16 T.C. 854">*855 Respondent has determined deficiencies in petitioners' income taxes as follows:

The deficiencies arise, mainly, from respondent's determination that the gain on registered cattle sold by petitioners is taxable as ordinary income and not at capital gains rates as reported by petitioners. The petitioners paid the amounts of the deficiencies after the filing of the petition, and in amended petitions claimed overpayments in the amounts so paid.

The cases were consolidated for hearing and opinion.

1951 U.S. Tax Ct. LEXIS 220">*221 FINDINGS OF FACT.

The petitioners, Walter S. Fox and Eleanor C. Fox, are husband and wife who reside at Highlands Farm, near Round Hill, Virginia. Their accounting records are maintained on a cash receipts and disbursements basis, and Federal income tax returns for the calendar years 1944, 1945, and 1946 were filed by each with the Collector of Internal Revenue for the District of Virginia.

During the years 1944, 1945, and 1946, the petitioners jointly owned and operated a 700-acre farm under the name of Highlands Farm, near Round Hill, in London County, Virginia. In the operation of the farm, they were engaged in the business of raising Aberdeen-Angus cattle and sheep and their foodstock. The Aberdeen-Angus breed is a beef animal. However, petitioners are engaged in raising the animals for sale to other breeders and not for sale as meat. One of the objectives of the petitioners was to correct existing faults of their cattle and produce a distinctive type of Aberdeen-Angus cattle, eventually to be sold as a herd or on a dispersal sale. The petitioners did not inventory their cattle for income tax purposes.

Petitioners began their cattle breeding business in 1939 with the purchase1951 U.S. Tax Ct. LEXIS 220">*222 of 10 heifers and one bull. Most of the animals born and raised on the farm were registered with the American Aberdeen-Angus Association¹ (hereinafter referred to as the Association) by the time they reached 6 months of age. No entry was made nor was there a record kept of the raised cattle which were registered with 16 T.C. 854">*856 the Association. The registered animals were kept in a separate pasture until they were old enough to be bred, which was 13 months in the case of bulls and 15 months in the case of heifers. The registered animals kept in the separate pasture were not all included in the breeding herd. Some were sold before they attained breeding age and many were sold shortly after they were bred once. The breeding herd was limited by such factors as the amount of pasture and shelter available.

On the average, not more than one out of every 100 male calves raised by petitioners possessed1951 U.S. Tax Ct. LEXIS 220">*223 breeding qualities that conformed with the standard at petitioners' farm, and at the time of the hearing not more than fifteen of such quality had ever been raised on the farm. It could not be determined that a bull possessed the proper breeding qualities until it was at least 32 months old. ²

The calves produced by petitioners' breeding herd were divided equally between bulls and heifers. On the average, one bull was sufficient to service 50 heifers or cows although at times petitioners used one bull to service as few as five females. The excess bulls were sold as part of petitioners' normal operations.

Each of the registered bulls that was 13 months 1951 U.S. Tax Ct. LEXIS 220">*224 of age was bred at least once prior to sale to protect petitioners' guarantee that the bulls were breeders. Each of the registered females that was 15 months of age was bred unless petitioners were requested to offer the animal without being bred. Such a request occurred not more than two or three times a year.

At the end of the years 1942 through 1946, petitioners owned the following numbers of registered cattle, which included animals not yet of breeding age, animals that had been bred but had not produced calves, male animals that had been used as sires, and female animals that had produced calves:

Of these, the following numbers had either been used as sires or had produced calves:

16 T.C. 854">*857 During the years in question, petitioners sold for $ 1,368.06, $ 2,579.16 and $ 1,477.95, respectively, cattle they had purchased, and sold for $ 1,093.78, $ 2,012.28 and $ 2,561.19, respectively, cattle which they had raised but had not registered with the Association. The gain on all these sales was reported as ordinary1951 U.S. Tax Ct. LEXIS 220">*225 income.

