T.C. Memo. 2019-2



                         UNITED STATES TAX COURT



  ESTATE OF ARTHUR S. ANDERSEN, DECEASED, TENA HAROLDSON,
      ERIC STOVAL, AND HAROLD ALBRIGHT, PERSONAL CO-
                REPRESENTATIVES, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 14067-14.                          Filed January 30, 2019.


      Dennis D. Evenson, for petitioners.

      John Schmittdiel and Beth A. Nunnink, for respondent.



                           MEMORANDUM OPINION


      HOLMES, Judge: The late Arthur S. Andersen was a businessman who

sold two Wyoming properties in 2010. The major issue in this case is about his

bases in those properties; but his fight with the IRS sprawled across three

schedules’ worth of deductions and a penalty too.
                                        -2-

[*2]                                Background

       Andersen’s background is somewhat mysterious. A substantial part of this

mystery stems from the fact that we never got to see Andersen or any other

witnesses, because the parties agreed to submit the case to us on a stipulated

record under Rule 122.1 That record shows that Andersen was an independent

businessman who owned a number of properties in Wyoming and South Dakota.

Two Wyoming properties are important here because he sold them in 2010: (1) a

motel and RV park, which he bought in 2006, and (2) what seems to be vacant

land that we’ll call the ranch, which he bought in 2007.

       Andersen didn’t file his return for 2010 when it was due, and the

Commissioner learned about the property sales from third-party filings. Out

popped a notice of deficiency (NOD) that set Andersen’s capital gain on the sales

equal to his proceeds. Andersen filed a petition and then finally filed his 2010

return. On it he unsurprisingly claimed that he had basis in each property that

would offset a large chunk of the gain that the Commissioner asserted. But

Andersen also claimed a wide variety of deductions to reduce his taxable income,

including a Schedule C, Profit or Loss From Business, that reported gross receipts

       1
       Unless we say otherwise, all section references are to the Internal Revenue
Code in effect for the year in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
                                        -3-

[*3] of $655 against expenses of more than $500,000. The Commissioner sensed

something might be amiss, poked around in the late-filed return, and disallowed a

great many of the deductions that Andersen claimed.

      Trial was delayed when Andersen’s health grew worse and delayed again as

new issues kept sprouting. After eighteen months, four status reports, and a

disregarded order to produce documents, we entered a preclusion order to bring

discovery to a close. We fixed a firm date for trial late in 2017. Andersen then

died, and the parties submitted the case for decision on a stipulated record.

      They settled many issues. And we are left to look at the gains Andersen

reported on Form 4797, Sales of Business Property, from the sales of the motel

and RV park, and of the ranch; deductions that he claimed on his Schedules C, E,

and A; and a late-filing penalty under section 6651(a)(1).2 The parties are farthest

apart--about $1.1 million apart--in their calculations of the two bases in dispute.

But their disputes about Andersen’s substantiation of his expenses are far greater

in number, if much smaller in amount. We summarize them here. From his

Schedule C:

      2
         We discuss this penalty only to record that the parties stipulated that
Andersen filed his 2010 return more than three years after it was due. He did not
address the penalty in his briefs and so has abandoned any right to argue that his
failure to timely file was due to reasonable cause. See Mendes v. Commissioner,

, 312-13 (2003).
                               -4-

[*4]                           Claimed on    Allowed in
                                  return     stipulation
Advertising                      $4,185          -0-
Car and truck                    61,401          -0-
Contract labor                   79,150          -0-
Depreciation                     89,174       $36,177
Insurance                            7,708      3,821
Interest:
    Mortgage                         7,290       -0-
    Other                        38,731        13,129
Legal and professional               8,752       -0-
 services
Office expense                   12,921          -0-
Rent or lease:
    Vehicles, machinery, and     61,000          -0-
     equipment
    Other business property      24,000          -0-
Repairs and maintenance              9,363       -0-
Supplies                         22,726          -0-
Taxes and licenses               15,354         3,503
Travel                               4,715       -0-
Utilities                        43,804         7,500
Wages                                7,115       -0-
Other expenses/motel             28,961          -0-
 expenses
                                    -5-

[*5] Total                           526,350        64,130

     His Schedule E:

