Roberts v. Comm'r
This text of 2014 T.C. Memo. 74 (Roberts v. Comm'r) is published on Counsel Stack Legal Research, covering United States Tax Court primary law. Counsel Stack provides free access to over 12 million legal documents including statutes, case law, regulations, and constitutions.
Opinion
Decision will be entered under
PARIS,
The issues for decision are: (1) whether petitioner engaged in various horse-related activities during tax years 2005, 2006, 2007, and 2008 with the expectation of making a profit; (2) whether petitioner is liable for accuracy-related penalties under
Some of the facts have been stipulated and are so found. The stipulation of facts and the exhibits received into evidence are incorporated herein by this reference. Petitioner lived in Indiana when he filed the petition.
In 1969 petitioner purchased an abandoned restaurant on Washington Street highway in Indianapolis, Indiana, around five miles from his current home. He worked two jobs and saved money for several years to be able to afford the *76 purchase. The restaurant had originally been built as part of the Horne's highway restaurant chain and came with a reputation of staying open 24 hours a day, seven days a week. An additional investor helped petitioner reopen the restaurant as a steakhouse called the Sherwood Inn. Petitioner, a high school graduate, did not perform any business studies or projections before opening the restaurant and instead anchored his business plan on "hard work". The Sherwood Inn was initially very successful but closed because of significant kitchen fire damage several months after*78 opening.
Petitioner sought to collect on the restaurant's insurance policy and eventually settled his claim nearly a year after the Sherwood Inn had burned. Petitioner was left without a source of income and used his personal savings to support his family of three children during this time.2 Because the insurance settlement was insufficient to rebuild a fully equipped restaurant, petitioner reopened the business as a bar around 1972.
The bar was near an airport and attracted airport employees at the end of their shifts. Specifically, "airport controllers" would often patronize petitioner's bar to celebrate passing certification tests. The "airport controllers" asked petitioner to arrange for exotic dancers to perform at the celebrations, and he *77 complied. Soon thereafter, the nights featuring exotic dancers became popular and well-attended events.
Although petitioner recognized the financial potential of operating a gentlemen's club, he chose to sell the business for moral reasons around 1973. The sale agreement required the buyers to make payments directly to petitioner. Petitioner then opened a pizza parlor about five*79 miles from his former bar. Around 1974 petitioner reclaimed the bar because the buyers failed to make payments. After explaining the specific circumstances to his family, petitioner continued to operate the bar on Washington Street highway as a gentlemen's club called Dancers.
Dancers turned into a very profitable venture, and petitioner expanded his business by opening other nightclubs and restaurants. At one point petitioner owned six operating establishments and a staffing company to coordinate personnel. Every restaurant or bar that petitioner opened was eventually successful and was still operating at the time of trial.
Petitioner actively participated in trade organizations that supported the nightclub industry. Petitioner originally joined the associations to learn about the industry and to stay current on industry techniques. Eventually petitioner ascended to multiple leadership roles within the organizations. Petitioner *78
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Decision will be entered under
PARIS,
The issues for decision are: (1) whether petitioner engaged in various horse-related activities during tax years 2005, 2006, 2007, and 2008 with the expectation of making a profit; (2) whether petitioner is liable for accuracy-related penalties under
Some of the facts have been stipulated and are so found. The stipulation of facts and the exhibits received into evidence are incorporated herein by this reference. Petitioner lived in Indiana when he filed the petition.
In 1969 petitioner purchased an abandoned restaurant on Washington Street highway in Indianapolis, Indiana, around five miles from his current home. He worked two jobs and saved money for several years to be able to afford the *76 purchase. The restaurant had originally been built as part of the Horne's highway restaurant chain and came with a reputation of staying open 24 hours a day, seven days a week. An additional investor helped petitioner reopen the restaurant as a steakhouse called the Sherwood Inn. Petitioner, a high school graduate, did not perform any business studies or projections before opening the restaurant and instead anchored his business plan on "hard work". The Sherwood Inn was initially very successful but closed because of significant kitchen fire damage several months after*78 opening.
Petitioner sought to collect on the restaurant's insurance policy and eventually settled his claim nearly a year after the Sherwood Inn had burned. Petitioner was left without a source of income and used his personal savings to support his family of three children during this time.2 Because the insurance settlement was insufficient to rebuild a fully equipped restaurant, petitioner reopened the business as a bar around 1972.
The bar was near an airport and attracted airport employees at the end of their shifts. Specifically, "airport controllers" would often patronize petitioner's bar to celebrate passing certification tests. The "airport controllers" asked petitioner to arrange for exotic dancers to perform at the celebrations, and he *77 complied. Soon thereafter, the nights featuring exotic dancers became popular and well-attended events.
