In the case of Parker v. Commissioner, TC Memo 2021-111[1] the taxpayers faced a number of issues related to their tax return for 2015. We will look at a few of the issues, primarily to discuss where the taxpayers failed to obtain the benefits they claimed on their returns.

Car and Truck Expenses

IRC §274(d) was enacted to override the option for taxpayers to attempt to use the Cohan rule to claim a deduction for certain expenses for which they do not have documentation.  The Cohan rule is described in the opinion as follows:

Under Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930), if a taxpayer claims a deduction but cannot fully substantiate the underlying expense, the Court in certain circumstances may approximate the allowable amount, “bearing heavily if it [so] chooses upon the taxpayer whose inexactitude is of his own making.” The Court must have some factual basis for its estimate, however, else the allowance would amount to “unguided largesse.” Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957).[2]

Congress later determined that some expenses must be documented and, if not documented, the expenses could not be deducted, regardless of whether the taxpayer otherwise met the Cohan rule.  IRC §274(d) provides for these rules:

(d) Substantiation required

No deduction or credit shall be allowed --

(1) under section 162 or 212 for any traveling expense (including meals and lodging while away from home),

(2) for any expense for gifts, or

(3) with respect to any listed property (as defined in section 280F(d)(4)),

unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer's own statement (A) the amount of such expense or other item, (B) the time and place of the travel or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of the person receiving the benefit. The Secretary may by regulations provide that some or all of the requirements of the preceding sentence shall not apply in the case of an expense which does not exceed an amount prescribed pursuant to such regulations. This subsection shall not apply to any qualified nonpersonal use vehicle (as defined in subsection (i)).

In this case the issue arose with regard to listed property, specifically expenses related to the business use of an automobile.  As the opinion notes:

Section 274(d)(4) sets forth heightened substantiation requirements (and overrides the Cohan rule) with respect to “listed property.” As in effect during 2015, “listed property” included “any passenger automobile.” Sec. 280F(d)(4)(A)(i); sec. 1.280F-6(b)(1)(i), Income Tax Regs. No deduction is allowed for vehicle expenses unless the taxpayer substantiates, by adequate records or sufficient evidence corroborating her own statements, the amount, time and place, and business purpose for each expenditure. See sec. 1.274-5T(c), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985). Substantiation by “adequate records” generally requires the taxpayer to “maintain an account book, diary, log, statement of expense, trip sheets, or similar record” prepared contemporaneously with the use of the vehicle, as well as evidence documenting the expenditures. Id. para. (c)(2), 50 Fed. Reg. 46017. An actual contemporaneous log is not strictly required, but records made at or near the time of the expenditure have greater probative value than records made later. Id. subpara. (1).[3]

The taxpayers had claimed the following deductions for auto expense:

On that Schedule C they claimed a deduction of $25,870 for car and truck expenses. They calculated $32,313 of expenses for operating the Camaro in 2015 and multiplied that sum by a “business use” percentage of 80.06% (assuming 10,662 business-use miles and 2,656 miles devoted to commuting or personal use). They also claimed a deduction of $4,083 for depreciation on the Camaro.[4]

The Court goes on to describe their records, which the Revenue Agent found adequate only to allow $4,815 of the auto expenses, though the entire depreciation deduction was allowed by the agent:

Petitioners did not keep a contemporaneous mileage log in 2015 and did not have access to reliable odometer readings from that period. During the IRS examination they tried to estimate Ms. Parker’s business mileage using her calendar, her driving habits, and distances drawn from Google Maps. They eliminated commuting miles from their calculus and assumed no personal miles other than weekly trips to buy groceries, biweekly trips to buy household items, and monthly trips to Costco. Alleging $29,402 of expenses for operating the Camaro and a “business use” percentage of 97%, they claimed a deduction of $28,520.[5]

The Tax Court sided with the IRS on this issue, noting:

In urging a larger deduction petitioners have changed their assumed facts and computational theory at least three times since filing their 2015 return. Their final position on post-trial brief is that they are entitled to a deduction of $23,358, reflecting $26,817 of expenses for the Camaro and a business use percentage of 87.1% (assuming 6,399 business miles and 951 personal miles).

