T.C. Mem o. 2 01 3- 22 1

UNITED STAT ES TAX COURT
ZAVRA D. RODRIGUEZ, Pet it io ne r v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt ANDREA M. RODRIGUEZ, Peti ti on er v . COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No s. 5 09 3- 11 , 50 94 -1 1. File d S ep te m be r 18 , 20 13
.
Ant ho ny V. Dio sd i, fo r pe ti ti on ers . Tim ot hy A. Fro eh le , forres po nd en t.

MEMORANDUM FINDINGS OF FACT AND OPINION LARO, Ju dg e: In s ep arat e n ot ic es of d efi ci en cy , res po nd en t d et erm in ed de fic ie nc ie s i n p et it io ne rs ’ Fed eral in co m e ta x andrel at edaccu racy-rela te d pe na lt ie s fo r 20 07 as f

ol lo ws:-2
- [* 2] Pet it io ne r Defi ci en cy Accu racy-rela te d p en al ty se c. 66 62 And rea M . Rodrig ue z $2 4,7 01 $4 ,94 0 Z av ra D. Ro dr ig ue z 22 ,22 8 4,4 45 Pet it io ne rs , whi le res id in g i n C al ifo rn ia , pet it io ne d thi s C ou rt f or a red et erm in at io n o f th ei r de fic ie nc ie s an d p en al ti es . The p art ie s wer e ab le to res ol ve a nu m

be r of is su es refl ect edinth e st ip ul at io n o f se tt le d i ss ue s fi le d Octo be r 23 , 20 12 . W e d eci de two rem ai ni ng is su es : (1 ) whe th er p et it io ne rs ’ ho rs e-b reed in g a ct iv ity

was “ anact iv it y

no t en ga ge d i n fo r pr of

it ” wit hi n t he
m ean in g o f se ct io n 1 83 for20 07 . W e h ol d i t was ; an d (2 ) whe th er p et it io ne rs are 1 li ab le forth e acc ur acy-relate d p en al ti es un de r se ct io n 6 66 2( a). W e h ol d t he y are no t. FINDINGS OF FACT The pa rti es ’ st ip ul at io n o f fac ts with a cco m pa nyin g e xh ib it s, the ir
supp le m en ta l s ti pu la ti on of f act s wi th acco m

pa nyin g e xh ib it s t o t he ex te nt adm it te d dur in g t ria l, an d t he st ip ul at io n o f se tt le d i ss ue s ar e in co rp or at edhe rei n by thi s re fere nc e. W e fi ndth e fac ts acco rd in gl y .
Unl es s o th erwi se in di cat ed , sec ti on refe ren ces are t o the Int ern al Rev enue 1 Co de (Co de ) in effe ctforth e y ear a t i ss ue , andRu 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
-

[* 3] I. Pet it io ne rs ’ wag e in co m e h is to ry Andrea h as be enem

pl oyed b y th e St at e o f Cal ifo rn iaas a“ st at e in ve st ig at or ” si nc e atlea st19 93 . Betwe en19 93 an d 2 00 0, An dr ea an d h er the n hu sb an d, J os é Ro dr ig ue z, fi le d ajoi ntFed eral in co m e ta x re tu rnforeach y ear a nd rep orte d aco m

bi ne d a nn ua l i nc om e, in cl ud in g wag es , ran gi ng fro m $7 8,0 00 to $1 08 ,00 0. Aft er the ir d iv or ce, An dr ea re po rte d h er an nu al in co m e, in cl ud in g wag es , ran gi ng fro m

$4 8,0 00 to $7 1,0 00 fory ears 20 01 th ro ug h 2 00 9; ex cep t tha t in 20 07 , th e y ear a t i ss ue , Andrea h ad$6 9,9 77 ad di ti on al in co m e fro m a di st rib ut io n fr om

pe ns io ns an d a nn ui ti es . Zav ra, An dr ea’s d au gh te r, be ga n fi li ng Fed eral in co m e ta x re tu rn s i n 2 00 2. Zav ra re po rte d a nn ua l wag e in co m e ran gi ng fro m $2 2,0 00 to $3 5,0 00 , exc ep t i n 20 07 when sh e al so rece iv eda di st rib ut io n fr om pe ns io ns an d a nn ui ti es of $6 9,9 77 (th e sa m e am ou ntAndrea r ecei ve d i n the same y ear)
. II. Pet it io ne rs ’ ho rs e-b reed in g a ct iv it y A. His to ry

of i nc om e an d l os se s fr om th e h or se -b reed in g a ct iv it y 1. Que en sl an d’s l os se s Andrea andhe r th enhu sb an d J os é b eg anth ei r ho rs e-b reed in g a ct iv it y , Que en sl an d Ho rs e Farm

(Que en sl an d) , in19 93 , whi chpe ti ti on ers ha ve co nduc te d atall rel ev an t t im es at a40 -acr e farm in g p ro pe rty in F arm in gt on , Cal ifo rn ia-4
-

[* 4] (Farmin gt on pro pe rty). Fro m it s i nc ep ti on th ro ug h 2 00 9, the ho rs e-b reed in g 2 act iv ity ne ve r turn eda pr of

itan d i n fa ctin cu rredm or e th an$1 .8 m il li on of l os se s rep orte d o n S ch edul e F, Pro fitor Lo ss Fro m Farm in g. Be twee n 2 00 2 an d 2 00 8, 3 Andrea a ndZavr a eac h c la im edha lf o f th e d educ ti on s fo r th e an nu al lo ss es res ul ti ng fro m

th e act iv ity . W ith t he lo ss es , pet it io ne rs were ab le to off se t al l o f th ei r in co m e dur in g t he pe rio d b etween19 93 an d 2 00 8 a ndin cu r zer o t ax li ab il ity as sh own inth e fo ll owi ng tab le : 4

Andrea a ndJo sé pu rch as edth e Farm in gt on pro pe rty in 1 98 9. Whenth ey 2 pu rch as edth e Farm in gt on pro pe rty, the pro pe rty als o i nc lu de d ares id en ce wh ere pe ti ti on ers ha ve li ve d s in ce. Zav ra b ecame Andr ea’s p artne r in th e h or se -b reed in g a ct iv it y in20 02 . See 3 in fra. Th e rec or d d oe s n otsh ow tha t Zav ra fi le d aFed eral in co m e ta x re tu rn be fo re 2 00 2. In20 09 Zavr a le ft the pa rtn ers hi p a nddi d n otcla im an y lo ss de du ct io n 4 fro m th e h or se -b reed in g a ct iv ity . As a res ul t, Zav ra h ada ta x l iabi li ty of $1 1,8 29 on he r $3 1,1 29 wage in co m e fro m 20 09
.-5
-

[* 5] Andr ea’ s Z avra’ s

Year 1 Inco m e &

wages (e xcl udi ng Sche dul e F inc om e) Sche dul e F

inc om e or (l oss ) T axable

inc om e (a ft er deduct ion s) Inco m e &

wages (e xcl udi ng Sche dul e F inc om e) Sche dul e F

inc om e or (l oss ) T axable

inc om e (a ft er deduct ion s) 1993 $7 7,66 4 ($ 113, 988) - 0-
- - - - - - - - - 1994 8 3,49 5 ( 57,3 21) - 0-
- - - - - - - - - 1995
- - - - - - - - - - - - - - - - - - 1996
- - - - - - - - - - - - - - - - - - 1997
- - - - - - - - - - - - - - - - - - 1998
- - - - - - - - - - - - - - - - - - 1999 10 5,46 8 ( 145, 699) - 0-
- - - - - - - - - 2000 10 7,94 7 ( 156, 149) - 0-
- - - - - - - - - 2001 5 7,48 7 ( 135, 370) - 0-
- - - - - - - - - 2002 5 8,50 5 ( 81,5 65) - 0- 2 1,50 3 ( 81,5 65) - 0- 2003 7 0,79 0 ( 59,9 24) - 0- 2 6,16 2 ( 59,9 24) - 0- 2004 6 7,79 8 ( 49,8 77) - 0- 3 3,40 1 ( 49,8 77) - 0- 2005 6 7,63 5 ( 58,1 18) - 0- 3 3,13 1 ( 58,1 18) - 0- 2006 5 0,15 8 ( 83,1 65) - 0- 3 4,73 8 ( 83,1 65) - 0- 2007 12 1,87 6 ( 105, 424) - 0- 10 4,60 7 (1 05,4 24) - 0- 2008 5 3,19 8 ( 97,6 62) - 0- 3 4,37 7 ( 97,6 62) - 0- 2009 4 7,73 5 ( 128, 452) - 0- 3 1,12 9
- 0- 11 ,829 T ota l 96 9,75 6 (1 ,272 ,714 ) - 0- 31 9,04 8 (5 35,7 35) 11 ,829 Andr ea andJ osé ’s Fed er al in come ta x r eturn s f or years 199 5 thro ugh 1998 ar e no t p art o f t he 1 re cor d. 2. Que en sl an d’s i nc om e Que en sl an d’s i nc om e st ream ov er the y ears was d is m al an d s po rad ic ; i t to ta le d app ro xi m at el y

$1 5,0 00 be twee n 1 99 3 and20 09 . Duri ng th e fi ve -y ear-6
-

[* 6] pe rio d b etween20 04 an d 2 00 8, Qu een sl an d g en erat edzero Sch edul e F in co m e. The fo ll owi ng tab le sh ows Quee ns la nd ’s hi st ory of f arm in co m e:
Yea r Schedule F income fr om Quee nsland 1993 $750 1994 775 1995
--- 1996
--- 1997
--- 1998
--- 1999 -0- 2000 -0- 2001 2,250 2002 5,000 2003 6,000 2004 -0- 2005 -0- 2006 -0- 2007 -0- 2008 -0- 2009 346 Total 15,121-7
-

[* 7] B. Pet it io ne rs ’ res earc h a ndex pe rti se rel at in g t o t he ho rs e-b reed in g

act iv ity 1. Andrea Andrea s ta rte d ri di ng ho rs es at t he ag e o f th ree a ndrece iv edform al in st ru ct io n wh ensh e was inhi gh sch oo l an d c ol le ge . As sh e tr av el edth e wor ld
an d b ecame fam il ia r with d iff eren t ty pe s o f ho rs es , Andrea b ecame fasci na te d wi th
warm bl oo ds , whi chare h or se bre ed s p rimaril y fro m co un tri es wher e ri di ng is an ol de r di sc ip li ne th anitis inth e Uni te d S ta te s. An dr ea p art ic ul arl y en joy edrid in g Swed is h warm

bl oo ds de sc rib edas m ed iu m -s iz edwarm bl oo ds th atare kno wn t o b e sp ort h or se s an d p erfo rm an ce h or se s. In19 90 Andrea t oo k acla ss indre ss ag e whe re s he lea rn eddre ss ag e ex erci se s an d t ech ni qu es . Dress ag e is aneque st ria n s po rt t ha t em ph as iz es co nt ro ll edath le ti c m ov em en ts of aho rs e an d re qu ire s the ho rs e to sp en d years t o be co m e athl et ic al ly fit en ou gh to pe rfo rm cert ai n ro ut in es ; i t i s v ery si mil ar t o gym na st ic s o r ba ll etforhu m an s. Th ere a re ce rta in bre ed s o f ho rs es th atare m or e su cces sf ul inth is di sc ip li ne be cau se of t he de si rab le ph en oty pe th atis m al le ab le to co nt ro ll edm ov em en ts . The m ed iu m -s iz edSwed is h warm bl oo d i s an id eal bre ed fo r th is type o f ri di ng .-8
-

[* 8] Befo re Qu een sl an d’s i nc ep ti on , Andrea a lre ady foc us edhe r res earc h o n br eed in g S wed is h warm

bl oo ds . She be cam e a m em be r of th e Swed is h Warm

bl oo d Ass oc ia ti on (SWA), whi chpe rio di cal ly dis pa tc he d i ns pe ct io n t eam s fr om Swed en to th e Uni te d S ta te s t o g rad e an d e va lu at e h or se s p res en te d at i ns pe ct io n e ve nt s. Eve n tho ug h s he di d n otownan y ho rs es at t he ti m e, Andrea wo ul d a tt en d t he in sp ect io ns to learnab ou t SWA’ s cr it eri a o f gr ad in g h or se s. An dr ea al so want ed to see th e h or se s i n p erfo rm an ces an d s tu dy the ov eral l p he no type tha t SWA’ s br eed in g p ro gr am

tri edto ach ie ve . In 1 98 9 An dr ea al so be cam e a m em be r of th e Cal ifo rn iaDres sa ge So ci ety , whi chso ug htto pro m ot e dres sa ge inCal ifo rn ia th ro ug h p erfo rm an ces , com pe ti ti on s, an d c li ni cs . Inad di ti on , Andrea c on ta ct edalm os t al l Swe di sh warm bl oo d b reed ers inth e Uni te d S tate s an d C an ad a an d agre atnu m be r of th em inSwed enforpu rp os es of
se ek in g e xp ertadvi ce o n b reed in g S wed is h warm bl oo ds . For e xa m

pl e, Andrea co nt act edJan Ph il li ps on , th e p res id en t o f ASVH, whi chis th e Swed is h warm bl oo d st at e as so ci at io n a ndreg is try, to s eekm ark et in g a dv ic e as well as a dv ic e o n t he
su it ab il it y of S wed is h warm

bl oo ds forsp ort p erfo rm an ces an d c om pe ti ti on s. Inth e ear ly 199 0s pe ti ti on ers als o m etwith Hel enDil worth on m ul ti pl e oc cas io ns . Ms. Di lwo rthat the ti m e h adown edan d o pe rat edTril og y Farm , a ho rs e-b reed in g fa rm

an d b us in es s i n S an taCru z, fo r fi ve y ears . Duri ng th ei r-9
-

[* 9] m eet in gs , pet it io ne rs wou ldaskMs . Dil worth ge ne ral qu es ti on s ab ou t h er ap pr oa chto bre ed in g S wed is h warm bl oo ds , eva lu at in g fo al s, an d m ark et in g a nd
va lu in g h or se s. Bu t M s. Di lwo rth di d n otpro vi de advi ce s pe ci fic to pe ti ti on ers ’
own op erat io n o r bu si ne ss pl an . Whi le Ms . Dil worthbe li ev es th atsh e b reed s go odho rs es , sh e al so ackno wled ge s tha t “ th ere a re v ery few p eo pl e inth e wor ld rig htno w th atare m ak in g a ny m on ey bre ed in g h or se s.” Th ere h as be enli tt le
co nt actbe twee n p et it io ne rs an d M s. Di lwo rth inth e p as t 1 0 years. Bes id es co nt act in g t ho se fam il ia r with b reed in g S wed is h warm bl oo ds , Andrea a ls o wen t t o t he Sm al l Bu si ne ss Adm in is tra ti on (SBA) i n S anFran ci sc o os te ns ib ly to o bt ai n b us in es s ad vi ce fr om th ei r SCORE Pr og ram . SCORE co ns is ts of a gr oup o f ret ire d e xe cu ti ve s wh o o fferm en to rin g s erv ic es to sm al l b us in es se s. Inco nn ect io n wi thob ta in in g b us in es s ad vi ce fr om SCORE, And rea s ub m it te d a bu si ne ss pl anin19 93 (19 93 bu si ne ss pl an ) th atco nt ai ne d o nl y ge ne ral in fo rm at io n. Se e in fra. Th e p la n m ai nl y di sc us se d b reed in g o f ho rs es . After Andrea s ub m it te d t he bu si ne ss pl an , sh e ta lk edto anin di vi du al fro m SCORE ab ou t the pl an , bu t the pe rs on ha d n o kno wled ge ab ou t h or se s, h adne ve r be enpa rt of an y ho rs e b us in es s, an d was no t ac qu ai nt edwith a nybo dy who h adho rs es or a ho rs e b us in es s. Th e rec or d i s d ev oi d o f de ta il s re ga rd in g t he co nt en t o f an y-1 0-

[* 10 ] bu si ne ss advi ce An dr ea m ig htha ve rece iv edfro m th e in di vi du al th ro ug h th is co ns ul ta ti on .

