                   T.C. Summary Opinion 2008-146



                       UNITED STATES TAX COURT



         MARIO MARQUETTE AND SHONEISHA MYERS, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 14323-06S.             Filed November 24, 2008.



     Mario Marquette and Shoneisha Myers, pro se.

     Beth A. Nunnink, for respondent.



     WELLS, Judge:   This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect

at the time the petition was filed.1    Pursuant to section

7463(b), the decision to be entered is not reviewable by any




     1
      All section references are to the Internal Revenue Code in
effect for the year in issue.
                                 -2-

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

for any other case.

     Respondent determined a deficiency of $6,766 and an addition

to tax of $1,353.20 with regard to petitioners’ Federal income

tax for 2004.   After concessions, the issues we must decide are:

(1) Whether petitioners are entitled to deduct certain expenses

for petitioner husband’s used car sales business in excess of

those previously allowed by respondent;2 (2) whether petitioners

are entitled to deduct certain expenses for a real estate

business reported on a Schedule C, Profit or Loss From Business,

attached to their return; and (3) whether petitioners are liable

for the accuracy-related penalty under section 6662(a).

                             Background

     Some of the facts and certain exhibits were stipulated by

the parties.    We incorporate the parties’ stipulations of fact in

this Summary Opinion and the parties’ stipulations of fact are

found accordingly.

     At the time they filed their petition in the instant case,

petitioners resided in Tennessee.

     Petitioners timely filed their 2004 tax return.   Petitioners

attached to their return a Schedule C for a real estate property

business.   On the Schedule C, petitioners failed to include the



     2
      Petitioners concede that they received gross receipts of
$39,900 in the Schedule C auto sales business.
                                -3-

gross receipts and expenses for petitioner husband’s used car

sales business.

     Petitioners maintained no books or ledgers in regard to

their businesses.   Petitioners dealt primarily in cash, debit

card charges, and checks.

     In a Form 1040X, Amended U.S. Individual Income Tax Return,

that petitioners gave respondent after the notice of deficiency

was sent to petitioners, petitioners claimed that they are

entitled to certain expenses.   Petitioners assert that the Form

1040X should be accepted as the “correct activity”.

     In the Form 1040X, petitioners included $39,900 of

gross receipts from the used auto sales business.   On the Form

1040X, petitioners also reported the following amounts on a

Schedule C:   cost of goods sold of $35,325, advertising expenses

of $644, car and truck expenses of $528, legal and professional

services expenses of $260, telephone expenses of $852, and office

expenses of $1,686.

     In the notice of deficiency, respondent disallowed the

claimed deductions for the real estate property business,

included the income of $39,900 for the used car sales business,

allowed $27,400 for cost of goods sold, and allowed deductions of

$1,086 for repairs and maintenance, $582 for commissions and

fees, and $5,175 for cost of labor.
                                -4-

                            Discussion

     Generally, deductions are a matter of legislative grace, and

the burden of clearly showing the right to claimed deductions is

on the taxpayer.   Welch v. Helvering, 290 U.S. 111 (1933).

Section 162(a) allows the deduction of “ordinary and necessary

expenses” incurred while carrying on a trade or business.     Cost

of goods sold is an offset to gross receipts in determining gross

income.   Sec. 1.61-3(a), Income Tax Regs.   Accordingly, cost of

goods sold is not treated as a deduction and is not subject to

requirements for deductions contained in sections 162 and 274.

Metra Chem Corp. v. Commissioner, 88 T.C. 654, 661 (1987).

However, any amount claimed as cost of goods sold must be

substantiated, and section 6001 requires a taxpayer to maintain

adequate books of accounts or records that are sufficient to

establish the amount of gross income, deductions, or other

matters required to be shown by such persons on their tax return.

See Nunn v. Commissioner, T.C. Memo. 2002-250.

     If a taxpayer establishes that a deductible expense has been

paid but is unable to substantiate the precise amount, the Court

may estimate the amount of the deductible expense bearing heavily

against the taxpayer whose inexactitude in substantiating the

amount of the expense is of his own making.    Cohan v.

Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930).    An estimate
                                -5-

is only possible, however, if the taxpayer presents evidence

sufficient to provide some basis upon which an estimate can be

made.   Vanicek v. Commissioner, 85 T.C. 731, 743 (1985).    We

address below the issues presented by the parties.

I.   Cost of Goods Sold and Deductions and Expenses for the Used

Car Sales Business

      Petitioners claimed the following cost of goods sold and

expenses in the Form 1040X:   cost of goods sold of $35,325,

advertising expenses of $644, car and truck expenses of $528,

legal and professional services expenses of $260, telephone

expenses of $852, and office expenses of $1,686.     As petitioners

assert that the Form 1040X furnished to respondent is correct, we

deem conceded any other amounts claimed by petitioners.

