Petition for Writ of Certiorari — Warden v. Commissioner

‘if Supreme Court. U.S.

FILED

97 845 NOV 1 8 1997

No.

OFFICE OF THE @LERK

IN THE

SUPREME COURT OF THE UNITED STATES

October Term, 1997

LEW WARDEN and NADJA J. WARDEN,

Petitioners,

.

COMMISSIONER OF INTERNAL REVE™TE.

On Petition For Writ Of Certiorari

To The United States Court Of Appeals

For The Ninth Circuit

PETITION FOR WRIT OF CERTIORARI

Lew Warden

Nadja J. Warden

Petitioners Pro Se.

12120 East Snyder Road

Tucson, Arizona 85749

(520) 760-2809

r

10

i)

,

A. QUESTIONS PRESENTED FOR REVIEW

1. Does the equal protection component of

the due process clause of the Fourth Amend-

ment, combined with the status of the Tax

Court of the United States as a court of

national jurisdiction, mandate that the tax

laws of the United States, in this case

sections 162, 183, and 212 of the Internal

Internal Revenue Code, be applied uniformly

throughout the United States irrespective of

contrary and conflicting opinions of and

between the several Circuit Courts of

Appeals?

2. Must a judge of the Tax Court follow

Opinions of panels of the Court of Appeals

to which an appeal may be taken, that in

cases arising under sections 162, 183, and

212 of the Internal Revenue Code, the burden

is on the taxpayer to prove that his primary

or dominant purpose in entering into an acti-

vity was to "profit", rather than applying

the Tax Court’s established standard that

it is sufficient compliance with these sec-

tions that he prove an "actual and honest"

intent" to profit?

3. Does Commissioner v. Groetzinger, 480

U.S. 23, 35 (1987), direct that in order to

qualify as a business, the primary and domi-

nant purpose of the taxpayer in commencing an

activity must be to "profit", as distinct

from and to the exclusion of "producing

income"?

4. In determining whether the "primary"

purpose of the taxpayer is to "profit",

where the taxpayer has multiple motives for

commencing an activity, is it the burden of

the taxpayer to "convince" the trial court

that his primary intent was to profit, or,

once multiple motives have been shown to

exists, should the trial court, as held by

this Court in Commissioner v. Soliman, 506

U.S. 168, 174-175 (1993), undertake a con-

parative analysis of such motives to deter-

mine which was primary?

x *

ii

B. TABLE OF CONTUNTS

page

PETITION FOR WRIT OF CERTIORARI 1

OPINIONS BELOW 1

JURISDICTION 1

CONSTITUTIONAL PROVISIONS, STATUTES

AND REGULATIONS INVOLVED IN THE CASE 2

STATEMENT OF THE CASE 2

REASONS FOR GRANTING THE WRIT 7

A. SUBSTANTIAL CONFLICT EXISTS

BETWEEN THE DECISIONS OF THE NINTH

CIRCUIT AND THE DECISIONS OF AT

LEAST SEVEN OTHER CIRCUITS AS TO

THE CORRECT STANDARD TO BE APPLIED

TO THE DETERMINATION OF WHETHER AN

ACTIVITY IS A "TRADE OR BUSINESS"

UNDER I.R.C. SEC. 167 7

B. THE COURT SHOULD MANDATE A

PROCEDURE WHEREBY THE TAX COURT MAY

EFFICIENTLY FULFILL ITS OBLIGATIONS

AS A COURT OF NATIONAL JURISDICTION

WITHOUT CHALLENGING THE OBLIGATIONS

OF THE CIRCUIT COURTS OF APPEALS TO

DECLARE THEIR VIEWS ON TAX LAW 12

C. THE COURT SHOULD AFFIRM THAT ITS

STATEMENTS IN COMMISSIONER vs GROET-

ZINGER WERE NOT INTENDED TO ESTABLISH

"PRIMARY INTENT TO PROFIT" AS A STAND-

ALONE TEST FOR DETERMINING WHETHER AN

ACTIVITY IS A TRADE OR A BUSINESS OR

iii

A MEANS OF PRODUCING INCOME, BUT

RATHER AS AN METHOD OF DISTINGUISHING

HOBBY-TYPE ACTIVITIES 17

D. THE COURT SHOULD DECLARE THAT

IN DETERMINING WHETHER A QUESTIONED

ACTIVITY IS A TRADE OR BUSINESS

OR INCOME PRODUCING ACTIVITY, AS

DISTINCT FROM A HOBBY OR AMUSEMENT

DIVERSION, THE COURTS BELOW SHOULD

UNDERTAKE A COMMISSIONER vs SOLIMAN

COMPARATIVE ANALYSIS TO DETERMINE

WHICH ACTIVITY IS PRIMARY 18

CONCLUSION ‘ 20

C. TABLE OF AUTHORITIES

United States Constitution

Amendment IV 2

Supreme Court Opinions

Commissioner v. Groetzinger,

480 U.S. 23 (1987) a) w. aey Aa

18

Commissioner v. Soliman,

506 U.S. 168 (1993) Ry) -F of Bo £0

19,° 20

Helvering v. National Grocery Co.,

304 U.S. 282 (1938) 8

Portland Golf Club v. Commissioner,

497 U.S. 154 (1990) 12

Rochin v. California,

342 U.S. 165 (1951) > 3

United States v. Correll,

(1967) 389 U.S. 299 A3

iv

a

Courts of Appeals Opinions

Antonides v. C.I.R.,

893 F.2d 656 (4th Cir. 1990)

’

274 F.2d 96 (9th Cir. 1959)

Bur

809 F.2d 355 (7th Cir. 1987)

;

797 F.2d 1049 (D.C. Cir. 1986)

Doggett v. Burnett,

62 App. D.C. 103,

65 F.2d 191 (1933)

Dreicer v. C.I.R.,

665 F.2d 1292 (DC Cir. 1981)

va ;

908 F.2d 369 (8th Cir. 1990)

rgu Vo fo at ’

29 F.3d 98, 102 (2nd Cir. 1994)

Hendricks v. C.I.R.,

32 F.3d 94 (4th Cir. 1994)

irsc e. is

315 F.2d 731 (9th Cir. 1963)

Mercer v. C.I.R.,

376 F.2d 708 (9th Cir. 1967)

Osteen v. C.I.R.,

62 F.2d 356 (11th Cir. 1995)

Ranciato v. C.I.R.,

52 F.3d 23 (2nd Cir. 1995)

Smith v. C.1.R.,

937 F.2d 1089 (6th Cir. 1991)

Snyder v. U.S.,

674 F.2d 1359 (10th Cir. 1982)

Tax Court Opinions

Estate of Willis Edward Clack,

96 TC 4562 (1966)

13

Christos Coutsoubelis,

66 TCM 935 (1993) 20

Lynn Crawford, 65 TCM 2540 (1993) 20

Ruth Giesbrecht, 69 TCM 2149 (1995) 20

Golsen v. C.1.R.,

54 T.C. 742, 757 (1970), affd.

445 F.2d 985

(10th Cir. 1971) ‘3, &6

2 ’

103 TC 29, (1993) 13

Lardas v. C.I.R., 99 TC 490 (192) 14

Lawrence v. C.I.R.,

27 T.C. 713 (1957), revd. on

other grounds 258 F.2d 562

(9th Cir. 1958) i3, 28

Peat Oil & Gas Associates v. C.I.R.,

100 TC 271 (1993), also

65 TCM 2250 (1993) GO, 229 (13

‘4, 26; 17, 20

Dennis A. Pryor, 61 TCM 2139 (1991) 11

Owen A. Steinberg,

69 TCM 2121 (1995) 20_

Statutes

26 U.S.C.

Sec. 162 2,3, 6, &

Appendix F, p. 44

Sec. 167 7

Appendix F, p. 44

Sec. 183 2, 3

Appendix F, p. 44

Sec. 212 a, 3) BS

Appendix F, p. 46

Secs. 7481-7483 7

28 U.S.C. sec. 1254(1) 1

vi

page

Supreme Court Rule 10 1

Treasury Regulaticns

26 CFR 1.183-2, 2

Appendix F, p. 46

1.212.1(c) 2, 10, 18

Appendix F, p. 48.

Other Authorities

Florida Bar Journal (March 1989) 8

D. OPINIONS BELOW

Order of United States Court of Appeals

for the Ninth Circuit, No. 95-70896,

denying petition for rehearing and

rejecting suggestion for rehearing en

banc, filed August 20, 1997. Not for

publication.

Appendix A, p. 1.

Memorandum opinion of United States Court

of Appeals for the Ninth Circuit, No.

95-70896, filed April 2, 1997. Not for

publication.

Appendix B, p. 2.

Memorandum of Opinion of United States Tax

Court, Docket no. 4829-92, T.C. Memo.

1995-176, filed April 17, 1995.

Appendix C, p. 12.

ELIE OS,

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1997

PETITION FOR WRIT OF CERTIORARI

Petitioners respectfully pray that a writ

of certiorari issue to review the

judgment below.

OPINIONS BELOW

The Memorandum opinion of the United

States Court of Appeals, no. 95-70896,

filed April 2, 1997 appears at Appendix B,

Pp. 3, to the petition and is unpublished.

The Memorandum of Opinion of the United

States Tax. Court, no. 4829-92, filed April

17, 1995, appears at Appendix C to the peti-

tion, p. 12, and is published as T.C. Memo.

1995-176.

JURISDICTION

The opinion of the Ninth Circuit Court

Of Appeals, sought to be reviewed was filed

April 2, 1997. Petitioners filed timely

petition for rehearing with suggestion for

rehearing en banc, which petition was denied

by unpublished order filed August 20, 1997,

appearing herein as Appendix A.

Jurisdiction exists by reason of Rule

10, and 28 U.S.C. sec. 1254(1).

-l-

CONSTITUTIONAL PROVISIONS, STATUTES AND

REGULATIONS INVOLVED IN THE CASE

Amendment IV, United States Constitution:

No person shall be deprived of

life, liberty, or property, with-

out due process of law.

Internal Revenue Code, Title 26, U.S.C.

Sec. 162, Appendix F, p. 44.

Sec. 167, Appendix F, p. 44.

Sec. 183, Appendix F, p. 44.

Sec. 212, Appendix F, p. 46.

Treasury Regulations

26 CFR 1.183-2, Appendix F, p. 46.

1.212.1(c), Appendix F, p. 48.

STATEMENT OF THE CASE

This petition involves conflicts between

between the Ninth Circuit and at least seven

of the other Circuit courts of appeal, con-

flicts between the Tax Court and panels of

the Ninth Circuit, and conflicts between the

judges of the Tax Court.

The focus of these conflicts is whether,

in determining if a particular activity qua-

lifies as a "trade or business" under I.R.C.

sec. 162, the test or standard by which the

taxpayer’s intent to profit is determined,

the taxpayer had an “actual and honest" in-

tent to profit, which is the rule of the Tax

Court and the Second, Fourth, Sixth, Seventh,

Eighth, Eleventh, and District of Columbia

Circuits, or the "primary and dominant" intent

to profit test applied by a dissenting Tax

Court judge in the instant case and upheld

-2-

by a panel of the Ninth circuit, and the

related issue of whether a taxpayer’s sub-

jective intent should be a matter of judi-

cial concern at all.

A second issue involves the duties of

the Tax Court and the Internal Revenue Ser-

vice to apply the tax laws uniformly among

the several states, and the correlative

right of the individual taxpayer, under the

equal protection component of the Due Pro-

cess Clause to the uniform application of

the tax laws.

4 third issue involves the scope and

application of this Court’s opinions in

i i Vv. i , 480 U.S. 23,

35 (1987) ana issi iman, 506

U.S. 168, 174-175 (1993) to sections 162,

183, and 212 of the Internal Revenue Code,

and the proper resolution of the question

of how the trial court Should determine

which, of multiple taxpayer’s motivations,

are primary.

