T.C. M em o . 2 0 2 1 -9

UNITED STATES TAX COURT

W ILLIAM BRUCE COSTELLO AND M ARITZA LEGARCIE, Pet i t i o ners v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 1 3 5 0-1 7. Fi l edJ an uary2 5 , 2 0 2 1
.

P-Wen g ag edi n a farm i n g act i v i ty fro m wh i ch , fo r t h e s ev en y ears up t o an di n cl u di n g th e t wo y ears i n i s s ue, s he rep o rt edl o s ses . Her s eri al at t em

p t s atrai s i n g ch i ck en s , g ro wi n g v eg et ab l es , an d rai s i ng cat t l e were al l u n s u cces s fu l . Sh e al s o en g ag ed i n a ren t al real es t at e act iv it y

fro m wh i ch , fo r t h e fi rs ty ear i n i s s u e, s h e rep o rt eda l o s s . R d i s al lo wedPs ' d edu ct i o n s fo r t h e farm i n g l o s s es o n th e g ro u n d s th atP-W h ad n o ti n cu rred th em i n carry in g o n a t rad e o r b u s i n es s . He d i sal l owedan o p erat i n g l o s s d edu ct i o n fo r o n e ren t al p ro p ert y o n th e g ro un d s th ati twas n o th el dfo r ren t al b ecau s e i th ad b een fl o o d ed , was i n n o co n di t i o n t o ren t , an dh ad n o tb een ad v ert i s ed fo r ren t al
. He d i s al l o wedth e s u m o f o p erat i n g l os s d edu ct i o n s fo r o th er ren t al p ro p ert ies as a p as s i v e l o s s . Ind et erm i n i n g th e p as s i v e l o s s , R t o o kn o acco u n to f a s ub st an t i al g ai n fro m the s al e o f t wo o f P-W 's ren t al p ro p ert i es . Hel d : Di s al l o w an ce o f d edu ct i o n s fo r l os s es fro m farm i n g act i v i ty s us t ai n edb ecau s e l o s s es were s tart up ex p en s es fo r wh ich I.R.C. s ec. 1 9 5 (a) p ro h i b i t s a cu rren td edu ct i o n. Served 01/25/21- 2
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[* 2 ] Hel d , fu rt h er, d i s al l o wan ce o f o p erat i n g l o s s d edu ct i o n fo r fi rs t ren t al p ro p ert y

s u st ai n edb ecau s e n o th el dfo r ren t al
. Hel d , fu rt h er, R erred i n d et erm i n i n g p as s i v e l os s ; d is al lo wan ce o f l o s s d edu ct i o n n o t s u st ai n ed
. Hel d , fu rt h er, ad d i t i o n t o t ax fo r fai l u re t o t im el y fi l e ret u rn s u s t ai n ed
. Hel d , fu rt h er, accu racy -rel at edp en al t ies s u s t ai n ed
.

W i l l i am Bru ce Co s tel l o an dM ari t za Leg arci e, p ro s es e. An drea M . Fal d erm ey er, J o rd an S. M u s en , an dSt ev en M . Ro th , fo r
res p o n d en t.

M EM ORANDUM FINDINGS OF FACT AND OPINION HALPERN, Ju d g e: Res p o n d en td et erm i n edd efi ci en ci es o f $ 35 ,0 0 3 an d $ 1 ,6 4 8 i n p et i t i o n ers ' 2 0 12 an d2 0 13 Fed eral i n co m e t ax , res p ect i v el y , an ad d i t i o n t o t ax o f $ 8 ,7 4 7 fo r 2 0 12 fo r fai l i n g t i m el y t o fi l e a ret u rn , an d accu racy -rel at ed p en al t i es o f $ 7 ,0 0 1 an d $ 3 3 0 fo r b o th y ears , res pect i vel y . Al l s ect i o n referen ces are t o the In t ern al Rev en ue Co de i n effect fo r t h e y ears i n i s s u e, an dal l Ru l e referen ces are t o t h e Tax Co u rt Ru l es o f Pract i ce an d- 3
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[* 3 ] Pro cedu re, u n les s o th erwi s e i n d i cat ed . W e ro u n dal l d o l lar am o u nt s t o th e
n eares td o l l ar. Aft er a co n ces s i o n , 1 th e i s s u es fo r d eci s i o n are wh ether: (1 ) p et i t i o n ers m ay d eductas b u s i n es s ex p en s es am o u n t s ex p en d edi n co nn ect i o n wi th v ari o u s ag ri cu l tu ral p u rs u i t s duri ng th e y ears i n i ss u e; (2 ) res p o n d en terred i n d i s al l o wi n g p et i t i o n ers ' real es t at e l o s s d educt i o n s ; (3 ) p et i t i o n ers are l i ab l e fo r t h e ad di t i o n t o t ax fo r fai l ure t o t i m el y

fi le t h ei r 2 0 1 2 ret urn ; an d (4 ) p et i t i o ners are l i ab l e fo r t h e
accu racy -rel at edp en al ti es . Pet i t i o ners b ear t h e b u rd en o f p ro of. 2 See Ru l e 1 4 2(a).

FINDINGS OF FACT Th e p art i es h av e s t ip ul at edcert ai n fact s an dth e au th en ti ci ty o f cert ai n d o cu m en t s . Th e fact s s t i p u l at edare s o fo u n d , an d d o cu m en t s s t i p ul at edare accep t edas au th en t i c. Pet i ti o n ers res id edi n Cal i fo rn i a wh en they fi l edth e p et i t i o n .

1 Pet i t i on ers co n ced e res po n d en t 's ad ju s tm en tfo r 2 0 1 2 d i s al l o wi n g th ei r $ 5 0 3 ,9 5 4 d edu ct i o n fo r a n eto p erat in g l o s s carry o v er.