2. Zav ra Zav ra b eg antak in g ri di ng les so ns when sh e was a ch il d. Sh e h as alway s en joy edbe in g a ro un d h or se s as th ey ha ve alway s b eena pa rt o f he r li fe, s o m uc h
so th atat o ne po in t s he dre am edof b eco min g aho rs e v et eri na ry ph y si ci an . As earl y as 1 98 5 wh enZavr a was 12 , sh e al read y be ga n s tu dyin g abo utho rs es . Between19 91 an d 1 99 3 s he att en de d Un iv ers it y of C al ifo rn iainDavi s (UC Dav is ) sp or ad ic al ly for two years andto okcla ss es inag ric ul tu ral sci en ces an d
an im al hu sb an dry . She als o t oo k c la ss es inho rs e b reed in g, arti fic ia l i ns em in at io n, an d g en eral m an ag em en t an d c are. Zav ra h adanin te rn sh ip at UC Da vi s o n h or se br eed in g a s wel l as in te rn sh ip s wi th lo cal ve te rin ari an s. Inad di ti on , sh e to ok cl as se s i n t he Swed is h l an gu ag e whi le at UC Da vi s wi th th e id ea tha t s he co ul d la te r co m m un ic at e wit h b reed ers inSwed en . Aro un d t he same tim e, Zav ra s tarte d t o fo cu s h er re se arch on bre ed in g Swed is h warm

bl oo ds . She co nt act edass oc ia ti on s i n S wed enan d re vi ewed
co m pe ti ti on res ul ts . Zavrabe li ev edon th e b as is of h er re se arch th atSwed is h
warm bl oo ds were m or e m ark et ab le an d m or e su it ab le forsp ort p erfo rm an ces an d
co m pe ti ti on s. In19 93 Zavr a tr av el edto Swed en , m etwith b reed ers th ere t o fi nd-1 1-

[* 11 ] th e b es t h or se s, an d b ro ug htba ckwith h er ab ou t fi ve ho rs es fro m Swed en . In19 96 sh e arr an ge d t he pu rch as e an d s hi pp in g o f ho rs e se m enfro m Swed en . C. The m an ne r in whi chpe ti ti on ers carr ie d o n t he ho rs e-b reed in g act iv ity 1. Bu si ne ss pl an Andrea a ll eg ed ly dev is eda bu si ne ss pl anforhe r ho rs e-b reed in g a ct iv it y as earl y as 1 98 1 a ndsubm it te d i t t o t he SBA in SanFran ci sc o fo r fee db ack . The 19 93 bu si ne ss pl ansubm it te d t o t he SBA was a rev is io n o f th is ori gi na l b us in es s pl anan d, ac co rd in g t o p et it io ne rs , was upd at edsev eral ti m es fol lo win g t he in it ia l
subm is si on to th e SBA. The in it ia l s ub m is si on fro m 19 93 is th e o nl y

bu si ne ss pl aninev id en ce. The reco rddo es no t s ho w when th e la stti m e p et it io ne rs rev is ed
orrev is it edth ei r bu si ne ss pl anwas. The 19 93 bu si ne ss pl anco nt ai ns fiv e p arag rap hs of g en eral de sc rip ti on of th e h or se -b reed in g a ct iv ity . It p ro vi de s m ai nl y in fo rm at io n o n b reed in g a nd tra in in g S wed is h warm

bl oo ds . It s ta te s tha t Qu een sl an d i s g eare d t owa rd“ th e se rio us up pe r-l ev el ho rs e ri de r[s ] * * * wh o are ab le to in ve sta gr eatde al of t im e, effo rt, andm on ey

in to th ei r sp ort.” Itco nt in ue s t o s ta te th at“ th e in it ia l i nv es tm en t of pu rch as in g aho rs e is th e le as t co st ly asp ectof Dre ss ag e an d Jum pi ng . The da il y care an d upk eep fora ho rs e is actua ll y th e g reat er ex pe ns e.” Itcla im s tha t-1 2-

[* 12 ] Quee ns la ndwou ldrequi re a l arg e upf ro ntin ve stm en t, i nc lu di ng st artup co st s, an d a ny retu rnonth e in ve st m en t wo ul d b e d el ay edun ti l the ho rs es be co m e m ark et ab le . Accor di ng to th e 1 99 3 b us in es s p la n, the st artup co stforQuee ns la nd
wou ldbe rou gh ly $56 0,0 00
. The 19 93 bu si ne ss pl aness en ti al ly ackn owl ed ge s tha t the pu rch as in g o f a ho rs e co ns ti tu te s o nl y

a sm al l p artof t he ov eral l l on gt erm in ve stm en t i n o wni ng an d t rai ni ng a Swed is h warm bl oo d fo r sp ort, an d t he gre at er ex pe ns e wou ldbe th e da il y care an d upk eep . It thu s ap pe ars th atth e lo ng er p et it io ne rs he ldon to a ho rs e, th e m or e th e p ot en ti al pro fitfro m th atho rs e wou lddi m in is h i n p artbe cau se of th e subs ta nt ia l o ve rh eadex pe ns es . Butth e b us in es s p la n fa il s t o i de nt ify any
co ns id erat io ns th atm ay

affe ctho w pet it io ne rs co ul d m ax im iz e p ro fit s fr om th ei r ho rs es . The 19 93 bu si ne ss pl anals o fa il s t o a rti cu la te sp eci fic bu si ne ss requi rem en ts forth e act iv ity or p ro vi de th e act iv ity ’s fin an ci al s. Fo r ex am pl e, th e bu si ne ss pl ando es no t h av e anop erat in g c os ts pro jecti on , a m

ul ti y ear p ro fitan d lo ss (P&L) p ro

jecti on , a ba la nc e sh eet , or acas hf lo w st at em en t o fte n fo un d i n m an y bu si ne ss pl an s.-1 3-

[* 13 ] 2. Adv ert is in g By 20 07 pe ti ti on ers ha d p la cedno m or e th ana ha nd fu l o f adve rti se m en ts in
va rio us tra de m ag azi ne s an d p ub li cat io ns to li stso m e o f th ei r ho rs es forsal e. The y ha d a ls o a dv ert is edth e se ll in g o f se m enof t he ir s ta ll io ns . Howev er, the re i s no ev id en ce tha t the se adve rti se m en ts ge ne rat edan y actua l s al es or we re su cces sf ul inreac hi ng any

po te nt ia l b uyers. Th ere i s n ot hi ng inth e rec or d
su gg es ti ng pe ti ti on ers have ex am in edth e eff ect iv en es s o f th ei r adve rti si ng effo rts . 3. Bu dg et in g At l eas t b efo re 1 99 9, An dr ea an d J os é, an d p os si bl y Zavr a as well , us edan acco un ti ng so ftwa re t o t rackex pe ns es an d asp eci al ho rs e-b reed in g s of twar e to tra ckth ei r in ve nt ory . Andrea wo ul d k eep tra ckof d ai ly exp en di tu res on in de x card s, an d s om eo ne wou ldth enen te r th e in fo rm at io n i nt o t he acco un ti ng so ftwa re. Pet it io ne rs m ai nt ai ne d asep arat e ch eck in g a cco un t fo r Que en sl an d b uton ly be twee n 1 99 3 a nd19 99
. Altho ug h p et it io ne rs ke pttra ckof Qu een sl an d’s ex pe ns es an d i nv en to ry , th ey ne ve r pe rs on al ly prep aredan y fin an ci al st at em en ts to scrut in iz e th e act iv it y ’s P&L, as se ts an d l iabi li ti es , or c as hf lo w des pi te th e fac t tha t the in fo rm at io n ne ed edto run th e fi na nc ia ls was, ac co rd in g t o An dr ea, rea di ly avai labl e th ro ug h th e acc ou nt in g s of

twar e. Non ethe le ss , pet it io ne rs all eg ed ly m ad e ro ug h fi na nc ia l-1 4-

[* 14 ] pro jecti on s an nu al ly to d et erm in e th e am ou ntof i nc om e n eces sa ry to reco ve r ex pe ns es in cu rredinth e p rev io us y ears an d t o g en erat e a p ro fit . Clea rly, any fin an ci al pro

jecti on s tha t p et it io ne rs m ig htha ve m ad e h adve ry li tt le im pa cton th e bu si ne ss de ci si on s re la ti ng to Quee ns la ndsi nc e th e act iv ity co nt in ue d t o l os e m on ey ev ery y ear and , as we wi ll di sc us s b el ow, p et it io ne rs di d v ery li tt le to tu rn th e ti de
. 4. In su ran ce co ve rag e Pet it io ne rs di d n otha ve an y in su ran ce co ve rag e fo r th ei r ho rs e-b reed in g act iv ity an d d idno t re cei ve an y

in su ran ce p ro ceed s fo r a cas ua lt y lo ss rel at in g t o th e act iv it y

as ares ul t o f a fi re i n 1 99 9 (1 99 9 fi re). Ho wev er, An dr ea an d h er the n hu sb an d h adanin su ran ce p ol ic y un de rwri tt enby Farm ers Ins ur an ce Gro up to co ve r th ei r pe rs on al pro pe rty onth e Farm in gt on pro pe rty andrece iv edin su ran ce pr oc eed s o f $1 65 ,48 5 c ov eri ng pe rs on al pro pe rty los t i n t he 19 99 fir e.

5. Fi na nc in g t he ho rs e-b reed in g a ct iv it y To fi na nc e th e h or se -b reed in g a ct iv it y , bo th Andrea andZavr a u se d t he ir wag e in co m e to pa y

th e act iv ity ’s exp en se s. An dr ea al so us edli fe i ns ur an ce pr oc eed s o f $2 42 ,00 0 tha t s he rece iv edin20 06 an d t he $1 00 ,00 0 o f pr oc eed s o f a 20 05 ho m e equi ty loan s ecu redby the Farm in gt onpro pe rty to p ay Quee ns la nd ’s
ex pe ns es .-1 5-

[* 15 ] Que en sl an d d idno t h av e an y ou ts id e in ve st or s, an d t he reco rddo es no t sh ow p et it io ne rs ha d s ecu reda co m m erci al lo anfro m

a th ird -p arty

len de r to fin an ce the ho rs e-b reed in g a ct iv it y . D. Ass et s u se d i n t he ho rs e-b reed in g a ct iv ity 1. The ho rs es Pet it io ne rs ’ ho rs e-b reed in g a ct iv it y in it ia ll y en co m pa ss edon ly the sel li ng of th e h or se s tha t the y

bre d. In20 07 Quee ns landha d 2 9 h or se s. Si nc e in cep ti on , pe ti ti on ers ha ve so ld7 h or se s as fol lo ws: Hors e Year s ol d Pri ce Sab el la 19 97 $6 ,50 0 Gwenn a 20 01 2,2 50 Garri ss on 20 02 5,0 00 Cas sa no va 20 03 2,5 00 L’ Irco 20 03 1,5 00 Ike ba no 20 03 1,5 00 Lam ira 20 10 5,0 00 Lam irawas an e xa m

pl e o f a d ip lo m a m are- -th atis , sh e was in sp ect edan d fo un d t o b e a h or se of h ig h qua li ty--andwas s ol d fo r $5 ,00 0 i n 2 01 0, am on g t he hi gh es t s el li ng pri ces inQuee ns la nd ’s hi st ory . Butth e jou rn ey sh e tr av el edto he r ev en tu al sal e was a co st ly one . Andrea b ou gh t Lam iraforap pr ox im at el y $1 5,0 00-1 6-

[* 16 ] in19 93 when sh e was ni ne m on th s o ld . For abo uteig hty ears Andrea h adto sp en d at l eas t $ 80 0 am on th to bo ardan d t rai n Lam ira , or abo ut$7 5,0 00 inth e ag gr eg at e. At o ne po in t dur in g t he m id19 90 s, Lam irawas app rai se d fo r $2 5,0 00
. Late r, pe ti ti on ers rece iv edanoff er t o p ur ch as e Lam irafor$1 10 ,00 0, wh ic h pe ti ti on ers reject ed . Peti ti on ers ev en tu al ly sol d Lam iraat t he ag e o f 17 for$5 ,00 0. In19 98 Andrea b eg anto in cl ud e th e se ll in g o f he r st al li on s’ sem enas p art of th e h or se -b reed in g a ct iv ity . At th e ti m e, sh e h adco nt ract edto sel l i n 1 99 9
ro ug hl y $2 5,0 00 wort h o f se m enth atwou ldha ve pro du ced10 bre ed in gs . Becau se th e 1 99 9 fi re d es tro y edth e se m enan d p rev en te d An dr ea fr om pe rfo rm in g the
co nt ract s, An dr ea d idno t co m pl et e an y of the co nt ract edsal es an d d idno t ac tu al ly
rece iv e an y

in co m e in 19 99 fro m

sel li ng ho rs e se m en . Peti ti on ers di d n otco nt ract fo r an y sal es of h or se semen in an y ot he r y ear. 2. The Farm in gt on pro pe rty Si nc e 1 98 9 wh enAndrea a ndhe r th enhu sb an d p ur ch as edth e Farm in gt on Pro pe rty, the y

ha d a ll eg ed ly m ad e certa in im pr ov em en ts . Pres en tl y , Andrea, Zav ra, an d Zav ra’s thr ee-year-o ldch il d l iv e atth e res id en ce o n t he Farm in gt on pr op erty . 5 Fo r 20 07 , pet it io ne rs cla im edut il ity an d i ns ur an ce ex pe ns es rel at in g t o 5 th ei r pe rs on al res id en ce as pa rt o f th e h or se -b reed in g a ct iv it y ’s exp en se s o n t he ir (co nt in ue d...)-1 7-

