                         T.C. Memo. 2017-73



                  UNITED STATES TAX COURT



     EDDIE BORNA AND VICTORIA BORNA, Petitioners v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 24641-11.                         Filed May 1, 2017.



       P-H is a real estate entrepreneur. During or before 1997, P-H
and at least two Chinese citizens who he believed were politically
influential formed a venture in China intending to prosper financially
from the Summer Olympics scheduled to be held in China in 2008.
P-H aimed to raise sufficient funds for the venture through a plan
under which he self-financed the purchase of third-party notes. The
venture failed. R determined, in part, that P-H failed to report as
income amounts that he received from the obligors of the third-party
notes.

      Held: Ps failed to report income to the extent stated herein.

       Held, further, tax consequences determined as to four items that
the parties dispute as to income that respondent determined was
reportable on Schedule D, Capital Gains and Losses.
                                           -2-

[*2]          Held, further, Ps may deduct sole proprietorship expenses for
       rents and leases, taxes and licenses, and commissions and fees to the
       extent stated herein.

              Held, further, Ps are liable for the accuracy-related penalties to
       the extent stated herein.



       Solis Cooperson, for petitioners.

       Steven M. Roth and Sarah A. Herson, for respondent




              MEMORANDUM FINDINGS OF FACT AND OPINION


       WHERRY, Judge: Petitioners petitioned the Court to redetermine

respondent’s determination of the following deficiencies in their Federal income

tax for 2004, 2005, and 2006, an addition to tax under section 6651(a)(1), and

accuracy-related penalties under section 6662(a):1

                                      Addition to tax     Accuracy-related penalty
           Year        Deficiency     sec. 6651(a)(1)         sec. 6662(a)

           2004        $267,397            $15,243                 $53,479
           2005         943,426               -0-                  188,685
           2006         340,121               -0-                   68,024

       1
        Unless otherwise indicated, section references are to the applicable versions
of the Internal Revenue Code of 1986, as amended for the years in issue (Code),
and Rule references are to the Tax Court Rules of Practice and Procedure. Dollar
amounts are rounded.
                                         -3-

[*3] Respondent subsequently altered that determination, asserting in an amended

answer that there are increased deficiencies, addition to tax, and accuracy-related

penalties as follows:2

                                      Addition to tax   Accuracy-related penalty
           Year          Deficiency   sec. 6651(a)(1)       sec. 6662(a)

           2004           $268,918        $15,319                $53,784
           2005          1,060,127           -0-                 212,025
           2006            479,940           -0-                  95,988

Respondent has since conceded that petitioners are not liable for the addition to

tax.

       Following concessions, we decide the remaining disputed issues for the

years in issue:

       1. whether petitioners failed to report income from petitioner husband Eddie

Borna’s sole proprietorship;

       2. the tax consequences of four items that the parties dispute as to income

that respondent determined were reportable on Schedule D, Capital Gains and

Losses;




       2
       Respondent’s alteration of the determination stemmed from respondent’s
review during this proceeding of newly acquired information and documentation.
The amended answer reflected further adjustments to sole-proprietorship
unreported income and allowable expenses and to capital gains or losses.
                                          -4-

[*4] 3. whether petitioners may deduct sole proprietorship expenses for rents and

leases, taxes and licenses, and commissions and fees in amounts greater than

respondent allowed; and

      4. whether petitioners are liable for the accuracy-related penalties that

respondent determined.

                                FINDINGS OF FACT

I. Preliminaries

      The parties submitted nine separate stipulations of facts and exhibits,

together with three separate stipulations of settled issues. We find the stipulated

facts and the settled issues accordingly. The stipulated facts and exhibits and the

stipulations of settled issues are incorporated herein by this reference.3

      Petitioners are husband and wife. They filed joint Federal income tax

returns for 2004 through 2006 (respectively, 2004 return, 2005 return, and 2006

return; collectively, subject returns). They timely filed their petition commencing

this action, and they resided in California at that time.




      3
       In the event of any perceived conflict between the balance of this opinion
and the parties’ three stipulations of settled issues, the Court intends that the
agreed-to settlements by both parties in the stipulations of settled issues shall
control. Where the three stipulations of settled issues indicate that an issue is not
resolved and agreed to or is for trial, this opinion shall control.
                                            -5-

[*5] II. Petitioners’ Business Activities

      A. Land Bank

      Mr. Borna owned a real estate business, Land Bank of America (Land

Bank). Land Bank was in California City, California, and it has been selling land

since 1980.4 Mr. Borna operated Land Bank as a sole proprietorship.

      B. Superb Properties

      Superb Properties was another business in California City. Superb

Properties, although owned by others, operated under Mr. Borna’s broker’s license,

primarily selling real estate through real estate agents. Mr. Borna normally

received 10% of the real estate agent’s commissions for the use of his real estate

broker’s license.

      C. Note Purchasing Business

             1. Background

      During or before 1997, Mr. Borna with at least two Chinese citizens who he

believed were politically influential formed a venture in China called Zhuo Zhou

Borna Plaza Real Estate Development, Ltd. (Zhuo Zhou Development). Originally

Mr. Borna conceived the idea for Zhuo Zhou Development and owned all of it.


      4
      Petitioners also bought and sold real estate which they held in their own
names. They reported some of these sales on the subject returns, more specifically,
on Forms 6252, Installment Sales Income.
                                         -6-

[*6] Early on to get going he partnered with an individual who he believed had

been or was the Finance Minister of the People’s Republic of China under Mao

Zedong’s government. This individual and/or his two daughters, who Mr. Borna

believed were children of the Finance Minister and one (Helen Fongii) who Mr.

Borna believed may have served in a governmental capacity, acquired a 5%

interest in Zhuo Zhou Development shortly after its formation. Zhuo Zhou

Development aimed to build a small town in China containing 15,000

condominiums, a very long strip mall, two or three schools, and a hospital plus

100,000 square meters of industrial and commercial buildings space.

      Mr. Borna, from its inception, did not have sufficient funds to invest in Zhuo

Zhou Development, and he consequently sought ways to raise funds for the

venture. Mr. Borna eventually met Nigel Barrow, who aspired to join the venture.

Both Mr. Barrow and Mr. Borna anticipated that Zhuo Zhou Development would

be profitable given, inter alia, that Bank of China financing was anticipated and the

Summer Olympics were scheduled to be held in China in 2008.

      The politics surrounding Zhuo Zhou Development’s operation in China and

its location thousands of miles from California City made it difficult for Mr.

Barrow to participate in the venture directly. Mr. Barrow structured a plan under

which Mr. Borna would acquire from Mr. Barrow third-party notes that he owned
                                        -7-

[*7] (Barrow notes).5 Mr. Borna could then use proceeds from the notes to help

fund Zhuo Zhou Development. Thereafter, Mr. Borna would pay to Mr. Barrow,

without stated interest, the principal amounts of the Barrow notes two years after

the due dates of the Barrow notes. These payments were generally scheduled to

come due during 2015.

             2. The Business

      Starting in or around 2002 through at least 2006, Mr. Borna acquired

approximately 100 Barrow notes from Mr. Barrow under a formal agreement that

they memorialized in writing on or about December 30, 2003. Mr. Borna acquired

the Barrow notes by contemporaneously creating financing notes (Borna notes),

each with corresponding identical principal balance due, which Mr. Borna in turn

executed and gave to Mr. Barrow. Mr. Borna promised in the Borna notes to pay

the face amount of the Barrow notes to Mr. Barrow in 2015; however, unlike the

Barrow notes, none of the Borna notes had stated interest. The Borna notes were

payable to Mr. Barrow at various dates in 2015, and no payments were due before



      5
        The record does not include copies of all of the Barrow notes, and it appears
that in some cases Mr. Borna did not acquire an actual note but simply a debt
(usually evidenced by a deed of trust) that was owed to Mr. Barrow arising from
his sale of real estate to various third parties. For simplicity and convenience, we
use the term “Barrow note” to include those debts for which a note is not in the
record (or may never have actually been issued).
                                        -8-

[*8] 2015. Each Borna note was secured by a stated percentage of Mr. Borna’s

interest in Zhuo Zhou Development.

      Mr. Borna was entitled to keep all payments on the Barrow notes except to

the extent that a payment was for principal. He had to account to Mr. Barrow for

all principal payments during 2015 on December 31, 2015. In lieu of making the

required principal payments to Mr. Barrow during 2015, Mr. Borna, at his sole

discretion, could assign to Mr. Barrow Mr. Borna’s interests in Zhuo Zhou

Development and in a second company.

      The Barrow notes generally had seven-year terms and provided for monthly

payments. The Barrow notes bore a stated annual rate of interest ranging from 5%

to 10.9%, and most of the Barrow notes that Mr. Borna acquired had stated interest

rates of 8.9% through 10.9%. Payments on the Barrow notes were applied first to

any interest due, and then to principal. Mr. Barrow and Mr. Borna knew that

collection action would be difficult, and at least some of the Barrow notes would

never be paid in full.

      Mr. Borna received payments on the Barrow notes, and he paid commissions

to persons who helped collect these payments. He committed some of the

payments to Zhuo Zhou Development and spent most of the payments on personal
                                         -9-

[*9] items such as petitioners’ mortgage, insurance, and credit card charges. Mr.

Borna at the time of trial had not made any payments on the Borna notes.

        Mr. Borna eventually turned over on-site management of Zhuo Zhou

Development to Mr. Barrow. The overheated Chinese real estate market crashed,

and his important contracts dissipated with the illness of the two sisters he believed

were the Finance Minister’s daughters, one of whom died resulting in a loss of the

project and the Chinese Government’s taking over Zhuo Zhou Development in

2007.

               3. Specifics of Barrow Notes and Payments Received Thereon

        The specifics of the Barrow notes and the payments that Mr. Borna received

thereon are as follows.

