This supplemental memorandum opinion addresses a taxpayer’s motion for reconsideration regarding the application and validity of Treasury Regulations governing the deduction of losses from activities not engaged in for profit, specifically in the wake of the Supreme Court’s ruling in Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244 (2024). This analysis focuses on whether Tecomate Industries, LLC (TI), a partnership, engaged in its farming activity with the requisite profit motive under Internal Revenue Code (I.R.C.) § 183.

Procedural Background and Initial Findings

This opinion supplements the prior decision in Schwarz v. Commissioner (Schwarz I), T.C. Memo. 2024-55. In Schwarz I, the court held that TI, a partnership owned by petitioners Gary M. and Marlee Schwarz (Ps), did not engage in the activity reported on Schedule F, Profit or Loss From Farming, for profit during the taxable years 2015–2017. The initial decision frequently cited Treasury Regulation (Treas. Reg.) §§ 1.183-1(d)(1) and 1.183-2(b).

Taxpayers’ Request for Relief

Following the Supreme Court’s issuance of Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244 (2024), on June 28, 2024, Ps filed a Motion for Reconsideration on September 16, 2024. Loper Bright overruled Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984) regarding the standard of review for an agency’s interpretation of a statute, holding that if an agency’s interpretation "is not the best, it is not permissible".

Ps alleged that Treas. Reg. §§ 1.183-1(d)(1) and 1.183-2(b) were invalid. They claimed the regulations were invalid because they (1) violate the notice-and-comment requirements of the Administrative Procedure Act (5 U.S.C. § 553), (2) do not represent the best interpretation of I.R.C. § 183, and/or (3) Congress did not delegate authority to the Secretary of the Treasury to issue them. Ps requested the court to "reconsider [our] holding" by interpreting the law without deferring to the regulations.

The Court’s Analysis of Regulatory Validity

The court agreed to reconsider Schwarz I but ultimately found it unnecessary to address the validity of Treas. Reg. §§ 1.183-1(d)(1) and 1.183-2(b). The court determined that the outcome would remain unchanged, even if those regulations were set aside. The critical elements of the challenged regulations are largely based on caselaw predating the adoption of I.R.C. § 183 and the regulations themselves. Applying that preexisting and more recent caselaw to the facts still resulted in the conclusion that TI lacked a profit motive.

Legal Framework: Ascertaining the Activity at Issue

The first step in an I.R.C. § 183 inquiry is ascertaining the activity or activities of the taxpayer. Petitioners argued that if Treas. Reg. § 1.183-1(d)(1) was invalid, TI’s farming activity and the petitioners’/Affiliated Entities’ real estate activities should be treated as a single activity. They claimed that, historically, farming and landholding were presumed to be one activity unless they were not interrelated, citing the now-repealed I.R.C. § 270 and corresponding Treas. Reg. § 1.270-1(a)(4).

The court rejected the petitioners’ arguments, noting that I.R.C. § 183 provides no definition or standard for what constitutes a separate activity. In the absence of statutory guidance, the court relies on relevant caselaw. Whether undertakings constitute one or more activities is a question of fact based on all facts and circumstances.

Factors considered by courts in addressing this question include:

The organizational and economic interrelationship of the undertakings.
Whether there were good business reasons for conducting the undertakings separately.
Whether the undertakings were conducted at the same place.
The degree to which the undertakings shared management, caretakers, accountants, books and records.
Whether one undertaking benefited from or was used to advertise the other.

The court reaffirmed its conclusion from Schwarz I that the real estate activities and TI’s farming activity were separate activities. The real estate activities were sophisticated, highly profitable operations aiming to capitalize on land appreciation, while TI’s farming activity was focused on extremely unprofitable ecotourism (selling hunting, fishing, and event packages). The ties between the two were considered weak, and the benefits conferred to the real estate activity by the ecotourism were minimal compared to the substantial losses incurred.

Legal Framework: Profit Motive

I.R.C. § 183(c) defines an "activity not engaged in for profit" by referencing activities for which deductions are not allowable under I.R.C. § 162 or I.R.C. § 212(1) or (2). The profit motive standard originated in early caselaw, which requires the activity to be entered into "in good faith, with the dominant hope and intent of realizing a profit". Although the expectation of profit need not be reasonable, the intent must be bona fide.

