                              T.C. Memo. 2018-11



                        UNITED STATES TAX COURT



                       MARION J. WELLS, Petitioner v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 13889-14.                        Filed January 31, 2018.


      Steven R. Anderson, Briana J. Fehringer, and Brian F. Huebsch, for

petitioner.

      Miles B. Fuller, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


      PARIS, Judge: By notice of deficiency issued pursuant to section 6212(a),1

respondent determined deficiencies in petitioner’s Federal income tax of $66,178


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

[*2] and $9,802 for 2010 and 2011, respectively. In the notice of deficiency

respondent also determined that petitioner is liable for a section 6662 accuracy-

related penalty of $13,235.60 for 2010.

      The issues for decision are: (1) whether petitioner may immediately deduct

expenditures under section 162 totaling $199,031 and $47,630 for 2010 and 2011,

respectively, and (2) whether petitioner is liable for an accuracy-related penalty

under section 6662(a) for 2010.

                               FINDINGS OF FACT

      Petitioner was a highway project engineer for the Colorado Department of

Transportation until she retired in 1996. She owns and lives on a 265-acre

property in Garfield County, Colorado. Petitioner has lived on the property

continuously since 1983. Before that she had lived on the property intermittently

since 1965 (her father owned the property before petitioner).

      Petitioner cultivates approximately 700 white French hybrid rind grapevines

on three patches of open land at the northern end of the property. In better years

the vines produced up to four tons of grapes, which petitioner would sell to a local

winery. More recently petitioner has harvested only 600 to 1,200 pounds of

grapes per year because adverse weather conditions (and bears, apparently) have

caused damage to her harvest. As her harvest has dwindled, petitioner has taken to
                                        -3-

[*3] crushing her grapes for juice, which she sells in gallon jugs to local buyers.

Petitioner also leases a portion of the southern part of the property for horse and

cattle grazing, although droughty weather conditions during parts of the year have

limited the number of animals she is able to graze on the land. Petitioner reported

$305 and $255 of gross income from farming for 2010 and 2011, respectively, on

Schedules F, Profit or Loss From Farming, attached to her returns for 2010 and

2011. Petitioner reported total farming expenses of $208,265 and $54,734 for

2010 and 2011, respectively.

      There is a spring in the southern part of petitioner’s property. In 1965

petitioner’s father installed an underground pipe to carry water from the spring to

other areas of petitioner’s property (spring line). The spring line runs downhill

from south to north for about 3,800 feet and supplies, among other things, the

grazing pasture and an irrigation system in the fields where petitioner grows

grapes. The spring line was originally constructed of 2-inch black polyethylene

pipe (black pipe), but at least 1,800 feet of the spring line was replaced in 2010

with 2-inch blue pure-core pipe (blue pipe). Sections of black pipe are connected

with joints that fit together and are then secured with a hose clamp. Sections of

blue pipe are connected with compression fittings and can withstand higher

pressures. Blue pipe is more expensive, higher quality pipe.
                                        -4-

[*4] Various roads, both public and private, traverse and border the property.

See infra appendix Exhs. 17-P, 23-R. One of the private roads runs from

petitioner’s father’s house in the north to above the spring in the south (access

road). Another private road runs from the county road in the east to the access

road (Kuiper Road). Additionally, the “Stubbs Pad”, an oil or gas site, sits to the

south of petitioner’s southern property line on a neighboring property (and above

the spring in terms of elevation).2

2010 Expenditures

      In 2010 petitioner hired Robert Schwartz to perform work on her property.

Petitioner paid Mr. Schwartz $198,207 for labor, equipment, and materials costs

relating to various projects in 2010. The projects included: work on, or relating

to, petitioner’s private roads; work on the spring line; digging holes for new grape

vines; spreading manure; and construction of a storage yard. Mr. Schwartz

provided petitioner invoices listing the work completed and the costs.




      2
        Over the course of several years petitioner made a variety of complaints to
the operator of the Stubbs pad, to the Energy Advisory Board, and to the Colorado
Oil and Gas Commission alleging, among other things, that the operator of the
Stubbs pad site was not properly handling runoff from the site. The records of
these three entities, however, contain no mention of a 2010 flood of water from the
Stubbs pad. Petitioner alleges that a 2010 flood occasioned many of the 2010
expenditures described below.
                                        -5-

[*5] Also in 2010 petitioner hired Mead Fencing to reset fences that had to be

removed to complete work on the spring line and the storage yard. Petitioner paid

$824.30 for the fencing work.

      Petitioner timely filed her 2010 Form 1040, U.S. Individual Income Tax

Return, reporting adjusted gross income of $1,282,990 and total tax of $316,689.

In the notice of deficiency, respondent determined that none of the 2010

expenditures discussed above are deductible under section 162. Respondent

allowed an increase in a depreciation deduction and section 179 expense of $9,952

for 2010.

2011 Expenditures

      In 2007 a wildfire burned approximately 26 acres of the property (burn

area). Before the fire, petitioner used a small part of that land for grazing. In 2011

petitioner determined--after consulting a friend who had experience restoring

burned land--that the fire had rendered the land hydrophobic, i.e., the heat of the

fire had decreased or destroyed the land’s capacity to absorb water. Petitioner

hired Mr. Schwartz to remove burned tree stumps and boulders and turn the soil so

that the entire 26-acre area could be used for forage. Petitioner paid Mr. Schwartz

$47,630 to rehabilitate the burn area in 2011. Mr. Schwartz again provided

petitioner invoices listing the work completed and the costs.
                                        -6-

[*6] Petitioner timely filed her 2011 Form 1040, reporting adjusted gross income

of $1,000,078 and total tax of $261,326. In the notice of deficiency, respondent

determined that the 2011 expenditures discussed above must be capitalized rather

than deducted immediately. Respondent allowed an increase in a depreciation

deduction and section 179 expense of $21,289 for 2011.

      Petitioner, who is a resident of Colorado, filed a timely petition contesting

the notice of deficiency.

