                        T.C. Memo. 1997-553



                      UNITED STATES TAX COURT



       RODNEY W. TARAS AND LINDA K. TARAS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 12177-93.                Filed December 18, 1997.



     Marc S. Fisher, for petitioners.

     Michael D. Baker, for respondent.


              MEMORANDUM FINDINGS OF FACT AND OPINION


     RUWE, Judge:   Respondent determined deficiencies in

petitioners' Federal income taxes and additions to tax as

follows:

                                              Addition to Tax
       Year           Deficiency              Sec. 6651(a)(1)

       1987           $8,053.15                  $1,873.11
       1988            8,904.00                   2,192.75
       1989            6,269.00                   1,572.00
       1990            8,970.00                   2,300.42
                               - 2 -

     After concessions,1 the issues remaining for decision are:

(1) Whether petitioners' horse racing and breeding activity

during 1987, 1988, 1989, and 1990 was an activity "not engaged in

for profit" within the meaning of section 183; and (2) whether

petitioners are liable for additions to tax pursuant to section

6651.2


                         FINDINGS OF FACT


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

The stipulation of facts and second stipulation of facts are

incorporated herein by this reference.   At the time the petition

was filed, petitioners resided in Walnutport, Pennsylvania.

     During the years at issue, Ms. Taras was employed as a full-

time secretary in the accounting department at Bethlehem Steel

Corp. (Bethlehem).   Ms. Taras worked 40 hours per week at

Bethlehem.   On their 1987, 1988, 1989, and 1990 Federal joint

income tax returns, petitioners reported gross income from

Bethlehem in the amounts of $26,690, $27,458, $29,576, and

$31,804, respectively.




     1
      Petitioners concede that the notice of deficiency for 1987
improperly allowed a gambling loss deduction in the amount of
$3,701, thereby erroneously reducing taxable income by $3,701.
     2
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                                 - 3 -

     During the years 1980 through 1995, Mr. Taras owned and

operated a framing and truss fabrication business in Walnutport,

Pennsylvania.   As a framing contractor, Mr. Taras employed and

supervised as many as 5 to 10 employees whose primary function

was to frame houses and fabricate trusses.    On Schedule C, Profit

or (Loss) From Business or Profession, petitioners reported net

income of $33,283, $32,261, $25,517, and $38,926 from the framing

and truss fabrication business for 1987, 1988, 1989, and 1990,

respectively.

     Mr. Taras grew up on his family’s farm.    During those years,

the family farm had horses as did other farms on which Mr. Taras

worked when he was a teenager.    In 1980, petitioners lived on a

1-acre parcel of land that is adjacent to a 2-acre parcel owned

by Mr. Taras’ parents.    Petitioners kept their horses on the 2-

acre parcel during the years at issue.

     Prior to 1980, petitioners made plans to begin racing and

breeding horses.   Petitioners did not have any experience in

racing or breeding horses.    Petitioners' plan generally consisted

of a desire to purchase racehorses, race those horses, and

thereafter to breed their horses in an effort to eventually race

the horses they bred.    In the summer of 1979, petitioners

contacted Ms. Audrey Kraynik, who represented that she was the

only female licensed horse trainer in Pennsylvania and that she

had trained horses for a number of years.    Petitioners did not

consult with anyone other than Ms. Kraynik and her two personal
                                - 4 -

references before they started their horse racing activity.    Upon

the recommendation of Ms. Kraynik, petitioners purchased a horse

named Stand Away in 1979 and seven horses in 1980 named Dublin

Bay, Captain’s K, Liberty Knoll, Bad Memories, Naughty Castle,

Distinctive Jet, and Talitha.    All these horses, with the

possible exception of Distinctive Jet, were purchased by

petitioners for a total original investment of approximately

$65,000.

     In 1983, petitioners and Ms. Kraynik became involved in a

dispute over the ownership of Distinctive Jet, which was

eventually resolved in 1987.    As a result of the dispute,

petitioners lost any ownership rights in Distinctive Jet and,

therefore, were unable to register any of the foals of

Distinctive Jet or use them for racing or breeding purposes.

