MEMORANDUM FINDINGS OF FACT AND OPINION 1997 Tax Ct. Memo LEXIS 381">*382

GALE, Judge1997 Tax Ct. Memo LEXIS 381">*383 : Respondent determined the following deficiencies in, and additions to, petitioners' Federal income taxes.

Petitioner James B. Murtaugh:

1997 Tax Ct. Memo LEXIS 381">*384 Petitioner Joan E. Murtaugh:

Unless otherwise noted, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

The parties agree that petitioners are entitled to joint filing status. Petitioners filed all of their joint tax returns for the years in issue between May 1995 and March 1996, after the notices of deficiency in this case were issued. Petitioners submitted three returns for tax year 1990. Petitioners' tax returns reported the following information:

The parties agree that if respondent prevails on the issues as stated below, the revised deficiencies and additions to tax will be as follows:

1997 Tax Ct. Memo LEXIS 381">*385 Petitioners concede that the overpayments are barred by section 6511(b)(2)(B).

We must decide the following issues:

(1) Whether petitioners are required to include, as ordinary income, the entire distribution of $ 25,313.22 received by James Murtaugh from the Union Camp Corporation retirement plan for the taxable year 1990. We hold that petitioners are required to include the entire distribution as ordinary income.

(2) Whether petitioners are entitled to an ordinary, rather than a capital, loss in the amount of $ 59,700 from the foreclosure in 1992 of petitioners' two timeshare units in a resort lodging facility. We hold that petitioners are entitled to an ordinary loss.

(3) Whether petitioners are liable for additions to tax for failure to file and for failure to pay estimated tax. We hold that petitioners are liable for additions to tax to the extent provided in the opinion.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. We incorporate by this reference the stipulation of facts and attached exhibits. At the time of filing the petition, petitioners resided in Tuckahoe, New York.

Issue 1. Distribution Under a Qualified Plan

In 1990, petitioner1997 Tax Ct. Memo LEXIS 381">*386 James Murtaugh (petitioner) received a distribution from his qualified pension plan at Union Camp Corporation. The gross distribution from the pension plan was in the amount of $ 25,313.22, composed of an actual distribution of $ 16,203.29, and an amount of $ 9,109.93 that offset an outstanding loan principal. Petitioner received the gross distribution because he ceased employment with Union Camp and his participation in the plan was terminated. At some point prior to the gross distribution petitioner had taken out a loan or loans from his pension plan account to pay for the education of petitioners' three children and to make improvements to petitioners' residence, resulting in the outstanding loan balance of $ 9,109.93 at the time of the gross distribution.

A statement of petitioner's pension plan account as of April 30, 1990, the effective date of petitioner's termination from the plan, indicated that there was an attached check in the amount of $ 16,203.29, and that the outstanding loan balance of $ 9,109.93 would be included in the gross distribution for purposes of determining taxable income. On the Form 1099R issued to petitioner, the plan administrator reported the gross 1997 Tax Ct. Memo LEXIS 381">*387 distribution as a taxable distribution of $ 25,313.12, indicating that this amount included a defaulted loan of $ 9,109.93. The Form 1099R indicated that no amount of the gross distribution was eligible for a capital gains election.

All of petitioners' tax returns for the years in issue were submitted to the Internal Revenue Service after the notices of deficiency in this case were issued. Petitioners did not pay any tax for the 1990 taxable year except withholding tax. With respect to the 1990 taxable year, petitioners filed a tax return and two amended returns during the first 3 months of 1996. There are inconsistencies within each return, and inconsistencies between the returns. Petitioners' first tax return for 1990 (original return) was submitted in January 1996. On the original return, petitioners attempted to elect 5-year averaging and capital gains treatment. On the original return, petitioners reported a gross distribution of $ 25,313, indicating that $ 9,202 was the taxable amount and $ 3,324 was capital gain. Petitioners submitted an amended return for 1990 (first amended return) in February 1996, on which petitioners did not elect 5-year averaging or capital gains treatment. 1997 Tax Ct. Memo LEXIS 381">*388 On the first amended return, petitioners reported a gross distribution of $ 25,313, indicating that $ 9,202 was the taxable amount. Petitioners submitted another amended return for 1990 (second amended return) in March 1996, on which petitioners attempted to elect 5-year averaging and capital gains treatment. On the second amended return, petitioners reported a gross distribution of $ 16,203, indicating that $ 12,706 was the taxable amount and $ 3,437 was capital gain. ¹

Issue 2. Capital or Ordinary Loss

On January 24, 1988, petitioners purchased a 25-percent timeshare interest in each of two condominium units (the timeshares) in B'Mae's Resort in Gilford, New Hampshire, a ski and lake resort area. The timeshares were purchased for a total of $ 89,700. During tax years 1988 and 1989, petitioners had rental income from the timeshares of $ 3,480 and $ 3,579.36, respectively.

