t c memo united_states tax_court elizabeth giles petitioner v commissioner of internal revenue respondent docket no filed date b paul husband for petitioner michael w berwind for respondent memorandum findings_of_fact and opinion haines judge respondent determined deficiencies of dollar_figure dollar_figure and dollar_figure and accuracy-related_penalties under sec_6662 for and respectively years in issue after concessions the issues for decision are unless otherwise noted all section references are to the continued whether petitioner’s horse activity was an activity engaged in for profit within the meaning of sec_183 during the years in issue and whether petitioner is liable for accuracy- related penalties under sec_6662 for and findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts the supplemental stipulation of facts and attached exhibits are incorporated herein by this reference a background at the time she filed the petition petitioner resided in riverside california petitioner is a dentist licensed by the dental board_of california petitioner operates her own dental practice as a professional_corporation of which she is the sole shareholder from through petitioner’s average annual income from her dental practice was dollar_figure during the years in issue petitioner reported income from her dental practice of dollar_figure dollar_figure and dollar_figure respectively continued internal_revenue_code as amended and all rule references are to the tax_court rules_of_practice and procedure respondent concedes that petitioner has substantiated all expenses reported on schedules c profit or loss from business for the years in issue as a result respondent concedes that there is no deficiency in and petitioner is not liable for an accuracy-related_penalty relating to that year b petitioner’s real_property falling water way on date petitioner purchased for dollar_figure real_property pincite0 falling water way in riverside california falling water way falling water way includes dollar_figure acres of land a big_number square-foot four-bedroom home a garage a four- stall barn with tack room feed rooms hay storage an arena and some paddocks falling water way is in an area with many horse properties falling water way is zoned residential agricultural by riverside county a riverside county zoning ordinance allows the noncommercial keeping of horses in residential agricultural zones the zoning ordinance permits breeding and raising of horses but prohibits falling water way from being used as a livery stable or a boarding stable the zoning ordinance limits the number of horses that can be kept at falling water way to four falling water way has been petitioner’s principal_residence since its purchase in petitioner put falling water way up for sale in but did not sell the property as of date falling water way had a fair_market_value of dollar_figure the fair_market_value of the horse facilities and property other than the house and the garage was dollar_figure gavilan hills in date petitioner purchased for dollar_figure dollar_figure acres of undeveloped ranch land in the unincorporated gavilan hills area of riverside county california gavilan hills gavilan hills is approximately miles from falling water way between august and date petitioner engaged wellmaster drilling inc to drill two wells at gavilan hills on date gavilan hills was zoned residential agricultural the new zoning laws allow up to horses to be kept on the property but prohibit the operation of a livery stable or boarding stable as of date the fair_market_value of gavilan hills was dollar_figure rialto property petitioner has operated her dental practice pincite north riverside avenue in rialto california rialto property since the rialto property consists of a big_number square-foot house zoned for professional office use from through petitioner’s professional_corporation leased the rialto property on date petitioner purchased the rialto property for dollar_figure from through except for the year petitioner’s professional_corporation paid petitioner dollar_figure annually for_the_use_of the rialto property in petitioner’s professional_corporation paid petitioner dollar_figure for_the_use_of the rialto property on her federal_income_tax return petitioner reported a rental loss of dollar_figure as a result of significant repair expenses_incurred upon acquisition of the property from to petitioner reported average annual rental income of dollar_figure during the years in issue petitioner reported rental income of dollar_figure dollar_figure and dollar_figure respectively c petitioner’s horse activity background petitioner was raised around horses and showed horses as a child and young adult in petitioner purchased her first horse feyras raehele in petitioner commenced her horse activity at falling water way under the name falling water arabians petitioner dealt only with purebred arabian horses at the time she started her activity petitioner did not know how many arabian horse breeders operated in california during the years in issue petitioner used falling water way for breeding training and working the horses however because petitioner has only dollar_figure acres at falling water way she often took the horses to gavilan hills to exercise and train them during the years in issue petitioner wormed and vaccinated her horses petitioner also ordered supplies and paid bills related to her horse activity petitioner maintained a library of horse-related reference materials including books trade journals periodicals and video sets during the years in issue petitioner spent to hours per month reading trade journals petitioner had a falling water arabians business card listing the falling water way address as the business address however the business card was prepared in the late 1980s and the phone numbers are no longer correct petitioner maintained a checking account with california bank trust in moreno valley california under the names elizabeth giles and falling water arabians from date to date the account’s average daily balance never exceeded dollar_figure a dollar_figure maintenance fee was deducted from the account monthly the only other withdrawal taken during this period was dollar_figure on date the purpose of which was not identified as of date the account had a negative balance of -40 cents the only deposit made before date was dollar_figure deposited on date in order to restore a positive account balance on date petitioner deposited dollar_figure received from the sale of bogaz as discussed below during the years in issue petitioner spent to hours a day with the horses in a typical day petitioner fed watered administered necessary medications to exercised and trained her horses in addition petitioner cleaned stalls during the years in issue petitioner showed two of her horses bogaz and kart blanche five to six times per year she did not show her other horses during the years in issue at the shows petitioner often rode the horses herself petitioner received only a few hundred dollars for showing the horses from through in petitioner switched to the show discipline of dressage during the years in issue petitioner did not ride her horses in parades petitioner did not attend any social or charity events relating to horses from to petitioner did not provide any services to third parties including training coaching or boarding from through and from through petitioner did not sell any horses in petitioner sold only one horse bogaz petitioner’s horses in and petitioner owned the following horses feyras raehele kart blanche borissa and bogaz petitioner dressage is a disciplined practice in which the horse is controlled in certain difficult steps and gaits by slight movements of the rider dressage is a competitive event in the olympic games the pan american games and other competitions there are two introductory levels of dressage four separate training levels and four separate competitive levels also held future income interests as discussed below in tf silent reign in and in tf silent reign and mon reve in at the beginning of petitioner owned feyras raehele kart blanche borissa and bogaz and continued to hold future income interests in tf silent reign and mon reve during petitioner acquired censuous by breeding in date petitioner sold bogaz for dollar_figure following is a description of petitioner’s horses and related breeding activity a feyras raehele and kart blanche in petitioner purchased feyras raehele an arabian mare4 foaled5 on date during petitioner bred feyras raehele on date feyras raehele produced a filly kart blanche b borissa bogaz and censuous in petitioner leased borissa a mare foaled in from raymond mazzei of furioso farm for breeding purposes on a mare is a female horse of reproductive age foaled is synonymous with born a foal is a baby horse of either sex in foal indicates that a mare is pregnant the gestation period for an arabian horse is typically months but can be anywhere from to months a filly is a female horse years old or younger date borissa produced a colt7 named vt kartel after seeing vt kartel petitioner purchased borissa for dollar_figure vt kartel died in in petitioner again bred borissa who produced bogaz on date petitioner did not breed borissa from through on date petitioner entered into a breeding contract with bishop lane farm to have borissa bred to bishop lane farm’s stallions borissa was in foal in but her foal died at birth in upon the advice of thomas hoyme d v m borissa was not rebred in in petitioner sent borissa to an equine breeding facility operated by richard k tramp d v m for the purpose of breeding borissa by use of shipped cooled semen despite this attempt borissa did not conceive in in petitioner bred borissa to concensus a stallion from bishop lane farm as a result borissa produced a filly named censuous on date in petitioner sold bogaz for dollar_figure on date petitioner deposited a dollar_figure check received on the sale into the california bank and trust account described above a colt is a male horse not castrated years old or younger a stallion is an adult male horse which has not been castrated petitioner invested the dollar_figure in an individual_retirement_account c tf silent reign and mon reve petitioner bought tf silent reign in for dollar_figure in petitioner transferred tf silent reign to her daughter michelle pope ms pope for zero dollars petitioner and ms pope had an oral agreement that ms pope would breed tf silent reign and pay all related expenses and they would split all future profits if any from the breeding in ms pope bred tf silent reign to monogramm an arabian stallion from bishop lane farm on date tf silent reign produced a filly named mon reve petitioner’s horse activity business plans a annual business plans ms pope is a certified_public_accountant c p a with the aid of ms pope petitioner prepared annual business plans for the years through each annual business plan is a one-page fill-in-the-blank form with handwritten responses each annual plan was prepared in the spring or summer of the year to which it relates in the annual plan petitioner listed her long-term goals as sell borissa’s foal estimate value after one year big_number to big_number rah’s feyras raehele’s foal for show estimate value if national winner approximately big_number in the annual plan petitioner listed her long-term goals as breeding selling and training horses for added value under plans for next year petitioner listed seek better trainer with better reputation in the annual plan petitioner listed her long-term goals as sell falling water way to set up business in gavilan hills for expansion breed show sell in the annual plan petitioner listed her long-term goals as move to gavilan hills for expansion under short-term goals petitioner listed tf silent reign to nationals with david garrett david