                          T.C. Memo. 1998-367



                        UNITED STATES TAX COURT



    JAMES L. SULLIVAN AND DOROTHY B. SULLIVAN, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 3332-96.                     Filed October 8, 1998.



        Bruce Locke, for petitioners.

     Roberta L. Shumway, for respondent.



                MEMORANDUM FINDINGS OF FACT AND OPINION


     GALE, Judge:     Respondent determined a deficiency of

$21,561.45 in petitioners' Federal income tax for taxable year

1992.    The issue for decision is whether petitioners' horse

breeding and showing activities constitute an "activity not
                                 - 2 -


engaged in for profit" within the meaning of section 183.1



                           FINDINGS OF FACT2

         Petitioners were married and filed a joint Federal income

tax return for the taxable year 1992.     At the time the petition

was filed, they resided in Hockley, Texas.

     Commencing in 1969, petitioners have been involved in

activities that include the breeding, care, showing, and

occasional sale of cutting horses (horse-related activities).

Cutting horses are quarter horses that are bred and trained to be

ridden into a herd of cattle to separate, or “cut”, one cow from

the rest of the herd.     Historically, the use of cutting horses

was to remove a cow from a herd for individual handling, such as

for medical attention.     However, performing this function has

become a sport, and cutting horse competitions are held

throughout the United States where prize money is awarded with

respect to horses that are judged best at "cutting".     Horses with

records of superior performance at cutting horse competitions

appreciate substantially.


     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
     2
       Some of the facts have been stipulated and are so found.
The stipulation of facts and attached exhibits are incorporated
herein by this reference.
                               - 3 -


     Since 1969, petitioners have owned as many as 20 horses and

as few as five.   In 1992, they owned six horses, including two

stallions.   Petitioners initially boarded their horses but in

1976 purchased a 17-acre tract on which they built a residence

and have since kept most of their horses.   The property includes

a barn that can accommodate six horses, other equine facilities,

and 10 acres of pasture.

     Petitioners' horse-related activities were conducted

predominantly by Mrs. Sullivan during 1992.   Mr. Sullivan worked

80 to 100 hours per week in his business, Sullivan Money

Management, Inc., during the year and does not ride or show

horses.   During 1992, Mrs. Sullivan devoted 6 to 7 hours per day

on weekdays to their horse-related activities and a like amount

of time on weekends when she participated in horse shows.    At the

time of trial, Mrs. Sullivan rode in nonprofessional and novice

class shows.   Mrs. Sullivan provided most of the manual labor

required in caring for their horses, such as cleaning stables,

without the assistance of hired labor.   Petitioners paid third

parties for veterinary, training, and farrier services and, in

1992, they paid a professional trainer to show one of their

stallions in competition.   Petitioners have never trained other

people's horses as part of their horse-related activities.

     Mrs. Sullivan has had a longstanding interest in horses,

from the time she was 14.   She participated in rodeo and hunter-
                               - 4 -


jumper competitions while in high school and college.   After

college, Mr. and Mrs. Sullivan repurchased the horse Mrs.

Sullivan had ridden while in high school.   Mrs. Sullivan has

considerable experience and knowledge with respect to cutting

horses, including familiarity with championship bloodlines and

the like.   She acquired knowledge about cutting horses by talking

to horse trainers, owners, and breeders between 1969 and the

present, attending clinics, reading cutting horse periodicals,

and through her personal experiences.   Although during 1992 she

held no position, Mrs. Sullivan was on the board of the Houston

Cutting Horse Association from 1973 to 1980, on the board of the

Sam Houston Horse Breeders Association from 1974 to 1979, on the

board of the Central Texas Horse Breeders Association from 1975

to 1978, a National Cutting Horse Association judge from 1975 to

1986, and a Director of the National Cutting Horse Association

from 1978 to 1980.

     In conducting their horse-related activities, petitioners

also relied upon the advice and assistance of two individuals,

Olan Hightower and Sam Wilson, each of whom has earned a living

for approximately 40 years from the breeding, training, and sale

of cutting horses and other quarter horses.   Mr. Wilson, with

whom petitioners boarded their horses prior to obtaining their

own facilities in 1976, operates a breeding farm on 250 acres of

land and anticipated breeding approximately 250 mares during the
                                - 5 -


year of trial.   Mr. Hightower generally keeps 20 to 22 horses.

In addition to breeding and selling horses, both Mr. Wilson and

Mr. Hightower earn income from training other people's horses.

During 1992, two of petitioners' horses were trained at Mr.

Hightower's ranch, and Mr. Hightower was paid $19,432 for

training and showing petitioners' horses for cutting horse

competitions.    Mr. Hightower and Mr. Wilson provided advice with

respect to petitioners' breeding decisions, training of horses,

and competition.    Their advice did not cover the financial

aspects of running a cutting horse operation.

     Mr. Sullivan was employed as an investment manager with

Sullivan Money Management, Inc., in 1992 and previously with

Painewebber, Inc.    His earnings from employment were as follows:

                      Year       Earnings

                      1989      $90,000.00
                      1990       90,000.00
                      1991       97,500.00
                      1992      108,750.00
                      1993      101,250.00
                      1994       90,000.00
                      1995      107,992.20

He has both a bachelor and master of business administration

degree from the University of Texas.

     The value of a cutting horse depends upon its possession of

desirable physical characteristics (conformance), its

demonstrated proficiency in cutting horse competitions, and, in

the case of a stallion, its demonstrated capacity to pass along
                               - 6 -


desirable traits to offspring, as evidenced by the offspring's

performance at cutting.   Extensive training, which begins around

age 2, is required to prepare a horse for cutting horse

competition and costs $500 to $1,500 per month.   A cutting horse

may demonstrate proficiency in competition rather quickly, as for

example making the finals in an initial competition held for 3-

year-olds, the "Futurity" sponsored by the National Cutting Horse

Association, or through a more lengthy process of competing in

numerous weekend events, called "campaigning", in which points

are awarded that may qualify the horse for the finals of the

annual National Cutting Horse Association World Championship.

