The opinion
T.C. Memo. 1996-78
UNITED STATES TAX COURT
MASCHMEYER’S NURSERY, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 22315-94. Filed February 26, 1996.
R determined that deductions claimed by P for
annual rental payments made to P’s sole shareholder
under a real property lease exceeded the fair rental
value of the property, and disallowed depreciation
deductions claimed by P for improvements made to a
residence used by P’s sole shareholder. Held: Rental
payments were not deductible to the extent that they
exceeded the amount allowed by R. Held, further, the
residence occupied by P’s sole shareholder was used in
P’s business for purposes of sec. 167, I.R.C., and
hence, depreciation may be deducted by P.
F. Pen Cosby, for petitioner.
Ronald T. Jordan, for respondent.
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MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: This case is before the Court on the petition
of Maschmeyer’s Nursery, Inc., to redetermine deficiencies and
accuracy-related penalties determined by respondent as follows:
Penalty
Year Deficiency Sec. 6662(a)
1989 $47,284 $9,457
1990 47,762 9,552
1991 43,777 8,755
The issues for decision are: (1) Whether annual payments
made by petitioner to its sole shareholder and his wife under a
lease of undeveloped land are deductible by petitioner as rent to
the extent that they exceed $65,000; (2) whether improvements to
a residence located on petitioner’s premises and used by its sole
shareholder qualify as property used in a trade or business for
which depreciation deductions claimed by petitioner are
allowable; and (3) whether petitioner is liable for accuracy-
related penalties under sections 6662(a) and (b)(1).1
FINDINGS OF FACT
Some of the facts have been stipulated, and are so found.
The stipulations and attached exhibits are incorporated herein by
this reference. Petitioner is an Indiana corporation with its
1
All section references are to the Internal Revenue Code in
effect for the years at issue and all Rule references are to the
Tax Court Rules of Practice and Procedures.
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principal office located in Whiteland, Indiana. Petitioner grows
nursery stock for sale at wholesale and provides landscaping
services. During the taxable years at issue petitioner’s sole
shareholder was James R. Maschmeyer (Maschmeyer). He became sole
shareholder in 1986 after petitioner redeemed the stock held by
his parents.
Rent Deductions
Petitioner owns a parcel of 265 acres. The scale of
petitioner’s operations is approximately twice this area,
however, because petitioner leases additional contiguous land
from Maschmeyer and his wife. The Maschmeyers acquired the land
for petitioner’s use as it became available over several years.
This arrangement was designed to avoid increasing the
corporation’s long-term debt, which would have jeopardized its
ability to borrow for working capital at favorable rates. Tract
B, comprising 126.5 acres situated on the southern border of
petitioner’s own land, was acquired by the Maschmeyers in two
parts: 37-1/2 acres in August 1984 at a price of $52,500 ($1,400
per acre) and 89 acres in December 1986 at a price of $180,000
($2,022.50 per acre). Tract A, comprising 123.5 acres situated
on the northern border of petitioner’s own land, was acquired in
January 1989 through an estate sale for $228,449 ($1,850 per
acre). Thus, the total investment by the Maschmeyers amounted to
approximately $461,000. In January 1989 they entered into a
5-year lease with petitioner for both tracts at an annual rental
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of $140,000 ($560 per acre). On its corporate tax returns, Form
1120, for the years at issue petitioner claimed a deduction for
this amount as an ordinary and necessary business expense. On
their individual tax returns for these years, the Maschmeyers
claimed mortgage interest deductions in connection with the lease
in the amounts of $25,031, $19,170, and $17,550.
The two tracts are essentially identical in soil quality,
grade, and drainage and have no improvements besides drainage
tile. About 30 percent of tract A is covered in woods and
consequently not used for cultivation. During the years at
issue, the tracts had access to some utilities. Sewer,
electricity, and telephone service were available to tract A.
Only electricity and telephone service were available to tract B.
