                         T.C. Memo. 2002-7



                      UNITED STATES TAX COURT



         ROBERT A. AND SHEILA D. ROUTON, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 18999-99.                    Filed January 9, 2002.


     B. Paul Husband, for petitioners.

     Daniel J. Parent, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     FOLEY, Judge:   By notice dated September 17, 1999,

respondent determined deficiencies of $29,717 and $38,195

relating to petitioners’ 1994 and 1995 Federal income taxes,

respectively, and a $7,313 section 6651(a)1 addition to tax


     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
                                                   (continued...)
                                 - 2 -

relating to 1994.     The issues for decision are whether

petitioners are:     (1) Entitled to certain deductions relating to

their horse training and breeding activities, and (2) liable for

a section 6651(a) addition to tax for 1994.

                           FINDINGS OF FACT

     Petitioners, husband and wife, resided in Somerset,

California, at the time their petition was filed.

         At all relevant times, Mrs. Routon has been a

schoolteacher.     Mr. Routon worked on his grandfather’s farm as a

youth, majored in zoology in college, and, after college, worked

as a veterinarian’s assistant.     He created two successful

businesses:     a newspaper distributorship that he sold in 1976;

and American Leak Detection (ALD), a water leak detection

business.     Both businesses operated profitably without a written

business plan.     In 1994 and 1995, respectively, Mr. Routon earned

$109,470 and $145,028 from ALD, and Mrs. Routon earned teaching

salaries of $41,751 and $43,575.

     In 1985, petitioners established Ascension Arabians

(Ascension), a horse breeding operation.      Petitioners believed

Ascension would provide substantial income in their retirement

years.     They maintained their full-time jobs, began devoting 35




     1
      (...continued)
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                                - 3 -

hours a week to Ascension’s activities, and regularly consulted

with Arabian horse experts relating to Ascension’s operations.

     Mr. Routon kept Ascension’s books and records, purchased

insurance, attended seminars, and occasionally showed the horses

at expositions and competitions.   He immersed himself in the

Arabian horse industry, taking various leadership positions in

trade organizations and writing columns for industry magazines.

Mrs. Routon searched for suitable horse breeding and farming

properties and tended to the horses when Mr. Routon was

unavailable.    Ascension’s horses were handled by a professional

trainer.   Expenses relating to Ascension and ALD were billed to,

and paid out of, the same account.      At the end of each year, Mr.

Routon would summarize the expenses relating to both businesses.

Mr. Routon promoted Ascension by conducting seminars; mailing

video tapes featuring their top stallion, Diamond Bask, to

seminar attendees; advertising in trade magazines; and attending

exhibitions.

     Petitioners’ horses have substantial value.     Diamond Bask,

their top stallion, is worth $250,000.     Despite the quality of

their horses, petitioners’ sales and marketing endeavors were

ineffective.    From 1988 through the years in issue, Ascension’s

cumulative income and expenses were $15,575 and $531,964,

respectively.   During this period, petitioners did not have a

profitable year but made several operational adjustments to
                                - 4 -

improve their chances of turning a profit (i.e., selling inferior

horse stock in 1989, reinvesting the horse sale proceeds in

national quality stock, investigating and implementing the use of

frozen semen, etc.).    During the years in issue, petitioners’

prospective horse sales failed because of injury to a horse and

misrepresentations made to petitioners.

     Petitioners’ tax returns for 1994 and 1995 were prepared by

an enrolled agent, James G. Joelson, who acquiesced to the tax

treatment of their horse activity.      Petitioners’ 1994 return was

filed on October 30, 1995.    Respondent disallowed all of

petitioners’ expenses relating to Ascension for 1994 and 1995,

contending that their horse activity was not engaged in for

profit.

                               OPINION

I.   Profit Objective

     Section 183 limits the deductions for an activity not

engaged in for profit.    Sec. 183(b).   This case is appealable to

the Ninth Circuit Court of Appeals.      The primary purpose standard

has been followed by that circuit in determining whether the

requisite profit objective exists.      See Wolf v. Commissioner, 4

F.3d 709, 713 (9th Cir. 1993), affg. T.C. Memo. 1991-212 (holding

that profit must be the predominant, primary, or principal

objective).   Petitioners bear the burden of proving the requisite
                                   - 5 -

profit motive.2      Skeen v. Commissioner, 864 F.2d 93, 94 (9th Cir.

1989).

