UNITED STATES TAX COURT

T.C. Memo. 1997-190

UNITED STATES TAX COURT

FRANK R. COURBOIS, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 24296-93.

Filed April 24, 1997.

Micael C. Chandler, for petitioner.

Ann L. Baker, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WHALEN, Judge:

Respondent determined that petitioner

is liable for the following deficiency, addition to tax,

and penalty for 1990:

Deficiency

Addition to Tax

Sec. 6651(a)(1)

Penalty

Sec. 6662

$26,206

$9,155

$5,241

- 2 Unless stated otherwise, all section references are to the

Internal Revenue Code as amended and in effect during 1990.

After concessions by petitioner, the issues for decision

are:

(1) Whether petitioner is entitled to treat a

sailboat as property held for the production of income

and to deduct certain expenditures and depreciation

attributable to the sailboat or whether petitioner's

activity with respect to the sailboat is an "activity not

engaged in for profit", as defined by section 183(c); and

(2) whether petitioner is liable for the accuracy-related

penalty under section 6662(a), as determined by respondent.

FINDINGS OF FACT

Petitioner resided in Oklahoma City, Oklahoma, when

the instant petition was filed.

The stipulation of facts

filed by the parties and the exhibits attached thereto are

hereby incorporated in this opinion.

Petitioner is an attorney who specializes in criminal

law.

In 1985, he purchased a 63-foot sailboat named

Cloudia for $110,000.

The Cloudia is a former Norwegian

fishing vessel that was built in 1934.

It was featured

in a motion picture that was originally released with the

title “Sea Gypsy” and was later renamed "The Shipwreck".

At no time after petitioner’s purchase of the Cloudia

in 1985 through the time of trial has the Cloudia been

- 3 seaworthy.

Among other problems, when petitioner

purchased the Cloudia it was infested with beetles and

other parasites, and her frames were badly worn back from

the planking of the vessel.

The sails on the boat were

theatrical sails that had been used in making the abovementioned motion picture and were not designed to withstand

winds.

Further, the sailboat has a foreign hull which

prevents it from being chartered in the United States.

After petitioner purchased the Cloudia, he began

to repair the boat, as his finances permitted, in an

attempt to make her seaworthy.

the following:

This work has included

Repair of the decks; repair of the masts;

repair of the spreaders; restoration of the frames and

planking; purchase of new sails; installation of a new

running rig fore and aft; and restoration of the interior

of the boat, including new reefers, sinks, stove, floors,

heads, and bunks.

Additionally, in or around 1987,

petitioner rewired and replaced the plumbing on the boat.

During the years 1987 through 1990, petitioner

occasionally allowed friends or acquaintances to rent the

Cloudia as a place to stay.

The persons who rented the

Cloudia included a boatwright who had worked on the boat

and several members of the Oklahoma City Boat Club.

Petitioner's activity of renting the Cloudia was sporadic.

- 4 He did not advertise the Cloudia’s availability for rental.

A summary of the income realized and expenses incurred by

petitioner from 1985 through the year in issue with respect

to the Cloudia is as follows:

1

Year

Rental

Income

Mortgage

Interest

Cash

Expenditures

Depreciation

1985

1986

1987

1988

1989

1990

--$825

1,200

680

600

$5,242

4,800

-----

--$3,920

4,768

12,049

13,014

--$3,929

30,690

29,038

20,741

($7,024)

(34,258)

(40,407)

(33,155)

3,305

10,042

33,751

84,398

(114,844)

Total

Net Income

(Loss)

2

2

1

The amounts in this column were not deducted dollar-for-dollar on

petitioner's returns because petitioner treated the rental of the Cloudia as

a passive activity subject to the limitation on the deduction of passive

activity losses set forth in sec. 469.

2

No net income (loss) figure is computed for this year because

petitioner claims that the vessel was not placed in service until 1987.

Petitioner did not maintain any formal or consistent

method of recording his expenditures with respect to the

Cloudia.

