                                T.C. Memo. 2017-49



                         UNITED STATES TAX COURT



      SAEID ZOLGHADR AND MANDANA ZOLGHADR, Petitioners v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 19241-14.                        Filed March 22, 2017.



      Saeid Zolghadr and Mandana Zolghadr, pro sese.

      Christopher R. Moran, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      LAUBER, Judge: With respect to petitioners’ Federal income tax for 2006-

2009, the Internal Revenue Service (IRS or respondent) determined deficiencies,

additions to tax, and penalties as follows:
                                           -2-

[*2]                                             Addition to tax       Penalty
                Year         Deficiency          sec. 6651(a)(1)     sec. 6662(a)

                2006          $30,222               $6,260             $6,044
                2007           20,845                4,167              4,168
                2008           20,340                4,508              4,068
                2009            3,812                 -0-                 762

          The issues for decision are: (1) whether petitioners received unreported in-

come in 2006-2009; (2) whether petitioners are entitled to deduct expenses on

Schedules C, Profit or Loss From Business, for 2006-2009, in excess of the

amounts respondent allowed; (3) whether petitioners are entitled to deduct mort-

gage interest claimed on Schedules A, Itemized Deductions, for 2006-2009, in ex-

cess of the amounts respondent allowed; (4) whether petitioners are entitled to de-

duct mortgage interest claimed on a Schedule E, Supplemental Income and Loss,

for 2009; (5) whether petitioners are liable for late-filing additions to tax for 2006-

2008; and (6) whether petitioners are liable for accuracy-related penalties for all

years at issue. With minor exceptions, we will sustain respondent’s determina-

tions.1




          1
        All statutory references are to the Internal Revenue Code (Code) in effect
for the years at issue, and all Rule references are to the Tax Court Rules of Prac-
tice and Procedure. We round all monetary amounts to the nearest dollar.
                                           -3-

[*3]                           FINDINGS OF FACT

       Some of the facts have been stipulated and are so found. The stipulations

and the attached exhibits are incorporated by this reference. Petitioners resided in

Virginia when they filed their petition.

       Mandana Zolghadr is a licensed dentist. She acquired a dental practice in

2002 from a group of dentists and operated this practice as a sole proprietorship

during 2006-2009 with several employees. She incurred expenses in the course of

her dentistry practice, including expenses for wages, supplies, advertising, and

depreciation on equipment. She did not maintain adequate books and records to

substantiate the expenses for her dental practice during any of the years at issue.

       Petitioners owned, either jointly or individually, three houses during the

years at issue. They owned a primary residence in Vienna, Virginia (Vienna prop-

erty). They owned a rental property in McLean, Virginia (McLean property), on

which they received monthly rent of $1,200 during 2006 and 2007, $1,250 during

2008, and $1,300 during 2009. Mr. Zolghadr also owned a house in West Virginia

(West Virginia property) that he purchased in 2008, which petitioners initially

used as a weekend retreat. He later operated a car dealership on the West Virginia

property and sometimes resided there in connection with this activity.
                                       -4-

[*4] Petitioners filed delinquent Forms 1040, U.S. Individual Income Tax Re-

turn, for 2006, 2007, and 2008; they filed a timely Form 1040 for 2009. They in-

cluded in each of these returns a Schedule C for the dental practice. For 2006 they

reported gross receipts for the dental practice of $398,864, returns and allowances

of $5,523, and total expenses of $392,108, for a net profit of $1,233. The reported

expenses were as follows:

                            Expense                Amount

                   Advertising                     $23,097
                   Car and truck                       558
                   Commissions and fees             10,146
                   Contract labor                    3,815
                   Section 179/depreciation         34,809
                   Insurance                        16,900
                   Interest                          3,567
                   Legal and professional fees       1,096
                   Office supplies                   4,763
                   Repairs and maintenance           6,788
                   Supplies                         97,738
                   Taxes and licenses                2,055
                   Travel                           28,250
                   Meals and entertainment           3,440
                   Utilities                         4,097
                   Wages                           149,451
                   Other                             1,538

      For 2007 they reported gross receipts of $331,315, returns and allowances

of $3,465, and total expenses of $336,455, for a net loss of $8,605. The reported

expenses were as follows:
                                       -5-

[*5]                       Expense                  Amount

                   Advertising                      $7,239
                   Car and truck                       568
                   Commissions and fees              6,781
                   Contract labor                      623
                   Section 179/depreciation         15,464
                   Insurance                        10,265
                   Interest                         17,410
                   Legal and professional fees         992
                   Office supplies                   3,820
                   Repairs and maintenance           1,139
                   Supplies                        126,282
                   Taxes and licenses                2,845
                   Travel                             -0-
                   Meals and entertainment              22
                   Utilities                         5,164
                   Wages                           137,220
                   Other                               621

