T.C. Memo. 1995-473
UNITED STATES TAX COURT
GENERAL K. HILLIARD AND IDA M. HILLIARD, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4929-93. Filed October 3, 1995.
Jeffrey A. Berchenko, for petitioners.
James P. Thurston and Bryce A. Kranzthor, for respondent.
MEMORANDUM OPINION
GERBER, Judge: Respondent determined deficiencies in
petitioners' Federal income tax and additions to tax for the
taxable years 1986, 1987, and 1988 as follows:
Additions to Tax
Sec. Sec. Sec. Sec.
Year Deficiency 6653(a)(1) 6653(a)(1)(A) 6653(a)(1)(B) 6661
1
1986 $38,390 -- $1,920 $9,598
1
1987 37,345 -- 1,867 9,336
1988 8,097 $405 -- -- 2,024
1
50 percent of the interest with respect to the portions of
the underpayments which are attributable to negligence.
After concessions1 by the parties, the issues remaining for
our consideration are: (1) Whether petitioners are entitled to
deduct losses from charter activities of two boats, which were
passed through to petitioners from their wholly owned S
corporation, "Island Ventures, Inc."; (2) whether petitioners are
entitled to deduct losses attributable to the rental of
residential property located in the Lake Tahoe area (the Tahoe
property); (3) whether petitioners are entitled to deduct
automobile expenses attributable to Mrs. Hilliard's self-
employment activity in an amount greater than that allowed by
respondent and, if not, whether petitioners are liable for
additional self-employment tax; (4) whether petitioners are
entitled to deduct mortgage interest in an amount greater than
that allowed by respondent; (5) whether petitioners are liable
for additions to tax for negligence; and (6) whether petitioners
are liable for additions to tax for substantial understatement of
their tax liability.
The question of whether petitioners are entitled to deduct
1
Petitioners conceded that: (1) Respondent's $11,992
investment tax credit recapture adjustment for 1987 is correct;
(2) respondent's adjustments regarding the Tahoe property in
items d, e, and i in the Adjustment to Income (Supplemental
Schedule) in the notice of deficiency are correct if the Court
should find that the Tahoe rental activity was not for profit
under sec. 183, I.R.C., and if the activity was for profit, then
the loss limitations of sec. 280A(e), I.R.C., would apply; (3)
they are not entitled to an interest deduction for $7,153 of
points claimed for 1987; (4) $2,625 of interest claimed for 1987
with respect to the Tahoe property is not allowable; (5) $1,385
of the investment interest claimed for 1988 is not allowable; and
(6) $460 of personal interest claimed for 1987 is not allowable.
the losses from boat chartering and residential rental activities
concerns whether those endeavors were "not engaged in for profit"
within the meaning of section 183.2 For simplicity and clarity,
we set forth the background facts and legal principles applying
generally to the boating and residential rental activities.
Thereafter, combined findings of fact and legal discussion are
presented in separate sections for each issue.
I. Background3
Petitioners, at all relevant times, were married, filed
joint income tax returns, and resided in Orinda, California.
Petitioners are medical doctors: Mrs. Hilliard is a psychiatrist
and Mr. Hilliard is a cardiologist. They practice medicine on a
full-time basis.
Mr. Hilliard has been involved in sailing as a hobby since
1966, and he purchased a small sailboat in 1970 and a fixed-keel
boat in 1975 or 1976 for his personal use.
On their 1986, 1987, and 1988 joint tax returns, petitioners
jointly reported wages and net income from the practice of
medicine in amounts ranging from approximately $166,000 to
$230,000 per year. Against the income reported, petitioners
claimed losses attributable to boating and residential rental
activities. Petitioners reported boat chartering income and
2
Section references are to the Internal Revenue Code in
effect for the years in issue. Rule references are to this
Court's Rules of Practice and Procedure.
3
The parties' stipulations of facts and exhibits are
incorporated by this reference.
expenses for the years 1984 through 1988 as follows:
1984 1985 1986 1987 1988
Income none $1,250 $2,900 none none
Expenses
Repairs 8,534 2,380 $4,029
Insurance,
taxes, fees 20,810 15,387 5,500 $939
Interest 17,333 20,366 10,520
Depreciation $28,482 47,851 47,260 39,875
Claimed Loss 28,482 93,278 82,493 59,924 939
Petitioners also claimed losses from rental activity in the
amounts of $19,068, $18,794, $19,649, $19,347, and $16,107 for
the years 1984, 1985, 1986, 1987, and 1988, respectively.
