                               T.C. Memo. 2018-108



                         UNITED STATES TAX COURT



      MARK E. BALOCCO AND PATRICIA A. BALOCCO, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket Nos. 15577-16, 2551-17.                Filed July 9, 2018.



      Sandeep Singh and Cliff Capdevielle, for petitioners.

      Victoria Z. Gu and Jason T. Scott, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      KERRIGAN, Judge: In these consolidated cases, respondent determined

the following deficiencies and penalties with respect to petitioners’ Federal

income tax for tax years 2013-15:
                                         -2-

[*2]                                                Penalty
                  Year          Deficiency        sec. 6662(a)
                  2013            $10,253            $2,050
                  2014             19,221             3,844
                  2015             12,608             2,521

Unless otherwise indicated all section references are to the Internal Revenue Code

(Code) in effect for the years at issue, and all Rule references are to the Tax Court

Rules of Practice and Procedure.

        After concessions there are two remaining issues for consideration:

(1) whether petitioners are entitled to deduct various expenses reported on their

Schedules C, Profit or Loss From Business, for tax years 2013 and 2014 and

(2) whether petitioners are entitled to a deduction for the rental real estate loss

they reported on their Schedule E, Supplemental Income and Loss, for tax year

2014.

                                FINDINGS OF FACT

        Some of the facts are stipulated and are so found. Petitioners resided in

California when they timely filed their petitions.

Petitioner Husband

        During the tax years at issue petitioner husband worked as an operations

manager at Criterion Catalysts, a subsidiary of Royal Dutch Shell, Inc. He had
                                         -3-

[*3] transitioned to that role in 2013 and begun working between 60 and 70 hours

a week.

      Petitioner husband owned a Cessna A185F airplane during the tax years at

issue. He has been flying airplanes since 1981.

      In 2011 petitioner husband started a business with his brother. The purpose

of the business was to purchase and flip homes after making renovations. The

brothers set up their business as a limited liability company, Balocco Properties,

LLC, in 2015. Before petitioner husband started the business with his brother,

petitioners had flipped a home in 2004, petitioner husband had assisted his parents

in flipping a home,1 and he and his brother had flipped a home on behalf of their

parents.2

      Petitioner husband’s parents created the Balocco Family Trust (Trust) in

2008. In January 2011 petitioner husband and his brother became acting trustees

for the Trust. The Trust became irrevocable in January 2013. On April 17, 2012,

the Trust bought a home in Brentwood, California. The Trust also sold this home




      1
      Petitioner husband’s parents’ names are on documents pertaining to the
purchase and sale.
      2
          Petitioner husband’s parents’ names are on the purchase agreement.
                                         -4-

[*4] in 2012. At the time of the sale the Trust was still a revocable trust which

paid income to petitioner husband’s mother.

      In 2013 petitioner husband looked at several homes, but he and his brother

did not purchase any. All of the homes were in the Sacramento, California, area,

and a real estate agent assisted in finding the properties. Petitioner husband would

use his airplane to travel to the properties. He did not provide a flight log

regarding this travel for 2013.

      Petitioner husband lived a driving distance of approximately two to three

hours from the Sacramento area. Flight time to the Sacramento area was 30

minutes. Usually petitioner husband would travel via airplane by himself to look

at properties, and he would either rent a car or arrange to be picked up from the

airport. Petitioner husband’s brother did not fly with him and did not use the

airplane.

      In 2014 petitioner husband continued to look for properties to purchase in

the Sacramento area. He used a real estate agent different from the one engaged in

2013. Petitioner husband also looked at properties in Bend, Oregon, but made no

offers on any properties. He also looked at properties in the Minden, Nevada, area

but did not make any offers. In 2014 petitioner husband and his brother did not

purchase or sell any properties.
                                           -5-

[*5] In 2014 petitioner husband used his airplane to travel to properties in

California, Oregon, and Nevada. The drive from his home to Minden, Nevada,

was approximately four hours, and the flying time was approximately 80 minutes.

Petitioner husband maintained a flight log for 2014 which included personal

travel.

