The opinion
T.C. Memo. 2002-55
UNITED STATES TAX COURT
HENRY A. JULICHER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 1102-99. Filed February 27, 2002.
Alan L. Frank and Robert A. Cohen, for petitioner.
Keith L. Gorman and John Gilbert, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GALE, Judge: Respondent determined a deficiency in
petitioner’s 1994 Federal income tax of $95,727, an addition to
tax under section 6651(a)(1)1 of $23,932, and an accuracy-
1
Unless otherwise noted, all section references are to the
Internal Revenue Code in effect for the year in issue, and all
Rule references are to the Tax Court Rules of Practice and
Procedure.
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related penalty under section 6662(a) of $19,145. By amendment
to answer, respondent asserted an increase in the deficiency. By
motion at the end of trial to conform the pleadings to the
evidence under Rule 41(b)(1), respondent asserted that petitioner
is liable for a fraud penalty under section 6663 on the portion
of the alleged underpayment attributable to a claimed casualty
loss deduction.
We must decide the following issues:
Whether respondent is entitled under the circumstances of
this case to amend his answer under Rule 41(b)(1) to assert fraud
under section 6663. We hold that he is not so entitled. Having
so held, we need not, and do not, address the question of whether
petitioner is liable for fraud.
Whether petitioner is entitled to a casualty loss deduction
in 1994 under section 165 with respect to the collapse of a
portion of the roof of petitioner’s warehouse. We hold that
petitioner is not entitled to a casualty loss deduction because
there was a reasonable prospect of recovery of insurance proceeds
during 1994.
Whether, and to what extent, petitioner is entitled to a
depreciation deduction during the year in issue. We hold that
petitioner is entitled to a depreciation deduction in the amount
claimed on his 1994 Federal income tax return, based on his
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allocation of a portion of the purchase price to his basis in the
depreciable property.
Whether petitioner is entitled to certain bad debt
deductions under section 166 claimed on his 1994 return. We hold
that he is not.
Whether petitioner is entitled to a tax return filing status
of “married filing jointly” for the year in issue. We hold that
he is not.
Whether petitioner is liable for an addition to tax and
accuracy-related penalty as determined by respondent. We hold
that he is.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. We
incorporate by this reference the stipulation of facts and
attached exhibits. At the time of filing the petition,
petitioner resided in Wayne, Pennsylvania.
Petitioner’s Businesses
Petitioner owned 100 percent of an S corporation, Julicher
Sports Facilities (Julicher Sports). Julicher Sports engaged in
the business of constructing sports facilities, with emphasis on
surfaces such as tennis courts, weight room floors, artificial
turf for football fields, ice-skating rinks, etc. In addition,
petitioner leased real property to Julicher Sports and to Rose
Weinstein, both discussed in greater detail below.
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Casualty Loss and Depreciation Deductions
Petitioner owned real property at 10 Balligomingo Road, West
Conshohocken, Pennsylvania (Property). The Property consisted of
6.836 acres with improvements, including three buildings, which
were referred to at trial as the north building (7,839 square
feet), the finger building (2,959 square feet), and the south
building (9,324 square feet). The majority of the land was
unimproved, and consisted of a creek and adjoining flood plain
and steep slopes. In addition, the neighboring landowner held
access and maintenance easements over the Property.
The south building consisted of three sections that we shall
refer to as the western section, the middle section, and the
eastern section. The three sections were separated by walls.
During the year in issue, petitioner leased the south building to
Julicher Sports and to other acquaintances and business
associates, as a warehouse. On both his 1993 and 1994 Federal
income tax returns, petitioner reported rental income from the
foregoing leasing activities.
Petitioner acquired the Property, including land and
improvements, on April 14, 1988, for a purchase price of
$393,378.2 In order to finance the purchase, petitioner obtained
2
Petitioner’s wife at the time, Melanie Julicher, was also
a purchaser, but in 1991 she transferred her interest in the
Property to petitioner. For convenience, we shall refer to
(continued...)
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a loan of $500,000 from a bank, which was secured by a first
mortgage. In a document from the loan officer to the bank’s loan
committee recommending approval of the loan, the loan officer
stated:
Although property in question is an old one and in
considerable need of repair, the property should be
desirable when rehabilitated and will have substantial
value.
With the potential rental income combined with the rent
saving of Julicher, cash flow should be adequate to
service the debt.
Petitioner used the balance of the loan over the purchase price
to make repairs to the buildings on the Property. Petitioner did
not increase his basis in the buildings by the amount of these
repairs. Petitioner bought the Property because he had lost his
lease on a previous location where his corporation conducted its
business, and the buildings on the Property were suitable for use
in the corporation’s business.
Petitioner allocated $107,759 of the purchase price to the
land and $285,619 to the buildings. Petitioner took depreciation
deductions on the buildings beginning in April 1988 using a basis
for depreciation of $285,619, the straight-line method, and a
recovery period of 31.5 years.3 Through 1993, petitioner had
2
(...continued)
petitioner as the only purchaser.
3
Petitioner did not allocate basis individually among the
(continued...)
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claimed depreciation deductions for the buildings of $9,068 per
year4 (prorated for the partial year 1988). In 1994, petitioner
claimed depreciation for the buildings of $4,179.
In 1988, petitioner was issued a citation from the Borough
of Conshohocken indicating there was an actual and immediate
danger of collapse of part of the south building. In 1992, the
eastern section of the south building suffered water damage
caused by sprinklers that were set off as a result of a fire in a
building on the land adjacent to the Property. The cost of any
repairs or improvements resulting from these incidents, or the
cost of any other repairs or improvements, was not added to the
buildings’ basis.
In the fall of 1993, petitioner sought to reduce the tax
assessment on the Property. In his request for a lower
assessment (assessment request), petitioner stated that he
purchased the Property in 1988 for $373,000 and that his opinion
of the market value of the Property at the time of the assessment
request was $350,000. In the assessment request petitioner
claimed: “There are currently about 20,000 SF [square feet] of
3
(...continued)
buildings at the time of purchase and did not claim separate
depreciation deductions for each building; rather, petitioner
claimed one composite depreciation deduction for all the
buildings, based on the composite basis figure.
