The opinion
T.C. Summary Opinion 2011-122
UNITED STATES TAX COURT
HATTIE M. BONDS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15479-09S. Filed October 17, 2011.
Hattie M. Bonds, pro se.
Melissa J. Hedtke, for respondent.
ARMEN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in
effect when the petition was filed.1 Pursuant to section
7463(b), the decision to be entered is not reviewable by any
1
Unless otherwise indicated, all subsequent section
references are to the Internal Revenue Code in effect for the
years in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
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other court, and this opinion shall not be treated as precedent
for any other case.
Respondent determined deficiencies in, and accuracy-related
penalties on, petitioner’s Federal income taxes as follows:
Year Deficiency Penalty - Sec. 6662(a)
2006 $3,211.00 $642.20
2007 2,499.00 499.80
The issues raised by the pleadings and tried to the Court
are as follows:
(1) Whether petitioner held certain real property for the
production of income. If so,
(2) whether losses claimed by petitioner in respect of such
real property are subject to the passive activity loss rules of
section 469. If not, or if excepted therefrom,
(3) whether petitioner substantiated losses claimed in
respect of such real property; and
(4) whether petitioner is liable for accuracy-related
penalties under section 6662(a).
We note that the notice of deficiency made other adjustments
to income but that petitioner never challenged those adjustments
either in the petition or at trial, or even on brief.2
2
Thus: For 2006 and 2007 respondent determined that
petitioner failed to report (1) IRA distributions of $2,087 and
$319 and (2) qualified dividends of $179 and $201, respectively.
Also for 2006 and 2007 respondent determined that petitioner was
liable for the 10-percent additional tax under sec. 72(t) on
early distributions from a qualified retirement plan.
(continued...)
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Accordingly, those adjustments are deemed to be conceded. See
Rule 34(b)(4) (“Any issue not raised in the assignments of error
shall be deemed to be conceded.”); McNeil v. Commissioner, T.C.
Memo. 2011-150 n.3 (issues not raised on brief or at trial are
deemed conceded).
Background
Some of the facts have been stipulated, and they are so
found. We incorporate by reference the parties’ stipulation of
facts and accompanying exhibits.
Petitioner resided in the State of Minnesota when the
petition was filed.
In or about 1988 petitioner moved to Minnesota and since
then has resided and worked in the metropolitan Minneapolis-St.
Paul area. During 2006 and 2007, the taxable years in issue,
petitioner worked full time as a vice principal at a high school
in Minneapolis, earning $94,082 in 2006 and $102,748 in 2007.
Prior to moving to Minnesota, petitioner lived in Kansas
City, Missouri, where she grew up. Much, if not most, of her
2
(...continued)
Additionally for 2007 respondent determined that petitioner
failed to report interest income of $509. Finally, respondent
partially disallowed itemized deductions claimed by petitioner on
Schedules A, Itemized Deductions, for charitable contributions in
2006 and 2007. (Certain of the foregoing adjustments served to
increase petitioner’s adjusted gross income, thereby increasing
the 2-percent floor on miscellaneous itemized deductions, see
sec. 67, and hence decreasing the allowable amounts, but this was
a purely mechanical matter.)
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family remains there. Specifically during 2006 and 2007,
petitioner’s parents lived in the Kansas City area, along with
three of her four siblings and “tons” of relatives; petitioner
also has lifelong friends there.
While living in the Kansas City area, petitioner purchased a
single-family house (Kansas City house) in the early or mid-1980s
and lived in it until she relocated to Minnesota. Although it
has a Kansas City mailing address, the house is located outside
the city limits, within a rural subdivision southwest of the
Kansas City airport in Platte County. The Kansas City house is
described by the county assessor as a one-story residence built
in 1972 having a stud frame with a total floor area of 1,008
square feet, a basement garage, and an appraised value as of May
15, 2010, of $91,583.
Petitioner held onto the Kansas City house when she
relocated to Minnesota, and she continues to own it to this day.
