t c memo united_states tax_court issachar ohana and rachel ohana petitioners v commissioner of internal revenue respondent docket nos filed date martin aaron shainbaum and bryant w h smith for petitioners jon d feldhammer thomas r thomas patricia a donahue and trent d usitalo for respondent memorandum findings_of_fact and opinion holmes judge issachar and rachel ohana moved from israel to northern california in soon after they bought two houses and from through poured money into them they claim deductions for the cost of these improvements and argue that they were in the trade_or_business of real- estate development without ever having bought or sold any real_estate during the years before us they did own the two properties and they certainly improved them and for part of that time even rented them out but did their activities amount to a trade_or_business if so what were their deductible expenses or is the commissioner correct that their activity was only home improvement findings_of_fact ohana grew up in israel and became a very educated man he earned his bachelor of science degree in electrical engineering and computer science he also obtained an mba with a focus in marketing and since at least he’s worked for ceva inc --a firm that develops and licenses digital-signal processor patents to computer-chip manufacturers ohana tempered his high-tech endeavors with old-fashioned real-estate investments in israel where he owned and rented two properties but it was ceva that was the focus of ohana’s attention after he’d worked there for ten years the company was sufficiently impressed that it offered him a senior-executive position anywhere in the world--and ohana chose the united_states two years later he became executive vice president of ceva all references to ohana in this opinion are to issachar mrs ohana’s only activity in this matter was signing the joint tax_return with her husband global his new position required constant travel and long and irregular hours those hours are irregular because part of his job is to attend meetings all over the world--often in exotic places like hawaii or morocco--for weeks at a time sometimes ohana even had a chance to work out of israel which gave him an opportunity to visit family his compensation however depended not on the number of hours worked but on whether his team met certain quotas and quotas they met ohana earned nearly dollar_figure in both and and more than dollar_figure even during the worst of the recession in ohana argues that despite his work for ceva he was also able to find the time to run a real-estate business exactly how much time he spent on his real- estate activity between and is fuzzy though since the only records ohana kept were reconstructed logs that he pieced together from his gmail account years later at trial he referred to it as a puzzle to put together he said that he planned to make money by flipping houses--ie buying a house with the intent to fix it up and then sell it at a profit successfully flipping houses depends on several steps’ being executed gracefully from choosing where to buy ideally in a neighborhood that attracts deep-pocketed customers to choosing the right people to do the renovations to keeping transaction costs low but if something goes wrong such as trying to flip after a market crash the flip can flop and the flipper can be stuck with a piece of real_estate ohana however claimed he had an exit strategy he would move into the house and live there until the market was more favorable and then he’d try again to sell the property the ohanas bought their first home in in saratoga california a town on the edge of silicon valley they bought the saratoga home in their own names and personally held title to it in ohana sold one of his properties in israel to fund his next acquisition a house on cowper street in palo alto gregg ann herrern a real_estate agent brokered the deal ohana intended from the get-go to tear down the cowper street home and build a new one but at first he made only enough repairs to make the property livable he quickly rented it out and left herrern to manage the property arrange for any necessary maintenance and collect rent each month later on when ohana tried to evict his cowper street tenants he emailed herrern i told them from day one that i am going to build my house on this property in fact that same day he drafted an email for herrern to deliver to the tenants saying the property was purchased years ago in order to build a new residence for my family we observe that this email--and only this email--was missing from the production set of emails that the ohanas provided to the irs the commissioner got the email directly from herrern in ohana began meeting with an architect and developing plans that included not only rebuilding the cowper street home but also building a separate cottage unit that would function as a guest house and rental property the cowper cottage was eventually given its own address and rented out but on the record deed documenting the purchase ohana checked a box on the form that he intended to eventually make the cowper street home his primary residence he also emailed the chief building official of the city of palo alto that he had bought the property to build my future home in palo alto at the beginning of however the ohanas were still living in their saratoga home which they began to remodel during that year ohana also began trying to get a construction loan to refinance his mortgages and fund the building of a new house and cottage on the cowper street property on this loan application ohana again stated that he would use the money to build a primary residence rather than invest in a business and that’s just what he got--the loan papers show that he received a residential not an investment mortgage ohana had by this time formed two limited-liability companies ohana consulting llc and zoop llc but these neither held title to the two properties nor were the named borrowers for the mortgage and construction loans indeed throughout the three years before us the ohanas were the sole title holders and borrowers for both properties even though the ohanas reported on their tax returns that ohana consulting and zoop owned both homes and incurred hundreds of thousands of dollars in expenses by the end of ohana’s general contractor had razed the home on the cowper street property and begun construction there are a number of facts that strongly suggest ohana intended the cowper street property to be his family’s personal_residence starting with his decision to enroll his daughters in the palo alto school system for the and school years before construction had even begun and as soon as construction was completed sometime in date the