                         T.C. Summary Opinion 2014-51



                         UNITED STATES TAX COURT



                MICHAEL J. RUBLOWSKY, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 16498-11S.                        Filed June 9, 2014.



      Michael J. Rublowsky, pro se.

      Eliezer Klein, for respondent.



                              SUMMARY OPINION


      GALE, Judge: This case was heard pursuant to the provisions of section

7463 of the Internal Revenue Code in effect when the petition was filed.1



      1
        Unless otherwise indicated, all section references are to the Internal
Revenue Code of 1986, as in effect for the year in issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
                                          -2-

Pursuant to section 7463(b), the decision to be entered is not reviewable by any

other court, and this opinion shall not be treated as precedent.

      Respondent determined a deficiency of $9,7382 and a penalty under section

6662(a) of $1,948 with respect to petitioner’s 2009 Federal income tax. After

concessions,3 the issues for decision are whether petitioner:




      2
          All dollar amounts are rounded to the nearest dollar.
      3
        Petitioner concedes that he failed to report $20 of taxable interest for 2009.
       The stipulation of facts states: “Petitioner concedes that he received
$57,887 of taxable IRA distributions in 2009.” In the notice of deficiency,
however, respondent determined that petitioner had gross retirement income of
$58,813, consisting of the $57,887 in individual retirement account (IRA)
distributions petitioner reported and a $926 distribution from a Roth IRA (as
indicated by the “J” distribution code on a Form 1099-R, Distributions From
Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance
Contracts, etc., for 2009 received by respondent) that petitioner did not report.
The notice of deficiency further determined that the taxable portion of the gross
retirement distribution is $55,038. We are unable to readily reconcile the notice of
deficiency’s determination of the taxable portion of petitioner’s IRA distribution
with the parties’ apparent position in the stipulation that the taxable portion is
$57,887. We expect the parties to address this possible discrepancy in their Rule
155 computations.
       Also, in his pretrial memorandum petitioner claimed entitlement to
deductions for a tax return preparation fee and other taxes, but at trial he did not
address these items or offer any evidence with respect to them. We therefore treat
these claims as abandoned.
                                         -3-

       (1) is entitled to deduct a casualty loss of $35,000. We hold that he is not;

       (2) is entitled to deduct certain mortgage interest and real property taxes as

expenditures arising from a personal residence or as trade or business expenses

arising from rental real estate. We hold that petitioner is entitled to deduct the

expenditures only as trade or business expenses from rental real estate;

       (3) is entitled to deduct certain mortgage insurance payments. We hold that

he is not; and

       (4) is liable for an accuracy-related penalty under section 6662(a). We hold

that he is not.

                                     Background

       Some facts have been stipulated and are incorporated herein by this

reference. At the time the petition was filed, petitioner resided in New York.

Petitioner graduated from law school in 2006 and thereafter passed the New York

bar examination and held a legal services job for a time. On January 28, 2010, the

Social Security Administration (SSA) determined that he was disabled and entitled

to disability benefits as of June 1, 2008. The SSA found that petitioner had, as of

that date, severe physical and mental impairments that limited his functional

capacity.
                                        -4-

      On February 28, 2007, a fire caused damage to a dwelling on a parcel of real

property that petitioner owned in Far Rockaway, New York (Far Rockaway

property). The New York City Fire Department prepared an incident report

regarding the fire. The incident report states that the dwelling was “occupied”,

that the fire was confined to the bedroom where it originated, and that the heat

source was a cigarette. The report further states: “Occupant Safraz Rustam

received minor burns to his left hand asn [sic] was treated at the scene by EMS”.

