Opinion
Docket No. 10833.
1947-12-18
NORTON L. SMITH AND JEAN T. SMITH, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Eugene L. Lora, Esq., for the petitioners. Neil D. McCarthy, Esq., for the respondent.
Petitioner sustained net losses in the operation of his farm in each of the years 1942 and 1943 and took deductions therefor in his income tax returns for those years. Respondent disallowed the deductions and on the basis thereof determined a deficiency in income and victory tax for 1943. The deductions were disallowed on the ground that the farm was not operated for profit. Held, the deductions were erroneously disallowed and, consequently, the determination of the deficiency in tax should not be sustained. Eugene L. Lora, Esq., for the petitioners. Neil D. McCarthy, Esq., for the respondent.
Respondent determined a deficiency in petitioner's income and victory tax for the year ended December 31, 1943, in the amount of $884.07. The deficiency results from respondent's disallowance of certain deductions claimed for farm losses in 1942 and 1943. The question for determination is whether such losses are deductible and that question in turn depends on whether the farm was operated for profit. Due to the forgiveness feature applicable to 1942 and 1943, the deficiency relates only to the latter year. Respondent's determination also reflects corrections of certain mathematical errors in petitioner's return for 1942. Such corrections reduced the tax liability shown in the return. Petitioners, on the basis of these corrections and on the basis of the claimed deductibility of the farm losses in issue, claim a refund for 1943 in the amount of $1,005.51. Petitioner Norman L. Smith filed an individual income tax return for 1942. Petitioners filed a joint return for 1943. The tax returns were filed with the collector of internal revenue for the fifth district of New Jersey. Petitioner Norman L. Smith will hereinafter be referred to as the petitioner.
FINDINGS OF FACT.
Petitioner is an executive of Chicopee Manufacturing Corporation and Johnson & Johnson Co.
In 1933 petitioner bought an 118-acres farm on South Middlebush Road near Middlebush;, New Jersey. He paid $13,000 for it. A reasonable allocation of the cost is residence $5,000, tenant house $1,000, farm buildings $1,500, and land $5,500. He acquired the farm for the purpose of occupying the main house thereon as a permanent home for himself and family and to operate the farm to supplement his income and increase his financial security. The dwelling house occupied by petitioner and his family was situated in one corner of the farm about 300 feet from the main highway on one side and about 300 feet from a side road on the other side. The farm and its buildings were in a run-down condition when acquired by petitioner. He spent $5,000 improving the main residence and $1,400 improving the tenant house.
For the first year or two petitioner rented the farm to a tenant farmer. This arrangement proved unprofitable and was discontinued. Petitioner then took over the farm, employed a farmer, purchased farm equipment, and endeavored to operate the farm himself. This arrangement likewise proved unprofitable. Petitioner next tried poultry raising and general farming. Later on he tried raising hogs and sheep and in about 1938 or 1939 he began raising and breeding beef cattle. All of the above activities were undertaken with the view to profit, but none proved profitable. In 1945 petitioner was unable to get sufficient help and sold off most of his cattle. He is now raising wheat, corn, and hay. Petitioner has also spent time and study to improve the soil and for this purpose has grown clover and legumes and has put lime and fertilizer on the land. He has reclaimed several eroded fields. He has increased the acreage devoted to agricultural uses from about 75 to 95 acres. Petitioner devotes considerable time on week ends actually working about the farm. On week days he usually confers 10 or 15 minutes with the hired help.
Petitioner sells the produce from his farm. He sell principally to a few local butchers and grocerymen. Some sales result from purchasers stopping by and picking up eggs and chickens. Occasionally petitioner has sold cattle to the Delaware Packing Co. at Trenton. Petitioner usually makes the selling arrangements except in instances when purchasers stop by the farm to buy eggs or chickens. Petitioner and his family also consume some produce from the farm. The amount so consumed is usually about 10 per cent of the produce raised on or a little less. It is included in farm income at prevailing market rates. The capital and operating expenses of the residence are and have been segregated from the farm expenses.
