T.C. Memo. 1996-145
UNITED STATES TAX COURT
JOHN ROBERT MAGUIRE, Petitioner v. COMMISSIONER OF
INTERNAL REVENUE, Respondent
Docket No. 14654-93. Filed March 21, 1996.
Robert T. Maguire, for petitioner.
John Aletta, for respondent.
MEMORANDUM OPINION
CLAPP, Judge: Respondent determined a deficiency of $10,669
in petitioner's 1990 Federal income tax and a penalty of $2,134
pursuant to section 6662(a).
After concessions by the parties, the issues for decision
are:
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(1) Whether petitioner's expenditures related to
residential real property were paid or incurred in carrying on a
trade or business pursuant to section 162 or for the production
of income pursuant to section 212. We hold that most of these
expenditures are not deductible under either section.
(2) Whether petitioner is liable for a penalty pursuant to
section 6662(a) for negligence or disregard of rules or
regulations. We hold that petitioner is liable for the penalty.
All section references are to the Internal Revenue Code in
effect for the year in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
We have combined our findings of fact and opinion. Some of
the facts are stipulated and are so found. We incorporate by
reference the stipulation of facts and attached exhibits.
Petitioner resided in Wallingford, Connecticut, at the time
he filed the petition in this case. Petitioner was a cash basis
taxpayer for the taxable year 1990. He was employed full time as
a policeman in Wallingford, Connecticut.
In 1989, petitioner purchased a single-family home on Cape
Cod at Harwichport, Massachusetts, for $114,000. This was
petitioner's first real estate purchase. Petitioner never
occupied the home as a personal residence, and he never intended
to do so. Petitioner originally intended to profit by selling
the property as opposed to renting it. When petitioner purchased
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the property, portions of the kitchen and bathroom floors were
rotted due to water damage. Rainwater had leaked into the
kitchen and caused the plywood flooring to rot. Some of the
kitchen and bathroom faucets in the home worked while others did
not. The house was badly run down and uninhabitable. It needed
considerable work to put it in condition for sale.
Petitioner removed the rotted plywood floor base below the
tile and replaced it with new plywood. Petitioner removed the
kitchen counter top and cabinets and installed a new counter top
and new kitchen cabinets. Petitioner installed new tile in the
kitchen and the bathroom. Petitioner hired a contractor to
rewire portions of the property. Petitioner purchased new
appliances in Connecticut and used a rented Ryder truck to
deliver the appliances to the Harwichport property. Petitioner
installed the appliances and sealed vent outlets that were no
longer needed. Petitioner hired a contractor to adjust the
septic line from the home to the septic tank to comply with State
environmental regulations. Petitioner installed new gutters,
storm doors, and a toilet. Petitioner hired an electrician to
install a new electrical distribution box with circuit breakers
which replaced the home's fuse box.
Petitioner performed most of the work himself and sometimes
would spend several consecutive days working on the Harwichport
property. On these occasions, he stayed at the Harwichport
property instead of renting a room at a motel. Petitioner spent
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in excess of 59 days working on the Harwichport property,
excluding travel time between the Harwichport property and
petitioner's residence in Wallingford, Connecticut.
In the Boston Globe on October 28, 1990, petitioner
advertised the Harwichport property for sale, "completely
furnished", for $154,500. In November 1990, petitioner placed
similar advertisements in the Cape Codder, and the Providence
Journal. There were no advertisements in 1990 offering the
property for rent.
Petitioner's employment as a police officer included the use
of an unmarked police car. The only restriction on petitioner's
use of the police car was that he could not take that vehicle
outside the State of Connecticut. Petitioner owned a Lincoln
Continental (Lincoln) which he left parked at his father's house
located in Warren, Connecticut. When petitioner needed to travel
to the Harwichport property, he would park his police car at his
father's house. Petitioner would then drive the Lincoln to the
Harwichport property. On the Form 4562 attached to petitioner's
1990 Form 1040, petitioner indicated a business use percentage of
90 percent for the Lincoln. Petitioner did not respond to the
questions "Do you have evidence to support the business use
claimed?" and "If 'Yes,' is the evidence written?" that appear on
lines 22a and 22b, respectively, of Form 4562.
