Wilson v. Commissioner

T.C. Memo. 1996-418

UNITED STATES TAX COURT

ROBERT J. AND ANNE L. WILSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 18481-93, 17723-94. Filed September 17, 1996.

Rex L. Sturm, for petitioners.

Michal Cline, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

PARR, Judge: Respondent determined deficiencies in, an

addition to tax on, and penalties on petitioners’ Federal income

tax for taxable years 1989 and 1990 as follows:

Addition to Tax Penalty
Sec. Sec.
Year Deficiency 6651(a)(1) 6662(a)

1989 $28,496.00 -0- $5,699.00
 - 2 -

1990 28,316.93 $7,293.98 5,663.39

After concessions,1 the issues for decision are: (1) Whether

petitioners can defer recognition of gain realized on receipt of

condemnation proceeds in taxable year 1989 under authority of

section 1033.2 We hold they may not. (2) Whether petitioners had

unreported interest income for taxable year 1989. We hold they

did. (3) Whether petitioners are entitled to the capital loss

claimed in taxable year 1989. We hold they are to the extent

provided below. (4) Whether petitioners had unreported dividend

income in taxable year 1989. We hold they did. (5) Whether

petitioners are liable for the section 6651 addition to tax

because they failed to timely file their 1990 income tax return.

We hold they are. (6) Whether petitioners are liable for

negligence under section 6662 for the years in issue. We hold

they are.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulated

facts and the accompanying exhibits are incorporated into our

findings by this reference. Petitioners, Robert J. and Anne L.

Wilson, resided in Gaithersburg, Maryland, on the dates the

1
Pursuant to a stipulation of settled issues, the parties
resolved a number of issues raised by the pleadings. We leave it
to the parties to include these adjustments in their Rule 155
computations.
2
All section references are to the Internal Revenue Code in
effect for the taxable years in issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure, unless
otherwise indicated.
 - 3 -

petitions were filed. The term "petitioner" refers to Robert J.

Wilson.

During the years at issue, petitioners owned two adjacent

parcels of real property located at DeSellum Avenue and Route 355

in Gaithersburg, Maryland (DeSellum property). From 1980 through

the years at issue, petitioners used the DeSellum property as

rental property: one parcel contained a residential rental unit,

and the other parcel contained a building housing the dental

offices of petitioner.

On June 5, 1980, the Maryland State Roads Commission of the

Maryland State Highway Administration (the State) filed a "quick

take" condemnation petition in the circuit court for Montgomery

County, Maryland (circuit court), pursuant to sections 8-318

through 8-331 of the Transportation Article of the Annotated Code

of Maryland (Maryland Code). The condemnation petition

designated for taking 9,957 square feet of the DeSellum property

in fee simple and 2,325 square feet of the DeSellum property in

temporary easement. The property to be acquired in fee simple

consisted of a strip of unimproved land along the entire front of

the DeSellum property (approximately 344 feet); the strip abutted

Route 355 and ranged in width from approximately 28.36 feet to

50.59 feet. The property to be acquired under a temporary

easement consisted of a 6-foot wide strip of unimproved land

which ran along almost the entire front of the DeSellum property

between the strip being acquired in fee simple and the Dessellum
 - 4 -

property not subject to the condemnation suit. The State needed

both the fee simple property and temporary easement property to

widen and improve Route 355.

The State determined that the fair market value of the

property and rights to be acquired was $28,400 as of June 5,

1980. Accordingly, on the same day the condemnation petition was

filed, the State, pursuant to Transportation section 8-323 of the

Maryland Code, deposited $28,400 with the circuit court.

