UNITED STA ES TAX COURT

T.C. Summa

Opinion 2013-37

UNITED STA ES TAX COURT

CHARLES MELLOR HARGREA ES AND KARIMA HARGREAVES,

Petiti ners v.

COMMISSIONER OF INTE

Docket No. 29208-11S.

AL REVENUE, Respondent "

Filed May 15, 2013.

Charles Mellor Hargreaves and K rima Hargreaves, pro sese.

Shannon Edelstone, for responden .

SUMMAR OPINION

HAINES, J_udge: This case was he rd pursuant to the provisions of section

7463 of the Internal Revenue Code in eff et when the petition was filed. Pursuant

SERVED HAy 15 2013

-2to section 7463(b), the decision to be entered is not reviewable by any other court,

and this opinion shall not be treated as precedent for any other case.

In a notice of deficiency dated October 19, 2009, respondent determined a

deficiency in petitioners' 2007 Federal income tax of $6,452 and a section

6662(a)1 accuracy-related penalty of $1,290.2 After concessions by respondent,3

the issues for decision are: (1) whether petitioners are entitled to deduct an

additional $33,289 of interest for 2007; and (2) whether petitioners are liable for

the section 6662(a) accuracy-related penalty for 2007.

Background

Some of the facts are stipulated and are so found. The stipulation of facts

and the attached exhibits are incorporated herein by this reference. Petitioners

resided in California at the time their petition was filed. 042

'Unless otherwise indicated, section references are to the Internal Revenue

Code in effect for 2007, and Rule references are to the Tax Court Rules of Practice

and Procedure. Amounts are rounded to the nearest dollar.

2When they petitioned this Court, petitioners did not dispute the receipt of

$20 of interest income from ING Direct set out in the notice of deficiency, and

they have thereby conceded the issue pursuant to Rule 34(b)(4).

3Respondent concedes a qualified residence interest deduction of $30,765

for 2007.

-3Petitioners timely filed a self-pre ared 2007 Form 1040, U.S. Individual

Income Tax Return, and claimed a qual'fied residence interest deduction of

$64,054. The notice of deficiency mail d to petitioners allowed a qualified.

residence interest deduction of $30,765 consisting of $4,499 and $26,266.paid to

Bank of America and the First Federäl ank of California (First Federal),

respectively, but denied the remaining 33,289 of interest petitioners claimed for

2007.

. : In 2005 petitioners purchased a h me in Los Gatos, California, for

$799,000. They paid $159,800 cash as downpayment and borrowed the

remainder of the purchase price, approx mately $639,200, fr'om First Federal. The

loan petitioners received from First Fed ral was called a "negative amortization

loan", a loan offered to a purchaser to p y a lower interest rate than the actual

interest rate which is based on an adjust ble index. The difference between the

amount of interest petitioners pay to Fir t Federal and the amount of actual interest

accrued.is the bank's "margin" in a nega ive amortization loan.

Petitioners received ä substitute F rm 1098, Mortgage Interest Statement,

from First Federal for 2007. The Form 1098 categorized interest paid to First .

Federal as (1) gross interest paid of $59, 54; (2) interest shortage of $33.,288; and

(3) net interest paid of $26,266. Petition rs deducted the gross interest paid of

$59,554 plus $4,499 paid to Bank of America, or $64,054 on their 2007 Federal

income tax return.4

The Form 1098 defined "gross interest paid" as "[t]otal interest paid on your

mortgage loan". It defined "interest shortage" as "[a]motint of interest charged to

your account but remaining unpaid by you after each installment has been applied.

This may have resulted in an increase in your principal balance." And "net

interest paid" was calculated by subtracting the "interest shortage" from the "gross

interest paid". Petitioners paid $26,266 of interest to First Federal in 2007. The

interest shortage of $33,288 was added to the principal of the loan. The beginning

balance of the loan in 2007 was $669,300, and its ending balance was $702,588.

There is río evidence in the record that petitioners paid the interest shortage-added

as principal to the First Federal loan.

Discussion

I. Burden of Proof

.

Deductions, including those for qualified residence interest, are a matter of

legislative grace. New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

A taxpayer bears the burden of proving entitlement to any deductions claimed.

See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). ;

4There is a dollar discrepancy from rounding.

-5II. Qualified Residence Interest

.

