Schwarz v. Dept. of Rev. ( 2017 )

IN THE OREGON TAX COURT
MAGISTRATE DIVISION
Income Tax
KATHERINE A SCHWARZ )
and ROBERT C. MAYNARD, )
)
Plaintiffs, ) TC-MD 160323N
)
v. )
)
DEPARTMENT OF REVENUE, )
State of Oregon, )
)
Defendant. ) FINAL DECISION1
Plaintiffs appealed Defendant’s Notice of Deficiency for the 2011 tax year2 and Notice of
Assessment dated July 1, 2016, for the 2012 tax year.3 A trial was held on March 29, 2017, in
the Oregon Tax Courtroom in Salem, Oregon. Plaintiffs appeared on their own behalf.
Robert C. Maynard (Maynard) testified on behalf of Plaintiffs. Tracy Skvarch-Pfannes
(Skvarch) appeared and testified on behalf of Defendant. Plaintiffs Exhibits 1 to 19 for the 2011
tax year, 1 to 16 for the 2012 tax year, and Defendant Exhibits A to K were received without
objection.
I. STATEMENT OF FACTS
This appeal concerns adjustments to Plaintiffs’ 2011 and 2012 Schedule E, reporting
income and expenses associated with a rental unit, and the disallowance of Plaintiffs’
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1
This Final Decision incorporates without change the court’s Decision, entered August 30, 2017. The
court did not receive a statement of costs and disbursements within 14 days after its Decision was entered. See Tax
Court Rule–Magistrate Division (TCR–MD) 16 C(1).
2
According to Defendant, Plaintiffs’ Notice of Deficiency was satisfied on December 28, 2015. (Ans at 1.)
3
The Notices were issued only to Plaintiff Katherine A. Schwarz. (See Compl at 2.) The 2011 and 2012
tax returns at issue were filed by Plaintiff Katherine A. Schwarz and claimed Plaintiff Robert C. Maynard as a
dependent. (See Def’s Ex D, F.)
FINAL DECISION TC-MD 160323N 1
Schedule A casualty loss for the 2012 tax year, associated with a flood of their house and rental
unit.
A. Plaintiffs’ 2011 and 2012 Tax Returns; Defendant’s Adjustments; Issues on Appeal
Plaintiffs’ 2011 tax return reported Schedule E income of $11,509 and expenses of: $252
for insurance; $150 for legal and professional fees; $2,597 for mortgage interest; $6,217 for
repairs; $3,438 for supplies; $946 for taxes; $2,408 for depreciation; and $3,216 for “other.”4
(Def’s Ex D at 9.) No expense was claimed for auto and travel. (See id.) Defendant disallowed
Plaintiffs’ claimed expenses for repairs, supplies, and other. (Def’s Ex C at 9.)
On their 2012 Schedule E, Plaintiffs reported income of $7,200 and only “auto and
travel” expenses of $2,287. (Def’s Ex F at 4.) Plaintiffs’ 2012 Schedule A reported a casualty
loss of $7,717 based on a “flood to rental.” (Id. at 10.) Plaintiffs reported a reduction of $10,000
in the fair market value of their property due to the flood, from $242,000 to $232,000. (See id.)
Defendant disallowed Plaintiffs’ 2012 Schedule E rental expenses and Schedule A casualty loss
after Plaintiffs failed to respond with requested substantiation. (Def’s Ex E at 9–10.)
At some point, Plaintiffs retained a bookkeeper who prepared an amended 2012
Schedule E reporting the following expenses: $279 for insurance; $2,864 for mortgage interest;
$3,454 for repairs; $1,029 for taxes; $2,070 for utilities; $3,237 for depreciation; and $534 for
other. (Def’s Ex G at 9.) It included a 2012 depreciation schedule listing “improvements” with
a cost basis of $12,871 at December 31, 2011, with a note stating “items not allowed as expense
on the 2011 return.” (Id. at 10.) There is no evidence that Plaintiffs’ 2012 amended return was
filed.
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4
The “other” expenses included $302 for dump fees; $125 for equipment rental; $1,631 for fence repairs;
$14 for gardening; and $1,144 for painting and decorating. (Def’s Ex D at 12.)
FINAL DECISION TC-MD 160323N 2
After this appeal was filed, Plaintiffs and Defendant attempted to reach a resolution of
this matter. Skvarch made a detailed review of Plaintiffs’ receipts supporting their claimed
expenses that were previously disallowed, calculating that they totaled $17,916.11 for the 2011
tax year and $5,893.28 for the 2012 tax year. (Def’s Exs I at 4, K at 3.) She determined that all
the expenses should be capitalized and depreciated over 27.5 years, with 50 percent of the
depreciation constituting an allowable deduction for the rental unit. (See Def’s Status Report
at 1, Jan 18, 2017.) Plaintiffs rejected Skvarch’s recommendation, reflected in her status report,
and requested trial. (Ptfs’ Ltr, Jan 25, 2017.) At trial, Skvarch testified that, in her view, all of
Plaintiffs’ expenses in 2011 and 2012 stemmed from the house remodel and must be capitalized.
