T.C. Summary Opinion 2008-159
UNITED STATES TAX COURT
RANDOLPH BRUCE AND RITA C. BEASLEY, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 1023-07S. Filed December 23, 2008.
Randolph Bruce and Rita C. Beasley, pro sese.
Spencer T. Stowe, for respondent.
GERBER, Judge: This case was heard pursuant to the
provisions of section 74631 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,
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for 2002, the taxable year at
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
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and this opinion shall not be treated as precedent for any other
case. Respondent determined a $2,226 deficiency in petitioners’
Federal income tax for 2002. The issues for our consideration
are: (1) Whether petitioners are entitled to claim a loss in
connection with their activity involving the rental of a
powerboat; and (2) whether petitioners are entitled to certain
business deductions in amounts greater than those respondent
allowed.
Background2
At the time their petition was filed, petitioners resided in
California. Petitioners were married during 2002. During 2002
Mr. Beasley was a crime scene investigator with the San
Bernardino County Sheriff’s Department. Petitioners owned two
single-family homes that they rented during 2002.
Mr. Beasley enjoyed fishing. Because he was approaching
retirement, he planned to start a sport fishing charter business.
It was his goal to take out fishing charters and/or to sublease a
boat to others. He purchased a boat that was located in Alabama
during June 2001. The boat was 32 feet long and had two
staterooms so that six people could sleep on the boat. The boat
was delivered to Mr. Beasley during July 2001. When the boat
arrived, he discovered that there was a problem with odors
2
The stipulated facts and the accompanying exhibits are
incorporated herein by this reference.
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emanating from the sanitation system. The odor problem limited
the amount for which the boat could be rented. Ultimately, the
entire sanitation system had to be replaced and the boat had to
be thoroughly cleaned.
Blisters discovered in the fiberglass hull early in 2002
caused the boat to be out of the water one-third of that year.
At this point, Mr. Beasley discovered that he would have to be
specially licensed to take out charters consisting of six
persons. Instead of taking out charters, he attempted to place
the boat in a harbor where it could be rented as sleeping
quarters, like a hotel, where the boat remains in the harbor
slip. That effort was also unsuccessful while the odor problem
continued.
For 2002 petitioners reported $2,800 in income from boat
rental on a Schedule C, Profit or Loss From Business.
Petitioners also reported $22,275 in deductions for a claimed
loss of $19,475 from the boat rental activity for 2002. Most of
the $22,275 comprised depreciation, mortgage interest,
maintenance, and slip fees. The rental income did not increase
for 2003. The “rentals” consisted of payments by petitioner’s
brother and friends in exchange for sharing his boat for a
fishing trip.
During 2002 Mrs. Beasley operated a daycare business out of
petitioners’ home. Petitioners claimed $7,118 for food expenses
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in connection with the operation of the daycare business.
Respondent, after audit, allowed one-half or $3,559. The
remaining food expenses were disallowed on the basis that
petitioners had not shown the amounts were paid or incurred and
were ordinary and necessary business expenses. Petitioners
computed the $7,118 as a percentage of their total food
expenditures. They had receipts for food totaling $11,434, which
represented food for the daycare children as well as for
petitioners. They determined that approximately 70 percent or
about $8,118 was for business and the remainder was for personal
use. To be on the safe side, they decreased that amount by
$1,000 and claimed only $7,118.
During 2002 petitioners had a daughter, age 18, and a son,
age 19, who lived at home and assisted Mrs. Beasley in the
operation of the daycare business. Normally, there were 13
children being cared for in the daycare business, and Mrs.
Beasley’s son and daughter assisted with the children. As an
example, the daughter changed diapers and the son supervised the
children in the yard. The amount of time that was spent
assisting was loosely kept track of, and petitioners would pay
their children in cash and by purchasing items for them. During
2002 both children were claimed as dependents of petitioners.
At the end of the year petitioners would go through check
and credit card records and isolate payments made to and
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purchases made for their children. Using this method,
petitioners determined that their son received payments and
benefits of $2,898, which petitioners reduced by approximately
$1,000 to account for items that petitioners would have purchased
for him as part of his support. Likewise, petitioners determined
that their daughter received payments and benefits of $4,097,
which petitioners reduced by approximately $3,000 to account for
items that petitioners would have purchased for her as part of
her support.
Many of the items petitioners purchased for their children
included medicine, car insurance, automobile-related items,
healthcare, and payments to a college. Petitioners deducted
$3,145 as the cost of labor for their children’s assistance in
the daycare business, and respondent disallowed the entire
amount.
