                                T.C. Memo. 2013-25



                          UNITED STATES TAX COURT



                   RAMON REYNOSO, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket Nos. 5475-10, 17215-10.                Filed January 22, 2013.



      Russell P. Briesacker, Jr., for petitioner.

      Mindy S. Meigs, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      MARVEL, Judge: In notices of deficiency for 2006 and 2007 respondent

determined the following deficiencies and additions to tax with respect to

petitioner’s Federal income tax:
                                           -2-

[*2]                                                 Additions to tax
   Year        Deficiency       Sec. 6651(a)(1)      Sec. 6651(a)(2)      Sec. 6654(a)

   2006         $229,591           $51,487               $34,324                $10,825
   2007          379,339            85,351                43,624                 17,265

In an amended answer respondent asserted an increased deficiency and increased

additions to tax for 2006. The deficiencies and additions to tax with respect to

petitioner’s Federal income tax in dispute are as follows:

                                                     Additions to tax
   Year        Deficiency       Sec. 6651(a)(1)      Sec. 6651(a)(2)       Sec. 6654(a)

   2006         $313,800           $70,434               $78,259                $14,810
   2007          379,339            85,351                43,624                 17,265

After concessions,1 the issues for decision are: (1) whether petitioner had

unreported income of $207,400 and $1,055,000 for 2006 and 2007, respectively;

(2) whether and to what extent petitioner is entitled to business expense

deductions for the years at issue; (3) whether petitioner is liable for self-


      1
        In a stipulation of settled issues the parties stipulated that for 2006 petitioner
did not receive wages of $25,419 as set forth in the notice of deficiency and that
petitioner received interest income of $20. At trial respondent conceded that
petitioner is entitled to joint filing status, and the parties agreed that petitioner is
entitled to three dependency exemptions for 2006.

       For 2007 respondent has conceded that petitioner is entitled to a married
filing separately status. At trial the parties agreed that petitioner is entitled to three
dependency exemptions for 2007. With the exception of the issues addressed in this
opinion, the remaining adjustments are computational.
                                          -3-

[*3] employment tax for the years at issue; (4) whether and to what extent petitioner

must recognize short-term capital gain from the sale of a property in 2006; (5)

whether petitioner is entitled to joint filing status for 2007; and (6) whether

petitioner is liable for additions to tax under sections 6651(a)(1)2 and (2) and 6654

for the years at issue.3

                                FINDINGS OF FACT

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

facts is incorporated herein by this reference. Petitioner resided in California when

he filed his petition.




       2
        Unless otherwise indicated, all section references are to the Internal Revenue
Code (Code), as amended and in effect for the years at issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure. Some monetary amounts
have been rounded to the nearest dollar.
       3
        In his opening brief petitioner raised two new issues: (1) whether he is
entitled to itemized deductions claimed on a Schedule A, Itemized Deductions, with
respect to the real property taxes and interest related to the property he sold in 2006;
and (2) if we disallow petitioner’s claimed joint filing status for 2007, whether he is
obligated to report only half of his income on the basis of California community
property laws. With respect to petitioner’s claimed itemized deductions, all of the
claimed deductions related to the property he sold in 2006; accordingly, we will
address his claim in part V.C. of this opinion. See infra pp. 42-43. Petitioner’s
community property argument relates to the 2007 filing status issue; accordingly, we
will address petitioner’s community property argument in part VI of this opinion.
See infra note 35.
                                             -4-

[*4] I.            Background

          Petitioner, a permanent U.S. resident, works in the construction industry. In

1999 he married Erika Avila Blanca (Mrs. Reynoso). He has seven children; Mrs.

Reynoso is the mother of his three youngest children.

II.       Petitioner’s Property Transactions

          On November 27, 2005, Aida Avila, petitioner’s relative, signed a grant deed

transferring the title to a property at Berkshire Drive, Riverside, California

(Berkshire property), to petitioner, ostensibly for no consideration.4 Before

transferring the title to petitioner Ms. Avila refinanced the Berkshire property and

secured a new mortgage. Petitioner and Mrs. Reynoso moved into the Berkshire

property at some point in 2005.

          While residing at the Berkshire property petitioner decided to renovate and

improve the property. On April 3, 2006, he secured an $85,000 loan from Money

Solutions Group, which he used in part to fund renovation work on the Berkshire

property, including improvements to the horse stables and driveway, installation of a

tennis court and a block wall, and interior improvements, such as installation of

crown molding and new flooring. On a date that is not in the record he hired

Alfredo’s Welding to perform welding work on the horse stables. Alfredo’s


          4
              The grant deed was not recorded until March 17, 2006.
                                          -5-

[*5] Welding had a mechanic’s lien on the Berkshire property as security for

payment.

       On or about May 31, 2006, petitioner sold the Berkshire property for

$675,000. Petitioner received a closing statement showing gross proceeds of

$675,000 with respect to the sale and various payees who received proceeds from

the sale. At the closing petitioner received a check for $5,243, the balance due to

him after payment of various liabilities and expenses. Respondent received a Form

1099-S, Proceeds From Real Estate Transactions, from New Century Title Co.

(New Century), on which New Century reported that petitioner received gross

proceeds of $675,000 from the sale of the Berkshire property.

       On August 14, 2006, petitioner purchased property at Ridge Point Way,

Riverside, California (Ridge Point property). Petitioner and Mrs. Reynoso resided

at the Ridge Point property beginning in August 2006 and throughout 2007.

III.   Petitioner’s Business Activities

       In 1997 petitioner began working as a contractor for Nijjar Realty, Inc.,

d.b.a. PAMA Management Co. (PAMA), a property management company.5

During the years at issue he worked for PAMA as an independent contractor under



       5
      PAMA classified petitioner as an independent contractor and not as an
employee during the years at issue.
                                          -6-

[*6] the trade names R&R Construction and Los Brothers Co., his sole

proprietorship construction businesses.

      During 2006 and continuing until sometime in early 2007 petitioner also

worked with Peter Ortiz to provide construction services for PAMA. After

petitioner ceased working with Mr. Ortiz on joint projects, Mr. Ortiz, doing

business as Peter Ortiz RCI, continued to provide construction services to PAMA

independently. However, Mr. Ortiz and petitioner continued to help each other on

PAMA projects from time to time.

      As payment for petitioner’s services PAMA wrote checks to R&R

Construction and Los Brothers Co. When PAMA issued a check, a PAMA

employee would record the check in its vendor histories.6 During 2006 PAMA

issued 6 checks to R&R Construction and 33 checks to Los Brothers Co., totaling

$21,000 and $186,400, respectively. During 2007 PAMA issued 186 checks to

R&R Construction totaling $961,000.



      6
        PAMA maintains vendor histories for each vendor. A PAMA employee
enters the relevant information when PAMA issues a check to a vendor. Each entry
includes the check number, amount, and date, as well as a description of the work
performed, including the name of the property where the vendor performed the
work. The descriptions of the work performed include the following: rehab, partial,
roof or roofing, asphalt, paint or painting, decking, carports, final, workers, stucco,
redesign, cement, labor, additional, wood, demolish, inspection, extra, facial,
garage, mold/mildew, beams, permits, construction, and inside units.
                                         -7-

[*7] Respondent did not receive any information returns with respect to

petitioner’s business activities for 2006. For 2007 respondent received the

following information returns with respect to petitioner’s business activities: (1) a

Form 1099-MISC, Miscellaneous Income, from Peter Ortiz RCI reporting

nonemployee compensation of $94,000; and (2) a Form 1099-MISC from PAMA

reporting nonemployee compensation of $961,000.

IV.   Petitioner’s Failure To Keep Records and Substantiate Business Expenses

      Petitioner did not maintain any ledgers or journals in which he recorded the

income and expenses of his construction businesses. He did not maintain records

showing the addresses of the worksites and the materials, workers, and

subcontractors required to complete the job. He did not maintain any form of

payroll records.

      Petitioner paid both business and personal expenses using his Bank of

America accounts. See infra. He engaged in numerous cash transactions, including

substantial cash deposits and withdrawals. Although petitioner paid various

business expenses in 2006 and 2007 with respect to the construction work he

performed for PAMA, he made minimal effort to reconstruct his business

expenditures during the course of these proceedings.
                                         -8-

[*8] V.      Petitioner’s Bank Accounts

      During 2006 petitioner maintained two personal bank accounts at Bank of

America, account No. 1420 and account No. 1421.7 He did not deposit any checks

from PAMA into either account during 2006. However, petitioner made a number

of large cash deposits into the accounts. During 2006 he maintained a third bank

account under the name “R&R Construction”.8 He deposited at least some of his

checks from PAMA into this third account.