However, she has not made personal use of it since moving.
Rather, after she relocated, petitioner rented the Kansas City
house to various tenants through 2004 or 2005. Since then the
house has not been rented. Petitioner attributes her failure to
rent the property during the last 6 or 7 years to a number of
factors, including the economy (“I think the economy was getting
a little bit difficult, and it became a little bit hard to
rent”), the property’s location (“there’s no bus line around
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there and it’s rural and people don’t really want to be there”),
and the disinclination of realtors to accept a listing for the
property (“the realtors, they say that it’s really hard to lease
out, too”).
Petitioner has never listed the Kansas City house for sale.
However, on one occasion she did speak with a realtor and
concluded that the appreciation of the house over the years since
her relocation to Minnesota was such that its sale would yield a
handsome gain.
During 2006 and 2007, petitioner traveled from Minnesota to
Kansas City several times a year, a round-trip distance of some
890 miles. In Kansas City, petitioner would stay with her
mother, as the Kansas City house was unfurnished. When in the
area, petitioner would post flyers advertising the house for
rent; at other times, petitioner might arrange for flyers to be
posted.
Petitioner filed Forms 1040, U.S. Individual Income Tax
Return, for 2006 and 2007 and attached to each of those returns a
Schedule E, Supplemental Income and Loss, in respect of the
Kansas City house. Without regard to the Schedules E, petitioner
reported adjusted gross income of $95,968 for 2006 and $104,899
and 2007. Neither the Schedule E for 2006 nor the Schedule E for
2007 reported any rents received. However, both Schedules E
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claimed losses, attributable to a variety of expenses and
depreciation, as follows:
2006 2007
Expenses
advertising $ 168 $ 175
auto/travel 2,003 1,746
cleaning/
maintenance 975 560
insurance 700 710
mortgage interest 3,042 3,400
taxes 935 935
utilities 1,460 1,475
“lodging in 4 day” 1,210 1,215
“meals at half” 462 486
10,955 10,702
Depreciation 1,974 1,974
Loss $12,929 $12,676
Petitioner’s returns for 2006 and 2007 were prepared by a
tax professional.
In the notice of deficiency, respondent disallowed the
claimed rental losses on the basis that: (1) The Kansas City
house was not held for the production of income; (2) the losses
resulted from a passive activity; and (3) the losses lacked
substantiation. However, respondent did allow the deductions
claimed for real estate taxes and mortgage interest, but those
deductions were recharacterized as itemized deductions allowable
only on Schedules A.3
3
For 2006, respondent allowed mortgage interest in respect
of the Kansas City house of $3,464, an amount greater than that
claimed by petitioner on her return.
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Discussion
I. Burden of Proof
In general, the Commissioner’s determinations set forth in a
notice of deficiency are presumed to be correct, and the taxpayer
bears the burden of showing that those determinations are in
error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933). Pursuant to section 7491(a), the burden of proof as to
factual matters shifts to the Commissioner under certain
circumstances. Petitioner has neither alleged that section
7491(a) applies, nor has she established her compliance with its
requirements. Accordingly, petitioner bears the burden of proof.
See Rule 142(a); Welch v. Helvering, supra at 115.
II. Deductibility of Claimed Rental Losses
A. Section 212
Respondent contends that petitioner did not hold the Kansas
City house for production of income in 2006 and 2007, suggesting
that petitioner held the property instead for personal reasons
related to the presence of family and friends in the area and the
desire to eventually retire there. In contrast, petitioner
insists that after relocating some 22 years ago she is a
Minnesotan and does not presently contemplate returning to the
Kansas City area upon retirement. Further, given that the Kansas
City house remains unfurnished, petitioner contends that she had
no economic reason not to try to rent the property.
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In the case of an individual, section 212 allows as a
deduction all ordinary and necessary expenses paid or incurred
during the taxable year for the production or collection of
income or for the management, conservation, or maintenance of
property held for the production of income. Sec. 212(1) and (2).
