T.C. Memo. 1998-182
UNITED STATES TAX COURT
CARL W. AND BARBARA H. PATTERSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10583-96. Filed May 18, 1998.
Carl W. Patterson and Barbara H. Patterson, pro sese.1
Gregory M. Hahn, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
ARMEN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7443A(b)(3) and Rules 180, 181, and
182.2
1
At the trial of this case, petitioners were represented by
Robert E. Kovacevich, an attorney admitted to practice before
this Court. After trial, however, Mr. Kovacevich was granted
leave to withdraw as counsel, and petitioners filed their brief
on a pro se basis.
2
Unless otherwise indicated, all section references are to
(continued...)
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Respondent determined a deficiency in petitioners' Federal
income tax for the taxable year 1992 in the amount of $4,339.
The issue for decision is whether a certain loss, which
respondent concedes is deductible, was incurred in 1992 as
petitioners contend.
The amount of miscellaneous itemized deductions to which
petitioners are entitled is a mechanical matter, the resolution
of which is solely dependent on our disposition of the disputed
issue. See sec. 67(a).
FINDINGS OF FACT
Some of the facts have been stipulated, and they are so
found. Petitioners resided in Lynnwood, Washington, at the time
when their petition was filed with the Court.
Carl Patterson (petitioner) has been actively engaged in the
commercial real estate market for approximately 40 years.
In 1990, petitioner began to consider the possibility of
acquiring commercial real estate in Houston, Texas. As part of
his investigation of such property, petitioner learned that
Skylane Apartment Projects (Skylane Apartments) was for sale by
its owner, Darby Suiter (Mr. Suiter).
Petitioner requested and received from Mr. Suiter a picture
and outline of Skylane Apartments. Thereupon, petitioner began
2
(...continued)
the Internal Revenue Code in effect for 1992, the taxable year in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
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evaluating the investment potential of Skylane Apartments. At
the same time, petitioner also considered different options for
obtaining real estate financing in Texas. Shortly thereafter,
petitioner traveled to Houston to visit Skylane Apartments.
On June 9, 1990, petitioner signed an "Earnest Money
Contract" (the Earnest Money Contract) to purchase Skylane
Apartments for $10,200,000. Petitioner did not pay any money to
Mr. Suiter upon execution of the Earnest Money Contract.
The Earnest Money Contract provided that the closing for the
sale of Skylane Apartments was to occur on or before August 8,
1990, 60 days after the Earnest Money Contract was signed. If
the closing for the sale did not occur by that time, then the
Earnest Money Contract provided that the parties would be
released from the agreement. In addition, the Earnest Money
Contract was subject to the purchaser obtaining financing.
At the time that the Earnest Money Contract was signed,
petitioner knew that real estate market conditions in Texas were
poor and that it would be difficult to obtain financing for the
purchase of Skylane Apartments. Although petitioner pursued
several different financing options, petitioner was unsuccessful
in obtaining financing by August 8, 1990, and the sale of Skylane
Apartments did not close. Thus, the Earnest Money Contract
expired on August 8, 1990.
Shortly after its expiration, petitioner requested that the
Earnest Money Contract be reinstated without changes and the
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closing date extended. Mr. Suiter agreed to extend the deadline
for the closing if petitioner signed an addendum to the Earnest
Money Contract (First Addendum). On August 30, 1990, petitioner
signed the First Addendum, and the deadline for the closing was
extended to October 19, 1990.
Pursuant to the First Addendum, the Earnest Money Contract
was not subject to petitioner's obtaining financing. Indeed,
petitioner represented therein that financing had already been
obtained.
The First Addendum required petitioner to tender $30,000 to
the Stewart Title Co. to be deposited in escrow. In the event of
default by petitioner, the First Addendum provided that Mr.
Suiter's sole remedy would be the receipt of the $30,000 deposit.
The First Addendum also contained certain disclaimers. The
First Addendum warned:
SELLER IS CONVEYING THE PREMISES AS IS WHERE IS. ALL
WARRANTIES OF EVERY KIND WITH RESPECT TO THE PREMISES
ARE HEREBY DISCLAIMED INCLUDING BUT WITHOUT LIMITING
THE WARRANTY OF MERCHANTABILITY AND HABITABILITY.
