UNITED STATES TAX COURT
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T.C. Memo. 2004-200
UNITED STATES TAX COURT
JOHN WELLER WOOD, JR., AND MAGDALENA FRANCES WOOD, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 5259-99, 15992-99.
Filed August 31, 2004.
John Weller Wood, Jr., and Magdalena Frances Wood, pro sese.
Lorianne D. Masano, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
JACOBS, Judge:
Respondent determined deficiencies in
petitioners’ Federal income tax and accuracy-related penalties as
follows:
- 2 -
Year
Deficiency
Accuracy-related penalty
Sec. 6662(a)
1994
1995
1996
$23,663
3,102
7,515
$4,732
620
1,503
After concessions by John Weller Wood (petitioner),1 the
issues to be decided in these cases are:
1.
Whether respondent violated the automatic stay under
section 362 of the Bankruptcy Code2 by auditing petitioner’s
Forms 1040, U.S. Individual Income Tax Return, and issuing
notices of deficiency for 1994, 1995, and 1996;
2.
whether petitioner’s capital gain in 1994 on the sale of
a house in Warren, New Jersey, was less than the $90,888
determined by respondent;
1
Petitioner concedes that:
1. For 1994, the amount allowable as an itemized deduction
for real estate taxes is $12,835 as determined by respondent,
rather than $24,389 as claimed on Schedule A, Itemized
Deductions, of the Form 1040, U.S. Individual Income Tax Return;
2. he is not entitled to deduct losses of $3,431 for 1994
and $809 for 1995 from IDN Distributorship or $1,578 for 1995
from Home Business Services;
3. for 1996, the amount allowable as a loss from the sale
of a Buick LeSabre is $201 as determined by respondent, rather
than $19,233 as reported on Form 4797, Sales of Business
Property; and
4. the statute of limitations does not bar assessment of
tax for 1994.
2
Bankruptcy Code references are to 11 U.S.C. (2000).
- 3 3.
whether petitioner understated the net profits from his
consulting business by $24,016 in 1994, $7,037 in 1995, and
$13,094 in 1996;
4. (a)
whether petitioner is a real estate dealer, and, if
so, whether he is entitled to deduct business losses of $121,966
reported in 1994, $72,546 reported in 1995, and $345,223 reported
in 1996, or alternatively
(b)
if petitioner is not a real estate dealer, then
whether he is entitled to (i) deductions on Schedule A, Itemized
Deductions, greater than $25,665 in 1994, $45,066 in 1995, and
$8,545 in 1996, as allowed by respondent, and (ii) deductions for
rental expenses on Schedule E, Supplemental Income and Loss,
greater than $13,977, as allowed by respondent for 1994;
5.
whether petitioner is entitled to deduct net operating
loss carryovers of $18,520 in 1994 and $36,389 in 1996;
6.
whether petitioner is liable for self-employment tax of
$5,902 for 1994, $3,102 for 1995, and $3,626 for 1996;3 and
7.
whether petitioner is liable for the accuracy-related
penalty under section 6662(a)4
for each of the years at issue.
3
The parties agree that in computing petitioner’s Federal
income tax liability for each year petitioner may deduct one-half
of the self-employment tax.
4
Unless otherwise noted, 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.
- 4 FINDINGS OF FACT
Some of the facts have been stipulated and are found
accordingly.
The stipulation of facts, the supplemental
stipulation of facts, and the exhibits submitted therewith are
incorporated herein by this reference.
Petitioner and his wife, Magdalena Frances Wood5 (Mrs.
Wood), resided in Orlando, Florida, when the petitions in these
cases were filed.
Petitioner graduated from West Point in 1960 and served in
the military until 1977.
In 1967 while he was in Florida
attending the Air Ground Operations School at Eglin Air Force
Base, petitioner and other officers became shareholders of
Miracle Strip Parkway Realty, Inc. (MSPR, Inc.), a corporation
organized for the purpose of buying land to be divided into lots.
Approximately 20 persons invested in MSPR, Inc.
At some time
before the years at issue, MSPR, Inc., converted to a limited
partnership and thereafter was known as Miracle Strip Parkway
Realty, Ltd. (MSPR, Ltd.).
MSPR, Ltd.
5
Petitioner was a limited partner of
Over the years, MSPR, Ltd., purchased and sold
Magdalena Frances Wood did not appear at the trial in these
cases and did not execute the stipulation of facts or the
supplemental stipulation of facts. Respondent filed a motion to
dismiss the cases with respect to Mrs. Wood for failure to
properly prosecute. The Court will grant respondent’s motion and
will dismiss these cases as to her. See Rule 123(b).
- 5 undeveloped land to individuals, real estate companies, and
developers.
In 1974, petitioner and Mrs. Wood purchased a house in
Annandale, Virginia (the Virginia house), for $57,000.
They
resided in the Virginia house until petitioner retired from the
military in 1977.
In 1976, petitioner and Mrs. Wood purchased undeveloped land
in Florida.
The land remained undeveloped through the years at
issue.
When petitioner retired from the military in 1977, he and
Mrs. Wood moved to New Jersey.
They sold the Virginia house for
$70,000 (incurring closing costs of $3,000 on the sale) and
purchased a house in Warren, New Jersey (the New Jersey house),
for $87,900 (incurring closing costs of $1,214.25).
Petitioner
and Mrs. Wood did not report the gain from the sale of the
Virginia house on their 1977 Federal income tax return.
While
living in the New Jersey house, they made capital improvements
costing $153,435.
In 1977, petitioner and Mrs. Wood purchased a 1-week
timeshare unit in Brookdale, Pennsylvania (the Brookdale
timeshare), for $7,900.
After petitioner moved to New Jersey, he was employed first
by Lockheed Electronics and then by ITT Avionics.
In 1981,
- 6 petitioner started a consulting business.
He also began a home
improvement business, operating under the name “J&M Enterprises”.
