Goode v. Comm'r

T.C. Summary Opinion 2007-73

UNITED STATES TAX COURT

ROBERT H. GOODE, JR. AND LOCKIE L. GOODE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 9978-05S, 4802-06S. Filed May 15, 2007.

Peter A. Lowy, for petitioners.

Thomas L. Fenner, for respondent.

JACOBS, Judge: These consolidated cases were heard pursuant

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

effect at the time the petitions were filed. Pursuant to section

7463(b), the decisions to be entered are not reviewable by any

other court, and this opinion shall not be treated as precedent

for any other case. Unless otherwise indicated, subsequent

section references are to the Internal Revenue Code in effect for
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the year in issue, and Rule references are to the Tax Court Rules

of Practice and Procedure.

Initially, 2 tax years were involved herein. Docket No.

9978-05S pertains to 2002. Docket No. 4802-06S pertains to 2003.

Before the trial of these cases, respondent conceded all issues

for 2003. Consequently, only the dispute for 2002 remains for

decision, and the issues to be resolved for that year are: (1)

Whether petitioner Robert H. Goode’s activity reported on Schedule

C, Profit or Loss from Business--a construction activity known

during 2002 as Robco Construction and Service Co. (Robco)--was an

activity engaged in for profit; and, if so, (2) whether

petitioners have satisfied the substantiation requirements for

claimed Schedule C expenses related to (a) the business use of a

pickup truck and stretch van and (b) power tools.

Background

Some of the facts have been stipulated and are so found. The

stipulation of facts and the attached exhibits are incorporated

herein by this reference. At the time they filed the petitions,

petitioners resided in Spring, Texas.

Petitioner Robert H. Goode (Mr. Goode) is a 1962 graduate of

the U.S. Military Academy at West Point, where he received degrees

in engineering. Mr. Goode served as an artillery officer in Korea

and Vietnam and received numerous commendations, including three

Purple Hearts, the Distinguished Flying Cross, the Distinguished
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Service Cross, the Silver Star, and the U.S. Army Leadership in

the Pacific Award. He was injured during his military service and

ultimately was rated 100 percent disabled by the U.S. Department

of Veterans Affairs.

After his discharge from the military in 1970, Mr. Goode

returned to his family in Louisiana and there engaged (as a sole

proprietor) in a construction activity using the business name

Robco Service Co. (Robco).1 Robco at first engaged in the

restoration and improvement of single-family homes pursuant to

contracts from agencies of the Federal Government. Petitioners

moved to Texas in the mid 1970s, and there Robco shifted from

Government construction contracts to private construction

contracts. In addition, Robco expanded into carpet cleaning and

installation. During its years of operations, Robco’s level of

activity and profits ebbed and flowed as Mr. Goode’s health

fluctuated and his other sources of income changed.

In 1980, Mr. Goode began to work full time for Southwestern

Bell; he worked there through 1999. During the period 1980-99,

the amount of time Mr. Goode dedicated to Robco decreased.

Nonetheless, Mr. Goode regularly filed documents required by Texas

1
At a time not specified in the record, the business name
Mr. Goode used for the construction activity changed from Robco
Service Co. to Robco Construction and Service Co.
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law to operate the construction activity under the Robco name,

maintained liability insurance for Robco, and reported Robco’s

profits on petitioners’ Federal income tax returns.

In 1999, Mr. Goode suffered from major health problems and as

a consequence could no longer physically participate in

construction operations. Mr. Goode’s managerial skills became his

primary contribution to Robco’s activities. Nevertheless, Robco

continued to earn a profit until 2001. In 2001, 2002, and 2003,

Robco sustained losses, but it returned to profitability in 2004.

During 2002, the year in issue, Robco entered into a contract

with the homeowners association of which Mr. Goode was president

and a board member. Because the bylaws of the homeowners

association prohibited board members from profiting from their

membership on the board, the work Robco performed for the

homeowners association--the remodeling of the central recreation

facility and pool--was on a cost basis.

