                              T.C. Memo. 2014-74



                        UNITED STATES TAX COURT



                 MERRILL C. ROBERTS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 12010-11.                  Filed April 29, 2014.



      Francis J. Emmons, for petitioner.

      Michael Dancz, Gorica Djuraskovic, and Grubert Roger Markley, for

respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


      PARIS, Judge: On March 1, 2011, respondent issued a notice of deficiency

to petitioner determining deficiencies of $169,785, $617,119, $297,150, and

$297,640 for tax years 2005, 2006, 2007, and 2008, respectively. Respondent also

determined that petitioner owed penalties under section 6662(a) of $33,957,
                                         -2-

[*2] $123,424.80, $59,430, and $59,528 for tax years, 2005, 2006, 2007, and

2008, respectively.1 Last, respondent determined petitioner owed an addition to

tax under section 6651(a)(1) of $16,894 for the 2007 tax year.

      The issues for decision are: (1) whether petitioner engaged in various

horse-related activities during tax years 2005, 2006, 2007, and 2008 with the

expectation of making a profit; (2) whether petitioner is liable for accuracy-related

penalties under section 6662(a) for tax years 2005, 2006, 2007, and 2008; and (3)

whether petitioner is liable for an addition to tax under section 6651(a)(1) for

failure to timely file his Federal income tax return for the 2007 tax year.

                               FINDINGS OF FACT

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

facts and the exhibits received into evidence are incorporated herein by this

reference. Petitioner lived in Indiana when he filed the petition.

I. Background

      In 1969 petitioner purchased an abandoned restaurant on Washington Street

highway in Indianapolis, Indiana, around five miles from his current home. He

worked two jobs and saved money for several years to be able to afford the

      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.
                                          -3-

[*3] purchase. The restaurant had originally been built as part of the Horne’s

highway restaurant chain and came with a reputation of staying open 24 hours a

day, seven days a week. An additional investor helped petitioner reopen the

restaurant as a steakhouse called the Sherwood Inn. Petitioner, a high school

graduate, did not perform any business studies or projections before opening the

restaurant and instead anchored his business plan on “hard work”. The Sherwood

Inn was initially very successful but closed because of significant kitchen fire

damage several months after opening.

      Petitioner sought to collect on the restaurant’s insurance policy and

eventually settled his claim nearly a year after the Sherwood Inn had burned.

Petitioner was left without a source of income and used his personal savings to

support his family of three children during this time.2 Because the insurance

settlement was insufficient to rebuild a fully equipped restaurant, petitioner

reopened the business as a bar around 1972.

      The bar was near an airport and attracted airport employees at the end of

their shifts. Specifically, “airport controllers” would often patronize petitioner’s

bar to celebrate passing certification tests. The “airport controllers” asked

petitioner to arrange for exotic dancers to perform at the celebrations, and he

      2
          Petitioner’s wife was estranged from the family for medical reasons.
                                         -4-

[*4] complied. Soon thereafter, the nights featuring exotic dancers became

popular and well-attended events.

      Although petitioner recognized the financial potential of operating a

gentlemen’s club, he chose to sell the business for moral reasons around 1973.

The sale agreement required the buyers to make payments directly to petitioner.

Petitioner then opened a pizza parlor about five miles from his former bar.

Around 1974 petitioner reclaimed the bar because the buyers failed to make

payments. After explaining the specific circumstances to his family, petitioner

continued to operate the bar on Washington Street highway as a gentlemen’s club

called Dancers.

      Dancers turned into a very profitable venture, and petitioner expanded his

business by opening other nightclubs and restaurants. At one point petitioner

owned six operating establishments and a staffing company to coordinate

personnel. Every restaurant or bar that petitioner opened was eventually

successful and was still operating at the time of trial.

      Petitioner actively participated in trade organizations that supported the

nightclub industry. Petitioner originally joined the associations to learn about the

industry and to stay current on industry techniques. Eventually petitioner

ascended to multiple leadership roles within the organizations. Petitioner
                                        -5-

[*5] ultimately was president of the Indiana Licensed Beverage Association for

four years and president of the Indiana Nightclub Association for eight years. The

organizations helped nightclub owners--like petitioner--protect their investments

by advocating for the businesses’ specific interests. For example, the

organizations helped defend bars against disgruntled neighbors who were unhappy

with a bar’s location or late hours. Petitioner undoubtedly learned valuable

lessons from the trade organizations and implemented the valuable knowledge in

his own operations.

      Petitioner also expanded his business activities by investing in real estate.

One of the properties that petitioner acquired was a 50-acre parcel of land that

fronted Washington Street. This parcel, bought in 1987, was directly across the

street from Dancers and about five miles from petitioner’s current home.

Petitioner paid about $250,000 for the 50 acres and rented it to a farmer for around

10 years. In 1997 or 1998 petitioner bought a 45-acre parcel of land directly north

of the 50-acre parcel for around $400,000.3 The former owner had used this land

to board horses, and there was an operational stable on the property. Petitioner

recognized there was a small income potential from the stable but actually

      3
        The 45-acre parcel fronted Morris Street. These two parcels are
collectively referred to as the Morris Street property to avoid confusion with
Dancers, which is also on Washington Street.
                                        -6-

[*6] intended to capitalize on the land by creating a 95-acre contiguous plot and

through appreciation, not through stable rental receipts.

       In the mid-1990s petitioner began to ease out of the nightclub industry.

Around this time he sold all of his shares of the nightclub business to his three

grown children. Petitioner also eventually relinquished control of his nightclub

businesses but continued to consult with the new management team. Because

petitioner had over 30 years of experience in the nightclub industry and his

experience was a valuable asset to the businesses, he created a new corporate

entity to structure a management consulting agreement. As his adult children

became more experienced, petitioner transitioned from his previous onsite

management to providing most of his day-to-day services through cell phone

consultations. Petitioner’s newly adopted cell phone management style and

reduced interest in his nightclub businesses allowed him to think about long-term

life goals.

       Around the time petitioner bought the Morris Street property, he was

contemplating a career change. He read that owning restaurants and nightclubs

was a particularly dangerous occupation and decided to change his life. Petitioner

started participating less in the nightclub businesses and started an insulation

company as well as a used car dealership. While petitioner did not lose money in
                                          -7-

[*7] these new endeavors, he was not happy working his new jobs. He was

eventually bought out of the insulation business, and he chose to close the car

dealership.

II. Horse-Related Activities

      In 1998 or 1999 the Indiana Thoroughbred Owners and Breeders

Association invited petitioner--as an owner of a horse boarding stable--to attend a

free dinner and a tour of Hoosier Park, the first horse racing track to be opened in

Indiana. The breeders association presented basic information about horse racing

and the potential financial gains associated with the activity. Petitioner was

interested in the financial prospect of horse racing even though he had been to a

horse track only once before the event.