BUYER ACKNOWLEDGES THAT INFORMATION, FINANCIAL AND
BUSINESS OPERATION RECORDS FURNISHED TO BUYER BY SELLER
REGARDING SELLER'S BUSINESS OPERATIONS ARE WITHOUT
WARRANTIES EXPRESS OR IMPLIED ALL OF WHICH IS
DISCLAIMED.
The First Addendum also stated:
Seller disclaims all representations and warranties
of every kind regarding the premises, Seller's records,
and/or Seller's business operations for the premises
except those specifically stated in this Addendum.
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Pursuant to the First Addendum, petitioner paid $30,000 to
Stewart Title Co. Petitioner then continued to seek financing
for the purchase of Skylane Apartments.
By October 19, 1990, petitioner was unable to obtain
financing for the purchase of Skylane Apartments, and the Earnest
Money Contract expired once again. At this time, petitioner
thought that he still could obtain financing for the purchase of
Skylane Apartments. Petitioner again convinced Mr. Suiter to
extend the closing date of the Earnest Money Contract, this time
from October 19, 1990 to November 19, 1990. As consideration for
extending the closing date, petitioner agreed to tender to Mr.
Suiter the $30,000 previously deposited in escrow with Stewart
Title Co. By letter dated October 22, 1990, petitioner
authorized Stewart Title Co. to disburse $30,000 to Mr. Suiter as
consideration for extending the closing date of the Earnest Money
Contract from October 19, 1990 to November 19, 1990.
Although petitioner continued to seek financing for the
purchase of Skylane Apartments, petitioner was once again
unsuccessful. The sale of Skylane Apartments did not close by
November 19, 1990. Once again, petitioner requested that Mr.
Suiter extend the closing date.
Mr. Suiter ultimately agreed to extend the closing date for
an additional 30 days. However, Mr. Suiter required petitioner
to sign a new addendum to the Earnest Money Contract (Second
Addendum) and pay a $25,000 fee. In a letter dated November 20,
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1990, Mr. Suiter, through his attorney William Boyd (Mr. Boyd),
expressed some reluctance about agreeing to another extension of
the closing date. Mr. Boyd stated in his letter:
Carl, Darby would prefer to terminate the
Contract. He is concerned that you will not be
able to raise the down payment and thus lose the
$25,000.00 extension payment. You have insisted
that you can close by December 19th. Darby has
reluctantly agreed to this extension but will not
be inclined to grant further extensions. Please
consider all of this carefully before spending
your $25,000.
In the same letter, Mr. Boyd indicated that Skylane Apartments
were averaging 82-85 percent occupancy. However, Mr. Boyd
warned:
You are required not to rely on this information but
to conduct your own independent analysis of these
matters.
Petitioner signed the Second Addendum and paid the $25,000
extension fee by money order dated November 26, 1990. According
to the Second Addendum, the sale price of Skylane Apartments
remained at $10,200,000. However, a cash downpayment in the
amount of $2,550,000 was required, and the remaining portion of
the purchase price was to be financed by Mr. Suiter. Pursuant to
the Second Addendum, the sale of Skylane Apartments was required
to close by December 19, 1990. In the event of default by
petitioner, the seller's only remedy would be termination of the
contract or specific performance. In addition, the Second
Addendum stated:
Buyer has had ample opportunity to inspect the books
and records of Seller and the premises and have
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experts selected by Buyer to inspect the books,
records and premises. SELLER IS CONVEYING THE
PREMISES AS IS WHERE IS. ALL WARRANTIES OF EVERY
KIND WITH RESPECT TO THE PREMISES, THE FINANCIAL
CONDITION OF THE PREMISES, THE BOOKS AND RECORDS
OF SELLER, PROFIT AND LOSS STATEMENTS, BALANCE
SHEETS, ARE HEREBY DISCLAIMED INCLUDING BUT
WITHOUT LIMITING THE WARRANTY OF MERCHANTABILITY
AND HABITABILITY AND FITNESS FOR PURPOSE INTENDED.
