T .C . Summary Opinion 2009-174

T .C . Summary Opinion 2009-174

UNITED STATES TAX COURT

JOHN ANTHONY LEONE AND MARY L . SPENCER-LEONE, Petitioners v .

COMMISSIONER OF INTERNAL REVENUE, Responden t

Docket No .

1221-08S' .

Filed November 24, 2009 .

John Anthony Leone and Mary L . Spencer-Leone, pro sese .

Ashley P . Vaughan , for respondent .

VASQUEZ,

Judge : This case was heard pursuant to th e

provisions of section 74631 of the Internal Revenue Code i n

effect when the petition was filed . Pursuant to section 7463(b) ,

,the decision to be entered is not reviewable by any other court ,

1 Unless otherwise indicated, all-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 .

SERVED NOV 2 4 2009

2 and this opinion shall' not be treated as precedent for any other

case .

Respondent determined deficiencies in petitioners John Leone

(Mr . Leone) and Mary Spencer-Leone's (Mrs . Leone) Federal income

taxes and accuracy-related penalties as follows :

Year

2004

2005

2006

Deficiency

$5,675

14,252

4,625

Penalty

Sec . 6662(a )

$1,135 .0 0

2,850 .4 0

925 .0 0

Afer concessions, the issues for decision are :2 (1) Whether

petitioners' drag racing activity was an activity engaged .in for

profit under section 183(a) ; (2) whether capital gain from th e

sale of rental property should have been reported on petitioners'

2005 Federal income tax return ; and (3) whether petitioners are

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

Background

Some of the facts have been stipulated and are so found .

The stipulation of facts, the supplemental stipulation of facts,

and the attached exhibits are incorporated herein by thi s

2 The notice of deficiency disallowed all expenses relating

to the drag racing activity . In respondent's pretrial

memorandum, respondent conceded the expenses related to"the drag

racing activity up to the amount of income from the activity .

The notice of deficiency contains adjustments to itemized

deductions (changes to the medical expenses and miscellaneous

deductions) for 2004, to 2006 . These are computational ,

adjustments and .are affected by the outcome of the issues to be

decided ; we do not separately address them .

- 3 reference . At the time petitioners filed the petition, they

resided in'Texas .

Racing Activitie s

During the years in issue petitioners were involved in a

drag racing activity . In each of the years petitioners were

full-time employees of the U .S . Postal Service . Mr . Leone was 53

at the time of trial and has been interested in car racing since

he was a teenager . With a self-proclaimed "natural attraction to

fast cars", Mr . Leone was "captivated" by the races he watched on

television while growing up . Mrs . Leone's interest in drag

racing emerged in 2002 when she started dating Mr . Leone .

Although Mr . Leone was unsure of whether he began his drag

racing activity at the end of 2002 or the beginning of 2003, he

first reported this activity on his Schedule C, Profit or Loss

From Business, under the name "First Strike Racing Team" (First

Strike) on his individual 2002 Federal income tax return an d

described the activity as "racing" . For years 2003 to 2006

petitioners filed joint returns with the same business name and

Schedule C activity description . Petitioners reported the

following income, expenses, and net losses from the drag racing

activity for 2002 to 2006 :

Year

.

2002

2003

2004

2005

2006

Total

Gross Income

Expenses

Gain (Loss )

$200

1,285

708

4,570

7,700

14,463

$17,915

20,220

21,706

25,912

25,719

111,472

($17,715 )

(18,935 )

(20,998 )

(21,342 )

(18,019 )

(97,009 )

Petitioners reported they were entitled to refunds on their 2004,

2005, and 2006 joint income tax returns .3 Respondent disputes

the drag racing activity expenses exceeding income generated from

the activity for years 2004, 2005, and 2006 .

Petitioners' business plan for First Strike centered on

winning as many "grassroots" level races as possible to offset

their expenses while gaining enough acclaim and exposure to

attract large sponsors . When deciding to enter a race,

petitioners would weigh the purse size and their chances of

winning against their total expenses . Petitioners did not have a

written business plan and did not solicit any professional

business advice .

Petitioners' racing activity generated income from : (1) cash

prizes for winning or place finishing in races ;' and (2) gift

certificates from local auto parts stores for petitioners '

displaying one of their race cars in front of the store .

3 Petitioners reported they were entitled to the following

refunds : $6,099 for 2004, $6,901 for 2005, and $5,631 for 2006 .

4 Different cash prize amounts are awarded depending on

whether one wins or places in a race, with the prize amount being

larger the higher one finishes .

