Budget Line Sales - 60,000 units at $ .25	$ 15,000

Retail sales - 100,000 albums - assume
retail program is only 25% effective -
25,000 units at $ 1.00	25,000

Mail order, foreign and all other
sources, 25,000 at $ .40	10,000

Gross annual income	$ 50,000

Gross income over ten years	$ 500,000

*535 The above computations reflect what Siner considered to be conservative projections derived from a seven-year marketing plan that he developed projecting annual sales of 360,000 records. This seven-year plan, in addition to using the existing retail distribution channels, contemplated innovative marketing techniques designed to reach the classical listeners who were not buying classical records. The underlying thrust of Siner's proposed marketing plan was geared at bringing the classical records directly to the consumer using direct mail and door-to-door sales. Siner envisioned civic groups or clubs, the PTA and other school organizations, the Boy Scouts and Girl Scouts, and other organizations selling classical records door-to-door earning royalties for their respective organizations. Siner also contemplated designing classical records with custom labels for particular groups of manufacturers as an alternative marketing technique, and also suggested that systems could be developed similar to that of Shaklee, Avon and Tupperware. Under his plan, Siner projected annual sales of 60,000 of classical records using the normal channel of distribution (retail outlets), another 100,000*536 sales by mail order and 200,000 sales using the service club approach. Siner's sales estimates, either the 360,000 or the "conservative" 110,000 per year, were wholly unrealistic.

Siner's seven-year marketing plan was not part of the distribution agreement between petitioner and Festival. Siner's seven-year marketing plan had never been proven successful by any company in the industry and has never been implemented. Moreover, at the time he prepared the appraisal, Siner had no idea of the total cost of implementing his proposed seven-year marketing plan. Siner was not familiar with Festival and knew nothing about its financial resources or ability to market classical recordings. The distribution agreement that petitioner entered into with Festival did not incorporate Siner's seven-year marketing plan, and Festival did not obligate itself to implement such a plan. However, at their meeting on July 28, 1977, Siner specifically told Stifelman that the marketing variables set forth in his appraisal would have to be undertaken to produce the value Siner had assigned to the master recording, in other words, that his valuation depended upon this marketing plan being carried out.

*537 In a letter to petitioner dated October 11, 1977, Festival acknowledged receipt of the master recording of petitioner's Beethoven symphony and indicated that the record manufacturing was in progress. Festival was only obligated to manufacture 2,500 records.

At some point petitioner received a royalty statement from Festival for the period ending November 30, 1977, that indicated that 1,000 units of petitioner's Beethoven's Symphony No. 3 had been sold and that petitioner was entitled to net royalties of $ 200. The royalty statement reflected gross royalties of $ 250 at the rate of $ .25 each, less $ 50 (20 percent) for a reserve for returns. Festival did not deduct from petitioner's royalties any amount to apply towards the nonrecourse note as specifically provided in the distribution agreement. Petitioner received a check from Festival dated December 28, 1977, in the amount of $ 200. This was the only income petitioner received from his master recording during any of the years in issue.

On or about January 10, 1978, petitioner received ten copies of his Beethoven record album. The first time petitioner ever listened to the recording he had purchased was in January of 1978*538 after receipt of those albums. On or about January 11, 1978, petitioner received for his signature a revised 1978 application for registration of a claim to copyright his master recording. A copyright of petitioner's master recording was registered with the United States Copyright office effective February 10, 1978. The copyright was registered in the name of Ralph Lowenbach c/o Calliope Records Inc. The registration fee was charged to the deposit account established by Calliope Records Inc., which was another of the many companies in which Weisel held an interest.

Itasca paid $ 100 for the liner notes (comments on the back of the album cover) prepared for petitioner's master recording. Itasca also paid $ 452.40 in sales tax for color separating for various classical recordings and paid Festival a $ 20,000 advance to promote the various classical recordings. However, Itasca was not obligated by its agreement with petitioner to pay any promotional expenses for the distribution of his master recording. Petitioner was not obligated to pay and did not pay any promotional expenses. Also Festival was not obligated by its agreement with petitioner to spend any particular amount for*539 promotion of his record.

By letter dated April 14, 1978 Festival informed petitioner that prior to delivery of the 1,000 record sale as reflected in the royalty statement submitted to petitioner in December of 1977, Festival decided to rescind the contract. Thus, petitioner was instructed to treat the $ 200 he had received in 1977 as an advance against royalties rather than actual royalties. Sales Unit PriceAmount100$ .95$ 95.005291.00529.00Gross Amount$ 624.00Cost For Goods Sold (629 x $ .65)408.85Balance$ 215.15Festival Fee(25%)53.79Net Due$ 161.36*540

On or about April 7, 1980, petitioner received from Festival the following accounting of the sales from his master recording for the period ending December 31, 1979:

Sales	Unit Price	Amount
20 albums	$ .90	$ 18.00
6 cassettes	1.00	6.00
Gross amount		$ 24.00
Cost for Goods Sold (26 x $ .65)		16.90
Balance		$ 7.10
Festival Fee (25%)		1.78
Net Due		$ 5.32

Petitioner never received any payments in 1978 or 1979 from the sales generated in those years, because the net amounts were less than the advance royalties paid in 1977.

