125 T.C. No. 13
UNITED STATES TAX COURT
DENNIS E. AND PAULA W. LOFSTROM, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4667-03. Filed November 22, 2005.
Ps are Mr. Lofstrom (H) and Paula Lofstrom (W-2). H was previously married to Dorothy Lofstrom (W-1). In satisfaction of his alimony obligations to W-1, H transferred his $29,000 interest in a contract for deed to W-1, along with $4,000 in cash. Ps deducted as alimony the value of the contract for deed. In addition, Ps claimed to operate the first floor of their residence as a bed and breakfast (B&B) and deducted related expenses. H, a retired doctor, also claimed to be engaged in the business of writing for profit and Ps deducted expenses attributable to H’s writing activities.
1. Held: A contract for deed is a third-party debt instrument under sec. 1.71-1T(b), Q&A-5, Temporary Income Tax Regs., 49 Fed. Reg. 34455 (Aug. 31, 1984). Ps may not deduct as alimony the value of a contract for deed transferred to W-1 because it does not constitute a cash payment. Id.; see secs. 61(a)(8), 71(a), 215(a) and (b). - 2 -
2. Held, further, Ps may not deduct expenses for a hotel or like establishment because they used the B&B for personal purposes for an indeterminate amount of time, and they failed to substantiate the expenses. Sec. 280A (c)(1), (d)(1), (f)(1)(B), (g).
3. Held, further, Ps may not deduct writing activity expenses where they failed to show that H was engaged in the activity of writing for profit. Secs. 162, 183; sec. 1.183-2(a), Income Tax Regs.
Steven Z. Kaplan, for petitioners.
Melissa J. Hedtke, for respondent.
OPINION
KROUPA, Judge: Respondent determined a $10,552 deficiency
in petitioners’ Federal income tax for 1997 and a $2,198
deficiency for 1998. After concessions,1 the issues for decision
are:
1. Whether petitioners may claim an alimony deduction for
$29,000 in 1997 for the transfer of a contract for deed. Because
we find the contract for deed does not constitute cash or a cash
equivalent, we hold that they may not.
1 Petitioners conceded several deductions, including auto expenses, legal expenses for Mr. Lofstrom’s divorce, real estate appraisal expenses, closing costs, flood insurance recovery costs, tax return preparation fees, land abstract costs, utilities, travel expenses, and other expenses claimed on Schedule F, Profit or Loss From Farming, and Schedule C, Profit or Loss From Business. - 3 -
2. Whether petitioners may deduct $19,158 in 1997 for
expenses incurred in the operation of a bed and breakfast (B&B).
Because we find they used the B&B for personal purposes for an
indeterminate period and failed to substantiate expenses, we hold
that they may not deduct these expenses.
3. Whether petitioners may deduct $1,664 in 1997 and $8,413
in 1998 for expenses related to Mr. Lofstrom’s writing
activities. Because we find they failed to show that
Mr. Lofstrom engaged in the activity of writing for profit, we
hold that they may not deduct these expenses.
Background
The parties submitted the case fully stipulated under Rule
122.2 The stipulation of facts and accompanying exhibits are
incorporated by this reference and are so found. Petitioners
resided in Overland Park, Kansas, at the time they filed this
petition.
Trial was first scheduled for June 14, 2004, but was
continued because petitioners were in Africa. Trial was then
rescheduled for June 6, 2005. Although petitioners were
represented by counsel, they were not present to testify or be
cross-examined. We admitted several documents at trial,
2 All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. - 4 -
including petitioners’ answers to interrogatories, over
respondent’s objections, but warned petitioners that we would
accord little weight to the documents. To hold otherwise would
prejudice respondent because he did not have the opportunity to
cross-examine petitioners regarding the authenticity of the
documents or the veracity of petitioners’ answers to
interrogatories. We stand by that ruling. The factual
background is therefore based on the stipulation of facts and
exhibits submitted to the Court.
Petitioner Dr. Dennis Lofstrom (Mr. Lofstrom) leads a very
active life. For most of his life, Mr. Lofstrom lived and worked
in Minnesota, where he raised a family of 11 children with his
wife, Dorothy Lofstrom (Dorothy). Mr. Lofstrom later divorced
Dorothy and retired from his full-time medical practice. Mr.
Lofstrom embarked at age 70 in 1995 upon a medical missionary
trip to Antarctica with his second wife, Paula Lofstrom (Paula).
Petitioners embarked upon another medical missionary trip in 2002
to serve at a hospital in Tanzania, Africa, for 5 years.
This case concerns three varieties of deductions that
petitioners claimed in 1997 and 1998. The first relates to
alimony.
Alimony Deduction
Mr. Lofstrom was ordered to pay Dorothy $1,500 per month in
alimony (or support maintenance payments) pursuant to their - 5 -
divorce decree. Mr. Lofstrom stopped making payments sometime in
1995 and a year later asked a Minnesota county court to terminate
his alimony obligations because his salary had been substantially
diminished after retirement. The State court instead found
Mr. Lofstrom in arrears to Dorothy for the time that he failed to
pay alimony and reduced his arrearage to a judgment for $18,000.
