The opinion
T.C. Memo. 2012-193
UNITED STATES TAX COURT
DARRON L. BENNETT AND JILL N. BENNETT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 30490-09. Filed July 12, 2012.
R determined deficiencies and penalties for Ps’ 2001-04 tax
years. The primary issue is whether petitioners had a loss on the sale
of property for the 2001 tax year and if so, whether the loss is properly
characterized as personal, capital, or ordinary and may be carried
forward to petitioners’ 2002, 2003, and 2004 returns.
Held: The property was a capital asset, and petitioners are liable
for the portion of the deficiency in income tax attributable to the sale of
the property as determined in this opinion.
Michael Charles Cohen, for petitioners.
Scott B. Burkholder, for respondent.
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MEMORANDUM FINDINGS OF FACT AND OPINION
WHERRY, Judge: This case is before the Court on a petition for
redetermination of deficiencies in income tax and penalties respondent determined
for petitioners’ 2001 through 2004 tax years.1
After concessions the issues remaining are:2
(1) whether petitioners had a loss of $1,337,325 on the sale of property at
11434 Bellagio Road, Bel Air, California (Bellagio property), for the 2001 tax year
and if so, whether the loss is properly characterized as personal, capital, or ordinary
1
Unless otherwise indicated, all section references are to the Internal Revenue
Code of 1986, as amended and in effect for the taxable years at issue. All Rule
references are to the Tax Court Rules of Practice and Procedure.
2
Petitioners concede that Jill Bennett had unreported income from Buttercup
Apparel of $55,000 and $25,400 for the 2001 and 2002 tax years, respectively.
Petitioners concede that Jill Bennett had unreported income reported on Forms
1099-MISC, Miscellaneous Income, of $2,010, $42,397, and $17,071, for the 2002,
2003, and 2004 tax years, respectively. Petitioners have also conceded that Jill
Bennett had additional unreported income for 2002 of $547. The parties agree that
the cost basis of the Bellagio property is not less than $4,335,471. Respondent
concedes that petitioners are not liable for 2001 for capital gains tax allegedly
arising from the sale of the Bellagio property. Petitioners concede additions to tax
under sec. 6651(a)(1) and (2) to the extent there is a tax deficiency for the years at
issue. Petitioners concede the sec. 6662(a) penalty for the years at issue to the
extent there is a tax deficiency except that respondent concedes that for any
deficiency arising out of the sale of the Bellagio property the sec. 6662(a) penalty
shall not apply.
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and may be in part deducted in 2001 and in part carried forward and deducted on
petitioners’ 2002, 2003, and/or 2004 Federal income tax returns,
(2) whether the basis of the Bellagio property should include $125,000 of
interior decorating fees,
(3) whether petitioner Mrs. Jill Bennett received unreported income from
Hajan Enterprises, Inc., of $85,000 for the 2002 tax year, and
(4) whether petitioner Mr. Darron L. Bennett received unreported income of
$47,069 for the 2002 tax year.
FINDINGS OF FACT
The parties’ stipulation of facts, with accompanying exhibits, and the
stipulation of settled issues are incorporated herein by this reference. At the time
the petition was filed, petitioners resided in California.
Petitioners’ Personal Background
Petitioner Mr. Bennett is a self-proclaimed “serial entrepreneur”, often trying
his hand at unsuccessful businesses. In the 1980s Mr. Bennett’s father passed
away, leaving him a substantial amount of jewelry. Mr. Bennett then began selling
jewelry, which later evolved into a jewelry brokering business.
In the early 1990s Mr. Bennett went into a business of “club promoting”, in
which he would book a concert and then promote the concert nightclub. When that
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business was unsuccessful he then tried the record and recording business, which
was also unsuccessful. In 1996 Mr. and Mrs. Bennett and Mrs. Bennett’s father
attempted to start a vitamin sales business. At some point Mr. Bennett also engaged
in a car leasing business.
According to the 1997 Form 1120S, U.S. Income Tax Return for an S
Corporation, petitioners incorporated Johnson Investment on February 8, 1995.
Petitioners explained that although the “Business Code” used on their Federal
income tax returns referred only to some form of a jewelry business, they actually
“did a lot of things under Johnson Investment.”