garrett is a trainer with whom petitioner consulted about breeding training and showing in the annual plan petitioner listed her long-term goals as move to gavilan hills breed sell under changes decisions to decrease chances of failure and increase revenues petitioner stated self train and self vet in the annual plan petitioner listed her long-term goals as same as ‘93 goals under successes petitioner stated found lou roper petitioner consulted with lou roper a national champion in the discipline of trail and hunting pleasure on horse training b general business plan petitioner and ms pope also prepared a general business plan concerning petitioner’s horse activity similar to the annual plans the general plan is a one-page fill-in-the-blank form with handwritten responses petitioner listed her objectives as breed raise show to increase value sell petitioner listed areas of opportunity for profit as selling quality show horses petitioner stated that she hoped to start making a profit in years it is not clear from the record when the general plan was prepared or whether it related to any specific years income and expenses from petitioner’s horse activity after the close of each year ms pope compiled canceled checks and credit card receipts and used these to categorize expenses and prepare profit and loss statements the profit and loss statements do not identify the costs specifically connected with each horse the profit and loss statements do not indicate what accounts the checks were drawn on charles e wessman mr wessman a c p a used the profit and loss statements to prepare petitioner’s schedules c profit or loss from business petitioner’s schedules c for through reflect the following year gross_receipts veterinary expenses advertising expenses total expenses profit loss dollar_figure big_number -0- big_number big_number big_number big_number big_number big_number big_number total big_number dollar_figure 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 dollar_figure -0- -0- big_number -0- -0- -0- big_number dollar_figure 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 dollar_figure 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 d tax treatment of petitioner’s horse activity audit of petitioner’s and tax returns in internal revenue_agent w dillard conducted a field_audit of petitioner’s and tax returns specifically examining petitioner’s schedule c horse activity under the passive_activity rules of sec_469 mr wessman handled the audit on behalf of petitioner on date respondent sent petitioner a letter stating we examined your tax_return s for and and made no changes to the tax you reported prior tax_court case involving and respondent audited petitioner’s and federal_income_tax returns specifically examining petitioner’s schedule c horse activity under the hobby_loss_rules of sec_183 respondent determined that petitioner’s horse activity was not an activity engaged in for profit and disallowed losses taken from that activity petitioner filed a petition with this court at docket no contesting respondent’s determination on date judge laro entered his decision for respondent see giles v commissioner tcmemo_2005_28 petitioner appealed to the court_of_appeals for the ninth circuit which dismissed the case on date the years in issue petitioner timely filed federal_income_tax returns for the years in issue these returns were prepared by mr wessman attached to each return was a schedule c listing breeding competing horses as the principal business and falling water arabians as the business name in petitioner deducted a schedule c loss of dollar_figure and reported adjusted_gross_income of dollar_figure on the attached schedule c petitioner reported gross_income of dollar_figure and total expenses of dollar_figure in petitioner deducted a schedule c loss of dollar_figure and reported adjusted_gross_income of dollar_figure on the attached schedule c petitioner reported gross_income of dollar_figure and total expenses of dollar_figure in petitioner reported schedule c income of dollar_figure and adjusted_gross_income of dollar_figure on the attached schedule c petitioner reported gross_income of dollar_figure and total expenses of dollar_figure on date respondent sent petitioner an initial contact letter asking her to produce books records and work papers used to prepare her schedule c for petitioner did not produce any books records or other work papers in response to the initial contact letter respondent subsequently expanded the examination to include and on date respondent sent petitioner a 30-day_letter covering and petitioner was given the opportunity to sign a period of limitations extension but refused to do so at the time petitioner had already filed a petition with this court relating to and petitioner wished to add the and years to the prior case in an effort to consolidate the cases petitioner forewent the administrative appeal process for the years in issue the cases were never consolidated on date respondent mailed petitioner a notice_of_deficiency for the years in issue respondent determined that petitioner’s horse activity expenses were not ordinary and necessary business_expenses respondent disallowed petitioner’s schedule c losses of dollar_figure and dollar_figure for and respectively respondent also disallowed petitioner’s schedule c expenses of dollar_figure for respondent determined deficiencies of dollar_figure dollar_figure and dollar_figure for and respectively in addition respondent determined petitioner was liable for accuracy-related_penalties under sec_6662 for the years in issue on date petitioner filed a petition with the court disputing the notice_of_deficiency a petitioner’s horse activity opinion the first issue for decision is whether petitioner’s horse activity was an activity engaged in for profit within the meaning of sec_183 during the years in issue sec_183 provides that if an individual engages in an activity but does not engage in that activity for profit no deduction attributable to such activity shall be allowed under this chapter except as provided in this section in the case of generally a taxpayer bears the burden of proving the commissioner’s determinations incorrect rule a 290_us_111 however under sec_7491 the burden_of_proof may shift to the commissioner in certain situations petitioner contends that sec_7491 requires respondent to bear the burden_of_proof we need not decide this issue because our findings and analysis in this case are based on the record before the court and do not depend on which party bears the burden_of_proof an activity_not_engaged_in_for_profit sec_183 allows deductions which are otherwise allowable without regard to whether the activity is engaged in for profit sec_183 allows deductions that would be allowable if the activity were engaged in for profit but only to the extent of gross_income received from the activity 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 the court_of_appeals for the ninth circuit to which an appeal of this case would lie absent stipulation otherwise has held that for a deduction to be allowed under sec_162 or sec_212 or the taxpayer must establish that she engaged in the activity with the predominant primary or principal objective of realizing an economic profit independent of tax savings 4_f3d_709 9th cir affg tcmemo_1991_212 see also 864_f2d_93 9th cir affg patin v commissioner sec_162 allows a taxpayer to deduct ordinary and necessary expenses of carrying on the taxpayer’s trade_or_business pars and of sec_212 allow the taxpayer to deduct expenses_incurred in connection with an activity engaged in for the production_or_collection_of_income or for the management_conservation_or_maintenance_of_property_held_for_the_production_of_income t c 781_f2d_724 9th cir affg lahr v commissioner tcmemo_1984_472 factors to be considered in determining whether an activity is engaged in for profit include the manner in which the taxpayer carries on the activity the expertise of the taxpayer or her advisers the time and effort expended 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 which are earned the financial status of the taxpayer and the elements of personal pleasure or recreation indep elec supply inc v commissioner supra pincite 91_tc_686 n affd 893_f2d_656 4th cir 72_tc_411 affd without published opinion 647_f2d_170 9th cir sec_1_183-2 income_tax regs no single factor or group of factors is determinative golanty v commissioner supra pincite 70_tc_715 affd 615_f2d_578 2d cir sec_1_183-2 income_tax regs a final_determination is made only after considering all facts and circumstances indep elec supply inc v commissioner supra pincite antonides v commissioner supra pincite golanty v commissioner supra pincite the proper focus of the test is the taxpayer’s subjective intent however objective indicia may be used to establish that intent skeen v commissioner supra pincite see also wolf v commissioner supra pincite indep elec supply inc v commissioner supra pincite the expectation of making a profit need not be reasonable 85_tc_557 78_tc_642 affd without opinion 702_f2d_1205 d c cir golanty v commissioner supra pincite however greater weight is given to objective facts than to a taxpayer’s self- serving statement of intent indep elec supply inc v commissioner supra antonides v commissioner supra 84_tc_1244 affd 792_f2d_1256 4th cir respondent determined that petitioner did not engage in her horse activity with an intent to derive a profit and therefore disallowed the schedule c loss deductions petitioner contends that she engaged in her horse activity with an intent to derive a profit and is therefore entitled to deduct from her gross_income schedule c losses relating to that activity to make our determination we address the nine factors found in sec_1_183-2 income_tax regs manner in which petitioner carried on the horse activity to determine whether a taxpayer carried on an activity in a businesslike manner three subfactors may be considered sec_1_183-2 income_tax regs a complete and accurate books_and_records the fact that the taxpayer carries on the activity in a businesslike manner and maintains complete and accurate books_and_records may indicate that the activity is engaged in for profit 90_tc_960 affd without published opinion 899_f2d_18 9th cir 72_tc_659 sec_1_183-2 income_tax regs petitioner asserts that she kept complete and accurate books_and_records and argues that respondent’s concession that she substantiated her schedule c expenses so indicates annual profit and loss statements were introduced into evidence for the years through including the years in issue these statements were prepared by ms pope and used by mr wessman to prepare petitioner’s schedules c although petitioner’s annual profit and loss statements were sufficient to substantiate her schedule c expenses these statements are not indicative that the horse activity was carried on for profit for the purposes of sec_1_183-2 income_tax regs this court has stated the purpose of maintaining books_and_records is more than to memorialize for tax purposes the existence of the subject transactions it is to facilitate a means of periodically determining profitability and analyzing expenses such that proper cost saving measures might be implemented in a timely and efficient manner burger v commissioner tcmemo_1985_523 affd 809_f2d_355 7th cir see also golanty v commissioner supra pincite mckeever v commissioner tcmemo_2000_288 wesinger v commissioner tcmemo_1999_372 even though a sophisticated accounting system is not necessary the usage of cost accounting techniques that at a minimum provide the entrepreneur with the information he requires to make informed business decisions is essential burger v commissioner supra see also golanty v commissioner supra mckeever v commissioner supra wesinger v commissioner supra petitioner introduced