Court Opinion

ID: 1016725
Source: CourtListenerOpinion
Date Created: 2013-07-04 21:53:42.261756+00
Date Added: 2024-06-11T15:27:07.259877
License: Public Domain

UNPUBLISHED

                    UNITED STATES COURT OF APPEALS
                        FOR THE FOURTH CIRCUIT

                             No. 04-1665

CSABA L. MAGASSY; FRANCES H. MAGASSY,

                                           Petitioners - Appellants,

           versus

COMMISSIONER OF INTERNAL REVENUE,

                                              Respondent - Appellee.

Appeal from the United States Tax Court.    (Tax Ct. No. 01-11982)

Argued:   May 25, 2005                      Decided:   July 26, 2005

Before WIDENER, WILKINSON, and NIEMEYER, Circuit Judges.

Affirmed by unpublished per curiam opinion.

ARGUED: Robert Doran Grossman, Jr., Las Vegas, Nevada, for
Appellants.   Samuel Ashby Lambert, UNITED STATES DEPARTMENT OF
JUSTICE, Tax Division, Washington, D.C., for Appellee. ON BRIEF:
Eileen J. O’Connor, Assistant Attorney General, Bruce R. Ellisen,
UNITED STATES DEPARTMENT OF JUSTICE, Tax Division, Washington,
D.C., for Appellee.

Unpublished opinions are not binding precedent in this circuit.
See Local Rule 36(c).
PER CURIAM:

            Taxpayers     Csaba    and     Frances    Magassy    appeal    from   a

decision    of   the    Tax   Court   upholding      a   determination     by   the

Commissioner of Internal Revenue of deficiencies in their federal

income taxes for the years 1995, 1996, and 1997.                  The Tax Court

denied the Magassys deductions they claimed for expenses related to

the operation of their 108-foot motor yacht during the years 1995,

1996, and 1997 and for the loss incurred from the sale of the yacht

in 1997.    The Tax Court concluded that under § 183 of the Internal

Revenue Code, the Magassys did not have an "actual and honest

objective" of making a profit in operating and selling the yacht,

and that under § 1231 of the Internal Revenue Code, the yacht's

chartering activity prior to its sale did not constitute a "trade

or business."     Finding no error in the Tax Court's decision, we

affirm.

                                          I

            Csaba Magassy and his wife, Frances Magassy, of Potomac,

Maryland, filed joint tax returns for the years 1995, 1996, and

1997.     During the relevant years, Csaba Magassy was engaged in a

successful plastic surgery practice in the Washington, D.C. area,

and Frances Magassy was engaged as a housewife.                  In their income

tax returns, the Magassys deducted from their ordinary income

$602,605, $1,137,377, and $454,678, respectively, in losses from

the   operation    of    their    yacht.       In    addition,    they    deducted

                                         -2-
$1,931,292 from their 1997 ordinary income based on the loss they

incurred from the yacht's sale.    The Commissioner disallowed these

deductions and sent the Magassys a notice of deficiency on June 25,

2001, citing income tax deficiencies of $245,790, $364,462, and

$989,450 for 1995, 1996, and 1997, respectively.        The Commissioner

based the disallowances on Internal Revenue Code ("I.R.C.") §§ 162,

183, and 280A.

          The    Magassys   (hereafter   "Taxpayers")    appealed   this

determination to the Tax Court, and after a two-day trial at which

the parties called thirteen witnesses, the Tax Court issued a

decision in favor of the Commissioner.         The Tax Court denied

Taxpayers the annual expense deductions under I.R.C. § 183 and

analyzed the 1997 loss-on-sale deduction under I.R.C. § 1231. With

respect to the expense deductions, the Tax Court observed that

Treasury Regulation § 1.183-2(b) sets out nine nonexclusive factors

for consideration, see 26 C.F.R. § 1.183-2(b), and proceeded to

address each factor, apply the circumstances of Taxpayers' case,

and resolve the factor against Taxpayers.       The court ultimately

concluded that Taxpayers had no actual and honest objective of

making a profit in owning, operating, and selling the yacht during

the tax years in question.     Consistent with this conclusion, the

court then found that the chartering activity leading up to the

vessel's sale did not constitute a trade or business for purposes

of I.R.C. § 1231.

