TAX COURT OPINION

Case: Beverly Hawley-Martin & Joseph Martin
Docket Number: 28942-07S
Judge: Colvin
Opinion Type: bench
Filed: 11/17/2009
Pages: 11

UNITED STATES TAX COURT WASHINGTON , D.C . 2021 7 BEVERLY HAWLEY-MARTIN AND JOSEPH MARTIN, Petitioners, v . Docket No . 28942-07S COMMISSIONER OF INTERNAL REVENUE , Respondent . O R D E R Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it i s ORDERED that the Clerk of the Court shall transmit to petitioners and to respondent a copy of the pages of the transcript of the proceedings of the above case before Judge Diane L . Kroupa at San Diego, California, on October 29, 2009, containing her oral findings of fact and opinion . In accordance with the oral findings of fact and opinion, decision will be entered pursuant to Rule 155 . (Signed) Diane L. Kroupa Judge Date : Washington, D .C . November 17, 2009 SERVED NOV 19 2009 1 Bench Opinion by Judge Diane L . Kroupa October 29, 2009 2 Beverly Hawley-Martin & Joseph Martin Docket No . 28942-07S 3 THE COURT : The Court has decided to render ora l 4 findings of fact and opinion in this case, and the following 5 represents the Court's oral findings of fact and opinion . 6 These oral findings of fact and opinion shall not be relied 7 upon as precedent in any other case . 8 This proceeding was conducted as a small tax case 9 under Section 7463 and Rules 170 through 175 . This benc h 10 opinion is made pursuant to the authority granted by Section 11 7459(b) and Rule 152 . All section references are to th e 12 Internal Revenue Code in effect for 2005, and all rule 13 references are to the Tax Court Rules of Practice and 14 Procedure . 15 Petitioners appeared pro se, and Chad Southall 16 appeared on behalf of Respondent . 17 FINDINGS OF FAC T 18 Certain facts have been . stipulated . The 19 stipulation of the facts the parties filed, wit h 20 accompanying exhibits, is incorporated by this reference . 21 The facts are so found . 22 Petitioners resided in California at the time they 23 filed the petition . 24 Petitioner Ms . Martin acquired her first piece of 25 investment real estate in 1998 . In 2001, when she married Heritage Reporting Corporatio n (202) 628-4888 1 Petitioner Mr . Martin, they decided to .convert Mr . Martin's 2 personal residence to investment property . Petitioner Ms . 3 Martin's son co-owned their personal residence with her, an d 3 paid half of the mortgage payment : Petitioner Ms . Martin did not include any rental income from her son for her personal residence . Petitioners acquired additional pieces of investment units from time to time . Petitioner Ms . Martin is a real estate agent, and has been licensed as such since 1995 . She has been a rea l estate agent for Security Pacific, Bank of America and Wells Fargo . During the year at issue,, she was employed b y 1 0 11 12 Washington Mutual as a real estate loan officer . Washington 13 Mutual had a reimbursement policy in effect for it s 14, employees in 2005 . 15 Petitioner Mr . Martin has retired from being a boat 16 mechanic for 40 years . During the year at issue, he had no 17 employer . Instead, he devoted his time to caring for th e 18 investment properties and the two personal residences he . had 19 with his wife . He would remove snow, fix floors, d o 20 plumbing, clean eaves, or in his words, "whatever it took to 21 keep the properties in rentable-form . " 22 He kept receipts . It appears he kept receipts 23 regarding work he .did regardless of whether it wa s 24 attributable to the rental units or the personal residences, 25 and regardless of whether . the expenses should have been Heritage Reporting Corporatio n (202) 628-4888 4 1 capitalized or expensed . His wife prepared a summary of the 2 days he worked on the . units and the personal residences i n 3 2005 . The record appears to be broad categorizations of 4 time with a lot of eight-hour days or 13-hour days when 5 travel was involved . 6 Respondent received Petitioners' original return 7 for 2005 on August 18th, 2006, after the original due date 8 and the August 15th, 2006 extended due date . Petitioners 9 reported they received $92,411 of rental income, but claimed 10 expenses attributable to their rental activities in excess 11 of their rental income by an additional $32,587 of expenses, 12 which they used to offset their other income . 13 Petitioner Ms . Martin-claimed expenses while a n 14 employee of Washington Mutual . She originally claimed them 15 on Schedule C expenses that Respondent disallowed for lac k 16 of substantiation . They attempted .to amend their return for 17 2005 to claim them as unreimbursed employee busines s 18, expenses . 19 Respondent issued a deficiency notic e 20 Petitioners determining a $17,511 deficiency in Petitioners' 21 income, a,$336 late filing addition, and a $3,502 accuracy- 22 related penalty for 2005 . Petitioners concede they received 23 the unreported interest and-dividend income Responden t 24 determined in the deficiency notice . 