. Ronk (Kenneth L. Greene with her on the br ief), Tax Department, Department of Justice, Washington, D.C., for Respon dent-Appellee.

Before SEYMOUR , Chief Judge, BRORBY and EBEL , Circuit Judges.

EBEL , Circuit Judge.1 On December 31, 1997, this court, sua sponte, order ed the parties to file

memorandum briefs addressing whether the notice of appeal in this case was timely filed. Both parties asserted in their memor andum briefs that the notice of appeal was timely, and our review of the issue conf irms that this court has jurisdiction to consider the appeal. - 2 - Appellants Stanley and Anne Kurzet (the “Kurzets,” with Stanley referred to individually as “Kurzet”) appeal the decision of the tax court, finding deficiencies in the personal income tax paid by the Kurzets for the years 1987, 1988, and 1989. We exercise jurisdiction pursuant to I.R.C. § 7482 1 and REVERSE in part and AFFIRM in part.
BACKGROUND In 1958, Kurzet formed ALS Corp., a company involve d in the design and manufacture of sophisticated electronic and enginee ring equipment for the United States’ military. In 1984, Kurzet sold his interes t in ALS to a third party for $20 million in cash. In connection with the sale, Kurz et signed a noncompete agreement and also agreed to serve in a consulting capacity to ALS for the next seven years at a salary of $10,000 per month. Kurz et made various purchases with the proceeds from the sale of ALS. As relevant here, these included: (1) a timber farm in Oregon; (2) real property in Tahiti; and (3) a Lear jet. Other assets owned by the Kurzets also play a role in the issues presented on appeal. These are: (4) the Kurzet’s 24-room mansion in Orange, Ca lifornia; (5) a warehouse in California; and (6) rental condominiums in Park City, Utah.- 3 -

The Commissioner of Internal Revenue (the “Commissi oner”) brought an action against the Kurzets, alleging that they were deficient in their tax payments for the years 1987, 1988, and 1989 and also sought accuracy-related penalties. In an order dated January 29, 1997, the tax court foun d that the Kurzets were deficient in their tax payments because they claime d impermissible tax deductions in connection with the Tahiti property, the Lear je t, and their California home, but did not require the Kurzets to pay any accuracy-rel ated penalties. The tax court felt that penalties were not appropriate in light o f the fact that the “errors on the tax returns were attributable to the amateurish boo ks and records that the petitioners unfortunately established to keep trackof their business, investment, and personal activities” and the fact that the Kurz ets had hired professional tax preparers who failed to explain the accounting prob lems to the couple. The tax court made additional findings in an opinio n issued from the bench on February 24, 1997, resolving a number of issues that had been omitted from the written order of January 29. As relevant here, in the bench opinion, the tax court refused to allow the Kurzets to change the ma nner in which they calculated depreciation for the reservoir they had constructedon their timber farm. On appeal, the Kurzets assert four claims of error. First, the Kurzets urge that the tax court erred in determining that the expenses attributable to the use of the Kurzets’ Lear jet were not deductible pursuant to I.R.C. § 162. Second, the- 4 -

Kurzets argue that the tax court erred in concludin g that none of the expenses attributable to the Kurzets’ California residence w ere deductible pursuant to I.R.C. § 280A(c)(1). Third, the Kurzets argue thatthe tax court erred in determining that the Kurzet’s Tahiti property was arecreational or personal use property rather than an investment under I.R.C. § 2 12. Finally, the Kurzets complain that they were not entitled to change the cost recovery period on the reservoir constructed on the Kurzets’ timber farm f rom 31.5 years to 15 years. We reverse as to the Kurzets’ first claim of error but affirm as to the three remaining issues.
DISCUSSION We review tax court decisions “in the same manner a nd to the same extent as decisions of the district courts in civil action s tried without a jury.” I.R.C. § 7482(a)(1). We review the Tax Court's factual findings under th e clearly erroneous standard and review its legal conclusions de novo. We review mixed questions of law and fact either under the clearly erroneous standard or de novo, depending on whether the mixed question is pr imarily factual or legal. Anderson v. Commissioner , 62 F.3d 1266, 1270 (10th Cir. 1995) (internal citations omitted). “The Supreme Court has defined mixed questions as those in which the historical facts are admitted or establis hed, the rule of law is undisputed, and the issue is whether the facts sati sfy the statutory standard, or to- 5 -

put it another way, whether the rule of law as appl ied to the established facts is or is not violated.” Love Box Co. v. Commissioner , 842 F.2d 1213, 1215 n.2 (10th Cir. 1988) (internal quotations and citation omitte d). I. Deduction of Lear Jet Expenses Section 162 of the Internal Revenue Code allows a t axpayer to “deduct[] all the ordinary and necessary expenses paid or incurre d during the taxable year in carrying on any trade or business.” The Kurzets cl aimed deductions on their tax returns for the years 1987, 1988, and 1989 pursuantto § 162 for expenses related to the operation of their Lear jet. The Kurzets us ed their jet to travel to their properties in Oregon, Utah, and Tahiti from their h ome in California and to transport equipment. The tax court denied all of the deductions sought b y the Kurzets in connection with the operation of their Lear jet. I n its written opinion, the tax court initially noted that the Kurzets were not ent itled to deduct travel expenses for their trips to Tahiti in light of its conclusio n that the Tahiti property was not held as investment property. The tax court then we nt on to explain that the “large transportation expenses (including significant nonc ash expenses such as depreciation) associated with the Lear jet appear t o be out of the ordinary and unnecessary in light of the fact that petitioner’s timber farm was not producing any current income (due to petitioner’s decision to defer cutting any of the- 6 -