Although petitioner recognized the financial potential of operating a gentlemen's club, he chose to sell the business for moral reasons around 1973. The sale agreement required the buyers to make payments directly to petitioner. Petitioner then opened a pizza parlor about five*79 miles from his former bar. Around 1974 petitioner reclaimed the bar because the buyers failed to make payments. After explaining the specific circumstances to his family, petitioner continued to operate the bar on Washington Street highway as a gentlemen's club called Dancers.
Dancers turned into a very profitable venture, and petitioner expanded his business by opening other nightclubs and restaurants. At one point petitioner owned six operating establishments and a staffing company to coordinate personnel. Every restaurant or bar that petitioner opened was eventually successful and was still operating at the time of trial.
Petitioner actively participated in trade organizations that supported the nightclub industry. Petitioner originally joined the associations to learn about the industry and to stay current on industry techniques. Eventually petitioner ascended to multiple leadership roles within the organizations. Petitioner *78 ultimately was president of the Indiana Licensed Beverage Association for four years and president of the Indiana Nightclub Association for eight years. The organizations helped nightclub owners—like petitioner—protect their investments by advocating for the*80 businesses' specific interests. For example, the organizations helped defend bars against disgruntled neighbors who were unhappy with a bar's location or late hours. Petitioner undoubtedly learned valuable lessons from the trade organizations and implemented the valuable knowledge in his own operations.
Petitioner also expanded his business activities by investing in real estate. One of the properties that petitioner acquired was a 50-acre parcel of land that fronted Washington Street. This parcel, bought in 1987, was directly across the street from Dancers and about five miles from petitioner's current home. Petitioner paid about $250,000 for the 50 acres and rented it to a farmer for around 10 years. In 1997 or 1998 petitioner bought a 45-acre parcel of land directly north of the 50-acre parcel for around $400,000.3*81 The former owner had used this land to board horses, and there was an operational stable on the property. Petitioner recognized there was a small income potential from the stable but actually *79 intended to capitalize on the land by creating a 95-acre contiguous plot and through appreciation, not through stable rental receipts.
In the mid-1990s petitioner began to ease out of the nightclub industry. Around this time he sold all of his shares of the nightclub business to his three grown children. Petitioner also eventually relinquished control of his nightclub businesses but continued to consult with the new management team. Because petitioner had over 30 years of experience in the nightclub industry and his experience was a valuable asset to the businesses, he created a new corporate entity to structure a management consulting agreement. As his adult children became more experienced, petitioner transitioned from his previous onsite management to providing most of his day-to-day services through cell phone consultations. Petitioner's newly adopted cell phone management style and reduced interest in his nightclub businesses allowed him to think about long-term life goals.
Around the time petitioner bought the Morris Street property, he was contemplating a career change. He read that owning restaurants and nightclubs was a particularly dangerous occupation and decided to change*82 his life. Petitioner started participating less in the nightclub businesses and started an insulation company as well as a used car dealership. While petitioner did not lose money in *80 these new endeavors, he was not happy working his new jobs. He was eventually bought out of the insulation business, and he chose to close the car dealership.
In 1998 or 1999 the Indiana Thoroughbred Owners and Breeders Association invited petitioner—as an owner of a horse boarding stable—to attend a free dinner and a tour of Hoosier Park, the first horse racing track to be opened in Indiana. The breeders association presented basic information about horse racing and the potential financial gains associated with the activity. Petitioner was interested in the financial prospect of horse racing even though he had been to a horse track only once before the event.
Petitioner asked a trainer who already worked at his boarding stables to "show [him] the ropes" of horse racing. The trainer taught petitioner some initial basic horse skills, and petitioner decided to acquire his owner's license. In 1999 petitioner purchased his first two young horses for $1,000 each and proceeded to work*83 with his trainer to prepare the young horses for the racetrack. Petitioner also bought two horse racing videos to help explain more about horse racing and built his first training track on the Morris Street property. In his first year of racing petitioner's net income was around $18,000 from his two horses. Petitioner *81 recognized the ease of accounting for only two horses, but he was also enticed by the profit potential of racing more horses. He decided he liked the activity and bought more horses.
Petitioner used several trainers in his first few years of horse racing and learned more about the industry.4 He increased his personal racing stable from 2 horses in 1999 to 10 horses in 2001 and also bought a breeding stallion. If he had a question about the business that his trainer could not answer, petitioner would turn to other experienced trainers because he did not "have twenty years to learn". Petitioner began working every day at the Morris Street property to develop the skills needed to become a licensed trainer, and he passed the trainer's license test in 2002. Unlike an owner's license, the trainer's license is much harder to obtain, and the State of Indiana required an applicant*84 to pass a rigorous test on a range of subjects from horse bridle construction to equine medication.
