Campbell v. Comm'r

T.C. Summary Opinion 2008-154

UNITED STATES TAX COURT

REYNARD CAMPBELL, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 18402-06S. Filed December 11, 2008.

Reynard Campbell, pro se.

Shannon Edelstone, for respondent.

WHERRY, Judge: This case was heard pursuant to section 7463

of the Internal Revenue Code in effect when the petition was

filed.1 Pursuant to section 7463(b), the decision to be entered

1
All subsequent section references are to the Internal
Revenue Code of 1986, as amended and in effect for the tax year
at issue. Rule references are to the Tax Court Rules of Practice
and Procedure.
 - 2 -

is not reviewable by any other court, and this opinion shall not

be treated as precedent for any other case.

Respondent determined a $14,508 deficiency in petitioner’s

Federal income tax for 2004. Respondent also determined a

$2,901.60 accuracy-related penalty under section 6662(a). After

concessions, the issues now before the Court are: (1) Whether

petitioner is entitled to additional deductions claimed on

Schedule C, Profit or Loss From Business, for business gifts,

contract labor, automobile insurance, meals and entertainment,

travel, legal fees, and car and truck expenses; (2) whether

petitioner is entitled to additional deductions claimed on

Schedule E, Supplemental Income and Loss, for repairs to two

multi-unit dwellings used as rental properties (4319 and 4329

Rilea),2 automobile and travel expenses, and legal and

professional fees; (3) whether petitioner is required to

capitalize certain expenditures relating to 4319 and 4329 Rilea;

and (4) whether petitioner is liable for an accuracy-related

penalty under section 6662(a).3

2
The two rental properties are located at 4319 and 4329
Rilea Way in Oakland, California.
3
In addition, respondent made two computational adjustments
that resulted from adjustments to petitioner’s gross and net
incomes--one computational adjustment relates to petitioner’s
itemized deductions and the other to his self-employment taxes.
Those computational adjustments will be resolved in the Rule 155
computation that the Court will direct in accordance with this
opinion.
 - 3 -

Background

Some of the facts have been stipulated, and the stipulated

facts and accompanying exhibits are hereby incorporated by

reference into our findings. At the time he filed his petition,

petitioner resided in California.

Petitioner Reynard Campbell is very industrious. He is a

certified public accountant (C.P.A.). In 2004 he was employed by

Bay Area Rapid Transit (BART). In addition, he maintained his

own auditing and accounting business, with respect to which he

reported a Schedule C loss of $3,191 on his Form 1040, U.S.

Individual Income Tax Return, for the 2004 tax year.4 He also

reported a Schedule E loss of $4,889 relating to 4319 and 4329

Rilea Way.5

On August 17, 2006, respondent issued a notice of deficiency

principally disallowing many of petitioner’s claimed Schedule C

and Schedule E deductions. Petitioner filed a timely petition

with this Court on September 12, 2006. A trial was held on May

23 and 25, 2007, in San Francisco, California.

At trial petitioner introduced 132 exhibits (including all

joint exhibits) many of which included multiple pages. These

4
Petitioner calculated that loss by subtracting $20,404 in
reported business expenses from $17,213 in reported business
income.
5
Petitioner calculated that loss by subtracting $77,964 in
expenses from $73,075 in rents received.
 - 4 -

documents established that many expenses were incurred and paid.

However, they frequently failed to demonstrate that the expenses

were deductible business expenses rather than nondeductible

personal expenses or they did not contain the detailed

contemporaneous information necessary to satisfy the heightened

substantiation requirements of section 274.

Discussion

I. Burden of Proof

The Commissioner’s determination of a taxpayer’s liability

is generally presumed correct, and the taxpayer bears the burden

of proving that the determination is improper. See Rule 142(a);

Welch v. Helvering, 290 U.S. 111, 115 (1933). However, pursuant

to section 7491(a), the burden of proof on a factual issue that

affects the taxpayer’s tax liability may shift to the

Commissioner where the “taxpayer introduces credible evidence

with respect to * * * such issue.” Petitioner argues that the

burden of proof shifts to respondent because petitioner has

produced credible evidence to substantiate his expenses and

because he “attended an office interview and appeals”. Because

petitioner has not complied with the requirements to substantiate

the remaining disallowed expenses and has not maintained all

required records regarding those expenses, that argument is

unpersuasive. Consequently, the burden of proof remains on

petitioner.
 - 5 -

II. General Deduction Rules

Deductions are a matter of legislative grace, and the

taxpayer must maintain adequate records to substantiate the

amounts of any deductions or credits claimed. Sec. 6001;

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); sec.

