T.C. Memo. 1998-192

UNITED STATES TAX COURT

LUCILA NOVOA, Petitioner v. COMMISSIONER OF

INTERNAL REVENUE, Respondent

Docket No. 2560-97. Filed May 26, 1998.

Thomas F. Dilullo, for petitioner.

Robert A. Fee, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

BEGHE, Judge: For the 1993 taxable year, respondent

determined a deficiency of $18,806 in petitioner's Federal income

tax and an accuracy-related penalty of $3,761. 

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year at issue, and
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1 Petitioner claimed a $2,117 income tax credit for the

purchase of a diesel-powered vehicle and for the purchase of

gasoline and diesel fuel pursuant to sec. 34. Respondent

disallowed the credit in the statutory notice of deficiency. On

brief, petitioner conceded that she is not entitled to the fuel

tax credit under sec. 34. Petitioner also claimed the earned

income credit. Whether petitioner is eligible for the earned

income credit, taking into account the increase to petitioner's

income resulting from this decision, is to be determined in the

Rule 155 computation. Respondent's concessions relate to the

reconstruction of petitioner's income and are explained below. 

2 All dollar figures are rounded to the nearest dollar.

all Rule references are to the Tax Court Rules of Practice and

Procedure. 

After concessions by the parties,1 the issues remaining for

decision are: (1) Whether petitioner had unreported income from

her trucking business of $25,6482 as determined by respondent or

some lesser amount; (2) whether respondent properly increased

petitioner's net rent income by $6,166; (3) whether petitioner

had gain of $2,350 or some lesser amount from the sale of a truck

held for use in her trucking business; and (4) whether petitioner

is liable for the accuracy-related penalty pursuant to section

6662(a).

We hold that petitioner had $17,449 of unreported income,

reflecting a reduction of $8,199 that petitioner received from

nontaxable sources. We hold that petitioner had additional net

rent income of $6,134 and gain of $2,350 on the sale of her

truck. Finally, we hold that petitioner is liable for the

accuracy-related penalty. 
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3 The record does not disclose how or whether the other

truck was being used while petitioner was making deliveries for

Cappy's, or whether the rate at which the one truck was being

driven by petitioner left time for someone else to drive it

during the taxable year.

FINDINGS OF FACT

Some of the facts have been stipulated and are incorporated

herein by this reference. Petitioner resided in North Bergen,

New Jersey, at the time the petition was filed. 

A. Trucking Business

During the taxable years 1992 and 1993, petitioner owned and

operated her own trucking business as a sole proprietor. At the

beginning of 1993, petitioner owned two Mack trucks. Petitioner

drove at least one of the trucks herself to transport cargo

containers for Cappy's Transport, Inc. (Cappy's) on behalf of

Goya Foods, Inc., from Goya's processing plant in Secaucus,

New Jersey, to Port Newark for shipment overseas.3 Petitioner

worked as an independent contractor and was paid according to the

number of containers delivered. Petitioner controlled the

conditions of her employment, working as little or as much as she

pleased. Petitioner failed to maintain adequate books and

records of the gross income and expenses of her trucking

business. 

 On Schedule C of her 1992 income tax return, petitioner

reported gross receipts of $68,145 and net business income of

$16,689 from her trucking business. 
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On her 1993 income tax return, petitioner claimed the

standard deduction and reported gross receipts and expenses of

her trucking business on Schedule C in the following amounts:

Gross receipts $44,275

Expenses

Tolls 2,900

Depreciation 3,000

Insurance 1,300

Repairs & maintenance 1,600

Supplies 1,335

Taxes (registration) 919

Wages 3,000

Other expenses (fuel, 

 tires, parking, road tax) 14,260

 Total expenses 28,314

Net business income 15,961 

At an unspecified time in 1993, petitioner sold one of her

trucks for $12,000. In July 1991, petitioner had purchased

the truck for $14,000 and had paid $500 for a truck warranty. 

Petitioner had claimed depreciation deductions on the truck of

$1,450 and $2,900 for the 1991 and 1992 taxable years,

respectively. Petitioner did not report the sale of the truck on

her 1993 tax return. 