Neither had access to municipal water. Both tracts were zoned
for residential use. The tracts are located about 15 to 20 miles
from downtown Indianapolis in a neighborhood consisting primarily
of agricultural land intermixed with single-family homes. During
the years at issue demand for undeveloped land in the
neighborhood was stable. But the neighborhood lies within a
narrow corridor formed by two major arteries to the Indianapolis
metropolitan area, I-65 and U.S. Highway 31, along which
considerable residential and commercial development was
occurring. The residential growth extending southward and
northward from the nearby cities of Greenwood and Franklin made
it likely that vacant land in this neighborhood would be subject
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to increasing demand from speculators and developers in the near
future.
In determining a rental rate for the tracts of $140,000,
Maschmeyer did not consult a real estate appraiser. He relied
instead upon the expertise that he had developed over nearly
20 years of full-time work in the nursery business and upon the
advice of a certified public accountant (C.P.A.), Daniel H.
Wagner (Wagner). Wagner had at least 10 years of experience in
tax accounting prior to the years at issue and personally
prepared petitioner’s tax returns for each year beginning in
1985. Maschmeyer and Wagner were not aware of any comparable
leases in the Indianapolis area, so they constructed what they
believed to be a fair and reasonable rent from, inter alia,
information they had as to prevailing cash rents for lower value
crops, productivity of nursery operations, petitioner’s projected
cash-flow, the Maschmeyers’ borrowing costs for purchase of the
tracts, loss of topsoil through harvesting practices, the
economies expected to result from the use of contiguous acreage,
and the prevailing yield on financial assets. In her notice of
deficiency respondent determined that only $23,000 of the annual
rental payments was deductible as an ordinary and necessary
business expense. Subsequently respondent revised her
determination to $65,000 on the basis of a professional real
estate appraisal.
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Depreciation Deductions
A house is located on petitioner’s property. The
Maschmeyers moved into this house in 1977 to replace the previous
tenant, who had lived there since about 1965 while employed as
petitioner’s foreman. Maschmeyer continued to occupy the house
throughout the years at issue. For the convenience of his wife
and children, however, in 1989 he purchased a home in
Indianapolis, where his wife and children lived during the week.
Maschmeyer assumed the foreman’s duties, securing the premises
and equipment, overseeing the gang of migrant workers housed in
mobile homes on the premises, and supervising pickup of trees
outside business hours during harvest seasons.
After Maschmeyer became sole shareholder, petitioner made
certain improvements to the house that Maschmeyer occupied. In
1986 a swimming pool was installed at a cost of $35,011. In 1987
a pool house and other amenities were added to the house at a
cost of $32,684. In 1988 and 1989 improvements were made to the
garage and a master bedroom was added to the house at a cost of
$94,295. Additional redecorating and wallpapering were done at a
cost of $4,482 in 1990. Petitioner claimed depreciation
deductions for the aforesaid improvements in 1989, 1990, and 1991
in the amounts of $4,212, $5,038, and $5,038, respectively.
Respondent disallowed these deductions in her notice of
deficiency.
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OPINION
1. Rent Deductions
Section 162 provides for the deduction of all ordinary and
necessary business expenses, including rentals required to be
paid as a condition for the use of property. Sec. 162(a)(3).
Although the statutory standard does not expressly limit the
deduction to a reasonable amount, where the lessor and lessee are
closely related and there is no arm’s-length dealing between
them, an inquiry into what constitutes a reasonable rental is
necessary to determine whether the sums paid exceed what the
lessee would have been required to pay in an arm’s-length
transaction with an unrelated party. Potter Elec. Signal &
Manufacturing. Co. v. Commissioner, 286 F.2d 200, 202-203 (8th
Cir. 1961), affg. T.C. Memo. 1960-030; Feldman v. Commissioner,
84 T.C. 1, 6-8 (1985); Davis v. Commissioner, 26 T.C. 49, 56
(1956); Place v. Commissioner, 17 T.C. 199, 203 (1951), affd. 199
F.2d 373 (6th Cir. 1952). Since Maschmeyer is petitioner’s sole
owner and it is undisputed that he played a major role in
determining the rental, we look beyond the agreement for evidence
of the fair rental value of the subject property.
