Goldberg v. Commissioner

T.C. Memo. 1997-74

UNITED STATES TAX COURT

LEO AND ALLA GOLDBERG, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 18842-94. Filed February 11, 1997.

Joseph E. Mudd and Jeri L. Gartside, for petitioners.

Miles D. Friedman and Zachary W. King, for respondent.

Table of Contents

Findings of Fact . . . . . . . . . . . 3

Petitioners' Residence . . . . . . . . . . . . . . . . . . . . 5
Malloy Property . . . . . . . . . . . . . . . . . . . . . . . 7
Exchange Properties . . . . . . . . . . . . . . . . . . . . . 8
Unemployment Compensation . . . . . . . . . . . . . . . . . . 12
Petitioners' Bank Accounts . . . . . . . . . . . . . . . . . . 12
Roman Kortava and Coastline Limited, Inc. . . . . . . . . . . 13
Saddle Rock and Martis Landing . . . . . . . . . . . . . . . . 16
Business School . . . . . . . . . . . . . . . . . . . . . . . 19
Vehicle Resale Business . . . . . . . . . . . . . . . . . . . 20
Vladimir Chorny . . . . . . . . . . . . . . . . . . . . . . . 21
15 Hastings . . . . . . . . . . . . . . . . . . . . . . . . . 22
Clerical Fee . . . . . . . . . . . . . . . . . . . . . . . . . 24
 -2-

Opinion . . . . . . . . . . . . . . 24

Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Unreported Income--Bank Deposits . . . . . . . . . . . . . . . 31
Unreported Income--Like-Kind Exchange . . . . . . . . . . . . 32
Unreported Income--Unemployment Compensation . . . . . . . . . 34
Unreported Income--Kortava . . . . . . . . . . . . . . . . . . 34
Mercedes . . . . . . . . . . . . . . . . . . . . . . . . 37
Saddle Rock and Martis Landing . . . . . . . . . . . . . 38
Unreported Income--Deeds in Lieu of Foreclosure . . . . . . . 42
Unreported Income--Interest . . . . . . . . . . . . . . . . . 45
Schedule C Income--1990 . . . . . . . . . . . . . . . . . . . 45
Business School . . . . . . . . . . . . . . . . . . . . . 46
Vehicle Resale Business . . . . . . . . . . . . . . . . . 46
Schedule C Expenses--1991 . . . . . . . . . . . . . . . . . . 48
Vehicle Resale Business . . . . . . . . . . . . . . . . . 48
Business School . . . . . . . . . . . . . . . . . . . . . 50
Unreported Income--Chorny . . . . . . . . . . . . . . . . . . 51
15 Hastings--Option Payment . . . . . . . . . . . . . . . . . 52
15 Hastings--Lease Versus Sale . . . . . . . . . . . . . . . . 55
Unreported Income--Clerical Fee . . . . . . . . . . . . . . . 59
Section 6651(a)(1) Addition to Tax . . . . . . . . . . . . . . 59
Section 6662(a) Penalty . . . . . . . . . . . . . . . . . . . 60

MEMORANDUM FINDINGS OF FACT AND OPINION

COHEN, Chief Judge: Respondent determined deficiencies in,

additions to, and penalties on petitioners' income taxes as

follows:

Additions to Tax and Penalty
Sec. Sec. Sec.
Year Deficiency 6651(a)(1) 6653(b)(1) 6663

1988 $108,150 --- $81,044 ---
1990 108,277 $27,069 --- $81,208
1991 1,926 29,349 --- 86,945

In the alternative to fraud, respondent determined that

petitioners were liable for the section 6653(a) addition to tax

for negligence for 1988 and the section 6662(a) accuracy-related

penalty for 1990 and 1991. Unless otherwise indicated, all

section references are to the Internal Revenue Code in effect for
 -3-

the years in issue, and all Rule references are to the Tax Court

Rules of Practice and Procedure.

After concessions by the parties, the issues remaining for

decision are:

For 1988, whether the statute of limitations bars assessment

and, if not, whether petitioners had unreported income from

various real estate transactions, unemployment compensation, and

unexplained bank deposits and whether they are entitled to

deductions relating to their taxi business.

For 1990 and 1991, whether petitioners had various items of

unreported income and whether they are entitled to deductions

relating to a vehicle resale business and a business school.

For all years, whether petitioners are liable for the

additions to tax and penalties determined by respondent.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.

Petitioners, Leo Goldberg (petitioner) and Alla Goldberg

(Mrs. Goldberg), were married and resided in Orange County,

California, at the time they filed their petition.

Petitioner immigrated to the United States from the Soviet

Union in 1977. Petitioner received a degree in engineering from

Moscow University, and he earned an M.B.A. from Pepperdine

University in December 1987. Petitioner has been involved, at

least to some extent, with real estate since 1986. He became
 -4-

familiar with Internal Revenue Code provisions dealing with real

estate transactions. He prepared petitioners' tax returns for

each of the years in issue. Mrs. Goldberg signed the returns,

but petitioner did not go over the contents of the returns with

her nor did she review the returns line by line.

Petitioners reported the receipt of the following amounts on

their 1988 return:

Rents $58,955
Interest 3,359
Dividends 877
Taxi 19,500

Petitioners' 1990 and 1991 returns were received by the

Laguna Niguel District Office on October 18, 1991, and

October 15, 1992, respectively. Although each return indicated

that an extension of time to file had been obtained, each

reported that no payment had been made with the extension

request.
 -5-

Petitioners' Residence

Beginning June 1, 1981, petitioners resided at 2311 Apricot,

Irvine, California (Apricot), a condominium with two bedrooms and

a loft.

On January 23, 1988, petitioners executed a "Reservation

Instrument" and made a deposit to purchase a residence located at

14 Siros, Laguna Niguel, California (14 Siros). They entered

into a purchase and sale agreement for 14 Siros on March 15,

1988, agreeing to acquire that residence for $274,900. In March

1988, they executed various documents selecting custom options

for paint, tile, and other features of the residence to be

completed at 14 Siros.

During 1988, homes in an exclusive gated community in Laguna

Niguel were made available to prospective purchasers through a

lottery conducted by Standard Pacific, L.P. (Standard Pacific).

Petitioners participated in the lottery and were selected to

acquire a residence at 25 Hastings, Laguna Niguel, on April 30,

1988. On May 1, 1988, petitioners executed a reservation

document and made a deposit for purchase of 25 Hastings.

On or after May 11, 1988, petitioners executed escrow

instructions that referred to the purchase of 14 Siros as

relating to "a 1031 tax deferred exchange". The exchange

provision of the escrow instructions was canceled in June 1988.

Construction at 14 Siros and petitioners' purchase of that

property were completed on August 2, 1988.
 -6-

On August 14, 1988, petitioners executed a purchase contract

and escrow instructions for the purchase of 25 Hastings. On

escrow instructions and loan applications relating to their

purchase of 25 Hastings, petitioners represented that their

residence was Apricot. On at least two occasions, petitioner

misrepresented his monthly income on residential loan

applications.

On August 23, 1988, petitioners hired Donna Nichols

(Nichols), a real estate agent, to sell 14 Siros. Nichols lived

at 16 Siros. On September 4, 1988, 14 Siros was sold for

$385,000.

In September 1988, petitioners entered into an agreement to

sell Apricot to Hector David Cordova for $137,000. The sale was

completed on November 9, 1988. At the time of the sale,

petitioners' adjusted basis in Apricot was $126,543.

Escrow closed on the purchase of 25 Hastings on November 1,

1988. Petitioners occupied 25 Hastings as their principal

residence from November 1988 at least through the time of trial

of this case in 1996.

At the time that they contracted to purchase 14 Siros,

petitioners intended to occupy it as their principal residence.

At the time that they contracted to purchase 25 Hastings,

however, petitioners abandoned their intention to occupy

14 Siros. Petitioners never occupied 14 Siros as their principal

place of residence.
 -7-

On their 1988 tax return, petitioners reported the sale of

Apricot as a sale of business property. They executed a

Form 2119, Sale of Your Home, with respect to 14 Siros. They

attached this form to their 1988 Federal tax return, thereby

claiming the right to defer under section 1034 a gain of $81,555

realized on sale of 14 Siros.

At the time that he prepared and filed petitioners' tax

return for 1988, petitioner was familiar with the requirements

for deferral of gain under section 1034. Petitioner knew that

petitioners did not qualify for deferral with respect to the gain

on the property at 14 Siros, but he nonetheless claimed the

deferral in order to defeat or avoid the taxes known to be owing

on the gain that they realized from sale of that property.

Malloy Property

On June 21, 1979, petitioner acquired an undivided one-half

interest in property at 8132 Malloy Drive, Huntington Beach,

California (Malloy). In July 1988, petitioners entered into an

agreement with Irvine Exchange Corporation (IEC) under which

petitioners were required to convey Malloy to IEC and IEC was to

act as an accommodator to petitioners for the exchange of then

unspecified property with then unknown third parties. That

exchange, however, was never completed with respect to Malloy.

Rather, on August 26, 1988, Malloy was sold to Anthony J. Vaccaro

for $209,000, of which $104,500 was for petitioners' interest in

Malloy.
 -8-

Petitioners reported gain from the sale of Malloy on their

Form 4797, Sales of Business Property, attached to their 1988

return. They misreported the net proceeds they received from

sale of the property, $37,531, as the "Gross sales price" and

calculated their gain as follows:

Gross sales price $37,531
Depreciation 12,333
Adjusted basis and expenses (44,554)
Gain reported $ 5,310

The gain should have been calculated as follows:

Gross sales price $104,500
Depreciation 18,333
Adjusted basis and expenses (52,254)
Gain realized $ 70,579

Thus, petitioners underreported their income of the Malloy

property by $65,269. At the time that he prepared petitioners'

1988 Federal tax return, petitioner knew that he was required to

report the gross sales price, not the net proceeds, in computing

the gain. He failed to report the gross sales price in order to

defeat or avoid the payment of taxes known to be owing on

petitioners' gain from the sale of Malloy.