                                     OPINION

      The Commissioner’s determinations in a notice of deficiency are generally

presumed correct, and the taxpayer bears the burden of proving by a

preponderance of the evidence that those determinations are erroneous. Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).3

I. Capital Expenditures v. Current Deductions

      Section 162 permits taxpayers to currently deduct the costs of ordinary and

necessary expenses (including incidental repairs) that neither materially add to the

value of property nor appreciably prolong its life but keep the property in an

ordinarily efficient operating condition. See sec. 1.162-4, Income Tax Regs. In

      3
       Petitioner filed a motion to shift the burden of proof under sec. 7491(a).
The Court will deny petitioner’s motion in an order released concurrently with this
opinion.
                                         -7-

[*7] contrast, section 263 requires taxpayers to capitalize costs incurred for

permanent improvements, betterments, or restorations to property; in general, a

taxpayer must capitalize expenditures that add to the value or substantially prolong

the life of the property or adapt the property to a new or different use. Sec.

1.263(a)-l(b), Income Tax Regs.

       Deductions under section 162 are exceptions to the norm of capitalization.

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

deduction is a matter of legislative grace; the taxpayer bears the burden of proving

its right to a claimed deduction. Rule 142(a); Welch v. Helvering, 290 U.S. at

115.

       “Whether an expense is deductible or must be capitalized is a factual

determination.” Norwest Corp. v. Commissioner, 108 T.C. 265, 280 (1997).

“Courts have adopted a practical case-by-case approach in applying the principles

of capitalization and deductibility.” Id. (citing Wolfsen Land & Cattle Co. v.

Commissioner, 72 T.C. 1, 14 (1979)). “The decisive distinctions between current

expenses and capital expenditures ‘are those of degree and not of kind.’” Id.

(quoting Welch v. Helvering, 290 U.S. at 114).

       In Ill. Merchs. Tr. Co. v. Commissioner, 4 B.T.A. 103, 106 (1926) (cited

with approval by United States v. Wehrli, 400 F.2d 686, 689 (10th Cir. 1968)),
                                         -8-

[*8] which involved the cost of shoring up a wall and repairing a foundation

needed to prevent a building from collapsing, the Board of Tax Appeals drew the

following distinctions:

      To repair is to restore to a sound state or to mend, while a
      replacement connotes a substitution. A repair is an expenditure for the
      purpose of keeping the property in an ordinarily efficient operating
      condition. * * * Expenditures for that purpose are distinguishable
      from those for replacements, alterations, improvements or additions
      which prolong the life of the property, increase its value, or make it
      adaptable to a different use. The one is a maintenance charge, while
      the others are additions to capital investment which should not be
      applied against current earnings. * * *

“An asset need not be completely out of service or in total disrepair for the general

plan of rehabilitation doctrine to apply.” Norwest Corp. v. Commissioner, 108

T.C. at 280.

      The U.S. Court of Appeals for the Tenth Circuit, to which this case is

appealable absent a stipulation to the contrary, see sec. 7482(b)(1)(A), has

“evolved what may be called the ‘one-year’ rule of thumb, under which an

expenditure should be capitalized ‘if it brings about the acquisition of an asset

having a period of useful life in excess of one year or if it secures a like advantage

to the taxpayer which has a life of more than one year’”, Wehrli, 400 F.2d at 689

(quoting Hotel Kingkade v. Commissioner, 180 F.2d 310, 312 (10th Cir. 1950),

aff’g 12 T.C. 561 (1949)). The Court of Appeals has cautioned, however, that the
                                         -9-

[*9] one-year rule was “intended to serve as a mere guidepost for the resolution of

the ultimate issue, not as an absolute rule requiring the automatic capitalization of

every expenditure providing the taxpayer with a benefit enduring for a period in

excess of one year.” Id. Moreover, the Court of Appeals, id. at 689-690, has

      superimposed * * * an overriding precept that an expenditure made
      for an item which is part of a ‘general plan’ of rehabilitation,
      modernization, and improvement of the property, must be capitalized,
      even though, standing alone, the item may appropriately be classified
      as one of repair. * * * Whether the plan exists, and whether a
      particular item is part of it, are usually questions of fact to be
      determined by the fact finder based upon a realistic appraisal of all
      the surrounding facts and circumstances, including, but not limited to,
      the purpose, nature, extent, and value of the work done, e.g., whether
      the work was done to suit the needs of an incoming tenant, or to adapt
      the property to a different use, or, in any event, whether what was
      done resulted in an appreciable enhancement of the property’s value.
      [Fn. ref. omitted.]

II. The Parties’ Arguments

      The parties agree that the primary issue before the Court is whether the

2010 and 2011 expenditures may be deducted under section 162. Respondent has

not asserted (1) under section 183 that petitioner’s farming activities were not

engaged in for profit or (2) that petitioner did not pay the costs listed on the

invoices in the appropriate years, and the Court therefore does not consider any

such issues.
                                         - 10 -

[*10] Petitioner argues that all of her expenditures are deductible under section

162 as repairs. Respondent argues that none of the expenditures is deductible

under section 162 either because the expenditures are personal under section 262,

or because the expenditures must be capitalized under section 263.

III. Petitioner’s Case

      As the principal pieces of evidence in support of her case, petitioner

provided (1) her testimony, (2) invoices from Mr. Schwartz describing the work he

performed on her property in 2010 and 2011 (and two invoices from Mead

Fencing describing associated work in 2010), and (3) an allocation document for

the 2010 expenses.

      There are six invoices from Mr. Schwartz listing expenditures made in

2010, two of which are composed of two separately numbered sheets. In keeping

with the convention adopted by the parties, the Court will refer to these as Invoice

7100, Invoice 7101-7102, Invoice 7112, Invoice 7113, Invoice 7114-7115, and

Invoice 7116. Each of the invoices contains a description of several different

projects and concludes with the total costs of materials, equipment, and labor used

for the projects listed on the invoice. The costs listed at the end of each invoice,

however, are not allocated among the various projects listed. For example, each

invoice lists only the aggregate labor cost for all of the work listed; the total labor
                                        - 11 -

[*11] cost for each invoice is not broken down to reflect the amount of labor cost

for each individual project. Additionally, most of the projects span more than one

invoice. For example, work relating to the spring line appears on all of the

invoices.