                                    Claimed on    Allowed in
                                       return     stipulation
Auto and travel                       $5,100          -0-
Insurance                             16,400        $3,821
Legal and other professional          32,525          -0-
 fees
Other interest                        44,900          -0-
Repairs                               50,398          -0-
Taxes                                     4,200      4,200
Other:
   Custom hire                        18,700          -0-
   Rent, vehicles, and                21,557          -0-
    machinery
   Rent land                          76,255          -0-
   Crop insurance premium                 6,992      6,992
   Farm expenses                      70,773          -0-
   Office expenses                    12,921          -0-
   Other                                  3,000       -0-
Total                                363,721        15,013

     And finally, his Schedule A:
                                         -6-

 [*6]                                     Claimed in                 Allowed in
                                       P’s opening brief             stipulation
 Installment for improvements               $33,129                      -0-
 Mortgage interest                           13,783                      -0-
 Mortgage interest                           30,055                      -0-
 Mortgage interest                             5,905                     -0-
     Total                                   82,872                      -0-

                                      Discussion

I.       Income

         The dispute about income is a dispute about the capital gains that Andersen

received when he sold his properties. The basics, in brief: Section 61(a)(3)

includes in gross income gain derived from the sale of real property. This gain

equals the excess of the amount realized from the sale over the property’s adjusted

basis. Sec. 1001(a). A property’s adjusted basis is its initial cost adjusted under

section 1016. See secs. 1012, 1011. Section 1016 lists a number of adjustments,

and it is these that the parties dispute for both properties that Andersen sold in

2010.
                                         -7-

[*7] The Code’s provisions for adjusted basis let us know that the Commissioner

got it wrong when he figured Andersen’s tax bill by setting his capital gain3 equal

to the sale proceeds--most property owners have some basis in what they sell.

      A.     Motel and RV Park

      We’ll look first at the sale of the motel and RV park. Back in 2006

Andersen agreed to buy approximately 51 acres of land in Fremont County,

Wyoming for $1.7 million. The deal closed in 2007, and Andersen became owner

of the land, fencing, RV park facilities, motel rooms, cabins, and a house. He sold

part of it--a little more than 35 acres--in 2010. The sale included the part of the

property with the fencing, motel, and RV park buildings. The parties agree on the

bases of the land and fencing--it’s only the bases of the various buildings on the

land that they still fight over. And it would seem that each party is a house--or

maybe an RV--divided against itself, with both Andersen and the Commissioner

shifting their positions on what the right basis is:




      3
         While the Commissioner ended up with a net capital gain, we also note
that he got the initial character of the gain wrong, stating in the NOD that
Andersen’s sale of properties resulted in short-term capital gain. Because
Andersen held both properties for more than one year, any gain resulting from
their sale is long-term capital gain. See sec. 1222(3).
                                            -8-

 [*8]                Per                        Per P          Per        Per P reply
                  Form 4797     Per exam     opening brief    R brief        brief
 Cost             $2,042,440 $1,680,688       $1,800,960     $1,445,000 $1,800,960
 Depr.               140,054      346,580         140,054       ---          148,205
 Adj. basis        1,902,386    1,334,108      1,660,906        ---       1,652,7554

        Andersen’s final computation of his adjusted basis had four parts:

        $1,680,688 (original cost, allocated for the portion of the property sold)

        + 106,210 (improvements, consisting of labor and restaurant expenses)

        +      14,062 (selling expenses)

        -     148,205 (depreciation)
            ________
            1,652,755

        Andersen began with the $1,680,688 cost basis determined by the

Commissioner in the notice of deficiency. He then added $106,210 in

“improvements,” consisting of $75,264 in contract-labor expenses and $30,946 in

“restaurant building” expenses; and $14,062 in selling expenses, resulting in a

total cost basis of $1,800,960. He then claimed $148,205 in depreciation for the

2006 through 2009 tax years. To calculate this depreciation, Andersen applied the


        4
        Andersen asserts in his reply brief that he had $1,800,960 in adjusted basis
for the motel and RV park. This number doesn’t reflect the $148,205 he claims in
depreciation. We assume this was a mistake and reduce his adjusted basis
accordingly.
                                         -9-

[*9] straight-line method for a nonresidential building with an associated 39-year

useful life. After reducing cost basis by depreciation, Andersen arrived at an

adjusted basis of $1,652,755.

      Let’s look at these numbers. First, there is Andersen’s $75,264 in contract-

labor expenses. The record does not show where Andersen came up with this

number or why it should be added to basis and not just claimed as a deduction on

Schedule C. Andersen in fact claimed a similar amount for contract labor as a

deductible trade or business expense on Schedule C of his filed return; it wasn’t

until his opening brief that he argued it should be added to basis. If, for example,

Andersen provided evidence that he paid the labor expense to replace the damaged

roof of a motel or RV park building, we would permit him to capitalize his

expenses under section 263(a)(1) as a permanent improvement or betterment. See,

e.g., Stark v. Commissioner, T.C. Memo. 1999-1, 

, at *13.