no evidence that she kept track of expenses throughout the year the statements categorized expenses but her records did not break down the expenses by horse by month or by any other means further the record is devoid of any evidence that petitioner used the statements in making decisions about the operation of her horse activity we find that petitioner’s annual profit and loss statements were nothing more than records compiled at the end of each year and used exclusively to prepare her schedules c petitioner did not use the statements to make informed business decisions this subfactor weighs in favor of respondent’s position b conduct substantially_similar to that of other profitable activities when the taxpayer conducts the activity in a manner substantially_similar to that of other activities of the same nature which are profitable a profit_motive may be indicated engdahl v commissioner supra pincite sec_1_183-2 income_tax regs petitioner presented no evidence on how profitable horse breeding operations are run however generally relevant indicators may include advertising maintaining a separate business bank account developing a written business plan and having a plausible strategy for earning a profit see morley v commissioner tcmemo_1998_312 butler v commissioner tcmemo_1997_408 de mendoza v commissioner tcmemo_1994_314 ellis v commissioner tcmemo_1984_50 in the years prior to the years in issue petitioner deducted less than dollar_figure of advertising and promotion costs during the years in issue petitioner did not advertise in trade magazines journals or other publications and she deducted no advertising or promotional costs on her schedules c petitioner testified that she felt showing horses was the best form of advertising and used competitions as her primary method of promotion the court recognizes that showing horses may be one method of advertising however given that petitioner’s activity is breeding and selling horses and that petitioner sold only one horse from through we find that her failure to advertise in an attempt to reach a larger customer base is not consistent with a profit_motive see dodge v commissioner tcmemo_1998_89 affd without published opinion 188_f3d_507 6th cir petitioner maintains a separate bank account under the names elizabeth giles and falling water arabians however it is clear from the record that petitioner did not use the account in conducting her horse activity from date to date petitioner made a single withdrawal of dollar_figure not including the monthly deductions for maintenance fees the purpose of the withdrawal was not identified in the record in addition ms pope testified that the canceled checks she used to prepare petitioner’s annual profit and loss statements were not from the elizabeth giles and falling water arabians bank account during the years in issue there were only two deposits into the account on date petitioner deposited dollar_figure in order to restore a positive account balance on date petitioner deposited dollar_figure received from the sale of bogaz petitioner invested the dollar_figure in an individual_retirement_account which is clearly not related to her horse activity on the basis of the above we find that petitioner did not maintain the bank account in a businesslike manner petitioner and ms pope prepared annual business plans for the years through and one undated general business plan these plans were on fill-in-the-blank forms with hand- written responses in each plan petitioner listed as a long- term goal to sell horses in her through plans petitioner stated that her goal was to move her horse activity to gavilan hills while petitioner had business plans for previous years she had no business plans for the years in issue petitioner introduced no evidence that she referred to the business plans during the years in issue despite petitioner’s stated goal of selling horses petitioner sold only one horse in years after the last business plan was prepared despite petitioner’s stated goal of moving her horse activity to gavilan hills from through the years in issue petitioner took no meaningful steps to make the property suitable for accommodating the activity we find that no positive inference can be drawn from petitioner’s business plans petitioner continually asserts that she is in the business of breeding and selling horses and intends to make a profit since petitioner has bred only borissa in that time borissa’s foal died in she was not bred from through her foal died at birth and she was not able to conceive by artificial insemination in in years borissa has produced only two surviving horses bogaz and censuous despite the many breeding problems petitioner testified that she considered borissa to be her best breeding mare petitioner also testified that she intends to offer services to third parties including training coaching and boarding yet since petitioner has offered no such services in addition the zoning restrictions at falling water way and gavilan hills prohibit petitioner from operating boarding or livery stables on the properties petitioner has pointed to nothing else from which she intends to derive a profit on the basis of these facts we find that petitioner does not have a plausible strategy for earning a profit petitioner has introduced no evidence that she operated her horse activity in a manner similar to that of profitable horse- breeding businesses none of the generally relevant indicators described above could lead us to conclude that petitioner operates her horse activity in a manner consistent with a profitable venture of any type this subfactor weighs heavily in favor of respondent’s position c changes to improve profitability when a taxpayer changes operating methods adopts new techniques or abandons unprofitable methods in a manner consistent with an intent to improve profitability a profit_motive may be indicated sec_1_183-2 income_tax regs petitioner argues that she has changed her methods over the years in an effort to improve profitability to advance this argument petitioner testified that from through she stopped breeding her horses because she perceived a downturn in the arabian horse market she began vaccinating worming and performing other basic veterinary services to save money and in she switched show disciplines to dressage because she felt dressage was becoming more popular petitioner introduced no evidence to corroborate her testimony that there was a downturn in the arabian horse market in the mid-1990s even if we accept petitioner’s statements as fact the halt in her breeding activity would not weigh in her favor petitioner reported the following total expenses from her horse activity on her schedules c year total expenses dollar_figure 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 during the period that petitioner stopped breeding her horses her total annual expenses were actually higher than during most years in which she was breeding them petitioner testified that she felt breeding would be unprofitable during the perceived downturn however petitioner did not state how if at all her decision would decrease expenses or otherwise improve profitability in her annual business plan petitioner indicated that she could lower costs by performing basic veterinary work it is unclear from the record when petitioner began performing this work on petitioner’s schedules c she reported the following veterinary expenses veterinary expenses dollar_figure 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 year there is no discernable pattern to the reported veterinary expenses that would indicate veterinary costs decreased as a result of petitioner’s performing some veterinary services on her own petitioner testified that in she switched show disciplines from western pleasure and trail to dressage because she perceived a greater demand for dressage horses petitioner presented no evidence that corroborates her perception petitioner did not indicate that her horses were marketed differently or how the switch in show disciplines would otherwise affect the profitability of petitioner’s horse activity on the basis of the above we cannot infer that petitioner’s decisions to halt breeding perform veterinary services or switch show disciplines were made in a manner consistent with an intent to improve profitability petitioner has not shown that the changes had or will have a material impact on her horse activity’s profitability see golanty v commissioner t c pincite changes must be sufficient to change materially the prospect of profitability mckeever v commissioner tcmemo_2000_288 accordingly this subfactor weighs in favor of respondent’s position d other considerations petitioner has a falling water arabians business card however this card was prepared in the late 1980s and the phone numbers are no longer correct the existence of an out-of-date business card does not weigh in favor of petitioner’s position petitioner keeps extensive records of health certification and pedigree as well as promotional materials used in picking stallions to breed borissa to and correspondence with other parties regarding her horse activity however the keeping of these records is as consistent with a hobby as with a business see golanty v commissioner supra pincite burger v commissioner tcmemo_1985_523 the existence of these records does not weigh in favor of petitioner’s position petitioner argues that her decision to lease borissa before buying her evidences businesslike behavior petitioner introduced no evidence that this is a common practice in profitable horse-breeding businesses this decision does not weigh in favor of petitioner’s position e summary taking into consideration the above we conclude that petitioner did not operate her horse activity in a businesslike manner this factor weighs in favor of respondent’s position expertise of petitioner or her advisers preparation for an activity by extensive study of its accepted business economic and scientific practices or consultation with those who are expert therein may indicate a profit_motive engdahl v commissioner t c pincite lundquist v commissioner tcmemo_1999_83 affd 211_f3d_600 11th cir sec_1_183-2 income_tax regs efforts to gain experience and a willingness to follow expert advice may also indicate a profit_motive dworshak v commissioner tcmemo_2004_249 lundquist v commissioner supra petitioner has been involved with raising and showing horses since she was a child petitioner has consulted many professionals regarding breeding and training horses including david garrett and lou roper in addition petitioner has read many books and publications regarding the breeding and training of horses while petitioner undoubtedly has expertise in breeding and training her expertise does not extend to the economics of the undertaking petitioner testified that when she started her horse activity she had no idea how many arabian horse breeders there were in california petitioner presented no evidence that she was aware of the state of the market or other factors that may affect profitability while a formal market study is not required a basic investigation of the factors that would affect profit is burger v commissioner supra see also golanty v commissioner supra pincite wesinger v commissioner tcmemo_1999_372 petitioner testified that she discussed aspects of her horse activity with two c p a s ms pope and mr wessman which their testimony corroborated however it is unclear whether they discussed anything more than petitioner’s expenses in preparing the annual profit and loss statements and schedules c while ms pope and mr wessman may have expertise in accounting neither testified to having experience in running a profitable horse- breeding business since petitioner has not consulted with experts regarding the economic aspects of running a profitable horse-breeding business