# UNITED STATES TAX COURT

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## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

T.C. Memo. 2012-118

UNITED STATES TAX COURT

PATRICK A. REESINK AND JILL MITCHEL REESINK, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2475-10.

Filed April 23, 2012.

Woodford Gregory Rowland, for petitioners.

Chong S. Hong, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: Respondent determined a deficiency in petitioners' 2005
joint Federal income tax of $184,349 and a section 6662(a)' accuracy-related

'Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the year in issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure.

$liRVED APR 2 3 2012

-2penalty of $36,870. After concessions, the issues remaining for decision are:

(1) whether petitioners' sale of rental property followed by their purchase
of real estate qualifies as a section 1031 like-kind exchange. We hold that it does;
(2) whether $60,000 paid to petitioners in settlement of a lawsuit is taxable
income to petitioners. We hold that it is; and
(3) whether petitioners are liable for the section 6662(a) accuracy-related
penalty in regard to the underpayment resulting from the like-kind exchange, the
settlement proceeds, underreported rental income,2 and travel expenses.3 We hold
that they are liable for the section 6662(a) penalty on portions of the
underpayment associated with the settlement proceeds, rental income, and travel

expenses.

F1NDINGS OF FACT
Petitioners resided in California at the time their petition was filed. They
married on September 1, 2000, and have two children--Patrick Reesink's son from

2Petitioners concede that they underreported $16,392 of rental receipts.
However, they contest whether they should be liable for the associated sec.
6662(a) accuracy-related penalty.
3Petitioners originally contested respondent's disallowance of $1,124 of
travel expenses. Petitioners now concede that they are unable to substantiate these
travel expenses.

-3a prior marriage (born in March 1991) and an adopted son (born in January 1996

and adopted July 25, 2007).4
Mr. Reesink was born and raised in San Francisco, California. In the 1970s,
he began working as a butcher and station cook for the Bohemian Club.5 Mr.
Reesink also worked for the Bohemian Grove every summer. In 2000 he bought a
trailer near the Bohemian Grove so that he would have a place to stay while
working there during the summer months. Mr. Reesink continued working for the
Bohemian Club and the Bohemian Grove until 2003 when he began to suffer from
a blood clot in his left ankle. He was declared permanently disabled by the Social
Security Administration as of April 4, 2004, and he began receiving monthly

disability benefits of approximately $1,700 in March 2006. Mr. Reesink was
unable to continue working for the Bohemian Club and the Bohemian Grove as a
result of his disability. Petitioners' wages decreased from $45,470 in 2002, to

4Petitioners were in adoption proceedings with respect to their adopted son
after they had physical custody in 1999. Mr. Reesink's son from his prior
marriage lives primarily with his biological mother. Mr. Reesink has been
responsible for paying approximately $490 per month in child support since 1991.
5The Bohemian Club is a private men's club in San Francisco, California,
which owns the Bohemian Grove. The Bohemian Grove is a 2,700-acre
campground near Guerneville, California.

$24,671 in 2003, $10,105 in 2004, $3,776 in 2005, and zero in 2006. Moreover,
Mrs. Reesink did not earn any wages during 2004, 2005, and 2006.
I. The Reesink Brothers
In 1985 brothers Patrick and Michael Reesink purchased a six-unit

apartment building (apartment building) on 38th Avenue, San Francisco,
California, from their parents. Each acquired a 50% tehancy in common
ownership interest in the building. And that concludes our record of civil behavior
between the two brothers. At trial Mr. Reesink accused Michael Reesink of

attacking and strangling him on several occasions as well as poisoning him by
pouring cleaning fluid into his drinking water. Conversely, Michael Reesink

stated at trial that Mr. Reesink has left him "holding the bag" on several occasioñs
while Mr. Reesink went out to have a "real, good, fancy time". At some time after
reviewing the financial statements for the apartment building, Mr. Reesink
determined that Michael Reesink had been stealing money from him.
In late 2002 Mr. Reesink sued his brother Michael Reesink in State court for
partition, breach of contract, breach of implied covenant of good faith and fair

dealing, fraud, negligent misrepresentation, and other causes of action with respect
to their joint interests in the apartment building. On September 3, 2004, the

brothers settled the case. Pursuant to the settlement agreement, the brothers

-5agreed to sell the apartment building and divide the net proceeds equally.
Moreover, the agreement instructed Michael Reesink to pay $60,000 from his
share of the net proceeds to Mr. Reesink.6