timber).” The tax court also regarded the “inconve nience that petitioners would have experienced a few times a year in flying to th e Oregon timber farm via commercial air carrier” as minimal, ordinary, and c ommon for individuals as well as businessmen. The tax court found that the Kurze ts did not establish that they had incurred the “extravagant costs of purchasing and maintaining a Lear jet to avoid such infrequent and slight inconvenience.” T he tax court did not preclude the Kurzets from deducting any costs associated with their travel to Oregon from their home in California, however. Rather, relying on its earlier determination that the Kurzets held and managed the timber farm a s a “for-profit business activity,” the tax court allowed the Kurzets to ded uct the cost of first-class travel on a commercial carrier for each of the trips. Fin ally, the tax court found that, although the Kurzets used the jet to transport equi pment and machinery to Oregon, they had not provided a basis upon which th e court could estimate what those transportation expenses would have been, and therefore denied any deduction for this use. The taxpayer bears the burden of proving his or herexpenditures are “ordinary and reasonable” under § 162. See Love Box Co. , 842 F.2d at 1216. The Supreme Court has indicated that an ordinary expense is one that is “normal, usual, or customary.” Deputy v. Du Pont , 308 U.S. 488, 495, 60 S. Ct. 363, 84 L. Ed. 416 (1940). Similarly, the Supreme Court has e xplained that an expense is- 7 -

ordinary if it is a “common and accepted” expense f or the taxpayer, comparing the taxpayer to “the group, the community, of which he is a part.” Welch v. Helvering , 290 U.S. 111, 114, 54 S. Ct. 8, 78 L. Ed. 212 (19 33). Expenses are necessary if they are “appropriate and helpful.” I d. at 113. For an expense to be considered ordinary and necessary, it must also be reasonable in amount. See Harmon City, Inc. v. United States , 733 F.2d 1381, 1383 (10th Cir. 1984) (“Although [§ 162] does not limit deductions . . . to a ‘reasonable’ amount, the reasonableness of such payments must be explored to determine whether they are ‘ordinary and necessary’ . . . .”); Commissioner v. Lincoln Electric Co. , 176 F.2d 815, 817 (6th Cir. 1949) (“[T]he element of reasona bleness is inherent in the phrase ‘ordinary and necessary.’”); United States v . Haskell Eng’g. & Supply Co. , 380 F.2d 786, 789 (9th Cir. 1967) (same (citing Lin coln )); see also Treas. Reg. § 1.162-2(a) (“Only such traveling expenses as are reasonable and necessary in the conduct of the taxpayer’s business and directlyattributable to it may be deducted.”). Both parties construe the tax court’s decision in d enying the deductability of Lear jet expenses in flying to and from the Kurz ets’ timber farm in Oregon as a finding that such expenses were not ordinary and ne cessary because they were “unreasonable,” and we agree with this interpretati on of the opinion. Thus, in this appeal, we are primarily concerned with the qu estion of whether the actual- 8 -

costs of operating the Lear jet were reasonable and could therefore be considered “ordinary and necessary” business expenses in conne ction with travel related to the Oregon timber farm. This circuit considers the question of whether expenses are reasonable, and are therefore ordinary and nece ssary under § 162, to be a factual question, and we therefore review for clearerror. See Harmon City , 733 F.2d at 1385; Cooke v. Commissioner , 203 F.2d 258, 262 (10th Cir. 1953); RotaCone Oil Field Operating Co. v. Commissioner , 171 F.2d 219, 222 (10th Cir. 1948).The Kurzets urge that the tax court made a number o f mistakes in connection with its assessment of whether the expen ses attributable to the operation of the Lear jet for travel related to the Oregon timber farm were reasonable and that these errors require this courtto reverse the tax court’s determination that actual expenses associated with operating the jet were not deductible pursuant to § 162. We agree with the Ku rzets that the tax court’s determination of reasonableness was clearly erroneo us. First, the Kurzets argue that the trial court impro perly considered the amount of depreciation claimed on the jet when it c onsidered whether the expenses the Kurzets sought to deduct were reasonab le. The tax court opinion concluded, “[t]he large transportation expenses (in cluding significant noncash expenses such as depreciation ) associated with the Lear jet appear to be out of the2 The Kurzets contend that the tax court found that K urzet made a total of

41 trips to Oregon in 1987, 1988, and 1989. While this may be true, the record reflects that Kurzet took two of the trips made in 1987 in his Cessna. Thus, these trips should not be considered in determining wheth er the costs associated with the operation of the Lear jet were reasonable. - 9 - ordinary and unnecessary.” (Emphasis added.) The Kurzets cite the tax court decision in Noyce v. Commissioner , 97 T.C. 670, 687 (1991), for the proposition that the depreciation of an airplane should not be considered when determining whether the expenses relating to the operation of t he plane are reasonable for purposes of § 162. In addition, the Kurzets argue that the tax court g rossly underestimated the number of trips they took to Oregon. In its writte n opinion, the tax court found that the Kurzets traveled to their Oregon timber fa rm “4 or 5” times a year. In its later bench ruling, the tax court revised the factu al finding made in its earlier written order when it assessed the constructive amo unt of traveling expenses that the Kurzets could deduct. Specifically, the tax co urt concluded that the Kurzets had made 74 trips to Oregon between them during the three-year period in question, with Kurzet making 14 trips in 1987, 11 trips in 1988, and 14 trips in 1989, 2 and his wife making 14 trips in 1987, 9 trips in 1 988, and 12 trips in 1989. Finally, the Kurzets argue that the tax court did n ot include a calculation of the time saved as a result of their use of the jet in determining whether the3 The Kurzets also contend that the tax court erred b y failing to consider the

