                              T.C. Memo. 2015-138



                         UNITED STATES TAX COURT



          HENRY J. HAFF AND DIANE M. LIS HAFF, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 6500-13.                           Filed August 3, 2015.



      William H. O’Toole, for petitioners.

      Alexander R. Roche, for respondent.



                           MEMORANDUM OPINION


      PUGH, Judge: In a notice of deficiency dated March 12, 2013, respondent

determined a deficiency in petitioners’ 2009 Federal income tax of $263,015.

      The issue for decision is whether petitioners are entitled to an additional

$730,786 in deductions related to a loss from a Ponzi scheme for the taxable year
                                           -2-

[*2] 2009. The disallowance of their deductions gives rise to the deficiency in this

case.

                                      Background

        This case was submitted fully stipulated under Rule 122.1 The stipulated

facts are incorporated in our findings by this reference. Petitioners resided in the

State of Illinois at the time they filed their petition.

        In 2005 Mr. Haff began to invest in GSH Development, LLC (GSH),

through his single-member LLC, HJH Hinsdale. GSH was a joint venture between

Mr. Haff and Grant Street Investors, LLC (Grant Street), formed to develop

condominiums and townhomes in Hinsdale, Illinois. WexTrust Capital, LLC

(WexTrust), directly or indirectly owned Grant Street. Neither party disputes, and

the regulations prescribe, that GSH should be treated as a partnership for Federal

tax purposes, although GSH never filed a Form 1065, U.S. Return of Partnership

Income, or provided petitioners with a Schedule K-1, Partner’s Share of Income,

Deductions, Credits, etc. See sec. 301.7701-3, Proced. & Admin. Regs. In 2005




        1
        Unless otherwise indicated, all Rule references are to the Tax Court Rules
of Practice and Procedure, and all section references are to the Internal Revenue
Code of 1986, as amended, in effect for the year in issue.
                                        -3-

[*3] Mr. Haff made a $1 million initial investment in GSH. Between 2005 and

2010 Mr. Haff contributed an additional $337,690 to GSH to cover expenses.2

      On August 11, 2008, the Securities and Exchange Commission filed a

complaint in the U.S. District Court for the Southern District of New York against

the owners of WexTrust alleging that WexTrust was a Ponzi scheme. A court-

appointed receiver determined that continued development of the GSH project was

not economically viable. As a result petitioners concluded that their entire

investment in GSH was lost. Petitioners claimed a bad debt expense deduction of

$2,068,476 for the 2009 tax year on account of that lost investment. The bad debt

expense deduction included the $1,337,690 that Mr. Haff contributed to GSH and

the $730,786 that petitioners allege GSH owed him as fees for his services in

development, sales, marketing, and construction. The $730,786 was never

included in petitioners’ income for tax purposes.

      In the notice of deficiency respondent denied petitioners’ bad debt expense

deduction for the $1,337,690 Mr. Haff contributed to GSH and the $730,786 that

GSH owed him. Respondent allowed, however, a theft loss deduction for the


      2
        All monetary amounts are rounded to the nearest dollar. Mr. Haff’s
additional contributions included $312,500 for a lawsuit settlement on May 14,
2007, $13,848 for attorney’s fees for closing the project on August 22, 2008, and
$11,342 for miscellaneous expenses spanning the years 2005-10.
                                         -4-

[*4] amount Mr. Haff contributed but limited petitioners’ theft loss deduction to

$1,317,004. Respondent now acknowledges that petitioners’ theft losses are

exempt from itemized deduction limitations, see secs. 67(b)(3), 68(c)(3), and

therefore concedes that petitioners are entitled to a theft loss deduction for the full

amount of Mr. Haff’s $1,337,690 contribution to GSH. Petitioners assert that the

additional $730,786 is deductible as a theft loss according to the safe harbor

provision set forth in Rev. Proc. 2009-20, 2009-14 I.R.B. 749.

                                     Discussion

      Section 165 prescribes rules for the deductibility of theft losses, including

timing and amount. The parties do not dispute that petitioners suffered a theft

loss; the issue to be decided is the amount of loss that may be deducted.

Petitioners claim that the deductible loss includes amounts owed but never paid

and never taxed; respondent disagrees.

      Ordinarily, the burden of proof in cases before the Court is on the taxpayer.

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). As presented by the

parties, the determinative question in this case is legal and not factual. Therefore,

the burden of proof does not affect our analysis. See Black v. Commissioner, T.C.

Memo. 2014-27.
                                         -5-

[*5] The amount of a theft loss that is deductible generally is limited to the

adjusted basis of the property taken. See sec. 1.165-1(c), Income Tax Regs.; see

also secs. 1.165-7(b)(1), 1.165-8(c), Income Tax Regs. The property at issue is

petitioners’ investment in GSH. Under section 705 a partner’s basis generally is

composed of contributions to the partnership, see sec. 722, plus his or her

distributive share of partnership income, see sec. 703(a), less distributions and his

or her distributive share of partnership losses or expenditures, see sec. 733; sec.

1.705-1(a)(2), Income Tax Regs. Basis does not include the value of services

performed unless and until the value of those services has been subjected to tax.

See Hutcheson v. Commissioner, 17 T.C. 14, 19 (1951) (explaining that a

deduction for the taxpayer’s loss of time or the value of that lost time is disallowed

because the taxpayer has not included any amount attributable to the lost time in

gross income and therefore has no tax cost basis in the lost time that he can

deduct); see also Tonn v. Commissioner, T.C. Memo. 2001-123 (holding that the

value of taxpayer labor does not increase basis and that a taxpayer is not entitled to

a deduction for the imputed value of services that he has not been required to

report as income), aff’d, 40 Fed. Appx. 337 (8th Cir. 2002). Therefore,

petitioners’ basis in GSH equals the initial investment of $1 million plus

subsequent contributions to GSH of $337,690.
                                        -6-

[*6] Petitioners do not argue that the additional $730,786 should be deductible

under the plain text of section 165. Rather, petitioners assert that Rev. Proc. 2009-

20, supra, allows a loss deduction for amounts not previously included in income

under a safe harbor and that the safe harbor applies to the amounts that GSH owed

them. Even if the revenue procedure applies, it would not permit petitioners to

deduct the additional $730,786 on their 2009 tax return. The safe harbor provision

of Rev. Proc. 2009-20, supra, permits deductions only to the extent of a “qualified

investment”. A qualified investment is defined as the taxpayer’s total amount of

cash, or the basis of property, invested plus “[t]he total amount of net income with

respect to the specified fraudulent arrangement that, consistent with information

received from the specified fraudulent arrangement, the qualified investor

included in income for federal tax purposes for all taxable years prior to the

discovery year, including taxable years for which a refund is barred by the statute

of limitations”, minus the total cash or property that the taxpayer withdrew in all

years. Rev. Proc. 2009-20, sec. 4.06(1)(a) and (b), 2009-14 I.R.B. at 750

(emphasis added).

      Petitioners did not include the $730,786, or any portion thereof, as income

for prior years. To constitute basis, for purposes of section 165 or Rev. Proc.

2009-20, supra, the amounts owed must have been included in income for tax
                                        -7-

[*7] purposes previously. Accordingly, petitioners are entitled to a theft loss

deduction for the adjusted basis in GSH of $1,337,690, but they are denied a

deduction for the additional $730,786 they claimed was owed them but was never

paid. Because we hold that none of the additional amount may be deducted, we

need not reach the issue of substantiation of the additional amount that respondent

raised.

      To reflect the foregoing,


                                                    Decision will be entered under

                                              Rule 155.