      Shortly after the fire occurred, petitioner filed an insurance claim under a

homeowners property casualty insurance policy (policy) that he had purchased

from State Farm Fire & Casualty Co. (State Farm). The parties do not dispute that

the policy provided casualty coverage only for a dwelling used by petitioner as his

residence. The record does not disclose the precise time at which State Farm

raised concerns about the validity of petitioner’s claim; but over an approximately

22-month period after he submitted the claim, State Farm sought to obtain from

petitioner documents and a sworn statement to substantiate that he was using the

Far Rockaway property as his residence at the time of the loss. State Farm

ultimately concluded that petitioner had failed to provide the required documents

and sworn statement and had materially misrepresented the facts concerning the

loss. Reciting the foregoing, in a December 11, 2008, letter to petitioner State
                                           -5-

Farm declined to provide coverage for the loss. With respect to the sworn

statement, the letter stated: “[Y]ou have not returned the signed copy of the

examination under oath transcript”.

      Petitioner wrote State Farm in January, February, March, April, and June

2009, disputing the denial of coverage. Although he insisted in one of these

letters that he had submitted to a sworn examination, he ignored State Farm’s

contention that he had failed to return a signed copy of the examination transcript.

There is no evidence that State Farm responded to any of petitioner’s followup

letters or made any payment with respect to the fire damage.

      On his Federal income tax return for 2008 (which has no entry indicating a

return preparer) petitioner deducted $17,500 in mortgage interest attributable to

the Far Rockaway property in part I of Schedule E, Supplemental Income and

Loss, which covers “Income or Loss From Rental Real Estate and Royalties”.

Also in that part, he reported rents received of $24,500.4

      On his 2009 return petitioner reported IRA distributions of $57,887 but

classified them as nontaxable. He did not claim a casualty loss deduction or any

other deductions with respect to the Far Rockaway property.


      4
          Petitioner’s Federal income tax return for 2007 is not in the record.
                                        -6-

      In April 2011 respondent mailed petitioner a statutory notice of deficiency

for his 2009 taxable year. The notice determined that petitioner incorrectly

excluded from his taxable income $55,038 of retirement income (attributable to

various IRA distributions).5 In response, petitioner submitted an amended return

for 2009 on which he reported $57,887 in IRA distributions as taxable and for the

first time claimed a casualty loss deduction of $35,000 arising from a “fire in

2007”, as well as deductions for home mortgage interest of $16,138, real estate

taxes of $751, and mortgage insurance premiums of $1,600.6 The casualty loss

was claimed in part B of Form 4684, Casualties and Thefts, of the amended

return--that is, as attributable to business or income-producing property--and

deducted in arriving at adjusted gross income. The mortgage interest, real estate

taxes, and mortgage insurance premium amounts were deducted on Schedule A,

Itemized Deductions, of the amended return, with the mortgage interest amounts

characterized as “home” mortgage interest.


      5
       The notice also disallowed a $33 earned income credit as a computational
adjustment.
      6
       The parties have stipulated that the mortgage interest and real estate taxes
noted above were paid by petitioner in 2009 with respect to the Far Rockaway
property. There is also no dispute that the casualty loss petitioner claimed on his
2009 amended return was premised on the 2007 fire damage to the Far Rockaway
property.
                                         -7-

      Petitioner timely filed a petition with the Court seeking a redetermination of

the deficiency.

                                      Discussion

      Generally, the Commissioner’s determinations in a notice of deficiency are

presumed correct, and the taxpayer bears the burden of proving that the

determinations are erroneous. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111,

115 (1933). Deductions are a matter of legislative grace, and the burden of

showing entitlement to a claimed deduction is on the taxpayer.7 Rule 142(a);

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).

Casualty Loss

       Respondent argues that petitioner is not entitled to a casualty loss

deduction for 2009 for damages to the Far Rockaway property caused by the fire

in 2007. We agree.

      Section 165(a) allows taxpayers to deduct any losses sustained during the

taxable year that are not compensated for by insurance or otherwise. For

individuals, deductible losses are limited to losses incurred in a trade or business

or in any transaction entered into for profit, or, in the case of losses of property not


      7
       Petitioner has not claimed or shown entitlement to any shift in the burden
of proof pursuant to sec. 7491(a).
                                        -8-

connected with a trade or business or a transaction entered into for profit, losses

that arose from casualty or theft. Sec. 165(c).

      In general, a loss is allowed as a deduction only for the taxable year in

which the loss is sustained. Sec. 165(a); sec. 1.165-1(d)(1), Income Tax Regs.