fact that the jet was used to travel to machinery a uctions and haul equipment for the timber farm. Our review of the tax court’s wri tten order indicates that the tax court did, in fact, consider these uses for the jetin assessing reasonableness. However, the tax court determined that there was in sufficient evidence in the record to calculate the constructive cost of transp orting the equipment and therefore denied the Kurzets’ deductions for these costs. - 10 - amount of the expenses was reasonable. 3 The Kurzets argue that this factor was significant because each of their round trips to Or egon on the Lear jet saved 12 hours of travel time over commercial air travel. We are persuaded by these arguments and conclude th at the tax court clearly erred in determining that the Kurzets’ expe nses associated with operating the Lear jet for travel related to the timber farm were unreasonable and therefore nondeductible pursuant to § 162. As an initial matter, we find that the tax court improperly considered depreciation in its assessment of reasonableness. In Noyce , the tax court held that depreciation should not b e considered in assessing whether business expenses are reasonable under § 16 2. Noyce , 97 T.C. at 687-88. In reaching this conclusion, the tax court first lo oked to the definition of “business expense” under Treasury Regulation § 1.16 2-1(a). See id. at 687. Section 1.162-1(a) provides: Business expenses deductible from gross income incl ude the ordinary and necessary expenditures directly connected with or pertaining to the taxpayer’s trade or business, except items whic h are used as the basis for a deduction or a credit under provisions of law other than section 162.4 In the findings of fact, the tax court stated that “[t]he Lear jet operating

expenses for 1987, 1988, and 1989, including deprec iationtotaled $667,709, $728,201, and $402,399, respectively.” (Emphasis a dded.) In addition, and as noted above, the tax court referred to the fact that the transportation expenses included noncash expenses such as depreciation in i ts analysis of the issue. - 11 - The tax court then explained that depreciation is “ not really an ‘expenditure’ but an allowance based on a presumed wasting of a previ ous capital investment” and further noted that deductions for depreciation are governed by I.R.C. § 168. See id. at 688. Based on these observations, the tax court concluded that depreciation does not “fall under the regulatory rubric of trade or business expense” and therefore should not be included in the amount of b usiness expense when assessing the reasonableness of that expense. Id. We agree with the reasoning in Noyce . Despite the Commissioner’s assertion to the contrary, we also find that the tax court’s written order reflects that it did, in fact, include depreciation in its assessment of whether the costs associated with ope rating the Lear jet were reasonable. 4 For these reasons, we conclude that the tax courtimproperly considered depreciation in its assessment of the re asonableness of the expenses associated with the Lear jet. By including depreciation in the costs associated w ith operating the airplane, the tax court was weighing reasonableness based on drastically overinflated numbers. In 1987, 1988, and 1989, the Kurzets claimed that the total amount of costs, including depreciation, attributab le to their travel to the timber5 These figures are found only in the Commissioner’s brief and the

Commissioner does not provide a cite to the record, other than to say these figures are from the Kurzets’ tax court brief, which we cou ld not locate as part of the record. However, we were able to extrapolate rough ly comparable figures from Joint Exhibit 66BN. For purposes of making a reaso nableness determination, we accept the figures in the Commissioner’s brief, alt hough for purposes of actually calculating the taxes due, the tax court may need t o make a more precise calculation of this amount on remand. - 12 - farm was $326,546, $307,332, and $97,895, respectiv ely. For each of these years, however, the alleged total cost for operating the j et allocatable to the operation of the timber farm, excluding depreciation, was only a bout $120,064, $121,871, and $42,582. 5 Thus, by including depreciation costs, the costs the tax court actually considered in assessing reasonableness were more th an two times the amount it should have considered. We also agree with the Kurzets’ contention that the tax court significantly underestimated the number of trips the Kurzets tookto their Oregon property in assessing reasonableness. Based on the estimate inthe written order that the Kurzets took four or five trips a year to their Ore gon property, the tax court must have believed that Kurzet and his wife made, at mos t, 30 trips to Oregon between them during 1987, 1988, and 1989. This figure repr esents less than half of the actual number of trips the tax court later calculat ed the Kurzets to have taken to Oregon on the Lear jet. Underestimating by more th an one half the number of trips caused the tax court to overestimate by more than a factor of two the cost,- 13 -

and hence the reasonableness or unreasonableness of the cost per trip for the Kurzets to use the Lear jet in flying to and from t heir Oregon timber farm. While the tax court referred to the “inconvenience” associated with normal commercial air travel versus use of the Lear jet in the written order, we also find that the tax court did not give sufficient weight t o the time-savings associated with the use of the Lear jet. The tax court made afactual finding that the average time for one-way commercial air travel between Oran ge, California and North Bend, Oregon was nine hours and involved two stops and at least one change of planes. The record reflects that this trip took le ss than three hours one way when using the Lear jet. Thus, our review of the record confirms the Kurzets’ claim that they saved twelve hours round trip when flying from California to Oregon. Based on a twelve-hour savings, the Kurzets saved approximately 888 hours of travel time when making the 74 trips to Oregon in 1 987, 1988, and 1989. This is 528 hours more than the amount of time saved based on the tax court’s initial erroneous estimate of 30 trips. Based on the correct number of trips, the fact thatthe Kurzets saved twelve hours each per trip, the tax court’s finding that K urzet’s time was worth $200/hour, and the tax court’s finding that the cos t of a first-class round-trip ticket was $1,600, a rough estimate of the value to the Kurzets of the use of the Lear jet to fly from California to Oregon for 1987, 1988, and 1989 was $156,800,- 14 -

