Shane v. Robison & Robin S. Robison v. Commissioner , 2018 T.C. Memo. 88 ( 2018 )

T.C. Memo. 2018-88UNITED STATES TAX COURT
SHANE V. ROBISON AND ROBIN S. ROBISON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 5339-15, 25120-16. Filed June 19, 2018.
Edward I. Kaplan, for petitioners.
Bryant W. Smith, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined deficiencies in petitioners’ Federal
income tax and penalties as follows:
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[*2] Penalty
Year Deficiency sec. 6662(a)
2010 $262,026 $52,405
2011 229,252 45,850
2012 217,416 43,483
2013 184,846 36,969
2014 136,184 27,237
Respondent has now conceded the section 6662(a) penalties. The issues for
decision are as follows: (1) whether petitioners were engaged in a ranching
activity with the objective of making a profit within the meaning of section 183;
and (2) if petitioners were engaged in a ranching activity with the objective of
making a profit within the meaning of section 183, whether petitioners materially
participated in the ranching activity within the meaning of section 469. Unless
otherwise indicated, all section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure. All monetary amounts are rounded to the nearest dollar.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated facts are
incorporated in our findings by this reference. Petitioners resided in Utah when
their petitions in these consolidated cases were filed.
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[*3] Petitioner Robin S. Robison (R. Robison) was a retired physical therapist
for the years in issue. She previously started and operated her own successful
physical therapy practice. Petitioner Shane V. Robison (S. Robison) had a highly
successful career working for a number of technology companies in Silicon
Valley. For 2010 and until November 2011, he worked as a successful computer
science executive at Hewlett Packard in Silicon Valley. In November 2011, he
retired from Hewlett Packard. He continues to serve on boards and as an adviser
to technology-based corporations. During the years in issue, S. Robison’s wages
and salary were as follows:
Year Wages/salary
2010 $10,531,957
2011 2,800,875
2012 4,369,496
2013 1,410,432
2014 1,927,874
The Ranch
In 1999 petitioners purchased a 410-acre ranch in a remote area of southern
Utah at an elevation of approximately 6,700 feet. The cost of the Ranch was
approximately $2 million. In 2000 and 2009 petitioners acquired additional
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[*4] acreage near and surrounding the property, increasing the total property to
more than 500 acres. In 2000 petitioners formed Robison Ranch, LLC (Robison
Ranch). Petitioners each own 50% of Robison Ranch. S. Robison has a family
background in ranching and farming although neither petitioner had ever
previously operated a ranch.
Upon purchasing Robison Ranch, petitioners were aware that it would
require significant time and capital investment on account of its poor physical
condition. Robison Ranch first operated as a horse breeding and training
operation with a small cattle herd but shifted its focus entirely to cattle ranching in
approximately 2000. Petitioners retroactively prepared business plans for Robison
Ranch for the years in issue.
From 2000 to 2015 petitioners never made a profit from Robison Ranch’s
ranching activities. The property is currently listed for sale for $10 million. For
the years in issue Robison Ranch filed Forms 1065, U.S. Return of Partnership
Income, and claimed its loss deductions on its Schedules F, Profit or Loss From
Farming. Petitioners claimed Robison Ranch’s loss deductions for the years in
issue on their Schedules E, Supplemental Income and Loss, in the respective
amounts of $657,356, $640,769, $606,633, $493,194, and $420,798. From 2000
to 2015 Robison Ranch reported over $9 million in losses on its Federal income
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[*5] tax returns. From 2000 to 2015 Robison Ranch reported the following on its
Federal income tax returns:
Year Income Expenses Net income/(loss)
2000 -0- $198,249 ($198,249)
2001 $3,385 431,154 (427,769)
2002 25,363 518,728 (493,365)
2003 8,355 819,241 (810,886)
2004 43,246 588,400 (545,154)
2005 49,408 719,435 (670,027)
2006 58,385 728,322 (669,937)
2007 58,103 641,105 (583,002)
2008 90,737 701,260 (610,523)
2009 60,604 800,452 (739,848)
2010 91,290 748,646 (657,356)
2011 70,983 711,752 (640,769)
2012 121,090 727,723 (606,633)
2013 166,971 660,165 (493,194)
2014 215,701 636,499 (420,798)
2015 126,082 598,597 (472,515)
After the years in issue petitioners created activity logs for their time spent
at Robison Ranch. R. Robison reported spending in excess of 1,500 hours on the
ranching activity during each year in issue. S. Robison reported spending in
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[*6] excess of 800 hours on the ranching activity during each year in issue. When
at the ranch petitioners would generally perform whatever work was needed, such
as maintenance work, cleaning, and the feeding and branding of livestock.