We find that petitioners have not proven their entitlement to a deduction larger than respondent has allowed. First, petitioners produced no contemporaneous (or otherwise reliable) records of the total mileage driven on the Camaro during 2015. Second, they have not satisfactorily accounted for both spouses’ personal use of the car. We do not find plausible their assumptions that their personal use of the Camaro was limited to weekly, biweekly, and monthly trips to buy groceries and household supplies. Third, the evidence they provided at trial to substantiate Ms. Parker’s business use of the Camaro was, at times, inconsistent with other evidence in the record and therefore not credible. We conclude that petitioners have fallen far short of satisfying the strict substantiation requirements of section 274(d).[6]

Retirement Plan Contributions

The taxpayers also claimed a deduction for $60,444 for funding a profit sharing/401(k) plan for the year (which the taxpayers referred to as a “Solo 401(k)” plan).  The facts outlined in the opinion are as follows:

In January 2015 petitioners created a “Solo 401(k)” plan for Ms. Parker’s personal training business, intending it as a vehicle for consolidating their existing [*7] retirement accounts. On April 14, 2016, they deposited $140,000 into this account, intending that the deposit be attributed to the 2015 tax year. This sum was broken into $100,267 (labeled “cashier’s check”), $26,793 (labeled “funds received”), and $12,940 (labeled “funds received”). The $26,793 was a rollover from Mr. Parker’s retirement account with British Telecom. The $12,940 was a rollover from Mr. Parker’s retirement account with CTS. The remaining $100,267 consisted of $39,823 rolled over from an earlier “Solo 401(k)” account plus $60,444 of unexplained funds.

On their 2015 return petitioners claimed a Self-Employed SEP, Simple, and Qualified Plans deduction of $60,444.[7]

The opinion outlines some of the rules surrounding the plan and deductions for funding it:

The Code allows taxpayers to deduct certain qualified contributions to retirement plans. Secs. 62(a)(6) and (7), 219(a), 404(a). As with other deductions, the burden of showing the amount and deductibility of contributions to an eligible plan is on the taxpayers. See Barie v. Commissioner, T.C. Memo. 2016-160, 112 T.C.M. (CCH) 255, 257. “Rollovers” — that is, transfers from one retirement account to another — are not deductible. See sec. 1.219-1(b)(2)(iii), Income Tax Regs.[8]

In this case, the Revenue Agent’s and Court’s skepticism arose from the fact that the taxpayers made a large part of the contributions to the plan during the year with a single cashier’s check, with at least a portion of the payment arising from a rollover, as well as depositing another rollover into the account.  When asked to show where the $60,444 for which they were claiming a current deduction came from, the taxpayers weren’t able to provide evidence of where the funds came from:

On April 14, 2016, petitioners deposited $140,000 into their “Solo 401(k)” account, intending to designate it for tax year 2015. Of that sum, $39,733 was rolled over from Mr. Parker’s retirement plans with British Telecom and CTS. The balance consisted of a $100,267 cashier’s check.

Petitioners contend that $39,823 of the latter sum was rolled over from an earlier “Solo 401(k)” plan and that the remaining $60,444 was a deductible retirement contribution. But they submitted no evidence showing where the $60,444 [*13] originated, i.e., whether it consisted of new cash or whether it was also a rollover from a preexisting retirement account. Admitting their failure to produce bank or brokerage records showing the source of these funds, they asserted in their post-trial brief that they prefer to keep their savings “at home where they are protected * * * and safe from unscrupulous individuals including IRS agents.” This assertion does not satisfy their burden of proof.[9]

The Court noted that the taxpayers had other sources of retirement funds, so it wasn’t clear this amount was not a rollover of funds from another plan or plans, rather than being pulled from their stash of funds in the mattress at home (or whatever their hiding spot for those funds from IRS agents and other “unscrupulous individuals” might be).

Mr. Parker testified that he created the new “Solo 401(k)” to consolidate petitioners' retirement accounts. Evidence in the record (including petitioners' prior tax returns) indicates that they had other retirement plan assets that could have been the source for the $60,444 slice of the cashier's check. For 2013 and 2014 alone, petitioners claimed deductions totaling $82,363 for contributions to self-employed SEP, SIMPLE, and qualified plans. But they admit a rollover from their prior “Solo 401(k)” of only $39,823. Viewing the evidence as a whole, we find that petitioners have failed to carry their burden of proving that any portion of the $60,444 contribution consisted of new cash rather than nondeductible rollover.[10]

Demolition Expenses for a Rental Property

The final item we’ll look at in this article is the taxpayer’s claim of rental repair expenses on Schedule E related to demolition expenses for a home the taxpayer had unsuccessfully attempted to rent in prior years and which had been destroyed in a fire the prior year.

The facts of this situation were described as follows:

In September 2008 Mr. Parker bought a house, sight unseen, on English Avenue in Atlanta (English Avenue property) for $17,000 and closing costs. He originally thought he might live in the house but decided against it after his first on-site visit. His initial efforts to rent the house were unsuccessful, and he never derived any income from it.

