Ruben v. Commissioner ( 1986 )

BARNEY C. RUBEN AND ELEANOR RUBEN ^{Ruben v. Commissioner}

Docket No. 5788-82.

United States Tax Court

T.C. Memo 1986-260; 1986 Tax Ct. Memo LEXIS 348; 51 T.C.M. (CCH) 1268; T.C.M. (RIA) 86260;

June 24, 1986.

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John P. Callahan, for the petitioners.

Rosa Berman, for the respondent.

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CLAPP

MEMORANDUM FINDINGS OF FACT AND OPINION

CLAPP, Judge: Respondent determined deficiencies in petitioners' Federal income tax as follows:

Year	Deficiency 1976	$28,323
1977	48,140
1978	35,567

The issue for decision is whether petitioners' horse operations constituted an activity engaged in for profit.

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference.

Petitioners resided in California at the time they filed their petition in this case.

Petitioner-husband is a successful and busy real estate businessman. He built and sold homes and buildings for over 40 years. To conduct his real estate business, he formed the following corporations: Oxnard & Cedros Co., Inc.; Kesto, Inc.; 14830 Oxnard Street Inc.; Kester & Oxnard Co., Inc.; Kester Avenue Land Corp.; Ruben Homes, Inc.; Ruben Land Corp.; Ruben Investment Co., Inc.; and Burvan Properties, Inc. In 1972, he formed an investment company from which he received a salary ranging from $73,500 in 1972 to $100,000 in 1978. Before taking into consideration the losses and property taxes of the ranch, petitioners' adjusted gross income for 1976, 1977 and 1978, the years at issue, was $370,326, $315,544 and $370,962, respectively.

In addition to petitioner-husband's real estate business, petitioners were involved in breeding, boarding and racing horses. Petitioners purchased their first horse in 1943.

Over the years, petitioners have owned four ranches: Van Nuys Ranch, El Bar Ranch, Running Springs Ranch at Newberry Park, California (Running Springs Rach I) and Running Springs Ranch at Santa Yuez, California (Running Springs Ranch II).

Petitioners purchased the Van Nuys, Ranch in 1943. It had 60 acres of land and a one-half mile track. Petitioners subdivided the ranch and built houses on it in 1947.

Petitioners purchased the El Bar Ranch in 1947. It had 40 acres of land and approximately 15 horses. Petitioner-husband did not like the location of the ranch because it was too far away from his real estate business. Petitioners sold the ranch in 1954.

Petitioners purchased Running Springs Ranch I in 1954. It had 272 acres and 11 horses. The value of the land appreciated because of an increase in the population in the area and its potential for residential and/or commercial development. The value of the land did not appreciate because of its use as a horse ranch. Petitioners became dissatisfied with the location of the ranch and, in 1962, sold the ranch to a real estate developer for residential and/or commercial development. Petitioners reported a gain on the sale of the ranch on the installment method. Petitioners' capital gain, and interest income on a note from the sale, was reported as follows:

Year	Capital Gain	Interest	Total
1962	$ 570,363	$ 0	$ 570,363
1963	256,503	62,494	318,997
1964	256,503	98,494	354,997
1965	4,275	78,743	83,018
1966	207,156	60,572	267,728
1967	85,501	67,840	153,341
1968	85,501	60,840	146,341
1969	399,718	53,840	453,558
1970	257,905	40,044	297,949
TOTAL	$2,123,425	$522,867	$2,646,292

In 1962, petitioners purchased Running Springs Ranch II, a 1,000 acre ranch petitioner-husband still owns. It has a main residence, a pool, two detached guest bedrooms, a guest house, a manager's apartment, employee quarters, a 24 stall barn, 17 paddocks, a 4-stall broodmare barn, a 7/16 mile training track and 55 acres of pasture and grazing land.

Petitioners usually stayed at the ranch from Thursday night until Monday. While at the ranch, petitioner-husband spent most of his time gardening and petitioner-wife, who had taken genetics classes, maintained breeding records and filed foaling and breeding reports with various associations.

