                                T.C. Memo. 2013-76



                          UNITED STATES TAX COURT



                    WILLIAM R. DODDS, Petitioner v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 23609-11.                       Filed March 13, 2013.



        Thomas Joe Doyle and Randi J. Winter, for petitioner.

        Blaine Charles Holiday, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


        KERRIGAN, Judge: Respondent determined the following deficiencies and

penalties with respect to petitioner’s Federal income tax for tax years 2007 and

2008:
                                            -2-

                       [*2]                                 Penalty
                       Year            Deficiency         sec. 6662(a)
                       2007              $39,685             $7,937
                       2008               47,757              9,551

          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 Procedure. All monetary amounts are rounded to the nearest

dollar.

          The issues for consideration are (1) whether petitioner engaged in a horse

breeding activity with the objective of making a profit within the meaning of section

183 and (2) whether petitioner is liable for accuracy-related penalties under section

6662(a).

                                  FINDINGS OF FACT

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

facts and the attached exhibits are incorporated herein by this reference. Petitioner

lived in Minnesota when he filed the petition.

Petitioner’s Accounting Practice

          Petitioner is an accountant with a master’s degree in business taxation from

the University of Minnesota. Petitioner received his undergraduate degree from St.

Cloud State University. From 1983 to January 2012 petitioner ran a successful
                                         -3-

[*3] accounting firm that he wholly owned. Petitioner typically spent 70 to 80 hours

a week at his accounting firm during tax season but no more than 20 hours a week

the rest of the year. In tax years 2007 and 2008 petitioner earned over $240,000

and over $280,000, respectively, from his work as an accountant.

Petitioner’s Horse Breeding Activity

      In 1995 petitioner decided to breed Morgan horses, purchasing two American

Morgan broodmares and one stallion. The leap from accountant to horse breeder

was not too great for petitioner; he grew up on a dairy farm and was generally

familiar with the care and maintenance of large animals, including cattle, swine,

sheep, and horses.

      Petitioner wanted to breed Morgan horses because he liked their poise, grace,

and elegance. He describes them as spirited, bright-eyed, up-headed, and easy.

Petitioner was also attracted by the history of the Morgan horse; in particular, he

enjoyed the fact that Morgan horses played a role in the Civil War. Petitioner bred

his horses under the name Aerie Meadow Morgans. Petitioner continued to

maintain his accounting practice after he started breeding horses.

      Before petitioner started his horse breeding activity, he moved to a property

with 18 acres of land. When petitioner purchased the land, it had a house with a

garage and a detached gazebo. To accommodate the horses on his property
                                         -4-

[*4] petitioner built several large structures, such as barns and lean-tos, and fenced

off approximately six acres for horse pastures.

      Petitioner managed the horse breeding activity himself. He worked over

1,500 hours per year mucking stalls, feeding and grooming the horses, maintaining

the property and grounds, administering medicine, arranging artificial inseminations,

delivering foals, and making all breeding decisions. His son, daughter, and close

friend assisted occasionally with feeding, watering, and bedding the horses.

Petitioner sometimes gave his children and the close friend monetary gifts for their

assistance. Petitioner did not ride recreationally, and he did not allow others to ride

his horses recreationally. His horses were ridden only by experienced trainers for

training and show purposes.

      Petitioner became a member of the American Morgan Association and the

North Central Morgan Association in 2000 and a member of the United States

Equestrian Federation in 2004. He also participated in horse shows. In both tax

year 2007 and 2008 petitioner participated in a local show, a regional show, and a

national show.

      In 2006 petitioner obtained a patent for a new style of horse feeder.

Petitioner designed the feeder to reduce feed waste and the risk of injury to horses.

He contracted with a marketing company for the marketing and sale of his feeder.
                                          -5-

[*5] Petitioner advertised his horses on the Aeire Meadow Morgans Web site. He

also advertised his horses in two national magazines and in local magazines for

Minnesota and surrounding States. Petitioner had a business card for his breeding

activity which he distributed to potential buyers at horse shows and other venues.

      Petitioner never had a written business plan. At first he attempted to breed

grade horses, i.e., horses that are a quality below show horses. Petitioner wanted to

sell the grade horses locally when they were weanlings so that he could avoid the

cost of raising the foals. He also wanted to avoid the high stud fees. Petitioner’s

plan was unsuccessful. In 2000 he sought advice from Charles and Cordia Pearson,

Morgan breeders, who convinced petitioner to geld his stallion and use their stallion

instead. Petitioner used their stallion until 2004.