Petitioner’s mother owned an apartment in Shrewsbury, New Jersey.
Over the years, petitioner repaired, cleaned, managed, and found
tenants for that apartment.6
Petitioner spent approximately 1
week each year maintaining and managing the apartment.
In 1982, petitioner filed a business name certificate with
the State of New Jersey, certifying that he was conducting a
business under the name “The Logistics Technology Group.”
The
nature of the business was described as defense electronics
consulting services, real estate dealer activities, and home
improvement services.
Petitioner opened a bank account titled
“Logistics Technology Group” (the LTG account).
In 1986, petitioner and Mrs. Wood purchased a house in
Hilton Head, South Carolina (the South Carolina house), and, in
1987, they purchased a 1-week timeshare unit in Gulfstream,
Florida (the Gulfstream timeshare), for $7,900.
In 1988, petitioner and Mrs. Wood purchased land in Boca
Raton, Florida, and, in 1989, they hired a builder to construct a
home on that property (the Florida house).
To help finance the
construction of the Florida house, petitioner and Mrs. Wood sold
the South Carolina house in 1989.
6
Petitioner began these activities in 1972 and continued
them through 1996.
- 7 In 1989 and 1990, petitioner generally paid the installments
on the New Jersey house mortgage, as well as the taxes and
related fees associated with the undeveloped land in Florida, the
Brookdale timeshare, and the Gulfstream timeshare, from the LTG
account.
Petitioner advertised the New Jersey house for sale and
found a buyer.
However, the buyer under the contract of sale
defaulted, and the sale did not go through.
(Petitioner was
relying on the proceeds from the sale of the New Jersey house to
repay loans for constructing the Florida house.)
After the buyer
defaulted, petitioner obtained money from his brother ($105,000)
and Mrs. Wood’s mother ($100,000) to assist with the cost of
constructing the Florida house.
Petitioner paid an additional
$155,000 of the cost and obtained a loan for the balance.
Petitioner and Mrs. Wood moved into the Florida house in
August 1990 and listed the New Jersey house for sale with a real
estate agent.
The real estate agent rented the New Jersey house
for petitioner on a month-to-month basis from 1992 until it sold
in 1994.
A lease, dated March 15, 1993, specified that the New
Jersey house would remain on the market for sale and could be
shown to prospective buyers by appointment.
The lease also
provided that, if a contract of sale was accepted, the tenant
would be given 90 days’ notice to vacate the property.
- 8 In 1994, petitioner and Mrs. Wood entered into a contract to
sell the undeveloped land in Florida, but the buyer failed to
perform under the contract.
On April 29, 1994, petitioner and Mrs. Wood filed for
bankruptcy under chapter 11 of the Bankruptcy Code (chapter 11)
in the U.S. Bankruptcy Court for the Southern District of Florida
(the bankruptcy court).
On May 9, 1994, petitioner and Mrs. Wood
sold the New Jersey house for $334,000.
expenses related to the sale.
They incurred $20,300 of
Allowable depreciation for the 3-
year period the house was rented totaled $9,737.
On September 13, 1994, the Internal Revenue Service (IRS)
filed with the bankruptcy court a proof of claim, claiming an
unsecured nonpriority claim of $2,200 and an unsecured priority
claim of $20,389.54.
On January 18, 1995, petitioner and Mrs. Wood filed with the
bankruptcy court their chapter 11 plan of reorganization.
Pursuant to the plan, the bankruptcy court retained jurisdiction
of the case until all payments and distributions called for under
the plan had been made.
The plan noted that the Florida house
had been listed with a licensed realtor for sale for $994,900.
By order dated February 6, 1995, the bankruptcy court
confirmed the plan of reorganization.
The order confirming the
plan proclaimed:
that, except as provided in the Plan, the individual
Debtors are discharged from any debt that arose before
- 9 the date of confirmation of the Plan, except any debts
excepted from discharge under § 523 of the Bankruptcy
Code, and except if the Debtors would be denied a
discharge under § 727(a) of a chapter 7 case; * * *
On May 18, 1995, the bankruptcy court issued its final
decree and closed the bankruptcy case.
Petitioner and Mrs. Wood resided in the Florida house until
January 1996, when the mortgage was foreclosed.
They continued
to own the undeveloped land in Florida, the Brookdale timeshare,
and the Gulfstream timeshare throughout 1996.
On their 1994, 1995, and 1996 Forms 1040, U.S. Individual
Income Tax Return, petitioner and Mrs. Wood reported the
following:
Income
Wages, salaries, tips, etc.
Taxable interest
Business income or (loss)--Schedule C
Capital gain or (loss)--Schedule D
Other gains or (losses)--Form 4797
Pensions & annuities--taxable amount
Other income
Total income
Schedule A
Medical & dental
Taxes
Real estate taxes
Personal property taxes
Home mortgage interest
Total itemized deductions
Itemized deductions/Standard deduction
Taxable income
1994
1995
1996
-$408
(107,644)
76,771
-021,372
-(9,093)
-$86
(58,440)
--21,965
-(36,389)
$1,442
908
(334,232)
-(20,581)
22,544
(36,389)
(366,308)
1,365
--
--
24,389
35
42,614
68,403
68,403
-0-
11,610
-23,476
35,086
35,086
-0-
----6,700
-0-
- 10 The capital gain reported in 1994 was gain on the sale of
the New Jersey house.
The business income reported each year was attributable to
three activities that were reported on separate Schedules C,
Profit or Loss From Business--one for Mr. Wood’s consulting
business (the consulting business Schedule C), one for his
property management/real estate activity (the property management
Schedule C), and one for a distributorship (the distributorship
Schedule C).
