The phrase "principal residence" is not defined by the Code; however, section 1.1034-1(c) (3) (i), Income Tax Regs., provides that the determination of whether a property is used by a taxpayer as his principal residence "depends upon all the facts and circumstances in each case, including the good faith of the taxpayer." Generally, for property to be "used by the taxpayer as his principal residence" within the meaning of section 1034(a), that taxpayer must physically occupy and live in the dwelling. Houlette v. Commissioner, 48 T.C. 350">48 T.C. 350, 48 T.C. 350">354 (1967); Stolk v. Commissioner, 40 T.C. 345">40 T.C. 345, 40 T.C. 345">353-356 (1963), affd. 326 F.2d 760">326 F.2d 760 (2d Cir. 1964). See generally Perry v. Commissioner, 91 F.3d 82">91 F.3d 82 (9th Cir. 1996), affg. T.C. Memo. 1994-247, for a recent summary of applicable rules.

For 1988, we have specifically found that petitioners did not occupy 14 Siros as their 1997 Tax Ct. Memo LEXIS 73">*103 principal place of residence. We also found that, when he prepared and filed petitioners' return for 1988, petitioner was familiar with the requirements for deferral of gain under section 1034 and knew that petitioners did not qualify for deferral with respect to the gain on the property at 14 Siros, but nonetheless claimed the deferral on the return in order to defeat or avoid the taxes known to be owing on the gain that they realized from sale of that property. In addition, petitioners reported sale of their actual residence, Apricot, as a sale of business property, thereby concealing the identity of their actual residence. We reject the testimony by both petitioners at trial that they actually resided at 14 Siros and that they received rental income from a tenant at Apricot. Petitioners' explanations are improbable, in view of the sequence of events, and were contradicted by disinterested witnesses. Implausible explanations of this kind are among identified badges of fraud. See 796 F.2d 303">Bradford v. Commissioner, supra.

We have also found that petitioner intentionally underreported income from sale of the Malloy property by $ 65,269 in order to defeat or avoid the payment of taxes known 1997 Tax Ct. Memo LEXIS 73">*104 to be owing on that gain. From his testimony and from the entire record, we are satisfied that petitioner had the education and intelligence to understand what was required and that he deliberately falsified his return in order to avoid payment of tax known to be owing. Although we do not believe her trial testimony, we have no evidence that Mrs. Goldberg had the education or experience to know that these transactions were falsely reported. The addition to tax for fraud for 1988 will be sustained only as to petitioner. See Minter v. Commissioner, T.C. Memo. 1991-448; Congelliere v. Commissioner, T.C. Memo. 1990-265.

Our conclusions as to the above two items for 1988 are sufficient to establish an underpayment of tax for that year and to shift to petitioner the burden of showing that any other portion of an underpayment is not due to fraud. Respondent has, however, conceded that certain disallowed expenses do not result in an underpayment due to fraud, and those concessions will affect the final computation.

Our conclusions regarding fraud are also sufficient under section 6501(c) (1) to overcome the bar of the statute of limitations for that year. See Stone v. Commissioner, 56 T.C. 213">56 T.C. 213, 56 T.C. 213">228 (1971). 1997 Tax Ct. Memo LEXIS 73">*105 Therefore, it is not necessary for us to discuss whether respondent has proven a substantial omission of income for purposes of section 6501(e) (1).

For 1990 and 1991, respondent bases her determination of fraud on petitioners' failure to report income allegedly embezzled from Kortava and on postponement of reporting income from the vehicle resale business. Respondent has not proven by clear and convincing evidence that petitioner embezzled money from Kortava or that petitioners failed to report money received from Kortava as income with knowledge that the funds were taxable. Although petitioner exercised control over the funds and was high-handed in his use of them, leading to a dispute with Kortava, it is not clear that petitioner intended permanently to deprive Kortava of his funds. Respondent has not disproved petitioners' explanation that they were investing money in real estate and in other businesses in accordance with an agreement with Kortava, as demonstrated by their return of $ 165,000 of Kortava's money on his demand. See, e.g., Baumgardner v. Commissioner, 251 F.2d 311">251 F.2d 311, 251 F.2d 311">322 (9th Cir. 1957), affg. T.C. Memo. 1956-112; Ishijima v. Commissioner, T.C. Memo. 1994-353. We are 1997 Tax Ct. Memo LEXIS 73">*106 not convinced that reporting income in 1991 instead of 1990 was due to fraud.

There is no apparent relationship between the transactions that we determined were fraudulently reported for 1988 and the transactions that were the basis of respondent's determination for 1990 and 1991. Thus, there is no discernible pattern from which fraud can be inferred. As appears from the discussion below, the other items in dispute for 1990 and 1991 would not support a determination of fraud. Respondent's determination under section 6663, therefore, will not be sustained. Respondent's alternative determination of the accuracy-related penalty under section 6662(a) for 1990 and 1991 is discussed below.

Unreported Income -- Bank Deposits

Respondent determined during the audit, based on a bank deposits analysis, that petitioners failed to report $ 48,160 of income on their 1988 return. At trial, respondent introduced a second bank deposits analysis increasing the claim for underreporting to $ 79,147. While petitioners generally argue that respondent's determination is incorrect, petitioners specifically contend that respondent's analyses do not accurately reflect certain income reported on their 1988 return. 1997 Tax Ct. Memo LEXIS 73">*107

The bank deposits analysis that was prepared during the audit of petitioners' return is not reliable. There is no evidence that this analysis took into account transfers, redeposits, or returned checks. Also, this analysis does not account for the proceeds from petitioners' sale of Analog stock.

The second bank deposits analysis identifies the following amounts as deposits of proceeds from:

The second analysis does not correctly take into account the amounts reported by petitioners.

We conclude that petitioners have unexplained deposits as follows:

Petitioners have failed to provide any other evidence that the unexplained deposits, as determined above, do not constitute unreported income. Thus, respondent's determination, as adjusted above, that petitioners had unreported income will be sustained.

