Zirker v. Comm'r of Internal Revenue

Decision Date30 October 1986
Docket NumberDocket No. 16762-85.
Citation87 T.C. No. 62,87 T.C. 970
PartiesLAURENCE R. AND MARGARET E. ZIRKER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

P's claimed Schedule F losses on their 1981 and 1982 Federal income tax returns from an investment in dairy cattle. The losses were comprised of investment credit and depreciation deductions as well as other claimed operating expenses. R disallowed the claimed losses. HELD, that no sale of the cattle occurred for tax purposes. Accordingly, P's are not entitled to the claimed losses. HELD FURTHER, that a valuation overstatement exists within the meaning of sec. 6659, since petitioners reported an adjusted basis in the cattle of $41,500 and the correct adjusted basis in the cattle is zero. HELD FURTHER, that the portion of the underpayment resulting from the disallowed depreciation deductions and disallowed investment credit is attributable to the valuation overstatement. Held further, P's are liable for additional interest under sec. 6621(d) with respect to the portion of the underpayment attributable to the valuation ovrstatement under sec. 6621(d)(3)(A)(i). Rex C. Bush, for the petitioners.

James B. Ausenbaugh, for the respondent.

WHITAKER, JUDGE:

This case was assigned to and heard by Special Trial Judge Peter J. Panuthos pursuant to the provisions of section 7456 of the Code and Rules 180 and 181. 1 The Court agrees with and adopts the Special Trial Judge's opinion, which is set forth below.

OPINION OF THE SPECIAL TRIAL JUDGE

PANUTHOS, SPECIAL TRIAL JUDGE:

Respondent determined the following deficiencies in petitioners' Federal income tax:

+----------------+
                ¦Year¦Deficiency ¦
                +----+-----------¦
                ¦1981¦2  $9,412  ¦
                +----+-----------¦
                ¦1982¦5,915      ¦
                +----------------+
                

In his notice of deficiency respondent disallowed claimed losses incurred by petitioners resulting from an investment in dairy cattle. Respondent also disallowed an investment credit claimed for 1981. By his answer respondent seeks additions to tax under section 6659 for valuation overstatements and further seeks additional interest under section 6621(d) on the grounds that the underpayments for 1981 and 1982 are attributable to a tax motivated transaction. 3

The issues for decision are whether petitioners are entitled to the claimed loss in connection with their investment in Holstein dairy ca tle and whether petitioners are subject to the additions to tax under section 6659 and to additional interest under section 6621(d).

FINDINGS OF FACT

At the time they filed their petition, petitioners resided in Columbus, Ohio. Some of the facts have been stipulated and are incorporated herein by this reference.

During 1981, petitioner Larry Zirker (petitioner) worked as a welder.

Roy Tolson (Tolson), promoter of the investment and owner of Financial Futures, contacted petitioner and encouraged petitioner to invest in cattle. Petitioner had known Tolson for many years, and it was through Tolson that petitioner had previously invested in cattle in 1980. Tolson provided petitioner with a prospectus of expected income and expenses. According to the prospectus, petitioner could expect a return on his investment of $119,437 in 1981 and $126,795 in 1982. Tolson presented the investment as a cattle breeding program; however, the cows were also to be milked and the milk sold for profit.

Before investing in the cattle, petitioner consulted with his friend Wayne Asay, a county extension agent in Wyoming. (A county extension agent is a governmental advisor to those involved in agricultural activity in the county.) Asay had no particular expertise in cattle or dairy farming. Nevertheless, Asay agreed that the cattle in which petitioner was interested were Holstein pedigrees and opined that they would be a good investment.

On June 24, 1981, petitioner entered into a purchase agreement whereby he agreed to purchase five registered Holstein dairy cattle. According to schedule A attached to the agreement, the total purchase price of the five cattle was $41,500. 4 It is not clear from the record what the purchase price of each separate animal was. The terms of the purchase were $2,500 in cash down; $2,500 due on a promissory note to be paid on closing; a second promissory note for $18,056; and a third promissory note for $18,444. The terms of the promissory note for $18,056 required payment in seven annual installments of $3,956. The promissory note for $18,444 required petitioner to pay that amount on January 1, 1988 together with interest at the rate of 9 percent per year on the unpaid principal.

The three notes given on June 24, 1981, were secured by cattle in the herd and were nonrecourse notes. In late 1981, Tolson sent petitioner new agreements to sign which altered the security on the notes. Petitioner signed notes which indicated that he was personally liable for their repayment. These notes were dated June 24, 1981, although they were sent to petitioner in November 1981. The notes purported to change petitioner's liability from nonrecourse to recourse. Petitioner received no consideration from Tolson in exchange for petitioner's promise to be personally liable on the notes.