       For 2008 they reported gross receipts of $347,933, returns and allowances

of $2,693, and total expenses of $316,563, for a net profit of $28,677. The report-

ed expenses were as follows:

                           Expense                  Amount

                   Advertising                      $5,939
                   Car and truck                     5,597
                   Commissions and fees              2,213
                   Contract labor                      454
                   Section 179/depreciation         12,275
                   Insurance                        11,663
                   Interest                         11,461
                   Legal and professional fees       1,393
                   Office supplies                   6,802
                                       -6-

[*6]               Repairs and maintenance           1,003
                   Supplies                        108,093
                   Taxes and licenses               41,905
                   Travel                             -0-
                   Meals and entertainment              87
                   Utilities                        11,528
                   Wages                            93,646
                   Other                             2,504

       For 2009 they reported gross receipts of $300,503, returns and allowances

of $3,165, and total expenses of $310,413, for a net loss of $13,075. The reported

expenses were as follows:

                            Expense                 Amount

                   Advertising                      $6,000
                   Car and truck                      -0-
                   Commissions and fees              8,941
                   Contract labor                    4,518
                   Section 179/depreciation         12,172
                   Insurance                        11,636
                   Interest                          6,010
                   Legal and professional fees       2,542
                   Office supplies                  21,330
                   Repairs and maintenance           2,431
                   Supplies                         67,660
                   Taxes and licenses               57,542
                   Travel                            2,500
                   Meals and entertainment             184
                   Utilities                         5,780
                   Wages                            99,667
                   Other                             1,500
                                        -7-

[*7] For 2006-2009 petitioners claimed on their Schedules A deductions for

mortgage interest expenses of $40,897, $27,280, $38,674, and $51,607, respec-

tively. For 2009 petitioners claimed on their Schedule E a deduction for mortgage

interest expense of $9,401 attributable to the West Virginia property.

      The IRS selected petitioners’ 2006-2009 returns for examination. On the

basis of a bank deposits analysis the IRS determined that petitioners had omitted

rental income from the McLean property for 2006-2009 and had misreported gross

receipts from the dental practice for 2007-2009. On the basis of third-party infor-

mation reports the IRS determined that petitioners had omitted dividend income,

interest income, and retirement income for 2007. The IRS disallowed portions of

the Schedule C deductions for lack of substantiation and disallowed some or all of

the mortgage interest deductions for lack of connection to a primary or secondary

residence. The IRS determined accuracy-related penalties with respect to these

adjustments and additions to tax for late filing of petitioners’ 2006-2008 returns.

On May 20, 2014, the IRS issued petitioners a timely notice of deficiency setting

forth these adjustments, and they timely petitioned this Court.
                                         -8-

[*8]                                 OPINION

I.     Burden of Proof

       The IRS’ determinations in a notice of deficiency are generally presumed

correct though the taxpayer can rebut this presumption. Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933). The U.S. Court of Appeals for the Fourth

Circuit, the appellate venue in this case absent stipulation to the contrary, has held

that the usual presumption of correctness applies in omitted income cases where

the IRS employs a “reasonable method of determining income,” such as the bank

deposits method. Williams v. Commissioner, 999 F.2d 760, 763-764 (4th Cir.

1993), aff’g T.C. Memo. 1992-153. Other courts have required the IRS in unre-

ported income cases to establish a “minimal evidentiary showing” connecting the

taxpayer with the income-producing activity. E.g., Blohm v. Commissioner, 994

F.2d 1542, 1548-1549 (11th Cir. 1993), aff’g T.C. Memo. 1991-636. If the IRS

were required to make a “minimal evidentiary showing” here, respondent has met

that burden by introducing bank records establishing that petitioners received un-

reported income from the dental practice and the McLean property.

       Petitioners thus bear the burden of proving by a preponderance of the evi-

dence that respondent’s determinations of unreported income are arbitrary or erro-

neous. See Williams, 999 F.2d at 763 (citing Helvering v. Taylor, 293 U.S. 507,
                                        -9-

[*9] 515 (1935)); Tokarski v. Commissioner, 87 T.C. 74 (1986). Petitioners

likewise bear the burden of proving their entitlement to deductions allowed by the

Code and of substantiating the amounts of claimed deductions. See INDOPCO,

Inc. v. Commissioner, 503 U.S. 79, 84 (1992); sec. 1.6001-1(a), Income Tax Regs.

