                        T.C. Memo. 2010-216



                      UNITED STATES TAX COURT



     JOHNNY L. DENNIS, JR. AND JENNIE DENNIS, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 6403-06, 23978-06.     Filed October 5, 2010.



     Donald J. Dombrowski, for petitioners.

     Sara D. Trapani, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     PARIS, Judge:   By notices of deficiency1 dated January 3,

2006, for the tax year 2001 and August 21, 2006, for the tax

years 2002 and 2003 respondent determined the following



     1
      On Nov. 24, 2004, petitioners executed Form 872, Consent to
Extend the Time to Assess Tax, consenting to extend the time for
respondent to assess their tax for the tax year 2001.
                                - 2 -

deficiencies in income tax and penalties for the respective

taxable years:

                                              Penalty
     Year            Deficiency              Sec. 6662

     2001             $30,836                $5,122.60

     2002              39,246                 7,849.20

     2003              66,241                13,248.20

Petitioners timely filed their petitions contesting the 2001,

2002, and 2003 income tax deficiencies and penalties.    The Court

must decide whether petitioners have engaged in their horse

breeding activity with the intent of making a profit within the

meaning of section 183.2

                       FINDINGS OF FACT

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

     Johnny L. Dennis, Jr. (Mr. Dennis), and Jennie Dennis (Mrs.

Dennis) are husband and wife, who timely filed joint Federal

income tax returns for the tax years 2001, 2002, and 2003.    When

the petitions were filed,3 they resided in Texas.




     2
      Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code in effect for the
years in issue.
     3
      On Nov. 21, 2009, the Court granted respondent’s motion to
consolidate the cases for trial, briefing, and opinion.
                               - 3 -

Petitioners’ Profiles

     Mr. Dennis was born in Galena Park, Texas, near the Houston

Ship Channel.   In 1956 his family moved to Magnolia, Texas, and

lived on a 2-acre farm, where they milked their own cows, raised

their own chickens, and rode their one horse.    In contrast, Mrs.

Dennis was raised in Chicago, Illinois.    Before engaging in the

horse breeding activity, Mrs. Dennis had limited experience with

horses, having ridden only twice as a young girl.    After

petitioners started their horse breeding activity, Mrs. Dennis

rarely rode any of their horses.

     During high school Mr. Dennis worked at a supermarket and

was quickly promoted.   Mr. Dennis initially performed clerical

duties but soon assumed managerial duties, including closing the

store and monitoring the safe, by his senior year.    Lewis & Coker

Supermarkets, Inc. (Lewis & Coker), a family-owned supermarket

company, hired Mr. Dennis as a manager trainee 6 months after his

high school graduation.   He quickly advanced and soon assumed

statewide managerial responsibilities.    As a part of those

responsibilities, Mr. Dennis traveled throughout Texas,

evaluating the failing supermarkets, devising solutions for them

or winding down a closing store’s affairs, and assessing the

closed store’s accounts, including its inventory, profits, and

losses.   In 1982 Mr. Dennis stopped traveling and became the

manager of a Lewis & Coker grocery store on Memorial Drive in
                                - 4 -

Houston, Texas.   Mr. Dennis continued in that position until

Lewis & Coker encountered financial difficulties in 1990 and

filed for bankruptcy in 1993.   After filing for bankruptcy, Lewis

& Coker’s board of directors removed the chief executive officer

for mismanagement of company finances.    The board then appointed

Mr. Dennis as Lewis & Coker’s president with the promise to give

him a grocery store as compensation if he managed the company

during the bankruptcy.   As Lewis & Coker’s president, Mr. Dennis

took a salary reduction to conserve funds to pay the company’s

attorney and reduced its debt from $1,300,000 to $600,000.

Unfortunately, Lewis & Coker did not survive the bankruptcy, nor

did Mr. Dennis receive a store.    Faced with starting over upon

the company’s bankruptcy in 1995, Mr. Dennis accepted a part-time

job assisting his friend to “redo” his convenience store and

received a wage of $10 per hour.    Over the next few years Mr.

Dennis researched and reviewed his options, and in 1999 he

decided to start a horse breeding activity.

     Before the commencement of the horse breeding activity, Mrs.

Dennis did not have any experience breeding and raising horses.

Mrs. Dennis focused on cosmetology beginning in high school and

received a high school diploma.    She attended college for a year

and a half, working toward a teacher’s certificate for

cosmetology.   Thereafter, Mrs. Dennis pursued a career in

cosmetology.   Mrs. Dennis now runs her own business that provides
                               - 5 -

cosmetology services to nursing home residents.   During the years

at issue, her cosmetology business earned an adjusted gross

income of $111,743 in 2001, $125,162 in 2002, and $202,209 in

2003.4

The Midway Purchase and the Construction

     In 1991 petitioners purchased a 30-acre plot in a rural

county, Midway, Texas (Midway property).   This property had a

water well and an abandoned 90-foot train car, but it had no

fences or any other buildings and improvements.   During his time

in the grocery business, Mr. Dennis relaxed on the Midway

property and sought refuge from his stressful job.   During the

mid-1990s, Mr. and Mrs. Dennis acquired two horses that they kept

on the Midway property.   Mr. Dennis had given Mrs. Dennis a horse

for Valentine’s Day and had received a horse as a birthday gift

from his friend Bob Griffin.   Petitioners did not ride the

horses, because Mrs. Dennis’ horse was not broken5 and Mr.