Mrs. Bennett engaged in a term life insurance business beginning in early
2000 and continuing through the years at issue. She would try to place clients with
an insurance carrier that the client could afford. Mrs. Bennett opened a bank
account for Buttercup Apparel. Mrs. Bennett deposited a check, dated March 7,
2002, from Hajan Enterprises, Inc., for $65,000 in this account. Mrs. Bennett
deposited another check from Hajan Enterprises, Inc., dated June 26, 2002, for
$20,000 in Buttercup Apparel’s account. Ms. Sharon Sumter, a family friend of the
Bennetts, was in the business of real estate development and owned Hajan
Enterprises, Inc.
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During the years at issue petitioners owned and lived in a property in
Henderson, Nevada (Henderson property). Petitioners refinanced the Henderson
property in early May 2000 and checked the “Declarations” box on page 3, Section
VIII of the loan application, stating that they intended to occupy the property as
their personal residence.
On March 31, 2000, Mr. Bennett was arrested in Los Angeles on Federal
drug charges. He was transferred to New York, where he was imprisoned until his
acquittal on January 25, 2001.
Bellagio Property
Mr. Bennett was at the office of an attorney, Mr. Roger Rosen, who was
looking at blueprints for a residential property. Mr. Rosen asked Mr. Bennett
whether he was interested in investing in the property. Mr. Bennett was already
familiar with this property; however, because Mr. Rosen wanted to build an English
Tudor style house and Mr. Bennett did not think that would sell, he declined.
A few months later Mr. Rosen called Mr. Bennett and explained that he was
getting out of the real estate business and asked Mr. Bennett whether he would like
to buy the property. Mr. Bennett was interested in the property, but before he
bought it, he contacted his architect/builder friend Mr. Harry Fox. Mr. Fox was
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available and thought that they could build a “nice house” on the property. Mr.
Bennett and Mrs. Bennett (Miss Johnson at the time) purchased the property from
Mr. Rosen as joint tenants with the right of survivorship. The grant deed was filed
on January 14, 1997.
Mr. Fox owned a property in Aspen, Colorado, that had a mortgage that was
about to be foreclosed on and offered to develop the Aspen property with Mr.
Bennett. Mr. Bennett then made an agreement with Mr. Fox to develop the Aspen
property along with the Bellagio property. The Aspen property was never
developed and was eventually sold.
Mr. Bennett was intensely involved in the development of the Bellagio
property. Even though his family home was in Nevada, Mr. Bennett determined he
spent roughly 85% of his time at the Bellagio property. Mr. Bennett put a trailer on
the Bellagio property to use as an office.
Mrs. Bennett was responsible for the “design side” and “overall look and
feel” of the Bellagio property. Mrs. Bennett worked with an interior decorator
named David Speeks who owned Tasty Designs. Mrs. Bennett worked with him in
order to design the interior of the house into something that would sell. Petitioners
paid Mr. Speeks and/or Tasty Designs $125,000 for his services.
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The Bennetts refinanced the Bellagio property on June 7, 1999, for a total
amount of $2,500,000. On the signature page of the loan documentation the
Bennetts checked a box in section VIII line L signifying that they planned to occupy
the property as their primary residence.
The Bennetts again refinanced the Bellagio property on December 27, 2000,
for a total amount of $3,250,000. This time, on the signature page of the loan
documentation the Bennetts checked a similar line L box signifying that they did not
plan on occupying the property as their primary residence. The Bennetts received
$1,059,141.08 from the refinance as cash to borrower.
Petitioners sold the Bellagio property on December 3, 2001, for $4 million in
order to “stop the bleeding”. Maryann Tyler, a friend of Mr. Bennett’s, was the
listing agent for the sale of the Bellagio property. The house was unfinished when it
was sold by the Bennetts, and after selling the Bellagio property they never invested
in real estate again during the tax years at issue.
Tax Returns
Greg Hookfin prepared petitioners’ tax returns for the years at issue. Mr.
Bennett provided Mr. Hookfin with his bank statements, and Mr. Hookfin calculated
the Bennetts’ tentative income by adding up the amounts Mr. Bennett had deposited
into his account. Mr. Bennett would then estimate the amount of money that he
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received that was not reflected in his bank accounts. Petitioners did not list any
business expense deductions on any of their Schedules C, Profit or Loss From
Business, for the years at issue. Mrs. Bennett engaged in businesses but did not
report income on separate Schedules C for the years at issue.
