Decisions will be entered under
HOLMES,
Ohana 1 grew up in Israel and became a very educated man. He earned his bachelor of science degree in electrical engineering and computer science. He also obtained an MBA with a focus in marketing. And since at least 1994, he's worked for CEVA, Inc.—a firm that develops and licenses digital-signal2014 Tax Ct. Memo LEXIS 84">*85 processor patents to computer-chip manufacturers. Ohana tempered his high-tech endeavors with old-fashioned real-estate investments in Israel, where he owned and rented two properties.
But it was CEVA that was the focus of Ohana's attention. After he'd worked there for ten years, the company was sufficiently impressed that it offered him a senior-executive position anywhere in the world—and Ohana chose the United States. Two years later he became executive vice president of CEVA *85 Global. His new position required constant travel and long and irregular hours. Those hours are irregular because part of his job is to attend meetings all over the world—often in exotic places like Hawaii or Morocco—for weeks at a time. Sometimes Ohana even had a chance to work out of Israel, which gave him an opportunity to visit family. His compensation, however, depended not on the number of hours worked, but on whether his team met certain quotas. And quotas they met: Ohana earned nearly $350,000 in both 2007 and 2008, and more than $550,000 even during the2014 Tax Ct. Memo LEXIS 84">*86 worst of the recession in 2009.
Ohana argues that despite his work for CEVA he was also able to find the time to run a real-estate business. Exactly how much time he spent on his real-estate activity between 2007 and 2009 is fuzzy though, since the only records Ohana kept were reconstructed logs that he pieced together from his Gmail account years later. At trial he referred to it as a "puzzle to put together." He said that he planned to make money by flipping houses—i.e., buying a house with the intent to fix it up and then sell it at a profit. Successfully flipping houses depends on several steps' being executed gracefully, from choosing where to buy (ideally in a neighborhood that attracts deep-pocketed customers) to choosing the right people to do the renovations to keeping transaction costs low. But if something goes wrong, such as trying to flip after a market crash, the flip can flop and the *86 flipper can be stuck with a piece of real estate. Ohana, however, claimed he had an "exit strategy:" He would move into the house and live there until the market was more favorable and then he'd try again to sell the property.
The Ohanas bought their first home in 2005 in Saratoga, California,2014 Tax Ct. Memo LEXIS 84">*87 a town on the edge of Silicon Valley. They bought the Saratoga home in their own names and personally held title to it. In 2006 Ohana sold one of his properties in Israel to fund his next acquisition, a house on Cowper Street in Palo Alto. Gregg Ann Herrern, a real estate agent, brokered the deal. Ohana intended from the get-go to tear down the Cowper Street home and build a new one, but at first he made only enough repairs to make the property livable. He quickly rented it out and left Herrern to manage the property, arrange for any necessary maintenance, and collect rent each month. Later on, when Ohana tried to evict his Cowper Street tenants, he emailed Herrern: "I told them from day one that I am going to build my house on this property."2 In fact, that same day, he drafted an email for Herrern to deliver to the tenants saying the property "was purchased 2 years ago in order to build a new residence for my family." *87 In 2007 Ohana began meeting with an architect and developing plans that included not only rebuilding the Cowper Street home, but also building a separate cottage unit that would function as a guest house and rental property. The Cowper Cottage was eventually given its2014 Tax Ct. Memo LEXIS 84">*88 own address and rented out. But on the record deed documenting the purchase, Ohana checked a box on the form that he intended to eventually make the Cowper Street home his primary residence. He also emailed the chief building official of the City of Palo Alto that he had bought the property "to build my future home in Palo Alto."
At the beginning of 2008, however, the Ohanas were still living in their Saratoga home, which they began to remodel. During that year, Ohana also began trying to get a construction loan to refinance his mortgages and fund the building of a new house and cottage on the Cowper Street property. On this loan application Ohana again stated that he would use the money to build a primary residence, rather than invest in a business. And that's just what he got—the loan papers show that he received a residential, not an investment, mortgage. Ohana had by this time formed two limited-liability companies, Ohana Consulting LLC and Zoop LLC, but these neither held title to the two properties2014 Tax Ct. Memo LEXIS 84">*89 nor were the named borrowers for the mortgage and construction loans. Indeed, throughout the three years before us, the Ohanas were the sole title holders and borrowers for *88 both properties, even though the Ohanas reported on their tax returns that Ohana Consulting and Zoop owned both homes and incurred hundreds of thousands of dollars in expenses.
