                         T.C. Memo. 2003-86



                       UNITED STATES TAX COURT



       ROBERT SCHWARTZ AND DIANE SCHWARTZ, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 13248-00.               Filed March 25, 2003.


     Ira B. Stechel and Robert J. Sickinger, for petitioners.

     Rosemarie D. Camacho and Peggy Gartenbaum, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     VASQUEZ, Judge:    Respondent determined deficiencies in

petitioners’ Federal income taxes and accuracy-related penalties

as follows:
                                 - 2 -



                                          Penalty
          Year        Deficiency         Sec. 6662

          1994         $51,294             $10,259
          1995          58,018              11,604
          1996          45,101               9,020
          1997          25,635               5,127

The issues for decision are:   (1) Whether the deductions taken by

petitioner Robert Schwartz (Mr. Schwartz) and petitioner Diane

Schwartz (Mrs. Schwartz) (collectively, petitioners) related to

flowthrough losses incurred by Diane Racing International’s

(Diane Racing’s) yacht activity were from an activity entered

into for profit for 1994, 1995, 1996, and 1997 (years in issue)

within the meaning of section 183;1 and (2) whether petitioners

are liable for accuracy-related penalties under section 6662.2

                        FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.   At the time they filed

the petition, petitioners resided in Islip, New York.




     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
     2
        Petitioners also dispute the allowable portion of their
itemized deductions claimed for each of the years in issue. As
this issue is computational, we leave it for the parties to
compute in accordance with this decision.
                                - 3 -

       During the years in issue, Mr. Schwartz practiced medicine

in West Islip and specialized in gynecological oncology.     During

the years in issue, Mrs. Schwartz was an Adjunct Professor of

Special Education at Dowling College and an Assistant Professor

at Hofstra University.    Petitioners have three adult children:

Benjamin, Anna, and Sarah.

       Mr. Schwartz’s interest in sailing began in the late 1960s.

Around this time, he purchased his first boat, a 24-foot

Columbian Challenger cruiser.    In the 1970s, Mr. Schwartz then

purchased a 34-foot Tartan cruiser.     Mr. Schwartz began racing

sailboats in 1980 and purchased a 39-foot Baltic racer-cruiser

(Baltic 39).    In 1984, Mr. Schwartz sold the Baltic 39 at a

profit and then purchased a 48-foot Baltic racer-cruiser (Baltic

48).    Mr. Schwartz then sold the Baltic 48 at a profit and

purchased a 50-foot Soverel racing boat (Soverel 50) around 1990

to learn more about the 50-foot class of boats.     Petitioners kept

the Soverel 50 for 9 months to learn about it and to determine

what expenses would be involved with this type of boat by

chartering it.

The Association

       Petitioners also purchased the Soverel 50 in order to join

the 50-foot Association (the Association).     The purpose of the

Association was to allow owners of a similar class of boats to

race at a variety of venues in the United States and other
                               - 4 -

countries.   The people involved with the Association were also

involved with the America’s Cup race.   The America’s Cup occurred

every 4 years, whereas the Association would have ongoing races.

The incorporation papers signed in 1989 stated that the

Association was formed as a “Social Club”.   By 1991, however,

owners were allowed to display advertising material from

sponsors, and the Association reported sponsorship income in its

financial reports.   Mr. Schwartz joined the Association during

this period when sponsorships were being sought.

     Mr. Schwartz viewed the Association as “an opportunity to

potentially make a lot of money.”   By 1990, the Association

obtained sponsorship of $3.5 million for a trip to Japan and

already conducted meetings with Volkswagen for other sponsorship.

Petitioners’ understanding of the Association was that any

sponsorship money that came to the Association would be handed

down to the members equally.

     Mr. Schwartz respected the advice from the Association’s

members because “that’s where all the best minds were” in the 50-

foot sailing industry.   Mr. Schwartz consulted with professional

racers regarding the business implications of owning a 50-foot

boat.   Mr. Schwartz also consulted other professionals, including

Stephen Benjamin, a sail manufacturer and sailing consultant,

regarding expenses that would be incurred, e.g., sails for the
                                - 5 -

boat.    Mr. Schwartz was advised by these sailing professionals

that purchasing a 50-foot boat would be a good investment.