      From February 13 through November 21, 2007, petitioner maintained an

account at Bank of America (account No. 4099) titled “Ramon Reynoso R and R

Construction”.9 From February 13 through December 24, 2007, he maintained an

account at Bank of America (account No. 4098) titled “Ramon Reynoso R and R

Construction”.10 In 2007 he deposited 23 checks from PAMA, totaling $126,000,


      7
       Petitioner made taxable deposits of $301,223 into account No. 1420 during
2006. From April 1 through December 31, 2006, he made taxable deposits of
$21,700 into account No. 1421. As of January 29, 2007, Bank of America had
closed account No. 1420.
      8
         The record does not contain copies of account statements or deposit slips for
this third account.
      9
       During 2007 petitioner made taxable deposits of $147,500 into account No.
4099, including the 23 PAMA checks.
      10
        During 2007 petitioner made taxable deposits of $631,735 into account No.
4098, including the 107 PAMA checks.
                                             -9-

[*9] into account No. 4099, and he deposited 107 checks from PAMA, totaling

$588,700, into account No. 4098.11

VI.     Notices of Deficiency

        Petitioner failed to timely file tax returns for 200612 and 2007.13

Consequently, respondent prepared substitutes for returns under section 6020(b) for

2006 and 2007. On the basis of the substitutes for returns, respondent mailed to

petitioner notices of deficiency for 2006 and 2007.



        11
        During the years at issue petitioner also cashed a number of checks,
including checks from PAMA. He often cashed his checks at Mira Loma Market.
        12
         On March 5, 2010, respondent received petitioner’s Form 1040, U.S.
Individual Income Tax Return, for 2006. On the Form 1040 petitioner used a filing
status of married filing jointly and listed his occupation as “construction”. He
reported a total tax liability of $3,813. He also claimed the earned income credit,
the additional child tax credit, a credit for Federal telephone excise tax paid, and a
refund of $1,109.

       On an attached Schedule C, Profit or Loss From Business, petitioner
identified his business name as R&R Construction and reported gross receipts and
total expenses of $41,000 and $14,016, respectively. He attached to his return a
Form 4562, Depreciation and Amortization, relating to depreciation of vehicles
purportedly used in his business activity. On an attached Schedule D, Capital Gains
and Losses, he reported a long-term gain of $24,922. He also attached a Form
4797, Sales of Business Property, on which he reported that on May 21, 2006, he
sold the Berkshire property for $675,000. On the Form 4797 he reported a gain of
$24,922 from the sale of the Berkshire property.
        13
             Petitioner had not filed a Federal income tax return for 2007 as of the date
of trial.
                                          - 10 -

[*10] In the notice of deficiency for 2006 mailed on November 30, 2009,

respondent determined that petitioner had compensation income of $25,419, interest

income of $20, and a short-term capital gain of $675,000. Respondent also

determined that petitioner was liable for additions to tax under sections 6651(a)(1)

and (2) and 6654. Respondent determined the 2006 income tax deficiency using

married filing separately filing status for petitioner.

       In an amended answer respondent made further adjustments with respect to

petitioner’s 2006 taxable year. Respondent alleged in the amended answer that, in

addition to the income items and capital gain set forth in the notice of deficiency,

petitioner had unreported Schedule C gross receipts of $207,400 from work he

performed for PAMA.14 Respondent also determined that petitioner was liable for

self-employment tax with respect to his income from PAMA.

       In the notice of deficiency for 2007 mailed on April 26, 2010, respondent

determined that petitioner had nonemployee compensation of $1,055,000 and

was liable for self-employment tax with respect to that compensation. Respondent

also determined that petitioner was liable for additions to tax under sections




       14
        Respondent did not consider the income reported on petitioner’s untimely
filed 2006 return in determining the amount of his unreported Schedule C gross
receipts set forth in the amended answer.
                                          - 11 -

[*11] 6651(a)(1) and (2) and 6654. Respondent determined the 2007 income tax

deficiency using a single filing status for petitioner.

VII. Petitioner’s Tax Court Proceedings

       After receiving the notices of deficiency petitioner15 filed petitions contesting

respondent’s determinations with respect to petitioner’s 2006 and 2007 taxable

years. We consolidated the two cases for trial, briefing, and opinion. During the

course of the trial petitioner did not call any subcontractors, laborers, or suppliers in

an effort to reconstruct his expenses. Petitioner also did not introduce any expert

testimony regarding the customary profit margin in the construction industry.

VIII. Petitioner’s Compliance History

       Petitioner failed to file Federal income tax returns for 2002-05 and 2007-10.

The record contains no indication that petitioner has ever filed Federal

employment tax returns or made any estimated tax payments. Petitioner’s history




       15
         Petitioner and Mrs. Reynoso jointly filed a petition contesting respondent’s
determinations with respect to 2006. Respondent subsequently filed a motion to
dismiss for lack of jurisdiction as to Mrs. Reynoso and to change caption on the
grounds that no notice of deficiency or notice of determination had been issued to
Mrs. Reynoso for 2006. We granted respondent’s motion and dismissed the case
for lack of jurisdiction as to Mrs. Reynoso.
                                        - 12 -

[*12] shows an extended failure to comply with his tax reporting and payment

obligations.

                                     OPINION

I.    Burden of Proof

      A.       In General

      Generally, the Commissioner’s determinations in a notice of a deficiency

are presumed correct, and the taxpayer bears the burden of proving that the

determinations are erroneous. See Rule 142(a); Welch v. Helvering, 290 U.S. 111,

115 (1933). The burden of proof shifts to the Commissioner, however, if the

taxpayer produces credible evidence to support the deduction or position, the

taxpayer complied with the substantiation requirements, and the taxpayer

cooperated with the Secretary16 with regard to all reasonable requests for

information. Sec. 7491(a); see also Higbee v. Commissioner, 116 T.C. 438, 440-

441 (2001). In addition, if the Commissioner raises a new issue or seeks an




      16
        The term “Secretary” means “the Secretary of the Treasury or his delegate”,
sec. 7701(a)(11)(B), and the term “or his delegate” means “any officer, employee,
or agency of the Treasury Department duly authorized by the Secretary of the
Treasury directly, or indirectly by one or more redelegations of authority, to perform
the function mentioned or described in the context”, sec. 7701(a)(12)(A)(i).
                                         - 13 -

[*13] increase in the deficiency, the Commissioner has the burden of proof as to the

new issue or the increased deficiency. See Rule 142(a)(1).

      Petitioner does not contend that section 7491(a)(1) applies, and the record

establishes that he did not satisfy the section 7491(a)(2) requirements. Accordingly,

petitioner bears the burden of proof with respect to all disputed factual issues,

except with respect to the increased deficiency asserted in respondent’s amended

answer. See Rule 142(a)(1). Respondent concedes that, under Rule 142(a)(1),

respondent bears the burden of proof with respect to the increased deficiency.

      B.     Burden of Production Under Section 6201(d)

      Under section 6201(d), if a taxpayer asserts a reasonable dispute with respect

to any item of income reported on an information return filed by a third party and

the taxpayer meets certain other requirements, the Commissioner bears the burden

of producing reasonable and probative information, in addition to the information

return, concerning the deficiency attributable to the income item. The burden shifts

to the Commissioner only if the taxpayer fully cooperates with the Commissioner by

providing, within a reasonable period of time, access to and inspection of all

witnesses, information, and documents within the control of the taxpayer as

reasonably requested. See id.
                                        - 14 -

[*14] Respondent received two information returns with respect to petitioner’s

income for 2007:17 a Form 1099-MISC from PAMA showing compensation of

$961,000 and a Form 1099-MISC from Peter Ortiz RCI showing compensation of

$94,000.18 Petitioner does not dispute that he received income from PAMA in

2007. However, he does dispute the accuracy of the amount of income PAMA

reported on the Form 1099-MISC.

      Petitioner has offered only vague contentions that the amount of income

reported on the Form 1099-MISC submitted by PAMA is erroneous. Furthermore,

in his brief, petitioner conceded that he “generally agrees” with the $961,000

amount PAMA reported on the Form 1099-MISC. Petitioner’s vague assertions are

insufficient to shift the burden of production to respondent under section 6201(d).19

See Sanders v. Commissioner, T.C. Memo. 2010-279.