The Schedules C reported aggregate net operating
losses each year as follows:
- 11 -
Consulting business Schedule C
Income
Expenses
Expense for business use of home
Net profit
Property management Schedule C
Income1
Expenses
Depreciation
Insurance
Mortgage interest
Other interest
Legal
Office expense
Repairs and maintenance
Taxes and licenses
Travel
Total
Net profit (loss)
Distributorship Schedule C
Income
Expenses
Net profit (loss)
1994
1995
1996
75,657
(51,879)
(6,025)
17,753
53,804
(27,527)
(11,362)
14,915
60,072
(42,829)
(4,674)
12,569
-0-
-0-
(336,981)
3,536
148
106,322
-283
236
7,196
3,659
586
121,966
(121,966)
27,525
-33,487
1,357
500
--9,677
-72,546
(72,546)
---8,242
-----8,242
(345,223)
(776)
(2,655)
(3,431)
-0(809)
(809)
-0(1,578)
(1,578)
1
For 1994 and 1995, petitioner reported no inventory at the beginning
and close of each year with respect to the property management and real
estate dealership business. For 1996, he reported opening inventory of
$355,966 and closing inventory of $18,985 for which he reported cost of goods
sold of $336,981. Petitioner did not attach an explanation as to why the
1996 beginning year inventory was different from the 1995 closing inventory.
In December 1997, the IRS began an examination of
petitioner’s 1994-96 returns.
On December 21, 1998, respondent
issued petitioner and Mrs. Wood a notice of deficiency for 1994.
On July 19, 1999, respondent issued them a notice of deficiency
for 1995-96.
In the notices of deficiency, respondent (1)
increased the capital gain on the sale of the New Jersey house by
$14,117 ($90,888 rather than the $76,771 reported on petitioner’s
- 12 1994 return), (2) increased petitioner’s profits from his
consulting business by $24,016 for 1994, $7,037 for 1995, and
$13,094 for 1996, consisting of omitted gross receipts and
disallowed claimed business expenses, (3) disallowed net losses
(for expenses attributable to the New Jersey house, the Florida
house, the undeveloped land in Florida, and the timeshares and a
loss on the sale of the Florida house) totaling $121,966 in 1994,
$72,546 in 1995, and $345,223 in 1996 claimed by petitioner and
Mrs. Wood on the property management Schedules C, (4) disallowed
losses of $3,431 for 1994, $809 for 1995, and $1,578 for 1995
claimed on the distributorship Schedules C, (5) allowed
petitioner deductions on Schedule E for expenses relating to the
rental of the New Jersey house before its sale that had been
claimed on the property management Schedules C, (6) made
adjustments to Schedule A itemized deductions, (7) disallowed
$19,032 of the $19,233 loss from the sale of a Buick LeSabre
petitioner claimed on Form 4797 of the 1996 return, (8)
determined that petitioner was liable for self-employment taxes
on the net profit from his consulting business and allowed
petitioner a deduction for half of those taxes, (9) allowed
petitioner a net operating loss carryover of $18,520 to 1994, and
(10) disallowed the net operating loss carryover of $36,389
petitioner claimed on the 1996 return.
- 13 OPINION
I.
Violation of Automatic Bankruptcy Stay
This Court has limited jurisdiction, and we may exercise
jurisdiction only to the extent authorized by Congress.
v. Commissioner, 85 T.C. 527, 529 (1985).
Naftel
Our jurisdiction to
redetermine a deficiency depends upon the issuance of a valid
notice of deficiency and a timely filed petition.
Rule 13(a),
(c); Monge v. Commissioner, 93 T.C. 22, 27 (1989); Normac, Inc.
v. Commissioner, 90 T.C. 142, 147 (1988).
Section 6212(a) expressly authorizes the Commissioner, after
determining a deficiency, to send a notice of deficiency to the
taxpayer by certified or registered mail.
The taxpayer, in turn,
generally has 90 days from the date the notice of deficiency is
mailed to file a petition in this Court for a redetermination of
the deficiency.
Sec. 6213(a).
An exception to the normal 90-day filing period arises where
the taxpayer has filed a petition for relief under the Bankruptcy
Code.
Sec. 6213(f).
The filing of a bankruptcy petition
operates as an automatic stay which precludes the commencement or
continuation of proceedings in this Court.
11 U.S.C. sec.
362(a)(8); Kieu v. Commissioner, 105 T.C. 387, 391 (1995);
Allison v. Commissioner, 97 T.C. 544, 545 (1991).
Petitioner contends that respondent violated the automatic
stay in his chapter 11 bankruptcy proceeding under section 362 of
- 14 the Bankruptcy Code by conducting a tax audit and issuing the
notices of deficiency.
Section 362(a) of the Bankruptcy Code provides in pertinent
part:
(a) Except as provided in subsection (b) of this
section, a petition filed under section 301, 302, or
303 of this title, * * * operates as a stay, applicable
to all entities, of–
*
*
*
*
*
*
*
(4) any act to create, perfect, or enforce any lien
against property of the estate;
(5) any act to create, perfect, or enforce against
property of the debtor any lien to the extent that such
lien secures a claim that arose before the commencement
of the case under this title;
(6) any act to collect, assess, or recover a claim
against the debtor that arose before the commencement
of the case under this title;
*
*
*
*
*
*
*
(8) the commencement or continuation of a proceeding
before the United States Tax Court concerning the
debtor. [11 U.S.C. sec. 362(a).]
A chapter 11 filing, however, does not operate as a stay of
either an audit by a governmental unit to determine tax liability
or the issuance to the debtor by a governmental unit of a notice
of tax deficiency.
11 U.S.C. sec. 362(b)(9)(A) and (B).
Thus,
during the stay, the IRS may conduct an audit and issue a notice
of deficiency to the debtor.
If the IRS issues a notice of deficiency to a taxpayer who
has filed a bankruptcy petition, the normal 90-day period for
- 15 filing a timely petition with this Court is suspended for the
period during which the taxpayer is prohibited by reason of the
automatic stay from filing a petition in this Court and for 60
days thereafter.