considering petitioner’s long history of losses this is not indicative of a profit_motive see golanty v commissioner supra pincite wesinger v commissioner supra hillman v commissioner tcmemo_1999_255 dodge v commissioner tcmemo_1998_89 none of petitioner’s reference materials and publications were devoted to the business aspects of horse breeding petitioner testified that only one of the references in her library might possibly contain information regarding the business aspects of horse breeding she further testified that some of the monthly publications contained business information however petitioner did not testify to how she used this information if at all in her activity on the basis of the above we conclude that petitioner was not an expert and did not seek out expert advice regarding the economic aspects of running a profitable horse-breeding business this factor weighs in favor of respondent’s position time and effort petitioner expended in carrying on the activity the fact that the taxpayer devotes much of her personal time and effort to carrying on an activity may indicate an intention to derive a profit particularly if the activity does not have substantial personal or recreational aspects golanty v commissioner t c pincite sullivan v commissioner tcmemo_1998_367 affd 202_f3d_264 5th cir morley v commissioner tcmemo_1998_312 sec_1_183-2 income_tax regs petitioner places heavy emphasis on morley v commissioner tcmemo_1998_312 where the court held that the taxpayer operated his horse activity for profit like petitioner mr morley worked days a week in his dental practice and days a week with his horse activity however the present case is readily distinguishable among other differences mr morley advertised created promotional materials and was not involved in the recreational components of horse ownership specifically riding his horses to any significant extent petitioner often spent hours a day with her horse activity petitioner argues that the activity does not have substantial personal or recreational aspects petitioner places heavy emphasis on the time spent feeding and watering her horses and cleaning stalls petitioner asserts that her horse activity did not have any personal or recreational aspects while the court recognizes that feeding and watering her horses and cleaning stalls may not be enjoyable activities unpleasant tasks associated with caring for horses are required regardless of whether the activity is pursued as a hobby or a business see sullivan v commissioner supra petitioner has ridden and shown horses since she was a child though she does not ride in parades or attend social or charity functions petitioner certainly derives some personal pleasure from riding and showing her horses however personal pleasure derived from an activity will not turn a business into a hobby 59_tc_312 see also mckeever v commissioner tcmemo_2000_288 petitioner spends a significant amount of time with her horse activity nevertheless because the horse activity has significant personal and recreational components this factor is neutral expectation that assets used in the activity may appreciate in value the expectation that assets used in the activity will appreciate in value sufficiently to lead to an overall profit when netted against losses may indicate a profit_motive engdahl v commissioner t c pincite lapinel v commissioner tcmemo_1989_685 affd 930_f2d_911 2d cir sec_1_183-2 income_tax regs petitioner argues that the appreciation of falling water way and gavilan hills combined with the value of her horses is significant enough to offset all prior losses a falling water way and gavilan hills petitioner asserts that falling water way and gavilan hills are held in connection with her horse activity respondent on the other hand argues that her holding of real_property is an activity separate from petitioner’s horse activity to make this determination sec_1_183-1 income_tax regs states all facts and circumstances must be taken into account generally the most significant facts and circumstances in making this determination are the degree of organizational and economic interrelationship of various undertakings the business_purpose which is served by carrying on the various undertakings separately or together and the similarity of various undertakings the taxpayer’s characterization will not be accepted when it appears that his characterization is artificial and cannot be reasonably supported under the facts and circumstances of the case if the taxpayer engages in two or more separate activities deductions and income from each separate activity are not aggregated either in determining whether a particular activity is engaged in for profit or in applying sec_183 falling water way is at the center of petitioner’s horse activity her horses are kept on the property and are bred fed and watered there petitioner testified that she trains her horses in the arena at falling water way however falling water way also includes petitioner’s four- bedroom house and a garage unrelated to her horse activity with the exception of the house and the garage we conclude that falling water way is a part of petitioner’s horse activity therefore any appreciation attributable to the horse facilities and land at falling water way may be taken into consideration when determining whether petitioner engaged in her horse activity for a profit gavilan hills is approximately miles from falling water way even though petitioner has not made significant improvements to the property since petitioner used gavilan hills to exercise and train her horses throughout the years in issue gavilan hills was not used for any purpose unrelated to petitioner’s horse activity we conclude that gavilan hills is a part of petitioner’s horse activity therefore any appreciation of gavilan hills may be taken into consideration when determining whether petitioner engaged in her horse activity for a profit b petitioner’s horses petitioner’s only evidence of the fair_market_value of her horses is based on the testimony of an expert witness janine esler ms esler ms esler is a professional horse trainer breeder bloodstock agent and business consultant she has trained arabian horses since her experience is sufficient to qualify her as an expert in the arabian horse field however we find that ms esler’s expert report does not provide reliable valuations of petitioner’s horses rule f states that a witness’s expert report shall state the opinion and the facts on which that opinion is based the report shall set forth in detail the reasons for the conclusion emphasis added in her report ms esler did not disclose her method of valuation at trial she testified that she used comparable values of horses but she could not be more specific ms esler further testified that a horse’s pedigree health condition training history and performance history are all factors to be considered in determining a horse’s fair_market_value yet these factors are not mentioned in her report in addition ms elser testified that it is important to view a horse from all angles and to watch the horse walking both towards and away from the observer however ms esler never personally observed two of the horses valued in her report tf silent reign and mon reve instead relying on still-shot photographs we find that ms esler’s report does not comply with rule f as it fails to set out in detail the reasons for her conclusions we further find that ms esler could not adequately explain her report at trial and her answers to many questions raise doubts as to the reliability of her valuations because petitioner introduced no other evidence regarding the values of her horses those values cannot be considered in determining whether petitioner engaged in her horse activity for profit c summary as outlined above the fair_market_value of falling water way and gavilan hills can be taken into account in considering this factor petitioner purchased falling water way for dollar_figure and gavilan hills for dollar_figure as of date the fair_market_value of the horse facilities and land at falling water way was dollar_figure and the fair_market_value of gavilan hills was dollar_figure falling water way and gavilan hills have appreciated substantially and petitioner can reasonably expect the properties to continue to appreciate therefore we find that this factor weighs in favor of petitioner’s position it is important to note however that an unsuccessful horse-breeding operation cannot be carried on forever simply because the price of land in that general area is rising lapinel v commissioner tcmemo_1989_685 success of petitioner in carrying on other similar or dissimilar activities the fact that the taxpayer has engaged in similar activities in the past and converted them to profitable enterprises may indicate that she engaged in the present activity for profit lundquist v commissioner tcmemo_1999_83 de mendoza v commissioner tcmemo_1994_314 sec_1_183-2 income_tax regs while petitioner has a long history of working with horses she had not previously engaged in a horse-breeding business petitioner runs a successful dental practice but she presented no evidence that she operated her horse activity in a similarly businesslike manner see dodge v commissioner tcmemo_1998_89 accordingly this factor is neutral petitioners’ history of income or losses with respect to the activity a series of losses during the initial or startup stage of an activity may not necessarily be an indication that the activity is not engaged in for profit engdahl v commissioner t c pincite sec_1_183-2 income_tax regs however losses that extend beyond the customary startup stage may indicate that the activity is not engaged in for profit engdahl v commissioner supra pincite sec_1_183-2 income_tax regs from through and through petitioner reported total schedule c losses of dollar_figure in petitioner reported a dollar_figure profit from her horse activity due to the sale of bogaz for dollar_figure petitioner argues that the history of losses does not indicate she lacked a profit_motive because her activity is in the startup stage this court has recognized that the startup stage for a horse-breeding activity may be to years engdahl v commissioner supra pincite mckeever v commissioner tcmemo_2000_288 dodge v commissioner supra petitioner argues that her startup stage should be extended because she encountered unforseen circumstances including the death of two foals in and respectively and the depressed arabian horse market in the mid-1990s the applicable regulations do not provide for an extension of the startup stage on account of unforeseen circumstances and petitioner cites no caselaw to support her argument instead sec_1_183-2 income_tax regs states if losses are sustained because of unforeseen or fortuitous circumstances which are beyond the control of the taxpayer such losses would not be an indication that the activity is not engaged in for profit even if unforeseen circumstances beyond petitioner’s control contributed to losses in earlier years this does not explain petitioner’s continued losses in and nor does it justify extending the long-recognized to 10-year startup stage petitioner began her horse activity in if we give her the full benefit of the recognized time period the startup stage of petitioner’s activity ended in in the subsequent years petitioner reported losses totaling dollar_figure while reporting a profit in just year of only dollar_figure petitioner also argues that her history of losses does not indicate she lacked a profit_motive because the losses were steadily declining until when a profit was achieved from through petitioner’s losses declined each year in and petitioner reported losses of dollar_figure and dollar_figure respectively in petitioner reported a profit of dollar_figure however in and petitioner reported losses of