                        T.C. Memo. 1996-174



                      UNITED STATES TAX COURT


                   HARM DE BOER, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 11047-94.              Filed April 10, 1996.



     Harm De Boer, pro se.

     James R. Robb, for respondent.




             MEMORANDUM FINDINGS OF FACT AND OPINION



     BEGHE, Judge:   Respondent determined deficiencies in

petitioner's 1990 and 1991 Federal income taxes of $5,263 and

$6,322, respectively, and negligence penalties under section 6662

of $1,053 and $1,264, respectively.1   The deficiencies arose from

     1
      Unless otherwise identified, section references are to the
Internal Revenue Code in effect for the years in issue, and all
                               - 2 -


respondent's disallowance of net operating loss carryovers and

Schedule C deductions claimed by petitioner in connection with

his drill rig activities.

     As a result of respondent's concession on an unrelated issue

brought up by petitioner's amendment of his 1990 return, the only

issues remaining for decision relate to the deficiency and

penalty for 1991, viz:   (1) Whether petitioner, in 1986, was

engaged in a trade or business under section 162, so as to be

entitled to a $25,547 net operating loss carryover from 1986; (2)

whether petitioner, in 1991, was entitled to deduct expenses of

$6,471 as (a) ordinary and necessary trade or business expenses

under section 162 or (b) expenses "for the management,

conservation, or maintenance of property held for the production

of income" under section 212(2); and (3) whether petitioner is

liable for a negligence penalty under section 6662.

     We hold: (1) Petitioner was engaged in a trade or business

in 1986; (2) petitioner (a) was not engaged in a trade or

business in 1991, but (b) did incur expenses in connection with

property held for the production of income within the meaning of

section 212; and (3) petitioner is not liable for a negligence

penalty under section 6662.2




Rule references are to the Tax Court Rules of Practice and
Procedure.
     2
      See appendix for rulings on evidentiary objections.
                                 - 3 -




                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts and attached exhibits are incorporated

herein.

     When petitioner filed his petition, he resided in the

vicinity of Fairbanks, Alaska.

     Petitioner has a degree in petroleum production engineering.

Prior to beginning a drilling business in 1978, petitioner spent

approximately 20 years in the petroleum industry as a drilling

engineer.

The First Drill Rig

     In December 1978, petitioner purchased a used Hughes Auger

drill rig for $76,181 and commenced a drilling business that he

called "De Boer Drilling Co."3    Petitioner's rig, rather than

being used to drill for oil, was used to drill large diameter

foundation support holes for construction projects, as well as

the holes needed to start oil wells.     During the years 1978

through 1981, petitioner operated the drill rig on a contract

basis for oil companies and construction companies on the north

slope of Alaska.   Petitioner performed drilling work for such oil

companies as Alyeska Oil Co., Atlantic Richfield, and British

     3
      The first drill rig is a Model TAP-50, approximately 12
feet wide and 70 feet long and weighing approximately 150,000
pounds. This drill is capable of drilling to a depth of
approximately 60 feet.
                               - 4 -


Petroleum, and such construction companies as Morrison Knudsen

Corp. and Green Construction Co.

     Petitioner had no employment other than the operation of his

drilling business during 1978 through 1981.    Over a 3-year

period, 1979 through 1981, petitioner earned approximately

$300,000 in revenues from his drilling business.    Because of the

short construction season and long Alaskan winter, petitioner's

revenues were earned during a 1- to 2-month period in each of

those years.

     In September 1981, petitioner moved from Alaska to

Stavanger, Norway, to accept employment as a drilling engineer

for Mobil Oil Co. on the North Sea.    Petitioner continued to work

overseas as a Mobil employee until May 1985.    From 1981 through

1984, petitioner returned to Alaska 4 to 6 weeks each year;

during these visits he worked on his drill rig and corresponded

with potential clients.   With the exception of a 1-week rental of

the drill rig in 1982, petitioner received no revenue from De

Boer Drilling Co. while he was employed by Mobil.

The Second Drill Rig

     In May 1985, soon after completing his employment with

Mobil, petitioner returned to Alaska.   In June 1985, petitioner

purchased at auction, for $50,000, another used drill rig that

had an original list price of $650,000, and the capacity to drill
                                 - 5 -


deeper than the first rig.4   Petitioner also purchased diesel and

electric welding equipment for $3,500.   Later during the year,

petitioner purchased "Inner Kelly" equipment for use with the

recently purchased rig, at a cost of $30,962.

     Although the second drill rig was in working order when

purchased by petitioner, he spent substantial time and money

renovating it, and keeping it in working order.    From the end of

May 1985, through the beginning of July 1987, petitioner had no

employment other than his drilling operation, and devoted the

bulk of his waking hours working on the drill rig and looking for

jobs on which he could use it.    Notwithstanding that petitioner

engaged in wage-earning employment after July 1987 for various

employers (see infra p.7), he continued to spend substantial time

on activities under the name "De Boer Drilling Co."   Petitioner

spent approximately 80 percent of this time working on the drill

rig and 20 percent looking for drilling jobs.

