                        T.C. Memo. 1997-475


                      UNITED STATES TAX COURT



          S.K. JOHNSTON, III AND JULIE N. BOYLE, F.K.A.
    JULIE N. JOHNSTON, ET AL.,1 Petitioners v. COMMISSIONER OF
                   INTERNAL REVENUE, Respondent


     Docket Nos. 16668-94, 16669-94,   Filed October 20, 1997.
                 16670-94.


     C. Christopher Trower, Reginald J. Clark, and W. Scott

Wright, for petitioners.

     Bonnie L. Cameron, for respondent.


                        MEMORANDUM OPINION

     PARR, Judge:   Respondent determined deficiencies in,

additions to, and a penalty on petitioners' Federal income tax as

follows:


1
     By order of this Court dated Dec. 11, 1995, cases of the
following petitioners were consolidated herewith for purposes of
trial, briefing, and opinion: S.K. Johnston, Jr., docket No.
16669-94; S.K. Johnston, Jr., and Gillian S. Johnston, docket No.
16670-94.
                                   - 2 -


S.K. Johnston III and Julie N. Boyle, f.k.a., Julie N. Johnston,

docket No. 16668-942:

                                           Additions to Tax
Year              Deficiency                 Sec. 6661
1987              $15,877.43                  $4,969.00
1988               16,890.08                   4,223.00
1989               12,026.80                      -



S.K. Johnston, Jr., docket No. 16669-94:


                                         Additions to Tax
Year             Deficiency        Sec. 6653(a)(1)   Sec. 6661
1988            $174,164.19           $8,708.21     $43,609.00



S.K. Johnston, Jr., and Gillian S. Johnston, docket No. 16670-94:



                                       Additions to Tax and Penalty
Year   Deficiency Sec. 6653(a)(1)(A)   Sec. 6653(a)(1)(B) Sec. 6661     Sec. 6662
1987   $222,349.65     $11,117.48            *           $55,587.00         -
1989    312,431.41         -                 -                -       $62,486.28

* 50 percent of the interest due on $21,235.83.


       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, unless otherwise

indicated.



2
     The only issue that involves S.K. Johnston III and Julie N.
Boyle, f.k.a. Julie N. Johnston is whether Bendabout Polo Sales
and Management Co. (BPS) was an activity engaged in for profit.
BPS, a partnership owned 75 percent by S.K. Johnston, Jr. and 25
percent by his son, S.K. Johnston III began operations on June 1,
1986, as a polo horse sales business.
                               - 3 -


     After concessions by the parties, the issues for decision

are: (1) Whether petitioners'3 farming activity known as

Bendabout Farm was an activity engaged in for profit under

section 183 during the taxable years in issue.     We hold it was.

(2) Whether petitioners' ranching activity known as Flying H

Ranch was an activity engaged in for profit under section 183

during the taxable years in issue.     We hold it was. (3) Whether

petitioners' horse sales activity operated through a partnership

known as Bendabout Polo Sales and Management was an activity

engaged in for profit under section 183 during the taxable years

in issue.   We hold it was. (4) Whether Gillian Johnston's horse

training activity known as GJ Stables, conducted at Bendabout

Farm, was an activity engaged in for profit under section 183

during the taxable years in issue.     We hold it was.   (5) Whether

$1,131,438 was the fair market value of a conservation easement,

encumbering the Flying H Ranch donated by petitioners to the

Nature Conservancy during 1989.   We hold it was.4

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

The stipulated facts and the accompanying exhibits are

incorporated into our findings by this reference.


3
     Hereinafter, the term "petitioners" refers to S.K. Johnston,
Jr. and Gillian Johnston, unless discussing BPS, where the term
petitioners refers to S.K. Johnston, Jr. and Gillian Johnston and
S.K. Johnston III and Julie N. Boyle, f.k.a. Julie N. Johnston.
4
     Due to our holding for petitioners on all five issues, we
need not address whether petitioners are liable for additions to
tax or accuracy-related penalties.
                               - 4 -


     At the time of filing the petition in their case,

petitioners S.K. Johnston III (S.K. Johnston) and Julie N. Boyle,

f.k.a. Julie N. Johnston (Julie Boyle), resided in Atlanta,

Georgia, and Camden, South Carolina, respectively.5   At the time

of filing the petition in his case, S.K. Johnston, Jr.

(petitioner), resided in Atlanta, Georgia.   At the time of filing

the petition in their case, Gillian S. Johnston (Gillian

Johnston) and petitioner (collectively the Johnstons) resided in

McDonald, Tennessee, and Atlanta, Georgia, respectively.6      For

convenience, we present a general background section and combine

our findings of fact with our opinion under each separate issue.

General Background

     Petitioners' Activities

     There are four activities at issue in the instant case,

which are conducted in three primary locations.    The first

activity is Bendabout Farm (Bendabout or the farm), which is

located approximately 10 miles east of Chattanooga, Tennessee.

The second activity is Flying H Ranch (Flying H or the ranch),

which is located on the eastern slope of the Bighorn Mountains in

north-central Wyoming near the Montana border.    The third

activity is Bendabout Polo Sales and Management Co. (BPS),

conducted by a partnership of which petitioner owns 75 percent,

5
     S.K. Johnston and Julie Boyle were married and filed joint
returns for 1987, 1988, and 1989.
6
     Petitioner and Gillian Johnston filed joint returns for 1987
and 1989, and separate returns for 1988.
                               - 5 -


and S.K. Johnston, his son, owns 25 percent.   The sales aspect of

BPS was primarily conducted in southern Florida, while the polo

pony training operations were conducted at Bendabout in Tennessee

and Flying H in Wyoming.   The fourth activity is GJ Stables (GJ

or the stables), a steeplechase horse training business conducted

by Gillian Johnston on 35 acres located at Bendabout.

     The parties have stipulated that petitioners carried on each

of these four activities in a businesslike manner and maintained

complete and accurate books and records.   With respect to all

four activities, the parties further stipulated that none of the

expenses in issue constitute personal living, or family expenses,

and that each activity keeps adequate accounting records

separating business from personal expenses, including gas and

utilities.

     Petitioner

     At the time of trial, petitioner was 62 years of age and

resided in Atlanta, Georgia.   He has lived at Bendabout his

entire life, including the years in issue.   Petitioner is married

to Gillian Johnston and they have five children.   During the

years in issue, two of the children were minors who lived with

them at Bendabout. Bendabout has been in the Johnston family

since the 1830's. Petitioner inherited the farm from his father

in 1985.

     Petitioner is a successful business executive.   He currently

serves as the president and chief operating officer of publicly
                               - 6 -


held Coca-Cola Enterprises, Inc.   Petitioner and his family

started and controlled the Johnston Coca-Cola Bottling Co.

(Johnston Coca-Cola) which operated bottling plants in Cleveland,

Tennessee, and other parts of the country.    Petitioner has been

successful in operating Johnston Coca-Cola.

     Gillian Johnston

     At the time of trial, Gillian Johnston was 54 years of age.

She grew up in England where she made her living training and

racing steeplechase horses.   After completing her studies and

prior to marrying petitioner, she came to the United States,

where she trained steeplechase horses for a living.    Since 1964,

she has been licensed by the State of New York as a steeplechase

horse trainer.   During the years at issue, Gillian Johnston

operated a steeplechase training and racing activity known as GJ

Stables out of a converted cow barn and pasture on approximately

35 acres at Bendabout.

     Dr. Ronald Haaland

     Dr. Ronald Haaland (Dr. Haaland) is an agricultural

scientist who taught soil sciences at Auburn University for 6

years and has been consulting and working in the agricultural

industry for more than 20 years.   In 1987, petitioner hired Dr.

Haaland to develop a complete management plan for both Bendabout

and Flying H.

     Dr. Haaland lived at Bendabout for approximately 2 years

during the years at issue, working closely with petitioner and
                                - 7 -


the farm's staff to develop a business plan for the farm.

Petitioner regularly interacted with Dr. Haaland on the Bendabout

business plans and has followed Dr. Haaland's recommendations.

        In 1990, after submitting numerous drafts to petitioner and

following several years of on-site work, Dr. Haaland completed

the business plan for Bendabout.    The purpose of the plan was to

refine objectives and strategies to improve the income potential

of the farm.    It analyzed the horse boarding operation, described

the businesslike manner in which the operation was then being

conducted, and concluded that more aggressive marketing should be

implemented to increase the projected profit by 10 percent per

year.