II. General Legal Principles
As a general rule, the Commissioner's determinations are
afforded a presumption of correctness, and the taxpayer bears the
burden of proving that those determinations are erroneous. Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Moreover,
deductions are a matter of legislative grace, and the taxpayer
bears the burden of proving that he is entitled to claimed
deductions. Rule 142(a); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1934); Welch v. Helvering, supra. This includes
the burden of substantiating the amount and purpose of the item
claimed. Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), affd.
per curiam 540 F.2d 821 (5th Cir. 1976).
In determining whether petitioners are entitled to deduct
losses from their boat chartering and residential rental
activities, we must decide whether these activities were engaged
in for profit within the meaning of section 183. Section 183(a)
provides generally that, if an activity is not engaged in for
profit, no deduction attributable to such activity shall be
allowed except as provided in that section. Section 183(b)(1)
provides that deductions that are allowable without regard to
whether the activity is engaged in for profit (e.g., real
property taxes) shall be allowed, and section 183(b)(2) provides
that deductions that would be allowable only if the activity were
engaged in for profit shall be allowed, "but only to the extent
that the gross income derived from such activity for the taxable
year exceeds the deductions allowable by reason of" section
183(b)(1).
Section 183(c) defines an "activity not engaged in for
profit" as "any activity other than one with respect to which
deductions are allowable for the taxable year under section 162
or under paragraph (1) or (2) of section 212".4 For a deduction
to be allowed under section 162 or section 212(1) or (2),
petitioners must establish that they engaged in the activity with
the actual and honest objective of making an economic profit,
independent of tax savings. Antonides v. Commissioner, 91 T.C.
686, 693-694 (1988), affd. 893 F.2d 656 (4th Cir. 1990); Dreicer
v. Commissioner, 78 T.C. 642, 644-645 (1982), affd. without
4
Under sec. 162, deductions are allowable for the expenses
of carrying on an activity that constitutes a trade or business
if those expenses are ordinary and necessary to the conduct of
the trade or business. Sec. 212 permits the deduction of
expenses incurred in connection with an activity engaged in for
the production or collection of income, or for the management,
conservation, or maintenance of property held for the production
of income.
opinion 702 F.2d 1205 (D.C. Cir. 1983). Their expectation of
profit need not have been reasonable; however, they must have
entered into the activity, or continued it, with the objective of
making a profit. Hulter v. Commissioner, 91 T.C. 371, 393
(1988); sec. 1.183-2(a), Income Tax Regs.
The burden is on petitioners to show error in respondent's
determination that the boat chartering and/or the residential
rental activities were not engaged in for profit. Rule 142(a);
Golanty v. Commissioner, 72 T.C. 411, 426 (1979), affd. without
published opinion 647 F.2d 170 (9th Cir. 1981); Boyer v.
Commissioner, 69 T.C. 521, 537 (1977); Benz v. Commissioner, 63
T.C. 375 (1974). Whether the requisite profit objective exists
is determined by looking at all the surrounding facts and
circumstances. Keanini v. Commissioner, 94 T.C. 41, 46 (1990);
sec. 1.183-2(b), Income Tax Regs. Greater weight is given to
objective facts than to a taxpayer's mere statement of his
intent. Thomas v. Commissioner, 84 T.C. 1244, 1269 (1985), affd.
792 F.2d 1256 (4th Cir. 1986); Beck v. Commissioner, 85 T.C. 557,
570 (1985); sec. 1.183-2(a), Income Tax Regs.