There are classes of competition for both professional and

nonprofessional riders, and if the horse competes with a

professional rider, the rider generally must be compensated.

Although prize money is also awarded at these competitions, the

transportation costs, entry fees, and other expenses associated

with participation generally exceed such prize money by a factor

of 3 to 1.   Horses with records of superior performance at

competitions are valuable, especially stallions that also

demonstrate an ability to pass along desirable traits to

offspring.   A superior mare or gelding may be worth $30,000 to

$100,000 and a superior stallion, $100,000 to $1 million.     Such a

stallion can command a fee of $5,000 per breeding.

     Mrs. Sullivan used her knowledge of bloodlines to acquire,
                                - 7 -


through considered breeding strategies, horses of superior

lineage--that is, horses descended from proven champions.

Petitioners would then incur the expense of training the horses

and entering them in competitions in an effort to demonstrate

their worth.    Petitioners had a stallion, Docs Fancy Feat, they

considered quite promising in the 1980's.   Docs Fancy Feat was

born in 1976, and as a 3-year-old missed by one-half point making

the finals in "open" (professional) class competition in the

National Cutting Horse Association Futurity in 1979.   He was

ridden in that competition by Mr. Hightower.   As a result, Mrs.

Sullivan embarked on a lengthier process of campaigning him at

weekend events in an effort to qualify for the World

Championship.   In 1981, Mrs. Sullivan became pregnant and did not

ride Docs Fancy Feat in competition in the remainder of that year

or 1982.   As a result, the horse was sent to a trainer in Arizona

who wished to campaign him.   However, the trainer's feeding

practices caused Docs Fancy Feat to suffer colic, which is

potentially lethal in horses, and he consequently was returned to

petitioners in December 1981.   The horse then required remedial

training for nearly 1 year to reverse certain undesirable

training received in Arizona.   Sometime during the period

starting in late 1982 and continuing through the end of 1985,

Mrs. Sullivan twice suffered ankle injuries.   Docs Fancy Feat

injured his leg in 1987, necessitating a year's rest from
                                - 8 -


competition.    Upon resumption of competition in 1988, he

reinjured the leg, causing permanent crippling.    Petitioners

estimated the value of Docs Fancy Feat at the time of trial as

$20,000.    The record does not contain Docs Fancy Feat's breeding

records.

     Sometime in 1985, Mrs. Sullivan concluded that it would be

advisable to experiment with a new bloodline.    Docs Fancy Feat's

lineage was from Doc Bar, a champion cutting horse whose

bloodline was so popular among cutting horse enthusiasts that

there was a proliferation of "Doc Bar" cutting horses.    Mrs.

Sullivan anticipated there would be a growing demand for superior

non-"Doc Bar" horses to be bred to the large numbers of "Doc Bar"

horses.    Consequently, she arranged a breeding of one of her

successful non-"Doc Bar" mares with a non-"Doc Bar" champion

stallion, Colonel Freckles.    The result was a colt, Colonel Rey

Lew, born in 1986.    Colonel Rey Lew did not enter the National

Cutting Horse Association Futurity as a 3-year-old.    Starting in

1989, he has been bred 22 times; his breeding fee in 1992 was

$500.   He was bred seven times in 1991, and three to four times

per year from 1992 through 1995.    Mr. Hightower was paid to

campaign Colonel Rey Lew in "open" or professional class weekend

competitions during 1992, in which the horse qualified for the

"open" finals of the National Cutting Horse Association World

Championship.    Mrs. Sullivan campaigned Colonel Rey Lew in
                               - 9 -


nonprofessional class weekend competitions in 1994 and likewise

qualified for the nonprofessional finals of the World

Championship.   Petitioners consider Colonel Rey Lew to be a very

promising stallion.   At the time of trial, they estimated his

value to be between $100,000 and $150,000.    Including Colonel Rey

Lew, the total value estimated by petitioners for the eight

horses they owned at the time of trial was between $170,000 and

$222,500.

     Petitioners sold two horses between 1989 and 1990, which

failed to show promise as cutting horses, for $3,500 and $4,000,

respectively.   Petitioners did not sell any horses during 1992.

Of the six horses they owned in 1992, one was sold in 1993 for

$6,500 and another in 1995 for $3,500.    There is no evidence

concerning the sale of any other horses that petitioners owned

between 1989 and 1995, except Miss Doc Chic, purchased by

petitioners for $100 in 1992 and sold back to the seller by them

approximately 18 months later for $100.    During the period they

owned Miss Doc Chic, petitioners treated the expenses of her

upkeep and costs associated with her entry in cutting horse

competitions as part of their horse-related activities.    Mrs.

Sullivan rode Miss Doc Chic in nonprofessional class

competitions3 during 1992 when Mr. Hightower was riding Colonel

     3
       In order to qualify for nonprofessional competition, the
horse must be ridden by an owner who is not a professional
                                                   (continued...)
                               - 10 -


Rey Lew in professional class competitions.

       Petitioners ceased insuring their horses in 1982.

       Mrs. Sullivan maintained detailed records of their horse-

related activities in 1992 which included the events in which

their horses competed, expenses, and winnings.

       Petitioners have reported a loss from their horse-related

activities for every year from 1969 through 1995, except for the

years 1972, 1981, and 1982.    The record does not disclose the

magnitude of the losses that occurred from 1969 through 1988.

The income, deductions, and net losses reported by petitioners on

their Schedule C for the years 1989 through 1995 are as follows:

Year        Gross Receipts/Income    Deductions      Net Loss

1989             $22,380.49          $63,306.14     $40,925.65
1990              13,336.31           53,305.36      39,969.05
1991              17,616.87           49,964.14      32,347.27
1992              21,465.62           72,760.23      51,294.61
1993              17,186.27           51,246.78      34,060.51
1994              25,130.04           72,298.66      47,168.62
1995              14,874.82           48,379.64      33,504.82

Petitioners made a profit of $985.05 in 1972, $7,336.07 in 1981,

and $11,742.18 in 1982, for a total profit of $20,063.30 during

the 26 years in which they have been engaged in their horse-

related activities.    Petitioners have no plans to discontinue

their horse-related activities.