     In 1980 and 1981, while petitioners were operating their

horse racing activity, a number of their horses were injured.

Liberty Knoll broke a bone in her leg and subsequently died;

Talitha suffered cuts from jumping out of a trailer while being

transported; Bad Memories suffered bone chips in her knee;

Captain's K developed tendon problems; and Naughty Castle

suffered injuries to her leg and foot.    Petitioners had purchased

Liberty Knoll for $11,000, Talitha for $2,500, Bad Memories for

$5,000, Captain's K for $10,000, and Naughty Castle for $10,500.

Several of petitioners' other horses suffered injuries as well.

In 1983, Ruth Ann K suffered internal lacerations while giving
                               - 5 -

birth; in 1994 or 1995, Traders K suffered internal injuries

related to complications with an unborn foal; and Tekla Tekla Two

and Captain Konik developed leg and knee problems.

     Sometime in 1981, in an effort to obtain information on

breeding race horses, Mr. Taras contacted Mr. Tom Regal and Mr.

Paul Mills, who each had experience in breeding horses.     Mr.

Regal and Mr. Mills both owned ranches in Pennsylvania, where

each had his own breeding operation.     Petitioners also joined the

Pennsylvania Breeders Association and began subscribing to

magazines and publications regarding the breeding of horses.

     Petitioners hired a number of professionals to assist them

in training, boarding, and caring for their horses.     Petitioners

hired licensed trainers including:     Ms. Audrey Kraynik, who

trained petitioners’ horses between 1980 and 1981; Mr. Keith

Lebaron, who trained their horses in 1982, 1983, 1985, 1989, and

1990; Mr. William Summers, who trained their horses for a brief

period of time; Mr. Leslie Vegh, who trained their horses in 1991

and 1992; and Mr. Rusty Albright, who trained petitioners' horses

from 1993 to the time of trial.   These trainers also fed and

cared for petitioners' horses during the period they trained

them.   Petitioners also hired veterinarians to care for their

horses.

     Petitioners each spent time working on their horse racing

and breeding activity.   Mr. Taras made improvements to the
                                 - 6 -

adjacent property, including a small barn and seven stalls, and

enclosed the area with fencing.    Later, a 20-stall barn was

built.   In an effort to reduce expenses during the years at

issue, petitioners increased the number of hours each spent

working on their horse activity.    They performed simple

veterinary tasks such as worming the horses and giving them

shots.   Petitioners began buying veterinary supplies from

different catalogs rather than tack shops and boarding their

horses on the adjacent 2-acre parcel when they were not racing.

Also during the years at issue, petitioners eliminated their farm

help and performed by themselves such activities as cleaning the

stalls and feeding and grooming the horses.

     Ms. Taras maintained the books and records of petitioners’

horse racing and breeding activity.      Petitioners offered a

detailed summary of expenses associated with their activity,

which included monthly expenses for feed, veterinarians,

trailering, jockey club fees, tack, boarding, farriery, breaking,

training, stud services, legal fees associated with the activity,

and other miscellaneous items.    Ms. Taras also kept a summary of

the dates they acquired their horses, the purchase prices, and

the proceeds received if a horse were sold.3     These records also


     3
      The following is a list of the horses purchased and the
calculation of gain or loss on each horse:


                                                       (continued...)
                               - 7 -

describe whether the horses were used for breeding or racing and

the amount of their winnings, if any.    Petitioners records

indicate that the income and expenses related to their horse

activity over the years from 1980 to 1995 resulted in gross

income of $76,648, expenses of $541,782, and a net loss of

$465,134.4   From time to time, petitioners used the books and



     3
      (...continued)
  Horse's         Year        Purchase       Sale
   Name         Purchased      Price       Proceeds    Gain/loss