By letter dated July 15, 1981, Weisel informed petitioner of a proposed agreement with Columbia Special Products division of CBS, Inc., to distribute petitioner's record as part of a line of budget classical records. Weisel also informed petitioner that selling off the existing Festival inventory of his product was a prerequisite of the deal with Columbia Special Products and that a bulk sale of his remaining inventory (1,170 units) had been recently negotiated at $ .55 per unit net, for a sum total of $ 643.50. *541

On October 28, 1981, Weisel, on behalf of Encino Joint Venture Entertainment (Encino), a partnership between Weisel and Lasky, entered into an agreement with CSP, as of June 15, 1981, relating to the marketing of various classical recordings by CSP, including petitioner's master recording. Valuation of*542 Petitioner's Master Recording

Petitioner's master recording is a rendition of the Beethoven Symphony No. 3 in E Flat Major, Op. 55, performed by the "Wurttembergische Philharmonic." There is no orchestra of that name and this anonymous, fictitious orchestra is made up of unidentified musicians and an unidentified conductor. The master recording lasts justs under 45 minutes, the average length of a performance of this symphony varying from 44 to 50 minutes. *543 its type of production.

Generally, the market value of a classical recording depends on its sales potential rather than on the production or manufacturing costs. The single most important factor contributing to the success of a classical master recording is the performing artist. However, with a symphony orchestra, the conductor has the greatest impact on the potential sales of the recording. Thus, the main commercial flaw in petitioner's master recording affecting its marketability and diminishing its market value is the failure to provide a conductor credit, i.e., to name the conductor. *544 it would be difficult to successfully market a classical recording in the absence of a conductor credit and with a fictitious orchestra.

Marketing classical recordings is highly specialized and competitive, and such marketing people are very knowledgeable about their product. Sales of classical recordings account for only a small fraction of the overall sales in the recording industry. In 1977, total sales of records, tapes, etc., at suggested retail prices within the recording industry was approximately $ 3-1/2 billion dollars and classics had about 4-1/2 percent of that market or about $ 150 million dollars.

Classical music is in the public domain and classical recordings are not unique of music such as one might find in popular music. Rather, recordings of the same symphony reflect various interpretations of the different artists and display certain quality factors that are either real or perceived on the part of the potential buyer. At the time petitioner purchased his master recording, numerous recordings of Beethoven's Symphony No. 3 were readily available to the*545 consumer. Schwann's Record and Tape Catalog, which is published monthly, contains a listing of all recordings in the active catalogs of record companies that are currently available. The Schwann Record and Tape Catalog is a necessary marketing tool in promoting a classical recording through retail outlets. It is the only catalog resource available to the public and the dealers often use it as a reference. Petitioner's recording was not listed in Schwann's during any of the years in issue. The Schwann Record and Tape Catalog contained at least 14 or 15 listings for Beethoven's Third Symphony. In addition, complete sets of Beethoven symphonies (including the Third Symphony) consisting of seven to eight albums were also listed and available for sale. Moreover, a number of classical recordings known as cut-outs or overruns that had been unloaded on the market as distress merchandise and not listed in the active catalogs of record companies were also available at that time. In fact, one of respondent's experts had at least 40 different recordings of Beethoven's Symphony No. 3 in his personal music library.

Generally, classical recordings are released and marketed at varying price*546 levels. In 1977, suggested retail for full-price product (top-of-the-line) was between $ 6.98 and $ 7.98; suggested retail for budget-price product was between $ 3.98 and $ 4.98. Recordings also sold in between those levels at mid-line prices, and stated prices at all levels were frequently discounted in practice. The failure to provide a conductor credit essentially eliminated petitioner's recording from being marketed at either the full-price level or the mid-line price level. Moreover, even with a conductor credit, the technical flaws in petitioner's master recording, if not corrected, would also have reduced its marketability at those levels. Thus, the sales potential of petitioner's recording was essentially limited to the budget-price market.

Budget-price classical recordings are distributed by major record companies and by specialty record companies. However, major companies generally do not record new material specifically to be released as a budget product. Usually, classical recordings released at budget prices by major companies are recordings that once had been released at a higher price and had outlived their commercial usefulness at that higher price, but still*547 had some value at a lower price. By that time, production costs of the stepped-down recordings had been either completely amortized or otherwise written off. Specialty companies, on the other hand, normally acquire classical recordings for budget release by license from other record companies.

Two of the main independents that specialized in classical recordings in 1977 were Quintessence Records and Vox Records. Quintessence acquired its classical recordings by license. Generally, those licenses ran for five years with renewal options. In acquiring those licenses, Quintessence usually was required to pay advances against royalties ranging from a low of $ 500 to a high of $ 2,000.

Quintessence had the clout of one of the largest marketing chains behind it. Its parent company, Pickwick International, was at that time the largest retailer of recordings, operating more than 400 retail outlets under the Musicland and Discount Records banners. Pickwick was also the largest rack jobber in the country with sales departments in literally thousands of department and discount stores, including Sears and Woolco. Pickwick was also a major wholesaler of recordings to other retailers. *548 Even with all of this established marketing support, an average sale for Quintessence of a good classical budget recording was in the area of 10,000 recordings per year, although certain records have generated annual sales of 30,000.