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Petitioner is a licensed real estate agent in the State of
Connecticut, but that license is not valid in the State of
Massachusetts.
The documents submitted at trial constitute all of the
Harwichport property expense records for 1990. During the
taxable year 1990, petitioner incurred and paid mortgage interest
expense of $9,513.23 and real estate taxes of $1,248.39.
In the notice of deficiency, respondent determined that
petitioner's expenditures were not paid or incurred in carrying
on a trade or business pursuant to section 162 or for the
production of income pursuant to section 212. Respondent also
determined that the expenditures were not ordinary and necessary.
Petitioner bears the burden of proving that respondent's
determination is not correct. Rule 142(a); Welch v. Helvering,
290 U.S. 111 (1933). Respondent filed an amended answer and
alleged that petitioner failed to substantiate the claimed
expenses as required by section 274(d), and that section 469
precludes petitioner from deducting the expenses. We conclude
that section 469 does not limit petitioner's deductions in 1990.
Petitioner participated in the activity for more than 100 hours,
and this amounted to substantially all of the participation in
the activity. See sec. 1.469-5T(a)(2) and (3), Temporary Income
Tax Regs., 53 Fed. Reg. 5725-5726 (Feb. 25, 1988). The parties
also disagree whether the expenditures were capital in nature or
currently deductible.
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Petitioner argues that his activity on the Harwichport
property constituted a trade or business, or, in the alternative,
that the Harwichport property was held for the production of
income. In order to be engaged in carrying on a trade or
business pursuant to section 162, the taxpayer must be involved
in the activity with continuity and regularity, and the
taxpayer's primary purpose for engaging in the activity must be
for income or profit. Commissioner v. Groetzinger, 480 U.S. 23
(1987); Juda v. Commissioner, 90 T.C. 1263, 1287 (1988), affd.
877 F.2d 1075 (1st Cir. 1989). The term "property held for the
production of income" pursuant to section 212 includes income
from the disposition of the property. Mitchell v. Commissioner,
47 T.C. 120, 128 (1966). Petitioner was not in the trade or
business of reconditioning dilapidated structures for resale.
This was petitioner's first real estate purchase. He worked on
the Harwichport property in his spare time while employed full
time as a police officer. Petitioner was not in the trade or
business of renting real estate in 1990. Petitioner testified
that he offered the property for rent in 1989, but we find that
the property was not suitable for sale or rent until late 1990.
He first tried to sell the Harwichport property on October 28,
1990, but when he could not sell it, he rented the property in
April 1991. Petitioner produced no advertisements indicating the
Harwichport property was available for rent in 1989 or 1990.
During discovery, respondent requested the advertisements related
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to the sale or rental of the Harwichport property. Petitioner
responded with cancelled checks payable to various newspapers,
but he produced no advertisements. The only advertisements
produced at trial were obtained by respondent. We find that the
Harwichport property was not available for rent in 1990 and that
the property was not available for sale prior to October 28,
1990. We conclude that petitioner's activity on the Harwichport
property did not constitute a trade or business in 1990.
Petitioner's level of activity and attempted disposition of the
Harwichport property indicate that petitioner prepared the
Harwichport property for resale during the year in issue. We
conclude that petitioner held the Harwichport property for the
production of income in 1990.