The original purchase agreement also contained a covenant by petitioner that he had a net worth in excess of $100,000 (exclusive of home, automobile, and furnishings) and that some portion of his 1981 income would be subject to a Federal or state tax of 50 percent. In addition, the original purchase agreement contained a clause in which petitioner acknowledged that anticipated tax benefits may not be realized as a result of changes in Federal tax laws.

According to the terms of the original purchase agreement and the schedule attached to it, petitioner could not sell, remove, destroy, or otherwise handle any cow without Tolson's written permission. Tolson and petitioner also entered into a management agreement whereby Tolson agreed to be responsible for management of the animals. Petitioner could not and did not operate or supervise the dairy, nor did he make any decisions affecting the cattle's breeding. Petitioner was never consulted on whether to artificially inseminate, which sire would be chosen, or which cattle would be bred. He never asked to exercise any control over these matters and had no say as to which cows would be sold, culled, or left in the breeding stock.

Petitioner spent only a minimal amount of time at the dairy. In the fall of 1984 he spent a few days building a fence at the dairy. Petitioner called Tolson from time to time to inquire about his investment.

Petitioners' gross receipts, total deductions and net farm loss as claimed on a Schedule F for 1981 and 1982 are as follows:

+---------------------------------------+
                ¦Item                 ¦1981    ¦1982    ¦
                +---------------------+--------+--------¦
                ¦Gross receipts       ¦$14,607 ¦$16,478 ¦
                +---------------------+--------+--------¦
                ¦Total deductions     ¦36,155  ¦39,620  ¦
                +---------------------+--------+--------¦
                ¦Net farm loss claimed¦(21,548)¦(23,142)¦
                +---------------------------------------+
                

The specific Schedule F deductions claimed are as follows:

+---------------------------------------+
                ¦Claimed farm deductions  ¦1981  ¦1982  ¦
                +-------------------------+------+------¦
                ¦Labor Hired              ¦$1,994¦$2,819¦
                +-------------------------+------+------¦
                ¦Repairs, maintenance     ¦159   ¦247   ¦
                +-------------------------+------+------¦
                ¦Interest                 ¦5,943 ¦7,130 ¦
                +-------------------------+------+------¦
                ¦Rent of farm, pasture    ¦1,989 ¦2,820 ¦
                +-------------------------+------+------¦
                ¦Feed purchased           ¦8,846 ¦7,914 ¦
                +-------------------------+------+------¦
                ¦Supplies purchased       ¦481   ¦972   ¦
                +-------------------------+------+------¦
                ¦Breeding fees            ¦288   ¦544   ¦
                +-------------------------+------+------¦
                ¦Veterinary fees, medicine¦322   ¦334   ¦
                +-------------------------+------+------¦
                ¦Gasoline, fuel, oil      ¦---   ¦101   ¦
                +-------------------------+------+------¦
                ¦Storage, warehousing     ¦5     ¦---   ¦
                +-------------------------+------+------¦
                ¦Taxes                    ¦110   ¦437   ¦
                +-------------------------+------+------¦
                ¦Insurance                ¦366   ¦218   ¦
                +-------------------------+------+------¦
                ¦Utilities                ¦449   ¦579   ¦
                +-------------------------+------+------¦
                ¦Freight, trucking        ¦466   ¦161   ¦
                +-------------------------+------+------¦
                ¦Transportation           ¦640   ¦240   ¦
                +-------------------------+------+------¦
                ¦Advertising              ¦140   ¦63    ¦
                +-------------------------+------+------¦
                ¦DHIA                     ¦557   ¦214   ¦
                +-------------------------+------+------¦
                ¦Registration             ¦---   ¦60    ¦
                +-------------------------+------+------¦
                ¦Subtotal                 ¦22,755¦24,853¦
                +-------------------------+------+------¦
                ¦Depreciation5            ¦13,400¦14,767¦
                +-------------------------+------+------¦
                ¦Total Deductions         ¦36,155¦39,620¦
                +---------------------------------------+
                

Petitioners also claimed an investment credit for the taxable year 1981 in the amount of $3,037 reporting an adjusted basis in the cattle of $41,500.

In his notice of deficiency dated April 15, 1985, respondent disallowed the claimed farm losses in full. As a basis for disallowance, respondent's notice stated as follows.:

a) The Schedule F. losses claimed by you in 1981 and 1982, in connection with ‘Financial Futures‘, are disallowed in full because you have not established, in support of your claimed losses, that you acquired any equitable, legal or other interest in dairy cattle. The Schedule F losses reported by you are disallowed in full because none of the losses have been verified, substantiated or demonstrated to be properly reportable and allowable under any provision of the Internal Revenue Code of 1954. Additionally, the losses are disallowed for the reason that you have not established that:

1)...

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