Section 1.183-2(b), Income Tax Regs., provides a list of
factors to be considered in the evaluation of a taxpayer's profit
objective: (1) The manner in which the taxpayer carries on the
activity; (2) the expertise of the taxpayer or his advisers;
(3) the time and effort expended in carrying on the activity;
(4) the expectation that assets used in the activity may
appreciate in value; (5) the success of the taxpayer in carrying
on other similar or dissimilar activities; (6) the taxpayer's
history of income or losses from the activity; (7) the amount of
occasional profits, if any, from the activity; (8) the financial
status of the taxpayer; and (9) elements of personal pleasure or
recreation. This list is nonexclusive, and no single factor or
even a majority of factors necessarily controls. Abramson v.
Commissioner, 86 T.C. 360, 371 (1986); sec. 1.183-2(b), Income
Tax Regs.
III. Boat Charter Activities
The boat charter activities were operated by Island
Ventures, Inc., petitioners' S corporation. The claimed losses
were passed through the S corporation to petitioners and claimed
on their joint Federal income tax returns.5 Losses attributable
to the sailboat charter activity were claimed only for the 1986
year because the sailboat was not offered for charter in later
years, even though it continued to be owned by petitioners.
Losses attributable to the fishing boat charter activity were
claimed for 1986 and 1987. For 1988, petitioners claimed legal
fees incurred in connection with the fishing boat.
A. Sailboat Activity
In 1979, Mr. Hilliard purchased a Columbia 32-foot sailboat
(sailboat) for approximately $65,000. The sailboat was placed
with Captain George's charter service in the San Francisco Bay
5
If we hold that either of the boat charter activities was
engaged in for profit, then we must decide whether the losses
from that activity are subject to the S corporation loss
limitation rules under sec. 1366(d)(1).
area. The sailboat was infrequently chartered, and it was not
maintained. Berth fees paid directly to Captain George's were
not forwarded to the harbor master. After 1 year, Mr. Hilliard
moved the boat to a marina in Richmond, California, and,
thereafter, petitioners attempted to charter the sailboat
themselves. Mr. Hilliard had no prior experience in sailboat
chartering. Petitioners posted notices on bulletin boards in the
hospitals where they worked, placed a sign on the boat, and
otherwise relied on word of mouth to advertise their sailboat for
charter. The sailboat, while located at the Richmond marina, was
seldom chartered. Petitioners received little income, and it was
substantially less than their claimed expenses. Petitioners
ceased sailboat charter activity during 1987, but they retained
the sailboat for personal use. During the time petitioners were
attempting to charter the sailboat, they personally used the boat
about once a month during the summer. The boat was not used
during the winter.
(1) Manner in which the taxpayer carries on the activity.
Attempts to publicize or advertise the chartering activities were
not significant. Petitioners did not prepare a written business
plan prior to the sailboat purchase. No separate books and
records or separate bank accounts were maintained regarding the
sailboat.
(2) The expertise of the taxpayer or his advisers. Although
Mr. Hilliard was an experienced sailor and sailed the boat during
the summer, he had no experience with chartering. Petitioners
did not seek out the assistance of their accountant or any other
assistance in connection with their sailboat charter activity.
(3) Time and effort expended by the taxpayer in carrying on
the activity. Petitioners, both of whom were full-time medical
doctors, spent little time with the chartering business. The
extent of their efforts included merely placing the sailboat in a
marina and attempting to solicit charter activity by placing
notices on bulletin boards at the hospitals where they worked.
(4) Expectation that assets used in the activity may
appreciate in value. Mr. Hilliard expected to benefit from
gaining equity in the boat by making monthly mortgage payments
derived from boat charter revenues. Mr. Hilliard was aware that
his sailboat was not likely to appreciate in value. Although,
for several years, the sailboat generated relatively large
amounts of expenses and little or no income, petitioners did not
make any meaningful changes to their approach, other than to move
the boat to another marina. Petitioners were content to claim
the deductions and have the boat available for their use during
the summer boating season.
(5) The success of the taxpayer in carrying on other similar
or dissimilar activities. Petitioners' attempt to charter the
sailboat was their first attempt at chartering. They offered no
other evidence of their success in other types of chartering
businesses prior to that date.
(6) The taxpayer's history of income and loss with respect
to the activity, and (7) the amount of occasional profits, if
any, that are earned. A record of substantial losses over many
years and the unlikelihood of achieving a profitable operation
may be important factors bearing on the taxpayer's intention.