Of the cattle which petitioners had registered with the Association, 43 were sold in 1944 for $ 21,349.27, 39 were sold in 1945 for $ 42,345, and 36 were sold in 1946 for $ 40,648. All had been raised by the petitioners and, with the exception of one which was sold in 1946 for $ 1,000, were held longer than six months. Profit from the sales was reported at capital gains rates.

The following schedule shows the approximate age of each of the cattle raised, registered, and sold by petitioners as of the date of their sale and the selling price received therefor:

None of the female animals less than 24 months old had dropped a calf while owned by petitioners. Nearly all of the female animals over that age had dropped a calf by the time they were 27 to 28 months old.

16 T.C. 854">*858 The selling expenses incurred in the sale of cattle that petitioners had registered with the Association during the years 1944, 1945, and 1946 were $ 1,879.83, $ 4,655.96, and $ 5,131.26, respectively. The cost of raising these cattle was charged to farming expense and a deduction therefor was allowed in computing petitioners' net income from farming operations. The petitioners have no cost or other basis for the cattle and the entire selling1951 U.S. Tax Ct. LEXIS 220">*227 price, minus selling expenses, constitutes gain on the sale.

During the years in question, petitioners sought to develop the interest of potential purchasers in animals they were offering for sale at the various shows through full-page advertisements in monthly magazines devoted to matters of interest to livestock breeders. The majority of the animals sold by petitioners to other breeders were sold at certain public auction sales held in conjunction with exhibitions regularly conducted by various associations. Petitioners were invited to participate in such combination shows and sales about two and one-half months prior to the date set therefor. If the invitation was accepted, the petitioners then indicated the number of animals they wished to consign to the sale. Decision as to the number of animals to be sold at a particular sale, usually between two and five animals, depending on the sale, was made in advance of the invitation to participate in such sale. Petitioners did not sell any animal for breeding purposes unless it was registered with the Association.

Petitioners, Walter S. Fox and Eleanor C. Fox, during the year 1944 paid medical expenses in the amount of $ 611.33 1951 U.S. Tax Ct. LEXIS 220">*228 and $ 680.40, respectively. Petitioners are entitled to a deduction for such expenses for the year 1944 to the extent that they exceed 5 per cent of their adjusted gross income.

OPINION.

The factual question before us is whether the cattle petitioners raised and registered and then sold during the years in question were part of their breeding herd or were held primarily for sale to customers in the ordinary course of business. This question arises from petitioners' contention that the gain on these sales is taxable at capital gains rates pursuant to section 117 (j) ³ of the Internal Revenue Code.

1951 U.S. Tax Ct. LEXIS 220">*229 16 T.C. 854">*859 Section 117 (j) provides for taxing as long term capital gains the net gains on sales of "property used in trade or business" provided, among other things, the property is not property of a kind which would properly be includible in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.

It has been held by the United States Court of Appeals for the Fifth and Eighth Circuits, in United Statesv. Bennett (C. A. 5, Jan. 8, 1951), and Albright v. United States, 173 F.2d 339, and by this Court in such cases as Isaac Emerson, 12 T.C. 875, Fawn Lake Ranch Co., 12 T.C. 1139, and Franklin Flato, 14 T.C. 1241, that the gain on the sale of cattle from a breeding herd is taxed at capital gains rates pursuant to section 117 (j).

The problem before us is to determine which of the cattle raised, registered and sold by petitioners were part of their breeding herd. Petitioners concede that the unregistered cattle raised1951 U.S. Tax Ct. LEXIS 220">*230 and sold by them were not part of their breeding herd.

It was petitioners' practice to register a large number of the cattle raised at the farm. Registration usually occurred before the calf was 6 months old. Petitioners argue that upon registration these cattle automatically became part of their breeding herd despite the fact that the heifers could not be bred until 15 months old and the bulls 13 months old, and despite the further fact that a large part of the animals were regularly sold in the normal course of operations.

