T.C. Memo. 2014-19
UNITED STATES TAX COURT
FIELDS CURTIS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7432-12. Filed January 28, 2014.
Fields Curtis, pro se.
Timothy R. Berry, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MARVEL, Judge: Respondent determined a deficiency in petitioner’s
Federal income tax of $80,319, an addition to tax under section 6651(a)(1)1 of
1
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. Monetary amounts have been
(continued...)
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[*2] $20,118, and an accuracy-related penalty under section 6662(a) of $16,064
for 2007. After concessions,2 the issues for decision are: (1) whether petitioner
had unreported capital gain of $432,350 from the involuntary conversion of
residential real property for 2007; (2) whether petitioner is entitled to a real estate
loss of $25,000 for 2007; (3) whether petitioner is liable for an addition to tax
under section 6651(a)(1) for 2007; and (4) whether petitioner is liable for an
accuracy-related penalty under section 6662(a) for 2007.
FINDINGS OF FACT
Some of the facts have been stipulated. The stipulations of facts are
incorporated herein by this reference. When he petitioned this Court, petitioner
resided in California.
Petitioner’s Residential Apartment Building
In 1991 petitioner purchased a residential apartment building for $82,500.
The apartment building had 11 private rooms, shared kitchens and bathrooms, and
a total living area of 3,306 square feet. Petitioner resided in one room of the
apartment building with a total living area of 165 square feet.
1
(...continued)
rounded to the nearest dollar.
2
Respondent concedes that petitioner purchased the apartment building for
$82,500.
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[*3] Condemnation Proceedings
In June 2006 the Los Angeles Unified School District initiated an eminent
domain proceeding against petitioner in the Superior Court of California, County
of Los Angeles, to acquire the apartment building. On or about July 19, 2006, (1)
the school district deposited $610,000 into an account for petitioner as probable
compensation for the taking of the apartment building,3 and (2) the superior court
issued an order authorizing the school district to take possession of the apartment
building on October 25, 2006. On October 24, 2007, the superior court entered a
judgment in condemnation providing for the sale of the apartment building to the
school district for $720,000. Petitioner did not purchase replacement property
within the meaning of section 1033.
Petitioner’s Income Tax Reporting
Petitioner did not receive an extension of time to file his 2007 Federal
income tax return. Petitioner filed a Form 1040, U.S. Individual Income Tax
Return, for 2007 on October 13, 2008. Petitioner filed a Form 1040X, Amended
U.S. Individual Income Tax Return (2007 amended return), for 2007 dated August
3
The superior court authorized the payment of this amount to petitioner on
or about December 5, 2006. Neither party has raised the issue of whether
petitioner should have reported this amount as income for 2006. Accordingly, we
will not address this issue.
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[*4] 23, 2010.4 On his 2007 amended return petitioner reported taxable income
and total tax of $9,781 and $1,075, respectively. On a Form 4797, Sales of
Business Property, attached to his 2007 amended return petitioner reported total
gain of $43,531 from the involuntary conversion of the apartment building. The
Form 4797 calculated petitioner’s total gain as follows:
Gross sales price $720,000
Cost or other basis plus expense of sale 770,687
Depreciation 94,218
Adjusted basis 676,469
Total gain 43,531
On a worksheet attached to petitioner’s 2007 amended return petitioner calculated
his basis before depreciation in the apartment building as follows:
Regular tax AMT
Original cost or other basis $241,127 $241,127
Improvements and restorations 461,504 461,504
Expense of sale 68,056 68,056
Basis before depreciation 770,687 770,687
Additionally, on a Schedule E, Supplemental Income and Loss, attached to his
2007 amended return petitioner reported rents received and a deductible rental real
estate loss of zero and $25,000, respectively.
4
Petitioner hired a paid preparer to prepare his 2007 amended return.
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[*5] OPINION
I. Burden of Proof
Generally, the Commissioner’s determination of a deficiency is presumed
correct, and the taxpayer bears the burden of proving that the determination is
improper. See Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). If,
however, a taxpayer produces credible evidence5 with respect to any factual issue
relevant to ascertaining the taxpayer’s liability for any tax imposed by subtitle A
or B of the Code and satisfies the requirements of section 7491(a)(2), the burden
of proof on any such issue shifts to the Commissioner. Sec. 7491(a)(1). Section
7491(a)(2) requires a taxpayer to demonstrate that he (1) complied with
requirements under the Code to substantiate any item, (2) maintained all records
required under the Code, and (3) cooperated with reasonable requests by the
Secretary6 for witnesses, information, documents, meetings, and interviews. See
also Higbee v. Commissioner, 116 T.C. 438, 440-441 (2001).