25 OPINIO N Heritage Reporting Corporation (202) .628-4888 5 We are asked to address whether Petitioners have 2 substantiated their claimed rental property expenses, an d 3 whether Petitioner Ms . Martin substantiated her unreimbursed 4 employee business expenses as an employee of Washingto n Mutual . We must also address whether Petitioners are liable for the late filing addition and the accuracy -related penalty. We begin with two fundamental principles of tax litigation . First, the Commissioner's determinations are generally presumed correct, and the taxpayer bears th e 6 7 9 10 11 burden of proving that those determinations are erroneous . 12 Rule 142(a) . 13 Second, deductions are a matter of legislativ e 14 grace, and the taxpayer must show that he or she is entitled 15 to any-deduction claimed . Rule 142(a) ; Welch v . Helvering, 16 290 U .S . 111 (1933) . This includes the burden o . Hradesky v . Commissioner , 65 T .C . 87, 9 0 f17 substantiation 18 (1975 ), aff'd . per curiam b F .2d 821 ( 5th Cir . 1976 ) . d .. 19 Substantiation means that a taxpayer shall keep suc h 20 permanent records or books of account as are sufficient to 21 establish the amount of deductions claimed on the return . 22 Sec . 6001 ; Sec . 1 .6001- 1(a), (e), Income Tax Regs . Th e 23 Court need not accept a taxpayer ' s'self - serving testimony 24 when the taxpayer fails to present other probative evidence . 25 Beam v . Commissioner , T .C . Memo . 1990-304 ( citing Tokarsk i Heritage Reporting Corporation (202) 628-4888 6 1 v . Commissioner , 87 T .C . 74, 77 (1986)) . 2 We begin with Petitioner Ms . Martin's unreimbursed 3 employee business expenses . Petitioners failed to provide 4 any documentation to substantiate any of these expenses . 5 Moreover, employees are not entitled to deduct expenses for 6 which they could have been reimbursed by their employer . 7 This is the case here . We therefore sustain Respondent's 8 determination in the deficiency notice regarding th e 9 employee business expense disallowance . 10 We next address whether Petitioners are entitled to 11 deduct the losses from their rental properties . The answer 12 to this question lies with whether Petitioner Mr . Marti n 13 qualifies as a real estate professional under Sectio n 14 469(c)(7), and, if so, whether he materially participated in 15 each rental activity . 16 Taxpayers generally may not deduct passive activity 17 losses, defined as aggregate losses from all passiv e 18 activities for the taxable year over the aggregate income 19 from all passive activities for that year . Sec . 469(a), 20 (d)(1) . A passive activity is any trade or business in 21 which the taxpayer does not materially participate . 22 Sec . 469(c)(1) . Passive activities include "any rental 23 activities ." A rental activity is generally treated a s 24 per se passive, except with respect to rental activities of 25 a taxpayer in the real property business . Sec . Heritage Reporting Corporation (202) 628-4888 1 469(c)(7)(B) . The rental activities of a real estat e 2 = professional-are not per se passive, but are treated as a 3 trade or business, and subject to the material participatio n requirements of Section 469(c)(1) . Sec . 1 .469-9(e)(1), 5 7 Income Tax Regs . To be considered a "real estate professional," the taxpayer must perform over half of all personal service s 8 performed in trades or businesses in a year, plus perfor m 9 more than 750 hours in the real estate trade or business in 10 the same year . Sec . 469(c)(7)(i) and (ii) . Petitioners 11 argue that they are entitled to deduct their losses fro m 12 their real estate rental .properties because Mr . Martin wasa 13 real estate professional,-and the real estate renta l 14 activities are a trade or business in which Petitioners 15 materially participated . 16 Respondent counters that Petitioners cannot include 17 any work performed as an investor, such as creating an d 18 monitoring financial statements . Sec . 1 .469-5T(f)(2) , 19 Temporary Income Tax Regs . Respondent also argues tha t 20 Petitioner Mr . Martin must have materially participated i n 21 each interest in rental real estate, unless Petitioners made 22 an election to'treat all interests in rental real estate as 23 a single rental real estate activity . Sec . 469(c)(7)(A) . 24 There is a question whether Petitioners made a 25 timely election . We. note, however, that Petitioners listed Heritage Reporting Corporatio n (202) 628-4888 8 1 all their rental income and losses on their original return 2 on Schedule E, and also combined all the information on Form 3 8582 entitled "Passive Activity Loss Limitations ." We find, 4 therefore, that Petitioners made an election to treat al l 5 their interests in rental real estate as a single rental 6 real estate activity . We further find that Petitioner Mr . 7 Martin spent more than 750 hours on this activity . 