4
The basis figure of $285,619 divided by a recovery period
of 31.5 years yields a yearly deduction of $9,067.27.
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dilapidated leaky buildings on the site of which 12,000 SF is
over 100 years old. The buildings are in poor condition and in
fact only 8,000 SF is even safe to use as warehouse.”5 In
November 1993 the local board of assessment appeals rejected the
assessment request.
On March 7, 1994, a part of the roof of the western section
of the south building collapsed. The roof was supported by
wooden trusses, which showed evidence of rot and decay at the
time of the collapse. During the period leading up to the
collapse, the roof of the south building was covered with ice and
snow from extensive storms in the area.
At the time of the collapse, Julicher Sports maintained
insurance on the buildings on the Property through Atlas
Assurance Company (Atlas). The insurance policy lists only
“CORPORATION” (i.e., Julicher Sports) as the “NAMED INSURED”; but
both Julicher Sports and petitioner are listed at the top of the
policy as follows:
JULICHER SPORTS FACILITIES,
INC., HENRY JULICHER, SPORT [sic]
PO BOX 720, 10 BALLIGOMINGO RD
W. CONSHOHOCKEN PA 19428
The policy, which was obtained in 1993, provided replacement
coverage for the north, finger, and south buildings collectively
5
We note that the square footage of the north building was
7,839, and the square footage of the south building (9,324) and
finger building (2,959) totaled 12,283.
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up to a limit of $852,000, subject to certain coinsurance. The
policy also covered damage to personal property owned by the
insured and used in the insured’s business.
Following the roof collapse, petitioner engaged Len Orloff
of Claims International, Inc., to submit to Atlas a claim of loss
from the collapse. On April 27, 1994, Mr. Orloff submitted a
claim to Atlas on behalf of Julicher Sports. The claim reflects
an estimated cost of damage to the south building of $68,365 and
to its contents of $172,177, for a total of $240,542. To provide
the estimate for the south building itself, Mr. Orloff engaged an
independent builder who prepared a written estimate of the cost
of repairing the building.
Atlas raised questions about the validity of the contents
claim as initially submitted because certain items claimed
thereon appeared duplicative of earlier losses submitted in
connection with a previous incident or otherwise appeared
unfounded. As a result of concerns expressed by Atlas,
petitioner’s adjuster submitted a revised inventory that reduced
the contents damage claim from $172,177 to $70,095. The damage
claim with respect to the building remained $68,365.
Atlas subsequently requested a sworn proof of loss, which
petitioner’s adjuster submitted on his behalf in October 1994.
The sworn proof of loss included the revised inventory claim of
$70,095 and the original claim for damage to the building of
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$68,365, totaling $138,460 less a deductible of $1,000.
Sometime during the fall of 1994, the zoning and building
official for the Borough of West Conshohocken, William Keil,
learned of the roof collapse. After inspecting the south
building, Mr. Keil determined that the collapse required the
western section of the south building to be either promptly
repaired or demolished. Mr. Keil also determined that the middle
and eastern sections of the south building were not affected by
the collapse and did not require immediate repair or removal.
However, Mr. Keil believed that, independent of the collapse of
the roof of the western section, the roofs of the middle and
eastern sections were not safe for persons to stand on, and he
notified the borough fire chief that, in the event of a fire in
the south building, firemen should not go onto the roof of, or
into, any section of the south building. Nonetheless, during a
later visit to the Property, Mr. Keil observed a landscape
contractor using the middle section of the south building for
equipment storage.
In accordance with his inspection of the south building, in
a letter dated November 17, 1994, Mr. Keil informed petitioner
that petitioner was required to repair or remove the damaged
section of the south building within 30 days of the receipt of
the letter. Mr. Orloff replied to Mr. Keil in a letter dated
December 21, 1994, indicating that petitioner intended to restore
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the building to a safe condition upon receipt of insurance
proceeds from Atlas. Mr. Orloff further indicated that appraisal
was being sought with respect to the insurance claim. Mr. Orloff
believed the 30-day limit prescribed by the November 17 letter
was not likely to be strictly enforced.
At some point during 1994, Atlas offered petitioner $22,000
for damage to the south building, but nothing for the contents;
petitioner rejected this offer. After the offer was rejected,
petitioner requested an “appraisal”, a formal procedure
authorized in the insurance policy designed to resolve
disagreements between insurer and insured as to the amount of
damages from a particular loss. In this procedure, each party to
the insurance policy nominates an appraiser, and the two
appraisers select an independent party who reaches a value of the
loss binding on both parties. From December 1994 until at least
February 1995, petitioner made repeated requests for appraisal.
Atlas did not respond to those requests, and informed petitioner
in February 1995 that petitioner’s claim was not ripe for
appraisal, primarily because Atlas had concluded that petitioner
was not entitled to coverage at all under the policy.
In March 1995, William Stewart (Mr. Stewart), an attorney
representing Atlas, conducted an examination under oath of
petitioner with respect to his claim for coverage arising from
the roof collapse. After the examination, in a letter to
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petitioner in May of 1995, Mr. Stewart informed petitioner that
Atlas was denying coverage. This letter (denial letter) alleges,
as the primary reason for denying coverage, that Julicher Sports
or its representatives had misrepresented or concealed material
facts concerning the loss. The denial letter further alleges
that, among other things, Julicher Sports overvalued, and
overstated the quantity of, the damaged property, misrepresented
the obsolescence of damaged property, and misrepresented the
condition of the building prior to the collapse. In addition to
misrepresentation, the denial letter alleges other grounds for
denying coverage, including certain exclusions in the policy and
the policy’s coinsurance provision.
Following the denial letter, on or about July 24, 1995,
petitioner and Julicher Sports initiated a lawsuit against Atlas
in Federal District Court. The complaint filed in the lawsuit
asserts that the value of plaintiffs’ loss due to the roof
collapse was $138,4606 and claims damages of $137,460 (the
asserted value of the loss minus $1,000 deductible).
Atlas, through Mr. Stewart, responded by filing an answer to
the complaint, a counterclaim against petitioner and Julicher
Sports, and joinder complaints against unrelated third parties.
