                          T.C. Summary Opinion 2012-60



                         UNITED STATES TAX COURT



     SAMUEL CARMICKLE AND PAULINE CARMICKLE, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 27793-09S.                         Filed June 26, 2012.



      Samuel Carmickle and Pauline Carmickle, pro sese.

      Martha J. Weber, for respondent.



                              SUMMARY OPINION


      RUWE, Judge: This case was heard pursuant to the provisions of section

74631 of the Internal Revenue Code in effect when the petition was filed. Pursuant



      1
       Unless otherwise indicated, all section references are to the Internal Revenue
Code as amended and in effect for the years in issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
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to section 7463(b), the decision to be entered is not reviewable by any other court,

and this opinion shall not be treated as precedent for any other case.

      Respondent determined deficiencies and penalties in petitioners’ 2005 and

2006 Federal income taxes.2 These amounts were subsequently amended in

respondent’s amendment to answer, filed June 7, 2011. Respondent’s amendment

to answer reflects concessions made by the parties in their supplemental

stipulation of facts, filed May 10, 2011.3 Respondent now asserts that the




      2
       The notice of deficiency indicated that respondent determined that petitioners
were liable for an addition to tax under sec. 6651(a)(1) for failing to timely file their
2006 return. Respondent has conceded that petitioners timely filed their 2006 return
and that imposition of the addition to tax under sec. 6651(a)(1) is not appropriate.
      3
        The parties stipulate that petitioners claimed a $53,162 loss on their 2005 tax
return. The parties agree the loss is $46,589 and that petitioners are entitled to
claim the loss for 2005.

       On their 2006 return petitioners claimed an $18,050 loss on Schedule E,
Supplemental Income and Loss, from their subchapter S corporation. The parties
agree that petitioners are entitled to claim the loss for 2006.

       In the notice of deficiency respondent allowed petitioners a $1,000 home
office deduction for 2006. The parties agree that petitioners are not entitled to the
$1,000 home office deduction. The parties also agree that petitioners failed to
report $825 of dividend income and $2,039 of wages for 2006.

       As a result of petitioners’ being allowed to deduct additional Schedule E
rental expenses of $15,911.50, the amount of gain from the sale of property for 2006
is increased from $73,359.00 to $89,270.50.
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deficiencies for 2005 and 2006 are $6,961 and $11,423, respectively, and that the

penalties under section 6662(a) for 2005 and 2006 are $1,392.20 and $2,284.60,

respectively.

         The issues remaining for decision are: (1) whether petitioners are entitled to

an $8,600 Schedule E deduction for “lost rent” for 2005; (2) whether petitioners are

entitled to deduct a $22,705 loss attributable to home office expenses for 2005; (3)

whether petitioners can exclude $89,270.50 in gain from the sale of an apartment

building for 2006 under section 121; and (4) whether petitioners are liable for an

accuracy-related penalty under section 6662(a) for 2005 and 2006.

                                       Background

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

facts, the supplemental stipulation of facts, and the attached exhibits are

incorporated herein by this reference.

         At the time the petition was filed, petitioners resided in Tennessee.

         Petitioners timely filed joint income tax returns for the 2005 and 2006 taxable

years.

         In 2005 petitioners owned individual properties in Evergreen Park, Central

Park, and Chicago, Illinois.
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Evergreen Park Property

      The Evergreen Park property is a six-unit apartment building which Mr.

Carmickle managed in 2005. Petitioners rented several units in the building to

tenants during 2005 and 2006.

      On a Schedule E attached to their 2005 return, petitioners claimed an $8,600

deduction for “lost rent” for the Evergreen Park property. Petitioners contend that

the “lost rent” deduction represents delinquent rent owed by their tenants.

      In 2006 petitioners sold the Evergreen Park property. On the Form 4797,

Sales of Business Property, attached to their 2006 return, petitioners reported gain

of $78,409 from the sale. However, petitioners did not include the gain as taxable

income on their 2006 return. The parties agree that $89,270.50 is the correct

amount of gain that petitioners realized from the sale of the apartment building. The

parties also agree that petitioners received rents of $13,855 in 2006 from the

property before it was sold, which they did not include as income on their 2006

income tax return.

Chicago Property

      Petitioners considered the Chicago property to be their personal residence.

