Karason v. Comm'r

T.C. Memo. 2007-103
UNITED STATES TAX COURT
JOHN KARASON, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12296-05. Filed April 26, 2007.
John Timothy Bender and J. Scott Broome, for petitioner.
Mark D. Eblen, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined a deficiency in
petitioner’s Federal income tax for 2001 of $14,575, as well as
an addition to tax under section 6662(a) of $2,915.1
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and Rule references are to
the Tax Court Rules of Practice and Procedure. Amounts are
(continued...)
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The issues for decision are: (1) Whether petitioner is
entitled to section 179 expense and section 167 depreciation
deductions; (2) whether petitioner has sufficient basis in a
partnership entitling him to deduct partnership losses; and (3)
whether petitioner is liable for an accuracy-related penalty
pursuant to section 6662(a).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. Contrary to the petition,
which indicated petitioner resided in Elizabethtown,
Pennsylvania, when the petition was filed petitioner resided in
Lincoln, California.
A. Petitioner’s Background
Petitioner graduated from college with a degree in political
science and accounting and subsequently pursued a master’s degree
in taxation and business administration. He did not complete the
graduate degrees. While working on his master’s in taxation,
petitioner was employed as a tax manager for Levin Rosenfeld in
Bedminster, New Jersey. A year later, he left Levin Rosenfeld
and moved to Ohio to work for Provident Nursing Homes as its
assistant controller. In January 1988, he began employment with
1
(...continued)
rounded to the nearest dollar.
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the Internal Revenue Service (IRS) as a revenue agent in the
Mansfield, Ohio, office. While in the Mansfield office, he
became an industry specialist in the fields of healthcare, horse
operations, and farming operations. In 1999, he was promoted to
group manager and later promoted to large case manager. In 2004,
petitioner was transferred to an IRS office in San Francisco,
California, where he remained until he terminated his position in
August 2005. During petitioner’s entire employment with the IRS,
he either audited or supervised the audits of taxpayers.
B. Dr. Michael Karason
Dr. Michael Karason (Dr. Karason), petitioner’s younger
brother, is a podiatrist licensed to practice in the States of
Ohio, Pennsylvania, and California. At the time of trial, he
practiced podiatry out of offices in Harrisburg and
Elizabethtown, Pennsylvania.
On December 21, 2000, Dr. Karason executed a “Bill Of Sale
And Agreement” (purchase agreement) to purchase the Harrisburg
podiatry practice of Dr. Harold A. Flom, D.P.M. (Dr. Flom) for
$31,000. The closing date was January 13, 2001. Dr. Flom’s
podiatry practice consisted of intangible assets, which included
patient lists, patients’ telephone numbers, and patients’ files,
and medical equipment, which included furniture, office items,
workroom items, and items in two treatment rooms. Each treatment
room’s items included a podiatry chair, a stool, a sitting chair,
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lights, paintings, and a podiatry wall cabinet with supplies.
The purchase agreement failed to specifically indicate what the
office and workroom items were, or the type of furniture. The
purchase agreement did not allocate a fair market value (FMV) to
each piece of property included in the intangible assets or
medical equipment.
Dr. Karason testified he did not have the funds to purchase
Dr. Flom’s practice. To finance the transaction, petitioner
obtained a $30,000 bank loan from The Farmers Savings Bank
(Farmers Bank) on December 22, 2000, and wired it to his brother
on January 9, 2001. The loan was secured with rental property
owned by Karason Capital Partners (KCP), petitioner’s and Dr.
Karason’s partnership.2 The promissory note for the loan stated
the loan’s purpose was for “BUSINESS: PURCHASE MEDICAL PRACTICE”.
Dr. Karason’s solely owned corporation, Karason Podiatric
Centers, Inc. (KCPI), paid the monthly bank loan payments to
Farmers Bank totaling $16,662 in 2001.
2
For convenience, the Court uses the terms “partnership”
and “partner” without deciding whether a partnership existed.
The promissory note stated the loan was secured “WITH OPEN-
END MORTGAGE ON REAL ESTATE LOCATED AT 901 CO. RD. 801, ASHLAND,
OHIO 44805 CONSISTING OF 9.51 ACRES WITH HOUSE AND BUILDINGS”.
This property was listed as KCP’s rental property on its Forms
8825, Rental Real Estate Income and Expenses of a Partnership or
an S corporation, for 1995 through 1997 and 1999 through 2001.