Petitioners would also perform managerial duties and oversee operations.
Petitioners were in charge of hiring and managing all ranch employees.
S. Robison was responsible for all top-level decisionmaking. R. Robison, Robison
Ranch’s chief financial officer, was responsible for all accounting and bill paying
aspects, preparing annual profit and loss statements, and all of its employment tax
filings and insurance policy needs. She used QuickBooks for Robison Ranch’s
financial recordkeeping. Petitioners employed a certified public accountant to
prepare the tax returns for Robison Ranch for the years in issue. Their personal
finances were maintained separately from Robison Ranch’s finances.
Petitioners employed a ranch manager and a ranch hand during the years in
issue. Both employees lived on site and signed employment and lease agreements.
During the years in issue petitioners had two different ranch managers. Daniel
Reeder served as ranch manager until 2012. Tabor Dahl, initially hired in 2011 to
manage and train the ranch’s horses, was promoted to ranch manager for the
remaining years in issue. Both Reeder and Dahl had formal training in agriculture.
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[*7] Dahl was raised on an unregistered cattle ranch and had experience working
on ranches but had never previously managed a ranch.
Petitioners held weekly meetings with Robison Ranch’s employees. The
meetings were held in person if petitioners were on site, and via conference call
when they were not. Minutes from the weekly meetings were kept and distributed
to participants.
When purchased, the structures on Robison Ranch were in very poor
condition, and none were habitable. Petitioners constructed Robison Ranch’s core
operating buildings. They acquired the equipment necessary to plant and harvest
hay, as well as tractors, loaders, road maintenance equipment, and trucks and
trailers for transporting livestock and supplies. The first structures petitioners
built were a horse barn, a small cow barn, and corrals for handling the livestock.
Petitioners also built a woodworking shop and a cement silo so that work
could be done on site. In 2005 petitioners constructed a house on the property
where they would stay when they were at the ranch. Petitioners later sold certain
heavy equipment and trucks that were used to build the infrastructure to reduce
unnecessary costs. Petitioners also purchased additional grazing permits and
water rights, and they improved their hay production in an effort to grow enough
hay to support all of the ranch’s livestock.
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[*8] Petitioners’ Horse Activity
Initially petitioners focused Robison Ranch’s business on the raising and
breeding of Paint Horses. In approximately 2000, after the Paint Horse business
proved unsuccessful, petitioners decided to shift to the raising and breeding of
Quarter Horses, a more established breed. Petitioners were not able to make a
successful business with the Quarter Horses and ultimately abandoned the horse
selling and showing business. During the years in issue petitioners sold almost all
of their horses not suited for cattle ranching.
Petitioners’ Cattle Ranching Activity
Also in approximately 2000 petitioners shifted their focus to cattle ranching.
During the years in issue petitioners sought to raise bulls and heifers as seedstock
for other ranchers as well as to become a supplier of grass-fed beef.
When forming Robison Ranch, petitioners consulted with their accountant,
a ranch attorney, other ranch owners, and trainers and breeders, as well as a local
veterinarian, Dr. Verland King. King was a local expert regarding brisket disease.
At high elevations cattle are at risk of brisket disease, which causes fluid
accumulation in a cow’s lung that can then cause it to suffocate. A cow with a low
pulmonary artery pressure score (PAP score) indicates an animal with a greatly
reduced risk of brisket disease. Because of Robison Ranch’s high elevation,
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[*9] petitioners sought to purchase and breed cattle with low PAP scores.
Petitioners worked with King to test the PAP scores of Robison Ranch’s registered
cattle. King kept the PAP score records.