B. Rental Activity

During 1993, petitioner purchased a two-family house in

North Bergen, New Jersey, and on April 1, 1993, she moved into

the house. Petitioner paid the purchase price of $170,000 for

the house in the following manner:

Initial deposit on purchase $22,500

Payment at closing of title 22,500 

Mortgage loan proceeds 125,000

Purchase price 170,000
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4 The record does not disclose the source of the additional

$2,000 paid as an initial deposit.

On December 22, 1992, petitioner wrote a check for $20,500 to her

attorney, William E. Powers, which was applied to the initial

deposit on the house.4 The check cleared on January 6, 1993. On

March 30, 1993, the purchase of the house closed and petitioner

paid $29,501 at the closing. Of this amount, $22,500 was a

further downpayment on the house, and $6,977 represented closing

costs paid to the mortgage lender, which included $2,500 as a

prepayment of interest, referred to as "points", on the mortgage. 

During 1993, petitioner spent $5,893 on property improvements to

the house. 

Beginning in May 1993, petitioner rented one-half of the

house to a tenant. Petitioner reported rent income and expenses

on the Schedule E of her 1993 return as follows: 

Rents received $5,600

Expenses

Insurance 996 

Mortgage interest 6,600

Repairs 4,000

Supplies 3,407

Taxes 2,128

Other (water, sewer, gas) 1,681

Depreciation expense 3,588

 Total expenses 22,400

 Income (loss) (16,800)

50 percent correction

only 1⁄2 of residence rented (8,400)

Petitioner reported expenses paid for the entire house,

even though she only rented one-half of it to a tenant. To
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correct the overstatement of expenses of the rental portion, she

divided the loss by one-half and reported a loss of $8,400

instead of $16,800. Petitioner has acknowledged in the

stipulation of facts that her procedure of dividing the loss in

half results in a computational error that overstates her loss by

$2,800, because it also has the effect of improperly reducing her

gross rental income by one-half.

In adjusting petitioner's Schedule E rent income, respondent

disallowed some expenses while allowing others in excess of the

amounts stated on the return. Respondent adjusted petitioner's

rent income as follows: 

Expense Item Expense Per Return Allowed

Insurance $996 $499 

Repairs 4,000 0 

Supplies 3,407 0 

Taxes 2,128 3,795 

Gas 1,113 0 

Depreciation 3,588 4,206

 15,232 8,500

Total disallowed expenses 6,732

50 percent business allocation x .50

Schedule E expense disallowance 3,366

Schedule E computational error 2,800

Schedule E adjustment in the 6,166 

notice of deficiency

C. Petitioner's Daughters

Petitioner has two daughters, Emelina and Jennifer, who in

1993 were 25 and 18 years old, respectively. Emelina and
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Jennifer lived with petitioner in her rented apartment in West

New York, New Jersey, from January 1 through March 30, 1993;

Jennifer and petitioner then moved into the recently purchased 

house in North Bergen, New Jersey. Emelina continued to live in

petitioner's apartment through the end of 1993. After petitioner

moved out of her apartment, she kept her lease on the apartment

and continued to make rental payments of $319 a month to the

landlord. While Emelina occupied the apartment through the end

of 1993, she reimbursed petitioner for the monthly rental

payments. 

During 1993, Jennifer was a high school student and also

worked part time at the Drug Festival, Inc., in Union City,

New Jersey. Jennifer would cash her weekly paycheck, keep $5

for herself, and give the remainder to petitioner. Jennifer

earned $6,329 of gross wages for the 1993 calendar year. A total

of $1,252 was withheld from her wages for Federal, State, and

payroll taxes. Petitioner used Jennifer's wages to pay household

expenses and buy clothing for Jennifer. 

D. Reconstruction of Income

In August 1995, Internal Revenue Service Tax Auditor Geneva

Dickerson (Ms. Dickerson) began an audit of petitioner's 1993

income tax return. After petitioner failed to provide adequate

books and records of her trucking business, Ms. Dickerson

reconstructed petitioner's income for the 1993 calendar year

using the bank deposit and cash expenditure method and determined
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that petitioner had unreported income in the amount of $26,987. 