Petitioners' contention is based on the theory that if raised cattle may in the future be used in the herd, they qualify as property used in a trade or business just as does machinery or other property which is acquired for use in the operation of a business but is not presently used for that purpose. Carter-Colton Cigar Co., 9 T.C. 219; Alamo Broadcasting Co., 15 T.C. 534. We think the point is without merit for, unlike machinery or other property in those cases, these cattle were not purchased but were born and raised on petitioners' farm. Their presence there does not necessarily evidence an1951 U.S. Tax Ct. LEXIS 220">*231 intention to use them in petitioners' business, i. e., to use them for breeding cattle, any more than it necessarily evidences an intention to sell them to customers. Furthermore, these cattle when registered were not ready for use, nor could petitioners then determine that they would be when the proper time arrived. They were, at most, merely potential members of a herd. As we pointed out in our findings, experience has shown that a large number of the cattle were disposed of before they dropped a calf or even were bred.

The mere act of registration does not, in our opinion, establish that the calves became a part of petitioners' breeding herd, for registration was of equal importance in insuring a market for such stock as breeders. 16 T.C. 854">*860 The evidence establishes that more bulls were registered than could possibly be used in the herd.

Nor does the fact that an animal was bred establish that it became a part of the breeding herd. Cf. Leonard C. Kline, 15 T.C. 998. Petitioners' custom of selling the heifers with calf, and the bulls with the guarantee that they were breeders, necessitated that they be bred once.

We are left with the problem of1951 U.S. Tax Ct. LEXIS 220">*232 determining which of the animals were eventually included in the breeding herd. The problem is rendered difficult by petitioners' failure to submit a detailed history of the animals on the basis of which we could make an accurate determination. The only criterion relied on by the petitioners is the fact of registration.

After a careful consideration of the entire record, we have concluded that the heifers raised, registered, and sold by petitioners before they dropped a calf should not be regarded as a part of the breeding herd, and those animals that dropped a calf while still owned by petitioners should be regarded as a part of that herd. Since we are unable to determine from the evidence the exact number of calves in each category, an approximation is necessary.

Inasmuch as the earliest age at which any of the heifers dropped a calf was 24 months and the latest was approximately 27 or 28 months, we adopt as average 26 months and for purposes of disposition of this case treat all females raised, registered, and sold by petitioners when 26 months old or over as having been a part of the breeding herd. The gain on their sale is taxable at capital gains rates. United Statesv. Bennett, supra;1951 U.S. Tax Ct. LEXIS 220">*233 Albright v. United States, supra; Isaac Emerson, supra;Fawn Lake Ranch Co., supra, and Franklin Flato, supra. The remainder were not part of the breeding herd but were instead held primarily for sale to customers. The gain on their sale is taxable as ordinary income.

There remains for classification the registered bulls raised by petitioners, i. e., those which may be regarded as a part of the breeding herd and those held primarily for sale to customers. Petitioner William S. Fox's testimony was that, on the average, one bull was sufficient to service 50 females although at times one bull was used to service as few as five. It appears that at the end of the years 1942 through 1945, the breeding herd had only two bulls used as sires and 57 cows. At the end of 1946 when the number of cows reached 80, the herd contained only four bulls used as sires. It also appears that until a bull reached an age of from 32 to 37 months, it could not be satisfactorily determined that it possessed the necessary breeding qualities for such a herd as petitioners were raising. From the record made before us, 1951 U.S. Tax Ct. LEXIS 220">*234 we have determined that of the registered bulls raised and sold by petitioners, only those 34 months or older should be classified as part 16 T.C. 854">*861 of the breeding herd and those under that age should be classified as property held by petitioners primarily for sale to customers.

The findings of fact set forth a list of the registered cattle sold during the years 1944 through 1946, inclusive, and other information needed to classify them as members of the breeding herd or property held primarily for sale to customers.

The medical expense deductions should be adjusted based on petitioners' income as herein determined. The agreed depreciation will likewise be given effect on final settlement.

Decisions will be entered under Rule 50.