Petitioners also kept livestock records. The ranch manager was in charge of
creating and maintaining these records. Robison Ranch’s data allowed them to
calculate the total cost of the herd. Robison Ranch also tracked certain expected
progeny differences (EPD) of its herd but became more specific about the EPD
data it collected beginning in 2010. EPD data is used as a prediction of how future
progeny of each animal are expected to perform relative to the progeny of other
animals in the breed or herd. EPDs are expressed in units of measure for the trait,
such as pounds for birth weight. Robison Ranch also registered their cattle with
the American Angus Association, which provided an online database in which
some of Robison Ranch’s livestock data was kept.
OPINION
Respondent determined that petitioners’ ranching activity was not an
activity engaged in for profit within the meaning of section 183 and disallowed the
loss deductions relating to Robison Ranch that petitioners claimed on their
Schedules E. Petitioners counter that they engaged in the ranching activity with
an intent to realize a profit. Respondent alternatively argues that if petitioners are
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[*10] found to be engaged in the ranching activity with an intent to realize a profit,
their loss deductions should be limited by the passive loss limitations of section
469.
The arguments made by the parties through counsel are tainted by extreme
views of the strength of their respective positions and attacks on the motives and
credibility of their opponent(s). They view the facts objectively only with respect
to the penalties that respondent conceded. We do not agree entirely with any of
those arguments. Petitioners appeared sincere and reasonable in their testimony.
The weakness in their position regarding the section 183 issue is primarily the
indisputable history and magnitude of losses, despite reduced losses during the
years in issue, and whether petitioners can expect to recoup them. But for their
financial position, these losses could not be afforded. At this point petitioners are
trying to minimize losses, but to prevail they must show a profit objective.
In addition to the section 183 analysis we address respondent’s alternative
argument that section 469 limits petitioners’ loss deductions for the years in issue.
That is, even if petitioners have adequately shown a profit objective, the absence
of reliable records is most obvious with respect to this issue, and petitioners’ reply
brief barely touches on respondent’s arguments in that regard.
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[*11] I. Burden of Proof
Neither party discusses the burden of proof at length. Respondent cites the
presumption of correctness, Rule 142(a), and Welch v. Helvering, 290 U.S. 111,
115 (1933), for the general rule, which is that the Internal Revenue Service’s
determinations in a notice of deficiency are generally presumed correct, and
taxpayers bear the burden of proving them erroneous. With respect to deductions,
the taxpayer almost always has that burden. INDOPCO, Inc. v. Commissioner,
503 U.S. 79, 84 (1992); sec. 1.6001-1(a), Income Tax Regs. Petitioners do not
contend that the burden of proof should shift to respondent under section 7491(a).
If section 7491(a) had been raised, the lapses in petitioners’ recordkeeping would
seem the primary impediment to shifting the burden of persuasion. The burden
remains on petitioners.
II. Section 183
Under section 183(a), if an activity is not engaged in for profit, no deduction
attributable to that activity is allowed except to the extent provided by section
183(b). In relevant part, section 183(b) allows those deductions that would have
been allowable had the activity been engaged in for profit only to the extent of
gross income derived from the activity (reduced by deductions attributable to the
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[*12] activity that are allowable without regard to whether the activity was
engaged in for profit).
Section 183(c) defines an activity not engaged in for profit as “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.” For expenses to
be deductible under section 162, Trade or Business Expenses, or section 212,
Expenses for Production of Income, and not subject to the limitations of section
183, taxpayers must show that they engaged in the activity with the primary
objective of making a profit. Westbrook v. Commissioner, 68 F.3d 868, 875 (5th
Cir. 1995), aff’g T.C. Memo. 1993-634.
The expectation of profit need not be reasonable, but the taxpayer must
conduct the activity with the actual and honest objective of making a profit.
Hildebrand v. Commissioner, 28 F.3d 1024, 1026-1027 (10th Cir. 1994), aff’g
Krause v. Commissioner, 99 T.C. 132 (1992); Keanini v. Commissioner, 94 T.C.