On their 2001 tax return petitioners reported Mr. Bennett’s Schedule C
business as “Diamond Broker”. On their 2002 tax return petitioners indicated Mr.
Bennett was a salesman and reported Mr. Bennett’s Schedule C business as
“DIAMOND BROKER/JEWELRY SALES”. On their 2003 and 2004 returns
petitioners indicated Mr. Bennett was a “Diamond Broker” and reported Mr.
Bennett’s Schedule C business as “Jewelry Sales”. Mr. Bennett included income
from other activities on these Schedules C. However, Mr. Bennett did not indicate
on his returns that his income came from any source except for the jewelry business.
On petitioners’ 2001 tax return they deducted $1,377,325 on Form 4797,
Sales of Business Property, for the sale of the Bellagio property. They reported a
sales amount of $4,000,000 and a basis of $5,377,325. This sale was not related to
the “Diamond Broker” business reported on the only Schedule C included with this
return.
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For the years at issue petitioners reported the following Schedule C income,
Schedule C expenses, Other taxable income, Net Operating Loss (NOL)
Carryforward, and Adjusted Gross Income (AGI):
2001 2002 2003 2004
Schedule C income $46,300 $342,889 $450,455 $472,254
Schedule C expenses 0 0 0 0
Other taxable income (1,377,325) 487 416 398
NOL carryforward 0 (342,889) (450,455) (146,581)
AGI (1,334,296) (9,369) (11,010) 314,297
On October 2, 2009, respondent sent to petitioner a notice of deficiency. On
December 23, 2009, petitioner timely petitioned the Court for redetermination of the
deficiency.
OPINION
I. Burden of Proof
The Commissioner’s determination of a taxpayer’s liability for an income tax
deficiency is generally presumed correct, and the taxpayer bears the burden of
proving that the determination is improper. See Rule 142(a); Welch v. Helvering,
290 U.S. 111, 115 (1933).
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The Court of Appeals for the Ninth Circuit, to which an appeal would lie
absent a stipulation to the contrary, has held that in unreported income cases, the
presumption of correctness applies only after the Commissioner introduces some
substantive evidence that the taxpayer received unreported income. Edwards v.
Commissioner, 680 F.2d 1268, 1270 (9th Cir. 1982); Weimerskirch v.
Commissioner, 596 F.2d 358, 360-362 (9th Cir. 1979), rev’g 67 T.C. 672 (1977). If
the Commissioner introduces such evidence, “the burden shifts to the taxpayer to
show by a preponderance of the evidence that the deficiency was arbitrary or
erroneous.” See Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999),
aff’g T.C. Memo. 1997-97.
Respondent used the specific income items method, which is a direct method
of proof approved by the Court. See Price v. Commissioner, T.C. Memo. 2004-
103. By introducing their Schedules C and the banking information of Mr. and Mrs.
Bennett respondent has introduced sufficient evidence connecting petitioners with
the unreported income. Consequently, respondent’s determination is entitled to the
presumption of correctness.
II. Recordkeeping Requirements
Taxpayers must maintain adequate records to substantiate their income and
deductions. Sec. 6001 (the taxpayer “shall keep such records”); INDOPCO, Inc. v.
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Commissioner, 503 U.S. 79, 84 (1992). As in this case, when taxpayers fail to
maintain adequate books and records, the Commissioner is authorized to use
whatever method he deems appropriate to determine the existence and amount of
the taxpayers’ income so long as, in the Commissioner’s reasonable opinion, the
method clearly reflects income. Sec. 446(b); Mallette Bros. Constr. Co. v. United
States, 695 F.2d 145, 148 (5th Cir. 1983); Gowni v. Commissioner, T.C. Memo.
2004-154.
III. Bellagio Property
Respondent makes three arguments with respect to the treatment of the sale
of the Bellagio property. First, respondent argues that petitioners purchased the
property and constructed the house as their personal residence and therefore any
loss incurred in the sale of the property is not deductible under section 165(c).3
Second, respondent argues that if the property was converted to nonresidential
property, the conversion value of the property is limited to the lesser of the adjusted
basis or fair market value at the time of the conversion. Finally, respondent argues
that under section 1221 the property was not held primarily for sale to customers in
3
Sec. 165(c) limits losses that can be deducted by individual taxpayers,
permitting a deduction only for losses incurred in a trade or business, in a
profit-making activity (though not connected with a trade or business), or from a
casualty or theft.