He occasionally collected receipts and stored

them in a box.

He kept receipts on the sailboat, at home,

and at his attorney’s office.

Petitioner used the same

bank account for his law practice, his activities involving

the Cloudia, his personal expenses, and his residential

rental properties, discussed below.

Petitioner did not

maintain a ledger or set of books with respect to any of

his activities involving the Cloudia.

- 5 Over the years, petitioner has built two sailboats.

One was a 24-foot sailboat which petitioner sold.

There

is no information in the record concerning the costs

petitioner incurred in building the 24-foot sailboat or

the price for which petitioner ultimately sold the boat.

Petitioner also built a 33-foot sailboat.

As of the time

of trial, petitioner still owned the 33-foot sailboat, and

he used it for recreational purposes.

In summary, petitioner reported the following adjusted

gross income on his Form 1040, U.S. Individual Income Tax

Return for 1990:

Interest income

Business income (Schedule C)

Capital gain (Schedule D)

Other gains or (losses) (Form 4797)

Rents, royalties, partnerships,

estates, trusts, etc. (Schedule E)

Total adjustments

Adjusted gross income

$29

78,253

71,683

3,612

(78,751)

(5,925)

68,901

The above business income consists of the net profit

from petitioner's law practice as reported on the Schedule

C, Profit or Loss from Business, attached to petitioner's

1990 tax return, as follows:

Gross income

Total expenses

Net profit (loss)

$157,391

79,138

78,253

- 6 Petitioner has conceded that for the year in issue, he

omitted from his Schedule C gross receipts from his law

practice in the amount of $19,125.

Petitioner reported the following capital gains and

losses on the Schedule D attached to his return, and he

reported the following ordinary income on Form 4797,

Sales of Business Property, attached to his return:

Gain from the sale of 2709 NW 12th

Gain from the sale of 1809 Carey Place

Loss from the sale of the "Edmond Lot"

Schedule D

Form 4797

$17,026

58,113

(3,456)

$2,762

850

--

71,683

3,612

Finally, petitioner reported rental income and

expenses from the Cloudia and three residential rental

properties on Schedule E, Supplemental Income and Loss.

Petitioner's Schedule E claims an aggregate loss of

$78,751, of which $74,350 is attributable to the Cloudia.

Petitioner's Schedule E reports the following:

Activity

2709 NW 12th

1813-15 NW 22d

1809 Carey Pl.

Cloudia

Total

Rents received

Cleaning and

maintenance

Insurance

Legal and

professional fees

--

$3,914

--

$600

$4,514

---

350

585

---

3,500

--

---

--

--

--

500

--

Mortgage interest

Repairs

Supplies

Taxes

Slip rental

Utilities

Depreciation

------$113

630

1,335

1,783

--1,736

1,483

--------

-1,257

-557

6,900

300

20,741

--------

Total expenses

113

7,902

--

33,755

--

- 7 Loss

(113)

(3,988)

--

(33,155)

--

Deductible rental loss

(113)

(3,116)

(1,172)

(74,350)

(78,751)

Petitioner treated his activities with respect to the

Cloudia and the three residential rental properties

identified on Schedule E as passive activities within the

meaning of section 469(c).

Accordingly, petitioner filed

Form 8582, Passive Activity Loss Limitations, with his 1990

return.

In substance, the losses deducted on Schedule E in

the aggregate amount of $78,751 were computed as follows:

Activity

2709

NW 12th

1813-15

NW 22d

1809 Carey Pl.

Cloudia

Total

Current year gains

Current year loss

Accumulated loss

$19,788

(113)

--

-($3,988)

(617)

$58,963

-(1,172)

-($33,155)

(76,738)

$78,751

---

Total gains

Total losses

19,675

--

-(4,605)

57,791

--

-(109,893)

77,466

(114,498)

---

0.04022

(3,116)

---

0.95978

(74,350)

1

(77,466)

-(113)

(1,489)

(3,116)

-(1,172)

(35,543)

(74,350)

(37,032)

(78,751)

Ratio of losses

Allowed losses

Passive activity

loss carryforward

Amount deducted

In the subject notice of deficiency, respondent

determined that petitioner is not entitled to deduct the

loss claimed on Schedule E with respect to the Cloudia.