In general, deductions incurred for the production of income
under section 212 are subject to the same requirements and
restrictions that apply to a trade or business expense deduction
under section 162. Estate of Davis v. Commissioner, 79 T.C. 503,
507 (1982); Hubbart v. Commissioner, 4 T.C. 121, 124 (1944). In
order to be deductible, the expenditures must be ordinary and
necessary. Secs. 162(a), 212. Petitioner must prove a proximate
connection between the expenditure and the conduct of a profit-
seeking activity. Larrabee v. Commissioner, 33 T.C. 838, 841
(1960). In general, an expenditure made primarily to secure a
personal benefit is not deductible, sec. 262; whereas, a similar
expenditure may be deductible if made primarily for a profit-
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seeking purpose. See Interstate Drop Forge Co. v. Commissioner,
326 F.2d 743, 747 (7th Cir. 1964), affg. T.C. Memo. 1963-149.
Respondent argues that many of the expenditures deducted by
petitioner are not ordinary and necessary and are instead
personal expenses not related to the Harwichport property. The
taxpayer must prove that he is entitled to any claimed
deductions. Rule 142(a); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1935); Welch v. Helvering, supra at 115. This
includes proof of 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); sec. 1.6001-1(a), Income Tax Regs.
A tax return is not proof of entitlement to a credit or deduction
claimed therein; a tax return merely sets forth the taxpayer's
claim. See Roberts v. Commissioner, 62 T.C. 834, 837 (1974);
Seaboard Commercial Corp. v. Commissioner, 28 T.C. 1034, 1051
(1957).
As a general rule, if the record provides sufficient
evidence that the taxpayer has incurred a deductible expense, but
the taxpayer is unable to substantiate adequately the amount, the
Court may estimate the amount of such expense and allow the
deduction to that extent bearing down heavily on the taxpayer
since the problem is of his own making. Cohan v. Commissioner,
39 F.2d 540, 543-544 (2d Cir. 1930). However, in order for the
Court to estimate the amount of an expense, we must have some
basis upon which an estimate may be made. Vanicek v.
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Commissioner, 85 T.C. 731, 743 (1985). Without such a basis, any
allowance would be unguided largesse. Williams v. United States,
245 F.2d 559, 560 (5th Cir. 1957).
Respondent argues that expenditures within the following
categories should be disallowed entirely, or in the alternative,
that the expenditures must be capitalized. Petitioner argues
that the same expenditures are currently deductible. The
disputed categories include: Travel expenses, utilities,
cellular phone service, cable service, advertisements, clock
repair, truck rental, real estate license, taxes, and
miscellaneous.
Travel Expenses
A deduction for travel expenses may be allowed where the
expenses are incurred while "away from home", are reasonable and
necessary, and bear a proximate relation to the profit-seeking
activity. Kinney v. Commissioner, 66 T.C. 122, 126 (1976);
McKinney v. Commissioner, T.C. Memo. 1981-181, affd. 732 F.2d 414
(10th Cir. 1983). Travel expenses must also be substantiated as
required by section 274(d).
Respondent disallowed an $832 deduction for meals, a $1,402
deduction for amounts paid to various oil companies, a $1,369
deduction for auto repairs, deductions of $119.50, $465, and $76
alleged to be for insurance on the Lincoln, and depreciation
deductions on the Lincoln.
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Petitioner testified that 90 percent of the Lincoln's use
related to the Harwichport property. He produced nothing to
corroborate that testimony, and he failed to explain how he
arrived at that figure. Petitioner produced a chart to show the
number of days he spent in Harwichport. Petitioner appears to
have constructed the chart using the receipts from purchases made
in Harwichport, assuming that he must have been in Harwichport
when he made the purchases. However, petitioner also appears to
contend that if there was no receipt, then he was not in
Harwichport, and he must have returned to Wallingford and
incurred travel expenses in doing so. Petitioner's contention is
a non sequitur that overstates the number of round trips from
Wallingford to Harwichport. It seems more likely that he was in
Harwichport on a number of days when he did not purchase
anything. As for meal expenses, petitioner used the number of
days shown on his chart along with a ballpark figure of $11 for
meals per day to calculate his meal expenses. Although it seems
clear that petitioner had some expenses for meals and travel
between Wallingford and Harwichport, he has failed to prove the
number of trips to Harwichport, the amount spent on meals and
travel, the percentage use of the Lincoln, and he failed to
maintain a log or other record as required by section 274(d).
Accordingly, we sustain respondent's disallowance of the travel
expenses.