2 Pet i t i on ers h av e n o trai s ed th e i s s u e o f s ec. 7 4 9 1 (a), wh i ch s h ift s th e b u rd eno f p ro of t o th e Co m m i ss i o n er i n cert ai n s i tuat i o n s . W e co n cl ud e t h ats ec. 7 4 9 1 (a) d o es n o t ap p ly

h ere b ecau s e p et i ti o n ers h av e n o tp ro du cedev i d en ce th at th ey h av e s at i s fi edth e p reco n d i t i o n s fo r i t s ap p l i cat i o n .- 4
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[* 4 ] Tax Retu rn s Pet i t i o ners m ad e jo i n tretu rn s o f i n co m e o n Fo rm 1 04 0 , U.S. In d iv i du al In co m e Tax Return , fo r b o th th ei r 2 0 1 2 an d2 0 1 3 t ax ab l e (cal en d ar) y ears . Th ey fi led th ei r 2 0 12 retu rn o n No v em b er 2 6, 2 0 1 3 . Att ach edt o each Fo rm 1 04 0 were
v ari o u s s ch edu l es o n wh i ch p et i t i o n ers cl ai m edd edu ct io n s fo r n etl o s s es fro m (1 ) a farm i n g act i v i ty

an d(2 ) a real es t at e act i v it y , b o th act i v i t i es carri ed o n b y p et i t i o n er wi fe (M s . Leg arci e). At i s s u e are t h o s e d edu ct i o n s . Al th o u g h
res p o n d en t d o es n o td i s pu t e t h atp et i t i o n ers s p en tth e am o u n t s d edu ct ed , h e d o es ch al l en g e t h ei r ri g h t t o th o s e d edu ct i o n s . Farm in g Act i v i t i es M s . Leg arci e h as s i n ce atl eas t2 0 07 carri ed o n a farm i n g act i vi ty o n a 6 ,5 00 -acre t ract o f l an d , Oas i s d el Ed en (p ro p ert y ), i n M ex i co . Beg i n ni n g wi th h er 2 0 0 7 Fo rm

1 0 40 , M s . Leg arci e h as , o n Sch edu l e F, Pro fi to r Lo s s Fro m Farm i n g , rep o rt edth e act i v i ty . Fi rs ts h e (rep o rt i n g s i n gl y ) an d t h en p et i ti o n ers (rep ort i n g jo i n t ly ) h av e rep o rt edn etl os s es fro m th e farm in g act i v i ty fo r ev ery y ear b eg i n n i n g wi th 2 00 7
. In 2 0 0 7 , M s . Leg arci e d eci d edt o rai s e ch i ck en s o n th e p ro pert y t o s el l fo r
m eat . Ap p aren t l y , th atact i v i ty d i dn o t g o wel l . Pet i t i o ner h u s b an d(M r. Co s t el l o )
co u ldn o trecal l wh et h er, fro m 2 0 0 7 th ro u gh 2 0 1 1 , p et i t io n ers s o ldan y o f t h e- 5
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[* 5 ] ch i ck en s , an d th e o nl y s al e t h at M s . Leg arci e rep o rt edfo r 2 0 0 7 thro u g h 2 0 1 1 i s $ 2 6 4 recei vedo n th e res al e (ata l o s s ) o f l i ves t o cki n 2 0 11
. So m et i m e i n 2 0 1 1 , M s . Leg arci e s wi t ch edfro m rai s i n g ch i ck en s fo r m eatt o rai s in g th em

fo r eg g p ro du ct i o n . By

2 0 1 2 , h owev er, s h e h add et erm i n edth ats h e
wo u l dn o tm ak e m o n ey

wi th co m

m erci al eg g p ro du ct io n b ecau s e o f an up ward tren di n t h e p ri ce o f ch i ck en feed . So s he s wi t ch edfro m co m m erci al eg g p ro duct i o n t o b u i l d i n g a fl o ck i n o rd er ag ai n t o s el l ch i ck en s fo r m eat . InM ay 2 0 1 2 , s h e p u rch as ed m o re t h an6 9 b i rd s , d i s tri b u t edam o n g at l eas t 1 4 b reed s . Sh e s ol dn o ch i ck en s i n 2 0 1 2 o r 2 0 1 3 b u th adp l an s t o b eg i n s al es i n 2 0 14 . Her p l an s were t h wart edwh en , i n J an u ary 2 0 14 , wi l d d o g s d es tro y edm o sto f t h e fl o ck
. Wh en M s . Leg arci e was rai si n g m eat ch i ck en s , s h e o ccas io nal l y s o l do r b art ered
ex ces s eg g s th at s he d idn o t n eedt o g ro w th e fl o ck . M s . Leg arci e's o n l y rep o rt ed i n co m e fro m

s el l i n g eg g s i s $ 1 ,0 6 8 s h e rep o rt ed fo r 2 0 1 2
. Bet ween 2 0 0 7 an d2 0 1 1 , M s . Leg arci e g rew wat erm el o n s , s qu as h , p ep p ers , ap p les , b an an as , p o m eg ran at es , d at e p al m s , an das parag u s o n t h e p ro p ert y . Sh e cl ai m edth e ex pen s es o f g ro wi n g th o s e cro p s as farm i n g ex p en s e d edu ct i o n s , b u t
s h e rep o rt ed n o rev en ues fro m s al es . Her l acko f rev en ue was du e t o th e fact th at th e p ro p ert y

i s o n th e ed g e o f t h e wo rl d's l arg es tev ap o rat i ve s al tp l an t , an d , i n 1 9 7 3 , a s p i l l fro m

the s al tp l an tcreat eda s al tfl at o n a p o rt i o n o f t he p ro pert y .- 6
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[* 6 ] M o reo v er, ev ap o rat i on fro m th e s al tp l an tb l o w s acro ss th e p ro pert y an d p o i s o n s th e s o i l
. Cro p s g ro wno n th e p ro p ert y are n o tco m m erci al l y accep t ab l e. In 2 0 1 2 , M s . Leg arci e p l an t eda t es t cro p o f p ep p ers , wh i ch was n o t
s u cces s fu l b ecau s e i n s ect s d es tro y edth e cro p . Inn ei th er 2 0 1 2 n o r 2 0 1 3 d i d M s . Leg arci e m ark et p ro du ce fro m th e p ro pert y . Inh i s t es t i m o n y , M r. Co s t el l o ag reedth atth e ex p en s es i ncu rredt o g ro w th e p ep pers were " p re-o p en i n g , ex p eri m en t al R&D ex pen s es ." In 2 0 1 2 , M s . Leg arci e acq u i redth ree co w s an dth ree cal v es . Her p l an , acco rd i n g t o M r. Co st el l o , was : " Feedthe cal v es , m ak e t h em b i g , s el l th em , i m p reg n at e t h e m o th ers * * * rep eat ." Th atp l an d i dn o two rkb ecau s e, as M r. Co st el lo ex pl ai n ed : " [I] tqu i ck l y b ecam e ap p aren tthatwe weren ' tg o in g t o
m ak e m o n ey