II. The Sale of the Apartment Building
On September 23, 2005, the brothers sold the apartment building for $1.4
million. Each brother's pro rata share of the gross sale price was $700,000.

Pursuant to the settlement agreement Michael Reesink paid Mr. Reesink $60,000
via the apartment building sale escrow account. Petitioners elected to pursue a

section 1031 like-kind exchange7 with respect to the proceeds--they paid the
remaining debt and associated expenses of the sale, received $56,417 which they

6The settlement agreement stated "[Michael] shall pay to * * * [Patrick] the
sum of.$60,000 as payment in full for his claims arising from the events described
in his complaint." While the purpose of the $60,000 payment is unclear because
of the multitude of allegations in the complaint, the complaint does not ask for
damages to compensate for physical injury or sickness. However, Michael
testified at trial: "I paid $60,000 to my brother in the sale of the proceeds of the
property because he and I had three physical, violent confrontations over different
times."

Petitioners were familiar with the concept of sec. 1031 like-kind exchanges
before the sale of the apartment building. In 2003 petitioners sold investment real
estate on Central Avenue, San Francisco, California, and used the proceeds to
purchase investment real estate on Janet Lane, Guerneville, California (Janet Lane
property). The Janet Lane property is a 1,063-square-foot single-family home
built in 1960. It has two bedrooms and one bath, with a total lot size of 6,780
square feet. Petitioners borrowed $147,000 of the $379,000 purchase price.

-6characterized as taxable boot under section 1031(b) ón their 2005 income tax
return, and used the remaining $519,843 to purchase property on Laurel Lane in
Guerneville, California (Laurel Lane property). Petitioners did not recognize the
$429,296 gain from the sale of their interest in the apartment building as income
on their 2005 income tax return.

III. The Laurel Lane Property
After selling the apartment building petitioners began searching for real

estate around Guerneville, California, and the Lake Tahoe area. On one trip to
Lake Tahoe, petitioners met with a realtor from Agate Bay Realty who presented
them with a few options. Petitioners eventually made an offer on one property,
but the deal fell through. Thereafter, Dave Millar, a realtor who had worked with
petitioners on.their 2003 purchase of the Janet Lane property, suggested

petitioners take a look at the Laurel Lane property--a 2,226-square-foot singlefamily home.
On November 4, 2005, petitioners purchased the Laurel Lane property for
$649,900 as well as an undeveloped adjacent lot for $30,000.8 They received a
residential loan of $138,200 from Home Loans USA to help finance the purchase
8The Laurel Lane property was built in 1980 and has three bedrooms, three
bathrooms, and a total lot size of 13,939 square feet. The adjacent lot size is 3,094
square feet.

-7of the Laurel Lane property, subject to a deed of trust. A bok was checked on the

loan application indicating that the Laurel Lane property was purchased for
investment purposes. Petitioners paid $27,456 of settlement charges associated
with the sale of the Laurel Lane property. The seller financed $27,000 of the
adjacent lot's selling price.
Petitioners posted flyers throughout Guerneville advertising the Laurel Lane
property for rent but did not advertise in the newspaper.9 Mr. Reesink's other
brother, Richard Reesink, changed light fixtures and installed security lighting at
the Laurel Lane property. He saw "for rent". signs at the Laurel Lane property
every time he was there, which he estimated to be at least 10 or 12 times.