dollar_figure and dollar_figure respectively in other words petitioner’s losses in and actually increased relative to her losses in and petitioner’s losses after the years in issue only confirm the general pattern of losses see dodge v commissioner supra given what has occurred since petitioner reported a profit in no positive inference can be made from the decline in losses before petitioner’s history of losses indicates that her horse activity was not engaged in for profit this factor weighs heavily in favor of respondent’s position the amount of occasional profits if any which are earned the amount of profits in relation to the amount of losses_incurred may provide a useful criterion in evaluating whether the taxpayer engaged in the activity for profit mckeever v commissioner supra dodge v commissioner supra sec_1_183-2 income_tax regs the regulations go on to state substantial profit though only occasional would generally be indicative that an activity is engaged in for profit where losses are comparatively small moreover an opportunity to earn a substantial ultimate profit in a highly speculative venture is ordinarily sufficient to indicate that the activity is engaged in for profit even though losses or only occasional small profits are actually generated sec_1_183-2 income_tax regs emphasis added petitioner has not generated a substantial profit in the years petitioner has operated her horse activity she reported a profit in year of only dollar_figure compared to total losses of dollar_figure the size of her losses compared to only a small profit is not indicative of a profit_motive petitioner argues that she has the opportunity to earn a substantial ultimate profit through the sale of potentially valuable horses petitioner introduced evidence that horses of the bloodlines she used in breeding borissa have sold for dollar_figure dollar_figure dollar_figure and dollar_figure petitioner also testified that some purebred arabian stallions have been syndicated for multimillion dollar values a taxpayer’s belief that she could one day sell a horse for a substantial amount of revenue and a correspondingly large profit may be indicative of a profit_motive if that belief is adequately supported see mckeever v commissioner supra dawson v commissioner tcmemo_1996_417 however petitioner has never produced a horse of the caliber that would generate such substantial revenue under the circumstances of this case the possibility of a highly speculative profit is insufficient to outweigh the substantial losses and relatively minuscule gain over a year period see mckeever v commissioner supra this factor weighs in favor of respondent’s position the financial status of petitioner substantial income from sources other than the activity may indicate that the taxpayer is not engaged in the activity for profit particularly if the losses generate substantial tax benefits engdahl v commissioner supra pincite sec_1_183-2 income_tax regs petitioner is a dentist and runs her own dental practice as a professional_corporation from through petitioner received wage income from her professional_corporation averaging dollar_figure annually in addition since petitioner has reported average annual rental income of dollar_figure despite her significant sources of current income petitioner argues that her lack of investments and other resources on which to retire indicate that she is running her horse activity for profit petitioner testified that she is not the owner or beneficiary of any trusts annuities or pension plans and her only investments consist of an individual_retirement_account worth less than dollar_figure and stocks and bonds worth less than dollar_figure petitioner further testified that she intended her horse activity to be her source of retirement income in making this argument petitioner disregards the value of her real_property as of date the combined fair_market_value of falling water way and gavilan hills was dollar_figure the fair_market_value of the rialto property is not in the recorddollar_figure in addition petitioner disregards the value of her professional_corporation of which she is the sole shareholder while the court recognizes that as long as tax_rates are less than percent there is no benefit to losing money see engdahl v commissioner t c pincite deducting these losses significantly reduced the after-tax cost of petitioner’s horse activity see hillman v commissioner tcmemo_1999_255 sullivan v commissioner tcmemo_1998_367 given the after-tax economics of petitioner’s activity petitioner’s significant annual wage and rental income supports an inference that the activity was not engaged in for profit this factor weighs in favor of respondent’s position elements of personal pleasure or recreation the presence of personal or recreational motives in conducting an activity may indicate that the taxpayer is not conducting the activity for profit mckeever v commissioner supra sec_1_183-2 income_tax regs however the fact that the taxpayer derives personal pleasure from engaging in the activity does not show that the taxpayer lacks a profit objective if the activity is in petitioner did not establish to what extent if any these properties are encumbered fact conducted for profit as evidenced by other factors sec_1_183-2 income_tax regs despite petitioner’s testimony that her horse activity did not have any personal or recreational aspects petitioner certainly derives some personal pleasure from riding and showing her horses as discussed above however this does not by itself indicate that petitioner lacked a profit_motive accordingly this factor is neutral conclusion petitioner repeatedly testified that she intended to derive a profit from her horse activity and wished to use the activity as her source for retirement income petitioner’s assertions however are not supported by the facts in years of operation petitioner had profitable year despite continual heavy losses petitioner did not seek out expert advice or attempt to educate herself on the economic aspects of running a profitable horse-breeding business petitioner did not operate the activity in a businesslike manner in addition if not for her significant annual wage and rental income petitioner would have been unable to continue the horse activity at a loss_year after year the only factor weighing in favor of petitioner the appreciation of falling water way and gavilan hills is not significant enough to overcome the other factors for these and all other reasons stated herein we find that petitioner’s horse activity was not engaged in for profit within the meaning of sec_183 therefore respondent’s determination that petitioner may not deduct losses from that activity is sustained b accuracy-related_penalty under sec_6662 respondent determined that petitioner is liable for accuracy-related_penalties under sec_6662 for and dollar_figure sec_6662 imposes a penalty in the amount of percent on the portion of the underpayment to which the section applies as relevant to this case the penalty applies to any portion of the underpayment that is attributable to any substantial_understatement_of_income_tax sec_6662 there is a substantial_understatement_of_income_tax if the amount of the understatement exceeds the greater of percent of the tax required to be shown on the tax_return or dollar_figure sec_6662 sec_7491 requires the commissioner to carry the burden of production with regard to penalties higbee v as previously noted respondent has conceded that petitioner is not liable for an accuracy-related_penalty for commissioner 116_tc_438 once the burden of production is met the taxpayer must come forward with sufficient evidence that the penalty does not apply id pincite the tax required to be shown on petitioner’s tax returns was dollar_figure and dollar_figure for and respectively because percent of the tax required to be shown is less than dollar_figure petitioner’s understatements are substantial if they exceed dollar_figure petitioner reported income_tax liabilities of dollar_figure and dollar_figure resulting in understatements of dollar_figure and dollar_figure for and respectively respondent has satisfied his burden by showing that petitioner’s understatements of tax which exceeded dollar_figure were substantial the accuracy-related_penalty is not imposed however with respect to any portion of the understatement if the taxpayer can establish that she acted with reasonable_cause and in good_faith sec_6664 the decision as to whether the taxpayer acted with reasonable_cause and in good_faith depends upon all the pertinent facts and circumstances sec_1_6664-4 income_tax regs circumstances indicating that a taxpayer acted with reasonable_cause and in good_faith include an honest misunderstanding of fact or law that is reasonable in light of all of the facts and circumstances including the experience knowledge and education of the taxpayer id petitioner asserts that she acted with reasonable_cause and in good_faith pointing out that in petitioner was audited on this same issue for the same business and received a no-change letter and petitioner consulted with mr wessman a c p a who prepared her federal_income_tax returns for the years in issue while petitioner did receive a no-change letter with respect to her horse activity during and the audit focused on the passive_activity rules of sec_469 because this case focuses on the hobby_loss_rules of sec_183 the no-change letter received in cannot serve as a basis for reasonable_cause reliance upon the advice of an expert tax preparer may demonstrate that a taxpayer acted with reasonable_cause and good_faith in the context of sec_6662 89_tc_849 affd 904_f2d_1011 5th cir affd 501_us_868 see sec_1 c income_tax regs petitioner provided mr wessman with the annual profit and loss statements prepared by ms pope respondent has conceded that these statements were adequate to substantiate all of petitioner’s claimed expenses for the years in issue mr wessman’s testimony that petitioner provided him with all the necessary information is bolstered by respondent’s concession mr wessman further testified that he believed petitioner’s returns were correct as filed petitioner credibly testified that she relied on mr wessman in determining the tax treatment of her horse activity petitioner did not produce any books records or other work papers in response to respondent’s initial contact letter additionally petitioner did not agree to extend the period of limitations or participate in the appeal process however mr wessman credibly testified that such actions were taken in order to expedite the review process so that the years in issue could be consolidated with the prior tax_court case given the circumstances we find petitioner did not act in bad faith we conclude that petitioner acted with reasonable_cause and in good_faith accordingly we hold that petitioner is not liable for the accuracy-related_penalties under sec_6662 in reaching our holdings we have considered all arguments and contentions made and to the extent not mentioned we conclude that they are moot irrelevant or without merit to reflect the foregoing and the concessions of the parties decision will be entered under rule


