T.C. Summary Opinion 2011-117



                        UNITED STATES TAX COURT



     THOMAS G. ROSE, SR., AND CHERYL G. ROSE, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 15061-10S.              Filed October 4, 2011.



     Vincent F. Heuser, Jr., for petitioners.

     Diana N. Wells, for respondent.



     RUWE, Judge:     This case was heard pursuant to the provisions

of section 74631 of the Internal Revenue Code in effect when the

petition was filed.    Pursuant to section 7463(b), the decision to



     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code as amended and in effect for the years
at issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
                               - 2 -

be entered is not reviewable by any other court, and this opinion

shall not be treated as precedent for any other case.

     Respondent determined deficiencies of $25,574 and $16,556 in

petitioners’ Federal income taxes for 2006 and 2007,

respectively.   The only issue for decision is whether petitioners

are entitled to mortgage interest deductions of $73,066 and

$67,489 for the taxable years 2006 and 2007, respectively,

related to real estate in Fort Myers Beach, Florida.

                             Background

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.

     At the time the petition was filed, petitioners resided in

Kentucky.

     In late 2005 petitioners began searching for property along

the Florida coastline upon which they could build a vacation

house.   In January 2006 petitioners entered into a contract for

the purchase of beachfront property in Fort Myers Beach, Florida,

for $1,575,000 (property).   At the time that petitioners entered

into the contract there was an existing house on the property.

Petitioners purchased the property in order to build a new house

on the lot and not because they intended to make use of the

existing house.   The purchase contract provided that the existing
                               - 3 -

house would be torn down and completely removed from the property

before the closing date.

     Petitioners borrowed $1,260,000 from Fifth Third Mortgage

Co. to facilitate their purchase of the property.   The loan was

secured by a mortgage on the property.   On March 6, 2006, the

parties closed on the purchase of the property.   At the time of

closing, the demolition work had been completed and the property

consisted of a vacant lot.

     In order to build a new house on the property, petitioners

were required to obtain a construction permit from the Florida

Department of Environmental Protection (department).   The

department requires the completion of a lengthy permitting

process whenever someone seeks to build on beachfront property.

The process requires that applicants exhibit that the proposed

building meets hurricane and flood standards, among other

requirements.   As part of this lengthy process, petitioners were

required to submit numerous items to the department, including

detailed survey work and core drilling samples.   During 2006

after the existing house had been demolished, petitioners had the

required survey work done and core samples taken.   Additionally,

during 2006 petitioners began working with a team of building

professionals that included architects, engineers, and designers.

That work continued during the time petitioners were readying

their permit application.
                               - 4 -

     As part of the process of building a new house on the

property, petitioners contacted Damon Warfel, president of Damon

Custom Structures, Inc. (DCS), about performing the construction

work.   By early January 2007 petitioners had entered into a

preliminary administration and coordination agreement with DCS.

The purpose of the agreement was to coordinate the work that was

being done by the project’s architects, engineers, designers, and

any other members of petitioners’ “permitting team”.    In

furtherance of their duties, the architect and engineer members

of the permitting team prepared detailed construction and site

plans for petitioners’ and DCS’ use during 2006 and 2007.     As

part of their agreement, DCS agreed to aid petitioners in

acquiring approval from the department to build a single-family

residence on the property.   After the agreement was signed, DCS

instructed members of petitioners’ permitting team to continue

with their preparatory activities so that the application for a

building permit could be assembled and submitted to the

department for approval.   The permitting team’s activities

continued at least until the time at which the application became

complete.

     On June 25, 2007, petitioners filed the application for a

permit for construction (application) with the department.

Before the application was filed, petitioners completed the

lengthy process of satisfying the various documentary
                               - 5 -

requirements that the department mandated should accompany an

initial permit application.   Petitioners were required to submit

numerous items to the department along with their initial

application, including, but not limited to:   (1) Evidence of

ownership and a legal description of the property; (2) written

evidence from an appropriate governmental agency indicating that

the proposed construction would not contravene setback

requirements or zoning codes; (3) engineering design computations

for any waste discharge; (4) two copies of a signed and sealed

survey of the property; (5) two copies of detailed final

construction plans signed by a licensed engineer or architect;

(6) two copies of a dimensioned detailed site and grading plan;

and (7) two copies of detailed planting plans.   The work

necessary to satisfy the permit application’s documentary

requirements began in 2006, before the signing of the DCS

preliminary administration and coordination agreement, and

continued throughout 2007.