Cannon v. Commissioner, 949 F.2d 345, 352 (10th Cir. 1991), affg.
T.C. Memo. 1990-148; Golanty v. Commissioner, 72 T.C. at 426-427.
Petitioners' chartering activities generated substantial losses
over a period of about 8 years, which petitioners used to offset
taxable income from other sources.
(8) The financial status of the taxpayer. During the period
petitioners owned and attempted to charter the sailboat, they
received substantial income from their full-time medical
practices. Petitioners' income from the practice of medicine
provided the base from which chartering activities losses were
deducted, providing tax benefits.
(9) The presence of elements of personal pleasure or
recreation. Mr. Hilliard has sailed as a hobby since 1966.
Petitioners used the sailboat personally about one weekend a
month during the summer.
Essentially, petitioners sought to deduct the cost of the
operation of their sailboat, which they had available for their
personal use. Their approach was not businesslike, and little
effort was invested in their attempt to charter the boat. We
note that the year after the fishing boat was purchased and
started the generation of substantial deductions (by way of
depreciation and credits), petitioners ceased any attempt to
charter the sailboat or to claim any operating expenses.
Accordingly, we hold that the attempt to charter the
sailboat was an activity "not engaged in for profit" within the
meaning of section 183. Hence, it is not necessary to discuss
the section 1366(d)(1) loss requirements regarding S
corporations.
B. Fishing Boat Activity
In 1985, Mr. Hilliard became aware of a boat investment
opportunity through his accountant, Nathaniel Brazil. Mr.
Brazil, who was married to Mr. Hilliard's cousin, was also a
friend and has been petitioners' accountant since 1968. Pursuant
to Mr. Brazil's proposal, petitioners were to purchase a boat and
place it in a charter activity in Florida using Inter Island
Charters, Inc.
Petitioners did not do any independent investigation and
relied on Mr. Brazil for investigation of the fishing boat
investment. There is no indication that Mr. Brazil traveled to
Florida to investigate the fishing boat. On Mr. Brazil's advice,
petitioners agreed to a $199,894 purchase price for a new 1985
Sport Strike Fisherman boat named "My Toy" (fishing boat) during
March or April 1985; the boat was to be docked in Fort
Lauderdale, Florida. Mr. Hilliard did not know whether Mr.
Brazil had any experience concerning investments in boat
chartering.
Early in March 1985, Mr. Hilliard executed a purchase order
for a fishing boat that he had not seen prior to making the
order. Mr. Brazil had arranged for petitioners to meet with the
sellers and with representatives of Inter Island Charters. At
the end of March 1985, petitioners traveled to Florida for a
weekend and arranged for purchase of the fishing boat.
Petitioners were not provided with a choice of boats from the
seller's inventory.
Prior to purchasing the boat, Mr. Hilliard was furnished
with a prospectus-type generic analysis of a boat investment
prepared by Robert Jarkow (Jarkow), a certified public
accountant. The report summarized projected cash-flow and net
after-tax benefits to be derived from the purchase and charter of
a "luxury sailing vessel." The analysis, based on various
assumptions regarding tax bracket, investment amount, and rental
revenues, contained the projections that there would be tax
losses for the first 5 years, and that investment tax credits and
depreciation would generate substantial tax benefits with nominal
amounts of cash expenditure. For example, Jarkow's analysis
reflected that an $11,200 initial investment would produce a
$51,000 tax loss in the first year. A review of the financial
and tax analysis in Jarkow's "prospectus" shows that tax benefits
would exceed out-of-pocket expenditures irrespective of whether
the boat was actually chartered. Petitioners did not review in
detail the profit projections for a "luxury sailing vessel"
prepared by Jarkow.
After viewing the fishing boat, petitioners completed the
purchase by signing several previously prepared documents,
including documents establishing petitioners' wholly owned S
corporation, Island Ventures, Inc., a North Carolina corporation,
as owner of the boat, the bill of sale, a note and security
agreement, and other financial disclosure forms required by law.
Mr. Hilliard's prior boat experience made him aware that boats
generally do not appreciate in value.
The fishing boat was purchased by petitioners jointly with
Island Charters Corp., set up by petitioners to be the corporate
owner of the boat. Island Charters Corp. was utilized to avoid
Florida sales taxes of $10,000 on the fishing boat purchase.