$112,000, and $145,600, respectively. Given that t he Kurzets actually sought to deduct only $120,064, $121,871, and $42,582, for tr ips allocatable to the operation of the timber farm for years 1987, 1988, and 1989, respectively, and that our rough estimates do not account for the val ue of Mrs. Kurzet’s time or for any value associated with the transportation of equ ipment to the timber farm, we conclude that the expenses which the Kurzets soughtto deduct were reasonable. In conclusion, we find that the tax court clearly e rred in finding that the Kurzets’ deductions for the cost of operating the L ear jet were not reasonable based on its significant overestimation of the cost s and significant underestimation of the use and benefits derived by the Kurzets from the Lear jet. While we conclude that the expenses associated with travel from California to Oregon were, in fact, reasonable, we decline to mak e a determination as to the actual amount of the expenses the Kurzets may deduc t pursuant to § 162 because some modest adjustments in these figures may be nec essary in order to determine the precise amount to allocate for travel and equip ment transportation expenses related to the Oregon timber farm. We therefore in struct the tax court to make factual findings on remand as to the amount of the expenses associated with the Lear jet that can properly be attributed to the ope ration of the Kurzets’ timber farm.
II. Home Office Deduction for the California Reside nce6 The Kurzets owned and rented out a commercial wareh ouse in California

and two condominiums in Park City, Utah. The courtfound that the extent to which a real estate management company was used in connection with the Utah properties was not clear. - 15 - Section 280A of the Internal Revenue Code provides that a taxpayer is not allowed to make deductions with respect to his dwel ling unit but that an exception applies where a portion of the dwelling unit is use d exclusively on a regular basis as the principal place of business for any trade orbusiness of the taxpayer. See I.R.C. § 280A(c)(1)(A). The Kurzets argue that the tax court erred in finding that they were not entitled to deductions in connection with the use of a portion of their home as a “principal place of business” for v arious business activities that they conducted. The Kurzets sought to deduct one-f ifth of all expenses of their residence in Orange, California. The Kurzets urge that the deduction is appropriate because a number of rooms in their twenty-four room mansion were dedicated to business activities, including their r eal estate business, 6 Kurzet’s consulting position at ALS, and a computer business

. The tax court found that the Kurzets “had rooms in [the California] residence in which the petitioner performed paperwo rk and computer tasks associated with his various activities” and that th ey “also performed bookkeeping, maintained reference manuals and industry publicati ons, and paid numerous bills relating to their many activities” in these rooms. The tax court further found that- 16 -

there was one room in the basement of the house whe re the Kurzets kept a computer and a copy machine; one room in the upper level where Mrs. Kurzet reviewed, paid, and maintained files relating to bu siness and personal bills and activities; and two additional rooms on the upper l evel where Kurzet maintained an office and a lab with electronic circuit testing equipment related to his consulting duties at ALS. Finally, the tax court f ound that Kurzet performed consulting work for ALS about three or four times ayear during the years in question and that he had no clients other than ALS. The tax court concluded that the Kurzets did not sh ow that the home was the principal place of business for any of their bu siness activities under § 280A. The court reasoned that the Oregon property was the principal place of business for the timber farm, that ALS was the principal pla ce of business for Kurzet’s consulting activities, and that the evidence in the record did not enable the court to find that the Kurzets’ home was the principal pl ace of business for their computer and real estate rental businesses. The co urt acknowledged the extensive investment activities of the Kurzets, but emphasize d that even where there is no suitable office or place outside of the taxpayer’s residence, the taxpayer may not automatically claim a deduction. The tax court stated that use of one’s personal residence to manage investments does not create a h ome office for purposes of §
280A.- 17 -

The taxpayer bears the burden of proving that he is entitled to a deduction for a home office pursuant to § 280A. See Pomarantz v. Commissioner , 867 F.2d 495, 496 (9th Cir. 1988). The Supreme Court set fo rth the manner in which the principal place of business is to be determined und er § 280A in Commissioner v. Soliman , 506 U.S. 168, 113 S. Ct. 701, 121 L. Ed. 2d 634 ( 1993). In Soliman , the Court found that a determination of whether the hom e office is the principal place of business necessarily requires a comparison betwe en the home and other places of business. See id. at 174. The Court indicated that two factors shou ld be considered in making this comparison: (1) “the relative importance of the activities performed at each business location”; an d (2) “the time spent at each place.” Id. at 175. The Court also emphasized, however, that [t]here may be cases when there is no principal pla ce of business, and the courts and the Commissioner should not strain t o conclude that a home office qualifies for the deduction simply beca use no other location seems to be the principal place. The taxp ayer’s house does not become a principal place of business by default

. Id. at 177. In addition to showing that the home offi ce is the principal place of business, § 280A also requires a taxpayer to prove that the home office was used “exclusively” and “on a regular basis” as the princ ipal place of business. See I.R.C. § 280A(c)(1)(A); see also Langer v. Commissioner , 989 F.2d 294, 295 (8th Cir. 1993) (affirming tax court’s denial of home of fice deduction based on taxpayer’s failure to show exclusive use); Browning v. Commissioner , 890 F.2d- 18 -