Festival's plan for petitioner's recording was primarily geared to reaching the unsophisticated novice or first-time buyers of classical recordings. The name of the conductor on a classical record is important to such a novice buyer because the novice is more likely to be familiar with a well-known conductor than with the name of the symphony or other classical piece. In its January 1977 issue, Schwann offered five versions of the Beethoven Third Symphony at budget prices, all with named conductors. Annual sales of petitioner's recording at budget prices through normal retail channels with no conductor credit and a fictitious orchestra would fall considerably short of 10,000. For these same reasons, it would be difficult to generate any significant number of sales through mail order.

In 1977, petitioner could have purchased or leased a master recording comparable to the one he purchased for far less than his stated purchase price of $ 150,000. He*549 could have had a master recording of Beethoven's Symphony No. 3 produced in the United States at union rates, and with a large (70-80 musicians) well-known orchestra and with a well-known conductor such as Leonard Bernstein, for $ 40,000 to $ 50,000. For approximately $ 2,000, he could have purchased in the United States or anywhere in Europe a master recording comparable to the one he purchased. He could have had a comparable master recording specially produced in Germany for $ 2,000 to $ 12,000 and in England for slightly more. He also could have obtained a license for a comparable master recording for $ 500 to $ 2,000. Itasca paid $ 3,000 for petitioner's master recording, which price was higher than the price of other comparable master recordings available in 1977. Based on realistic potential sales of his recording and the cost of other comparable master recordings, the fair market value of petitioner's master recording in 1977 was not in excess of $ 3,000.

On a Schedule C, attached to his Federal income tax returns for each of the years in issue, petitioner claimed the following amounts of income and deduction from his master sound recording venture:

	1977	1978	1979	1980
Gross Receipts	$ 250	$ -0-	$ -0-	$ -0-
Cost of Goods
Sold	-0-	-0-	-0-	-0-
Depreciation	21,429	36,735	26,239	18,742
Net Loss	($ 21,179)	($ 36,735)	^{($ 18,742)}

*550

Petitioner computed his depreciation deduction using the double declining balance method, a seven-year useful life, and a cost basis of $ 150,000. Petitioner also claimed a tentative investment tax credit of $ 15,528 in 1977, which exceeded his computed tax of $ 12,518 for the year and $ 11,990 of which was attributable to the purchase of his master recording. Respondent determined that neither the depreciation deductions nor the investment tax credit claimed by petitioner attributable to his master sound recording are allowable, and accordingly has determined deficiencies for the years 1977 through 1980.

ULTIMATE FINDINGS OF FACT

1. Petitioner did not have an actual and honest profit objective at the time he purchased his master sound recording.

2. The fair market value of his master sound recording in 1977 was not in excess of $ 3,000.

OPINION

The sole*551 issue in this case is whether petitioner is entitled to depreciation deductions and the investment tax credit in connection with acquiring his master recording. Resolution of this issue depends on whether petitioner entered into the activity with an actual and honest objective of making a profit.

Section 167(a) Flowers v. Commissioner,80 T.C. 914">80 T.C. 914, 931 (1983); Siegel v Commissioner,78 T.C. 659">78 T.C. 659, 698 (1982); Brannen v. Commissioner,78 T.C. 471">78 T.C. 471, 505-506 (1982), affd. 722 F.2d 695">722 F.2d 695 (11th Cir. 1984); Engdahl v. Commissioner,72 T.C. 659">72 T.C. 659, 666 (1979). The same kind of profit-making objective is also a prerequisite for deductions under section 212(1) and (2). Lemmen v. Commissioner,77 T.C. 1326">77 T.C. 1326, 1340 (1981); Jasionowski v. Commissioner,66 T.C. 312">66 T.C. 312, 318-319 (1976),*552 and for the investment tax credit under section 38. Flowers v. Commissioner, supra, at 931 n. 24; Pike v. Commissioner,78 T.C. 822">78 T.C. 822, 841-842 (1982), affd. without published opinion 732 F.2d 164">732 F.2d 164 (9th Cir. 1984).

Petitioner's profit expectation need not be reasonable, but he must have an actual and honest profit objective. Section 1.183-2(a), Income Tax Regs.; Beck v. Commissioner,85 T.C. 557">85 T.C. 557, 569 (1985); Flowers v. Commissioner, supra,80 T.C. at 931; Dreicer v. Commissioner,78 T.C. 642">78 T.C. 642 (1982), affd. without opinion 702 F.2d 1205">702 F.2d 1205 (D.C. Cir. 1983); Allen v. Commissioner,72 T.C. 28">72 T.C. 28, 33 (1979); Bessenyey v. Commissioner,45 T.C. 261">45 T.C. 261, 274 (1965), 379 F.2d 252">379 F.2d 252 (2d Cir 1967). The issue is one of fact to be resolved on the basis of all of the surrounding circumstances. Beck v. Commissioner, supra,85 T.C. at 570;*553 Flowers v. Commissioner, supra,80 T.C. at 931-932; Lemmen v. Commissioner, supra,77 T.C. at 1340; Dunn v. Commissioner,70 T.C. 715">70 T.C. 715, 720 (1978), affd. 615 F.2d 578">615 F.2d 578 (2d Cir. 1980). Petitioner has the burden of proving the requisite profit objective. Rule 142(a); Beck v. Commissioner, supra,85 T.C. at 570; Flowers v. Commissioner, supra,80 T.C. at 932; Golanty v. Commissioner,72 T.C. 411">72 T.C. 411, 426 (1979), affd. without published opinion 647 F.2d 170">647 F.2d 170 (9th Cir. 1981). In making this factual determination, we give greater weight to objective factors than to the taxpayer's mere statement of his intent. Section 1.183-2(a), Income Tax Regs.; ^{Beck v. Commissioner, supra,85 T.C. at 570; Flowers v. Commissioner, supra,80 T.C. at 932; Siegel v. Commissioner, supra,78 T.C. at 699; Churchman v. Commissioner,68 T.C. 696">68 T.C. 696, 701 (1977).}