The State court did grant Mr. Lofstrom a reduction, however, in
his monthly alimony payments from $1,500 to $1,000.
Shortly thereafter, Dorothy agreed to relinquish her past
and future claims for alimony against Mr. Lofstrom in exchange
for $4,000 cash and Mr. Lofstrom’s interest in a contract for
deed valued at $29,000. The contract for deed entitled Dorothy
to principal and interest payments until the principal was fully
paid.3 Payments under the contract for deed were to be made
irrespective of when Dorothy died.
Petitioners initially deducted as alimony only the $4,000
cash payment on their joint return for 1997. They later amended
their return for 1997 and deducted the $29,000 value of the
contract for deed. Respondent granted petitioners the $4,000
deduction but denied the $29,000 deduction.
3 The contract for deed was entered into between Mr. Lofstrom, as trustee of the Dennis Lofstrom Trust, and Mark Lofstrom, the son of Mr. Lofstrom and Dorothy. The contract for deed required a $1,408.34 payment upon execution, $4,200 or more annually at a rate of $350 monthly, and interest at a rate of 7.5 percent per year. - 6 -
Bed and Breakfast and Writing Activity Deductions
Petitioners also deducted expenses related to a B&B that
they listed as their principal trade or business on Schedule C,
Profit or Loss from Business, for 1997. Petitioners called the
B&B, “Angel’s Rest Arrowhead Ranch - Fly In Bed And Breakfast”
and listed related gross receipts of $649 and expenses of
$19,158.4 Petitioners allowed Mr. Lofstrom’s daughter and her
family to use the B&B rent-free for an unspecified period of time
that same year. Petitioners failed to introduce any evidence
that they rented the B&B to anyone else.
In addition, petitioners deducted expenses for
Mr. Lofstrom’s writing activities in 1997 and 1998.
Specifically, petitioners deducted $1,664 for travel expenses and
writing supplies in 1997 and $8,413 in 1998.
Respondent mailed petitioners a deficiency notice on
December 20, 2002, disallowing their $29,000 alimony deduction
for 1997, B&B-related deductions for 1997, and writing activity
deductions for 1997 and 1998. Petitioners timely filed a
petition with the Court.
Discussion
We must decide whether Mr. Lofstrom’s transfer of a contract
for deed constitutes deductible alimony. We must also decide
4 Of this amount, $12,622 is depreciation expenses, which petitioners concede. - 7 -
whether petitioners may deduct B&B expenses and writing activity
expenses. We first address who bears the burden of proof.
Petitioners bear the burden to prove that respondent’s
determination is wrong. See Rule 142(a); INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992); Welch v. Helvering, 290
U.S. 111, 115 (1933). Moreover, deductions are a matter of
legislative grace, and petitioners bear the burden to prove that
they are entitled to the claimed deductions.5 See New Colonial
Ice Co. v. Helvering, 292 U.S. 435 (1934); Hradesky v.
Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam 540 F.2d
821 (5th Cir. 1976). In addition, where as here petitioners
failed to testify, we can presume that their testimony would have
been unfavorable. Wichita Terminal Elevator Co. v. Commissioner,
6 T.C. 1158, 1165 (1946) (citing Walz v. Fidelity-Phoenix Fire
Ins. Co., 10 F.2d 22 (6th Cir. 1926); Equip. Acceptance Corp. v.
Arwood Can Mfg. Co., 117 F.2d 442 (6th Cir. 1941); Bomeisler v.
M. Jacobson Trust, 118 F.2d 261 (1st Cir. 1941); Hann v. Venetian
Blind Corp., 111 F.2d 455 (9th Cir. 1940); Sears, Roebuck & Co.
v. Peterson, 76 F.2d 243 (8th Cir. 1935)), affd. 162 F.2d 513
(10th Cir. 1947).
5 Petitioners did not move to shift the burden of proof to respondent. Sec. 7491(a)(2)(A) and (B). Nor would petitioners have qualified because they failed to present credible evidence, substantiate their claimed expenses, or maintain adequate books and records. - 8 -
A. Deduction for the Value of the Contract for Deed
Next, we address whether petitioners are entitled to deduct
as alimony $29,000 for the value of a contract for deed that
Mr. Lofstrom transferred to Dorothy in 1997. Alimony (or
separate maintenance) payments are deductible from income by the
payor and includable in the income of the payee. Secs. 61(a)(8),
71(a), 215(a) and (b). The payments must meet certain
requirements to be deductible, however. See secs. 71, 215.
Among those requirements,6 payments must be made in cash or
a cash equivalent. See sec. 71(b)(1). A check or money order
that is payable on demand is a cash equivalent. A debt
instrument that is transferred is not. Sec. 1.71-1T(b), Q&A-5,
Temporary Income Tax Regs., 49 Fed. Reg. 34455 (Aug. 31, 1984).
