T.C. Summary Opinion 2009-18



                        UNITED STATES TAX COURT



               JAMES ANTHONY GREIF, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

           VANLAN     T. BUI, Petitioner v. COMMISSIONER
                    OF INTERNAL REVENUE, Respondent



     Docket Nos. 4709-07S, 4710-07S.       Filed February 4, 2009.



     Young B. Chung, for petitioners.

     Alexander D. DeVitis, for respondent.



     GERBER, Judge:    These consolidated cases1 were heard

pursuant to the provisions of section 7463 of the Internal



     1
      These cases are consolidated for purposes of trial,
briefing, and opinion and involve coowners of realty who filed
separate petitions with respect to a casualty loss regarding
their coowned real property. Petitioners are James Anthony Greif
and VanLan T. Bui.
                                - 2 -

Revenue Code in effect when the petitions were filed.   Unless

otherwise indicated, all section references are to the Internal

Revenue Code in effect for 2003, the taxable year in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.   Pursuant to section 7463(b), the decisions to be

entered are not reviewable by any other court, and this opinion

shall not be treated as precedent for any other case.   For Mr.

Greif’s and Miss Bui’s 2003 tax years, respondent determined

income tax deficiencies of $9,191 and $11,447, respectively.

Respondent also determined accuracy-related penalties under

section 6662(a) for Mr. Greif and Miss Bui of $1,838 and $2,289,

respectively.   The sole question for our consideration is whether

petitioners incurred a deductible casualty or theft loss during

their 2003 tax years.

                            Background2

     At the time their petitions were filed, petitioners resided

in Washington State.    Each petitioner’s 2003 Federal income tax

return included a gross casualty loss of $171,163.   After

computational limitations, Mr. Greif claimed $164,672 and Miss

Bui claimed $163,991 as a casualty loss on their respective 2003

Schedules A, Itemized Deductions.




     2
      These cases were submitted at a Los Angeles, California,
trial session under Rule 122 with the facts fully stipulated by
the parties.
                               - 3 -

     On May 4, 1999, petitioners purchased, for $57,100,

unimproved real property (parcel) in SeaTac, Washington, with the

intent of placing a personal residence on the property.     The

parcel was roughly square with boundaries from approximately 208

to 224 feet.   The parcel had a relatively steep grade, dropping

60 feet from one side to the other.    The improved real property

had been appraised on April 13, 1999, at a projected value of

$320,000 upon completion of the planned improvements.

     Petitioners secured a $236,848 construction loan and on or

about March 28, 1999, hired Gifford Olson (Mr. Olson) as a

general contractor to build the residence at that price.

Construction began in June 1999.   Later that year it was

discovered that Mr. Olson had built the driveway on a portion of

the area intended for the septic system drain field.    Because

this deviated from the plans approved by the city and violated

the King County Health Department’s setback requirement,

petitioners were denied an occupancy permit.    Other problems

included the removal of vegetation on the slopes of the property

and the negligent construction of the road leading to the house.

These errors created instability in the soil.

     The costs to correct the various problems mounted, and after

drawing $182,500 from the $236,848 construction loan, Mr. Olson

abandoned the project in June 2000.    At that point, the home

building project was 70 percent complete.    At petitioners’
                               - 4 -

request, the King County Board of Equalization reduced the

assessed value of the improved real property to $23,000 on the

basis that the parcel was considered “unbuildable” for lack of a

sewer connection.

     On September 29, 2000, Mr. Olson sued petitioners alleging

that he was still owed $35,000 for materials and labor.

Petitioners answered Mr. Olson’s complaint, denying they owed any

amount.   Without setting forth a specific amount of relief,

petitioners counterclaimed for breach of contract, negligence,

and violation of the Washington State Consumer Protection Act.

In addition to a few other complaints about Mr. Olson’s

performance, petitioners sought relief for the denial of the

occupancy permit due to the misplacement of the road and the

damage to the slope and drain field.