BUYER ACKNOWLEDGES THAT THE INFORMATION REGARDING
SELLER'S BUSINESS WHICH HAS PREVIOUSLY BEEN
FURNISHED BY SELLER TO BUYER DOES NOT CONSTITUTE
A REPRESENTATION FOR ANY PURPOSE. THE FINANCIAL
BUSINESS OPERATION RECORDS OF THE SELLER ARE
FURNISHED TO THE BUYER FOR INFORMATIONAL PURPOSES
ONLY. BUYER AGREES THAT BUYER WILL HAVE ITS OWN
INDEPENDENT AUDITORS, FINANCIAL EXPERTS, TAX
ADVISORS, ATTORNEYS, ACCOUNTANTS TO REVIEW THE
BUSINESS OPERATIONS AND BUYER WILL SATISFY BUYER'S
SELF, WITHOUT RELIANCE UPON ANY INFORMATION BY
SELLER, AS TO WHETHER BUYER INTENDS TO PURCHASE
THE PROPERTIES OR NOT.
Shortly after signing the Second Addendum, petitioner and
petitioner Barbara H. Patterson, together with their accountant,
traveled to Houston to examine the financial records of Skylane
Apartments. Upon arriving there, petitioners were given access
to Mr. Suiter's records regarding Skylane Apartments, including
rent receipts and bank deposits.
By December 19, 1990, petitioner was unable to make the
downpayment of $2,550,000, and the sale of Skylane Apartments did
not close. The Earnest Money Contract expired, and no additional
extensions were granted.
On or before December 20, 1990, petitioner retained an
attorney, John Trueheart (Mr. Trueheart), to seek recovery of the
amounts paid to Mr. Suiter.
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In a letter dated December 20, 1990, Mr. Trueheart demanded
from Mr. Suiter a refund of $55,000 for the amounts paid (i.e.,
$30,000 + $25,000) for the extensions of the Earnest Money
Contract. In his letter, Mr. Trueheart alleged that "we have
discovered significant discrepancies between income and expenses
information you have provided Mr. Patterson and the actual
operation and [sic] of the projects." In addition, Mr. Trueheart
alleged that the square footage attributable to Skylane
Apartments differed substantially from the description of the
property in the Harris County records.
Mr. Boyd responded to petitioner's allegations in a letter
dated December 28, 1990. Mr. Boyd recounted that Mr. Suiter had
not been anxious to extend the deadline for the closing of the
sale of Skylane Apartments but that petitioner had been
"insistent". Mr. Boyd observed that petitioner "was always
optimistic that financing would be obtained". Mr. Boyd also
observed that both addenda to the Earnest Money Contract
contained specific disclaimers concerning the accuracy of the
financial data that was made available by Mr. Suiter. Finally,
Mr. Boyd stated that Mr. Suiter refused to refund the $55,000.
After Mr. Trueheart's letter dated December 20, 1990, there
were no further oral or written demands made by petitioner or Mr.
Trueheart on Mr. Suiter for the refund of the $55,000. Further,
petitioner had no communication with Mr. Trueheart after 1990,
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and Mr. Trueheart did not render any services for petitioner
after 1990.
Petitioner paid Mr. Trueheart $1,000 in December 1990 for
Mr. Trueheart's services. Petitioner did not pay Mr. Trueheart
any further amount.
Petitioner continued to engage in the commercial real estate
market in 1991 and 1992. Petitioner reported income and expense
from his commercial real estate activities for those years on
Schedules C (Profit or Loss from Business). On his Schedule C
for 1991, petitioner deducted travel expense in the amount of
$9,509.
In mid-1992, approximately 1-1/2 years after Mr.
Trueheart's letter dated December 20, 1990, petitioner flew to
Texas and met with Mr. Trueheart's associate Dan Bendinger (Mr.
Bendinger) ostensibly to discuss options for recovering the
$55,000. Mr. Bendinger reported to petitioner that no work had
been performed on petitioner's case since 1990 and that the
prospects of recovering $55,000 from Mr. Suiter were poor.
Petitioner never filed a lawsuit to recover any amount from
Mr. Suiter.
On his Schedule C for 1992, petitioner deducted a loss in
the amount of $30,000 for "exten[s]ion consideration fee to Darby
Suiter of Houston, Texas for investment purchase". Petitioner
did not deduct on his 1992 Schedule C the additional $25,000 fee
paid to Mr. Suiter in 1990.