The primary disagreement between the parties concerns whether Plaintiffs’ house-related
expenses were fully deductible for the year in which they were incurred as repair expenses, or
whether they must be deducted over multiple years in the form of depreciation because they are
capital expenditures. Plaintiffs stated at trial that they do not stand by the expenses reported in
their 2011 and 2012 tax returns. Instead, Plaintiffs provided as exhibits several documents
listing their house-related expenses based on categories including “electrical,” “tools,” “repairs,”
“labor,” “dump,” and so forth. (See Ptfs’ Exs 1, 2, 4 (2011); Ex 2 (2012).)
B. Plaintiffs’ House and Rental Unit
Maynard testified that, in 2010, Plaintiffs purchased a house on Meadowlawn in Salem,
Oregon. (See also Def’s Exs D at 9, G at 10.) Maynard testified that the house was
approximately 4,000 square feet, with 1,787 square feet downstairs and 2,083 square feet
upstairs. He testified that the prior owner of the property was a hoarder so Plaintiffs had to
remove a lot of trash from the house. At the time Plaintiffs purchased the house, there was no
ceiling over the downstairs, only rafters. Maynard testified that Plaintiffs created a separate
FINAL DECISION TC-MD 160323N 3
rental unit downstairs, including a separate driveway and entrance. They built a kitchen in the
rental unit by expanding an existing kitchenette; installed cabinets and countertops; hung
sheetrock; and replaced windows on the side of the house. (See Ptfs’ 2011 Ex 19 (photographs).)
Plaintiffs leased the rental unit beginning in March 2011. (See Ptfs’ Ex 16 (2011).)
Maynard testified that the house turned out to be a “money pit” with numerous problems,
including a leaking roof and flood damage in late 2011 and early 2012. Regarding the flood,
Maynard testified that it was due to “hydrostatic pressure” in the ground. He testified that many
houses in Salem are affected by hydrostatic pressure, although he did not know that prior to
Plaintiffs’ flood. Plaintiffs provided a letter from their tenant describing the flood:
“The flooding was so bad one interior wall had to be replaced along with some
wiring and water filled my home and patio with almost six inches of water that
seemed to come in waves through my patio door walls and flooring. Couldn’t get
it out until he put a pump under my bathtub.”
(Ptfs’ Ex 16 (2011).) Maynard testified that Plaintiffs had to install two pumps in the basement
to drain the water. (See also id.) He testified that Plaintiffs attempted to clean the carpets using
a dehumidifier, but it did not work and they had to replace the carpet and vinyl flooring.
Maynard testified that Plaintiffs installed a French drain to address the underlying problem that
caused the flood. He testified that other expenses associated with the flood included sheetrock,
dump fees, driveway repair, and pipes. (See Ptfs’ 2012 Exs 3 at 1–10, 4 at 4–5, 16.)
C. Plaintiffs’ House-Related Expenses
Maynard testified describing the work completed on the house in 2011 and 2012. He
conceded that certain projects were properly classified as capital improvements. During the two
tax years at issue, Plaintiffs allocated one third of their utilities to the rental unit and allocated 50
percent of other house-related expenses to the rental unit.
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FINAL DECISION TC-MD 160323N 4
1. Capital improvements conceded by Plaintiffs for 2011
Maynard conceded that the work undertaken in January and February 2011 to create the
rental unit constituted capital improvements. Plaintiff provided a document listing and itemizing
expenses incurred in January and February 2011.5 (Ptfs’ Ex 2 at 1–2.) The items listed total
$6,717.04, less $19.95 spent at the MAC store for a computer related purchase. (See id.)
Plaintiffs provided receipts and invoices supporting the expense items listed. (See Id. at 3-35.)
Maynard conceded that expenses associated with creating a new sidewalk to the house
were capital expenditures. Plaintiffs reported expenses totaling $1,272.98 for that project and
provided receipts and invoices to substantiate the amount. (See Ptfs’ Ex 4 at 5, Ex 13.) Maynard
conceded that several items he previously categorized as repairs should be treated as capital
improvements: $175.93 to purchase and install downspouts (Ptfs’ Ex 7 at 33); certain painting
expenses totaling $53.10 (Id. at 36–37); various purchases from Home Depot and Lowes totaling
$134.43 (Id. at 44, 47–48; see also Ptfs’ Ex 4 at 4); payments for labor to clean up and prepare
the house in February 2011 totaling $840 (Ex 10 at 1); payments for labor to finish sheetrock
totaling $180 (Ex 10 at 6); and $557 for a sump pump (Ex 10 at 3).
2. Capital improvements conceded by Plaintiffs for 2012
Maynard conceded that certain expenses associated with the flood were capital
expenditures. Specifically, expenses pertaining to the French drain, including a payment of
$2,170.49 to Chris Reed on February 24 for labor (Ptfs’ Ex 2 at 2, Ex 4 at 5) and a total of
$694.89 in various purchases that Plaintiffs previously classified as “repairs” (Ptfs’ Ex 2 at 2–4,
Ex 5 at 14–18, 20–21, 23–30), for a total of $2,865.38.
5
Plaintiffs provided another list of expenses incurred in January and February 2011 that totaled
$17,123.88. (Ptfs’ Ex 1 at 1.) The specific expenses listed are: $5,184.48 for labor and repairs; $4,137.85 for
materials; $320.00 for dump; $2,904.00 for truck; $281.41 for maintenance; $735.05 for grass and yard; $1,272.98
for rental sidewalk and walkway to house; $592.49 for mandatory electrical for code; $673.21 for tool deduction;
and $1,022.41 for five-year depreciation of tools. (Ptf’s Ex 1 at 1.) Plaintiffs provided no supporting documents.