The facts of this case, for the purposes

of this petition, are Substantially as set

forth in the Tax Court’s Memorandum of Opi-

nion. (Appendix C, pp. 13-25.) We briefly

review them to orient the Court to the plight

petitioners found themselves in as a conse-

quence of a failed business venture.

Petitioner Lew Warden (herein Lew) is a

is a retired attorney, and petitioner Nadja

Warden (herein Nadja) is his wife. In 1986

Lew, then 66 years Old, sought to withdraw

from the practice of law and to earn petiti-

oners’ livelihood in the charterboat business.

-3-

To this end the Wardens purchased a 55-foot

sailboat, which they named Rocking Chair,

from Windships, Inc., a yacht brokerage firm

in Oakland, California, and, in 1987, placed

the yacht in service in Windships’ charter

department.

Within a matter of months--because Wind-

ships was not performing its obligations to

commission the yacht, to provide warranty

support to remedy the numerous mechanical

problems which developed, and to provide

petitioners with the volume of charters it

had represented petitioners could expect-~-

it became apparent to petitioners that their

project was in jeopardy. In order to extri-

cate themselves from this situation, petiti-

oners did most of the commissioning and re-

pair work themselves and put the yacht up for

sale.

In 1988, under the impact of declining

yacht sales due to changes in policy by the

Commissioner, Windships went out of business,

Rocking Chair continued to have major mecha-

nical failures which made it inoperable for

for extended periods of time, and Lew moved

out of his apartment and onto the yacht in

order to reduce expenses and to be close to

the work which he and others were doing on

the yacht, and continued listing it for sale.

(At the time, Nadja was living in the family

home in San Luis Obispo, California. )

In 1989, Lew moved the yacht to Southern

California in search of a better sale market

and chartering opportunities. There he con-

tinued working to repair the boat’s defects,

obtained a few charters, and experienced fur-

Se

ther major mechanical failures. In 1989,

petitioners sold their property in San Luis

Obispo, and purchased a home in Castro Valley,

California.

In late 1990, the yacht’s mechanical pro-

blems still persisting, Lew gave up any fur-

ther efforts to charter the yacht, filed a

lawsuit (ultimately successful) against Wind-

ships and the yacht’s Taiwanese builder, and

brought the yacht back to Northern California

for major repairs.

After this work was done, Lew again pla-

ced the yacht for sale with a yacht broker,

but withdrew the offering when a marine sur-

veyor reported that although the yacht still

had a substantial value, because of its his-

tory of problems and petitioners’ obligation

to fairly disclose such problems to prospec-

tive buyers, for all practical purposes it

was unmarketable.

The trial judge, in an effort to divine

petitioners’ profit intent at the time they

first purchased the yacht, extensively revi-

ewed their post-purchase activities, placed

his own interpretation of these events and

concluded that petitioners had failed to

"convince" him that their "primary" intent

was to profit. (Appendix C, p. 34.)

The trial judge applied this test, at

the behest of counsel for respondent, in lieu

of the Tax Court’s long-established more len-

ient "actual and honest" standard, because

the case was appealable to the Ninth Cir-

cuit. (Appendix C, p. 27.)

Crucial to petitioners’ appeal to the

Ninth Circuit and this petition are the fol-

lowing findings by the trial judge:

1. Petitioners "honestly hoped that

their yachting activity would generate a pro-

fit." (Appendix C, p. 32.)

2. "Profit was one objective of their

activity." (Ibid. )

3. To prevail, “petitioners must show

that their yachting activities were engaged

in primarily for the purpose of making a

profit." (Ibid. )

4. Petitioners "were ready to retire

and wanted to live in a pleasant, recrea-

tional setting." (Appendix C, p. 33.)

5. “Based upon the entire record, we

are not convinced that petitioners’ primary

objective was to make a profit." (Ibid. )

6. “Rather, the evidence is more con-

sistent with the conclusion that petitioners

wished to retire from the practice of law,

had a desire to sail, had the financial re-

sources to pursue that desire, and had some

hope that they could combine their dream re-

tirement with an income-producing venture."

(Ibid. )

In reaching his conclusion, the Tax Court

judge did not undertake the kind of objective

comparative analysis mandated by this Court in

Commissioner v. Soliman, 506 U.S. 168, 174-

175 (1993), but rather based his determination

on petitioners’ failure to sustain their burden |

to "convince" him that their intent to profit

was their primary motivation in entering into

the charterboat business.

Pursuant to the provisions of 26 0.8.C.

secs. 7481-7483, petitioners appealed to the

Court of Appeals for the Ninth Circuit from

the Memorandum of Opinion of the Tax Court

(Appendix C) upholding determinations by res-

pondent Commissioner of Internal Revenue dis-

allowing petitioners claimed deductions for

the tax year 1989. The Court Of Appeals,

while recognizing that other circuits fol-

lowed a different rule, affirmed on the gro-

und that the Ninth Circuit followed the pri-

mary intent to profit standard. (Appendix B,

Pp. 5-7.) The Court of Appeal also rejected

petitioners’ contentions made herein that the

Tax Court, as a court of national jurisdic-

tion, was obliged to apply its own rule ab-

sent binding precedent, and that its failure

to apply a uniform standard denied petition-

ers due process of law. (Appendix B, pp. 10-

ai)

REASONS FOR GRANTING THE WRIT

A

SUBSTANTIAL CONFLICT EXISTS BETWEEN THE DECI-

SIONS OF THE NINTH CIRCUIT AND THE DECISIONS

OF AT LEAST SEVEN OTHER CIRCUITS AS TO THE

CORRECT STANDARD TO BE APPLIED TO THE DETER-

MINATION OF WHETHER AN ACTIVITY IS A "TRADE OR

BUSINESS" UNDER I.R.C. SEC. 167

Although sec. 167 of the Internal Reve-

nue Code does not expressly so provide, it

has long been judicially established that

-7-

the intent to profit is an essential element

in the determination of whether a particular

activity is a "trade or business" under sec.

162. As Judge Swift, in his concurring opi-

nion in Peat Oil_& Gas Associates. et al.. v.

v. C.I.R., 65 TCM 2259 (1993)*, at p. 14,

fn 2, noted: "[Tjhe primary coaninell first

appeared as a judicial gloss on the statutory

language of section 165(c)(2) in Helvering v.

National Grocery Co., 304 U.S. 282 (1938)".

Until recently, the Tax Court almost in-

variably followed the rule, first approved

by the District of Columbia Circuit Court of

Appeals in Doggett v. Burnett, 62 App. D.C.

103, 65 F.2d 191 (1933), that the question of

whether a taxpayer had the requisite "intent

to profit" was to be determined by whether

he had "an actual and honest" intent to pro-

fit. Hence, we, as do professional practi-

tioners see "Equine Endeavors: Hobby v. Busi-

ness", Florida Bar Journal (March 1989), pp.

33, 36 n. 4) refer to the "actual and honest"

* Also reported as Peat Oil and Gas Associa-

tes v. C.I.R. (1993) 100 T.C. 271. Peat

is a very significant case as it sets forth

the differing views of the several Tax Court

judges on the issues raised herein, views

which help explain the differences between

the several Circuits and underline the need

for this Court to exercise its supervisory

powers and to settle important questions of

federal tax law. All of the issues presented

herein, save the constitutional issue, are

discussed and highlighted by the several Tax

Court judges in Peat.

-8-

test as the Tax Court’s rule. The Tax

Court also often cites ,

665 F.2d 1292 (DC Cir. 1981) as authority

for its rule.

In 1959, a panel of the Ninth Cir-

cuit, citing , supra,

held that a "good faith" intent to profit

was sufficient to establish the requisite

profit fit motive, and reversed a Tax Court

ruling against the taxpayer. (

C.I.R.,_ 274 F.2d 96 (9th Cir. 1959).)

Four years later another panel of the

Ninth Circuit, also citing Doggett v. Burn-

ett, supra, sustained a Tax Court’s ruling

against the taxpayer and, by way of dicta,

stated that the test was whether the taxpayer

had entered into the questioned activity in

"good faith, with the dominant hope and in-

tent of realizing profit, i.e., taxable in-

come". (Hirsch v. C.I.R., 315 F.2a 731, 736-

737 (9th Cir. 1963).) As indicated by the

Ninth Circuit’s opinion herein (Appendix B

P- 5), in subsequent opinions the concepts

of "good faith", "hope", and "income" were

dropped and the Ninth Circuit’s test, as dis-

tinguished from that of the Tax Court and the

several other circuits referred to herein,

became simply the "primary or dominant intent

to profit".

Further, as applied by the trial judge

herein, and affirmed by the Court of Appeals,

this test became a stand-alone, virtually in-

Surmountable obstacle to the taxpayer, not

a test requiring objective judicial compari-

son with other taxpayer motivations, as indi-

cated by this Court in Commissioner v. Groet-

oe

zinger, 480 US 23, 35-36 (1987) and Treasury

Regulations sec. 1. 212.1(c). (Appendix E, pp.

47-48.) See Commissioner v. Soliman, 506

U.S. 168, 174-175 (1993) where this Court in

a closely analogous situation calling for the

judicial determination of primacy, held that

the trial court must make a comparative ana-

lysis of the alternative factors.

The following cases from the Second,

Fourth, Sixth, Seventh, Eighth, Eleventh,

and District of Columbia circuits, all apply-

ing the Tax Court’s traditional "actual and

honest" intent to profit standard, and being,

according to our latest research, the latest

published opinions of these circuits, high-

light the differences between the Ninth

Circuit and these other cir uits:

Ranciato v. C.I.R., 52 F.3d 23, 25 (2nd

Cir. 1995); cf._Ferguson v. C.I.R., 29

F.3d 98, 102 (2nd Cir. 1994).

endri Vv , 32 F.3d 94, 97 (4th Cir.

1994); cf. “Antonides v. C.I.R., 893

F.2d 656, 659 (4th Cir. 1990).

Smith v. O.2 Ris 937 F.2d 1089, 1093 (6th Cir.

1991).

Burger v. C.I.R., 809 F.2d 355, 358 (7th Cir.

1987).

Evans v. C.I.R., 908 F.2d 369, 1373 (8th Cir.

1990).

Osteen v. C.I.R., 62 F.2d 356, 358 (11th Cir.

1995).

Cornfield v. C.I.R., 797 F.2d 1049 (D.C.

Cir. 1986).

We have also collected, in Appendix D,

pp. 39-41, a random sampling of some 42 post-

‘Commissioner v. Groetzinger Tax Court cases

-10-

(from some 229 sec. 183 cases reported by

Commerce Clearing House), all appealable to

the Ninth Circuit, and only four of which

mentioned the Ninth Circuit’s rule, much less

indicated an obligation to be bound by it.

Although most of these recent Tax Court

cases do not suggest that other judges of the

Tax Court are about to abandon the traditional

"actual and honest" test, the fact that some

judges feel obliged to cite both standards or

to otherwise equivocate on the issue, suggests

some uncertainty, blurs the essential distinc-

tion between the two tests, and obscures the

rights of the parties.

The distinction between these two tests

not only is emphasized by the outcome of pe-

titioners’ case, but also is demonstrated by

a post- issi in opinion by

the same Tax Court judge as here and where,

on remarkably parallel facts--although in

our biased: opinion, we believe we had much

the stronger case--the court upheld the tax-

payer against the Commissioner by applying

the "actual and honest" test. ( j

Pryor, 61 TCM 2139 (1991).

Compare Judge Swift’s plea in Peat Oil

ssoci Vv. C.I.R. (1993) 100 T.c.

271, 285-286, that the Tax Court, the forum

most likely to be adversely impacted by the

resolution of such a subjective matter as a

taxpayer’s primary intent, be spared such

burdens. If judicial standards are too ephe-

meral, decisions become "ad hoc and episodic",

and contravene accepted due process princi-

ples. (Rochin v. California, 342 U.S. 165,

172 (1951).)