Petitioners deducted $4,502 as a business expense for use of
their motor vehicles, and respondent allowed one-half or $2,251.
During 2002 petitioners owned two automobiles and one truck.
The $4,502 deduction was based on an estimate of the percentage
of business mileage times the total annual mileage for each of
the two vehicles. Using that method, petitioners claimed 70
percent of the total mileage of their truck and 15 percent of the
total mileage of one of their automobiles. Petitioners did not
keep specific records as to whether the business mileage was for
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the boat rental, daycare, or Mr. Beasley’s noncommuting
transportation in connection with his job.
Discussion
I. Boat Rental Adjustment
The issues involving the $19,475 loss claimed with respect
the boat are somewhat involved. Because the income from the boat
was shown as being derived from rentals, respondent determined
that the resulting loss was from a passive activity within the
meaning of section 469. With certain exceptions, losses from
passive activities cannot be deducted from nonpassive income
(such as wages) but may be carried forward and deducted against
future years’ passive income. An exception involves a rental
real estate activity as defined in section 469(i). Rental real
estate losses are deductible from nonpassive income in amounts
that do not exceed $25,000. Sec. 469(i). Respondent determined
that Mr. Beasley’s boat was not “real estate” within the meaning
of section 469(i) and, therefore, the provisions of that section
did not apply. Petitioners had already claimed losses with
respect to the two real estate rental properties, so that the
claimed boat loss could not be absorbed or used to reduce that
passive-activity income.
In the event that the claimed losses from his boat do not
come within the section 469(i) provisions, Mr. Beasley argues, in
the alternative, that his boat activity was a nonpassive
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business. In that event, respondent contends that petitioners
have not shown that their boat activity was a nonpassive activity
and, if they do, respondent alternatively argues that petitioners
failed to substantiate the amounts claimed.
Section 469(i), in pertinent part, provides:
SEC. 469(i). $25,000 Offset for Rental Real Estate
Activities.--
(1) In general.–-In the case of any natural person,
subsection (a) shall not apply to that portion of the
passive activity loss or the deduction equivalent * * *
of the passive activity credit for any taxable year
which is attributable to all rental real estate
activities with respect to which such individual
actively participated in such taxable year * * * .
Petitioners contend that there are examples in the law where
a boat is treated in the same manner as “real estate” and that
approach should carryover into section 469(i). We cannot accept
petitioners’ contention because the above-quoted language is
without ambiguity and applies to “real estate”. Although a boat
may in some instances be treated the same as real estate for tax
purposes, that is not the case in section 469(i). Accordingly,
we sustain respondent’s determination that petitioners are not
entitled to apply boat rental income against nonpassive income.
Alternatively, petitioners contend that they were involved
in a nonpassive activity with respect to the boat. The facts in
this case belie any such contention. Mr. Beasley was not
licensed to take people out and engage in charter activity. In
effect, he engaged in fishing trips with friends and family and
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they paid him in order to defer the cost of the operation of his
boat. Although it was his intent and hope to engage in a charter
business after he retired from his full-time job sometime after
2002, his activity in 2002 was preliminary to any such business;
and a good portion of his expenditures would have been considered
startup expenses that he would be required to capitalize.
Respondent determined in the notice of deficiency that Mr.
Beasley’s loss from rental of the boat was not deductible in 2002
because of section 469 limitations. Respondent also determined
that Mr. Beasley could apply the loss against passive income in
the years after 2002. Respondent did not determine that the
deductions that generated the loss were unsubstantiated.
Respondent questioned the underlying substantiation only in the
setting of petitioners’ alternative argument that the income, and
therefore the loss, was nonpassive or a Schedule C business item.
Because we have decided that Mr. Beasley’s boat-rental activity
resulted in a passive loss, respondent’s original determination
is sustained.
Petitioners raise one additional argument in connection with
the boat. They contend that if they are not entitled to a
passive or nonpassive loss, the boat should be treated as a
“qualified home” for purposes of deducting the mortgage interest
paid on the boat loan. Petitioners deducted $3,032 in mortgage
interest with respect to the boat for 2002. Section 163(h)
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generally provides that no deduction is allowed for personal
interest paid during a taxable year. An exception to that
general rule is any qualified residence interest. Sec.
163(h)(2)(D). Interest paid on a main home or a second home is
deductible as an itemized deduction, subject to certain
limitations. For this purpose, the term “residence” can include
a boat. Secs. 163(h)(4)(A)(i)(II), 280A(d)(1), (f)(1)(A).