Thereafter, petitioner was entitled to withdraw these funds by

submitting a written request to the circuit court pursuant to

section 8-323 of the Maryland Code. After filing the

condemnation petition and depositing the $28,400 with the circuit

court, the State, pursuant to Transportation section 8-324 of the

Maryland Code, was entitled to take possession of the property

designated in the petition.3

On June 24, 1980, petitioner withdrew the $28,400 that the

State had deposited with the circuit court. In withdrawing these

funds, petitioner acknowledged that, pursuant to section 8-323 of

the Maryland Code, he was entitled to receive the sum without

prejudice to any of his rights, provided he agreed to pay back

the State the difference between the amount withdrawn and the

3
In a quick-take condemnation proceeding, the Maryland State
Roads Commn. generally may take possession of the property before
it acquires legal title to the property. Md. Code Ann. Transp.
secs. 8-324 and 8-325 (1993); see State Roads Commn. v. Orleans,
211 A.2d 715, 722 (Md. 1965).
 - 5 -

final award, if the final award was less than the amount

withdrawn.

Negotiations to obtain legal title to the property without a

trial were unsuccessful, and, on May 20, 1981, the State adopted

a resolution to institute formal condemnation proceedings against

petitioner and to prosecute such proceedings to a conclusion.

The condemnation trial was set for March 31, 1987.4

However, sometime prior to the trial, petitioner advised the

State that the condemnation petition did not correctly identify

the total area to be acquired in that it omitted 642 square feet

of land. More specifically, the State had omitted from the

description contained in the condemnation petition a 4-foot wide

strip of land, approximately 160 feet long, extending along the

front of a portion of the DeSellum property between Route 355 and

the property described in the previously filed condemnation

petition. The State had actually taken possession of this

property on June 16, 1980.

Due to the discrepancies between the property actually

possessed by the State and the property described in the

condemnation petition, the trial was postponed. The circuit

4
Although the State utilized the "quick take" condemnation
procedure to acquire petitioners' property, the record
demonstrates that there was nothing quick about the condemnation.
Sometime between 1980, when the condemnation petition was filed,
and 1985, the parties agreed to place the condemnation case on a
"stet" docket until the construction plans for final phase of the
Route 355 project were completed. In 1985, the construction
plans for the final phase of the Route 355 project were
completed, and a motion was filed to take the case off the stet
docket. The case was then reset for trial in 1987.
 - 6 -

court granted the State permission to amend the condemnation

petition.

On December 16, 1987, the State adopted an amended

resolution, authorizing condemnation proceedings against the

portion of the DeSellum property omitted from the condemnation

petition. On January 5, 1988, the State filed an amended

condemnation petition; the amended petition included the 642

square feet of the DeSellum property omitted from the original

petition. In addition, on January 5, 1988, the State deposited

$13,996 with the clerk of the circuit court, which was the

State's estimated fair value for the additional 642 square feet

of the DeSellum property.

In a letter to petitioner's attorney, R. Edwin Brown

(petitioner's attorney), dated March 18, 1988, the State, through

Assistant Attorney General Frank W. Wilson (AAG), offered to

settle the condemnation case. More specifically, the State

offered $54,921 for the 10,599 square feet condemned in fee

simple and $5,231 for the 2,325 square feet taken in temporary

easement, or $60,152 in total. In addition, the State offered

prejudgment interest of 10 percent for 7-1/2 years on the excess

of $60,152 over $28,400, the latter figure representing the

amount deposited in 1980. The prejudgment interest on this

excess amount, or $31,752, amounted to $23,814. In addition, the

State offered $3,500 in "additional compromise". Thus, the
 - 7 -

State's total offer was $87,466, which the State rounded to an

offer of $87,500.

On July 14, 1989, in response to the foregoing offer,

petitioner's attorney made the following counteroffer:

If you will add the $3,500 additional compromise ahead of
the pre-judgment interest and figure the pre-judgment
interest at 10% for nine years and two months, I will
recommend the settlement, on condition that this amount of
money is on the table.

On July 28, 1989, the AAG responded to the foregoing

letter as follows:

I am writing in reply to your letter of July 14, 1989. As
you know, on January 7, 1988 we posted in Court an
additional $13,996. Therefore, I believe the additional 1-
1/2 years of interest at 10% per annum would be on $17,756
as opposed to the larger amount. That amount of interest
comes to $2,663.40.

As to the other point you made, I am not agreeable to paying
interest on the $3,500 additional compromise. That is
simply a "sweetener" to close this case.

