T.C. Memo. 1997-270
UNITED STATES TAX COURT
DONALD L. HEAD, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12675-94. Filed June 16, 1997.
Donald L. Head, pro se.
Michelle K. Loesch, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
JACOBS, Judge: Respondent determined deficiencies in
petitioner's Federal income taxes for 1986 and 1988 in the
respective amounts of $6,551 and $3,043, and additions to tax for
1986 and 1988 under section 6651(a)(1) in the respective amounts of
$1,471 and $357.
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Following a concession by petitioner, the issues for decision
are: (1) Whether petitioner is entitled to deduct $47,405 as a
business foreclosure loss in 1986; (2) whether petitioner is
entitled to a dependency exemption for his companion, Florence H.
Ratliff, in 1986; (3) whether petitioner is entitled to a $17,769
net operating loss carryover from 1983, 1984, and 1986 to 1988; and
(4) whether petitioner is liable for section 6651(a)(1) additions
to tax for failure to timely file his 1986 and 1988 Federal income
tax returns.
All section references are to the Internal Revenue Code in
effect for the years in issue. All Rule references are to the Tax
Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are found
accordingly. The stipulation of facts and the attached exhibits
are incorporated herein by this reference.
Background
At the time he filed his petition, Donald L. Head (petitioner)
resided in Arlington, Washington. Petitioner did not timely file
his 1986 and 1988 Federal income tax returns.
Petitioner was married to Diyana A. Head (Ms. Head). They
separated sometime in 1985 and divorced in March 1992.
The Jensen Road Property
In 1972, petitioner purchased property located at 2630 Jensen
Road in Bellingham, Washington (the Jensen Road property).
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Petitioner and Ms. Head began building a residential structure for
investment speculation purposes on the Jensen Road property (the
Jensen Road house or house) in that year. During the construction,
petitioner and Ms. Head resided in a mobile home. Construction of
the Jensen Road house was completed in September 1980. The Jensen
Road house was immediately put up for sale; a potential purchaser
was located, but the anticipated sale did not materialize. Because
petitioner and Ms. Head had no other residence, and the house could
not be insured if vacant, they moved into the Jensen Road house in
late October 1980. Petitioner lived in the Jensen Road house until
June 1985. Ms. Head lived in the Jensen Road house until May 1986.
The Norwest Commercial Bank Loans
In January 1983, petitioner borrowed funds in the amounts of
$10,000 and $40,000 from Norwest Commercial Bank (NCB), securing
both loans with a mortgage against the Jensen Road house. In May
1984, petitioner borrowed an additional $2,000 from NCB, again
securing the loan with a mortgage against the Jensen Road house.
Petitioner used a portion of the loan proceeds to operate a
retail coin and stamp business and a portion of the loan proceeds
for personal purposes. He operated the coin and stamp business
until April or May 1985. In June 1985, petitioner moved to
California, where he began working for The Boeing Co.
The Foreclosure
On May 27, 1986, NCB foreclosed upon its mortgages and took
possession of the Jensen Road property and house. At this point in
time, Ms. Head moved out of the Jensen Road house.
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Petitioner's 1986 and 1988 Federal Income Tax Returns
On Schedule C (relating to petitioner's retail coin and stamp
business) attached to petitioner's 1986 Federal income tax return,
petitioner deducted $54,0001 as a loss from "foreclosure to pay
business loan".
On petitioner's 1986 return, petitioner claimed a dependency
exemption for Florence H. Ratliff, who was listed on the return as
petitioner's "companion". Petitioner was not married to Florence
H. Ratliff (Ms. Ratliff) in 1986 or 1988, nor were they related.
On his 1988 Federal income tax return, petitioner deducted
$17,769 as a net operating loss carryover from 1983, 1984, and
1986.