The Diane and Diane Racing

     On February 13, 1991, Mr. Schwartz purchased a 50-foot

Nelson Marek racing sailboat (the Diane) from an unrelated third

party for $350,000.    At the time of purchase, the Diane had a

market value of $680,000.    Mr. Schwartz was able to purchase the

Diane for approximately half its value because repairs were

needed to the hull.    Mr. Schwartz thought he could make a profit

from this venture because he bought the Diane at a “bargain”

price.    Before purchasing the Diane, petitioners received oral

financial projections from experts, including the then president

of the Association, Wictor Forss.

     In order to purchase the Diane and the necessary sails and

equipment, petitioners received a mortgage on the Diane for

$485,000.    Diane Racing’s attorney, Ira Stechel, advised

petitioners that ownership of the Diane should be maintained

individually because the insurance policy would not allow Diane

Racing to have ownership and the mortgage contained an

acceleration clause if ownership changed.

     The Diane was designed as a racing sailboat and did not

include any personal amenities (e.g., toilet, kitchen, or

sleeping quarters).    At the time they purchased the Diane,

petitioners also owned two other boats (a 25-foot Black Fin and a
                               - 6 -

J-27 sailboat) which were used solely for recreation and

maintained near petitioners’ residence.    The Diane, because of

its vast size, was maintained in a professional yard in

Jamestown, Rhode Island, a 5-hour drive from petitioners’

residence.   The Diane was also stored out of the water on dry

dock.

     After joining the Association, knowing of the sponsors, and

purchasing the Diane, in August 1991, petitioners incorporated

Diane Racing.   Mrs. Schwartz was the sole shareholder of Diane

Racing.   Diane Racing was incorporated as an S corporation.

     Petitioners had experience in business from their rental

real estate business (Schwartz Realty) in Washington, D.C.     Mrs.

Schwartz did the paperwork for Diane Racing, such as paying the

bills, maintaining an annual ledger and other financial records

(e.g., keeping the canceled checks of expenses paid), maintaining

correspondence, sending out promotional mailings, making boat

arrangements (e.g., transporting the boat), and creating and

maintaining a Web site for Diane Racing.   Petitioners spent an

average of 15 to 20 hours per week on Diane Racing.

     Petitioners’ son Benjamin was named president of Diane

Racing.   Having Benjamin as president allowed Diane Racing to

qualify for lower insurance rates because Benjamin had a

captain’s license and was capable of repairing the Diane’s

engine.   Additionally, through petitioners’ and Benjamin’s
                                 - 7 -

contacts in the industry, petitioners were able to recruit a

capable, professional crew.

     The bank records of Diane Racing were originally maintained

in Washington, D.C., so Benjamin could oversee the account while

he was in Washington, D.C.     Petitioners paid some boat expenses

through their personal checking accounts because some expenses

needed to be paid immediately and there was a lag time for checks

to clear from the bank account in Washington, D.C.     Once Benjamin

left Washington, D.C., the bank account was moved to New York.

     During the years in issue, the Diane participated in four to

nine events each season, and each event could involve multiple

races.   The Diane received publicity because of its photos in

sailing calendars, in a Patagonia catalog, and in a commercial

for an Italian deodorant company.

     The crew on the Diane was professionally operated.        To

participate in a race, the Diane required a crew of 15 members.

Petitioners’ children had participated as members of the crew;

however, they would sail rarely because the children lived in

different cities.    Mrs. Schwartz has not stepped aboard the Diane

since 1991 because of an arthritic condition.

The Activity

     Petitioners expected the Diane to make a profit through the

following ways:     (1) Obtaining sponsorships that included
                                   - 8 -

advertisements on the Diane; (2) building franchises; (3)

chartering the Diane; and (4) reselling the Diane.

