                  T.C. Summary Opinion 2010-146



                      UNITED STATES TAX COURT



         CARLOS SADA, JR. AND AMANDA SADA, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 11362-08S.            Filed September 27, 2010.



     Carlos Sada, Jr. and Amanda Sada, pro sese.

     Brooke S. Laurie, for respondent.



     DAWSON, 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   Pursuant to section 7463(b), the

decision to be entered is not reviewable by any other court, and



     1
      Unless otherwise indicated, references to sections other
than sec. 7463 are to the Internal Revenue Code (Code) in effect
for the years at issue, and Rule references are to the Tax Court
Rules of Practice and Procedure.
                                - 2 -

this opinion shall not be treated as precedent for any other

case.

       Respondent determined the following deficiencies in

petitioners’ Federal income taxes and accuracy-related penalties

under section 6662(a) for 2004, 2005, and 2006:

                                  Accuracy-Related Penalty
           Year   Deficiency           Sec. 6662(a)

           2004    $15,564               $3,112.80
           2005     28,182                5,636.40
           2006     27,264                5,452.80

       Respondent filed an amended answer asserting that

petitioners are liable for an increased deficiency in income tax

of $21,125 (a $5,561 increase) and an increased penalty under

section 6662(a) of $4,225 (a $1,112.20 increase) for 2004, and an

increased deficiency in income tax of $33,288 (a $5,106 increase)

and an increased penalty under section 6662(a) of $6,657.60 (a

$1,021.20 increase) for 2005.

       After concessions by the parties,2 the issues to be decided

are:


       2
      The parties agree that (1) subject to the limitations in
sec. 221(b), petitioners are allowed deductions for (A) student
loan interest payments of $141 in 2004, $165 in 2005, and $157 in
2006 and (B) tuition and fees expenses of $3,000 in 2006; (2)
petitioners omitted $49 of interest income from Texas State Bank
on their 2004 return; and (3) petitioners have substantiated
charitable contributions of $4,200 in 2004, $3,885 in 2005, and
$3,955 in 2006.
                               - 3 -

     (1) Whether petitioners are entitled to deductions claimed

on Schedules C, Profit or Loss From Business (Sole

Proprietorship), of their 2004, 2005, and 2006 Federal income tax

returns;

     (2) whether petitioners had gross receipts from a trade or

business as reported on Schedules C of their 2004, 2005, and 2006

returns;

     (3) whether depreciation petitioners claimed on their 2003

return is subject to section 1245 recapture in 2004;

     (4) whether petitioners are liable for self-employment taxes

on the gross receipts reported on Schedules C of their 2004,

2005, and 2006 returns and on gain realized on the sale of

section 1245 property in 2004, if any;

     (5) whether petitioners are entitled to deduct under section

213 medical expenses of $17,083 for 2006; and

     (6) whether petitioners are liable for accuracy-related

penalties under section 6662(a) for the years at issue.

                            Background

     Some of the facts have been stipulated.    The stipulation of

facts and the attached exhibits are incorporated herein by this

reference.   Petitioners are married individuals who filed joint

Federal income tax returns for 2004, 2005, and 2006.   Petitioners

resided in Texas when their petition was filed.   They have two

children, who were ages 12 and 9 at the time of trial.
                               - 4 -

     Petitioner Amanda Sada (Mrs. Sada) is a teacher and was

employed as such during the years at issue.

     Petitioner Carlos Sada (Mr. Sada) has a bachelor of science

degree.   He has been selling cars for 10 or 11 years.   During the

years at issue, he worked as a new car sales manager at Boggus

Ford.   As such he was entitled to purchase under the Ford D plan

one or two new cars each year at $100 over the invoice cost plus

tax, title, and license.

     During the years at issue Mr. Sada purchased new vehicles

from Boggus Ford, kept them for about a year, and then traded

them in on the purchase of newer vehicles.    The trade-in

allowances he received for the old vehicles were less than the

balances owed on the loans obtained to purchase the old vehicles.

He obtained sufficient financing on the purchase of the new

vehicles to pay off the balance owed on the old vehicles over the

amount of the trade-in allowance.

     Mr. Sada and his wife used the vehicles for commuting and

other personal daily activities, but they kept a “for sale” sign

on each vehicle from the time of purchase until Mr. Sada traded

it in on a new one.   Although Mr. Sada’s employment with Boggus

Ford generally did not involve selling used cars, he negotiated

the selling price of the vehicles he traded in.    Petitioners

reported the purchases and sales of the vehicles as Mr. Sada’s
                               - 5 -

business activity on Schedules C of their 2004, 2005, and 2006

Federal income tax returns.

     Mr. Sada owned two 2003 Toyota Sequoias--a desert-colored

Sequoia, which he had purchased for $36,171.35 in November 2002

at which time it had an odometer reading of 52 miles (the desert

2003 Sequoia), and another (the second 2003 Sequoia), for which

the record does not disclose the date of purchase, purchase

price, color, or odometer reading at time of purchase.3   He also

owned a 1998 Isuzu Trooper which he had purchased used for $5,500

to $6,000 in 2003.   In 2004 he sold the Trooper in a cash

transaction for $7,500, making a profit of $2,000.