     On July 25, 2007, petitioners signed a form titled “Damon

Custom Structures, Inc. Owner/Contractor Building Contract”.    The

building contract reflected the particulars involved with the

construction of the planned residence, as had been determined by

the previous efforts of petitioners and their architects,

engineers, interior designers, and landscape design specialists.

The contract also provided that its enforceability was contingent
                                - 6 -

on petitioners’ ability to procure construction financing for the

project, on terms that petitioners found acceptable.    The final

price for the work to be performed by DCS under the contract was

$1,961,548.64.

     Petitioners were notified that the department considered

their application to be complete as of September 27, 2007.     After

petitioners submitted their permit application, the department

contacted them on several occasions in the following months to

clarify various issues with their application.    The department’s

requests for clarification led to the permitting process taking

longer than initially expected.    One of the key issues the

department inquired about dealt with making sure that the

lighting on the house would meet the department’s turtle nesting

requirements.    The department wanted to determine that the

lighting scheme for the project would not interfere with sea

turtle nesting and hatchling turtles.    Petitioners complied with

the department’s continued requests for clarification and waived

several of the department’s own mandatory decision deadlines, on

the basis of their understanding that the application would be

denied if they failed to cooperate and allow the department the

additional time.    The department ultimately granted petitioners a

construction permit on February 11, 2008, almost 2 years from the

date petitioners purchased the property.
                                - 7 -

     In order for petitioners to proceed with their plans to

build a residence on the property, it was necessary for them to

secure an additional bank loan to cover the construction costs.

However, the residential real estate market in Florida had

changed significantly between the time that petitioners purchased

the property and the date on which the construction permit was

granted.    Due to the realities of a constrained credit market,

petitioners were unable to secure financing that would allow them

to proceed with the completion of their plan to build a residence

on the property.

     On June 11, 2009, petitioners sold the property for

$750,000.    As a result petitioners suffered an $825,000 loss on

the property within 3-1/2 years from its purchase.

     Petitioners filed joint Federal income tax returns for the

taxable years 2006 and 2007.    On their returns, petitioners

deducted $87,016 and $82,201 in home mortgage interest for the

taxable years 2006 and 2007, respectively.    Respondent determined

that the interest expense deductions claimed for the property

were not qualified residence interest, and, as a result,

determined deficiencies of $25,574 and $16,556 in petitioners’

Federal income taxes for 2006 and 2007, respectively.

                             Discussion

     Section 163(a) allows a deduction for all interest paid or

accrued within the taxable year on indebtedness.     Joseph v.
                               - 8 -

Commissioner, T.C. Memo. 2005-169.     Section 163(h)(1), however,

provides that, in the case of a taxpayer other than a

corporation, no deduction is allowed for personal interest.

However, qualified residence interest is excluded from the

definition of personal interest and thus is deductible under

section 163(a).   See sec. 163(h)(2)(D).   Qualified residence

interest is any interest that is paid or accrued during the

taxable year on acquisition indebtedness or home equity

indebtedness.   See sec. 163(h)(3)(A).   Acquisition indebtedness

is any indebtedness secured by the qualified residence of the

taxpayer and incurred in acquiring, constructing, or

substantially improving the qualified residence.    See sec.

163(h)(3)(B).   Section 163(h)(4)(A)(i) defines a qualified

residence as “the principal residence (within the meaning of

section 121) of the taxpayer” and “1 other residence of the

taxpayer which is selected by the taxpayer for purposes of this

subsection for the taxable year and which is used by the taxpayer

as a residence (within the meaning of section 280A(d)(1)).”      For

a dwelling unit to qualify as a residence pursuant to section

280A(d)(1) the taxpayer must use it for the greater of 14 days or

10 percent of the number of days during the taxable year for

which the unit is rented at a fair rental price.    Sec.

