Adams v. Comm'r

T.C. Memo. 2010-72

UNITED STATES TAX COURT

ANTHONY J. ADAMS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2563-08. Filed April 13, 2010.

Anthony J. Adams, pro se.

Bryan E. Sladek and Robert D. Heitmeyer, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

VASQUEZ, Judge: For 2003 and 2004 respondent determined

deficiencies in petitioner’s Federal income taxes, additions to

tax, and penalties as follows:

Addition to Tax Penalty
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)

2003 $38,020 $6,304.00 $7,604
2004 20,705 1,983.25 4,141
 - 2 -

As an initial matter, neither party argued or briefed

whether: (1) The Essex Drive trust should have claimed the

mortgage interest deduction pursuant to section 163(h)(4)(D)1 and

the provisions of subchapter J; (2) petitioner could have claimed

the mortgage interest deduction as investment interest, Davies v.

Commissioner, 54 T.C. 170, 176 (1970) (property that was a

residence in the taxpayer’s hands was business property in the

land trust’s hands); or (3) the Essex Drive trust was a mere

nominee, a sham, or should otherwise be disregarded, see Norton

v. Commissioner, T.C. Memo. 2002-137 (land trusts disregarded as

shams and income taxable to beneficiaries). These issues are

deemed waived. See Rule 40; Muhich v. Commissioner, 238 F.3d

860, 864 n.10 (7th Cir. 2001) (issues not addressed or developed

are deemed waived--it is not the Court’s obligation to research

and construct the parties’ arguments), affg. T.C. Memo. 1999-192;

330 W. Hubbard Rest. Corp. v. United States, 203 F.3d 990, 997

(7th Cir. 2000) (same); Larson v. Northrop Corp., 21 F.3d 1164,

1168 n.7 (D.C. Cir. 1994) (declining to reach issues neither

argued nor briefed). Accordingly, our decision in the case will

be based upon the extent to which section 1.163-1(b), Income Tax

1
Unless otherwise indicated, all section references are to
the Internal Revenue Code (I.R.C.) in effect for the year in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
 - 3 -

Regs., applies and on the arguments the parties asserted or

briefed with respect thereto.

For 2003 and 2004, respectively, respondent concedes that

petitioner is entitled to deductions for: (1) State and local

income taxes of $3,823 and $4,161; (2) real estate taxes of

$3,346 and $5,020; (3) charitable contributions of $11,263 and

$11,637; (4) miscellaneous expenses of $1,330 and $989 (before

application of the section 67(a) 2-percent floor); and (5)

“Schedule E” net losses of $81,226 and $34,645.

The issues remaining for decision for 2003 and 2004 are

whether petitioner is: (1) Entitled to his claimed mortgage

interest deductions; (2) liable for the section 6651(a)(1)

additions to tax; and (3) liable for the section 6662(a)

accuracy-related penalties.

FINDINGS OF FACT

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

Michigan when the petition was filed.

I. The Essex Drive Trust: Formation and Trust Agreement

In 2003 Michael and Zina Gedz transferred legal and

equitable title to 325 Essex Drive (Essex Drive property) for a
 - 4 -

5-year period2 to Equity Holding Corp. as trustee for the Essex

Drive Trust pursuant to a trust agreement. A warranty deed

memorializing the transfer was recorded by the Register of Deeds,

Oakland County, Michigan.3

The trust agreement provides that the purpose of the Essex

Drive Trust is to hold the Essex Drive property and the proceeds

and profits therefrom in trust for the beneficiaries’ use and

benefit. The trustee is to deal with the Essex Drive property

only when the beneficiaries authorize it to do so.

According to the trust agreement, the beneficiaries’

“interests * * * consist solely” of: (1) A power of direction to

authorize the trustee to deal with the Essex Drive property;4

(2) the right to receive or direct the disposition of proceeds

from the Essex Drive property; (3) the right to purchase, lease,

manage, and control the Essex Drive property; and (4) “the

2
The trust agreement provides that the Essex Drive trust
would terminate on Feb. 28, 2008, unless extended by mutual
direction of the beneficiaries.
3
The Gedzes also executed a beneficiary agreement, an
assignment of beneficial interest, and a rider to the trust
agreement with Bill Gatten (Mr. Gatten). These documents define
their interests, rights, and obligations. The Gedzes transferred
to Mr. Gatten a 90-percent beneficial interest and the
corresponding proportionate share of the power of direction.
4
The power of direction includes the right to direct the
trustee to make and execute contracts or deeds for the sale of,
to execute mortgages, leases, or options on, and to otherwise
deal with the Essex Drive property; to dispose of the proceeds
from rentals, mortgages, insurance, and sales; and to dispose of
the Essex Drive property.
 - 5 -