     During the years in issue, Dr. Haaland traveled frequently

to Flying H.    He spent time there during the various seasons in

an effort to appreciate the property's multi-seasonal use

potential.    Dr. Haaland and Archie MacCarty (MacCarty), the

manager of Flying H worked closely to develop a business plan for

the ranch.

Issue 1. Whether Petitioners' Farming Activity Known as Bendabout
Farm was an Activity Engaged in For Profit

     Bendabout Farm

     During the years in issue Bendabout Farm consisted of

approximately 2,000 acres, most of which was utilized as follows:

            Alfalfa/rye                        32   acres
            Corn                               62   acres
            Cattle                            215   acres
            Horse boarding                    191   acres
                               - 8 -


          GJ Stables/steeplechase             35 acres
          Horse breeding/thoroughbred         86 acres
          Woods and roads                  1,022 acres

     In the early 1980's, petitioner began taking over the farm

operations from his father, who died in 1985.    Petitioner, who

grew up around horses and followed the horse breeding industry,

has acquired knowledge about horse activities, including

thoroughbred breeding.

     From the early to mid-1980's, the thoroughbred industry was

healthy, growing, and considered to be a good investment among

professionals in that field.   Given the robustness of the

thoroughbred industry, petitioner thought that operating a

thoroughbred breeding business at Bendabout could be very

lucrative.   Under the management of petitioner's father,

Bendabout had been used to range cattle.   Petitioner, however,

believed that the pastures, barns, and other physical facilities

at Bendabout could be used most efficiently for thoroughbred

breeding and boarding operations, and that using the farm's

facilities primarily for such operations would be more profitable

than the cattle operations.

     It takes a number of years to build a viable horse breeding

operation.   The parties agree that the minimum startup period in

the thoroughbred breeding business is 7 years.    It takes at least

2 years from the time of purchasing a mare to realize any income

from the investment, because there is an 11-month gestation

period, and it takes another year to raise the foal to a
                                - 9 -


yearling, which is the most profitable time to sell the horse.

If the mare loses her foal, or is barren, there will be no income

for an even longer period.

     During the years in issue, petitioner started a program of

acquiring brood mares and stallions for Bendabout's thoroughbred

activity.    He used approximately 86 acres of the farm for this

purpose.    The thoroughbred operation was concentrated in the

northwestern section of the farm and consisted of approximately

six or seven pastures, barns, and a training track.      In 1987 and

1988, Bendabout generated stud fees from its stallions of $12,721

and $9,500, respectively.

     From approximately 1985 through 1990, the outset of

Bendabout's thoroughbred breeding program, the farm suffered

substantial losses.    Many of its brood mares aborted, had low

fertility, and lost milk.    The foals of brood mares that failed

to produce milk were put on nurse mares brought in from Kentucky,

which are very expensive to lease and the foals often do not feed

as well on their milk.    These problems plagued Bendabout for the

first years of it foaling program.      Neither petitioner nor his

farmhands could determine the cause of the problem.      In response,

Bendabout changed its operation leaving its brood mares in

Kentucky to foal after purchasing them.      This was an expensive

change, however, because the farm incurred costs to board the

mares in Kentucky and then to transport them back to Tennessee.
                               - 10 -


     When petitioner discovered that horse farms all over

Kentucky and Tennessee were experiencing similar problems, he

consulted with Dr. Haaland, a leading agribusiness specialist and

expert in grass technology.    After analyzing grass samples from

Bendabout's pasture, Dr. Haaland determined that the grass was

contaminated with a toxic fungus, which was causing the mares'

reproduction problems.   Dr. Haaland recommended that Bendabout

replant its pastures if it intended to maintain its breeding

program.   Sometime prior to 1990, Bendabout incurred substantial

expenses in land preparation and seed costs replanting 45 acres

of pasture.   During this time, Tennessee entered into a severe 4-

year drought period which devastated much of the farm industry in

the southeast.   As a result, the first two or three attempts to

reestablish the pastures failed.   Finally, after the pastures had

been replanted, Bendabout purchased seven well-bred and conformed

mares to enhance the breeding business.

     The farm's thoroughbred program faced further difficulties

stemming from problems in the industry itself.   In 1986, there

was a drastic drop in the average and median prices for

yearlings.    Starting in approximately 1988 through 1995, many of

the historically very successful and well-known horse breeding

farms filed for bankruptcy.    After a history of losses, Bendabout

liquidated its thoroughbred breeding program in 1993.

     Another part of petitioner's business plan for Bendabout was

to convert some of the cattle business to a more profitable polo
                                - 11 -


pony boarding program.    As a longtime amateur polo player and

past president and chairman of the U.S. Polo Association,

petitioner had developed many polo contacts from all over the

world.   Petitioner knew that polo players board their horses

every few months.     Typically, a horse can play polo for about 3

months, and then it will need about 6 to 10 weeks to recuperate.

Many international players play polo in Florida during the winter

months and board their horses in the United States for the rest

of the year, because it is too expensive to ship the horses back

to their home countries.     Petitioner believed that Bendabout was

well-suited for boarding polo ponies, because it was located

between Florida and the other States where polo is played

regularly.   Bendabout has boarded up to 300 horses during the

course of a year.     During the years in issue, Bendabout used

approximately 190 acres to board horses owned by third parties on

a daily fee basis.    Polo players from as far away as Nigeria,

England, Argentina, and Germany boarded their horses at the farm.

For 1987, 1988, and 1989 revenues from boarding third party

horses at Bendabout were $164,365, $169,500, and $185,000,

respectively.   Additional income from vanning, shoeing, and

related services generated between $25,000 and $35,000 in

revenues each year.    Although the polo boarding program generated

substantial revenues during the years in issue, the activity was

hindered by severe droughts, which curtailed the farm's grazing

potential and limited the number of polo horses that could be
                               - 12 -


boarded at any given time.    Bendabout also lost one of its best

clients, whose polo career ended when he was shot.

       Another part of petitioner's business plan for Bendabout was

to develop the wooded areas of the farm for a wildlife habitat in

order to generate revenue from hunting, fishing, and recreational

use.    Dove hunting, deer hunting, and quail hunting were all

available at Bendabout during the years in issue.    Food patches

for quail were planted throughout the woods.    Several open fields

were planted with species that benefit both dove and quail.

Bendabout had approximately 4 acres of water, including Woods

Lake, Boone Lake, Barn Lake, and Silo Pond which were available

for fishing during the years in issue.

Discussion

       Respondent determined that the Johnstons did not engage in

their farm activity with the intent to earn a profit, and

therefore pursuant to section 183 disallowed the related

Schedule F losses for the years in issue.    Petitioners assert

that they entered into and carried on Bendabout with the intent

to earn a profit, and therefore their losses are allowable.

       Section 183(a) provides that if an activity is not engaged

in for profit, "no deduction attributable to such activity shall

be allowed", except as otherwise provided in section 183(b).7

7
   Sec. 183(b)(1) provides that deductions which would be
allowable without regard to whether such activity is engaged in
for profit shall be allowed, such as interest and State and local
taxes. Sec. 183(b)(2) provides that deductions which would be
                                                   (continued...)
                                - 13 -


Section 183(c) defines an 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."

     The test for determining whether an individual is carrying

on a trade or business under section 183 is whether the

taxpayer's actual and honest objective in engaging in the

activity is to make a profit.    Dreicer v. Commissioner, 78 T.C.

642, 645 (1982), affd. without opinion 702 F.2d 1205 (D.C. Cir.

1983); sec. 1.183-2(a), Income Tax Regs.   While a taxpayer's

expectation of profit need not be reasonable, there must be a

good faith objective of making a profit.   Allen v. Commissioner,

72 T.C. 28, 33 (1979); sec. 1.183-2(a), Income Tax Regs.

      To determine whether the requisite profit objective exists,

we examine a variety of objective facts.      Engdahl v.

Commissioner, 72 T.C. 659, 666 (1979); sec. 1.183-2(a), Income

Tax Regs.   Thus, the determination of whether the requisite

profit objective exists depends upon all the surrounding facts

and circumstances of the case.    Keanini v. Commissioner, 94 T.C.

41, 46 (1990); sec. 1.183-2(b), Income Tax Regs.    The burden of

proving the requisite profit objective is on the taxpayer. Rule

142(a); Allen v. Commissioner, supra at 34.

