TAX COURT OPINION

Case: Steven P. & Ellen B. Kenney
Docket Number: 21574-12
Judge: Marvel
Opinion Type: bench
Filed: 11/18/2013
Pages: 12

UNITED STATES TAX COURT WASHINGTON, DC 20217 STEVEN P. & ELLEN B. KENNEY, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ) ) ) ) ) Docket No. 21574-12 ) ) ) ) ORDE R Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit to petitioner and to respondent a copy of the pages of the transcript of the proceedings of the above case before Judge L. Paige Marvel at Boston, Massachusetts, on November 6, 2013, containing the Court's oral findings of fact and opinion. In accordance with the oral findings of fact and opinion, a decision will be entered for respondent. (Signed) L. Paige Marvel Judge Dated: Washington, D.C. November 18, 2013 SERVED NOV 1 9 2013 Capital Reporting Company 3 1 2 3 4 5 6 7 8 Bench Opinion by Judge L. Paige Marvel November 6, 2013 Steven P. & Ellen B. Kenney v. Commissioner Docket No. 21574-12 THE COURT: The Court has decided to render oral findings of fact and opinion in this case and the following represents the Court's Oral Findings of Fact and Opinion. The Oral Findings of Fact and 9 Opinion shall not be relied upon as precedent in any 10 11 12 13 14 other case. This bench opinion is made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code of 1986 as amended and Rule 152 of the Tax Court Rules of Practice and Procedure. 15 Hereinafter in this bench opinion, unless otherwise 16 17 18 19 20 indicated, section references are to the Internal Revenue Code of 1986 as amended. Petitioners Steven P. Kenney and Ellen B. Kenney appeared pro sese. Derek W. Kelley appeared on behalf of Respondent. Petitioners resided in 21 Massachusetts when they petitioned this Court. 22 23 24 25 The parties have stipulated some of the relevant facts, which we incorporate herein by this reference. We also find facts on the basis of the stipulated exhibits, and to the extent we find it 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 4 1 2 credible, sworn testimony. Respondent determined deficiencies in 3 Petitioners' Federal income tax of $3,490 and $44,011 4 5 6 7 for 2003 and 2005, respectively, and accuracy-related penalties under section 6662(a) of $698 and $8,802.20 for 2003 and 2005, respectively. After Petitioners' concessions, the issues for decision are: (1) 8 whether, pursuant to section 121, Petitioners may 9 exclude $255,598 in long-term capital gain income in 10 11 12 13 14 2005; and (2) whether Petitioners are liable for accuracy-related penalties under section 6662(a) for 2003 and 2005. Facts Petitioners purchased a home on Madison 15 Street, Wrentham, Massachusetts (Madison Street 16 property) on February 8, 1982, for $41,500. 17 Petitioners lived there until on or about October 13, 18 19 1998. On or about October 13, 1998, Petitioners purchased and moved into a property on Bennett 20 Street, Wrentham, Massachusetts (Bennett Street 21 property). Petitioners moved out of the home on the 22 Madison Street property because, "after living there 23 24 25 for 16 years and with 4 children *** [they] needed a bigger house." Petitioners planned on selling the Madison 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 5 1 Street property in 1998, but they learned that they 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 could not sell it until its septic system was replaced and passed inspection. Because Petitioners were told that it would take at least a year for a compliant sewer system to be designed, approved by the necessary government agencies, installed and inspected, Petitioners decided to rent the Madison Street property. They leased the property to Charles and Marie Adams (the tenants) and beginning in 1998, began to receive monthly rental payments from the tenants, who were also offered the opportunity to buy the property once the new septic system was installed. It took two years for the new septic system to be designed, approved, installed and inspected. In 2000 Petitioners received a certificate of compliance with respect to the Madison Street property's septic system, and, as a result, they were finally in a position where they could offer the 20 Madison Street property for sale and sell it once 21 22 23 24 they had identified a buyer. Petitioners spoke to the tenants about Petitioners' desire to sell the property, but the tenants claimed that they were not in a position to purchase the property at that time. 25 Petitioners advised the tenants that they would 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 6 1 2 continue to rent to the tenant but that the lease L would be an at-will arrangement in anticipation that 3 Petitioners might sell the property. The tenants 4 5 6 7 continued to express an interest in buying the property and Petitioners hoped to sell it to them. Petitioners continued to rent to the tenants until sometime in 2004 when the Madison 8 Street property was raided by agents of the Internal 9 Revenue Service, who were executing search warrants 10 in connection with an investigation of the tenants. 11 After the raid occurred, Petitioners evicted the 12 13 14 tenants. In November 2004, Petitioners finally listed the Madison Street property for sale and on 15 April 26, 2005, they sold it for $317,500. 16 Petitioners had purchased the property in 1982 for 17 18 19 20 21 22 23 24 25 $41,500, and had made various improvements to the property. The parties agree that Petitioners realized capital gain of $255,598 on the 2005 sale. Petitioners filed joint Forms 1040, U.S. Individual Income Tax Return, for 2003 and 2005, respectively. Petitioners reported Mr. Kenney's occupation as police officer and Mrs. Kenney's occupation as housewife. Mr. Kenney prepared both returns and did not consult with any return preparer 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 7 1 2 3 4 5 6 or tax advisor before he did so. Petitioners did not report any of the rental income they received during 1998 through 2003 on their Federal income tax returns although they did deduct on their Schedule A, Itemized Deductions, certain expenses they paid with respect to the 7 Madison Street property during those years. During 8 9 2003, Petitioners received $22,400 of rental income that they did not report on their 2003 return. On 10 Schedules A of their 2003 and 2005 tax returns, 11 Petitioners deducted real estate taxes and mortgage 12 13 14 15 16 17 18 19 20 21 22 23 24 interest with respect to the Madison Street property. During the criminal investigation of the tenants, Respondent discovered that Petitioners had unreported rental income from the Madison Street property and unreported capital gain from the 2005 sale of the property. In 2008, Mr. Kenney was indicted on four counts of willfully filing false tax returns for the taxable years 