Conrad v. Comm'r of Internal Revenue

1

T.C. Memo. 2023-100

THOMAS D. CONRAD AND MARGARET JOAN CONRAD, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 7692-13

United States Tax Court

August 7, 2023

Thomas D. Conrad, pro se.

Courtney S. Bacon, for respondent.

TABLE OF CONTENTS

MEMORANDUM FINDINGS OF FACT AND OPINION ..................... 4

FINDINGS OF FACT 6

I. FMC ownership; FMC's management of hedge fund; FMC's use of the Conrads' condominium and house; FMC's yacht; FMC's airplane ................................................................................. 7

II. Tax reporting .................................................................................. 12

A. 2008 returns ............................................................................ 12

1. FMC's 2008 tax return .................................................... 12

2. The Conrads' 2008 tax return ......................................... 14

B. 2009 returns ............................................................................ 15

1. FMC's 2009 tax return .................................................... 15 2. The Conrads' 2009 tax return ......................................... 17

III. Notice of deficiency and determination of accuracy-related penalties under section 6662(a) ..................................................... 19

A. Audit and penalty approval form ........................................... 19

B. Notice of deficiency ................................................................. 20

1. 2008 .................................................................................. 20

2. 2009 .................................................................................. 22

IV. Trial proceedings ............................................................................ 24

OPINION ................................................................................................ 26

I. It is unnecessary to determine who has the burden of proof regarding deficiencies. .................................................................... 27

II. FMC cannot deduct depreciation for its yacht and its airplane but can deduct expenses for storage, maintenance, and upkeep of both and for the costs of Dr. Conrad's flying lessons. ............................................................................................ 27

A. We sustain the disallowance of depreciation deductions FMC claimed for its yacht. ..................................................... 28

B. The expenses for the storage, maintenance, and upkeep of FMC's yacht are deductible. ............................................... 28

C. FMC cannot deduct depreciation for its airplane. ................. 38

D. FMC can deduct expenses for the storage, maintenance, and upkeep of its airplane, as well as the cost of Dr. Conrad's flying lessons. ........................................................... 41

E. A summary of the allowed deductions related to the yacht and airplane for 2008 and 2009. ................................... 44

III. For both 2008 and 2009 the Conrads can deduct portions of the expenses related to their residences. ....................................... 44

A. 2008 ......................................................................................... 56

1. The Conrads' 2008 tax return ......................................... 58

2. The notice of deficiency ................................................... 59

3. The IRS's primary litigating position ............................. 60

4. The IRS's alternative litigating position ........................ 61

5. The Court's conclusion .................................................... 61

B. 2009 ......................................................................................... 66

1. The Conrads' 2009 rental income from FMC ................. 68

2. Residence deductions ....................................................... 68

a. The Conrads' 2009 tax return .................................. 69

b. The notice of deficiency ............................................ 71

c. The IRS's primary and alternative litigating positions .................................................................... 72

d. The Court's conclusion ............................................. 72

IV. The interest deduction claimed on Mrs. Conrad's 2009 Schedule C is deductible for FMC, not Mrs. Conrad. .................... 77

V. The Conrads' liability for section 6662 accuracy-related penalties for the years at issue ...................................................... 78

A. The IRS bears the burden of production, and Dr. Conrad bears the burden of persuasion. ............................................. 80

B. The requirements of section 6751(b)(1) are met for a substantial understatement but not for negligence. ............. 81

1. Substantial Understatement .......................................... 81

2. Negligence ........................................................................ 82

C. The Conrads are liable for penalties for substantial understatements if the parties' Rule 155 computations show that the Conrads substantially understated their tax liabilities for 2008 and 2009 (but no penalty is imposed on the portions of the underpayments attributable to the deductions claimed for depreciation of the yacht and the airplane because these portions are attributable to reasonable cause and good faith). ................. 84

MEMORANDUM FINDINGS OF FACT AND OPINION

MORRISON, JUDGE

Respondent (who we refer to as the IRS) issued a notice of deficiency to petitioners, Thomas D. Conrad (Dr. Conrad)^1[] and Margaret Joan Conrad (Mrs. Conrad), for 2008 and 2009, the tax years at issue. The IRS determined tax deficiencies of $134,250 for 2008 and $73,132 for 2009 and accuracy-related penalties under section 6662(a)^2[] of $26,850 for 2008 and $14,626 for 2009. The Conrads timely filed a Petition for redetermination under section 6213(a). We have jurisdiction under section 6214(a).^3[]

The parties have resolved some issues through concessions.^4[] The remaining issues and our holdings are summarized below.

1. FMC's deductions related to its yacht and its airplane. The Conrads were 51.25% owners of Financial Management Corporation (FMC), a subchapter S corporation. FMC owned a yacht and an airplane during the years at issue. On its Forms 1120S, U.S. Income Tax Return for an S Corporation, FMC deducted depreciation for the yacht and the airplane in the total amounts of $959,265 (for 2008) and $281,347 (for 2009). We sustain the IRS's disallowance of the depreciation deductions. FMC also deducted nondepreciation expenses for the yacht and the airplane. For 2008 FMC deducted $256,934 for the storage, maintenance, and upkeep of the yacht and the airplane (an amount that also included the cost of training Dr. Conrad to fly the airplane). For 2009 FMC deducted $21,893 for the storage, maintenance, and upkeep of the yacht and the airplane. We allow these nondepreciation deductions.

2. The Conrads' deductions related to the rental use of their homes. In addition to being 51.25% shareholders in FMC, during the years at issue Dr. Conrad provided management services to FMC, and in 2009 Mrs. Conrad provided accounting services to FMC. Both Dr. Conrad and Mrs. Conrad provided their services as independent contractors. During the years at issue the Conrads rented portions of their residences, a condominium in Florida from 2008 until July 2009 and a house in Georgia for the remainder of 2009, to FMC. On Dr Conrad's Schedule C, Profit or Loss From Business, attached to their tax return for 2008, the Conrads deducted $222,207 for the business use of the condominium. On Dr. Conrad's 2009 Schedule C the Conrads deducted $288,000 for the business use of the condominium and the house. On Mrs. Conrad's 2009 Schedule C the Conrads deducted $48,542 for total condominium fees and $43,200 for total rent paid for the house. The notice of deficiency determined that in 2008 the condominium was not Dr. Conrad's principal place of business and consequently disallowed the $222,207 deduction for the expenses of the business use of the condominium. On the other hand, the notice of deficiency allowed an $18,443 deduction from Schedule E, Supplemental Income and Loss (a deduction the Conrads had not claimed on that schedule), for renting the condominium to FMC. The notice of deficiency determined that in 2009 neither the condominium nor the house was Dr. Conrad's principal place of business and consequently disallowed the $288,000 deduction for the expenses of the business use of these residences. The notice of deficiency also determined that the condominium fees and rent for the house were not ordinary and necessary expenses of Mrs. Conrad's accounting business and consequently disallowed the $48,542 deduction for condominium fees and the $43,200 deduction for rent. However, the notice of deficiency allowed a $3,885 Schedule C deduction for Mrs. Conrad's use of the condominium and the house for her accounting business. The IRS also argues that the Conrads failed to report the $104,333 of rental income received from FMC in 2009. For 2008 we hold that the Conrads are entitled to (1) $184,010 of mortgage interest as an itemized deduction and (2) $144,000 of their mortgage interest as a rental-property deduction. For 2009 we hold that the Conrads are entitled to (1) $61,983 of mortgage interest and real estate taxes as itemized deductions; (2) $100,448 of their residence expenses as rental-property deductions; and (3) $3,885 of their residence expenses as a business-use-of-home deduction on Mrs....