Dublin Bay          1980       $6,500        $500       ($6,000)
Captain's K         1980       10,000         -0-       (10,000)
Liberty Knoll       1980       11,000         -0-       (11,000)
Bad Memories        1980        5,000         -0-        (5,000)
Naughty Castle      1980       10,500         110       (10,390)
Distinctive Jet     1980        2,500         -0-        (2,500)
Talitha             1980        2,500         380        (2,120)
Royale Finale       1981          900         -0-          (900)
Hermit's Glory      1981        1,637         -0-        (1,637)
Fab's Last          1981        1,637         600        (1,037)
Ruth Ann K          1982        1,000         -0-        (1,000)
Kings Linn          1983        5,000       3,200        (1,800)
Anda                1983        2,500         300        (2,200)
Kashmir             1983         -0-          -0-          -0-
Thaddius            1983         -0-          500           500
Snickers            1983         -0-          200           200
Tamara              1983         -0-          315           315
Scoundrel           1984         -0-          260           260
Filly             unknown        -0-          440           440
Colt              unknown        -0-          140           140
2 fillies         unknown        -0-          290           290
Dublin Bay's        1986         -0-          425           425
  colt
Anda's colt           1987       -0-          300           300
2 colts               1988       -0-        1,000         1,000
Apple Writer          1990      2,000         500        (1,500)

  Total                       $62,674      $9,460       ($53,214)
     4
      See appendix.
                                - 8 -

records to determine what, if any, income and expenses they had

in connection with their horse activity.

     Petitioners also maintained records on the breeding of each

of their horses.    Beginning in 1982, petitioners bred the horses

they purchased.    Later, during 1991 and 1992, petitioners bred

their mares Traders K, Angular Pleasure, Bad Memories, and Its

Legit to the stallion Tagish for a stud fee of $2,000 each.

During 1993, petitioners bred their mares Its Legit and Angular

Pleasure to the stallion Deerhound for a stud fee of $2,500 each.

Angular Pleasure was again bred to Deerhound in 1994 for a stud

fee of $3,000.    Finally, petitioners bred their mares Traders K

and Tekla Tekla Two to the stallion Norquestor for a stud fee of

$3,500 each.

     As a result of petitioners’ having bred their mares to the

above-mentioned stallions, a number of foals have been produced.

By breeding their mares to Norquestor, petitioners had produced,

at the time of trial, one horse of racing age and two yearlings.

Petitioners estimate an average value of $15,000 for each of

their foals bred from Norquestor.

     The property upon which petitioners maintained their horse

operations and their horses was not open to the public.

Petitioners did not ride the horses themselves nor allow others,

except for professional trainers, to ride their horses.
                                - 9 -

Petitioners attended horseraces, watched their horses race, and

gambled on horses at various times.

     During the years at issue, petitioners filed their tax

returns after the due date for each year.      Petitioners filed

their tax returns for the tax years 1987, 1988, and 1989 on

August 23, 1991, and their tax return for the tax year 1990 on

June 19, 1992.    On March 15, 1993, respondent mailed petitioners

a notice of deficiency for each of the taxable years 1987, 1988,

1989, and 1990.

                               OPINION


     The first issue we must decide is whether petitioners' horse

racing and breeding operation was an activity "not engaged in for

profit" as defined in section 183.      Section 183(a) provides

generally that no deduction attributable to an activity which is

not engaged in for profit is allowed except as provided in

section 183(b).   Section 183(b)(1) allows those deductions which

are otherwise allowable regardless of profit objective.      Section

183(b)(2) allows those deductions which would be allowable if the

activity were engaged in for profit, but only to the extent that

gross income attributable to the activity exceeds the deductions

permitted by section 183(b)(1).   Section 183(c) defines "activity

not engaged in for profit" as "any activity other than one with

respect to which deductions are allowable for the taxable year

under section 162 or under paragraph (1) or (2) of section 212."
                              - 10 -

     Deductions are allowed under section 162 for the ordinary

and necessary expenses of carrying on an activity which

constitutes the taxpayer's trade or business.   Deductions are

allowed under section 212 for expenses paid or incurred in

connection with an activity engaged in for the production or

collection of income, or for the management, conservation, or

maintenance of property held for the production of income.    With

respect to either section, the taxpayer must demonstrate a profit

objective for the activities in order to deduct associated

expenses.   See Agro Science Co. v. Commissioner, 934 F.2d 573,

576 (5th Cir. 1991), affg. T.C. Memo. 1989-687; Antonides v.

