                 T.C. Summary Opinion 2010-176



                      UNITED STATES TAX COURT



         RICHARD A. AND DELORES L. FRIMML, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 5229-09S.                Filed December 28, 2010.



     Scott M. O’Shea, for petitioners.

     Susan K. Bollman and Michael W. Bitner, for respondent.



     KROUPA, Judge:   This case was heard pursuant to the

provisions of section 74631 of the Internal Revenue Code in

effect when the petition was filed.   Pursuant to section 7463(b),

the decision to be entered is not reviewable by any other court,




     1
      All section references are to the Internal Revenue Code
unless otherwise indicated.
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and this opinion shall not be treated as precedent for any other

case.

     Respondent determined deficiencies in petitioners’ Federal

income taxes of $4,809 and $6,105 for 2005 and 2006 (the years at

issue), respectively, and $961.80 and $1,191 accuracy-related

penalties under section 6662(a) for those years.   We are asked to

decide two issues in this case.   The first issue is whether

petitioners conducted their American Paint Horse breeding

activity (horse activity) for profit within the meaning of

section 183 when they failed to generate a profit for 10 years

(including the years at issue) despite allocating substantial

funds and time to their horse activity.   We hold that petitioners

did conduct their horse activity for profit.   The second issue is

whether petitioners are subject to the accuracy-related penalty

under section 6662(a).   We hold that they are not.

                            Background

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

The stipulation of facts and the accompanying exhibits are

incorporated by this reference.   Petitioners resided in Luzerne,

Iowa at the time they filed the petition.

     Petitioners both grew up on farms and were married in 1985.

They purchased their first two horses in 1988 and spent the next

10 years learning about horse breeding and developing a
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business plan.    Their business plan came to focus on American

Paint Horses (Paints or Paint horses), a breed identified by

their colorful coat patterns, strict bloodline requirements and

distinctive stock-horse body types.     Petitioners’ knowledge at

trial was extensive as it related to breeding and artificially

inseminating Paint horses.    Their knowledge included the

genetics, the mechanics and the financial aspects of breeding.

     Petitioners purchased a 6-acre property on which to develop

their business in 1998, which they substantially repaired and

improved on a cash available basis for the next seven or eight

years.   This property had more than doubled in value by the time

of trial, in part because of petitioners’ work.     Petitioners

initially maintained a very small stable of Paint breeding mares

and sought to earn income by showing and selling the foals.       They

consulted experts on various aspects of the horse activity

including showing, breeding and selling the Paints.

     They leased an older Paint mare, Crymanitly, and found that

she produced an excellent quality of foal.     As a result,

petitioners sought expert help and paid significant amounts to

breed Crymanitly despite her older age.     They also boarded her

during her pregnancy to improve her chances of producing a

healthy foal.    Crymanitly produced a stallion named Zippos

Special Reserve (Special) and petitioners adapted their business

plan to include training, showing and breeding Special.       They
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also hired a professional to train and show Special to increase

his value.   They have identified semen production by Special as a

potential future source of revenue.

     Petitioners made many business decisions regarding the

purchase, care and sale of a number of Paint horses for their

horse activity.   Petitioners paid extensive amounts to care for

Special when he was injured.   On the other hand, petitioners

decided to put down a 2-year-old foal that hurt her leg in a

fence accident because the cost to heal her exceeded the

projected price in selling her.

     Petitioners advertised their Paint horse activity primarily

by showing their Paints.   They considered showing their Paint

horses to be the best advertising possible.       They also advertised

by boarding Special with a well-known professional horse trainer

whose facilities “had a lot of traffic.”       They intended to set up

a Web site as well, but had not done so as of the trial because

Special was still in training.

     Petitioners both had full-time jobs during the years at

issue.   Mr. Frimml repaired tracks and ties for Union Pacific

Railroad and his railroad schedule allowed him generally equal

days off after working seven days.       He worked on the horse

activity 6 to 10 hours per day during the time that he was home,

caring for the horses, making improvements to the property and

their facilities and transporting the Paint horses.       While he was
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away, Mrs. Frimml spent approximately 1-1/2 hours per day

attending to the regular obligations of their horse activity.

She was employed full time as an office worker at Dieomatic

Incorporated.    Petitioners have also spent substantial time

attending Paint horse shows, learning about regional horses and

horse facilities and otherwise advancing their activity.    They

rarely spent free time away from the Paint horse activity.      In

fact, one of them usually stayed back from family events so that

the Paint horses were not unattended.    Petitioners and their

family and friends did not ride the horses.

     Petitioners intended their Paint horse activity to provide

retirement income.    They did not believe their savings and assets

were sufficient to cover their retirement needs.    Petitioners had

no sizable investments or substantial source of retirement income

to augment their railroad retirement money and a small 401(k).

Petitioners’ gross wages and salaries totaled more than $90,000

for each year at issue.    Their total expenses for the Paint horse

activity during these years were $26,794 and $25,350.

Petitioners organized their income and expenses by means of a

check register.