     For the purchase price and capital costs of work done on the

second drill rig from 1985 through 1989, petitioner claimed cost

recovery deductions of approximately $88,000.   Petitioner also

claimed expense deductions for De Boer Drilling Co. of

approximately $113,000 during 1985 through 1991.   During this


     4
      The second drill rig is a Hughes Tool Co. Model TAP-120T,
also approximately 12 feet wide and 70 feet long, and weighing
approximately 150,000 pounds. This rig is capable of drilling
holes from 18 inches in diameter to 120 inches in diameter and
can dig efficiently to a depth of 120 feet.
                               - 6 -


period, petitioner filed Federal income tax returns, identifying

his occupation as "drilling contractor", with Schedule C forms

identifying the principal service as "drilling services," and the

business name as "De Boer Drilling Co."   For the years 1985

through 1991, petitioner reported gross receipts, expenses, and

losses for De Boer Drilling Co., as follows:

                 Gross                                         Net Profit
                                                         [5]
Tax Year        Receipts    Expenses      Depreciation         (Or Loss)
  1985            -0-       $16,752         $23,957            ($40,709)
  1986           $2,148      20,987          27,973             (46,812)
  1987            8,280      12,834          25,356             (29,910)
  1988            -0-        12,092          24,739             (36,831)
  1989            -0-        31,994          17,738             (49,732)
  1990            -0-        12,112            -0-              (12,112)
  1991            -0-         6,471            -0-               (6,471)


Petitioner’s net loss for 1986 was shown on his 1986 return as a

net operating loss, for which he claimed a carryover deduction in

1991.

     The gross receipts shown above for 1986 and 1987 resulted

from sales of metal well casing purchased by petitioner for

     5
      Petitioner was still claiming depreciation deductions on
the first drill rig (on a straight-line basis over 10 years)
during this period. Depreciation deductions claimed by
petitioner with respect to the first drill rig and other
equipment purchased during the period 1978-81 and the second
drill rig and related equipment purchased in 1985 are as follows:

                       Depreciation
Tax Year   First Drill Rig     Second Drill Rig                 Total
  1985         $9,514               $14,443                    $23,957
  1986          7,618                20,355                     27,973
  1987          5,618                17,738                     23,356
  1988          7,001                17,738                     24,739
  1989              0                17,738                     17,738
                                   - 7 -


$6,535 in September 1978, and on which he had claimed

depreciation deductions for the years 1978 through 1985.

Petitioner had no other receipts or gross income from De Boer

Drilling Co. for the years 1985-91.        Petitioner received and

reported wages in the following amounts on his Federal income tax

returns from 1985 through 1991:

Tax
Year          Wages      Employer                  Dates Worked      Hrs./Wk.
1985         $89,555     Mobil Exploration            1/1-5/20         50
                         Norway, Inc.

1986           7,254     Mobil expense reimbursement

1987          14,228     U.S. Army                   7/11-10/30       35
                         Everts Air Fuel             12/1-12/31       35

1988          21,639     Everts Air Fuel               1/1-12/31      35

1989          20,285     Everts Air Fuel              1/10-6/10       35
                         Craig Taylor Equip. Co.     11/11-12/31      40

1990          31,894     Craig Taylor Equip. Co.       1/1-12/31      40

1991          36,332     Craig Taylor Equip. Co.         1/1-2/15     40
                         University of Alaska           2/26-12/31    38

       In 1987, petitioner attempted to sell the second drill rig,

and entered negotiations to sell it at a price of approximately

$400,000.       However, he did not sell it.6

           During the years 1985-91, petitioner listed De Boer

Drilling Co. in the Fairbanks, Alaska yellow pages under the

heading "drilling contractors" at a cost of approximately $150 to

       6
      There is no evidence in the record as to what petitioner
did with the first rig after he bought the second rig, and all
further references herein to “the drill rig” are to the second
drill rig.
                               - 8 -


$200 per year.   Petitioner also maintained business licenses, and

submitted written proposals to provide drilling services to oil

and construction companies during the relevant period.     With the

exception of written proposals in 1992 and 1993, petitioner did

not retain written records of his efforts to find work for his

drilling operation.

     While petitioner used the drill rig to drill some holes on

his own property,7 he has never been able to obtain contracts to

use the drill rig commercially for clients.   Petitioner

attributes his inability to obtain drilling business to a general

depression in the level of economic activity in Alaska during

this period, due to the decline in oil prices.   Indeed, oil

prices did decline sharply in 1986, and thereafter, through 1991,

remained at substantially lower levels than they were at in 1984

and 1985.8


     7
      The record does not disclose the nature of petitioner's
property, which he characterizes as "commercial", and whether
petitioner's drilling on the property was merely to test
operative capabilities of petitioner's equipment or to benefit
the property.
     8
      Neither party asked the Court to take judicial notice of
the decrease in oil prices or general economic activity that
began in 1985. However, on brief and at trial, both parties
referred to a decline in oil prices during the relevant period
and appear to agree that it had a general depressing effect on
the levels of construction and general economic activity in
Alaska. Crude oil price summaries for the relevant periods are
available, and we take judicial notice of them, under Fed. R.
Evid. 201(a).