Petitioners used the address for the Chicago property as their mailing address.
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Petitioners also parked their personal vehicles in the garage of the Chicago

property.

      Petitioners were shareholders of Carmickle & Associates, an S corporation

involved in the business of renovating, developing, and managing properties. On

their 2005 return petitioners claimed a flowthrough loss of $22,705 from Carmickle

& Associates. Petitioners contend that the loss relates to a home office expense for

an office that Mr. Carmickle claims to have maintained at the Chicago property.

Petitioners’ home office deduction for 2005 included amounts claimed for

purchases, automobile insurance, automobile depreciation, and automobile repairs.

                                      Discussion

      As a general rule, the Commissioner’s determinations are presumed correct,

and taxpayers bear the burden of proving that those determinations are erroneous.

Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Welch v.

Helvering, 290 U.S. 111, 115 (1933). In the amendment to answer, respondent

made several adjustments, including increasing the amount of gain from the sale of

the Evergreen Park property in 2006 from $73,359 to $89,270.50. This, along with

petitioners’ failure to include $13,855 of rent from the Evergreen Park property on

their 2006 return, resulted in a deficiency for 2006 that is greater than respondent
                                         -6-

determined in the notice of deficiency for that year. Therefore, respondent has the

burden of proof with regard to the increase in the deficiency for 2006. See Rule

142(a). On the basis of the parties’ arguments, documentary evidence, and

testimony in the record before us, we find that respondent has satisfied this

burden.

      Deductions are a matter of legislative grace, and taxpayers generally bear the

burden of proving that they are entitled to any deduction claimed. Rule 142(a);

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

290 U.S. at 115. To meet the burden, taxpayers must supply substantiation of any

deductions and expenses claimed. Hradesky v. Commissioner, 65 T.C. 87, 89

(1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976); see sec. 6001; sec. 1.6001-

1(a), Income Tax Regs. (requiring taxpayers to maintain sufficient records to permit

verification of deductible expenses).

I. “Lost Rent” Deduction

      Section 162(a) allows as a deduction all the ordinary and necessary expenses

paid or incurred during the taxable year in carrying on any trade or business. In

general, business expenses, which are deductible from gross income, include the

ordinary and necessary expenditures directly connected with or pertaining to the

taxpayer’s trade or business. Sec. 1.162-1(a), Income Tax Regs.
                                        -7-

      Taxpayers have the burden of establishing their right to a claimed deduction

as an “ordinary and necessary expense[] paid or incurred during the taxable year in

carrying on any trade or business.” Kalamazoo Oil Co. v. Commissioner, 693 F.2d

618, 620 (6th Cir. 1982), aff’g T.C. Memo. 1981-344.

      The amount petitioners deducted as “lost rent” represented amounts their

tenants owed them for past-due rent. We have held that past-due or unpaid rents are

not a deductible expense where they have not previously been included as income

on the taxpayers’ return. Mills v. Commissioner, T.C. Memo. 1991-592.

      In addition, as previously noted, petitioners must supply adequate

substantiation of any deductions and expenses claimed. See Hradesky v.

Commissioner, 65 T.C. at 89; see also sec. 1.6001-1(a), Income Tax Regs. In order

to do so, taxpayers must keep adequate records reflecting that their business

expenses are ordinary and necessary. Secs. 162, 6001. Petitioners have not

provided the Court with evidence sufficient to meet these substantiation

requirements. The evidence presented to the Court is not sufficient to enable us to

verify the amount of the “lost rent” expense claimed by petitioners. Petitioners

presented no lease or loan documents representing amounts due from their tenants

or showing that amounts were “loaned” to tenants in order to cover their rent

obligations. Instead, petitioners presented only a handwritten “Summary of
                                         -8-

Tenants”, which lists only the names of tenants, their current rent charges, and

amounts listed as “Loan to Tenant Rent Short”.

      Therefore, we hold that petitioners are not entitled to the claimed $8,600 “lost

rent” deduction for 2005 and sustain respondent’s determination.

II. Home Office Expense Deduction

      On their 2005 return petitioners claimed a nonpassive loss of $22,705 from

Carmickle & Associates, for which the record does not reflect a filed tax return for

2005 or any gross income for 2005. Petitioners contend that the entire loss is for

estimated expenses claimed for a home office at the Chicago property.