- 5 -

Petitioners' cash-prizes for drag racing activities from 2004

through 2006-is as follows :

•

2004 :

;one place finish ;

2005 :

three place finishes ; and

2006 : one or two wins, one-or two place finishes .

!Petitioners received'an undisclosed amount of gift certificates

from local auto-parts stores in 2005 and'2006 . Additionally, in

12006 petitioners received $4,600 from the sale of a broke n

engine . 5

Petitioners= ;claimed the following deductions on thei r

Schedules :C'for 2004, 2005,

Advertising

Car and .truck expenses

tCommissions and fees

(,'Depreciation

!Office expenses

Lease of business property

Supplies

!Taxes and licenses

4Travel expenses

lOther expenses

and 2006 :

2004

2005

200 6

$819

5,457

720

$1,129

3,934

1,600

2,880

2,800

1,514

8,733

200

-3,122

. $1,37 0

4,89 5

1,51 0

1,72 8

1,94 0

1,56 1

9,20 0

24 0

-.3,27 5

10,610

200

1,416

324

-1,200

960

Petitioners' did not establish a budget for expenses, kee p

financial books or records,

r maintain a separate bank accoun t

,for First Strike.

5 Mr . Leone testified he routinely broke at least two

!engines a year but that he "had enough spare parts on hand to

(piece [an engine] together to keep [racing] " . .

Petitioners had two race cars : a 2000 Chevy Dragster and a

1969 Chevelle . They also owned a 2004 Cross Country . '

'Petitioners initially referred to their race cars, as "dragsters"

but later clarified that the'Chevelle was just .a "regular race

car" they : used ,in drag races . '

Petitioners,placed their Chevelle into service in. January

2004 . They . reported 100 percent business use and_a basis of,

$18,000 and claimed depreciation deductions for 2004, 2005, and

2006 . Petitioners acquired the Chevy Dragster for $23,000 in

2001 and sold it for $19,000 in 2003 . Mr . Leone built one of his

cars with the aid of a local speed shop for around $22,000 .= Upon

quitting the activity in late 200,6 or 2007,

he sold the car for

around $10,000 . Mr . Leone did not specify which car he built or

to whom he sold it . No record of this alleged .sale was

presented .

6 Mr . Leone described the Chevy Dragster as .a. 32-foot

"long-rail" with a backside"engine and topside spoiler .

' Petitioners never mentioned the Cross Country during

their testimony ; however, it is listed as an asset on their 2005

and 2006 returns . The 2005 and 2006 returns show they placed'the

Cross Country into service in December of 2004, listed no basis,

and used . the standard mileage rate deduction for-the Cross

Country in 200 .and

5

2006, claiming 9,100 business miles in 2005

and 11,000 business miles in 2006 . It is unclear from the record

whether the Cross Country is a race car .

Petitioners used the term "dragster" when discussing

their cars .

-7

During the years in issue .Mr . Leone spent approximately 1 0

,j to 25 hours' .per week on,,the drag racing activity, Mrs . Leone

,spent approximately 10 .hours,per .week on the drag racing

activity, and occasionally friends helped with the drag racing

!activity . Petitioners worked on the drag racing activity either

rat the storage area where they kept . the drag racing cars or a t

their home . During the years-in issue petitioners did not keep a

time log or . calendar of these-hours .

Petitioners were the only drivers for First Strike . When

Mrs . Leone would'race, Mr . Leone . would "de-tune" the race car and

restrictits .maximum speed .

Petitioners ;, participated in approximately 10 races per year .

Some ,of the races-had a ,cash prize of $8,000 to $10,000 .

The

1largest prize petitioners received from any particular race was

1$1,500 .' The races were sponsored by the International Hot Ro d

Association and took place in different cities around th e

southwestern United States . Petitioners did not provide record s

}of ..race .participation despite having stated they possessed suc h

records' .

Petitioners did not conduct a written cost analysis for an y

of the races in which they participated . Petitioners did no t

61

provide any documents or records to show what changes ;- if any, to

improve profitability were made .

8 -

Petitioners discontinued their drag racing activity in 2007 .

Although they enjoyed the sport, the losses were .too=great .

Petitioners . liquidated the assets_from .their drag racing

activity .

Sale of Rental Hom e

In 1992 Mr . Leone purchased a property in El Paso'/ Texas .

used,it .as his primary residence until .2002 . During June 2002

Mr . Leone converted it into a,-rental property . In December of

2003 he agreed to sell it to a .coworker-for,$54•,000 .