     1.      Sponsorships

     The 50-foot class of boats developed in the late 1980s in

Europe for the Admiral’s Cup race.         At that time, yacht races for

this class of boats were heavily sponsored by different banks and

corporations; thereafter, the class began to develop in America

with numerous sponsors in order to train for the America’s Cup

race.     Further, yachting events have become major sporting

events, with races being nationally televised.

     Petitioners, therefore, expected to find sponsors through

the Association, which made a promotional videotape.         Petitioners

also mailed out hundreds of letters, with followup phone calls,

to solicit other sponsors in 1993.         Because of Mr. Schwartz’s

profession, petitioners expected to receive sponsorships from

pharmaceutical companies.

     2.      Franchising

     Petitioners foresaw the formation of an ongoing franchise

league for sailboat racing because of the 4-year gap between the

America’s Cup races.       Petitioners envisioned that the league

would have 20 teams that represented 10 countries.         Petitioners

planned to encourage international interest (and, therefore,

international sponsorship) in the league by having the Diane

sail around the world twice promoting the league.         Petitioners
                                  - 9 -

were encouraged about forming a racing league because many of the

owners in the Association had experience in sports franchising

and, by 1991, there was media coverage of the 50-foot class of

boats, e.g., television programs and hundreds of magazine

articles.

     3.     Chartering Activity

     The Diane was well suited for racing or racing-related

charters, with its good design, decent size, simplicity of deck

layout and sail plan, good sails, stable platform, and reasonable

price.    Further, petitioners foresaw that people would charter

boats in order to test crews, sails, and other equipment, and to

compete in events.    Chartering for a race is common.

     In order to obtain charters during the years in issue,

petitioners placed advertisements in yachting magazines and the

New York Times, created and maintained a Web site, used a broker,

and sent out promotional materials.       For publicity purposes,

petitioners placed the Diane in “the most visible” regattas each

year.     Petitioners calculated that they would make a profit if

they could find five or six steady charterers.

     4.      Resale

     Petitioners expected to make a profit from the Diane because

they had profited from the resales of their prior boats and

thought that the replacement value of boats would keep

increasing.
                              - 10 -

     Petitioners were able to receive only one sponsorship from a

Japanese company through the Association, which soon after

disbanded in 1993.   Petitioners expected to receive sponsorships

from pharmaceutical companies because of Mr. Schwartz’s

profession; however, Congressional investigations of these

companies deterred any sponsorships.    At this point, petitioners

began to focus their efforts on chartering the Diane.

     During the years in issue, Mr. Schwartz had triple bypass

heart surgery and was not aboard the Diane as often as in prior

years.   Petitioners also experienced financial pressure during

the years in issue because they supported their children’s

graduate educations and were also subjected to malpractice

lawsuits.   Further, petitioners had lost $300,000 in savings

because of activities by their pension plan administrator, who

was indicted and went to jail because of his illegal activities

with other pension plans.

     During the years in issue, petitioners tried to increase

profitability and to cut the Diane’s costs by dismissing its

full-time paid captain, hiring crew only when needed, racing in

local races to lower the Diane’s transportation costs, moving

equipment containers to a free storage location, leaving the mast

in for the winter, refinancing the Diane, and having the Diane

reappraised to lower insurance rates.   They also sold some of the

sails that were not needed and placed more advertisements for
                               - 11 -

chartering the Diane.    At that time, petitioners still felt that

the Diane could be chartered and a profit could be realized if

they could secure a few charters annually.    Unfortunately,

petitioners lost their two main charterers, Mark Morita and David

Howell, because Mr. Morita went bankrupt and Mr. Howell died.3

Change in International Racing Rules

     Beginning around the years in issue, the international

racing rules changed.    In sailboat racing, certain rules exist in

order to determine a sailboat’s handicap for racing purposes.