1.6001-1(a), Income Tax Regs.

Generally, the Court may allow for the deduction of a

claimed expense even where the taxpayer is unable to fully

substantiate it, provided the Court possesses an evidentiary

basis for doing so. Cohan v. Commissioner, 39 F.2d 540, 543-544

(2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743

(1985); sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed.

Reg. 46014 (Nov. 6, 1985). In these instances, the Court is

permitted to approximate the allowable expense, bearing heavily,

if it so chooses, against the taxpayer whose inexactitude is of

his or her own making. Cohan v. Commissioner, supra at 544.

III. Deductibility of Expenses Relating to Petitioner’s Schedule
C and Schedule E Businesses

Section 162(a) authorizes a deduction for “all the ordinary

and necessary expenses paid or incurred during the taxable year

in carrying on any trade or business”. A trade or business

expense is ordinary for purposes of section 162 if it is normal

or customary within a particular trade, business, or industry and

is necessary if it is appropriate and helpful for the development

of the business. Commissioner v. Heininger, 320 U.S. 467, 471
 - 6 -

(1943); Deputy v. du Pont, 308 U.S. 488, 495 (1940). In

contrast, “personal, living, or family expenses” are generally

nondeductible. Sec. 262(a).

Certain business expenses described in section 274(d) are

subject to strict substantiation rules that supersede the Cohan

doctrine. Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968),

affd. per curiam 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a),

Temporary Income Tax Regs., supra. Section 274(d) applies to:

(1) Any traveling expense, including meals and lodging away from

home; (2) entertainment, amusement, and recreational expenses;

(3) any expense for gifts; or (4) the use of “listed property”,

as defined in section 280F(d)(4), including passenger

automobiles. To deduct expenses to which section 274(d) applies,

the taxpayer must substantiate by adequate records or sufficient

evidence to corroborate the taxpayer’s own testimony: (1) The

amount of the expenditure or use, which includes mileage in the

case of automobiles; (2) the time and place of the travel,

entertainment, or use; (3) its business purpose; and in the case

of entertainment, (4) the business relationship to the taxpayer

of each expenditure or use. Sec. 274(d) (flush language).

A. Expenses Not Subject to Section 274(d)

1. Contract Labor

Petitioner argues that he is entitled to deduct contract

labor expenses in addition to the $1,699 respondent conceded on
 - 7 -

brief. After this concession, $310 remains in dispute. This

amount appears to be comprised of (1) $170 that petitioner paid

his then girlfriend, Joyce Jones (Ms. Jones), who is now his

wife, in June 2004, for “office help” and (2) $140 that

petitioner paid Ling T. Lin (Ms. Lin) in October 2004 purportedly

to reimburse her for providing a contract employee of

petitioner’s named Ethel Lu (Ms. Lu) with lodging while Ms. Lu

was working on an audit for petitioner in October 2003.

Petitioner has provided copies of canceled checks evidencing

those payments, both of which reflect notations that they were

for contract labor. Nevertheless, as explained below, petitioner

has failed to carry his burden of substantiating at least one of

those claimed business expenses.

At trial petitioner testified that Ms. Jones “would assist

me in my business, and, you know, just doing things and which I

did not pay her for, so from time to time I would just simply

give her a gift.” The record also contains copies of two

canceled checks for $200 and $150 made payable to Ms. Jones for

“BG”, which is short for business gifts. Ms. Jones did not

testify at trial. Although petitioner paid Ms. Jones $170 on

June 25, 2004, the purpose of that payment is unclear. No

evidence was introduced at trial that Ms. Jones included the $170

in her gross income. Moreover, even if it was a nontaxable

business gift to Ms. Jones, it would not be deductible to the
 - 8 -

extent that it exceeded the maximum allowable gift limitation of

$25. See sec. 274(b)(1). As a result, petitioner has failed to

satisfy his burden of proving that the payment was income to Ms.

Jones and a deductible business expense for him.