. .

Section 163 generally allows a d duction for all interest paid or accrued

within the taxable year on indebtedness Sec. 163(a). However, no deduction is

allowed for personal interest paid·or ac rued during the taxable year·únless

specifically allowed by statute. Sec. 16 (h). Among the enumerated items of

deductible personal interest is qualified esidence interest. Sec. 163(h)(2)(D).

Qualified residence interest is any intere t which is paid or accrued during the.

taxable year on acquisition indebtedness secuted by any qualified residence of the

taxpayer and interest paid or accrued dur'ng the taxable year on home equity indebtedness secured by any qualified re idence of the taxpayer. Sec.

163(h)(3)(A). Acquisition indebtedness s indebtedness incurred in acquiring,

constructing, or substantially improving ny qualified residence of the taxpayer

and is secured by such residence. Sec. 1 3(h)(3)(B)(i).

There is no dispute that petitioners home is a qualified residence. The -

parties also agree that petitioners paid qu lified residence interest during 2007.

Respondent has conceded that $30,765 w s paid, but petitioners are claiming

$64,054. The difference of $33,289 is in ispute.

Petitioners are cash receipts and dis ursements method taxpayers. Section

1.461-1(a)(1), Income Tax Regs., provide that, under the cash receipts and

-6disbursements method of accounting, amounts representing allowable deductions

shall, as a general rule, be taken into account for the taxable year in which paid.

Payment must be made in cash or its equivalent. Davison v. Commissioner, 107

T.C. 35, 41 (1996), aff'd, 141 F.3d 403 (2d Cir: 1998); Smoker v. Commissioner,

T.C. Memo. 2013-56. The delivery of a promissory note to satisfy an interest

.

obligation, .without an accompanying discharge of the note, is a mere promise to

pay and not a payment in a cash equivalent. Don E. Williams Co. v.

Commissioner, 429 U.S. 569, 577-578 (1977). Similarly, because First Federal

added interest to petitioners' principal on their loan, petitioners are able to

postpone paying the interest due to sometime in the future, either over the life of

the loan or as part of a balloon payment upon maturity. See Smoker v.

Commissioner, T.C. Memo. 2013-56. Because the $33,288 of interest added to

petitioners' principal on their loan was not paid in 2007, petitioners are not

entitled to a current interest deduction for the $33,288. See Heyman v.

Commissioner, 70 T.C. 482, 485-487 (1978), aff'd without published opinion, 633

F.2d 215 (6th Cir. 1980); Smoker v. Commissioner, T.C. Memo. 2013-56.

III. Accuracy-Related Penalty

Under section 7491(c), respondent bears the burden of production with

respect to petitioners' liability for any accuracy-related penalty. To meet this

-7burden, respondent "must come forwar with sufficient evidence indicating that it

is appropriate to impose the relevant pe alty." Higbee v. Commissioner, 116 T.C.

438, 446 (2001). Once respondent sust ins his burden of production, however,

petitioners bear the burden of proving t at the penalty is unwarranted by.

establishing an affirmative defense suc as reasonable cause or substantial

authority. See id. at 446-447.

Respondent determined that petiti ners are liable for an accuracy-related

penalty of 20% under section 6662(a) o $1,290. The penalty applies to any

underpayment of tax required to be sho n on a return that is attributable to

negligence or disregard of rules or regul tions under section 6662(b)(1).

Negligence is defined as any failure to m ke a reasonable attempt to comply with

the provisions of the Internal Revenue C de. Sec. 6662(c). However, section

6664(c)(1) provides that a penalty under ection 6662 will not be imposed on any

portion of an underpayment if the taxpay r shows reasonable cause for such

portion and the taxpayer acted in good fai h with respect to such portion.

Mr. Hargreaves prepared the 2007 ederal income tax return. He credibly

testified that he reported the interest dedu tion using what he thought the Form

1098 stated. He made a reasonable attem t to comply with the provisions of the

Internal Revenue Code and established wi h his testimony that he acted in good

-8faith. Therefore, we hold that petitioners are not liable for the section 6662(a)

penalty.

In reaching our holdings herein, we have considered all arguments made,

and, to the extent not mentioned above, we conclude they are moot, irrelevant, or

without merit.

To reflect the foregoing,

Decision will be entered

under Rule 155.