*554 Although Section 183 is actually an allowance provision rather than a disallowance provision, allowing limited deductions for nonprofit-making activities, Brannen v. Commissioner, supra,78 T.C. at 500, the inquiry into the taxpayer's profit-making objective is the same. Accordingly, the factors listed in section 1.183-2(b), Income Tax Regs., provide a useful framework for resolving this factual issue. See n. 25, supra; Beck v. Commissioner, supra,85 T.C. at 569-570; Flowers v. Commissioner, supra,80 T.C. at 931-932; Brannen v. Commissioner, supra;Siegel v. Commissioner, supra,78 T.C. at 699; Wildman v. Commissioner,78 T.C. 943">78 T.C. 943, 953-954 (1982).

Based on our consideration of all the facts and circumstances, we conclude that petitioner did not engage in his master recording activity with an actual and honest objective of making a profit. Therefore, petitioner is not entitled to an investment tax credit regarding the master recording activity and deductions for depreciation attributable to such activity are allowable only to the limited extent permitted by section 183(b). *555

*556 Petitioner's conduct prior to his purchase of the master recording does not indicate a profit objective. Petitioner was not involved in any of the negotiations preceding his acquisition of the master recording and relied entirely on Stifelman to investigate the venture, and to negotiate the terms of the purchase agreement and the distribution agreement. Petitioner had no experience in any facet of the recording industry, and he also knew that Stifelman did not have any experience or expertise in this area. Indeed, by his own admission, Stifelman had no background in music or in the recording industry, and had never had any previous dealings with the recording industry. In 1977 neither Weisel, the promoter, nor Siner, the seller's appraiser, had any experience in the classical music subsector of the industry. Nevertheless, neither petitioner nor Stifelman consulted with any independent experts regarding the distribution of master recordings, or specifically regarding the profit potential of the particular classical master recording that petitioner purchased.

The Confidential Record Memorandum distributed by Itasca repeatedly warned that the record business was highly speculative*557 and involved a substantial degree of risk. Petitioner chose to ignore those warnings, treating them as just something to protect the promoter. Moreover, the Confidential Record Memorandum specifically warned potential purchasers that the minimum number of sales required to recover the down payment of $ 25,000 and the minimum of sales required to pay off the nonrecourse loan were in excess of the industry norm. See n. 10, supra. Furthermore, if petitioner or Stifelman had seriously considered the nontax merits of this investment, it is improbable that they would have blindly relied on the appraisal furnished by the seller, particularly in view of the cautionary language in the Confidential Record Memorandum. See Beck v. Commissioner, supra,85 T.C. at 572; Elliott v. Commissioner,84 T.C. 227">84 T.C. 227, 240 (1985), affd. without published opinion 782 F.2d 1027">782 F.2d 1027 (3d Cir. 1986). Had petitioner or Stifelman made even a minimal independent investigation of the representations made by Itasca in its Confidential Record Memorandum and the projected sales of the master recording based on a seven-year marketing plan as described in Siner's appraisal,*558 they would have discovered that the projected sales of his classical master recording were totally unrealistic and unattainable.

Petitioner argues that the fact that Stifelman, his principal advisor/attorney, investigated, negotiated, and then followed up on the transactions with Itasca and the distributor Festival is persuasive evidence of petitioner's profit motive. Petitioner contends that Stifelman performed the necessary "due diligence" investigation to satisfy himself and petitioner that the investment in the master recording had real economic potential. We disagree.

At trial and on brief there were frequent references to Stifelman's "due diligence" investigation, a term apparently applicable to the securities field but not determinative of the issues of this case. See Estate of Canfield v. Commissioner,T.C. Memo 1987-294">T.C. Memo. 1987-294. This Court cannot on this record and need not determine whether Stifelman's investigation satisfied whatever duty, if any, he may have had under rules and regulations of the Securities and Exchange Commission (SEC) or the National Association of Securities Dealers (NASD). We do not know if Stifelman served as a private finder or as*559 a NASD licensed broker-dealer in this master recording transaction. In any event, those matters are not determinative of any issue before this Court. We merely note that Stifelman performed a competent job as a lawyer, see n. 8, supra, but lawyers are not "all-purpose experts." Stifelman is not an economist and he has no experience or expertise in music or in the recording industry. Stifelman's "due diligence" investigation was geared solely to the legal paperwork to try to insure the tax benefits of the transaction. See n.8, supra. There was no investigation as to the economics of the transaction.