7
 (...continued)
allowable only if such activity is engaged in for profit shall be
allowed "but only to the extent that the gross income derived
from such activity for the taxable year exceeds the deductions
allowable by reason of paragraph (1)."
                              - 14 -


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

nonexclusive list of factors to be considered in determining

whether an activity is engaged in for profit.   These factors

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 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 taxpayers; and (9)

any elements indicating personal pleasure or recreation.

Although these factors are helpful in ascertaining a taxpayer's

objective in engaging in the activity, no single factor, nor the

existence of even a majority of the factors, is controlling;

rather, the facts and circumstances of the case remain the

primary test.   Keanini v. Commissioner, supra at 47.

     Respondent argues that the Johnstons were not engaged in

their farm activity with an intent to make a profit.    To support

this contention respondent relies on Bessenyey v. Commissioner,

45 T.C. 261, 274 (1965), affd. 379 F.2d 252 (2d Cir. 1967), and

section 1.183-2(b)(6), Income Tax Regs. for the proposition that

losses which continue to occur beyond the formative years, if not

explained, may indicate that an activity is not engaged in for
                              - 15 -


profit.   From 1982 through 1992, Bendabout showed a profit only

in 1986, and that was due to a depreciation recapture adjustment.

Respondent notes that each year since 1986, Bendabout generated

roughly the same amount of income, while its expenses more than

doubled from 1986 to 1992.   Moreover, respondent contends that

petitioners will never recoup their losses, because Bendabout

liquidated its thoroughbred operation in 1993.

     Respondent's reliance on Bessenyey v. Commissioner is

misplaced.   Petitioners' losses were incurred during the

formative years of Bendabout's operation and were due to

unforeseen events which were beyond petitioners' control.    On

brief, respondent conceded that 7 years is the minimum startup

period for this thoroughbred breeding business; it takes at least

2 years from the time of purchasing a mare to realize any income

on the investment and if the mare loses the first foal, or is

barren, petitioners will not generate any income for an even

longer period.   Petitioners inherited Bendabout in 1985, and they

started a program of acquiring brood mares and stallions for

Bendabout's thoroughbred program during the years in issue.

Thus, the losses were incurred during the startup period of

petitioners' activity.   See Enghdahl v. Commissioner, 72 T.C.

supra at 669.

     More importantly, losses sustained because of unforeseen or

fortuitous circumstances beyond petitioners' control do not

indicate that the activity was not engaged in for profit.
                               - 16 -


Engdahl v. Commissioner, supra at 669.     From approximately 1985

through 1990, Bendabout suffered unforeseen losses resulting from

a high rate of abortion in its brood mares, which occurred

because the pastures on which they were grazing were contaminated

with a toxic fungus.    Respondent argues, however, that after

petitioners replaced 45 acres of pasture land at a substantial

cost they abandoned the thoroughbred program.    Respondent

contends that discontinuing an activity after expending large

sums to improve its productivity does not support a profit

objective.

     Respondent fails to mention, however, that petitioners

replanted the pastures prior to 1990, and they did not liquidate

their horse breeding program until 1993.    In fact, on brief,

respondent conceded that after petitioners had replanted the

pastures, Bendabout purchased several well-bred mares to enhance

its thoroughbred business.    Furthermore, respondent ignores the

harsh reality of Mother Nature.    During the years in issue, the

entire southeast entered into a severe 4-year drought.    As a

result, Bendabout's first two or three efforts in reestablishing

the pastures were unsuccessful, exacerbating petitioners' losses.

Respondent further ignores the changes that occurred in the

market during this time. Robert Hill (Hill), petitioners' expert

witness in the thoroughbred industry, credibly testified that the

late 1980's brought a drastic drop in the average and median

prices for yearlings.    He noted, however, that this price decline
                               - 17 -


was somewhat camouflaged by the polarization of the thoroughbred

industry due to the fact that the upper-end of the market was

controlled by Middle Eastern oil sheiks, who continued to pay top

dollar for yearlings.    In the late 1980's, when the sheiks'

demand for thoroughbreds declined, the yearling prices plummeted.

As a result, both newcomers and old-line professional

thoroughbred farmers were faced with substantial losses.     In

fact, it was during this time that many of the historically well-

known and successful horse breeding farms went bankrupt.

     Respondent further argues that the Johnstons received

personal pleasure and recreational benefits from operating

Bendabout, which is persuasive evidence that the activity was not

engaged in for profit.    Respondent notes that during the years in

issue the Johnstons lived on the farm, and petitioner spent time

there hunting and fishing.    Moreover, respondent focuses on the

fact that during the years in issue petitioner held a dove hunt

and fish fry at Bendabout to entertain his Coca-Cola colleagues.

We note, however, that the parties stipulated that none of the

losses claimed by petitioners with respect to their farm activity

constituted personal, living, or family expenses.    Moreover, at

trial petitioner credibly testified that he paid for the cost of

the annual dove hunt and fish fry out of his pocket.

     Respondent contends that because of petitioners' financial

status the losses from Bendabout actually generated a tax

benefit.   Given petitioner's substantial other income, it is true
                                - 18 -


that the Johnstons could easily afford to operate the farm

activity at a loss.   This fact alone, however, is not overly

persuasive, because "As long as tax rates are less than 100

percent, there is no 'benefit' in losing money."    Engdahl v.

Commissioner, 72 T.C. at 670.

     Finally, the following factors are indicative of a profit

motive.   The parties stipulated that petitioners conducted their

farm activity in a businesslike manner, maintained accurate books

and records, hired expert advisers, employed competent farmhands,

and had personal experience in the activity in question.     The

parties further stipulated that Gillian Johnston regularly

performed hard manual and menial labor at Bendabout, including

feeding and grooming horses, mucking out stalls, and cleaning

barns.

     Respondent further concedes that petitioners responded to

setbacks at the farm and tried to make corrective changes in its

overall operations, including changing management two or three

times and trying to increase the value of Bendabout's brood mares

by breeding them to good pedigreed stallions in New York and

Kentucky, such as D'Accord and Java Gold, both of which had good

stud records.

     Moreover, a taxpayer's regular experimentation with new

sources of revenue is further evidence of a profit motive.       Hoyle

v. Commissioner, T.C. Memo. 1994-592.    Here, petitioners

continued to seek out the most profitable uses for the farm,
                              - 19 -


including boarding polo ponies, which brought in substantial

revenues, and developing the wildlife habitat in an effort to

generate revenue from hunting, fishing, and recreational use.

     Thus, viewing the record as a whole, we hold that the

Johnstons engaged in their farm activity with a bona fide intent

to make a profit.   Accordingly, the losses incurred in such

activity during the years in issue are fully deductible.

Issue 2. Whether Petitioners' Ranching Activity Known as Flying H
Ranch Was an Activity Engaged in For Profit

     Flying H Ranch

     In December 1985 petitioner acquired a 1,381-acre tract of

rangeland, known as the Flying H Ranch, located on the eastern

slope of the Bighorn Mountains near Sheridan, Wyoming, in north-

central Wyoming, close to the Montana border.   Subsequent

purchases of 2,367 acres in December 1986, 925 acres in April

1989, and 3,902 acres in October 1989 increased Flying H to 8,575

acres, its size during the years in issue.   The ranch property is

rural rangeland, which is located approximately 5 miles from the

Bighorn Equestrian Center, and approximately 250 miles from the

Flying D Ranch, owned by Ted Turner, which is considered to be in

the same general area by those traveling out west to hunt.

Flying H is a multi-use activity.

     Petitioner hired MacCarty, a well-respected and qualified

rancher, to manage Flying H, and Dr. Haaland, an agribusiness
                              - 20 -


expert, as an adviser.   Dr. Haaland's primary responsibility was

to devise a more profitable business plan for Flying H.

      At the time of acquiring Flying H, petitioner believed that

he would be able to put together a profitable cattle operation

through better management of the land.    When petitioner acquired

Flying H, his initial herd of cattle was 20 head of longhorn.

Later, when petitioner and his advisers realized that the

longhorn were not profitable, they decided not to expand that

aspect of the ranching operation.    To cut losses, they put the

longhorn to work as lead cattle.

     During 1986 and 1987, Flying H continued to run cattle under

rate-of-gain contracts, as it had done under previous owners.