Petitioners owned a pickup truck and a stretch van that Mr.

Goode used in the construction activity. Petitioners owned other

vehicles that they used for personal purposes.

On Schedule C of their 2002 Federal income tax return,

petitioners reported, with respect to Robco, gross receipts of

$9,297, cost of goods sold of $8,517, and gross income of $780.

The Schedule C listed expenses totaling $12,212 and a resulting

loss of $11,432. Of the claimed expenses, respondent disputed the
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deductibility of car and truck expenses of $1,708, depreciation

expense of $4,139, insurance expense of $694, and power tools

expense of $1,820.

After petitioners filed their 2002 return, in which they

claimed a refund, petitioners received a letter from respondent

informing them that respondent had not received schedules in

support of their 2002 tax return. Thereafter, petitioners

submitted a copy of their Schedule C to respondent but failed to

retain a copy for their own records. Shortly thereafter,

petitioners received a letter from respondent with a refund check

enclosed. Subsequently, respondent issued his notice of

deficiency.

At trial, respondent introduced into evidence a Schedule C

that Mr. Goode had reconstructed from amounts that were shown on

petitioners’ 2002 return. The original Schedule C petitioners had

prepared and submitted with their return, as well as the copy of

Schedule C that petitioners submitted to respondent in response to

respondent’s subsequent request, were not introduced. Respondent

asserts that petitioners did not submit Schedule C with their 2002

return and that the only Schedule C that respondent received is

the reconstructed version that was introduced into evidence at

trial.
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Discussion

Section 183 precludes deductions for activities not engaged

in for profit except to the extent of the gross income derived

from those activities. Sec. 183(a) and (b)(2). Thus, deductions

are not allowable for activities that a taxpayer carries on

primarily for sport, as a hobby, or for recreation. Sec. 1.183-

2(a), Income Tax Regs. For a taxpayer’s expenses in an activity

to be deductible under section 162, entitled “Trade or Business

Expenses”, or section 212, entitled “Expenses for Production of

Income”, and not subject to the limitations of section 183, a

taxpayer must show that the taxpayer engaged in the activity with

an actual and honest objective of making a profit. Hulter v.

Commissioner, 91 T.C. 371, 392 (1988); Dreicer v. Commissioner, 78

T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205 (D.C.

Cir. 1983); Hastings v. Commissioner, T.C. Memo. 2002-310.

Whether a taxpayer has an actual and honest profit objective is a

question of fact to be answered from all the relevant facts and

circumstances. Hulter v. Commissioner, supra at 393; Hastings v.

Commissioner, supra; sec. 1.183-2(a), Income Tax Regs. Greater

weight is given to objective facts than to a taxpayer’s mere

statement of intent. Dreicer v. Commissioner, supra at 645; sec.

1.183-2(a), Income Tax Regs.

The regulations set forth a nonexhaustive list of factors

that may be considered in deciding whether a taxpayer had a profit
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objective. These factors are: (1) The manner in which the

taxpayer carries on the activity; (2) the expertise of the

taxpayer or his advisers; (3) the time and effort expended by the

taxpayer in carrying on the activity; (4) the expectation that the

assets used in the activity may appreciate in value; (5) the

success of the taxpayer in carrying on other similar or dissimilar

activities; (6) the taxpayer’s history of income or losses with

respect to the activity; (7) the amount of occasional profits, if

any, which are earned; (8) the financial status of the taxpayer;

and (9) any elements indicating personal pleasure or recreation.

See sec. 1.183-2(b), Income Tax Regs.

No single factor, nor even the existence of a majority of

factors favoring or disfavoring the existence of a profit

objective, is controlling. Hendricks v. Commissioner, 32 F.3d 94,

98 (4th Cir. 1994), affg. T.C. Memo. 1993-396; Brannen v.