                          Interest  Date of             Total payments received
           1
Exhibit #      Amount      rate    Barrow note        2004        2005       2006

 1017-P $95,000             6.9     12/19/2004      $50,448           -0-       -0-
 1040-P   52,000            9.9       4/3/2004       16,819        $15,021    $9,466
 1069-P   20,800            9.9       8/1/2004        4,987          3,435     2,748
 1070-P   48,000            9.9      1/29/2004       20,501         11,213    13,348
 1071-P   16,000            9.9     10/21/2002        2,913          2,118     2,939
 1072-P   22,500            9.9       8/3/2004         -0-          21,531       -0-
 1073-P   32,000            9.9       7/6/2004         -0-            -0-        -0-
       2
 1074-P   52,000            9.9     10/23/2002        6,774          6,427     9,997
       2
 1075-P   16,800            9.9       3/3/2003        2,189          2,076     3,230
       2
 1076-P 176,000             9.9      9/15/2002       33,262         25,453    39,759
 1077-P2 144,000            8.9      7/31/2002       18,760         17,797    27,683
 1078-P2 101,250            8.9      7/31/2002       13,190         12,513    19,464
 1079-P   21,600            9.9       9/9/2004        8,501          3,825     3,253
                                     - 10 -

[*10]                  Interest    Date of         Total payments received
 Exhibit #   Amount      rate     Barrow note    2004        2005       2006

 1080-P3     105,500     7.9      11/20/2002     8,979       29,516   15,869
 1081-P3     140,000     5.9       5/20/2002    11,915       39,168   21,059
 1082-P3      40,000     5.9       5/20/2002     3,404       11,191    6,017
 1083-P3      52,500     7.9       7/24/2003     4,468       14,688    7,897
 1084-P3      20,000     5.9       5/20/2002     1,702        5,595    3,008
 1085-P3     290,000     5.9        7/1/2002    24,680       81,135   43,621
 1086-P3     296,000    10.9       2/27/2004    25,191       82,814   44,524
 1087-P3     158,000     5.9       2/25/2002    13,446       44,205   23,766
 1088-P      296,000    10.9       2/27/2004    33,287       10,829   13,536
 1089-P       30,490     9.9      11/14/2004    30,724         -0-      -0-
 1090-P       18,000     9.9      10/27/2003     6,238        2,681    2,979
 1091-P       28,000     9.9       9/21/2004    15,256       10,128    8,937
 1092-P       22,000     9.9       6/15/2004     8,640        4,872    3,542
 1093-P       17,600     9.9       6/15/2004     3,820        3,000    2,913
 1094-P       20,000     9.9       8/19/2004     4,162        2,648    2,643
 1095-P       17,600     9.9       8/04/2004     6,661        2,912    2,913
 1096-P       16,000     9.9       7/14/2004     2,959       15,000     -0-
 1097-P       17,500     8.9       9/12/2004      -0-          -0-      -0-
 1098-P4      12,000     9.9       2/16/2003      -0-         4,431    2,991
 1099-P       14,000     9.9       4/09/2003     3,081        2,085    2,549
 1100-P4      14,400     9.9       5/11/2003     7,646        5,317    3,589
 1101-P5      59,500     8.9       7/27/2004    25,263        9,631    9,631
 1102-P5      28,000     9.9       7/27/2004    11,888        4,532    4,532
 1103-P      296,000    10.9       2/27/2004    32,397       34,771   18,973
 1104-P6      36,000     9.9        5/7/2004    10,277       14,206    9,470
 1105-P6      12,000     9.9        5/7/2004     3,426        4,735    3,157
 1106-P       29,000     ---       8/22/2004    28,105         -0-      -0-
 1107-P       20,000     9.9       4/24/2004    13,258        1,589    3,641
 1108-P       18,000     9.9      11/28/2003     5,504        2,419    2,719
 1109-P       28,000     9.9       9/21/2004    12,366        3,336    3,290
 1110-P       16,000     9.9        7/6/2004     4,957        1,849    2,905
 1111-P       15,200     9.9       6/15/2004     4,252        2,541    2,012
 1112-P       24,000     9.9        7/6/2004     8,224        3,212    4,005
 1113-P7      44,000     9.9       3/22/2003     5,223        4,944    3,860
 1114-P7      30,000     9.9       3/22/2003     3,561        3,371    2,632
                                    - 11 -

[*11]                  Interest  Date of         Total payments received
 Exhibit #   Amount     rate    Barrow note    2004        2005       2006

 1115-P       20,800     9.9      3/26/2004   21,139         -0-    -0-
 1116-P       40,000     9.9       7/9/2005     -0-        40,213   -0-
 1117-P       45,000     7.9       3/6/2005     -0-        62,493   -0-
 1118-P       49,500     ---      7/15/2005     -0-        49,746   -0-
 1119-P       15,000     6.9       4/9/2005     -0-        16,861  2,031
 1120-P       35,000     9.9       6/5/2005     -0-        36,707   -0-
 1121-P      105,000     7.9      4/22/2005     -0-        42,735   -0-
 1122-P       17,600     9.9     4/24/2004     5,212        3,962  3,508
 1123-P       15,200     9.9      7/24/2003     -0-           600  2,000
 1124-P       45,000     7.9      7/22/2005     -0-        31,138   -0-
 1125-P       30,000     9.9      2/22/2005     -0-          -0-    -0-
 1126-P8      30,000     9.9     2/22/2005      -0-        30,647  3,406
 1127-P       29,600     9.9    10/18/2004       980        8,000  8,000
 1128-P       66,000     7.9      2/10/2005     -0-        51,561  8,203
 1129-P       71,332     9.9       5/8/2005     -0-        26,881  9,797
 1130-P      120,000     9.9      2/26/2006     -0-          -0-  64,100
 1131-P       35,200     9.9      1/14/2006     -0-          -0-  13,277
 1132-P       21,600     9.9       9/2/2004    7,500        4,397  3,968
 1133-P       80,000     9.9      2/26/2006     -0-          -0-  29,768
 1134-P       52,000     9.9    11/20/2005    31,080       13,350  3,528
 1135-P       28,000     9.9       3/6/2005     -0-        10,075  4,634
 1136-P       36,000            12/20/2006      -0-          -0-   6,300
 1137-P        ---       ---       ---          -0-          -0-    -0-
 1138-P       15,600     9.9     6/15/2004     5,864        1,549  2,582
 1139-P       30,000     9.9     2/27/2005      -0-        14,586   -0-
 1140-P       19,000     ---     6/26/2004    18,617         -0-    -0-
 1141-P8      75,000     6.9     2/12/2005      -0-        76,619  8,515
 1142-P        ---       ---       ---          -0-          -0-    -0-
 1143-P       14,000     9.9   10/23/2003      2,549        2,317  2,317
 1144-P       14,800     9.9     1/10/2004     1,788          779   -0-
 1145-P       20,000     9.9     1/15/2004      -0-          -0-    -0-
 1146-P       14,400     9.9     6/18/2003     1,501        1,703    238
 1147-P       21,600     9.9   11/28/2004      1,787       20,681  2,134
 1148-P       16,000     9.9     10/4/2003     3,111          842    265
 1149-P       52,000     9.9     5/10/2004    16,747        9,466  8,606
                                        - 12 -

[*12]                    Interest Date of               Total payments received
 Exhibit #   Amount       rate Barrow note            2004        2005       2006

 1150-P      20,000         9.9    6/10/2003           5,641        5,726   6,508
 1151-P      14,400         9.9    5/22/2003           3,092        1,971   2,383
 1152-P9     27,500         6.9    7/15/2002           4,634        4,634   4,634
 1153-P9     19,500         6.9    7/26/2002           3,286        3,286   3,286
 1154-P      13,200         9.9    6/17/2003           2,750        2,500   3,500
 1155-P      16,400         9.9    8/23/2003           3,023        2,212   2,248
 1156-P      13,600         9.9    5/17/2003           2,264        1,814   2,503
 1157-P      15,000         9.9   10/21/2002           2,248        1,664   2,823
 1158-P      14,000         8.9     4/4/2004           8,018        1,796   2,021
 1159-P      20,800         9.9    3/26/2004           1,750        2,450   3,450
 1160-P      12,000         9.9   10/28/2002             993          -0-    -0-
 1161-P10    29,600         9.9    7/23/2002           5,378        3,419   2,441
 1162-P10    40,000         9.9    9/15/2002           7,267        4,620   3,298
 1163-P      16,000         9.9     8/5/2002           3,005        1,989   2,498
                                                   11
                                                      34,528    1,180,749 643,837
             1
              We list the Barrow notes by exhibit number rather than by
      issuer name because the identities of the issuers are not relevant to our
      analysis.
             2
              As to the Barrow note in Exhibit 1076-P, Mr. Borna received
      payments of $10,333, $3,702, and $5,924 in the respective years in
      issue. In addition, as to the five Barrow notes in Exhibits 1074-P
      through 1078-P, Mr. Borna received other payments totaling $63,842,
      $60,564, and $94,209 in the respective years in issue. The record,
      however, does not allow us to find the specific portions of those other
      payments that apply to each of the notes. We apportion the total other
      payments for each year among the notes in accordance with the ratio
      that the amount of each note bears to the total amount of these notes.
             3
              As to the eight Barrow notes in Exhibits 1080-P through
      1087-P, Mr. Borna received payments totaling $93,785, $308,312, and
      $165,761 in the respective years in issue. The record, however, does
      not allow us to find the specific portions of those payments that apply
      to each of the notes. We apportion the total other payments for each
                                       - 13 -