For this purpose, a loss is treated as sustained when it is evidenced by closed and

completed transactions and fixed by identifiable events. Sec. 1.165-1(d)(1),

Income Tax Regs. However if, in the year of a casualty which may result in a loss,

there is a claim for reimbursement with respect to which there is a reasonable

prospect of recovery, no portion of the loss with respect to which reimbursement

may be received is treated as sustained until it can be ascertained with reasonable

certainty whether such reimbursement will be received. Sec. 1.165-1(d)(2)(i),

Income Tax Regs.

      The casualty giving rise to the loss at issue occurred in 2007. Thus, the loss

is treated as sustained in that year unless petitioner had a claim for reimbursement

with respect to which there was a reasonable prospect of recovery as of the close

of 2007. Petitioner had taken out the policy with respect to the Far Rockaway

property, so the question becomes whether he had a reasonable prospect of

recovery on a claim for reimbursement under that policy.
                                        -9-

      Whether a taxpayer has a reasonable prospect of recovery on an insurance

claim is a question of fact, determined by examining all the facts and

circumstances of the case. Id. The test is an objective one; the taxpayer’s

subjective belief concerning recovery is not controlling. Instead, the expectation

of recovery must be reasonable in the light of objective facts and circumstances

bearing on it at the close of the taxable year. See Boehm v. Commissioner, 326

U.S. 287, 292-293 (1945); Estate of Fuchs v. Commissioner, 413 F.2d 503, 507-

508 (2d Cir. 1969), aff’g T.C. Memo. 1968-188; Ramsay Scarlett & Co. v.

Commissioner, 61 T.C. 795, 812-813 (1974), aff’d, 521 F.2d 786 (4th Cir. 1975).

A reasonable prospect of recovery exists when the insurance claim is bona fide

and has a substantial likelihood of being decided in the taxpayer’s favor. See

Ramsay Scarlett & Co. v. Commissioner, 61 T.C. at 811 (citing Scofield’s Estate

v. Commissioner, 266 F.2d 154, 159 (6th Cir. 1959), aff’g in part, rev’g in part 25

T.C. 774 (1956)). Claims for recovery with a remote or nebulous potential for

success are insufficient grounds for postponing a deduction from the year in which

the loss occurs. See id. (citing United States v. S.S. White Dental Mfg. Co., 274

U.S. 398, 403 (1927)). Where the circumstances show that the claim is based on

an insurance policy that does not cover the casualty, there is no reasonable

prospect of recovery sufficient to postpone recognition of the loss to a year after
                                         - 10 -

the year in which it occurs. Coastal Terminals, Inc. v. Commissioner, 25 T.C.

1053, 1057 (1956).

      Petitioner does not dispute that the policy required that he use the dwelling

as his residence. Instead, petitioner contends that he was using the property as his

residence at the time of the fire, notwithstanding State Farm’s position to the

contrary. As discussed below, we conclude on the basis of the preponderance of

the evidence that petitioner was not using the Far Rockaway property as his

residence when the fire occurred.

      The fire department’s incident report states that an “occupant” of the Far

Rockaway property, Safraz Rustam, suffered burns and was treated on the scene.

Confronted with this potential inconsistency with his claim of residing there,

petitioner testified vaguely to the effect that he was in Florida at the time of the

fire and that he allowed his sister, and any other persons she chose, to live there.

But he was at best vague with respect to his familiarity with Safraz Rustam.

Petitioner could have called his sister as a witness to corroborate the foregoing (or

explained her unavailability), but he did not. In these circumstances, respondent is

entitled to an inference that her testimony would have been unfavorable to

petitioner’s contentions. See Wichita Terminal Elevator Co. v. Commissioner, 6

T.C. 1158, 1165 (1946), aff’d, 162 F.2d 513 (10th Cir. 1947). This conclusion is
                                        - 11 -

reinforced by the fact that the incident report was a stipulated exhibit in the case,

one with which petitioner was familiar. His apparent dissembling regarding the

identity of Safraz Rustam significantly undermines his credibility.