280A(d)(1).   However, if the taxpayer does not rent the dwelling

unit at any time during a taxable year, the unit may be treated
                                 - 9 -

as a residence for the taxable year, notwithstanding section

280A(d)(1).   Sec. 163(h)(4)(A)(iii).

     It is undisputed that petitioners never completed the

construction of a residence on the property.    We have previously

found that interest paid by a taxpayer in relation to a vacant

lot which she and her husband owned and on which they camped

yearly was not qualified residence interest within the meaning of

section 163(h)(3) because the interest was not paid on a

principal or second residence.    See Garrison v. Commissioner,

T.C. Memo. 1994-200, affd. without published opinion 

(6th Cir. 1995).   However, the fact that there was no residence

or dwelling unit on petitioners’ property during the taxable

years 2006 and 2007 does not end our inquiry.   Pursuant to

section 1.163-10T(p)(5)(i), Temporary Income Tax Regs., 52 Fed.

Reg. 48419 (Dec. 22, 1987), a taxpayer may treat a residence that

is “under construction” as a qualified residence for a period of

up to 24 months if the residence becomes a qualified residence as

of the time that the residence is ready for occupancy.2    The


     2
      Sec. 1.163-10T(p)(5), Temporary Income Tax Regs., 52 Fed.
Reg. 48419 (Dec. 22, 1987), provides:

          (5) Residence under construction.--(i) In
     general--A taxpayer may treat a residence under
     construction as a qualified residence for a period of
     up to 24 months, but only if the residence becomes a
     qualified residence, without regard to this paragraph
     (p)(5)(i), as of the time that the residence is ready
     for occupancy.
                             - 10 -

example in section 1.163-10T(p)(5)(ii), Temporary Income Tax

, clarifies that a taxpayer may treat a residence

under construction as his or her second residence for up to 24

months “commencing on or after the date that construction is

begun”.3

     We have found that petitioners purchased the property with

the intention of constructing a qualified residence and that

their actions regarding the property during the years 2006 and

2007 were in furtherance of that goal.

     3
      Sec. 1.163-10T(p)(5)(ii), Temporary Income Tax 

, provides:

          (ii) Example.--X owns a residential lot suitable
     for the construction of a vacation home. On April 20,
     1987, X obtains a mortgage secured by the lot and any
     property to be constructed on the lot. On August 9,
     1987, X begins construction of a residence on the lot.
     The residence is ready for occupancy on November 9,
     1989. The residence is used as a residence within the
     meaning of paragraph (p)(3)(iii) of this section during
     1989 and X elects to treat the residence as his second
     residence for the period November 9, 1989, through
     December 31, 1989. Since the residence under
     construction is a qualified residence as of the first
     day that the residence is ready for occupancy (November
     9, 1987) [sic], X may treat the residence as his second
     residence under paragraph (p)(5)(i) of this section for
     up to 24 months of the period during which the
     residence is under construction, commencing on or after
     the date that construction is begun (August 9, 1987).
     If X treats the residence under construction as X’s
     second residence beginning on August 9, 1987, the
     residence under construction would cease to qualify as
     a qualified residence under paragraph (p)(5)(i) on
     August 8, 1989. The residence’s status as a qualified
     residence for future periods would be determined
     without regard to paragraph (p)(5)(i) of this section.
                             - 11 -

     The issues we must decide are:   (1) Whether the residence

was “under construction” during the taxable years at issue, and,

if so, (2) whether the fact that events occurred after the

taxable years in issue that prevented the completion of

construction of a qualified residence should disqualify the

interest deduction for prior years.

Under Construction

     The term “under construction” is not defined in section 163

or by section 1.163-10T(p)(5)(i), Temporary Income Tax 

, or any other related section of the regulations.    As such,

we must decide its proper interpretation.

     Petitioners contend that the term “under construction” is

broad enough to include their work done in applying for permits,

doing preparatory measurements, surveying, drawing plans, and

causing the existing house to be demolished and the site cleared.

Petitioners encourage us to hold that the work on the property

was part of the construction process and that this process began

in 2006.