      Petitioner asked a trainer who already worked at his boarding stables to

“show [him] the ropes” of horse racing. The trainer taught petitioner some initial

basic horse skills, and petitioner decided to acquire his owner’s license. In 1999

petitioner purchased his first two young horses for $1,000 each and proceeded to

work with his trainer to prepare the young horses for the racetrack. Petitioner also

bought two horse racing videos to help explain more about horse racing and built

his first training track on the Morris Street property. In his first year of racing

petitioner’s net income was around $18,000 from his two horses. Petitioner
                                          -8-

[*8] recognized the ease of accounting for only two horses, but he was also

enticed by the profit potential of racing more horses. He decided he liked the

activity and bought more horses.

      Petitioner used several trainers in his first few years of horse racing and

learned more about the industry.4 He increased his personal racing stable from 2

horses in 1999 to 10 horses in 2001 and also bought a breeding stallion. If he had

a question about the business that his trainer could not answer, petitioner would

turn to other experienced trainers because he did not “have twenty years to learn”.

Petitioner began working every day at the Morris Street property to develop the

skills needed to become a licensed trainer, and he passed the trainer’s license test

in 2002. Unlike an owner’s license, the trainer’s license is much harder to obtain,

and the State of Indiana required an applicant to pass a rigorous test on a range of

subjects from horse bridle construction to equine medication.

      In 2004 petitioner started consulting a specialized professional called a

blood stock agent for horse purchasing and breeding advice so he could

substantially expand the bloodlines of the horses in his breeding program. By

2005 petitioner felt comfortable with his knowledge of horse racing and wanted to

build his own horse training facility on the Morris Street property. The original

      4
          Some of petitioner’s trainers passed away, and he fired others for cause.
                                         -9-

[*9] boarding stable was in disrepair and not suitable for petitioner’s intended

activity. Petitioner started building a new facility on the Morris Street property,

but the City of Indianapolis attempted to stop him from training horses despite the

agricultural zoning of the property. The city raised his property taxes from around

$1,000 to $17,000 per year and was fining him $100 for every day that he was out

of compliance. Further, before he could construct any new structures, the city

required all new buildings, including barns, to meet strict city building codes. For

example, the city required petitioner to hire an architect to design and draw the

proposed barns before construction could commence. The city’s actions

discouraged petitioner from building on the Morris Street property, and he started

looking for a new location to build a horse training facility.

      Around 2005 an unrelated party offered to buy the entire 95-acre Morris

Street property from petitioner for around $2.2 million,5 and in June 2006

petitioner closed the sale. Petitioner chose to recognize gain on the 45-acre parcel

and reinvest the proceeds from the 50-acre parcel through a section 1031 exchange

into property that would be better suited for training horses.6 On June 20, 2006,


      5
        As noted, the Morris Street property, also includes the abutting Washington
Street property. See supra note 3.
      6
          Instead of recognizing a $902,887 gain from the 50-acre parcel, petitioner
                                                                       (continued...)
                                          - 10 -

[*10] petitioner purchased a 180-acre parcel of land near Mooresville, Indiana--

around 16 miles from his current home--for $1 million, and within the next six

months he invested between $500,000 and $600,000 in building improvements for

a horse training facility.7 Petitioner recognized the land would probably

appreciate because of its proximity to a planned highway project, but he sought the

land specifically to suit his horse-related activities.

      Petitioner decided to build a first-class training facility on the Mooresville

property, and he sought out expert advice for its design. He asked his trusted

blood stock agent to help design the new training facility, and the bloodstock

agent advised petitioner on many aspects of the new facility. The facility--

completed and placed in service in 2007--includes a large training track, portable

horse stalls, unique rehabilitation equipment, several specialized training areas,

and small apartments for employees. In petitioner’s view, he built an

extraordinary training facility unmatched in the State of Indiana, offering the

unique aspect that his facility is used to condition horses rather than race horses.




      6
       (...continued)
chose to defer the gain through a sec. 1031 exchange.
      7
       The exact costs of improvements are unknown because these records were
destroyed in a 2012 fire.
                                         - 11 -

[*11] As a new participant in the race horse industry petitioner developed his own

training philosophy. He determined that to be successful he needed to motivate a

horse to race rather than force the horse to race, and he built his horse facilities

specifically for conditioning and motivating. The move to 180 acres also allowed

him to offset his previously considerable hay expense by using a part of the

Mooresville property to grow hay for his horses, and he purchased a significant

amount of equipment to harvest and process the horse hay. In addition, the

Mooresville property was large enough that petitioner rented out about 90 acres of

the land for around $20,000 a year.

      In the 2005 through 2008 tax years petitioner was involved in multiple

aspects of the race horse industry, including boarding, breeding, training, and

racing horses.8 Petitioner primarily raced horses in Indiana but also raced at least

11 races per year in Kentucky and intermittently raced in other States including

Ohio, Louisiana, North Dakota, Minnesota, and West Virginia.9 Before buying the

Mooresville property, petitioner split his time between the track and his training


      8
        Collectively these activities will be referred to as petitioner’s horse-related
activities. The boarding and breeding activities were reported together, and the
percentage of the activities the breeding program represented during tax years
2005 through 2008 is unclear.
      9
       Petitioner believes that racing in at least 11 Kentucky races per year makes
him eligible for a trainer-specific retirement plan.
                                         - 12 -

[*12] operation, but in 2007 he hired a full-time assistant trainer when he started

his operations at the Mooresville property. During racing season petitioner’s

assistant trainer worked at the racetrack while petitioner worked at the training

facility. Petitioner structured the arrangement so that he collected fees when his

trainer performed services for third parties. Petitioner did most of the manual

labor to keep the facility in “excellent condition”, while his assistant coordinated

each horse on race day.

      Petitioner’s evenings were now generally spent choosing the races in which

each horse would compete. He spent substantial time studying track condition

books and picking specific races for specific horses. This required matching the

attributes of a horse to the requirements of each race. If petitioner erred, he could

have been fined for not meeting race requirements. But more importantly, because

many of the races were “claiming races”, his horse might have been purchased

cheaply if the horse was worth more than the claiming amount.10 In petitioner’s

view, “find[ing] the right race for the right horse * * *[i]s the secret to” the horse

      10
         A claiming race is a race in which any entered horse may be purchased by
any owner for a set price before the start of the race. For example, in a $10,000
claiming race any horse may be purchased before the race for $10,000, and the
new owner takes delivery of the horse after the race. In other words, every time
petitioner entered a horse into a claiming race, he risked losing the horse to a
claimant. Accordingly, it was in petitioner’s interest to match a specific horse to
certain races according to the value or potential of the horse.
                                        - 13 -

[*13] racing business, and it took him some time to learn the skill. To ensure

compliance with racing regulations and entry strategy, petitioner would often

confer with his assistant trainer about race entries. This strategy has produced

some successful horses, and one of petitioner’s horses was nominated to run in the

Triple Crown Races.