Unreported Income -- Like-Kind Exchange

Respondent initially argued that petitioners' transfer of $ 80,000 1997 Tax Ct. Memo LEXIS 73">*108 from the 14 Siros escrow to Shumin for the downpayment on 29 Hastings and their provision of other amounts necessary for Shumin's purchase of 29 Hastings somehow alter the exchange. Respondent has not argued that petitioners were not repaid for the advances to Shumin.

That petitioners provided funds for Shumin's purchase of 29 Hastings does not change the treatment of the exchange of properties. In 124 Front Street, Inc. v. Commissioner, 65 T.C. 6">65 T.C. 6 (1975), the taxpayer owned an option to purchase property that Fireman's Insurance Company (Fireman's) wanted to acquire. Fireman's advanced to the taxpayer the funds to acquire the property so that the taxpayer could exchange the property for property owned by Fireman's. We held that the transaction was a like-kind exchange and that the advance, which was bona fide, was not boot to the taxpayer. 65 T.C. 6">Id. at 15-16; see also Biggs v. Commissioner, 69 T.C. 905">69 T.C. 905 (1978), affd. 632 F.2d 1171">632 F.2d 1171 (5th Cir. 1980). In the instant case, as in 124 Front Street, Inc., there is no evidence that the advances that were made by petitioners were not bona fide. Petitioners acquired 29 Hastings in a transaction that will be respected for tax purposes. See, e.g., Estate of Bowers v. Commissioner, 94 T.C. 582">94 T.C. 582, 94 T.C. 582">590 (1990); 1997 Tax Ct. Memo LEXIS 73">*109 69 T.C. 905">Biggs v. Commissioner, supra at 918(courts have afforded great latitude in structuring exchanges under section 1031).

Section 1031(a) provides the general rule that "No gain or loss shall be recognized on the exchange of property held solely for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment." Emphasis added. Petitioners exchanged two pieces of real estate (the Detroit properties and the 8th Street property) for one piece of real estate (29 Hastings) plus the excess cash proceeds. Cash is not property of like kind to real estate, and, thus, petitioners' exchange was not solely in kind. Gain must be recognized to the extent of such cash received (boot). See sec. 1031(b).

The excess proceeds must be taken into account as boot because the replacement property, 29 Hastings, cost IEC less than the proceeds available from the disposition of the relinquished property. By using the excess proceeds to increase their equity in 29 Hastings (by reducing the mortgage) instead of receiving the excess proceeds outright, petitioners attempted 1997 Tax Ct. Memo LEXIS 73">*110 to avoid treating the excess proceeds as property not of like kind. That petitioners, not IEC, agreed to pay down the mortgage on 29 Hastings is indicative of petitioners' control over the excess proceeds. "'The power to dispose of income is the equivalent of ownership of it. The exercise of that power to procure the payment of income to another is the enjoyment, and hence the realization, of the income by him who exercises it.' * * * [The taxpayer's] failure to receive cash was entirely due to his own volition." Murphy v. United States, 992 F.2d 929">992 F.2d 929, 992 F.2d 929">931 (9th Cir. 1993) (quoting Helvering v. Horst, 311 U.S. 112">311 U.S. 112, 311 U.S. 112">118 (1940)).

Petitioners realized gain of over $ 176,000 and, thus, must recognize gain on the exchange equal to $ 36,335.11. Sec. 1031(b).

Unreported Income--Unemployment Compensation

Respondent determined that petitioners failed to report $ 4,606 of unemployment compensation that petitioner received during 1988. Petitioners claim that the amount they reported, $ 1,328, represented unemployment compensation and that the $ 4,606 amount that respondent claims they failed to report represented disability compensation. Petitioner, however, has provided neither explanation nor 1997 Tax Ct. Memo LEXIS 73">*111 corroboration of any alleged disability. Petitioner's testimony was not persuasive. Respondent's determination that the unreported amounts represented taxable unemployment compensation will be sustained.

Unreported Income--Kortava

Respondent determined that petitioners failed to report income received from Kortava during 1990 and 1991. Petitioner received $ 292,544 and $ 275,612, in 1990 and 1991, respectively, from Kortava. Petitioner returned $ 165,000 to Kortava in 1991.

Preliminarily, petitioners contend that respondent's proof at trial and argument on brief do not conform to the notice of deficiency or to the affirmative pleadings. Petitioners note that the statutory notice of deficiency and answer refer to "foreign fund income" as an adjustment to income in the amounts of $ 220,000 and $ 233,566 for 1990 and 1991, respectively. The notice of deficiency explains this determination as "Supplemental compensation and bonuses are includable in gross income." Respondent's answer, in alleging fraud, states: "The petitioners fraudulently and with intent to evade income taxes failed to report foreign fund income in the respective amounts of $ 220,000 and $ 233,566 during 1990 and 1991 1997 Tax Ct. Memo LEXIS 73">*112 taxable years." Respondent's argument on this issue on brief is that "petitioners stole $ 568,156, both concealing and misrepresenting their use of these funds to Kortava, and failing to report most of their embezzlement on their returns."

In the notice of deficiency and at trial, respondent maintained the position that petitioners had failed to report income received from foreign sources. The record does not indicate that petitioners misunderstood respondent's position. In this instance, the evidence that is required to disprove the determination in the notice of deficiency is not different than that required to meet the position taken by respondent at trial. Cf. Estate of Falese v. Commissioner, 58 T.C. 895">58 T.C. 895, 58 T.C. 895">899 (1972). Respondent has not raised a new matter. Respondent has proposed a new theory, merely clarifying or developing the original determination. Respondent does not bear the burden of proof on a new theory. See Estate of Jayne v. Commissioner, 61 T.C. 744">61 T.C. 744, 61 T.C. 744">748-749 (1974).

Petitioners do not contest that Kortava transferred funds in the above-stated amounts to petitioners during 1990 and 1991. Petitioners' position is that their mere receipt of the funds as agents of Kortava 1997 Tax Ct. Memo LEXIS 73">*113 does not produce taxable income.