Stifelman traveled to California in July of 1977 and visited the premises of the proposed distributor, Festival, met with Siner, the seller's appraiser, and met with Weisel, the promoter of the master recording, all in about a nine-hour period. By his own admission, Stifelman visited Festival to satisfy himself that Festival was in existence and was an actual business and to determine whether the people seemed to know what they were doing. See Flowers v. Commissioner,80 T.C. 914">80 T.C. 914, 934 (1983). However, Stifelman did no inspect the books and records of Festival*560 and did not inquire whether Festival had the financial resources to distribute the master recordings according to the seven-year plan set forth in Siner's appraisal. Although Stifelman had read Siner's appraisal depicting the seven-year marketing plan, Stifelman did not ask Siner or anyone else what kind of financial investment it would take to implement such a plan or whether Festival had the resources to implement such a plan. In sum, the record discloses that Stifelman's meeting with Siner was superficial at best and no attempt was made to elicit from Siner, or to seek from an independent industry expert, the information necessary to make a reasonably informed decision as to the economic substance of the transaction.

Stifelman also retained a Los Angeles law firm for advice on the impact of the master recording, issues of title to the master recording, and to review the documents as they were negotiated. Stifelman also requested and received an opinion letter from Itasca's legal counsel to the effect that Itasca had good title to the master recording sold to petitioner. These steps taken by Stifelman were routine legal procedures that any attorney worth his salt would have taken to insure the legalities of any purchase and sale transaction.

More importantly, neither petitioner nor Stifelman ever attempted to negotiate (with Weisel) a lower purchase price for the master recording. *562 While several changes were made to the proposed distribution agreement with Festival, similar to the changes made to the purchase agreement with Itasca, these changes did not relate to the overall profitability of the transaction.

Both petitioner and Stifelman read Siner's draft appraisal prior to petitioner's entering into the transaction. The appraised value of the master recording was based on implementing a seven-year marketing plan described in the draft appraisal. However, the distribution agreement did not obligate Festival to use the marketing plan as described in the appraisal. Under the agreement Festival was obligated to distribute the master recording, but the manner of distribution was left to Festival's soled discretion. In addition, although the agreement provides that Festival "shall advertise" the master*563 recording, the agreement does not specifically obligate Festival to expend any amount on advertising. Also telling of petitioner's lack of profit motive is the fact that under the agreement Festival was specifically obligated to manufacture and distribute only "2,500 copies of the LP (including DJ copies, 'freebies' and bonus LP's)." However, the Confidential Record Memorandum, which petitioner said he had read, projected a minimum of 93,000 record sales needed to recoup his $ 25,000 cash investment and a minimum of 900,000 record sales needed to pay off the $ 125,000 nonrecourse note.

Petitioner also did not listen to the master recording of Beethoven's Third Symphony before buying it and did not consult with any industry expert regarding his selection. Rather, petitioner selected his master recording from a list of eight or ten master recordings and selected the Beethoven Symphony No. 3, the only Beethoven symphony left on the list, because he felt that a Beethoven symphony would be more marketable and more interesting to people than some of the other classical pieces on the list. Neither petitioner nor Stifelman ever investigated to see how many recordings of Beethoven's Third*564 Symphony were already available to the consumers; some 14 or 15 other recordings are already listed in the Schwann Record and Tape Catalog that was published monthly.

Petitioner's conduct after his purchase of the master recording is also indicative of a lack of profit objective. Petitioner did not maintain a separate bank account for this activity. Moreover, Festival did not provide petitioner the periodic statements as required under the distribution agreement and petitioner did nothing to enforce compliance. In addition, petitioner first began writing letters to Weisel during the end of 1978 regarding the lack of performance of Festival. This was after the Internal Revenue Service had begun an audit of his 1977 tax return. While the record contains several letters written by petitioner and letters received by petitioner regarding his master recording, we are satisfied that these letters represent petitioner's efforts to paper the file for the appearance of a profit objective, particularly after the audit began. Petitioner never sought out a different distributor for his master recording and as of the date of trial had not terminated his distribution agreement with Festival, *565 although Festival encountered financial difficulties in 1978 and had become moribund by 1980.

Petitioner's use of a large nonrecourse note also indicates the lack of an actual and honest profit objective because the note was contingent, illusory, and without any real economic substance.Seaman v. Commissioner,84 T.C. 564">84 T.C. 564, 596 (1985). See Estate of Baron v. Commissioner,83 T.C. 542">83 T.C. 542, 556 (1984), affd. 798 F.2d 65">798 F.2d 65 (2d Cir. 1986).