Prior to the purchase of the timeshares, petitioner had some previous1997 Tax Ct. Memo LEXIS 381">*389 experience with owning rental property. Petitioner had purchased a condominium on Cape Cod, Massachusetts, in 1985, and sold it in 1988 at a profit of around $ 20,000 to $ 25,000. Petitioner rented the Cape Cod property to one individual as a residence. Petitioner decided that he could do better by renting a property at $ 110-$ 150 per night, similar to a hotel or motel. Petitioner looked at properties in Orlando, Florida, and Myrtle Beach, South Carolina, and other places along the east coast. Petitioner's investigation revealed that southern locations were patronized heavily in the winter and lightly in the summer. Petitioner saw advantages with B'Mae's Resort. The resort was located on a resort lake, was close to snow skiing facilities, and was also a suitable venue for viewing fall foliage. Thus, petitioner expected it would be well patronized for several months out of the year. In addition, the timeshare interests offered for sale by B'Mae's were suites, and petitioner thought that suites, compared with single rooms, would be an advantage to families. When B'Mae's decided to add a new wing of condominiums and offered quarter (13-week) timeshare interests in the properties, petitioner1997 Tax Ct. Memo LEXIS 381">*390 decided to purchase the timeshares. Petitioner felt that the timeshares had a good potential for generating cash-flow over and above expenses. Petitioner used profits from the sale of the Cape Cod property to purchase the timeshares.

B'Mae's was a resort hotel with approximately 24-30 total units, half of which were single rooms and half of which were suites. B'Mae's owned and rented out the single rooms itself, and offered the suites for sale as condominiums or timeshares. Petitioner had an agreement with B'Mae's whereby B'Mae's would manage the rental of the timeshares, including promotional advertising, rental contracts, housekeeping, replenishment of inventory, and guest registration, for a fee of 40 percent of rents paid. This was the standard agreement that B'Mae's had offered to other condominium owners for renting the suites. B'Mae's exclusively handled the rental of the timeshares. Petitioner did make people aware that he had the timeshares for rent, but no actual rentals occurred based on those efforts.

Petitioner visited the timeshares approximately once a year from 1988 to 1992. He stayed at one of the timeshares during his visits, usually for 2 nights and usually in1997 Tax Ct. Memo LEXIS 381">*391 the off-season. He did not use the pool or the lake when he visited the timeshares, although he would eat dinner and Sunday brunch at the resort facility. He once brought his daughter along and once brought his son. Petitioners did not take any depreciation on the timeshares. In preparing to buy the timeshares from B'Mae's, petitioner did not prepare an economic projection or cash flow analysis, but he considered the number of days of rental and costs involved.

After 2 years, when it was clear that the rentals were not generating a positive cash flow, petitioner spoke with B'Mae's about why there were not more rentals. However, petitioner did not put much effort into trying to rent the timeshares on his own. For instance, he did not advertise. He made only one minor suggestion about improving the rentals. Petitioner only occasionally communicated with B'Mae's. For instance, B'Mae's contacted petitioner about using one of the timeshares during a telephone strike in New Hampshire. He did not maintain books and records for the timeshares other than the records he got from B'Mae's. He did not maintain a separate bank account for the timeshares. However, petitioner was engaged in a consulting1997 Tax Ct. Memo LEXIS 381">*392 activity separate from his job, and he maintained books and records and a separate account for the consulting activity. The primary source of petitioners' income during the years in issue was their wages.

B'Mae's had given petitioner some information, in the form of brochures, suggesting that petitioner did not need to be actively involved in the renting of the property for it to generate cash flow. Petitioner understood that B'Mae's would take care of all day-to-day aspects of renting the timeshares.