However, adding the $2,663 to the $87,466 brings us to
$90,129. If that is acceptable to your client, I will seek
authority from our Baltimore Office to do a Consent
Inquisition.

In a further attempt to settle the case without a trial, the

AAG and petitioner's attorney met for a settlement conference on

September 20, 1989. In connection with the conference, the

parties completed settlement conference statements. In the

settlement conference statement completed by the AAG, the State

indicated that it would settle the matter for "$63,652 + pre-

judgment interest of $26,477 = $90,129.00 total." In the

settlement conference statement completed by petitioner's
 - 8 -

attorney, petitioner's attorney indicated that petitioner would

settle the matter for "Land $9.00 per square foot. Prejudgment

interest at 10% per annum. Landscaping $14,275 (see attached)

waived if settled."

The parties reached an agreement on September 20, 1989,

whereby petitioners would receive $104,000 for the DeSellum

property acquired by the State. In a letter to the circuit

court, dated September 20, 1989, petitioner's attorney indicated

that, because of tax considerations, it was important that

prejudgment interest be included in the court's judgment. On

October 19, 1989, a consent inquisition was signed and sealed by

the circuit court, noting that upon the consent of the parties it

was necessary for the State to acquire the property described in

the amended petition and that the damages sustained by petitioner

were in the sum of $104,000. In a stipulation and waiver entered

into by the State and petitioner, the parties agreed that the

$104,000 settlement set forth in the consent inquisition included

all prejudgment interest. In addition, the State and petitioner

agreed that effective September 20, 1989, petitioner would be

entitled to postjudgment interest of 10 percent per annum on the

sum of $61,604 until said sum is paid, with the $61,604

representing the unpaid difference between the $104,000 and the

$42,396 previously deposited by the State with the circuit court.

The AAG explained the settlement with petitioner in a letter

dated October 27, 1989, to Edward S. Harris, Esq., Maryland
 - 9 -

Assistant Attorney General/Chief Counsel. In the letter, the AAG

noted that $42,396 of the $104,000 settlement had been deposited

with the circuit court, leaving the remainder, or $61,604, to be

paid. He also noted that the $61,604 accrued postjudgment

interest at 10 percent per annum from September 20, 1989, until

actually paid; furthermore, he noted that, the "settlement

includes all prejudgment interest." Finally, the AAG indicated

that the prejudgment interest included in the settlement was

$34,618.

On December 7, 1989, the State deposited with the circuit

court $62,937.35 in full payment of the agreement entered into on

September 20, 1989; this amount included the balance of $61,604

due on the consent inquisition, and postjudgment interest of

$1,333.35 through December 8, 1989. However, a schedule attached

to the letter which included the foregoing deposit indicated that

no prejudgment interest was due and payable.

On January 10, 1990, petitioner petitioned the circuit court

to withdraw the $13,996 and 62,937.35 previously deposited by the

State, or $76,933.35, plus interest thereon. On January 11,

1990, the clerk of the circuit court issued a check to petitioner

for $79,094.05, which included $76,933.35 previously deposited by

the State and interest of $2,160.70.

From 1980 through the taxable years in issue, petitioners

did not report on their Federal tax returns any of the

condemnation proceeds received from the State, nor did they
 - 10 -

report any interest income received from the State. However,

petitioners now concede that, for taxable year 1989, they had

unreported postjudgment interest income from the State in the

amount of $1,333.35.5

Petitioners never asked the Internal Revenue Service (IRS)

for an extension of time in which to buy replacement property

pursuant to section 1033. Furthermore, petitioners did not,

prior to October 1991, notify the IRS that they had bought

replacement property with the condemnation proceeds.

In 1989, petitioners purchased property in Bath County,

Virginia (Bath Co. property), paying $125,000 for such property.

In 1993, petitioners rented out the Bath County property with the

agreement that the property would remain on the market and, if

sold, the rental agreement would terminate. Petitioner called

the IRS in the Spring of 1989, and he was referred to section

1033; after reviewing the code section, he concluded that he had

acquired replacement property that complied with section 1033.