On November 26, 1996, respondent issued a statutory notice of

deficiency. Ms. Dickerson's report reconstructing petitioner's

income was attached. The notice of deficiency listed the

following adjustments to petitioner's income: (1) $44,471

increase in Schedule C net profit resulting from the $26,987 of

unreported income determined by Ms. Dickerson's reconstruction

of petitioner's income and the disallowance for lack of

substantiation of $17,484 in deductions for Schedule C business

expenses; (2) $2,350 increase of "other income", representing

petitioner's gain on the truck sale; and (3) $6,166 increase in

rent income, resulting from petitioner's $2,800 computational

error plus $3,366 of expenses disallowed for lack of

substantiation. 

Following pretrial discovery, respondent made several

adjustments to Ms. Dickerson's reconstruction of petitioner's

income and recomputed petitioner's unreported income. Respondent

determined that petitioner had unreported income of $25,648,

$1,339 less than the unreported income originally determined by

Ms. Dickerson and set forth in the statutory notice of

deficiency.

The following table sets forth Ms. Dickerson's initial

reconstruction of petitioner's unreported Schedule C income and

respondent's reconstruction and revised computation:
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Ms. Dickerson's

 Reconstruction 

 Respondent's Revised 

Reconstruction

Bank Deposit Portion

Total deposits $85,924

Bank Deposit Portion

Total deposits $87,853

Nontaxable deposits Nontaxable deposits

Proceeds of truck sale 12,000 Proceeds of truck sale 12,000

Interbank transfers 22,500

Net taxable deposits 73,924 Net taxable deposits 53,353

Cash Expenditure Portion Cash Expenditure Portion

Total expenditures 85,932 Total expenditures 98,441

Check disbursements 89,773

and savings account

withdrawals

Check disbursements 69,202

and savings account

withdrawals

Less disallowed (6,166)

Schedule E expenses

Cash outlays1 3,841 Cash outlays 23,073

Recomputed income 77,765 Recomputed income 77,765

Reported income 50,778 Reported income 50,778

Unreported income 26,987 Unreported income 25,648

1 Ms. Dickerson erroneously concluded that petitioner had

$3,841 of cash outlays, when $3,841 was the excess of total

checks written over expenditures.

Respondent's recomputation of petitioner's unreported

Schedule C income primarily differed from Ms. Dickerson's initial

computation in two ways. First, respondent subtracted interbank

transfers between petitioner's accounts totaling $22,500,

representing transfers from her savings account to her checking
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5 Respondent's subtraction of $22,500 of bank deposits led

to a corresponding $22,500 increase in cash expenditures insofar

as the amount of total checks disbursed was reduced by $22,500

and petitioner's cash expenditures were calculated by subtracting

the amount of total checks disbursed from total expenditures. 

6 The Schedule C included a $3,000 depreciation deduction, a

noncash expenditure, which explains why only $25,314 of the

$28,314 was included in petitioner's cash expenditures.

7 The following is an abbreviated explanation of how

respondent's determination of petitioner's unreported income was

revised from the amount contained in the statutory notice.

(continued...)

account in order to make payments at the closing of her house. 

The $22,500 was then subtracted from the total checks disbursed

amount that was used to calculate petitioner's cash expenditures,

thereby not altering the amount of petitioner's unreported

income.5

Second, respondent allowed Schedule C deductions of $28,314

claimed by petitioner for business expenses in their entirety,

unlike Ms. Dickerson's report, which allowed only $10,830 of the

claimed Schedule C deductions. The allowance of the additional

Schedule C deductions of $17,484 first reduced respondent's

Schedule C net income adjustment from $44,471 to $26,987, the

amount of petitioner's unreported Schedule C gross income. The

allowance of the remaining Schedule C deductions also led

respondent to add $25,3146 of paid business expenses to

petitioner's cash expenditures for purposes of computing her

unreported income, thereby increasing her unreported income in a

corresponding amount.7 
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7(...continued)