      Petitioner prepared the allocation document in anticipation of trial and

offered it to supplement her testimony. Petitioner testified that the figures on the

allocation document represent her estimates of how the costs on each invoice

should be divided among the various projects listed on each invoice. The

allocation document lists a series of project categories, estimates relating to each

project category, and the invoices to which each estimate relates.

      Petitioner argues that, if the Court finds that some of her 2010 expenditures

are not deductible under section 162, then the Court should estimate, under the

so-called Cohan rule, an amount for each project that would be deductible under

section 162. See Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir. 1930).

Petitioner contends that the documents just described provide a sufficient basis for

estimation. While it is true that “a court should allow the taxpayer some

deductions if the taxpayer proves he is entitled to the deduction but cannot

establish the full amount claimed”, Edelson v. Commissioner, 829 F.2d 828, 831

(9th Cir. 1987), aff’g T.C. Memo. 1986-223, “the Cohan rule does not ‘require that
                                        - 12 -

[*12] such latitude be employed’”, Norgaard v. Commissioner, 939 F.2d 874, 879

(9th Cir. 1991) (quoting Williams v. United States, 245 F.2d 559, 560 (5th Cir.

1957)), aff’g in part, rev’g in part T.C. Memo. 1989-390. “[T]o qualify for the

estimation treatment under Cohan, the taxpayer must establish that he is entitled to

some deduction.” Id. (citing Edelson v. Commissioner, 829 F.2d at 831); Vanicek

v. Commissioner, 85 T.C. 731, 742-743 (1985) (“[W]e must have some basis on

which an estimate may be made.”). As the Court of Appeals stated in Cohan v.

Commissioner, 39 F.2d at 543-544: “Absolute certainty in such matters is usually

impossible and is not necessary”, but a court “should make as close an

approximation as it can, bearing heavily if it chooses upon the taxpayer whose

inexactitude is of his own making.”

      The invoices Mr. Schwartz provided to petitioner with respect to work

completed in 2011 all relate to a single project: rehabilitation of the burn area.

There is therefore no need for any estimate with respect to 2011. The only issue

presented with respect to 2011 is whether the rehabilitation project is a capital

improvement.
                                         - 13 -

[*13] IV. 2010 Expenditures

      A. Spring Line

      The Court finds that no expenditures in 2010 relating in any way to the

spring line are deductible under section 162 because they must be capitalized

under section 263.

      Petitioner alleges that the spring line was entirely replaced in 2009 with new

black pipe. Petitioner testified that after the first replacement

      [t]he black poly pipe began leaking the first year it was put in [i.e.,
      2009] and we replaced a section of it in the fall of 2009. And then
      when spring [2010] came along there were also new leaks that
      cropped up in the new black poly and we replaced those three
      locations. So it just was an ongoing problem with the new black
      poly[. It] was not holding. * * * There was water bubbling out of the
      ground[.] * * * We dug out from the point the water was bubbling out
      of the ground until we found * * * [the source of the leak,] which was
      at [the] joints.

Petitioner and Mr. Schwartz were unsure what the exact cause of the leaks was.

The only explanation offered was that the joints between the pipe sections were

not secured to the pipe sections well enough to withstand the water pressure

through the line.

      The record does not show how much of the new black pipe was replaced in

2009. But Mr. Schwartz’ testimony and invoices support petitioner’s testimony

with respect to the work completed in 2010. Invoice 7100 shows that three
                                        - 14 -

[*14] portions of the spring line were replaced with blue pipe early in 2010.

Petitioner testified that these three replacements amounted to 600 feet of the line.

And Mr. Schwartz’ testimony and Invoice 7112 show that an additional 1,200 feet

was also replaced with blue pipe in 2010. Petitioner testified that the entire length

of the line is 3,800 feet. Altogether, the replacements in 2010 amounted to

approximately 47% of the line ((600 + 1,200 ) / 3,800 = 47%).

      Petitioner explained: “[A]s soon as we knew that the new black poly joints

were failing regularly, we decided to replace the remaining black poly pipe that we

hadn’t replaced in 2009 and 2010. We finished the job.” In other words, if the

Court takes petitioner at her word, the spring line was replaced once completely in

2009 (with new black pipe), and then apparently was entirely replaced, again,

between 2009 and 2010 (with blue pipe).

      On the basis of the entire record, the Court finds that the whole spring line

was replaced at least once over the course of 2009 and 2010. On that point, all the

evidence is in agreement. Petitioner’s allegation, however, that the spring line was

completely replaced twice is supported only by her own testimony, which conflicts

with Mr. Schwartz’ testimony. Mr. Schwartz testified that when he replaced a

portion of the spring line with blue pipe in 2010, “to begin with it [the black pipe

he was replacing in 2010] was put in I don’t know how many years ago, but a long
                                         - 15 -

[*15] time.” He also testified that he was “not around when that [black pipe] was

put in”, even though petitioner claimed Mr. Schwartz began working for her in

2009. Although Mr. Schwartz did acknowledge that his memory was not perfect,

the Court found him to be a credible witness.

      If, as Mr. Schwartz’ testimony would suggest, there was only one

replacement of the spring line, then the work Mr. Schwartz completed in 2010 was

part of a “‘general plan’ of rehabilitation, modernization, and improvement” to

completely replace the spring line, a project petitioner took up in 2009 and

completed in 2010, the costs of which must be capitalized. Wehrli, 400 F.2d at

689. This is clear because (1) the relevant asset, i.e., the spring line, was

completely replaced, (2) the use of blue pipe to replace the old black pipe

extended the life of the asset well beyond 2010, and (3) the value of the spring line

was increased (because of the use of a new and better pipe with better joints).

Petitioner argues that the life of the asset was not extended and that the value of

the spring line was not increased. Yet it is difficult to understand how asset life

and value could remain the same considering that the old, crumbling, and leaky

pipe was entirely replaced with new and higher quality pipe.