Gross income includes all "accessions to wealth, clearly realized, and over which the taxpayers have complete dominion". James v. United States, 366 U.S. 213">366 U.S. 213, 366 U.S. 213">219 (1961) (quoting Commissioner v. Glenshaw Glass Co., 348 U.S. 426">348 U.S. 426, 348 U.S. 426">431 (1955)). There can be no doubt that petitioners exercised control over the funds that were deposited in or transferred to their personal accounts. We must decide whether the extent of their control was such that they are taxable on the amounts that were transferred from Kortava in the years of the transfers.

The transfers from Kortava went into two accounts: California Federal account number 6130, in petitioner's name, and California Federal account number 6250, in Coastline's name. Petitioners then transferred these funds to other Coastline accounts and to their own savings account.

Petitioners claim that the funds that were transferred to their personal savings account were payment for petitioners' Mercedes that was sent to Russia and payment for petitioners' interest in Martis Landing and Saddle Rock.

Mercedes

We have found as a fact that Kortava transferred $ 20,000 to petitioner as consideration for petitioner's sending 1997 Tax Ct. Memo LEXIS 73">*114 his Mercedes to Russia. Petitioner did not report this amount on his 1990 return. Respondent determined that this amount represented unreported income.

When it became apparent that petitioner would not be able to meet the requirements of specific vehicles as contemplated by the agreement between Kortava and petitioner, petitioner sent his personal car, the Mercedes, to Russia. The acquisition expense of the Mercedes was not shown on the Schedule C for 1990 or 1991. There is no evidence that the Mercedes was ever treated as the property of the Schedule C business. All of the indications are that the Mercedes was the personal car of petitioners. Thus, we conclude that the transaction occurred outside the Schedule C business. Petitioner testified that he paid "about $ 20,000" for the Mercedes when he purchased it in 1985. His testimony in this respect is not incredible and is not contradicted. Thus, the amount petitioner received in payment for the Mercedes was not in excess of the cost of the Mercedes; therefore, petitioners have no gain from the sale of their car to Kortava and have not failed to report income related to the sale of the Mercedes.

Saddle Rock and Martis Landing

Petitioners 1997 Tax Ct. Memo LEXIS 73">*115 claim that their investment in Saddle Rock and Martis Landing was $ 188,000, consisting, in part, of the following:

Respondent contends that petitioners did not have an investment in these properties because these amounts were paid with funds received from Kortava.

Petitioners claim that $ 188,000 received from Coastline represents a payment for their interest in Saddle Rock and Martis Landing. We must decide whether Coastline ever owned the properties.

We found as a fact that Coastline was not a party to the sale of Martis Landing. Furthermore, petitioners reported the sale of Martis Landing on their 1991 personal return. The proceeds of the sale of Martis Landing were deposited into petitioner's personal account, California Federal account number 6130. No evidence has been presented that Coastline was an owner of Martis Landing or that Coastline received the proceeds from the sale of Martis Landing. Petitioners never effectuated a transfer of Martis Landing to Coastline; thus, no portion of the money transferred from Coastline's account was in payment 1997 Tax Ct. Memo LEXIS 73">*116 for petitioner's interest in Martis Landing.

Petitioners claim that they transferred Saddle Rock to Coastline and that Coastline then sold Saddle Rock to Moeller. Petitioners rely on certain documents, including the following: (1) A Long Form Security (Installment) Land Contract with Power of Sale between petitioners, as vendors, and Coastline, as vendee, notarized on June 21, 1991, and recorded on November 18, 1994; (2) a Grant Deed from petitioners to Coastline dated "as of January 1, 1992" and notarized on November 17, 1994, and filed on November 18, 1994; (3) a Long Form Security (Installment) Land Contract with Power of Sale between Coastline, as vendor, and Moeller, as vendee, dated January 1, 1992, and recorded on November 18, 1994; and (4) a Notice of Supplemental Assessment from the Orange County Assessor showing Coastline as owner of Saddle Rock due to a change of ownership effective on June 21, 1991.

For purposes of Federal income taxation, a sale occurs upon the transfer of benefits and burdens of ownership, rather than upon the satisfaction of the technical requirements for the passage of title under State law. Derr v. Commissioner, 77 T.C. 708">77 T.C. 708, 77 T.C. 708">723-724 (1981); Yelencsics v. Commissioner, 74 T.C. 1513">74 T.C. 1513, 74 T.C. 1513">1527 (1980). 1997 Tax Ct. Memo LEXIS 73">*117 The question of when a sale is complete for Federal income tax purposes is essentially one of fact. Baird v. Commissioner, 68 T.C. 115">68 T.C. 115, 68 T.C. 115">124 (1977). The applicable test is a practical one that considers all of the facts and circumstances, with no single fact controlling the outcome. 77 T.C. 708">Derr v. Commissioner, supra at 724; 68 T.C. 115">Baird v. Commissioner, supra at 124; Deyoe v. Commissioner, 66 T.C. 904">66 T.C. 904, 66 T.C. 904">910 (1976). Generally, a sale of real property is complete upon the earlier of the transfer of legal title or the practical assumption of the benefits and burdens of ownership. 77 T.C. 708">Derr v. Commissioner, supra at 724; 68 T.C. 115">Baird v. Commissioner, supra at 124; 66 T.C. 904">Deyoe v. Commissioner, supra at 910.

Coastline did not receive the benefits and burdens of ownership upon the execution of the contract of sale from petitioners. Coastline was not entitled to possession until the recording of the contract of sale (which occurred November 18, 1994). Risk of loss did not pass until Coastline had possession. Coastline had no obligation to furnish insurance for Saddle Rock until it gained possession of the property. Coastline's only responsibility upon the execution of the contract of sale was the payment of real estate 1997 Tax Ct. Memo LEXIS 73">*118 taxes.

Coastline also did not have full legal title at the time the contract of sale was executed. Under California law, delivery and acceptance of a deed passes full legal title. Cal. Civ. Code, sec. 1056 (West 1982). We have only the Grant Deed dated "as of January 1, 1992" and notarized on November 17, 1994, in the record. Even if the deed were effective retroactively to January 1, 1992, Coastline did not have title to Saddle Rock on June 21, 1991, when petitioner transferred $ 188,000 from Coastline's account to petitioners' personal account.

