t c memo united_states tax_court zavra d rodriguez petitioner v commissioner of internal revenue respondent andrea m rodriguez petitioner v commissioner of internal revenue respondent docket nos filed date anthony v diosdi for petitioners timothy a froehle for respondent memorandum findings_of_fact and opinion laro judge in separate notices of deficiency respondent determined deficiencies in petitioners’ federal_income_tax and related accuracy-related_penalties for as follows petitioner andrea m rodriguez zavra d rodriguez deficiency dollar_figure big_number accuracy-related_penalty sec_6662 dollar_figure big_number petitioners while residing in california petitioned this court for a redetermination of their deficiencies and penalties the parties were able to resolve a number of issues reflected in the stipulation of settled issues filed date we decide two remaining issues whether petitioners’ horse-breeding activity was an activity_not_engaged_in_for_profit within the meaning of sec_183 for we hold it was and whether petitioners are liable for the accuracy-related_penalties under sec_6662 we hold they are not findings_of_fact the parties’ stipulation of facts with accompanying exhibits their supplemental stipulation of facts with accompanying exhibits to the extent admitted during trial and the stipulation of settled issues are incorporated herein by this reference we find the facts accordingly unless otherwise indicated section references are to the internal_revenue_code code in effect for the year at issue and rule references are to the tax_court rules_of_practice and procedure i petitioners’ wage income history andrea has been employed by the state of california as a state investigator since at least between and andrea and her then husband josé rodriguez filed a joint federal_income_tax return for each year and reported a combined annual income including wages ranging from dollar_figure to dollar_figure after their divorce andrea reported her annual income including wages ranging from dollar_figure to dollar_figure for year sec_2001 through except that in the year at issue andrea had dollar_figure additional income from a distribution from pensions and annuities zavra andrea’s daughter began filing federal_income_tax returns in zavra reported annual wage income ranging from dollar_figure to dollar_figure except in when she also received a distribution from pensions and annuities of dollar_figure the same amount andrea received in the same year ii petitioners’ horse-breeding activity a history of income and losses from the horse-breeding activity queensland’s losses andrea and her then husband josé began their horse-breeding activity queensland horse farm queensland in which petitioners have conducted at all relevant times at a 40-acre farming property in farmington california farmington property from its inception through the horse-breeding activity never turned a profit and in fact incurred more than dollar_figure million of losses reported on schedule f profit or loss from farming between and andrea and zavra each claimed half of the deductions for the annual losses resulting from the activity with the losses petitioners were able to offset all of their income during the period between and and incur zero tax_liability as shown in the following table andrea and josé purchased the farmington property in when they purchased the farmington property the property also included a residence where petitioners have lived since zavra became andrea’s partner in the horse-breeding activity in see infra the record does not show that zavra filed a federal_income_tax return before in zavra left the partnership and did not claim any loss deduction from the horse-breeding activity as a result zavra had a tax_liability of dollar_figure on her dollar_figure wage income from andrea’s zavra’s income wages excluding schedule f income schedule f income or loss taxable_income after deductions income wages excluding schedule f income dollar_figure dollar_figure schedule f income or loss taxable_income after deductions --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number -0- -0- -0- -0- big_number big_number big_number --- --- --- --- big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number --- --- --- --- --- --- --- --- big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number year1 total record big_number big_number andrea and josé’s federal_income_tax returns for years through are not part of the big_number big_number big_number queensland’s income queensland’s income stream over the years was dismal and sporadic it totaled approximately dollar_figure between and during the five-year period between and queensland generated zero schedule f income the following table shows queensland’s history of farm income year total schedule f income from queensland dollar_figure --- --- --- --- -0- -0- big_number big_number big_number -0- -0- -0- -0- -0- big_number b petitioners’ research and expertise relating to the horse-breeding activity andrea andrea started riding horses at the age of three and received formal instruction when she was in high school and college as she traveled the world and became familiar with different types of horses andrea became fascinated with warmbloods which are horse breeds primarily from countries where riding is an older discipline than it is in the united_states andrea particularly enjoyed riding swedish warmbloods described as medium-sized warmbloods that are known to be sport horses and performance horses in andrea took a class in dressage where she learned dressage exercises and techniques dressage is an equestrian sport that emphasizes controlled athletic movements of a horse and requires the horse to spend years to become athletically fit enough to perform certain routines it is very similar to gymnastics or ballet for humans there are certain breeds of horses that are more successful in this discipline because of the desirable phenotype that is malleable to controlled movements the medium-sized swedish warmblood is an ideal breed for this type of riding before queensland’s inception andrea already focused her research on breeding swedish warmbloods she became a member of the swedish warmblood association swa which periodically dispatched inspection teams from sweden to the united_states to grade and evaluate horses presented at inspection events even though she did not own any horses at the time andrea would attend the inspections to learn about swa’s criteria of grading horses andrea also wanted to see the horses in performances and study the overall phenotype that swa’s breeding program tried to achieve in andrea also became a member of the california dressage society which sought to promote dressage in california through performances competitions and clinics in addition andrea contacted almost all swedish warmblood breeders in the united_states and canada and a great number of them in sweden for purposes of seeking expert advice on breeding swedish warmbloods for example andrea contacted jan phillipson the president of asvh which is the swedish warmblood state association and registry to seek marketing advice as well as advice on the suitability of swedish warmbloods for sport performances and competitions in the early 1990s petitioners also met with helen dilworth on multiple occasions ms dilworth at the time had owned and operated trilogy farm a horse-breeding farm and business in santa cruz for five years during their meetings petitioners would ask ms dilworth general questions about her approach to breeding swedish warmbloods evaluating foals and marketing and valuing horses but ms dilworth did not provide advice specific to petitioners’ own operation or business plan while ms dilworth believes that she breeds good horses she also acknowledges that there are very few people in the world right now that are making any money breeding horses there has been little contact between petitioners and ms dilworth in the past years besides contacting those familiar with breeding swedish warmbloods andrea also went to the small_business administration sba in san francisco ostensibly to obtain business advice from their score program score consists of a group of retired executives who offer mentoring services to small businesses in connection with obtaining business advice from score andrea submitted a business plan in business plan that contained only general information see infra the plan mainly discussed breeding of horses after andrea submitted the business plan she talked to an individual from score about the plan but the person had no knowledge about horses had never been part of any horse business and was not acquainted with anybody who had horses or a horse business the record is devoid of details regarding the content of any business advice andrea might have received from the individual through this consultation zavra zavra began taking riding lessons when she was a child she has always enjoyed being around horses as they have always been a part of her life so much so that at one point she dreamed of becoming a horse veterinary physician as early as when zavra wa sec_12 she already began studying about horses between and she attended university of california in davis uc davis sporadically for two years and took classes in agricultural sciences and animal husbandry she also took classes in horse breeding artificial insemination and general management and care zavra had an internship at uc davis on horse breeding as well as internships with local veterinarians in addition she took classes in the swedish language while at uc davis with the idea that she could later communicate with breeders in sweden around the same time zavra started to focus her research on breeding swedish warmbloods she contacted associations in sweden and reviewed competition results zavra believed on the basis of her research that swedish warmbloods were more marketable and more suitable for sport performances and competitions in zavra traveled to sweden met with breeders there to find the best horses and brought back with her about five horses from sweden in she arranged the purchase and shipping of horse semen from sweden c the manner in which petitioners carried on the horse-breeding