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May 16, 2012
The Tax Court held that a married couple who engaged in a cattle and horse breeding activity were not engaged in a business, despite the full-time nature of the venture. The case was Garbini v. Commissioner IRS [T.C. Summary Opinion 2004-7]. Mr. Garbini, of Myrtle Creek, Oregon, listed his occupation as a rancher, and his wife indicated she was a housewife. Both taxpayers were retired during the two taxable years in issue and for Mr. Garbini, this was a full time venture. They had a net loss of $127,341 in one year and $124,584 for the second year at issue.
The court examined whether the taxpayers carried on the activity with the actual and honest objective of making a profit. Although a reasonable expectation of profit is not required, the facts and circumstances must indicate that the taxpayer entered into the activity, or continued the activity, with the actual and honest objective of making a profit.
The court said that the taxpayers did not seek expert advice before entering the activity and that was viewed with disfavor. They had no business plan to prove that their activity originated with the honest objective of making a profit. No single factor is controlling in deciding whether a horse or cattle venture is engaged in for profit. In applying the factors to determine profit objective, the court focused on the manner in which Mr. Garbini carried on the activity. The fact that the taxpayer carries on the activity in a businesslike manner and maintains complete and accurate books and records indicates that the activity is engaged in for profit. In this case, the court said that there was little by way of books and records. Rather, Mr. Garbini made a monthly list of expense categories and, based on his canceled checks, recorded the amounts expended for each category.
At trial, Mr. Garbini submitted various invoices, canceled checks, and the monthly lists for the taxable years in issue. The court said that he did not keep the type of records which could be used to increase the profitability of a business. He never prepared budgets or market projections which would outline strategies for ensuring a profitable business venture. The court said that his recordkeeping practice of creating monthly lists from canceled checks simply was inadequate and not indicative of a prudent and reasonable person in business.
Mr. Garbini said that he made efforts to reduce expenses in order to operate the ranch in a profitable manner. Nothing in the record indicated what efforts he actually made to reduce expenses. Mr. Garbini never ascertained how or when he would make a profit or how he could change his operating methods to improve his profitability. Mr. Garbini worked on the ranch almost every day and employed one full-time ranch hand, who performed general maintenance of the property and barns. Mr. Garbini occasionally hired outside temporary labor.
There were no sales during the years at issue.
One strength in this case that unfortunately was not set forth adequately in the evidence was that according to Mr. Garbini, the ranch had increased in value as a result of improvements he had made. Mr. Garbini testified that he bought the property for $566,000 in its undeveloped condition and its value at the time of trial was $15 million. However, he did not provide any evidence other than his verbal testimony. In order to prove this, there must be introduced into evidence an expert’s report showing the appreciation in value, but all the court had was the taxpayer’s testimony.
Mr. Garbini also argued that part of the ranch activity involved planting and harvesting trees. He stated that he had planted 3,000 to 5,000 trees per year, and that they are suitable for harvesting after 7 years. The court noted that no trees were harvested during the taxable years in issue.
The court also considered the history of income or losses with respect to the activity. Mr. Garbini did not provide a history of income or losses for the activity. During the taxable years in issue, losses exceeded $250,000, an average of $125,000 for each year. Mr. Garbini claimed that the losses have gradually declined, but this was not adequately presented. Over a period of about 12 years, the losses were over $1,500,000. There was no evidence of any profit year.
The court considered the financial status of the taxpayers. The court noted that as a result of their other income, the taxpayers realized substantial tax benefits from the approximate $125,000 loss deduction for each taxable year in issue.
The court also said that there were elements of personal pleasure or recreation even though they did not ride the horses. The court simply said that the taxpayers probably had personal pleasure from residing on a large ranch.
Taking the record as a whole, the court concluded that the taxpayers did not possess the actual and honest objective of making a profit from their operations. Because they had no gross income for the taxable years in issue, none of their claimed expenses were deductible.
John Alan Cohan is a lawyer who has served the horse, livestock and farming industries since l98l. He serves clients in all 50 states, and can be reached by telephone at (3l0) 278-0203 or via e-mail at JohnAlanCohan@aol.com, or visit his website at www.JohnAlanCohan.com.