In 2004 petitioner started consulting a specialized professional called a blood stock agent for horse purchasing and breeding advice so he could substantially expand the bloodlines of the horses in his breeding program. By 2005 petitioner felt comfortable with his knowledge of horse racing and wanted to build his own horse training facility on the Morris Street property. The original *82 boarding stable was in disrepair and not suitable for petitioner's intended activity. Petitioner started building a new facility on the Morris Street property, but the City of Indianapolis attempted to stop him from training horses despite the agricultural zoning of the property. The city raised his property taxes from around $1,000 to $17,000 per year and was fining him $100 for every day that he was out of compliance. Further, before he could construct any new structures, the city required all new buildings, including barns, to meet strict city building codes. For example, the city required petitioner to hire an architect to design*85 and draw the proposed barns before construction could commence. The city's actions discouraged petitioner from building on the Morris Street property, and he started looking for a new location to build a horse training facility.
Around 2005 an unrelated party offered to buy the entire 95-acre Morris Street property from petitioner for around $2.2 million,5 and in June 2006 petitioner closed the sale. Petitioner chose to recognize gain on the 45-acre parcel and reinvest the proceeds from the 50-acre parcel through a
Petitioner decided to build a first-class training facility on the Mooresville property, and he sought out expert advice for its design. He asked his trusted blood stock agent to help design the new training facility, and the bloodstock agent advised petitioner on many aspects of the new facility. The facility—completed and placed in service in 2007—includes a large training track, portable horse stalls, unique rehabilitation equipment, several specialized training areas, and small apartments for employees. In petitioner's view, he built an extraordinary training facility unmatched in the State of Indiana, offering the unique aspect that his facility is used to condition horses rather than race horses. *84 As a new participant in the race horse industry petitioner developed his own training philosophy. He determined that to be successful he needed to motivate a horse to race rather than force the horse to race, and he built his horse facilities specifically for conditioning and motivating. The move*87 to 180 acres also allowed him to offset his previously considerable hay expense by using a part of the Mooresville property to grow hay for his horses, and he purchased a significant amount of equipment to harvest and process the horse hay. In addition, the Mooresville property was large enough that petitioner rented out about 90 acres of the land for around $20,000 a year.
In the 2005 through 2008 tax years petitioner was involved in multiple aspects of the race horse industry, including boarding, breeding, training, and racing horses.8 Petitioner primarily raced horses in Indiana but also raced at least 11 races per year in Kentucky and intermittently raced in other States including Ohio, Louisiana, North Dakota, Minnesota, and West Virginia.9 Before buying the Mooresville property, petitioner split his time between the track and his training *85 operation, but in 2007 he hired a full-time assistant trainer when he started his operations at the Mooresville property. During racing season petitioner's assistant trainer worked at the racetrack while petitioner worked at the training facility. Petitioner structured the arrangement so that he collected fees when his trainer performed services*88 for third parties. Petitioner did most of the manual labor to keep the facility in "excellent condition", while his assistant coordinated each horse on race day.
Petitioner's evenings were now generally spent choosing the races in which each horse would compete. He spent substantial time studying track condition books and picking specific races for specific horses. This required matching the attributes of a horse to the requirements of each race. If petitioner erred, he could have been fined for not meeting race requirements. But more importantly, because many of the races were "claiming races", his horse might have been purchased cheaply if the horse was worth more than the claiming amount.10 In petitioner's view, "find[ing] the right race for the right horse * * *[i]s the secret to" the horse *86 racing business,*89 and it took him some time to learn the skill. To ensure compliance with racing regulations and entry strategy, petitioner would often confer with his assistant trainer about race entries. This strategy has produced some successful horses, and one of petitioner's horses was nominated to run in the Triple Crown Races.
Petitioner suffered several mishaps during his first few years of horse racing. Several of his best horse prospects were injured or killed in unfortunate accidents or lost during foaling season. For example, petitioner has lost numerous horses to lightning strikes and in-race injuries. Also, after moving to the Mooresville property petitioner*90 was also swindled when a fence builder substituted flimsy poplar lumber to build a paddock fence rather than the agreed-upon oak. Before petitioner could rebuild the poplar fence, two stallions were spooked, stampeded through the fence, and died on the impaling timbers. The loss of the stallions and the cost of a replacement fence were serious setbacks to petitioner. Additionally, in 2008 many of his horses were captured in a quarantined stable when another owner's horse tested positive for a contagious infection within the same building. As a result petitioner could not race any of these horses for a significant part of the 2008 season.