      In 2004 petitioner decided to try to produce world-caliber foals. He stopped

using the Pearsons’ stallion and began using all national or world champion stallions

or grand national stallions. Petitioner began seeking advice from horsetrainer Eileen

O’Bradovich, who had started to train petitioner’s horses, as well as from

professional horseman Jordy Johns and from a friend who grew up raising Arabian

horses. Ms. O’Bradovich helped petitioner pick out the right stallions to breed to

his mares. Her business, however, focused on training rather than breeding, and

Ms. O’Bradovich had never trained Morgan horses before.
                                         -6-

[*6] Petitioner also researched the Morgan horse bloodlines. He studied a set of

cards he purchased from the American Morgan Horse Association. The cards

detailed the old Morgan bloodlines and showed which horses were winning horses

and “golden cross”, i.e., world-champion, Morgan stallions. Petitioner used these

cards to determine which stallions he should use so that he could produce a world

caliber horse.

      Petitioner did not maintain a separate bank account for his breeding activity.

Although petitioner used QuickBooks for his financial records, which allowed him

to separate his personal finances from his breeding activity, he commingled his

personal and horse breeding funds. Petitioner never made financial projections for

his breeding activity, nor did he maintain a budget for his breeding activity.

Petitioner was able to generate profit and loss statements from QuickBooks.

      Petitioner retained receipts relating to all expenses incurred in connection

with the horse breeding activity for the years at issue. He also insured the buildings

he used in the horse breeding activity and a number of his horses. Petitioner

depreciated assets associated with his breeding activity.

      Petitioner failed to make his horse breeding activity profitable. In tax year

2007 petitioner sold two horses. On his Schedule F, Profit or Loss From Farming,

for that year he reported $7,042 of gross income and $129,848 of expenses. In tax
                                       -7-

[*7] year 2008 petitioner sold four horses. On his Schedule F for tax year 2008

petitioner reported $11,018 of gross income and $155,676 of expenses. Petitioner

reported the following gross income, expenses, and net losses on his Schedules F for

tax years 1995 through 2011:
                                           -8-

         [*8] Year         Gross income          Expenses           Net loss
           1995                    n/a                   (1)       ($13,550)
           1996                    n/a             ---               (13,639)
           1997                    n/a             ---               (11,751)
           1998                    n/a             ---               (41,152)
           1999                    n/a             ---               (61,916)
           2000                    n/a             ---               (56,617)
           2001                    n/a             ---               (40,264)
           2002                    -0-             ---               (50,356)
           2003                $3,500              ---               (78,951)
           2004                13,359              ---             (128,767)
           2005                    5,722           ---             (125,317)
           2006                    7,500         $125,518          (118,018)
           2007                    7,042          129,848          (122,806)
           2008                11,018             155,676          (144,658)
           2009                    3,161          170,584          (167,423)
           2010                14,545             150,990          (136,445)
           2011                    7,210          185,065          (177,855)

                  1
                 The parties did not provide any information regarding the
           expenses petitioner reported for tax years 1995 through 2005.


In total petitioner accumulated a net loss of $1,448,885 from his horse breeding

activity during those tax years.
                                          -9-

[*9] Petitioner timely filed his Forms 1040, U.S. Individual Income Tax Return,

for tax years 2007 and 2008. On each tax return petitioner reported his occupation

as “accountant”. On July 15, 2011, respondent sent petitioner a notice of deficiency

regarding tax years 2007 and 2008. Respondent disallowed petitioner’s Schedule F

sales and expenses for both years because petitioner did not show that he operated

the activity for the good faith purpose of making a profit. Respondent also

determined accuracy-related penalties under section 6662(a) for both tax years. In

response petitioner filed a petition with the Court. Petitioner contends that he

engaged in his horse breeding activity to make a profit during the years at issue and

that he is not liable for the accuracy-related penalties.