     Respondent contends that we should interpret “under

construction” much more narrowly by requiring petitioners to have

begun the “physical building process” before being entitled to

claim a home mortgage interest deduction.   Respondent claims that

petitioners’ preliminary site work as part of the permitting

process does not constitute construction for the purposes of
                               - 12 -

section 1.163-10T(p)(5)(i), Temporary Income Tax 

,

because construction requires the act of building or putting

parts together.   See Black’s Law Dictionary 355 (9th ed. 2009).

     In order to determine the proper meaning attributable to the

term “under construction” it is useful to consult the meanings

ordinarily given to those words.   See Asgrow Seed Co. v.

Winterboer, 

, 187 (1995).   “Construction” is defined

as “the act or process of constructing”.   Webster’s New World

College Dictionary 313 (4th ed. 2009) (emphasis added); The

American Heritage Dictionary 315 (2d College ed. 1985).

Furthermore, the applicable definition of “under” defines the

word as “in the process of”.   (In fact, one of the examples given

following the definition is “under construction”.)    Webster’s

Third New International Dictionary 2487 (1986); see also The

American Heritage Dictionary (2d College ed. 1985).    The

definitions commonly attributed to both “under” and

“construction” acknowledge that the terms can be read as being

broad enough to encompass the entire process of construction and

not simply the physical assembly of building materials.

Therefore, the question becomes whether petitioners’ activities

during 2006 and 2007 amounted to the commencement of the process

of construction rather than merely preparatory activities.

     The record indicates that in early 2006 petitioners

purchased the property and caused the demolition of the existing
                              - 13 -

house.   Although the house was leveled and the lot was cleared

before petitioners received legal title to the property in March

2006, the work would not have occurred had petitioners not

bargained for it in the purchase and sale agreement.   For all

practical purposes, petitioners were responsible for the

demolition work, and it came about as a direct result of their

purchasing the property.   The fact that petitioners did not hold

legal title to the property at the time that the work occurred

does not negate its relevance to our inquiry, especially given

the real property laws of the State of Florida.4   At the time the

actual demolition and cleanup work took place with respect to the

property, petitioners were possessors of equitable title.    As

such, petitioners were the beneficial owners of the property when

the demolition of the existing house took place.   Therefore, we

find that by causing an entire house to be demolished and by

clearing the lot so that it would be suitable for a new

residence, petitioners undertook significant steps in the process

of constructing their vacation house, as early as January 2006.




     4
      The doctrine of equitable conversion has become thoroughly
ingrained and embedded in Florida real estate law. Fla. Dept. of
Revenue v. Mesmer, 

, 386 (Fla. Dist. Ct. App.
1977). The doctrine of equitable conversion becomes operative
upon entry of an agreement to convey title to realty.

becomes the beneficial owner, and the vendor
retains only naked legal title as security for payment of the
purchase price.

Such steps have been recognized as the beginning of

construction.5

     In addition to the demolition work on the existing house,

petitioners also completed extensive planning and preparatory

work as part of the construction permitting process.   In 2006

petitioners had survey work and core drilling done on the

property to satisfy permitting requirements.   Petitioners also


     5
      When discussing the enactment of sec. 189, dealing with the
deductibility of construction period interest, the congressional
committee stated:

          The conferees understand that the construction
     period commences with the date on which the
     construction of a building or other improvement begins
     and ends on the date that the building or improvement
     is ready to be placed in service or is ready to be held
     for sale. * * * Generally the construction period
     will be considered to have commenced when land
     preparations and improvements, such as clearing,
     grading, excavation, and filling, are undertaken.
     However, the construction period will not be considered
     to have commenced solely because clearing or grading
     work is undertaken, or drainage ditches are dug, if
     such work is undertaken primarily for the maintenance
     or preservation of raw land and existing structures and
     is not an integral part of a plan for the construction
     of new or substantially renovated buildings and
     improvements. In the case of the demolition of
     existing structures where the construction period has
     not otherwise commenced, the construction period is
     considered to commence when demolition begins if the
     demolition is undertaken to prepare the site for
     construction. The construction period will not be
     considered to commence solely because of the demolition
     of existing structures if the demolition is not
     undertaken as part of a plan for the construction of
     new or substantially renovated buildings or
     improvements. [H. Conf. Rept. 97-760, at 1264 (1982),
     1982-2 C.B. 600, 608; emphasis added.]
                              - 15 -