ohanas moved in and began renting out the saratoga home the new cowper street home also had several quirks such as a custom-built door with a peephole low enough that the five-foot-four ohana could reach it and ohana obsessed over every detail of the project--he was very particular about materials design the interior decoration and even which workers his contractor could use he visited the property every day he was in northern california and even had cameras installed so he could monitor the progress from afar david avny his fellow israeli friend and a ceva co-worker described ohana as involved in everything not only in real_estate it’s everything about him he’s very methodical ohana’s real-estate activity was not entirely limited to the two properties that he owned in his free time he and avny went around looking at multi-million- dollar properties in the area he was on an email listserv that alerted him daily about properties in the area and he spent a fair amount of time talking with avny about potential acquisitions but during the years we’re looking at this was the extent of his real-estate activity with avny--just scoping out the market and strategizing late into the night about their possible future plans ohana nevertheless considered avny a partner in his real-estate endeavors even though they never went in together on a development project and not once did they even buy a property through a partnership their relationship we therefore find was more of a friendship between two men who both dabbled in real_estate and not a partnership and of course ohana not only didn’t sell or offer to sell either of the two properties that he did own but he actually used both albeit at different times as his personal residences ohana’s scrupulous attention to detail in building his homes and working for ceva did not carry over into his tax preparation he says that he didn’t read or even look at his or individual or partnership tax returns before signing and submitting them to the irs he didn’t compare his quickbooks accounting_records to his tax_return and he didn’t provide receipts to the revenue_agent during the examination to substantiate the business_expenses claimed by ohana consulting and zoop instead of checking his returns ohana relied on the tax-preparation skills of urs--an organization that specialized in pitching services to israeli immigrants many of urs’s employees were israelis who would spend most of the year back home and come back to the united_states just before tax season ohana’s friend avny was cautious about using the firm and he refused to allow anyone but the owner of urs a man named nadav to do his taxes ohana was not as picky his return preparer shalom eyal bitton was neither an accountant nor a lawyer though he was a former cfo of an israeli company and he came from an elite unit in the israeli army--not particularly relevant experience when it came to tax preparation but perhaps some indicator of trustworthiness to this particular expatriate community bitton assured ohana that the software urs used should eliminate any concerns and would confine his role to data entry as a bonus bitton promised that nadav would review ohana’s returns ohana sent bitton all the information related to his income and there are several cases pending in our court naming urs as the tax preparer a great many of urs’s clients are being investigated by the irs criminal charges have been filed against urs in the central district of california on allegations that the firm deliberately aided abetted and assisted some of its clients in hiding money in luxembourg after filing false tax returns we stress that ohana is not one of these clients deductions including his real-estate activities on documents entitled profit and loss details urs then entered this data into a computer and generated a tax_return ohana’s experience with urs was apparently typical--although a first-time taxpayer who used urs’s services would undergo a two-to-three hour interview and hand over all his income and deduction information later interaction was minimal it is unclear from the record whether urs generally acted as a preparer that relied on its clients to characterize items of expense and income or as a professional that advised its clients of the correct characterization of those items but we do find that ohana’s dialogue with urs was limited and that after his first conversation he went straight to a receptionist who already had his returns prepared all a taxpayer like ohana had to do then was cut a check and send the return to the irs the ohanas claimed deductions for nonrental business_expenses and rental real-estate activity losses during and in the following amounts the ohanas also claimed a long-term_capital_loss of dollar_figure on their return as a result of not applying their long-term_capital_loss carryover from to their capital_gains in but they failed to address this issue on brief and we consider it abandoned for purposes of these cases year nonrental dollar_figure big_number big_number rental dollar_figure big_number big_number the commissioner issued notices of deficiency to the ohanas for the tax years in in them the commissioner determined that the ohanas’ rental real-estate losses were passive and also disallowed all of the ohanas’ claimed nonrental real-estate expenses the notices disallowed the expenses of ohana consulting and zoop and asserted penalties too the ohanas timely filed petitions to the tax_court we tried the cases in california where the ohanas live now as they did when the cases began opinion a deductibility of expenses for rental and nonrental activity taxpayers are generally allowed to deduct business and investment_expenses under sec_162 and sec_212 but sec_469 puts strict limits on current all section references are to the internal_revenue_code in effect for the tax years in issue all rule references are to the tax_court rules_of_practice and continued deductibility if a taxpayer incurs those expenses in a passive_activity sec_469 the sec_469 regulations make rental activities per se passive unless the taxpayer engaging in them is a real-estate professional sec_1_469-1t and ii income_tax regs fed reg date hoskins v commissioner tcmemo_2013_36 ohana conceded at trial that he was not a real-estate professional for the years at issue and that rental is not his main source of business even though all his income during aside from his ceva paychecks came from renting the cowper and saratoga properties we therefore find that ohana’s rental income comes from a passive_activity which means that his rental expenses are deductible only to the extent of his passive_income sec_469 the deductibility of ohana’s nonrental expenses turns on whether they were