                          T.C. Summary Opinion 2016-31



                         UNITED STATES TAX COURT



       NAYEMUL B. CHOWDHURY AND LAILA BANU, Petitioners v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 10034-14S.                         Filed June 30, 2016.



      Nayemul B. Chowdhury and Laila Banu, pro sese.

      Theresa McQueeney, for respondent.



                              SUMMARY OPINION


      PANUTHOS, Chief Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in effect when the

petition was filed. Pursuant to section 7463(b), the decision to be entered is not

reviewable by any other court, and this opinion shall not be treated as precedent

for any other case. Unless otherwise indicated, subsequent section references are
                                         -2-

to the Internal Revenue Code (Code) in effect for the year in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

      In a notice of deficiency dated February 3, 2014, respondent determined a

deficiency of $7,305 in petitioners’ 2011 Federal income tax, a section 6662(a)

accuracy-related penalty of $1,461, and a section 6651(a)(1) addition to tax of

$135 for failure to timely file a return. After concessions,1 the issues for decision

are: (1) whether petitioners are entitled to deduct losses from the sale and

abandonment of business property; (2) whether petitioners are entitled to

deductions claimed on Schedule E, Supplemental Income and Loss of $5,419; (3)

whether petitioners are entitled to itemized deductions of $6,177 in excess of the




      1
        Respondent agrees that petitioners did not receive any income from their
business, Food and Frozen Stuff, LLC. Petitioners agree that they had no
deductible expenses from this same business. Respondent agrees that petitioners
are entitled to dependency exemption deductions for R. Begum and A. Ahmed.
Petitioners conceded that they are not allowed a dependency exemption deduction
for S. Farhana. In addition, petitioners conceded that they failed to report $1,163
of income from a New York State tax refund and had $59 in taxable interest.
Petitioners did not assign error to the determination of the addition to tax under
sec. 6651(a)(1) for failure to timely file their 2011 Federal income tax return and
did not offer any evidence with respect to this determination. We therefore
assume that petitioners have conceded the correctness of the determination of this
addition to tax. See Lawson v. Commissioner, T.C. Memo. 1963-179, aff’d, 350
F.2d 396 (4th Cir. 1965).
                                          -3-

amount respondent allowed; and (4) whether petitioners are liable for an accuracy-

related penalty under section 6662(a).2

                                     Background

      Some of the facts have been stipulated, and we incorporate the stipulation of

facts by this reference. At the time the petition was timely filed, petitioners

resided in New York.

      On January 6, 2009, petitioners purchased a Häagen-Dazs franchise that

would expire on January 31, 2012, from a private seller for a fee of $10,000. The

transfer was approved by Häagen-Dazs on January 7, 2009. Petitioners operated

this franchise together with a Submarina franchise that they had purchased.3

Petitioners entered into a lease with 3143 Steinway Street, LLC, for the store

premises for both franchises at the same location in Astoria, Queens, New York,

effective February 1, 2009. In order to operate the franchises, petitioners were



      2
       The adjustments in the notice of deficiency to the child tax credit and the
self-employment tax are computational and will be resolved by the concessions
and the Court’s conclusion on other issues.
      3
        These franchises were operated under the name Food & Frozen Stuff, LLC.
The record does not show the legal nature of this “LLC”. Petitioners reported the
expenses from this entity on Schedule C, Profit or Loss From Business for 2011.
Respondent does not assert that these expenses should not have been reported on
petitioners’ return. Accordingly, we assume that the LLC was a sole
proprietorship for tax purposes.
                                         -4-

required to renovate the premises. The record is not entirely clear, but it appears

that the store was open for two or three months in early 2009 before petitioners

closed the store for renovation.

      In July 2009, the U.S. Small Business Administration (SBA), through

Shinhan Bank America, approved a $180,000 loan to petitioners. Petitioners also

invested approximately $120,000 of their own funds in the business. These funds

came from various sources including bank accounts and the sale of personal

assets.

      Petitioners made the following payments to vendors to renovate the store:4
                              Vendor                   Amount
                 F.C. Dadson, Inc.                     $51,916
                 Fitch                                   15,000
                 Shepler Refrigeration                    7,000
                 Postmatic                                1,750
                 Henderson Mill & Fixture Group          16,354
                 Custom Business Solutions                5,386
                 Reddy Builders                        121,500
                 Bohler Engineering                       2,500
                 New York City Department of
                 Buildings                                1,698
                 Jam Consultants, Inc.                    1,200


      4
          Consolidated by vendor and rounded to the nearest dollar.
                                           -5-

      The store reopened in January 2010. The store did not generate the revenue

that petitioners had expected. By August petitioners had fallen behind on the store

rent. The store closed on January 20, 2011, and petitioners were evicted and

abandoned the leasehold improvements. Petitioners defaulted on the SBA loan.