entered into a contract with DCS during 2007 so that it could

coordinate and administer their ongoing permitting efforts.     As a

part of that agreement, DCS agreed to arrange the work that was

being done by the architects, engineers, designers, and other

members of petitioners’ permitting team.     This work had to be

completed by petitioners before they could file a complete

application with the department.    The application required

petitioners to provide evidence of ownership, governmental

reassurances, engineering computations, surveys of the property,

and detailed construction, site, and planting plans.     The work

petitioners were required to complete before filing the

application was extensive and required the labor of multiple

building and design professionals.     This work took place

throughout 2006 and 2007.   Petitioners undertook significant work

in preparing to obtain a construction permit, and that work was a

necessary component of the overall process of construction.     We

hold that the property was “under construction” as a residence

during 2006 and 2007.

Subsequent Events That Prevented Completion of a Qualified
Residence

     Respondent contends that because petitioners sold the

property in 2009 before completion of a residence that was ready

for occupancy, petitioners failed to satisfy the requirement that

the property must become a qualified residence as of the time the

residence is ready for occupancy.    See sec. 1.163-10T(p)(5)(i),
                              - 16 -

Temporary Income Tax 

.     We find this contention

unpersuasive.   Section 1.163-10T(p)(5)(i) and (ii), Temporary

Income Tax 

, allows qualified residence interest to

be deducted for the 24-month period following the commencement of

construction.   In the event the residence under construction has

not been completed and is not ready for occupancy by the end of

the 24-month period, the residence under construction ceases to

qualify under paragraph (p)(5)(i) after that 24-month period

ends.6   If petitioners intended to claim the deduction for

qualified residence interest during the construction period, they

had to claim it on their returns for the years immediately

following the commencement of construction in January 2006.      It

is a well-known principle that each taxable year stands alone and

is evaluated separately.   United States v. Lewis, 

(1951); Rose v. Commissioner, 

, 32 (1970).    In

evaluating each year on its own, it would be impossible for



     6
      Although the example in sec. 1.163-10T(p)(5)(ii), Temporary
Income Tax 

, provides that a residence under
construction ceases to qualify under par. (p)(5)(i) for periods
beyond the end of the 24-month period, it also provides that the
ongoing construction of a qualified residence beyond that period
does not affect a taxpayer’s right to claim the deduction for the
entire 24 months. The example describes a situation where
construction began on Aug. 9, 1987, and the residence did not
become ready for occupancy until Nov. 9, 1989. The regulation
acknowledges that the fact that the residence was not ready for
occupancy until more than 24 months had passed from the date that
construction began had no bearing on the taxpayer’s ability to
claim the deduction for the first 24 months of the construction
period.
                                - 17 -

petitioners or the Internal Revenue Service to have known that

the proposed residence would never become ready for occupancy.7

The appropriateness of the deductions petitioners claimed should

be evaluated on the basis of the facts and circumstances as they

existed in 2006 and 2007.     Events beyond petitioners’ control

occurred in subsequent years and prevented petitioners from

completing a residence.

     We hold that petitioners’ planned residence was under

construction during 2006 and 2007 for the purpose of section

1.163-10T(p)(5)(i), Temporary Income Tax 

.

Therefore, petitioners are entitled to the claimed mortgage

interest deductions for the taxable years 2006 and 2007.

         To reflect the foregoing,


                                           Decision will be entered

                                      for petitioners.




     7
      Indeed, the regulation does not recognize that the
residence under construction became a qualified residence within
a specified period and does not address the situation where the
residence under construction never becomes ready for occupancy.
The regulation requires only that the residence “becomes a
qualified residence * * * as of the time that the residence is
ready for occupancy.” Sec. 1.163-10T(p)(5)(i), Temporary Income
Tax 

.