Initial unreported income in the $26,987

statutory notice 

 Cash expenditure increase for additional +14,484

Schedule C deductions allowed

Decrease in bank deposits for interbank -22,500

transfers 

Increase in cash expenditures resulting +22,500

from decrease in total checks disbursed

Decrease in cash expenditures resulting -1,975

from decrease in total expenditures

relating to overstatement of payment at 

closing of the house in the statutory 

notice

Decrease in cash expenditures relating -6,166

to Schedule E expenses disallowed

Adjustment for $3,841 error in -7,682

Ms. Dickerson's report. Instead of being 

a cash outlay, such amount represents an

excess of total checks disbursed over total

expenditures 

Revised unreported income 25,648

In January 1993, petitioner's friend, Vilma Reye, lent her

$500. In April 1993, Petitioner repaid the loan in its entirety.

OPINION

A. Respondent's Reconstruction of Income

Section 6001 requires all taxpayers to maintain adequate

books and records of taxable income. In the absence of adequate

books and records, the Commissioner is authorized to reconstruct

the taxpayer's income by any reasonable method that clearly

reflects the taxpayer's income. Sec. 446(b); Holland v. United
- 12 -

8 Petitioner testified that she provided her return preparer

a handwritten list of the business expenses of her trucking

business. Petitioner also proffered into evidence copies of

receipts for the cash purchase of diesel fuel totaling $8,069,

and copies of truck repair and maintenance expense receipts

totaling $3,003. Respondent has conceded the deductibility of

all trucking business expenses claimed by petitioner, but treated

(continued...)

States, 348 U.S. 121, 130-132 (1954); Parks v. Commissioner, 94

T.C. 654, 658 (1990). 

One of these methods, whose propriety is well established,

is the bank deposits and cash expenditure method. Parks v.

Commissioner, supra; Nicholas v. Commissioner, 70 T.C. 1057, 1065

(1978). Under this method, respondent estimates the taxpayer's

cash expenditures and determines the amount of bank deposits for

the taxable years at issue in order to arrive at petitioner's

income, which is then compared with petitioner's reported income

to determine the amount of petitioner's unreported income. See

United States v. Abodeely, 801 F.2d 1020, 1023-1025 (8th Cir.

1986). The method is premised on the assumption that the

taxpayer has disposed of unreported income by depositing part of

it into bank accounts and by making cash expenditures of the

other part. 

In the present case, petitioner did not keep adequate books

and records. Petitioner did not retain a bookkeeper or

accountant and did not keep formal books of account recording the

day-to-day receipt of income and payment of expenses of her

trucking business.8 Respondent, therefore, properly used the
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8(...continued)

all such expenses, except depreciation, as cash expenditures for

purposes of reconstructing petitioner's income. 

9 Respondent's reconstruction of income is a revised version

of the Tax Auditor's reconstruction that was attached to the

statutory notice of deficiency. Respondent's revised

reconstruction determines petitioner to have less unreported

income than the original reconstruction. See supra pp. 8-9. 

10 In cases of unreported income, the Court of Appeals for

(continued...)

bank deposits and cash expenditure method to reconstruct

petitioner's income and to determine that petitioner had

unreported income for the 1993 taxable year.9 The reconstruction

is especially reliable in the present case because petitioner

either stipulated or verified through her testimony the amount of

deposits made to her bank accounts and the amount of cash that

she expended during the 1993 calendar year.

Generally, respondent's determination in a statutory notice

of deficiency is entitled to a presumption of correctness. Welch

v. Helvering, 290 U.S. 111, 115 (1933). The fact that

respondent's revised reconstruction reduces the amount of

petitioner's unreported income does not affect the presumption of

correctness attached to respondent's original determination of

petitioner's tax deficiency, to the extent not reduced by

respondent's revision. Gobins v. Commissioner, 18 T.C. 1159,

1168-1169 (1952), affd. per curiam 217 F.2d 952 (9th Cir. 1954). 

Petitioner does not argue that respondent's determination is

not entitled to a presumption of correctness.10 Instead,
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10(...continued)

the Third Circuit, the circuit to which this case is appealable,

recognizes an exception to the general rule that respondent's

determination is entitled to a presumption of correctness. 