On advice from Mr. Millar, petitioners attempted to rent the Laurel Lane
property for $3,000 per month. On two different occasions, potential renters
Tabatha Howell and Scott Wright visited the Laurel Lane property. However,
both parties ultimately notified petitioners by letter that they had decided not to

rent the Laurel Lane property because the monthly rent was out of their price

9Petitioners used a similar advertising strategy to rent the Janet Lane
property, which was renting for $1,200 to $1,400 per month. Petitioners reported
gross rental income for the Janet Lane property of $15,400 for 2006, zero for

2005, $4,500 for 2004, and $1,830 for 2003.

-8range. Petitioners never lowered their monthly asking price, nor did they ever find

tenants for the Laurel Lane property.
IV. Petitioners' Move to the Laurel Lane Property
At the beginning of 2006 petitioners owned the following properties: (1)
their primary residencei° on 48th Avenue, San Francisco, California (primary

residence); (2) the Janet Lane property; and (3) the Laurel Lane property with
adjacent lot. Petitioners were responsible for making mortgage payments
associated with all of the properties, as well as payments on a home equity line of
credit (HELOC) associated with their primary residence. Before the sale oftheir

primary residence, petitioners' material liabilities consisted of: (1) primary
residence--$78,294; (2) Janet Lane property--$145,597; (3) HELOC--$105,761;
and (4) Laurel Lane property,$137,569. On the Laurel Lane mortgage
application petitioners valued their primary residence at $800,000 and the Janet
Lane property at $379,000. While petitioners purchased the Laurel Lane property
and adjacent lot for $649,900 and $30,000, respectively, they believe the values of
these properties had dropped significantly since their purchase. Finally,
petitioners faced current or upcoming payments for their son's adoption, their
1°Mr. Reesink acquired the primary residence around 1992. It was a
Victorian style house, one block from the ocean, with a large yard and a view of
the ocean.

-9children's tuition, child support, litigation expenses associated with the apartment
building, real property expenses, and other standard living expenses.
After failing to rent the Laurel Lane property for several months, Mr.

Reesink became concerned that they could no longer afford all three properties.
Mrs. Reesink became very upset when Mr. Reesink proposed that they sell their
primary residence"--she loved living in San Francisco, she did not want to transfer
their adopted son to another school, and she thought about leaving Mr. Reesink if
he insisted on níoving.

On or around April 4, 2006, petitioners entered into a contract to list their
primary residence for sale. Petitioners believed they had two options at the time
they placed their primary residence for sale--either temporarily move in with Mr.
Reesink's sister or live at the Laurel Lane property. They did not consider
purchasing another property. On May 17, 2006, petitioners entered into a contract

to sell their primary residence, and they closed the sale on June 30, 2006: The
house sold for $810,000, with petitioners receiving $587,382 in net proceeds.
Petitioners moved into the Laurel Lane property in June 2006 and continue to

reside there today.
"Petitioners believed that the Laurel Lane property had dropped
significantly in value in the wake ofthe housing crises and that their primary
residence was the only property in which they had accumulated much equity.

- 10 V. Other Matters

Michael McLaughlin, an enrolled agent, has prepared Mr. Reesink's tax
return every year since 1990 as well as petitioners' joint income tax returns every
year since their marriage. He first learned of the sale of the apartment building
and purchase of the Laurel Lane property in 2006 upon receiving petitioners' 2005
tax information. Petitioners' eventual décision to move into the Laurel Lane
property was never discussed with Mr. McLaughlin, nor was the $60,000
petitioners received from the settlement agreement with Michael Reesink.

Michael Reesink provided Mr. McLaughlin with the 2005 income and
expense statements for the apartment building. The statements were handwritten
and incomplete. Mr. McLaughlin mistakenly underreported petitioners' 2005

gross rental receipts by $16,392.9 Petitioners also reported a $1;124
miscellaneous itemized deduction on Schedule A, Itemized Deductions, for 2005.
That deduction was for expenses incurred while traveling to and from the Lake
Tahoe region in*seárch of réal estate. Petitioners timely filed their 2005 joint

Petitioners reported $10,400 of rental gross receipts from the apartment
building on their 2005 joint Federal income tax return. Actual 2005 gross rental
receipts from the apartment building were $26,792. Moreover, petitioners' rental
gross rental receipts fròm the apartment building were $41',538 for 2004, $38,430
for 2003, and $41,145 for 2002.