                                       OPINION

Horse Breeding Activity

      Respondent determined that petitioner’s horse breeding activity was not an

activity engaged in for profit within the meaning of section 183 and disallowed loss

deductions he claimed on his Schedules F for the years at issue. Petitioner claims

that he engaged in the horse activity with an intent to realize a profit. A taxpayer

may not fully deduct expenses regarding an activity under section 162 or 212 if the

activity is not engaged in for profit. Sec. 183(a), (c); see also Keanini v.

Commissioner, 94 T.C. 41, 45 (1990). Under section 183(a), if an activity is not
                                         - 10 -

[*10] engaged in for profit, no deduction attributable to that activity is allowed

except to the extent provided by section 183(b). In relevant part, section 183(b)

allows deductions that would have been allowable had the activity been engaged in

for profit but only to the extent of gross income derived from the activity (reduced

by deductions attributable to the activity that are allowable without regard to

whether the activity was 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.” For expenses to be fully deductible under section 162 or

212, taxpayers must show that they engaged in the activity with the primary

objective of making a profit. See Westbrook v. Commissioner, 68 F.3d 868, 875

(5th Cir. 1995), aff’g per curiam T.C. Memo. 1993-634; see also Foster v.

Commissioner, T.C. Memo. 2012-207.

      Under section 183(d), an activity that consists in major part of the breeding,

training, showing, or racing of horses is presumed to be engaged in for profit if the

activity produces gross income in excess of the deductions for any two of seven

consecutive years, unless the Commissioner establishes to the contrary. See also

Wadlow v. Commissioner, 112 T.C. 247, 250 (1999). Petitioner’s horse breeding
                                         - 11 -

[*11] activity failed to produce income in excess of its deductions at any time during

its operation. Accordingly, the presumption does not apply in this case.

      The expectation of a profit need not be reasonable, but the taxpayer must

conduct the activity with the actual and honest objective of making a profit. Keating

v. Commissioner, 544 F.3d 900, 904 (8th Cir. 2008), aff’g T.C. Memo. 2007-309.

We give greater weight to objective facts than to the taxpayer’s statement of intent.

Sec. 1.183-2(a), Income Tax Regs.; see also Keating v. Commissioner, 544 F.3d at

904. Evidence from years after the years in issue is relevant to the extent it creates

inferences regarding the taxpayer’s requisite profit objective in earlier years. E.g.,

Foster v. Commissioner, T.C. Memo. 2012-207; Bronson v. Commissioner, T.C.

Memo. 2012-17.

      Generally, a taxpayer bears the burden of proving that the requisite profit

objective exists. Westbrook v. Commissioner, 68 F.3d at 876; see also Rule

142(a); Foster v. Commissioner, T.C. Memo. 2012-207. In order to shift the

burden, the taxpayer, among other things, must introduce credible evidence with

respect to that issue. Sec. 7491(a)(1); see also Higbee v. Commissioner, 116 T.C.

438, 441 (2001). Credible evidence is evidence the court would find sufficient upon

which to base a decision on the issue in favor of the taxpayer if no contrary

evidence were submitted. Rendall v. Commissioner, T.C. Memo. 2006-174, aff’d,
                                         - 12 -

[*12] 535 F.3d 1221 (10th Cir. 2008); see Higbee v. Commissioner, 116 T.C. at

442-443. As discussed below, petitioner failed to provide evidence for many of the

issues. If we were to consider solely the evidence petitioner presented, we would

find that petitioner did not engage in the horse breeding activity for profit as a matter

of fact. Therefore, petitioner failed to provide credible evidence within the meaning

of section 7491(a)(1), and the burden of proof remains with petitioner.

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

following nine factors used to determine whether an activity is engaged in for profit:

(1) whether the taxpayer carries on the activity in a businesslike manner; (2) the

expertise of the taxpayer and his or her advisors; (3) the time and effort expended by

the taxpayer in carrying on the activity; (4) whether the taxpayer expects that the

assets used in the activity might appreciate in value; (5) whether the taxpayer has

had success carrying on other similar 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 taxpayer’s financial status; and (9) elements of personal

pleasure or recreation. All facts and circumstances are to be taken into account, and

no single factor is determinative. Sec. 1.183-2(b), Income Tax Regs.; see also

Keating v. Commissioner, 544 F.3d at 904.
                                        - 13 -

[*13] 1.     Manner in Which Petitioner Carried On the Activity

      The fact that the taxpayer carries on an activity in a businesslike manner and

maintains complete and accurate books and records may indicate a profit motive.

