                         T.C. Memo. 1996-259



                       UNITED STATES TAX COURT


            RICHARD H. DALEY AND ESTATE OF ANNE H. DALEY,
         DECEASED, RICHARD H. DALEY, EXECUTOR, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 9816-93.              Filed June 5, 1996.



     Gregory A. Robinson, for petitioners.

     Thomas S. Dileonardo, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     WRIGHT, Judge: Respondent determined deficiencies in, an

addition to, and penalties on petitioners’ Federal income taxes

as follows:1


     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years at issue, and
all Rule references are to the Tax Court Rules of Practice and
                                                   (continued...)
                                    - 2 -

                                 Addition to Tax and Penalties
Year          Deficiency        Sec. 6661          Sec. 6662(a)

1988          $11,351            $2,838                 ---
1989           11,536              ---                 $2,307
1990           10,058              ---                  2,012


       After concessions, the issues for decision are:

(1)    Whether petitioners' horse activity during the taxable years

at issue was engaged in for profit.         We hold that it was not.

(2)    Whether petitioners are liable for the addition to tax under

section 6661 for a substantial understatement for taxable year

1988.      We hold that they are.

(3)    Whether petitioners are liable for the accuracy-related

penalty under section 6662(a) for a substantial understatement

for taxable years 1989 and 1990.       We hold that they are.



                             FINDINGS OF FACT

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

The stipulation of facts and attached exhibits are incorporated

herein.      At the time the petition was filed, petitioner2 resided

in Phoenix, Arizona.       All references to petitioner in the

singular are to Richard H. Daley.




       1
      (...continued)
Procedure.
       2
      Anne H. Daley died during taxable year 1989, and petitioner
Richard H. Daley is the executor of Anne H. Daley's estate.
                                - 3 -

     Petitioner has practiced medicine as a surgeon in Arizona

since 1967.   His medical practice requires between 50 and 60

hours of his time each week.    During the 12-year period ending

with 1992, petitioner's average wage income from his medical

practice was $266,507.   Similarly, during the taxable years at

issue, petitioner's average wage income from his medical practice

was $299,687.   Petitioner has always relied on a professional

accountant to manage the books and records of his medical

practice.

     During the years 1972 through 1986, petitioner was a partner

in M.L. Leasing, a partnership engaged in the leasing of various

types of goods.   In 1987, this partnership was dissolved and

petitioner began operating M.L. Leasing as a sole proprietorship.

Petitioner continued to operate M.L. Leasing as such through at

least March 1994.   M.L. Leasing's books and records were managed

by a professional bookkeeping service.    During taxable years 1983

through 1992, petitioner reported the following profits and

losses from his interest in M.L. Leasing:3

     Year                 Profit (Loss)

     1983                      $7,270
     1984                       1,280
     1985                       7,565
     1986                      (2,000)
     1987                       9,283
     1988                       4,429

     3
      Until 1987, M.L. Leasing was a partnership. Accordingly,
the amounts reflected for years prior to 1987 indicate
petitioner's share of partnership profit and losses.
                                - 4 -

     1989                      (2,313)
     1990                      (4,535)
     1991                       4,665
     1992                       5,458


     Petitioner grew up in rural Nebraska and spent much of his

time "on the farm".    He developed an interest in horses at a

young age and retained that interest into adulthood.    Sometime

during the 1970's, petitioner developed an interest in "cutting

horses".    Historically, a cutting horse was a horse bred and

trained to serve as a tool for separating (cutting) cattle from a

herd.   Generally speaking, cutting horses are now assets that are

used by their owners to compete against other cutting horse

owners in organized "cutting" competitions for prize money.

Competitions featuring cutting horses are held at both national

and local levels, and entrants are judged on their ability to

"cut" a single steer from a herd of steers.

     Petitioner began engaging in cutting horse activities in

1979.   This activity has continued uninterrupted since its

commencement and has involved breeding and training horses to

compete in organized events.    Petitioner entered his horse

activity without the aid of a written market study, and he has

not relied on a formal profit or business plan at any time.      In

managing the affairs of his activity, petitioner used a ledger to

record various transactions and events.   He also maintained a

separate "drop" file for most of his horses.    The ledger and drop
                                - 5 -

files, however, are not completely accurate, and some significant

discrepancies and omissions exist in each.