Under rate-of-gain contracts, the ranch does not buy cows or

calves; rather, it allows the calves of others to graze on the

ranch for a fee computed on the basis of how much weight the

calves gain.   These contracts were less profitable than

petitioner had expected and resulted in overgrazing.

     In 1987, petitioner employed Dr. Haaland to analyze the

ranch operations in an effort to improve its profitability.

After examining the ranch, Dr. Haaland found that the pastures

had been overgrazed and that the facilities were in disrepair.

Dr. Halland's initial plan for Flying H was to reduce grazing and

rebuild the ranch's infrastructure, such as the fences,

buildings, and irrigation systems.     In order to let the pastures

recover, grazing had to be limited for a short while.    With this
                                - 21 -


plan, however, in the long term Flying H would be able to run

more cows and, therefore, make more money.       To assist this

process, Dr. Haaland recommended that petitioner directly manage

the ranch rather than allow the rate-of-gain contracts to

continue.   He concluded that through direct management petitioner

could correct the condition of the land and make it more

productive.

     Thereafter, petitioner attempted to develop Flying H as a

typical western cattle ranch.    In 1988, Flying H initiated a

yearling grazing stocker program.8       Consistent with its plan to

reestablish its pasture, the ranch ran only 305 and 393 head of

cattle in 1988 and 1989, respectively.       As the pastures improved,

the ranch increased the number of cattle it grazed to 780 head in

1990, 1,256 in 1991, 1,447 in 1992, and 1,971 in 1993.       The

location of Flying H is an excellent habitat for elk, deer,

antelope, and other species of American wild game.       Petitioner

recognized that the ranch presented a lucrative opportunity to

offer big game hunting, because demand for hunting was increasing

and hunters were willing to pay substantial fees to hunt big

game.   For instance, other ranches in the same general area

charged as much as $9,000 for an elk hunt.




8
     In a "stocker" program, yearling cattle are purchased each
spring from a cow-calf operation, fattened over the summer, and
then resold in the fall. In a cow-calf operation, the ranch owns
the cows that it breeds.
                               - 22 -


     Petitioner is actively involved in examining the annual

business plans for Flying H.   During the years in issue,

petitioner's business manager would review the financial results

of the operation in detail with MacCarty, working up budgets and

plans, which petitioner studied and either approved or amended.

     Respondent concedes that Flying H is not an over-improved

property.   The main ranch house was on the property when

petitioner purchased it.   Respondent further concedes that the

facilities at Flying H are not extravagant or showy, but are

rather ordinary and functional, just like any other working

western ranch.

     Discussion

     As evidence of a lack of profit motive, respondent focuses

on Flying H's history of losses, petitioners' use of such losses

to offset other income, and the pleasure aspect of the activity.

As discussed above, these factors alone do not negate a finding

that petitioners engaged in their ranch activity with an intent

to make a profit, especially given that the years in issue fall

within the startup period of the activity.   See Trafficante v.

Commissioner, T.C. Memo. 1990-353 (a series of losses during the

initial stages of an activity does not necessarily indicate that

the activity was not engaged in for profit).

     The parties have stipulated that petitioners carried on

their ranching activity in a businesslike manner and maintained

complete and accurate records.   Moreover, respondent concedes
                              - 23 -


that petitioner believed he would be able to put together a

profitable operation through better management of the land.

Petitioner's testimony and demeanor, combined with other

evidence, convince us that petitioners had an actual and honest

objective of making a profit in conducting their ranch activity.

     During the years in issue petitioner hired Dr. Haaland, an

agricultural consultant, who evaluated the ranch's operations and

developed a complete business plan for the ranch.    See Hoyle v.

Commissioner, T.C. Memo. 1994-592 (proof of detailed business

plans and projections are evidence of a profit motive).

Respondent concedes that Dr. Haaland is an expert in his field,

and that MacCarty, a well-respected and qualified rancher managed

Flying H during the years in issue.    Respondent further concedes

that petitioner never expressed to MacCarty that he did not care

whether the ranch was profitable, and neither petitioner nor his

business managers ever suggested a method of operation to

MacCarty that was inconsistent with a profit objective.

Furthermore, part of   MacCarty's compensation was based on

whether the ranch operations came in under budget, and he had a

commission arrangement for cattle sold.

     Respondent concedes that petitioner was actively involved in

reviewing the business plans and annual budgets for Flying H, and

that he spent substantial time at the ranch talking with MacCarty

about options for the ranch's most productive use.   Petitioner
                              - 24 -


carefully reviewed monthly reports and held his managers

accountable for variances from the business plan and budget

     A change of operating methods, adoption of new techniques,

or abandonment of unprofitable methods is further evidence of

petitioners' profit motive.   Eldridge v. Commissioner, T.C. Memo.

1995-384; sec. 1.183-2(b)(1), Income Tax Regs.   Here, petitioner

implemented numerous changes in operation to try to improve

profitability.

     When petitioner acquired Flying H, he began his operation

with 20 longhorn cattle.   Thereafter, he and his advisers

determined that the longhorn were not profitable and decided not

to expand that aspect of the business.   Moreover, in an effort to

cut losses, they put the longhorn to work as lead cattle.

     In 1987, Dr. Haaland determined that operating under rate-

of-gain contracts was ruining the pastures' potential for long-

term profits and recommended that petitioner take over the direct

management of the ranch.   Petitioner, following Dr. Haaland's

advice, cut back on grazing, which gave the pastures a chance to

recover.   In the short-term, however, this meant that Flying H

was not operating at its maximum cattle capacity, and therefore

it was not maximizing its short-term earning potential.

     In 1993, after running a stocker operation for several

years, petitioner and his advisers determined that it would be

more profitable to combine the stocker operation with a calf-cow

operation, so that in 1995 it ran 1,050 stockers and 265 cows.
                               - 25 -


Furthermore, the ranch expanded its operation to take advantage

of economies of scale.    In 1995, petitioner made the necessary

capital outlays to buy more land about 40 miles south of Flying H

to bring in productive resources like hay pasture and other

resources that were directly related to the cattle program and to

provide a cheaper alternative for wintering his cows.

       In an effort to generate new sources of revenue, petitioner

began a big game hunting operation.     Respondent concedes that

this program has taken a long time to develop because the ranch

needed to improve its wildlife habitat, allow the game on the

ranch to mature, and adjust the herd distributions.     Moreover,

the trophy hunting business is a new industry in the west, and it

takes a long time to produce high quality game and build a

clientele of hunters.    Respondent further concedes that the game

hunting program is expected eventually to be a thriving,

profitable aspect of the ranch.

       In passing we note that while petitioner did occasionally

use the ranch for recreational hunting, the parties stipulated

that none of the expenses at issue concern petitioners' personal

use.    Moreover, petitioner's use of the ranch was no different

from that of other farmers and ranchers who hunt and fish on

their own lands.    We find that any element of personal recreation

the petitioner derived from the ranch was merely incidental to

the overall ranching activity.    See Hoyle v. Commissioner, supra
                               - 26 -


(farm activity was operated for profit despite the fact that the

taxpayer and his children used it for vacations).

     Thus, based on the entire record we find that petitioners

operated Flying H with an intent to make a profit, and therefore

the losses incurred during the years in issue are fully

deductible.

Issue 3. Whether Petitioners' Polo Sales Activity Known as
Bendabout Polo Sales & Management Co. Was an Activity Engaged in
For Profit

     Bendabout Polo Sales & Management Co.

     Bendabout Polo Sales and Management Co, or BPS, is a

partnership, of which petitioner owns 75 percent and S.K.

Johnston, petitioner's son, owns 25 percent.   BPS began

operations in 1986 as a polo horse sales business.   BPS' sales

were primarily conducted in southern Florida, while the polo pony

training operations were conducted at Bendabout in Tennessee and

Flying H in Wyoming.

     Petitioner is a longtime amateur polo player and served as

president of the U.S. Polo Association from 1980 to 1984 and

chairman from 1984 to 1988.   Petitioner retired from playing polo

in 1989, and the parties stipulated that he did not ride any of

BPS' polo ponies during the years in issue.

     Petitioner has developed many contacts in the polo community

worldwide.    Based on his knowledge of polo and his contacts with

people involved in the sport, petitioner thought there would be a

profitable market for selling polo ponies.    Respondent concedes
                               - 27 -


that petitioner's contacts in the polo community were helpful in

selling horses.

