SKALKA v. COMMISSIONER

T.C. Summary Opinion 2003-107

UNITED STATES TAX COURT

PHILIP AND MARGERY SKALKA, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2952-00S. Filed July 29, 2003.

Philip and Margery Skalka, pro sese.

Patricia A. Riegger, for respondent.

GOLDBERG, Special Trial Judge: This case was heard pursuant

to the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed. The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority. Unless otherwise indicated,

subsequent section references are to the Internal Revenue Code in

effect for the year at issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.
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Respondent determined a deficiency of $4,860 in petitioners’

Federal income tax for the taxable year 1997. The cover page of

the notice of deficiency shows a deficiency of $14,341 for the

year at issue. The $9,481 discrepancy relates to tax previously

assessed because of computational errors on petitioners’ 1997

Federal tax return. See sec. 6213(b)(1). When issuing the

notice of deficiency, respondent inadvertently included the tax

previously assessed because of the computational errors in the

amount of the deficiency. Accordingly, the amount in dispute

determined in the notice of deficiency is $4,860.1

In the notice of deficiency, respondent also determined that

petitioners failed to report $6,043 of alternative minimum tax

(AMT).

Some of the facts in this case have been stipulated and are

so found. The stipulation of facts and the attached exhibits are

incorporated herein by this reference. At the time the petition

was filed, petitioners lived in Woodbury, New York.

In the stipulation of facts, respondent concedes that

petitioners are entitled to (1) an additional deduction of $300

for State and local income taxes above the amount originally

claimed on Schedule A, Itemized Deductions, and (2) a $7 foreign

1
The inconsequential error on the cover page of the notice
of deficiency does not affect the validity of the notice. See
Stussy v. Commissioner, T.C. Memo. 2002-257.
 - 3 -

tax credit. Petitioners concede in the stipulation that they are

not entitled to a miscellaneous itemized deduction of $89.10

claimed on Schedule A. However, the $89.10 miscellaneous

itemized deduction was one of the computational errors that

resulted in the $9,481 of tax previously assessed pursuant to

section 6213(b)(1). The parties further stipulated that

petitioners made a total of $70,308.20 in Federal tax payments

for the year at issue.2

At trial, the parties orally stipulated that $32,029 of gain

from the sale of business real estate which was not included in

income on petitioners’ tax return is includable in income as a

capital gain. The testimony of Philip Skalka (petitioner)

corroborated this further stipulation. However, the parties

dispute at which capital gains tax rate the $32,029 capital gain

is to be taxed.

After the trial, respondent filed an answer seeking an

increased deficiency of $8,006, for a total deficiency of

$12,866. See sec. 6214(a). It is well established that the

Court has jurisdiction to review an increased deficiency asserted

by the Commissioner at or before the hearing or rehearing. Sec.

2
Respondent’s recalculation of petitioners’ tax liability
reflects that petitioners made only $69,829 in Federal tax
payments for 1997. In accordance with the holding in this
opinion, respondent shall apply the stipulated tax payment amount
of $70,308.20 when preparing the Rule 155 computation.
 - 4 -

6214(a); Evans Publg., Inc. v. Commissioner, 119 T.C. 242, 247

(2002).

In petitioners’ motion for summary judgment,3 trial

memorandum, and “Addendum to Petitioner’s Trial Testimony of

9/9/2002”, petitioners request an abatement of all interest

associated with the determined deficiency. In their petition,

petitioners did not request an abatement of interest, nor did

they amend their petition to claim such relief. However, when

issues not raised by the pleadings are tried by express or

implied consent of the parties, the issues shall be treated as if

they had been raised in the pleadings. Rule 41(b). Respondent

was on notice before trial that petitioners were requesting

interest abatement. Further, respondent did not object at trial

when petitioners requested such relief. The interest abatement

issue was tried by consent of the parties, and we shall treat

that claim as if it had been made in the pleadings, pursuant to

Rule 41(b)(1).

On the basis of the above, the issues for decision for the

1997 taxable year are: (1) The capital gains tax rate applicable

to petitioners’ capital gains; (2) whether petitioners are liable

for the AMT; and (3) whether petitioners are entitled to interest

abatement.

3
Petitioners’ motion for summary judgment was denied on
July 8, 2002. See infra p. 7.
 - 5 -

On July 6, 1977, petitioners purchased a two-story

residential property (investment property) at 7708 Bay Parkway,

Brooklyn, New York. For approximately 20 years, petitioners

rented the two-family investment property to various tenants. In

addition, the testimony of Philip Skalka (petitioner) maintained

his dental office on the second floor. Petitioner testified that

he depreciated the investment property over a 20-year period.