The precise reason for petitioner’s $140 payment to Ms. Lin

in October 2004 is similarly opaque. The record contains a copy

of a canceled $160 check from Ms. Lu to Ms. Lin dated October 22,

2003, $140 of which was for “rent”. Also of record are (1) a

note from Ms. Lu to petitioner dated February 17, 2004, in which

Ms. Lu requested that petitioner reimburse her for the $140 that

she had paid Ms. Lin the previous year and (2) a letter from Ms.

Lin to petitioner dated August 3, 2004, informing petitioner that

Ms. Lu had paid Ms. Lin $140 and asking petitioner to reimburse

Ms. Lu for that expense. For reasons unknown, petitioner then

paid Ms. Lin $140 in October 2004. Thus, even accepting

arguendo, as the Court does, that petitioner had agreed to

reimburse Ms. Lu for her living expenses and that such

reimbursement would have been an ordinary and necessary business

expense of petitioner, there is only ambiguous evidence that

petitioner ever actually did so. Nevertheless, the Court will

accept petitioner’s testimony, which is corroborated by Ms. Lu’s

note, that the $140 payment to Ms. Lin was for a deductible

business expense and that the accounting was ultimately sorted
 - 9 -

out by Ms. Lu and Ms. Lin. We will therefore allow the claimed

$140 deduction.

2. Legal Fees

Legal fees are ordinarily deductible under section 162 on

Schedule C only if (1) the matter with respect to which the fees

were incurred originated in the taxpayer’s trade or business and

(2) the claim is sufficiently connected to that business. See

United States v. Gilmore, 372 U.S. 39 (1963); Test v.

Commissioner, T.C. Memo. 2000-362, affd. 49 Fed. Appx. 96 (9th

Cir. 2002).

Petitioner argues that he is entitled to a Schedule C

deduction for $2,000 in retainer fees paid to an attorney,

Melinda J. Burns (Attorney Burns), hired to represent him in

seeking to “reopen” a ruling against him, apparently, by the

California State Board of Accountancy.6 Although the record

contains copies of petitioner’s canceled personal checks, one for

$1,800 and the other for $200, to Attorney Burns on April 26,

2004, petitioner no longer possesses a copy of the relevant

retainer agreement because he “misplaced” or “accidentally

shredded it”.

6
On brief, respondent concedes that petitioner is entitled
to a $130 deduction for Schedule C legal and professional fees.
Due to a rounding error, the amount conceded should have been
$131. Respondent has also conceded $171.30 for Schedule E legal
and professional fees.
 - 10 -

Petitioner’s vague testimony sheds little light on his

precise reasons for hiring Attorney Burns. His failure to

produce a copy of the retainer agreement or any other relevant

information does not help matters. Consequently, we are unable

to conclude that the hiring of Attorney Burns was related to his

Schedule C business as opposed to his employment with BART or

some personal matter. See Test v. Commissioner, supra. As a

result, petitioner is not entitled to a Schedule C deduction for

the $2,000 that he paid Attorney Burns in 2004.

The remainder of petitioner’s claimed Schedule C legal fees

relate to his purchase of prepaid legal services. Petitioner has

provided bank statements relating to his auditing and accounting

business that reflect seven monthly payments to LawAmerica, Inc.,

in 2004 for the purchase of prepaid legal services.7 Although

those bank statements reflect that petitioner used that account

to pay for both personal expenses and business expenses, we find

credible petitioner’s testimony that the prepaid legal services

were purchased for his business. We will therefore allow

petitioner to deduct legal expenses of $224.47.

After respondent’s $171.30 concession, $579.70 of

petitioner’s claimed $751 in deductions for legal fees associated

7
The first of those payments was for $29.95, and the
remaining six were for $32.42, for a total of $224.47.
 - 11 -

with petitioner’s Schedule E business remains in dispute.8 Of

that amount, $337.50 was incurred when he hired an attorney to

create a revocable inter vivos trust into which he transferred

4319 and 4329 Rilea.9 In his brief, referring to section 1.212-

1(g), Income Tax Regs., petitioner asserts that he did so “to

avoid probate with respect to the income-producing properties

used to fund the trust.”10 He argues that “This purpose lends

support to characterizing the transaction as one for the

conservation and maintenance of property held for the production

o[f] income.”