-lli-

In concluding this section, we note that

in Portland Golf Club v. Commissioner, 497

U.S. 154 (1990), Justice Kennedy, in a parti-

ally concurring opinion, joined in by Justice

O’Connor and Justice Scalia, wrote that he saw

"no justification for making the profit-motive

requirement more demanding than necessary to

distinguish trades and businesses from other

activities pursued by taxpayers."

B

THE COURT SHOULD MANDATE A PROCEDURE WHEREBY

THE TAX COURT MAY EFFICIENTLY FULFILL ITS

OBLIGATIONS AS A COURT OF NATIONAL JURIS~-

DICTION WITHOUT CHALLENGING THE OBLIGATIONS

OF THE CIRCUIT COURTS OF APPEALS TO DECLARE

THEIR VIEWS ON TAX LAW

With 12 Circuit Courts of Appeal, most

often acting through lesser panels, faced

with the responsibility for resolving appeals

from a flood of Tax Court decisions by indi-

vidual Tax Court judges, not to speak of

appeals from the many District Courts within

their respective jurisdictions, it is small

wonder that basic conflicts on points of tax

law develope within the system.

However, while the federal court system

and the complexity of the tax laws necessar-

ily create diversity of opinion, it is not

seemly that the Internal Revenue Service and

the Tax Court should complicate the process

by themselves advancing diverse points of

view.

In theory, uniformity of opinion on

matters of law is imposed upon the Internal

-12-

Revenue Service by the Treasury Regulations.

(United States v. Correll (1967) 389 U.S.

299, 305-306.) But in fact, the Internal

Revenue Service has never felt the const-

raints of "petty consistency", and takes

its victories wherever and however it can

find them.

The Tax Court has a policy--of some 40

years duration and restated from time to

time--whereby it may assert its views on a

particular point of tax law against contrary

opinion by a particular Circuit court.

Thus, in Peat Oil and Gas Associates

Vv. C.I.R. (1993) 100 T.C. 271, a remarkably

illuminating opinion in which all 15 of

the Tax Court judges made their views known

on the issues of "profit" motives and

conflicts between the Tax Court and the

Courts of Appeals, the Court spoke to its

policy of refusing to defer to contrary

Circuit opinion unless the Tax Court had

first been reversed on precisely the same

point, and to hold to its opinion until

the matter has been ruled upon by this

Court.

This policy, flowing from its status

as a court of national jurisdiction and

its duty to apply the tax laws uniformly,

has been articulated in numerous other Tax

Court cases, e.g., 27

T.C. 713, 716-717 (1957), revd. on other

grounds 258 F.2d 562 (9th Cir. 1958);

Vv 2, 54 T.C. 742, 757 (1970),

affd. 445 F.2d 985 (10th Cir. 1971);

L113 Gdward Clack, 96 TC 4562

(1966); Krumhorn v. C.I.R., 103 TC 29,

-13-

30-31 (1993), an opinion by same trial

judge who deferred to 9th Circuit dicta

herein; Lardas v. C.I.R., 99 TC 490, 494

(1992).

This policy, as set forth in the Tax

Court’s majority opinion in Peat, is as

follows:

(1) The Tax Court will "follow a Court of

Appeals decision which is squarely in point

where the appeal from our decision lies to

that Court of Appeals and that court alone."

(Golsen v. C.I.R., 54 T.C. 742, 757 (1970),

affd. 445 F.2d 985 (10th Cir. 1971).)

(2) If appeal from the Tax Court’s deci-

Sion "lies to a Court of Appeals that does not

have a decision squarely in point, we, as a

court of national jurisdiction, must thorough-

ly reconsider an issue in light of the reason-

ing of a reversing appellate court and, if

still of the opinion that our original result

was right, follow our own beliefs until the

Supreme Court decides the point." (Lawrence |

y, ©, 348.1, 27 F.Cae i. 2732+ 746-717 €2967), revd.

on other grounds 258 F.2d 562 (9th Cir.

1958).

However, and for reasons not disclosed

in its opinion, this policy manifestly was

not followed by the Tax Court judge in peti-

tioners’ case. Indeed, the opinions of the

Ninth Circuit relied upon by the judge in his

opinion (Appendix C, p. 27) and cited by the

Ninth Circuit panel herein (Appendix B, p. 5)

did not involve reversals of Tax Court deci-

sions but rather were opinions sustaining the

Tax Court’s decisions on their facts, facts

-14-

SIA rca iinet

which were entirely unrelated to those of

petitioners’ case. Nor did the Tax Court

judge or the Ninth Circuit panel herein re-

cognize the existence of two Ninth Circuit

holdings which reversed Tax Court decisions

by applying the "good faith" intent to profit

test to facts which are similar to the facts

herein. (Brooks v. C.I.R., 274 F.2d 96 (9th

Cir. 1959); Mercer v. C.I.R., 376 F.2d 708

(9th Cir. 1967).)

The willingness of the Tax Court judge in

this case to break ranks with the Tax Court’s

policy of defending its national jurisdiction

in the interest of uniformity of tax law,

Suggests that other devices may be required

to assure such uniformity.

Our review of the many appeals from Tax

Court determinations in this area of law, per-

Suades us that rarely do the Courts of Appeal

take issue with the Tax Court on matters of

tax law, and that rarely do the decisions of

the Tax Court involve varying interpretations

of law. Rather, Tax Court trials usually are

are fact-finding proceedings, and the Courts

of Appeal, quite appropriately, extend great

deference to those fact determinations.

Thus it does not seem appropriate, even

though theoretically within their jurisdic-

tion, that the Circuit courts~--particularly

panels of those courts--should challenge the

Tax Court in its determinations of tax law

in the usual case. Indeed, we might reason-

ably suppose that it is of no great moment

to the orderly administration of the tax

laws and the national fisc that the Tax

Court should be left free to follow its

-15-

rule that an individual taxpayers intent to

profit--if such indeed must be a requirement

of sec. 162--is established if he has shown

an "actual and honest" intent to profit.

However, the contrary is not true. It is

of great moment to the trial judge and to the

individual taxpayer if the taxpayer must

"convince" the trial judge, or, more appro-

priately, prove by a preponderance of evid-

ence, that his "primary" motivation was to

make a profit. For in such case the court

and the parties--as this case well illustra-

tes--are at sea in a welter of testimony and

evidence subject to all manner of interpre-

tation and conflict. It is for this reason

that Judge Swift pleads for respite. (Peat

Oil and Gas Associates v. C.I.R. (1993) 100

T.C. 271, 285-286. )

We submit that this Court should craft

a rule which will complement the Tax Court’s

policy, a rule which would recognize the ob-

ligations of both the Tax Court and the Cir-

cuit Courts of Appeals, and yet reduce the

potential for conflict between the several

circuits and the Tax Court. We submit that

the Court, on the one hand, should approve

the Tax Court’s policy while directing that

the individual tax judges should not resolve

individual cases on points of law upon which

a majority of Tax Court judges have not ag-

reed, and, on the other hand, directing that

the Circuit courts follow a correlative pol-

icy of declining to review Tax Court opinions

which are based upon principles of tax law

upon which the Tax Court has not "spoken as

one voice", and should reverse such opinions

with directions that the Tax Court reconsider

-16-

the matter and reach uniformity of opinion

on the particular point of tax law.

The Tax Court struggles to establish

uniformity of tax law, as is its mandate,

but under the pressures of the enormous

volume of cases it processes, it must rely

on decisions by individual judges, a number

of whom do not share the same views, and

some of whom may be so convinced of the

merit of their own views as to proceed with

ad hoc rulings designed to advance such

views. Certainly, it appears from Peat

that the Tax Court judges are seriously

divided on this profit issue--which has a

far wider range of application than merely

to hobby cases--and could well use a cla-

rifying opinion by this Court.

As matters now stand, the Tax Court

does not appear to have any mechanism

whereby a litigant, caught up in this con-

troversy, can move the Tax Court to estab-

lish uniformity of opinion on matters of tax

law among its several judges prior to hav-

ing an adverse decision by an individual

judge passed on to a court of appeals for

review, a process which contributes to div-

ersity of opinion, conflict, and the unequal

application of the federal tax laws.

Cc

THE COURT SHOULD AFFIRM THAT ITS STATEMENTS IN

Vv e) WERE NOT INTENDED

TO ESTABLISH "PRIMARY INTENT TO PROFIT" AS A

STAND-ALONE TEST FOR DETERMINING WHETHER AN

ACTIVITY IS A TRADE OR A BUSINESS OR A MEANS

OF PRODUCING INCOME, BUT RATHER AS A METHOD

-17=-

OF DISTINGUISHING HOBBY-TYPE ACTIVITIES

It seems apparent, from the paucity of Tax

Court opinions mentioning Commissioner v. Groet

Zinger, 40 U.S. 23 (1987), that the Tax Court

judges are having difficulties in fitting all

of that opinion into the overall picture of

tax cases impacted by profit-motive questions.

However, the Court of Appeal herein cited

Groetzinger (see Appendix B, p. 5)--although

notably the Tax Court did not--as support for

its "primary" intent to profit rule. But pe-

titioners do not believe that this Court in-

tended that its comments on primacy have such

sweeping applications.

It appears abundantly clear that the sense

in which this Court used the expression "pri-

mary" was merely to distinguish a business or

income-producing activity from a "hobby or an

amusement diversion". (Ibid. at pp. 35-35.)

Which is completely in accord with I.R.C.

sec. 212 and Treasury Regulation 1.212.1(c).

(Appendix E, pp. 45, 47-48.)

D

THE COURT SHOULD DECLARE THAT IN DETERMINING

WHETHER A QUESTIONED ACTIVITY IS A TRADE OR

BUSINESS OR INCOME PRODUCING ACTIVITY, AS

DISTINCT FROM A HOBBY OR AMUSEMENT DIVERSION,

THE COURTS BELOW SHOULD UNDERTAKE A_COMMIS-_

SIONER vs SOLIMAN COMPARATIVE ANALYSIS TO

DETERMINE WHICH ACTIVITY IS PRIMARY

The manner in which the primary intent

rule should be applied is an important is-

issue of novel impression. No Ninth Circuit

-18-

decision stating the rule has explored its

parameters or discussed how this stringent

and highly subjective test is to be applied.

Nor did the Court of Appeals herein mention

our discussion of j j .

506 U.S. 168, 174-175 (1993), and contention

that it should be applied to the Tax Court ’s

findings in this case.

In Soliman this Court discussed the

analogous issue of whether a physician’s

home or the hospitals in which he practiced

was his "principal place of business", and

held that the determination of this ques-

tion requires a court to make a comparative

analysis of "the relative importance of the

activities performed at each business loca-

tion and the time spent at each place."

Similarly, courts cannot objectively

assess whether any one purpose is primary

or dominant without comparing it to the

other purpases which motivated the tax-

payer to enter into or continue a questioned

activity. And since, as shown by the inst-

ant case, the determination of the tax-

payer’s intent is determined by his actions

rather than his own statements, it follows

that the actions taken to show one purpose

or another must be analysed, weighed, and

compared before the ultimate conclusion is

reached.

Although petitioners have not been

able to establish that the Soliman rule of

analysis has received appellate court con-

Sideration in this context (cf. :

U.S., 674 F.2a 1359, 1363-1364 (10th Cir.

1982), the Tax Court on several recent

-19-

occasions has discussed and applied this

rule in precisely the sense in which

petitioners contend it ought to be applied:

Lynn Crawford, 65 TCM 2540, 2544 (1993).

Christos Coutsoubelis, 66 TCM 935, 938-939

(1993).

Ruth Giesbrecht, 69 TCM 2149, 2151 (1995),

appealable to 9th Circuit.

Peat Oil & Gas Associates, 65 TCM 2259,

2264-2265 (1993).

Qwen A. Steinberg, 69 TCM 2121, 2136

(1995).

Even the trial judge herein had pre-

viously recognized that Soliman, taken in

the profit context, requires the court to

undertake a comparative analysis of alter-

native motives (Peat Oil & Gas Associates

v. C.I.R., 100 TC 271, 291 (1993), he omit-

to do so in the instant case.