Anastasato v. Commissioner, 794 F.2d 884, 887 (3d Cir. 1986),

vacating T.C. Memo. 1985-101. In cases of unreported income,

whether derived from legal or illegal sources, the Commissioner

must provide some predicate evidence connecting the taxpayer to

an income-producing activity in order to prevent the

determination from being a "naked assessment" without any factual

foundation. Id. Respondent's proper reconstruction of a

taxpayer's income can also provide the factual foundation

necessary to entitle respondent's determination to a presumption

of correctness. See Portillo v. Commissioner, 932 F.2d 1128,

1133-1134 (5th Cir. 1991) ("before we will give the Commissioner

the benefit of the presumption of correctness, he must engage in

one final foray for truth * * * such as by showing the taxpayer's

net worth, bank deposits, cash expenditures”), affg. in part and

revg. in part T.C. Memo. 1990-68, citing Weimerskirch v.

Commissioner, 596 F.2d 358, 362 (9th Cir. 1979), revg. 67 T.C.

672 (1977); see also Hoffman v. Commissioner, 298 F.2d 784, 786

(3d Cir. 1962) (respondent's reconstruction of income was

evidence of petitioner's unreported income entitling respondent's

determination to a presumption of correctness), affg. in part

T.C. Memo. 1960-160; Tokarski v. Commissioner, 87 T.C. 74, 76

(1986) (where respondent determined that petitioner had

unreported income using the bank deposits method, respondent was

not required to produce evidence linking petitioner's income to

an income producing activity); Alvarez v. Commissioner, T.C.

Memo. 1995-414 (distinguishing cases that required linking

unreported income to an income-producing activity where

respondent reconstructed petitioner's income). 

petitioner argues that she effectively rebutted the presumption

of correctness by presenting competent and relevant evidence

showing that the determination is erroneous. We do not

completely agree.

 At trial, petitioner proffered into evidence a copy of a

Form 1099-MISC (Form 1099), listing Cappy's as the payor and

petitioner as the recipient of $44,275 of nonemployee
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11 Respondent objected to the admission into evidence of

the Form 1099, and the parties did argue the question of its

admissibility in their initial briefs. Although at trial

petitioner did pull out of her purse a copy of the Form 1099

(introduced into evidence at trial as Exhibit 19), a copy of

the same Form 1099 was attached to Exhibit 2-B, a copy of

petitioner's 1993 income tax return that was part of the

stipulation of facts, which states that all evidentiary

objections to stipulated exhibits are waived unless specifically

expressed therein. Respondent did not raise any evidentiary

objections to Exhibit 2-B in the stipulation of facts. 

Therefore, the Form 1099 was properly admitted into evidence. 

compensation.11 The total payment reported on the Form 1099 is

identical to the amount of gross receipts reported by petitioner

on her 1993 Schedule C for her trucking business. Petitioner

also testified that Cappy's paid her by check, that Cappy's was

her only client, and that she had no other earnings from the

operation of her trucking business during 1993.

Petitioner's presentation of the Form 1099 together with

her testimony does not effectively rebut the presumption of

correctness attached to respondent's reconstruction of income. 

First, the Form 1099, in and of itself, does not prove that

petitioner did not have other customers in her trucking business

and does not prove that she did not have any other income from

the use and ownership of the two trucks. Second, although

petitioner's testimony that she did not perform services for

clients other than Cappy's and that she had reported all her

earnings from her trucking business in 1993 on her return seems

credible, nevertheless her testimony does not rebut respondent's

determination, insofar as she might have had unreported rental
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12 We note that, for the immediately preceding year,

petitioner reported gross receipts of $68,145 from her trucking

business, approximately $24,000 more than she reported for the

taxable year in issue. 

13 Petitioner's failure to report the sale of the second

Mack truck raises from another angle the question of whether her

failure to report income was connected to income generated by

other use or rental of the truck that was sold.

income from her ownership of the trucks and their use by other

persons. 