The Notice of Deficiency
In the notice of deficiency, respondent disallowed $47,405 of
the claimed foreclosure loss, allowing the remaining $6,595 as an
interest expense. Respondent also disallowed the claimed
dependency exemption for Ms. Ratliff. Finally, respondent
disallowed the claimed $17,769 net operating loss carryover for
1988 on the basis that petitioner failed to timely elect to
carryforward his net operating losses from tax years 1983 and 1984.
Moreover, respondent determined that petitioner had not established
that any portion of those prior years' losses would be available
for 1988. Respondent accordingly increased petitioner's 1988
taxable income by $17,769.
1
The record does not indicate how petitioner arrived at
the $54,000 figure; his borrowings from NCB totaled $52,000.
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OPINION
Issue 1. Foreclosure Loss
The first issue we consider is whether petitioner is entitled
to the claimed foreclosure loss deduction in 1986. Petitioner
argues that the Jensen Road property was constructed as a "spec"
house, and as such constituted business or investment property. He
asserts that even though the Jensen Road house was used as his and
Ms. Head's residence after the anticipated sale of the house fell
through, the house retained its business character because it was
used to obtain financing for his retail coin and stamp business.
Respondent disagrees, contending that once petitioner used the
Jensen Road house as his and Ms. Head's residence, the business or
investment character, if any, of the Jensen Road property
terminated. Thus, respondent asserts, the foreclosure loss is not
deductible as it was sustained in connection with property held by
petitioner for personal purposes.
Section 165(a) allows as a deduction any loss sustained by the
taxpayer during the taxable year not compensated for by insurance
or otherwise. However, section 165(c) limits deductions for losses
of individuals to those incurred in a trade or business, incurred
in a transaction for profit, or as a result of a casualty or theft.
For tax law purposes, a foreclosure has the same effect as a
"sale or exchange". Helvering v. Hammel, 311 U.S. 504 (1941);
Quinn v. Commissioner, T.C. Memo. 1983-485. Losses attributable to
the sale of a family residence are nondeductible personal losses.
Sec. 262; Austin v. Commissioner, 35 T.C. 221 (1960), affd. 298
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F.2d 583 (2d Cir. 1962); Doerries v. Commissioner, T.C. Memo. 1991-
396; sec. 1.262-1(b)(4), Income Tax Regs. The burden of proving
that petitioner is entitled to deduct the loss rests with
petitioner. See Welch v. Helvering, 290 U.S. 111 (1933).
While we accept petitioner's testimony that he originally
built the Jensen Road house for investment purposes, the investment
character of the house terminated when the house became
petitioner's personal residence in October 1980. The house
remained petitioner's and Ms. Head's residence for almost 5 years,
and the house was used as Ms. Head's residence after petitioner
separated from her until foreclosure of the property took place in
May 1986.
Petitioner presented no evidence regarding the extent or
duration of his efforts to sell the Jensen Road property after the
house was used as his residence. We therefore conclude that the
Jensen Road property was held by petitioner for personal, and not
investment, purposes from October 1980 and at all relevant times
thereafter.
Petitioner asserts that because the Jensen Road property was
used to secure a business loan, it should be characterized (for tax
purposes) as business property. Although petitioner may have used
the equity in the Jensen Road property to secure a loan for
business purposes, that act in and of itself does not cause the
character of the property to change from a personal residence to
business property. The personal use of the Jensen Road property
had to terminate in order to effectuate a change of the character
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of the property to a trade or business or profit-motivated use.
See McBride v. Commissioner, 50 T.C. 1, 7 (1968); Leslie v.
Commissioner, 6 T.C. 488, 493 (1946).
Petitioner's coin and stamp business was not conducted on the
Jensen Road property, nor was the property used in connection with
that business. Moreover, petitioner did not terminate his personal
use of the property before or after obtaining the loan. Petitioner
and Ms. Head resided in the Jensen Road house for more than 2 years
prior to obtaining the loan. They continued residing there during
the operation of petitioner's business, and even after petitioner's
business failed. Further, the proceeds from the bank loans were
not used strictly for business purposes; a portion of the proceeds
was used for personal expenditures.