obligation for expenses and disbursements relative to the trust

property.” The beneficiaries’ rights to the proceeds are “deemed

to be personal property”; the beneficiaries do not possess “any

right, title, or interest * * * [in the Essex Drive property]

either legal or equitable”.5 Expenses of the Essex Drive Trust

are allocated among the beneficiaries according to their

respective percentages of beneficial interests unless otherwise

agreed. The beneficiaries also are required to obtain insurance

for the Essex Drive property. A beneficiary’s interest passes to

an executor or administrator of his or her estate on death;

otherwise, a transfer of a beneficiary’s interest to a third

party is subject to the other beneficiaries’ rights of first

refusal, and no assignment of a beneficiary’s interests is valid

unless all beneficiaries consent, a copy of the assignment is

delivered to the trustee, and the trustee indicates its

acceptance thereon.

The trust agreement further provides that the trustee is not

obligated to file any Federal income tax returns or schedules on

behalf of the Essex Drive Trust notwithstanding “section 671 of

the * * * [I.R.C.] of 1954 or any other applicable regulations.”6

5
The trust agreement further provides that a beneficiary
“has only an interest in the proceeds and profits” and the
trustee is to “vest with full legal and equitable title to the”
Essex Drive property.
6
The trust agreement does not discuss sec. 641 (tax
(continued...)
 - 6 -

If it becomes necessary for the Essex Drive Trust to file a Form

1041, U.S. Income Tax Return for Estates and Trusts, or other

informational returns under “section 6031 of the * * * [I.R.C.]

of 1954,” the trustee will not be obligated to prepare them, but

the trustee will sign informational returns if necessary at the

beneficiaries’ request. The beneficiaries are to report and pay

all taxes on the earnings and proceeds of the Essex Drive

property or otherwise arising from their beneficial interests.

II. Petitioner’s Beneficial Interest and Trust Documents

In 2003 the Gedzes assigned a 40-percent beneficial interest

in the Essex Drive Trust to BOGAT Management and a 50-percent

beneficial interest in the Essex Drive Trust to petitioner and

Sandra Adams.7

A. Beneficiary Agreement

The Gedzes, BOGAT Management, and petitioner and Sandra

Adams entered into a beneficiary agreement that provides that the

beneficiaries collectively have the: (1) Power of direction to

authorize the trustee to deal with the Essex Drive property’s

6
(...continued)
imposed on taxable income of estates or of any kind of property
held in trust) or 6012(a)(4) (return filing requirement for
trusts with “any taxable income, or gross income of $600 or over,
regardless of the amount of taxable income”). As stated supra,
neither party briefed these issues, and we do not discuss them
further.
7
Sandra Adams is petitioner’s wife; they were separated
when the petition was filed.
 - 7 -

title; (2) “right to receive and/or direct the disposition of

proceeds from rentals, mortgages, sales, or other related income

sources”; (3) right and duty to manage the Essex Drive property;

and (4) obligation to pay the Essex Drive property’s expenses.

The beneficiaries’ interests in the Essex Drive Trust are

personal property interests. The beneficiaries share in the

Essex Drive property’s earnings, gains, proceeds, and expenses

according to their respective percentages of beneficial

interests. No beneficiary may make material alterations or

improvements to the Essex Drive property without the trustee’s

and the other beneficiaries’ prior written consent. The

beneficiaries’ rights to transfer their beneficial interests are

subject to the provisions of the trust agreement, and any

transfer must be agreed to by a majority of the beneficiaries.

The beneficiary agreement further provides that the Essex

Drive property will be sold at termination (i.e., February 28,

2008) subject to a first right to purchase (right of first

refusal) held by petitioner and Sandra Adams. The terms of the

right of first refusal are that the Essex Drive property is to be

made available for sale to petitioner and Sandra Adams at a price

equal to what would be proposed by a third party and that they

have a right to offset the sale price by the value of their share

of profits and any contributions that are agreed to have been
 - 8 -

paid by and refundable to petitioner and Sandra Adams.8

Petitioner and Sandra Adams’ right of first refusal “begins with

the date of * * * [the beneficiary agreement (March 1, 2003) and

terminates on the Essex Drive property’s] sale or other

disposition.” According to “Exhibit ‘A’ To Beneficiary

Agreement”, petitioner and Sandra Adams’ refundable contribution

is $12,000. Their initial contribution consists of all

nonrecurring costs contributed including closing costs,

contributions to existing equity “($0.00 -‘Down Payment’),”

realtor commissions, and costs of agreed-upon expenditures for

repairs and capital improvements to the Essex Drive property by

petitioner and Sandra Adams. Petitioner and Sandra Adams’

contributions are “Refundable At Termination, If Equity Permits”.