6
Although the complaint does not describe how this amount
was determined, we note that it is the same as in the sworn proof
of loss; i.e., the sum of the second contents claim of $70,095
and the original claim for damage to the building of $68,365.
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The answer lists nine affirmative defenses, most of which follow
along the lines of the reasons for denial provided in the denial
letter. The lawsuit was eventually settled by agreement of all
the parties thereto.7 In the settlement, no party admitted or
conceded liability, and no damages were awarded.
The western portion of the south building was torn down in
1996. The middle and eastern portions of the south building were
not torn down.
Petitioner filed his 1994 Federal income tax return (the
1994 return) on April 26, 1996. The 1994 return was due to be
filed on October 15, 1995. Petitioner’s accountant, Charles
Finder, began preparing the 1994 return sometime in 1995. In
November or December 1995, petitioner gave Mr. Finder a document
for use in preparing the 1994 return. This document provides
brief descriptions of some of the buildings on the Property, and
claims that two masonry buildings, exceeding 50 years of age and
with a combined value of approximately $154,000, were damaged by
the collapse in 1994. It further claims that the value of the
damaged buildings after the collapse was zero. Mr. Finder relied
on the document in preparing the 1994 return. On Form 4684,
Casualties and Thefts, of the 1994 return, petitioner claimed a
casualty loss in connection with the collapse. The Form 4684
7
The record does not disclose the date of the settlement.
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states a basis for the damaged building of $155,836 and states
that the fair market value of the damaged building before
casualty was $154,000, and after casualty was $0.8 The Form 4684
claims a total casualty loss of $155,836.9
Respondent’s examination in the instant case commenced prior
to July 22, 1998. During the examination, Mr. Finder submitted
the document petitioner had given him to the revenue agent
conducting the examination to support the claimed deduction.
In the notice of deficiency, respondent determined that
petitioner was not entitled to the claimed loss deduction because
he did not (1) establish the decrease in the fair market value of
the Property as a result of the roof collapse, (2) establish his
adjusted basis in the Property, and (3) provide documentation to
support the claimed deduction.
Bad Debt Deduction (Ms. Weinstein)
In addition to leasing buildings to his corporation,
petitioner also leased real property to successive businesses
owned by Rose Weinstein (Ms. Weinstein), a professional tennis
instructor. The businesses operated swim and tennis clubs.
The businesses paid annual rents to petitioner ranging from
8
The record does not reflect how these figures were
generated.
9
Because the building was alleged to have been totally
destroyed, the Form 4684 uses the stated basis as the casualty
loss deduction, even though that amount exceeded the stated value
of the south building of $154,000. See sec. 1.165-7(b)(1)(ii),
Income Tax Regs.
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$60,000 to $80,000, including $60,000 in 1994. One of these
businesses, a corporation called Indian Falls Racquet Club
(Indian Falls), experienced financial difficulties soon after it
opened. Ms. Weinstein borrowed money from petitioner in order to
keep Indian Falls running.
Petitioner lent the money in installments of irregular
amounts at irregular intervals, over a period of approximately 8
months. There was no formal agreement as to the terms of a
loan; rather, it was understood that Ms. Weinstein would pay back
the amounts as soon as possible. She did not pay back any of the
amounts, and petitioner continued lending additional amounts
until the total grew to $44,000. Eventually, on August 23, 1989,
she and petitioner formalized the existence of the debt and
established a repayment schedule with a document entitled “Loan
Agreement”. The Loan Agreement provides for a loan from
petitioner to Ms. Weinstein of $44,000 for a period of 3 years at
10 percent interest.
Indian Falls was a seasonal business, opening April 1 and
closing after Labor Day each year. At the end of each season up
to and including 1993, Ms. Weinstein did not make a profit from
Indian Falls, and the income she received from offering tennis
lessons (separate from Indian Falls’s business) was sufficient
only to maintain her standard of living. In each year from 1989
through 1993, after the close of Indian Falls for the season, Ms.
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Weinstein told petitioner she was insolvent and that she could
not repay the loan.
In January of each year, Ms. Weinstein sought additional
funding in order to maintain the financial condition of Indian
Falls to ensure it could open in April. In January 1994,
however, Ms. Weinstein was unable to obtain the additional
funding necessary to open in the spring. Thus, Indian Falls
ceased doing business in January 1994. However, in July 1994 Ms.
Weinstein obtained sufficient funding to begin a new business
operating a swim and tennis club, which was essentially the same
business as Indian Falls, operating at a different site. This
business was operating as of the end of 1994. At some point
during 1994, petitioner told Ms. Weinstein that if she did not
pay him the $44,000 she owed, he might sue her to recover.
On Schedule E, Supplemental Income and Loss, of the 1994
return, petitioner reported rental income of $143,059, a portion
of which was received from Ms. Weinstein. Also, on Schedule E,
petitioner claimed a bad debt deduction of $44,000 by listing
that amount as an item of expense with respect to the rental
income.10
10
Petitioner’s accountant, Mr. Finder, believed it was
correct to claim the bad debt deduction on the schedule reporting
the rental income from Ms. Weinstein’s business, since the bad
debt, in his view, was directly related to rental operations.
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In the notice of deficiency, respondent determined that
petitioner was not entitled to the claimed bad debt deduction
because he did not (1) establish a business purpose for the loss,
(2) show that the loss resulted from a bad debt and in particular
his bad debt, and (3) show that all reasonable steps were taken
to collect the debt.
Bad Debt Deduction (Attieh Bros.)
In 1987 Julicher Sports was engaged by Attieh Bros. Co.
(Attieh Bros.), a family-owned business in Amman, Jordan, to
install the rink and other flooring materials for a skating rink
called the Skating Palace in Amman. Attieh Bros. paid Julicher
Sports approximately $150,000 for the installation. Petitioner
developed a close relationship with the Attieh family, in
particular the brothers Thair and Nidal Attieh and their father
Raouf, and soon he was treated as if he were a member of the
family. Raouf was a commercial attaché for the Jordanian
Government with ties to the King of Jordan, and petitioner felt
he would be a valuable business contact in Jordan.
On October 15, 1989, petitioner individually (i.e., not
Julicher Sports) and Attieh Bros. entered into a loan agreement
(First Loan Agreement) whereby petitioner would lend Attieh Bros.