For purposes of this section, the term “income” includes not only
income of the current year but also income that may be realized
in a subsequent year. Sec. 1.212-1(b), Income Tax Regs.; see
Bradley v. Commissioner, T.C. Memo. 1998-170 (“The term ‘held for
the production of income’ includes held for appreciation in
value”). “[O]rdinary and necessary expenses paid or incurred in
the management, conservation, or maintenance of a building
devoted to rental purposes are deductible notwithstanding that
there is actually no income therefrom in the taxable year”. Sec.
1.212-1(b), Income Tax Regs. The fact that a building may have
been formerly held by the taxpayer for use as a home is no bar to
the deductibility of ordinary and necessary expenses if the
property is subsequently converted and held for production of
income. Murphy v. Commissioner, T.C. Memo. 1993-292; sec. 1.212-
1(h), Income Tax Regs.
In the instant case, the record establishes that petitioner
converted the Kansas City house from personal use to property
held for production of income when she relocated to Minnesota
around 1988. At that time, and through 2004 or 2005, petitioner
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rented the property to various tenants at various times. Since
2005 petitioner has not derived any rental income; however, given
the property’s postconversion appreciation, the possibility of
gain upon sale distinctly existed in 2006 and 2007.
It may be that an abandonment by petitioner of any
meaningful attempt to rent the Kansas City house, coupled with
the collapse of the real estate market, might negate a finding
for some future year that the property was held for production of
income. But for 2006 and 2007 the record supports such a
finding, and we so hold.
B. Section 469
The fact that we reject respondent’s section 212
determination does not end our inquiry, as respondent also relies
on section 469. Accordingly, we turn now to that section.
Section 469 generally disallows for the taxable year any
passive activity loss. Sec. 469(a). A passive activity loss is
defined as the excess of the aggregate losses from all passive
activities for the taxable year over the aggregate income from
all passive activities for that year. Sec. 469(d)(1). A passive
activity is any trade or business in which the taxpayer does not
materially participate, sec. 469(c)(1), or to the extent provided
in regulations, any activity with respect to which expenses are
allowable as a deduction under section 212, sec. 469(c)(6)(B).
Rental activity is generally treated as a per se passive activity
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regardless of whether the taxpayer materially participates. Sec.
469(c)(2), (4).
There are two principal exceptions to the general rule that
rental activities are per se passive activities.
(1) Real Estate Professional
The first exception to the general rule is found in section
469(c)(7). Under that section, the rental activities of
taxpayers in real property trades or businesses (so-called real
estate professionals) are not treated as per se passive
activities but rather as trade or business activities, subject to
the material participation requirements of section 469(c)(1).
Sec. 469(c)(7); see also sec. 1.469-9(e)(1), Income Tax Regs.
A taxpayer qualifies as a real estate professional and is
not engaged in a passive activity if:
(i) more than one-half of the personal services
performed in trades or businesses by the taxpayer
during such taxable year are performed in real property
trades or businesses in which the taxpayer materially
participates, and
(ii) such taxpayer performs more than 750 hours of
services during the taxable year in real property
trades or businesses in which the taxpayer materially
participates.
Sec. 469(c)(7)(B). A taxpayer must satisfy both requirements of
section 469(c)(7)(B) in order to qualify as a real estate
professional.
In the present case, petitioner does not contend that she is
a real estate professional, and the record does not establish
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that she is. For one thing, petitioner was employed in 2006 and
2007 and worked full time as a vice principal at a high school in
Minneapolis, earning approximately $100,000 each year. A trade
or business includes being an employee. Putoma Corp. v.
Commissioner, 66 T.C. 652, 673 (1976), affd. 601 F.2d 734 (5th
Cir. 1979); Fowler v. Commissioner, T.C. Memo. 2002-223. Thus,
it cannot be said that petitioner devoted more than one-half of
her total personal services working hours to the Kansas City
house. See sec. 469(c)(7)(B)(i); Anyika v. Commissioner, T.C.