[*13] year among the notes in accordance with the ratio that the amount of
      each note bears to the total amount of these notes.
            4
              As to the two Barrow notes in Exhibits 1098-P and 1100-P,
      Mr. Borna received payments totaling $9,748 and $6,580 in 2005 and
      2006, respectively. The record, however, does not allow us to find the
      specific portions of those payments that apply to each of the notes.
      We apportion the total other payments for each year among the notes
      in accordance with the ratio that the amount of each note bears to the
      total amount of these notes.
            5
              As to the two Barrow notes in Exhibits 1101-P and 1102-P,
      Mr. Borna received payments totaling $37,151, $14,163, and $14,163
      in the respective years in issue. The record, however, does not allow
      us to find the specific portions of those payments that apply to each of
      the notes. We apportion the total other payments for each year among
      the notes in accordance with the ratio that the amount of each note
      bears to the total amount of these notes.
            6
              As to the two Barrow notes in Exhibits 1104-P and 1105-P,
      Mr. Borna received payments totaling $13,703, $18,941, and $12,627
      in the respective years in issue. The record, however, does not allow
      us to find the specific portions of those payments that apply to each of
      the notes. We apportion the total other payments for each year among
      the notes in accordance with the ratio that the amount of each note
      bears to the total amount of these notes.
            7
              As to the two Barrow notes in Exhibits 1113-P and 1114-P,
      Mr. Borna received payments totaling $8,784, $8,315, and $6,492 in
      the respective years in issue. The record, however, does not allow us
      to find the specific portions of those payments that apply to each of
      the notes. We apportion the total other payments for each year among
      the notes in accordance with the ratio that the amount of each note
      bears to the total amount of these notes.
                                          - 14 -
              8
[*14]           As to the two Barrow notes in Exhibits 1126-P and 1141-P,
        Mr. Borna received payments totaling $107,266 and $11,921 in 2005
        and 2006, respectively. The record, however, does not allow us to
        find the specific portions of those payments that apply to each of the
        notes. We apportion the total other payments for each year among the
        notes in accordance with the ratio that the amount of each note bears
        to the total amount of these notes.
              9
                As to the two Barrow notes in Exhibits 1152-P and 1153-P,
        Mr. Borna received payments totaling $7,920 in each of the years in
        issue. The record, however, does not allow us to find the specific
        portions of those payments that apply to each of the notes. We
        apportion the total other payments for each year among the notes in
        accordance with the ratio that the amount of each note bears to the
        total amount of these notes.
              10
                 As to the two Barrow notes in Exhibits 1161-P and 1162-P,
        Mr. Borna received payments totaling $12,645, $8,039, and $5,739 in
        the respective years in issue. The record, however, does not allow us
        to find the specific portions of those payments that apply to each of
        the notes. We apportion the total other payments for each year among
        the notes in accordance with the ratio that the amount of each note
        bears to the total amount of these notes.
              11
                 Our rounding of the individual payments for 2004 has resulted
        in the total payments’ being $2 greater than they actually were.


        D. Rental Income

        During all three of the taxable years in issue, petitioners received rent from

various persons for property they leased to those persons. Petitioners deposited the

rent into the Land Bank accounts discussed infra.
                                         - 15 -

[*15] III. Bank Accounts

      A. Bank of America Accounts 7874 and 8887

      Mr. Borna owned and controlled Land Bank accounts at Bank of America

ending in 7874 and 8887 (account 7874 and account 8887, respectively).6 All

receipts from sales in the name of Mr. Borna, all moneys that Mr. Borna received

on the Barrow notes, and all rent that Mr. Borna received were deposited into

account 7874 (or starting about February 10, 2006, into account 8887).

      Mr. Borna was responsible for the Land Bank check register. He retrieved

the statements and looked at them to see whether checks had cleared. He or

someone else made the deposits.

      B. Bank of the Sierra Account 9280

      During 2006, Mr. Borna owned and controlled an account at Bank of the

Sierra ending in 9280 (account 9280).

      C. CitiBank Account 6516

      Mrs. Borna received wages from an independent employer, Macy’s, Inc.,

during each year in issue. Those wages, net of certain amounts withheld (including

$48 in 2006 for a contribution to the United Way) were deposited into her

CitiBank account ending in 6516 (account 6516).

      6
      At least once, the trial transcript refers incorrectly to the latter account as
account number 2887.
                                         - 16 -

[*16] D. Accounts 1692 and 2484

      Superb Properties maintained two accounts at Mojave Desert Bank. These

accounts ended in numbers 1692 and 2484 (account 1692 and account 2484,

respectively).

IV. Preparation of the Subject Returns

      Solis Cooperson’s firm prepared the subject returns. Each subject return

included, among other forms and schedules, a Schedule C, Profit or Loss From

Business, and a Schedule D.

      Mr. Borna understood that he and his wife signed the subject returns under

penalty of perjury and were responsible for their accuracy. Mr. Borna did not

review the subject returns. Petitioners did not give Mr. Cooperson all of the

relevant documents (e.g., all of the notes and deeds of trust) related to the Borna

note transactions before the preparation of the subject returns.

V. Audit

      A. Overview

      Respondent began auditing the 2004 return and later expanded the audit to

include the 2005 return and the 2006 return. Respondent’s revenue agent, Daniel

Huh, met on various occasions with Mr. Cooperson in his capacity as petitioners’

representative.
                                         - 17 -

[*17] During the audit petitioners did not give Mr. Huh everything that he

requested from them, in part because that many of petitioners’ business and tax

returns were lost as a result of a series of burglaries of Land Bank’s and Superb

Properties’ offices and storage locations and of petitioners’ personal residence in

California City. Included in the lost property were two computers that stored

business records. Mr. Huh eventually issued bank summonses and multiple

information document requests to get information that he sought.

      Since the audit and after the issuance of the notice of deficiency, petitioners’

attorney’s accounting assistant, Ms. Wang, has made a yeoman’s effort to

reconstruct petitioners’ records primarily utilizing copies of petitioners’ canceled

checks obtained from Mr. Borna’s and his businesses’ banks. This effort has been

both arduous and tiring because of the number of transactions at issue, the fact that

many checks did not identify the reason for the check on the memo line, and the

passage of time. Consequently, many alleged expenses and income items remain

in dispute although the parties have tried hard to resolve as many substantiation

issues as possible, with some success.
                                         - 18 -

[*18] B. Bank Deposits Analysis

             1. Analysis During Audit

      Mr. Huh prepared the following bank deposits analysis (BDA) to reconcile

petitioners’ bank deposits to the income reported on the subject returns.


                                                    2004         2005             2006

 Net deposits from account 1692                    $217,843    $546,880       $416,930
 Net deposits from account 2484                     112,698      44,568          13,900
 Net deposits from account 7874                   1,263,604   3,033,599         545,388
 Net deposits from account 6516                      38,399      46,081          39,138
 Net deposits from account 8887                       -0-          -0-       1,033,139
 Net deposits from account 9280                       -0-          -0-           36,245
                                                                            1
  Total net deposits                              1,632,544   3,671,128       2,084,739

 Escrow deposits                                   197,013      443,026          251,583
 Gross receipts per Schedules C                    201,493      217,612          414,197
 Installment sales interest per tax returns         62,907      105,217          146,382
 State tax refund per tax returns                    2,673        -0-               -0-
 Rents received per tax returns                     34,923       31,387           64,280
                                                                                 2
 Ms. Borna’s net wages per tax returns              37,901       36,772            38,780
 Installment sales payments received per
   tax returns (excluding interest income)          495,568        53,436         327,650
                                                                            1
   Total reductions                               1,032,478      887,450        1,242,871
                                                              1
     Unexplained deposits                           600,066     2,783,679         841,868

 Additional Schedule D gross sales                 319,500    1,055,000          352,000

 Additional Schedule C gross receipts              280,566    1,728,679          489,868
             1
                 We note a discrepancy of $1.
                                         - 19 -
              2
[*19]          Mr. Huh improperly included the $48 contribution in this
        amount. The parties should correct this error in their computations
        under Rule 155.

        Mr. Huh requested proof of petitioners’ escrow deposits for the years in

issue. Mr. Borna provided information for 2004, but not for 2005 or 2006. Mr.

Huh determined petitioners’ escrow deposits for 2005 and 2006 by multiplying

each year’s total net deposits by the ratio of the escrow deposits for 2004 over the

total net deposits for 2004.

        Mr. Huh arrived at the additional Schedule C gross receipts by subtracting

from the unexplained deposits the amounts that he determined were additional

Schedule D sales. As to the Schedule D sales, Mr. Huh identified the properties

that Mr. Borna purchased and sold by reviewing Kern County property

transactions for 2004, 2005, and 2006 where Mr. Borna was listed as the grantee or

grantor. Mr. Huh calculated the selling and purchase prices (tax basis) by dividing

the property tax paid by the property tax transfer tax rate of .11%. Mr. Huh

matched up a sale by Mr. Borna with the unreported purchase (tax basis) to

establish the gain, if any, on property sold and not reported.7




        7
        Mr. Huh’s computations were not always accurate or carefully checked. As
a result, the Court has given them reduced credibility when weighing the evidence.
                                           - 20 -

[*20]         2. Analysis After Audit

        During this proceeding Revenue Agents Laura Hurtado and Sunny Lee

reviewed Mr. Huh’s BDA and revised it to include cash out from deposits on two

accounts. Cash out represents the amount of cash that is taken out at the time of

deposit. Cash out is important because some banks reflect only the net amount of

the deposit on a bank statement, and a review is required to make sure that all

income is actually reported.

        Mr. Huh’s BDA did not include any cash out. The revised BDA (revised

BDA) included for the respective years in issue cash outs of $27,800, $20,273, and

$13,000 for account 7874. For 2006, the revised BDA also included cash out of

$8,000 for account 8887.

        Ms. Hurtado and Mr. Lee in the revised BDA also adjusted the Schedule D

gross sales. They listed properties that were identified as sold but not reported by

Mr. Borna. They took into account amounts determined to be Mr. Borna’s

purchase price, the sale price, amounts received, costs incurred at the time of

purchase, and the capital gain realized.

        The escrow amounts in the BDA for 2005 and 2006 correspondingly

changed in the revised BDA. At trial, respondent conceded an additional

adjustment to acknowledge a division error by Mr. Huh in computing the selling
                                         - 21 -

[*21] price, by a factor of 10 pointed out by the Court, which had resulted in a

large price discrepancy as reflected on Mr. Huh’s examination work papers. This

error and others were apparently corrected later in the examination and the

preparation of the statutory notice of deficiency. Other mathematical and/or

factual errors were not corrected.

