Stonecipher v. Commissioner

¶2MEMORANDUM FINDINGS OF FACT AND OPINION

¶3THORNTON, JUDGE: Respondent determined deficiencies in petitioners' Federal income taxes for 1993, 1994, and 1995 as follows:

¶4          Year       Deficiency

¶5          ____       __________

¶6          1993       $ 37,804

¶7          1994        44,796

¶8          1995        49,306

¶9After settlement of some issues, the primary issue remaining for decision is whether petitioners' cattle ranch activity qualifies as a for-profit activity.

¶10Unless otherwise noted, 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.

¶11FINDINGS OF FACT

¶12The parties have stipulated some of the facts, which are so found. When they filed their petition, petitioners resided in Centrahoma, Oklahoma.

¶13*446 A sharecropper's son, Harland Stonecipher (petitioner) grew up on a family ranch in Oklahoma. As a youth, petitioner was responsible for various chores on the ranch, helping to maintain and manage it and to care for the few head of cattle raised there.

¶14Petitioner received a college degree with a major in education. His first job out of college was as an insurance agent.

¶15In 1972, petitioner founded Pre-Paid Legal, Inc. (Pre-Paid Legal), as a corporation to provide prepaid legal services to the public. During 1976, Pre-Paid Legal went public with a listing on the NASDAQ Exchange. In 1986, Pre-Paid Legal stock was traded on the American Stock Exchange, and as of the time of trial, Pre-Paid Legal stock was traded on the New York Stock Exchange. Since 1986, Pre-Paid Legal has been profitable. As of the time of trial, Pre-Paid Legal had accumulated $ 50 million in cash and investment assets.

¶16During most of the years since 1976 and specifically during the years in issue, petitioner has worked as a full-time officer and employee of Pre-Paid Legal with such positions as chairman of the board of directors, president, and chief executive officer.

¶17In 1975, petitioners paid $ 40,000 for 40*447 acres of property in Coal County, Oklahoma (the 40 acres). Over the years since 1975, petitioners' immediate family has occupied the residence on the 40 acres. Petitioners have improved the residence by adding three rooms, a bath, a sunroom, a three-car garage, and a carport at a total cost of $ 233,000. Petitioners have also improved the property immediately surrounding the residence by constructing hound kennels at a cost of $ 90,000 and a well house, two storage buildings, and a hay shed at a cost of $ 36,000. The cumulative cost of the 40 acres, the residence, and improvements described above was $ 399,000.

¶18From 1981 through 1997, petitioners purchased additional unimproved property adjacent to or near the 40 acres, as follows:

¶19                     Petitioners' Cumulative

¶20  Year   Acres Purchased    Cost    Total Acreage At Yearend

¶21  ____   _______________    ____    ________________________

¶22  1981       50     $ 10,000        ¹ 90

¶23  1982      160      38,750         250

¶24  1985      220      66,000        *448 470

¶25  1986      220      55,000         690

¶26  1992      300      75,000         990

¶27  1993      220       6,000        1,210

¶28  1995       60      18,000        1,270

¶29  1995       5       6,000        1,275

¶30  1996      320      96,000        1,595

¶31  1996      200      40,000        1,795

¶32  1997       40      10,000        1,835

¶33Petitioners generally paid from $ 200 to $ 350 an acre for the property described above, much of which was wooded or partly wooded.

¶34Also, during 1993, 1994, and 1995, petitioners leased 2,680 additional acres located near the above property.

¶35By 1999, petitioners owned approximately 2,000 acres and leased an additional 2,680*449 acres. Petitioners' fee ownership and leasehold interest in the above property apparently did not include the right to mineral interests in the property.

¶36Since 1982, when petitioners first purchased cattle to raise on their property, petitioners have made improvements to the property, in addition to those improvements previously mentioned, related to raising cattle, at a cost to petitioners, where indicated in the record, as follows:

¶37       Improvement        Cost

¶38       ___________        ____

¶39     Barn            $ 40,000

¶40     Cabin            40,000

¶41     2-

¶42During 1993, 1994, and 1995, petitioners' property was also the site of a tenant house and a mobile home, occupied for a period by petitioners' son.

¶43Petitioners may be regarded as first-generation cattle ranchers in the sense that they did not receive or inherit any cattle from their parents. Instead, petitioners had to purchase their initial head of cattle. From 1982 through 1992 or 1993, petitioners sold the cattle that they raised each year, including all the male and female calves. After market*450 prices fell in 1992, petitioner began retaining most of the female calves, until 1998, when he began selling them again.

