Ashley v. Commissioner

T.C. Memo. 2000-376

UNITED STATES TAX COURT

WILLIAM JOEL ASHLEY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 11673-99. Filed December 13, 2000.

William J. Ashley, pro se.

Jean Song, for respondent.

MEMORANDUM OPINION

VASQUEZ, Judge: Respondent determined the following

deficiencies in and additions to petitioner’s 1992 and 1994

Federal income taxes:

Additions to Tax
Tax Year Deficiency Sec. 6651(a) Sec. 6654(a)

1992 $1,676 $419 —
1994 70,074 17,519 $3,611
 - 2 -

All section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.

After concessions,1 the first set of issues for decision is

whether petitioner incurred a gain or a loss on the disposition

of residential real property and whether the gain or loss should

be treated as ordinary or capital. Subsumed within this first

set of issues are the questions of whether petitioner has

adequately substantiated the expenditures claimed for the

residential real property and whether that property was primarily

held for sale to customers in the ordinary course of a trade or

business.

The second set of issues deals with whether petitioner is

entitled to a variety of deductions pursuant to sections 163,

164, 165, and 170. Finally, we must decide whether petitioner is

liable for the additions to tax under sections 6651(a) and

6654(a).

We combine our findings of fact and opinion under each

separate issue heading. Some of the facts have been stipulated

and are so found. The stipulation of facts, the supplemental

stipulations of facts, and the attached exhibits are incorporated

1
Respondent concedes the tax deficiency and sec. 6651(a)
addition to tax for 1992. For the 1994 tax year, the parties
agree that petitioner realized the following income: (1) A $107
net short-term capital gain, (2) $41 in dividend income, and (3)
$6,025 in interest income.
 - 3 -

herein by this reference. At the time he filed his petition,

petitioner resided in Los Angeles, California.

I. Residential Real Property

On March 29, 1985, petitioner purchased residential real

property located at 127 N. 31st Avenue, Longport, New Jersey

(Longport property), for $106,000. Petitioner, however, did not

reside at the Longport property. In 1985, petitioner expended

significant amounts in renovating the property. During and

subsequent to 1985, petitioner purchased furniture, appliances,

and various household items for the purpose of renting the

Longport property primarily as a summer vacation home. On

September 30, 1994, petitioner sold the property for $216,000.

A. Gain or Loss on Disposition of Property

In the notice of deficiency, respondent asserted that the

entire $216,000 generated from the Longport property was subject

to tax.2 Subsequent to the issuance of the notice of deficiency,

in June of 1999, petitioner filed a tax return for 1994 with the

Internal Revenue Service Center in Fresno, California. Using

Form 4797, Sales of Business Property, petitioner claimed a

$140,000 ordinary loss on the 1994 tax return with regard to the

Longport property.

In exhibits submitted to the Court, petitioner now claims

2
Respondent now concedes that petitioner is entitled to an
offset of $106,000 (subject to depreciation) for the initial
investment in the Longport property.
 - 4 -

only a $73,651.92 ordinary loss. Petitioner computes the loss on

the sale of the Longport property by claiming an adjusted basis

of $289,651.92 in the property against the sales proceeds of

$216,000.

Petitioner computes the $289,651.92 adjusted basis for the

Longport property as follows:

Initial Purchase Price $106,000.00

+Improvements & Repairs
1985 $27,496.58
1986 1,371.05
1987 1,525.32
1988 3,500.44
1989 881.37
1990 304.07
1991 2,117.00
1992 0.00
1993 5,637.07
1994 6,370.40
Total 49,203.30

+Costs in Anticipation of Sale 2,250.00
1
+Closing Costs of Sale 2,834.31
+Personal Property 10,509.89
+1994 Operating Costs 13,306.08
+Section 263A Capitalization 105,548.34

Adjusted Basis 289,651.92
1
Respondent concedes that these costs should be
allowed to petitioner.

Petitioner contends that because he engages in the trade or

business of restoring homes and historical properties for the

purpose of resale, he was obligated to capitalize all the amounts

allegedly expended on the Longport property into the adjusted

basis of the property. Specifically, petitioner asserts that

section 263A requires capitalization of various operating

expenditures (such as insurance, refinancing, interest, and real

estate tax expenses allegedly paid from 1987 to 1993).
 - 5 -

Respondent asserts that petitioner was merely an investor in

the Longport property, was not entitled to capitalize any of the

claimed expenditures under the tax law, and in any event has

failed to substantiate most of those expenditures. Further,

respondent asserts that petitioner operated the Longport property

as a summer rental.

