UNITED STATES TAX COURT

cLC

T.C. Memo.

2011-188

UNITED STATES TAX COURT

MARK E. AND PATTI L. BLACKWEL , Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No.

29287-09.

iled August 8,

2011.

Thomas M. Regan and Beniat in A. W gner, for petitioners.

William R. Peck, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION t

SWIFT, Judge:

Respondent determ

ed deficiencies in

petitioners' Federal income taxes for 2005 and 2006 in the

respective amounts of $46,504 and $34,500.

The issue for decision. is whether petitioners' horse

breeding activity constituted lan activity carried on for profit

SERVED Aug 08 2011

- 2 under section 183.1

The trial was held on March 3, 2011, in St.

Paul, Minnesota.

FINDINGS OF FACT

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

At

the time the petition was filed, petitioners resided in

Minnesota.

Petitioner Mark Blackwell (Mark) has an M.B.A. degree and 30

years of significant experlence in business management.

In the early 1970s Mark was a motocross racer and

instructor.

He participated in national and international

motocross racing events, and in 1971 he was national motocross

champion.

Mark established the first motocross drivers' school

for Suzuki.

From the late 1970s through the present time Mark has had a

successful business career as manager and senior officer for a

number of motorcycle, snowmobile, ATV, and personal watercraft

manufacturing companies--for Suzuki as instructor and manager of

a winning professional motocross racing team, including six

national championships, and as head of Suzuki's motorcycle and

ATV division;- for Husqvarna Motorcycle Co.; for Arctic Cat; and

1All 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.

for Polaris Industries, manufacture and seller of, among other

things, Victory motorcycles.

At these various jobs Mark typicall.y worked over 40 hours a

week.

In the mid-to-late 1980s, while working full time, Mark

completed his college degree and earned an M.B.A. from Pepperdine

University.

Over the years Mark has participated in a number of

executive management programs, such as a business strategy course

at the Wharton School at the University of Pennsylvania.

Petitioner Patti Blackwell (Patti) has a college degree in

nursing.

During 2000, 2001, and 2002 Patti did not work, apart

from her involvement in the horse activity described below.

Beginning in 2003 Patti worked approximately 30 hours a week as a

rehabilitation nurse counselor for the State of Minnesota,

generally working out of the family résidence.

In 2003 through 2009 petitioners

salaries from their above

employment were as f ollows :

Year

Mark

Patti

Total

2003

2004

2005

2006

2007

2008

2009

$1,187,118

585,923

646,579

479, 091

904 , 97Ë

474, 279

311, 997

$36,157

4 ,622

43,820

50, 163

56, 780

54 , 433

5 , 043

$1,223,275

633,545

690,399

529, 254

961, 751

528, 712

371, 040

- 4 Mark did not grow up around farm animals or horses and

learned how to ride horses on family vacations.

Patti grew up around farm animals and horses and always

dreamed of owning and raising horses.

In 1993 petitioners purchased their first horse, and from

then until 2000 petitioners purchased a number of additional

horses; read books and magazines, including the Quarter Horse

Journal, Quarter Horse News, and the Reiner magazine; and watched

videos about horse management and breeding, bloodlines, and horse

operations.

Petitioners also attended a number of national horse

shows.

In the mid-1990s petitioners developed an interest in

starting up an activity of purchasing, breeding, and training

horses.

In approximately 1996 Patti enrolled in the Equine Industry

Management bachelor's degree program at the University of

Minnesota.

In that program Patti took courses relating to the

health care, showing, judging, breeding, bloodlines, and training

of horses; the management of a horse activity as a business; and

the economic aspects of horse breeding and training.

In that

program Patti in 1998 received another bachelor's degree magna

cum laude.

By the late 1990s, as a result of their reading and

research, their conversations with horsemen, and a number of

training programs they had participated in relating to horse

breeding and training, petitioners' interest became focused on

western performance horses; namely, reining and cutting horses

and working cow horses.

In 1999, in further prepažation for starting up their horse

breeding and training activity, Mark, with Patti's assistance,

prepared a detailed business plan relating to the purchase,

breeding, training, showing, and sale of reining horses.

The

business plan included sections entitl d "Executive Summary",

"Market Overview",

"Advertising and Promotion", and "Proforma

Income Statement".

The business plan stated

hat Pat i would act as the barn

and breeding manager and would be responsible for the health,

care, nutrition, and training bf the horses, and that Mark would

be responsible for the business and marketing side of the horse

activity.