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Utilities, Cellular Phone Service, and Cable Service
Respondent has conceded some of the utility expenses but
argues that other utility expenses deducted by petitioner do not
relate to the Harwichport property. We conclude that the
payments to NE Tel, HarWater, Commonwealth Electric, and Hall Oil
relate to petitioner's income-producing activity and are either
capital expenditures or currently deductible as discussed below.
Respondent disallowed deductions for petitioner's cellular
phone and related service fees and charges. Petitioner merely
testified that he had the cellular phone installed in the
Lincoln. Petitioner deducted the cost of cable television
service at the Harwichport property, and respondent disallowed
that deduction. We find that the cellular phone and cable
television service were personal expenses and sustain
respondent's disallowance of these items.
Advertisements, Clock Repair, and Truck Rental
Petitioner deducted $262 for newspaper advertisements, and
respondent disallowed $114 of that deduction. The $114 in
dispute relates to advertisements allegedly placed prior to
October 28, 1990. Petitioner produced none of the alleged
newspaper advertisements placed prior to October 28, 1990.
Petitioner testified that he advertised nothing but the
Harwichport property in newspapers during 1990, but respondent
produced an advertisement wherein petitioner had offered his
automobile for sale in the New York Times on October 28, 1990.
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Petitioner has failed to prove that the $114 in dispute related
to advertisement of the Harwichport property. We sustain
respondent's disallowance of these items.
Respondent disallowed a $486 deduction for the overhaul of a
clock. Petitioner offered no evidence relating this item to the
Harwichport property. We sustain respondent's disallowance of
this item.
Respondent disallowed a $322 deduction for the rental of a
Ryder truck. Petitioner used the Ryder truck to deliver new
appliances to the Harwichport property. We find that the $322
truck rental expense must be capitalized as a preopening expense
as discussed below.
Real Estate License
Respondent disallowed the costs associated with the renewal
of petitioner's Connecticut real estate license. We find no
connection between petitioner's real estate license and his
activity on the Harwichport property. We sustain respondent's
disallowance of these items.
Taxes
Respondent disallowed a $126 payment to the Town of Warren
for personal property tax on the value of the Lincoln; a $10
payment to the Wallingford Tax Office; and a $248 payment listed
under "90' Cap. Exp." Petitioner is entitled to deduct personal
property taxes associated with the Lincoln pursuant to section
164(a)(2). Petitioner offered no explanation for the $10 payment
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to the Wallingford Tax Office or the $248 payment, and we sustain
respondent's disallowance of these items.
Miscellaneous items
Respondent disallowed the following deductions that
petitioner characterized as supplies: $12 for books; $3,649 for
rugs; $883 for a television; $107 for furniture; $45 for sheets;
$90 for pillows; $658 for lamps; and $101 for linens. Petitioner
testified that he rented the Harwichport property furnished in
1991, but we do not consider this general testimony sufficient to
conclude that the items outlined above related to the production
of income from the Harwichport property in 1990. We sustain
respondent's disallowance of these items in 1990.
Depreciation of Capital Improvements
Respondent disallowed depreciation deductions related to
$16,064 of capital improvements allegedly made in 1989.
Petitioner argues that in 1989 he added $16,064 of capital
improvements to the Harwichport property, and he began
depreciating those improvements in 1990. The taxpayer must
establish the property's depreciable basis by showing the cost of
the property, its useful life, and the previously allowable
depreciation. E.g., Delsanter v. Commissioner, 28 T.C. 845, 863
(1957), affd. in part, revd. in part and remanded per curiam 267
F.2d 39 (6th Cir. 1959). Petitioner's father testified that the
cost of "some" of the 1989 improvements to the property was
"carried over" to 1990 and added to the depreciable basis of the
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Harwichport property. We have no way of sorting out petitioner's
1989 expenditures. We sustain respondent's determination.
