                         T.C. Memo. 1998-312



                       UNITED STATES TAX COURT



    DONALD KEITH MORLEY AND REBECCA B. MORLEY, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 19814-94.                Filed August 24, 1998.



     Rodney S. Klein, for petitioners.

     William W. Kiessling, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     VASQUEZ, Judge:    Respondent determined the following

deficiencies in, and additions to, petitioners' Federal income

taxes:

                                         Addition to Tax
     Year           Deficiency           Sec. 6651(a)(1)

     1985               $6,507                   ---
     1986               13,877                   ---
     1987               15,800                   ---
     1988               14,305                 $3,576
     1989               18,027                  4,506
                                - 2 -


     1990              13,370                3,342
     1991              10,963                 ---

     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.   The issues for

decision are:   (1) Whether a horse-breeding activity was an

activity not engaged in for profit; and (2) whether petitioners

are liable for additions to tax pursuant to section 6651(a)(1)

for 1988, 1989, and 1990.

                         FINDINGS OF FACT

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

The stipulation of facts, the second supplemental stipulation of

facts, and the attached exhibits are incorporated herein by this

reference.   Petitioners Donald Keith Morley (Mr. Morley) and

Rebecca B. Morley, husband and wife, resided in Elizabethton,

Tennessee, at the time they filed their petition.     During the

years in issue,1 petitioners had three children.     Petitioners

filed their 1988, 1989, and 1990 Federal income tax returns in

April 1990, August 1991, and April 1992, respectively.

     Mr. Morley operated a dental practice that was the sole

source of income for his family.   His dental practice income

averaged $128,866.




     1
        Unless otherwise indicated, all descriptions refer to the
1985, 1986, 1987, 1988, 1989, 1990, and 1991 tax years.
                                 - 3 -


     Petitioners did not have a retirement plan.    During the

years in issue, petitioners placed approximately $6,000 into an

IRA account.

     In 1985, Mr. Morley met Ed Horton (Mr. Horton).    Mr. Horton

and his wife owned a horse farm.    Mr. Horton had been in the

horse-breeding business for many years, and he had an impressive

reputation regarding his knowledge of horse business operations

and the area horse market.

     During 1985, Mr. Horton convinced Mr. Morley that there was

great potential for profit in breeding and selling Arabian

horses.   Mr. Horton showed Mr. Morley how to use Arabian horses

to provide a retirement plan.2

     Mr. Horton assisted Mr. Morley's entry into breeding and

selling Arabian horses (the horse-breeding activity).    From the

inception of the horse-breeding activity, Mr. Morley consulted

with other horse breeders and read journal articles about horse

breeding.   He attended seminars, took courses, and purchased

video tapes on breeding Arabian horses and horse farm management.

Mr. Morley also did a break-even analysis at the inception of his

horse-breeding activity.

     In June 1985, Mr. Morley acquired a 34-acre farm (the farm)

located approximately 6 miles from petitioners' residence.    Mr.

Morley conducted the horse-breeding activity on the farm.


     2
        Prior to 1985, Mr. Morley had no knowledge of breeding
Arabian horses.
                                - 4 -


Petitioners also had a barn at their home that Mr. Morley used

for foaling.    When mares were ready to give birth to a foal, Mr.

Morley moved the mare from the farm to the barn located at

petitioners' home.    He attached a "monitor" to the mare that

would go off when the horse was ready to give birth.3      When the

monitor went off, it signaled a beeper that Mr. Morley carried

with him at all times.

     Additionally, petitioners had a closed-circuit television

system that monitored horses about to give birth.       The barn

located at petitioners' home contained a camera in the stall with

the horse.    A separate bedroom in petitioners' home contained a

monitor that received the transmissions from the camera.       When a

horse was about to give birth, Mr. Morley slept apart from his

wife in the separate bedroom containing the monitor.       When the

mare gave birth, Mr. Morley delivered the foal.

     In 1985, Mr. Morley purchased two broodmares that were in

foal, Sophia and Khola, and a syndicate share of a stallion, T.O.

Bolero.    T.O. Bolero was a Bask-bred horse.4     The most Mr. Morley

paid for a horse was $10,500.    Mr. Morley maintained casualty

loss insurance on some of the horses.    Between 1985 and 1991, Mr.