FINAL DECISION TC-MD 160323N 5
Maynard conceded that a payment of $1,373.25 to Jacob Anderson6 on December 30 for
roof repairs should be capitalized. (See Ptfs’ Ex 2 at 2, Ex 4 at 6.)
Maynard conceded that certain expenses totaling $718.46 and consisting primarily of
purchases at Home Depot are properly classified as capital expenditures. (See Ptfs’ Ex 2 at 3–4,
Ex 5 at 31–39.) He conceded a packet of exhibits labeled “improvements” and totaling
$1,378.99 are all properly classified as capital expenditures. (See Ptfs’ Ex 2 at 5–6, Ex 7.)
Maynard conceded that tool purchases identified as “five year” tools and totaling $208.52
should be depreciated over five years. (See Ptfs’ Ex 9 at 1, Ex 14 (receipts).) He testified that a
purchase of $142.76 from Home Depot on June 19 was for “shop tools.” (Ptfs’ Ex 5 at 41–43.)
3. Other house-related expenses for 2011
Maynard testified that the roof of Plaintiffs’ house leaked in 2011, ruining some
sheetrock and carpet. He testified that the corner of the roof was rotted, requiring 15 to 20
percent of the roof to be replaced. Maynard testified that Plaintiffs twice hired individuals to fix
the roof, but neither individual successfully fixed the roof. Plaintiffs did not separately break out
expenses pertaining to the roof repair; rather, the expenses are spread throughout several of
Plaintiffs’ expense categories. (See Ptfs’ Ex 4.) Maynard testified regarding which expenses
pertained to the roof repair, resulting in a total of $2,640.18.7 (See Ptfs’ Ex 4 at 2–4, Ex 7, Ex 10
at 7–8.) Maynard testified that Plaintiffs also took 17 to 19 loads to the dump, some of which
were related to the roof repair and some of which were related to the yard. Plaintiffs reported
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6
The “Statement” detailing the payment and work done identifies “Jacob Anderson,” but Maynard’s
itemized list of expenses identifies “Jacob Abbott.” (See Ptfs’ Ex 2 at 2, Ex 4 at 6.)
7
That total is based upon general “repair” receipts totaling $4,137.85, less nonroof-related “repair” receipts
totaling $1,617.67, plus roof “labor” of $120. (See Ptfs’ Ex 7 at 1, 10–11, 15–16, 32–33, 36–39, 41–42, 44–48
(“repair” receipts identified by Maynard during trial as unrelated to the roof repair).)
FINAL DECISION TC-MD 160323N 6
expenses totaling $320 for “dump” fees and provided some receipts. (Ptfs’ Ex 4 at 7, Ex 11.) It
is unclear which receipts pertained to the roof repair. (See id.)
Maynard testified that the bathtub in the rental unit cracked and had to be replaced. He
testified that Plaintiffs had to cut through the wall to remove the existing bathtub. Maynard
identified a payment of $347 for labor as pertaining to the bathtub. (See Ptfs’ Ex 10 at 3.)
Maynard testified that a check dated February 15 for $2,153.58 was to repair clogged
pipes in the rental unit. (Ptfs’ Ex 3.) He testified that Plaintiffs incurred other plumbing related
expenses: $183.47 to Mr. Rooter to fix backed up plumbing on February 15 (Ptfs’ Ex 7 at 1);
$194 to ARS Rescue Rooter on August 9 (Id. at 15–16); and $22.24 to George Morlan Plumbing
Supply on December 2 (Id. at 38–39).
Maynard testified that Plaintiffs had to make additional electrical repairs to bring the
house up to code, for expenses totaling $1,468.16 for an electrician and related supplies.
(Ptfs’ Ex 4 at 1, Ex 5, Ex 7 at 32, Ex 10 at 5.) Plaintiffs provided receipts and invoices dated in
March, October, November, and December. (See id.)
Maynard testified that Plaintiffs planted a new lawn at the house because the original
yard was a “mud pit.” They reported expenses totaling $735.05 for “grass/yard” in May and
June, but did not provide any receipts to substantiate those expenses. (Ptfs’ Ex 4 at 9.) Maynard
testified that payments to three individuals named “Clinton, Cameron, and Tony” totaling $872
was for their work to clean up the yard, including removing five cords of rotted wood and
concrete blocks. (See Ptfs’ Ex 10 at 4 (statement dated December 5).)
Maynard testified that Plaintiffs paid $432.41 for paint because their tenant wanted a
different color. (Ptfs’ Ex 4 at 6, Ex 8.) Plaintiffs provided receipts related to paint expenses
dated in March, April, and October. (See id.)
FINAL DECISION TC-MD 160323N 7
Maynard testified that Plaintiffs paid $483 to replace the furnace in the rental unit.
(Ptfs’ Ex 7 at 42.) They provided a service work order dated December 31. (Id.)
Maynard testified that expenses totaling $37.05 were for general maintenance. (Ptfs’
Ex 7 at 45–46.) They provided invoices from Miller Paints dated December 20 and 22. (Id.)