       In the notice of deficiency, respondent determined that


       3
      (...continued)
trainer.
                              - 11 -


petitioners were not engaged in their horse-related activities

for profit within the meaning of section 183(a) and disallowed

the loss for 1992.

                              OPINION

     The issue to be resolved is whether petitioners' horse-

related activities4 constituted an "activity not engaged in for

profit" within the meaning of section 183.   Section 183(a)

generally disallows a deduction for activities not engaged in for

profit except as provided in section 183(b).   Section 183(b)(1)

allows deductions for an activity which are otherwise allowable

regardless of profit objective.   Section 183(b)(2) allows those

deductions which would be allowable if the activity were engaged

in for profit, but only to the extent that gross income

attributable to the activity exceeds the deductions permitted by

section 183(b)(1).   Section 183(c) defines "activity not engaged

in for profit" as "any activity other than one with respect to

which deductions are allowable for the taxable year under section

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

     Deductions are allowable under section 162 with respect to

activities for which the taxpayer has demonstrated that his

"primary purpose for engaging in the activity * * * [was] for

income or profit."   Commissioner v. Groetzinger, 480 U.S. 23, 35

     4
       The parties have treated all of petitioners' horse-related
activities as a single activity for purposes of sec. 183. See
sec. 1.183-1(d)(1), Income Tax Regs.
                                - 12 -


(1987).    Similarly, deductibility under section 212 depends upon

whether the expenditures were made "primarily in furtherance of a

bona fide profit objective."     Agro Science Co. v. Commissioner,

934 F.2d 573, 576 (5th Cir. 1991), affg. T.C. Memo. 1989-687.

     It is therefore the taxpayer's intent to earn a profit that

determines the deductibility of an activity's losses under

section 183.     Dreicer v. Commissioner, 78 T.C. 642, 645 (1982),

affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983); Bessenyey

v. Commissioner, 45 T.C. 261, 273-274 (1965), affd. 379 F.2d 252

(2d Cir. 1967).     Such intent is to be determined by examining all

the facts and circumstances, giving greater weight to objective

facts than to the taxpayer's statement of intent.     Siegel v.

Commissioner, 78 T.C. 659, 699 (1982); Engdahl v. Commissioner,

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

Regs.     Although a reasonable expectation of profit is not

required, the facts and circumstances must indicate that the

taxpayer entered into the activity, or continued the activity,

with the actual and honest objective of making a profit.       Keanini

v. Commissioner, 94 T.C. 41, 46 (1990); Dreicer v. Commissioner,

supra at 644-645; sec. 1.183-2(a), Income Tax Regs.     The taxpayer

bears the burden of proving the requisite profit objective.       Rule

142(a); Dreicer v. Commissioner, supra at 646; Golanty v.

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

opinion 647 F.2d 170 (9th Cir. 1981).     Moreover, the Court of
                              - 13 -


Appeals for the Fifth Circuit, to which this case is appealable,

has stated that taxpayers whose activities are challenged under

section 183 "bear the burden of proving that their activities

* * * were engaged in with the primary purpose of earning a

profit."   Westbrook v. Commissioner, 68 F.3d 868, 876 (5th Cir.

1995), affg. per curiam T.C. Memo. 1993-634.   (Emphasis added.)

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

nonexclusive list of factors that should normally be taken into

account in determining whether the requisite profit objective has

been shown.   The factors are: (1) Manner in which the taxpayer

carries on the activity; (2) the expertise of the taxpayer or his

advisers; (3) the time and effort expended by the taxpayer; (4)

expectation that assets used in activity may appreciate in value;

(5) the success of the taxpayer in carrying on similar or

dissimilar activities; (6) the taxpayer's history of income or

losses with respect to the activity; (7) the amount of occasional

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

the taxpayer; and (9) elements of personal pleasure or

recreation.   No single factor is determinative.   Sec. 1.183-2(b),

Income Tax Regs.

     Petitioners argue that their horse-related activities were

engaged in for profit because they were trying, albeit with

limited success, to develop a championship quality cutting horse

stallion that would appreciate in value substantially and command
                              - 14 -


breeding fees of as much as $5,000, and that the work required of

Mrs. Sullivan in pursuit of that goal was far too onerous to

constitute recreation.   Respondent contends that petitioners'

long history of losses demonstrates that their horse-related

activities were not profit-oriented, but instead served Mrs.

Sullivan's personal and recreational interests, given her

longstanding passion for horses.   We shall evaluate the evidence

of profit motive with reference to the factors enumerated in the

regulations and any other relevant indicia.

Manner in Which Activity Conducted

     The fact that a taxpayer carries on the activity in a

businesslike manner and maintains complete and accurate books and

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

Sec. 1.183-2(b)(1), Income Tax Regs.   Petitioners point to the

detailed records that Mrs. Sullivan maintained as evidence of the

businesslike conduct of their horse-related activities.   However,

if there is a lack of evidence that the taxpayer's records were

utilized to improve the performance of a losing operation, such

records generally do not indicate a profit motive.   Golanty v.

Commissioner, supra at 430; Osteen v. Commissioner, T.C. Memo.

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

1995); see also Burger v. Commissioner, 809 F.2d 355, 359 (7th

Cir. 1987), affg. T.C. Memo. 1985-523.   Despite more than 2

decades of losses, petitioners presented no convincing evidence
                              - 15 -


that their records were used to devise methods of modifying their

operations to improve profitability.   Mrs. Sullivan testified

merely that she reviewed the records to economize generally and

to insure that she was receiving the "best buys" on supplies.

