TAX COURT OPINION

Case: Rick B. & Janna L. Delamarter
Docket Number: 10256-09
Judge: Colvin
Opinion Type: bench
Filed: 05/06/2010
Pages: 17

UNITED STATES TAX COURT WASHINGTON , DC 2021 7 RICK B . & JOANNA L . DELAMARTER , Petitioner v . Docket No . 10256-09 . COMMISSIONER OF INTERNAL REVENUE , Respondent O R D E R Pursuant to Rule 152(b), Tax Court Rules of Practice an d Procedure, it i s ORDERED that the Clerk of the Court shall transmit herewith to petitioners and to respondent a copy of the pages of the transcript of the trial in the above case before Judge Joseph Robert~Goeke at Los Angeles, California, on April 27, 2010, containing his oral findings of fact and opinion rendered at the conclusion of the trial . In accordance with the oral findings of fact and opinion, a decision will be entered under Rule 155 . (Signed) Joseph Robert Goeke Judge Dated : Washington, D .C . May 6, 2010 SERVED MAY 7 2010 1 Bench Opinion by Judge Joseph Robert Goek e 2 Delamarter v . Commissioner Docket No . 10256-0 9 3 April 27, 2010 4 THE COURT : The Court has decided to lende r 5 oral findings of fact and opinion in this case, and 6 the following represents the Court's oral findings of 7 fact and opinion . The oral findings of fact an d 8 opinion shall not be relied upon as precedent in any 9 other case . 10 This opinion is rendered pursuant to section 11 7459(b) of the Internal Revenue Code and Rule 152 of 12 the Tax Court Rules of Practice and Procedure . 13 This is a Tax Court deficiency cas e 14 regarding the 2004 income tax return of Dr . AndrMrs . 15 Delamarter, who are the petitioners . The petitioners 16 resided in Los Angeles, California, when they filed 17 their petition in this case, and venue for appea l 18 would normally lie in the United States Court of 19 Appeals for the Ninth Circuit . 20 The notice of deficiency and pleadings i n 21 this case framed many issues, including respondent' s 22 alternative arguments for additions to tax . The 23 parties' advised the Court that all of the issues 24 have been settled with the exception of the questio n 25 whether petitioners' claimed deductions of $1181,721 on Heritage Reporting Corporatio n (202) 628-4888 4 1 Schedule F of their 2004 joint federal income ta x 2 return for a cattle ranch in Oregon should b e 3 disallowed as a passive activity for which losses are 4 limited by Section 469(h)(i) of the Internal Revenue 5 Code and Section 1 .469-5(T)(a) of the Temporary 6 Treasury Regulations . 7 The issue that remains in the case is a 8 factual one and involves the question whether Dr . 9 Delamarter was involved in the ranch activities on a 10 regular, continuous and substantial basis in 2004 . 11 The parties dispute who has the burden of proof on 12 this factual issue . Petitioner maintains that th e 13 burden should shift to Respondent under Section 749 1 14 of the Internal Revenue Code because they maintai n 15 they cooperated with respondent's examining agent and 1 16 that they have introduced evidence such that th e 17 burden of proof should shift to Respondent . 18 We agree with petitioners' analysis, bu t 19 this case is not decided on the burden of proof in an y 20 event as the determination is based upon the record of 21 trial and the facts presented through testimony and 22 stipulations and exhibits . 23 The stipulations and record of trial 24 establish the following facts . Dr . Delamarter' s 25 professional success as a surgeon is uncontested . He Heritage Reporting Corporatio n (202) 628-4888 17 5 1 practices in the Los Angeles area, which is far! 2 removed from the location of the cattle ranch i n 3 question, and this has served to raise Respondent' s 4 concerns about whether he was sufficiently involved i n 5 the cattle ranch to avoid passive loss treatment . 6 There's no question that the doctor's! 7 success has caused him to be a very busy an d 8 multifaceted individual . He grew up in centra l 9 Oregon, and after a very successful academic career in 10 undergraduate school and medical school, he worked his 11 way through the medical profession to become a highly 12 respected orthopaedic surgeon, pioneering surgica l 13 treatments of the back and neck . He holds patents on 14 advanced technological tools used to fuse injure d 15 spines, and he has a well established surgica l 16 practice in addition to being the director of a ;well 17 respected research institution . 