T.C. Memo. 2006-176
UNITED STATES TAX COURT
THOMAS R. JONES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14608-04. Filed August 22, 2006.
Thomas R. Jones, pro se.
Susan S. Hu and Edwin A. Herrera, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined a deficiency in
petitioner’s 2000 Federal income tax and additions to tax as
follows:
Additions to Tax
Deficiency Sec. 6651(a)(1) Sec. 6654(a)
$2,726 $682 $146
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Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
The issues for decision are whether petitioner may deduct as
mortgage interest and real property taxes amounts petitioner paid
under a real property lease-option agreement and whether
petitioner is liable for additions to tax under sections
6651(a)(1) and 6654(a).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
At the time the petition was filed, petitioner resided in
Highland, California.
Prior to 2000, petitioner was employed by Union Pacific
Railroad.
In February of 1995, petitioner moved to a house in
Highland, California (the property), renting the property under a
written rental agreement from Robert Peterson (Peterson) for $850
per month. Petitioner’s first check to Peterson, written on
February 14, 1995, was for $2,100 and included rent for the first
and last unspecified month of the rental period and a $400
security deposit.
In mid-August of 1996, petitioner and Peterson modified
their rental agreement with respect to the property, converting
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the agreement to a lease-option agreement (the agreement). It is
not clear whether the agreement was formalized in a written
document, and many of its terms are not clear.
Under the agreement, petitioner was to pay Peterson $5,000
for an option to purchase the property at any time prior to
August of 2002. Also under the agreement, petitioner’s monthly
rental payments increased from $850 to $1,051 per month. The
$1,051 was equivalent to the amount Peterson paid to his mortgage
lender each month on the mortgage on the property. In written
correspondence to petitioner, Peterson informed petitioner that
“about $990 [of the $1,051] is the deductible interest,” but
Peterson did not specify by whom he intended the interest to be
deductible.
Under the agreement, it was understood that petitioner was
to pay the real property taxes on the property, and Peterson
apparently told petitioner that for Federal income tax purposes
petitioner could deduct the property taxes.
Peterson agreed to continue to pay fire insurance on the
property for at least 1 additional year in exchange for
petitioner’s agreeing to repair the roof.
According to the agreement, to exercise the purchase option
any time before August of 2002, petitioner was to pay Peterson a
second $5,000 and to pay off the outstanding balance of the
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mortgage on the property, which balance was $106,000 at the time
the agreement was entered into.
In September of 1996, petitioner paid Peterson the $5,000
for the option to purchase the property. Beginning in September
of 1996 and continuing through 2000, petitioner also paid
Peterson $1,051 per month.
In a December 2, 1998, letter to petitioner, Peterson
referred to the property as “my property” and acknowledged that
he, Peterson, was still using the property as his address for the
purpose of receiving mail. Peterson consistently referred to the
agreement as an “option” agreement, and in September of 2001
Peterson wrote a letter to petitioner in which Peterson made it
clear that he understood that petitioner was not yet bound under
the agreement to purchase the property.
In 1999, Peterson considered refinancing the mortgage on the
property and so informed petitioner, telling petitioner that this
would “actually [result] in a savings to * * * [petitioner]
during * * * [the] option period.” Petitioner apparently wanted
to participate in the refinancing of the property. Petitioner,
however, did not respond when Peterson mailed to petitioner bank
disclosure documents, and the refinancing of the mortgage on the
property was never completed.
In connection with his efforts to refinance, Peterson
queried petitioner about the condition of the property and
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informed petitioner that petitioner was responsible for repairing
damage to the garage door, replacing a wooden barrier that
blocked access to a building on the property, and removing
clutter from the yard. Throughout the term of the agreement,
petitioner complied with these and other maintenance requests
from Peterson.
From 1996 through 2000, petitioner continued to live on the
property, repaired the roof of the property, and paid real
property taxes on the property, including $806 in 2000. The real
property taxes were assessed to Peterson, and Peterson apparently
paid the fire insurance relating to the property.
In 1999, petitioner was diagnosed with an illness which
involved mental distress, and through 2000 petitioner did not
work.
On petitioner’s 1999 individual Federal income tax return,
prepared by a tax return preparer, petitioner reported zero tax
liability.