activity business plan andrea allegedly devised a business plan for her horse-breeding activity as early as and submitted it to the sba in san francisco for feedback the business plan submitted to the sba was a revision of this original business plan and according to petitioners was updated several times following the initial submission to the sba the initial submission from is the only business plan in evidence the record does not show when the last time petitioners revised or revisited their business plan was the business plan contains five paragraphs of general description of the horse-breeding activity it provides mainly information on breeding and training swedish warmbloods it states that queensland is geared toward the serious upper-level horse rider s who are able to invest a great deal of time effort and money into their sport it continues to state that the initial investment of purchasing a horse is the least costly aspect of dressage and jumping the daily care and upkeep for a horse is actually the greater expense it claims that queensland would require a large upfront investment including startup costs and any return on the investment would be delayed until the horses become marketable according to the business plan the startup cost for queensland would be roughly dollar_figure the business plan essentially acknowledges that the purchasing of a horse constitutes only a small part of the overall longterm investment in owning and training a swedish warmblood for sport and the greater expense would be the daily care and upkeep it thus appears that the longer petitioners held on to a horse the more the potential profit from that horse would diminish in part because of the substantial overhead expenses but the business plan fails to identify any considerations that may affect how petitioners could maximize profits from their horses the business plan also fails to articulate specific business requirements for the activity or provide the activity’s financials for example the business plan does not have an operating costs projection a multiyear profit and loss p l projection a balance_sheet or a cashflow statement often found in many business plans advertising by petitioners had placed no more than a handful of advertisements in various trade magazines and publications to list some of their horses for sale they had also advertised the selling of semen of their stallions however there is no evidence that these advertisements generated any actual sales or were successful in reaching any potential buyers there is nothing in the record suggesting petitioners have examined the effectiveness of their advertising efforts budgeting at least before andrea and josé and possibly zavra as well used an accounting software to track expenses and a special horse-breeding software to track their inventory andrea would keep track of daily expenditures on index cards and someone would then enter the information into the accounting software petitioners maintained a separate checking account for queensland but only between and although petitioners kept track of queensland’s expenses and inventory they never personally prepared any financial statements to scrutinize the activity’s p l assets and liabilities or cashflow despite the fact that the information needed to run the financials was according to andrea readily available through the accounting software nonetheless petitioners allegedly made rough financial projections annually to determine the amount of income necessary to recover expenses_incurred in the previous years and to generate a profit clearly any financial projections that petitioners might have made had very little impact on the business decisions relating to queensland since the activity continued to lose money every year and as we will discuss below petitioners did very little to turn the tide insurance coverage petitioners did not have any insurance coverage for their horse-breeding activity and did not receive any insurance proceeds for a casualty_loss relating to the activity as a result of a fire in fire however andrea and her then husband had an insurance_policy underwritten by farmers insurance group to cover their personal_property on the farmington property and received insurance proceeds of dollar_figure covering personal_property lost in the fire financing the horse-breeding activity to finance the horse-breeding activity both andrea and zavra used their wage income to pay the activity’s expenses andrea also used life_insurance_proceeds of dollar_figure that she received in and the dollar_figure of proceeds of a home equity loan secured_by the farmington property to pay queensland’s expenses queensland did not have any outside investors and the record does not show petitioners had secured a commercial loan from a third-party lender to finance the horse-breeding activity d assets used in the horse-breeding activity the horses petitioners’ horse-breeding activity initially encompassed only the selling of the horses that they bred in queensland had horses since inception petitioners have sold horses as follows horse sabella gwenna garrisson cassanova l’irco ikebano lamira year sold price dollar_figure big_number big_number big_number big_number big_number big_number lamira was an example of a diploma mare--that is she was inspected and found to be a horse of high quality--and was sold for dollar_figure in among the highest selling prices in queensland’s history but the journey she traveled to her eventual sale was a costly one andrea bought lamira for approximately dollar_figure in when she was nine months old for about eight years andrea had to spend at least dollar_figure a month to board and train lamira or about dollar_figure in the aggregate at one point during the mid 1990s lamira was appraised for dollar_figure later petitioners received an offer to purchase lamira for dollar_figure which petitioners rejected petitioners eventually sold lamira at the age of for dollar_figure in andrea began to include the selling of her stallions’ semen as part of the horse-breeding activity at the time she had contracted to sell in roughly dollar_figure worth of semen that would have produced breedings because the fire destroyed the semen and prevented andrea from performing the contracts andrea did not complete any of the contracted sales and did not actually receive any income in from selling horse semen petitioners did not contract for any sales of horse semen in any other year the farmington property since when andrea and her then husband purchased the farmington property they had allegedly made certain improvements presently andrea zavra and zavra’s three-year-old child live at the residence on the farmington property for petitioners claimed utility and insurance expenses relating to their personal_residence as part of the horse-breeding activity’s expenses on their continued there is nothing in the record showing the fair_market_value of the farmington property and the improvements on the property e time and efforts spent in the horse-breeding activity in andrea worked hours a week as a litigation investigator for department of transportation for the state of california andrea claims that she also worked to hours every week in petitioners’ horse-breeding activity during all relevant times andrea also claims that in some years she had other part-time employments and worked to additional hours a week according to andrea there were days when she worked two or three days through without sleep as well as days when she slept in the barn with the horses when the mares were about to give birth she includes the number of hours spent sleeping with her horses as hours worked for the horse-breeding activity even though petitioners hired manual labor from time to time andrea put in a lot of her own physical labor in the horse-breeding activity for example she physically built the barns herself--putting up outdoor shelters digging holes for fence posts setting the posts with cement putting up plywood and corrugating roofs she also installed the watering systems to three of the barns and built continued schedule f arenas for horse training andrea performed many repairs using her knowledge in welding work such as building a gate a typical day for andrea at queensland would start between a m and a m when she would go out to the farm and check on the horses and the other animals to make sure they were where they were supposed to be she would also feed the animals and closely examine them to make sure that they were eating and not lame and had no big cuts or scrapes in addition she sometimes would need to worm the animals which is a process of killing intestinal parasites andrea has always been very meticulous and insisted on performing these tasks herself to ensure her animals receive the best care or at least the standard of care that would be satisfactory to her in zavra worked at least hours a week for the horse-breeding activity she was also employed part time as a vendor rep for excell marketing lc working to hours per week f petitioners’ other activities engaged in for profit during all relevant times petitioners did not conduct any similar or dissimilar activities engaged in for profit g intervening event sec_1 selenium deficiency in the surrounding area around andrea discovered that hay from her local area which she used to feed her horses was deficient in selenium a lack of selenium in a horse’s diet would have a negative effect on the horse’s muscles and could cause medical problems that can be life threatening to rectify the problem andrea began to import hay containing adequate amounts of selenium from other parts of the country importing hay from other areas proved to be very costly--instead of dollar_figure a bale for local hay imported hay could cost petitioners as much as dollar_figure a bale or more the fire the fire caused damage to petitioners’ residence on the farmington property as well as property that was part of the horse-breeding activity the fire consumed many acres of the farm and other queensland assets such as inventory blankets show bridles halters show halters and books_and_records of the activity after the fire destroyed the barn the barn was rebuilt and placed