personal or incurred in connection with a trade_or_business see sec_162 sec_262 ohana testified that he planned to generate income not through renting his two houses but by buying improving and then selling them at a profit but did his activity amount to being in a trade_or_business continued procedure the definition of trade_or_business is not found in the code but the supreme court has provided us with the a well-known rule_of thumb to be engaged in a trade_or_business a taxpayer must be involved in the activity with continuity and regularity the primary purpose of which is income or profit 480_us_23 we discuss each factor in turn continuity and regularity many witnesses credibly testified that ohana was heavily involved in his real-estate projects but while ohana may have been extremely involved in the remodeling and renovating of his homes he was not continuously or regularly involved in the business of buying and selling real_estate during the years before us he did not sell or buy a single property and there is ample caselaw holding that taxpayers with significantly more nonrental real-estate activity than ohana did not show the high frequency required to be considered regular and continuous in douglas v commissioner tcmemo_1998_165 aff’d 181_f3d_87 4th cir for example the taxpayer purchased eleven properties renovated seven of them and sold two before the tax years at issue we held that even this was not the documentary_evidence on which ohana relies eg binders and time logs is not very probative as he put them together only for trial from approximations based on some of his emails and calendar enough to be considered regular and continuous because none of the sales occurred during the tax years before the court we similarly find that ohana’s two renovations without purchases or sales likewise is not a regular and continuous real-property development business see also wolfgram v commissioner tcmemo_2010_69 intention to operate property as a bed and breakfast before operation began not regular or continuous activity finnegan v commissioner tcmemo_1997_486 single venture not trade_or_business where speculative venture no preexisting arrangement for transfer and no objective facts of intent to sell aff’d 168_f3d_498 9th cir and while we conclude that ohana intended to eventually sell the saratoga and cowper street homes the only steps he took during the relevant tax years were in preparation to rent out the saratoga home and in preparation to move into the cowper street home simply upgrading his homes with the desire to make a profit on a sale at some time in the future is not sufficient to meet the regular-and-continuous-activity test for a trade_or_business primary purpose there is a second test that taxpayers must pass to show they were engaged in a trade_or_business and that is proof that their primary purpose in engaging in the activity was for profit the case here is affected by the fact that ohana’s activities revolved around properties that either were or became his homes and we need to figure out whether ohana’s expenses in improving these personal residences were in the pursuit of profit see 54_tc_1298 explaining that facts and circumstances dictate whether a former residence used for personal purposes has been converted in the hands of the same taxpayer into property_held_for_the_production_of_income we think not the saratoga home we use five factors to determine whether an individual has converted his personal_residence into property_held_for_the_production_of_income the length of time the house was occupied by the individual as his home before placing it on the market for sale whether the individual permanently abandoned all further personal_use of the house the character of the property offers to rent and offers to sell 84_tc_809 aff’d without published opinion 800_f2d_260 4th cir 81_tc_840 aff’d in part rev’d in part on another issue 776_f2d_1428 9th cir grant sprang from an ugly divorce after the taxpayer left the home his estranged wife rented out a portion of it and in doing so assumed the responsibility of paying the maintenance_expenses the wife then left the house followed several months later by the tenant the taxpayer faced with an empty house personally took on the maintenance_expenses to avoid problems with the insurance and utility companies while he tried to sell the house he claimed a deduction for these expenses on the ground that he held the house for the production_of_income since his ex-wife had converted the property into a rental property and he had never moved back in while trying to sell it t c pincite but we concluded that he was not entitled to any deductions for two reasons he never received any rent or participated in any way in his ex’s rental_activity and there was no evidence that he was holding the empty home for appreciation in the short time between his regaining possession and its ultimate sale id pincite bolaris was a little bit different in that case the taxpayers had moved out of their old home and were trying to sell it when they received no acceptable offers they began to rent it out month to month while still trying to find a buyer we denied them their claimed deductions for rental expenses because we thought it inconsistent with their simultaneous claim to nonrecognition of their gain under old sec_1034 t c pincite the ninth circuit disagreed with our analysis and reasoned that renting a house at its fair_market_value showed that a taxpayer has a profit_motive id f 3d pincite the ohanas’ situation is different from both of these--they lived in the saratoga home until when they began to rent it out--but they never tried to sell it ohana may have chosen to do this because of unfavorable market conditions but grant bolaris and cases like them reasonably suggest that someone who argues that he’s in the business of selling homes should show at least an attempt to sell one and in any event ohana unfortunately didn’t record any of his expenses for the saratoga home in his accounting_records so we’d have to deny his claimed deductions for lack of substantiation as well because ohana meets neither of the two requirements for characterizing his activities concerning his saratoga home as a trade_or_business we agree with the before repeal sec_1034 allowed a taxpayer to completely defer recognition of gain on the sale of his principal_residence provided that within two years before or two years after the sale he purchase a new residence and use it as his principal_residence and the adjusted sale price of the old residence did not exceed the cost of the new residence see sec_1034 and b before the taxpayer_relief_act_of_1997 pub_l_no sec_312 sec_111 stat pincite worse still ohana claims to have known full well