During tax year 1992, the Bank of New Hampshire foreclosed on the timeshares. Petitioners received $ 15,000 in proceeds for each unit, resulting in a loss totaling $ 59,700.

OPINION

Petitioners have the burden of proof for all of the issues discussed below. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 290 U.S. 111">115 (1933).

Issue 1. Distribution Under a Qualified Plan

Petitioners argue that the $ 9,109.93 amount of the outstanding loan proceeds was not income to them when the gross distribution was received. ² We disagree. Petitioner received a gross distribution of $ 25,313.22 from his pension plan account, and this amount was reduced, or offset, ³1997 Tax Ct. Memo LEXIS 381">*393 by the amount of the outstanding loan balance of $ 9,109.93. Petitioner received a check for only $ 16,203.29 because of the outstanding loan. Therefore, he in effect repaid the loan out of his pension plan account.

1997 Tax Ct. Memo LEXIS 381">*394 If the loan proceeds were taxed when first received by petitioner, taxing them at the time of the gross distribution would lead to double taxation of the same funds, a result generally to be avoided. See Campbell v. Commissioner, 108 T.C. 54">108 T.C. 54, 108 T.C. 54">67-68 (1997). However, petitioners are required to show that the loan proceeds were taxed when first received in order to avoid taxation at the time they were offset against the gross distribution, and they have not done so. Petitioners make no allegation or argument that the loan proceeds were taxed when first received, and the available evidence suggests otherwise. First of all, petitioner received a statement from the plan with respect to the gross distribution that indicated that the $ 9,109.93 loan proceeds would be included in the gross distribution for purposes of taxable income. Thus, the plan administrators believed, and so advised petitioner, that the loan proceeds were includable in income.

Moreover, it appears that the loan to petitioner was not income when received because it was a loan of $ 10,000 or less. In general a loan from a qualified plan to a plan participant is treated as a distribution 1997 Tax Ct. Memo LEXIS 381">*395 from the plan under section 72(p)(1), and therefore included in income under section 72. See sec. 402(a). However, section 72(p)(2)(A) provides an exception to the general rule for certain loans, and petitioner's loan appears to have satisfied the basic requirements of the exception. Petitioners have presented no evidence of the terms of the loan in question. Although we need not, and do not, make a finding to this effect, we think it probable that the loan to petitioner qualified for the exception. If the $ 9,109.93 loan fell under the exception of section 72(p)(2), it would not have been a distribution when received, but rather would have simply been a loan, not taxable to the borrower. Commissioner v. Indianapolis Power & Light Co., 493 U.S. 203">493 U.S. 203, 493 U.S. 203">207 (1990). In any event, petitioners have presented no evidence to show that the loan was in fact includable in income when received. The mere fact that the loan proceeds were offset against the balance of petitioner's account before the gross distribution, so that petitioner received only $ 16,203.29, does not prevent the $ 9,109.93 from being income to petitioner.

Petitioners argue that section 72(e)(4)(A) 1997 Tax Ct. Memo LEXIS 381">*396 provides the relief they seek. However, section 72 (e)(4)(A) does not apply in this case. Section 72(e)(4)(A) applies if an individual "receives * * * any amount as a loan" under an annuity contract. Thus, if section 72(e)(4)(A) were to have any application on the facts of this case, it would have been when petitioners received the proceeds of the loan in question, not when the gross distribution was made. Moreover, section 72(e)(4)(A) merely designates loans under annuity contracts as amounts "not received as an annuity". Petitioners incorrectly conclude that any amount not received as an annuity is not includable in income. See sec. 72(e)(2)(B).

With respect to the actual distribution of $ 16,203.29, which petitioners agree must be included in income in some form, petitioners attempted to elect 5-year averaging and capital gains treatment in the second amended return for tax year 1990. ⁴ Respondent argues that petitioners do not qualify for either 5-year averaging or capital gains treatment because the elections were untimely, and that petitioners have failed to prove that they qualify for capital gains treatment in any event.