5
“‘Credible evidence is the quality of evidence which, after critical analysis,
the court would find sufficient upon which to base a decision on the issue if no
contrary evidence were submitted (without regard to the judicial presumption of
IRS correctness).’” Higbee v. Commissioner, 116 T.C. 438, 442 (2001) (quoting
H.R. Conf. Rept. No. 105-599, at 240-241 (1998), 1998-3 C.B. 747, 994-995).
6
The term “Secretary” means the Secretary of the Treasury or his delegate.
Sec. 7701(a)(11)(B).
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[*6] Petitioner contends that the burden of proof should shift to respondent under
section 7491(a). However, the record shows that petitioner did not meet the
requirements of section 7491(a)(1) and (2). Accordingly, the burden of proof
remains on petitioner.
II. Involuntary Conversion Income
A. Petitioner’s Gain From the Involuntary Conversion
Gross income includes all income from whatever source derived, including
gains derived from dealings in property. See sec. 61(a)(3). Gain from the sale or
exchange of property must be recognized, unless the Code provides otherwise.
Sec. 1001(c). Section 1001(a) defines gain from the sale of property as the excess
of the amount realized on the sale of the property over the adjusted basis of the
property sold or exchanged. See also sec. 1.61-6(a), Income Tax Regs. The
amount realized is the sum of any money received plus the fair market value of
any other property received, reduced by the expenses of selling the property. See
sec. 1001(b); Chapin v. Commissioner, 12 T.C. 235, 238 (1949), aff’d, 180 F.2d
140 (8th Cir. 1950).
Section 1011 provides that a taxpayer’s adjusted basis for determining the
gain or loss from the sale or other disposition of property shall be its cost, adjusted
to the extent provided in section 1016. See also sec. 1012. A property’s cost is
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[*7] “the amount paid for such property in cash or other property.” Sec.
1.1012-1(a), Income Tax Regs. The term “cost” includes “any indebtedness to the
seller for the purchase price of the property and any indebtedness to a third party
secured by the property”, as well as expenses a taxpayer incurs in acquiring the
property. Metrocorp, Inc. v. Commissioner, 116 T.C. 211, 242 (2001). The
taxpayer may increase his basis in the property even if he does not personally
assume the indebtedness. See Crane v. Commissioner, 331 U.S. 1, 11-12 (1947).
If a taxpayer places a mortgage on property he already owns, the mortgage
generally does not affect the basis of the property. See Woodsam Assocs., Inc. v.
Commissioner, 16 T.C. 649 (1951), aff’d, 198 F.2d 327 (2d Cir. 1952).
Under section 1016(a)(1), the basis of property must be adjusted for
expenditures, receipts, losses, or other items properly chargeable to capital
account. The costs of improvements and betterments made to a taxpayer’s
property are among the items properly chargeable to capital account. See sec.
1.1016-2(a), Income Tax Regs. The taxpayer has the burden of proving the basis
of property for purposes of determining the amount of gain the taxpayer must
recognize. See O’Neill v. Commissioner, 271 F.2d 44, 50 (9th Cir. 1959), aff’g
T.C. Memo. 1957-193.
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[*8] The parties agree that the amount petitioner realized from the involuntary
conversion of the apartment building was $720,000. The parties disagree,
however, with respect to petitioner’s adjusted basis in the apartment building.
Respondent contends that petitioner had an adjusted basis in the apartment
building of $221,114.7 Petitioner contends that respondent’s basis calculation is
erroneous.
The parties agree that petitioner purchased the apartment building for
$82,500. They appear to disagree, however, regarding the costs of various
improvements that petitioner made to the apartment building. Respondent
contends that petitioner paid improvement costs of $129,938. Petitioner offered
testimony regarding various improvements that he made to the apartment building
and several receipts and contracts for work on the property. However, taken
together, petitioner’s testimony and documentary evidence fail to persuasively
show that petitioner had a basis in the apartment building that is greater than the
basis that respondent allowed or has conceded. Accordingly, we sustain
respondent’s revised basis calculation.
7
Respondent’s brief erroneously computes petitioner’s basis as $221,364 but
also includes the correctly computed amount of $221,114. Respondent’s proposed
findings of fact state that petitioner’s basis in the apartment building is $220,718.
However, this lower amount appears to be the result of a transpositional error.
