                            T.C. Memo. 1999-72



                          UNITED STATES TAX COURT



             RICHARD L. AND MARJORIE A. PITTS, Petitioners v.
               COMMISSIONER OF INTERNAL REVENUE, Respondent


       Docket No. 3937-97.                 Filed March 10, 1999.


       Chester A. Swart, for petitioners.

       Bradley T. Stanek, for respondent.


                            MEMORANDUM OPINION


       NAMEROFF, Special Trial Judge:     This case was heard pursuant

to the provisions of section 7443A(b)(3)1 and Rules 180, 181, and

182.       Respondent determined a deficiency in petitioners’ 1993

Federal income tax in the amount of $3,141 and an accuracy-

related penalty under section 6662(a) in the amount of $628.

       The issues for decision are:    (1) Whether petitioners

engaged in their horse-related activity during 1993 with the


       1
        All section references are to the Internal Revenue Code
in effect for the year at issue. All Rule references are to the
Tax Court Rules of Practice and Procedure.
                               - 2 -


objective of making a profit within the meaning of section 183;

if so, (2) whether petitioners are entitled to a depreciation

deduction for their barn; (3) whether petitioners realized a

capital gain in the amount of $2,000 in 1993; and (4) whether

petitioners are liable for the accuracy-related penalty pursuant

to section 6662(a).2

                            Background

     As a preliminary matter, both parties raised relevancy

objections to certain exhibits.    Rule 401 of the Federal Rules of

Evidence, applicable to this Court pursuant to Rule 143 and

section 7453, defines relevant evidence as “evidence having 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.”    Upon reviewing the

exhibits in question, we find they are relevant within the

meaning of rule 401 of the Federal Rules of Evidence.    The

objections are overruled.

     Some of the facts have been stipulated, and they are so

found.   The stipulation of facts and the attached exhibits are

incorporated herein by this reference.    At the time they filed

their petition, petitioners resided in Whittier, California.

     Marjorie Pitts (petitioner) acquired her first horse and

started training horses in 1958.   She started showing horses

professionally in 1960 for an executive on the east coast.      Two


     2
        Petitioners raised the issue of innocent spouse (as to
one or both) in their petition but conceded the matter at trial.
                               - 3 -


of those horses that petitioner showed won New England Champion.

In the early 1960's, both petitioners worked for the California

Breeders Association in Circleville, Utah.   Petitioners were in

charge of breeding 12 stallions to over 100 mares on this farm.

After leaving the California Breeders Association, petitioners

moved to California and worked for Mr. John Dick, where they

managed and trained horses on his farm.   Then in the mid-1960's,

petitioners took jobs not associated with the horse business.

     In 1982 petitioners bought their house in Whittier on a

half-acre parcel zoned “R-1”, which does not permit horses.

However, many of petitioners’ neighbors also kept horses.    In

1984, petitioners erected a portable barn on their property.      The

barn had a breezeway and four stalls.   In back of the barn were

four pipe pens.   Petitioners acquired quarter horses around this

time with the intent to breed and race them.   In 1985 petitioners

filed a Fictitious Business Name Statement stating that they were

doing business as Midget Acres.   Petitioners also received a

public health license issued by the County of Los Angeles.    Los

Angeles County Code section 7.04.010 requires a license before

the commencement of any business activity.   Petitioners did not

have a business license.

     In 1986 and 1987 petitioners worked at the Kerr stock farm

(the Kerr farm) where petitioner trained horses.3   Petitioners

took their own horses with them to the Kerr farm, where they


     3
        Petitioner testified that Mr. Pitts worked on underwater
treadmills for the horses at the Kerr farm.
                                - 4 -


raised, bred, and raced them.    The costs for the caring of

petitioners’ horses at the Kerr farm were included as part of

petitioners’ wages.    Petitioners hired professional trainers for

the racing of the horses.    Their horses were racing at Los

Alamitos, Golden Gate, and Bay Meadows racetracks.

     Petitioners left the Kerr farm in 1987 and moved back to

their house in Whittier with their horses.    Petitioner was

employed at Lawyers Mutual Insurance Co., and Mr. Pitts,

suffering from a muscle-wasting disease which required drug

therapy, stayed home.