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Petitioners reported zero taxable income on their income tax
return for 1992, and they paid no income tax for that year.
In the notice of deficiency, respondent determined that
petitioner's transaction with Mr. Suiter "closed" in 1990 and
that the $30,000 loss was therefore not deductible in 1992.
In their petition, petitioners alleged that they were
entitled to deduct a $30,000 loss in 1992. Petitioners also
alleged that "The additional $25,000 was not included but is
alleged as an additional loss in 1992 for abandonment" and that
"an additional abandonment loss in the amount of $25,000 has also
occurred in 1992 resulting in a refund and carryback and
carryforward loss."3
OPINION
As a general rule, the Commissioner's determinations are
presumed correct, and the taxpayer bears the burden of proving
that those determinations are erroneous. Rule 142(a); INDOPCO,
Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Welch v. Helvering,
290 U.S. 111, 115 (1933).
Section 165(a) permits a taxpayer to deduct "any loss
sustained during the taxable year and not compensated for by
insurance or otherwise." Only a loss "sustained during the
taxable year" may be deducted under section 165(a). Petitioners
3
We find that the $25,000 loss was sufficiently alleged in
the petition to give respondent fair notice of the total amount
of loss claimed by petitioners in this case for the taxable year
in issue.
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contend that a loss in the amount of $55,000 was "sustained" in
1992. Respondent contends to the contrary. We agree with
respondent for the following reasons.
In order to be deductible under section 165, "a loss must be
evidenced by closed and completed transactions, fixed by
identifiable events, and * * * actually sustained during the
taxable year." Sec. 1.165-1(b), Income Tax Regs; see also sec.
1.165-1(d)(1), Income Tax Regs. A loss is not sustained during
the taxable year if "there exists a claim for reimbursement with
respect to which there is a reasonable prospect of recovery".
Sec. 1.165-1(d)(2)(i) and (3), Income Tax Regs. In this event,
the deductibility of a loss is postponed until the taxable year
in which "it can be ascertained with reasonable certainty whether
or not such reimbursement will be received." Sec. 1.165-
1(d)(2)(i), Income Tax Regs; see sec. 1.165-1(d)(3), Income Tax
Regs. "Whether a reasonable prospect of recovery exists with
respect to a claim for reimbursement of a loss is a question of
fact to be determined upon an examination of all facts and
circumstances." Sec. 1.165-1(d)(2)(i), Income Tax Regs.
Petitioners bear the burden of proof on this question of fact.
Rule 142(a); INDOPCO, Inc. v. Commissioner, supra at 84; Welch v.
Helvering, supra at 115.
We hold that petitioner failed to prove that he had a
reasonable prospect of recovering any part of the $55,000 from
Mr. Suiter after 1990.
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At trial, petitioner alleged that Mr. Suiter should have
known that petitioner would be unable to obtain financing for the
purchase of Skylane Apartments. Thus, petitioner alleged as a
basis for the recovery of the $55,000 amount that he was misled
by Mr. Suiter.
We are not persuaded by petitioner's allegations regarding
being misled by Mr. Suiter. First, an individual with 40 years
of experience in the commercial real estate market should be
familiar with the problems of obtaining real estate financing.
Moreover, petitioner testified at trial that he was aware of the
difficulties in obtaining financing specific to the real estate
market in Texas at the time that he signed the Earnest Money
Contract.
There is no persuasive evidence in the record that supports
petitioner's allegation that he was misled by Mr. Suiter. To the
contrary, the record contains direct evidence that petitioner was
motivated by his own sense of optimism to extend the Earnest
Money Contract. Thus, when petitioner was unable to meet the
original closing date deadline of August 8, 1990, it was
petitioner who requested an extension. Also, in signing the
First Addendum, petitioner falsely represented that financing had
already been obtained. When petitioner was unable to close the
transaction by October 19, 1990, petitioner again requested an
extension of the closing date. At trial, petitioner testified
that he was motivated to extend the closing date deadline from
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October 19, 1990 to November 19, 1990, because he thought he had
some potential financing options. Subsequently, when petitioner
was unable to meet the November 19, 1990 deadline, and after he
requested another extension, petitioner was cautioned by Mr.