Sec. 1.183-2(b)(1), Income Tax Regs. Characteristics of a businesslike operation

include the preparation of a business plan and, in the case of horse breeding and

sales, a consistent and concentrated advertising program. Bronson v.

Commissioner, T.C. Memo. 2012-17 (citing Golanty v. Commissioner, 72 T.C. 411,

431 (1979), aff’d without published opinion, 647 F.2d 170 (9th Cir. 1981), Keating

v. Commissioner, T.C. Memo. 2007-309, and Dodge v. Commissioner, T.C. Memo.

1998-89, aff’d without published opinion,188 F.3d 507 (6th Cir. 1999)). The

regulations further provide that a profit motive is indicated when a taxpayer changes

operating methods or adopts new techniques with an intent to improve profitability.

Sec. 1.183-2(b)(1), Income Tax Regs.

      Petitioner advertised his horses on the Aeire Meadow Morgans Web site, in

national and local magazines, and with his business cards at horse shows and other

venues. In those cases where we have found that an animal breeder operated in a

businesslike manner, generally the breeder not only participated in shows but

engaged in other forms of substantial advertising. See, e.g., Engdahl v.

Commissioner, 72 T.C. 659, 667 (1979); Keating v. Commissioner, T.C. Memo.
                                         - 14 -

[*14] 2007-309. The taxpayer’s advertising efforts, however, may not be

insubstantial compared to the cost of the activity. See Bronson v. Commissioner,

T.C. Memo. 2012-17. Because petitioner failed to provide any evidence regarding

the cost of his advertising efforts, we are unable to determine that his advertising

efforts were substantial compared to the cost of his horse breeding activity.

      Petitioner failed to provide a business plan that included more than just

generalized goals. See Foster v. Commissioner, T.C. Memo. 2012-207. Petitioner

testified: “My initial plan wasn’t written, but my plan was to breed grade horses”.

When he abandoned that plan, petitioner testified that he was aiming to breed world

caliber foals that could become successful show horses. Petitioner’s plan is

inadequate for us to conclude that he had an established business plan. See Keating

v. Commissioner, T.C. Memo. 2007-309 (finding that the taxpayer’s plan “to raise

good quality horses, well-trained horses, horses that will give * * * [the taxpayer] a

good reputation, horses that will do well in the market” was inadequate for us to

conclude that the taxpayer had an established business plan).

      Petitioner likewise failed to maintain a budget or to make any financial

projections, economic forecast, or other analyses demonstrating financial

management or planning. See Keating v. Commissioner, 544 F.3d at 904; Foster v.

Commissioner, T.C. Memo. 2012-207. Petitioner used profit and loss
                                        - 15 -

[*15] statements prepared with QuickBooks, but there is scant evidence that

petitioner used them for the important purposes of cutting expenses, increasing

profits, and evaluating the overall performance of the operation. See Golanty v.

Commissioner, 72 T.C. at 430; Foster v. Commissioner, T.C. Memo. 2012-207.

      Petitioner retained all receipts and insured his buildings and some of the

horses. Petitioner, however, commingled the financial affairs of his horse breeding

activity with his personal finances. Although QuickBooks allowed petitioner to

separate his personal finances from his breeding activity, he paid all the expenses of

the horse activity from his personal account. This commingling of personal and

activity funds is not indicative of businesslike practices. See Montagne v.

Commissioner, T.C. Memo. 2004-252, aff’d, 166 Fed. Appx. 265 (8th Cir. 2006).

      Perhaps the most important indication of whether an activity is being

performed in a businesslike manner is whether the taxpayer implements methods for

controlling losses, including efforts to reduce expenses and generate income. See

Foster v. Commissioner, T.C. Memo. 2012-207; Dodge v. Commissioner, T.C.

Memo. 1998-89. Petitioner provided no evidence showing that he tried to reduce

his expenses, abandoned specific activities that had proven unprofitable, or

implemented any cost-cutting measures. Rather, petitioner maintained a steady
                                        - 16 -

[*16] pace of losses which skyrocketed to six figures in 2004, and petitioner

continued to hemorrhage money from 2004 to 2011, including the years at issue.