B. “NEHT Occupancy” Agreement

The beneficiary agreement also provides that no beneficiary

is entitled to occupy or possess the Essex Drive property unless

an NEHT Occupancy agreement accompanies the beneficiary

agreement. The NEHT Occupancy agreement refers to the Essex

Drive Trust as “Landlord” and to petitioner and Sandra Adams as

“Tenant” and provides that Landlord agrees to lease to Tenant the

Essex Drive property. Tenant is to pay rent of $2,900 per month,

which includes principal and interest on all loans secured by the

8
From the record, it appears that the sale price of the
Essex Drive property that petitioner and Sandra Adams agreed to
was $320,000.
 - 9 -

Essex Drive property. Tenant is required to maintain insurance

coverage for and is liable for all repairs and maintenance of the

Essex Drive property. Tenant may not make material alterations

to the Essex Drive property without Landlord’s consent, and

expenditures for repairs are not refundable or creditable to

Tenant unless done at Landlord’s written direction. Tenant may

not assign or sublet his interest under the NEHT Occupancy

agreement.

C. Related Documents

Petitioner and Sandra Adams received other documents for the

Essex Drive property. The first document, titled “Beautiful

Home”, states: (1) No bank qualifying, no credit approval, and

immediate tax benefits; (2) “Rent to Own”; (3) three payments and

closing costs get you in at $320,000; and (4) participate in

future appreciation and benefit in equity buildup. The second

document, titled “How We (TK Investment Properties, LLC) Can

Benefit You (the Buyer))”, states that benefits provided to a

buyer include: (1) Easier credit qualification and payment

arrangements; (2) entitlement to all income tax deductions for

“Mortgage Investors and Property Tax payments,” even though title

does not pass to buyer; (3) receipt of equity buildup from

reduction of the mortgage principal as payments are made;

(4) receipt of appreciation of the Essex Drive property;

(5) protection of the Essex Drive property from the buyer’s
 - 10 -

creditors; and (6) the pride of ownership without the rules and

constraints of conventional real estate acquisition and mortgage

processes. These documents include an amortization table that

was provided to petitioner and Sandra Adams, and it sets forth

the amounts of mortgage interest and principal paid for each

payment.

III. Petitioner’s Occupancy

Petitioner and Sandra Adams moved into the Essex Drive

property in June 2003 and resided there for 5 years. During that

time petitioner made improvements to the Essex Drive property.

For example, he replaced the cedar deck for about $1,700 and

installed an automatic garage door opener for about $500 to $600.

He relandscaped the Essex Drive property and incurred costs of

about $1,500 for “Dirt shoveling, [and] stuff like that.” He

also incurred costs of about $500 to $600 to have glass block

windows installed in the basement because of Michigan’s harsh

winters. The Essex Drive property’s value declined, however, and

at the end of the contract term petitioner did not exercise the

right of first refusal to purchase the Essex Drive property.

Petitioner sent Equity Management Services9 payments of

$2,900 per month that included principal and interest on all

loans secured by the property. Petitioner credibly testified

9
The Gedzes and the Essex Drive Trust used Equity
Management Services as a “bill paying” or collection service.
 - 11 -

that the fair rental value of the Essex Drive property was about

$1,500 to $1,600 per month.

The escrow account statements from which the mortgage

payments were made bear the Gedzes’ names as mortgagees, and the

Forms 1098, Mortgage Interest Statement, also bear the Gedzes’

names as mortgagees.10 Equity Management Services sent

petitioner copies of the escrow account statements and the Forms

1098.

IV. Petitioner’s Tax Returns

Petitioner filed his 2003 Form 1040, U.S. Individual Income

Tax Return, in November 2005. He filed his 2004 Form 1040 in

February 2006.11 For 2003 and 2004, respectively, he claimed

mortgage interest deductions of $24,135 and $23,471 that

respondent disallowed.

OPINION

Petitioner has neither claimed nor shown that he satisfied

the requirements of section 7491(a) to shift the burden of proof

to respondent. Accordingly, petitioner bears the burden of

proof. See Rule 142(a).

10
The Gedzes’ mortgage is held by National City Mortgage
Co. There is no indication in the record as to the original
principal amount.
11
Petitioner did not apply for extensions of time to file
his Forms 1040.
 - 12 -

I. Mortgage Interest Deductions

Section 163(h)(1) generally disallows a deduction for

personal interest. An exception to this rule is qualified

residence interest. Sec. 163(h)(2)(D). Qualified residence

interest includes interest paid or accrued during the taxable

year on acquisition indebtedness. Sec. 163(h)(3)(A).