Exchange Properties

On or about January 31, 1986, petitioners acquired for

$205,000 an interest in certain property in Orange County,

California, known as the Detroit properties. In February 1986,

petitioners conveyed an undivided one-half interest in the

Detroit properties to Boris and Natliya Landau (the Landaus) for

no cash consideration.
 -9-

In August 1988, petitioners entered into an exchange

agreement under which they would exchange their interest in the

Detroit properties for yet unspecified property that was subject

to a mortgage of at least $106,523. By grant deed dated August

31, 1988, petitioners transferred their interest in the Detroit

properties to IEC. IEC and the Landaus then conveyed the Detroit

properties to a purchaser for $365,000, or $182,500 for

petitioners' one-half interest. On their 1988 return,

petitioners reported that their adjusted basis in the Detroit

properties was $132,840 and that the Detroit properties were sold

in a transaction in which no gain or loss was recognized under

section 1031. By the end of 1988, petitioners had taken

depreciation on the Detroit properties equal to $14,073.

On or about July 10, 1986, petitioners acquired an interest

in certain real property in Huntington Beach, California, known

as the 8th Street property. On or about August 19, 1986,

petitioners acquired an additional interest in the 8th Street

property.

In September 1988, petitioners entered into an exchange

agreement with IEC to exchange their interest in the 8th Street

property for, as of then, unidentified property. By grant deed

dated September 12, 1988, petitioners transferred their interest

in the 8th Street property to IEC. IEC then conveyed the 8th

Street property to a purchaser for $344,000. Petitioners

reported that their adjusted basis in the 8th Street property was
 -10-

$219,234 and that allowable depreciation totaled $13,753. On

their 1988 return, petitioners reported that the 8th Street

property was sold in a transaction in which no gain or loss was

recognized under section 1031.

Standard Pacific allowed each purchaser to purchase only one

home on Hastings through its lottery system. Lisa Shumin

(Shumin), Mrs. Goldberg's mother, entered the lottery with

Standard Pacific and was selected to acquire 29 Hastings. The

total purchase price of 29 Hastings was $475,000. Standard

Pacific received an initial deposit of $8,000 in Shumin's name on

or about May 2, 1988.

During 1988 through 1990, Shumin worked as an accountant and

earned approximately $24,000 per year. Shumin qualified to

purchase 29 Hastings only because she misrepresented her income

and job title on the Buyer's Financial Worksheet provided to

Standard Pacific's representative and on the loan application

with Home Savings of America under which the bank loaned $356,200

to her. Of the $122,500 that was needed as a downpayment to

acquire 29 Hastings, petitioners provided at least $93,500,

including the initial deposit and $80,000 that was transferred

from petitioners' escrow on the sale of 14 Siros.

On August 14, 1988, escrow opened for Shumin's purchase of

29 Hastings. Shumin paid $10,119 for flooring installed in 29

Hastings. From December 2, 1988, until February 1989, Shumin

paid $46,500 for landscape improvements to 25 and 29 Hastings.
 -11-

On October 5, 1988, petitioners, Shumin, and IEC executed a

document entitled "Acquisition of Exchange Property Instructions"

that designated 29 Hastings as the exchange property for the

Detroit properties and the 8th Street property. IEC agreed to

purchase 29 Hastings for $540,000.

Escrow closed for Shumin's purchase of 29 Hastings on

October 21, 1988. The proceeds from Shumin's $356,200 Home

Savings of America loan were remitted to Standard Pacific.

On December 15, 1988, escrow closed on Shumin's sale of

29 Hastings to petitioners (through IEC), and she received

$180,094 from Merrill Lynch Escrow. Petitioners assumed the Home

Savings of America loan on 29 Hastings. The proceeds from the

sales of the Detroit properties and the 8th Street property

resulted in a balance of approximately $219,516.78 in

petitioners' escrow account. Approximately $184,000 of these

funds was needed for the purchase of 29 Hastings. Instead of

receiving the excess proceeds from the escrow, petitioners, under

the terms of the exchange agreement, deposited the excess

proceeds to be used to pay down the mortgage they assumed on 29

Hastings. On December 21, 1988, Home Savings of America received

$36,335.11 from Merrill Lynch Escrow on behalf of petitioners to

be applied to reduce the mortgage on 29 Hastings. Home Savings

of America confirmed, in a letter to petitioners dated

February 1, 1989, that petitioners' December 20, 1988, payment

was received on December 21, 1988, and was applied to the
 -12-

principal ($33,366.58) and to the interest ($2,818.53) on the

29 Hastings loan.

Petitioners realized gain from the above exchange

transactions in an amount equal to the following:

Fair market value of property received $540,000.00
Cash received 36,335.11
Indebtedness on property surrendered 279,987.00
Total consideration received 856,322.11
Basis of properties surrendered
Detroit $132,840
8th Street 219,234
352,074
Less depreciation
Detroit $ 14,073
8th Street 13,753 (27,826) (324,248.00)

Indebtedness on property received (356,024.77)

Gain realized $176,049.34

Unemployment Compensation

Until February 27, 1988, petitioner was employed full time

as an engineer for Analog. For the remainder of the year,

petitioner received checks for unemployment compensation.

Petitioner received a total of $5,934 in unemployment

compensation from the State of California during 1988.

Petitioners reported $1,328 of unemployment compensation on their

1988 tax return.

Petitioners' Bank Accounts

During all or part of the years in issue, petitioners

maintained the following banking and brokerage accounts:
 -13-

Location Account # Name on Account

California Federal 6130 Petitioner
California Federal 5272 Joint1
California Federal 502396 Joint
California Federal 6250 Coastline Limited
California Federal 4959 Joint
Bank of America 127021914 Petitioner
Bank of America 10223-338 Coastline Limited
Great Western 503146 Petitioner
American Savings Bank 530934 Joint
Dean Witter 370892 Joint
Charles Schwab 5900 Joint
Charles Schwab 5846 Petitioner
California Federal 6654 Petitioner3
California Federal 503864 Petitioner
California Federal 6737 Petitioner4
California Federal 503960 Joint5
California Federal 503987 Petitioner6
California Federal 504025 Petitioner7
Dean Witter 37733 Coastline Limited
Dean Witter 37088 Petitioner
Charles Schwab 3843 Coastline Ltd.
1
This account was petitioners' personal savings
account.
2
Originally, this was account number 29623.
3
This account was a fiduciary account set up for
David Michael Goldberg, petitioners' son.
4
This account was a fiduciary account set up for
Josephine D. Goldberg, petitioners' daughter.
5
Petitioner's mother, Faina Gruzman, was also
listed on this account.
6
Faina Gruzman was also listed on this account.
7
Gregory P. Moeller and Nathan Totosian were also
listed on this account.

Petitioners sold Analog Devices (Analog) stock and

deposited, on June 9, 1988, $44,816 of proceeds from the sale

into their Charles Schwab brokerage accounts. There was no

taxable gain on the sale of the Analog stock.

Roman Kortava and Coastline Limited, Inc.

Petitioner met Roman Kortava (Kortava) in 1989 at a party in

the United States for their wives' relatives. From 1990 through
 -14-

1992, Kortava, a native of Leningrad, lived and worked as a

banker in the former Soviet Union. Kortava founded his own bank

and monetary fund. Kortava made approximately $500,000 through

foreign currency exchange transactions during 1989 and 1990.

On September 10, 1990, Kortava and petitioner agreed that

Kortava would transfer $500,000 to petitioner for real estate

investments in the United States. Petitioner was to manage these

funds. Within days, they modified their agreement. Kortava

decided it would be better to organize a corporation and transfer

his funds to it and not to petitioner personally.

Coastline Limited (Coastline), a California corporation, was

incorporated for the purposes of real estate, consulting, and

marketing trade. Kortava nominally was the chief financial

officer of Coastline. Coastline never filed a Federal income tax

return.

Kortava transferred by wire to petitioner the following

amounts:

Date Amount Transferred to1

10/22/90 $ 20,000 6130
11/19/90 38,000 61302
11/19/90 20,000 61302
12/12/90 200,000 6250
12/21/90 14,544 61302
$292,544

01/29/91 7,046 6130
04/17/91 85,000 6130
05/31/91 80,000 6130
07/11/91 29,985 6130
07/12/91 35,000 61303
10/03/91 1,581 6130
 -15-

10/11/91 17,000 6130
10/11/91 20,000 6130
$275,612
1
All account numbers are for California Federal
accounts.
2
These amounts are considered under Schedule C
Income.
3
Petitioners reported this amount on their 1991
Schedule C for the resale vehicle business.

In 1991, at Kortava's request, petitioner returned $165,000 to

Kortava.

On October 24, 1990, petitioner transferred to California

Federal account number 5272 the $20,000 that Kortava wired on

October 22, 1990. On December 15, 1990, petitioner transferred

$50,000 from California Federal account number 6250 to open Bank

of America account number 10223-338. On February 6, 1991,

petitioner transferred $50,000 from California Federal account

number 6250 to open Dean Witter account number 37733. On May 30,

1991, petitioner transferred $85,000 from California Federal

account number 6250 to Schwab account number 3843. On August 8,

1991, petitioner transferred $19,000 from California Federal

account number 6250 to Dean Witter account number 37733. On

April 30, 1991, Mrs. Goldberg transferred $51,151.95 from Bank of

America account number 10223-338 to Schwab account number 3843.

On June 21, 1991, petitioner transferred $188,000 from California

Federal account number 6130 to petitioners' personal savings

account, California Federal account number 5272.
 -16-

Some of petitioners' personal expenses were paid with funds

from Coastline.

Saddle Rock and Martis Landing

On March 6, 1990, petitioners withdrew $80,000 from

California Federal account number 5272. Petitioners loaned

$88,800 ($8,800 represented interest) to Lee and Catherine Wood

(the Woods) by note dated March 7, 1990 (the March 7 note). The

March 7 note was secured by a deed of trust on the Woods'

property at 25881 Saddle Rock Place, Laguna Hills, California

(Saddle Rock).