We must decide the appropriate amounts for the amount

realized and the adjusted basis in order to arrive at the gain or

loss on the sale of the Longport property. See sec. 1001.

Before we address the items to be included in the adjusted basis

computation, we conclude that the amount realized consists of the

sales proceeds of $216,000 less costs related to the sale

($2,834.31 + $1,500), which petitioner has substantiated.

In order to determine the adjusted basis of the Longport

property, we first address petitioner’s argument that his trade

or business encompasses selling restored properties. Section

263A(b)(2)(A) provides that the capitalization rules of section

263A will apply to real property “described in section 1221(1)

which is acquired by the taxpayer for resale.”3 To meet the

requirements of section 1221(1), the real property must be

“property held by the taxpayer primarily for sale to customers in

3
Petitioner does not contend that the property, in whole
or in part, was produced by him within the meaning of sec.
263A(b)(1); we therefore give no consideration to that provision.
Further, the record does not reflect operating costs with regard
to the improvements made by the taxpayer which could be
capitalized pursuant to sec. 263A(b)(1).
 - 6 -

the ordinary course of his trade or business”.

In deciding whether a taxpayer holds property “primarily for

sale to customers in the ordinary care of his trade or business”,

the Court must evaluate the particular facts of each case. The

Court considers various factors such as: (1) The purpose for

which the property was initially acquired; (2) the purpose for

which the property was subsequently held; (3) the extent to which

improvements, if any, were made to the property by the taxpayer;

(4) the frequency, number, and continuity of sales; (5) the

extent and nature of the transactions involved; (6) the ordinary

business of the taxpayer; (7) the extent of advertising,

promotion, or other active efforts used in soliciting buyers for

the sale of the property, (8) the listing of property with

brokers; and (9) the purpose for which the property was held at

the time of sale. See Maddux Constr. Co. v. Commissioner, 54

T.C. 1278, 1284 (1970); Hustead v. Commissioner, T.C. Memo. 1994-

374.

The record does not support a finding that petitioner was in

the business of renovating buildings for resale. At most, the

record supports that petitioner made an investment in the

Longport property, which was subsequently converted into a rental

real estate business as a result of a depressed real estate

market. Petitioner’s operating expenditures (1987 through 1993
 - 7 -

and 1994) therefore are not subject to capitalization under the

rules of section 263A or the Treasury regulations thereunder.

Petitioner’s adjusted basis in the Longport property, however,

will include the property’s purchase price ($106,000) reduced by

allowed or allowable depreciation. See secs. 1011, 1012, 1016.

Pursuant to section 263, “any amount paid out for * * *

permanent improvements or betterments made to increase the value

of any property” must be capitalized. This includes any amount

paid or incurred which adds to the value, or substantially

prolongs the useful life, of property owned by the taxpayer. See

sec. 1.263(a)-1(b), Income Tax Regs. However, amounts paid or

incurred for incidental repairs and maintenance of property are

not subject to capitalization. See id. Incidental repairs and

maintenance expenses do not materially add to the value of the

property nor appreciably prolong its useful life, but merely keep

it in an ordinarily efficient operating condition. See sec.

1.162-4, Income Tax Regs.

Respondent argues that all of the expenses characterized as

“Improvements and Repairs” by petitioner constitute incidental

repairs and maintenance which should be treated as ordinary and

necessary expenses under section 162. After reviewing the

record, however, we feel that there is sufficient evidence to

indicate that petitioner completed various projects and expended

significant amounts that materially added value to the property
 - 8 -

or substantially prolonged its useful life. We therefore find

that because petitioner has substantiated the following capital

expenditures, they should be added to the adjusted basis of the

Longport property:

Capital Expenditures1

1985 $18,838.49
1986 1,437.26
1987 1,525.32
1988 3,358.68
1989 0.00
1990 304.07
1991 2,117.00
1992 0.00
1993 5,637.07
1994 6,056.07

Total 39,273.96
1
For a breakdown of the capital
expenditures, see the appendix.

We, however, note that this amount, like the purchase price, is

subject to reduction after considering the allowance for

depreciation.