Maynard testified that expenses totaling $1,770.76 were for tools including a tiller, drills,
and a sander. (See Ptfs’ Ex 4 at 1, Ex 6.) He paid $44.97 for saw blades. (Ptfs’ Ex 7 at 41.)
Maynard agreed that most of the tools should be depreciated over five years. Plaintiffs provided
receipts and invoices from April through December. (See id.)
Plaintiffs reported spending $2,192.67 on items related to the fence. (Ptfs’ Ex 4 at 4–5.)
Maynard testified that those expenses were for maintenance and not deducted. Plaintiffs did not
provide any receipts or invoices substantiating their fence expenses and made a note stating “not
counted” with respect to some of the expenses. (See id. at 4.)
Plaintiffs reported spending $2,904.71 on their “work truck” and provided receipts and
invoices to support that amount. (Ptfs’ Ex 4 at 8-9, Ex 12.) Plaintiffs’ truck is a 1978 pickup
truck. (See Ptfs’ Ex 12 at 1–2.) Maynard testified that Plaintiffs used the work truck only in
association with the house. Plaintiffs did not provide a log or other similar record detailing their
use of the truck.
Plaintiffs provided a one-page document pertaining to their utilities. (Ptfs’ Ex 17.) It
states $1,346.11 paid for Natural Gas and $1,876.68 paid for PGE. (Id.) Plaintiffs provided no
receipts or statements supporting those total amounts.
4. Other house-related expenses for 2012
Maynard testified that Plaintiffs incurred expenses to rent air compressors, jackhammers,
and other similar equipment to repair flood damage, and provided receipts and invoices totaling
FINAL DECISION TC-MD 160323N 8
$1,038.23 for those rentals. (See Ptfs’ Ex 2 at 1, Ex 3.) Maynard testified that Plaintiffs paid for
labor to repair flood damage and provided receipts and invoices totaling $3,838.14. (See Ptfs’
Ex 2 at 2, Ex 4 at 1–5.) The first receipt for $375 was for electrical work. (Ptfs’ Ex 4 at 1.) The
second receipt for $1,225 is unclear with respect to the specific work performed because the
handwriting is illegible. (Id. at 2.) The third receipt for $2,145.92 included a summary of work
performed: “excavation of driveway, repair wall as needed (multiple areas damaged), demolition
and repair of damages inside rental (lower floor), removal of debris, replace driveway.” (Id. at 4;
see also Ptfs’ Ex 2 at 2.) Maynard testified that certain expenses consisting primarily of
purchases at Home Depot and totaling $1,048.72 were repair expenses related to the flood.
(See Ptfs’ Ex 2 at 2–3, Ex 5 at 1–13, 16–19, 22–24.) The receipts were dated from January 2
through February 5. (See id.) Maynard testified that a payment to Salem Mobile Mix on
February 7 for $719 was to fix a crack in the foundation, related to the flood. (See Ptfs’ Ex 16.)
Maynard testified that certain expenses totaling $1,630.88 were for repairs and
maintenance. (See Ptfs’ Ex 2 at 3–5; Ex 5 at 19, 22, 29, 44, 45; Ex 6; Ex 14 at 4.) Plaintiffs
provided receipts and invoices to substantiate those expenses. (See id.) The nature of the
purchases is not entirely clear; some pertain to the deck and yard improvements. (See id.)
Maynard testified that Plaintiffs’ purchases, totaling $39.34, were for “one year disposal”
tools. (See Ptfs’ Ex 9 at 1.) He testified that a $30 payment for “power cord repair/labor” on
March 1 was for tool repair. (See Ptfs’ Ex 5 at 10.)
Plaintiffs provided a one-page document pertaining to their utilities. (Ptfs’ Ex 10.) It
states $1,036.11 paid for Natural Gas and $2,236.63 paid for PGE. (Id.) Plaintiffs provided no
receipts or statements supporting those total amounts.
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FINAL DECISION TC-MD 160323N 9
D. Plaintiffs’ Casualty Loss
Plaintiffs claimed a casualty loss of $10,000 on their 2012 Schedule A, for a deduction of
$7,717. (Def’s Ex F at 3.) Plaintiffs presented no evidence of the value of their house either
before or after the flood. The only evidence that Plaintiffs presented of flood damage was the
expenses associated with the flood repairs, discussed above. Defendant provided a property tax
statement from the 2011-12 tax year reporting the house’s real market value as $157,870 for the
2011-12 tax year, down from $179,470 for the prior tax year. (Def’s Ex D at 18.) Skvarch
testified that Plaintiffs failed to provide any records describing the flood, such as a newspaper
article. She disagreed that the flood was “sudden, unexpected, or unusual” as required by IRC
section 165. Skvarch testified that, in her view, the flood was due to a long-term maintenance
issue rather than a catastrophic event qualifying as a casualty.
II. ANALYSIS
The issues presented are: (1) whether any of the expenses incurred by Plaintiffs for work
on their rental property in 2011 and 2012 were repairs deductible under IRC section 162, rather
than capital expenditures; (2) whether Plaintiffs should be allowed deductions for the 2011 and
2012 tax years for other expenses associated with their rental property, including a “work truck”
and utilities; and (3) whether Plaintiffs should be allowed a casualty loss deduction for the 2012
tax year under IRC section 165(a) associated with a flood that occurred at their house.