internal_revenue_service number release date index number ------------------------- ------------------------------ ---------------------------------------- ----------------------------------- in re ----------------------------------------- ---------------------------------------- -------------------------- --------------------------- 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 pa apjp b02 plr-155683-04 date date date of death ------------------- date of death ------------------- legend decedent decedent's spouse date date date date state x a property property property property property llc ----------------------------------------------------- ----------------------------- ----------------------- ------------------- ---------------------- -------------------------- ------------ --------------------------- ----------------------------------- ----------------------------------- ---------------------------------------- ----------------------------- ------------------------ --------------------------------------- ------------------------- --------------------------- ------------------------------ ----------------------------------------- ----------------------------------------- ----------------------------------------------- ---------------------------------------------------------- --------------------------------------------------------------------------------- --------------------------------------------------------------------------------- plr-155683-04 llc llc llc llc proprietorship entity trust trust a --------------------------------------------------------------------------------------------------------------- trust b --------------------------------------------------------------------------------------------------------------- trust c --------------------------------------------------------------------------------------------------------------- dear ------------------- this letter is in response to your request for a private_letter_ruling dated date concerning whether decedent’s interests in certain real_estate qualify as an interest_in_a_closely_held_business for the purposes of sec_6166 of the internal_revenue_code code the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination facts decedent’s spouse died on date a resident of state x decedent died on date also a resident of state x when decedent’s spouse experienced intermittent health problems throughout her lifetime decedent assumed the duties decedent’s spouse customarily performed for the various real_estate interests when decedent experienced physical limitations --------------------------------------------------------------------------------- plr-155683-04 herself decedent’s spouse managed her individually owned real_estate interests as her agent under a durable_power_of_attorney further if decedent or decedent’s spouse experienced health problems a their son assumed their various duties as of the date of decedent’s spouse’s death decedent’s spouse was managing various properties through proprietorship which had full-time employees including a decedent decedent’s spouse or a supervised various agents and employees including on-site managers for the larger properties who approved of rental applications performed routine maintenance and repair and kept financial records the employees worked in or out of the building which decedent’s spouse maintained an office to oversee the entire operation following decedent spouse’s death a qualified the decedent spouse’s estate to do business in state x as entity a continues to run the business in the same manner in which decedent and decedent’s spouse operated the various real_estate interests during their lifetimes at decedent’s death the assets to which trust a was entitled to as residuary beneficiary of decedent spouse’s estate included five apartment complexes and related buildings thirteen single-family rental residences big_number square feet of commercial rental space ownership_interest in llc whose principal asset is property ownership_interest in llc whose principal asset is property and ownership_interest in llc whose principal asset is property at the time of decedent’s death decedent also had the following ownership interests ownership_interest in llc whose principal asset is property ownership_interest in llc whose principal asset is property and ownership_interest in llc decedent’s spouse formed trust on date and amended and restated it on date trust contains trust a_trust b and trust c trust provides that upon decedent spouse’s death the assets of trust would be divided among three trusts trust a_trust b and trust c trust b would be funded first with assets from trust equal in value to decedent spouse’s remaining available generation-skipping_transfer gst_exemption trust a would be funded second with assets from trust that qualify for the marital_deduction_trust c would be funded with the remaining assets from trust trust a provides that upon decedent spouse’s death if decedent survived him a fractional share of trust assets are to be placed in trust a a marital trust all of the net_income from trust a would be paid at least quarterly to decedent for her life from the time of his death in addition the trustee of trust a may from time to time pay to or apply for the benefit of decedent such sums from the principal of trust a as may be reasonably necessary to provide for decedent’s care maintenance and support in her accustomed manner of living and her hospital medical dental and nursing expenses and expenses of invalidism taking into consideration any other means readily available for such purpose upon the death of decedent a portion of the remaining principal of trust a would be placed in trust b a gst_trust equal to decedent’s unused gst_exemption and the balance of the principal of trust a would be placed in trust c trusts b and c would be established for the benefit of a and any of his issue plr-155683-04 on decedent’s spouse’s timely filed united_states estate and generation-skipping_transfer_tax return form_706 decedent’s spouse’s executor elected to treat trust a as a qualified_terminable_interest_property qtip that qualified for the marital_deduction in determining the federal estate_tax payable by reason of his death trust provides that upon decedent’s death the trustee shall from the remaining principal of trust a place in trust b an amount equal to decedent’s remaining generation-skipping_transfer_exemption and shall place the remaining principal of trust a in trust c rulings requested on the basis of the above facts and representations the following rulings have been requested whether decedent’s interest in certain real_estate_assets qualifies as an interest_in_a_closely_held_business within the meaning of sec_6166 whether the transfer of assets comprising the closely_held_business from trust a to trusts b and c of trust will not constitute a distribution sale exchange or other_disposition of an interest_in_a_closely_held_business under sec_6166 and therefore will not result in acceleration of installment payments relevant authorities the tax reform act of created a new sec_6166 of the code and redesignated the former section as sec_6166a pub_l_no a the economic_recovery_tax_act_of_1981 repealed sec_6166a and amended sec_6166 so that it would apply in most cases that were previously governed by sec_6166a pub_l_no sec_422 neither the economic_recovery_tax_act_of_1981 nor its legislative_history indicate any intent on the part of congress that a disposition of an interest under sec_6166a would not be a disposition under sec_6166 as a result the regulations under sec_6166a are considered applicable to this ruling_request to the extent that those regulations are not inconsistent with the language of sec_6166 under sec_6166 if the value of an interest_in_a_closely_held_business included in determining the gross_estate of a decedent exceed sec_35 percent of the adjusted_gross_estate the executor of the estate may elect to pay part or all of the tax imposed by sec_2001 estate_tax in two or more but not exceeding ten equal installments sec_6166 of the code provides that the term_interest in a closely_held_business means a an interest as a proprietor in a trade_or_business carried on as a proprietorship plr-155683-04 b an interest as a partner in a partnership carrying_on_a_trade_or_business if- i percent or more of the capital interest in such partnership is included in determining the gross_estate of the decedent or such partnership had or fewer partners or c stock in a corporation carrying_on_a_trade_or_business if- ii i ii percent or more in value of the voting_stock of such corporation is included in determining the gross_estate of the decedent or such corporation had or fewer shareholders sec_6166 a - c the determination under sec_6166 shall be made as of the time immediately before the decedent’s death sec_6166 sec_6166 provides that for purposes of sec_6166 and in determining the closely_held_business_amount the value of any interest_in_a_closely_held_business shall not include the value of the portion of such interest which is attributable to passive_assets held by the business sec_6166 provides that passive_asset means in general any asset other than an asset used in carrying_on_a_trade_or_business sec_6166 a provides that if i any portion of an interest_in_a_closely_held_business which qualifies under sec_6166 is distributed sold exchanged or otherwise_disposed_of or money and other_property attributable to such an interest is withdrawn from such trade_or_business and ii the aggregate of such distributions sales exchanges or other dispositions and withdrawals equals or exceed sec_50 percent of the value of such interest then the extension of time for payment of tax provided in sec_6166 shall cease to apply and the unpaid portion of the tax payable in installments shall be paid upon notice_and_demand from the secretary sec_6166 provides that the acceleration rule_of sec_6166 does not apply to a transfer of property of the decedent to a person entitled by reason of the decedent's death to receive the property under the decedent's will the applicable law of descent and distribution or a_trust created by the decedent for purposes of determining whether acceleration of payments is triggered the phrase distributed sold exchanged or otherwise_disposed_of ' is broad in scope and comprehends all possible ways by which an interest_in_a_closely_held_business ceases to form a part of the gross_estate sec_20_6166a-3 revrul_75_365 1975_2_cb_471 considered a situation where a decedent individually maintained a fully equipped business office to collect rental payments on commercial and farm rental properties receive payments on notes receivable negotiate leases make occasional loans and direct the maintenance of the properties by contract the ruling holds that the decedent was merely an owner managing investment_assets to obtain the income ordinarily expected from them rather than conducting a business therefore the commercial and farm rental properties and notes plr-155683-04 receivable included in the decedent’s gross_estate did not constitute an interest_in_a_closely_held_business for purposes of sec_6166 revrul_75_366 1975_2_cb_472 involved a decedent who paid percent of the expenses received percent of the crops and actively participated in important management decisions of a tenant farm included in the decedent’s gross_estate the decedent made almost daily visits to inspect and discuss operations and occasionally delivered supplies to the tenants the ruling holds that farming under these circumstances is a productive enterprise like a manufacturing enterprise distinguishable from management of investment_assets therefore the decedent’s farm asset constitutes an interest_in_a_closely_held_business revrul_75_367 1975_2_cb_472 holds that a decedent’s ownership of percent of the stock of an electing small_business_corporation that built homes on land owned and developed by the decedent and a business office and warehouse used by the corporation and the decedent constituted an interest_in_a_closely_held_business the ruling holds however that eight homes built by the corporation that decedent owned and rented collected rents made the mortgage payments and made necessary repairs and maintenance was not an interest_in_a_closely_held_business because the decedent’s interest in such homes merely represented an investment sec_2001 imposes a tax on the transfer of the taxable_estate of every decedent who is a citizen or resident_of_the_united_states