T.C. Summary Opinion 2010-146
UNITED STATES TAX COURT
CARLOS SADA, JR. AND AMANDA SADA, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11362-08S. Filed September 27, 2010.
Carlos Sada, Jr. and Amanda Sada, pro sese.
Brooke S. Laurie, for respondent.
DAWSON, Judge: This case was heard pursuant to the
provisions of 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 is not reviewable by any other court, and
1
Unless otherwise indicated, references to sections other
than sec. 7463 are to the Internal Revenue Code (Code) in effect
for the years at issue, and Rule references are to the Tax Court
Rules of Practice and Procedure.
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this opinion shall not be treated as precedent for any other
case.
Respondent determined the following deficiencies in
petitioners’ Federal income taxes and accuracy-related penalties
under section 6662(a) for 2004, 2005, and 2006:
Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)
2004 $15,564 $3,112.80
2005 28,182 5,636.40
2006 27,264 5,452.80
Respondent filed an amended answer asserting that
petitioners are liable for an increased deficiency in income tax
of $21,125 (a $5,561 increase) and an increased penalty under
section 6662(a) of $4,225 (a $1,112.20 increase) for 2004, and an
increased deficiency in income tax of $33,288 (a $5,106 increase)
and an increased penalty under section 6662(a) of $6,657.60 (a
$1,021.20 increase) for 2005.
After concessions by the parties,2 the issues to be decided
are:
2
The parties agree that (1) subject to the limitations in
sec. 221(b), petitioners are allowed deductions for (A) student
loan interest payments of $141 in 2004, $165 in 2005, and $157 in
2006 and (B) tuition and fees expenses of $3,000 in 2006; (2)
petitioners omitted $49 of interest income from Texas State Bank
on their 2004 return; and (3) petitioners have substantiated
charitable contributions of $4,200 in 2004, $3,885 in 2005, and
$3,955 in 2006.
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(1) Whether petitioners are entitled to deductions claimed
on Schedules C, Profit or Loss From Business (Sole
Proprietorship), of their 2004, 2005, and 2006 Federal income tax
returns;
(2) whether petitioners had gross receipts from a trade or
business as reported on Schedules C of their 2004, 2005, and 2006
returns;
(3) whether depreciation petitioners claimed on their 2003
return is subject to section 1245 recapture in 2004;
(4) whether petitioners are liable for self-employment taxes
on the gross receipts reported on Schedules C of their 2004,
2005, and 2006 returns and on gain realized on the sale of
section 1245 property in 2004, if any;
(5) whether petitioners are entitled to deduct under section
213 medical expenses of $17,083 for 2006; and
(6) whether petitioners are liable for accuracy-related
penalties under section 6662(a) for the years at issue.
Background
Some of the facts have been stipulated. The stipulation of
facts and the attached exhibits are incorporated herein by this
reference. Petitioners are married individuals who filed joint
Federal income tax returns for 2004, 2005, and 2006. Petitioners
resided in Texas when their petition was filed. They have two
children, who were ages 12 and 9 at the time of trial.
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Petitioner Amanda Sada (Mrs. Sada) is a teacher and was
employed as such during the years at issue.
Petitioner Carlos Sada (Mr. Sada) has a bachelor of science
degree. He has been selling cars for 10 or 11 years. During the
years at issue, he worked as a new car sales manager at Boggus
Ford. As such he was entitled to purchase under the Ford D plan
one or two new cars each year at $100 over the invoice cost plus
tax, title, and license.
During the years at issue Mr. Sada purchased new vehicles
from Boggus Ford, kept them for about a year, and then traded
them in on the purchase of newer vehicles. The trade-in
allowances he received for the old vehicles were less than the
balances owed on the loans obtained to purchase the old vehicles.
He obtained sufficient financing on the purchase of the new
vehicles to pay off the balance owed on the old vehicles over the
amount of the trade-in allowance.
Mr. Sada and his wife used the vehicles for commuting and
other personal daily activities, but they kept a “for sale” sign
on each vehicle from the time of purchase until Mr. Sada traded
it in on a new one. Although Mr. Sada’s employment with Boggus
Ford generally did not involve selling used cars, he negotiated
the selling price of the vehicles he traded in. Petitioners
reported the purchases and sales of the vehicles as Mr. Sada’s
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business activity on Schedules C of their 2004, 2005, and 2006
Federal income tax returns.
Mr. Sada owned two 2003 Toyota Sequoias--a desert-colored
Sequoia, which he had purchased for $36,171.35 in November 2002
at which time it had an odometer reading of 52 miles (the desert
2003 Sequoia), and another (the second 2003 Sequoia), for which
the record does not disclose the date of purchase, purchase
price, color, or odometer reading at time of purchase.3 He also
owned a 1998 Isuzu Trooper which he had purchased used for $5,500
to $6,000 in 2003. In 2004 he sold the Trooper in a cash
transaction for $7,500, making a profit of $2,000.