CONCLUSION

Petitioners respectfully urge the Court

to grant certiorari to review these impor-

tant tax matters. The institutional pres-

sures all tend toward diversity and conflict.

And only this Court is positioned to estab-

lish uniformity, a daunting picture for one

seeking the Court’s attention. But the vol-

ume of tax cases is so great, and the invi-

tation to litigate engendered by conflicting,

confusing, and uncertain court decisions so

alluring, that surely a great positive gain

can be anticipated from a ruling of this

Court that will not only remove uncertainty

and diversity from the narrower issues at

hand, but also from the institutional sug-

-20-

gestions we have raised herein to limit

conflict between the Tax Court and the

Courts of Appeals.

Respectfully submi

Of November, 1997.

this 17th day

Lew Wa

Pe

~*~,

rd&n,

titioner.

- Warden,

Petitioner

No.

IN THE

SUPREME COURT OF THE UNITED STATES

October Term, 1997

LEW WARDEN and NADJA J. WARDEN,

Petitioners,

Vv.

COMMISSIONER OF INTERNAL REVENUE.

On Petition For Writ Of Certiorari

To The United States Court Of Appeals

For The Ninth Circuit

APPENDICES TO PETITION FOR WRIT

OF CERTIORARI

Lew Warden

Nadja J. Warden

Petitioners Pro Se.

12120 East Snyder Road

Tucson, Arizona 85749

(520) 760-2809

INDEX TO APPENDICES

page

APPENDIX A - Order, 9th Circuit Court

of Appeals, denying peti-

tion for rehearing and

rejecting suggestion for

rehearing en banc, filed

August 20, 1997 1

APPENDIX B - Memorandum opinion, 9th

Circuit Court of Appeals,

filed April 2, 1997 3

APPENDIX C

Memorandum Opinion, Tax

Court, filed April 17,

1995 pe

APPENDIX D Tax Court Decisions:

1. Recent Tax Court

decisions, appealable

to the 9th Circuit, where

the Tax Court has applied

the "actual and honest"

intent to profit test 39

2. Recent Tax Court

decisions, appealable to

the 9th Circuit, where

the Tax Court has equi-

vocated as to the proper

test 40

4. Tax Court Cases Hold-

ing That an Activity En-

tered into for The Pur-

pose of Supplementing

Retirement Income Is An

Activity for Profit 41

APPENDIX E - Internal Revenue Code

Sections and Regulations 43

Sec. 162 43

Sec. 167 43

Sec. 183 43

Sec. 212 45

26 CFR 1.183-2 45

1.212-1(c) 47

ii

APPENDIX A

NOT FOR PUBLICATION

FILED

Aug 20 1997

Cathy A. Caterson, Clerk

U.S. Court of Appeals

IN THE UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

LEW WARDEN and NADJA J.

WARDEN, No. 95-70896

Appellants, Tax Court

No. 4829-92

v %

COMMISSIONER OF INTERNAL

REVENUE,

ORDER

Respondent.

Pe Nee ee ee Ne ee ee Ne ee es ee

Before: SCHROEDER AND O’SCANNLAIN,

Circuit Judges, and

KELLEHER, * District Judge.

The panel as constituted above has

*Honorable Robert J., Kelleher, Senior

United States District Judge for the

Central District of California, sitting

by designation.

voted to deny the petition for rehearing

and to reject the suggestion for re-

hearing in banc.

The full court has been advised of

the suggestion for a rehearing en banc

and no judge of the court has requested

a vote on the suggestion for rehearing

en banc. Fed. R. App. P. 35.

The petition for rehearing is denied

and the suggestion for rehearing en banc

is rejected.

(N.B. No date or signature provided. )

APPENDIX B

NOT FOR PUBLICATION

FILED

Apr 2 1997

Cathy A. Caterson, Clerk

U.S. Court of Appeals

IN THE UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

LEW WARDEN and NADJA J.

WARDEN, No. 95-70896

Appellants, Tax Court

No. 4829-92

Vv.

COMMISSIONER OF INTERNAL,

REVENUE,

MEMORANDUM

Respondent.

Pe Ne ae ee ee es as es a

Appeal from the United States Tax Court

Robert P. Ruwe, Tax Court Judge, Presiding

Argued and Submitted February 13, 1997

San Francisco, California

Before: SCHROEDER AND O’SCANNLAIN,

Circuit Judges, and

KELLEHER,** District Judge.

* This disposition is not appropriate for

publication and may not be cited to or by

-3-

i

Mr. and Lew Warden and Mrs. Nadja

Warden ("Appellants") challenge the find-

ings of the U.S. Tax Court. In its Memo-

randum Opinion of April 17, 1995, the Tax

Court held that expense deductions taken

by Appellants--alleged to have been incur-

red in relation to a yacht chartering bus-

iness--were improper. See I.R.C. secs.

162; 183. The Tax Court, applying the

"primary" or "dominant" purpose test, de-

termined that the yachting activity was

not engaged in with the primary purpose of

making a profit. Appellants contend that

the Tax Court incorrectly applied the pri-

mary purpose test in lieu of the more len-

ient "good faith" test. Appellants further

contend that even under the primary purpose

test, the Tax Court’s finding was clearly

erroneous. Because the Ninth Circuit pre-

cedent is clear that the primary purpose

test governs, and because Appellants have

not shown clear error, we affirm the judg-

ment of the Tax Court.

Decisions that are asserted to have

misapplied a given "profit" rule are to be

reviewed de novo.

Club v. Commissioner, 877 F.2d 750, 755

(9th Cir. 1989). There can be no question,

the courts of this circuit except as pro-

vided by Ninth Circuit Rule 36-3.

** Honorable Robert J., Kelleher, Senior

United States District Judge for the

Central District of California, sitting

by designation.

a

however, as to whether the Tax Court app-

lied the correct rule. Section 183 deals

with attempted deductions for activities

not engaged in with the proper profit mo-

tive. See I.R.C. sec. 183. Sec. 162, for

its part, deals with allowable deductions

as to activities that are engaged in with

the proper profit motive. This section

allows the deduction of Ordinary and nec-

essary expenses paid or incurred in connec-

tion with the operation of a trade or busi-

ness. See I.R.C. sec. 162.

For an activity to generate deductions

under section 162, we have Clearly stated

that a taxpayer must show "that the acti-

vity was entered into with the dominant

hope and intent of realizing a profit."

j j , 933 F.2d 757, 758

(9th Cir.) cert. denied, 502 U.S. 984

(1991). We have held that "(p)rofit must

be the predominant, primary or principal

objective .... ." issi , 4

F.3d 709, 713 (9th Cir. 1993); see also

, 820 F.2d 321, 323

(9th Cir. 1987);

, 781 F.2d 724, 728-29 (9th

Cir. 1986) ("Independent Electric"); Car-

issi , 645 F.2d 784, 786 (9th

Cir. 1981); issi , 315

F.2d (9th Cir. 1963). Though other cir-

cuits may apply a different standard, our

holdings in this area are in line with

those of the Supreme Court. See Commis-

| i , 480 U.S. 23, 25

| (1987); j j n-

Gowment, 477 U.S. 105, 110 n.1 (1986).

The correct test having been applied

=-5—

—EEE————E

by the Tax Court, our second duty is to

evaluate its conclusion that the yachting

activity did not carry with it the requi-

site profit motive. We have held that "[a]

finding of to profit motive must be affirmed

on appeal absent clear error." Wolf, 4

F.3d at 712 (citing Independent Elec., 781

F.2d at 727). We must uphold the Tax Court’s

finding unless we are “left with the definite

and firm conviction that a mistake has been

committed." Id. Further "{i]jf the [Tax

Court’s] account of the evidence is plausible

in the light of the record viewed in its

entirety, the court of appeals may not rev-

erse it even though convinced that had it

been sitting as the trier of fact, it would

have weighed the evidence differently."

tical Practices Comm’n, 955 F.2d 1312, 1317

n.7 (9th Cir.), cert. denied, 505 U.S. 1230

(1992).

The Tax Court determined that the

engagement in a trade or business--though

possibly a purpose--was not the primary

purpose of the yachting enterprise. The

Tax Court concluded its findings as to pro-

fit motive by writing:

Based on the entire record, we are not

convinced that petitioners’ primary

objective was to make a profit. See

Snyder v. United States, 674 F.2d 1359,

1362-64 (10th Cir. 1982). Rather, the

evidence is more consistent with the

conclusion that petitioners wished to

retire from the practice of law, had a

desire to sail, had the financial resour-

ces to pursue that desire, and had some

-6-

CO

hope that they could combine their dream

retirement with an income-producing

ture.

Appellants essentially contend that the Tax

Court gave certain pieces of evidence too much

or too little weight.

Without offering explanation or support

in the case law, Appellants first assert that

several findings of fact were not supported

by “substantial evidence". These six factors

are: that Appellants had the financial re-

sources to retire, that the yacht was used

for alternative purposes other than char-

tering, that Appellants took long trips on

the yacht, that mechanical failures could

have been foreseen had proper research been

performed, that Appellants should have pre-

pared a written business plan, and that

both Appellants loved to Sail. Appellants

assert that there not "substantial" evidence

to support the Tax Court’s implicit find-

ings of fact as to each of these facts. yet

employing the "clearly erroneous" standard

of review, we find that as there was a basis

1. Facts that Appellants suggest were not

considered but do appear in the Tax Court’s

opinion are as follows: (i) that Appel-

lants had attempted to acquire an interest

(ii) that mechanical failures caused the

losses related to the yacht; (iii) that

Appellants engaged in some business-like

activity; (iv) that Appellants prosecuted

~ os

for each of the findings--that is, each is

supported by the record--we must affirm the

judgment of the Tax Court.

Appellants then list several facts

that they assert that Tax Court did not

properly consider. This assertion is

patently absurd given that a majority of

the facts are specifically referenced in

the Tax Court’s memorandum and the remain-

der of the facts are expressly noted in

Mr. Warden’s Trial Memorandum--which was

admitted into evidence in lieu of direct

testimony by Mr. Warden--and are nonethe-

less dealt with in the Tax Court judgment

in some fashion. (fn 2.) Given that each

fact was present in the record before the

Tax Court and most were referenced expli-

citly in the Tax Court opinion, there is

no basis for us to presume that these facts

were not considered. In assessing a sim-

ilarly situated taxpayer’s previous chal-

lenge to a Tax Court’s findings, we wrote

litigations against the manufacturers and

sellers of the yacht; and (v) that real

losses, beyond mere depreciation expenses

were felt.

2. Facts that the court did not specifi-

cally reference but were either present in

Mr. Warden’s testimony or summarized in

slightly different terms include: (i) that

there was a 12 year absence between Appel-

lants’ ownership of their prior boat and

their ownership of the Rocking Chair in

1986 (the opinion instead stated that Mr.

-8-

that "[a]t best... appellants manage only

to show that their activities might have

had a profit motive; they do not show that

the Tax Court was clearly erroneous ...

- " Independent Electric, 781 F.2d at 727.

Furthermore, the fact that some evidence

Shows manifestations of a business does not

merit a reversal of the Tax Court’s deci-

sion. See Carter, 645 F.2d at 786-87

(facts showing that the taxpayers did not

engage in yachting activities primarily for

profit significantly outweighed facts indi-

cating that taxpayers’ activities had some

manifestations of a business). Appellants

bring to our attention the Same facts that

were before the Tax Court. Appellants have

made no argument whatsoever as to why we

Warden’s previous ownership of boats began

in 1947 and went on for twenty years--

which certainly displays an understanding

on the part of the Tax Court that no yachts

were owned between 1974 and 1986); (ii)

that Mr. Warden had found replacement coun-

sel for all but two of his Clients (the

opinion states merely that Mr. Warden con-

tinued to operate his law firm); (iii) that

the cost of additional insurance was double

the cost of having only personal insurance

(the opinion, however, does reference the

need for additional insurance in general

terms); and (iv) that Ms. Warden was deathly

afraid of sailing on the ocean (this was

clear in the admitted testimony of Mr.