On April 20, 1990, petitioner withdrew $50,000 from

California Federal account number 5272, and petitioners loaned

$55,500 ($5,500 represented interest) to the Woods. The Woods

gave to petitioner a $55,000 note (the April 20 note). The

April 20 note was secured by two deeds of trust, one on Saddle

Rock and the other on 1114 Martis Landing, Truckee, California

(Martis Landing).

Because of financial problems, the Woods could no longer

continue to pay their liabilities to petitioners. On June 19,

1991, the Woods and petitioners entered into an agreement whereby

the Woods conveyed Martis Landing and Saddle Rock to petitioners

by deeds in lieu of foreclosure. In return, petitioners released

the Woods from the March 7 note and the April 20 note.
 -17-

When the Woods conveyed Martis Landing to petitioners, Bank

of America held a first deed of trust with a balance of about

$135,990 on the property.

Petitioners took title to Saddle Rock subject to a deed of

trust in favor of Hawthorne Savings and Loan Association

(Hawthorne), securing a mortgage with a balance, as of June 7,

1991, of $464,300.37. Petitioners also took title to Saddle Rock

subject to a deed of trust that secured a real estate loan with

Topa Savings Bank (Topa) with a balance of $203,610.12 on June 4,

1991. On June 21, 1991, petitioner paid $20,000 from California

Federal account number 5272 to Mission Viejo National Bank in

satisfaction of a third trust deed on Saddle Rock.

The funds for the following payments were withdrawn from one

of petitioners' joint accounts, California Federal account number

5272: (1) $80,000 for a loan to the Woods; (2) $50,000 for a

loan to the Woods; (3) $28,529 for a payment to Topa; and

(4) $20,000 for a payment to Mission Viejo National Bank.

Petitioners also paid the following amounts out of Dean Witter

account number 37733, a Coastline account: (1) $4,191.02 to

Placer County Tax Collector for delinquent property taxes on

Martis Landing; (2) $2,547.38 to Bank of America for delinquent

payments on the Martis Landing loan; and (3) $8,203.72 to Orange

County Tax Collector for delinquent property taxes on Saddle

Rock. The funds in Dean Witter account number 37733 were

transferred from California Federal account number 6250, a
 -18-

Coastline account, where Kortava's initial wire transfer of

$200,000 was deposited. Petitioners did not have an investment

in Saddle Rock and Martis Landing to the extent of the delinquent

tax payments, because those payments were made with funds

belonging to Coastline, but the other items were paid with

petitioners' personal funds.

On October 29, 1991, petitioners sold Martis Landing for

$225,000 and received their net proceeds, $65,837.62, by check.

Petitioners reported the sale of Martis Landing on Form 4797 on

their 1991 return, reporting $13,958 of selling expenses and

$10,312 of gain. Coastline was not a party to the sale of Martis

Landing.

On January 1, 1992, Saddle Rock was sold to Gregory P.

Moeller (Moeller) for $850,000. A Long Form Land Contract

between Coastline, as vendor, and Moeller, as vendee, for the

sale of Saddle Rock was not recorded until November 18, 1994.

Petitioners' and Moeller's signatures on the contract were not

acknowledged before a notary public until November 1994.

Kortava emigrated from Russia in March 1992 and lived in

California for the remainder of 1992.

In 1994, Kortava hired an attorney to assist him in

determining the ownership of Martis Landing and Saddle Rock.

Because of title reports provided by the attorney and a real

estate agency, Kortava believed that petitioners, not Coastline,

owned the properties.
 -19-

Business School

Petitioner operated the business school as a sole

proprietorship under the name Coastline Ltd. The business school

was formed to send American instructors to Russia to train

Russian business students in the areas of economics,

international marketing, general management, and comparative

international management.

Petitioners reported all of the income and expenses of the

business school on their Schedule C. Petitioner received a total

of $34,544 from Kortava in 1990 for use in the business school.

Petitioner, d/b/a Coastline, Inc., entered into a contract

with Advanced Education Systems, Inc. (AESI contract).

Petitioners paid at least $20,033 of expenses incurred under the

AESI contract with funds from Dean Witter account number 37733,

including the following:

Date Payee Amount

03/15/91 Carrousel Tour Travel $ 830
04/11/91 AESI 4,000
04/23/91 Carrousel Tour Travel 7,391
06/02/91 AESI 4,000
08/28/91 AESI 1,000
08/29/91 Carrousel Tour Travel 1,104
09/13/91 AESI 240
09/91 VISA1 1,468

1
Includes gasoline, meals, lodging, and
entertainment.

Petitioner and seven others traveled to Russia as part of

the operation of the business school. At the end of the course

in Russia, the top students were invited to visit the United

States for additional studies.
 -20-

Vehicle Resale Business

Petitioner conducted a vehicle resale business as a sole

proprietorship. The vehicle resale business was reported on

petitioners' Schedule C under the name Coastline Ltd., Leo

Goldberg sole proprietor. Petitioners paid $125 and $3,650 from

Schwab account number 3843 for expenses of the vehicle resale

business.

During 1990 and 1991, Kortava transferred $72,544 of his

personal funds to petitioner to purchase cars for resale in

Russia. In 1990, petitioner received $38,000 from Kortava and

deposited this amount in California Federal account number 6130,

one of his personal accounts. Petitioners reported $72,544 in

gross receipts on Schedule C of their 1991 return. The contract

for the sale of vehicles required specific vehicles to be

delivered to Russia. If petitioner could not provide those

specific vehicles, the money was to be returned to Kortava in

Russia. When it was obvious that petitioner would not be able to

meet the requirements of the contract, the agreement was

modified, and petitioner sent to Russia his personal vehicle, a

1984 Mercedes Benz (Mercedes), and another replacement vehicle in

1991. The Mercedes had scratches and some additional damage when

petitioner shipped it to Kortava. Kortava wired to petitioner

$20,000 as consideration for petitioner's shipping the Mercedes

to Russia.
 -21-

During 1990 and 1991, petitioner purchased the following

cashier's checks with funds from California Federal account

number 6130:

Date Payee Amount

12/31/90 Coastline Imports $ 8,500
01/03/91 Coastline Imports 5,340
02/20/91 Ranko Balog Co. 3,600
07/17/91 Sharp Auto Sales 17,000

These checks were used to pay expenses of the resale vehicle

business.

Petitioners did not pay any of the claimed $62,808 of

expenses for the vehicle resale business with their own funds.

Vladimir Chorny

During 1990, petitioners received the following amounts from

Vladimir Chorny (Chorny):

Date Amount Purpose

01/27/90 $ 5,000 Real estate services
02/19/90 1,800 Real estate services
02/26/90 60 [Unclear from the record.]
02/26/90 2,435 Real estate services
04/07/90 1,050 Possibly real estate services
04/12/90 15,412 Engineering consulting

Petitioners reported $5,285 of the above amounts on their 1990

Schedule C as income from real estate consulting.

During 1991, petitioners received the following amounts from

Chorny:

Date Amount

07/29/91 $ 250
09/02/91 9,000
 -22-

The purpose of these checks is unclear from the record.

Petitioners did not report any of the above amounts on their 1991

Schedule C.

During 1990 and 1991, petitioners paid the following amounts

to the Chornys:

Date Payee Amount Memo

01/19/90 Vladimir Chorny $ 2,025 5,000 for stock @ 18¢ per share
01/19/90 Vladimir Chorny 5,000 None
06/24/91 Margarita Chorny 30,000 Lisa Shumin loan 1 year
09/20/91 Vladimir Chorny 9,000 None

15 Hastings

On November 10, 1986, petitioners acquired Lots 20 and 22 in

Block 212 of Huntington Beach, California (13th Street), for

$225,000. On October 30, 1989, petitioners opened escrow on

their purchase of 15 Hastings, Laguna Niguel, California

(15 Hastings), for $610,000. Petitioners considered 15 Hastings

to be the property that replaced the 13th Street property.

On or about November 15, 1989, petitioners obtained a

$390,000 loan from World Savings and Loan Association (World

Savings) and used the proceeds from this loan to acquire

15 Hastings. The World Savings loan was secured by a first trust

deed on 15 Hastings. On November 20, 1989, escrow closed for

petitioners' acquisition of 15 Hastings.

On November 1, 1989, petitioners and the Woods executed a

four-page document entitled "Lease Option" for 15 Hastings. The

Woods were in the midst of a divorce, and Catherine Wood

(Mrs. Wood) needed a place to live. At this same time, the Woods

were trying to sell their marital residence. The Lease Option
 -23-

was to expire June 3, 1991. The Lease Option provided that the

monthly lease payments would equal "the principal, interest,

taxes, insurance and Association dues. (NONE of which is to be

applied towards the purchase price.)" Under the terms of the

Lease Option, the seller/optionor (petitioners) was to "keep

current the existing trust deed loans, taxes and insurance and

homeowners association dues during the entire option period to

the close of escrow." Lee Wood (Mr. Wood) was to be provided

with the necessary documentation for purposes of tax deductions

related to 15 Hastings to be taken by Mr. Wood.

On November 3, 1989, petitioners and the Woods signed a

two-page document entitled "Real Estate Purchase Option"

agreement for the property located at 15 Hastings. The Real

Estate Purchase Option was to expire June 1, 1991. The terms of

the Real Estate Purchase Option were different than those

contained in the Lease Option. The Real Estate Purchase Option

did not provide for lease payments but instead stated that

"optionees agree to pay all carrying costs in respect to the said

property for the duration of the term of this option period to

include: principal, interest, taxes, monthly association dues,

any applicable insurance premiums; optionees further agree to

maintain the property in good repair".

Also on November 3, 1989, the Woods deposited $10,000 with

Escrow Masters as an option fee. The option fee was available to

petitioners at any time following consummation of this option

agreement. On December 1, 1989, petitioners withdrew the $10,000
 -24-

option fee from their escrow account at Escrow Masters and

deposited it into California Federal account number 502396.

Petitioners did not report receipt of the $10,000 option fee on

their 1989, 1990, or 1991 return.

On December 1, 1989, the Woods executed a note in favor of

petitioners in the amount of $232,000. The terms of the note

were "On or before June 3, 1991", with interest from November 20,

1989, payable in interest only until June 3, 1991, with the

entire principal and accrued interest being due in full at that

time.