Mr. Sullivan conceded that he reviewed the records only "when I

make out the income taxes".   Since the records were not employed

to improve operations or stem the recurring, significant losses

from petitioners' horse-related activities, we discount them.

Golanty v. Commissioner, supra; Bessenyey v. Commissioner, supra

at 274.

     A change of operating methods or abandonment of unprofitable

methods in a manner consistent with an intent to improve

profitability may indicate a profit motive.    Sec. 1.183-2(b)(1),

Income Tax Regs.   Petitioners contend that their decisions to

cease insuring their horses and to purchase only used trucks

after 1982 constitute changes in operating methods designed to

improve profitability.5   The evidence provided by petitioners is

too sketchy to be persuasive of their claim.   Although Mr.

Sullivan provided some testimony regarding current costs for

horse insurance, without more information regarding the value of

petitioners' horses over the years, the significance of insurance

     5
       Petitioners also argue that Mrs. Sullivan performed all of
the unskilled manual labor attendant to keeping horses (such as
cleaning stables) and paid only for veterinarians, trainers, and
farriers. However, there is no evidence that this practice
represents any change in their mode of operation from the outset.
                               - 16 -


savings in relation to petitioners' losses cannot be assessed for

most years.    However, for 1992, if we accept petitioners'

estimate of the value of their horses in that year, and Mr.

Sullivan's testimony that premiums for horse insurance are

approximately 4 percent of value, the cost of insurance is

relatively small in relation to the $51,295 in losses incurred

that year.    There is no evidence of the savings from purchasing

used trucks.    On this record, we do not believe petitioners have

shown that the foregoing cost-cutting measures were material in

relation to the losses they were regularly incurring.    Cf. Taras

v. Commissioner, T.C. Memo. 1997-553; Smith v. Commissioner, T.C.

Memo. 1997-503.

     Petitioners cite their 1985 decision to try a different

bloodline as evidence of a change in operating methods to improve

profitability.    While we believe this change constitutes the type

of change contemplated in the regulations, it has not stemmed

petitioners' substantial losses, and 10 years of unbroken losses

have followed it.    Moreover, the absence of any additional

significant changes since 1985, in the face of losses of the

magnitude being incurred by petitioners through 1995, creates an

inference adverse to petitioners' profit motivation.

     A profit motive may be indicated where an activity is

carried on in a manner substantially similar to other activities

of the same nature which are profitable.    Sec. 1.183-2(b)(1),
                               - 17 -


Income Tax Regs.    Petitioners maintain that the manner in which

they conducted their horse-related activities was substantially

similar to that of two other breeders, Mr. Hightower and Mr.

Wilson, each of whom has earned a living from horse operations

for approximately 40 years.    We reject the contention that

petitioners' activities are comparable, however.    The activities

of Mr. Hightower and Mr. Wilson were more extensive than

petitioners'.    Petitioners owned six horses, a six-horse barn,

and 10 acres of pasture in 1992.    They produced evidence with

respect to the breeding of only one horse, and in 1992 that horse

was bred only three times.    Mr. Wilson had three stallions and

250 acres and anticipated breeding approximately 250 mares in the

year of trial.    Mr. Hightower generally kept 20 to 22 horses.

Petitioners also conceded they did not enter horses in

competitions as extensively as Mr. Hightower and Mr. Wilson did,

even though all testimony in the case indicated that extensive

nationwide competition was an important means of proving a

horse's value.    Perhaps the most critical difference is that both

Mr. Wilson and Mr. Hightower earned income in their operations by

training other people's horses.    Petitioners not only did not

train others' horses, they paid for training, in significant

amounts so far as the record reveals.6   In 1992, petitioners paid


     6
       The only year for which any break-out of petitioners'
training expenses is available is 1992.
                               - 18 -


Mr. Hightower $19,432 to train and show their horses at

competitions, which amount equals approximately 38 percent of

their net loss of $51,295.    Both Mr. Hightower and Mr. Wilson

testified that training income was an important component in

meeting their expenses.   Had petitioners generated training

income instead of expense, they may have shown a profit.    In any

event, the fact that training for petitioners was a significant

expense rather than a source of income distinguishes their horse-

related activities from the profitable cutting horse operations

in evidence.

     Finally, there is evidence that petitioners conducted their

horse-related activities in an unbusinesslike manner.    First,

petitioners purchased Miss Doc Chic for a nominal sum ($100) in

1992 and resold her to the seller 18 months later for the same

amount.   Forgoing the right to any appreciation in value while

paying (and deducting) the horse's training and competition

expenses was not a businesslike transaction.    Petitioners'

explanation for this transaction is that it was the most cost

effective means of providing Mrs. Sullivan with a horse on which

to compete in 1992 to keep her riding skills honed because their

prize stallion (Colonel Rey Lew) was being ridden in competition

by Mr. Hightower that year.    Although there is evidence in the

record that a cutting horse's full value is demonstrated by its

performance with both professional and nonprofessional riders,
                               - 19 -


and evidence that Mrs. Sullivan supplied the latter service, we

believe on balance that the transaction involving Miss Doc Chic

demonstrates that Mrs. Sullivan's actual participation in cutting

horse competition, which undeniably has a substantial

recreational component, was an important priority in petitioners'

horse-related activities.

     Second, although it is petitioners' contention that a key

component of a cutting horse stallion's value is the demonstrated

performance of his offspring, at trial they were uncertain of the

number of offspring sired by their current prize stallion

(Colonel Rey Lew) and were familiar with the performance of only

seven or eight such offspring, whereas there were 22 documented

breedings of that stallion.    Thus we do not believe petitioners

were documenting the value of their stallion in a businesslike

manner.