In the business plan, the proforma income statement

projected estimated losses for 2000 and 2001 of $24,000 and

$7,000 and estimated profits for 2002 through 2005 of $3,000,

$33,000,

$48,000, and $68,000,

respectively.

The estimated

profits were based on projectÊons petitioners made of breeding

fees and horse sale proceeds.

Beginning in 2000, on their horse ranch property in Delano,

Minnesota, on which petitioners' family residence also was

located, petitioners began an American Quarter Horse breeding

activity and training activity under the name of Fresh Horses

Farm (FHF) with the objective of purchasing, breeding, training,

and selling reining horses.

As planned, Patti was in charge of

the horses, and Mark was responsible for the business and

marketing side of the horse activity.

Generally, petitioners sought to purchase quarter horses

that had already had some success in regional horse shows and/or

that had recognized bloodlines.

Patti, with some advice from Mark, would make the decisions

as to which horses, to purchase.

Patti and Mark jointly would

decide which stallions to hire to breed with their mares and

whether and when to sell their horses.

During the years in issue petitioners did not hire anyone to

manage their horse activity.

Patti typically spent 15 to 20

hours a week taking care of the horses, and Mark spent 2 to 5

hours a week in the horse activity.

Each day Patti would feed the horses, groom them, exercise

them, turn them out, and clean out the horse stalls.

With her training in medicine and to avoid additional

expenses, Patti did much of the health maintenance on the horses

- 7 without hiring a veterinarian.

horses.

Patti vaccinated and dewormed the

She did the "foal watch" and would assist in the

delivery of the foals.2

In connection with their FHF horse activity, petitioners

maintained a bank account under the nahe of FHF, and petitioners

used BarnPro, a recognized horse farm software program, to record

and keep track of FHF income· aÄd expenses .

In connection with their ownershi

of horses and the

activities of FHF, one or both!of petitioners were members of the

following horse organizations:1

American Quarter Horse

Association (1993 to present) , L National Reining Horse Association

(1998 to present) , North Central Rein ng Horses Association (1998

to present), National Cutting Horses Association (2006 to 2010),

and Minnesota Cutting Horses Association (2006 to 2010).

Both Mark and Patti- occasionally rode their horses in horse

shows, won some nominal prize money, a1d participated in social

events at horse shows.

In 2002 and later years petitionecs sought and received

advice on their FHF horse activity fro.n a number of expert

horsemen, including Bob Janssen of Janssen Performance Horses, a

nationally recognized horse trainer.

2"Foal watch" consists of 24-hour observation of a mare

about to deliver a foal.

Over the years petitioners advertised their horses on their

own FHF Web site, on business cards, calendars, clothing, flyers,

and in videos and magazine articles.

Occasionally petitioners would hire professional horse

trainers to work with their horses and to show or ride their

horses in horse shows.

In 2006 petitioners shifted their horse breeding and

training activity from reining horses to cutting horses because

by 2006 cutting horses were in greater demand in the horse

industry.

At one point petitioners began trying to sell some of their

horses as long yearlings to avoid horse training expenses they

would incur if they kept the horses longer.

Petitioners purchased three horses in 1998, one horse in

1999, three horses in 2000, one horse in 2003, one horse in 2004,

one horse in 2005, three horses in 2007, and two horses in 2008.

All but four of the horses petitioners eventually sold were sold

at a loss, three were sold at a small profit over petitioners'

purchase price (not taking into account expenses relating to the

horses), and one died for which petitioners received an insurance

payment.

The schedule below provides some detail about the

horses petitioners purchased and sold:

Horse Name

Year

Purchased

Purchase

Price

Selling

Price

Year

Sold

Glo Jessie Glo

Calico Catalyst

ZF Zap Em

Dunitz Midnight Glo

Miss Bessie Westwind

CeeCee Pauli

Sheza Chexy DunIt

Smart Little Dun It

Smart Chic Hoo Does

Sweet Sugar Boon

U Neek Hickory

Lenas Lucky Chic

Memphis Chic

To Smart Lil Juice

1998

1998

1998

1999

2000

2000

2000

2003

2005

2007

2007

2007

2008

2008

$12,500

12, 00

2,000

5,Ò 0

20,,0 0

13,000

11,000

25,000

15,000

30,000

11,000

1,000

3,500

15,000

$7,500

7,000

3,200

3,750

15,000

5,500

15,000

15,000

15,000

8,300

6,100

4,000

1,500

9,800

2002

2003

2001

2003

2007

2002

2003

2007

2005

2010

2010

2008

2008

2009

Petitioners purchased the following five additional horses

which, as of the date of trial, either had died or were still

owned by petitioners:

Horse Name

Year

Purchased

Dudes Jackie May

Sonata Starlight

Smart Chicaway

High Brow Madonna

Jodies BH

1993

2004

2006

2007

2000

Purchase

Price

$2,000 .