Paralleling his participation in nightclub trade associations, petitioner joined several professional horse racing associations, and from 2005 through 2008 he served as a board member for two of the organizations.11 In 2007 petitioner's peers asked him to run for a leadership position within the Indiana Horsemen's Benevolent and Protective Association (HBPA). The HBPA, in addition to other missions, was responsible for allocating broadcasting funds and negotiating race purse structure. After serving as*91 an HBPA board member for over a year, petitioner resigned to spend more time training horses.
Also similar to his nightclub professional activities, petitioner was involved in lobbying the Indiana State Legislature for horse racing interests. Specifically, petitioner acted as a sounding board for his bloodstock agent, who was a key Indiana horse racing lobbyist. When he was preparing to testify or lobby at the State legislature, the bloodstock agent would stay at petitioner's house, and petitioner would help the bloodstock agent prepare to testify in support of Indiana professional horse racing. In the spring of 2007 the lobbying activities were successful and helped pass legislation to permit slot machines at racetracks. *88 House Bill No. 1835, the "slot bill", substantially increased the purses for horse racing in Indiana. For example, the new law increased a $13,000 purse to a $35,000 purse for one race. Further, the bill led to more races for unproven prospects, allowing trainers more opportunities to race*92 young horses.
Petitioner's certified public accountant (CPA) had handled his nightclub business accounting needs for about 20 years, and he used the same CPA for his horse-related activities. Petitioner first met this CPA through a mutual acquaintance after being dissatisfied with several other accountants. Petitioner continuously used this same CPA for his accounting needs, including representation during two audits before the tax years in issue. Neither of the prior audits resulted in an increased tax deficiency, and he continued to seek the CPA's tax advice on tax matters.
Petitioner used a rudimentary accounting system for all of his businesses, including his horse-related finances. Petitioner gave his CPA receipts for cash expenditures and relied on canceled checks and bank statements to track expenses. Some of these receipts were turned over to respondent in bundled reclosable plastic bags. For gross receipts, petitioner partly relied on a complex Internet database devoted to horse racing records. The Internet database is extensive and *89 tracks, inter alia, each horse, trainer, owner, and jockey. The database keeps detailed records of each horse's history,*93 complete with total earnings, earnings per start, and earnings per year. The database is maintained by a private organization and is publicly available. Petitioner also tracked the cost of boarding a horse and the amount of feed each of his horses required. He knew the cost of keeping each of his horses at his property or boarding them elsewhere during the racing season.
For tax years 1999 through 2006 petitioner reported horse-racing income, expenses, and deductions from his horse-related activities on Schedules C, Profit or Loss From Business, of his personal income tax returns. In addition, he reported what was described as the horse farm portion of the income, expenses, and deductions on Forms 1120S, U.S. Income Tax Return for an S Corporation, for an S corporation he owned, Merrill C. Roberts, Inc. Petitioner then reported the net ordinary income or loss and any separately stated items reported by the S corporation on its corporate income tax returns on various schedules to his personal income tax returns for the corresponding years. Petitioner switched his tax reporting in 2007. Beginning in 2007 petitioner began reporting all of the horse-related income, expenses, and deductions*94 on the S corporation forms. On his 2005 Schedule C petitioner reported income of $64,948 and deductions of $162,450 for a loss of $97,502 for his horse-related activities. The 2005 Form *90 1120S shows income of $47,247 and deductions of $103,165 for a loss of $55,918 in horse-related activities. On his 2006 Schedule C petitioner reported income of $184,661 and $169,809 of deductions for a profit of $14,852. The 2006 Form 1120S shows income of $38,013 and deductions of $83,469 for a loss of $45,456. The 2007 Form 1120S shows income of $258,433 and deductions of $356,684 for a loss of $98,251. For tax year 2008, the year in which petitioner's horses were quarantined for a significant portion of the race season, the Form 1120S shows income of $65,563 and deductions of $357,451 for a loss of $291,888.12
In 2008 while preparing his 2007 tax return*95 some of petitioner's financial records were permanently lost when a former girlfriend burned the records in a fireplace. Additionally, petitioner's personal returns reflect less than $3,000 in gambling income for all of the tax years in issue.
The Commissioner's determinations in a notice of deficiency are presumed correct, and the taxpayer generally bears the burden of proving that the *91 determinations are in error.
It is unclear whether petitioner complied with all the substantiation requirements or complied with all relevant recordkeeping requirements. The parties' dispute concerns whether petitioner engaged in his horse-related activities with the requisite profit objective, and the very little evidence provided in regard to petitioner's rudimentary style of recordkeeping did not show the adequacy of petitioner's substantiation or recordkeeping practices with respect to the requirements of
Under
The existence of the requisite profit objective is a question of fact that must be decided on the basis of all of the facts and circumstances.