     Petitioners also argue that their use of stallions, rather

than geldings or mares, in cutting horse competitions indicates

that they conducted their activities as a business rather than a

hobby.    According to petitioners and other knowledgeable

witnesses, stallions are less tractable and more temperamental

than geldings or mares, and thus using stallions in cutting horse

competitions is much more difficult.    A hobby enthusiast would

utilize a gelding or mare in cutting horse competitions, it is

argued; only a business-oriented participant, interested in the
                               - 20 -


profits from breeding fees and greater appreciation potential in

a champion stallion, would undergo the greater difficulties of

riding or showing stallions in cutting horse competitions.

Expertise of Petitioners

     Preparation for an activity by extensive study or

consultation with experts may indicate a profit motive where the

taxpayer conducts the activity in accordance with such study or

advice.    Sec. 1.183-2(b)(2), Income Tax Regs.   We believe the

record amply demonstrates that Mrs. Sullivan developed expertise

in cutting horse bloodlines, breeding, and showing.     She attended

several clinics over the years, read industry publications, and

followed the advice of acknowledged experts with respect to the

breeding, training, and showing of horses.    She held leadership

and judging positions with various equine organizations over many

years.    However, expertise with respect to the breeding and

showing of horses and other animals is to be distinguished from

expertise in the economics of these undertakings.     See, e.g.,

Burger v. Commissioner, 809 F.2d at 359; Surridge v.

Commissioner, T.C. Memo. 1998-304; Dodge v. Commissioner, T.C.

Memo. 1998-89; Smith v. Commissioner, T.C. Memo. 1997-503; see

also Golanty v. Commissioner, 72 T.C. at 432.     Mrs. Sullivan had

no experience with the economics of a profitable cutting horse

operation, and her consultations with experts did not include

advice regarding the financial aspects of petitioners' horse-
                                - 21 -


related activities.   Expertise regarding breeding and competition

is not inconsistent with the pursuit of cutting horse activities

as a hobby, and we thus do not attach great significance to Mrs.

Sullivan's knowledge and experience in these areas in deciding

whether a profit motive can be inferred.

     Petitioners’ apparent inability to provide all of the

training necessary for their horses to perform as cutting horses

is also relevant.   As previously discussed, whereas the two

profitable cutting horse professionals who testified at trial

both engaged in extensive training of cutting horses for

compensation, petitioners did not do so.    We believe the lack of

this expertise figured prominently in their history of losses.

Time and Effort Expended

     The fact that the taxpayer devotes much of his or her

personal time and effort to carrying on an activity, particularly

if the activity does not have substantial recreational aspects,

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

Regs.   In 1992 Mrs. Sullivan was predominantly involved in

petitioners' horse-related activities, as Mr. Sullivan spent 80

to 100 hours per week working at his business.    Petitioners place

considerable emphasis on the hours devoted by Mrs. Sullivan and

argue that the onerous manual labor performed by her in caring
                                - 22 -


for the horses,7 such as cleaning stables, as well as her arduous

schedule of attending horse shows most weekends, was too

unpleasant to constitute a hobby.

         With respect to Mrs. Sullivan's schedule of weekend horse

shows, records have only been provided for 1992.     A portion of

Mrs. Sullivan's attendance at shows that year was for the purpose

of competing on Miss Doc Chic, a horse in which petitioners did

not retain any possibility of profit.     Their prize stallion

Colonel Rey Lew, on which their argument of profit motivation is

staked, was being ridden in competition by someone else in 1992.

     Nevertheless, even if we accept that Mrs. Sullivan traveled

to an extensive number of weekend horse shows that year and

provided the manual labor required to care for the horses kept on

petitioners' premises, we have some difficulty with petitioners'

argument that Mrs. Sullivan's time and effort were too extensive

to be other than profit-oriented.     The regulations effectively

provide that time and effort are somewhat discounted as a factor

when the activity has substantial recreational aspects.     Keeping


     7
       Petitioners exaggerate somewhat the labor expended by Mrs.
Sullivan. While petitioners on brief repeatedly invite us to
contemplate the rigors of cleaning stables, etc., for seven, or
seven to nine, horses, the record demonstrates that in 1992,
petitioners owned six horses, two of which were kept at Mr.
Hightower's farm. The record further reveals that an individual
was compensated during 1992 to exercise at various times two of
the four horses kept on petitioners' premises. Nonetheless, we
accept that Mrs. Sullivan provided significant manual labor in
caring for the horses kept on petitioners' premises.
                               - 23 -


and showing horses has recreational aspects, in particular for

someone with a demonstrated, long-term interest in horses, such

as Mrs. Sullivan.    Whether her schedule of horse shows was too

arduous to constitute recreation requires a highly subjective

determination.   The regulations address this problem by providing

for some discounting of time and effort where recreational

elements are inherent in the activity, which we shall do.     In

addition, the unpleasant tasks associated with caring for horses

are required regardless of whether the activity is pursued as a

hobby or business.    Although we believe that Mrs. Sullivan put

considerable time and effort into petitioners' horse-related

activities, this factor is not dispositive.

Expectation That Assets May Appreciate

     An expectation that assets used in the activity will

appreciate in value may indicate a profit objective.      Sec. 1.183-

2(b)(4), Income Tax Regs.    Petitioners argue that the

appreciation in value of their horses,8 which they expect to

occur as a result of astute breeding decisions and arduous

promotion, demonstrates their profit motive notwithstanding years

of operating losses.    The regulations further explain that a

profit motive may be inferred where there are no operating

profits, so long as the appreciation in value of the activity's


     8
       There is no evidence that petitioners' land or other
assets besides horses will appreciate in value.
                                - 24 -


assets exceeds the operating losses.     Id.   The appreciation in

value must be sufficient, however, to recoup the accumulated

losses of prior years.     Golanty v. Commissioner, supra at 427-

428; Bessenyey v. Commissioner, 45 T.C. at 274; Dodge v.

Commissioner, supra; Taras v. Commissioner, T.C. Memo. 1997-553.