As a result of the default, Shinhan Bank America repossessed some of petitioners’

equipment and sold it at auction. The net proceeds of $9,3635 from the auction

were applied to the amount that petitioners owed on the loan.

      Petitioners were also part owners in a Sunoco gasoline station. This

business closed in February 2011. Petitioners’ home and property in Florida were

also subject to foreclosure. Nayemul Chowdhury (petitioner) filed for bankruptcy

protection on January 5, 2012 and he received a bankruptcy discharge on April 11,

2012. Petitioners were able to keep their home and the property in Florida.

      On Schedule C for Food and Frozen Stuff, LLC, for 2011, petitioners

reported $70,000 in income and $236,707 in expenses, for a net loss of $166,707.

As mentioned above, respondent and petitioners now agree that petitioners had no

income and no deductible expenses from this business for 2011. Petitioners assert

that some of the expenses reported on this Schedule C should have been reported

as losses on the sale or abandonment of property. On Form 4797, Sales of

      5
          Rounded to the nearest dollar.
                                            -6-

Business Property, petitioners reported losses of $33,793 from the abandonment of

assets in their franchise activity. Respondent did not allow a deduction for any of

these losses in the notice of deficiency.

      On Schedule E petitioners reported no income and $5,419 of expenses

related to a rental property in Naples, Florida. Respondent did not allow a

deduction for any of these expenses in the notice of deficiency. On their 2011 tax

return petitioners claimed itemized deductions totaling $30,237. Respondent

allowed itemized deductions totaling $24,060 in the notice of deficiency.

      Petitioners did not provide any evidence to support their deductions on

Schedule E or the disallowed itemized deductions. To the extent petitioners

presented records of their franchise activity, those records were disorganized and

incomplete.

                                     Discussion

I.    Burden of Proof

      In general, the Commissioner’s determination set forth in a notice of

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

the determination is in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933). Pursuant to section 7491(a), the burden of proof as to factual matters

shifts to the Commissioner under certain circumstances. Petitioners did not allege
                                        -7-

or otherwise show that section 7491(a) applies. See sec. 7491(a)(2)(A) and (B).

Therefore, petitioners bear the burden of proof. See Rule 142(a).

II.   Losses From the Sale and Abandonment of Business Property

      A.     Sale of Repossessed Business Property

      Petitioners seek to deduct losses from the sale of assets repossessed by their

creditor. A sale in which the collateral is repossessed from the debtor constitutes a

taxable sale or exchange by the debtor of the encumbered property. See Helvering

v. Hammel, 311 U.S. 504, 506-511 (1941); Estate of Delman v. Commissioner, 73

T.C. 15, 28 (1979). The debtor’s gain or loss in the disposition is measured by the

difference between the amount realized in the disposition of the property and the

debtor’s adjusted basis in the property. Sec. 1001(a). In the case of recourse debt,

the amount realized is the fair market value of the property repossessed. Frazier v.

Commissioner, 111 T.C. 243, 245 (1998). In general, the debtor’s basis is cost.6

Sec. 1012. The debtor’s basis must be reduced by the amount of depreciation that

was allowed or allowable during 2010 and 2011. Sec. 1016(a)(2).




      6
         Respondent argued that petitioners’ basis in the assets should not include
any amount paid for the assets with indebtedness that was discharged in 2012. We
note that the proper basis for property includes amounts paid by indebtedness even
if that indebtedness is discharged in a later year. See Crane v. Commissioner, 331
U.S. 1, 11 (1947).
                                        -8-

      If a taxpayer establishes that he or she paid or incurred a deductible business

expense but does not establish the amount of the expense, we may approximate the

amount of the allowable deduction, bearing heavily against the taxpayer whose

inexactitude is of his or her own making. Cohan v. Commissioner, 39 F.2d 540,

543-544 (2d Cir. 1930). In Benichou v. Commissioner, T.C. Memo. 1970-263, the

Court used the Cohan rule to approximate the taxpayer’s basis. In order for the

Cohan rule to apply, there must be sufficient evidence in the record to provide a

basis for the estimate. Vanicek v. Commissioner, 85 T.C. 731, 743 (1985).