     3
        Horses lie down flat on the ground when they give birth.
Horses only lie down to give birth. The monitor detected when
the horse lied down, thus signaling the impending birth of a
foal.
     4
          This means that it was a famous horse.
                               - 5 -


Morley sold a total of five or six horses.   The most he received

for a horse was $5,000 plus another horse in return.5

     Mr. Morley established a separate bank account and

maintained a general ledger for the horse-breeding activity.      He

classified expenses under various categories and provided these

figures on a yearly basis to his C.P.A.

     Mr. Morley obtained business cards for the horse-breeding

activity.   Additionally, he designed a logo for his farm which he

displayed on materials related to the horse-breeding activity--

banners, jackets, hats, and horse coolers--in order to advertise

the horse-breeding activity (the promotional materials).    The

promotional materials were orange and white--matching the colors

of the University of Tennessee.

     Mr. Morley maintained extensive books and records on the

horse-breeding activity.   He used business documents, including

bills of sale and security agreements, purchase-and-sale

contracts, breeding contracts, and boarding contracts.    Mr.

Morley's books and records included "teasing" and breeding

records on the horses, pedigrees for each of the horses, and

veterinarian and health records of the horses.   He also kept

other records, including bills, from outside organizations that

trained the horses.




     5
         The record does not indicate the value of the acquired
horse.
                                - 6 -


     Mr. Morley attended horse shows to learn about the horse-

breeding business.    He also showed his horses at these events and

won several ribbons.   After initially hiring a local trainer, Mr.

Morley hired a professional trainer to show and care for his

horses.   Additionally, Mr. Morley maintained a booth at the horse

shows displaying the farm logo, the promotional materials, and

ribbons that the horses had won.

     Mr. Morley made "notices" with information on each of his

horses.   These notices contained the name, registration number,

breed, color, sex, and price of the horses for sale.    The notices

also contained information on who the horse was "in foal to"

(i.e., to whom the horse was bred and when the foal was due).

     Mr. Morley advertised the horse-breeding activity in various

equine periodicals.    He provided notices and narratives about his

horses to potential purchasers.    He also prepared, for

prospective customers, a document containing a cost analysis of

raising a horse.

     All year round, Mr. Morley worked 4 days a week at his

dental practice and 7 days a week on the farm.    During the fall,

winter, and spring, he spent 40 hours a week at his dental

practice and 10 to 20 hours on the horse-breeding activity.     In

the summer, Mr. Morley worked 40 hours on the farm and 32 hours

at his dental practice.

     Mr. Morley personally handled many horse-breeding activity

duties.   He fenced the farm, repaired equipment, cleaned the
                                - 7 -


barn, ensured security, bathed and fed the horses, and handled

all the veterinary work himself.

     Prior to engaging in the horse-breeding activity, Mr. Morley

spent a lot of time with Mrs. Morley and their three children.

Throughout the years in issue, Mr. Morley arrived home after

dark, very tired, in a bad mood, and dirty with a "certain aroma"

from his work on the farm.   Due to his schedule, Mr. Morley ate

dinner later than the rest of the family and spent less time with

his family.

     In 1986, the horse market began to decline.   Mr. Morley was

unable to sell his foals.    Mr. Morley modified his business plan.

He expanded the horse-breeding activity to include dealing in

horse gestation monitoring equipment, and he displayed literature

for the equipment at his horse show booths.

     Mr. Morley also took measures to reduce the expenses of the

horse-breeding activity.    He sold several colts, which were not

breeding stallions, instead of incurring the costs associated

with maintaining them.   Additionally, he leased another farm with

a larger barn with more facilities in order to have a more

inviting establishment, to attract more people, and thereby sell

more horses.   This also allowed Mr. Morley to open the farm to

board other people's horses.

     In 1991, two of Mr. Morley's horses, Khola and Kholetta,

disappeared.   After a search revealed no indication as to either

horse's whereabouts, Mr. Morley assumed that someone had stolen
                                - 8 -


them.    Several weeks later someone discovered that Khola and

Kholetta had fallen into a sinkhole on the farm and died.    These

horses had been central to the horse-breeding activity.

     Mr. Morley "lost" other horses too.    He leased one horse to

a man who kept the horse inside an electric fence.    One night,

the man forgot to turn on the electric fence.    The horse escaped,

a car hit it, and the horse died.    Additionally, a prize-winning

stallion, T.A. Kolero,6 stepped into a hole and broke its leg.