8 The documents Petitioners used to substantiate the 9 hours he spent during 2005 are less than desirable . W e 10 acknowledge, however, that 750 hours a year is the 11 equivalent of 14 hours a week . Petitioner Mr . Martin had no 12 other employment during the year . We are satisfied tha t 13 Petitioner Mr . Martin spent more than 14 hours a week on 14 their rental units . In addition, activities performed by 15 Petitioner Ms . Martin may be aggregated with those of her 16 husband for purposes of the material participatio n 17 requirement of Section 469(c)(1)(B) . See Sec . 469(h)(5) . 18 We are not so convinced, however, with the basic 19 substantiation of their rental activity expenses . I t 20 appeared to the Court that Petitioners wanted to deduct 21 expenses attributable to their two residences, and als o 22 sought to deduct expenses that are personal in nature . As 23 the Court explained during trial, personal living expenses 24 are not deductible . Sections 162(a) and 262(a) . In fact, 25 there are many expenses that are helpful, even essential, t o Heritage Reporting Corporation (202) 628-4888 9 1 one's business, but which are not deductible in our tax 2 system . See Carroll v . Commissioner , 51 T .C . 213, 215 3 (1968), aff'd . 418 F .2d 91 (7th Cir . 1969) . 4 We therefore find that Petitioners are not able to 5 deduct any of the claimed expenses attributable to their two 6 residences . This is true whether they received and reported 7 any rental income from their residences . We also found that 8 their records lacked the specificity required to show the y 9 were attributable to the specific piece of real estat e 10 involved . In addition, the Court was not persuaded that the 11 claimed expenses were properly expensed versus whether they 12 should have been capitalized and amortized over the useful 13 life of the asset . In addition, it does not appear that the 14 fuel and vehicle expenses were properly allocated betwee n 15 personal versus business use . 16 The Court is also concerned that no copies o f 17 leases were . provided to show what expenses, if any, were to 18 be paid by Petitioners as landlord, or to be paid by th e 19 tenants . It appears as if Petitioners deducted internet and 20 cable costs attributable to their rental properties . Th e 21 Court finds this unjustified . The Court would be hard- 22 pressed to find an arms' length lease where the landlor d 2 3 24 pays all utilities, including internet service . Based on the record as a whole, Petitioners shal l 25 not be entitled to deduct any more than 25 percent of th e Heritage Reporting Corporation (202) 628-4888 1 0 1 deductions they claimed with respect to their rental rea l 2 estate activity for 2005 . We therefore sustain Respondent's 3 disallowance of those expenses in the deficiency notice t o 4 the tune of 75 percent . 5 We now turn to Respondent ' s determination tha t 6 Petitioners are liable for the late filing addition under 7 Section 6651 ( a)(1) and the accuracy - related penalty . 8 Respondent has the burden of production under Sectio n 9 7491(c), and must come forward with sufficient evidence that 10 is appropriate to impose the penalty . See Higbee v . 11 Commissioner , 116 T .C . 438 , 446-447 ( 2001) . 12 Section 6651 ( a)(1) provides for a five percent per 13 month addition to tax, not to exceed 25 percent, if a 14 taxpayer fails to file a timely federal income tax return . 15 Petitioners' tax return for 2005 was due to be filed no 16 later than April 15th , 2006 . The record reflects that 17 Petitioners failed to file a federal tax return by that 18 date . In fact, the record reflects that Petitioners only 19 filed their return on August 18 , 2006 . Petitioners argue 20 that they had an automatic extension to file, but wer e 21 unable to verify this information . Petitioners therefore 22 have failed to file their tax return timely, and Respondent 23 has satisfied his burden of production . 24 Respondent has also satisfied his burden o f 25 production that Petitioners substantially understated their Heritage Reporting Corporatio n (202) 628-4888 1 1 1 income for 2005 by failing to substantiate thei r 2 unreimbursed employee business expenses, and failing t o 3 substantiate 75 percent of their rental activity expenses . 4 We therefore sustain Respondent's determinations in th e 5 deficiency .notice regarding the late filing addition and th e 6 accuracy-related penalty . We note that the accuracy-related penalty amount needs to-be adjusted from .that in the deficiency notice to reflect .this Court's findings . > 9 10 We hope that Petitioners have learned their lesson on the kind of records they need to maintain to claim the . 11 expenses as deductions . The Court has tried to give them 12 the benefit of the doubt . The Court urges them, however, to 13 keep better records in the future . 14 To reflect the foregoing, decision will be entered 15 under Rule 155 . 16 This concludes the Court's oral findings of fact 17 and opinion in this case . 18 (Whereupon, at 10 :00 a .m ., the bench opinion in the 19 above-entitled case was concluded . ) 20 21 22 23 24 25 // Heritage Reporting Corporation (202) 628-4888 _,