Petitioner-husband was president of the California Harness Horse Breeders Association from 1953 to 1955 and a member of the California Standardbred Sires Stakes Committee from 1976 to 1978. Both petitioners were active in horse industry associations.

Petitioners employed several people to assist them with the activities and record keeping of the ranch. They employed a maid who helped with the housekeeping and a ranch manager who had only an adequate reputation. Accountants maintained records of petitioners' personal, ranch and business affairs and prepared their tax returns from 1962 through 1982. Petitioner-husband did not review the tax returns prepared by his accountants but did keep some informal ranch records of his own. Petitioners did not prepare budgets for the ranch and used the same bank account for their personal and ranch expenditures.

As the owners of Running Springs Ranch II, petitioners were able to breed, board and race standardbred harness horses, activities which gave petitioners a great deal of pleasure. During 1976, 1977 and 1978, petitioners owned 30 brood mares and several stallions. During this same 3-year period, 48 mares were bred at the ranch. Petitioners raced 9 horses in 1976, 10 horses in 1977 and 7 horses in 1978. Breeding fees, boarding revenue, racing purses, other miscellaneous revenues, total expenses and net income for 1976, 1977 and 1978 were as follows:

	1976	1977	1978
Breeding fees	$719	$3,716	$3,238
Boarding revenues	12,585	31,031	26,149
Racing purses	48,711	86,479	87,080
Other revenues	32,253	7,733	13,135
Total expenses	(135,037)	(198,914)	(181,639)
Net Income	($40,769)	($69,955)	($52,037)

An itemization of the revenues and expenses associated with Running Springs Ranch II from 1962 to 1982 follows:

Line	Income:	1962	1963	1964	1965
1	Sales of Horse	$200	$1,500	$400	$1,000
2	Pasture & Boar	9,218	10,397	7,272	4,717
3	Breeding Fees	465	718	0	861
4	Racing Purses	15,835	20,059	7,609	29,508
5	Leasing & Misc	5,000		238	3,932
6
7	Total Income	$30,718	$32,674	$15,519	$40,018
8
9	Expenses
10	Advertising
11	Bad Debts
12	Blacksmith
13	Breeding Fees
14	Commissions
15	Depreciation
16	Dues & Subs.
17	Feed
18	Gas and Oil
19	Insurance
20	Misc.
21	Payroll Taxes
22	Repairs
23	Salaries
24	Seed & Fertilizer
25	Stake Fees
26	Supplies
27	Taxes & Licenses
28	Telephone
29	Training/Drivers
30	Travel
31	Trucking
32	Utilities
33	Veterinary
34
35	Total Expens	93,590	118,418	98,762	114,862
36
37	Net Income	$ -62,872	$ -85,744	$ -83,243	$ -74,844
38

Line	Income:	1966	1967	1968	1969
1	Sales of Horse	$2,650	$11,625	$6,810	$12,770
2	Pasture & Boar	3,621	3,068	6,722	13,969
3	Breeding Fees	310	400	405	1,799
4	Racing Purses	37,717	5,481	834	9,695
5	Leasing & Misc	1,465	421	275	2,029
6
7	Total Income	$45,763	$20,995	$15,046	$40,262
8
9	Expenses
10	Advertising
11	Bad Debts
12	Blacksmith			930	406
13	Breeding Fees			5,150	820
14	Commissions
15	Depreciation			21,884	22,092
16	Dues & Subs.			352	319
17	Feed			5,935	7,929
18	Gas and Oil			2,709	1,372
19	Insurance			4,423	3,338
20	Misc.			151	656
21	Payroll Taxes			1,445	1,267
22	Repairs			8,493	5,151
23	Salaries			17,492	13,370
24	Seed & Fertilizer			791	522
25	Stake Fees			40	150
26	Supplies			2,568	1,435
27	Taxes & Licenses			8,612	8,757
28	Telephone			1,546	813
29	Training/Drivers			16,517	40,622
30	Travel			272	435
31	Trucking			607	2,383
32	Utilities			3,666	1,867
33	Veterinary			1,753	2,043
34
35	Total Expens	127,525	102,423	105,336	115,747
36
37	Net Income	$ -81,762	$ -81,428	$ -90,290	$ -75,485
38