      In this case, neither party provided evidence of the fair market value of the

property repossessed. We conclude that the fair market value of the property

repossessed was the $9,363 that the creditor received from selling the property at

auction. Therefore, the amount realized is $9,363.

      Although it is clear that many items were sold at the auction, it is not clear

from the record how the items sold correspond to the assets purchased. In order to

compute the basis and allowable depreciation, we consider those purchases for

items that were subject to auction. Upon reviewing the invoices and checks in the

record for payments to F.C. Dadson, Inc., Shepler Refrigeration, Postmatic, and

Custom Business Solutions, we conclude that these payments were for the items
                                         -9-

sold in the auction. These payments total $66,052.7 In order to arrive at

petitioners’ adjusted basis, this amount must be reduced by the amount of

allowable depreciation for 2010 and 2011, because these assets were placed in

service in January 2010 when the store reopened.8

      With some exceptions, section 168(k) allows an additional 50%

depreciation deduction for the year in which property is placed in service if it is

for property that (1) has a recovery period of 20 years or less; (2) was first used by

the taxpayer; (3) was acquired by the taxpayer after December 31, 2007, and

before January 1, 2013; and (4) is placed in service by the taxpayer before January

1, 2013. Upon reviewing the record, we conclude that these items were eligible

for the additional 50% depreciation for 2010.

      We also need to consider: (1) the classification of the property, (2) the basis

for depreciation, (3) the recovery period, (4) the convention, and (5) the method.

See secs. 167 and 168. Upon reviewing the record, we conclude that: (1) the

property is a seven-year property, sec. 168(e)(3)(C)(v)(I); (2) the basis for




      7
      $51,916 (F.C. Dadson, Inc.) + $7,000 (Shepler Refrigeration) + $1,750
(Postmatic) + $5,386 (Custom Business Solutions) = $66,052.
      8
        We note that no depreciation was claimed on these assets for 2010 and that
petitioners conceded that there were no expenses for this business for 2011.
                                        - 10 -

depreciation is $33,026;9 (3) the recovery period is seven years, sec. 168(c);

(4) the half-year convention is applicable, sec. 168(d)(1); and (5) the applicable

depreciation method is the straight line method, sec. 1016(a)(2).

      On the basis of the above conclusions, the parties can compute the

depreciation allowable for 2010 and 2011 in order to ultimately compute the loss

from the sale of the repossessed property under Rule 155.10

      B.       Abandonment of Business Property

      In addition to the assets that were repossessed, petitioners abandoned other

property used in the business. Losses resulting from abandonment are sustained

during the year of abandonment and are deductible in the taxable year in which the

abandonment occurs. Dezendorf v. Commissioner, T.C. Memo. 1961-280, aff’d,

312 F.2d 95 (5th Cir. 1963). In order to establish abandonment, there must be an



      9
          $66,052 less 50% special depreciation allowance.
      10
         In his pretrial memorandum respondent incorrectly refers to this loss as a
capital loss. The sale of certain property used in a trade or business is accorded
favorable tax treatment. Sec. 1231. With some exceptions that are inapplicable
here, the term “property used in a trade or business” includes property that is:
(1) used in a trade or business; (2) subject to the allowance for depreciation; and
(3) held for more than one year. Sec. 1231(b)(1). If the losses from the sale of
property used in a trade or business exceed the gains from the sale of property
used in a trade or business, then the net losses are treated as ordinary losses. Sec.
1231(a)(2). We conclude that the losses from the sale of the repossessed business
property are losses from the sale of property used in a trade or business.
                                       - 11 -

intention of the owner to abandon the property, coupled with an act of

abandonment. W.B. Davis & Son, Inc. v. Commissioner, 5 T.C. 1195, 1219

(1945). The intention and the action are ascertained from the facts and

circumstances. Id. Petitioners abandoned the leasehold improvements in the store

and the Häagen-Dazs franchise when they were evicted from the store by their

landlord.

      In general, section 165(a) allows as a deduction any loss sustained during

the taxable year and not compensated for by insurance or otherwise. A deductible

loss may arise from the permanent withdrawal of property used in a trade or

business. Secs. 1.165-2(a), (c), 1.167(a)-8, Income Tax Regs. The basis for

determining the deduction is the adjusted basis provided in section 1011 for

determining the loss from the sale or other disposition of property. Sec. 165(b).

