T.C. Memo. 2010-84
UNITED STATES TAX COURT
FRANKLIN M. AND ERLINDA L. SYKES, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7275-08. Filed April 21, 2010.
R determined a deficiency and an accuracy-related
penalty pursuant to sec. 6662(a), I.R.C., for the 2004 tax
year. After R’s concessions, the issues for decision are:
(1) Whether Ps are entitled to a casualty loss deduction
pursuant to sec. 165(c), I.R.C.; and (2) whether Ps are
liable for the accuracy-related penalty pursuant to sec.
6662(a), I.R.C.
Held: Ps are liable for the deficiency and the
accuracy-related penalty.
Franklin M. Sykes, pro se.
Donna F. Herbert, for respondent.
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MEMORANDUM FINDINGS OF FACT AND OPINION
WHERRY, Judge: This case is before the Court on a petition
for redetermination of an alleged income tax deficiency that
respondent determined for petitioners’ 2004 tax year. After
concessions by respondent,1 the issues for decision are: (1)
Whether petitioners are entitled to a $28,877 casualty loss
claimed on Schedule A, Itemized Deductions, pursuant to section
165(c) for water damage sustained to their home; and (2) whether
petitioners are liable for a section 6662 accuracy-related
penalty.2
FINDINGS OF FACT
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 they filed their
petition, petitioners resided in California.
On or about September 29, 2004, petitioners’ home sustained
water damage due to the bursting of a bathroom sink water pipe.
Petitioners submitted a claim to their insurance company and
1
Respondent conceded expense adjustments of $1,913 relating
to auto and travel, $2,091 relating to depreciation for
petitioners’ home, and $4,681 relating to mortgage interest for
petitioners’ home.
2
Unless otherwise indicated, all section references are to
the Internal Revenue Code of 1986, as amended and in effect for
the tax year at issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
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received a settlement check on or about February 23, 2005, in the
amount of $4,330.51. The insurance company’s evaluation of the
damage was based on a building repair estimate of $6,098.71, from
which the company subtracted a $1,000 deductible and $768.20 for
depreciation.
Petitioners allege that the loss relating to the water
damage was greater than that allowed by their insurance claim.
They claim that the value of their home was reduced by
approximately $45,000 as a result of the water damage, creating
an additional casualty loss for the 2004 tax year of $40,080.3
Petitioners base the estimate of their loss on an appraisal of
their home conducted by Mr. Albert L. Romero.4 Mr. Romero’s
appraisal estimates the value of petitioners’ property as of
November 1, 2004. It assumes that the property was in “average
overall condition during the effective date of the appraisal” and
states that “Adjustments were made for room count (at $10M per
room / $8M per bath) and gross living area (at $40 per SF
rounded).” Petitioners use the adjustment values in Mr. Romero’s
3
With adjustments the total casualty loss claimed on
petitioners’ Form 1040X, Amended U.S. Individual Income Tax
Return, for 2004 was $28,877.
4
The parties dispute the admissibility of Mr. Romero’s
appraisal under Rule 143(g), formerly Rule 143(f). Because of
respondent’s objection and petitioners’ failure to call the
appraiser as a witness to identify his expert report and to be
available for cross-examination about the report, it is
inadmissible. In any event, the outcome of the case does not
turn on the admissibility of the appraisal.
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appraisal to estimate the amount of the damage caused by the
burst pipe. Additionally, petitioners base their estimate on the
“loss of use” of the portion of their home that suffered water
damage during the period they conducted the repairs.
OPINION
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 factual issues that
affect the taxpayer’s tax liability may be shifted to the
Commissioner. Petitioners have not established that they meet
the requirements under section 7491(a)(1) and (2) for such a
shift. Consequently, the burden of proof remains on them.
Moreover, deductions are a matter of legislative grace, and
petitioners bear the burden of proving that they are entitled to
any of the deductions claimed. INDOPCO, Inc. v. Commissioner,
503 U.S. 79, 84 (1992). A taxpayer must keep sufficient records
to substantiate any deductions claimed. Sec. 6001.