Two months after payment and prior to delivery of the
fishing boat, petitioners discovered that Inter Island Charters
ceased business and that payments were not being made to the bank
on the promissory note. Mr. Hilliard traveled to Florida and
arranged with Mr. and Mrs. Winters to handle the charter
activities. Mrs. Winters had been an employee of Inter Island
Charters. The arrangements were made with the Winterses at a
time when Mr. Hilliard was aware that Inter Island Charters had
gone out of business and Mr. Hilliard had been interviewed by the
Federal Bureau of Investigation concerning Inter Island Charters
and its employees. Mr. Hilliard did not ask the Winterses why
Inter Island Charters failed.
The Winterses controlled the fishing boat and rented it just
one time during the period 1985 through most of 1987. The
Winterses allowed the fishing boat to fall into a state of
disrepair. Around that time, Mr. Hilliard received a call from
Mr. Quartiano, a Florida shark fisherman, who advised him that
petitioners' boat was not being properly serviced and that Mr.
Quartiano would be willing to take over charter operations.
During September 1987, petitioners ceased making payments to the
bank on the promissory note. Prior to finalizing any arrangement
with Mr. Quartiano, during November 1987, the financing bank
brought a Complaint in Admiralty against petitioners and their
North Carolina corporation in Federal court to foreclose on a
"United States First Preferred Ship Mortgage and Marine Security
Agreement", and the fishing boat was seized by U.S. marshals
pursuant to a court order. The fishing boat was sold under a
court order on June 24, 1988, for $50,000. Petitioners claimed
depreciation and expenses connected with the fishing boat through
1987. For 1988, the $939 claimed represented legal fees in
connection with the lawsuit and foreclosure of the fishing boat.
Other than one short ride, there was no personal use of the
fishing boat by the petitioners. Petitioners believed that the
revenues from chartering the fishing boat would be sufficient to
cover the mortgage payments on the boat. Petitioners received
monthly charter summaries revealing that the boat had been
chartered very little.
(1) Manner in which the taxpayer carries on the activity.
The fishing boat activity was operated through petitioners' S
corporation, and petitioners relied on their accountant and
independent charter contractors. Although several entities were
interposed between the fishing boat and petitioners, ultimately
as owners, it was, in effect, their charter business. In this
regard, petitioners showed little interest in the charter
activity, the keeping of books for the activity, or the manner in
which the Winterses controlled the boat or conducted the charter
activity.
(2) Expertise of the taxpayer or his advisers.
Mr. Hilliard, although an experienced sailor, had no experience
with chartering a fishing boat. Petitioners had several years of
experience attempting to charter the sailboat. These efforts
resulted in repeated and relatively large losses. Despite these
experiences, petitioners relied on their accountant, Mr. Brazil.
It was not shown that Mr. Brazil had experience with fishing boat
chartering. Petitioners did not seek the expertise of any third
party, and, after the original charter company failed,
petitioners allowed employees of the failed company to continue
in their role as charterer. They allowed the Winterses to
control the boat and arrange charters, even though there were
suspicious circumstances surrounding their former employer. We
find it curious that Mr. Hilliard, when he had made arrangements
with the Winterses, did not inquire about the reason or the
circumstances behind the failure of the original charter company.
(3) Time and effort expended by the taxpayer in carrying on
the activity. Petitioners were engaged in the full-time practice
of medicine. They spent little time with their fishing boat
chartering business. They did not carefully read the analytical
materials provided or investigate the circumstances of the
investment in the fishing boat. Instead, petitioners relied
solely on their accountant, a friend and part of their extended
family.
Following in that pattern, petitioners traveled to Florida
to purchase the fishing boat and again when the charter company
failed. Other than those two trips, petitioners were oblivious
to the fishing boat activity. After 2 years without supervision
of the Winterses, petitioners found out from a third party that
their fishing boat was in poor condition and was not being
properly managed. Shortly thereafter, petitioners discontinued
mortgage payments, and the boat was seized.
