TAX COURT OPINION

Case: D.L. White Construction, Inc.
Docket Number: 8523-08
Judge: Marvel
Opinion Type: memo
Filed: 06/28/2010
Pages: 12

T .C . Memo . 2010-14, 1 UNITED STATES TAX COUR T D .L . WHITE CONSTRUCTION, INC ., Petitioner v . COMMISSIONER OF INTERNAL REVENUE, Responden t Docket No . 8523-08 . Filed June 28, 2010 . David L . White (an officer), for petitioner . Aimee R . Lobo-Berc{ , for respondent . MEMORANDUM FINDINGS OF FACT AND OPINIO N MARVEL, Judcre : Respondent determined a deficiency in pet'itioner's Federal income tax of $79,982 for the taxable year ending on September 30, 2002 .(2002 taxable year) . Afte r SERVED JUN 2 8 2010 concessions,1 the issue for :decision is whether petitioner was ' entitled, to claim $220,000 of the cost of acquiring unimprove d real estate in December 2001 as cost 'of goods sold' 'or_ alternatively, to deduct the amount asa business loss under, section 165 (a),2 . for the 2002 taxable "year . facts is incorporated hereingb y ipal place of business was in Idaho when its petition wa s filed . . Petitioner, a C corporation(cid:127)that . uses ,a .fiscal-year3 ending September 30 and .a cash,receipts and disbursements , (cash bass), method of accountng,4 is in the business of q residential real . estate construction . During -its 2002 taxable 'In the notice of deficiency' respondent disallowed $9,931- that petitioner claimed, as a' bad 'debt deduction' and $4, 722 tha t petitioner deducted as the cost of employee benefit, program s Although petitioner has not expressly conceded these adju'stnents,' , petitioner'failed .to contest the adjustments in 'its, petitionI .or at any time during this proceeding . 'Accordi nigly ' we' deem thes e issues conceded . See Rule 34(b)(4), Tax Court Rules-:of-,Practice ' and . Procedure . ,.?Unless otherwise indicated all section reference s the Internal Revenue 'Code , as amende d amended- ' Sec'. '441-(e )' defines a fiscal -year for a taxpayer that. has not made an election, under sec . 441(f)'asa period of 12 months . ending on the last day of any month other than Decembe r 4Sec 448 (a) provides ,that, except as ot herwise 'provided :ln.: sec . 448, a C corporation ' s taxable income shall not ' be . compute d under the cash receipts and disbursements method of accounting : year and at all relevant-times petitioner : had two corporate officers, David L . White (Mr . White) and Michelle White (Mrs . White) . . Mr . and . Mrs . White are husband and wife . On or about December 20, 2001, petitioner purchased four parcels of adjoining land in northern Idaho (the Blossom Mountain property), totaling approximately 80 acres, from Vernon J . Mortensen (Mr . Mortensen) for $290,000 . Petitioner paid $10,000 to Mr . Mortensen's company, Timberland Ag L .L .C ., on November 1, 2001, and $190,000, $1 ;669 .34,. and $28'to North Idaho Title Co . on December 21, 2001, April 1, 2002, and July 17, 2002, respectively . The balance of the purchase price, approximately $90,000, was financed through a promissory notes Petitione r ,planned to build four homes on the Blossom Mountain property and sell the homes at a profit . To,reach the Blossom Mountain property, petitioner used an access road that crossed an adjoining property owned by Dennis and Sherrie Akers (Mr . and Mrs . Akers) . On January 10, 2002, Mr . and Mrs . Akers filed suit against petitioner and Mr . and Mrs . White in the District Court for the First Judicial District of Idaho (Idaho district court) for negligence and trespass .and to quiet title . Mr . Mortensen and his wife, Martie Mortensen, were later added as defendants . 'The details regarding the promissory note are unclear but ultimately are not necessary to resolve the issue in this . .case . On .December.'20,„ 2002, „,petitioner, filed its Form- 1120, sU :'S. . Corporation Income Tax ,_.Return, . .for the! ,2002 taxable ' year . _:On the' Form 1120 petitioner , included, the $ 220 ;000 it-allegedly' sp e''nt 6 with respecttto the Blossom' . Mountain property xin petitioner' s :cost of goodsf~,sold-=.7 Although the Akerses ' L.'lawsuit was : still- ongoing when' petitioner :-If'iled it s', Form '1120 for .4the~(cid:127) 2002' taxable year ;" petitioner, claimed the $220', :000 ;amount : on, i t s . - , ' 2 002 taxable ;.' year return . because 9 petitioner, :did 'not -,have ,. legal access ,, to Tthe Blossom mountain property and contended that the-property was°- e worthless .. ' x { . On January,3 ; ;2003, the ,Idaho, district .court issued its findings of' fact and conclusions of ,law and --order , (decision? , i n favor'l-of "Mr . and Mrs Akers, finding that ._ the defendants .,_ including. petitioner, did not- . h ave 'a ,complete p easement pver,Mr and Mrs . Akers' property ; had t respassed ,,,were negligent, and had ; engaged- (cid:127)in malicious conduct . On ;August 2 1 2003 , ,,the ;defendants filed'' a_ motion for :: a new trial :' " The ,l Idaho district cour t 'The record does" not explain how petitioner calcul'ated'the ' - $220, 0.00 amount . ,;, 'On„its 2002 Form 1120 petitioner claimed that it was a cash basis taxpayer' ; but it reported gross receipts or sales'of $1,312,157, cost of goods sold of $1,139,540, and opening and closing inventory amounts of $5,000 each . In 'the notice of„' deficiency respondent reduced the cost-of goods sold by .$220,000 because "there is not a closed and complete transaction whiich occurred,during * * *' [the 2002 'taxable year]" . -'The 'record "does not explain~L_.why petitioner.; 'a 'cash basis : taxpayer, ., was allowed to .' claim any cost of g oods t sold adjustment characterized the defendants ' motion fora new trial as a motion to reopen the previous trial on the basis of new evidence and granted the motion . . On April 1, 2004, the Idaho district cour t ( issued a second decision in which it again found in .favor of Mr . and Mrs . Akers . The Idaho district court imposed willful trespass damages against the defendants in the trebled amount of $51,008 .55 and imposed punitive damages ;of $30,000 against Mr . White . After the Idaho district court issued its April 1, 2004, .decision, North Idaho Title Co .'s insurer issued a $200,000 chec k petitioner . Petitioner gave'thecheck to its attorney, Rober t Covington (Mr . Covington), who deposited the check into his client trust . account on August 17, 2004 . On May 28, 2004, petitioner filed a notice of appeal with the .Idaho supreme court. On October 14, 2004, Mr . Covington used $154,049 of the $200,000 he had received from North Idaho Title Co .'s insurer to secure a bond with the'Idaho supreme court with respect to petitioner ' s appeal . On December 30, 2005, the Idaho supreme court remanded the .case to the Idaho district' court . October 6,' 2006, the Idaho district court issued its decision on remand, once again finding that the defendants, including petitioner, did not have a complete easement to the Blossom Mountain property, that Mr . and Mrs . Akers were entitled to costs and attorney ' s fees, and that the defendants were liable for damages .k.fThe ;defendants(cid:127)appealed~th e order on remand ., and '_on Jun e 4 , ;" 2 0.0 8.,, issued, an"unpublished opinion remanding'the cas e district 'court, . ' On January .11,° .2008 ;. _r:esporident .' issued a notice . deficiency to petitioner with respect _to -pe :titioner',s 200 2 taxable year -.that r reduced * petition'er's . cost o f $220,000 . In ""a manufacturing„ -' .merchandising, ,or ,mining business, . gross . income means,-Itheytotal,sales°of .,the business less th e goods sold plus any income from'investments arid)from :inciderita l or outside operations or sburces '1,,Sec . , :l,. 61--3,(a) , Income, Tax Regs :' 'A taxpayer's cost of goods-,bold is .determined i n accordar cep with,,,-the, . method of -accounting -consistently used ;by th e taxpayer . Id . . The .amount a taxpayer, claims a s We'Atake judicial notice that on Jan ., 22, 2009,,,theSupreme Court of Idaho withdrew its unpublished"opinion' :issued ' on' Jun, 4 2008, and issued,- a new opinion affirming the Idaho district ' court'sjudgment that the defendants did not have an"implie d easement and that the'deferidants'pres-criptive easement is 12 . 2 feet wide, vacating the Idaho district court'sjudgment ,' .as to the,, location ;of .the prescriptive easement and the award of damage s attorne s fees and 'costs "and, remanding the case ' for furthe r proceedings ., Akers v . Mortensen , 205 P .3d117 .5, .'1185 (Idah o On'Oct . .- 6 ; . 