Boyd. Mr. Boyd advised petitioner that Mr. Suiter was reluctant
to extend the Earnest Money Contract because he was unsure that
petitioner would be able to finance the purchase. Mr. Boyd
observed that Mr. Suiter only agreed to extend the closing date
because petitioner "insisted" that he could close by December 19,
1990. Thus, we are not convinced that it was Mr. Suiter who
misled petitioner into thinking that financing was obtainable for
the purchase of Skylane Apartments.
We also find that petitioner had no reasonable prospect of
recovering the $55,000 based on the allegations set forth in Mr.
Trueheart's letter dated December 20, 1990. In his letter, Mr.
Trueheart alleged that Mr. Suiter provided petitioner with
inaccurate information concerning Skylane Apartments.
The record clearly demonstrates that Mr. Suiter specifically
disclaimed warranties with respect to his records. Both addenda
to the Earnest Money Contract advised petitioner that he should
not rely on the seller's records but should perform his own
independent analysis of Skylane Apartments. For example, the
Second Addendum stated:
SELLER IS CONVEYING THE PREMISES AS IS WHERE IS.
ALL WARRANTIES OF EVERY KIND WITH RESPECT TO THE
PREMISES, THE FINANCIAL CONDITION OF THE PREMISES,
THE BOOKS AND RECORDS OF THE SELLER, PROFIT AND LOSS
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STATEMENTS, BALANCE SHEETS, ARE HEREBY DISCLAIMED * * *
BUYER AGREES THAT BUYER WILL HAVE ITS OWN INDEPENDENT
AUDITORS, FINANCIAL EXPERTS, TAX ADVISORS, ATTORNEYS,
ACCOUNTANTS TO REVIEW THE BUSINESS OPERATIONS AND BUYER
WILL SATISFY BUYER'S SELF, WITHOUT RELIANCE UPON ANY
INFORMATION BY SELLER, AS TO WHETHER BUYER INTENDS TO
PURCHASE THE PROPERTIES OR NOT.
Petitioner was also cautioned by Mr. Boyd about relying on
Mr. Suiter's records. Although Mr. Boyd's letter dated November
20, 1990, contained information about the occupancy of Skylane
Apartments, Mr. Boyd's letter specifically warned petitioner not
to rely on the information presented but rather to perform his
own "independent analysis". Certainly with his many years of
commercial real estate experience, petitioner had reason to heed
the disclosures in the addenda and the warnings in Mr. Boyd's
letter. Therefore, we cannot find that petitioner reasonably
relied on the information provided by Mr. Suiter or that
petitioner had a reasonable prospect of recovering the $55,000
based on a theory that he was provided with inaccurate
information.
Finally, petitioner alleged at trial that he continued to
pursue the recovery of $55,000 from Mr. Suiter until 1992. To
the contrary, we find that petitioner failed to pursue seriously
the recovery of such amount after December 1990. Indeed, after
Mr. Trueheart's letter dated December 20, 1990, there were no
further demands made for the refund of the $55,000 (much less the
commencement of any litigation).
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At trial, petitioner alleged that he made some telephone
calls to Mr. Trueheart concerning his claims. However,
petitioner admitted that his telephone calls were unanswered, and
he did not persist in making contact with Mr. Trueheart.
At trial, petitioner also alleged that he had health
problems that prevented him from actively pursuing his claim
against Mr. Suiter until 1992. Despite these allegations,
petitioner was actively involved in the commercial real estate
market in 1991. Indeed, on his Schedule C for that year,
petitioner deducted travel expense in the amount of $9,509.
Thus, we cannot credit petitioner's allegation that health
problems prevented him from pursuing his claims against Mr.
Suiter in 1991.
Based on the foregoing, we find that petitioner had no
reasonable prospect of recovering the $55,000 from Mr. Suiter
after 1990. We uphold respondent's determination that
petitioner's loss from the transaction with Mr. Suiter was not
sustained in 1992. Petitioner's loss is therefore not deductible
in 1992.
To reflect our disposition of the disputed issue,
Decision will be entered
for respondent.