T.C. Memo. 2005-236
UNITED STATES TAX COURT
NHUSS TRUST, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 9938-04, 9939-04, Filed October 11, 2005.
10070-04, 10071-04.
Anthony V. Diosdi, for petitioners.
John W. Strate and Thomas D. Greenaway, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined deficiencies and
penalties in petitioners’ Federal income tax as follows:
1
Cases of the following petitioners are consolidated
herewith: In God and Trust, a.k.a. In God We Trust, docket No.
9939-04; RJ Pendergraft Trust, Joyce Pendergraft, Trustee, docket
No. 10070-04; Riley and Joyce Pendergraft, docket No. 10071-04.
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NHUSS Trust:
Year Deficiency Penalty
1999 $358,038 $71,608
2000 329,456 65,891
In God and Trust, a.k.a. In God We Trust (In God We Trust):
Year Deficiency Penalty
1999 $58,072 $11,614
2000 66,074 13,215
RJ Pendergraft Trust, Joyce Pendergraft, Trustee:
Year Deficiency Penalty
1999 $ 95,958 $19,192
2000 438,772 87,754
Riley and Joyce Pendergraft:
Year Deficiency Penalty
1999 $416,081 $83,216
2000 445,987 89,197
Unless otherwise indicated, 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. All references to petitioners are to petitioners
Riley and Joyce Pendergraft, and all references to petitioner in
the singular are to Riley Pendergraft.
After concessions by all parties (particularly a concession
collapsing the income and expenses of the above three trusts for
each year into petitioners’ income and expenses) and settlements
entered into by all parties (particularly settlements relating to
various business and personal deductions), the only remaining
issues for decision are: (1) The amount of petitioners’ gain on
the sale of their residence; (2) the fair market value of a van
on the date the van was donated to charity; and (3) petitioners’
liability for the negligence penalty under section 6662(a) in the
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total amounts of $83,216 and $89,197 for 1999 and 2000,
respectively, with respect to the tax adjustments relating to the
three trusts, the gain on the sale of petitioners’ residence, and
the donation of the van.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
At the time the petition was filed, petitioners resided in
Gilroy, California.
Petitioners’ Residence
In 1972, petitioners purchased for $45,000 a residence
located in San Jose, California. In 2000, petitioners sold the
residence for $790,000.
Set forth in the schedule below is a list of various
categories of improvements that petitioners claim they made on
their residence prior to its sale in 2000, the total improvement
costs petitioners claim they incurred in each category, and the
improvement costs relating to each category that respondent has
allowed.
Costs
Petitioners Respondent
Category of Improvement Claim Has Allowed
Residence $ 28,000 $28,000
Swimming pool 38,515 6,245
Second story addition 60,000 16,665
Interior remodeling 114,500 1,022
Exterior 43,191 3,527
Alarm 1,864 825
Total $286,070 $56,284
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The above improvement costs claimed by petitioners are
reflected either in various building permits obtained by
petitioners (Appendix A), in other contemporaneous records
maintained by petitioners (Appendix B), or in petitioners’
testimony at trial (Appendix C).2 The $56,284 in improvement
costs that respondent has allowed are based on the costs that are
reflected in the building permits (Appendix A) and on some but
not all of the costs reflected in the contemporaneous records
(Appendix B). Also, a few additional costs that respondent has
allowed are reflected in Appendix D. Respondent has disallowed
all of the costs reflected in Appendix C.
Further, in connection with the sale of their residence,
petitioners incurred closing costs of $61,864.
In summary, petitioners and respondent calculate
petitioners’ cost basis in the residence as follows:
Calculation of
Cost Basis in Residence
Petitioners Respondent
Purchase price $ 45,000 $ 45,000
Improvements 286,070 56,284
Closing costs 61,864 61,864
Total $392,934 $162,968
2
For purposes of the above schedule, where the various
sources of evidence in the case reflect different amounts for the
same improvement, the schedule reflects the higher amounts.
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Donation of Van
In October of 1996, petitioners purchased a 1996 Ford E150
conversion van. On October 30, 2000, petitioners donated the van
to the Cancer Fund. At the time of the donation, the van had
been used in petitioners’ furniture business and had
approximately 220,000 miles on it,3 and the van had, among other
things, a cracked windshield and a broken fender.