Schedules C

          For tax years 2013 and 2014 petitioners reported no gross receipts on their

Schedules C for petitioner husband’s investment management business. On their

Schedules C petitioners claimed deductions for the following:

          Deduction                    Tax year 2013            Tax year 2014

Depreciation and sec. 179
 expense deduction                        $12,920                  $22,887

Insurance (other than health)               1,874                     2,099

Interest (other)                            3,361                     3,618

Repairs and maintenance                    11,053                     8,594

Taxes and licenses                          1,411                     1,320

Aviation fuel                               1,226                     1,714

Hangar airport                               -0-                        709

 Total                                     31,845                    40,941
                                        -6-

[*6] Petitioners’ Rental Properties

      During tax years 2013 and 2014 petitioner wife was a licensed real estate

agent. She has been in the real estate industry since 2001. Petitioners owned two

rental properties in 2014 on Isabella Court (Isabella property) and Asini Court

(Asini property) in Sparks, Nevada (Sparks). The Isabella property was purchased

in October 2014, and the Asini property was purchased in November 2014. A real

estate agent in Sparks helped them find properties and, once the properties were

purchased, individuals to rent the properties.

      Petitioner husband flew to Sparks several times to look at real estate before

the purchases of the two properties. Petitioner wife flew with him two or three

times, but she preferred to drive. Petitioner hired landscapers to work on the

properties. Service providers were hired to provide window coverings for both

properties.

      Petitioners rented the Isabella property on December 1, 2014. They

reported rental income of $2,500 for the Isabella property on their Schedule E for

tax year 2014. The Asini property was not rented until 2015, and they reported no

rental income for the Asini property on their Schedule E for tax year 2014.

      On their Schedule E for tax year 2014 petitioners reported losses for both

properties totaling $17,588. Petitioners did not attach a statement to their 2014 tax
                                          -7-

[*7] return electing to treat all real estate as one rental real estate activity. They

did not file an amended tax return for 2014.

      Both petitioners had real estate logbooks. Petitioner husband’s logbook

pertained to the Isabella and Asini properties. Petitioner wife’s logbook included

additional properties. She prepared her logbook in preparation for trial.

                                       OPINION

I.    Burden of Proof

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

presumed correct, and a taxpayer bears the burden of proving those determinations

are erroneous. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). In

order to shift the burden the taxpayer must comply with all substantiation and

recordkeeping requirements and cooperate with all reasonable requests by the

Commissioner for witnesses, information, documents, meetings, and interviews,

pursuant to section 7491(a)(2). See Higbee v. Commissioner, 116 T.C. 438, 441

(2001). Petitioners did not argue that the burden should shift, and they failed to

introduce credible evidence that respondent’s determinations are incorrect.
                                         -8-

[*8] II.     Schedule C Expenses

       Section 162(a) allows a taxpayer to deduct all ordinary and necessary

expenses paid or incurred in carrying on a trade or business. Except as provided

in section 183, no deduction is allowed for an expense incurred in connection with

an activity that is not engaged in for profit. See sec. 183(a); sec. 1.183-2(a),

Income Tax Regs. An ordinary expense is one that commonly or frequently

occurs in the taxpayer’s business, Deputy v. du Pont, 308 U.S. 488, 495 (1940),

and a necessary expense is one that is appropriate and helpful in carrying on the

taxpayer’s business, Welch v. Helvering, 290 U.S. at 113. The expense must

directly connect with or pertain to the taxpayer’s business. Sec. 1.162-1(a),

Income Tax Regs. A taxpayer may not deduct a personal, living, or family

expense unless the Code expressly provides otherwise. Sec. 262(a).

       Whether an expenditure is ordinary and necessary is generally a question of

fact. Commissioner v. Heininger, 320 U.S. 467, 475 (1943). A taxpayer must

show a bona fide business purpose for the expenditure; there must also be a

proximate relationship between the expenditure and his or her business.

Challenge Mfg. Co. v. Commissioner, 37 T.C. 650 (1962); see also Heinbockel v.

Commissioner, T.C. Memo. 2013-125. In general, where an expense is primarily

associated with profit-motivated purposes and personal benefit can be said to be
                                        -9-

[*9] distinctly secondary and incidental, it may be deducted under section 162(a).

