A. Ross Winans Grantor Trust v. Commissioner

• Decision Date: 12 December 1989
• Docket Number: 22951-86,16789-84,20239-84,13781-83,37873-86,22984-83,17733-87.,Docket No. 12684-83,12364-85,40729-86,23383-86,16429-85,24330-86
• Citation: 1989 TC Memo 653,58 TCM (CCH) 884
• Parties: A. Ross Winans Grantor Trust, William A. Malis, Trustee, et al. v. Commissioner.
• Court: U.S. Tax Court

58 T.C.M. (CCH) 884 (1989)

T.C. Memo. 1989-653.

A. Ross Winans Grantor Trust, William A. Malis, Trustee, et al.^* v. Commissioner.

Docket Nos. 12684-83, 13781-83, 22984-83, 16789-84, 20239-84, 12364-85, 16429-85, 22951-86, 23383-86, 24330-86, 37873-86, 40729-86, 17733-87.

United States Tax Court.

Filed December 12, 1989.

Alfred R. Westfall, 1020 Mission St., S. Pasadena, Calif., Robert B. Martin, Jr., 350 W. Colorado Blvd., Pasadena, Calif., and John Deacon, for the petitioners in all docket numbers. Bruce I. Hochman and Steven Toscher, for the petitioner in Docket No. 37873-86. Lynda Taylor, Jeffrey Sherman, and Phoebe Tang, for the respondent.

Memorandum Findings of Fact and Opinion

COHEN, Judge:

Respondent determined deficiencies in and additions to petitioners' Federal income taxes as follows:

                                                                                       Additions to Tax
                                                               
                Sec
                Sec. 6653(a) or Sec. Sec. Sec
                Petitioner & Docket No. Year Deficiency 6651(a)(1) 6653(a)(1)*    6653(a)(2) 6659 6661
                Winans Trust
                12684-83 ................ 1979    $  5,811      —      $   291.00          —       —      —
                Winans
                13781-83 ................ 1979     103,293      —        5,165.00          —       —      —
                16789-84 ................ 1980      81,913      —        4,096.00          —       —      —
                12364-85 ................ 1981     126,069      —        6,303.00          **     $37,821.00     —
                24330-86 ................ 1982     529,582      —       26,479.10          **      15,610.80   $49,441.20
                Swainn Trust
                23383-86 ................ 1982     494,525      —       24,726.00          **       —     49,453.00
                Fowler
                22984-83 ................ 1979      34,412      —        1,721.00           —       —     —
                20239-84 ................ 1980      37,219      —        1,861.00           —       —     —
                16429-85 ................ 1981      31,553      —        1,577.65           **      7,644.30     —
                22951-86 ................ 1982     131,384      —        6,569.20           **      5,622.60    12,687.60
                Uversa, Inc
                17733-87 ................ 1982      37,463      —        1,873.00           **        —    9,366.00
                                          1983     149,517      —        7,476.00           **        —   37,379.00
                

Steinbrecher
                37873-86 ................ 1982    131,255    $30,469.25      6,841.70       ***              —            —
                Jasmine
                40729-86 ................ 1983     ****            ****           ****         ****         ****         ****
                * For taxes the last date prescribed for payment of which is after December 31, 1981, section 6653(a) was revised and
                divided into section 6653(a)(1) and (a)(2)
                ** 50 percent of the interest due on the deficiency.
                *** 50 percent of the interest due on $131,200.
                **** Docket No. 40729-86 is a partnership level proceeding involving the redetermination of partnership items under a
                Notice of Final Partnership Administrative Adjustment (FPAA).
                

Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended and in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

After concessions, the issues remaining for decision are:

I. Grantor Trust Issues,

(1) whether petitioners Winans and Fowler are entitled to deductions in connection with their investments in thoroughbred horses;

(2) whether petitioners Winans and Fowler are entitled to report the sales of their interests in thoroughbred horses on the installment basis; and

(3) whether petitioners Winans and Fowler are subject to additions to tax as set forth above.

II. Partnership Level Issues

(1) whether the thoroughbred broodmare leasing programs established by petitioners Uversa and Jasmine are bona fide trades or businesses.

III. Partner Level Issues

(1) whether petitioners Uversa, Inc. and Steinbrecher, as partners in Uversa and Jasmine, respectively, are entitled to deduct losses with respect to the thoroughbred horse investments of the partnerships;

(2) whether Uversa, Inc. underreported taxable income by $49,662 for the year ended November 30, 1983;

(3) whether Uversa, Inc. is entitled to deductions for attorney fees, commissions, and depreciation; and

(4) whether petitioners Uversa, Inc. and Steinbrecher are subject to additions to tax as set forth above.