.Title

complications delayed the closing of the sale, . and-petitioners

did not receive the funds from the sale of the home until July2005_

Petitioners included the expected proceeds from the=sale of

the home on their 2003,return and reported that .the sale had .

closed on December 15 ; 2003 . Petitioners,reported they had

received $54,000 for the . house and sustained an $11,237 ordinary

loss on the-sale of the property . 9

Petitioners did not receive the proceeds from the'sale of,

the home until 2005 . Petitioners received $51,640 .97 for .the-~

home .

9 On their 2003 Form 4797, Sales of Business Property, part

I, Sales or'Exchanges of Property Used in a Trade or Business and

Involuntary Conversions From Other Than Casualty or Theft- .-Most

Property Held More Than 1 Year, petitioners reported their rental

property had a basis of $69,000, they had deducted depreciation

of $3,763,,and they sold the home for $54,000 .

9

Petitioners . reported $54,000 as•the•selling price on thei r

200

.return

3

because .it was the initially agreed-upon price .

Petitioners reported $69,000 as the-=basis because it was th e

(value assigned to : the rental property by-the El Paso County tax

assessor . Subsequently, the parties stipulated that petitioners

had a $20,400 initial basis in the property :

Petitioners : subtracted $3,763 of depreciation from thei r

!basis to calculate the $11,237 ordinary loss reported on their

X2003 joint tax return . Petitioners claimed rental hom e

i

{depreciation deductions on their tax returns for,2002 and 200 3

!totaling $5,471 ; Mr . Leone deducted $2,016 of'-depreciation for

2002 on his : individual . tax return, and the Leones deducted $3,45 5

of depreciation for 2003 'on ..their. joint -tax return ., N o

explanation was given for the disparity in the depreciatio n

Discussion

" Activity Not Engaged In for Profit ,.

Section 183(a) provides generally that, if an activity i s

not engaged in for profit, no deduction attributable to suc h

activity shall be-allowed except as provided in section 183(b) .

Section 183,(c) defines an "activity not-engaged in for profit" a s

"any activity other than one,with respect to which'deductions ar e

,~allowable•for the taxable year under section 162 or unde r

paragraph (1) or (2) of section 212 ."

10 The Court of Appeals for the Fifth .. Circuit, to which an

appeal in this case would lie but for section 7463(b), has held

that for a deduction to be allowed under section 162 or 212(1) or

(2), a taxpayer must establish that he engaged in the activity

with the primary purpose and intent of realizing an economic

profit independent of tax savings .

Westbrook v . Commissioner , 68

F .3d 868, 875 (5th Cir . 1995), affg . T .C . Memo . 1993-634 .

The expectation of profit need not have been reasonable ;

however, the taxpayer must have entered into the activity, o r

continued it, . with the objective of making a profit .

Commissioner , 91 T .C . 371,

393(,1988) ;

Hulter v .

sec . 1 .183-2(a), Income

Tax Regs . Whether the requisite profit objective exists i s

determined by looking at all the surrounding facts and

circumstances .

Keanini v . Commissioner , . 94 T .C . 41, 46 (1990) ;

sec . 1 .183-2(b), Income Tax Regs . Greater weight is given to

objective facts than to a taxpayer' s mere statement of intent .

Thomas v . Commissioner , 84 T .C . 1244, 1269 (1985), affd . 792 F .2d

1256 (4th Cir . 1986) ; sec . 1 .183-2(a), Income Tax Regs .

Petitioners bear the burden of .proof . 10 See Rule 142(a) .

Section 1 .183-2(b), Income .Tax Regs ., provides a list of

factors to be considered in the evaluation of a taxpayer's profit

objective : (1) The .manner in which :the .taxpayer• carries on th e

10 Petitioners have neither claimed nor shown that they

satisfied the requirements of sec . 7491(a) to shift the burden of

proof to respondent with regard to any factual issue .

- 11 !activity ; ( 2) the expertise of the taxpayer or,his advisers ; (3)

the time and effort expended by the taxpayer in carrying on the .

{

activity ; ( 4) the expectation that assets . used in the activity

fmay appreciate in value ;

( 5) the success of the taxpayer in-

carrying on other similar or dissimilar activities ; ( 6) the .

taxpayer 's history of income or losses with respect,to th e

!activity ; (7) the amount of .occasional profits, if

~,activity ; .( 8) the financial status of the taxpayer ;

elements of .personal pleasure or recreation .

nonexclusive ,

any, from the

and (9)

This list is

and the number of factors for or - against th e

taxpayer is not necessarily determinative . Rather, all facts

nand circumstances must be taken into-account, . and more weight ma y

be given to .. some- factors :than to others .