o n co w s b ecau s e wh en I tu rn edth em o u t o n t o th e * * * 6 , 5 0 0 acres , th ey co u l dn 'tfi n d en ou g h t o eat . * * * W e i m m ed i at el y g o tri do f th e co ws ." M s . Leg arci e s o l dth e co ws i n 2 0 1 3 fo r $ 4 ,8 0 0 , wh i ch i s th e o n l y farm act i v i ty i n co m e rep o rt ed fo r 2 0 1 3
. M r. Co s t el lo ex pl ai n edth e i m p etu s b eh in dM s . Leg arci e's p ro g res s i on fro m act i vi ty t o act i v i ty : " When y ouh av e s om et h i n g i n a b u s i n es s th ati s n otm ak i n g
m o ney , y o u ch an g e i t , an dy o ufi g u re o u t wh y i t ' s n o tm ak i n g m o n ey . Yo u
ev al u at e t o s ee i f y o uco u ldm ak e i tm ak e m o n ey . If i td o es n 't , y o us t o p d oi n g th at- 7
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[* 7 ] an d y o us t artd o in g s o m et h i n g el s e. He co n ced ed : " [W ] e h av e t ri ed s ev eral th i n g s o n th i s p ro p ert y ; s o far, n o th i n g h as wo rk ed ." He was , h o wev er, h o p efu l th ats o m et h i ng wo u l d co m e al o n g th atwo u ldwo rkan db e p ro fi t ab l e: " W i l l
s o m et h in g co m e al on g th atwi l l wo rk ? Wh en th e ri g h to p p o rtu n i ty co m es , fi nan ci al co n d i t i o ns ch an ge, m ark etco n d i t i o n s ch an g e, t h en y es , I fu l l y ex p ectt o b e ab le t o m ak e a p ro fi t . Atth e p res en tm o m en t , n o , * * * [we] d o n 't ." Fo r 2 0 1 2 an d2 01 3, M s . Leg arci e rep o rt ed o n Sch edu l es F th e g ro s s i n co m e
an d ex p en s es fro m

h er farm i ng act i v i t i es . Sh e d es cri b ed h er p ri n ci pal cro p o r act i vi ty o n th e s ch edul es as " Po u l try Pro du ct s " . Fo r 2 0 1 2 , s h e rep o rt edi n co m e o f $ 1 ,0 6 8 fro m

eg g s al es , an d , fo r 2 0 13 , i n co m e o f $ 4,8 0 0 fro m th e s al e o f t h e co w s . Sh e rep o rt edh er d edu ct ib l e ex p en ses fo r each y ear b ot h o n t h e Sch edul e F an do n th e Sch edu l e C, Pro fi to r Lo s s Fro m Bu s i n es s (Sch edu l e C (farm i n g )). Th e p art i es ag ree t h atth e Sch edu l e C (farm i n g ) ex p en s es s h o u l d h av e b een rep ort edo n th e Sch edu l es F an dth at th e t reat m en to f t h e Sch edu l e C (farm i n g) ex pen s es fo l l o ws th ato f t he Sch edu l e F ex p en s es . Th e fo ll o wi n g t ab l es s h o w th e p art i cu l ars o f M s . Leg arci e's t ax rep o rt i ng fo r h er farm i n g act i v i ty .- 8
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[* 8] Sch edu l e C (Farm i n g ) 2 01 2 2 0 1 3 Gro s s i n co m e -0
- -0
- Car an dtru ck

ex p en s es ($ 2 ,6 1 8 ) -0
- Dep reci at i o n (8 52 ) -0
- Tax es an dl i cen s es (2 62 ) ($ 2 6 2 ) To t al (3 ,7 3 2 ) (2 6 2 ) Sch edu l e F 2 01 2 2 0 1 3 Gro s s i n co m e $ 1,0 6 8 $ 4 ,8 0 0 Car an dtru ck

ex p en s es (8 0 ) -0
- Feed (6 ,6 3 6 ) (1 8 ,4 6 1 ) Gas o li n e, fu el , an do i l (5 ,5 3 0 ) (1 ,1 4 0 ) To t al (1 1 ,1 7 8) (1 4 ,8 0 1 ) Res p o n d en td i s al l o wedp et it i on ers ' d edu ct i o ns fo r M s . Leg arci e's n et Sch edu l e C (farm i n g ) l o s ses an dal s o d i s al l o w edth ei r d edu ct i o n s fo r h er n et Sch edu l e F l o s s es o f $ 10 ,1 10 an d$ 1 0 ,0 0 1 fo r 2 0 1 2 an d2 0 13 , res p ect i vel y . Inh i s p ret ri al m em o ran du m , res p on d en tex pl ai n s t h at , fo r each y ear, h e erro n eo u s l y
s ub tract ed M s . Leg arci e's Sch edu l e F g ro ss i nco m e fro m h er n etSch edu l e F l o ss i n d et erm i n i n g th e Sch edu l e F d i s al l o wan ce. He m ak es n o cl ai m fo r an ad d ed d efi ci en cy

o n acco u n to f t h atm i s t ak e. Res p on d en tex p l ai ns th ath e m ad e h i s- 9
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[* 9 ] ad ju s t m en t s, d i s al l o wi n g M s . Leg arci e's farm in g l o ss es b ecau s e s h e d i dn o t i n cu r t ho s e l o s s es carry i n g o n a t rad e o r b u s i n es s. Real Es t at e Act i v it y Pet i t i o ners at t ach edSch edu l e E, Sup p l em en t al In co m e an dLo s s , t o each o f th ei r 2 01 2 an d2 0 1 3 Fo rm s 1 0 40 rep o rt i ng i n co m e an dl o s s es fro m ren t al real
es t at e. Onth o se Sch edu l es E, p et i t i o ners rep o rt edth atthey were real es t at e p ro fes s i on al s wh o m at eri al l y p art i ci p at edi n a ren t al real es t at e act i v i ty . Onth e 2 0 1 2 Sch edu l e E, th ey

l i s tedfo u r s ep arat e p ro p ert i es , an d , o n th e 2 0 13 Sch edu l e E, th ey li s t edtwo o f t h o s e fo u r p ro p ert ies . Th e fo l l o w i n g t ab le s h o ws th e p ro p ert i es l i st edan d th e Sch edu l e E i n co m e o r l o s s fro m each
. Pro p ert y 2 01 2 2 0 1 3 Sp ro u l e Av e., Paco i m a, CA $ 1 , 2 60 -0
- Tru m an St ., San Fern an d o , CA 2 6 , 1 10 $ 5 0 ,5 4 0 San Fern an d o Rd
. , San Fern an d o , CA (3 9 ,2 40 ) -0
- Si lv ert i p Dr., Bi g Bear Lak e, CA (8 ,8 2 5 ) (9 ,0 9 4 ) To t al (2 0 ,6 95 ) 4 1 ,4 4 6 Th e Si l v ert i p Dr. p ro p ert y was fl o o d eds o m et i m e i n t h e 2 00 0 s an dwas n ot th ereaft er i n co n d i t i o n t o ren t. Pet i t i o n ers d i dn ot ad v ert i s e i t fo r ren t al an d rep o rt edn o ren t al i n co m e fo r i taft er 2 00 5
.- 1 0 -

