                                T.C. Memo. 2014-19



                         UNITED STATES TAX COURT



                    FIELDS CURTIS, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 7432-12.                         Filed January 28, 2014.



      Fields Curtis, pro se.

      Timothy R. Berry, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      MARVEL, Judge: Respondent determined a deficiency in petitioner’s

Federal income tax of $80,319, an addition to tax under section 6651(a)(1)1 of


      1
       Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the year in issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure. Monetary amounts have been
                                                                        (continued...)
                                          -2-

[*2] $20,118, and an accuracy-related penalty under section 6662(a) of $16,064

for 2007. After concessions,2 the issues for decision are: (1) whether petitioner

had unreported capital gain of $432,350 from the involuntary conversion of

residential real property for 2007; (2) whether petitioner is entitled to a real estate

loss of $25,000 for 2007; (3) whether petitioner is liable for an addition to tax

under section 6651(a)(1) for 2007; and (4) whether petitioner is liable for an

accuracy-related penalty under section 6662(a) for 2007.

                                 FINDINGS OF FACT

      Some of the facts have been stipulated. The stipulations of facts are

incorporated herein by this reference. When he petitioned this Court, petitioner

resided in California.

Petitioner’s Residential Apartment Building

      In 1991 petitioner purchased a residential apartment building for $82,500.

The apartment building had 11 private rooms, shared kitchens and bathrooms, and

a total living area of 3,306 square feet. Petitioner resided in one room of the

apartment building with a total living area of 165 square feet.


      1
      (...continued)
rounded to the nearest dollar.
      2
      Respondent concedes that petitioner purchased the apartment building for
$82,500.
                                        -3-

[*3] Condemnation Proceedings

      In June 2006 the Los Angeles Unified School District initiated an eminent

domain proceeding against petitioner in the Superior Court of California, County

of Los Angeles, to acquire the apartment building. On or about July 19, 2006, (1)

the school district deposited $610,000 into an account for petitioner as probable

compensation for the taking of the apartment building,3 and (2) the superior court

issued an order authorizing the school district to take possession of the apartment

building on October 25, 2006. On October 24, 2007, the superior court entered a

judgment in condemnation providing for the sale of the apartment building to the

school district for $720,000. Petitioner did not purchase replacement property

within the meaning of section 1033.

Petitioner’s Income Tax Reporting

      Petitioner did not receive an extension of time to file his 2007 Federal

income tax return. Petitioner filed a Form 1040, U.S. Individual Income Tax

Return, for 2007 on October 13, 2008. Petitioner filed a Form 1040X, Amended

U.S. Individual Income Tax Return (2007 amended return), for 2007 dated August


      3
        The superior court authorized the payment of this amount to petitioner on
or about December 5, 2006. Neither party has raised the issue of whether
petitioner should have reported this amount as income for 2006. Accordingly, we
will not address this issue.
                                          -4-

[*4] 23, 2010.4 On his 2007 amended return petitioner reported taxable income

and total tax of $9,781 and $1,075, respectively. On a Form 4797, Sales of

Business Property, attached to his 2007 amended return petitioner reported total

gain of $43,531 from the involuntary conversion of the apartment building. The

Form 4797 calculated petitioner’s total gain as follows:

                 Gross sales price                             $720,000

                 Cost or other basis plus expense of sale       770,687
                 Depreciation                                    94,218
                  Adjusted basis                                676,469
                  Total gain                                     43,531

On a worksheet attached to petitioner’s 2007 amended return petitioner calculated

his basis before depreciation in the apartment building as follows:

                                                 Regular tax      AMT

               Original cost or other basis       $241,127       $241,127
               Improvements and restorations       461,504        461,504
               Expense of sale                      68,056         68,056
                Basis before depreciation          770,687        770,687

Additionally, on a Schedule E, Supplemental Income and Loss, attached to his

2007 amended return petitioner reported rents received and a deductible rental real

estate loss of zero and $25,000, respectively.




      4
          Petitioner hired a paid preparer to prepare his 2007 amended return.
                                        -5-

[*5]                                 OPINION

I.     Burden of Proof

       Generally, the Commissioner’s determination of a deficiency is presumed

correct, and the taxpayer bears the burden of proving that the determination is

improper. See Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). If,

however, a taxpayer produces credible evidence5 with respect to any factual issue

relevant to ascertaining the taxpayer’s liability for any tax imposed by subtitle A

or B of the Code and satisfies the requirements of section 7491(a)(2), the burden

of proof on any such issue shifts to the Commissioner. Sec. 7491(a)(1). Section

7491(a)(2) requires a taxpayer to demonstrate that he (1) complied with

requirements under the Code to substantiate any item, (2) maintained all records

required under the Code, and (3) cooperated with reasonable requests by the

Secretary6 for witnesses, information, documents, meetings, and interviews. See

also Higbee v. Commissioner, 116 T.C. 438, 440-441 (2001).