(4) Expectation that assets used in the activity may
appreciate in value. Mr. Hilliard was of the view that boats
normally do not appreciate in value. The circumstances here
reflect that petitioners focused primarily on the tax benefits
(deductions) and the sheltering of their medical practice income.
In this regard, there is some indication in the materials
concerning the foreclosure of the maritime mortgage that
petitioners may have overpaid for the fishing boat. In that
regard, the purchase price was nearly $200,000, and the fishing
boat was sold less than 3 years later, without much intervening
use, for $50,000.
(5) The success of the taxpayer in carrying on other similar
or dissimilar activities. Petitioners had several years of
experience attempting to charter the sailboat. Those efforts
resulted in repeated and relatively large losses. Despite those
experiences, petitioners relied on their accountant, Mr. Brazil.
Petitioners' attempt to charter My Toy was their first attempt at
chartering a fishing boat. Disregarding their negative
experience with the sailboat, they sought out no independent
expertise in the fishing boat chartering business. We also note
that petitioners had experienced losses with respect to the Tahoe
property. See discussion infra.
(6) The taxpayer's history of income and loss with respect
to the activity, and (7) the amount of occasional profits, if
any, that are earned. A record of substantial losses over many
years and the unlikelihood of achieving a profitable operation
are important factors bearing on the taxpayer's intention.
Cannon v. Commissioner, 949 F.2d 345, 352 (10th Cir. 1991), affg.
T.C. Memo. 1990-148; Golanty v. Commissioner, 72 T.C. at 426-427.
Petitioners' chartering activities generated substantial losses,
mostly attributable to depreciation, from 1985 through 1987.
Petitioners used these losses to offset taxable income from other
sources.
(8) The financial status of the taxpayer. During the period
petitioners owned and attempted to charter the fishing boat, they
received ample income from their full-time medical practice.
Because of the relatively large amount of income from their
medical practices, petitioners attempted to obtain tax benefits
by claiming the losses generated by the chartering activities.
(9) The presence of elements of personal pleasure or
recreation. Unlike the sailboat, petitioners did not have any
interest in or use of the fishing boat.
Petitioners failed to conduct any meaningful investigations
of the fishing boat venture, and they relied on their accountant.
That reliance is not reasonable under circumstances where the
accountant has not been shown to have had any expertise.
Petitioners had loss experiences with the chartering of their
sailboat, and they did not attempt to determine if the same
problems could occur with chartering the fishing boat. Their
lack of action and lack of interest regarding the operation of
the fishing boat charter reflect that their motivation was
primarily tax benefits. Further inquiry might have given
petitioners insight into the likelihood of many of the problems
that they encountered. See Thomas v. Commissioner, 84 T.C. 1244,
1278 (1985), affd. 792 F.2d 1256 (4th Cir. 1986).
Based on the entire record, we are not convinced that
petitioners' primary objective was to make a profit. See Snyder
v. United States, 674 F.2d 1359, 1362-1364 (10th Cir. 1982).
Petitioners did not have an actual and honest objective of making
an economic profit independent of tax savings. We hold that
petitioners' fishing boat chartering activity was not engaged in
for profit within the meaning of section 183(c).
IV. Tahoe Rental Activity6
Petitioners acquired a residence in Tahoe by paying $11,000
in mortgage payment arrears and by accepting responsibility for
6
If we find that petitioners' residential rental activity
was engaged in for profit, then petitioners concede that the loss
limitation rules under sec. 280A(e) apply.
the $95,000 mortgage balance. The residence was located in a
popular winter vacation area. No business analysis or plan was
prepared by petitioners, who did not have any experience in the
rental property business. Petitioners did not consult with their
accountant in connection with the purchase or operation of their
Tahoe property. Petitioners, on their joint income tax returns
for 1983 through 1988, claimed losses ranging from a low of
$16,107 to a high of $21,385, with an average of $19,066
attributable to their Tahoe residential property. Those losses
resulted from the excess of claimed deductions for maintenance,
interest, taxes, and depreciation over rental receipts. The
annual rental receipts for the period ranged from a low of $300
to a high of $1,238, with an average of $711.
Petitioners did not place the Tahoe property with a real
estate agent for rental purposes or consult with their accountant
in connection with their investment in the Tahoe property.