In 2000, petitioner received $19,500 in Social Security
benefits from the Railroad Retirement Board (RRB) and $22,324 in
disability payments from Union Central Life Insurance (UCLI)
relating to his mental distress.
For 2000, RRB submitted to respondent a Form 1099-R,
Distributions From Pensions, Annuities, Retirement or Profit-
Sharing Plans, etc., with regard to the $19,500 paid to
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petitioner, but it is not clear whether petitioner received a
copy of this Form 1099.
Also for 2000, UCLI submitted to respondent a Wage and Tax
Statement, Form W-2, Wage and Tax Statement, with regard to the
$22,230 paid to petitioner, and petitioner received a copy of
this W-2.
Without consulting a tax professional and apparently under
the impression that the disability benefits he received in 2000
did not constitute taxable income, petitioner did not file a
Federal income tax return for 2000.
On his 2000 individual Federal income tax return, Peterson
claimed an interest deduction in the amount of the total monthly
mortgage payments that were made on the property in 2000.
In May of 2002, petitioner obtained a $100,000 mortgage on
the property, and Peterson’s mortgage was paid off. Petitioner
exercised the option to purchase the property and paid Peterson
the required $5,000 exercise price. The legal title to the
property was then transferred from Peterson to petitioner.
Upon audit, respondent determined that petitioner’s 1999
Federal income tax liability was $13,236. Petitioner remitted
this amount to respondent plus penalties and interest.
At respondent’s request, on October 9, 2002, petitioner
filed his 2000 individual Federal income tax return, upon which
he reported zero taxable income.
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On May 3, 2004, respondent mailed to petitioner a notice of
deficiency in the amount of $2,726 with regard to petitioner’s
2000 Federal income tax return in which respondent determined
that $3,127 of the $19,500 petitioner received from RRB and the
$22,230 received from UCLI constituted taxable income to
petitioner. Respondent also determined that petitioner was
liable for a section 6651(a)(1) failure to file addition to tax
and a section 6654(a) addition to tax for failure to make
estimated tax payments.
For 2000, petitioner does not dispute the income adjustments
relating to the funds received from RRB and UCLI. Petitioner,
however, argues that he should be able to deduct as mortgage
interest and as real property taxes a portion of the payments he
made in 2000 relating to the property.
OPINION
Interest and Property Tax Payments
Under section 163, interest paid on a mortgage relating to a
qualified residence generally is deductible. Sec. 163(h)(2) and
(3). For the mortgage interest to be deductible by a particular
taxpayer, the mortgage must be the obligation of the taxpayer
claiming the deduction, not the obligation of another. Golder v.
Commissioner, 604 F.2d 34, 35 (9th Cir. 1979), affg. T.C. Memo.
1976-150. However, under section 1.163-1(b), Income Tax Regs.,
even though property may not be in a taxpayer’s name, as long as
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the taxpayer is the legal or equitable owner thereof and is at
least indirectly liable on the mortgage, the taxpayer may deduct
mortgage interest he or she pays relating to the property.
Under section 164, real property taxes paid by a taxpayer
may be deductible by the person upon whom the taxes are imposed.
Sec. 1.164-1(a), Income Tax Regs.; see Magruder v. Supplee, 316
U.S. 394, 396 (1942). The equitable or beneficial owner of real
property who pays taxes assessed against the property to protect
his or her interest therein may deduct the taxes he or she paid
even though legal title to the property may be held by another
person. Estate of Movius v. Commissioner, 22 T.C. 391, 394
(1954).
Generally, taxpayers bear the burden of proving that they
are entitled to deductions claimed. See Rule 142(a); New
Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); Hradesky
v. Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam 540 F.2d
821 (5th Cir. 1976).
For Federal income tax purposes, a sale occurs upon the
earlier of transfer of legal title or the practical assumption of
the benefits and burdens of ownership. Keith v. Commissioner,
115 T.C. 605, 611 (2000); Baird v. Commissioner, 68 T.C. 115, 124
(1977). In deciding whether transfer of either legal title or
the benefits and burdens has occurred, we look to State law.
Keith v. Commissioner, supra at 611.