- 11 Federal income tax return, and on October 22; 2009, respondent issued to

petitioners a notice of deficiency.

OPINION
Generally, the Commissioner's determination of a deficiency is presumed
correct, and the taxpayer has the burden of proving it incorrect. Rule 142(a);

Welch v. Helvering, 290 U.S. 111 115 (1933).13
I. The Like-Kind Exchange
Section 1031(a) provides that no gain or loss shall be recognized on the
exchange of property held for productive use in a trade or business or for
investment if the property is exchanged solely for property of a like kind that is to

be held either for productive use in a trade or business or for investment." One of
the primary purposes for allowing the deferral of gain in a like-kind exchange is to
avoid imposing a tax upon a taxpayer who, while changing his form of ownership,
is continuing the nature of his investment. Wagensen v. Commissioner, 74 T.C.

653, 658 (1980). Under section 1031(d), the basis of property acquired in a

Petitioners do not contend that sec. 7491(a) should apply to shift the
burden of proof to respondent.
In an otherwise qualifying like-kind exchange, a taxpayer's realized gain
is recognized to the extent the consideration received includes unqualified
property (boot). Sec. 1031(b)j sec. 1.1031(a)-1(a)(2), Income Tax Regs.

- 12 section 1031 exchange is the same as the basis of the property exchanged,
decreased by any money that the taxpayer receives and increased by any gain that
the taxpayer recognizes.
Section 1031 and the regulations thereunder allow for deferred exchanges of
property. Under section 103.1(a)(3) and section 1.1031(k)-1(b), Income Tax Regs.,

however, the property a taxpayer receives in the exchange (replacement property)
must be: (1) identified within 45 days of the transfer of the property relinquished
in the exchange (relinquished property), and (2) received by the earlier of 180 days
after the transfer of the relinquished property or the due date (including

extensions) of the transferor's tax return for the tax year in which the relinquished
property is transferred Respondent concedes that these timing requirements were
met.

Respondent disputes only whether petitioners held the Laurel Lane property
with investment intent at the time of the exchange. A taxpayer's intent to hold a
property for productive use in a trade or business or for investnient is a question of
fact that must be determined at the time of the exchange. Bolker v. Commissioner,

81 T.C. 782, 804.(1983), aff'd, 760 F.2d 1039 (9th Cir. 1985); Click v.
Commissioner, 7.8 T.C. 225, 231 (1982). Taxpayers bear the burden of proving
that they had the requisite investment intent. Click v. Commissioner, 78 T.C. at

- 13 231; Regals Realty Co. v. Commissioner, 43 B.T.A. 194, 208 (1940), aff'd, 127
F.2d 931 (2d Cir. 1942). We have held that investment intent must be the
taxpayer's primary motivation for holding the exchanged property in order for the
property to qualify as held for investment for purposes of section 1031. Moore v.

Commissioner, T.C. Memo. 2007-134. The use of property solely as a personal
residence is antithetical to its being held for investment. Starker v. United States,

602 F.2d 1341, 1350-1351 (9th Cir. 1979).
Respondent cites Goolsby v. Commissioner, T.C. Memo. 2010-64, to
support his allegation that petitioners did not hold the Laurel Lane property with

investment intent. In Goolsby, the taxpayers made the purchase of the
replacement property contingent on the sale of their former personal residence and

sought advice regarding whether they could move into the replacement property if
renters could not be found. The taxpayers' only rental efforts consisted of placing

a single advertisement in a neighborhood newspaper. Within two weeks of
purchasing the property, the taxpayers began preparations to refinish the basement.
The taxpayers subsequently moved into the replacement property within two
months of acquiring it. On the basis of the above events, we found the taxpayers
did not hold the replacement property with investment intent at the time of the
exchange.