back in service around the fire took down queensland’s utility lines for months leaving it without electricity and running water while they were down one horse died from the incident and many others became stressed it also destroyed the tanks that stored the horse semen petitioners had allegedly planned to sell according to petitioners the fire adversely affected petitioners’ ability to breed horses because it destroyed much of the necessary equipment the farm’s reconstruction was not completed until missed inspection in petitioners had organized an inspection to be conducted by the swedish warmblood association of north america swana at the fairgrounds in santa rosa california petitioners rented the fairgrounds and planned to have some of their horses inspected by the swana team they anticipated future breeders and prospective swedish warmblood buyers who had previously contacted them to express interest in purchasing their horses to attend the event the inspection was scheduled to take place on date as a result of the terrorist attacks on the world trade center the day before the scheduled inspection the swana inspectors were unable to travel to santa rosa and the inspection was canceled consequently the swana team did not inspect the to horses that petitioners planned to bring to the inspection and petitioners did not meet with the prospective buyers and breeders at the canceled event even though another inspection was set to take place the next day on date at ms dilworth’s trilogy farm in santa cruz petitioners took only one or two young stallions to that inspection santa cruz inspection andrea explained at trial that logistical issues prevented the transport of the remaining horses to santa cruz andrea could not recall whether she took her horses to another inspection in nor is there anything in the record showing they took any of their horses to an inspection in subsequent years according to andrea horses must be inspected at a certain age to receive a certain type of recognition and thus missing the inspection has had an adverse impact on the values of her horses however petitioners have failed to state or quantify with specificity the extent to which the missed inspection has had an adverse impact on the values of their horses h partnership between andrea and zavra in zavra joined andrea as a partner to conduct the horse-breeding activity however petitioners did not memorialize their alleged oral agreement to form a partnership the arrangement between petitioners appears to be that zavra would contribute her services as well as her wage income to pay certain expenses of the horse-breeding activity in exchange for a interest in the partnership petitioners do not recall the amount of queensland’s expenses zavra has paid on farmington is about equidistant between santa cruz and santa rosa behalf of the partnership or the value of any property or services zavra might have contributed to the partnership andrea’s then husband also contributed about dollar_figure every month--presumably while they were married--to the horse- breeding activity but did not receive any partnership_interest in return and thus had never been a partner in the horse-breeding activity petitioners filed forms u s return of partnership income for and for and petitioners answered no to the question is this partnership subject_to the consolidated audit procedures of sec_6221 through for and petitioners answered no to the question did the partnership file form_8893 election of partnership level tax treatment or an election statement under sec_6231 for partnership-level tax treatment that is in effect for this tax_year i jurisdiction opinion generally disputes over partnership items are subject_to the unified_audit and litigation procedures of the tax equity and fiscal responsibility act of in the record are forms attached to andrea’s and federal_income_tax returns but not zavra’s returns for these years and forms to zavra’ sec_2002 and returns but not andrea’s returns for these years despite the incomplete record we are satisfied that both petitioners filed or at least intended to file an identical form_1065 for each of these four years tefra pub_l_no sec_402 stat pincite see generally sec_6221 sec_6225 to decide whether a partnership engages in an activity for profit under sec_183 we determine profit_motive at the partnership level see 204_f3d_1214 9th cir citing 820_f2d_321 9th cir aff’g tcmemo_1985_197 and 4_f3d_709 9th cir aff’g t c memo correspondingly the disputed losses from queensland are partnership items of petitioners’ partnership in the horse-breeding activity during the year at issue thus absent an applicable exception we do not have jurisdiction over the disputed losses in these individual deficiency proceedings sec_6231 provides the so-called small_partnership_exception the term partnership under tefra does not include any partnership with or t he term ‘partnership’ includes a syndicate group pool joint_venture or other unincorporated organization through or by means of which any business financial operation or venture is carried on and which is not a corporation or a_trust or estate sec_761 a partnership exists when the parties in good_faith and acting with a business_purpose intend to join together in the present conduct of the enterprise 337_us_733 the parties do not dispute that petitioners intended to join together to conduct the horse-breeding activity through a partnership described in sect a one question presented here is whether that activity was engaged in for profit in the year at issue while we may occasionally refer to queensland as a partnership throughout this opinion we do not intend to suggest that queensland was a profit-making bona_fide partnership for federal_income_tax purposes fewer partners who are individuals unless the partnership makes an election to have the tefra procedures apply sec_6231 petitioners claim that they orally entered into a partnership_agreement in to carry on the horse-breeding activity and that they were the only partners in the year at issue thus their partnership is not a partnership under sec_6231 petitioners’ forms for their partnership for and show that they declined to make the election to have tefra apply while there is no evidence of a form_1065 filed for there is likewise no evidence showing petitioners filed a form_8893 election of partnership level tax treatment and made an election under sec_6231 in or any of the previous years to have the tefra procedures apply to them for we are thus satisfied that an election under sec_6231 was not in effect for because petitioners’ purported partnership is a small_partnership that has not elected to have tefra apply for we have jurisdiction to review in these individual deficiency cases items otherwise subject_to partnership-level proceedings including the disputed losses from the horse-breeding activity 132_tc_161 n citing wadsworth v commissioner t c memo aff’d 408_fedappx_908 6th cir ii perception of andrea and zavra as witnesses in all cases we observe the candor sincerity and demeanor of each witness in order to evaluate her testimony and to assign weight to that testimony for the primary purpose of finding disputed facts we determine the credibility of each witness weigh each piece of evidence draw appropriate inferences and choose between conflicting inferences in finding the facts of a case the mere fact that one party presents unopposed testimony does not necessarily mean that the elicited testimony will result in a finding of fact in that party’s favor we will not accept a witness’ testimony on its face if we find that our impression of the witness coupled with our review of the credible facts at hand conveys to us an understanding contrary to the spoken word see 115_tc_43 aff’d 299_f3d_221 3d cir hie holdings inc v commissioner tcmemo_2009_130 97_tcm_1672 aff’d ___ fed appx ___ wl 9th cir date we find andrea’s testimony to be generally unhelpful and unreliable her testimony especially during cross-examination was ambiguous equivocal and sometimes evasive for example andrea was never able to provide during her testimony a timeframe when the farmington property became partly operational or fully operational after the fire her testimony was also contradicted several times by her responses to the interrogatories that respondent had previously propounded to her and other prior statements for example andrea testified at trial that after the fire she began to use an accounting software different from the one she used before the fire ie macintosh quicken as opposed to microsoft quicken however her responses to respondent’s interrogatories stated that she abandoned her previous accounting methods and devices altogether after date ostensibly to explain why she did not have an accounting system for the year at issue as another example andrea testified that she took two young stallions to the santa cruz inspection but her own notes next to a copy of a refund check from swana for inspection fees in connection with the santa cruz inspection state that she took only one stallion for inspection while we believe zavra to be generally credible we find her testimony similarly unhelpful and unreliable she claims that she entered into a partnership with andrea to carry on the horse-breeding activity for profit but at the same time she testified she did not know about the finances of the activity and not even the dollar_figure loss incurred in the year prior to her joining the partnership it appears her knowledge of queensland’s operations and finances is extremely limited in sum we give petitioners’ testimony little weight in our profit_motive determination iii an activity_not_engaged_in_for_profit sec_183 generally limits the deductions for an activity_not_engaged_in_for_profit to the amount of gross_income received from the activity sec_183 and b sec_183 defines an activity_not_engaged_in_for_profit as any activity other than one with respect to which deductions are allowable for the taxable_year under sec_162 or under paragraph or of sec_212 in the court_of_appeals for the ninth circuit the court to which an appeal of this case most likely lies an activity is engaged in for profit if the taxpayer's predominant