The basis is cost reduced by the amounts of amortization or depreciation that were

allowed or allowable during 2010 and 2011. See secs. 1012, 1016(a)(2). As

mentioned above, in Benichou the Court used the Cohan rule to estimate the

taxpayer’s basis.

      In January 2009 petitioners purchased a Häagen-Dazs franchise for a

transfer fee of $10,000. The store was open at least briefly in 2009, presumably

starting in February 2009, and it closed in January 2011. On the basis of these
                                       - 12 -

facts, the parties can compute the amortization allowable under section 197 for

2009, 2010, and 2011 in order to ultimately compute the loss from the

abandonment of the franchise fee under Rule 155.

      Petitioners also made substantial leasehold improvements. Although it is

clear that petitioners invested significant funds in leasehold improvements, they

have provided incomplete records regarding these purchases. In order to compute

the basis and allowable depreciation, we have reviewed the invoices and checks in

the record for payments to Fitch, Henderson Mill & Fixture Corp., Reddy

Builders, Bohler Engineering, New York City Department of Buildings, and Jam

Consultants, Inc.; we conclude that these payments were for abandoned leasehold

improvements. These payments total $158,252.11 In order to arrive at petitioners’

adjusted basis, we need to reduce this amount by the amounts of allowable

depreciation for 2010 and 2011 because the assets were placed in service in

January 2010, when the store reopened.12




      11
       $15,000 (Fitch) + $16,354 (Henderson Mill & Fixture Group) + $121,500
(Reddy Builders) + $2,500 (Bohler Engineering) +$1,698 (New York City
Department of Buildings) + $1,200 (Jam Consultants, Inc.) = $158,252.
      12
        We note that no depreciation was claimed on these assets for 2010 and that
petitioners conceded that there were no expenses for this business for 2011.
                                       - 13 -

      In order to calculate the allowable depreciation, we consider whether a

special depreciation allowance was available on these items for 2010. With some

exceptions, section 168(k) allows an additional 50% depreciation deduction for

property that (1) is qualified leasehold improvement property; (2) was first used by

the taxpayer; (3) was acquired by the taxpayer after December 31, 2007, and

before January 1, 2013; and (4) is placed in service by the taxpayer before January

1, 2013. In general, qualified leasehold improvement property is an improvement

to the interior portion of a nonresidential real property where the improvement is

made under the lease, the improved portion of the building is occupied exclusively

by the lessee, and the improvement is placed in service more than three years after

the date the building was first placed in service. Sec. 168(k)(3)(A). Upon

reviewing the record, we conclude that these leasehold improvements were

eligible for the additional 50% depreciation for 2010.13

      We also need to consider: (1) the classification of the property, (2) the basis

for depreciation, (3) the recovery period, (4) the convention, and (5) the method.

      13
        We need not consider whether the leasehold improvements are either
qualified restaurant property or qualified retail improvement property because (1)
both qualified restaurant property and qualified retail improvement property are
also 15-year property, sec. 168(e)(3)(E), and (2) qualified restaurant property and
qualified retail improvement property are eligible for the additional 50%
depreciation when the property is also qualified leasehold improvement property,
sec. 168(e)(7)(B), (8)(D).
                                         - 14 -

See secs. 167 and 168. Upon reviewing the record, we conclude that: (1) the

property is a 15-year property, sec. 168(e)(3)(E)(iv); (2) the basis for depreciation

is $79,126;14 (3) the recovery period is 15 years, sec. 168(c); (4) the half-year

convention is applicable, sec. 168(d)(1); and (5) the applicable depreciation

method is the straight line method, sec. 1016(a)(2).

      On the basis of the above conclusions, the parties can compute the

depreciation allowable for 2010 and 2011 in order to ultimately compute the

amount of the loss from the abandonment of the leasehold improvements under

Rule 155.15

      C.       Effect of 2012 Bankruptcy

      Respondent asserts that the loss reported on abandonment and sale of

petitioners’ property was addressed by the bankruptcy court. Nothing in the

record supports respondent’s claim. Petitioner received his discharge in

bankruptcy on April 11, 2012. Respondent’s account transcript shows that

petitioners’ 2011 tax return was not received until September 16, 2012, after the



      14
           $158,252 less 50% special depreciation allowance.
      15
         Respondent incorrectly refers to this loss as a capital loss in his pretrial
memorandum. An abandonment loss under sec. 165 is an ordinary loss unless it
arises from the sale or exchange of a capital asset. Allen v. Commissioner, T.C.
Memo. 1994-165.
                                         - 15 -

discharge in bankruptcy. In addition, the records from the bankruptcy that were

included as part of the record for this case do not show that petitioner sought to be

relieved of his 2011 tax liability in the bankruptcy case.

