                          T.C. Memo. 2002-76



                        UNITED STATES TAX COURT



       JOHN G. PARKER AND JANICE E. PARKER, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 9781-98.                 Filed March 27, 2002.



     Jerome L. Blut and Elliot S. Blut, for petitioners.

     Rollin G. Thorley, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     SWIFT, Judge:     Respondent determined deficiencies and

accuracy-related penalties against petitioners for 1994, 1995,

and 1996 as follows:
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                                           Accuracy-Related Penalty
            Year      Deficiency                 Sec. 6662(a)
            1994       $21,603                      $4,321
            1995        20,881                       4,176
            1996        18,608                       3,722


     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.

     References to petitioner in the singular are to John G.

Parker.

     The primary issue for decision is whether significant

expenses that petitioner incurred in purchasing, building,

improving, and flying airplanes were incurred by petitioner in an

activity engaged in for profit.


                          FINDINGS OF FACT

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

     At the time the petition was filed, petitioners resided in

Reno, Nevada.

     Since the age of 16, petitioner has been a licensed airplane

pilot.    While in the U.S. Air Force, petitioner earned a degree

in aeronautical engineering from the Air Force Institute of

Technology.    Upon leaving the Air Force in 1965, petitioner

became a full-time pilot for American Airlines (American) where
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he worked for the next 33 years.   Petitioner also became a

licensed airplane mechanic.

     Beginning in 1967, petitioner also became engaged in an

activity that, over the course of the next 34 years, involved the

building, improving, and flying of four small airplanes that

petitioner owned (airplane activity), three of which petitioner

built from kits.   When not flying for American, petitioner

personally would spend many hours each week working on his

airplanes, seeking to improve their mechanical operation and

flight speed.

     Over the years, including 1994, 1995, and 1996, petitioner

entered his airplanes in a number of air shows and air races.

Flight logs relating to petitioner’s airplanes for 1994, 1995,

and 1996 reflect that petitioner won either first or second place

in five air races.   In 1977, petitioner won a national

championship race for the class relating to one of his airplanes.

Only petitioner flew his airplanes in the above air shows and air

races.

     In 1994, petitioner installed in one of his airplanes a

direct ignition system that he had developed.   Petitioner hoped

that his direct ignition system could replace standard magnetos

typically used in airplanes.   Petitioner thought that such a

direct ignition system might improve the speed of airplanes.
                                - 4 -

     During 1995 and 1996, petitioner sold six or seven of his

direct ignition systems for use in experimental aircraft for

approximately $1,900 to $3,000 each.

     In December of 1996, petitioner obtained from the City of

Reno, Nevada, a general business license relating to his airplane

activity.

     Also in 1996, petitioner leased property in Reno, Nevada, on

which petitioner constructed a 7,000-square foot hangar to be

used as a place to build and work on his airplanes.

     In 1998, petitioner retired from American.

     On a Schedule C, Profit or Loss From Business, filed with

petitioners’ joint Federal income tax returns for 1989 through

1999 that were prepared by an accountant, petitioners reported

gross income, ordinary business expenses, and net losses relating

to petitioner’s airplane activity, and unrelated wage and taxable

pension and annuity income as follows:


                                                      Unrelated
                            Airplane Activity           Wages,
Pensions,
     Year    Gross Income   Expenses    Net (Loss)   & Annuities
     1989      $ 3,048      $ 83,216    ($ 80,168)   $ 169,433
     1990        7,119        45,000      (37,881)      166,643
     1991        4,944        49,930      (44,986)      186,683
     1992        1,596        78,367      (76,771)      180,683
     1993        9,942       112,549     (102,607)      188,829
     1994        2,002        80,899      (78,897)      182,590
     1995        3,810        76,826      (73,016)      183,415
     1996       10,390        76,277      (65,887)      185,770
     1997       22,545        82,673      (60,128)      206,506
     1998       23,773       103,889      (80,116)      110,844
     1999        5,402        88,713      (83,311)      202,559

     TOTAL     $94,571      $878,339    ($783,768)   $1,963,955
                               - 5 -


     As a result of an audit examination, on May 6, 1998,

respondent issued a notice of deficiency to petitioners in which

respondent determined that, for 1994, 1995, and 1996,

petitioner’s airplane activity was not engaged in for profit

under section 183, and respondent disallowed the claimed losses

for each of those years.   Also, respondent determined accuracy-

related penalties under section 6662.

     Respondent has conceded that the claimed expenses relating

to petitioner’s airplane activity have been substantiated for the

years at issue and that during the years 1986 through 2001

petitioner spent approximately $1 million of his own funds on his

airplane activity.

     During a prior audit of petitioners’ 1989, 1990, and 1991

Federal income tax returns, respondent did not raise an issue as

to petitioner’s profit objective relating to petitioner’s

airplane activity.


                              OPINION

Activity not Engaged in for Profit

     Generally, under section 183, if an activity is not engaged

in for profit, deductions for expenses relating to such activity

are allowable only to the extent of gross income derived from the

activity.
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     An activity is not regarded as engaged in for profit unless

it is conducted by the taxpayer with an actual and honest

expectation of making a profit.   Dreicer v. Commissioner, 78 T.C.

642, 645 (1982), affd. without published opinion 702 F.2d 1205

(D.C. Cir. 1983); Golanty v. Commissioner, 72 T.C. 411, 425-426

(1979), affd. without published opinion 647 F.2d 170 (9th Cir.