¶44Petitioners' cattle ranch may accurately be described as a no-frills cattle operation. Petitioners' improvements to the ranch property were not extravagant. Neither petitioners nor other members of petitioners' family, some of whom also lived on the property, made significant recreational use of the ranch property. There was no swimming pool, golf course, tennis court, Jacuzzi, or other significant recreational amenity. Petitioners did not construct on the ranch any fancy or showy fences or make other improvements that would be indicative of a dude ranch.

¶45The cattle petitioners purchased and raised on the property were Brahman crossbreed cattle suited to that part of Oklahoma because of their ability to tolerate rough grazing conditions, because of their thin hides that enabled them to tolerate the Oklahoma heat better than other cattle, and because of their high tolerance for insects and parasites. Also, Brahman crossbreed cattle have smaller calves, making calving easier. Petitioners' cattle were not shown at cattle shows.

¶46Generally, petitioner worked only a*451 limited number of hours on the ranch each week -- an hour or two on weekday evenings and a number of hours on Sundays. Occasionally, petitioner himself would participate in bulldozing the land and in worming, dehorning, castrating, branding, and vaccinating the cattle.

¶47Since 1987, petitioner has employed on the ranch either one of his sons or another full-time hired hand. On weekday evenings, petitioner occasionally would talk to his employed son or to the hired hand about management of the ranch. Occasionally, petitioner pulled calves out of the cows at calving and brush-hogged (cleared brush from) the land.

¶48The ranch land was fertilized and sprayed for weeds. Rotational grazing of the cattle generally was not done in this part of Oklahoma, and it was not done on petitioners' ranch.

¶49Over the years, petitioners undertook a number of changes or improvements to their cattle raising activity. They cleared, bulldozed, and brush-hogged portions of the property to make dirt roads and to improve the pasture for the cattle. As previously indicated, they built some fencing and three ponds. They planted Bermuda and Lespedeza grasses on some of the property.

¶50Petitioners were thrifty and frequently*452 looked for bargains in managing their cattle ranch. For example, at one point, petitioners made a bargain purchase of 26 tons of feed pellets. To store the feed, they poured all 26 tons of it through a chimney and into an unoccupied old ranch house on the property. For many years, they fed their cattle from old used bathtubs, which they purchased for this purpose, rather than spend $ 300 each for cattle feeders. In 1993, so that they could buy feed in bulk and thereby save on feed costs and related labor, petitioners purchased a bulk feed bin for $ 3,500. Also in 1993, to save on labor, petitioners changed from using square bales of hay to rolled bales.

¶51During the years in issue, on condition that they be allowed to keep the hay for no charge, petitioners made a deal with the State of Oklahoma to cut and bale hay on a nearby State highway right-of-way.

¶52Petitioners bought used trucks and equipment, including two junk trucks for parts.

¶53Petitioners did not hire any ranch consultants to assist in managing the cattle ranch. Petitioners did not belong to a cattlemen's association.

¶54During the years in issue and in prior years, petitioners maintained no formal books and records relating*453 to the cattle ranch, no records of the cattle inventory, and no ledgers, written business plans, or written cost analyses. Petitioners maintained no records of which cows were bred, nor of which cows were calved and sold.

¶55Petitioner did make some miscellaneous handwritten notes about the cattle on scratch pads, which he generally kept on the dashboard of his truck for a while before discarding.

¶56During 1993, petitioners maintained no separate bank account relating to the ranch activity. Rather, financial matters relating to petitioners' personal and family activities and to the ranch activity were handled through the same bank account. During 1994 and 1995, petitioners did maintain a separate bank account for financial activity relating to the cattle ranch.

¶57For the years in issue, petitioners retained receipts relating to expenses incurred in connection with the cattle ranch activity.

¶58Petitioners estimate that as of 1999 the property and improvements on the ranch had a market value of approximately $ 750,000 and that the equipment, vehicles, and bulldozer on the ranch had a market value of approximately $ 335,000.

