Williams v. Commissioner
| Decision Date | 23 June 1987 |
| Docket Number | Docket No. 25804-85. |
| Citation | 53 TCM (CCH) 1203,1987 TC Memo 308 |
| Parties | John D. Williams and Suzanne M. Williams v. Commissioner. |
| Court | U.S. Tax Court |
John N. Moore, 34200 Solon Rd., Solon, Ohio, for the petitioners. Susan M. Gray, for the respondent.
PATE, Special Trial Judge:
This case was heard pursuant to the provisions of section 7456(d) of the Code (redesignated as sec. 7443A(b) by the Tax Reform Act of 1986, Pub. L. 99-514, section 1556, 100 Stat. 2755) and Rules 180, 181 and 182.1
Respondent determined the following deficiencies in petitioners' Federal income taxes:
Year Deficiency
1978 .......................... $1,187.25
1979 .......................... 834.75
1980 .......................... 2,103.00
1981 .......................... 3,816.60
After concessions, we must decide: (1) whether petitioners may deduct a loss realized on their horse farm; (2) whether investment credits previously claimed on horse farm property must be recaptured in 1981; (3) whether petitioners may deduct a loss realized on their aircraft leasing activities; (4) the correct amounts of the ACRS deduction attributable to assets used in petitioners' muffler shop and auto repair business; and (5) whether petitioners are entitled to deduct expenses relating to an office in their home.2 Some of the facts have been stipulated and are so found.
John D. Williams (hereinafter "John") and Suzanne M. Williams (hereinafter "Suzanne") are husband and wife and filed joint income tax returns for the years in issue. Petitioners have resided at the same address in Burton, Ohio at all times relevant to this case. During 1981, John was employed as a senior project engineer and Suzanne was employed as a bookkeeper.
Both petitioners held similar positions during 1978, 1979, 1980, 1982 and 1983. Since the issues for our decision involve three disparate activities, we have combined the findings of fact and opinion relating to each such activity.
Issues No. 1 and 2 — Horse Farm
Petitioners owned a piece of land in Burton, Ohio on which their residence was located. In 1976, John built a two-story barn, consisting of four horse stalls and a storage area for feed and hay, on the land contiguous thereto. In 1979, petitioners began boarding horses for outsiders. In this regard, petitioners deducted the following farm losses:
Tax Year Gross Income Expenses Losses
1979 ............................. $1,200 $2,760 $1,560
1980 ............................. 360 3,247 2,887
1981 ............................. 360 4,392 4,032
1982 ............................. 430 5,155 4,675
1983 ............................. 450 6,807 6,357
In addition, on their 1979 income tax return, petitioners claimed an investment credit on certain farm property.
Respondent disallowed petitioners' 1981 loss on the grounds that the horse farm was not an activity engaged in for profit and, alternatively, that the deductions attributable thereto had not been substantiated. Respondent also determined that the investment credit claimed on the farm property must be recaptured in 1981.
Suzanne was the petitioner primarily responsible for the horse farm operations. She had been raised on a farm and wanted her children to have experience with horses. She kept only the most rudimentary of business records: receipts, cancelled checks and lists of income and mileage to purchase hay. However, she did consult with John regarding the financial aspects of the operations, and, in this regard, John estimated potential gross receipts from operations of $4,000 per year with estimated expenses of $2,000 per year. At trial, John could not explain on what basis he had computed these projections.
In fact, Suzanne charged only $60 per month for board when services (such as feeding and cleaning the stall) were included, and only $30 per month if the horse's owner performed these duties. We note that, at these rates, the maximum annual income possible was $2,880 ($60 × 4 stalls for 12 months). Therefore, even with all four stalls occupied and Suzanne rendering services to all owners, expenses would exceed gross income.3 Further, although Suzanne's rates were below those prevailing in the area, she boarded only one or two horses at any time from 1979 to 1981.
Realizing that their potential boarding income was limited, petitioners acquired additional land in 1979 to expand their facilities. Despite this acquisition, Suzanne neither expanded the facilities or services nor raised prices in subsequent years. Further, she did nothing to cut costs.
Sections 183(a) and (b) provide that expenses attributable to an activity "not engaged in for profit" are deductible only to the extent that gross income is derived from the activity. Therefore, petitioners' 1981 loss is allowable if, and only if, their horse farm is an activity engaged in for profit.