On November 18, 2004, Mr. Sada traded in the desert 2003
Sequoia for a gold 2005 Ford Expedition, which he purchased for
$38,251.71. He received a $27,500 allowance for the desert 2003
Sequoia and financed the balance of the purchase price. The
desert 2003 Sequoia had an odometer reading of 17,435 miles and a
3
Mr. Sada asserts that he owned only one 2003 Toyota
Sequoia. In respondent’s brief, respondent agrees that
petitioners did not own the second 2003 Sequoia. However, motor
vehicle purchase orders from Boggus Ford dated Nov. 18, 2004, and
July 8, 2005, indicate that: (1) Carlos Sada traded in a 2003
Toyota Sequoia, serial number ending 149129, on the Gold 2005
Ford Expedition that he acknowledges he purchased in 2004 and (2)
he traded in a 2003 Toyota Sequoia, serial number ending 150073,
on a white 2005 Ford Expedition that he acknowledges he purchased
in 2005. Mr. Sada also stipulated that he traded in the second
Sequoia on the white 2005 Expedition. Respondent’s concession is
clearly contrary to the stipulation and to the facts that we have
found are established by the record, and we shall disregard it.
See Cal-Maine Foods, Inc. v. Commissioner, 93 T.C. 181, 195
(1989).
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payoff amount of $28,518 at the time of the trade-in. At the
time of the purchase the gold 2005 Expedition had an odometer
reading of 11 miles.
Mr. Sada purchased two vehicles in 2005. In July 2005 Mr.
Sada traded in the second 2003 Sequoia for a white 2005
Expedition. He purchased the white 2005 Expedition for
$37,310.21; he received a $22,000 allowance from the trade-in of
the second 2003 Sequoia towards the purchase price and financed
the balance. The second 2003 Sequoia had an odometer reading of
25,877 miles and a payoff amount of $25,947.81 at the time of the
trade-in. The white 2005 Expedition had an odometer reading of
37 miles at the time of purchase.
In December 2005 Mr. Sada traded in the gold 2005 Expedition
on a 2006 gray Expedition. He purchased the gray 2006 Expedition
for $37,631.16; he received a $32,000 allowance from the trade-in
of the gold 2005 Expedition towards the purchase price and
financed the balance. The gold 2005 Expedition had an odometer
reading of 10,078 miles and a payoff amount of $33,110 at the
time of the trade-in. The gray 2006 Expedition had an odometer
reading of 376 miles at the time of purchase and 13,771 miles on
April 19, 2007.
Mr. Sada purchased two vehicles in July 2006. He purchased
a white 2006 Ford Fusion for $22,428; he paid $500 down and
financed the balance. He also traded in the white 2005
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Expedition on a black 2006 Ford F-250, which he purchased for
$42,205.75. He received a $30,000 allowance from the trade-in of
the white 2005 Expedition and financed the balance. At the time
of trade-in the white 2005 Expedition had an odometer reading of
9,186 miles and a payoff amount of $33,990.
Petitioners reported income on their 2003, 2004, 2005, and
2006 returns as follows:
2003 2004 2005 2006
Wages, salaries, tips, etc. $106,324 $143,027 $159,594 $188,737
Interest 16 -- 78 56
Business income (Schedule C) (35,635) (43,533) (97,782) (73,503)
Total income 70,705 99,494 61,890 115,290
Adjustments (223) (2,910) (250) (3,354)
Adjusted gross income 70,482 96,584 61,640 111,936
Petitioners filed an amended return for 2004, reducing their
adjusted gross income to $92,675 for a $3,909 overstatement of
wages.
Petitioners reported gross receipts, expenses, and net
losses on the purchases and sales of the vehicles on Schedules C
of their 2003, 2004, 2005, and 2006 Federal income tax returns,
as follows:
2003 2004 2005 2006
Income:
Gross receipts $1,325 $3,190 $4,269 $9,468
Cost of goods sold 7,850 -- -- --
Gross profit (6,525) 3,190 4,269 9,468
Expenses:
Advertising 1,249 150 -- --
Car/Truck expenses 778 2,948 -- 4,810
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Depreciation 17,708 32,938 91,821 72,208
Insurance -- 2,880 --
Legal/professional services 1,250 1,350 500
Office expense 186 -- --
Rent/equipment 267
Repairs/maintenance 250 182 -- --
Supplies 113
Meals/entertainment 5,626 7,293 4,413 1,425
Cell phone 1,347 1,524 1,326 1,248
Internet 252 252 261 --
Roadrunner -- -- 580
Computer 1,520 -- -- 2,200
Total expenses 29,110 46,723 102,051 82,971
Net profit (loss) (35,635) (43,533) (97,782) (73,503)
Mr. Sada did not include the $7,500 he received on the sale
of the Isuzu Trooper in the gross receipts for 2004.