[* 17 ] The re i s n othi ng inth e rec or d s ho win g t he fai r m ark etva lu e o f th e Farm in gt on pro pe rty andth e im pr ov em en ts on th e p ro pe rty. E. Tim e an d e ffo rts sp en t i n t he ho rs e-b reed in g a ct iv it y In20 07 Andrea wo rk ed40 ho ur s a we ek as ali ti ga ti on in ve st ig at orfor Dep artm en t o f Tran sp orta ti onforth e St at e o f Cal ifo rn ia . Andrea c la im s tha t s he al so work ed84 to 11 2 h ou rs ev ery weekinpe ti ti on ers ’ ho rs e-b reed in g a ct iv it y du rin g a ll rel ev an t t im es . Andrea a ls o c la im s tha t i n s om e y ears sh e h adot he r pa rt- ti m e em

pl oym en ts an d wo rk ed10 to 25 ad di ti on al ho ur s a we ek . Accor di ng to Andrea, the re were day s wh ensh e worke d t wo o r th ree d ay s thr ou gh witho ut sl eep as we ll as d ay s wh ensh e sl ep t i n t he ba rnwith the ho rs es whenth e m ares were ab ou t t o g iv e b irth. Sh e in cl ud es th e num be r of ho ur s s pe ntsl eep in g wi th he r ho rs es as h ou rs work edforth e h or se -b reed in g a ct iv it y . Eve n t ho ug h p et it io ne rs hi redm anua l l ab or fro m ti m e to ti m e, Andrea p utin a lo t o f he r own ph y si cal lab orinth e h or se -b reed in g a ct iv it y . For e xa m pl e, sh e ph y si cal ly bui ltth e b arn s h ers el f--p ut ti ng up ou td oo r sh el te rs , di gg in g h ol es for fen ce p os ts , set ti ng th e p os ts with c em en t, p ut ti ng up pl ywoo d, an d c orru ga ti ng ro of s. Sh e al so in st al le d t he wate rin g s y st em s t o t hr ee o f th e b arn s an d b ui lt (...co nt inue d) 5 Sch edul e F.-1 8-

[* 18 ] aren as for

ho rs e tr ai ni ng . Andrea p erfo rm edm an y rep ai rs us in g h er kn owl ed ge inweld in g wo rksu chas b ui ld in g agate . A ty pi cal day forAndrea a t Qu een sl an d wo ul d s ta rt b etween4 a.m . and5
a.m . whensh e wou ldgo ou t t o t he farm an d c he ckon th e h or se s an d the ot he r an im al s t o m ak e su re the y were wh ere t he y

were s up po se d t o b e. Sh e wou ldals o feedth e an im al s an d c lo se ly exam in e th em to m ak e su re tha t the y

were ea ti ng an d
no t l am e an d h adno bi g c ut s o r sc rap es . In ad di ti on , sh e so m et im es wou ldne edto

“ worm ” th e an im al s, wh ic h i s a p ro ces s o f ki ll in g i nt es ti na l p aras it es . Andrea h as al way s b eenve ry

m et ic ul ou s an d i ns is te d o n p erfo rm in g t he se tas ks he rs el f to
en su re h er an im al s re cei ve th e b es t care o r atlea stth e st an da rdof c are t ha t wo ul d be sat is fact ory

to he r. In20 07 Zavr a worke d a t l eas t 4 0 h ou rs a weekforth e h or se -b reed in g act iv ity . She was a ls o e m pl oyed p artti m e as a “ ve nd orrep ” fo r Exc el l M ark et in g LC, work in g 2 to 16 ho ur s p er week
. F. Pet it io ne rs ’ ot he r act iv it ie s en ga ge d i n fo r pr of it Dur in g a ll rel ev an t t im es , pet it io ne rs di d n otco nduc t an y si m il ar o r di ss im il ar ac ti vi ti es en ga ge d i n fo r pr of it
.-1 9-

[* 19 ] G. In te rv en in g e ve nt s

1. Sel en iu m

de fic ie nc y

inth e su rro un di ng area Aro un d 1 99 8 An dr ea d is co ve redth atha y fro m he r lo cal area , whi chsh e us edto feedhe r ho rs es , was d efi ci en t i n s el en iu m . A lackof s el en iu m ina ho rs e’s di etwou ldha ve a ne ga ti ve effe cton th e h or se ’s m us cl es an d c ou ldcau se m ed ic al pr ob le m s tha t ca n b e li fe thr eat en in g. To rect ify the pro bl em , Andrea b eg anto im po rt h ay co nt ai ni ng ad equa te am ou nt s o f se le ni um fro m othe r pa rts of t he
co un try. Im

po rti ng ha y

fro m ot he r are as pro ve d t o b e v ery co st ly--in st eadof $ 3 a ba le forlo cal ha y , im

po rte d h ay

co ul d c os t p et it io ne rs as m uc h a s $ 17 a ba le , or 60 0% m or e. 2. The 19 99 fir e The 19 99 fir e cau se d d am ag e to pe ti ti on ers ’ res id en ce o n the Farm in gt on pr op erty as we ll as p ro pe rty tha t was pa rt o f th e h or se -b reed in g a ct iv ity . The fi re co ns um edm an y

acre s o f th e farm

an d o th er Qu een sl an d a ss et s, s uc h a s i nv en to ry , bl an ke ts , sh ow b rid le s, h al te rs , sh ow h al te rs , andbo ok s an d re co rd s o f th e act iv ity . Afte r th e fi re d es tro y edth e b arn , th e b arnwas re bu il t an d p la cedba ckinservi ce aro un d 2 00 7. The fir e to okdo wn Qu een sl an d’s u ti li ty lin es form on th s, l eav in g i t wi th ou t el ectric it y an d ru nn in g wat er wh il e th ey were d own . One h or se di edfro m th e-2 0-

[* 20 ] in ci de nt , andm an y

ot he rs be cam e st res se d. Itals o d es tro y edth e ta nk s tha t st or edth e h or se semen p et it io ne rs ha d a ll eg ed ly plann edto sel l. Acco rd in g t o pe ti ti on ers , th e fi re ad ve rs el y affe ct edpe ti ti on ers ’ ab il it y to bre edho rs es be cau se itde st ro y edm

uc h o f th e n eces sa ry

equi pm en t. The farm ’s reco ns tru ct io n was no t co m pl et edun ti l 2 00 8. 3. Mi ss edin sp ect io n i n 2 00 1 Pet it io ne rs ha d o rg an iz edanin sp ect io n t o b e co nduc te d b y th e Swed is h W arm bl oo d As so ci at io n o f North Am eri ca (S WANA) at the fai rg ro un ds inSan ta Ro sa , Cal ifo rn ia . Peti ti on ers ren te d t he fai rg ro un ds an d p lann edto ha ve so m e o f th ei r ho rs es in sp ect edby the SWANA team . They an ti ci pa te d fu tu re b reed ers an d pr os pe ct iv e Swed is h warm bl oo d b uyers, wh o h adpre vi ou sl y co nt act edth em

to ex pr es s i nt eres t i n p ur ch as in g t he ir h or se s, t o a tt en d t he ev en t. The in sp ect io n was sc he du le d t o t ak e p la ce o n S ep te m be r 12 , 20 01
. As a re su ltof the terro ris t at ta ck s o n t he W or ldTrad e Cen te r th e d ay be fo re th e sc he du le d i ns pe ct io n, the SWANA in sp ect or s wer e unabl e to tra ve l t o S an ta Ro saan d t he in sp ect io n was can cel ed . Con se qu en tl y , th e SWANA tea m di d n ot in sp ectth e 1 5 t o 1 9 h or se s tha t p et it io ne rs pl anne d t o b rin g t o t he in sp ect io n, an d p et it io ne rs di d n otm eetwith t he pro sp ect iv e b uyers an d b reed ers at t he
can cel edev en t. Eve n tho ug h a no th er i ns pe ct io n was setto tak e p la ce the ne xtda y-2 1-

[* 21 ] on Sep te m

be r 13 , 20 01 , at M s. Di lwo rth ’s Tril og y Farm inSan taCru z, 6 pe ti ti on ers to okon ly one or t wo youn g s ta ll io ns to th atin sp ect io n (S an taCru z in sp ect io n) . Andrea e xp la in edat t ria l tha t l og is ti cal is su es pre ve nt edth e tr an sp ort of th e rem ai ni ng ho rs es to San taCru z. Andrea c ou ldno t re cal l wh ethe r sh e to okhe r ho rs es to an ot he r in sp ect io n i n 20 02 ; n oris th ere a nyth in g i n t he reco rdsh owi ng th ey to okan y of t he ir h or se s t o anin sp ect io n i n s ub se qu en t years. Acco rd in g t o An dr ea, h or se s m us t b e in sp ect ed ata cert ai n a ge to rece iv e a ce rta in type o f rec og ni ti on , andthus m is si ng th e in sp ect io n 2 00 1 h as ha d a n a dv ers e im pa cton th e v al ue s o f he r ho rs es . Howev er, pe ti ti on ers ha ve fai le d t o s ta te or qua nt ify withsp eci fic it y th e ex te ntto whi chth e m is se d i ns pe ct io n h as ha d an a dv ers e im pa cton th e v al ue s o f th ei r ho rs es . H. Part ne rs hi p b etweenAndrea a ndZavr a In20 02 Zavr a joi ne d An dr ea as a pa rtn er t o c on du ctth e h or se -b reed in g act iv ity . Howev er, p et it io ne rs di d n otm em or ia li ze the ir a ll eg edora l ag reem en t t o fo rm a pa rtn ers hi p. Th e arr an ge m en t b etweenpe ti ti on ers ap pe ars to be th atZavr a wou ldco nt rib ut e h er s erv ic es as we ll as h er wag e in co m e to pa y cert ai n e xp en se s of th e h or se -b reed in g a ct iv ity inex ch an ge fora 50 % in te res t i n t he partn ers hi p. Pet it io ne rs do no t re cal l the am ou ntof Qu een sl an d’s ex pe ns es Zavr a h as pa idon Farm in gt on is ab ou t equi di st an t b etweenSan taCru z an d S an taRo sa . 6-2 2-

[* 22 ] be ha lf o f th e p artne rs hi p o r th e v al ue of a ny pro pe rty or s erv ic es Zavr a m ig htha ve co ntrib ut edto th e p artne rs hi p. An dr ea’s the n h us ba ndals o c on tri bu te d ab ou t $ 2,0 00 ev ery m on th --p res um ab ly whi le th ey were m arri ed --t o t he ho rs ebr eed in g a ct iv ity

bu t d idno t re cei ve an y

pa rtn ers hi p i nt eres t i n re tu rnan d thu s h ad
ne ve r be ena pa rtn er i n t he ho rs e-b reed in g a ct iv ity . Pet it io ne rs fil edFo rm s 1 06 5, U.S. Return o f Part ne rs hi p In co m e, fo r 20 02 , 20 03 , 20 05 , and20 06
. For20 02 an d 2 00 3 p et it io ne rs an swe red“No” to th e 7 qu es ti on “ Is th is pa rtn ers hi p s ub ject t o t he co ns ol id at edau di t p ro cedur es of
se ct io ns 62 21 th ro ug h 6 22 3? ” Fo r 20 05 an d 2 00 6 p et it io ne rs an swe red“No” to th e que st io n “ Didth e p artne rs hi p fi le Fo rm 88 93 , Elect io n o f Part ne rs hi p Lev el Tax Treatm en t, o r anele ct io n s ta te m en t u nd er s ect io n 6 23 1( a)(1 )(B) (ii ) fo r pa rtn ers hi p- le ve l t ax tre atm en t, tha t i s i n e ffec t fo r th is tax y ear? ” OPINION I. Ju ris di ct io n Gen eral ly, di sp ut es ov er p artne rs hi p i te m s ar e subjec t t o t he un ifi edau di t an d l it ig at io n p ro cedur es of t he Tax Equi ty andFis cal Res po ns ib il ity Act o f 19 82 Inth e rec or d a re Fo rm s 1 06 5 a tt ach edto Andrea’s 2 00 3 a nd20 05 Fed eral 7 in co m e ta x re tu rn s (b utno t Zav ra’s returns forth es e y ears ) an d F orm s 1 06 5 t o Zav ra’s 2 00 2 a nd20 06 returns (bu t n otAndrea’s re tu rn s fo r th es e y ears ). Desp it e th e in co m pl et e rec or d, we ar e sa ti sf ie d t ha t b oth p et it io ne rs fil edor a t l eas t in te nd edto fil e anid en ti cal Fo rm 10 65 foreach of t he se fou r y ears .-2 3-

[* 23 ] (TEFRA), Pub. L. No. 9 7- 24 8, s ec. 4 02 (a), 9 6 S ta t. at64 8. Se e g en eral ly
se cs . 62 21 , 62 25 (a). To de ci de whet he r a p artne rs hi p e ng ag es inanact iv it y for pr of itun de r se ct io n 1 83 , we det erm in e p ro fitm ot iv e atth e p artne rs hi p l ev el . See Hil l v . Comm is si on er, 2 04 F.3d12 14 , 12 18 (9t h C ir. 2 00 0) (ci ti ng Po la ko f v. Co m m is si on er, 8 20 F.2d32 1, 3 23 (9t h C ir. 1 98 7) , aff’g T.C. Mem o. 1 98 5- 19 7,
an d Wol f v. C omm is si on er, 4 F.3d70 9, 7 13 (9t h C ir. 1 99 3) , aff’g T.C. Mem o 19 91 -2 12 ). Co rres po nd in gl y , th e d is pu te d l os se s fr om Quee ns la ndare p artne rs hi p it em s o f pe ti ti on ers ’ pa rtn ers hi p i n t he ho rs e-b reed in g a ct iv ity du rin g t he y ear a t is su e. Thu s, ab se ntanap pl ic ab le ex cep ti on , we do no t h av e juri sd ic ti on ov er the 8 di sp ut edlo ss es inth es e in di vi du al de fic ie nc y pro ceed in gs . Sect io n 6 23 1( a)(1 )(B) pro vi de s the so -cal le d s m al l p artne rs hi p e xc ep ti on . The term “partn ers hi p” un de r TEFRA do es no t i nc lu de an y pa rtn ers hi p wi th 10 or

“ [T]he te rm

‘ pa rtn ers hi p’ in cl ud es a synd ic at e, gr oup, p oo l, joi ntve ntur e, 8 orot he r un in co rp or at edorg an iz at io n t hr ou gh or b y m ean s o f whi chan y

bu si ne ss , fin an ci al op erat io n, o r ve ntur e is carr ie d o n, an d wh ic h i s n ot* * * a c or po rat io n ora trus t o r es ta te .” Sec. 7 61 (a). A pa rtn ers hi p e xi st s wh en“ th e p art ie s i n g oo d fai th an d a ct in g wi th a bu si ne ss pu rp os e in te nd [] to jo in to ge th er i n t he pre se nt co nduc t o f th e en te rp ris e.” Co m m is si on er v . Cul be rts on , 33 7 U.S. 7 33 , 74 2 (1 94 9) . The p art ie s d o n otdi sp ut e th atpe ti ti on ers in te nd edto joi n t og ethe r to co nduc t the ho rs e-b reed in g a ct iv it y th ro ug h apartn ers hi p d es cri be d i n s ect . 76 1( a). One qu es ti on pre se nt edhe re i s wh ethe r th atact iv it y was e ng ag edinfor pr of itinth e y ear a t i ss ue . Whi le we m ay oc cas io na ll y

refe r to Quee ns la ndas a pa rtn ers hi p t hr ou gh ou t thi s o pi ni on , we do no t i nt en d t o s ug ge stth atQuee ns la nd was a pr of

it -m ak in g, b on a fi de pa rtn ers hi p fo r Fed eral in co m e ta x p ur po se s.-2 4-