18 In 1999, the doctor moved his medica l 19 practice to St . Johns Health Center in Santa Monica, 20 California, where he continued to practice throughout 21 2004 . He was also a research director at St . John s 22 Health Center in Santa Monica . Also during 2004, Dr . 23 Delamarter had a relationship with at least tw o 24 manufacturers of technical medical devices and 25 surgical tools who paid him roughly $500,000 as : Heritage Reporting Corporatio n (202) 628-4888 6 1 consulting fees in that year . He also received 2 roughly $ 1 .9 million in income from his professiona l 3 corporation and from St . Johns Health Center . 4 Dr . Delamarter's interest in the cattl e 5 ranch arises from his childhood where until the age of 6 10 he grew up on a cattle ranch and in his later years 7 through high school he worked on cattle ranches an d 8 farms . In 2004, he was not compensated for his l 9 services for the cattle ranch in question which,is 10 named Twin Buttes Ranch and is located in Post , 11 Oregon . The ranch was purchased by the petitioners in 12 1996 for $1 .3 million . The ranch consists of land 13 with improvements, irrigated farming equipment , 14 irrigated pastures, irrigated meadows, range land, 15 home sites, irrigation equipment, cattle and 16 contiguous growing allotments from the Bureau of Land 17 Management . The ranch is zoned exclusively for . 18 agricultural use and does not provide persona l 19 recreation facilities . The ranch has roughly 10,00 0 20 acres available for grazing together with roughly 21 30,000 acres of land from the Bureau of Land 22 Management also available for grazing cattle . 23 In 2004, the ranch held roughly 600 head of 24 Black Angus beef cows which would produce calves which 25 were the product that was sold by the ranch . Th e Heritage Reporting Corporation (202) 628-4888 7 ranch also had 50 bulls to breed with these cows . The 2 ranch land is roughly six miles by 10 miles i n 3 dimension . The ranch also included roughly nin e 4 working horses and various all-terrain vehicles it o 5 manage the cattle and move about the property . 1 6 In addition to raising the cattle, the ranch 7 activities'included raising and storing hay for winte r feed and irrigating fields of the farm for grazing an d 9 supporting the hay crop . In 2004, the ranch had thre e i 10 full-time employees onsite and had 18 part-time 11 laborers to assist at certain busy-times during th e 12 year . In addition, the petitioners and family member s 13 would participate in the ranch activities, especiall y 14 Dr . Delamarter . 15 The calves which are sold each year by th e 16 ranch are through relationships with third partie s 17 which are negotiated by Dr . Delamarter . This was true 18 in 2004 as well as the prior and subsequent years of 19 the ranch operations . The ranch expenses were claimed 20 on Schedule F . Associated with the ranch activities 21 was a partnership and a Subchapter S corporation, both 22 of which were owned 100 percent by the petitioners . 23 The existence of these entities is no t 24 deemed to affect the income tax consequences of 'thi s 25 case by either party, and the Court will analyze th e Heritage Reporting Corporation (202) 628-4888 8 1 ranching activities as if they were conducted ash a 2 sole proprietorship . 3 During 2004, the three principal onsite 4 employees of the ranch were a married couple, the 5 Hartzalls, and their adult son . All three of these 6 individuals lived and worked at the ranch . They, 7 worked over 40 hours a week and possibly quite mor e 8 per week depending on the time of the year . 9 During 2004, the Hartzalls and their son 10 received wage income from the ranch, as did the 1 11 temporary employees needed for certain busy times of 12 the year . The Hartzalls and their son were als o 13 reimbursed for the monthly cost of health insurance . 14 In 2004, Dr . Delamarter communicated with 15 the Hartzalls by telephone, fax and email to explain 16 what he wanted done at the ranch and how he wanted it 17 done . He set up a system of regular reporting fo r 18 both the ongoing activities at the ranch and other 19 specific items, primarily gasoline and diesel fuel 20 usage . The parties have stipulated that Dr . I 21 Delamarter makes all decisions regarding which calves 22 to sell and to whom the calves would be sold . 