However, he provided no such evidence, leading us to consider this cost of

contract labor a Schedule C expense.

      Andersen next claimed $30,946 in “restaurant building” expenses as an

addition to basis. His only substantiation for this was a handwritten ledger. While

we discuss substantiation in more detail below, we note here that this ledger is an

assertion, and an assertion isn’t proof. It is wholly inadequate to establish that he
                                        - 10 -

[*10] paid the amounts he claimed as either deductible expenses or as additions to

basis. We deny Andersen’s inclusion of these expenses in basis.

      Andersen also added $14,062 in selling expenses to basis. While there is

sufficient evidence in the record to substantiate these expenses, we believe they

more appropriately reduce the amount realized than increase the cost basis, though

it wouldn’t alter the computation of gain. See Kurata v. Commissioner, T.C.

Memo. 1997-252, 

, at *3 n.2.

      Andersen next reduced basis by $148,205 in depreciation. Under

Andersen’s 39-year straight-line method, depreciation should equal $184,714 (=

$1,800,960 cost basis / 39-year useful life x 4 years in service), not $148,205. To

figure out where Andersen’s calculation went awry, we reverse engineered the

amount of depreciation that he claimed: $148,205 depreciation / 4 years in service

x 39-year useful life = $1,445,000 in cost basis. This, it seems, is the same cost

basis that the Commissioner asserts in his brief.

      Perhaps this is a subtle concession by Andersen, but it has no effect on our

conclusion because we disagree with his choice of depreciation method. He cited

section 1016(a)(2), which tells property owners to use the straight-line method

“[w]here no method has been adopted.” He argued that because the Commissioner

did not specify the method he used in the exam to calculate depreciation, we must
                                         - 11 -

[*11] use the default straight-line method. We disagree. If Andersen claimed any

depreciation for the years before he sold the motel and RV park, he undoubtedly

adopted some depreciation method. But he failed to produce any filed returns

other than his 2010 return, meaning we have no way to determine what method he

used. A taxpayer bears the burden of substantiating his basis, and Andersen failed

to bear his. We therefore accept the Commissioner’s position in the notice of

deficiency as correct. See Doll v. Commissioner, T.C. Memo. 2005-269, 

, at *4; Knauss v. Commissioner, T.C. Memo. 2005-6, 

, at *11.

        Adopting the Commissioner’s cost basis and depreciation leads to a finding

that Andersen’s adjusted basis in the motel and RV park is $1,334,108.

        B.    Ranch Sale

                    Per                        Per P          Per      Per P reply
                 Form 4797    Per exam      opening brief    R brief      brief
 Cost            $852,534     $378,540        $740,000      $300,000     $740,000
 Depr.              -0-         52,554             ---         ---         52,554
 Adj. basis       852,534      325,986            740,000      ---        687,446

        In 2007 Andersen bought the ranch from Nancy Johnson, and in 2010 he

sold it to Roger and Sadie Leseberg. Andersen financed the purchase with a

$300,000 mortgage to Johnson. The parties agree that this is properly included in
                                       - 12 -

[*12] basis because it was part of the price that Andersen paid for the property.

Andersen, however, claimed that we should also include in basis a second

mortgage of $440,000 issued by the Farm Credit Services of America, FLCA

(FCSA) in 2008.

      We disagree. Although the FCSA mortgage was secured by the same

property as the Johnson mortgage, there is nothing in the record to suggest that the

FCSA mortgage was part of the purchase price of the land--there is, for example,

no indication of a staggered payment schedule in the documentation at the time of

sale in 2007. Just mortgaging property one already owns doesn’t increase one’s

basis. See sec. 1012 (basis equals the cost to acquire property); see also Astone v.

Commissioner, T.C. Memo. 1983-747, 

, 656 n.24 (1983)

(“Clearly, the giving of a mortgage on a piece of property during the period of

ownership does not, in itself, increase the basis of the property”). The FCSA

mortgage did not increase Andersen’s basis in the ranch.

      This leaves the ranch’s basis at $300,000. But this turns out to be less than

the adjusted basis that the Commissioner already allowed in his NOD. We’ll take

that higher figure as a concession, which gives us an adjusted basis for the ranch

of $325,986.
                                        - 13 -

[*13] II.    Expenses

      The parties also dispute deductions that Andersen took on his Schedules C,

E, and A.