Sec. 6213(f); Olson v. Commissioner, 86 T.C.
1314, 1318-1319 (1986).
Unless relief from the automatic stay is granted by order of
the bankruptcy court, the automatic stay generally remains in
effect until the earliest of the closing of the case, dismissal
of the case, or the grant or denial of a discharge.7
11 U.S.C.
sec. 362(c)(2); Guerra v. Commissioner, 110 T.C. 271, 275 (1998);
Allison v. Commissioner, supra at 545; Smith v. Commissioner, 96
T.C. 10, 14 (1991); Neilson v. Commissioner, 94 T.C. 1, 8 (1990).
Petitioner filed for bankruptcy on April 29, 1994.
The
bankruptcy court confirmed the plan of reorganization by order
7
The period that the automatic stay remains in effect is
prescribed in 11 U.S.C. sec. 362(c) as follows:
(c) Except as provided in subsections (d), (e), and (f)
of this section-(1) the stay of an act against property of the estate
under subsection (a) of this section continues until
such property is no longer property of the estate; and
(2) the stay of any other act under subsection (a) of
this section continues until the earliest of-(A) the time the case is closed;
(B) the time the case is dismissed; or
(C) if the case is a case under chapter 7 of this title
concerning an individual or a case under chapter 9, 11,
12, or 13 of this title, the time a discharge is
granted or denied.
- 16 dated February 6, 1995, and closed the case on May 18, 1995.
The
order confirming the plan specifically discharged petitioner and
Mrs. Wood.
Therefore, the automatic stay of Bankruptcy Code
section 362 was lifted no later than May 18, 1995, when the order
closing the case was entered.
Respondent issued to petitioner and Mrs. Wood a notice of
deficiency for 1994 on December 21, 1998, and a notice of
deficiency for 1995 and 1996 on July 19, 1999.
Thus, the notices
of deficiency were issued, and the petitions in these cases were
filed, well after the automatic stay in petitioner and Mrs.
Wood’s bankruptcy case was lifted.
Petitioner contends, and asks us to rule, that respondent’s
claims against him were discharged in bankruptcy.
We do not have
authority in these cases to decide whether respondent’s claims
against petitioner have been discharged because in a deficiency
proceeding our subject matter jurisdiction is generally limited
to the redetermination of the correct amount of a deficiency
determined by the Commissioner and is unrelated to the collection
of the tax.
Swanson v. Commissioner, 65 T.C. 1180, 1184 (1976).
An action brought for redetermination of a deficiency “has
nothing to do with collection of the tax nor any similarity to an
action for collection of a debt”.
Id.
Thus, in deficiency
proceedings commenced in this Court under section 6213, such as
these cases, while we have jurisdiction to redetermine the
- 17 Federal income tax deficiencies, we do not have jurisdiction to
determine whether a bankruptcy court has discharged a taxpayer
from an unpaid tax liability.
Neilson v. Commissioner, supra at
9; Graham v. Commissioner, 75 T.C. 389, 399 (1980); Bilski v.
Commissioner, T.C. Memo. 1994-55; McAlister v. Commissioner, T.C.
Memo. 1993-166.8
II.
Capital Gain in 1994 on the Sale of New Jersey House
Respondent determined that petitioner’s corrected capital
gain on the sale of the New Jersey house was not $76,771 (as
reported on petitioner’s 1994) return but rather $90,888,
computed as follows:
8
In contrast to a deficiency proceeding, a lien proceeding
commenced in this Court under sec. 6330(d)(1) “is closely related
to and has everything to do with collection of a taxpayer’s
unpaid liability for a taxable year.” Washington v.
Commissioner, 120 T.C. 114, 120 (2003). Thus, this Court has
jurisdiction in a lien or levy proceeding commenced under sec.
6330(d)(1) to determine whether a bankruptcy court has discharged
the taxpayer from unpaid tax liabilities. Swanson v.
Commissioner, 121 T.C. 111 (2003); Washington v. Commissioner,
supra.
- 18 Sale price
Closing costs
Amount realized
Purchase price
Closing costs
Improvements
Cost basis
Depreciation allowed
1992
1993
1994
Total
Deferred gain from
sale of Virginia house
Sale price
Cost
Closing costs
Deferred gain
Adjusted basis
Gain on sale
$334,000
(20,300)
$313,700
87,900
1,214
153,435
$242,549
3,455
3,455
2,827
(9,737)
70,000
(57,000)
(3,000)
(10,000)
(222,812)
90,888
Respondent increased petitioner’s cost basis in the New
Jersey house by $153,435 for improvements petitioner made to the
house.
Respondent included in the improvements to the New Jersey
house $20,000 petitioner established he incurred in 1984 for
modifications to the kitchen.
Petitioner asserts that he spent
$22,500 for modifications to the kitchen of the New Jersey house.
Respondent’s determinations are presumed to be correct and
petitioner bears the burden of proof on all issues in these
cases.9
9
See Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111,
Sec. 7491, which is effective for court proceedings arising
in connection with examinations commencing after July 22, 1998,
shifts the burden of proof to the Commissioner in certain
circumstances and places on the Commissioner the burden of
production with respect to penalties and additions to tax. Sec.
7491 is inapplicable in these cases because the examination of
petitioner and Mrs. Wood’s returns commenced in December 1997.
- 19 115 (1933).
Petitioner has not established that he paid more for
kitchen remodeling than the $20,000 respondent allowed.
He
provided two documents from Frank and Sal Fricano for material
and labor for “tiling kitchen & foyer”.10
for tiling an area of 305 square feet.
Both documents provide
The documents could be
estimates rather than invoices, and they do not establish that
the work was completed or that the stated amounts were paid.
Petitioner asserts that he spent several thousand dollars to
add fireplaces to the New Jersey house.
He did not provide any
checks or receipts to substantiate the cost of the fireplaces.