     On March 13, 2002, Judge Michael J. Heavey, Superior Court

for King County, State of Washington, issued a memorandum opinion

in which he generally described the contractual dealings between

Mr. Olson and petitioners as follows:

     The plaintiff [Olson] and defendant [petitioners] were
     both greedy. The plaintiff saw an opportunity to break into
     fullscale home building and the defendant saw an opportunity
     to get a custom home as opposed to a modular home. They
     ignored problems and cut corners. The contract and
     specifications they entered into were deficient. There was
     no survey of the lot corners. They both ignored that it was
     a difficult lot; with a challenging access, septic, and site
     location issues. No persons (contractor, owner, sanitarian,
     engineer) located the drain field and reserve drainfield
     areas and flagged them off. They needed serious legal,
     engineering, architectural and licensed sanitarian
                               - 5 -

     professional help. Their collective ignorance and greed
     blinded them to these realities. Both were reluctant to
     fully discuss and resolve overruns. They continually danced
     around these issues without fully addressing them. There
     was no schedule, no change order process, no definitions of
     “allowance” or “default allowance”, no clear statement of
     work, and no real specifications: i.e., a prescription for
     disaster.

     On the basis of those and other found facts, Judge Heavey

held that Mr. Olson did not commit a deceptive trade practice but

that he did default on the contract and negligently damaged the

septic drain field.   Petitioners were awarded costs of obtaining

a new septic field design and approval and the costs of

“rockery”, or a retaining wall to preserve the drain field.

Petitioners were also awarded a $38,150 judgment to supplement

the $40,000 remaining in the construction loan in order to finish

the home.

     Petitioners also filed a claim with Mr. Olson’s insurance

carrier seeking to recoup $280,000 of alleged damage to

petitioners’ parcel by Mr. Olson.   After discussions with the

carrier, petitioners’ attorney advised them that Mr. Olson’s

policy did not cover the type of damage caused to petitioners’

property. Petitioners, during 2003, filed a claim under their own

homeowner’s policy but were denied on the basis that it covered

only damage to the improvements and not the realty.   Petitioners,

however, did not concede that the insurance companies were

without liability.
                               - 6 -

     On March 9, 2001, the King County Health Department granted

Mr. Greif a waiver on the setback requirement.    Petitioners were

required only to submit the new plans for approval and to

construct the septic system in order to obtain the occupancy

permit.   Neither was done, and later surface erosion invalidated

the waiver.   Petitioners’ later requests for a new waiver were

denied.

     During April 2002 the city of Kent hired a geotechnical

engineer to inspect petitioners’ parcel of land.   The engineer

concluded that there was instability in the slope and roadway

alignment which, if uncorrected, could result in a landslide and

cause damage to the real property improvements.    Petitioners

subsequently hired a geotechnical engineering firm, Krazan &

Associates, Inc. (Krazan), to examine the property.    Krazan’s

report made findings similar to the city engineer’s.    Petitioners

contend some earth movement occurred sometime between May 2002

and June 2003, resulting in the accumulation of soil along the

eastern edge of the property and causing some damage to

vegetation and a gate.

     On November 25, 2002, petitioners filed a motion for

reconsideration and clarification of Judge Heavey’s March 13,

2002, memorandum opinion.   In their motion petitioners pointed

out that there was evidence that it would cost $153,000 to

correct the problems with the road that cut across the drain
                                - 7 -

field.    During a period of cross-motions in the superior court

proceeding (petitioners’ motion for reconsideration and Mr.

Olson’s motion to dismiss) Mr. Olson voluntarily entered into a

liquidating bankruptcy on May 1, 2003.      In the bankruptcy

proceeding Mr. Greif filed a motion, that was granted, seeking to

lift the stay as it related to his pursuit of Mr. Olson in the

superior court proceeding.    Petitioners also filed an adversary

proceeding complaint objecting to the discharge of Mr. Olson’s

debt.    Mr. Olson moved to dismiss petitioners’ complaint, and on

December 12, 2003, petitioners’ response indicated they would not

oppose the motion but would proceed with their action in Superior

Court for King County.    On January 8, 2004, the bankruptcy

trustee filed a report of no distribution, and on May 11, 2004,

Mr. Olson’s claimed debt to petitioners was discharged.

     Mr. Greif claimed casualty or theft losses with respect to

the subject property on his 2001 and 2002 income tax returns of

$23,000 and $48,000, respectively.      Petitioners claimed a

casualty loss for 2003 on the basis of their belief that Mr.

