T.C. Summary Opinion 2008-110
UNITED STATES TAX COURT
TERRY R. AND MARGARET E. REITER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11708-06S. Filed August 26, 2008.
Terry R. and Margaret E. Reiter, pro sese.
Kathryn A. Meyer, for respondent.
GOLDBERG, Special Trial Judge: This case was heard pursuant
to the provisions of section 7463 of the Internal Revenue Code in
effect when 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, all subsequent section
references are to the Internal Revenue Code in effect for the
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year in issue, and all Rule references are to the Tax Court Rules
of Practice and Procedure.
Respondent determined a deficiency of $4,841 in petitioners’
2003 Federal income tax. The sole issue for decision is whether
petitioners are entitled to a deduction for interest of $42,950
paid on a home mortgage loan during the year in issue.
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. Petitioners resided in
California at the time they filed their petition.
In 1974 petitioners formed California Digital, Inc., a
closely held corporation. Petitioners are the sole shareholders
of the corporation, each holding 50 percent of the outstanding
stock. Petitioner husband serves as the president and secretary
of the corporation, and petitioner wife serves as the
corporation’s treasurer. Although California Digital, Inc., once
occupied a 40,000-square-foot facility, the corporation is
presently operated out of a spare bedroom in petitioners’ home.
In 1981 petitioners purchased a single-family home for
$775,000. The sellers had two mortgages on the property at the
time of the sale. A first mortgage in the amount of $247,537.29
was held by Gibraltar Savings Bank, and a second mortgage in the
amount of $327,462.71 was held by City National Bank.
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Petitioners paid the sellers a $200,000 downpayment and agreed to
purchase the home subject to and assuming both of the existing
mortgages on the property.
On March 3, 1988, petitioners paid approximately $247,000 to
Gibraltar Savings Bank in full satisfaction of the first mortgage
on the property. On October 23, 1987, petitioners paid
approximately $25,000 to City National Bank in full satisfaction
of the amount remaining due on the second mortgage. A full
reconveyance of title and deed of trust in favor of petitioners
was executed and recorded on February 25, 1988.
Petitioners timely filed their 2003 Form 1040, U.S.
Individual Income Tax Return, on which they reported: (1)
$18,884 of taxable interest; (2) $5,111 of ordinary dividends;
(3) $7,763 of capital gain; and (4) $56,518 of income on Schedule
E, Supplemental Income and Loss. On Schedule A, Itemized
Deductions, attached to the return, petitioners claimed a $42,950
home mortgage interest deduction that was not reported on a Form
1098, Mortgage Interest Statement. Since no Form 1098 was
issued, petitioners indicated (as required under such
circumstances by the instructions on line 11 of the Schedule A)
that they had made mortgage payments to California Digital, Inc.-
-the “person” from whom petitioners purchased the home.
As the sole shareholders and officers for California
Digital, Inc., petitioners filed Form 1120, U.S. Corporation
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Income Tax Return, for the corporation for taxable year 2003
(California Digital return). The California Digital return
reported $601,514 of total assets, which included $450,0001 of
mortgage and real estate loans, and a $301,703 loan from
shareholders. The value of this loan at the beginning of the tax
year was $304,523--a difference of $2,820.
On March 7, 2006, respondent sent petitioners a notice of
deficiency disallowing the $42,950 home mortgage interest
deduction claimed on their return.
Discussion
Generally, taxpayers bear the burden of proving the
Commissioner’s determinations are erroneous. Rule 142(a); Welch
v. Helvering, 290 U.S. 111, 115 (1933). Deductions are strictly
a matter of legislative grace, and taxpayers bear the burden of
proving they are entitled to any claimed deductions. INDOPCO,
Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice
Co. v. Helvering, 292 U.S. 435, 440 (1934). Taxpayers are
required to maintain records sufficient to substantiate the
amounts of deductions claimed.
The sole issue before us is whether petitioners are entitled
to claim a Schedule A deduction for mortgage interest payments.
Section 163(a) and (h)(2)(D) generally allows a deduction for all
1
This amount was the same at the beginning and at the end
of the corporation’s taxable year.
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interest paid or accrued within the taxable year on indebtedness
on a qualified residence. “Qualified residence” within the
meaning of section 163 is the taxpayer’s principal place of
residence. Sec. 163(h)(4)(A). As with any deduction, however,
petitioners must be able to substantiate the amount claimed. See
sec. 6001; sec. 1.6001-1(a), Income Tax Regs.
Respondent disallowed petitioners’ home mortgage interest
deduction for lack of substantiation that they paid such interest
in 2003.