48,000

30,0Ó0

15,000

16,Õ 0

Year

Died

Petitioners

Still Own

2007

12007

-------

----Yes

Yes

Yes

1When Sonata Starlight died unexpectedly in 2007

from colic, petitioners eceived a $48,000 insurance

payment.

.

From 1999 through 2008 petitioner

acquired and sold 21

additional horses which petitioners acquired by breeding their

mares to outside horses, for

fees.

hich stud services petitioners paid

The resulting foals, aËter being raised and trained for a

period by petitioners, were sÅld by petitioners as follows:

- 10 -

Birth

Year

Horse Name

Stud

Fee

Selling

Price

Year

Sold

1999

Dunitz Fresh Dude

Jessies Gotta Whiz

Arcticatalyst

$300

2,500

300

$5,000

4,000

7,600

2002

2003

2002

2000

Fresh N Dun

Get Fresh With Me

Freshinic

300

3,000

750

1,000

7,000

1,700

2001

2001

2003

2001

Fresh Champagne

Fresh Victory

A Farm Fresh Chic

Mid West Whiz

500

2,500

2,000

1,500

3,000

2,800

5,000

12,500

2002

2002

2006

2004

2002

Over the Reinbow

To The Moon

2,500

500

2,750

2,000

2004

2004

2003

Foxy Cleopatra

After Midnight

Lil Ruf Shagwell

372

771

3,050

1,000

3,400

9,800

2005

2005

2009

2004

Ruf Talkin Dunit

1,500

50,000

2007

2005

Chics Big Star

(1)

25,000

2006

2006

Smart Lil Miss

Starry Eyed Chic

6,000

11,000

8,000

11,000

2007

2009

2007

Fresh Juice

Little Wrangler

Sonatas Rock Star

1,291

4,500

(2)

6,600

1,550

2,200

2009

2009

2010

2008

Total

Boonalicious

18,000

63, 134

6,500

179, 400

2009

1The foal Chics Big Star was purchased in utero.

2Petitioners incurred no stud fee for Sonatas Rock

Star as their mare was bred with one of their own

stallions.

A horse (Smart Chicaway) that petitioners purchased in 2006

for $30,000 and which petitioners still own has sired a number of

horses--all owned by others--which horses have won a number of

- 11 -

horse cutting competitions and have ear1ed a total of $27,998 in

winnings for their owners in events spohsored by the National

Cutting Horse Association and

total

f $22,952 in winnings in

events sponsored by the NationÊl Reining Horse Association.

Petitioners still own a h rse called Starbucks Fresh Brew

which petitioners acquired through breeding one of their mares

for a stud fee of $1,500.

Petitioners believed that two particular horses--Smart Lena

and Sonata Starlight--that petitioners purchased in 2003 and 2004

had the potential (with the right breeding) to produce foals that

would have bloodlines attracti e on tÑe national horse market.

Petitioners' horse activity was marred by a number of

illnesses their horses experienced.

T e sudden and unexpected

death of Sonata Starlight in 2007 was a major setback to

petitioners' plans to have successful and profitable breeding

mares that would produce foals that would eventually be sold at

the national level.

Petitioners propose, respondent does not object to, and we

find the following additional facts:

Petitioners believed in 2004 they had a broodmare band

which would allow them to sell their foals at the

national level.

They hoped the sale of Sonata's foal

would recoup much of FHF s inves ment.

At one point two of peti ioners' horses were shipped to

Missouri for sale with the hope of selling each horse

for $15,000. Because of a softe ing of the.horse

market, the horses were each sold for less than onehalf of the price expected.

- 12 -

One of petitioners' foals (Boonalicious) was a filly by

a leading cutting stallion. Boonalicious' stud fee was

$15,000.

Petitioners were optimistic about their

prospects with this filly.