      The revised BDA is as follows:

                                                    2004        2005          2006

 Net deposits from account 1692                    $217,843    $546,880     $416,930
 Net deposits from account 2484                     112,698      44,568        13,900
 Net deposits from account 7874                   1,291,404   3,053,872       558,388
 Net deposits from account 6516                      38,399      46,081        39,138
 Net deposits from account 8887                       -0-          -0-     1,041,139
 Net deposits from account 9280                       -0-          -0-         36,245
                                                                          1
  Total net deposits                              1,660,344   3,691,401     2,105,739

 Escrow deposits                                   197,013     438,013      249,862
 Gross receipts per Schedules C                    201,493     217,612      414,197
 Installment sales interest per return              62,907     105,217      146,382
 State tax refund per tax returns                    2,673       -0-          -0-
 Rents received per tax returns                     34,923      31,387       64,280
 Ms. Borna’s net wages per tax returns              37,901      36,772       38,780
 Installment sales payments received per
   tax returns (excluding interest income)          495,568      53,436     327,650
   Total reductions                               1,032,478     882,437   1,241,151
     Unexplained deposits                           627,866   2,808,964     864,588

 Additional Schedule D gross sales                 101,680     198,400        25,500

 Additional Schedule C gross receipts              526,186    2,610,564     839,088
      1
          We note a discrepancy of $1.
                                        - 22 -

[*22] The parties eventually agreed to remove from the revised BDA the balances

in account 1692 and in account 2484. Thus, on the basis of this agreement,

respondent now asserts that the additional Schedule C gross receipts for the

respective years in issue are as follows:

                                                   2004        2005         2006

 Additional Schedule C gross receipts            $526,186 $2,610,564 $839,088
 Net deposits from account 1692                  (217,843)  (546,880) (416,930)
 Net deposits from account 2484                  (112,698)   ( 44,568) (13,900)
  Total adjustment                                330,541     591,448 430,830

 Additional Schedule C gross receipts
  (as adjusted)                                   195,645    2,019,116     408,258


VI. Schedule C Expenses for Taxes and Licenses

      Petitioners claimed on the subject returns that they were entitled to deduct

for 2004, 2005, and 2006 $56,403, $681, and $697, respectively, for taxes and

licenses. Respondent allowed $5,703 for 2004, and the deduction amounts claimed

for 2005 and 2006. For the respective years in issue, petitioners submitted at trial

negotiated checks for reported taxes and licenses expenses totaling $47,197,

$96,917, and $18,584.
                                         - 23 -

[*23] VII. Schedule C Rent Expenses

      Petitioners claimed on the subject returns that they were entitled to deduct

for 2004, 2005, and 2006 $24,377, $24,238, and $24,369, respectively, as Schedule

C rent expenses. Respondent allowed $7,210, $7,210, and $6,089, respectively.

      Petitioners did not give Mr. Huh any checks to support the deduction for rent

expenses for 2004. Therefore, Mr. Huh allowed a conservative estimate amount

based on that allowed for the subsequent tax years. For the respective years in

issue, petitioners submitted at trial for rent expenses negotiated checks totaling

$76,125, $43,438, and $66,564.

      In 2004, Mr. Borna paid $1,600 to Aspen Investment as a reported office

rental expense. Danny Jones is associated with Aspen Investment. A Land Bank

check for $50,929 made payable to him was cashed by Danny Jones on June 14,

2006. The check indicates that it is for “notes 4076 [and] 4079”.

VIII. Schedule C Commissions Expenses

      A. Overview

      Mr. Borna paid commissions ranging from 10% to 50% for property that he

owned individually and sold through Land Bank. Petitioners paid and reported

“commission and other expenses” on the Forms 6252 filed with the subject returns.

These amounts related to properties that Mr. Borna owned. The “other expenses”
                                        - 24 -

[*24] represented costs paid for, among other things, grading, taxes, licenses, and

escrow fees. Petitioners also paid commissions and other expenses on other

unreported property sales; those expenses included costs such as grading, taxes,

licenses, and escrow fees.

      B. 2004

      For 2004, petitioners deducted $58,121 as Schedule C commissions

expenses. Respondent allowed $14,462.

      Petitioners did not give Mr. Huh checks to support the claimed commissions

expenses. Mr. Huh used the amounts reflected on various Forms 1099 to

determine what he considered to be the commissions paid. He determined that

petitioners paid $444,273 in commissions for both Schedule C and D transactions.

In calculating the allowable commissions allocated to Schedule C, he considered

Mr. Borna’s statement that he paid 3% to 5% commissions on Schedule C sales

and 20% commissions on Schedule D sales. Mr. Huh determined it was closer to

1% to 3% on Schedule C sales and allowed 3%. He multiplied his determination

of Schedule C gross receipts as adjusted by 3%, resulting in $14,462. He

determined the total of petitioners’ Schedule D sales per his calculations and

allowed Schedule D commissions based on 20%. For 2004, the amount he allowed

for Schedule D was $429,811.
                                       - 25 -

[*25] C. 2005

      For 2005, petitioners deducted $100,811 as Schedule C commissions

expenses. Respondent allowed $58,389.

      Mr. Huh determined that petitioners paid $508,103 in commissions for both

Schedules C and D. In calculating the allowable commissions allocated to

Schedule C, Mr. Huh used petitioners’ accounting records and Mr. Cooperson’s

statements. Mr. Huh allowed 3% for Schedule C sales per his calculations. Mr.

Huh multiplied the Schedule C gross receipts as adjusted by him by 3%, resulting

in $58,311. Mr. Huh determined the total of petitioners’ Schedule D sales per his

calculations and allowed Schedule D commissions based on 20%. For 2005, the

amount of commissions allowed for Schedule D is $449,714.

      D. 2006

      Petitioners deducted $376,697 as Schedule C commissions expenses.

Respondent allowed $27,122.

      Mr. Huh determined that petitioners paid $357,897 in commissions for both

Schedules C and D. In calculating the allowable commissions allocated to

Schedule C sales, Mr. Huh allowed 3% per his calculations. Mr. Huh multiplied

the Schedule C gross receipts as adjusted by him by 3%, to come up with $27,122.

Mr. Huh determined the total of petitioners’ Schedule D sales per his calculations
                                       - 26 -

[*26] and allowed Schedule D commissions based on 20%. For 2006, the amount

allowed for Schedule D was $330,775.

IX. Notice of Deficiency

      The notice of deficiency lists the following adjustments:

                                         2004           2005         2006

 Sch C1--Taxes and licenses             $50,700           -0-         -0-
 Sch C1--Rent/lease--
   Other business property               17,167        $17,028      $18,280
 Sch C1--Commissions and fees            43,659         42,422      349,575
 Sch C1--Additional sales from
   Sch C properties                     280,566      1,728,679      489,868
 Sch D--S T Gain/Loss
   Forms 6252/4684/6781/8824            299,000        674,986        64,290
 Sch E1--Rents Received                   34,923         31,387       38,105
 S/E AGI adjustment                      (14,673)       (38,563)     (18,187)
 Itemized deductions                      21,340         69,203       18,839
 Exemptions                                4,650          7,680         -0-
   Total                                737,332      2,532,822      960,770

X. Amended Answer

      The amended answer lists the following revised adjustments:

                                         2004           2005         2006

 Sch C1--Taxes and licenses             $50,700           -0-         -0-
 Sch C1--Rent/lease--
  Other business property                17,167        $17,028      $18,280
 Sch C1--Commissions and fees            36,291         15,966      339,099
 Sch E1--Rents received                  34,923         31,387       38,105
 Sch C1--Additional sales from
  Sch C properties                      526,186      2,610,564      839,088
 Capital gain or loss                    68,667        141,597      100,283
                                         - 27 -

[*27]
 S/E AGI adjustment                        (13,860)       (40,979)           (21,862)
 Itemized deductions                        21,602         69,203             26,260
 Exemptions                                  4,650          7,680               -0-
   Total                                  746,326       2,852,446          1,339,253


                                      OPINION

I. Perception of Mr. Borna and Mr. Huh and of Certain Exhibits

      A. Mr. Borna

      Mr. Borna testified at length. The Court did not perceive him to be entirely

credible, and we consider portions of his testimony to be unreliable. We are not

required to rely on unreliable testimony, and we do not consider aspects of his

testimony sufficiently reliable to establish petitioners’ positions with respect to

certain of the issues at hand. See Neonatology Assocs., P.A. v. Commissioner, 115

T.C. 43, 84-87 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002); see also Ruark v.

Commissioner, 449 F.2d 311, 312 (9th Cir. 1971), aff’g per curiam T.C. Memo.

1969-48; Clark v. Commissioner, 266 F.2d 698, 708-709 (9th Cir. 1959), aff’g in

part and remanding T.C. Memo. 1957-129.

      Nor do we rely on the principal vis-a-vis interest allocations that petitioners

set forth in various payment schedules that they offered into evidence to

characterize sole proprietorship receipts (or portions thereof) as nontaxable returns

of principal. We consider those documents to be untrustworthy. For example, as
                                        - 28 -

[*28] to one of the schedules, Exhibit 1181-P, Mr. Borna helped prepare the entries

in that exhibit contemporaneously with the trial in this case; and as discussed

supra, we find that his testimony (which includes his statements as to the accuracy

of the exhibit) is unreliable. We also have further reservations as to the accuracy

of that exhibit in that, as discussed infra, we find that petitioners’ bookkeeping was

substandard. We also note that Mr. Borna’s testimony and overall understanding

of the amount of principal that he received vis-a-vis the amount of interest that he

received has not always been consistent.

      B. Mr. Huh

      Mr. Huh also testified extensively at the trial. The Court’s impression of his

testimony and audit efforts was that he was annoyed with the status of petitioners’

books and records and lack thereof. He was more interested in the burden of proof

than in determining the correct amount of tax even when, because of his efforts and

bank deposits methodology, canceled checks and other documents were available

to assist him in determining allowable deductions. Further, he made computations

which had to be corrected by other Internal Revenue Service personnel, including

Revenue Agents Laura Hurtado and Sunny Lee, at the request of respondent’s
                                         - 29 -

[*29] counsel. We give little evidentiary weight to Mr. Huh’s testimony and,

except to the extent stated herein, to his work product.8

II. Burden of Proof

      A. General Rules

      The Commissioner’s determinations in a deficiency notice are generally

presumed correct, and taxpayers generally bear the burden of proving those

determinations wrong. See Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115

(1933). The Court of Appeals for the Ninth Circuit, to which an appeal of this case

ordinarily would lie, absent a stipulation to the contrary, has held that the

presumption of correctness attaches to a notice of deficiency in unreported income

cases only when the Commissioner establishes a minimal evidentiary foundation

linking the taxpayer to the source of the unreported income. See Palmer v. U.S.

IRS, 116 F.3d 1309, 1312-1313 (9th Cir. 1997); Weimerskirch v. Commissioner,

596 F.2d 358, 360-362 (9th Cir. 1979), rev’g 67 T.C. 672 (1977). Once such a

foundation is established, the burden shifts to the taxpayer to prove by a

preponderance of the evidence the portion of the unreported income that is not

taxable. See Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999), aff’g

T.C. Memo. 1997-97; Palmer, 116 F.3d at 1312-1313; see also Helvering v.