primary or principal objective in engaging in the activity was to profit wolf v commissioner f 3d pincite in this context the term profit means economic profit independent of tax savings id petitioners bear the burden of proving that they entered into and during the year in issue remained in the horse-breeding activity with a predominant primary or principal objective of earning a profit see rule a 290_us_111 giles v commissioner tcmemo_2005_28 89_tcm_770 we determine profit intent on the basis of all surrounding facts and circumstances 72_tc_411 aff’d without published opinion 647_f2d_170 9th cir sec_1_183-2 income_tax regs while our inquiry into a taxpayer’s objective in engaging in an activity focuses on the taxpayer’s subjective intent we as the finder of fact need not rely solely on the taxpayer's statement of intent but may resort to objective facts to decide the true intent see 781_f2d_724 9th cir aff’g lahr v commissioner tcmemo_1984_472 sec_1_183-2 income_tax regs the regulations set forth a nonexclusive list of nine factors in ascertaining a taxpayer’s objective in engaging in an activity the manner in which the taxpayer carries on the activity the expertise of the taxpayer or his advisers the time and effort spent by the taxpayer in carrying on the activity the expectation that assets used in the activity may appreciate in value the success of the taxpayer in carrying on other similar or dissimilar activities the taxpayer's history of income or losses with respect to the activity the amount of occasional profits if any the financial status of the taxpayer and elements of personal pleasure or recreation none of these factors is controlling in and of itself and a decision as to a taxpayer’s intent is not governed by a numerical preponderance of the factors sec_1_183-2 income_tax regs see also golanty v commissioner t c pincite 72_tc_28 we will examine these factors in turn a the manner in which petitioners carried on the activity the fact that a taxpayer carries on an activity in a businesslike manner may indicate that the activity is engaged in for profit sec_1_183-2 income_tax regs subfactors to consider in deciding whether a taxpayer has conducted an activity in a businesslike manner include whether the taxpayer maintained complete and accurate books_and_records for the activity whether the taxpayer conducted the activity in a manner substantially_similar to those of other comparable activities that were profitable and whether the taxpayer changed operating procedures adopted new techniques or abandoned unprofitable methods in a manner consistent with an intent to improve profitability giles v commissioner t c m cch pincite citing 72_tc_659 sec_1_183-2 income_tax regs petitioners argue that they conducted queensland in a businesslike manner primarily on the basis of three claims first they developed a business plan that they have modified over the years to reflect changing business environment second they maintained complete and accurate records third they advertised the sales of their horses petitioners’ claims are not supported by the record business plan andrea allegedly devised a business plan as early as and submitted it to the sba for feedback she again submitted a business plan in presumably updated from the plan to the sba to get further business advice but the business plan contains largely her descriptions of breeding and training horses and says very little about how to turn the activity profitable moreover when the business plan does touch on profit-minded matters such as financials and startup costs it includes only very high-level discussion that would leave any businessperson very few clues as to how to make a profit from queensland indeed the business plan itself raises other red flags it states that queensland is geared toward the serious upper-level horse rider s who are able to invest a great deal of time effort and money into their sport suggesting that the market for selling swedish warmbloods is a niche market with very few buyers on the other hand the business plan also states that the ongoing operational costs are high on the basis of the history of lamira for example we know a swedish warmblood’s value tends to decrease over time after it reaches its prime in other words petitioners’ business is selling a product that is subject_to depletion and with significant overhead and its target market is small and potentially highly competitive we would expect a person who is seriously profit-minded to discuss in her business plan how she intends to control costs and overhead to promote her products through consistent and aggressive marketing efforts to broaden the purchaser base and to maximize the retail value of her horses by determining when it is the optimal time to sell but petitioners’ business plan fails to address any of these important business issues thus we give the business plan very little weight we also find no credible_evidence to support petitioners’ claim that they regularly updated their business plan to reflect changing market conditions despite the discovery of selenium deficiency in the local hay in the fire the terrorist attacks in and the economic downturn that followed in addition to a history of substantial losses there is no evidence showing petitioners have done anything to adapt to the market challenges or adopt new techniques and operating methods to turn the losing activity into a profitable venture see sec_1_183-2 income_tax regs action--or inaction in this case--speaks louder than words see phillips v commissioner tcmemo_1997_128 t c m cch finding business plan can be evidenced by action petitioners’ inaction here convinces us that they did not change their business plan if there ever was one in a manner consistent with a business venture engaged in for profit maintaining complete and accurate books_and_records the failure to keep financial records such as journals ledgers income and expense reports income statements p l statements and financial projections indicates a lack of businesslike operations giles v commissioner t c m cch pincite citing surridge v commissioner t c memo although a taxpayer need not maintain a sophisticated cost accounting system for any purported business activity she must at least keep and produce records that would enable her to make informed business decisions and otherwise allow her to cut expenses increase profits or evaluate the activity’s overall performance id pincite citing cases finally the failure to maintain a separate bank account or to prepare a budget also indicates a lack of businesslike operations id pincite at the outset we express our doubt over andrea’s testimony that she kept financial records for the horse-breeding activity using macintosh quicken after the fire including the year in issue her prior inconsistent statements given in response to respondent’s interrogatories impeached that testimony further petitioners failed to corroborate their testimony that they kept complete and accurate business records with documentary_evidence thus we decline to find as a fact that they continued to keep such books_and_records after the fire even if we assume for the sake of the argument that petitioners used some sort of accounting system to keep track of queensland’s expenses and inventory andrea’s own testimony reveals that they have never used the available data to produce or to prepare any p l statements earnings reports budgets break-even analyses or any similarly detailed financial statements that would help them to cut expenses increase profits and evaluate the overall performance of their horse- breeding activity see golanty v commissioner t c pincite at most the types of records petitioners maintained would help them substantiate queensland’s expenses but that is insufficient to show they kept them in a business fashion to foster profit see mckeever v commissioner tcmemo_2000_288 80_tcm_358 and the fact that queensland incurred losses year after year allows us to draw a factual inference that in evaluating queensland’s declining financial performance petitioners did not actually rely on any rough financial projection that they might have made as to the activity finally in fact petitioners’ records can substantiate only dollar_figure of the dollar_figure expenses reported on their schedule f petitioners stopped maintaining a separate bank account for the activity after making it harder to separate and track business_expenses and personal expenses in sum petitioners failed to present credible_evidence that they used any record to implement cost-saving measures or to improve profitability advertising petitioners rely on a handful of advertisements placed idly in trade magazines and publications to argue that they embarked on an intensive advertising program to market their products as we noted earlier the nature of petitioners’ target market would require them to market their products competitively and aggressively to reach a broad buyer base we find it difficult to believe that only a handful of advertisements placed in trade magazines and publications can achieve that result indeed the small volume of sales petitioners generated over the years allows an inference that their advertising efforts were futile thus their failure to expand their marketing efforts over the years to reach a larger customer base is not consistent with the behavior of a profit-oriented taxpayer see mckeever v commissioner t c m pincite citing dodge v there is at least one other instance of commingling accounts for petitioners reported utility and insurance expenses relating to their personal_residence as part of the horse-breeding activity’s expenses on their schedule f commissioner tcmemo_1998_89 aff’d without published opinion 188_f3d_507 6th cir moreover petitioners fail to provide any evidence to show their participation in certain marketing events actually generated any actual leads or sales it is unclear whether petitioners have ever examined the effectiveness of their advertising efforts and whether they have explored other marketing avenues in sum we give little weight to petitioners’ claim that they engaged in advertising in a businesslike manner insurance coverage petitioners did not have adequate