Olson’s bankruptcy rendered any relief in the superior court

proceeding uncollectable and also because of their inability to

recover from insurance companies.    On their respective 2003

income tax returns, petitioners each claimed a $171,163 basis in

the improved real property, no insurance recovery, and a fair

market value of $250,000 before and $78,837 after the casualty.
                                  - 8 -

      During 2004 development of the surrounding area made the

municipal sewer system accessible to petitioners’ property.

Petitioners were granted an occupancy permit, and they moved into

the residence in the latter part of 2006 or early 2007.     On

January 25, 2007, petitioners’ improved realty was assessed on

the local tax rolls at $496,000, comprised of $69,000 for land

and $427,000 for improvements.

      On October 26, 2006, petitioners stipulated to the superior

court’s dismissal of their suit against Mr. Olson.     In 2007

petitioners accepted $7,500 from Mr. Olson’s insurance carrier in

settlement of their claims.

                               Discussion

     The parties submitted this case fully stipulated, thereby

rendering irrelevant questions about whether the burden of proof

shifted.   See sec. 7491(a).    Petitioners, however, bear the

burden of showing entitlement to casualty loss deductions.       See

Rule 142(a); New Colonial Ice Co. v. Helvering, 

, 440

(1934).    In addition, respondent bears the burden of production

with respect to the accuracy-related penalties determined under

section 6662(a).   See sec. 7491(c).

I.   Casualty Loss Deduction

      Under section 165(a), deductions are allowable for losses

not compensated for by insurance or otherwise.     In the case of an

individual, section 165(c)(3), subject to the limitations of
                                - 9 -

sections 165(h), permits a nonbusiness casualty loss.      Section

165(h) sets forth dollar and percentage limitations or thresholds

for claiming casualty losses.   Section 165(h) permits an

individual to deduct a casualty loss only to the extent each loss

exceeds $100 and the aggregate of such casualty gains and losses

exceeds 10 percent of adjusted gross income.

     A.   Casualty Loss

     The term “casualty” is not clearly defined in the Code or

the regulations.   Section 165(c)(3) mentions losses arising from

“fire, storm, shipwreck, or other casualty”.      In defining the

term “other casualty”, courts apply the rule of ejusdem generis

and look for characteristics similar to those of a fire, storm,

or shipwreck.   Maher v. Commissioner, 

, 596 (1981),

affd. 

(11th Cir. 1982).      Courts have interpreted

“other casualty” to require an undesigned, sudden and unexpected

event, or a sudden, cataclysmic, and devastating loss.      Torre v.

Commissioner, T.C. Memo. 2001-218, affd. 

(9th

Cir. 2002).

     Petitioners claim two losses.      First, petitioners contend

they were denied an occupancy permit because damage to the septic

system drain field made the septic area unusable and

significantly decreased the value of the property.      Second,

petitioners contend the land was rendered unstable when Mr. Olson
                               - 10 -

removed vegetation along the slopes of the property and cut the

road too steep into the hillside.

     Petitioners argue that the damage to the drain field and

slope was sudden because it was not caused by gradual

deterioration and happened over a relatively short period.

Petitioners argue that the damage was unexpected because such

damage does not usually occur during the construction of homes on

similarly situated properties.    Petitioners correctly observe

that negligence is not an automatic bar to a casualty loss

deduction.   See White v. Commissioner, 

, 435 (1967).

The foreseeability of an event or the presence of negligence does

not preclude the finding that the event was a casualty.       Heyn v.

Commissioner, 

, 308 (1966).    Both are merely factors

in making such a determination.

that petitioners’ losses were not

casualties because neither was the result of sudden or unexpected

events.    Damage caused by faulty construction methods has long

been held not to constitute a casualty loss.    Matheson v.

Commissioner, 

(1930), affd. 

(2d Cir.

1931).    In petitioners’ litigation against Mr. Olson, the court

found that Mr. Olson mistakenly encroached onto the area of the

septic system drain field while excavating for the driveway.