Dennis’ horse had laminitis6 in the front foot.   Also,

petitioners did not use those horses as breeding stock.    In 1996

or 1997 petitioners purchased an additional 30-acre plot


     4
      These figures are based on the adjustments upon which the
parties have agreed.
     5
      Horse breaking refers to the process in which a horse is
trained to be ridden by humans or harnessed for other activities.
     6
      Laminitis is a disease that causes a horse’s hooves to be
inflamed. See Webster’s New World College Dictionary 803 (4th
ed. 2008).
                                - 6 -

contiguous to their land.    Before that purchase, the additional

parcel lacked an easement to any road.

     Before 1995 petitioners lived in a suburb of Houston.     In

1995 petitioners moved to the Midway property and converted the

abandoned train car into their residence.    Mr. Dennis removed all

the train seats, built an annexed kitchen, and added two used

“double-wide” trailers he had renovated.    Over the years,

including the years at issue, Mr. Dennis was personally involved

in the daily operation of the Midway property and performed all

the labor to cultivate the land and erect structures.    He planted

grass; built five-strand barbed wire fences; constructed several

barns, several horse arenas, fences, and gates; and placed ponds

and water troughs on their land.   His efforts served several

important purposes:   The cultivation of the Midway property

provided pastures where all of petitioners’ horses--as many as 46

horses at one time--could graze, a barn housed those horses, and

several horse arenas provided a safe area where they could be

trained.

The Horse Breeding and Training Activity

     By 1999 petitioners had decided to breed, raise, and sell

horses.    Mr. Dennis had no other employment and devoted all his

time and attention to this activity.    From March 15 to December

11, 1999, petitioners acquired eight registered quarter horses--

one stallion and seven mares--from Triple T Horse Farms.
                                 - 7 -

     To conduct this activity, Mr. Dennis had acquired knowledge

from his reading of horse magazines and all of John Lyons’ books.

John Lyons is an expert on how to train, care for, and breed

horses.    Mr. Dennis also sought advice from several individuals,

including Rick Doyle, who worked at Triple T Horse Farms.    Mr.

Doyle’s practice was to purchase the cheapest horse suitable for

his purposes and sell it after training that horse for only 4 to

5 days.    Mr. Dennis also sought advice from Mr. Griffin, who

operated under a business plan substantially different from Mr.

Doyle’s.   Mr. Griffin had successfully trained and broken horses

and had a history of his horses and mules winning prizes at

livestock competitions.    Mr. Dennis met Mr. Griffin in 1984 when

Mr. Griffin’s construction company refurbished the Lewis & Coker

store on Memorial Drive.   They became neighbors soon after Mr.

Dennis purchased the Midway property, which was a few miles from

Mr. Griffin’s property.    Their proximity and friendship allowed

them to exchange encyclopedic information about horse training,

but Mr. Griffin died in 1998, before petitioners’ commencement of

their horse breeding activity.    Mr. Dennis also reviewed the

business model of Johnny Higgins.    Although Mr. Higgins focused

on training his horses to compete in races, he rendered valuable

general training advice to petitioners.

     Mr. Dennis evaluated and considered several business models

and decided upon a breeding program.     He planned to raise only
                               - 8 -

horses that he had produced from his horse breeding activity,

distinguishing his operation from Mr. Doyle’s.   Mr. Dennis

compared the selling price of horses with unknown blood lines,

which ranged from $3,000 to $5,000, to the selling price of well-

bred quarter and paint horses,7 which ranged from $25,000 to

$30,000.   Additionally, a well-bred quarter horse that qualifies

as a show horse could be sold for $50,000 to $100,000.    To ensure

a return on his horse investment, Mr. Dennis purchased horses

accompanied with a certificate of registration documenting the

horse’s lineage and maintained that certificate of registration

for his potential sale transactions of that horse or the foals8

produced from that horse.

     Once he began his horse breeding activity, he used two

veterinarians, Dr. Posey and Dr. Craven, to gain medical

information and practical experience.   Mr. Dennis immediately

recognized that the routine veterinarians’ visits were costly.

Each trimming of a horse’s hooves cost $30 to $35, and

maintaining the horseshoes cost $65 to $80 per horse.    Also,

after a short time he realized that he would have to weigh the

cost of the veterinary service against its effectiveness and make


     7
      According to Webster’s New World College Dictionary 1174
(4th ed. 2008), a quarter horse belongs to a certain breed of
light muscular horse of a solid, usually dark color. Because of
their quick reactions quarter horses are used in Western range
work and in rodeo.
     8
      The word “foal” refers to a horse youngling that is usually
less than 1 year old.
                                - 9 -

the difficult decision to forgo any costly service that would

provide ineffective treatment to his horses.    For example, the

treatment of colic9 cost $6,000 to $12,000, yet it had a low

success rate.    After deciding that the exorbitant cost of the

colic treatment would outweigh the value of that horse and the

success rate of such treatment, Mr. Dennis would deny his horse

the medical treatment for colic.

     Mr. Dennis also studied and learned how to facilitate every

part of the breeding process beginning with the initial act of

insemination, followed by the gestation of a foal, which lasted

for 340 days from the date of conception, and ending with the

delivery of the foal.    Using his own research and what he had

learned from the veterinarians, he bred his own horses and

delivered their foals.    Instead of using the pasture method, Mr.

Dennis selected the hand-breeding method to ensure successful

impregnation.    To execute this method, he gained the skills to

coordinate the stallion’s impregnation of the mare.    Mr. Dennis

also delivered the foals with his own hands.    Mr. Dennis had a

successful breeding program in which he delivered approximately 25

to 30 foals.    His mares and stallion produced all but two of those



     9
      Colic is a medical condition commonly referred to as the
“twisted gut”. A horse with colic experienced abdominal pain,
because a portion of the horse’s intestine has been displaced or
moved into an abnormal position in the abdomen, causing blockage
of the digestive process.
                                - 10 -

foals.   He had purchased two already-impregnated mares.   He

acquired and developed an advanced set of skills to assist a mare

in the delivery of a healthy foal.    This hand-delivering method

allowed him to manage any complications that could endanger the

lives of a foal and a mare during the birth of the foal.    Mr.