Petitioners do not contend, and they could not plausibly contend, that the burden

of proof as to any issue of fact should shift to respondent under section 7491(a).

II.   Unreported Income

      Section 61(a) defines gross income as “all income from whatever source de-

rived,” including income derived from business. A taxpayer must maintain books

and records establishing the amount of his or her gross income. See sec. 6001.

When a taxpayer does not keep accurate books and records, the IRS may deter-

mine his or her income “under such method as, in the opinion of the Secretary,

does clearly reflect income.” Sec. 446(b); see Petzoldt v. Commissioner, 92 T.C.

661, 693 (1989). And where the taxpayer has unexplained bank deposits, the IRS

may employ the bank deposits method to estimate his or her income. Estate of

Hague v. Commissioner, 132 F.2d 775 (2d Cir. 1943), aff’g 45 B.T.A. 104 (1941);

Estate of Mason v. Commissioner, 64 T.C. 651, 657 (1975), aff’d, 566 F.2d 2 (6th

Cir. 1977). The IRS has great latitude in reconstructing a taxpayer’s income, and
                                       - 10 -

[*10] the reconstruction “need only be reasonable in light of all surrounding facts

and circumstances.” Petzoldt, 92 T.C. at 687.

      Bank deposits are prima facie evidence of income. The bank deposits meth-

od starts with the presumption that all money deposited in a taxpayer’s bank ac-

count during a given period constitutes taxable income. Price v. United States,

335 F.2d 671, 677 (5th Cir. 1964). This presumption is rebutted to the extent the

deposits are shown to include nontaxable amounts, and “the Government must

take into account any non-taxable source * * * of which it has knowledge.” Ibid.;

DiLeo v. Commissioner, 96 T.C. 858, 868 (1991), aff’d, 959 F.2d 16 (2d Cir.

1992).

      After the IRS reconstructs a taxpayer’s income and determines a deficiency,

the taxpayer bears the burden of proving that the IRS’ implementation of the bank

deposits method was unfair or inaccurate. See Clayton v. Commissioner, 102 T.C.

632, 645 (1994); DiLeo, 96 T.C. at 871-872. The taxpayer may do so by showing

(among other things) that certain deposits came from nontaxable sources. See

Clayton, 102 T.C. at 645. Nontaxable sources include funds attributable to inter-

account bank transfers and returned checks as well as “loans, gifts, inheritances, or

assets on hand at the beginning of the taxable period.” Burgo v. Commissioner,
                                        - 11 -

[*11] 69 T.C. 729, 743 n.14 (1978) (quoting Troncelliti v. Commissioner, T.C.

Memo. 1971-72).

      The revenue agent (RA) employed the bank deposits method to reconstruct

petitioners’ income. After obtaining copies of petitioners’ bank statements by

issuing summonses to their banks, the RA used the statements (which are part of

the record) to prepare schedules listing all deposits. After eliminating nontaxable

receipts of which she was aware, the RA prepared and provided to petitioners

schedules that determined unreported income attributable to the McLean property

for 2006-2009 and to the dental practice for 2007-2009.

      Petitioners reported rental income from the McLean property of $14,400

annually for 2006-2008 and $12,000 for 2009. The RA determined that petition-

ers had underreported rental income by $200, $800, $1,200, and $3,600 for 2006-

2009, respectively. At trial petitioners conceded that they had underreported their

rental income. They contend that the unreported income should not be taxable

because it corresponded to rent increases they received in exchange for performing

repairs and maintenance to the property.

      This contention is meritless. Rent is specifically included in the definition

of gross income, sec. 61(a)(5), and represents payment “received or accrued for

the occupancy of real estate or the use of personal property,” sec. 1.61-8(a), In-
                                        - 12 -

[*12] come Tax Regs. The Code provides no exclusion from gross income where

(as commonly occurs) the lessor incurs expenses for repairs or maintenance in

consideration of receiving rent. We accordingly find that petitioners received

unreported rental income from the McLean property in the amounts stated above.

      With respect to the dental practice, the RA initially performed a bank de-

posits analysis that considered all of petitioners’ bank accounts, both business and

personal. After petitioners provided additional documentation to her, the RA fo-

cused her analysis chiefly on one of the business bank accounts, a SunTrust Bank

account ending in 5432 (SunTrust account). On the basis of this analysis she de-

termined that petitioners had understated gross receipts by $6,504 and $12,890 for

2007 and 2008, respectively, and had overstated gross receipts by $27,770 for

2009. Petitioners contend that the RA failed to account for certain nontaxable

items allegedly deposited into this account.