                                  -3-
               The   underlying     facts   were   undisputed.        Dr.    Magassy

purchased the yacht -- a 1963 108-foot Feadship -- in 1990 after

Mark Mogul, a real estate broker who worked for Dr. Magassy's

brother-in-law's real estate firm, Legum & Norman, had presented

Dr. Magassy with the opportunity.              Mark Mogul's father, Lee Mogul,

owned a yacht brokerage firm in Fort Lauderdale, Florida, that was

offering the yacht for sale.           The Moguls told Dr. Magassy that the

vessel was available for $1.625 million and presented him with a

survey conducted by American Marine Surveyors, dated February 28,

1990, which listed the yacht's fair market value at $2.4 million

and its replacement cost at over $9 million.                     The report from

American Marine Surveyors noted that the survey was conducted while

the vessel was afloat and that when the vessel was last hauled out

of the water, the hull was "Audio Gauged and [it] indicated no

appreciable wastage to the steel hull."

               Shortly after learning of the opportunity, Dr. Magassy

executed       a   contract   to    purchase    the   yacht   from    Lee    Mogul's

brokerage, Boats, Yachts & Ships, for $1.625 million and subject to

specified contingencies.             The parties also executed a separate

agreement reducing the purchase price to $1.3 million and providing

that     the       "sales   price    include[]     the   total       and    complete

refurbishment of [the] vessel at approximately $300,000."                     Thus,

$300,000 of the $1.3 million was to go to refurbishment of the

yacht.    The contract and separate agreement also provided for the

                                        -4-
payment of a $78,000 fee to Legum & Norman by Boats, Yachts &

Ships; an exclusive listing with Boats, Yachts & Ships and Legum &

Norman for any resale of the yacht; and payment to William Norman

(Dr. Magassy's brother-in-law) and Mark Mogul of 25% of any net

profits realized from such a sale.

           Dr. Magassy never personally inspected the yacht prior to

closing.   Instead, Norman traveled to Florida and reported back

that the yacht was "terrific, . . . looks great."   But Dr. Magassy

did obtain an additional survey, which was conducted by Alexander

& Associates on May 9, 1990, also while the vessel was afloat.   The

survey stated that the yacht's market value was $1.85 million, its

fully restored value was $3.2 million, and its replacement cost was

$8.7 million.

           Closing on the purchase of the vessel occurred on May 29,

1990, at which time Dr. Magassy also closed on a $1 million loan

from NCNB National Bank of Florida.   As of May 29, however, Boats,

Yachts & Ships apparently did not yet own the yacht.      Lee Mogul

purchased the yacht for Boats, Yachts & Ships on May 30 for $1

million, and its seller was required to pay the brokerage a

$245,621 commission.

           The vessel thereafter remained in Lee Mogul's care until

the end of January 1991.   Dr. Magassy saw the yacht for the first

time in July 1990, when he discovered that it was in a state of

total disrepair.    Upon returning in November 1990, Dr. Magassy

                                -5-
found that little progress had been made on its restoration, and he

learned from Lee Mogul that the full $300,000 designated for

restoration work had been spent.    Having lost confidence in Mogul,

Dr. Magassy decided to have the yacht moved to Angus Shipyard in

Bayou La Batre, Alabama, for continued restoration work.

           In July 1991, Dr. Magassy filed suit against Lee Mogul,

Mark Mogul, and Boats, Yachts & Ships to recover the $300,000

intended   for    repairs,   alleging   breach   of   contract,   unjust

enrichment, and conversion.     Dr. Magassy, however, was never able

to effect service on the defendants.       Moreover, in October 1991,

the Florida Secretary of State administratively dissolved Boats,

Yachts & Ships.