The Oregon Legislature intended to “[m]ake the Oregon personal income tax law
identical in effect to the provisions of the [IRC] relating to the measurement of taxable income of
individuals, estates and trusts, modified as necessary by the state’s jurisdiction to tax and the
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FINAL DECISION TC-MD 160323N 10
revenue needs of the state[.]” ORS 316.007(1).8 “Any term used in this chapter has the same
meaning as when used in a comparable context in the laws of the United States relating to federal
income taxes, unless a different meaning is clearly required or the term is specifically defined in
this chapter.” ORS 316.012. On the issues presented in this case, “Oregon law makes no
adjustments to the rules under [the IRC] and therefore, federal law governs the analysis.” See
Porter v. Dept. of Rev., 20 OTR 30, 31 (2009).
Taxpayers must be prepared to produce “any books, papers, records or memoranda
bearing upon [any] matter required to be included in the return[.]” ORS 314.425(1); see also
Gapikia v. Comm’r, 81 TCM (CCH) 1488, WL 332038 at *2 (2001) (“[t]axpayers are required to
maintain records sufficient to substantiate their claimed deductions”). Generally, if a claimed
business expense is deductible, but the taxpayer is unable to substantiate it fully, the court is
permitted to make an approximation of an allowable amount. Cohan v. Comm’r (Cohan),
39 F2d 540, 543–44 (2nd Cir 1930). The estimate must have a reasonable evidentiary basis.
Vanicek v. Comm’r, 85 TC 731, 743 (1985). IRC section 274(d) supersedes the Cohan rule and
imposes more stringent substantiation requirements for travel, meals, entertainment, gifts, and
listed property under IRC section 280F(d)(4). Treas Reg § 1.274-5T(a).
Deductions are “a matter of legislative grace” and taxpayers bear the burden of proving
their entitlement to the deductions claimed. INDOPCO, Inc. v. Comm’r, 503 US 79, 84,
112 S Ct 1039, 117 L Ed 2d 226 (1992). “In all proceedings before the judge or a magistrate of
the tax court and upon appeal therefrom, a preponderance of the evidence shall suffice to sustain
the burden of proof. The burden of proof shall fall upon the party seeking affirmative relief
8
The court’s references to the Oregon Revised Statutes (ORS) are to 2011. Although the 2009 ORS are
applicable for the 2011 tax year, there is no material difference between the 2009 and 2011 versions of the ORS
sections cited in this Decision.
FINAL DECISION TC-MD 160323N 11
* * *.” ORS 305.427. Plaintiffs must establish their claim “by a preponderance of the
evidence[,]” which “means the greater weight of evidence, the more convincing evidence.”
Feves v. Dept. of Revenue, 4 OTR 302, 312 (1971). “[I]f the evidence is inconclusive or
unpersuasive, the taxpayer will have failed to meet his burden of proof * * *.” Reed v. Dept. of
Rev., 310 Or 260, 265, 798 P2d 235 (1990). “In an appeal to the Oregon Tax Court from an
assessment made under ORS 305.265, the tax court has jurisdiction to determine the correct
amount of deficiency * * *.” ORS 305.575.
A. Deduction of Claimed Repair Expenses
IRC sections 162 and 212 “generally permit taxpayers to deduct ordinary and
necessary expenses paid or incurred in carrying on a trade or business for the production of
income.” Hailstock v. Comm’r, 112 TCM (CCH) 200, WL 4183241 at *6 (2016). Ordinary and
necessary expenses of renting a property may include repair expenses. See Treas Reg § 1.162-4.
However, under IRC section 263(a)(1), “no deduction shall be allowed for * * * [a]ny amount
paid out for new buildings or for permanent improvements or betterments made to increase the
value of any property or estate.” See also Moss v. Comm’r (Moss), 831 F2d 833, 835 (9th Cir
1987), citing IRC §§ 162(a), 263(a)(1) (“Generally speaking, expenditures for ordinary and
necessary repairs may be deducted in the year incurred, while expenditures for permanent
improvements or betterments made to increase the value of any property must be capitalized and
depreciated over the useful life of the improvement”).
The applicable Treasury Regulation provides additional guidance on the distinction
between repairs and capital improvements:
“The cost of incidental repairs which neither materially add to the value of the
property nor appreciably prolong its life, but keep it in an ordinarily efficient
operating condition, may be deducted as an expense, provided the cost of
acquisition or production or the gain or loss basis of the taxpayer’s plant,
FINAL DECISION TC-MD 160323N 12
equipment, or other property, as the case may be, is not increased by the amount
of such expenditures. Repairs in the nature of replacements, to the extent that
they arrest deterioration and appreciably prolong the life of the property, shall
either be capitalized and depreciated in accordance with section 167 or charged
against the depreciation reserve if such an account is kept.”
Treas Reg § 1.162-4.9 Except as otherwise provided, no deduction is allowed for
“(1) Any amount paid out for new buildings or for permanent improvements or
betterments made to increase the value of any property or estate, or
“(2) Any amount expended in restoring property or in making good the
exhaustion thereof for which an allowance is or has been made in the form of a
deduction for depreciation, amortization, or depletion.”