$50,000 for a period of 5 years, to be repaid on or before
October 15, 1994. The money was to be used to add a franchise
restaurant to the Skating Palace. The First Loan Agreement
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provides for 25 percent interest per year and calls for quarterly
payments of interest only (i.e., no principal) in the amount of
$3,125 beginning January 15, 1990, and ending at the end of the
loan term, October 15, 1994. The First Loan Agreement also
provides for fees in the event of late payments.
At some point after January 15, 1990, Attieh Bros. made the
first payment called for by the First Loan Agreement. Sometime
around March 1990, members of the Attieh family asked petitioner
to lend Attieh Bros. an additional $20,000. Petitioner agreed,
and he sent Nidal Attieh a letter dated March 28 outlining the
terms of a new agreement under which the $20,000 would be added
to the previous principal of $50,000. Petitioner subtracted from
the $20,000 certain amounts, totaling $8,000, that he felt were
owed him: $3,925 for video games he had purchased on behalf of
Attieh Bros.; $3,125 for the next quarterly payment under the
First Loan Agreement, which was due April 15, 1990; and $950 in
late fees and interest arising from the untimeliness of the
January 15, 1990, quarterly payment. At some point in late March
or early April, petitioner sent Attieh Bros. the additional
$12,000.
On April 2, petitioner and Attieh Bros. entered into a loan
agreement (Second Loan Agreement) that replaced and superseded
the first, providing for a principal amount of $70,000 (original
$50,000 plus additional $20,000), with an interest rate of 25
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percent per year and a term of 5 years ending April 15, 1995.
The Second Loan Agreement calls for quarterly payments of
interest in the amount of $4,375, plus concurrent quarterly
payments of principal in the amount of $3,500, for a total of
$7,875 each quarter. The first such payment was due July 15,
1990.
Neither Attieh Bros. nor the Attiehs made this payment or
any other payment due under the Second Loan Agreement, with the
exception of $1,500 paid to petitioner in July 1991. Beginning
July 31, 1990, and continuing periodically for the next several
years, petitioner sent telefax correspondence to Thair, Nidal, or
Raouf Attieh inquiring about the lack of payment and requesting
payment.11 The Attiehs replied sometimes with explanations for
their failure to pay (such as the Gulf War, which, according to
the correspondence, reduced business and limited the ability to
transfer money out of Jordan) and sometimes with promises to
begin paying after money became available from a new source, such
as the sale of property.12 The correspondence reflects
petitioner’s mounting frustration at receiving virtually no
payments on the loan.
11
The record contains seven faxes from petitioner in 1990,
two in 1991, seven in 1992, and one in 1993. The record contains
no faxes sent in 1994 or later.
12
The record contains four faxes from the Attieh family in
1990, five in 1991, two in 1992, and two in 1993. The record
contains no faxes sent in 1994 or later.
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From the period the loan was made through the year in issue,
the Attiehs advised petitioner that they intended to repay the
loan. In a fax dated August 3, 1993, Thair informed petitioner
that the Attiehs would begin paying $2,000 per month starting
September 15, 1993, which was repeated in a fax dated August 19,
1993. During this period and through the time of trial, Thair
and petitioner spoke often on the telephone. Petitioner remained
in a close personal relationship with the Attiehs and
occasionally sought further business dealings with them.
The Skating Palace operated as a going concern until at
least 1998.
On the 1994 return, petitioner claimed a bad debt deduction
of $70,000. In the notice of deficiency, respondent determined
that petitioner was not entitled to the claimed bad debt
deduction because he did not (1) establish a business purpose for
the loss, (2) show that the loss resulted from a bad debt and in
particular his bad debt, and (3) show that all reasonable steps
were taken to collect the debt.
Joint Filing Status
On their 1993 joint Federal income tax return, petitioner
and his wife at the time Margit Julicher (Mrs. Julicher) selected
“married filing joint” status. Petitioner, Mrs. Julicher, and
Mr. Finder (as return preparer) signed the 1993 return. On the
1994 return, petitioner selected “married filing separate”
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status. Petitioner and Mr. Finder (as return preparer) signed
the 1994 return.
In late 1997 or early 1998, during the examination of
petitioner’s 1994 taxable year, Mr. Finder, petitioner’s
authorized representative before the Internal Revenue Service,
met with the revenue agent conducting the examination, Venita
Lucas. In one of the meetings, which took place before February
6, 1998, Mr. Finder raised an issue with respect to a net
operating loss carryback deduction. Mr. Finder discussed the net
operating loss with Ms. Lucas, and Ms. Lucas requested from Mr.
Finder a Form 1040 (1994 Form 1040) to be used in claiming the
net operating loss deduction. Mr. Finder tendered the requested
1994 Form 1040, and Ms. Lucas informed him that he should
consider it filed. The 1994 Form 1040 reflects a filing status
of “married filing joint”. The “label” field of the 1994 Form
1040 contains petitioner and Mrs. Julicher’s names, and both
petitioner’s and Mrs. Julicher’s Social Security numbers are
contained on the 1994 Form 1040. Mr. Finder said nothing to Ms.
Lucas with respect to the “married filing joint” filing status of
the 1994 Form 1040. The 1994 Form 1040 was not signed by
petitioner, Mrs. Julicher, or Mr. Finder, and contains no
inscription to the effect of its being an amended return.
The notice of deficiency in this case was issued to
petitioner only. Attached to the notice was Form 4549, Income
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Tax Examination Changes, prepared by Ms. Lucas and dated March 6,
1998. The Form 4549 used “Married - Separate” filing status in
computing the amount of the adjustments to income.
OPINION
Respondent’s Motion To Amend the Pleadings
At the conclusion of the trial, respondent moved to amend
the pleadings to conform to the evidence under Rule 41(b)(1). In
his motion, respondent argues that he should be permitted to
assert a fraud penalty under section 6663 against petitioner on
the basis that the issue of fraud had been tried by consent of
the parties. Respondent contends that petitioner committed fraud
by claiming a casualty loss deduction to which he knew he was not
entitled, by falsely claiming that the Property’s south building
had been completely destroyed and providing false information
regarding the building’s value. We shall deny respondent’s
motion to amend the pleadings.