- 14 In Moore, we found the taxpayers' sale of one vacation property followed
by the purchase of another vacation property did not qualify as a section 1031
like-kind exchange because at the time of the exchange the taxpayers' primary
motivation for holding the properties was not for investment. The taxpayers used

both vacation properties exclusively for recreational purposes--they never
attempted to rent either property. We held that the mere expectation that the
properties would increase in value is not enough to show the properties were held

primarily with investment intent.
Unlike the taxpayers in Goolsby, who placed a single advertisement in a
newspaper and then moved into the replacement property two months later,
petitioners placed fliers throughout Guerneville, showed the Laurel Lane property
to potential renters, and waited almost eight months before moving in. More

importantly, the taxpayers in Goolsby made the purchase of the replacement
property contingent on the sale of their personal residence. Petitioners, on the

other hand, decided to sell their personal residence almost six months after
purchasing the Laurel Lane property. Furthermore, unlike the taxpayers in Moore,
petitioners made attempts to rent the Laurel Lane property and refrained from
using it for recreational purposes before moving in.

- 15 Respondent argues that petitioners' actions surrounding the purchase of the
Laurel Lane property were so unreasonable that they could not have intended to
hold the Laurel Lane property for investment purposes and that they really .

purchased the Laurel Lane property to use as their residence. Respondent supports
his argument by emphasizing that petitioners had a "healthy balance sheet" and by
pointing to all of the actions they could have taken." In 2005 petitioners' decision
to purchase the Laurel Lane property may not have been financially sound, but it
was not unreasonable for them to believe they could supplement their diminishing

wages with rental proceeds.
Moreover, we do not determine petitioners' intent on the basis of their

financial position because we find the trial testimony of Mrs:Reesink, Richard

.

"While petitioners' financial position has not been fully established by the
parties, respondent's analysis of their "healthy balance sheet" is misguided.
Respondent places improper emphasis on comparing petitioners' total assets to
total liabilities, while ignoring their potential liquidity problems. Petitioners were
unable to rent the replacement property, and Mr. Reesink's wages had drastically
decreased because of his disability. On the other hand, petitioners had a multitude
of current liabilities, including their children's tuition, child support, adoption
expenses, three mortgage payments, a home equity line of credit, and other real
property expenses. Most of petitioners' assets were invested in real property, and
they chose to sell their personal residence to alleviate their liquidity problems. It
is unclear whether petitioners spent or retained any proceeds from the litigation
settlement or the taxable boot at the time they decided to sell their personal
residence; but even if they had retained the money, they were still not in the
healthy financial position that respondent envisions.

. - 16 Reesink, and Scott Wright to be credible. . Mrs. Reesink testified that she never

discussed moving to Guerneville until after the exchange had been completed, and
petitioners believed they were in a financial predicament. Richard Reesink
testified that petitioners were having a hard time renting the Laurel Lane property

and that he was surprised they sold their primary residence. Finally, Scott Wright
testified that he visited the Laurel Lane property with the intention of renting it.
Perhaps the strongest indicator of petitioners' intent at the time of the

exchange comes from respondent's witness--Michael Reesink. He testified that
Mr. Reesink had told him on several occasions that petitioners planned to sell their
personal residence and move to Guerneville once their children were out of high
school. Mr. Reesink's oldest son was born in March 1991, the apartment building

was sold September 23, 2005, and the Laurel Lane property was purchased
November 4, 2005. Therefore, at all times during the exchange process
petitioners' eldest son was only 14 years old. Moreover, he was only 15 years old
when petitioners moved into the Laurel lane property-- he was still in high school
throughout all of the events surrounding the like-kind exchange. Michael
Reesink's testimony supports the proposition that at the time of the exchange,
petitioners held the Laurel Lane property with investment intent.