      With respect to 2007, petitioners produced a bank statement for November

2007 listing a “miscellaneous credit” of $1,329 that they contend should have been

allowed as an offset against the net taxable deposits. But they failed to establish

the nature of this credit; Dr. Zolghadr testified vaguely that it was for “excess de-

posits” with the bank. We find that petitioners have failed to carry their burden of
                                       - 13 -

[*13] showing error in the RA’s analysis. We will therefore sustain respondent’s

determination of unreported income attributable to the dental practice for 2007.

      With respect to 2008, respondent concedes that the RA should have elimi-

nated a $10,000 deposit attributable to a nontaxable loan from Dr. Zolghadr’s

sister. This leaves in question $2,890 of deposits for 2008. Petitioners contend

that a $5,000 deposit was a loan from Dr. Zolghadr’s mother, but the only evi-

dence they submitted was documentation showing that a $5,000 cash deposit was

made. They produced no loan agreement or other evidence to show that this de-

posit corresponded to a loan from Dr. Zolghadr’s mother (or anyone else). And

we do not accept Dr. Zolghadr’s testimony on this point, which we did not find

credible. See Tokarski, 87 T.C. at 74. We accordingly find that petitioners re-

ceived during 2008 unreported income of $2,890 from the dental practice.

      With respect to 2009, the RA determined that petitioners overstated their

gross receipts by $27,700, chiefly by misclassifying inter-account transfers as re-

ceipts of the dental practice. Petitioners seek to exclude another $1,500 of depos-

its, alleging that these were payments for overdraft protection. But all the docu-

ments to which they point concern overdraft protection in accounts other than the

SunTrust account, which was the only account on which the RA performed a bank

deposits analysis. We therefore sustain respondent’s determination that peti-
                                        - 14 -

[*14] tioners for 2009 overstated gross receipts attributable to the dental practice

by $27,770.

       The IRS also determined, on the basis of third-party information reports,

that petitioners had received the following taxable income in 2007: (1) $24 of

dividend income from MetLife; (2) $678 of retirement income from an individual

retirement account distribution; and (3) $2,139 of interest income from three banks

and an LLC. Petitioners conceded at trial that they received, but failed to report,

each of these items. We sustain respondent’s determination in each respect.

III.   Schedule C Expenses

       Deductions are a matter of legislative grace. The taxpayer bears the burden

of proving that reported business expenses were actually incurred and were “ordi-

nary and necessary.” Sec. 162(a); Rule 142(a). The taxpayer also bears the bur-

den of substantiating expenses underlying his claimed deductions by keeping and

producing records sufficient to enable the IRS to determine the correct tax liabil-

ity. Sec. 1.6001-1(a), (e), Income Tax Regs. The failure to keep and present such

records counts heavily against a taxpayer’s attempted proof. Rogers v. Commis-

sioner, T.C. Memo. 2014-141, 108 T.C.M. (CCH) 39, 43. In certain circumstances

the Court may approximate the amount of an expense if the taxpayer proves it was

incurred but cannot substantiate the exact amount. Cohan v. Commissioner, 39
                                       - 15 -

[*15] F.2d 540, 543-544 (2d Cir. 1930). But the taxpayer must provide some basis

for such an estimate. Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).

      Section 274(d) imposes stricter substantiation requirements for deductions

claimed for expenses of travel, meals, and entertainment. No such deduction is

allowed unless the taxpayer substantiates, by adequate records or by sufficient

evidence corroborating his own statements, the amount, time and place, and busi-

ness purpose for each expenditure. Sec. 274(d); sec. 1.274-5T(a), (b), and (c),

Temporary Income Tax Regs., 50 Fed. Reg. 46014-46017 (Nov. 6, 1985). A court

may not apply the Cohan rule to approximate expenses covered by section 274(d).

Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968), aff’d per curiam, 412

F.2d 201 (2d Cir. 1969).

       During the examination petitioners produced bank statements, a modest

volume of invoices and bills, and QuickBooks summaries with little supporting

documentation. After review of these documents the RA allowed deductions for

significant expenses in most expense categories; for certain categories (such as

wages and health insurance) she allowed deductions larger than those petitioners

had claimed. Respondent contends that the remaining deductions were properly

disallowed because the expenses were not substantiated or were personal ex-
                                          - 16 -

[*16] penses. See sec. 262(a) (denying deduction for “personal, living, or family

expenses”).