Int’l Artists, Ltd. v. Commissioner, 55 T.C. 94, 104 (1970); see also G.D. Parker,

Inc. v. Commissioner, T.C. Memo. 2012-327. Conversely, if an expense is

primarily motivated by personal considerations, no deduction for it will be allowed

under section 162(a). Henry v. Commissioner, 36 T.C. 879, 884 (1961); see also

G.D. Parker, Inc. v. Commissioner, at *15. A taxpayer’s general statement that his

or her expenses were incurred in pursuit of a trade or business is not sufficient to

establish that the expenses had a reasonably direct relationship to any such trade or

business. Ferrer v. Commissioner, 50 T.C. 177, 185 (1968), aff’d per curiam, 409

F.2d 1359 (2d Cir. 1969); see also Adams v. Commissioner, T.C. Memo. 2013-92.

      Deductions are a matter of legislative grace, and a taxpayer must prove his

or her entitlement to a deduction. INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

Taxpayers are required to substantiate the expense underlying each claimed

deduction by maintaining records sufficient to establish the amount and to enable

the Commissioner to determine the correct tax liability. Sec. 6001; Higbee v.

Commissioner, 116 T.C. at 440.
                                        - 10 -

[*10] Normally, the Court may estimate the amount of a deductible expense if a

taxpayer establishes that an expense is deductible but is unable to substantiate the

precise amount. See Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir.

1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). This principle is

often referred to as the Cohan rule. See e.g., Estate of Reinke v. Commissioner,

46 F.3d 760, 764 (8th Cir. 1995), aff’g T.C. Memo. 1993-197.

      Certain expenses specified in section 274 are subject to strict substantiation

rules. No deductions under section 162 shall be allowed for “listed property” as

defined in section 280F(d)(4), “unless the taxpayer substantiates by adequate

records or by sufficient evidence corroborating the taxpayer’s own statement”.

Sec. 274(d) (flush language). Listed property includes passenger automobiles and

other property used for transportation, including airplanes. Sec. 280F(d)(4)(A)(i)

and (ii); sec. 1.280F-6(b)(2), Income Tax Regs.

      To meet these strict substantiation rules, a taxpayer must substantiate by

adequate records or by sufficient evidence corroborating the taxpayer’s own

statement (1) the amount, (2) the time and place of the travel or use, and (3) the

business purpose. Sec. 274(d). To substantiate by adequate records, the taxpayer

must provide (1) an account book, log, or similar record and (2) documentary

evidence, which together are sufficient to establish each element of an
                                       - 11 -

[*11] expenditure. Sec. 1.274-5T(c)(2)(i), Temporary Income Tax Regs., 50 Fed.

Reg. 46017 (Nov. 6, 1985). Documentary evidence includes receipts, paid bills, or

similar evidence. Sec. 1.274-5(c)(2)(iii), Income Tax Regs. To substantiate by

sufficient evidence corroborating the taxpayer’s own statement, the taxpayer must

establish each element by his or her own statement and by documentary evidence

or other direct evidence. Sec. 1.274-5T(c)(3)(i), Temporary Income Tax Regs., 50

Fed. Reg. 46020 (Nov. 6, 1985). To establish the business purpose of an

expenditure, however, a taxpayer may corroborate his or her own statement with

circumstantial evidence. Id.

      Respondent contends that the expenses reported on petitioners’ Schedules C

are for the maintenance of petitioner husband’s airplane and that these expenses

are not ordinary and necessary and were not substantiated. Petitioners contend

that petitioner husband’s business was a trade or business pursuant to section 162

and not an activity not engaged in for profit pursuant to section 183 and that the

expenses were ordinary and necessary. Since we conclude that the deductions are

not allowable as ordinary and necessary and were not substantiated, we do not

need to determine whether petitioner husband’s Schedule C business was a trade

or business within the meaning of section 162 or an activity not engaged in for

profit pursuant to section 183.
                                       - 12 -

[*12] All of petitioners’ Schedule C deductions for tax years 2013 and 2014 were

attributable to petitioner husband’s airplane. We first determine whether the

deductions are ordinary and necessary. These deductions included depreciation of

the airplane. The authority for deducting an allowance for depreciation is section

168, and therefore it is not treated as trade or business expense. Noyce v.

