T.C. Summary Opinion 2002-62
UNITED STATES TAX COURT
ROBERT LEE AND REBECCA WATERS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11643-00S. Filed May 30, 2002.
Robert Lee Waters, pro se.
Alexandra E. Nicholaides, for respondent.
ARMEN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in
effect at the time that the petition was filed.1 The decision to
be entered in this case is not reviewable by any other court, and
this opinion should not be cited as authority.
1
All subsequent section references are to the Internal
Revenue Code in effect for 1997, the taxable year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
- 2 -
Respondent determined a deficiency in petitioners’ Federal
income tax, an accuracy-related penalty, and an addition to tax
for 1997 as follows:
Penalty Addition to tax
Year Deficiency Sec. 6662 Sec. 6651(a)(1)
1997 $7,889 $1,577.80 $441
After concessions by petitioners,2 the issues for decision
are as follows:
(1) Whether for 1997, the taxable year in issue, petitioners
are entitled to a deduction under section 165(c)(2) for a loss
attributable to (a) the unauthorized removal of furnishings and
fixtures from an apartment building in 1996 and (b) the
foreclosure on such building in 1996. We hold that they are not.
(2) Whether petitioners are liable for the accuracy-related
penalty under section 6662(a) for negligence or intentional
disregard of rules or regulations. We hold that they are to the
extent provided herein.
2
In the petition, petitioners disputed the entire
deficiency determined by respondent in the notice of deficiency.
However, petitioners did not assign any error or allege any facts
with respect to respondent’s determinations regarding: (1) The
receipt of unreported nonemployee compensation in the amount of
$3,525; (2) the imposition of self-employment tax on such
nonemployee compensation; and (3) the disallowance of itemized
deductions for charitable contributions and unreimbursed employee
expenses. Moreover, at trial, petitioners did not dispute any of
these adjustments. Accordingly, we regard petitioners as having
conceded these matters.
- 3 -
(3) Whether petitioners are liable for an addition to tax
under section 6651(a)(1) for failure to timely file an income tax
return. We hold that they are.
Background
Some of the facts have been stipulated, and they are so
found. Petitioners resided in Southfield, Michigan, at the time
that their petition was filed with the Court.
A. Petitioners
During 1997, the taxable year in issue, petitioner Robert
Lee Waters (petitioner) was employed full-time as a teacher by
the Board of Education of Detroit, Michigan. During that same
year, petitioner Rebecca Waters was a housewife.
B. Acquisition of the Hazelwood Property
In June 1986, a group of six individuals (the land contract
vendees) purchased a parcel of improved real estate in Detroit,
Michigan (the Hazelwood property), under a land contract. The
land contract vendees included petitioners, petitioner’s father,
Marland and Dortha Moore, and Marland Moore’s mother. The
Hazelwood property consisted of a 38-unit, 4-story apartment
building with an elevator. The memorandum of land contract that
was recorded with the Register of Deeds for Wayne County,
Michigan, did not disclose the purchase price of the Hazelwood
property.
- 4 -
In March 1987, the land contract vendees received a warranty
deed to the Hazelwood property. The warranty deed recites that
the Hazelwood property was conveyed for the “full consideration”
of $55,000.
In October 1988, Marland and Dortha Moore and Marland
Moore’s mother conveyed their interest in the Hazelwood property
to petitioners and petitioner’s father. According to the quit
claim deed, the conveyance was for the “full consideration” of
$50,000.
C. Mortgage on the Hazelwood Property
In February 1990, a loan in the amount of $70,000 was
obtained from First Independence National Bank of Detroit (First
Independence). As security for the loan, petitioners and
petitioner’s father gave First Independence a mortgage on the
Hazelwood property.