Although the option was to expire in June 1991, on March 7,

1991, the Woods decided not to exercise their option on

15 Hastings. At this time, Mrs. Wood entered into a rental

agreement with petitioners whereby she rented 15 Hastings for

$3,149.69 per month, plus the association fee and gardening

expenses. Petitioners reported the rent received from the Woods

on Schedule E of the 1990 and 1991 returns as rental income.

Clerical Fee

On August 12, 1991, petitioner received a $535 check drawn

on the account of Wood and Morimoto, P.C.

OPINION

Because the statutory notice of deficiency for 1988 was sent

on July 20, 1994, more than 3 years after the filing of the 1988

return, assessment of a deficiency for that year is barred unless

either section 6501(c)(1), dealing with false or fraudulent
 -25-

returns, or section 6501(e)(1)(A), dealing with substantial

omission of income, extends the period for assessment. If we

were to decide that neither section applies in this case,

discussion of the other issues for 1988 would be unnecessary.

With respect to fraud, conduct over a period of years may be

considered in determining fraudulent intent for a particular

year. Spies v. United States, 317 U.S. 492, 499 (1943).

Respondent must prove fraud by clear and convincing evidence.

Sec. 7454(a); Rule 142(b). She must prove an underpayment

without reliance on petitioners' failure to overcome the normal

presumption of correctness of the notice of deficiency. Otsuki

v. Commissioner, 53 T.C. 96, 106 (1969). On the other hand, a

determination that respondent has not proven fraud by clear and

convincing evidence is not inconsistent with a determination that

petitioners have failed in their burden of proof or that the

preponderance of the evidence establishes that they have

unreported income or have claimed deductions to which they are

not entitled.

For the foregoing reasons, we begin our discussion with an

analysis of the issues relating to fraud. For the reasons set

forth below, we conclude that respondent has proven fraud for

1988 but has not proven fraud for 1990 or 1991.

Fraud

The addition to tax for fraud under section 6653(b), and its

successor penalty under section 6663, are civil sanctions
 -26-

intended to safeguard the revenue and to reimburse the Government

for the heavy expense of investigation and for the loss resulting

from a taxpayer's fraud. Helvering v. Mitchell, 303 U.S. 391,

401 (1938); Ianniello v. Commissioner, 98 T.C. 165, 183-185

(1992). Respondent has the burden of proving, by clear and

convincing evidence, an underpayment for each year and that some

part of the underpayment was due to fraud. If respondent

establishes that any portion of the underpayment is attributable

to fraud, the entire underpayment is treated as attributable to

fraud and subjected to a 75-percent addition to tax or penalty,

unless the taxpayer establishes that some part of the

underpayment is not attributable to fraud. See section

6653(b)(2) for 1988 and section 6663(b) for 1990 and 1991.

Respondent's burden with respect to fraudulent intent is met

if it is shown that the taxpayer intended to conceal, mislead, or

otherwise prevent the collection of taxes known to be owing.

See, e.g., Webb v. Commissioner, 394 F.2d 366, 377 (5th Cir.

1968), affg. T.C. Memo. 1966-81. Fraud may be proved by

circumstantial evidence because direct proof of the taxpayer's

intent is rarely available. The taxpayer's entire course of

conduct may establish the requisite fraudulent intent. Stone v.

Commissioner, 56 T.C. 213, 223-224 (1971); Otsuki v.

Commissioner, supra at 105-106. Fraudulent intent may be

inferred from various "badges of fraud". Bradford v.
 -27-

Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo.

1984-601.

Respondent has alleged several items that petitioners

omitted from their reported income for the years in issue that

result in an underpayment of tax. Respondent also contends that

petitioners failed to cooperate and to produce books and records

and that such failure is evidence of fraudulent intent.

Respondent contends that petitioners filed a false Form 2119

relating to their gain from sale of 14 Siros when they knew they

were not entitled to application of section 1034 to that sale.

Section 1034 clearly applies only to property used by a taxpayer

as his or her principal residence. The concept of principal

residence is neither complicated nor arcane. By 1988, petitioner

had been involved in real estate transactions for over 2 years

and had earned an M.B.A. degree. He testified that he read the

instructions concerning section 1034. In their brief,

petitioners do not contend that they were entitled to apply

section 1034; they merely argue:

While perhaps the home at Apricot should have been
considered their principal residence and the home at
14 Siros should have been left out of the equation, to
take the best advantage under the tax laws is what the
Petitioners thought they could legally do. They
believed that the intent to make 14 Siros their home,
coupled with the actions such as delivery of furniture
and so forth, adequately complied with the law relative
to Internal Revenue Code sec. 1034.

The phrase "principal residence" is not defined by the Code;

however, section 1.1034-1(c)(3)(i), Income Tax Regs., provides
 -28-

that the determination of whether a property is used by a

taxpayer as his principal residence "depends upon all the facts

and circumstances in each case, including the good faith of the

taxpayer." Generally, for property to be "used by the taxpayer

as his principal residence" within the meaning of section

1034(a), that taxpayer must physically occupy and live in the

dwelling. Houlette v. Commissioner, 48 T.C. 350, 354 (1967);

Stolk v. Commissioner, 40 T.C. 345, 353-356 (1963), affd. 326

F.2d 760 (2d Cir. 1964). See generally Perry v. Commissioner, 91

F.3d 82 (9th Cir. 1996), affg. T.C. Memo. 1994-247, for a recent

summary of applicable rules.

For 1988, we have specifically found that petitioners did

not occupy 14 Siros as their principal place of residence. We

also found that, when he prepared and filed petitioners' return

for 1988, petitioner was familiar with the requirements for

deferral of gain under section 1034 and knew that petitioners did

not qualify for deferral with respect to the gain on the property

at 14 Siros, but nonetheless claimed the deferral on the return

in order to defeat or avoid the taxes known to be owing on the

gain that they realized from sale of that property. In addition,

petitioners reported sale of their actual residence, Apricot, as

a sale of business property, thereby concealing the identity of

their actual residence. We reject the testimony by both

petitioners at trial that they actually resided at 14 Siros and

that they received rental income from a tenant at Apricot.
 -29-

Petitioners' explanations are improbable, in view of the sequence

of events, and were contradicted by disinterested witnesses.

Implausible explanations of this kind are among identified badges

of fraud. See Bradford v. Commissioner, supra.

We have also found that petitioner intentionally

underreported income from sale of the Malloy property by $65,269

in order to defeat or avoid the payment of taxes known to be

owing on that gain. From his testimony and from the entire

record, we are satisfied that petitioner had the education and

intelligence to understand what was required and that he

deliberately falsified his return in order to avoid payment of

tax known to be owing. Although we do not believe her trial

testimony, we have no evidence that Mrs. Goldberg had the

education or experience to know that these transactions were

falsely reported. The addition to tax for fraud for 1988 will be

sustained only as to petitioner. See Minter v. Commissioner,

T.C. Memo. 1991-448; Congelliere v. Commissioner, T.C. Memo.

1990-265.

Our conclusions as to the above two items for 1988 are

sufficient to establish an underpayment of tax for that year and

to shift to petitioner the burden of showing that any other

portion of an underpayment is not due to fraud. Respondent has,

however, conceded that certain disallowed expenses do not result

in an underpayment due to fraud, and those concessions will

affect the final computation.
 -30-

Our conclusions regarding fraud are also sufficient under

section 6501(c)(1) to overcome the bar of the statute of

limitations for that year. See Stone v. Commissioner, 56 T.C.

213, 228 (1971). Therefore, it is not necessary for us to

discuss whether respondent has proven a substantial omission of

income for purposes of section 6501(e)(1).

For 1990 and 1991, respondent bases her determination of

fraud on petitioners' failure to report income allegedly

embezzled from Kortava and on postponement of reporting income

from the vehicle resale business. Respondent has not proven by

clear and convincing evidence that petitioner embezzled money

from Kortava or that petitioners failed to report money received

from Kortava as income with knowledge that the funds were

taxable. Although petitioner exercised control over the funds

and was high-handed in his use of them, leading to a dispute with

Kortava, it is not clear that petitioner intended permanently to

deprive Kortava of his funds. Respondent has not disproved

petitioners' explanation that they were investing money in real

estate and in other businesses in accordance with an agreement

with Kortava, as demonstrated by their return of $165,000 of

Kortava's money on his demand. See, e.g., Baumgardner v.

Commissioner, 251 F.2d 311, 322 (9th Cir. 1957), affg. T.C. Memo.

1956-112; Ishijima v. Commissioner, T.C. Memo. 1994-353. We are

not convinced that reporting income in 1991 instead of 1990 was

due to fraud.
 -31-

There is no apparent relationship between the transactions

that we determined were fraudulently reported for 1988 and the

transactions that were the basis of respondent's determination

for 1990 and 1991. Thus, there is no discernible pattern from

which fraud can be inferred. As appears from the discussion

below, the other items in dispute for 1990 and 1991 would not

support a determination of fraud. Respondent's determination

under section 6663, therefore, will not be sustained.

Respondent's alternative determination of the accuracy-related

penalty under section 6662(a) for 1990 and 1991 is discussed

below.

Unreported Income--Bank Deposits

Respondent determined during the audit, based on a bank

deposits analysis, that petitioners failed to report $48,160 of

income on their 1988 return. At trial, respondent introduced a

second bank deposits analysis increasing the claim for

underreporting to $79,147. While petitioners generally argue

that respondent's determination is incorrect, petitioners

specifically contend that respondent's analyses do not accurately

reflect certain income reported on their 1988 return.

The bank deposits analysis that was prepared during the

audit of petitioners' return is not reliable. There is no

evidence that this analysis took into account transfers,

redeposits, or returned checks. Also, this analysis does not

account for the proceeds from petitioners' sale of Analog stock.
 -32-

The second bank deposits analysis identifies the following

amounts as deposits of proceeds from:

Rents $26,617
Interest 2,504
Dividends 119
Taxi checks 7,764

The second analysis does not correctly take into account the

amounts reported by petitioners.