Petitioners contend that the damage to the drain field site

occurred instead when a subcontractor negligently drove a
                               - 11 -

bulldozer over the area.   Regardless of how the drain field was

damaged, the end result was the placement of the driveway over a

portion of the intended drain field site.   When this occurred,

the location of the driveway no longer conformed with the

approved plans and violated the setback requirement.   For that

reason, petitioners were denied an occupancy permit, and the

property lost most of its value.

     Casualty losses have been allowed in faulty construction

cases typically where there has been a subsequent, unexpected

event apart from the contractor’s negligence.   See Marx v.

Commissioner, T.C. Memo. 1991-598 (subsequent leaks in taxpayer’s

roof arising from its negligent repair were a casualty loss, but

the original leak from its faulty construction was not); Hayutin

v. Commissioner, T.C. Memo. 1972-127 (flood damage proximately

caused not by faulty construction of taxpayer’s home, but by

plumber stepping on unprotected pipe), affd. 

(10th

Cir. 1974).   Whether the encroachment onto the drain field site

was the result of negligent excavation or a bulldozer running

over the area is irrelevant.   Denial of the occupancy permit was

based on the driveway being too close to the drain field.     The

improper placement of the driveway is simply a matter of faulty

construction.   Once the driveway had been constructed, there was

no later event that caused further harm to the property.
                              - 12 -

     Petitioners cite the Heyn case as an example of the

allowance of a casualty loss based on a contractor’s negligence.

In Heyn v. Commissioner, supra at 305, the contractor

unilaterally deviated from the prescribed excavation method and

was warned of the likelihood of a landslide occurring.

Nevertheless, the Court allowed the casualty loss because the

physical characteristics of the landslide were those normally

associated with a casualty, and the landslide involved a sudden

and violent movement of a large mass of earth that was

cataclysmic in character.

     We have held that the magnitude of the taxpayer’s loss is

another factor to consider in the casualty loss analysis.    See

White v. Commissioner, supra at 434.   It was the physical

characteristics and magnitude of the taxpayer’s loss which the

Court in Heyn found akin to the sudden and devastating loss

suffered during a fire, storm, or shipwreck.

     Petitioners contend the soil instability culminated in a

landslide sometime between May 2002 and June 2003.    However, the

record does not adequately support this contention.   The

geotechnical engineer’s report from Krazan merely notes

instability created by the removal of vegetation from the slopes

and the steep angle of the driveway.   The report stated that if

those conditions were not mitigated, there would be an adverse

effect on the property; but it made no mention of a landslide.
                               - 13 -

Similarly, a letter from the Department of the Army notes that

the city’s engineering manager made the same observations about

the instability on the property.   This letter is dated June 11,

2003 (after the purported landslide), and also fails to mention

that such an event occurred. In the absence of such an event

petitioners have experienced only instability in the slopes of

their property.   This is not the type of loss that can be

considered sudden, cataclysmic, and devastating or the result of

an undesigned, sudden, and unexpected event.

     Furthermore, a taxpayer may not knowingly allow his property

to be damaged or willfully damage the property himself.    See

White v. Commissioner, supra at 435; Pryor v. Commissioner, T.C.

Memo. 1987-80.    Petitioners were granted a waiver on the setback

requirement and could have thus obtained an occupancy permit,

thereby mitigating the loss they suffered.    By failing to pursue

the variance, petitioners knowingly perpetuated the impediment to

completion of the real property improvements.

     Petitioners’ loss was the product of Mr. Olson’s negligent

construction and not some unexpected event.    There was no

devastating or cataclysmic damage to the property, such as a

landslide.   Petitioners could have remedied the occupancy permit

problem, but they neglected to take the necessary steps to do so.

We accordingly hold that petitioners’ loss was not a casualty.
                                  - 14 -

     B.    Amount of Loss3

     The amount of a particular casualty loss deduction is

limited to the lesser of (1) the difference between the fair

market value of the property before and after the loss, or (2)

the adjusted basis provided in section 1011 for determining the

loss from the sale or other disposition of the property.      Sec.

165(b); secs. 1.165-7(b)(1), 1.165-8(c), Income Tax Regs.

