                             T.C. Memo. 2019-159



                          UNITED STATES TAX COURT



      JOYNER FAMILY LIMITED PARTNERSHIP, GARY JOYNER
  REVOCABLE TRUST, A PARTNER OTHER THAN THE TAX MATTERS
  PARTNER, JANEL JOYNER REVOCABLE TRUST, A PARTNER OTHER
   THAN THE TAX MATTERS PARTNER, AND JOYNER INVESTMENT
       COMPANY, INC., TAX MATTERS PARTNER, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 24704-15.                       Filed December 11, 2019.



      Juan F. Vasquez, Jr., Jaime Vasquez, A. Leonides Unzeitig, and Adrian

Ochoa, for petitioners.

      Lauren N. May, Danielle R. Dold, Christa A. Gruber, Tess deLiefde, and

Thomas F. Harriman, for respondent.
                                         -2-

[*2]        MEMORANDUM FINDINGS OF FACT AND OPINION


       GOEKE, Judge: Joyner Family Limited Partnership (JFLP) is a small,

family-run business that sells land and mobile homes primarily to low-income,

high-credit-risk individuals under seller-financed deferred payment plans. It

received cash payments from the buyers of less than $500,000 during 2010, 2011,

and 2012 (years at issue) and is facing an $8.7 million adjustment on the basis of

the face values of promissory notes it received in the sales, the substantial majority

of which were defaulted on and went unpaid.

       On May 11, 2015, respondent issued a notice of final partnership

administrative adjustment (FPAA) to JFLP for the years at issue, asserting that

JFLP is not entitled to use the section 453 installment method to report the mobile

home sales and must report income from the sales upon receipt of the notes,

increasing JFLP’s gross receipts by $1,759,306, $1,250,278, and $606,412 for

2010, 2011, and 2012, respectively.1 For 2010 he also asserted a section 481

adjustment for pre-2010 sales of approximately $3.8 million. He did not assert an

adjustment for JFLP’s sales of land that did not include mobile homes (land-only


       1
      Unless otherwise stated all section references are to the Internal Revenue
Code (Code) in effect at all relevant times, and all Rule references are to the Tax
Court Rules of Practice and Procedure. Amounts are rounded to the nearest dollar.
                                          -3-

[*3] sales).2 In the FPAA respondent allowed JFLP substantial worthless debt

deductions for the defaulted-on notes, which reduced JFLP’s taxable income for

2010 and resulted in tax losses of $281,332 and $953,657 for 2011 and 2012.

      Respondent filed an amendment to the answer, asserting for the first time

that JFLP was not entitled to report its land-only sales under the installment

method and increasing JFLP’s 2010 and 2011 gross receipts by $1,001,665 and

$19,328, respectively, for the land-only sales. Respondent also asserted that JFLP

was not entitled to the worthless debt deductions that he had previously allowed.

As a result of these further assertions, respondent is seeking increases in JFLP’s

taxable income for the years at issue of over $8.7 million.

      The issues for decision are: (1) whether JFLP is entitled to use the section

453 installment method to report the mobile home sales or the land-only sales; we

hold for mobile homes sales, it is not, and for land-only sales, it is; (2) whether

respondent may change JFLP from the cash receipts and disbursements method of

accounting (cash method) to the accrual method; we hold respondent may not; and

(3) whether respondent abused his discretion by requiring JFLP to report its

income from the mobile home sales upon receipt of the notes on the basis of the


      2
      For simplicity, we refer to a sale that included land and a mobile home as a
mobile home sale and a sale of land without a mobile home as a land-only sale.
                                         -4-

[*4] notes’ face values and asserting a related section 481 adjustment; we hold he

did.

                               FINDINGS OF FACT

       JFLP had its principal place of business in Arkansas when the petition was

timely filed. Petitioners Gary Joyner Revocable Trust and Janel Joyner Revocable

Trust were limited partners with a 49.5% interest each. Joyner Investments Co.,

Inc., is an Arkansas corporation, the tax matters partner, and a 1% general partner.

I.     Background

       Gary and Janel Joyner met in junior high school and married after high

school graduation. In 1985 they began to purchase large tracts of land in rural

Arkansas and subdivide the land for resale. They purchased their first tract of

land, an 80-acre parcel, from a great-uncle, Dean Martin, who had encouraged

them (and others in his church) to invest in real estate and subdivide and resell the

land. Mr. Martin financed the purchase and retained title until the Joyners paid

him in full, approximately 14 years later.

       The Joyners subdivided the land into 10 to 12 lots. Before subdividing the

land, they performed a percolation test of the soil to determine the rate of water

absorption. They laid gravel roads to the subdivided lots but did not make

improvements to the lots. The electric company installed electrical poles on the
                                         -5-

[*5] land at no charge. The Joyners marketed the lots primarily to low-income

individuals. The buyers used the land for mobile homes that they purchased from

mobile home retailers and financed through third-party financing companies, some

of which specialized in financing the purchase of mobile homes. The buyers used

the mobile homes as their permanent residences. Typically, the buyers removed

the wheels from the mobile homes and placed them on structural supports. The

buyers installed septic tanks and water wells or water lines. They also paid to lay

their own driveways and provided their own electrical hookups.

      Initially the Joyners operated the business in their individual capacities. In

1998 they organized JFLP on the advice of their certified public accountant

(C.P.A.), Richard Bell of Bell & Co., P.A. (Bell & Co.). Mr. Martin referred the

Joyners and the other individuals that he had encouraged to invest in real estate to

Bell & Co. Starting in the mid-1980s, Bell & Co. had approximately 10 to 12

clients who were engaged in similar real estate businesses in the rural Arkansas

community where JFLP was located. Bell & Co. has prepared the Joyners’ joint

returns and the entity returns for over 25 years.

      In total, the Joyners and JFLP have purchased at least 16 parcels of land

consisting of over 2,300 acres and have subdivided the land into over 400 lots.

The sizes of the lots ranged from 4 to 10 acres in the earlier years and 1 to 2 acres
                                         -6-

[*6] for land purchased after 2002. JFLP often owned the land for a significant

number of years before selling all the lots. In the beginning, the Joyners

purchased land through seller-financing, including additional purchases from Mr.

Martin. Later they obtained bank loans for the purchases secured by the land, and

JFLP resold the subdivided lots subject to the bank mortgages. JFLP remained

liable for the bank loans and continued to repay them. As of the end of 2010 JFLP

had outstanding mortgages on five parcels.

      At first, JFLP sold only the land. Around 2000 JFLP started to purchase

used mobile homes and resell them on its lots. It entered into this new line of

business slowly. JFLP sold its first mobile home in 1999 and two more in 2001.

Land-only sales remained a significant percentage of its sales until 2005, the first

year JFLP sold more mobile homes (30) than lots (16). For the most part, JFLP’s

purchases of mobile homes were sporadic with a high of 11 purchases in 2008 and

2010 and as few as 1 to 4 in other years, especially the earlier years, 2001 through

2004. JFLP often bought mobile homes in foreclosure sales; some of those homes

were on JFLP’s lots. During the years at issue JFLP paid $7,000 to $17,000 for

the used mobile homes, depending on the size of the mobile home, single or

double wide, for an average of approximately $11,000.
                                         -7-

[*7] The economic downturn in 2008 significantly affected the mobile home

market in JFLP’s area. Sources of third-party financing dried up, and many

mobile home retailers went out of business. The prices that JFLP paid for used

mobile homes also dropped significantly. JFLP paid as much as $23,900 in 2002

and $27,000 in 2006 for used mobile homes. Even these higher prices were

generally less than half the prices of new mobile homes.