Dennis’ skills became critical when the foal was breeched,

entering the birth canal buttocks or feet first.   A breech birth

could endanger a foal’s life, because the umbilical cord could get

wrapped around its neck causing strangulation and causing damage

to the mare’s cervix, preventing her from having other foals.

These acquired skills enabled Mr. Dennis to reposition the foal

during its birth, so that the foal’s head would come out first and

thus substantially increased the chance of the foal’s survival.

     Mr. Dennis instituted a training program and followed Mr.

Doyle’s advice regarding the breaking of his horses and invested

most of his days in acquiring the skill of breaking horses.     Mr.

Dennis believed that seeing a gentle horse would persuade

prospective buyers to inspect his other inventory and ultimately

purchase a horse.   Under the guidance of such experts as Mr.

Griffin and the Turpin family, Mr. Dennis trained in the art of

breaking horses.    The Turpin family, consisting of a father and

his two sons, had worked all their lives on ranches.   Mr. Dennis

paid them a salary and provided them with housing on the Midway
                                - 11 -

property in exchange for their labor and their personal

instruction on how to break horses.

     The breaking process requires intense effort and therefore

required Mr. Dennis to devote much of his time to breaking his

stock.    This process is initiated about 6 months after the mare

has given birth to a foal.    Mr. Dennis would spend days rubbing

the 6-month-old foal all over to familiarize it with human scent.

After some time, he would place a halter on the foal and lead it,

and teach that foal how to respond to hand and voice commands.      As

that horse grew older, Mr. Dennis continued its training in the

horse arenas he had built.    Most of the breaking process occurred

in the arenas.    Seldom did Mr. Dennis or Mrs. Dennis ride the

horses.

     On the basis of the 340-day gestation cycle and breaking

process, Mr. Dennis estimated that a horse would be marketable

when it was 3 to 4 years old.    After the horse had completed its

training, he used various means of advertisement to sell it.      Mr.

Dennis entered his horses into a trail ride where a group of

people would ride his horses from South Texas to the Fat Stock

Show and Exposition, which is commonly known as the “Rodeo”.

These trail rides would cover several hundred miles and last at

least 10 days.    To advertise their horses petitioners had T-shirts

and hats produced so that their riders could wear them during the

trail rides.   Mr. Dennis also registered his horses in roping
                                 - 12 -

shows to showcase their breeding and training.   Neither petitioner

participated in the roping shows or the trail rides.

     During the tax years at issue petitioners engaged in two

activities:   The horse breeding activity and a cosmetology

business.   Petitioners used the same accounting software program,

Quickbooks, for the cosmetology business and the horse breeding

activity.   This computer program assisted them in tracking their

expenses and generating charts illustrating their expenses.     They

had separate accounts for the cosmetology business and the horse

breeding activity and separated those accounts from other

accounts.   Petitioners kept better records for their horse

breeding activity than for their cosmetology business.    They were

able to differentiate their other expenses from their horse

breeding activity expenses.   Petitioners hired a certified public

accountant, Lawrence Hoole, to prepare their tax returns for the

tax years 2002 and 2003.   Mr. Hoole often provided them advice

relating to Mrs. Dennis’ cosmetology business.

     In addition to the horse stock on the Midway property, Mr.

Dennis kept llamas to keep the predators, including wolves and

coyotes, away from the horses.

The Drought, a New Line of Business, and an Alternative Source of
Feed

     During the years at issue a large portion of Texas had

experienced a drought and the Midway property suffered from the

drought beginning in 2002 and extending through 2004.    This
                               - 13 -

drought forced Mr. Dennis to modify his original business plan.

At first petitioners thought that the drought was temporary and

relied on the local feed store to provide the custom square bales

of hay which they were then unable to grow on the parched land.

Mr. Dennis estimated that the cost of hay processed in custom

square bales to feed up to 46 horses would be $18,000 to $20,000

annually.   The drought continued with no end in sight.   Faced with

the high cost of custom square bales of hay for his horses and

observing the drought’s effects on his pastures, Mr. Dennis

recognized that a business opportunity was available and pursued

it.   Mr. Dennis entered into a custom hay baling agreement with

other farmers.   The agreement required Mr. Dennis to provide

equipment used to cut and bale the hay while his partners provided

the acres of land and fertilizer to grow the hay.    In 2002 Mr.

Dennis purchased a tractor for $60,000, a baler for $30,000, a

cutter for $8,500, and a speciality square baler for $8,900.    Mr.

Dennis sought assistance from Mr. Higgins who had experience in

the custom square baling business.    Mr. Dennis viewed the custom

hay baling operation as an alternative source of feed and as a

potential supplement to his income.     After feeding his horses, he

sold the remaining bales of hay.   However, he soon realized that

the custom hay baling operation was not profitable even though the

hay price was inflated by the drought.    Each bale of hay sold for

only $15 to $16.   Mr. Dennis terminated that agreement and was not
                                - 14 -

able to recover the equipment investment during the years at

issue.

The Losses

     Petitioners were not successful at selling their well-bred

horses.   Mr. Dennis’ plan required 3 to 4 years for a horse to be

bred and trained.   Under his plan, the first marketable group of

foals would not be available until 2002 at the earliest.     In 2001

petitioners sold one of their purchased horses, “Black Beuty”, at

a loss of $1,843.   For the tax years 2001, 2002, and 2003

petitioners incurred losses of $78,521, $89,054, and $125,801,

respectively, from their horse breeding activity.    Beginning in

2002 their expenses increased because Mr. Dennis commenced and

operated a custom hay baling business to generate food for his

horses during a drought and to provide supplemental income to

compensate for his losses.    The horse breeding activity had also

incurred losses in the previous years, especially 1999 when

petitioners purchased the original breeding stock.