By the end of 2008 Ohana's general contractor had razed the home on the Cowper Street property and begun construction. There are a number of facts that strongly suggest Ohana intended the Cowper Street property to be his family's personal residence, starting with his decision to enroll his daughters in the Palo Alto school system for the 2008 and 2009 school years, before construction had even begun. And as soon as construction was completed (sometime in September 2009), the Ohanas moved in and began renting out the Saratoga home. The new Cowper Street home also had several quirks, such as a custom-built door with a peephole low enough that the five-foot-four Ohana could reach it. And Ohana obsessed over every detail of the project—he was very particular about materials, design, the interior decoration, and even which workers his contractor2014 Tax Ct. Memo LEXIS 84">*90 could use. He visited the property every day he was in Northern California and even had cameras installed so he could monitor the progress from afar. David Avny, his fellow Israeli friend and a CEVA co-worker, described Ohana as involved in everything, "not only in real estate. It's everything about him. He's very methodical."
*89 Ohana's real-estate activity was not entirely limited to the two properties that he owned. In his free time he and Avny went around looking at multi-million-dollar properties in the area. He was on an email listserv that alerted him daily about properties in the area. And he spent a fair amount of time talking with Avny about potential acquisitions. But during the years we're looking at, this was the extent of his real-estate activity with Avny—just scoping out the market and strategizing late into the night about their possible future plans. Ohana nevertheless considered Avny a "partner" in his real-estate endeavors, even though they never went in together on a development project, and not once did they even buy a property through a partnership. Their relationship, we therefore find, was more of a friendship between two men who both dabbled in real estate, and2014 Tax Ct. Memo LEXIS 84">*91 not a partnership. And, of course, Ohana not only didn't sell or offer to sell either of the two properties that he did own, but he actually used both (albeit at different times) as his personal residences.
Ohana's scrupulous attention to detail in building his homes and working for CEVA did not carry over into his tax preparation. He says that he didn't read or even look at his 2007, 2008, or 2009 individual or partnership tax returns before signing and submitting them to the IRS. He didn't compare his Quickbooks accounting records to his tax return. And he didn't provide receipts *90 to the revenue agent during the examination to substantiate the business expenses claimed by Ohana Consulting and Zoop. Instead of checking his returns, Ohana relied on the tax-preparation skills of URS—an organization that specialized in pitching services to Israeli immigrants.3 Many of URS's employees were Israelis who would spend most of the year back home and come back to the United States just before tax season. Ohana's friend Avny was cautious about using the firm, and he refused to allow anyone but the owner of URS, a man named Nadav, to do his taxes. Ohana was not as picky. His return preparer, Shalom2014 Tax Ct. Memo LEXIS 84">*92 Eyal Bitton, was neither an accountant nor a lawyer, though he was a former CFO of an Israeli company, and he came from an elite unit in the Israeli army—not particularly relevant experience when it came to tax preparation, but perhaps some indicator of trustworthiness to this particular expatriate community. Bitton assured Ohana that the software URS used should eliminate any concerns and would confine his role to data entry. As a bonus, Bitton promised that Nadav would review Ohana's returns. Ohana sent Bitton all the information related to his income and *91 deductions, including his real-estate activities, on documents entitled "Profit and Loss Details." URS then entered this data into a computer and generated a tax return.
Ohana's experience with URS was apparently2014 Tax Ct. Memo LEXIS 84">*93 typical—although a first-time taxpayer who used URS's services would undergo a two-to-three hour interview and hand over all his income and deduction information, later interaction was minimal. It is unclear from the record whether URS generally acted as a preparer that relied on its clients to characterize items of expense and income, or as a professional that advised its clients of the correct characterization of those items. But we do find that Ohana's dialogue with URS was limited, and that after his first conversation he went straight to a receptionist who already had his returns prepared. All a taxpayer like Ohana had to do then was cut a check and send the return to the IRS.
The Ohanas claimed deductions for nonrental business expenses and rental real-estate activity losses during 2007, 2008, and 2009 in the following amounts:42014 Tax Ct. Memo LEXIS 84">*94
| 2007 | $96,780 | $138,874 |
| 2008 | 45,128 | 90,560 |
| 2009 | 145,472 | 55,492 |
The Commissioner issued notices of deficiency to the Ohanas for the 2007-2009 tax years in 2011. In them, the Commissioner determined that the Ohanas' rental real-estate losses were passive and also disallowed all of the Ohanas' claimed nonrental real-estate expenses. The notices disallowed the expenses of Ohana Consulting and Zoop, and asserted penalties, too. The Ohanas timely filed petitions to the Tax Court.