Line	Income	1970	1971	1972
1	Sales of Horse	$52,715	$36,000	$5,000
2	Pasture & Boar	19,216	23,584	36,475
3	Breeding Fees	3,529	818	1,788
4	Racing Purses	30,451	18,417	24,541
5	Leasing & Misc	3,456	1,162	780
6
7	Total Income	$109,367	$79,981	$68,584
8
9	Expenses
10	Advertising	325	344
11	Bad Debts
12	Blacksmith	1,116	2,312	2,855
13	Breeding Fees	200		2,229
14	Commissions	257
15	Depreciation	21,232	21,500	23,079
16	Dues & Subs.	430	1,055	2,195
17	Feed	22,829	8,051	29,149
18	Gas and Oil	1,382	1,989	3,157
19	Insurance	2,472	2,551	2,000
20	Misc.	22
21	Payroll Taxes	1,588	1,343	2,049
22	Repairs	5,285	4,782	9,353
23	Salaries	10,928	10,631	19,295
24	Seed & Fertilizer	581	747
25	Stake Fees	483	450	150
26	Supplies	267	569	2,565
27	Taxes & Licenses	218	305	164
28	Telephone	213	332
29	Training/Drivers	32,455	14,148	33,000
30	Travel
31	Trucking	1,905	2,025	1,200
32	Utilities	877	1,268	1,111
33	Veterinary	3,004	3,969	7,308
34
35	Total Expens	108,069	78,371	140,859
36
37	Net Income	$1,298	$1,610	$ -72,275
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Line	Income:	1973	1974	1975
1	Sales of Horse	$10,310	$10,849	$12,421
2	Pasture & Boar	29,404	38,028	32,957
3	Breeding Fees	925	2,720	1,175
4	Racing Purses	11,683	25,321	48,437
5	Leasing & Misc	517	212
6
7	Total Income	$52,839	$77,130	$94,990
8
9	Expenses:
10	Advertising
11	Bad Debts	1,400
12	Blacksmith	994	818	999
13	Breeding Fees	1,239	1,229
14	Commissions
15	Depreciation	23,581	21,757	21,178
16	Dues & Subs.	2,803	986	752
17	Feed	5,648	6,371	11,763
18	Gas and Oil	2,618	3,515	2,557
19	Insurance	2,364	1,716	2,041
20	Misc.			273
21	Payroll Taxes	1,321	1,335	1,290
22	Repairs	5,911	4,620	3,135
23	Salaries	16,028	17,190	15,303
24	Seed & Fertilizer
25	Stake Fees		2,740	2,700
26	Supplies	75		2,125
27	Taxes & Licens	1,273	1,300	3,363
28	Telephone
29	Training/Drive	25,861	41,425	52,747
30	Travel
31	Trucking	3,160	4,920	881
32	Utilities	1,153	1,366	1,450
33	Veterinary	4,283	3,404	2,279
34
35	Total Expense	$99,712	$114,692	$124,836
36
37	Net Income	$ -46,873	$ -37,562	$ -29,846
38