41, 46 (1990). Because petitioners were the only partners in Robison Ranch, we
need not separately determine the intent at the partnership level. Greater weight is
given to objective facts than to a taxpayer’s self-serving statement of intent. King
v. Commissioner, 116 T.C. 198, 205 (2001); sec. 1.183-2(a) and (b), Income Tax
Regs. Evidence from years subsequent to the years in issue is relevant to the
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[*13] extent it creates inferences regarding a taxpayer’s requisite profit objective
in earlier years. See Hoyle v. Commissioner, T.C. Memo. 1994-592; Smith v.
Commissioner, T.C. Memo. 1993-140.
Section 1.183-2(b), Income Tax Regs., provides a nonexclusive list of
factors to be weighed when considering whether a taxpayer is engaged in an
activity for profit. These factors include the following: (1) the manner in which
the taxpayer carried on the activity; (2) the expertise of the taxpayer or his
advisers; (3) the time and effort expended by the taxpayer in carrying on the
activity; (4) the expectation that the assets used in the activity may appreciate in
value; (5) the success of the taxpayer in carrying on other similar or dissimilar
activities; (6) the taxpayer’s history of income or losses with respect to the
activity; (7) the amount of occasional profits, if any, that are earned from the
activity; (8) the financial status of the taxpayer; and (9) whether elements of
personal pleasure or recreation are involved in the activity. All facts and
circumstances are to be taken into account, and no single factor or mathematical
preponderance of factors is determinative. Westbrook v. Commissioner, 68 F.3d
at 876; Hildebrand v. Commissioner, 28 F.3d at 1027. We address the most
relevant factors in determining petitioners’ intent.
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[*14] A. Manner in Which Activity Is Conducted
Carrying on an activity in a businesslike manner, such as by maintaining
complete and accurate books and records, conducting the activity in a manner
similar to other activities of the same nature that are profitable, and making
changes in operations to adopt new techniques or abandon unprofitable methods,
is a factor that may indicate a profit objective. Sec. 1.183-2(b)(1), Income Tax
Regs. Businesslike conduct is characterized by careful and thorough investigation
of the profitability of a proposed venture, monitoring of a venture in progress, and
attention to problems that arise over time. See Ronnen v. Commissioner, 90 T.C.
74, 93 (1988); Taube v. Commissioner, 88 T.C. 464, 481-482 (1987).
While a taxpayer need not maintain a sophisticated cost accounting system,
the taxpayer should keep records that enable the taxpayer to make informed
business decisions. See Burger v. Commissioner, 809 F.2d 355, 359 (7th Cir.
1987), aff’g T.C. Memo. 1985-523. For a taxpayer’s books and records to indicate
a profit motive, the books and records should enable a taxpayer to cut expenses,
increase profits, or evaluate the overall performance of the operation. See Abbene
v. Commissioner, T.C. Memo. 1998-330. Petitioners kept many financial and
administrative records, such as weekly meeting minutes, employment contracts,
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[*15] payroll tax returns, insurance policies and payments, and formal leases for
employees who lived on Robison Ranch.
Although petitioners’ records were voluminous, respondent argues that
petitioners’ administrative and financial recordkeeping was more akin to a
conscious attention to detail than to something used to analyze expenses or
improve profitability. See Golanty v. Commissioner, 72 T.C. 411, 430 (1979),
aff’d, 647 F.2d 170 (9th Cir. 1981). Petitioners contend that R. Robison used
QuickBooks’ profit and loss statements to monitor the ranch’s finances and cut
costs. We believe petitioners used them for the important purposes of cutting
expenses, increasing profits, and evaluating the overall performance of the
operation. See id. However, there is no evidence that they used them to create
budgets or make income projections, which would have been advantageous and
further indicative of operating in a businesslike manner. See Keating v.
Commissioner, 544 F.3d 900, 904 (8th Cir. 2008), aff’g T.C. Memo. 2007-309;
Foster v. Commissioner, T.C. Memo. 2012-207, slip op. at 14.
Petitioners also kept multiple records regarding their cattle though these
records varied during the years in issue. Robison Ranch’s animal records
significantly improved with the hiring of Dahl as ranch manager in 2012,
particularly in regard to EPD data, which petitioners had begun to track better in
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[*16] 2010. Petitioners were able to use their cattle records to make meaningful
projections as well as make educated decisions in regard to cattle purchases and
sales, current and future. The improved data recording during the years in issue
evidences petitioners’ increasingly businesslike approach to Robison Ranch’s
cattle activity.
