Prieto v. Commissioner T.C. Memo.

2001-266 (2001)

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Nature of the Case

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Facts

Prieto (P) is an orthopedic surgeon. P runs his own medical practice. His wife also worked in his medical practice. From 1991 through 1998, P had no substantial income-producing assets or any other substantial source of income other than the medical practice. Net profits ranged from $450k per year to $794k. From the age of 4 to 5, P's wife rode horses on the farm where she lived. From the age of 16 to 18, she owned a horse that was an ex-barrel racer. None of these horses were show jumpers. P's wife had no experience with show jumpers or showing horses. Ps have two children. When they were 7 and 5 they began riding horses. By 1990, Ps owned three ponies and the daughters competed in horse shows. Ps started Fordham Farms that included purchasing, training, showing, and selling 'hunter', 'jumper', and 'equitation' horses. None of the horses in the horse activity were held for breeding or bred. Ps used the same ponies that their children rode for pleasure to start the horse activity. Ps purchased Welsh ponies for the horse activity. Ps talked to veterinarians, trainers, and other owners and read periodicals about hunter and jumper horses. Ps also owned books about ponies, hunters, and jumpers. Ps attended seminars, clinics, and award banquets put on by horse organizations. Ps hired Joe Norick to be the horse activity's trainer. Ps hired Nicole Shahinian (Nicole) to ride their horses. Ps decided to replace Norick with a new trainer. Ps decided to replace Norick was because their daughters could not ride the horses Ps owned. Ps replaced Norick with Nicole. Nicole had no experience as a trainer or running a business and just turned 18 years old. Wilson was hired as an assistant trainer. Nissen as veterinarian, and Sasaki as bookkeeper. Hurley was the accountant for the horse activity, and Carlos Soriano was a groom. Ps also hired many temps at shows to braid the horses, horseshoers, and a night watchman. Ps had 'business cards' and stationery that bore their logo. Ps also used envelopes bearing the name Fordham Farms. Ps did not have a written business plan or make a budget for the horse activity. Ps did not have bills of sale for every horse they owned. Some were in Ps' names rather than the name of the horse activity. Ps insured only some of their horses. Ps would not force people to pay money owed to them. Their daughters advised Ps which horses to purchase and sell. In 1993, their opening balance sheet listed 'Cody Williams' as an asset. Cody Williams is not a horse; he is a person. Ps placed ads in show programs and Horse International but all of them featured their daughters, listing their medals and wishing them good luck in 1995. Ps did list general goals and did sell some of their horses but never for more than they paid. Ps incurred $1,676,963 of losses through 1995 and $2,555,935 of losses through 1998. During these years, the loss from the horse activity averaged $319,492. Excluding 1996, the losses averaged $367,091. In 1996 they made a profit of $13,703. From 1991 through 1998, Ps' readjusted adjusted gross income averaged $ 635,981. Ps’ time with the activity revolved around their daughters, particularly on the weekends. Ps had a sufficient amount in savings to fund the startup of the horse activity. The horse activity had cash shortages, and Ps borrowed money from P's medical practice line of credit and transferred funds out of the medical practice bank accounts to provide working capital for the horse activity. When Jill was 20 and Claire 18 they closed the business. D assessed taxes and penalties and P petitioned the tax court.