      A. Cost of Goods Sold

      For cost of goods sold, petitioners reported inventory at

the beginning of year of $33,825, no inventory at the end of the

year, and cost of labor of $1,500, for cost of goods sold of

$35,325.   However, petitioners had previously provided to

respondent cash receipts for cost of labor of $5,175, which

respondent allowed in the notice of deficiency.    Respondent

allowed inventory of $27,400 and cost of labor of $5,175, for

total cost of goods sold of $32,575.

      Petitioners offered an auto repair order dated July 31,

2004, for a 1994 Audi.   The record does not indicate whether the
                                 -6-

amount stated in the auto repair order was actually paid.

Petitioners had previously provided to respondent a “cash

receipt” dated August 18, 2004, for the 1994 Audi for $375, and

respondent allowed the $375 for the 1994 Audi in cost of labor.

In the notice of deficiency, respondent allowed more cost of

labor than petitioners claimed in the Form 1040X.

     Petitioners dealt mainly in cash.   Petitioners offered no

documents regarding inventory and cost of goods sold.

     On the basis of the record, we hold that petitioners have

not shown that they are entitled to any additional cost of labor

beyond the amount allowed by respondent in the notice of

deficiency.

     B. Commissions and Fees

     In the notice of deficiency, respondent allowed fees of

$582.   Petitioners offered 11 receipts from a “Commercial

Appeal”.    Of those receipts, respondent allowed as expenses some

of the debit card charges labeled Trade Pub, Shoppers Press, or

Commercial Appeal.   Petitioners have failed to offer any invoices

or receipts that show the business purpose of the payments to

Trade Pub, Shoppers Press, or Commercial Appeal.    Petitioners

used their checking account for both personal and business

expenses.   On the basis of the record, we conclude that

petitioners have failed to show that the remaining debit card

charges for Trade Pub, Shoppers Press, and the Commercial Appeal
                                  -7-

were business expenses.   Accordingly, we hold that petitioners

are not entitled to any additional fees beyond the amount allowed

by respondent in the notice of deficiency.

     C. Car and Truck Expenses

     Petitioners claim they are entitled to a deduction of $528

for car and truck expenses.   Petitioners offered one auto fuel

receipt for $12 from Kroger, but the record contains no evidence

as to any car and truck expenses.

     Car and truck expenses are subject to the strict

substantiation requirements found in section 274(d).    See also

sec. 280F(d)(4)(A)(i) and (ii).    The taxpayer must provide

documents that corroborate by adequate records or by sufficient

evidence the amount of the expense, the mileage for each business

use of the automobile and the total mileage for all uses of the

automobile during the taxable period, the date of the business

use, and the business purpose for the use.    Sec. 1.274-5T(b)(6),

Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).

The taxpayer must substantiate each element of an expenditure or

use by adequate records or by sufficient evidence.    Sec. 1.274-

5T(c), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6,

1985).

     Petitioners have failed to meet the strict substantiation

requirements.   Consequently, we hold that they are not entitled

to deduct car and truck expenses.
                                  -8-

     D. Legal and Professional Services

     Petitioners claim they are entitled to deduct expenses of

$260 for legal and professional services.       At trial, petitioners

offered an invoice dated August 31, 2004, of $500 for tax

preparation fees.   Petitioner husband testified that the invoice

was for the 2004 tax return.    However, the document appears to be

the tax preparation fees for petitioners’ individual income

returns for 2001, 2002, and 2003.       Petitioners claimed tax

preparation fees of $250 on their Schedule A of Form 1040X.       No

checks or cash receipts are in the record to show that the $500

invoice actually was paid.    The record contains no other evidence

of any expenses for legal or professional services for the used

car sales business.    On the basis of the record, we hold that

petitioners are not entitled to a deduction for legal or

professional services.

     E. Telephone Expenses

     Petitioners claimed telephone expenses of $852.        Cellular

phones are included in the definition of “listed property” for

purposes of section 274(d)(4) and are thus subject to the strict

substantiation requirements of section 274(d).      See sec.

280F(d)(4)(A)(v).     Gaylord v. Commissioner, T.C. Memo. 2003-273.

A taxpayer must establish the amount of business use and the

amount of total use for the property in order to substantiate the

amount of expenses for listed property.       Nitschke v.
                                 -9-

Commissioner, T.C. Memo. 2000-230; sec. l.274-5T(b)(6)(i)(B),

Temporary Income Tax Regs., supra.

    Petitioners offered records for Cingular and BellSouth

cellular phone accounts.    However, petitioners offered no

evidence that such phones were business phones or, if they were,

the amount of business conducted with such phones.    The Cingular

bills appear to be for two phone numbers, which appear to share

minutes.   Petitioners offered no evidence as to why two phones

would be necessary for the Schedule C business.    Petitioners

offered partial account information for October 28 through

December 28, 2004.   While the only payment shown on the Cingular

account is an $80.18 payment on December 15, 2004, the detailed

account information shows a large portion of the calls being made

between the two phones.    We conclude that petitioners have not

shown that the cellular phones are used solely for business.

Consequently, we hold that petitioners are not entitled to

deductions for the cellular phone expenses.