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In the instant case, the August 1996 agreement between
petitioner and Peterson was not accompanied by a transfer of
legal title, so we must decide whether the agreement included
terms that were sufficient to transfer to petitioner the benefits
and burdens of ownership of the property.
As we observed in Keith v. Commissioner, supra, factors
frequently cited by this and other courts as indicative of the
benefits and burdens of property ownership include:
A right to possession; an obligation to pay taxes,
assessments, and charges against the property; a
responsibility for insuring the property; a duty to
maintain the property; a right to improve the property
without the seller’s consent; a bearing of the risk of
loss; and a right to obtain legal title at any time by
paying the balance of the full purchase price. [Id. at
611-612.]
The key question before us is whether the agreement between
petitioner and Peterson constituted a mere option or an actual
purchase of the property by petitioner. If the agreement
constituted a mere option and not a purchase, then under
California law the agreement would vest in petitioner no
ownership interest in the property. See Staudigl v. Harper, 173
P.2d 343, 347 (Cal. Dist. Ct. App. 1946).
The test of whether the agreement constituted an option or a
purchase by petitioner is whether petitioner was obligated to
purchase the property. See Allen v. Smith, 114 Cal. Rptr. 2d
898, 905 (Ct. App. 2002) (written contract treated as purchase
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and sale, not as an option, where buyer was obligated to proceed
with the purchase after inspection contingency was satisfied);
Welk v. Fainbarg, 63 Cal. Rptr. 127, 132-133 (Ct. App. 1967)
In the instant case, the bulk of the evidence establishes
that Peterson had no legal authority to require specific
performance by petitioner. Petitioner was not obligated to
exercise the option or otherwise liable to pay the purchase price
to Peterson if petitioner decided not to exercise the option. In
the communications between petitioner and Peterson, Peterson
referred to the exercise of the option contract as something
petitioner could exercise or not as he chose. The communications
between petitioner and Peterson referred to Peterson as the
owner.
Although we conclude that the agreement constituted only an
option and not a purchase or sale of the property itself, we
consider petitioner’s claim that he held an equitable ownership
interest in the property.
Petitioner argues that under California law he should be
considered to beneficially own the property. However, under
California law beneficial ownership contrary to legal title may
be established only by clear and convincing proof. Cal. Evid.
Code sec. 662 (West 1995); see Pac. Sw. Realty Co. v. County of
Los Angeles, 820 P.2d 1046, 1052 (Cal. 1991).
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Beneficial ownership has been characterized as when “the
buyer has the possession and use of the property to the complete
exclusion of the seller, subject only to the seller’s remedies in
case of default.” County of San Diego v. Davis, 33 P.2d 827, 828
(Cal. 1934).
Petitioner argues that under the terms of the agreement,
beginning in September of 1996 petitioner acquired equitable
ownership of the property. Petitioner points out that he
possessed the property, that after entering into the agreement he
began making larger payments to Peterson, and that he paid $5,000
to Peterson as well as property taxes on the property.
We agree with respondent that the evidence does not
establish that during 2000 petitioner was the equitable owner of
the property.
Various benefits and burdens were retained by Peterson.
Peterson continued to pay insurance on the property and to pay
other liabilities as owner of the property. Peterson made
decisions relating to improvements on the property.
We are sympathetic to petitioner, as the agreement did
convey to petitioner some benefits and burdens of ownership.
However, given the facts before us, California courts would
construe the agreement at issue as an option contract, not as a
purchase and sale contract.
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Petitioner has not met his burden of proving either that
petitioner and Peterson in fact had an agreement for the purchase
and sale of the property (as opposed to an option agreement) or
that in 2000 petitioner had acquired sufficient benefits and
burdens relating to the property to be deemed the equitable owner
of the property.
For 2000, petitioner is not entitled to deduct as mortgage
interest or as real property taxes the payments he made on the
property.
Additions to Tax
Under section 7491(c), the Commissioner has the burden of
production with respect to additions to tax. Once the
Commissioner meets that burden, the burden of proof shifts back
to the taxpayer with regard to additions to tax. Rule 142(a);
Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Respondent has
established petitioner’s tax liability and therefore has
satisfied his burden of production under section 7491(c).