Mr. Sada reported the vehicles as 3-year property on Forms
4562, Depreciation and Amortization (Including Information on
Listed Property), attached to his joint returns for 2003 through
2006. The depreciation petitioners claimed for 2003 included a
special depreciation allowance of $12,750 and general
depreciation of $4,958 for property placed in service in 2003. The
depreciation petitioners claimed for 2004 included: (1) A special
depreciation allowance of $21,250 and general depreciation of $1,771
for property placed in service in 2003 and (2) MACRS depreciation
of $9,917 for assets place in service before 2004. The
depreciation petitioners claimed for 2005 included: (1) A
special depreciation allowance of $39,500 and general
depreciation of $5,188 for property placed in service in 2005 and
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(2) MACRS4 depreciation of $45,570 for property placed in service
before 2005. The depreciation petitioners claimed for 2006
included: (1) A special depreciation allowance of $10,610 and
general depreciation of $5,655 for property placed in service in
2006 and (2) MACRS depreciation of $48,166 for property placed in
service before 2006.
On their 2004, 2005, and 2006 returns, petitioners claimed
the following deductions on Schedule A, Itemized Deductions:
Schedule A 2004 2005 2006
Medical/dental1 -- -- $8,688
Taxes $4,590 $6,449 6,273
Interest 5,770 4,948 7,720
Gifts to charity 5,500 4,090 3,935
Total deductions 15,860 15,487 26,616
1
Total medical expenses ($17,083 for 2006) over 7.5 percent of
adjusted gross income ($8,395 for 2006).
In addition to the itemized deductions claimed on Schedules
A, petitioners claimed deductions for: (1) Student loan interest
of $2,660 for 2004 and $104 for 2006, (2) educator expenses of
$250 each year, (3) tuition and fees of $2,660 for 2004, and (4)
domestic production activities of $3,000 for 2006. Petitioners
also claimed child tax credits of $2,000 for 2004 and 2005 and
$1,900 for 2006.
4
MACRS refers to the “Modified Accelerated Cost Recovery
System”. Generally, MACRS is used to depreciate any tangible
property placed in service after 1986.
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On February 7, 2008, respondent mailed to petitioners a
statutory notice of deficiency for 2004, 2005, and 2006
disallowing their deductions for business expenses claimed on
Schedules C and increasing their taxable income by $46,723 for
2004, $102,051 for 2005, and $82,971 for 2006. As a result of
the disallowance of the deductions for the business expenses,
respondent determined that Mr. Sada was subject to self-
employment taxes of $85 for 2004, $114 for 2005, and $254 for
2006 on the gross receipts reported on the Schedules C and was
entitled to a deduction each year for one-half of the self-
employment tax.
Respondent also disallowed petitioners’ itemized deductions
claimed on Schedules A for medical expenses of $17,083 claimed
for 2006 and charitable contributions of $5,500, $4,090, and
$3,935 claimed respectively for 2004, 2005, and 2006. The
disallowance of those itemized deductions increased petitioners’
taxable income by $5,500 for 2004, $4,621 for 2005, and $13,571
for 2006. The adjustments to petitioners’ total income caused
the following computational adjustments: (1) The tuition and
fees deduction for 2006, the student loan interest deduction for
2006, the child tax credits for 2005 and 2006, and the education
credits for 2004 and 2005 were disallowed in full, and (2) the
child tax credit for 2004 was reduced to $500. Additionally,
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respondent determined that petitioners were not liable for the
alternative minimum tax reported for 2006.
Discussion
I. Income (Loss) From Activity of Buying and Selling Vehicles
Mr. Sada contends that he purchased the vehicles during the
years at issue with the purpose of selling them at a profit and
properly reported the activity on Schedules C of his tax returns
for the years at issue. He therefore argues that the expenses
claimed on the Schedules C are deductible. To the contrary,
respondent asserts that Mr. Sada has not established that the
expenses were incurred in a trade or business within the meaning
of section 162 or for the production of income within the meaning
of section 212. Respondent asserts that the expenses are
personal expenses, deductions for which are disallowed by section
262.
A. Claimed Schedule C Expenses
Taxpayers generally may deduct expenses that are ordinary
and necessary in carrying on a trade or business. Sec. 162(a).
Taxpayers also generally may deduct expenses that are ordinary
and necessary for (1) the production or collection of income, or
(2) the management, conservation, or maintenance of property held
for the production of income. Sec. 212(1) and (2). Further,
while business expenses and expenses related to income-producing
property are currently deductible, a taxpayer is not entitled to
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deduct a capital expenditure (i.e., an amount paid out for new
buildings or for permanent improvements or betterments made to
increase the value of any property or estate),5 sec. 263(a)(1),
but may be allowed a depreciation deduction if the property is
used in a trade or business or is held for the production of
income, sec. 167; see INDOPCO, Inc. v. Commissioner, 503 U.S. 79,
83-84 (1992). Personal, living, and family expenses, on the
other hand, generally may not be deducted to any extent unless
otherwise expressly allowed in the Code (e.g., State and local
real property taxes are deductible pursuant to section
164(a)(1)). Sec. 262(a). The prohibitions of section 262
regarding deductibility of personal expenses take precedence over
the allowance provisions of sections 162 and 212. Commissioner
v. Idaho Power Co., 418 U.S. 1, 17 (1974); Sharon v.
Commissioner, 66 T.C. 515, 523 (1976), affd. 591 F.2d 1273 (9th
Cir. 1978). As stated by the Supreme Court in Commissioner v.