that the market was about to crash and that he would be unable to sell at a profit commissioner that the ohanas can deduct no expenses other than mortgage interest and property taxes with respect to that property see sec_163 sec_164 the cowper street property ohana argues that the expenses which he incurred in building the new cowper street home and cottage were not personal because he intended to make a profit on their eventual sale but as we said in 66_tc_312 citing 309_f2d_525 9th cir aff’g t c memo if hoping to eventually sell a house at a profit was by itself sufficient to establish a profitmaking intent rare indeed would be the homeowner who purchased a home several years ago who could not make the same claim the facts here however show that ohana always intended to make the new cowper street property home his personal_residence see haddock v commissioner tcmemo_1986_476 saunders v commissioner tcmemo_2002_143 aff’d 75_fedappx_494 6th cir cf russel v commissioner tcmemo_1982_709 when he bought the home he told third parties it was to be his primary residence the deed registration form he filed with the county said that he intended to make it his primary residence even the email that he wrote to his real-estate agent said that he’d told his tenants from day one that he was going to build his house on this property he had his agent draft an email to those tenants bluntly stating that he would eventually oust them to build his new residence he also enrolled his children in the palo alto school system for the and school years--before the home was ready for him and his family to move into his loans were of the sort one would get for a primary residence instead of for a business or for an investment_property and there were even minor touches like the personalized peephole that made the home a bit less marketable for sale and a bit more useful for ohana himself to use all this leads us to find that he had an intent all along to re-root his family to cowper street we find that ohana like many homeowners worked on home-improvement projects with an eye to their effect on his property’s value--but that doesn’t mean that his activity was engaged in for profit we therefore find that the ohanas were not engaged in the trade_or_business of real-estate development from to we likewise reject the ohanas’ alternative argument that their expenses are deductible as investment_expenses under sec_212 sec_469 however authorized regulations that to include such expenses within the definition of trade_or_business in applying the passive-activity loss rules sec_1_469-4 inc tax regs was the response and it requires us to combine ohana’s rental and nonrental real-estate expenses and then subject them to disallowance under sec_469 as a consequence of his concession that he was not a real-estate professional the parties skirmished on who should bear the burden_of_proof this continued b effects this finding has consequences for the rest of the ohanas’ case we cannot allow a great many of their contested deductions because they are not connected to a trade_or_business but there are other problems with them to which we now turn the ohanas claimed deductible nonrental expenses on the tax returns they filed for ohana consulting and zoop--the partnerships we’ve already found did not own either of the two ohana homes--for each year at issue continued fight is relevant only in the rare instances where there is an evidentiary tie see eg 136_tc_263 131_tc_185 and we do not need to resolve the issue of who has the burden_of_proof if we find that the commissioner proved his case by a preponderance_of_the_evidence see 89_fedappx_656 9th cir aff’g tcmemo_2002_276 ohana consulting and zoop were both llcs with only two members the ohanas because the ohanas didn’t elect to treat them as corporations both llcs are classified as partnerships under the code see sec_301_7701-3 proced admin regs auto and truck expense meals and entertainment telephone travel total dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number the only documents in evidence substantiating most of these expenses are ohana’s quickbooks profit and loss detail charts but these are just summaries of his assertions and a taxpayer’s uncorroborated statements are generally not enough to support deductions for unsubstantiated amounts claimed mitchell v commissioner tcmemo_1996_217 see also 139_tc_19 general ledgers by themselves are insufficient to substantiate a taxpayer’s claimed deductions but there was not even any evidence at trial to support any of the expenses the ohanas claimed to have substantiated there was nothing in the record to support the automobile and truck expenses claimed-- nothing in the logs to indicate how many miles were driven and nothing describing the business purposes for the trips see pace v commissioner tcmemo_2010_272 approximating petitioner’s car expenses prohibited by section 274’s strict substantiation requirements indeed aside from his business trips for ceva ohana provided only two travel receipts one for a stay in morocco with his family made out to mr and mrs ohana and another for his stay at the disneyland marriott--both of which he deducted as travel_expenses we disallow these as personal expenses some of these expenses are deductible albeit as personal expenses that the code allows individuals to deduct including their mortgage-interest expenses state-income tax_payments and gifts to charity home mortgage interest state income taxes gifts to charity dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number these are allowed we’re left with what to do about the expenses_incurred to renovate both the saratoga and cowper properties the ohanas claimed the following deductions for these expenses on their partnership tax returns tax and licenses interest insurance outside services utilities total dollar_figure --- big_number big_number dollar_figure --- big_number --- big_number big_number dollar_figure big_number --- --- big_number expenses related to real-estate activities are subject_to the code’s capitalization_rules sec_263 prohibits a deduction for amounts paid for new buildings permanent improvements or betterments made to increase the value of any property or estate the regulations add that nondeductible expenditures include amounts paid_or_incurred to add to the value or substantially prolong the useful_life of property owned by the taxpayer or to adapt the property to a new or different use these rules apply to the new cowper street home because we find that ohana built it for use as a personal_residence under sec_1_263_a_-1 income_tax regs these cost-capitalization rules also apply with respect to the production of real_property for use in an activity conducted for profit and