We conclude that petitioners have unexplained deposits as

follows:

Unexplained deposits as determined by respondent $79,147
Less: Income reported by petitioners but not
accounted for by respondent:
Rent (32,338)
Interest ( 855)
Dividends ( 758)
Taxi (11,736)
Adjusted unexplained deposits $33,460

Petitioners have failed to provide any other evidence that the

unexplained deposits, as determined above, do not constitute

unreported income. Thus, respondent's determination, as adjusted

above, that petitioners had unreported income will be sustained.

Unreported Income--Like-Kind Exchange

Respondent initially argued that petitioners' transfer of

$80,000 from the 14 Siros escrow to Shumin for the downpayment on

29 Hastings and their provision of other amounts necessary for

Shumin's purchase of 29 Hastings somehow alter the exchange.

Respondent has not argued that petitioners were not repaid for

the advances to Shumin.

That petitioners provided funds for Shumin's purchase of

29 Hastings does not change the treatment of the exchange of
 -33-

properties. In 124 Front Street, Inc. v. Commissioner, 65 T.C. 6

(1975), the taxpayer owned an option to purchase property that

Fireman's Insurance Company (Fireman's) wanted to acquire.

Fireman's advanced to the taxpayer the funds to acquire the

property so that the taxpayer could exchange the property for

property owned by Fireman's. We held that the transaction was a

like-kind exchange and that the advance, which was bona fide, was

not boot to the taxpayer. Id. at 15-16; see also Biggs v.

Commissioner, 69 T.C. 905 (1978), affd. 632 F.2d 1171 (5th Cir.

1980). In the instant case, as in 124 Front Street, Inc., there

is no evidence that the advances that were made by petitioners

were not bona fide. Petitioners acquired 29 Hastings in a

transaction that will be respected for tax purposes. See, e.g.,

Estate of Bowers v. Commissioner, 94 T.C. 582, 590 (1990); Biggs

v. Commissioner, supra at 918 (courts have afforded great

latitude in structuring exchanges under section 1031).

Section 1031(a) provides the general rule that "No gain or

loss shall be recognized on the exchange of property held solely

for productive use in a trade or business or for investment if

such property is exchanged solely for property of like kind which

is to be held either for productive use in a trade or business or

for investment." Emphasis added. Petitioners exchanged two

pieces of real estate (the Detroit properties and the 8th Street

property) for one piece of real estate (29 Hastings) plus the

excess cash proceeds. Cash is not property of like kind to real
 -34-

estate, and, thus, petitioners' exchange was not solely in kind.

Gain must be recognized to the extent of such cash received

(boot). See sec. 1031(b).

The excess proceeds must be taken into account as boot

because the replacement property, 29 Hastings, cost IEC less than

the proceeds available from the disposition of the relinquished

property. By using the excess proceeds to increase their equity

in 29 Hastings (by reducing the mortgage) instead of receiving

the excess proceeds outright, petitioners attempted to avoid

treating the excess proceeds as property not of like kind. That

petitioners, not IEC, agreed to pay down the mortgage on

29 Hastings is indicative of petitioners' control over the excess

proceeds. "'The power to dispose of income is the equivalent of

ownership of it. The exercise of that power to procure the

payment of income to another is the enjoyment, and hence the

realization, of the income by him who exercises it.' * * * [The

taxpayer's] failure to receive cash was entirely due to his own

volition." Murphy v. United States, 992 F.2d 929, 931 (9th Cir.

1993) (quoting Helvering v. Horst, 311 U.S. 112, 118 (1940)).

Petitioners realized gain of over $176,000 and, thus, must

recognize gain on the exchange equal to $36,335.11. Sec.

1031(b).

Unreported Income--Unemployment Compensation

Respondent determined that petitioners failed to report

$4,606 of unemployment compensation that petitioner received
 -35-

during 1988. Petitioners claim that the amount they reported,

$1,328, represented unemployment compensation and that the $4,606

amount that respondent claims they failed to report represented

disability compensation. Petitioner, however, has provided

neither explanation nor corroboration of any alleged disability.

Petitioner's testimony was not persuasive. Respondent's

determination that the unreported amounts represented taxable

unemployment compensation will be sustained.

Unreported Income--Kortava

Respondent determined that petitioners failed to report

income received from Kortava during 1990 and 1991. Petitioner

received $292,544 and $275,612, in 1990 and 1991, respectively,

from Kortava. Petitioner returned $165,000 to Kortava in 1991.

Preliminarily, petitioners contend that respondent's proof

at trial and argument on brief do not conform to the notice of

deficiency or to the affirmative pleadings. Petitioners note

that the statutory notice of deficiency and answer refer to

"foreign fund income" as an adjustment to income in the amounts

of $220,000 and $233,566 for 1990 and 1991, respectively. The

notice of deficiency explains this determination as "Supplemental

compensation and bonuses are includable in gross income."

Respondent's answer, in alleging fraud, states: "The petitioners

fraudulently and with intent to evade income taxes failed to

report foreign fund income in the respective amounts of $220,000

and $233,566 during 1990 and 1991 taxable years." Respondent's
 -36-

argument on this issue on brief is that "petitioners stole

$568,156, both concealing and misrepresenting their use of these

funds to Kortava, and failing to report most of their

embezzlement on their returns."

In the notice of deficiency and at trial, respondent

maintained the position that petitioners had failed to report

income received from foreign sources. The record does not

indicate that petitioners misunderstood respondent's position.

In this instance, the evidence that is required to disprove the

determination in the notice of deficiency is not different than

that required to meet the position taken by respondent at trial.

Cf. Estate of Falese v. Commissioner, 58 T.C. 895, 899 (1972).

Respondent has not raised a new matter. Respondent has proposed

a new theory, merely clarifying or developing the original

determination. Respondent does not bear the burden of proof on a

new theory. See Estate of Jayne v. Commissioner, 61 T.C. 744,

748-749 (1974).

Petitioners do not contest that Kortava transferred funds in

the above-stated amounts to petitioners during 1990 and 1991.

Petitioners' position is that their mere receipt of the funds as

agents of Kortava does not produce taxable income.

Gross income includes all "accessions to wealth, clearly

realized, and over which the taxpayers have complete dominion".

James v. United States, 366 U.S. 213, 219 (1961) (quoting

Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955)).
 -37-

There can be no doubt that petitioners exercised control over the

funds that were deposited in or transferred to their personal

accounts. We must decide whether the extent of their control was

such that they are taxable on the amounts that were transferred

from Kortava in the years of the transfers.

The transfers from Kortava went into two accounts:

California Federal account number 6130, in petitioner's name, and

California Federal account number 6250, in Coastline's name.

Petitioners then transferred these funds to other Coastline

accounts and to their own savings account.

Petitioners claim that the funds that were transferred to

their personal savings account were payment for petitioners'

Mercedes that was sent to Russia and payment for petitioners'

interest in Martis Landing and Saddle Rock.

Mercedes

We have found as a fact that Kortava transferred $20,000 to

petitioner as consideration for petitioner's sending his Mercedes

to Russia. Petitioner did not report this amount on his 1990

return. Respondent determined that this amount represented

unreported income.

When it became apparent that petitioner would not be able to

meet the requirements of specific vehicles as contemplated by the

agreement between Kortava and petitioner, petitioner sent his

personal car, the Mercedes, to Russia. The acquisition expense

of the Mercedes was not shown on the Schedule C for 1990 or 1991.
 -38-

There is no evidence that the Mercedes was ever treated as the

property of the Schedule C business. All of the indications are

that the Mercedes was the personal car of petitioners. Thus, we

conclude that the transaction occurred outside the Schedule C

business. Petitioner testified that he paid "about $20,000" for

the Mercedes when he purchased it in 1985. His testimony in this

respect is not incredible and is not contradicted. Thus, the

amount petitioner received in payment for the Mercedes was not in

excess of the cost of the Mercedes; therefore, petitioners have

no gain from the sale of their car to Kortava and have not failed

to report income related to the sale of the Mercedes.

Saddle Rock and Martis Landing

Petitioners claim that their investment in Saddle Rock and

Martis Landing was $188,000, consisting, in part, of the

following:

Loan to Lee Wood $80,000
Loan to Lee Wood 50,000
Payment to Topa 28,529
Payment to Mission Viejo National Bank 20,000
Delinquent taxes 8,203

Respondent contends that petitioners did not have an investment

in these properties because these amounts were paid with funds

received from Kortava.

Petitioners claim that $188,000 received from Coastline

represents a payment for their interest in Saddle Rock and Martis

Landing. We must decide whether Coastline ever owned the

properties.
 -39-

We found as a fact that Coastline was not a party to the

sale of Martis Landing. Furthermore, petitioners reported the

sale of Martis Landing on their 1991 personal return. The

proceeds of the sale of Martis Landing were deposited into

petitioner's personal account, California Federal account number

6130. No evidence has been presented that Coastline was an owner

of Martis Landing or that Coastline received the proceeds from

the sale of Martis Landing. Petitioners never effectuated a

transfer of Martis Landing to Coastline; thus, no portion of the

money transferred from Coastline's account was in payment for

petitioner's interest in Martis Landing.

Petitioners claim that they transferred Saddle Rock to

Coastline and that Coastline then sold Saddle Rock to Moeller.

Petitioners rely on certain documents, including the following:

(1) A Long Form Security (Installment) Land Contract with Power

of Sale between petitioners, as vendors, and Coastline, as

vendee, notarized on June 21, 1991, and recorded on November 18,

1994; (2) a Grant Deed from petitioners to Coastline dated "as of

January 1, 1992" and notarized on November 17, 1994, and filed on

November 18, 1994; (3) a Long Form Security (Installment) Land

Contract with Power of Sale between Coastline, as vendor, and

Moeller, as vendee, dated January 1, 1992, and recorded on

November 18, 1994; and (4) a Notice of Supplemental Assessment

from the Orange County Assessor showing Coastline as owner of
 -40-

Saddle Rock due to a change of ownership effective on June 21,

1991.

For purposes of Federal income taxation, a sale occurs upon

the transfer of benefits and burdens of ownership, rather than

upon the satisfaction of the technical requirements for the

passage of title under State law. Derr v. Commissioner, 77 T.C.