1981).   An expectation of profit need not be reasonable.     Id.

Petitioners have the burden of proof on this issue.1   Rule

142(a); Golanty v. Commissioner, supra at 426.

     In considering whether a taxpayer engaged in an activity for

profit, greater weight is given to objective factors, taking into

account all of the facts and circumstances, than to a taxpayer’s

mere statement of intent.   Beck v. Commissioner, 85 T.C. 557, 570

(1985); sec. 1.183-2(a), Income Tax Regs.

     In section 1.183-2(b), Income Tax Regs., a nonexclusive list

of factors is provided for use in analyzing whether an activity

is engaged in for profit.   Such factors include:   (1) The manner

in which the taxpayer carried on the activity; (2) the expertise

of the taxpayer or his advisers; (3) the time and effort expended



1
    Because the examination in this case commenced before
July 23, 1998, sec. 7491, which places the burden of proof with
respect to any fact issue on respondent where the taxpayer
maintains adequate records, satisfied applicable substantiation
requirements, cooperated with respondent, and produced credible
evidence with regard to the fact issue, does not apply. See
Internal Revenue Service Restructuring and Reform Act of 1998,
P.L. 105-206, sec. 3001, 112 Stat. 685, 726.
                                - 7 -

by the taxpayer in carrying on the activity; (4) the expectation

by the taxpayer 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 earned by the taxpayer, if any;

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

recreation or personal pleasure in the taxpayer’s carrying on the

activity.

     Although no single factor is conclusive, a record of

substantial losses over many years and the unlikelihood of

achieving a profit are important factors bearing on whether the

taxpayer had a profit objective in carrying on the activity.

Golanty v. Commissioner, supra at 426; sec. 1.183-2(b)(6), Income

Tax Regs.   Generally, the profit-objective test looks for a

profit on the entire activity, including profits to recoup losses

from prior years.   Golanty v. Commissioner, supra at 427 (citing

Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965), affd.

379 F.2d 252 (2d Cir. 1967)).

     Substantial income from sources other than the activity,

particularly where the activity generates large losses that

result in substantial tax benefits, may indicate that the

activity is not engaged in for profit, especially if the activity
                                - 8 -

has personal or recreational elements.    Sec. 1.183-2(b)(8),

Income Tax Regs.

     Petitioner contends that he engaged in the airplane activity

for profit.   We disagree.

     The evidence does not establish that petitioner carried on

his airplane activity in a businesslike manner.

     Petitioner has consistently reported substantial net losses

from his airplane activity and used the losses to offset

significant wages that petitioner earned from American and

taxable pensions and annuity income.    The uninterrupted,

substantial losses realized in petitioner’s airplane activity

over many years are highly indicative of a lack of profit

objective.    See Golanty v. Commissioner, supra at 426.

     Petitioner testified that a business plan for his airplane

activity was developed in 1996 (namely, to build from kits and to

sell airplanes for a substantial profit).    Petitioner, however,

did not offer into evidence written documentation of this

business plan.   Petitioner acknowledged that prior to 1996 his

airplane activity was “a pencil and paper operation”.

     Other than income tax returns, flight logs, and a business

license (issued to petitioner during the last month of the last

year at issue herein), petitioner did not offer into evidence any

written documentation of his business plans or projections,

payroll or other employee records, sales contracts, or any other
                              - 9 -

business records regarding petitioner’s airplane activity from

1967 to the time of trial in 2001.

     Petitioner’s testimony that during the late 1970s and early

1980s his airplane activity realized some profits was not

corroborated.

     Petitioner testified that at the time of trial he employed

three people in his airplane activity and that he had contracts

to build from kits two Glasair airplanes and one Thunder Mustang

airplane for an expected profit of approximately $462,000.

Petitioner, however, did not offer into evidence written

documentation of the above contracts or any employee records to

corroborate petitioner’s testimony.

     Petitioner is a highly educated, trained, and experienced

pilot who loves airplanes and who has devoted much of his time

and money to his airplane activity.

     We conclude, for the years in issue, that petitioner’s

airplane activity constitutes a hobby and is not to be regarded

as an activity engaged in for profit under section 183.

Accordingly, we sustain respondent’s disallowance of the losses

relating to petitioner’s airplane activity.


Accuracy-Related Penalties

     Under section 6662, a 20-percent accuracy-related penalty is

imposed on the portion of any underpayment of tax attributable

to, among other things, negligence or disregard of Federal tax
                                - 10 -

rules and regulations, or a substantial understatement of tax.

An understatement of tax is substantial if it exceeds either 10

percent of the tax required to be shown on the return, or $5,000.

Sec. 6662(d)(1)(A).

     The above accuracy-related penalty, however, is not imposed

with respect to any portion of a taxpayer’s understatement of tax

for which the taxpayer acted with reasonable cause and in good

faith.   Sec. 6664(c)(1).

     In our discretion, and based on the facts before us, we

conclude that petitioners had reasonable cause in treating

petitioner’s airplane activity as a for profit activity.

Petitioners are not liable for the accuracy-related penalties

determined by respondent under section 6662 with respect to the

deficiencies at issue herein.

     To reflect the foregoing,



                                          Decision will be entered
                                     under Rule 155.