[* 1 0 ] Pet i t i o ners s o l d b o th th e San Fern an d o Rd . an d th e Sp ro u l e Av e. p ro p ert i es i n 2 0 1 2 an drep o rt edfro m th os e s al es a l o n g -t erm

cap i t al g ai n o f $ 3 12 ,7 4 7
. Pet i t i o ners al s o cl ai m edo n Sch edu l es C (Sch edu l es C (real es t at e)) fo r b o t h 2 0 1 2 an d2 0 1 3 d edu ct i o n s fo r ex p en s es rel at edt o the real es t at e act i v i ty rep o rt ed
o n th ei r 2 0 1 2 an d2 01 3 Sch edu l es E. Th ey cl ai m edo n th o s e Sch edu l es C (real
es t at e) d edu ct i on s o f $ 1 4,6 1 7 an d$ 2 5 ,3 0 8 fo r 2 0 1 2 an d 2 0 1 3 , res p ect i vel y . Pet i t io n ers cl ai m ed th o s e d edu ct i o n s o n th e Sch edu les C (real es t at e) rat h er t h an ap p ort i o n th em

b etween the p ro p ert i es l i s t ed o n t h ei r Sch edu l es E b ecau s e, M r. Co s t el l o t es t i fi ed , h e d i dn o ts ep arat el y trackth e ex p en s es fo r each p ro p erty . Res p o n d en td i s al l o wedp et it i on ers ' d edu ct i o ns fo r t h e cl ai m edl o s s es o n th e Si l v ert i p Dr. p ro p ert y

fo r b o th 2 0 1 2 an d2 0 1 3 o n th e g ro u n d s th ati twas n o ta
ren t al p ro p ert y . He d i s al l o wedp et i t i o n ers ' rem ai n i n g 2 0 12 Sch edu l e E l o s s o f $ 1 1 ,8 7 1 ($ 1 1 ,8 7 1 = $ 2 0 ,6 9 6

! 8 ,8 2 5 ) o n th e g ro un d s th ati twas a p as s i v e act i v i t y l o s s . He d et erm i n edth atth e d i s al l o wed p as s i v e act i v i ty l o s s co u l d b e carri edo v er
an d cl ai m edag ai n s tp as s i v e act i v i ty i n co m e i n 2 0 13 . Th atredu cedp et i t i o n ers ' 2 0 1 3 ren t al i n co m e (d i s reg ard i n g th e d i s al l o wedSi lv ert i p Dr. l o s s ) t o $ 3 8 ,6 6 9 ($ 3 8 , 66 9 = $ 5 0,5 4 0

! 1 1 ,8 7 1 ), wh i ch was $ 2,7 7 7 l es s th an th e am o u n trep o rt edo n p et i t i o n ers ' 2 0 1 3 Sch edu l e E. Res p o n d en tm ad e an ap p ro pri at e ad ju s t m en tt o p et i t i o n ers ' 2 0 1 3 t ax ab l e i nco m e. Res p o n den td i s al l o wedth e $ 1 4 ,6 1 7 an d- 1 1 -

[* 1 1 ] $ 2 5 ,3 0 8 Sch edul e C (real es t at e) l o s s es fo r 2 0 1 2 an d2 0 1 3 , res p ect i v el y , o n th e g ro u n d s thatM s . Leg arci e was n o ti n a real es tat e t rad e o r b u si nes s . He n o w
co n ced es , h o wev er, th at th e Sch edu l e C (real es t at e) l o s s es were rel at edt o p et i t i o n ers ' Sch edu le E act i vi ty . Pen al t i es Res p o n d en td et erm i n edth at p et i t i o n ers are l i ab l e fo r an ad d i t io n t o t ax fo r fai l u re t o fi l e a t i m el y

t ax retu rn fo r 2 0 1 2 an daccu racy -rel at edp en al t ies b as edo n
n eg li g en ce an da s ub st an t i al u n d ers tat em en to f i n co m e t ax fo r 2 0 1 2 an do n
n eg li g en ce fo r 2 0 1 3. Th e reco rdi n cl u d es a Ci v i l Pen al ty Ap p ro val Fo rm , d at ed M ay 4 , 2 0 1 6 , an ds i g nedb y

th e i m m ed iat e s up erv i s o r o f t h e rev en u e ag en twh o
co n du ct ed th e ex am i nat i o n i n th i s cas e, ap p ro v i n g the ad d i t i o n t o t ax an d t h e p en al t i es b efo re th e d at e t he n ot i ce o f d efi ci en cy was i s s u ed
. OPINION I. Farm i ng Act iv i t i es Res p o n d en td i s al l o wedM s . Leg arci e's farm i n g -act i v i ty l o s s es o n th e g ro u nd s th ats h e h ad n o ti n cu rredth e l o s s es i n carry i n g o n a t rad e o r b u s i n es s . Sect i o n 1 6 2 (a) al l o ws " as a d edu ct i o n al l th e o rd i n ary an dn eces s ary

ex p en s es p ai d
o r i n cu rreddu ri n g th e t ax ab l e y ear i n carry i n g o n an y trad e o r b u s i nes s "
. Res po n d en targ u es th atM s . Leg arci e can n o t d edu cth er farm i n g -act i v i ty l o s s es- 1 2 -

[* 1 2 ] u n d er s ect i o n 1 6 2 fo r t wo reas o n s ; o n e, s h e l ack eda p ro fi t m o t i v e, an d , two , h er b u si n es s h adn o tduri ng 2 0 1 2 an d2 0 1 3 y etco m m en ced . " [Her] farm

act i v i t y
n ev er m ov ed b ey o n di ni t i al res earch an di n ves t i g at i o n i n t o an o p erat i ng b u s i n es s ." Wh i l e i ti s tru e t h ats ect io n 1 83 (a) as a g en eral ru l e d i s al l o ws an y d edu ct i o n at tri b u t ab l e t o an act iv i ty n o ten g ag edi n fo r p ro fi tan dth at th e reg u l at io n s i m p l em en t i n g s ect i o n 1 8 3 l ay ou tn i n e n o n ex cl us i v e fact o rs fo r d et erm i n i n g wh et h er an act i v i ty

i s en g ag ed i n fo r p ro fi t , s o m e o f wh i ch fav o r M s . Leg arci e 3
an d s om e o f wh ich d o n o t, 4 M r. Co s t el l o h as co nv i n cedu s th at , n o twi th s tan d i n g
s ev en fal l o w y ears , h i s wi fe was d et erm i n ed l y s eek i n g du ri n g th e y ears i n i s s u e t o
earn a p ro fi tfro m

farm i n g . Nev ert h el es s , we d o ag ree wi th res p o n d en t th at , du ri n g 2 0 1 2 an d2 0 1 3, h er act i v i t i es were fo r t h e m o s t p art p reo p erat i o n al an d , fo r th atreas on , s h e m ay

n o t d educth er l o s s es . In o rd er fo r ex p en s es t o b e d edu ct i b l e u n d er s ect i o n 1 6 2 (a), t h e ex pen s es
m u strel at e t o a t rad e o r b u si n es s fu n ct i on i n g wh en th e ex p en s es were i n cu rred
.