 We believe petitioner's testimony--in response to the

questions she was asked at trial--literally to be true, but it

does not cover all possible sources of income from the use of her

truck or trucks during the taxable year. Petitioner did not

explain how two Mack trucks were used in her trucking business

during a portion of 1993. Petitioner's testimony does not

exclude the possibility that she drove one truck herself to

provide transportation services for Cappy's and allowed someone

else either to use her truck when she was not driving it,12 or to

use the other truck to provide transportation services for

others, giving rise to rent income rather than earned income.13

In this way, petitioner's testimony that she had no other clients

and that she reported all her earnings would literally be true,

and still fail to rebut the presumption of correctness of

respondent's determination that petitioner had unreported income

from another source whose likely existence is disclosed by the

record.
- 17 -

Insofar as petitioner's testimony implied and was intended

to convey the impression that she reported all her income on her

1993 return, we find her testimony improbable and questionable,

in light of respondent's reconstruction evidencing the receipt of

income exceeding the amounts petitioner received from Cappy's. 

See Demkowicz v. Commissioner, 551 F.2d 929, 931 (3d Cir. 1977)

(this Court is not bound to accept taxpayer's testimony if it

finds it to be either improbable, unreasonable, or questionable),

revg. T.C. Memo. 1975-278; Sundel v. Commissioner, T.C. Memo.

1998-78.

Petitioner further argues that respondent overlooked several

nontaxable sources of income for the year in issue. Petitioner

contends that the inclusion of such amounts overstated

respondent's determination of her unreported income. 

Specifically, petitioner testified that after she moved out of

her apartment, her daughter Emelina continued to live in the

apartment from April through December 1993. Petitioner continued

to pay the rent on the apartment for those 9 months. We find

that Emelina reimbursed petitioner for the rent on the apartment

for those 9 months in the amount of $319 per month, totaling

$2,871 for the 1993 year. 

Petitioner also testified that her daughter Jennifer, who

lived with her and worked part time at the Drug Festival, Inc.,

would cash her paycheck, keep $5 and give the remainder to her

mother. Jennifer testified at trial about her practice of
- 18 -

turning over to her mother the bulk of the proceeds from cashing

her pay checks. Petitioner submitted a Form W-2 reflecting 1993

wages paid by Drug Festival, Inc., to Jennifer in the gross

amount of $6,330. After Federal, State, and payroll taxes were

withheld, Jennifer's net wages amounted to $5,078. Subtracting

$250, approximately the amount she kept for herself during the

year, we find that Jennifer gave petitioner $4,828 in 1993.

Finally, petitioner testified that in January 1993, her

friend Vilma Reye lent her $500 in order to help her pay her

bills, and that in April 1993, petitioner repaid the $500 loan.

We find the testimony of petitioner and her daughter to be

credible with respect to these items. We therefore find that

petitioner has carried her burden of proving that the foregoing

amounts were received from nontaxable sources and were

erroneously included in respondent's determination, thereby

overstating petitioner's unreported income by $8,199. We

therefore sustain respondent's revised determination of

unreported income only to the extent of $17,449. 

B. Rental Expenses Reported on Schedule E

Respondent's determination added $6,166 to petitioner's rent

income. The adjustment consisted of a $2,800 computational error

relating to the way petitioner allocated her Schedule E expenses

to the rental portion of the two-family residence. Petitioner

has conceded the computational error portion of the adjustment.
- 19 -

The remaining portion of the adjustment is attributable to a

$3,366 net disallowance of deductions for rental expenses claimed

on petitioner's 1993 Schedule E. Petitioner has failed to

substantiate the rental expenses, specifically those relating to

the payment of insurance, repairs, supplies, and gas, which

respondent disallowed. 

Petitioner argues that, in determining the amount of

petitioner's cash expenditures for purposes of reconstructing her

income, the parties stipulated that petitioner spent $5,893 on

property improvements to the house, and that therefore petitioner

is entitled to an additional depreciation deduction under section

168. 

We do not agree with petitioner. Respondent allowed

petitioner a 1993 depreciation deduction for the house that is

$618 greater than what she claimed on Schedule E. Although

the record does not disclose how this increase was computed in

its entirety, we do have in evidence Ms. Dickerson's worksheet

describing and itemizing the expenditures for the total

improvements of $5,893. It appears that Ms. Dickerson allocated

these expenditures between the rental and personal use portions

of the house and allowed an additional depreciation deduction

for the portion of the year that petitioner owned the house. 