The notice of deficiency explains this adjustment as

follows:

It is determined the Schedule E passive

activity loss of $74,350.00 relating to the

vessel, Cloudia, is disallowed because it

has not been established that the property is

held for use by customers pursuant to Internal

Revenue Code Temporary Regulation 1.469-1T(e)(3)

and 1.469-4T(b). In addition, the deductions

- 8 are not allowed pursuant to Internal Revenue Code

Section 212 because it has not been established

that the property is held for the production of

income. The allowable passive activity losses

have been adjusted to reflect the disallowance

of this loss, figured as shown on the attached

Exhibits #1 through #6.

The notice of deficiency also determines, as an "alternative position", that the loss attributable to the Cloudia

is subject to the limitation set forth in section 183.

The notice of deficiency states as follows:

Alternatively, if the determination set forth

above is not sustained for the taxable year ended

December 31, 1990, see the alternative position

pursuant [sic] under Section 183 of the Internal

Revenue Code attached.

*

*

*

*

*

*

*

Expenses incurred in connection with an activity

not engaged in for profit are generally deductible only to the extent of income from such

activity. However, those expenses which would

otherwise be allowable under the Internal Revenue

Code are deductible even if they exceed the

income from the activity, but reduce the amount

of income against which other expenses can be

offset. The other expenses then offset the

reduced income in the following order: (1)

operating expenses other than depreciation and

(2) depreciation and other basis adjustment

items. Accordingly, your taxable income for

taxable year ended December 31, 1990, is

decreased $557. * * *

Notwithstanding the amount of the adjustment set forth

in the explanation quoted above, respondent determined an

adjustment with respect to petitioner's passive activity

- 9 losses in the amount of $74,763.

The notice of deficiency

does not explain how this adjustment was computed or why

it is $413 more than the deduction claimed with respect to

the Cloudia.

The amount of the adjustment appears to be

the difference between the aggregate amount deducted on

Schedule E, $78,751, and the current year loss with

respect to the property at 1813-15 NW 12th, $3,988.

Thus,

it appears that in computing the adjustment respondent

disallowed a current loss with respect to the property at

2709 NW 12th in the amount of $113 and disallowed losses

accumulated from prior years with respect to the properties

at 1813-15 NW 22d and 1809 Carey Place in the amount of

$617 and $1,172, respectively.

OPINION

The principal issue in this case involves respondent's

disallowance of $74,763 of the deductions claimed by

petitioner on the Schedule E, Supplemental Income and Loss,

filed as part of petitioner's 1990 return.

Petitioner

argues that this amount is deductible under section 212(1)

or (2).

The premise of petitioner's argument is that the

entire amount of the adjustment is attributable to

"Petitioner's conduct of the Cloudia activity".

However,

according to petitioner's 1990 return, after applying the

passive loss limitation rules of section 469, petitioner

- 10 claimed a deduction of only $74,350 with respect to the

Cloudia.

The record does not explain the nature of the

additional amount disallowed by respondent, viz $413, and

petitioner has raised no issue regarding this additional

amount.

The dispute between the parties over the deduction of

petitioner's alleged losses incurred in connection with

the Cloudia turns on whether the losses were incurred in

an activity not entered into for profit.

Section 183(a)

provides:

(a) General Rule.--In the case of an

activity engaged in by an individual or an S

corporation, if such activity is not engaged

in for profit, no deduction attributable to

such activity shall be allowed under this

chapter except as provided in this section.

For this purpose, section 183(c) defines the phrase

"activity not engaged in for profit" to mean "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."