[* 24 ] fewer p artne rs who are i nd iv idua ls un le ss th e p artne rs hi p m ak es anele ct io n to ha ve th e TEFRA pr oc edur es ap pl y . Sec. 6 23 1( a)(1 )(B) (ii ). Pet it io ne rs cla im

th atth ey ora ll y en te redin to a pa rtn ers hi p a gr eem en t i n 20 02 to carry

on th e h or se -b reed in g a ct iv ity an d t ha t the y

were the on ly partne rs in th e y ear a t i ss ue . Thu s, the ir p artne rs hi p i s n ota pa rtn ers hi p u nd er s ect io n 62 31 (a)( 1) (B). Pet it io ne rs ’ Fo rm s 1 06 5 fo r th ei r partn ers hi p fo r 20 02 , 20 03 , 20 05 , an d 2 00 6 s ho w th atth ey

de cl in edto m ak e th e el ect io n t o h av e TEFRA ap pl y . Whi le th ere i s n o e vi de nc e o f a Fo rm 10 65 fil edfor20 07 , th ere i s l ik ewis e n o ev id en ce s ho win g p et it io ne rs fil eda Fo rm 88 93 , Elect io n o f Part ne rs hi p Lev el Tax Treat m en t, an d m ad e anele ct io n u nd er s ect io n 6 23 1( a)(1 )(B) (ii ) in 20 07 or a ny of th e p rev io us y ears to ha ve th e TEFRA pr oc edur es ap pl y to th em for20 07 . W e are th us sat is fie d t ha t an ele ct io n u nd er s ect io n 6 23 1( a)(1 )(B) (ii ) was no t i n e ffec t fo r 20 07
. Bec au se pe ti ti on ers ’ pu rp orte d p artne rs hi p i s a “ sm al l p artne rs hi p” th atha s no t el ect edto ha ve TEFRA app ly for 2 00 7, we h av e juri sd ic ti on to rev ie w inth es e in di vi du al de fic ie nc y

cas es it em s o th erwi se subjec t t o p artne rs hi p- le ve l pr oc eed in gs , in cl ud in g t he di sp ut edlo ss es fro m th e h or se -b reed in g a ct iv it y . New Ph oe ni x S un ris e Co rp . v. Co m mis si on er, 1 32 T.C. 16 1, 1 73 n.3 (20 09 ) (ci ti ng-2 5-

[* 25 ] W ad swo rth v. Co m mis si on er, T.C. Mem o. 2 00 7- 46 ), aff’d, 4 08 Fed . App x. 90 8 (6 thCir . 20 10 ). II. Perc ep ti on of An dr ea an d Zav ra as witne ss es Inall cas es , we ob se rv e th e can do r, si nc eri ty, an d d em ean orof e ach witne ss in ord er t o e va lu at e h er t es ti m on y an d t o a ss ig n wei gh t t o t ha t t es ti m on y forth e pr im ary pu rp os e o f fi nd in g d is pu te d fa ct s. We det erm in e th e cre di bi li ty of eac h witne ss , weig h e ach pi ece o f ev id en ce, draw ap pr op ria te in fere nc es , andch oo se be twee n c on fli ct in g i nf

eren ces infin di ng th e fac ts of acas e. The m ere f actth at on e p arty pre se nt s u no pp os edtes ti m on y do es no t n eces sa ril y

m eanth atth e el ic it ed te st im on y wil l re su ltina fi nd in g o f factinth atpa rty’ s fa vo r. W e wil l n otacce pta witne ss ’ te st im on y

on it s fa ce i f we fi ndth atou r im pr es si on of the witne ss co up le d with o ur rev ie w of the cred ib le fact s athandco nv ey s t o u s an un de rs ta nd in g co nt rary to the sp ok enword . See Neo na to lo gy Asso cs ., P.A. v. Co m m is si on er, 11 5 T.C. 4 3, 8 4- 87 (20 00 ), aff’d, 2 99 F.3d22 1 (3 d C ir. 2 00 2) ; HIE Ho ld in gs , Inc . v. Co m m is si on er, T.C. Mem o. 2 00 9- 13 0, 9 7 T.C.M . (CCH) 1 67 2, 1 73 3 (2 00 9) , aff’d, _

__Fed . App x. _

__ , 20 13 W L 13 65 35 4 (9 thCir . Apr. 5 , 20 13 ). W e fi ndAndrea’s t es ti m on y to be ge ne ral ly unh el pf

ul an d u nr el iabl e. Her te st im on y , esp eci al ly dur in g c ro ss -ex am in at io n, was am bi gu ou s, equi vo cal , and
so m et im es ev as iv e. Fo r ex am pl e, Andrea was ne ve r ab le to pro vi de du rin g h er-2 6-

[* 26 ] tes ti m on y

a ti m efra m e whe n t he Farm in gt on pro pe rty beca m e p art ly op erat io na l o r fu ll y

op erat io na l af

te r th e 1 99 9 fi re. Her t es ti m on y was a ls o co nt rad ic te d s ev eral ti m es by her re sp on se s t o t he in te rro ga to rie s tha t re sp on de nt ha d p rev io us ly pro po un de d t o h er an d o th er p rio r st at em en ts . For e xa m pl e, Andrea t es ti fie d a t tria l tha t af te r th e 1 99 9 fi re, s he be ga n t o u se anacco un ti ng so ftwa re d iff

eren t fr om

th e o ne sh e u se d b efo re the fir e (i .e., Maci nt os h Qu ic ke n as op po se d t o M ic ro so ft Qu ic ke n) ; h owe ve r, he r res po ns es to res po nd en t’s in te rro ga to rie s s ta te d t ha t s he ab an do ne d h er p rev io us acco un ti ng m etho ds an d de vi ces alt og ethe r aft er J ul y 19 99 , os te ns ib ly to ex pl ai n wh y sh e d idno t h av e an acco un ti ng syste m

forth e y ear a t i ss ue . As an ot he r ex am pl e, Andrea t es ti fie d t ha t sh e to oktwo y ou ng st al li on s t o t he San taCru z in sp ect io n, b uthe r own no te s n ex t to a co py of a re fundch eckfro m SWANA for i ns pe ct io n fe es inco nn ect io n wi th th e San taCru z in sp ect io n s ta te th atsh e to okon ly one st al li on forin sp ect io n. Whi le we be li ev e Zav ra t o b e g en eral ly credi bl e, we fi ndhe r te st im on y si mil arl y un he lp fu l an d u nr el iabl e. Sh e cl ai m s tha t s he en te redin to a pa rtn ers hi p with An dr ea t o c arry on t he ho rs e-b reed in g a ct iv it y forpro fit , bu t atth e sa m e ti m e sh e te st ifi edsh e d idno t kno w abo utth e fi na nc es of t he act iv it y an d n otev enth e $1 35 ,00 0 l os s i nc urredinth e y ear p rio r to he r joi ni ng th e p artne rs hi p. Itap pe ars he r kn owl ed ge of Qu een sl an d’s o pe rat io ns an d fi na nc es is ex tre m el y li m it ed
.-2 7-

[* 27 ] Insu m , we gi ve pe ti ti on ers ’ te st im on y li tt le weig htinour pr of

itm ot iv e de te rm in at io n. III. “ An ac ti vi ty noten ga ge d i n fo r pr of it ” Sect io n 1 83 ge ne ral ly lim it s the de du ct io ns foran“ act iv it y no t en ga ge d i n fo r pr of it ” to th e am ou ntof g ro ss in co m e rec ei ve d fr om th e act iv it y . Sec. 1 83 (a)
an d (b ). Sect io n 1 83 (c) d efi ne s an “ act iv it y no t en ga ge d i n fo r pr of

it ” as “ any act iv ity ot he r th anon e wit h re sp ectto whi chde du ct io ns are al lo wab le forth e ta xabl e y ear u nd er s ect io n 1 62 or u nd er p arag rap h (1 ) or(2) of s ect io n 2 12 .” In th e Co urt o f App eal s fo r th e Nin th Cir cu it , th e co urt t o wh ic h a n app eal of t hi s cas e m os t l ik el y

li es , an a ct iv ity

is en ga ge d i n fo r pr of

itif the tax pa y er's

“pr ed om in an t, p rimary

or p rin ci pa l o bjec ti ve ” in en ga gi ng inth e act iv it y was t o pr of it . W ol f v. C omm is si on er, 4 F.3dat 7 13 . In thi s co nt ex t, the term “pr of it ”
m ean s ec on om ic pro fit , in de pe nd en t o f ta x s av in gs . Id. Pet it io ne rs be ar the burd enof p ro vi ng th atth ey en te redin to an d dur in g t he y ear i n i ss ue rem ai ne d i n t he ho rs e-b reed in g a ct iv it y with apre do m in an t, p rimary , orpri nc ip al ob

jecti ve of e arn in g apro fit . See Ru le 14 2( a)(1 ); Welc h v . Helv eri ng , 29 0 U.S. 1 11 , 11 5 (1 99 3) ; Gi le s v . Comm is si on er, T.C. Mem o. 2 00 5- 28 , 89 T.C.M. (CC H) 77 0, 7 75 (20 05 ). W e d et erm in e p ro fitin te ntonth e b as is of a ll
su rro un di ng fact s an d c irc um st an ces . Gol an ty v. Comm is si on er, 7 2 T.C. 4 11 , 42 6-2 8-

[* 28 ] (19 79 ), aff’d wi th ou t p ub li sh edop in io n, 6 47 F.2d17 0 (9 th Cir .19 81 ); s ec. 1.1 83 -2 (b ), In co m e Tax Reg s. Whil e o urin qu iry int o atax pay er’s o bjec ti ve in
en ga gi ng inanact iv ity

foc us es on th e ta xp ay er’s s ub jecti ve in te nt , we as t he fin de r of factne edno t re ly sol el y

on th e ta xp ay er's st at em en t o f in te ntbu t m ay res ort t o ob jecti ve fact s t o d eci de th e true in te nt . See In de p. El ec. Supp ly, In c. v. Co m m is si on er, 7 81 F.2d72 4, 7 26 (9t h C ir.1 98 6) , aff’g Lah r v. C omm is si on er, T.C. Mem o. 1 98 4- 47 2; sec . 1.1 83 -2 (a), In co m e Tax Reg s. The reg ul at io ns setforth a no ne xc lu si ve li stof n in e fac to rs inasc ert ai ni ng a ta xp ay er’s o bjec ti ve inen ga gi ng inanact iv it y : (1 ) th e m an ne r in whi chth e ta xp ay er ca rri es on th e act iv ity ; (2 ) th e ex pe rti se of t he tax pa y er o r hi s ad vi se rs ; (3 ) th e ti m e an d e ffo rt s pe ntby the tax pa y er i n c arrying onth e act iv it y ; (4 ) th e ex pe ct at io n tha t as se ts us edinth e act iv it y m ay ap pr eci at e in va lu e; (5) th e su cces s of th e ta xp ay er i n c arrying on othe 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 hi st ory

of i nc om e o r lo ss es with re sp ectto th e act iv it y ; (7 ) th e am ou nt of oc cas io na l p ro fit s, i f 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 ) el em en ts of p ers on al pl eas ur e o r rec reat io n. No ne of t he se fact or s i s co nt ro ll in g i n an d o f it se lf, anda de ci si on as t o atax pa y er’s i nt en t i s n otgo ve rn edby a
nu m eri cal pre po nd eran ce o f th e fac to rs . Sec. 1 .18 3- 2( b) , Inc om e Tax Reg s.; see-2 9-

[* 29 ] als o Go la nt y

v. Co m mis si on er, 7 2 T.C. at42 6; All env. Co m m is si on er, 7 2 T.C. 28 , 34 (19 79 ). W e wil l ex am in e th es e fac to rs intu rn . A. The m an ne r in whi chpe ti ti on ers carr ie d o n t he act iv it y The factth ata ta xp ay er carri es on anact iv ity ina bu si ne ss li ke m an ne r m ay in di cat e th atth e act iv ity

is en ga ge d i n fo r pr of

it . Sec. 1 .18 3- 2( b) (1 ), In co m e Tax Reg s. Subf

act or s t o c on si de r in de ci di ng whet he r a t axpa y er h as co nduc te d a n act iv ity ina bu si ne ss li ke m anne r in cl ud e: (1) whethe r th e ta xp ay er m ai nt ai ne d
co m pl et e an d a ccu rat e b oo ks an d re co rd s fo r th e act iv it y ; (2 ) whe th er the tax pa y er co nduc te d t he act iv ity

ina m anne r subs ta nt ia ll y si m il ar t o t ho se of o th er co m pa rab le act iv it ie s tha t wer e p ro fit ab le ; an d (3 ) whe th er the tax pa y er ch an ge d op erat in g p ro cedur es , ado pt edne w tec hn ique s, o r ab an do ne d unp ro fit ab le
m etho ds ina m an ne r co ns is te ntwith a n i nt en t t o i m pr ov e p ro fit ab il it y . Gile s v . Co m m is si on er, 8 9 T.C.M . (CCH) at77 6 (c it in g En gd ah l v . Comm is si on er, 7 2 T.C. 65 9 (1 97 9) ); s ec. 1 .18 3- 2( b) (1 ), In co m e Tax Reg s. Pet it io ne rs arg ue th atth ey co nduc te d Qu een sl an d i n abu si ne ss li ke m an ne r pr im ari ly on t he ba si s o f th ree c la im s: firs t, the y de ve lo pe d abu si ne ss pl anth at th ey ha ve m od ifi edov er the y ears to refl ectch an gi ng bu si ne ss envi ro nm en t; se co nd , th ey

m ai nt ai ne d c om

pl et e an d a ccu rat e rec or ds ; thi rd , th ey adve rti se d t he
sa le s o f th ei r ho rs es . Peti ti on ers ’ cl ai m s ar e n otsupp orte d b y th e rec or d.-3 0-