To defend against a section 6651 addition to tax for failure
timely to file a tax return, a taxpayer must establish both that
failure to timely file was not due to willful neglect and that it
was due to reasonable cause. United States v. Boyle, 469 U.S.
241, 245 (1985).
Willful neglect means conscious, intentional failure or
reckless indifference. Id. A failure to file will be regarded
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as due to “reasonable cause” if the taxpayer exercised ordinary
business care and prudence and nevertheless was unable to file
his return by the due date. Crocker v. Commissioner, 92 T.C.
899, 913 (1989); sec. 301.6651-1(c)(1), Proced. & Admin. Regs.
In the absence of competent tax advice, a mistaken belief on
the part of a taxpayer that no tax return was required under the
statute generally will not support reasonable cause for not
filing a tax return. Shomaker v. Commissioner, 38 T.C. 192, 202
(1962); French v. Commissioner, T.C. Memo. 1991-196 (honest
belief that no tax was due does not constitute reasonable cause
where a taxpayer did not make good faith effort to ascertain
whether filing was necessary).
Where a taxpayer’s disability is raised as part of a
reasonable cause defense, we have looked to the severity of the
disability and the impact it had on the taxpayer’s life,
explaining that “significant psychiatric disorder and * * *
[mental incapacitation] during the period under consideration”,
Shaffer v. Commissioner, T.C. Memo. 1994-618, or confinement to
various hospitals for “severe mental illness,” Carnahan v.
Commissioner, T.C. Memo. 1994-163, affd. 70 F.3d 637 (D.C. Cir.
1995), may provide reasonable cause. But see Thomas v.
Commissioner, T.C. Memo. 2005-258 (taxpayer suffering from
bilateral tendinitis, carpal tunnel syndrome, and depression did
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not show reasonable cause when she was employed and running her
own business during the period in question).
It is undisputed that petitioner herein failed to file a
2000 Federal income tax return within the prescribed deadline.
Petitioner argues that he simply did not realize that disability
benefits were to be treated as taxable income.
Especially, however, after receiving the UCLI W-2 form
showing the disability benefits as taxable, petitioner did not
seek the advice of a professional and did not exercise ordinary
care and prudence as to the taxability of the disability
payments.
We conclude that neither petitioner’s lack of knowledge nor
his health problems constitute reasonable cause for his failure
to file his 2000 Federal income tax return. Petitioner is liable
for the section 6651(a)(1) addition to tax for failure to file a
return.
Section 6654(a) imposes an addition to tax on an
underpayment of estimated tax unless one of the statutory
exceptions applies. Niedringhaus v. Commissioner, 99 T.C. 202,
222 (1992). The enumerated exceptions provide that the addition
shall not be imposed: (1) If the tax is less than $1,000, or
(2) where there was no tax liability for the preceding taxable
year. Sec. 6654(e)(1) and (2). For the latter purpose, we look
to the tax liability shown on the return for the previous year,
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rather than the tax liability ultimately assessed by the
Commissioner, even when income for the preceding year was
fraudulently understated on the return. Mendes v. Commissioner,
121 T.C. 308, 324 (2003). An invalid return, however, for the
previous year will not suffice for purposes of the safe harbor
under section 6654(e)(2). Mendes v. Commissioner, supra.
If petitioner’s 1999 tax return is to be treated as a valid
tax return on which zero liability was reported, despite
respondent’s later deficiency assessment, petitioner might
qualify for the section 6654(e)(2) safe harbor for 2000.
Because, however, the record herein does not include evidence as
to the validity of petitioner’s 1999 income tax return, this safe
harbor is not available to petitioner.
Section 6654(e)(3)(B)(i) and (ii) also provides an exception
to this addition to tax where a taxpayer became disabled during
either the year the estimated tax payments were not made or the
preceding year, and where the tax underpayment is due to
reasonable cause and not due to willful neglect. See Thomas v.
Commissioner, T.C. Memo. 2005-258.
Petitioner was diagnosed with mental distress in 1999, the
year preceding the year in issue. Petitioner, however, has not
shown that his failure to pay estimated tax was due to reasonable
cause.
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For 2000, petitioner is liable for a section 6654 addition
to tax.
To reflect the foregoing,
Decision will be entered
for respondent.