3 See, e.g ., s ec. 1 .1 8 3-2 (b )(1 ), In co m e Tax Reg s . (" A ch an g e o f o p erat i n g m et h o ds , ad o p t i o n o f n ew t ech n i qu es o r ab an do n m en to f u npro fi tab l e m et h o d s i n a m an n er co ns i s t en twi th an i n t en tt o i m p ro ve p ro fi t ab i l i ty

m ay * * * i n d icat e a p ro fi t m o t i v e." ).

4 See, e.g ., s ec. 1 .1 8 3-2 (b )(7 ), In co m e Tax Reg s . (" An o ccas i on al s m al l p ro fi t fro m

an act i v it y

g en erat i n g l arg e l o s s es * * * wo u l dn otg en eral l y b e d et erm i n at i v e t h atth e act i v i ty i s en g ag edi n fo r p ro fi t ." ).- 1 3 -

[* 1 3 ] Hard y

v . Co m m i s s i on er, 9 3 T.C. 6 8 4 , 6 8 7 (1 9 8 9 ). A t ax p ay er h as n o t

" 'en g ag edi n carry i n g o n an y trad e o r b u s i n es s ' wi th i n th e i n t en dm en t o f s ect i o n 1 6 2 (a) u nt i l s u ch t i m e as th e b u s i n es s h as b eg u n t o fu nct i o n as a g oi n g co ncern
an d p erfo rm edth os e act i v i t i es fo r wh i ch i twas o rg an ized ." Ri ch m o n d Tel ev i s i o n Co rp . v . Un i t edSt at es , 3 4 5 F.2 d9 01 , 9 07 (4 th Ci r. 1 9 6 5 ), v acat ed an drem an d ed
o n o th er g ro u n d s , 3 82 U.S. 6 8 (1 96 5 ). " Carry i n g o n a t rad e o r b u s i nes s " req u i res a
s h o wi n g o f m o re t h ani n i t i al res earch i n t o o r i nv es t ig at io n o f b u s i n es s p o t en t i al
. Sec. 1 6 2(a); Dean v . Co m m i s s i o n er, 5 6 T.C. 8 9 5 , 9 02 (1 9 7 1 ). " T h e b u s in es s
o p erat i o n s m

u s th av e act u al l y

co m m en ced ." M cKel v ey

v . Co m m i s s i o n er, T.C. M em o. 2 0 0 2 -6 3 , 2 0 0 2 W L 3 41 0 4 4 , at* 3 , aff'd , 7 6 F. Ap p ' x 8 0 6 (9 th Ci r. 2 0 0 3 ).

" Un t i l th e t i m e t h e b u s in es s i s 'p erfo rm i n g th e act i v i t i es fo r wh i ch i twas
o rg an i zed ,' ex p en s es rel at edt o th atact i vi ty are n o tcu rren tl y

d edu ct i b le u n d er
s ect i on 1 6 2 ." Hei nbo ck el v . Co m m i s s i o n er, T.C. M em o . 2 0 1 3 -1 2 5 , at* 4 2 (qu o ti n g Gl o t o v v . Co m

m i s s i o n er, T.C. M em o . 2 0 0 7 -1 4 7 , 2 0 0 7 W L 1 7 0 2 6 1 8 , at* 2 ). Th ey

are i n s t eadcl as si fi ed as " s t artup " o r " p re-o pen i n g" ex p en s es . Hardy
v . Co m m i s s i o n er, 9 3 T.C. at6 8 7 . An ds t artup ex p en ses --wh i ch i n cl u de t h o s e i n cu rred" b efo re th e d ay

o n wh i ch th e act i v e t rad e o r b u s i nes s b eg in s " --are o n l y d educt i b l e o v er t i m e o nce an act i v e t rad e o r b u si n es s b eg i n s. See s ec. 1 9 5 (a), (c)(1 )(A)(i i i ).- 1 4 -

[* 1 4 ] Sect io n 1 9 5 (a) p ro v i d es th atn o d edu ct i on s h al l b e al lo wedfo r s tart up
ex p en d i tu res . Sect i o n 1 9 5(c)(1 ) d efi n es s t artup ex p en d itu res as , am o n g o th er th i n g s , an y

am o un tp ai di n co n n ect io n wi th creat in g an act i v e trad e o r b u si n es s , wh i ch , i f p ai do r i n cu rredi n co n n ect i o n wi th th e o p erat i on o f an ex is t in g act i v e trad e o r b u si n es s , wo u ldb e al l o wab l e as a d edu ct i o n fo r t h e t ax ab l e y ear i n wh i ch p ai do r i n cu rred
. Sect i o n 1 9 5 (b ) p ro v i d es thats t artup ex p en d i tu res m ay , atth e el ect io n o f t h e t ax p ay er, b e t reat edas d eferred ex p en ses th atare al l o wedas a d educt i o n p ro rat edequ al l y o v er a 1 5-y ear p eri odb eg i n n i ng wi th th e m o n th i n wh i ch th e act i ve t rad e o r b u s i n es s b eg i n s. St artup ex p en ses i n cu rredi n an
u n s u cces s fu l at t em

p tt o creat e a b u s i n es s m ay b e d edu ct i b l e i f t h e at t em p ti s far
en o ug h al o n g . See, e.g ., Seed v . Co m m i s s io n er, 5 2 T.C. 8 8 0 (1 9 69 ) (fi n d i n g d educt i b l e l o s s u n d er s ect i o n 1 6 5 (c)(2 ) fo r l eg al an do th er ex p en s es o n ab an do n m en to f b u s in es s v en tu re fo l lo wi n g d en ial o f ap pl i cat io n fo r ch art er); Rev
. Ru l
. 7 7 -2 5 4, 1 9 7 7 -2 C.B. 6 3
. M cKel v ey

i s i n s tru ct i v e h ere. Th e t ax p ay er t h ere p u rch as ed3 9 acres wi t h a b arn , an da cab i n th ath e u s edas h i s p ers o n al res i d en ce. M cKel v ey v . Co m m i s s i o n er, 2 0 0 2 W L 3 4 10 4 4 , at* 1 . He i nt en d edt o s t arta t ree-farm i n g b u s i n es s o n th e p ro p ert y . Id . Inth e s eco n dy ear du ri n g wh i ch h e o wn edth e p ro p erty (t h e fi rs t y ear i n i ss ue), h e b eg an b y co n duct i n g a " p i l o tt es t ", p l an t i n g o f- 1 5 -