         In the tables below we set forth for each year the Schedule C expenses peti-

tioners reported on their return, the amount the RA allowed as a deduction for

each category of expense, and the amount remaining in dispute:

             2006           Amount claimed         Amount allowed   Amount in dispute
 Interest                        $3,567                  -0-             $3,567
 Advertising                     23,097               $22,772               325
 Health insurance                 -0-                   4,614              -0-
 Utilities                        4,097                 3,813               284
 Repairs and
  maintenance                     6,788                   636             6,152
 Insurance                       16,900                 5,808            11,092
 Depreciation and
  section 179 expense            34,809                16,044            18,765
 Taxes and licenses               2,055                 5,500              -0-
 Office supplies                  4,763                 3,669             1,094
 Car and truck                     558                   -0-                558
 Commissions and fees            10,146                 7,314             2,832
 NOL carryforward                42,773                  -0-             42,773
 Other                            1,538                        75         1,463
 Wages                         149,451                141,797             7,654
 Meals and
  entertainment                   3,440                        65         3,375
                                      - 17 -

[*17]
Travel                       28,250                 -0-              28,250
Supplies                     97,738                56,068            41,670


            2007         Amount claimed        Amount allowed   Amount in dispute
Interest                    $17,410                 -0-             $17,410
Advertising                   7,239                $2,870             4,369
Health insurance              -0-                   5,028              -0-
Utilities                     5,164                 4,702               462
Repairs and
 maintenance                  1,139                   741               398
Insurance                    10,265                 4,671             5,594
Depreciation and
 section 179 expense         15,464                12,599             2,865
Taxes and licenses            2,845                 5,710              -0-
Office supplies               3,820                 2,875               945
Car and truck                  568                  -0-                 568
Commissions and fees          6,781                 3,334             3,447
NOL carryforward             24,241                 -0-              24,241
Other                          621                        75            546
Wages                       137,220               146,093              -0-
Supplies                    126,282                54,704            71,578
Legal and professional
 fees                          992                  1,156              -0-
Contract labor                 623                    813              -0-
                                    - 18 -

[*18]
            2008       Amount claimed        Amount allowed   Amount in dispute
Interest                  $11,461                 -0-             $11,461
Advertising                 5,939                  $209             5,730
Health insurance            -0-                   5,920              -0-
Utilities                  11,528                 4.965             6,563
Repairs and
 maintenance                1,003                   830               173
Insurance                  11,663                 5,675             5,988
Taxes and licenses         41,905                15,627            26,278
Office supplies             6,802                 6,412               390
Car and truck               5,597                 -0-               5,597
Commissions and fees        2,213                 1,963               250
NOL carryforward           51,703                 -0-              51,703
Other                       2,504                       75          2,429
Wages                      93,646               129,455              -0-
Supplies                  108,093                63,321            44,772


            2009       Amount claimed        Amount allowed   Amount in dispute
Interest                   $6,010                 -0-              $6,010
Advertising                 6,000                 -0-               6,000
Health insurance            -0-                  $6,780              -0-
Utilities                   5,780                 5,122               658
Repairs and
 maintenance                2,431                   600             1,831
Insurance                  11,636                 9,269             2,007
                                           - 19 -

 [*19]
 Taxes and licenses               57,542              20,809               46,733
 Office supplies                  21,330               5,087               16,243
 Commissions and fees              8,941               2,111                6,830

 NOL carryforward                 30,772                -0-                30,772
 Other                             1,500                -0-                 1,500
 Wages                            99,667             138,156                 -0-
 Travel                            2,500                -0-                 2,500
 Supplies                         67,660              34,146               33,514
 Legal and professional
  fees                             2,542               1,978                  564
 Contract labor                    4,518                -0-                 4,518

         At trial petitioners produced few contemporaneous records for the dental

practice. They produced tabulations of alleged expenses with attached Quick-

Books summaries (prepared just before trial), miscellaneous printouts of Excel

spreadsheets for the SunTrust account, other bank account statements, handwritten

“personal lists” that allegedly separated business from personal expenses, and a

letter that Dr. Zolghadr had sent to the RA. They also presented testimony from

Dr. Zolghadr, which we found confusing and in most respects not credible.

         At the close of trial the Court left the record open to allow petitioners to

submit additional documentary evidence that they had allegedly forgotten to bring

with them to trial. They submitted two CD-ROMs containing more QuickBooks
                                        - 20 -

[*20] summaries (again prepared just before trial) and various bank statements and

invoices. This additional evidence is little more than a digital shoebox: To the ex-

tent these documents substantiate any expenses, they substantiate expenses that the

IRS had already allowed.