     During the course of the 14-year period ending with 1992,

petitioner owned in excess of 30 horses.4    These horses were

either purchased by petitioner or born to horses that he already

owned.    In either event, most were eventually sold during this

14-year period, although some died and others were donated to

various people or organizations.

     Throughout the entire course of his horse activity,

petitioner never experienced a net profit, although he did

generate some income.    Income was generated from several sources,

including prize winnings, foal sales, and stud fees.    Expenses

from petitioner's horse activity, however, always exceeded such

income.    Boarding and training costs have constituted the

majority of such expenses.

     Petitioner rode his horses in the evenings and on weekends.

He also rode his horses at numerous organized cutting horse

events.    Although petitioner's spouse had little interest in

horses, petitioner's two children occasionally rode certain

horses for various reasons.    On the average, petitioner devoted

10 to 12 hours each week to his horse activity.




     4
      In any one year petitioner owned as few as 2 and as many as
11 horses. Petitioner owned an average of approximately eight
horses per year.
                                 - 6 -

     Petitioner boarded his horses at a local stable and relied

extensively on the services of a David Costello (Costello) to

maintain and train his horses.    The maintenance performed by

Costello consisted of typical physical labors associated with

horse ownership.    Costello is a professional horse trainer and

has a national reputation in the cutting horse industry.    He

owned and operated the stables and training facility used by

petitioner during the taxable years at issue.

     Petitioner began deducting expenses associated with his

horse activity in 1979, its year of inception.    The following

table lists the income, expenses, and losses reported by

petitioner during the 12-year period ending with 1992:

  Year      Gross Receipts       Expenses       Loss

  1981                 $0        $27,598        $27,598
  1982              8,770         41,149         32,379
  1983             15,050         49,715         34,665
  1984              4,746         33,498         28,752
  1985              1,949         33,397         31,448
  1986              2,531         36,888         34,357
  1987             12,580         72,858         60,278
  1988              7,588         46,295         38,707
  1989              3,927         37,414         33,487
  1990              1,273         33,448         32,175
  1991                167         33,438         33,271
  1992              3,271         46,460         43,189
                   ______        _______        _______
    Total          61,852        492,158        430,306



     Respondent determined that petitioner did not operate his

horse activity with the intent of earning a profit and disallowed
                                - 7 -

the claimed expenses to the extent such expenses exceed the

income generated by the activity for each taxable year at issue.

                               OPINION

     We must decide whether section 183 applies to petitioner's

horse activity.    Respondent maintains that section 183 limits the

amount of expenses petitioner is entitled to deduct to an amount

equal to the amount of gross income earned from his horse

activity.   In contrast, petitioner contends that section 183 is

inapplicable because he conducted his horse activity with the

requisite profit motive.   We agree with respondent.

     Section 183 allows only specified deductions unless an

activity is 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 under section 162

or under paragraphs (1) or (2) of section 212.      An activity

engaged in for profit is one in which the taxpayer has an actual

and honest objective of making a profit.      Dreicer v.

Commissioner, 78 T.C. 642, 645 (1982), affd. without opinion 702

F.2d 1205 (D.C. Cir. 1983).   This profit expectation need not

have been reasonable, but the activity must have been either

entered into or continued with a bona fide objective of making a

profit.   Taube v. Commissioner, 88 T.C. 464, 478-479 (1987);

Dreicer v. Commissioner, supra at 644-645; sec. 1.183-2(a),

Income Tax Regs.   Profit in this context means economic profit,
                                 - 8 -

independent of tax consequences.     Antonides v. Commissioner, 91

T.C. 686, 694 (1988), affd. 893 F.2d 656 (4th Cir. 1990).

     The determination of profit objective is factually based and

requires a consideration of all the surrounding facts and

circumstances.   Finoli v. Commissioner, 86 T.C. 697, 722 (1986);

sec. 1.183-2(b), Income Tax Regs.    Although the purpose of the

inquiry is to ascertain the taxpayer's subjective intent, greater

weight is given to objective facts than to self-serving

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

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

     In conducting the profit objective analysis, courts have

relied on a nonexclusive list of nine factors enumerated in the

regulations under section 183.    See Hendricks v. Commissioner, 32

F.3d 94 (4th Cir. 1994), affg. T.C. Memo. 1993-396; Independent

Elec. Supply, Inc. v. Commissioner, 781 F.2d 724 (9th Cir. 1986),

affg. Lahr v. Commissioner, T.C. Memo. 1984-472; Elliott v.