      Petitioner’s failure to produce any significant income was a key factor in his

failure to earn a profit. See Foster v. Commissioner, T.C. Memo. 2012-207; Dodge

v. Commissioner, T.C. Memo. 1998-89. Petitioner contends that he made changes

in his operations over the years in an effort to increase his income. Those changes

involved switching from the Pearsons’ stallion in 2000 and then switching to

national, world champion, or grand national stallions in 2004. Petitioner did not

produce any evidence demonstrating that he made a careful and thorough

investigation of the potential profitability of these changes before making them. See

Foster v. Commissioner, T.C. Memo. 2012-207 (citing Taube v. Commissioner, 88

T.C. 464, 481 (1987)).

      On balance, we are not persuaded that petitioner carried on his horse activity

in a businesslike manner. This factor weighs against a profit objective.

      2.     Expertise of Petitioner and His Advisors

      The taxpayer’s expertise, research, and extensive study of an activity, as well

as his or her consultation with experts, may be indicative of a profit motive. See

sec. 1.183- 2(b)(2), Income Tax Regs. As a successful accountant, petitioner did

not need to seek further business and tax advice when he started his breeding
                                          - 17 -

[*17] activity. Petitioner had knowledge about raising horses and other large farm

animals from growing up on a farm, but his knowledge was not extensive; there is

no indication that he garnered any horse breeding experience at that time. During

the course of his horse breeding activity, petitioner consulted with persons who

were knowledgeable about horse breeding, including professional breeders, a

professional trainer, and a professional horseman, and petitioner followed the advice

they gave him. See id.; see also Foster v. Commissioner, T.C. Memo. 2012-207.

Petitioner spent time studying the Morgan bloodlines, but the record does not

indicate that petitioner spent an extensive amount of time studying the bloodlines.

Petitioner, however, hired a trainer who lacked experience with Morgan horses. On

balance, this factor weighs slightly in favor of a profit objective.

      3.     Time and Effort Petitioner Expended in Carrying On the Activity

      The taxpayer’s devotion of much of his or her personal time and effort to

carrying on an activity may indicate a profit motive, particularly if the activity

does not involve substantial personal or recreational aspects. Sec. 1.183-2(b)(3),

Income Tax Regs. Although petitioner continued to maintain his accounting

practice, he spent over 1,500 hours each year working on his horse breeding

activity, often performing hard manual and menial tasks such as feeding and
                                         - 18 -

[*18] walking the horses and mucking stalls. See Foster v. Commissioner, T.C.

Memo. 2012-207 (the taxpayers demonstrated the requisite profit objective when

they spent 20 hours a week doing hard manual and menial tasks in their horse

activity). This factor weighs in favor of a profit objective.

      4.     Expectation That the Horses May Appreciate in Value

      An expectation that assets used in the activity will appreciate in value may

indicate a profit motive even if the taxpayer derives no profit from current

operations. Sec. 1.183-2(b)(4), Income Tax Regs. Petitioner credibly testified that

he expected his horses would appreciate because of his successful breeding program

and that he believed he could eventually produce a “golden cross” Morgan horse

capable of garnering stud fees exceeding $10,000 and a sale price exceeding

$100,000. Petitioner also provided some evidence that his 18-acre property

increased in value over time, from an estimated $207,000 in 2002 to an estimated

$361,900 in 2009.

      A profit objective, however, may be inferred from such expected

appreciation of the activity’s assets only where the appreciation exceeds operating

expenses and would be sufficient to recoup the accumulated losses of prior years.

Foster v. Commissioner, T.C. Memo. 2012-207; see Golanty v. Commissioner, 72

T.C. at 427-428. The appreciation of petitioner’s horse breeding assets does not
                                         - 19 -

[*19] begin to approach the amount of losses petitioner has reported since the

beginning of his horse activity. Petitioner also failed to provide any evidence

linking his 18-acre property’s increase in value to his horse breeding activity.

Without more information, we cannot conclude that the property increased in value

because of petitioner’s horse breeding activity. On balance, this factor is neutral.

      5.     Petitioner’s Success in Similar Activities

      Section 1.183-2(b)(5), Income Tax Regs., provides, in pertinent part: “The

fact that the taxpayer has engaged in similar activities in the past and converted

them from unprofitable to profitable enterprises may indicate that he is engaged in

the present activity for profit”. Although petitioner successfully ran his accounting

practice, his work as an accountant is not sufficiently similar to operating a horse

breeding activity to indicate that he could do so successfully. See Berry v.