2003 through 2006 in violation of 26 U.S.C. section 7206(1). Following a jury trial, Mr. Kenney was acquitted on all counts. At the trial in this case, Mr. Kenney testified that he did not report the rental income in 2003 because it was a hassle, and that he thought 25 Petitioners' rental income and rental expenses were a 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 8 1 2 3 4 5 6 7 8 9 10 11 12 13 14 wash. Mr. Kenney admitted at trial that Petitioners did not keep records to substantiate their rental income and expenses. Mr. Kenney also testified that he believed that Petitioners had unforeseen circumstances that excused their failure to report the capital gains from the sale of the Madison Street property and that permitted them to exclude the capital gain under section 121 even though they did not reside in the Madison Street property for two out of the five years immediately preceding the year of sale as required by section 121. With the exception of the 2005 capital gain of $255,598, Petitioners concede all of the adjustments to income from the Notice of Deficiency. 15 Discussion 16 17 18 19 20 21 22 23 24 25 Gross income means all income from whatever source derived, including a gain realized from the sale of the property. Sec. 61(a) (3). Section 121(a), however, allows a taxpayer to exclude from income certain gain on the sale or exchange of property if the taxpayer has owned and used such property as his principal residence for at least two out of the five years immediately preceding the sale. A taxpayer who fails to satisfy the ownership and use requirements under section 121(a) may still qualify 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 9 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 for a prorated exclusion if "such sale or exchange is by reason of a change in place of employment, health, or, to the extent provided in regulations, unforeseen circumstances." Sec. 121(c) (2) (B). It is undisputed that Petitioners did not reside at the Madison Street property during two of the five years before they sold it. Accordingly, they do not qualify for the exclusion under section 121(a). Petitioners contend, however, that they were unable to sell the Madison Street property earlier because of the septic system problem that prevented them from selling the property and that therefore they qualify for the prorated exclusion due to unforeseen circumstances pursuant to section 121(c). Petitioners' contention is without merit. By its terms, section 121(c) only applies when a sale or exchange occurs by reason of unforeseen circumstances; it does not apply where a sale or exchange fails to occur by reason of unforeseen circumstances. Accordingly, because they only contend that they did not sell the Madison Street property sooner because of unforeseen circumstances, 23 Petitioners do not qualify for the section 121(c) 24 25 exception to the ownership and use requirements of section 121(a). Petitioners are therefore not 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 10 entitled to the section 121 exclusion. Section 6662 (a) and (b) (1) authorize the Commissioner to impose a 20 percent penalty on an underpayment of tax that is attributable to, among other things, negligence or disregard of rules ãe44-~ Or' regulations. The term "negligence" includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue laws, and the term "disregard" includes any careless, reckless, or intentional disregard. Sec. 6662(c); sec. 1.6662- 3(b) (1) and (2), Income Tax Regs. 'Negligenc also includes any failure by the taxpayer to keep adequate books and records or to substantiate items properly." Sec.· 1.6662-3(b) (1), Income Tax Regs. Disregard of rules egulations "is 'careless' if the taxpayer does not exercise reasonable diligence to determine the correctness of a return position" and "is 'reckless' if the taxpayer makes little or no effort to determine whether a rule or regulation exists, under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable person would observe." Sec. 1.6662- 3(b) (2), Income Tax Regs.; see also Neely v. Commissioner, 85 T.C. 934, 947 (1985). The accuracy-related penalty does not apply 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 1 with respect to any portion of the underpayment for 11 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 which the taxpayer shows that there was reasonable cause and that he or she acted in good faith. Sec. 6664 (c) (1). The decision as to whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all of the pertinent facts and circumstances. See sec. 1.6664-4 (b) (1), Income Tax Regs. "Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of all the facts and circumstances, including the experience, knowledge, and education of the taxpayer." Id. The Commissioner bears the burden of production with respect to the taxpayer's liability for the section 6662(a) penalty and must produce sufficient evidence indicating that it is appropriate to impose the penalty. See sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). Once the Commissioner meets his burden of production, the taxpayer must come forward with persuasive evidence that the Commissioner's determination is incorrect or that the taxpayer had reasonable cause or substantial authority for the position. See Higbee v. Commissioner, 116 T.C. at 446-447. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 12 1 2 3 4 5 6 7 8 9 Petitioners were required but failed to report rental income from the Madison Street property in 2003. Petitioners were also required but failed to report capital-gain income from the sale of that property in 2005. Respondent has, therefore, met his burden of producing evidence showing that a section 6662 (a) penalty for an underpayment of tax attributable to negligence or disregard of rules gulations with 10 respect to the understatements in 2003 and 2005 is 11 12 13 14 15 16 17 18 19 20 appropriate. Petitioners have not produced any credible evidence that they acted with reasonable cause and in good faith with respect to the underpayments. Accordingly, Petitioners are liable for section 6662(a) penalties for underpayments of tax attributable to negligence or disregard of rules gulations for 2003 and 2005. We have considered the rema1n1ng arguments made by the parties, and to the extent not discussed above, we conclude those arguments are irrelevant, 21 moot, or without merit. 22 23 24 25 To reflect the foregoing, decision will be entered for Respondent. This concludes the Court's Oral Findings of Fact and Opinion in this case. 866.488.DEPO www.CapitalReportingCompany.com 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 Capital Reporting Company (Whereupon, at 10:00 a.m., the above- entitled matter was concluded.) 13 866.488.DEPO www.CapitalReportingCompany.com