Petitioner’s argument is unavailing. Except for tax advice,

which is not at issue here, fees paid in connection with the

planning of a taxpayer’s personal or family affairs have long

been considered nondeductible personal expenditures under section

262. See Epp v. Commissioner, 78 T.C. 801, 805-806 (1982);

8
The $751 in disputed deductions for Schedule E legal and
professional fees relates entirely to 4329 Rilea.
9
He paid the attorney, Randall C. Thompson, $675, half of
which he allocated to 4329 Rilea. For unknown reasons, in the
notice of deficiency, respondent did not disallow the other half,
$337.50, allocated to 4319 Rilea. Respondent has not raised that
issue in these proceedings.
10
Under sec. 212(2), a deduction is allowed for ordinary and
necessary expenses paid or incurred “for the management,
conservation, or maintenance of property held for the production
of income”. Sec. 1.212-1(g), Income Tax Regs., addresses the
deductibility of “Fees for services of investment counsel,
custodial fees, clerical help, office rent, and similar expenses
paid or incurred by a taxpayer in connection with investments
held by him”.
 - 12 -

Bagley v. Commissioner, 8 T.C. 130, 135 (1947). Moreover,

avoiding probate would not have benefited petitioner in producing

income for himself. See Epp v. Commissioner, supra at 805-806

(“[E]ven if the creation of the trust would save some probate

expenses, such savings would not benefit the petitioner, but

would benefit her estate or her sisters.”). Petitioner has not

demonstrated that any portion of the fees paid to create an inter

vivos trust is deductible under either section 162 or section

212.

A review of petitioner’s bank records reveals that the

remaining disputed Schedule E deductions for legal and

professional fees relate to membership fees petitioner paid,

apparently to the Rental Housing Association of Northern Alameda

County.11 We will allow him a deduction of $252.10 for those

expenses.12

11
The bank statements reflect a $75 debit in August 2004 and
a $210 debit in November 2004 by “Rental Housing Associat”.
Because petitioner was a landlord in Oakland, California, it is
reasonable to infer that the “Rental Housing Associat” was the
Rental Housing Association of Northern Alameda County, “a
nonprofit trade association representing over 20,000 rental
property owners in the cities of Oakland, Berkeley, Alameda,
Albany, Emeryville, and Piedmont.”

12
Although petitioner only requests $232.50 in deductions,
that appears to be because of a mathematical error. In his
general ledger, he apparently allocated $32.50 of the $75 August
2004 membership payment to 4319 Rilea and $32.50 of that $75
payment to 4329 Rilea, leaving $10 unaccounted for.
 - 13 -

B. Expenses Subject to Strict Substantiation Under Section
274(d)

1. Automobile Expenses

Petitioner owns five automobiles and claims that he used one

car and two pickup trucks in his Schedule C and Schedule E

businesses. He claims that he is entitled to deductions using

the actual cost method for expenses relating to those vehicles.

The car is a Nissan Maxima that petitioner purchased on March 11,

2003, for which he also claimed a $3,938 mileage deduction on

Schedule A, Itemized Deductions. Respondent has not challenged

that deduction. We note that taxpayers are prohibited from

claiming duplicate expenses on the same automobile by deducting

an automobile expense using the actual cost method and using the

standard mileage rate. See Tesar v. Commissioner, T.C. Memo.

1997-207 (“Automobile expense may be computed using actual costs,

such as depreciation, or using the standard mileage method; thus,

petitioners cannot deduct depreciation expense and use the

standard mileage rate.”).13 The trucks are a Toyota (model

unknown) and a Ford Ranger.

Respondent has conceded that of the $3,521 of automobile

insurance in dispute, petitioner is entitled to a $1,599

13
To allow taxpayers to claim both would be to allow double
dipping. See Campana v. Commissioner, T.C. Memo. 1990-395
(noting that “the standard mileage rate includes an allowance for
depreciation, as well as for maintenance and repairs, tires,
gasoline, oil, insurance, and registration fees”).
 - 14 -

deduction for insurance on the Toyota truck.14 The remaining

$1,500 Schedule E deduction for that vehicle relates to “engine

work” allegedly preformed by petitioner’s friend, which

petitioner paid for in cash. Petitioner’s self-serving testimony

alone is insufficient to support that deduction.