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C. Petitioner’s 2001 Federal Income Tax Return
Petitioner’s Form 1040, U.S. Individual Income Tax Return,
for 2001 (2001 return) reported that he, not Dr. Karason or KCPI,
purchased Dr. Flom’s medical equipment. Petitioner’s Form 4562,
Depreciation and Amortization, reported that he paid $27,000 for
the medical equipment, made a section 179 election to expense
$24,000 of the equipment’s cost, and claimed an additional $6003
depreciation deduction. He also reported a depreciation
deduction of $994 for other medical equipment purchased prior to
Dr. Karason’s purchase of the podiatry practice.
Petitioner’s Schedule C, Profit or Loss From Business,
reported that he leased the medical equipment to KCPI and
received $16,662 as gross rents from KCPI, which equaled the
amount of KCPI’s 2001 loan payments to Farmers Bank. After
deducting a total of $25,594 for section 179 expense and section
167 depreciation deductions and $2,307 interest expense on the
Farmers Bank loan, petitioner claimed on the Schedule C a net
loss of $11,239.
Petitioner and Dr. Karason did not enter into a written
agreement memorializing either the purported sale of the medical
equipment to petitioner or the lease of the medical equipment to
3
Petitioner listed $3,000 of the cost of the medical
equipment as 5-year property on Part II, MACRS Depreciation for
Assets Placed in Service Only During Your 2001 Tax Year, Section
B--General Depreciation System, of Form 4562, Depreciation and
Amortization.
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KCPI. The purchase agreement between Dr. Karason and Dr. Flom
did not mention petitioner’s name, indicate that the medical
equipment was assigned to petitioner, or that petitioner was
going to purchase the equipment.
D. Karason Capital Partners
Petitioner formed KCP in 1989 with members of his family for
the purpose of investing in property.4 Petitioner prepared all
of KCP’s Federal partnership tax returns. According to the
partnership returns, petitioner was a partner from 1989 through
1993 and 1996 through 2001,5 and Dr. Karason was a partner in KCP
from its formation.6 In 2001, petitioner owned a 70-percent
interest in KCP, and Dr. Karason owned the remaining 30 percent.
During 2001, KCP’s purported business activities included
renting real property and breeding race horses. KCP’s Form 1040
Schedule E, Supplemental Income and Loss, for 2001 reported that
the rental properties generated a $31,337 loss, and Form 1040
Schedule F, Profit or Loss From Farming, for 2001 reported the
horse breeding activities generated a $13,933 loss. KCP’s
Schedule K-1, Partner’s Share of Income, Credits, Deductions,
4
The partnership also went by the names Karason Family
Partnership and Karason Family Investment Club.
5
Petitioner did not own a direct partnership interest in
KCP in 1994 and 1995.
6
From 1990 through 1999, KCP’s partners at various times
included petitioner’s mother, father, and various other entities.
Petitioner and Dr. Karason were the only partners in 2001.
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etc., for 2001 reported petitioner’s distributive share of KCP
losses was $31,689.7 Petitioner deducted his share of the losses
on his 2001 Federal income tax return. From 1990 through 2003,
KCP did not generate a profit.
E. The Audit
In July 2004, respondent began the audit of petitioner’s
2001 return. Respondent requested documentation from petitioner:
(1) Establishing that he owned the medical equipment including
purchase invoices, settlement sheets, and receipts; (2)
substantiating the medical equipment’s FMV and depreciable basis;
(3) identifying bank accounts used in his medical equipment
rental business including the bank account records; and (4)
substantiating his adjusted basis in KCP.
To substantiate his basis in the medical equipment,
petitioner provided a handwritten depreciation schedule for the
medical equipment titled “Depreciation 2005”8 with no supporting
documentation other than a copy of the promissory note for the
loan from Farmers Bank. Petitioner also provided a Form 1099-
MISC, Miscellaneous Income, for 2001 from KCPI indicating it had
paid $16,662 to petitioner as rent for its use of the medical
equipment in 2001. This form was not filed with the IRS.
7
Schedule E loss of $31,337 + Schedule F loss of $13,933
($45,270) x petitioner’s 70 percent ownership (.70) = $31,689.
8
Although the schedule was titled “Depreciation 2005”, it
listed the medical equipment depreciation deduction amounts from
2001 through 2006.
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To substantiate his basis in KCP, petitioner provided his
personal bank account statements from the Auto Workers Credit
Union and a handwritten statement, without supporting
documentation, stating his adjusted basis in KCP in 2001 was
$221,194, calculated as follows:
Item Amount
JCK (K-1) share of $ 70,000
recourse liabilities
Petitioner’s beginning 159,746
capital account
2001 cash contributions 23,000
2001 income/loss per K-1
1
for JCK share (net) (31,552)
Ending capital account 221,194
1
Petitioner reduced the $31,689 loss reported on KCP’s Schedule K-1 for
2001 to reflect his receipt of $137 of ordinary dividend income ($31,689 -
$137 = $31,552).