Petitioner has not shown that she is entitled to any additional

depreciation deduction for the house.
- 20 -

Petitioner next argues that she is entitled to claim a

deduction under section 163 of $1,250 for prepaid interest

(points) that she paid in connection with the purchase of her

house, and that she is entitled to amortize and deduct a portion

of the remaining $1,250 payment of points as a rental expense on

Schedule E. Respondent argues that petitioner is not entitled

to claim any deductions for the $2,500 payment of points.

In order to deduct points paid in the connection with debt

acquired for the purchase of a principal residence, petitioner

must elect to itemize her deductions. Secs. 63(b), 163(h)(2)

and (3). Petitioner claimed the standard deduction and did not

itemize. Therefore, she is not entitled to deduct $1,250 of the

points paid in connection with the debt acquired to purchase her

principal residence.

Neither is petitioner entitled to deduct the full amount of

the $1,250 of points paid in connection with her purchase of

residential rental property. Section 461(g) provides that in the

case of a cash basis taxpayer the prepayment of interest is not

deductible in the year of payment, but must be capitalized and

deducted ratably over the term of the loan to the extent that the

interest paid represents the cost of using the borrowed funds

during each tax year in the term. Petitioner has not presented

any evidence as to the term of, or rate of interest on, the

$125,000 mortgage loan. 
- 21 -

14 The amount of the deduction is computed by dividing

$1,250 by 30, then multiplying such product by 276/365 because 

petitioner purchased the home and acquired the related

indebtedness on Mar. 30, 1993.

Because petitioner has shown that she is entitled to a pro

rata amortization deduction for her payment of points, but has

not shown the amount of such deduction, we are permitted to

estimate the amount under the rule of Cohan v. Commissioner,

supra. The Court in Cohan directed the Board of Tax Appeals to

estimate expenses "bearing heavily if it chooses upon the

taxpayer whose inexactitude is of his own making.” We therefore

conservatively estimate that the term of petitioner's mortgage

loan is 30 years, and allow her a deduction for the amortization

of her payment of points attributable to the rental portion of

the house, in the amount of $32.14 Respondent's adjustment to

petitioner's rent income is sustained to the extent of $6,134, an

amount equal to respondent's original adjustment of $6,166, less

the $32 deduction allowed for the amortization of the payment of

points. 

C. Gain Recognized on Sale of Truck

Section 1001 provides that gain from the sale of property

equals the excess of the amount realized from the sale over the

adjusted basis in the property sold. Generally, the adjusted

basis of property equals its original cost, increased by

expenditures properly chargeable to capital account, and
- 22 -

15 Petitioner claimed depreciation deductions using a

$14,500 adjusted basis, rather than a $14,000 adjusted basis,

which yielded petitioner larger depreciation deductions. 

However, in calculating her adjusted basis for purposes of

determining gain on the disposition of the property, the full

amounts of depreciation deductions previously claimed by

petitioner decrease her basis in the truck, even though she was

not entitled to deduct the full amounts. See sec. 1016(a)(2);

sec. 1.1016-3(a)(1), (b), Income Tax Regs. 

decreased by the greater of amounts allowed or allowable as

depreciation deductions. Secs. 1011, 1012, 1016(a)(1) and (2). 

On July 18, 1991, petitioner purchased a Mack truck for

$14,000, and paid an additional $500 for a warranty. At some

undisclosed time in 1993, petitioner sold the Mack truck for

$12,000. Petitioner computed her depreciation deductions on the

truck using a basis of $14,500, the original cost of the truck

increased by the $500 warranty expenditure. Petitioner applied

the straight-line method of depreciation over a 5-year recovery

period to the $14,500 basis in order to claim depreciation

deductions of $1,450 and $2,900 for tax years 1991 and 1992,

respectively. 