A review of the amount realized and adjusted basis

computations (without accounting for depreciation) reveals that

petitioner sold the Longport property at a gain.4 Although this

4
There is evidence in the record suggesting that other
individuals were involved in this venture. Petitioner, however,
claims entirely for himself the loss that he has computed for the
Longport property. Because the weight of the evidence suggests
that petitioner was running the operation primarily for his own
benefit and because petitioner argues that the entire alleged
loss should be allocated to him, we agree with respondent that
the gain calculated with regard to the sale of the Longport
(continued...)
 - 9 -

gain is not subject to the section 1221 capital gain preference

as a result of the application of section 1221(2), petitioner’s

gain does receive preferential treatment under section 1231. But

see sec. 1250.

As a final matter, petitioner claims that he received the

sales proceeds on account of the Longport property and certain

personal property, such as appliances purchased for the rental

unit. We find petitioner’s claim credible. We therefore

allocate $1,000 of the sales proceeds to the sale of a

refrigerator and washer/dryer and conclude that the following

amounts (which petitioner has substantiated) should constitute

the adjusted basis of the personal property:

Personal Property Date of Purchase Amount

Refrigerator Nov. 7, 1985 $1,010.69
Washer/Dryer May 18, 1993 881.02

Petitioner, however, must reduce the adjusted basis of this

property as well for depreciation allowed or allowable. See

secs. 1231 and 1245 with regard to the characterization of the

gain or loss.

B. Operating Expenditures

Deductions are a matter of legislative grace, and petitioner

bears the burden of proving that he is entitled to the deductions

4
(...continued)
property should be allocated solely to petitioner.
 - 10 -

claimed.5 See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503

U.S. 79 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435

(1934). Taxpayers are required to maintain records that are

sufficient to enable the Commissioner to determine their correct

tax liability. See sec. 6001; sec. 1.6001-1(a), Income Tax Regs.

In addition, the taxpayer bears the burden of substantiating the

amount and purpose of the item for the claimed deduction. See

Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam

540 F.2d 821 (5th Cir. 1976).

At trial, petitioner, in addition to his section 263A

capitalization argument, referred to the operating expenditures

that he claims for prior years as being subject to the passive

activity rules and argued that they had been suspended. While we

agree that petitioner’s rental activity was subject to the

passive activity rules of section 469, petitioner has not proved

that he had losses which were suspended in prior years.

Petitioner, however, is entitled to deduct the operating expenses

5
The Internal Revenue Service Restructuring & Reform Act
of 1998, Pub.L. 105-206, sec. 3001, 112 Stat. 685, 726, added
sec. 7491, which is applicable to court proceedings arising in
connection with examinations commencing after July 22, 1998.
Under sec. 7491, Congress requires the burden of proof to be
shifted to the Commissioner, subject to certain limitations,
where a taxpayer introduces credible evidence with respect to
factual issues relevant to ascertaining the taxpayer’s liability
for tax. In the instant case, petitioner has not raised the
application of this provision. Further, although petitioner, in
addressing other matters, stated at trial that respondent
conducted an examination in 1998, we cannot ascertain from the
record whether the Commissioner’s examination commenced after
July 22, 1998, in order even to consider whether sec. 7491 is
applicable in this case.
 - 11 -

he incurred and paid in 1994. The parties have stipulated that

these expenditures amount to $13,215.94.6

Finally, we address petitioner’s claim that $4,782.15 in

refinancing costs must be included in the adjusted basis of the

Longport property. While we agree that expenses incurred in

connection with securing a loan must be capitalized, we have

previously stated that those expenses must be amortized and

deducted over the life of the loan. See The Austin Co. v.

Commissioner, 71 T.C. 955, 965 (1979); Buddy Schoellkopf Prods.,

Inc. v. Commissioner, 65 T.C. 640, 649 (1975). If the loan is

repaid prior to maturity, however, “the unamortized expenses may

be fully deducted in the year of repayment.” Buddy Schoellkopf

Prods., Inc. v. Commissioner, supra at 649; see Anover Realty

Corp. v. Commissioner, 33 T.C. 671, 674 (1960). We estimate the

unamortized costs at $3,800, which petitioner is entitled to

deduct. See Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir.

1930), affg. in part and remanding in part 11 B.T.A. 743 (1928).