The regulations set forth a nonexhaustive list of factors that may be considered in deciding whether a profit objective exists. These factors are: (1) the *94 manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that the assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses with respect*99 to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) any elements indicating personal pleasure or recreation.
The first factor the Court considers is the manner in which the taxpayer carries 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 objective.
Petitioner demonstrated significant changes in operation, adoption of new techniques, and abandonment of unprofitable methods when he moved his horse racing activity from the Morris Street property to the Mooresville property. He recognized that the Morris Street property was not suitable because the buildings were in disrepair and building a new facility at this location was cost prohibitive because of the city's building codes. The city was imposing a $100-a-day fine and increased his property tax from around $1,000 a year to $17,000. Petitioner chose to mitigate these expenses by liquidating his old facility and moving to a property that would help make him more money.
The larger Mooresville property allowed petitioner to build substantially larger and better new facilities and the increased size also allowed petitioner to reduce his fixed feeding costs by growing his own hay and renting out part of the property. Petitioner rented out 90 acres of the Mooresville property*101 for around $20,000 a year—further reducing his horse racing activity costs. The Mooresville *96 property was suitable for producing high-quality horse hay, which he planted and harvested, demonstrating petitioner's willingness to adopt new cost-saving techniques.
Further, while petitioner did not undertake any business studies, he did significantly change his business model when he hired an assistant trainer after moving to the Mooresville property.
Petitioner also treated other aspects of his horse-related activities in a professional manner. For example, petitioner planned to take advantage of a retirement system for horse trainers in Kentucky. According to petitioner, the *97 retirement program divided an amount of money between trainers and assistant trainers who are retiring and who ran 11 horse races in Kentucky per year. Petitioner was based in Indiana but raced in other States. Petitioner credibly testified that he had run at least 11 races in Kentucky for several years and that he believed that if he continued his current racing schedule, he would qualify to collect some of the Kentucky trainers' retirement benefits.
Respondent points to petitioner's accounting methods to show he was not carrying on the activities in a businesslike manner. Primarily, respondent suggests petitioner's disorganization and reliance on an accountant is not businesslike. However, the accounting method needs only "provide the entrepreneur with the information * * * require[d] to make informed business decisions."
The next factor to consider is the expertise of the taxpayer and his advisers. Preparation for an activity by extensive study of its accepted business, economic, and scientific practices, or consultation with those who are expert therein, may indicate that the taxpayer has a profit objective where the taxpayer carries on the activity in accordance with*104 such practices.
Respondent contends that petitioner developed only an "expertise with respect to the actual boarding, breeding, and training of horses * * * [but] developed no expertise in the financial aspects of the horse-related activities." Respondent, however, omitted an important aspect of petitioner's horse-related activities: racing. To enter a horse into a race, the decisionmaker—whether trainer or owner—must have an in-depth understanding of the financial aspects of the proposition. If a superb horse enters into a low-claim claiming race, the horse may be bought cheaply from the owner and the owner will lose money. If an outmatched horse enters a stakes race, the owner will not earn back the entry fee. Petitioner learned about how to enter races and how to pick a horse for a specific race to maximize his potential prize. Thus, to navigate the complex regulations and financial possibilities of horse racing, petitioner was required to gain expertise *100 in the financial aspects of his horse-related activities. For example, petitioner learned of ruses that unscrupulous racers would use to maximize profit potential. In one case, petitioner heard*106 of racers affixing raw cuts of meat to a horse's ankles so that the horse would appear to be in poor shape and not be claimed. A racer that is aware of the ruse may claim the horse and profit from the transaction.
Petitioner credibly testified that he spent significant effort and time to match the right horse to the right race. He spent this time matching each horse to a race with the expectation of making a profit. He admitted that it took time to learn this skill but that it was the "secret" to the business. Petitioner's custom-tailored entry strategy shows he was an expert in the financial aspects of his horse-related activities.
Petitioner also displayed his expertise through his participation in trade associations. Much like his progression from member to leader of nightclub associations, petitioner rose through the ranks into leadership roles at two professional horse racing associations. In one organization, petitioner's peers placed enough weight on his expertise to ask him to run for the leadership role. Petitioner did not independently volunteer for the position but was asked to run for it presumably because his peers trusted him with the responsibility. *101 Further, petitioner*107 shows that he was an expert in the financial aspects of the horse racing industry through his contributions to the horse racing lobbying effort. An experienced horse racing lobbyist credibly testified that he would discuss the finer points of horse racing with petitioner in connection to the lobbying effort. The legislature eventually passed the slot bill, which would significantly affect the financial aspects of horse racing in Indiana. Petitioner knew the new bill would increase the purse size and wished to contribute to the effort. In other words, petitioner was on the ground floor of improving economic conditions for horse racing in Indiana. Accordingly, this factor weighs in favor of petitioner's profit objective for all the tax years in issue.