Memo. 2011-69.
Second, there is nothing in the record to support a finding
that petitioner satisfied the conjunctive requirement of section
469(c)(7)(B)(ii), i.e., the 750-hour service performance
requirement, for each of the years in issue. Given the fact that
petitioner worked full time at what must have been a demanding
job as a vice principal of a high school, it seems virtually
impossible that she would have had time to devote the equivalent
of ninety-four 8-hour days to the Kansas City house. But we need
not presume, because petitioner never alleged that she even
maintained a log or a calendar or otherwise kept track of the
time devoted to the property, and the law is clear that the
regulations do not allow a postevent “ballpark guesstimate” of
the time committed to material participation in a rental
activity. Moss v. Commissioner, 135 T.C. 365, 369 (2010).
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(2) Offset for Rental Real Estate Activities
The second exception, albeit a potentially limited one, to
the general rule that rental real estate activities are per se
passive activities (and therefore subject to the disallowance
rule of section 469(a)) is found in section 469(i). Thus, a
taxpayer who “actively” participates in a rental real estate
activity may deduct a maximum loss of $25,000 per year related to
the activity. See sec. 469(i)(1) and (2). This exception is
subject to phaseout when the taxpayer’s adjusted gross income
(determined without regard to any passive activity loss) exceeds
$100,000. Sec. 469(i)(3).
The active participation standard can be satisfied without
regular, continuous, and substantial involvement in an activity;
the standard is satisfied if the taxpayer participates in a
significant and bona fide sense in making management decisions
(such as approving new tenants, deciding on rental terms,
approving capital expenditures) or arranging for others to
provide services such as repairs. Madler v. Commissioner, T.C.
Memo. 1998-112.
In the instant case, it is clear that petitioner owns the
Kansas City house and that she is the one who is not only
responsible for making all management decisions but who in fact
makes such decisions. We therefore find that petitioner
satisfied the active participation standard in 2006 and 2007 and
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is therefore entitled to offset her nonpassive income for 2006
and 2007 by her substantiated rental losses, subject to the
phaseout limitation (potentially applicable only in 2007).
C. Substantiation
Finally, insofar as the deductibility of the claimed rental
losses is concerned, we turn to the matter of substantiation.
Here respondent concedes that petitioner substantiated the
payment of mortgage interest of $3,464 and $3,400 for 2006 and
2007, respectively, and real estate taxes of $935 for each year.4
We turn, therefore, to the remaining deductions, all of which are
disputed.
We begin by observing that if, in the absence of required
records, a taxpayer provides sufficient evidence that the
taxpayer has incurred a deductible expense, but the taxpayer is
unable to adequately substantiate the amount of the deduction to
which he or she is otherwise entitled, the Court may estimate the
amount of such expense and allow the deduction to that extent.
Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930).
However, the Court may bear heavily against the taxpayer, whose
inexactitude is of his or her own making. Id. Before doing so,
we must have some basis upon which an estimate may be made.
4
Respondent did not concede that those deductions are
allowable on Schedule E, but our analysis above makes clear that
all deductions allowable in respect of the Kansas City house
properly reside on Schedule E and not on Schedule A.
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Vanicek v. Commissioner, 85 T.C. 731, 743 (1985). Without such a
basis, any allowance would amount to unguided largesse. Williams
v. United States, 245 F.2d 559, 560 (5th Cir. 1957).
Notwithstanding the foregoing, in the case of certain
expenses, section 274(d) expressly overrides the so-called Cohan
doctrine. Sanford v. Commissioner, 50 T.C. 823, 827 (1968),
affd. per curiam 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a),
Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).
Specifically, and as pertinent herein, section 274(d) provides
that no deduction is allowable for traveling expenses (including
meals and lodging while away from home) or with respect to listed
property such as a passenger automobile, see sec.