- 17 On the basis of the foregoing discussion, we hold that petitioners held the
Laurel Lane property with investment intent at the time of the exchange.
Therefore, petitioners' sale of the apartment building followed by their purchase of
the Laurel Lane property qualifies as a section 1031 like-kind exchange, and they

are not required to recognize gain on the sale of the apartment building for 2005.
II. Proceeds From Litigation Settlement
Section 61(a) includes in gross income "all income from whatever source

derived" unless excluded by a specific provision of the Code.. This statute is
construed broadly, whereas exclusions from gross income are construed narrowly.

.

Commissioner v. Schleier, 515 U.S. 323, 328 (1995); United States v. Burke, 504

U.S. 229, 233 (1992); Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431
(1955). Section 104(a)(2) excludes from gross income "the amount of any
damages (other than punitive damages) received (whether by suit or agreement
and whether as lump sums or as periodic payments) on account of personal
physical injuries or physical sickness".16

16The Small Business Job Protection Act of 1996 (SBJPA), Pub. L. No.
104-188, sec. 1605, 110 Stat. at 1838, amended sec. 104(a)(2) to narrow the
exclusion for damages received for personal injuries or sickness to damages for
personal injury or sickness that is physical, effective for amounts received after
August 20, 1996. See United States v. Burke, 504 U.S. 229, 236 n.6 (1992)
(preamendment personal injuries or sickness did not include damages pursuant to
.

(continued...)

- 18 To be eligible for the section 104(a)(2) exclusion, a.taxpayer must
demonstrate that (1) the underlying cause of action giving rise to the recovery is.
based in tort or tort-type rights, and (2) the damages were received on account of
personal physical injuries or physical sickness. Commissioner v. Schleier, 515
U.S. at 337; Prasil v. Commissioner, T.C. Memo. 2003-100. In the context of

section 104(a)(2), the terms "physical injury" and "physical sickness" do not
include emotional distress, except..to the extent of damages not in excess of the

amount paid for medical care described in section 213(d)(1)(A) and (B)
attributable to emotional distress. See sec. 104(a).
When damages are received pursuant to a settlement agreement, the nature
of the claim that was the actual basis for settlement, and not the validity of the
claim, controls whether the amount is excludable under section 104(a)(2). United

States v. Burke, 504 U.S. at 237; see also Bagley v. Commissioner, 105 T.C. 396,
406 (1995) ("[T]he critical question is, in lieu of what was the settlement amount .

paid?"), aff'd, 121 F.3d 393 (8th Cir. 1997). The determination of the nature of

16(...Continued)
the settlement of purely economic rights but did include "nonphysical injuries to
the individual, such as those affecting emotions, reputation, or character").
SBJPA also amended seb. 104(a)(2) to except punitive damages from the
exclusion irrespective of whether they derived from a case involving physical or
nonphysical injury.

the claim is a factual inquiry and is generally made by reference to the settlement
agreement in the light of the surrounding circumstances. Robinson v.
Commissioner, 102 T.C. 116, 126 (1994), aff'd in part, rev'd in part on another
issue, 70 F.3d 34 (5th Cir. 1995). An express allocation in the settlement
agreement of a portion of the.proceeds to tort or tortlike claims is generally
binding for tax purposes if the agreement was entered into by the parties in an
adversarial relationship at arm's length and in good faith. Baglev v.