II.   Sales

      Mr. Joyner was the sales agent and was responsible for purchasing used

mobile homes to resell. Ms. Joyner performed bookkeeping and administrative

work. JFLP did not have any other employees but engaged several independent

contractors with respect to the mobile homes that JFLP offered for sale, to relocate

mobile homes that JFLP purchased, to provide electrical hookups, to install water

wells or water lines, septic tanks, and air conditioning units, to construct gravel

driveways, and to perform general maintenance.

      During the years at issue JFLP offered options to rent or purchase mobile

homes or to purchase land only. Typically, JFLP’s customers had not previously

owned homes. They were primarily low income, had poor credit histories and

unstable employment histories, and could not obtain traditional financing to

purchase homes. JFLP offered affordable housing. Mr. Joyner determined the
                                         -8-

[*8] amount of the monthly payment on the basis of what the customer could

afford. Monthly payments ranged from $100 to $700.

      The Joyners are well respected in the community. They rarely declined to

sell to a prospective buyer except if they suspected the buyer was involved with

drugs. Their philosophy was to give people a chance. For some buyers JFLP

obtained the necessary information to perform credit checks, but the Joyners did

not perform credit checks because of the costs of running credit checks and

because Mr. Joyner believed that the buyers’ poor financial situation made the

credit checks pointless. Mr. Joyner would ask prospective buyers whether they

had jobs, but he did not request any documentation, such as pay stubs, or

otherwise verify their employment or income.

      For each sale JFLP and the buyer executed a purchase agreement and a note.

The Joyners used forms purchased from an office supply store. The agreement

stated the sale price, the amount of the monthly payment, and the interest rate.

The agreement did not state the length of time that it would take for the buyer to

pay the entire sale price, state the number of payments necessary to pay off the

loan, or include an amortization schedule. The Joyners typically did not collect

downpayments because the buyers could not afford to make them.
                                        -9-

[*9] Under the purchase agreement, JFLP retained legal title until the buyer paid

the full sale price. The purchase agreement prohibited the buyer from recording

the agreement without JFLP’s consent. Agreements from approximately 60

properties, representing approximately 15% of the sales over the history of JFLP’s

business, were recorded. The buyer had the right to immediate possession and

occupancy and was required to pay property tax, maintain insurance, and maintain

and repair the property. The purchase agreement prohibited the buyer from

selling, transferring, or assigning the property without JFLP’s written consent.

For some properties, the buyers paid the property taxes; for others, JFLP paid them

and billed the buyers. Because JFLP retained legal title, nonpayment of property

taxes would have jeopardized its ownership of the property. The buyers often

purchased insurance as required by the purchase agreements. However, the

Joyners purchased insurance if they knew a buyer had not.

      Like the purchase agreement, the note did not state the term of the loan or

the number of payments required to pay the note in full or include an amortization

schedule. Amortization of the notes on the basis of the principal amounts,

monthly payments, and interest rates would result in terms ranging from 11 to 36

years and an average term of 22 years for the notes executed during the years at
                                         -10-

[*10] issue. The note stated that it was a lien against the property until the sale

price was paid in full.

      On default, the note granted JFLP the right to declare the unpaid balance

due and payable after 30 days’ notice. The purchase agreement also gave JFLP

the right to declare the entire unpaid balance due and payable; however, it also

provided JFLP with the alternative of rescinding the sale. In all instances, JFLP

chose to rescind the sale. It never attempted to collect the unpaid balance and

never declared the unpaid balance on a note due and payable. When JFLP

rescinded a sale, the purchase agreement gave JFLP the right to retain all

payments “not as a penalty, but as rent of the property”. Under the purchase

agreements JFLP could demand that the buyers vacate the property, or if the buyer

did not vacate the property, JFLP could convert the sale to a rental at a monthly

rent equal to the monthly payment. On occasion, a previous buyer purchased a

different mobile home from JFLP and returned the first mobile home to JFLP,

referred to as a swap. JFLP did not give the buyer any credit against his new

purchase for prior payments.

      JFLP executed approximately 450 purchase agreements and notes from

1999 through 2009 ranging from a high of 61 land-only sales in 2002 to a low of

28 total sales in 2007. During the years at issue it had the following mobile home
                                        -11-

[*11] and land-only sales, with total sale prices and reported income from

payments received as follows:

             Year No. of sales      Total sale price   Reported income
             2010        21           $2,648,700           $149,480
             2011        27            2,023,600            146,599
             2012        19            1,352,541            153,665

       JFLP had unpaid balances on 221 sales during 2010, 208 sales during 2011,

and 181 sales during 2012. Its gross profit margins ranged from 30% to 84%

during the years at issue with an average profit margin of 71%, calculated using an

average sale price of $77,481 and an average cost basis of $22,532. JFLP listed

the notes’ unpaid balances as “deferred installment income” as liabilities on the

balance sheets of its partnership returns, reporting $5,516,199, $4,940,699, and

$3,956,235 for the end of 2010, 2011, and 2012, respectively.

III.   Rentals

       JFLP began renting mobile homes around 2006. It slowly entered into this

new line of business. JFLP participated in the federally funded low income

housing program known as Section 8 housing for renters who met the maximum

income threshold. Under the program the local housing authority paid rent

assistance directly to JFLP and required the renters to commit to a one-year lease.
                                         -12-

[*12] During the years at issue JFLP executed the rental agreements and reported

rental income as follows:

                    Year    No. of agreements       Rental income
                    2010            10                 $37,233
                    2011            25                   90,272
                    2012            64                 232,050

      At the time of trial, most of JFLP’s gross receipts derived from rentals rather

than sales. The Joyners preferred to rent because of the stability of rental

payments under the Section 8 housing program and the tax issues they are facing

here. JFLP has allowed buyers to convert their sales to rentals to take advantage

of the Section 8 housing program.

IV.   Repossessions

      JFLP experienced a very high default rate on mobile home sales during the

years at issue. When a buyer failed to make a monthly payment, the Joyners often

allowed the buyer to pay late and would not evict the buyer, particularly if he was

facing a financial hardship or a medical problem making it difficult for him to

work. When the Joyners did demand that a buyer vacate the property, it was

usually after his missing multiple payments. The Joyners would send the

defaulting buyer a notice to vacate that they based on a form purchased from an
                                        -13-

[*13] office supply store. Generally, the buyers voluntarily vacated after receiving

the notice. On a few occasions, JFLP needed assistance from the sheriff’s office

to evict a buyer. JFLP did not take legal action or otherwise attempt to collect the

unpaid balance of the note. Instead, it repossessed the mobile home and attempted

to resell it. It reduced its deferred installment income by the note’s unpaid

balance. JFLP did not obtain appraisals for the mobile homes or land that it

repossessed. It often needed to make repairs to the repossessed mobile homes to

make them livable. JFLP did not repossess property sold in land-only sales.

      On its partnership returns JFLP accounted for the repossessions as

generating income, reporting the portions of the buyers’ payments that it had

previously allocated to basis recovery as “gain on repossession”. During the years

at issue JFLP repossessed mobile homes, decreased its deferred installment

income, and reported gain on repossession as follows:

                                         Decrease in            Gain on
          Year     No. repossessed     deferred income        repossession
          2010            26              $1,161,607             $28,007
          2011            35               1,531,600               3,541
          2012            35               1,560,069              31,594

      For sales during the years at issue, approximately 31.9% of the buyers

defaulted within one year, 60.9% defaulted within two years, 79.7% defaulted
                                        -14-

[*14] within three years, and 92.8% defaulted within six years. Of the 69

installment sales during the years at issue, only 5 buyers had not defaulted by the

time of trial. When a buyer defaulted in the same year as the purchase, JFLP

reported the monthly payments as income from sales, not as rent.