[* 1 5 ] 5 1 Co u l t er p i n e trees , t o d et erm i n e wh et h er t h e l an dco ul ds up p o rt
co m m erci al Co u l t er p i nes . Th e t es tqu i ck l y p ro v edu n su cces s fu l b ecau se t h e l an d
co u ldn o ts up p o rtth e t rees . Id . at* 2 . By th e en do f th e th irdy ear du ri n g wh i ch h e
o wn edth e p ro p ert y

(an dth e s eco n d y ear i n i s s u e), h e h adn o td eci d edwh at
s p eci es o f t rees t o p l an tan dh adn o th arv es t edan y o f t h e ex i s t i n g trees o n th e p ro p erty . Id . In d eed , as o f t he ei g ht h y ear du ri n g wh i ch h e o wn edth e p ro p ert y , h e h adn o t h arv es tedan y

trees , h adn o t p lan t edan y n ew t rees , an d h adn o ty et d eci d ed wh i ch s p eci es o f t rees t o p l an t . Id . W e ag reedwi th th e Co m m i s s i o n er th atwh atal l th atm ean twas th atthe t ax p ay er du ri n g th e t wo y ears i n i s s u e d i dn o t h av e a fu n ct i o n i ng b us i nes s. Id . at* 3 . Hi s ex p en s es were t h erefo re s tart up
ex p en s es fo r wh i ch o n acco u n to f s ect i o n 1 95 (a) we al l o wedn o cu rren td edu ct i o n . Id . at* 3 -* 4
. Reem s v . Co m

m i s s io n er, T.C. M em o . 1 9 9 4 -2 5 3 , 1 9 94 Tax Ct . M em o LEXIS 2 5 6 , i s s i m i lar. Th e t ax p ay er t h ere al so p u rch as edp ro pert y o n wh i ch t o rai s e an dh arv es t ti m

b er an d h adt ak en th e fi rs ts t ep s i n a p ro g ram t o s t arta
co m m erci al t i m

beri n g b u si n es s , p ay i n g s o m e $ 30 ,0 0 0 i n ex p en s es . Reem s v . Co m m i s s i o n er, 1 9 9 4 Tax Ct
. M em o LEXIS 2 5 6 , at* 7 -* 8 . No twi th s t an di ng s o m e i n ci d en t al s al es o f fi rewo o dan dwal n u ttrees fro m th e p ro pert y , we fo u n dth at , du ri n g th e y ear i n i s s u e, h e h adn o tco m m en cedan act iv e b u s in es s o n t h e p ro p ert y .- 1 6 -

[* 1 6 ] Id . at* 1 2 . W e al l owedn o d edu ct i o n fo r wh atwe d es cri b edas " 's t art -up
ex p en d i tu res '[,] * * * cl earl y co v eredb y

s ect i o n 1 9 5 " . Id
. at* 1 1; s ee al so Hei nb o ck el v . Co m

m i s s io n er, T.C. M em o . 2 0 1 3 -1 2 5
. Beg i n n in g i n 2 0 0 7 an dth ro u g h th e y ears i n i s s u e, M s . Leg arci e's farm i n g act i vi t i es n ev er m o v edb ey o n di n i t i al ex p eri m en t at i on an di n v es t i gat i on i n to an
o p erat i n g b u s i nes s. In 2 0 1 2 an d2 0 1 3 , s h e was s ti ll p l an t i n g res earch cro p s . W i t h
res p ectt o t h e p ep pers p l an t edi n 2 0 1 2 , M r. Co st el l o ag reedth atth e ex p en s es o f g ro wi n g th e p ep p ers were " p re-o p en i n g , ex peri m en t al , R&D ex p en s es ." M s . Leg arci e d es cri b edh er p ri n ci p al cro p o r act iv i ty o n th e 2 01 2 an d 2 01 3 Sch edu l es F as " Po u l try

Pro du ct s " , a d es cri p ti o n we as s u m e i n cl ud edb o th p o u l t ry
m eatan d eg g p ro du ct i on . Bu t , i n fact , s he n ev er s o l dan y ch i ck en s fo r m eat , ev en th o u g h s h e rai s eda fl o ck o f m eatch i ck en s b et ween 2 0 07 an d2 0 11 . Sh e s o l dan d b art eredeg g s fro m

2 0 07 th ro u gh 2 0 13 , b ut , fro m 2 00 7 t o 2 0 1 1 , th os e eg g s were b y p ro duct s fro m

rai s in g m eatch i ck en s . Sh e b ri efl y co n cen trat edo n co m

m erci al eg g p ro du ct io n i n 2 0 11 ; b u t b y th e b eg i n ni n g o f 2 0 12 , s h e h add et erm i n edt o s to p b ecau s e i two u l d no tm ak e m o ney . Sh e t h enwen tb ackt o m eatp ro du ct i o n, wh i ch
s h e co nt i n u edu ns u cces s fu l l y u n t i l J anu ary

2 0 1 4 , wh ich i s aft er t h e y ears i n i s s u e. M r. Co st el lo s umm edh i s wi fe's farm i n g act i v i t i es wh enh e t es t i fi ed : " [W ] e h av e tri ed sev eral thi ng s o n th i s p ro p ert y ; s o far, n o thi n g h as wo rk ed ."- 1 7 -

[* 1 7 ] Th ere i s s o m e ques ti o n o f wh et h er t o treatal l o f M s . Leg arci e's farm i n g act i vi t i es as o n e act i v i ty o r t reat p o u l try , cat t l e, an dcro p s as s ep arat e act i v i t i es fo r d et erm i n i n g wh eth er s h e h adco m m en cedan act i v e t rad e o r b us i n es s . It m ay n o t
m ak e m u ch d i fferen ce. Sh e h as n o ts eg reg at edh er co s t s b y act i v it y . W e ag ree th at , l i k e t h e t ree farm ers i n M cKel v ey an d Reem s, M s . Leg arci e h adn o t , as o f 2 0 1 2 , co m

m en cedan y

act i v e b u s i n es s o n t h e p ro p ert y . Th e eg g -s al e m o n ey th at
s h e rep o rt ed fo r 2 0 1 2 was an i n ci d en t al recei p treal i zedaft er s h e h add et erm i n ed t o ab an d o n co m

m erci al eg g p ro duct i o n an ds wi t ch ag ai n , t o m eatp ro du ct i o n , wh i ch s h e carri ed o n th o u g h 2 0 1 3 . Sh e m ay h av e en d edh er cat t l e act i v i ty i n 2 0 1 3 , b u twe h av e n o i t em i zat io n o f t he co s t s o f th at act i v i ty o r an y b as i s t o
es t i m at e an y

d edu ct i b l e l o s s . See Co han v . Co m m i ss i o n er, 3 9 F.2 d5 4 0 , 5 43 -5 4 4 (2 dCi r. 1 9 3 0). M o s to f h er Sch edu les C (farm in g ) an d F ex p en s es are s t artup
ex p en s es fo r wh i ch s ect io n 1 95 (a) p ro h i b i t s a cu rren td edu ct i o n . 5 To thatex t en t ,