Commissioner, 105 T.C. at 406-407; Robinson v. Commissioner, 102 T.C. at
I

126-127. If the settlement agreement lacks express language stating what the
settlement amount was paid to settle, we look to the intent of the payor, based on

all the facts and circumstances of the case, including the complaint that was filed
and the details surrounding the litigation. Knuckles v. Commissioner, 349 F.2d

610, 613 (10th Cir. 1965), aff'g T£. Memo. 1964-33; Robinson v. Commissioner,
102 T.C. at 127.
At the beginning of trial petitioners conceded that they should3have reported
the $60,000 of settlement proceeds received from Michael Reesink on their 2005

joint Federal income tax return. However, petitioners now wish to contest the
issue after Michael Reesink testified that "I paid $60,000 to * * * [Mr. Reesink] *
* * because * * * [Mr. Reesink] and I had three physical, violent confrontations

- 20 over different times." The settlement agreement provided that Michael Reesink

should pay Mr. Reesink "$60,000 as payment in full for his claims arising from the
events described in his complaint." (Emphasis added.) Mr. Reesink did not
describe any events rising to the level of physical injuries or physical sickness in
his complaint, nor did the complaint ask for damages for physical injuries or
physical sickness. Moreover, Michael Reesink's testimony could just as easily
have been referring to emotional distress (damages for which would be taxable

income) as it could have been for physical injury. Petitioners bear the burden of
proof, and there is insufficient evidence to lead us to conclude that Mr. Reesink

was compensated for physical injuries or physical sickness. Without more, we
find that the $60,000 payment from Michael Reesink to Mr. Reesink was taxable
income to petitioners.

III. Section 6662(a) Accuracy-Related Penalty
Respondent determined that petitioners are liable for a section 6662(a) and

(b)(1) accuracy-related penalty for an underpayment resulting from their

negligence in failing to substantiate travel expenses, failing to report $60,000 of
settlement proceeds as taxable income, and failing to report $16,392 of rental
gross receipts.

- 21 Under section 7491(c), the Commissioner bears the burden of production
with regard to penalties and must come forward with sufficient evidence
indicating that it is appropriate to impose.penalties. See Higbee v. Commissioner,

116 T.C. 438, 446 (2001). However, once the Commissioner has met the burden
of production, the burden of proof remains with the taxpayer, including the burden
of proving that the penalties are inappropriate because of reasonable cause or
substantial authority under section 6664. See Rule 142(a); Higbee v.

Commissioner, 116 T.C. at 446-447. We find respondent has met the burden of
production for the settlement proceeds, travel expenses, and rental receipts.
Section 6662(c) defines negligence as including any failure to make a
reasonable attempt to comply with the provisions of the Code. Section 6662(c)
also defines ''disregard" as any careless, reckless, or intentional disregard.
Disregard of rules or regulations is careless if the taxpayer does not exercise
reasonable diligence to determine the correctness of a tax return position that is

contrary to rules or regulations: Sec. 1.6662-3(b)(2), Income Tax Regs. Disregard
of rules or regulations is reckless if the taxpayer makes little or no effort to
determine whether a rule or regulation exists. Id. Disregard of rules or regulations
is intentional if the taxpayer has knowledge of the rule or regulation that he
. disregards. Id.

-22An underpayment is not attributable to negligence or disregard to the extent
that the taxpayer shows that the underpayment is due to the taxpayer's having
reasonable cause and acting in good faith. Sec. 6664(c)(1); Neonatology Assocs.,

P.A. vL Commissioner, 115 T.C. 43, 98 (2000), aff'd, 299 F.3d. 221 (3d Cir. 2002).
Reasonable caùse requires that the taxpayer have exercised ordinary business care
and prudence as to the disputed item. See United States v. Boyle, 469 U.S. 241

(1985); Estate of Young v. Commissioner, 110 T.C. 297, 317 (1998). Good-faith
reliance on the advice of an independent, competent professional as to the tax
treatment of an item may meet this requirement. See United States v. Boyle, 469

U.S. at 241; sec. 1.6664-4(b), Income Tax Regs. The decision as to whether a
taxpayer acted with reasonable cause and in göod faith is made on a case-by-case

basis, taking into account all of the pettinent facts and circumstances. Sec.