Commissioner, 722 F.2d 695, 704 (11th Cir. 1984), affg. 78 T.C.

471 (1982); sec. 1.183-2(b), Income Tax Regs. Rather, the

relevant facts and circumstances of the case are determinative.

Keanini v. Commissioner, 94 T.C. 41, 46 (1990); Allen v.

Commissioner, 72 T.C. 28, 34 (1979); sec. 1.183-2(b), Income Tax

Regs.

Generally, the Commissioner’s determinations are presumed

correct, and the taxpayer bears the burden of proving those

determinations wrong. Rule 142(a); INDOPCO, Inc. v. Commissioner,
 - 8 -

503 U.S. 79, 84 (1992); Welch v. Helvering, 290 U.S. 111, 115

(1933). Section 183(d), however, presumes an activity is

conducted for profit if the gross income exceeds the attributable

deductions for 3 out of 5 consecutive years before the year in

issue. The presumption applies only after the third profit year.

Mitchell v. Commissioner, T.C. Memo. 2006-145 (citing section

183(d)).

The 5 consecutive years before 2002, the year in issue, were

1997, 1998, 1999, 2000, and 2001. Mr. Goode’s uncontroverted

testimony, which we find credible, established that Robco was

profitable for 4 of these 5 years, the only exception being 2001.

Therefore, petitioners are entitled to a presumption that Robco

was an activity conducted for profit for 2002, which respondent

did not rebut. However, as discussed infra, we find that Robco

was an activity conducted for profit even in the absence of the

presumption of section 183(d).

We do not believe it necessary to analyze each of the factors

enumerated in section 1.183-2(b), Income Tax Regs. Rather, we

focus on the ones we believe more important.

Robco is a small operation, conducted primarily by Mr. Goode,

a trained engineer with substantial experience in the field of

home and business construction and renovation. Given its size, we

would not expect Robco to have (nor did it have) an extensive

system of bookkeeping or financial statement analysis. But Mr.
 - 9 -

Goode did keep substantial records for Robco, including bids,

invoices, receipts, and other documentation.

While it is true, as respondent points out, that most of the

work Robco performed in 2002 was on a cost basis and that Mr.

Goode, because of his deteriorating health, was unable to devote a

great deal of time or energy to Robco’s affairs, these

circumstances explain why Robco was not profitable in 2002, as

opposed to establishing a lack of profit objective, especially in

the light of Mr. Goode’s success in taking steps to improve

Robco’s performance in later years.

Mr. Goode succeeded in recruiting a family member from

another State to move to Texas to join Robco, with the result that

Robco returned to profitability by 2004. We believe it unlikely

that the family member would have moved and joined Robco if the

member believed Mr. Goode carried on Robco’s activities as a hobby

and not for profit.

The record shows that petitioners had other sources of income

during 2002, and thus petitioners were not reliant on Robco to

generate income to pay their basic living expenses. The record is

equally clear that at its inception, Robco was petitioners’

primary source of income. Nothing in the record leads us to

believe that Robco was transformed from a profit-oriented activity

into a hobby or recreational pursuit. Mr. Goode, the only person

to testify at trial, did not seem to us to be a person who is
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inattentive or indifferent to the outcome, in terms of profit or

loss, of Robco’s activities. On the contrary, he was scrupulous

in his dealings with the homeowners association, ensuring that

while Robco did not make a profit, Robco’s costs were fully

reimbursed.

In sum, we hold that Robco was an activity conducted for

profit in 2002. We therefore now must decide whether the amounts

petitioners claimed as expenses in connection with Robco are

allowable deductions.

Section 162(a) allows a deduction for ordinary and necessary

business expenses paid or incurred during the taxable year in

carrying on any trade or business. For an expense to be

“ordinary” the transaction that gives rise to it must be of a

common or frequent occurrence in the type of business involved.