     Around 1988, petitioners decided that racing quarter horses

was too expensive.    The trainer’s fees were high, and the purses

were small.    Petitioner owned a thoroughbred with five other

people which had won $25,000 in a race in 1987.    Petitioners

decided to switch to thoroughbred horses because stakes races

(such as the Kentucky Derby) paid higher purses.    Petitioners

sold some of their quarter horses and started acquiring

thoroughbreds.4

     Initially, petitioners acquired two thoroughbred mares and

Ding Dong Daddy, a thoroughbred stallion that came from good

blood lines.    Petitioners offered Ding Dong Daddy for stud.

According to a promotional flyer that petitioners distributed,

Ding Dong Daddy had earned $24,964 in his first 2 years of

racing.   The flyer also detailed the horse’s sire and female


     4
        Petitioners did retain one quarter horse that they raced,
and another that they bred.
                                - 5 -


lines and the racing history of those horses.     Petitioners did

not race Ding Dong Daddy.    Petitioners bred him with their own

horses and with outside horses for a stud fee.     Petitioner bred

Ding Dong Daddy with one of her mares and produced Blue’s Ding

Dong, which she sold.    Blue’s Ding Dong became a successful

racing horse.

       Petitioners also acquired another stallion named Halyard

that allegedly sired $4 million worth of winners.     Halyard, an

older horse, was known to be a difficult breeder.     Indeed, he

produced no offspring for petitioners.     Halyard died in 1996.

       Petitioners listed both Ding Dong Daddy and Halyard in the

Thoroughbred Times in 1993.    The Thoroughbred Times is a stallion

directory, and in petitioners’ listings, they listed the

bloodlines and the stud fees.    The stud fee for Ding Dong Daddy

was $1,000 and for Halyard, $1,250.     But both fees were, as

petitioner stated, “negotiable”.    Petitioners did not do any

other advertising.

       Midget Acres provided a “stallion service contract” to horse

owners who wanted to breed a mare with one of petitioners’

stallions.    Petitioners would board a mare at their barn, and

petitioner would check the mare to see when she was in heat and

then determine when to do the breeding.     Petitioners charged a

booking fee which was 10 percent of the stud fee.     If the mare

gave birth to a live foal, petitioners would collect the stud

fee.    According to petitioner, it takes about a year from

conception for the mare to give birth.     Therefore, petitioners
                                   - 6 -


would typically receive the booking fee in one year and the stud

fee in the next.

        During the year at issue, in addition to the quarter horses,

petitioners owned seven horses:       Ding Dong Daddy and Halyard,

three mares, and two yearlings.       Petitioners also boarded four

additional horses during 1993.5      According to a chart submitted

at trial, petitioners would charge $7 a day for boarding or $7.50

per day if the horse had a foal at her side.       These fees included

feed.       The cost of feed per month per horse is about $100.

Petitioners would add veterinarian and trimming fees to the bill.

Of the four boarded horses, two were bred for which petitioners

charged a $100 breeding fee.       Another horse had a foal at her

side; it had been bred at Midget Acres in 1992, but the stud fee

had not yet been collected.

     Petitioners sold two of their horses, Jenny Sport and Actis

Uptis, in October of 1993 for $1,000 each.       (It is not clear

whether these horses were included in the seven referred to

above.)       Jenny Sport was a racing horse that was a gift to

petitioner after it broke down at the track, and Actis Uptis,

sired by Ding Dong Daddy, was born at Midget Acres.       Petitioners

did not have a cost basis for either horse.

     Petitioners billed a total of $4,297 in 1993.      However, they

collected only $2,892, including the $2,000 for the sales of the


        5
        With only four stalls and four pipe pens, petitioners had
room for only eight horses. When they had the additional
boarders, petitioners sent their own horses to the neighbor’s
pen.
                               - 7 -


two horses.   According to petitioner, two of the horse owners

never paid petitioners for boarding and fees; petitioners did not

take legal action and were unsuccessful collecting the debt.