      A.     Schedule C Deductions

      Section 162 allows a deduction for ordinary and necessary business

expenses, but taxpayers have the burden of proof. INDOPCO, Inc. v.

Commissioner, 

, 84 (1992); see sec. 1.6001–1(a), Income Tax Regs.

That a taxpayer claims deductions on his return is not itself substantiation. See,

e.g., Wilkinson v. Commissioner, 

, 639 (1979). When a taxpayer fails

to substantiate his deductions with precision, we may estimate certain kinds of

expenses but only if he provides at least some evidence to support an estimate and

we are convinced he incurred them in connection with his trade or business.

Williams v. United States, 

, 560 (5th Cir. 1957); Cohan v.

Commissioner, 

, 543-44 (2d Cir. 1930); Finney v. Commissioner, T.C.

Memo. 1968-283, 

, 1516 (1968).

      Certain deductions have enhanced substantiation requirements under

sections 274 and 280F. These categories include travel, meals and entertainment,

gifts, and certain forms of “listed property.” To deduct expenses that fall into

these categories, a taxpayer must “substantiate[] by adequate records or by
                                        - 14 -

[*14] sufficient evidence” the amount, time and place, and business purpose of the

expenditure. Sec. 274(d). Section 274’s requirements deprive us of any power to

estimate under 

. See sec. 1.274-5T(a)(4), Temporary

Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).

      Andersen deducted a wide range of business expenses on his Schedule C

and claimed he incurred them in the ordinary course of running the motel and RV

park. We divide these claimed expenses into two categories--those governed by

section 274 and those that are not--and look at each.5

              1.   Section 274 Expenses

                   a.     Car & Truck

  Claimed on       R concession     P claimed in    R concession      P claimed in
    return         in stip. facts   opening brief      in brief        reply brief
    $61,401             -0-           $30,889            -0-           $30,8896



      5
       The briefs show that the parties agree that Andersen is entitled to deduct
expenses for (1) insurance of $3,821; (2) depreciation of $36,177; (3) interest of
$13,129; and (4) taxes and licenses of $3,503.
      6
        Andersen claimed $30,889 in car-and-truck expenses in his opening brief.
However, in the “recommended findings of fact” section of his reply brief, he
made no claim for car-and-truck expenses but significantly increased his claim for
advertising expenses--from $4,130 to $30,889. We are convinced that this was
only poor proofreading, because it matches his initial claim for car-and-truck
expenses. Andersen also conceded all advertising expenses in his reply brief. So
we’ll treat this reference to “Advertising” as if it read “Car and truck.”
                                         - 15 -

[*15] Section 280F(d)(4)(A)(I) makes cars and trucks “listed property,” so

Andersen had to meet the strict substantiation requirements of section 274(d).

This requires proof of the amount of each such expense (e.g., maintenance and

repairs), a measure of its use in his business (typically mileage), the total use of the

listed property for the tax period, the date of that use, and his business purpose in

that use. Sec. 1.274-5T(b)(6), Temporary Income Tax Regs., 50 Fed. Reg. 46016

(Nov. 6, 1985).

      What we got instead was a spreadsheet on which Andersen listed all his

reported expenses. Of the eleven that he claims under “Car and truck,” seven have

no support in the record beyond Andersen’s handwritten ledger--no invoices, no

checks, no notes or records. We have no idea if Andersen even kept this ledger

during 2010 or created it as a summary of argument for this case. But even if we

assume it was contemporaneous, it is devoid of the detail needed for substantiation

of the specific facts that section 274 requires. As a result, we find that Andersen

failed to meet the substantiation requirements under section 274 for these

amounts.

      Of Andersen’s remaining four car-and-truck expenses, he produced a

combination of checks and bank statements to show that he had paid them. For

example, his claim of a $9,144 car-and-truck expense is supported by a check paid
                                      - 16 -

[*16] to Brazos Helicopters, LLC. But section 274 requires more than proof of

payment. We have no testimony, receipts, invoices, or other evidence to link this

or any of the other claimed expenses to his motel and RV park business. Section

274 requires proof of a business purpose, so we deny Andersen any deductions for

these expenses too.

                   b.     Travel

  Claimed on      R concession     P claimed in    R concession     P claimed in
    return        in stip. facts   opening brief      in brief       reply brief
    $4,715              -0-           $5,621            -0-              ---