If we find on the

basis of all of the facts and circumstances of the case

that petitioner's activity with respect to the Cloudia

was "not engaged in for profit" within the meaning of

section 183(c), then no deductions with respect to that

- 11 activity are allowable under section 212.

Sec. 183(c);

sec. 1.183-2(a), Income Tax Regs.

An activity is engaged in for profit if the taxpayer

has an "actual and honest objective of making a profit".

Keanini v. Commissioner, 94 T.C. 41, 46 (1990); Dreicer v.

Commissioner, 78 T.C. 642, 644-645 (1982), affd. without

opinion 702 F.2d 1205 (D.C. Cir. 1983).

Although the

expectation of profit need not be reasonable, it must

be shown that a bona fide profit objective did exist.

Golanty v. Commissioner, 72 T.C. 411, 425-426 (1979),

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

1981); sec. 1.183-2(a), Income Tax Regs.

In this context,

profit means economic profit, independent of tax savings.

Hulter v. Commissioner, 91 T.C. 371, 393 (1988).

Whether

petitioner engaged in the Cloudia activity with the

requisite profit objective is a question of fact to be

determined from all the facts and circumstances.

Keanini

v. Commissioner, supra at 46; Golanty v. Commissioner,

supra at 426; secs. 1.183-2(a), 1.212-1(c), Income Tax

Regs.

Petitioner bears the burden of proving that

respondent's determination is wrong.

Rule 142(a), Tax

Court Rules of Practice and Procedure (hereinafter all

Rule references are to the Tax Court Rules of Practice

and Procedure).

- 12 Section 1.183-2(b), Income Tax Regs., sets forth

a nonexclusive list of nine factors to be considered in

determining whether an activity is engaged in for profit.

These factors are:

(1) The manner in which the taxpayer

carries on the activity; (2) the expertise of the taxpayer

or his advisers; (3) the time and effort of the taxpayer

which is expended in carrying on the activity; (4) the

expectation that the assets which are used in the activity

may appreciate in value; (5) the taxpayer’s success in

carrying on other similar or dissimilar activities; (6)

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

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

which is earned; (8) the taxpayer’s financial status; and

(9) whether the taxpayer experiences personal pleasure or

recreation in carrying on the activity.

Based entirely upon his own testimony at trial,

petitioner argues that he purchased the Cloudia in 1985

and held it in 1990 with the actual and honest objective

of making a profit.

He claims to have purchased the

Cloudia for the purpose of renting it to the partners of a

bookstore venture to be opened in Hawaii on the Island of

Maui.

Shortly after purchasing the sailboat, petitioner

claims that the bookstore venture was abandoned because the

partners were not able to acquire certain property on which

- 13 to operate the bookstore.

At the same time, petitioner

claims to have discovered various defects in the Cloudia,

described above, that necessitated substantial repairs

in order to make the vessel seaworthy.

Petitioner's brief

describes his objective as follows:

Subsequently, upon the failure of this [bookstore] venture, and the discovery of the defects

in the vessel's condition, he [petitioner]

decided to overhaul the vessel, and rent it as

he could (and he has rented it, albeit nominally

as of 1990), until such time is [sic] it became

seaworthy enough to sell at a price that would

maximize the recovery on his investment.

In 1987, after owning the vessel for 2 years, petitioner

permitted an individual who had worked on the vessel to

stay on it in return for rent and claims to have thus

placed the vessel in service as a rental activity.

From

1987 through 1990, petitioner claims to have realized a

total of $3,305 in rental income from permitting various

friends and acquaintances to stay aboard the Cloudia.

During the same period, petitioner claims to have incurred

cash expenses of $33,751 and depreciation of $84,398, or

total expenses of $118,149, attributable to this activity.

After considering the record in this case, we find

that petitioner has failed to prove that he engaged in

his activity with respect to the Cloudia with the

requisite profit objective.

We base our decision

- 14 generally, on all of the facts and circumstances of the

record, and specifically, on the factors set forth in

section 1.183-2(b), Income Tax Regs.