1084, 1087-88 (9th Cir. 1989) (affirming tax court’ s denial of home office deduction because taxpayer failed to meet requireme nt of regular use). Whether a taxpayer’s residence is his personal plac e of business is primarily a factual question, and we therefore revi ew the tax court’s findings in this case for clear error. See Langer , 989 F.2d at 295; Pomarantz 867 F.2d at 497. Reviewing the tax court’s finding that the Kurzets were not entitled to deduct home office expenses under this standard, we cannotconclude that reversal is warranted in this case. The Kurzets argue that the tax court did not apply the balancing test set forth in Soliman . We find that this contention is without merit. The tax court cited Solimanin the written opinion and clearly balanced the importance of the activities and the time spent at each location with respect to the timber farm. The tax court’s conclusion with respect to the timber f arm is clearly correct in light of the extensive time the Kurzets spent there and the extent to which improvements on the Oregon property were the focus of the busine ss. To the extent that the tax court’s application of t he Solimon“balancing” is less clear in connection with the remaining busines ses, we nonetheless cannot find clear error. The Kurzets do not refer to fact ual findings of the tax court or other facts in the record that would allow this cou rt to evaluate the manner in which they used the rooms in their home. The Kurze ts merely make the- 19 -

conclusory assertion in their brief that all of the ir activities related to the consulting work and the real estate and computer bu sinesses were conducted from their home. The Supreme Court clearly indicated in Solimonthat courts are not to conclude that the home is the principal place of bu siness by default. Thus, the Kurzets’ assertion that there is no other place of business with respect to some of the Kurzets’ business ventures does not automatical ly entitle them to a home office deduction and is an insufficient basis for t his court to find clear error. This court is also persuaded that the Kurzets are not en titled to a home office deduction in light of their failure to direct this court’s attention to portions of the record which clearly establish that their use of th ese rooms was “exclusive” and “regular” as required pursuant to § 280A. III. Investment Property Deduction for Tahiti Home Section 212(2) of the Internal Revenue Code provide s that an individual may deduct all the ordinary and necessary expenses paid or incurred during the taxable year for the “management, conservation, or maintenance of property held for the production of income.” The Kurzets allege that the trial court erred in finding that the Tahiti property was not held for t he production of income and that their expenses relating to the Tahiti property were therefore not deductible. In denying deductions for the Kurzets’ Tahiti prope rty, the tax court found that the property “has inherently associated with i t extensive recreational and7 Section 183 of the Internal Revenue Code provides that deductions are

generally not allowed where an activity is not enga ged in for profit. The code defines an activity not engaged in for profit with reference to § 212. See I.R.C. § 183(c). Similarly, the regulations accompanying § 212 specifically refer to § 183. See Treas. Reg. § 1.212-1(c) (“For provisions relating to activities not engaged in for profit applicable to taxable years beginning af ter December 31, 1969, see section 183 and the regulations thereunder.”) In l ight of the interrelated nature of §§ 183 and 212, it is appropriate to refer to Treas ury Regulation § 1.183-2 in our (continued...) - 20 - personal aspects” and that the Kurzets did not “sat isfy their burden of proof that the Tahiti Property was held and managed by them fo r anything other than personal reasons.” The court also noted that the K urzets did not maintain complete and adequate records with regard to expend itures made on the property and that there was no proof of the unrealized econo mic gain of $1.94 million dollars on the property claimed by the Kurzets. Sp ecifically, the court determined that “no credible evidence supports either the amou nt or nature of the claimed expenses petitioners incurred on the Tahiti Property, nor the fair market value of the Tahiti Property.” Like all other deductions, the taxpayer bears the b urden of proving that he is entitled to a deduction for expenses related to investment property. See Welch , 290 U.S. at 115; Cannon v. Commissioner , 949 F.2d 345, 350 (10th Cir. 1991). The tax regulations set forth guidelines for determ ining if an activity is engaged in for profit, and provide, in part, that “greater weight is given to objective facts than to the taxpayer's mere statement of his intent .” Treas. Reg. § 1.183-2(a). 77 (...continued)

analysis. See Cannon , 949 F.2d at 349. - 21 - The regulations further instruct us to take “all fa cts and circumstances with respect to the activity . . . into account,” when d eciding if property is used for personal or investment purposes, but warn that “no one factor is determinative in making this determination.” Id. § 1.183-2(b). The regulation states that the following factors are among those which should norm ally be taken into account in determining if a taxpayer is entitled to a deductio n pursuant to § 212(2): (1) manner in which the taxpayer carries on the activity; (2) expertise of the taxpayer or his advisors; (3) time and effort expended by th e taxpayer in carrying on the activity; (4) expectation that assets used in activ ity may appreciate in value; (5) the success of the taxpayer in carrying on other si milar or dissimilar activities; (6) the taxpayer's history of income or losses with res pect to the activity; (7) the amount of occasional profits, if any, which are ear ned; (8) the financial status of the taxpayer; and (9) elements of personal pleasure or recreation. See id. In support of their claim that the tax court erred in finding that there were no allowable deductions for expenses on the Tahiti property, the Kurzets emphasize that there was evidence in the trial reco rd to support the conclusion that their home in Tahiti was investment property. The Kurzets point to: (1) the summary of the expenses they incurred on the Tahiti property; (2) the fact that the8 The Kurzets argue that the tax court improperly exc luded a then-current

appraisal of the property. The record reflects that the Kurzets sought to admit this evidence pursuant to Federal Rule of Evidence 807 (formerly Federal Rule of Evidence 803(24)), but that the Commissioner object ed on the ground that he had not received adequate notice as required under the rule. We find no abuse of discretion in this ruling. See Cartier v. Jackson , 59 F.3d 1046, 1048 (10th Cir. 1995) (explaining that this court reviews evidentiary rulings under an abuse of discretion standard). The Kurzets also contend in their reply brief the tax court erred in excluding Exhibits 126 and 133, which summ arized some of the Tahiti expenditures. We deem this argument to have been r aised for the first time in the Kurzets’ reply brief, and we therefore decline to c onsider it on appeal. See Lyons v. Jefferson Bank & Trust , 994 F.2d 716, 724 (10th Cir. 1993). - 22 - property was listed for sale in 1989; (3) Kurzet’s testimony that he believed that the property increased in value to $3.7 million by 1994; 8 (4) testimony regarding the fact that money was transferred from the United States to Tahiti to improve the property; and (5) testimony from the Kurzets an d two of their former employees that the Kurzets spent all of their time in Tahiti working to improve the property and none of it swimming in the ocean o r otherwise relaxing. We review the question of whether an activity has b een engaged in for profit pursuant to § 212 under a clearly erroneous standard as it is a question of fact. See Cannon , 949 F.2d at 349. In light of the factors to be c onsidered under the regulations, we find that the district court di d not clearly err in denying the deduction pursuant to § 212. While the fact that the Kurzets had not realized a profit on their property is not fatal to their claim, see Treas. Reg. § 1.183-2(b)(4) (“[T]he taxpayer may- 23 -