      8
        We note, however, that we agree with Mr. Huh’s conclusion that petitioners
failed to report significant amounts of income that Mr. Borna’s businesses realized.
                                         - 30 -

[*30] Taylor, 293 U.S. 507, 515 (1935); Tokarski v. Commissioner, 87 T.C. 74,

76-77 (1986).

      Respondent determined that petitioners failed to report certain items of

income, and the evidence at hand establishes a minimal evidentiary foundation

linking petitioners to the source of that unreported income. The primary source for

the unreported income is Mr. Borna’s sole proprietorship. We conclude that

petitioners bear the burden of proof as to the deficiencies determined in the notice

of deficiency. Our conclusion applies to both the unreported income and to the

disallowed deductions underlying those deficiencies.9

      B. Section 7491(a)

      Section 7491(a)(1) provides an exception to the general rules on burden of

proof by shifting the burden of proof to the Commissioner as to any factual issue

relevant to a taxpayer’s liability for tax if the taxpayer meets certain conditions.10

These conditions require in part that individual taxpayers establish that they

      9
       Respondent in the amended answer asserts that petitioners are liable for
deficiencies in amounts greater than the amounts determined in the notice of
deficiency. While respondent bears the burden of proof as to any increased
deficiency, see Rule 142(a)(1), we do not find any increased deficiency in this
case.
      10
        Sec. 7491(a)(1) generally provides that “[i]f, in any court proceeding, a
taxpayer introduces credible evidence with respect to any factual issue relevant to
ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B, the
Secretary shall have the burden of proof with respect to such issue.”
                                        - 31 -

[*31] complied with the substantiation requirements set forth in the Code, that they

maintained all records required by the Code, and that they cooperated fully with

the Commissioner’s reasonable requests for, among other things, information and

documents. See sec. 7491(a)(2);11 Estate of Dieringer v. Commissioner, 146 T.C.

117, 127-128 (2016).

      We hold that section 7491(a) does not apply to shift the burden of proof to

respondent. This is because we do not find that petitioners cooperated with

respondent’s reasonable requests for documents and information or that petitioners

established their compliance with the substantiation and recordkeeping

requirements of the Code. Petitioners assert that they fully cooperated with Mr.

Huh throughout the audit, that they answered all of his questions, and that they

gave him all of the documents that he requested (except to the extent of certain

documents which petitioners claim were stolen). We disagree on each of these

points. The record establishes, and we find as facts, that petitioners did not

cooperate with Mr. Huh, that petitioners did not give Mr. Huh all of the documents

that he requested (e.g., Mr. Huh was required to get a significant amount of


      11
        Sec. 7491(a)(2) provides that the general rule of sec. 7491(a)(1) applies to
an individual taxpayer only if “the taxpayer has complied with the requirements
under this title to substantiate any item; * * * [and] the taxpayer has maintained all
records required under this title and has cooperated with reasonable requests by the
Secretary for witnesses, information, documents, meetings, and interviews”.
                                         - 32 -

[*32] information directly from third parties), and that petitioners did not timely

supply Mr. Huh with all of the information that he requested.

III. Unreported Income

      A. Overview

      Gross income includes all income from whatever source derived, including

gross income derived from business. See sec. 61(a)(2). This definition sweeps

broadly to reach all accessions to wealth over which a taxpayer has complete

control. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955). A

taxpayer’s receipt of an item of income “constitutes taxable income when its

recipient has such control over it that, as a practical matter, he derives readily

realizable economic value from it”, and a taxpayer has dominion and control of the

item when the taxpayer is free to use the item at will. Rutkin v. United States, 343

U.S. 130, 137 (1952). A taxpayer’s use of funds for personal purposes indicates

dominion and control, even if those funds are in an account titled in someone else’s

name. See, e.g., Gardner v. Commissioner, T.C. Memo. 2013-67, at *13.

      Taxpayers are required to maintain books and records sufficient to establish

the amount of their gross income. See sec. 6001. When taxpayers fail that

requirement, the Commissioner may reconstruct their income using any reasonable

method. See Holland v. United States, 348 U.S. 121, 130-131 (1954); see also
                                        - 33 -

[*33] DiLeo v. Commissioner, 96 T.C. 858, 867 (1991) (“The use of the bank

deposits method for computing income has long been sanctioned by the courts.”),

aff’d, 959 F.2d 16 (2d Cir. 1992).

      The record establishes, and we find, that petitioners failed to maintain the

requisite books and records as to Mr. Borna’s sole proprietorship or to properly

reconstruct any stolen records. See Gizzi v. Commissioner, 65 T.C. 342, 346

(1975) (noting that taxpayers whose records are lost on account of a casualty are

required to reasonably reconstruct their missing records). We conclude, therefore,

that respondent properly undertook a BDA to determine petitioners’ income and

that respondent properly determined through this BDA that petitioners

underreported their income for the years in issue. A BDA is a reasonable method

of reconstructing income, and the Commissioner may rely on a BDA to reconstruct

a taxpayer’s income where the taxpayer failed to maintain sufficient records. See

Nicholas v. Commissioner, 70 T.C. 1057, 1064 (1978). Bank deposits are

considered prima facie evidence of a taxpayer’s receipt of taxable income. See

Parks v. Commissioner, 94 T.C. 654, 658 (1990) (citing Tokarski v.

Commissioner, 87 T.C. 74, 77 (1986)).

      After the Commissioner reconstructs a taxpayer’s income and determines a

deficiency, as he has done here, the taxpayer bears the burden of proving that the
                                         - 34 -

[*34] use of the BDA was unfair or inaccurate. See Clayton v. Commissioner, 102

T.C. 632, 645 (1994). The taxpayer may do so by showing (among other things)

that certain deposits came from nontaxable sources. See id. Nontaxable sources

include funds attributable to interaccount bank transfers and returned checks, as

well as “loans, gifts, inheritances, or assets on hand at the beginning of the taxable

period.” Burgo v. Commissioner, 69 T.C. 729, 743 n.14 (1978) (quoting

Troncelliti v. Commissioner, T.C. Memo. 1971-72); see also Clayton v.

Commissioner, 102 T.C. at 645-646.

      B. Sole Proprietorship Income

      Respondent asserts that petitioners failed to report sole proprietorship

income for each year in issue. According to the amended answer, as adjusted to

reflect the parties’ agreement as to the deposits into accounts 1692 and 2484,

petitioners’ unreported sole proprietorship income for the respective years in issue

totals $195,645, $2,019,116, and $408,258.

      Petitioners argue that most of the unreported deposits are not taxable income

to them because, they assert, those deposits represent the payment of principal on

the Barrow notes. According to petitioners, the principal payments represent a

dollar-for-dollar return in the basis that Mr. Borna received in the Barrow notes
                                         - 35 -

[*35] through his issuance of the Borna notes.12 We disagree with petitioners’

argument. We do not find that all of the disputed amounts are a return of basis, as

petitioners claim.

      Mr. Borna received numerous payments on the Barrow notes, and those

payments are naturally characterized as principal or interest. Stated interest is

computed from the stated interest rates in the Barrow notes. Petitioners, as cash

basis taxpayers, must recognize all interest that Mr. Borna received on the Barrow

notes, see sec. 61(a)(4), notwithstanding what his bases may be in those notes.

      Respondent asserts on brief that petitioners received unreported stated

interest for the respective years in issue of $33,480, $69,327, and $57,586. We

have reviewed respondent’s calculations underlying those amounts and note further

that petitioners have not, in their answering brief, specifically identified any error

in the mechanics of those calculations. We sustain respondent’s position that

petitioners failed to recognize for each year in issue stated interest from Mr.

Borna’s sole proprietorship. We also sustain respondent’s calculations of the

amounts of unreported stated interest, except to the extent that the numbers in

respondent’s calculations would change on account of our findings of fact, which

we set forth supra section II.C.3 (pp. 9-11), or our holding as to respondent’s

      12
        In this vein, petitioners assert, the deposits are not receipts of Mr. Borna’s
sole proprietorship but are receipts from the sale of capital assets.
                                          - 36 -

[*36] asserted prepayments, discussed infra p. 38. To the extent that those

numbers would change on account of those findings and holding, we direct the

parties, in their Rule 155 computations, to recalculate the amounts in accordance

with our findings of fact supra section II.C.3 (pp. 9-11) and holding infra p. 38.

      Section 483 generally imputes interest to a contract for the sale or exchange

of property if the contract has “total unstated interest”, sec. 483(a), and unstated

interest is not a part of a purchaser’s basis in the property, see sec. 1.483-1(a)(2)(i),

Income Tax Regs. As relevant here, section 483 applies to such a contract if the

contract provides for deferred payments and the total payments due under the sales

contract are equal to or less than $250,000. See secs. 483(c), (d), 1274(c)(3). If

section 483 applies, a portion of the total unstated interest is imputed to each

deferred payment of principal. See sec. 483(a). Section 483(b) requires that

certain deferred payments be discounted to present value in order to ascertain

whether there is total unstated interest and, therefore, whether section 483 applies.

Section 483(b) and (c) requires that total unstated interest be computed by

discounting deferred payments under the method required by section 1274(b)(2)

and by using discount rates tied to the applicable Federal rate (AFR).13 The

amount of each note’s unstated interest is generally the difference between its

      13
      The AFRs are published each month as revenue rulings in the Internal
Revenue Bulletins.
                                         - 37 -

[*37] stated principal amount and the present value of the payments due thereunder

as determined under section 1.483-2, Income Tax Regs.

      Petitioners argue that Mr. Borna received a dollar-for-dollar basis in the

Barrow notes on account of his issuance of the Borna notes. We disagree. The

Borna notes lacked any stated interest and thus had unstated interest under section

483 and section 1.483-2, Income Tax Regs. The amount included in basis on

account of a promissory note issued to acquire nonpublicly traded property such as

the Barrow notes is the stated principal amount of the note, reduced by any

unstated interest. See sec. 1.1012-1(g)(1), Income Tax Regs. Mr. Borna’s basis in

each Barrow note thus equals the corresponding Borna note’s stated principal

amount less unstated interest. See id.