Consequently, Mr. Morley had to put T.A. Kolero to sleep.

     On Schedule F, Profit or Loss From Farming, attached to

their 1988, 1989, and 1990 Federal income tax returns,

petitioners reported gross receipts from the horse-breeding

activity in the amounts of $2,229, $3,236, and $5,400,

respectively.    On Schedule F attached to their 1985, 1986, 1987,

1988, 1989, 1990, and 1991 Federal income tax returns,

petitioners reported net losses from the horse-breeding activity

in the amounts of $27,767, $47,387, $52,379, $52,142, $59,266,

$41,581, $34,530, respectively.    Losses sustained by petitioners

were out-of-pocket economic losses with the exception of amounts

deducted for depreciation.



     6
        For clarity, we note that T.A. Kolero and T.O. Bolero
were different horses.
                                 - 9 -


                               OPINION

I.   Horse-Breeding Activity

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

not engaged in for profit, no deduction attributable to such

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

Section 183(c) defines an "activity not engaged in for profit" as

"any activity other than one with respect to which deductions are

allowable for the taxable year under section 162 or under

paragraph (1) or (2) of section 212."

     The U.S. Court of Appeals for the Sixth Circuit, to which an

appeal in this case would lie, has held that for a deduction to

be allowed under section 162 or section 212(1) or (2), a taxpayer

must establish that he engaged in the activity with the primary

purpose and dominant hope and intent of realizing an economic

profit independent of tax savings.       Hayden v. Commissioner, 889

F.2d 1548, 1552 (6th Cir. 1989), affg. T.C. Memo. 1988-310;

Godfrey v. Commissioner, 335 F.2d 82, 84 (6th Cir. 1964), affg.

T.C. Memo. 1963-1.   The expectation of profit need not have been

reasonable; however, the taxpayer must have entered into the

activity, or continued it, with the objective of making a profit.

Hulter v. Commissioner, 91 T.C. 371, 393 (1988); sec. 1.183-2(a),

Income Tax Regs.; see also Campbell v. Commissioner, 868 F.2d

833, 836 (6th Cir. 1989), affg. in part, and revg. in part and

remanding T.C. Memo. 1986-569.
                              - 10 -


     Whether the requisite profit objective exists is determined

by looking to all the surrounding facts and circumstances.

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

Income Tax Regs.   Greater weight is given to objective facts than

to a taxpayer's mere after-the-fact statement of intent.      Thomas

v. Commissioner, 84 T.C. 1244, 1269 (1985), affd. 792 F.2d 1256

(4th Cir. 1986); sec. 1.183-2(a), Income Tax Regs.   Petitioners

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

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

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

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

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

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

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

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

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

taxpayer's history of income or loss with respect to the

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

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

elements of personal pleasure or recreation.   This list is

nonexclusive, and the number of factors for or against the

taxpayer is not necessarily determinative but rather all facts

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

be given to some factors than to others.   See sec. 1.183-2(b),
                              - 11 -


Income Tax Regs.; cf. Dunn v. Commissioner, 70 T.C. 715, 720

(1978), affd. 615 F.2d 578 (2d Cir. 1980).

     Petitioners contend that the losses from the horse-breeding

activity are properly deductible because the activity was profit

motivated.   Conversely, respondent asserts that the activity was

not engaged in for profit.   We find that Mr. Morley engaged in

the horse-breeding activity with the primary purpose and dominant

hope and intent of realizing a profit.

     A.   Manner in Which the Activity is Conducted

     Relevant factors in determining profit motive include

whether the taxpayer:   Maintained complete and accurate books and

records, conducted the activity in a manner substantially similar

to other comparable businesses which are profitable, and

attempted changes in order to improve profitability.   Sec. 1.183-

2(b)(1), Income Tax Regs.

     Respondent argues that Mr. Morley failed to operate his

horse-breeding activity in a businesslike manner.   Mr. Morley

kept extensive records.   In managing the farm, Mr. Morley used

business documents.   His books and records for the farm included

teasing and breeding records on his horses, self-generated

pedigrees for each of his horses, and veterinarian and other

types of health records on his horses.   He insured the horses

that he purchased under contract.

