T.C. Summary Opinion 2001-155

UNITED STATES TAX COURT

THOMAS W. BURTON, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 5613-00S. Filed September 26, 2001.

Thomas W. Burton, pro se.

Thomas J. Fernandez and Miriam A Howe, for respondent.

PAJAK, Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed. The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority. Unless otherwise indicated,

subsequent section references are to the Internal Revenue Code in

effect for the year in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure. 
- 2 -

Respondent determined a deficiency of $26,921 in

petitioner's 1995 Federal income tax and a section 6662(a)

penalty of $5,384.20. The parties now agree: (1) Mortgage

interest and property tax claimed on petitioner's Schedule F,

Profit or Loss From Farming, are properly deductible on his

Schedule A, Itemized Deductions, as expenses for a second home,

which, together with other changes respondent made to

petitioner's Schedule A, results in a $22,622 increase of

itemized deductions; (2) petitioner is entitled to a net

operating loss carryover of only $1,146 for the 1995 tax year

rather than the $64,898 claimed by him; (3) petitioner's Schedule

E, Supplemental Income and Loss, rental activities are passive;

and (4) petitioner is not liable for the accuracy-related

penalty.

This Court must decide: (1) Whether petitioner is entitled

to deduct Schedule C expenses which respondent disallowed in the

amounts of $4,633 for meals and entertainment, $6,533 for travel,

and $19,113 for interest; (2) whether petitioner's farm activity

was engaged in for profit during 1995 and, if so, whether it was

a passive activity; and (3) whether petitioner is entitled to a

Schedule E rental loss in the amount of $3,712.

Some of the facts in this case have been stipulated and are

so found. Petitioner resided in Newport Beach, California, at

the time he filed his petition. 
- 3 -

Petitioner is an attorney practicing in the areas of

business law, trusts, estates, and technology. He was admitted

to the California State Bar in 1973. Petitioner operated a law

practice with one office in San Diego and one in Orange County. 

On his Schedule C for 1995, petitioner reported $144,787 in gross

income from his law practice and deducted expenses of $83,466.

Respondent disallowed $30,279 of petitioner’s Schedule C

deductions because petitioner did not substantiate these

deductions. The amount disallowed consists of $4,633 for meals

and entertainment, $6,533 for travel, and $19,113 for interest. 

At trial respondent asserted that the meals and entertainment and

travel expense deductions were disallowed because petitioner

allegedly did not maintain a contemporaneous business record

showing a business purpose and because he deducted in 1995 some

expenses charged on a credit card in 1994 but paid in 1995.

Deductions are strictly a matter of legislative grace. 

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New

Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). 

Taxpayers must substantiate claimed deductions. Hradesky v.

Commissioner, 65 T.C. 87, 89 (1975), affd. per curiam 540 F.2d

821 (5th Cir. 1976). Section 7491 does not change the burden of

proof where a taxpayer has failed to substantiate deductions. 

Higbee v. Commissioner, 116 T.C. 438 (2001). Moreover, taxpayers

must keep sufficient records to establish the amounts of the

deductions. Meneguzzo v. Commissioner, 43 T.C. 824, 831 (1965);
- 4 -

sec. 1.6001-1(a), Income Tax Regs.

Generally, except as otherwise provided by section 274(d),

when evidence shows that a taxpayer incurred a deductible

expense, but the exact amount cannot be determined, the Court may

approximate the amount bearing heavily if it chooses against the

taxpayer whose inexactitude is of his own making. Cohan v.

Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). The Court,

however, must have some basis upon which an estimate can be made. 

Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). 

Section 274(d) imposes stringent substantiation requirements

for the deduction of travel and entertainment expenses. 

Taxpayers must substantiate by adequate records the following

items in order to claim these deductions: The amount of such

expense, the time and place of the travel or entertainment, the

business purpose of the expense, and the business relationship to

the taxpayer of persons entertained. Sec. 274(d); sec. 1.274-

5T(b)(2) and (3), Temporary Income Tax Regs., 50 Fed. Reg. 46014-

46015 (Nov. 6, 1985). To substantiate a travel or meals and

entertainment deduction by means of adequate records, a taxpayer

must maintain an account book, diary, log, statement of expense,

trip sheet, and/or other documentary evidence which, in

combination, are sufficient to establish each element of

expenditure or use. Sec. 1.274-5T(c)(2)(i), Temporary Income Tax

Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985). Travel and meals and

entertainment expenses cannot be estimated under Cohan. Shea v.