                                                    (continued...)
                                  - 9 -


     Petitioner is a skilled mechanic and engineer.      His long

hours of work on the drill rig, in the face of his inability to

find work for it, are attributable both to the profit that he

expected to earn from its operation and disposition and the

enjoyment he derived from working on the equipment, upgrading it,

and keeping it in a state of readiness.

     Petitioner reported taxable income of $35,354 and a tax

liability of $7,774 on his Federal income tax return for 1985.

However, foreign tax credits arising from petitioner's foreign

source income from his work overseas reduced that liability to

zero.    Petitioner reported no taxable income and a tax liability

of zero on each of his Federal income tax returns for the period

1986 through 1991.




     8
      (...continued)
     The largest decline in the spot price of crude oil occurred
in 1986, and the price never recovered during the relevant period
to 1984-85 levels.

     Selected domestic prices per barrel follow:

            Year                                            Price
            1984   average..................................$25.88
            1985   average.................................. 24.09
            1986   average.................................. 12.51
            1987   average.................................. 15.40
            1988   average.................................. 12.58
            1989   average.................................. 15.86
            1990   average.................................. 20.03
            1991   average.................................. 16.54

Energy Information Administration/Historical Monthly Energy
Review 1973-1992, at 249.
                                - 10 -


        Petitioner's 1985-89 Federal income tax returns were

examined by respondent.     The examination resulted in petitioner’s

receipt, in March 1992, of respondent’s no-change report and

letter with respect to his 1989 reported income and deductions.



                                OPINION

     Section 162 allows as a deduction all ordinary and necessary

expenses paid or incurred during the taxable year in carrying on

a trade or business.     Section 172(d)(4) allows section 162

deductions in excess of gross income to be carried forward as a

net operating loss for 15 years following the taxable year of the

loss.     Section 167 provides, in part, for depreciation deductions

with respect to property used in a trade or business.

     Respondent determined that petitioner did not engage in the

drilling business during the taxable years 1986 and 1991 with the

intent to earn a profit.     Respondent disallowed the deductions in

1991 attributable to petitioner's drill rig activity, maintaining

that petitioner was not in business in 1986, and that

petitioner's drilling equipment was not in business use in 1986

or 1991.

     Respondent concedes that if petitioner was engaged in

business in 1986, he incurred a net operating loss of $25,546

that he can carry forward to 1991, the year before us, without

regard to his later trade or business status and the proper
                              - 11 -


treatment of the losses he claimed for the intervening years

1987-90.   If petitioner was engaged in the drilling business in

1986, the net operating loss carryover taken as a deduction in

1991 was proper, because the loss would have been incurred in the

operation of a trade or business.   See, e.g., Swisher v.

Commissioner, 33 T.C. 506, 510 (1959).9

     Respondent maintains that the business begun by petitioner

in 1978 ended in 1981 when petitioner accepted overseas

employment, and that, upon returning from Norway, petitioner

began a new activity that never became a trade or business.

Petitioner maintains that his business continued from 1978

through 1991 and thereafter, and that his purchase of and work on

the second drill rig and efforts to obtain contracts for its use

were a continuation of his preexisting business.

     It is sometimes necessary to decide whether a taxpayer
     has terminated his business (so that expenditures to
     reenter the area are not incurred in “carrying on” the
     business) or has only suspended business activities
     temporarily, in which event the taxpayer's status
     continues for purposes of Section 162(a). [Bittker &



     9
      Respondent, in her notice of deficiency, determined that
petitioner was not engaged in business in 1986 and therefore
disallowed the net operating loss from that year. Respondent did
not determine alternatively that, even if petitioner was engaged
in a trade or business in 1986, he was not engaged in business in
the intervening years 1987 through 1990. It would follow, if
petitioner was not engaged in business or income production
during the intervening years, that petitioner's income from these
years would have absorbed the net operating loss from 1986,
leaving nothing to be carried forward to 1991. Respondent did
not make this argument, and we do not address it.
                                - 12 -


     Lokken, Federal Taxation of Income, Estates and
     Gifts, par. 20.1.6, at 20-19 (2d ed. 1989)].

Issue 1.    Whether Petitioner Was in a Trade or Business in 1986

     Expenses incurred in a trade or business are generally fully

deductible.     However, an activity must be engaged in for income

or profit in order to constitute a trade or business.

Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).         This

requires the taxpayer to have an "actual and honest objective of

making a profit."     Ronnen v. Commissioner, 90 T.C. 74, 91 (1988);

Dreicer v. Commissioner, 78 T.C. 642, 645 (1982) affd. without

pub. op 702 F.2d 1205 (D.C. Cir. 1983).       The taxpayer may have a

bona fide objective of making a profit, even if the expectation

of profit is not reasonable.     Hulter v. Commissioner, 91 T.C.

371, 393 (1988); Allen v. Commissioner, 72 T.C. 28, 33 (1979);

Dunn v. Commissioner, 70 T.C. 715, 720 (1978), affd. without

published opinion 607 F.2d 995 (2d Cir. 1979), affd. on another

issue 615 F.2d 578 (2d Cir. 1980).       Whether a taxpayer has the

requisite actual and honest objective of making a profit is a

question of fact to be resolved on the basis of all of the facts

and circumstances of the particular case.       Golanty v.