insurance coverage to insure queensland’s assets against casualty_loss as a result petitioners were not able to recover the value of queensland’s assets after they were destroyed in the fire not having adequate insurance coverage is inconsistent with carrying on an activity in a businesslike manner changing methods to improve profitability a change_of operating methods adoption of new techniques or abandonment of unprofitable methods may also indicate a profit objective sec_1_183-2 income_tax regs petitioners claim that they began to sell their stallions’ semen as a way to generate additional profit in they contracted to sell about dollar_figure worth of semen that could produce breedings assuming petitioners could sustain the same level of semen sales every year after the sales would generate only very moderate income but would do little to affect the activity’s bottom line queensland was incurring expenses of dollar_figure or more every year the amount of income that any semen sales could potentially generate would be insufficient to defray queensland’s annual expenses not to mention to recuperate losses from the previous years in fact petitioners were never able to generate any income from the sales of semen petitioners blame the failure in making semen sales on the fire which they claim destroyed the semen that they could have sold but petitioners fail to explain why they could not sell semen in other years after the fire indeed petitioners blame a series of unfortunate events for their losses the discovery of selenium deficiency in local hay in the fire the terrorist attacks in and the recession we do not doubt that these events had a serious impact on petitioners’ activity so much so that they might have crumpled a business but facing these multiple hurdles and setbacks of the magnitude petitioners are pleading a profit-minded person likely would have cut her losses and abandoned the venture altogether unless there was some reasonable expectation that she could overcome these hurdles by adopting new strategies or techniques to improve profitability absent such reasonable expectation a profit- oriented person likely would not continue to pour money into a losing venture petitioners want us to believe the above unfortunate events affected their ability to make queensland profitable be that as it may petitioners fail to tell us what they have done to adapt to and to adjust their methods to meet these challenges indeed the record shows they have done very little recovery could take time especially given the economic environment but there had been six to nine years between the intervening events and the tax_year at issue and all signs were pointing to a grimmer outlook notwithstanding that petitioners continued to contribute substantial amounts of their own cash into the activity without any change in their way of running queensland petitioners’ failure to improve profitability and unwillingness to abandon the venture under the circumstances only lead us to conclude as a factual matter that they were personally attached to the venture and their predominant primary or principal objective was not to profit conclusion there is no credible_evidence showing that petitioners carried on their horse-breeding activity in a businesslike manner this factor favors respondent b the expertise of petitioners or their advisers a taxpayer’s expertise research and study of the accepted business economic and scientific practices of an activity as well as his or her consultation with experts may be indicative of a profit objective sec_1_183-2 income_tax regs in a case concerning a horse-breeding activity our focus is to examine a taxpayer’s knowledge of the business or economic aspects of horse breeding as opposed to her knowledge on the subject of horse breeding from the perspective of a horse breeder see giles v commissioner t c m cch pincite petitioners assert that they sought business advice from the sba in san francisco first in and again in around the time when they started the activity they also point out that they sought business and marketing advice from ms dilworth in the early 1990s finally they claim that they asked for business advice from other breeders here and in sweden about breeding and training swedish warmbloods at the outset we note that besides petitioners’ self-serving and vague testimony about having received some unspecified expert advice the record is devoid of credible_evidence suggesting that petitioners prepared for the economic aspects of the activity by study or consultation with experts or that they were informed of what the ultimate costs might be how they could achieve any level of cost efficiency the amount of revenue they could reasonably expect or any potential risks that might negatively affect their breeding activity see id further the credible_evidence in the record does not show petitioners have sought relevant business advice with respect to the advice they sought from the sba there is no credible_evidence to show that petitioners talked to anyone from the sba who was knowledgeable of horse breeding or the economic aspects of a horse-breeding business in fact andrea acknowledged at trial that the individual who allegedly advised her had no knowledge about horse breeding or its business aspects further andrea went to the sba between the early 1980s and the early 1990s but petitioners cannot explain how any business advice that they obtained then would continue to be relevant to their horse-breeding activity after which marked the beginning of a series of unfortunate events and disasters ie the fire the recession etc that allegedly had an unforeseen impact on their activity in the same vein any advice petitioners might have obtained from other breeders in the united_states and abroad two decades ago would be unhelpful petitioners’ claim that they relied on ms dilworth’s advice is similarly unpersuasive when petitioners approached ms dilworth in the early 1990s ms dilworth had been in the horse-breeding business for no more than five years in the light of our decision in engdahl in which we found the startup phase of a horse-breeding activity to be to years see engdahl v commissioner t c pincite we have reservations over ms dilworth’s qualification as an expert in the business and economic aspects of breeding swedish warmbloods at that time moreover despite the frequent initial visits and telephone calls petitioners had not spoken to ms dilworth much in the past years any relevant advice ms dilworth might have given in the 1990s just like the advice from the sba would no longer be relevant given the new problems facing petitioners during the years since the lack of business contact between ms dilworth and petitioners in the last years is significant one would expect that a profit-minded taxpayer would have sought out ms dilworth--or the sba--for updated advice based on new information about the new challenges petitioners were then facing petitioners’ indeed ms dilworth testified that there are very few people in the world right now that are making any money breeding horses failure to at least attempt to obtain updated and relevant business advice after the intervening events is inconsistent with an intent to profit this factor favors respondent c the time and effort spent by petitioners in carrying on the activity the fact that a taxpayer devotes much of her personal time and effort to an activity may indicate a profit objective especially where the activity does not involve substantial personal or recreational aspects giles v commissioner t c m cch pincite citing mckeever v commissioner tcmemo_2000_288 and daley v commissioner t c memo a taxpayer’s withdrawal from another occupation to devote his or her time and effort to an activity also may indicate a profit objective id citing burleson v commissioner t c memo sec_1_183-2 income_tax regs petitioners allege that they performed almost all of the work with little help from hired labor andrea claims she spent to hours week in the horse- breeding activity in addition to working to hours a week in her full-time and part-time jobs zavra asserts she worked hours a week in the horse-breeding activity and to hours a week in her part-time job we find petitioners’ assertions to be incredible first petitioners presented no documentary_evidence or testimony from third parties to support their claims or the proposition that of the time they spent was for business andrea acknowledged at trial that some of the to hours included time she slept in the barn with her horses thus we discount her testimony that of her time was spent for business there is likewise a lack of credible_evidence to show that zavra’ sec_40 hours spent every week was all business especially in the light of the fact that queensland has been a family activity in which she spent many hours with her family we also note that andrea’s testimony was incredible on its face by her count between her other employments and time spent on the activity she worked hours to hours a week when there are only hours in a week the only way she could possibly work this many hours is by neither sleeping nor eating for days without any other evidence to corroborate this fantastical claim we decline to accept it moreover andrea never decreased the number of hours worked in her full- time job sometimes she even worked extra hours in her part-time employments thus we draw an inference from this fact and believe that andrea had to keep her paid employments in order to subsidize her losing horse-breeding activity in other words if andrea really expected that the activity was on its way to turn a profit one would expect that she would have slowly phased out of her full-time and part-time jobs and focused her energy primarily on queensland because she did not we suspect that she intended to continue to rely on her other employment to make a living and subsidize the horse-breeding activity this factor favors respondent d the expectation that assets used in the activity may appreciate in value a taxpayer’s expectation that assets such as land and other tangible_property used in an activity may appreciate to create an overall profit may indicate that the taxpayer has a profit objective as to