       To determine whether petitioners conducted their activity

for profit, we must weigh all facts and circumstances.        Golanty

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

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

Tax Regs., sets forth a nonexclusive list of nine factors to

guide courts in analyzing a taxpayer’s profit objective.         See

Elliott v. Commissioner, 90 T.C. 960 (1988), affd. without

published opinion 899 F.2d 18 (9th Cir. 1990).       The nine factors

are:       (1) The manner in which the taxpayer carries on the

activity; (2) the expertise of the taxpayer or his advisers; (3)

the time and effort expended by the taxpayer in carrying on the

activity; (4) the expectation that 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, that are

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

elements of personal pleasure or recreation involved in the

activity.       Sec. 1.183-2(b), Income Tax Regs.   Upon review of

these factors, we conclude that section 183 does not limit




       2
        Sec. 7491 is not applicable to this case.
                                  - 6 -

petitioners’ deductions because petitioners engaged in their

horse breeding activity to make a profit.

     A.     Businesslike Manner

     Petitioners invested significantly in advertising and

promotions, attended expositions, used professional trainers,

purchased insurance, and kept records in the same manner Mr.

Routon has for his successful business ventures.     Further, they

abandoned unprofitable methods in a manner consistent with an

intent to improve profitability.     See sec. 1.183-2(b)(1), Income

Tax Regs.

     B.     Expertise

     Mr. Routon consulted extensively with Arabian horse industry

experts.    He also had previous experience with farming and

animals before establishing Ascension and has since immersed

himself in the Arabian horse industry.     In addition, Mr. Routon

has significant business experience from his other ventures.

     C.     Time Devoted to the Activity

     Respondent does not contest the fact that petitioners

handled virtually all material aspects of Ascension.    In addition

to their full-time engagements, petitioners devoted substantial

time and energy caring for and maintaining Ascension’s horses.

     D.     Expectation That Assets May Appreciate

     Assets related to Ascension have appreciated and, in

accordance with petitioners’ plan, may further appreciate.
                                 - 7 -

Petitioners’ uncontradicted expert testimony is that petitioners’

horses and land are worth approximately $2 million.

     E.    Taxpayers’ Financial Status

     Petitioners had modest resources yet consistently invested

nearly half their annual income in Ascension because they

sincerely believed that they would eventually turn a profit.

Petitioners were shrewd, hardworking, diligent, and levelheaded.

We do not believe that they would squander their hard-earned

money on an extravagant hobby.

     F.    Amount of Profits

     Although Ascension produced only losses, the opportunity to

earn substantial profits in a highly speculative venture is

sufficient to indicate that the activity is engaged in for

profit.   Sec. 1.183-2(b)(7), Income Tax Regs.   For example, “it

may be found that an investor in a wildcat oil well who incurs

very substantial expenditures is in the venture for profit even

though the expectation of a profit might be considered

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

     Petitioners were simply poor marketers who lacked the

requisite reputation in the industry, but they had quality horses

and a venture that could be profitable if they changed their

business practices.   For example, petitioners’ expert witnesses

indicated that syndication of one of Diamond Bask’s offspring,

Diamonds N Jazz, would be quite profitable.
                               - 8 -

     G.    History of Income and Losses

     Entrants in the horse industry may incur substantial losses

during a lengthy startup stage.   See Engdahl v. Commissioner, 72

T.C. 659, 669 (1979).   Such losses are not necessarily an

indication that the activity was not engaged in for profit.    See

sec. 1.183-2(b)(6), Income Tax Regs.   Petitioners believed that

their losses would be recouped by the breeding, and sale, of one

or more preeminent stallions and that Ascension would provide an

income stream during their retirement years.   See Bessenyey v.

Commissioner, 45 T.C. 261, 274 (1965) (stating that there is an

overall profit if net earnings and appreciation are enough to

recoup losses sustained in prior years), affd. 379 F.2d 252 (2d

Cir. 1967).

     H.   Personal Pleasure or Recreation

     Petitioners did not ride Ascension’s horses for pleasure,

nor did they typically travel with the horses to exhibitions and

competitions.   While petitioners thoroughly enjoy their work, a

business will not be turned into a hobby merely because the owner

finds it pleasurable.   See Jackson v. Commissioner, 59 T.C. 312,

317 (1972).

     I.    Success in Similar or Dissimilar Activities

     Prior to establishing Ascension, Mr. Routon created two

successful business ventures for which he had limited expertise

at the outset, a newspaper distributorship and a leak detection
                                  - 9 -

business.    Petitioners established that they are just as

determined to earn a profit with Ascension.

II.   Section 6651 Addition to Tax

      Section 6651(a)(1) imposes an addition to tax for failure to

file a required return on the date prescribed, unless it is shown

that such failure is due to reasonable cause and not willful

neglect.    Petitioners have not shown that such failure to file by

the prescribed date was due to reasonable cause and not willful

neglect.    Accordingly, petitioners are liable for the 1994

addition to tax.

      To reflect the foregoing,



                                            Decision will be entered

                                      under Rule 155.