Petitioner claims that he is entitled to a $6,750 Schedule E

deduction for the purchase of the Ford Ranger. His testimony

relating to that vehicle was particularly evasive and perplexing.

He claims to have paid an unnamed individual $6,750--in the form

of a cashier’s check--for that vehicle, apparently at some point

in 2003. He testified that he was sure he had a copy of that

check somewhere in his house, but it was never provided. He also

testified that he never had the truck insured, that he intended

to use it in his business, and that he then sold it for a price

that he could not remember. He has therefore failed to

substantiate any deductions relating to that vehicle.

Petitioner argues that he is entitled to a $5,716 Schedule C

deduction for expenses relating to the Nissan Maxima, which he

14
Petitioner has conceded that he is not entitled to
deductions for the insurance premiums paid in 2004 on his two
other cars, a Honda Civic ($381) and a Chevrolet Impala ($449).
After the parties’ concessions, the amount of automobile
insurance still in dispute relates primarily to the Nissan Maxima
($804). Petitioner is not entitled to a deduction for that
amount, as is discussed later in this section of the opinion.
The remaining $288 in dispute is from a prior balance on
petitioner’s account with his insurance company. Because he has
introduced no evidence regarding his prior balance, petitioner is
not entitled to a deduction for paying it off in 2004.
 - 15 -

claims to have used exclusively (or almost exclusively) in

connection with his auditing business.15 However, he has failed

to introduce adequate evidence to show which part of the

automobile expense, if any, was personal and which part, if any,

related to his Schedule C business. The document prepared by

petitioner shortly before trial and his numerous receipts and

bank statements are not sufficiently probative for that purpose.

See sec. 1.274-5T(c)(1), Temporary Income Tax Regs., 50 Fed. Reg.

46016 (Nov. 6, 1985).

At trial petitioner appears to have argued that because of

his accounting and rental businesses all of his travel was

business related and he never incurred commuting expenses. We

are unpersuaded and believe that he used the Nissan Maxima to

commute to his full-time job with BART. In fact, on his Schedule

C, petitioner stated that he drove the Nissan Maxima 10,200 miles

for business, 2500 miles for commuting, and 300 miles for

“Other”. Petitioner’s trial testimony also suggests that BART

sometimes required him to use the Nissan Maxima for work and that

15
How petitioner came up with $5,716 is not determinable
from the record. We are also perplexed by our observations that
respondent appears to have allowed petitioner (1) a $4,900
depreciation deduction on the Nissan Maxima claimed on Form 4562,
Depreciation and Amortization, filed with respect to 4329 Rilea
for 2004, which was then included on line 20 of Schedule E and
deducted as part of his $4,889 rental loss on line 17 of his Form
1040 and (2) a $3,938 Schedule A mileage deduction relating to
the Nissan Maxima for 10,500 miles for 2004, as was asserted by
petitioner on Form 2106-EZ, Unreimbursed Employee Business
Expenses.
 - 16 -

he might have been reimbursed by BART for such use. This

undercuts his argument that he used that vehicle exclusively for

his Schedule C business.16 Accordingly, for all the reasons

stated, the Court sustains respondent’s adjustment as to this

issue.

2. Meals and Entertainment Expenses

Petitioner has provided copies of a number of receipts, some

of which are illegible, in support of claimed deductions of

$1,155 for what he characterizes as “small value meals incurred

when meeting and dealing with perspective [sic] clients and

colleagues with matters associated with Petitioner’s business.”17

He has also produced a self-prepared “General Ledger” detailing

monthly charges to his bank account for “Travel, meals &

entertain.” along with copies of associated bank records.

Because petitioner has provided neither the name of even a

single person with whom he met nor any corroborating evidence

that the claimed expenditures for business meals had a business

purpose, he has not demonstrated entitlement to deductions for

16
Commuting expenses are generally considered personal and
nondeductible. Commissioner v. Flowers, 326 U.S. 465, 473-474
(1946); sec. 1.162-2(e), Income Tax Regs.
17
Petitioner improperly claimed the entire $1,155 as a
deduction without accounting for the 50-percent reduction imposed
by sec. 274(n).
 - 17 -

business meals.18 See sec. 1.274-5T(b)(3)(iv) and (v), Temporary

Income Tax Regs., 50 Fed. Reg. 46015 (Nov. 6, 1985). Although he

asks us to apply our discretion to allow him some deductions for

those expenses, as noted earlier, the strict substantiation

requirements of section 274(d) preclude us from doing so. See

supra p. 6. Accordingly, we sustain respondent’s determination

on this issue.