that activity sec_1_183-2 income_tax regs an overall profit is present if net_earnings and appreciation are enough to recoup losses sustained in prior years giles v commissioner t c m cch pincite citing 45_tc_261 aff’d 379_f2d_252 2d cir petitioners claim that they reasonably expected that their inventory and the farmington property would appreciate to generate an overall profit the credible_evidence in the record does not support such a claim as to the farmington property purchased in petitioners have failed to produce any credible_evidence to suggest that it has appreciated sufficiently to offset over dollar_figure million of losses queensland suffered between and nor is there any credible_evidence showing the specific fair_market_value of the farmington property as to the horses by andrea’s admission she projected that she could sell all of her horses for dollar_figure to make a dollar_figure profit for in other words at the time she made the projection for she no longer expected that she could recuperate queensland’s prior losses of more than dollar_figure million yet she continued to invest more than dollar_figure in the activity in this is inconsistent with a profit intent setting aside petitioners’ inability to recoup all prior losses andrea’s expectation that she could make a dollar_figure profit for was itself unrealistic to create that profit margin petitioners would have to sell all of her horses at about dollar_figure per horse the most petitioners have ever received from selling a horse was dollar_figure in 1997--which was before the fire the terrorist attacks and the recession--and the most horses petitioners have ever sold in any given year was three in the projection obviously based on an assumption that would have been used by only the most incorrigible optimist is overwhelming evidence of the andrea’s testimony shows that petitioners at one point hoped to sell their horses for dollar_figure to dollar_figure each however it is clear from andrea’s testimony that she no longer had that expectation by the time she made her income projection for absence of a profit_motive see swigert v commissioner tcmemo_1982_500 44_tcm_992 wittstruck v commissioner tcmemo_1980_62 39_tcm_1168 continued retention of the disputed activity after any reasonable hope of profit has clearly been ruled out makes it very difficult for us to find a good_faith expectation of profit aff’d 645_f2d_618 8th cir this factor favors respondent e petitioners’ success in carrying on other similar or dissimilar activities although an activity is unprofitable the fact that a taxpayer has previously converted comparable activities from unprofitable to profitable enterprises may show a profit objective sec_1_183-2 income_tax regs the record shows that petitioners have not engaged in other activities similar or dissimilar to the horse-breeding activity by which we may evaluate their success in those other activities thus this factor is neutral see rundlett v commissioner tcmemo_2011_229 102_tcm_307 whitecavage v commissioner tcmemo_2008_203 96_tcm_119 f the history of income or losses with respect to the activity the fact that a taxpayer incurs a series of losses beyond an activity’s startup years may indicate the absence of a profit objective as to that activity unless the losses are attributable to unforeseen or fortuitous circumstances beyond the taxpayer's control sec_1_183-2 income_tax regs we have previously held that the startup phase of a horse-breeding activity may be to years see engdahl v commissioner t c pincite petitioners argue that their losses following the startup years were attributable to unforeseen and fortuitous circumstances beyond their control we disagree selenium deficiency in petitioners discovered hay local to queensland did not have adequate selenium resulting in selenium deficiency in their horses’ diet that could cause serious medical problems to their horses as a result petitioners had to import hay from other areas at significant costs while the discovery might have been unforeseen in the problem was ongoing and by it was no longer an unforeseen or fortuitous event one would thus expect a profit-oriented person to explore other more cost-effective alternatives or if breeding and raising horses at the same location continued to be cost prohibitive one would expect it to be a factor to consider in deciding whether to relocate the activity or to abandon it altogether petitioners’ failure to show us that they have considered these business issues makes it difficult for us to believe that their decision to stay at the same location was motivated by profit fire petitioners contend that the fire also adversely affected their horse- breeding activity because it destroyed some inventory mostly semen and the equipment for breeding horses andrea testified that the farm’s reconstruction was not completed until however it is not clear when queensland returned to being operational on the basis of petitioners’ own testimony it appears the fire affected only their ability to breed horses and sell semen petitioners presented no credible_evidence that can substantiate a claim that the fire prevented them from continuing to train and sell their horses in stock if for the sake of argument the fire completely shut down queensland so that petitioners were no longer able to train and sell their horses until they completed the reconstruction in we question why any profit-minded person would continue to hold on to the inventory during the 10-year period instead of relocating or liquidating the inventory if the fire did not affect petitioners’ ability to train and sell their horses queensland’s history of generating dismal income from selling horses leaves us unpersuaded that the fire had anything to do with the activity’s bottom line finally we attribute losses resulting from the fire to petitioners’ failure in the first instance to get adequate insurance coverage on the activity’s property getting sufficient insurance coverage was something within their control and what they could have done if petitioners had bought adequate insurance coverage as a business-minded person would have they could have recovered any casualty_loss and rebuilt the farm more quickly in sum we decline to find that the activity’s losses can be attributed to the fire when petitioners could have prevented and mitigated some if not most of the losses missed inspection in petitioners also assert that the missed horse inspection in santa rosa in negatively affected the marketability of their horses and thus their values we find petitioners’ argument incredible on its face the lack of evidence showing petitioners have taken any of their horses to an inspection since leads us to find that they did not do so if inspections were important as petitioners claim to marketing a horse and increasing its value we question why petitioners failed to take any of the horses that missed the inspection to another inspection in subsequent years to obtain value- enhancing diplomas for these horses andrea testified that horses must be inspected at a certain age this testimony suggests that many of the horses that missed the inspection would not be eligible for another inspection in a subsequent year if so there would be little hope that these horses would appreciate if their value depended on inspection thus petitioners’ decision to continue to hold on to these horses with no reasonable expectation for appreciation is inconsistent with a profit intent especially in the light of the fact that keeping these horses requires substantial costs either way there is no credible_evidence to support petitioners’ claim that the activity’s losses can be attributed to the missed inspection in depressed market conditions during the recession finally petitioners attribute their losses to the recession in the 2000s and the resulting depressed market conditions they argue that their case is strikingly similar to engdahl we disagree in the engdahl case we agreed with the taxpayers that their losses from the horse-breeding activity could be explained by a series of unfortunate events beyond their control engdahl v commissioner t c pincite some of these events included a change in market conditions and the rising costs associated with maintaining and training horses but in engdahl unlike in the present case we found there was a profit intent because the taxpayers there made changes to their operation and when they realized their activity would not become profitable they attempted to sell it id here as we stated earlier petitioners did not present credible_evidence that they made any changes to their operation or adopted any new techniques or business methods to weather the recession nor have they tried to dispose_of the activity when it should have become apparent that the activity would not be profitable even after the year when the activity’s earnings did not meet petitioners’ expectation according to andrea’s own testimony petitioners continued to incur additional expenses of about dollar_figure in and about dollar_figure in this is yet more overwhelming evidence that shows a lack of profit intent conclusion for reasons stated this factor favors respondent g the amount of occasional profits the amount of profits earned in relation to the amount of losses_incurred the amount of the investment and the value of the assets in use may indicate a profit objective see sec_1_183-2 income_tax regs absent actual profits the opportunity to earn substantial profits in a highly speculative venture may be enough to indicate profit intent see id see also giles v commissioner t c m cch pincite citing dawson v commissioner t c memo petitioners argue that they embarked on a business to introduce a popular but underrepresented breed of performance horse to the united_states and it presented an opportunity for significant profit we are not persuaded petitioners again presented no credible_evidence other than their self- serving and vague testimony that they could sell their horses at top prices to offset years of losses petitioners’ speculation was not grounded in anything other than an empty aspiration that is insufficient to overcome the complete absence of profits in queensland’s history