Commissioner, 72 T.C. 411, 426 (1979), affd. without published

opinion 647 F.2d 170 (9th Cir. 1981); Dunn v. Commissioner, 70

T.C. at 720.     The taxpayer bears the burden of proof on this

issue.     Rule 142(a).
                              - 13 -


     Viewing the record as a whole, we believe that petitioner,

in 1986, had a bona fide intention to derive a profit from his

drilling activity.   Petitioner had operated a successful drilling

business in 1978 through 1981, prior to accepting employment in

Norway at the end of 1981.   In the taxable years 1979 through

1981, petitioner earned approximately $300,000 in revenues from

his drilling business.   Although the record contains no direct

evidence of petitioner’s profits in 1979-81, the gross revenue

that he earned in these years must have generated profits.     The

existence of such profits can be inferred from the levels of

annual expenses in later years for which we do have evidence.

     Because petitioner's drilling operation from 1978 through

1981 had been successful, he reasonably believed that drilling

work would be available upon his return to Alaska in 1985.     Cf.

sec. 183(d).   The fact that a drop in oil prices coincided with

petitioner's attempt to reactivate the business does not weigh

against petitioner's profit objective in 1986, even if we were to

conclude, in the light of hindsight, that petitioner's

expectation of profitability was unreasonable in 1986.   Provided

petitioner had a genuine expectation of profit during 1986, as we

believe he did, the possibility or probability that it may have

been or become objectively unreasonable does not gainsay our

conclusion that petitioner was engaged in the activity for profit

in 1986.   See Stahnke v. Commissioner, T.C. Memo. 1980-369.
                                - 14 -


     Petitioner had worked full time in his drilling operation

from 1978 through 1981.   From 1981 through 1984, during the

period petitioner was working for Mobil, he returned to Alaska 4

to 6 weeks each year, during which time he worked on his drilling

equipment and corresponded with potential clients.   In 1982,

petitioner earned income from the use of his drill rig.

     In 1986, petitioner had no outside employment and did no

work other than his drilling activity.    Petitioner claims to have

devoted 3,285 hours to his drilling operation in 1986, which

amounts to more than 80 hours per week.   Even one-half of the

hours claimed by petitioner would amount to a work week for the

average individual during this year.

     We deem it unnecessary to decide whether petitioner's drill

rig activities in 1985-86 were a continuation or reactivation of

his 1978-81 trade or business, or an attempt to start a new

business, with the old business of 1978-81 having been terminated

by petitioner's full time employment overseas with Mobil.   We

conclude that, during the year 1986, petitioner engaged in the

drilling activity for profit.    Commissioner v. Groetzinger, 480

U.S. 23, 35 (1987).

     Respondent argues that the losses incurred by petitioner in

both of the years at issue, as well as the intervening years,

petitioner's lack of formal operating statements or records, and

the recreational benefit derived by petitioner from his drilling
                                - 15 -


activity are indicative of petitioner's lack of profit objective

in 1986.

     We do not find petitioner's losses after 1986 indicative of

his profit intention in 1986.    In 1986, petitioner had reasonably

expected continued success in the drilling business, based on his

earlier success.   Moreover, losses sustained because of

unforeseen circumstances, which are beyond the control of the

taxpayer, such as depressed market conditions, would not be an

indication that the activity is not engaged in for profit.     Sec.

1.183-2(b)(6), Income Tax Regs.    Petitioner maintains, and

respondent does not dispute, that there was a decline in oil

prices during the period at issue, which was largely responsible

for the overall decline in construction and drilling activity

throughout Alaska.

     Respondent argues that petitioner's activity should have

been unaffected by the decline in oil prices, because

petitioner's drilling activity consisted only of foundation work

for construction projects and oil companies.    Respondent

maintains that there was still a market for petitioner's

services.

     We find petitioner's argument more persuasive on this point.

As the figure of speech, "if it's not broken, don't fix it",

suggests, we believe that, when petitioner returned from Norway

in 1986, he conducted his drilling activity in much the same way

he had from 1978 through 1981, when he had earned large revenues
                              - 16 -


and substantial profits.   Although there had been a market for

petitioner's services in 1978 through 1981, the decline in oil

prices in 1986 resulted in a general economic decline with a

correlative reduction in construction activity during the period

after his return to Alaska, which obviously had an adverse effect

on petitioner's ability to obtain drilling contracts.

     Petitioner admits that he enjoys working on his equipment.

While petitioner's drilling activity included recreational and

personal elements, we do not find that those aspects outweighed

petitioner's profit objective.    A taxpayer's enjoyment of an

activity does not demonstrate a lack of profit objective if the

activity is, in fact, conducted for profit as shown by other

factors.   Jackson v. Commissioner, 59 T.C. 312, 317 (1972); sec.

1.183-2(b)(9), Income Tax Regs.

     Petitioner expended a great deal of money renovating his

drill rig.   We do not believe that petitioner would have embarked

on such a time-consuming, costly, labor-intensive venture without

a profit objective.   The fact that petitioner derived a level of

personal satisfaction from working on the equipment does not

belie his underlying profit objective.    Sec. 1.183-2(b)(9),

Income Tax Regs.