3. Expenses for Business Gifts

Petitioner claims entitlement to a deduction of $1,426 for

business gifts. Under section 274(b), no deduction is allowed

under section 162 for any expense for gifts made directly or

indirectly to any individual to the extent that such expense

exceeds $25. Of petitioner’s 13 claimed business gifts, 11

exceed $25.19

Additionally, to substantiate expenses relating to gifts, a

taxpayer must provide adequate records or corroborating evidence

showing, among other things, the business purposes of the gifts

and the business relationships between the taxpayer and the gift

recipients. Sec. 274(d); sec. 1.274-5T(b)(5), (c), Temporary

18
Moreover, we agree with respondent that some of the meals
for which petitioner claimed deductions appear to have been for a
single person.
19
Petitioner lists only 12 business gifts in his self-
prepared ledger. However, his final ledger entry under the
heading “Business gifts” is for $141.33. The $141.33 actually
represents two separate purported business gifts, one for $76.10
and the other for $65.23.
 - 18 -

Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985). The

evidence petitioner presented falls far short of satisfying that

standard, and petitioner’s trial testimony does not help matters.

Although petitioner characterized many of the claimed business

gifts as charitable contributions, he failed to demonstrate that

they were to organizations described in section 170(c)(2) for

which a charitable contribution deduction can be claimed under

section 170(a).

Nevertheless, we will allow petitioner two Schedule A

deductions--one for $20 paid to Skyline High School on June 4,

2004, and one for $50 paid to the San Francisco Aids Foundation

on September 3, 2004.20 The rest of petitioner’s claimed

business gifts were to individuals or organizations for which

there is no evidence they were qualifying organizations under

section 170(c)--some were even personal gifts to his girlfriend

and mother. Additionally, petitioner has not demonstrated that

any of those claimed business gifts were ordinary and necessary

business expenses or that they qualify as charitable contribution

20
Skyline High School is a public high school in Oakland,
California. In accordance with sec. 170(c)(1), we will allow
petitioner a Schedule A itemized deduction for the $20 paid to
Skyline High School. The San Francisco Aids Foundation is listed
in IRS Publication 78, Cumulative List of Organizations described
in Section 170(c) of the Internal Revenue Code of 1986. We will
therefore allow petitioner a Schedule A itemized deduction for
the $50 paid to that organization. See sec. 170(c)(2).
 - 19 -

deductions. He is therefore not entitled to deductions for those

expenditures.

4. Travel Expenses

Section 162(a)(2) permits taxpayers to deduct travel

expenses incurred “while away from home in the pursuit of a trade

or business.” The phrase “away from home”, as it is used in

section 162(a)(2), means that the taxpayer must be on a trip

requiring sleep or rest. See United States v. Correll, 389 U.S.

299, 303-304 (1967).

Petitioner’s “home” for purposes of section 162(a)(2) is

in Oakland, California.21 His Schedule C and Schedule E

businesses are also located there. The only specific business

trips “away from home” that petitioner alleges with respect to

2004 were “to Rancho Cordova to take training.” However, he has

no documentation to support any of those trips. Consequently, he

has not substantiated the claimed travel expenses of $1,405, and

we sustain respondent’s determination on this issue.

21
A taxpayer’s home, for purposes of sec. 162(a)(2), “means
the vicinity of the taxpayer’s principal place of employment and
not where his personal residence is located, if such residence is
located in a different place from his principal place of
employment.” Kroll v. Commissioner, 49 T.C. 557, 561-562 (1968).
Petitioner lives and has a full-time job in Oakland, California.
 - 20 -

IV. Whether Petitioner Was Required To Capitalize Certain
Expenditures Relating to 4319 and 4329 Rilea

The parties’ $2,283 dispute with respect to 4319 Rilea

concerns petitioner’s deductions for expenses incurred to install

a garage door opener and a vinyl floor.22 Their $3,581 dispute

with respect to 4329 Rilea concerns petitioner’s deductions for

expenses incurred to (1) replace a garage door opener, (2)

replace a formica countertop with a granite countertop, and (3)

refinish cabinets.