       5
       “‘Credible evidence is the quality of evidence which, after critical analysis,
the court would find sufficient upon which to base a decision on the issue if no
contrary evidence were submitted (without regard to the judicial presumption of
IRS correctness).’” Higbee v. Commissioner, 116 T.C. 438, 442 (2001) (quoting
H.R. Conf. Rept. No. 105-599, at 240-241 (1998), 1998-3 C.B. 747, 994-995).
       6
       The term “Secretary” means the Secretary of the Treasury or his delegate.
Sec. 7701(a)(11)(B).
                                         -6-

[*6] Petitioner contends that the burden of proof should shift to respondent under

section 7491(a). However, the record shows that petitioner did not meet the

requirements of section 7491(a)(1) and (2). Accordingly, the burden of proof

remains on petitioner.

II.   Involuntary Conversion Income

      A.     Petitioner’s Gain From the Involuntary Conversion

      Gross income includes all income from whatever source derived, including

gains derived from dealings in property. See sec. 61(a)(3). Gain from the sale or

exchange of property must be recognized, unless the Code provides otherwise.

Sec. 1001(c). Section 1001(a) defines gain from the sale of property as the excess

of the amount realized on the sale of the property over the adjusted basis of the

property sold or exchanged. See also sec. 1.61-6(a), Income Tax Regs. The

amount realized is the sum of any money received plus the fair market value of

any other property received, reduced by the expenses of selling the property. See

sec. 1001(b); Chapin v. Commissioner, 12 T.C. 235, 238 (1949), aff’d, 180 F.2d

140 (8th Cir. 1950).

      Section 1011 provides that a taxpayer’s adjusted basis for determining the

gain or loss from the sale or other disposition of property shall be its cost, adjusted

to the extent provided in section 1016. See also sec. 1012. A property’s cost is
                                        -7-

[*7] “the amount paid for such property in cash or other property.” Sec.

1.1012-1(a), Income Tax Regs. The term “cost” includes “any indebtedness to the

seller for the purchase price of the property and any indebtedness to a third party

secured by the property”, as well as expenses a taxpayer incurs in acquiring the

property. Metrocorp, Inc. v. Commissioner, 116 T.C. 211, 242 (2001). The

taxpayer may increase his basis in the property even if he does not personally

assume the indebtedness. See Crane v. Commissioner, 331 U.S. 1, 11-12 (1947).

If a taxpayer places a mortgage on property he already owns, the mortgage

generally does not affect the basis of the property. See Woodsam Assocs., Inc. v.

Commissioner, 16 T.C. 649 (1951), aff’d, 198 F.2d 327 (2d Cir. 1952).

      Under section 1016(a)(1), the basis of property must be adjusted for

expenditures, receipts, losses, or other items properly chargeable to capital

account. The costs of improvements and betterments made to a taxpayer’s

property are among the items properly chargeable to capital account. See sec.

1.1016-2(a), Income Tax Regs. The taxpayer has the burden of proving the basis

of property for purposes of determining the amount of gain the taxpayer must

recognize. See O’Neill v. Commissioner, 271 F.2d 44, 50 (9th Cir. 1959), aff’g

T.C. Memo. 1957-193.
                                          -8-

[*8] The parties agree that the amount petitioner realized from the involuntary

conversion of the apartment building was $720,000. The parties disagree,

however, with respect to petitioner’s adjusted basis in the apartment building.

Respondent contends that petitioner had an adjusted basis in the apartment

building of $221,114.7 Petitioner contends that respondent’s basis calculation is

erroneous.

      The parties agree that petitioner purchased the apartment building for

$82,500. They appear to disagree, however, regarding the costs of various

improvements that petitioner made to the apartment building. Respondent

contends that petitioner paid improvement costs of $129,938. Petitioner offered

testimony regarding various improvements that he made to the apartment building

and several receipts and contracts for work on the property. However, taken

together, petitioner’s testimony and documentary evidence fail to persuasively

show that petitioner had a basis in the apartment building that is greater than the

basis that respondent allowed or has conceded. Accordingly, we sustain

respondent’s revised basis calculation.