      Petitioner suffered several mishaps during his first few years of horse

racing. Several of his best horse prospects were injured or killed in unfortunate

accidents or lost during foaling season. For example, petitioner has lost numerous

horses to lightning strikes and in-race injuries. Also, after moving to the

Mooresville property petitioner was also swindled when a fence builder

substituted flimsy poplar lumber to build a paddock fence rather than the agreed-

upon oak. Before petitioner could rebuild the poplar fence, two stallions were

spooked, stampeded through the fence, and died on the impaling timbers. The loss

of the stallions and the cost of a replacement fence were serious setbacks to

petitioner. Additionally, in 2008 many of his horses were captured in a

quarantined stable when another owner’s horse tested positive for a contagious

infection within the same building. As a result petitioner could not race any of

these horses for a significant part of the 2008 season.
                                       - 14 -

[*14] III. Professional Horse Racing Industry Activities

      Paralleling his participation in nightclub trade associations, petitioner joined

several professional horse racing associations, and from 2005 through 2008 he

served as a board member for two of the organizations.11 In 2007 petitioner’s

peers asked him to run for a leadership position within the Indiana Horsemen’s

Benevolent and Protective Association (HBPA). The HBPA, in addition to other

missions, was responsible for allocating broadcasting funds and negotiating race

purse structure. After serving as an HBPA board member for over a year,

petitioner resigned to spend more time training horses.

      Also similar to his nightclub professional activities, petitioner was involved

in lobbying the Indiana State Legislature for horse racing interests. Specifically,

petitioner acted as a sounding board for his bloodstock agent, who was a key

Indiana horse racing lobbyist. When he was preparing to testify or lobby at the

State legislature, the bloodstock agent would stay at petitioner’s house, and

petitioner would help the bloodstock agent prepare to testify in support of Indiana

professional horse racing. In the spring of 2007 the lobbying activities were

successful and helped pass legislation to permit slot machines at racetracks.

      11
        Petitioner served on only one board at a time because the professional
associations forbid concurrent board membership. He resigned in 2008 to spend
more time training his horses.
                                        - 15 -

[*15] House Bill No. 1835, the “slot bill”, substantially increased the purses for

horse racing in Indiana. For example, the new law increased a $13,000 purse to a

$35,000 purse for one race. Further, the bill led to more races for unproven

prospects, allowing trainers more opportunities to race young horses.

IV. Petitioner’s Finances

      Petitioner’s certified public accountant (CPA) had handled his nightclub

business accounting needs for about 20 years, and he used the same CPA for his

horse-related activities. Petitioner first met this CPA through a mutual

acquaintance after being dissatisfied with several other accountants. Petitioner

continuously used this same CPA for his accounting needs, including

representation during two audits before the tax years in issue. Neither of the prior

audits resulted in an increased tax deficiency, and he continued to seek the CPA’s

tax advice on tax matters.

      Petitioner used a rudimentary accounting system for all of his businesses,

including his horse-related finances. Petitioner gave his CPA receipts for cash

expenditures and relied on canceled checks and bank statements to track expenses.

Some of these receipts were turned over to respondent in bundled reclosable

plastic bags. For gross receipts, petitioner partly relied on a complex Internet

database devoted to horse racing records. The Internet database is extensive and
                                       - 16 -

[*16] tracks, inter alia, each horse, trainer, owner, and jockey. The database keeps

detailed records of each horse’s history, complete with total earnings, earnings per

start, and earnings per year. The database is maintained by a private organization

and is publicly available. Petitioner also tracked the cost of boarding a horse and

the amount of feed each of his horses required. He knew the cost of keeping each

of his horses at his property or boarding them elsewhere during the racing season.

      For tax years 1999 through 2006 petitioner reported horse-racing income,

expenses, and deductions from his horse-related activities on Schedules C, Profit

or Loss From Business, of his personal income tax returns. In addition, he

reported what was described as the horse farm portion of the income, expenses,

and deductions on Forms 1120S, U.S. Income Tax Return for an S Corporation,

for an S corporation he owned, Merrill C. Roberts, Inc. Petitioner then reported

the net ordinary income or loss and any separately stated items reported by the S

corporation on its corporate income tax returns on various schedules to his

personal income tax returns for the corresponding years. Petitioner switched his

tax reporting in 2007. Beginning in 2007 petitioner began reporting all of the

horse-related income, expenses, and deductions on the S corporation forms. On

his 2005 Schedule C petitioner reported income of $64,948 and deductions of

$162,450 for a loss of $97,502 for his horse-related activities. The 2005 Form
                                        - 17 -

[*17] 1120S shows income of $47,247 and deductions of $103,165 for a loss of

$55,918 in horse-related activities. On his 2006 Schedule C petitioner reported

income of $184,661 and $169,809 of deductions for a profit of $14,852. The 2006

Form 1120S shows income of $38,013 and deductions of $83,469 for a loss of

$45,456. The 2007 Form 1120S shows income of $258,433 and deductions of

$356,684 for a loss of $98,251. For tax year 2008, the year in which petitioner’s

horses were quarantined for a significant portion of the race season, the Form

1120S shows income of $65,563 and deductions of $357,451 for a loss of

$291,888.12

      In 2008 while preparing his 2007 tax return some of petitioner’s financial

records were permanently lost when a former girlfriend burned the records in a

fireplace. Additionally, petitioner’s personal returns reflect less than $3,000 in

gambling income for all of the tax years in issue.

                                     OPINION

      The Commissioner’s determinations in a notice of deficiency are presumed

correct, and the taxpayer generally bears the burden of proving that the

      12
         Petitioner may have reported additional income, deductions, and credits
related to his horse-related activities on various other schedules for various years.
For example, petitioner may have listed real estate rental income related to the
horse activities on a Schedule E, Supplemental Income and Loss, and Form 4835,
Farm Rental Income and Expenses.
                                        - 18 -

[*18] determinations are in error. See Rule 142(a); Welch v. Helvering, 290 U.S.

111, 115 (1933). Taxpayers also bear the burden of proving that they are entitled

to any deductions claimed. See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84

(1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Taxpayers

must maintain sufficient records to establish the amounts of allowable deductions

and to enable the Commissioner to determine the taxpayers’ correct tax liabilities.

See sec. 6001; Shea v. Commissioner, 112 T.C. 183, 186 (1999); sec. 1.6001-1(a),

Income Tax Regs.

      Section 7491(a) provides an exception that can shift the burden of proof to

the Commissioner if the taxpayer introduces credible evidence regarding relevant

factual issues and has: (1) complied with all relevant substantiation requirements;

(2) complied with all relevant recordkeeping requirements; and (3) cooperated

with reasonable requests by the Commissioner for meetings, interviews, witnesses,

documents, and information. Sec. 7491(a)(1) and (2)(A) and (B). Credible

evidence is evidence that, after critical analysis, the Court would find sufficient

upon which to base a decision on the issue if no contrary evidence were submitted.

Higbee v. Commissioner, 116 T.C. 438, 442 (2001). A taxpayer who provides

only self-serving testimony and inconclusive documentation has been held not to
                                        - 19 -

[*19] have provided credible evidence. See id. at 445-446; Blodgett v.

Commissioner, T.C. Memo. 2003-212, aff’d, 394 F.3d 1030 (8th Cir. 2005).