     To feed the horses and pay other expenses incurred in their

horse breeding activity, petitioners borrowed an amount of money

not specified in the record from Mrs. Dennis’ mother and $100,000

from Mrs. Dennis’ sister.    Consequently, Mrs. Dennis’ sister has a

lien on petitioners’ land.

     After facing such accumulated unexpected expenses caused by

the drought and other challenges, petitioners decided to terminate
                                 - 15 -

their horse breeding activity.     They anticipate selling all their

horses.     However, petitioners do not have plans to sell their

land.

                                OPINION

        The Court must decide whether petitioners engaged in the

horse breeding activity with the intent of making a profit within

the meaning of section 183.     A taxpayer who carries on a trade or

business may deduct ordinary and necessary expenses incurred in

connection with the operation of the business.       Sec. 162(a).

Section 183 disallows certain deductions attributable to an

activity not engaged in for profit.       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.

        Breeding and raising horses may be an activity entered into

for profit pursuant to section 162.       See Engdahl v. Commissioner,

72 T.C. 659, 665 (1979).    Such a determination will depend upon

whether an individual engaged in the activity with the primary

purpose of making a profit.    See id. at 666; Dunn v. Commissioner,

70 T.C. 715, 720 (1978), affd. 615 F.2d 578 (2d Cir. 1980);

Jasionowski v. Commissioner, 66 T.C. 312, 319 (1976).       A

taxpayer’s expectation of profit need not be reasonable.        See sec.

1.183-2(a), Income Tax Regs.; see also Engdahl v. Commissioner,
                                - 16 -

supra at 666; Feldman v. Commissioner, T.C. Memo. 1986-287.

Nonetheless, a taxpayer must establish that he has continued his

pursuit with the objective of making a profit.    See sec. 1.183-

2(a), Income Tax Regs.; see also Engdahl v. Commissioner, supra at

666; Feldman v. Commissioner, supra.

     The Court must consider all facts and circumstances in the

determination of whether a taxpayer has a profit objective.     See

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

Regs., enumerates nine factors:   (1) The manner in which the

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

taxpayer or his advisors; (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, which are earned; (8) the financial status of the taxpayer;

and (9) the presence of personal pleasure or recreation.   No one

factor nor a majority of factors necessarily determines the

outcome.   A court may consider other factors in this

determination.   See id.   Objective facts bear greater importance

than a taxpayer’s mere statement of his intent.   See sec. 1.183-

2(a), Income Tax Regs.
                               - 17 -

     On the facts of these cases, the Court holds that petitioners

engaged in the horse breeding activity with a profit objective

despite their failure to secure any such profit.    Therefore,

petitioners are entitled to deduct their losses for the tax years

2001, 2002, and 2003.

Manner in Which the Taxpayers Carried On the Activity

     The Court must first examine the manner in which petitioners

carried on their horse breeding activity.   The fact that a

taxpayer carries on an activity in a businesslike manner may

indicate a profit objective.   See sec. 1.183-2(b)(1), Income Tax

Regs.   Courts review a taxpayer’s business plan, books and

records, abandonment of unprofitable techniques and adaptation of

new techniques, and means of advertisement to determine whether

the taxpayer carried on the activity in a businesslike manner.

See id.; see also Golanty v. Commissioner, 72 T.C. 411 (1979),

affd. without published opinion 647 F.2d 170 (9th Cir. 1981);

Dodge v. Commissioner, T.C. Memo. 1998-89, affd. without published

opinion 188 F.3d 507 (6th Cir. 1999); Burger v. Commissioner, T.C.

Memo. 1985-523, affd. 809 F.2d 355 (7th Cir. 1987).

     Having a business plan may suggest that a taxpayer conducted

the activity in a businesslike manner.   See Sanders v.

Commissioner, T.C. Memo. 1999-208; Dodge v. Commissioner, supra;

Phillips v. Commissioner, T.C. Memo. 1997-128.     A business plan

need not be written or oral; it can be evidenced by a taxpayer’s
                                - 18 -

actions.    See Lundquist v. Commissioner, T.C. Memo. 1999-83, affd.

without published opinion 211 F.3d 600 (11th Cir. 2000); Phillips

v. Commissioner, supra.

     Petitioners concede that they did not have a formal plan.

Nonetheless, the Court infers from their actions that they did

have a business plan.    Mr. Dennis effected a business strategy

based upon breaking well-bred horses and forecasted that a horse

would become marketable after a 3-year period of nurture and

training.    Contrary to respondent’s argument that characterizes

Mr. Dennis’ plan as an abstract one, he personally executed every

detail of his plan:    He cultivated the land so that 46 horses

could graze, maintained that pastureland, constructed barns to

house his horses and several horse arenas where he could break and

train his horses, learned how to break and train his horses so

that he could advertise them as gentle and well-bred and

ultimately, sell them, and found an alternative feeding source

when his pastureland dried up as an effect of the drought.

     In addition, maintaining complete and accurate books and

records may indicate that a taxpayer has engaged in an activity

for profit.    See sec. 1.183-2(b)(1), Income Tax Regs.   The

commingling of personal and business funds would signify that a

taxpayer did not conduct his activity in a businesslike manner.

