Glen Head, NY

The taxpayer in Whitecavage v. Comr., T.C. Memo 2008-203, was an IRS revenue agent who was breeding greyhounds for the purpose of entering them in dog races. Because of his full-time job at the IRS, Mr. Whitecavage did not spend much time with the dogs during workdays, but he fed and cleaned up after them mornings and evenings. He did not hire a caretaker to tend to the dogs while he was at work.

He kept the dogs on his property until they were a little over one-year old and then he would send them to Florida, Oklahoma, or New Mexico to train for racing on a track. After being trained, the greyhounds were raced in Florida and Arizona, and Mr. Whitecavage received a percentage of any winnings.

Over 10 years, Mr. Whitecavage raised approximately 88 greyhounds. Not all of the dogs survived training; about 20 greyhounds died as the result of bad training methods used by the trainers. The greyhounds that survived spent the rest of their racing lives on the track. At the end of their racing lives the greyhounds generally would be adopted or euthanized.

Mr. Whitecavage did not consult an economist or other professional business adviser prior to commencing his breeding activity and, although he received some racetrack winnings, he never realized a profit from breeding and racing the greyhounds. He ceased his breeding activity in 2006, the same year he retired from the IRS.

Mr. Whitecavage deducted losses - as business losses - from this activity on his 2001, 2002, and 2003 tax returns in the amounts of $9,645, $49,484, and $15,663. These deductions were disallowed as “not entered into for profit” under §183 of the Internal Revenue Code. That section provides in part that if an activity is not engaged in for profit, any deduction attributable to such activity shall be allowed only to the extent that the gross income derived from such activity for the taxable year exceeds the deductions. In other words - no losses - and the deductions could be used only to reduce the income. This is sometimes called “The Hobby Loss Rule.”

The Treasury Regulations state that “[i]n determining whether an activity is engaged in for profit, all facts and circumstances with respect to the activity are to be taken into account. No one factor is determinative in making this determination.” Regs. §1.183-2(b)(1). The following factors are listed as those which “should normally be taken into account”:

(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 the taxpayer spent 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.

The court analyzed this case with respect to each of these factors and found that all but one factor weighed against Mr. Whitecavage and ruled that he failed to prove that he engaged in his greyhound activity for profit. The court also upheld a 20% accuracy-related penalty for the tax year in which Mr. Whitecavage's understatement of income tax exceeded $5,000.00, because he did not claim that he had reasonable cause or acted in good faith.

It's hard to find sympathy for Mr. Whitecavage, not because he's a revenue agent, but because in discussing the last factor listed above, the court found:

that petitioner's activity of breeding greyhounds for racing, (was) conducted by petitioner in a seemingly inhumane manner (for many years keeping numerous dogs confined in crates … while he worked a full-time job at the IRS, sending the pups off to “training” that almost a fourth of them would not survive, and ultimately casting off most of the others for possible adoption or destruction).

Section 183(d) allows a presumption that an activity is engaged in for profit if that activity shows a profit for a certain number of years. If that test can't be met then the above nine factors must be considered.

For more information, in the Tax Management Portfolios, see Wood, 548 T.M., Hobby Losses, and in Tax Practice Series, see ¶2450, Hobby Losses.