In addition, when an asset is purchased using nonrecourse financing, *566 whether the fair market value of the asset approximated its purchase price is a factor to be considered in determining the necessary profit objective of the taxpayer. Beck v. Commissioner,85 T.C. 557">85 T.C. 557, 577 (1985), and the cases cited therein. We have found that the fair market value of petitioner's master recording when he acquired it in 1977 was not in excess of $ 3,000, the same amount Itasca had just paid Transworld for the master recording. This figure is slightly higher than the greater of the values determined by respondent's experts, whom we found to be very well qualified, competent and persuasive. However, this figure is considerably less than petitioner's cash investment of $ 25,000. Although petitioner's expert, Siner, valued the master recording at more than $ 150,000, we reject his opinion as without factual basis and vastly inflated. In 1977 petitioner could have had a master recording of Beethoven's Third Symphony produced in the United States, at union rates and with a large, well-known orchestra and a well-known conductor such as Leonard Bernstein, for $ 40,000 to $ 50,000. While Siner had experience in the recording industry, his experience*567 was in popular music and prior to 1977 he was not involved in the marketing of classical recordings. In addition, Siner has never budgeted or produced a classical recording.

It is unclear whether Siner actually listened to petitioner's master recording prior to preparing his appraisal. In fact, the record shows that Siner prepared one form appraisal relating to classical recordings in general, and this same appraisal was used for the 18 to 25 master recordings for which he supplied appraisals. Siner merely made minor and insignificant changes to conform with the specific master recording. Siner's appraisal was made up of vague generalities and shocking inaccuracies that revealed his lack of knowledge of classical music in general and of the recording of classical music in particular. See nn. 14, 20, supra. Siner also did not take into account the serious commercial flaws in petitioner's master recording including the absence of a conductor credit. Rather, Siner valued the master recording based on projected sales using a seven-year marketing plan. However, this seven-year plan had never been previously proven successful by any record distributor. Moreover, prior to preparing*568 his appraisal Siner knew that Weisel wanted to sell the single disc master recordings for around $ 150,000. We are satisfied that Siner's 1977 appraisal and his expert report for the trial (which are essentially identical) do not accurately represent the fair market value of petitioner's master recording. Siner's projection of sales for petitioner's master recording is wholly unrealistic and unattainable. Siner's appraisal represents nothing more than a "pie-in-the-sky" valuation concocted to support Itasca's predetermined sales price of $ 150,000, which was 50 times more than Itasca had just paid for the master recording. Thus, we have given no weight to Siner's valuation.

By contrast, each of respondent's experts had extensive experience in classical music and in the classical recording industry and each provided specific, detailed factual testimony regarding the realistic sales potential of petitioner's master recording. Based on the testimony and the reports of respondent's experts, we are satisfied that in 1977 petitioner's master recording had a fair market value not in excess of $ 3,000. While petitioner's cash out-of-pocket is considerably more than the fair market value*569 we have determined, the Court is satisfied that the excess of the cash investment over the fair market value represented the purchase price for the purported tax benefits associated with the activity.

We are also not persuaded by petitioner's argument tha the losses petitioner sustained were due to "unforeseen or fortuitous circumstances" beyond his control such as "depressed market conditions," which he claims seriously hampered Festival's efforts to commercially exploit the master recording. First, except for Weisel's vague and generalized testimony, there is little evidence indicating the effort Festival made to commercially exploit petitioner's master recording. While Weisel testified that Festival expended between $ 300,000 to $ 400,000 to promote its classical catalog that included petitioner's master recording, there is absolutely nothing in the record to corroborate his testimony. Moreover, we have given little weight to the alleged downturn in the recording industry subsequent to petitioner's acquisition of the master recording. We note that this coincided with the very period when petitioner's expert, Siner, became president of MCA and turned that company from a loss to*570 a profit. We are satisfied that no record distribution company, even in a strong market, could have attained the level of sales for petitioner's master recording necessary for petitioner to have the opportunity to make a profit.

Petitioner argues that the proper measuring point in evaluating whether he had an opportunity to make a profit is his cash investment of $ 25,000, and not the total purchase price of $ 150,000, citing Wildman v. Commissioner,78 T.C. 943">78 T.C. 943 (1982), and Bizub v. Commissioner,T.C. Memo. 1983-280. Petitioner points out that under the terms of the purchase agreement with Itasca, he was entitled to keep 85 percent of the first $ 29,000 of proceeds received, and 50 percent of the proceeds in excess of $ 29,000. Thus, petitioner contends he would have recovered his $ 25,000 cash investment after the recording had generated just $ 29,700 in sales. ($ 29,000 x 85% + $ 700 x 50% = $ 25,000.) After any combination of retail and mail order sales totaled (approximately) $ 29,700, petitioner contends that he would begin receiving a profit on his investment because he was to receive from Festival $ 1.00 for each record sold at retail and*571 $ .99 for each mail order sale. We need not belabor whether that is the proper measuring point in terms of evaluating profit objective, and we think it is not. ^{*572 In conclusion, we hold that petitioner failed to satisfy his burden of proving that he engaged in the master recording activity with an actual and honest objective of making a profit. Decisions will be entered under Rule 155.}