D. Rental of the Hazelwood Property
In or about May 1994, petitioner3 purportedly entered into a
lease with a nonprofit housing corporation, operated by Reverend
Jim Holley, which converted the Hazelwood property into a
homeless shelter. This arrangement allegedly ended in February
or March 1996, at which time petitioner took back possession of
3
For the sake of convenience, we may sometimes refer to
petitioner as the owner of the Hazelwood property even though
petitioners and petitioner’s father were the record owners of the
property.
- 5 -
the building only to discover that “Everything had been trashed.”
In this regard, petitioner testified at trial as follows:
And see, in these apartments I had 38 stoves, 38
refrigerators, and like that. All this was gone. When
I came back there was no stoves, no refrigerators, no
faucets, no shower heads, no knobs on the door. I mean
everything. No light fixtures in the hall and
whatever, and this is what I came back to and I had to
try to refurbish.
Petitioner did not maintain insurance on the Hazelwood
property, and at trial he made no mention of ever having filed
any police report. Regardless, petitioner never pursued any
recovery against either the nonprofit housing corporation or its
operator because they were insolvent.
E. Foreclosure and Mortgage Sale of the Hazelwood Property
As early as 1991, petitioner began having difficulty in
making payments to First Independence. Indeed, in June 1991,
First Independence filed a lis pendens with the Register of Deeds
for Wayne County, Michigan.
Petitioner continued having difficulty in making payments to
First Independence. In particular, petitioner did not make all
payments in 1995, and he did not make any payment in 1996.
Foreclosure proceedings against the Hazelwood property were
commenced by First Independence in 1996. The proceedings
culminated on June 27, 1996, with a mortgage foreclosure sale.4
4
The outstanding balance at that time was $70,686,
consisting of principal of $58,148, interest of $11,214, and an
(continued...)
- 6 -
At that time, First Independence, as highest bidder with an offer
of $50,000 at public auction, received a sheriff’s deed dated
June 27, 1996 (the sheriff’s deed).
The sheriff’s deed gave notice, in part, that “During the
six months immediately following the sale, the property may be
redeemed”.
Neither petitioner nor petitioner Rebecca Waters nor
petitioner’s father redeemed the Hazelwood property.
In March 1997, First Independence conveyed the Hazelwood
property by warranty deed to an unrelated third-party.
F. Petitioners’ Income Tax Return
On May 27, 1998, respondent received petitioners’ U.S.
Individual Income Tax Return, Form 1040, for 1997. The return
was signed by petitioners and dated April 28, 1998. Petitioners
did not apply for, or receive, any extension of time to file.
On their return, petitioners reported adjusted gross income
of $64,806.99 and taxable income of zero. Petitioners reported
no tax liability and claimed a refund in the amount of the tax
that had been withheld from petitioner’s wages as a teacher.
Petitioners itemized their deductions for 1997. In this
regard, petitioners attached Schedule A, Itemized Deductions, to
their return and claimed total itemized deductions of $311,514.
4
(...continued)
escrow deficiency of $1,324.
- 7 -
Of this amount, $295,000 was claimed for a casualty or theft loss
in respect of the Hazelwood property.
In support of their claimed casualty or theft loss,
petitioners attached Form 4684, Casualties and Thefts, to their
return. In Section B, Business and Income-Producing Property,
petitioners computed their claimed loss as follows:
Cost or adjusted basis $300,000
Less: insurance or other reimbursement -0-
Fair market value before casualty/theft 360,000
Fair market value after casualty/theft 65,000
Diminution in fair market value 295,000
Lesser of: cost or adjusted basis or
Diminution in fair market value 295,000
Casualty or theft loss 295,000
Discussion
A. Loss Deduction5
1. The Parties’ Contentions
Petitioners contend they are entitled to a casualty or theft
loss based on theft of the furnishings and fixtures of the
Hazelwood property and the subsequent foreclosure on the property
itself. Petitioners further contend that they are entitled to
deduct the loss in 1997 because that was the year in which they
surrendered possession of the Hazelwood property. In this
regard, petitioners allege that after the foreclosure sale on
5
We decide this issue without regard to the burden of
proof. Accordingly, we need not decide whether the general rule
of sec. 7491(a)(1) is applicable to this issue. See Higbee v.
