Charles H. Butler and Judith K. Butler - Page 7

                                                 - 7 -                                                   

            were judged and, eventually, sold at auction.  The children did                              
            not reside on the ranch during the years at issue.                                           
                  There were occasional sales only in 1992, through auctions,                            
            of livestock (cattle and sheep) and a goat.                                                  
                  Petitioners were members of the San Mateo Farm Bureau.  This                           
            organization provided literature and advice on farming as well as                            
            farm-related supplies.  The Bureau also provided insurance for                               
            buildings on the farm.  Petitioners also obtained information on                             
            agriculture from local farmers as well as publications from the                              
            University of California at Davis, the U.S. Soil Conservation                                
            Agency, and the U.S. Department of Agriculture.                                              
            Dell'Oca Suit                                                                                
                  Petitioners executed a water use agreement (agreement) with                            
            the owner of an adjoining parcel of land, Conrad J. Dell'Oca                                 
            (Dell'Oca), in conjunction with the purchase of the Pescadero                                
            property.  The agreement provided that petitioners and Dell'Oca                              
            would have "exclusive dominion" over the reservoir water.                                    
            Additionally, the agreement stated that there would be                                       
            restrictions on withdrawals of water during times of shortage if                             
            such withdrawals would interfere with the intended use of the                                
            pond for protecting and sustaining livestock, fish, and wildlife.                            
                  On July 5, 1985, petitioners applied to the California State                           
            Water Control Board (water control board) for a permit to divert                             
            and store water from an outside stream into the reservoir on the                             





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