     Respondent also points to the fact that Mr. Morley did not

create or follow a written business plan, and did not prepare any
                               - 12 -


written profit or loss statements or balance sheets for the

horse-breeding activity.   Mr. Morley, however, had a business

plan, which was to develop the horse-breeding activity into an

enterprise that would support himself and his wife during their

retirement years, and he modified the plan in order to reduce

expenses and in an attempt to generate a profit.    The business

plan was evidence by Mr. Morley's actions:   Mr. Morley purchased

the farm for the horse-breeding activity, bred his horses to

produce foals, showed his horses, and advertised his horses for

sale.    See Phillips v. Commissioner, T.C. Memo. 1997-128.

     Mr. Morley maintained an itemized list of expenses and a

general ledger for the horse-breeding activity.    He also

consulted with other horse breeders and educated himself about

breeding Arabian horses and horse farm management.7

     Mr. Morley maintained a separate bank account for the horse-

breeding activity.   He advertised his horses.   Mr. Morley

marketed his horses with promotional materials whose color

pattern matched those of the University of Tennessee.8   He


     7
        We have previously held that a taxpayer's informal and
continuous consultations with experts knowledgeable about horses
and horse-breeding activities demonstrated the taxpayer's intent
to engage in horse breeding for profit even though the taxpayer
did not conduct a formal market study. Engdahl v. Commissioner,
72 T.C. 659, 668 (1979).
     8
        Mr. Morley testified that he chose the color pattern for
his promotional materials because orange and white were the
colors of the University of Tennessee, and he lived in "Big
Orange" country. We understand his statement about "Big Orange"
                                                   (continued...)
                               - 13 -


provided notices and narratives about every horse to potential

purchasers.   Based on the facts of this case, we find that Mr.

Morley carried on the horse-breeding activity in a businesslike

manner, and this indicates a profit motive.

     B.   Expertise of Mr. Morley and His Advisers

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

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

profit motive.    Sec. 1.183-2(b)(2), Income Tax Regs.    Respondent

argues that the type and quality of advice sought by Mr. Morley

was not indicative of an intent to engage in an activity for

profit.

     Prior to 1985, Mr. Morley had no knowledge about breeding

Arabian horses.    Initially, he discussed the Arabian horse-

breeding business with Mr. Horton.      Mr. Horton had been in the

horse-breeding business for many years and the community regarded

him as having a quality reputation for his knowledge of the

business operations and the area horse market.      Mr. Horton

provided projections to Mr. Morley of the potential profit from

the horse-breeding activity.    Additionally, Mr. Horton assisted

Mr. Morley's entry into Arabian horse breeding.

     Mr. Morley also consulted with other horse breeders and read

journal articles for information about horse breeding.      He



     8
      (...continued)
country to mean that people located in this part of the country
are devoted fans of the University of Tennessee.
                               - 14 -


attended seminars, took courses, and purchased video tapes for

information on breeding Arabian horses, equine health care

issues, and horse farm management.      He attended horse shows to

learn about the horse-breeding business.      He hired professional

trainers.   Mr. Morley's consultation with experts and his efforts

to educate himself about horse-breeding activities indicate a

profit motive.

     C.     Personal Pleasure and the Time and Effort
            Spent by Mr. Morley

     The fact that a 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.   Respondent concedes that Mr.

Morley spent a substantial amount of time on the horse-breeding

activity but argues that he derived a significant amount of

personal pleasure from the activity.      The absence of personal

pleasure or recreation relating to the activity in question may

indicate the presence of a profit objective.      Sec. 1.183-2(b)(9),

Income Tax Regs.

     Mr. Morley's work on the farm was difficult, and it often

precluded him from spending time with his family.     Mrs. Morley

credibly testified that she and her children missed her husband

and that she would have preferred it if Mr. Morley had been at

home instead of working on the horse-breeding activity.      Mr.
                              - 15 -


Morley arrived home after dark, very tired, in a bad mood, and

dirty with a "certain aroma" from his work on the farm.    It

appeared to the Court that Mrs. Morley resented the amount of

time Mr. Morley spent on the horse-breeding activity and that she

was unhappy that her husband came home every night dirty and

smelly.   We are not convinced that Mr. Morley would subject

himself to such rigors solely for recreation or pleasure.