Commissioner, 116 T.C. 438 (2001).
- 8 -
June 27, 1996, they remained in possession of the Hazelwood
property until mid-January 1997, when, for the first time since
the foreclosure sale, they were contacted by First Independence
and told that the bank would immediately take possession of the
property.
Respondent acknowledges that a theft loss may be deductible,
as may be a loss attributable to the foreclosure of property.
However, respondent contends that any loss to which petitioners
may be entitled is deductible in 1996, the year in which any
theft was allegedly discovered and the year in which petitioners’
equity of redemption was extinguished.
2. Deductibility of Losses, in General
As a general rule, section 165(a) allows as a deduction any
loss sustained during the taxable year and not compensated for by
insurance or otherwise. However, in the case of an individual,
section 165(c) limits the deduction to: (1) Losses incurred in a
trade or business; (2) losses incurred in any transaction entered
into for profit; and (3) losses of property not connected with a
trade or business or with a transaction entered into for profit,
if such losses arise from fire, storm, shipwreck, or other
casualty, or from theft.
A loss is “treated as sustained during the taxable year in
which the loss occurs as evidenced by closed and completed
transactions and as fixed by identifiable events occurring in
- 9 -
such taxable year.” Sec. 1.165-1(d)(1), Income Tax Regs; see
also sec. 1.165-1(b), Income Tax Regs. However, if there exists
a claim for reimbursement with respect to which there is a
reasonable prospect of recovery, no portion of a loss with
respect to which reimbursement may be received is “sustained”
until 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.
3. Casualty and Theft Losses
Under section 165(a), a loss arising from theft is sustained
during the taxable year in which the taxpayer discovers the loss.
See sec. 165(e); sec. 1.165-1(d)(3), Income Tax Regs; sec. 1.165-
8(a)(2), Income Tax Regs. The term theft includes, but is not
limited to, larceny, embezzlement, and robbery. See sec. 1.165-
8(d), Income Tax Regs. Whether a theft exists “depends upon the
law of the jurisdiction wherein the particular loss occurred.”
Manteleone v. Commissioner, 34 T.C. 688, 692 (1960).
Petitioner urges us to find that the theft6 of the
furnishings and fixtures of the Hazelwood property occurred in
1997. At trial, however, petitioner candidly admitted that he
discovered the loss of such furnishings and fixtures early in
1996 when he regained possession of the building from his tenant.
6
In order to expedite our discussion, we shall accept that
any unauthorized removal of furnishings and fixtures from the
Hazelwood property constituted a theft under Michigan law.
- 10 -
Petitioner’s testimony at trial graphically illustrates this
admission:
Q: Okay. But the damage occurred prior to ‘97.
Correct?
A: Yes.
Q: And the foreclosure occurred in ‘96.
A: It started –- yes.
Q: Okay. So there was no event –- no damage or
vandalization in ‘97 that gave rise to the loss?
A: No. The rise to the loss happened in ‘96, not
‘97.
It is clear, therefore, that any casualty or theft loss that
petitioner may have sustained from an unauthorized removal of
furnishings and fixtures from the Hazelwood property was not
sustained in 1997 but in an earlier year(s). See sec. 165(e);
sec. 1.165-1(d)(3), Income Tax Regs; sec. 1.165-8(a)(2), Income
Tax Regs. Thus, not only did petitioner discover the loss, at
the latest, in February or March 1996, but no reasonable prospect
of reimbursement existed at that time that would have served to
defer recognition of the loss to 1997.
Equally unpersuasive is petitioners’ related contention that
the foreclosure of the Hazelwood property was tantamount to a
casualty loss. Rather, the disposition of mortgaged property
at a foreclosure sale is treated as a sale or exchange from which
the mortgagor may realize gain or loss under section 1001. See
- 11 -
Helvering v. Hammel, 311 U.S. 504 (1941). We therefore turn to
that matter.