To conclude, the Jensen Road property was neither an
investment nor business property at any time after October 1980.
Accordingly, petitioner's 1986 foreclosure loss was personal and is
not deductible under section 165(c).
Issue 2. Dependency Exemption
The second issue for consideration is whether petitioner is
entitled to a dependency exemption for Ms. Ratliff in 1986.
Petitioner has the burden of proving that he is entitled to the
exemption claimed. Rule 142(a); Welch v. Helvering, supra.
Section 151(c) provides an exemption for each of a taxpayer's
dependents. Among other things, a taxpayer must provide over half
the support of any dependent during the calendar year in order to
claim the exemption. Sec. 152(a).
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Petitioner has failed to present any evidence on this issue.
Accordingly, petitioner is not entitled to the claimed dependency
exemption for Ms. Ratliff in 1986.
Issue 3. Net Operating Loss Carryover
The third issue for consideration is whether petitioner is
entitled to a $17,769 net operating loss carryover from 1983, 1984,
and 1986 to 1988. Respondent claims that the net operating loss
carryover was fully absorbed in previous tax years. Petitioner
disagrees.
Section 172(a) authorizes a net operating loss deduction.
Simply put, a net operating loss is the excess of a taxpayer's
deductions over his gross income, with certain modifications.
These modifications, which are enumerated in section 172(d),
include capital gains and losses, personal exemption deductions,
and nonbusiness deductions. A net operating loss in a given year
may be carried back for the 3 preceding years and carried forward
for the 15 succeeding years. Sec. 172(b).
The taxpayer bears the burden of proving the fact and amount
of the loss. Rule 142(a); Ocean Sands Holding Corp. v.
Commissioner, T.C. Memo. 1980-423, affd. without published opinion
701 F.2d 163 (4th Cir. 1983). Petitioner failed to present any
evidence to substantiate the claimed carryover. Accordingly,
petitioner failed to meet his burden of proof with respect to this
issue. We therefore sustain respondent's determination.
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Issue 4. Section 6651(a)(1) Additions to Tax
Respondent determined additions to tax pursuant to section
6651(a)(1) for petitioner's 1986 and 1988 taxable years.
Petitioner can avoid these additions to tax by proving that his
untimely filings were: (1) Due to reasonable cause, and (2) not due
to willful neglect. Sec. 6651(a); Rule 142(a); United States v.
Boyle, 469 U.S. 241, 245-246 (1985); United States v. Nordbrock, 38
F.3d 440 (9th Cir. 1994). "Reasonable cause" requires a taxpayer
to demonstrate that he exercised ordinary business care and
prudence and was nevertheless unable to file a return within the
prescribed time. United States v. Boyle, supra at 246; sec.
301.6651-1(c)(1), Proced. & Admin. Regs. Willful neglect means a
conscious, intentional failure to file or reckless indifference.
United States v. Boyle, supra at 245.
Petitioner was required to timely file Federal income tax
returns for 1986 and 1988. He filed those returns in April 1991.
Petitioner offered two explanations for untimely filing his 1986
return: (1) "[M]y records and personal papers were pretty scattered
at that time"; and (2) a house laborer mistakenly took the box
containing petitioner's records to the garbage dump, forcing
petitioner to reconstruct important figures.
Petitioner's justification is insufficient. Construction of
the house was completed in September 1980, and according to
petitioner's testimony, he discovered the records were mistakenly
taken about a week or so after the incident occurred. The tax
return to which such documents might have related was petitioner's
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1986 return, which was due to be filed on April 15, 1987, almost 7
years after the records were "scattered". Moreover, petitioner
failed to offer any explanation for his failure to timely file his
1988 Federal income tax return.
Because petitioner has failed to show reasonable cause for the
late filing of either his 1986 or 1988 Federal income tax return,
we sustain respondent's determination of the section 6651(a)(1)
additions to tax.
To reflect the foregoing,
Decision will be entered
for respondent.