In 1987, petitioners bought 691.043 shares of International

Stock Fund from T. Rowe Price (stock fund) for the total amount

of $19,750. In 1987, petitioners received distributions from the

stock fund in the amount of $7,006.92. Petitioners reinvested

this amount into the stock fund. In 1988, petitioners received

5
Although the parties stipulated that the postjudgment
interest was $1,335.35, this appears to be a typographical error,
as the schedule accompanying the State's deposit listed the
postjudgment interest as $1,333.35. Accordingly, we find that
the stipulated postjudgment interest income is $1,333.35.
 - 11 -

distributions from the stock fund in the amount of $2,457.46 and

reinvested this amount in the stock fund. In 1989, petitioners

received distributions from the stock fund in the amount of

$2,104.66. Petitioners did not report the receipt of the

$2,104.66 on their 1989 income tax return. In 1989, petitioners

sold the stock fund and received $27,205.57. On their 1989 tax

return, petitioners did not report the sale of the stock fund.

For taxable year 1989, petitioners received a $573

distribution from a trust which they did not include in income.

For taxable year 1990, petitioners requested and were

granted an extension to file their individual income tax return

until August 15, 1991. Petitioners jointly filed their 1990

individual income tax return on October 14, 1991.

OPINION

As a preliminary matter, we must resolve which party bears

the burden of proof with respect to the issues presented.

Generally, the taxpayer bears the burden of proof. Rule 142(a);

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). However,

the Commissioner bears the burden of proof with respect to,

inter alia, any new matter. Rule 142(a); Wayne Bolt & Nut Co. v.

Commissioner, 93 T.C. 500, 507 (1989). "A new theory that is

presented to sustain a deficiency is treated as a new matter when

it either alters the original deficiency or requires the

presentation of different evidence." Wayne Bolt & Nut Co. v.
 - 12 -

Commissioner, supra at 507; Achiro v. Commissioner, 77 T.C. 881,

890-891 (1981).

At trial, petitioners asserted that respondent's argument

regarding prejudgment interest presented a new matter under Rule

142(a). Respondent's prejudgment interest argument did not

require an increase in the deficiency arising from the

condemnation proceeds, which were characterized as ordinary

income in the notice. However, respondent's prejudgment interest

argument did require the presentation of different evidence.

Accordingly, at trial, we shifted the burden of proof to

respondent on this issue. Rule 142(a); Wayne Bolt & Nut Co. v.

Commissioner, supra at 507; Achiro v. Commissioner, supra at 890-

891. Respondent does not dispute this determination on brief.

In regard to the remaining issues, however, petitioners bear the

burden of proof. Rule 142(a); INDOPCO, Inc. v. Commissioner,

supra at 84.

Issue 1. Involuntary Conversion

Respondent determined that the $62,937.35 paid by the State

to petitioners in tax year 1989 should be included in their

income. Respondent further asserted that a portion of this

$62,937.35 should be characterized as interest. Petitioners

concede that $1,333.35 of the $62,937.35 is taxable interest

income, but no more. Furthermore, they argue that, under the

authority of section 1033, the remaining amount ($61,604) should

not be included in their income in tax year 1989.
 - 13 -

The Internal Revenue Code generally takes gains and losses

into account only when they are realized by a sale or exchange.

Sec. 1001(a), (c); sec. 1.1001-1(a), Income Tax Regs. When a

taxpayer receives money or other property as consideration for

the condemnation of his property, there has been an "exchange"

for income tax purposes. See sec. 1033(a); Kieselbach v.

Commissioner, 317 U.S. 399, 402 (1943); Tiefenbrunn v.

Commissioner, 74 T.C. 1566, 1570 (1980).

Gain from the exchange of property is the excess of the

amount realized from the exchange over the property's adjusted

basis, while loss is the excess of the adjusted basis over the

amount realized. Sec. 1001(a). The "amount realized" in an

exchange is the sum of any money received plus the fair market

value of any property (other than money) received. Sec. 1001(b).