Commissioner, 893 F.2d 656, 659 (4th Cir. 1990), affg. 91 T.C.

686 (1988); Allen v. Commissioner, 72 T.C. 28, 33 (1979);

Jasionowski v. Commissioner, 66 T.C. 312, 320-322 (1976); Rand v.

Commissioner, 34 T.C. 1146, 1149 (1960); sec. 1.183-2(a), Income

Tax Regs.   While a reasonable expectation of profit is not

required, a taxpayer's profit motive must be bona fide.     Simon v.

Commissioner, 830 F.2d 499, 500 (3d Cir. 1987), affg. T.C. Memo.

1986-156.

     Respondent argues that for purposes of section 183, a

taxpayer must prove that profit was the primary purpose for

engaging in the activity.   In Simon v. Commissioner, supra at

500, the Court of Appeals for the Third Circuit, the court to

which this case is appealable, stated:
                              - 11 -


          It is well established that in order to take a
     deduction for expenses incurred in carrying out a trade
     or business the taxpayer must have entered into the
     venture with the primary and predominant purpose and
     objective of making a profit. See Thomas v.
     Commissioner, 792 F.2d 1256, 1259 (4th Cir. 1986);
     Tallal v. Commissioner, 778 F.2d 275, 276 (5th Cir.
     1985). "Primary" in this context means "of first
     importance" or "principally", while "profit" means
     economic profit independent of tax savings. Malat v.
     Riddell, 383 U.S. 569, 572 (1966); accord, Surloff v.
     Commissioner, 81 T.C. 210, 233 (1983); Seaman v.
     Commissioner, 84 T.C. 564, 588 (1985). * * *[5]


The existence of the requisite profit objective is to be

determined by examining all the facts and circumstances, giving

greater weight to objective facts than to the taxpayer's

statement of intent.   Siegel v. Commissioner, 78 T.C. 659, 699

(1982); sec. 1.183-2(a) and (b), Income Tax Regs.   Section 1.183-

2(b), Income Tax Regs., lists nine nonexclusive factors relevant

to the issue of profit objective.6


     5
      The Supreme Court also addressed the standard to be applied
when it stated: "We accept the fact that to be engaged in a
trade or business, the taxpayer must be involved in the activity
with continuity and regularity and that the taxpayer's primary
purpose for engaging in the activity must be for income or
profit." Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).
     6
      In order to determine whether, and to what extent, sec. 183
and the regulations thereunder apply, the activity or activities
of the taxpayer must be ascertained. Sec. 1.183-1(d)(1), Income
Tax Regs. Generally, the Commissioner will accept the
characterization by the taxpayer of several undertakings as
either a single activity or separate activities. Id.
Petitioners have treated their horse racing and breeding
operations as one activity, and respondent has accepted this
treatment.
                                                   (continued...)
                                - 12 -

     Section 1.183-2(b), Income Tax Regs., contains a

nonexclusive list of objective factors to be considered in

deciding whether an activity is engaged in for profit.      The

factors are:    (1) The manner in which the taxpayer carries on the

activity; (2) the expertise of the taxpayer or the taxpayer's

advisers; (3) the time and effort expended by the taxpayer in

carrying on the activity; (4) the expectation that assets used in

the activity may appreciate in value; (5) the success of the

taxpayer in carrying on 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)

elements of personal pleasure or recreation.     Allen v.

Commissioner, supra at 33.    No single factor is determinative.

Petitioners have the burden of proving that they had the

requisite profit objective and that respondent's determination is

incorrect.     Welch v. Helvering, 290 U.S. 111 (1933).


Businesslike Manner


     The fact that a taxpayer carries on the activity in a

businesslike manner and maintains complete and accurate books and




     6
      (...continued)
                               - 13 -

records may indicate that the activity was engaged in for profit.

Sec. 1.183-2(b)(1), Income Tax Regs.

     Petitioners kept books and records for their horse racing

and breeding activity.    Petitioners kept detailed ledgers by date

and check number in which they tracked monthly expenses.