Line	Income:	1976	1977	1978
1	Sales of Horse	$32,253	$6,471	$13,135
2	Pasture & Boar	12,585	31,031	26,149
3	Breeding Fees	719	3,716	3,238
4	Racing Purses	48,711	86,479	87,080
5	Leasing & Misc		1,262
6
7	Total Income	$94,268	$128,959	$129,602
8
9	Expenses:
10	Advertising
11	Bad Debts
12	Blacksmith	51		500
13	Brooding Fees		3,646	4,274
14	Commissions
15	Depreciation	18,441	17,710	16,578
16	Dues & Subs.	597	469	884
17	Feed	8,643	2,316	11,029
18	Gas and Oil	2,267	2,221	66
19	Insurance	2,234	2,292	2,571
20	Misc.	246	35	329
21	Payroll Taxes	1,116	1,280	1,162
22	Repairs	4,532	2,306	2,384
23	Salaries	12,035	13,895	14,624
24	Seed & Fertilizer	370	350	401
25	Stake Fees	900	2,745	100
26	Supplies	3,451	9,431
27	Taxes & Licens	2,176	1,134	2,098
28	Telephone	98	139
29	Training/Drive	65,017	114,197	102,035
30	Travel
31	Trucking	6,381	15,010	11,747
32	Utilities	1,649	2,073	1,578
33	Veterinary	4,833	7,665	9,279
34
35	Total Expense	$135,037	$198,914	$181,639
36
37	Net Income	$ -40,769	$ -69,955	$ -52,037
38

Line	Income:	1979	1980	1981	1982
1	Sales of Horse	$17,000	$12,570	$58,905	$34,329
2	Pasture & Boar	25,840	90,344	72,552	111,472
3	Breeding Fees	3,442	910	1,415	4,353
4	Racing Purses	28,914	18,157	27,126	68,861
5	Leasing & Misc		500
6
7	Total Income	$75,196	$122,481	$159,998	$219,015
8
9	Expenses:
10	Advertising
11	Bad Debts
12	Blacksmith	2,399	1,896	382	708
13	Breeding Fees	250
14	Commissions	3,600	6,191	9,802	4,474
15	Depreciation	15,341	14,462	18,022	11,436
16	Dues & Subs.	1,197	478	63	1,327
17	Feed	7,030	20,851	18,720	34,368
18	Gas and Oil	56			25
19	Insurance	4,666	5,017	2,971	3,016
20	Misc.	2,014	1,535		114
21	Payroll Taxes
22	Repairs	1,798	2,505	3,846	4,286
23	Salaries	28,064	32,377	34,737	32,957
24	Seed & Fertilizer
25	Stake Fees	1,620	2,865	4,625	7,575
26	Supplies	1,926	1,175	1,422	266
27	Taxes & Licens	3,186	2,848	3,296	3,274
28	Telephone
29	Training/Drive	47,524	18,040	33,705	65,388
30	Travel
31	Trucking	22,487	1,352	10,296	5,840
32	Utilities	1,574	1,858	826	1,036
33	Veterinary	4,574	1,127	2,826	1,145
34
35	Total Expense	$149,306	$114,577	$145,539	$177,235
36
37	Net Imcome	$ -74,110	$7,904	$14,459	$41,700
38

As reflected in the charts, Running Springs Ranch II was not profitable. It suffered a substantial loss in each year during the 18-year period 1962-1979. In 1970 and 1971, and through 1982, petitioners' accountants improperly reported real property taxes. If the real property taxes had been properly reported, the net income of Springs Ranch II for 1970 *360 boarded at the ranch pursuant to the agreement. SCRA paid petitioners $36,000 in 1980 and $40,000 in each of the years 1981, 1982 and 1983. In 1984, SCRA sold its only asset and dissolved. The purchaser of SCRA's asset was the successor in interest to the lease between petitioners and SCRA. The purchaser decided it did not need the boarding facilities at Runnings Springs Ranch II and cancelled the lease in 1984.

ULTIMATE FINDING OF FACT

Petitioners' horse operations did not constitute an activity engaged in for profit during the years 1976, 1977 and 1978.

OPINION

Section 183(a) provides generally, if an activity is not engaged in for profit, no deduction attributable to such activity shall be allowed except as otherwise provided for in that section. Section 183(c) defines "activity not engaged in for profit" as "any activity other than one with respect to which deductions are allowable * * * under section 162 or * * * paragraph (1) or (2) of section 212." Section 1.183-2(b), Income Tax Regs. , provides a list of nine factors to consider in the determination of whether an activity is engaged in for profit. Engdahl v. Commissioner,72 T.C. 659">72 T.C. 659, 666 (1979). In order for the taxpayer to prevail, the facts and circumstances must indicate that the taxpayer entered into, or continued, the activity with an actual and honest objective of making a profit. Dreicer v. Commissioner,78 T.C. 642">78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205">702 F.2d 1205 (D.C. Cir. 1983).