4. Foreclosure Loss
Petitioner contends that the foreclosure loss occurred in
1997 because “That’s when the bank came and said: 'This is my
building now'.” Respondent contends that the loss occurred in
1996, the year in which the period of redemption expired and the
sheriff’s deed became final.
In Michigan, the period of redemption from a foreclosure
sale depends on a number of factors, including the type and size
of the property, the date of the mortgage, and the amount of the
debt owed. As applicable herein, a 6-month period of redemption
applies for mortgages executed on or after January 1, 1965, on
multifamily residential property in excess of four units and not
more than 3 acres in size if more than two-thirds of the mortgage
debt remains outstanding. Mich. Comp. Laws Ann. sec.
600.3240(7), (8) (West 2000).
Because the right to redeem is statutory, the redemption
period may not be extended by a court, absent unusual
circumstances such as fraud. Flynn v. Korneffel, 451 Mich. 186,
207 (1996); see Cameron v. Adams, 31 Mich. 426, 428 (1875)
(refusing to extend the redemption period despite the fact that
the mortgagor had paid part of the redemption amount and a
serious illness had prevented him from conducting his personal
- 12 -
business during the redemption period).
When the redemption period expires, both legal title and the
right to possession vest in the purchaser. Mich. Comp. Laws Ann.
sec. 600.3236 (West 2000); Bankers Trust Co. v. Rose, 322 Mich.
256, 259 (1948); Shelby Co. v. Dickinson, 259 Mich. 197, 198
(1932). Possession of the property by the mortgagor after the
redemption period expires is unlawful, and no notice to quit is
necessary. Shelby Co. v. Dickinson, supra.
In view of the foregoing, it is clear that upon the
expiration of the 6-month redemption period on December 27, 1996,
petitioner no longer had any ownership right or possessory
interest in the Hazelwood property. Equally clear is the fact
that any delay by First Independence to take actual possession of
the property is without legal consequence. Thus, by virtue of
Michigan law, any loss that petitioner may have sustained from
the foreclosure on the Hazelwood property was sustained in 1996,
the year in which petitioner’s equity of redemption was
extinguished. See sec. 1.165-1(d)(1), Income Tax Regs; see also
sec. 1.165-1(b), Income Tax Regs.
5. Conclusion
Because no loss was sustained in 1997, the only taxable year
before the Court, we hold that the deduction in issue is not
allowable for that year.
- 13 -
B. Accuracy-related Penalty
Next, we consider whether petitioners are liable for the
accuracy-related penalty under section 6662(a).
Section 6662(a) and (b)(1) provides that if any portion of
an underpayment of tax is attributable to negligence or disregard
of rules or regulations, then there shall be added to the tax an
amount equal to 20 percent of the amount of the underpayment that
is so attributable. The term “negligence” includes any failure
to make a reasonable attempt to comply with the provisions of the
internal revenue laws, and the term “disregard” includes any
careless, reckless, or intentional disregard. Sec. 6662(c); see
sec. 1.6662-3(b)(2), Income Tax Regs. However, no penalty shall
be imposed with respect to any portion of an underpayment if it
is shown that there was a reasonable cause for such portion and
that the taxpayer acted in good faith with respect to such
portion. Sec. 6664(c).
Applicable to court proceedings arising in connection with
examinations commencing after July 22, 1998, section 7491(c)
places on the Commissioner the burden of production with respect
to a taxpayer’s liability for any penalty or addition to tax.
See Internal Revenue Service Restructuring and Reform Act of
1998, Pub. L. 105-206, sec. 3001(a), (c)(1), 112 Stat. 685, 726,
727. However, the taxpayer still bears the burden of proving
that the negligence penalty is inapplicable. Rule 142(a);
- 14 -
INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Welch v.