      After carefully reviewing the evidence, we conclude that the deductions pe-

titioners claimed (in excess of amounts respondent allowed) for advertising, util-

ities, repairs and maintenance, insurance, depreciation, taxes and licenses, office

supplies, commissions and fees, travel, supplies, legal and professional fees, con-

tract labor, and “other expenses” have not been substantiated or have not been

shown to be business related. We sustain respondent’s determination to disallow

these deductions to that extent. We also sustain respondent’s determination to

allow additional deductions that petitioners had not claimed as set forth in the

tables above. We will briefly address the remaining items.

      • Petitioners reported section 179 expenses for 2006 and 2007. Dr. Zol-

ghadr testified that these amounts were partially attributable to section 179 ex-

penses carried forward from prior years. Section 179(a) allows a taxpayer to elect

to expense, rather than capitalize, qualified business property. Qualified business

property must be: (1) tangible property to which section 168 applies; (2) section

1245 property; and (3) property “acquired by purchase for use in the active con-
                                        - 21 -

[*21] duct of a trade or business.” Sec. 179(d). The taxpayer is required to main-

tain records reflecting how and from whom the section 179 property was acquired

and when it was placed in service. Sec. 1.179-5(a), Income Tax Regs.

      In order to expense qualified business property, a taxpayer must make an

election to do so by specifying the property to which the election applies and mak-

ing the election on his tax return. Sec. 179(c). The election is normally made by

attaching Form 4562, Depreciation and Amortization, to the taxpayer’s return.

Visin v. Commissioner, T.C. Memo. 2003-246, aff’d, 122 F. App’x 363 (9th Cir.

2005). If a taxpayer makes this election, he is entitled to a current deduction that

cannot exceed the taxable income derived from the active conduct of his business

during the year. Sec. 179(b)(3)(A). If the taxpayer cannot expense the full

amount, the unused portion is carried forward indefinitely. Sec. 179(b)(3)(B). If

the taxpayer fails to make the election, he waives the benefits of section 179. See

Patton v. Commissioner, 116 T.C. 206 (2001); Verma v. Commissioner, T.C.

Memo. 2001-132; Fors v. Commissioner, T.C. Memo. 1998-158.

      Petitioners have failed to meet the substantiation requirements of section

179. Although they filed Forms 4562 for 2006 and 2007, they failed to establish

when and from whom they had purchased the supposed equipment, and they failed

to establish that they had made a valid section 179 election for years before 2006
                                         - 22 -

[*22] (as would be required to carry forward pre-2006 amounts). The only evi-

dence they submitted was a partially legible sales contract showing a purchase of

unspecified equipment for $597 and copies of emails apparently sent by Dr. Zolg-

hadr. These documents do not satisfy the statutory requirements, and we therefore

sustain respondent’s disallowance of the claimed section 179 expense deductions.

      • Petitioners reported an NOL carryforward for each year. Dr. Zolghadr

testified that the NOLs were attributable to a condominium unit she purchased in

2002 from a failing dental practice. Unless an exception applies, an NOL must

first be carried back 2 years and then carried forward 20 years. Sec. 172(b)(1)(A).

If a taxpayer claims an NOL deduction, he must file with his return “a concise

statement setting forth * * * all material and pertinent facts relative thereto, in-

cluding a detailed schedule showing the computation” of the NOL deduction. Sec.

1.172-1(c), Income Tax Regs.

      Petitioners have satisfied none of these requirements. They did not attach to

any of their returns a concise statement including material and relevant facts or a

detailed schedule showing computation of the NOL amount. They have not ex-

plained how a condominium could give rise to an NOL for a dental practice. They

did not prove that Dr. Zolghadr’s dental practice actually incurred losses before

2006 or (if it did) that the NOL had not previously been carried back. On the latter
                                        - 23 -

[*23] point the only evidence was Dr. Zolghadr’s testimony that the NOLs were

reported on petitioners’ prior returns; this was a statement of their position, not

proof. See Whitaker v. Commissioner, T.C. Memo. 2010-209. Because petition-

ers have failed to prove that an allowable NOL existed, we will sustain respon-

dent’s disallowance of the NOL carryforward deductions for 2006-2009.

      • Petitioners claimed deductions for each year for interest expenses alleg-

edly connected to the dental practice. Mrs. Zolghadr testified that this interest was

paid on loans obtained to purchase dental equipment. We did not find this testi-

mony credible. In support she provided bank statements (none of which were for

business bank accounts) that listed “finance charges.” Petitioners provided no evi-

dence that these finance charges were paid on business rather than personal loans.

We will therefore sustain respondent’s disallowance of these deductions.

      • Petitioners reported wage expenses for the dental practice for each year.