     Although petitioner's records of his drilling activities and

efforts to find work for the rig left much to be desired, the

absence of accurate books and records does not conclusively

establish the lack of a profit objective.    See Farrell v.
                               - 17 -


Commissioner, T.C. Memo. 1983-542.      We find petitioner's

marketing efforts more indicative of his profit objective.

Petitioner held himself out as a drilling contractor during the

relevant period by listing his business in the telephone

directory.    Also, petitioner submitted proposals to provide

drilling services to oil and construction companies.     Petitioner

actively sought contracts to use the drill rig commercially.

     Finally, we consider petitioner's financial status.

Petitioner is not a wealthy individual whose unprofitable

drilling activity would suggest an effort to shelter unrelated

income through deliberate losses.    While substantial income from

sources other than the activity may indicate that the activity is

not engaged in for profit, the fact that the taxpayer does not

have substantial income from sources other than the activity

tends to indicate that an activity is engaged in for profit.

Sec. 1.183-2(b)(8), Income Tax Regs.     The legislative history of

the Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat. 487

discloses a particular concern about wealthy individuals

attempting to generate paper losses for the purpose of sheltering

unrelated income.    See H. Rept. 91-413 (1969), 1969-3 C.B. 200,

244-245.    We have no such concerns with respect to petitioner,

particularly with respect to the year 1986, when he had no wage

income.    We do not believe that petitioner’s intention in 1986,

when he earned no wages, was to generate a large net operating

loss that he could carry to a later period.     Petitioner's
                                - 18 -


financial status, combined with the substantial amount of money

he expended in renovating the drill rig, weighs in favor of his

profit objective.

     We conclude that petitioner was engaged in a trade or

business with regard to the drill rig during 1986, and is

entitled to the net operating loss carryover deducted in 1991.

Issue 2(a). Whether Petitioner Was Engaged in a Trade or
Business in 1991

     Our finding that petitioner's activity constituted a trade

or business under section 162 in 1986 does not warrant a finding

that petitioner was engaged in a trade or business in 1991.

     If an activity is one "not engaged in for profit", section

183(a) provides that "no deduction attributable to such activity

shall be allowed", except as otherwise provided in section

     183(b).10    Petitioner has not persuaded us that he continued

to be engaged in a trade or business during 1991.

     Our finding is based on the manner in which petitioner

carried on his activity from 1987 through 1990, including part of

1991.     Because no one factor is determinative, we are most

persuaded by petitioner's continued dependence on techniques that

produced no revenue.    While losses often occur during the

     10
      First, sec. 183(b)(1) allows the full amount of those
deductions available without regard to the profit objective of
the activity. Then, sec. 183(b)(2) allows those deductions
normally permitted only if such activity was engaged in for
profit, but limits them to the amount by which the gross income
from that activity exceeds any deductions taken under sec.
183(b)(1).
                               - 19 -


formative years of a business, "the goal must be to realize a

profit on the entire operation, which presupposes not only future

net earnings but also sufficient net earnings to recoup the

losses which have meanwhile been sustained in the intervening

years."   Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965) affd.

379 F.2d 252 (2d Cir. 1967).   Before going to Norway,

petitioner's drilling activity had been successful.   Thus, when

petitioner returned from Norway in 1985, his expectation of

continued success in the drilling business was bona fide.

However, we simply are unable to impute a continuing profit

objective to petitioner, when he continued the activity that had

generated no revenue and incurred losses for a period of 6

consecutive years, without changing the manner in which he

carried it on.   Petitioner’s continued lack of revenue and

resulting losses year after year, coupled with his failure to

change his approach or terminate the activity, supports the

inference that, by 1991, he had become indifferent to whether the

losing trend could be reversed.   See Hendricks v. Commissioner,

32 F.3d 94 (4th Cir. 1994) affg. T.C. Memo. 1993-396.

     While each case is unique, and we are not willing to place a

strict length-of-time requirement on when an activity is no

longer carried on for profit, we do not think that the profit

objective petitioner had in 1986 could have continued through
                                - 20 -


1991.     We sustain respondent's determination that petitioner was

not engaged in a trade or business in 1991.

Issue 2(b). Whether Petitioner's Activity Was Engaged In For
Profit Within the Meaning of Section 212

        Having concluded that petitioner was not engaged in a trade

or business under section 162 in 1991, we consider whether, in

1991, petitioner was engaged in an activity for the production of

income under section 212.     While both sections 162 and 212 allow

a deduction for ordinary and necessary expenses, section 162(a)

requires that the expenses be paid or incurred in carrying on a

trade or business, whereas section 212 requires only that the

expenses be paid or incurred for (1) the production or collection

of income, Tybus v. Commissioner, T.C. Memo. 1989-309, or (2)

"the management, conservation, or maintenance of property held

for the production of income", sec. 212(2).

     Expenses paid or incurred in managing, conserving, or

maintaining property held for investment may be deductible under

section 212 even though the property is not currently productive.

Sec. 1.212-1(b), Income Tax Regs.     Section 212 was designed to

allow deductions for certain nontrade or nonbusiness expenses.

Lykes v. United States, 343 U.S. 118 (1952).