      It is unclear whether petitioner complied with all the substantiation

requirements or complied with all relevant recordkeeping requirements. The

parties’ dispute concerns whether petitioner engaged in his horse-related activities

with the requisite profit objective, and the very little evidence provided in regard

to petitioner’s rudimentary style of recordkeeping did not show the adequacy of

petitioner’s substantiation or recordkeeping practices with respect to the

requirements of section 7491. Accordingly, the burden has not shifted to

respondent.

I. Section 183

      Under section 183(a), if an activity is not engaged in for profit, then no

deduction attributable to that activity is allowed except to the extent provided by

section 183(b). In pertinent part, section 183(b) allows those deductions that

would have been allowable had the activity been engaged in for profit only to the

extent of gross income derived from the activity, reduced by deductions

attributable to the activity that are allowable without regard to whether the activity

was engaged in for profit.
                                        - 20 -

[*20] 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.” Deductions are

allowable under section 162 or under section 212(1) or (2) if the taxpayer is

engaged in the activity with the actual and honest objective of making a profit.

Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), aff’d without published

opinion, 702 F.2d 1205 (D.C. Cir. 1983). The taxpayer need not, however,

establish that his or her expectation of profit was reasonable. Golanty v.

Commissioner, 72 T.C. 411, 425-426 (1979), aff’d without published opinion, 647

F.2d 170 (9th Cir. 1981); sec. 1.183-2(a), Income Tax Regs.

      The existence of the requisite profit objective is a question of fact that must

be decided on the basis of all of the facts and circumstances. Elliott v.

Commissioner, 84 T.C. 227, 236 (1985), aff’d without published opinion, 782

F.2d 1027 (3d Cir. 1986); sec. 1.183-2(b), Income Tax Regs. In resolving this

factual question, greater weight is given to objective facts than to a taxpayer’s

statement of intent. See Elliott v. Commissioner, 84 T.C. at 236-237; sec. 1.183-

2(a), Income Tax Regs.

      The regulations set forth a nonexhaustive list of factors that may be

considered in deciding whether a profit objective exists. These factors are: (1) the
                                         - 21 -

[*21] 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 the 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, which are earned; (8) the

financial status of the taxpayer; and (9) any elements indicating personal pleasure

or recreation. Sec. 1.183-2(b), Income Tax Regs. These factors are not exclusive,

and no single factor is determinative. Id.

      A. Manner of Carrying on the Activity

      The first factor the Court considers is the manner in which the taxpayer

carries on the activity. The fact that the taxpayer carries on an 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. Similarly,

where an activity is carried on in a manner substantially similar to other profitable

activities of the same nature, a profit objective may be indicated. Id. A change of

operation 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 objective. Id. A taxpayer should use some cost accounting
                                        - 22 -

[*22] techniques that, at a minimum, provide the entrepreneur with the

information required to make informed business decisions. Burger v.

Commissioner, 809 F.2d 355, 359 (7th Cir. 1987), aff’g T.C. Memo. 1985-523.

Without such a basis for decisions affecting the enterprise, the incidence of a

profit in any period would be wholly fortuitous, and losses would be expected. Id.

      Petitioner demonstrated significant changes in operation, adoption of new

techniques, and abandonment of unprofitable methods when he moved his horse

racing activity from the Morris Street property to the Mooresville property. He

recognized that the Morris Street property was not suitable because the buildings

were in disrepair and building a new facility at this location was cost prohibitive

because of the city’s building codes. The city was imposing a $100-a-day fine and

increased his property tax from around $1,000 a year to $17,000. Petitioner chose

to mitigate these expenses by liquidating his old facility and moving to a property

that would help make him more money.

      The larger Mooresville property allowed petitioner to build substantially

larger and better new facilities and the increased size also allowed petitioner to

reduce his fixed feeding costs by growing his own hay and renting out part of the

property. Petitioner rented out 90 acres of the Mooresville property for around

$20,000 a year--further reducing his horse racing activity costs. The Mooresville
                                        - 23 -

[*23] property was suitable for producing high-quality horse hay, which he

planted and harvested, demonstrating petitioner’s willingness to adopt new cost-

saving techniques.

      Further, while petitioner did not undertake any business studies, he did

significantly change his business model when he hired an assistant trainer after

moving to the Mooresville property. See Phillips v. Commissioner, T.C. Memo.

1997-128 (explaining a business plan was evidenced by actions instead of a

written document). Instead of balancing a schedule between the racetrack and the

training facility, petitioner could delegate tasks and potentially increase

profitability by hiring a full-time assistant trainer. In his own words, petitioner

would “meet himself coming and going”, and the employee allowed petitioner to

spend more of his time training horses while his assistant coordinated racing

activities. Petitioner also earned additional income from trainer’s fees when his

assistant trained third-party horses. These significant changes in operating

methods suggest petitioner engaged in horse racing activities for profit once his

new facility was placed in service starting in the 2007 tax year.

      Petitioner also treated other aspects of his horse-related activities in a

professional manner. For example, petitioner planned to take advantage of a

retirement system for horse trainers in Kentucky. According to petitioner, the
                                        - 24 -

[*24] retirement program divided an amount of money between trainers and

assistant trainers who are retiring and who ran 11 horse races in Kentucky per

year. Petitioner was based in Indiana but raced in other States. Petitioner credibly

testified that he had run at least 11 races in Kentucky for several years and that he

believed that if he continued his current racing schedule, he would qualify to

collect some of the Kentucky trainers’ retirement benefits.

      Respondent points to petitioner’s accounting methods to show he was not

carrying on the activities in a businesslike manner. Primarily, respondent suggests

petitioner’s disorganization and reliance on an accountant is not businesslike.

However, the accounting method needs only “provide the entrepreneur with the

information * * * require[d] to make informed business decisions.” Burger v.

Commissioner, 809 F.2d at 359. While rudimentary, petitioner’s system of

recordkeeping allowed him to make informed business decisions. His daily costs

for each horse were consistent, and he had a method of keeping receipts or bank

documents to track additional expenses. A publicly available Internet database

conveniently tracks the starts, placement, earnings, and other information of each

horse petitioner raced. The database also tracks entry fees and awarded purses,

allowing racehorse professionals to closely monitor the performance of each horse

on line. Petitioner’s accounting methods, at a minimum, provided him with
                                        - 25 -

[*25] enough information to make informed business decisions. This factor is

neutral for tax years 2005 and 2006. For 2007 and 2008, however, when

petitioner made significant changes to his operating procedure and location, this

factor favors petitioner.

      B. Expertise of Taxpayer or Advisors

      The next factor to consider is the expertise of the taxpayer and his advisers.

Preparation for an activity by extensive study of its accepted business, economic,

and scientific practices, or consultation with those who are expert therein, may

indicate that the taxpayer has a profit objective where the taxpayer carries on the

activity in accordance with such practices. Sec. 1.183-2(b)(2), Income Tax Regs.