The Diane had been built under the International Offshore Rule

(IOR).    The IOR had been the international rule since the late

1960s and early 1970s and through the year petitioners purchased

the Diane.    The IOR allowed yachts of different sizes to compete

fairly.    The IOR was replaced by the International Measurement

System (IMS) and the Performance Handicap Racing Fleet (PHRF)

system by 1993 or 1994.4   In order to increase the marketability

of the Diane, petitioners modified the Diane so it could race

under IMS and PHRF by removing the IOR speed bumps, changing the

shape of the keel, and moving the weight around.    Before its

modification, the Diane was one of the three fastest boats on the


     3
        In 1992, Mr. Morita chartered the Diane and then filed
for bankruptcy. Petitioners chartered the Diane to David Howell
from 1993 to 1995. Mr. Howell promised to charter the Diane as
long as he could, but then he died.
     4
        The IOR is still used in Mexico; however, the last IOR
premier race occurred in 1993.
                                - 12 -

course.   After modification, the Diane was capable of sailing

under IOR, IMS, and PHRF.5

Effect of Luxury Tax on Industry

     Another problem for petitioners occurred when the sailboat

racing industry slowed in the early 1990s because of the

imposition of the luxury tax under section 4002.   During this

time, approximately 480,000 people lost jobs in the marine

industry; as a result, there were not as many races and fewer

people were chartering boats.

Tax Returns

     In preparing their tax returns, petitioners consulted

Leonard Fruchter, a partner at a C.P.A. firm.   Mr. Fruchter

concluded that petitioners had a profit motive after reviewing

petitioners’ efforts to find sponsors and to advertise,

petitioners’ ownership of other boats that were specifically used

for recreational purposes instead of the Diane, and petitioners’

maintenance of a journal for business expenses.    For each of the

years in issue, on Schedule E, Income or Loss From Partnerships

and S Corporations, petitioners claimed deductions for the

flowthrough losses from Diane Racing.




     5
        Changes could have been made to make the boat more
attractive for chartering as an excursion boat (i.e., adding
amenities, raising the deck, altering the interior structure of
the boat), but they would have made the Diane incompatible for
racing.
                              - 13 -

     On September 26, 2000, respondent sent petitioners a notice

of deficiency.   Respondent determined that petitioners were not

allowed deductions relating to losses from Diane Racing under

section 183 because Diane Racing was not an activity entered into

for profit.   On December 26, 2000, petitioners filed a petition

with this Court disputing respondent’s determination.

                              OPINION

     Section 183(a) provides generally that, if an activity is

not engaged in for profit, no deduction attributable to such

activity shall be allowed except as provided in section 183(b).

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 basic standard for determining whether an expense is

deductible under sections 162 and 212 (and thus not subject to

the limitations of section 183) is that the taxpayer must show

that the taxpayer engaged in or carried on the activity with an

actual and honest objective of making a profit.   Ronnen v.

Commissioner, 90 T.C. 74, 91 (1988); Dreicer v. Commissioner, 78

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

Cir. 1983); see Dunn v. Commissioner, 70 T.C. 715, 720 (1978),

affd. 615 F.2d 578 (2d Cir. 1980).
                              - 14 -

     Whether the requisite profit objective exists is determined

by looking at all the surrounding facts and circumstances.

Keanini v. Commissioner, 94 T.C. 41, 46 (1990); sec. 1.183-2(b),

Income Tax Regs.   In determining whether such objective exists,

it may be sufficient that there is a small chance of making a

large profit.   Sec. 1.183-2(a), Income Tax Regs.   Greater weight

is given to objective facts than to taxpayer’s mere statement of

intent.   Thomas v. Commissioner, 84 T.C. 1244, 1269 (1985), affd.

792 F.2d 1256 (4th Cir. 1986); sec. 1.183-2(a), Income Tax Regs.

Petitioners bear the burden of proof.6   Rule 142(a).