           At Angus Shipyard, the vessel was removed from the water

and extensive hull deterioration was discovered.         Despite Angus'

initial estimate for restoration work of $218,000, by November

1991, Dr. Magassy had already paid $428,648 and had been billed for

an additional $527,637.      When Dr. Magassy refused to pay, Angus

Shipyard filed a maritime lien against the vessel and a suit in

federal court to enforce the lien.      The parties ultimately settled

the suit in November 1992, with Dr. Magassy paying Angus Shipyard

$300,000 in cash and giving it a $180,000 promissory note.

     In May 1992, Dr. Magassy's accountant referred him to a law

firm for tax advice regarding the sale of the yacht, since by then

"[t]he combined acquisition and refurbishing costs of the [yacht]

                                  -6-
substantially exceed[ed] the boat's fair market value."                        The law

firm prepared a memorandum analyzing whether a loss realized on the

sale of the yacht could be treated as a "§ 1231 loss" -- that is,

whether the loss could be treated as an ordinary loss and used to

offset   Taxpayers'      unrelated       ordinary    income.         The   memorandum

concluded    that    "[i]n   order     to   qualify      for   section     1231    loss

treatment,    Dr.    Magassy     would    be   required      to     commence   a   boat

chartering business and use the [yacht] in that business prior to

the sale."

            Following this advice, in December 1994, Dr. Magassy

created S.M.S.M., Inc., a Florida subchapter S corporation, of

which he was the sole shareholder and director and his wife was the

secretary-treasurer, and he registered the corporation as a sales

and charter boat dealer.         Weeks later, he listed the yacht for sale

with Richard Bertram Yachts for $2.4 million. The following March,

he transferred the yacht's title to S.M.S.M., and S.M.S.M. borrowed

$874,000 to refinance and pay off the NCNB purchase-money loan.

Also   during     this   period,      S.M.S.M.      signed     an    agreement     with

Priscilla Yacht Management, whereby the yacht became part of

Priscilla's charter fleet, and the yacht was subsequently featured

in a number of print advertisements in chartering magazines.

S.M.S.M. maintained separate checking and credit card accounts,

and,   starting     in   1996,   an   employee      of   Dr.      Magassy's    medical

                                         -7-
practice began keeping computerized records associated with the

company.

            From     January   1995   until     April   1997,    the   yacht    was

chartered to paying customers approximately 20 times.                     It was

chartered    twice    to   Plastic    Surgery    Associates,     Dr.   Magassy's

medical practice. And members of the Magassy family used the yacht

on numerous other occasions.          Dr. Magassy's two sons were aboard

the yacht during two March 1995 sea trials and a June 1995 charter

by Plastic Surgery Associates.           One of his sons was also aboard

during a July 1995 charter.           Dr. Magassy's daughter was aboard

during one of the March sea trials.           Mrs. Magassy was aboard during

the first March sea trial, and both she and Dr. Magassy were aboard

during the second sea trial, which was a four-day trip from Fort

Lauderdale, Florida to Hurricane Hole, Bahamas.             On at least three

additional    occasions,       different     Magassy    family    members      took

personal vacations on board the yacht while it was in the Bahamas.

On a number of occasions Taxpayers held dinner cruises and cocktail

parties on the vessel, and on other occasions, members spent

daytime and evening hours partying on the yacht without staying

overnight.

             In April, 1997, Dr. Magassy sold the yacht for $1.1

million, realizing a substantial loss.

                                       -8-
                                   II

            Taxpayers contend that the Tax Court erred in several

respects.    First, Taxpayers argue that the Tax Court applied the

wrong legal standard to determine whether they had a profit motive

under I.R.C. § 183.      They assert that the Tax Court's language

reveals that it applied a "reasonable man" standard, erroneously

asking whether Taxpayers were reasonable to expect to make a

profit, rather than whether they actually and honestly had the

objective of making a profit.     Second, Taxpayers contend that the

Tax Court clearly erred in its factual finding that they lacked a

profit motive.    In particular, they assign error to (1) the Tax

Court's application of the nine Treasury regulation factors; (2)

its failure to specify the exact point at which they lost their

profit motive, which the Commissioner conceded existed in 1990; (3)

the Tax Court's consideration of the ownership and operation of the

vessel as discrete activities in the profit motive analysis; and

(4) its use of the fact that they listed the yacht for sale at a

loss as an indication of a lack of a profit motive.             Finally,

Taxpayers assert that the exclusion of some of Dr. Magassy's

testimony on hearsay grounds was an abuse of discretion.

