T.C. Summary Opinion 2008-110

UNITED STATES TAX COURT

TERRY R. AND MARGARET E. REITER, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 11708-06S. Filed August 26, 2008.

Terry R. and Margaret E. Reiter, pro sese.

Kathryn A. Meyer, for respondent.

GOLDBERG, Special Trial Judge: This case was heard pursuant

to the provisions of section 7463 of the Internal Revenue Code in

effect when the petition was filed. Pursuant to section 7463(b),

the decision to be entered is not reviewable by any other court,

and this opinion shall not be treated as precedent for any other

case. Unless otherwise indicated, all subsequent section

references are to the Internal Revenue Code in effect for the
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year in issue, and all Rule references are to the Tax Court Rules

of Practice and Procedure. 

Respondent determined a deficiency of $4,841 in petitioners’

2003 Federal income tax. The sole issue for decision is whether

petitioners are entitled to a deduction for interest of $42,950

paid on a home mortgage loan during the year in issue. 

Background

Some of the facts have been stipulated and are so found. 

The stipulation of facts and the attached exhibits are

incorporated herein by this reference. Petitioners resided in

California at the time they filed their petition. 

In 1974 petitioners formed California Digital, Inc., a

closely held corporation. Petitioners are the sole shareholders

of the corporation, each holding 50 percent of the outstanding

stock. Petitioner husband serves as the president and secretary

of the corporation, and petitioner wife serves as the

corporation’s treasurer. Although California Digital, Inc., once

occupied a 40,000-square-foot facility, the corporation is

presently operated out of a spare bedroom in petitioners’ home. 

In 1981 petitioners purchased a single-family home for

$775,000. The sellers had two mortgages on the property at the

time of the sale. A first mortgage in the amount of $247,537.29

was held by Gibraltar Savings Bank, and a second mortgage in the

amount of $327,462.71 was held by City National Bank. 
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Petitioners paid the sellers a $200,000 downpayment and agreed to

purchase the home subject to and assuming both of the existing

mortgages on the property. 

On March 3, 1988, petitioners paid approximately $247,000 to

Gibraltar Savings Bank in full satisfaction of the first mortgage

on the property. On October 23, 1987, petitioners paid

approximately $25,000 to City National Bank in full satisfaction

of the amount remaining due on the second mortgage. A full

reconveyance of title and deed of trust in favor of petitioners

was executed and recorded on February 25, 1988. 

Petitioners timely filed their 2003 Form 1040, U.S.

Individual Income Tax Return, on which they reported: (1)

$18,884 of taxable interest; (2) $5,111 of ordinary dividends;

(3) $7,763 of capital gain; and (4) $56,518 of income on Schedule

E, Supplemental Income and Loss. On Schedule A, Itemized

Deductions, attached to the return, petitioners claimed a $42,950

home mortgage interest deduction that was not reported on a Form

1098, Mortgage Interest Statement. Since no Form 1098 was

issued, petitioners indicated (as required under such

circumstances by the instructions on line 11 of the Schedule A)

that they had made mortgage payments to California Digital, Inc.-

-the “person” from whom petitioners purchased the home. 

As the sole shareholders and officers for California

Digital, Inc., petitioners filed Form 1120, U.S. Corporation
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1 This amount was the same at the beginning and at the end

of the corporation’s taxable year. 

Income Tax Return, for the corporation for taxable year 2003

(California Digital return). The California Digital return

reported $601,514 of total assets, which included $450,0001 of

mortgage and real estate loans, and a $301,703 loan from

shareholders. The value of this loan at the beginning of the tax

year was $304,523--a difference of $2,820. 

On March 7, 2006, respondent sent petitioners a notice of

deficiency disallowing the $42,950 home mortgage interest

deduction claimed on their return. 

Discussion 

Generally, taxpayers bear the burden of proving the

Commissioner’s determinations are erroneous. Rule 142(a); Welch

v. Helvering, 290 U.S. 111, 115 (1933). Deductions are strictly

a matter of legislative grace, and taxpayers bear the burden of

proving they are entitled to any claimed deductions. INDOPCO,

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

Co. v. Helvering, 292 U.S. 435, 440 (1934). Taxpayers are

required to maintain records sufficient to substantiate the

amounts of deductions claimed. 

The sole issue before us is whether petitioners are entitled

to claim a Schedule A deduction for mortgage interest payments. 

Section 163(a) and (h)(2)(D) generally allows a deduction for all
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interest paid or accrued within the taxable year on indebtedness

on a qualified residence. “Qualified residence” within the

meaning of section 163 is the taxpayer’s principal place of

residence. Sec. 163(h)(4)(A). As with any deduction, however,

petitioners must be able to substantiate the amount claimed. See

sec. 6001; sec. 1.6001-1(a), Income Tax Regs. 