Id .

! Commissioner , 701T .C . 715, 720 (1978), affd .

cf .

Dunn v .

:615tF .2d 578 (2d

}Cir . 1980) .

Petitioners assert the losses from their drag racing

activity-in 2004, 2005, and 2006 are deductible because they

i. engaged in the activity for profit : Respondent asserts

petitioners' .drag racing activity in 2004,°2005, and 2006 was not

!,engaged in for profit . . After considering the factors in section

1 .183-2(b), Income Tax Regs .=, we .agree'with respondent'and

conclude petitioners' drag racing activity-in-2004, 2005 ; . an d

2006 ..was not engaged in for-profit and, accordingly, petitioner s

fare-not entitled to deduct-losses-incurred =in such activity .

- 12 A.

Manner in Which the Activity Is Conducte d

,Section 1 .,183-2(b)(1), Income Tax Regs ., provides that

carrying on an activity,in a businesslike . manner maybe

indicative of a profit objective . The regulation further

identifies three practices consistent with businesslike

operations : (1) Maintaining-complete and accurate books and .

records ; (2) conducting the activity in,a .manner substantially

similar to that of ..profitable businesses,of ;the same nature ; .and

(3) changing operational methods and techniques . .to improve,

profitability . See id .

The Tax Court has found . establishing a

business, plan to be a fourth practice evidencing businesslike

operations . See Sanders-v. . .Commissioner , T .C . Memo . 1999-208 . .

Petitioners did not .maintain any financial books or ledgers

for their racing activity and had1no records of the races in .

which they raced . In addition, petitioners did not keep a budget

of their expenses or record how much income they received,or from

where it was,generated . This lack of elementary business'

practices, indicates a lack of . profit' objective . See Snoddy v .

Commissioner , T .C .• Memo .-1991-251(stating that "we think a

serious business-operation would have kept records to show races

petitioner entered,- and what his winnings were . in each .. race") ;

'Woods v . Commissioner ,,T .C . Memo . . 1985-233 (finding that ..

taxpayer whodid"not-maintain a formal general- ledger, account s

receivable ledger, accounts payable ledger,, or asset ledgers in

- 13 ,stock racing-activity-did not operate ina businesslike manner) ;

whitener v . Commissioner , T .C . Memo . 1979-415 (finding that a

Itaxpayer who kept no . business books or-records did not conduct

his stock car racing -activity in a businesslike manner) .

Petitioners' alleged efforts to improve profitability'-by

changing their=methods ands-techniques of conducting their drag

racing activity is .not substantiated by the ;,record . Mr . Leon e

"testified that he received advice-fromfellow racers on variou s

racing issues and as,a result he and his . wife were more frugal i n

advertising First Strike . However, no•evidence was,presented t o

!show what changes were made or when <they were implemented .

Further, petitioners' tax returns reveal their advertising

expenses steadily increased each year from 20041to 2006 . . Cf .

[ Dwyer v . Commissioner , T .C . Memo . 1991-123 ;:(finding indication o f

profit objective .for taxpayer's .financing . .son'.s auto racing

career .where taxpayer changed operating .methods, tried-new

approaches, and discontinued methods that did not work) :

Petitioners testified that they intended tozmake First

Strike„a profitable business by .winning races as often as , .

possible in hopes of .attracting a large sponsor .- Petitioners did

not present a wwritten business plan .

. .A, lack of,a formal written

business plan isnot determinative of a lack of profit . objective .

;,See Sanders v . . Commissioner ,- supra . . Nevertheless, some

14 indication of a plan for success (i .e ., profitability) should be

given .

Id .

Given the substantial costs associated with operating

petitioners', drag racing team, more than petitioners' vague and

wishful representation that they would be profitable by winning

often is needed to conclude petitioners had a plan to make a

profit . See id . ;

Spear v . Commissioner , T .C . Memo . 1994-354

(finding unpersuasive a business plan for racing activity that

consisted solely of the taxpayer's claiming it would take°10

years before the activity would become profitable) . This factor

weighs against finding petitioners' drag racing activity was

engaged in for profit .

B.