Petitioner acknowledged that merely buying a horse does not make the owner an

expert. Petitioner did, however, have enough business acumen to seek sound

advice from horse breeding and racing experts. He noted that he entered the horse

racing profession later than many other professionals and wanted to rapidly learn

about the business. Petitioner consulted with bloodstock agents and respected

trainers on various aspects of the horse racing business. When he had a question

about the business, he would call an expert to find an answer. For example, when

building a new training facility, petitioner incorporated advice from industry

experts into the design of the buildings and improvements.
                                        - 26 -

[*26] Further, petitioner immersed himself in all aspects of the horse racing

business, becoming an expert in his own right. Instead of taking a cursory interest

in horses, he chose to be intimately involved with, and gain valuable knowledge

from, the horse racing business. Petitioner learned to administer medication,

choose specific events for each horse, rehabilitate injured horses and assemble

racing equipment, and he acquired many other skills usually possessed by an

expert in the horse racing business.

      Respondent contends that petitioner developed only an “expertise with

respect to the actual boarding, breeding, and training of horses * * * [but]

developed no expertise in the financial aspects of the horse-related activities.”

Respondent, however, omitted an important aspect of petitioner’s horse-related

activities: racing. To enter a horse into a race, the decisionmaker--whether trainer

or owner--must have an in-depth understanding of the financial aspects of the

proposition. If a superb horse enters into a low-claim claiming race, the horse may

be bought cheaply from the owner and the owner will lose money. If an

outmatched horse enters a stakes race, the owner will not earn back the entry fee.

Petitioner learned about how to enter races and how to pick a horse for a specific

race to maximize his potential prize. Thus, to navigate the complex regulations

and financial possibilities of horse racing, petitioner was required to gain expertise
                                        - 27 -

[*27] in the financial aspects of his horse-related activities. For example,

petitioner learned of ruses that unscrupulous racers would use to maximize profit

potential. In one case, petitioner heard of racers affixing raw cuts of meat to a

horse’s ankles so that the horse would appear to be in poor shape and not be

claimed. A racer that is aware of the ruse may claim the horse and profit from the

transaction.

       Petitioner credibly testified that he spent significant effort and time to match

the right horse to the right race. He spent this time matching each horse to a race

with the expectation of making a profit. He admitted that it took time to learn this

skill but that it was the “secret” to the business. Petitioner’s custom-tailored entry

strategy shows he was an expert in the financial aspects of his horse-related

activities.

       Petitioner also displayed his expertise through his participation in trade

associations. Much like his progression from member to leader of nightclub

associations, petitioner rose through the ranks into leadership roles at two

professional horse racing associations. In one organization, petitioner’s peers

placed enough weight on his expertise to ask him to run for the leadership role.

Petitioner did not independently volunteer for the position but was asked to run for

it presumably because his peers trusted him with the responsibility.
                                          - 28 -

[*28] Further, petitioner shows that he was an expert in the financial aspects of

the horse racing industry through his contributions to the horse racing lobbying

effort. An experienced horse racing lobbyist credibly testified that he would

discuss the finer points of horse racing with petitioner in connection to the

lobbying effort. The legislature eventually passed the slot bill, which would

significantly affect the financial aspects of horse racing in Indiana. Petitioner

knew the new bill would increase the purse size and wished to contribute to the

effort. In other words, petitioner was on the ground floor of improving economic

conditions for horse racing in Indiana. Accordingly, this factor weighs in favor of

petitioner’s profit objective for all the tax years in issue.

      C. Time and Effort Devoted to the Activity

      The third factor to consider is the time and effort expended by the taxpayer

in carrying on the activity. The fact that the taxpayer devotes much of his personal

time and effort to carrying on an activity, particularly if the activity does not have

substantial personal or recreational aspects, may indicate an intention to derive a

profit. Sec. 1.183-2(b)(3), Income Tax Regs. A taxpayer’s withdrawal from

another occupation to devote most of his energies to the activity may also be

evidence that the activity is engaged in for profit. Id. The fact that the taxpayer

devotes a limited amount of time to an activity does not necessarily indicate a lack
                                        - 29 -

[*29] of profit objective where the taxpayer employs competent and qualified

persons to carry on the activity. Id.

      In Barbour v. Commissioner, T.C. Memo. 1976-85, the Court found that

full-time participation in an activity tended to show that a taxpayer was engaged in

a for-profit activity. Petitioner was working on horse-related activities some

portion of every day by at least 2002 and full time by at least 2005. He treated the

activities as a full-time profession and worked long hours to train horses. Horse

racing is a seasonal activity, and it was sometimes necessary for petitioner to work

longer hours when horses were training and racing.

      Further, the Barbour case suggests that participation in unpleasurable work

associated with an activity tends to show a profit objective. In Barbour, the Court

found that enduring cold temperatures and administering medication to ensure the

profitability of an animal showed a profit objective. Similar to the taxpayer in that

case, petitioner often endured cold winter temperatures to work with his horses.

He also performed other unpleasant and burdensome activities such as

administering shots and rebuilding fences. In sum, petitioner devoted a significant

amount of his personal time and effort to carrying on the activities where the
                                         - 30 -

[*30] activities did not have substantial personal or recreational aspects, and this

tends to show a profit objective.13

      Respondent questions the amount of time actually dedicated to horse-related

activities during the tax years in issue. Specifically, respondent points to the fact

that petitioner continued to earn income related to his former occupation of

running nightclubs. Respondent seems to challenge whether petitioner could have

spent the amount of reported time dedicated to horse-related activities and still

performed functions deserving remuneration from other sources. Indeed,

petitioner did not deny that he was still tangentially involved in the nightclub

industry.14 He credibly testified that he was able to consult on high-level decisions

by using his cell phone. He explained that cell phones allowed him to consult

with business contacts several times a day but that it did not detract from time

dedicated to training horses. Petitioner credibly testified that he could not “stop

* * * [his] training of the horses to go over there and sit and talk for hours.”

Instead, his cell phone allowed him to balance his time between the two activities.


      13
         As discussed infra, petitioner transitioned from participating in the more
recreational aspect to the more businesslike aspect of his operation in tax year
2007 when he moved to the Mooresville property and began spending most of his
time at the training facility rather than at the racetrack.
      14
        Petitioner retained no financial interests in his nightclub businesses but for
his consulting fees and rental payments.
                                         - 31 -

[*31] Accordingly, by tax year 2005 petitioner devoted time and effort appropriate

to demonstrate a profit objective for all the tax years in issue.

      D. Expectation That the Assets Used in the Activity Will Appreciate in
         Value

      The fourth factor to consider is the expectation that the assets used in the

activity may appreciate in value. The term “profit” encompasses appreciation in

the value of assets, such as land, used in the activity. Sec. 1.183-2(b)(4), Income

Tax Regs. Thus, the taxpayer may intend to derive a profit from the operation of

the activity, and may also intend that, even if no profit is derived from current

operations, an overall profit will result when appreciation in the value of the assets

used in the activity is realized since income from the activity together with the

appreciation of the assets will exceed expenses of operation. Id.

      Petitioner’s horse-related activities include two different types of

appreciable assets: first, the horses that petitioner bred and trained; second, the

real property and capital improvements associated with his training facility.

Respondent does not dispute that petitioner purchased or bred each horse with the

expectation the horse would increase in value.