¶59Petitioners have never realized a profit from their cattle ranch*454 activity. On their joint Federal income tax returns for 1993, 1994, and 1995, petitioners claimed ordinary expense deductions relating to the cattle ranch activity, and they claimed depreciation deductions relating to a house, a cabin, a mobile home, and other improvements and equipment located and used on the ranch. The schedule below reflects the gross receipts, expenses, depreciation, and net losses relating to petitioners' cattle ranch activity that were reported on petitioners' joint Federal income tax returns for 1983 through 1997:

¶60            Expenses

¶61     Gross     (Excluding

¶62Year   Receipts    Depreciation)   Depreciation    Net Loss

¶63____   ________    _____________   ____________    ________

¶641983     --      $ 25,793      $ 15,834    ¹ $ 41,627

¶651984    $ 3,621      34,195       24,680     ² 55,254

¶661985     3,200      20,414       26,092      43,306

¶671986     6,213      39,016       32,419      65,222

¶681987     2,745      26,096       45,084      68,435

¶691988*455      361      57,128       44,968      101,735

¶701989     1,013      50,905       32,915      82,807

¶711990    23,174      72,540       25,935      75,301

¶721991    20,021      70,169       16,853      67,001

¶731992     7,240      74,345       25,645      92,750

¶741993    17,162      87,921       32,637      103,396

¶751994   2 8,528      71,605       48,690      111,767

¶761995    14,268      72,903       53,408      112,043

¶771996     6,746      Unknown      Unknown      111,291

¶781997    16,618      Unknown      Unknown      97,463

¶79For all years in issue (and apparently*456 for all of the other years indicated above), on petitioners' joint Federal income tax returns, the reported net losses from petitioners' cattle ranch activity offset and reduced petitioner's substantial taxable income from Pre-Paid Legal.

¶80On audit, respondent determined that petitioners' cattle ranch activity was not operated for profit and disallowed their claimed net losses relating thereto.

¶81OPINION

¶82Under section 183(b)(2), if an activity engaged in by an individual is not engaged in for profit, deductions relating thereto are allowable only to the extent gross income derived from the activity exceeds deductions allowable under section 183(b)(1) without regard to whether the activity constitutes a for-profit activity. See Allen v. Commissioner, 72 T.C. 28, 33 (1979).

¶83For purposes of section 183, an activity is not considered engaged in for profit unless it is conducted by the taxpayer with an actual and honest objective of making a profit. See Hildebrand v. Commissioner, 28 F.3d 1024, 1027 (10th Cir. 1994), affg. Krause v. Commissioner, 99 T.C. 132 (1992); Antonides v. Commissioner, 91 T.C. 686, 693-694, 696-697 (1988), affd. *457893 F.2d 656 (4th Cir. 1990); Dreicer v. Commissioner, 78 T.C. 642, 645-646 (1982), affd. without opinion 702 F.2d 1205 (D.C. Cir. 1983). Petitioners have the burden of proof. See Rule 142(a); Cannon v. Commissioner, 949 F.2d 345, 348- 349 (10th Cir. 1991), affg. T.C. Memo 1990-148.

¶84The regulations under section 183 provide a nonexclusive list of factors to be considered in determining whether an activity is engaged in for profit. The factors include: (1) The manner in which the taxpayer carried on the activity; (2) the expertise of the taxpayer or his advisors; (3) the time and effort the taxpayer expended in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the taxpayer's success in carrying on other 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; (8) the taxpayer's financial status; and (9) whether elements of personal pleasure or recreation are involved. See sec. 1.183-2(b), Income Tax Regs.; see also Cannon v. Commissioner, 949 F.2d at 348-349.*458

¶85The taxpayer's expectation of profit need not be reasonable but must be in good faith. See Golanty v. Commissioner, 72 T.C. 411, 425-426 (1979), affd. without published opinion 647 F.2d 170 (9th Cir. 1981); Allen v. Commissioner, supra at 33; sec. 1.183- 2(a), Income Tax Regs. In determining whether an activity is engaged in for profit, greater weight is given to objective factors than to a taxpayer's mere statement of intent. See Anderson v. Commissioner, 62 F.3d 1266, 1274 n.16 (10th Cir. 1995), affg. T.C. Memo 1993-607; Cannon v. Commissioner, supra at 351 n.8; sec. 1.183-2(a), Income Tax Regs.

¶86Although no one factor is conclusive, see sec. 1.183-2(b), Income Tax Regs., a record of substantial losses over many years and the unlikelihood of achieving a profit are indicative that an activity is not engaged in for profit, see Hildebrand v. Commissioner, supra at 1027; Cannon v. Commissioner, supra at 352; Golanty v. Commissioner, supra at 426; sec. 1.183-2(b)(6), Income Tax Regs.