Petitioner acknowledged during his testimony that he

was not businesslike in his approach to the activity.

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

receipts of his cash expenditures.

a bank account for the activity.

See

He did not maintain

He did not establish

He did not maintain any

books and records for the activity.

He did not advertise

the availability of the vessel.

We are skeptical about petitioner's testimony concerning his alleged intent for acquiring and holding the

Cloudia.

We find it difficult to believe that petitioner,

an attorney, would pay $110,000 for a sailboat without

first determining whether it was seaworthy and whether

it could be used for its intended purpose.

We note that

petitioner made passing reference during his testimony

to an "initial survey" of the vessel, but he failed to

introduce any such survey into evidence.

We are also skeptical about petitioner’s assertion

that he held Cloudia for appreciation in value.

1.183-2(b)(4), Income Tax Regs.

See sec.

Petitioner testified that

as of the time of trial he could sell the Cloudia for

"somewhere" between $125,000 and $150,000.

However, as

- 15 of the end of 1990, petitioner had received total rental

income from the Cloudia of $3,305 and had made cash

expenditures amounting to $33,751.

Thus, as of the end

of 1990, petitioner had made net out-of-pocket expenditures

of $30,446 on the Cloudia.

That amount, plus the original

cost of the Cloudia, $110,000, put petitioner’s total

investment in the sailboat, as of 1990, at $140,446.

Petitioner also testified that at the time he purchased

the Cloudia for $110,000, it would have cost him approximately $60,000 to restore the boat.

Thus, considering

petitioner's testimony, we cannot find that petitioner has

shown that he could profit from appreciation in the value

of the Cloudia.

See Cannon v. Commissioner, 949 F.2d 345,

352 (10th Cir. 1991) (a record of substantial losses over

many years and the unlikelihood of achieving a profitable

operation are important factors bearing on a taxpayer's

intention), affg. T.C. Memo. 1990-148; Antonides v.

Commissioner, 91 T.C. 686, 696-697 (1988) (“any such

appreciation would have allowed petitioners to do little

more than break even” and “Chartering a yacht to others in

order to afford to keep it through tax savings for one’s

personal enjoyment is not the same as having a profit

objective”), affd. 893 F.2d 656 (4th Cir. 1990); see also

- 16 Martin v. Commissioner, 50 T.C. 341, 364 (1968); Rand v.

Commissioner, 34 T.C. 1146, 1149-1150 (1960).

We also note that during 1990 petitioner reported

substantial income from sources other than his activity

with respect to the Cloudia.

Income Tax Regs.

See sec. 1.183-2(b)(8),

He reported gross income from his legal

practice in the amount of $157,391, and a net profit from

that activity in the amount of $78,253.

In addition,

petitioner reported capital gains of $75,139 from the sale

of 2709 NW 12th and 1809 Carey Place, two of his rental

properties, ordinary income of $3,612 from the sale of

those two rental properties, and a loss of $3,456 from the

sale of the “Edmond Lot”.

In sum, for the 1990 tax year,

petitioner realized income of $153,548 from sources other

than the rental of the Cloudia.

Finally, the record suggests that petitioner derived

personal enjoyment from his activity with respect to the

Cloudia.

See sec. 1.183-2(b)(9), Income Tax Regs.

Petitioner testified that ever since he was young he

wanted to be involved with boats, and that the first time

he stepped onto the Cloudia he “felt like Errol Flynn”.

Petitioner also testified that he had built two other

sailboats, one which he sold, and one which he retained

for recreational purposes.

- 17 In summary, petitioner has not shown that he engaged

in his activity with respect to the Cloudia with an actual

and honest objective of making a profit.

Accordingly, we

find on the basis of all of the facts and circumstances of

this case that petitioner's activity with respect to the

Cloudia is an activity not engaged in for profit and is

subject to the limitation on deductions imposed by section

183.

We note that the notice of deficiency refers to the

application of section 183 as respondent's "alternative

position".

