TAX COURT OPINION

Case: Michael Wayne & Jane Annette Downey
Docket Number: 19139-11
Judge: Holmes
Opinion Type: bench
Filed: 12/13/2012
Pages: 14

UNITED STATES TAX COURT WASHINGTON, DC 20217 MICHAEL WAYNE & JANE ANNETTE DOWNEY, ) ) Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent ) ) Docket No. 19139-11. ) ) ) ) ) ) ) ) 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 herewith to petitioner and to ! respondent a copy of the pages of the transcript of the trial ofthe above case before Judge Mark V. Holmes Los Angeles, California on October 23, 2012, containing his oral findings of fact and opinion rendered after the conclusion of trial. In accordance with the oral findings of fact and opinion, a decision for Respondent will be entered. (Signed) Mark V. Holmes Judge Dated: Washington, D.C. December 13, 2012 SERVED DEC 1 7 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 3 1 Bench Opinion by Judge Mark V. Holmes 2 October 23, 2012 3 Michael Wayne & Jane Annette Downey 4 Docket No.: 19139-11 5 6 THE COURT: In the case of Michael Wayne & Jane Annette Downey, Docket Number 19139-11, the 7 Court has decided to render oral findings of fact and 8 opinion, and the following represents the Court's 9 oral findings of fact and opinion. 10 This bench opinion is made pursuant to the 11 authority granted by Section 7459(b) of the Internal 12 Revenue Code of 1986, as amended, and Rule 152 of the 13 Tax Court Rules of Practice and Procedure. 14 15 This case is about the tax consequences of the foreclosure of the Downeys' home in 2007. The 16 Downeys are convinced, and I believe them sincere in 17 18 their conviction, that this foreclosure and the related conduct of their lender was wrongful; quite 19 possibly, that it violated the terms of their 20 contract with the lender or the lender's obligations 21 22 under state law. They ended up, as a result of their dispute 23 with the lender, having to hire a lawyer to get 24 mortgage foreclosure surplus returned to them, and as 25 well ended up renting a hotel room for a couple of (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 4 1 months, having to buy storage, and then moving things 2 3 into storage and out of storage when they finally, at the end of their ordeal, repurchased their home at a 4 higher price. I have no doubt that they suffered 5 great harm in terms of both out-of-pocket expenses 6 7 8 9 and emotional turmoil. But what I have to decide are the tax consequences of their expenses in 2007. On their return, the Downeys claimed $104, 000 in what they 10 called house loss, what they paid on repurchase of 11 their home versus what the foreclosure bid was. They 12 also took $7,000 -- I'm sorry -- approximately 13 14 15 16 17 18 $27,000 in legal fees to regain their mortgage foreclosure surplus that they were entitled to; $16,000 in closing costs to repurchase their home; and more than $14,000, which they subsequently increased to $18,000y in pretrial proceedings in t expenses during their time between the loss of the 19 home and regaining it, mostly the cost of staying at 20 21 22 a nearby hotel. They quite clearly labeled these expenses as deductions and noted them on their return. 23 Altogether they claimed $161,369 that the IRS 24 disallowed. The Downeys then filed their petition in 25 our court on time and assert some slightly different (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 1 numbers from what they have on their return, plus an 2 additional deduction of more than $9,000 for moving 5 3 4 5 6 expenses, mostly, as I said, the storage and the return of their property, out of their home and then back into it. The Commissioner disagrees and added 7 penalties to the Downeys for failing to file timely 8 as well as an accuracy related penalty. The Downeys 9 were California residents before, during and after 10 their ordeal, and especially when they filed their 11 petition. 12 13 14 15 With this background, I'll divide the remainder of my opinion into talking about the tax and talking about the penalties. As to the tax, the preliminary question is 16 whether this was, in some sense, a theft loss. If it 17 wasn't, then I'll break it down into the individual 18 19 components that the Downeys listed on their return and in their pretrial proceedings, namely, one, the 20 loss of value; two, the legal fees to recover the 21 mortgage foreclosure surplus; three, the closing 22 23 24 25 costs on repurchase of their home; four, the living expenses while they were excluded from their home; and, five, the moving costs to and from their home. The big overall question is, was this, in (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 6 1 2 some sense, a deductible theft loss. Section 165(e) governs here and tells me to look at state law. As 3 my court held in Monteleone v. Commissioner, 34 T.C. 4 5 6 7 688, 692, "For tax purposes, whether a theft loss has been sustained depends upon the law of the jurisdiction wherein the particular loss occurred." And here I have to defer to the California 8 State Court System, which concluded that the Downeys' 9 lender was, in fact, entitled to foreclose on their 10 property back in 11 12 13 2007. As the Eighth Circuit held in a case called Johnson v. United States, 291 F.2d. 908, 909, "The 14 Court also further instructed generally that a 15 foreclosure by a bank on property to enforce its 16 security