Question

Case: In Yaryan v. Commissioner, TC Memo 2018-129, the Tax Court allowed only a nonbusiness bad debt for losses incurred in a real estate joint venture as the taxpayer’s activities did not constitute a business (this case disfavors those hoping on a broad definition of business for the Section 199A deduction).

Summary should be include the following five sections: 1>. case citation.2.> facts.3.>issues.4>holding and 5>.rationale.

Answer 1

T.C. Memo. 2018-129

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated facts and exhibits are incorporated in our findings by this reference. Petitioners resided in Colorado when they timely filed their petition.

I. Petitioner's Background and Relationship With Prime Realty, Inc.

Terry L. Yaryan (petitioner) holds a bachelor's degree and a master's degree in electrical engineering. In 1994 he joined UGC Consulting, a firm that specialized in providing consulting services related to geographic information systems. Petitioner retired in 2002.

In 1994 petitioners purchased a home in Colorado from Prime Realty, Inc. (Prime), a Colorado corporation. Petitioner met Leslie Olson (L. Olson), a general contractor who worked on building custom homes and other projects through Prime from at least 1994 to 2011. Prime was an S corporation, and its sole shareholder was Pat Olson (P. Olson), L. Olson's wife.

Shortly after petitioner's retirement, petitioners hired Prime as the general contractor to work on a greenhouse that they planned to build on their property. After completing work on petitioners' home, L. Olson approached petitioner to discuss Prime's construction business. Generally, Prime's business model at that time was to build and market one new home at a time. Petitioner believed that Prime's business model was inefficient, and he suggested a new strategy in which Prime would focus on building three homes at once.

Attorney(s) appearing for the Case

William L. Henry , David A. Sprecace , and Lucas P. Frei , for petitioners.

Michael T. Garrett and Matthew A. Houtsma , for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

KERRIGAN, Judge.

Respondent determined the following deficiencies, addition to tax, and accuracy-related penalties with respect to petitioners' Federal income tax for 2008, 2009, 2010, 2012, and 2013 (years in issue):

Addition to tax Penalty Year Deficiency sec. 6651(a)(1) sec. 6662(a) 2008 $11,481 --- --- 2009 17,985 --- --- 2010 6,089 --- --- 2012 15,404 $770 (1) 2013 27,249 --- $5,450

1 In the first amendment to answer respondent asserted that petitioners are liable for the sec. 6662(a) penalty for 2012. Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. We round all monetary amounts to the nearest dollar.

The issues for our consideration are: (1) whether petitioners may deduct under section 166 business bad debts that they contend they incurred during the years in issue;¹ (2) whether petitioners are liable for the addition to tax for 2012; and (3) whether petitioners are liable for the accuracy-related penalties for 2012 and 2013.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated facts and exhibits are incorporated in our findings by this reference. Petitioners resided in Colorado when they timely filed their petition.

I. Petitioner's Background and Relationship With Prime Realty, Inc.

Terry L. Yaryan (petitioner) holds a bachelor's degree and a master's degree in electrical engineering. In 1994 he joined UGC Consulting, a firm that specialized in providing consulting services related to geographic information systems. Petitioner retired in 2002.

In 1994 petitioners purchased a home in Colorado from Prime Realty, Inc. (Prime), a Colorado corporation. Petitioner met Leslie Olson (L. Olson), a general contractor who worked on building custom homes and other projects through Prime from at least 1994 to 2011. Prime was an S corporation, and its sole shareholder was Pat Olson (P. Olson), L. Olson's wife.

Shortly after petitioner's retirement, petitioners hired Prime as the general contractor to work on a greenhouse that they planned to build on their property. After completing work on petitioners' home, L. Olson approached petitioner to discuss Prime's construction business. Generally, Prime's business model at that time was to build and market one new home at a time. Petitioner believed that Prime's business model was inefficient, and he suggested a new strategy in which Prime would focus on building three homes at once.

II. Joint Venture Agreement

L. Olson, with the assistance of his attorney, drafted a joint venture agreement (JVA) that he presented to petitioner.² On or about August 5, 2003, petitioner and L. Olson, on behalf of Prime, executed the JVA. Dorothy H. Yaryan (petitioner wife) was not a party to the JVA.

Pursuant to the JVA Prime would purchase residential lots in its name, and petitioner would hold a secured interest in the lots for his contributions and for a fee to be paid to him as required by the agreement. The terms of the JVA applied only when Prime granted a deed of trust to petitioner.