     F. Office Expenses

     Petitioners claimed office expenses of $1,686.   Computer or

peripheral equipment is included in the definition of listed

property for purposes of section 274(d)(4) and is thus subject to

the strict substantiation requirements of section 274(d).     See

sec. 280F(d)(4)(A)(iv).    Petitioners offered a “missing receipt

affidavit” for a computer and accessories that totaled $1,686.
                                 -10-

No additional evidence was offered at trial showing that

petitioners incurred expenses for a computer and accessories.

The receipts, invoices, and other records petitioners offered did

not indicate that petitioners owned a computer.    Petitioners

offered no computer generated books, ledgers, or other records

that would indicate a computer was used in petitioners’

businesses.   We conclude that petitioners have failed to show any

business usage of a computer.    Consequently, we hold that

petitioners are not entitled to deductions for the claimed office

expenses.

II.   Expenses for the Real Estate Business

      On October 8, 2004, petitioners purchased a single-family

residence located at 1650 Hanauer Street, Memphis, Tennessee (the

Hanauer property) for $16,000.    Petitioners converted the Hanauer

property to a six-unit apartment building.    On their return,

petitioners deducted expenses related to the Hanauer property.

      The costs of starting up a new income producing activity are

“inherently capital because they are expenses of creating or

acquiring a capital asset.”     Hardy v. Commissioner, 93 T.C. 684,

690 (1989), affd. in part and remanded in part per order (10th

Cir., Oct. 29, 1990).   Expenses must relate to trades or

businesses functioning at the time the expenses are incurred.

Id. at 688.   Pursuant to section 263(a), capital expenses include

items that would be currently deductible but for the fact they
                                 -11-

are expended for the acquisition or permanent improvement of a

capital asset.   A taxpayer’s pre-opening expenses are not

ordinary expenses, but capital expenditures.    Hardy v.

Commissioner, supra at 690.

     The receipts, invoices, and contracts offered by petitioners

relating to the Hanauer property appear to relate to the

conversion of the single-family residence into six apartments.

Although petitioners claim an apartment was rented during 2004,

petitioners’ return does not report any rent.    Moreover, the

record shows that petitioners never obtained a certificate of

occupancy for the Hanauer property.

     Petitioners provided a month-to-month lease agreement dated

December 16, 2004, for apartment #3 of the Hanauer property.

However, as stated above, petitioners did not report any rental

income for taxable year 2004 on either their Form 1040, U.S.

Individual Income Tax Return, or their unfiled Form 1040X

prepared by their accountants.    Moreover, the building permit

dated November 11, 2004, specifically states it is for a single-

family residence.   The record discloses that a permit was not

requested for a multifamily residence until 2005.    Additionally,

the record does not show that any certificate of occupancy has

been issued for the Hanauer property.    The single-family permit

issued in 2004 expired on June 9, 2005, without any inspection or

certificate of occupancy.   Additionally, it appears that
                                 -12-

significant work remained to be done on the Hanauer property at

the close of 2004.    On the basis of the record, we hold that

petitioners have failed to prove that the Hanauer property was

placed in service during 2004.    Accordingly, we hold that the

expenses in issue are pre-opening expenses and are capital

expenditures that are not currently deductible.      Respondent also

contends that petitioners have failed to substantiate the

expenses.     However, on the basis of our holding that the expenses

are all pre-opening expenses, we need not address that issue.

III.    The Accuracy-Related Penalty Under Section 6662(a)

       Section 6662(a) and (b)(1) and (2) imposes a penalty on the

portion of a taxpayer’s underpayment of tax which is attributable

to a substantial understatement of income tax, negligence, or

disregard of rules or regulations.      A “substantial

understatement” of income tax exists for any taxable year when

the amount of the understatement exceeds the greater of $5,000 or

10 percent of the tax required to be shown on the return.      Sec.

6662(d)(1).    Negligence is any failure to make a reasonable

attempt to comply with the provisions of the Internal Revenue

Code, and disregard is any careless, reckless, or intentional

disregard.    Sec. 6662(c).   Negligence includes the failure of a

taxpayer to keep proper records or to substantiate his reported

expenses.    Sec. 1.6662-3(b)(1), Income Tax Regs.    Pursuant to
                                 -13-

section 7491(c), the Commissioner bears the burden of production

with respect to the imposition of any penalty.

     Petitioners failed to maintain books, ledgers, and financial

records for the used car sales business and real estate business.

Petitioners failed to report the used car sales business on their

return that they filed.   Petitioners dealt mainly in cash and did

not have receipts, invoices, or contracts for many of the claimed

expenses.   On the basis of the record, we conclude that

petitioners were negligent.   Consequently, we hold that

petitioners are liable for the penalty under section 6662.

     We have considered all of the contentions and arguments of

the parties, and to the extent not discussed herein, we conclude

that they are without merit, irrelevant, or moot.

     To reflect the foregoing,


                                             Decision will be entered

                                        for respondent.