Respondent determined that petitioner failed to establish
his cost basis in the medical equipment and failed to provide
supporting information to substantiate his basis in KCP. On June
29, 2005, respondent mailed petitioner a notice of deficiency
disallowing his section 179 expense and section 167 depreciation
deductions of $25,594, and his share of KCP’s losses of $31,689.
F. Tax Court Proceedings
Petitioner timely filed his petition on July 5, 2005. On
January 6, 2006, respondent served on petitioner a request for
production of documents. The documentation requested included
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accounting books, records, invoices, and bank records related to
the medical equipment business, documentation related to the
purchase of the medical equipment, depreciation schedules for the
medical equipment, canceled checks verifying petitioner’s initial
investment and additional capital contributions to KCP, loan
agreements relating to KCP, and books and records of KCP used to
compute petitioner’s basis in KCP. Petitioner did not provide
the requested documents.
On February 10, 2006, respondent filed a motion seeking an
order to compel production of documents. On February 23, 2006,
the Court ordered petitioner to “on or before March 10, 2006,
produce to counsel for respondent, for inspection and copying,
each and every document requested in respondent’s request for
production of documents”.
In response, to substantiate his basis in KCP, petitioner
produced a one-page typed statement of his KCP capital account
titled “Karason Family Investment Club Capital Account - JCK”.
The typed statement contradicted the handwritten statement
petitioner had provided during the audit. The typed statement
indicated that he had a 2001 capital balance of $81,806 and
contributed $18,500 to KCP in 2001. The typed statement also
indicated he made capital contributions every year from 1986
through 2001 and incurred $31,552 of partnership losses in 2001.
No supporting documentation was provided to substantiate these
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amounts. Petitioner also produced 2001 personal bank account
statements for an account with Auto Worker’s Credit Union in the
name of his mother, Marie J. Vignovich, and on which petitioner
had signatory authority. Petitioner did not provide any
documentation with respect to the medical equipment.
OPINION
I. Medical Equipment
Petitioner contends he purchased the medical equipment from
Dr. Karason in 2001 and leased it back to KCPI in 2001 along with
other medical equipment as part of his medical equipment rental
business. Thus, he asserts he is entitled to expense $24,000 of
the cost of the medical equipment purchased in 2001 pursuant to
section 179 and depreciate the remaining amount pursuant to
section 167, and that he is entitled to section 167 depreciation
deductions for previously purchased medical equipment.
Section 179 allows a taxpayer to elect to treat the cost of
section 179 property as a current expense in the year such
property is placed in service, within certain dollar limitations.
Sec. 179(a) and (b). To substantiate this expense, the taxpayer
must maintain records which specifically identify each item of
section 179 property and reflect how and from whom such property
was acquired and when such property was placed in service. See
sec. 1.179-5(a), Income Tax Regs. Section 179 property is
defined as property acquired by purchase for use in the active
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conduct of a trade or business. Sec. 179(d)(1). The term
“purchase” means generally “any acquisition of property”. Sec.
179(d)(2); sec. 1.179-4(c), Income Tax Regs. Property is deemed
acquired when reduced to physical possession, or control.
Baicker v. Commissioner, 93 T.C. 316, 322 (1989); secs. 1.48-
2(a)(2)(b)(6), 1.167(c)-(1)(a)(2), Income Tax Regs.
Section 167 allows a depreciation deduction for the
exhaustion, and wear and tear of property used in the trade or
business or held for the production of income. Depreciation is
not necessarily predicated upon ownership of the property but
rather upon an investment in property.9 Arevalo v. Commissioner,
124 T.C. 244, 251-252 (2005), affd. 469 F.3d 436 (5th Cir. 2006);
Gladding Dry Goods Co. v. Commissioner, 2 B.T.A. 336, 338 (1925);
Stiebling v. Commissioner, T.C. Memo. 1994-233, affd. without
published opinion 113 F.3d 1242 (9th Cir. 1997). The taxpayer
bears the burden of proving the Commissioner’s determinations are
incorrect.10 See Rule 142(a).
9
“The important question is * * * who made the investment
of the capital which is to be recovered over the period of the
exhaustion of the property. The one who made the investment is
entitled to its return.” Gladding Dry Goods Co. v. Commissioner,
2 B.T.A. 336, 338 (1925).
10
The burden of proof may shift to the Commissioner under
sec. 7491(a) if the taxpayer has produced credible evidence with
respect to a factual issue relating to the tax liability at
issue, has met substantiation requirements, maintained records,
and cooperated with the Secretary’s reasonable requests for
documents, witnesses, and meetings.