At the time of the donation, the Kelley Bluebook indicated
generally a wholesale value of $14,750 and a retail value of
$20,425 for a van of the same year, make, and model.
On November 10, 2000, Mr. Monte Sobrero appraised the van at
$19,750.
The record does not reflect who hired Mr. Sobrero, how much
Mr. Sobrero was paid, or who paid Mr. Sobrero for his appraisal.
The record is also unclear as to whether the van was still in
petitioners’ possession at the time of its appraisal by
Mr. Sobrero.
Mr. Sobrero’s stated appraisal qualifications include 40
years as a craftsman in metal finishing and paint restoration, 30
years as a licensed automotive dealer in California, 15 years as
owner-operator of an automotive shop, 10 years as owner-manager
3
Petitioner testified that the van was driven between
55,000 and 60,000 miles a year in petitioners’ furniture
business. On their 2000 joint Federal income tax return,
petitioners indicated that in 2000 petitioners drove the van
72,000 miles.
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of an automotive leasing and rental business, and certification
in the International Automotive Appraisers Association.
Mr. Sobrero’s appraisal of petitioners’ van consisted of a
visual inspection. Mr. Sobrero, however, did not take into
account in his appraisal the mileage of the van.
On December 16, 2000, 6 weeks after receiving the donated
van from petitioners, the van was sold at auction by the Vehicle
Donation Processing Center, Inc., for $6,900.
Negligence Penalty and Petitioners’ Three Trusts
During 1999 and 2000, petitioners were engaged in the
wholesale furniture business in Nevada and northern California.
For more than a decade before 1997, petitioners operated their
furniture business as a corporation called NHUSS, Inc. In 1997,
petitioners dissolved NHUSS, Inc., and began operating their
furniture business through a trust called the NHUSS Trust.
In a brochure distributed by National Trust Service (NTS),
founded and promoted by one Roy Fritz, NTS claimed that taxpayers
could “with [their] custom designed NTS Trust Document * * *
regain [their] inalienable rights and freedoms” by attending an
NTS workshop where they would learn to create their own trusts
that purportedly would protect taxpayers’ assets while lowering
or eliminating their tax liabilities. Petitioners paid
approximately $10,500 to attend the NTS workshop. Mr. Fritz
claimed to be a lawyer and “world authority on complex trusts.”
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Petitioner did not seek a second opinion regarding the
legitimacy of NTS or its trust services. Petitioner did not
investigate Mr. Fritz’s background or attempt to confirm
Mr. Fritz’s qualifications. Petitioner did not consult his
personal accountant about NTS’s proposal that he establish trusts
as a means to protect assets and reduce tax liabilities.
Petitioners did not research NTS.
Instead, in addition to Mr. Fritz, petitioners relied on
information provided to them by representatives of NTS and by
other purported clients of NTS. Other than NTS’s promotional
materials, petitioners did not receive any written advice, such
as a written opinion from an attorney, regarding the promotional
materials received from NTS.
On August 21, 1997, pursuant to information received by
petitioners at the NTS seminar, petitioners formed RJ Pendergraft
Trust using a trust indenture notarized by an NTS employee.
Petitioner was the grantor, and petitioners were named trustees
of RJ Pendergraft Trust.
On August 22, 1997, two additional trusts, NHUSS Trust and
In God We Trust, were formed using declarations of trust
notarized by an NTS employee, which declarations were prepared by
NTS. NHUSS, Inc., was grantor, and petitioners were named
trustees of NHUSS Trust. NHUSS Trust was grantor, and
petitioners were named trustees of In God We Trust.
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Upon the formation of NHUSS Trust, NHUSS, Inc., purportedly
contributed all of its assets relating to petitioners’ furniture
business to NHUSS Trust. It is unclear what, if any, assets were
purportedly contributed to RJ Pendergraft Trust and to In God We
Trust.
On May 31, 2002, petitioners reported to respondent their
status as trustees of the above three trusts on separate Forms
56, Notice Concerning Fiduciary Relationship.