rights on overdue notes does not involve 17 stealing, " and "But for purposes of income tax 18 deduction, losses from theft consist only of takings 19 and deprivations in which the element of criminal 20 21 intent has been involved. " This means that I have to conclude that 22 under 165(e) the foreclosure of the Downeys' home in 23 2007 by their lender through the California State 24 Court System was not a criminal act. 25 Now, 165(a) does say that losses sustained (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 7 1 2 3 4 and not compensated for by insurance are deductible. The Downeys did suffer a loss. However, for individuals like the Downeys, unless those losses are incurred in a trade or business or in a transaction 5 entered into for profit, or from a casualty or theft, 6 7 8 9 those losses aren't deductible. So I sympathize with the Downeys and I conclude that they did, in fact, suffer an economic loss. It's just that 165 of the Tax Code doesn't 10 make it deductible. The losses suffered by the 11 Downeys are not these kind of losses, even if the 12 extent of the losses that they claimed deductions for 13 are direct enough to be considered a loss sustained. 14 I can't consider them a casualty loss 15 either. As we said in Johnson v. Commissioner, T.C. 16 Memo 2001-97, "Equally unpersuasive is any contention 17 that the foreclosure of the property constitutes a 18 19 20 21 casualty loss within the meaning of Section 165(c) (3). A casualty loss is limited to a loss caused by some sudden, unexpected and external force such as fire, storm, shipwreck, or other similar 22 event or accident. Petitioners' loss of their 23 property by foreclosure was not caused by any sudden, 24 unexpected or external force, but rather by their 25 failure to properly make payments on their mortgage (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 8 1 2 3 4 5 6 7 8 9 10 11 loan." So this means that I can't sustain all five categories of loss claimed by the Downeys on their return under the category of theft loss, casualty loss, or some other more general loss under Section 165 of the Code. So I will look at each of their five categories of expense to see if they fit within some more specific provision of the Code and regulations. The first of these was their loss in home value, i.e., the difference between the auction price 12 of the home and the repurchase price of the home. 13 The regulations are quite clear on this point. 26 14 15 C. F. R. Section 1. 165-9 (a) states, "A loss is sustained on the sale of residential property 16 purchased or constructed by the taxpayer for use as 17 his personal ·residence and so used by him up to the 18 19 time of sale is not deductible under Section 165 (a) . " That loss cannot be sustained as a 20 deduction. 21 22 23 The second category are the legal fees to recover the mortgage foreclosure surplus that their lender was not giving to them and to which they were 24 entitled. 25 Here again, the regulation is clear. The (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 9 1 2 3 regulation in this case is 26 C.F.R. Section 1.212- 1 (K) : "Expenses paid or incurred in defending title to property in recovering prop- -- or in recovering 4 property constitute a part of the cost of the 5 property and are not deductible expenses." 6 7 8 Again, I have to rule in favor of the IRS on this point. The third category of deductions that the 9 Downeys claimed were their closing costs on the 10 repurchase of their home. 11 Here again, the Commissioner has the better 12 of the argument because a taxpayer may not deduct 13 14 15 closing costs associated with the purchase or refinancing of a personal residence. A representative case here is Lange v. Commissioner, 16 T.C. Memo.2005-176 at pages 18-20 (2005). 17 The fourth category of expense were the 18 moving expenses that the Downeys claimed for moving 19 out of and then back into their home. 20 21 There is again a large amount of case law that forces me to rule against them on this point. 22 See, for example, Doyle v. Commissioner, 354 F.2d 23 480, 482: "The mere fact that the claimed expenses 24 were incurred by the taxpayer while he was 'away from 25 home' does not of itself establish their (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 1 deductibility. In Commissioner of Internal Revenue 2 v. Flowers, 326 U.S. 465 (1946) the Supreme Court 3 held that to qualify for deductibility the expense 4 must be incurred 'while away from home,' and must be 10 5 6 7 8 9 incurred 'in pursuit of business. '" See, also, Daly v. Commissioner, 782 T.C. 190, 194 (1979). Again, the Commissioner has to prevail on 10 the question of the deductibility of the Downeys' 11 moving expenses. 12 Finally, there are -- oh, I'm sorry. That 13 was the living expenses of the Downeys, namely their 14 hotel bill. They do not get those because of the 15 Doyle and Daly cases. 16 17 18 Finally, the last category are moving costs. A taxpayer may deduct moving expenses if they are paid or incurred in connection with a taxpayer 19 receiving employment at a new principal place of 20 business. See Internal Revenue Code Section 217 (a). 21 Moving expenses incurred due to foreclosure are not 22 deductible. Lockett v. Commissioner, 306 Fed. Appx. 23 464, 468 (11th Circuit 2009), affirming T.C. Memo. 24 2008-5. 