23 The record as a whole establishes that h e 24 basically made all the decisions concerning the, 25 management and operation of the ranch except for Heritage Reporting Corporatio n (202) 628-4888 9 1 mundane operation decisions as far as day-to-day . 2 activities, which would be done by the Hartzalls Bu t 3 any significant activity or even somewhat mundane 4 purchases were all coordinated with Dr . Delamart,er . 1 5 This was done through his assistant in Santa Monlica , 6 who is also the bookkeeper of both the farm activitie s 7 and Dr . Delamarter's medical practice . 8 In analyzing the applicable legal standard 9 in this case, we look to Section 469(a) of the , 10 Internal Revenue Code initially . Pursuant to tha t 11 section , a passive activity loss of an individual fo r 12 the taxable year is generally not allowed as a 1 13 deduction for such year . For this purpose, the , 14 passive activity loss for the taxable year i s 15 generally the amount by which the passive activity 16 deductions for the taxable year exceed the passiv e 17 activity gross income . This is pursuant to subsectio n 18 (d) (1) of Section 469 . 19 As pertinent here in this case, Section 20 469(c) defines the term passive activity to include 21 any activity which involves the conduct of any trad e 22 or business and in which the taxpayer does no t 23 materially participate . The parties do not contest in 24 this case the existence of a trade or business in th e 25 ranch operations . So the sole factual issue before u s Heritage Reporting Corporation (202) 628-4888 10 1 is whether Dr . Delamarter should be considered to hav e 2 materially participated in the ranch operations in 3 2004 . 4 Section 469(h)(1) provides that generally an 5 individual is to be treated as materiall y 6 participating in an activity only if such individual 7 is involved in the operations of the activity on a 8 basis that is regular, continuous and substantial . 9 Congress expressly authorized the Secretary of th e 10 Treasury to prescribe regulations to describe what 11 constitutes material participation . Both temporary 12 and final regulations relating to the meaning of the 13 terms participation and material participation have 14 been promulgated under Section 469 . 15 With regard to the term participation ; final 16 regulations issued under Section 469 provide tha t 17 generally any work done by an individual withou t 18 regard to the capacity in which the individual does 19 the work in connection with an activity in which the 20 individual owns an interest at the time the work is 21 done shall be treated for purposes of this section a s 22 participation of the individual in the activity ;. 23 Section 1 .469-5(f)(1) of the Income Tax Regulations . 24 Temporary regulations issued under Section 25 469 provide certain exceptions to this definition o f Heritage Reporting Corporation (202) 628-4888 1 participation . As pertinent in this case , Section 2 1 .469-5(T) (f) (2) (ii ) ( A) provides that work done by an 1 1 3 individual in the individual ' s capacity as an investor //~~ 4 in an activity is not to be treated as participation ~~O A 5 by the individual in the activity unless th e 6 individual is involved in the day-to-day management o r 7 operations of the activity . For this purpose, wor k 8 done by an individual in such individual's capacity a s 9 an investor is an activity that includes (1) studying 10 and reviewing financial statements or reports o n 11 operations of the activity, (2) preparing or compiling 12 summaries or analyses of the finances or operations of 13 the activity for the individual's own use, and (3 ) 14 monitoring the finances or operations of the activity 15 in a non-managerial capacity . 16 Temporary regulations relating to the ! 