Citing section 1.162-4, Income Tax Regs., petitioner argues

that he was not required to capitalize “repair expenses” for work

done on 4319 and 4329 Rilea. Respondent counters that the

repairs petitioner made must be capitalized because they were in

the nature of replacements or improvements that substantially

prolonged the useful lives of petitioner’s properties.

Section 263 generally prohibits deductions for capital

expenditures. Nondeductible capital expenditures include “Any

amount paid out * * * for permanent improvements or betterments

made to increase the value of any property”. Sec. 263(a)(1).

In contrast, deductible expenditures include those made merely to

maintain property in operating condition. See Ill. Merchs. Trust

Co. v. Commissioner, 4 B.T.A. 103, 106 (1926) (“A repair is an

22
On brief, respondent concedes that petitioner is entitled
to a $195 deduction relating to 4319 Rilea, apparently for
expenses incurred in patching discolored carpeting in the hallway
and living room.
 - 21 -

expenditure for the purpose of keeping the property in an

ordinarily efficient operating condition.”). The distinction

between a nondeductible capital expenditure and a deductible

repair is summarized in section 1.162-4, Income Tax Regs.:

The cost of incidental repairs which neither materially
add to the value of the property nor appreciably
prolong its life, but keep it in an ordinarily
efficient operating condition, may be deducted as an
expense, provided the cost of acquisition or production
or the gain or loss basis of the taxpayer’s plant,
equipment, or other property, as the case may be, is
not increased by the amount of such expenditures.
Repairs in the nature of replacements, to the extent
that they arrest deterioration and appreciably prolong
the life of the property, shall either be capitalized
and depreciated in accordance with section 167 or
charged against the depreciation reserve if such an
account is kept.

The deductibility of repair expenses also depends upon the

context in which the repairs are made. Courts have held that

expenses incurred as part of a general plan of rehabilitation

must be capitalized even if they would have been deductible as

ordinary and necessary business expenses if separately incurred.

See United States v. Wehrli, 400 F.2d 686, 689 (10th Cir. 1968);

Norwest Corp. v. Commissioner, 108 T.C. 265, 280 (1997).

Contrary to petitioner’s belief, a number of the disputed

deductions relate to expenditures made to improve, not maintain,

his rental properties. The installation of new flooring in 4319

Rilea, the installation of the new granite kitchen countertop in

4329 Rilea, and the replacement of two garage door openers that
 - 22 -

petitioner has acknowledged were broken and unused were

improvements or replacements that added to the value of his

residential rental properties. As such, petitioner was required

to capitalize them.23 However, we will allow petitioner to

deduct $1,250 that he paid to strip and refinish kitchen cabinets

as part of “regular maintenance” of 4329 Rilea.24

V. Section 6662 Penalty

The notice of deficiency included the imposition of an

accuracy-related penalty under section 6662(a).25 Under section

7491(c), respondent bears the burden of production with respect

to petitioner’s liability for the section 6662(a) penalty. This

means that respondent “must come forward with sufficient evidence

indicating that it is appropriate to impose the relevant

23
We note respondent’s concession that “petitioner may be
entitled to segregate out the amounts spent on removing the
formica countertop and the garage door openers” and deduct,
rather than capitalize, those removal costs, if any. Petitioner
has not attempted to do so.
24
In light of this deduction, petitioner is not entitled to
$179 of depreciation that respondent had allowed with respect to
the refinished cabinets. Respondent had allowed $784 of
depreciation with respect to 4319 Rilea and 4329 Rilea. In light
of this adjustment, petitioner is entitled to a revised $605
depreciation deduction adjustment.
25
The explanatory form attached to the notice of deficiency
apprised petitioner that the sec. 6662 penalty was being imposed
on the basis of one or more of the elements set forth in sec.
6662(b). In respondent’s pretrial memorandum and on brief,
respondent argues for the imposition of the penalty on two
grounds--that petitioner substantially understated his income tax
and that such understatement was attributable to negligence or
disregard of the rules or regulations.
 - 23 -

penalty.” Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

Respondent has done so.