      In its letter denying coverage, State Farm cited petitioner’s failure to

provide a signed copy of his examination transcript as a reason for denying

coverage. Petitioner did not take specific issue with State Farm’s assertion at the

time. At trial he testified that he did not recall whether he had provided a signed

copy. Petitioner’s evasiveness regarding signing a sworn statement concerning his

use of the Far Rockaway property as his residence is at odds with his contention in

this proceeding that he was doing so at the time of the fire.

      Finally, petitioner took a position on his 2009 amended return that is

inconsistent with his contention that he was using the Far Rockaway property as

his residence in 2007. The amended return claimed the casualty loss arising from

the 2007 fire at the Far Rockaway property as a loss attributable to business or

income-producing property.8 In addition, on his 2008 return, petitioner treated the

Far Rockaway property as a rental property, deducting the mortgage interest paid


      8
       The Form 4684 on which petitioner claimed the loss had a separate part for
casualty losses from personal use property (described thereon as “property not
used in a trade or business or for income-producing purposes”).
                                        - 12 -

with respect to it on a Schedule E as an expense of a rental property and reporting

rental income of $24,500 in that year.9 While it is possible that petitioner in fact

used the Far Rockaway property as his residence in early 2007 and then

commenced renting it sometime thereafter, he made no attempt to reconcile his

claimed personal use in 2007 with his acknowledged rental use in 2008.

      Given the objective evidence that the Far Rockaway property was being

used as a rental property at the time of the fire in 2007, and petitioner’s vague,

inconsistent, and implausible testimony to the contrary, we find on this record that

petitioner was not using the Far Rockaway property as his residence at the time of

the fire in 2007. Consequently, the policy did not cover the loss attributable to the

fire. Thus, as a matter of objective fact, notwithstanding any subjective belief

petitioner held, there was no reasonable prospect of recovery on any claim for

reimbursement from State Farm as of the close of the 2007 taxable year. Any

casualty loss arising from the fire is treated as sustained and deductible in 2007,

not 2009. See Coastal Terminals, Inc. v. Commissioner, 25 T.C. at 1057 (no

reasonable prospect of recovery postponing casualty loss deduction where


      9
        Confronted with a transcript of his 2008 return at trial, petitioner testified
that the reporting of the $24,500 as rental income was a “mistake” because the Far
Rockaway property was fire-damaged at the time, but he offered no further
explanation as to the possible source of $24,500 in rental income for that year.
                                        - 13 -

taxpayer’s engineers concluded, before close of the year of loss, that property

damage was attributable to cause not covered by insurance policy).

Mortgage Interest and Real Estate Taxes

      Petitioner claims entitlement to deduct $16,138 in mortgage interest and

$753 in real estate taxes paid with respect to the Far Rockaway property in 2009

and not claimed on his original 2009 return as filed. Respondent concedes that

petitioner paid these amounts in 2009 with respect to the Far Rockaway property

but takes issue with petitioner’s contention that he is entitled to deduct these

amounts on Schedule A as itemized deductions, arguing instead that petitioner is

entitled to the deductions only as trade or business expenses.10 We agree with

respondent.

      Petitioner reported the Far Rockaway property as rental property on his

2008 return and has offered no testimony or other evidence to support a finding

that the use of the property changed between 2008 and 2009. Moreover,

petitioner, an individual, has not shown that the mortgage interest he paid is not

“personal interest” disallowed pursuant to section 163(h)--except to the extent




      10
        Respondent does not contend that these deductions are subject to
disallowance under sec. 469 because the expenditures were incurred in connection
with rental real estate activities.
                                        - 14 -

respondent has conceded that the interest was paid on indebtedness properly

allocable to the trade or business of property rental.

       Because we find on this record that the Far Rockaway property was a rental

property in 2009, we hold that petitioner is entitled to deduct $16,138 in mortgage

interest and $753 in real estate taxes as trade or business expenses under section

162.

