                        T.C. Summary Opinion 2015-61



                        UNITED STATES TAX COURT



    RICHARD IRWIN WIDEMAN AND KRISTINA NOVAK, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 23018-12S.                       Filed October 5, 2015.



      Richard Irwin Wideman, pro se.

      Richard Irwin Wideman (specially recognized), for petitioner Kristina

Novak.

      Sarah A. Herson, for respondent.



                             SUMMARY OPINION


      CARLUZZO, Special Trial Judge: This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect when the
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petition was filed.1 Pursuant to section 7463(b), the decision to be entered is not

reviewable by any other court, and this opinion shall not be treated as precedent

for any other case.

      In a notice of deficiency dated June 13, 2012 (notice), respondent

determined a $3,731 deficiency in petitioners’ 2009 Federal income tax and

imposed a $746 section 6662(a) accuracy-related penalty. After concessions,2 the

issues for decision are whether petitioners: (1) are entitled to a deduction in

excess of the amount respondent allowed for telephone expenses; (2) are entitled

to a deduction for miscellaneous expenses; (3) are entitled to a casualty loss

deduction; and (4) are liable for a section 6662(a) accuracy-related penalty.




      1
        Unless otherwise indicated, subsequent section references are to the
Internal Revenue Code of 1986, as amended, in effect for 2009. Rule references
are to the Tax Court Rules of Practice and Procedure.
      2
        The parties now agree that: (1) petitioners are not required to include
$13,056 in the income reported on the Schedule C, Profit or Loss From Business,
included with their 2009 Federal income tax return; (2) $1,984 of interest is not
includable in petitioners’ income; (3) petitioners’ income is increased by $3,468
(omitted wage income--respondent concedes that petitioners are entitled to a
withholding credit of $19 related to this item); and (4) petitioners are entitled to a
$1,700 deduction for office expenses in excess of the amount allowed in the
notice.
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                                    Background

      Some of the facts have been stipulated and are so found. At all times

relevant, petitioners were married to each other. At the time the petition was filed,

they resided in California.

      Mr. Wideman (petitioner) is an attorney. He has been licensed to practice in

California since 1967 but is not admitted to practice before this Court. Before the

year in issue petitioner taught at the University of Virginia School of Law and the

Washington and Lee School of Law.

      In 2006 petitioners purchased a 10-acre parcel of land in Santa Ynez,

California, on which they built their residence and various other structures. These

structures include three barns and a horse riding arena (riding arena) used in a

horse boarding and sales business operated by Santa Ynez Valley View Farm,

LLC (Farm), a California limited liability company which petitioners formed in

2007 and, at all times relevant, wholly owned. Farm is treated as a partnership for

Federal taxation purposes; its 2009 Form 1065, U.S. Return of Partnership

Income, shows an ordinary business loss of $96,127, which is taken into account

in the negative $55,966 “adjusted gross income” reported on petitioners’ 2009

joint Federal income tax return (return). The Form 1065 includes a depreciation

schedule which shows that a deduction for depreciation on the riding arena is
                                         -4-

taken into account in the loss reported on that return. The income reported and the

deductions claimed on the Form 1065 are computed using the cash receipts and

disbursements method of accounting (cash method).

      Construction of the riding arena began in the middle of 2006 and was

completed in early 2007. The depreciation schedule attached to the Form 1065

suggests that the initial cost of the riding arena was $150,000. The riding arena is

a complicated structure, and proper construction was required to ensure the safety

of the horses and riders that used it. As it turned out, defects in the construction of

the riding arena required petitioners to expend more than $100,000 in 2007 and

2008 in order to remedy the defects. Petitioners sued the original contractor for

the defective construction and in 2009 settled the lawsuit for a payment of

$50,000.

      During 2009 petitioner conducted his law practice from an office in his

residence (home office). According to petitioner, the home office was shared with

Ms. Novak, who is a licensed real estate agent. Petitioners did not report any

earnings from, or claim any deductions attributable to, Ms. Novak’s real estate

activity on their return. Petitioners reported income and claimed deductions

attributable to petitioner’s law practice on a Schedule C included with petitioners’

return, which was prepared by a certified public accountant. Petitioners deducted
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various expenses related to petitioner’s law practice on that Schedule C, including

a $12,698 deduction for “other expenses”, consisting, in part, of telephone

expenses that total $7,962 and $25 identified as “miscellaneous” expenses. The

telephone expenses include charges for three cellular telephone lines, two land

telephone lines (one servicing petitioners’ residence and the other servicing one of

the barns), and Internet service. The income reported and deductions claimed on

the Schedule C are computed under the cash method.