Treas Reg § 1.263(a)-1(a).10 That regulation continues:
“In general, the amounts referred to in paragraph (a) of this section include
amounts paid or incurred (1) to add to the value, or substantially prolong the
useful life, of property owned by the taxpayer, such as plant or equipment, or (2)
to adapt property to a new or different use. Amounts paid or incurred for
incidental repairs and maintenance of property are not capital expenditures within
the meaning of subparagraphs (1) and (2) of this paragraph.”
Treas Reg § 1.263(a)-1(b). Capital expenditures include “[t]he cost of acquisition, construction,
or erection of buildings, machinery and equipment, furniture and fixtures, and similar property
having a useful life substantially beyond the taxable year.” Treas Reg § 1.263(a)-2(a).
The Ninth Circuit characterized the distinction between repairs and capital improvements
as “the difference between ‘keeping’ and ‘putting’ a capital asset in good condition:
‘The test which normally is to be applied is that if the improvements were made
to ‘put’ the particular capital asset in efficient operating condition, then they are
capital in nature. If, however, they were made merely to ‘keep’ the asset in
efficient operating condition, then they are repairs and are deductible.’
Moss, 831 F2d at 835, citing Estate of Walling v. Comm’r, 373 F2d 190, 192–93 (3d Cir 1967).
9
The quoted version of Treasury Regulation section 1.162-4 is that which was in effect as of the 2011 and
2012 tax years.
10
The quoted version of Treasury Regulation section 1.263(a)-1 is that which was in effect as of the 2011
and 2012 tax years.
FINAL DECISION TC-MD 160323N 13
The proper characterization of expenditures depends on the context in which they are made. Id.
at 835–36 (citations omitted). For instance, in the context where the taxpayer has erected a new
building, “items of work which the contractor might have undertaken to prepare the building for
occupancy such as carting away refuse or painting or even washing windows, could hardly be
separated from the whole cost and deducted as expenses.” Stoeltzing v. Comm’r, 266 F2d 374,
377 (3d Cir 1959).
“[A]n expenditure made for an item which is part of a ‘general plan’ of rehabilitation,
modernization, and improvement of the property, must be capitalized, even though, standing
alone, the item may appropriately be classified as one of repair.” U.S. v. Wehrli, 400 F2d 686,
689 (10th Cir 1968).
“Whether the plan exists, and whether a particular item is part of it, are usually
questions of fact to be determined by the fact finder based upon a realistic
appraisal of all the surrounding facts and circumstances, including, but not limited
to, the purpose, nature, extent, and value of the work done, e.g., whether the work
was done to suit the needs of an incoming tenant, or to adapt the property to a
different use, or, in any event, whether what was done resulted in an appreciable
enhancement of the property’s value.”
Id. at 690. The court in Kaonis v. Comm’r )(Kaonis), declined to follow the rehabilitation
doctrine with respect to expenditures associated with renovating a rental house. 37 TCM (CCH)
792 (1978), aff’d mem., 639 F2d 788 (9th Cir 1981). The court disallowed current deductions for
capital expenditures and replacements, including “additions to the existing structure, such as the
patio, fence, gate, floor tile, window treatments, paneling, and light fixtures” and “bathroom
fixtures and wash basins, tile, a stove, and certain other items.” Id. However, the court allowed
a current deduction for expenditures including “painting, cleaning and certain repairs to the
property.” Id. The court declined to follow the rehabilitation doctrine in that case because “the
property was tenantable and generally suitable for its use in the trade or business.” Id.
FINAL DECISION TC-MD 160323N 14
1. 2011 tax year
Plaintiffs conceded that the expenses associated with renovating the house and creating a
rental unit – incurred in January and February – were capital expenditures. The court agrees
with Plaintiffs that those expenses were capital expenditures because the effect of the work was
to adapt the house to a new use; i.e., as a rental unit within a structure that was formerly a single-
family residence. Unlike in Kaonis, the house was not usable as a rental unit until Plaintiffs
completed the renovations. Thus, other house-related expenses incurred in January and February
2011 must be capitalized. Plaintiffs conceded that expenses totaling $9,930 were capital
expenditures. The court concludes that Plaintiffs’ plumbing expenses totaling $2,337 incurred in
February must also be capitalized as part of Plaintiffs’ renovation.
The court finds that other expenses incurred by Plaintiffs had the effect of increasing the
value of the house or extending its life. Specifically, expenses incurred to replace a bathtub in
the rental unit; to bring the electrical wiring to code; and to replace the furnace were capital
expenditures. The court finds that Plaintiffs incurred capital expenditures totaling $14,567 in
2011. Additionally, Plaintiffs conceded that expenses totaling $1,776 were for tools that should
be depreciated over five years.
Plaintiffs presented evidence of expenses incurred to repair the roof of the house,
resulting in about 15 to 20 percent of the roof being replaced. The repairs in 2011 were
unsuccessful and Plaintiffs made further repairs in 2012. The court finds that the expenses
Plaintiffs incurred in 2011 to repair the roof are deductible repairs. See Farmers Creamery Co.
of Fredericksburg, Va. v. Comm’r, 14 TC 879, 880, 882–83 (1950) (allowing a current year
repair deduction for structural repairs to a building that were necessary to “maintain and continue
the efficient use of the building” and where “the repairs never replaced as much as one-half of
FINAL DECISION TC-MD 160323N 15
any wall, ceiling, or floor and they did not in any way enlarge or change the design of the
building”). The court further finds that the following expenses incurred by Plaintiffs are
deductible as repairs: dump expenses incurred after February; plumbing expenses incurred after
February; expenses associated with cleaning up the yard; and new paint for the tenant. Those
expenses, along with the roof repairs, totaled $4,518.