      Respondent asserts on brief that petitioners received market discount income

for the respective years in issue of $142,421, $277,099, and $203,031, an assertion

due in part to the fact that the Borna notes did not provide for any interest. We

have reviewed respondent’s calculations underlying those amounts and note further

that petitioners have not in their answering brief specifically identified any error in

the mechanics of those calculations. For the reasons stated above, we sustain

respondent’s position that petitioners failed to recognize for each year in issue

market discount income from Mr. Borna’s sole proprietorship. We also sustain
                                        - 38 -

[*38] respondent’s calculations of the amounts of market discount income, except

to the extent that the numbers in respondent’s calculations would change on

account of our findings of fact, which we set forth supra section II.C.3 (pp. 9-11),

or our holding as to respondent’s asserted prepayments, discussed immediately

below. To the extent that those numbers would change on account of those

findings and holding, we direct the parties, in their Rule 155 computations, to

recalculate the amounts in accordance with our findings of fact in the just-

referenced pages.

      Respondent also asserts that petitioners must recognize certain payments that

third parties made to Mr. Borna after certain Borna notes were issued but before

the “start date” of those notes. More specifically, respondent asserts, petitioners

must recognize for the respective years in issue $220,184, $138,875, and $59,200.

We disagree. To the extent that third parties paid Mr. Borna amounts before a

note’s start date, we find and hold that those payments are prepayments made on

the corresponding notes. We therefore reject respondent’s position that petitioners

failed to recognize these payments as income (except to the extent that the

payments would be stated or unstated interest within the realm of our discussion of

those items supra). We direct the parties, in their Rule 155 computations, to reflect

this holding consistently with that discussion.
                                         - 39 -

[*39] Finally, respondent asserts that petitioners must recognize short-term capital

gain with respect to six Barrow notes (notes 1089-P, 1115-P, 1118-P, 1120-P,

1126-P, and 1141-P) that respondent asserts were paid off shortly after Mr. Borna

acquired them. We agree with respondent that petitioners realized short-term

capital gains to the extent that our findings of fact, which we set forth supra

section II.C.3 (pp. 9-11), and our holding as to respondent’s asserted prepayments,

discussed supra p. 38, establish as to each note respectively that petitioners

received principal payments on the note in excess of Mr. Borna’s basis in the note.

Mr. Borna’s basis in each note equals the present value of the note. We direct the

parties, in their Rule 155 computations, to reflect this holding consistently with our

discussion herein.

      C. Schedule D Income

             1. Background

      The parties agree that petitioners received and failed to report Schedule D

income. This income stems from additional sales of property that petitioners

personally owned. The parties have settled all issues as to this matter except for

four items. We address these items seriatim.
                                           - 40 -

[*40]         2. Items in Dispute

                     a. $1,000 Sales Expense

        The parties dispute whether petitioners may deduct a $1,000 sales expense in

connection with the sale of a parcel of Kern County, California, property (referred

to as APN 294-010-01) for $10,000 in 2004. Petitioners did not report this sale on

their tax return because they believed no gain was realized. Petitioners originally

claimed sales expenses of $2,650.

        Petitioners failed to adduce any credible evidence on this issue, and the

record does not otherwise persuade us that petitioners are entitled to deduct the

$1,000 in dispute. We hold for respondent on this issue on the basis of petitioners’

failure to meet their burden of proof.14

                     b. Amounts Received in Connection With Certain Sales

        In or before 2003, petitioners purchased properties referred to as APN

212-251-18, APN 203-168-01, APN 203-166-02, and APN 203-166-03. They sold

the properties in 2004, but the buyers rescinded the sales in 2005. Petitioners

argue that rescission of the sales means that they did not realize any income on the

sales. We disagree.


        14
         Respondent’s opening brief sets forth no assertion that petitioners did not
realize any portion of the $10,000 in proceeds as gain. We therefore do not
consider that issue.
                                          - 41 -

[*41] Tax liability is generally based on transactions that occur during the taxable

year, without regard to transactions in later years. See Security Flour Mills, Co. v.

Commissioner, 321 U.S. 281, 285-286 (1944). In this vein, a cash method

taxpayer who receives proceeds under a claim of right and without restriction as to

their disposition is currently taxed on the receipt in the taxable year of receipt even

if, in a later taxable year, some or all of the proceeds must be returned. See Burnet

v. Sanford & Brooks Co., 282 U.S. 359, 363-364 (1931).

       With respect to the referenced four sales, the sales occurred in 2004 and the

rescissions occurred in 2005. Petitioners therefore, as cash basis taxpayers, must

report any gain or loss on the sales for 2004. Accord Felt v. Commissioner, T.C.

Memo. 2009-245, 98 T.C.M. (CCH) 372, 377 (2009), aff’d, 433 F. App’x 293 (5th

Cir. 2011).

              c. Repossessed Properties

       On December 18, 1991, petitioners purchased properties referred to as APN

305-050-14 and APN 305-071-15. Kern County sold those properties in 2004 for

back taxes of $4,250 and $1,707, respectively, that petitioners owed. Petitioners’

basis in each property was $1,800.

       Petitioners maintain that they did not realize any gain or loss on the

county’s sale of the properties. Instead, as we understand their position, they
                                         - 42 -

[*42] sustained a loss when the county took those properties, equal to their costs

for the properties. We disagree. A tax sale of property is a disposition of the

property. Petitioners therefore realized a long-term capital gain of $2,450 on one

of the properties ($4,250 ! $1,800) and a long-term capital loss of $93 on the other

property ($1,707 ! $1,800).

             d. Sales Expenses and Basis for APN 302-330-35

      On May 26, 2005, petitioners sold property referred to as APN 302-330-35

that they had purchased on March 2, 2005. Respondent concedes that petitioners

may claim a sales expense of $15,650 and that petitioners had a basis in the sold

property of $9,900. Petitioners request higher amounts as to both items.

Specifically, petitioners claim a cost basis of $19,000 (apparently including $5,500

of improvements), but they provided no backup evidence; and Exhibit 1042-P

would seem to disprove a commission expense above $15,650.

      Although petitioners provided Exhibit 1042-P, which addressed this sales

transaction, they failed to adduce any credible evidence on theses issues.

Petitioners bear the burden of disproving respondent’s determination as to this

matter. See Rule 142(a). They have failed to do so. We conclude that petitioners

are not entitled to a sales expense in excess of $15,650 or to a basis in excess of

$9,900.
                                       - 43 -

[*43] IV. Sole Proprietorship Expenses

      A. Preliminary

      We decide whether petitioners may deduct sole proprietorship expenses for

taxes and licenses, rent and lease, and commissions and fees in amounts greater

than respondent allowed. The amounts of these expenses that petitioners reported

on their tax returns and the amounts that respondent disallowed and allowed in the

notice of deficiency are as follows:

                                       Amount       Amount        Amount
   Year          Type of expense       reported    disallowed     allowed

   2004        Taxes and licenses        $56,403    $50,700        $5,703
               Rent and lease             24,377     17,167         7,210
               Commissions and fees       58,121     43,659        14,462
   2005        Taxes and licenses            681      -0-             681
               Rent and lease             24,238     17,028         7,210
               Commissions and fees      100,811     42,422        58,389
   2006        Taxes and licenses            697      -0-             697
               Rent and lease             24,369     18,280         6,089
               Commissions and fees      376,697    349,575        27,122


      As discussed infra, petitioners currently argue that they may deduct amounts

different from those they claimed, and respondent currently concedes that

petitioners may deduct amounts different from those determined in the notice of

deficiency.
                                        - 44 -

[*44] B. Substantiation of Deductions

      A second difficulty here is that the record before us falls short of providing

adequate substantiation for all of petitioners’ costs. Deductions are a matter of

“legislative grace”, and “a taxpayer seeking a deduction must be able to point to an

applicable statute and show that he comes within its terms.” New Colonial Ice Co.

v. Helvering, 292 U.S. 435, 440 (1934); see also Rule 142(a). The applicable

section here, section 162(a), generally allows “a deduction [for] all the ordinary

and necessary expenses paid or incurred during the taxable year in carrying on any

trade or business”. An expense is ordinary if it is “normal, usual, or customary”

within a particular trade, business, or industry. See Deputy v. du Pont, 308 U.S.

488, 495 (1940). An expense is necessary if it is appropriate and helpful for the

development of the business. See Commissioner v. Heininger, 320 U.S. 467, 471

(1943). The breadth of section 162(a) is tempered by the requirement that any

amount reported as a business expense must be substantiated, and taxpayers are

required to maintain records sufficient therefor. See sec. 6001; Hradesky v.

Commissioner, 65 T.C. 87, 89-90 (1975), aff’d, 540 F.2d 821 (5th Cir. 1976); sec.

1.6001-1(a), Income Tax Regs.

      When a taxpayer adequately establishes that he or she paid or incurred a

deductible expense but does not establish the precise amount, we may in some
                                        - 45 -

[*45] circumstances estimate the allowable deduction, bearing heavily against the

taxpayer whose inexactitude is of his or her own making. See Cohan v.

Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). There must, however, be

sufficient evidence in the record to provide a basis upon which an estimate may be

made and to permit us to conclude that a deductible expense, rather than a

nondeductible personal expense, was incurred in at least the amount allowed. See

Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957); Vanicek v.

Commissioner, 85 T.C. 731, 742-743 (1985).

      Three categories of expenses are in dispute for 2004, 2005, and 2006. The

categories are (1) taxes and licenses; (2) rent and lease expenses; and

(3) commissions and fees expenses. The disputes are detailed in the parties’ “Third

Stipulation of Settled [and Unsettled] Issues” filed by the Court’s Clerk as a

Stipulation of Settled Issues. Because of a stolen computer with at least some, if

not all, of the business records and somewhat shoddy overall recordkeeping,

petitioners have had to report their expenses by reconstructing their records

utilizing copies of their canceled checks apparently obtained from their banks.

      C. Expenses in Issue

      The specific amounts in dispute per the parties’ stipulation are as follows.

These amounts take into account respondent’s amended answer.
                                           - 46 -

[*46]         1. Schedule C Business Expenses

                     a. 2004

        The parties have stipulated for 2004:

                                 Amounts             Amounts       Amounts
                                 reported           allowed per   remaining
        Expense category       by petitioners       respondent     in dispute
                                     1
    Taxes and licenses                   $47,197       $15,618      $16,373
    Rent/lease--Other
     business property                   76,125         14,090       62,034
    Commissions and
                                     1
     fees                                249,696        30,654      211,176


              1
                These are the amounts listed on petitioners’ tally sheets.
        Respondent, however, asserts that these amounts include some
        duplicated items. Neither the parties nor the record explains the
        discrepancy of $15,206 between, on the one hand, the difference of
        $31,579 in the total claimed taxes and licenses expense of $47,197
        and the total of the amount allowed by respondent of $15,618 and, on
        the other hand, the amount remaining in dispute of $16,373. The
        same is true as to the discrepancy of $7,866 between, on the one hand,
        the difference in total claimed commissions and fees expense of
        $249,696 and the amount allowed by respondent of $30,654 and, on
        the other hand, the amount remaining in dispute of $211,176.