[* 30 ] 1. Bu si ne ss pl an Andrea a ll eg ed ly dev is eda bu si ne ss pl anas e arl y as 1 98 1 a ndsubm it te d i t to th e SBA fo r fee db ack . She ag ai n s ub mit te d abu si ne ss pl anin19 93 , pr es um ab ly upd at edfro m th e 1 98 1 p la n, t o t he SBA to ge t fu rth er b us in es s ad vi ce. Bu t the 19 93 bu si ne ss pl anco nt ai ns lar ge ly her d es cri pt io ns of b reed in g a nd tra in in g h or se s an d s ay s v ery li tt le ab ou t h ow t o turn t he act iv it y pro fit ab le
. Mo reo ve r, whe n t he bu si ne ss pl ando es to uc h o n p ro fit -m in de d m atte rs , su chas fin an ci al s an d s tartup c os ts , itin cl ud es on ly very hi gh -le ve l d is cu ss io n t ha t wo ul d le av e an y bu si ne ss pe rs on ve ry

few cl ue s as to ho w to m ak e a p ro fitfro m Que en sl an d. In de ed , th e 1 99 3 b us in es s p lan i ts el f rai se s o th er re d fl ag s. Itst at es th at Que en sl an d i s g eare d t owa rd“ th e se rio us up pe r-l ev el ho rs e ri de r[s ] * * * wh o a re ab le to in ve sta gr eatde al of t im e, effo rt, andm on ey in to th ei r sp ort” , su gg es ti ng th atth e m ark etforsel li ng Swed is h warm bl oo ds is a ni ch e m ark etwith v ery few bu y ers . On th e o th er h an d, the bu si ne ss pl anals o s ta te s tha t the on go in g op erat io na l co st s ar e h ig h. Onth e b as is of t he hi st ory of Lam ira , forex am

pl e, we kn ow a S wed is h warm

bl oo d’s v al ue ten ds to de crea se ov er t im e aft er i t re ach es it s pr im e. Inot he r wor ds , pet it io ne rs ’ bu si ne ss is sel li ng a pr oduc t tha t i s s ub ject t o de pl et io n a ndwith s ig ni fic an t o ve rh ead , andit s t arg etm ark etis sm al l an d-3 1-

[* 31 ] po te nt ia ll y

hi gh ly com

pe ti ti ve . W e wou ldex pe cta pe rs on who is ser io us ly pr of it -m in de d t o d is cu ss inhe r bu si ne ss pl anho w sh e in te nd s t o c on tro l co st s an d
ov erh ead , to pro m ot e h er p ro du ct s thr ou gh co ns is te ntan d a gg res si ve m ark et in g effo rts to bro ad enth e p ur ch as er b as e, an d t o m ax im iz e th e ret ai l v al ue of h er ho rs es by det erm in in g wh enitis th e o pt im al ti m e to sel l. Bu t p et it io ne rs ’ 19 93 bu si ne ss pl anfai ls to ad dr es s an y of t he se im

po rta ntbu si ne ss is su es . Thu s, we gi ve th e 1 99 3 b us in es s p la n v ery li tt le weig ht
. W e al so fin d n o c red ib le ev id en ce t o s up po rt p et it io ne rs ’ cl ai m th atth ey reg ul arl y up da te d t he ir b us in es s p la n t o re fle ctch an gi ng m ark etco nd it io ns . Des pi te th e d is co ve ry

of s el en iu m

de fic ie nc y

inth e lo cal ha y

in19 98 , th e 1 99 9 fir e, th e te rro ris t at ta ck s i n 2 00 1, an d t he eco no m ic do wnturn t ha t fo ll owe d, i n ad di ti on to a hi st ory

of s ub st an ti al lo ss es , th ere i s n o e vi de nc e sh owi ng pe ti ti on ers ha ve do ne an yth in g t o a daptto th e m ark etch al le ng es or a do ptne w tec hn ique s an d op erat in g m etho ds to tu rnth e lo si ng act iv it y in to a pr of

it ab le ve ntur e. See s ec. 1.1 83 -2 (b )(1 ), In co m e Tax Reg s. Act io n- -o r in act io n i n t hi s ca se --s pe ak s l ou de r th anword s. See Ph il li ps v. Co m m is si on er, T.C. Mem o. 1 99 7- 12 8, 7 3 T.C. M. (CCH) 22 96 , 23 00 (19 97 ) (fi nd in g b us in es s p la n c anbe ev id en cedby acti on ). Pet it io ne rs ’ in act io n h ere c on vi nc es us th atth ey di d n otch an ge th ei r bu si ne ss-3 2-

[* 32 ] pl an , if the re ev er was on e, in a m an ne r co ns is te ntwith abu si ne ss ve ntur e en ga ge d i n fo r pr of

it
. 2. Mai nt ai ni ng co m

pl et e an d a ccurat e b oo ks an d re co rd s The fai lu re t o k eep fin an ci al reco rd s, s uc h a s jo urna ls , led ge rs , in co m e an d
ex pe ns e rep orts , in co m e st at em en ts , P&L st at em en ts , andfin an ci al pro jecti on s in di cat es a la ckof b us in es sl ik e o pe rat io ns . Gile s v . Comm is si on er, 8 9 T.C.M
. (CCH) at 7 76 (ci ti ng Surri dg e v . Comm is si on er, T.C. Mem o. 1 99 8- 30 4)
. Altho ug h atax pa y er n eedno t m ai nt ai n aso ph is ti cat edco stacco un ti ng syste m for
an y pu rp orte d b us in es s ac ti vi ty, sh e m us t atlea stke ep an d p ro du ce re co rd s tha t wou lden ab le he r to m ak e in fo rm edbu si ne ss de ci si on s an d o th erwi se all ow h er t o cu t ex pe ns es , in crea se pro fit s, o r ev al ua te th e act iv it y ’s ov eral l p erfo rm an ce. Id . at 77 7 (c it in g c as es ). Fin al ly, th e fai lure t o m ai nt ai n asep arat e b an k a cco un t o r to pr ep are abu dg etals o i nd ic at es a la ckof b us in es sl ik e o pe rat io ns . Id. at77 6. At the ou ts et , we exp res s o urdo ub t o ve r And rea’s t es ti m on y th atsh e k ep t fin an ci al reco rd s fo r th e h or se -b reed in g a ct iv it y us in g M aci nt os h Qu ic ke n a fte r th e 19 99 fir e (i nc lu di ng th e y ear i n i ss ue ). Her pr io r in co ns is te ntst at em en ts gi ve n i n res po ns e to res po nd en t’s i nt erro ga to rie s i m pe ach edth attes ti m on y . Furt he r, pe ti ti on ers fai le d t o c orro bo rat e th ei r te st im on y th atth ey ke ptco m pl et e an d-3 3-

[* 33 ] accu rat e b us in es s re co rd s wi th do cu m en ta ry ev id en ce. Thu s, we d ecl in e to fin d a s a f actth atth ey

co nt inue d t o k eep su chbo ok s an d re co rd s af te r th e 1 99 9 fir e. Eve n i f we as su m e fo r th e sa ke of t he arg um en t tha t p et it io ne rs us edso m e so rt o f acc ou nt in g s y st em to ke ep tra ckof Qu een sl an d’s ex pe ns es an d i nv en to ry , Andrea’s o wn t es ti m on y

rev eal s tha t the y

ha ve ne ve r us edth e av ai labl e d at a to pr oduc e o r to pre pa re an y P&L s ta te m en ts , earn in gs rep orts , bu dg et s, b reak -ev en an al y se s, o r an y

si m il arl y de ta il edfin an ci al st at em en ts th atwou ldhe lp th em to cu t ex pe ns es , in crea se pro fit s, an d e va lu at e th e o ve ral l p erfo rm an ce o f th ei r ho rs ebr eed in g a ct iv ity . See Go la nt y v. Co m m is si on er, 7 2 T.C. at43 0. Atm os t, the types of r eco rd s p et it io ne rs m ai nt ai ne d wo ul d h el p t he m subs ta nt ia te Quee ns la nd ’s
ex pe ns es , bu t tha t i s i ns uf fic ie ntto sh ow the y

ke ptth em

ina bu si ne ss fas hi on to 9 fo st er p ro fit . See Mc Keev er v . Comm is si on er, T.C. Mem o. 2 00 0- 28 8, 8 0 T.C.M
. (CCH) 35 8, 3 67 (20 00 ). Andth e fac t tha t Qu een sl an d i nc urredlo ss es y ear a fte r y ear a ll ows us to dra w a factua l i nf eren ce tha t i n e va lu at in g Qu een sl an d’s de cl in in g fi na nc ia l p erfo rm an ce, p et it io ne rs di d n otactua ll y rel y on an y rou gh fin an ci al pro

jecti on th atth ey

m ig htha ve m ad e as to th e act iv it y . Fin al ly,
Infact , pet it io ne rs ’ reco rd s ca n s ub st an ti at e o nl y $1 06 ,70 0 o f th e $ 21 0,8 47 9 ex pe ns es rep orte d o n t he ir 2 00 7 S ch edul e F.-3 4-

[* 34 ] pe ti ti on ers st op pe d m ai nt ai ni ng a se pa rat e b an k a cco un t fo r th e act iv it y aft er 19 99 , m ak in g i t h ard er t o s ep arat e an d t rackbu si ne ss ex pe ns es an d p ers on al
ex pe ns es . In s um , pet it io ne rs fai le d t o p res en t cr ed ib le ev id en ce tha t the y us ed 1 0
an y reco rdto im

pl em en t co st -s av in g m eas ur es or t o i m pr ov e p ro fit ab il it y . 3. Adv ert is in g Pet it io ne rs rel y

on a ha nd fu l o f adve rti se m en ts pl acedid ly in trad e m ag azi ne s an d p ub li cat io ns to arg ue th atth ey “ em ba rk edon anin te ns iv e adve rti si ng pro gr am ” to m ark etth ei r pr oduc ts . As we n ot edearl ie r, th e n atur e o f pe ti ti on ers ’ targ etm ark etwou ldrequi re the m to m ark etth ei r pr oduc ts co m pe ti ti ve ly andag gr es si ve ly to re ach a br oa d b uyer ba se . W e fi nditdi ffi cu ltto be li ev e th aton ly a han df

ul of a dv ert is em en ts pl acedintra de m ag azi ne s an d publ ic at io ns canach ie ve th atres ul t. In de ed , th e small v ol um e o f sa le s p et it io ne rs ge ne rat edov er the y ears all ows anin fere nc e th atth ei r adve rti si ng effo rts were fu ti le . Thu s, the ir f

ai lu re t o e xp an d t he ir m ark et in g e ffo rts ov er the y ears to reac h a la rg er cu st om er b as e is no t co ns is te ntwith t he be ha vi orof apro fit -o rie nt ed ta xp ay er. See McKee ve r v. C omm is si on er, 8 0 T.C.M . at 3 68 (ci ti ng Dod ge v.

The re i s atlea ston e o th er i ns ta nc e o f co m m in gl in g a cco un ts . For20 07 1 0 pe ti ti on ers rep orte d u ti li ty andin su ran ce ex pe ns es rel at in g t o t he ir p ers on al res id en ce as part o f th e h or se -b reed in g a ct iv it y ’s exp en se s o n t he ir S ch edul e F.-3 5-

[* 35 ] Co m

m is si on er, T.C. Mem o. 1 99 8- 89 , aff’d wit ho utpubl is he d o pi ni on , 18 8 F.3 d 5 07 (6t h C ir. 1 99 9) ). Mo reo ve r, pe ti ti on ers fai l t o p ro vi de an y ev id en ce t o s ho w th ei r pa rti ci pa ti on incert ai n m ark et in g e ve nt s ac tu al ly gen erat edan y actua l l ead s o r sa le s. Itis un cl ear wh ethe r pe ti ti on ers have ev er ex am in edth e eff ect iv en es s o f th ei r adve rti si ng effo rts an d wh ethe r th ey ha ve ex pl or edot he r m ark et in g a ve nu es . Insu m , we gi ve li tt le weig htto pe ti ti on ers ’ cl ai m th atth ey en ga ge d i n adve rti si ng ina bu si ne ss li ke m an ne r.

4. In su ran ce co ve rag e Pet it io ne rs di d n otha ve ad equa te in su ran ce co ve rag e to in su re Que en sl an d’s as se ts ag ai ns t ca su al ty los s. As a res ul t, p et it io ne rs were n otab le to reco ve r th e v al ue of Qu een sl an d’s as se ts aft er the y were d es tro y edinth e 1 99 9 fir e. Notha vi ng ad equa te in suran ce co ve rag e is in co ns is te ntwith c arrying on an act iv ity ina bu si ne ss li ke m anne r. 5. Ch an gi ng m etho ds to im pr ov e p ro fit ab il it y A cha ng e o f op erat in g m etho ds , ado pt io n o f ne w tec hn ique s, o r ab an do nm en t o f unpr of

it ab le m etho ds m ay

als o i nd ic at e a p ro fitob

jecti ve . Sec. 1.1 83 -2 (b )(1 ), In co m e Tax Reg s.-3 6-

[* 36 ] Pet it io ne rs cla im

th atth ey be ga n t o s el l the ir s ta ll io ns ’ se m enas away to ge ne rat e ad di ti on al pro fit . In 1 99 8 t he y co nt ract edto sel l ab ou t $ 25 ,00 0 wo rth of
se m enth atco ul d p ro du ce 1 0 b reed in gs . Ass um in g p et it io ne rs co ul d s us ta in th e sa m e le ve l o f se m ensal es ev ery y ear a fte r 19 99 , th e sa le s wo ul d g en erat e o nl y ve ry m od erat e in co m e b utwou lddo li tt le to affe ctth e act iv it y ’s bo tt om li ne . Que en sl an d was in cu rri ng ex pe ns es of $ 10 0,0 00 or m or e ev ery y ear. Th e am ou nt of in co m e th atan y

semen sa le s co ul d p ot en ti al ly gen erat e wou ldbe in su ffi ci en t t o de fray Queen sl an d’s an nu al ex pe ns es , no t t o m en ti onto recupe rat e lo ss es fro m th e pr ev io us y ears . Infact , pet it io ne rs were n ev er ab le to ge ne rat e an y in co m e fro m

th e sa le s o f
se m en . Peti ti on ers bl am e th e fai lu re i n m ak in g s em ensal es on th e 1 99 9 fi re, whi chth ey

cla im de st ro y edth e se m enth atth ey co ul d h av e so ld . Butpe ti ti on ers fai l t o e xp la in why th ey

co ul d n otsel l s em eninot he r y ears aft er the fir e. In de ed , pet it io ne rs bl am e a s eri es of u nf ortuna te ev en ts forth ei r lo ss es : the di sc ov ery of

sel en iu m de fic ie nc y

inlo cal ha y

in19 98 , th e 1 99 9 fi re, the terro ris t at ta ck s i n 2 00 1, an d the rece ss io n. We do no t d oubtth atth es e ev en ts ha d a
se rio us im

pa cton pe ti ti on ers ’ act iv it y , so m uc h s o t ha t the y

m ig htha ve cru m

pl eda bu si ne ss . Butfaci ng th es e m ul ti pl e hur dl es an d s etba ck s o f th e m ag ni tu de pe ti ti on ers are p le ad in g, a p ro fit -m in de d p ers on li ke ly w ou ldha ve cu t h er l os se s-3 7-