(continued...)
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Respondent contends petitioner is not entitled to a section
167 depreciation deduction or a section 179 expense deduction
because he did not prove he invested in or purchased the
equipment that he purportedly used in his medical equipment
rental business.
Petitioner and Dr. Karason testified that, pursuant to an
oral agreement, Dr. Karason assigned the medical equipment to
petitioner, and petitioner invested in and purchased the
equipment when he wired the bank loan funds to Dr. Karason on
January 9, 2001. They also testified that the FMV of the medical
equipment was determined pursuant to consultations with Gill
Podiatry and Moore Medical, purveyors of podiatry equipment.
Outside of the handwritten depreciation schedule, petitioner did
not produce documentation supporting either the cost or the FMV
of the medical equipment or that these consultations actually
occurred. Petitioner also testified that he did not obtain
insurance covering the medical equipment.
Petitioner and Dr. Karason testified that immediately after
petitioner purchased the medical equipment, pursuant to an oral
10
(...continued)
In this case, petitioner bears the burden of proof because
he did not: (1) Introduce credible evidence with respect to any
factual issue relevant to ascertaining his liability; (2)
substantiate his expenses; (3) maintain the required records; and
(4) cooperate with respondent's requests. Sec. 7491(a); see
Higbee v. Commissioner, 116 T.C. 438, 440-441 (2001).
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lease agreement, petitioner leased it, along with other medical
equipment, to KCPI, and as rent KCPI paid the bank loan payments
attributable to the purchase of the podiatry practice.
Petitioner testified that in years subsequent to 2001, KCPI’s
rent increased, but he produced no documentary evidence to
support this testimony.
The facts as presented support respondent’s argument that
petitioner did not invest in or purchase the medical equipment.
First, the Purchase Agreement between Dr. Karason and Dr. Flom
did not mention petitioner’s name, indicate that the medical
equipment was assigned to petitioner, or state that petitioner
was going to purchase the equipment. Second, Dr. Karason
testified that if not for the funds provided by petitioner, he
could not have paid the purchase price for the podiatry practice.
Third, the loan was secured with KCP’s property (Petitioner’s and
Dr. Karason’s partnership). Fourth, the promissory note on the
loan stated the loan was for the purpose of “BUSINESS: BUSINESS,
PURCHASE MEDICAL PRACTICE”. Fifth, Dr. Karason’s professional
corporation, KCPI, paid the monthly loan payments to the bank,
not petitioner.
Petitioner testified that his and Dr. Karason’s attorney and
accountant advised them that they did not need to enter into a
written agreement to either assign and purchase the medical
equipment or to lease the equipment to KCPI because petitioner
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and Dr. Karason were brothers. The Court finds this difficult to
believe. Petitioner was employed by the IRS for more than 17
years either auditing or supervising the audits of taxpayers. He
should have known to document the purported purchase of the
medical equipment, the lease agreement with KCPI, and the medical
equipment’s cost and FMV.
Petitioner did not produce any documentation showing either
he invested in or purchased the medical equipment. For the
foregoing reasons, the Court concludes petitioner is not entitled
to deduct the costs of the medical equipment under sections 179
and 167.11
II. Karason Capital Partners
Petitioner contends he had a sufficient basis in KCP to
allow him to deduct $31,689 as passthrough losses from KCP in
2001.
Respondent contends petitioner failed to substantiate his
purported adjusted basis in KCP, and he cannot deduct the $31,689
of passthrough losses from KCP.
Section 704(d) limits the deduction of a partner’s
distributive share of partnership loss to the partner’s adjusted
basis in the partnership at the end of the partnership year.
Sec. 1.704-1(d)(1), Income Tax Regs. The partner’s adjusted
11
Because this Court found that petitioner did not invest
in or purchase the equipment, Dr. Karason’s bank loan payments of
$16,662 did not constitute income to petitioner.
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basis in the partnership interest reflects, inter alia, the
adjusted basis in any property the partner has contributed to the
partnership. Secs. 705(a), 722. Section 6001 requires taxpayers
to maintain adequate records from which their correct tax
liability may be determined. Petzoldt v. Commissioner, 92 T.C.
661, 686 (1989).