sec_2031 provides that the value of the gross_estate of the decedent shall be determined by including to the extent provided for in this part the value at the time of his death of all property real or personal tangible or intangible wherever situated sec_2033 provides that the value of the gross_estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his death sec_2044 and b generally provide that on the death of the surviving_spouse the surviving spouse’s gross_estate includes the value of any property subject_to a qualified_terminable_interest_property election for which a marital_deduction was allowed under sec_2056 under sec_2056 for purposes of sec_2001 the value of the taxable_estate is determined by deducting from the value of the gross_estate an amount equal to the value of any interest in property which passes or has passed_from_the_decedent to the surviving_spouse but only to the extent that such interest is included in determining the value of the gross_estate sec_2056 provides the general_rule that if the interest in property passing to the surviving_spouse is a terminable_interest the interest will not qualify for the marital_deduction a terminable_interest is one where on the lapse of time on the occurrence of plr-155683-04 a contingency or on the failure of an event or contingency to occur an interest passing to the surviving_spouse will terminate or fail sec_2056 provides an exception to the nondeductible terminable_interest_rule in the case of qualified_terminable_interest_property under sec_2056 qualified_terminable_interest_property is property a which passes from the decedent b in which the surviving_spouse has a qualifying_income_interest_for_life and c to which an election applies under sec_2056 generally the surviving_spouse has a qualifying_income_interest_for_life if the surviving_spouse is entitled to all the income from the property payable annually or at more frequent intervals and no person has a power to appoint any part of the property to any person other than the surviving_spouse during the spouse’s lifetime under sec_2056 the election is to be made by the executor on the estate_tax_return the election once made is irrevocable analysis sec_6166 was enacted to permit the deferral of the federal estate_tax where in order to pay the tax at one time it would be necessary to sell assets used in a going business and thereby disrupt or destroy the business_enterprise this section was intended to permit deferral of tax on income rather than income solely from the ownership of a property sec_6166 was intended to apply only with respect to a business such as manufacturing mercantile or service enterprise as distinguished from management of investment_assets as rev ruls and suggest the level of the activity is the factor that distinguishes a trade_or_business under sec_6166 from the act of merely managing rental property to obtain the rents ordinarily expected in the course of business in determining the level of activity carried on by a proprietorship partnership or corporation the activities of agents and employees are taken into account a determination as to whether an interest_in_a_closely_held_business exists is to be made at the time immediately preceding a decedent’s death therefore if the certain assets included in the decedent’s spouse’s estate qualify as an interest_in_a_closely_held_business they retain the same character when distributed to the decedent if decedent’s spouse was actively engaged in a trade_or_business with respect to certain assets operated by decedent’s spouse his employees or agents the assets are to decedent what they were to decedent’s spouse so long as there is not a material_change in form or operation of those assets decedent’s level of activity in connection with propertie sec_1 and attributable to llc sec_1 and respectively determines whether the properties are part of a plr-155683-04 trade_or_business for purposes of sec_6166 the activities with respect to the properties by decedent decedent’s spouse a agents and employees went beyond the typical activities associated with merely managing investment_assets such as collecting rents making mortgage payments and making necessary repairs with respect to the day-to-day management of these properties the full-time employees reported to decedent decedent’s spouse or a decedent and decedent’s spouse were not passive owners of income producing assets but rather running a large scale real_estate rental operation thus decedent’s spouse up until his death as assisted by employees and agents operated propertie sec_1 and as active businesses after decedent spouse’s death decedent a and their employees and agents continued to operate decedent spouse’s assets as an active trade_or_business for the benefit of decedent up until her death and the assets retain their character as an active trade_or_business accordingly decedent’s interests in llc sec_1 and which own propertie sec_1 and respectively are interests in a closely_held_business however for purposes of determining the value of an interest_in_a_closely_held_business under sec_6166 the value of any passive_assets of llc sec_1 or should not be included thus the estate_tax attributable to the closely_held_business assets held in the marital trust that are includable in decedent spouse’s gross_estate under sec_2044 can be paid in installments under sec_6166 provided the other requirements for qualification under sec_6166 are met on the estate_tax_return for decedent’s spouse the executor elected to have trust a treated as qualified_terminable_interest_property under sec_2056 trust provides that upon decedent spouse’s death if decedent survived him a fractional share of trust assets are to be placed in trust a a marital trust all of the net_income from trust a would be paid at least quarterly to decedent for her life from the time of his death this provision satisfies the requirement under sec_2056 that the surviving_spouse have a qualifying_income_interest_for_life in the trust trust satisfies the other requirements under sec_2056 and the regulations thereunder accordingly the value of trust a on the date of decedent’s death is includible in her gross_estate under sec_2044 to the extent decedent owned or had an interest in the other assets listed above these assets would be includible in decedent’s estate under sec_2031 or sec_2033 sec_2044 provides that for estate_tax purposes property included in the gross_estate of the decedent under sec_2044 is treated as passing from the decedent to the recipient of the property accordingly property included in the gross_estate under sec_2044 is treated for estate_tax purposes in the same manner as those interests specifically described in sec_6166 further sec_20_2044-1 specifically provides that the estate_tax imposed on property includible under sec_2044 is eligible for the installment_payment of tax under sec_6166 accordingly we conclude that the transfer of assets from trust a to trusts b and c of trust will not plr-155683-04 constitute a disposition of closely_held_business property within the meaning of sec_6166 conclusions based on the facts and information submitted and the representations set forth above we rule as requested with respect to the following decedent’s interest in certain real_estate_assets qualify as interests in a closely_held_business within the meaning of sec_6166 the transfer of assets from trust a to trusts b and c of trust will not constitute a distribution sale exchange or other_disposition of an interest_in_a_closely_held_business under sec_6166 and therefore will not result in acceleration of installment payments this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent a copy of this letter should be attached to decedent’s federal estate_tax_return in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to the taxpayer if you have questions please contact -----------------------at -------------------- sincerely assistant chief_counsel administrative provisions judicial practice by blaise g dusenberry special counsel administrative provisions judicial practice procedure administration enclosures copy of letter copy for sec_6110 purposes


internal_revenue_service number release date index number ----------------------------------------------------- ---------------------------------- ----------------------------- ---------------------------- - 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 psi plr-124849-05 date january ---------------------------------------------------------- ------------------- ----------------------- --------------------------------- --------------------------------------- ------------------------------- --------------------------------------------------------------------------------------- re ------------------------------------------------------- legend trust x decedent date child child child bank --------------------------------------------------------------------------- city state spouse a b c d e year year date court ------------ ------------ ------------------------------------ ------------------------------ -------------------------- ----------------------------- -------------------------------- ----------------------- ------ ------ ----------------------- ------------------------------------------------------- this is in response to a letter dated date submitted on your behalf by plr-124849-05 dear -------------- your authorized representative requesting rulings on the gift generation-skipping_transfer gst and income_tax consequences of a proposed change_of advisory committee members of trust x will created three separate and equal trusts for the benefit of his three children their spouses and their issue child trust child trust and child trust pursuant to the terms of decedent’s will bank was appointed trustee of all trusts created under the will decedent died on date which was prior to date decedent's the facts submitted and representations made are as follows under clause b of decedent's will the income of each trust is to be paid in reasonable installments to the child for whose benefit it is set apart and upon the child's death to the deceased child's spouse to whom the child was married at the time of decedent's death and after the death of such spouse to the child's issue per stirpes if prior to the death of the last survivor of decedent’s children a child should die leaving no spouse or issue surviving the deceased child's trust is to be divided equally between the trusts for the two surviving children thereafter if a second child should die leaving no spouse or issue surviving the entire property in the two trusts is to be held as one trust for the benefit of the last survivor of decedent’s children clause c of decedent's will provides that the trusts shall terminate upon the death of the last to die of decedent's children and the spouses to whom they were married at the time of decedent's death upon termination the property in each trust is to be paid over to the issue per stirpes of the child for whose benefit the trust was created under clause of his will decedent appointed child child and child as an advisory committee any two of whom by writing signed by them were given the power with respect to the trusts created under the will to a b direct decedent’s executor and trustee as to what action is to be taken by it as owner of shares of corporate securities in the voting of such securities or in consenting to or protesting against proposed corporate action direct the executor and trustee as to sales of property held by it either as executor or trustee and sales and purchases of property plr-124849-05 c d shall be made by decedent's executor and trustee upon the direction and approval of the advisory committee remove the trustee at any time by instrument in writing designating as successor trustee a corporate fiduciary having its