      17
       The record also contains a copy of a Form 1099-MISC purportedly issued
by PAMA showing payment of $146,400 of nonemployee compensation to Los
Brothers Co. in 2006. The record contains no evidence that PAMA actually filed
the Form 1099-MISC.
      18
       Petitioner does not dispute the accuracy of the 2006 Form 1099-S
respondent received with respect to the Berkshire property.
      19
       Even if we were to assume that petitioner’s dispute is reasonable,
respondent has introduced probative evidence that petitioner had unreported taxable
income as shown on the information returns.
                                        - 15 -

[*15] Petitioner also disputes that he received any income from Peter Ortiz RCI in

2007. Petitioner admitted, however, that he worked for Mr. Ortiz during 2007. He

further testified that he deposited checks made payable to Mr. Ortiz into his own

bank account.20 Petitioner’s attempt to dispute the accuracy of the information

return under these circumstances is not reasonable. Accordingly, we find that the

burden of production with respect to petitioner’s 2007 income from Peter Ortiz RCI

did not shift to respondent under section 6201(d).

II.   Unreported Income

      Section 61(a) defines gross income as “all income from whatever source

derived” and includes compensation paid for services, whether furnished by the

taxpayer as an employee, a self-employed person, or an independent contractor. A

taxpayer must maintain books and records establishing the amount of his or her

gross income. Sec. 6001. If a taxpayer fails to maintain the required books and

records, the Commissioner may determine the taxpayer’s income by any method

that clearly reflects income. See sec. 446(b); Petzoldt v. Commissioner, 92 T.C.

661, 693 (1989). The Commissioner’s reconstruction of income “need only be


      20
        In addition, respondent introduced evidence that petitioner failed to
cooperate. Petitioner testified that he previously told respondent’s counsel that he
never had worked for Mr. Ortiz. He admitted during his testimony that he began
working with Mr. Ortiz in 2005 and that he worked with Mr. Ortiz through 2007.
                                         - 16 -

[*16] reasonable in light of all surrounding facts and circumstances.” Petzoldt v.

Commissioner, 92 T.C. at 687.

      The Commissioner has great latitude in reconstructing a taxpayer’s income.

See sec. 446(b); Petzoldt v. Commissioner, 92 T.C. at 687, 693. The Commissioner

may reconstruct a taxpayer’s income using third-party information returns. See

Parker v. Commissioner, 117 F.3d 785 (5th Cir. 1997); Ketler v. Commissioner,

T.C. Memo. 1999-68. The Commissioner also may use bank records and other

third-party records to reconstruct a taxpayer’s income. See Parkinson v.

Commissioner, 647 F.2d 875, 876 (9th Cir. 1981), aff’g T.C. Memo. 1979-319; see

also Williams v. Commissioner, 999 F.2d 760, 764 (4th Cir. 1993), aff’g T.C.

Memo. 1992-153.

      As noted above, the Commissioner’s deficiency determination normally is

entitled to a presumption of correctness. See Rule 142(a); see also United States v.

Stonehill, 702 F.2d 1288, 1293 (9th Cir. 1983). However, when a case that

involves unreported income is appealable to the U.S. Court of Appeals for the Ninth

Circuit, as this case appears to be absent a stipulation to the contrary, see sec.

7482(b)(1)(A), (2), the Commissioner’s determination of unreported income is

entitled to a presumption of correctness only if the Commissioner first establishes

“some evidentiary foundation” connecting the taxpayer with the income-producing
                                        - 17 -

[*17] activity, see Weimerskirch v. Commissioner, 596 F.2d 358, 361-362 (9th Cir.

1979), rev’g 67 T.C. 672 (1977), or demonstrating that the taxpayer actually

received unreported income, see Edwards v. Commissioner, 680 F.2d 1268, 1270-

1271 (9th Cir. 1982). If the Commissioner introduces some evidence that the

taxpayer received unreported income, the burden of production shifts to the

taxpayer, who must establish by a preponderance of the evidence that the deficiency

was arbitrary or erroneous. See Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th

Cir. 1999), aff’g T.C. Memo. 1997-97.

      The parties stipulated that during the years at issue petitioner operated two

sole proprietorship construction businesses and provided construction services for

PAMA through those businesses. Petitioner testified that he did not keep any sort

of ledger or journal with respect to the income of his construction businesses. He

stipulated that he received PAMA checks during 2006 and 2007, but he testified

that he did not record his receipt of checks from PAMA. The parties also

stipulated that petitioner maintained bank accounts into which he deposited

receipts during the years at issue. Accordingly, we find that respondent acted

reasonably in reconstructing petitioner’s income. We address each year in turn.
                                       - 18 -

[*18] A.     2006

      Respondent introduced copies of PAMA’s vendor histories showing that in

2006 PAMA made payments to R&R Construction and Los Brothers Co. of

$21,000 and $186,400, respectively. Respondent also introduced copies of

canceled checks that PAMA wrote to R&R Construction and Los Brothers Co.

during 2006. Petitioner’s endorsement appears on a number of the canceled checks.

      Petitioner testified that he worked on all of the properties listed on PAMA’s

2006 vendor histories for R&R Construction and Los Brothers Co. He further

testified that he deposited checks from PAMA into one of his bank accounts.

      We find that respondent has connected petitioner with the income-producing

activity. Consequently, petitioner bears the burden of proving that respondent’s

determinations were erroneous, see Weimerskirch v. Commissioner, 596 F.2d at

361, except with respect to the additional unreported income of $207,400 for 2006,

see Rule 142(a)(1).

      Respondent relies on PAMA’s vendor histories, canceled checks, and

petitioner’s own admissions, all of which show that petitioner, operating through

his sole proprietorship construction businesses, performed services for and

received income from PAMA during 2006. Petitioner has raised no issues with
                                        - 19 -

[*19] respect to respondent’s determination and, in his brief, has conceded that he

“generally agrees” with respondent’s determination of unreported income for 2006.

Accordingly, we sustain respondent’s determination with respect to petitioner’s

unreported income for 2006.

      B.     2007

      For 2007 respondent introduced a wage and income transcript showing that

petitioner received compensation from PAMA and Peter Ortiz RCI of $961,000 and

$94,000, respectively, and that respondent received Forms 1099-MISC from PAMA

and Peter Ortiz RCI with respect that income. Respondent also introduced a copy

of PAMA’s vendor history for R&R Construction showing payments of $961,000 to

R&R Construction during 2007. Respondent introduced deposit slips for account

Nos. 4098 and 4099 showing that petitioner deposited checks from PAMA made

payable to R&R Construction and to Mr. Ortiz. Respondent also introduced copies

of canceled checks from PAMA that petitioner had endorsed. Petitioner admitted at

trial that he worked for PAMA and Mr. Ortiz during 2007.

      We find that respondent has introduced sufficient evidence to connect

petitioner with the income-producing activities. Consequently, petitioner bears the

burden of proving that respondent’s determinations were arbitrary or erroneous.

See Weimerskirch v. Commissioner, 596 F.2d at 361.
                                          - 20 -

[*20] Petitioner raises two arguments with respect to respondent’s reconstruction of

income. First, while petitioner has conceded that he “generally agrees” that he

received $961,000 from PAMA in 2007, he continues to question the accuracy of

PAMA’s records. Second, he disputes that he received payments from Peter Ortiz

RCI during 2007.

      Petitioner examined copies of the canceled checks from PAMA at trial and

testified that he did not cash certain checks. With respect to some of the checks,

petitioner testified that he did not work at the jobsite identified on the face of the

check. With respect to at least two of the disputed checks, however, petitioner later

testified that he did work at that jobsite. In addition, when respondent questioned

petitioner about one of the checks during cross-examination, he admitted that he

may have cashed the check and that he was not sure whether the signature on the

check was his own.

      In response to petitioner’s testimony that he did not cash certain checks,

respondent introduced copies of deposit slips for petitioner’s bank accounts

showing that he deposited a number of the disputed checks into his bank accounts.

While the endorsements on some of the other disputed checks are illegible, a

number of the checks bear the endorsement “R&R Construction”. With respect to

check No. 1316, petitioner testified that he did not cash the check and that Mr.
                                        - 21 -

[*21] Ortiz endorsed the check; however, the check bears markings including

petitioner’s birthdate and identification card number and a stamp indicating that it

was cashed at Mira Loma Market, a place where petitioner regularly cashed checks.

      Petitioner offered no evidence to explain why other individuals would have

cashed or deposited checks made payable to his sole proprietorship businesses. At

one point petitioner testified that he was unsure as to whether anyone else had

signatory authority on his bank accounts. However, he also testified that he was the

only individual with signatory authority on his bank accounts.