                                   A

            Taxpayers   first   argue   that   "[t]he   key   issue   for

resolution by [the court of appeals] is whether the Tax Court

employed and applied the proper legal (profit motive) standard in

                                  -9-
deciding the case."    Noting that I.R.C. § 183 commands an inquiry

into whether Taxpayers had "an actual and honest objective of

making a profit," rather than whether a reasonable person would

have expected such a profit, they contend that the Tax Court in

this case erred by employing a "reasonable person" standard.

            Internal Revenue Code § 183, the "hobby loss" provision,

limits deductions from activities not engaged in for profit to the

extent of gross income derived from such activities.    26 U.S.C. §

183(b). Activities by an individual or a subchapter S corporation,

however, that are in fact engaged in for profit, are not subject to

that limitation, and losses incurred from such activities are

deductible from the taxpayer's ordinary income under I.R.C. §§ 162

and 212.    See 26 U.S.C. §§ 183(a), 183(c).

            The key under § 183(b) to whether a taxpayer may deduct

losses from ordinary income generally lies in the determination of

whether the taxpayer had a profit motive in engaging in the

activity.    The starting point for addressing that question is

Treasury Regulation § 1.183-2 which provides in part:

     The determination whether an activity is engaged in for
     profit is to be made by reference to objective standards,
     taking into account all of the facts and circumstances of
     each case. Although a reasonable expectation of profit
     is not required, the facts and circumstances must
     indicate that the taxpayer entered into the activity, or
     continued the activity, with the objective of making a
     profit. . . . In determining whether an activity is
     engaged in for profit, greater weight is given to
     objective facts than to the taxpayer's mere statement of
     his intent.

                                -10-
26 C.F.R. § 1.183-2(a); see also Faulconer v. Commissioner, 748

F.2d 890, 894-902 (4th Cir. 1984) (applying § 1.183-2(a)).

             Taxpayers in this case contend that various statements

that   the   Tax   Court   made   in    its   opinion   employing   the   term

"reasonable" indicate that the court ignored the proper legal

standard.     Our review of those statements, however, leads us to

conclude that, far from evidencing the employment of an erroneous

standard, the Tax Court's statements show its faithful application

of Treasury Regulation § 1.183-2(a) and Faulconer.              The Tax Court

was required to refer to "objective standards" and determine

whether "the facts and circumstances" of Taxpayers' case actually

supported the asserted profit objective.           26 C.F.R. § 1.183-2(a);

Faulconer, 748 F.2d at 894.            And the Faulconer Court made clear

that "[a] taxpayer's mere statement of intent is given less weight

than objective facts." 748 F.2d at 894. Taxpayers, instead, would

have   the   court   blindly   adopt     their   assertions    of   intent   as

sacrosanct.    Such an interpretation of the standard is contrary to

precedent and the regulations.          We conclude, accordingly, that the

Tax Court properly applied the governing legal standard in its

I.R.C. § 183 analysis.

                                        B

             Taxpayers next contend that the Tax Court improperly

found as fact that they lacked a profit motive.               We review these

                                       -11-
findings for clear error.            See Hendricks v. Commissioner, 32 F.3d

94, 97 (4th Cir. 1994).

               According to Treasury Regulation § 1.183-2(b), "[i]n

determining whether an activity is engaged in for profit, all facts

and circumstances with respect to the activity are to be taken into

account," and "[n]o one factor is determinative."                         26 C.F.R. §

1.183-2(b).         In addition, the regulation sets out nine factors for

consideration, although "it is not intended that only [those]

factors    .    .    .   are   to   be   taken   into      account   in    making    the

determination, or that a determination is to be made on the basis

[of] the number of factors" supporting a conclusion.                    Id.    In other

words, the regulation intends to be a wide-ranging qualitative

analysis.        See Faulconer,          748   F.2d   at   896-902     (applying     the

factors). The listed factors, "which should normally be taken into

account," are:

     (1)       Manner in which           the   taxpayer      carries      on   the
               activity. . . .