See Ballich v. Commissioner, T.C. Memo. 1978-497.    A taxpayer’s

books and records must serve a cost-effective purpose beyond the
                                - 19 -

task of tax preparation.    See Burger v. Commissioner, supra.    His

books and records must facilitate a periodic determination of

profitability and an expense analysis that may be used to

implement cost-saving measures timely and efficiently.    See

Golanty v. Commissioner, supra at 431; Burger v. Commissioner,

supra.   A taxpayer need not maintain a sophisticated cost

accounting system.   He must institute “the usage of cost

accounting techniques that, at a minimum, provide the entrepreneur

with the information he requires to make informed business

decisions.”    Burger v. Commissioner, supra.   In Burger, this Court

explained:    “Without such a basis for decisions affecting the

enterprise, the incidence of a profit in any given period would be

a wholly fortuitous result.”    See id.   In its review of the Tax

Court’s Burger decision, the U.S. Court of Appeals for the Seventh

Circuit stated that a taxpayer should not limit his cost

accounting technique to recording expenses per animal.    See Burger

v. Commissioner, 809 F.2d at 359.    A taxpayer may be expected to

implement effective methods to control and monitor costs, such as

monthly expense reports and income projections.    See Engdahl v.

Commissioner, 72 T.C. 659 (1979); Burger v. Commissioner, T.C.

Memo. 1985-523.

     Petitioners maintained some financial records and books for

their horse breeding activity, and they used accounting software

to categorize their expenses and organize that information.
                                 - 20 -

Petitioners separated their business and personal accounts and, in

addition, had different accounts for each of the businesses.    They

maintained their horse breeding activity’s business records far

better than those of their hairstyling business, which the IRS

found to be a business.

     However, respondent contends that petitioners did not keep

the records necessary to create and implement any cost-saving

strategy and kept those records only for the purpose of tax

preparation.   Petitioners did not record the expenses per horse.

However, this Court is satisfied that their records were adequate

to keep track of the activity.    See Helmick v. Commissioner, T.C.

Memo. 2009-220.    Petitioners’ rudimentary record system allowed

them to assess their horse breeding activity’s economic

performance and identify any cost-reducing strategy.    Mrs. Dennis

testified that the Quickbooks program allowed them to categorize

their horse breeding activity expenses and generate the profit and

loss statements, which were later used to file their taxes.    Their

record system further allowed them to identify the escalating

veterinary expenses and prescribed a cost-reducing strategy.    In

the beginning of their horse breeding activity, Mr. Dennis could

pinpoint immediately that the weekly cost of the trimming of the

horses’ hooves and the necessary inoculations added up to a

substantial sum.   In an effort to reduce the accumulating

veterinary costs, he acquired the skills to trim the horses’
                               - 21 -

hooves, personally administered inoculations, and denied

ineffective and expensive colic treatment to his dying horses.

Respondent agreed that Mr. Dennis’ actions would reduce the

veterinary costs, and the record confirms that petitioners’

efforts were successful.   Mr. Dennis reduced the $9,682 of

veterinary and horse care expenses in 2001 by 67 percent (to

$3,180) for the tax year 2002 and 53 percent (to $4,541) for the

tax year 2003.

     Mr. Dennis implemented the same effective cost analysis to

evaluate and to terminate his supplementary hay activity.     He

entered into a custom hay baling agreement in order to defray the

escalating feed cost.   Respondent contends that Mr. Dennis

conducted a cost analysis only after he executed the agreement,

and therefore his cost analysis would not have been effective

since each custom square bale of hay was sold at $15 or $16.

However, respondent did not consider the fact that Mr. Dennis took

into account that the cost of custom square bales needed to feed

46 horses would be $18,000 to $20,000 per year.   Mr. Dennis later

terminated the agreement because, even with consideration of the

high cost of feeding his horses, the actual amount of hay sold

during 2003 was so low that it would not generate an ultimate

return on his equipment purchase.   Therefore, this Court concludes

that petitioners used their books and records not only for tax
                                - 22 -

preparation, but also for identifying and implementing cost-saving

strategies and attempting to foster profitability.

     A taxpayer may further exhibit his profit objective in the

manner in which he advertises his business.   A single form of

substantial advertisement itself may not establish that a taxpayer

has carried on his activity in a businesslike manner.    See

McKeever v. Commissioner, T.C. Memo. 2000-288; Cohn v.

Commissioner, T.C. Memo. 1983-301, affd. 742 F.2d 1432 (2d Cir.

1984).   Different kinds of advertising media may allow the

taxpayer “to expand [his] potential market and to attract new

individuals”.   Cohn v. Commissioner, supra; see also Miller v.

Commissioner, T.C. Memo. 2008-224.   Horse shows may be an

effective advertising method.   See Engdahl v. Commissioner, supra

at 662-663; Dodge v. Commissioner, T.C. Memo. 1998-89.

     Petitioners’ different methods of advertising demonstrated

their profit objective.   Mr. Dennis often permitted his horses to

be used on 10-day trail rides starting from South Texas and ending

at the Fat Stock Show in either Dallas or Houston.   To advertise

his horses petitioners purchased promotional clothing and hats and

distributed them to those who rode his horses during the trail

rides.   Mr. Dennis targeted another segment of potential buyers

when he entered his horses in the roping shows.   The trail rides

and the roping shows serve as two different forums to promote his
                                - 23 -

horses’ gentleness and their ability to be controlled by any

potential owner.

     A taxpayer’s change of operating methods, adoption of new

techniques, or abandonment of unprofitable methods may indicate a

profit objective.   Sec. 1.183-1(b)(1), Income Tax Regs.; see also

Golanty v. Commissioner, 72 T.C. at 430-431.    Petitioners’ change

of operating methods and abandonment of unprofitable methods

evidence their profit objective.   Mr. Dennis provided credible

testimony as to how he changed his method of caring for his

horses.    He learned how to care for his horses himself and thus

reduced his veterinary expenses.   He listed the cost of each of

the veterinary services and calculated the cost-reducing effect of

performing the veterinary services himself.    As stated before, he

succeeded in reducing the veterinary costs for the later years of

the horse breeding activity.