principal_place_of_business in city state and give its consent so that decedent's executor and trustee may borrow money when it is considered by the advisory committee that the borrowing of such money is for the benefit of any trust estate the will further provides that when any member of the advisory committee dies or becomes unwilling to act or incapable of acting the other two members are to select a person to fill the vacancy by a writing signed by the remaining members and delivered to the trustee if two members are deceased or unwilling to serve or become incapable of serving the remaining member is to select two other persons to fill the two vacancies by delivering a writing signed by the remaining member to the trustee at any time there are only two members of the committee such two members are to have full power to act but in case of disagreement between the two members the chief_executive_officer of trustee is to serve as the third member of the committee until such time as a third member is selected in the manner provided at any time there is only one member of the advisory committee alive and willing to and capable of taking action the one member is to have the power to exercise the powers of the committee but only during such time as he does not have a reasonable opportunity to select two members to fill the vacancies any member of the advisory committee who is not a beneficiary of a_trust under decedent’s will is to be paid compensation_for his services at the present time child child child and the spouses of child and child are deceased the spouse of child is still living the child trust the child trust and the child trust will terminate on the death of spouse of child child died in year and his spouse died in year child was survived by three children b d and e on date by order of court the child trust was divided into three separate trusts each consisting of a one-third interest in each asset trust x was created for the benefit of b and her descendants the current members of the advisory committee of trust x are a b and c a b and c have entered into an agreement of sequential resignations and successor appointments in accordance with the terms of decedent's will that will become effective upon the receipt of favorable rulings from the service under the agreement a will be deemed to have resigned as an advisor and b and c the remaining advisors will be deemed to have appointed as a new advisor a member of a class which includes descendants of decedent including potentially beneficiaries of trust x and other adult individuals including potentially the spouses of such beneficiaries thereafter c will be it is represented that the new advisors will operate in accordance with the plr-124849-05 deemed to have resigned as an advisor and b and the advisor appointed by b and c will be deemed to have appointed another member of the class as an advisor provisions set forth in decedent's will for the advisory committee as described above it is also represented that no additions have been made to the child trust or to trust x since decedent's death the following rulings are requested the proposed resignation of advisors and appointment of successor advisors with respect to trust x will not subject trust to the application of the generation- skipping transfer gst tax under sec_2601 of the internal_revenue_code and applicable regulations the proposed resignation of advisors and appointment of successor advisors with respect to trust x will not result in any taxable gift_for federal gift_tax purposes the proposed resignation of advisors and appointment of successor advisors with respect to trust x will not result in the recognition of gain_or_loss for federal_income_tax purposes to trust x or any beneficiaries of trust x ruling sec_2601 of the internal_revenue_code imposes a tax on every under section a of the tax_reform_act_of_1986 act and section generation-skipping_transfer which is defined under sec_2611 as a taxable_distribution a taxable_termination and a direct_skip a of the generation-skipping_transfer_tax regulations the gst tax is generally applicable to generation-skipping transfers made after date however under section b a of the act and sec_26_2601-1 the tax does not apply to a transfer under a_trust that was irrevocable on date but only to the extent that such transfer is not made out of corpus added to the trust after date or out of income attributable to corpus so added sec_26_2601-1 provides rules for determining when a modification judicial construction settlement agreement or trustee action with respect to a_trust that is exempt from the gst tax under sec_26_2601-1 will not cause the trust to lose its exempt status sec_26_2601-1 provides that a modification will not cause an exempt trust to be subject_to the gst tax if the modification does not shift a beneficial_interest in the trust to any beneficiary who occupies a lower generation as defined in plr-124849-05 sec_2651 than the person or persons who held the beneficial_interest prior to the modification and the modification does not extend the time for vesting of any beneficial_interest in the trust beyond the period provided for in the original trust a modification of an exempt trust will result in a shift in beneficial_interest to a lower generation beneficiary if the modification can result in either an increase in the amount of a generation-skipping_transfer or the creation of a new generation-skipping_transfer a modification that is administrative in nature that only indirectly increases the amount transferred will not be considered to shift a beneficial_interest in the trust sec_26_2601-1 example considers a situation where a_trust is modified by decreasing the number of trustees the modification pertains to the administration of the trust and does not shift a beneficial_interest in the trust to any beneficiary who occupies a lower generation than the person or persons who held the beneficial_interest prior to the modification in addition the modification does not extend the time for vesting of any beneficial_interest in the trust beyond the period provided for in the original trust therefore the modification will not subject the trust to the provisions of chapter accordingly the proposed resignation of the current advisors and the appointment of successor advisors with respect to trust x is a modification that is administrative in nature this modification does not shift any beneficial_interest in trust x to any beneficiary who occupies a generation lower than the persons holding the beneficial interests further the proposed modification will not extend the time for vesting of any beneficial_interest in trust x beyond the period provided under the provisions of decedent's will or constitute an addition to trust x accordingly the proposed changes will not cause trust x to lose its gst exempt status under sec_26_2601-1 ruling sec_2501 provides that a tax computed as provided in sec_2502 is hereby imposed for each calendar_year on the transfer of property by gift during such calendar_year by any individual resident or nonresident sec_2511 provides that subject_to the limitations contained in chapter the gift_tax imposed by sec_2501 will apply whether the transfer is in trust or otherwise whether the gift is direct or indirect and whether the property is real or personal tangible or intangible sec_2512 provides that if a gift is made in property the value thereof at the date of the gift shall be considered the amount_of_the_gift sec_2512 provides that where property is transferred for less than adequate_and_full_consideration in money or money s worth the amount by which the value of the property exceeded the value of the consideration shall be deemed a gift plr-124849-05 based on the facts submitted and representations made we conclude that the proposed resignation of the current advisors and the appointment of successor advisors with respect to trust x will not change the beneficial interests in trust x otherwise provided for under the terms of decedent's will therefore based on the facts submitted and representations made we conclude that the proposed change_of advisors of trust x will not result in a taxable gift_for federal gift_tax purposes sec_1001 provides that the gain from the sale_or_other_disposition of sec_1001 states that the amount_realized from the sale_or_other_disposition ruling sec_61 provides that gross_income includes gains derived from dealings in property and under ' a from an interest in a_trust property shall be the excess of the amount_realized there from over the adjusted_basis provided in ' for determining gain and the loss shall be the excess of the adjusted_basis provided in ' for determining loss over the amount_realized of property shall be the sum of any money received plus the fair_market_value of the property other than money received under ' c except as otherwise provided in subtitle a the entire amount of gain_or_loss determined under ' on the sale_or_exchange of property shall be recognized sec_1_1001-1 of the income_tax regulations provides that the gain_or_loss realized from the conversion of property into cash or from the exchange of property for other_property differing materially either in_kind or in extent is treated as income or loss sustained issue of when a sale_or_exchange has taken place that results in realization of gain_or_loss under sec_1001 in cottage savings a financial_institution exchanged its interests in one group of residential mortgage loans for another lender's interests in a different group of residential mortgage loans the two groups of mortgages were considered substantially identical by the agency that regulated the financial_institution concluded that sec_1_1001-1 reasonably interprets sec_1001 and that an exchange of property gives rise to a realization event under sec_1001 if the properties exchanged are materially different in defining what constitutes a material difference for purposes of sec_1001 the court stated that properties are different in the sense that is material to the code so long as their respective possessors enjoy legal entitlements that are different in_kind or extent cottage savings u s pincite the court held that mortgage loans made to different obligors and secured_by different homes embody distinct legal entitlements and that the taxpayer realized losses when it exchanged interests in the loans cottage savings u s pincite the supreme court of the united_states in cottage savings u s pincite 499_us_554 concerns the the resignation of current advisory committee members and the subsequent plr-124849-05 appointment of replacement advisory committee members will take place in accordance with the existing terms of the trust moreover the successor advisory committee members must abide by the same terms and conditions of the trust as the current advisory committee members accordingly the proposed resignation of the current advisory committee members and the immediate appointment of their successors once done will merely be an exercise of the administrative provisions of the trust and will not result in the recognition of gain_or_loss for federal_income_tax purposes to the trust or any beneficiaries in accordance with the power_of_attorney on file with this office a copy of this the rulings contained in this letter are based upon information and except as expressly provided herein no opinion is expressed or implied letter is being sent to your authorized representative concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination provides that it may not be used or cited as precedent this ruling is directed only to the taxpayer s requesting it sec_6110 sincerely yours _________________________ katherine a mellody senior technician reviewer office of the associate chief_counsel passthroughs and special industries enclosure cc copy for sec_6110 purposes