      Andersen conceded that he is not entitled to deduct any of his claimed travel

expenses. This makes it easy, and we deny these deductions too.
                                           - 17 -

[*17]           2.     Other Expenses

                      Claimed         R           P claimed        R       P claimed
                         on      concession      in opening   concession    in reply
                       return   in stip. facts       brief      in brief      brief
 Advertising           $4,185        -0-            $4,130       -0-         -0-7
 Supplies &            32,089        -0-            42,454     $28,612     $42,454
  repairs
 Legal &                8,752        -0-            17,764       -0-        17,764
  professional
 Office                12,921        -0-            10,410        380       10,410
  expenses
 Contract labor        79,150        -0-            76,264       3,250      76,264
 Wages                  7,115        -0-             7,115       6,103        7,115
 Other (motel)         28,961        -0-            14,963       -0-        14,963
  expenses
 Utilities             43,804      7,500            17,655       7,500      17,6558

        Andersen’s claims of deductions for even those expenses not subject to

section 274 are also defective. For example, while he explicitly accepted the

Commissioner’s position that he is not entitled to deduct any of his claimed

        7
            See supra note 6.
        8
        We are again forced to make sense of Andersen’s position. In his reply
brief, Andersen claimed $40,891 in utilities expenses. However, this amount
includes $9,973 in various nondeductible house expenses and $13,263 in “VI
Pro,” which Andersen admitted is nondeductible. Removing these nondeductible
expenses from the amount claimed leaves $17,655, the amount claimed by
Andersen in his opening brief.
                                       - 18 -

[*18] advertising expenses, he also claimed in the same sentence that these

expenses are consistent with the ordinary expenses for the motel industry. The

same is true of his claimed deduction for unspecified “wages”. If this is a

suggestion that he wants us to estimate these expenses under Cohan, we won’t,

because all he has in support is that handwritten ledger. Nothing in the stipulated

record would give us anything to use to estimate such expenses, and we will not

just guess. See Adams v. Commissioner, T.C. Memo. 2013-92, at *14-*15.

      For expenses in the remaining categories he sometimes had additional

support in the form of bank statements. While these statements show that he paid

those amounts to someone for something, there is insufficient evidence that these

expenses were for his business. Many are in Andersen’s wife’s name, include

both personal and possible business expenses, and fail to even identify the payee.

This is not enough for us to make even an educated guess under Cohan. We deny

all of them other than those that the Commissioner has already conceded.

      The contract-labor category is a little bit different. Remember that

Andersen claimed we should add these expenses to his basis in the motel and RV

park. We already explained why we won’t do that, but we’ll give him the benefit

of assuming that as an alternative he wants to claim these on his Schedule C, as he

did on his return. He claimed $76,264 in such expenses. The Commissioner
                                        - 19 -

[*19] concedes 2 of the 26 contract-labor expenses for a total of $3,250. Of the 24

remaining contract-labor expenses, 22 are supported by the ledger alone. These

fail. Andersen tried to substantiate the final two with checks. These at least show

the amounts that he paid, but we again lack anything that would link those

payments to his trade or business.

      B.     Schedule E Deductions

      Andersen also claimed significant Schedule E deductions. On his return

these were quite large--$363,721--but they shrank in his brief and now he claims

only $47,490. The Commissioner conceded $15,013. Andersen’s only support for

the remaining expenses was a spreadsheet where he listed them as “Farm Expenses

and Rent.” Some checks and bank statements show some of these expenses were

paid, but nothing shows to whom or for what.

      Nothing more here than what the Commissioner conceded.

      C.     Schedule A Deductions

      That leaves a few personal deductions. Andersen claimed in his opening

brief that he is entitled to $82,872 in installment improvements and interest

deductions. As the Commissioner correctly notes, however, Andersen neither

elected to itemize his deductions on his filed return, nor raised this issue at any

point before filing his brief. What’s more confusing, Andersen’s reply brief made
                                       - 20 -

[*20] no mention of Schedule A deductions. As a result, we are unsure whether

Andersen continues to defend his entitlement to these deductions.

      In any event, we generally don’t consider issues raised by either the

taxpayer or the Commissioner for the first time on brief. Foil v. Commissioner, 

, 418 (1989), aff’d, 

(5th Cir. 1990); Markwardt v.

Commissioner, 

, 997 (1975). Even if we did, we see nothing in the

record that shows that any part of this amount is deductible under section 163(h)

as interest on home-mortgage or home-equity debt. We deny these deductions too.


                                                Decision will be entered under

                                      Rule 155.