Commissioner, 97 T.C. 670, 688 (1991). We will not include the depreciation of

the airplane for our determination of whether the Schedule C expenses are both

reasonable and ordinary and necessary.

      Only petitioner husband used the airplane; his brother did not. During tax

years 2013 and 2014 petitioner husband and his brother purchased no investment

properties. Petitioners reported no gross receipts for petitioner husband’s

Schedule C business for tax years 2013 and 2014.

      Petitioner husband used his airplane to fly to locations that he could have

driven to or flown to commercially. All of the properties that petitioner husband

testified he looked at in 2013 were in the Sacramento area. He testified that he

used the airplane in 2014 to fly to Sparks. These trips to Sparks were included in

his flight log for 2014. They were not business trips because they pertain to the

real estate that he purchased with his wife and therefore were not for his Schedule

C business.
                                       - 13 -

[*13] For an expense to be considered ordinary and necessary, it must also be

reasonable. Noyce v. Commissioner, 97 T.C. at 687; sec. 1.162-2(a) Income Tax

Regs. There is no evidence to support petitioner husband’s claim that use of the

airplane was reasonable. Petitioners deducted $18,925 and $18,054 for expenses

related to the airplane for tax years 2013 and 2014, respectively.

      He did not show that maintaining and flying his own airplane provided any

cost savings or was necessary for his business. He contends that he needed to fly

because of a busy schedule. However, he provided no evidence to show that he

would have been unable to look at a property without flying. There is also no

evidence to support the necessity of using the airplane for the success of his

business.

      Even if the expenses were ordinary and necessary they would not be

deductible because they were not substantiated. Petitioner husband testified that

he visited numerous properties during 2013 and 2014. The properties visited in

2013 were all in the Sacramento area. He testified that he made offers on several

properties. According to his testimony only one offer was accepted in 2013, but

he withdrew the offer after an inspection of the property. However, he provided

no supporting documentation regarding any of the offers he made on properties.

He maintained no flight log for his airplane use in 2013.
                                         - 14 -

[*14] Petitioner husband kept a flight log only for 2014, and this log is

insufficient to meet the requirements of section 274(d). Some of the business trips

listed on the logs were visits to relatives. Others were described as business

related, but petitioner husband provided no documentation supporting the purpose

of these trips. Several of the trips pertained to the Spark real estate properties.

Petitioner and his wife owned the Spark properties. These properties were not

purchased on behalf of the business reported on the Schedule C.

      Petitioner husband’s testimony was inconsistent with the flights listed in the

flight log. For example, he testified that he flew to Citrus Heights, California, but

no trips to Citrus Heights were recorded in the log. Petitioners provided bank

records, copies of receipts, and maintenance records for the airplane. However,

these records provided no information as to how these expenses were related to the

airplane’s business use.

      Petitioners have not provided documentation supporting their claim that the

expenses reported on the Schedules C were business expenses. They acknowledge

that the airplane was for both personal and business use. They claimed 70% and

71% of the airplane’s use was for business in 2013 and 2014, respectively.

Petitioners provided no evidence supporting these calculations. They did not meet

the requirement of section 274(d), and therefore the expenses are not deductible.
                                        - 15 -

[*15] As for the depreciation of the airplane, section 274(d) also disallows any

deduction otherwise allowable under sections 167 and 168 with respect to any

listed property unless the taxpayer satisfies the substantiation requirements of that

section. See Weekend Warrior Trailers, Inc. v. Commissioner, T.C. Memo. 2011-

105, slip op. at 56. Since an airplane is listed property, the substantiation

requirements of section 274 need to be met in order to deduct the depreciation of

the airplane. See sec. 1.280F-6(b)(2), Income Tax Regs.

       As we discussed previously, petitioner husband did not keep a flight log for

2013 and there were discrepancies in the flight log for 2014. Petitioner husband

did not produce adequate records to show each element of the business use. See

sec. 1.274-5T(c)(2)(ii)(C)(1), Temporary Income Tax Regs., 50 Fed. Reg. 46018

(Nov. 6, 1985). We conclude that the requirements of section 274(d) for a

depreciation deduction were not met.