Respondent also argued that petitioners had no written business plan for
Robison Ranch. Numerous court opinions mention that a businesslike operation
often would involve a business plan. See, e.g., Wesinger v. Commissioner, T.C.
Memo. 1999-372. Petitioners retroactively created business plans for the years in
issue, which were largely narratives of the actions petitioners took during those
years. The fact that petitioners had no written business plan does not negate a
profit motive, as a business plan can be evidenced by actions. See Annuzzi v.
Commissioner, T.C. Memo. 2014-233, at *16; Phillips v. Commissioner, T.C.
Memo. 1997-128 (stating that written financial plan not required for 32-horse farm
where business plan was evidenced by action). Nevertheless, a business plan
likely would have aided petitioners in creating analyses for the future financial
management or planning of the activity. See Foster v. Commissioner, T.C. Memo.
2012-207, slip op. at 14.
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[*17] Maintaining an additional bank account for the activity separate from a
taxpayer’s personal finances is indicative of an activity being carried on in a
businesslike manner. See Wayts v. Commissioner, T.C. Memo. 1992-82 (finding
horse racing and breeding activity was carried on in a businesslike manner because
it had a separate bank account) (citing Pryor v. Commissioner, T.C. Memo. 1991-
109). Petitioners’ separate maintenance of their personal finances and Robison
Ranch’s are indicative of operating in a businesslike manner.
Perhaps the most important indication of whether an activity is being
performed in a businesslike manner is whether the taxpayer implements methods
for controlling losses, including efforts to reduce expenses and generate income.
See Dodge v. Commissioner, T.C. Memo. 1998-89, aff’d without published
opinion, 188 F.3d 507 (6th Cir. 1999). Petitioners contend that they made changes
to their operating methods, adopted new techniques, and abandoned unprofitable
methods that contributed to their losses. The record supports this contention.
Petitioners made changes in their ranching activity when they realized that certain
operations would not be profitable, changing Robison Ranch’s operation two
times--from Paint Horses, to Quarter Horses, to a registered cattle herd. Cf.
Williams v. Commissioner, T.C. Memo. 2018-48, at *24-*25 (finding cattle
operation was not carried on in a businesslike manner because taxpayer did not
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[*18] make changes or transition his operation for 10 years despite continued
losses).
Petitioners also sought to reduce expenses by obtaining increased water
rights, producing their own hay, purchasing additional grazing permits, selling
unnecessary equipment, and increasing the tracking and recording of EPD data for
their cattle herd. All of these decisions were business decisions designed to
reduce expenses and were not made merely on the basis of petitioners’ whim or
fancy. See Welch v. Commissioner, T.C. Memo. 2017-229, at *31. Petitioners
were able to reduce their expenses, which led to a decrease in their net losses for
the years in issue. Petitioners’ implementation of operating changes to combat
continued losses indicates their intention to make a profit.
After carefully considering the evidence, we conclude that this factor favors
petitioners.
B. Expertise of the Taxpayer or His/Her Advisers
The taxpayers’ expertise, research, and study of an activity, as well as their
consultation with experts, may be indicative of a profit motive. See sec. 1.183-
2(b)(2), Income Tax Regs. S. Robison has a family background in ranching and
farming although he had never previously operated a ranch. Petitioners consulted
with persons who were knowledgeable about ranching, including a ranch attorney,
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[*19] other ranch owners, trainers and breeders, and their veterinarian. See
Givens v. Commissioner, T.C. Memo. 1989-529 (a profit objective was indicated
where the taxpayer sought and acquired advice in all aspects of Tennessee
Walking Horse breeding from experienced owners, trainers, and a veterinarian).
Petitioners also sought advice regarding the business elements of starting Robison
Ranch from their accountant. In the face of mounting losses, it would have been
prudent to seek further business advice; however, we believe this factor favors
petitioners.