Respondent disallowed petitioners’ home mortgage interest

deduction for lack of substantiation that they paid such interest

in 2003. 

Petitioners testified that following the success of

California Digital, Inc., in the mid-1980s, they borrowed funds

from the corporation to pay off the outstanding balances due on

the mortgages on the property, and that after making these

payoffs, they began to pay back the corporation by making

mortgage payments to it. Petitioners testified that they agreed

to pay California Digital, Inc., $450,000 at an annual rate of

9.544 percent, payable in full on or before February 13, 2008. 

As evidence of this arrangement, petitioners point to the

California Digital, Inc. return for 2003 which shows a $450,000

loan to shareholders. Petitioners also testified that a

promissory note secured by deed of trust was executed on or about

February 13, 1988, between petitioners and California Digital,

Inc. 
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Petitioners’ position is that because they made interestonly home mortgage payments on a $450,000 loan secured by their

home to the corporation, they are entitled to claim a home

mortgage interest deduction for 2003. Respondent argues that

there is no valid proof that petitioners made such payments. For

the reasons discussed infra we agree with respondent. 

Contrary to petitioners’ testimony, no creditworthy

promissory note secured by deed of trust was produced at trial. 

Petitioners attempted to have the Court receive into evidence a

document entitled “Promissory Note Secured by Deed of Trust”. 

This document recited a promise on the part of petitioners to

repay California Digital, Inc., $450,000 at an annual interest

rate of 9.544 percent. Upon examination of the document, the

Court suspected that it was self-serving and inauthentic. To

wit, although the paper was lightly affixed with a raised,

notary’s stamp, it appeared in all other ways (printed on an inkjet printer; multiple grammar and spelling errors; undated on

signature line; not witnessed or signed by the notary) to be a

poor reconstruction of a purported promissory agreement between

petitioners and their corporation, California Digital, Inc. When

further questioned by the Court, petitioners finally admitted

that the document was not an authentic copy of a promissory note

but rather their attempt to reconstruct the terms of the loan

that they testified was entered into between them and California
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Digital, Inc., in 1988. Petitioners insisted that a promissory

note was, in fact, executed in 1988 but that they were unable to

presently find a copy of it. Because petitioners did not produce

an authentic copy of any promissory note evincing the existence

of any loan, the presumption is that such evidence--if it indeed

existed--would not have been favorable to petitioners. See

Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158

(1946), affd. 162 F.2d 513 (10th Cir. 1947). 

Second, and also contrary to petitioners’ testimony, there

was no recordation of any mortgage on the property held by

California Digital, Inc. Petitioners testified that the mortgage

was recorded on the property on the morning of the Tax Court

trial, 9 years after the purported title transfer. Over

respondent’s objections, petitioners attempted to have a copy of

the recordation received into evidence, contending that because

the recordation referenced the promissory instrument, the

recordation should suffice as evidence that a promissory note did

exist. The Court sustained respondent’s objections and refused

to receive the recordation into evidence. 

Third, and finally, petitioners’ testimony as to how their

mortgage payments were made to California Digital, Inc., was

contradictory, self-serving, and incredible. First, petitioners

testified that they made mortgage payments to the corporation

during 2003 out of the salary that California Digital, Inc., paid
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to petitioner husband. Petitioners’ 2003 return does not reflect

that petitioners received any salary income in 2003, and the

California Digital return does not show that the corporation paid

any salaries to any of its officers or employees during the year

in issue. When the foregoing was brought to petitioners’

attention at trial, they changed their account, testifying that

the payments were made to the corporation by personal check and

that the payments were recorded as corporate journal entries. 

When questioned further by the Court as to any evidence of such

journal entries, petitioners again changed their testimony. 

Petitioners then testified that the payments were recorded by the

corporation as book entries, although only their accountant--who

was not in court--could confirm this. Finally, petitioners

testified that the payments--totaling $42,950--were subtracted

from a $304,523 loan that petitioners had previously made to the

corporation. The California Digital, Inc. return, however, shows

that the amount of the loan decreased by only $2,820--and not

$42,950--during the year in issue. Accordingly, we conclude that

petitioners’ confusing and constantly changing line of testimony

with respect to the payments is entirely incredible, and supports

respondent’s position that petitioners cannot substantiate that 

any home mortgage interest payments were made to California

Digital, Inc., during 2003.

 
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In sum, petitioners provided no documentation before,

during, or after trial, such as canceled checks, that would

substantiate their claim that they paid $42,950 of home mortgage

interest, the deduction for which respondent disallowed. 

Accordingly, without any credible evidence that petitioners

actually paid the $42,950, we sustain respondent’s determination

with respect to petitioners’ 2003 income tax liability. 

To reflect the foregoing, 

Decision will be entered

 for respondent.