      Buyers often made improvements and repairs to the mobile homes, adding

porches and decks, replacing carpets and flooring, remodeling bathrooms,

renovating kitchens, adding insulation, repairing structural supports, and repairing

or replacing septic tanks. When JFLP repossessed a mobile home, it did not

reimburse the buyer for the improvements and did not consider whether the

improvements increased the value of the mobile home above the amount still

owed. The mobile homes depreciated over time.

      In a significant number of instances the buyer did not maintain the home

and left it in poor condition when he defaulted and vacated. Some buyers also left

behind old furniture, broken appliances, abandoned cars, and unwanted pets.

When JFLP repossessed a mobile home, it often had to repair the mobile home to

make it livable before it could resell or rent it. On occasion, a repossessed mobile

home was beyond repair or repairs were too costly for JFLP, and JFLP disposed of

the mobile home. Under the purchase agreement, the property left on the land or
                                        -15-

[*15] in the mobile home when a buyer vacated is considered abandoned and JFLP

had the right to dispose of it.

V.    Books and Records

      When the Joyners formed JFLP, Mr. Bell recommended that it use the cash

method for its books and records and for tax purposes. At that time JFLP sold

only real estate, and Mr. Bell recommended that JFLP report income from the land

sales under the installment method. He also recommended this method to his

other clients in the business of selling real estate. He viewed this approach as

conservative and believed that it appropriately matched tax liability with the

client’s ability to pay tax upon receipt of the monthly payments. He sought legal

advice from three different tax attorneys who each agreed with the use of the

installment method. When it began selling mobile homes, JFLP continued to

report its sales in this manner at Mr. Bell’s recommendation. On the basis of his

experience, Mr. Bell believed that JFLP’s method of accounting was the industry

standard for reporting income from seller-financed deferred payment sales in its

rural Arkansas community. Bell & Co.’s other clients’ returns have also been

audited, and the audits resulted in no adjustments.

      Ms. Joyner maintained the books and records using QuickBooks and an

Excel spreadsheet developed by Bell & Co. The spreadsheet included formulas to
                                        -16-

[*16] calculate the portion of each monthly payment attributable to principal,

interest, and a nontaxable return of basis. The spreadsheet also tracked the

“deferred gross profit” on the sales, a portion of which JFLP realized on each

payment. Ms. Joyner did not have any formal training in bookkeeping. LaNell

Sterling, a C.P.A. at Bell & Co. with 30 years of accounting experience, explained

to Ms. Joyner how to maintain the books, use QuickBooks and the spreadsheet,

and use an accounts receivable system to track unpaid balances. When JFLP sold

a mobile home, Ms. Joyner increased the deferred installment income, which JFLP

referred to as accounts receivable for book purposes, for the sale price. On a

repossession, she removed the unpaid balance from the deferred installment

income and restored the property to the assets account on the balance sheet. She

recorded all payments from buyers and renters including cash that JFLP received.

JFLP did not have any unrecorded or unreported cash receipts. We find that JFLP

did not have any unreported gross receipts.

VI.   Tax Returns

      Bell & Co. prepared JFLP’s partnership returns for the years at issue. On

those returns JFLP checked the box indicating that it used the cash method. JFLP

used the installment method to report income from its sales. JFLP did not report

income from the receipt of the notes. It reported income as it received payments
                                         -17-

[*17] on the notes, allocating portions to gross receipts, nontaxable recovery of

basis, and interest income. It also reported “section 453 interest” income to

account for the benefit of the deferral in reporting its income on the sales and

reported “gain on repossession” for each repossession, computed as the sum of the

deferred gross profit at the time of the repossession and the original cost basis, less

the unpaid balance of the sale price. JFLP did not report inventory on its

partnership returns or adjust its gross receipts for the cost of goods sold. It

deducted expenses for the year of payment.

VII. Expert Witnesses

      Respondent presented expert testimony of Thomas Reed on the fair market

value of the land JFLP sold during the years at issue. Mr. Reed did not provide his

opinion on the values of the mobile homes. Respondent did not present any expert

testimony on the fair market values of the notes.

      Petitioners presented testimony of two experts, Albert Harkins and Taylor

West, on the marketability of the notes and the notes’ fair market values. Mr.

Harkins has over 40 years of banking experience, including experience in real

estate and mobile home financing and in the evaluation of loans for reselling in a

secondary market. He testified to numerous problems that affect the marketability

of the notes, including problems with the terms and executions of the notes and
                                        -18-

[*18] purchase agreements, JFLP’s business practices, the high default rates, and

JFLP’s outstanding mortgages on the land. He identified the lack of credit checks

and the buyers’ inability to obtain bank loans as support for a finding that the

notes lack marketability. He concluded that the notes were not marketable.

      Mr. West is the managing director of valuation advisory services at Duff &

Phelps. In his report, dated January 12, 2018, he opined that the fair market values

of the notes could not be determined without making extraordinary assumptions

that would make the valuation unreliable. He relied on the definition of an

extraordinary assumption in Uniform Standards of Professional Appraisal

Practice:

      an assumption * * * which, if found to be false, could alter the
      appraiser’s opinions or conclusions.

      Comment: Extraordinary assumptions presume as fact otherwise
      uncertain information about physical, legal, or economic
      characteristics of the subject property; or about conditions external to
      the property, such as market conditions or trends; or about the
      integrity of data used in an analysis.

Appraisal Standards Board of The Appraisal Foundation, Uniform Standards of

Professional Appraisal Practice, 2016-2017, at 3.

      Mr. West identified multiple extraordinary assumptions that he would need

to make to value the notes, including assumptions regarding the probability and
                                         -19-

[*19] timing of a default at the time of each sale, JFLP’s ability to collect the

unpaid balance on a default, and the existence of a willing buyer for the notes. He

testified to multiple problems with the notes including inadequate information

collected about the buyers’ financial situations and creditworthiness, the

conversion of sales to rentals, including conversions after defaults, the costs

associated with collecting on defaulted-on notes, and the enforceability of the

notes. He concluded that on the basis of these issues any valuation of the notes

would be unreliable. Mr. West further testified that to determine a fair market

value, a market must exist; and after due diligence, he was unable to identify a

market for the notes. Respondent did not present any credible evidence that a

market did exist.

                                      OPINION

      Respondent asserts that JFLP is not entitled to use the section 453

installment method because it is a dealer. Petitioners do not challenge JFLP’s

dealer status for its mobile home sales; they do for the land-only sales. Instead,

they argue that JFLP used a hybrid method to report its mobile home sales under

the umbrella of its overall cash method of accounting and that hybrid method

clearly reflects income. According to petitioners, the hybrid method makes two

“tweaks” to the installment method. For the first “tweak”, JFLP reports “section
                                        -20-

[*20] 453 interest” on the principal portion of each payment to compensate for the

benefit of the deferred income reporting. This alleged tweak aligns with the

requirement of section 453(l)(3), applicable to installment sales of unimproved

residential lots, that increases the tax on payments received under installment

obligations by an interest amount determined under section 453(l)(3)(B). Second,

for repossessed mobile homes, it reports “gain on repossession” for the payments

that it previously allocated to nontaxable basis recovery. Accordingly, for

repossessed properties, JFLP ultimately reported the full amounts of the payments

it received as income.