On June 21, 1991, Coastline was not the owner of Saddle Rock, and, therefore, no portion of the money transferred from Coastline's account was in payment for petitioner's interest in Saddle Rock.

In summary, petitioners have unreported income to the extent of the moneys transferred into their personal accounts and to the extent that moneys in Coastline accounts were used to pay expenses of Saddle Rock and Martis Landing.

In 1991, petitioners returned to Kortava $ 165,000, representing a portion of the moneys received from him. This repayment should be taken into account in the parties' Rule 155 computation.

Respondent also determined that 1997 Tax Ct. Memo LEXIS 73">*119 petitioners used funds for unidentified and personal expenses of $ 8,264.64 from Dean Witter account number 37733 and $ 2,736.23 from Schwab account number 3843. Petitioners, in their response to a proposed finding of fact regarding Schwab account number 37733, claim that certain charges from Budapest and Madrid that are reflected in the proposed finding and on account statements are not personal expenses. Petitioners state on brief that respondent was shown petitioners' passports and that the passports did not reflect travel to Budapest or Madrid. No such evidence was presented at trial, nor was any other evidence presented concerning the actual purpose of these expenditures. Respondent's determination that petitioners failed to report the amounts paid as personal expenditures will be sustained.

Unreported Income--Deeds in Lieu of Foreclosure

Respondent determined that petitioners failed to report income received from their acceptance of Martis Landing and Saddle Rock by deeds in lieu of foreclosure from the Woods.

Preliminarily, petitioners contend that respondent's proof and argument on brief do not conform to the notice of deficiency or the pleadings. Petitioners note that the 1997 Tax Ct. Memo LEXIS 73">*120 statutory notice of deficiency and answer refer to "debt extinguishment" as an adjustment to income in the amount of $ 74,321. The notice of deficiency explains this determination as "The amount of your debt which was cancelled or forgiven is includable in income." Respondent's argument on this issue on brief is that "petitioners must recognize $ 82,485 of ordinary income from receipt of deeds in lieu of foreclosure." Petitioners claim that, because "debt extinguishment" is not an issue in this case, petitioners were not adequately warned of the nature of the deficiency alleged by respondent.

Petitioners had fair warning of respondent's position on this issue. On brief, petitioners state: "In preparation for trial, it was first realized that the Respondent was talking about something totally different than debt extinguishment." Emphasis added. Petitioners had the opportunity to present pertinent evidence on this issue; therefore, we may fairly consider it. However, the evidence that is required to disprove the determination in the deficiency notice is different than that required to meet the position taken by respondent at trial. See Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500">93 T.C. 500, 93 T.C. 500">507 (1989); 1997 Tax Ct. Memo LEXIS 73">*121 Colonnade Condominium, Inc. v. Commissioner, 91 T.C. 793">91 T.C. 793, 91 T.C. 793">795 n.3 (1988); Estate of Falese v. Commissioner, 58 T.C. 895">58 T.C. 895, 58 T.C. 895">899 (1972). Thus, respondent bears the burden of proof on this issue.

Respondent contends that petitioners had income from the acceptance of the deeds in lieu of foreclosure, calculated as follows:

Petitioners' contention regarding respondent's calculation is that respondent has not proven the fair market values of the properties. Respondent bases the value of the properties on subsequent sales contracts. On October 29, 1991, Martis Landing was sold for $ 225,000. On January 1, 1992, petitioners signed an agreement to sell Saddle Rock for $ 850,000. Petitioners have not claimed that these sales were anything other than arm's length nor have they provided any evidence that the fair market values of the properties on June 19, 1991, were substantially different from the fair market values on the date of the subsequent sales of the properties.

This case is unlike the situation covered by section 1038, where the seller of real property reacquires his property in satisfaction of indebtedness to the seller. In that case, section 1038 provides that no gain or loss shall result to the seller because the seller/mortgagee is reacquiring that which was initially sold to the purchaser/borrower. In this case, petitioners loaned $ 130,000 and received, through deeds in lieu of foreclosure, property with a net value in excess of $ 130,000. Petitioners have realized 1997 Tax Ct. Memo LEXIS 73">*123 ordinary (because there has been no sale or exchange for purposes of section 1231) income to the extent that the net fair market value of the properties received exceeded their adjusted basis in the debt. See Commissioner v. Spreckels, 120 F.2d 517">120 F.2d 517, 120 F.2d 517">521 (9th Cir. 1941); Pender v. Commissioner, 110 F.2d 477">110 F.2d 477, 110 F.2d 477">478 (4th Cir. 1940).

In our findings of fact, we found that each of the items that respondent used to calculate petitioners' income from the acceptance of the deeds in lieu of foreclosure was paid or reported by petitioners in the amounts stated above. Petitioners have not offered any evidence of other items that would reduce their income from the acceptance of the deeds in lieu of foreclosure. Respondent's determination, in an amount as corrected above, that petitioners had ordinary income from the acceptance of deeds in lieu of foreclosure will be sustained.

Unreported Income--Interest

Respondent determined that petitioners failed to report interest earned on their funds in the name of Shumin. Petitioners have not presented any argument regarding respondent's determination other than to assert, in response to respondent's proposed finding of fact, that "respondent offered no evidence 1997 Tax Ct. Memo LEXIS 73">*124 on this issue."

Petitioners bear the burden of proving that respondent's determination is incorrect. Rule 142(a). They failed to offer any proof. Respondent's determination on this issue will be sustained.

Schedule C Income--1990

Respondent determined that petitioners reported as income in 1991 funds that they received in 1990, including approximately $ 34,544 from Kortava for the business school and $ 38,000 from Kortava for the vehicle resale business. Petitioners exercised complete dominion and control over these amounts and, as such, have gross income in the amounts we conclude below. See James v. United States, 366 U.S. 213">366 U.S. 213, 366 U.S. 213">219 (1961).