Warden but not referenced in the opinion

itself).

should find that the Tax Court’s decision

should be overturned for clear error.

Appellants make two other brief con-

tentions on appeal--both of which are with-

out merit. First, Appellants argue that

the Tax Court’s use of the word "convince,"

in relation to Appellant’s burden of proof,

indicates that the Tax Court required a

level of proof beyond the preponderance of

the evidence. In its opinion, the Tax

Court did state that "[b]Jased on the en-

tire record, we are not convinced that pe-

titioners’ primary objective was to make

a profit." Yet this statement in no way

indicates a movement away from the prepon-

derance of the evidence standard. In

fact, the Tax Court implicitly referenced

such a standard when it stated that Appel-

lants carried the burden of proof, but

that the evidence was "more consistent"

with the profit motive being just one, and

not the primary, consideration.

Second, and distinct from their argu-

ment that the Tax Court misapplied the pri-

mary purpose test, Appellants make a brief

argument that the application of the Ninth

Circuit rule was both inconsistent with the

practice of the Tax Court and violative of

their constitutional rights. Appellants

argue that the Tax Court, as a court of

national jurisdiction, should follow its

own rules and not the rules set out by the

Ninth Circuit. Appellants, however, cannot

point to Ninth Circuit case law supporting

this notion and otherwise provide no cases

where the Tax Court has expressly rejected

binding precedent of the relevant circuit

-10-

in favor of the Tax Court rule. To the

contrary, a brief review of recent Tax

Court opinions instructs that the Tax Court

regularly defers to the Ninth Circuit when

the Ninth Circuit has provided a clear rule

of law. See, e.g., Beaver Bolt Inc. v. Com-

missioner, 1997 WL 28676 (U.S. Tax Ct.); Sun-

issioner, 72 T.C.M.

(CCH) 1606 (1997).

In extending its weak argument, Appel-

lants next contend that by following the

Ninth Circuit, the Tax Court denied Appel-

lants due process and violated the equal

protection clause in that taxpayers not un-

der the jurisdiction of the Ninth Circuit

are treated more favorably. Appellants

provide no support for this theory that the

application of a rule by a United States

Court of Appeals (as well as by the courts

reviewable by that Court) can be unconsti-

tutional where the underlying rule confl-

icts with a more favorable rule by another

circuit. Where we follow clear Supreme

Court precedent, but other circuit or trial

courts do not, a constitutional violation

cannot be said to have occurred with regard

to the person against whom a correct rule

of law has been applied.

For the foregoing reasons, we affirm

the Tax Court’s judgment finding deficien-

cies in Appellants’ federal income taxes in

the amount of $28,344 and adding an "addi-

tion to tax" under I.R.c. sec. 6662(b)(2)

of $4,725.

AFFIRMED.

-ll-

APPENDIX C

T.C. Memo. 1995-176

UNITED STATES TAX COURT

LEW WARDEN and NADJA J. WARDEN,

Petitioners,

Vv.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

Docket No. 4829-92. Filed April 17, 1995.

Lew Warden, for petitioners.

Debra K. Estrem, for respondent.

MEMORANDUM OPINION

RUWE, Judge: Respondent determined

deficiencies in petitioners’ Federal income

taxes and additions to tax as follows:

Addition to Tax

Year Deficiency Sec. 662(b)(2)

1986 5.17338 --

1989 28,344 $4,725

-12-

After concessions, (fn 1) the primary

issue for decision is whether petitioners’

yacht-related activities were engaged in

for profit within the meaning of section

183. Subsidiary issues are: (1) Whether

petitioners properly deferred recognition

of a gain pursuant to section 1033; (2)

whether petitioners are entitled to offset

1989 income by net operating losses that

were allegedly incurred in 1987 and 1988;

and (3) whether petitioners are liable for

the addition to tax for substantial

understatement of income tax pursuant to

section 6662(b)(2) for the taxable year

1989.

FINDINGS OF FACT

Some of the facts have been stipulated

and are so found. The first stipulation of

facts, second stipulation of facts, and at-

tached exhibits are incorporated herein by

this reference. Petitioners resided in

Castro Valley, California, when they filed

their petition.

1. At trial, petitioners conceded the defi-

ciency determinations for the taxable year

1986.

2. Unless otherwise indicated, all section

references are to the Internal Revenue Code

in effect for the taxable years in issue,

and all Rule references are to the Tax Court

Rules of Practice and Procedure.

3. Hereinafter, petitioners will be refer-

-13-

Beginning in 1953, through the years

in issue, petitioner Lew Warden practiced

law as a sole proprietor in Alameda County

California. Petitioner Nadja Warden (fn 3)

worked in her husband’s law office keep-

ing the books, but she received no pay or

benefits. She held no other jobs. Mr.

Warden retired from his law practice in

1993.

In 1974, petitioners acquired a one-

sixth interest in an abandoned tennis and

swim club in Pleasanton, California, from

Mr. Warden’s client, Julius Kahn. The re-

maining five-sixths of the property was

held by Julius and his two brothers. As

a result of controversies between the three

brothers, the property had fallen into dis-

repair, and petitioners and Julius planned

to reconstruct and operated the property as

a recreational facility. Petitioners hoped

to retire from the practice of law and

spend their retirement years working in the

"congenial and pleasant surroundings" of a

recreational club. Petitioners moved onto

the property and, until about 1980, attemp-

ted to repair it. However, the property

never operated as a tennis and swim club.

Around 1980, the Kahn brothers contem-

plated partitioning the property. Ensuing

litigation resulted in a 1980 judgment by

the Alameda County Superior Court, which

ordered the property sold and the proceeds

red to as Mr. Warden or Mrs. Warden where

necessary for clarification.

-14-

partitioned between petitioners and the

Kahn brothers. The property was sold in

1980 for $316,000; petitioners received

$183,642.15 of the sale proceeds, and the

remainder was distributed to the Kahn bro-

thers. In 1981, petitioners appealed from

the partition judgment. In 1984, while the

appeal was still pending, petitioners filed

suit against various parties involved in

the partition sale, alleging that the sale

was fraudulent. The appeal and lawsuits

alleging a fraudulent sale continued until

1989; at that time, all petitioners claims

regarding the Pleasanton property were set-

tled for $170,000. Petitioners thus rece-

ived $353,642.15 from the disposition of

the Pleasanton Property ($170,000 plus

prior payments of $183,642.15).

For tax purposes, petitioners assumed

that the use of the Pleasanton property was

50 percent business and 50 percent residen-

tial, and treated the disposition of the

property as having commenced in 1981 and

concluded in 1989. On their 1989 Federal

income tax return petitioners treated the

business portion of the gain received from

the Pleasanton property ($85,000) as "rol-

led over" into the cost of a yacht they had

previously purchased in 1986.

In March 1986, petitioners ordered a

1986 Tayana model 55-foot, sailing yacht,

with a 120 horsepower, freshwater-cooled

diesel engine. It was to be built in Tai-

wan by Ta Yang Yacht Building Co. and sold

through Windships, Inc., of Oakland, Cali-

fornia (Windships). Petitioners prepared

detailed specifications for the construc-

-15-

tion of the yacht, which were attached to

the purchase agreement with Windships. The

name of the yacht was Rocking Chair. Rock-

ing Chair was spacious, nicely equipped,

and furnished. It had a saloon, a galley,

two bathrooms, and could comfortably sleep

ten. It also had a telephone, a microwave

oven, a coffeemaker, and a library, which

contained periodicals, books, and video-

tapes. The total cost of Rocking Chair was

$231,667, which included the cost of acces-

sories and commissioning. Petitioners paid

a deposit of $46,333 on March 24, 1986.

The yacht was delivered to petitioners

on December 29, 1996, 6 months later than

promised by the seller. Upon delivery, pe-

titioners discovered many defects and fail-

ures to complete the yacht according to

their specifications. Windships represented

that it would correct the defects but did

not do so in a timely manner. As a result,

petitioners performed much of the work to

prepare the yacht for commissioning. After

the yacht was commissioned, petitioners

continued to experience various equipment

failures, including problems with the bat-

tery system, autopilot, and refrigerator as

well as a transmission failure. Petition-

ers brought suit in 1989 for breach of con-

tract, breach of warranty, and fraud aga-

inst Windships, Ta Yang Yacht Building Co.,

and the owners of Windships. In 1992, pe-

titioners obtained a default judgment against

Windships in the amount of $153,164.50 and

against Ta Yang Yacht Building Co. in the

amount of $212,764.50. In 1993, the Superior

Court also entered judgment against the

owners of Windships, finding them person-

-16-

ally liable for the acts of Windships.

Mr. Warden was an experienced sailor,

who had taken courses in nautical naviga-

tion, boat handling, disaster control, and

diesel engine maintenance. At the age of

17, he was a seaman on a Swedish oil tanker.

He had also been an Air Force navigator and

pilot, performing both combat and instruc-

tional work. After purchasing their first

Sailboat in 1947, petitioners engaged in

extensive cruising and yacht racing in the

San Francisco Bay and offshore. They con-

tinued boating for the next 20 years, dur-

ing which time they purchased and built or

rebuilt three sailboats.

At the time petitioners purchased Rock-

ing Chair, they were looking forward to en-

joying life in somewhat warmer climates than

the San Francisco Bay Area presented. Mr.

Warden, then age 66, was becoming increas-

ingly dissatisfied with the practice of law

and sought to earn a living in a more plea-

Sant recreational Setting. The purchase of

ir was part of his Plan for imp-

lementing this desire, and as a part of his

plan, he intended to charter the yacht. At

the time petitioners purchased j air

they had a net worth of approximately

$1,027,000.

Prior to purchasing j ir, peti-

tioners had no experience with chartering.

Petitioners’ preparation for entering the

chartering activity consisted of talking to

friends, clients, and other acquaintances

engaged in chartering activities; going out

on a charterboat during a bar association

-17-

meeting in Jamaica; studying yachting maga-

zines; and talking with people at resorts,

such as Club Med. From this they learned

of the going rates for different types of

charters and decided that the most profit-

able and least burdensome type of charter-

ing activity would be to conduct day-sail-

ings as opposed to overnight or extended

cruises.

Petitioners did not prepare a written

business plan prior to purchasing Rocking

Chair. Although Mr. Warden claimed to be

very knowledgeable about the expenses in-

volved in operating and maintaining a yacht,

he claimed no such expertise with regard to

income from chartering activities. The

yacht salesmen at Windships represented to

petitioners that they could earn substantial

income chartering boats--about $36,000 per

season as estimated by the salesmen. Al-

though Mr. Warden was aware, prior to pur-

chasing Rocking Chair, that there was a 55-

foot yacht in Windships’ marina that was

being chartered by Windships, he never dis-

cussed the profitability of chartering with

the owner of the yacht, nor did he check

Windships’ chartering records to verify the

salesmen’s statement. He simply concluded

from several months of spending time at the

harbor and watching the charter boat come

and go, that "They were getting charters."

Windships informed petitioners of the

chartering arrangement between it and the

owners of the other 55-foot yacht that it

was chartering. This arrangement involved

Windships’ maintaining the yacht and re-

ceiving 60 percent of the chartering reve-

-18-

nues, leaving the owners only 40 percent of

the revenues. Petitioners desired a differ-

ent arrangement, where they would perform

most of the labor and maintain insurance on

the yacht and receive 60 percent of the re-

venues rather than 40 percent. Mr. Warden

prepared a detailed charter/lease agreement

to this effect, which included charter rate

schedules; however, the agreement was never

Signed by Windships. Petitioners did, in

fact, perform most of the labor in cleaning

and maintaining the yacht and kept a detailed

log reflecting the use and maintenance of the

yacht. In June 1988, after Rocking Chair’s

transmission failed, Mr., Warden moved onto

the yacht, using it as his residence.