        The Supreme Court first interpreted section 212 in Bingham’s

Trust v. Commissioner, 325 U.S. 365 (1945).     While the Court in

Bingham’s Trust stressed the parallelism between sections 212 and

162, it held that deductible expenses need not relate directly to
                               - 21 -


the production of income for the business.    Instead, the effect

of section 23, the predecessor to section 212, was to provide for

a class of nonbusiness deductions that were incurred in the

production of income or in the management or conservation of

property held for the production of income.    Id. at 373-374.   The

Court rejected the Commissioner’s claim that expenses can be

deducted under section 23 only if they produce immediate

income.11

     Respondent does not dispute that the expenses listed on

petitioner’s tax return were paid by petitioner.   However, in her

statutory notice of deficiency, respondent maintains that no

deduction is allowable because petitioner had not placed his

drill rig into business use.   Under Bingham’s Trust, petitioner

did not need to place his drill rig into business use in 1991 in

order to be entitled to deductions for expenses incurred in

maintaining his drill rig, as long as he had a profit objective

with respect to its ultimate disposition.

     Petitioner has expended substantial amounts of money, time

and effort in the renovation and maintenance of his drill rig.


     11
      See also Bittker & Lokken, Federal Taxation of Income,
Estates and Gifts, par. 20.5.1, at 20-104 (2d ed. 1989). Bittker
& Lokken suggest that the “nonbusiness” label for sec. 212
purposes is simply an abbreviated way of referring to profit-
oriented activities that are not sufficiently frequent and
continuous to be a trade or business. Thus, it follows that sec.
162 allows deductions for expenses incurred in a trade or
business, while sec. 212 allows deductions for expenses incurred
in maintaining an income-producing asset.
                                - 22 -


The taxpayer may hope to derive a profit from an activity, and

may intend that, even if no profit is derived from current

operations, an overall profit will result when appreciation in

the value of property used in the activity is realized.    Sec.

1.183-2(b)(4), Income Tax Regs.

     Although petitioner's work on his drill rig was a source of

personal satisfaction, a drill rig would hardly qualify as a

recreational vehicle.    Profit objective is to be determined on an

objective basis.     Engdahl v. Commissioner, 72 T.C. 659, 666

(1979).   A drill rig drills holes in the ground for purposes of

starting wells or foundations of improvements to real property.

Thus, we do not characterize a drill rig as a recreational

vehicle, as we would a motorcycle or sports car.    Section 1.212-

1(b), Income Tax Regs., provides in relevant part, that the term

"income" includes income that the taxpayer may realize in

subsequent taxable years, and is not confined to recurring

income, but applies as well to gains from the disposition of

property.   We thus find that, during 1991, petitioner's drill rig

was property held for the production of income within the meaning

of section 212.

     Petitioner maintains that his drill rig has a present value

of $500,000 to $750,000.    The value of a capital asset is a

function of the stream of income that it can produce, and

petitioner has failed to produce any revenue through the use of

the drill rig.     Nevertheless, we are persuaded that the expenses
                               - 23 -


incurred by petitioner in 1991 were "ordinary and necessary" in

helping to maintain the appreciated value of petitioner's drill

rig, whose original $50,000 basis had been reduced to zero by

depreciation deductions allowed.

       Respondent questions the reasonableness of petitioner's

estimate of value, particularly because petitioner did not

present appraisals or expert testimony of the value of the drill

rig.    Petitioner testified, however, that he was in negotiations

to sell the drill rig in 1987 for approximately $400,000.    Even a

lesser increase in value would still provide petitioner with a

substantial profit, without the benefit of depreciation

deductions.    See Lemmen v. Commissioner, 77 T.C. 1326, 1343

(1981).    Even though petitioner's opinion regarding the value of

his drill rig may be overly optimistic, there appears to be some

substantial likelihood that petitioner will eventually realize

some profit from the sale of the drill rig.    We thus find that

petitioner has proven his intention to realize a profit from the

time and effort expended on maintenance of the drill rig, at

least with respect to its ultimate sale.    The lack of expert

testimony regarding the value of the drill rig speaks only to the

extent of its appreciation.

       Respondent argues that petitioner did not "hold" his drill

rig with the primary objective of making a profit.    However, even

if this were true, section 212(2) allows a deduction for expenses

paid or incurred for the management, conservation, or maintenance
                              - 24 -


of property held for the production of income.   Respondent

appears to assert that the objective of "making a profit" is the

same as the objective of "producing income."   So restrictive an

interpretation would be unwarranted.   The Code is replete with

instances in which the expression "taxable income" is used to

refer only to receipts remaining after deduction of expenses.

See, e.g., secs. 63, 161.   Hartford v. United States, 265 F.

Supp. 86 (W.D. Wis. 1967)(expenses incurred in the maintenance of

rental property were deductible under section 212, even though

the expenses exceeded receipts from the rental).   Section 212

refers to property held for the production of income, not

property held for the production of current taxable income.

Respondent cites no authority to support her view that "income"

in section 212 is to be so limited to current taxable income.

Property held for the production of income does not require that

the property be currently productive, but instead includes

property held for the production of income from gain from its

sale.   See Robinson v. Commissioner, 2 T.C. 305 (1943)(upkeep

expense and depreciation deductions allowed on a vacant building

that could not be currently rented).