Acquisition indebtedness means any indebtedness that is incurred

in acquiring, constructing, or substantially improving any

qualified residence of the taxpayer and is secured by the

residence. Sec. 163(h)(3)(B)(i). A qualified residence includes

the principal residence of the taxpayer. Sec. 163(h)(4)(A).

Generally, for interest on a mortgage to be deductible the

indebtedness must be an obligation of the taxpayer and not an

obligation of another. Smith v. Commissioner, 84 T.C. 889, 897

(1985), affd. without published opinion 805 F.2d 1073 (D.C. Cir.

1986). But section 1.163-1(b), Income Tax Regs., provides:

“Interest paid by the taxpayer on a mortgage upon real estate of

which he is the legal or equitable owner, even though the

taxpayer is not directly liable upon the bond or note secured by

such mortgage, may be deducted as interest on his indebtedness.”

Where a taxpayer has not established legal, equitable, or

beneficial ownership of property, we have disallowed the

taxpayer’s claimed mortgage interest deduction. Hynes v.

Commissioner, 74 T.C. 1266, 1288 (1980); Song v. Commissioner,
 - 13 -

T.C. Memo. 1995-446; Bonkowski v. Commissioner, T.C. Memo.

1970-340, affd. 458 F.2d 709 (7th Cir. 1972).

The Court considers State law to determine the nature of the

taxpayer’s property rights. United States v. Natl. Bank of

Commerce, 472 U.S. 713, 722 (1985); Aquilino v. United States,

363 U.S. 509, 513 (1960).12 The Court also considers certain

factors to determine whether a taxpayer is an equitable or

beneficial owner of the property, including whether the taxpayer:

(1) Has a right to possess the property and to enjoy the use,

rents, or profits thereof; (2) has a duty to maintain the

property; (3) is responsible for insuring the property; (4) bears

the property’s risk of loss; (5) is obligated to pay the

property’s taxes, assessments, or charges; (6) has the right to

improve the property without the owner’s consent; and (7) has the

right to obtain legal title at any time by paying the balance of

the purchase price. Blanche v. Commissioner, T.C. Memo. 2001-63,

affd. 33 Fed. Appx. 704 (5th Cir. 2002).

Under Michigan law, the term “trust” includes an express

trust wherever and however created (with certain exceptions not

shown here). Mich. Comp. Laws Serv. sec. 700.1107(m) (Lexis

Nexis 2005). Express trusts may be created to sell, mortgage, or

12
Whatever rights or interests petitioner held in the
Essex Drive property are determined under Michigan law because
the property is in Michigan, see Altmann v. Commissioner, 20 T.C.
236, 252 (1953), and the trust agreement provides that it is
governed by Michigan law.
 - 14 -

lease lands; to receive the rents and profits of lands and apply

them to the use of any person, during the life of the person, or

for any shorter term subject to the rules prescribed in Mich.

Comp. Laws Serv. chapter 554; or for the beneficial interest of

any person where the trust is fully expressed and clearly defined

upon the face of the instrument creating it subject to the

limitations as to time. Mich. Comp. Laws Serv. sec. 555.11

(Lexis Nexis 2007).

Petitioner’s property rights or interests are as follows:

he is a beneficiary of the Essex Drive Trust, which meets the

definition of an express trust under Michigan law; however, the

trust agreement provides that he does not have any right, title,

or interest in the Essex Drive property.13 See id. Other

documents refer to him as a buyer and certain attributes of a

sale are present such as a downpayment, closing costs,14 and

petitioner’s payment of principal and interest, while other

attributes of a sale are not present such as a transfer of the

13
As stated supra pp. 3-4, the trust agreement provides
that its purpose is to hold the Essex Drive property and the
proceeds and profits therefrom in trust for the beneficiaries’
use and benefit; and collectively, the trust documents were used
to facilitate the purported lease of the Essex Drive property to
petitioner.
14
Petitioner and Sandra Adams agreed to pay their
respective closing costs pursuant to the document titled
Assignment of Beneficial Interest, and as stated supra, the
document titled Exhibit A To Beneficiary Agreement also
references closing costs and a downpayment.
 - 15 -

Essex Drive property by deed to petitioner. The NEHT Occupancy

agreement refers to him as Tenant and to his monthly payments as

rent. The escrow account statements, the Forms 1098, and an

amortization table were sent to petitioner, even though he was

not personally liable for the mortgage, and the escrow account

statements and the Forms 1098 bear the Gedzes’ names. We now

turn to the benefits and burdens of ownership factors.