Footnotes

1. Respondent's deficiency determination for 1978 included an alternative position based on a "burnout" adjustment and an investment tax credit recapture regarding the acquisition of the master sound recording, both of which he conceded prior to trial. Petitioners conceded and paid the tax attributable to certain other miscellaneous adjustments, which are unrelated to the master sound recording activity. The deficiencies still in dispute for all the years in issue involve claimed deduction and credits from the acquisition of the master sound recording in 1977. Thus, our resolution of the issues as to the 1977 master sound recording transaction will dispose of all four years. ↩
2. Schedules 1 and 2 of the agreement were missing from the copy of the agreement that the parties submitted with their stipulation of facts, and those schedules have not been made part of the evidentiary record in this case. ↩
3. There is nothing in the record to indicate that Transworld perfected its security interest in the master sound recordings sold to Itasca. However, the record shows that Itasca paid the amount due on the nonrecourse note for petitioner's master recording at some point between January of 1978 and April of 1978. ↩
4. Itasca purchased only 35 or 36 of the masters made available. ↩
5. Stifelman did not meet the other appraiser, Mr. Krizman, until April of 1983. ↩
6. Siner and Weisel agreed that Siner would receive $ 7,500 for the initial data and appraisal report of the classical recordings. However, Siner testified that he had received only $ 800 for his appraisals. ↩
7. The affidavit attached to the opinion letter was a German-to-English translation of an affidavit from Transworld Music Establishment. It is unclear who provided the translation, but in any event neither Weisel nor Stifelman could read German. The translation of that affidavit acknowledged Transworld as the producer of the master recordings and that no indebtedness existed against any of the recordings. It also warranted that the masters had never been previously sold or licensed. The Court makes no finding based upon that affidavit and makes no finding as to good title vel non. ↩
8. The paperwork in this transaction is of a much better quality than the Court frequently sees in such master recording transactions. For the two most recent master recording cases, see McCain v. Commissioner,T.C. Memo. 1987-285, and Secoy v. Commissioner,T.C. Memo. 1987-286. For a compilation of master recording cases decided by this Court, see footnote 8 in the Secoy↩ opinion. However, while the legal paperwork in the instant case is carefully done, Stifelman's investigation as to the economic viability or economic substance of this master sound recording transaction is another matter. In that respect this case does not differ substantially from the other master recording cases.
9. Petitioner's understanding of the future tax consequences and the economics, if any, of this transaction was somewhat vague and confusing. Petitioner testified that he never thought of this transaction in terms of economic risk but rather in terms of $ 25,000 cash gone, less whatever tax benefits he derived over 10 years plus recapture on the $ 125,000 nonrecourse note in 10 years if the venture was unsuccessful. Petitioner stated that he never quantified these computations. ↩
10. Petitioner testified that he did not recall reading in the Confidential Record Memorandum that the minimum levels of sales needed to recoup the cash investment and to pay off the nonrecourse note were above industry norms. This statement appears in the last sentence of the paragraph entitled "RISKS OF THE RECORD BUSINESS" and again as the last sentence of the paragraph entitled "DISTRIBUTION NOT NECESSARILY PROFITABLE." ↩
11. In connection with the acquisition of the Beethoven master recording, petitioner received from Itasca a document entitled "Assignment of Copyright" and a document entitled "Bill of Sale," both dated September 20, 1977. Itasca received from petitioner a document entitled "Security Agreement" and a document entitled "Mortgage of Copyright," both dated September 7, 1977. The acquisition of the Beethoven symphony was formalized through the mail, which accounts for the discrepancies in the parties' execution dates. Petitioner executed the documents on September 7, 1977, mailed them to Itasca, and Itasca executed the documents on September 20, 1977. ↩
12. The parties stipulated that petitioner has made no payments of interest or principal on the nonrecourse note. However, at trial petitioner suggested that possibly $ 40 or $ 50 was applied to the nonrecourse note in 1981, a taxable year not in issue herein. However, the Court will not disregard a stipulated fact based upon such vague, unsupported testimony. ↩
13. Stifelman testified that the final appraisal dated October 5, 1977, was almost exactly the same as the draft form appraisal he had received prior to his meeting in July of 1977 with Weisel and Siner. However, the record does not establish that the draft form appraisal he saw in July pertained to petitioner's particular master recording or indeed to any particular master recording. ↩
14. There are numerous obvious errors in Siner's appraisal for petitioner and his expert report for the trial (which are essentially identical). These errors reflect a woeful lack of knowledge of classical music in general and of producing and recording classical music in particular. There is an error in the title of Beethoven's Third Symphony (described as E Sharp Major rather than E Flat Major). Leonard Bernstein is erroneously described as a foreign-born conductor. Many items of recording expense listed by Siner pertain to popular music but are not applicable in recording classical music. And the sales figures projected by Siner are wholly unrealistic when compared to actual results obtained by Quintessence Records with its well-established distribution system for classical recordings. ↩
15. The appraisal placed a replacement value of petitioner's master recording at $ 158,852. The replacement value was put in the appraisal purportedly as a guideline as to the cost of duplicating the master in the United States in case it was destroyed. Siner received the various costs he used for replacement value from the staff of MCA but never independently verified any of the figures. The actual cost of producing a comparable master recording in the United States was considerably less than that depicted by Siner. ↩