In early 2010 Mr. Parker canceled the insurance policy on the house. In January 2014 vandals broke into the building and set a fire that destroyed it. In 2015 petitioners paid $10,000 to have the burned-out structure demolished and $175 for a related permit. Mr. Parker continued to own the property as of the trial date.

On Schedule E, Supplemental Income and Loss, petitioners claimed a deduction of $10,000, denominated a “repairs” expense, for the cost incurred to have the structure demolished.[11]

Before the Tax Court the taxpayers agreed that it was not proper to deduct the amount on Schedule E (which the IRS disallowed), but argued instead they should have been able to claim a deduction on Schedule A for a larger amount that, in addition to the demolition expenses, included a permit for the demolition and their basis in the demolished building.

In 1984 Congress adopted IRC §280B to deal with expenses related to the demolition of structures.  That provision reads:

In the case of the demolition of any structure--

(1) no deduction otherwise allowable under this chapter shall be allowed to the owner or lessee of such structure for--

(A) any amount expended for such demolition, or

(B) any loss sustained on account of such demolition; and

(2) amounts described in paragraph (1) shall be treated as properly chargeable to capital account with respect to the land on which the demolished structure was located.

The taxpayer first argued that, despite that provision in the IRC, they are allowed to claim the loss based on Reg. §1.165-3, but the Tax Court pointed out that enactment of §280B in 1984 overrode that 1960 regulation:

In support of a contrary conclusion petitioners cite section 1.165-3, Income Tax Regs. That regulation, captioned “Demolition of Buildings,” was promulgated in 1960 and amended in 1976. See T.D. 6445, 1960-1 C.B. 93, as amended by T.D. 7447, 1977-1 C.B. 51. This regulation has no effect for demolitions carried out after section 280B’s effective date. See Tonawanda Coke Corp. v. Commissioner, 95 T.C. 124, 128 & n.2 (1990) (applying the regulation to a demolition expense deduction claimed for 1978 but noting that section 280B applies to all demolitions after July 18, 1984).[12]

But the taxpayers had another theory to advance to allow their deduction.  They claimed the loss, including the demolition costs, would be allowed as a casualty loss.  The taxpayers claimed their loss is supported by Notice 90-21.  But the Tax Court found two distinct problems with this view.

First, the fire had taken place in 2014, not 2015 which was the year before the Court.  So, to the extent amounts would be allowed as a casualty loss on the building, those losses had to be claimed on the 2014 return. A taxpayer does not, absent a specific provision in the IRC, get to select the year in which a deduction will be claimed—the taxpayer either claims it in the proper year or never obtains the benefit of the deduction.

Second, the Court points out the Notice in question does not allow a deduction for demolition expenses.

…Notice 90-21, supra, does not support their position. The relevant passage (much of which they omit from their brief) reads as follows:

Section 280B of the Code does not disallow casualty losses allowable under section 165, but it does apply to amounts expended for the demolition of a structure damaged or destroyed by casualty, and to any loss sustained on account of such a demolition. If a casualty damages or destroys a structure, and the structure is then demolished, the basis of the structure must be reduced by the casualty loss allowable under section 165 before the “loss sustained on account of” the demolition is determined. [Notice 91-21, 1990-1 C.B. at 333.]

The notice includes several examples. In Example (2), the owner of a building damaged by an earthquake pays a contractor $200,000 to demolish the building and dispose of the rubble. The notice states that the owner “may not deduct the $200,000 expense. Under section 280B of the Code, * * * [the owner] must charge that expense to capital account with respect to the land.” Id. at 334.[13]

No deduction will be allowed either on Schedule E or Schedule A, as the Court concludes:

In sum, petitioners are not entitled to deduct for 2015 any amounts related to the demolition of the structure at the English Avenue property. Any costs associated with the demolition must be capitalized into the basis of the land and will be recovered if and when the land is sold. To the extent petitioners are seeking to deduct a casualty loss attributable to the fire itself, that loss deduction cannot be claimed on their 2015 return.[14]

[1] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/couple-denied-business%2c-retirement%2c-demolition-deductions/79g2y (retrieved September 24, 2021)

[2] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021

[3] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021

[4] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021

[5] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021

[6] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021

[7] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021

[8] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021

[9] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021

[10] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021

[11] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021

[12] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021

[13] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021

[14] Parker v. Commissioner, TC Memo 2021-111, September 23, 2021