      7
       Respondent’s brief erroneously computes petitioner’s basis as $221,364 but
also includes the correctly computed amount of $221,114. Respondent’s proposed
findings of fact state that petitioner’s basis in the apartment building is $220,718.
However, this lower amount appears to be the result of a transpositional error.
                                         -9-

[*9] B.      Section 1033

      Section 1033(a) provides that when property is compulsorily or

involuntarily converted no gain shall be recognized if within two years the

taxpayer purchases other property similar or related in service or use to the

condemned property. Section 1033(g) provides that when property held for

productive use in a trade or business or for investment is compulsorily or

involuntarily converted, property of a like kind to be similarly held shall be treated

as property similar or related in service to the property converted. If the

requirements of section 1033 are complied with, recognition of gain on the sale of

property is limited to the difference between the amount realized and the cost of

replacement property. Sec. 1033(a)(2)(A).

      The parties stipulated that petitioner did not purchase replacement property

for the apartment building within the meaning of section 1033. Accordingly, we

conclude that section 1033 does not exempt petitioner from recognizing the

amount realized from the involuntary conversion of the apartment building.

      C.     Section 121

      Section 121 provides for the exclusion from gross income of up to $250,000

of gain from the sale or exchange of property if the property was owned and used

by a taxpayer as the taxpayer’s principal residence for periods aggregating two
                                        - 10 -

[*10] years or more during the five-year period preceding the sale or exchange.

See sec. 121(a) and (b). If the taxpayer uses only a portion of the property as the

taxpayer’s principal residence, only the gain allocable to that portion is excludable

under section 121. See sec. 1.121-1(e)(1), Income Tax Regs.

       The parties stipulated that petitioner used only 165 of 3,306 square feet, or

close to 5%, of the apartment building as his personal residence. Respondent

allowed petitioner to exclude 5% of the gain from gross income. Petitioner has

not introduced any evidence or made any argument regarding whether any portion

of the gain attributable to the shared facilities of the apartment building should be

excluded under section 121. Accordingly, we conclude that petitioner is entitled

to exclude only 5% of the gain from the involuntary conversion of the apartment

building under section 121.

III.   Real Estate Loss

       Respondent disallowed petitioner’s claimed rental real estate loss of

$25,000. Generally, a taxpayer who is carrying on a trade or business may deduct

ordinary and necessary expenses incurred in connection with the operation of the

business. Sec. 162(a). On or about July 19, 2006, the superior court authorized

the school district to take possession of the apartment building on October 25,
                                        - 11 -

[*11] 2006, and we infer from the record that the school district did so.8

Additionally, petitioner reported rents received of zero for 2007. Accordingly, we

conclude that petitioner was not engaged in the trade or business of renting real

estate in 2007 and is therefore not entitled to deduct the claimed rental real estate

loss.

IV.     Addition to Tax and Penalty

        A.    Burden of Proof

        The Commissioner bears the burden of production with respect to a

taxpayer’s liability for additions to tax and penalties and must produce sufficient

evidence indicating that it is appropriate to impose the additions to tax or

penalties. See sec. 7491(c); Higbee v. Commissioner, 116 T.C. at 446-447. Once

the Commissioner carries the burden of production, the taxpayer must come

forward with persuasive evidence that the Commissioner’s determination is

incorrect or that the taxpayer had reasonable cause or substantial authority for the

position. See Higbee v. Commissioner, 116 T.C. at 447.




        8
      Petitioner does not claim that he owned any other rental property during
2006 or 2007.
                                         - 12 -

[*12] B.     Addition to Tax Under Section 6651(a)(1)

      Section 6651(a)(1) authorizes the imposition of an addition to tax for failure

to timely file a return, unless it is shown that such failure is due to reasonable

cause and not due to willful neglect. See United States v. Boyle, 469 U.S. 241,

245 (1985); United States v. Nordbrock, 38 F.3d 440, 444 (9th Cir. 1994). A

failure to timely file a Federal income tax return is due to reasonable cause if the

taxpayer exercised ordinary business care and prudence but nevertheless was

unable to file the return within the prescribed time. See sec. 301.6651-1(c)(1),

Proced. & Admin. Regs. Circumstances that are considered to constitute

reasonable cause for failure to timely file a return are typically those outside of the

taxpayer’s control, including, for example: (1) unavoidable postal delays; (2) the

timely filing of a return with the wrong office; (3) the death or serious illness of a

taxpayer or a member of the taxpayer’s immediate family; (4) a taxpayer’s

unavoidable absence from the United States; (5) destruction by casualty of a

taxpayer’s records or place of business; and (6) reliance on the erroneous advice of

an Internal Revenue Service officer or employee. McMahan v. Commissioner,

114 F.3d 366, 369 (2d Cir. 1997), aff’g T.C. Memo. 1995-547.

      The parties agree that petitioner failed to timely file a Federal income tax

return for 2007. Accordingly, respondent has carried his burden of producing
                                        - 13 -

[*13] evidence showing that an addition to tax under section 6651(a)(1) for 2007

is appropriate.