      Petitioner argues that--even if the line was completely replaced only once--

replacement of the line was a repair (or a repair in part) because large discharges
                                        - 16 -

[*16] of water from the Stubbs pad destroyed parts of the spring line in 2009 and

2010, and replacement was her only option. But even if the complete replacement

of the spring line described above was occasioned by a flood or a series of floods,

it would not change the result. In Hunter v. Commissioner, 46 T.C. 477, 484

(1966), an old dam was washed out by flooding, and the Court found that the

construction cost of a replacement dam had to be capitalized:

             We find no merit in petitioner’s contention that the
      expenditures in question were for the ‘repair’ of the old dam, a part of
      which remained in the Purgatoire River as an integral part of the
      overall irrigation system. The record shows that the new dam was
      constructed 30 feet downstream from the site of the former dam, was
      of a different and sturdier type of construction, and undoubtedly has a
      greater useful life than the old dam. * * * The record indicates that
      Highland and its stockholders had attempted to repair the old dam
      without success, and then decided to build a new dam. * * *

The Court finds petitioner’s situation closely analogous. Whether the spring line

ceased to work because of a flood or merely because of the passage of time,

petitioner ultimately decided to replace, rather than repair, the whole line with a

different and sturdier pipe of greater value and useful life than the pipe that was

removed. See Wehrli, 400 F.2d at 689 (“[A]n expenditure made for an item which

is part of a ‘general plan’ of rehabilitation, modernization, and improvement of the
                                         - 17 -

[*17] property, must be capitalized, even though, standing alone, the item may

appropriately be classified as one of repair.”).4

      In the alternative, petitioner contends that the complete replacement was

merely a conglomeration of repairs deferred from years in which she did not have

the funds to complete repairs. But this alternative argument fails for the same

reason as the argument just addressed. If petitioner did defer repairs for many

years, nevertheless she ultimately decided that complete replacement of the asset

was the proper course of action. Therefore replacement of the spring line was a

capital improvement.

      Even if the Court were to accept for the sake of argument petitioner’s claim

that the spring line was entirely replaced twice, the expenditures petitioner made

in 2010 were still part of a single general plan of rehabilitation. While it is not

altogether clear from her briefs, petitioner’s argument appears to be: (1) petitioner

completely replaced the spring line in 2009 under a plan of capital improvement;

(2) that plan of capital improvement ended when the first replacement of the

spring line was complete; (3) faulty joints and flooding required that the line be

replaced, again, in 2009 and 2010; but (4) the second replacement was merely a

repair of the asset which had been installed in 2009.

      4
          The Court will address petitioner’s flooding argument more fully below.
                                         - 18 -

[*18] But even if the spring line was replaced twice, petitioner decided to entirely

replace the spring line the second time, rather than repair it. The work in 2010

was therefore a capital improvement--it does not matter whether petitioner had no

other option than to replace the line.

      And in any event, the work completed in 2010 was merely a continuation of

the capital improvement begun in 2009 with the first replacement of the line.

“Unanticipated expenses that would be deductible as business expenses if incurred

in isolation must be capitalized when incurred pursuant to a plan of

rehabilitation.” Norwest Corp. v. Commissioner, 108 T.C. at 280 (citing Cal.

Casket Co. v. Commissioner, 19 T.C. 32 (1952)). If, as petitioner claims, the

spring line was replaced twice because of failure of joints or because of flooding,

nevertheless all of these expenditures were unanticipated expenses incurred in

pursuit of the overall goal of the first plan of rehabilitation, namely, to replace the

old spring line with a new and working spring line. Cf. Bank of Houston v.

Commissioner, T.C. Memo. 1960-110, 1960 Tax Ct. Memo LEXIS 175, at *12

(“The Code * * * does not envision the fragmentation of an over-all project for

deduction or capitalization purposes.”).

      Petitioner argues against this conclusion, again contending that the alleged

second replacement of the spring line, or at least work done to a spring box and
                                         - 19 -

[*19] pressure tank (specific components of the spring line), were repairs required

because of damage from large water flows across the property in 2010.

Respondent argues that petitioner has not established that these water flows ever

occurred and that therefore petitioner has not met her burden to show that

replacement of the line was a repair. As the Court will describe in the next few

paragraphs, after careful review of the record the Court finds that petitioner has

not met her burden to show that any water damage to the spring line was not a

direct result of--and therefore an unanticipated expense relating to--her capital

improvement program.

      On the basis of consistent statements across the entire record, the Court is

satisfied that (1) relevant parts of petitioner’s property are on a relatively steep

grade; (2) the surface is relatively loose and gravely over most of petitioner’s

property; and (3) in 2009 and 2010 petitioner’s property experienced high amounts

of rainfall. (Petitioner testified that “in 2010 we had heavy rains. We also had

flooding issues. The high water * * * ran longer and harder than normal.”)

      Petitioner explained that the spring head is in a “gulch”. This gulch is

visible on the map of the property that she provided. See infra appendix Exhs. 17-

P, 23-R. According to petitioner’s map, the spring head is toward the bottom of

the gulch (in the northern part of the gulch). Petitioner’s south field and the
                                        - 20 -

[*20] Stubbs pad are above the spring head to the south-southwest (the Stubbs pad

is to the south of petitioner’s south field). It may be true that runoff from the

Stubbs pad went down through the gulch. But given the topography of the

southern portion of petitioner’s property, it must also be true that the gulch

naturally collects runoff from a portion of the southernmost part of petitioner’s

land and from at least some of the land above her southern property line.

      Replacement of the entire spring line, as petitioner claims occurred, would

have necessitated digging up the portion of the spring line in the gulch. This

conclusion is supported by the report compiled by the Colorado Oil and Gas

Commission in response to petitioner’s report of an alleged 2009 Stubbs pad spill.

The report states: “In physical investigations it was clear that a significant amount

of water had flowed down the gully from the Stubbs pond causing erosion of

recently excavated ground and damaging the spring”. (Emphasis added.) That is,

the ground damaged by runoff in 2009 had been recently disturbed.