     On November 18, 2004, Mr. Sada traded in the desert 2003

Sequoia for a gold 2005 Ford Expedition, which he purchased for

$38,251.71.   He received a $27,500 allowance for the desert 2003

Sequoia and financed the balance of the purchase price.   The

desert 2003 Sequoia had an odometer reading of 17,435 miles and a


     3
      Mr. Sada asserts that he owned only one 2003 Toyota
Sequoia. In respondent’s brief, respondent agrees that
petitioners did not own the second 2003 Sequoia. However, motor
vehicle purchase orders from Boggus Ford dated Nov. 18, 2004, and
July 8, 2005, indicate that: (1) Carlos Sada traded in a 2003
Toyota Sequoia, serial number ending 149129, on the Gold 2005
Ford Expedition that he acknowledges he purchased in 2004 and (2)
he traded in a 2003 Toyota Sequoia, serial number ending 150073,
on a white 2005 Ford Expedition that he acknowledges he purchased
in 2005. Mr. Sada also stipulated that he traded in the second
Sequoia on the white 2005 Expedition. Respondent’s concession is
clearly contrary to the stipulation and to the facts that we have
found are established by the record, and we shall disregard it.
See Cal-Maine Foods, Inc. v. Commissioner, 93 T.C. 181, 195
(1989).
                                - 6 -

payoff amount of $28,518 at the time of the trade-in.    At the

time of the purchase the gold 2005 Expedition had an odometer

reading of 11 miles.

     Mr. Sada purchased two vehicles in 2005.    In July 2005 Mr.

Sada traded in the second 2003 Sequoia for a white 2005

Expedition.    He purchased the white 2005 Expedition for

$37,310.21; he received a $22,000 allowance from the trade-in of

the second 2003 Sequoia towards the purchase price and financed

the balance.    The second 2003 Sequoia had an odometer reading of

25,877 miles and a payoff amount of $25,947.81 at the time of the

trade-in.   The white 2005 Expedition had an odometer reading of

37 miles at the time of purchase.

     In December 2005 Mr. Sada traded in the gold 2005 Expedition

on a 2006 gray Expedition.    He purchased the gray 2006 Expedition

for $37,631.16; he received a $32,000 allowance from the trade-in

of the gold 2005 Expedition towards the purchase price and

financed the balance.    The gold 2005 Expedition had an odometer

reading of 10,078 miles and a payoff amount of $33,110 at the

time of the trade-in.    The gray 2006 Expedition had an odometer

reading of 376 miles at the time of purchase and 13,771 miles on

April 19, 2007.

     Mr. Sada purchased two vehicles in July 2006.    He purchased

a white 2006 Ford Fusion for $22,428; he paid $500 down and

financed the balance.    He also traded in the white 2005
                                   - 7 -

Expedition on a black 2006 Ford F-250, which he purchased for

$42,205.75.    He received a $30,000 allowance from the trade-in of

the white 2005 Expedition and financed the balance.                      At the time

of trade-in the white 2005 Expedition had an odometer reading of

9,186 miles and a payoff amount of $33,990.

     Petitioners reported income on their 2003, 2004, 2005, and

2006 returns as follows:

                                  2003           2004             2005         2006

  Wages, salaries, tips, etc.    $106,324  $143,027             $159,594      $188,737
  Interest                             16      --                     78            56
  Business income (Schedule C)    (35,635)  (43,533)             (97,782)      (73,503)
    Total income                   70,705    99,494               61,890       115,290
  Adjustments                        (223)   (2,910)                (250)       (3,354)
  Adjusted gross income            70,482    96,584                61,640      111,936

     Petitioners filed an amended return for 2004, reducing their

adjusted gross income to $92,675 for a $3,909 overstatement of

wages.

     Petitioners reported gross receipts, expenses, and net

losses on the purchases and sales of the vehicles on Schedules C

of their 2003, 2004, 2005, and 2006 Federal income tax returns,

as follows:

                                      2003              2004          2005       2006

  Income:
    Gross receipts                   $1,325         $3,190           $4,269     $9,468
    Cost of goods sold                7,850           --                --         --
    Gross profit                     (6,525)         3,190            4,269      9,468
  Expenses:
    Advertising                          1,249            150            --        --
    Car/Truck expenses                     778          2,948            --      4,810
                                  - 8 -

    Depreciation                    17,708    32,938      91,821    72,208
    Insurance                                    --        2,880       --
    Legal/professional services                1,250       1,350       500
    Office expense                               186         --        --
    Rent/equipment                    267
    Repairs/maintenance               250        182         --       --
    Supplies                          113
    Meals/entertainment             5,626      7,293       4,413     1,425
    Cell phone                      1,347      1,524       1,326     1,248
    Internet                          252        252         261       --
    Roadrunner                                   --          --        580
    Computer                         1,520       --          --      2,200
        Total expenses              29,110    46,723     102,051    82,971

  Net profit (loss)                (35,635)   (43,533)   (97,782) (73,503)

     Mr. Sada did not include the $7,500 he received on the sale

of the Isuzu Trooper in the gross receipts for 2004.