Some factors weigh in favor of finding that petitioner had

assumed the benefits and burdens of ownership of the Essex Drive

property while others weigh against. Factors that indicate that

petitioner assumed the benefits and burdens of ownership are:

(1) He had a duty to repair or maintain the Essex Drive property;

(2) he was responsible for insuring the Essex Drive property;

(3) he had a duty to pay the Essex Drive property’s taxes,

assessments, or charges; (4) he had a right to the Essex Drive

property’s proceeds from rents, mortgages, or sales; (5) he had

the right to obtain legal title at any time by paying the balance

of the purchase price: his right of first refusal began on the

date of the beneficiary agreement and terminated on the Essex

Drive property’s sale or other disposition; (6) he bore some risk

of loss because he was required to maintain insurance on the

Essex Drive property and because he could lose his refundable

contribution, which may have included the value of the

improvements petitioner made, if there was no equity in the Essex
 - 16 -

Drive property; and (7) he agreed to pay the mortgage principal

and interest under the NEHT Occupancy and beneficiary agreements.

See Amundson v. Commissioner, T.C. Memo. 1990-337 (finding

agreement to make mortgage payments created “enforceable

interest-bearing debt” to taxpayer’s sister); see also Belden v.

Commissioner, T.C. Memo. 1995-360.15 In short, petitioner

treated the Essex Drive property as if he owned it. See Amundson

v. Commissioner, supra (taxpayer’s performance of obligations as

owner is indicative of ownership interest); see also Trans v.

Commissioner, T.C. Memo. 1999-233 (same); Uslu v. Commissioner,

T.C. Memo. 1997-551 (same).

Factors that indicate that petitioner did not assume the

benefits and burdens of ownership are: (1) He could choose not

to exercise his right of first refusal and to walk away from the

Essex Drive property, see Randolph v. Reisig, 727 N.W.2d 388, 392

(Mich. Ct. App. 2006) (right of first refusal does not create

interest in land); see also Jones v. Commissioner, T.C. Memo.

2006-176 (optionee was not entitled to mortgage interest

deduction because under California law he had no ownership

15
Pursuant to the beneficiary agreement, the beneficiaries
agreed that any failure to pay the Essex Drive property’s
expenses created, at the option of the majority interest of the
other beneficiaries, a debt from the delinquent beneficiary to
the other beneficiaries plus 10 percent interest per annum until
paid. Moreover, the “uncollected balance” might be collected by
lawsuit or by charge against the proceeds otherwise due to the
delinquent party.
 - 17 -

interest in property and because he had not acquired sufficient

benefits and burdens of ownership to establish that he was

equitable owner); (2) he had to enter into an NEHT Occupancy

agreement with the Essex Drive Trust to possess or enjoy the use

of the Essex Drive property, see Ryan v. Commissioner, T.C. Memo.

1995-579; and (3) although petitioner made substantial

improvements to the Essex Drive property, the beneficiary and

NEHT Occupancy agreements provide that he could not make material

alterations or improvements to the Essex Drive property without

certain consents.

On the unique facts of this case, we conclude that the

benefits and burdens that favor ownership outweigh the factors

against ownership. Petitioner has assumed the benefits and

burdens of ownership of the Essex Drive property. See, e.g.,

Derr v. Commissioner, 77 T.C. 708, 725-728, 724 n.11 (1981)

(beneficiary of an Illinois land trust possessed most attributes

of ownership). Petitioner, therefore, is entitled to the

mortgage interest deductions. Respondent’s determinations are

not sustained.

II. Section 6651(a)(1) Additions to Tax

The section 6651(a)(1) additions to tax were based on the

deficiencies. Because of our holding that petitioner is entitled

to the mortgage interest deductions and because respondent

conceded the other deductions that he had disallowed in the
 - 18 -

notice of deficiency, see supra p. 3, petitioner is not liable

for the deficiencies. As there are no deficiencies, petitioner

is not liable for the additions to tax.

III. Section 6662(a) Accuracy-Related Penalties

Because of our holding that petitioner is entitled to the

mortgage interest deductions and because respondent conceded the

other deductions that he had disallowed in the notice of

deficiency, see supra p. 3, there are no underpayments16 of tax.

Therefore, petitioner is not liable for the section 6662(a)

accuracy-related penalties. Respondent’s determinations are not

sustained.

To reflect the foregoing,

Decision will be entered

under Rule 155.

16
An “underpayment” is the amount by which the tax imposed
exceeds the excess of the sum of the amount shown as the tax by
the taxpayer on his return, plus amounts not so shown that were
previously assessed (or collected without assessment), over the
amount of rebates made. Sec. 6664(a).