The granting of a motion to conform the pleadings to the
evidence is within the discretion of the Court, tempered by sound
reason and fairness. Federated Graphics Cos. v. Commissioner,
T.C. Memo. 1992-347. Our review of the entire record in this
case convinces us that respondent was aware before trial of the
essential facts upon which his assertion of fraud is based. This
is demonstrated by an examination of respondent’s specific
allegations. Respondent relies primarily on the document
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petitioner gave to his accountant in support of the claimed
casualty loss deduction. Respondent notes petitioner’s claim in
the document of a loss of about $156,000 resulting from damage to
two buildings that rendered them completely useless, compared
with petitioner’s claim in the lawsuit against Atlas of a loss of
about $68,000 resulting from damage to one building. However,
respondent discussed this discrepancy in his trial memorandum,
which was served on petitioner more than 2 weeks before trial.
As further support for fraud, respondent cites the
discrepancy between petitioner’s claim in the document given to
his accountant that the Property’s two masonry buildings were
over 50 years old and rendered useless by the collapse, with
petitioner’s claim in a document given to the local board of
property assessment appeals (before the collapse) that the same
buildings were over 100 years old and not safe for use. However,
respondent almost certainly had both documents before trial. The
document petitioner gave his accountant had, at a minimum, been
exchanged prior to trial,13 and the document given to the board
of assessment appeals was mailed to respondent’s counsel more
than 2 weeks before trial.
13
Respondent did not cite any failure to receive this
document in advance of trial when petitioner sought to have it
admitted, whereas respondent did object to several other
documents on this ground.
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Respondent also cites the discrepancy between (i)
petitioner’s claim in the document given to his accountant and in
his petition that the buildings in issue were valuable before,
and useless after, the claimed casualty, and (ii) the testimony
of Mr. Keil, the building inspector, to the effect that the
buildings in question were being used after the roof collapse.
But Mr. Keil was respondent’s witness, and his testimony was
characterized in respondent’s trial memorandum as concerning the
buildings’ condition before and after the claimed casualty. Thus
respondent knew prior to trial that he had an independent witness
to contradict petitioner’s various assertions that the buildings
were rendered useless by the claimed casualty.
We conclude that the essential facts on which respondent
bases his allegations of fraud were known to respondent’s counsel
prior to trial. Under the circumstances of this case, the
failure to give notice to petitioner that he was required to
defend against fraud results in significant prejudice. Cf.
Pallante v. Commissioner, T.C. Memo. 1989-334 (counsel for
respondent sought amendment to pleadings to assert fraud after
trial, based on facts known prior to trial). While there is
evidence in the record that might support a finding that
petitioner committed fraud, petitioner was entitled to notice and
an adequate opportunity to rebut respondent’s evidence.
Accordingly, respondent’s motion to amend is denied.
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Casualty Loss Deduction
Respondent determined that petitioner is not entitled to a
casualty loss deduction of $155,836 claimed on the 1994 return.
We sustain respondent’s determination for the reasons discussed
below.
Section 165(a) permits a deduction for “any loss sustained
during the taxable year and not compensated for by insurance or
otherwise.” There is no question that the collapse of a portion
of the roof of the south building occurred in 1994 and was not
compensated for by insurance or otherwise. However, the
deduction under section 165 is allowed only for the year in which
the loss is “sustained”, as defined in section 1.165-1(d), Income
Tax Regs. Because we find that the loss in the instant case was
not sustained in 1994, the only year before us, we conclude the
deduction is not allowable in that year.
A loss is sustained when it is evidenced by closed and
completed transactions and fixed by identifiable events. Sec.
1.165-1(d)(1), Income Tax Regs. If the taxpayer has a claim for
reimbursement of a casualty loss and there is a reasonable
prospect of recovery, the casualty loss is not sustained until it
can be ascertained with reasonable certainty whether or not the
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reimbursement will be received. Sec. 1.165-1(d)(2)(i), Income
Tax Regs.14
Petitioner had a claim for reimbursement in this case. The
buildings were insured for replacement costs of up to $852,000
and petitioner had submitted a claim that was pending as of the
close of the taxable year at issue.15 Thus, we must decide
whether petitioner had a reasonable prospect of recovery.
Whether the taxpayer has a reasonable prospect of recovery is a
question of fact. Boehm v. Commissioner, 326 U.S. 287, 292-293
(1945); Estate of Wagner v. Commissioner, T.C. Memo. 1998-338.
We rely on objective facts primarily, but the taxpayer’s
14
Respondent disputes whether the roof collapse was a
casualty within the meaning of sec. 165, arguing that the
collapse resulted from the slow deterioration of the roof
trusses, and thus lacked the requisite suddenness to qualify as a
casualty. See Maher v. Commissioner, 76 T.C. 593 (1981), affd.
680 F.2d 91 (11th Cir. 1982). Neither party produced admissible
expert testimony on the cause of the collapse. Assuming arguendo
that the collapse constituted a casualty, it still must be shown
that there was no reasonable prospect of recovery during the year
in issue before petitioner would be entitled to the claimed
deduction. Because we hold that there was a reasonable prospect
of recovery during the year in issue, we need not, and do not,
decide whether the collapse was a casualty.
15
Although Julicher Sports, rather than petitioner, was the
named insured, petitioner does not argue that he had no claim for
reimbursement and therefore that he, as the only petitioner in
the instant case, should be entitled to a casualty loss
deduction. Indeed, petitioner owned the building and joined in
the lawsuit against Atlas. Moreover, Mr. Stewart, Atlas’s
attorney during the investigation of the claim, testified that
Atlas would have been “hard pressed” to deny coverage to
petitioner on the ground that he was not the named insured, since
his name was on the insurance policy in conjunction with the name
of Julicher Sports.
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subjective beliefs are also relevant. Estate of Wagner v.
Commissioner, supra; see Boehm v. Commissioner, supra; see also
Ramsay Scarlett & Co. v. Commissioner, 61 T.C. 795, 812 (1974),
affd. 521 F.2d 786 (4th Cir. 1975). Denial of liability by an
insurance company is one factor in deciding whether a reasonable
prospect of recovery exists, but not the sole factor. Gale v.