require taxpayers to capitalize the direct and indirect_costs of producing such real_property sec_263a sec_1 263a- e and income_tax regs sec_263a defines producing as constructing building installing manufacturing developing or improving sec_1_263a-2 income_tax regs likewise sec_263a requires the ohanas to capitalize their direct and indirect_costs related to building the cowper cottage because it was constructed for--and used as--a rental property these expenses include property taxes outside services expenses such as the architect’s fees and expenses for licenses insurance and utilities directly benefiting or incurred by reason of the cowper cottage see 112_tc_14 104_tc_207 wilson v commissioner tcmemo_2002_61 aff’d 71_fedappx_623 9th cir tsakopoulos v commissioner tcmemo_2002_8 aff’d 63_fedappx_400 9th cir the renovations of the saratoga property are a hybrid renovation expenses are properly capitalized under the rules of sec_263 for the and years while the ohanas still lived there and then under sec_263a in once they moved into the cowper street home and held the saratoga property as a rentaldollar_figure the court will enter decisions under rule in these cases the parties should sort out these details of allocation in that process c penalty all that is left are the penalties a substantial_underpayment exists if the understatement_of_tax exceeds the greater of percent of the amount of tax required to be shown on the return or dollar_figure see sec_6662 the following chart illustrates the tax_liability of the ohanas based on their concession that they are not real-estate professionals tax required to be shown less tax on return understatement of tax required to be shown dollar_figure big_number big_number dollar_figure dollar_figure big_number big_number big_number big_number dollar_figure dollar_figure dollar_figure the understatements for and exceed both percent of the tax required to be shown and dollar_figure based on this concession alone the commissioner therefore meets his burden of production on the penalty with simple arithmetic the only issue left in dispute is whether ohana has a sec_6664 reasonable-cause-and-good-faith defense sec_6664 sec_1_6664-4 income_tax regs this requires us to look at the relevant facts and circumstances including the taxpayer’s efforts to assess his own proper tax_liability and whether he had reasonable_cause and showed good_faith by relying on professional advice we must first decide whether ohana received any advice at all from urs regarding his tax_liabilities sec_1_6664-4 of the regulation defines advice as a communication that reflects analysis and conclusions of the tax adviser see 136_tc_585 advice reflects adviser’s analysis or conclusion and taxpayer relied in good_faith on adviser’s judgment ohana provided books_and_records to urs that stated he was in a real-estate trade_or_business the documents are entitled profit and loss detail for each year at issue and while ohana met with his tax preparer once during his initial interview with urs his later meetings were with a receptionist who already had his returns prepared ohana himself testified that urs performed mainly data entry into software that would generate a tax_return and these advisers were neither lawyers nor accountants as is plain from the obvious errors on the tax returns--for example ohana’s rental property in israel was completely omitted from his returns even though income and expenses from those properties were included in his quickbooks files in fact his returns didn’t line up with his accounting_records at all see 240_f3d_842 9th cir reliance on tax adviser’s advice not reasonable where no evidence of adviser’s professional qualifications or nature of advice received aff’g tcmemo_1998_447 this all leads us to conclude that he didn’t receive advice from urs at all even if we assume he did receive advice the caselaw lists three factors we need to look at to decide whether his reliance on it was reasonable 115_tc_43 aff’d 299_f3d_221 3d cir first was the adviser a competent professional who had sufficient expertise to justify reliance second did the taxpayer provide necessary and accurate information to the adviser third did the taxpayer actually rely in good_faith on the adviser’s judgment competent professional we have already touched the first factor--urs was a group of mostly untrained individuals whose responsibilities involved rote data entry based on documents provided by their clients the documents that ohana gave them-- spreadsheets entitled profit and loss details--bear a title that would likely lead a number cruncher to assume ohana was running a business still we need to carefully focus on the main issue--whether ohana reasonably knew or should have known that the tax preparer lacked knowledge in the relevant areas of tax law hristov v commissioner tcmemo_2012_147 sec_1_6664-4 income_tax regs ohana had a background in u s accounting principles as part of his mba curriculum but he was not sophisticated in tax matters by any means his friend avny didn’t fully trust the urs preparers--he fired his original urs preparer and had the owner of urs a cpa sign his income-tax returns to ensure they were properly handled but while ohana was also skeptical he still went through with it he was assigned a preparer bitton whom he knew was new to the job and who had little-to-no background in tax preparation he relied on bitton’s assurances that the software urs used was very sophisticated and would eliminate any of ohana’s concerns because bitton’s main role would be reduced to mere data entry reliance on tax-preparation software may not constitute reasonable_cause for underreporting of income and corresponding underpayment of income_tax see eg bartlett v commissioner tcmemo_2012_254 ohana however saves this part of his argument only because he was offered an added bonus a promise that the ceo of urs would personally review ohana’s returns--and that ceo was a cpa and a competent professional and owner of the tax-preparation company--factors that we find are sufficient to lead ohana to believe that urs had the requisite knowledge of tax law to prepare his returns see estate of robinson v commissioner tcmemo_2010_168 disbarred lawyer appeared competent necessary and accurate information the ohanas however must also establish that they provided necessary and accurate information with respect to all items reported on their tax returns so that the incorrect returns resulted from the adviser’s own errors hristov tcmemo_2012_147 see also eg 68_f3d_868 5th cir aff’g tcmemo_1993_634 70_tc_158 59_tc_473 sec_1 c i of the regulation also requires a taxpayer to disclose all pertinent facts and circumstances that the taxpayer knows or reasonably should know