708, 723-724 (1981); Yelencsics v. Commissioner, 74 T.C. 1513,

1527 (1980). The question of when a sale is complete for Federal

income tax purposes is essentially one of fact. Baird v.

Commissioner, 68 T.C. 115, 124 (1977). The applicable test is a

practical one that considers all of the facts and circumstances,

with no single fact controlling the outcome. Derr v.

Commissioner, supra at 724; Baird v. Commissioner, supra at 124;

Deyoe v. Commissioner, 66 T.C. 904, 910 (1976). Generally, a

sale of real property is complete upon the earlier of the

transfer of legal title or the practical assumption of the

benefits and burdens of ownership. Derr v. Commissioner, supra

at 724; Baird v. Commissioner, supra at 124; Deyoe v.

Commissioner, supra at 910.

Coastline did not receive the benefits and burdens of

ownership upon the execution of the contract of sale from

petitioners. Coastline was not entitled to possession until the

recording of the contract of sale (which occurred November 18,

1994). Risk of loss did not pass until Coastline had possession.

Coastline had no obligation to furnish insurance for Saddle Rock
 -41-

until it gained possession of the property. Coastline's only

responsibility upon the execution of the contract of sale was the

payment of real estate taxes.

Coastline also did not have full legal title at the time the

contract of sale was executed. Under California law, delivery

and acceptance of a deed passes full legal title. Cal. Civ.

Code, sec. 1056 (West 1982). We have only the Grant Deed dated

"as of January 1, 1992" and notarized on November 17, 1994, in

the record. Even if the deed were effective retroactively to

January 1, 1992, Coastline did not have title to Saddle Rock on

June 21, 1991, when petitioner transferred $188,000 from

Coastline's account to petitioners' personal account.

On June 21, 1991, Coastline was not the owner of Saddle

Rock, and, therefore, no portion of the money transferred from

Coastline's account was in payment for petitioner's interest in

Saddle Rock.

In summary, petitioners have unreported income to the extent

of the moneys transferred into their personal accounts and to the

extent that moneys in Coastline accounts were used to pay

expenses of Saddle Rock and Martis Landing.

In 1991, petitioners returned to Kortava $165,000,

representing a portion of the moneys received from him. This

repayment should be taken into account in the parties' Rule 155

computation.
 -42-

Respondent also determined that petitioners used funds for

unidentified and personal expenses of $8,264.64 from Dean Witter

account number 37733 and $2,736.23 from Schwab account number

3843. Petitioners, in their response to a proposed finding of

fact regarding Schwab account number 37733, claim that certain

charges from Budapest and Madrid that are reflected in the

proposed finding and on account statements are not personal

expenses. Petitioners state on brief that respondent was shown

petitioners' passports and that the passports did not reflect

travel to Budapest or Madrid. No such evidence was presented at

trial, nor was any other evidence presented concerning the actual

purpose of these expenditures. Respondent's determination that

petitioners failed to report the amounts paid as personal

expenditures will be sustained.

Unreported Income--Deeds in Lieu of Foreclosure

Respondent determined that petitioners failed to report

income received from their acceptance of Martis Landing and

Saddle Rock by deeds in lieu of foreclosure from the Woods.

Preliminarily, petitioners contend that respondent's proof

and argument on brief do not conform to the notice of deficiency

or the pleadings. Petitioners note that the statutory notice of

deficiency and answer refer to "debt extinguishment" as an

adjustment to income in the amount of $74,321. The notice of

deficiency explains this determination as "The amount of your

debt which was cancelled or forgiven is includable in income."
 -43-

Respondent's argument on this issue on brief is that "petitioners

must recognize $82,485 of ordinary income from receipt of deeds

in lieu of foreclosure." Petitioners claim that, because "debt

extinguishment" is not an issue in this case, petitioners were

not adequately warned of the nature of the deficiency alleged by

respondent.

Petitioners had fair warning of respondent's position on

this issue. On brief, petitioners state: "In preparation for

trial, it was first realized that the Respondent was talking

about something totally different than debt extinguishment."

Emphasis added. Petitioners had the opportunity to present

pertinent evidence on this issue; therefore, we may fairly

consider it. However, the evidence that is required to disprove

the determination in the deficiency notice is different than that

required to meet the position taken by respondent at trial. See

Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500, 507 (1989);

Colonnade Condominium, Inc. v. Commissioner, 91 T.C. 793, 795 n.3

(1988); Estate of Falese v. Commissioner, 58 T.C. 895, 899

(1972). Thus, respondent bears the burden of proof on this

issue.

Respondent contends that petitioners had income from the

acceptance of the deeds in lieu of foreclosure, calculated as

follows:
 -44-

Fair market value of properties $1,075,000.00
Less:
Basis in notes 130,000.00
Mortgages assumed:
Martis Landing 135,990.00
Saddle Rock
Hawthorne loan 464,300.37
1
Topa loan 203,610.12
Delinquent taxes paid:
Martis Landing 4,191.02
Saddle Rock 8,203.72
Mortgage payments:
Martis Landing 2,547.38
Saddle Rock
Topa loan 28,529.53
Mission Viejo National Bank 20,000.00
Martis Landing selling expenses 13,958.00
Gain reported on sale of Martis Landing 10,312.00
2
$ 53,357.86
1
Respondent's initial calculation used $184,794.94
as the amount of the Topa loan. The parties have
stipulated that the amount of the loan is $203,610.12.
2
Respondent has conceded the difference between
the $74,321 she determined in the notice of deficiency
and the $72,173.04, as she calculated using $184,794.94
as the amount of the Topa loan. We adjust the
concession to reflect the stipulated amount of the Topa
loan set out above.

Petitioners' contention regarding respondent's calculation

is that respondent has not proven the fair market values of the

properties. Respondent bases the value of the properties on

subsequent sales contracts. On October 29, 1991, Martis Landing

was sold for $225,000. On January 1, 1992, petitioners signed an

agreement to sell Saddle Rock for $850,000. Petitioners have not

claimed that these sales were anything other than arm's length

nor have they provided any evidence that the fair market values

of the properties on June 19, 1991, were substantially different
 -45-

from the fair market values on the date of the subsequent sales

of the properties.

This case is unlike the situation covered by section 1038,

where the seller of real property reacquires his property in

satisfaction of indebtedness to the seller. In that case,

section 1038 provides that no gain or loss shall result to the

seller because the seller/mortgagee is reacquiring that which was

initially sold to the purchaser/borrower. In this case,

petitioners loaned $130,000 and received, through deeds in lieu

of foreclosure, property with a net value in excess of $130,000.

Petitioners have realized ordinary (because there has been no

sale or exchange for purposes of section 1231) income to the

extent that the net fair market value of the properties received

exceeded their adjusted basis in the debt. See Commissioner v.

Spreckels, 120 F.2d 517, 521 (9th Cir. 1941); Pender v.

Commissioner, 110 F.2d 477, 478 (4th Cir. 1940).

In our findings of fact, we found that each of the items

that respondent used to calculate petitioners' income from the

acceptance of the deeds in lieu of foreclosure was paid or

reported by petitioners in the amounts stated above. Petitioners

have not offered any evidence of other items that would reduce

their income from the acceptance of the deeds in lieu of

foreclosure. Respondent's determination, in an amount as

corrected above, that petitioners had ordinary income from the

acceptance of deeds in lieu of foreclosure will be sustained.
 -46-

Unreported Income--Interest

Respondent determined that petitioners failed to report

interest earned on their funds in the name of Shumin.

Petitioners have not presented any argument regarding

respondent's determination other than to assert, in response to

respondent's proposed finding of fact, that "respondent offered

no evidence on this issue."

Petitioners bear the burden of proving that respondent's

determination is incorrect. Rule 142(a). They failed to offer

any proof. Respondent's determination on this issue will be

sustained.

Schedule C Income--1990

Respondent determined that petitioners reported as income in

1991 funds that they received in 1990, including approximately

$34,544 from Kortava for the business school and $38,000 from

Kortava for the vehicle resale business. Petitioners exercised

complete dominion and control over these amounts and, as such,

have gross income in the amounts we conclude below. See James v.

United States, 366 U.S. 213, 219 (1961).

Business School

Petitioners have conceded that the proper year for reporting

the business school income is 1990, but petitioners have not

conceded the amount of income that should be reported.

Petitioners have not presented argument or evidence to show that

the amount of respondent's determination, $34,544, is incorrect.

Thus, respondent's determination that petitioners' 1990
 -47-

Schedule C income from operation of the business school be

increased by $34,544 will be sustained. In accord with the

parties' agreement, a corresponding reduction will be made in

petitioners' 1991 Schedule C income from operation of the

business school.

Vehicle Resale Business

As to the vehicle resale business, on brief petitioners

state: "it does appear possible that at least a portion of the

income on the cash basis should have been reported in 1990."

Petitioners admit that $38,000 was received via wire transfer

during 1990.

At trial, petitioner testified that he received the wire

transfer in 1990 but that, if he had been unable to deliver the

cars as specified in the agreement, the money would have been

returned to Kortava. However, the parties modified the agreement

so that petitioner did not have to return any of the money.

As a general rule, cash basis taxpayers, such as

petitioners, must report income upon its receipt. Sec. 451(a).

Petitioners' argument appears to be that, although $38,000 was

received in 1990, the money was subject to a contractual

restriction that prohibited it from being income in 1990.

Respondent's determination is based on the claim of right

doctrine.

Income received under a claim of right is taxable in the

year received even though the recipient may be under a contingent

obligation to return it at a later time. North Am. Oil Consol.
 -48-

v. Burnet, 286 U.S. 417, 424 (1932). "The mere fact that income

received by a taxpayer may have to be returned at some later time

does not deprive it of its character as taxable income when

received." Woolard v. Commissioner, 47 T.C. 274, 279 (1966). To

avoid the application of the claim of right doctrine, however,

the recipient must recognize in the year of receipt an existing

and fixed obligation to repay the amount received and must make

provisions for repayment. Hope v. Commissioner, 55 T.C. 1020,

1030 (1971), affd. 471 F.2d 738 (3d Cir. 1973). A restriction on

the disposition or the use of the funds may also prevent the

application of the claim of right doctrine. Commissioner v.