     The parties stipulated that BPS employed expert advisers and

competent and qualified persons to carry on its horse sales

activities.   In 1986, petitioners hired Jeff Atkinson (Atkinson),

a seven-goal professional polo player and professional horse

trainer, to run BPS.    Atkinson's duties included training horses,

supervising grooms, organizing the shipping of the horses, and

selling horses.   Prior to joining BPS, Atkinson had been in the

polo sales business for many years.     During that time, his sales

business accounted for over 60 percent of his income, and he had

sold more than 100 polo ponies.

     The initial strategy of BPS was to purchase horses in

Argentina because of the country's reputation in the polo

community for producing high-quality horses.    Some of these

horses would be ready to play with little training and could be

resold immediately.    Petitioner and Atkinson thought that BPS

would be able to double its money on those horses because

petitioner had a source from which BPS could acquire the horses

cheaply.   BPS also intended to develop a brood mare string from

the Argentinean horses, breed the mares, and train and sell the

foals as polo ponies.    During the years at issue, BPS generally

had about 12 to 24 horses in training and for sale at any one

time.
                               - 28 -


       Polo ponies are generally sold in private transactions where

the prospective purchaser tries out the pony by riding it and

playing it in a polo game.    It typically takes 2 years of

training before a pony is ready for sale.     Petitioner and

Atkinson believed that the best strategy for selling a polo pony

is to show a horse's abilities either by allowing a prospective

purchaser to ride the horse during a polo game, or by playing a

horse in a highly visible tournament where purchasers pay high

stakes for horses that play well.    Atkinson encouraged S.K.

Johnston to play BPS' horses in matches to show potential

purchasers that the horses were not only good for professional

players, but for amateurs as well.      With respect to advertising,

the plan was to play the higher level tournaments to make a name

for the company and establish its credibility; the idea was that

the exposure in the higher level tournaments would eventually pay

off.    During the years in issue, a top quality polo pony would

sell for $30,000 or $40,000, and an average polo pony would sell

for around $10,000.    The higher the tournament played, however,

the higher the costs.

       To get ready for the winter selling season in December, BPS'

schedule began in October.    Atkinson, along with the required

number of grooms, traveled with the horses to Florida where most

of the elite polo clubs are located.     The sale season lasted from

the end of December until the beginning of April.     In April, they

would return to Bendabout or Flying H, to allow the horses that
                              - 29 -


had not been sold to recuperate, and start training another

string of horses for the summer selling season.    This string was

not of the same quality as the Florida horses, because the level

of play at the summer selling clubs was not as high, and second-

tier purchasers were not willing to spend as much money.

      Petitioner and S.K. Johnston would meet with Atkinson at

the beginning of each year to discuss the selling strategy during

the upcoming season.   During this time the three of them would

decide which clubs and tournaments Atkinson would travel to based

on the caliber of clientele attending.    Atkinson knew the level

of players at the various clubs and tournaments and what the

purchasers at those events would be willing to spend.    Based on

that information, petitioner, S.K. Johnston, and Atkinson decided

which ponies Atkinson would take with him to Florida.    They would

also prepare a budget for the upcoming sales season.

     During the years at issue, BPS made additional income from

an annual sponsorship fee that Coca-Cola Co. paid the partnership

to put together a polo team to play in matches.

     BPS faced a history of losses.    After losing its key

employee, BPS sold off the remaining horses and in 1993 the

partnership was dissolved.

     Discussion

     Once again, respondent points to a history of losses,

petitioners use of such losses to offset other income, and the
                                - 30 -


pleasure aspect of the activity to establish that petitioners did

not have a profit objective.9

     The parties stipulated that petitioners carried on their

horse sales activity through BPS in a businesslike manner,

maintained complete and accurate books and records, and employed

expert advisers and competent help in operating BPS.    Atkinson,

BPS' primary adviser, was a seven-goal professional polo player

and horse trainer, who owned a profitable pony polo sales

business for many years prior to coming to work for BPS.

     Moreover, petitioner himself had extensive knowledge in this

field.   As a longtime amateur polo player and past president and

chairman of the U.S. Polo Association, petitioner developed polo

contacts worldwide.   Based on his knowledge of polo and his

contacts with people involved in the sport, petitioner thought he

could make a profit selling polo ponies.    Respondent concedes

that petitioner's contacts in the polo community were helpful in

selling horses.   Moreover, petitioner knew inexpensive sources of

supply for polo ponies in Argentina.     Thus, BPS' strategy was to

purchase horses cheaply, train them, and sell them at a profit.

     Respondent argues that BPS' failure to spend more than

minimal funds on advertising is persuasive evidence that BPS was


9
     For 1987 and 1989, the term petitioners in this context
refers to petitioner and Gillian Johnston and S.K. Johnston and
Julie Boyle. For 1988, Gillian Johnston filed a separate return
and a notice of deficiency was not issued to her with respect to
BPS. Accordingly, for 1988, the term petitioners in this context
refers to only petitioner, S.K. Johnston, and Julie Boyle.
                               - 31 -


not engaged in selling ponies for profit.    We disagree.   BPS did

not spend a lot of money on advertising through conventional

means, such as listing ads in various horse magazines.      BPS did,

however, expend substantial sums on registration fees to enter

its horses into tournaments.    Respondent concedes that polo

ponies are generally sold in private transactions where the

prospective purchaser tries out the pony by riding it and playing

it in a polo game.    Accordingly, petitioner and Atkinson believed

that the best advertising strategy was to show a horse's

abilities either by allowing a prospective purchaser to ride the

horse during a polo game, or by playing a horse in a highly

visible tournament where purchasers pay high stakes for horses

that play well.    Thus, BPS' advertising plan was to establish

credibility and make itself known by high level, visible

tournament play.

      That petitioner and S.K. Johnston devoted ample time to BPS

is further evidence of a profit motive.    At the beginning of each

year, they met with Atkinson to discuss strategies for the

upcoming season.    They planned the clubs and tournaments that

Atkinson would travel to, decided which ponies Atkinson would

take with him to Florida, and prepared a budget for the upcoming

sales season which petitioner reviewed throughout the year.

     Finally, that BPS was ultimately liquidated in 1993, after

losing its key employee and facing a history of losses is

additional evidence that the activity was not a hobby.      "If the
                               - 32 -


horse operation were a mere hobby, activity for pleasure, or a

business founded solely for tax benefits, it would not seem

petitioner would entirely abandon the operation."    Trafficante v.

Commissioner, T.C. Memo. 1990-353.

     Thus, based on the entire record we find that petitioners,

through BPS, operated their horse sales activity with the intent

to make a profit.   Accordingly, petitioners' related losses for

the years in issue are deductible.

Issue 4. Whether Gillian Johnston's Horse Training Activity Known
as GJ Stables, Conducted at Bendabout Farm, Was an Activity
Engaged in For Profit

     GJ Stables

     During the years in issue, Gillian Johnston, a licensed

steeplechase horse trainer since 1964, operated a steeplechase

training and racing activity known as GJ Stables out of a

converted cow barn and pasture on approximately 35 acres at

Bendabout farm.   Gillian Johnston has had one assistant for at

least 8 years.    Respondent stipulated that petitioners employed

competent help to carry on the horse training and racing

activities of the stable.

     Unlike a breeding stable which makes money by selling

horses, a racing stable such as GJ makes money primarily by

racing its horses to win purses.   There is, however, always the

possibility that a very successful racing horse may be purchased.

     In operating the stable, Gillian Johnston consulted with

recognized experts in the steeplechase business, including Dr.
                               - 33 -


John Griggs (Dr. Griggs).   Dr. Griggs served on the board of

directors of the Midwest Steeplechase Association and had been

involved successfully in the steeplechase business for many

years.   He was honored by the National Steeplechase Association

on several occasions for having superior horses, and he has

trained horses that won the Eclipse Award, which is the highest

honor awarded to a steeplechase horse.

     The stables would typically have five to six horses in

training at a time.   Gillian Johnston owns all of the

steeplechase horses that she trains; she does not train other

people's horses.   Generally, she would get the horses in

competitive condition at GJ and then she would send them to

experts in Pennsylvania for galloping and jumping training.     The

horses would be returned to the stables for further exercise

prior to being entered into a steeplechase tournament.