We find that petitioner has not established that the capital
improvements he and Mrs. Wood made to the New Jersey house
totaled more than $153,435.
We sustain respondent’s
determination on this issue.
III. Net Profits From Petitioner’s Consulting Business
For the years at issue, petitioner reported the following on
the consulting business Schedules C:
Income
Expenses
Expense for business use of
Net profit
10
1994
1995
1996
$75,657
(51,879)
(6,025)
17,753
$53,804
(27,527)
(11,362)
14,915
$60,072
(42,829)
(4,674)
12,569
One is clearly dated “June 5 - 84”. The second document
is also dated June 5 but it appears the “84” has been changed to
“85”.
- 20 Respondent determined that petitioner’s profits from his
consulting business should be increased by $24,016 for 1994,
$7,037 for 1995, and $13,094 for 1996, consisting of omitted
gross receipts and disallowed claimed business expenses.
In addition to compensation for his consulting services,
petitioner received reimbursement from his clients for expenses.
The reimbursements were not included in the compensation reported
on Forms 1099 issued by the clients but were deducted by
petitioner on the consulting business Schedules C.
Petitioner
did not keep accurate records of his reimbursed expenses.
The
invoices he submitted to the clients did not match deposits made
into his bank accounts.
During the audit, petitioner identified
certain deposits as amounts he received from clients for services
and reimbursed expenses (the consulting business deposits).
In computing the gross receipts from petitioner’s consulting
business, respondent used the specific items method; i.e., the
consulting business deposits.
The consulting business deposits
totaled $83,966 in 1994, $56,066 in 1995, and $63,651 in 1996.
At trial petitioner offered no evidence to establish that the
deposits were not amounts paid to him by his clients or were
nontaxable amounts.
We find that petitioner’s gross receipts
from the consulting business were as determined by respondent;
namely $83,966 in 1994, $56,066 in 1995, and $63,651 in 1996.
- 21 The parties stipulated that petitioner’s total business
expenses allowable on the consulting business Schedules C were
$42,197 for 1994, $34,114 for 1995, and $37,988 for 1996, as
respondent determined in the notices of deficiency.
We thus hold that petitioner had additional profits from his
consulting business of $24,016 for 1994, $7,037 for 1995, and
$13,094 for 1996, computed as follows:
Gross receipts
Expenses
Net profit
Less net profit reported on return
Additional profits
IV.
1994
1995
1996
$83,966
$56,066
$63,651
41,769
(17,753)
24,016
21,952
25,663
7,037
13,094
Business Losses as Real Estate Dealers
For the years at issue, petitioner and Mrs. Wood claimed
deductions on the property management Schedules C for expenses
(that resulted in net losses) related to their ownership of real
property, including the New Jersey house, the Florida house, the
undeveloped land in Florida, the Brookdale timeshare, and the
Gulfstream timeshare, and petitioner’s management of the
apartment owned by his mother.
In addition, in 1996, they
claimed a business loss on the sale of the Florida house.
Respondent disallowed the net losses petitioner claimed on
the property management Schedules C ($121,966 in 1994, $72,546 in
1995, and $345,223 in 1996) because petitioner did not establish,
alternatively, (1) that he and Mrs. Wood were in the property
- 22 management business during the years at issue, (2) that the
activities were entered into for profit within the meaning of
section 183, or (3) that any amount was for an ordinary and
necessary business expense or was expended for the purpose
designated.
Respondent, however, treated the New Jersey house as
property held for the production of income and, pursuant to
section 212,11 allowed petitioner deductions on Schedule E for
claimed expenses relating to the rental of the New Jersey house
before its sale.
Respondent also allowed deductions on Schedule
A for State and local property taxes for all other properties,
pursuant to section 164, and for interest paid on the Florida
house mortgage, pursuant to section 163(h).
Petitioner contends that he and Mrs. Wood were real estate
dealers and thus the expenses and loss incurred in that business
are deductible under sections 162 and 165.
On the other hand,
respondent asserts that the expenses and loss on the foreclosure
of the Florida house are nondeductible personal expenses and
loss.
11
An individual is entitled to deduct all the ordinary and
necessary expenses paid or incurred during the taxable year “for
the management, conservation, or maintenance of property held for
the production of income”. Sec. 212(2).
- 23 A.
Expenses
Taxpayers generally may deduct expenses that are ordinary
and necessary in carrying on a trade or business.
Sec. 162(a).
Also, taxpayers generally may deduct expenses that are ordinary
and necessary for (1) the production or collection of income, or
(2) the management, conservation, or maintenance of property held
for the production of income.
Sec. 212(1) and (2).
Further,
while business expenses and expenses related to income-producing
property are currently deductible, a taxpayer is not entitled to
deduct a capital expenditure; i.e., an amount paid for new
property or for permanent improvements or betterments made to
increase the value of any property or estate.12
Sec. 263(a)(1).
Instead, a depreciation deduction may be allowed if the property
is used in a trade or business or held for the production of
income.
Sec. 167; see INDOPCO, Inc. v. Commissioner, 503 U.S.
79, 83-84 (1992).
Personal, living, and family expenses, on the
other hand, may not be deducted unless the Internal Revenue Code
expressly provides otherwise; e.g., State and local real property
taxes are deductible pursuant to section 164(a)(1).
Sec. 262(a).
The statutory prohibitions of sections 262 and 263 regarding
deductibility of personal and capital expenses take precedence
over the allowance provisions of sections 162 and 212.
12
Generally, the cost of acquisition of property having a
useful life substantially beyond the taxable year is a capital
expenditure. Sec. 1.263(a)-2(a), Income Tax Regs.
- 24 Commissioner v. Idaho Power Co., 418 U.S. 1, 17 (1974); Sharon v.
Commissioner, 66 T.C. 515, 523 (1976), affd. 591 F.2d 1273 (9th
Cir. 1978).