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

factors to be considered in the evaluation of a taxpayer’s profit

objective:   (1) The 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 in carrying on the

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

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

carrying on other similar or dissimilar activities; (6) the

taxpayer’s history of income or losses with respect to the

activity; (7) the amount of occasional profits, if any, from the

activity; (8) the financial status of the taxpayer; and (9)

elements of personal pleasure or recreation.   This list is



     6
        The parties do not argue the applicability of sec.
7491(a).
                              - 15 -

nonexclusive, and the number of factors for or against the

taxpayer is not necessarily determinative, but rather all facts

and circumstances must be taken into account, and more weight may

be given to some factors than to others.   Id.; cf. Dunn v.

Commissioner, supra.

     As an initial matter, we found petitioners’ testimonies

regarding the yacht activity to be credible.   Other witnesses

corroborated their testimonies.

Manner in Which Petitioners Carry On the Activity

     The fact that a taxpayer carries on the activity in a

businesslike manner and maintains complete and accurate books and

records may indicate a profit objective.   Sec. 1.183-2(b)(1),

Income Tax Regs.   A change of operating methods, adoption of new

techniques, or abandonment of unprofitable methods in a manner

consistent with an intent to improve profitability may also

indicate a profit motive.   Id.

     Petitioners carried on the activity in a businesslike

manner.   A separate banking account for Diane Racing was

maintained during the years in issue.   Mrs. Schwartz did the

paperwork for Diane Racing, including paying the bills,

maintaining the bank account, and sending out correspondence.    At

trial and attached to the stipulation of facts, canceled checks

relating to expenses paid for the Diane during the years in issue
                               - 16 -

and an example of the ledger that Mrs. Schwartz maintained were

provided.

     Further, during the years in issue, petitioners attempted to

improve the profitability of Diane Racing through various

methods, including hiring paid crew only when needed, entering

local races in order to lower the Diane’s transportation costs,

refinancing the Diane, lowering the Diane’s insurance rates,

changing to a free storage location for the Diane’s equipment,

and modifying the Diane in order to meet the new international

racing rules.    Additionally, petitioners sent mass promotional

mailings with followup phone calls, advertised, and created a Web

site for the Diane in order to find sponsors and customers.

Expertise of Petitioners or Their Advisers

     A taxpayer’s expertise, research, and study of an activity,

as well as his consultation with experts, may be indicative of a

profit intent.    Sec. 1.183-2(b)(2), Income Tax Regs.   Mr.

Schwartz’s expertise in boats and research of the 50-foot boat

industry indicate a profit intent.

     Mr. Schwartz has been sailing since the 1960s.      Prior to the

Diane, Mr. Schwartz owned at least five other boats of various

sizes and capabilities.    The parties provided the sailing resumes

of petitioners and Benjamin and extensive list of readings

regarding the sailboat industry in petitioners’ library.       We have
                               - 17 -

no doubt that petitioners have expertise in the sailboat

industry.

     Further, petitioners joined the Association specifically to

learn about 50-foot sailboat industry from the professionals in

the field.   Mr. Schwartz also consulted with others in the

business who could advise him regarding the expenses involved

with 50-foot sailboats and how to reduce those expenses.

Time and Effort Expended by Petitioners

     The fact that the taxpayer devotes much of his personal time

and effort to carrying on an activity may indicate an intention

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

Petitioners testified that they spent an average of 15 to 20

hours per week on Diane Racing.    We find this time spent

indicative of petitioners’ commitment to this endeavor.

Success of Petitioners in Carrying On Other Activities

     We have recognized that a taxpayer’s success in other

business activities may indicate a profit objective.    See Hoyle

v. Commissioner, T.C. Memo. 1994-592; sec. 1.183-2(b)(5), Income

Tax Regs.    We conclude that petitioners’ success in other

sailboat activities (e.g., reselling the Baltic 39 and Baltic 48

at a profit, chartering the Soverel 50) indicates a profit

objective.
                              - 18 -

History of Income or Losses

     A record of substantial losses over several years may be

indicative of the absence of a profit motive.    Golanty v.