Amounts received as interest are not part of the "amount

realized" from the exchange of property. Kieselbach v.

Commissioner, supra at 403; Tiefenbrunn v. Commissioner, supra at

1572. The "adjusted basis" of property exchanged is the

property's unadjusted basis (e.g., section 1012 cost basis)

adjusted as provided in section 1016 (e.g., reduced for

depreciation allowable). Sec. 1011(a).

Generally, gain or loss realized on an exchange of property

must be recognized. Sec. 1001(c). An important exception to

this general rule is provided by section 1033, which allows gain

realized from certain involuntary conversions to be deferred.
 - 14 -

Realized gain can be deferred under section 1033 if (1)

nonrecognition treatment is elected, (2) qualified replacement

property is purchased within time limits specified, and (3) the

cost of the qualified replacement property equals or exceeds the

amount realized on the conversion. Sec. 1033(a)(2)(A). The

regulations provide that section 1033 deferral is "deemed" to be

elected to the extent that a realized gain from an involuntary

conversion is not included in the return for the taxable year or

years in which any of such gain is realized. Sec. 1.1033(a)-

2(c)(2), Income Tax Regs. If the property condemned is "real

property (not including stock in trade or other property held

primarily for sale) held for productive use in a trade or

business", then replacement property will qualify for

nonrecognition if it is either of "like kind" or "similar or

related in service or use" to the property converted. Sec.

1033(g)(1); cf. sec. 1033(a)(2)(A) (property not described in

sec. 1033(g)(1) may only be replaced with property that is

"similar or related in service or use"). Furthermore, if the

condemned property falls under the section 1033(g) rules, the

replacement period is extended from 2 years to 3 years. Sec.

1033(g)(4); cf. sec. 1033(a)(2)(B)(i). Finally, if the taxpayer

purchases replacement property for an amount less than the amount

realized on the conversion, gain must be recognized on this

excess amount pro tanto. Sec. 1033(a)(2)(A).
 - 15 -

Respondent determined that gain realized on the condemnation

of the DeSellum property did not qualify for nonrecognition under

section 1033 because qualified replacement property was not

purchased within the statutory replacement period. Petitioners

assert that the Bath Co. property was qualified replacement

property that was purchased within the statutory replacement

period.

Respondent concedes that petitioners' DeSellum property was

real property held for productive use in a trade or business;

accordingly, the 3-year replacement period applies to

petitioners. Sec. 1033(g)(4). To resolve the issue of whether

qualified replacement property was timely acquired, we must

determine when the 3-year replacement period began and ended.

Pursuant to section 1033(a)(2)(B), the 3-year replacement

period begins "with the date of the disposition of the converted

property, or the earliest date of the threat or imminence of

requisition or condemnation of the converted property, whichever

is the earlier". Section 1033(a)(2)(E) defines "disposition of

the converted property" to mean, inter alia, the "condemnation of

the converted property * * *." Whether there has been a

condemnation for Federal tax law purposes depends on the

substantive rights arising under State law. Dear Publication &

Radio, Inc. v. Commissioner, 31 T.C. 1168, 1174 (1959), affd. 274

F.2d 656 (3d Cir. 1960); see Morgan v. Commissioner, 309 U.S. 78,

81 (1940).
 - 16 -

There is no dispute that a portion of the DeSellum property

was "involuntarily converted", as required by section 1033.

There is a dispute, however, regarding the date of the

conversion. Petitioners assert that the DeSellum property

described in the original petition and the DeSellum property

described in the amended petition were both condemned on December

16, 1987, noting that prior to this date the State had not

properly commenced quick take condemnation proceedings against

the subject property. Although the description of the property

to be acquired in the original condemnation petition was

incorrect, we do not think this fact is significant. Rather, we

conclude that the property described in the original condemnation

petition and the property described in the amended petition were

condemned on June 16, 1980, because by that date the State had

taken possession of both portions of the DeSellum property. It

is this dispossession and appropriation of property by the State

that Maryland law treats as a condemnation. State v. G.L.

Cornell Co., 584 A.2d 1331, 1336-1337 (Md. 1991).