2. 2012 tax year
Plaintiffs conceded that expenses totaling $6,336 were capital expenditures. The court
finds that Plaintiffs’ various expenses totaling $1,631 were capital expenditures rather than
repairs, because Plaintiffs did not provide persuasive evidence concerning the work performed.
Furthermore, some of those expenses were clearly capital expenditures, such as for a new deck.
The court finds that Plaintiffs’ capital expenditures totaled $7,967. Additionally, Plaintiffs
conceded that expenses totaling $351 were for tools that should be depreciated over five years.
Plaintiffs presented evidence of flood-related repair expenses totaling $6,644. The court
finds that Plaintiffs’ expenses to remove flood water from the house and fix a crack in the
driveway were repairs rather than capital expenditures because they returned the house to the
state it was in before the flood. See Schladweiler v. Comm’r, 80 TCM (CCH) 681 (WL 1690282
at **5–6 (2000), citing Plainfield-Union Water Co. v. Comm’r, 39 TC 333, 337 (1962).
Additionally, Plaintiffs presented evidence that they incurred expenses totaling $69 for
disposable tools and tool repair.
B. Other Deductions Associated with the Rental Property
1. Work truck
As noted above, IRC section 274(d) imposes more stringent substantiation requirements
for travel, meals, entertainment, gifts, and listed property under IRC section 280F(d)(4). Treas
FINAL DECISION TC-MD 160323N 16
Reg § 1.274-5T(a). Passenger automobiles are defined as “listed property” under IRC section
280F(d)(4) and are, therefore, subject to strict substantiation under IRC section 274(d). Certain
“qualified nonpersonal use vehicles” are not subject to strict substantiation. Such vehicles
include those which, by reason of their nature, are “not likely to be used more than a de minimis
amount for personal purposes. IRC § 274(i).11 Plaintiffs’ “work truck” is a 1978 pickup truck.
Plaintiffs presented no evidence that the truck is a “qualified nonpersonal use vehicle.” Thus,
Plaintiffs must substantiate their truck-related expenses in accordance with IRC section 274(d).
Under IRC section 274(d), Plaintiffs must substantiate “by adequate records or by
sufficient evidence corroborating the taxpayer’s own statement” the amount of their truck
expenses; the time and place of their use of the truck; and the business purpose of their use of the
truck. Plaintiffs presented proof of the amount of their truck expenses incurred in 2011.
However, they failed to present evidence of their use of the truck besides Maynard’s testimony
that the truck was used solely for work related to the house. That testimony is insufficient under
IRC section 274(d) without adequate records to corroborate it.
2. Utilities
Plaintiffs failed to present any persuasive evidence of their utility expenses for either tax
year. For each tax year at issue, Plaintiffs provided only a one-page document listing an amount
paid for natural gas and an amount paid to PGE. Plaintiffs failed to provide any cancelled
checks, invoices, or statements showing their utility payments. There is no evidence from which
the court can make a reasonable estimation of Plaintiffs’ utility expenses.
///
11
“Qualified nonpersonal use vehicles” include “clearly marked police and fire vehicles, ambulances,
hearses, vehicles designed to carry cargo with a gross weight of more than 14,000 pounds, bucket trucks, cement
mixers, combines, cranes, derricks, delivery trucks with seating only for the driver, dump trucks, flatbed trucks,
forklifts, refrigerated trucks, school buses, tractors, and other special purpose farm vehicles.” Ewell v. Comm’r, 71
TCM (CCH) 3134, WL 283684 at *11 (1996) (citation omitted).
FINAL DECISION TC-MD 160323N 17
C. Deduction for Casualty Loss
IRC section 165(a) provides a deduction for “any loss sustained during the taxable year
and not compensated for by insurance or otherwise.” For individuals, such losses are limited to:
“(1) losses incurred in a trade or business;
“(2) losses incurred in any transaction entered into for profit, though not
connected with a trade or business; and
“(3) except as provided in subsection (h), losses of property not connected with a
trade or business or a transaction entered into for profit, if such losses arise from
fire, storm, shipwreck, or other casualty, or from theft.”
IRC § 165(c). An individual’s casualty loss deduction is limited to the excess over $100 per
casualty and to the excess over 10 percent of the individual’s adjusted gross income per the total
of personal casualty losses. IRC § 165(h).
To qualify as an “other casualty” under the code, the event must be “analogous to fire,
storm, or shipwreck.” Rev Rul 72-592, 1972-2 CB 101 (1972). The event must be “of a sudden,
unexpected, and unusual nature.” Id.
“To be ‘sudden’ the event must be one that is swift and precipitous and not
gradual or progressive.
“To be ‘unexpected’ the event must be one that is ordinarily unanticipated that
occurs without the intent of the one who suffers the loss.
“To be ‘unusual’ the event must be one that is extraordinary and nonrecurring,
one that does not commonly occur during the activity in which the taxpayer was
engaged when the destruction or damage occurred, and one that does not
commonly occur in the ordinary course of day-to-day living of the taxpayer.”