     Mr. Sada reported the vehicles as 3-year property on Forms

4562, Depreciation and Amortization (Including Information on

Listed Property), attached to his joint returns for 2003 through

2006.   The depreciation petitioners claimed for 2003 included a

special depreciation allowance of $12,750 and general

depreciation of $4,958 for property placed in service in 2003.         The

depreciation petitioners claimed for 2004 included:      (1) A special

depreciation allowance of $21,250 and general depreciation of $1,771

for property placed in service in 2003 and (2) MACRS depreciation

of $9,917 for assets place in service before 2004.         The

depreciation petitioners claimed for 2005 included:         (1) A

special depreciation allowance of $39,500 and general

depreciation of $5,188 for property placed in service in 2005 and
                                 - 9 -

(2) MACRS4 depreciation of $45,570 for property placed in service

before 2005.     The depreciation petitioners claimed for 2006

included:     (1) A special depreciation allowance of $10,610 and

general depreciation of $5,655 for property placed in service in

2006 and (2) MACRS depreciation of $48,166 for property placed in

service before 2006.

        On their 2004, 2005, and 2006 returns, petitioners claimed

the following deductions on Schedule A, Itemized Deductions:

 Schedule A                      2004        2005         2006

Medical/dental1                   --          --         $8,688
Taxes                           $4,590      $6,449        6,273
Interest                         5,770       4,948        7,720
Gifts to charity                 5,500       4,090        3,935
  Total deductions              15,860      15,487       26,616
    1
     Total medical expenses ($17,083 for 2006) over 7.5 percent of
adjusted gross income ($8,395 for 2006).

        In addition to the itemized deductions claimed on Schedules

A, petitioners claimed deductions for:     (1) Student loan interest

of $2,660 for 2004 and $104 for 2006, (2) educator expenses of

$250 each year, (3) tuition and fees of $2,660 for 2004, and (4)

domestic production activities of $3,000 for 2006.     Petitioners

also claimed child tax credits of $2,000 for 2004 and 2005 and

$1,900 for 2006.




        4
      MACRS refers to the “Modified Accelerated Cost Recovery
System”. Generally, MACRS is used to depreciate any tangible
property placed in service after 1986.
                              - 10 -

     On February 7, 2008, respondent mailed to petitioners a

statutory notice of deficiency for 2004, 2005, and 2006

disallowing their deductions for business expenses claimed on

Schedules C and increasing their taxable income by $46,723 for

2004, $102,051 for 2005, and $82,971 for 2006.   As a result of

the disallowance of the deductions for the business expenses,

respondent determined that Mr. Sada was subject to self-

employment taxes of $85 for 2004, $114 for 2005, and $254 for

2006 on the gross receipts reported on the Schedules C and was

entitled to a deduction each year for one-half of the self-

employment tax.

     Respondent also disallowed petitioners’ itemized deductions

claimed on Schedules A for medical expenses of $17,083 claimed

for 2006 and charitable contributions of $5,500, $4,090, and

$3,935 claimed respectively for 2004, 2005, and 2006.   The

disallowance of those itemized deductions increased petitioners’

taxable income by $5,500 for 2004, $4,621 for 2005, and $13,571

for 2006.   The adjustments to petitioners’ total income caused

the following computational adjustments:   (1) The tuition and

fees deduction for 2006, the student loan interest deduction for

2006, the child tax credits for 2005 and 2006, and the education

credits for 2004 and 2005 were disallowed in full, and (2) the

child tax credit for 2004 was reduced to $500.   Additionally,
                                - 11 -

respondent determined that petitioners were not liable for the

alternative minimum tax reported for 2006.

                              Discussion

I.     Income (Loss) From Activity of Buying and Selling Vehicles

       Mr. Sada contends that he purchased the vehicles during the

years at issue with the purpose of selling them at a profit and

properly reported the activity on Schedules C of his tax returns

for the years at issue.     He therefore argues that the expenses

claimed on the Schedules C are deductible.     To the contrary,

respondent asserts that Mr. Sada has not established that the

expenses were incurred in a trade or business within the meaning

of section 162 or for the production of income within the meaning

of section 212.     Respondent asserts that the expenses are

personal expenses, deductions for which are disallowed by section

262.

       A.   Claimed Schedule C Expenses

       Taxpayers generally may deduct expenses that are ordinary

and necessary in carrying on a trade or business.     Sec. 162(a).

Taxpayers also generally may deduct expenses that are ordinary

and necessary for (1) the production or collection of income, or

(2) the management, conservation, or maintenance of property held

for the production of income.     Sec. 212(1) and (2).   Further,

while business expenses and expenses related to income-producing

property are currently deductible, a taxpayer is not entitled to
                               - 12 -

deduct a capital expenditure (i.e., an amount paid out for new

buildings or for permanent improvements or betterments made to

increase the value of any property or estate),5 sec. 263(a)(1),

but may be allowed a depreciation deduction if the property is

used in a trade or business or is held for the production of

income, sec. 167; see INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

83-84 (1992).   Personal, living, and family expenses, on the

other hand, generally may not be deducted to any extent unless

otherwise expressly allowed in the Code (e.g., State and local

real property taxes are deductible pursuant to section

164(a)(1)).   Sec. 262(a).   The prohibitions of section 262

regarding deductibility of personal expenses take precedence over

the allowance provisions of sections 162 and 212.    Commissioner

v. Idaho Power Co., 418 U.S. 1, 17 (1974); Sharon v.

Commissioner, 66 T.C. 515, 523 (1976), affd. 591 F.2d 1273 (9th

Cir. 1978).   As stated by the Supreme Court in Commissioner v.