Petitioners did not keep separate records for the Tahoe property,
and their only attempts to advertise its rental availability were
to post flyers at the hospitals where they practiced medicine.
Petitioners, on occasion, spent winter weekends at the Tahoe
property. They did not use the property off-season (e.g., during
the summer).
(1) Manner in which the taxpayer carries on the activity.
Attempts to publicize the rental property were insignificant.
Petitioners did not prepare a written business plan prior to
their purchase of the Tahoe property. No separate books and
records or bank accounts were maintained. No action was taken in
later years to address the lack of rental in earlier years.
(2) The expertise of the taxpayer or his advisers.
Petitioners were not shown to have had experience or to rely on
others with expertise regarding their Tahoe rental activity.
(3) Time and effort expended by the taxpayer in carrying on
the activity. Petitioners practice medicine on a full-time
basis. They spent little time with the rental activity, other
than by Mr. Hilliard's making some repairs during petitioners'
occasional trips to the property.
(4) Expectation that assets used in the activity may
appreciate in value. Mr. Hilliard purchased the property in
connection with a foreclosure and sold the property for a gain.
No analysis was conducted with respect to the potential for
profit from the rental of the property or with respect to the
potential for gain from any appreciation of the Tahoe property.
(5) The success of the taxpayer in carrying on other similar
or dissimilar activities. Petitioners experienced losses from
their Tahoe rental activity for several years prior to the years
in question, and, in addition, they had experienced losses
regarding the sailboat chartering activities.
(6) The taxpayer's history of income and loss with respect
to the activity, and (7) the amount of occasional profits, if
any, that are earned. A record of substantial losses over many
years, coupled with little potential for profit are important
factors bearing on the taxpayer's intention. Cannon v.
Commissioner, 949 F.2d at 352; Golanty v. Commissioner, 72 T.C.
at 426-427. Petitioners generated substantial losses from their
rental activity, mostly from depreciation, and were able to
shelter their medical income with the losses.
(8) The financial status of the taxpayer. Because of
petitioners' income from their medical practices, they obtained
significant tax benefit from the rental activity losses.
(9) The presence of elements of personal pleasure or
recreation. Mr. Hilliard went to the property occasionally to do
repairs; however, petitioners used the property for personal
trips and recreational purposes.
We hold that petitioners' Tahoe rental activity was not
engaged in for profit within the meaning of section 183(c).
V. Automobile Expenses
During the years in issue, petitioners owned four
automobiles. Mrs. Hilliard drove the Mercedes, which was used to
commute to work, to drive between different work locations, and
for personal errands. Her offices were in Oakland, California,
for all of the years in issue and in San Ramon, California, for 3
months during 1986. The commute from Mrs. Hilliard's residence
to her office was 8 to 9 miles, and the distance between the San
Ramon and Oakland offices was 15 miles. Mrs. Hilliard made early
morning rounds in two hospitals: one which was about 3 miles
from her Oakland office, and the other was less than 1 mile from
her Oakland office. The majority of her patients were at the
hospital that was closer to her office. For the 3 months during
1986 when Mrs. Hilliard maintained two offices, she would drive 1
day each week from Oakland to San Ramon and then home.
Petitioners claimed 85 percent business use of
Mrs. Hilliard's automobile, and respondent, in the notice of
deficiency, determined 17 percent business use. At trial,
Mrs. Hilliard estimated about 50 to 60 percent business use.
Section 274(d)(4) (which is effective for taxable years
beginning on or after January 1, 1986, the beginning of the first
year in issue) requires substantiation by adequate records or
evidence, in addition to mere testimony, to be entitled to travel
expenses. Petitioners offered no records or other evidence of
the business use of Mrs. Hilliard's automobile other than her
testimony, which was expressed in terms of an estimate.