     Petitioners incurred operating losses in 23 of the 26 years

in which they have been engaged in their horse-related

activities.   For 16 of the loss years, the amount of the loss is

not available.   For the remaining 7 loss years, which are the

most recent 7 years through 1995, accumulated losses total

$279,270.   Even accepting arguendo petitioners' own estimates of

the value of their horses in 1996, such estimates are in a range

of $170,000 to $222,500.    Thus the appreciated value of

petitioners' horses, by their own estimate, does not recoup the

losses of the last 7 years, let alone the accumulated losses of

the other 16 loss years.    Nor do we think there is reason to

believe that future appreciation will recoup petitioners' losses.

Petitioners estimated that Colonel Rey Lew, their current prize

stallion, was worth $100,000 to $150,000 in 1996, and they

offered speculation that he had tremendous potential yet to be

realized.   We are not persuaded by such speculation.    The horse

has been old enough to compete since 1989 and has achieved

significant success in both professional and nonprofessional

competition since that time.    As distinguished from the situation
                              - 25 -


with Docs Fancy Feat, petitioners have not cited any mishaps that

have interfered with Colonel Rey Lew's career.   Petitioners have

failed to demonstrate how additional time in competition is

likely to change Colonel Rey Lew's value dramatically.    As to

petitioners' contention that Colonel Rey Lew's value will rise if

his offspring are successful, we note that petitioners at trial

were not even certain of the number of his offspring.    Beyond

bare speculation, petitioners have failed to show that Colonel

Rey Lew's value is likely to appreciate dramatically beyond their

current estimate.   While their current estimate represents

substantial appreciation, it falls short of recouping their

losses.   As a result, the anticipated appreciation in value of

petitioners' assets is insufficient to create an inference of

profit motive.   Golanty v. Commissioner, 72 T.C. 411, 427-428

(1979); cf. Dodge v. Commissioner, T.C. Memo. 1998-89; Taras v.

Commissioner, supra.

Past Success in Similar or Dissimilar Activities

     A taxpayer's past success in similar or dissimilar

activities is relevant in determining profit motive.    Sec. 1.183-

2(b)(5), Income Tax Regs.

     It has been stipulated that in 1992 petitioners' horse-

related activity was predominantly operated by Mrs. Sullivan, and

that Mr. Sullivan worked 80 to 100 hours per week in his job as

an investment manager.   Given the demands of Mr. Sullivan's job
                                - 26 -


and his testimony that he only examined the records of their

horse-related activities when he prepared the couple's tax

returns, we find his involvement in the activities was quite

limited.    Thus Mr. Sullivan's success as an investment manager

has no significant bearing on the assessment of the horse-related

activity.    Cf. Surridge v. Commissioner, T.C. Memo. 1998-304.

There is no evidence that Mrs. Sullivan has been involved in

other profit-seeking activities prior to or during her operation

of petitioners' horse-related activity.

The Activity's History of Income and Losses

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

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

Regs.   Unless explained by customary business risks or unforeseen

or fortuitous circumstances beyond the taxpayer's control, a

record of continuous losses beyond the period customarily

required to attain profitability may indicate that the activity

is not engaged in for profit.    Id.

     Given petitioners’ extraordinary history of losses, and

their efforts to account for it, this factor is central to this

case.   Petitioners have reported losses from their horse-related

activities for 23 of the 26 years in which they have been engaged

therein.    The last profitable year was 1982.   Prior to 1989,

there were 16 loss years and 3 income years.     The amount of loss

in each pre-1989 loss year is not available; the parties have
                                - 27 -


merely stipulated that losses were reported in those years.9       The

3 income years were 1972, 1981, and 1982, in which net income was

$985, $7,336, and $11,742, respectively.     For the post-1988 loss

years (1989-95), the yearly loss amounts ranged from

approximately $32,000 to approximately $51,000, with an average

annual loss of approximately $40,000 during these years.

     To the extent petitioners seek to account for this

extraordinary record of losses, they emphasize a series of

unforeseen mishaps in the 1980's as well as what they effectively

contend is a lengthy "startup" period in realizing a cutting

horse's full value.    Given the significance of these losses, we

will carefully evaluate petitioners' explanations.

     From 1969 through 1980, petitioners experienced 11 years of

losses and 1 year (1972) in which they realized a gain of $985.

Although petitioners' testimony and argument sought primarily to

account for their losses since 1982, they did experience some

unforeseen adverse events in the 1970's.10    In any event, this

     9
       Petitioners produced return information for income, but
not loss, years prior to 1989. Given their production of return
information for income years going back to 1972, we believe
return information for loss years prior to 1989 was also
available to petitioners. They have in any event offered no
explanation for its absence. Given their failure to produce
return information for loss years prior to 1989, we presume such
evidence would be unfavorable to petitioners if produced.
Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165
(1946), affd. 162 F.2d 513 (10th Cir. 1947).
     10
          Petitioners testified that a promising stallion they
                                                      (continued...)
                               - 28 -


initial string of losses may qualify as a "startup" period, which

suggests that later periods of losses may not so qualify.

       After two profitable years in 1981 and 1982, petitioners

realized losses in every year from 1983 through 1995.

Petitioners' efforts to account for this period center on the

careers of two prize stallions, Docs Fancy Feat and Colonel Rey

Lew.

       Petitioners attempt to account for roughly the first half of

these losses by citing a series of mishaps and bad luck they

encountered with Docs Fancy Feat.    Docs Fancy Feat was born in

1976 and was from respected bloodlines.    He showed great promise

as a 3-year-old, missing by a fraction of a point the finals of

the Futurity competition for 3-year-olds in 1979, while being

ridden by Mr. Hightower.    Nevertheless Docs Fancy Feat never

realized his true potential to become quite valuable, according

to petitioners, because of a series of problems.    First, Mrs.