II. Casualty Loss Expenses
Section 165(a) allows as a deduction any loss sustained
during the taxable year and not compensated for by insurance or
otherwise. Section 165(c) limits the allowance of losses in the
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case of individuals. Section 165(c)(3) allows as a deduction to
an individual certain losses commonly referred to as casualty
losses. A casualty loss is allowable to a taxpayer for a loss of
property not connected with a trade or business or a transaction
entered into for profit if the loss results from “fire, storm,
shipwreck, or other casualty”. See id. Pursuant to section
165(h)(2), a net casualty loss is only allowed to the extent it
exceeds 10 percent of adjusted gross income.
The amount of the casualty loss allowed under sec. 165(a) is
the lesser of the fair market value of the property immediately
before the casualty reduced by the fair market value of the
property immediately after the casualty; or “The amount of the
adjusted basis prescribed” in section 1.1011-1, Income Tax Regs.,
“for determining the loss from the sale or other disposition of
the property involved.” Sec. 1.165-7(b)(1), Income Tax Regs.
The method of valuation to be used in determining a casualty
loss is prescribed in section 1.165-7(a)(2), Income Tax Regs.,
which provides as follows:
(i) In determining the amount of loss deductible under * * *
[section 165], the fair market value of the property
immediately before and immediately after the casualty shall
generally be ascertained by competent appraisal. This
appraisal must recognize the effects of any general market
decline affecting undamaged as well as damaged property
which may occur simultaneously with the casualty, in order
that any deduction under * * * [section 165] shall be
limited to the actual loss resulting from damage to the
property.
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(ii) The cost of repairs to the property damaged is
acceptable as evidence of the loss of value if the taxpayer
shows that (a) the repairs are necessary to restore the
property to its condition immediately before the casualty,
(b) the amount spent for such repairs is not excessive, (c)
the repairs do not care for more than the damage suffered,
and (d) the value of the property after the repairs does not
as a result of the repairs exceed the value of the property
immediately before the casualty.
Only the amount of the loss resulting from physical damage to
property is deductible under section 165. Squirt Co. v.
Commissioner, 51 T.C. 543, 547 (1969), affd. 423 F.2d 710 (9th
Cir. 1970).
In 2007 petitioners retained Albert L. Romero, an allegedly
certified appraiser, to assess the value of their home after
sustaining the water damage. In his appraisal Mr. Romero
determined that the fair market value of petitioners’ home as of
November 1, 2004, was $715,000, not taking into account the water
damage. However, petitioners claim that the value of their home
in September 2004, before the pipe burst, was $700,000.
Petitioners allege that the appraisal conducted by Mr. Romero was
overstated due to the “rapidly increasing appreciation of
property in Southern California during the period in question”
and hence, the comparable property values he used were not
reliable. However, Mr. Romero used six comparable properties in
his appraisal, showing values of $660,500, $718,500, $728,500,
$712,000, $742,000, and $746,500. To support their position that
Mr. Romero’s appraisal was overstated, petitioners cite
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zillow.com, an online appraisal service, to estimate that the
fair market value of their home in 2004, not taking into account
the water damage, was approximately $700,000.
To determine the value of their home after the water damage,
petitioners use Mr. Romero’s valuations of $10,000 per bedroom,
$8,000 per bathroom and $40/square foot, calculating a loss of
approximately $44,831.20. This calculation assumes the complete
removal of two bedrooms, a bathroom, and various common areas
from their home. In summary, petitioners claim the value of
their home after the water damage was $655,000, resulting
approximately in a $45,000 casualty loss.
A review of the evidence compels us to conclude that both
petitioners’ estimates of the before and after values of their
home do not constitute “competent appraisals”, nor are they
otherwise adequate to satisfy the requirements of the statute and
regulations. Petitioners provide no probative evidence as to why
Mr. Romero’s before appraisal of $715,000 is “overstated” or why
their estimate of $700,000 is more reliable. Further,
petitioners provide no probative evidence that their calculation
of the casualty loss, based on Mr. Romero’s per-room and square-
foot valuations, is an accurate portrayal of the amount of the
damage. Petitioners are not experts in the area of home
valuation, and yet they have provided no evidence to the Court
that their $45,000 estimate for the water damage is properly
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calculated. Petitioners did not call any witnesses or even
themselves to substantiate the valuation of their casualty loss,
nor did they submit any supplemental materials to establish that
their estimation is reliable.