intend to derive a profit from the operation of the activity, and may also intend that, even if no profit from current operations is derived, an overall profit will result when appreciation in the value of land used in the activity is realized since income from the activity together with the appreciation of land will exceed expenses of operation.”), we nonetheless find that there is no evidence in the record which shows that the tax court was clearly e rroneous in finding that the Kurzets had failed to show that the Tahiti propertywas held for profit. The Kurzets’ recordkeeping concerning their expendi tures relating to the Tahiti property weighs both ways. The treasury reg ulations indicate that “the fact that the taxpayer carries on the activity in a busi nesslike manner and maintains complete and accurate books and records may indicat e that the activity is engaged in for profit.” Id. § 1.183-2(b)(1). Thus, conversely, the inadequate record keeping supports the conclusion that an activity wa s not engaged in for profit. In their opening brief, the Kurzets only point to a co nclusory summary of their expenses related to the Tahiti property and testimo ny of Mrs. Kurzet that she kept track of the money transfers and expenditures relat ed to the Tahiti property on her home computer. This would not satisfy the recordke eping factor. However, in their reply brief, the Kurzets refer to Joint Exhib it 70BR as evidence of their expenses associated with the Tahiti property. Exhi bit 70BR provides a list of every expenditure the Kurzets’ made by check and cr edit card in the years 1987,- 24 -

1988, and 1989. While these lists describe the gen eral category for every expenditure (e.g., operating supplies, repairs and maintenance, etc.) and are more complete than the other records, we do not find that this evidence necessarily supports the conclusion that the Tahiti property wa s held for profit. This is because the lists indicate that the Kurzets designated most of their expense entries associated with the Tahiti property as nondeductibl e personal expenses. By contrast, the Kurzets sought to deduct most expense s associated with their timber farm as business expenses. In addition, adequate r ecordkeeping is only one of the factors to consider in determining whether the prop erty was being held for profit. With respect to the second factor, there is no evid ence to show that the Kurzets prepared to invest in Tahiti by “extensive study of its accepted business, economic, and scientific practices,” see id. § 1.183-2(b)(2), or that they sought advice concerning the investment. This is in contr ast to their decision to invest in the timber farm. While the fact that the Kurzets spent considerable time and effort working to improve the property is an indication that they may have purchased the Tahiti property with an eye toward obtaining a profit, thi s fact does not compel the conclusion that the tax court erred. The Kurzets c ould easily have sought to make the improvements to the property for the purpose of maximizing their own enjoyment. See Carkhuff v. Commissioner , 425 F.2d 1400, 1405 (6th Cir. 1970)- 25 -

(finding that improvements that taxpayers had made to a vacation cottage which would have made the cottage suitable for rental als o could have been “intended to satisfy the personal tastes and comfort of the taxp ayers” and explaining that “[t]he making of repairs and improvements . . . does not c ompel the conclusion that a profit motive was present.”). Indeed, the tax court found that the following improvements, which are consistent with personal en joyment, were made to the Tahiti property: “petitioners or others paid by pet itioners remodeled and renovated a house, installed a solar heating system , a spa, a culinary water system, and underground utilities, dredged a boat channel, added a satellite TV system, converted the electrical power to 110 volts, instal led a diesel power generator as an alternate source of electricity, and made other significant improvements.” In addition, although the evidence suggesting that the Kurzets expected the property to appreciate in value carries some weight , we conclude that it does not compel a finding of error on the part of the tax co urt either. Kurzet testified that he purchased the property because of its “excellentcommercial potential” and because he thought it was “an excellent hotel site. ” There was no evidence, however, to suggest that the Kurzets ever tried to maximize this potential by pursuing development plans with commercial develope rs or even by renting the9 The fact that the Kurzets did not rent out the prop erty is inconsistent with

their other real estate ventures. See Treas. Reg. 1.183-2(b)(5) (noting that the “success of the taxpayer in carrying on other simil ar or dissimilar activities” may be weighed in assessing profit motive). The tax co urt found that an industrial warehouse and two condominiums in Park City, Utah o wned by the Kurzets were all rented to tenants. (See Add A. at 24.) - 26 - property when they were not using it. 9 We also find persuasive the Commissioner’s argument that the Kurzets’ work to d evelop the property was, in fact, inconsistent with the intent to develop its c ommercial potential as a hotel site. In addition, the evidence that the Kurzets p ut the property on the market in 1989 does not necessarily signify that the propertywas purchased with the intention of making a profit, particularly in lightof the fact that the Kurzets still owned the Tahiti property at the time of the trial in 1995. Finally, while actual appreciation in value may provide some evidence that a property may be held for profit, we conclude that Kurzet’s subjective believ e as to the value of the property in 1995 is not sufficient to establish a profit mot ive. As a final matter, we address briefly Holmes v. Com missioner , 184 F.3d 536 (6th Cir. 1999), and Hoyle v. Commissioner , 68 T.C.M. (CCH) 1321 (1994), which the Kurzets cite in support of their contenti ons relating to the § 212 deduction. These cases deal with situations where taxpayers sought to deduct costs associated with working farms that were also used by the taxpayers for recreational purposes. We find that Holmes and Hoyle have no bearing on our- 27 -