Each party presented the opinion of a professional real
estate appraiser to establish fair rental value. Both appraisers
were highly qualified by education and experience to render an
expert opinion. Since neither expert was able to identify
comparable lease transactions within the Indianapolis region,
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each resorted to an alternate method. Respondent’s expert,
Michael C. Lady (Lady), arrived at a figure of $65,000 ($260 per
acre) by comparing the subject property with certain nursery
properties under long-term lease in the vicinity of the Chicago
metropolitan area. Petitioner’s expert, Stephen L. Cobb (Cobb),
used financial theory to calculate a market rate of return on the
appraised value of the subject property. He conservatively
estimated this return at $111,500 ($446 per acre), but values of
$139,000 to $156,000 would have provided the lessor with a more
reasonable return in his opinion. Petitioner bears the burden of
proof. Rule 142(a). Accordingly, the question for the Court to
decide is whether petitioner, through its expert, has justified
rental payments in excess of the amount of $65,000 adopted by
respondent in her revised determination.
The first step in Cobb’s analysis was to determine the fair
market value of the subject property as of June 1990, assuming
based on neighborhood growth trends that its current agricultural
use was an interim use and that residential development was
likely in the near future. For each tract Cobb identified six
sale transactions in the neighborhood involving vacant land with
comparable characteristics. After making certain adjustments to
correct for significant differences, such as size, utilities, and
zoning, he appraised tract at $593,000 ($4,800 per acre) and
tract B at $278,000 ($2,200 per acre). The aggregate value of
the subject property in Cobb’s opinion was therefore $871,000
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(about $3,500 per acre). Respondent challenges the reliability
of Cobb’s appraisal on several grounds. Respondent argues that
three of the sale transactions used to support the valuation of
tract A are unrepresentative because two of the properties are
located within the city limits of Greenwood, where residential
development is more advanced than in the immediate environs of
the subject property, and the third is known to have been sold to
a developer for residential subdivision. The weakness in this
argument is that respondent concedes that the other sales
comparables used by Cobb to value tract A and tract B are
unbiased and consistent with the fair market value determined by
her own expert, and yet all of these properties were also located
in Greenwood and some were intended for immediate residential
development, like the comparables which respondent believes to be
unrepresentative.
Respondent also points out the large discrepancy between the
$593,000 value Cobb assigns to tract as of 1990 and the $228,500
price at which it was acquired by the Maschmeyers in 1989. Cobb
explained this discrepancy by the fact that the Maschmeyers
acquired tract A in the settlement of an estate; hence in his
view the price of that acquisition had not reflected the
property’s fair market value. A more serious problem in Cobb’s
appraisal is the discrepancy between his values for tract A
($4,800 per acre) and tract B ($2,200 per acre). The only
important difference between the tracts is that one has access to
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a sewer and the other does not. This difference is important:
in reconciling the sales comparables to the subject property,
Cobb used an adjustment factor of plus 60 percent or minus 30
percent to correct for inferior or superior utility service
relative to the subject property. Yet, if tract B were correctly
valued at $2,200 per acre, application of Cobb’s adjustment
factor would yield a value for tract A of $3,520 per acre. On
the other hand, if tract A were correctly valued at $4,800 per
acre, application of Cobb’s adjustment factor would yield a value
for tract B of $3,360 per acre. Either way there is a sizable
residual discrepancy that Cobb has not explained. That only 70
percent of tract A is currently tillable makes the discrepancy
all the more puzzling. Respondent reasons that Cobb has grossly
overstated the value of tract A. An alternative interpretation,
however, is that Cobb understated the value of tract B. The
inconsistency calls into question the reliability of Cobb’s
appraisal.
The next step in Cobb’s analysis was to calculate the amount
of rental income that a hypothetical investor in the subject
property would require. This was accomplished by multiplying the
estimated fair market value of each tract by a “built-up” rate.