     Petitioners' detailed bookkeeping does not, by itself,

demonstrate an intent to generate a profit.    Golanty v.

Commissioner, 72 T.C. 411, 430 (1979), affd. without published

opinion 647 F.2d 170 (9th Cir. 1981).    A lack of profit objective

may exist where a taxpayer fails to abandon unprofitable methods,

change operations, or adopt new techniques in an attempt to

improve profitability.    Sec. 1.183-2(b)(1), Income Tax Regs.

Accordingly, the maintenance of detailed books and records may

reveal the mere "trappings" of a profit objective, particularly

when a taxpayer fails to produce income statements, profit plans,

or business plans created to alter operations in an attempt to

reverse mounting losses.    Osteen v. Commissioner, T.C. Memo.

1993-519, affd. in part and revd. in part 62 F.3d 356 (11th Cir.

1995).

     Petitioners contend that before conducting any racing or

breeding activities, they consulted with individuals who had

experience in racing horses who helped them establish a business

plan.    Petitioners also argue that since commencing their
                              - 14 -

activity, they have attempted to increase profitability by

reducing expenses.

     Although petitioners sought advice from several successful

horse trainers and breeders, their testimony in this regard was

vague and the meetings yielded no concrete plan of operation.

Petitioners decided to commence their activity with little

concept of the expenses involved or of the steps required to

achieve cost efficiency and an eventual profit.    See Daley v.

Commissioner, T.C. Memo. 1996-259.

     With respect to petitioners’ assertion that they constantly

analyzed and modified their business plan and operation in order

to minimize expenses, petitioners have failed to introduce

specific credible evidence to indicate that increased profit

potential would result.   The record shows that expenses over 16

years of operating their horse racing and breeding activity have

generally remained constant or increased.7   Petitioners assert

that they reduced veterinary expenses between 1987 and 1990 and

reduced expenses by boarding their horses at their property as

part of a plan to increase profitability.    The record shows a

reduction of veterinary expenses in those years, but veterinary

expenses for the 7 years prior and 5 years after that period have

remained constant or increased as time passed.    Moreover,

veterinary expenses account for less than 10 percent of overall


     7
      See appendix.
                               - 15 -

expenses in all years.   Even assuming that petitioners were able

to reduce their board and veterinary expenses to zero for all

years, total losses would have only been reduced by approximately

40 percent.    In the face of successive or increasing losses,

petitioners have failed to materially alter their operations or

their prospects of generating profits.    Golanty v. Commissioner,

supra at 428.


Expertise


     Preparation for an activity by extensive study of its

accepted business, economic, and scientific practices, or

consultation with those who possess expertise in the activity,

may indicate that the taxpayer has a profit objective.    Sec.

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

     Mr. Taras grew up on a farm and worked with horses during

those years.    Mr. Taras also became a member of the Pennsylvania

Breeders Association and educated himself through industry

publications.    Petitioners sought out, consulted with, and hired

professional racehorse trainers and breeders throughout the years

of operation of their activity.    Petitioners followed the advice

of Ms. Audrey Kraynik, who represented that she was a licensed

trainer experienced in training racehorses.    With respect to the

breeding of their horses, petitioners consulted with two horse
                               - 16 -

breeders, Mr. Tom Regal and Mr. Paul Mills.     Petitioners sought

and received professional training and breeding advice.


Time Devoted to the Activity


     The fact that a taxpayer devotes much of his personal time

and effort to carrying on an activity may indicate an intention

to derive a profit.    Sec. 1.183-2(b)(3), Income Tax Regs.

     Petitioners contend that they personally devoted a

substantial amount of time to the activity.     Ms. Taras testified

that she spent approximately 30 hours per week on projects

related to the activity, including:     Bookkeeping, feeding the

horses, cleaning the stalls, and exercising the horses.     Mr.

Taras testified that during the years at issue, he spent

approximately 39 to 45 hours per week taking care of the horses,

feeding and exercising the horses, and performing routine

veterinary services.