Indianapolis Power & Light Co., 493 U.S. 203, 209 (1990).

Petitioners have not met these exceptions.

Petitioner was under a contingent, not a fixed, obligation

to repay the funds to Kortava pursuant to their agreement.

Furthermore, while Kortava may have had in mind a restriction on

the use of the funds, petitioner deposited the $38,000 in one of

his personal accounts, not in one of Coastline's accounts.

Respondent's determination that petitioners failed to report

$38,000 that was received from Kortava during 1990 will be

sustained. In accord with the parties' agreement, a

corresponding reduction will be made in petitioners' 1991

Schedule C income from operation of the vehicle resale business.

Schedule C Expenses--1991

On their 1991 Schedule C, petitioners claimed expenses

relating to a vehicle resale business and a business school.
 -49-

Respondent disallowed $13,188 of expenses related to the vehicle

resale business and $28,417 of expenses related to the business

school, based on her position that petitioners did not pay the

claimed expenses with their own funds. Petitioners contend that

they are entitled to these deductions because they reported the

corresponding income from these activities on their 1991

Schedule C. We have concluded that petitioners exercised the

requisite dominion and control such that the funds received from

Kortava for the vehicle resale business and the business school

are includable in petitioners' gross income. Thus, the expenses

that petitioners incurred in the operation of the Schedule C

businesses that have been properly substantiated and that are

ordinary and necessary are deductible by them.

Vehicle Resale Business

To substantiate disallowed deductions claimed in relation to

the vehicle resale business, petitioners introduced an exhibit

that included various receipts and their 1991 tax return.

Petitioner also testified at trial as to the existence of the

various expenses.

The information contained on a tax return is not proof of

the amount of deductions contained therein. Wilkinson v.

Commissioner, 71 T.C. 633, 639 (1979). Although petitioner

testified to the contrary, the exhibit introduced at trial did

not contain receipts for gas or office expense. We require more

than petitioner's unsubstantiated and unverified testimony as to

the existence of gas expense and office expense. Wood v.
 -50-

Commissioner, 338 F.2d 602, 605 (9th Cir. 1964), affg. 41 T.C.

593 (1964).

One repair receipt totaling $125 and marked paid is included

in petitioners' exhibit. This additional amount will be allowed.

As for additional vehicle expenses, we cannot determine from

the receipts in evidence that petitioners are entitled to any

deductions other than those already allowed by respondent.

Petitioners claimed that they did not include the value of their

Mercedes that they shipped to Russia as an expense when they were

preparing their 1991 Schedule C. Petitioner testified that the

Mercedes was worth $20,000 when it was shipped to Russia.

Kortava testified that the Mercedes was worth approximately

$10,000. The damage report that was completed before shipping

notes that the Mercedes had several minor scratches and a broken

headlight, as well as additional damage. No additional evidence

was presented to show the value of the 1984 Mercedes. We found

as a fact that petitioners received $20,000 in 1990 from Kortava

as consideration for petitioner's sending his Mercedes to Russia

and that petitioners did not recognize a gain from this

transaction. The record does not provide any evidence that the

Mercedes ever became the property of Coastline. Thus, the

transaction took place outside of the Schedule C vehicle resale

business, and petitioners are not entitled to a deduction on

their 1990 Schedule C for the expense of the Mercedes.
 -51-

Business School

Petitioners claimed $28,417 of expenses related to the

business school on their 1991 Schedule C. Respondent disallowed

all of the claimed deductions.

We found as a fact that petitioners paid at least $20,033 of

expenses associated with the AESI contract, including $9,240 to

AESI and $10,793 for gasoline, travel, lodging, meals, and

entertainment. Petitioners have failed to substantiate any

additional expenses. We must thus determine whether the

substantiated expenses are ordinary and necessary and, therefore,

deductible.

Section 162(a) allows a deduction for "all the ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business". "Ordinary" has been defined

as that which is "normal, usual, or customary" in the taxpayer's

particular trade or business. Deputy v. du Pont, 308 U.S. 488,

495 (1940). The expense need not be one common for the

particular taxpayer, but instead one that is not rare in the

taxpayer's business. See Welch v. Helvering, 290 U.S. 111, 114

(1933). The substantiated expenses included "normal" expenses

for the conduct of a business school abroad, including travel to

and from Russia for petitioner and the faculty; the expenses for

AESI's building the curriculum and locating the faculty; the

food, meals, and lodging for the faculty in Russia; and the

travel, food, meals, and lodging for the top students from Russia

who came to the United States after the school.
 -52-

"Necessary" has been construed to mean "appropriate" or

"helpful", not "indispensable" or "required". Ford v.

Commissioner, 56 T.C. 1300, 1306 (1971), affd. 487 F.2d 1025 (9th

Cir. 1973). It is sufficient if "there are also reasonably

evident business ends to be served, and the intention to serve

them appears adequately from the record." B. Manischewitz Co. v.

Commissioner, 10 T.C. 1139, 1145 (1948). The substantiated

expenses were also necessary, in that they were incurred with the

intention of serving the business end, mainly the conduct of a

business school in Russia.

Petitioners are entitled to deduct $20,033 as ordinary and

necessary expenses of the business school on their 1991

Schedule C.

Unreported Income--Chorny

Respondent determined that petitioners failed to report

Schedule C income of $20,472 and $9,250 in 1990 and 1991,

respectively.

At trial, petitioner testified that the payments received

from Chorny represented loan repayments. As evidence of the

debt, petitioners offered reproductions of checks payable to

Chorny or Margarita Chorny.

We are not persuaded by the checks payable to the Chornys

that Chorny was indebted to petitioner or that the checks

petitioner received during 1990 and 1991 from Chorny were not

includable in petitioners' income. At the trial of this case,
 -53-

Chorny could not recall whether petitioner lent him money during

1990 or 1991 nor could he recall whether he paid money to

petitioner for any reason during 1990 or 1991. Petitioner's

explanation at trial about the existence of loans is not

credible. For example, petitioner stated that he gave to Chorny

a $9,000 check on September 20, 1991, representing a short-term

loan that Chorny paid back shortly thereafter. The $9,000 check

that petitioners received from Chorny was dated September 2,

1991.

Petitioners have not established by a preponderance of the

evidence that the checks from Chorny represented loan repayments.

Thus, respondent's determination that petitioners failed to

report $20,472 and $9,250 in 1990 and 1991, respectively, as

Schedule C income from real estate consulting activities will be

sustained.

15 Hastings--Option Payment

Respondent determined that petitioners failed to report on

their 1991 return the $10,000 option fee that was received from

the Woods.

As part of the lease option agreement for 15 Hastings,

petitioners received an option fee from the Woods in the amount

of $10,000. This amount was deposited with Escrow Masters on

November 3, 1989. The parties have agreed that the option fee

was available at any time following the consummation of the

option agreement. On December 1, 1989, petitioners withdrew the
 -54-

option fee from their account at Escrow Masters and deposited it

into California Federal account number 502396. The Woods decided

not to exercise their option on March 7, 1991.

Respondent argues that proceeds from binding legal options

are not taxed until the option is exercised or lapses.

Petitioners contend that the $10,000 was received by petitioners

in 1989 and was taxable in the year of receipt.

Petitioners rely on Estate of Gordon v. Commissioner, 17

T.C. 427 (1951), affd. 201 F.2d 171 (6th Cir. 1952). In Estate

of Gordon, a $25,000 "option" payment was taxable income to the

taxpayer-decedent in the year of receipt under a claim of right.

In Estate of Gordon, the decedent had inherited a theater and

business property from her husband. A man was interested in

acquiring the property and negotiated two instruments with the

decedent. The purchase price was $125,000, and decedent received

$25,000 initially and interest was to be computed on the balance

of the purchase price, with one of the instruments requiring

quarterly interest payments. The lessee was given the privilege

of purchase at any time at the expiration of 6 months after the

death of the decedent and undertook the insurance and real estate

tax responsibilities. No outright sale was accomplished because

the lessee was not bound to purchase the property.

The present situation is distinguishable from that in Estate

of Gordon. We incorporate herein the reasoning of the Court of

Appeals for the Third Circuit when it distinguished the option in

Estate of Gordon from true options:
 -55-

Again any analogy of this case to the present one
fails. The time during which the option could be
exercised was largely uncertain--at any time six months
after the owner's demise running the term of the lease
of twenty-five years. The primary purpose seemed to be
to provide an elderly widow with an income for her
lifetime and it was held in effect, that as such, the
$25,000 payment was to be regarded as rent or income in
advance and hence was includable in her taxable income
when she received it. [Commissioner v. Dill Co., 294
F.2d 291, 299 (3d Cir. 1961), affg. 33 T.C. 196
(1959).]

In the present case, the option term was certain, expiring in

June 1991. The primary purpose of the option payment was to

allow the Woods time to arrange funds for a downpayment.

For cash method taxpayers, such as petitioners, section

451(a) provides that an item of income shall be included in gross

income in the taxable year in which it is received by the

taxpayers. One exception to this rule of recognition is that,

when it cannot be determined whether payments received will, at

some future date, represent income or a return of capital, they

are not taxed until their character becomes fixed. Burnet v.

Logan, 283 U.S. 404, 413 (1931); Dill Co. v. Commissioner, 33

T.C. 196, 200 (1959), affd. 294 F.2d 291 (3d Cir. 1961); Virginia

Iron Coal & Coke Co. v. Commissioner, 37 B.T.A. 195, 198 (1938),

affd. 99 F.2d 919 (4th Cir. 1938). Respondent argues that the

option payment received by petitioners falls within this

exception.

The deferral of the taxability of option payments is based

on two considerations: (1) The grantor of an option must wait

until the option is exercised or lapses to determine whether the
 -56-

proceeds for it are reportable as taxable income or as a

nontaxable return of capital and (2) if the option proceeds are

income to the grantor of the option, the character of the income

as capital or ordinary must be determined. See Old Harbor Native

Corp. v. Commissioner, 104 T.C. 191, 200 (1995). These

considerations remain even though the grantor retains the option

amount whether or not the option is exercised. See Hicks v.