      Petitioner has failed to introduce evidence showing that he had reasonable

cause for failing to timely file a 2007 Federal income tax return. Accordingly, we

conclude that petitioner is liable for an addition to tax under section 6651(a)(1).

      C.     Accuracy-Related Penalty Under Section 6662(a)

      Section 6662(a) and (b)(1) and (2) authorizes the Commissioner to impose a

20% penalty on an underpayment of tax that is attributable to, among other things,

(1) negligence or disregard of rules or regulations or (2) any substantial

understatement of income tax. Only one section 6662 accuracy-related penalty

may be imposed with respect to any given portion of an underpayment. New

Phoenix Sunrise Corp. v. Commissioner, 132 T.C. 161, 187 (2009), aff’d, 408 Fed.

Appx. 908 (6th Cir. 2010); sec. 1.6662-2(c), Income Tax Regs.

      The term “negligence” includes any failure to make a reasonable attempt to

comply with the provisions of the internal revenue laws, and the term “disregard”

includes any careless, reckless, or intentional disregard. Sec. 6662(c); sec.

1.6662-3(b)(1) and (2), Income Tax Regs. “‘Negligence’ also includes any failure

by the taxpayer to keep adequate books and records or to substantiate items

properly.” Sec. 1.6662-3(b)(1), Income Tax Regs. Disregard of rules or
                                        - 14 -

[*14] regulations “is ‘careless’ if the taxpayer does not exercise reasonable

diligence to determine the correctness of a return position” and “is ‘reckless’ if the

taxpayer makes little or no effort to determine whether a rule or regulation exists,

under circumstances which demonstrate a substantial deviation from the standard

of conduct that a reasonable person would observe.” Sec. 1.6662-3(b)(2), Income

Tax Regs.; see also Neely v. Commissioner, 85 T.C. 934, 947 (1985). An

understatement means the excess of the amount of the tax required to be shown on

the return over the amount of the tax imposed which is shown on the return,

reduced by any rebate. Sec. 6662(d)(2)(A). An understatement is substantial in

the case of an individual if the amount of the understatement for the taxable year

exceeds the greater of 10% of the tax required to be shown on the return or

$5,000. Sec. 6662(d)(1)(A).

      On his 2007 amended return petitioner reported total tax of $1,075. The

amount required to be shown on the return and the understatement as determined

by respondent in the notice of deficiency are $81,394 and $80,319, respectively.

With the exception of respondent’s concession regarding petitioner’s basis in the

apartment building we have sustained respondent’s deficiency determination.

Even after respondent’s concession petitioner’s understatement will be greater

than 10% of the amount required to be shown on the return, which will be greater
                                         - 15 -

[*15] than $5,000. Accordingly, respondent has shown that an accuracy-related

penalty for 2007 is appropriate.

      A taxpayer can avoid liability for the accuracy-related penalty with respect

to any portion of the underpayment for which the taxpayer proves that there was

reasonable cause and that he or she acted in good faith. Sec. 6664(c)(1). The

decision as to whether a taxpayer acted with reasonable cause and in good faith is

made on a case-by-case basis, taking into account all of the pertinent facts and

circumstances. See sec. 1.6664-4(b)(1), Income Tax Regs. “Circumstances that

may indicate reasonable cause and good faith include an honest misunderstanding

of fact or law that is reasonable in light of all of the facts and circumstances,

including the experience, knowledge, and education of the taxpayer.” Id.

      A taxpayer may also establish reasonable cause and good faith by

introducing evidence that he relied on a professional tax adviser. To prove that

the taxpayer’s reliance on an adviser establishes reasonable cause and good faith,

the taxpayer must prove that (1) the taxpayer selected a competent tax adviser, (2)

the taxpayer supplied the adviser with all relevant information, and (3) the

taxpayer relied in good faith on the adviser’s professional judgment. See

Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299

F.3d 221 (3d Cir. 2002).
                                       - 16 -

[*16] Although petitioner hired a paid tax preparer to prepare his 2007 amended

return, petitioner did not introduce any credible evidence showing that he (1)

selected a competent tax return preparer or (2) supplied accurate and complete

information to his tax return preparer. Accordingly, we conclude that petitioner is

liable for a section 6662(a) penalty for an underpayment of tax attributable to a

substantial understatement of income tax.

      We have considered the parties’ remaining arguments, and to the extent not

discussed above, conclude those arguments are irrelevant, moot, or without merit.

      To reflect respondent’s concession and the foregoing,


                                                     Decision will be entered

                                                under Rule 155.