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the ordinary course of petitioners’ trade or business and therefore any loss incurred
on the sale of the property is a capital loss and not an ordinary loss.
A. Personal Residence
At trial petitioners testified that they never planned on living in the Bellagio
property. However, respondent vehemently argues that petitioners purchased the
property as their primary residence and that their “intent is clearly shown in the
many documents they signed stating that the Bellagio property was to be their
primary residence”.
On the loan documents used to refinance the Bellagio property on June 7,
1999, for a total loan amount of $2,500,000, the Bennetts did check a box signifying
that they planned to occupy the property as their primary residence. The Bennetts
also signed a fair lending notice certifying that they planned to occupy the Bellagio
property. However, Mr. Fox, petitioners’ architect/developer, explained that he did
not get the impression that the Bellagio project was going to be a residence for them
and he explained “that a lot of developers that I work with always say it’s their
house because they get better financing from the bank as opposed to disclosing it’s a
business entity.”
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The Bennetts also purchased their personal residence, the Henderson
property, around the same time that they purchased the Bellagio property and
intended to live in it. We conclude that petitioners did not intend to occupy the
Bellagio property as their personal residence.
B. Conversion
Because we find that petitioners never intended to occupy the Bellagio
property as their personal residence, the property was never converted from
residential to nonresidential property.
C. Section 1221
Respondent argues that “under section 1221 and Biedenharn Realty Co. [v.
United States, 526 F.2d 409, 414-415 (5th Cir. 1976)] and related cases, the
Bellagio property was not ‘property held by [petitioners] primarily for sale to
customers in the ordinary course of [their] trade or business.’” Therefore respondent
disallowed the ordinary loss petitioners claimed on their 2001 tax return.
Section 1221 defines all property held by a taxpayer as a “capital asset” and
then explicitly excludes eight categories of property.4 Petitioners argue that the
4
Sec. 1221(a) provides in pertinent part as follows:
(continued...)
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Bellagio property was not a capital asset because it falls within the first exception
and was held primarily for the sale to customers in the ordinary course of their trade
or business and therefore any loss incurred with respect to the property is ordinary.
The Court of Appeals for the Ninth Circuit has explained that:
We have looked to a number of factors in determining whether
properties are “held . . . primarily for sale to customers in the ordinary
course of . . . business,” I.R.C. §1221, including “the nature of the
acquisition of the property, the frequency and continuity of sales over
an extended period, the nature and the extent of the taxpayer's
business, the activity of the seller about the property, and the extent
and substantiality of the transactions.” Austin v. Commissioner, 263
F.2d 460, 462 (9th Cir. 1959). See Parkside, Inc. v. Commissioner,
571 F.2d 1092, 1096 (9th Cir. 1977); Los Angeles Extension Co. v.
United States, 315 F.2d 1, 2-3 (9th Cir. 1963). But we have also
warned that “each case must be decided upon its particular facts, and
the presence of any one or more of these factors may or may not be
determinative of a particular case.” Austin v. Commissioner, supra,
263 F.2d at 462.
4
(...continued)
SEC. 1221. CAPITAL ASSET DEFINED.
(a) In General.--For purposes of this subtitle, the term “capital asset”
means property held by the taxpayer (whether or not connected with his trade
or business), but does not include--
(1) stock in trade of the taxpayer or other property of a kind
which would properly be included in the inventory of the taxpayer if on
hand at the close of the taxable year, or property held by the taxpayer
primarily for sale to customers in the ordinary course of his trade or
business;
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Redwood Empire Savings & Loan Ass’n v. Commissioner, 628 F.2d 516, 517 (9th
Cir. 1980), aff’g 68 T.C. 960 (1977).5
1. Nature of the Acquisition
Although initially Mr. Bennett was not interested in investing in the property
when the design was not to his liking, after Mr. Rosen decided to sell the property,
Mr. Bennett did express interest. However, before deciding to purchase
the Bellagio property he contacted his architect/builder friend Mr. Fox to make sure
he was available and that they could build a house on the property.