On October 27, 1997, petitioners sold the investment

property for a gross sale price of $297,500. Petitioners

reported the property sale on Form 4797, Sale of Business

Property. On Form 4797, petitioners reported a cost or other

basis in the property of $85,611.69 and depreciation allowed or

allowable of $59,187.69. Accordingly, petitioners reported an

adjusted basis of $26,242, for a total gain from the sale of

$271,076. Petitioners further reported on Form 4797 that $32,029

of the total gain was from section 1250 property. Petitioners

subtracted the $32,029 of reported section 1250 gain from the

total gain amount to arrive at a capital gain of $239,047.

Petitioners included the $239,047 of capital gain as income on

their 1997 tax return. However, petitioners did not include the

$32,029 of section 1250 gain in income.

Using Schedule D, Capital Gains and Losses, petitioners

determined their 1997 Federal income tax using the maximum

capital gains rates. In the tax computation, petitioners
 - 6 -

reported $27,159 of unrecaptured section 1250 gain, to which they

applied a 25-percent capital gains tax rate. Petitioners did not

include the $32,029 of reported section 1250 gain in the Schedule

D tax computation.

Petitioners did not file a Form 6251, Alternative Minimum

Tax--Individuals, with their 1997 tax return, nor did petitioners

report any amount of AMT on their tax return for the year at

issue.

On October 14, 1998, petitioners submitted a Form 1040X,

Amended U.S. Individual Income Tax Return, for the 1997 tax year.

In their amended return, petitioners (1) increased their itemized

deductions for the additional $300 of State tax paid, and (2)

reduced their deductions for the $89.10 miscellaneous itemized

deduction to which they are not entitled. In addition,

petitioners submitted a self-modified 1997 Form 1040, U.S.

Individual Income Tax Return, that excluded all capital gains

from income and contained a separate 20-percent capital gains tax

computation. In the explanation of changes on the amended

return, petitioners assert that long-term capital gains should

not be included in adjusted gross income and can be taxed at a

maximum rate of only 20 percent.

The Internal Revenue Code (Code) does not explicitly provide

for the filing or acceptance of amended returns. Badaracco v.

Commissioner, 464 U.S. 386, 393 (1984). Although the
 - 7 -

Commissioner has permitted the use of amended income tax returns,

amended returns are creatures of administrative convenience, and,

except as otherwise provided by regulations, the Commissioner is

free to accept or reject them. Terrell v. Commissioner, T.C.

Memo. 1986-507. Here, respondent did not accept petitioners’

amended return.

On May 23, 2002, petitioners filed a motion for summary

judgment with the Court. In the motion, petitioners argued for

interest abatement, relief from AMT, and a maximum capital gains

tax rate of 20 percent. Petitioners stated in the motion that

capital gains should not be included in adjusted gross income and

the capital gains tax should be determined at a 20-percent rate

separate from the regular tax computation. Petitioners’ motion

for summary judgment was denied on July 8, 2002.

At trial, petitioners raised the same capital gains tax

arguments asserted in their amended tax return and motion for

summary judgment. Additionally, petitioners claimed that they

are entitled to interest abatement because of ministerial and

managerial errors committed by employees of the Internal Revenue

Service.

Capital Gains Tax Rates

Petitioners argue that the $32,029 of gain not previously

included in income should be taxed at only 20 percent.

Respondent asserts that the $32,029 is unrecaptured section 1250
 - 8 -

gain subject to a section 1(h) tax rate of 25 percent.

Petitioners assert that long-term capital gains are taxed at

a maximum 20-percent rate; therefore, the entire gain from the

sale of their investment property should be taxed at only 20

percent. While the Taxpayer Relief Act of 1997 (1997 Act), Pub.

L. 105-34, sec. 311, 111 Stat. 831, did reduce the maximum

capital gains rate on net capital gains from 28 percent to 20

percent, petitioners’ assertion fails to take into consideration

all of the relevant changes made by the 1997 Act.

The 1997 Act made several changes to the capital gains tax.