To be deductible under section 162(a), an item must (1) be
paid or incurred during the taxable year, (2) be for carrying on
any trade or business, (3) be an expense (rather than a capital
expenditure), (4) be a necessary expense, and (5) be an ordinary
expense.
Commissioner v. Lincoln Sav. & Loan Association, 403
U.S. 345, 352 (1971).
Here, we are primarily concerned with the
second requirement; i.e., whether petitioner and Mrs. Wood
incurred the disallowed expenses while carrying on a trade or
business.
Petitioner contends that he and Mrs. Wood were in the trade
or business of dealing in real estate.
He asserts that their
intent and commitment to be real estate dealers is evidenced by
(1) petitioner’s promoter activities with MSPR, Inc., (2)
petitioner’s and Mrs. Wood’s obtaining real estate licenses,
taking real estate education courses, and being employed by a New
Jersey real estate development company, (3) petitioner’s
registering the business name “Logistics Technology Group” in New
Jersey, establishing bank accounts in that business name, and
paying the expenses of their seven properties from that account,
and (4) petitioner’s advertising the New Jersey house, the
Florida house, and the undeveloped Florida land.
- 25 To be engaged in a trade or business the taxpayer must have
a good faith expectation of profit although that expectation need
not be reasonable.
Burger v. Commissioner, 809 F.2d 355, 358
(7th Cir. 1987), affg. T.C. Memo. 1985-523; Golanty v.
Commissioner, 72 T.C. 411, 425-426 (1979), affd. without
published opinion 647 F.2d 170 (9th Cir. 1981).
However, as
stated by the Supreme Court in Commissioner v. Groetzinger, 480
U.S. 23, 35 (1987):
not every income-producing and profit-making endeavor
constitutes a trade or business. * * * to be engaged in
a trade or business, the taxpayer must be involved in
the activity with continuity and regularity and * * *
the taxpayer’s primary purpose for engaging in the
activity must be for income or profit. * * *
Although an individual who is engaged in the business of selling
real estate to customers may be characterized as a real estate
dealer, an individual who holds real estate for investment or
speculation, and receives rentals therefrom, is not a real estate
dealer.
Sec. 1.1402(a)-4(a), Income Tax Regs.
Petitioner asserts that he and Mrs. Wood were real estate
dealers and that the properties constituted inventory held for
sale to customers.
Whether property is held by a taxpayer for
sale to customers in the ordinary course of the taxpayer’s
business or for another purpose is a question of fact, and each
property must be considered individually.
Gartrell v. United
States, 619 F.2d 1150, 1153 (6th Cir. 1980); Cottle v.
Commissioner, 89 T.C. 467, 486-487 (1987).
- 26 The taxpayer’s primary purpose for holding the property must
be determined by reference to his purpose “at some point before
he decided to make the sale”.
Suburban Realty Co. v. United
States, 615 F.2d 171, 182 (5th Cir. 1980).
Earlier events may be
considered in deciding what the taxpayer’s primary purpose was at
the time of sale.
The ownership and maintenance of the property
must relate primarily to a business, rather than a social or
personal, purpose.
Intl. Artists, Ltd. v. Commissioner, 55 T.C.
94, 104 (1970); Chapman v. Commissioner, 48 T.C. 358, 366 (1967).
Over the years, courts have considered a variety of factors
in determining the taxpayer’s primary purpose for holding
property, including (1) the taxpayer’s purpose in acquiring the
property and the duration of his ownership, (2) the purpose for
which the property was subsequently held; (3) the taxpayer’s
everyday business and the relationship of realty income to total
income, (4) the frequency, continuity, and substantiality of
sales of property, (5) the extent of developing and improving the
property to increase 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.
United States v. Winthrop, 417 F.2d 905,
- 27 910 (5th Cir. 1969); Cottle v. Commissioner, supra at 487;
Raymond v. Commissioner, T.C. Memo. 2001-96; Neal T. Baker
Enters., Inc. v. Commissioner, T.C. Memo. 1998-302; Nadeau v.
Commissioner, T.C. Memo. 1996-427; Tollis v. Commissioner, T.C.
Memo. 1993-63, affd. without published opinion 46 F.3d 1132 (6th
Cir. 1995).
Although these factors may aid the finder of fact in
determining, on the entire record, the taxpayer’s primary purpose
for holding property, they have no independent significance and
individual comment on each factor is not necessary or required.
Cottle v. Commissioner, supra at 487-489; see also Suburban
Realty Co. v. United States, supra at 177-179; Hay v.
Commissioner, T.C. Memo. 1992-409.
Petitioner and Mrs. Wood did not purchase and hold the
Virginia house, the New Jersey house, or the Florida house for
sale to customers in the ordinary course of a trade or business.
Petitioner and Mrs. Wood purchased the Virginia house in 1974.
They resided in that house until 1977 when they moved to New
Jersey after petitioner retired from the military.
Petitioner
and Mrs. Wood sold the Virginia house and purchased a new
residence, the New Jersey house.
They lived in the New Jersey
house until 1990 when they moved into their next residence, the
newly constructed Florida house.
After the contract for sale of
the New Jersey house fell through, they rented that house on a
month-to-month basis until it was sold.
To satisfy their
- 28 mortgage obligation, they borrowed money from relatives and
placed the Florida house on the market.
The timeshares and the South Carolina house were personal
vacation properties.
They were not listed for sale until funds
were needed to pay for the Florida house.
These vacation
properties were not purchased or held for sale to customers in
the ordinary course of business.
Moreover, petitioner’s ownership of the undeveloped land in
Florida does not establish that petitioner and Mrs. Wood were
dealers in real estate.
undeveloped land in 1976.
Petitioner and Mrs. Wood purchased the
In 1994, petitioner and Mrs. Wood
entered into a contract to sell that land, but the buyer failed
to perform under the contract.
The land remained undeveloped,
and petitioner continued to own it through 1996.