The only documentation petitioner provided to substantiate
his basis in KCP was the handwritten statement, a typed statement
which contradicted the handwritten statement, and his and his
mother’s bank statements. The handwritten statement indicated
his adjusted basis in KCP in 2001 was $221,194. On brief,
petitioner argued that even though the handwritten statement was
accurate, his 2001 adjusted basis in KCP was actually $184,486,
comprising $70,000 of recourse liabilities, $19,628 of 2001 cash
contributions, and a $81,806 capital account.
Although respondent repeatedly requested documentation and
the Court ordered petitioner to comply with respondent’s
requests, petitioner did not provide any documentation or
testimony substantiating the $70,000 of recourse liabilities.
This Court finds petitioner failed to prove he had recourse
liabilities of $70,000.
In an attempt to substantiate the 2001 cash contributions to
KCP of $19,628, petitioner produced copies of his mother’s 2001
Auto Workers Credit Union account statements, which listed him as
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a joint member, and produced copies of his 2001 Auto Workers
Credit Union account statements, which listed his mother as a
joint member. Petitioner testified that the account in his
mother’s name was actually the KCP business account. The account
did not contain a taxpayer identification number for KCP, even
though, as admitted on cross-examination, he was aware that KCP
was required to put its taxpayer identification number on its
bank account. He explained that the account was in his mother’s
name because an individual was allowed to open only one account,
and the credit union did not allow business entities to have an
account.
Petitioner testified, and the account statements showed,
that he deposited money from his personal account to his mother’s
account. He testified that the money was transferred to fund
KCP. However, he did not provide any checks or other
documentation showing that his mother’s account was a business
account or that the withdrawals from his mother’s account were
for KCP expenses. Petitioner testified that he lived with and
supported his mother, claimed his mother as a dependent in 2001,
and claimed a standard deduction as head of household for 2001.
The facts indicate the transfer of money from petitioner’s
account to his mother’s account was to provide funds for his
mother, whom he supported. For the foregoing reasons, this Court
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finds petitioner failed to prove he contributed $19,628 to KCP in
2001.
To substantiate his purported 2001 capital account of
$81,806, petitioner produced a typed statement listing his
capital contributions. The statement contradicted KCP’s returns
and the stipulated facts by claiming petitioner made capital
contributions to KCP in: (1) 1986 through 1998, years before KCP
was formed; and (2) 1994 and 1995, years when petitioner was not
a direct partner of KCP.
Dr. Karason, a 30-percent owner of KCP since 1989, testified
that he knew nothing about KCP or its operations. He also
admitted he did not know when KCP was formed, when he became a
partner, how he acquired an interest, how much money, if any, he
contributed, whether KCP had a bank account, and whether KCP had
ever distributed stocks, bonds, or real estate to him. To this
extent, the Court believes Dr. Karason’s testimony.
Petitioner admitted that respondent repeatedly requested
documentation from him and his attorney to support his purported
basis in KCP, and he was aware it was his responsibility to prove
such basis. He offered only his self-serving testimony, and he
failed to produce any documentation to substantiate his adjusted
basis in KCP. For the foregoing reasons, this Court finds
petitioner is not entitled to deduct $31,689 as passthrough
losses from KCP in 2001.
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III. Section 6662
Section 6662(a) imposes a 20-percent accuracy-related
penalty on the portion of any underpayment attributable to
negligence or disregard of rules or regulations. Sec. 6662(b).
The term “negligence” includes any failure to make a reasonable
attempt to comply with the provisions of the Internal Revenue
Code, including any failure by the taxpayer to keep adequate
books and records or to properly substantiate items. Sec.
6662(c); sec. 1.6662-3(b), Income Tax Regs. Section 7491(c)
provides that the Commissioner bears the burden of production
with respect to accuracy-related penalties. See Higbee v.
Commissioner, 116 T.C. 438, 446-447 (2001).
Petitioner reported expenses and deductions for medical
equipment without any documentation to show he purchased or
invested in the equipment. Additionally, petitioner reported his
share of KCP’s losses without providing documentation to
substantiate his purported basis in KCP.
Petitioner was an employee of the IRS for more than 17 years
and spent the majority of this time either auditing or
supervising the audits of taxpayers. He testified he was well
aware of his responsibility to provide documentation to
substantiate his expenses, deductions, and partnership basis, but
he failed to do so even after the Court ordered him to comply
with respondent’s request for production. Respondent has met the
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burden of production, and petitioner, having failed to show
reasonable cause, substantial authority, or other basis for
reducing the underpayment on which the penalty is imposed, is
liable for the section 6662 penalty for 2001.
The Court, in reaching its holding, has considered all
arguments made and concludes that any arguments not mentioned
above are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.