     During the years in issue, Gillian Johnston spent most of

her time tending to the business of GJ Stables.   On weekdays, she

would work in the stables from 8:30 a.m. until late afternoon

with the help of one assistant.   On weekends, she would work in

the stables all day, starting at 7 a.m., without any assistance.

Once trained, the horses would compete for substantial purses on

the regular steeplechase circuit.   Currently, purses at some of

these races exceed $100,000.   GJ's horses have won major

steeplechase races, including Saratoga in 1987 and 1991.    Gillian

Johnston has not done any steeplechase racing in this country;
                              - 34 -


rather she employs professional jockeys to ride the horses in all

races.

     Discussion

     Respondent points to three factors to show a lack of profit

motive for the years in issue:10   A history of losses,

petitioners' use of such losses to offset other income, and the

pleasure provided by the activity.

     The parties stipulated that Gillian Johnston11 carried on

her steeplechase activity in a businesslike manner, maintained

complete and accurate books and records, had expertise in

steeplechase training and racing, and employed competent help in

carrying on such activity.   Moreover, she consulted with other

recognized experts in the steeplechase business, including Dr.

Griggs.

     During the years at issue, Gillian Johnston personally

operated the stables on a full-time basis.   On weekdays, she

worked in the stables from 8:30 a.m. until late afternoon with

the help of one assistant.   On weekends, she worked all day,

starting at 7 a.m., without a helper.   The work she performed was

10
     The Johnstons filed joint returns for 1987 and 1989, and
separate returns for 1988. Respondent did not issue a deficiency
notice to Gillian Johnston for 1988, and the notice issued to
petitioners for 1988 does not make a determination with respect
to the stables. Thus, 1987 and 1989 are the years in issue with
respect to GJ Stables.
11
     With respect to GJ Stables, although respondent issued a
joint notice of deficiency to the Johnstons for 1987 and 1989,
the parties stipulated that it was Gillian Johnston who operated
the stables during the years in issue.
                              - 35 -


time-consuming, physically exhausting, and dirty.    In fact, the

parties stipulated that she regularly performed hard manual and

menial labor at the stables, including exercise and training of

steeplechase horses in good weather and bad, feeding and grooming

horses, cleaning tack and other equipment, washing blankets and

bandages, mucking out stalls, cleaning and disinfecting the

stables, and transporting the horses to races.    Gillian

Johnston's personal effort is highly persuasive evidence of her

profit motive, especially given that she had the financial means

to hire as many stable hands and grooms as she wanted.

     With respect to expenses, we note that on brief, respondent

conceded that Gillian Johnston "scrupulously watches costs,

shopping around for the best deals on feed and equipment and

repairing equipment rather than throwing it away."

     We note that although GJ's operations were unsuccessful

during the years at issue, racing businesses are highly

speculative and risky by nature.   The activity, however, provided

Gillian Johnston an opportunity to earn substantial profits by

having her horses compete for large purses.   GJ has had some

successes, winning as much as $25,000 in one race.   The current

purses at some of the races in which GJ's horses compete exceed

$100,000.   We note that an opportunity to earn a substantial

ultimate profit in a highly speculative venture is ordinarily

sufficient to indicate that the activity is engaged in for profit
                                - 36 -


even though losses or only occasional small profits are actually

generated.   Sec. 1.183-2(b)(7), Income Tax Regs.

     Respondent focuses on the fact that Gillian Johnston grew up

training and racing horses, enjoys steeplechase training, and

still loves to ride.   Thus, respondent contends that most of her

activities in connection with GJ Stables were for pleasure and

recreation rather than for business.     We disagree.   First, we

note that Gillian Johnston has not done any steeplechase racing

in this country, and she employs professional jockeys to ride the

stable's horses in all races.    Moreover, if GJ was actually a

hobby, Gillian Johnston most likely would have hired others to

perform the dirty tasks associated with running a stable.

However, in an effort to reduce costs, she performed these

arduous tasks herself, including shoveling horse manure.

     Finally, in passing we note that the tax law does not

prohibit an individual from enjoying his or her work.      See Cole

v. Commissioner, T.C. Memo. 1992-51 (personal pleasure derived

from operating a pecan farm did not indicate lack of profit

motive).

     Thus, based on the entire record, we hold that GJ Stables

was an activity engaged in for profit.     Accordingly, petitioners

may deduct their related losses sustained during the years in

issue.

Issue 5. Whether $1,131,438 Was the Fair Market Value of a
Conservation Easement Encumbering the Flying H Ranch, Donated By
Petitioners to the Nature Conservancy During 1989
                               - 37 -


       The Conservation Easement

       In December 1989, petitioners donated to the Nature

Conservancy (the Conservancy) a conservation easement encumbering

4,898 acres of the Flying H Ranch (the easement).    The parties

stipulated that the easement was a "qualified conservation

contribution" for the purposes of section 170(f)(3)(B)(iii) and

(h).

       The easement encumbers a highly aesthetic portion of Flying

H know as Moncreiffe Ridge located near Big Horn, Wyoming.      The

ridge forms the highest part of the property with deeded lands

descending to the north, south, and west.    The land consists of

level to rolling foothill rangelands that vary from open to

timbered land along the west slopes of the Big Horn Mountains,

and is bounded on its southern border by the Big Horn National

Forest.    Most of the easement's northern boundary is bordered by

Wyoming State lands.

       Several improved gravel roads provide direct access to the

property from petitioners' property, and the easement grants the

Conservancy the right of access for ingress and egress.      The

easement has superior interior access that is provided by a

gravel road known as the Gulf road, constructed for oil and gas

exploration by Gulf Oil in the early 1980's, and numerous jeep

trails.    The Gulf road traverses the lower areas of the easement

along the northern slope of Moncreiffe Ridge and continues to the

extreme southern areas on the property adjacent to Bighorn
                                - 38 -


National Forest.   The road terminates at a large level site where

the Gulf drilling rig once operated.     At this site there are

several capped water wells.   Electrical power is installed to the

northeast corner of the property where several radio towers are

located.

     The property affords panoramic views of the Sheridan Valley

and the Big Horn National Forest.    It has numerous flowing

streams, onsite springs, and level sites suitable for rural

development.   There are no zoning restrictions on the property

provided the land is divided into lots of 35 acres or more.       The

area of Sheridan County is well known for its recreational

aspects that over the years have attracted guest ranching

enterprises and rural estate residences.     There is a 2,000-acre

rural development in the high mountain area approximately 4.5

miles north of the easement known as Teepee Creek, consisting of

approximately 20 different ownerships of seasonal cabins and

recreational-type properties.    The Teepee Creek property is

accessible from a public road which is closed during the winter

because the county does not plow snow.     The Equestrian Hills

Development in Big Horn, Wyoming, lies just off the northeast

corner of the lower portion of Flying H, and the easement is near

the Bighorn Equestrian Center, one of the oldest polo clubs in

the United States.

     The easement allows Flying H to graze and range horses,

cattle, and buffalo.   It allows petitioner to continue to use the
                               - 39 -


three cabins already existing on the property.   The easement also

gives petitioner the right to construct one additional cabin on

the property not to exceed a height of 20 feet and area of 1,500

square feet on each floor.

     The upper area of Flying H, which incorporates the easement,

is utilized by the ranch for summer livestock grazing.   Cattle

are moved up onto the easement, as well as onto adjoining

national forest lands, over which Flying H controls grazing

rights.   The easement, however, places numerous restrictions on

petitioners' right to use the property.   Development of the

property by subdivision is completely prohibited, as are all

residential, commercial, or industrial uses.   Oil and mineral

exploration and extraction are prohibited.   Agricultural use is

severely limited; no crops can be grown, and no timber can be

harvested.   Livestock grazing is restricted to 300 Animal Unit

Months12 (AUM's) per year.   In addition, the easement gives the

Conservancy several possessory rights, such as the right to enter

the property, to cut and remove vegetation, and to conduct

prescribed burns.

     Norman C. Wheeler (Petitioner's Expert)

     Norman C. Wheeler (Wheeler) is the owner of Norman C.

Wheeler & Associates, a 35-year-old agricultural management and

consulting firm with offices throughout Montana.   He is a

12
      An animal unit month, or AUM is the amount of forage that
one 1,000 pound cow will consume with a calf at its side that has
not been weaned.
                              - 40 -


qualified appraiser of rural property, who has been actively

engaged in the appraisal field for 18 years.   Wheeler has been

awarded the designation of Accredited Rural Appraiser (ARA), the

highest professional designation offered by the American Society

of Farm Managers and Rural Appraisers and is licensed by the

State of Montana as a Certified General Appraiser.