Additionally, petitioners have provided no evidence to
sustain their assertion that “the casualty loss was not only the
cost of tearing out, replacing the walls; and, remediating the
mold; but, the substantial loss of use of space, which was not a
part of the insurance company assessment.” With regard to the
costs of the repair work, petitioners have not provided the Court
with any documentation that shows the actual cost or extent of
the repairs, either in the form of receipts or work reports.
Further, petitioners have submitted no evidence concerning any
loss of use of the residence or any costs associated with such
alleged loss of use other than cryptic notes of the appraiser,
Mr. Romero, stating that adjustments were made for “$10,000 per
room, $8,000 per bathroom, and $40 per square foot.” Mr.
Romero’s notes do not explain why these estimates were computed
or how the amounts were determined. Regardless of whether
petitioners could quantify the “loss of use” of their property,
only loss for actual physical damage is deductible under section
165.
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The burden of proving the amount of the casualty loss is on
petitioners, and they have not established that they are entitled
to more than has been allowed.
III. Section 6662 Penalties
Under section 7491(c), respondent bears the burden of
production with respect to petitioners’ 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 penalty.” Higbee v. Commissioner, 116 T.C.
438, 446 (2001).
Section 6662(a) and (b)(1), (2), and (3) imposes an
accuracy-related penalty equal to 20 percent of any portion of an
underpayment attributable to a taxpayer’s negligence or disregard
of rules or regulations, a substantial understatement of tax, or
a substantial valuation misstatement. Respondent alleges that
petitioners’ actions constitute either negligence or disregard of
the rules or regulations. Therefore, the Court will not address
whether petitioners’ actions constitute a substantial
understatement of tax or a substantial valuation misstatement.
Section 6662(c) defines “negligence” as “any failure to make
a reasonable attempt to comply with the provisions of” the
Internal Revenue Code. “‘Negligence’ also includes any failure
by the taxpayer to keep adequate books and records or to
substantiate items properly.” Sec. 1.6662-3(b)(1), Income Tax
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Regs. “[D]isregard” of rules and regulations means any
“careless, reckless, or intentional disregard” of rules and
regulations. Sec. 6662(c). “A disregard of rules or regulations
is ‘careless’ if the taxpayer does not exercise reasonable
diligence to determine the correctness of a return position that
is contrary to the rule or regulation.” Sec. 1.6662-3(b)(2),
Income Tax Regs.
The accuracy-related penalty is not imposed with respect to
any portion of the underpayment as to which the taxpayer acted
with reasonable cause and in good faith. Sec. 6664(c)(1). The
determination of whether the taxpayer acted with reasonable cause
and in good faith depends upon all the pertinent facts and
circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. Relevant
factors include the taxpayer’s efforts to assess his proper tax
liability, including the taxpayer’s reasonable and good faith
reliance on the advice of a professional such as an accountant.
Id. Further, an honest misunderstanding of fact or law that is
reasonable in the light of the experience, knowledge, and
education of the taxpayer may indicate reasonable cause and good
faith. Id.
Petitioners submitted no evidence with respect to the
section 6662 penalty. In their petition for redetermination
petitioners claim that their accountant at the time “didn’t know
what he was doing.” However, petitioners did not call their
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accountant as a witness at trial, nor did they testify themselves
as to his alleged incompetence. See Neonatology Associates, P.A.
v. Commissioner, 115 T.C. 43, 99-100 (2000), affd. 299 F.3d 221
(3d Cir. 2002).
Petitioners also failed to keep adequate books and records
and/or to substantiate properly the items in question. Such a
failure is evidence of negligence. See sec. 1.6662-3(b), Income
Tax Regs. Consequently, we conclude that respondent has met his
burden of production for his determination of the
accuracy-related penalty based on negligence or disregard of
rules or regulations. Additionally, with regard to that
determination, petitioners have failed to meet their burden of
proving that they acted with reasonable cause and in good faith.
We therefore sustain respondent’s determination that petitioners
are liable for the accuracy-related penalty on the underpayment
associated with the disallowed itemized deductions of
petitioners.
We have considered all of the other arguments made by the
parties, and, to the extent that we have not specifically
addressed them, we conclude they are without merit.
Decision will be entered
under Rule 155.