III.   Schedule E Real Estate Loss

       Taxpayers may deduct certain business and investment expenses under

section 162. However, if the taxpayer is an individual, section 469 generally

disallows any passive activity loss deduction for the taxable year and treats it as a

deduction or credit for the next taxable year. Sec. 469(a) and (b). A passive

activity loss is defined as the excess of the aggregate losses from all passive
                                         - 16 -

[*16] activities for the taxable year over the aggregate income from all passive

activities for that year. Sec. 469(d)(1). A passive activity is any trade or business

in which the taxpayer does not materially participate. Sec. 469(c)(1). A taxpayer

is treated as materially participating in an activity only if his or her involvement in

the operations of the activity is regular, continuous, and substantial. Sec.

469(h)(1)(A)-(C). Rental activity is generally treated as a per se passive activity

regardless of whether the taxpayer materially participates. Sec. 469(c)(2).

      Section 469(c)(7) provides an exception to the rule that a rental activity is

per se passive. The rental activities of a taxpayer in a real property trade or

business (a real estate professional) are not subject to the per se rule of section

469(c)(2). Sec. 469(c)(7)(A); see Kosonen v. Commissioner, T.C. Memo. 2000-

107, slip op. at 9; sec. 1.469-9(b)(6), (c)(1), Income Tax Regs. Rather, the rental

activities of a real estate professional are subject to the material participation

requirements of section 469(c)(1). See sec. 1.469-9(e)(1), Income Tax Regs.

      A taxpayer qualifies as a real estate professional if: (1) more than one-half

of the personal services performed in trades and businesses by the taxpayer during

the taxable year are performed in real property trades or businesses in which the

taxpayer materially participates and (2) the taxpayer performs more than 750 hours

of services during the taxable year in real property trades or businesses in which
                                         - 17 -

[*17] the taxpayer materially participates. Sec. 469(c)(7)(B)(i) and (ii). In case of

a joint return the above requirements are satisfied if and only if either spouse

separately satisfied these requirements. Sec. 469(c)(7)(B).

      A taxpayer is considered to have materially participated in an activity if one

of the seven tests listed in the regulations is satisfied. Sec. 1.469-5T(a),

Temporary Income Tax Regs., 53 Fed. Reg. 5725-5726 (Feb. 25, 1988). A

taxpayer may establish hours of participation by any reasonable means. Id. para.

(f)(4), 53 Fed. Reg. 5727. Contemporaneous daily reports are not required if the

taxpayer can establish participation by other reasonable means. Id. Reasonable

means includes “appointment books, calendars, or narrative summaries” that

identify the services performed and “the approximate number of hours spent

performing such services”. Id. We have noted previously that we are not required

to accept a postevent “ballpark guesstimate” or the unverified, undocumented

testimony of taxpayers. See, e.g., Moss v. Commissioner, 135 T.C. 365, 369

(2010); Lum v. Commissioner, T.C. Memo. 2012-103; Estate of Stangeland v.

Commissioner, T.C. Memo. 2010-185.

      Respondent concedes that petitioner wife met the first prong of the test to

qualify as a real estate professional because more than one-half of her personal

services were performed in a real property trade or business. Petitioners contend
                                          - 18 -

[*18] that petitioner wife met the 750-hour requirement. If a taxpayer is married,

activity by the taxpayer’s spouse counts in determining “material participation” by

the taxpayer. See sec. 469(h)(5); sec. 1.469-5T(f)(3), Temporary Income Tax

Regs., supra. Spousal attribution may not be used for the purpose of satisfying the

750-hour annual service requirement. See Oderio v. Commissioner, T.C. Memo.

2014-39, at *6.

      We need not determine whether petitioner wife was a real estate

professional for 2014. Even if she was, the material participation requirements for

rental real estate activity were not met. See sec. 1.469-9(e)(1), Income Tax Regs.