We tried the cases in California where the Ohanas live now, as they did when the cases began.
Taxpayers are generally allowed to deduct business and investment expenses under
The deductibility of Ohana's nonrental expenses turns on whether they were personal or incurred in connection with a trade or business.
But did his activity amount to being in a trade or business? *94 The definition of "trade or business" is not found in the Code, but the Supreme Court has provided us with the a well-known rule of thumb: to be engaged in a trade or business, a taxpayer must (1) be involved in the activity with continuity and regularity (2) the primary purpose of which is income or profit.
Many witnesses credibly testified that Ohana was heavily involved in his real-estate projects.6 But while Ohana may have been extremely involved in the remodeling2014 Tax Ct. Memo LEXIS 84">*96 and renovating of his homes, he was not "continuously or regularly" involved in the
There is a second test that taxpayers must pass to show they were engaged in a trade or business, and that is proof that their primary purpose in engaging in the activity was for profit. The case here is affected by the fact that Ohana's *96 activities revolved around properties that either were or became his homes, and we need to figure out whether Ohana's expenses in improving these
We use five factors to determine whether an individual has converted his personal residence into property held for the production of income: • the length of time the house was occupied by the individual as his home before placing it on the market for sale; • whether the individual permanently abandoned all further personal use of the house; • the character of the property; • offers to rent; and • offers to sell.
The Ninth Circuit disagreed with our analysis2014 Tax Ct. Memo LEXIS 84">*100 and reasoned that renting a house at its fair market value showed that a taxpayer has a profit motive.
Because Ohana meets neither of the two requirements for characterizing his activities concerning his Saratoga home as a trade or business, we agree with the *99 Commissioner that the Ohanas can deduct no expenses other than mortgage interest and property taxes with respect to that property.
Ohana argues that the expenses2014 Tax Ct. Memo LEXIS 84">*101 which he incurred in building the new Cowper Street home and cottage were not personal because he intended to make a profit on their eventual sale. But as we said in
We therefore find that the Ohanas were not engaged in the trade or business of real-estate development from 20072014 Tax Ct. Memo LEXIS 84">*103 to 2009.10
This finding has consequences for the rest of the Ohanas' case. We cannot allow a great many of their contested deductions because they are not connected to a trade or business. But there are other problems with them, to which we now turn. The Ohanas claimed deductible nonrental expenses on the tax returns they filed for Ohana Consulting and Zoop—the partnerships 11 we've already found did not own either of the two Ohana homes—for each year at issue.
*102| Auto and truck expense | $10,242 | $13,541 | $8,938 |
| Meals and entertainment | 2,327 | 1,771 | 1,177 |
| Telephone | 1,332 | 1,327 | 2,380 |
| Travel | 14,305 | 10,860 | 12,950 |
| Total | 28,206 | 27,499 | 25,445 |
The only documents2014 Tax Ct. Memo LEXIS 84">*104 in evidence substantiating most of these expenses are Ohana's Quickbooks Profit and Loss Detail charts. But these are just summaries of his assertions, and a taxpayer's uncorroborated statements are generally not enough to support deductions for unsubstantiated amounts claimed.
Some of these expenses are deductible, albeit as personal expenses that the2014 Tax Ct. Memo LEXIS 84">*105 Code allows individuals to deduct, including their mortgage-interest expenses, state-income tax payments, and gifts to charity.
| Home mortgage interest | $54,859 | $47,711 | $38,659 |
| State income taxes | 24,481 | 24,628 | 35,686 |
| Gifts to charity | 1,520 | 1,424 | 1,320 |
These are allowed.
We're left with what to do about the expenses incurred to renovate both the Saratoga and Cowper Properties. The Ohanas claimed the following deductions for these expenses on their partnership tax returns: *104
| Tax and licenses | $11,189 | $800 | $4,246 |
| Interest | — | — | 72,701 |
| Insurance | 256 | 3,593 | 617 |
| Outside services | 44,478 | — | — |
| Utilities | 859 | 1,566 | — |
| Total | 56,782 | 5,959 | 77,564 |
Expenses related to real-estate activities are subject to the Code's capitalization rules.