C. Taxpayers’ Time and Effort Devoted to the Activity
The taxpayers’ devotion of much of their personal time and effort to
carrying on an activity may indicate a profit motive, particularly if the activity
does not involve substantial personal or recreational aspects. Sec. 1.183-2(b)(3),
Income Tax Regs. A profit motive may also be indicated if a taxpayer “employs
competent and qualified persons to carry on such activity.” Id. Petitioners hired
professionals to manage Robison Ranch, employing a full-time ranch manager and
a ranch hand during the years in issue, both of whom lived on site. Petitioners
also conducted weekly meetings with Robison Ranch employees. While Dahl was
not an expert in registered Angus cattle ranching, nor had he managed a ranch
previously, he was experienced in cattle ranching, having been raised on an
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[*20] unregistered cattle ranch. Further, petitioners made use of a local
veterinarian who was an expert regarding brisket disease and the effects of high
altitudes on cattle. This factor favors petitioners.
D. Expectation That the Activity’s Assets May Appreciate
An expectation that assets used in the activity will appreciate may indicate a
profit motive even if the taxpayers derive no profit from current operations. Id.subpara. (4). However, a profit objective may be inferred from such expected
appreciation of the activity’s assets only where the appreciation exceeds operating
expenses and is sufficient to recoup the accumulated losses of prior years. See
Golanty v. Commissioner, 72 T.C. at 427-428; Hillman v. Commissioner, T.C.
Memo. 1999-255.
Respondent argues that petitioners’ objective must include recoupment of
all of Robison Ranch’s past losses. This expectation is too high. See Welch v.
Commissioner, at *35. “An overall profit is present if net earnings and
appreciation are sufficient to recoup the losses sustained in the ‘intervening years’
between a given tax year and the time at which future profits were expected.”
Helmick v. Commissioner, T.C. Memo. 2009-220, slip op. at 27 (citing Bessenyey
v. Commissioner, 45 T.C. 261, 274 (1965), aff’d, 379 F.2d 252 (2d Cir. 1967)).
Therefore, the question is not whether petitioners would recoup all of Robison
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[*21] Ranch’s losses but whether they would recoup the losses between the years
in issue and the “hoped-for profitable future.” See id. at 28.
Petitioners did not provide a valuation of Robison Ranch. There is not
enough evidence in the record to determine the current value of or petitioners’
adjusted basis in the ranch property, and we are therefore unable to determine the
amount of appreciation, if any. Accordingly, this factor is neutral.
E. Taxpayers’ History of Income or Loss From the Activity
A history of continued losses with respect to the activity may indicate the
lack of profit motive. See sec. 1.183-2(b)(6), Income Tax. Regs. While a series of
losses during the startup stage of an activity may not necessarily indicate a lack of
profit motive, a record of large losses over many years is persuasive evidence that
a taxpayer did not have such a motive. See Golanty v. Commissioner, 72 T.C. at
426. An activity’s cumulative losses should not be of such a magnitude that an
overall profit on the entire operation, including recoupment of past losses, could
not possibly be achieved. Bessenyey v. Commissioner, 45 T.C. at 274.
Petitioners realized no profits whatsoever in 16 years of engaging in their
ranching activity. Petitioners contend that the years in issue are the startup stage
for their cattle ranching activity. See Burrus v. Commissioner, T.C. Memo. 2003-
285 (finding that losses incurred in the first six years of a cattle activity occurred
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[*22] during its startup stage). However, petitioners began their cattle operation in
approximately 2000; thus the years in issue are beyond the startup stage.
Further, despite reduced expenses and increased profits during the years in
issue, petitioners produced no detailed or concrete plans as to how to further
reduce their losses or as to when they expect to make a profit. The possibility of a
speculative profit is insufficient to outweigh the absence of profits for a sustained
period of years. See Chandler v. Commissioner, T.C. Memo. 2010-92 (the
possibility of a speculative profit did not outweigh more than 20 years of losses
reported for the taxpayer’s horse activity). This factor strongly favors respondent.
F. Taxpayers’ Financial Status
Substantial income from sources other than the activity may indicate that the
activity is not engaged in for profit. See sec. 1.183-2(b)(8), Income Tax Regs.
This is particularly true if the losses from the activity generate substantial tax
benefits. Golanty v. Commissioner, 72 T.C. at 429. A taxpayer with substantial
income unrelated to the activity can more readily afford a hobby. See Wesley v.
