# UNITED STATES TAX COURT

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A96597123def3425f

## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

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.

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A96597123def3425f. Public record. Not legal advice.