Petitioners have not met the section 274(d) requirements
necessary to show entitlement to transportation deductions in
excess of the amounts allowed by respondent. Rule 142(a).7
VI. Mortgage Interest
Petitioners, for 1988, claimed $85,151 of mortgage
interest. Respondent's agent was shown substantiation for
$83,216 of mortgage interest. Petitioners, for 1987, claimed
$33,629 of mortgage interest, and respondent determined that all
7
Our determination of Mrs. Hilliard's automobile use
results in an adjustment to her self-employment income, which in
turn increases her self-employment tax liability. This
adjustment is automatic (purely mathematical) and requires no
further discussion.
but $614 was substantiated by petitioners. In the notice of
deficiency, respondent determined that petitioners overstated
their mortgage interest deductions for 1987 and 1988 by $614 and
$8,315, respectively. On brief, respondent conceded a portion of
the mortgage interest deduction for 1988, and $1,935 remains in
controversy for 1988. Petitioners failed to present any evidence
substantiating the disallowed mortgage interest of $614 for 1987
or the $1,935 remaining in dispute for 1988. Accordingly,
petitioners are not entitled to deductions for mortgage interest
for 1987 and 1988 in excess of the amounts determined by or
agreed to by respondent.
VII. Negligence
Negligence includes a lack of due care or a failure to do
what a reasonable and ordinarily prudent person would do under
the circumstances. Neely v. Commissioner, 85 T.C. 934, 947
(1985). Petitioners bear the burden of proving that respondent's
determination of negligence is erroneous. Rule 142(a); Bixby v.
Commissioner, 58 T.C. 757, 791-792 (1972).
A taxpayer can avoid liability for the addition to tax for
negligence if the taxpayer can show that he reasonably relied on
the advice of a competent and experienced accountant or attorney
to prepare his return. Weis v. Commissioner, 94 T.C. 473, 487
(1990); Conlorez Corp. v. Commissioner, 51 T.C. 467, 475 (1968).
The taxpayer must show that all necessary information was
supplied to the return preparer and that the error on the return
resulted from the preparer's mistake. Pessin v. Commissioner, 59
T.C. 473, 489 (1972); Enoch v. Commissioner, 57 T.C. 781, 803
(1972); see Ma-Tran Corp. v. Commissioner, 70 T.C. 158, 173
(1978).
Petitioners claimed to have relied solely on their
accountant. Such reliance, to mitigate negligence, must be
reasonable. Petitioners are college- and medical school-educated
individuals who pursued rental and charter activities with the
sole or primary purpose of off-setting ordinary income from their
professional activities. They paid little attention to
information provided by the promoter, and they did not make
business plans or seek professional advice regarding their rental
and charter activities. Petitioners' accountant was not shown to
have expertise in the boat charter business, nor did petitioners
show that their reliance on him was reasonable under the
circumstances. After making the investment in the fishing boat,
petitioners paid little or no attention to the major asset of
their activity, a boat with a value approaching $200,000. All
that mattered to them were the deductions.
With respect to their sailboat and Tahoe property, those
assets were available for petitioners' personal use and no
meaningful efforts were made to seek a profit or to improve the
circumstances after repeated losses and lack of rental income
were experienced. Petitioners' claim of reliance upon their
accountant or return preparer does not entitle them to avoid the
imposition of an addition to tax for their negligence.
Accordingly, we find that petitioners are liable for an
addition to tax for negligence under section 6653(a) for each of
the taxable years in issue.
VIII. Substantial Understatement
Section 6661(a) imposes an addition to tax equal to 25
percent of the amount attributable to a substantial
understatement. An understatement is substantial if it exceeds
the greater of 10 percent of the tax required to be shown on the
return or $5,000. Sec. 6661(b)(1).
If an item is not attributable to a tax shelter, then any
understatement may be reduced by amounts represented by items for
which a taxpayer had substantial authority or which were
adequately disclosed in the return or in a statement attached
thereto. Sec. 6661(b)(2)(B)(i) and (ii).
Although the legal standards for evaluating section 183
cases are well-developed, petitioners have not argued or shown
that there was substantial authority for their tax treatment of
any of the items of income or expense that were adjusted by
respondent or that any of the adjusted items were adequately
disclosed on the returns for the period in controversy.
Accordingly, to the extent that petitioners' understatement, for
any taxable period under consideration, is substantial within the
meaning of section 6661, petitioners are liable for the addition
to tax for a substantial understatement under section 6661.
To reflect the foregoing and to reflect concessions and
agreements of the parties,
Decision will be entered under
Rule 155.