      Petitioner’s testimony was inconsistent during trial and conflicts with other

credible evidence in the record. In the absence of corroborating evidence, we find

his testimony regarding the disputed checks to be self-serving and unreliable. See

Tokarski v. Commissioner, 87 T.C. 74, 76-77 (1986). Petitioner has failed to

introduce any credible evidence that PAMA incorrectly reported compensation it

paid to petitioner on its vendor history and on the Form 1099-MISC.

      With respect to the income from Peter Ortiz RCI, respondent introduced

copies of deposit slips for petitioner’s account Nos. 4098 and 4099. The deposit

slips show that during 2007 petitioner deposited checks made payable to Peter Ortiz

R&R Construction, and Peter Ortiz RCI Construction, totaling $15,800, into
                                         - 22 -

[*22] account No. 4098. Respondent also introduced copies of canceled checks

made payable to Peter Ortiz R&R Construction that petitioner cashed.

      Petitioner testified that he worked on some projects for Mr. Ortiz in 2007 and

that he may have received payment from Mr. Ortiz. He further testified that if Mr.

Ortiz could not work on a particular PAMA project, he would complete the project

under Mr. Ortiz’s name. He testified that Mr. Ortiz may have performed work for

PAMA under petitioner’s name. Petitioner testified that he deposited checks made

payable to Mr. Ortiz into his bank accounts. He further testified that the payments

he received may have derived from his sale of trucks to Mr. Ortiz in 2007.

      Petitioner neither called Mr. Ortiz as a witness at trial nor introduced any

documents relating to his alleged sale of trucks to Mr. Ortiz. Moreover, petitioner

admitted that he worked for Mr. Ortiz during 2007. Petitioner has failed to

introduce any credible evidence that he did not work for Peter Ortiz RCI or that

Peter Ortiz RCI incorrectly reported compensation paid to petitioner during 2007.

See, e.g., Parker v. Commissioner, 117 F.3d 785 (holding that the Commissioner

did not act arbitrarily in relying upon third-party payor reports to determine a

taxpayer’s income where the taxpayer failed to file a return or other sworn

document disputing the income reflected in such reports). Accordingly, we sustain
                                          - 23 -

[*23] respondent’s determinations with respect to petitioner’s unreported income

for 2007.

III.   Business Expenses

       Generally, a taxpayer is entitled to deduct ordinary and necessary expenses

paid or incurred in carrying on a trade or business. Sec. 162(a); Am. Stores Co. v.

Commissioner, 114 T.C. 458, 468 (2000). An expense is ordinary if it is customary

or usual within the particular trade, business, or industry or if it relates to a

transaction “of common or frequent occurrence in the type of business involved.”

Deputy v. du Pont, 308 U.S. 488, 495 (1940). An expense is necessary if it is

appropriate and helpful for the development of the business. See Commissioner v.

Heininger, 320 U.S. 467, 471 (1943). Personal, living, or family expenses generally

are not deductible. See sec. 262(a).

       Deductions are a matter of legislative grace, and ordinarily a taxpayer must

prove that he is entitled to the deductions he claims. INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992). A taxpayer must maintain records to

substantiate claimed deductions and to establish the taxpayer’s correct tax liability.

Higbee v. Commissioner, 116 T.C. at 440; see also sec. 6001. The taxpayer must

produce such records upon the Secretary’s request. Sec. 7602(a); see also sec.

1.6001-1(e), Income Tax Regs. Adequate substantiation must establish the nature,
                                        - 24 -

[*24] amount, and purpose of a claimed deduction. Higbee v. Commissioner, 116

T.C. at 440; see also Hradesky v. Commissioner, 65 T.C. 87 (1975), aff’d per

curiam, 540 F.2d 821 (5th Cir. 1976). In deciding whether a taxpayer adequately

substantiated a claimed deduction, we are not required to accept the taxpayer’s

“self-serving, unverified, and undocumented testimony.” Shea v. Commissioner,

112 T.C. 183, 189 (1999).

      When a taxpayer establishes that he paid or incurred a deductible expense

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

the deductible expense. Cohan v. Commissioner, 39 F.2d 540, 542-544 (2d Cir.

1930); see also Friscia Constr., Inc. v. Commissioner, T.C. Memo. 2000-192

(estimating that a construction company had a profit margin of approximately 12%

on the basis of the taxpayer’s testimony, canceled checks, and banking records);

Booher v. Commissioner, T.C. Memo. 1986-475 (estimating that a drywall

contractor incurred expenses equal to approximately 27% of his income for the

year at issue on the basis of the taxpayer’s testimony and the Commissioner’s

concessions for prior years). However, we cannot estimate the amount unless the

taxpayer introduces evidence that he paid or incurred the expense and the evidence

is sufficient for us to develop a reasonable estimate. Williams v. United States,

245 F.2d 559, 560 (5th Cir. 1957). In estimating the amount, we bear heavily
                                       - 25 -

[*25] upon the taxpayer who failed to maintain and produce the required records.

See Cohan v. Commissioner, 39 F.2d at 544.

      Petitioner admits that he failed to maintain and produce adequate records to

substantiate his claimed business expenses.21 Petitioner contends, however, that

this Court should estimate his business expenses pursuant to Cohan v.

Commissioner, 39 F.2d 540. On brief he asks this Court to find that he incurred

business expenses equal to approximately 60% of his income from PAMA for

each year at issue.22 He calculated this figure by analyzing PAMA’s vendor

histories and dividing PAMA’s payments to him into four categories:

subcontractor payments, worker and permit payments, inspection payments, and




      21
         Petitioner appears to argue that this Court should estimate his business
expenses because his accountant, William Turner, lost petitioner’s business records.
We reject this argument because petitioner has not convinced us that his accountant
had any of petitioner’s business records. In addition, when a taxpayer’s records
have been destroyed or lost due to circumstances beyond his control, for example,
fire, flood, earthquake, or other casualty, the taxpayer may substantiate the claimed
deductions by a reasonable reconstruction of his expenditures. See Christensen v.
Commissioner, T.C. Memo. 2006-62. Petitioner did not do so.
      22
       Petitioner does not contend that he is entitled to deduct any business
expenses with respect to the income he received from Peter Ortiz RCI.
Furthermore, he has introduced no evidence and offered no testimony regarding
whether he incurred business expenses while working for Peter Ortiz RCI.
Accordingly, we consider only whether petitioner incurred business expenses in
performing services for PAMA during the years at issue.
                                        - 26 -

[*26] other payments (including all payments for smaller jobs that did not require a

subcontractor). He estimated that he earned a 30% profit from subcontractor

payments,23 a 10% profit from worker and permit payments,24 a 100% profit from

inspection payments, and a 50% profit from other payments.25 Respondent contends

that petitioner is not entitled to deduct any business expenses because he has neither

substantiated the claimed expenses nor introduced evidence upon which this Court

may base a reasonable estimate.

      The record contains copies of receipts and invoices from 2006-07, as well as

check registry excerpts and carbon copies of checks for 2007. The majority of the




      23
         Petitioner testified that he typically earned a 15% profit from jobs that
required subcontractor work. He has conceded that because he failed to maintain
the required books and records, he is not entitled to use a 15% profit margin in
calculating his expenses. He doubled the 15% profit margin figure and used a 30%
profit margin to calculate his expenses with respect to the subcontractor payments.
      24
        Petitioner contends that a 10% profit margin is appropriate because he used
almost the entirety of the worker and permit payments to pay for business expenses.
      25
         Petitioner contends that this Court should use a 50% profit margin to
calculate business expenses incurred with respect to the other payments because
petitioner expected to earn a higher profit from smaller jobs that he completed
himself.
                                        - 27 -

[*27] receipts and invoices are not credible,26 and the check registry excerpts and


      26
        A number of invoices show the purchaser as an individual other than
petitioner. None of the delivery addresses on the invoices correspond with the
addresses for the PAMA properties where petitioner worked during 2006. Some of
the invoices clearly relate to work petitioner performed outside of his employment
with PAMA. In particular, a number of invoices related to work performed at a
property on Gerona Street. The record contains no evidence regarding the owner of
the Gerona Street property and what type of work, if any, petitioner performed at
the property.

       Petitioner also introduced copies of permit applications filed in 2006; two of
the permit applications do not bear an address for the relevant property, and one
application shows the relevant address as the Gerona Street property. He also
introduced receipts from the Home Depot and a lumber store. The receipts do not
show that petitioner made the purchases or the property for which petitioner
purportedly purchased the supplies.