     The parties stipulated that the following income, expenses,

and losses from the horse-related activity were reported in

petitioners’ returns for the years 1986 through 1994 and 1996:6

     Year       Gross Income           Expenses    Net Loss
     1986            $600               $19,900   ($19,300)
     1987           1,182                11,055     (9,873)
     1988            ---                  ---       (9,032)
     1989            ---                  ---       (9,194)
     1990            ---                  ---      (12,655)
     1991           4,208                13,544     (9,336)
     1992            ---                  ---      (15,970)
     1993           2,802                13,732    (10,930)
     1994           2,000                 7,146     (5,146)
     1996              15                 9,577     (9,562)

     The record does not disclose the nature of the various gross

income figures; i.e., whether from stud fees, boarding fees,

sales of offspring, etc.   Copies of the various Schedules C were

not exhibited, so we cannot even identify the major expense

groups or whether any cost savings plans were put into effect.

     For 1995, petitioners did not file a Schedule C, Profit or

Loss From Business, with respect to the horse-related activity.

According to petitioner, that year the stallions were sent away.

Around 1996, a foal was born to petitioner’s quarter horse mare,

and petitioner is currently training this foal to be a show

horse.   According to petitioner, the colt has received “reserved

champion Pacific Coast quarter horse”.


     6
        For the years 1988, 1989, 1990, and 1992, only the net
losses were provided.
                               - 8 -


     During 1993, petitioner worked about 35-37 hours a week as a

litigation specialist, and Mr. Pitts, not working because of his

disability, would feed and water the horses every day.    After

work, petitioner cleaned the stalls and did the heavy work that

Mr. Pitts could not do.   Petitioner consulted her breeding charts

to see if any mares were due to breed, and she would do the

breeding.   Ding Dong Daddy was the stud used by petitioner in

1993.

     For 1993, petitioner earned $52,815, and Mr. Pitts collected

$11,6597 in Social Security benefits.    On their Schedule C for

1993 petitioners listed Midget Acres as their business.    They

reported $2,8028 in gross income and claimed the following

expenses:


                  Expense                  Amount
                Car and truck              $2,182
                Depreciation                1,818
                Office                         72
                Dues and subscriptions        161
                Feed                        6,854
                Shoeing                       400
                Trash                         744
                Vet fees                    1,501
                  Total                    13,732

This resulted in a net loss of $10,930.    Petitioners retained

receipts for the horse-related expenses.




     7
         Of this amount, $5,830 was taxable.
     8
        We note that petitioners’ chart shows that they collected
$2,892. This discrepancy was neither noticed nor explained but
is irrelevant in light of our holding on the sec. 183 issue.
                               - 9 -


     Petitioners’ return was prepared by a certified public

accountant whom they have used for a number of years.

Petitioners were audited with regard to their horse-related

activity for taxable year 1987 and were represented by their

accountant for this audit.   In the end, there was no deficiency

for 1987 with respect to the horse-related activity.

                             Discussion

     In the notice of deficiency, respondent disallowed the

claimed loss on the basis that petitioners did not establish that

their horse activity was entered into for profit.   Respondent

also determined that petitioners failed to report a capital gain

in the amount of $2,000 from the sales of two horses.

     Substantiation is not an issue except for $753, the amount

that petitioners claimed for depreciation of their barn.

Petitioners no longer have documentation for their cost basis of

the barn.

Horse-Related Activity

     We must decide whether petitioners’ horse-related activity

was engaged in for profit.   Section 183(a) generally provides

that if an activity engaged in by an individual is not entered

into for profit, no deduction attributable to the activity shall

be allowed, except as otherwise provided in section 183(b).9     An



     9
        Sec. 183(b) allows deductions for ordinary and necessary
expenses arising from an activity not engaged in for profit only
to the extent of gross income from the activity, less the amount
of those deductions which are allowable regardless of whether
the activity is engaged in for profit.
                               - 10 -


“activity not engaged in for profit” means any activity other

than one for which deductions are allowable under section 162 or

under paragraphs (1) and (2) of section 212.   See sec. 183(c).

     Section 162(a) allows a deduction for all ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on a trade or business.   To be engaged in a trade or

business within the meaning of section 162, “the taxpayer must be

involved in the activity with continuity and regularity and * * *

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).