Petitioners claim the boat as a second home for the second
home mortgage interest deduction. If a second home is rented or
held out to rent to others, a taxpayer must meet special
requirements before interest is deductible. Those special
requirements are set forth in section 280A(d). Where the home
(boat) is rented, as petitioners claimed in this case, a taxpayer
must use that home for more than 14 days or more than
10 percent of the number of days during the year that the home is
rented at a fair rent, whichever is longer. Sec. 280A(d)(1).
Because petitioners reported $2,800 of rental income, they must
show that they meet the section 280A(d) requirements.
Petitioners have not shown that they meet these requirements, and
therefore their argument that the mortgage interest is deductible
must fail.
II. Daycare Food Deduction
Petitioners claimed $7,118 as an expense for food that was
provided to the children in Mrs. Beasley’s daycare business.
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They arrived at the amount by estimating the food expenses that
were personal and business, because daycare food purchases were
not segregated from other food purchases. Petitioners have been
able to show receipts for food greater than the $7,118 claimed
and the $3,559 respondent allowed. Respondent’s allowance is
based on a 50-percent personal--50-percent business allocation.
Because petitioners claimed about 70 percent of their actual food
purchases, respondent’s 50-percent allowance equals approximately
35 percent of total food purchases.
Under section 162(a) petitioners are entitled to deduct
ordinary and necessary business expenses. Providing meals to
children in the setting of a daycare business can be an ordinary
and necessary business expense. The question is whether
petitioners have shown that the amount claimed was expended for
food for the children.
Petitioners attempted to estimate the amount of food used
for the daycare business by using a percentage of total food
purchases. It is not clear, however, that the percentage
petitioners used reasonably reflects the cost of the food used to
feed the children in the daycare business. Petitioners caused
this dilemma because they did not take care to purchase food
separately or to segregate purchases for daycare and personal
use. On the record in this case, petitioners have not
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shown that they are entitled to any amount greater than the
$3,559 respondent allowed.
III. Payments to and Purchases Made for Petitioners’ Children
Petitioners’ children assisted Mrs. Beasley in the operation
of the daycare center, and petitioners deducted $3,145 as payment
for their labor. Under section 162(a) petitioners are entitled
to deduct ordinary and necessary business expenses. The cost of
labor to assist in the operation of the business would certainly
be an ordinary and necessary business expense. The problem we
confront is that petitioners did not pay their children in the
same way they would have paid third parties.
Instead of making a cash or check payment based on an hourly
rate times the hours worked, petitioners provided some cash and
mostly purchased items for their children. Further complicating
their approach, petitioners did not keep records or provide
reliable estimates of the hours worked and failed to segregate
those items that were payments for work performed and items that
petitioners would have purchased to support their children
whether they worked in the daycare or not.
At the end of the year petitioners went through their check
book and/or credit card receipts and picked out all purchases for
their children. The amounts that were clearly for their
children’s support (as opposed to payment in exchange for their
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labor) were not carefully extracted. Instead, petitioners
reduced the total by approximated rough amounts such as $3,000 or
$1,000.
We are convinced that petitioners’ children did assist in
the operation of the daycare business, but we are unable to
accept or adopt petitioners’ approach to arriving at the
deductible amount of their compensation. It is noted that
petitioners’ dilemma is of their own making because they failed
to keep specific or accurate records of the hours worked by their
children and the amounts paid for their children’s services.
With that in mind, we find that petitioners are entitled to
$2,000 of the $3,145 claimed as a deduction for their children’s
labor in the daycare business.
IV. Use of Motor Vehicles
Petitioners deducted $4,502 as a business expense for the
use of a truck and an automobile in the operation of their boat
rental and daycare business and for Mr. Beasley’s job. With
respect to the use of listed property such as a truck or an
automobile, in addition to the section 162 requirement that the
expense be ordinary and necessary, section 274(d) requires more
stringent recordkeeping to show entitlement to a deduction.
Secs. 274(d)(4), 280F(d)(4)(A)(i). In particular, a taxpayer
must show with specificity the business use of the listed
property by means of logs and other detailed records.
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Petitioners failed to keep such records of their claimed truck
and automobile expenses.
In spite of the fact that petitioners did not have the
records required by section 274(d), respondent allowed
petitioners a $2,251 deduction, one-half of the claimed truck and
automobile expense deduction. Under the circumstances, the Court
is not in a position to improve on respondent’s largess.
Accordingly, we hold that petitioners are entitled to the $2,251
respondent allowed.
To reflect the foregoing,
Decision will be entered
under Rule 155.