On June 19, 1987, petitioners filed a

business tax declaration with the city of Oak-

terly state, local, and district sales and

use tax returns with the State of California,

which covered the periods between January

1987 and December 1989. Petitioners obtained

an employer identification number in the name

of Rocking Chair Cruises from the Internal

Revenue Service on June 30, 1987. Using this

number, petitioners filed a Form 941 (Emplo-

yer’s Quarterly Federal Tax return) and re-

mitted the required withholding tax for two

employees who worked for them on a few occa-

sions during 1987. These employees helped to

Clean the yacht and cut and lay carpet for

the yacht. Petitioners determined that it

was not feasible to continuing hiring people

for such maintenance work and ceased using

employees. Petitioners Opened a separate

-19-

checking account in the name of Rocking Chair

and drew checks on this account for expenses

relating to Rocking Chair. However, most of

the checks that were issued for yacht-related

expenses were drawn on Mr. Warden’s law prac-

tice account or on Mrs. Warden’s personal

account. Petitioners maintained a telephone

on the yacht, the account for which was in

the name of Rocking Chair, from April 14,

1987, through July 19, 1989. Petitioners

also obtained additional insurance coverage

for chartering activities but dropped this

additional coverage in 1991. Petitioners

obtained a Coast Guard certificate of docu-

mentation dated November 19, 1988, for rec-

reational use only.

Petitioners made attempts to advertise

Rocking Chair for charter. They ran an ad in

the classified section of "Latitude 38" during

March, April, and May 1988, and they ran an ad

in the 1987 Pacific Bell Oakland Yellow Pages.

Rocking Chair was only chartered on a few

occasions. In 1987, petitioners received

three charters through Windships. In 1988

Rocking Chair was not chartered at all. In

1989, Mr. Warden took Rocking Chair south to

Santa Barbara, where he listed it for sale

with a broker. While there, he met a charter-

boat operator who was doing business as Sun-

set Kidd Sailing Charters (Sunset Kidd). Pe-

titioners obtained three charters through

Sunset Kidd in 1989. In 1990, petitioners

chartered the yacht once and have not chart-

ered it since.

Around 1989 or 1990, Mr. Warden attempted

to enter into a working relationship with Mr.

-20-

Neil Weinberg, who owned a Tayana boat fran-

chise. Mr. Warden anticipated starting a pro-

gram to sell standardized Tayana boats, using

i ir as a pilot for the program. As

@ part of the proposed sales program, custo-

mers would be taken on a cruise to Mexico

where they would learn the details and tech-

niques of Sailing their new boats. This plan

never materialized.

Petitioners attempted to sell

Chair after they encountered defects and mech-

anical problems. Petitioners entered into

various agency listing agreements, authorizing

the agents to sell j ir. Petitioners

entered into five such agreements in all;

the first agreement was dated September -

1989, (fn 4) and the most recent agreement was

dated October 14, 1992. Petitioners ran an ad

in "SAIL" magazine for 2 months at the end of

1990 offering the yacht for sale, and they ran

an ad in the classified section of "Latitude

38" from June 1991 through January 1992.

Petitioners reported large net losses on

their Federal income tax returns (Schedule C)

come, expenses, and net losses Claimed by

petitioners with respect to chartering acti-

vities:

4. Although the evidence contains a central

agency listing agreement that petitioners

purportedly entered into with Gary Helms on

Oct. 1, 1988, the agreement is not signed.

-21-

Taxable Gross Expenses** Net Income

ear income {Loss )

1987 $2,118 $75,712 ($73,594)

1988 5,429* 47,536 ( 42,107)

1989 8,189* 75,343 ( 67,154)

1990 638 81,876 ( 81,238)

1991 153 60,552 ( 60,399)

1992 0 45,885 ( 45,885)

*In each of the taxable years 1988 and 1989,

$5,429 represents an amount that Mr. War-

den allocated for his living on the yacht;

it is not charter income.

**These expenses include depreciation clai-

med in each of the taxable years 1987

through 1992 of $40,225, $33,573, $38,139,

$41,184, $40,496, and $34,626, respectively.

During these years, Mr. Warden continued to

operate his law practice. The following sun-

mary reflects the gross income, expenses, and

net income (losses) claimed by petitioners

with respect to the law practice:

Taxable Gross Expenses** Net Income

ear Income (Loss )

1986 $146,027 $121,922 $24,105

1987 60,119 89,490 (29,371)

1988 163,021 65,297 97,724

1989 92,248 64,249 27,999

1990 63,880 41,278 22,602

1991 108,946 63,781 45,165

1992 4,720 12,939 O*

*Although reported expenses exceed reported

gross income, indicating that petitioners

=-22-

incurred an operating loss in 1992, they

reported a net income (loss) of zero.

Petitioners maintained detailed con-

puter records of the capital expenditures,

depreciation, other expenses, and revenues

generated by the yacht-related activities.

Of 35 pages of records covering the years

1987 through 1990, 33 pages pertain to ex-

penses, while only two pages pertain to

income.

During the years in issue, petitioners

admitted to using j ir on at least

a few occasions for reasons unrelated to

their chartering activities. These trips,

however, do not appear in their operating

log. The only trips that appear in petiti-

oners’ log were reflected as charters or as

linked to testing or repairing the yacht and

its equipment. Petitioners’ maintenance log

reflects the following trips through 1990:

ate Port/Purpose of Trip

5/24/87 Golden Gate Bridge charter

5/31/87 Guest sail

6/6/87 Guest sail/promotion

6/13/87 Charter

8/14/87 Charter - 2 days

9/4/87 Depart for Sacramento shakedown

cruise. Anchor at Angel Island.

9/5/87 Leave Angel Island; anchor in

Lockport.

9/6/87 Leave Lockport; anchor in Sacra-

mento. Stayed for 4 days. De-

part for home on 9/10/87.

1/7/88 Depart for Puerto Rico for Ocean

Navigator Instructional cruise.

-23-

7/2/88

7/3/88

7/4/88

4/29/89

7/10/89

7/11/89

7/12/89

7/13/89

7/14/89

7/16/89

9/3/89

9/10/89

9/11/89

10/8/89

11/7/89

11/20/89

11/24/89

12/1/89

12/3/89

12/5/89

Stayed for 12 days.

Depart for Delta shakedown cruise.

Anchor at Angel Island.

Leave Angel Island; anchor in

Antioch.

Leave Antioch; anchor in Mande-

ville Cut. Stayed for 2 days.

Depart for home on 7/6/88.

Sail to Sausalito for purpose of

testing a potential crew member.

Begin trip south. Anchor at

Sausalito.

Leave Sausalito; anchor at Half

Moon Bay.

Leave Half Moon Bay; anchor at

Santa Cruz.

Leave Santa Cruz; anchor at

Monterey.

Leave Monterey; anchor at San

Simeon. Stayed for 2 days.

Leave San Simeon; anchor at Pt.

San Luis. Stayed until 9/3/89.

Leave Pt. San Luis; anchor at

Santa Barbara.

Sail to Santa Cruz Island for

the purpose of demonstrating

the yacht, and testing Sunset

Kidd charter boat operator.

Return to Santa Barbara.

Charter - 3 days.

Sail to Marina del Rey to re-

pair water maker. Returned

the next day.

Charter.

Charter.

Depart for Newport.

Ventura.

Leave Ventura; anchor at Oxnard.

Leave Oxnard; anchor at Marina

Anchor at

-24-

ieeeeeeererememnnentiiisiiiiiiaiiaailiitia dail iaaitiial

del Rey.

12/6/89 Leave Marina del Rey; anchor at

Long Beach. Stayed for almost

1 month.

1/2/90 Leave Long Beach; anchor at New-

port. Stayed for almost 2 months.

2/25/90 Leave Newport; anchor at Dana

Point.

2/26/90 Leave Dana Point; anchor at San

Diego.

2/28/90 Leave San Diego; anchor at Ense-

nada, Mexico.

3/1/90 Leave Ensenada. Travelled north

reaching Ventura again on 3/24/90.

Stayed for 4 months.

7/2/90 Move from Ventura to Oxnard to

check out Marina Sailing per-

sonnel. Stayed for almost 4

months.

10/28/90 Depart for Santa Barbara.

11/6/90 Leave Santa Barbara; anchor at

Santa Cruz.

11/9/90 Leave Santa Cruz; arrive back in

San Francisco.

At the time of trial, Mr. Warden had

taken the yacht to Mexico, and Mrs. Warden

was planning to move to Mexico to join him.

OPINION

We must first decide whether petition-

ers’ ownership and Operation of Rocking Chair

were activities that were "not engaged in for

profit" within the meaning of section 183(c).

Section 183(a) provides generally that if an

activity is not engaged in for profit, no

deduction attributable to such activity shall

be allowed, except as otherwise provided in

-25-

section 183(b). (fn 5) Section 183(c) de-

fines an activity not engaged in for pro-

fit as "any activity other than one with

respect to which deductions are allow-

able for the taxable year under section

162 or under paragraph (1) or (2) of sec-

tion 212."

Deductions are allowed under section 162

for the ordinary and necessary expenses of

carrying on an activity which constitutes the

taxpayer’s trade or business. Deductions are

allowed under section 212 for expenses paid

or incurred in connection with an activity

engaged in for the production or collection

of income, or for the management, conserva-

tion, or maintenance of property held for the

production of income. With respect to either

section, however, the taxpayer must demons-

trate a profit objective for the activities

in order to deduct associated expenses. Jas-

ionowski v. Commissioner, 66 T.C. 312, 320-322

(1976); sec. 1.183-2(a), Income Tax Regs. The

profit standards applicable to section 212 are

the same as those used in section 162. See

Agro Science Co. v. Commissioner, 934 F.2d

573, 576 (Sth Cir. 1991), affg. T.C. Memo.

5. Sec. 183(b)(1) permits a deduction for ex-

penses that are otherwise deductible without

regard to whether or not the activity is en-

gaged in for profit, such as interest and per-

sonal property taxes. Sec. 183(b)(2) permits

a deduction for expenses that would be deduc-

tible only if the activity were engaged in

for profit, but only to the extent of the

total gross income derived from the activity

-26-

1989-687; Vv. Commissioner, 893 F.2q

656, 659 (4th Cir. 1990), affg. 91 T.c. 686

(1988); Allen v. Commissioner, 72 T.c. 28,

33 (1979); Rand v. Commissioner, 34 T.c.

1146, 1149 (1960).

Respondent argues that for purposes of

section 183, a taxpayer must prove that profit

was the primary purpose for engaging in the

activity. This case is appealable to the

Ninth Circuit Court of Appeals. The primary

purpose standard has been followed by the

Court of Appeals for the Ninth Circuit in

determining whether the requisite profit ob-

jective exists. See issi .

4 F.3d 709, 713 (9th Cir. 1993), affg. T.C.

Memo. 1991-212; Polak YC issioner,

820 F.2d 321 (9th Cir. 1987), aft¢ge :TiCi

Memo. 1985-197; Indepe dent ec. S 4 Pe

Commissioner, 781 F.2d 724 (9th Cir. 1986)

affg. T.C. Memo. 1984-472; =

missioner, 645 F.2d 784 (9th Cir. 1981) affg.

T.C. Memo. 1978-202 (disallowing deductions

related to yacht chartering and writing acti-

vities under section 183); Hi is-

sioner, 315 F.2d (9th Cir. 1963), affg. T.C.

Memo. 1961-256.

Whether the required profit motive exi-

sts is to be determined on the basis of all

the facts and circumstances of each case.

irsc - Commissi , 315 F.2d at 373;

an Vv. Commissi 1 72 T.C. 411, 426

(1979), affd. without published opinion 647

F.2d 170 (9th Cir. 1981); sec. 1.183-2(a),

less deductions allowed by sec. 183(b)(1).

-27-

Sea a are ce eel

Income Tax Regs. While the focus of the test

is on the subjective intention of the tax-

payer, greater weight is given to the objec-

tive factors than to the taxpayer’s mere

statement of his intent. Independent Elec.