Commissioner, 112 T.C. 183, 188 (1999); sec. 1.274-5T(a),
- 5 -

Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).

Petitioner submitted a copy of his business day calendar for

1995. The calendar was written in various inks and records the

names of the clients and employees that petitioner had lunch or

dinner with on each specific day and the dates on which he

traveled. We find that this record was made contemporaneously

during the time the expenses were incurred. The day calendar,

along with petitioner's detailed memoranda explaining the

circumstances of the meals and entertainment and travel expenses,

and copies of the receipts and credit card statements provide

satisfactory evidence of the time and place of the expenses and

that they had a business purpose. We find that the requirements

of section 274(d) are satisfied. 

However, of the total amount disallowed by respondent for

these deductions, $642.20 of meals and entertainment expenses and

$1,516.40 of travel expenses, which had been charged on a credit

card in 1994, were deducted by petitioner in 1995, the year in

which petitioner paid the credit card bill. We have previously

held that for cash-basis taxpayers, the "use of a credit card for

an otherwise deductible expense qualifies as a payment in the

year the credit card charge is made, regardless of when the

issuer is repaid". Schroeder v. Commissioner, T.C. Memo. 1986-

583; see also Goldman v. Commissioner, T.C. Memo. 1990-8. 

Therefore, the payments made in 1995 for expenses charged in 1994

are not properly deductible in 1995. Accordingly, we sustain

respondent's disallowance of meals and entertainment expense to
- 6 -

the extent of $321 ($642 less 50 percent pursuant to section

274(n)), and of travel expense to the extent of $1,516. Thus,

petitioner is entitled to deduct $4,312 for meals and

entertainment and $5,017 for travel in addition to the amounts

allowed by respondent.

In 1994, petitioner did not have enough cashflow to fully

pay off his credit cards, so he made minimum payments. In 1995,

petitioner was able to pay an accumulated balance and the

corresponding interest. Petitioner deducted $26,113 of interest

expense on his Schedule C. Respondent allowed the deduction of

$7,000 but disallowed $19,113 of the alleged interest expense

paid to the credit card company, MBNA. Respondent contends that

petitioner did not substantiate that he paid the $19,113 in

interest or that the expense is deductible under section 162.

In general, there is "allowed as a deduction all interest

paid or accrued within the taxable year on indebtedness." Sec.

163(a). Nevertheless, an individual is not entitled to a

deduction for personal interest. Sec. 163(h). Certain interest,

including "interest paid or accrued on indebtedness properly

allocable to a trade or business (other than the trade or

business of performing services as an employee)" is not personal

interest. Sec. 163(h)(2)(A). Because petitioner is a cash basis

taxpayer, interest allocable to his business debts is deductible

when paid. Sec. 163(a).

Petitioner's bookkeeper testified that petitioner used his

MBNA credit card almost exclusively for business purposes and
- 7 -

that he had a separate card for personal use. The charges on the

MBNA statements are for business meals, as we have previously

determined, cellular phone, gas, and other such items. However,

there are some charges that may or may not be business related. 

Petitioner's bookkeeper testified that she actually generated all

the checks. We found her to be a credible witness.

Petitioner had a balance of more than $37,000 in his MBNA

credit card account on January 1, 1995. Petitioner paid a total

of $33,715 to MBNA in 1995. We believe that many of the charges

on the MBNA credit card account were for business expenses under

section 162 and that interest was paid in 1995, as well as much

of the debt. However, there is no evidence that $19,113 of the

$33,715 paid to MBNA was for interest, not debt. Moreover,

respondent allowed petitioner an interest deduction of $7,000. 

This amount roughly corresponds to 16.9 percent interest, the

interest rate on the MBNA card, applied to an average balance of

$37,000 for one year. Because petitioner was carrying the

$37,000 balance in the prior year and was making minimal

payments, it is likely that additional interest accumulated which

was paid off in 1995 when petitioner made the larger payments to

MBNA. Accordingly, under Cohan v. Commissioner, supra, we allow

petitioner to deduct $2,000 of interest in addition to the amount

allowed by respondent and sustain respondent's disallowance to

the extent of $17,113.