     Wheeler's field of expertise is in the appraisal of

conservation easements, specifically in the western part of the

United States.   He has completed courses on appraising

conservation easements.   More importantly, he has been appraising

easements in the Wyoming area since 1982.   Since that time,

Wheeler has appraised more than 100 conservation easements and

currently spends 70 percent of his professional time appraising

conservation easements which are primarily in the Montana and

Wyoming area.

     Wheeler's clients have included individual landowners,

banks, corporations, and Government agencies, such as the

Internal Revenue Service (IRS), the U.S. Department of

Agriculture, and the U.S. Forest Service.

     John J. Boyett (Respondent's Expert)

     John J. Boyett (Boyett) is a State certified general real

estate appraiser.   Boyett has worked in the appraisal field for

the past 28 years and has been employed by the IRS for the last

14 years.   Boyett has attended numerous real estate appraisal

courses; however, he has never evaluated the effect of a
                              - 41 -


conservation easement.   Boyett has valued farmland and ranches

for individual farmers and for companies.   His experience is

primarily confined to the southeast.

     Discussion

     On their 1989 return, the Johnstons claimed a $960,000

charitable contribution deduction for the easement granted to the

Conservancy.   The amount of the deduction was based upon an

appraisal which valued the property before the easement at

$2,035,00013 and after the easement at $1,075,000; the $960,000

difference between the before and after value represents the

value of the easement.   Respondent determined that the easement

reduced petitioners' property value by $203,500,14 not $960,000

as claimed on their 1989 return.   Accordingly, respondent reduced

petitioners' deduction for the value of the easement by $756,500;

the difference between the $960,000 claimed on their original

1989 return and the $203,500 allowed by respondent pursuant to

the notice of deficiency.




13
     On brief, respondent concedes that $2,057,160 was the
property's value before the easement. This amount is $22,160
greater than petitioners' original valuation of $2,035,000.
14
     In the notice of deficiency, respondent determined that the
easement reduced petitioners' property value by $203,500. On
brief, however, respondent contends that the easement reduced
petitioners' property value by $407,000, which is double the
amount originally allowed by respondent in the notice of
deficiency. Although, the record is silent as to why respondent
made this adjustment, we find this to be a concession in
petitioners' favor.
                               - 42 -


     The parties agree that the easement granted by the Johnstons

in December 1989 was a qualified conservation contribution under

section 170(f)(3)(B)(iii) and (h), and that the grant of the

conservation easement qualifies as a deductible charitable

contribution under section 170(a)(1) and (c).   Unresolved,

however, is the value of the charitable contribution amount.

Subsumed in this issue is the question of whether the highest and

best use of the property before the date of gift was

predominantly rural development as argued by petitioners, or

whether it was primarily recreational as argued by respondent.

     An easement is an interest in real property that conveys

use, but not ownership, of a portion of an owner's property.

Dorsey v. Commissioner, T.C. Memo. 1990-242.    The value of an

easement is estimated as some part of the amount of value it adds

to the property it benefits, or the loss in value to the property

it burdens.   Id.

     The amount allowable as a deduction with respect to a

charitable contribution of property is usually determined by the

fair market value of the property donated; i.e., the price at

which the property would change hands between a willing buyer and

willing seller, on the date of the gift.   Sec. 1.170A-1(c)(2),

Income Tax Regs.    A conservation easement, however, is normally

granted by deed of gift; consequently, there is rarely an

established market from which to derive fair market value.    See

Symington v. Commissioner, 87 T.C. 892, 895 (1986).    Therefore,
                               - 43 -


the fair market value of an easement usually will be determined

indirectly by applying a "before-and-after" analysis, thereby

determining the negative effect the easement has on the value of

the total property.15   Thus, the difference between the fair

market value of the total property before the granting of the

easement and the fair market value of the property after the

grant is the fair market value of the easement.    Id.

     The fair market value of the easement should be based on the

highest and best use for the property on its valuation date,

including potential development.   See generally Stanley Works v.

Commissioner, 87 T.C. 389, 400 (1986); Hilborn v. Commissioner,

85 T.C. 677, 688 (1985); sec. 1.170A-14(h)(3)(i) and (ii), Income

Tax Regs.

     In determining the before and after highest and best use,

the fair market value of property is not affected by whether the

owner actually has put the property to its highest and best use.

Symington v. Commissioner, supra at 896; Stanley Works v.

Commissioner, supra.    Rather, the realistic, objective potential

uses for property control the valuation thereof.    Symington v.

Commissioner, supra.    Thus, in determining the reasonable and

probable use that supports the highest present value we focus on


15
     The before-and-after method of valuing conservation
easements is approved by the IRS. See Rev. Rul. 73-339, 1973-2
C.B. 68, as clarified by Rev. Rul. 76-376, 1976-2 C.B. 53, and
endorsed by Congress in connection with the adoption of the Tax
Treatment Extension Act of 1980, S. Rept. 96-1007 (1980), 1980-2
C.B. 599, 606.
                              - 44 -


the highest and most profitable use for which the property is

adaptable and needed or likely to be needed in the reasonably

near future.   Olson v. United States, 292 U.S. 246, 255-256

(1934).

     The value of the property after the donation must also

reflect its highest and best use.   Accordingly, consideration of

any new restrictions the easement places on the property must be

taken into account.   Losch v. Commissioner, T.C. Memo. 1988-230.

     To establish the fair market value of the easement, each

party offered the report and testimony of an expert witness:

Wheeler, for petitioners, and Boyett, for respondent.

     At the outset, we note that petitioners' expert had

extensive experience appraising conservation easements.    In fact,

since 1982, Wheeler has appraised more than 100 conservation

easements, and spent close to 70 percent of his time appraising

conservation easements primarily in Montana and Wyoming.    In

contrast, Boyett, respondents' expert has never evaluated the

effect of a conservation easement on property.    Any real estate

appraisal experience he has is primarily limited to the

southeast.

     In determining the value of the easement, Wheeler concluded

that the most profitable before use was primarily rural

development and recreational use, in connection with

agriculture, either in parcels or as a whole.    Accordingly, he

concluded that the easement had a fair market value at the time
                              - 45 -


of donation of $1,131,438, which represented a 55 percent

reduction in the $2,057,160 before value of the property.    Boyett

concluded that the highest and best use before the easement was

primarily recreational, with some nominal grazing and timber

harvesting.   Accordingly, he concluded that the easement had a

fair market value at the time of donation of $407,000, which

represented a 20 percent reduction in the $2,035,00016 before

value of the property.

     We note that both experts agree that the before-and-after

method should be used to determine the fair market value of the

easement, that recreational use was part of the before and after

highest and best use, and that the highest and best post-easement

use was primarily recreational and secondarily agricultural.

They further agree that easements generally are segregated into

three categories, and that each category is related to the amount

of loss in value the property incurs due to the easement's use

restrictions; the more restrictive an easement, the greater the

percentage decrease of value to the encumbered property.    The

difference between both experts' opinions turns on their

estimation of the property's highest and best use before the

easement was granted and on the after value of the property.

16
     The $22,160 difference in the experts' before values is
attributable to the fact that, in his comparable sales analysis,
Boyett merely relied on the purchase price allocations of another
appraiser, whereas Wheeler performed his own independent inquiry
to determine the purchase price allocations. On brief,
respondent concedes that $2,057,160 was the fair market value of
the property before the easement was granted.
                              - 46 -


After careful consideration of the entire record, we agree with

petitioners.

     Wheeler determined that the property's highest and best use

before the easement would be for rural development comparable to

that already existing in the area, together with recreational and

agricultural use.   Respondent argues, however, that the property

has no future development potential, limited agricultural

potential, and therefore the highest and best use before the

easement would be recreational.   To support this position,

respondent points to the fact that restrictive land ownerships

have precluded intensive development.   The owners in the area are

investors or established residents who have tried to preserve the

aesthetic appearance in the area.   In making such argument,

however, respondent fails to realize that as long as the highest

and best use for which the property is adaptable and needed or

likely to be needed in the near future is not prohibited by law,

community opposition to such a use does not preclude us from

valuing the property as if it were so used.   Symington v.