Groetzinger, 480 U.S. 23, 35 (1987):
not every income-producing and profit-making endeavor
constitutes a trade or business. * * * [T]o be engaged
in a trade or business, the taxpayer must be involved
in the activity with continuity and regularity and
* * * the taxpayer’s primary purpose for engaging in
the activity must be for income or profit. * * *
5
Sec. 1.263(a)-2(a), Income Tax Regs., generally provides:
“The cost of acquisition * * * of * * * property having a useful
life substantially beyond the taxable year” is a capital
expenditure.
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In order to be deductible, vehicle expenses must be incurred
in the pursuit of a trade or business. Sec. 162(a). Expenses
incurred in commuting from a residence to a business or in the
course of other personal use are nondeductible personal expenses.
Sec. 262; Green v. Commissioner, 59 T.C. 456 (1972). Similarly,
automobile depreciation is permitted as a deduction only if, and
to the extent that, the automobile is used in the pursuit of a
trade or business or for the production of income. Sec. 167(a).
The ownership and maintenance of the property must relate
primarily to a business or profit-making endeavor, rather than a
personal purpose. Intl. Artists, Ltd. v. Commissioner, 55 T.C.
94, 104 (1970); Chapman v. Commissioner, 48 T.C. 358, 366 (1967).
If the acquisition and maintenance of property such as an
automobile are primarily profit motivated and personal use is
distinctly secondary and incidental, deductions for maintenance
expenses and depreciation will be permitted; if acquisition and
maintenance are motivated primarily by personal considerations,
deductions are disallowed; and if substantial business and
personal motives exist, allocation becomes necessary. Intl.
Trading Co. v. Commissioner, 275 F.2d 578, 584-587 (7th Cir.
1960), affg. T.C. Memo. 1958-104; Intl. Artists, Ltd. v.
Commissioner, supra at 104-105; Deihl v. Commissioner, T.C. Memo.
2005-287; Mann v. Commissioner, T.C. Memo. 1981-684. If
allocation is necessary, the deduction for allocable business use
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in such cases is computed by reference to the ratio of time or
space devoted to business as compared with total use. Intl.
Artists, Ltd. v. Commissioner, supra at 105.
Over the years, courts have considered a variety of factors
in determining the taxpayer’s primary purpose for holding
property, including: (1) The taxpayer’s purpose in acquiring the
property and the duration of his ownership, (2) the purpose for
which the property was subsequently held, (3) the taxpayer’s
everyday business and the relationship of income from the
property to total income, (4) the frequency, continuity, and
substantiality of the sales, (5) the extent to which the taxpayer
used advertising, promotion, or other activities to increase
sales, and (6) the time and effort the taxpayer habitually
devoted to the sales. United States v. Winthrop, 417 F.2d 905,
910 (5th Cir. 1969); Cottle v. Commissioner, 89 T.C. 467, 487
(1987); Raymond v. Commissioner, T.C. Memo. 2001-96; Neal T.
Baker Enters., Inc. v. Commissioner, T.C. Memo. 1998-302; Nadeau
v. Commissioner, T.C. Memo. 1996-427; Tollis v. Commissioner,
T.C. Memo. 1993-63, affd. without published opinion 46 F.3d 1132
(6th Cir. 1995). Although these factors may aid the finder of
fact in determining, on the entire record, the taxpayer’s primary
purpose for holding property, they have no independent
significance and individual comment on each factor is not
necessary or required. Cottle v. Commissioner, supra at 487-489;
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see also Suburban Realty Co. v. United States, 615 F.2d 171,
177-179 (5th Cir. 1980); Hay v. Commissioner, T.C. Memo.
1992-409.
Mr. Sada asserts that he purchased the vehicles intending to
make a profit by selling them at the manufacturer’s suggested
retail price over his employee bargain purchase price. As an
experienced new car salesman, Mr. Sada had reason to know that a
new car purchaser most often can negotiate a price that is less
than the manufacturer’s suggested retail price. Indeed, it is
not unusual for new car dealers to advertise a promotional price
below the manufacturer’s suggested retail price. Moreover, the
new vehicles became “used” once Mr. Sada drove them off the car
lot. Mr. Sada merely placed “for sale” signs on the vehicles and
did not use any other advertising, promotion, or other activities
to increase sales. He made no effort toward and devoted no time
to the sales other than driving the vehicles for commuting and
other personal purposes. Mr. Sada held the vehicles for more
than a year, and he and Mrs. Sada used the vehicles solely for
personal purposes. He traded in the used vehicles on new ones
and did not sell them to end users. The frequency, continuity,
and substantiality of the sales are consistent with usual
consumer ownership and do not show a profit-making motive.
Although Mr. Sada may have hoped to make profits on the
sales of his vehicles, that is not sufficient to convert
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inherently personal expenses into deductible business expenses.6
Sapp v. Commissioner, 36 T.C. 852 (1961), affd. 309 F.2d 143 (5th
Cir. 1962); see also Finney v. Commissioner, T.C. Memo. 1980-23
(because the automobile was used 100 percent of the time for
personal reasons, any business deductions with respect to that
automobile taken on the taxpayers’ joint return for the taxable
years in issue were properly denied under section 262).