Respondent’s adjustments on these items largely favored petitioners. For 2006 the

IRS determined that they had overstated wage expenses by $7,654; for 2007-2009

the IRS determined that they had understated wage expenses by $8,873, $35,809,

and $38,489, respectively. Petitioners nevertheless challenge the disallowance for

2006; the Forms W-3, Transmittal of Wage and Tax Statements, that they supplied

to support their challenge, however, show wage expenses $10,000 lower than the
                                        - 24 -

[*24] adjusted amount the IRS has allowed. Petitioners offered no credible

evidence on this point, and we will accordingly sustain respondent’s deter-

minations for all four years.

IV.   Mortgage Interest

      A.     Schedule A Mortgage Interest

      Section 163(h)(1) generally disallows a deduction for personal interest. For

individual taxpayers, an exception to this rule is “qualified residence interest.”

Sec. 163(h)(2)(D). Qualified residence interest is interest that is paid or accrued

during the taxable year on “acquisition indebtedness” or “home equity indebted-

ness” with respect to any “qualified residence” of the taxpayer. Sec. 163(h)(3)(A).

A “qualified residence” includes the taxpayer’s “principal residence” and one

other home “which is selected by the taxpayer for purposes of this subsection for

the taxable year and which is used by the taxpayer as a residence.” Sec.

163(h)(4)(A)(i). Both “acquisition indebtedness” and “home equity indebtedness”

must be secured by the qualified residence. Sec. 163(h)(3)(B)(i)(II), (C)(i).

      For 2006 petitioners claimed a Schedule A mortgage interest deduction of

$40,897, which was attributable to four loans. The IRS allowed a deduction of

$29,897, attributable to two loans secured by the Vienna property. The IRS cor-

rectly disallowed the interest deduction for the third loan because petitioners had
                                       - 25 -

[*25] deducted the same interest on Schedule E as a rental expense of the McLean

property. The IRS correctly disallowed the interest deduction for the fourth loan,

an $80,000 line of credit, because petitioners provided no evidence that this loan

was secured by any real property. We thus sustain respondent’s determination for

2006.

        For 2007 petitioners claimed a Schedule A mortgage interest deduction of

$27,280. The IRS increased this deduction by $2,579. Petitioners agree with this

adjustment.

        For 2008 petitioners claimed a Schedule A mortgage interest deduction of

$38,674. The IRS allowed a deduction of $29,772, attributable to the two loans

secured by the Vienna property. At trial petitioners produced a Form 1098, Mort-

gage Interest Statement, issued by Wachovia showing interest paid on two loans.

However, the IRS had already allowed a deduction for the interest on one of these

loans, and petitioners produced no evidence to show that the other loan was se-

cured by a primary or secondary residence. We thus sustain respondent’s determi-

nation for 2008.

        For 2009 petitioners claimed a Schedule A mortgage interest deduction of

$51,607. The IRS allowed $31,431 of this deduction, again attributable to the two
                                       - 26 -

[*26] loans secured by the Vienna property.2 Petitioners again produced a Form

1098 showing interest paid on two loans. But as was true for 2008, the IRS had

already allowed a deduction for the interest paid on one of the loans, and pe-

titioners failed to provide any evidence that the other loan was secured by any real

property. The IRS disallowed an interest deduction with respect to a fourth loan;

petitioners on brief did not dispute the basis for this disallowance, and we deem it

conceded. We accordingly sustain respondent’s determinations for 2009 in full.

      B.     Schedule E Mortgage Interest

      For 2009 petitioners filed a Schedule E reporting income from leasing space

for a billboard on their West Virginia property. On this Schedule E they reported

mortgage interest expense of $9,401. They substantiated this expense with a Form

1098 from BB&T Bank and a $146,250 mortgage note secured by the property.

      A “qualified residence” for purposes of section 163 includes the taxpayer’s

primary residence and one other home “which is used by the taxpayer as a resi-

dence (within the meaning of section 280A(d)(1)).” To meet the latter require-

ment the taxpayer must use the home “for personal purposes for a period exceed-

ing the greater of 14 days or 10% of the number of days during the year for which


      2
      The interest deduction on the second loan was limited because of the
$100,000 cap on home equity indebtedness. See sec. 163(h)(3)(C)(ii).
                                        - 27 -

[*27] the unit is rented at fair rental.” Sec. 280A(d)(1). Since petitioners did not

rent the West Virginia home, the 14-day test supplies the governing standard here.