     Mr. Dennis also testified to his determination to enter into

and his decision to abandon the custom hay baling agreement.     Mr.

Dennis’ original business plan involved the cultivation of the

nonarable land into pastureland, on which his horses would graze.

The drought threatened this part of his plan.    From the tax year

2001 to the tax year 2002, Mr. Dennis’ feeding costs almost

doubled.    His intent in entering into a custom hay baling

agreement was to reduce the escalating cost of hay and possibly to

increase profit derived from the horse breeding activity.     Mr.
                               - 24 -

Dennis bought the least expensive equipment to bale the hay while

using his partner’s land to grow the hay.     He expected that

starting a custom hay baling business would increase the earnings

from the horse breeding activity.     However, Mr. Dennis soon

realized that he could not sell enough square bales of hay to

recover the cost of his equipment.     Although Mr. Dennis’ initial

plan reduced his feeding costs, he did not recover his equipment

expenses, and his abandonment of his custom hay baling business

prevented those costs from escalating further.

     This Court considers this factor--the manner in which the

activity is conducted--to be mixed.     However, overall, this factor

favors the Dennises, indicating that they had the requisite profit

objective.

Expertise of Taxpayers or Their Advisers

     Preparation for the activity by extensive study of its

accepted business, economic, and scientific practices or

consultation with industry experts may indicate a profit objective

where a taxpayer carries on the activity in accordance with such

practices.   See sec. 1.183-2(b)(2), Income Tax Regs.    A taxpayer

does not have to pursue a formal market study; nevertheless, his

failure to investigate the most basic facts affecting profit may

indicate an absence of a profit objective.     See Engdahl v.

Commissioner, 72 T.C. at 668; Golanty v. Commissioner, supra at

432; Burger v. Commissioner, T.C. Memo. 1985-523.     A taxpayer may
                                - 25 -

be expected to seek an expert’s advice or develop his own

understanding of what his “ultimate costs might be, how [he] might

operate at the greatest cost efficiency, how much revenues [he]

could expect or what risks could impair the generation of

revenues.”   Burger v. Commissioner, T.C. Memo. 1985-523.

     Mr. Dennis sought advice from Mr. Hoole, Mr. Griffin, Mr.

Higgins, and Mr. Doyle.   The record does not indicate that Mr.

Griffin or Mr. Higgins provided any economic advice.    Mr. Griffin

and Mr. Higgins had horse training experience.   Mr. Hoole only

rendered advice relating to petitioners’ tax returns.   However,

Mr. Doyle provided important business advice.    Mr. Doyle laid out

a business model contemplating that a horse seller would purchase

the cheapest horse at the auction house, break that horse within a

few days, and immediately thereafter sell it for approximately

$3,000 to $5,000.    Mr. Doyle’s business plan informed Mr. Dennis’

own business model of breeding, breaking, and selling horses with

“good bloodlines”.   Mr. Dennis estimated that a well-bred horse

would yield approximately six to eight times more than the sale of

Mr. Doyle’s typical horses.   Mr. Dennis estimated that well-broken

and well-bred horses would be sold at $25,000 to $30,000.

Although Mr. Dennis did not follow Mr. Doyle’s plan exactly, his

improvement upon Mr. Doyle’s plan still indicates his profit

objective.
                               - 26 -

     Although Mr. Dennis was raised in a rural area, he did not

have any experience with breeding, raising, or selling horses.

Neither did Mrs. Dennis.   Despite his lack of knowledge, Mr.

Dennis learned to provide veterinary care to his horses, break and

train his horses, and deliver foals.    The Court observed in Easter

v. Commissioner, T.C. Memo. 1992-188, that performing various

tasks to save money did not indicate that a taxpayer studied the

business aspect of the activity.   In Easter, a taxpayer learned

how to worm the horses, trim their hooves, and suture their cuts

for the sole purpose of saving money.    This Court distinguishes

the present case from Easter, because Mr. Dennis studied the

business aspect of the horse breeding activity and developed a

plan.   Mr. Dennis took each calculated step, including the

development of the veterinary and training skills, in the effort

to actuate his business model, which required a 3-to-4-year period

to breed and train a horse to be sold at a profit.

     This factor supports a finding that petitioners had a profit

objective.

Taxpayers’ Personal Motives

     Having personal motives in carrying on the activity may

indicate that a taxpayer did not engage in this activity for

profit, especially where recreational elements exist.   See sec.

1.183-2(b)(9), Income Tax Regs.    Such personal pleasure will not

cause the taxpayer’s activity to be classified as a hobby if the
                                - 27 -

activity is in fact engaged in for profit as evidenced by other

facts.   See id.

     Respondent argues that Mr. Dennis chose this lifestyle, used

the farm as a means to escape his business life, and selected

friends on the basis of the horse breeding activity.   The Court

disagrees.   At first, Mr. Dennis might have chosen the undeveloped

property as a refuge from his business life; however, he turned

that refuge into a place of business.    The Court recognizes that

even during the period of his unemployment he worked when he

arrived on the property and sought others as a source of

information regarding how to set up a horse breeding business.

His friendships were helpful to his horse breeding and selling

activity.    Mr. Higgins taught him how to cultivate and bale the

hay, and Mr. Griffin showed him how horses were sold and which

horses were valuable.

     Respondent argues that Mr. and Mrs. Dennis love animals and

their love was the primary motive underlying these activities.

