Nickerson v. Commissioner of Internal Revenue
700 F.2d 402 (1983)
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Rule of Law:
An activity is considered "engaged in for profit" under I.R.C. § 183 if the taxpayer has a bona fide and sincere expectation of realizing a profit in the future, even if the activity incurs losses during a prolonged start-up phase and the expectation of profit is not immediate.
Facts:
- Melvin Nickerson, an advertising professional in his forties, decided to pursue dairy farming as an alternative future source of income.
- In preparation, he and his wife Naomi purchased a run-down 80-acre farm in Wisconsin, later adding an adjacent 40 acres.
- The farm had not been operational for eight years and its equipment was obsolete or in disrepair.
- The Nickersons leased the tillable land to a tenant-farmer, who, as part of the agreement, would improve the land's crop yield over time; this lease was the farm's only income.
- Melvin Nickerson devoted most weekends to performing hard manual labor on the farm, such as renovating the farmhouse and an orchard.
- To gain expertise, Nickerson read agricultural journals, consulted with government agents, and worked on neighboring farms.
- The Nickersons did not anticipate making a profit for approximately ten years and incurred losses of $8,668 in 1976 and $9,872 in 1977.
- The farm lacked any recreational facilities and was never used for personal entertainment or hosting guests.
Procedural Posture:
- The Commissioner of Internal Revenue disallowed Melvin and Naomi Nickerson's deductions for farm-related losses for the 1976 and 1977 tax years.
- The Nickersons (petitioners) challenged the Commissioner's determination in the United States Tax Court, a trial-level court.
- The Tax Court ruled in favor of the Commissioner, finding that the Nickersons did not operate the farm with the primary goal of making a profit.
- The Nickersons (appellants) appealed the Tax Court's judgment to the United States Court of Appeals for the Seventh Circuit.
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Issue:
Does a taxpayer's bona fide expectation of future profit, evidenced by diligent preparatory activities and substantial personal effort, satisfy the 'engaged in for profit' requirement of I.R.C. § 183, even if the activity generates significant losses during its formative years?
Opinions:
Majority - Pell, Circuit Judge
Yes. A taxpayer's diligent preparatory work and personal effort demonstrate a bona fide expectation of future profit sufficient to satisfy the requirements of I.R.C. § 183, even when the venture incurs losses in its early stages. The Tax Court was clearly erroneous because it improperly evaluated whether the petitioners could profit from their current, part-time level of activity, rather than whether their current actions were motivated by a sincere expectation of future profitability. The court reasoned that start-up losses are not inconsistent with a profit motive, especially when substantial effort is required to make an enterprise profitable. The court re-weighed the nine factors from the Treasury Regulations, finding that the petitioners' hiring of a tenant-farmer, their efforts to gain expertise, the necessary renovation of the farmhouse for future living, and the complete absence of any recreational use of the property all strongly indicated a profit motive. The court distinguished this case from those involving wealthy taxpayers creating 'hobby losses' to offset other income, noting the petitioners were a family of modest means investing significant time and labor to prepare for a new career.
Analysis:
This decision clarifies the application of the I.R.C. § 183 'engaged in for profit' test, particularly for start-up ventures and individuals undertaking a career change. It establishes that the profit motive analysis should focus on the taxpayer's long-term goals and sincere intent, rather than an expectation of immediate profitability. The court's emphasis on the 'totality of the circumstances'—including the absence of personal pleasure and the taxpayer's 'prodigious' efforts—signals that subjective intent, when supported by objective factors like hard work, can outweigh a history of initial losses. This precedent provides protection for taxpayers genuinely building a business that requires a long and costly preparatory period before it can become profitable.