Under
The renovations of the Saratoga property are a hybrid: Renovation expenses are properly capitalized under the rules of
All that is left are the penalties. A substantial underpayment exists if the understatement of tax exceeds the greater of 10 percent of the amount of tax required to be shown on the return or $5,000.
| Tax required to be shown | $54,297 | $55,658 | $115,398 |
| Less: Tax on return | 12,524 | 27,230 | 95,972 |
| Understatement | 41,773 | 28,428 | 19,426 |
| 10% of Tax required to be shown | 5,429.70 | 5,565.80 | 11,539.80 |
The understatements for 2007, 2008, and 2009 exceed both 10 percent of the tax required to be shown and $5,000, based on this concession alone. The Commissioner therefore meets his burden of production on the penalty with simple arithmetic.
The only issue left in dispute is whether Ohana has a
We must first decide whether Ohana received any advice at all from URS2014 Tax Ct. Memo LEXIS 84">*108 regarding his tax liabilities.
Even if we assume he did receive "advice" the caselaw lists three factors we need to look at to decide whether his reliance on it was reasonable. • First, was the adviser a competent professional who had sufficient expertise to justify reliance? • Second, did the taxpayer provide necessary and accurate information to the adviser? • Third, did the taxpayer actually rely in good faith on the adviser's judgment?
We have already touched the first factor—URS was a group of mostly untrained individuals whose responsibilities involved rote data entry based on documents provided by their clients. The documents that Ohana gave them—spreadsheets entitled Profit and Loss Details—bear a title that would likely lead a *109 number cruncher to assume Ohana was running a business. Still, we need to carefully focus on the main issue—whether Ohana reasonably knew or should have known that the tax preparer lacked knowledge in the relevant areas of tax law.
The2014 Tax Ct. Memo LEXIS 84">*111 Ohanas, however, must also establish that they provided necessary and accurate information with respect to all items reported on their tax returns, so that the incorrect returns resulted from the adviser's own errors.
There are problems here. Ohana testified that he had provided all of his real-estate emails to his attorney, who was then supposed to turn them over to the IRS, but we have found that he omitted the one least favorable email—the one in which he told his real-estate agent that he bought the Cowper Street property to *111 build a future home for his family. Ohana also testified that he managed all of his rental properties during 2007-09, but we've found that Herrern was the one who took the tenant applications, picked up their rent checks, handled maintenance requests, and mailed final notices of termination when the Ohanas decided to move in. This casts grave doubt about whether Ohana provided necessary and accurate information to URS, a doubt that becomes still graver2014 Tax Ct. Memo LEXIS 84">*112 because the documents that he gave to URS were estimated reconstructions—unsupported by receipts—of what Ohana believed his income and expenses to be. And given the discrepancies between Ohana's Quickbooks logs and his tax returns, we find that Ohana did not furnish necessary and accurate information to URS.
The general rule is that a taxpayer can not avoid his duty to file accurate returns by placing the responsibility on an agent.
While reliance on a professional tax preparer may save a taxpayer from accuracy-related penalties, it won't where an intelligent and skilled taxpayer *113 provided inaccurate information to the return preparer and claims improbably not even to have glanced at his returns to make sure they were satisfactorily prepared.
1. All references to Ohana in this opinion are to Issachar. Mrs. Ohana's only activity in this matter was signing the joint tax return with her husband.↩
2. We observe that this email—and only this email—was missing from the production set of emails that the Ohanas provided to the IRS. The Commissioner got the email directly from Herrern.↩
3. There are several cases pending in our Court naming URS as the tax preparer. A great many of URS's clients are being investigated by the IRS. Criminal charges have been filed against URS in the Central District of California on allegations that the firm deliberately aided, abetted, and assisted some of its clients in hiding money in Luxembourg after filing false tax returns. (We stress that Ohana is not one of these clients.)↩
4. The Ohanas also claimed a long-term capital loss of $1,277 on their 2009 return as a result of not applying their long-term capital loss carryover from 2008 to their capital gains in 2009. But they failed to address this issue on brief, and we consider it abandoned for purposes of these cases.
5. All section references are to the Internal Revenue Code in effect for the tax years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩
6. The documentary evidence on which Ohana relies (e.g. binders and time logs) is not very probative as he put them together only for trial from approximations based on some of his emails and calendar.↩
7. Before repeal,
8. Worse still, Ohana claims to have known full well that the market was about to crash and that he would be unable to sell at a profit.↩
9. We likewise reject the Ohanas' alternative argument that their expenses are deductible as investment expenses under
10. The parties skirmished on who should bear the burden of proof. This fight is relevant only in the rare instances where there is an evidentiary tie.
11. Ohana Consulting and Zoop were both LLCs with only two members (the Ohanas). Because the Ohanas didn't elect to treat them as corporations, both LLCs are classified as partnerships under the Code.
12. The Court will enter decisions under
