T.C. Summary Opinion 2008-61
UNITED STATES TAX COURT
GERARD EUGENE STEVENS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13218-06S. Filed June 3, 2008.
Gerard Eugene Stevens, pro se.
Julie Jebe, 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. Pursuant to section
7463(b), the decision to be entered is 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 (hereafter
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Code) in effect for the year in issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
Respondent determined a $21,323 deficiency in petitioner’s
Federal income tax for 2003 and a $4,264 accuracy-related penalty
under section 6662(a).
The issues for decision are: (1) Whether petitioner failed
to include in income for 2003 income from discharge of
indebtedness and (2) whether petitioner is liable for the
accuracy-related penalty under section 6662(a).
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.
Petitioner resided in Illinois when he filed his petition.
Sometime in either January or February 2002 petitioner and his
former spouse, Sharon Stevens (the Stevenses), purchased real
property located at 5015 South Wabash Avenue, Chicago, Illinois.
The property purchased was a two-story residence in need of
rehabilitation. The Stevenses purchased the property for
investment purposes and intended to rehabilitate the dwelling and
either rent the property or sell it thereafter. Petitioner and
Sharon Stevens (Ms. Stevens) were married at the time the real
property was purchased, and they resided in Evergreen Park,
Illinois. The purchase price of the property was approximately
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$256,000. The Stevenses financed the purchase by borrowing money
from Homecomings Financial. The Stevenses executed a note and
deed of trust/mortgage with Homecomings Financial and held title
to the property as joint tenants. The record does not contain
the note and deed of trust/mortgage.
Sometime later in 2002 the Stevenses found themselves unable
to make the mortgage payments on the property. In order to avoid
a foreclosure, which would have adversely affected their credit
rating, they decided to sell the property in a short sale1 with
the approval of Homecomings Financial.
On January 3, 2003, the Stevenses (sellers) entered into a
purchase agreement with Jemal King (buyer) to sell the property
for $200,000. At that time the unpaid balance of the mortgage
was greater than the selling price.
On February 14, 2003, the Stevens separated. Petitioner
moved from the marital residence in Evergreen Park, Illinois, to
Chicago, Illinois.
The short sale occurred on or about March 20, 2003. The
property was conveyed to Jemal King by warranty deed executed by
the Stevenses and recorded with the Cook County Recorder of Deeds
on April 28, 2003.
1
A “short sale” in real estate occurs when the outstanding
loans against a property are greater than what the property is
worth and the lender agrees to accept less than it is owed to
permit a sale of the property that secures its note.
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Homecomings Financial approved the “short sale” subject to
the following terms and conditions: (1) Homecomings Financial
was to receive no less than $181,461.31 for satisfaction of the
debt, (2) certified payoff funds were to be received no later
than March 24, 2003, (3) Homecomings Financial was to receive a
certified copy of the final HUD settlement statement showing all
taxes as paid, (4) the Stevenses were to receive no sale proceeds
in the transaction and any excess funds were to be forwarded to
Homecomings Financial, (5) the sale price was to be $200,000, (6)
real estate commissions were not to exceed $10,000, and (7)
closing costs, including taxes and repairs, were not to exceed
$8,538.69. These terms and conditions extended only to the short
sale of the property to Jemal King by the purchase agreement
dated January 3, 2003.
Additionally, if the foregoing conditions were not met,
Homecomings Financial reserved the right to return the payoff
funds and require payment in full in accordance with the original
terms of the note and deed of trust/mortgage. Homecomings
Financial also noted that it might report the amount of the
“discount” to the Internal Revenue Service.
Homecomings Financial subsequently mailed a Form 1099-C,
Cancellation of Debt, to petitioner at his previous address in
Evergreen Park, Illinois. The Form 1099-C stated that the
mortgage loan debt of $74,494.96 was canceled by Homecomings
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Financial on March 27, 2003. A duplicate Form 1099-C was mailed
to Ms. Stevens also at the Evergreen Park, Illinois, address,
reporting the same information as on the Form 1099-C mailed to
petitioner. On March 27, 2003, petitioner resided at the Chicago
address and Ms. Stevens resided at the Evergreen Park address.
Ms. Stevens received both copies of the Form 1099-C and notified
petitioner that she was in receipt of his copy.