[* 37 ] an d aba nd on edth e v en ture al to ge th er, unl es s the re was so m e rea so nabl e ex pe ct at io n tha t s he co ul d o ve rco m e th es e hur dl es by ado pt in g n ew st rat eg ie s o r te ch ni qu es to im

pr ov e p ro fit ab il it y . Abs en t s uc h re as on ab le ex pe ct at io n, a p ro fit
or ie nt edpe rs on li ke ly w ou ldno t co nt in ue to po urm on ey in to a lo si ng ve ntur e. Pet it io ne rs wantus to be li ev e th e ab ov e unf ortu na te ev en ts affe ct edth ei r ab il it y to m ak e Que en sl an d p ro fit ab le . Be th atas i t m ay , pet it io ne rs fai l t o t el l u s wha t the y ha ve do ne to ad ap t t o a ndto ad jus t the ir m etho ds to m eetth es e ch al le ng es . Ind eed , th e rec or d s ho ws the y ha ve do ne ve ry

li tt le . Reco ve ry

co ul d ta ke ti m e, es pe ci al ly giv enth e eco no m ic en vi ro nm en t, b utth ere h adbe ensi x t o ni ne y ears be twee n t he in te rv en in g e ve nt s an d t he tax y ear a t i ss ue , andall si gn s were p oi nt in g t o agri m

m er o ut lo ok . Notwiths ta nd in g t ha t, p et it io ne rs co nt in ue d to co nt rib ut e subs ta nt ia l am ou nt s o f th ei r own cas h i nt o t he act iv it y witho utan y ch an ge inth ei r way

of run ni ng Quee ns la nd . Peti ti on ers ’ fai lu re t o i m pr ov e pr of it ab il it y an d u nwi ll in gn es s t o aba nd on th e v en tu re u nd er the cir cu m st an ces on ly leadus to co nc lu de as afactua l m at te r th atth ey were p ers on al ly atta ch edto th e v en tu re an d t he ir “ pr ed om in an t, p rimary or p rin ci pa l o bjec ti ve ” was no t t o pr of it
.-3 8-

[* 38 ] 6. Co nc lu si on The re i s n o c red ib le ev id en ce s ho win g t ha t p et it io ne rs carr ie d o n t he ir ho rs e-b reed in g a ct iv ity

ina bu si ne ss li ke m anne r. Thi s fa ct orfav or s re sp on de nt . B. The ex pe rti se of p et it io ne rs or t he ir a dv is ers A tax pa y er’s ex pe rti se , res earc h, an d s tu dy of th e acc ep te d b us in es s, eco no m ic , andsci en ti fic pra ct ic es of a n a ct iv ity , as wel l as hi s o r he r co ns ul ta ti on with e xp ert s, m ay

be in di cat iv e o f a p ro fitob jecti ve . Sec. 1 .18 3- 2( b) (2 ), In co m e Tax Reg s. Ina cas e co nc ern in g aho rs e-b reed in g a ct iv it y , our fo cu s i s t o e xa m in e a ta xp ay er’s kno wled ge of t he bu si ne ss or e co no mic asp ect s o f ho rs e b reed in g a s op po se d t o h er kno wled ge on th e subjec t o f ho rs e b reed in g fr om th e p ers pe ct iv e o f a h or se bre ed er. See Gil es v. Co m m is si on er, 8 9 T.C.M . (CCH) at77 8. Pet it io ne rs ass ertth atth ey so ug htbu si ne ss advi ce fr om th e SBA i n S an Fran ci sc o fi rs t i n 1 98 1 a ndag ai n i n 1 99 3 a ro un d the ti m e whe n t he y st art edth e act iv ity . They al so po in t o utth atth ey so ug htbu si ne ss an d m ark et in g a dv ic e fro m Ms . Dil worth inth e ear ly 199 0s . Fin al ly, th ey cla im th atth ey ask edforbu si ne ss advi ce fr om

ot he r br eed ers he re an d i n S wed enab ou t b reed in g a ndtra in in g Swed is h warm

bl oo ds
. At the ou ts et , we no te th at , bes id es pe ti ti on ers ’ se lf- se rv in g andva gu e te st im on y ab ou t h av in g re cei ve d s om e uns pe ci fie d e xp ertadvi ce, the reco rdis-3 9-

[* 39 ] de vo idof c red ib le ev id en ce s ug ge st in g t ha t p et it io ne rs pre pa redforth e eco no m ic asp ect s o f th e act iv ity by stu dy or co ns ul ta ti on with e xp ert s o r th atth ey were i nf orm edof wh atth e u lt im at e co st s m ig htbe , ho w th ey co ul d a ch ie ve an y le ve l o f co steffi ci en cy , th e am ou ntof r ev enue th ey co ul d re as on ab ly exp ect , or an y po te nt ia l ri sk s tha t m ig htne ga ti ve ly affectth ei r br eed in g a ct iv ity . See i d. Furth er, the cred ib le ev id en ce i n t he reco rddo es no t s ho w pet it io ne rs ha ve so ug htrel ev an t b us in es s ad vi ce. With res pe ctto th e advi ce the y so ug htfro m

th e SBA, th ere i s n o c red ib le ev id en ce t o s ho w th atpe ti ti on ers tal ke d t o a nyon e fro m th e SBA wh o was kn owl ed ge ab le of h or se bre ed in g o r th e eco no m ic asp ect s o f a ho rs e-b reed in g b us in es s. Infact , Andrea a ckno wled ge d a t tria l tha t the in di vi du al who all eg ed ly adv is edhe r ha d n o kno wled ge ab ou t h or se bre ed in g o r it s b us in es s as pe ct s. Fu rth er, An dr ea wen t t o t he SBA b etweenth e ear ly 198 0s an d t he earl y 19 90 s. Bu t p et it io ne rs can no t ex pl ai n h ow an y bu si ne ss advi ce tha t the y ob ta in ed th enwou ldco nt inue to be rel ev an t t o t he ir h or se -b reed in g a ct iv it y aft er 1 99 8, whi chm ark edth e b eg in ni ng of aser ie s o f “un fo rtu na te ” ev en ts an d d is as te rs (i.e ., th e 1 99 9 fi re, the rece ss io n, et c.) tha t al le ge dl y ha d a n u nf

or es eenim

pa cton th ei r act iv ity . In the same vei n, an y advi ce p et it io ne rs m ig htha ve ob ta in edfro m ot he r br eed ers inth e Uni te d S ta te s an d abr oa d t wo d ecad es ag o wo ul d b e unh el pf ul
.-4 0-

[* 40 ] Pet it io ne rs ’ cl ai m

th atth ey rel ie d o n M s. Di lwo rth ’s adv ic e is si m il arl y unpe rs ua si ve . W

he n p et it io ne rs ap pr oa ch edMs . Dil worth inth e ear ly 199 0s , Ms . Dil worthha d b eeninth e h or se -b reed in g b us in es s fo r no m or e th anfiv e y ears . In th e li gh t o f ou r de ci si on inEng da hl inwhi chwe fo un d the st artup ph as e o f a ho rs e-b reed in g a ct iv ity

to be 5 t o 1 0 years, s ee En gd ah l v . Comm is si on er, 7 2 T.C. at66 9, we h av e res erv at io ns ov er Ms . Dil worth ’s qu al ifi cat io n a s an ex pe rt i n t he bu si ne ss an d e co no m ic asp ect s o f br eed in g S wed is h warm bl oo ds at t ha t t im e. Mo reo ve r, de sp it e th e fre qu en t i ni ti al vi si ts an d t el ep ho ne cal ls , pet it io ne rs ha d n ot sp ok ento Ms . Dil worth m uc h i n t he pa st10 y ears . Any rel ev an t ad vi ce M s. Dil worthm ig htha ve gi ve n i n t he 19 90 s, jus t l ik e th e advi ce fr om th e SBA, wo ul d
no lo ng er b e rel ev an t g iv enth e n ew pr ob le m s fa ci ng pe ti ti on ers du rin g t he y ears si nc e 1 99 8. The lac k o f bu si ne ss co nt actbe twee n M s. Di lwo rth an d p et it io ne rs inth e la st10 y ears is si gn ifi can t. On e wou ldex pe ctth ata pr of it -m in de d t ax pa y er wo ul d ha ve so ug htou t M s. Di lwo rth --o r th e SBA-- fo r up da te d a dv ic e b as edon ne w in fo rm at io n abo utth e n ew ch al le ng es pe ti ti on ers were the n fa ci ng . Pet it io ne rs ’ 1 1

In de ed , Ms . Dil worth tes ti fie d tha t “ th ere a re v ery few p eo pl e in th e wor ld 1 1 rig htno w th atare m ak in g a ny m on ey bre ed in g h or se s.”-4 1-

[* 41 ] fai lu re t o a t l eas t at te m ptto ob ta in up da te d a ndrel ev an t b us in es s advi ce aft er the in te rv en in g e ve nt s i s i nc on si st en t wi th anin te ntto pro fit
. Thi s fa ct orfav or s re sp on de nt . C. The ti m e an d e ffo rt s pe ntby pet it io ne rs incarry in g o n t he act iv it y The factth ata ta xp ay er d ev ot es m uc h o f he r pe rs on al ti m e an d e ffo rt t o a n act iv ity m ay in di cat e a p ro fitob

jecti ve , esp eci al ly whe re the act iv it y do es no t in vo lv e subs ta nt ia l p ers on al or r ecre at io na l as pe ct s. Gil es v. Co m m is si on er, 8 9 T.C.M. (CC H) at77 9 (c it in g M cKeev er v . Comm is si on er, T.C. Mem o. 2 00 0- 28 8
an d Dal ey

v. Co m m is si on er, T.C. Mem o. 1 99 6- 25 9) . A tax pa y er’s withd rawal fro m an othe r oc cupa ti on to de vo te hi s o r he r ti m e an d e ffo rt t o a n a ct iv it y als o m ay in di cat e a p ro fitob

jecti ve . Id. (ci ti ng Burle so n v . Comm is si on er, T.C. Mem o. 19 83 -5 70 ); s ec. 1 .18 3- 2( b) (3 ), In co m e Tax Reg s. Pet it io ne rs all eg e th atth ey pe rfo rm edalm os t al l o f th e work wi th li tt le he lp fro m hi redlab or . Andrea c la im s s he sp en t 8 4 t o 1 12 ho ur s wee k i n t he ho rs ebr eed in g a ct iv ity

inad di ti on to work in g 4 0 t o 6 5 h ou rs a weekinhe r fu ll -ti m e an d pa rt- ti m e job s. Zav ra as se rts sh e worke d 4 0 h ou rs a weekinth e h or se -b reed in g act iv ity an d 2 to 16 ho ur s a we ekinhe r part- ti m e job
. W e fi ndpe ti ti on ers ’ as se rti on s t o b e in cred ib le . Firs t, p et it io ne rs pre se nt ed
no do cu m en ta ry

ev id en ce o r te st im on y

fro m th irdpa rti es to supp ort the ir c la im s o r-4 2-

[* 42 ] th e p ro po si ti onth at10 0% o f th e ti m e th ey sp en t was forbu si ne ss . Andrea ackno wled ge d a t tria l tha t s om e o f th e 8 4 t o 1 12 ho ur s i nc lu de d t im e sh e sl ep t i n th e b arnwith h er h or se s. Thus we di sc ou nthe r te st im on y th at10 0% o f he r ti m e was sp en t fo r bu si ne ss . There is li ke wis e a l ackof c red ib le ev id en ce t o s ho w th at Zav ra’s 4 0 h ou rs sp en t ev ery week was a ll bu si ne ss , esp eci al ly in the li gh t o f th e factth atQuee ns la ndha s b eena fam il y act iv it y inwhi chsh e sp en t m an y ho ur s with h er fam il y . W e al so no te th atAndrea’s t es ti m on y was i nc red ib le onit s fa ce. By he r co un t, b etweenhe r ot he r em pl oym en ts an d t im e sp en t o n t he act iv it y , sh e worke d 12 4 h ou rs to 17 7 h ou rs a weekwhen th ere a re o nl y 16 8 h ou rs ina week . The o nl y way sh e co ul d p os si bl y

workth is m any

ho ur s i s b y

ne it he r sl eep in g n oreat in g fo r da y s. With ou t an y

ot he r ev id en ce t o c orro bo rat e th is fan ta st ic al cla im , we dec li ne to acce ptit
. Mo reo ve r, Andrea n ev er d ecre as edth e num be r of ho ur s wo rk edinhe r fu ll
ti m e job ; s om et im es sh e ev enwork edex traho ur s i n h er p art -ti m e em pl oym en ts . Thu s, we draw anin fere nc e fro m th is factan d b el ie ve th atAndrea h adto ke ep he r pa idem pl oym en ts inord er t o s ub si di ze h er l os in g h or se -b reed in g a ct iv it y . In ot he r wor ds , if An dr ea re al ly exp ect edth atth e act iv it y was o n i ts way

to tu rna pr of it , on e wou ldex pe ctth atsh e wou ldha ve sl owl y ph as edou t o f he r fu ll -ti m e-4 3-

[* 43 ] an d p art -ti m e job s an d fo cu se d h er en erg y pri m ari ly on Qu een sl an d. Bec au se sh e d idno t, we s us pe ctth atsh e in te nd edto co nt in ue to rel y on he r ot he r em pl oym en t t o m ak e a l iv in g a ndsubs id iz e th e h or se -b reed in g a ct iv ity . Thi s fa ct orfav or s re sp on de nt . D. The ex pe ct at io n t ha t as se ts us edinth e act iv it y m ay ap pr eci at e in va lu e A tax pa y er’s ex pe ct at io n t ha t as se ts su chas l an d a ndot he r ta ng ib le pro pe rty us edinanact iv ity

m ay ap pr eci at e to create anov eral l p ro fitm ay in di cat e th atth e ta xp ay er h as a pr of

itob jecti ve as t o t ha t ac ti vi ty. Sec. 1 .18 3- 2( b) (4 ), In co m e Tax Reg s. Anov eral l p ro fitis pre se ntif n etearn in gs an d app reci at io n a re en ou gh to reco up lo ss es su st ai ne d i n p rio r y ears . Gile s v . Comm is si on er, 8 9 T.C.M . (CCH) at77 9 (c it in g B es 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.2 d 2 52 (2dCir . 19 67 )). Pet it io ne rs cla im

th atth ey reas on ab ly exp ect edth atth ei r in ve nt ory an d t he Farm in gt on pro pe rty woul d app reci at e to ge ne rat e anov eral l p ro fit . The cre di bl e ev id en ce i n t he reco rddo es no t s up po rt s uc h acla im
. As t o t he Farm in gt onpro pe rty purch as edin19 89 , pet it io ne rs ha ve fai le d t o pr oduc e an y

cred ib le ev id en ce t o s ug ge stth atitha s ap pr eci at edsu ffi ci en tl y to of fs etov er $ 1.8 m il li on of l os se s Qu een sl an d s uf fere d b etween19 93 an d 2 00 9.-4 4-