In the present case, the evidence does not support a finding that petitioners' activities were engaged in for profit. First, petitioners did not carry on the activity in a businesslike manner. Although petitioner-husband kept some informal records or notes and petitioner-wife kept breeding records, nothing in the record suggests that petitioners had anything but a vague understanding of the finances of the ranch. Petitioners did not prepare a budget for the ranch. They advertised in only two years; in 1970 they spent $325 on advertising and in 1971 they spent $344. Petitioners did not maintain a separate bank account for the ranch.

Secondly, petitioners did not devote a significant amount of time to the activities of the ranch. Although they each kept some records, they usually spent only weekends at the ranch, and even then, petitioner-husband devoted most of his energies to gardening. Lack of time devoted to an activity is not necessarily indicative of a lack of profit motive where other competent and qualified people carry on the activity. Section 1.183-2(b)(3), Income Tax Regs. In the present case, however, petitioners' ranch manager had only an adequate reputation and we were not informed as to the reputation of petitioners' other employees.

Finally, Running Springs Ranch II suffered a loss in each year during the 18-year period 1962-1979. During this period, the losses totalled over $1,000,000. During 1976, 1977 and 1978, the years at issue, Running Springs Ranch II had a net income (loss) of ($40,769), ($69,955) and ($52,037), respectively. The only apparent rewards petitioners received from the ranch were the tax benefits associated with the losses and the personal pleasure derived from the activities of the ranch.

Petitioners argue that because they reported the capital gain and interest income from the sale of Running Springs Ranch I on the installment method, their ranching operations actually were profitable from 1962 through 1970. We disagree. When land/a ranch appreciates independently of the horse related activities, the gain on the sale of the land is not taken into account when evaluating petitioner's profits and losses from their ranching operations. section 1.183-1(d)(1), Income Tax Regs.

Petitioners also argue on brief that their ranch was profitable from 1980 through 1982. *365 Decision will be entered under Rule 155.

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Footnotes

• 1. Mrs. Ruben died February 15, 1985 prior to trial.↩

• 2. In an amendment to answer, respondent alleged that the correct amounts of the deficiencies are $34,785.23, $54,976.14 and $40,282.06 for the years 1976, 1977 and 1978, respectively. The increased deficiencies are a result of respondent's shifting real property taxes associated with petitioners' ranch from Schedule A to Schedule F. Petitioner has conceded that the change is correct. Section 183(b)↩ provides that deductions attributable to an activity not engaged in for profit are allowable in a certain order, starting with deductions otherwise allowable, e.g., taxes and interest. The remaining deductions, which would be allowable if they had been incurred in an activity engaged in for profit, are then allowed to the extent that gross income from the activities exceeds the deductions which were allowed first. Here, the real property taxes shifted from Schedule A to Schedule F are deducted first and result in increased deficiencies if petitioner's activities were not engaged in for profit.

• 3. For any taxable year beginning after December 31, 1969, a presumption that horse related activities are engaged in for profit applies if the activities are profitable in two out of seven consecutive years. Sections 183(d) and (e)(1)↩.

• 4. The factors are:

  (1) The manner in which the taxpayer carried 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) the expectation that the assets used in the 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 loss with respect to the activity; (7) the amount of occasional profit, if any, which is earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved.↩

• 5. LaMusga v. Commissioner,T.C. Memo. 1982-742. Cf. Engdahl v. Commissioner,72 T.C. 659">72 T.C. 659, 668↩ (1979) (appreciation in value of ranch based on its use as a horse ranch).

• 6. At trial, petitioners contended that these years were irrelevant because they dealt with years subsequent to the years at issue.↩