in these years none of petitioners’ horses except lamira was of the quality to generate top prices when someone offered to buy lamira for dollar_figure petitioners rejected the offer petitioners have not brought any of their horses to another inspection since and have not attempted to expand their customer base by engaging in more aggressive advertising or marketing petitioners’ conduct during these years simply does not support their contention that significant profit sufficient to offset their substantial accumulated losses was attainable in sum this factor favors respondent h petitioners’ financial status a taxpayer’s lack of substantial income or capital from sources other than an activity may indicate that the activity is engaged in for profit see sec_1 b income_tax regs the fact that a taxpayer does have substantial income from sources other than an activity on the other hand may indicate that the activity is not engaged in for profit the latter is especially true where losses from the activity generate substantial tax benefits or where there are personal or recreational elements involved sec_1_183-2 income_tax regs petitioners maintain that they are not wealthy individuals and that they used their wage income and other savings to finance their horse-breeding activity petitioners argue that this factor thus lies in their favor we disagree we have previously held that sec_183 does not apply only to wealthy taxpayers who engage in unprofitable activities to create paper losses to offset against unrelated income ranciato v commissioner tcmemo_1996_67 71_tcm_2116 under this factor we compare the income generated by an activity with the taxpayer’s taxable_income from sources other than the activity and query whether the taxpayer’s ability to earn income elsewhere allows her to finance an otherwise unprofitable activity from which she derives some personal or tax benefits see id between and petitioners together had a combined wage income of dollar_figure million on the other hand queensland’s income during the same period was less than dollar_figure but it incurred more than dollar_figure million in expenses to finance these expenses petitioners used their wage income as well as life_insurance_proceeds proceeds from a home equity loan and personal savings the income and funds from these other sources thus enabled petitioners to engage in their horse-breeding activity that as we discuss below has strong personal elements moreover the losses from queensland significantly reduced petitioners’ tax_liability between and 2008--that is to say petitioners paid zero federal_income_tax on a combined income of dollar_figure million from these years thus the tax_liability petitioners would have incurred but for queensland’s losses has gone to subsidize an activity that lacks a profit_motive this is a substantial tax_benefit this factor favors respondent zavra did not file a federal_income_tax return before and thus had no reported wage income as to zavra this figure includes only her wage income beginning in it is also telling that petitioners never attempted to finance queensland with a commercial loan or if they tried to apply for one they did not get one while it is not a requirement financing an activity with a business loan from a disinterested party at arm’s length is indicative of the for-profit nature of the activity i elements of personal pleasure or recreation the presence of personal pleasure or recreation from an activity may indicate the absence of a profit objective sec_1_183-2 income_tax regs the mere fact that a taxpayer derives personal pleasure from an activity however does not necessarily mean that she lacks a profit objective with respect to the activity a profit objective may be present in the latter case if the activity is truly engaged in for profit as evidenced by other factors giles v commissioner t c m cch pincite citing 59_tc_312 petitioners argue that the record does not have any evidence that petitioners ever rode horses for pleasure they also point out that andrea does not enjoy horseback riding on account of an old injury in these cases we believe petitioners derive pleasure from their horse- breeding activity because they are attached to their horses both andrea and zavra grew up around horses even though andrea may no longer ride horses we believe that she enjoys being around them zavra has always enjoyed being around horses and at one point aspired to be a horse veterinarian this attachment may explain why petitioners would not let go of their horses and continue to incur substantial expenses to care for them we also believe andrea derives an additional pleasure from having her family live in the same household that queensland has made possible further andrea through queensland has been able to provide a secure and permanent environment for her daughter to engage in an activity for which zavra has a special passion as we have stated before the gratification derived from an occupation worth doing possibly beneficial to others and probably requiring long hours of arduous labor must still not be confused with an intention to return a profit 23_tc_90 aff’d 227_f2d_779 6th cir this factor favors respondent j conclusion we conclude on the basis of our discussion above that petitioners did not carry on their horse-breeding activity in with a predominant primary or principal profit objective iv accuracy-related_penalty respondent determined that petitioners are liable for accuracy-related_penalties for because petitioners substantially understated their income_tax or alternatively because they were negligent or disregarded rules or regulations see sec_6662 and b and there is a substantial_understatement of income_tax if the amount of the understatement for the taxable_year exceeds the greater of of the tax required to be shown on a return for a taxable_year or dollar_figure sec_6662 alternatively we will sustain respondent’s determination to impose accuracy-related_penalties if we determine petitioners failed to make a reasonable attempt to comply with provisions of the internal revenue laws or disregarded rules or regulations by acting carelessly recklessly or with intentional disregard sec_6662 sec_1_6662-3 and income_tax regs only one accuracy-related_penalty may be imposed for a given portion of an underpayment even though that portion implicates more than one form of misconduct described in sec_6662 sec_1_6662-2 income_tax regs because respondent has carried his burden under sec_7491 to show that petitioners’ losses claimed for resulted in substantial understatements of their income_tax we need not decide whether petitioners would also be liable for the penalties by reason of negligence or reckless disregard of rules or regulations once respondent has proved his prima facie case for imposing penalties under sec_6662 petitioners bear the burden of proving that the penalties are unwarranted by establishing an affirmative defense such as reasonable_cause or substantial_authority see sec_6664 sec_6662 although we have determined that petitioners’ horse-breeding activity was not engaged in for profit under the circumstances of this case we find that petitioners made a reasonable and good_faith error in applying the law to the facts of this case see connolly v commissioner tcmemo_1994_218 67_tcm_2973 aff’d 58_f3d_637 5th cir petitioners have indeed made some good-faith efforts to comply with the law but those efforts nonetheless fell short accordingly on the specific facts of this case the totality of the circumstances and evidence presented at petitioners’ trial we find petitioners not liable for the sec_6662 accuracy-related_penalties for the year at issue v conclusion any arguments not discussed in this opinion are irrelevant moot or lacking in merit to reflect the foregoing decisions will be entered under rule


internal_revenue_service number release date index numbers ---------------------- ------------------------------ ---------------------------------------------------- ------------------------------------ ------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact --------------------- id no ------------- telephone number --------------------- refer reply to cc corp b04 plr-150826-07 date date legend government ----------------------------- insurance_business ---------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------ unit ----------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- commissioner ------------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------ newco ----------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --- ------------------------------------------------------------ --------------------------------------------------------- ------------------------ privatization legislation ----------------------------------------------------------------------- -------------------------------------------------------------------------------- ------------------------------------------------------------------------ ------------------------- chief elected official policyholders ------------------------------ ---------------------------------------------------------- plr-150826-07 ------------------------------------------------------------------------ ---------------------------------------------------- interests ---------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------- ------------------------------------------------------------------------ ------------------------------------------------------------ contracts fund fund fund ------------------------ ---------------------------------------- ---------------------------------------------- --------------------------------------- note ---------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------- ------------------------------------------------------------------------ ------------------------------------------------------------------------ ------------------ year a date b date c date d date e date f date g date h date i a b ------- ---------------------- -------------------------- ------------------- ---------------------- -------------------------- ---------------------- ------------------------- ---------------------- ----------------- -------------- plr-150826-07 c