                             T.C. Summary Opinion 2019-2



                            UNITED STATES TAX COURT



                   THAD MARSHALL PUGH, Petitioner v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 13462-16S.                            Filed February 28, 2019.



      Peter A. Lowy, for petitioner.1

      Lewis A. Booth II, for respondent.



                                 SUMMARY OPINION


      CARLUZZO, 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.2 Pursuant to section 7463(b), the decision to be entered is not

      1
        Mr. Lowy’s appearance was entered on the day of trial as a result of his
participation in a pro bono program sponsored by the American Bar Association.
      2
          Unless otherwise indicated, section references are to the Internal Revenue
                                                                          (continued...)
                                         -2-

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

for any other case.

      In a notice of deficiency (notice) dated March 7, 2016, respondent

determined deficiencies in petitioner’s 2010 and 2011 Federal income tax and

imposed additions to tax under sections 6651and 6654.

      After significant concessions by both parties, the issues for decision for

each year are whether petitioner is entitled to deductions for (1) mortgage interest

and (2) legal fees claimed on Schedules C, Profit or Loss From Business, included

with his untimely (and apparently unprocessed) Federal income tax returns.3

                                     Background

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

petition was filed, petitioner resided in Texas.

      During each year in issue petitioner, who holds a bachelor of science degree

in electrical engineering, was the sole proprietor of Pi Integrated Systems (Pi). At



      2
        (...continued)
Code of 1986 as amended, in effect for the years in issue, and Rule references are
to the Tax Court Rules of Practice and Procedure.
      3
        All of the adjustments made in the notice have been resolved between the
parties. The issues that remain in dispute arise from deductions claimed on the
untimely Federal income tax returns submitted to respondent, one after the notice
was issued.
                                        -3-

all times relevant, Pi was engaged in the business of software development. Pi had

few employees during the years in issue, and the business was conducted from an

office in petitioner’s house. In earlier years things looked good, and petitioner had

a plan to expand the business.

      In business sometimes things do not go as planned.

      In 2005 and 2006 petitioner purchased two vacant lots, one adjacent to land

he already owned and the other directly across the street (properties). He had to

borrow money to do so, and he paid interest on those loans during each of the

years in issue. Later he purchased two steel buildings, disassembled them, and

stored some of the components on one of the properties. His plan was to re-

assemble the buildings on the properties as shown on a site plan prepared by an

architect in 2007. Petitioner intended that the reassembled buildings would serve

as Pi’s “headquarters”.

      Circumstances, however, did not cooperate. Before petitioner’s plan could

be put into effect, Pi lost a major customer, revenues sharply decreased, and later

some of its employees left to work for other employers. As of the date of trial, the

properties, some of which were sold, remained undeveloped, and some of the

components of the steel buildings were sold as scrap metal.
                                       -4-

      Petitioner submitted 2010 and 2011 Federal income tax returns to

respondent long after each was due. Each included a Schedule C for Pi, and each

Schedule C included numerous deductions. We need to focus on only two

deductions for each year: (1) a deduction for mortgage interest and (2) a

deduction for legal fees. Respondent allowed most of the deductions claimed for

legal fees; the deductions for mortgage interest have been disallowed.

                                    Discussion

      As we have observed in countless opinions, deductions are a matter of

legislative grace, and the taxpayer bears the burden of proving entitlement to any

claimed deduction.4 Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

      A taxpayer claiming entitlement to a deduction must demonstrate that the

deduction is allowable pursuant to some statutory provision and must further

substantiate that the expense to which the deduction relates has been paid or

incurred. See sec. 6001; Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975),

aff’d, 540 F.2d 821 (5th Cir. 1976); sec. 1.6001-1(a), Income Tax Regs.




      4
        Petitioner does not claim and the record does not show that the provisions
of sec. 7491(a) are applicable, and we proceed as though they are not.
                                        -5-

Mortgage Interest

      Section 163(a) provides: “There shall be allowed as a deduction all interest

paid or accrued within the taxable year on indebtedness.” This general rule is

simple and seemingly should resolve the dispute between the parties on the point.

It is undisputed that the interest as shown on the Schedules C was paid on the

indebtedness created by the acquisition of the properties. But the simple general

rule in subsection (a) is followed by no less than 13 other subsections, some

including multiple paragraphs, subparagraphs, clauses, and subclauses, that

establish a variety of limitations and exceptions to the general rule. We need to

concern ourselves with only some of the exceptions.

      The first is subsection (d). According to respondent, the interest deductions

here in dispute are limited by section 163(d) that provides that a taxpayer, other

than a corporation, may deduct “investment interest” only to the extent of

investment income. For purposes of section 163(d) and in general, “investment

interest” means interest that is “paid or accrued on indebtedness properly allocable

to property held for investment.” Sec. 163(d)(3)(A). According to respondent,

because the properties were never actually used in petitioner’s trade or business,

the properties must be treated as property held for investment. Because petitioner

does not claim to have enjoyed any investment income during either year in issue,
                                         -6-

respondent argues that petitioner is not entitled to deduct any of the interest paid

in connection with the indebtedness that burdens the properties.

      But “property held for investment” is specifically defined in section

163(d)(5), and the properties do not fit within that definition. Consequently, the

interest paid to finance the acquisition of the properties is not treated as

investment interest, and petitioner’s entitlement to deductions for that interest is

not, as respondent argues it is, subject to limitation under section 163(d). That

does not, however, end the matter.

      Another exception to the general rule that must be taken into account is

section 163(h) that provides that a taxpayer, other than a corporation, is not

entitled to a deduction for personal interest. For purposes of section 163(h) and as

relevant here, “interest paid or accrued on indebtedness properly allocable to a

trade or business” is excluded from the exception. Sec. 163(h)(2)(A).

      As respondent notes, the properties were not actually used in petitioner’s

trade or business during the years in issue. Nevertheless, we are satisfied that the

properties were certainly “allocable” to that business. Consequently, the interest

paid in connection with the indebtedness on the properties is not treated as

personal interest. Respondent does not suggest that any of the other exceptions or

limitations to the general rule set forth in section 163(a) are applicable, and we are
                                         -7-

satisfied that none are. That being so, we find that petitioner is entitled to the

deduction claimed for mortgage interest for each of the years in issue. We further

find that because the deduction for each year is “allocable” to petitioner’s trade or

business, the deduction is properly taken into account in the computation of

petitioner’s adjusted gross income. See sec. 62(a)(1).

Legal Fees

      Respondent has already allowed all but small portions of the deductions

claimed for legal fees on the Schedules C included with the untimely returns. No

explanation has been provided that shows why some portions were allowed and

others not. But more significantly, petitioner has not established the nature of the

legal services, how the legal services relate to his trade or business, or the amounts

actually paid or incurred for those legal services. Given the small amounts

involved, we can understand the parties’ failure to address the items; but that small

amounts remain in dispute does not relieve petitioner of his burden to prove

entitlement to all of the deductions claimed.

      The parties stipulated the proper deduction for legal fees and expenses for

each year; nevertheless, both proceeded as though the small amount that

respondent has not allowed for each year remains in dispute. We will follow their

lead and ignore the stipulation; however, there is really not much for us to do.
                                         -8-

Because petitioner has failed to establish the nature of the legal services involved,

how those services relate to his trade or business, or the amounts actually paid or

incurred for those services, he is not entitled to a deduction for legal fees in excess

of the amount already allowed by respondent for each year in issue.

      To reflect the foregoing and the concessions of the parties,


                                               Decision will be entered under

                                        Rule 155.