We note that, had we found that Mr. Sada was in the trade or
business of selling the vehicles or held them for the production
of income, sections 274 and 280F provide further limitations with
potential bearing on business-related deductions claimed under
section 162 or 167. Pursuant to section 274(d), no deduction or
credit is allowed with respect to any listed property, within the
meaning of section 280F(d)(4) unless the taxpayer substantiates
by adequate records or sufficient evidence corroborating the
taxpayer’s own statement: (1) The amount of the expense; (2) the
time and place of the use of the property; and (3) the business
purpose of the expense. Sec. 274(d); Vaksman v. Commissioner,
6
The purchase of a personal vehicle is analogous to the
purchase of a residence. Although people who buy residential
property generally are interested in making a later profitable
sale, the purchase or construction of a personal residence
generally is not considered a transaction entered into for
profit. “A loss sustained on the sale of residential property
purchased or constructed by the taxpayer for use as his personal
residence and so used by him up to the time of the sale is not
deductible under section 165(a).” Sec. 1.165-9(a), Income Tax
Regs.
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T.C. Memo. 2001-165, affd. 54 Fed. Appx. 592 (5th Cir. 2002).
Section 280F limits the allowable amount of depreciation for
“listed property” to a multiple equal to the percentage of actual
business use. A.J. Concrete Pumping, Inc. v. Commissioner, T.C.
Memo. 2001-42; sec. 1.280F-2T(i), Temporary Income Tax Regs., 49
Fed. Reg. 42707 (Oct. 24, 1984). Pursuant to section
280F(d)(4)(A)(i) and (ii), passenger automobiles and any other
property used as a means of transportation are “listed property”
subject to the strict substantiation requirements of section
274(d). Cellular telephones are also “listed property” subject
to the strict substantiation requirements of section 274. Mr.
Sada failed to submit any documentation to establish the business
use of his cellular telephone.
Similarly, Mr. Sada has failed to provide any evidence of a
business purpose for all other expenses claimed on Schedules C of
petitioners’ income tax returns for the years at issue.
Accordingly, we hold that petitioners are not entitled to deduct
any of the expenses claimed on Schedules C for those years
because Mr. Sada was not in the business of selling cars as a
sole proprietor and did not hold the vehicles for the production
of income.
B. Gross Receipts Reported on Schedules C
Respondent disallowed all the expenses claimed on the
Schedules C but did not make any adjustments to the gross
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receipts. We have held that Mr. Sada was not in the trade or
business of selling the vehicles and did not hold the vehicles
for the production of income. Consequently, Mr. Sada did not
have Schedule C gross receipts from his purchase and sale of the
vehicles. Therefore, the gross receipts should be eliminated
from the computations of petitioners’ taxes for the years at
issue.
C. Gain or Loss on Sales of Vehicles
1. Desert 2003 Sequoia
In the amended answer respondent asserts that petitioners
must “recapture” the depreciation on vehicles claimed on Schedule
C in 2003 in the year of the sale of the vehicle; i.e., gain on
the sale of the vehicles attributable to depreciation deductions
they claimed on their 2003 return is taxable as ordinary income
in the year of sale. Respondent has the burden of proving any
new matter pleaded in the amended answer. See Rule 142(a); Canal
Corp. v. Commissioner, 135 T.C. , (2010) (slip op. at 30).
Respondent was uncertain whether the depreciation claimed on
petitioners’ 2003 return should be recaptured in 2004, when the
desert 2003 Sequoia was traded in, or 2005, when the second 2003
Sequoia was traded in. Therefore, in the amended answer
respondent asserted the full amount of the recapture in each tax
year 2004 and 2005.
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Motor vehicle purchase orders from Boggus Ford dated
November 18, 2004, and July 8, 2005, indicate that: (1) Mr. Sada
traded in the desert 2003 Sequoia (serial number ending 149129)
on the Gold 2005 Expedition, which he acknowledges he purchased
in 2004, and (2) he traded in another 2003 Toyota Sequoia with a
different serial number (ending 150073) on the white 2005
Expedition, which he acknowledges he purchased in 2005. However,
Mr. Sada denied owning a 2003 Sequoia other than the desert 2003
Sequoia. He testified that the depreciation deduction claimed on
the 2003 return was for the desert 2003 Sequoia, and we so find.
Respondent’s position on brief is that in 2004 Mr. Sada is
required to recapture as ordinary income $9,037 of the
depreciation deducted in 2003 for the desert 2003 Sequoia and he
is not required to recapture any of the depreciation deductions
in 2005.
Although Mr. Sada was not in the trade or business of
selling the vehicles and did not hold the vehicles for the
production of income, petitioners must report on their returns
for the years at issue any gains Mr. Sada realized on sales of
the vehicles when he traded them in for new ones.
Section 1001 provides that gain from the sale or other
disposition of property equals the excess of the amount realized
from the sale over the adjusted basis in the property sold.