280F(d)(4)(A)(i), unless the deduction is substantiated in
accordance with the strict substantiation requirements of section
274(d) and the regulations promulgated thereunder.
In the instant case, the documentary evidence regarding the
disputed deductions is relatively scant. At trial, petitioner
testified that she kept her tax records in the basement of her
home in Minnesota and that the basement was flooded on three
separate occasions, once when a sump pump failed, once when her
hot water tank failed, and once after “a big storm”, which
“soaked” certain of her records, prompting her to throw them out.
However, it remains unclear why petitioner could not have
reconstructed at least some of her records by contacting third-
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party payees, such as insurance and utility companies.5 Indeed,
at trial, petitioner did not testify that she made serious
attempts to do so.
Insofar as utilities are concerned, the Kansas City house
was not occupied during 2005 and 2006, and it was located in a
rural area. It is not clear from the record what utilities may
have been necessary and whether, if the house utilized a well
and a septic field, utilities expenses such as water and sewer
charges would have even been incurred. On the other hand, given
weather extremes in the midcontinent, the Kansas City house would
have needed some source of power for heat during the winter and
for other essential requirements. In the absence of adequate
records, which should have been easily obtainable from third-
party payees, we allow $1,000 for utilities expenses for each
year.
Insofar as insurance is concerned, the Kansas City house was
mortgaged, and the mortgagee would undoubtedly have required some
form of fire and casualty insurance. In the absence of adequate
records, which should have been easily obtainable from third-
party payees, we allow $500 for each year.
As just mentioned, the Kansas City house was not occupied
and would not therefore have required much care insofar as
5
It should be recalled that the Schedules E listed
deductions for insurance and utilities expenses for both 2006 and
2007.
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cleaning was concerned. But the grass did need to be cut and
other such maintenance performed. In the absence of adequate
records, we allow $500 for each year.
Petitioner made an effort to rent the Kansas City house by
posting flyers (or having flyers posted) in the area. In the
absence of adequate records, we allow $100 for advertising
expenses for each year.
Regarding the deduction for “lodging in 4 day”, petitioner
offered four “Petty Cash” form receipts, each dated “2006”
without further specification and containing only the word
“Lodging” without further description. None of these “receipts”
is signed; and each is for some even multiple of $100, e.g.,
$300. Although we accept petitioner’s testimony that she stayed
with her mother when in Kansas City, we question whether
petitioner was charged by her mother for doing so and we most
certainly do not accept the “receipts” as probative of any
deductible expense. See Tokarski v. Commissioner, 87 T.C. 74, 77
(1986); Diaz v. Commissioner, 58 T.C. 560, 564 (1972); Kropp v.
Commissioner, T.C. Memo. 2000-148. In short, we are not
convinced that any amounts given by petitioner to her mother were
motivated by other than love and affection. Accordingly, we
allow nothing for lodging expenses.
Insofar as depreciation is concerned, the record is silent
regarding petitioner’s basis in the Kansas City house or its fair
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market value upon conversion from personal use to production-of-
income use. See Halle v. Commissioner, T.C. Memo. 1996-116
(basis of property converted from personal use is the lesser of
adjusted basis or fair market value on the date of conversion).
Lacking any evidence upon which to decide the amount of an
appropriate allowance, an estimate on our part would constitute a
sheer guess and therefore be proscribed largesse. See Williams
v. United States, supra at 560; Vanicek v. Commissioner, supra at
743; see also Rule 143(c) (statements in briefs do not constitute
evidence).
Finally, we consider the expenses claimed for auto, travel,
and meals. We accept the fact that it was prudent to inspect the
Kansas City house from time to time and to address any issues
that ownership of property inevitably engenders. However, there
was obviously also a personal dimension to petitioner’s trips to
Kansas City, and it is not possible to decide whether a
particular trip was principally personal or investment related.
But such quandary is one reason why the heightened substantiation
requirements of section 274(d) exist. In the absence of the
records that such section demands, we have no discretion to make
an allowance as much as we might wish to.
