TAX COURT OPINION

Case: Thomas Edgar Mahlin
Docket Number: 17264-10S
Judge: Gale
Opinion Type: bench
Filed: 02/23/2012
Pages: 12

UNITED STATES TAX COURT WASHINGTON, DC 20217 RMM THOMAS EDGAR MAHLIN, Petitioner, v. COMMISSIONER OF 1NTERNAL REVENUE, Respondent ) ) ) ) ) Docket No. 17264-10S. ) ) ) ) ORD E R Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit herewith to petitioner and to respondent a copy of the pages of the transcript of the trial in the above case before Judge Joseph H. Gale at Denver, Colorado, on January 25, 2012, containing his oral findings of fact and opinion rendered after the trial. Decision will be entered for respondent in accordance with the oral findings of fact and opinion. (Signed) Joseph H. Gale Judge Dated. Washington, D.C. February 23, 2012 SERVED Feb 23 2012 1 2 3 4 5 6 7. 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Bench Opinion by Jud e Joseph H. Gale January 25, 2012 (cid:16)042 Mahlin, v. Commission r Docket No. 17264-10S THE OOURT: THE COURT HAS DECIDED TO RENDER ORAL FINDINGS OF FAC AND OPINION IN THIS CASE AND . THE FOLLOWING REPRESENTS THE COURT ' S ORAL FINDINGS OF FACT AND OPINION. THE ORAL FINDINGS OF FACT AND OPINION SHALL NOT BE RELIED ÜPON AS PRECEDENT IN ANY OTHER CASE. This case as heard as a Small Tax Case pursuant to· the prov sions of section 7463 of the Internal Revenue Cod in effect when the petition was filed. This bencil o >inion is made pursuant to the authority granted by section 7459 (b) of the Internal . Revenue Code and Ru e 152 of the Tax Court Rules of Practice and Procedure. Hereinafter, all section references are to the Internal Revenue Code in effect for the year at issue, and all Rule references. are to the Tax Court Rules of Practice and Procedure . Thomas Edg r Mahlin appeared on^ his own behalf . . Luke D. Ortner appeared on behalf of resporident . The Comm ssioner determined a deficiency in Mr. Mahlin's 2008 Federal income.tax of $6,250 and an accuracy-related perialty under section 6662 (a) of Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 $1,250. The issues f or decision are: (1) Whether Mr. Mahlin is entitled tö deduct the rental real estate loss he claimed for 2008; and (2) whether Mr. Mahlin is liable for the ac uracy-related penalty. Some of th facts have been stipulated and are so found. Mr. M hlin resided in Colorado when he f.iled . the petition. In July 20Ò8, Mr. Mahlin signed a purchase agreement and put a 25, 000 earnest money deposit down for the purpose of a quiring a house in Golden, Colorado. Mr. Mahli 1 intended to use the house as his personal residence, hs he needed more space and handicap accessibiliby for his motheri who was residing with him at the time and for whom he. was serving as caregiver. The house was 50 percent complete at the time . Although the purchase agreement required the builder to complete construction within 12 months, Mr. Mahlin claims he and the builder had an oral understanding that construction would be completed in 4 to 5 weeks. Mr. Mahlin testified that the builder stopped working on the house after collecting the depo it. By November-2008, Mr. Mahlin was so dissatisfied with the progress of construction that he asked for his deposit back. Mr. Mahlin was still seeking a refund of .his deposit at the end of Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 5 2008, notwithstanding the builder's claim that construction would be completed in early 2009. The builder treated the purchase agreement as canceled on January 1, 2009, and treated Mr. Mahlin's deposit as forfeited in March 2009, on the grounds that the deposit constituted liquidated damages to which the builder was entitled, under the terms of the purchase agreement, upon Mr. Mahlin's breach of the agreement. On his Federal income tax return for 2008 Mr. Mahlin claimed a $25,000·rental real estate loss deduction. Mr. Mahlin claimed the loss of his deposit as a rental real estate expense because, upon moving into the new house, he intended to convert his previous residence to a rental property. The IRS issued Mr. Mahlin a notice of deficiency denying the deduction and determining a deficiency and an accuracy-related penalty. As of the end of 2008, and up to the time of trial in January 2012, Mr. Mahlin had not instituted any kind of civil or criminal action against the builder or consulted a lawyer regarding his effort to get his deposit back. Indeed, insofar as the evidénce discloses, Mr. Mahlin has not even made a written demand for return of his deposit. Deductions are a matter of legislative Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 grace, and the burden of showing entitlement to a claimed deduction is on the taxpayer. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). While in certain circumstances the burden of proof may shift to the Commissioner pursuant to section 7491(a), our findings in this case do not depend upon the burden of proof but instead are based upon a preponderance of the evidence. See Blodgett v. Commissioner, 394 F.3d 1030, 1039 (8th Cir. 2005), aff'g T.C. Memo. 2003-212. Taxpayers are entitled to deduct all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. Sec. 162(a). Taxpayers are also entitled to deduct such expenses paid or incurred for the management, consërvation, or maintenance of property held for the production of income. Sec. 212(2). Individual taxpayers may deduct uncompensated losses sustained during the taxable year if those losses are incurred in a trade or business or in any transaction entered into for profit. Sec. 165(a) and (c). Taxpayers are not allowed deductions for personal, living, or family expenses and may not deduct personal losses unless they arise from casualty or theft. Secs. 262(a), 165(c) (3). Mr. Mahlin's claim that the loss of his Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 deposit can be deducted as a rental real estate expense is unavailing. Mr. Mahlin was not in the rental property business in 2008 or holding any property for the proÔuction of income in that year. He owned no rental properties and reported no income from rental activities. Mr. Mahlin's plan to convert his existing residence into a rental property sometime after 2008 does not change this result. Since he was not in the rental real estate business or holding any property for the production of income in 2008, Mr. Mahlin is not entitled to a rental real estate loss deduction for that year. At trial Mr. Mahlin offered another justification for deducting in 2008 the deposit that was not returned to him. He testified that he had worked as a professional photographer earlier in his life and intended to resume the conduct of a photography business in a few years when he retired from his current occupation. Further, he intended to use a portion of the house to be constructed pursuant to the purchase agreement he entered in 2008 as a home office for this planned photography business. Nonetheless, Mr. Mahlin did not conduct a photography business in 2008, and he had no income in that year from any work as a photographer. Consequently, Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 8 neither the residence in which he lived in 2008 nor the one under construction in that year to which he expected to move wasjused in a trade or business, and there is no basis for a business expense or loss deduction arising as1 a.result of Mr. Mahlin's intention to engage in a photography business at some future, undetermined time. In short, Mr. Mahlin's loss of his deposit was not an expense related to a trade or business or a loss incurred in a transaction entered into for profit and therefore it is not deductible under section 162, 165, or 212. Instead, the deposit was paid in connection with the acquisition of a personal residence. It is therefore a personal expense that is nondeductible under section 262. We consider also whether the claimed loss is deductible as a theft loss. Taxpayers are entitled to deduct losses of property not connected with a trade or business or a transaction entered into for profit if such losses arise from theft. See section 165(c). To prove he is entitled to a theft loss deduction, Mr. Mahlin would have to show that the builder committed theft under Colorado law and that, at the end of 2008, he did not have a claim for reimbursement with respect to which there was a reasonable prospect of recovery. Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 9 See Monteleone v. Commissioner, 34 T.C. 688, 692 (1960); Section 1.165-1(d) (3), Income Tax Regulations. Although he at times suggested that he had been a victim of theft or wrongdoing by the builder, Mr. Mahlin did not prove the essential elements of a section 165(c) theft loss at trial. The evidence shows that the builder took the position that it was entitled to retain the deposit as liquidated damages because Mr. Mahlin had breached the purchase agreement. Thus, at best, at the end of 2008, Mr. Mahlin had a contractual dispute with the builder over his right to have the deposit returned and his prospects for recovery we:re unknown. Moreover, Mr. Mahlin's own actions belie the claim that any theft loss occurred here. At nb point in 2008, nor indeed until the time of trial in early 2012, did Mr. Mahlin make a written demand for return of the deposit, institute a civil or criminal action for recovery, or even consult an attorney in that regard. Such complacency both undermines the claim that Mr. Mahlin was the victim of theft and fails to establish whether or not there was a reasonable prospect of recovery in 2008. Accordingly, Mr. Mahlin is not entitled to a theft loss deduction. See Jeppsen v.. Commissioner, 128 F.3d 1410, 1418 (10th Cir. 1997). Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 10 Because Mr. Mahlin is not entitled to the deduction he claimed for the loss of his deposit, we sustain the Commissioner's determination disallowing Mr. Mahlin's claimed $25,000 loss for 2008. Accordingly, Mr. Mahlin has a deficiency in his Federal income tax for that year of $6,250. The Commissioner also determined an accuracy-related penalty under section 6662 of $1,250. Section 6662 imposes a penalty equal to 20 percent of the underpayment of tax when the underpayment is attributable to, among other things, negligence or disregard of the rules, or a substantial understatement of income tax. The taxpayer is negligent if he fails to make a reasonable attempt to comply with th¢ provisions of the internal revenue laws or to exercise ordinary and reasonable care in the preparation of a tax return. Section 1.6662-3(b) (1), Income Tax Regulations. An understatement.of income tax is the excess of the amount of tax required to be shown on the return over the amount of tax shown on the return. Sec. 6662(d) (2) (A). An understatement is substantial when it exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000. Section 6662(d) (1). Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 11 The Commissioner bears the burden of production with respect to a taxpayer's liability for penalties. Section 7491(c). To satisfy that burden, the Commissioner must offer sufficient evidence to indicate that it is appropriate to impose the penalty. See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). If the Commissioner satisfies his burden of production, the taxpayer bears the burden of proving it is inappropriate to impose the penalty because of reasonable cause, substantial authority, or a similar provision. Id. The Commissioner has carried his burden of production with regard to the accuracy-related penalty. Because we sustained a $6,250 deficiency in Mr. Mahlin's income tax and that amount exceeds both $1,355 (10 percent of the tax required to be shown on Mr. Mahlin's return) and $5,000, his underpayment is attributable to a substantial understatement. Mr. Mahlin is also liable for the penalty on the grounds of negligence. He did not consult a tax professional or any published IRS guidance before claiming a deduction equal to nearly one-third of his reported income. A reasonable attempt to comply with the internal revenue laws, given the absolute size of the deduction claimed and its relation to Mr. Mahlin's Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 12 total income, requires more. The section 6662(a) penalty is not imposed on any portion of an underpayment as to which the taxpayer acted with reasonable cause and in good faith. Sec. 6664 (c) (1). The determination of whether a taxpayer acted with reasonable cause and good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances, the most important of which is the taxpayer's effort to assess his proper tax liability. Section 1.6664-4 (b) (1), Income Tax Regulations. The taxpayer's experlence, knowledge, and education are also relevant in determining whether the taxpayer had an honest misunderstanding of fact or law that is reasonable in the circumstances. Id. We find that Mr. Mahlin did not have reasonable cause to claim a deduction for the loss of his deposit. Mr. Mahlin is college-educated, with an accounting degree, yet he failed to investigate the propriety of deducting a loss which was required to have been incurred in connection with a trade or business. Mr. Mahlin's contentions regarding the trade or business connection of the loss were premised on mere speculation about events that might occur in some future year but were clearly not present for the Heritage Reporting Corporation (202).628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 13 year in.which the loss was claimed. Instead, the loss was straightforwardly incurred in connection with the purchase of a personal residence. Deductions of such losses are clearly proscribed in the Internal Revenue Code. He did not consult a tax professional or make any other effort to determine if it was proper to claim a $25,000 deduction in these circumstances. Mr. Mahlin has shown no other extenuating circumstances that would constitute reasonable cause. Accordingly, we sustain the Commissioner's determination of a section 6662(a) accuracy-related penalty of $1,250 for 2008. On the basis of the foregoing, decision will be entered for respondent. THIS CONCLUDES THE COURT'S ORAL FINDINGS OF FACT AND OPINION IN THIS CASE. (Whereupon, at 3:57 p.m, the bench opinion in the above-entitled matter was concluded.) // // // // // // // Heritage Reporting Corporation (202) 628-4888