Neither petitioner nor Ms. Stevens included the $74,494.96
resulting from the cancellation of mortgage loan debt in income
for 2003 when they filed their respective Federal income tax
returns. Further, neither petitioner nor Ms. Stevens reported
the sale of the property on their respective 2003 income tax
returns.
Discussion
In general, the Commissioner’s determination as set forth in
a notice of deficiency is presumed correct, and the burden of
proof is on the taxpayer to prove otherwise. Rule 142(a)(1);
Welch v. Helvering, 290 U.S. 111, 115 (1933). However, under
certain circumstances the burden shifts where a taxpayer
introduces credible evidence with respect to any factual issue
relevant to ascertaining the income tax liability of the
taxpayer. Sec. 7491(a)(1). The resolution of whether petitioner
had cancellation of indebtedness income does not depend on which
party has the burden of proof. For the reasons discussed
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infra we conclude that petitioner has failed to prove that he did
not receive income from the relief of indebtedness.
Furthermore, section 6201(d), as pertinent here, provides
that in any court proceeding, if a taxpayer asserts a reasonable
dispute with respect to any item of income reported on an
information return such as a Form 1099 filed by a third party and
the taxpayer has fully cooperated with the Internal Revenue
Service, the Commissioner has the burden of producing reasonable
and probative information concerning the deficiency in addition
to information on the return itself. Petitioner does not dispute
the information contained on the Form 1099-C filed by Homecomings
Financial. Therefore, there is no burden of production on
respondent.
Generally, a taxpayer must include income from the discharge
of indebtedness. See sec. 61(a)(12); sec. 1.61-12(a), Income Tax
Regs. However, there are exceptions to this general rule.
Section 108(a) provides that a taxpayer may exclude income from
the discharge of indebtedness if the discharge occurs in a
bankruptcy case, or when the taxpayer is insolvent, or if the
indebtedness is qualified farm or business real estate debt.
Although the real estate property was held by the Stevenses as
investment property for the production of income, we cannot, for
lack of sufficient facts, determine whether the exclusion for
qualified real property indebtedness under section 108(a)(1)(D)
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might apply. Likewise, the record is devoid of sufficient facts
upon which we may determine whether the exclusion for insolvency
under section 108(a)(1)(B) might apply. The record is similarly
devoid of evidence suggesting that Homecomings Financial intended
to make a gift to the Stevenses and to petitioner, specifically.
Where property subject to recourse debt is disposed of in
satisfaction of the debt, the debt is deemed discharged. The
disposition by the mortgagor of the property for a release of
liability is treated as a sale or exchange upon which gain or
loss is realized. Frazier v. Commissioner, 111 T.C. 243, 245
(1998). The amount of gain realized is the excess of the amount
realized over the taxpayer’s adjusted basis in the property, and
correspondingly the amount of loss realized is the excess of the
adjusted basis over the amount realized. Sec. 1001(a). The
amount realized is defined by section 1001(b) as the sum of any
money received plus the fair market value of the property
received.
Petitioner’s gain or loss on the short sale of the South
Wabash Avenue property is computed pursuant to section 1001. As
a general rule, the amount realized includes the full amount of
the remaining debt if the debt is nonrecourse. Sec. 1.1001-
2(a)(1), Income Tax Regs. Section 1.1001-2(a)(2), Income Tax
Regs., however, provides: “The amount realized on a sale or
other disposition of property that secures a recourse liability
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does not include amounts that are (or would be if realized and
recognized) income from the discharge of indebtedness under
section 61(a)(12).”
This regulation actually bifurcates a transaction such as
the present one into a taxable sale of property and a taxable
discharge of indebtedness. Cf. Michaels v. Commissioner, 87 T.C.
1412, 1415 (1986). Accordingly, under this regulation, each part
should be treated as a separate transaction for tax purposes.
Id.
While the Stevenses’ amount realized for the South Wabash
Avenue property would be $255,956.27,2 the application of section
1.1001-2(a)(2), Income Tax Regs., reduces that sum by the amount
of income received from discharge of indebtedness. Although the
note and deed of trust/mortgage is not in evidence, on the basis
of the record we feel confident that the Note was a recourse
liability. Therefore, the Stevenses’ amount realized for the
property was $181,461.31. Accordingly, the Stevenses realized no
capital loss on the sale of the South Wabash Avenue property.