Business School

Petitioners have conceded that the proper year for reporting the business school income is 1990, but petitioners have not conceded the amount of income that should be reported. Petitioners have not presented argument or evidence to show that the amount of respondent's determination, $ 34,544, is incorrect. Thus, respondent's determination that petitioners' 1990 Schedule C income from operation of the business school be increased by $ 34,544 will be sustained. In accord with the parties' agreement, a corresponding reduction will 1997 Tax Ct. Memo LEXIS 73">*125 be made in petitioners' 1991 Schedule C income from operation of the business school.

Vehicle Resale Business

As to the vehicle resale business, on brief petitioners state: "it does appear possible that at least a portion of the income on the cash basis should have been reported in 1990." Petitioners admit that $ 38,000 was received via wire transfer during 1990.

At trial, petitioner testified that he received the wire transfer in 1990 but that, if he had been unable to deliver the cars as specified in the agreement, the money would have been returned to Kortava. However, the parties modified the agreement so that petitioner did not have to return any of the money.

As a general rule, cash basis taxpayers, such as petitioners, must report income upon its receipt. Sec. 451(a). Petitioners' argument appears to be that, although $ 38,000 was received in 1990, the money was subject to a contractual restriction that prohibited it from being income in 1990. Respondent's determination is based on the claim of right doctrine.

Income received under a claim of right is taxable in the year received even though the recipient may be under a contingent obligation to return it at a later time. North Am. Oil Consol. v. Burnet, 286 U.S. 417">286 U.S. 417, 286 U.S. 417">424 (1932). 1997 Tax Ct. Memo LEXIS 73">*126 "The mere fact that income received by a taxpayer may have to be returned at some later time does not deprive it of its character as taxable income when received." Woolard v. Commissioner, 47 T.C. 274">47 T.C. 274, 47 T.C. 274">279 (1966). To avoid the application of the claim of right doctrine, however, the recipient must recognize in the year of receipt an existing and fixed obligation to repay the amount received and must make provisions for repayment. Hope v. Commissioner, 55 T.C. 1020">55 T.C. 1020, 55 T.C. 1020">1030 (1971), affd. 471 F.2d 738">471 F.2d 738 (3d Cir. 1973). A restriction on the disposition or the use of the funds may also prevent the application of the claim of right doctrine. Commissioner v. Indianapolis Power & Light Co., 493 U.S. 203">493 U.S. 203, 493 U.S. 203">209 (1990). Petitioners have not met these exceptions.

Petitioner was under a contingent, not a fixed, obligation to repay the funds to Kortava pursuant to their agreement. Furthermore, while Kortava may have had in mind a restriction on the use of the funds, petitioner deposited the $ 38,000 in one of his personal accounts, not in one of Coastline's accounts. Respondent's determination that petitioners failed to report $ 38,000 that was received from Kortava during 1990 will be sustained. 1997 Tax Ct. Memo LEXIS 73">*127 In accord with the parties' agreement, a corresponding reduction will be made in petitioners' 1991 Schedule C income from operation of the vehicle resale business.

Schedule C Expenses--1991

On their 1991 Schedule C, petitioners claimed expenses relating to a vehicle resale business and a business school. Respondent disallowed $ 13,188 of expenses related to the vehicle resale business and $ 28,417 of expenses related to the business school, based on her position that petitioners did not pay the claimed expenses with their own funds. Petitioners contend that they are entitled to these deductions because they reported the corresponding income from these activities on their 1991 Schedule C. We have concluded that petitioners exercised the requisite dominion and control such that the funds received from Kortava for the vehicle resale business and the business school are includable in petitioners' gross income. Thus, the expenses that petitioners incurred in the operation of the Schedule C businesses that have been properly substantiated and that are ordinary and necessary are deductible by them.

Vehicle Resale Business

To substantiate disallowed deductions claimed in relation to the vehicle 1997 Tax Ct. Memo LEXIS 73">*128 resale business, petitioners introduced an exhibit that included various receipts and their 1991 tax return. Petitioner also testified at trial as to the existence of the various expenses.

The information contained on a tax return is not proof of the amount of deductions contained therein. Wilkinson v. Commissioner, 71 T.C. 633">71 T.C. 633, 71 T.C. 633">639 (1979). Although petitioner testified to the contrary, the exhibit introduced at trial did not contain receipts for gas or office expense. We require more than petitioner's unsubstantiated and unverified testimony as to the existence of gas expense and office expense. Wood v. Commissioner, 338 F.2d 602">338 F.2d 602, 338 F.2d 602">605 (9th Cir. 1964), affg. 41 T.C. 593">41 T.C. 593 (1964).

One repair receipt totaling $ 125 and marked paid is included in petitioners' exhibit. This additional amount will be allowed.

As for additional vehicle expenses, we cannot determine from the receipts in evidence that petitioners are entitled to any deductions other than those already allowed by respondent. Petitioners claimed that they did not include the value of their Mercedes that they shipped to Russia as an expense when they were preparing their 1991 Schedule C. Petitioner testified that the Mercedes1997 Tax Ct. Memo LEXIS 73">*129 was worth $ 20,000 when it was shipped to Russia. Kortava testified that the Mercedes was worth approximately $ 10,000. The damage report that was completed before shipping notes that the Mercedes had several minor scratches and a broken headlight, as well as additional damage. No additional evidence was presented to show the value of the 1984 Mercedes. We found as a fact that petitioners received $ 20,000 in 1990 from Kortava as consideration for petitioner's sending his Mercedes to Russia and that petitioners did not recognize a gain from this transaction. The record does not provide any evidence that the Mercedes ever became the property of Coastline. Thus, the transaction took place outside of the Schedule C vehicle resale business, and petitioners are not entitled to a deduction on their 1990 Schedule C for the expense of the Mercedes.

Business School

Petitioners claimed $ 28,417 of expenses related to the business school on their 1991 Schedule C. Respondent disallowed all of the claimed deductions.

We found as a fact that petitioners paid at least $ 20,033 of expenses associated with the AESI contract, including $ 9,240 to AESI and $ 10,793 for gasoline, travel, lodging, meals, 1997 Tax Ct. Memo LEXIS 73">*130 and entertainment. Petitioners have failed to substantiate any additional expenses. We must thus determine whether the substantiated expenses are ordinary and necessary and, therefore, deductible.