      Petitioners advance multiple alternative arguments if JFLP cannot use the

hybrid installment method. They argue that respondent’s method does not clearly

reflect income and respondent cannot change JFLP from an incorrect method to

another incorrect method. They argue that respondent’s method does not comport

with economic reality and is inconsistent with the Code, regulations, and caselaw

because respondent incorrectly taxes JFLP on the notes’ face values and JFLP

should be taxed on the notes’ fair market values. As a second alternative

argument, they argue that under the purchase agreement, upon a default all

payments are treated as rent and the Court should treat the payments as rent and

not tax JFLP on its receipt of the note. Third, they argue that if we hold that JFLP
                                          -21-

[*21] must report the sales on the basis of the notes’ face values, JFLP is entitled

to worthless debt deductions for the unpaid balances of the defaulted-on notes as

respondent initially allowed in the FPAA.

I.    Section 453 Installment Method

      Section 453 allows taxpayers to delay recognition of gain until they receive

payments on installment sales. An installment sale is defined as “a disposition of

property where at least 1 payment is to be received after the close of the taxable

year in which the disposition occurs.” Id. subsec. (b)(1). The seller may defer

gain recognition over the period of the installment payments rather than being

taxed on the entire gain in the year of the sale or upon receipt of a debt obligation

evidencing the installment sale. Id. subsec. (a). The seller must recognize income

for the proportion of payments received during the tax year that the gross profit

bears to the total contract price. Id. subsec. (c). A seller is required to use the

section 453 installment method for all qualifying installment sales unless it elects

out of the installment method. Id. subsecs. (a), (d)(1). Dealers of real property

(other than unimproved residential lots) or inventories of personal property do not

qualify for section 453 reporting. Id. subsecs. (b)(2), (l)(1). A seller of

unimproved residential property is excepted from the definition of a dealer and is
                                        -22-

[*22] permitted to report its sales under the installment method. Id. subsec.

(l)(2)(B)(ii)(II).

       A.     Land-Only Sales

       JFLP made land-only sales during 2011 and before 2010 that are part of the

section 481 adjustment.3 Respondent asserted for the first time in the amendment

to the answer that JFLP cannot report the pre-2010 and 2011 land-only sales under

section 453 because the land was improved. The amendment to the answer

increases JFLP’s gross receipts for the years at issue by over $1 million. We

previously held that respondent has the burden of proof on this issue.

       A residential lot is land upon which the purchaser intends to construct a

dwelling unit for use as his residence. Wang v. Commissioner, T.C. Memo. 1998-

127. JFLP’s buyers purchased the land for mobile homes that they used as their

residences. Respondent has not challenged the permanent placement of a mobile

home as the construction of a dwelling unit. We hold that it does in this case.


       3
        As an alternative, petitioners argue that we should divide each mobile
home sale into two separate transactions, the sale of a mobile home and the sale of
land, and allow JFLP to report the land sale portion under the installment method.
They argue that under State law the mobile homes are personal property, not real
property, because they are not affixed to the land. However, the facts establish
that the mobile homes were permanently affixed to the land. There is no factual
basis to separate a mobile home sale into two transactions for tax purposes, and we
will not further address this argument.
                                          -23-

[*23] Instead, respondent contends that JFLP improved the land by adding

driveways, septic tanks, water wells, and electrical hookups to the benefit of the

individual lots. He cites portions of the transcript and record that do not support

his contention that JFLP made these alleged improvements. We found credible

Mr. Joyner’s testimony that he did not make the types of improvements that

respondent alleges. Mr. Joyner credibly testified that when he started selling land

he added roads to access the subdivided lots and the local electric company

installed poles without charge. The buyers installed driveways, septic tanks, water

wells, and electrical hookups to mobile homes that they purchased and financed

through third parties. This changed when JFLP started selling mobile homes.

JFLP made the improvements identified by respondent for mobile homes that it

sold on the lots. We find that JFLP did not make improvements to the lots in the

land-only sales. JFLP is not a dealer with respect to the land-only sales and is

permitted by the Code to report its land-only sales under section 453.4

      B.       Mobile Home Sales

      Petitioners argue that JFLP used a hybrid installment method that is the

industry standard within its local real estate industry. We find that petitioners

concede that JFLP is a dealer with respect to its mobile home sales and cannot

      4
          JFLP has not repossessed property sold in a land-only sale.
                                         -24-

[*24] report the sales under section 453. Both Mr. Bell and Ms. Sterling credibly

testified about their familiarity with similar real estate businesses in JFLP’s rural

Arkansas community and the development of JFLP’s real estate activities. They

credibly testified that other businesses in the local community used the same

installment method. Mr. Bell sought advice from three independent tax attorneys

before recommending the installment method to his clients.5 Bell & Co.’s other

clients also have faced audits relating to their use of the installment method that

concluded without any adjustments or changes to their methods of accounting.

Respondent counters that Bell & Co.’s 10 to 12 clients do not constitute an

industry and no industry standard exists. He further argues that Mr. Bell and Ms.

Sterling are not experts on the industry standard.

      We find Mr. Bell’s and Ms. Sterling’s testimony credible. The regulations

under section 446 make accepted practices with a particular trade or business a

relevant consideration to the determination of whether a method of accounting

clearly reflects income. See sec. 1.446-1(a)(2), Income Tax Regs. (providing that

a method of accounting “ordinarily” will clearly reflect income when it “reflects

the consistent application of generally accepted accounting principles in a


      5
       Respondent mischaracterizes statements by petitioners’ prior counsel as
advice that JFLP was not entitled to use the installment method.
                                         -25-

[*25] particular trade or business in accordance with accepted conditions or

practices in that trade or business”). However, the question with respect to the

installment method does not involve the clear reflection of income. Rather, using

the installment method for dealer dispositions is statutorily proscribed for JFLP.

Sec. 453(b)(2)(A). JFLP is a dealer with respect to its mobile home sales. An

industry standard cannot condone the use of a method of accounting that is

expressly prohibited by the Code. See Thor Power Tool Co. v. Commissioner,

439 U.S. 522, 532-535 (1979).

      Similarly, while taxpayers can use a combination of accounting methods,

the methods used in combination must be “permitted under regulations prescribed

by the Secretary.” Sec. 446(c)(4). For its mobile home sales, JFLP is prohibited

from using the section 453 method, as a hybrid or in combination with other

methods. Furthermore, we do not agree with the characterization of JFLP’s

method as a hybrid method, a position petitioners assert for the first time in their

briefs. Rather, JFLP improperly used the installment method. It attached a

statement to its return for each year at issue that it used the section 453 installment

method. We hold that pursuant to section 453 JFLP is not entitled to report its

mobile home sales under the installment method, as part of a hybrid method or

otherwise.
                                       -26-

[*26] II.   Section 1001 Computation of Gain

      JFLP must realize income from its mobile home sales pursuant to section

1001. Under section 1001(a) and (b), the amount of the gain is the excess of the

amount realized from the sale over the taxpayer’s adjusted basis in the property

sold; the amount realized includes money received plus the fair market value of

property (other than money) received. Taxpayers must compute their taxable

income in accordance with their method of accounting.6 See sec. 451(a) (requiring

taxpayers to include items in gross income for the year they were received, unless,

under the taxpayer’s method of accounting, the amount is properly accounted for

in a different period). A cash method taxpayer reports income when it is actually

or constructively received. Sec. 1.451-1(a), Income Tax Regs. An accrual method

      6
        Sec. 1.1001-1(g), Income Tax Regs., provides that the amount realized
attributable to debt instruments issued in exchange for property is the issue price
subject to the original issue discount provisions irrespective of the taxpayer’s
method of accounting. It further provides for separate treatment for contingent
payment debt instruments. Special rules also exist for debt instruments given in
exchange for the use of property. See sec. 467. Respondent did not argue that the
regulation applies. Accordingly, we do not consider it. Respondent’s decision not
to address the regulation is understandable given the speculative nature of JFLP’s
arrangements with the buyers. In practice, both JFLP and the buyers treated the
sales as contingent on the buyers’ continued use of the homes. The buyers
defaulted on the notes at extremely high rates; they abandoned the mobile homes
and did not try to enforce equitable interests on the basis of their payments. JFLP
did not seek to enforce the purchase agreements or collect on the unpaid notes.
See Felt v. Commissioner, T.C. Memo. 2009-245 (considering cash equivalency of
note with stated interest rate), aff’d, 433 F. App’x 293 (5th Cir. 2011).
                                        -27-

[*27] taxpayer recognizes income when “all the events have occurred that fix the

right to receive the income and the amount of the income can be determined with

reasonable accuracy.” Sec. 1.446-1(c)(1)(ii), Income Tax Regs. Generally, under

the “all events” test accrual method taxpayers recognize income when it is paid,

due, or earned, whichever occurs first. See, e.g., Schlude v. Commissioner, 372

U.S. 128, 133 n.6 (1963).