Having found that the section 1033 replacement period began

on June 16, 1980, we now must examine when the replacement period

ended. The replacement period ends 3 years "after the close of

the first taxable year in which any part of the gain upon the

conversion is realized, or * * * subject to such terms and

conditions as my be specified by the Secretary". Sec.

1033(a)(2)(B)(i). In regard to the latter ending date, the
 - 17 -

application for extension must be filed prior to the expiration

of 3 years after the close of the first taxable year in which any

part of the gain from the conversion is realized. Sec.

1.1033(a)-2(c)(3), Income Tax Regs.

Petitioners have stipulated that they did not ask the IRS

for an extension of time in which to buy replacement property

pursuant to section 1033. Accordingly, we must determine whether

petitioners purchased replacement property within 3 years after

the close of the first taxable year in which any part of the gain

upon the conversion was realized. Sec. 1033(a)(2)(B)(i). The

key to resolving this issue is the date on which gain was

realized, if at all, on the conversion of the petitioners'

property.

On June 5, 1980, the State deposited $28,400 with the

circuit court as compensation to petitioners for condemnation of

their property. The condemnation actually occurred on June 16,

1980, and, on June 24, 1980, petitioners withdrew the $28,400

deposit. Despite withdrawing these funds in 1980, petitioners

argue that no amount was realized until 1989, when the amount of

compensation that they were entitled to receive as a result of

the condemnation was finally determined. We have previously

addressed this argument in the context of condemnation deposits,

and it is well settled that, under the claim of right doctrine,

such amounts are realized to the taxpayer in the year received

even though at the time of receipt conditions exist which might
 - 18 -

require the taxpayer to return all or part of such sums. E.g.,

Casalina Corp. v. Commissioner, 60 T.C. 694, 699 (1973), affd.

511 F.2d 1162 (4th Cir. 1975); R. A. Stewart & Co. v.

Commissioner, 57 T.C. 122, 126 (1971); Scolari v. Commissioner,

T.C. Memo. 1973-166, affd. 497 F.2d 962 (9th Cir. 1974); Town

Park Hotel Corp. v. Commissioner, T.C. Memo. 1970-261, affd. 446

F.2d 878, 879 (6th Cir. 1971). Accordingly, petitioners realized

$28,400 on the condemnation of their property in 1980. Sec.

1001(b).

Whether petitioners had a realized "gain" in 1980 depends

upon their adjusted basis in the property condemned. Sec.

1001(a). The taxpayer's basis in property is a question of fact,

and the taxpayer generally has the burden of proof on this issue.

Burnet v. Houston, 283 U.S. 223, 227-228 (1931); Biltmore Homes,

Inc. v. Commissioner, 288 F.2d 336, 342 (4th Cir. 1961), affg.

T.C. Memo. 1960-53. Here, petitioners presented no evidence

regarding their basis in the condemned property, nor did they

offer evidence of the basis of the entire DeSellum property.

Furthermore, they did not address this issue at trial or on

brief. Since there is no proof that petitioners had any basis in

the condemned property, we must treat the entire amount realized

in 1980 as gain realized. Sec. 1001(a); Burnet v. Houston, supra

at 227-228; Biltmore Homes, Inc. v. Commissioner, supra at 342;

Calderazzo v. Commissioner, T.C. Memo. 1975-1; cf. Ternovsky v.

Commissioner, 66 T.C. 695, 698 (1976).
 - 19 -

Since petitioners realized a gain upon the conversion of

their property in 1980, which they did not include on their 1980

tax return, they constructively elected to have section 1033

apply to the gains arising from the condemnation. James River

Apartments, Inc. v. Commissioner, 54 T.C. 618, 631 (1970), affd.

per curiam 440 F.2d 412 (4th Cir. 1971); sec. 1.1033(a)-2(c)(2),

Income Tax Regs. However, to defer this gain under section 1033,

petitioners had to purchase replacement property within 3 years

after the close of their 1980 taxable year. Sec.