For the 1997 tax year, the capital gains tax rates vary depending

on the type, nature, and amount of the gain. In addition, the

length of time the asset was held before its disposition and the

date of the disposition affect the capital gains tax rates for

1997. Section 1(h), in pertinent part, provides as follows:

SEC. 1(h). Maximum Capital Gains Rate.-–

(1) In general.--If a taxpayer has a net capital gain
for any taxable year, the tax imposed by this section for
such taxable year shall not exceed the sum of--

(A) a tax computed at the rates and in the same
manner as if this subsection had not been enacted on
the greater of--

(i) taxable income reduced by the net capital
gain, or

(ii) the lesser of--

(I) the amount of taxable income taxed
at a rate below 28 percent, or
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(II) taxable income reduced by the
adjusted net capital gain, plus

(B) 25 percent of the excess (if any) of--

(i) the unrecaptured section 1250 gain (or,
if less, the net capital gain), over

(ii) the excess (if any) of--

(I) the sum of the amount on which tax
is determined under subparagraph (A) plus the
net capital gain, over

(II) taxable income, plus

(C) 28 percent of the amount of taxable income in
excess of the sum of--

(i) the adjusted net capital gain, plus

(ii) the sum of the amounts on which tax is
determined under subparagraphs (A) and (B), plus

(D) 10 percent of so much of the taxpayer’s
adjusted net capital gain (or, if less, taxable income)
as does not exceed the excess (if any) of--

(i) the amount of taxable income which would
(without regard to this paragraph) be taxed at a
rate below 28 percent, over

(ii) the taxable income reduced by the
adjusted net capital gain, plus

(E) 20 percent of the taxpayer’s adjusted net
capital gain (or, if less, taxable income) in excess of
the amount on which a tax is determined under
subparagraph (D).

Accordingly, petitioners’ claim that their entire gain from

the sale of the property is taxed at a maximum rate of 20 percent
 - 10 -

is without merit. Petitioners’ claim is made without a clear

understanding of section 1(h) and its interaction with section

1250.

For the 1997 tax year, the maximum capital gains rate is

generally 20 percent on the gain from the disposition of a

capital asset held more than 18 months and sold after July 28,

1997. However, the 20-percent rate does not apply to

unrecaptured section 1250 gain, which is subject to a 25-percent

tax rate. See sec. 1(h)(1)(B).

Pursuant to the pertinent part of section 1231(b), “property

used in the trade or business” means real property used in a

trade or business, held for more than 1 year, and subject to the

allowance for depreciation. Since petitioners’ investment

property meets these criteria, the property is section 1231

property. Pursuant to section 1231(a)(3)(A)(i), the term

“section 1231 gain” means any recognized gain on the sale or

exchange of property used in a trade or business. Likewise, the

term “section 1231 loss” means any recognized loss from a sale or

exchange of property used in a trade or business. Sec.

1231(a)(3)(B). If, as here, the section 1231 gains exceed the

section 1231 losses for the year, the gains and losses shall be

treated as long-term capital gains and long-term capital losses,
 - 11 -

respectively. Sec. 1231(a)(1). Accordingly, the gain

petitioners recognized on the sale of the investment property is

long-term capital gain.

Pursuant to section 1250(c), section 1250 property is any

real property subject to the allowance for depreciation that is

not section 1245 property. The investment property in the hands

of petitioners was real property subject to the allowance for

depreciation. Further, petitioners’ investment property is not

of any kind described in section 1245(a)(3). Therefore,

petitioners’ investment property is also section 1250 property.

Gain realized on the disposition of section 1250 property is

recaptured as ordinary income, rather than capital gains, to the

extent that the depreciation amount allowed or allowable exceeds

the amount of depreciation that would have resulted under the

straight-line method. See sec. 1250(a). Pursuant to section

1250(a)(1)(A), the section 1250 gain shall be recognized as

ordinary income notwithstanding any other provisions of subtitle

A of the Code. Therefore, since petitioners’ section 1231

property is also subject to depreciation recapture under section

1250, the amount of the long-term capital gain would be reduced

by the amount of section 1250 gain recaptured at ordinary income

tax rates.

The 1997 Act amended section 1(h) to include section

1(h)(1)(B), which taxes unrecaptured section 1250 gain at a
 - 12 -

capital gains tax rate of 25 percent. Pursuant to the pertinent

part of section 1(h)(6)(A), the term “unrecaptured section 1250

gain” means the amount of long-term capital gain which would be

treated as ordinary income if section 1250(b)(1) included all

depreciation. Accordingly, under this definition, unrecaptured

section 1250 gain would include all the depreciation allowed or

allowable on the property.

The unrecaptured section 1250 gain definition in the 1997

Act effectively eliminates the possibility of any section 1250

gain’s being recaptured at ordinary income tax rates because all

the depreciation is considered unrecaptured section 1250 gain,

taxed at 25 percent. See sec. 1(h)(1)(B). However, since the

section 1250 gain rules apply notwithstanding any other

provisions of subtitle A of the Code and section 1(h) is included

in subtitle A, the section 1(h)(6)(A) definition of unrecaptured

section 1250 gain cannot override the section 1250(a) ordinary

income treatment of section 1250 gain recapture.