Commissioner, 90 T.C. 960 (1988), affd. without published opinion

899 F.2d 18 (9th Cir. 1990).   No single factor is determinative

of the issue, however.    Golanty v. Commissioner, 72 T.C. 411

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

1981).   The nine factors set forth under section 1.183-2(b),

Income Tax Regs., 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 other similar or dissimilar activities; (4) the
                                - 9 -

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.

     A careful review of the entire record in this case convinces

us that petitioner has failed to carry his burden in proving that

his horse activity was motivated by an actual and honest

objective of making a profit.   The objective facts indicate that

most of the above-enumerated factors weigh in favor of

respondent.

Issue 1.   Profit Motive

Businesslike Manner & Adequate Records

     The fact that an activity is carried on in a businesslike

manner and complete and accurate books and records are maintained

is a factor indicating the existence of a profit objective with

respect to such activity.   Sec. 1.183-2(b)(1), Income Tax Regs.

Respondent argues that petitioner failed to operate his horse

activity in a businesslike manner.      In support of this argument,

respondent advances several contentions.5     First, respondent

argues that petitioner failed to conduct a formal market study

     5
      To the extent that such arguments are not addressed herein,
we have found them to be without merit.
                               - 10 -

prior to undertaking his horse activity.    Respondent also

contends that petitioner's failure to formulate a credible

business or profit plan indicates that his actions were not

businesslike and that he lacked a profit motive.    We agree with

both of these contentions.   While the law does not require a

taxpayer to engage in extensive formalities prior to undertaking

a venture, it does require that the taxpayer conduct a basic

investigation of the factors that would affect profit.       Golanty

v. Commissioner, supra at 432.   Although petitioner testified

that he started his horse activity after consultation with

various professionals within the industry, such testimony was not

credible, and it appears that petitioner did little else in terms

of an investigation.   Petitioner undertook his horse activity

with no concept of what his ultimate costs might be or how he

might achieve any degree of cost efficiency.    Similarly,

petitioner entered and conducted his activity not knowing the

amount of revenues he could expect or what risks might impair the

generation of such revenues.   It is quite likely that this stems

from his failure to consider any type of financial planning

instrument during the course of his activity.    Moreover, at trial

petitioner was asked whether he was aware of the amount of losses

incurred since the inception of his horse activity.    Not only was

petitioner unaware of the amount of total losses incurred, but he

was also unaware of the amount of losses incurred during 1993,

the year immediately prior to trial.    It seems to us peculiar
                               - 11 -

that someone claiming a particular activity is motivated by

profit would not know simple but significant information such as

this with respect to that activity.

     Respondent also points to numerous omissions in petitioner's

records as further support for her contention that petitioner

lacked the requisite profit motive with respect to his horse

activity.   We agree.   While maintaining less than precise records

does not conclusively establish the lack of a profit objective,

see Engdahl v. Commissioner, 72 T.C. 659, 666-667 (1979),

petitioner's records are so fraught with omissions and

inconsistencies that it is difficult to imagine how they served

any beneficial purpose.   Petitioner's records do not reflect the

income and expenses associated with each individual horse, and

petitioner testified that he could not otherwise tell from his

records whether any one horse was profitable in any particular

year.   Similarly, as noted earlier, petitioner's records do not

reflect the activity's past losses.     Furthermore, petitioner

testified that the ledger contained various data pertaining to

each horse; however, respondent has shown that much of such data

is lacking from the ledger.    Petitioner's drop files are equally

incomplete.   In fact, petitioner failed to maintain a drop file

on several of his horses.    The drop files are supposed to contain

information pertaining to registration and breeding, among other

things, but such information is lacking from several of the files

that do exist.   Not only are petitioner's records incomplete,
                              - 12 -

some contain inconsistencies of a significant nature.

Inconsistencies also exist between petitioner's records and the

information contained on some of his tax returns.

     In light of the facts before us, we find that petitioner did

not operate his horse activity in a businesslike manner.    We also

find that he maintained inadequate and insufficient records with

respect to such activity.   Accordingly, we find that this factor

weighs in favor of respondent.