Supply, Inc. v. Commissioner, 781 F.2d at

726; Dreicer v. Commissioner, 78 T.C. 642,

645 (1982), affd. without published opinion

702 F.2d 1205 (D.C. Cir. 1983); sec. 1.183-

2(a), Income Tax Regs. Petitioners have the

burden of proving that they had the requisite

intention and that respondent’s determination

that the activities were not engaged in for

profit is incorrect. Rule 142(a); Welch v.

Helvering, 290 U.S. 111 (1933).

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

sets forth some relevant factors for de-

termining whether an activity is engaged in

for profit. No one factor is controlling.

Brannen v. Commissioner, 722 F.2d 695, 704

(11th Cir. 1984), affg. 78 T.C. 471 (1982);

Golanty v. Commissioner, 72 T.C. at 426.

The relevant factors are: (1) The manner in

which the taxpayer carries on the activity;

(2) the expertise of the taxpayer or his ad-

visers; (3) the time and effort expended by

the taxpayer in carrying on the activity;

(4) the expectation that 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 to the activity; (7) the amount of

occasional profits, if any, which are earned;

the financial status of the taxpayer; and

(9) the presence of elements of personal

pleasure or recreation. Sec. 1.183-2(b),

Income Tax Regs.

{

Fy

-23-

—

(1) i 3

ivi We recognize that

there are some manifestations of a business

in petitioners’ yacht-related activities.

Petitioners kept records of the income and

expenses and a detailed log reflecting the

use and maintenance of the yacht. Peti-

tioners opened a separate checking account

in the name of Rocking Chair; however most

of the checks that were issued for yacht-

related expenses were drawn on Mr. Warden’s

law practice account or on Mrs. Warden’s

personal account. Petitioners also filed a

business tax declaration, obtained a seller’s

permit, filed sales and use tax returns, ob-

tained an employer identification number, ob-

tained additional insurance, and maintained

a telephone on the yacht. Petitioners adver-

tised the yacht’s availability for charter in

the classifieds and the yellow pages; however,

attempts to publicize the chartering activi-

ties were not Significant. Petitioners also

attempted -to sell the yacht when they encoun-

tered defects and mechanical problems.

Petitioners did not prepare a written

business plan prior to purchasing Rocking

Chair. Petitioners relied on representations

by the yacht salesmen at Windships that they

could expect revenue of about $36,000 per sea-

son chartering the yacht. Petitioners did not

check Windships’ chartering records to verify

the salesmen’s statement, nor did they attempt

to determine whether the represented income of

$36,000 would be sufficient to cover antici-

pated expenses. Petitioners did not discuss

-29°-

ked to acquaintances in the chartering busi-

ness and studied yachting magazines prior to

purchasing Rocking Chair, there has been no

showing of the specific nature of the infor-

mation and advice they received from these

sources. Even though petitioners kept records

of their income and expenses, there has been

no showing that they used these records to

improve the profitability of the operation.

(2) The expertise of the taxpayer or

his advisers. Mr. Warden was an experienced

sailor, and he had experience maintaining and

building yachts. However, petitioners had no

experience with chartering. While they clai-

med to have gained knowledge of the charter-

ing business through talking with acquaint-

ances in the business and studying yachting

magazines, no reliable evidence exists to

show the specific nature of the information

and advice that petitioners received from

these sources.

(3) j ax-

payer in carrying on the activity. Petition-

ers spent a good deal of time cleaning and

maintaining the yacht; however, these activi-

ties are also consistent with use of the yacht

for recreation.

(4) Expectation that assets used in the

activity would appreciate in value. Petition-

ers argue that they thought the yacht would

appreciate in value because of inflation and

the declining value of the dollar. Petitioners

did not offer any evidence as to their meas-

urement of the yacht’s expected appreciation.

(5) The success of the taxpayer in car-_

-30-

Similar or dissimilar activi-

ties. Petitioners have not previously enga-

ged in yacht-chartering activities.

(6) ’ isto of income and

losses with respect to the activity, and (7)

which are earned. Petitioners’ chartering

activities generated substantial losses over

a period of six years, which petitioners used

to offset taxable income from other sources.

A record of substantial losses over many years

and the unlikelihood of achieving a profitable

operation are important factors bearing on the

taxpayer’s intention. issioner

949 F.2d 345, 352 (10th Cir. 1991), affg. T.Cc.

Memo. 1990-148; Golanty v. Commissioner, 72 T.

C. at 426-427. The presence of such losses in

the formative years of a business is not in-

consistent with an intent to achieve a later

profitable level of operation; however, the

goal must be to realize a profit on the en-

tire operation, which presupposes sufficient

future net earnings from the activity to re-

coup the losses. Vv. issioner,

Supra at 427. In the present case, petition-

ers reported losses over 6 years of operation

totaling $370,377.

(8) The financial status of the tax-

payer. When petitioners purchased Rocking

Chair, their net worth was approximately

$1,027,000. During the period in which peti-

tioners operated Rocking Chair, they received

income from Mr. Warden’s law office and

other sources such as interest. While such

non~-chartering income was not overwhelming,

petitioners did obtain a tax benefit from

the losses generated by the chartering acti-

-31-

vities.

(9) The presence of elements of perso~_

j Mr. Warden was

no longer happy in his practice of law, and

he was of an age where he was ready to re-

tire. Petitioners wanted to live in a more

pleasant, recreational setting. They clearly

enjoyed sailing and had engaged in sailing

activities for recreation for at least 20

years prior to purchasing Rocking Chair.

The yacht was custom built and was equipped

with all the amenities. Beginning in 1988,

Mr. Warden lived on the yacht and used it

as his residence. Petitioners admittedly

used Rocking Chair for activities unrelated

to chartering but did not document these

trips in their operating log. Petitioners’

documented trips on Rocking Chair were to

locations such as Sacramento, Santa Cruz,

Monterey, Santa Barbara, Newport, San Diego,

and Ensenada, Mexico. Petitioners often

stayed for extended periods of time at these

locations.

Based on a consideration of all the

above factors and having heard petitioners’

testimony at trial, we believe that they

honestly hoped that their yachting activity

would generate a profit. Profit was one ob-

jective of their activity. However, to pre-

vail, petitioners must show that their

yachting activities were engaged in primar-

ily for the purpose of making a profit.

Petitioners argue that they would not

have purchased Rocking Chair unless their

primary objective was to offer it for char-

ter and thereby earn a livelihood. Peti-

-32-

tioners argue that due to limited finances,

they could not have used Rocking Chair pri-

marily for personal purposes. However, at

the time petitioners purchased Rocking Chair,

they had an estimated net worth of over

$1 million, and Mr. Warden was still genera-

ting income from the law practice. We can-

not overlook the significant recreational

elements associated with the yacht. Peti-

tioners loved to sail. They were ready to

retire and wanted to live in a pleasant, re-

creational setting. They did, in fact,

travel to many locations. These factors

strongly indicate a personal objective.

Petitioners contend that the losses sus-

tained as a result of their chartering acti-

vities were attributable to unforeseen cir-

cumstances, consisting of repeated equipment

failures and failures of the seller and man-

ufacturer to correct the yacht’s defects.

Losses sustained because of unforeseen or

fortuitous circumstances beyond the control

of the taxpayer do not necessarily indicate

that the activity was not engaged in for pro-

fit. j i » 72 T.C. 659,

669 (1979); sec. 1.183-2(b)(6), Income Tax

Regs. There is evidence that some of peti-

tioners’ problems stemmed from mechanical

defects. However, petitioners failed to con-

duct the type of preliminary investigations

that one would expect from someone who was

motivated primarily by a profit objective.

Further inquiry might have given petitioners

into the likelihood off many of the problems

they encountered. See issi

84 T.C. 1244, 1278 (1985), affd. 792 F.2a

1256 (4th Cir. 1986).

-33-

Where taxpayers have both personal and

profit objectives for engaging in an activ-

ity, it is our task to determine which was

"primary". Based upon the entire record, we

are not convinced that petitioners’ primary

objective was to make a profit. See

v. United States, 674 F.2d 1359, 1362-1364

(10th Cir. 1982). Rather, the evidence is

more consistent with the conclusion that

petitioners wished to retire from the prac-

tice of law, had a desire to sail, had the

financial resources to pursue that desire, and

had some hope that they could combine their

dream retirement with an income-producing

venture. Based on this record, we simply

do not believe that petitioners’ profit ob-

jective was the primary or dominant reason

for engaging in the activity in question.

We hold that petitioners’ yacht-related

activities were not engaged in for profit

within the meaning of section 183(c). Peti-

tioners’ deduction of the loss associated

with these activities is, therefore, sub-

ject to the limitations set forth in section

183(b).

Respondent disallowed the entire loss

that petitioners claimed in 1989 regarding

the yacht. As noted previously, section

183(b)(1) permits a deduction for expenses

that are otherwise deductible without regard

to profit objective, such as interest and

taxes. Included in petitioners’ claimed loss

was an interest expense deduction of $15,782

and a tax deduction of $3,908. Respondent

makes no claim that these amounts were not

paid. Rather, respondent’s position in both

the notice of deficiency and on brief is that

-34-

————————————————

petitioners were not engaged in the charter-

ing activity for a profit. Petitioners are,

therefore, entitled to deduct these items

pursuant to section 183(b)(1). (fn 6) Be-

cause these deductions exceed the total

gross income reported from the activity,

(i.e., $8,189), petitioners are not allowed

any deduction pursuant to section 183(b)(2).

Next, we must determine whether petiti-

oners may defer recognition of the gain on

the disposition of the Pleasanton property

pursuant to section 1033. Section 1033(a)

provides that if property is compulsorily or

involuntarily converted "as a result of its

destruction in whole or in part, theft,

seizure, or requisition or condemnation or

threat or imminence thereof", then the gain

from the conversion shall not be recognized,

provided the converted property is replaced

by property that is "similar or related in

service or use" within a specified time

period.

6. Respondent disallowed the entire loss,

or the difference between the gross income

and the total expenses, claimed by petiti-

oners with regard to yacht-chartering acti-

vities. Because this calculation subtracts

out an amount equal to the gross income from

the activity, petitioners have already been

allowed a "deduction" of $8,189. Therefore,

petitioners’ total expenses of $19,690 for

interest and taxes must be reduced by the

$8,189 already taken into account, leaving

an allowable deduction of $11,501.

-35-

Whether replacement property is similar

or related in service or use depends upon

whether the taxpayer’ s use of the replace-

ment property is similar to his use of the

original A eee Filippini v. United

States, 318 F.2d 841, 844 (9th Cir. 1963);

ankarst, eeenhonhianis 58 T.C. 459, 463

(1972). Petitioners have conceded that if

we find that their yacht related activities

do not constitute a trade or business, they

are not entitled to roll over the business

portion of the gain from the Pleasanton pro-

perty into the cost of

Accordingly, we uphold respondent’s deter-

mination on this issue. (fn 7)

Alternatively, petitioners contend

that pursuant to section 172(b)(1)(B), they

are entitled to carry forward certain net

operating losses for taxable years 1987 and

1988 to offset any taxable income for 1989.

Petitioners argue that the net operating

losses would fully absorb any income

required to be recognized for 1989.

7. Even if the replacement property were

Similar or related in service of use, there

has been no involuntary conversion of the

Pleasanton property within the meaning of

sec. 1033. Petitioners contend that the

court-ordered sale of the Pleasanton prop-

erty, which petitioners challenged on appeal

and later alleged to be fraudulent, consti-

tuted a theft or seizure of their property

within the meaning of sec. 1033(b). There

has been no prior adjudication or admission

of fraud, and petitioners have presented no

-36-

a

Petitioners did not claim any net opera-

ting loss carryover on their 1989 Federal in-

come tax return; this issue was first raised

in the petition. Petitioners bear the bur-

den of proving that they are entitled to a

net operating loss carryover. Rule 142(a).