17 meaning of the term material participation in Section 18 469(h)(1) provide that in general an individual shal l 19 be treated for purposes of Section 469 and th e 20 regulations _het ___ under as materially participating 21 in an activity for the taxable year if and onlylif (1) 22 the individual participates in the activity for more 23 than 500 hours during such year, (2) the individual's 24 participation in the activity for the taxable yea r 25 constitutes substantially all of the participation in Heritage Reporting Corporatio n (202) 628-4888 1 2 1 such activity of all individuals, includin g 2 individuals who are not owners of interest in the 3 activity for such year, (3) the individua l 4 participates in the activity for more than 100 hour s 5 during the taxable year and such individual' s 6 participation in the activity for the taxable year is 7 not less than the participation in the activity ;of any 8 other individuals, including individuals who are no t 9 owners of interest in the activity for such year ; (4 ) 10 the activity is a significant participation activity 11 within the meaning of paragraph (c) of this section 12 for the taxable year and the individual's aggregate 13 participation in all significant participatio n 14 activities through such year exceeds 500 hours ;1(5 ) 15 the individual materially participated in the activity 16 determined without regard to paragraph (a)(5) for any 17 five taxable years, whether or not consecutive during 18 the 10 taxable years that immediately precede th e 19 taxable year in question ; (6) the activity is a 20 personal service activity within the meaning o f 21 paragraph (d) of this section and the individua l 22 materially participated in the activity for any thre e 23 taxable years whether or not consecutive preceding the 24 taxable year or (7) based on all of the facts an d 25 circumstances, taking into account the rules in Heritage Reporting Corporation (202) 628-4888 1 3 1 paragraph (b) of this section, the individua l 2 participates in the activity on a regular, continuous 3 and substantial basis during such year . 4 These seven tests are contained in Sectio n 5 1 .469-5(T)(a) of the temporary income tax regs . ' 6 Subsection (b)(2)(iii) of that section provides that 7 material participation under Part 7 of the seven-par t test will not be found if an individual did no t 9 participate at least 100 hours in the activity . ' 10 Respondent in this case is generall y 11 attacking petitioners' position because petitioner 12 obviously was not present throughout the year at the 13 ranch and the petitioner, Dr . Delamarter, was a r 14 extremely busy individual involved in research , 15 surgical operations and other aspects of his medical 16 practice . 17 Respondent characterizes the testimony o f 18 petitioners' witnesses as self-serving, thes e 19 witnesses including Dr . Delamarter, employees of the 20 ranch, Dr . Delamarter's outside accountant and Dr . 21 Delamarter's bookkeeper . We find that the witnesses 22 were generally favorably disposed to the Petitioners ' 23 cause in this case . But we also find that the 24 documentation supports the testimony and that th e 25 witnesses were forthright and nonevasive in answerin g Heritage Reporting Corporation (202) 628-4888 1 4 1 questions posed by the Court and Respondent's counsel . 2 Therefore, in the overall, we find the testimony, o f 3 the petitioners' witnesses to be credible . 4 A key question in the case is whether th e 5 evidence that has been provided by the petitioners is 6 sufficient to sustain their burden that they mee t 7 paragraph 1 or paragraph 7 or both of the tests . 8 provided by Treasury Reg . Section 1 .469-5(T)(a) . 9 In this regard, the regulation in subsection 10 (f)(4) provides that the extent of an individual' s 11 participation in an activity may be established by any 12 reasonable means . Contemporaneous daily time reports, 13 logs or similar documents are not required if th e 14 extent of such participation may be . established by 15 other reasonable means . Reasonable means for purposes 16 of this paragraph may include but are not limited to 17 the identification of services performed over alperiod 18 of time, the appropriate number of hours spen t 19 performing such services during such period based o n 20 appointment books, calendars and narrative summaries . 21 In this case, the evidence offered b y 22 petitioners includes the reporting requirements that 23 Dr . Delamarter gave to his employees onsite at th e 24 ranch and samples of the documents they produced on a 25 regular basis which he reviewed . It also include s Heritage Reporting Corporation (202) 628-4888 1 5 1 financial statements which he reviewed and used to 2 manage the farm business . 