                               T.C. Memo. 2015-181



                         UNITED STATES TAX COURT



      CHARLES OKONKWO AND CECILIA OKONKWO, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 23496-13.                          Filed September 14, 2015.



      Charles Okonkwo and Cecilia Okonkwo, pro sese.

      Michael W. Tan, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      FOLEY, Judge: After concessions, the issues for decision are whether

petitioners may deduct certain expenses and whether they are liable for section

6662(a) accuracy-related penalties.1


      1
      Unless otherwise indicated, all section references are to the Internal
Revenue Code relating to the years in issue, and all Rule references are to the Tax
                                                                       (continued...)
                                          -2-

[*2]                            FINDINGS OF FACT

       During 2008, 2009, and 2010 (years in issue) Charles Okonkwo was a

cardiologist and his wife, Cecilia, worked in his medical practice. Their principal

residence (Bel Air residence) was in the Bel Air neighborhood of Los Angeles,

California. Petitioners, in 1992, purchased a vacant lot in Woodland Hills,

California; in 1997, constructed a single-family house on the lot; and, through

2001, attempted to sell it. They ceased their sales efforts in 2002 and through

2006 rented the Woodland Hills house for $6,000 per month to an unrelated

tenant. From 2007 through March 2010, petitioners’ daughter resided in the

Woodland Hills house and paid rent of $2,000 per month. During this time,

petitioners resumed their sales efforts and routinely cleaned the Woodland Hills

house.

       Harry Stiritz, Jr., a certified public accountant (C.P.A.) with real estate

investment experience, prepared petitioners’ returns using estimates of certain

deductions that Mr. Okonkwo conveyed during their conversations. Petitioners

timely filed Forms 1040, U.S. Individual Income Tax Return, relating to the years

in issue. On Schedule A, Itemized Deductions, of their 2008 Form 1040, they


       1
      (...continued)
Court Rules of Practice and Procedure.
                                        -3-

[*3] reported $100,915 of mortgage interest relating to the Bel Air residence. On

Schedule E, Supplemental Income and Loss, petitioners indicated that the

Woodland Hills house was rental real estate and reported rent of $24,000, total

expenses (i.e., mortgage interest, taxes, insurance, and depreciation) of $158,360,

and a net loss of $134,360. On Form 8582, Passive Activity Loss Limitations,

they characterized their 2008 Schedule E net loss as passive. Before he prepared

their 2009 and 2010 returns, Mr. Stiritz noticed, and asked petitioners about, the

significant decrease in their rental income relating to the Woodland Hills house.

In response, petitioners informed him that the decrease was attributable to the

previous tenant’s moving out of, and their daughter’s moving into, the house. On

Schedules C, Profit or Loss From Business, of their 2009 and 2010 Forms 1040,

respectively, petitioners reported gross receipts of $24,000 and $6,000, total

expenses of $108,600 and $113,820, and net losses of $84,600 and $107,820 and

indicated that they were in the construction business.

      During respondent’s examination, and pursuant to Mr. Stiritz’ advice,

petitioners filed a 2008 Form 1040X, Amended U.S. Individual Income Tax

Return, on which they reported, on Schedule C, the income and expenses relating

to the Woodland Hills house and claimed a refund of $8,789. These items had

previously been reported on petitioners’ Schedule E. On July 8, 2013, respondent
                                         -4-

[*4] issued petitioners a notice of deficiency relating to 2008 in which respondent

disallowed the refund claim, disallowed $19,211 of the mortgage interest

deduction relating to the Bel Air residence, and determined that petitioners owed

income tax of $4,295 and were liable for a section 6662(a) accuracy-related

penalty. Respondent, on July 8, 2013, issued a notice of deficiency relating to

2009 and 2010 in which respondent disallowed petitioners’ Schedule C deductions

(i.e., mortgage interest, taxes, repairs, and insurance) and adjusted certain itemized

deductions (i.e., mortgage interest relating to the Bel Air residence, taxes, and

retirement contributions). Respondent further determined that petitioners held the

Woodland Hills house for the production of income; that the losses reported,

pursuant to section 469, were passive; that petitioners owed income tax of $18,425

and $32,256, relating to 2009 and 2010, respectively; and that petitioners were

liable for section 6662(a) accuracy-related penalties.