25 So on each of these five categories of (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 1 expenses, as well as their overall characterization 2 of their losses incurred in 2007 as a result of their 3 4 foreclosure, I have to rule against the Downeys. That brings me to the penalties part of the 5 discussion. There were two penalties asserted by the 11 6 7 8 9 Commissioner: One, a failure to timely file their return under 6651(a) (1), and an accuracy related penalty under Section 6662. I'll start with the easier of these, which 10 is the failure to timely file a penalty. A taxpayer 11 who fails to file a return is subject to a five 12 percent penalty for each month or fraction thereof 13 until he does file his return. Internal Revenue Code 14 Section 6651(a) (1). 15 The Downey's return was due on October 16 15th, 2008, and yet they did not file their return 17 until November 10th, 2008. Their explanation was 18 that they mistook the due date of the return. This 19 is not reasonable cause. I must sustain the 20 Commissioner's penalty for failure to timely file. 21 That leaves me to the more complicated 22 question of the accuracy related penalties asserted 23 against the Downeys for taking the position they did 24 25 on their 2007 tax return. These penalties were determined by the (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 12 1 Commissioner under Internal Revenue Code Section 2 3 6662(a), which provides that a taxpayer who makes an underpayment of income tax due to negligence or 4 disregard of tax rules and regulations, or a 5 6 7 8 substantial understatement of income tax is subject to an accuracy related penalty of 20 percent. The Commissioner made his prima facie showing that this penalty applied by demonstrating, 9 quite obviously, that the position the Downeys took 10 was not in any way justified by the Internal Revenue 11 Code or its regulations. 12 The key here is whether the Downeys 'can 13 make up a defense under Internal Revenue Code 'Section 14 15 6664. Here, the regulation goes into some detail about what the Downeys or people in the Downey,s' 16 position must prove . 26 C. F. R. Section 1. 6664 4 (a) 17 states, "No penalty may be imposed under Section 6662 18 with respect to any portion of an underpayment upon a 19 showing by the taxpayer that there was reasonable 20 21 22 cause for and the taxpayer acted in good faith with respect to such portion. In Subsection (b) (1) of that regulation, it 23 goes on to state, "The determination of whether a 24 25 taxpayer acted with reasonable cause and in goöd faith is made on a case by case basis, taking into (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 1 account all pertinent facts and circumstances. 2 Generally, the most important factor is the extent of 13 3 4 5 6 7 8 the taxpayer's effort to assess the taxpayer's proper tax liability, 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 a taxpayer." Here, Mr. Downey and Mrs. Downey are both 9 well- educated, but with no great understanding or 10 experience in tax law. I believe that they acted in 11 12 13 14 15 good faith, at least to the extent that they asserted that they were the victims of a wrongful foreclosure and incurred real losses of that foreclosure. However, the regulation requires that I consider all the facts and circumstances, and among 16 these are that they claimed their itemized -- they 17 claimed their deductions as itemized miscellaneous 18 deductions, not really as a theft loss. If they had 19 thought that this was a theft loss, they should have 20 taken it as a theft loss. 21 Moreover, when I asked Mr. Downey if he had 22 read the instructions or researched the matter before 23 calling this a theft loss, he said, no. I have to 24 also take into consideration his high level of 25 education and sophistication. Somebody in his (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 1 position before taking over $150,000 in deductions 14 2 3 4 5 6 7 should have at least read the instructions and pondered whether his attempted deductions met the standards given at least in the instruction booklet, if not the actual regulations and legal precedents that I have to follow. Moreover, I have to observe that the 8 Downeys claimed even more than their out-of-pocket 9 losses in building up such an enormous amount of 10 miscellaneous deductions. 11 12 13 14 Therefore, I think it more likely than not that the Downeys claimed their deductions negligently in an intentional disregard of the rules and regulations. I also specifically find that they did 15 not act reasonably in doing so, thereby negating a 16 defense of reasonable cause and good faith. 17 18 I, therefore, find for Respondent as to the following deficiencies in additions tax and conclude 19 that the Downeys owe a deficiency in income tax for 20 the tax year of 2007 of $55,759.00, in addition to 21 tax under Section 6662(a) of $11,151.80, and a 22 penalty under Section 6651(a) (1) of $682.90. 23 24 This concludes the Court's oral findings of fact and opinion in this case, and concludes this 25 L.A. session. (866) 448 - DEPO www.CapitalReportingCompany.com 2012 Capital Reporting Company Wayne & Downey Bench Opinion 10-23-2012 1 2 Thank you very much. (Whereupon, at 10:23 a.m., the bench 3 opinion in the above-entitled matter was concluded.) 15 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 (866) 448 - DEPO www.CapitalReportingCompany.com 2012