However, petitioners seldom rode any of the horses.    Petitioners

did not participate in either the trail rides or the roping shows.

Moreover, caring for their horses demanded a rigorous work

schedule of rising early to feed the animals, staying up all night

to monitor horses ready to give birth or to die, and cleaning

their barns.   Such laborious activities could not be considered

pleasurable.   See Engdahl v. Commissioner, supra at 670.
                                - 28 -

Petitioners’ treatment of their horses also indicated their

business objective.   Mr. Dennis treated his horses like inventory.

He withheld medical treatment from a horse dying from colic after

he decided that the high cost of the medical procedure and its

ineffectiveness outweighed the value of that horse’s life.     The

other animals to which respondent referred served a certain

purpose.   For example, the llamas kept predators away from the

horses.    Even if petitioners did have an abstract love for

animals, it does not necessarily follow that they conducted their

horse breeding activity for pleasure rather than profit.    See

Davis v. Commissioner, T.C. Memo. 2000-101; Harvey v.

Commissioner, T.C. Memo. 1988-13.    Last, respondent argues that

petitioners’ kind treatment and care for their horses indicated

their personal devotion as pet owners rather than as horse

trainers and sellers.    On the contrary, petitioners’ care and

training of the horses would be instrumental to the process of

acclimating the horses to human smells and voices so as to carry

out petitioners’ plan to market them as gentle animals.

     This Court finds that this factor supports petitioners.

The Time and Effort Expended by Taxpayers

     A taxpayer’s amount of time and effort spent on the activity

may substantiate his profit objective.    The fact that the taxpayer

devotes much of his personal time and effort to carrying on the

activity, particularly if the activity does not have substantial
                                - 29 -

personal recreational aspects, may indicate an intention to make a

profit.   Sec. 1.183-1(b)(3), Income Tax Regs.   Respondent conceded

that Mr. Dennis had dedicated a substantial amount of his time to

this activity.   Nonetheless, respondent attempted to discount the

value of Mr. Dennis’ time and effort.    Respondent argued that most

of Mr. Dennis’ time and effort had been focused on the upkeep of

his homestead and his unemployment had permitted Mr. Dennis to

attend to these chores.   The Court disagrees.   The construction

and upkeep of the barns, the horse arenas, and the pastureland

provide housing, training, and food for the horses.   This Court

finds that his substantial time and effort dedicated to raising

and breeding horses support the conclusion that he engaged in the

activity with the requisite objective of earning profit.

     Petitioners established, through credible testimony, that

they contributed vast amounts of time to their horse breeding

activity.   Petitioners did not spend time riding their horses or

attending horse shows.    Petitioners spent their time meeting the

grueling and strenuous demands of hand-breeding their horses,

feeding their horses, caring for sick horses, assisting their

mares to give birth to their foals, and grooming, taming and

training their horses.    These demands required Mr. and Mrs. Dennis

to attend to them morning, day, and night.   In addition, Mr.

Dennis dedicated much of his time to maintaining their pastureland

so that horses could have a feed source, cleaning barns, breaking
                                 - 30 -

his horses in arenas he built, and learning how to provide

veterinary care.   Petitioners did not complete these tasks for

their personal pleasure.   In fact, they spent their time and

effort trying to reduce costs.

     For example, when the drought forced petitioners to use a

substantially more expensive source of horse feed, Mr. Dennis

attempted to secure a long-term source of quality hay even if that

business venture did not prove profitable.   Also, Mr. Dennis

reduced the cost of veterinary services by learning how to

administer daily veterinary care.    Petitioners managed to reduce

their expenses by dedicating their own time and effort to

maintaining their pastureland, their farm, and their horses.

     This factor strongly favors petitioners.

The Expectation That Assets May Appreciate in Value

     The word “profit” can encompass appreciation in the value of

assets, such as land, used in the taxpayer’s activity.   See sec.

1.183-2(b)(4), Income Tax Regs.    Even if no profit is derived from

the current operation, a taxpayer may intend that an overall

profit will result when appreciation in the value of the land used

in the activity is realized because income from the activity

together with the appreciation of land will exceed the operation’s

expenses.

     Mr. Dennis expected that the land would appreciate.    He

cultivated the land substantially and erected barns, horse arenas,
                                 - 31 -

gates, and fences on the land.    Having this expectation, he used

the land as collateral for a loan.    However, he does not intend to

sell the land to offset the losses his horse breeding activity

incurred.

     Although this factor indicates that petitioners lacked a

profit objective, one factor cannot alone determine the outcome.

See sec. 1.183-2(b), Income Tax Regs.; see also Miller v.

Commissioner, T.C. Memo. 2008-224.

Taxpayers’ Success in Carrying On Other Similar or Dissimilar
Activities

     The fact that a taxpayer has engaged in similar activities in

the past and converted them from unprofitable to profitable may

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

even though the activity is presently unprofitable.    See sec.

1.183-2(b)(5), Income Tax Regs.    In addition, a taxpayer’s

successes in other unrelated activities may help to demonstrate

that his present objective is profit.     See Rabinowitz v.

Commissioner, T.C. Memo. 2005-188; Daugherty v. Commissioner, T.C.

Memo. 1983-188.   A court can infer that a taxpayer’s diligence,

initiative, foresight, and other qualities will generally lead to

success in other business activities if he has demonstrated those

qualities by starting his own business and turning that business

into a relatively large and profitable enterprise.    See Daugherty

v. Commissioner, supra.
                                - 32 -

     Respondent urges the Court to make a comparison between Mr.

Dennis’ cattle operation and his horse breeding activity.    The

Court cannot do so, because the record does not provide any facts

relating to Mr. Dennis’ cattle operation.    Furthermore, the Court

cannot compare Mr. Dennis’ employment at Lewis & Coker with his

commencement and operation of a “business” of his own.