Id. “The progressive deterioration of property through a steadily operating cause is not a
casualty.” Oliver v. Comm’r, 73 TCM (CCH) 2035, WL 66769 at *17 (1997) (citation omitted).
To establish the amount of the loss, “the fair market value of the property immediately
before and immediately after the casualty shall generally be ascertained by competent appraisal.”
FINAL DECISION TC-MD 160323N 18
Treas Reg § 1.165-7(a)(2)(i). However, the appraisal must take into account the effect of any
market decline that occurred simultaneously with the casualty. Id. The cost of repairs to the
property damaged may be acceptable evidence of the loss of value. Treas Reg § 1.165-
7(a)(2)(ii). However, the taxpayer must show the following:
“(a) the repairs are necessary to restore the property to its condition immediately
before the casualty, (b) the amount spent for such repairs is not excessive, (c) the
repairs do not care for more than the damage suffered, and (d) the value of the
property after the repairs does not as a result of the repairs exceed the value of the
property immediately before the casualty.”
Id.
The first question is whether the flood of Plaintiffs’ house qualifies as a “casualty.”
According to Plaintiffs, the flood was due to “hydrostatic pressure” in the ground. Maynard’s
testimony that many other homes in the area are affected by hydrostatic pressure suggests that
resulting floods are not “unusual” events. Plaintiffs provided no additional evidence concerning
the flood, such as whether it was preceded by unusually heavy rainfall or whether other, nearby
properties were unexpectedly flooded. The U.S. Tax Court declined to find a casualty where the
taxpayer reported “cracks and fissures in the wall and floor of the basement,” explaining:
“It is possible that excessive hydrostatic pressure under proper circumstances
might rise to the stature of a casualty. But, in view of the record, we need not
decide that question. In conclusion, the suggestion that the damage may have
been caused by hydrostatic pressure will not suffice as proof of a casualty in this
case.”
Dvorkovitz v. Comm’r, 25 TCM (CCH) 43 (1967) (citation omitted). Here, the court reaches the
same conclusion. Plaintiffs’ limited evidence concerning the cause of the flood is insufficient to
support a finding that the flood was due to a sudden, unexpected, and unusual event.
Because Plaintiffs failed to prove that the flood qualified as a casualty under IRC section
165(c), the court need not address whether Plaintiffs presented persuasive evidence of the loss
FINAL DECISION TC-MD 160323N 19
resulting from the flood. The court’s conclusion here does not alter its conclusion that Plaintiffs
may deduct expenses associated with repairing the rental unit after the flood.
III. CONCLUSION
After careful consideration, the court concludes that Plaintiffs are allowed a depreciation
deduction for the 2011 tax year based on $14,567 in capital expenditures to improve the house
and based on $1,776 in purchases of tools with a five-year useful life. Plaintiffs are allowed a
deduction for the 2011 tax year based on $4,518 in expenses to repair the house. For the 2012
tax year, Plaintiffs are allowed a depreciation deduction based on $7,967 in capital expenditures
to improve the house and based on $351 in purchases of tools with a five-year useful life. For
the 2012 tax year, Plaintiffs are allowed deductions based on $6,644 in expenses to repair flood
damage to the house and on $69 in expenses for tools with a one-year life and tool repair.
Plaintiffs’ house-related deductions are subject to an allocation of 50 percent for the rental unit
and 50 percent for personal use. Plaintiffs’ claimed deductions for utilities and vehicle expenses
are disallowed for both the 2011 and 2012 tax years. Plaintiffs’ claimed casualty loss deduction
is disallowed for the 2012 tax year. Now, therefore,
IT IS THE DECISION OF THIS COURT that, for the 2011 tax year, Plaintiffs are
allowed a depreciation deduction based on $14,567 in capital expenditures to improve the house
and based on $1,776 in purchases of tools with a five-year useful life. Plaintiffs are allowed a
deduction based on $4,518 in expenses to repair the house.
IT IS FURTHER DECIDED that, for the 2012 tax year, Plaintiffs are allowed a
depreciation deduction based on $7,967 in capital expenditures to improve the house and based
on $351 in purchases of tools with a five-year useful life. Plaintiffs are allowed deductions
///
FINAL DECISION TC-MD 160323N 20
based on $6,644 in expenses to repair flood damage to the house and on $69 in expenses for
tools with a one-year life and tool repair.
IT IS FURTHER DECIDED that, for the 2011 and 2012 tax years, Plaintiffs’ house-
related deductions are subject to an allocation of 50 percent for the rental unit and 50 percent for
personal use.
IT IS FURTHER DECIDED that, for the 2011 and 2012 tax years, Plaintiffs’ claimed
deductions for utilities and vehicle expenses are disallowed.
Dated this day of September, 2017.
ALLISON R. BOOMER
MAGISTRATE
If you want to appeal this Final Decision, file a complaint in the Regular
Division of the Oregon Tax Court, by mailing to: 1163 State Street, Salem, OR
97301-2563; or by hand delivery to: Fourth Floor, 1241 State Street, Salem, OR.
Your complaint must be submitted within 60 days after the date of the Final
Decision or this Final Decision cannot be changed. TCR-MD 19 B.
This document was signed by Magistrate Boomer and entered on September 19,
2017.
FINAL DECISION TC-MD 160323N 21