1997 Tax Ct. Memo LEXIS 381">*397 Section 402(e) permits a taxpayer to elect 5-year averaging. With 5-year averaging, the tax is imposed in the year of distribution, but the amount of the tax is equal to the tax on 1/5 of the distribution multiplied by 5, giving the taxpayer the advantage of lower tax rates on the smaller amount of income. ⁵ Under section 11.402(e)(4)(B)-1(c)(1), Temporary Income Tax Regs., 40 Fed. Reg. 1016 (Jan. 6, 1975), an election for 5-year averaging must be made within the time for filing a claim for refund under section 6511. See also section 1.402(e)-3(c)(1), Proposed Income Tax Regs., 40 Fed. Reg. 18810 (Apr. 30, 1975).⁶1997 Tax Ct. Memo LEXIS 381">*399 In this case, petitioners have stipulated that their claims for refund for tax years 1987, 1988, and 1991 were barred by section 6511(b)(2)(B). Petitioners made no such stipulation with respect to tax year 1990. ⁷ For tax year 1990, petitioners did not file a return until on or around January 15, 1996, and had not paid any tax by that date, except withholding tax. Pursuant to section 6513(b)(1), petitioners are deemed to have paid the withholding tax on April 15, 1991. Because petitioners did not file a return before1997 Tax Ct. Memo LEXIS 381">*398 receiving the notice of deficiency, the time period in which they must claim any refund is 2 years from the time the tax was paid. See Commissioner v. Lundy, 516 U.S.    ,    , 116 S. Ct. 647, 652 (1996). Thus, when they filed their original return for tax year 1990 they were barred from claiming a refund. Consequently, under section 11.402(e)(4)(B)-1(c)(1), Temporary Income Tax Regs., 40 Fed. Reg. 1016 (Jan. 6, 1975), petitioners are barred from electing 5-year averaging.⁸

Petitioners have also not demonstrated that they are eligible for capital gains treatment. They have presented no evidence or argument attempting to establish that they are entitled to capital gains treatment. Prior to 1986, section 402(a)(2) of the Code as then in effect permitted capital gains treatment for the portion of certain lump sum distributions from pension plans that was attributable to plan participation before 1974. The Tax Reform Act of 1986 (TRA 1986), Pub. L. 99-514, 100 Stat. 2085, prospectively eliminated capital gains treatment for lump sum distributions. However, taxpayers who attained age 50 before January 1, 1986, 1997 Tax Ct. Memo LEXIS 381">*400 could elect to have the pre-TRA 1986 law apply. See TRA 1986, sec. 1122(h)(3)(A), (C), 100 Stat. 2470-2471. Respondent concedes on brief that petitioner had reached age 50 before January 1, 1986. Thus, petitioner meets the threshold requirement of the transitional relief. However, petitioner must still satisfy the requirements of the pre-TRA 1986 law in order to get capital gains treatment. Under the pre-TRA 1986 law, capital gains treatment was available only if the taxpayer was an active participant in the plan prior to January 1, 1974. See sec. 402(a)(2) of the pre-TRA 1986 Code. Petitioners have presented no evidence to show that petitioner was a participant in the plan before January 1, 1974. Therefore petitioners have failed to prove that they are eligible for capital gains treatment. On the other hand, there is evidence in the record supporting their ineligibility. The Form 1099R that petitioner received with respect to the gross distribution states that no part of the gross distribution is eligible for capital gains treatment. We hold that petitioners are not eligible for capital gains treatment with respect to any part of the gross distribution. Accordingly, petitioners must1997 Tax Ct. Memo LEXIS 381">*401 include the entire $ 25,313.22 distribution as ordinary income during tax year 1990.

Issue 2. Capital or Ordinary Loss

There is no question in this case that the foreclosure of the timeshares was a sale or exchange under which loss was realized, and hence recognized. Sec. 1001(a) through (c); Helvering v. Hammell, 311 U.S. 504">311 U.S. 504 (1941). The only question is the character of that loss. Section 1221(2) provides that certain property used in a trade or business is not a capital asset. ⁹ The parties agree that this issue turns on whether the timeshares were used in a trade or business. If so, petitioners are entitled to an ordinary loss; if not, petitioners must take a capital loss.

1997 Tax Ct. Memo LEXIS 381">*402 The Supreme Court has stated that

to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer's primary purpose for engaging in the activity must be for income or profit. * * * [Commissioner v. Groetzinger, 480 U.S. 23">480 U.S. 23, 480 U.S. 23">35 (1987).]