      Putting all this together, the Court concludes that--whether or not there was

a discharge of water from the Stubbs pad--petitioner has not met her burden to

show that any damage to the spring line was anything other than an unanticipated

expense relating to replacement of the spring line. In 2009 petitioner dug a four-
                                           - 21 -

[*21] foot-deep trench5 to replace the pipe the first time, in the process necessarily

breaking up any surface vegetation or soil compaction that would naturally retard

erosion and hold the soil in place. She dug this ditch at the bottom of a gully that

provides natural drainage on a relatively steep grade for at least a couple dozen

acres, and the ditch was roughly parallel to the natural direction of water flow off

the bottom of the gully. No evidence in the record indicates that any form of

swale or retaining wall was installed above the spring head. As might have been

expected, some or all of the recently disturbed gravelly soil at the top of the spring

head was dislodged in 2009 by water flowing down the steep grade and through

the gulch following a heavy rain. Petitioner replaced the soil in 2009 (again, no

evidence indicates that any form of swale or retaining wall was installed above the

spring head), and according to petitioner it was again washed out in 2010 after

another period of heavy rain. Considering these facts, the Court concludes that--

whether water was discharged from Stubbs pad or not--petitioner has failed to

establish that any work done to the spring line at the spring head after the initial

replacement was anything other than continued efforts to prevent erosion that

arose as a direct result of her plan of replacement.




      5
          Petitioner testified that the trench was four feet deep.
                                        - 22 -

[*22] A similar situation occurred in Mt. Morris Drive-In Theatre Co. v.

Commissioner, 25 T.C. 272 (1955), where the taxpayer constructed a drive-in

theatre without including a drainage system for runoff from the parking area. It

became clear that the remodeled topography caused a material increase in runoff

onto abutting properties. As the Court described, id. at 274:

             Within a year after petitioner had finished its inadequate
      construction of the drive-in theatre, the need of a proper drainage
      system was forcibly called to its attention by one of the neighboring
      property owners, and under the threat of a lawsuit filed approximately
      a year after the theatre was constructed, the drainage system was built
      by petitioner who now seeks to deduct its cost as an ordinary and
      necessary business expenses, or as a loss.

The Court held that construction of the drainage system was a capital expenditure.

      Assuming that petitioner replaced the whole line in 2009, petitioner

embarked on a plan at that time to replace whatever existed before 2009 with a

working spring line, just as the taxpayer in Mt. Morris embarked on a plan to

construct a drive-in theatre. Like that of the taxpayer in Mt. Morris, petitioner’s

first attempt was inadequate because the joints failed (for whatever reason) and

because the spring head eroded (and mud washed into the line, damaging the

spring box and pressure tank, among other things). To complete her plan

petitioner claims that in 2009 and 2010 she dug out the new black pipe and

replaced it, again, with blue pipe--a more expensive, higher quality pipe.
                                         - 23 -

[*23] Petitioner also claims she repeatedly replaced the newly disturbed soil on

top of the spring head because the disturbed soil would not stay in place. These

efforts, like the efforts of the taxpayer in Mt. Morris, were the result of the capital

improvement project of the previous year and were necessary in this case to bring

a plan of capital improvement, i.e., complete replacement of the asset, to working

order. Therefore, considering all the facts and circumstances, the Court concludes

that the current case is more similar to Mt. Morris than it is to, for example, such

cases as Midland Empire Packing Co. v. Commissioner, 14 T.C. 635 (1950)

(lining basement walls with concrete to prevent seepage of oil from a neighboring

property into the basement was a repair, whose costs were immediately

deductible), or Plainfield-Union Water Co. v. Commissioner, 39 T.C. 333 (1962)

(lining a pipe with concrete after acidic water wore away the previous lining was a

repair, whose costs were immediately deductible). In those cases it was clear that

the context in which the expenditures were made was one of repair whereas in this

case there is a direct causal link between a clear plan of improvement and the

subsequent, temporally proximate, unanticipated expenditures.

      For these reasons, the Court finds that all of the expenditures relating to the

spring line must be capitalized and therefore are not deductible under section 162.
                                        - 24 -

[*24] B. Access Road Washout

      Petitioner also claims that flooding completely destroyed a portion of one of

the roads on her property, requiring her to replace it. Petitioner argues on brief:

      When the storm water was released onto petitioner’s property, a long
      portion [of the] Access road from the spring to the south field was
      washed away. The water came down and flowed south from the
      Stubbs Pad, completely washing out the gravel and road. It was as if
      it never existed because the damage was so bad. Mr. Schwartz’s
      testimony simply confirms what petitioner said about that portion of
      the Access [road], which was that it was rebuilt. [Citations of the
      record omitted.]

By petitioner’s own admission, therefore, the work done on the access road was a

complete replacement of that portion of the road, rather than maintenance of an

existing road. Like the dam in Hunter v. Commissioner, 46 T.C. at 484, described

above, the asset petitioner claims to have repaired had been completely washed

away. In other words, this is not a case involving normal grading and regraveling

of a dirt road, or repair of minor weather damage; rather, the entire portion of the

road that was destroyed had to be completely rebuilt from the ground up. Because

by petitioner’s own admission the work on the access road as a result of flooding

was a complete replacement of the portion of the road from the south field to

below the spring, it must be capitalized. (Further, petitioner has not provided

evidence sufficient to demonstrate how much was spent on the access road project;
                                        - 25 -

[*25] even if petitioner were to prevail on this issue, there is not enough in the

record to estimate an amount allocable to the access road project.6)

      C. Aggregate Cost of Spring Line and Access Road Replacement

      Petitioner describes the first project category on her allocation document as

“Damage from * * * Stubbs Well Pad”. In her opening brief petitioner explains

that this category comprises expenditures relating to “[r]epair of damage to the

Spring Line and Access Road caused by the water released from the * * * Stubbs

Well Pad ($61,161.10, plus $860.00 for the cost to repair the Spring Box)”.