analysis in this case as the Kurzets’ Tahiti property is not sufficiently analogous to a working farm. Moreover, both Holmes and Hoyle are distinguishable from the present case because there was significant evid ence in those cases concerning the business activities and types of improvements that occurred on the farms, and which allowed for the conclusion that the taxpayers undertook the farming activities for the purpose of obtaining a profit. In conclusion, we find that the tax court was not c learly erroneous in denying a deduction for the expenses associated with the Tahiti property. IV. Calculation of the Cost Recovery Period on the Reservoir At trial, the Kurzets sought to change the period o f time over which the reservoir located on their Oregon property was depr eciated. The Kurzets had constructed the reservoir in 1988 after purchasing the timber farm. On the tax returns filed by the Kurzets, they calculated the a mount of depreciation of the reservoir based on a 31.5-year recovery period. Th e Kurzets argued before the tax court that the depreciation of the reservoir ac tually should have been calculated pursuant to a 15-year recovery period. As relevant here, prior to enactment of the Acceler ated Cost Recovery System (“ACRS”) and Modified Accelerated Cost Recov ery System (“MACRS”) schemes for depreciation, the period of time used t o determine the amount of depreciation that could be claimed by a taxpayer wa s called the “useful life.” The- 28 -

useful life was the period of time over which the a sset may be reasonably expected to be useful to the taxpayer in his trade or business. See Treas. Reg. § 1.167(a)-1(b). Useful life was determined by weigh ing a number of factors, including wear and tear, industry developments and changes in the taxpayer’s business, climatic conditions peculiar to the taxpayer’s trade or business, and the taxpayer’s policy as to repairs. See id. Thus, the regulations reflect that the useful life of an asset was calculated on a case-by -case basis. Congress enacted the ACRS depreciation scheme in 1981 and assigned a ll types of depreciable assets predeterminedrecovery periods, thus abandoning the “useful life ” concept with regard to property acquired after 1980. See Grinalds v. Commissioner , 65 T.C.M. (CCH) 1971, 1972 (1993); see also Rev. Proc. 87-56, 1987-2 C.B. 674 (setting forth recovery period for various assets). The parties agree that, under the current MACRS scheme (the successor to the ACRS scheme), the reservoir recovery period would be 15 years. The tax court decided this issue in its bench opini on of February 24, 1997. The tax court made three findings in connection wit h the Kurzets’ claim. First, the tax court found that the Kurzets had adequately raised the issues as to depreciation and that the issue was properly before the court. The court went on to “note[] and emphasize[] [that] the petitioners a re not electing and utilizing MACRS. They are utilizing a straight line method.” Based on this factual- 29 -

finding as to the method of accounting used by the Kurzets to calculate depreciation, the court concluded: The straight line method taxpayer for useful life d oes not necessarily use an MACRS or ACRS class life, but rather the eco nomically determined actual useful life of the asset. There is no evidence here that–specific evidence as to–that would support the change from 31 [sic] years as claimed on the taxpayers’ return to the 15 years as an economic matter, and the court declines to approve of this required change in the useful life of the reservoir based on the lack of evidence that would support it. As an initial matter, we must address the Commissi oner’s assertion that the Kurzets waived this argument before the tax court. In support of this argument, the Commissioner cites the fact that the none of th e Kurzets’ petition, amended petition, or pretrial memorandum referred to this i ssue and also emphasizes that the court stated during its bench opinion that the court only “reluctantly” treated the issue as having being raised. Our review of th e record suggests that the tax court elected to treat the question of the recovery based on the belief that the issue had been tried by consent of the parties. We review such a finding for an abuse of discretion. See Gold v. Local 7 United Food & Commercial Workers Union , 159 F.3d 1307, 1309 (10th Cir. 1998) (decision to allow parties to amend pleadings based on trial by implied consent is disc retionary). A discretionary decision of this nature should only be reversed if “we have a definite and firm conviction that the trial court made a clear error of judgment or exceeded the bounds of permissible choice in the circumstances,” Richardson v. Missouri Pac.- 30 -

R.R. Co. , 186 F. 3d 1273, 1276 (10th Cir. 1999) (internal q uotations and citation omitted). The Commission cites no evidence that le ads us to the conclusion that the issue was not tried by the parties, and we ther efore decline to consider this argument to have been waived. With respect to the substantive question presented on appeal, the Kurzets argue that the tax court correctly found that the K urzets used a straight-line method of calculating depreciation of the reservoir , but improperly concluded that the Kurzets were not using MACRS. The Kurzets emph asize that this error led the court to believe erroneously that the Kurzets h ad to provide evidence to show that the “useful life” was 15 years rather than 31. 5 years. The Kurzets argue that question of useful life is irrelevant under MACRS and that the tax court should have simply reclassified the reservoir as 15-year p roperty pursuant to Revenue Procedure 87-56. The first issue this court must resolve is whether the tax court improperly concluded that the Kurzets were not using MACRS to calculate depreciation. The Kurzets contend that they were using MACRS to calcu late the recovery period because the reservoir was placed in service in 1988 . Congress enacted MACRS in 1986, and it is “effective generally for tangible, depreciable property placed in service after December 31, 1986.” Hospital Corp. o f America v. Commissioner , 109 T.C. 21, 42 (1997). Thus, it would appear thatMACRS should be used to10 The Commissioner suggests that the Kurzets’ attorne y created the tax