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[*9] B. Section 1033
Section 1033(a) provides that when property is compulsorily or
involuntarily converted no gain shall be recognized if within two years the
taxpayer purchases other property similar or related in service or use to the
condemned property. Section 1033(g) provides that when property held for
productive use in a trade or business or for investment is compulsorily or
involuntarily converted, property of a like kind to be similarly held shall be treated
as property similar or related in service to the property converted. If the
requirements of section 1033 are complied with, recognition of gain on the sale of
property is limited to the difference between the amount realized and the cost of
replacement property. Sec. 1033(a)(2)(A).
The parties stipulated that petitioner did not purchase replacement property
for the apartment building within the meaning of section 1033. Accordingly, we
conclude that section 1033 does not exempt petitioner from recognizing the
amount realized from the involuntary conversion of the apartment building.
C. Section 121
Section 121 provides for the exclusion from gross income of up to $250,000
of gain from the sale or exchange of property if the property was owned and used
by a taxpayer as the taxpayer’s principal residence for periods aggregating two
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[*10] years or more during the five-year period preceding the sale or exchange.
See sec. 121(a) and (b). If the taxpayer uses only a portion of the property as the
taxpayer’s principal residence, only the gain allocable to that portion is excludable
under section 121. See sec. 1.121-1(e)(1), Income Tax Regs.
The parties stipulated that petitioner used only 165 of 3,306 square feet, or
close to 5%, of the apartment building as his personal residence. Respondent
allowed petitioner to exclude 5% of the gain from gross income. Petitioner has
not introduced any evidence or made any argument regarding whether any portion
of the gain attributable to the shared facilities of the apartment building should be
excluded under section 121. Accordingly, we conclude that petitioner is entitled
to exclude only 5% of the gain from the involuntary conversion of the apartment
building under section 121.
III. Real Estate Loss
Respondent disallowed petitioner’s claimed rental real estate loss of
$25,000. Generally, a taxpayer who is carrying on a trade or business may deduct
ordinary and necessary expenses incurred in connection with the operation of the
business. Sec. 162(a). On or about July 19, 2006, the superior court authorized
the school district to take possession of the apartment building on October 25,
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[*11] 2006, and we infer from the record that the school district did so.8
Additionally, petitioner reported rents received of zero for 2007. Accordingly, we
conclude that petitioner was not engaged in the trade or business of renting real
estate in 2007 and is therefore not entitled to deduct the claimed rental real estate
loss.
IV. Addition to Tax and Penalty
A. Burden of Proof
The Commissioner bears the burden of production with respect to a
taxpayer’s liability for additions to tax and penalties and must produce sufficient
evidence indicating that it is appropriate to impose the additions to tax or
penalties. See sec. 7491(c); Higbee v. Commissioner, 116 T.C. at 446-447. Once
the Commissioner carries the burden of production, the taxpayer must come
forward with persuasive evidence that the Commissioner’s determination is
incorrect or that the taxpayer had reasonable cause or substantial authority for the
position. See Higbee v. Commissioner, 116 T.C. at 447.
8
Petitioner does not claim that he owned any other rental property during
2006 or 2007.
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[*12] B. Addition to Tax Under Section 6651(a)(1)
Section 6651(a)(1) authorizes the imposition of an addition to tax for failure
to timely file a return, unless it is shown that such failure is due to reasonable
cause and not due to willful neglect. See United States v. Boyle, 469 U.S. 241,
245 (1985); United States v. Nordbrock, 38 F.3d 440, 444 (9th Cir. 1994). A
failure to timely file a Federal income tax return is due to reasonable cause if the
taxpayer exercised ordinary business care and prudence but nevertheless was
unable to file the return within the prescribed time. See sec. 301.6651-1(c)(1),
Proced. & Admin. Regs. Circumstances that are considered to constitute
reasonable cause for failure to timely file a return are typically those outside of the
taxpayer’s control, including, for example: (1) unavoidable postal delays; (2) the
timely filing of a return with the wrong office; (3) the death or serious illness of a
taxpayer or a member of the taxpayer’s immediate family; (4) a taxpayer’s
unavoidable absence from the United States; (5) destruction by casualty of a
taxpayer’s records or place of business; and (6) reliance on the erroneous advice of
an Internal Revenue Service officer or employee. McMahan v. Commissioner,
114 F.3d 366, 369 (2d Cir. 1997), aff’g T.C. Memo. 1995-547.
The parties agree that petitioner failed to timely file a Federal income tax
return for 2007. Accordingly, respondent has carried his burden of producing
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[*13] evidence showing that an addition to tax under section 6651(a)(1) for 2007
is appropriate.