2009, We ordered tYe'rparties 'to . fileposttrai f briefs : Only respondent filed .a posttrial brief ., . _ 7 sold is not subject to the limitations on .deductions found in sections 162 and 274 but rather is treated as a subtraction from gross sales to arrive at a qualifying business' gross income . See B .C . Cook & Sons, Inc . v . Commissioner , 65. T .C . 422, 428 (1975), affd . 584 F .2d 53 (5th Cir . 1978) ; see also Metra Chem Corp . v . Commissioner , 88 T .C . 654, 661 (1987) . A taxpayer must substantiate the amount it reports as cost of goods sold and . must maintain adequate records for this purpose . Sec ., 6001 ; . Nunn v . - Commissioner , T..C . Memo . . 2002-250 ; Wrightv . Commissioner , T .C . Memo . 1993-27 ; sec . 1 ..6001-1(a), Income Tax Regs . As a general rule, in all cases in which the production, purchase, or sale of merchandise of"any kind (inventory),is an income-producing factor, inventory on hand at the beginning .and end of the year shall be taken into account in computing the taxable income for the year . Secs . .1 .446-1(a)(4)(i), 1 .471=1, Income Tax Regs . If a taxpayer must use an inventory, th e taxpayer ordinarilyis .required to use the accrual method of accounting with regard to purchases and sales unless otherwise authorized . Sec . 1 .446-1(c)(2)(i), Income Tax Regs . Section 471 generally prohibits . the use of inventory accounting for property other than merchandise . Homes by Ayres v . Commissioner , 795 F .2d 832, 836 (9th Cir . 1986), affg . T .C . Memo . 1984-475 . Property other than merchandise may be inventoried only if the regulations under section 471 expressly provide for invento'r'y .: account-ing ;'or-> the,,Commissioner has ' consented to the use, of-:inventories :for such-property .,,, Id,-. general rule,„real property is not=merchandise,forpurposes ;of inventory accounting . .'See ;W C & A . N . . Miller- Dev . Co v . Commissioner , x°81 a'T . C .; 619 '' :'1630 = '( 1983)' ; :,"Coast" Reaity Co . v . Commissioner , 'I1 B .T A" 416:, . 415, & (1928 ) Petitioner apparently .uses -'an$inventory,in its,-,business eve n though it- claims to be ;-,a cash bas is .',taxpayer . ,. The record & doe s not explain. this 'oddity,:, "('- Assuming f or Tthe . sake _,Of argument, , however, that merchandise is,an income-producing factor i n petitioner'as business band that petitioner, is ;required to use inventory, petitioner' .ha s failed _to prove : that the ::Blossom Mountain-property is-..,merchandis e properly .' includable ::;: in calculating_petitioner'' s cost ofagoods sold . f Petitioner also'; failed°to tprove ;that the',Blossom Mountain property , 'properly-classified ,as-merchandise ,,includable ; in inventdry,t should not ' haven been -, ;included' in closing ~ inventory for,purpose s of calculating petitioner' s . cost 'of- goods sold :} Finally , petitioner failed to c .prove !that any, amount, in excess o f $201, 697 . 34.r. was the cost associated -with . acquiring,&the 11 Mountain ,property .1 ° "Even if : the Blossom Mountain property were-proper ly , classified as inventory ; petitioner would not be en t'itled''t o include the cost of the property . in its cost of goods sol d expense for the'Etaxabie . year 2002 because It continued to own the, : .(continued . II . Business Los s We turn then to the real issue as . we see it- -whether petitioner is entitled to deduct a loss on its 2002 taxable year return for its cost in acquiring the Blossom Mountain property because the property became worthless in that year . Petitioner acknowledges that its Form 1120 may have-been prepared incorrectly with respect to the $ .220,000 deduction for cost of goods sold but argues that it may nonetheless deduct a loss attributable to the Blossom Mountain property . Although petitioner's argument is not entirely clear, petitioner appears to suggest that the $220,000 it deducted with respect to the Blossom Mountain property qualifies as a business loss under section 165 .11 Section 165(a) allows a taxpayer to deduct any loss sustained during the taxable year and not compensated for by insurance or otherwise . To-be allowable under section 165(a), the loss must be evidenced by a closed and completed transaction, fixed by identifiable events, and actually sustained during th e '(_continued) property on Sept . 