Commissioner, T.C. Memo. 2000-109. This factor weighs against a profit

objective.

      6.     Petitioner’s History of Income or Losses

      A history of continued losses with respect to an activity may indicate a lack

of a profit motive. See sec. 1.183-2(b)(6), Income Tax Regs. While a series of

losses during the initial or startup stage of an activity may not necessarily indicate
                                        - 20 -

[*20] a lack of a profit motive, a record of large losses over many years is

persuasive evidence that the taxpayer did not have such a motive. Golanty v.

Commissioner, 72 T.C. at 426; Foster v. Commissioner, T.C. Memo. 2012-207.

      An activity’s cumulative losses should not be of such a magnitude that an

overall profit on the entire operation, including recoupment of past losses, could not

possibly be achieved. Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965), aff’d,

379 F.2d 252 (2d Cir. 1967); Foster v. Commissioner, T.C. Memo. 2012-207. If

losses are sustained because of unforeseen or fortuitous circumstances beyond the

control of the taxpayer, such losses would not be an indication of the lack of a profit

motive. See sec. 1.183-2(b)(6), Income Tax Regs.

      Petitioner realized no profits whatsoever in 17 years of engaging in his

horse breeding activity. He contends that his losses are not an indication that he

lacked a profit objective because the losses were caused by factors beyond his

control. Petitioner cites unexpected deaths, miscarriages, stillborn foals, and the

negative effect of the recession on horse sales. We acknowledge that horse

breeding is a speculative activity, but these events hardly account for an unbroken

string of 17 years of losses. Furthermore, petitioner did not show that his horse

breeding activity would have been profitable if events beyond his control had not
                                         - 21 -

[*21] occurred. See Burger v. Commissioner, 809 F.2d 355, 360 n.8 (7th Cir.

1987), aff’g T.C. Memo. 1985-523; Foster v. Commissioner, T.C. Memo. 2012-

207.

       Petitioner also contends that because he switched from trying to breed grade

horses to world caliber horses in 2004, his horse breeding activity was in its initial

or startup stage in tax years 2007 and 2008. Petitioner, however, continuously

maintained a horse breeding activity from 1995 through 2011 with the same

knowledge, equipment, and space. The only change petitioner made was from

trying to produce one caliber of horse to trying to produce another caliber of horse.

We are unconvinced by this argument, and we decline to “reset the clock” in 2004

simply because petitioner altered the goal of his horse breeding activity.

       Petitioner further contends that he could potentially earn a substantial profit

with one outstanding horse. The possibility of a speculative profit in a taxpayer’s

horse activity, however, is insufficient to outweigh the absence of profits for a

sustained period of years. See Foster v. Commissioner, T.C. Memo. 2012-207; see

also Chandler v. Commissioner, T.C. Memo. 2010-92, aff’d, 481 Fed. Appx. 400

(9th Cir. 2012); McKeever v. Commissioner, T.C. Memo. 2000-288. This factor

weighs heavily against a profit objective.
                                        - 22 -

[*22] 7.     Amount of Petitioner’s Occasional Profits

      The amount of profits in relation to the amount of losses incurred may provide

useful criteria in determining the taxpayer’s intent. Sec. 1.183-2(b)(7), Income Tax

Regs. Petitioner never earned a profit from his horse breeding activity. This factor

weighs against a profit objective.

      8.     Petitioner’s Financial Status

      Substantial income from sources other than the activity may indicate that the

activity is not engaged in for profit. Sec. 1.183-2(b)(8), Income Tax Regs. A

taxpayer with substantial income unrelated to the activity can more readily afford a

hobby. Foster v. Commissioner, T.C. Memo. 2012-207. This is particularly true if

the losses from the activity might generate substantial tax benefits. Golanty v.

Commissioner, 72 T.C. at 429; Foster v. Commissioner, T.C. Memo. 2012-207.

Petitioner’s substantial income from his accounting firm allowed him to continue his

horse breeding activity despite 17 years of substantial losses. See Foster v.