For 1999 and 2000, petitioners’ joint individual Federal
income tax returns and the three trusts’ Federal income tax
returns were prepared by Sam Fung (a.k.a. Fong), purportedly a
certified public accountant.
In connection with the preparation of their joint Federal
income tax returns, petitioners provided to Mr. Fung check
registers relating to petitioners’ furniture business along with
a summary of the various related expenses (e.g., cost of goods
sold and transportation).
Petitioners reported on their joint Federal income tax
returns for 1999 and 2000 nominal wages as taxable income, which,
after petitioners’ personal exemptions, was reduced to zero
taxable income and resulted in no tax liability being reported on
petitioners’ joint individual Federal income tax returns for 1999
and 2000.
On trust Federal income tax returns for 1999 and 2000, filed
with respondent on behalf of NHUSS Trust, the income of the
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furniture business was reported, and improper deductions were
claimed for purported distributions to the other two trusts (RJ
Pendergraft Trust and In God We Trust) and for alleged business
expenses relating to petitioners’ furniture business, all of
which offset NHUSS Trust’s reported income, and resulted in no
tax liability being reported on NHUSS Trust’s tax returns.
On the 1999 and 2000 trust Federal income tax returns of RJ
Pendergraft Trust and In God We Trust, various improper
deductions were claimed for business and personal expenses that
offset the trusts’ reported income and that resulted in no tax
liability being reported.
The following schedules summarize the gross income, taxable
income (loss), and tax liability reported on the above joint
individual and trust Federal income tax returns for 1999 and
2000:
1999
Reported
Date Type of Gross Taxable Tax
Filed Return Taxpayer Income Income (Loss) Liability
04/10/00 Trust NHUSS Trust $886,784 ($69) -0-
04/10/00 Trust In God We Trust 149,180 (62) -0-
04/10/00 Trust RJ Pendergraft Trust 244,850 (72) -0-
04/09/00 Joint Petitioners 4,800 -0- -0-
2000
Reported
Date Type of Gross Taxable Tax
Filed Return Taxpayer Income Income (Loss) Liability
04/10/01 Trust NHUSS Trust $805,884 ($73) -0-
04/10/01 Trust In God We Trust 169,425 (55) -0-
04/10/01 Trust RJ Pendergraft Trust 696,857 (60) -0-
04/09/01 Joint Petitioners 4,800 -0- -0-
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On July 23, 2002, respondent’s revenue agent mailed a letter
to petitioner Joyce Pendergraft with respect to an examination of
petitioners’ 1999 and 2000 joint individual Federal income tax
returns, which letter included a request for certain books,
records, and documents relating to petitioners’ three trusts and
the sale of petitioners’ residence.
On October 21, 2002, petitioners entered into a closing
agreement with respondent in which agreement petitioners agreed,
in principle, that for 1999 and 2000 the NHUSS Trust, the In God
We Trust, and the RJ Pendergraft Trust would be disregarded for
Federal income tax purposes, that the reported income and
expenses of the three trusts would be collapsed into petitioners’
income and expenses, and that petitioners were liable for the tax
deficiencies for 1999 and 2000 that related to the trusts’ income
and expenses being charged to petitioners. In the above-
referenced October 21, 2002, closing agreement, the parties did
not finalize or specify the specific amounts of the income and
expenses of the trusts that would be charged to petitioners, nor
did the parties specify the amounts of the deficiencies that
would be charged to petitioners.4
4
We note that, in the closing agreement petitioners
entered into with respondent, petitioners appear to have agreed
that they would be liable for penalties relating to the collapse
of the income and expenses of the three trusts into petitioners’
income and expenses. However, in the trial stipulation, the
parties stipulate that petitioners’ liability for these penalties
is still in issue, and the parties have briefed this issue. We
(continued...)
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In November of 2002, a second request was made by respondent
for petitioners’ books and records.
During respondent’s audit examination, petitioners did not
provide to respondent the requested books and records.
On April 2, 2004, respondent mailed to petitioners separate
notices of deficiency for 1999 and 2000 with respect to NHUSS
Trust, RJ Pendergraft Trust, and In God We Trust. In the notices
of deficiency, respondent determined, among other things, that in
1999 and 2000 various claimed deductions (e.g., deductions
relating to purported distributions made between the trusts and
business expense deductions relating to the furniture business)
were not properly substantiated, that in 1999 and 2000 rental
income was not reported, and that in 1999 and 2000 various
charitable deductions (including the charitable deduction for the
donation of the van) claimed by RJ Pendergraft Trust were not
properly substantiated.