Commissioner, 87 T.C. 892 (1986).

     Respondent further stresses the fact that pursuant to local

ordinances lots created below 35 acres are subject to strict

subdivision review.   In response to this argument, petitioners

correctly point out that rural development does not necessarily

mean planned small-tract development as is found in the urban and

suburban regions of the eastern United States.   Rather,
                                - 47 -


petitioners argue that rural development in Sheridan County means

larger (i.e., 35-acre lots or greater) tract development with

residences built on prominent points overlooking scenic views, or

rural acreage tracts used for the buyer's personal recreation, or

to build cabin sites.   Thus, local zoning ordinances have no

effect on rural development of the type petitioners describe.

     In determining the property's highest and best use,

respondent relies heavily on Boyett's finding that the property

had no development potential.    At trial, Boyett testified that

the property at issue is not located in an area where there are

other residential or commercial developments.    This conclusion is

in direct conflict with the evidence.    First, we mention that the

property is located approximately 5 miles from the Bighorn

Equestrian Center, one of the oldest polo clubs in the United

States, which also provides community facilities, such as fields

for soccer and baseball, and a clubhouse that can be rented out

for weddings and funerals.   There is a development of houses and

cabins just southeast of the property, which is situated on rough

mountainous land similar to portions of the easement property.

Moreover, just 4 or 5 miles west of the property, there is a

2,000-acre development known as Teepee Creek, which is 1,000 feet

higher in elevation than the easement property and has similar

mountainous topography.   Just off the southwest portion of the

easement property, composed of some of the roughest terrain,

there is a seasonal cabin of the type commonly found in this
                               - 48 -


area, and it is accessed by the Gulf Road.   Finally, we mention

that at trial and again on brief, respondent argues that even if

the property at issue had the possibility of being developed,

such potential was diminished by the fact that the easement

property was landlocked.    However, such is not the case, because

pursuant to the easement, petitioners also granted the

Conservancy a right of ingress and egress over their property to

access the easement land.

     Moreover, at trial, Boyett testified that he talked to many

local people in the area, including Century 21 realtors

(Century), to assist him in reaching the conclusion that the

property did not have development potential.   On October 6, 1993,

however, Boyett wrote a memorandum to Archie Thurman, the Appeals

officer in the instant case, in which he stated that he spoke

with Jack Pelissier (Pelissier) at Century in Sheridan, Wyoming;

Bill King (King) at King Land Investments in Big Horn, Wyoming;

and Ron Prestfeldt (Prestfeldt) of Prestfeldt Engineering, all of

whom concluded that the property had development potential.

Pelissier stated that if the Gulf Road accessed the subject

easement (which it does), then the property definitely has

development potential, because the Gulf Road runs off a county

road to the Bighorn National Forest.    Prestfeldt and King noted

that Moncreiffe Ridge had the potential to be developed into a

retirement community with single-family seasonal dwellings.    In

light of these comments, we have difficulty understanding why
                              - 49 -


Boyett concluded that the property had no future development

potential, especially given that rural development indeed exists

in close proximity to the property at issue.   Thus, based on the

entire record, we agree with petitioners that the highest and

best before value use of the property was rural development, with

recreational and agricultural use as secondary.

     We next turn to the issue of the property's value after the

granting of the easement.   At trial, petitioners' expert

testified that by prohibiting development and subdivision, the

conservation easement prevents the property from attaining its

highest and best use.   He concluded that the property, in effect,

is reduced to an agricultural-recreational unit, and the other

restrictions of the easement limit the agricultural use to 25

percent of its potential.   Wheeler, relying on data provided by

the Soil Conservation Service, specifically relating to the

carrying capacity of the property at issue demonstrated that the

livestock grazing of such property was 1,400 AUM's per year.    The

easement restricts grazing to 300 AUM's per year.   Thus, Wheeler

concluded that this greater than 75-percent restriction on

grazing contributes to the diminution in value caused by the

easement, because it narrows the market of potential buyers

further than if the easement had only prohibited development.

Moreover, at trial, Wheeler credibly testified that the

conservation easement in the instant case was one of the most
                              - 50 -


restrictive he had seen in his more than 13 years of experience

appraising conservation easements.

     Due to the absence of sales of easement encumbered property

in the immediate area to determine the after value of the

property, Wheeler examined sales data of easement-encumbered

properties in other similar locales.   At the time of valuing the

easement at issue, Wheeler had tracked the sales of easement

encumbered properties in Wyoming and Montana for over 10 years

and had developed a database of 13 such sales.   Wheeler analyzed

each of these sales individually to determine the values

associated with the sale, the market conditions at the time of

sale, and the easement restrictions placed on the property sold.

This information was not available through public records because

both Montana and Wyoming are nondisclosure States.   Wheeler

testified that the goal in analyzing these sales was not to

derive a specific per-acre value, but rather to determine the

percentage diminution in value due to the conservation easement.

     Wheeler credibly testified that the local sales suggested

losses due to the conservation easements of between 30 to 60

percent.   The percentage diminutions vary directly with the scope

and amount of restrictions placed on the property; the more

severe the restrictions, the greater the percentage diminution.

Wheeler further testified that conservation easements cause

reductions in value in direct relation to the amount and type of

restrictions placed on the property.   The evidence Wheeler
                               - 51 -


submitted at trial shows that nationwide, the diminutions in

value associated with easements prohibiting development and

natural resource uses ranged from 64 percent to 90 percent, with

an average of 77 percent.    Easements prohibiting development, but

allowing resource uses such as timber harvesting ranged from 21

percent to 81 percent, with an average loss of 53 percent.

Finally, easements allowing development ranged from 5 percent to

39 percent, with an average loss of 22 percent.   Wheeler

determined, based on the prohibited development of the property

at issue, that the easement would be included in the second

category, suggesting a minimum average rate of diminution of 53

percent.   The most comparable local easement suggested a

diminution rate of 59 percent, which, like the easement in the

case at bar, was a restrictive development easement that

controlled timber and mineral use and reduced livestock grazing

by 66 percent.   Based on the range of 53 percent to 59 percent,

Wheeler concluded that a 55 percent rate of diminution adequately

reflected the effect of the easement of the appraised property.

Thus, based on the established value of $2,057,160 and the 55-

percent rate of diminution in value attributable to the

conservation easement, Wheeler concluded that the after value of

the property was $925,722.   Accordingly, he subtracted the after

value from the $2,057,160 before value to get $1,131,438 as the

value of the conservation easement.
                               - 52 -


     Respondent criticizes Wheeler's method of determining the

after value of the property.   Respondent argues that Wheeler did

not locate any comparable sales closer to the property at issue

than comparables from Montana.   At trial, however, respondent's

own expert testified that he, like Wheeler, could not find any

comparables within "a long distance of Sheridan."   Boyett used

comparables from sales in Colorado, Montana, Idaho, and in the

Yellowstone Park vicinity of Wyoming.

     Respondent also argues that a 55-percent reduction to the

value of the easement property is excessive.   Respondent bases

this argument primarily on Boyett's conclusion that the 300 AUM's

restrictions under the easement did not affect the after value of

the property at all.   We find Boyett's analysis to be flawed.

Boyett's conclusion was based on the following: (1) A discussion

with MacCarty, the former ranch manager, during which time

MacCarty told him that the easement's restriction of grazing to

300 AUM's did not affect the after value of the property, because

Flying H did not intend to run more than 300 AUM's on the

easement property, and (2) his own calculations.    First, we note

that Boyett's conversation with MacCarty regarding petitioners'

intentions for the use of the property is irrelevant in

determining the highest and best use.   Dorsey v. Commissioner,

T.C. Memo. 1990-242.   Value is not affected by whether an owner

actually intends to put, or has put, the property to its highest

and best use before the date of donation.   Moreover, were we to
                              - 53 -


rely on Boyett's calculations, we would have to reject the site

specific data provided by the Soil Conservation Service that the

AUM capacity was 1,400 AUM's per year.     We are not prepared to do

this.   Finally, based on the data submitted by petitioners at

trial, we find that a 55-percent diminution factor is a

conservative diminution estimate.

     Thus, based on the entire record, we hold that $1,131,438

was the fair market value of the conservation easement

encumbering the Flying H Ranch donated by petitioners to the

Nature Conservancy during 1989.

           To reflect the foregoing,

                                       Decisions will be entered

                               for petitioners.