Petitioner has never made a profit from farm operations. His net losses for the years indicated have been as follows:
+--------------+ ¦1934¦$494.00 ¦ +----+---------¦ ¦1940¦2,000.00 ¦ +----+---------¦ ¦1941¦1,200.00 ¦ +----+---------¦ ¦1942¦1,086.50 ¦ +----+---------¦ ¦1943¦2,035.89 ¦ +----+---------¦ ¦1944¦2,800.00 ¦ +----+---------¦ ¦1945¦386.69 ¦ +----+---------¦ ¦1946¦1,100.00 ¦ +--------------+
Petitioner's farm inventory for income computation for 1942 was shown on Form 1040 F as follows:
+-----------------------------------------------------------------------------+ ¦ ¦On hand at ¦Purchased ¦Raised during ¦ ¦ ¦beginning ¦during ¦ ¦ +-----------------------+------------------+---------------+------------------¦ ¦ ¦of year ¦year ¦year ¦ +-----------------------+------------------+---------------+------------------¦ ¦Description (kind of ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦livestock, crops or ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦other products) ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦ ¦Quantity¦Inventory¦Quantity¦Amount¦Quantity¦Inventory¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦ ¦ ¦value ¦ ¦paid ¦ ¦value ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Poultry ¦120 ¦$120 ¦300 ¦$66 ¦ ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Turkeys ¦70 ¦280 ¦300 ¦152 ¦ ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Cows ¦2 ¦170 ¦ ¦ ¦ ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Beef cattle ¦14 ¦1,395 ¦1 ¦200 ¦6 ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Wheat ¦180 ¦180 ¦ ¦ ¦240 ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Oats ¦170 ¦102 ¦ ¦ ¦300 ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Corn ¦600 ¦450 ¦ ¦ ¦700 ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Barley ¦120 ¦84 ¦ ¦ ¦198 ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Soy bean ¦ ¦ ¦ ¦ ¦36 ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Hay ¦85 ¦128 ¦ ¦ ¦9 ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Eggs ¦ ¦ ¦ ¦ ¦1,937 ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Milk ¦ ¦ ¦ ¦ ¦1,000 ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦ ¦_ ¦_ ¦_ ¦_ ¦_ ¦_ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Total ¦ ¦2,909 ¦ ¦418 ¦ ¦ ¦ +-----------------------------------------------------------------------------+
Consumed or lost Sold during year On hand at end during year of year. Quantity Inventory Quantity Amount Quantity Inventory value received value Poultry $50 230 $161.00 140 $140 Turkeys 50 265 1,114.00 55 266 Cows 2 170 Beef cattle 4 562.25 17 1,620 Wheat 240 180 180 Oats 270 200 120 Corn 600 700 525 Barley 168 150 105 Soy bean 6 30 45 Hay 10 7 105 Eggs 1,937 732.90 Milk 500 500 150.00 _ _ _ _ _ _ Total 2,720.15 3,276
Farm expenses for 1942 were shown as follows:
+--------------------------------------------------------+ ¦Labor hired ¦$1,290.00¦ +----------------------------------------------+---------¦ ¦Feed purchased ¦532.29 ¦ +----------------------------------------------+---------¦ ¦Seed, plants and trees purchased ¦172.57 ¦ +----------------------------------------------+---------¦ ¦Machine hire ¦132.00 ¦ +----------------------------------------------+---------¦ ¦Supplies purchased ¦173.05 ¦ +----------------------------------------------+---------¦ ¦Cost of repairs and maintenance ¦282.17 ¦ +----------------------------------------------+---------¦ ¦Fertilizers and lime ¦172.02 ¦ +----------------------------------------------+---------¦ ¦Veterinary and medicine for livestock ¦45.00 ¦ +----------------------------------------------+---------¦ ¦Gasoline, other fuel and oil for farm business¦135.23 ¦ +----------------------------------------------+---------¦ ¦Insurance on property (except dwelling) ¦113.25 ¦ +----------------------------------------------+---------¦ ¦Water rent, electricity, and telephone ¦33.15 ¦ +----------------------------------------------+---------¦ ¦Spray material ¦13.56 ¦ +----------------------------------------------+---------¦ ¦ ¦_ ¦ +----------------------------------------------+---------¦ ¦Total ¦3,094.29 ¦ +--------------------------------------------------------+
Depreciation on buildings and machinery was taken in the amount of $661.36. The above designated items of expense in the total amount of $3,094.29 were ordinary and necessary expenses paid by petitioner in 1942 in the operation of his farm and $661.36 was a reasonable amount to be allowed as depreciation on the farm buildings and machinery. Petitioner sustained a net loss in 1942 of $1,086.50 in the operation of the farm. Petitioner's farm inventory for income tax purposes for 1943 is shown on Form 1040 F as follows:
+-----------------------------------------------------------------------------+ ¦ ¦On hand at ¦Purchased ¦Raised during ¦ ¦ ¦beginning ¦during ¦ ¦ +-----------------------+------------------+---------------+------------------¦ ¦ ¦of year ¦year ¦year ¦ +-----------------------+------------------+---------------+------------------¦ ¦Description (kind of ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦livestock, crops or ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦other products) ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦ ¦Quantity¦Inventory¦Quantity¦Amount¦Quantity¦Inventory¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦ ¦ ¦value ¦ ¦paid ¦ ¦value ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Poultry ¦140 ¦$140 ¦500 ¦$200 ¦ ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Turkeys ¦55 ¦266 ¦300 ¦165 ¦ ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Cows ¦2 ¦140 ¦ ¦ ¦ ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Beef cattle ¦17 ¦1,620 ¦ ¦ ¦11 ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Wheat ¦180 ¦180 ¦ ¦ ¦220 ¦$220 ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Oats ¦200 ¦120 ¦ ¦ ¦250 ¦175 ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Corn ¦700 ¦525 ¦ ¦ ¦250 ¦200 ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Barley ¦150 ¦105 ¦ ¦ ¦ ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Soy bean ¦30 ¦45 ¦ ¦ ¦50 ¦100 ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Hay ¦7 ¦105 ¦ ¦ ¦15 ¦450 ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Eggs ¦ ¦ ¦ ¦ ¦2,152 ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦(doz.) ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Milk ¦ ¦ ¦ ¦ ¦900 ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦(gal.) ¦ ¦ +-----------------------+--------+---------+--------+------+--------+---------¦ ¦Total ¦ ¦3,276 ¦ ¦365 ¦ ¦ ¦ +-----------------------------------------------------------------------------+
Consumed or lost Sold during year On hand at end during year of year. Quantity Inventory Quantity Amount Quantity Inventory value received value Poultry 80 230 $323 330 $264 Turkeys 50 295 1,706 10 48 Cows 2 170 Beef cattle 4 524 24 1,970 Wheat 340 $340 60 60 Oats 400 260 50 35 Corn 900 685 50 40 Barley 150 105 Soy bean 30 45 50 100 Hay 20 495 2 60 Eggs 2,152 968 Milk 500 400 120 Total 3,641 2,747
Farm expenses for 1943 were shown as follows:
+------------------------------------------------------------------------+ ¦Labor hired ¦$1,483.50¦ +--------------------------------------------------------------+---------¦ ¦Feed purchased ¦1,005.12 ¦ +--------------------------------------------------------------+---------¦ ¦Seed, plants and trees purchased ¦225.00 ¦ +--------------------------------------------------------------+---------¦ ¦Machine hire ¦125.00 ¦ +--------------------------------------------------------------+---------¦ ¦Supplies purchased ¦66.21 ¦ +--------------------------------------------------------------+---------¦ ¦Cost of repairs and maintenance ¦685.07 ¦ +--------------------------------------------------------------+---------¦ ¦Veterinary and medicine for livestock ¦34.00 ¦ +--------------------------------------------------------------+---------¦ ¦Gasoline, other fuel and oil for farm business ¦177.13 ¦ +--------------------------------------------------------------+---------¦ ¦Taxes, property (1/2) ¦173.00 ¦ +--------------------------------------------------------------+---------¦ ¦Interest on farm notes and mortgages, Federal L.B. mort. (1/2)¦45.00 ¦ +--------------------------------------------------------------+---------¦ ¦Water rent, electricity, and telephone ¦44.00 ¦ +--------------------------------------------------------------+---------¦ ¦Miscellaneous ¦1.75 ¦ +--------------------------------------------------------------+---------¦ ¦Registration fees ¦41.25 ¦ +--------------------------------------------------------------+---------¦ ¦ ¦_ ¦ +--------------------------------------------------------------+---------¦ ¦Total ¦4,104.03 ¦ +------------------------------------------------------------------------+
Depreciation on buildings and machinery was taken in the amount of $678.86. The above designated items of expense in the total amount of $4,104.03 were ordinary and necessary expenses paid by petitioner in 1943 in the operation of his farm and $678.86 was a reasonable amount to be allowed as depreciation on the farm buildings and machinery. Petitioner sustained a net loss in 1943 of $2,035.89.
In 1933 petitioner received compensation from Johnson and Johnson in the amount of $22,809.49, of which $9,000 was paid in cash. An undisclosed but substantial portion of this compensation was received in the form of stock or other noncash form. In 1934 petitioner received compensation from Johnson & Johnson and from Chicopee in the aggregate amount of $18,741.91, of which $12,000 was paid in cash. An undisclosed amount of this compensation included noncash items. Petitioner's 1934 compensation was the least he has ever received since 1933. His compensation has at times been in the neighborhood of $90,000 to $100,000 a year. In 1942 he received compensation for his services in the amount of $64,808 and in 1943 he similarly received $73,896.