      Respondent also asserts that the basis of the assets sold and abandoned

should be reduced as tax attributes because of petitioner’s discharge in bankruptcy

in 2012. Section 108(a) allows taxpayers to exclude discharge of indebtedness

income from gross income in certain circumstances. Section 108(b) may require

the reduction of tax attributes when discharge of indebtedness income is excluded

under section 108(a). The amount of the reduction of tax attributes is generally

the amount of the discharge of indebtedness income that is excluded from income.

Sec. 108(b)(1), (3). Barring an election otherwise, net operating losses for the

year of discharge and any net operating loss carried over to the year of discharge

are reduced before the basis of the property of the taxpayer is reduced. Sec.

108(b)(2). Any amount of discharge of indebtedness income that is left after tax

attribute reduction is disregarded and does not either result in income or have any

other tax consequences.16 The reductions to tax attributes are made after the

determination of income tax for the year of discharge. Sec. 108(b)(4)(A).




      16
           S. Rept. No. 96-1035, at 13 (1980), 1980-2 C.B. 620, 626.
                                        - 16 -

       In this case, the year of discharge is 2012. To the extent that any discharge

of indebtedness income was excluded for 2012, section 108(b) may require a

reduction in tax attributes. However, this reduction in tax attributes would not

occur until after taxable income had been calculated for 2012, the year of the

discharge. The basis of the assets repossessed or abandoned in 2011 is not

reduced for 2011 as tax attributes under section 108 for the exclusion of discharge

of indebtedness income that may have occurred in 2012.

III.   Deductions

       A taxpayer must substantiate amounts claimed as deductions by maintaining

the records necessary to establish he or she is entitled to the deductions. Sec.

6001. Petitioners did not attempt to substantiate either their deductions claimed

on Schedule E or their itemized deductions. Petitioners did not otherwise provide

evidence disputing respondent’s determinations for these deductions.

Accordingly, the disallowed amounts for these deductions are deemed conceded

by petitioners. See Rule 149(b).

IV.    Accuracy-Related Penalty

       Section 6662(a) and (b)(1) imposes a penalty of 20% of the portion of an

underpayment of tax attributable to the taxpayer’s negligence. “Negligence”

includes any failure to make a reasonable attempt to comply with the Code,
                                        - 17 -

including any failure to keep adequate books and records or to substantiate items

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

       The section 6662(a) accuracy-related penalty does not apply with respect to

any portion of an underpayment if the taxpayer proves that there was reasonable

cause for such portion and that he acted in good faith with respect thereto. Sec.

6664(c)(1). The determination of whether a taxpayer acted with reasonable cause

and in good faith depends on the pertinent facts and circumstances, including the

taxpayer’s efforts to assess the proper tax liability; the knowledge and the

experience of the taxpayer; and any reliance on the advice of a professional, such

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

important factor is the taxpayer’s effort to assess the taxpayer’s proper tax

liability. Id.

       The Commissioner has the burden of production under section 7491(c) with

respect to the accuracy-related penalty under section 6662. To satisfy that burden,

the Commissioner must produce sufficient evidence showing that it is appropriate

to impose the penalty. Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

Respondent determined the accuracy-related penalty was due to negligence.

Respondent has satisfied his burden by producing evidence that petitioners failed

to maintain adequate books and records. Accordingly, because respondent has
                                       - 18 -

met his burden of production, petitioners must come forward with persuasive

evidence that the accuracy-related penalty should not be imposed with respect to

the underpayment because, for example, they acted with reasonable cause and in

good faith. See sec. 6664(c)(1); Rule 142(a); Higbee v. Commissioner, 116 T.C.

at 446-447.

      Petitioners provided no evidence of expenses underlying either their

Schedule E deductions or their itemized deductions. Petitioners conceded that

they claimed losses on their Schedule C to which they are not entitled.

Petitioners’ records did not support the loss reported on Form 4797. Petitioners

have not demonstrated that they acted with reasonable cause and in good faith

with respect to the recordkeeping requirements; therefore, the Court sustains

respondent’s determinations on this issue.

      We have considered all of the parties’ arguments, and, to the extent not

addressed herein, we conclude that they are moot, irrelevant, or without merit.

      To reflect the foregoing,


                                                Decision will be entered

                                      under Rule 155.