II. Schedule A, Itemized Deductions

In documents submitted to the Court, petitioner claims (1) a

$70,078.01 deduction for casualty losses to his real and personal

property, (2) a $3,244.08 and a $26,691.43 deduction for taxes

and interest, respectively, with regard to two homes, and (3) a

6
We note that petitioner is also entitled to a deduction
for depreciation relating to 1994. The benefit that petitioner
receives from the depreciation deduction for 1994, however, is
offset by a lower adjusted basis in the Longport property and the
personal property.
 - 12 -

$450 charitable contribution.

A. Casualty Losses

Pursuant to section 165(a) and (c)(3), a taxpayer is allowed

a deduction for an uncompensated loss that arises from fire,

storm, shipwreck, or other casualty. Section 165(h), however,

states that any “loss * * * shall be allowed only to the extent

that the amount of the loss to such individual arising from each

casualty * * * exceeds $100” and only to the extent that the net

casualty loss “exceeds 10 percent of the adjusted gross income”.

Petitioner has the burden of proving the casualty losses. See

Rule 142(a).

The proper measure of the amount of the loss sustained is

the difference between the fair market value of the property

immediately before and after the casualty, not to exceed its

adjusted basis. See sec. 1.165-7(b)(1), Income Tax Regs. The

fair market values required by the Treasury regulations must

generally be ascertained by competent appraisal. See sec. 1.165-

7(a)(2)(i), Income Tax Regs. As an alternative, the Treasury

regulations provide that if the taxpayer has repaired the

property damage resulting from the casualty, the taxpayer may use

the cost of repairs to prove the casualty loss. See sec. 1.165-

7(a)(2)(ii), Income Tax Regs. Estimates of the cost of repairs,

however, are not evidence of the actual costs of repairs unless

the repairs are actually made. See Lamphere v. Commissioner, 70

T.C. 391, 396 (1978); Farber v. Commissioner, 57 T.C. 714, 719

(1972).
 - 13 -

Petitioner claims a casualty loss deduction in the amount of

$72,708.01 constituting one-half of the damages to his residence

(since he jointly owns the home with another individual) and all

the damages to his personal property from an earthquake in 1994.

Although petitioner has not provided any reliable appraisals with

regard to the fair market values of the damaged property,7

petitioner has provided the Court with several proposals and

contracts describing the estimated costs for repairs to his

personal residence and various insurance checks made out to the

order of petitioner and the other joint owner.8 Petitioner,

however, has failed to support the proposals and contracts with

other documentary evidence9 showing that the repairs were

actually undertaken and the contract amounts paid.10 We

7
At trial, petitioner introduced an appraisal for his
personal property which was admitted into evidence. After
reviewing the document more closely, we do not place any weight
on the opinions expressed in that document.
8
Petitioner also submitted a document describing $2,000
worth of repairs for a piano allegedly damaged in the 1994
earthquake. We are unable to ascertain whether this document
purports to be an estimate or a receipt for services rendered.
9
Although we do not expect petitioner to be familiar with
the intricacies of the tax law, we do expect petitioner, a law
school graduate, to at least present some evidence of payment,
such as canceled checks.
10
In addition, sec. 1.165-7(a)(2)(ii), Income Tax Regs.,
requires the taxpayer to show:

(a) the repairs are necessary to restore the property
to its condition immediately before the casualty, (b)
the amount spent for such repairs is not excessive, (c)
the repairs do not care for more than the damage
(continued...)
 - 14 -

therefore reject petitioner’s claimed casualty loss deduction.

B. Interest and Real Estate Taxes

Section 163(h) denies deductions for personal interest paid

or accrued during the taxable year unless it fits within certain

narrowly prescribed categories. Section 163(h)(2)(D), one of

those prescribed categories, allows a deduction for interest on a

qualified residence. Petitioner submitted Forms 1098, Mortgage

Interest Statement, to the Court for two personal residences,

claiming only one-half of the reported interest as he jointly

owns the properties with another individual. Because his

testimony was consistent with the submitted Forms 1098, we allow

the deduction for interest. We also allow the real estate taxes

claimed with regard to the same properties.

C. Charitable Contributions

The next issue for decision concerns petitioner’s claimed

deduction for charitable contributions, which respondent

disallowed for lack of substantiation. Petitioner testified that

the claimed contributions were “donations for AIDS, * * *,

support for scholastic issues”, which were collected by

individuals going “door-to-door”. Section 170(a)(1) provides

that a charitable deduction is allowed “only if verified under

regulations prescribed by the Secretary.” For contributions by

10
(...continued)
suffered, and (d) the value of the property after the
repairs does not as a result of the repairs exceed the
value of the property immediately before the casualty.