     During the period in which petitioners each claim they spent

a large number of hours on their horse activity, they also

participated in other time-demanding activities.     Mr. Taras has

owned and managed a framing and truss fabrication business in

which he employed and managed between 5 and 10 persons to help

him do on-site framing of homes and fabrication of trusses while

he claimed to have worked approximately 40 or more hours per week

on petitioners' racehorse activity.     Similarly, Ms. Taras worked
                              - 17 -

at a full-time job requiring 40 hours per week at Bethlehem,

while claiming that she contributed 30 hours per week year after

year in petitioners' horse activity.


Expectation That Assets May Appreciate


     The appreciation of assets, including land used in the

activity, is to be considered in determining whether a taxpayer

intended to derive a profit from his activity.   Sec. 1.183-

2(b)(4), Income Tax Regs.   An expectation that assets used in the

activity may appreciate may be an indication of profit objective.

Engdahl v. Commissioner, 72 T.C. 659, 669 (1979).

     Petitioners resided on a 1-acre parcel of land during the

years in issue.   Petitioners maintained their horses on a

separate but adjacent 2-acre parcel of land, which was owned by

Mr. Taras' parents.   Because petitioners do not own the land upon

which they kept their horses during the years at issue, we do not

consider the land an asset that may be used in determining

whether petitioners had a profit objective.

     Petitioners’ horses were the only assets used in the

activity that might have appreciated.    Petitioners argue that the

quality of their horses improved over time and that on the basis

of this improvement, petitioners expected to recoup their prior

losses.   Mr. Taras testified that each of three horses bred from

the stallion Norquestor and owned by petitioners has a value of
                               - 18 -

"close to $15,000."   Petitioners' net losses from their horse

operation total $465,134 for all the years of operation.8    In

1995, petitioners reported a loss from their horse activity of

$57,291.   At the time of trial, petitioners had sold or disposed

of 25 horses and realized an overall loss of $53,205 on the sale

of those horses over the course of 15 years.   Of the 25 horses

disposed of, petitioners realized a gain on 12 of the horses.

The total gain realized on the combined sale of all 12 horses was

$3,870.    Of the 12 horses on which gain was reported on sale, no

more than $500 of gain was reported on any single sale.9    Even if

petitioners' three most valuable horses were sold for the maximum

amount that petitioners believe they are worth, it would still

not offset the losses reported from their horse activity in 1995.

It is, therefore, unlikely that petitioners will generate profits

on the sale of their horses in the near future that would recoup

more than a fraction of the past or current losses.


Past Successes in Activity


     The fact that a taxpayer has engaged in similar activities

in the past and converted them from unprofitable to profitable

enterprises may indicate that he is engaged in the present


     8
      See appendix.
     9
      In 1988, petitioners sold two colts which they bred for
$1,000. We assume that the proceeds were allocated pro rata
between the two horses sold.
                               - 19 -

activity for a profit, even though the activity is presently

unprofitable.   Sec. 1.183-2(b)(5), Income Tax Regs.   Petitioners

have offered no evidence that before commencing their horse

racing and breeding activity, they had engaged in similar

activities that were profitable.


History of Income and Losses


     A taxpayer's history of income, losses, and occasional

profits with respect to an activity may indicate the presence or

absence of a profit objective.     Golanty v. Commissioner, 72 T.C.

at 426; sec. 1.183-2(b)(6), Income Tax Regs.    Respondent contends

that petitioners consistently incurred losses on their horse

racing and breeding activity over many years, indicating that

they did not have the requisite profit objective.

     A horse racing and breeding activity may be deemed to be

engaged in for profit despite consistent losses during the

initial startup phase.   Golanty v. Commissioner, supra at 427.

We have previously found that the startup phase for an activity

involving horses may be between 5 and 10 years.     Engdahl v.

Commissioner, supra at 669; Phillips v. Commissioner, T.C. Memo.

1997-128.   Losses sustained beyond the period normally required

to generate profits may be an indication of a lack of profit

objective unless such losses occurred because of unforeseen or

unfortuitous circumstances.    Petitioners sustained losses on
                               - 20 -

their horse racing and breeding activity for 16 consecutive

years.