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

opinion 647 F.2d 170 (9th Cir. 1981).   Section 1.183-2(b)(6),

Income Tax Regs., provides, however, that if losses are sustained

because of unforeseen or fortuitous circumstances which are

beyond the control of the taxpayer, such losses would not be an

indication that the activity is not engaged in for profit.    We

conclude that the losses sustained were the result of unforeseen

circumstances and are not an indication that the activity is not

engaged in for profit.

     Those unforeseen circumstances include:    (1) Congressional

investigations into the pharmaceutical industry which deterred

sponsorships to petitioners by the industry; (2) the adverse

effect of the luxury tax on the sailboat industry in the 1990s;

and (3) after petitioners purchased the Diane, the change in the

international racing rules.   The Diane was built under the IOR,

the system that had been in place since the late 1960s and early

1970s.   Petitioners could not have known that the rules would

change 2 years after their purchase of the Diane.    Although the

Diane was still a competitive boat, it was less attractive to

charterers because it was built under the old system.
                              - 19 -

     Additionally, petitioners were unable to obtain sponsors

because of the dissolution of the Association, petitioners lost

their two main charterers when one went bankrupt and one died,

and petitioners were distracted by Mr. Schwartz’s surgery,

malpractice suits, and their loss of savings due to a bad pension

administrator.

Amount of Occasional Profits From the Activity

     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 even though losses or

only occasional small profits are actually generated.     Sec.

1.183-2(b)(7), Income Tax Regs.   We conclude that petitioners had

an opportunity to ultimately profit from the activities

associated with the Diane even though losses were actually

generated.   For example, petitioners expected to make an overall

profit with the resale of the Diane because they purchased the

Diane for half its then market value, they attempted to lower

expenses related to the Diane, and they had experience reselling

their other sailboats at a profit.     The fact that losses were

actually generated was caused by factors beyond petitioners’

control rather than petitioners’ lack of effort.

Financial Status of Petitioners

     We conclude that petitioners’ financial status during the

years in issue indicates that the activity was engaged in for
                              - 20 -

profit.   During the years in issue, petitioners were concerned

about their financial status because Mr. Schwartz took time from

work for his surgery, petitioners paid for their three children

to attend graduate school, and petitioners experienced a large

loss in savings because of a bad pension administrator.   During

these years, petitioners felt that they could not be involved

with an activity that would result in large losses.

Elements of Personal Pleasure or Recreation

     The absence of personal pleasure or recreation relating to

the activity in question may indicate the presence of a profit

objective.   Sec. 1.183-2(b)(9), Income Tax Regs.   The mere fact

that a taxpayer derives personal pleasure from a particular

activity does not, per se, demonstrate a lack of profit motive.

     We are convinced that the personal pleasure of owning and

using the Diane was secondary to petitioners’ use of the Diane

for profit because, during the years in issue, petitioners owned

other boats that were used solely for personal pleasure or

recreation and the Diane had no personal amenities (e.g., no

toilet, sleeping quarters, etc.).   Further, Mrs. Schwartz had not

stepped aboard the Diane since 1991 because of an arthritic

condition.

Conclusion

     We hold that petitioners met their burden of proving that

the Diane’s activity was engaged in with an actual and honest
                              - 21 -

objective of making a profit; therefore, because deductions are

allowable under sections 162 and 212 (and thus not subject to the

limitations of section 183), we render respondent’s alternative

argument on this point as moot.7   Further, respondent based the

accuracy-related penalties upon respondent’s disallowance of

petitioners’ deduction for flowthrough losses from Diane Racing’s

yacht activity.   Accordingly, we render the issue moot.

     In reaching our holdings herein, we have considered all

arguments made, and to the extent not mentioned above, we

conclude them to be moot, irrelevant, or without merit.

     To reflect the foregoing,

                                                Decision will be

                                         entered for petitioners.




     7
        Respondent argued in the alternative that the deductions
related to flowthrough losses claimed by petitioners from Diane
Racing, which included depreciation deductions, should be
disallowed as personal expenses under sec. 162.