Section 162(a) allows a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business". "Ordinary" has been defined as that which is "normal, usual, or customary" in the taxpayer's particular trade or business. Deputy v. du Pont, 308 U.S. 488">308 U.S. 488, 308 U.S. 488">495 (1940). The expense need not be one common for the particular taxpayer, but instead one that is not rare in the taxpayer's business. See Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 290 U.S. 111">114 (1933). The substantiated expenses included "normal" expenses for the conduct of a business school abroad, including travel to and from Russia for petitioner and the faculty; the expenses for AESI's building the curriculum and locating the faculty; the food, meals, and lodging for the faculty in Russia; and the travel, food, meals, and lodging for the top students from Russia who came to the United States after the school.

"Necessary" has been construed to mean "appropriate" or "helpful", not "indispensable" 1997 Tax Ct. Memo LEXIS 73">*131 or "required". Ford v. Commissioner, 56 T.C. 1300">56 T.C. 1300, 56 T.C. 1300">1306 (1971), affd. 487 F.2d 1025">487 F.2d 1025 (9th Cir. 1973). It is sufficient if "there are also reasonably evident business ends to be served, and the intention to serve them appears adequately from the record." B. Manischewitz Co. v. Commissioner, 10 T.C. 1139">10 T.C. 1139, 10 T.C. 1139">1145 (1948). The substantiated expenses were also necessary, in that they were incurred with the intention of serving the business end, mainly the conduct of a business school in Russia.

Petitioners are entitled to deduct $ 20,033 as ordinary and necessary expenses of the business school on their 1991 Schedule C.

Unreported Income--Chorny

Respondent determined that petitioners failed to report Schedule C income of $ 20,472 and $ 9,250 in 1990 and 1991, respectively.

At trial, petitioner testified that the payments received from Chorny represented loan repayments. As evidence of the debt, petitioners offered reproductions of checks payable to Chorny or Margarita Chorny.

We are not persuaded by the checks payable to the Chornys that Chorny was indebted to petitioner or that the checks petitioner received during 1990 and 1991 from Chorny were not includable in petitioners' income. At 1997 Tax Ct. Memo LEXIS 73">*132 the trial of this case, Chorny could not recall whether petitioner lent him money during 1990 or 1991 nor could he recall whether he paid money to petitioner for any reason during 1990 or 1991. Petitioner's explanation at trial about the existence of loans is not credible. For example, petitioner stated that he gave to Chorny a $ 9,000 check on September 20, 1991, representing a short-term loan that Chorny paid back shortly thereafter. The $ 9,000 check that petitioners received from Chorny was dated September 2, 1991.

Petitioners have not established by a preponderance of the evidence that the checks from Chorny represented loan repayments. Thus, respondent's determination that petitioners failed to report $ 20,472 and $ 9,250 in 1990 and 1991, respectively, as Schedule C income from real estate consulting activities will be sustained.

15 Hastings--Option Payment

Respondent determined that petitioners failed to report on their 1991 return the $ 10,000 option fee that was received from the Woods.

As part of the lease option agreement for 15 Hastings, petitioners received an option fee from the Woods in the amount of $ 10,000. This amount was deposited with Escrow Masters on November 1997 Tax Ct. Memo LEXIS 73">*133 3, 1989. The parties have agreed that the option fee was available at any time following the consummation of the option agreement. On December 1, 1989, petitioners withdrew the option fee from their account at Escrow Masters and deposited it into California Federal account number 502396. The Woods decided not to exercise their option on March 7, 1991.

Respondent argues that proceeds from binding legal options are not taxed until the option is exercised or lapses. Petitioners contend that the $ 10,000 was received by petitioners in 1989 and was taxable in the year of receipt.

Petitioners rely on Estate of Gordon v. Commissioner, 17 T.C. 427">17 T.C. 427 (1951), affd. 201 F.2d 171">201 F.2d 171 (6th Cir. 1952). In Estate of Gordon, a $ 25,000 "option" payment was taxable income to the taxpayer-decedent in the year of receipt under a claim of right. In Estate of Gordon, the decedent had inherited a theater and business property from her husband. A man was interested in acquiring the property and negotiated two instruments with the decedent. The purchase price was $ 125,000, and decedent received $ 25,000 initially and interest was to be computed on the balance of the purchase price, with one of the instruments 1997 Tax Ct. Memo LEXIS 73">*134 requiring quarterly interest payments. The lessee was given the privilege of purchase at any time at the expiration of 6 months after the death of the decedent and undertook the insurance and real estate tax responsibilities. No outright sale was accomplished because the lessee was not bound to purchase the property.

The present situation is distinguishable from that in Estate of Gordon. We incorporate herein the reasoning of the Court of Appeals for the Third Circuit when it distinguished the option in Estate of Gordon from true options:

Again any analogy of this case to the present one fails. The time during which the option could be exercised was largely uncertain--at any time six months after the owner's demise running the term of the lease of twenty-five years. The primary purpose seemed to be to provide an elderly widow with an income for her lifetime and it was held in effect, that as such, the $ 25,000 payment was to be regarded as rent or income in advance and hence was includable in her taxable income when she received it. [Commissioner v. Dill Co., 294 F.2d 291">294 F.2d 291, 294 F.2d 291">299 (3d Cir. 1961), affg. 33 T.C. 196">33 T.C. 196 (1959).]

For cash method taxpayers, such as petitioners, section 451(a) provides that an item of income shall be included in gross income in the taxable year in which it is received by the taxpayers. One exception to this rule of recognition is that, when it cannot be determined whether payments received will, at some future date, represent income or a return of capital, they are not taxed until their character becomes fixed. Burnet v. Logan, 283 U.S. 404">283 U.S. 404, 283 U.S. 404">413 (1931); Dill Co. v. Commissioner, 33 T.C. 196">33 T.C. 196, 33 T.C. 196">200 (1959), affd. 294 F.2d 291">294 F.2d 291 (3d Cir. 1961) ; Virginia Iron Coal & Coke Co. v. Commissioner, 37 B.T.A. 195">37 B.T.A. 195, 37 B.T.A. 195">198 (1938), affd. 99 F.2d 919">99 F.2d 919 (4th Cir. 1938). Respondent argues that the option payment received by petitioners falls within this exception.