The legislative history of I.R.C. § 183 suggested Congress intended an objective rather than a subjective approach for determining profit motive. Petitioners argued this meant excluding subjective factors like personal pleasure. However, the court disagreed that Congress "tweaked" the I.R.C. § 162 standard, noting that I.R.C. § 183(c) merely adopted the pre-existing standard.

Furthermore, courts have consistently relied on a summary of caselaw factors, which are largely codified in Treas. Reg. § 1.183-2(b), to determine whether a profit motive exists under I.R.C. §§ 162 and 212. Even if Treas. Reg. § 1.183-2(b) were invalid, the court would employ these same caselaw factors. The factors considered include:

The manner in which the taxpayer carries on the activity (Lamont v. Commissioner, 339 F.2d 377, 379–80 (2d Cir. 1964)).
The expertise of the taxpayer or advisers (Babbitt v. Commissioner, 23 T.C. 850, 867 (1955)).
The time and effort expended by the taxpayer.
The expectation that assets used in the activity may appreciate in value (Blake v. Commissioner, 38 B.T.A. 1457 (1938)).
The taxpayer’s history of income or losses with respect to the activity (Bessenyey v. Commissioner, 45 T.C. 261, 275 (1965)).
The financial status of the taxpayer.
Whether elements of personal pleasure or recreation are involved (Bessenyey, 45 T.C. at 275).

Application of Law to the Facts and Valuation Corrections

Petitioners’ argument heavily relied on the expectation that assets would appreciate in value (Factor 4). To support this, they presented expert testimony from Mr. Swanson regarding property valuations.

Valuation Errors: The court found significant errors in Mr. Swanson’s valuation of the La Perla HQ Tract and Jalisco Ranch.

Overvaluing Major Water Features: Mr. Swanson determined that the major water features (lakes/ponds) doubled the value of the underlying land (a 2.0 multiple). This was based on nine case studies that the court found to be geographically dissimilar to the properties in Zapata County, Texas, a drought-prone region. Crucially, the court found the contiguous Twin Lakes South property (which contained a 30-acre lake) to be a better comparable. Based on the Twin Lakes sales, the court determined that the lake increased the land value by only 5–20% more than a 3-acre stock tank. Correcting for non-comparable case studies and incorporating the Twin Lakes data, the court determined that a 63% valuation premium (down from Mr. Swanson’s 96% average/2.0 multiple) was appropriate for the major water features.
Overvaluing Underlying Land: Mr. Swanson failed to properly account for $330,000 in Jalisco Lake Infrastructure improvements, which should have been subtracted when valuing the underlying land. Additionally, Mr. Swanson used an erroneous methodology when applying percentage adjustments to comparable sales: he improperly added the value of water rights, irrigation systems, and improvements before applying positive percentage adjustments, allowing these values to be inflated before they were subtracted back out.

Corrected Conclusions: After correcting these methodological errors, the court determined the value of the La Perla HQ Tract as of October 31, 2022, was $7.5 million (down from Mr. Swanson’s $9,347,000). The value of Jalisco Ranch was determined to be $3,335,000 (down from Mr. Swanson’s $4,765,000).

Final Conclusions on Profit Motive

Even incorporating the corrected appreciation values and assuming, arguendo, that the farming and landholding were a single activity, the outcome remained the same. The court emphasized that the most important facts were TI’s long history of substantial losses and lack of realistic future profit.

TI reported Schedule F losses exceeding $15 million for 2005–2020.
Corrected analysis showed that LSLP’s unrealized property gains attributable to the ranches (as of December 31, 2017) were substantially lower (by at least $3 million) than the petitioners’ initial estimates.
LSLP’s unrealized gains were far lower than TI’s farming activity losses of over $12 million for 2005–2017.
Further, property appreciation during 2018–2020 offset less than 9% of the additional losses TI incurred in its farming activity during that period.

The necessary profit analysis requires that net earnings and appreciation be sufficient to recoup losses sustained in intervening years and establish an overall expectation of profit (Helmick v. Commissioner, T.C. Memo. 2009-220, 2009 Tax Ct. Memo LEXIS 222, at 32; Golanty v. Commissioner, 72 T.C. 411, 427 (1979)). The evidence showed that a bona fide expectation to earn an overall profit did not exist during the years at issue. The court concluded that Dr. Schwarz pursued this activity based on a "longtime passion for deer and ranch development" rather than a genuine profit objective.

The court again held that TI’s farming activity was not engaged in for profit in the years at issue.

Prepared with assistance from NotebookLM.