      In the FPAA respondent asserted that JFLP cannot use the installment

method to report its mobile home sales. In his posttrial brief he argues that JFLP

must report income from the mobile home sales under the accrual method. JFLP’s

partnership returns state that JFLP is a cash method taxpayer. Accordingly, we

find that respondent is asserting his authority to change a taxpayer’s method of

accounting under section 446(b) from the cash method to the accrual method on

the basis that JFLP’s method of accounting does not clearly reflect its income. It

is clear that respondent seeks this change in accounting with respect to the mobile

home sales; however, we are uncertain of respondent’s intended effect with

respect to JFLP’s overall method of accounting.

      The term “method of accounting” is used to describe both an overall method

of accounting and the accounting treatment of any item. The regulation lists

examples of overall methods, “the cash receipts and disbursements method, an
                                        -28-

[*28] accrual method, combinations of such methods, and combinations of the

foregoing with various methods provided for the accounting treatment of special

items.” Sec. 1.446-1(a)(1), Income Tax Regs. A method of accounting is the

consistent treatment of any recurring, material item, whether that treatment is

correct or incorrect. Bank One Corp. v. Commissioner, 120 T.C. 174, 282 (2003),

aff’d in part, vacated in part sub nom. JP Morgan Chase & Co. v. Commissioner,

458 F.3d 564 (7th Cir. 2006); H.F. Campbell Co. v. Commissioner, 53 T.C. 439,

447 (1969), aff’d, 443 F.2d 965 (6th Cir. 1971). A method of accounting may

exist without a pattern of consistent treatment, but in most instances an accounting

method is not established without such consistent treatment. Sec. 1.446-

1(e)(2)(ii)(a), Income Tax Regs.

      As a general rule taxpayers must compute their taxable income under the

method of accounting that they use to compute their income in keeping their

books. Sec. 446(a). A further requirement is that the taxpayer’s chosen method

clearly reflect its income. Id. subsec. (b). In general, a method of accounting

clearly reflects income when it results in accurately reported taxable income under

a recognized method of accounting. RLC Indus. Co. & Subs. v. Commissioner, 98

T.C. 457, 490 (1992), aff’d, 58 F.3d 413 (9th Cir. 1995). “[N]o uniform method of

accounting can be prescribed for all taxpayers.” Sec. 1.446-1(a)(2), Income Tax
                                        -29-

[*29] Regs. Ordinarily, a method of accounting will clearly reflect income when

the taxpayer consistently uses a recognized method of accounting that comports

with generally accepted accounting principles that are prevalent in the taxpayer’s

industry. See RLC Indus. Co. & Subs. v. Commissioner, 98 T.C. at 490; Peninsula

Steel Prods. & Equip. Co. v. Commissioner, 78 T.C. 1029, 1045 (1982).

      The Secretary has broad authority to determine whether the taxpayer’s

method of accounting clearly reflects income; and if he determines it does not, he

has broad authority to choose the taxpayer’s method. Thor Power Tool Co. v.

Commissioner, 439 U.S. at 532; Ansley-Sheppard-Burgess Co. v. Commissioner,

104 T.C. 367, 370 (1995); Peninsula Steel Prods. & Equip. Co. v. Commissioner,

78 T.C. at 1044-1045; Bay State Gas Co. v. Commissioner, 75 T.C. 410, 417

(1980), aff’d, 689 F.2d 1 (1st Cir. 1982). In that case “the computation of taxable

income shall be made under such method as, in the opinion of the Secretary, does

clearly reflect income.” Sec. 446(b). We review the Secretary’s determinations

for abuse of discretion. Commissioner v. Hansen, 360 U.S. 446, 467 (1959);

RECO Indus., Inc. v. Commissioner, 83 T.C. 912, 920 (1984).

      A.    Cash or Accrual Method

      Before we can address the clear reflection question, we must determine

what method of accounting JFLP uses and what method respondent chose for it.
                                        -30-

[*30] Petitioners argue that JFLP is a cash method taxpayer and respondent did

not timely exercise his authority to change JFLP’s overall method of accounting to

the accrual method. They argue that the assertion of the accrual method is a new

matter raised for the first time in respondent’s briefs. They argue that we should

preclude respondent from raising the change to the overall accrual method on the

basis of fairness and surprise. We agree.

      On its partnership returns JFLP checked the box indicating that it was a cash

method taxpayer, and it reported cash payments when they were received and

deducted expenses when they were paid. JFLP improperly used the installment

method to report its income from the mobile home sales. It did not report the sales

using the cash method, and the method it regularly and consistently used is not

permissible. When a taxpayer has not regularly and consistently used a method of

accounting, the Commissioner has authority to choose the taxpayer’s method of

accounting. Sec. 446(b). However, we find that respondent did not timely

exercise his authority to change JFLP’s method from the cash method to the

accrual method.

      Respondent challenges JFLP’s use of the cash method. He contends that

JFLP’s QuickBooks work papers are labeled “accrual basis”, JFLP accounted for

inventories, and JFLP deducted accrued expenses. The record does not support
                                         -31-

[*31] the latter two allegations. However, that is not respondent’s only problem.

In the FPAA respondent did not assert that JFLP’s cash method did not clearly

reflect income. Nor did he assert that position in the amendment to the answer.

Rather, respondent asserted that JFLP was not eligible to report its sales under the

installment method. Our inquiry, as the parties set it forth in the FPAA and the

pleadings, is whether JFLP is entitled to use the installment method; that inquiry

does not require an analysis of the clear reflection of income or respondent’s

exercise of his section 446 authority. Rather, we consider JFLP’s eligibility under

the requirements of section 453.

      Respondent raised the change to the accrual method for the first time in his

posttrial briefs. In the FPAA respondent asserted that JFLP must report income in

the year of a mobile home sale using the face values of the notes as the amount

realized. Likewise, respondent computed the section 481 adjustment on the notes’

face values. These computations are consistent with both the cash and accrual

methods of accounting and thus do not support a finding that respondent timely

raised his section 446 authority to change JFLP’s method of accounting. See

Raymond v. Commissioner, T.C. Memo. 2001-96 (holding that the amounts

realized by a cash method taxpayer were the face values of the notes received

because the taxpayer did not present sufficient evidence to establish that their fair
                                        -32-

[*32] market values were less than their face values). We further note that in his

briefs respondent did not address the application of the accrual method’s all events

test to the notes. He did argue that the sales were completed under the burdens

and benefits of ownership test, which is a separate issue that does not adequately

address the all events test. See Grodt & McKay Realty, Inc. v. Commissioner, 77

T.C. 1221, 1237-1238 (1981).