This rate is the sum of (1) the risk-free rate of return for a
term of years equal to that of the lease, represented by the
yield of 8.77 percent on 5-year U.S. Treasury bonds as of April
1990; (2) a minimum risk premium of 2 percent, reflecting the
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riskiness associated with investment in real estate; and (3) a
minimum soil depletion factor of 2 percent, reflecting a
conservative forecast of the loss of topsoil through nursery
cultivation. Cobb’s conservative estimate of the required rate
of return is thus 12.77 percent. Although Cobb believes that
more reasonable estimates of each component would imply a rate of
return in the range of 16 to 18 percent, Cobb adopted the
conservative figure in his conclusions:
Required rent = ($871,000) (12.77%)
= $111,2272
Respondent contends that “Cobb committed a fundamental error
in financial analysis” by computing the hypothetical investor’s
rate of return on investment in terms of the fair market value of
the subject property instead of the original investment cost.
The Maschmeyers purchased the tracts for a total of $461,000. If
Cobb had multiplied his estimate of the required rate of return
by this amount, his conclusion would have been an annual rent of
less than $59,000, an amount which does not exceed the deduction
respondent has allowed.
We believe respondent misconstrues what Cobb’s required
return attempts to measure. As we understand it, his calculation
is based on the opportunity cost as of mid-1990 of holding the
subject property. The opportunity cost of an investment is the
2
Cobb’s figure is $111,562. This discrepancy is due to
rounding.
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highest alternative return from assets of equivalent risk which
the investor forgoes as a result of his investment.3 Where, as
here, the fair market value of an asset substantially exceeds the
cost of acquisition, it would make little sense to measure the
opportunity cost of holding the asset by the return that the
investor could otherwise earn on the cost of the investment,
since he could sell the asset at its higher fair market value and
reinvest the proceeds. Thus, the amount that Cobb’s hypothetical
investor forgoes by holding the subject property as of mid-1990,
and which the land must yield in order to induce him to continue
holding it, is the amount that the current cash value of the land
would yield if this sum were invested in financial assets of
equivalent risk.4
In other respects, however, Cobb’s methodology seems to us
unsound. First, we are not convinced that a 2-percent allowance
should be made for soil depletion. Respondent’s expert testified
that information he received from other nursery operators whom he
interviewed suggests that topsoil loss over the limited period
3
See generally Brealey & Myers, Principles of Corporate
Finance 87-88, 248-249 (2d ed. 1984).
4
The capital gains tax that would be incurred in this
alternative reinvestment strategy represents a cost that would
reduce the return from the alternative investment relative to the
return from holding the land. Ideally this should be taken into
account. However, the size of this cost would depend upon the
hypothetical investor’s effective tax rate and whether the tax
was spread out over multiple years by use of an installment sale,
matters as to which we have no information.
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over which agricultural use of the land is expected to continue
would probably be much less than Cobb estimates. Moreover, the
value of the land for residential use would not decline with
moderate amounts of topsoil loss, because less topsoil is needed
for this purpose. Maschmeyer himself, through careful and
well-informed calculations submitted for the record, estimated
that $9,125 per year would compensate him for soil depletion.
This represents only 1.05 percent of the fair market value
determined by Cobb.
More importantly, Cobb’s analysis fails to take into account
changes in land value. If one measured the return from corporate
stock solely in terms of dividend yield, one would not be able to
explain why so many investors hold stock as an alternative to
corporate bonds offering much higher coupon yields. The
investor’s total return from land is the sum of the periodic
income plus capital appreciation minus any depreciation in the
land owing to soil depletion. By omitting an appreciation
factor, Cobb’s equation overstates the amount of rent that an
investor would require.
Omission of an appreciation factor is also inconsistent with
characterization of agriculture as only an interim use, a major
premise of Cobb’s fair-market value appraisal. If the return
from the agricultural use in the form of annual rent were
sufficient to satisfy the investor, then agriculture would be the
highest and best use of the land. The phenomenon of speculative
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appreciation in and around the neighborhood of the subject
property due to the expectation of, and opportunities for,
residential development is one empirical fact on which both
experts agreed, and it plays a central role in their assessment
of the market. As Cobb in his report observes:
This vacant land is in the likely path of
development and would be appealing to a potential
developer as demand is increased. This investor would
be interested in holding the property in anticipation
of a future reward for the investment as utilities are
extended toward the subject.