5 Onth e Sch edu l es C (farm i n g), s h e cl ai m ed a d edu ct i o n fo r s o m e am o u n to f t ax es p ai d . If s ec. 1 6 4 al l o w s a d edu ct i o n fo r t h o s e p aym en ts , th o s e t ax es p ai dare n o ts t artup ex p en d i tu res . See s ec. 1 9 5 (c)(1 )(B). If n eces s ary , th e p art ies can ad dres s th at i n th ei r Ru l e 1 55 co m p u t at i on .- 1 8 -

[* 1 8 ] we s u s t ai n res p o n d en t's ad ju s tm en t s d i s al l o wi n g p et i t i o ners ' Sch edu l e C (farm i ng ) an dF l o s ses . 6 II. Real Es t at e Act i v it i es Pet i t i o ners h av e fai ledt o co n v i n ce u s th atth e Si l v ert i p Dr. p ro p ert y , wh i ch h ad b een fl o o ded , was i n n o co n d i t i o n t o ren t , an d h adn otb een ad v ert i s edfo r
ren t al , was , du ri n g 2 0 1 2 o r 2 0 1 3 , a ren t al p ro p ert y . In d eed , p et i ti o n ers m ak e n o arg u m en tth atu n d er ei th er s ect i o n 1 62 (Trad e o r Bu s in es s Ex p en s es ), s ect io n 2 1 2 (Ex p en ses fo r Pro du ct io n o f In co m e), o r an y o th er s ect i o n o f t h e In t ern al Rev en u e Co d e are t h ey

en ti t ledt o an y d edu ct i o n wi th res p ectt o th e Si lv ert i p Dr. p ro p ert y fo r ei th er y ear. W e wi l l s u st ai n res p o n d en t's ad ju s t m en t d i s al l o wi n g p et i t i o n ers cl ai m edl o s s d edu ct i on s o f $ 8 ,8 2 5 an d $ 9 ,0 9 4 wi th res p ectt o th e p ro p ert y fo r 2 0 1 2 an d2 0 1 3 , res p ect i v el y . W i th res p ect t o th e rem ai n in g 2 0 1 2 Sch edu l e E l o s s o f $ 1 1,8 7 1 an dth e 2 0 1 2 Sch edu l e C (real es t at e) l o s s o f $ 1 4 ,6 17 (wh o se t reat m en t fo l l o ws the treat m en to f t h e Sch edul e E l o s s ), res p o nd en t n o w co n ced es th ath e erredi n d et erm i n i n g th atfo r 2 01 2 th ere was an y p as s i v e act i v i ty

l o s s . Ina p o s tt ri al
co n feren ce wi th th e p art i es , th e Co u rt p o i n t edo u t th at , i n 2 0 1 2, p et i t i o n ers s o l d

6 Al s o , res p o n d en th as d i s al l o wedM s . Leg arci e's farm -act i v i ty l o s ses o n l y

t o th e ex t en tth ey

ex ceed h er farm -act i v i ty i n co m e. Sec. 1 9 5 d o es n o tap p ear s o res tri ct ed . W e wi l l n o tg o b ey o n dres p o n den t 's ad ju st m en t s .- 1 9 -

[* 1 9 ] b o th th e 1 6 63 San Fern an d o Rd . an dth e 1 1 7 2 7 Sp ro u l e Av e. p ro p ert i es an d rep o rt edfro m

th o s e s al es a 2 0 1 2 l o n g -t erm cap i t al g ai n o f $ 3 1 2 ,7 4 7
. Res po n d en t
co n ced es th atth e am o un to f g ai n was p arto f p et i t i o ners ' " ag g reg at e i n co m e fro m
* * * p as s i v e act i v i t i es " fo r 2 0 1 2 . See s ec. 4 6 9 (d )(1 )(B); s ec. 1 .4 6 9 -2 T (c)(2 ), In co m e Tax Reg s ., 5 3 Fed . Reg . 5 7 1 1 (Feb . 2 5 , 1 98 8 ). M o reo v er, b ecau s e t h e 2 0 1 2 ag g reg at e i n co m e fro m p as s i v e act i v i ti es g reat l y ex ceed edthe y ear's ag g reg at e l o ss es fro m

p as s i v e act i v i t i es (i ncl u d i n g the Sch edu l e C (real es tat e) l o s s ), th ere was n o 2 0 1 2 p as s i v e act iv i ty l o ss . See s ec. 4 6 9 (d )(1 ). An d , fo r t h at
reas on , th ere was n o p as s i v e act i v it y l o s s th atco u l db e carri edo v er t o 2 01 3
. 7 In s u m , ex cep tfo r res p o n d en t 's Sch edu l e E ad ju st m en td i s al l o wi ng an y l o s s d educt i o n wi th res p ect t o th e Si l v ert i p Dr. p ro p ert y , h is Sch edul e E an dSch edu l e C ad ju s t m en t s fo r b o th 2 0 1 2 an d2 0 1 3 were i n erro r an dm u s tb e rev ers ed . Th at wi l l n eces s i t at e a Ru le 1 5 5 co m p u t at i o n . III. Ad d it i on t o Tax an dPen al t i es A. In tro du ct io n Sect io n 7 4 9 1 (c) i m

p o s es th e b u rd en o f p ro du ct i o n i n an y co u rtp ro ceed i n g
o n th e Co m

m i s s i o n er wi th res p ectt o th e l i ab il i ty o f an y i n d i vi du al fo r p en al t i es

7 An dp et i t i on ers m ak e n o arg u m en tfo r an y p as s i v e l o s s carry o v er fro m 2 0 1 1 t o 2 0 1 2
.- 2 0 -