See sec. 1001(a). The Stevenses realized $74,494.96 of ordinary
income from discharge of indebtedness. See sec. 61(a)(12); sec.
1.61-12(a), Income Tax Regs. Since petitioner has not proven
2
This amount represents the sum of $181,461.31 (the net
amount to be received at closing and accepted by Homecomings
Financial on the short sale) and $74,494.96, the amount
characterized as income from cancellation of debt on the Form
1099-C that Homecomings Financial issued to the Stevenses.
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that any of the aforementioned exceptions under section 108(a)
applies to his case, we hold that petitioner’s income for 2003
includes the $74,494.96 from the discharge of indebtedness that
was not reported on his 2003 return.3
Section 6662(a) Accuracy-Related Penalty
In the notice of deficiency, respondent determined that
petitioner was liable for the accuracy-related penalty under
section 6662(a) for underpayment of tax. Section 6662(a) imposes
a 20-percent penalty with respect “to any portion of an
underpayment of tax required to be shown on a return”. This
penalty applies to underpayments attributable to any substantial
understatement of income tax. Sec. 6662(a) and (b)(2).
An “understatement” of income tax is defined as the excess
of the tax required to be shown on the return over the tax
actually shown on the return. Sec. 6662(d)(2)(A). An
understatement is “substantial” if it exceeds the greater of 10
percent of the tax required to be shown on the return or $5,000.
Sec. 6662(d)(1)(A).
3
Under the applicable Illinois statute, as joint tenants
the Stevenses are jointly and severally liable for all debts and
obligations arising from their ownership of the South Wabash
Avenue property. 765 Ill. Comp. Stat. Ann. 1005/3 (West 2001).
Accordingly, and in light of our decision, petitioner might look
to a civil remedy against Ms. Stevens (either under Illinois law
or pursuant to sec. 6015) for contribution as to the amount of
tax due as a result of the income from cancellation of
indebtedness for 2003.
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Section 6664 provides a defense to the accuracy-related
penalty if a taxpayer establishes that there was reasonable cause
for any portion of the underpayment and that he or she acted in
good faith with respect to that portion. Sec. 6664(c)(1); sec.
1.6664-4(a), Income Tax Regs. Although not defined in the Code,
“reasonable cause” is determined under the regulations on a case-
by-case basis, taking into account all the pertinent facts and
circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. The
taxpayer’s education, experience, and knowledge are considered in
determining reasonable cause and good faith. Id. And,
generally, the most important factor is the extent of the
taxpayer’s effort to assess his or her proper tax liability. Id.
Respondent determined an accuracy-related penalty under
section 6662(a) to be applicable because petitioner understated
his income tax by $21,323 on his return. Because petitioner’s
understatement of tax was greater than 10 percent of the tax
required to be shown on the return or $5,000, the understatement
was a substantial understatement of income tax pursuant to
section 6662(d)(1)(A).
Petitioner argues that he should not be held liable for the
penalty because of his reliance on Ms. Stevens to report all of
the Form 1099-C income from the cancellation of indebtedness on
her income tax return since both Forms 1099-C were mailed to her
address.
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Respondent carries the burden of production under section
7491(c) with respect to the accuracy-related penalty under
section 6662. To meet that burden, respondent must come forward
with sufficient evidence indicating that it is appropriate to
impose the penalty. The burden of proof to establish reasonable
cause remains with petitioner. See Higbee v. Commissioner, 116
T.C. 438, 446 (2001).
We conclude that petitioner has failed to show that his
reliance on Ms. Stevens’s reporting the full amount of income and
paying the requisite tax on that income was reasonable.
Petitioner admitted that he knew Ms. Stevens had received both
Forms 1099-C and that the amount at issue, $74,494.96, should
have been reported--either in full or in part--on one of or both
of the Stevenses’ returns for that year. The record is silent as
to any facts that would have led to a reasonable assumption on
the part of petitioner that he was not responsible for reporting
the amount contained on the Form 1099-C in income. Petitioner
has, therefore, failed to carry his burden of showing any
reasonable cause for the underpayment of tax for 2003. See sec.
6664(c)(1).
On the entire record before us, we hold that petitioner has
failed to carry his burden of proving that he is not liable for
an accuracy-related penalty for 2003 under section 6662(a). We
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accordingly sustain respondent’s determination with respect to
that issue.
Decision will be entered
for respondent.