[* 44 ] Nor i s the re an y

cred ib le ev id en ce s ho win g t he sp eci fic fai r m ark etva lu e o f th e Farm in gt on pro pe rty. As t o t he ho rs es , by Andrea’s ad m is si on , sh e p ro jecte d t ha t s he co ul d s el l al l of he r ho rs es for$2 25 ,00 0 t o m ak e a $ 15 ,00 0 p ro fitfor 20 07
. In o th er wo rd s, at

1 2 th e ti m e sh e m ad e th e p ro jecti on for20 07 , sh e n o l on ge r ex pe ct edth atsh e co ul d
recupe rat e Que en sl an d’s p rio r lo ss es of m or e th an$1 m il li on . Yet s he co nt in ue d to in ve stm or e th an$2 00 ,00 0 i n t he act iv it y in20 07 . This is in co ns is te ntwith a pr of itin te nt . Set ti ng asi de pe ti ti on ers ’ in ab il ity to reco up all pri or

lo ss es , Andrea’s
ex pe ct at io n tha t s he co ul d m ak e a $ 15 ,00 0 p ro fitfor20 07 was i ts el f un real is ti c. To cr eat e th atpro fitm arg in , pet it io ne rs wou ldha ve to sel l al l o f he r 29 ho rs es at ab ou t $ 7,7 50 pe r ho rs e. The m os t p et it io ne rs have ev er re cei ve d fr om sel li ng a ho rs e was $6 ,50 0 i n 1 99 7- -wh ic h was be fo re the fir e, th e te rro ris t at ta ck s, an d t he
rece ss io n- -an d t he m os t h or se s p et it io ne rs ha ve ev er s ol d i n a ny giv eny ear was th ree i n 2 00 3. Th e p ro

jecti on , ob vi ou sl y

ba se d o n an a ss um

pt io n t ha t wo ul d h av e be enus edby onl y

th e m os t i nc orrig ib le op ti m is t, i s o ve rwh el m in g e vi de nc e o f th e
Andrea’s t es ti m on y

sh ows th atpe ti ti on ers at o ne po in t h op edto sel l the ir 1 2 ho rs es for$5 0,0 00 to $6 0,0 00 each . Howev er, i t i s cl ear f ro m Andrea’s t es ti m on y th atsh e n o l on ge r ha d t ha t ex pe ct at io n b y th e ti m e sh e m ad e h er i nc om e p ro jecti on fo r 20 07
.-4 5-

[* 45 ] ab se nc e o f a p ro fitm ot iv e. See Swi ge rt v . Comm is si on er, T.C. Mem o. 19 82 -5 00 , 44 T.C.M. (CCH) 9 92 , 99 6 (1 98 2) ; Witt st ru ckv. Co m m is si on er, T.C. Mem o. 1 98 0- 62 , 39 T.C.M. (CCH) 1 16 8, 1 17 0 (1 98 0) (“ Co nt in ue d re te nt io n o f th e * * * [di sp ut edact iv ity ] aft er an y reas on ab le ho pe of p ro fitha s cl earl y be en ru le d o utm ak es itve ry

di ffi cu ltforus to fin d ago odfai th ex pe ct at io n o f pr of it .”), aff’d, 6 45 F.2d61 8 (8 th Cir . 19 81 ). Thi s fa ct orfav or s re sp on de nt . E. Pet it io ne rs ’ su cces s i n c arrying onot he r si m il ar o r di ss im il ar act iv it ie s Altho ug h a n a ct iv ity

is unpr of it ab le , th e fac t tha t a t ax pa y er h as pre vi ou sl y co nv ert edco m

pa rab le act iv it ie s fr om

unpr of it ab le to pro fit ab le en te rp ris es m ay sh ow a p ro fitob

jecti ve . Sec. 1 .18 3- 2( b) (5 ), In co m e Tax Reg s. The reco rdsh ows th atpe ti ti on ers have no t en ga ge d i n o th er ac ti vi ti es si mil ar o r di ss im il ar t o t he ho rs e-b reed in g a ct iv it y by whi chwe m ay

ev al ua te th ei r su cces s i n t ho se ot he r act iv it ie s. Thus , th is fact oris ne utral . See Ru nd le ttv. Co m m is si on er, T.C. Mem o. 2 01 1- 22 9, 1 02 T.C.M. (CCH) 3 07 , 31 0 (2 01 1) ; Whi te cav ag e v . Comm is si on er, T.C. Mem o. 2 00 8- 20 3, 9 6 T.C.M . (CCH) 1 19 , 12 2 (2 00 8)
.-4 6-

[* 46 ] F. The hi st ory

of i nc om e o r lo ss es with re sp ectto th e act iv ity The factth ata ta xp ay er i nc ur s a s eri es of l os se s b ey on d a n a ct iv it y ’s st artup y ears m ay

in di cat e th e ab se nc e o f a p ro fitob jecti ve as t o t ha t ac ti vi ty unl es s the lo ss es are at tri bu tabl e to un fo res eenor f ortu it ou s ci rcu m st an ces be y on d t he ta xp ay er's co nt ro l. Sec . 1.1 83 -2 (b )(6 ), In co m e Tax Reg s. We hav e p rev io us ly he ldth atth e st artup ph as e o f a h or se -b reed in g a ct iv ity m ay be 5 t o 1 0 years. Se e Eng dahl v. Co m

m is si on er, 7 2 T.C. at66 9. Pet it io ne rs arg ue th atth ei r lo ss es fol lo win g t he st artup y ears were at tri bu tabl e to un fo res eenan d fo rtu it ou s ci rcu m st an ces be y on d t he ir c on tro l. We di sa gr ee. 1. Sel en iu m de fic ie nc y In19 98 pe ti ti on ers di sc ov eredha y lo cal to Quee ns la nddi d n otha ve ad equa te sel en iu m , res ul ti ng insel en iu m de fic ie nc y

inth ei r ho rs es ’ di etth atco ul d
cau se ser io us m ed ic al pro bl em s t o t he ir h or se s. As a res ul t, p et it io ne rs ha d t o im po rt h ay fro m ot he r are as at s ig ni fic an t co st s. Whil e th e d is co ve ry m ig htha ve be enun fo res eenin19 98 , th e p ro bl em was o ng oi ng an d b y

20 07 itwas n o l on ge r anun fo res eenor f

ortu it ou s ev en t. On e wou ldth us ex pe cta pr of it -o rie nt edpe rs on to ex pl or e o th er m or e co st -eff ect iv e al te rn at iv es ; o r if

bre ed in g a ndrai si ng ho rs es atth e sa m e lo cat io n c on ti nu edto be co stpro hi bi ti ve , on e wou ldex pe ctitto be a-4 7-

[* 47 ] fact orto co ns id er i n d eci di ng whet he r to rel oc at e th e act iv it y or t o aba nd on italt og ethe r. Pet it io ne rs ’ fai lu re t o s ho w us th atth ey ha ve co ns id eredth es e bu si ne ss is su es m ak es itdi ffi cu ltforus to be li ev e th atth ei r de ci si on to st ay at t he
sa m e lo cat io n was m ot iv at edby pro fit
.

2. 19 99 fir e Pet it io ne rs co nt en d t ha t the 19 99 fir e al so adve rs el y affe ct edth ei r ho rs ebr eed in g a ct iv ity

be cau se itde st ro y edso m e in ve nt ory (m os tl y semen) an d t he equi pm en t fo r br eed in g h or se s. An dr ea t es ti fie d tha t the farm ’s reco ns tru ct io n was no t co m pl et edun ti l 2 00 8; ho wev er, i t i s n otcle ar wh enQuee ns landreturne d t o be in g o pe rat io na l. On the ba si s o f pe ti ti on ers ’ own tes ti m on y , itap pe ars th e 1 99 9 fi re af fect ed
on ly the ir abi li ty to b reedho rs es an d s el l s em en . Peti ti on ers pre se nt edno cred ib le
ev id en ce tha t ca n s ub st an ti at e a cl ai m th atth e fi re p rev en te d t he m fro m co nt in ui ng to tra inan d s el l the ir h or se s i n s to ck . If, forth e sa ke of a rg um en t, the fir e co m pl et el y sh utdo wn Qu een sl an d s o t ha t p et it io ne rs were n o l on ge r ab le to tra in
an d s el l the ir h or se s u nt il th ey co m pl et edth e rec on st ru ct io n i n 2 00 8, we que st io n why any pro fit -m in de d p ers on wou ldco nt in ue to ho ldon to th e in ve nt ory du rin g th e 1 0- y ear p eri odin st eadof r el oc at in g o r li qu id at in g t he in ve nt ory . If th e fi re d id
no t af fectpe ti ti on ers ’ ab il ity

to tra in an d s el l the ir h or se s, Qu een sl an d’s h is to ry of-4 8-

[* 48 ] ge ne rat in g d is m al in co m e fro m sel li ng ho rs es lea ve s u s u np ers ua de d t ha t the 19 99 fir e h adan yth in g t o d o wi th th e act iv it y ’s bo tt om li ne . Fi na ll y , we att rib ut e lo ss es res ul ti ng fro m th e fi re t o p et it io ne rs ’ fai lu re i n th e fi rs t i ns ta nc e to ge t ad equa te in su ran ce co ve rag e o n t he act iv ity ’s pro pe rty; ge tt in g s uf

fic ie ntin su ran ce co ve rag e was so m ethi ng withi n t he ir c on tro l an d wh at th ey co ul d h av e d on e. If p et it io ne rs ha d b ou gh t ad equa te in su ran ce co ve rag e as a bu si ne ss -m in de d p ers onwou ldha ve , th ey co ul d h av e rec ov eredan y cas ua lt y lo ss an d re bu il t the farm

m or e qui ck ly. Insu m , we dec li ne to fin d t ha t the act iv it y ’s lo ss es canbe att rib ut edto th e 19 99 fir e whe n p et it io ne rs co ul d h av e p rev en te d andm it ig at edso m e if no t m os t o f th e lo ss es . 3. Mi ss edin sp ect io n i n 2 00 1 Pet it io ne rs als o a ss ertth atth e m is se d h or se in sp ect io n i n S an taRo sain 20 01 ne ga ti ve ly affect edth e m ark et ab il it y of t he ir h or se s an d t hu s the ir v al ue s. W e fi ndpe ti ti on ers ’ arg um en t i nc red ib le on it s fa ce. The lac k o f ev id en ce s ho win g p et it io ne rs ha ve tak enan y of the ir h or se s t o anin sp ect io n s in ce 2 00 1 l ead s u s t o fi ndth atth ey di d n otdo so . If in sp ect io ns were i m po rtant , as p et it io ne rs cla im , to m ark et in g aho rs e an d i nc reas in g i ts va lu e, we qu es ti on why pe ti ti on ers fai le d t o t ak e an y of t he ho rs es th atm is se d the 20 01-4 9-

[* 49 ] in sp ect io n t o a no th er i ns pe ct io n i n s ub se qu en t years t o o bt ai n v al ue en ha nc in g d ip lo m as forth es e h or se s. Andrea t es ti fie d t ha t h or se s m us t b e in sp ect edat acert ai n a ge . This te st im on y su gg es ts th atm an y

of t he ho rs es th atmis se d t he 20 01 in sp ect io n wo ul d
no t b e el ig ib le foran ot he r in sp ect io n i n asubs eque nty ear. If s o, the re wo ul d b e li tt le ho pe th atth es e h or se s wo ul d app reci at e if th ei r va lu e d ep en de d o n in sp ect io n. Thus , pet it io ne rs ’ de ci si on to co nt in ue to ho ldonto th es e h or se s wi th
no reas on ab le ex pe ct at io n fo r ap pr eci at io n i s i nc on si st en t wi th a pr of itin te nt , es pe ci al ly in the li gh t o f th e fac t tha t k eep in g t he se ho rs es requi res subs ta nt ia l
co st s. Eit he r way , th ere i s n o c red ib le ev id en ce t o s up po rt p et it io ne rs ’ cl ai m th at th e act iv it y ’s lo ss es canbe attrib ut edto th e m is se d i ns pe ct io n i n 2 00 1.

4. Dep res se d m ark etco nd it io ns du rin g t he rece ss io n Fi na ll y , pet it io ne rs att rib ut e th ei r lo ss es to th e rec es si on inth e 2 00 0s an d th e res ul ti ng de pr es se d m ark etco nd it io ns . They arg ue th atth ei r cas e is “ strik in gl y si mil ar” t o En gd ah l. We dis ag ree. Inth e Eng da hl cas e, we ag reedwith the tax pa y ers th atth ei r lo ss es fro m th e ho rs e-b reed in g a ct iv ity

co ul d b e ex pl ai ne d b y

a se rie s o f un fo rtu na te ev en ts be y on d t he ir c on tro l. Eng da hl v. Co m m is si on er, 7 2 T.C. at66 9. So m e o f th es e ev en ts in cl ud eda ch an ge inm ark etco nd it io ns an d t he ris in g c os ts ass oc ia te d wi th-5 0-

[* 50 ] m ai nt ai ni ng an d t rai ni ng ho rs es . ButinEng da hl , un li ke inth e p res en t ca se , we fo un d t he re was a pr of itin te ntbe cau se th e ta xp ay ers th ere m ad e ch an ge s t o th ei r op erat io n; an d wh enth ey real iz edth ei r act iv it y

wou ldno t b eco m e p ro fit ab le , th ey att em pt edto sel l i t. Id . Here, as we st at edearl ie r, pe ti ti on ers di d n otpre se nt cred ib le ev id en ce tha t the y m ad e an y

ch an ge s t o t he ir o pe rat io n o r ad op te d a ny ne w tec hn ique s o r bu si ne ss m etho ds to weathe r th e rec es si on ; n or ha ve th ey

tri ed to di sp os e o f th e act iv ity

when itsh ou ldha ve be co m e ap pa ren t tha t the act iv it y wou ldno t b e p ro fit ab le . Evenaft er 2 00 7, the y ear wh enth e act iv it y ’s earn in gs di d
no t m eetpe ti ti on ers ’ ex pe ct at io n a cco rd in g t o An dr ea’s o wn t es ti m on y , pet it io ne rs co nt in ue d t o i nc urad di ti on al expe ns es of abo ut$2 00 ,00 0 i n 2 00 8 a ndab ou t $1 30 ,00 0 i n 2 00 9. Th is is y etm or e o ve rwh el m in g e vi de nc e th atsh ows a la ckof pr of itin te nt . 5. Co nc lu si on Fo r rea so ns st at ed , th is fact orfav or s re sp on de nt . G. The am ou ntof o ccas io na l p ro fit s The am ou ntof p ro fit s ea rn edinrel at io n t o t he am ou ntof l os se s i nc urred , th e am ou ntof t he in ve st m en t, an d t he va lu e o f th e as se ts inus e m ay in di cat e a pr of itob jecti ve . See s ec. 1 .18 3- 2( b) (7 ), In co m e Tax Reg s. Ab se ntactua l p ro fit s, th e o pp ortu ni ty to ea rnsubs ta nt ia l p ro fit s i n ahi gh ly spe cu la ti ve ve ntur e m ay be-5 1-