Petitioner has spent money beautifying his residence and has used it for normal social purposes. His residential expenses have, however, been segregated from his farm expenses. The farm itself, excluding the residence, is not used for social purposes.
The farm, separate and apart from the residence, was operated by the petitioner during the years herein involved for profit and its operation constituted a business regularly carried on for profit during such years.
OPINION.
HILL, Judge:
The question is whether petitioner operated the farm as a trade or business or for profit, on the one hand, or for recreational purposes or as a hobby, on the other. As is implicit or stated in the cases cited by both petitioner and respondent, the answer to this question lies in determining petitioner's intention from all of the evidence. We have concluded that the facts show that the petitioner's intent in operating the farm was primarily for the purposes of making a profit.
Respondent bases his argument that petitioner had no intent to operate the farm as a trade or business or for profit on the following points: (1) That the operation of the farm resulted in a series of uninterrupted losses, (2) that petitioner's purchase of the farm was essentially motivated by his desire to have a country estate for his home, and (3) that petitioner operated the farm in order to supply his family with food for home consumption.
It is true that the petitioner has experienced continuous annual losses from the operation of his farm since its acquisition in 1933 and through the taxable years in question. Moreover, the record discloses that after the taxable years involved here there were further losses in 1944, 1945, and 1946. The fact that the operation of the farm has resulted in a series of losses, however, is not controlling if the other evidence shows there is a true intention of eventually making a profit. See Israel O. Blake, 38 B.T.A. 1457. Respondent cites the case of Thacher v. Lowe, 288 Fed. 994, to support his argument. The court in that case stated:
* * * it is difficult to imagine how a farm which has been running the number of years which this had could be thought capable of turning a deficiency of 90 percent into a profit.
On the facts in the instant case, however, we can not say that there is no reasonable expectation of realizing a profit.
We do not agree with the respondent that petitioner purchased the farm primarily to satisfy his desire to live on a country estate. It may be true that petitioner experienced pleasure from residing in a country home, but this fact alone does not negative his intent to operate the farm for profit. Wilson v. Eisner, 282 Fed. 38. Nor is such intent negatived by the fact assumed by respondent that petitioner, as a business executive, has received an annual s sufficiently high to indicate no need to supplement his income by the farm operation.
We are convinced from the record that it has at all times been petitioner's intention to operate the farm for profit, and that he had reasonable expectations of accomplishing that result. His efforts to make a profit have included increasing the land in cultivation and in pasturage from 75 to 95 acres, renting the farm, employing an experienced farmer to operate it under his supervision, improving the land by reclamtion practices and fertilization and soil conservation methods, and engaging at various times in a number of diversified types of farming. He spends most of his week ends working on the farm, performing such odd jobs as repairing buildings or equipment, feeding poultry, and spraying orchards. On week days he usually consults with his employees for 10 to 15 minutes each morning in connection with problems related to the operation of the farm. In addition he has expended a great deal of money in repairing farm buildings and buying farm equipment, all of which was for utilitarian rather than beautification purposes. He has always considered the farm separate from his home, he has segregated the capital and operating expenses of the residence from the farm expenses, and he has not used the farm for any social or recreational purposes, nor does it have any such facilities.
This leaves for our consideration respondent's argument that petitioner operated the farm primarily for the purpose of providing wholesome food for his family. It should be noted, first, that petitioner and his family consumed at the most only 10 per cent of the farm products on the average and that all of those used were included and reported in the farm income at regular prices. The other approximately 90 per cent of the farm produce was sold by the petitioner to local butchers and grocerymen, to purchasers stopping by the farm, and occasionally to the Delaware Packing Co. at Trenton. In addition to that, the types of products raised by petitioner included poultry, eggs, cattle, sheep, wheat, corn and hay, many of which are not readily adaptable to home consumption, and such of them as were so adaptable were produced in far greater quantities than his home consumption requirements. The petitioner's primary intention, therefore, was not to produce good food for home consumption. Consequently, the case of Louise Cheney, 22 B.T.A. 672, cited by respondent, is not in point.
We hold that petitioner's farm operations during the taxable period here involved were a business regularly carried on by him for profit and that the losses in question resulted from ordinary and necessary expenses paid during such taxable period in carrying on such business and, therefore, are deductible for income tax purposes.
It follows that respondent erred in his determination.
In view of petitioner's claim of overpayment,
Decision will be entered under Rule 50.