        Of the disputed taxes and licenses amount of $16,373 respondent would

allow $11,655 and $2,160 as Schedule A “Other Miscellaneous Itemized

Expense[s]”. The remaining disputed amount comprises seven payments made to

the County Recorder Office totaling $2,558.
                                         - 47 -

[*47]                b. 2005

        The parties have stipulated for 2005:

                                Amounts            Amounts        Amounts
                               claimed by         allowed per    remaining
         Expense category      petitioners        respondent      in dispute
                                                                   1
         Taxes and                $96,917           $105,776           $11,830
          licenses
         Rent/lease--
                                                                       1
          Other business           51,226             15,288               28,878
          property
         Commissions and
                                                                   1
          fees                    316,392             48,684           285,432

              1
               The table’s taxes and licenses amounts are confusing since
        respondent allowed more than petitioners claimed. The additional
        amount allowed was $8,859 which does not jive with the $11,830
        shown in the parties’ stipulated table. The correct amount would
        seem to be a negative $8,859, rather than the $11,830 in the stipulated
        table. Nor is there an explanation for the discrepancy of $7,060 of the
        claimed rent/lease expense of $51,226 and the total of the amount
        allowed by respondent of $15,288 and the amount remaining in
        dispute of $28,878, which together total $44,166. Nor is there an
        explanation for the apparent discrepancy of $17,724 of the claimed
        commissions and fees of $316,392 and the total of the amount allowed
        by respondent of $48,684 and the amount remaining in dispute of
        $285,432, which together total $334,116.
                                           - 48 -

[*48]                c. 2006

        The parties have stipulated for 2006:

                                  Amounts            Amounts       Amounts
                                 reported by        allowed per   remaining
          Expense category        petitioners       respondent     in dispute
                                                                     1
         Taxes and                     $18,584         $13,936           $4,583
         licenses
         Rent/lease--Other
                                                                     1
          business                     66,564           12,267           54,291
         property
         Commissions and
          fees                          58,386           7,853           50,532
              1
               The apparent discrepancy between the stipulated total reported
        taxes and licenses expenses of $18,584 and the total of the amount
        allowed by respondent, $13,936, and the amount remaining in dispute
        of $4,583, which together total $18,519, is not explained by the
        record. Nor is the discrepancy of $6 between the claimed rent/lease
        expense of $66,564 and the amount allowed by respondent of $12,267
        and the amount remaining in dispute of $54,291, which together total
        $66,558.

              2. Positions

                     a. Taxes and Licenses

                             i. 2004

        Petitioners argue that they may deduct, for 2004, taxes and licenses expenses

of $47,197. Petitioners presented at trial negotiated checks totaling that amount.

Respondent concedes that petitioners may deduct $15,618.
                                        - 49 -

[*49] The parties continue to dispute as to this year the deductibility of $16,373.

The amounts and payees of the negotiated checks underlying the $16,373 are as

follows:

                   Check payee                   Check amount

             L.A. County Tax Collector               $2,160
             Kern County Tax Collector               11,655
             County Recorder Office                     823
             County Recorder Office                     370
             County Recorder Office                      54
             County Recorder Office                     123
             County Recorder Office                     151
             County Recorder Office                     411
             County Recorder Office                     626
              Total                                  16,373

      Respondent objects to the claimed deduction of these payments on the

grounds that petitioners were already allowed a $3,712 Schedule C business

expense deduction for 2004 recorder fees and petitioners have not established that

the $2,558 is not included in the $3,712. Given that the disputed amount is derived

solely from the canceled checks used to reconstruct petitioners’ records, we agree

with respondent that if anything the allowed deduction here may be overgenerous.

      Respondent concedes that petitioners may deduct the $2,160 and $11,655

amounts as miscellaneous itemized deductions, as opposed to deducting the

amounts as a business expense. While petitioners reserved the right to try to prove
                                        - 50 -

[*50] those amounts could be deducted elsewhere they failed to do so. We will

allow these two amounts as miscellaneous itemized deductions.

                          ii. 2005

      Petitioners argue that they may deduct for 2005 taxes and licenses expenses

of $96,917. Respondent concedes that petitioners may deduct $105,776. We will

allow petitioners to deduct $105,776 without further comment.15

                          iii. 2006

      Petitioners argue that they may deduct for 2006 taxes and licenses expenses

of $18,584. Respondent concedes that petitioners may deduct $13,936.

      The parties continue to dispute as to this year the deductibility of $4,583.

The $4,583 represents a check payable to the Los Angeles County Tax Collector.

Respondent asserts that the $4,583 is deductible as a miscellaneous itemized

deduction. While petitioners reserved the right to try to prove it could be deducted

elsewhere, they fail to do so. The Court will allow this amount as a miscellaneous

itemized deduction.




      15
        In addition to the $105,776 that we allow, respondent concedes that
petitioners may deduct $7,807 as a miscellaneous itemized deduction. The $7,807
represents check 8630 paid from account 7874 to the L.A. County Tax Collector.
We allow this miscellaneous itemized deduction in full.
                                          - 51 -

[*51]                      iv. Analysis

        Mr. Borna testified that he paid taxes on three groups of property: property

he personally owned, property he owned for sale to third parties, and property that

Mr. Barrow sold to third parties. He did not, however, identify to which of those

groups each of the 10 remaining disputed checks related.

        Respondent asserts that petitioners have failed to show that the amounts

remaining in dispute were not already allowed as deductions. As to the County

Recorder Office payments, we agree. Petitioners reported on their Forms 6252

“commission and other expenses”. The amounts reported included taxes and

licenses. Petitioners also incurred “commission and other expenses” on unreported

sales of property, which also included taxes and licenses. We conclude it is

probable that the County Recorder Office payments were included in these

deductions. Consequently, we are not persuaded that petitioners may deduct any of

those remaining disputed amounts as Schedule C expenses.

                     b. Rent and Lease

                           i. 2004

        Petitioners argue that they may deduct for 2004 rent and lease expenses of

$76,125. Petitioners presented at trial negotiated checks in the total amount of

$76,125. Respondent concedes that petitioners may deduct $14,090.
                                        - 52 -

[*52] The parties continue to dispute as to this year the deductibility of $62,035.

The $62,035 is attributable to six checks totaling that amount, payable to Aspen

Investments. Five of the checks are for $1,600; the sixth check is for $54,035.

                          ii. 2005

      Petitioners argue that they may deduct for 2005 rent and lease expenses of

$51,226. Petitioners presented at trial negotiated checks in the total amount of

$51,226. Respondent concedes that petitioners may deduct $15,288.

      The parties continue to dispute as to this year the deductibility of $28,878,

which represents checks payable as follows:

                          Payee                      Amount

                   Allan/Daisy Paredes               $15,459
                   Danny Jones ALC PSP                 1,121
                   Danny Jones ALC PSP                 2,243
                   Danny Jones ALC PSP                 1,121
                   Danny Jones ALC PSP                 1,121
                   Danny Jones ALC PSP                 1,121
                   Danny Jones ALC PSP                 1,121
                   Danny Jones ALC PSP                 1,121
                   Danny Jones ALC PSP                 1,454
                   Danny Jones ALC PSP                 1,121
                   Legaspi                             1,875
                    Total                             28,878
                                           - 53 -

[*53]                       iii. 2006

        Petitioners argue that they may deduct for 2006 rent and lease expenses of

$66,564. Petitioners presented at trial negotiated checks in the total amount of

$66,564. Respondent concedes that petitioners may deduct $12,267.

        The parties continue to dispute, as to this year, the deductibility of $54,291.

The $54,291 represents checks payable as follows:

                            Payee                      Amount

                     Danny Jones ALC PSP               $50,928
                     Danny Jones ALC PSP                 1,121
                     Danny Jones ALC PSP                 1,121
                     Danny Jones ALC PSP                 1,121
                      Total                             54,291

                            iv. Analysis

                                    a. 2004

        For 2004, the notation on check 8053 for $54,035 appears to be, in part,

“payoff”. Mr. Borna testified that he “rented a huge place from [Aspen

Investment] * * * for a few months * * * to hold [an] event * * * to capture the

client. * * * We invite different speakers, and they talk. And then the people, they

come to the event. We get their name, and we will call them. My agent would call

them and ask them to sell – to buy property. * * * it was for the rental of * * * that

place.” The check indicates it was for “payoff net at 3235 Aspen Mall”. Mr.
                                        - 54 -

[*54] Borna explained that “we give them a notation that I’m going to pay you

before middle of the year, so that’s why this was pay off that.” This check appears

not to be for rent but for a payoff of a real estate transaction. The Court concludes

that the amount is excessive for an event rental and is more consistent with a

note(s) payoff. Further support for this conclusion can be found in the 2006 check

1047 for $50,929, paid to Danny Jones (who is Aspen Investments), which

petitioners also claim as a rent expense deduction. The notations on the check,

“notes 4076 [and] 4079,” indicate that it was a payment made on two notes, rather

than a payment of rent. Mr. Borna did not produce a lease agreement associated

with either of these large reported expenses.

      An overwhelming amount of the rent expense in dispute for each year,

$62,035 for 2004, $11,543 for 2005, and $54,291 for 2006, relates to Danny Jones

d.b.a Aspen Investment, yet petitioners did not call him or any of his associates or

employees at the trial or attempt to introduce by sworn affidavit Aspen Investments

business records. See Wichita Terminal Elevator Co. v. Commissioner, 6 T.C.

1158, 1165 (1946) (noting the presumption that if produced the evidence would be

unfavorable “is especially true where * * * the party failing to produce the

evidence has the burden of proof”), aff’d, 162 F. 2d 513 (10th Cir. 1947).
                                       - 55 -

[*55] Respondent asserts that petitioners have failed to show that the amounts

remaining in dispute were not already allowed as deductions. Petitioners reported

on their Forms 6252 “commission and other expenses”; the amounts reported

included taxes and licenses. Petitioners also incurred “commission and other

expenses” on unreported sales of property, which also included taxes and licenses.