[* 51 ] en ou gh to in di cat e p ro fitin te nt . See i d.; see als o Gi le s v . Comm is si on er, 8 9 T.C.M. (CC H) at78 0- 78 1 (c it in g Daws on v. Co m m is si on er, T.C. Mem o. 1 99 6- 41 7)
. Pet it io ne rs arg ue th atth ey em ba rk edon a bu si ne ss to in tro du ce a p op ul ar bu t u nd erre pr es en te d b reedof p erfo rm an ce h or se to th e Uni te d S ta te s an d i t pr es en te d a n o pp ortu ni ty for s ig ni fic an t p ro fit . W e are no t p ers ua de d. Pet it io ne rs , aga in , pre se nt edno cred ib le ev id en ce, o th er tha n t he ir s el fse rv in g a ndva gu e te st im on y , th atth ey co ul d s el l the ir h or se s atto p p ric es to off se t 15 y ears of l os se s. Pet it io ne rs ’ sp ecu lati on was n otgro un de d i n anyth in g o th er th ananem

pt y asp ira ti on th atis in su ffi ci en t t o o ve rco m e th e co m pl et e ab se nc e o f pr of it s i n Qu een sl an d’s h is to ry . In the se 15 y ears , no ne of p et it io ne rs ’ ho rs es , ex cep t Lam ira , was o f th e qua li ty to g en erat e to p p ric es . Whe n s om eo ne off ered to bu y Lam irafor$1 10 ,00 0, p et it io ne rs reject edth e o ffer . Peti ti on ers ha ve no t br ou gh t an y

of t he ir h or se s t o a no th er i ns pe ct io n s in ce 2 00 1 a ndha ve no t at te m pt edto ex pa ndth ei r cu st om er b as e b y en ga gi ng inm or e ag gr es si ve adve rti si ng or m ark et in g. Pe ti ti on ers ’ co nduc t dur in g t he se y ears si m pl y do es no t supp ort the ir c on te nt io n t ha t “ si gn ifi can t p ro fit ” su ffi ci en t t o o ffs etth ei r subs ta nt ia l ac cu m

ul at edlo ss es was a tt ai nabl e. Insu m , th is fact orfav or s re sp on de nt .-5 2-

[* 52 ] H. Pet it io ne rs ’ fin an ci al st atus A tax pa y er’s l ackof s ub st an ti al in co m e o r cap it al fro m so ur ces ot he r th an anact iv it y

m ay in di cat e th atth e act iv it y

is en ga ge d i n fo r pr of

it . See s ec. 1 .18 3- 2( b) (8 ), In co m e Tax Reg s. Th e fac t tha t a t ax pa y er d oe s h av e subs ta nt ia l i nc om e fro m so ur ces othe r th ananact iv it y , onth e o th er h an d, 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 . The l at te r is esp eci al ly true wher e lo ss es fro m th e act iv it y

ge ne rat e subs ta nt ia l t ax be ne fit s o r whe re the re ar e p ers on al or recr eat io na l el em en ts in vo lv ed . Sec. 1 .18 3- 2( b) (9 ), In co m e Tax Reg s. Pet it io ne rs m ai nt ai n tha t the y are n otweal th y

in di vi du al s an d t ha t the y us ed th ei r wag e in co m e an d o th er s av in gs to fin an ce the ir h or se -b reed in g a ct iv ity . Pet it io ne rs arg ue th atth is fact orth us li es inth ei r fav or . W e d is ag ree. W e h av e p rev io us ly hel d t ha t s ect io n 1 83 do es no t ap pl y on ly to wea lt hy ta xp ay ers who en ga ge inunpr of it ab le act iv it ie s t o c reat e “pape r” l os se s t o o ffs et ag ai ns t u nr el at edin co m e. Ran ci at o v . Comm is si on er, T.C. Mem o. 1 99 6- 67 , 71 T.C.M. (CC H) 21 16 , 21 19 (19 96 ). Und er thi s fa ct or , we compare the in co m e ge ne rat edby an act iv ity

with t he tax pa y er’s t ax ab le in co m e fro m so ur ces ot he r th anth e act iv ity

an d que ry

whet he r th e ta xp ay er’s ab il it y to earn in co m e el se whe re al lo ws h er t o fi na nc e anot he rwis e unp ro fit ab le act iv it y fro m whi chsh e d eri ve s so m e p ers on al or t ax be ne fit s. See id
.-5 3-

[* 53 ] Between19 93 an d 2 00 8, p et it io ne rs to ge th er h ada co m bi ne d wag e in co m e of $1 .2 m il li on . On the ot he r ha nd , Quee ns la nd ’s in co m e dur in g t he same peri od

1 3
was les s tha n $ 15 ,00 0 b utitin curredm or e th an$1 .6 m il li on inex pe ns es . To fin an ce the se ex pe ns es , pet it io ne rs us edth ei r wag e in co m e as well as l ife in su ran ce p ro ceed s, p ro ceed s fr om a 20 05 ho m e equi ty loan, an d p ers on al
sa vi ng s. The i nc om e an d fu nd s fr om th es e o th er s ou rces th us en ab le d p et it io ne rs 1 4 to en ga ge inth ei r ho rs e-b reed in g a ct iv it y th at , as we d is cu ss be lo w, has stro ng pe rs on al ele m en ts . Mo reo ve r, th e lo ss es fro m Quee ns la ndsi gn ifi can tl y reduc edpe ti ti on ers ’ ta x li ab il it y be twee n 1 99 3 a nd20 08 --tha t i s t o s ay pe ti ti on ers pa idzero Fed eral in co m e ta x o n aco m

bi ne d i nc om e o f $1 .2 m il li on fro m th es e 1 5 years. Th us , th e ta x l iabi li ty pet it io ne rs wou ldha ve in cu rredbu t fo r Que en sl an d’s l os se s h as go ne to subs id iz e anact iv ity

th atlac ks a pr of

itm ot iv e. Thi s i s a s ub st an ti al tax be ne fit
. Thi s fa ct orfav or s re sp on de nt . Zav ra d idno t fi le a Fed eral in co m e ta x re turnbe fo re 2 00 2 a ndth us ha d n o 1 3 rep orte d wag e in co m e. As t o Zav ra, thi s fi gu re i nc lu de s o nl y he r wag e in co m e be gi nn in g i n 2 00 2. It i s al so tel li ng th atpe ti ti on ers ne ve r at te m pt edto fin an ce Qu een sl an d 1 4 with aco m

m erci al lo an ; o r if

th ey tri edto ap pl y

foron e, th ey

di d n otge t o ne . Whi le itis no t a r equi rem en t, fi na nc in g a n a ct iv it y with abu si ne ss lo anfro m a di si nt eres te d p arty

at arm ’s len gt h i s i nd ic at iv e o f th e fo r-p ro fitna ture o f th e act iv ity .-5 4-

[* 54 ] I. Elem en ts of p ers on al pl eas ur e o r rec reat io n The pre se nc e o f pe rs on al pl eas ur e o r rec reat io n fr om anact iv it y

m ay in di cat e th e ab se nc e o f a p ro fitob jecti ve . Sec. 1 .18 3- 2( b) (9 ), In co m e Tax Reg s. The m ere f

actth ata ta xp ay er d eri ve s p ers on al pl eas ur e fro m anact iv it y , ho wev er, do es no t n eces sa ril y

m eanth atsh e la ck s a p ro fitob jecti ve with re sp ectto th e act iv ity . A pro fitob

jecti ve m ay

be pre se ntinth e la tt er ca se if the act iv it y is tru ly
en ga ge d i n fo r pr of

itas e vi de nc edby oth er fa ct or s. Gil es v. Co m mis si on er, 8 9 T.C.M. (CC H) at78 1 (c it in g J ack so n v . Comm is si on er, 5 9 T.C. 3 12 , 31 7 (1 97 2) ). Pet it io ne rs arg ue th atth e rec or d d oe s n otha ve an y ev id en ce tha t p et it io ne rs ev er ro de ho rs es forpl eas ur e. They als o p oi ntou t tha t An dr ea d oe s n oten joy ho rs eb ackrid in g o n a cco un t o f anol d i njury . Inth es e cas es , we bel ie ve pe ti ti on ers de riv e p le as ur e fro m th ei r ho rs ebr eed in g a ct iv ity

be cau se th ey

are at ta ch edto th ei r ho rs es . Bot h An dr ea an d Zav ra g rew up a ro un d h or se s. Ev enth ou gh Andrea m ay no lo ng er ri de ho rs es , we be li ev e th atsh e en

joy s b ei ng aro un d t he m . Zavraha s al way s en joy edbe in g aro un d h or se s an d a t o ne po in t as pi redto be a ho rs e v et eri na ria n. Th is att ach m en t
m ay ex pl ai n wh y

pe ti ti on ers wou ldno t l etgo of t he ir h or se s an d c on ti nu e to in cu r subs ta nt ia l ex pe ns es to care forth em .-5 5-

[* 55 ] W e al so be li ev e And rea d eri ve s an ad di ti on al pl eas ur e fro m ha vi ng he r fam il y li ve inth e sam e h ou se ho ldth atQuee ns la ndha s m ad e p os si bl e. Furth er, Andrea, thr ou ghQuee ns la nd , has be enab le to pro vi de a se cure an d p erm an en t en vi ro nm en t fo r he r daug ht er t o e ng ag e in anact iv it y for whi chZavr a h as a sp eci al pa ss io n. As we ha ve st at edbe fo re: “ The gra ti fic at io n d eri ve d fr om an oc cupa ti on wort h d oi ng , po ss ib ly ben efi ci al to ot he rs , andpro babl y requi rin g l on g ho ur s o f arduo us lab or , m us t s ti ll no t b e co nf

us edwith a n i nt en ti on to return a pr of it .” Whi te v. Co m

m is si on er, 2 3 T.C. 9 0, 9 4 (1 95 4) , aff’d, 2 27 F.2d77 9 (6 th Ci r. 19 55 ). Thi s fa ct orfav or s re sp on de nt . J. Co nc lu si on W e co nc lu de onth e b as is of o urdi sc us si on ab ov e th atpe ti ti on ers di d n ot carry on th ei r ho rs e-b reed in g a ct iv it y in20 07 with apre do m in an t, p rimary , or pr in ci pa l p ro fitob

jecti ve . IV. Accu racy-rela te d p en al ty Res po nd en t d et erm in edth atpe ti ti on ers are l iabl e fo r acc ur acy-rela te d pe na lt ie s fo r 20 07 be cau se pe ti ti on ers subs tant ia ll y un de rs ta te d t he ir i nc om e ta x or , alt ern at iv el y , bec au se th ey were n eg li ge ntor d is reg ard edrul es or r eg ul at io ns . See s ec. 6 66 2( a) an d (b )(1 ) an d (2 ). Ther e is a subs ta nt ia l u nd ers ta te m en t o f-5 6-

[* 56 ] in co m e ta x i f th e am ou ntof t he un de rs ta te m en t fo r th e ta xabl e y ear e xc eed s th e g reat er o f 10 % of t he tax requi redto be sh own on a return fo r a t ax ab le y ear o r $5 ,00 0. Se c. 66 62 (d )(1 )(A). Alt ern at iv el y , we wil l s us ta in res po nd en t’s de te rm in at io n t o i m

po se accuracy-rela te d p en al ti es if we d et erm in e p et it io ne rs fai le d t o m ak e a rea so nabl e at te m ptto co m pl y with p ro vi si on s o f th e in te rn al
rev enue laws or d is reg ard edrul es or r eg ul at io ns by acti ng care le ss ly, reck le ss ly, or with i nt en ti on al di sr eg ard . Sec. 6 66 2( c); sec . 1.6 66 2- 3( b) (1 ) an d (2 ), In co m e Tax Reg s. On ly one accu racy-rela te d p en al ty m ay be im po se d fo r a g iv enpo rti on of a n un de rp aym en t ev enth ou gh th atpo rti on im pl ic at es m or e th anon e fo rm of
m is co nduc t d es cri be d i n s ect io n 6 66 2( b) . Sec. 1 .66 62 -2 (c), In co m e Tax Reg s. Bec au se res po nd en t h as carr ie d h is bu rd enun de r se ct io n 7 49 1( c) t o s ho w th at pe ti ti on ers ’ lo ss es cla im edfor20 07 res ul te d i n s ub st an ti al un de rs tate m en ts of t he ir in co m e ta x, we n eedno t d eci de whet he r pe ti ti on ers wou ldals o b e li ab le forth e pe na lt ie s b y

reas on of n eg li ge nc e o r reck le ss di sr eg ardof rul es or r eg ul at io ns . Onc e res po nd en t h as pro ve d h is pri m a fac ie cas e fo r im po si ng pe na lt ie s un de r se ct io n 6 66 2( a), p et it io ne rs be ar the bu rd enof p ro vi ng th atth e p en al ti es are un warrant edby establ is hi ng anaffi rm at iv e d efen se su chas r eas on ab le cau se or subs ta nt ia l au th or ity . See s ecs . 66 64 (c)( 1) , 66 62 (d )(2 )(B)
.-5 7-

[* 57 ] Altho ug h we h av e d et erm in edth atpe ti ti on ers ’ ho rs e-b reed in g a ct iv it y was no t en ga ge d i n fo r pr of

it , un de r th e ci rcu m st an ces of t hi s ca se , we fin d tha t pe ti ti on ers “ m ad e a rea so nabl e an d g oo d fa it h e rro r in ap pl y in g t he law t o t he fact s of th is cas e.” See Co nn ol ly v. Comm is si on er, T.C. Mem o. 1 99 4- 21 8, 6 7 T.C.M
. (CCH) 29 73 , 29 74 (19 94 ), aff’d, 5 8 F .3d63 7 (5 thCir .19 95 ). Pet it io ne rs ha ve in de edm ad e so m e g oo d- fai th effo rts to co m pl y with t he law, b utth os e eff orts no ne th el es s fe ll sh ort. Acco rd in gl y , onth e sp eci fic fact s o f th is cas e, th e to ta li ty of th e ci rcu m st an ces , andev id en ce p res en te d a t p et it io ne rs ’ tri al , we fin d pe ti ti on ers no t l iabl e fo r th e se ct io n 6 66 2( a) ac cu racy-rela te d p en al ti es forth e y ear atis su e. V. Co nc lu si on Any argu m en ts no t d is cu ss edinth is op in io n are i rrel ev an t, m oo t, o r la ck in g in m eri t. To re fle ctth e fo reg oi ng , Deci si on s wi ll be en te redun de r Ru le 15 5.