Sullivan became pregnant in 1981 and did not ride Docs Fancy Feat

in competition in that year or 1982.    Due to Mrs. Sullivan's

condition, Docs Fancy Feat was sent in August 1981 to a trainer

in Arizona, who wished to ride him in competition.    However, Docs

Fancy Feat suffered colic from the trainer's feeding practices


       10
      (...continued)
purchased in 1969 was injured and had to be euthanized, and a
superior mare suffered a nonfatal injury and had difficulties
delivering a live foal in the mid-1970's.
                              - 29 -


and had to be returned to petitioners in December 1981.

According to petitioners, it then took nearly a year to reverse

certain undesirable training that Docs Fancy Feat had received in

Arizona.   Mrs. Sullivan then suffered two different ankle

injuries, each precluding riding for 6 months, sometime during

the period between late 1982 and the end of 1985, although

petitioners' testimony is too vague to pinpoint the time with any

precision.   Docs Fancy Feat suffered a leg injury in 1987, was

required to avoid competition for an extended period, and then

reinjured the leg in 1988, becoming permanently crippled.

     Petitioners' explanations are not entirely convincing.    Mrs.

Sullivan's pregnancy, Docs Fancy Feat’s unfortunate episode in

Arizona, and his retraining took place during 1981 and 1982.

These were the 2 years in which petitioners earned significant

profits.   With Mrs. Sullivan unable to ride and Docs Fancy Feat

experiencing remedial training, how did they do so?   The record

does not disclose.   Moving to 1983 through 1985, if Mrs.

Sullivan's ability to ride was interrupted for two 6-month

periods, did petitioners seek another rider for Docs Fancy Feat,

as they did for the Futurity competition in 1979, and attempted

in 1981?   According to the record, there was nothing wrong with

Docs Fancy Feat from 1983, when he was 7, until sometime in 1987,

when he was 10, and yet the horse generated no profits during
                               - 30 -


that period.11   While it would appear that petitioners

experienced some unforeseen circumstances during the 1980's that

hampered profitability, we do not believe that the problems cited

by petitioners can entirely account for the losses between 1983

and 1987.

     Other than a failed effort to lease Docs Fancy Feat for

breeding in 1991 or 1992, petitioners cite no mishaps or other

unforeseen circumstances that interfered with the profitability

of their activity subsequent to his crippling injury in 1988.

Although they argue that the passive loss provisions of the Tax

Reform Act of 1986 (1986 Act), Pub. L. 99-514, sec. 501, 100

Stat. 2233, had a depressive impact on horse prices, we do not

believe any impact from the 1986 Act constitutes an unforeseeable

circumstance into the early 1990's, particularly in the absence

of any post-1986 changes by petitioners in operating methods to

improve profitability.   The only significant change, namely, the

decision to switch bloodlines, occurred in 1985.

     To account for their losses from the late 1980's through

1995, petitioners cite the career of a second prize stallion,

Colonel Rey Lew.   Petitioners cite no mishaps with respect to

Colonel Rey Lew; they appear to rely instead on the lengthy

period of development for a champion cutting horse stallion.

     11
       Mr. Sullivan testified that he was offered $1.25 million
for Docs Fancy Feat in 1985 by an offeror whose credit references
were negative. There is no evidence to corroborate this claim.
                                - 31 -


Petitioners testified that the value of a cutting horse is

established through conformance, proficiency in competition and,

for stallions, through demonstrated capacity to pass along their

conformance and skills to offspring.     According to petitioners,

training of a cutting horse begins between ages 2 and 3,

competition begins at age 3, and demonstrating proficiency in

competition can entail extensive "campaigning" at weekend events.

Petitioners generally did not breed their horses until they were

at least 4 or 5 years old, although Colonel Rey Lew was bred as

early as age 3.12   Given petitioners' contention that a

stallion's offspring's performance affects his value, the upshot

of their argument is that the value of a cutting horse stallion

may not begin to emerge until sometime after 7 or 8 years of age.

     Colonel Rey Lew was born in 1986 and was old enough to

commence competition in 1989.    The record indicates that Mr.

Hightower rode Colonel Rey Lew in professional competition in

1992, and Mrs. Sullivan rode him in nonprofessional competition

in 1994.   Nevertheless, petitioners' losses have not abated as

Colonel Rey Lew has reached full maturity.    From 1992 through

1995, when Colonel Rey Lew was 6 through 9 years old,

petitioners' losses were never less than $33,500 per year.

     12
       Although the parties have stipulated that petitioners do
not breed their horses until they are at least 4 or 5 years old,
the stipulated exhibits in this case include Colonel Rey Lew’s
breeding records, which document that he was bred in 1989, when
he was 3 years old.
                              - 32 -


Colonel Rey Lew has been bred only 3 to 4 times per year since

199213 and his breeding fee in 1992 was $500.   Notwithstanding

petitioners' contention that a cutting horse stallion's full

value depends upon the success of his offspring, at trial they

were uncertain of the total number of Colonel Rey Lew’s offspring

and were familiar with only seven or eight of such offspring.

Thus it would appear either that petitioners have not been

businesslike in monitoring Colonel Rey Lew's value, or the

performance of offspring is not as important as petitioners

argue, which suggests a shorter development period.    In any

event, petitioners estimated Colonel Rey Lew’s value at the time

of trial, when he was a 10-year-old, as between $100,000 and

$150,000.   Although petitioners offered much speculation at trial

that Colonel Rey Lew would continue to grow in value, we do not

believe the evidence provides any basis to believe that the

horse's value will increase dramatically in future years.    He has

already been "campaigned" extensively in professional and

nonprofessional classes, has been bred, and, according to

petitioners, has produced some offspring of promise.    Thus we

believe he has completed any fair approximation of a development

period.   Yet even petitioners' estimate of his value, though

     13
       Petitioners and Mr. Hightower testified that extensive
breeding interferes with competition, which may explain less
breeding in 1992 and 1994, years in which the record indicates
that Colonel Rey Lew competed extensively. However, no such
explanation exists for 1993 or 1995.
                                - 33 -


substantial, falls far short of the accumulated losses of their

horse-related activities.     Their cumulative losses during the

period 1989-95, the years in which Colonel Rey Lew has been old

enough to compete, total $279,270.       With losses averaging $40,000

annually over the last 7 years, we are not persuaded that

petitioners have a realistic prospect of recouping their losses

in the future or, based on this record, much prospect of even

stemming annual losses.