1.6664-4(b)(1), Income Tax Regs.
For a taxpayer to rely reasonably upon advice so as possibly to negate a

section 6662 accuracy-related penalty determined by the Commissioner, the
taxpayer must prove by a preponderance of the evidence that the taxpayer meets
each requirement of the following three-prong test: (1) the adviser was a
competent professional who had sufficient expertise to justify reliance; (2) the
taxpayer provided necessary and accurate information to the adviser; and (3) the

- 23 taxpayer actually relied in good faith on the adviser's judgment. Neonatology

Assocs., P.A. v. Commissioner, 115 T.C. at 99.
A. Substantiation of Travel Expenses
Petitioners concede that they are unable to substantiate $1,124 of travel
expenses incurred in searching for replacement property for the section 1031 likekind exchange. While petitioners testified that: . (1) the expenditures were actually
incurred, and (2) they provided a summary worksheet of the expenses to their tax

preparer, no summary worksheet was produced. Petitioners have failed to show
reasonable cause for failure to substantiate their travel expenses. Therefore, we.

hold that petitioners are liable for the section 6662(a) accuracy-related penalty on
the portion of the underpayment associated with the travel expenses deducted on

their joint 2005 Federal income tax return.
B. Settlement Proceeds
Petitioners argue that they provided Mr. McLaughlin with the closing
statement from the sale of the apartment building, and the closing statement listed
"Settlement from Michael Reesink to Patrick Reesink--$60,000" separately from

the sale proceeds. While Mr. McLaughlin was aware that petitioners received
$56,417 of taxable boot in the like-kind exchange, Mr. McLaughlin testified that
hb was not told about the $60,000 of settlement proceeds. Petitioners argue that

.

- 24 Mr. McLaughlin confused the two numbers and therefore failed to report the

settlement proceeds.
Even if petitioners informed Mr. McLaughlin about the settlement proceeds,
we still find petitioners liable for the section 6662(a) accuracy-related penalty.
Both the settlement proceeds and the boot received in the like-kind exchange were

tãxable. Even a cursory review of petitioners' 2005 tax return would have
revealed that the $60,000 of settlement proceeds was not reported. There is no
evidence that petitioners ever inquired with a professional or anyone else about the
taxability of the settlement payment. Therefore, we hold petitioners have failed to

show reasonable cause and are liable for the section 6662(a) accuracy-related
penalty on the portion of the underpayment associated with the settlement

proceeds.

.

,

C. Underreported Rental Gross Receipts
Petitioners also concede that they failed to report $16,392 of rental gross

receipts. Michael Reesink was in charge of keeping the accounting records for the
apartment building. He provided Mr. McLaughlin with handwritten income and
expense statements for the apartment building for the 2005 tax year. While these

statements were sloppily constructed, petitioners should have noticed that rental
gross receipts had substantially declined in 2005 from what was reported on their

- 25 2002, 2003, and 2004 joint Federal income tax returns. While the sale of the
apartment building during 2005 may have accounted for some of this discrepancy,
petitioners were well aware that Michael Reesink's bookkeeping could.not be
trusted. Petitioners failed to make even basic inquiries into the substantial

decrease in rental gross receipts. Therefore, petitioners have failed to show
reasonable cause and are liable for the section 6662(a) accuracy-related penalty on
the portion of the underpayment associated with their failure to report $16,392 of
rental gross receipts.

IV. Conclusion

We conclude that petitioners' sale of the apartment building followed by the
purchase of the Laurel Lane property qualifies as a section 1031 like-kind
exchange. Moreover, we conclude that the $60,000 of settlement proceeds should
have been reported as taxable income on petitioners' 2005 joint Federal income

tax return. Finally, we conclude that petitioners are liable for the section 6662(a)
accuracy-related penalty associated with the portions of the underpayment relating
to the settlement proceeds, the rental income, and the travel expenses. In reaching

our holding herein, we have considered all arguments made by the.parties, and, to
the extent not mentioned above, we conclude they are moot, irrelevant, or without
merit.

- 26 To reflect the foregoing,
Decision will be entered
under Rule 155.

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A767ee1c76aae1517. Public record. Not legal advice.