Groetzinger, 480 U.S. 23, 35 (1987):

     not every income-producing and profit-making endeavor
     constitutes a trade or business. * * * [T]o be engaged
     in a trade or business, the taxpayer must be involved
     in the activity with continuity and regularity and
     * * * the taxpayer’s primary purpose for engaging in
     the activity must be for income or profit. * * *




     5
      Sec. 1.263(a)-2(a), Income Tax Regs., generally provides:
“The cost of acquisition * * * of * * * property having a useful
life substantially beyond the taxable year” is a capital
expenditure.
                              - 13 -

     In order to be deductible, vehicle expenses must be incurred

in the pursuit of a trade or business.   Sec. 162(a).   Expenses

incurred in commuting from a residence to a business or in the

course of other personal use are nondeductible personal expenses.

Sec. 262; Green v. Commissioner, 59 T.C. 456 (1972).    Similarly,

automobile depreciation is permitted as a deduction only if, and

to the extent that, the automobile is used in the pursuit of a

trade or business or for the production of income.   Sec. 167(a).

     The ownership and maintenance of the property must relate

primarily to a business or profit-making endeavor, rather than a

personal purpose.   Intl. Artists, Ltd. v. Commissioner, 55 T.C.

94, 104 (1970); Chapman v. Commissioner, 48 T.C. 358, 366 (1967).

If the acquisition and maintenance of property such as an

automobile are primarily profit motivated and personal use is

distinctly secondary and incidental, deductions for maintenance

expenses and depreciation will be permitted; if acquisition and

maintenance are motivated primarily by personal considerations,

deductions are disallowed; and if substantial business and

personal motives exist, allocation becomes necessary.    Intl.

Trading Co. v. Commissioner, 275 F.2d 578, 584-587 (7th Cir.

1960), affg. T.C. Memo. 1958-104; Intl. Artists, Ltd. v.

Commissioner, supra at 104-105; Deihl v. Commissioner, T.C. Memo.

2005-287; Mann v. Commissioner, T.C. Memo. 1981-684.    If

allocation is necessary, the deduction for allocable business use
                               - 14 -

in such cases is computed by reference to the ratio of time or

space devoted to business as compared with total use.    Intl.

Artists, Ltd. v. Commissioner, supra at 105.

     Over the years, courts have considered a variety of factors

in determining the taxpayer’s primary purpose for holding

property, including:    (1) The taxpayer’s purpose in acquiring the

property and the duration of his ownership, (2) the purpose for

which the property was subsequently held, (3) the taxpayer’s

everyday business and the relationship of income from the

property to total income, (4) the frequency, continuity, and

substantiality of the sales, (5) the extent to which the taxpayer

used advertising, promotion, or other activities to increase

sales, and (6) the time and effort the taxpayer habitually

devoted to the sales.    United States v. Winthrop, 417 F.2d 905,

910 (5th Cir. 1969); Cottle v. Commissioner, 89 T.C. 467, 487

(1987); Raymond v. Commissioner, T.C. Memo. 2001-96; Neal T.

Baker Enters., Inc. v. Commissioner, T.C. Memo. 1998-302; Nadeau

v. Commissioner, T.C. Memo. 1996-427; Tollis v. Commissioner,

T.C. Memo. 1993-63, affd. without published opinion 46 F.3d 1132

(6th Cir. 1995).   Although these factors may aid the finder of

fact in determining, on the entire record, the taxpayer’s primary

purpose for holding property, they have no independent

significance and individual comment on each factor is not

necessary or required.    Cottle v. Commissioner, supra at 487-489;
                               - 15 -

see also Suburban Realty Co. v. United States, 615 F.2d 171,

177-179 (5th Cir. 1980); Hay v. Commissioner, T.C. Memo.

1992-409.

       Mr. Sada asserts that he purchased the vehicles intending to

make a profit by selling them at the manufacturer’s suggested

retail price over his employee bargain purchase price.    As an

experienced new car salesman, Mr. Sada had reason to know that a

new car purchaser most often can negotiate a price that is less

than the manufacturer’s suggested retail price.    Indeed, it is

not unusual for new car dealers to advertise a promotional price

below the manufacturer’s suggested retail price.    Moreover, the

new vehicles became “used” once Mr. Sada drove them off the car

lot.    Mr. Sada merely placed “for sale” signs on the vehicles and

did not use any other advertising, promotion, or other activities

to increase sales.    He made no effort toward and devoted no time

to the sales other than driving the vehicles for commuting and

other personal purposes.    Mr. Sada held the vehicles for more

than a year, and he and Mrs. Sada used the vehicles solely for

personal purposes.    He traded in the used vehicles on new ones

and did not sell them to end users.     The frequency, continuity,

and substantiality of the sales are consistent with usual

consumer ownership and do not show a profit-making motive.

       Although Mr. Sada may have hoped to make profits on the

sales of his vehicles, that is not sufficient to convert
                              - 16 -

inherently personal expenses into deductible business expenses.6

Sapp v. Commissioner, 36 T.C. 852 (1961), affd. 309 F.2d 143 (5th

Cir. 1962); see also Finney v. Commissioner, T.C. Memo. 1980-23

(because the automobile was used 100 percent of the time for

personal reasons, any business deductions with respect to that

automobile taken on the taxpayers’ joint return for the taxable

years in issue were properly denied under section 262).