Petitioner has failed to introduce evidence showing that he had reasonable
cause for failing to timely file a 2007 Federal income tax return. Accordingly, we
conclude that petitioner is liable for an addition to tax under section 6651(a)(1).
C. Accuracy-Related Penalty Under Section 6662(a)
Section 6662(a) and (b)(1) and (2) authorizes the Commissioner to impose a
20% penalty on an underpayment of tax that is attributable to, among other things,
(1) negligence or disregard of rules or regulations or (2) any substantial
understatement of income tax. Only one section 6662 accuracy-related penalty
may be imposed with respect to any given portion of an underpayment. New
Phoenix Sunrise Corp. v. Commissioner, 132 T.C. 161, 187 (2009), aff’d, 408 Fed.
Appx. 908 (6th Cir. 2010); sec. 1.6662-2(c), Income Tax Regs.
The term “negligence” includes any failure to make a reasonable attempt to
comply with the provisions of the internal revenue laws, and the term “disregard”
includes any careless, reckless, or intentional disregard. Sec. 6662(c); sec.
1.6662-3(b)(1) and (2), Income Tax Regs. “‘Negligence’ also includes any failure
by the taxpayer to keep adequate books and records or to substantiate items
properly.” Sec. 1.6662-3(b)(1), Income Tax Regs. Disregard of rules or
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[*14] regulations “is ‘careless’ if the taxpayer does not exercise reasonable
diligence to determine the correctness of a return position” and “is ‘reckless’ if the
taxpayer makes little or no effort to determine whether a rule or regulation exists,
under circumstances which demonstrate a substantial deviation from the standard
of conduct that a reasonable person would observe.” Sec. 1.6662-3(b)(2), Income
Tax Regs.; see also Neely v. Commissioner, 85 T.C. 934, 947 (1985). An
understatement means the excess of the amount of the tax required to be shown on
the return over the amount of the tax imposed which is shown on the return,
reduced by any rebate. Sec. 6662(d)(2)(A). An understatement is substantial in
the case of an individual if the amount of the understatement for the taxable year
exceeds the greater of 10% of the tax required to be shown on the return or
$5,000. Sec. 6662(d)(1)(A).
On his 2007 amended return petitioner reported total tax of $1,075. The
amount required to be shown on the return and the understatement as determined
by respondent in the notice of deficiency are $81,394 and $80,319, respectively.
With the exception of respondent’s concession regarding petitioner’s basis in the
apartment building we have sustained respondent’s deficiency determination.
Even after respondent’s concession petitioner’s understatement will be greater
than 10% of the amount required to be shown on the return, which will be greater
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[*15] than $5,000. Accordingly, respondent has shown that an accuracy-related
penalty for 2007 is appropriate.
A taxpayer can avoid liability for the accuracy-related penalty with respect
to any portion of the underpayment for which the taxpayer proves that there was
reasonable cause and that he or she acted in good faith. Sec. 6664(c)(1). The
decision as to whether a taxpayer acted with reasonable cause and in good faith is
made on a case-by-case basis, taking into account all of the pertinent facts and
circumstances. See sec. 1.6664-4(b)(1), Income Tax Regs. “Circumstances that
may indicate reasonable cause and good faith include an honest misunderstanding
of fact or law that is reasonable in light of all of the facts and circumstances,
including the experience, knowledge, and education of the taxpayer.” Id.
A taxpayer may also establish reasonable cause and good faith by
introducing evidence that he relied on a professional tax adviser. To prove that
the taxpayer’s reliance on an adviser establishes reasonable cause and good faith,
the taxpayer must prove that (1) the taxpayer selected a competent tax adviser, (2)
the taxpayer supplied the adviser with all relevant information, and (3) the
taxpayer relied in good faith on the adviser’s professional judgment. See
Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299
F.3d 221 (3d Cir. 2002).
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[*16] Although petitioner hired a paid tax preparer to prepare his 2007 amended
return, petitioner did not introduce any credible evidence showing that he (1)
selected a competent tax return preparer or (2) supplied accurate and complete
information to his tax return preparer. Accordingly, we conclude that petitioner is
liable for a section 6662(a) penalty for an underpayment of tax attributable to a
substantial understatement of income tax.
We have considered the parties’ remaining arguments, and to the extent not
discussed above, conclude those arguments are irrelevant, moot, or without merit.
To reflect respondent’s concession and the foregoing,
Decision will be entered
under Rule 155.