The JVA provided that petitioner would be paid a sum equal to and not to exceed 15% of his investment in a lot, "which sum shall be so stated in the promissory note * * * for each lot subject to this Joint Venture Agreement and due at closing." Under the JVA Prime was to receive two fees for its services to the joint venture, both calculated as percentages of the costs associated with constructing the residences on the lots. Prime would receive fees equal to (1) 8% of construction costs as "compensation for construction supervision and coordination", payable at closing of the sale of the constructed residence, and (2) 7% of construction costs as an "overhead fee", payable monthly based on the last month's construction costs and from the proceeds available from the construction loan. The JVA provided that after all debts and liabilities of the joint venture had been paid in full "investment distributions" of any remaining net proceeds from the sale would be paid to Prime and petitioner "in the same proportions as the investment made or obligation incurred" for the purchase of the lot and the construction of the residence.

Issues Involved

The issues for our consideration are: (1) whether petitioners may deduct under section 166 business bad debts that they contend they incurred during the years in issue;¹ (2) whether petitioners are liable for the addition to tax for 2012; and (3) whether petitioners are liable for the accuracy-related penalties for 2012 and 2013.

As explained previously, the constructive dividends we have determined exceed, by themselves, the amounts of unreported income that respondent contends were received by Messrs. Perslow, Severson, Krebs, and Hartwell during the years at issue. Because we cannot allocate to those four individuals unreported income in excess of the amounts set forth in the notices of deficiency, we need not consider respondent’s “assignment of income” argument as applied to them. The situation again differs for Mr. Boultinghouse. Respondent alleges that he received unreported income of $304,205 for 2005, but we find that he received constructive dividends of only $147,192 for that year. We accordingly must consider respondent’s “assignment of income” theory as applied to the $157,013 balance of the alleged unreported income. As explained previously, the constructive dividends we have determined exceed, by themselves, the amounts of unreported income that respondent contends were received by Messrs. Perslow, Severson, Krebs, and Hartwell during the years at issue.

Because we cannot allocate to those four individuals unreported income in excess of the amounts set forth in the notices of deficiency, we need not consider respondent’s “assignment of income” argument as applied to them. The situation again differs for Mr. Boultinghouse. Respondent alleges that he received unreported income of $304,205 for 2005, but we find that he received constructive dividends of only $147,192 for that year. We accordingly must consider respondent’s “assignment of income” theory as applied to the $157,013 balance of the alleged unreported income.

Respondent also bears the burden of proof with respect to the 2012 penalty, because it was asserted for the first time in respondent's answer. See Rule 142(a). The evidence establishes that petitioners' understatement of income tax for 2012 was substantial within the meaning of section 6662(d)(1), and therefore respondent has met the burden of proof.

In light of our holdings above with respect to the Water Companies and the five principals, we need not address any of respondent’s determinations in the FPAA issued to PMG. The Water Companies and the principals are the only taxpaying persons in these cases. Having adjudicated all items in the notices of deficiency issued to them, we have no reason to discuss any of respondent’s arguments in the FPAA, which respondent tendered as alternative grounds for ruling in his favor.

Rationale

Under section 7491(c) the Commissioner bears the burden of producing evidence with respect to the liability of the taxpayer for any additions to tax. See Higbee v. Commissioner, 116 T.C. at 446-447. Petitioners' IRS account transcript reflects their request for an extension of time to file their 2012 income tax return not later than October 15, 2013. They filed their 2012 return on December 23, 2013. Respondent has met the burden of production.

We also agree with respondent that the Civil Penalty Approval Form is a record kept in the ordinary course of a business activity and is authenticated by the declaration of the immediate supervisor. See Fed. R. Evid. 803(6), 902(11). Petitioners do not challenge the evidence as unreliable. We will admit the Civil Penalty Approval Form into evidence and the declaration for the purpose of authentication under rule 902(11) of the Federal Rules of Evidence. See Clough v. Commissioner, 119 T.C. 183, 190-191 (2002). Respondent has met the burden of production for the penalty for 2013.

The evidence that is the subject of respondent's motion would not be cumulative of any evidence in the record, and it would not be impeaching material. Respondent bears the burden of production with respect to penalties and would offer the evidence as proof that the requirements of section 6751(b)(1) have been met. The subject evidence is material to the issues involved in the case, and we conclude that the outcome of the case will be changed if we grant respondent's motion.