There is no
evidence that petitioner offered the land for sale before 1994 or
that he ever attempted to develop the land.
We conclude that
petitioner purchased the land as an investment and not as
property held for sale to customers in the ordinary course of
business.
Finally, petitioner’s investment in MSPR, Ltd., does not
establish that he was a dealer in real estate.
Petitioner’s
partnership interest in MSPR, Ltd., was not real property held
for sale to customers in the ordinary course of petitioner’s
business.
It is settled law that a partnership is an
- 29 independently recognizable entity apart from its partners, and
that business conducted by a partnership is considered apart from
any business activity conducted by its partners on their own
behalves.
See, e.g., Madison Gas & Elec. Co. v. Commissioner,
633 F.2d 512, 517 (7th Cir. 1980) (expenses were characterized as
“pre-operational costs” of the partnership even though the
general partner was already in the same business), affg. 72 T.C.
521 (1979); Brannen v. Commissioner, 78 T.C. 471, 505 (1982)
(“the partnership is an independently recognizable entity apart
from its partners for the purposes of the calculation of its
taxable income under section 703”), affd. 722 F.2d 695 (11th Cir.
1984); see also Polakof v. Commissioner, 820 F.2d 321, 323 (9th
Cir. 1987) (in characterizing partnership income “it is the
dominant economic motive of the partnership, not that of the
individual investors, that is determinative”), affg. T.C. Memo.
1985-197; Tallal v. Commissioner, 778 F.2d 275, 276 (5th Cir.
1985) (“When the taxpayer is a member of a partnership, we have
interpreted 26 U.S.C. § 702(b) to require that business purpose
must be assessed at the partnership level.”), affg. T.C. Memo.
1984-486.
Ltd.
Moreover, petitioner was a limited partner of MSPR,
He did not actively participate in the conduct of the
partnership business.
The frequency of the taxpayer’s sales “is highly probative
in the real estate context because the presence of frequent sales
- 30 ordinarily belies the contention that the property is being held
‘for investment’ [or for personal purposes] rather than ‘for
sale.’”
Major Realty Corp. & Subs. v. Commissioner, 749 F.2d
1483, 1488 (11th Cir. 1985), affg. in part and revg. in part T.C.
Memo. 1981-361.
Petitioner and Mrs. Wood did not make frequent sales of
property.
Over the 20-year period that included 1977 through
1996, petitioner and Mrs. Wood sold four properties that they
owned--the Virginia house in 1977, the North Carolina property in
1989, the New Jersey house in 1994, and the Florida house in
1996.
The infrequency of sales is highly probative that the
properties were held for personal or investment reasons rather
than for sale.
We conclude that the residences, the vacation
properties, the undeveloped land in Florida, and the partnership
interest in MSPR, Ltd., were not properties purchased or held for
sale to customers.
We find that petitioner and Mrs. Wood were
not real estate dealers and hold, therefore, that the disallowed
amounts are not business expenses deductible under section 162.
B.
Loss on Sale of Florida House
Petitioner claimed an ordinary loss on the foreclosure of
the Florida house in 1996.
Section 165(a) allows a deduction for
any loss sustained during the taxable year that is not
compensated for by insurance or otherwise.
However, in the case
- 31 of an individual, section 165(c) limits the deduction to (1)
losses incurred in a trade or business, (2) losses incurred in
any transaction entered into for profit, even though not
connected with a trade or business, and (3) losses of property
not connected with a trade or business or with a transaction
entered into for profit, if such losses arise from fire, storm,
shipwreck, or other casualty, subject to limitations set forth in
section 165(h).
Petitioner asserts that the Florida house was held primarily
for sale to customers in the ordinary course of either (1) his
and Mrs. Wood’s trade or business as a real estate dealers or (2)
their family partnership’s business of constructing the house for
immediate sale.
We have found that petitioner and Mrs. Wood were
not real estate dealers.
Further, we do not think that the
arrangement petitioner had with his brother and Mrs. Wood’s
mother constituted a partnership that carried on a business.
There is no evidence in the record that a partnership was
created.
Neither petitioner’s brother nor Mrs. Wood’s mother
testified at the trial in these cases.
The records from the
bankruptcy proceeding lead us to believe that the funds advanced
by petitioner’s brother and Mrs. Wood’s mother were debts of
petitioner and of Mrs. Wood.
Furthermore, the activities of constructing, owning, and
selling the Florida house were not carried on as a trade or
- 32 business.
Petitioner and Mrs. Wood retained ownership of the
Florida house.
They resided in the house.
They never paid any
rent to any partnership for their use of the house.
And they
claimed the Florida house as their residence in their bankruptcy
case.
Considering all the facts and circumstances, we find that
the Florida house was not property related to, or used in, any
trade or business.
Finally, we note that generally even though people who buy
property for their own residential purposes are interested in
making a potentially profitable purchase, the purchase or
construction of a personal residence is not considered a
transaction entered into for profit.
The primary motive of
acquiring a family residence brings the purchase within the ambit
of section 262, which provides that “no deduction shall be
allowed for personal, living, or family expenses.”
regulations under section 165 provide:
The
“A loss sustained on the
sale of residential property purchased or constructed by the
taxpayer for use as his personal residence and so used by him up
to the time of the sale is not deductible under section 165(a).”
Sec. 1.165-9(a), Income Tax Regs.
The regulations also provide
that in order to be allowed a loss on the sale of property which
at an earlier time was used as a personal residence, a taxpayer
must show that his purpose for owning the residence changed and
- 33 that the new purpose was for the production of income.
Sec.
1.165-9(b)(1), Income Tax Regs.
Petitioner and Mrs. Wood purchased the Florida lot with the
intent to build their personal residence on it.
Petitioner and
Mrs. Wood used the Florida house as their personal residence
until it was sold in 1996.
The property was never rented or
otherwise changed to income-producing property.