     (2)       The expertise of the taxpayer or his advisors. . .
               .

     (3)       The time and effort expended by the taxpayer in
               carrying on the activity. . . .

     (4)       Expectation that assets used                 in   activity      may
               appreciate in value. . . .

     (5)       The success of the taxpayer in carrying on other
               similar or dissimilar activities. . . .

     (6)       The taxpayer's history of income or losses with
               respect to the activity. . . .

                                          -12-
       (7)   The amount of occasional profits, if any, which are
             earned. . . .

       (8)   The financial status of the taxpayer. . . .

       (9)   Elements of personal pleasure or recreation. . . .

26 C.F.R. § 1.183-2(b).       In addition, "at all times, the taxpayer

has the burden of showing that the activity was engaged in for

profit."     Hendricks, 32 F.3d at 98.

             In its opinion, the Tax Court addressed each of the nine

factors and concluded that, based on the facts, each suggested the

absence of an actual and honest profit motive by the Taxpayers.            As

to factor (1), the Tax Court found that the Taxpayers' endeavor was

not conducted in a businesslike manner:            no business plans or

restoration budget was ever produced; no reasonable investigation

was made; and the restoration work was not properly monitored.              As

to factor (2), the court found that Taxpayers had no experience in

owning or investing in yachts and that those they relied on as

"experts" were all interested parties.         As to factor (3), the Tax

Court noted Taxpayers' lack of time devoted to the restoration and

chartering of the yacht.       As to factor (4), the Tax Court stated

that even though Taxpayers might have had an expectation in 1990

that   the   yacht   would   appreciate   in   value,   by   1995   any   such

expectation had evaporated, given the price at which the yacht was

listed for sale in 1994.        As to factor (5), the Tax Court noted

Taxpayers' lack of any former experience in yacht chartering or

restoration.      As to factor (6), the Tax Court observed that

                                   -13-
S.M.S.M. incurred substantial and mounting losses, year after year,

and that there was no way by which Taxpayers could honestly have

expected to generate positive net income from the chartering

activities. In addition, the Tax Court observed that the yacht was

listed for sale at a price at which it would have been impossible

for Taxpayers to have generated any income.           As to factor (7), the

Tax Court noted the existence of continuing losses from chartering

the yacht and the impossibility of Taxpayers' profiting from the

yacht's    sale.   As   to   factor   (8),   the     Tax   Court    pointed   to

Taxpayers' substantial income from sources other than the loss-

producing activity to "indicate that the activity [was] not engaged

in   for   profit[,]    especially    if     there    [were]       personal   or

recreational elements."       26 C.F.R. § 1.183-2(b)(8).             The court

noted that the significant losses of S.M.S.M. served to shield

Taxpayers' unrelated income from taxation.            And as to factor (9),

the Tax Court noted the inherent recreational element involved in

the ownership of a luxury motor yacht.          These findings are amply

supported by the record, and we hold that they appropriately lead

to the conclusions under Treasury Regulation § 1.183-2(b) that the

Tax Court reached.

            Taxpayers contend that in applying these factors, the Tax

Court was required to have identified the exact moment between 1990

and 1995, at which they lost their profit motive.            While Taxpayers

correctly note that the Commissioner conceded their genuine and

                                  -14-
honest   profit   motive   in    acquiring     the    yacht   in   1990,     they

themselves   concede   that     "every   tax   year    presents    a   new    and

different cause of action."       In this case, the Tax Court correctly

considered the factors relevant only to the three years for which

the Commissioner denied the deductions.

           Taxpayers also argue that the Tax Court erroneously

failed to consider ownership and operation of the vessel as a

single activity. They argue that if the ownership and operation of

the yacht are viewed together, their profit motive for the sale of

the vessel rendered any lack of profit motive for the chartering

operations irrelevant.     This argument, however, flies in the face

of the facts of this case.         There is no evidence to support a

profit motive for the sale of the vessel because by 1995, Taxpayers

had listed the vessel for sale at a price that made it impossible

for them to realize a profit.