      Petitioners’ return also includes a Schedule A, Itemized Deductions, on

which petitioners claimed a $69,100 casualty loss deduction.

      In the notice respondent, among other things: (1) disallowed half of the

deduction for telephone expenses and the entire deduction for miscellaneous

expenses claimed on the Schedule C; (2) disallowed the casualty loss deduction

claimed on the Schedule A; and (3) imposed a section 6662(a) accuracy-related

penalty. According to the notice, respondent disallowed the deductions claimed

on the Schedule C because petitioners failed to establish that the underlying

expenses were ordinary and necessary trade or business expenses and/or because

petitioners failed to substantiate the amount paid or incurred for each expense.

Respondent disallowed the casualty loss deduction petitioners claimed on the

Schedule A because petitioners “did not establish that (a) a casualty or theft
                                        -6-

occurred, and (b) any loss was sustained”. Respondent also imposed a section

6662(a) accuracy-related penalty for “negligence or disregard of rules or

regulations.” Other adjustments made in the notice are computational or have

been resolved by the parties and will not be discussed.

                                     Discussion

      As we have observed in countless opinions, deductions are a matter of

legislative grace, and the taxpayer bears the burden of proof to establish

entitlement to any claimed deduction.3 Rule 142(a); INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292

U.S. 435, 440 (1934). This burden requires the taxpayer to substantiate expenses

for deductions claimed by keeping and producing adequate records that enable the

Commissioner to determine the taxpayer’s correct tax liability. Sec. 6001;

Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975), aff’d per curiam, 540 F.2d

821 (5th Cir. 1976); Meneguzzo v. Commissioner, 43 T.C. 824, 831-832 (1965).

A taxpayer claiming a deduction on a Federal income tax return must demonstrate

that the deduction is allowable pursuant to some statutory provision and must

further substantiate that the expense to which the deduction relates has been paid

      3
       Petitioners do not claim and the record does not otherwise demonstrate that
the provisions of sec. 7491(a) are applicable here, and we proceed as though they
are not.
                                         -7-

or incurred. See sec. 6001; Hradesky v. Commissioner, 65 T.C. at 89-90; sec.

1.6001-1(a), Income Tax Regs.

I. Schedule C Deductions

      Taxpayers may deduct ordinary and necessary expenses paid or incurred in

connection with operating a trade or business. Sec. 162(a); Boyd v.

Commissioner, 122 T.C. 305, 313 (2004). Petitioners claimed various deductions

on the Schedule C for petitioner’s law practice; some have been allowed and some

disallowed. The parties now dispute only respondent’s disallowances of one-half

of the telephone expenses and the entire amount of miscellaneous expenses.

      A. Telephone Expenses

      According to petitioners, the telephone expenses relate to the five telephone

lines described above. More specifically, petitioners attribute one cellular

telephone line to Ms. Novak’s business, two cellular telephone lines to petitioner’s

law practice, one landline telephone to the home office, and the other landline

telephone to Farm. The record does not allow for a particular phone service/line

to be identified with a particular activity or location. It does not appear that

petitioners subscribed to any other telephone services during 2009.

      All of the telephone expenses are included in a deduction claimed on the

Schedule C for petitioner’s law practice. This is fundamentally wrong. In general,
                                         -8-

if otherwise deductible as a trade or business expense, the expense is deductible by

the taxpayer who operates/owns the trade or business. Cf. Deputy v. DuPont, 308

U.S. 488, 494 (1940). At least two of the telephone services had nothing to do

with petitioner’s law practice. If it was otherwise deductible, whichever telephone

service expense was attributable to the trade or business of Farm should have been

shown as a deduction on the Form 1065.4 Furthermore, because there is no

showing that Ms. Novak was actively conducting any trade or business during

2009, whichever telephone service expense is attributable to her must be

considered a nondeductible personal expense. See sec. 262(a). Moreover, since

there is no showing that petitioners’ residence was serviced by a telephone service

other than the one identified with petitioner’s home office, the cost of at least one

of the two landlines is also treated as a nondeductible personal expense even if

that landline was used in the home office. See sec. 262(b).