See, e.g.,
Newcombe v. Commissioner, 54 T.C. 1298, 1301-1302 (1970); Newbre
v. Commissioner, T.C. Memo. 1971-165.
In sum, we hold that petitioner is not entitled to deduct
any loss on the foreclosure of the Florida house.
We have
considered all of petitioner’s arguments regarding the disallowed
expenses and loss claimed on the property management Schedules C,
and to the extent not specifically addressed, we find them
unpersuasive.
V.
Schedule A Itemized Deductions
For 1994, respondent made the following adjustments to the
itemized deductions petitioner claimed on the 1994 return:
1994 Itemized Deductions
Medical & dental
Taxes
Home interest
Contributions
Miscellaneous
AGI limitation
Total
Per Return
Per Exam
Adjustment
$1,365
24,424
42,614
-0-0–68,403
-0$12,456
6,632
304
6,488
(215)
25,665
$1,365
11,968
35,982
(304)
(6,488)
(215)
42,738
- 34 For 1995, respondent made the following adjustments to the
itemized deductions petitioner claimed on the 1995 return:
1995 Itemized Deductions
Per Return
Per Exam
Adjustment
Taxes
Home mortgage interest
Contributions
Total
$11,610
23,476
-035,086
$11,865
32,871
330
45,066
($255)
(9,395)
(330)
(9,980)
For 1996, respondent determined that the standard deduction
was less than petitioner’s itemized deductions and made the
following adjustments for itemized deductions:
1996 Itemized Deductions
Standard deduction
Itemized deductions
Taxes
Home mortgage interest
Total
Per Return
Per Exam
Adjustment
$6,700
-0-
$6,700
-0-06,700
$303
8,242
8,545
(303)
(8,242)
(1,845)
Aside from petitioner’s claim that the taxes13 and mortgage
interest were trade or business expenses deductible on Schedules
C for his and Mrs. Wood’s business as dealers in real estate,
petitioner does not challenge respondent’s adjustments for
itemized deductions.
We have found that petitioner and Mrs. Wood
are not dealers in real estate, and, therefore, we sustain
respondent on this issue.
13
Respondent allowed petitioner to deduct on the consulting
business Schedule C 10 percent of the taxes as a home office
expense of Mr. Wood’s consulting business.
- 35 VI.
Schedule E Rental Expenses for 1994.
Petitioner documented taxes of $2,526 on the New Jersey
house, which respondent allowed as a rental expense deduction on
Schedule E.
Respondent determined that $13,997 of expenses for
depreciation, repairs, and other expenses disallowed for 1994 as
deductions on property management Schedule C were deductible in
1994 on Schedule E as expenses related to the rental of the New
Jersey house.
Aside from his claim that these items were trade
or business expenses deductible on Schedules C for the business
dealing in real estate, petitioner does not challenge these
adjustments.
We have found that petitioner and Mrs. Wood are not
dealers in real estate, and, therefore, we sustain respondent on
this issue.
VII. Self-Employment Tax and Net Operating Loss Carryovers
Respondent determined that petitioner was liable for selfemployment tax of $5,902 in 1994, $3,102 in 1995, and $3,626 in
1996 on the net profit from his consulting business and allowed
petitioner a deduction for half of those taxes ($2,951 in 1994,
$1,551 in 1995, and $1,813 in 1996).
Respondent also allowed petitioner a net operating loss
carryover of $18,520 to 1994 from the examination of earlier
years but, on the basis of the adjustments made to 1995,
disallowed the net operating loss carryover of $36,389 petitioner
claimed on the 1996 return.
- 36 Petitioner has not addressed these issues and is deemed to
have conceded them.
Therefore, we sustain respondent on these
issues.
VIII.
Accuracy-Related Penalty Under Section 6662(a)
Respondent determined that petitioner is liable for the
accuracy-related penalty under section 6662(a).
As pertinent
here, section 6662(a) imposes a 20-percent penalty on the portion
of an underpayment attributable to negligence or disregard of
rules or regulations.
Sec. 6662(b)(1).
Negligence includes any
failure to make a reasonable attempt to comply with the
provisions of the Internal Revenue Code, including any failure to
keep adequate books and records or to substantiate items
properly.
Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.
The penalty under section 6662(a) does not apply to any
portion of an underpayment of tax if it is shown that there was
reasonable cause for the taxpayer’s position and that the
taxpayer acted in good faith with respect to that portion.
6664(c)(1).
Sec.
The determination of whether a taxpayer acted with
reasonable cause and in good faith is made on a case-by-case
basis, taking into account all the pertinent facts and
circumstances.
Sec. 1.6664-4(b)(1), Income Tax Regs.
The most
important factor is the extent of the taxpayer’s effort to assess
his/her proper tax liability for the year.
Id.
The good faith
reliance on the advice of an independent, competent professional
- 37 as to the tax treatment of an item may meet this requirement.
Sec. 1.6664-4(b), Income Tax Regs.
Petitioner has made no showing that he made a reasonable
attempt to comply with the tax rules and regulations with regard
to those deductions he took for the years at issue which have
been disallowed.
Hence, with respect to those deductions,
petitioner has failed to show that he was not negligent.
Moreover, petitioner has not shown that he acted in good faith
with respect to, or that there was reasonable cause for, the
position he took.
Further, petitioner does not claim that he
relied on a tax professional as to the tax treatment of the
expenses and losses at issue, including those related to his
personal residences.
Petitioner simply asserts that the
accuracy-related penalty does not apply because he properly
claimed the deductions under section 162(a).
We have found to
the contrary.
Under these circumstances, we are compelled to hold that
petitioner is liable for the accuracy-related penalty for the
years at issue.
- 38 To reflect the foregoing,
Decisions will be entered for
respondent as to petitioner John
Weller Wood, Jr., and orders of
dismissal and decision will be
entered as to petitioner Magdalena
Frances Wood.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.