      Respondent does, however, contend that petitioner’s real property is not an

asset used in the activities and that any expectation of appreciation is not a factor
                                         - 32 -

[*32] to be considered in determining whether petitioner was engaged in his

horse-related activities for profit. Respondent is correct for the 2005 and 2006 tax

years and incorrect for the 2007 and 2008 tax years because petitioner moved his

horse-related activities during the 2007 tax year.

      Where land is purchased or held primarily with the intent to profit from an

increase in its value, and a taxpayer also engages in another activity on the land,

the activity and the holding of the land will ordinarily be considered a single

activity only if the income derived from the activity exceeds the deductions

attributable to that activity which are not directly attributable to the holding of the

land. Sec. 1.183-1(d)(1), Income Tax Regs. In other words, when a taxpayer buys

land mainly to profit from its appreciation, the potential appreciation of the land is

relevant to a section 183 analysis only if the activity generates income in excess of

the deductions for the activity. When a taxpayer’s primary intent is not to profit

from the land, then the appreciation of the land is considered in a section 183

profit analysis. See Perry v. Commissioner, T.C. Memo. 1997-417 (citing Hoyle

v. Commissioner, T.C. Memo. 1994-592).

      Petitioner’s primary intent in purchasing and holding the Morris Street

property was to gain from the real estate appreciation. When asked whether he

intended to use the Morris Street property for horse-related activities, petitioner
                                        - 33 -

[*33] responded: “No, in my mind the property is going to [be] worth a lot of

money * * * I’ll just make a little money, pay the taxes, hang on to it until I can

sell it.” This is a clear indication that his primary purpose was not to train or race

horses on the Morris Street property. Further, petitioner’s horse-related activities

did not reduce the net cost of carrying the Morris Street property. As a result,

holding the Morris Street property was an activity separate from petitioner’s

horse-related activities, and any expectation of appreciation of that real estate does

not contribute to a finding that he was engaged in those activities for profit.

      In contrast, petitioner specifically purchased and held the Mooresville

property to breed and train horses. His primary intent was to build a premier horse

training facility, and he purchased property to suit his needs. Petitioner started

searching for a new location because problems arose from building a barn on the

Morris Street property. He recognized that to be a competitive horse trainer he

needed to “build a better mousetrap in the horse business”. A major aspect of his

improved mousetrap included a better location because the Morris Street property

was not ideal for horse training. Petitioner sought a new location and intended to

train horses on the land when he purchased the Mooresville property. Further,

petitioner followed through and completed a well-furnished horse operation. He

improved the land with a significant amount of specialized equipment, and in his
                                        - 34 -

[*34] opinion the training facility was unmatched in the State of Indiana.

Admittedly, petitioner recognized that the land might appreciate, but capitalizing

on appreciation was not his primary intent in purchasing or holding the

Mooresville property. Accordingly, the Mooresville property’s expected

appreciation is relevant to whether petitioner carried on his horse-related activities

with the intent to profit under section 183. However, petitioner transferred the

headquarters of his horse-related activities to Mooresville in 2007, and thus, tax

year 2007 is the first tax year that real estate appreciation expectation weighs in

favor of finding for petitioner’s profit objective under section 183. For tax years

2005 and 2006 the factor is neutral.

      E. Success in Carrying On Other Activities

      The fifth factor to consider is the success of the taxpayer in carrying on

other similar or dissimilar activities. The fact that the taxpayer has engaged in

similar activities in the past and converted them from unprofitable to profitable

enterprises may indicate that he is engaged in the present activity for profit, even

though the activity is presently unprofitable. Sec. 1.183-2(b)(5), Income Tax

Regs. Moreover, diligence, initiative, foresight, and other qualities that generally

lead to success in other business activities may help demonstrate profit objective
                                         - 35 -

[*35] of a new venture. See McNaught v. Commissioner, T.C. Memo. 1999-25;

Daugherty v. Commissioner, T.C. Memo. 1983-188.

      Petitioner built a successful nightclub business from very humble

beginnings. He turned a single unprofitable bar into a network of up to six

different establishments, employing enough individuals to necessitate creating a

staffing company to coordinate shifts. Later, petitioner started a successful car

dealership and an insulation company. Moreover, petitioner appears to be a

successful real estate speculator. Further, petitioner’s peers trusted him to serve as

a representative and advocate for two different industries within Indiana,

demonstrating his ability to transfer skills across vastly different trades. He

worked hard and showed initiative, foresight, and other qualities that led to

success in his other business activities, and he had reason to expect eventual

success in his horse-related activities. Accordingly, this factor weighs in

petitioner’s favor.

      F. History of Income or Losses

      The sixth factor to consider is the taxpayer’s history of income or losses

with respect to the activity in question. A series of losses during the initial or

startup stage of an activity may not necessarily be an indication that the activity is

not engaged in for profit. Sec. 1.183-2(b)(6), Income Tax Regs. However, where
                                         - 36 -

[*36] losses continue to be sustained beyond the period which customarily is

necessary to bring the operation to profitable status, such continued losses, if not

explainable as due to customary business risks or reverses, may be indicative that

the activity is not being engaged in for profit. Id. A record of substantial losses

combined with a remote chance of achieving a profitable operation are important

factors bearing on a taxpayer’s intent to make a profit. Schlafer v. Commissioner,

T.C. Memo. 1990-66.

      The startup phase for some horse-related activities can be between 5 and 10

years. See Engdahl v. Commissioner, 72 T.C. 659, 669 (1979). Petitioner started

his horse-related activities in 1998, and the years in issue fall within this startup

phase. Further, sustaining losses after the expected startup period is not

necessarily indicative that a taxpayer is not engaged in horse-related activities for

profit where the losses can be explained. See Farris v. Commissioner, T.C. Memo.

1972-165. If losses are sustained because of unforeseen or fortuitous

circumstances which are beyond the control of the taxpayer, such as drought,

disease, fire, theft, weather damages, other involuntary conversions, or depressed

market conditions, these losses would not be an indication that the activity is not

engaged in for profit. Sec. 1.183-2(b)(6), Income Tax Regs. Some of petitioner’s

losses can be explained by a series of unfortunate events beyond his control.
                                        - 37 -

[*37] These events include the untimely death of several racing and breeding

prospects, an unfortunate quarantine during racing season, a contractor’s building

a shoddy fence that factored into the accidental death of two stallions,15 and the

need to hire and fire several different trainers. Accordingly, the startup phase and

unforeseen expenses balance the history of large losses, and this factor is neutral

for all tax years in issue.