The third factor to consider is the time and effort expended by the taxpayer in carrying on the activity. The fact that the 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.
In
Respondent questions the amount of time actually dedicated to horse-related activities during the tax years in issue. Specifically, respondent points to the fact that petitioner continued to earn income related to his former occupation of running nightclubs. Respondent seems to challenge whether petitioner could have spent the amount of reported time dedicated to horse-related activities and still performed functions deserving remuneration from other sources.*110 Indeed, petitioner did not deny that he was still tangentially involved in the nightclub industry.14 He credibly testified that he was able to consult on high-level decisions by using his cell phone. He explained that cell phones allowed him to consult with business contacts several times a day but that it did not detract from time dedicated to training horses. Petitioner credibly testified that he could not "stop * * * [his] training of the horses to go over there and sit and talk for hours." Instead, his cell phone allowed him to balance his time between the two activities. *104 Accordingly, by tax year 2005 petitioner devoted time and effort appropriate to demonstrate a profit objective for all the tax years in issue.
The fourth factor to consider is the expectation that the assets used in the activity may appreciate in value. The term "profit" encompasses appreciation in the value of assets, such as land, used in the activity.
Petitioner's horse-related activities include two different types of appreciable assets: first, the horses that petitioner bred and trained; second, the real property and capital improvements associated with his training facility. Respondent does not dispute that petitioner purchased or bred each horse with the expectation the horse would increase in value.
Respondent does, however, contend that petitioner's real property is not an asset used in the activities and that any expectation of appreciation is not a factor *105 to be considered in determining whether petitioner was engaged in his horse-related activities for profit. Respondent is correct for the 2005 and 2006 tax years and incorrect for the 2007 and 2008 tax years because petitioner moved his horse-related activities during the 2007 tax year.
Where land is purchased or held primarily*112 with the intent to profit from an increase in its value, and a taxpayer also engages in another activity on the land, the activity and the holding of the land will ordinarily be considered a single activity only if the income derived from the activity exceeds the deductions attributable to that activity which are not directly attributable to the holding of the land.
Petitioner's primary intent in purchasing and holding the Morris Street property was to gain from the real estate appreciation. When asked whether he intended to use the Morris Street property for horse-related activities, petitioner *106 responded: "No, in my mind the property is going to [be] worth a lot of*113 money * * * I'll just make a little money, pay the taxes, hang on to it until I can sell it." This is a clear indication that his primary purpose was not to train or race horses on the Morris Street property. Further, petitioner's horse-related activities did not reduce the net cost of carrying the Morris Street property. As a result, holding the Morris Street property was an activity separate from petitioner's horse-related activities, and any expectation of appreciation of that real estate does not contribute to a finding that he was engaged in those activities for profit.
In contrast, petitioner specifically purchased and held the Mooresville property to breed and train horses. His primary intent was to build a premier horse training facility, and he purchased property to suit his needs. Petitioner started searching for a new location because problems arose from building a barn on the Morris Street property. He recognized that to be a competitive horse trainer he needed to "build a better mousetrap in the horse business". A major aspect of his improved mousetrap included a better location because the Morris Street property was not ideal for horse training. Petitioner sought a new*114 location and intended to train horses on the land when he purchased the Mooresville property. Further, petitioner followed through and completed a well-furnished horse operation. He improved the land with a significant amount of specialized equipment, and in his *107 opinion the training facility was unmatched in the State of Indiana. Admittedly, petitioner recognized that the land might appreciate, but capitalizing on appreciation was not his primary intent in purchasing or holding the Mooresville property. Accordingly, the Mooresville property's expected appreciation is relevant to whether petitioner carried on his horse-related activities with the intent to profit under
The fifth factor to consider is the success of the taxpayer in carrying on other similar or dissimilar activities. The fact that the taxpayer has*115 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, even though the activity is presently unprofitable.
Petitioner built a successful nightclub business from very humble beginnings. He turned a single unprofitable bar into a network of up to six different establishments, employing enough individuals to necessitate creating a staffing company to coordinate shifts. Later, petitioner started a successful car dealership and an insulation company. Moreover, petitioner appears to be a successful real estate speculator. Further, petitioner's peers trusted him to serve as a representative and advocate for two different industries within Indiana, demonstrating his ability to transfer skills across vastly different trades. He worked hard and showed initiative, foresight,*116 and other qualities that led to success in his other business activities, and he had reason to expect eventual success in his horse-related activities. Accordingly, this factor weighs in petitioner's favor.
The sixth factor to consider is the taxpayer's history of income or losses with respect to the activity in question. A series of losses during the initial or startup stage of an activity may not necessarily be an indication that the activity is not engaged in for profit.
