Decisions will be entered under
GOEKE,
(1) Whether petitioners' gains from sales of real property during tax years 1998-2000 were ordinary income or capital gain;
(2) whether petitioners are liable for self-employment taxes;
(3) whether petitioners are entitled to deduct additional costs associated with the gross income received from purchasing and selling real property;
(4) whether petitioners are liable for income tax on dividends received;
(5) whether petitioners are liable for income tax on interest received in 1998;
(6) whether petitioners must reduce their itemized deductions for all years and their child tax credit for 1998;
(7) whether petitioners are liable for a failure to timely file addition to tax pursuant to
Petitioners resided in Maryland when they filed their petitions. On March 22, 2002, petitioners filed their delinquent joint Federal income tax returns for tax years 1998, 1999, and 2000.
On June 8, 2007, respondent issued a notice of deficiency (notice). On September 4, 2007, petitioners timely filed their petitions in this Court for tax years 1998, 1999, and 2000. The notice mailed to petitioners reflects, among other adjustments, a recharacterization of petitioners' real estate transactions. Specifically, respondent classified income from these transactions as ordinary income from a trade or business rather than royalty income, or capital gains as petitioners now claim.3 Respondent made additional adjustments, some resulting from his recharacterization of the income from real estate sales. The overall adjustments *299 are as follows:
Schedule C: Income | $834,000 | $604,500 | $473,000 |
Capital gain or loss | -0- | 27 | -0- |
Self-employment tax | 13,240 | 13,789 | 16,439 |
Self-employment tax deduction | (6,620) | (6,895) | (8,220) |
Cost of goods sold | (656,315) | (426,000) | (212,000) |
Dividend income | 38 | 38 | 37 |
Interest income | 50 | -0- | -0- |
Schedule E: Royalty income | (63,991) | (47,121) | (73,464) |
Itemized deductions | (44,328) | (16,656) | 1,478 |
Exemptions | -0- | -0- | 8,064 |
During tax years 1998 through 2000, petitioners regularly purchased and sold real estate within short periods. Petitioner husband earned not more than $40,000 annually as a mortgage banker, and petitioners' purchases and sales of real estate contributed substantially to their income. Many of the properties petitioners purchased were in foreclosure.
In 1998 petitioners sold eight parcels of real property. Petitioners did not claim expenses or repairs for any of these properties on their 1998 Form 4797, Sales of Business Property. Petitioners sold all those properties within 2 months of purchase, with one exception. *300 In 1999 and 2000 petitioners sold four parcels of real property each year. Petitioners listed expenses and repairs on their 1999 Form 4797. Petitioners sold each property within 10 weeks of acquiring it. Over the 3 years petitioners did not rent any of the properties before selling them.
Trial was held on December 7 and 9, 2009, in Washington, D.C. On March 11, 2009, the Court had granted respondent's motion for leave to amend the answer. Respondent's amended answer asserted increased deficiencies and
Original | Increased | |||
Original | Increased | |||
1998 | $27,118 | $69,298 | $6,779 | $17,324 |
1999 | 32,532 | 84,259 | 8,133 | 21,052 |
2000 | 65,751 | 109,348 | 16,473 | 35,489 |
Respondent's increased deficiencies and additions to tax are based on property sale proceeds not included in the notice of deficiency. Those proceeds increased petitioners' self-employment taxes and their adjusted gross income. The changes to petitioners' adjusted gross income resulted in increased self-employment tax deductions and reductions in itemized deductions and exemptions.
On his posttrial brief, respondent again revised his position *301 regarding unreported income from petitioners' real estate transactions as follows (the amounts in the notice of deficiency are shown as well):
Notice of deficiency | ||
net real estate | Revised self- | |
income adjustment to | employment income | |
self employment | per respondent's | |
1998 | $177,685 | $196.138.79 |
1999 | 178,729 | 112,505.08 |
2000 | 261,000 | 196,607.57 |
At trial petitioners submitted Forms 1040X, Amended U.S. Individual Income Tax Return, for these years. Petitioners also entered into the record Forms 4797 which listed the costs of repairs and expenses for real estate. Both sets of documents were admitted to help the Court understand petitioner husband's testimony. However, petitioners produced no receipts, invoices, or any other evidence to substantiate the expenses petitioners claim they paid on their real estate ventures. Respondent submitted deeds and Forms HUD-1, Settlement Statement, for the properties petitioners purchased and sold during the years at issue and used these documents to calculate the gains by subtracting from sale proceeds the purchase and settlement costs.
The taxpayer bears the burden of proving by a preponderance of the evidence that the Commissioner's *302 determinations in the notice of deficiency are incorrect.
The first issue is whether petitioners are entitled to capital gains treatment for proceeds of their property sales.4 Respondent argues that the real estate petitioners purchased and sold was held primarily for sale to customers in the ordinary course of petitioners' trade or business of real estate refurbishment and not for investment. If petitioners held the property primarily for sale to customers in the ordinary course of business, as respondent argues, petitioners' gains will be treated as ordinary income.
Petitioners assert they purchased real estate for the purpose of holding it for investment and with the intent of renting it. Respondent argues that petitioners' intent was to resell the property. A "capital asset" is broadly defined as property held by the taxpayer, whether *304 or not connected with his or her trade or business, subject to a number of exceptions.
The Supreme Court has defined "primarily" as used in this context to mean "principally" or "of first importance".