Petitioner also filed a Schedule F for an apple and timber

farm located on Palomar Mountain. The farm was acquired by
- 8 -

petitioner in 1977, and the apple and timber activity began a

couple of years thereafter. The farm consists of five parcels of

land. Four of the parcels are used in farming and the fifth has

a house on it. The apple orchard portion of the property

consists of approximately 10 acres with about 250 apple trees. 

The house is on a parcel of 18 acres. Approximately 92 acres

consist of either a mixed forest or hardwoods that petitioner has

planted. The hardwoods are primarily oak and black walnut. The

trees will take about 40 years to mature. The farm income is

from people who pick their own apples in the orchard or who buy

bags of apples that petitioner picked and bagged. The farm

activity has never generated a profit. 

In 1995, petitioner reported $3,833 in gross income and

$42,938 in expenses for his farm activity. Petitioner claimed a

loss of $39,105. Respondent allowed the expenses to the extent

they offset the income and disallowed the loss of $39,105. 

Petitioner and respondent agree that the mortgage interest of

$17,291 and the property taxes of $5,544 claimed on the Schedule

F are properly deducted as itemized deductions on Schedule A as

expenses for a second home. The remaining expenses at issue

total $16,270 ($39,105 loss less $17,291 mortgage interest less

$5,544 property taxes). 

Section 183(a) disallows any deductions attributable to

activities not engaged in for profit except as provided under

section 183(b). Taxpayers need not have a reasonable expectation

of profit. However, the facts and circumstances must demonstrate
- 9 -

that they entered into the activity, or continued the activity,

with the actual and honest objective of making a profit. Taube

v. Commissioner, 88 T.C. 464, 478 (1987); Dreicer v.

Commissioner, 78 T.C. 642, 645 (1982), affd. without opinion 702

F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a), Income Tax Regs. 

The taxpayer's motive to make a profit must be analyzed by

looking at all the surrounding objective facts. Id. at 645. 

These facts are given greater weight than petitioner’s mere

statement of intent. Dreicer v. Commissioner, supra.

Section 1.183-2(b), Income Tax Regs., provides a

nonexclusive list of relevant factors which should be considered

in determining whether the taxpayer has the requisite profit

objective. The factors are: (1) The manner in which the taxpayer

carries on the activity; (2) the expertise of the taxpayer or his

advisers; (3) the time and effort expended by the taxpayer in

carrying on the activity; (4) the expectation that the assets

used in the activity may appreciate in value; (5) the success of

the taxpayer in carrying on other similar or dissimilar

activities; (6) the taxpayer's history of income or losses with

respect to the activity; (7) the amount of occasional profits, if

any, which are earned; (8) the financial status of the taxpayer;

and (9) any elements indicating personal pleasure or recreation. 

Sec. 1.183-2(b), Income Tax Regs. These factors are not

applicable or appropriate in every case. Abramson v.

Commissioner, 86 T.C. 360, 371 (1986).

In determining whether petitioner was engaged in the apple
- 10 -

and timber activity with the requisite intent to make a profit,

all of the facts and circumstances of his situation must be taken

into account. Golanty v. Commissioner, 72 T.C. 411, 426 (1979),

affd. without published opinion 647 F.2d 170 (9th Cir. 1981);

sec. 1.183-2(a) and (b), Income Tax Regs. No single factor is

controlling, nor is the existence of a majority of factors

favoring or disfavoring a profit objective necessarily

controlling. Hendricks v. Commissioner, 32 F.3d 94, 98 (4th Cir.

1994), affg. T.C. Memo. 1993-396; sec. 1.183-2(b), Income Tax

Regs.

We first consider the manner in which the taxpayer carries

on the activity. In this case, petitioner never had a written

business plan. He did not separate the expenses between the

apple and timber portions of the activity. Petitioner did not

prepare budgets with respect to the activity. We have no

evidence regarding the number of trees petitioner planted, the

cost of such trees, or the condition of the trees. Petitioner

did not carry on the activity in a businesslike manner. 

We consider the expertise of the taxpayer or his advisers. 