      A taxpayer’s material participation in a rental real estate activity is

considered separately with respect to each rental property unless the taxpayer

makes an election to treat all interests in rental real estate as a single rental real

estate activity. Sec. 469(c)(7)(A); sec. 1.469-9(e)(1), Income Tax Regs. A

taxpayer makes the election by “filing a statement with the taxpayer’s original

income tax return for the taxable year.” Sec. 1.469-9(g)(3), Income Tax Regs.

The statement must contain a declaration that the taxpayer is a qualifying taxpayer

for the taxable year and is making the election pursuant to section 469(c)(7)(A).

Id.
                                         - 19 -

[*19] Petitioners did not file with their 2014 income tax return an election to treat

their rental properties as a single rental real estate activity. Petitioners sought to

make a late election, but they did not file an amended income tax return for 2014

that included a statement requesting an election.3

      Pursuant to section 301.9100-3(a), Proced. & Admin. Regs., the

Commissioner may grant extensions of time to make the election under section

469(c)(7)(A). To make a late election a taxpayer must file an amended return and

mail it to the Internal Revenue Service Center where the taxpayer will file its

current year tax return and attach the declaration required under section 1.469-

9(g)(3), Income Tax Regs. Rev. Proc. 2011-34, 2011-24 I.R.B. 875. Petitioners

did not meet these requirements.

      Petitioners contend that they met the third of the seven tests for material

participation, which requires that the individual participate in the activity more

than 100 hours during the taxable year and that the individual’s participation in the

activity not be less than the participation of any other individual (including

individuals who are not owners of interests in the activity) for such year. Sec.

1.469-5T(a)(3), Temporary Income Tax Regs., supra. Petitioner wife testified that


      3
       Petitioners attempted to make this request in their pretrial memorandum,
during trial, and in their posttrial brief.
                                         - 20 -

[*20] she created a log in preparation for the trial and that the log was based on

her calendars and notes. These calendars and notes were not produced as

evidence.

      Petitioner wife contends that she spent 101 hours on rental real estate. Her

logbook includes entries for the Isabella property, the Asini property, and for both

properties. For the entries that include both properties, the time is not split

between the properties. Her logbook shows that she spent at least 26 hours on just

the Asini property. These hours cannot count towards the 100 hours for the

Isabella property. Petitioner wife’s logbook does not show 100 hours for the

Isabella property.

      Petitioner husband has a logbook, and these hours can be counted towards

the 100 hour requirement. He contends that he spent 98.5 hours on rental real

estate. He provided no supporting documents or any testimony about the creation

of his logbook. Several of his hours for the Isabella property are for hours

preceding petitioners’ ownership of the property. For work to count towards

material participation, the individual who does the work must own an interest in

the property at the time the work is done. Sec. 1.469-5(f)(1), Income Tax Regs.

We will look only at the hours after the Isabella property had been purchased.
                                         - 21 -

[*21] The entries in both petitioners’ logbooks for the Isabella property included

several entries for landscaping, including the moving of rocks. Petitioner wife

testified that a landscaper was hired for the property. The evidence does not show

that the landscaper performed fewer hours of service than petitioners. The entries

are vague and often list more than one activity without time allocation.

Petitioners’ estimates are uncorroborated and do not reliably reflect the hours that

they spent on real estate activities. See Bailey v. Commissioner, T.C. Memo.

2001-296, slip op. at 13. We conclude petitioners’ loss deduction for 2014 with

respect to the Isabella property was properly disallowed.

        The log entries for the Asini property were vague and included activities

that preceded the purchase of the property. Several entries included work for both

properties without dividing up the time spent for each property. There is no

supporting documentation for the logbooks. The logs appear to be postevent

“ballpark guesstimates” which we are not required to accept.

        Even if we accept all of their after-purchase entries for the Asini property,

their combined hours do not reach 100 hours. Petitioners have not met their

burden of proving that they materially participated in the Asini property activity.

Their loss deductions with respect to the Asini property are disallowed for tax year

2014.
                                      - 22 -

[*22] We have considered all of the arguments made by the parties, and to the

extent we did not mention them above, we conclude that they are moot, irrelevant,

or without merit.

      To reflect the foregoing,


                                               Decisions will be entered

                                     under Rule 155.