      On October 17, 2013, petitioners, while residing in California, filed a

petition with the Court. On April 15, 2015, the Court filed respondent’s first

amendment to answer in which respondent contended that the deductions at issue

are limited, pursuant to section 280A, to the amounts of petitioners’ rental income.
                                         -5-

[*5]                                  OPINION

       In general, a taxpayer may not claim deductions that would otherwise be

allowable (e.g., pursuant to section 212) relating to the use of a dwelling unit as a

residence. See sec. 280A(a). A dwelling unit is used as a residence if the

taxpayer, or a family member, uses it for personal purposes for more than the

greater of 14 days a year or 10% of the number of days it is rented at fair rental

that year. See sec. 280A(d)(1) and (2)(A). Respondent contends that petitioners’

deductions relating to the Woodland Hills house are limited because their daughter

resided there.2 See sec. 280A(a), (c)(5). Petitioners, however, contend that they

are real estate developers and rented the Woodland Hills house to their daughter

because their homeowners policy required that the house be occupied. Petitioners,

in essence, contend that section 280A is inapplicable.

       Petitioners’ daughter’s use of the Woodland Hills house was personal and is

attributed to petitioners. See secs. 267(c)(4), 280A(d)(1) and (2)(A). Because

their daughter did not pay fair rental, they do not qualify for an exception to this




       2
       Respondent asserted this contention in his first amendment to answer and
accordingly has the burden of proof. See Rule 142(a). Respondent has, however,
met his burden.
                                        -6-

[*6] rule. See sec. 280A(d)(2)(C). Accordingly, deductions relating to the

Woodland Hills house are limited to the extent of rental income.3 See sec.

280A(c)(5).

      Respondent determined and established that petitioners are liable for a

section 6662(a) and (b)(1) accuracy-related penalty for negligence relating to

2008.4 Petitioners did not make a reasonable attempt to comply with the law or

maintain adequate books and records relating to their 2008 return. See sec.

6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. Indeed, Mr. Okonkwo and Mr.

Stiritz both readily acknowledged that the claimed mortgage interest deduction

relating to the Bel Air residence (i.e., the only item adjusted) was based on Mr.

Okonkwo’s estimate. Accordingly, we sustain respondent’s determination. See

sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. 438, 448-449 (2001).

      Petitioners’ understatements of income tax relating to 2009 and 2010

exceeded both 10% of the tax required to be shown on the returns and $5,000, and

thus, were substantial understatements. See sec. 6662(d)(1)(A). Petitioners were


      3
        Deductions disallowed pursuant to sec. 280A(c)(5) may be carried forward
to the succeeding taxable year. We need not determine whether petitioners’ losses
were passive pursuant to sec. 469. See sec. 469(j)(10).
      4
      Respondent bears, and has met, his burden of production relating to the
2008 sec. 6662(a) and (b)(1) accuracy-related penalty. See sec. 7491(c); Higbee v.
Commissioner, 116 T.C. 438, 446 (2001).
                                         -7-

[*7] also negligent relating to their 2009 and 2010 underpayments to the extent

attributable to itemized deductions, all of which were based on Mr. Okonkwo’s

erroneous estimates.5 See sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.

Petitioners, however, reasonably relied on Mr. Stiritz’ advice regarding whether

their 2009 and 2010 deductions relating to the Woodland Hills house were limited

by section 280A. Mr. Stiritz, a C.P.A. with real estate investment experience, was

aware that during 2009 and 2010 petitioners’ daughter resided in the Woodland

Hills house and did not pay petitioners fair rental. Petitioners, in good faith, relied

on his judgment that expenses relating to the house were fully deductible.

Accordingly, they are not liable for section 6662(a) accuracy-related penalties

relating to the portions of the underpayments attributable to respondent’s section

280A determinations. See sec. 6664(c)(1); Neonatology Assocs., P.A. v.

Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002); sec.

1.6664-4(c), Income Tax Regs. Petitioners are, however, liable for section

6662(a) accuracy-related penalties relating to the portions of the underpayments

attributable to erroneously claimed itemized deductions. See sec. 6662(c); sec.

1.6662-3(b)(1), Income Tax Regs.

      5
      Respondent has met his burden of production, and petitioners bear the
burden of proving a defense to the penalties. See sec. 7491(c); Higbee v.
Commissioner, 116 T.C. at 446-447.
                                      -8-

[*8] Contentions we have not addressed are irrelevant, moot, or meritless.

      To reflect the foregoing,


                                                  Decision will be entered

                                            under Rule 155.