Petitioner does not appear to have any previous farming

experience. Petitioner said that he became involved in the farm

activity because he was interested in preserving old varieties of

apple trees. It was a local wood cutter who suggested that

petitioner could sell his timber. Prior to starting the apple

and timber activity, petitioner did not consult any experts in

this activity. Petitioner later consulted with outside
- 11 -

agronomists. He has paid for consultations regarding the

property. Petitioner also regularly read magazines relating to

agriculture. Petitioner has professional companies come to his

property to prune the trees. If a tree dies, petitioner does not

have someone come and determine the cause. It appears that

petitioner does not have expertise in regards to farming and

consults experts only occasionally.

We consider the time and effort expended by the taxpayer in

carrying on the activity. An intent to derive a profit may be

demonstrated by a taxpayer who devotes much of his personal time

and effort to the activity, a taxpayer who withdraws from another

occupation to devote most of his energies to the activity, or a

taxpayer who devotes a limited amount of time but employs

competent and qualified people to carry on the activity. Sec.

1.183-2(b)(3), Income Tax Regs. Petitioner is an attorney who

operates two law offices. He usually goes to the farm on

Thursday and comes back on Saturday or Sunday. He has conceded

that the home on the farm property is a second home. He

estimates that he spends one full day a month on farming

activities. He has no full-time help. On the whole, petitioner

expends only minimal time and effort on the farm activity. 

We consider the taxpayer's expectation that assets used in

the activity may appreciate in value. If land is purchased or

held primarily with the intent to profit from the increase in its

value, and the taxpayer also engages in farming on the land, the

farming and the holding of the land will ordinarily be considered
- 12 -

a single activity only if the farming activity reduces the net

cost of carrying the land for its appreciation in value. Sec.

1.183-1(d)(1), Income Tax Regs. Therefore, the farming and

holding of the land will be considered a single activity only if

the income derived from farming exceeds the deductions

attributable to the farming activity which are not directly

attributable to the holding of the land such as mortgage interest

and property taxes. Sec. 1.183-1(d)(1), Income Tax Regs. 

Petitioner paid roughly $1,250 an acre for his property. 

Similar property across the street from petitioner's property

sold for $20,000 an acre. Undoubtedly, petitioner's land has

appreciated in value. However, the claimed farming expenses

exceed the profit from farming by $16,270, even after making the

adjustments described above. Therefore, the farming activity is

to be considered separately from the holding of the land for

appreciation. Zdun v. Commissioner, T.C. Memo. 1998-296, affd.

without published opinion 229 F.3d 1161 (9th Cir. 2000). 

Petitioner argues that we should consider the revenue from the

sale of the trees 20 years from now. Petitioner estimated that a

black walnut tree could sell for $3,000 to $4,000 per tree and

that he has thousands of trees. He provided no witnesses as to

the value of the trees in 20 years and was inexact about the

number of trees he owned. Nevertheless, we believe the trees

have some value and take that into consideration. 

We consider the success of the taxpayer in carrying on other

similar or dissimilar activities. There is no evidence that
- 13 -

petitioner has engaged in this type of activity before.

We consider the taxpayer's history of income or losses with

respect to the activity. Petitioner's farming activities have

not generated a profit since their inception in 1979. In 1993,

1994, and 1995, petitioner's reported farming expenses were

$49,876, $42,218 and $49,938, respectively, and farming income

was $3,373, $3,372, and $3,833, respectively. Even if we exclude

the deductions for mortgage interest and property taxes that were

properly reportable on Schedule A, the expenses for all three

years greatly exceed the income.

We consider the amount of occasional profits, if any, which

are earned. Substantial profit, though only occasional, is

generally indicative of a profit objective if the losses are

comparatively small. Sec. 1.183-2(b)(7), Income Tax Regs. As we

have set forth above, petitioner has a history of losses. 

Petitioner contends that he will make more than enough revenue

from the sale of the trees to cover the farming expenses incurred

over the 40 year growing period. The evidence presented to

substantiate this contention is minimal. Moreover, petitioner

has yet to sell a single tree even though some of the trees must

have reached maturity during the past 20 years, because the

forest was already in existence when petitioner bought the

property. Nonetheless, we find that the trees are of increasing

value, and we take that into consideration.

We consider the financial status of the taxpayer. 