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The amount of gain realized is the excess of the amount
realized over the taxpayer’s adjusted basis in the property, and
the amount of loss realized is the excess of the adjusted basis
over the amount realized. Sec. 1001(a). For purposes of
computing gain or loss, the “amount realized” is defined by
section 1001(b) as the sum of any money received plus the fair
market value of the property received. Furthermore, the amount
realized generally includes the amount of liabilities from which
the transferor is discharged as a result of the sale or
disposition. Crane v. Commissioner, 331 U.S. 1 (1947); sec.
1.1001-2(a), Income Tax Regs. While the amount realized by the
seller includes the amount of any debt secured by the property
that is assumed by the purchaser, settlement charges to the
seller used to pay off an existing loan do not increase the
amount realized on the sale of property. See Kurata v.
Commissioner, T.C. Memo. 1997-252. In such an instance, the
seller has paid the debt; there is no cancellation or forgiveness
of the indebtedness. Here, Boggus Ford did not assume the
outstanding loans on the old vehicles. Mr. Sada effectively paid
off the outstanding balances with the trade-in allowances and the
new financing for the purchase of the new vehicles. The amount
realized by Mr. Sada on the trade-in of the desert 2003 Toyota
was the $27,500 trade-in allowance he received.
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Generally, the adjusted basis of property equals its
original cost, increased by expenditures properly chargeable to
capital account, and decreased by the greater of amounts allowed
or allowable as depreciation deductions. Secs. 1011, 1012,
1016(a)(1) and (2). Thus, if the taxpayer claimed depreciation
deductions and the Internal Revenue Service did not audit the
return or otherwise disallow the deductions, the full amounts of
depreciation deductions claimed by the taxpayer decrease the
basis in the property even if the deductions were not properly
allowable. Sec. 1016(a)(2); sec. 1.1016-3(a)(1), (b), Income Tax
Regs.
Mr. Sada purchased the desert 2003 Sequoia for $36,171.35 in
November 2002. On Form 4562 of his 2003 return he reported that
it was placed in service in 2003, and he deducted $17,708 on
Schedule C. Petitioners’ 2003 return was not audited, and Mr.
Sada was allowed a deduction for the depreciation claimed for the
desert 2003 Sequoia on the 2003 return. Thus, his basis in the
desert 2003 Sequoia was reduced to $18,463.35 ($36,171.35 -
$17,708). In 2004 Mr. Sada received a $27,500 trade-in allowance
towards the purchase price of the Gold 2005 Expedition. Thus, he
realized $9,036.65 of gain on the disposition of the desert 2003
Sequoia in 2004.
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Respondent asserts that pursuant to section 1245(a)(1), Mr.
Sada is required to recognize the $9,036.65 gain as ordinary
income in 2004.
Section 1245(a)(1) provides for the recapture of
depreciation as ordinary income upon the disposition of section
1245 property. As relevant here, section 1245 property includes
personal property “which is or has been property of a character
subject to the allowance for depreciation provided in section
167”. Section 167(a) provides the following general rule:
There shall be allowed as a depreciation deduction a
reasonable allowance for the exhaustion, wear and tear
(including a reasonable allowance for obsolescence)--
(1) of property used in the trade or business, or
(2) of property held for the production of income.
We have held that Mr. Sada did not use the vehicles for
which he claimed depreciation, including the desert 2003 Sequoia,
in a trade or business or for the production of income.
Consequently, the desert 2003 Sequoia is not section 1245
property.
Nonetheless, respondent argues that petitioners must
“recognize the recapture income” because they treated the desert
2003 Sequoia as section 1245 property by claiming depreciation
deductions for it on their 2003 return and the period of
limitations for 2003 has expired, so that respondent cannot
adjust petitioners’ 2003 return by disallowing the improperly
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claimed depreciation for that year. In support of that position
respondent cites Herrington v. Commissioner, 854 F.2d 755 (5th
Cir. 1988), affg. Glass v. Commissioner, 87 T.C. 1087 (1986),
which applies the duty of consistency.
The duty of consistency applies when: (1) The taxpayer made
a representation or reported an item for Federal income tax
purposes in one year, (2) the Commissioner acquiesced in or
relied on that representation or report for that year, and (3)
the taxpayer attempts to change that representation or report in
a subsequent year, after the period of limitations has expired
with respect to the year of the representation or report, and the
change is detrimental to the Commissioner. LeFever v.
Commissioner, 103 T.C. 525, 543 (1994), affd. 100 F.3d 778 (10th
Cir. 1996); see also Herrington v. Commissioner, supra at 758.
When these requirements are met, the Commissioner may treat the
previous representation by the taxpayer as true, although, in
fact, it is not. Herrington v. Commissioner, supra at 758. The
duty of consistency is an affirmative defense raised by
respondent, and respondent has the burden of showing that it
applies. See rule 142(a). Respondent did not raise the duty of
consistency as an affirmative defense in the amended answer but
merely alluded to it in respondent’s opening brief by citing
Herrington. Moreover, as discussed below, respondent has not
shown that the third requirement has been met and, thus, has not
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met his burden of establishing that the duty of consistency
applies.
