Complex New Tax Ruling Is a Victory for the Industry
By John Alan Cohan, Attorney at Law

The cattle industry and horse industry are related in that they both follow the same tax laws as to whether the activity is conducted for profit under IRS section 183.

In a complex new case, Dr. George Burrus, a physician, and his wife Barbara Burrus, of Nashville, Tennessee [T.C. Memo 2003-285] won a victory in Tax Court. The case about $350,000 in deficiencies from 1990-1995.

Dr. Burrus has been involved with farming and cattle since his childhood. He had check-writing authority for his father's farm, starting as a teenager, and his active involvement continued on weekends and during the summer in college.

Dr. Burrus entered into a partnership to breed purebred horned Hereford cattle, and acquired 505 acres of property in Cheatham County, Tennessee.

After losses continued for several years, Dr. Burrus became convinced that a cattle breeding venture that utilized the embryo transfer technique could not be run profitably, and as a consequence liquidated the partnership. Dr. Burru obtained sole ownership by paying $818,053 to his partner for his interest in the farmland. Then, in 1990, Dr. Burrus commenced a new purebred horned Hereford cattle breeding activity. The activity consisted primarily of breeding and selling registered horned Hereford cattle.

Three farm properties were used to raise the cattle. Appraisals showed the principal farm property increased from a value of $200,000 in 1990 and to $400,000 in 1995, and another property increased from $316,000 in 1990 to $700,000 in 1995.

The taxpayer sold cattle at auctions in Alabama and Florida. He did not advertise his livestock during the years in issue. His farm manager maintained herd inventory records, consisting of two parts. The first was the "Office Copy of Breeding and Calving Record," which contained information regarding the cattle, including their parentage, birth date, birth weight, and identification number. The second record was the "Herd Performance Enrollment," which listed cattle that were registered and their registration numbers.

In 1998, two of the cows received "Dam of Distinction" awards from the American Hereford Association (AHA) for exceeding certain calf production standards.

The primary financial record maintained was a ledger used to record the activity occurring in the three bank accounts. Mrs. Burrus, who was responsible for writing checks and preparing the ledger, would generally obtain information necessary for this purpose from Dr. Burrus and the farm manager.

During the years in issue, petitioners did not have financial statements prepared for the activity, nor did they seek advice from any outside management or agricultural consultant.

In addition to their cattle undertaking, petitioners used the property for recreation. There were four or five horses on the property that were ridden occasionally by petitioners and members of their family. Petitioners conducted an annual dove hunt and barbecue for about 50 to 75 guests. Petitioners' children and grandchildren visited the property many times, and would often canoe and fish on a pond located at the property.

During the years in issue, Dr. Burrus attended two conventions of the AHA, and showed bulls there. He attended annual meetings of the Western Stock Breeders Convention in Denver, Colorado. He also was a member of the Tennessee Hereford Association, and had shown Hereford cattle at fairs. Income ranged from $10,000 to $44,000 per year, with losses per year ranging from a low of $129,000 to a high of $260,000. In addition to livestock sales, there was a tobacco allotment income and income from rental houses located on the properties.

The court wrote a lengthy opinion part of which determined that petitioners held the three farms primarily with the intent to profit from the increase in the land value. Since petitioners' income derived from farming did not exceed the deductions attributable thereto, their cattle activity must be treated as a separate activity from the holding of land. That is, the land was deemed held primarily with the intent to profit from its appreciation rather than for purposes of conducting the cattle activity. As a consequence, any anticipated appreciation in the realty is not considered in ascertaining the existence of an intent to profit from the cattle. I may devote a future column to this important point.

The court then analyzed whether the cattle activity, alone, was an activity engaged in for profit, and concluded that there was an actual and honest profit objective.

Petitioners did not have a written business plan, nor did they prepare income or budget projections. But Dr. Burrus believed the cattle activity would begin to show a profit once the herd reached approximately 100 productive cows, and he was endeavoring towards that goal. The herd inventories were adequate to document the herd's productivity, to an extent sufficient to earn recognition from the AHA.

The financial ledgers maintained by Mrs. Burrus, though not flawless, represented a reasonably accurate attempt to record the activity's financial results. Moreover, petitioners maintained separate bank accounts for the purpose of conducting the cattle business. Overall, the court held that petitioners conducted their cattle breeding activity in a businesslike manner and maintained adequate records.

The IRS argued that the petitioners should have developed a genetically superior stock in order to make a profit, but the court rejected that claim.

The IRS argued that embryo transfer should have been used in a profitable operation, whereas petitioners’ expert testified that a switch from embryo transfer to natural selection was a valid business decision, given the then high cost of embryo transfer.

The court held that Dr. Burrus and his farm manager possessed substantial experience with respect to breeding and caring for cattle. While neither of them had formal training regarding the economics of operating a profitable cattle breeding business, both of them had been around cattle breeding operations for the better part of their lives. The fact that the Dr. Burrus devoted a limited amount of time to the activity did not necessarily indicate a lack of profit motive because he employed competent and qualified persons to carry on such activity. And sometimes Dr. Burrus worked 7 days a week for 10 to 12 hours per day. In addition, the court held that Dr. Burrus had an expectation that the herd would appreciate in value.

The court held that recreational elements engaged in by the petitioner were associated with the landholding activity and not the cattle activity. The court held that attendance, and occasional showing of animals, at livestock conventions and fairs, was a minor recreational component.

In conclusion, the court said that the petitioners' purebred Hereford herd grew significantly during the first 6 years of operation. Their herd inventory records document this herd building process. While losses were incurred in all 6 years, such losses are consistent with a startup period inherent in herd building and therefore do not necessarily indicate a lack of profit motive. Given the growth in petitioners' herd, the demonstrated market value of purebred Hereford bulls, and the absence of significant recreational elements, the court was ruled that petitioners had an actual and honest intent to profit from their cattle activity.

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