     Respondent issued the deficiency notice to petitioners,

disallowing the Schedule F losses for the years at issue and

determining the deficiencies and accuracy-related penalty for

those years.    Petitioners timely filed a petition.
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                             Discussion

     We must decide whether Paint horse owners engaged in

breeding horses for profit within the meaning of section 183 when

they allocated substantial funds and time to their horse activity

over a period of 10 years (including the years at issue) yet

failed to generate a profit.   We also must decide whether

petitioners are liable for the accuracy-related penalty for the

years at issue.    We begin with an analysis of the horse activity

under section 183.

     Whether a taxpayer may deduct expenses related to an

activity depends on whether it is carried on for profit.     Secs.

162, 212.   Subject to two exceptions in section 183(b) that do

not apply here, a taxpayer may not deduct losses attributable to

an activity unless that activity is engaged in for profit.    Sec.

183(a).   An activity is engaged in for profit if the taxpayer has

an actual, honest profit objective, even if it is unreasonable or

unrealistic.   Sec. 1.183-2(a), Income Tax Regs.

     We structure our analysis of whether an activity is engaged

in for profit around nine nonexclusive factors.    Sec. 1.183-2(b),

Income Tax Regs.   The nine factors are:   (1) the manner in which

the taxpayer carried on the activity, (2) the expertise of the

taxpayer or his or her advisers, (3) the time and effort expended

by the taxpayer in carrying on the activity, (4) the expectation

that the assets used in the activity may appreciate in value, (5)
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the success of the taxpayer in carrying on other similar or

dissimilar activities, (6) the taxpayer’s history of income or

loss with respect to the activity, (7) the amount of occasional

profits, if any, which are earned, (8) the financial status of

the taxpayer, and (9) whether elements of personal pleasure or

recreation are involved.   Id.

     No factor or set of factors is controlling, nor is the

existence of a majority of factors favoring or disfavoring a

profit objective controlling.     Keating v. Commissioner, 544 F.3d

900, 904 (8th Cir. 2008), affg. T.C. Memo. 2007-309; Hendricks v.

Commissioner, 32 F.3d 94, 98 (4th Cir. 1994), affg. T.C. Memo.

1993-396; sec. 1.183-2(b), Income Tax Regs.    The individual facts

and circumstances of each case are the primary test, with greater

weight to be given to objective facts than to the taxpayer’s

statement of intent.   See Evans v. Commissioner, 908 F.2d 369,

373 (8th Cir. 1990), revg. T.C. Memo. 1988-468; Abramson v.

Commissioner, 86 T.C. 360, 371 (1986).     We now apply the factors

to the facts here.

     We begin with the first factor by considering whether

petitioners carried on the Paint horse activity in a businesslike

manner.   See sec. 1.183-2(b)(1), Income Tax Regs.   Factors that

may indicate a profit objective include whether petitioners had a

business plan, attempted changes in an effort to earn a profit,

maintained complete and accurate books and records, and
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advertised the horse activity.    See Engdahl v. Commissioner, 72

T.C. 659, 666-667 (1979); Rinehart v. Commissioner, T.C. Memo.

2002-9; sec. 1.183-2(b)(1), Income Tax Regs.

     Petitioners spent a decade formulating a business plan for

breeding Paint horses and adapted their business plan in efforts

to earn a profit.   Their failure to reduce the business plan to

writing is not fatal as its formulation and alteration over time

are evident.   See Rinehart v. Commissioner, supra; Phillips v.

Commissioner, T.C. Memo. 1997-128.       Petitioners purchased and

substantially improved a 6-acre property on which to develop

their business.   They adapted their initial plan of maintaining a

very small stable of breeding mares once they learned the

excellent quality of foal Crymanitly produced.      Petitioners again

changed their business plan after Crymanitly’s foal, Special, was

born to incorporate training, showing and breeding Special.      They

have identified semen sales by Special for artificial

insemination as a potential source of future revenue.

     The Court specifically notes petitioners’ businesslike

descriptions of decisions regarding their Paint horses.

Petitioners paid extensive amounts to heal Special when he was

hurt.   On the other hand, they put down a 2-year-old foal that

hurt her leg in a fence accident because the cost to heal her

exceeded the projected price in selling her.
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     Petitioners’ check register, which they used to organize

their income and expenses, was maintained in an unprofessional

and imprecise manner.   Petitioners’ advertising was also not

extensive.   Petitioners advertised by showing their Paint horses

and boarding Special with a well-known professional horse trainer

whose facilities “had a lot of traffic.”    They intended to

develop a Web site but had not done so by the time of trial

because Special was still in training.    Petitioners’ business

plan and businesslike approach to the horses suggest a profit

objective, but their imprecise bookkeeping and limited

advertising detract from this conclusion.    This factor is

neutral.

     A second factor is the taxpayer’s expertise, research and

study of an activity, including consultation with experts.      Sec.