      We do not share petitioners’ view that respondent “arbitrarily” disallowed

one-half of the telephone expense deduction. Instead, in the absence of specific

information showing which telephone service and how much of the charges should

be allocated to which petitioner or location, we find that petitioners have failed to

      4
      Petitioners’ argument that it made no difference where Farm’s telephone
expense was deducted is rejected if only because of the effect the deduction would
have on petitioner’s sec. 1401 tax (tax on self-employment income).
                                         -9-

show that they are entitled to a deduction for telephone expenses in excess of the

amount respondent allowed.

      B. Miscellaneous Expenses

      Petitioners offered no explanation for the $25 deduction for miscellaneous

expenses shown on the Schedule C. An unexplained expense is hardly deductible.

Accordingly, respondent’s disallowance of petitioners’ claimed deduction for

miscellaneous expenses is sustained.

II. Loss Deduction

      According to petitioners, the additional expenditures to correct the defects

in the riding arena equate to a loss for which they5 are entitled to a deduction. On

their return petitioners characterized the loss as a casualty loss and claimed a

$69,1006 deduction for it on the Schedule A. As noted, this deduction is

disallowed in the notice. At trial petitioners, to some extent, retreated from the

position taken on their return and alternatively argued that they are entitled to a



      5
       Although we see it differently, for the sake of simplicity, we will go along
with petitioners’ suggestion that it matters not whether the loss, if otherwise
deductible, should be claimed as a deduction on Farm’s Form 1065 or in some
manner or another on their return.
      6
        It is unclear exactly how this amount was computed. We expect that it
takes into account the expenditures paid to correct the defective construction and
the $50,000 recovered from the original contractor.
                                              - 10 -

$69,100 deduction for a loss sustained in a trade or business. We address

petitioners’ entitlement to a loss deduction under either theory.

          A. Casualty Loss

          Section 165(a) allows as a deduction any loss sustained during a taxable

year and not compensated for by insurance or otherwise. Section 165(c) limits the

allowance of losses in the case of individuals.7 Subject to certain limitations,

section 165(c)(3) provides that an individual is entitled to a deduction for the loss

of property not connected with a trade or business or a transaction entered into for

profit if the loss results from “fire, storm, shipwreck, or other casualty, or from

theft.”

          Respondent argues, and we agree, that no event occurred that would qualify

as a “casualty” as that term is used in section 165(c)(3). As we have noted: “In

numerous cases the courts have stated the term ‘other casualty’ must be restricted

to mean events of the same kind or the same characteristics as those specifically

enumerated in the statute. The casualties enumerated are unusual, and unexpected

events * * * caused by a sudden or destructive force.” Daugette v. Commissioner,

T.C. Memo. 1977-56. Expenses paid or incurred to correct damage caused by

faulty construction methods are not deductible as a casualty loss. See, e.g.,

          7
              The provisions of sec. 165(c) also apply to partnerships. See sec. 703(a).
                                        - 11 -

Matheson v. Commissioner, 18 B.T.A. 674 (1930), aff’d, 54 F.2d 537 (2d Cir.

1931); see also Portman v. United States, 683 F.2d 1280, 1281 (9th Cir. 1982);

McDaniel v. Commissioner, T.C. Memo. 1980-557; Berry v. Commissioner, T.C.

Memo. 1969-162.8

      In this case the defective construction allowed sinkholes to form in the

riding arena that made it unsafe for use; there was no independent, sudden, or

unexpected event that caused the damage to the property. Accordingly, petitioners

are not entitled to a casualty loss deduction for the extra expenditures paid to

correct the defects in the original construction of the riding arena.

      B. Property Loss Incurred in a Trade or Business

      Section 165(c)(1) and (2) allows for the deduction of a loss incurred in a

trade or business or a transaction entered into for profit. For a taxpayer to be

allowed a deduction under section 165(a), a loss must be evidenced by closed and

completed transactions, fixed by identifiable events, and actually sustained during

the taxable year. Sec. 1.165-1(b), Income Tax Regs. In general, to be entitled to a

      8
        We are aware that deductions for casualty losses have been allowed in
faulty construction cases if there has been a subsequent, unexpected event apart
from the faulty construction. See Hayutin v. Commissioner, T.C. Memo. 1972-
127 (finding flood damage proximately caused not by faulty construction of
taxpayer’s home but by plumber stepping on unprotected pipe), aff’d, 508 F.2d
462 (10th Cir. 1974). That is not the situation here.
                                        - 12 -

deduction for the loss of a business asset, the taxpayer must either sell the asset or,

if its usefulness in the business has been destroyed and it is not sold, must

permanently discard it from use in the business. Abrams v. Commissioner, T.C.