      Dr. Zolghadr testified that when her husband purchased the property in mid-

2008 it was used initially as their secondary residence.3 Petitioners began re-

ceiving rental income from the billboard shortly thereafter, and in 2009 Mr. Zol-

ghadr engaged in some sort of car dealership activity on the property. In connec-

tion with this activity, Dr. Zolghadr testified that her husband often resided at the

property for extended periods because of its distance from their home in Vienna.

Her testimony on this point was credible, and we find that Mr. Zolghadr resided in

the West Virginia home for more than 14 days during 2009.

      We conclude that petitioners have met their burden of showing that the

West Virginia property was a secondary residence and that one or both petitioners

resided in it for more than 14 days during 2009. Although petitioners erroneously

reported the mortgage interest on Schedule E, we find that they are entitled to an

additional Schedule A mortgage interest deduction of $9,401 for 2009.




      3
       Mr. Zolghadr is fluent only in Farsi, and because of language difficulties he
did not testify at trial.
                                         - 28 -

[*28] V.     Additions to Tax and Penalties

       Section 6651 provides for an addition to tax of 5% of the tax required to be

shown on the return for each month or fraction thereof for which there is a failure

to file the return, not to exceed 25% in toto. The parties stipulated that petitioners’

2006 and 2007 returns were not filed until October 5, 2009, and that their 2008 re-

turn was not filed until November 1, 2009. Because all three returns were indis-

putably filed late, respondent has met his burden of production under section

7491(c).

       A taxpayer who files his return late is liable for this addition to tax unless he

shows that his failure was due to reasonable cause and not due to willful neglect.

Sec. 6651(a)(1); United States v. Boyle, 469 U.S. 241, 245 (1985). In their peti-

tion, petitioners did not assign error to respondent’s determination that they are

liable for late-filing additions to tax. See Rule 34(b)(4) (adjustments to which

error is not assigned are deemed conceded); Swain v. Commissioner, 118 T.C.

358, 358 (2002). In any event, petitioners produced no evidence that their late

filings were due to reasonable cause, and we accordingly sustain the additions to

tax.

       The Code imposes a 20% penalty on the portion of any underpayment of tax

attributable to “[n]egligence or disregard of rules and regulations” or “[a]ny sub-
                                       - 29 -

[*29] stantial understatement of income tax.” Sec. 6662(a) and (b)(1) and (2).

Negligence includes “any failure to make a reasonable attempt to comply” with the

internal revenue laws. Sec. 6662(c). An understatement of income tax is “sub-

stantial” if it exceeds the greater of $5,000 or 10% of the tax required to be shown

on the return. Sec. 6662(d)(1)(A). Under section 7491(c) respondent bears the

burden of production with respect to the liability of any individual for any penalty.

See Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

      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 thereto. The

taxpayer bears the burden of proving reasonable cause and good faith. Id. at 444-

447. Reasonable cause can be shown by good-faith reliance on the advice of a

qualified tax professional. Sec. 1.6664-4(b)(1), (c), Income Tax Regs. Whether

the taxpayer actually relies on the advice and whether such reliance is reasonable

present questions of fact. Neonatology Assocs., P.A. v. Commissioner, 115 T.C.

43, 98 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002); sec. 1.6664-4(c)(1), Income Tax

Regs. For reliance to be reasonable, the taxpayer must prove (among other things)

that he provided “necessary and accurate information to the adviser.” Neonatol-

ogy Assocs., 115 T.C. at 99.
                                        - 30 -

[*30] Respondent has met his burden of production with respect to petitioners’

negligence. They presented virtually no credible evidence with respect to their

underreporting of income. They maintained wholly inadequate books and records

for Dr. Zolghadr’s dental practice. And most of the records they did provide were

cobbled together shortly before trial and lacked credibility.

      Petitioners have woefully failed to establish that they made a good-faith

effort to determine their Federal income tax liabilities correctly. Although they

hired a tax return preparer for their returns, they presented no credible evidence

regarding what if any records they provided to that person to substantiate their

income and expenses. Nor have they shown that their return preparer was compe-

tent; the preparer’s unquestioning acceptance of their obviously inflated Schedule

C expenses, in the absence of any plausible books and records, suggests otherwise.

We accordingly conclude that all of the underpayments (as redetermined) are at-

tributable to negligence. Alternatively, in the event the Rule 155 computations

show that the various understatements of income tax exceed the greater of $5,000

or 10% of the amounts required to be shown on the respective returns, we con-

clude that those underpayments are attributable to substantial understatements of

income tax for which reasonable cause has not been shown.
                                    - 31 -

[*31]   To reflect the foregoing,


                                             Decision will be entered

                                    under Rule 155.