Commissioner, T.C. Memo. 2012-207. Petitioner’s horse breeding activity also

generated generous tax savings in the form of net losses that offset petitioner’s

substantial accounting income. This factor weighs against a profit objective.
                                         - 23 -

[*23] 9.     Elements of Personal Pleasure or Recreation

      The presence of personal motives and recreational elements in carrying on an

activity may indicate that the activity is not engaged in for profit. Sec. 1.183-

2(b)(9), Income Tax Regs. Petitioner argues that neither he nor his family members

rode his horses and that his horse breeding activity required him to engage in hard

manual labor. We question, however, whether he would have continued his money-

losing horse breeding activity for 17 years unless he received some satisfaction from

the work. See Foster v. Commissioner, T.C. Memo. 2012-207 (the taxpayers’ horse

activity involved hard work, but the taxpayers would not have continued the losing

horse activity for many years had they not received satisfaction from the work). It is

more likely that such satisfaction, rather than a profit objective, accounts for

petitioner’s persistence. On balance, this factor is neutral.

Conclusion

      After weighing all the facts and circumstances in the light of the relevant

factors, we conclude that petitioner did not engage in his horse breeding activity for

the years at issue with the requisite profit objective. Petitioner’s many years of

losses without a meaningful plan for recouping them are most persuasive. See id.
                                        - 24 -

[*24] Accordingly, we sustain respondent’s determination regarding petitioner’s

horse breeding activity.

Accuracy-Related Penalties Under Section 6662(a)

      Respondent determined that petitioner is liable for accuracy-related penalties

pursuant to section 6662(a) for tax years 2007 and 2008. Section 6662(a) adds to a

tax 20% of any underpayment attributable to, among other things, (1) negligence or

disregard of rules or regulations within the meaning of section 6662(b)(1); or (2) any

substantial understatement of income tax within the meaning of section 6662(b)(2).

A substantial understatement of income tax is defined as an understatement that

exceeds the greater of $5,000 or 10% of the income tax required to be shown on the

return for the taxable year. Sec. 6662(d)(1)(A).

      The Commissioner bears the burden of production with respect to this

penalty. Sec. 7491(c). This burden is satisfied if the Commissioner comes

forward with sufficient evidence indicating that it is appropriate to impose the

relevant penalty. Higbee v. Commissioner, 116 T.C. at 446. Respondent

determined that petitioner should have reported $58,092 on his 2007 Federal

income tax return and $70,846 on his 2008 Federal income tax return. Respondent

also determined that petitioner understated his income tax by $39,685 for tax year
                                         - 25 -

[*25] 2007 and by $47,757 for tax year 2008, which are both greater than $5,000

and greater than 10% of the income tax required to be shown on the returns for the

taxable years. Thus, respondent has carried his burden to show that petitioner

substantially understated his income tax for tax years 2007 and 2008.

      If a taxpayer had reasonable cause for and acted in good faith regarding part

of the underpayment, no penalty is imposed on that part. See sec. 6664(c)(1); sec.

1.6664-4(a), Income Tax Regs. An important factor for demonstrating reasonable

cause and good faith is the extent of the taxpayer’s effort to determine the proper

tax liability. Sec. 1.6664-4(b)(1), Income Tax Regs. Petitioner, a successful

accountant, did not provide any evidence regarding what, if any, effort he made to

determine his proper tax liability at the time of filing his 2007 or 2008 tax return.

Each year petitioner sustained significant losses from his horse breeding activity,

and any gross income he received from that activity was substantially lower than his

losses. Yet, he did not seek advice about whether to continue to treat his horse

activity as engaged in for profit. Petitioner is well educated and familiar with

Federal income tax laws and regulations. His experience, knowledge, and education

weigh against him. See Brown v. Commissioner, T.C. Memo. 2011-83, aff’d, 693

F.3d 765 (7th Cir. 2012). Petitioner failed to show that he had reasonable cause for

and acted in good faith regarding the underpayment.
                                        - 26 -

[*26] We hold that petitioner is liable for the substantial understatement penalty

under section 6662(a) and (b)(2). We need not address the applicability of the

penalty on the grounds of negligence or disregard of rules or regulations within the

meaning of section 6662(b)(1) for tax years 2007 and 2008. See sec. 1.6662-2(c),

Income Tax Regs. Contentions we have not addressed are irrelevant, moot, or

meritless.

      To reflect the foregoing,


                                                 Decision will be entered for

                                       respondent.