Petitioner describes the second project category on her allocation document as

“Spring line Repairs”. In her opening brief, petitioner explains that this category

comprises expenditures relating to “[o]ther Spring Line repairs due to leaks and a

tank blowout ($61,610.65)”. Additionally, the record reflects that petitioner also

paid $167.50 to Mead Fencing for fencing completed as part of the spring line

replacement project.

      For the reasons provided above, all of the work on the spring line (in both

project categories, and including the related fencing cost and the cost of repairing

the spring box) must be capitalized; the replacement of the access road must also

be capitalized. In total, $123,799.25 is attributable to these two projects on the

      6
          See infra note 13.
                                        - 26 -

[*26] basis of petitioner’s allocation. This amount may not be deducted under

section 162.

      D. Storage Yard

      Petitioner claims that $16,202.50 was spent on construction of a storage

yard, and $656.80 was spent on fencing work relating to the new construction.

Mr. Schwartz testified that the storage yard did not exist before he built it.

Petitioner’s testimony supports Mr. Schwartz’ testimony. Petitioner has not

offered any argument that construction of the storage yard was anything other than

a capital improvement. Moreover, nothing in the record supports a finding that the

cost of work done to the storage yard was for any kind of repair or other

deductible expense. Petitioner’s implication appears to be that because she used

the bare patch of earth where the storage yard now sits as a parking area before the

new construction, the newly constructed yard is not a capital improvement because

it is now used for the same purpose. But new construction on top of previously

unimproved land is necessarily an “improvement”, and consequently the costs

must be capitalized. Therefore, petitioner may not deduct under section 162 the

$16,859.30 she estimated for the storage yard project.
                                          - 27 -

[*27] E. Invoice 7100

      In light of the foregoing analysis, the Court now completes its examination

of petitioner’s 2010 expenditures by looking at each of the 2010 invoices in turn.

      Invoice 7100 references excavation “in front of house”, which Mr. Schwartz

testified set a new grade around a garage near petitioner’s father’s house so that

water would drain away from the garage.7 The Court finds that the cost of the new

grade of the garage area is not deductible under section 162 because setting the

grade was a capital improvement to the garage,8 and in any event the record does

not demonstrate that this was anything other than a personal expenditure.

      In her allocation document, petitioner attributes all the expenditures listed

on Invoice 7100 to the spring line project, work done in relation to a “High Water

Ditch”, and “Tree Cutting & Removal”.9 Petitioner’s allocation document does


      7
       The Court understands “setting a new grade” to have a meaning different
from “grading a road”. When one sets a new grade around a building, for
example, one is changing the level or pitch of the ground, i.e., changing the
subgrade. “Grading a road”, on the other hand, typically means putting a finished
grade on the surface, i.e., the subgrade remains generally unchanged. The grading
around the garage changed the subgrade because it changed the drainage pattern.
      8
       No evidence suggests that the new grade was anything other than a capital
improvement; and in any event it is unclear how setting a new grade could be
anything other than a capital improvement.
      9
          Mr. Schwartz testified that the tree cutting was part of the access road
                                                                           (continued...)
                                        - 28 -

[*28] not allocate any expenditures from Invoice 7100 to the new grade project

around petitioner’s garage. That is, what appears to be a relatively substantial

number of nondeductible expenditures listed on Invoice 7100 is not accounted for

in petitioner’s allocation document. The Court therefore finds that the allocation

document does not accurately allocate the expenditures listed on Invoice 7100,

and accordingly the Court disregards the allocation document with respect to

Invoice 7100. The record is otherwise devoid of any basis on which to estimate

the number of deductible expenditures on Invoice 7100. Consequently, petitioner

may not deduct under section 162 any of the expenses listed on Invoice 7100.

      F. Invoice 7101-7102

      In her allocation document, petitioner attributes all of the expenditures on

Invoice 7101-7102 to the spring line project, “Road Maintenance”, repair of a

culvert that was destroyed by flooding, “Tree Cutting & Removal”, digging holes

for new grape plants, and spreading manure on the south field.

      The Court has held above that expenditures included in the spring line

project are not deductible under section 162. Petitioner has not argued that




      9
       (...continued)
project already discussed. As such, it is a capital expenditure.
                                       - 29 -

[*29] expenditures for digging holes for grapes plants are deductible, and in any

event section 263A requires that those expenditures be capitalized.10

      The Court also concludes that none of the “Road Maintenance”

expenditures on Invoice 7101-7102 are deductible. A substantial portion of the

“Road Maintenance” expenditures were for work done to “driveways” and work

done around a “new barn”. No evidence in the record suggests that the

“driveways” are anything other than petitioner’s personal driveways. The

expenditures on driveways are therefore not deductible under section 162 by

reason of section 262. Mr. Schwartz testified that the barn was newly constructed,

and that before the work listed on Invoice 7101-7102, there was no gravel around

the barn. The Court finds that the work done around the barn was part of the barn

construction project. It was therefore a capital improvement, and the costs may

not be deducted under section 162. Because the record provides no basis for

estimating how much of the “Road Maintenance” amount is attributable to

nondeductible expenditures, the Court finds that the whole category is not

deductible under section 162.

      10
        Sec. 263A requires that expenditures relating to tangible personal property
produced by a taxpayer must be capitalized. Sec. 263A(d)(1)(A)(ii) provides an
exception for “[a]ny plant which has a preproductive period of 2 years or less”; but
petitioner conceded during her testimony that grape vines have a preproductive
period of 4 to 10 years.
                                        - 30 -

[*30] Respondent concedes that the remaining expenditures listed, i.e., those

relating to repair of a culvert, tree cutting, and manure spreading, are deductible

under section 162, and the Court accepts respondent’s concessions. Respondent

argues, however, that petitioner’s allocation of expenses to these items is not

reasonable and therefore that no amount may be deducted. The Court notes that,

in addition to the expenditures listed on petitioner’s allocation document, Invoice

7101-7102 also indicates that Mr. Schwartz charged for moving equipment used in

several of the projects on and off site and for hauling in a stockpile of road

materials.11 That is, like Invoice 7100, Invoice 7101-7102 lists expenditures not

accounted for in petitioner’s allocation document.