"Substantial income from sources other than the activity
- 14 -

(particularly if the losses from the activity generate

substantial tax benefits) may indicate that the activity is not

engaged in for profit especially if there are personal or

recreational elements involved." Sec. 1.183-2(b)(8), Income Tax

Regs. Petitioner had $144,787 in gross receipts from legal

services. On his return, he reported $61,321 of business income

from the law offices and $44,369 of capital gain. Obviously,

petitioner does not rely on his farm activity for income. The

income from petitioner's law practice gives petitioner the means

to wait for the trees to grow. The losses from the activity

generate substantial tax benefits for petitioner. In addition,

he benefits from the recreational elements involved in visiting

his second home every weekend.

We consider whether there are elements of personal pleasure

or recreation. "The presence of personal motives in carrying on

of an activity may indicate that the activity is not engaged in

for profit, especially where there are recreational or personal

elements involved." Sec. 1.183-2(b)(9), Income Tax Regs. 

Petitioner travels to his second home in the mountains every

weekend and spends up to 3 days in that home. He claims he

spends the equivalent of 1 day a month on activities allegedly

related to the apples and timber. When he purchased the property

he did not plan on using it to grow timber. As petitioner

admits, the property was purchased primarily for recreational

reasons; i.e., for use as a second home.

Petitioner mainly relies upon the argument that after the
- 15 -

trees have matured 40 years he will make more than enough money

to cover the expenses he has incurred. While this may or may not

be true, that contention alone does not turn this activity into a

business. Petitioner is merely waiting while the trees

appreciate in value. We would expect someone who operates a

timber farm for profit to keep records regarding the specifics of

the trees, such as the date the trees were planted and the cost

of the trees that were planted, along with a business plan and

records of expenses. Experts would be consulted prior to

engaging in the activity and used thereafter as needed. A farm

would have employees to maintain and care for the trees. 

Petitioner would have to spend more than one day a month on farm

activities if he had no employees. A timber farm normally would

not have a vacation house located on the property.

Factors that would tend to establish that a timber farm is

entered into for profit are clearly shown in Kurzet v.

Commissioner, T.C. Memo. 1997-54, affd. in part and revd. in part

222 F.3d 830 (10th Cir. 2000). In contrast, to describe the

amount of time and energy petitioner has put into the apple and

timber farm as an "activity" is generous. At the most,

petitioner has an investment. We also note that petitioner

deducted personal expenses for telephone, painting, and cleaning

services on the Schedule F. These are nondeductible under

section 262. When taken in conjunction, all of these factors we

have reviewed establish that petitioner does not have a profit

objective for the apple and timber activity. Petitioner did not
- 16 -

operate the farm with an intent to make a profit. Accordingly,

we sustain respondent's determinations with regard to the farm

expenses remaining in issue.

Petitioner's residence is in the front house of three units

on his property. There are two smaller units in the backyard

which he rents. Petitioner testified that his house is about 950

square feet and that the rental units are 650 and 350 square

feet. Petitioner resides in his house for about 4 days of the

week. He allocated the expenses which he claims are related to

all three houses, one-third to his personal residence and twothirds to the rental units. Respondent did not question the

proposition that all the expenses related to all three units.

On his Schedule E, petitioner reported $7,866 of gross rents

and deducted $16,910 of expenses, which resulted in a loss of

$9,044. The $16,910 of claimed deductions on the Schedule E were

expenses pertaining to petitioner’s personal residence and

expenses pertaining to the rental units. Respondent allowed the

deduction of the full amount of taxes and interest deducted, $757

and $11,699, respectively. The remaining expenses which

petitioner deducted were $1,449 for insurance, $1,204 for

utilities, $1,362 for depreciation, $369 for gardening, and $70

for miscellaneous. These total $4,454, and respondent disallowed

$3,712 of that amount.

Respondent’s position is that petitioner's apportionment is

not reasonable. Upon our own consideration of the record, we

find that petitioner is entitled to deduct 40 percent of the
- 17 -

insurance, utilities, depreciation, and miscellaneous expense. 

Petitioner is not entitled to deduct the gardening expense. 

Because petitioner deducted two-thirds of the total expenses,

total expenses (excluding gardening expenses) equal $6,128.

Forty percent of that amount is $2,487, the amount deductible by

petitioner. As mentioned, the rental activities are passive.

To the extent that we have not addressed any of the parties'

arguments, we have considered them and conclude they are

irrelevant or without merit.

Reviewed and adopted as the report of the Small Tax Case

Division.

Decision will be entered

under Rule 155.