    This factor is neutral.

Taxpayers’ History of Income or Loss

     Next, the Court will examine petitioners’ history of income

or loss.    A history of substantial losses may indicate that the

taxpayer did not conduct the activity for profit.    See Golanty v.

Commissioner, 72 T.C. at 427; see also sec. 1.183-2(b)(6), Income

Tax Regs.   A series of losses during the initial or startup phase

of an activity may not necessarily indicate that the activity is

not engaged in for profit.    See sec. 1.183-2(b)(6), Income Tax

Regs.   Where 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 indicate that the

activity is not being engaged in for profit.    See id.

     Petitioners commenced their horse breeding activity in 1999.

Each year from 1999 through 2004 petitioners made no profits and

incurred substantial losses.    In 2001 Mr. Dennis sold only one

horse, and it was at a loss.    Petitioners’ losses during these
                               - 33 -

early years of their operation are attributable to the startup

phase of their activity.   The startup phase of a breeding

operation may last 5 to 10 years.   See Engdahl v. Commissioner, 72

T.C. at 669.   The substantial losses incurred in the tax years at

issue have fallen within the startup period and do not indicate

that petitioners did not have profit objective while pursuing this

activity.

     The drought during tax years 2002 to 2004 had inflated

petitioners’ costs of feeding as many as 46 horses.   This Court

finds Mr. Dennis’ testimony credible as to the duration of the

drought and its devastating effects on petitioners’ horse breeding

activity.   The Court will not consider such losses arising from

unforeseen or deleterious events as an indication that their

activity was a hobby because such circumstances lie beyond

petitioners’ control.   See sec. 1.183-2(b)(6), Income Tax Regs.

     This factor then remains neutral.

Taxpayers’ Financial Status

     Other substantial sources of income or capital may indicate

that a taxpayer does not engage in an activity for profit,

especially if personal or recreational elements are involved.    See

sec. 1.183-2(b)(8), Income Tax Regs.; see also Rozzano v.

Commissioner, T.C. Memo. 2007-177; Phillips v. Commissioner, T.C.

Memo. 1997-128.   Tax benefits resulting from the activity do not

compel a conclusion that a taxpayer engaged in an activity without
                                 - 34 -

a profit objective.    See Engdahl v. Commissioner, supra at 670;

McKeever v. Commissioner, T.C. Memo. 2000-288.      Instead, a court

should only take that fact into consideration.     See Engdahl v.

Commissioner, supra at 670.     More importantly, the inquiry should

be focused upon whether petitioners have a genuine profit

objective.   See id.

     Petitioners had limited income sources on the date they

commenced their operation.     For the tax years at issue Mr. Dennis

did not have any employment other than the horse breeding

activity.    Although Mr. Dennis did receive some government benefit

income, the insignificant dollar amount could not have offset the

significant amount of his operation’s losses.

     Respondent argued that petitioners had other sources of

income, including the revenues from Mrs. Dennis’ business, their

property, and loans from her family.      Mr. Dennis testified that he

will not sell his property, and respondent acknowledged this fact

in his brief.   The land serves as the sole collateral for

petitioners’ debt.     Respondent also argued that petitioners

received money from Mrs. Dennis’ mother and sister.     The record

indicated that petitioners borrowed money from Mrs. Dennis’

sister, who now has a lien on the land.     However, the record does

not indicate the amount of money provided by Mrs. Dennis’ mother,

leaving the Court unable to evaluate this source of funds.       The
                               - 35 -

income derived from Mrs. Dennis’ beauty salon remained the primary

source of petitioners’ income during the years at issue.

     Petitioners could have applied losses from their horse

breeding activity against the income from Mrs. Dennis’ cosmetology

business and thus realized tax benefits.   However, overall,

petitioners struggled financially to sustain themselves. The

adjusted gross income of Mrs. Dennis’ cosmetology business alone

would not have been enough to pay their living costs along with

the expenses of the horse breeding activity.   Mrs. Dennis’

business had $111,743 of adjusted gross income for tax year 2001,

$125,162 for tax year 2002, and $202,209 for tax year 2003.    Mr.

Dennis reported losses of $89,570 on his activity for tax year

2001, $89,054 for tax year 2002, and $125,801 for tax year 2003.

These figures indicate that the income from Mrs. Dennis’ business

could not have absorbed the losses Mr. Dennis’ horse breeding

activity incurred while paying petitioners’ living costs.

Petitioners faced economic hardship as a result of those losses.

Furthermore, petitioners did not engage in this activity to create

losses on paper; these losses were actual, depleting their

available cash and savings.   Depreciation accounted for only 9

percent ($7,666) of the expenses of the horse breeding activity in

the tax year 2001, 35 percent ($35,072) of the expenses in the tax

year 2002, and 19 percent ($19,881) of the expenses in the tax

year 2003.   These percentages indicate that most of petitioners’
                               - 36 -

horse breeding activity expenses were paid out of their own

pockets.   Therefore, the income derived from Mrs. Dennis’

cosmetology business is not indicative that the horse breeding

activity lacked a profit objective.

     This factor favors petitioners.

Conclusion

     Viewing the record as whole, this Court concludes that

petitioners engaged in their horse breeding activity with a bona

fide profit objective within the meaning of section 183.

Therefore, petitioners can deduct the losses the parties have

stipulated for the years at issue.

     Because petitioners may deduct their losses for the years at

issue pursuant to section 162, any issue of whether a penalty

should be imposed under section 6662 as a result of petitioners’

horse breeding activity for those years is moot.


                                             Decision will be entered

                                      under Rule 155.