Commissioner, 41 T.C. 269, 276 (1963). The fact that a taxpayer
files a lawsuit to recover the loss gives rise to an inference of
a reasonable prospect of recovery. Dawn v. Commissioner, 675
F.2d 1077, 1078 (9th Cir. 1982), affg. T.C. Memo. 1979-479.
The evidence in this case shows that petitioner had a
reasonable prospect of recovery in 1994 with respect to his
claimed casualty loss. Although Atlas developed suspicions
regarding petitioner’s contents claim, Atlas sought a sworn proof
of loss in October 1994. At some point Atlas offered $22,000
with respect to the damage to the building. Petitioner rejected
it and was seeking to invoke an appraisal as of December 1994.
On December 21, petitioner intended to make repairs to the
building once the insurance proceeds were received. Petitioner
was still pursuing his claim in March 1995, when he gave
testimony in an examination under oath with a representative of
Atlas. There was no denial of coverage by Atlas until May 1995.
Further, petitioner and Julicher Sports filed suit against Atlas
in July 1995, asserting that petitioner was entitled to $137,460,
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a figure that encompassed his claim of damage to the building.16
Atlas filed its answer and counterclaims in August of that year.
Some time thereafter, the lawsuit was settled, with no damages
awarded.17
Based on the foregoing, we find that not only did petitioner
believe he had a reasonable prospect of recovery at the end of
1994, he in fact had a reasonable prospect of recovery with
respect to the building damage at the end of that year. Thus, we
sustain respondent’s disallowance of the deduction for 1994.
Depreciation Deduction
Petitioner claimed a depreciation deduction with respect to
the Property’s buildings of $4,179 for 1994. In an amendment to
answer, respondent asserted an increase in deficiency on the
ground that petitioner was not entitled to the claimed
depreciation. Respondent concedes he has the burden of proof on
this issue. See Rule 142(a). We hold that petitioner is
entitled to the depreciation deduction as claimed.
In support of his position, respondent argues that
petitioner improperly allocated basis between the Property’s
16
As noted in our Findings of Fact, the amount claimed by
petitioner in the lawsuit against Atlas is the sum of the repairs
estimated for the building ($68,365) and the amount of contents
damage asserted in the second claim ($70,095). Thus,
petitioner’s averments included a claim for compensation with
respect to damage to the building.
17
The date of the settlement is not in the record, although
it clearly occurred sometime after August 1995.
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buildings and land. When depreciable and nondepreciable property
are acquired together for a lump-sum purchase price, the
regulations under section 167 require basis to be apportioned
based on relative value at the time of purchase. Sec. 1.167(a)-
5, Income Tax Regs. Under the regulation, the ratio of (i) the
portion of the purchase price allocated as basis of the
depreciable property to (ii) the total purchase price cannot
exceed the ratio of (a) the value of the depreciable property to
(b) the value of the entire property. Id. Of the total purchase
price of $393,378, petitioner allocated $285,619 as basis in the
depreciable property, i.e., the buildings; thus, under
petitioner’s allocation the value of the buildings equaled
approximately 73 percent ($285,619 ÷ $393,378) of the value of
the whole. Respondent’s argument is that the value of the
buildings was proportionally less. We find that respondent has
failed to carry his burden of proof.
Respondent has not presented any appraisals or other
specific evidence of the value of the buildings and land at the
time petitioner purchased the Property. Rather, respondent
relies on more general evidence to cast doubt on petitioner’s
allocation, such as the fact that in 1988 (the year petitioner
acquired the Property), petitioner was issued a citation because
a portion of the south building was at risk of collapse.
Respondent’s argument, essentially, is that the buildings had
- 29 -
little to no value and that petitioner bought the Property
solely, or primarily, for the land.
There is substantial independent evidence demonstrating that
respondent’s basic premise, that the buildings had little to no
value when acquired, is wrong. A loan officer for the bank
extending a $500,000 loan for petitioner’s purchase of the
Property recommended approval of the loan, on the grounds that
the buildings, although “old” and in “need of repair”, could be
rehabilitated to produce rental income to service the debt.
Moreover, in 1993 an unrelated insurer issued a policy providing
$852,000 in coverage for the buildings, and there was no evidence
of substantial capital improvements to the buildings between the
time of their acquisition by petitioner in 1988 and the issuance
of the policy. We believe it is unlikely an insurer would have
extended coverage of this magnitude for buildings of negligible
value. In addition, the land contained steep slopes and a flood
plain and was subject to maintenance and access easements held by
petitioner’s neighbor, the combination of which would suggest
that any attempt to use the land in a configuration other than
the one existing at the time would require considerable capital
investment. Given the lack of evidence of relative value offered
by respondent, we conclude that respondent has failed to carry
his burden of showing that petitioner is not entitled to the
depreciation deduction in the amount claimed on the 1994 return.
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Bad Debt Deductions-–Weinstein and Attieh Bros.
Petitioner claimed bad debt deductions for the amounts lent
to Ms. Weinstein and Attieh Bros. In the notice of deficiency,
respondent disallowed both deductions. Petitioner has the burden
of proof. Rule 142(a).18 We sustain respondent’s determination
on the ground that petitioner has not carried his burden of
proving that the debts became worthless during the year in issue.
The initial step in establishing entitlement to a bad debt
deduction is proof of a bona fide debtor-creditor relationship
that obligates the debtor to pay a fixed or determinable amount.
Calumet Indus., Inc. v. Commissioner, 95 T.C. 257, 284 (1990);
sec. 1.166-1(c), Income Tax Regs. A gift or contribution to
capital is not a debt. Calumet Indus., Inc. v. Commissioner,
supra; sec. 1.166-1(c), Income Tax Regs. We find that the loans
at issue were genuine debts. In both cases, loan agreements
providing for interest payments evidenced the existence of the
debts. See Lerma v. Commissioner, T.C. Memo. 1995-586; sec.
1.166-1(c), Income Tax Regs. Moreover, Ms. Weinstein’s business
and Attieh Bros. were going concerns at the time the loans were
made. See Lerma v. Commissioner, supra. Finally, the
communications between both Ms. Weinstein and the Attiehs and
18
Sec. 7491 does not apply to this case because the
examination commenced prior to July 22, 1998, the effective date
of that section. See Internal Revenue Service Restructuring and
Reform Act of 1998, Pub. L. 105-206, sec. 3001(c)(1), 112 Stat.