Commissioner, T.C. Memo. 2007-78. Petitioners’ substantial income from
S. Robison’s career has allowed them to continue their ranching activity in spite of
16 years of losses. Further, the activity has also generated tax savings in the form
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[*23] of net losses that offset that income, resulting in much smaller after-tax
burden for the years in issue. This factor favors respondent.
G. Conclusion
This is a very close case, and our determination for the years in issue is
limited to the facts found for those years. After weighing all the facts and
circumstances in the light of the relevant factors, we conclude that petitioners
engaged in their ranching activity for the years in issue with the requisite profit
objective. Petitioners’ activities cannot be characterized as a “hobby” during those
years. Petitioners’ efforts to reduce Robison Ranch’s expenses and the resulting
decrease in petitioners’ net losses during the years in issue are most persuasive.
Accordingly, we reject respondent’s disallowance of the loss deductions relating
to the ranching activity under section 183.
III. Section 469 Passive Activity
We must now consider whether petitioners’ losses from Robison Ranch
were passive under section 469. Loss deductions from a passive activity are
generally allowed for the years in which the losses are sustained only to the extent
of passive activity income. Sec. 469(a)(1)(A), (d)(1). In general, a passive
activity is a trade or business in which the taxpayer does not materially participate.
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[*24] Sec. 469(c)(1). A taxpayer materially participates in an activity when he or
she is involved on a regular, continuous, and substantial basis. Sec. 469(h)(1).
A passive activity loss is the amount by which the aggregate losses from all
passive activities for the taxable year exceed the aggregate income from all
passive activities for such year. Sec. 469(d)(1). Passive activity losses are
suspended until the taxpayer either has offsetting passive income or disposes of
the taxpayer’s entire interest in the passive activity. Sec. 469(b), (g).
Application of section 469 might permit petitioners a future use of the
accumulated but disallowed losses, particularly if they are able to sell the ranch at
the currently listed price. Sec. 469(b), (g). Petitioners’ activities in operating
through the ranch manager suggest characterization of the activity as passive--that
of an investor. That was the observation of the Court at the conclusion of the trial,
and our impression has not been altered.
In general, a taxpayer is treated as materially participating in a trade or
business if the taxpayer is involved in the operations of the trade or business on a
regular, continuous, and substantial basis. Sec. 469(h)(1). A taxpayer can
establish material participation by satisfying any one of seven tests provided in the
regulations. Sec. 1.469-5T(a), Temporary Income Tax Regs., 53 Fed. Reg. 5725-
5726 (Feb. 25, 1988); see Miller v. Commissioner, T.C. Memo. 2011-219; Bailey
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[*25] v. Commissioner, T.C. Memo. 2001-296. Of these, the two following tests
are most relevant to the case:
(1) The individual participates in the activity for more than 500
hours during such year;
* * * * * * *
(7) Based on all of the facts and circumstances * * * the
individual participates in the activity on a regular, continuous, and
substantial basis during such year.
Sec. 1.469-5T(a), Temporary Income Tax Regs., supra.
Material participation of a taxpayer in an activity is determined separately
for each taxable year, and the taxpayer generally has the burden of proving
material participation. See sec. 469(a); see also Harrison v. Commissioner, T.C.
Memo. 1996-509. In determining whether a taxpayer materially participates, the
participation of the spouse of the taxpayer shall be taken into account. Sec.
469(h)(5). We therefore treat petitioners as a unit for the purposes of
participation.
Generally, any work done by an individual in connection with an activity in
which he or she owns an interest at the time the work is done is treated as
participation of the individual in the activity. Sec. 1.469-5(f)(1), Income Tax
Regs. However, activity performed in an individual’s capacity as an investor does
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[*26] not qualify as participation in an activity, unless the individual is directly
involved in the day-to-day management of the activity. Sec. 1.469-5T(f)(2)(ii)(A)
and (B), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988).