5
Under Golsen we apply the factors of the Court of Appeals to which the case
is appealable. Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d, 455 F.2d 985
(10th Cir. 1971). We note that this Court also examines
[S]everal different factors when analyzing such a scenario, including:
(1) The taxpayer’s purpose in acquiring the property; (2) the purpose
for which the property was subsequently held; (3) the taxpayer’s
everyday business and the relationship of the income from the property
to total income; (4) the frequency, continuity, and substantiality of
sales of property; (5) the extent of developing and improving the
property to increase the sales; (6) the extent to which the taxpayer used
advertising, promotion, or other activities to increase sales; (7) the use
of a business office for the sale of property; (8) the character and
degree of supervision or control the taxpayer exercised over any
representative selling the property; and (9) the time and effort the
taxpayer habitually devoted to the sales. [Citations omitted.]
Rice v. Commissioner, T.C. Memo. 2009-142.
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We found above that petitioners did not purchase the Bellagio property to
build a private residence, but to build a house that would sell. We find that this
factor weighs in favor of finding that the Bellagio property was property held
primarily for the sale to customers in petitioners’ ordinary course of business.
2. Frequency and Continuity of Sales
Petitioners purchased the Bellagio property and held it for almost five years
before eventually selling it in an unfinished condition at a loss. Petitioners also
participated in the Aspen property; however, the record is extremely sparse
regarding the Aspen property and it was never developed. Petitioners developed
only the Bellagio property.
Although petitioners point to a couple of cases that hold that very few sales
can still qualify for a finding that the property was held primarily for the sale to
customers in the ordinary course of business, we do not find that the facts of this
case weigh in favor of finding that the Bellagio property was held for sale in the
ordinary course of business. As this Court explained in Finnegan v. Commissioner,
T.C. Memo. 1997-486, aff’d without published opinion, 168 F.3d 498 (9th Cir.
1999), the two cases petitioners point to, S&H, Inc. v. Commissioner, 78 T.C. 234
(1982), and Morley v. Commissioner, 87 T.C. 1206 (1986), can be distinguished
from the case at hand.
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The Court in Finnegan explained that the holding in S&H, Inc. focused on the
fact that a preexisting arrangement existed to sell the property when the taxpayers
purchased and developed the property. Finnegan v. Commissioner, T.C. Memo.
1997-486. The Court in Finnegan also elaborated on this point noting: “[A]
taxpayer engaged in a single venture can be found to be in a trade or business in
‘situations where, at the time the property was acquired by the taxpayer, he intended
promptly to resell the property and the objective facts show that he proceeded to
attempt to implement that intent’. Morley v. Commissioner, supra at 1211.”
Petitioners, like the taxpayers in Finnegan, were never licensed real estate brokers,
did not have a preexisting contract to sell the house, and simply did not meet their
burden of showing that their Bellagio real estate activity was a trade or business
rather than an investment. See id. In sum “[t]he number of lots petitioners sold in
toto was small.” Rice v. Commissioner, T.C. Memo. 2009-142. And we are not
convinced that petitioners were in the business of real estate development but rather
that they held the Bellagio property for investment purposes. We find this factor
weighs against petitioners.
3. Nature and Extent of the Bennetts’ Business
The Bennetts are self-described serial entrepreneurs. Petitioners were
primarily engaged in a jewelry business and reported all of their income on a single
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Schedule C under that business. Although petitioners credibly testified that they had
other sources of income which they also reported on the jewelry business’s
Schedule C, they did not document any of the other businesses. We find it
incredible that petitioners ran a fully functioning real estate business but reported it
on their returns as a jewelry business. Before investing in the Bellagio and Aspen
properties petitioners had not invested in real estate, other than their home in
Nevada, and after the Bellagio property they never invested in real estate again. We
find this factor weighs against petitioners.
4. Activity of the Seller
Petitioners hired a friend as their realtor. There is no indication in the record
that petitioners ever tried to advertise the Bellagio property or that they did anything
particular to prepare for the sale of the property. In fact petitioners explained that
they were just trying to be rid of the property. We find that this factor weighs
against petitioners.