       Additionally, petitioner introduced invoices to substantiate depreciation
deductions he claimed on his 2006 Form 4562. The record includes a schedule,
ostensibly prepared by Mr. Turner, showing that petitioner claimed depreciation
with respect to four vehicles: a 1985 Ford truck, a 2002 Chevrolet truck, a 1993
Peterbilt dumptruck, and a 2004 Ford Expedition. With respect to the 1985 Ford
truck, the record shows that the vehicle actually was purchased by Anatalio
Hidalgo, Jr. With respect to the 2002 Chevrolet truck, the record contains a copy of
a purchase agreement showing that Gilberto Ruiz Olvera purchased the truck and
that the primary use of the truck was personal, family, or household. With respect
to the 2004 Ford Expedition, the record contains a copy of a purchase agreement
showing that Esther Soto and petitioner purchased the vehicle and that the primary
use of the truck was personal, family, or household.

       Petitioner introduced the following documents purportedly to substantiate his
claimed business expenses for 2007: (1) an invoice from Dunn-Edwards, Corp., (2)
a signed statement from Wheeler Paving, Inc., and (3) nine invoices from J.R.
Painting Cleaning Services. We find that the signed statement from Wheeler
Paving, Inc., is not credible. The statement from Wheeler Paving, Inc., indicates
                                                                       (continued...)
                                       - 28 -

[*28] carbon copies are unreadable.

      The record also contains copies of PAMA’s vendor histories for 2006 and

2007. The vendor histories show that PAMA issued checks to petitioner as

payment for labor, workers, materials, subcontractor expenses, permits, and

inspections. With respect to the subcontractor expenses, PAMA’s vendor histories

indicate that PAMA issued checks to petitioner for particular subcontractor




      26
         (...continued)
that on July 3, 2007, petitioner paid Wheeler Paving, Inc., a $10,000 deposit for
work on a PAMA property. However, petitioner’s bank statements show that he
neither wrote a check for $10,000 during July 2007 nor withdrew a sufficient
amount of cash to pay the deposit.

       We find that the invoices from Dunn-Edwards and J.R. Painting Cleaning
Services are credible. The Dunn-Edwards invoice shows the purchaser as RCI
Construction and the total amount due as $1,051.54. The record contains a copy of
a canceled check drawn on petitioner’s Bank of America account for $1,051.54
made payable to Dunn-Edwards. Furthermore, the invoice and check bear a
notation showing that the job location was one of the PAMA properties where
petitioner worked. The J.R. Painting Cleaning Services invoices, which total
$3,860, each bear a notation showing that job location as one of the PAMA
properties where petitioner worked. Furthermore, petitioner made a large cash
withdrawal from account No. 4099 around the same time as the delivery date on the
invoices. Accordingly, petitioner has substantiated business expenses of $5,382 for
2007. Because we find that petitioner is entitled to deduct as business expenses an
amount equal to 30% of his total PAMA gross receipts, see infra p. 35, we will treat
these expenses as included in the expense deduction we allow for 2007.
                                         - 29 -

[*29] services. For example, PAMA’s vendor history for Los Brothers Co. for 2006

shows that PAMA issued checks for roofing, asphalt, painting, and carport work.27

      Petitioner testified that he purchased materials to complete work for PAMA.

Although this testimony may be credible, petitioner did not introduce any other

credible evidence to substantiate the purported materials expenses. Furthermore,

when questioned about a particular job, he could not recall what materials he

purchased or how much he spent. He also testified that he may have used funds

from checks designated as payments for materials for other purposes.

      With respect to permit expenses he allegedly incurred, petitioner testified as

follows:

      •      He received payment from PAMA for securing permits;

      •      he would pay for the permits and PAMA would refund him the money;

             and

      •      he used almost the full amounts of the checks designated as permit




      27
         Daljit Kler, a PAMA employee, testified that when a PAMA property
required construction work, a PAMA employee would request proposals from
petitioner and other contractors. She further testified that petitioner was required to
submit a proposed budget for each project itemizing the various costs. Petitioner
did not introduce any copies of his proposals or budgets with respect to his work on
PAMA properties.
                                          - 30 -

               [*30] payments for securing the permits.

Petitioner did not introduce any credible evidence to substantiate the purported

permit expenses. Furthermore, he testified that he used at least some of the permit

payment checks for other purposes.

      With respect to subcontracting expenses he allegedly incurred, petitioner

testified as follows:

      •        He hired subcontractors to work on PAMA properties when necessary;

      •        he hired subcontractors to perform asphalt, concrete, roofing,

               framing,28 landscaping, stucco, extensive painting, and mold and

               mildew work;

      •        he paid the subcontractors in cash and with checks;

      •        after he paid the subcontractors, the subcontractors would sign a lien

               release; and

      •        when he hired subcontractors to work on a PAMA job, he typically had

               a 10% to 15% profit margin.29

      28
           On its vendor histories PAMA identified framing work as “facials”.
      29
        Ms. Kler testified that subcontractors who worked for petitioner on PAMA
properties would demand payment from her for their work because petitioner had


                                                                          (continued...)
                                        - 31 -

[*31] Petitioner did not introduce any credible evidence to substantiate the

purported subcontracting expenses. He did not introduce copies of canceled checks

showing payments to subcontractors or the lien releases the subcontractors

purportedly signed. Furthermore, while petitioner testified as to the names of the

subcontractors he hired for different PAMA projects, he was unable to recall the

subcontractors he hired for particular PAMA projects, and he did not call any

subcontractors to testify.

      With respect to worker expenses that he allegedly incurred, petitioner

testified as follows:

      •      He hired daily workers and that he paid them in cash and with checks;

      •      he typically paid daily workers $80 to $100 a day, but he paid some

             daily workers up to $150 per day;

      •      he did not keep any money from the checks that PAMA designated as

             payment for workers; and

      •      the daily workers signed documents indicating that they were paid in

             full.



      29
        (...continued)
 not paid them. Ms. Kler further testified that in some instances, petitioner received
full payment for projects that he failed to complete.
                                         - 32 -

[*32] Petitioner did not introduce any credible evidence to substantiate the

purported worker expenses. He did not introduce any documents signed by the

workers showing that petitioner actually paid the workers. Petitioner’s bank

statements do not show any large cash withdrawals that can be tied to a particular

project or the regular occurrence of cash withdrawals in similar amounts. While

petitioner testified as to the names of some of the individuals he hired as daily

workers for PAMA jobs, he did not call any of the workers to testify. Furthermore,

petitioner’s testimony was inconsistent at best. For instance, he testified that he

occasionally hired daily workers to assist with inspections, then later testified that

the checks designated as payment for inspections constituted pure profit to him. He

also testified that he used checks designated for worker payment to pay other

expenses and that the checks that PAMA designated as payment for labor were

payments to petitioner personally.

      Petitioner also testified regarding his use of Ray Roy Moorefield’s

contractor’s license as follows:

      •      Because he did not have a contractor’s license, petitioner arranged to

             use Mr. Moorefield’s contractor’s license;

      •      Mr. Moorefield’s contractor’s license was under the name R&R

             Construction;
                                        - 33 -

      [*33] •       he agreed to pay Mr. Moorefield 10% of the contract price for

                    projects that required use of the contractor’s license; and

      •      Mr. Moorefield would secure permits for him in some instances.

Petitioner did not introduce any credible evidence to substantiate the purported

expenses for use of Mr. Moorefield’s contractor’s license. He did not call Mr.

Moorefield to testify at trial. He did not introduce any documentation showing

payment to Mr. Moorefield. Furthermore, he did not testify as to which projects

required him to use Mr. Moorefield’s contractor’s license.

      Petitioner admitted that he did not maintain records of his business expenses

for the years at issue. Most of the records petitioner introduced to substantiate his

reported expenses were either not credible or not sufficient to adequately

substantiate any business expenses. His failure to call witnesses or introduce

evidence within his control gives rise to the presumption that such evidence would

be unfavorable. See Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158,

1165 (1946), aff’d, 162 F.2d 513 (10th Cir. 1947). Furthermore, at trial he offered

vague and inconsistent testimony, particularly in regard to the purposes of the

designated payments, how PAMA identified the purpose of and calculated the

amount of each designated payment, and how he used the designated payments.
                                         - 34 -

[*34] Accordingly, we find that petitioner has failed to substantiate most of his

claimed business expenses for the years at issue.

      Although petitioner urges us to adopt his proposed profit margin estimate,

petitioner offered only his own self-serving, unverified testimony to support the

estimate. Petitioner’s testimony alone is an inadequate basis for us to accept his

proposed estimate of the amounts of his business expenses for the years at issue.