Expertis e

A taxpayer's expertise, research, and study of an activity,

as well as his consultation with experts ; may be indicative of .a

profit intent . Sec . 1 .183-2(b)(2), Income Tax Regs . Taxpayers

should not only familiarize-themselves with the undertaking, but

should also consult or employ an expert, if needed, for advice on

how to make the operation profitable .

809 F .2d 355,

Burger v . Commissioner ,

359 (7th Cir . 1987), affg . T .C . Memo . 1985-523 .

Courts have made clear that the focus is upon expertise and

preparation with regard to the economic aspects of the particular

business .

Wesinger v . Commissioner , T .C . Memo . 1999-372 (citing

15 Golanty v .--Commissioner , 72 T .C . 411, 432

published opinion 647 F .2d 170

( 1 9 .79 ),

affd . without

( 9th Cir . 1981)) .

Petitioners ; had no experience managing adrag racing-team .

Despite incurring significant - losses and rarely winning or

placing, petitioners . never solicited the aid of any professiona l

!business advisers .

:drag racers ,

Petitioners did receive advice from fellow

but no evidence was presented to suggest these drag

,tracers were . experts or had experience -with- the business side o f

racing . This factor weighs against finding petitioners' drag

racing activity was engaged in-for profit .

C. .

I

Time . and Effort Expende d

The fact that a taxpayer spends much time and effort in

conducting an activity may indicate that he or she .has a .profi t

objective, particularly if the activity-does-'not have substantial

!personal or recreational aspects . Sec . 1- .183-2(b)(3), Income Tax

1Regs .

During the years in issue petitioners were both employe d

.Gfull .time by the"U .S . Postal Service . Petitioners devoted their

time after work hours and on weekends to First Strike .

Petitioners . .did not maintain'a professional crew, received

sporadic help from friends, and were the only drivers for ; Firs t

Strike . The activity primarily consisted of Mr .-Leone's workin g

on the cars, petitioners' driving to races, and the race s

themselves . Although the . record does indicate petitioners spent

- 16 time (outside of their full-time postal employment) on their drag

racing activity, this does little to support petitioners' claim

that it was a serious activity engaged in for profit . See Snoddv

v . Commissioner , T .C . Memo . 1991-251 (finding lack of support for

a profit motive in a car racing activity when the taxpayer was a

full-time manager at an auto parts store, mainly worked on the

car after hours and on weekends, enlisted volunteers to help with

working on the car and serve in the "pit", and had an independent

driver) . Further, it is clear this activity had substantial

recreational aspects for Mr . Leone . This factor weighs against

finding petitioners' drag racing activity was engaged in for

profit .

D.

The Expectation That Assets May Appreciate in Value

A taxpayer may intend, despite the lack of profit from

current operations, that an overall profit will result when

appreciation in the value of assets used in the activity is

realized .

Bessenyey v . Commissioner , 45 T .C . 261, 274 (1965),

affd . 379 F .2d 252 (2d Cir . 1967) ; sec . 1 .183-2(b)(4), Income Tax

Regs .

Petitioners routinely broke at least two'drag racing car

engines per year, a fact that seems inconsistent with their claim

that the drag racing cars would appreciate in value . Petitioners

sustained a loss when they sold the Chevy Dragster in 2003 .

Petitioners presented no evidence regarding the appreciation of

17 their remaining assets . This factor weighs against finding

petitioners' drag racing activity was engaged in for profit .

E.

Success in Similar or Dissimilar Activitie s

If a taxpayer has previously engaged in similar activities

and made them profitable, this success may show that the taxpayer

has a profit objective, even though . the activity is presently

unprofitable . Sec . 1 .183-2(b)(5), Income Tax Regs . Success in

unrelated . activities may also be indicative of a profit objective

in the challenged activity . See Daugherty v . Commissioner , T .C .

.Memo . 1983-188 (finding that a taxpayer who started and

maintained a profitable screws product company had reason to

believe he would be successful in a farming activity) .

Conversely, a lack of such experience does not necessarily

indicate the activity was not engaged in with the objective o f

l

making a profit .'

Arwood v . Commissioner , T .C . Memo . 1993-352 .

;,Petitioners had no previous experience in any other businesses .

This factor is neutral .

F.

Historyfof Income or Loss and Potential

for Profitabilit y

A record of substantial losses over several years may b e

indicative of the absence of a profit objective . See Golanty v .

. Commissioner ,

{

supra . The amount of profits in relation to the

amount of losses incurred, and in relation to the amount of th e

taxpayer's investment and the value of the assets used in th e

[activity, may provide useful criteria in determining the

t

- 18 taxpayer's intent . Sec . 1 .183-2(b)(7), Income Tax Regs . An

occasional small profit from an activity generating large losses,

or from an activity in which the taxpayer has made a large

investment, would not generally be determinative that the

activity is engaged in for profit .