     In Ray v. Commissioner, T.C. Memo. 1989-628, we held that

where a taxpayer claims to hold property for investment purposes,

there must be some affirmative act on the part of the taxpayer to

show that the property has been appropriated to an income-

producing purpose.   Because the property at issue in Ray was real
                               - 25 -


property that had appreciated in value without any affirmative

act by the taxpayer, we held that expenses incurred by the

taxpayer were not expenses incurred for the management,

conservation, or maintenance of property held for the production

of income.

     The case at hand is distinguishable from Ray.    We believe

that petitioner's actions have caused his drill rig to appreciate

in value.    A major purpose of petitioner in continuing to expend

the time, money, and effort on maintaining the drill rig in 1991

was to enhance the likelihood of obtaining a return on his

investment if and when he should subsequently sell the drill rig.

We hold that all expenses listed on Schedule C, for the tax year

1991, which we find were attributable to the management,

conservation, or maintenance of petitioner's drill rig, to be

properly deductible under section 212.

     Under section 67, in the case of an individual, the

miscellaneous itemized deductions for any taxable year are

allowed only to the extent that the aggregate of such deductions

exceeds 2 percent of adjusted gross income.   Section 1.67-

1T(a)(1)(ii), Temporary Income Tax Regs., 53 Fed. Reg. 9875 (Mar.

28, 1988) provides the deduction under section 67 includes

expenses for the production or collection of income for which a

deduction is otherwise allowable under section 212(1) or (2).

Thus, petitioner's allowable deduction for 1991 is subject to the
                               - 26 -


2-percent limitation of section 67, and account should be taken

of the limitation in the Rule 155 computation.

Issue 3.    Section 6662 Negligence Penalty

       Respondent determined that petitioner is liable for a

penalty for negligence pursuant to section 6662(a), (b)(1) and

(c).    Section 6662(a) imposes a penalty of 20 percent of the

portion of the underpayment to which section 6662 applies.

Section 6662(b)(1) provides a penalty for negligence or

intentional disregard of rules or regulations.    Section 6662

defines "negligence" as including any failure to make a

reasonable attempt to comply with the provisions of the Code.

       Negligence is defined as the lack of due care or the failure

to do what a reasonable and ordinarily prudent person would do

under similar circumstances.    Anderson v. Commissioner, 62 F.3d

1266, 1271 (10th Cir. 1995), affg. T.C. Memo. 1993-607; Norgaard

v. Commissioner, 939 F.2d 874, 880 (9th Cir. 1991), affg. in part

and revg. in part on other grounds T.C. Memo. 1989-390.

Petitioner bears the burden of proving that respondent's

determination of negligence is erroneous.     Rule 142(a); Allen v.

Commissioner, 925 F.2d 348, 353 (9th Cir. 1991); Bixby v.

Commissioner, 58 T.C. 757, 791-792 (1972).

       We have held for petitioner on the substantive issues of the

net operating loss carryover from 1986 and the 1991 expense

deductions, which remove both from consideration as a possible

source of support for respondent's determination of negligence.
                               - 27 -


However, on his 1991 return, petitioner deducted the entire

amount of expenses incurred in 1991 as trade or business

expenses.   We have determined that petitioner's deductions for

1991 are allowed only as expenses incurred in the production of

income under section 212, subject to the 2-percent limitation

imposed by section 67.

     We find no affirmative evidence of negligence or disregard

of the rules or regulations.    We have found petitioner to be an

intelligent and credible witness.    Even a taxpayer well-versed in

the Code requirements for carrying on a trade or business often

encounters difficulty in determining what would satisfy the

requirements.   We find that petitioner was acting in reasonable

good faith when he concluded that the items in question were

deductible as trade or business expenses.    Sec. 6664(c)(1); see

Kasey v. Commissioner, 54 T.C. 1642 (1970), affd. per curiam 457

F.2d 369 (9th Cir. 1972).

     While we have disagreed with petitioner's characterization

of his expenses for 1991, and found his claims of business

expense deductions to be incorrect, petitioner had a reasonable

basis for his claims.    After audit, petitioner received a no-

change letter in March 1992 for the taxable year 1989, stating

that petitioner’s business deductions for that year were proper.

Petitioner timely filed his 1991 Federal income tax return in

April 1992, shortly after receipt of the no-change letter.    It

was reasonable for petitioner to rely on the no-change letter as
                              - 28 -


an indication of respondent’s agreement that he continued to be

engaged in a trade or business, see Matthews v. Commissioner, 92

T.C. 351, 363 (1989) affd. 907 F.2d 1173 (D.C. Cir. 1990), even

though the letter does not require the conclusion that he was so

engaged.   See infra note 12, appendix.

     Accordingly, we decline to sustain the imposition of any

penalty under section 6662(a), (b), and (c).

     To reflect the foregoing,




                                          Decision will be

                                    entered under Rule 155.
                              - 29 -




                             Appendix

     The Federal Rules of Evidence generally apply to proceedings

in this Court.   Sec. 7453; Estate of Shafer v. Commissioner, 80

T.C. 1145, 1151 (1983), affd. 749 F.2d 1216 (6th Cir. 1984).

Issue (a). Exhibits 6 and 7, Income Tax Examination Changes and
No-Change Letter For 1989

     Respondent objects to the admission of the 1989 income tax

examination report and no-change letter.   Citing Gordon v.