Petitioners hired an experienced horseman to fit and

present Boonalicious at the National Reined Cow Horse

Futurity in Reno, Nevada. They understood that the

horseman was the best of the best. They were

devastated when they received only $6,500 for the

horse, less than 10 percent of what similar horses had

sold for in prior years and what they thought she was

worth.

Petitioners consulted all the experts and did

everything the experts told them to do, but finally in

2009 petitioners determined that their FHF horse

business was not sustainable.

Petitioners kept track of the income and expenses of their

FHF horse activity by making entries into their BarnPro horse

management farm software.

Annually, petitioners prepared a summary report of their

expenses involving their ownership of horses and FHF's

activities.

In 2009, because of the losses they continued to experience,

petitioners terminated their horse breeding activity.

On the Schedules C, Profit or Loss From Business, attached

to their 2003 through 2009 Federal income tax returns,

petitioners reported gross income, total expenses (including

depreciation), net operating losses, and gain from the sales of

business property (Form 4797 gain), relating to their FHF horse

activity, as follows:

- 13 Net

Year

2003

2004

2005

2006

2007

2008

2009

Total

Gross Income

Total

Expenses

perating

Loss

Form

4797 Gain

$1, 011

3, 106

10,020

30,870

67, 420

7,952

46,261

166, 640

$69 468

90, 809

132,416

123,217

148, 286

133,270

108,811

806, 277

($68, 457)

(87, 703)

(122,396)

(92,347)

(80, 866)

(125,318)

(62,550)

(639, 637)

$18, 934

17, 250

4,152

-046, 373

-0-086, 709

On the Schedules C attached to the r 2005 and 2006 Federal

income tax returns, petitioners claimed the following business

expenses relating to their FHF horse aó ivity:

Expense

2005

2006

Advertising

Commission/ f ees

$1,8 0

5 2

$3,505

3, 752

Depreciation

Insurance

29,4 2

3 , 610

22,738

4 , 529

Repairs/maintenance

G27

---

Supplies

Board

Breeding

Farrier

Feed hay

1, 388

7 , 910

25, 61

3 , 284

5, 95

202

4 , 191

11, 892

4 , 701

5, 580

Health maintenance

7,147

2, 581

Membership

525

210

Miscellaneous

- -

140

Shavings

Show expense

Training

Tack

1/026

13, 540

14, 49

- -

1, 225

10 , 282

32,132

509

Transportation

Vet

Total

1, 20

620

14 950

132 116

14,428

123, 217

On audit for 2005 and 2006 respondent determined that

petitioners' FHF horse activity did not qualify as an activity

engaged in for profit, and respondent disallowed deductions for

- 14 -

all of the reported business expenses in excess of income

received.

OPINION

Under section 183(a) and (b), if an activity is not engaged

in for profit by a taxpayer the deductions claimed by the

taxpayer relating to the activity are not allowed except to the

extent of income received from the activity.

To be treated as

"engaged in for profit" an activity must be carried on by the

taxpayer with an actual and honest profit objective.

Commissioner,

F.2d 1205

78 T.C.

642,

(D.C. Cir.

1983).

645

Dreicer v.

(1982), affd. without opinion 702

Activities carried on primarily for sport, hobby, or

recreation do not qualify as for-profit activities.

Sec. 1.183-

2(a), Income Tax Regs.

Whether a taxpayer has the requisite profit objective with

respect to an activity is a question of fact that is to be

decided on the basis of all the evidence in a case.

Generally,

the taxpayer bears the burden of proving that he or she carried

on the activity with a profit objective.3

Rule 142(a).

In deciding this question, regulations under section 183 set

forth a nonexclusive list of nine factors which generally are

3Petitioners do not argue for a shift of the burden of proof

to respondent under sec. 7491(a).

- 15 -

considered and which we discuss below.

Sec. 1.183-2 (b) , Income

Tax Regs.

Manner in Which the Activity Is Carried On

Petitioners generally carried on their FHF horse activity in

a reasonably businesslike manner.

During the 1990s petitioners

prepared to start up a horse breeding and training activity by

taking educational courses relating to the care, management,

breeding, and economics of horÃes, and by purchasing, caring for,

training, and selling a number of horses.

Petitioners developed

a rather comprehensive written business plan relating to the

proposed horse activity.

Beginning in 1994 petitioners took 6 or 7 years learning

about horse breeding and management before attempting to engage

in a for-profit horse breeding, activit .

In Mark's words:

were pretty cautious, so we didn' t jump into it .