Id .

Petitioners suffered an uninterrupted history of losses from

their drag racing activity from 2002 through 2006 and never

turned a profit . Petitioners invested $111,472 in their drag

racing venture yet earned only $14,463 and sustained a net loss

of $97,009 .

Furthermore, it does not appear petitioners would have had

the ability to recoup their losses or make a profit .

Petitioners have not produced any evidence to suggest they were

close to securing a large sponsor . In petitioners' case the

potential for profitability through winning races alone seems

implausible . Petitioners participated in about 10 races a year,

with some purses in the range of $8,000 to $10,000 . However,

petitioners' winnings suggest they were limited .to winning small

races with small purses . See Dwyer v . Commissioner , T .C . Memo .

1991-123 (finding a profit objective for a taxpayer involved in a

stock car racing activity where, inter alia, the taxpayer could

conceivably recoup past losses and turn a profit because purses

averaged hundreds of thousands of dollars) . This factor weighs

- 19 -

against finding petitioners' drag racing activity was engaged in

for profit .

G.

Financial Statu s

Substantial income from sources other than the activity in

question, particularly if the activity's losses generate

substantial tax benefits, may indicate that the activity is not

engaged in for profit . See sec . 1 .183-2(b)(8), Income Tax Regs .

Petitioners' annual combined income was approximately

$100,000 from their employment as U .S . postal workers .

Petitioners derived substantial tax benefits from deducting the

.losses associated with their Schedule C activity . First Strike's

losses offset roughly one-fifth of petitioners' income an d

,resulted in petitioners claiming refunds for each year . This

factor weighs against finding petitioners' drag racing activity

was engaged in for profit .

Elements of Personal Pleasur e

.The absence of personal pleasure or recreation relating t o

the activity in question may indicate the presence of a profit

objective, but the mere fact that a taxpayer derives persona l

pleasure from a particular activity does not, per se, demonstrate

°a lack of a ,profit objective . See Rinehart v . Commissioner , T .C .

I

CMemo . 1998 - 205 ; sec . 1 .183-2( b)(9), Income Tax Regs . However,

,should the likelihood of profit be small compared to th e

possibility for gratification, the latter possibility may be the

- 20 primary motivation for the activity .

Filios v . Commissioner ,

T .C . Memo . 1999-92 (citing White v . Commissioner , 23 T .C . 90, 94

(1954), affd . per curiam 227 F .2d 779 (6th Cir . 1955)), affd . 224

F .3d 16 (1st Cir . 2000) .

Petitioners readily admitted they enjoyed .racing . Despite

petitioners' substantial losses and small chance to turn a

profit, petitioners continued to race . Petitioners spent their

time repairing the drag racing cars and driving to various cities

to participate in drag races . We have previously stated that

automobile racing is often engaged in for amusement and as

a

.hobby, and that this tends to militate against a finding that the

activity was engaged in for profit .

Whitener v . Commissioner ,

T .C . Memo . 1979-415 (citing McLean v . Commissioner , 285 F .2d 756

(4th Cir . 1961), affg . per curiam T .C . Memo . 1960-128) .

Petitioners' approach to their drag racing activity suggests they

viewed drag racing as a recreational getaway rather than a

profit-earning activity . This factor weighs against finding

petitioners' drag racing activity was engaged in for profit . .

I .

Conclusio n

Petitioners did not conduct their drag racing activity in a

businesslike manner . They had an extended, uninterrupted period

of substantial losses and had no practical possibility of

recouping their losses and turning a profit . Furthermore, there

was a substantial recreational aspect to petitioners' drag racing

21 activity . Accordingly, we hold that petitioners' drag racing

activity was not engaged in for profit during 2004, 2005, and

2006, and section 183(b)(2) prohibits any deduction of expenses'

greater than the gross income derived from the activity .

II .

Sale of Rental Propert y

Section 61( a) defines gross income to include all incom e

from whatever source derived, and section 61(a)(3) specifically

provides that gross income includes gains derived from dealings

in property . Section 1001(a) provides that the gain from the

sale of property shall be the excess of the . amount realize d

4therefrom over the taxpayer's adjusted basis in the property .

Section 1001(b) defines the amount realized from the sale or

other disposition of property as the sum of any money plus the

fair market value of the property received . See also sec .