Commissioner, T.C. Memo. 1978-373. Petitioners, although they

had control over and had unfettered use of the $10,000 in 1989,

had income in the year the option lapsed, 1991.

15 Hastings--Lease Versus Sale

We now must decide whether the "Lease Option" executed on

November 1, 1989, and the "Real Estate Purchase Option" executed

on November 3, 1989, effected a sale or a lease with an option to

buy. If we decide that the agreements effected a sale, we must

then decide the proper characterization of the payments received

by petitioners and the expenses claimed by petitioners.

Respondent argues that petitioners mischaracterized the

agreement by reporting the related items as though the agreement

were a lease instead of a sale. Petitioners contend that they

properly characterized the transaction as a lease with an option.

In this instance, we are not required to decide which of the two

agreements, the Lease Option or the Real Estate Purchase Option,

represented the bargain between petitioners and the Woods.

Whether a sale is complete for Federal tax purposes depends

on all of the facts and circumstances. Derr v. Commissioner, 77
 -57-

T.C. 708, 724 (1981); Baird v. Commissioner, 68 T.C. 115, 124

(1977); Clodfelter v. Commissioner, 48 T.C. 694, 700-701 (1967),

affd. 426 F.2d 1391 (9th Cir. 1970). We consider the following

factors in deciding whether a sale has occurred: (1) Whether the

seller transferred legal title; (2) whether the benefits and

burdens of ownership passed to the buyer; (3) whether the owner

had a right under the agreement to require the other party to buy

the property; and (4) how the parties treated the transaction.

Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221, 1237-

1238 (1981); Derr v. Commissioner, supra at 724; Baird v.

Commissioner, supra at 124; Merrill v. Commissioner, 40 T.C. 66,

74 (1963), affd. per curiam 336 F.2d 771 (9th Cir. 1964); Haggard

v. Commissioner, 24 T.C. 1124, 1129 (1955), affd. 241 F.2d 288

(9th Cir. 1956).

1. Title Passage to the Woods

While not a single determinative factor, passage of title is

an important consideration. Harmston v. Commissioner, 61 T.C.

216, 229 (1973), affd. per curiam 528 F.2d 55 (9th Cir. 1976).

Title to 15 Hastings never passed to the Woods.

2. Benefits and Burdens to the Woods

To decide whether the Woods acquired the benefits and

burdens of ownership in 15 Hastings, we look to whether the

Woods: (1) Bore the risk of loss; (2) were obligated to pay all

taxes, assessments, and charges against the property; (3) had the

duty to maintain the property; (4) were responsible for insuring

the property; (5) had the right to possess the property; (6) had
 -58-

the right to improve the property without the sellers' consent;

and (7) had the right to obtain legal title at any time by paying

the balance of the full purchase price. Grodt & McKay Realty,

Inc. v. Commissioner, supra at 1237-1238.

In this case, the Woods had the right to possess the

property, the right to obtain legal title by paying the balance

of the full purchase price, and the duty to maintain the property

and to pay insurance costs and taxes (under one agreement). The

Woods did not bear the risk of loss. This factor weighs in favor

of the agreement's being treated as a sale.

3. Compelling the Exercise of the Option

Under California law, an instrument is a contract of sale if

the optionee has an obligation to buy that the owner can enforce

by specific performance. Welk v. Fainbarg, 255 Cal. App.2d 269,

63 Cal. Rptr. 127, 132-133 (1967). Neither the Lease Option nor

the Real Estate Purchase Option provided that petitioners could

force the Woods to purchase 15 Hastings.

4. Intent of the Parties

Petitioner testified that title to 15 Hastings was never

transferred to anyone. Petitioners treated the agreement with

the Woods as a lease on their 1990 return. Mr. Wood testified

that he and Mrs. Wood were not renting 15 Hastings. Mr. Wood

classified the transaction, however, as a lease/option purchase

contract. Mrs. Wood said the agreement was initially

contemplated as a lease option. Mrs. Wood testified that their
 -59-

original intent was to purchase 15 Hastings, but they could not

get the funds together for the downpayment. Mrs. Wood said the

agreement was then converted to a straight month-to-month lease.

The testimony given by the parties as to the agreement is

consistent with treating the agreement as a lease option.

Although the Woods wished to purchase 15 Hastings, the agreement

gave them the option of purchasing the property if they could

sell their home and get the funds for the downpayment on

15 Hastings. Because the Woods were in the midst of a divorce,

Mrs. Wood needed a place to live; thus, the lease option

agreement met the intention of the parties to the agreement.

Respondent also argues that the execution of the $232,000

note was in essence a downpayment by petitioners and that the

note is evidence of a sale. However, under a consideration of

all of the facts and circumstances, we do not conclude that this

factor is controlling.

In summary, the passage of benefits and burdens of ownership

to the Woods in the absence of title, of an enforceable land sale

contract, and of intent to effect an immediate sale does not give

us grounds for treating the agreement between petitioners and the

Woods as anything other than a lease option agreement.

Unreported Income--Clerical Fee

Respondent determined that, in 1991, petitioners received a

clerical fee in the amount of $535 from Mr. Wood. Petitioners

did not present any evidence to contradict respondent's
 -60-

determination. Mr. Wood testified that, to the best of his

recollection, this check represented payment to petitioner for

expenses and time incurred by petitioner in helping Mr. Wood's

law firm with a case. Absent any evidence to the contrary,

respondent's determination that petitioners failed to report $535

of taxable income in 1991 will be sustained.

Section 6651(a)(1) Addition to Tax

Respondent determined that petitioners are liable for the

section 6651(a) addition to tax for 1990 and 1991. Section

6651(a)(1) imposes an addition to tax for failure to file timely

a return, unless the taxpayer establishes that the failure to

file did not result from "willful neglect" and that the failure

was due to "reasonable cause". "Willful neglect" has been

interpreted to mean a conscious, intentional failure or reckless

indifference. United States v. Boyle, 469 U.S. 241, 245-246

(1985). "Reasonable cause" requires taxpayers to demonstrate

that they exercised ordinary business care and prudence and were

nonetheless unable to file a return within the prescribed time.

Id. at 246; sec. 301.6651-1(c)(1), Proced. & Admin. Regs. The

addition to tax equals 5 percent of the tax required to be shown

on the return for the first month, with an additional 5 percent

for each additional month or fraction of a month during which the

failure to file continues, not to exceed a maximum of 25 percent.

Sec. 6651(a)(1).
 -61-

Petitioners' 1990 return was received by the Laguna Niguel

District Office on October 18, 1991. Petitioners' 1991 return

was received by the Laguna Niguel District Office on October 15,

1992.

Respondent contends that the extensions of time to file that

were obtained by petitioners are invalid because petitioners

failed to estimate properly the tax that was unpaid as of the

date prescribed for filing the return. No payments were included

with the requests for extensions. Petitioners bear the burden of

proving that respondent's determination was incorrect. Rule

142(a); Cluck v. Commissioner, 105 T.C. 324, 339 (1995).

Petitioners have failed to produce evidence that their extension

requests properly estimated the tax due, and we sustain

respondent's determination that petitioners are liable for the

section 6651(a)(1) addition to tax for 1990 and 1991.

Section 6662(a) Penalty

For 1990 and 1991, section 6662(a) imposes a penalty in an

amount equal to 20 percent of the underpayment of tax

attributable to one or more of the items set forth in section

6662(b). Respondent asserts that the entire underpayment of

petitioners’ tax was due to negligence or intentional disregard

of rules or regulations. Petitioners bear the burden of proving

that respondent's determinations are erroneous. Rule 142(a);

Bixby v. Commissioner, 58 T.C. 757, 791 (1972).
 -62-

“Negligence” includes a failure to make a reasonable attempt

to comply with the provisions of the internal revenue laws. Sec.

6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. “Disregard”

includes any careless, reckless, or intentional disregard of

rules or regulations. Sec. 6662(c); sec. 1.6662-3(b)(2), Income

Tax Regs.

The section 6662 accuracy-related penalty does not apply

with respect to any portion of an underpayment if it is shown

that there was reasonable cause for such portion and that

petitioners acted in good faith with respect to such portion.

Sec. 6664(c)(1). The determination of whether petitioners acted

with reasonable cause and in good faith depends upon the

pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income

Tax Regs. Petitioners have not established reasonable cause or

good faith reliance to excuse themselves from the penalties for

negligence or intentional disregard of rules or regulations. See

Mack v. Commissioner, T.C. Memo. 1995-482. Petitioners have

presented no evidence that their failure to file timely or to

report their income properly in 1990 or 1991 was due to anything

other than negligence or disregard of the tax laws. See Rapp v.

Commissioner, 774 F.2d 932, 935 (9th Cir. 1985).

Petitioners' failure to maintain and to produce reliable

records of their taxi business also supports a conclusion of

negligence. Crocker v. Commissioner, 92 T.C. 899, 917 (1989);

Schroeder v. Commissioner, 40 T.C. 30, 34 (1963). Thus,
 -63-

respondent's determination that petitioners are liable for the

accuracy-related penalty for 1990 and 1991 will be sustained.

Mrs. Goldberg is not excused from the negligence addition to

tax and penalties for 1990 and 1991 solely because of her failure

to read petitioners' returns or her reliance on petitioner for

the accuracy of the returns. Failure to read a return and blind

reliance on another for the accuracy of a return are not

sufficient bases to avoid liability for negligence. See Bollaci

v. Commissioner, T.C. Memo. 1991-108 (citing Bagur v.

Commissioner, 66 T.C. 817, 823-824 (1976), remanded on other

grounds 603 F.2d 491 (5th Cir. 1979)). Taxpayers have a duty to

read a return and to make sure all items are included. Magill v.

Commissioner, 70 T.C. 465, 479-480 (1978), affd. 651 F.2d 1233

(6th Cir. 1981) (citing Bailey v. Commissioner, 21 T.C. 678, 687

(1954)).

To reflect the foregoing and the concessions by the parties,

Decision will be entered

under Rule 155.