     We note that, had we found that Mr. Sada was in the trade or

business of selling the vehicles or held them for the production

of income, sections 274 and 280F provide further limitations with

potential bearing on business-related deductions claimed under

section 162 or 167.   Pursuant to section 274(d), no deduction or

credit is allowed with respect to any listed property, within the

meaning of section 280F(d)(4) unless the taxpayer substantiates

by adequate records or sufficient evidence corroborating the

taxpayer’s own statement:   (1) The amount of the expense; (2) the

time and place of the use of the property; and (3) the business

purpose of the expense.   Sec. 274(d); Vaksman v. Commissioner,



     6
      The purchase of a personal vehicle is analogous to the
purchase of a residence. Although people who buy residential
property generally are interested in making a later profitable
sale, the purchase or construction of a personal residence
generally is not considered a transaction entered into for
profit. “A loss sustained on the sale of residential property
purchased or constructed by the taxpayer for use as his personal
residence and so used by him up to the time of the sale is not
deductible under section 165(a).” Sec. 1.165-9(a), Income Tax
Regs.
                              - 17 -

T.C. Memo. 2001-165, affd. 54 Fed. Appx. 592 (5th Cir. 2002).

Section 280F limits the allowable amount of depreciation for

“listed property” to a multiple equal to the percentage of actual

business use.   A.J. Concrete Pumping, Inc. v. Commissioner, T.C.

Memo. 2001-42; sec. 1.280F-2T(i), Temporary Income Tax Regs., 49

Fed. Reg. 42707 (Oct. 24, 1984).   Pursuant to section

280F(d)(4)(A)(i) and (ii), passenger automobiles and any other

property used as a means of transportation are “listed property”

subject to the strict substantiation requirements of section

274(d).   Cellular telephones are also “listed property” subject

to the strict substantiation requirements of section 274.    Mr.

Sada failed to submit any documentation to establish the business

use of his cellular telephone.

     Similarly, Mr. Sada has failed to provide any evidence of a

business purpose for all other expenses claimed on Schedules C of

petitioners’ income tax returns for the years at issue.

Accordingly, we hold that petitioners are not entitled to deduct

any of the expenses claimed on Schedules C for those years

because Mr. Sada was not in the business of selling cars as a

sole proprietor and did not hold the vehicles for the production

of income.

     B.   Gross Receipts Reported on Schedules C

     Respondent disallowed all the expenses claimed on the

Schedules C but did not make any adjustments to the gross
                                - 18 -

receipts.   We have held that Mr. Sada was not in the trade or

business of selling the vehicles and did not hold the vehicles

for the production of income.    Consequently, Mr. Sada did not

have Schedule C gross receipts from his purchase and sale of the

vehicles.   Therefore, the gross receipts should be eliminated

from the computations of petitioners’ taxes for the years at

issue.

     C.   Gain or Loss on Sales of Vehicles

            1.   Desert 2003 Sequoia

     In the amended answer respondent asserts that petitioners

must “recapture” the depreciation on vehicles claimed on Schedule

C in 2003 in the year of the sale of the vehicle; i.e., gain on

the sale of the vehicles attributable to depreciation deductions

they claimed on their 2003 return is taxable as ordinary income

in the year of sale.    Respondent has the burden of proving any

new matter pleaded in the amended answer.      See Rule 142(a); Canal

Corp. v. Commissioner, 135 T.C.        ,      (2010) (slip op. at 30).

     Respondent was uncertain whether the depreciation claimed on

petitioners’ 2003 return should be recaptured in 2004, when the

desert 2003 Sequoia was traded in, or 2005, when the second 2003

Sequoia was traded in.    Therefore, in the amended answer

respondent asserted the full amount of the recapture in each tax

year 2004 and 2005.
                              - 19 -

     Motor vehicle purchase orders from Boggus Ford dated

November 18, 2004, and July 8, 2005, indicate that:   (1) Mr. Sada

traded in the desert 2003 Sequoia (serial number ending 149129)

on the Gold 2005 Expedition, which he acknowledges he purchased

in 2004, and (2) he traded in another 2003 Toyota Sequoia with a

different serial number (ending 150073) on the white 2005

Expedition, which he acknowledges he purchased in 2005.     However,

Mr. Sada denied owning a 2003 Sequoia other than the desert 2003

Sequoia.   He testified that the depreciation deduction claimed on

the 2003 return was for the desert 2003 Sequoia, and we so find.

Respondent’s position on brief is that in 2004 Mr. Sada is

required to recapture as ordinary income $9,037 of the

depreciation deducted in 2003 for the desert 2003 Sequoia and he

is not required to recapture any of the depreciation deductions

in 2005.

     Although Mr. Sada was not in the trade or business of

selling the vehicles and did not hold the vehicles for the

production of income, petitioners must report on their returns

for the years at issue any gains Mr. Sada realized on sales of

the vehicles when he traded them in for new ones.