1 .1001-1(a), Income Tax Regs . Petitioners sold their rental home

in 2005 .for gross proceeds of $51,640 .97 . Accordingly,

petitioners realized $51,640 .97 for the sale of their rental hom e

in 2005,.

Section 101,2 provides that a property's adjusted basis shall

be the cost of such property, and cost is defined as the amount

paid for the property*in cash or other'property . Sec . 1 .1012'a1(a), Income Tax,Regs . In addition, section 1016(a)(2) provides

that the basis should be adjusted for depreciation deductions .

Leone paid $20,400 in 1992 for his rental . home and deducted

- 22 $5,47111 of depreciation for 2002 and 2003 . In 2003 petitioners

had an adjusted basis of $14,929 .

When petitioners received $51,640 .97 in 2005 for the sale of

their rental property, they recognized a gain of $36,711 .97 . See

sec . 1001 ( c) . Because this was a sale of qualified section 1231

property and petitioners had no other section 1231 propert y

dispositions, the gain is taxed at 2005 capital gain rates .1 2

See sec . 1231 ( a)(1), (b) ; sec . 1 .1231-1( a), '(c), Income Tax Regs .

III .

Accuracy-Related Penalt y

Respondent determined that petitioners are liable for

accuracy-related penalties under section 6662 for 2004, 2005, and

2006 . Respondent argues that petitioners are liable for th e

section 6662 accuracy-related penalty attributable to one or mor e

of the following : ( 1) Negligence or disregard of rules o r

regulations ; (2) substantial understatement of income tax ; and

11 For 2002 Mr . Leone deducted depreciation of $2,016, and

for 2003 petitioners deducted depreciation of $3,.455 .

12 On brief respondent argued that the tax benefit rule

dictates that petitioners' 2005 income should be increased by

$11,237 (the amount of the ordinary loss deducted on the sale of

the property in 2003) . We consider the tax benefit rule to be a

new matter because it would require the presentation of different

evidence from the evidence required to tax petitioners on the

gain resulting from the sale of their house in 2005 . The . tax

benefit rule and 2003 were not referenced in the statutory notice

of deficiency, and respondent never amended his answer . We find

that this issue is not before the Court . See Foil v .

Commissioner , 92 T .C . 376, 418 (1989), affd . per curiam 920 F .2d

1196 (5th Cir . 1990) ; Markwardt v . Commissioner , 64 T .C . 989, 997

(1975)

- 23 (3)-substantial valuation misstatement (overstatement) .

See sec .

6662(b) . Respondent has not alleged a substantial valuation

(misstatement for 20 .04, 2005,"or 2006 . 8

Section 7491(c) provides that the Commissioner bears th e

burden of production with respect to'the liability of an y

{individual for additions to tax"and penalties . The

!Commissioner's ..burden of production under section 7491(c) is t o

,produce evidence that-it is appropriate to impose the relevant

penalty, addition to tax, or additional amount .

Swain,v .

CCommissioner, '118 T .C . 358, 363 (2002) ; see also= Higbee v .

Commissioner , 116 T .C . 438, 446 (2001) If a taxpayer files a

petition alleging some error in the determination of an, addition

to tax or a penalty, the taxpayer's challenge will succeed unless

the Commissioner, produces evidence-that the addition•to tax or

the penalty is appropriate . ' Swain v . Commissioner ,

supra at,363-

365~ . The Commissioner, however,-does not have the obligation to

introduce evidence regarding reasonable cause or substantial

authority .

Higbee_v_ Commissioner ,

supra at 446-447 .

'Section 6662(a) imposes a .penalty in an amount equal_.to 2 0

(percent of the .portion_,of the underpayment of tax attributable to

done or more of the items set forth in section .6662(b), including

!negligence or .disregard of rules or regulations and substantial

understatement of income tax . "Negligence" includes any failur e

to make a reasonable attempt to comply with the provisions of the

- 24 internal revenue laws and is the failure to exercise due care or

the failure to do what a reasonable and prudent person would do

under the circumstances . Sec . 6662(c) ;

Neely v . Commissioner , 85

T .C . 943, 947 (1985) ; sec . 1 .6662-3(b)(1), Income Tax Regs .

"Disregard" includes any careless, reckless, or intentiona l

disregard of rules or regulations . Sec . 6662(c) ; sec . 1 .66623(b)(2), Income Tax Regs . An "understatement" of income tax is

the difference between the amount of tax required to be shown on

the return and the amount of tax actually shown on the return .