Also on April 2, 2004, respondent mailed to petitioners a
notice of deficiency for 1999 and 2000 relating to petitioners’
joint individual Federal income tax liabilities. Respondent
determined, among other things, that for 1999 and 2000 the
trusts’ income and expenses were to be collapsed into
petitioners’ income and expenses and that for 2000 petitioners
4
(...continued)
treat petitioners’ liability for the negligence penalty with
respect to the tax adjustments relating to the three trusts as
still in issue.
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realized $230,460 in taxable capital gain on the sale of their
residence.5
During the trial of these consolidated cases involving both
petitioners and the trusts, the parties stipulated the specific
amounts that were to be collapsed from the trusts’ reported
income and expenses into petitioners’ income and expenses as
follows:
1999
Trust Income and Expenses to Be
Charged to Petitioners Amount
NHUSS Trust income $881,779
In God We Trust income adjustment (149,180)
Rental income 19,200
Cost of goods sold (230,005)
Commission expense (20,189)
Car and truck expense (10,000)
Meals and entertainment expense (4,082)
Travel expense (837)
Home office expense (417)
5
In the notice of deficiency respondent’s calculation of
petitioners’ gain on the sale of their residence was based on a
cost of $45,000 and, due to the failure of petitioners to provide
their books and records, improvements of only $14,540 for a total
cost basis of $59,540. The sale price of $790,000, less the
$59,540 cost basis, less the $500,000 exemption, equals the
$230,460 in capital gain computed by respondent in the notice of
deficiency. Once petitioners, prior to the scheduled trial,
herein, provided their books and records to respondent,
respondent agreed to an increase in petitioners’ cost basis in
the residence from $59,540 to $162,968.
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2000
Trust Income and Expenses to Be
Charged to Petitioners Amount
NHUSS Trust income $786,223
In God We Trust income adjustment (169,425)
Ordinary recapture income 29,770
Rental income 19,200
Cost of goods sold (265,153)
Gross income adjustment (70,000)
Commission expense (27,334)
Car and trust expense (18,374)*
Home office expense (7,866)
Meals and entertainment expense (2,766)
Travel expense (1,035)
Charitable deduction (336)
* At trial, respondent stated that the parties agreed
that petitioners’ car and truck expenses in 2000 were
$15,691. The parties, however, stipulated in writing that
the car and truck expenses were $18,374, and we use the
stipulated amount.
The parties’ stipulation does not separately identify any
income and expenses of RJ Pendergraft Trust that are to be
charged to petitioners. We understand, however, that the income
and expenses of RJ Pendergraft Trust were appropriately collapsed
into petitioners’ income and expenses and are reflected in the
above figures.
OPINION
Burden of Proof
Generally, under section 7491(a), the burden of proof
relating to factual issues relevant to an individual’s tax
liability may shift from the taxpayer to respondent where the
taxpayer: (1) Has credible evidence to substantiate the item in
question; (2) has maintained appropriate records relating
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thereto; and (3) has cooperated with reasonable requests by
respondent for information relating to the item in question.
Sec. 7491(a)(1) and (2); Rule 142(a).
Petitioners’ failure to cooperate with respondent during the
audit of the tax years at issue precludes a shift in the burden
of proof from petitioners to respondent with respect to the
factual issues before us. Sec. 7491(a)(2)(B). Further, during
respondent’s audit, petitioners failed to provide books and
records relating to the cost basis in their residence, and
petitioners failed to produce credible evidence with regard to
the value of the van. See infra. Generally, for purposes of
section 7491(a)(2)(B), later cooperation by taxpayers will not
act to cure prior noncooperation at examination or Appeals. H.
Conf. Rept. 105-599, at 239 (1998), 1998-3 C.B. 747, 993-994.
The burden of proof with respect to the amount of gain
petitioners realized on the sale of their residence and the
amount of petitioners’ charitable deduction relating to the van
is not shifted to respondent and remains on petitioners.