Commissioner, 63 T.C. 51, 78 (1974), respondent maintains that

the fact that there was no change to petitioner's 1989 reported

income is irrelevant to the issues in this case.   We disagree.

     Rule 401 of the Federal Rules of Evidence provides that a

statement is relevant if it has "any tendency to make the

existence of any fact that is of consequence to the determination

of the action more probable or less probable than it would be

without the evidence."   In Gordon, we agreed with the

Commissioner that the amount of unreported wagering income

determined by the Commissioner in a specific year was not

dependent upon the taxpayer's activities in earlier years.     While

the years at issue in the case at hand are 1986 and 1991, we

also consider petitioner's activities during the intervening

years to determine whether petitioner carried on a trade or

business in 1991.
                                - 30 -


     Petitioner claimed deductions in 1989 for depreciation and

other expenses related to his drilling operation.   Respondent,

after audit, concluded that petitioner's return for the tax year

1989 should be accepted with no change in the reported taxable

income for that year.   Respondent's concession is an admission

that has a tendency to show that petitioner was engaged in a

trade or business in 1989.   Exhibits 6 and 7 are relevant to

whether petitioner was engaged in a trade or business in 1991.12

Issue (b).   Exhibits 8 and 9, Income Tax Examination and Report
for 1991

     Respondent objects to the admission of the 1991 income tax

examination and report.   Respondent relies on Dellacroce v.

Commissioner, 83 T.C. 269, 280 (1984), and Greenberg's Express,

Inc. v. Commissioner, 62 T.C. 324, 327 (1974), for the

proposition that the Tax Court generally does not look behind the

statutory notice of deficiency to examine the basis of the

Commissioner's determination.    Petitioner asserts that Exhibits 8



     12
      We should note that the no-change letter issued by
respondent for the tax year 1989 is not controlling evidence that
petitioner was engaged in a trade or business in that year. For
respondent's no-change letter to be binding, petitioner must show
the elements of estoppel, Fitzpatrick v. Commissioner, T.C. Memo.
1995-548, or that the no-change letter amounted to a closing
agreement. Respondent's audit and resulting no-change letter
occurred in 1992, after the relevant period. Thus, petitioner
could not have detrimentally relied on the no-change letter, a
key condition which a taxpayer claiming estoppel against the
Government must satisfy, Boulez v. Commissioner, 76 T.C. 209, 215
(1981) affd. 810 F.2d 209 (D.C. Cir. 1987), in continuing his
drilling activity. However, we have taken the letter into
account in assessing the reasonableness of petitioner’s return
position for the purpose of the sec. 6662 penalty.
                                - 31 -


and 9 explain why adjustments were made with respect to

petitioner's tax liability for 1991, and how respondent

calculated the deficiency at issue.

     We agree with respondent.    A trial before the Tax Court is a

proceeding de novo.     Greenberg's Express, Inc. v. Commissioner,

supra at 328.   Our decision in this case must be based on the

record of the case, not the record developed at the

administrative level.    See O'Dwyer v. Commissioner, 28 T.C. 698,

702-704 (1957), affd. 266 F.2d 575, 581 (4th Cir. 1959).

Inasmuch as petitioner has not shown that respondent's deficiency

determination was arbitrary and erroneous, or that the

determination was not supported by the proper foundation

evidence, see Weimerskirch v. Commissioner, 596 F.2d 358, 362

(9th Cir. 1979) revg. 67 T.C. 672 (1977), it is inappropriate for

us to look behind the deficiency notice to examine the basis for

respondent's determination.

Issue (c).   Exhibit 10, IRS Settlement Proposal

     Respondent objects to the admission of an offer in

settlement sent by an IRS Appeals officer to petitioner.    Rule

408 of the Federal Rules of Evidence renders inadmissible any

evidence of conduct or statements made in negotiations to

compromise a claim.   Petitioner relies on the third sentence of

Rule 408, which provides that the rule does not require "the

exclusion of any evidence otherwise discoverable merely because

it is presented in the course of compromise negotiations."    There
                               - 32 -


is nothing in respondent's settlement offer that was "otherwise

discoverable" within the meaning of rule 408.    We agree with

respondent and have not considered the Appeals officer's

settlement proposal for any purpose.

Issue (d).   Exhibits J and K, Petitioner's 1992 and 1993 Tax
Returns

     Petitioner objects, on the ground of lack of relevance, to

the admission of his 1992 and 1993 Federal income tax returns.

Respondent maintains that petitioner's returns for the years 1992

and 1993 are evidence that petitioner is still earning no revenue

from his drilling activity.    This, respondent argues, is relevant

to the determination of whether petitioner carried on a trade or

business.    Petitioner maintains that the years covered in this

case include years prior to 1992, and evidence relating to

whether he maintained a trade or business should be limited to

those years.

     We agree with respondent.    The tax years before this Court

are 1986 and 1991.    Respondent seeks admission of the 1992 and

1993 tax returns for the purpose of showing that De Boer Drilling

Co. continued to earn no revenue.    This evidence is relevant to

whether petitioner was engaged in a trade or business in 1991,

the immediately preceding year.