The deferral of the taxability of option payments is based on two considerations: (1) The grantor of an option must wait until the option is exercised or lapses to determine whether the proceeds for it are reportable as taxable income or as a nontaxable return of capital and (2) if the option proceeds are income to the grantor of 1997 Tax Ct. Memo LEXIS 73">*136 the option, the character of the income as capital or ordinary must be determined. See Old Harbor Native Corp. v. Commissioner, 104 T.C. 191">104 T.C. 191, 104 T.C. 191">200 (1995). These considerations remain even though the grantor retains the option amount whether or not the option is exercised. See Hicks v. Commissioner, T.C. Memo. 1978-373. Petitioners, although they had control over and had unfettered use of the $ 10,000 in 1989, had income in the year the option lapsed, 1991.

15 Hastings--Lease Versus Sale

We now must decide whether the "Lease Option" executed on November 1, 1989, and the "Real Estate Purchase Option" executed on November 3, 1989, effected a sale or a lease with an option to buy. If we decide that the agreements effected a sale, we must then decide the proper characterization of the payments received by petitioners and the expenses claimed by petitioners.

Respondent argues that petitioners mischaracterized the agreement by reporting the related items as though the agreement were a lease instead of a sale. Petitioners contend that they properly characterized the transaction as a lease with an option. In this instance, we are not required to decide which of the two agreements, the Lease 1997 Tax Ct. Memo LEXIS 73">*137 Option or the Real Estate Purchase Option, represented the bargain between petitioners and the Woods.

Whether a sale is complete for Federal tax purposes depends on all of the facts and circumstances. Derr v. Commissioner, 77 T.C. 708">77 T.C. 708, 77 T.C. 708">724 (1981); Baird v. Commissioner, 68 T.C. 115">68 T.C. 115, 68 T.C. 115">124 (1977); Clodfelter v. Commissioner, 48 T.C. 694">48 T.C. 694, 48 T.C. 694">700-701 (1967), affd. 426 F.2d 1391">426 F.2d 1391 (9th Cir. 1970). We consider the following factors in deciding whether a sale has occurred: (1) Whether the seller transferred legal title; (2) whether the benefits and burdens of ownership passed to the buyer; (3) whether the owner had a right under the agreement to require the other party to buy the property; and (4) how the parties treated the transaction. Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221">77 T.C. 1221, 77 T.C. 1221">1237-1238 (1981); 77 T.C. 708">Derr v. Commissioner, supra at 724; 68 T.C. 115">Baird v. Commissioner, supra at 124; Merrill v. Commissioner, 40 T.C. 66">40 T.C. 66, 40 T.C. 66">74 (1963), affd. per curiam 336 F.2d 771">336 F.2d 771 (9th Cir. 1964); Haggard v. Commissioner, 24 T.C. 1124">24 T.C. 1124, 24 T.C. 1124">1129 (1955), affd. 241 F.2d 288">241 F.2d 288 (9th Cir. 1956).

1. Title Passage to the Woods

While not a single determinative factor, passage of title is an important consideration. Harmston v. Commissioner, 61 T.C. 216">61 T.C. 216, 61 T.C. 216">229 (1973), 1997 Tax Ct. Memo LEXIS 73">*138 affd. per curiam 528 F.2d 55">528 F.2d 55 (9th Cir. 1976). Title to 15 Hastings never passed to the Woods.

2. Benefits and Burdens to the Woods

To decide whether the Woods acquired the benefits and burdens of ownership in 15 Hastings, we look to whether the Woods: (1) Bore the risk of loss; (2) were obligated to pay all taxes, assessments, and charges against the property; (3) had the duty to maintain the property; (4) were responsible for insuring the property; (5) had the right to possess the property; (6) had the right to improve the property without the sellers' consent; and (7) had the right to obtain legal title at any time by paying the balance of the full purchase price. 77 T.C. 1221">Grodt & McKay Realty, Inc. v. Commissioner, supra at 1237-1238.

In this case, the Woods had the right to possess the property, the right to obtain legal title by paying the balance of the full purchase price, and the duty to maintain the property and to pay insurance costs and taxes (under one agreement). The Woods did not bear the risk of loss. This factor weighs in favor of the agreement's being treated as a sale.

3. Compelling the Exercise of the Option

Under California law, an instrument is a contract of sale if the 1997 Tax Ct. Memo LEXIS 73">*139 optionee has an obligation to buy that the owner can enforce by specific performance. Welk v. Fainbarg, 255 Cal. App. 2d 269, 63 Cal. Rptr. 127">63 Cal. Rptr. 127, 63 Cal. Rptr. 127">132-133 (1967). Neither the Lease Option nor the Real Estate Purchase Option provided that petitioners could force the Woods to purchase 15 Hastings.

4. Intent of the Parties

Petitioner testified that title to 15 Hastings was never transferred to anyone. Petitioners treated the agreement with the Woods as a lease on their 1990 return. Mr. Wood testified that he and Mrs. Wood were not renting 15 Hastings. Mr. Wood classified the transaction, however, as a lease/option purchase contract. Mrs. Wood said the agreement was initially contemplated as a lease option. Mrs. Wood testified that their original intent was to purchase 15 Hastings, but they could not get the funds together for the downpayment. Mrs. Wood said the agreement was then converted to a straight month-to-month lease. The testimony given by the parties as to the agreement is consistent with treating the agreement as a lease option. Although the Woods wished to purchase 15 Hastings, the agreement gave them the option of purchasing the property if they could sell their home and get 1997 Tax Ct. Memo LEXIS 73">*140 the funds for the downpayment on 15 Hastings. Because the Woods were in the midst of a divorce, Mrs. Wood needed a place to live; thus, the lease option agreement met the intention of the parties to the agreement.