3 The parties do not dispute the fact that he 4 did manage the farming business and made all the key 5 decisions concerning the ranch operations . 6 Respondent, however, maintains that reviewin g 7 financial statements, regardless of the purpose of A5 8 reviewing of that information, would not qualify hi U"O 9 time that should be considered as qualifying Dr . 10 Delamarter for having material participation inlth e 11 ranch operations . 12 Respondent cites BARD 15 I S v . Commissioner , T .C . 13 /1 Memo 1999-258 . Respondent also cite s pi0 ~ N 14 rase , T .C . Memo 2004 -222 . The Court has reviewed 15 these cases . The first case deals with individuals 16 who owned a condominium and relied upon othe r 17 individuals to manage and operate the condominium . 18 The Court found in that case a failure by th e 19 petitioners in that case to establish that they~had 20 participated in the management of the condominium fo r 21 100 hours in the taxable year . 22 The subsequent case deals with individuals 23 who managed what is characterized as a hote l 24 condominium and involves testimony by thos e 25 individuals that they spent significant time reviewing Heritage Reporting Corporatio n (202) 628-4888 1 6 1 financial statements . The Court found in that case 2 that the taxpayers were not actively engaged in th e 3 management of the hotel condominium and that therefore 4 their review of the financial statements did no t 5 qualify as time that should be included in considering 6 whether the taxpayers materially participated in th e 7 activity . 8 We note that the regulation itself and the 9 analysis in the case cited by the Respondent mad e 10 clear that review of financial statements for 11 management purposes would qualify and would b e 12 considered properly in determining whether a taxpayer 13 materially participated in an activity . 14 We find that in the present case, Dr . l 15 Delamarter's review of the financial statements was 16 clearly designed to manage the business . He wa s 17 interested in seeing t e the f- t that the business was 18 operated in accord with his instructions and tha t 19 budgets were followed and that expenses wer e 20 maintained at a level that he felt was appropriate . 21 The correspondence demonstrates this repeatedly, and 22 therefore we find that his review and analysis on a 23 monthly basis of the financial statements i s 24 distinguishable from the cases cited by Respondent and 25 is properly included in determining whether the doctor Heritage Reporting Corporatio n (202) 628-4888 1 7 1 materially participated in the activities of the , 2 ranch . 3 As to the question of whether the docto r 4 participated 500 hours in the year 2004, the testimony 5 that he was onsite for a certain number of days in the 6 year seems uncontested but for respondent's arguments 7 that he has not established plane flights for two o f 8 those trips . We find his testimony regarding those 9 other two trips to be credible, and we would credit 10 him with being onsite for the 10 days that he claims . 11 Respondent alludes to the fact that some of 12 that time was spent in recreational activities . It is 13 possible that the doctor was engaged in huntinglon one 14 of those days . But on the other days, we find that he 15 was engaged in business activities . We also find that 16 he actively engaged in the business, both in managing 17 and researching potential purchases of equipment , 18 bulls and general management techniques to better 19 improve the operations of the ranch . 20 Given our analysis of the record and based 21 upon the facts in this case, we find that Dr . 22 Delamarter participated in the activity in 2004 for 23 over 500 hours and that he also participated in the 24 ranching activities on a regular, continuous an d 25 substantial basis throughout 2004 . Heritage Reporting Corporation (202) 628-4888 18 1 Given those findings on the issue before us, 2 we find for the Petitioner . Given the parties ' 3 concessions and settlements in this case, it will be 4 necessary that a Rule 155 computation be entered . 5 This concludes the Court's oral findings o f 6 fact and opinion in this case . 7 (Whereupon, at 5 :16 p .m ., this bench opinion 8 in the above - entitled matter was concluded . ) 9 10 11 12 13 14 15 1 6 17 18 19 20 21 / / 2 2 23 2 4 25 Heritage Reporting Corporation (202) 628-4888