Respondent argues that all of the 1990 expenditures must be
capitalized as preopening expenses. Startup expenses must be
capitalized pursuant to the preopening expense doctrine, and that
doctrine is applicable to section 212 activities as well as
section 162 activities. Hardy v. Commissioner, 93 T.C. 684, 688
(1989); Sorrell v. Commissioner, 882 F.2d 484 (11th Cir. 1989),
revg. T.C. Memo. 1987-351. Petitioner produced no advertisements
showing the Harwichport property for rent or sale. Respondent
produced newspaper advertisements published on or after October
28, 1990, showing the Harwichport property for sale. We have
found that the property was not available for sale prior to
October 28, 1990. We conclude that the expenses incurred prior
to October 28, 1990, are preopening expenses and must be
capitalized. Accordingly, they are not deductible currently
under section 212 but must be added to the basis of the property.
We next address the post-October 28, 1990, expenditures in
dispute. Capital expenditures add to the value or substantially
prolong the useful life of the property. Sec. 1.263(a)-1(b),
Income Tax Regs. Expenses for incidental repairs or maintenance
are deductible currently if they neither materially add to the
value of the property nor appreciably prolong the property's
useful life. Sec. 1.162-4, Income Tax Regs. The remaining
expenditures include: Plumbing expenses in the amounts of $12.56
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and $50.90 paid on November 5, 1990, and December 26, 1990,
respectively; and expenses for hardware items in the amounts of
$37.84 and $58.22 paid on November 5, 1990, and December 26,
1990, respectively. Petitioner paid $29 to the Town of
Harwichport on November 11, 1990, and we find that this payment
related to trash removal. We conclude that these remaining items
are deductible in 1990.
Respondent determined that petitioner is liable for a
penalty pursuant to section 6662(a). Section 6662(a) imposes a
penalty equal to 20 percent of the portion of the underpayment
which is attributable to negligence or disregard of rules or
regulations.
Negligence is defined as the lack of due care or the failure
to do what a prudent person would do under the circumstances.
Marcello v. Commissioner, 380 F.2d 499, 506 (5th Cir. 1967),
affg. in part and remanding in part 43 T.C. 168 (1964); Neely v.
Commissioner, 85 T.C. 934, 937 (1985). Petitioner must prove
that the negligence penalty does not apply. Bixby v.
Commissioner, 58 T.C. 757, 791 (1972).
Petitioner contends that he and his father meticulously
prepared his Federal income tax return for 1990. Generally, the
duty of filing accurate returns cannot be avoided by placing
responsibility on an agent. Metra Chem. Corp. v. Commissioner,
88 T.C. 654, 662 (1987); Enoch v. Commissioner, 57 T.C. 781, 802
(1972). Petitioner cannot rely on the advice of his father to
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avoid the negligence penalty, because petitioner failed to show
that his father had any expertise in tax matters. See Allen v.
Commissioner, 925 F.2d 348, 353-354 (9th Cir. 1991), affg. 92
T.C. 1 (1989).
Failure to keep adequate records is some evidence of
negligence. Marcello v. Commissioner, supra at 507; Magnon v.
Commissioner, 73 T.C. 980, 1008 (1980). Petitioner's records
were incomplete and in disarray. At trial, petitioner offered
cancelled checks with few of the corresponding receipts. These
records provided very little, if any, indication of how the
cancelled checks related to the Harwichport property. For
example, the cancelled checks payable to the oil companies did
not indicate the items purchased, the dates of purchase, or where
the transactions took place.
The testimony of petitioner and his father gave the distinct
impression that petitioner kept no contemporaneous records of his
expenses. Petitioner's testimony that he advertised no property
in the New York Times other than the Harwichport property was
incorrect. Petitioner deducted items such as clock repair and
then offered nothing at trial that related the clock to the
Harwichport property. We conclude that the understatement is
attributable to negligence.
We have addressed the items still in dispute that we can
discern from the record. However, the record and the briefs in
this case leave much to be desired. If items remain, we expect
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the parties to resolve them in the context of a Rule 155
computation. To reflect the foregoing and the concessions by the
parties,
Decision will be entered
under Rule 155.