Recognizing that this conflict existed, Congress included

technical corrections in the Internal Revenue Service

Restructuring and Reform Act of 1998 (1998 Act), Pub. L. 105-206,

sec. 6005(d), 112 Stat. 800, which revised and clarified the

definition of unrecaptured section 1250 gain under the 1997 Act.

Under the 1998 Act, the definition of unrecaptured section

1250 gain was amended to include long-term capital gain that is
 - 13 -

not otherwise treated as ordinary income. Pursuant to section

6024 of the 1998 Act, 112 Stat. 826, the amendment to the

definition took effect as if included in the 1997 Act.

Therefore, for the 1997 tax year, if long-term capital gain is

subject to section 1250, the section 1250 gain is recaptured at

ordinary income tax rates, and the remaining depreciation claimed

is unrecaptured section 1250 gain taxed at the 25-percent rate.

Here, the parties have stipulated that none of the long-term

capital gain attributable to depreciation claimed on the

investment property is section 1250 gain recaptured at ordinary

income tax rates. Petitioners reduced their basis in the

property by $59,1884 of depreciation claimed over a 20-year

period. On Schedule D, petitioners reported only $27,159 of the

total depreciation claimed as unrecaptured section 1250 gain.

Therefore, the remaining $32,029 of depreciation claimed is

subject to the section 1250 gain rules and the unrecaptured

section 1250 gain rules. However, since the parties have

stipulated that none of the $59,188 of depreciation is to be

recaptured as ordinary income under section 1250, the entire

$59,188 is considered unrecaptured section 1250 gain.

4
This amount is rounded to the nearest dollar.
 - 14 -

Accordingly, the $32,029 of gain at issue is unrecaptured section

1250 gain subject to the capital gains tax rate of 25 percent.

See sec. 1(h)(1)(B).

Capital Gains Included in Adjusted Gross Income

Citing the 1997 Act, petitioners argue that by law the

maximum long-term capital gains tax rate is 20 percent.

Petitioners claim that including capital gains in their adjusted

gross income results in a loss of deductions pursuant to sections

68(a) and 151(d)(3). Petitioners further argue that this loss of

deductions (1) increases the effective tax rate on their capital

gains above 20 percent, and (2) affects the AMT. Petitioners

conclude that since their capital gains tax rate is effectively

increased above 20 percent, respondent has not correctly

determined their tax within the law.

Contrary to petitioners’ interpretation, gain from the sale

of investment property is includable in a taxpayer’s adjusted

gross income (AGI) and subject to the tax imposed under section

1. Pursuant to section 61(a)(3), “gross income” includes gains

derived from dealings in property. The term “adjusted gross

income” means gross income minus various deductions. See sec.

62(a). For a taxpayer who itemizes deductions, “taxable income”

means gross income minus allowed deductions. Sec. 63(a). In

addition, the section 68 limitation on itemized deductions and

the section 151(d)(3) phaseout of the exemption amount are
 - 15 -

determined on the basis of AGI. Accordingly, the gain

petitioners derived from the sale of their investment property is

includable in petitioners’ gross income, AGI, and taxable income.

Further, the gain is included when determining various

limitations and phaseouts based on AGI.

Petitioners do not contest that the gain from the sale of

the investment property is long-term capital gain; petitioners

argue only that long-term capital gains should be excluded from

gross income. However, pursuant to section 1222(3), the term

“long-term capital gain” means gain from the sale of a capital

asset held for more than 1 year if, and to the extent, such gain

is taken into account in computing gross income. Further,

section 1231 gains are treated as long-term capital gains only

if, and to the extent, the gains are taken into account in

computing gross income. Sec. 1231(a)(4)(A)(i). The Code

requires petitioners’ long-term capital gains to be included in

their gross income. Accordingly, petitioners’ claim that long-

term capital gains should not be included in income is contrary

to the Code and completely without merit.

Alternative Minimum Tax

The AMT provisions of the Code, sections 55-59, were enacted

to establish a floor for tax liability so that a taxpayer will

pay some tax regardless of the exclusions, deductions, and

credits otherwise available to him under the regular income tax
 - 16 -

statutes. See S. Rept. 99-313, at 518 (1986), 1986-3 C.B. (Vol.

3) 1, 518. The AMT provisions accomplish this goal by

eliminating favorable treatment given to certain items for

purposes of the regular income tax. See secs. 55(b)(2), 56, 57,

and 58.