d e -------------- -------------- ------------- dear -------------- this letter responds to your authorized representative’s letter dated date requesting rulings under sec_351 and sec_832 of the internal_revenue_code code regarding a completed transaction the information provided in that letter and in later correspondence is summarized below the rulings contained in this letter are based on facts and representations submitted by the taxpayer and accompanied by a penalties of perjury statement executed by an appropriate party this office has not verified any of the material submitted in support of the request for rulings verification of the information representations and other data may be required as part of the audit process facts government conducted the insurance_business through various state agencies from year a until date c from date b until date c government conducted the insurance_business through unit for purposes of this letter_ruling government includes unit for what are represented to be valid business reasons government moved the insurance_business from public to private ownership pursuant to the privatization legislation through the following transactions the conversion_transaction i newco was organized on date d as a private mutual_insurance_company as such newco has no shares of capital stock outstanding on date e the internal_revenue_service granted newco an exemption from federal taxation under sec_501 through date f ii effective date g unit transferred the assets relating to the insurance_business including fund to newco and newco assumed the liabilities associated with the insurance_business all contracts along with any advanced deposits with unit novated to and were deposited in an account with newco plr-150826-07 prior to the conversion_transaction the historic funds of the insurance_business were held in fund which as of date c held an estimated dollar_figurea in assets pursuant to the privatization legislation and the proclamation issued by chief elected official on date h the dollar_figurea of assets in fund was allocated between three funds including fund fund received assets from fund in the amount of dollar_figureb of the dollar_figureb amount in fund dollar_figurec is subject_to repayment by newco according to the terms of note government retained custody of the other two funds holding the remaining dollar_figured of assets from fund iii newco issued all of its interests directly to the policyholders the interests entitle holders to receive policyholder dividends if and when declared and after date f to vote for a board_of directors the chief elected official appoints the newco board_of directors including any vacancies until date f in addition the interests do not entitle holders to receive proceeds in the event of liquidation because newco’s tax-exempt status requires that liquidation be prohibited representations the taxpayer has made the following representations regarding the conversion_transaction no stock securities or other ownership interests have been or will be issued a for services rendered to or for the benefit of newco in connection with the conversion_transaction and no stock securities or other ownership interests have been or will be issued for indebtedness of newco that is not evidenced by a security or for interest on indebtedness of newco which accrued on or after the beginning of the holding_period of unit for the debt all rights title and interests for each copyright in each medium of b exploitation were transferred to newco in the conversion_transaction the conversion_transaction was not the result of the solicitation by a c promoter broker or investment house unit did not retain any significant_power_right_or_continuing_interest within d the meaning of sec_1253 in any trademarks or trade names being transferred government through commissioner did not retain any rights in the property e transferred to newco the adjusted bases and the fair_market_value of the assets transferred by unit f to newco in each instance equaled or exceeded the total liabilities assumed as determined under sec_357 by newco plr-150826-07 the total fair_market_value of the assets transferred to newco by unit g exceeded the sum of i the amount of liabilities assumed as determined under sec_357 by newco in connection with the exchange ii the amount of liabilities owed to newco by unit that were discharged or extinguished in connection with the exchange and iii the amount of any money and the fair_market_value of any other_property other than stock permitted to be received under sec_351 without the recognition of gain received by unit in connection with the exchange the fair_market_value of the assets of newco exceeded the amount of its liabilities immediately_after_the_exchange the aggregate fair_market_value of the assets transferred to newco by unit h equaled or exceeded the aggregate adjusted bases of such assets immediately_after_the_exchange the liabilities of unit assumed as determined under sec_357 by i newco were incurred in the ordinary course of business and were associated with the assets transferred other than the note there is and was no indebtedness between newco and j unit and there will be no indebtedness created in favor of unit as a result of the conversion_transaction the transfers and exchanges occurred under a plan agreed upon before the k conversion_transaction in which the rights of the parties were defined l all exchanges occurred on date i effective date g there is no plan or intention on the part of newco to redeem or otherwise m reacquire any stock indebtedness or ownership interests issued in the conversion_transaction n taking into account any issuance of additional shares of newco stock or other ownership interests any issuance of stock or other ownership interests for services the exercise of any transferee stock_rights warrants or subscriptions a public offering of newco stock and the sale exchange transfer by gift or other_disposition of any of the stock or other ownership interests of newco received in the conversion_transaction unit was in control of newco within the meaning of sec_368 in the conversion_transaction unit constructively received equity interests in o newco approximately equal to the fair_market_value of the property transferred to newco plr-150826-07 newco will remain in existence and retain and use the property transferred to p it in a trade_or_business there is no plan or intention by newco to dispose_of the transferred property q other than in the normal course of business operations the privatization legislation established fund funded with dollar_figuree to pay the r legal operational consultative and human resource related expenses associated with the establishment of newco and transferring personnel from unit to newco to the extent not covered by fund unit the policyholders and newco each paid its or their own expenses if any incurred in connection with the conversion_transaction newco is not an investment_company within the meaning of sec_351 s and sec_1_351-1 t unit is not under the jurisdiction of a court in a title_11_or_similar_case within the meaning of sec_368 and the stock securities or other ownership interests received in the conversion_transaction will not be used to satisfy the indebtedness of such debtor newco is not a personal_service_corporation within the meaning of section u 269a unit would be permitted under the constitution of government to own all of v the stock or other equity ownership interests in newco rulings based solely on the information and representations submitted we rule as follows on the conversion_transaction for federal_income_tax purposes the conversion_transaction will be treated as if a government through unit had transferred the insurance_business to newco on date i in exchange for all of the interests in newco and the assumption by newco of related liabilities collectively the exchange and b government had transferred a portion of the interests to the policyholders see 70_tc_121 cf 338_f2d_815 2nd cir the interests deemed received by government through unit in the exchange are treated as stock under sec_351 plr-150826-07 government through unit recognized any realized gain on the exchange in an amount not in excess of the fair_market_value of the note sec_351 and b the requirement of sec_351 that government through unit control newco immediately_after_the_exchange was satisfied because government through unit had the right in choosing the method of privatizing the insurance_business either to retain the interests or to designate other persons to receive the interests see d’angelo associates inc v commissioner no loss was recognized on the exchange sec_351 no income gain_or_loss was recognized by newco as a result of the exchange sec_1032 the basis of each asset of the insurance_business received by newco in the exchange equals the basis of that asset in the hands of government through unit immediately before the exchange increased by the amount of gain if any recognized on the exchange sec_362 the holding_period of each asset of the insurance_business received by newco in the exchange includes the holding_period of that asset in the hands of government through unit immediately before the exchange sec_1223 for newco’s first year as a taxable entity year ending december ------- the deduction for losses_incurred under sec_832 will be computed using discounted_unpaid_losses as of december --------and december ------- caveats no opinion is expressed about the tax treatment of the conversion_transaction under other provisions of the code and regulations or on the tax treatment of any conditions existing at the time of or effects resulting from the conversion_transaction that are not specifically covered by the above rulings procedural statements this ruling letter is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent a copy of this letter must be attached to any income_tax return to which it is relevant alternatively taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter_ruling plr-150826-07 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representatives sincerely _______________________________ lewis k brickates chief branch associate chief_counsel corporate