Petitioner has also failed to prove those requirements.
 - 15 -

cash or check, the regulations require the taxpayer to maintain

specific records. See sec. 1.170A-13(a), Income Tax Regs.

Petitioner did not produce any evidence, beyond his vague and

incomplete testimony, to substantiate the $450 claimed

contributions of money.11 Accordingly, he has failed to

substantiate the deduction for charitable contributions as

required by the Treasury regulations.

III. Section 6651(a) and Section 6654(a) Additions to Tax

Section 6651(a) imposes an addition to tax for a taxpayer’s

failure to file a required return on or before the specified

filing date, including extensions. The addition to tax is

inapplicable, however, if the taxpayer shows that the failure to

file the return was due to reasonable cause and not to willful

neglect. See sec. 6651(a)(1).

Petitioner argues that respondent erred in imposing the

section 6651(a) addition to tax because petitioner timely filed

his return. Because the record does not support petitioner’s

contention, we conclude that the addition to tax is warranted if

the Rule 155 computations show that petitioner has an

underpayment of tax.

On brief, petitioner does not specifically address the

section 6654 addition to tax for a taxpayer’s failure to make

estimated tax payments other than stating that he does not have a

11
We need not accept a taxpayer’s self-serving and
uncorroborated testimony. See Wood v. Commissioner, 338 F.2d
602, 605 (9th Cir. 1964), affg. 41 T.C. 593 (1964); Tokarski v.
Commissioner, 87 T.C. 74, 77 (1986).
 - 16 -

tax liability. We therefore conclude that petitioner is liable

for the section 6654 addition to tax to the extent that the Rule

155 computations show an underpayment of tax.

To the extent not herein discussed, we have considered the

parties’ other arguments and found them to be irrelevant or

without merit.

Decision will be entered

under Rule 155.
 - 17 -

Appendix

1985 Capital Expenditures

Vendor/Service Provider Expenditure

Schutze’s Landscaping & Lawn Maintenance $300.00
Affordable Mike Moving & Hauling Co. 150.00
Gilmore Construction Company, Inc. 13,366.38
Atlantic City Shade Shop 344.50
Avalon Commercial Corporation 3,650.00
Kennedy’s Farm Market 131.80
Schutze’s Landscaping & Lawn Maintenance 61.48
Ronnie’s Garden Center 65.89
Pullan Electric Supply Inc. 149.85
Atlantic City Shape Shop 24.38
Joe’s Farm Market and Garden Center 102.77
Quaker Interiors 63.00
Franklin Electric Company 106.74
Quaker Interiors 5.00
Nick Nicholas Plumbing & Heating, Inc. 66.23
Nick Nicholas Plumbing & Heating, Inc. 250.47
Total 18,838.49

1986 Capital Expenditures

Vendor/Service Provider Expenditure

Kay Building Company $1,000.00
Nick Nicholas Plumbing & Heating, Inc. 184.40
Joe’s Farm Market and Garden Center 65.72
Joe’s Farm Market and Garden Center 187.14
Total 1,437.26

1987 Capital Expenditures

Vendor/Service Provider Expenditure

A-1 Plumbing Heating & Air-Conditioning, Inc. $1,525.32

1988 Capital Expenditures

Vendor/Service Provider Expenditure

Frank & Jim’s Storm Windows & Doors $1,423.58
Perrone Door Company, Inc. 1,262.00
Ace Auto Glass & Mirror Company 673.10
Total 3,358.68
 - 18 -

1990 Capital Expenditures

Vendor/Service Provider Expenditure

Bradlees Hardware $69.92
Frank and Jim’s Storm Windows & Doors 234.15
Total 304.07

1991 Capital Expenditures

Vendor/Service Provider Expenditure

A-1 Mechanical Contractors, Inc. $1,700.00
A-1 Mechanical Contractors, Inc. 417.00
Total 2,117.00

1993 Capital Expenditures

Vendor/Service Provider Expenditure

William Smith Construction Company $5,000.00
Billows Electric Supply Company 40.07
William Smith Construction Company 510.00
Borough of Longport 87.00
Total 5,637.07

1994 Capital Expenditures

Vendor/Service Provider Expenditure

Glick’s Painting & Handyman $5,627.00
Soltz Paint, Inc. 429.07
Total 6,056.07