Deputy v. du Pont, 308 U.S. 488, 495 (1940). To be “necessary” an

expense must be “appropriate and helpful” to the taxpayer’s

business. Welch v. Helvering, supra at 113-114.

Where a taxpayer establishes entitlement to a deduction but

does not establish the amount of the deduction, the Court in some

circumstances is allowed to estimate the amount allowable. Cohan

v. Commissioner, 39 F.2d 540 (2d Cir. 1930). But see sec. 1.274-

5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6,

1985). However, there must be sufficient evidence in the record

to permit the Court to conclude that a deductible expense was
 - 11 -

incurred in at least the amount allowed. Williams v. United

States, 245 F.2d 559, 560 (5th Cir. 1957). In estimating the

amount allowable, we bear heavily on the taxpayer whose

inexactitude in substantiating the amount of the expense is of his

own making. See Cohan v. Commissioner, supra at 544.

We are convinced that the Robco vehicles generated expenses

which, if substantiated, would be deductible by petitioners.

Robco vehicle expenses were reported in three different ways on

petitioners’ return: As a separate depreciation expense

deduction, as a separate insurance expense deduction, and as a

separate vehicle deduction based on the standard mileage rate.

Respondent correctly points out that the last of these deductions,

the deduction for vehicle expenses based on the standard rate, may

be used only in lieu of the first two. See sec. 1.274-5(j)(2),

Income Tax Regs.; Rev. Proc. 2001-54, 2001-2 C.B. 530. Therefore,

we must determine which, if any, of these deductions are

allowable; the three cannot be allowed together.

Section 167(a) allows a deduction for a reasonable allowance

for the exhaustion, wear and tear, and obsolescence of property

used in a trade or business or held for the production of income.

The basis on which a depreciation deduction is allowable with

respect to any property under section 167(a) is the adjusted basis
 - 12 -

of the property, determined under section 1011 for the purpose of

determining gain on the sale or other disposition of the property.

See sec. 167(c).

Mr. Goode testified that the claimed depreciation expense

deduction of $4,139 was calculated with reference to the previous

year’s return, which showed the same or a very similar amount. We

do not have the benefit of the previous year’s return, nor do we

have the benefit of any documentation or testimony that would

establish the adjusted bases of the Robco vehicles or the method

of depreciation used in calculating depreciation with respect to

those vehicles. While we are satisfied that the Robco vehicles

are depreciable property, we cannot find any basis in this record

for determining the amount of the depreciation expense.

Therefore, we will not allow any deduction for depreciation

expense for the Robco vehicles.

Petitioners claimed a $694 insurance expense deduction in

connection with the Robco vehicles. A receipt for insurance

coverage for the period November 2001 through April 2002 shows

that the monthly cost of insurance for the Robco van was $19.16.

The cost of insurance for the Robco pickup truck is not shown on

the November 2001 through April 2002 receipt, but the receipt for

a later period, May 2003 through October 2003, shows the insurance

cost for both the van and the pickup truck. The cost of insuring

the pickup truck was greater than the cost of insuring the van;
 - 13 -

therefore, we are confident that the cost of insurance on the

pickup truck was at least $19.16 per month in 2002. Consequently,

we will allow an insurance expense deduction for Robco vehicles of

$459.84, consisting of $19.16 per vehicle per month.

In addition to depreciation and insurance expenses for Robco

vehicles, petitioners claimed a $1,708 deduction for car and truck

expenses. In the case of traveling expenses and certain other

expenses, such as entertainment, gifts, and expenses relating to

the use of listed properties, including passenger vehicles and

other property used as a means of transportation, computers, and

cellular phones under section 280F(d)(4)(A), section 274(d)