Gain on Sale of Petitioners’ Residence
For 2000, under sections 61 and 1001, gain on the sale or
disposition of a personal residence is included in gross income,
subject to an exclusion, for married taxpayers filing joint tax
returns, of up to $500,000. Sec. 121(a) and (b)(2).
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The basis of property is determined by its cost. Sec. 1012;
Gandy v. Commissioner, T.C. Memo. 1997-532, affd. 199 F.3d 440
(5th Cir. 1999).
Respondent contends that petitioners have failed to
substantiate a cost basis in their residence above the $163,148
determined by respondent at trial and that petitioners therefore
in 2000 realized $126,852 in capital gain on the sale.6
With one exception noted below, we regard all of the costs
petitioners claim in excess of the $163,148 allowed by respondent
as not sufficiently substantiated. We do allow petitioners an
increase of $24,945 in their cost basis to reflect additional
swimming pool improvement costs that are reflected in
petitioners’ contemporaneous records (Appendix B). Respondent
himself has allowed all of the other costs reflected in Appendix
B, and evidence relating to the swimming pool is as credible as
the evidence relating to the other items allowed by respondent.
We believe petitioners’ contemporaneous records (Appendix B)
substantiate a $24,945 increase in the cost basis of the swimming
pool to a total swimming pool cost of $31,190.
The following schedule reflects our findings with regard to
petitioners’ cost basis in the residence at the time of its sale
in 2000:
6
The sale price of $790,000, less the $163,148 cost basis
respondent allows, less the $500,000 exemption, equals $126,852
in capital gain.
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Residence Cost Basis Amount
Purchase price $ 45,000
Improvements
Residence 28,000
Swimming pool 31,190
Second story addition 16,665
Interior remodeling 1,022
Exterior 3,527
Alarm 825
Closing costs 61,864
Total $188,903
We calculate petitioners’ taxable gain on the sale of the
residence in 2000 to be $101,907 ($790,000 sale price, less
$188,903 cost basis, less $500,000 exemption, equals $101,907
capital gain).
Charitable Deduction for Value of Van
Generally, under section 170(a)(1), a deduction is allowed
for charitable contributions made within the year. See sec.
1.170A-1, Income Tax Regs. The regulations state that the amount
to be allowed for a charitable contribution of property other
than money is to be the “fair market value of the property at the
time of the contribution”. Sec. 1.170A-1(c)(1), Income Tax Regs.
Generally, the best evidence of fair market value is an
actual sale of the property in an arm’s-length transaction within
a reasonable time before or after the valuation date. Berry
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Petroleum Co. v. Commissioner, 104 T.C. 584, 637 (1995), affd.
142 F.3d 442 (9th Cir. 1998).7
Six weeks after petitioners donated the van, petitioners’
van was sold for an amount almost $13,000 less than Mr. Sobrero’s
appraisal. In his appraisal, Mr. Sobrero failed to account for
the mileage of the van, which mileage, based on petitioner’s
testimony, would have been approximately 220,000 miles.
On the evidence before us, we conclude that the fair market
value of petitioners’ van on the date of its donation, for
purposes of the claimed charitable contribution deduction, was
its $6,900 sale price in December of 2000.
Section 6662(a) Negligence Penalty
Under section 6662(a), a penalty is imposed on “any portion
of an underpayment of tax required to be shown on a return” that
is attributable to negligence or to disregard of the rules or
regulations. Sec. 6662(b)(1). Respondent has asserted the
negligence penalty against petitioners with respect to the
adjustments collapsing the reported income and expenses of the
three trusts into petitioners’ income and expenses, the gain on
the sale of petitioners’ residence, and the donation of the van.
7
We note that the American Jobs Creation Act of 2004, Pub.
L. 108-357, sec. 884, 118 Stat. 1632, effective for years
beginning after 2004, added a provision in sec. 170 generally
limiting a taxpayer’s charitable deduction relating to a donation
of a vehicle to the actual sales price of the vehicle when sold
by the donee organization. Sec. 170(f)(12)(A)(ii).
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For purposes of section 6662, negligence “includes any
failure to make a reasonable attempt to comply with the
provisions of this title,” and disregard “includes any careless,
reckless, or intentional disregard.” Sec. 6662(c); Drum v.