1033(a)(2)(B)(i). Petitioners did not comply with this

requirement, as they did not purchase the alleged qualified

replacement property until 1989 (Bath Co. property), well after

the close of the 3-year replacement period. Accordingly, we must

sustain respondent's determination that no part of the $61,604

paid by the State to petitioners in tax year 1989 is entitled to

nonrecognition under section 1033.

Issue 2. Interest Income

Although we have held that petitioners recognized gain from

the condemnation of their property and that this gain cannot be

deferred under section 1033, we still must address respondent's

argument that some portion of the $61,604 represents interest

income, with the remainder being gain for the exchange of the

condemned property. Petitioner argues that no portion of the

amount realized should be characterized as interest. As
 - 20 -

discussed above, respondent has the burden of proof on this

issue.

We note that the parties to the condemnation proceeding

reached an agreement on September 20, 1989, whereby petitioners

would receive $104,000 for the DeSellum property condemned by the

State. The $61,604 at issue herein represents the excess of the

$104,000 awarded to petitioners over the $42,396 previously

deposited by the State with the circuit court ($28,400 on June 5,

1980 and $13,996 on January 5, 1988).6

Petitioners initially contend that, under Maryland law,

prejudgment interest awarded in a condemnation is not interest,

but is part of the "just compensation" to which petitioners were

entitled under Maryland law. Respondent does not challenge

petitioners' claim that the interest was part of the just

compensation to which petitioners were entitled under Maryland

law. See King v. State, 467 A.2d 1032, 1035 (Md. 1983).

Instead, respondent argues that State law does not control the

income tax consequences of the receipt of interest, and that

interest received as part of the condemnation award is properly

taxable as ordinary income, not as gain from the sale of

property. We agree with respondent, as it is well settled that

interest paid to compensate the property owner for delay in

payment of a condemnation award is taxable as ordinary income to

the recipient even though it is considered part of just

6
The interest income conceded by petitioners ($1,333.35)
represents the postjudgment interest accrued on the $61,604.
 - 21 -

compensation under State law. Kieselbach v. Commissioner, 317

U.S. 399, 403 (1943); Tiefenbrunn v. Commissioner, 74 T.C. 1566,

1571 (1980); Ferreira v. Commissioner, 57 T.C. 866, 871 (1972);

Fulks v. Commissioner, T.C. Memo. 1989-190 (involving Maryland

quick-take condemnation).

Petitioner next argues that, even if prejudgment interest is

taxable as ordinary income, no portion of the $61,604 included

prejudgment interest. To determine whether interest was included

in the condemnation settlement, we must examine the facts and

circumstances of the case. Smith v. Commissioner, 59 T.C. 107

(1972). Principally, petitioner relies on the fact that a

schedule attached to the letter which included the State's final

installment of the condemnation award indicated that no

prejudgment interest was payable. We reject this argument, as

the following facts and circumstances indicate that prejudgment

interest was included in the $61,604: (1) Prejudgment interest

is a required component of just compensation under Maryland law,

see King v. State, supra at 1035; (2) in the negotiations

preceding the agreed upon condemnation award, prejudgment

interest was included in the proposed settlement amounts, with

the only issue being the principal amount upon which it would be

computed and the rate of interest to be used; (3) on the date the

settlement was reached, petitioners' counsel specifically asked

the circuit court to include prejudgment interest in the court's

judgment; and (4) in a stipulation and waiver entered into by
 - 22 -

petitioner and the State, the parties agreed that settlement

included prejudgment interest. Based on the foregoing facts and

circumstances, we find that $34,618 of the $61,604 should be

treated as interest income to petitioners.

Issue 3. Capital Loss

In 1989, petitioners sold the stock fund for $27,205.57.

Respondent determined that petitioners had a basis of $29,214.38

in the stock fund. On brief, respondent concedes that

petitioners had a basis of $29,214.38 in the stock fund,

representing their original $19,750 investment plus two dividend

reinvestments of $7,006.92 and $2,457.46. Accordingly, respondent

further concedes that petitioners are entitled to a $2,008.81

loss on the sale of the stock fund. Petitioners argue that their

basis should be $2,104.66 higher than determined by respondent

because they received a $2,104.66 distribution from the stock

fund in 1989 that they reinvested in the stock fund.