On Form 4562 of petitioners’ 2003 return Mr. Sada reported
that depreciable property was placed in service in 2003, and he
claimed a depreciation deduction of $17,708 on Schedule C. Thus,
the first requirement is met.
The Commissioner acquiesces or relies on a representation of
the taxpayer when the taxpayer files a return that contains an
inadequately disclosed item and the Commissioner accepts that
return and allows the period of limitations to expire without an
audit of that return. Herrington v. Commissioner, supra at 758.
Petitioners’ 2003 return was not audited, and Mr. Sada was
allowed a deduction for the depreciation claimed for the desert
2003 Sequoia on the 2003 return. Thus, the second requirement is
also met.
However, Mr. Sada never took an inconsistent position with
respect to his activity of buying and selling the vehicles.
Petitioners’ 2004 return claimed depreciation for property placed
in service before 2003. When respondent audited petitioners’
2004 return, respondent disallowed that depreciation deduction.
The 2004 return put respondent on notice that Mr. Sada likely
claimed depreciation for that property on his 2003 return.
Respondent has not established that the period of limitations for
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assessing additional tax for 2003 had expired when the audit of
petitioners’ 2004 return was completed.
Because respondent did not raise the duty of consistency as
an affirmative defense in the amended answer and has not met the
burden of establishing that the duty of consistency applies in
this case, we hold that Mr. Sada is not subject to the recapture
provisions of section 1245. Mr. Sada purchased the desert 2003
Sequoia in November 2002 and disposed of it in November 2004.
The gain he realized is taxable in 2004 as long-term capital gain
and not as ordinary income. See sec. 1222(3).
2. Other Vehicles
The record establishes that the trade-in allowances Mr. Sada
received for all of the vehicles was less than the amounts he
paid for them. Mr. Sada has not been allowed the depreciation
deductions he claimed on the vehicles except for the depreciation
deductions he claimed for the desert 2003 Sequoia on petitioners’
2003 return. Consequently, Mr. Sada realized losses on the other
vehicles when he traded them in.
Section 165(a) generally allows a deduction for any loss
sustained during the taxable year that is not compensated by
insurance or otherwise. However, in the case of an individual,
section 165(c) limits deductible losses that are not incurred
either in a trade or business or a transaction entered into for
profit to losses arising from fire, storm, shipwreck, or other
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casualty or from theft. A loss sustained on the sale of a
vehicle used exclusively for personal use is not deductible
pursuant to section 165(c), and petitioners may not deduct Mr.
Sada’s losses on the vehicles.
II. Self-Employment Taxes
Respondent determined that Mr. Sada was liable for self-
employment tax on the gross receipts he reported on the Schedule
C for each year at issue and allowed petitioners a deduction for
half of those taxes. We have held that those gross receipts are
not included in Mr. Sada’s income. Consequently, he is not
subject to self-employment taxes on the gross receipts reported
on the Schedules C for the years at issue.
III. Medical Expenses
Respondent disallowed petitioners deduction for medical
expenses of $8,688 claimed on Schedule A of their 2006 return.
Section 213(a) allows a deduction for expenses paid during the
taxable year for medical care that are not compensated for by
insurance or otherwise and to the extent that such expenses
exceed 7.5 percent of adjusted gross income. For 2006
petitioners reported total medical expenses of $17,083 and
adjusted gross income of $111,936. Their adjusted gross income
for 2006 is increased by $73,503 to $185,439 for the disallowed
net loss claimed on Schedule C for that year. Consequently, if
petitioners had substantiated the amount of medical expenses they
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paid in 2006, they could have deducted only medical expenses in
excess of $13,908.
At trial Mr. Sada produced receipts and statements regarding
medical services provided to him and his family during the years
at issue. He provided explanations of benefits from Mutual of
Omaha for 2004 and most of 2005 and from American Administrative
Group for the end of 2005 and all of 2006. The explanations of
benefits indicate that the medical insurance was provided through
Mrs. Sada’s employment. The Mutual of Omaha explanations of
benefits show that Mrs. Sada and the rest of the Sada family were
also covered by another insurance carrier and show the amount of
the claim paid by coinsurance. The explanations of benefits from
American Administrative Group did not show the amount paid by
coinsurance. Mr. Sada did not provide the Court with the other
carrier’s explanation of benefits.
Of the two dozen receipts for 2006, all but two were for $45
or less. One receipt was for $269. A receipt dated March 28,
2006, from a surgeon indicates that Mrs. Sada paid a $500 cash
deposit for surgery on March 31, 2006. Her insurance company’s
explanation of benefits shows a claim totaling $8,450 for
services provided by that surgeon to Mrs. Sada on March 31, 2006.
The explanation states that the claim was being denied because it
was filed late. Petitioners did not provide an explanation of
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benefits from the coinsurance or a statement of Mrs. Sada’s
account from the surgeon.