16. We rather doubt that any records were even manufacted in 1977. Petitioner did not receive copies of his record until Jannuary of 1978, and the alleged contract to sell 1,000 records in the latter part of 1977 was not produced at trial. Except for Weisel's testimony, which we found to be vague and confusing on this point, there is nothing in the record to indicate that any records were actually manufactured or sold in 1977. ↩
17. It is unclear whether the sales consisted of record albums, cassettes, or both.↩
18. The record shows that 1,116 units were sold at $ .50 per unit for a total of $ 558. ↩
19. According to Weisel, Encino was used essentially as an agent for the numerous owners of the classical master recordings because CSP did not want to deal individually with the 34 or 35 owners.↩
20. Siner's expert report gave the length of this master recording as 35 minutes, but Beethoven's Symphony No. 3 could not be compacted into 35 minutes. Also Siner gave the same playing period for Beethoven's Ninth Symphony which is much longer than the Third. ↩
21. The performance represents the musical direction and the musical conception of the conductor and the ability of the orchestra to perform and capture that conception. A good recording will be a good representation of the conductor's concept of the performance. ↩
22. This is not a situation of a little known or a virtually unknown conductor, but of no name at all. ↩
23. On the same Schedule C attached to his joint return for 1979, petitioner reported income and deductions for his oil and gas venture as well as his master recording venture. The claimed depreciation and the ensuing net loss attributable to the master recording venture was $ 26,239 which respondent disallowed.↩
24. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years in question, and all "Rule" references are to the Tax Court Rules of Practice and Procedure. ↩
25. Section 1.183-2(b), Income Tax Regs.↩, lists some of the relevant factors to be considered in determining whether an activity is engaged in for profit. These factors include: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayers 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 other similar or dissimilar activities; (6) the taxpayer's history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved.
26. Section 183(b) provides in pertinent part:
In the case of an activity not engaged in for profit * * *, there shall be allowed --
(1) the deductions which would be allowable under this chapter for the taxable year without regard to whether or not such activity is engaged in for profit, and
(2) a deduction equal to the amount of the deductions which would be allowable under this chapter for the taxable year only if such activity were engaged in for profit, but only to the extent that the gross income derived from such activity for the taxable year exceeds the deductions allowable by reason of paragraph (1).
We note that petitioner reported income of $ 250 in 1977 in connection with his master recording activity. No income was reported from this activity during any other years in issue. On Schedule C attached to his 1977 tax return (Form 1040), petitioner reported income of $ 250 and claimed a deduction for depreciation in the amount of $ 21,429 resulting in a net loss off $ 21,179. In his statutory notice of deficiency for 1977, respondent disallowed the net loss of $ 21,179 and increased petitioner's income accordingly. Respondent allowed petitioner a depreciation deduction in the amount of $ 250 to offset the amount of gross income derived from his master recording activity in 1977. Thus, petitioner is not entitled to any additional deductions regarding his master recording activity during any of the years in issue.
On Schedule A attached to his 1978 return, petitioner claimed as an itemized deduction the $ 233 of interst paid to Itasca on the recourse promissory note in January of 1978. Respondent has allowed this deduction. That his master sound recording transaction lacks economic substance and was not entered into with a profit objective does not preclude petitioner from claiming a deduction under section 163 for any interest actually paid on a genuine recourse indebtedness. See Rice's Toyota World, Inc. v. Commissioner,752 F.2d 89">752 F.2d 89, 96 (4th Cir. 1985), revg. on this issue 81 T.C. 184">81 T.C. 184 (1983), and Rose v. Commissioner,88 T.C. 386">88 T.C. 386, 423↩ (1987).
27. Since this was a leveraged sale with a $ 125,000 nonrecourse note payable solely from the proceeds of any record sales and the purported tax benefits to be derived therefrom were based on the total purchase price, it would not have been to petitioner's tax advantage to acquire the master recording at a lower price if his cash investment remained the same. ↩
28. See Seely v. Commissioner,T.C. Memo. 1986-216↩.
29. See Estate of Baron v. Commissioner,83 T.C. 542">83 T.C. 542 (1984), affd. 798 F.2d 65">798 F.2d 65↩ (2d Cir. 1986).
30. Our analysis is based upon the fact that this case was tried and briefed by the parties in terms of the presence of a profit objective under section 183 and the regulations thereof. We recognize that our recent opinion in Rose v. Commissioner,88 T.C. 386">88 T.C. 386 (1987), adopts a test of economic substance in the category of "generic" tax shelters. Our conclusion under that test would be the same. See Taube v. Commissioner,88 T.C. 464">88 T.C. 464 (1987); Leger v. Commissioner,T.C. Memo 1987-146">T.C. Memo. 1987-146; Vandenhoff v. Commissioner,T.C. Memo. 1987-116↩.

Document Info

Docket Number： Docket Nos. 17760-81; 11547-83.

Citation Numbers： 54 T.C.M. 715, 1987 Tax Ct. Memo LEXIS 492, 1987 T.C. Memo. 496

Filed Date： 9/28/1987

Precedential Status： Non-Precedential

Modified Date： 11/20/2020

Authorities (4)

Rice's Toyota World, Inc. (Formerly Rice Auto Sales, Inc.) ... , 752 F.2d 89 ( 1985 )

Estate of Sydney S. Baron, Sylvia S. Baron, Administratrix, ... , 798 F.2d 65 ( 1986 )

Herbert A. Dunn and Georgia E. Dunn v. Commissioner of ... , 615 F.2d 578 ( 1980 )

E.A. Brannen and Frances K. Brannen v. Commissioner of ... , 722 F.2d 695 ( 1984 )

View All Authorities »