Typically, the factors in making this determination include: (1) The taxpayer's purpose in acquiring the property; (2) the purpose for which the property was subsequently held; (3) the taxpayer's everyday business and the relationship of the income from the property to the total income; (4) the frequency, continuity, and *305 substantiality of sales of property; (5) the extent of developing and improving the property to increase the sales revenue; (6) the extent to which the taxpayer used advertising, promotion, or other activities to increase sales; (7) the use of a business office for the sale of property; (8) the character and degree of supervision or control the taxpayer exercised over any representative selling the property; and (9) the time and effort the taxpayer habitually devoted to the sales.
We first examine petitioners' purpose for acquiring and holding the properties. Petitioner husband testified that sales of the acquired properties resulted from a difficult market and a desire for immediate funds. The record demonstrates that petitioners purchased and sold real *306 estate with the purpose of receiving the maximum gain within a short period. None of the alleged investment properties were leased and only one was held for more than 1 year before being sold. These real estate transactions were entered into regularly and resulted in significant gains during the 3 years at issue. We find that the overall purpose of acquiring the properties was to benefit from the immediate financial gains in selling them as quickly as possible.
Although petitioner husband was employed as a mortgage banker during these years, this employment was secondary to the real estate transactions he and his wife pursued. Petitioners' earnings from the real estate transactions constituted their primary source of income.
We also consider the frequency, continuity, and substantiality of petitioners' property sales. See
Petitioner husband testified: "I'm in the business of buying material, fixing houses and reselling them." This undertaking involved procuring insurance before the title transfer in order to *307 accelerate the resale. Petitioners did not hold properties as an investment and did not rely on the services of a real estate agent or another third party to select, promote, or sell their properties.
Petitioners' real estate transactions were conducted in the ordinary course of a trade or business and not for investment purposes. Accordingly, we find that respondent correctly treated petitioners' real estate activities as giving rise to ordinary income derived from a trade or business.
Respondent argues that petitioners were in the business of renovating properties. Respondent describes petitioners' regular business activity as finding, purchasing, renovating, and selling foreclosed properties, and respondent allowed expenses for settlement and purchase costs. Petitioner husband explained that the renovation process required procuring insurance, purchasing materials, and hiring additional labor to assist with the repairs and improvements. Notwithstanding the description of these activities, petitioners failed to produce any receipts or other reliable basis for fixing the amounts of repairs or other expenditures incurred during their renovation activities. We therefore find that we cannot approximate allowable amounts for petitioners' reported repairs and expenditures because petitioners provided nothing on which we could rationally base an estimate. *309 However, to the extent respondent seeks additional deficiencies, respondent has not shown that petitioners actually realized net gains from sales of real estate as asserted in his amended answer, and we do not uphold the increased deficiencies sought for 1998. We note that on brief respondent asserts smaller amounts of gains and self-employment income than in the notice of deficiency for 1999 and 2000.
Under
During tax years 1998, 1999, and 2000, petitioners received dividends of $38, $38, and $37, respectively, from their stock in AT&T. Petitioners introduced no evidence to contradict these adjustments, and, accordingly, respondent's determination will be sustained.
Under
Petitioners claimed *310 various itemized deductions including taxes, mortgage interest, charitable contributions, dependency exemption deductions, and the child tax credit. Respondent allowed mortgage interest expenses for years 1998-2000 but adjusted petitioners' dependency exemption deductions, itemized deductions, and child tax credit. Petitioners' entitlement to other itemized deductions for each year was automatically adjusted on the basis of respondent's calculations of their adjusted gross income. Petitioners failed to produce receipts, expense reports, or other records indicating that they qualified for deductions in excess of the amounts respondent allowed, and petitioners are not entitled to additional deductions.
This addition to tax may be avoided if the failure to file timely was due to reasonable cause and not willful neglect.
Petitioners filed their 1998, 1999, and 2000 Federal income tax returns in 2002. Petitioner husband acknowledged this error at trial and stated he had no excuse to explain the delayed filing. Petitioners did not show reasonable cause or otherwise indicate that the delay resulted from something other than neglect resulting in a failure to comply with filing requirements. We therefore find petitioners did not have reasonable cause and are liable for the
Petitioners regularly purchased and sold real estate properties *312 in the ordinary course of their trade or business and are thus liable for the adjustment to their gross income and self-employment taxes. Respondent's assertion of increased deficiencies and additions to tax based on the inclusion of income in 1998 in excess of the amounts determined in the notice of deficiency fails because respondent has not established that the increased sales were not offset by costs petitioners asserted at trial. Thus, to the extent that respondent increased the amount of income for real property sales during 1998 over the amounts determined in the notice of deficiency, petitioners are not liable for either the increased deficiency or the increased addition to tax. On brief respondent conceded some amounts of self-employment income from real estate sales for 1999 and 2000, and these concessions as listed in the Findings of Fact are accepted. Concerning petitioners' request for additional expense deductions in 1998, 1999, and 2000, petitioners have not met their burden to establish that they qualify for additional deductions in excess of those allowed. Petitioners are liable for the
To reflect the foregoing,
Footnotes
1. Unless otherwise indicated, all section references are to the Internal Revenue Code, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩
2. Respondent concedes the gain on the foreclosure sale of one property known as the Dumbarton property.↩
3. Petitioners contend that they incorrectly reported proceeds from sales of real estate as royalty income on their returns, and they now argue that the proceeds should be capital gains.↩
4. Although petitioners claimed royalty income on their returns, they now claim the income should be treated as capital gains.↩