Further, if we credit petitioner’s claim regarding the
repeated flooding of her basement, the law is clear that a
taxpayer must still (1) first demonstrate that the taxpayer
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maintained records during the years in issue that were sufficient
to meet the strict substantiation requirements of section 274(d)
for travel and automobile use and then (2) reasonably and
creditably reconstruct those records through secondary evidence
to show claimed expenditures and use. Boyd v. Commissioner, 122
T.C. 305, 320 (2004); sec. 1.274-5T(c)(5), Temporary Income Tax
Regs., 50 Fed. Reg. 46022 (Nov. 6, 1985); see Gizzi v.
Commissioner, 65 T.C. 342, 345 (1975); Fernandez v. Commissioner,
T.C. Memo. 2011-216; Davis v. Commissioner, T.C. Memo. 2006-272.
At trial, petitioner never testified about what type of
required records (e.g., account book, diary, log, or trip sheets)
that she might have maintained; we are therefore unable to make a
finding that she satisfied the heightened substantiation
requirements of section 274(d) prior to any flood. And the
absence of a reasonable and creditable reconstruction of
expenditures and use further precludes us from making any
allowance if we were so inclined.
In sum, petitioner is entitled to deduct only the following
expenses on her Schedules E for the years in issue:
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Expenses 2006 2007
advertising $ 100 $ 100
cleaning/
maintenance 500 500
insurance 500 500
mortgage interest 3,464 3,400
taxes 935 935
utilities 1,000 1,000
$6,499 $6,435
III. Accuracy-Related Penalty
Section 6662(a) and (b)(1) imposes a penalty equal to 20
percent of the amount of any underpayment attributable to
negligence or disregard of rules or regulations. The term
“negligence” includes any failure to make a reasonable attempt to
comply with tax laws, and “disregard” includes any careless,
reckless, or intentional disregard of rules or regulations. Sec.
6662(c). Negligence also includes any failure by the taxpayer to
keep adequate books and records or to substantiate items
properly. Sec. 1.6662-3(b)(1), Income Tax Regs.
Section 6664(c)(1) provides an exception to the imposition
of the accuracy-related penalty if the taxpayer establishes that
there was reasonable cause for, and the taxpayer acted in good
faith with respect to, the underpayment. Sec. 1.6664-4(a),
Income Tax Regs. The determination of whether the taxpayer acted
with reasonable cause and in good faith is made on a case-by-case
basis, taking into account the pertinent facts and circumstances.
Sec. 1.6664-4(b)(1), Income Tax Regs. The taxpayer bears the
burden of proving that he or she acted with reasonable cause and
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in good faith. Rule 142(a); Welch v. Helvering, 290 U.S. at 115;
Higbee v. Commissioner, 116 T.C. 438, 446 (2001); see sec.
7491(c) (regarding the Commissioner’s burden of production).
Petitioner did not address the accuracy-related penalty
issue either at trial or on brief (nor did she raise it in her
petition), implying only that in the absence of an underpayment
there can be no penalty. But, as mentioned much earlier, see
supra note 2 and associated text, petitioner is deemed to have
conceded certain adjustments in the deficiency notice that she
never sought to challenge. Clearly as to the underpayments
attributable to those adjustments we conclude that respondent has
carried his burden of production and that petitioner has failed
to satisfy her burden of proof.
As to the underpayments attributable to the Schedule E
adjustments, we likewise conclude that imposition of the
accuracy-related penalties is warranted. Here petitioner’s
reticence in addressing the matter directly weighs heavily
against her, as does not merely her lack of substantiating
records but her failure to seriously attempt to reasonably and
creditably reconstruct essential records through secondary
evidence.
Conclusion
We have considered all of the arguments made by the parties
and, to the extent that we have not specifically addressed any of
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those arguments, we conclude that they are moot, irrelevant, or
without merit.
To give effect to the foregoing,
Decision will be entered
under Rule 155.