Sec . 6662(d)(2)(A) . A "substantial understatement" exists if the

understatement exceeds the greater of (1) 10 percent of the tax

required to be shown on the return for a taxable year, or (2)

$5,000 .

Sec . 6662(d) (1) (A) .

The section 6662(a) accuracy-related penalty does not apply

with respect to any portion of an underpayment if it is shown

that there was reasonable cause for such portion and that the

taxpayer acted in good faith with respect to such portion . Sec .

6664(c)(1) . The determination of whether a taxpayer acted with

reasonable cause and in good faith depends on the pertinent

facts and circumstances . Sec . 1 .6664-4(b) .(l), Income Tax Regs .

The most important factor is the extent of the taxpayer's effort

to assess his or her proper tax liability .

Id .

Petitioners do not contest the penalties relating to their

drag racing activity . Accordingly, we sustain the section 6662

- 25

(penalties with regard to petitioners'

drag racing activity fo r

!2004, 2005, . and 2006 . See sec . 7491(c) .

However, petitioners contend that they'are'not liable for

{the portion of-,the accuracy-related penalty for 2005 related t o

the sale of their rental home . They claim they already paid tax

for 2003 relating-to the sale of their rental home13 and were

simply following . the advice of-their tax adviser .

Petitioners' failure to report the gain from the sale of

their-rental-home in 2005 was negligent . See sec . 6662(c) ;-sec .

1 .6662-3(b)(1) and (2), Income Tax Regs .

Petitioners claim their understatement was reasonable and i n

l .good-faith because they'relied u'pon the°advice of their ta x

return`preparer ; Ms Barton; when reporting the' sale •of thei r

rental home for 2003 . . Reliance on a return preparer may reliev e

{a taxpayer from the addition to`tax for negligence where th e

taxpayer's reliance is reasonable .

T .C .

849, 888

1501 U .S .

( 1987 ),

868 (1991 ) .

Freytag v . Commissioner , 8 9

affd . 904 F . 2d 1011

A taxpayer ,

( 5th Cir . 1990), affd .

however, is not relieved from

Lliability for the addition to tax for negligence merely by

(shifting the responsibility to .a tax -professional .

Enoch v .

Commissioner , 57~,T .C . 781, 802 (1972)' . Reliance on an expert i s

not "an absolute defense but is ' a factor to be considered :

13 On their income tax return for 2003, petitioners

reported a loss from the sale of the rental property and received

a tax benefit .

- 26 Freytag v . Commissioner ,

supra at 888 . A taxpayer's reliance

must be in good faith and demonstrably reasonable .

Ewing v .

Commissioner , 91 T .C . 396, 423 (1988), affd . without published

opinion 940 F .2d 1534 (9th Cir . 1991) ;

Freytag v . Commissioner ,

supra at 888-889 . In such a case, a taxpayer will be entitled to

rely upon an expert's advice, even if the advice should prove to

be erroneous .

Jackson v . Commissioner , 86 T .C . 492, 539 (1986),

affd . on other issues 864 F .2d 1521 (10th Cir . 1989) ;

Brown v .

Commissioner , 47 T .C . 399, 410 (1967), affd . per curiam 398 F .2d

832 (6th Cir . 1.968) .

The ultimate responsibility for a correct return lies with

the taxpayer, who must furnish the necessary information to the

agent who prepared the return .

Enoch v . Commissioner ,

supra at

802 . In other words, reliance upon expert advice will . no t

exculpate a taxpayer who supplies the return preparer with

incomplete or inaccurate information .

Lester Lumber Co . v .

Commissioner , 14 T .C . 255, 263 (1950) .

Petitioners stated they informed Ms . Barton that the sale

did not close until 2005 but did not think they provided her with

the closing papers . Accordingly, petitioners have not

established that they acted in good faith or had reasonable cause

in failing to report capital gain from the sale of their rental

home . See Green v . Commissioner , 507 F .3d 857, 872 (5th Cir .

2007) (upholding imposition of section 6662 penalty even though

taxpayer consulted a professional because "there was no evidence

as to what * * * r [the taxpayer] told the` preparer, what the

preparer told * * *[the taxpayer], and whether or not'* * * [the

taxpayer' .s] reliance on any advice from the preparer was

reasonable ."), affg . T .C .Memo . 2005-250 . Given this lack o f

evidence, we sustai n respondent's determination of,the sectio n

6662 (a) .penalty .

To reflect the foregoing,

'Decision will be entered

under Rule 155 .