court’s confusion. Our review of the record indicates that an attorney representing the Commissioner also contributed sign ificantly to the court’s confusion by stating, “MACRS is a different method than what they were using. They weren’t using MACRS .” (Emphasis added.) - 31 - calculate depreciation for the reservoir. Moreover , the Commission agrees with the Kurzet’s claim that they calculated depreciatio n for the reservoir under MACRS. We therefore find that the tax court erred in concluding that the Kurzets were not using MACRS. 10 We must now determine whether the Kurzets were, in fact, entitled to change the recovery period for the reservoir under MACRS from 31.5 to 15 years. The Commissioner urges us to affirm the tax court’s decision on the ground that a taxpayer can only change the recovery period with t he permission of the Commissioner. The Kurzets do not dispute the Commi ssioner’s assertion that permission to change the recovery period was not ob tained. We agree with the Commissioner that it was necessary for the Kurzets’ to have obtained permission in order to have changed the recovery period on the reservoir, and we affirm the tax court’s decision to deny the change in recoveryperiod on this alternate ground. See United States v. Sandoval , 29 F.3d 537, 542 n.6 (10th Cir. 1994) (“We are free to affirm a district court decision o n any grounds for which there is a record sufficient to permit conclusions of law, e ven grounds not relied upon by the district court.” (quotations omitted)).- 32 -

Section 446(d) of the Internal Revenue Code provide s that “a taxpayer who changes the method of accounting on the basis of wh ich he regularly computes his income in keeping his books shall, before computing his taxable income under the new method, secure the consent of the Secretary.” See also Treas. Reg. § 1.446(e)(2)(i) (“[A] taxpayer who changes the metho d of accounting employed in keeping his books shall, before computing his incom e upon such new method for purposes of taxation, secure the consent of the Com missioner.”). Thus, the question in this case is whether a change in the re covery period under MACRS for an asset is a change in the method of accounting. Treasury Regulation § 1.446(e)(2)(ii)(a) defines this phrase as follows: A change in the method of accounting includes a cha nge in the overall plan of accounting for gross income or dedu ctions or a change in the treatment of any material item used i n such overall plan . . . A material item is any item which involves th e proper time for the inclusion of the item in income or the taking o f a deduction. Under the plain language of the regulation, it appe ars that a change in the recovery period is a change in the method of accoun ting because it affects the time at which a deduction is taken. However, a cha nge in the “useful life” of an asset was not considered to be a change in an accou nting method and therefore could be modified by a taxpayer without permission. See Treas. Reg. § 1.446- 1(e)(2)(ii)(b) (“[A] change in the method of accounting does not include . . . an adjustment in the useful life of a depreciable asse t.”). The Kurzets argue that a- 33 -

“recovery period” under MACRS should be treated in a like manner to its predecessor, the “useful life,” and that permission to change the recovery period is therefore not required. This approach is not consistent with that taken by the Commissioner. The Commissioner interprets the regulations as requirin g a taxpayer to obtain permission for a change in the recovery period desp ite the fact that permission is not required for a change in useful life. See Rev. Proc. 96-31, 1996-1 C.B. 714 (“A change from not claiming the depreciation or am ortization allowable . . . to claiming the depreciation allowable is a change in the method of accounting for which consent of the Commissioner is required.”); I .R.S. Pub. 538 (1993) (“Some changes that are not changes in accounting methods and do not require consent are: . . . (4) an adjustment in the useful life of a depreciable asset. You cannot change the recovery period for ACRS or MACRS property (depreciable property placed in service after 1980).”). We are required to give deference to this interpretation, unless it is plainly erroneous or i nconsistent with the regulation. Thomas Jefferson Univ. v. Shalala , 512 U.S. 504, 512, 114 S. Ct. 2381, 129 L. Ed. 2d 405 (1994); see also Connecticut General Life Ins. Co. v. Commissioner , 177 F.3d 136, 144 (3d Cir. 1999) (applying plainly erroneous standard to Commissioner of Internal Revenue’s interpretations of Treasury Regulations);- 34 -

Harbor Bancorp & Subsid. v. Commissioner , 115 F.3d 722, 727 (9th Cir. 1997) (same). While there is some persuasive value to the argumen t that a change in recovery period under MACRS should be treated like a change in the useful life, we cannot conclude that the Commissioner’s interpre tation is “plainly erroneous” or “inconsistent” with the regulation. The plain l anguage of the regulations only excludes an adjustment for a change in the calculat ion of useful life from the requirement of obtaining the Commissioner’s consent . Moreover, had the Commission intended to exclude a change in recoveryperiod under MACRS as well as a change in useful life from the permission requirement, it had ample opportunity to do so in light of the fact that Trea sury Regulation § 1.466-1 was amended on at least seven occasions following the e nactment of the ACRS. See T.D. 8067, 51 FR 378, Jan. 6, 1986; T.D. 8131, 52 F R 10084, March 30, 1987; T.D. 8408, 57 FR 12419, April 10, 1992; T.D. 8482, 58 FR 42233, Aug. 9, 1993; T.D. 8608, 60 FR 40078, Aug. 7, 1995; T.D. 8719, 62 FR 26741, May 15, 1997; T.D. 8742, 62 FR 68169, Dec. 31, 1997. In conclusi on, we find that the tax court did not err in preventing the Kurzets from modifyin g the recovery period for the reservoir.- 35 - CONCLUSION We reverse the judgment of the tax court with respe ct to its determination of whether the Kurzets were entitled to deductions for expenses associated with the operation of their Lear jet. In connection wit h that claim, we reverse and remand with an instruction for that court to calcul ate the appropriate value for the deductions and to amend its order to allow the dedu ctions consistent with this opinion. We affirm all other aspects of the judgme nt.