Although Mr. Sada produced the receipt for the cash deposit
for the surgery, as well as receipts for smaller amounts that he
or Mrs. Sada paid in cash for medical services on other dates, he
did not provide a receipt from the surgeon or a canceled check
showing that petitioners had in fact paid any or all of the
$8,450. He did not provide any evidence of cash withdrawals used
to pay the bill, and the bank records Mr. Sada produced did not
show any cash withdrawals large enough to pay the bill.
Accordingly, we hold that petitioners have failed to
substantiate that they paid medical expenses in excess of 7.5
percent of their adjusted gross income for 2006.
IV. Accuracy-Related Penalties
Initially, the Commissioner has the burden of production
with respect to any penalty, addition to tax, or additional
amount. Sec. 7491(c). The Commissioner satisfies this burden of
production by coming forward with sufficient evidence that
indicates it is appropriate to impose the penalty. See Higbee v.
Commissioner, 116 T.C. 438, 446 (2001). Once the Commissioner
satisfies this burden of production, the taxpayer must persuade
the Court that the Commissioner’s determination is in error by
supplying sufficient evidence of an exception. Id.
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Respondent determined an accuracy-related penalty against
petitioners under section 6662(a) for each of the years at issue.
Section 6662(a) and (b)(1) imposes a penalty in an amount equal
to 20 percent of the portion of the underpayment attributable to
negligence or disregard of rules or regulations. “Negligence”
includes any failure by the taxpayer to make a reasonable attempt
to comply with the provisions of the Internal Revenue Code, to
keep adequate books and records, or to substantiate items
properly. See 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.
The term “disregard” includes any careless, reckless, or
intentional disregard. Sec. 6662(c). 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. A taxpayer is not liable for
the penalty if he shows that he had reasonable cause for the
underpayment and that he acted in good faith. Sec. 6664(c).
Respondent has established that there is an underpayment of
tax for each of the years at issue attributable to
unsubstantiated itemized deductions claimed on Schedules A and
net losses claimed on Schedules C for Mr. Sada’s purchases and
sales of vehicles that petitioners used solely for personal
purposes. Petitioners failed to maintain and produce adequate
records to substantiate the deductions they claimed on the
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Schedules A and C. The records they produced were incomplete and
thus misleading. The law is clear that deductions for vehicles
used solely for personal purposes are not allowed. Accordingly,
respondent has met the burden of production with respect to the
accuracy-related penalty for each year at issue.
Section 6664(c) provides that the section 6662(a) penalty
shall not apply to any portion of an underpayment if it is shown
that there was reasonable cause for such portion and the taxpayer
acted in good faith. Whether a taxpayer acted with reasonable
cause and in good faith is determined on a case-by-case basis,
taking into account all relevant facts and circumstances,
including the taxpayer’s experience, knowledge, and education.
Sec. 1.6664-4(b)(1), Income Tax Regs. Generally, the most
important fact is the taxpayer’s effort to assess the proper
liability. Id.
Reliance on a tax professional may demonstrate that the
taxpayer had reasonable cause and acted in good faith where the
taxpayer establishes that: (1) The adviser was a competent
professional with sufficient expertise to justify the taxpayer’s
reliance, (2) the taxpayer provided the adviser with necessary
and accurate information, and (3) the taxpayer actually relied in
good faith on the adviser’s judgment. 3K Inv. Partners v.
Commissioner, 133 T.C. 112, 117 (2009); DeCleene v. Commissioner,
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115 T.C. 457, 477 (2000); Sklar, Greenstein & Scheer, P.C. v.
Commissioner, 113 T.C. 135, 144-145 (1999).
Petitioners have not established that their reliance on
their return preparer was reasonable or in good faith. First,
petitioners presented no evidence with respect to their return
preparer’s experience or qualifications. Petitioners’ return
preparer attended the trial but did not testify. Mr. Sada stated
that the return preparer was neither an accountant nor an
enrolled agent. Second, petitioners did not establish that they
provided necessary and accurate information to the return
preparer, particularly regarding the purchases and sales of the
vehicles. Petitioners presented no evidence regarding what, if
anything, Mr. Sada discussed with the return preparer. Finally,
petitioners did not establish that they actually relied in good
faith on the return preparer’s judgment. Mr. Sada hired him
because he “came highly recommended”. Mr. Sada initially
testified that his return preparer had been recommended to him by
“more than a thousand people” but later reduced the number to “a
couple dozen people”. However, Mr. Sada knew nothing of the
preparer’s qualifications except that “he has a license to be in
business as a tax preparer” and “has prepared thousands of income
tax returns for people.” Mr. Sada did not investigate whether
his return preparer was a certified public accountant. Mr. Sada
did not establish that his return preparer was a competent
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professional with sufficient expertise to justify his reliance on
him.
Petitioners did not seek professional advice from an
accountant or an attorney. They have not shown that they acted
with reasonable cause or made a good faith effort to properly
report their taxes for the years at issue.
Accordingly, we hold that petitioners are liable for the
accuracy-related penalties under section 6662(a) for 2004, 2005,
and 2006.
We have considered all arguments made, and, to the extent
not mentioned, we conclude they are moot, irrelevant or without
merit.
To reflect the foregoing, and the concessions of the
parties,
Decision will be entered
under Rule 155.