     Petitioners have not met their burden of establishing the

amount of their loss.    They have not demonstrated the value of

the property before their loss.       Petitioners purchased the parcel

on May 4, 1999, for $57,100.       No appraisal was made at that time.

Petitioners did submit an appraisal performed before the purchase

(dated April 13, 1999) as proof that the property was valued at

$320,000.     However, the report was marked “subject to completion

per plans and specifications.”       Construction of the home began in

June.     The encroachment of the driveway into the septic system

drain field was discovered later that year, and construction had

not yet been completed at that time.       Therefore, the property

could not have been worth as much as the full estimated value in

that appraisal report.       The next valuation of the property was



     3
      We consider whether petitioners have established the amount
of a loss because petitioners have made the generalized
alternative contention that their loss was a theft loss. Because
we conclude that the amount of the loss has not been established,
no further consideration need be given to petitioners’
alternative contention.
                                - 15 -

not made until after petitioners’ loss, when it was assessed at

$23,000 for the 2000 tax year.

        Petitioners have also failed to establish their adjusted

bases in the property at the time of the loss.       Petitioners now

contend that they each had an adjusted basis of $119,725.       They

arrived at this number by adding the $57,100 purchase price of

the parcel to the $182,500 already paid to Mr. Olson at the time

he stopped work on the home in June 2000.       These calculations are

imprecise, and the measure of their loss has more to do with the

construction of the driveway over the drain field site.

Petitioners have not documented how much of the $182,500 paid to

Mr. Olson was for work done afterwards.       Such amounts are not

properly includable in petitioners’ adjusted basis at the time of

the loss.

     Petitioners have not provided sufficient evidence for us to

determine the value of the property before the loss and their

adjusted bases at the time of the loss.       Both of these figures

are necessary to determining the proper amount allowable as a

loss.     We therefore hold that petitioners have not established

the amount of their loss.

     C.     Reasonable Prospect of Recovery

        Even when a taxpayer has suffered a casualty loss, he cannot

deduct the loss if he has a claim for reimbursement with a

reasonable prospect of recovery.     Sec. 1.165-1(d)(2)(i), Income
                                - 16 -

Tax Regs.     Deduction of the loss is disallowed until the taxable

year in which it can be ascertained with reasonable certainty

whether reimbursement will be received.

be made upon a settlement, an adjudication, or an abandonment

of the claim.

objective standard in determining whether

such a “reasonable expectation” existed at the end of the year

the deduction is claimed.     Ramsay Scarlett & Co. v. Commissioner,

, 811-812 (1974), affd. 

(4th Cir. 1975).

The standard is applied with foresight, and facts not reasonably

foreseeable at the close of the particular year are not

considered.

of litigation suggests a

reasonable prospect of recovery existed but does not require such

a finding.    See Halliburton Co. v. Commissioner, 

, 775

(1989), affd. 

(5th Cir. 1991).       Proof of subsequent

events may, however, be allowed to confirm a conclusion as to

whether there was a reasonable prospect of recovery.

       Petitioners contend that the denial of coverage by Mr.

Olson’s insurance carrier proves they had no reasonable prospect

of recovery.     Petitioners note that their attorney advised them

on January 21, 2007, that Mr. Olson’s insurance policy did not,

in fact, cover their claim.
                               - 17 -

     Petitioners litigated the denial of coverage, and we

accordingly hold that they have not met their burden of proving a

reasonable prospect of recovery did not exist at the end of 2003.

In Mr. Olson’s 2003 bankruptcy proceeding petitioners stated that

Mr. Olson’s insurance carrier was liable for many of Mr. Greif’s

claims against him.    Petitioners requested that the stay to be

lifted so that they could proceed against the insurance carrier.

As of December 12, 2003, petitioners indicated their intent to

continue with the litigation against Mr. Olson.    While

petitioners’ decision to litigate does not decide the issue, it

does demonstrate that they had not yet abandoned their claim for

reimbursement.    With the ongoing litigation, it could not be

ascertained with reasonable certainty that petitioners would not

prevail in their suit against Mr. Olson and recover the judgment

from his insurance carrier.    The continuation of the litigation

until 2006 and the fact that a settlement was reached in 2007

suggest that a reasonable prospect of recovery did exist.