1.183-2(b)(2), Income Tax Regs.    Petitioners studied horse

breeding in general and Paint horse breeding specifically for a

decade before beginning their horse activity.    The Court is

convinced from their trial testimony that they have the requisite

knowledge of breeding, including the genetics, mechanics and

financial aspects of breeding.    Petitioners also consulted

experts on various aspects of the Paint horse breeding business

including showing, breeding and selling the horses.    They sought

expert help to breed Crymanitly and boarded her during her

pregnancy to improve her chances of delivering a healthy foal.
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They hired a professional to train and show Special to increase

his value.    This factor favors the requisite profit objective.

     The third factor is whether the taxpayer devotes much

personal time and effort to carrying on the activity,

particularly if the activity does not have substantial personal

or recreational aspects.    Sec. 1.183-2(b)(3), Income Tax Regs.

Petitioners both had full-time jobs.     Mr. Frimml’s job schedule,

however, required that he travel for work for approximately a

week and then have a week off.    He worked on the Paint horse

activity 6 to 10 hours per day during the time that he was home,

caring for the horses, making improvements to the property and

their facilities and transporting the horses.     While he was away,

Mrs. Frimml spent approximately 1-1/2 hours per day attending to

the obligations of their horse activity.     Petitioners have also

spent substantial amounts of time attending Paint horse shows,

learning about regional Paint horses and horse facilities and

otherwise advancing their activity.      They rarely spent free time

away from the horse activity.    In fact, one of them usually

stayed back from family events so that the Paints were not

unattended.    This factor indicates a profit objective.

     A fourth factor is the taxpayer’s expectation that assets

used in the activity may appreciate in value and generate an

overall profit.    Sec. 1.183-2(b)(4), Income Tax Regs.    The

property that petitioners acquired to start their horse activity
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has more than doubled in value, in part because of improvements

petitioners made.   Moreover, petitioners boarded Special with a

well-known, professional trainer to increase his value.     We

believe that petitioners expected that the value of assets used

in their horse activity would increase.     We further believe that

the expectation was sufficient to explain their willingness to

sustain continued operating losses.     See Allen v. Commissioner,

72 T.C. 28, 36 (1979).    This factor indicates the requisite

profit objective.

     We now consider, as a fifth factor, whether petitioners have

previously converted similar activities from unprofitable to

profitable enterprises.    Sec. 1.183-2(b)(5), Income Tax Regs.

Petitioners both grew up on farms.      We have no evidence, however,

that they had ever undertaken similar activities in the past.

This factor favors respondent.

     We now consider the sixth and seventh factors, which center

on petitioners’ record of substantial losses and their absence of

occasional profits.   Sec. 1.183-2(b)(6) and (7), Income Tax Regs.

A series of losses during the startup phase of an activity may

fail to indicate that the activity is not engaged in for profit.

Sec. 1.183-2(b)(6), Income Tax Regs.     This Court has recognized

that the startup phase of an American saddle-bred breeding

activity is 5 to 10 years and that a period of 5 to 10 years for

the startup phase of an Arabian breeding operation is not
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unreasonable.    Engdahl v. Commissioner, 72 T.C. at 669; Phillips

v. Commissioner, T.C. Memo. 1997-128.      The years in issue, 2005

and 2006, are within this startup window.     We treat these factors

as neutral because petitioners’ losses and absence of profit

during the years at issue were during the startup phase of their

Paint horse activity.   See Strickland v. Commissioner, T.C. Memo.

2000-309.

     An eighth factor is whether petitioners earned substantial

income from sources other than the horse activity.     Sec.

1.183-2(b)(8), Income Tax Regs.   Petitioners both had full-time

jobs and made over $90,000 a year.      We do not find, however, that

they were using their salaries to support their horse activity as

a hobby.    Petitioners established their Paint horse activity with

the hope of satisfying their retirement needs.     They had no

sizable investments or substantial source of retirement income

other than their railroad retirement money and a small 401(k).

We think it unlikely that petitioners would embark on a hobby

consuming so much of their income and entailing so much physical

labor and time commitment without a profit motive.     See Engdahl

v. Commissioner, supra at 670; Mary v. Commissioner, T.C. Memo.

1989-118.   This factor indicates a profit objective.

     The final factor is whether petitioners received personal

pleasure and recreational benefits from their Paint horse

activity.   Sec. 1.183-2(b)(9), Income Tax Regs.    Petitioners have
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made substantial improvements to their property and have spent

significant time caring for their Paint horses and maintaining

their facilities.   They did not ride their Paint horses, and they

did not allow family and friends to ride them either.   This

factor indicates a profit objective.

     After considering all the facts and circumstances, we find

that petitioners have shown that they engaged in their horse

activity for profit.   Respondent did not contest the specific

dollar amounts petitioners claimed as losses for the years at

issue, and therefore petitioners can deduct all of the claimed

losses.   Petitioners are also not liable for the accuracy-related

penalty for the years at issue because of our holding regarding

the deficiencies.

     We have considered all arguments made in reaching our

decision and, to the extent not mentioned, we conclude that they

are moot, irrelevant, or without merit.

     To reflect the foregoing,


                                          Decision will be entered

                                    for petitioners.