Helvering, 290 U.S. 111, 115 (1933); Higbee v. Commissioner, 116
T.C. 438, 446-447 (2001).
As we see it, the principal issue in this case involves an
issue of timing; i.e., the year in which a loss may properly be
deducted. We have decided that issue in respondent’s favor.
However, we can appreciate how petitioner might have concluded
that the foreclosure of the Hazelwood property was not complete
until January 1997, since that is when he apparently surrendered
possession of the property. Similarly, although petitioner may
have discovered the unauthorized removal of furnishings and
fixtures in 1996, we can appreciate how he might have concluded
that such removal was inextricably connected with the ultimate
fate of the Hazelwood property, which, at the time, was either in
or on the verge of foreclosure proceedings.
In view of the foregoing, we do not sustain respondent’s
determination of the penalty under section 6662(a) to the extent
that the underpayment of tax in this case is attributable to the
loss deduction under section 165(c)(2).
In contrast, we sustain respondent’s determination of the
penalty under section 6662(a) to the extent that the underpayment
of tax in this case is attributable to the adjustments conceded
by petitioners. See supra note 2. In this regard, we observe
that a taxpayer’s failure to keep adequate books and records or
- 15 -
to properly substantiate items constitutes negligence. Sec.
1.6662-3(b)(1), Income Tax Regs. In addition, negligence is
strongly indicated where a taxpayer fails to include on an income
tax return an amount of income shown on an information return.
Sec. 1.6662-3(b)(1)(i), Income Tax Regs.
C. Addition To Tax Under Section 6651(a)(1)
Finally, we consider whether petitioners are liable for an
addition to tax under section 6651(a)(1).
Section 6651(a)(1) imposes an addition to tax for failure to
timely file an income tax return. The addition to tax may be
avoided if the failure to timely file is due to reasonable cause
and not willful neglect. “Reasonable cause” contemplates that
the taxpayer exercised ordinary business care and prudence and
was nonetheless unable to file a return within the prescribed
time. United States v. Boyle, 469 U.S. 241, 246 (1985); sec.
301.6651-1(c)(1), Proced. & Admin. Regs. “Willful neglect” means
a conscious, intentional failure or reckless indifference.
United States v. Boyle, supra at 245.
Section 7491(c) places on the Commissioner the burden of
production with respect to a taxpayer’s liability for any penalty
or addition to tax. However, as previously mentioned, the
taxpayer still has the burden of proving that the Commissioner's
determination of the addition to tax is erroneous. Rule 142(a);
INDOPCO, Inc. v. Commissioner, supra; Welch v. Helvering, supra;
- 16 -
Higbee v. Commissioner, supra; BJR Corp. v. Commissioner, 67 T.C.
111, 131 (1976); Bebb v. Commissioner, 36 T.C. 170 (1961).
Absent an extension of time to file, petitioners’ 1997
income tax return was required to be filed by Wednesday, April
15, 1998. See sec. 6072(a). However, petitioners did not apply
for, or receive, any extension of time to file, and their tax
return (bearing their signatures and the date of April 28, 1998)
was not received by respondent until May 27, 1998. Such evidence
satisfies respondent’s burden of production under section
7491(c).
At trial, petitioners did not introduce any evidence
regarding reasonable cause or lack of willful neglect. Indeed,
apart from arguing that there is no deficiency in income tax,
petitioners have not argued that they should be excused from
liability for the addition to tax. Finally, there is nothing in
the record to suggest that petitioners’ failure to timely file
was due to reasonable cause and not willful neglect.
Accordingly, we sustain respondent’s determination on this is
sue.
D. Conclusion
Reviewed and adopted as the report of the Small Tax Case
Division.
- 17 -
To give effect to our disposition of the disputed issues, as
well as petitioners’ concessions, see supra note 2,
Decision will be entered
under Rule 155.