30, 2002, and did not prove that the property was worthless as of that date. 1-Petitioner stated .in its petition : "'At the time of our tax preparation, we were unable to use, access, sell, build, or borrow money against this property because of legal litigation . Since this was a useless' investment at the time, and we were led to .believe that this purchase was a complete loss to our'company, we believed that taxes were prepared properly ." taxable , year . (cid:127) Natl . Home Prods ., Inc ., v . Commissioner ,: .71 T . 501, 521 . (1979 ). ; sec .,,.-.-!,1_16S.71 (b)-j,,;,Income -Ta x 1 .16.5=.1 (d) (2) ( ) Income Tax tRegs . . ' provide s If a- casualty,: or -other event ,occurs . which -may,:result a loss -and, in the year of such casualty or : event , * rc is no portion .. there exists a,claim „for, ._reimbursement: of the loss * * * is sustained, for purposes of 'sectio n 165, until, it cant be- ascertained, with reasonable- -_,, . certainty whether or not such reimbursement will b e received . Whether,a .reasonable prospect of,recovery .. exists with respect to a claim .for reimbursement of- a loss is, a ; question . of - ;fact to be .determined . upon an examination of all facts and circumstances . * * * . ;* ; favor . Ramsay Scarlett & Co . v . Commissioner , ,(1974), affd . 521 F . 2d 786 (4th Cir . 1975) . As with most other deductions, a taxpaye r 4 proving' each o f Y the elements of the deductibility of petitioner-'"s allege d to its investment in the Blossom Mountain property at the close of petitioner' .s2062 taxabl e year, petitioner's alleged loss was evidenced„by,a,closed and , completed transaction, fixed 'by identifiable events ;'and actuall y sustained during the taxable year . 'Moreover,'petitioner"must ' rove that asof'September .30 2002,-,-t here was' no =reasonable. prospect' of recovery with respect ., to its i n'vestment''' in the 0 11 - Blossom Mountain property . See Natl . Home Prods ., Inc . v . Commissioner , supra at 522 . Petitioner has failed to prove any of . these elements . 'Petitioner ' s .claimed loss with 'respect to the Blossom Mountain property was not evidenced by a :closed and completed transaction, fixed by identifiable events . On the contrary , at the . close of petitioner ' s 2002'taxable year the Idaho district court had not yet issued its first opinion in Mr . :and Mrs.. Akers' lawsuit . The lawsuit remains unresolved to this day . Mr . White's belief that the lawsuit would be resolved against petitioner, howeve r sincere, .does not qualify as either a completed transaction or an identifiable event . In addition, petitioner failed to show that the claimed loss was actually sustained . during petitioner's . 200 2 taxable year or in any other year . . White testified that he considered the Blossom Mountain property worthless as of the end of the 2002 taxable year because petitioner did not have any access to .the property . . However, petitioner continued to own the property, and there is no credible evidence that petitioner could not acquire access to the property in some other way or that the property had become worthless as of September .30, 2002 . Finally, even if petitioner had established that it sustained a $220,000 loss with respect to the Blossom Mountain 'property during the taxable year 2002, it still could not deduct . the loss because it had'a reasonable prospect of recovery as of insurance policy . Indeed, . .. petitioner .actually received , reimbursement ; of $200,000for its ~loss from .North ~Idaho°Title .: Co . ' s insurer .,.a"fter the 'Idaho district cotirt issued its .aApri°i 2004, ,,opinion' . Accordingly:, petitioner,has'; failed vt o it . is entitled to .a . business 16ss ° deduction under 'section . X165 (a) . with respect .. to .:its' investment=in the .Blossom Mountain property , VIII . Conclusion- = For,the foregoing' reasons, „ we hold -that petitione r entitled-"to-include ~in_ its cost of goods . , sold . fo r year 2002 ,the sum of .$ 220 ., 00.0 .or, any .- other amount attributable t o its acquisition '"of the 'Blossom Mountain -property :. we' hold that' petitioner has, not . met pits ryburden . of ,proving that , it is entitled$to .deduct the .$220,000-amount 'as a,business los s under,. section 165 (a ) To "reflect the foregoing,