       G. The Amount of Occasional Profits

       The seventh factor to consider is the amount of occasional profits, if any,

which are earned in the course of conducting the activity. Profit is generally

defined as receipts in excess of costs. See Portland Golf Club v. Commissioner,

497 U.S. 154, 166 (1990). The amount of profits in relation to the amount of

losses incurred, and in relation to the amount of the taxpayer’s investment and the

value of the assets used in the activity, may provide useful criteria in determining

the taxpayer’s intent. Sec. 1.183-2(b)(7), Income Tax Regs. An occasional small

profit from an activity generating large losses, or from an activity in which the

taxpayer has made large investment, would not generally be determinative that the

       15
        Horse breeding and racing is speculative, and the loss of some horses may
be foreseen, see Chandler v. Commissioner, T.C. Memo. 2010-92, aff’d, 481 Fed.
Appx. 400 (9th Cir. 2012), but petitioner’s loss of two stallions was more similar
to an involuntary conversion because the deaths were from injuries relating to a
dishonest contractor.
                                        - 38 -

[*38] activity is engaged in for profit. Id. However, 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. Id. For example, an investor in a

wildcat oil well who incurs substantial expenditures is engaging in the activity for

profit even though the expectation of a profit is very small. Sec. 1.183-2(a),

Income Tax Regs.

      Horse racing can be very speculative, and the expectation of profit may be

very small. Racing a horse has been compared to investing in a wildcat oil well,

where there may be substantial expenditures with little chance of profit. See

Dawson v. Commissioner, T.C. Memo. 1996-417; sec. 1.183-2(a), Income Tax

Regs. Petitioner had success with his first two horses and expected that success to

continue. He knew continuing to race horses was a highly speculative activity, but

there was a small possibility of large profits. However, because of his

participation in various organizations and his assisting with some lobbying efforts,

petitioner knew that prize purses were increasing in Indiana. In other words, the

ultimate profit potential would significantly increase. Further, one of petitioner’s

horses was nominated to run in the Triple Crown Races, showing that his horses

have the potential to race at a very high level and possibly earn significant
                                         - 39 -

[*39] profits.16 Accordingly, petitioner’s expectation of future profits was

consistent with the existence of a profit objective for all the tax years in issue. See

Betts v. Commissioner, T.C. Memo. 2010-164.

      H. Financial Status

      The eighth factor to consider is the financial status of the taxpayer. The fact

that the taxpayer does not have substantial income or capital from sources other

than the activity may indicate that an activity is engaged in for profit. Sec. 1.183-

2(b)(8), Income Tax Regs. 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

personal or recreational elements are involved. Id.

      Petitioner earned income from sources other than horse-related activities.

The losses claimed in relation to the horse-related activities had the effect of

reducing petitioner’s taxable income. Petitioner, however, was not an excessively

wealthy individual. His house was mortgaged and he continued to work long

hours at a physically demanding endeavor after resigning from several successful

ventures. Further, petitioner participated less in the personal and recreational


      16
       According to petitioner, once his horse was nominated, it had a 1 in 144
chance of running the races.
                                        - 40 -

[*40] aspects of the horse-related activities starting in tax year 2007, as discussed

infra. Under the strict wording of the regulations, this factor favors respondent for

all the tax years in issue.

       I. Elements of Personal Pleasure or Recreation

       The final factor that should be considered is whether the activity in question

involves personal pleasure or recreation. The presence of personal motives in the

carrying on of an activity may indicate that the activity is not engaged in for profit,

especially where recreational or personal elements are involved. Sec. 1.183-

2(b)(9), Income Tax Regs. Further, there is likely no profit objective where a

taxpayer combines horse racing with social and recreational activities. Sec. 1.183-

2(c), Example (4), Income Tax Regs.

       Petitioner was first enticed into the horse racing business through a social

gathering at a racetrack, where he was invited to a free dinner and a tour of the

facilities. Petitioner met trainers and learned about the business. As a result of the

social meeting, petitioner registered for an owner’s license and bought two young

horses. He asked a trainer using his facilities to show him some training basics

and only later applied to become a trainer. From 1998 until 2007 petitioner

divided his time between racetracks and the training facility. While there is

certainly work involved while at racetracks, there is also a higher level of
                                         - 41 -

[*41] recreation and social activity available at a racetrack. A horse trainer can

socialize with other trainers and owners. The concessions and public wagering

options available also show that a racetrack is a very social and recreational venue,

although there is no evidence that petitioner actually participated in the wagering

options. Further, a physical embodiment of a trainer’s exertions and skills are on

public display while a horse is racing. The owner and trainer of a winning horse

may get applauded and get his or her picture taken in a winner’s circle.

      In contrast, the training facility is a largely private operation void of social

or recreational activities. Activities such as grading the track, mucking stalls,

baling hay, administering medication, and building fences are all necessary for a

successful horse race operation, but these activities are rarely publicly displayed,

much less applauded. Similar, a trainer cannot socialize or confer with other

racing professionals face to face while at the training facility; if a trainer has a

question, he or she must call a specialist in order to solicit advice.

      During tax years 2005 and 2006 petitioner attended both the track and

training activities of his operation. He was able to train horses at his facility, but

he was also able to accept the accolades of a successful race. In other words,

petitioner participated equally in the social and business aspects of horse racing.

In the 2007 tax year, however, petitioner hired an assistant trainer to take over the
                                        - 42 -

[*42] more socially oriented track activities. In doing so, petitioner actively chose

to undertake the less glamorous and less recreational activities of his operation.

This is indicative that before tax year 2007 petitioner enjoyed some recreational

aspects of horse racing, but starting in 2007 he became more interested in the

business aspects of the activity.

      The Mooresville property was not a recreational facility or a retirement

property for petitioner. Petitioner did not build a new house on the Mooresville

property, and in fact the new facility was significantly farther from petitioner’s

home than the Morris Street property. Petitioner’s commute to the Mooresville

property was about 20 miles a day longer than his commute to the Morris Street

property. Petitioner did not purchase the property to have a place to enjoy the

golden years of his retirement but instead purchased the property to run a business.

Accordingly, the elements of personal pleasure or recreation weigh in

respondent’s favor for the 2005 and 2006 tax years and in petitioner’s favor for tax

years 2007 and 2008.

      An activity that was previously carried on without a profit objective does

not preclude a finding that it has become a trade or business. See Demler v.

Commissioner, T.C. Memo. 1966-117. A taxpayer may start an activity without a

profit objective and later develop the desire and objective to earn a profit from the
                                           - 43 -

[*43] undertaking. A taxpayer should not be denied the opportunity to deduct

expenses from his or her business merely because the profit objective was not

evident from the outset of the activity.

      Petitioner started his horse-related activities without a profit objective but

later turned his social and recreational activity into a serious business venture.

Petitioner’s objective may have been gradually changing from the outset of his

horse-related activities, but beginning operations at the Mooresville property is a

clear indication that his motivation had fully turned to seeking a profit. In 2006

petitioner--a successful businessman--was given an opportunity to exit the horse

training and racing business and pursue other ventures. While petitioner acquired

the land for his horse-related activities in 2006, he could have left it unimproved

and stopped his horse activities. Instead, he chose to reinvest in the activities and

open a premier training facility in 2007. Thus, petitioner’s profit objective was

first shown in 2007 when he began operating his horse-related activities at the

Mooresville property.

      Further, the Indiana slot bill was introduced and passed in the spring of

2007. Petitioner was on the ground floor of the lobbying efforts to pass the

legislation and was in a position to recognize the increased profit potential. He
                                        - 44 -

[*44] chose to build a custom training facility to take advantage of the new racing

opportunities that the 2007 bill created.