Whether an activity is engaged in for profit turns on whether the taxpayer has an actual and honest objective of making a profit. Sec. 1.183-2(a), Income Tax Regs.; Surloff v. Commissioner Dec. 40,419, 81 T.C. 210, 233 (1983); Dreicer v. Commissioner Dec. 38,948, 78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983). The taxpayers' expectation of profit need not be a reasonable one, but there must be a good-faith objective of making a profit. Sec. 1.183-2(a), Income Tax Regs.; Golanty v. Commissioner Dec. 36,111, 72 T.C. 411, 426 (1979), affd. without published opinion 647 F.2d 170 (9th Cir. 1981); Allen v. Commissioner Dec. 35,777, 72 T.C. 28, 33 (1979). Although profit need not be the sole purpose for undertaking or continuing an activity, it must be the primary purpose. Sec. 1.183-2(b)(9), Income Tax Regs.; Lemmen v. Commissioner Dec. 38,510, 77 T.C. 1326, 1340 (1981). See Commissioner v. Groetzinger 87-1 USTC ¶ 9191, ___ U.S. ___ (1987). The determination of whether the requisite profit objective exists is to be resolved on the basis of all the surrounding facts and circumstances. Sec. 1.183-2(a), Income Tax Regs.; Dunn v. Commissioner Dec. 35,353, 70 T.C. 715, 720 (1978), affd. on another issue 80-1 USTC ¶ 9187 615 F.2d 578 (2d Cir. 1980). Mere statements of intent are not determinative. Engdahl v. Commissioner Dec. 36,167, 72 T.C. 659, 666 (1979). Petitioners bear the burden of proving that their primary purpose was to make a profit. Welch v. Helvering 3 USTC ¶ 1164, 290 U.S. 111 (1933); Rule 142(a).
The regulations set out nine relevant factors to be considered among others in determining whether an activity is engaged in for profit. Briefly, these factors include: (1) the manner in which the taxpayer carried on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on similar or dissimilar activities; (6) the taxpayer's history of income or loss with respect to the activity4; (7) the amount of occasional profit, if any, which is earned; (8) the financial status of the taxpayer; and (9) whether the elements of personal pleasure or recreation are involved. Sec. 1.183-2(b), Income Tax Regs. No one factor is controlling in making this determination. Sec. 1.183-2(b), Income Tax Regs.; Golanty v. Commissioner, 72 T.C. at 426.
In making our determination, we immediately are struck by the fact that petitioners' horse farm had none of the "trappings of a business." See Bessenyey v. Commissioner Dec. 27,660, 45 T.C. 261, 274 (1965), affd. 67-2 USTC ¶ 9488 379 F.2d 252 (2d Cir. 1967). When John originally built the barn in 1976, it was strictly for personal use. When petitioners began boarding horses in 1979 they did not take any steps to acquire the expertise necessary to carry on this activity as a business. Although Suzanne grew up on a farm, there is no indication that she knew how to run a horse farm, nor is there any evidence that she made any effort to obtain such expertise either from experts, seminars or publications. In fact, both John and Suzanne had outside employment and devoted little time to the farm.
Further, John made only a rough guess at the potential income and expenses, without adequately exploring the grounds for such estimates, and Suzanne kept minimal records of the income and expenses of the farm operations. Had proper records been kept, they would have realized that the venture could not be profitable based on the established price structure and mode of operations. See Golanty v. Commissioner, 72 T.C. at 430.
Petitioners have also failed to show that any advertising or other promotional activity took place to increase the number of horses boarded. Moreover, although petitioners realized that they needed to expand their facilities as early as 1979 and purchased additional land to do so, they subsequently did nothing to enlarge their barn, expand their services, raise their prices, or reduce costs. See Burger v. Commissioner 87-1 USTC ¶ 9137, 809 F.2d 355, 360-361 (7th Cir. 1987), affg. T.C. Memo. 1985-523.
Therefore, it is not surprising that from 1979 until 1983, petitioners sustained steadily increasing losses. These losses did not result from nonrecurring start-up costs or unforeseen or fortuitous circumstances beyond petitioners' control. Cf. Engdahl v. Commissioner, supra at 669. Rather, they resulted from a failure to conduct the horse farm with an objective for profit. Bessenyey v. Commissioner, 45 T.C. at 275. Consequently, we conclude that petitioners' horse farm operations were not entered into with a primary objective of profit, and, accordingly, sustain respondent's disallowance of petitioners' 1981 horse farm loss.5
Respondent maintains that the investment credit...
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