Respondent also argues that the execution of the $ 232,000 note was in essence a downpayment by petitioners and that the note is evidence of a sale. However, under a consideration of all of the facts and circumstances, we do not conclude that this factor is controlling.

In summary, the passage of benefits and burdens of ownership to the Woods in the absence of title, of an enforceable land sale contract, and of intent to effect an immediate sale does not give us grounds for treating the agreement between petitioners and the Woods as anything other than a lease option agreement.

Unreported Income--Clerical Fee

Respondent determined that, in 1991, petitioners received a clerical fee in the amount of $ 535 from Mr. Wood. Petitioners did not present any evidence to contradict respondent's determination. Mr. Wood testified that, to the best of his recollection, this check represented payment to petitioner for expenses and time incurred by petitioner in helping Mr. Wood's law firm 1997 Tax Ct. Memo LEXIS 73">*141 with a case. Absent any evidence to the contrary, respondent's determination that petitioners failed to report $ 535 of taxable income in 1991 will be sustained.

Section 6651(a) (1) Addition to Tax

Respondent determined that petitioners are liable for the section 6651(a) addition to tax for 1990 and 1991. Section 6651(a)(1) imposes an addition to tax for failure to file timely a return, unless the taxpayer establishes that the failure to file did not result from "willful neglect" and that the failure was due to "reasonable cause". "Willful neglect" has been interpreted to mean a conscious, intentional failure or reckless indifference. United States v. Boyle, 469 U.S. 241">469 U.S. 241, 469 U.S. 241">245-246 (1985). "Reasonable cause" requires taxpayers to demonstrate that they exercised ordinary business care and prudence and were nonetheless unable to file a return within the prescribed time. 469 U.S. 241">Id. at 246; sec. 301.6651-1(c) (1), Proced. & Admin. Regs. The addition to tax equals 5 percent of the tax required to be shown on the return for the first month, with an additional 5 percent for each additional month or fraction of a month during which the failure to file continues, not to exceed a maximum of 25 percent. 1997 Tax Ct. Memo LEXIS 73">*142 Sec. 6651(a)(1).

Petitioners' 1990 return was received by the Laguna Niguel District Office on October 18, 1991. Petitioners' 1991 return was received by the Laguna Niguel District Office on October 15, 1992.

Respondent contends that the extensions of time to file that were obtained by petitioners are invalid because petitioners failed to estimate properly the tax that was unpaid as of the date prescribed for filing the return. No payments were included with the requests for extensions. Petitioners bear the burden of proving that respondent's determination was incorrect. Rule 142(a); Cluck v. Commissioner, 105 T.C. 324">105 T.C. 324, 105 T.C. 324">339 (1995). Petitioners have failed to produce evidence that their extension requests properly estimated the tax due, and we sustain respondent's determination that petitioners are liable for the section 6651(a) (1) addition to tax for 1990 and 1991.

Section 6662(a) Penalty

For 1990 and 1991, section 6662(a) imposes a penalty in an amount equal to 20 percent of the underpayment of tax attributable to one or more of the items set forth in section 6662(b). Respondent asserts that the entire underpayment of petitioners' tax was due to negligence or intentional disregard 1997 Tax Ct. Memo LEXIS 73">*143 of rules or regulations. Petitioners bear the burden of proving that respondent's determinations are erroneous. Rule 142(a); Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 58 T.C. 757">791 (1972).

"Negligence" includes a failure to make a reasonable attempt to comply with the provisions of the internal revenue laws. Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs."Disregard" includes any careless, reckless, or intentional disregard of rules or regulations. Sec. 6662(c); sec. 1.6662-3(b)(2), Income Tax Regs.

The section 6662 accuracy-related penalty does not apply with respect to any portion of an underpayment if it is shown that there was reasonable cause for such portion and that petitioners acted in good faith with respect to such portion. Sec. 6664(c)(1). The determination of whether petitioners acted with reasonable cause and in good faith depends upon the pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. Petitioners have not established reasonable cause or good faith reliance to excuse themselves from the penalties for negligence or intentional disregard of rules or regulations. See Mack v. Commissioner, T.C. Memo. 1995-482. Petitioners have presented no evidence that their 1997 Tax Ct. Memo LEXIS 73">*144 failure to file timely or to report their income properly in 1990 or 1991 was due to anything other than negligence or disregard of the tax laws. See Rapp v. Commissioner, 774 F.2d 932">774 F.2d 932, 774 F.2d 932">935 (9th Cir. 1985).

Petitioners' failure to maintain and to produce reliable records of their taxi business also supports a conclusion of negligence. Crocker v. Commissioner, 92 T.C. 899">92 T.C. 899, 92 T.C. 899">917 (1989); Schroeder v. Commissioner, 40 T.C. 30">40 T.C. 30, 40 T.C. 30">34 (1963). Thus, respondent's determination that petitioners are liable for the accuracy-related penalty for 1990 and 1991 will be sustained.

Mrs. Goldberg is not excused from the negligence addition to tax and penalties for 1990 and 1991 solely because of her failure to read petitioners' returns or her reliance on petitioner for the accuracy of the returns. Failure to read a return and blind reliance on another for the accuracy of a return are not sufficient bases to avoid liability for negligence. See Bollaci v. Commissioner, T.C. Memo. 1991-108 (citing Bagur v. Commissioner, 66 T.C. 817">66 T.C. 817, 66 T.C. 817">823-824 (1976), remanded on other grounds 603 F.2d 491">603 F.2d 491 (5th Cir. 1979)). Taxpayers have a duty to read a return and to make sure all items are included. Magill v. Commissioner, 70 T.C. 465">70 T.C. 465, 70 T.C. 465">479-480 (1978), 1997 Tax Ct. Memo LEXIS 73">*145 affd. 651 F.2d 1233">651 F.2d 1233 (6th Cir. 1981) (citing Bailey v. Commissioner, 21 T.C. 678">21 T.C. 678, 21 T.C. 678">687 (1954)).

To reflect the foregoing and the concessions by the parties,

Decision will be entered under Rule 155.