     Petitioners argue that their losses occurred because of

unforeseen circumstances.   A portion of petitioners' losses can

be explained by a series of unfortunate events beyond their

control.   In 1983, petitioners were involved in a dispute with

their first trainer, Ms. Audrey Kraynik, over the ownership of a

stud horse named Distinctive Jet, which resulted in the loss of

Distinctive Jet.   Also, as a result of the dispute, petitioners

could not register their foals from Distinctive Jet with the

Jockey Club, which prevented petitioners from racing any of the

foals.

     Petitioners’ horses sustained numerous injuries, which

contributed to their losses.   Some of the injuries were as

follows:   Liberty Knoll broke a bone in her leg, an accident

which ended in her death; Talitha jumped out of a trailer while

being transported; Bad Memories suffered bone chips in her knee;

Captain’s K developed tendon problems; Naughty Castle suffered

injuries to her leg and foot; and several of petitioners' other

horses suffered injuries as well.   These injuries prevented

petitioners from racing the injured horses.

     A number of the aforementioned injuries occurred to horses

which were originally purchased by petitioners in 1980.   The

injuries to Liberty Knoll, Captain's K, Bad Memories, and Naughty
                                - 21 -

Castle occurred in 1980 and 1981.    The injury to Ruth Ann K

occurred in 1983.    The injuries to Traders K, Tekla Tekla Two,

and Captain Konik occurred after the years in issue.    We

recognize that these injuries to some of petitioners' horses

caused some of the losses.    However, petitioners did not offer

any objective evidence to explain how injuries between 1980 and

1983, and subsequent to 1990, prevented them from operating a

profitable activity during the years 1987, 1988, 1989, and 1990.

Indeed, despite the fact that petitioners sustained consistent

losses over 16 consecutive years, they continued to engage in

horse racing and breeding.


Amount of Profits


     The amount of profits earned in relation to the amount of

losses incurred, the amount of the investment, and the value of

the assets in use may indicate a profit objective.    Sec. 1.183-

2(b)(7), Income Tax Regs.    The opportunity to earn substantial

profits in a highly speculative venture may be sufficient to

indicate that the activity is engaged in for profit even though

only losses are produced.     Id.; see Dawson v. Commissioner, T.C.

Memo. 1996-417.     In determining whether the taxpayer entered into

the activity for profit, a small chance of making a large profit

may indicate the requisite profit objective.    Sec. 1.183-2(b)(7),

Income Tax Regs.
                               - 22 -

     Petitioners may have believed that there was a possibility

of producing a champion horse that could generate a substantial

amount of revenue and correspondingly large profits.   However,

the fact that petitioners suffered substantial losses year after

year without significantly changing their method of operation in

a meaningful way supports the inference that profit was not their

primary reason for engaging in this activity.    Ranciato v.

Commissioner, 52 F.3d 23, 26 (2d Cir. 1995), vacating and

remanding T.C. Memo. 1993-536.


Taxpayers' Financial Status


     The fact that the taxpayer does not have substantial income

or capital from sources other than the activity may indicate that

the activity is engaged in for profit.   Sec. 1.183-2(b)(8),

Income Tax Regs.    The legislative history of section 183(a) and

(b) indicates a particular concern about wealthy individuals

attempting to generate paper losses for the purpose of sheltering

unrelated income.    Ranciato v. Commissioner, supra at 25-26; S.

Rept. 91-552, at 95-100 (1969), 1969-3 C.B. 423, 484-487.      In

this respect, the Senate report focused primarily on farming

operations, including specifically the racing of horses, and

noted an overall concern about taxpayers with substantial income.

S. Rept. 91-552, supra at 95-98, 1969-3 C.B. at 485-486; see also

Ranciato v. Commissioner, supra at 25 n.3.
                              - 23 -

     On their Federal joint income tax returns, petitioners

reported wage income of $26,690, $27,458, $29,576, and $31,804 in

the years 1987, 1988, 1989, and 1990, respectively.   Petitioners

also reported on Schedules C income of $33,283, $32,261, $25,517,

and $38,926 from their framing and truss fabrication business in

1987, 1988, 1989, and 1990, respectively.   In each of the years

at issue, the excess losses generated by petitioners' horse

racing and breeding activity were used to offset their otherwise

taxable income.   On the other hand, petitioners were actually

sustaining economic losses that were offsetting relatively modest

amounts of wage and business income.   On balance, this factor

generally supports petitioners' position.