      On the basis of the record and considering the nine factors discussed above,

the Court finds that petitioner did not engage in horse-related activities for profit

during the 2005 and 2006 tax years. However, petitioner demonstrated a profit

objective beginning in tax year 2007 when he significantly changed his operation,

opened a new facility on real estate specifically purchased for horse-related

activities, and transitioned out of the recreational aspect of horse racing.

Accordingly, petitioner demonstrated the requisite profit objective under section

183 to deduct business expenses for tax years 2007 and 2008 but not for tax year

2005 or 2006.

II. Section 6662(a) Penalty

      Section 6662(a) and (b)(1) and (2) imposes an accuracy-related penalty

equal to 20% of the portion of the underpayment attributable to any substantial

understatement of income tax or to negligence or disregard of rules or regulations.

Under section 7491(c), the Commissioner has the burden of production to show

that the imposition of a penalty under section 6662(a) is appropriate. Respondent

has met this burden by presenting evidence that petitioner’s underpayments were
                                         - 45 -

[*45] attributable to substantial understatements of income tax for tax years 2005

and 2006.

      With exceptions not here relevant, a taxpayer may avoid a section 6662(a)

accuracy-related penalty with respect to any portion of an underpayment by

showing that he acted with reasonable cause and in good faith with respect to that

portion. Sec. 6664(c)(1). Reasonable cause requires that the taxpayer exercise

“ordinary business care and prudence” as to the disputed item. United States v.

Boyle, 469 U.S. 241, 246 (1985). The term “good faith” has no precise definition

but means, among other things, (1) an honest belief and (2) the intent to perform

all lawful obligations. E.g., United States v. Hirschfeld, 964 F.2d 318, 322 (4th

Cir. 1992). Those determinations are made on a case-by-case basis, taking into

account all pertinent facts and circumstances, including the taxpayer’s knowledge

and experience. Sec. 1.6664-4(b)(1), Income Tax Regs. “Circumstances that may

indicate reasonable cause and good faith include an honest misunderstanding of

fact or law that is reasonable in light of all of the facts and circumstances,

including the experience, knowledge, and education of the taxpayer.” Id. The

most important factor is the taxpayer’s efforts to assess the proper tax liability. Id.

      The duty of filing accurate returns generally cannot be avoided by placing

the responsibility on an employee or tax return preparer. See Metra Chem Corp. v.
                                        - 46 -

[*46] Commissioner, 88 T.C. 654, 662 (1987); Slawek v. Commissioner, T.C.

Memo. 1991-338 (finding no reasonable cause defense where taxpayers blamed

their employees and accountants for erroneous returns), aff’d without published

opinion, 972 F.2d 1332 (3d Cir. 1992). A taxpayer, however, may demonstrate

reasonable cause through good-faith reliance on the advice of an independent

professional, such as a tax adviser, a lawyer, or an accountant, as to an item’s tax

treatment. Boyle, 469 U.S. at 251; Canal Corp. & Subs. v. Commissioner, 135

T.C. 199, 218 (2010). To prevail, the taxpayer must show that he: (1) selected a

competent adviser with sufficient expertise to justify reliance, (2) supplied the

adviser with necessary and accurate information, and (3) actually relied in good

faith on the adviser’s judgment. 106 Ltd. v. Commissioner, 136 T.C. 67, 77

(2011) (citing Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99

(2000), aff’d, 299 F.3d 221 (3d Cir. 2002)), aff’d, 684 F.3d 84 (D.C. Cir. 2012).

      Petitioner hired a CPA for his auditing and tax requirements. Petitioner had

not been satisfied with the work performed by several accountants before he hired

his current CPA, who he met through a mutual acquaintance, to handle the tax

aspects of his nightclub businesses. The CPA had experience in the nightclub

industry, and petitioner recognized that a CPA might have more skills than a non-

CPA accountant. Petitioner continued to employ this CPA for over 20 years.
                                       - 47 -

[*47] Petitioner’s returns were audited twice before the tax years in issue, and both

times he fared well as a result of his CPA’s work. Further, as discussed above,

petitioner maintained a rudimentary recordkeeping system but did turn over the

necessary documents to his CPA in the form of receipts, canceled checks, and

bank statements for tax years 2005, 2006, 2007, and 2008. Last, petitioner

credibly testified that he relied on his CPA and his attorney for business and tax

advice. Accordingly, petitioner demonstrated reasonable cause through good faith

for tax years 2005 and 2006. There is no section 6662 penalty with respect to the

section 183 adjustments for tax year 2007 or 2008 because there is no deficiency.

III. Section 6651(a)(1) Addition to Tax

      Failure to file a tax return on the date prescribed leads to a mandatory

addition to tax unless the taxpayer shows that such failure was due to a reasonable

cause and not due to willful neglect. Sec. 6651(a)(1). For each month the return

is late, an addition to tax equal to 5% of the amount of tax required to be shown on

the return shall be assessed, not exceeding 25% in the aggregate. Id. The amount

of tax required to be shown on the return shall be reduced by the amount of any

part of the tax which is paid on or before the payment due date. Sec. 6651(b)(1).

Under section 7491(c), the Commissioner has the burden of production to show

that the imposition of an addition to tax under section 6651(a)(1) is appropriate.
                                        - 48 -

[*48] Petitioner conceded that respondent met his burden by presenting evidence

that petitioner failed to timely file his 2007 Federal income tax return.

      Petitioner’s position, based on section 301.6661-1(c), Proced. & Admin.

Regs., is that a reasonable cause outside his control caused his delayed filing.

Petitioner contends that he had reasonable cause to file his return late because

some of his records were burned in a fireplace by a former girlfriend. Petitioner

cites a case where a taxpayer was not held liable for a section 6651(a)(1) addition

to tax because a hurricane destroyed critical tax documents. The wrath of a former

girlfriend may be a formidable force, but it is not analogous to a hurricane-like

natural disaster, and it does not constitute a reasonable cause outside petitioner’s

control. Further, petitioner did not present any evidence showing the records were

actually destroyed or document any attempts to find the lost information.

      Petitioner also suggests that the Commissioner’s audits of prior-year returns

was a reasonable cause for his delay. He contends that he knew the 2007 tax

return would likely be audited, and he spent extra time to make sure the return was

correct. Preoccupation with an audit, however, does not constitute a reasonable

cause for failing to timely file a Federal tax return. United States, IRS v.

Craddock (In re Craddock), 149 F.3d 1249, 1255 (10th Cir. 1998) (citing Morgan

v. Commissioner, 807 F.2d 81, 83 (6th Cir. 1986), aff’g T.C. Memo. 1984-384).
                                        - 49 -

[*49] Accordingly, petitioner is liable for an addition to tax for the 2007 tax year

under section 6651(a)(1).

      We have considered the remaining arguments made by the parties and, to

the extent not discussed above, conclude those arguments are irrelevant, moot, or

without merit.

      To reflect the foregoing,


                                                      Decision will be entered

                                                 under Rule 155.
