by: John Alan Cohan
Attorney at Law
In an interesting Tax Court case, Texas residents Anthony and Florence Jorgenson failed to persuade the court that their activity was a trade or business engaged in for profit [TC Memo 2000-038]. The Jorgensons, both of whom are full time physicians, were audited in connection with their ranches, and then went to Tax Court.
The taxpayers claimed losses totaling $l,284,349 over an eight-year period. They raised crossbred cattle at first, then decided to breed purebred cattle. They purchased a registered Black Brangus herd consisting of 110 head of cattle. As part of their effort to breed purebred cattle, they entered into an artificial insemination program for their cattle. Still, they failed to make a profit. On one ranch they liquidated the herd dismissed their ranch manager, and ceased operations.
They then decided again to raise crossbred cattle and acquired 51 head. However, their new ranch manager was killed in a propane explosion, and they could not tend to the herd with their full time medical practices, so they sold the steers.
One ranch they operated was in Colorado, which served as a summer steer or heifer operation due to the short grazing season. They experienced severe rains and flooding that damaged the hay meadows. They participated in a Government-sponsored conservation program to replant the hay. They bought adjacent acreage, increasing the size of this ranch from l,200 acres to 2,040 acres. They made major improvements including repairing dams, removing debris, and restoring irrigation systems. They replanted and restored the hay meadows and grasses.
The Jorgensons also had a 100 acre farm in Texas where they intended to retire and harvest pecans. They built a house for themselves and a caretaker's house, cleared the land of cedar and rocks, leveled the land, and made various other improvements. They planted pecan trees, which they expected would become profitable 7 to 10 years after planting.
I think one reason why the taxpayers lost was that they did not maintain any business records such as budgets, operating statements, written business plans, or financial projections on the four properties. The court noted that they failed to maintain logs or journals with regards to their participation in the activities on the four properties.
In the court's opinion, the Jorgensons failed to establish that they engaged in the ranching activity with an actual and honest objective of making a profit. The court felt that they conducted their activities unaware of the amount of revenue they could reasonably generate, and had no credible estimate of the costs associated with the four properties.
The court said that one factor in their favor was that they hired ranch managers and sought advice from local Government conservation agencies with regard to maintaining the four properties. Although they devoted a very limited time to their ranching and farming activities, they employed competent and qualified persons to carry on the activities.
One problem with their case was that they claimed their properties had appreciated in value more than enough to offset their historical losses, but they offered no documentary evidence or expert witness on that point. It is always important to have formal appraisals to show appreciation in the value of ranch property.
The court was also influenced by the long history of losses and the fact that the petitioners waited two years before planting pecan trees on their Texas farm, preferring to focus first on building their residence.
The court concluded that the Jorgensons did not engage in the ranching and farming activities with an actual and honest objective of making a profit. They could have won had their counsel presented a better picture of their case, with documentary evidence as mentioned above.
The main lesson to be learned from this case is that expert testimony and written appraisals are crucial evidence to help show that your property has increased in value as a result of your improvements, and that priority should be given to maintaining proper business records and financial projections. If you are audited by the IRS you have many rights and should consult an expert to discuss strategy.
[John Alan Cohan is a lawyer who has served the livestock, horse and farming industry since l98l. He serves clients in all 50 states, and can be reached at: (3l0) 278-0203 or via e-mail at email@example.com, or visit his web site at www.JohnAlanCohan.com.]
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