Respondent argues that for the 1993 taxable year petitioner

had gain of $2,350 on the sale of her truck. Respondent

calculated the gain by subtracting petitioner's adjusted basis,

calculated to be $9,650 ($14,000 original cost - $4,350 of

depreciation deductions), from the truck sale proceeds of

$12,000.15
- 23 -

Petitioner argues only that her adjusted basis in the truck

should be increased by $500 to reflect petitioner's payment for

the truck warranty. Petitioner argues that petitioner's $500

expenditure in 1991 resulted in the creation of an asset having a

useful life beyond the end of the 1991 taxable year. We

understand petitioner to argue that the warranty expenditure is

therefore properly chargeable to capital account, thereby

increasing petitioner's adjusted basis by $500, thereby reducing

the gain on the sale of the truck from $2,350 to $1,850. 

Although this Court has recognized that warranty

expenditures that prolong the life or enhance the value of an

asset are capital in nature, see Spritzer v. Commissioner, T.C.

Memo. 1988-347 (citing Commissioner v. Lincoln Sav. & Loan

Association, 403 U.S. 345, 353 (1971) and Otis v. Commissioner,

73 T.C. 671, 674 (1980), affd. without published opinion 665 F.2d

1053 (9th Cir. 1981)), petitioner has neither entered a copy of

the warranty into evidence nor testified as to the term and

conditions of the warranty. Under these circumstances,

petitioner has failed to prove that the warranty she purchased

created an asset with a useful life that is properly chargeable

to capital account. Accordingly, we reject petitioner's argument

that her adjusted basis be increased by the $500 warranty
- 24 -

16 The entire $2,350 of recognized gain is subject to the

recapture provision of sec. 1245 and is therefore treated as

ordinary income. 

expenditure, and sustain respondent's determination that

petitioner recognized gain of $2,350 on the sale of her truck.16

D. Accuracy-Related Penalty

Section 6662(a) and (b)(1) imposes a penalty equal to 20

percent of the portion of an underpayment of tax that is

attributable to negligence or disregard of rules or regulations. 

"Negligence" includes any failure to make a reasonable attempt to

comply with the provisions of the internal revenue laws. Sec.

6662(c). The regulations further define "negligence" to include

failure by the taxpayer to exercise ordinary and reasonable care

in the preparation of a tax return. The penalty does not apply

to any portion of an underpayment for which the taxpayer had

reasonable cause and acted in good faith. Sec. 6664(c). In

determining whether a taxpayer has acted with reasonable cause

and in good faith, all pertinent facts and circumstances are

taken into account. Sec. 1.6664-4(b)(1), Income Tax Regs. The

burden of proving that the accuracy-related penalty should not be

imposed rests with the taxpayer. Rule 142(a); INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992).

We find that petitioner did not make a reasonable attempt to

comply with the provisions of the internal revenue laws, and that

she did not act with reasonable cause and good faith. Petitioner
- 25 -

17 The accuracy-related penalty was also imposed on the

portion of the underpayment attributed to the disallowance of the

fuel tax credit under sec. 34 claimed by petitioner. Petitioner

has conceded that she is not entitled to the sec. 34 credit. 

failed to report a substantial amount of her income on her 1993

return, including income from her trucking business and income

from the sale of her truck. Petitioner overstated her Schedule E

losses by adjusting her rental expenses in an unacceptable

manner, and failed to substantiate expenses that she deducted on

her Schedule E.17

Petitioner's arguments against the imposition of the

accuracy-related penalty relate only to the portion of the

underpayment attributable to her unreported Schedule C income. 

Petitioner argues that she provided her tax preparer with

receipts of her business expenses and with the Form 1099 received

from Cappy's. She maintains that she was not negligent insofar

as she maintained adequate books and records to substantiate all

of her business expenses properly. 

We need not address whether petitioner maintained adequate

books and records for purposes of the accuracy-related penalty.

In light of petitioner's failure to report substantial amounts of

her income, grounds for sustaining respondent's determination

that she is liable for the accuracy-related penalty exist

independently of finding negligence based on the lack of

maintaining adequate books and records. Accordingly, petitioner
- 26 -

is liable for the accuracy-related penalty under section 6662(a)

on all portions of her underpayment of tax. 

To reflect the foregoing,

 Decision will be entered

 under Rule 155.