Respondent has not challenged the already-allowed deductions and has introduced

no evidence that certain of the claimed rent or lease expense deductions have

already been allowed.

      Respondent seems to believe that petitioners must establish the negative that

there is no needle in the haystack. We do not agree. If respondent believes

deductions for the items were allowed under some other category, respondent

should have challenged the expenses under that category as well as the expenses

here or produced evidence, as he has with respect to commissions, that the expense

deductions claimed here were already allowed elsewhere.

      We are persuaded by petitioner’s testimony, canceled checks, and the regular

periodic payments for essentially similar amounts that the five checks, each for

$1,600, represent rent expenses incurred in 2004; and we find no creditable

evidence that these rent expenses were allowed as deductions elsewhere. Thus

petitioners have carried their burden of proof, by a preponderance of the evidence,
                                       - 56 -

[*56] that these payments should be, and they shall be, allowed as deductible rent

expenses.

                                b. 2005

      The amounts remaining in dispute include seven checks to Danny Jones for

$1,121. As with 2004, we are persuaded that these checks represent rent payments

which are deductible and will be allowed for 2005. The balance of the unagreed

rent and lease expense consists of a check for $15,459 to Allan/Daisy Paredes, two

checks to Danny Jones for $2,243 and $1,454, and a check to Legaspi for $1,875.

We will allow as a deductible rent expense the $2,243 check, which we conclude is

a payment for two months of the $1,121 regular rent. We will not, however, allow

any deduction for the $1,454 check (which Mr. Borna curtly identified as rent with

no elaboration to explain the unique amounts, although asked “why?”) or the

$15,459 check to Allan/Daisy Paredes (which Mr. Borna identified as a “referral

check”), or the $1,875 check to Legaspi which indicates it is a “referral” and may

in fact be a referral fee per Mr. Borna’s testimony. We conclude petitioners have

failed to bear their burden of proof as to these checks. As Mr. Borna

acknowledged, these checks, if deducted at all, would be deductible as

commissions and fees, not as rent or lease expenses. We decide infra Mr. Borna’s

allowable deduction for 2005 commissions and fees.
                                         - 57 -

[*57]                             c. 2006

        The amounts remaining in dispute for 2006 include three checks to Danny

Jones for $1,121 each and the aforementioned check for $50,928. As mentioned

above, the notations on this check of “note 4076 [and] 4079” indicate that the

check reflects payments made on two notes rather than rent. Consequently, the

$50,928 amount will not be allowed. However, as with 2004 and 2005, the three

checks for $1,121 will be allowed as deductible rent expenses for the same reasons

discussed above.

                     c. Commissions and Fees

                            i. 2004

        Petitioners argue that they may deduct for 2004 commissions and fees

expenses of $249,649. Petitioners presented at trial negotiated checks in the total

amount of $249,696. Respondent concedes that petitioners may deduct $30,654.

        The parties continue to dispute as to this year the deductibility of $211,176.

The $211,176 represents 18 checks totaling $107,668, payable to Elizabeth

PeCayo; 11 checks totaling $29,737, payable to Rosalinda Garcia; 11 checks

totaling $18,000, payable to Gary Young; 1 check for $2,750, payable to Efinegie

Ventura; 1 check for $2,250, payable to Famie Ventura; 2 checks totaling $17,145,

payable to Flor De Lys Barawid; 1 check for $5,000, payable to Brian Borna;
                                        - 58 -

[*58] 9 checks totaling $2,664, payable to Transasia real estate services for

Mdelma; 1 check for $1,254, payable to Zalco Co.; 6 checks totaling $4,410,

payable to David Galdamez; 4 checks totaling $19,238, payable to cash; 1 check

for $260, payable to Joseph Nolan; and 1 check for $500, payable to James

PeCayo.16 Respondent concedes that petitioners may deduct $13,738 of the checks

payable to cash as a miscellaneous itemized deduction.

                          ii. 2005

      Petitioners argue for 2005 that they may deduct commissions and fees

expenses of $316,392. At trial, petitioners presented negotiated checks totaling

$316,392. Respondent concedes that petitioners may deduct $48,684.

      The parties continue to dispute as to this year the deductibility of $285,432.

The $285,432 represents 21 checks totaling $176,909, payable to Elizabeth

PeCayo; 11 checks totaling $30,823, payable to Rosalinda Garcia; 1 check for

$10,000, payable to Rosalinda Lising; 7 checks totaling $27,485 payable to Lemie

Ventura; 1 check for $12,030, payable to Flor De Lys Barawid; 1 check for $2,400,

payable to Mel Mantuario; 2 checks totaling $3,000, payable to Robert Williams; 1

check for $2,000, payable to David Galdamez; 1 check for $405, payable to Maria


      16
       We recognize that the checks referenced in this sentence total $210,876.
The parties have not explained the $300 difference between the $211,176 and the
$210,876.
                                         - 59 -

[*59] Galdamez; 1 check for $300, payable to Marco Galdamez; 1 check for $333,

payable to Mdelma; 1 check for $2,000, payable to Disnordas Sosnaski; 1 check

for $10,000, payable to Paulita Tajiboy; 1 check for $739, payable to McGraw

Insurance; 1 check for $250, payable to Mid Valley; 1 check for $5,860, payable to

Mayiga; and 1 check for $898, payable to Al Gagnon.

                          iii. 2006

      Petitioners argue that they may deduct for 2006 commissions and fees

expenses of $58,386. Petitioners presented at trial negotiated checks totaling

$58,386. Respondent concedes that petitioners may deduct $7,853.

      The parties continue to dispute for this year the deductibility of $50,532.

The $50,532 represents 8 checks totaling $43,857, payable to Rosalinda Garcia; 1

check for $1,400, payable to Lemie Ventura; 1 check for $2,786, payable to Gade 1

Travel; 1 check for $1,739, payable to Gina Dancel; 1 check for $500, payable to

Disnordas Sosnaski; and 1 check for $250, payable to David Galdamez.

                          iv. Analysis

      Petitioners have failed to show that the 2004, 2005, and 2006 items

remaining in dispute are deductible as they claim. Petitioners paid and claimed

deductions for “commission and other expenses” on the Forms 6252 filed with

their tax returns and paid commission expenses concerning unreported property
                                         - 60 -

[*60] sales (full and installment). We cannot determine whether respondent has

already allowed deductions for the commissions in dispute. We find, for example,

that some disputed items include payments that respondent has already allowed.

Many of the payees on the checks petitioners presented at trial are the same

individuals paid commissions with respect to property Mr. Borna owned and sold,

both reported and unreported. These are PeCayo, David Galdamez, Rosalinda

Garcia, and Flor de Lys Barawid. Likewise, numerous checks petitioners

presented bear no notation as to the property to which they relate, and Mr. Borna

failed to clarify that point at trial.

              3. Other for 2004

       Respondent concedes and we agree that petitioners may deduct $1,550 as

legal and professional fees. This $1,550 was paid through 10 checks. Respondent

also concedes that petitioners may deduct another $27,533 as a miscellaneous

itemized deduction. We allow both miscellaneous itemized deductions.

V. Accuracy-Related Penalties

       Respondent determined for each year in issue that petitioners are liable for

an accuracy-related penalty under section 6662(a). Respondent bears a burden of

production with respect to those determinations. See sec. 7491(c); Rule 142(a)(2).

Respondent may meet this burden by producing sufficient evidence indicating that
                                        - 61 -

[*61] it is appropriate to impose the accuracy-related penalty on petitioners. See

Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001).

      Section 6662(a) imposes a 20% accuracy-related penalty on the

underpayment of tax required to be shown on a return. Section 6662(b)(1) imposes

an accuracy-related penalty on the portion of an underpayment which is

attributable to negligence or to disregard of rules or regulations. Negligence

includes “any failure to make a reasonable attempt to comply with the provisions”

of the Code “or to exercise ordinary and reasonable care in the preparation of a[n]

[income] tax return.” See sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.

“‘Negligence’ also includes any failure by the taxpayer to keep adequate books and

records or to substantiate items properly.” See sec. 1.6662-3(b)(1), Income Tax

Regs. “‘[D]isregard’ includes any careless, reckless or intentional disregard of

rules or regulations.” See id. subpara. (2). Section 6662(b)(2) imposes an

accuracy-related penalty on the portion of an underpayment which is attributable to

a substantial understatement of income tax. In the case of individual taxpayers, a

substantial understatement of income tax exists if the amount of the understatement

exceeds the greater of 10% of the tax required to be shown on the return or $5,000.

See sec. 6662(d)(1)(A).
                                         - 62 -

[*62] We find that respondent has met his burden of production. The record

establishes, and we find, that petitioners were negligent and disregarded rules and

regulations in that they failed to report significant amounts of taxable income for

each year in issue, they failed to maintain adequate books and records, they failed

to substantiate items properly, and they were in careless, reckless, or in intentional

disregard of rules and regulations applicable to the payment of Federal income tax.

Respondent also meets his burden of production to the extent that any of

petitioners’ understatements meets the statutory definition of a “substantial

understatement”.

      Once the Commissioner has met the burden of production, as he has here,

the taxpayer must come forward with persuasive evidence that the imposition of a

penalty is inappropriate because, for example, the taxpayer acted with reasonable

cause and in good faith. See sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at

448-449. Petitioners made no argument in their posttrial brief that imposition of

the accuracy-related penalties is inappropriate. While petitioners’ attorney Mr.

Cooperson prepared petitioners’ 2004, 2005, and 2006 Federal income tax returns,

he did this using solely the information provided by petitioners and was never

consulted for any tax advice concerning the source, accuracy, or computations of

the tax information petitioners provided to him. Since accurate and complete
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[*63] information was not provided to the tax return preparer, petitioners, who did

not even review the tax returns, had no right to rely on the prepared tax returns as

being accurate and in accordance with the Code for the years in issue here. See

Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 99. Consequently, we

conclude that imposition of the accuracy-related penalties is not inappropriate and

sustain respondent’s determination that an accuracy-related penalty under section

6662(a) applies for each year in issue.

VI. Epilogue

      We have considered all arguments that the parties made and have rejected

those arguments not discussed here as without merit.

      To reflect the foregoing,


                                                        Decision will be entered under

                                                   Rule 155.