     The fact that petitioners maintained their claim for

insurance reimbursement and had a reasonable prospect of recovery

at the end of 2003 also militates against allowing them a

casualty loss deduction.

     D.   Conclusion

     Petitioners’ loss was not of the type contemplated by

section 165(c).    Petitioners failed to establish the true amount
                                - 18 -

of their loss and still had a claim for reimbursement with a

reasonable prospect of recovery in 2003.    For these reasons, we

hold that petitioners are not entitled to casualty loss

deductions.

II.   Accuracy-Related Penalties

      Section 6662(a) and (b)(1) and (2) imposes an accuracy-

related penalty of 20 percent on the portion of an underpayment

attributable to negligence, disregard of rules or regulations, or

a substantial understatement of income tax.    Negligence is

defined as a lack of due care or failure to do what a reasonable

person would do under the circumstances.    A disregard of rules or

regulations includes any careless, reckless, or intentional

disregard.    Sec. 6662(c).   An understatement is substantial if it

exceeds the greater of:    (1) 10 percent of the tax required to be

shown on the return for the taxable year, or (2) $5,000.    Sec.

6662(d)(1)(A).    Neely v. Commissioner, 

, 947 (1985).

Section 6001 requires taxpayers to maintain adequate records from

which their correct tax liability may be determined.

      Petitioners’ understatements of income tax are substantial.

Mr. Greif reported a tax liability of zero, whereas his correct

liability was $9,191.    Miss Bui also reported a tax liability of

zero, whereas her correct liability was $11,447.    Both

understatements of income tax are substantial because they exceed
                               - 19 -

$5,000 or 10 percent of the tax required to be shown on the

return.

     Petitioners’ underpayments are also attributable to

negligence.   Petitioners declared a total adjusted basis of

$342,326 in their 2003 returns, but they provided no

documentation as to how they arrived at this figure.   Petitioners

have since claimed the adjusted basis was $239,450 without

explaining this discrepancy.   Both petitioners claimed casualty

loss deductions of $171,163.   The deductions far exceed the

$239,450 petitioners now claim to be the property’s total

adjusted basis.   Even if we assume the $239,450 figure is correct

and ignore the property’s preloss value, petitioners’ claimed

casualty losses plainly exceeded the $239,450 adjusted basis

limitation on their casualty loss deductions.

     As discussed above, petitioners also failed to properly

establish the value of the property before their loss.

Petitioners claimed preloss value of $320,000 was based on an

appraisal report conditioned on the completion of the planned

improvements.   Such improvements had not been completed at the

time petitioners’ loss occurred.   At the time their loss

occurred, petitioners should have known that the property was not

worth the full value listed in the appraisal report.

     Petitioners contend that they acted in good faith and with

reasonable cause by relying on the advice of a tax professional.
                              - 20 -

Section 6664(c)(1) provides that the section 6662 penalty does

not apply to any portion of an underpayment if reasonable cause

existed and the taxpayers acted in good faith.

     Reliance on the advice of a tax professional is not an

absolute defense to negligence.    Freytag v. Commissioner, 

, 888 (1987), affd. 

(5th Cir. 1990), affd. 

(1991).   Such reliance does not necessarily establish

reasonable cause and good faith.   Sec. 1.6664-4(b)(1), Income Tax

Regs.   The determination of whether a taxpayer acted with

reasonable cause and in good faith is made by taking into account

all pertinent facts and circumstances.

faith reliance, taxpayers must prove that:       (1) They provided the

preparer complete and accurate information, (2) an incorrect

return was a result of the preparer’s mistakes, and (3) the

taxpayers believed in good faith that they were relying on a

competent return preparer’s advice.    Estate of Goldman v.

Commissioner, 

, 324 (1999), affd. without published

opinion sub nom. Schutter v. Commissioner, 

(10th

Cir. 2000).

     Petitioners have not shown how they calculated $342,326 as

their adjusted basis.   They should have known that the $171,163

deduction was overstated irrespective of who chose to use that

figure.   Accordingly, petitioners are liable for the accuracy-

related penalties under section 6662(a).
                        - 21 -

To reflect the foregoing,


                                  Decisions will be entered

                             for respondent.