Taxpayer Expertise

     The expertise of the taxpayer or his or her advisers is

another factor relevant to the determination of whether such

taxpayer possessed the requisite profit motive with respect to

the activity in question.   Sec. 1.183-2(b)(2), Income Tax Regs.

Petitioner lacked any meaningful degree of expertise with regard

to his horse activity, and we are not convinced that he was

developing an expertise merely as a result of his associations

with professionals within the cutting horse industry.    However,

petitioner relied extensively on Costello, an individual

possessing much expertise involving horses.    Because of the

extent Costello was involved in petitioner's horse activity, we

conclude that this factor favors petitioner.

Time and Effort Expended

     The time and effort expended by the taxpayer in carrying on

the activity at issue is an indication of whether a profit motive

existed with respect to such activity, particularly if there are
                                - 13 -

no substantial personal or recreational elements associated with

such activity.    Sec. 1.183-2(b)(3), Income Tax Regs.   Petitioner

maintains that he spent 10 to 12 hours each week engaged in his

horse activity.    Yet he failed to produce credible evidence

explaining the type of work he performed.    The available evidence

indicates that petitioner spent much of his time riding his

horses.   Petitioner contends, however, that such riding was not

recreational.    Instead, petitioner maintains that his riding

served several business purposes, including exercising and

training.   Petitioner also maintains that the reason he rode his

horses during competitive events was to develop a better

appreciation for his business and illustrate to perspective

purchasers that his horses were suitable for novice riders.

     The record does not support petitioner's arguments.

Essentially, by relying on Costello to maintain and train his

horses, petitioner avoided the rigors of his horse activity and

indulged himself with its pleasantries.    Petitioner's testimony

otherwise is simply not credible, and we are reluctant to accept

Costello's testimony as corroboration in light of his business

relationship with petitioner.    We conclude that petitioner's

horse activity contained substantial elements of a recreational

and personal nature.    Accordingly, we find that this factor

favors respondent.
                              - 14 -

Expectation that Assets will Appreciate

     An expectation that assets used in the activity in question

may appreciate in value may also be an indication of the

taxpayer's motive with respect to such activity.     Sec. 1.183-

2(b)(4), Income Tax Regs.   Petitioner contends that a principal

factor underlying his motivation for engaging in his horse

activity was the expectation that he would experience

appreciation in the value of his horses.     We recognize that

appreciation in the horse industry often requires the passage of

many years and is frequently dependent upon on a successful

breeding and training program.   It is not enough, however, that

petitioner maintained the objective that his horse activity would

eventually become profitable as a result of appreciation in the

value of his horses.   It is necessary that the objective be to

realize a profit on the entire operation.     Bessenyey v.

Commissioner, 45 T.C. 261, 274 (1965), affd. 379 F.2d 252 (2d

Cir. 1967).   This presupposes not only future net earnings but

also future net earnings sufficient to recoup the losses which

have been sustained in prior years.    Id.   Petitioner failed to

produce credible evidence that would suggest that his activity

had any realistic chance of recovering the enormous losses

previously incurred.

     In light of this record, we are not convinced that

petitioner maintained a good faith belief that his horses would

appreciate over time and that such appreciation would eventually
                                  - 15 -

be sufficient to account for the losses experienced prior to such

appreciation.    Accordingly, we find that this factor favors

respondent.

Other Activities

     The success of the taxpayer in carrying on other activities

can also be some indication of whether the taxpayer had a profit

motive for the activity in question.       Sec. 1.183-2(b)(5), Income

Tax Regs.     Petitioner has no experience in similar activities;

however, both his medical practice and his leasing business are

successful profit-oriented activities.      In any event, we find

that this factor neither supports nor weakens either party's

position.

Income, Losses, and Occasional Profits

     A history of income, losses, and occasional profits with

respect to an activity can be indicative of whether a profit

objective exists with respect to such activity.      Sec. 1.183-

2(b)(6), Income Tax Regs.     Respondent contends that the history

of losses relating to petitioner's horse activity suggests that

he lacked the requisite profit motive necessary to render section

183 inapplicable.     We agree.   Petitioner's contention that he

expected to eventually experience a profit is self-serving,

unsupported by the record, and otherwise unrealistic.      The

uninterrupted series of losses has been sustained beyond the

period which is customarily necessary to bring a similar

operation to profitable status.      See Engdahl v. Commissioner, 72
                                - 16 -

T.C. 659 (1979).   In light of the instant facts, we find that

petitioner's history of losses suggests that he lacked a profit

motive in carrying on his horse activity.    Accordingly, we find

that this factor favors respondent.