5. Conclusion
After analyzing the relevant factors and the specific facts of this case, we do
not find that the Bennetts held the Bellagio property in the ordinary course of their
trade or business for sale to customers. Therefore, the loss realized from the sale of
the Bellagio property was a capital loss and not an ordinary loss.
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IV. $125,000 of Interior Decorating Fees
Respondent disputes $125,000 petitioners claim should be included in the
basis of the Bellagio Property. Respondent argues that the checks submitted in
evidence are mere carbon copies and do not substantiate the expense. However, we
find Mrs. Bennett’s testimony in addition to the carbon copies of the checks
sufficient to substantiate the fact that petitioners worked with David Speeks of Tasty
Designs and paid $125,000 for his services.
Mrs. Bennett explained that she used an interior designer during construction
of the Bellagio property because she wanted the inside of the house to also be
designed in a manner that would sell. The checks written to David Speeks and
Tasty Designs were written in 1998 and 1999, which was the period the house was
under construction. Because the $125,000 paid to David Speeks and Tasty Designs
was an amount paid for the design of a new building, it must be capitalized. See
sec. 1.263(a)-1(a)(1), Income Tax Regs. We conclude that the Bennetts must
include the $125,000 in the basis of the Bellagio property. Therefore petitioners’
basis in the Bellagio property is $4,460,471 ($4,335,471 (see supra note 2) +
$125,000).
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V. $85,000 From Hajan Enterprises, Inc.
In 2002 Mrs. Bennett deposited two checks from Hajan Enterprises, Inc.
Mrs. Bennett explained that she “was just in a cash crunch, so * * * [she] went to a
friend and that she’s just been a confidant of mine for a while”. The friend she went
to was Sharon Sumter, the sole owner of Hajan Enterprises, Inc. At trial Ms.
Sumter credibly corroborated Mrs. Bennett’s testimony and explained that “Jill
[Mrs. Bennett] and I are friends, and she needed money and I gave it to her.”
Although the loans were made without interest, without a promissory note, and
without any formalities, Ms. Sumpter still expects to be paid back.
Respondent failed to introduce evidence that these funds were in fact income
or were related to any goods or services Mrs. Bennett or her husband provided to
Hajan Enterprises, Inc., or Ms. Sumpter. We consequently determine that the
preponderance of the evidence corroborates Mrs. Bennett’s testimony and supports
petitioners’ contention that the $85,000 from Hajan Enterprises, Inc., was a loan or
perhaps a gift from Ms. Sumter and, therefore, not includable in petitioners’ income.
VI. Unreported Income of $47,069
Through the specific items method, respondent determined that for 2002 Mr.
Bennett did not report income of $47,069. Because respondent has introduced
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sufficient evidence connecting petitioners with the unreported income, he is entitled
to the presumption of correctness. Mr. Bennett and Mr. Hookfin each explained
that petitioners reported their income on a gross basis and would try to estimate the
amount of income that they had coming in. Petitioners did not present a schedule of
how they arrived at the amounts of income reported on their returns nor did they
present any evidence with respect to their income. Petitioners’ failure to introduce
evidence “which, if true, would be favorable to [them], gives rise to the presumption
that if produced it would be unfavorable”. Wichita Terminal Elevator Co. v.
Commissioner, 6 T.C. 1158, 1165 (1946), aff’d, 162 F.2d 513 (10th Cir. 1947).
We are also not persuaded by petitioners’ vague self-serving testimony
implying that the amounts were included in the random number they chose to report
on their return. See Page v. Commissioner, 58 F.3d 1342, 1346 (8th Cir. 1995),
aff’g T.C. Memo. 1993-398; Schneebalg v. Commissioner, T.C. Memo. 1988-563.
Petitioners never explained or itemized the amounts included on the Federal tax
return or showed that the $47,069 was included in the reported income. Petitioners
had the burden of establishing that the $47,069 was included in their income for
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2002 or was a loan and they failed to do either; therefore, petitioners are liable for
the income tax deficiency on the $47,069 for the 2002 tax year.
The Court has considered all of petitioners’ and respondent’s contentions,
arguments, requests, and statements. To the extent not discussed herein, we
conclude that they are meritless, moot, or irrelevant.
To reflect the foregoing,
Decision will be entered
under Rule 155.