     Section 1001 provides that gain from the sale or other

disposition of property equals the excess of the amount realized

from the sale over the adjusted basis in the property sold.
                                - 20 -

     The amount of gain realized is the excess of the amount

realized over the taxpayer’s adjusted basis in the property, and

the amount of loss realized is the excess of the adjusted basis

over the amount realized.   Sec. 1001(a).     For purposes of

computing gain or loss, the “amount realized” is defined by

section 1001(b) as the sum of any money received plus the fair

market value of the property received.      Furthermore, the amount

realized generally includes the amount of liabilities from which

the transferor is discharged as a result of the sale or

disposition.   Crane v. Commissioner, 331 U.S. 1 (1947); sec.

1.1001-2(a), Income Tax Regs.    While the amount realized by the

seller includes the amount of any debt secured by the property

that is assumed by the purchaser, settlement charges to the

seller used to pay off an existing loan do not increase the

amount realized on the sale of property.      See Kurata v.

Commissioner, T.C. Memo. 1997-252.       In such an instance, the

seller has paid the debt; there is no cancellation or forgiveness

of the indebtedness.   Here, Boggus Ford did not assume the

outstanding loans on the old vehicles.      Mr. Sada effectively paid

off the outstanding balances with the trade-in allowances and the

new financing for the purchase of the new vehicles.      The amount

realized by Mr. Sada on the trade-in of the desert 2003 Toyota

was the $27,500 trade-in allowance he received.
                               - 21 -

     Generally, the adjusted basis of property equals its

original cost, increased by expenditures properly chargeable to

capital account, and decreased by the greater of amounts allowed

or allowable as depreciation deductions.   Secs. 1011, 1012,

1016(a)(1) and (2).   Thus, if the taxpayer claimed depreciation

deductions and the Internal Revenue Service did not audit the

return or otherwise disallow the deductions, the full amounts of

depreciation deductions claimed by the taxpayer decrease the

basis in the property even if the deductions were not properly

allowable.    Sec. 1016(a)(2); sec. 1.1016-3(a)(1), (b), Income Tax

Regs.

     Mr. Sada purchased the desert 2003 Sequoia for $36,171.35 in

November 2002.   On Form 4562 of his 2003 return he reported that

it was placed in service in 2003, and he deducted $17,708 on

Schedule C.   Petitioners’ 2003 return was not audited, and Mr.

Sada was allowed a deduction for the depreciation claimed for the

desert 2003 Sequoia on the 2003 return.    Thus, his basis in the

desert 2003 Sequoia was reduced to $18,463.35 ($36,171.35 -

$17,708).    In 2004 Mr. Sada received a $27,500 trade-in allowance

towards the purchase price of the Gold 2005 Expedition.     Thus, he

realized $9,036.65 of gain on the disposition of the desert 2003

Sequoia in 2004.
                               - 22 -

     Respondent asserts that pursuant to section 1245(a)(1), Mr.

Sada is required to recognize the $9,036.65 gain as ordinary

income in 2004.

     Section 1245(a)(1) provides for the recapture of

depreciation as ordinary income upon the disposition of section

1245 property.    As relevant here, section 1245 property includes

personal property “which is or has been property of a character

subject to the allowance for depreciation provided in section

167”.   Section 167(a) provides the following general rule:

     There shall be allowed as a depreciation deduction a
     reasonable allowance for the exhaustion, wear and tear
     (including a reasonable allowance for obsolescence)--

            (1) of property used in the trade or business, or

            (2) of property held for the production of income.

     We have held that Mr. Sada did not use the vehicles for

which he claimed depreciation, including the desert 2003 Sequoia,

in a trade or business or for the production of income.

Consequently, the desert 2003 Sequoia is not section 1245

property.

     Nonetheless, respondent argues that petitioners must

“recognize the recapture income” because they treated the desert

2003 Sequoia as section 1245 property by claiming depreciation

deductions for it on their 2003 return and the period of

limitations for 2003 has expired, so that respondent cannot

adjust petitioners’ 2003 return by disallowing the improperly
                               - 23 -

claimed depreciation for that year.     In support of that position

respondent cites Herrington v. Commissioner, 854 F.2d 755 (5th

Cir. 1988), affg. Glass v. Commissioner, 87 T.C. 1087 (1986),

which applies the duty of consistency.

     The duty of consistency applies when:    (1) The taxpayer made

a representation or reported an item for Federal income tax

purposes in one year, (2) the Commissioner acquiesced in or

relied on that representation or report for that year, and (3)

the taxpayer attempts to change that representation or report in

a subsequent year, after the period of limitations has expired

with respect to the year of the representation or report, and the

change is detrimental to the Commissioner.     LeFever v.

Commissioner, 103 T.C. 525, 543 (1994), affd. 100 F.3d 778 (10th

Cir. 1996); see also Herrington v. Commissioner, supra at 758.

When these requirements are met, the Commissioner may treat the

previous representation by the taxpayer as true, although, in

fact, it is not.   Herrington v. Commissioner, supra at 758.     The

duty of consistency is an affirmative defense raised by

respondent, and respondent has the burden of showing that it

applies.   See rule 142(a).   Respondent did not raise the duty of

consistency as an affirmative defense in the amended answer but

merely alluded to it in respondent’s opening brief by citing

Herrington.   Moreover, as discussed below, respondent has not

shown that the third requirement has been met and, thus, has not
                                - 24 -

met his burden of establishing that the duty of consistency

applies.

      On Form 4562 of petitioners’ 2003 return Mr. Sada reported

that depreciable property was placed in service in 2003, and he

claimed a depreciation deduction of $17,708 on Schedule C.    Thus,

the first requirement is met.