Section 165(a) allows a taxpayer to deduct "any loss

sustained during the taxable year and not compensated for by

insurance or otherwise." However, section 165(c) limits the

scope of this deduction for individuals. Individuals may take

deductions only for losses which are incurred in a trade or

business, losses incurred in transactions entered into for

profit, and certain casualty and theft losses. Sec. 165(c)(1),

(2), and (3).
 - 23 -

The basis for determining the amount of a loss is the

adjusted basis for determining loss on a sale or exchange. Sec.

165(b); sec. 1.165-1(c), Income Tax Regs. Generally, the

adjusted basis for determining gain or loss is the cost of such

property. Secs. 1011 and 1012. It is generally accepted that an

income item cannot be transformed into a capital asset, having a

cost basis, until it is first included in income. Bryan v.

Commissioner, 16 T.C. 972, 980-981 (1951); Gorman v.

Commissioner, T.C. Memo. 1986-344. Thus, when a dividend is

received and reinvested, the taxpayer's basis will include the

amount of the dividend only to the extent that the dividend was

included in income. See Gorman v. Commissioner, supra.

Petitioners did not report the receipt of the $2,104.66

distribution from the stock fund on their 1989 income tax return.

Accordingly, they cannot claim that this amount was included in

their stock fund basis. Therefore, we sustain respondent's

determination.
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Issue 4. Dividend Income

Respondent determined that the $573 distribution petitioners

received from a qualified plan in 1989 should be included in

petitioners' income. Petitioners argue that the distribution was

rolled over into another qualified plan. We sustain respondent's

determination, as petitioners have presented no evidence

demonstrating that the distribution was properly reinvested.

Rule 142(a).

Issue 5. Addition To Tax for Failure To Timely File

Respondent determined an addition to tax under section

6651(a) for petitioners' failure to timely file their 1990

Federal income tax return. Such addition is presumed correct and

will be upheld unless the taxpayer presents evidence

controverting its applicability. Abramo v. Commissioner, 78 T.C.

154, 163 (1982).

Section 6651(a)(1) provides for an addition to tax for

failure to file a Federal income tax return by its due date

determined with regard to any extension of time for filing,

unless it is shown that such failure is due to reasonable cause

and not due to willful neglect. Calendar year individual

taxpayers must file their Federal income tax return by April 15

following the close of the calendar year. Sec. 6072(a). In this

case, respondent concedes that petitioners were granted an

extension of time to file their 1990 income tax return until
 - 25 -

August 15, 1991. However, petitioners did not file their 1990

return until October 14, 1991.

Petitioners presented no evidence to prove that their

failure to timely file their 1990 tax return was due to

reasonable cause and not due to willful neglect. We therefore

hold that petitioners are liable for the addition to tax under

section 6651(a)(1).

Issue 6. Negligence Penalty

Respondent determined an accuracy-related penalty for

negligence under section 6662(a) against petitioners for their

1989 and 1990 taxable years.

Section 6662(a) and (b)(1) provides that if any portion of

an underpayment of tax is attributable to negligence or disregard

of rules or regulations, then there shall be added to the tax an

amount equal to 20 percent of the amount of the underpayment

which is so attributable. The term "negligence" includes any

failure to make a reasonable attempt to comply with the statute,

and the term "disregard" includes any careless, reckless, or

intentional disregard. Sec. 6662(c). Petitioners have the

burden of proving that respondent's determination of the penalty

is in error. Rule 142(a); Billman v. Commissioner, 83 T.C. 534,

541 (1984), affd. 847 F.2d 887 (D.C. Cir. 1988).

At trial and on brief, petitioners did not specifically

address the issue of negligence. Therefore, we conclude that
 - 26 -

petitioners failed to carry their burden of proof, and we sustain

respondent's determination of the penalty for negligence for 1989

and 1990.

To reflect the foregoing,

Decisions will be entered

under Rule 155.