726.
- 31 -
petitioner indicate that the parties to the loans intended
genuine debts. See id.
In order to be entitled to a bad debt deduction, petitioner
must prove that each debt had value at the beginning of 1994 and
became worthless during that year. Milenbach v. Commissioner,
106 T.C. 184, 204 (1996). There is no standard method to decide
worthlessness within the taxable year; rather, each case depends
on all its facts and circumstances. Id.; Crown v. Commissioner,
77 T.C. 582, 598 (1981). The year of worthlessness is generally
fixed by identifiable events that form the basis for reasonable
grounds for abandoning any hope of recovery. Milenbach v.
Commissioner, supra at 205; Crown v. Commissioner, supra at 598.
As for the Weinstein debt, we find petitioner has failed to
prove that any part of it became worthless during 1994. In
testimony, petitioner justified claiming the deduction in 1994
merely on the basis that it had been 5 years since he had made
the loan. However, “the fact that accounts are overdue, standing
alone, does not warrant deducting them as worthless.” Milenbach
v. Commissioner, supra at 205. Petitioner pointed to no
identifiable event that provided reasonable grounds for
abandoning hope of recovery of even a part of the debt in 1994.
Ms. Weinstein testified that she paid $60,000 in rent to
petitioner in 1994, and Mr. Finder recalled that Ms. Weinstein’s
rent payments made up “the bulk” of the $143,059 in rental income
- 32 -
reported as one line item on the 1994 return. That rent was well
in excess of the $44,000 debt Ms. Weinstein owed petitioner,
suggesting her ability to pay. Moreover, even if Ms. Weinstein’s
successive businesses were “insolvent” at the end of each season,
as she told petitioner, she maintained the businesses as going
concerns, providing an apparent source from which to pay the
debt. Cf. Riss v. Commissioner, 56 T.C. 388, 408 (1971) (even
where liabilities of business exceed assets, fact that it
continues to operate as going concern is evidence that its debts
are not uncollectible), affd., revd. and remanded on another
issue 478 F.2d 1160 (8th Cir 1973), affd. sub nom. Commissioner
v. Transport Manufacturing & Equip. Co., 478 F.2d 731 (8th Cir.
1973). As respondent points out on brief, the fact that Ms.
Weinstein’s business, Indian Falls, failed in 1994, which might
suggest that she no longer had a source of income to pay the
debt, see Bowman v. Commissioner, T.C. Memo. 1995-259, is
unavailing to petitioner here: Ms. Weinstein began a new
business in July 1994. Thus, not only has petitioner failed to
point to an identifiable event indicating the debt was
uncollectible, the evidence shows that Ms. Weinstein had sources
from which to pay the debt. Petitioner has failed to prove the
Weinstein debt became worthless in 1994, and we sustain
respondent’s disallowance of the bad debt deduction.
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As for the Attieh Bros. debt, we reach the same conclusion.
Petitioner has not shown any identifiable event that occurred in
1994 which demonstrates the Attieh Bros. debt would not be
repaid.19 The most significant factor in our reaching this
conclusion is the fact that the Skating Palace continued to
operate as a going concern throughout 1994. See Riss v.
Commissioner, supra. Petitioner twice on brief cites the failure
of the Attieh Bros.’ business in support of his bad debt claim,
but the record establishes that the Skating Palace continued
operation until at least 1998.
In addition, we find it remarkable that the extensive
written correspondence, i.e., faxes, between petitioner and the
Attiehs concerning the loan and its repayment ends abruptly in
August 1993. The volume of this correspondence before 1993
demonstrates that it was petitioner’s and the Attiehs’ well-
established practice to communicate by fax concerning the loan.
They exchanged at least 11 such faxes in 1990, 7 in 1991, and 9
in 1992. Yet petitioner produced no faxes subsequent to an
19
Respondent disputes the amount of the debt, arguing (1)
that a portion of the $20,000 second loan amount was not part of
the debt since it was held back to pay amounts already owed by
the Attiehs to petitioner and (2) that a portion of both the
$50,000 original loan and the $20,000 second loan was equipment
rather than cash, and that petitioner, having failed to prove his
basis in the equipment, would be denied a deduction under sec.
166(b). Because we hold the entire bad debt deduction to be
disallowed because petitioner has not proven worthlessness during
the year in issue, we do not address these arguments.
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August 19, 1993 fax (in which the Attiehs represent that a
payment will be made in September). While it is clear that
petitioner and the Attiehs remained in close contact through the
time of trial, petitioner would have us believe that all contact
with the Attiehs after the August 19, 1993, fax was oral only.
On this record, we do not believe that the fax correspondence
between petitioner and the Attiehs ceased in August 1993. See
Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). We can conclude
only that petitioner was either unable or unwilling to produce
later faxes that might bear more directly on the prospects for
recovery in 1994.20 Petitioner bears the burden of proving that
the Attieh Bros. loan became worthless in 1994. The last piece
of documentary evidence shows that the Attiehs were still
attempting to make repayment arrangements into September of 1993.
Even if we believed no later faxes were sent, the testimony given
by petitioner and Thair is too vague to provide any basis to
conclude that the situation as documented in August 1993
specifically changed in 1994. On this record, we conclude that
petitioner has failed to show that the Attieh Bros. loan became
worthless in 1994.
20
The numerous instances in the record where petitioner
gave conflicting statements in connection with the casualty loss
have damaged his credibility with respect to all issues in the
case.
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Accordingly, we sustain respondent’s determination
disallowing the bad debt deductions claimed by petitioner in
1994.
Filing Status
Petitioner argues that he is entitled to joint filing status
(and the rates under section 1(a)) in accordance with section
6013(b), because the 1994 Form 1040 constitutes a joint income
tax return filed by petitioner and Mrs. Julicher after he filed
separately for taxable year 1994.21 Respondent argues that the
1994 Form 1040 relied on by petitioner is not a valid joint
return and consequently that petitioner did not elect to make a
joint return prior to the issuance of the notice of deficiency.22
We agree with respondent.