     The Commissioner acquiesces or relies on a representation of

the taxpayer when the taxpayer files a return that contains an

inadequately disclosed item and the Commissioner accepts that

return and allows the period of limitations to expire without an

audit of that return.     Herrington v. Commissioner, supra at 758.

Petitioners’ 2003 return was not audited, and Mr. Sada was

allowed a deduction for the depreciation claimed for the desert

2003 Sequoia on the 2003 return.    Thus, the second requirement is

also met.

     However, Mr. Sada never took an inconsistent position with

respect to his activity of buying and selling the vehicles.

Petitioners’ 2004 return claimed depreciation for property placed

in service before 2003.    When respondent audited petitioners’

2004 return, respondent disallowed that depreciation deduction.

The 2004 return put respondent on notice that Mr. Sada likely

claimed depreciation for that property on his 2003 return.

Respondent has not established that the period of limitations for
                                  - 25 -

assessing additional tax for 2003 had expired when the audit of

petitioners’ 2004 return was completed.

      Because respondent did not raise the duty of consistency as

an affirmative defense in the amended answer and has not met the

burden of establishing that the duty of consistency applies in

this case, we hold that Mr. Sada is not subject to the recapture

provisions of section 1245.       Mr. Sada purchased the desert 2003

Sequoia in November 2002 and disposed of it in November 2004.

The gain he realized is taxable in 2004 as long-term capital gain

and not as ordinary income.       See sec. 1222(3).

          2.     Other Vehicles

     The record establishes that the trade-in allowances Mr. Sada

received for all of the vehicles was less than the amounts he

paid for them.    Mr. Sada has not been allowed the depreciation

deductions he claimed on the vehicles except for the depreciation

deductions he claimed for the desert 2003 Sequoia on petitioners’

2003 return.   Consequently, Mr. Sada realized losses on the other

vehicles when he traded them in.

     Section 165(a) generally allows a deduction for any loss

sustained during the taxable year that is not compensated by

insurance or otherwise.    However, in the case of an individual,

section 165(c) limits deductible losses that are not incurred

either in a trade or business or a transaction entered into for

profit to losses arising from fire, storm, shipwreck, or other
                                  - 26 -

casualty or from theft.      A loss sustained on the sale of a

vehicle used exclusively for personal use is not deductible

pursuant to section 165(c), and petitioners may not deduct Mr.

Sada’s losses on the vehicles.

II.    Self-Employment Taxes

       Respondent determined that Mr. Sada was liable for self-

employment tax on the gross receipts he reported on the Schedule

C for each year at issue and allowed petitioners a deduction for

half of those taxes.       We have held that those gross receipts are

not included in Mr. Sada’s income.         Consequently, he is not

subject to self-employment taxes on the gross receipts reported

on the Schedules C for the years at issue.

III.    Medical Expenses

       Respondent disallowed petitioners deduction for medical

expenses of $8,688 claimed on Schedule A of their 2006 return.

Section 213(a) allows a deduction for expenses paid during the

taxable year for medical care that are not compensated for by

insurance or otherwise and to the extent that such expenses

exceed 7.5 percent of adjusted gross income.         For 2006

petitioners reported total medical expenses of $17,083 and

adjusted gross income of $111,936.         Their adjusted gross income

for 2006 is increased by $73,503 to $185,439 for the disallowed

net loss claimed on Schedule C for that year.         Consequently, if

petitioners had substantiated the amount of medical expenses they
                               - 27 -

paid in 2006, they could have deducted only medical expenses in

excess of $13,908.

     At trial Mr. Sada produced receipts and statements regarding

medical services provided to him and his family during the years

at issue.   He provided explanations of benefits from Mutual of

Omaha for 2004 and most of 2005 and from American Administrative

Group for the end of 2005 and all of 2006.     The explanations of

benefits indicate that the medical insurance was provided through

Mrs. Sada’s employment.   The Mutual of Omaha explanations of

benefits show that Mrs. Sada and the rest of the Sada family were

also covered by another insurance carrier and show the amount of

the claim paid by coinsurance.    The explanations of benefits from

American Administrative Group did not show the amount paid by

coinsurance.   Mr. Sada did not provide the Court with the other

carrier’s explanation of benefits.

     Of the two dozen receipts for 2006, all but two were for $45

or less.    One receipt was for $269.   A receipt dated March 28,

2006, from a surgeon indicates that Mrs. Sada paid a $500 cash

deposit for surgery on March 31, 2006.     Her insurance company’s

explanation of benefits shows a claim totaling $8,450 for

services provided by that surgeon to Mrs. Sada on March 31, 2006.

The explanation states that the claim was being denied because it

was filed late.   Petitioners did not provide an explanation of
                               - 28 -

benefits from the coinsurance or a statement of Mrs. Sada’s

account from the surgeon.

      Although Mr. Sada produced the receipt for the cash deposit

for the surgery, as well as receipts for smaller amounts that he

or Mrs. Sada paid in cash for medical services on other dates, he

did not provide a receipt from the surgeon or a canceled check

showing that petitioners had in fact paid any or all of the

$8,450.   He did not provide any evidence of cash withdrawals used

to pay the bill, and the bank records Mr. Sada produced did not

show any cash withdrawals large enough to pay the bill.