to be relevant to the tax treatment of an item see diaz v commissioner tcmemo_2012_280 there are problems here ohana testified that he had provided all of his real-estate emails to his attorney who was then supposed to turn them over to the irs but we have found that he omitted the one least favorable email--the one in which he told his real-estate agent that he bought the cowper street property to build a future home for his family ohana also testified that he managed all of his rental properties during but we’ve found that herrern was the one who took the tenant applications picked up their rent checks handled maintenance requests and mailed final notices of termination when the ohanas decided to move in this casts grave doubt about whether ohana provided necessary and accurate information to urs a doubt that becomes still graver because the documents that he gave to urs were estimated reconstructions-- unsupported by receipts--of what ohana believed his income and expenses to be and given the discrepancies between ohana’s quickbooks logs and his tax returns we find that ohana did not furnish necessary and accurate information to urs actual reliance in good_faith the general_rule is that a taxpayer can not avoid his duty to file accurate returns by placing the responsibility on an agent 63_tc_149 it is not reasonable to fully rely on a professional simply because he is a return preparer see neonatology assocs t c pincite the mere fact that a cpa has prepared a tax_return does not mean that he or she has opined on any or all of the items reported therein and it is not sufficient that a taxpayer relied unconditionally on a preparer the taxpayer must also exercise d iligence and prudence 92_tc_958 aff’d without published opinion 921_f2d_280 9th cir as we said in estate of stiel v commissioner tcmemo_2009_278 taxpayers have a duty to read their returns to ensure that all income items are included see also 88_tc_654 reliance on preparer with complete information not reasonable_cause where cursory review would have revealed errors 70_tc_465 taxpayer still has duty to read return to make sure all income included even if all data given to tax preparer aff’d 651_f2d_1233 6th cir given ohana’s unusually focused attention to detail in other areas of his life we do not find him credible when he says that he never once looked at his tax returns and that he kept accounting_records but never once made sure they tied with his form sec_1040 or forms u s return of partnership income is telling claiming reliance on a tax preparer and choosing to maintain ignorance of the contents of his returns is not reasonable reliance in good_faith and we will not permit ohana to avoid accuracy-related_penalties for substantially understating his tax_liabilities while reliance on a professional tax preparer may save a taxpayer from accuracy-related_penalties it won’t where an intelligent and skilled taxpayer provided inaccurate information to the return preparer and claims improbably not even to have glanced at his returns to make sure they were satisfactorily prepared decisions will be entered under rule


internal_revenue_service number release date index number ------------------------------------------------------- ---------------- --------------------- --------------------------- ------------------------------------------------------------ department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------ id no ------------- telephone number --------------------- refer reply to cc psi b1 plr-150282-07 date date legend x -------------------------------------------------- -------------------------------------------------------- country date --------------------- -------------------- dear -------------- this is in response to a letter dated date requesting an extension of time pursuant to sec_301_9100-3 of the procedure and administration regulations to file an election to treat x as a partnership for federal tax purposes under sec_301_7701-3 facts according to the information submitted x is an entity organized under the laws of country x was eligible to make an election to be treated as a partnership for federal tax purposes effective date however due to inadvertence form_8832 entity classification election was not timely filed law and analysis sec_301_7701-3 provides guidance on the classification of a foreign eligible_entity for federal tax purposes generally unless the entity makes an election to be treated otherwise a foreign eligible_entity is treated as an association_taxable_as_a_corporation if all members have limited_liability if a foreign eligible_entity has only one plr-150282-07 owner it may elect to be treated as a disregarded_entity pursuant to the rules in sec_301_7701-3 if a foreign eligible_entity has more than one owner it may elect to be treated as a partnership pursuant to the rules in sec_301_7701-3 sec_301_7701-3 further provides that an entity classification election must be filed on form_8832 entity classification election and can be effective up to days prior to the date the form is filed or up to months after the date on which the form is filed under sec_301_9100-1 the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as including an election with a deadline prescribed by a regulation published in the federal_register sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make an election sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides extensions of time for making elections that do not meet the requirements of sec_301_9100-2 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 conclusion based solely upon the information submitted we conclude that the requirements of sec_301_9100-1 and sec_301_9100-3 have been satisfied as a result an extension of days from the date of this letter is granted to elect to treat x as a partnership for federal tax purposes effective date the entity classification election should be made by filing form_8832 with the appropriate service_center a copy of this letter should be attached to the form_8832 a copy is enclosed for that purpose except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer s requesting it sec_6110 of the internal_revenue_code provides that it may not be used or cited as precedent plr-150282-07 in accordance with the power_of_attorney on file with this office a copy of this letter will be sent to your authorized representative sincerely william p o’shea william p o’shea associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes


t c memo united_states tax_court abhimanyu swain petitioner v commissioner of internal revenue respondent docket no filed date abhimanyu swain pro_se helen f rogers for respondent memorandum findings_of_fact and opinion panuthos chief special_trial_judge this case was heard pursuant to the provisions of sec_7443a and rule sec_180 sec_181 and sec_182 respondent determined deficiencies in unless otherwise indicated all section references are to the internal_revenue_code in effect for the taxable years in issue all rule references are to the tax_court rules_of_practice and procedure petitioner's and federal income taxes in the amounts of dollar_figure and dollar_figure respectively and penalties pursuant to sec_6662 in the amounts of dollar_figure and dollar_figure respectively after concessions the issues for decision are whether petitioner is entitled to home_office_deductions in the amounts claimed on his returns or in lesser amounts as determined by respondent whether petitioner is entitled to deduct legal fees and whether the accuracy-related_penalties as determined by respondent should be sustained at the time of filing the petition herein petitioner resided in damascus maryland findings_of_fact during and petitioner was a research hydraulic engineer for the u s army corps of engineers in the spring of petitioner taught a course for the u s army corps of engineers at mississippi state university petitioner reported dollar_figure and dollar_figure as total wages on his and federal_income_tax returns respectively on schedule a of his return petitioner claimed deductions for office space in the amount of dollar_figure and legal expense in the amount of dollar_figure on schedule a of his return petitioner claimed deduction sec_2 at trial petitioner conceded the following adjustments petitioner failed to report dollar_figure and dollar_figure in state_income_tax refunds on his and returns respectively petitioner failed to report interest_income in the amount of dollar_figure and dollar_figure on his and returns respectively petitioner is not entitled to deduct personal sales_tax in the amounts of dollar_figure and dollar_figure on his and returns respectively for office space in the amount of dollar_figure and legal fee in the amount of dollar_figure petitioner asserts that a friend prepared his and returns the record does not indicate the name or occupation of the preparer the return preparer signature line on each of the and returns is blank petitioner could not explain the basis for many of the deductions claimed on the returns as previously indicated petitioner conceded some of the claimed deductions at trial petitioner asserts that the deductions claimed for the home_office and legal fees are correct as reflected on his and returns petitioner arrived at the amounts of his home_office_deductions by approximating the cost of renting comparable office space for the year respondent allowed petitioner deductions of one-sixth of the costs associated with his home petitioner's home consists of six rooms one of which was used as an office the room petitioner utilized as an office measures feet by feet or square feet in a home that is approximately big_number square feet in this room petitioner reviewed the homework of his students and prepared for class petitioner asserts that he incurred legal expenses relating to an action brought by his former wife in to gain custody at trial petitioner indicated that the total amount of legal fees claimed on his and returns was incorrect petitioner indicated that he should have claimed dollar_figure in legal fees on each of his and returns of their child and to take possession of the house and with respect to a criminal action against petitioner which was ultimately dismissed a letter dated date reflects that petitioner paid a total of dollar_figure in legal fees to labarre labarre a law firm and owed an additional dollar_figure the letter reflects the following services were rendered services - state v swain first trial per agreement services - state v swain second trial services - chancery contempt proceedings dollar_figure dollar_figure dollar_figure dollar_figure petitioner wrote at the bottom of this letter paid in and dollar_figure to vance in a canceled check dated date in the amount of dollar_figure reflects that the check was in payment of a chancery contempt case opinion at the outset we note that respondent's determinations are presumed correct and petitioner bears the burden of proving that those determinations are erroneous rule a 290_us_111 in addition deductions are a matter of legislative grace and petitioner bears the burden of proving that he is entitled to the claimed deductions rule a 292_us_435 the home_office deduction sec_280a permits the deduction of expenses allocable to a portion of the dwelling_unit that is used exclusively and on a regular basis as the principal_place_of_business for any trade_or_business of the taxpayer sec_280a additionally items such as interest and taxes are deductible without regard to sec_280a sec_280a as indicated petitioner claimed dollar_figure and dollar_figure as home_office_deductions for and respectively respondent does not question petitioner's entitlement to a home_office deduction but rather determined that the amount claimed is excessive petitioner did not allocate his expenses based upon the number of rooms in his house or by actual floor space apparently petitioner estimated his home_office_deductions on the basis of how much it would cost if he rented a room of comparable size this is not a proper method to compute deductions attributable to a home_office the allocation method utilized by petitioner is based upon his personal estimate of comparable rental space such a method is based purely upon conjecture and in any event is not supported by any evidence in the record accordingly respondent's determination is sustained deductibility of legal fees the thrust of petitioner's argument is that the legal expenses were incurred to protect his interest in his property based upon petitioner's testimony and estimates of the total square footage of his home in comparison to the square footage of the home_office it appears that respondent's allowance of one-sixth of the total square footage was generous and hence his home_office petitioner argues that the amounts paid in are deductible on his and returns because the case continued into respondent argues that the expenses relate to a claim which is personal in nature and therefore are not deductible sec_212 provides in pertinent part that expenses for the production_of_income ie legal expenses are deductible as ordinary and necessary business_expenses if the expenses are-- paid_or_incurred during the taxable year-- for the production_or_collection_of_income for the management_conservation_or_maintenance_of_property_held_for_the_production_of_income or in connection with the determination collection_or_refund_of_any_tax sec_262 provides that in general no deduction shall