The notice of deficiency also suggests that

the adjustment with respect to the Cloudia would be

computed differently under section 183 than the adjustment

determined in the notice.

For this reason, the Court will

enter decision in this case under Rule 155.

Accuracy-Related Penalty

Respondent determined that petitioner’s underpayment

of income tax for 1990 was due to negligence or disregard

of rules or regulations, and that he is liable for the

accuracy-related penalty under section 6662(a).

Petitioner

bears the burden of proving that respondent's determination

is wrong.

Rule 142(a).

Section 6662(a) imposes an accuracy-related penalty

equal to 20 percent of the portion of the underpayment

- 18 which is attributable to negligence or disregard of rules

or regulations.

The term “negligence” includes any failure

to make a reasonable attempt to comply with the provisions

of the Internal Revenue Code, and the term “disregard”

includes any careless, reckless, or intentional disregard.

Sec. 6662(c).

Negligence is defined as the lack of due

care or the failure to do what a reasonable and ordinarily

prudent person would do under the circumstances.

E.g.,

Neely v. Commissioner, 85 T.C. 934, 947 (1985).

Section 6664(c) provides that no penalty shall be

imposed under section 6662 with respect to any portion of

an underpayment if it is shown that there was reasonable

cause for such portion and that the taxpayer acted in good

faith with respect to such portion.

Petitioner does not

assert that he has met the requirements of section 6664(c).

Petitioner argues that the penalty under section

6662(a) should not be imposed for two reasons.

First,

petitioner argues that the "tax treatment of his investment

in the vessel Cloudia * * * was * * * based on substantial

authority".

According to petitioner:

An amount of understatement attributable

to a treatment by a taxpayer based on substantial authority does not constitute a

"substantial understatement" by definition.

IRC § 6662 (d)(1)(A).

- 19 Second, petitioner argues:

the failure of Respondent to object to this

treatment during examinations by Respondent

of Petitioner's returns in prior years,

although not rising to the level of estoppel,

tend[s] to support the inference that the

position adopted by Petitioner was not undertaken without due regard for the rules and

regulations and was adequately disclosed.

As to petitioner's first argument, we agree that

for the purpose of determining whether the portion of

any underpayment is attributable to a "substantial understatement", the amount of the understatement is reduced

by that portion attributable to the "tax treatment of

any item by the taxpayer if there is or was substantial

authority for such treatment".

Sec. 6662(d)(2)(B)(i).

However, we do not agree with petitioner's assertion that

there was substantial authority for the tax treatment of

petitioner's loss attributable to the Cloudia.

For the

reasons discussed above, we have found that petitioner

did not engage in the Cloudia activity with an actual and

honest objective of making a profit.

We know of no

authority that permits a deduction under section 212 for

the expenses paid or incurred with respect to such an

activity.

See Antonides v. Commissioner, 91 T.C. 686,

704 (1988), affd. 893 F.2d 656 (4th Cir. 1990).

- 20 We also reject petitioner's second argument that

respondent's failure to "object" to petitioner's treatment

of losses from the Cloudia during prior audit examinations

proves that there was no negligence.

Petitioner testified

that the first audit during which this issue was raised

was the audit that led to the subject notice of deficiency.

Based upon these facts, we cannot draw the "inference"

offered by petitioner that "the position adopted by

Petitioner was not undertaken without due regard for the

rules and regulations and was adequately disclosed."

In this case, there is ample evidence of negligence.

Petitioner kept no regular records or logs of his

activities with respect to the Cloudia, he commingled

funds from his business and personal activities, and he

claimed the subject deductions despite the fact that he

had no actual and honest objective of making a profit.

Further, petitioner concedes the omission of $19,125 of

income from his legal practice.

Petitioner has offered no

evidence to rebut respondent’s determination of negligence.

Accordingly, we find that petitioner has not met his

burden, and we sustain respondent’s determination of the

section 6662 penalty.

To reflect the foregoing,

Decision will be entered

under Rule 155.