Petitioners testified that following the success of
California Digital, Inc., in the mid-1980s, they borrowed funds
from the corporation to pay off the outstanding balances due on
the mortgages on the property, and that after making these
payoffs, they began to pay back the corporation by making
mortgage payments to it. Petitioners testified that they agreed
to pay California Digital, Inc., $450,000 at an annual rate of
9.544 percent, payable in full on or before February 13, 2008.
As evidence of this arrangement, petitioners point to the
California Digital, Inc. return for 2003 which shows a $450,000
loan to shareholders. Petitioners also testified that a
promissory note secured by deed of trust was executed on or about
February 13, 1988, between petitioners and California Digital,
Inc.
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Petitioners’ position is that because they made interest-
only home mortgage payments on a $450,000 loan secured by their
home to the corporation, they are entitled to claim a home
mortgage interest deduction for 2003. Respondent argues that
there is no valid proof that petitioners made such payments. For
the reasons discussed infra we agree with respondent.
Contrary to petitioners’ testimony, no creditworthy
promissory note secured by deed of trust was produced at trial.
Petitioners attempted to have the Court receive into evidence a
document entitled “Promissory Note Secured by Deed of Trust”.
This document recited a promise on the part of petitioners to
repay California Digital, Inc., $450,000 at an annual interest
rate of 9.544 percent. Upon examination of the document, the
Court suspected that it was self-serving and inauthentic. To
wit, although the paper was lightly affixed with a raised,
notary’s stamp, it appeared in all other ways (printed on an ink-
jet printer; multiple grammar and spelling errors; undated on
signature line; not witnessed or signed by the notary) to be a
poor reconstruction of a purported promissory agreement between
petitioners and their corporation, California Digital, Inc. When
further questioned by the Court, petitioners finally admitted
that the document was not an authentic copy of a promissory note
but rather their attempt to reconstruct the terms of the loan
that they testified was entered into between them and California
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Digital, Inc., in 1988. Petitioners insisted that a promissory
note was, in fact, executed in 1988 but that they were unable to
presently find a copy of it. Because petitioners did not produce
an authentic copy of any promissory note evincing the existence
of any loan, the presumption is that such evidence--if it indeed
existed--would not have been favorable to petitioners. See
Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158
(1946), affd. 162 F.2d 513 (10th Cir. 1947).
Second, and also contrary to petitioners’ testimony, there
was no recordation of any mortgage on the property held by
California Digital, Inc. Petitioners testified that the mortgage
was recorded on the property on the morning of the Tax Court
trial, 9 years after the purported title transfer. Over
respondent’s objections, petitioners attempted to have a copy of
the recordation received into evidence, contending that because
the recordation referenced the promissory instrument, the
recordation should suffice as evidence that a promissory note did
exist. The Court sustained respondent’s objections and refused
to receive the recordation into evidence.
Third, and finally, petitioners’ testimony as to how their
mortgage payments were made to California Digital, Inc., was
contradictory, self-serving, and incredible. First, petitioners
testified that they made mortgage payments to the corporation
during 2003 out of the salary that California Digital, Inc., paid
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to petitioner husband. Petitioners’ 2003 return does not reflect
that petitioners received any salary income in 2003, and the
California Digital return does not show that the corporation paid
any salaries to any of its officers or employees during the year
in issue. When the foregoing was brought to petitioners’
attention at trial, they changed their account, testifying that
the payments were made to the corporation by personal check and
that the payments were recorded as corporate journal entries.
When questioned further by the Court as to any evidence of such
journal entries, petitioners again changed their testimony.
Petitioners then testified that the payments were recorded by the
corporation as book entries, although only their accountant--who
was not in court--could confirm this. Finally, petitioners
testified that the payments--totaling $42,950--were subtracted
from a $304,523 loan that petitioners had previously made to the
corporation. The California Digital, Inc. return, however, shows
that the amount of the loan decreased by only $2,820--and not
$42,950--during the year in issue. Accordingly, we conclude that
petitioners’ confusing and constantly changing line of testimony
with respect to the payments is entirely incredible, and supports
respondent’s position that petitioners cannot substantiate that
any home mortgage interest payments were made to California
Digital, Inc., during 2003.
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In sum, petitioners provided no documentation before,
during, or after trial, such as canceled checks, that would
substantiate their claim that they paid $42,950 of home mortgage
interest, the deduction for which respondent disallowed.
Accordingly, without any credible evidence that petitioners
actually paid the $42,950, we sustain respondent’s determination
with respect to petitioners’ 2003 income tax liability.
To reflect the foregoing,
Decision will be entered
for respondent.