      Accordingly, we hold that petitioners have failed to

substantiate that they paid medical expenses in excess of 7.5

percent of their adjusted gross income for 2006.

IV.   Accuracy-Related Penalties

      Initially, the Commissioner has the burden of production

with respect to any penalty, addition to tax, or additional

amount.   Sec. 7491(c).   The Commissioner satisfies this burden of

production by coming forward with sufficient evidence that

indicates it is appropriate to impose the penalty.       See Higbee v.

Commissioner, 116 T.C. 438, 446 (2001).    Once the Commissioner

satisfies this burden of production, the taxpayer must persuade

the Court that the Commissioner’s determination is in error by

supplying sufficient evidence of an exception.     Id.
                              - 29 -

     Respondent determined an accuracy-related penalty against

petitioners under section 6662(a) for each of the years at issue.

Section 6662(a) and (b)(1) imposes a penalty in an amount equal

to 20 percent of the portion of the underpayment attributable to

negligence or disregard of rules or regulations.    “Negligence”

includes any failure by the taxpayer to make a reasonable attempt

to comply with the provisions of the Internal Revenue Code, to

keep adequate books and records, or to substantiate items

properly.   See 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.

The term “disregard” includes any careless, reckless, or

intentional disregard.   Sec. 6662(c).   Disregard of rules or

regulations is careless if the taxpayer does not exercise

reasonable diligence to determine the correctness of a return

position that is contrary to the rule or regulation.    Sec.

1.6662-3(b)(2), Income Tax Regs.   A taxpayer is not liable for

the penalty if he shows that he had reasonable cause for the

underpayment and that he acted in good faith.    Sec. 6664(c).

     Respondent has established that there is an underpayment of

tax for each of the years at issue attributable to

unsubstantiated itemized deductions claimed on Schedules A and

net losses claimed on Schedules C for Mr. Sada’s purchases and

sales of vehicles that petitioners used solely for personal

purposes.   Petitioners failed to maintain and produce adequate

records to substantiate the deductions they claimed on the
                              - 30 -

Schedules A and C.   The records they produced were incomplete and

thus misleading.   The law is clear that deductions for vehicles

used solely for personal purposes are not allowed.   Accordingly,

respondent has met the burden of production with respect to the

accuracy-related penalty for each year at issue.

     Section 6664(c) provides that the section 6662(a) penalty

shall not apply to any portion of an underpayment if it is shown

that there was reasonable cause for such portion and the taxpayer

acted in good faith.   Whether a taxpayer acted with reasonable

cause and in good faith is determined on a case-by-case basis,

taking into account all relevant facts and circumstances,

including the taxpayer’s experience, knowledge, and education.

Sec. 1.6664-4(b)(1), Income Tax Regs.   Generally, the most

important fact is the taxpayer’s effort to assess the proper

liability.   Id.

     Reliance on a tax professional may demonstrate that the

taxpayer had reasonable cause and acted in good faith where the

taxpayer establishes that:   (1) The adviser was a competent

professional with sufficient expertise to justify the taxpayer’s

reliance, (2) the taxpayer provided the adviser with necessary

and accurate information, and (3) the taxpayer actually relied in

good faith on the adviser’s judgment.   3K Inv. Partners v.

Commissioner, 133 T.C. 112, 117 (2009); DeCleene v. Commissioner,
                              - 31 -

115 T.C. 457, 477 (2000); Sklar, Greenstein & Scheer, P.C. v.

Commissioner, 113 T.C. 135, 144-145 (1999).

     Petitioners have not established that their reliance on

their return preparer was reasonable or in good faith.   First,

petitioners presented no evidence with respect to their return

preparer’s experience or qualifications.   Petitioners’ return

preparer attended the trial but did not testify.   Mr. Sada stated

that the return preparer was neither an accountant nor an

enrolled agent.   Second, petitioners did not establish that they

provided necessary and accurate information to the return

preparer, particularly regarding the purchases and sales of the

vehicles.   Petitioners presented no evidence regarding what, if

anything, Mr. Sada discussed with the return preparer.   Finally,

petitioners did not establish that they actually relied in good

faith on the return preparer’s judgment.   Mr. Sada hired him

because he “came highly recommended”.   Mr. Sada initially

testified that his return preparer had been recommended to him by

“more than a thousand people” but later reduced the number to “a

couple dozen people”.   However, Mr. Sada knew nothing of the

preparer’s qualifications except that “he has a license to be in

business as a tax preparer” and “has prepared thousands of income

tax returns for people.”   Mr. Sada did not investigate whether

his return preparer was a certified public accountant.   Mr. Sada

did not establish that his return preparer was a competent
                               - 32 -

professional with sufficient expertise to justify his reliance on

him.

       Petitioners did not seek professional advice from an

accountant or an attorney.    They have not shown that they acted

with reasonable cause or made a good faith effort to properly

report their taxes for the years at issue.

       Accordingly, we hold that petitioners are liable for the

accuracy-related penalties under section 6662(a) for 2004, 2005,

and 2006.

       We have considered all arguments made, and, to the extent

not mentioned, we conclude they are moot, irrelevant or without

merit.

       To reflect the foregoing, and the concessions of the

parties,


                                          Decision will be entered

                                     under Rule 155.