      As a general rule, section 280A(a) provides that no deduction shall be

allowed with respect to the business use of a dwelling unit that is used by the

taxpayer during the year as a residence. However, section 280A(c)(1) provides an

exception for certain business use of a dwelling unit, provided that a portion of the

dwelling unit is exclusively used on a regular basis as the principal place of

business. The term “a portion of the dwelling unit” refers to “a room or other

separately identifiable space;” a permanent partition marking off the area is not

necessary. Hefti v. Commissioner, T.C. Memo. 1993-128, Tax Ct. Memo LEXIS

133, at *22. The term “principal place of business” includes a place of business

used by the taxpayer to perform administrative or management activities related to
                                         -9-

the trade or business if there is no other fixed location of the trade or business where

substantial administrative or management activities are undertaken. Sec.

280A(c)(1).

      Petitioners claimed a flowthrough loss of $22,705 as a “home office”

nonpassive loss from Schedule K-1, Partner’s Share of Income, Deductions, Credits,

etc., on the Schedule E attached to their 2005 return. To support their home office

expenses, petitioners provided an estimate of the home office expenses they

incurred for 2005 in the form of a handwritten schedule or log. Petitioners offered

no further documentation to explain how they arrived at the estimated amounts, nor

is there evidence such as receipts or invoices establishing that the expenses were

incurred for the home office. Petitioners’ estimate of home office expenses included

purchases of inventory, automobile insurance, automobile depreciation, and

automobile repairs.

      We find that petitioners have not adequately substantiated their home office

expenses. Petitioners produced no books or records supporting their claimed

expenses. We are left with little more than petitioners’ handwritten schedule of

expenses, which is not sufficient to meet their burden. See Cluck v. Commissioner,

105 T.C. 324, 338 (1995) (summary schedules insufficient to entitle the taxpayer to

claimed deductions). The summary schedule petitioners provided does not
                                        - 10 -

demonstrate their entitlement to the claimed deductions. In addition, petitioners

have not offered any of the documentation underlying their schedule of expenses.

We are not required to accept Mr. Carmickle’s unsubstantiated testimony, and we

decline to do so. See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).

Accordingly, on the grounds of inadequate substantiation and a general lack of

evidence, petitioners are not entitled to deduct any of the disputed home office

expenses for 2005. We therefore sustain respondent’s disallowance of the

deduction for home office expenses.

III. Gain From the Sale of the Evergreen Park Property

      In 2006 petitioners sold the six-unit Evergreen Park property. On the

Schedule E relating to the Evergreen Park property, which was attached to their

2006 tax return, petitioners reported realized gain and asserted that the gain was not

taxable under section 121. The net gain from the sale of the property is

$89,270.50.

      Section 121 provides for the exclusion from gross income of up to $250,000

of gain from the sale or exchange of property if the property was owned and used

by the taxpayer as the taxpayer’s principal residence for periods aggregating two

years or more during the five-year period preceding the sale or exchange. A

husband and wife filing a joint return may exclude a maximum of $500,000 of the
                                         - 11 -

gain from gross income if at least one spouse meets the ownership requirement and

both spouses meet the use requirement of section 121(a). Sec. 121(b).

      Petitioners contend that during 2006 Mr. Carmickle “occupied 5/6 of the

rental property (83%) UNITS” as his residence and that “[p]etitioners are therefore

entitled to eliminate capital gains of all the building” under section 121.

      Whether a residence qualifies as the taxpayer’s principal residence for

purposes of section 121 is a question of fact that is resolved with reference to all the

facts and circumstances. Sec. 1.121-1(b)(2), Income Tax Regs.; see also Thomas v.

Commissioner, 92 T.C. 206, 244 (1989); Clapham v. Commissioner, 63 T.C. 505,

508 (1975).

      For 2005 and 2006 petitioners claimed a home office expense on behalf of

Mr. Carmickle for the Chicago property, which implies that he resided there during

those years. In addition, it is not contested that Mrs. Carmickle resided at the

Chicago property and that she never resided at the Evergreen Park property. Mr.

Carmickle received mail at the Chicago property, including all of his utility bills.

Furthermore, it is undisputed that neither petitioners nor their family members

resided at the Evergreen Park property in the years before 2006.

      The record is devoid of evidence supporting petitioners’ claim that Mr.