See Smith v. Commissioner, T.C. Memo. 2000-290. Furthermore, petitioner’s

testimony at trial was inconsistent with the profit margin estimate set forth in his

brief.30 Finally, petitioner’s proposed profit margin estimate depends on this Court

finding that the PAMA worksheets properly designated the purpose and amount of

each payment made to petitioner, a finding that, on the basis of the record, we are

unable to make. Accordingly, we decline to apply the profit margin estimate

petitioner proposed in his brief.

      While petitioner has failed to introduce credible evidence to substantiate the

precise amounts of his business expenses or allow us to accept his proposed profit


      30
         For example, petitioner proposed a 10% profit margin with respect to the
worker payments; however, he testified that he used funds from checks designated
as worker payments to pay other expenses and that he occasionally retained the
funds from those checks. Additionally, petitioner used a 10% profit margin with
respect to payments designated as labor payments, but he testified that the labor
payments constituted pure profit to him.
                                         - 35 -

[*35] margin estimate, petitioner has introduced evidence that he incurred some

business expenses. The record shows that petitioner made large cash withdrawals

consistent with his testimony. He introduced a number of invoices purportedly

related to his construction businesses, some of which provided credible evidence of

his business expenses. See supra note 26. Furthermore, although we do not find

petitioner’s testimony credible in all respects, we find that petitioner credibly

testified that he incurred some expenses in connection with the operation of his

construction businesses. Given the nature of petitioner’s line of work, it is clear to

us that he incurred some business expenses.

      On the basis of petitioner’s testimony and the evidence in the record, we are

convinced that petitioner was operating a construction business and necessarily

had a variety of expenses in connection with the operation of that business, which

would be allowed as deductions under section 162(a). We may allow petitioner a

reasonable amount of estimated deductions under section 162(a) in connection

with his construction businesses. See Friscia Constr., Inc. v. Commissioner, T.C.

Memo. 2000-192. We find that petitioner is entitled to deduct business expenses

in an amount equal to 30% of his total gross receipts from PAMA for each of the

years in issue. This percentage is substantially lower than petitioner’s proposed

expense percentage because we have absolutely no basis for estimating a higher
                                       - 36 -

[*36] percentage. As we have observed in prior opinions, in estimating the amount

of a taxpayer’s business expenses, we bear heavily upon the taxpayer who failed to

maintain and produce the required records. See Cohan v. Commissioner, 39 F.2d at

544. Therefore, petitioner is entitled to deduct as business expenses an amount

equal to 30% of his gross receipts from PAMA for each of 2006 and 2007.

IV.   Petitioner’s Liability for Self-Employment Tax

      A taxpayer’s self-employment income is subject to self-employment tax. Sec.

1401(a) and (b). Self-employment tax is assessed and collected as part of the

income tax, must be included in computing any income tax deficiency or

overpayment for the applicable tax period, and must be taken into account for

estimated tax purposes. Sec. 1401; see also sec. 1.1401-1(a), Income Tax Regs.

Self-employment income generally is defined as “the net earnings from self-

employment derived by an individual”.31 Sec. 1402(b). Section 1402(a) defines

“net earnings from self-employment” as follows:



      31
         With respect to the old-age, survivors, and disability tax imposed by sec.
1401(a), sec. 1402(b)(1) provides that a taxpayer’s self-employment income shall
not include “that part of the net earnings from self-employment which is in excess of
(i) an amount equal to the contribution and benefit base (as determined under
section 230 of the Social Security Act) which is effective for the calendar year in
which such taxable year begins, minus (ii) the amount of wages paid to such
individual during such taxable years”.
                                       - 37 -

      [*37] The term “net earnings from self-employment” means the gross
      income derived by an individual from any trade or business carried on
      by such individual, less the deductions allowed by this subtitle which
      are attributable to such trade or business, plus his distributive share
      (whether or not distributed) of income or loss described in section
      702(a)(8) from any trade or business carried on by a partnership of
      which he is a member * * *

See also sec. 1.1402(a)-1, Income Tax Regs. Income earned for services performed

as an independent contractor is self-employment income. See sec. 1402(c)(2) and

(3); Jackson v. Commissioner, 108 T.C. 130, 133-134 (1997).

      During 2006 petitioner performed services for PAMA through his sole

proprietorship construction businesses. He was an independent contractor and not

an employee of PAMA. All of his unreported income for 2006 arose from his

performance of services for PAMA. Accordingly, all of petitioner’s unreported

income for 2006, less the attributable deductions allowed, is self-employment

income that is subject to self-employment tax.

      During 2007 petitioner performed services for PAMA through his sole

proprietorship construction businesses. He was an independent contractor and not

an employee of PAMA. During 2007 petitioner also provided services to Peter

Ortiz RCI. He received nonemployee compensation of $94,000 from Peter Ortiz

RCI. Petitioner admitted that during 2007 he was self-employed. Accordingly, all
                                        - 38 -

[*38] of petitioner’s unreported income for 2007, less the attributable deductions

allowed, is self-employment income that is subject to self-employment tax.

V.    Petitioner’s 2006 Sale of the Berkshire Property

      Gross income includes all income from whatever source derived, including

gains derived from dealings in property. See sec. 61(a)(3). Gain from the sale or

exchange of property must be recognized, unless the Code provides otherwise. Sec.

1001(c). Section 1001 defines gain from the sale of property as the excess of the

amount realized on the sale of the property over the adjusted basis of the property

sold or exchanged. See also sec. 1.61-6, Income Tax Regs.

      A.     Amount Realized

      The first step in determining gain on the sale of property involves

calculating the amount realized. The amount realized is the sum of any money

received plus the fair market value of any other property received, reduced by the

expenses of selling the property. See sec. 1001(b); Chapin v. Commissioner, 12

T.C. 235, 238 (1949), aff’d, 180 F.2d 140 (8th Cir. 1950). The amount realized

includes “the amount of liabilities from which the transferor is discharged as a

result of the sale or disposition.” Sec. 1.1001-2(a)(1), Income Tax Regs. Selling

expenses include advertising expenses, see sec. 1.1034-1(b)(4)(i), Income Tax

Regs., commissions, see Black v. Commissioner, 60 T.C. 108, 110 (1973); sec.
                                         - 39 -

[*39] 1.1034-1(b)(4)(i), Income Tax Regs., and deed and title preparation expenses,

see Chapin v. Commissioner, 12 T.C. at 238; sec. 1.1034-1(b)(4)(i), Income Tax

Regs.

        Petitioner sold the Berkshire property on May 31, 2006, for $675,000.

Respondent concedes that petitioner incurred the following selling expenses: (1) a

buyer’s credit of $16,225; (2) commissions of $16,875; (3) escrow charges of

$1,396; (4) title charges of $3,580; and (5) a property disclosure settlement amount

of $50. Accordingly, respondent contends that petitioner may reduce his amount

realized by $38,126. Petitioner appears to contend that he incurred additional

“seller fees” of $2,848.

        The seller closing statement shows that part of the sale proceeds was used to

satisfy various liabilities, including a liability identified as the “GMAC

Mortgage”. With respect to the “GMAC Mortgage”, the seller closing statement

identifies the following costs: payoff of the principal balance, accrued interest,

prepayment, recon fee, interest, late charge, and other fees and costs. The seller

closing statement identifies the $2,848 amount as “Other Fees and Costs - GMAC

Mortgage”. Petitioner has introduced no evidence regarding the meaning of “other

fees and costs”. He simply has identified the other fees and costs amount as

“seller fees” in his brief without providing any explanation. Petitioner has failed
                                         - 40 -

[*40] to satisfy his burden of proving that he incurred additional selling expenses

and therefore he is not entitled to reduce his amount realized by an additional

$2,848. Accordingly, we find that petitioner’s amount realized from sale of the

Berkshire property was $636,874.

      B.     Adjusted Basis

      To calculate the gain realized from petitioner’s sale of the Berkshire

property, we must subtract his adjusted basis in the property from the amount he

realized from its sale. Section 1011 provides that a taxpayer’s adjusted basis for

determining the gain or loss from the sale or other disposition of property shall be its

cost, adjusted to the extent provided in section 1016. See also sec. 1012. A

property’s cost is “the amount paid for such property in cash or other property.”

Sec. 1.1012-1(a), Income Tax Regs. The term “cost” includes “any indebtedness to

the seller for the purchase price of the property and any indebtedness to a third party

secured by the property”, as well as expenses a taxpayer incurs in acquiring the

property. Metrocorp, Inc. v. Commissioner, 116 T.C. 211, 242 (2001). The

taxpayer may increase his basis in the property even if he does not personally

assume the indebtedness. See Crane v. Commissioner, 331 U.S. 1, 11-12 (1947).