      In the amendment to the petition, petitioners assert that JFLP was a cash

method taxpayer, which respondent denies without any further explanation or

assertions. In his pretrial memorandum respondent does not identify JFLP’s

overall method of accounting as an issue for trial or assert that he exercised his

section 446 authority to change JFLP’s overall method of accounting. In the

memorandum respondent stated that he had discretion to change JFLP’s

accounting of a specific item to deny the use of the installment method for JFLP’s

sales: “The Commissioner has determined that the petitioners are dealers and are

not entitled to use the installment method of accounting for the sale income * * *

and all income must be recognized in the year of the sale” as required by section

1001. Finally, at trial respondent’s counsel stated that JFLP was a cash basis

taxpayer. Respondent characterizes petitioners’ arguments relating to the cash

method as a retroactive change in JFLP’s method of accounting that requires his
                                       -33-

[*33] consent and therefore is not permitted. See sec. 446(e). However,

petitioners are not arguing for a retroactive change. JFLP made that assertion on

its partnership returns. Respondent has not timely challenged that declaration.

      We find that respondent did not timely raise a change in JFLP’s accounting

method from the cash to the accrual method or timely exercise his section 446

authority to change JFLP’s method of accounting. A taxpayer’s entitlement to use

the section 453 installment method does not depend on whether the method clearly

reflects income. In the FPAA respondent did not challenge JFLP’s use of the

overall cash method or assert the cash method did not clearly reflect JFLP’s

income. Nor did he assert his authority to change JFLP’s overall method of

accounting from the cash method to the accrual method. Petitioners are unfairly

surprised and prejudiced by respondent’s new position on brief to require JFLP to

change to the accrual method of accounting. See Dirico v. Commissioner, 139

T.C. 396, 415-417 (2012); Ware v. Commissioner, 92 T.C. 1267, 1269 (1989),

aff’d, 906 F.2d 62 (2d Cir. 1990). Accordingly, we find that respondent cannot

now assert his authority under section 446 to change JFLP to the accrual method.

JFLP may report the mobile home sales under its overall cash method of

accounting.
                                        -34-

[*34] B.     Cash Equivalence

      Under section 1001(a), JFLP has gain from a mobile home sale equal to the

excess of the amount realized on the sale over its adjusted basis in the mobile

home sold. The amount realized is the sum of money received plus the fair market

value of property (other than money) received. Id. subsec. (b). A promissory note

is property other than money for purposes of section 1001(b). McShain v.

Commissioner, 71 T.C. 998, 1004 (1979). Accordingly, we must determine the

fair market values of the notes, if possible. Petitioners argue that for cash method

taxpayers a note is included in income upon receipt only if the note is the

equivalent of cash, citing Cowden v. Commissioner, 289 F.2d 20 (5th Cir. 1961),

rev’g and remanding 32 T.C. 853 (1959), Warren Jones Co. v. Commissioner, 60

T.C. 663 (1973), rev’d, 524 F.2d 788 (9th Cir. 1975),7 and Felt v. Commissioner,


      7
        In Warren Jones Co. v. Commissioner, 60 T.C. 663 (1975), the Tax Court
adopted the cash equivalency doctrine as set forth in Cowden v. Commissioner,
289 F.2d 20 (5th Cir. 1961), rev’g and remanding 32 T.C. 853 (1959), and held
that the debt obligation was not income because it was not a cash equivalent. The
Court of Appeals for the Ninth Circuit reversed and held that if a debt obligation
has an ascertainable fair market value, the amount realized includes that value,
without separately asking whether the note is a cash equivalent. Warren Jones Co.
v. Commissioner, 524 F.2d 788, 791-795 (9th Cir. 1975). We find infra pp. 39-42
that the notes at issue did not have ascertainable fair market values and thus would
not be included in the amounts realized under either doctrine. See McShain v.
Commissioner, 71 T.C. 998, 1004-1005 (1979) (declining to express an opinion on
the issues presented in Warren Jones).
                                          -35-

[*35] T.C. Memo. 2009-245, aff’d, 433 F. App’x 293 (5th Cir. 2011). They argue

that the notes are not cash equivalents and JFLP did not have any gain upon

receipt of the notes.

      When a cash method seller receives a debt instrument that entitles it to a

future income stream, we have traditionally evaluated the debt instrument for its

“cash equivalence” when the seller is not using the installment method to report

payments upon the instrument. See Griffith v. Commissioner, 73 T.C. 933, 937

(1980); Watson v. Commissioner, 69 T.C. 544, 549-552 (1978), aff’d, 613 F.2d

594 (5th Cir. 1980); W. Oaks Bldg. Corp. v. Commissioner, 49 T.C. 365, 376

(1968); Ennis v. Commissioner, 17 T.C. 465, 470 (1951). Under the cash

equivalency doctrine, we consider whether a debt obligation is a “promise to pay

of a solvent obligor and the obligation is unconditional and assignable, not subject

to set-offs, and is of a kind that is frequently transferred to lenders or investors at a

discount not substantially greater than the generally prevailing premium for the

use of money”. Cowden v. Commissioner, 289 F.2d at 24;8 see Watson v.

      8
        In Cowden v. Commissioner, 289 F.2d at 24-25, the Court of Appeals for
the Fifth Circuit held that the Tax Court had improperly held that the amount
realized was the full contract price on the basis that the other party to the contract
was willing to pay the full price so the taxpayer could have received the entire
payment in the year the contract was executed. The Court of Appeals held that the
amount realized includes a debt obligation that is a cash equivalent to the extent of
                                                                          (continued...)
                                         -36-

[*36] Commissioner, 69 T.C. at 551-552. A note is a cash equivalent if the holder

of the note can sell it for an immediate cash value even if that cash value is less

than the note’s face value. Felt v. Commissioner, slip op. at 14.

      Petitioners have the burden to prove that the notes are not cash equivalents.

We have held that a taxpayer can meet its burden of proof by showing “that the

debtors were insolvent, the notes could not be assigned, or the notes would have

traded at a deep discount.” Id., slip op. at 15 (citing Cowden v. Commissioner,

289 F.2d at 24). In Felt v. Commissioner, slip op. at 10-12, we held that the note

of an insolvent debtor was worthless at the time it was received and its receipt did

not result in taxable income for the cash method taxpayers. We find that

petitioners have met their burden. The notes are not cash equivalents.

      Most buyers were low income, had poor credit and unstable job histories,

and could not obtain traditional bank loans to purchase homes. While these facts

may not establish that the buyers were insolvent, it is clear that JFLP could not

have sold the notes or, if it had, the sale would have been at a deep discount. JFLP

did not perform credit checks, making it difficult to determine the likelihood that

any individual buyer would default or the length of time before he would default.

      8
         (...continued)
its fair market value irrespective of the amount the taxpayer could have received if
he had made a different bargain. Id. at 25.
                                        -37-

[*37] The Joyners accepted the buyer’s word that he had a job and did not verify

the buyer’s employment or the amount of his wages. Respondent argues that JFLP

did perform credit checks. However, Mr. Joyner testified that he did not and

explained his reasons for not doing so. We found him credible.

      JFLP marketed the mobile homes to low-income individuals and assumed

the risk of nonpayment. In turn, it charged higher than market interest rates and

had high profit margins on the sales, suggesting that the sale prices significantly

exceeded the values of the land and mobile homes sold. The notes did not state

the number of payments required to pay the notes in full or the length of time it

would take for the buyers to pay off the notes. The average term of the notes was

22 years. A number of buyers paid in full and received title to their homes.