Carmickle used one or more of the units in the Evergreen Park property as his
                                         - 12 -

principal residence during 2006, other than his self-serving testimony that he

maintained an office at the apartment building and spent about 20 hours a week at

the property. We need not accept a taxpayer’s self-serving testimony when the

taxpayer fails to present corroborative evidence. Broz v. Commissioner, 137 T.C.

46, 59 (2011).

      Taking into account all of the facts and circumstances before us, we are

satisfied that petitioners did not use the property as a principal residence during

2006. We therefore find that it was not petitioners’ principal residence, as that term

is used in section 121. Accordingly, we sustain respondent’s determination

that petitioners are not entitled to exclude from their 2006 gross income the gain

realized on the sale of the Evergreen Park property.

IV. Section 6662(a) Accuracy-Related Penalty

      Section 6662(a) imposes an accuracy-related penalty equal to 20% of the

underpayment to which section 6662 applies. Section 6662 applies to the portion of

any underpayment which is attributable to, inter alia, negligence, sec. 6662(b)(1), or

a substantial understatement of income tax, sec. 6662(b)(2).

      Respondent determined that petitioners were liable for section 6662(a)

accuracy-related penalties of $1,392.20 and $2,284.60 for the taxable years 2005

and 2006, respectively. Respondent contends that the underpayments of tax are
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attributable either to negligence or substantial understatements of income tax.

Respondent’s contentions necessarily reflect alternative grounds for imposing the

section 6662 penalties because only one section 6662 accuracy-related penalty may

be imposed with respect to any given portion of any underpayment, even if the

underpayment is attributable to more than one of the types of listed conduct. See

New Phoenix Sunrise Corp. v. Commissioner, 132 T.C. 161, 187 (2009), aff’d, 408

Fed. Appx. 908 (6th Cir. 2010); sec. 1.6662-2(c), Income Tax Regs.

      For purposes of section 6662, negligence is any failure to make a reasonable

attempt to comply with the provisions of the Internal Revenue Code, and disregard

includes any careless, reckless, or intentional disregard. Sec. 6662(c); see also

Neely v. Commissioner, 85 T.C. 934, 947 (1985) (negligence is lack of due care or

failure to do what a reasonably prudent person would do under the circumstances);

sec. 1.6662-3, Income Tax Regs. Negligence also includes any failure to exercise

ordinary and reasonable care in the preparation of a tax return or any failure to keep

adequate books and records and to properly substantiate items. Sec. 1.6662-

3(b)(1), Income Tax Regs.

      We find that petitioners acted negligently by failing to keep adequate books

and records and by not exercising reasonable care given the circumstances.

Petitioners could not and did not substantiate the deductions that respondent
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disallowed. Petitioners failed to comply with the internal revenue laws or to

exercise ordinary and reasonable care in preparing their 2005 and 2006 tax returns.

That petitioners’ claimed deductions and exclusions from income were not

supported by their documentation exhibits that, at the very least, they were careless

about complying with their income tax obligations.

      Section 6664(c)(1) provides that the penalty under section 6662(a) shall not

apply to any portion of an underpayment if it is shown that there was reasonable

cause for the taxpayers’ position and that the taxpayers acted in good faith with

respect to that portion. See Higbee v. Commissioner, 116 T.C. 438, 448 (2001).

The determination of whether taxpayers acted with reasonable cause and in good

faith is made on a case-by-case basis, taking into account all the pertinent facts and

circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. “Circumstances that may

indicate reasonable cause and good faith include an honest misunderstanding of fact

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

experience, knowledge, and education of the taxpayer.” Id.

      Petitioners have not shown reasonable cause, as their theories purporting to

justify erroneous deductions are implausible. In addition, petitioners failed to seek

competent tax advice in filing their returns. Petitioners offered no evidence or

explanation that indicates that there was reasonable cause, and that they acted in
                                         - 15 -

good faith, with respect to the underpayments. As a result, we hold that petitioners

are liable for the accuracy-related penalties under section 6662(a), and the penalties

are sustained on the recomputed deficiencies. Because we conclude that petitioners

were negligent, we need not address respondent’s alternative grounds for imposing

the section 6662 penalties.

         In reaching our decision, we have considered all arguments made by the

parties. To the extent not mentioned or addressed, they are irrelevant or without

merit.

         To reflect the foregoing,


                                                              Decision will be entered

                                                  under Rule 155.