The subject’s proximity to employment centers,
surrounding land development and extended utility
development supports the speculative attitude toward
the subject tracts, especially tract A. It is obvious
that the subject has the potential for becoming
speculative land.
It is clear that an analysis of an investor’s total return
from the land should take into account the rent plus actual or,
more appropriately, expected appreciation. The difficulty is to
estimate the rate of appreciation. Lady used a figure of 4
percent per year to correct for time differences in the four
comparable sales transactions that he identified in the
neighborhood of the subject property between 1990 and 1992 as the
basis of his fair market value appraisal. If we used 4 percent
as a measure of the return received by an investor in the form of
land appreciation, and limited the soil depletion factor to
1.05 percent, we would adjust Cobb’s equation as follows:
Required rent + 4% = ($871,000) (8.77% + 2% + 1.05%)
Required rent = $68,112
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The basis for Lady’s 4-percent figure is not evident from
his report, but as an estimate of the expected rate of
appreciation during the years at issue it seems very
conservative. The consumer price index for the 2 years prior to
April 1990 was increasing at 4-1/2 to 5 percent. An investor
holding land for interim agricultural use in the vicinity of
substantial residential development could presumably have
expected it to appreciate significantly in excess of the general
inflation rate. Information in the record is not sufficient for
the Court to estimate what rate of appreciation an investor could
reasonably have expected. Suffice it to say, however, that if we
selected a rate even one-half percentage point higher than
4 percent, the required rent implied by Cobb’s equation would no
longer exceed the amount determined by respondent.
Required rent = ($871,000) (7.32%)
= $63,760
Accordingly, Cobb’s analysis does not persuade us that
respondent’s determination is incorrect.
Our result would not be materially different if we
constructed an arm’s-length rent in a manner similar to that used
by Maschmeyer and petitioner’s accountant. The rental amount
determined by respondent would cover the Maschmeyers’ actual
costs and provide a reasonable return for ownership risk.
In his computation Maschmeyer allowed $26,004 for the
Maschmeyers’ average borrowing costs. Why this amount exceeds
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the mortgage interest deductions claimed on the Maschmeyers’
individual tax returns for the years at issue was not
satisfactorily explained. The average of the amounts claimed on
the returns is $20,584. To this we add the annual allowance for
soil depletion that Maschmeyer carefully calculated and used in
his computation; viz., $9,125. These are the lessors’ costs. We
can also include in the arm’s-length price the $25,000 location
premium that Maschmeyer calculated based on the savings to the
corporation in labor and fuel costs. It is an elementary fact of
real estate markets that land is not fungible, and locational
differences can account for significant price differences within
a competitive market. Because contiguous acreage is more
valuable to petitioner than otherwise identical property situated
at a distance, even if the land owner were an unrelated party
negotiating at arm’s length he would be in a position to capture
at least some of the premium value that the land would generate
in petitioner’s operations.
Maschmeyer included in the rent an additional amount
representing a 10-percent return on investment ($46,592). In
support of this item he noted that the return per acre for a
nursery operation is approximately 25 times that from typical
farming operations. We think this item is unwarranted for three
reasons. First, the return per acre is a function not only of
land but also of labor and capital inputs. Maschmeyer apparently
made no attempt to quantify the relative contribution of each of
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these three factors of production in nursery operations.
Consequently, this comparison is of little, if any, probative
value. Second, the location premium itself represents pure
profit, which ought to be included in the landowner’s return.
Third, a rate of return as high as 10 percent has not been
justified. Petitioner’s own expert estimated that a 2-percent
premium would adequately compensate an investor for the risks of
ownership. The $25,000 location premium alone provides more than
that, measured either in relation to the Maschmeyers’ original
investment cost or the current value of their investment.
Finally, Maschmeyer included in his calculation a base rental
amount equal to the market rent for land used to grow corn and
beans ($37,500 or $150 per acre). We fail to see the relevance
of this item and accordingly exclude it. The total of the
justifiable items enumerated above does not exceed $65,000.