Investor-related activities not qualifying as material participation include: (1)
studying and reviewing financial statements or reports on operations; (2) preparing
or compiling summaries or analyses of the finances or operations of the activity
for the individual’s own use; and (3) monitoring the finances or operations of the
activity in a nonmanagerial capacity. Id.A. 500-Hour Test
The extent of an individual’s participation in an activity may be established
by any reasonable means. Id. subpara. (4). Contemporaneous daily time reports or
logs are not required. Id. While the regulations permit some flexibility with
respect to the evidence required to prove material participation, we are not
required to accept postevent “ballpark guesstimates”, nor are we bound to accept
the unverified, undocumented testimony of taxpayers. See Estate of Stangeland v.
Commissioner, T.C. Memo. 2010-185; Shaw v. Commissioner, T.C. Memo.
2002-35; Scheiner v. Commissioner, T.C. Memo. 1996-554.
The records petitioners introduced for the years at issue provide a broad
overview of their time spent at Robison Ranch. These records predominantly
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[*27] appear to be estimates prepared noncontemporaneously, with the exception
of the minutes kept from the weekly conference calls petitioners had with ranch
employees. The annual log petitioners provided for each tax year reports hours
assigned to activities years after the fact, in preparation for trial, and based solely
on their judgment and experience as to how much time the activities must have
taken them.
The weekly minutes indicate that petitioners were typically working on
activities such as minutes, payroll, taxes, and house issues. The annual logs also
include similar activities, such as generating payroll, paying bills, communicating
with staff members, and the hiring and firing of ranch employees. Petitioners’
weekly minutes and annual logs also fail to show what specifically petitioners did
day to day and exactly how much time they spent on matters directly relating to
the ranch, making it impossible to conclude that this activity was conducted
outside of an investor-type capacity. See Iversen v. Commissioner, T.C. Memo.
2012-19.
We do not doubt that while away from Robison Ranch petitioners spent
time on ranch activities, talking on the telephone to the ranch manager and
employees, reading articles on cattle ranching, receiving bills and correspondence,
and maintaining the financial and business records. Also, we acknowledge that
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[*28] while at Robison Ranch petitioners participated in and assisted with the
cattle operation, ranch maintenance, and improvements. However, a very
significant portion of the time petitioners spent on Robison Ranch activities
appears to have been in the capacity of investors not involved in the day-to-day
activities or management. These hours cannot be counted toward the 500-hour
test of subparagraph (1), nor towards participation on the regular, continuous or
substantial basis required by subparagraph (7), discussed below. See sec. 1.469-
5T(f)(2)(ii)(B), Temporary Income Tax Regs., supra.
B. Facts and Circumstances Test
Under section 1.469-5T(b)(2)(ii)(A) and (B), Temporary Income Tax Regs.,
53 Fed. Reg. 5726 (Feb. 25, 1988), a taxpayer’s management activities under the
facts and circumstances test shall not be taken into account if another person also
receives compensation for management services relating to the activity or if
another person spends more time performing management services relating to the
activity than the taxpayer. The presence of a full-time paid ranch manager at the
ranch for all of the years at issue disqualifies petitioners’ time working on Robison
Ranch management services from counting towards their participation. As a
result, petitioners do not meet the facts and circumstances test under subparagraph
(7). See sec. 1.469-5T(a), Temporary Income Tax Regs., supra.
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[*29] C. Conclusion
The weight of the evidence before us does not establish that during the years
at issue the majority of hours petitioners spent were hours spent in a capacity other
than as investors. After the hours attributable to investor types of activities are
subtracted, and in the light of the fact that Robison Ranch employed a full-time
ranch manager, petitioners did not spend the required 500 hours on the Robison
Ranch activity, nor were they engaged on a regular, continuous, and substantial
basis, as required under section 469 and the related regulations.
We conclude that petitioners did not materially participate in Robison
Ranch and it was a passive activity. Petitioners’ losses reported for the years at
issue with respect to the ranching activity are subject to the passive loss
limitations imposed by section 469, and these losses are suspended until
petitioners either have offsetting income or dispose of their entire interest in
Robison Ranch.
In reaching our conclusions, we have considered all arguments made by the
parties and, to the extent not mentioned above, we conclude they are moot,
irrelevant, or without merit.
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[*30] To reflect the foregoing,
Decisions will be entered
under Rule 155.