      The Court is satisfied, however, that petitioner is entitled to deduct $9,000

under section 162 with respect to the culvert, tree cutting, and manure spreading.

See Cohan v. Commissioner, 39 F.2d at 544 (the Court may estimate expenses if




      11
       The record does not disclose exactly when and where these stockpiles
were used.
                                        - 31 -

[*31] there is an adequate basis for doing so).12 In total, therefore, petitioner may

deduct $9,000 of the expenditures listed on Invoice 7101-7102.

      G. Invoice 7112 and Invoice 7113

      Petitioner’s allocation document allocates all of the expenditures on

Invoices 7112 and Invoice 7113 to the spring line and storage yard projects. As

described above, the Court has found that these expenditures are not deductible.

Therefore, none of the expenditures listed on these two invoices is deductible.

      H. Invoice 7114-7115

      Petitioner’s allocation document states that all expenditures listed on

Invoice 7114-7115 are attributable to the storage yard project and to two separate

but identically titled “Weather Damage” subcategories of “Damage from * * *

Stubbs Well Pad”. As noted above, petitioner has stated that “Damage from * * *

Stubbs Well Pad” consists entirely of expenditures relating to “[r]epair of damage

to the Spring line and Access road caused by the water released from the * * *

Stubbs Well Pad”. Accordingly, because the Court held above that expenditures

relating to the storage yard, access road, and spring line projects are not deductible

      12
        The Court is satisfied that petitioner’s estimate of $1,080 with respect to
the culvert repair is accurate. The Court is also satisfied that petitioner has
provided enough of a basis to estimate expenditures for tree cutting and manure
spreading in an amount which is approximately two-thirds of the amounts
petitioner estimated.
                                       - 32 -

[*32] under section 162, no expenditures listed on Invoice 7114-7115 are

deductible.13

      I. Invoice 7116

      Invoice 7116 lists work that was apparently a continuation of work listed on

Invoice 7114-7115, i.e., the access road project. As described above, this portion

of the expenditures is not deductible under section 162. The invoice also lists

expenditures petitioner concedes are not deductible because they were personal.

      13
         For the sake of completeness the Court also notes that, even if petitioner
had not admitted that the access road project was a complete replacement of the
portion of the road replaced, the record provides no basis to estimate how much
was spent on the access road, and therefore petitioner may not deduct under sec.
162 any amount relating to the access road. It may be that petitioner meant the
Court to infer that one of the “Weather Damage” subcategories relates to the
spring line project and one to the access road project; but Invoice 7114-7115 also
lists unrelated weather damage near petitioner’s father’s house, so it may also be
that one of the “Weather Damage” subcategories refers to that project and the
other “Weather Damage” subcategory relates to both the spring line and access
road projects.

      Additionally, Invoice 7114-7115 lists expenditures not accounted for
anywhere: The invoice states that Mr. Schwartz moved baskets of dirt and
concrete forms, established a grade around one of the houses and one of the
garages, and worked on a driveway. These unallocated expenditures appear to be
personal (the record does not provide a basis for any other conclusion) and
therefore may not be deducted under sec. 162.

      In short, the Court has carefully reviewed Invoice 7114-7115 and all related
evidence, and finds that as a result of the irregularities and ambiguities just
described, the record does not provide sufficient basis to make an estimate of the
access road expenditures.
                                       - 33 -

[*33] These personal expenditures are not accounted for anywhere in petitioner’s

allocation document.

      In addition to the access road and personal expenditures, Invoice 7116 also

lists expenditures on a road from “Kuiper’s Gate” to the access road below the

spring area, i.e. Kuiper Road. Curiously, petitioner’s allocation document

indicates that “Kuiper gravel & grade” expenditures listed on Invoice 7116 are a

subcategory of “Damage from * * * Stubbs Well Pad”. As described above,

petitioner’s brief describes the “Damage from * * * Stubbs Well Pad” category as

comprising expenditures relating to the spring line and access road projects,

whereas Mr. Schwartz clearly testified (and petitioner’s map shows) that Kuiper

Road is a different road.

      The Court has carefully reviewed Invoice 7116 and all related evidence, and

concludes that (1) the irregularity with respect to the Kuiper Road expenditures

and (2) the unallocated personal expenditures appearing on Invoice 7116

considerably undermine the allocation document with respect to this invoice. The

Court finds as a result that there is insufficient evidence on which to make an

estimate of deductible expenses and holds that none of the expenditures listed on

Invoice 7116 is deductible under section 162.
                                        - 34 -

[*34] J. Mead Fencing Invoices

      As noted above, expenditures on the two invoices from Mead Fencing relate

to the spring line and access road projects and are therefore not deductible.

      K. Conclusion

      In sum, for 2010 petitioner may deduct $9,000 out of the $199,031

disallowed by respondent. The remainder is not deductible under section 162.

V. 2011 Expenditures

      As petitioner claims, the “only work for which a deduction was claimed in

2011, involved removing burned tree stumps and boulders from the Burn Area.”

Petitioner testified that the reason for removing the stumps and boulders was to

bring the land back to productive use following a fire.

      Petitioner offered no argument in her opening brief to address whether the

2011 expenditures may be deducted; the Court could therefore deem petitioner to

have waived or conceded this issue but will nevertheless consider the merits.

      Petitioner testified that the burn area rehabilitation project “is going to be a

long-term process. Decades before it even grows forage as it would normally do

in that area.” Respondent’s opening brief argues that the 2011 expenditures are

part of a plan of rehabilitation under Wehrli, 400 F.2d at 689. In her answering

brief, petitioner argues that (1) respondent has offered no evidence of a plan of
                                        - 35 -

[*35] rehabilitation, (2) the expenditures did not improve the land or the value of

the land, (3) the work was not extensive, (4) the work was not directed at adapting

the burn area to a new or different use, and (5) the expenditures are repairs under

R.R. Hensler v. Commissioner, 73 T.C. 168 (1979). The Court will address each

argument briefly.