If a taxpayer places a mortgage on property he already owns, the mortgage
                                        - 41 -

[*41] generally does not affect the basis of the property. See Woodsam Assocs.,

Inc. v. Commissioner, 16 T.C. 649 (1951), aff’d, 198 F.2d 327 (2d Cir. 1952).

      Under section 1016(a)(1), the basis of property must be adjusted for

expenditures, receipts, losses, or other items properly chargeable to capital account.

The cost of improvements and betterments made to a taxpayer’s property are among

the items properly chargeable to capital account. See sec. 1.1016-2(a), Income Tax

Regs. The taxpayer has the burden of proving the basis of property for purposes of

determining the amount of gain the taxpayer must recognize. See O’Neill v.

Commissioner, 271 F.2d 44, 50 (9th Cir. 1959), aff’g T.C. Memo. 1957-193;

Rodriguez v. Commissioner, T.C. Memo. 2009-22.

      Petitioner appears to argue that he had a basis 32 in the Berkshire property of


      32
        In a letter to respondent regarding the notice of deficiency, Mr. Turner
wrote that petitioner had a basis in the Berkshire property of $578,860. On the
Form 4797 attached to his 2006 return, petitioner reported that he had a basis in the
Berkshire property of $650,078. In his brief petitioner contends that he had a basis
in the Berkshire property of $488,903.84. In calculating his basis of $488,903.84,
petitioner included the following amounts: (1) the payoff amount of the GMAC
mortgage principal balance ($447,949.45); (2)“seller fees” of $2,848.39; (3) escrow
charges of $1,396; (4) title charges of $3,580; (5) commissions of $16,875; and (6)
a buyer’s credit of $16,255. As noted, the escrow charges, title charges,
commissions, and buyer’s credit are expenses that reduce petitioner’s amount
realized on the sale of the Berkshire property. See supra pp. 38-39.

       Although petitioner argued that he had a basis of $650,078 on the Form 4797
attached to his 2006 return, petitioner abandoned this argument in his subsequent
                                                                        (continued...)
                                         - 42 -

[*42] $447,949. In the notice of deficiency respondent determined that petitioner

had a basis of zero in the Berkshire property. However, in respondent’s opening

brief, respondent appears to concede that petitioner had a basis of $447,949 in the

Berkshire property by requesting a finding of fact that petitioner had a basis of

$447,949. Moreover, in respondent’s reply brief, respondent abandons any

argument that petitioner had a basis of zero in the property. Because respondent

effectively has conceded that petitioner had a basis of $447,949 in the Berkshire

property, we find that petitioner had a basis of $447,949 in the Berkshire property.

      C.     Claimed Itemized Deductions

      In his opening brief petitioner argues for the first time that he is entitled to

itemized deductions for the real property taxes and interest charges related to the

sale of the Berkshire property. Petitioner contends that he is entitled to deduct the

following: (1) interest charges of $17,221, $14,850, $1,417, and $1,178;33 (2)


      32
         (...continued)
filings with this Court. Accordingly, we deem petitioner to have abandoned his
argument that he had a basis in the Berkshire property in excess of $488,903.84.
Because the escrow charges, title charges, commissions, and buyer’s credit properly
are applied to reduce petitioner’s amount realized, we find petitioner’s argument to
be that he had a basis of $447,949 in the Berkshire property.
      33
         The seller closing statement shows that the amounts petitioner claims as
interest are related to the GMAC mortgage as follows: (1) $17,221 for accrued
interest to May 18, 2006; (2) $14,850 for prepayment; (3) $1,417 for interest from
                                                                        (continued...)
                                         - 43 -

[*43] property taxes and penalties of $6,467; and (3) supplemental taxes and

penalties of $343.34

      Petitioner did not attach a Schedule A to his untimely filed 2006 return and he

did not elect to itemize his deductions for that year. See sec. 63(e)(1). He did not

introduce any evidence at trial other than the closing statement regarding the

payment of real property taxes or of the interest. He did not introduce a Form 1098,

Mortgage Interest Statement, for 2006. With respect to the property taxes,

petitioner introduced no evidence to show which portions of the $6,467 and $343

amounts constituted taxes as opposed to penalties. See sec. 162(f); sec. 1.162-21,

Income Tax Regs.

      Most importantly, petitioner did not give respondent any notice in his

petition, his pretrial memorandum, or at trial that he was claiming these itemized

deductions. In the reply brief respondent contends that petitioner untimely raised

this issue and the parties did not try the issue by consent. Given the lack of

evidence in the record and petitioner’s delay in raising the issue until his opening

brief, we conclude that petitioner did not timely raise the issue, and we decline to

      33
       (...continued)
May 19 through June 2, 2006; and (4) $1,178 for a late charge.
      34
         With respect to the property taxes, petitioner acknowledges that he is not
entitled to deduct the amount of property taxes paid for the period from May 31
through July 1, 2006.
                                          - 44 -

[*44] decide it. See DiLeo v. Commissioner, 96 T.C. 858, 891 (1991), aff’d, 959

F.2d 16 (2d Cir. 1992); Foil v. Commissioner, 92 T.C. 376, 418 (1989), aff’d, 920

F.2d 1196 (5th Cir. 1990).

      D.     Conclusion

      We find that petitioner’s amount realized from the sale of the Berkshire

property was $636,874 and that he had an adjusted basis in the Berkshire property

of $447,949. Accordingly, petitioner must recognize a short-term capital gain of

$188,925 with respect to his 2006 sale of the Berkshire property.

VI.   Petitioner’s 2007 Filing Status

      Section 6013(a) authorizes spouses to elect to file a joint Federal income tax

return. If they elect to do so, the tax required to be shown on the return is

computed on their combined income, expenses, and credits, and their liability for

the tax is joint and several. See sec. 6013(d)(3). To qualify for the tax rate

applicable to joint filers, a taxpayer must file a joint return with his spouse

pursuant to section 6013. See sec. 1(a)(1); see also Brunner v. Commissioner,

T.C. Memo. 2004-187, aff’d, 142 Fed. Appx. 53 (3d Cir. 2005). “[W]here the

taxpayer has filed no return as of the date the case is submitted for decision * * *

no returns would be in the record, and, therefore, no joint filing status could be
                                        - 45 -

[*45] claimed.” Phillips v. Commissioner, 86 T.C. 433, 441 n.7 (1986), aff’d in

part, rev’d in part on another issue, 851 F.2d 1492 (D.C. Cir. 1988).

      For 2007 neither petitioner nor Mrs. Reynoso filed a Federal income tax

return. Accordingly, we sustain respondent’s determination to use a married filing

separately status for petitioner for 2007.35 See supra note 1.

VII. Additions to Tax

      If the taxpayer assigns error to the Commissioner’s determination that a

taxpayer is liable for an addition to tax, the Commissioner has the burden, under

section 7491(c), of producing evidence with respect to the liability of the taxpayer

for the addition to tax. See Higbee v. Commissioner, 116 T.C. at 446-447. To

meet his burden of production, the Commissioner must come forward with

sufficient evidence that it is appropriate to impose the addition to tax. Id. Once


      35
         In his opening brief petitioner argues for the first time that if joint filing
status is disallowed for 2007, petitioner must report only half of his income because
California is a community property State. Petitioner did not give respondent any
notice in his petition, his pretrial memorandum, or at trial that he was claiming that
he was obligated to report only half of his income. Petitioner’s failure to raise his
community property argument before briefing prejudiced respondent. Respondent
did not introduce evidence or elicit testimony to rebut the statutory presumption that
the income was community property, see In re Jolly’s Estate, 238 P. 353 (Cal.
1925), or to support potential arguments under secs. 66(b) or 879(a), see also Shea
v. Commissioner, 112 T.C. 183 (1999). We conclude, therefore, that petitioner did
not timely raise the issue, and we decline to decide it. See DiLeo v. Commissioner,
96 T.C. 858, 891 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992); Foil v. Commissioner,
92 T.C. 376, 418 (1989), aff’d, 920 F.2d 1196 (5th Cir. 1990).
                                         - 46 -

[*46] the Commissioner meets his burden, the taxpayer must come forward with

evidence sufficient to persuade this Court that the determination is incorrect. Id.

Respondent has the burden of proof with respect to the increased additions to tax for

2007 because respondent asserted them in the amended answer. See Rule

142(a)(1).

      Respondent determined that petitioner is liable for additions to tax for failure

to timely file a return for each year in issue under section 6651(a)(1).