¶87Before, *459 during, and after the years in issue, the limited time petitioner spent working in the cattle ranch activity is inconsistent with a legitimate for-profit objective. The lack of formal books and records, of a ledger, of a budget, and of a meaningful business plan for the ranch indicates that petitioners' ranch activity was not carried on in a businesslike manner.

¶88Petitioners used the ranch for a personal residence and apparently intended to retire there. Petitioners' ranch activity realized losses every year, and from 1983 through 1997 it accumulated, before depreciation, approximately $ 700,000 in total losses.

¶89Petitioner acknowledges that he had no expectation of realizing income from the ranch in any of the early years. Petitioner states that his intention for the ranch was, over the course of 15 years, to retain female calves born each year and, by breeding the cows, to build up the cattle herd to 500 mature cows and to build up the total ranch acreage to 2,000 acres. At that point, by the sale of female calves that would be born each year, petitioner claims that he expected the cattle ranch to provide comfortable retirement income for him and his wife.

¶90Petitioner's assertions*460 as to his long-term strategy with regard to the ranch are undermined by the lack of breeding and calving records and by petitioners' sale each year (at least through 1992 and possibly through 1993) of all their female calves. ¹ These circumstances speak loudly to the nonprofit nature of petitioners' cattle ranch activity, particularly where the buildup of the cattle herd and the profit were to be based on the successful breeding of the cows.

¶91Petitioners claim that the for-profit nature of the cattle ranch is indicated by, among other things, the no-frills nature of the property, the lack of recreational use of the property, and the alleged long-range plan or purpose*461 to use income from the ranch to support petitioners in their retirement. With regard specifically to the alleged long-range plan, petitioners offered into evidence a calendar for 1983 on which were entered a few brief words as follows:

¶92          Retire age 60 -- 1998

¶93          2500 acres paid

¶94          500 mama cows paid

¶95We do not believe that this brief calendar entry adequately corroborates the existence of a long-range business or profit plan for the ranch. Rather, we regard the calendar entry as reflecting, at most, a general goal or desire. The credible testimony and other evidence in the record do not support petitioner's claim that he established a meaningful business plan for the ranch. Contrary to petitioner's testimony that his business plan (during the years before us and in prior years) was to retain female calves and to sell only male calves, in many years petitioners sold the female calves along with the male calves.

¶96Acknowledging that he maintained no formal books and records for the ranch activity, petitioner emphasizes that he did keep all expense receipts and was able to substantiate, to respondent's*462 satisfaction, the ranch-related expenses claimed on petitioners' tax returns. We believe, however, that these circumstances are more indicative of good tax planning than operation of a for-profit business.

¶97The credible evidence does not establish that petitioners' cattle ranch was operated for profit. The ranch never came close to making a profit. Petitioner testified that he did not believe he would ever achieve profitability as long as he was buying land, but thereafter he could "revive" it. Petitioner testified:

¶98     I don't know that you can ever become profitable in this

¶99   business if you're first generation [raising cattle]. … if

¶100   you start at ground level zero, you don't own an acre of land,

¶101   you don't own a cow, you have got to buy the land and improve it

¶102   and put the cattle on it, I don't know if you would ever reach

¶103   profitability that way.

¶104Petitioner's statement reveals that he viewed the ranch activity as having no profit potential for the years in issue, during which petitioners were continuing to acquire significant acreage, improve it, and put cattle on it. Rather, it appears that petitioner actually anticipated*463 incurring losses from the ranch activity over a long period, including the years in issue and thereafter. Petitioner's anticipation of these ongoing losses as being practically inevitable, rather than the result of unpredictable events, signals the absence of an actual and honest profit objective with respect to the ranch activity during the years in issue. See Mattfeld v. Commissioner, T.C. Memo 1992-273, affd. without published opinion 15 F.3d 1087 (9th Cir. 1994). We are not persuaded that these losses are attributable merely to a startup period, of a kind which is customarily necessary to bring such an activity to profitable status, especially since petitioner's annual selling off of female calves during the first 10 years of operation was inconsistent with his own asserted business plan.

¶105Petitioners' witnesses gave vague testimony based on general observations and not supported by a professional and thorough appraisal of petitioners' cattle ranch activity.

¶106On the basis of all the evidence, we conclude that petitioners have failed to establish that they engaged in the ranch activity with an actual and honest objective to make a profit within the meaning*464 of section 183.

¶107To reflect the foregoing,

¶108Decision will be entered under Rule 155.