imposes stringent substantiation requirements to document

particularly the nature and amount of such expenses. For such

expenses, substantiation of the amounts claimed by adequate

records or by other sufficient evidence corroborating the claimed

expenses is required. Sec. 274(d); sec. 1.274-5T(a), Temporary

Income Tax Regs., supra. To meet the adequate records

requirements of section 274(d), a taxpayer “shall maintain an

account book, diary, log, statement of expense, trip sheets, or

similar record * * * and documentary evidence * * * which, in

combination, are sufficient to establish each element of an

expenditure”. Sec. 1.274-5T(c)(2)(i), Temporary Income Tax Regs.,

50 Fed. Reg. 46017 (Nov. 6, 1985). These substantiation

requirements are designed to encourage taxpayers to maintain
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records, together with documentary evidence substantiating each

element of the expense sought to be deducted. Sec. 1.274-

5T(c)(1), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6,

1985).

Mr. Goode testified that the claimed deduction for car and

truck expenses was based on the standard mileage rate. In lieu of

substantiating the actual amount of an expenditure relating to the

business use of a passenger automobile, a taxpayer may use a

standard mileage rate established by the Internal Revenue Service.

See sec. 1.274-5(j)(2), Income Tax Regs.; Rev. Proc. 2001-54,

supra. Use of the standard mileage rate establishes the amount

deemed expended with respect to the business use of a passenger

automobile, but it does not relieve a taxpayer of his burden of

substantiating the other elements required by section 274 and the

regulations issued thereunder. Sec. 1.274-5(j)(2), Income Tax

Regs.

Petitioners introduced no evidence that would establish the

number of miles the Robco vehicles were driven. There is nothing

in the record that satisfies the substantiation requirements of

section 274. Therefore, we cannot allow the claimed deduction for

car and truck expenses.2

2
In any event, petitioners would not have been entitled to
claim the deduction for car and truck expenses in addition to the
insurance expense deduction which we found is allowable.
 - 15 -

Finally, petitioners claimed a $1,820 deduction for the

acquisition of power tools used in Robco activities. Amounts paid

to acquire machinery, equipment, and similar property having a

useful life substantially beyond the taxable year are capital

expenditures and generally are not deductible. Sec. 263(a)(1);

sec. 1.263(a)-2, Income Tax Regs. If the capital expenditure is

for property used in a trade or business or held for the

production of income, the taxpayer may be allowed a deduction for

depreciation under section 167. See, e.g., INDOPCO, Inc. v.

Commissioner, 503 U.S. at 83-84. Alternatively, the cost may be

expensed pursuant to section 179 if the requirements of that

section are satisfied. The cost may not be expensed, however, in

the absence of an election. Sec. 179(c); Visin v. Commissioner,

T.C. Memo. 2003-246; sec. 1.179-5, Income Tax Regs. Furthermore,

section 179 limits the amount of the deduction to the amount of

taxable income derived from the trade or business, although a

disallowed deduction may be carried over to later tax years. Sec.

179(b)(3)(A) and (B). Petitioners did not have taxable income

derived from Robco activities in 2002, and they failed to make any

election under section 179.3 That being the case, petitioners may

3
The election would typically be made using Part I, Election
to Expense Certain Tangible Property Under Section 179, of Form
4562, Depreciation and Amortization. Petitioners did not attach
Form 4562 to their return and did not otherwise make an election
under sec. 179.
 - 16 -

not expense the cost of Robco’s power tools.

Mr. Goode testified that $1,820, the amount petitioners

claimed as a deduction, was his conservative estimate of the cost

of several power tools Robco acquired during 2002, which ranged in

price from $2 to $300. In view of the nature of Robco’s

activities, and because we find Mr. Goode’s testimony in this

regard credible, we hold that petitioners expended $1,820 for the

acquisition of power tools in 2002 and are therefore entitled to

an appropriate depreciation deduction with respect to that

acquisition. The parties shall determine the exact amount of the

depreciation deduction to which petitioners are entitled in their

Rule 155 computations.

To reflect the foregoing,

Decision will be entered

for petitioners in docket

No. 4802-06S.

Decision will be entered

under Rule 155 in docket No.

9978-05S.