"[W]e

We just kept

trying to learn and figure out is this a business that we could

* * * be in and be successful, and it took us some time to make

the final decision to get in."

Once petitioners started up their FHF horse activity in 2000

and during the years in issue

petitioners were not absentee,

aloof, or recreational horse owners.

Patti managed and worked

diligently and daily on the horse activity, doing essentially all

of the horse maintenance herself .

Pe itioners consulted expert

horsemen, hired expert horse trainers to assist in training the

- 16 -

horses, advertised, showed the horses, and paid significant stud

fees to have their mares bred with stallions which they regarded

as having good bloodlines.

In their efforts to make improvements to the horse activity,

petitioners made adjustments in their business plan, moving from

reining horses to cutting horses and selling their horses as

yearlings.

Petitioners maintained reasonably good books and records of

income and expenses relating to their horse activity.

In 2009 petitioners terminated their unprofitable horse

activity in light of the losses realized.

Expertise of the Taxpayer

Through Patti's experience with and her education relating

to horses and through Mark's business experience, petitioners

were reasonably well qualified to engage in a horse breeding

activity for profit.

Mark's business qualifications were

particularly strong and he had a gifted ability to make good

business decisions, to market and advertise effectively, and to

work successfully with others.

Time and Effort Expended in Carrying On the Activity

The time, effort, and financial resources petitioners

personally put into and invested in their FHF horse activity are

not indicative of a hobby; rather, they are indicative of a for-

- 17 -

profit activity.

Of the time petitione s spent with the horses,

most of it was daily hard work.

Expectation That the Horses May Appreci te in Value

Petitioners certainly had the expectation, and acted

thereon, that at least some of their horses would become valuable

as reining or cutting horses or as valuable mares or stallions

with recognized bloodlines wïth significant value for breeding

purposes.

Success in Other Activities

Patti's degree from the University of Minnesota relating to

horse management indicates some likelihood of success and a.high

commitment to petitioners' horse activity.

Mark's obvious business acumen and success in business

development and management wit

other

ompanies, along with

petitioners' credible testimony, indicate, to us, an ability,

determination, and savvy to make a pr fit and be successful in

petitioners' horse activity.

History of Income or Losses

A series of losses during the sta:tup period of an activity

is not necessarily an indication that the activity is not engaged

in for profit, bearing in mind, however, that the objective must

be to realize a profit on the entire operation--future net

earnings and also enough earnings to recoup losses that have been

incurred in interven1ng years

Bessehvey v. Commissioner, 45

- 18 T.C. 261,

274

(1965),

affd. 379 F.2d 252

(2d Cir.

1967); Emerson

v. Commissioner, T.C. Memo. 2000-137.

We note that in 2006, 2007, and 2009 petitioners did receive

significant gross income from their horse activity ($30,870,

$67,420, and $46,261, respectively), although not what

petitioners hoped for.

The bottom line losses realized in petitioners' horse

activity were substantial.

However, the losses were realized

during what we, in this case, regard as still the early or

startup years of the activity, and petitioners terminated the

horse activity in 2009 when it became clear to petitioners that

the likelihood of profitability was remote.

Amount of Occasional Profits

An opportunity to earn a substantial ultimate profit in a

highly speculative venture may be sufficient to indicate that an

activity is engaged in for profit.

Sec. 1.183-2(b) (7), Income

Tax Regs.

Horse breeding and training is a speculative

venture.

Petitioners have convinced us that they had an

opportunity or the potential to earn a profit in their FHF horse

activity.

Financial Status

Petitioners did have substantial wealth and resources not

related to their horse activity, but in light of the minimal

recreational aspects of petitioners' horse activity, we do not

- 19 -

.regard petitioners' wealth as ihdicative of a nonprofit objective

for petitioners' horse activity.

Elements of Personal Pleasure

Although Patti had a lifelong interest in horses, the facts

of this case do not indicate that petitioners' FHF horse activity

was motivated or driven by per onal pl

sure alone.

As we have

found, petitioners' had actual hopes f r the sale of their horses

at a profit, and petitioners' horse activity is appropriately

described as a "business" .

Petitioners' business plan did not work out and income did

not exceed expenses, but we discern few recreational and sports

aspects in petitioners' FHF horse acti1rity; rather, in

petitioners' motive, efforts, and investment in carrying on their

FHF horse activity during the years in issue we discern and find

a profit objective.

We so hold.

Decision will be entered

for petitioners.