Section 6013 in general entitles married taxpayers to make a
joint income tax return. See sec. 6013(a). Section 6013(b)(1)
further provides that even where a taxpayer has filed a separate
21
Petitioner also argues that, because he elected to make a
joint return under sec. 6013(b), the notice of deficiency is
invalid because it was sent to him alone. Because we conclude
herein that petitioner has not validly elected to make a joint
return under that section, this argument is likewise without
merit.
22
Respondent also asserts that this issue was not raised on
a timely basis by petitioner but concedes there is no prejudice
to him so long as the parties’ stipulation characterizing the
1994 Form 1040 as an “amended return” is not treated as binding
on respondent for purposes of this issue. Since petitioner has
not sought to rely on the stipulation for this purpose, we find
no prejudice and shall decide the issue.
- 36 -
return for a taxable year and the time prescribed for filing has
expired, the taxpayer may nevertheless make a joint return with
his or her spouse, subject to specified limitations. One such
limitation is that the election to make a joint return may not be
made after a notice of deficiency for the year at issue has been
mailed to either spouse, if the spouse files a timely petition
with the Tax Court. Sec. 6013(b)(2)(C). A joint return filed
pursuant to section 6013(b)(1) constitutes the spouses’ return
for the taxable year. Sec. 6013(b)(1).
Petitioner argues that the submission of the 1994 Form 1040
by his authorized representative to the revenue agent examining
his 1994 taxable year, where the agent requested that it be
submitted to her and represented that it should be considered
filed, coupled with the failure of the Internal Revenue Service
subsequently to advise petitioner that the 1994 Form 1040 had not
been accepted, should constitute an election to make a joint
return under section 6013(b). We hold that no election was made,
because the 1994 Form 1040 was not a valid joint return.
Entitlement to joint filing status requires the filing of a
valid joint return. Thompson v. Commissioner, 78 T.C. 558
(1982). A return that is not signed by either spouse, as in the
instant case, is not a valid return. Olpin v. Commissioner, 270
F.3d 1297, 1300 (10th Cir. 2001), affg. T.C. Memo. 1999-426.
Thus, regardless of whether the submission of the 1994 Form 1040
- 37 -
to the examining agent herein constitutes filing, the document is
not a valid joint return. Cf. Olpin v. Commissioner, supra
(unsigned joint return is invalid return even though IRS had
treated it as filed, processed it as joint return, and accepted
payment of liability reflected thereon). Since the unsigned 1994
Form 1040 is not a valid return, petitioner failed to elect to
make a joint return prior to the issuance of the notice of
deficiency in this case. See sec. 6013(b)(2)(C).23
Petitioner appears to argue that various actions and/or
inactions24 by Internal Revenue Service personnel should
constitute a waiver of the signature requirement. However, the
signature requirement for purposes of a valid joint return may
not be waived by Internal Revenue Service personnel. Olpin v.
Commissioner, supra at 1301 (“acceptance cannot cure an invalid
return”); see also Lucas v. Pilliod Lumber Co., 281 U.S. 245
23
Sec. 6013(b)(2)(C) is currently codified as sec.
6013(b)(2)(B), effective for taxable years beginning after July
30, 1996. Taxpayer Bill of Rights 2, Pub. L. 104-168, sec.
402(a), 110 Stat. 1459 (1996).
24
In addition to the arguments already noted, petitioner
contends that the Internal Revenue Service failed to advise him
that his attempt to claim joint filing status had not been
accepted. In response, respondent points to the Form 4549,
Income Tax Examination Changes, prepared by the revenue agent and
dated Mar. 6, 1998, which is attached to the notice of
deficiency. Respondent contends that the Form 4549, which
employed a “Married - Separate” filing status, put petitioner on
notice that his claim of joint filing status had not been
accepted. The record in this case, however, does not establish
that the Form 4549 was provided to petitioner prior to the
mailing of the notice of deficiency.
- 38 -
(1930) (signature requirement may not be waived by IRS personnel
for purposes of statute of limitations); Bachner v. Commissioner,
81 F.3d 1274, 1279-1280 (3d Cir. 1996) (to same effect); Doll v.
Commissioner, 358 F.2d 713, 714 (3d Cir. 1966) (to same effect
where purported joint return lacked signature of either spouse),
affg. T.C. Memo. 1965-191.
Thus, we are satisfied that the 1994 Form 1040 was not a
valid joint return, the notice of deficiency was properly issued
to petitioner alone, and petitioner is not entitled to the income
tax rates applicable to joint filers.
Addition to Tax and Accuracy-Related Penalty
In the notice of deficiency respondent determined an
addition to tax under section 6651(a)(1) and an accuracy-related
penalty under section 6662(a). In both his petition and his
amended petition, petitioner assigned error with respect to
respondent’s determination of the deficiency, but he did not do
so with respect to either the addition to tax or the accuracy-
related penalty. Respondent, in a letter to petitioner
initiating informal discovery before trial, and also in his trial
memorandum, stated that these issues would be treated as conceded
by petitioner because they were not mentioned in the petition.
See Rule 34(b)(4). Petitioner, in his trial memorandum, asserted
that the addition to tax and accuracy-related penalty were in
dispute. Nonetheless, petitioner, on brief, still did not
- 39 -
address either the addition to tax or the accuracy-related
penalty.25 Thus, either because of petitioner’s failure to
assign error to these determinations in the petition, Rule
34(b)(4), or because petitioner has abandoned the issue on brief,
see Zidar v. Commissioner, T.C. Memo. 2001-200 (citing Bradley v.
Commissioner, 100 T.C. 367, 370 (1993)), we sustain respondent’s
determinations.
An Order and Decision will be entered denying respondent’s
oral motion to conform the pleadings to the proof, and decision
will be entered for respondent with respect to the deficiency,
addition to tax, and accuracy-related penalty, as set forth in
the notice of deficiency, and for petitioner with respect to the
increase in deficiency.
To reflect the foregoing,
An appropriate Order and
Decision will be entered.
25
The only statement petitioner makes on brief with respect
to these issues is to request a reduction in the deficiency and
“a corresponding reduction in interest and penalties assessed
thereon.”