     In order for taxpayers to deduct expenses of an activity

pursuant to section 162, profit must be their primary or dominant

purpose for engaging in the activity.   See Wolf v. Commissioner,

4 F.3d 709, 713 (9th Cir. 1993), affg. T.C. Memo. 1991-212;

Polakof v. Commissioner, 820 F.2d 321 (9th Cir. 1987), affg. per

curiam T.C. Memo. 1985-197; Independent Elec. Supply, Inc. v.

Commissioner, 781 F.2d 724, 726 (9th Cir. 1986), affg. Lahr v.

Commissioner, T.C. Memo. 1984-472; Carter v. Commissioner, 645

F.2d 784, 786 (9th Cir. 1981), affg. T.C. Memo. 1978-202; Hirsch

v. Commissioner, 315 F.2d 731, 736 (9th Cir. 1963), affg. T.C.

Memo. 1961-256.   Whether the taxpayer had the requisite profit

objective is a question of fact to be resolved from all relevant

facts and circumstances.    See, e.g., Drobny v. Commissioner, 86

T.C. 1326, 1341 (1986), affd. 113 F.3d 670 (7th Cir. 1997); sec.

1.183-2(b), Income Tax Regs.   Profit in this context means
                              - 11 -


economic profit independent of tax savings.   See, e.g., Antonides

v. Commissioner, 91 T.C. 686, 694 (1988), affd. 893 F.2d 656 (4th

Cir. 1990).

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

exclusive list of factors we consider to determine whether the

taxpayers are engaged in the venture with a profit objective.

They include:   (1) The manner in which the taxpayers carried on

the activity; (2) the expertise of the taxpayers or their

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

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

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

the taxpayers in carrying on other similar or dissimilar

activities; (6) the taxpayers’ history of income or loss with

respect to the activity; (7) the amount of occasional profits

that are earned; (8) the financial status of the taxpayers; and

(9) whether elements of personal pleasure or recreation are

involved.   No single factor is controlling, and we do not reach

our decision by merely counting factors that support each party’s

position.   See Dunn v. Commissioner, 70 T.C. 715, 720 (1978),

affd. 615 F.2d 578 (2d Cir. 1980); sec. 1.183-2(b), Income Tax

Regs.   Certain elements are given more weight than others because

they are more meaningfully applied to the facts in our case.

     1. Manner in Which Activity Is Conducted

     The fact that a taxpayer carries on the activity in a

businesslike manner and maintains complete and accurate books and

records may indicate that the activity was engaged in for profit.
                               - 12 -


Sec. 1.183-2(b)(1), Income Tax Regs.    Petitioners kept records of

what was owed to them and how much to bill for veterinarian

services and trimmings for the horses that they boarded.

Petitioners maintained records for everything they spent on the

activity and were able to substantiate just about every expense

claimed.    Nevertheless, petitioner testified that they referred

to these records only when preparing their tax returns, not to

monitor their expenses.

     When petitioners determined that the breeding and racing of

quarter horses would not be profitable, petitioners modified

their operations by switching to thoroughbreds.    However, other

than owning a successful thoroughbred in a joint venture with

several others, there is no evidence that petitioners

investigated the merits of such a switch.    Moreover, petitioners

kept two quarter horses, the expenses for which were claimed on

the Schedule C.   Petitioner failed to explain why keeping those

quarter horses reflected a profit objective.    Furthermore,

petitioner testified that Ding Dong Daddy and Halyard were

valuable horses, but she did not reveal the price that was paid

for them.   Additionally, Halyard was an older horse and known to

be a difficult breeder, and petitioner did not have any bookings

for him.    We fail to see a profit objective in acquiring Halyard,

but more significantly, in keeping an unproductive stallion for

nearly 8 years.

     Petitioners did not prepare business or profit plans with

cost projections or budgets.    Petitioner stated that the
                              - 13 -


operation was too small for that.    It does not appear that Midget

Acres had a separate bank account.     We find that petitioners did

not conduct this activity in a businesslike manner.