be allowed for personal living or family_expenses a ttorney's fees and other costs paid in connection with a divorce separation or decree for support are not deductible by either the husband or the wife sec_1_262-1 income_tax regs expenses_incurred in connection with a divorce property settlement are not deductible because such expenses are derived we note that petitioner's proposition that expenses_incurred by a cash_basis taxpayer in year are deductible in the next is erroneous taxpayers on a cash_basis ordinarily may claim deductions only in the year such expenses are actually paid sec_1_461-1 income_tax regs from the marital relationship rather than the spouse's activities in holding such income-producing property in 372_us_39 the supreme court indicated that-- the origin and character of the claim with respect to which an expense was incurred rather than its potential consequences upon the fortunes of the taxpayer is the controlling basic test of whether the expense was business or personal and hence whether it is deductible or not under the predecessor to sec_212 see also 372_us_53 even if the legal fees were incurred to protect the ownership of petitioner's home and consequently the home_office petitioner has failed to show that the fees are deductible as expenses of a profit-seeking activity in united_states v gilmore supra pincite the supreme court stated-- if two taxpayers are each sued for an automobile accident while driving for pleasure deductibility of their litigation costs would turn on the mere circumstance of the character of the assets each happened to possess that is whether the judgments against them stood to be satisfied out of income- or nonincome-producing property we should be slow to attribute to congress a purpose producing such unequal treatment among taxpayers resting on no rational foundation petitioner has not demonstrated that the legal expenses_incurred in the criminal action are related to his trade_or_business or to any other income-producing activity conducted by him 383_us_687 therefore the legal expenses attributable to the criminal action are not deductible united_states v gilmore supra pincite accordingly we hold that the payments made by petitioner are not deductible as business or profit-seeking expenses the accuracy-related_penalty sec_6662 imposes an accuracy-related_penalty equal to percent of the portion of the underpayment to which sec_6662 applies sec_6662 applies to that portion of the underpayment attributable to negligence or disregard of rules or regulations sec_6662 the term negligence includes any failure to make a reasonable attempt to comply with the internal_revenue_code and the term disregard includes any careless reckless or intentional disregard sec_6662 negligence is defined as a lack of due care or the failure to do what a reasonably prudent person would do under the circumstances 85_tc_934 we find that petitioner was negligent for both years petitioner conceded at trial that he was not entitled to some of the deductions he claimed on his income_tax returns petitioner argued that he supplied all of his income_tax information to a friend who used this information to prepare petitioner's and returns in addition petitioner argued that some of the deductions claimed were not derived from the information provided to his friend at the time petitioner signed the returns petitioner should have reviewed the returns for their accuracy a cursory review would have revealed that the returns contained claimed deductions to which petitioner is not entitled we are satisfied that the underpayment_of_tax was due to negligence to reflect the foregoing decision will be entered for respondent


o f f i c e o f t h e c h i e f c o u n s e l department of the treasury i n t e r n a l r e v e n u e s e r v i c e w a s h i n g t o n d c date cc psi b01 genin-115606-16 number release date uil ------------------ ------------------------------------ -------------------- ------------------------- ------------------------------------ sec_1_761-2 of the income_tax regulations provides that any this letter refers to a document received by our office on behalf of taxpayer taxpayer -------------------------------------------------- dear ------------- electing to be excluded from the provisions of subchapter_k pursuant to sec_761 of the internal_revenue_code our office is unable to process this election please file the election in accordance with the regulations under sec_761 unincorporated organization that meets certain requirements and wishes to be excluded from all of subchapter_k must make the election provided for in sec_761 in a statement attached to or incorporated in a properly executed partnership return form_1065 the return should be filed with the internal revenue_officer with whom a partnership return form_1065 would be required to be filed if no election were made where for the purpose of determining such officer it is necessary to determine where the electing organization has its principal office or place of business the principal office or place of business of the person filing the return will be considered the principal office or place of business of the organization the partnership return must be filed no later than the time prescribed by sec_1 e including extensions for filing the partnership return for the first taxable_year for which exclusion from subchapter_k is desired the partnership return should contain only the name or other identification and the address of the organization together with the information on the return or in a statement attached to the return showing the names addresses and identification numbers of all the members of the organization a statement that the organization sec_1_761-2 provides that if an unincorporated organization does not genin-115606-16 qualifies under sec_1_761-2 and or a statement that all of the members of the organization elect that it be excluded from all of subchapter_k and a statement indicating where a copy of the agreement under which the organization operates is available make the election as provided in sec_1_761-2 it shall nevertheless be deemed to have made the election if it can be shown from all the surrounding facts and circumstances that it was the intention of the members of such organization at the time of its formation to secure exclusion from all of subchapter_k beginning with the first taxable_year of the organization we are returning your original correspondence with this letter so that you can file it with the appropriate service_center if there are any questions please contact me at -- -------------------- sincerely joy c spies joy c spies senior technician reviewer branch office of the associate chief_counsel passthroughs special industries