However, the majority of buyers during the years at issue defaulted within two

years, and over 92% defaulted within six years. Respondent challenges the 92%

default rate, but we find petitioners’ witnesses credible.9 We find that his

allowance of the worthless debt deductions in the FPAA is an admission of the

high default rate. His assertion in the amendment to the answer that JFLP is not


      9
       We find purported discrepancies in JFLP’s records between repossession
dates and the dates of last payments immaterial. Mr. Joyner credibly testified he
allowed multiple missed payments, and Ms. Joyner credibly testified that she
accurately reported all sales and repossessions.
                                         -38-

[*38] entitled to the worthless debt deductions on the basis of section 1038, which

disallows such deductions on the repossession of property in satisfaction of the

debt secured by the property, is not related to the values of the notes or the high

default rate.

      JFLP’s business practices further affected the marketability of the notes.

Usually the Joyners would allow buyers to miss multiple payments before they

asked the buyers to vacate the property and at times allowed extended periods of

missed payments if the buyers were in financial distress because of medical

reasons, lost jobs, or other issues. They believed in giving people a chance. When

a buyer defaulted, JFLP never tried to collect the unpaid balance after the default,

and it is unlikely that it could have done so given the typical buyer’s financial

situation. JFLP simply retook possession of the mobile home and offered it for

sale or rent. There was no expectation by the buyers that they were indebted to

JFLP for the full sale prices despite signing the notes. The buyers understood that

the notes would not be enforced. For the most part, the Joyners did not expect the

buyers to pay the notes in full, and the buyers understood the notes would not be

enforced if they vacated. For JFLP’s typical buyer there was no reasonable

expectation of full payment. See Litton Bus. Sys., Inc. v. Commissioner, 61 T.C.
                                         -39-

[*39] 367, 377 (1973) (stating that a genuine debt includes a reasonable

expectation of repayment).

      Other of JFLP’s business practices also negatively affected the notes’

marketability. JFLP also allowed buyers to convert their sales to rentals, which

effectively nullified the notes. It even allowed buyers to convert to rentals after

they had already defaulted on their notes. In addition, JFLP had outstanding

mortgages on its land and sold lots subject to the mortgages, which would have

severely affected its ability to market the notes.

      Petitioners also presented credible and helpful expert testimony on the

notes’ lack of marketability. We agree with petitioners’ experts. There was no

market for JFLP to sell the notes. We find that it is highly unlikely that JFLP

could have sold the notes and any sale would have been at a deep discount. See

Estate of Wiggins v. Commissioner, 72 T.C. 701 (1979) (finding buyers’ payment

obligations were unmarketable and applying the open transaction doctrine where

the seller did not perform credit checks and buyers defaulted a rate of 40%). The

notes were not the equivalent of cash.

      C.     Fair Market Value

      As we have found that the notes are not the equivalent of cash, JFLP is not

required to report income for the years it received the notes. We have found that
                                         -40-

[*40] there was not a market for the notes. Nevertheless, we briefly address the

parties’ arguments regarding the notes’ fair market values. Fair market value is

the price at which a willing buyer and willing seller would exchange property

when neither party is acting under a compulsion to buy or sell and both parties

have reasonable knowledge of the relevant facts. United States v. Cartwright, 411

U.S. 546, 551 (1973). Fair market value is a question of fact, and “only in rare and

extraordinary cases will property be considered to have no fair market value.”

Sec. 1.1001-1(a), Income Tax Regs. Courts will find fair market value

ascertainable unless the “total amount payable under an obligation * * * [is] so

speculative, or the right to receive any payments at all [is] so contingent, that the

fair market value * * * cannot be fixed.” Warren Jones Co. v. Commissioner, 524

F.2d at 794. “[T]he solvency of the maker of a note is of prime importance in

determining whether it is worth its face value.” Tietig v. Commissioner, T.C.

Memo. 2001-190, slip op. at 21, aff’d, 57 F. App’x 414 (11th Cir. 2003).

      Petitioners presented expert testimony on the notes’ fair market values;

respondent did not. Rather, respondent asserts that the notes are worth their face

values; they clearly are not. He presented expert testimony of the fair market

value of the land and argues that we can determine the fair market values of the

mobile homes using a simple equation of the sale prices less the land values. He
                                        -41-

[*41] argues that the notes have the same values as the land and mobile homes

sold. See United States v. Davis, 370 U.S. 65 (1962) (holding that the value of

property received in exchange can be inferred from the value of the property given

up). We do not agree. When we consider the prices that JFLP paid for the used

mobile homes, it is clear that JFLP set above-market sale prices for them as part of

the seller-financing arrangements. JFLP’s gross profit margins on the sales were

between 50% and 60%; some sales had gross profit margins as high as 80%.

Respondent’s method of valuation is not persuasive especially in the light of the

buyers’ financial situations. We find respondent’s method of valuation is not

supported by the record.

      Finally, we address respondent’s challenges to the reliability of petitioners’

experts. He argues that petitioners’ experts based their opinions on inadequate

and irrelevant information and they lacked experience in the valuation of land,

mobile homes, and seller-financed transactions. He further argues that Mr. West

improperly relied on assistants in the preparation of his report. Respondent also

argues that he was prejudiced because petitioners did not produce the documents

that the experts used to prepare their reports. We find that petitioners produced

sufficient documentation to support their experts’ testimonies, and respondent was

not prejudiced by their testimonies. Both of petitioners’ experts were knowl-
                                        -42-

[*42] edgeable, and their testimonies were reliable. Mr. West’s use of assistants

did not make his testimony unreliable under the circumstances of this case.

      We find Mr. Harkins’ and Mr. West’s testimonies helpful and convincing.

We agree that issues with the terms, the executions, and the enforcement of the

notes and agreements rendered the notes unmarketable. The notes executed during

the years at issue had extremely high default rates. JFLP marketed the mobile

homes to low-income individuals, did not perform credit checks, and knew that the

buyers could not obtain bank loans to finance the purchases of homes. We find

petitioners’ evidence credible and persuasive including the facts and

circumstances relating to the buyer’s financial situation, the lack of a market for

the notes, JFLP’s business practices, the high default rate, and petitioners’ experts’

testimony. We find respondent’s challenges to these facts lack support in the

record and are without merit. Respondent did not present evidence of the notes’

fair market values and merely continued to advance the face value argument. He

is held to that choice. We hold that the notes had no value when executed.

      D.     Unreported Sales or Gross Receipts

      Respondent argues that JFLP’s books and records contained numerous

errors and JFLP failed to report all gross receipts. He spends a considerable

amount of time in his briefs citing purported evidence of unreported sales and
                                        -43-

[*43] payments. He argues that JFLP did not report all sales, failed to report

monthly payments and downpayments, reported sales as occurring in the wrong

year, changed the names of buyers to conceal sales, and did not report cash

payments from buyers. He identifies concerns with the reporting of specific sales.

He does not seek to increase JFLP’s gross receipts for the years at issue on the

basis of this alleged underreporting. Instead, he argues that these alleged

omissions give him authority to change JFLP’s method of accounting to the

accrual method. He argues that if there is an omission or other error in a

taxpayer’s reporting, the taxpayer’s method of accounting does not clearly reflect

income and he may reconstruct the taxpayer’s income using any reasonable

method, citing caselaw involving the bank deposit analysis.