Subsection (a) of section 6662 imposes an accuracy-related

penalty on an underpayment of tax that is equal to 20 percent of

any underpayment that is attributable to a list of causes

contained in subsection (b). Among the causes justifying the

imposition of the penalty are (1) negligence or disregard of

rules or regulations and (2) any substantial understatement of

income tax. Sec. 6662(b)(1) and (2). Section 6662(c) defines

negligence as “any failure to make a reasonable attempt to comply

with the provisions of this title”. “[D]isregard” is defined to

include “any careless, reckless, or intentional disregard.” Id.

Under caselaw, “‘Negligence is a lack of due care or the failure

to do what a reasonable and ordinarily prudent person would do

under the circumstances.’” Freytag v. Commissioner, 89 T.C. 849,

887 (1987) (quoting Marcello v. Commissioner, 380 F.2d 499, 506

(5th Cir. 1967), affg. on this issue 43 T.C. 168 (1964) and T.C.

Memo. 1964-299), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501

U.S. 868 (1991).

There is a “substantial understatement” of income tax for an

individual in any tax year where the amount of the understatement

exceeds the greater of (1) 10 percent of the tax required to be

shown on the return for the taxable year or (2) $5,000.

Sec. 6662(d)(1)(A). However, the amount of the understatement is
 - 24 -

reduced to the extent it is attributable to an item (1) for which

there is or was substantial authority for the taxpayer’s

treatment thereof, or (2) with respect to which the relevant

facts were adequately disclosed on the taxpayer’s return or an

attached statement and there is a reasonable basis for the

taxpayer’s treatment of the item. See sec. 6662(d)(2)(B).

There is an exception to the section 6662(a) penalty when a

taxpayer can demonstrate (1) reasonable cause for the

underpayment and (2) that the taxpayer acted in good faith with

respect to the underpayment. Sec. 6664(c)(1). Regulations

promulgated under section 6664(c) further provide that the

determination of reasonable cause and good faith “is made on a

case-by-case basis, taking into account all pertinent facts and

circumstances.” Sec. 1.6664-4(b)(1), Income Tax Regs.

On brief, petitioner argues that he did not substantially

understate his 2004 income tax because his claimed deductions

were proper. At trial he testified that he relied on Internal

Revenue Service (IRS) Publication 463, Travel, Entertainment,

Gift, and Car Expenses, and Publication 527, Residential Rental

Property, in claiming the disallowed deductions. Respondent

counters that petitioner is a C.P.A. who failed to maintain

adequate records and claimed deductions for business expenses

that were “purely personal.” Regarding petitioner’s reliance on

the aforementioned IRS publications, respondent asserts that
 - 25 -

petitioner has not demonstrated that his treatment of the

expenses at issue is consistent with the guidance set forth in

those publications.

In light of our conclusions in earlier portions of this

opinion, petitioner substantially understated his 2004 Federal

income tax liability.26 Because he is a C.P.A. who knew or

should have known that he was claiming many deductions to which

he was not entitled, petitioner was negligent in underpaying his

2004 Federal income tax. His asserted reliance on IRS

publications does not demonstrate reasonable cause and good faith

for the underpayment. To begin with, such publications are not

authoritative sources of Federal tax law. See Zimmerman v.

Commissioner, 71 T.C. 367, 371 (1978), affd. without published

opinion 614 F.2d 1294 (2d Cir. 1979). Moreover, even assuming

that reliance on IRS publications could shield petitioner from

the imposition of the section 6662 penalty, the publications he

cites do not support the propositions for which he cites them.

Because petitioner has not demonstrated reasonable cause and good

faith for the underpayment, we sustain respondent’s imposition of

the section 6662(a) penalty.

26
Respondent asserts correctly that there is a substantial
understatement even after accounting for respondent’s many
concessions. The same is true after accounting for our decision
to allow petitioner to deduct some of his expenditures for
contract labor, charitable gifts, membership fees, repairs, and
prepaid legal services for his businesses in 2004.
 - 26 -

The Court has considered all of petitioner’s contentions,

arguments, requests, and statements. To the extent not discussed

herein, we conclude that they are meritless, moot, or irrelevant.

To reflect the foregoing and concessions made by the

parties,

Decision will be entered

under Rule 155.