     Petitioners appear to argue that their 23 years of losses

can be attributed to a startup period in the 1970's, a period of

mishaps in the 1980's involving Docs Fancy Feat, and the

resumption of a new startup period with Colonel Rey Lew

commencing in the late 1980's which will eventually produce

profits.     By this logic, if Colonel Rey Lew were injured,

petitioners could begin anew with another horse and incur losses

for another decade without creating an inference that a profit

motive was lacking.    We do not believe that petitioners have

satisfactorily accounted for their history of substantial losses.

Losses in 23 of 26 years, that can only partially be attributed

to unforeseen circumstances, create a strong inference that an

activity was not engaged in for profit.       Golanty v. Commissioner,

72 T.C. at 427.    Petitioners' expressed intention to continue

their activities in the face of these losses reinforces the

inference.    Cf. Engdahl v. Commissioner, 72 T.C. at 669
                               - 34 -


(taxpayers' decision to terminate consistently unprofitable horse

operation indicative of profit motive).

Amount of Occasional Profits

     The amount of any occasional profits, if large in relation

to losses incurred or the taxpayer's investment, may indicate a

profit motive.   Sec. 1.183-2(b)(7), Income Tax Regs.    The

possibility of a substantial profit in a highly speculative

venture may indicate a profit motive even where profits are

occasional and small or nonexistent.    Id.    Petitioners' 3 profit

years generated income totaling $20,063, which is small in

relation to the reported losses, the total amount of which is

unknown but since 1989 totaled $279,270.      As noted, petitioners

offer speculation concerning the value that Colonel Rey Lew,

their current prize stallion, may reach, but we do not believe

that the record provides any basis to believe that the horse's

value will increase dramatically in the future.     Thus petitioners

have not shown any likelihood of a large profit in the future

that will recoup the losses they have incurred and continue to

incur.

Taxpayer's Financial Status

     Substantial income from sources other than the activity,

particularly if the losses from the activity generate substantial

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

for profit, especially if there are personal or recreational
                              - 35 -


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

     Mr. Sullivan's earnings from his employment as an investment

manager were $108,750 in 1992 and never less than $90,000

annually from 1989 through 1995.   Clearly, Mr. Sullivan's

employment income allowed petitioners to sustain annual losses

from their horse-related activities averaging $40,000 during

these years.   Deducting these losses significantly reduced the

after-tax cost of such activities to petitioners.   Cf. Golanty v.

Commissioner, supra at 429; Osteen v. Commissioner, T.C. Memo.

1993-519.   When combined with the recreational elements present

for Mrs. Sullivan, we believe the after-tax economics of

petitioners' horse-related activities support an inference that

they were not engaged in for profit.

Personal Pleasure or Recreation

     The existence of recreation elements in the activity may

indicate the activity is not engaged in for profit; conversely,

where an activity lacks any appeal other than profit, a profit

motivation may be thereby indicated.   Sec. 1.183-2(b)(9), Income

Tax Regs.

     The record in this case amply supports a finding that Mrs.

Sullivan's recreational objectives were a significant component

of petitioners' horse-related activities.   As noted, Mrs.

Sullivan has been actively pursuing an interest in horses since

she was 14, rode while in high school and college, and after
                              - 36 -


college she and Mr. Sullivan bought back the horse she had ridden

during high school.   More recent evidence of the importance to

Mrs. Sullivan of personally competing in cutting horse

competitions occurred in 1992, when petitioners engaged in an

essentially noneconomic transaction of contracting for the

purchase and sale-back of a horse for a nominal price so that

Mrs. Sullivan would have a mount for cutting horse competition

while their prize stallion was being ridden by Mr. Hightower.

Conclusion

     The most compelling factor in this case is the extent of

petitioners' history of losses--23 of 26 years.   For all years in

which information is available, those losses were substantial,

averaging $40,000 annually.   Petitioners' attempts to account for

losses over this lengthy period are unpersuasive.   Also striking

is the absence of any significant attempt since 1985 to modify

methods of operation to improve profitability, even though losses

have been continuous since 1982.   The extent of petitioners'

losses and their complacency therein outweigh any unforeseen

circumstances cited by petitioners, the time and effort expended

by Mrs. Sullivan, and any business purpose that may be evidenced

by their keeping stallions rather than only mares or geldings.

When combined with the recreational elements of keeping and

showing horses, we believe that petitioners' failure to take

action to address losses of this magnitude creates a compelling
                              - 37 -


inference that petitioners lacked a profit motive.

     Petitioners cite Burrow v. Commissioner, T.C. Memo.

1990-621, in support of their position, but that case is readily

distinguishable.   Burrow was concerned with the first 4 years of

losses in a horse breeding operation, not 23 years out of 26.

Moreover, in Burrow receipts for years 5 through 7 of the

operation had increased dramatically over the first 4 years,

providing evidence that the initial losses would not persist.    We

concluded that because the losses were in the early period of the

activity, they were not evidence of lack of profit intent.    The

patent difference in petitioners' loss history distinguishes

Burrow.

     For the foregoing reasons, petitioners have failed to show

that they entered into and continued their horse-related

activities with the actual and honest objective of making a

profit.   Dreicer v. Commissioner, 78 T.C. 642 (1982); Golanty v.

Commissioner, supra.   Likewise we believe they have failed to

show that their horse-related activities were engaged in with the

"primary" purpose of earning a profit.    Cf. Westbrook v.

Commissioner, 68 F.3d 868 (5th Cir. 1995).

     To reflect the foregoing,

                                      Decision will be entered for

                                 respondent.
- 38 -