Amount and Frequency of Occasional Profits

     The amount and frequency of occasional profits earned from

the activity at issue may also be indicative of a profit

objective.    Sec. 1.183-2(b)(7), Income Tax Regs.   Petitioner's

horse activity had several sources of income, yet none proved

fruitful.    While an opportunity to earn a substantial ultimate

profit in a highly speculative venture may be sufficient to

indicate that the activity is engaged in for profit even though

only losses are generated, sec. 1.183-2(b)(7), Income Tax Regs,

we are convinced that such a likelihood was too remote in the

instant case.    Accordingly, we find that this factor favors

respondent.

Petitioner's Financial Status

     The lack of substantial income from sources other than the

activity in question may indicate the existence of a profit

motive with respect to such activity.    Sec. 1.183-2(b)(8), Income

Tax Regs.    As petitioner is a successful orthopedic surgeon

earning in excess of $250,000 per year, there is little doubt

that this factor favors respondent.
                               - 17 -

Personal Pleasure or Recreation

     The absence of personal pleasure or recreation relating to

the activity in question may indicate the presence of a profit

motive.    Sec. 1.183-2(b)(9), Income Tax Regs.   As noted earlier

in this opinion, we are convinced that petitioner's horse

activity contained significant recreational aspects that gave

rise to many personal pleasures.    We find that the personal

pleasure derived from petitioner's horse activity was the

principal factor motivating his decision to enter into and carry

on such activity.    Accordingly, we find that this factor favors

respondent.

     Having considered the facts and circumstances of this case

in light of the factors set forth in section 1.183-2(b), Income

Tax Regs., we conclude that petitioner did not engage in his

horse activity with an actual and honest objective of making a

profit within the meaning of section 183.

Issue 2.    Addition to Tax, Sec. 6661

     Respondent determined that petitioners are liable for the

addition to tax pursuant to section 6661 for taxable year 1988

due to a substantial understatement of income tax.     This

determination is benefited by a presumption of correctness.       Rule

142(a).

     The addition to tax is 25 percent of any underpayment

attributable to a substantial understatement.     Sec. 6661(a).   A
                                   - 18 -

substantial understatement is one that exceeds the greater of 10

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

Sec. 6661(b)(1).    If a taxpayer has substantial authority for the

tax treatment of any item on the return, the understatement is

reduced by the amount attributable to such authority.    Sec.

6661(b)(2)(B)(i).    Similarly, the amount of the understatement is

reduced for any item adequately disclosed either on the

taxpayer's return or in a statement attached to the return.     Sec.

6661(b)(2)(B)(ii).    Because petitioner has presented no argument

on this issue other than to deny the underlying deficiencies,

respondent's determination is sustained.

Issue 3.   Accuracy-Related Penalty, Sec. 6662

     Respondent determined that petitioners are liable for the

accuracy-related penalty pursuant to section 6662 for taxable

years 1989 and 1990 because the underpayment of income tax for

such years was attributable to a substantial understatement.

Again, respondent's determination is benefited by a presumption

of correctness.     Rule 142(a).

     The accuracy-related penalty is equal to 20 percent of the

portion of an underpayment to which section 6662 applies.    Sec.

6662(a).   Section 6662(b)(2) provides that section 6662 applies

to an underpayment attributable to any substantial understatement

of income tax.     A substantial understatement is one that exceeds

the greater of 10 percent of the tax required to be shown on the
                              - 19 -

return, or $5,000.   Sec. 6662(d)(1)(A).   Petitioner has presented

no argument on this issue other than to deny the underlying

deficiencies.   Because the understatements at issue are

substantial and neither is subject to reduction pursuant to

section 6662(d)(2)(B)(i), section 6662(d)(2)(B)(ii), or section

6664(c)(1), respondent's determination is sustained.

     To reflect the foregoing,

                                           Decision will be

                                    entered under Rule 155.