[* 2 0 ] an d ad d i t i o n s t o t ax . See Hi g b ee v . Co m m i s s i on er, 1 1 6 T.C. 4 3 8 , 4 46 -4 4 7 (2 0 0 1). In o rd er t o m eetth e b u rd en o f p ro du ct i o n u n d er s ect i o n 7 4 91 (c), t h e Co m m i s s i o n er n eedo n l y

m ak e a p ri m a faci e cas e t h ati m po s it i on o f t h e p en al ty o r ad d it i o n t o t ax i s ap p ro p ri at e. E.g ., Bal l v . Co m m i s s i o n er, T.C. M em o . 2 0 2 0 -1 5 2, at* 1 2
. If t h e Co m

m i s s i o n er carri es h i s b u rd en , th e t ax pay er h as th e b u rd en o f p ro v in g th atan y

affi rm at i ve d efen s es ap p ly , s u ch as reas o n ab l e cau s e. Hi g b ee v . Co m m i s s i o n er, 1 1 6 T.C. at4 4 6-4 4 7 ; Bal l v . Co m m i s s i on er, at* 12
. B. Ad d it i on t o Tax fo r Fai l u re To Fi l e Ret u rn Ti m el y Sect io n 6 6 5 1 (a)(1 ) i m

p o s es an ad d i t io n t o t ax fo r fai lu re t o fi l e a t i m el y t ax retu rn . Th e ad di t i o n equ al s 5 % o f t h e am o u n treq u i redt o b e s h o wn as t ax o n th e d el i n qu en tretu rn fo r each m o n th o r fract i o n thereo f duri n g wh i ch th e ret u rn
rem ai n s d el i n qu en t , up t o a m ax i m u m ad di t i o n o f 2 5% fo r return s m o re t h an fo u r
m o nt h s d el i n quen t . Id . Th e ad d i t i o n t o t ax d o es n o tap p l y i f t he fai l u re t o fi l e t i m el y is du e t o reas o n ab l e cau s e an dn o tt o wi l l fu l n eg lect . Id
. Pet i t i o ners fi l edth ei r 2 0 1 2 t ax retu rn o n No v em b er 2 6 , 2 0 1 3 , s ev eral
m o nt h s aft er i twas due. See s ec. 6 0 7 2 (a). Res p o n d en th as , th erefo re, s at i s fi edh i s b u rd eno f p ro du ct i o n . Pet i ti o n ers m ak e n o arg u m en tth atth ei r fai l u re t o fi le t h e retu rn t i m el y

was du e t o reas o n ab l e cau s e an dn o twi l lfu l n eg l ect . Thus , we wi l l
s u s t ai n th e s ect i on 6 65 1 (a)(1 ) ad d i t i o n t o t ax fo r 2 0 1 2
.- 2 1 -

[* 2 1 ] C. Sect io n 6 6 6 2 Accu racy -Rel at ed Pen al t i es Sect io n 6 6 6 2 (a) an d(b )(1 ) an d(2 ) p ro v i d es fo r anaccu racy -rel at edp en al t y
o f 2 0 % o f t h e p o rt i on o f an y u n d erp aym en tat tri b u t ab l e t o , am o n g o th er t h in g s , n eg li g en ce o r d i sreg ardo f ru les o r reg u l at i o ns (wi th o utd i s t i n ct i o n , n eg li g en ce) o r
an y s ub s tan t ial u nd ers t at em en to f i n co m e t ax . Th e t erm " n eg li g en ce" i ncl u d es

" an y fai l u re t o m ak e a reas o n ab l e at tem p t t o co m p l y wi th th e p ro vi s i o n s " o f t h e In t ern al Rev enu e Co d e o r a fai l u re t o ex erci se " o rd i naryan dreas on ab l e care i n th e p rep arat i o n o f a t ax retu rn ." See s ec. 1 .6 6 6 2 -3 (b )(1 ), In co m e Tax Reg s . Sect i o n 6 6 6 2 (d )(2 )(A) g en eral l y

d efi n es the t erm

" u n ders t at em en t " as th e ex ces s o f t h e t ax req u i redt o b e s h o wno n th e retu rn o v er t h e am o u n ts h o wn o n the ret u rnas fi l ed
. In th e cas e o f an i n d i v i dual , an u n d ers t at em en ti s " s ub s t an t i al " i f i tex ceed s th e g reat er o f 1 0 % o f t h e t ax req u i redt o b e s h o wno n th e ret u rn o r $ 5 ,0 00
. Sec. 6 6 62 (d )(1 )(A). An u n ders t at em en ti s redu ced , h o wev er, b y th e p o rt i o n at tri b u t ab l e t o th e t reat m en t o f ani t em fo r wh ich th e t ax p ay er h ad " s ub s t an t i al
au th o ri ty " o r, i n t h e cas e o f i t em s ad equ at el y d i s cl o s ed , a " reas o nab l e b as i s "
. Sec. 6 6 62 (d )(2 )(B). Sect io n 6 66 4 (c)(1 ) p ro v i des an ex cep ti o n t o th e i m p o s i t i o n o f th e s ect i o n 6 6 6 2 (a) accu racy -rel at edp en al ty i f i t i s s h o wnthatth ere was
reas on ab l e cau s e fo r t h e u n d erp aym en t an dth e t ax p ay er act edi n g o odfai th
.- 2 2 -

[* 2 2 ] Becau s e we d o n o ts u s t ai n al l o f res po n d en t's ad ju s t m en t s t o p et i ti o n ers ' i n co m e fo r 2 0 12 , we can n o td et erm i n e wh et h er p et i t i o n ers s ub s t an t i al l y
u n d ers t at edth ei r 2 0 1 2 i n co m e t ax . W e n eedn o td o s o b ecau s e res p o n d en th as
s at i s fi edh i s b u rd en o f p ro du ct i o n wi th res p ectt o p et it i o n ers ' n eg l i g en ce fo r 2 0 1 2
an d 2 0 1 3 . Pet i t i o n ers co n ced edth atth ey i m p ro p erl y cl ai m edth e NOL carry o v er d educt i o n o n th ei r jo i n t 2 0 1 2 t ax return . Th ey al s o erro neo u sl y cl ai m ed d educt i o n s fo r Sch edu l es C (farm i n g ) an d F l o ss es fo r M s . Leg arci e's farm i n g act i vi ty t o wh i ch th ey

are n o ten t i t l ed
. Res po n d en t h as p ro duced a Ci v il Pen al ty Ap p ro v al Fo rm

m eet i n g th e requ i rem en t s o f s ect i on 6 7 5 1(b ). Res p o n d en t h as m et h i s b u rd en o f p ro du ct i o n. Pet i t i o ners d i dn o tad dres s th e s ect i o n 6 6 6 2 (a) p en al t i es ei th er attri al o r i n th ei r b ri ef, an dth e ev i d en ce b efo re u s fai l s t o d em o n s trat e t h atth ey act edwi th
reas on ab l e cau s e o r i n g o o dfai th . W e s u s tai n the accu racy -rel at edp en al t i es d et erm i n edb y

res p o n den t . IV. Co n cl u si o n To refl ectthe fo reg o i n g an d co n ces s io ns b y th e p art i es , Deci s i o n wi ll b e en t eredu n d er Ru l e 1 5 5
.