Findings of Fact

Some of the facts have been stipulated, and the facts set forth in the stipulations are incorporated in our findings by this reference.

At the time they filed their petitions, the individual petitioners were all residents of California, and the entities had their principal places of business in California.

The Thoroughbred Industry

The thoroughbred industry has as its goal the breeding and raising of horses that will achieve success at the racetrack. In addition to the racetrack earning power of the horse, there are other areas in which the owner of a thoroughbred horse has the potential to make money. A successful male horse (stallion) can command attractive syndication prices when he is sold to a syndicate in which more than one person shares in the ownership of the horse. Although they constitute a substantial economic industry, thoroughbred racing and breeding transactions are frequently conducted without formal documentation.

A stallion is normally syndicated into 40 undivided fractional interests (shares), with each share valued at an amount between 3 to 5 times the breeding "nomination" cost or "stud fee." Syndicate shareholders gain the right to breed their female horses (broodmares) to the stallion each year. Alternatively, the syndicate shareholders can sell their breeding nominations or "seasons." During the thoroughbred's natural mating season from February 15 to June 15 each year, the average stallion will breed to some 50 or 60 mares. Artificial insemination is not used to breed thoroughbreds.

A broodmare's value is determined by her pedigree (family history), race record, and physical conformation. Pedigree is the more heavily weighted variable. The values of the top female racehorses are enhanced beyond their racetrack earnings when they are bred to stallions. Owners of broodmares can breed their mares to stallions in which they own syndicated breeding rights or to stallions in which breeding rights for that season have been purchased. Breeding rights can be purchased either privately or at auction. The value of a breeding nomination is a statistical matter of record and is published in the private newsletter Racing Update. This publication also provides stallion yearling average values that may be referred to when evaluating foals and yearlings.

The universal birthday for all thoroughbred horses born in North America is January 1, regardless of when they are actually foaled. The gestation period is 11 months. Mares are generally bred no earlier than February 15 each year to prevent the possibility of having a foal born a few days prior to January 1, when it would be deemed to be a year old although actually newly born. Thus, most foals are born between January 10 and the end of May. The dam (mother) nurses her foal from birth until late summer when it becomes a "weanling." Weanlings can be offered at public auction in October and November and usually bring two-thirds of the price they would sell for as "yearlings" the following summer.

If a broodmare conceives and successfully carries her foal through the 11-month gestation period, the young horse can be sold at auction, usually as a yearling, or kept by the owner to be raced. A female racehorse is normally given the chance to become a broodmare after her 4-year-old racing season and is bred as long as she is able to conceive. The average thoroughbred mare has her last foal between 15 and 20 years of age.

Top auction prices for single yearlings, a generally accepted barometer of the economic status of the thoroughbred industry, moved from less than $100,000 prior to 1960 to the multimillion dollar range in the early 1980's. In addition, single stallion syndications, another generally accepted barometer of the industry, increased during the same period from the $1 million range to over $30 million.

The average price paid for yearlings sold at public auction in North America increased by 6.2 percent from 1973 to 1976, when 5,001 thoroughbred yearlings sold for an average of $13,021. By 1980, however, the number of yearlings sold increased by 41.5 percent to 7,079, and the average price increased by 128 percent to $29,683. Similarly, the average price paid for the 4,950 broodmares sold in North America in 1979 was $17,696, while the 1983 average price increased 93.3 percent to $34,208. The number of horses foaled each year increased from 37,100 in 1980 to 48,600 in 1983.

While the average price of thoroughbreds increased steadily from 1973 to 1983, the increase in value of better quality horses was even more pronounced during this period. The Keeneland Race Course sales in Lexington, Kentucky, are considered to be the measure of industry health. The Keeneland summer yearling sale of "select" horses (the sale company selects which horses it wants to sell) and the fall sale of top-quality broodmares were leaders in their respective categories. Average prices at the Keeneland summer select yearling sale increased by 25.1 percent, 29.6 percent, 22.8 percent, and 32.5 percent annually between 1979 and 1982, respectively. Average prices for broodmares sold at Keeneland in November increased by 50.4 percent, 53.7 percent, 5 percent, and 41.6 percent between 1978 and 1982, respectively.

After 1984, thoroughbred prices fell to their pre-1982 levels, with the average Keeneland select yearling prices declining by 10.7 percent and 23.3 percent in 1985 and 1986, respectively, from $601,567 in 1984 to $411,755 in 1986.

Jockey Club Registration

The Jockey Club is the thoroughbred breed registry in the United States. A Jockey Club "registration...