Personal Pleasure or Recreation


     The absence of personal pleasure or recreation relating to

the activity indicates the presence of a profit objective.     Shane

v. Commissioner, T.C. Memo. 1995-504; sec. 1.183-2(b)(9), Income

Tax Regs.

     Petitioners argue that they did not ride their horses or

make them available for others to ride and, therefore, there were

no elements of pleasure or recreation involved.   While it is true

that petitioners did not ride their horses, nor permit others,

except qualified jockeys, to ride them, it is obvious that

petitioners' racehorses were not the kind of horses that are
                               - 24 -

ridden around the farm for pleasure.    The record shows that

petitioners attended races at the track, watched their horses

race, and also gambled on horses while they were in attendance at

the races.    In the final analysis, we are convinced that

petitioners' enjoyment of being engaged in horse racing and

breeding was the most significant reason why they continued to

engage in this activity despite their record of consistent

losses.

Conclusion


     Having considered the factors listed in section 1.183-2(b),

Income Tax Regs., all contentions presented by the parties, and

the facts and circumstances of this case, we believe that

petitioners honestly hoped that their horse racing and breeding

activity would generate a profit and that profit was one of their

objectives.    However, in order to prevail, petitioners must show

that their horse racing and breeding activity was engaged in

primarily for the purpose of making a profit.    Simon v.

Commissioner, 830 F.2d at 500; Warden v. Commissioner, T.C. Memo.

1995-176, affd without published opinion 111 F.3d 139 (9th Cir.

1997).

     Petitioners engaged in horse racing and breeding activities

for at least 16 years, losing more than $465,000 without coming

near a profit in any of those years.    Petitioners initiated their

activity without developing a business plan commensurate with
                              - 25 -

that which would be expected from someone who was motivated

primarily by a profit objective.   Throughout all the years of

continuous losses, petitioners did not materially alter their

mode of operation.   Petitioners maintained two full-time jobs and

had access to sufficient property with which they could maintain

a number of racehorses that they personally enjoyed breeding and

racing.

     Based on the entire record, we are not convinced that

petitioners' primary objective was to make a profit.    Rather, the

evidence is more consistent with the conclusion that petitioners

enjoyed breeding and racing their horses and, therefore, were

willing to sustain continuing losses despite the improbability of

profits.   Consequently, we hold that petitioners' horse racing

and breeding activity was not primarily engaged in for profit

within the meaning of section 183(c).

     Respondent also determined additions to tax under section

6651(a)(1) for petitioners' failure to file their 1987 through

1990 returns.   Section 6651(a)(1) imposes an addition to tax of 5

percent of the amount of the tax due for each month a return is

delinquent, up to a maximum of 25 percent.    The addition to tax

is not applicable if it is shown that the failure is due to

reasonable cause and not willful neglect.    Sec. 6651(a)(1);

United States v. Boyle, 469 U.S. 241, 245 (1985).    Petitioners

have the burden of proving that their failure to file was due to
                              - 26 -

reasonable cause and not willful neglect.    Niedringhaus v.

Commissioner, 99 T.C. 202, 220-221 (1992).   Petitioners filed

their tax returns for the tax years 1987, 1988, and 1989 on

August 23, 1991, and their tax return for the tax year 1990 on

June 19, 1992.   Petitioners have failed to show that their

failure to file returns for the taxable years 1987 through 1990

was due to reasonable cause and not willful neglect.   Petitioners

are liable for the additions to tax under section 6651(a)(1) for

the taxable years 1987 through 1990.



                                         Decision will be entered

                                    under Rule 155.



[The appendix is a 1-page spreadsheet in Lotus format

that is incompatible with the Wordperfect format of

this opinion.     A copy of the appendix may be obtained

from chambers.]