Memo. 1981-231. A loss deduction is generally not permitted where there is a

mere shrinkage in value; rather, there must be a complete elimination of all value

plus a recognition by the owner that his property no longer has any utility to him

by means of a specific act proving his abandonment of all interest in it. Id.; see

New York Sun, Inc. v. Commissioner, 27 T.C. 319, 328 (1956), aff’d, 253 F.2d

487 (2d Cir. 1958); sec. 1.167(a)-8, Income Tax Regs. The abandonment or

permanent withdrawal constitutes the “closed and completed transaction, fixed by

identifiable events” required as a prerequisite to deduction. Section 1.165-2(c),

Income Tax Regs., refers us to section 1.167(a)-8, Income Tax Regs., which

provides that withdrawal of depreciable property used in a trade or business may

be accomplished by several methods. Withdrawal may be accomplished by sale,

exchange, retirement, or “actual abandonment”. See Orozco v. Commissioner,

T.C. Memo. 1994-407, aff’d without published opinion, 67 F.3d 314 (11th Cir.

1995); sec. 1.167(a)-8, Income Tax Regs. It follows that a taxpayer may not

normally claim a loss deduction for mere damage to an asset which he continues to

use in his trade or business.
                                       - 13 -

      The riding arena was not sold, abandoned, or permanently withdrawn from

use during 2009. Accordingly, petitioners are not entitled to the loss deduction

here in dispute.9

III. Section 6662(a) Accuracy-Related Penalty

      Lastly, we consider whether petitioners are liable for a section 6662(a)

accuracy-related penalty.

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

“an underpayment of tax required to be shown on a return” if the underpayment is

due to negligence or to one or more of the other reasons listed in subsection (b).

Respondent bears the burden of production with respect to the imposition of a

section 6662(a) accuracy-related penalty. See sec. 7491(c). The section 6662(a)

accuracy-related penalty does not apply to any portion of an underpayment as to

which there was reasonable cause and the taxpayer acted in good faith. Sec.

6664(c)(1); sec. 1.6664-4(b)(1), Income Tax Regs.

      9
        Petitioners’ argument that the expenditures should be treated as currently
deductible repairs is also unavailing. First, as cash basis taxpayers, neither
petitioners nor Farm would be entitled to the deduction for 2009 because the
expenditures were made in prior years. Second, as respondent suggests, the
expenditures should be treated as capital, which would increase petitioners’ basis
in the asset. See sec. 263; Jenkins v. Commissioner, T.C. Memo. 1982-407; see
also Driscoll v. Commissioner, 147 F.2d 493 (5th Cir. 1945), aff’g in part, rev’g in
part a Memorandum Opinion of this Court; sec. 1.263(a)-1(a)(1), Income Tax
Regs.
                                        - 14 -

      According to respondent, petitioners are liable for a section 6662(a) penalty

on the entire underpayment (which, in this case, equals the deficiency) upon the

ground of negligence. In his pretrial memorandum respondent argues that

petitioners “have failed to present respondent with sufficient information or

documentation to substantiate reasonable cause or show that the understatement of

tax for the 2009 tax year was not the result of negligence or disregard of rules of

regulations.” Respondent’s pretrial memorandum goes on to acknowledge his

burden of production under section 7491(c) and argues that his burden has been

satisfied because petitioners “have not complied with all substantiation

requirements or maintained all records under the Code”.

      We are mindful that the failure to keep adequate records to substantiate

expenses underlying claimed deductions can support the imposition of the section

6662(a) accuracy-related penalty on the ground of negligence, see sec. 1.6662-

3(b)(1), Income Tax Regs., but, for the most part, we agree with respondent only

with respect to those adjustments petitioners conceded. With the exception of the

deduction for miscellaneous expenses, the disallowances of the deductions

addressed in this opinion are based upon technical reasons rather than lack of

substantiation. We can envision a case where the mere disallowance of a

deduction on a technical ground, in and of itself, could give rise to the taxpayer’s
                                         - 15 -

liability for a negligence penalty, but this is not that case. Petitioners are liable for

a section 6662(a) penalty, but only with respect to the underpayment of tax

attributable to: (1) the adjustments they otherwise conceded and (2) the

disallowance of the deduction for miscellaneous expenses.

      To reflect the foregoing,


                                                  Decision will be entered

                                         under Rule 155.