           Taxpayers respond to this observation by contending that

listing the yacht for sale at a loss was not inconsistent with

their having a profit motive because "profit" in this case "is

synonymous with capital preservation." Their only support for this

argument, however, is Feldman v. Commissioner, 55 T.C.M. (CCH) 450

(1988), and that case is not on point.                 In Feldman, a case

involving the application of I.R.C. § 183 to a taxpayer's ownership

and chartering of a sailboat, the Tax Court merely stated that

"petitioner's actions in discontinuing operations after less than

                                    -15-
one charter season and putting the boat up for sale indicate that

tax motives were not uppermost in petitioner's mind."          Id. at 454.

"Had [Feldman] been primarily interested in reaping tax benefits,"

the Tax Court continued, "he would certainly have held the yacht

longer than the one charter season he did, before offering it for

sale."    Id.   That, however, is exactly what Taxpayers did in this

case.    They continued to refurbish, operate, and charter the yacht

at a loss, knowing that they would never be able to recoup those

losses at the time of the yacht's sale.

            For all of the reasons stated, we conclude that the Tax

Court did not clearly err in its findings of fact under I.R.C. §

183.

                                   C

            Finally, Taxpayers argue that the Tax Court erroneously

excluded certain of Dr. Magassy's testimony on hearsay grounds.

According to Taxpayers, this testimony should have been admitted to

establish Dr. Magassy's actual and honest belief regarding profit

motive.

       While Taxpayers' attorney was questioning Dr. Magassy as to

his conversations with Lee Mogul about chartering the yacht, the

attorney asked, "Do you remember how many weeks he said, for the

chartering?"      The   Commissioner   objected,   and   the   Tax   Court

sustained the objection on hearsay grounds.          Dr. Magassy then

testified that, based on his conversations with Lee Mogul, he

                                 -16-
thought the chartering was "[v]ery doable" -- that is, profitable.

The attorney then asked him if Lee Mogul "[told] [him] it was

doable?"   And the Tax Court sustained the Commissioner's objection

to that question as well.     Taxpayers argue that "[p]reventing [Dr.

Magassy] from testifying as to what was in his mind, which is the

only relevant issue, prevented the Tax Court from making a proper

factual finding."

            But Taxpayers' attorney never asked that the testimony be

admitted only for the purpose of showing Dr. Magassy's state of

mind.   Moreover, Dr. Magassy was permitted to testify to his state

of mind -- that he, based on his conversation with Lee Mogul,

thought that the chartering business could be profitable.           The Tax

Court's    evidentiary   rulings   did    not   amount   to   an   abuse   of

discretion.

                                   III

            Taxpayers failed to address directly the Tax Court's

disallowance of their deduction of the loss from the sale of the

yacht in 1997.      The deductibility of that loss is governed by

I.R.C. § 1231, which creates an even higher hurdle for Taxpayers

than does I.R.C. § 183.     Internal Revenue Code § 1231 allows a net

gain to be treated as a long-term capital gain, but allows a net

loss to be deducted from ordinary income.                See 26 U.S.C. §

1231(a)(1), (a)(2).      To qualify under I.R.C. § 1231, however, the

gain or loss must have been recognized "on the sale or exchange of

                                   -17-
property   used   in   [a]   trade   or   business."   26   U.S.C.    §

1231(a)(3)(A)(i) (emphasis added); id. § 1231(a)(3)(B).

           The Tax Court noted that "[i]n analyzing whether an

activity in connection with which property is sold constituted a

trade or business (for purposes of ordinary loss treatment under

section 1231), a taxpayer480 U.S. 23, 35 (1987); see also Helvering v. Highland, 124 F.2d

556, 561 (4th Cir. 1942) (noting that "the profit motive and

presence of business-like policies should be given great weight" in

                                 -18-
determining whether an activity qualifies as a trade or business).

Thus, we conclude that the Tax Court did not err in its application

of I.R.C. § 1231.

                                                          AFFIRMED

                               -19-