Section 6651(a)(1) authorizes the imposition of an addition to tax for failure to

timely file a return, unless it is shown that such failure is due to reasonable cause

and not due to willful neglect. See United States v. Boyle, 469 U.S. 241, 245

(1985); United States v. Nordbrock, 38 F.3d 440, 444 (9th Cir. 1994). A failure to

timely file a Federal income tax return is due to reasonable cause if the taxpayer

exercised ordinary business care and prudence but nevertheless was unable to file

the return within the prescribed time. See sec. 301.6651-1(c)(1), Proced. & Admin.

Regs. Willful neglect means a conscious, intentional failure to file or reckless

indifference toward filing. Boyle, 469 U.S. at 245. The failure to timely file a

return is not excused by the taxpayer’s reliance on an agent to file the required

return. See id. at 252.
                                          - 47 -

[*47] Petitioner stipulated that he did not timely file returns for the years at issue. In

addition respondent introduced Forms 4340, Certificate of Assessments, Payments,

and Other Specified Matters, for 2006 and 2007 which confirm that petitioner failed

to timely file returns for the years at issue. Consequently, we conclude that

respondent has satisfied his burden of production under section 7491(c), and

petitioner must come forward with evidence sufficient to persuade the Court that

respondent’s determination is erroneous. Petitioner appears to argue that his failure

to timely file his returns was due to reasonable cause because he relied on his

accountant, Mr. Turner, to prepare and file returns for the years at issue. Even if we

were to accept petitioner’s testimony regarding his relationship with Mr. Turner as

credible, which we do not, petitioner’s reliance on Mr. Turner does not excuse

petitioner from responsibility to timely file his returns.36 Accordingly, we sustain

respondent’s determinations as to the section 6651(a)(1) additions to tax for 2006

and 2007.

      Respondent also determined that petitioner is liable for additions to tax for

failure to pay tax shown on a return under section 6651(a)(2). Section 6651(a)(2)

imposes an addition to tax for failure to pay the amount of tax shown on a

      36
        We note that petitioner failed to file returns for 2002-05 and 2007-10.
Petitioner’s pattern of noncompliance weighs against a finding of reasonable cause.
See Judge v. Commissioner, 88 T.C. 1175, 1189-1191 (1987).
                                        - 48 -

[*48] taxpayer’s Federal income tax return on or before the payment due date,

unless such failure is due to reasonable cause and not willful neglect.37 A failure to

pay will be considered due to reasonable cause if the taxpayer makes a satisfactory

showing that he exercised ordinary business care and prudence in providing for

payment of his tax liability and was nevertheless unable to pay the tax or would

suffer undue hardship if he paid on the due date. See sec. 301.6651-1(c)(1), Proced.

& Admin. Regs. The section 6651(a)(2) addition to tax applies only when an

amount of tax is shown on a return filed by the taxpayer or prepared by the

Secretary. Sec. 6651(a)(2), (g)(2); Cabirac v. Commissioner, 120 T.C. 163, 170

(2003). When a taxpayer has not filed a return, the section 6651(a)(2) addition to

tax may not be imposed unless the Secretary has prepared a substitute for return that

satisfies the requirements of section 6020(b). See Wheeler v. Commissioner, 127

T.C. 200, 210 (2006), aff’d, 521 F.3d 1289 (10th Cir. 2008).

      Respondent introduced into evidence substitutes for returns that satisfy the

requirements of section 6020(b), as well as the Forms 4340. The substitutes for

returns and the Forms 4340 establish that petitioner failed to pay the tax shown

on the substitutes for returns. Respondent has satisfied his burden of production

      37
         The sec. 6651(a)(2) addition to tax is 0.5% of the amount of tax shown on
the return, with an additional 0.5% per month during which the failure to pay
continues, up to a maximum of 25%.
                                          - 49 -

[*49] under section 7491(c). Petitioner did not introduce any evidence that he was

unable to pay the taxes owed or that he would have suffered undue hardship if he

had paid the taxes on the due dates. Accordingly, we sustain respondent’s

determinations as to the section 6651(a)(2) additions to tax.

      Respondent also determined that petitioner is liable for additions to tax for

failure to pay estimated tax under section 6654. Section 6654 imposes an addition

to tax on an individual who underpays his estimated tax.38 The addition to tax is

calculated with reference to four required installment payments of the taxpayer’s

estimated tax liability. Sec. 6654(c) and (d). In general, each required installment

of estimated tax is equal to 25% of the “required annual payment”. Sec. 6654(d).

A taxpayer has an obligation to pay estimated tax only if he has a “required annual

payment”. Wheeler v. Commissioner, 127 T.C. at 212; see also Mendes v.

Commissioner, 121 T.C. 308, 324 (2003). The “required annual payment” is equal

to the lesser of (1) 90% of the tax shown on the individual’s return for that year

(or, if no return is filed, 90% of his tax for such year), see sec. 6654(d)(1)(B)(i), or


      38
        Unless a statutory exception applies, the sec. 6654(a) addition to tax is
mandatory, see sec. 6654(a), (e); Recklitis v. Commissioner, 91 T.C. 874, 913
(1988), and sec. 6654 does not contain a general exception for reasonable cause or
absence of willful neglect, see Grosshandler v. Commissioner, 75 T.C. 1, 21 (1980).
Petitioner does not contend that any of the statutory exceptions under sec. 6654(e)
are applicable to this case.
                                         - 50 -

[*50] (2) if the individual filed a return for the immediately preceding taxable year,

100% of the tax shown on that return, see sec. 6654(d)(1)(B)(ii); see also sec.

6654(d)(1)(A), (B), and (C). If, after the Commissioner issues a notice of

deficiency for a taxable year, a taxpayer files a return for that year showing no tax

due, the Court will disregard the return for purposes of determining whether the

taxpayer satisfies “the return-filed safe harbor of section 6654(d)(1)(B)(i).” Mendes

v. Commissioner, 121 T.C. at 328.

      Respondent introduced evidence to prove that petitioner was required to file

Federal income tax returns for 2006-07, that petitioner failed to file returns for 2005

and 2007 and failed to timely file a return for 2006, and that petitioner did not make

any estimated tax payments for 2006 and 2007.

      Because petitioner did not file a return for 2005, petitioner’s required annual

payment for 2006 was equal to 90% of the tax shown on his return for that year at

issue or, if no return was filed, 90% of his tax for the year. See sec.

6654(d)(1)(B). We disregard petitioner’s untimely filed 2006 return because it

was filed after respondent mailed the notice of deficiency for 2006. Mendes v.

Commissioner, 121 T.C. at 324-325. Respondent has produced sufficient

evidence to demonstrate that petitioner had a required annual payment for 2006

equal to 90% of his tax for the year, that petitioner did not make any estimated tax
                                          - 51 -

[*51] payments for 2006, and that petitioner is liable for the section 6654 addition to

tax for 2006. Petitioner does not contend that any statutory exception to the

addition to tax applies. Accordingly, we sustain respondent’s determination as to

the section 6654 addition to tax for 2006.

      We reach a different conclusion with respect to 2007, however. Petitioner

failed to file a return for 2007, but he filed a return for 2006 before respondent

mailed the notice of deficiency for 2007. On petitioner’s 2006 return, he reported

total tax of $3,813. After petitioner subtracted his credits against tax from his total

tax figure, he calculated that he had zero tax due and requested a refund. See

supra note 12; see also sec. 6654(f). For purposes of deciding petitioner’s tax

liability for 2006, we look to his tax liability after adjustments for credits against

tax. See sec. 6654(f)(3). Accordingly, petitioner’s 2006 return showed no tax

liability,39 and therefore petitioner did not have a required annual payment for


      39
         Furthermore, we note that a taxpayer’s estimated tax liability is determined
on the basis of the original tax return, and not on the basis of the notice of
deficiency or our decision with respect to the taxpayer’s ultimate liability. See
Mendes v. Commissioner, 121 T.C. 308, 324 (2003). The taxpayer may rely on an
untimely filed original return provided that the return was filed before the issuance
of the notice of deficiency. See Ellis v. Commissioner, T.C. Memo. 2007-207, aff’d
in part and rev’d in part, 346 Fed. Appx. 346 (10th Cir. 2009). While petitioner
filed his 2006 return after respondent issued the notice of deficiency for 2006,
petitioner filed the return before respondent mailed him the notice of deficiency for
2007.
                                         - 52 -

[*52] 2007. Accordingly, we do not sustain respondent’s determination as to the

section 6654(a) addition to tax for 2007.

         We have considered all the other arguments made by the parties, and to the

extent not discussed above, find those arguments to be irrelevant, moot, or without

merit.

         To reflect the foregoing,


                                                  Decisions will be entered under

                                         Rule 155.