Mortgage Insurance

       Petitioner also claims entitlement to deduct $1,600 in mortgage insurance

premiums paid with respect to the Far Rockaway property in 2009 that was not

claimed on his original 2009 return. As petitioner offered no document or other

convincing evidence that would substantiate his payment of any amount for

mortgage insurance in 2009, we hold that he is not entitled to the deduction

claimed.

Accuracy-Related Penalty

       Respondent determined that petitioner is liable for an accuracy-related

penalty with respect to the underpayment reflected on his 2009 return. After the

parties’ various concessions, there remains an underpayment attributable to
                                        - 15 -

petitioner’s failure to report $57,88711 in IRA distributions as taxable and his

failure to report $20 of taxable interest. (Petitioner has conceded that he received

the latter.) Petitioner contends that he had reasonable cause for his reporting of

the IRA distributions as nontaxable, given the cognitive impairments he was

suffering at the time he prepared his 2009 return, as evidenced by the SSA

determination that he was disabled. We agree.

      Section 6662(a) and (b)(1) and (2) imposes a penalty equal to 20% of an

underpayment of tax required to be shown on a return that is attributable to a

substantial understatement of income tax or negligence. However, no penalty is

imposed with respect to any portion of an underpayment if the taxpayer acted with

reasonable cause and in good faith with respect to that portion. Sec. 6664(c)(1);

sec. 1.6664-4(a), Income Tax Regs. The determination of whether a taxpayer

acted with reasonable cause and in good faith is made on a case-by-case basis,

taking into account all pertinent facts and circumstances. Sec. 1.6664-4(b)(1),

Income Tax Regs. Generally, the most important factor is the taxpayer’s effort to

assess his or her proper tax liability. Id. The taxpayer’s cognitive impairment or

emotional distress may constitute reasonable cause for underpayments arising

from mistakes or omissions on a tax return. See Ruckman v. Commissioner, T.C.

      11
           The figure may instead be $55,038. See supra note 3.
                                        - 16 -

Memo. 1998-83; Carnahan v. Commissioner, T.C. Memo. 1994-163, aff’d without

published opinion, 70 F.3d 637 (D.C. Cir. 1995).

      Petitioner testified that, when preparing his 2009 return, he was confused

regarding whether his disabled status exempted him from income tax on his IRA

distributions or merely from the penalty on early distributions. In this confusion,

he reported the distributions on his return but categorized them as nontaxable.

      On January 28, 2010, less than three months before petitioner filed his 2009

return, the SSA had issued a determination that petitioner was entitled to disability

benefits. The determination was based on findings, inter alia, that petitioner had

the following “severe” impairments: “dysthymic disorder [depression]; anxiety

related disorder; and ADHD [attention deficit hyperactivity disorder].” The

determination found that the “claimant [petitioner] has the residual capacity to

perform light work * * * except for the limited ability to use judgment and public

transportation unaccompanied” and concluded that petitioner was limited to

“simple, nonpublic, unskilled work”. (Emphasis added.) The determination

further found that petitioner’s condition would prevent him from performing legal

services work, which he had performed before the onset of his disability.

      The SSA disability determination is the most reliable evidence in the record

of petitioner’s condition at the time he filed his 2009 return. In view of
                                         - 17 -

petitioner’s demonstrated cognitive impairment at the time,12 we are satisfied that

his error in reporting the IRA distributions as nontaxable is due to reasonable

cause and his disclosure of the distributions on the return is evidence of good

faith. We therefore hold that petitioner had reasonable cause for the portion of the

underpayment attributable to his failure to report the IRA distributions as taxable.

        That leaves only a de minimis portion of the underpayment attributable to

petitioner’s failure to report $20 of taxable interest. That amount is too small to

give rise to a substantial understatement, nor does the omission establish

negligence, given its isolated nature and petitioner’s cognitive impairment at the

time.

        We therefore hold that petitioner is not liable for any penalty under section

6662.

        To reflect the foregoing,


                                                  Decision will be entered under Rule

                                        155.




        12
       While the SSA determination demonstrates petitioner’s cognitive
impairment at the time he filed his return, we are satisfied on the basis of our
observation of him at trial that he was competent to litigate this case.