Pursuant to section 55(a), the AMT is applicable only if,

and to the extent that, the “tentative minimum tax” exceeds the

taxpayer’s “regular tax”.5 The starting point in computing the

AMT liability is determining the alternative minimum taxable

income (AMTI), which equals the taxpayer’s taxable income for the

year with the adjustments provided in sections 56 and 58, and

increased by the amount of tax preference items set forth in

section 57. To determine the taxable amount of AMTI, the AMTI is

reduced by an exemption amount, which for taxpayers filing a

joint return is $45,000, subject to a gradual phaseout of the

exemption amount as AMTI exceeds $150,000. See sec. 55(d)(1),

(3). The applicable AMT rates are then applied to the AMTI, as

reduced by the exemption amount, to determine the tentative

minimum tax (TMT). See sec. 55(b). For taxpayers reporting

capital gains on Form 1040, the TMT is the lesser of (1) the

amount of AMT determined without regard for section 55(b)(3), or

5
For petitioners, “the term ‘regular tax’ means the
regular tax liability for the taxable year (as defined in sec.
26(b)).” Sec. 55(c)(1).
 - 17 -

(2) the amount of AMT determined applying the maximum rate of tax

on net capital gains, pursuant to section 55(b)(3). The

taxpayer’s regular income tax amount is then compared to the TMT.

If the TMT is greater than the regular income tax, the difference

is added to the regular tax amount to determine the final tax

liability for the taxable year. See sec. 55(a).

Petitioners argue that since their capital gains should not

be included in income, the capital gains should not be included

when determining AMTI. As stated above, petitioners’ capital

gains are included in their taxable income. Since the AMTI is

determined by making adjustments to taxable income, petitioners

cannot exclude their capital gains for AMT purposes.

Petitioners’ argument is without merit and contrary to the AMT

provisions.

We find no fault with respondent’s application of the AMT

provisions or the method by which respondent computed

petitioners’ AMT liability. However, the computations for

taxable income and AMT submitted with respondent’s answer are

computed without regard for the $300 of additional State income

tax allowed as an itemized deduction. Because this adjustment

affects taxable income and the AMT, the $300 additional itemized

deduction must be included in respondent’s Rule 155 computation.

Petitioners further argue that the AMT was created to apply

only to high-income taxpayers who pay little or no tax because of
 - 18 -

their ability to use tax preferences, and, accordingly, the AMT

is not applicable in this instance because petitioners paid over

$70,000 in Federal income tax for the year at issue. This

argument is also without merit. If a taxpayer is subject to the

regular tax, the taxpayer is also subject to the AMT. Sec.

55(b)(2). However harsh and unfair the AMT may seem to

petitioners, Congress enacted the law, and we have no authority

to disregard the AMT Code provisions. See Holly v. Commissioner,

T.C. Memo. 1998-55.

Interest Abatement

The Tax Court is a court of limited jurisdiction, and we may

exercise our jurisdiction only to the extent authorized by

Congress. Naftel v. Commissioner, 85 T.C. 527, 529 (1985).

Whether this Court has jurisdiction is fundamental and may be

raised by a party or on the Court’s own motion. Fernandez v.

Commissioner, 114 T.C. 324, 328 (2000); Naftel v. Commissioner,

supra at 530.

Consistent with section 6404(g)(1), the Court’s jurisdiction

depends on a valid final determination letter and a timely filed

petition for review. See Rule 280(b); Gati v. Commissioner, 113

T.C. 132, 134 (1999); White v. Commissioner, 109 T.C. 96, 98

(1997). The Commissioner’s final determination letter “is a
 - 19 -

prerequisite to the Court’s jurisdiction and serves as a

taxpayer’s ‘ticket’ to the Tax Court.” Bourekis v. Commissioner,

110 T.C. 20, 26 (1998).

There is nothing in the record to indicate that respondent

intended for the notice of deficiency issued to petitioners to be

considered a final determination letter under section 6404(g).

See id.; Ho v. Commissioner, T.C. Memo. 1998-363. Further, the

parties stipulated that petitioners did not receive a written

notice of determination from respondent denying a request for

interest abatement.

Petitioners assert that their interest abatement claim is

properly before the Court because (1) interest was included in

the notice of deficiency and a proposed stipulation-decision

document, and (2) an Appeals officer verbally denied their

interest abatement claim. However, because of the absence of a

final determination letter denying a request for abatement of

interest, the Court lacks jurisdiction under section 6404(g) to

decide this issue.

Reviewed and adopted as the report of the Small Tax Case

Division.

Decision will be entered

under Rule 155.