The startup phase for some horse-related activities can be between 5 and 10 years.
The seventh factor to consider is the amount of occasional profits, if any, which are earned in the course of conducting the activity. Profit is generally defined as receipts in excess of costs.
Horse racing can be very speculative, and the expectation of profit may be very small. Racing a horse has been compared to investing in a wildcat oil well, where there may be substantial expenditures with little chance of profit.
The eighth factor to consider is the financial status of the taxpayer. The fact that the taxpayer does not have substantial income or capital from sources other than the activity may indicate that an activity is engaged in for profit.
Petitioner earned income from sources other than horse-related activities. The losses claimed in relation to the horse-related activities had the effect*121 of reducing petitioner's taxable income. Petitioner, however, was not an excessively wealthy individual. His house was mortgaged and he continued to work long hours at a physically demanding endeavor after resigning from several successful ventures. Further, petitioner participated less in the personal and recreational *113 aspects of the horse-related activities starting in tax year 2007, as discussed
The final factor that should be considered is whether the activity in question involves personal pleasure or recreation. The presence of personal motives in the carrying on of an activity may indicate that the activity is not engaged in for profit, especially where recreational or personal elements are involved.
Petitioner was first enticed into the horse racing business through a social gathering at a racetrack, where he was invited*122 to a free dinner and a tour of the facilities. Petitioner met trainers and learned about the business. As a result of the social meeting, petitioner registered for an owner's license and bought two young horses. He asked a trainer using his facilities to show him some training basics and only later applied to become a trainer. From 1998 until 2007 petitioner divided his time between racetracks and the training facility. While there is certainly work involved while at racetracks, there is also a higher level of *114 recreation and social activity available at a racetrack. A horse trainer can socialize with other trainers and owners. The concessions and public wagering options available also show that a racetrack is a very social and recreational venue, although there is no evidence that petitioner actually participated in the wagering options. Further, a physical embodiment of a trainer's exertions and skills are on public display while a horse is racing. The owner and trainer of a winning horse may get applauded and get his or her picture taken in a winner's circle.
In contrast, the training facility is a largely private operation void of social or recreational activities. Activities such*123 as grading the track, mucking stalls, baling hay, administering medication, and building fences are all necessary for a successful horse race operation, but these activities are rarely publicly displayed, much less applauded. Similar, a trainer cannot socialize or confer with other racing professionals face to face while at the training facility; if a trainer has a question, he or she must call a specialist in order to solicit advice.
During tax years 2005 and 2006 petitioner attended both the track and training activities of his operation. He was able to train horses at his facility, but he was also able to accept the accolades of a successful race. In other words, petitioner participated equally in the social and business aspects of horse racing. In the 2007 tax year, however, petitioner hired an assistant trainer to take over the *115 more socially oriented track activities. In doing so, petitioner actively chose to undertake the less glamorous and less recreational activities of his operation. This is indicative that before tax year 2007 petitioner enjoyed some recreational aspects of horse racing, but starting in 2007 he became more interested in the business aspects of the activity.*124
The Mooresville property was not a recreational facility or a retirement property for petitioner. Petitioner did not build a new house on the Mooresville property, and in fact the new facility was significantly farther from petitioner's home than the Morris Street property. Petitioner's commute to the Mooresville property was about 20 miles a day longer than his commute to the Morris Street property. Petitioner did not purchase the property to have a place to enjoy the golden years of his retirement but instead purchased the property to run a business. Accordingly, the elements of personal pleasure or recreation weigh in respondent's favor for the 2005 and 2006 tax years and in petitioner's favor for tax years 2007 and 2008.
An activity that was previously carried on without a profit objective does not preclude a finding that it has become a trade or business.
Petitioner started his horse-related activities without a profit objective but later turned his social and recreational activity into a serious business venture. Petitioner's objective may have been gradually changing from the outset of his horse-related activities, but beginning operations at the Mooresville property is a clear indication that his motivation had fully turned to seeking a profit. In 2006 petitioner—a successful businessman—was given an opportunity to exit the horse training and racing business and pursue other ventures. While petitioner acquired the land for his horse-related activities in 2006, he could have left it unimproved and stopped his horse activities. Instead, he chose to reinvest in the activities and open a premier training facility in 2007. Thus, petitioner's profit objective was first shown in 2007 when he began operating his horse-related activities at the Mooresville property.
Further, the Indiana slot bill was introduced and passed in the spring of 2007. Petitioner was on the ground floor of the lobbying efforts to pass the legislation and was in a position to recognize the increased profit potential. He *117 chose to build*126 a custom training facility to take advantage of the new racing opportunities that the 2007 bill created.