     2. Expertise of Petitioners

     Preparation for an activity by extensive study or

consultation with experts may indicate a profit motive where the

taxpayer conducts the activity in accordance with such study or

advice.   See sec. 1.183-2(b)(2), Income Tax Regs.   Petitioner has

a long history with horses.   Both petitioners have worked with

horses, and petitioner especially has great knowledge and

experience about bloodlines and with raising, training, showing,

and breeding of various types of horses.    Petitioners also spent

quite a few years working for horse farms where they observed

operations.   Petitioner often helped out friends and business

associates with the purchase of racing horses.    Petitioner

testified that she sought advice from Robert Hundley who was a

trainer as Santa Anita Hollywood Park and a breeder of

thoroughbred horses.   However, petitioner did not testify as to

the kind of advice sought nor the nature of the advice received.

     While petitioners have excellent credentials for horse

breeding, training, and racing, it is not clear whether they were

experienced or sought advice with regard to the financial aspects

of operating a horse business.

     3. Time and Effort Spent in Conducting Activity

     The fact that the taxpayer devotes much of his or her

personal time and effort to carrying on an activity, particularly
                                - 14 -


if the activity does not have substantial recreational aspects,

may indicate a profit motive.     See sec. 1.183-2(b)(3), Income Tax

Regs.     Petitioner devoted about 20 to 25 hours per week to the

horses, in addition to the amount of time Mr. Pitts spent feeding

and watering the horses.     It is not clear from the record how

much time Mr. Pitts spent on the horse activity.     Petitioner did

all of the cleaning, breeding, and heavy work that Mr. Pitts

could not do.     Petitioner would consult the breeding charts and

keep an eye on the mares to determine when they were in heat.

This factor favors petitioners.

     4. Expectation That Assets Will Appreciate in Value

        An expectation that assets used in that activity will

appreciate in value may indicate a profit objective.     See sec.

1.183-2(b)(4), Income Tax Regs.     Petitioner testified that she

expected to get champions out of Ding Dong Daddy and Halyard

since they came from good bloodlines.     In fact, one of Ding Dong

Daddy’s offspring was a successful racing horse.     However, there

is nothing in the record that shows costs of petitioners’ horses

or fluctuations in their value.

        5. Petitioners’ Success in Similar or Dissimilar Activities

        The fact that the taxpayer has engaged in similar activities

in the past and converted them from unprofitable to profitable

enterprises may indicate that he or she is engaged in the present

activity for profit, even though the activity is presently

unprofitable.     See sec. 1.183-2(b)(5), Income Tax Regs.   There is

no evidence that petitioners had been involved in other profit-
                               - 15 -


seeking activities before or during the operation of their horse-

related activity.   This factor is neutral.

     6. Activity’s History of Income and/or Loss

     An activity’s history of income or loss may reflect whether

the taxpayer has a profit motive.    See sec. 1.183-2(b)(6), Income

Tax Regs.    Unless explained by customary business risks or

unforeseen or fortuitous circumstances beyond the taxpayer’s

control, a record of continuous losses beyond the period

customarily required to attain profitability may indicate that

the activity is not engaged in for profit.    See id.

     Petitioners have not had a profitable year since they

started their horse-related activity.    While petitioners may have

expected the switch to thoroughbreds to be more profitable,

according to the history of their activity, their losses

increased.    Petitioner testified that they switched because the

stakes races had higher purses; however, in 1993 petitioners were

not racing their horses, only breeding them.    Furthermore,

petitioners failed to produce credible evidence that the horse-

related activity had a chance of recovering the losses they had

already incurred.    See Bessenyey v. Commissioner, 45 T.C. 261,

274 (1965), affd. 379 F.2d 252 (2d Cir. 1967).

     7. Amount of Occasional Profits

     Occasional profits which are earned from an activity may

indicate a profit motive.    See sec. 1.183-2(b)(7), Income Tax

Regs.   The possibility of a substantial profit in a highly

speculative venture may indicate a profit motive even where
                               - 16 -


profits are occasional and small or nonexistent.    See id.   Horse

breeding and racing are highly speculative ventures.    Petitioners

did not report a profit in any of the years they carried on the

horse-related activity.