$20,584 average borrowing cost
9,125 depletion cost
25,000 location premium/profit
54,709
We need not make our own determination of fair rental value.
Petitioner has justified no more than the amount allowed by
respondent.
2. Depreciation Deductions
Respondent disallowed depreciation deductions claimed by
petitioner for improvements to a residence occupied by Maschmeyer
during the years at issue. Section 167 authorizes a depreciation
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deduction equal to a reasonable allowance for the exhaustion and
wear and tear of property used in a trade or business. In
determing whether living accommodations provided to a corporate
employee constitute property used in a trade or business for
purposes of section 167, this Court has taken into account the
requirements of section 119: (1) The living accommodations are
furnished on the business premises of the employer; (2) they are
furnished for the convenience of the employer; and (3) the
employee is required to accept such living accommodations as a
condition of his employment. The third requirement can be
satisfied by a showing that acceptance of the accommodations was
necessary in order for the employee properly to perform his
duties, as for instance, where he must be available for duty at
all times on the premises of the employer. Johnson v.
Commissioner, T.C. Memo. 1985-175; J. Grant Farms v.
Commissioner, T.C. Memo. 1985-174; sec. 1.119-1(b), Income Tax
Regs. Thus, in the companion cases of Johnson and J. Grant Farms
we held that a corporation in the business of farming was
entitled to deduct depreciation on a residence used by its sole
owner/farm operator because he was required to live on site in
order to be available for duty at all times in connection with
his managerial responsibilities. Petitioner bears the burden of
proving that its deductions are allowable. Rule 142(a).
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The dispute between the parties focuses on the third
requirement.5 Respondent argues that because Maschmeyer was
employed as petitioner’s president, in order to satisfy the third
requirement petitioner must demonstrate that Maschmeyer was
required to use the residence in order to perform his executive
duties. In respondent’s view, petitioner has not satisfied its
burden.
We are not persuaded by respondent’s logic, which reflects
an unduly narrow understanding of the scope of Maschmeyer’s
executive duties. Maschmeyer testified that petitioner needed
someone on the premises at all times for the security of its
500-acre nursery and valuable equipment, for supervision of
resident migrant workers, and for shipment of trees after
business hours during the busy harvest season. He testified that
for more than a decade the residence was occupied by the foreman
who performed these duties. He testified that he assumed these
duties when the foreman secured employment elsewhere.
Maschmeyer’s testimony was credible and uncontroverted. It is
clear from the nature of these duties that they required presence
on-site at all times during the work week. If Maschmeyer had not
been required by his responsibilities to reside on-site, there
would be no explanation for the fact that he continued to live
5
Both parties seem to have taken it for granted that
improvements to a residence should be treated no differently from
the residence for purposes of this analysis. We shall therefore
do likewise.
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there after his family moved to a different home in 1989. No
evidence was offered from which we can properly infer any other
reason for this separation.6 That Maschmeyer served as
petitioner’s president is beside the point. His use of the
residence was necessary to petitioner’s business as described
above. We are satisfied that the residence was used in
petitioner’s business for purposes of section 167.
Respondent attaches great importance to the fact that the
improvements commenced immediately after Maschmeyer became sole
shareholder. From this respondent infers that the improvements
were made to benefit Maschmeyer as a shareholder rather than as
an employee. There is no support in the analogous cases,
J. Grant Farms v. Commissioner, supra, and Johnson v.
Commissioner, supra, for the proposition that because the farm
operators who lived on site were also sole owners of the
corporation, the accommodations were being furnished to them in
their capacity as shareholders. Inasmuch as Maschmeyer continued
throughout the taxable years at issue to perform the employment
duties for which the corporate residence was made available to
him, we find that any distinction between benefits he received as
an employee and benefits he received as a shareholder is not
6
We are not persuaded otherwise by the evidence that he is
currently in the process of obtaining a divorce. We find that he
was required to live on petitioner’s property in order to
discharge his responsibilities as manager of petitioner’s
business.