Other than their 1987 and 1988 returns, peti-

tioners have offered no evidence that they

Sustained losses in these years. (fn 8) An

entry on a tax return does not prove prove

the existence of losses. -

Sioner, 7 T.C. 245 (1946), affd. 175 F.2d

500 (2d Cir. 1949); is-

Sioner, T.C. Memo. 1994-402. Therefore,

petitioners have not met their burden of

proof on this issue. (fn 9)

Respondent determined that petitioners

evidence that the court-ordered sale was

fraudulent or constituted theft as that term

is used in the Internal Revenue Code. See

j = S woe 1020, 1034-1035

(1971), affd. 471 F.2a 738 (3d Cir. 1973).

8. We note that petitioners’ reported net

operating losses from the taxable years 1987

and 1988 arose in large part from the losses

from their yacht-chartering activities.

9. Even had petitioners met their burden of

proving the existence of net operating losses,

they have not shown that they made a proper

election to relinquish the 3-year carryback

period, such that they would be entitled to

Carry any net operating loss forward. Sec.

172(b)(3)(C).

-37-

are liable for the addition to tax under sec-

tion 6662(b)(2) for the taxable year 1989.

Section 6662, which is applicable to returns

due after December 31, 1989, imposes an addi-

tion to tax in an amount equal to 20 percent

of the portion of any underpayment attribut-

able to a substantial understatement of in-

come tax. Sec. 6662(a), (b)(2). An under-

statement is substantial if it exceeds the

greater of 10 percent of the correct tax or

$5,000. Sec. 6662(d)(1)(A).

Petitioners bear the burden of proving

that respondent’s determination of an addi-

tion to tax is erroneous. Rule 142(a).

Petitioners presented no evidence to rebut

respondent’s determination, and they made

no argument in brief separately challenging

their liability for the section 6662(b)(2)

addition to tax for the taxable year 1989.

Accordingly, respondent’s determination is

sustained.

Decision will be entered

under Rule 155.

-38-

APPENDIX D

TAX COURT DECISIONS

1. Recent Tax Court Decisions, Post Com-

, 480 U.S. 23

(1987), and All Appealable to the Ninth

Circuit, Where The Tax Court Has Applied

the "Actual and Honest" Intent to Profit

Test:

Thomas J. Barnes, 64 TCM 1552 (1992).

Jerome F. Bischoff

, 69 TCM 1741, 1744

(1995).

Frank Bizjak, 67 TCM 3142, 3143-3 (1994).

Roland C. Briggs, 67 TCM 2484, 2994 (1994)

David E. Buckner, 68 TCM 352, 354-355

(1994).

Harris Cashman, 58 TCM 270, 272 (1989),

aff’d 9th Circuit unpublished opinion

5/2/91.

, 65 TCM 2371, 2372-2373

(1993), also citing Commissioner v.

Groetzinger, supra.

William James Courville, 71 TCM 2496, 2497

(1996).

, 71 TCM 3147, 3147-3

(1996).

- Dickerson, 73 TCM 2506,

2513 (1997).

Elliott v. C.I.R., 90 T.C. 960, 970 (1988).

Barbara Jean Crail, 65 TCM 1846, 1848

(1993).

George W. Gagnon, 72 TCM 701, 703 (1996),

also citing Commissioner v. Groet-

zinger, supra.

William B. Hart, 69 TCM 1822, 1823 (1995).

Gerald K. Hilliard, 70 TCM 898, 900 (1995).

Clarence A. Hunt, Jr.

2, 72 TCM 457 (1996).

-39-

Oe

Richard L. Kaufman, 68 TCM 4, 6 (1994).

Charles D. Keller, 66 TCM 682, 683 (1993).

Keanini v. C.I.R., 94 TC 41, 46 (1990).

William R. King, Jr., 65 TCM 2811, 2813

(1993).

John H. Lewis, 64 TCM 269, 274 (1992).

Joseph E. Machado,_70 TCM 1165, 1170 (1995).

Mark Massingill, 71 TCM 2651, 2654 (1996).

Hoolae Paoa, 66 TCM 377 (1993).

Geraldine H. Pearson, 71 TCM 2109, 2112

(1996).

Trilby Pederson, 68 TCM 1142, 1145 (1994).

Bernard Michael Reed, 70 TCM 1485, 1486

(1995), also citing Commissioner v.

Groetzinger, supra.

Dennis W. Schillinger, 60 TCM 1470, 1477

(1990), aff’d by Order 9th Circuit,

91-70386, 8/12/93, "For the reasons

given by the Tax Court in its opinion

Sheldon M. Sisson, 68 TCM 1078, 1083 (1994).

Kenneth A. Smith, 65 TCM 2289, 2295 (1993).

Joseph Spear, 68 TCM 238, 240 (1994).

wa wood, 58 TCM 731, 734 (1989).

Lee W. Yates, 72 TCM 1193, 1195 (1996).

2. Recent Tax Court Decisions, All Appeal-

able to the Ninth Circuit, Where the Tax

Court Has Equivocated As to the Proper

Test:

Arrowhead Mountain Getaway, Ltd., 69 TCM 1805,

1818 (1995): “Whether the participants

must have profit as their ‘primary

purpose’, or whether it suffices that

they have an ‘actual and honest’ profit

objective, does not matter. In the

case at hand, petitioner and intervenor

have shown neither."

-40-

William T. Heywood, 68 TCM 1240, 1242 (1994).

No standard mentioned.

, 70 TCM 150,

152 (1995): Tax Court declined to apply

the primary profit intent rule on the

the ground that it could not predict

that the 9th Circuit would apply a

particular rule.

John J. Shell, 67 TCM 2692, 2694 (1994):

"good faith purpose of making a profit";

"a sporadic activity, a hobby, or an

amusement diversion does not qualify",

citing Commissioner v. Groetzinger,

supra.

Lester R. Westphal, 68 TCM 1038, 1041 (1994):

"basic or dominant motive to realize a

profit or taxable income"; "expectation

of profit need not be reasonable"; "must

be a good faith objective of making a

profit". (Covering all bases!)

3. Tax Court Cases Holding That an Activity

Entered into for the Purpose of Supplementing

Retirement Income Is An Activity for Profit.

David E. Buckner, 68 TCM 352, 354-355

(1994). (Citing "actual and honest"

test. )

Ro W. ickson, 47 TCM 509, 511, 512,

514 (1983). (Citing “actual and honest"

test.)

Robert Scott Cronhardt, 52 TCM 287, 288,

291, 292 (1986). (Citing "actual and

honest" test, and appealable to the

9th Circuit. )

Engdahl_v. C.I.R., 646 TC 659, 661, 666

(1979). (Citing "predominant purpose"

and "bona fide and good faith" tests.

Edwin B. Feldman, 55 TCM 450, 451, 452 (1988).

-41-

(Citing both "actual and honest" and

"primary profit motive" tests. )

D.K. Hatch, 57 TCM 280, 281, 282 (1989).

(Citing “actual and honest" test. )

William Hellings, 67 TCM 1988, 1989, 1991

(1994), citing “actual and honest"

test. )

~42-

APPENDIX E

Internal Revenue Code Sections and

Regulations

Title 26, U.S.C.

Sec. 162. Trade or business expenses

(a) In general.-- There shall be allowed

as a deduction all the ordinary and nec-

essary expenses paid or incurred during

the taxable year in carrying on a trade

or business.

* *& *

Sec. 167 - Depreciation

(a) General rule.-- There shall be allo-

wed as a depreciation deduction a reason-

able allowance for the exhaustion, wear

and tear (including a reasonable allow-

ance for obsolescence) --

1. of property used in the trade or

business, or

2. of property held for the

production of income.

oe. 8-2

Sec. 183. iviti > ed

for profit

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

activity engaged in by an individual or

an S corporation, if the activity is not

engaged in for profit, no deduction att-

ributable to such activity shall be

-43-

allowed under this chapter except as

provided in this section.

(b) Deductions allowable.-- In the case

of an activity not engaged in for profit

to which subsection (a) applies, there

shall be allowed--

(1) the deductions which would be allow-

able under this chapter for the taxable

year without regard to whether or not

such activity is engaged in for profit,

and

(2) a deduction equal to the amount of

the deductions under this chapter for

the taxable year only if such activity

was engaged in for profit, but only to

the extent that the gross income derived

from such activity for the taxable year

exceeds the deductions allowable by

reason of paragraph (1).

(c) Activity not engaged in for profit

defined.-- For purposes of this section,

the term "activity not engaged in for

profit" means 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.

(ad) Presumption.-- If the gross income

derived from an activity for 3 or more

of the taxable years in the period of

5 consecutive taxable years which ends

with the taxable year exceeds the deduc-

tions attributable to such activity

(determined without regard to whether

-44-

Sec.

or not such activity is engaged in for

profit), then, unless the Secretary

establishes to the contrary, such

activity shall be presumed for the

purposes of this chapter for such

taxable year to be an activity engaged

in for profit. In the case of such an

activity which consists in major part

of the breeding, training, showing,

or racing of horses, the preceding

sentence shall be applied by substi-

tuting "2" for "3" and "7" for "5",

* *&

212. Expenses for production of income.

In the case of an individual, there

shall be allowed as a deduction all

the ordinary and necessary expenses

paid or incurred during the taxable

year--

(1) for the production or collection

of income;

(2) for the management, conservation,

or maintenance of property held for

the production of income . .

2:2: @

TREASURY REGULATIONS

26 CFR 1.183-2 Activity not engaged in for

profit defined.

(a) In general. For purposes of section

183 and the regulations thereunder, the

term activity not engaged in for profit

profit means any activity other than

one with respect to which deductions

-~45-

are allowable for the taxable year under

section 162 or under paragraph (2) or

(2) of section 212. Deductions are

allowable under section 162 for expenses

of carrying on activities which consti-

tute a trade or business of the taxpayer

and under section 212 for expenses incur-

red in connection with activities engaged

in for the production or collection of

income or for the management, conserva-

tion or maintenance of property held for

the production of income. Except as

provided in section 183 and sec. 1.183-1,

no deductions are allowable for expenses

incurred in connection with activities

which are not engaged in for profit.

Thus, for example, deductions are not

allowable under section 162 for activi-

ties which are carried on primarily as

a sport, hobby, or for recreation. The

determination whether an activity is

engaged in for profit is to be made by

reference to objective standards, tak-

ing into account all of the facts and

circumstances of each case. Although

a reasonable expectation of profit is

not required, the facts and circun-

stances must indicate that the taxpayer

entered into the activity, or continued

the activity, with the objective of mak-

ing a profit. * * * In determining whe-

ther an activity is engaged in for pro-

fit, greater weight is given to objec-

tive facts than to the taxpayer’s mere

statement of his intent.

x eke

(9) Elements of personal pleasure or

recreation. The presence of personal

-46-

motives in carrying on an activity may

indicate that the activity is not eng-

aged in for profit, especially where

there are recreational or personal ele-

ments involved. On the other hand, a

profit motivation may be indicated

where an activity lacks any appeal

other than profit. It is not, however,

necessary that an activity be engaged

in with the exclusive intention of

deriving a profit or with the intention

of maximizing profits. For example,

the availability of other investments

which would yield a higher return, or

which would be more likely to be profit-

able, is not evidence that an activity

is not engaged in for profit. An ac-

tivity will not be treated as not enga-

ged engaged in for profit merely because

the taxpayer has purposes or motivations

other than solely to make a profit.

Also, the fact that the taxpayer deri-

ves personal pleasure from engaging in

the activity is not sufficient to cause

the activity to be classified as not en-

gaged in for profit if the activity is

in fact engaged in for profit as evi-

denced by other factors whether or not

listed in this paragraph.

> 2

1.212.1(c) - The question of whether or not

a transaction is carried on primarily

for the production of income or for

the management, conservation, or main-

tenance of property held for the produc-

tion of income, rather than primarily

as a sport, hobby, or recreation, is

not to be determined solely from the

-47-

oo

intention of the taxpayer but rather

from all the circumstances of the case.

For example, consideration will be

given to the record of prior gain or

loss of the taxpayer in the activity,

the relationship between the type of

activity and the principal occupation

of the taxpayer, and the uses to which

the property or what it produces is

put by the taxpayer.

x ke

-48-