      As with respondent’s attempt to change JFLP to the accrual method, the

unreported gross receipts issue is not properly before the Court. Nevertheless, we

find that JFLP did not omit any gross receipts from its partnership returns as

respondent alleges. Ms. Joyner credibly testified that she recorded all sales and

payments received in the books and records and JFLP reported all gross receipts

on its partnership returns. We find her honest and forthright in her testimony. The

purported discrepancies in JFLP’s workpapers and records identified by

respondent are immaterial as we do not find any alleged discrepancies that resulted
                                          -44-

[*44] in an underreporting of sales or gross receipts. We find that JFLP reported

the payments it actually received. Any inadequacies in JFLP’s books and records

did not result in underreported income.

      E.     Substantiation of Basis

      Respondent also argues that JFLP’s books and records do not adequately

substantiate its bases in repossessed mobile homes and JFLP improperly recouped

bases multiple times because it did not reduce bases for the portions of the buyers’

payments allocated to basis recovery. We find that JFLP did in fact adequately

account for basis recovery. The unrecovered basis for a repossessed mobile home

is the difference between the unpaid principal balance of the note and the gross

deferred income at the time of the repossession. The recovered basis is easily

computed by subtracting the unrecovered basis from the original cost basis. JFLP

reported its previous basis recovery as “gain on repossession” for each year at

issue, and we find its computations accurate. Respondent’s arguments to the

contrary are unfounded.

      Furthermore, there are obvious explanations for the basis discrepancies that

respondent cites. He identifies several instances where JFLP increased its basis in

a repossessed home on its resale. JFLP often made improvements to a repossessed

mobile home before its resale, allowing it to increase its basis. Mr. Joyner
                                       -45-

[*45] credibly testified that repossessed mobile homes were often in poor

condition and required repairs to make them livable. Respondent also argues that

some buyers made improvements to their mobile homes that increased their values

and that JFLP did not account for the buyers’ improvements on the

repossessions.10 He cites a mobile home sold in October 2010 for $70,000,

arguing that the buyer made substantial improvements that increased the home’s

value and then swapped it for another mobile home in early 2011. JFLP resold the

home for the same $70,000 price in July 2011 despite these allegedly substantial

improvements. Respondent’s arguments are without merit.

      Respondent also argues that JFLP failed to maintain adequate records of the

mobile homes it repossessed and its bases in the repossessed mobile homes. He

argues that the inadequacy of JFLP’s records entitles him to change JFLP to the

accrual method. We have already held that respondent did not timely raise the

change in JFLP’s overall method of accounting. Furthermore, we find that

petitioners have established the number of repossessions with adequate records

and credible, persuasive testimony. In the FPAA respondent accepted JFLP’s

      10
        Respondent argues that JFLP did not keep adequate records of the buyers’
improvements to repossessed properties and did not obtain appraisals of the
improvements or maintain adequate records of its bases in the repossessed
properties adjusted for the improvements. He did not properly raise these
arguments in his pleadings or otherwise.
                                         -46-

[*46] books and records as accurate and allowed JFLP to deduct as worthless debt

the unpaid note balances for the repossessed homes. He did not challenge the

accuracy of JFLP’s records. Respondent thereafter raised the substantiation issue.

We held before trial that respondent has the burden of proof on issues raised in the

amendment to the answer. He has not met his burden.

III.   Clear Reflection of Income

       The final issue presented by the parties is whether JFLP’s method of

accounting and the method of accounting chosen by respondent clearly reflect

income. As stated supra pp. 28-29, the taxpayer’s chosen method must clearly

reflect its income; and if the Secretary determines that it does not, the Secretary

has broad authority to choose a method that in his opinion does clearly reflect the

taxpayer’s income. Sec. 446(b). However, we have held that respondent did not

timely exercise his authority to change JFLP from the overall cash method to the

accrual method. Rather, respondent timely asserted that JFLP cannot use the

installment method. That argument does not involve an examination of the clear

reflection of income. Respondent did not determine that JFLP’s chosen overall

cash method did not clearly reflect income. Nor did he timely choose a different

method of accounting for JFLP. Respondent has made no timely determination

under section 446, and thus there is no method chosen by respondent for us to
                                        -47-

[*47] consider.11 Accordingly, we will not consider whether JFLP’s overall cash

method clearly reflects its income and will allow JFLP to use the overall cash

method to report its mobile home sales during the years at issue and for purposes

of the section 481 adjustment.

      To the extent that respondent argues that his valuations of the notes are

entitled to review for abuse of discretion, we disagree. Valuation is a question of

fact and relates to the amount realized on JFLP’s receipt of a note. See sec.

1.1001-1(a), Income Tax Regs. It is not an accounting method choice.

Furthermore, respondent’s use of the notes’ face values is clearly improper.

Respondent made no effort to determine the notes’ fair market values in this case.

Respondent’s valuation of the notes at their face values is arbitrary and without


      11
         As we find that JFLP is not required to report the face values of the notes
upon receipt, we do not need to address whether JFLP is entitled to a worthless
debt deduction upon a default. We note that respondent’s arguments with respect
to the worthless debt deductions are problematic. For example, he failed to
consider the sec. 1038 basis adjustment rules that would allow JFLP a stepped-up
basis upon the resale of a repossessed mobile home. JFLP resold one mobile
home three times, in 2009, 2010, and 2011. Respondent computed the gain on the
2010 and 2011 sales without the sec. 1038 basis adjustments. Petitioners identify
at least nine properties subject to this distortion. Further, respondent makes the
nonsensical argument that JFLP should be taxed on the notes’ face values but
denied a worthless debt deduction because petitioners have not established the
notes had value when executed, a requirement for a worthless debt deduction.
See Sensenig v. Commissioner, T.C. Memo. 2017-1, at *17-*18, aff’d, 720 F.
App’x 139 (3d Cir. 2018).
                                        -48-

[*48] basis in fact or law. Accordingly, respondent’s valuation method would fail

the abuse of discretion standard.

IV.   Conclusion

      Petitioners have met their burden of proving that the notes are not cash

equivalents and there was no market for them. They have further met their burden

of proving that the notes had no ascertainable value. Respondent chose not to

provide evidence on the notes’ fair market values to counter petitioners’

persuasive evidence, instead relying on the notes’ face values. Although JFLP

improperly reported the mobile home sales under the section 453 installment

method, we hold that on the basis of the record JFLP is entitled to report its mobile

home sales using the overall cash method of accounting. We further hold that

JFLP did not have gain upon receipt of the notes as the notes had no value.

Accordingly, JFLP may report income from the mobile home sales as of when it

received the payments on the notes. See Golden Gate Litho v. Commissioner,

T.C. Memo. 1998-184, slip op. at 28 (holding that when the Commissioner has

abused his discretion “the Court may choose to let * * * [the taxpayer’s improper

method] stand”). Likewise, we hold that any section 481 adjustments are

determined on the basis that JFLP may report its sales on the cash method and it

had no gain upon receipt of the notes. We further hold that JFLP reported all sales
                                         -49-

[*49] and reported all payments that it received, having found Ms. Joyner credible

in her testimony to these facts.

      Key principles underlying methods of accounting are that the taxpayer’s

lifetime income does not change irrespective of the taxpayer’s method of

accounting and tax corresponds to the taxpayer’s ability to pay. Respondent’s

adjustments would result in a substantial amount of income for JFLP, more than

$8 million, far in excess of its actual cash receipts. Clearly, JFLP did not generate

sufficient receipts during the years at issue to pay the $8 million of tax asserted as

due. Nor could it sell the notes.

      In reaching our holding, we have considered all arguments made, and, to the

extent not mentioned above, we conclude they are moot, irrelevant, or without

merit. In the light of our decision that JFLP is not entitled to report the mobile

home sales under section 453,


                                                     Decision will be entered under

                                                Rule 155.