On the basis of the record and considering the nine factors discussed above, the Court finds that petitioner did not engage in horse-related activities for profit during the 2005 and 2006 tax years. However, petitioner demonstrated a profit objective beginning in tax year 2007 when he significantly changed his operation, opened a new facility on real estate specifically purchased for horse-related activities, and transitioned out of the recreational aspect of horse racing. Accordingly, petitioner demonstrated the requisite profit objective under
With exceptions not here relevant, a taxpayer may avoid a
The duty of filing accurate returns generally cannot be avoided by placing the responsibility on an employee or tax return preparer.
Petitioner hired a CPA for his auditing and tax requirements. Petitioner had not been satisfied with the work performed by several accountants before he hired his current CPA, who he met through a mutual acquaintance, to handle the tax aspects of his nightclub businesses. The CPA had experience in the nightclub industry, and petitioner recognized that a CPA might have more skills than a non-CPA accountant. Petitioner continued to employ this CPA for over 20 years. *120 Petitioner's returns were audited twice before the tax years in issue, and both times he fared well as a result of his CPA's work. Further, as discussed above, petitioner maintained a rudimentary recordkeeping system but did turn over the necessary documents to his CPA in the form of receipts, canceled checks, and bank statements for tax years 2005, 2006, 2007, and 2008. Last, petitioner credibly testified that he relied on his CPA and his attorney for business and tax advice. Accordingly, petitioner demonstrated reasonable cause through good faith for tax years 2005 and 2006. There is no
Failure to file a tax return on the date prescribed leads to a mandatory addition to tax unless the taxpayer shows that such failure was due to a reasonable cause and not due to willful neglect.
Petitioner's position, based on
Petitioner also suggests that the Commissioner's audits of prior-year returns was a reasonable cause for his delay. He contends that he knew the 2007 tax return would likely be audited, and he spent extra time to make sure the return was correct. Preoccupation with an audit, however, does not constitute a reasonable cause for failing to timely file a Federal tax return.
We have considered the remaining arguments made by the parties and, to the extent not discussed above, conclude those arguments are irrelevant, moot, or without merit.
To reflect the foregoing,
Footnotes
1. 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.↩
2. Petitioner's wife was estranged from the family for medical reasons.↩
3. The 45-acre parcel fronted Morris Street. These two parcels are collectively referred to as the Morris Street property to avoid confusion with Dancers, which is also on Washington Street.
4. Some of petitioner's trainers passed away, and he fired others for cause.↩
5. As noted, the Morris Street property, also includes the abutting Washington Street property.
See supra↩ note 3.6. Instead of recognizing a $902,887 gain from the 50-acre parcel, petitioner chose to defer the gain through a
sec. 1031↩ exchange.7. The exact costs of improvements are unknown because these records were destroyed in a 2012 fire.↩
8. Collectively these activities will be referred to as petitioner's horse-related activities. The boarding and breeding activities were reported together, and the percentage of the activities the breeding program represented during tax years 2005 through 2008 is unclear.↩
9. Petitioner believes that racing in at least 11 Kentucky races per year makes him eligible for a trainer-specific retirement plan.↩
10. A claiming race is a race in which any entered horse may be purchased by any owner for a set price before the start of the race. For example, in a $10,000 claiming race any horse may be purchased before the race for $10,000, and the new owner takes delivery of the horse after the race. In other words, every time petitioner entered a horse into a claiming race, he risked losing the horse to a claimant. Accordingly, it was in petitioner's interest to match a specific horse to certain races according to the value or potential of the horse.↩
11. Petitioner served on only one board at a time because the professional associations forbid concurrent board membership. He resigned in 2008 to spend more time training his horses.↩
12. Petitioner may have reported additional income, deductions, and credits related to his horse-related activities on various other schedules for various years. For example, petitioner may have listed real estate rental income related to the horse activities on a Schedule E, Supplemental Income and Loss, and Form 4835, Farm Rental Income and Expenses.↩
13. As discussed
infra↩ , petitioner transitioned from participating in the more recreational aspect to the more businesslike aspect of his operation in tax year 2007 when he moved to the Mooresville property and began spending most of his time at the training facility rather than at the racetrack.14. Petitioner retained no financial interests in his nightclub businesses but for his consulting fees and rental payments.↩
15. Horse breeding and racing is speculative, and the loss of some horses may be foreseen,
see Chandler v. Comm'r , T.C. Memo 2010-92aff'd ,481 Fed. Appx. 400↩ (9th Cir. 2012) , but petitioner's loss of two stallions was more similar to an involuntary conversion because the deaths were from injuries relating to a dishonest contractor.16. According to petitioner, once his horse was nominated, it had a 1 in 144 chance of running the races.↩
Related
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