      First, the burden is on petitioner to prove her case. Respondent is not

required to offer evidence to prove that petitioner had a formal plan. Moreover,

the evidence in this case clearly shows that petitioner has developed a plan of

rehabilitation for the burn area; petitioner said as much. Second, petitioner clearly

thinks that the expenditures will improve (over a very long period) both the land

and the value of the land; it is difficult to understand why petitioner would have

spent $47,630 otherwise. Third, the work was clearly extensive as it involved

removal of stumps and boulders, at significant expense, from the entire burn area,

which petitioner testified comprises about 26 acres.

      Fourth, petitioner testified that before the fire the burn area was used for

“shade and privacy for the property. Shade and a little bit of grazing for horses or

cattle.” The Court understands this statement to mean that a small portion of the

burn area was used for grazing before the fire and the rest of the burn area had no
                                        - 36 -

[*36] relation to petitioner’s business.14 After the fire petitioner cleared the whole

26-acre area for future use in the production of forage. That is, before the fire, a

small portion of the area was used for grazing and forage, whereas after the fire,

the whole area was converted to that use. On these facts the Court is unable to

conclude that petitioner’s expenditures did not adapt a significant portion of the

land to a new use. Accordingly, the Court rejects petitioner’s argument that her

plan of rehabilitation did not adapt the area to a new or different use.

      Finally, with respect to petitioner’s last argument, R.R. Hensler v.

Commissioner, 73 T.C. at 181-182, involved repair of machinery after damage

from a flood--as the Court described:

      [M]achinery and equipment used directly in the conduct of * * * [the
      taxpayer’s] business was damaged by a flood, and the expenditures
      were made to recover and repair the equipment for further use in the
      business. How long the equipment would be used after it was repaired
      is not apparent from the record, but a major portion of it would
      apparently be used only to complete the contract, and the repairs did
      not extend its useful life or improve it over its condition prior to the
      flood. * * *

R.R. Hensler is distinguishable because a major portion of the repairs held to be

deductible in that case served to complete the immediate contract, whereas as

described above petitioner appears to have changed her use of the property from

      14
        Petitioner provided no clearer statement explaining the use of the burn
area before and after the fire.
                                          - 37 -

[*37] mostly undeveloped land before the fire to forage or pasture land after the

fire--i.e, some substantial portion of the expenditures appears to have been

directed at developing a business use for the burn area.

      Accordingly, the Court sustains respondent’s determination that petitioner

may not deduct under section 162 any of the $47,630 of 2011 deductions

disallowed in the notice of deficiency.

VI. 2010 Section 6662(a) Penalty

      Section 6662(a) imposes a penalty of 20% on the portion of an

underpayment attributable to any one of various factors, including “[n]egligence

or disregard of rules or regulations” and “[a]ny substantial understatement of

income tax.” Sec. 6662(a) and (b)(1) and (2).15 Respondent has determined a

section 6662(a) penalty on petitioner’s 2010 underpayment for both reasons.




      15
         Respondent has the burden of production with respect to penalties. Sec.
7491(c). In Graev v. Commissioner, 149 T.C. ___ (Dec. 20, 2017), supplementing
and overruling in part Graev v. Commissioner, 147 T.C. ___ (Nov. 30, 2016), the
Court held that showing compliance with sec. 6751(b) is part of the Commis-
sioner’s burden of production under sec. 7491(c) for those penalties to which sec.
6751(b) applies. This case was submitted before these developments. Consequent-
ly, the parties have not addressed the application of sec. 6751(b) to this case in the
light of Graev. It is, however, unnecessary to consider whether the requirement of
sec. 6751(b) applies or is met in this case because on the basis of the specific facts
of this case and for the reasons specified below the Court has determined that the
sec. 6662 penalty does not apply.
                                        - 38 -

[*38] A penalty under section 6662(a) does not apply to any part of an

underpayment of tax if there was reasonable cause for such portion and the

taxpayer acted in good faith with respect to such portion. Sec. 6664(c)(1).

Petitioner bears the burden of proving reasonable cause and good faith. See

Higbee v. Commissioner, 116 T.C. 438, 449 (2001). “Circumstances that may

indicate reasonable cause and good faith include an honest misunderstanding of

fact or law that is reasonable in light of all the facts and circumstances, including

the experience, knowledge, and education of the taxpayer.” Sec. 1.6664-4(b)(1),

Income Tax Regs.

      Respondent determined a section 6662(a) penalty with respect to 2010 only.

Petitioner was ultimately incorrect in her attempt to claim the deductions the Court

has disallowed with respect to 2010. Considering all of petitioner’s testimony and

the documentary evidence she submitted, the Court is nevertheless satisfied that

even though she spent extensive time and effort researching and preparing her tax

return petitioner honestly misunderstood both the facts and the law applicable to

her case. Taking into account petitioner’s relative inexperience preparing tax

returns, her lack of knowledge with respect to the sometimes complicated issue of

whether an expenditure must be capitalized, and the fact that she did have

extensive records showing in detail the expenditures that had been made, the Court
                                       - 39 -

[*39] concludes on the basis of the entire record that petitioner has shown

reasonable cause and good faith with respect to her entire 2010 underpayment.

Accordingly, the Court does not sustain the section 6662(a) penalty.

      To reflect the foregoing,


                                                      An appropriate order will be

                                                issued, and decision will be entered

                                                under Rule 155.
                                       - 40 -

[*40]                               APPENDIX

Exhibit 17-P

                                 Aerial Map Legend

1.      Damage from WPX Stubbs Well Pad

2.      Spring Line Repairs

3.      Road Maintenance

4.      High Water Ditch Damage

5.      Tree Cutting & Removal

6.      Grape Holes

7.      South Field Manure Spread

8.      Storage Yard

9.      Mead Fencing Repairs

10.     Burn Area
        - 41 -
[*41]
                     - 42 -

[*42] Exhibit 23-R