     Furthermore, the record indicates that, as of the time of

trial, Mr. Morley had ridden the horses no more than three times

and only in conjunction with his work on the farm.    The time and

effort Mr. Morley spent on the horse-breeding activity combined

with his lack of personal pleasure from the activity indicate a

profit motive.

     D.    History of Income or Losses

     A record of substantial losses over several years may be

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

Commissioner, 72 T.C. 411, 426 (1979), affd. without opinion 647

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

Regs., however, provides that a series of losses during the

startup phase of an activity may not necessarily be an indication

that the activity is not engaged in for profit.    Furthermore, if

losses are sustained because of unforseen circumstances beyond

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

indication that the activity is not engaged in for profit.      Id.
                              - 16 -


     Respondent argues that Mr. Morley's consistent history of

losses in the horse-breeding activity is persuasive evidence that

he did not expect to make a profit.    Mr. Morley argues that he

sustained losses because of unforeseen circumstances beyond his

control; i.e., the decline in the horse market, the death of two

horses that were central to the horse-breeding activity in a

sinkhole accident, and the loss of other horses due to a fatal

collision with a car and a broken leg.

     We conclude that the financial losses Mr. Morley sustained

were the result of unforeseen circumstances beyond his control.

Furthermore, during the last few years of years in issue, the

losses from the horse-breeding activity had been steadily

decreasing.   Additionally, from 1992 through 1995, petitioners'

net losses from the horse-breeding activity declined even further

to an average of $11,515.   Mr. Morley also testified that in 1996

he made a profit from the horse-breeding activity.    Moreover, we

believe that the years in issue encompassed a startup period.

See Phillips v. Commissioner, T.C. Memo. 1997-128; see also

Engdahl v. Commissioner, 72 T.C. 659, 669 (1979).    As

petitioners' losses were sustained during the startup phase of

the horse-breeding activity and were the result of unforseen

circumstances beyond petitioners' control, we conclude that the

losses sustained are not an indication that the horse-breeding

activity was not engaged in for profit.
                               - 17 -


     E.   Petitioners' Financial Status

     Substantial income from sources other than the activity in

question, particularly if the activity's losses generate

substantial tax benefits, may indicate that the activity is not

engaged in for profit.   Sec. 1.183-2(b)(8), Income Tax Regs.

     Respondent argues that Mr. Morley greatly reduced the taxes

due from his dental practice income by his reported losses from

the horse-breeding activity.   Petitioners argue that they and

their three children lived a middle class lifestyle.    They also

point out that they did not maintain a retirement plan or have

substantial savings to satisfy their financial needs during

retirement.

     We have previously stated that it is unconvincing to argue

that a taxpayer would spend $1 with the objective of saving a

portion of that dollar on taxes.    "'As long as tax rates are less

than 100 percent, there is no 'benefit' in losing money'."

Harrison v. Commissioner, T.C. Memo. 1996-509 (quoting Engdahl v.

Commissioner, 72 T.C. at 670).     We believe that Mr. Morley

engaged in the horse-breeding activity to provide for his and his

wife's retirement.   Based on these facts, we do not find that

this factor indicates that the horse-breeding activity was not

engaged in for profit.

     F.   Conclusion

     After reviewing the entire record, we conclude that Mr.

Morley engaged in the horse-breeding activity with the primary
                                - 18 -


purpose and dominant hope and intent of making a profit within

the meaning of section 183.

II.   Failure To Timely File

      The section 6651(a)(1) additions to tax for 1988, 1989, and

1990 were based on:   (1) The deficiencies determined by

respondent (the deficiency portion); and (2) amounts petitioners

listed on their 1988, 1989, and 1990 Federal income tax returns

as due and owing (the return portion).      As a result of our

holding that Mr. Morley engaged in the horse-breeding activity

for profit, petitioners are not liable for the 1985 through 1991

deficiencies.   Therefore, petitioners are not liable for the

amounts of the section 6651(a)(1) additions to tax attributable

to the deficiency portion.     As the remaining amounts of the

section 6651(a)(1) additions to tax are attributable to the

return portion, and not to the deficiencies, we have no

jurisdiction over these additions.       See sec. 6665(b); Meyer v.

Commissioner, 97 T.C. 555, 562 (1991).

      To reflect the foregoing,

                                             Decision will be entered

                                      for petitioners.