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dispositive.7 Petitioner has satisfied its burden of proving
that disallowance of the depreciation deductions on the grounds
adduced therefor by respondent was improper.8
3. Accuracy-Related Penalty
Section 6662 provides for a penalty equal to 20 percent of
any portion of the underpayment that is attributable to
negligence or disregard of rules or regulations. Sec. 6662(a)
and (b)(1). Negligence generally is defined as lack of due care
or failure to do what a reasonable and ordinarily prudent person
would do under the circumstances. Neely v. Commissioner, 85 T.C.
934, 942 (1985); cf. sec. 6662(c). The penalty can be avoided by
good faith reliance on the expertise of a professional adviser
after full disclosure of relevant information. United States v.
Boyle, 469 U.S. 241, 250-251 (1985); Patin v. Commissioner,
88 T.C. 1086, 1129-1131 (1987), affd. sub nom. Gomberg v.
Commissioner, 868 F.2d 865 (6th Cir. 1989), affd. without
published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186
7
Cf., e.g., Gill v. Commissioner, T.C. Memo. 1994-92, affd.
___ F.3d ___ (6th Cir. Jan. 23, 1996), where we disallowed
depreciation deductions claimed by a corporation with respect to
a residence furnished to its shareholder-employee, because the
primary purpose for the corporation’s acquisition and maintenance
of the residence was to serve the shareholder’s personal benefit.
8
The deduction provided by sec. 167 is limited to a
reasonable allowance. Respondent has not challenged the
depreciation deductions on the ground that the expenditures for a
pool, pool house, master bedroom, interior redecorations, and the
like were extravagant or extraneous to the business purpose of
the residence.
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(4th Cir. 1988), affd. sub nom. Skeen v. Commissioner, 864 F.2d
93 (9th Cir. 1989), affd. without published opinion 865 F.2d 1264
(5th Cir. 1989); Pessin v. Commissioner, 59 T.C. 473, 489 (1972);
sec. 6664(c)(1); sec. 1.6664-4(b)(1) and (2), Example (1), Income
Tax Regs. Reliance on an adviser will not immunize the taxpayer
from liability, however, where the taxpayer knew or should have
known that its adviser lacked sufficient knowledge regarding the
subject matter of the consultation. Patin v. Commissioner,
supra; Ellwest Stereo Theaters v. Commissioner, T.C. Memo.
1995-610; sec. 1.6664-4(b)(1) and (2), Example (1), Income Tax
Regs.
It is undisputed that Maschmeyer relied on the advice of
petitioner’s accountant, Wagner, in determining a rental for the
lease of tracts A and B, and in preparing the corporate tax
returns reflecting these rental payments. Respondent argues that
the penalty is nevertheless appropriate because Maschmeyer did
not rely on the advice of a real estate appraiser. Respondent’s
argument is unwarranted on the particular facts of this case.
Maschmeyer is highly knowledgeable about a business he has been
engaged in for 20 years. Wagner is a C.P.A. with many years’
experience in tax return preparation and thorough familiarity
with petitioner’s tax and financial situation. It was not
unreasonable for Maschmeyer to believe that together they could
determine an arm’s-length rent that accounted for all relevant
business and financial factors. Their testimony and the exhibits
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they prepared explaining how the rental was derived display a
conscientious, if not wholly convincing, effort to arrive at an
accurate appraisal. As the wide discrepancy between the
appraisals presented to the Court by the parties’ experts, Lady
and Cobb, illustrates, the making of an appraisal is not an exact
science. We are satisfied that Maschmeyer’s conduct on
petitioner’s behalf was consistent with ordinary business care
and prudence.
Indeed the $140,000 rental deduction claimed by petitioner
on its tax returns falls squarely within the range that Cobb, in
his expert opinion, considered reasonable ($871,000 x 16% =
$139,360; $871,000 x 18% = $156,780). Thus, petitioner’s
valuation was in fact consistent with that of a professional real
estate appraiser.
The accuracy-related penalty does not apply. To reflect the
foregoing,
Decision will be entered
under Rule 155.