Commissioner, T.C. Memo. 1994-433, affd. without published
opinion 61 F.3d 910 (9th Cir. 1995).
Under section 7491(c), respondent bears the burden of
production with respect to the section 6662(a) penalty. See also
Rule 142(a). If, however, respondent satisfies his burden of
production, the taxpayer continues to have the burden of proof
with respect to imposition of this penalty. Rule 142(a); Higbee
v. Commissioner, 116 T.C. 438 (2001).
Respondent has satisfied his burden of production under
section 7491(c) because petitioners have conceded that they are
liable for increased tax liabilities relating to the collapse of
the trusts and because we have found that petitioners understated
the amount of gain they realized on the sale of their residence
and overstated the amount of their charitable deduction with
respect to the van.
Petitioners unreasonably relied on NTS and Mr. Fritz in
establishing the three trusts, on unsubstantiated costs with
regard to the gain on the sale of the residence, and on an
appraisal that was not credible with regard to the value of the
van.
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Under the circumstances, we find that petitioners’
underpayments of Federal income taxes for 1999 and 2000 were due
to negligence and that petitioners are liable for the section
6662(a) negligence penalty for 1999 and 2000 with respect to the
adjustments relating to the three trusts, to the gain on the sale
of petitioners’ residence, and to the donation of the van.
We have considered all arguments made herein, and, to the
extent not addressed, we conclude that they are without merit or
are irrelevant.
To reflect the foregoing,
Decisions will be entered
under Rule 155.
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Appendix A
Improvements and costs reflected on building permits obtained by petitioners:
Category of Improvement Date Permit No. Description Cost
Residence 09/12/72 74338 Improvements $28,000
Swimming pool 05/07/73 76866 Swimming pool 3,500
Second story addition 11/14/78 14021 Second story 16,665
Interior remodeling 05/01/00 P0057485 Plumbing Unknown
Total $48,165
Appendix B
Improvements and costs reflected in contemporaneous records maintained by
petitioners relating to improvements made to the residence:
Category of Improvement Cost
Swimming pool
Pool $15,370.00
Cement 14,200.00
Wrought iron fence 1,620.10
$31,190.10
Interior remodeling
Plumbing $ 136.81
Wallpaper and paint 133.86
Curtains and curtain rods 301.16
Garage storage 241.82
Miscellaneous improvements 136.26
949.91
Exterior
Landscaping $ 2,791.48
Cabana, shed, and lighting 435.21
Outside fence 47.45
3,274.14
Total $35,414.15
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Appendix C
Improvements and costs testified to at trial without supporting documentation:
Category of Improvement Cost
Installed alarm system $ 1,864
$ 1,864
Swimming pool
Swimming pool and spa $ 15,370
Cement deck 14,200
Wrought iron fence 1,200
Replaced wrought iron fence 2,000
Solar panels 2,745
Replaced solar panels 3,000
38,515
Second story addition
Added second story, stairs, plumbing $ 60,000
60,000
Interior remodeling
Re-carpeted (three times) $ 15,000
Master bedroom, bathrooms, kitchen remodel 87,000
Plumbing repairs 2,000
Soft water system 750
Re-tiled master bathroom shower 5,000
Replaced water heater (two times), etc. 2,000
Chair molding, hallways 750
Crown molding, living and dining rooms 2,000
114,500
Exterior
Plants, flower beds $ 6,000
Replaced gutters 1,200
Storage shed, roof 3,900
Second storage shed 800
Replaced sidewalk 1,000
Replaced garage door 700
Backyard electrical lighting 300
Added door from garage to yard 500
Side yard electrical 500
Garage exterior lighting 450
Replaced roof 22,500
Shutters 3,341
Replaced redwood fence (two times) 2,000
43,191
Total $258,070
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Appendix D
Additional improvements and costs agreed to by respondent:
Category of Improvement Cost
Alarm $ 825
$ 825
Swimming pool
Solar $2,745
2,745
Interior remodeling
Garage cupboards $ 154
Dining 255
Molding shutters 613
1,022
Exterior
Shutters $3,361
Trees 166
Exterior total 3,527
Total $8,119