     8. Petitioners’ Financial Status

     Substantial income from sources other than the activity,

particularly if the losses from the activity generate substantial

tax benefits, may indicate that the activity is not engaged in

for profit, especially if there are personal or recreational

elements involved.   See sec. 1.183-2(b)(8), Income Tax Regs.

     Petitioner earned $52,815 in 1993, and Mr. Pitts received

$11,659 in Social Security benefits.    Petitioners derived some

tax benefits from their claimed losses.

     9. Elements of Personal Pleasure

     The mere fact that a taxpayer derives personal pleasure from

a particular activity does not show a lack of profit motive.    See

sec. 1.183-2(b)(9), Income Tax Regs.    The presence of personal

motives may indicate that the activity is not engaged in for

profit.   This is especially true when there are recreational

elements involved.   See id.

     It is not clear from the record whether petitioner rode the

horses.   We assume that Mr. Pitts could not because of his

disability.   It is clear, though, that petitioners enjoyed horses

and have a long history of working with them.
                               - 17 -


     10. Conclusion

     While the matter is not free from doubt, on the basis of all

the facts and circumstances, we hold that petitioners failed to

prove that they engaged in their horse-related activity with the

primary purpose and dominant intent of making a profit within the

meaning of section 183.    Accordingly, petitioners are not

entitled to horse-related expense deductions in excess of their

reported horse-related income.

     As respondent has already prevailed on the primary issue, we

need not address the substantiation issue with respect to the

depreciation deduction for petitioners’ barn.

Unreported Capital Gain

     Respondent determined that petitioners failed to report

$2,000 they received from the sale of Jenny Sport and Actis

Uptis.   We find that respondent is in error.   According to the

chart detailing the income activity of the business, petitioners

reported the income from the sale of the horses along with the

amounts they collected for boarding and booking fees on their

Schedule C.   Petitioners do not have unreported capital gain.

Accuracy-Related Penalty

     Section 6662(a) imposes a penalty of 20 percent on any

portion of an underpayment of tax that is attributable to

negligence or disregard of rules or regulations.    See sec.

6662(a) and (b)(1).   “Negligence” is defined as any failure to

make a reasonable attempt to comply with the provisions of the

Internal Revenue Code, and the term “disregard” includes any
                              - 18 -


careless, reckless, or intentional disregard.     See sec. 6662(c).

A position with respect to an item is attributable to negligence

if it lacks a reasonable basis.   See sec. 1.6662-3(b)(1), Income

Tax Regs.   Moreover, taxpayers are required to keep adequate

books and records sufficient to establish the amount of

deductions or other items required to be shown on their returns.

Failure to maintain adequate books and records or to substantiate

items properly also constitutes negligence.     See id.

     Section 6664(c)(1) provides that the penalty under section

6662(a) shall not apply to any portion of an underpayment if it

is shown that there was reasonable cause for the taxpayer’s

position with respect to that portion and that the taxpayer acted

in good faith with respect to that portion.     See sec. 6664(c)(1).

The determination of whether a taxpayer acted with reasonable

cause and good faith within the meaning of section 6664(c)(1) is

made on a case-by-case basis, taking into account all the

pertinent facts and circumstances.     See sec. 1.6664-4(b)(1),

Income Tax Regs.

     Generally, the duty of filing accurate returns cannot be

avoided by placing the responsibility on a tax return preparer.

See Metra Chem Corp. v. Commissioner, 88 T.C. 654, 662 (1987).

Although a taxpayer remains liable for a deficiency attributable

to a return prepared by an accountant, a taxpayer who supplies a

qualified tax return preparer with all relevant information and

who reasonably and in good faith relies on the preparer’s advice

is not negligent and has not disregarded rules or regulations,
                              - 19 -


even if the advice is incorrect and results in a deficiency.       See

Freytag v. Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d

1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991).

     Petitioners provided all of their records to their

accountant.   Since petitioners’ Schedule C loss was allowed after

the audit for taxable year 1987, the accountant continued

treating it as a business without question to petitioners.       We

find that petitioners reasonably and in good faith relied on

their accountant’s advice.   Therefore, we hold that petitioners

are not liable for the accuracy-related penalty for the year at

issue.

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