This is the first time that this Court is asked to address
whether the transfer of a third-party debt instrument satisfies
the requirements to qualify as alimony. Specifically, we address
whether the “contract for deed” that Mr. Lofstrom transferred to
6 Other requirements are that the alimony must be received by a spouse under a divorce or separation instrument, the payments cannot be designated in the divorce or separation instrument as a payment for something other than alimony, the payee spouse and the payor spouse must not be members of the same household at the time of payment, and the payments must terminate at the death of the payee spouse. Sec. 71(b)(1)(A)-(D). - 9 -
Dorothy in part satisfaction of Mr. Lofstrom’s accrued and future
alimony obligations to Dorothy qualifies as alimony.7
A contract for deed is a financing arrangement that allows a
buyer (or vendee) to purchase property by borrowing the money for
the purchase from the seller (or vendor). In re Butler, 552
N.W.2d 226, 229-230 (Minn. 1996). Here, Mr. Lofstrom had
transferred property to Mark Lofstrom in return for periodic
payments from Mark Lofstrom until the full principal amount, with
interest, was paid. The contract for deed represented,
therefore, a debt obligation of Mark Lofstrom to Mr. Lofstrom.
Because the contract for deed transferred to Dorothy is a debt
instrument of a third party, it does not qualify as a cash
payment and is not deductible as alimony.8 See secs. 71(b)(1),
215(a); sec. 1.71-1T(b), Q&A-5, Temporary Income Tax Regs.,
7 The Minnesota legislature has sanctioned contracts for deed because they provide a useful alternative financing mechanism, which promotes the availability of credit and the transferability of property. In re Butler, 552 N.W.2d 226, 229-230 (Minn. 1996) (citing Minn. Stat. sec. 559.205-.216 (1994)). 8 Further, once Mr. Lofstrom transferred the contract for deed to Dorothy, Mark Lofstrom’s liability to make payments under the contract would not end at Dorothy’s death. We note that alimony does not include a liability to make payments after the payee’s death. Sec. 71(b)(1)(D); see also Sugarman v. Commissioner, T.C. Memo. 1996-410 (payments found in the nature of a property settlement rather than alimony where payments would not necessarily have terminated if the taxpayer died before the end of the payment stream because the taxpayer’s estate would have had a valid claim for the remainder of the payments). - 10 -
supra. Accordingly, we sustain respondent’s determination
disallowing a deduction for the value of the contract for deed.9
B. Bed And Breakfast Expenses
We must next determine whether petitioners are entitled to
deduct expenses related to operating a B&B on the first floor of
their home. Generally, taxpayers are restricted from deducting
expenses of their residences, or more specifically, expenses
related to a “dwelling unit” that taxpayers use as a personal
residence.10 Sec. 280A(d)(1).
Petitioners admit that they used their dwelling unit, at
least in part, as a personal residence. Unless an exception
applies, therefore, petitioners may not deduct expenses of their
residence. Respondent argues, and we agree, that petitioners
failed to substantiate and hence meet their burden to prove that
they operated a portion of their residence as a business.
Deducting the business portion of a dwelling unit is
restricted. For example, if personal use of the business portion
of a dwelling unit exceeds the greater of 14 days or 10 percent
9 We find no merit in petitioners’ arguments concerning the doctrines of “constructive receipt” or “origin of claim” to characterize the transfer of the contract for deed as alimony. 10 This general rule does not apply to those expenses that are deductible regardless of any connection with a trade or business, such as mortgage interest on the residence under sec. 163, real estate taxes under sec. 164, or casualty losses under sec. 165. Sec. 280A(b). - 11 -
of the number of days the unit is rented at fair rental value, no
deduction is allowed. Sec. 280A(a), (d)(1). Nor may taxpayers
deduct expenses for the portion of a residence not “exclusively”
used for business purposes. See sec. 280A(c)(1), (f)(1)(B); see
also Langer v. Commissioner, 989 F.2d 294, 295 (8th Cir. 1993)
(affirming this Court’s denial of a home office deduction based
on taxpayer’s failure to show exclusive use); Byers v.
Commissioner, 82 T.C. 919, 925 (1984) (rent-free personal use of
a unit barred a finding that the unit was used exclusively as a
hotel); Grigg v. Commissioner, T.C. Memo. 1991-392, affd. 979
F.2d 383 (5th Cir. 1992). Personal use includes use by a
taxpayer’s lineal descendants, unless fair rental value is paid.
See sec. 267(c)(4).
Petitioners admit that Mr. Lofstrom’s daughter (and her
family) used the B&B rent-free for an indefinite period of time
in 1997, which constitutes personal use by petitioners. See sec.
280A(d)(2) and (3). Because petitioners have not shown how long
Mr. Lofstrom’s daughter stayed,11 petitioners have failed to meet
their burden that personal use of the B&B did not exceed the
greater of 14 days or 10 percent of the number of days that the
unit was rented at fair rental value.12 See sec. 280A(d)(1),
11 Petitioners vaguely assert that she stayed on a “single occasion.” 12 Nor have petitioners carried their burden to prove that they rented the unit for at least 15 days in 1997. See sec. 280A(g); Stoddard v. Commissioner, T.C. Memo. 2002-31 (rental (continued...) - 12 -
(2)(A). Petitioners have also failed to show that they used the
B&B exclusively for business purposes.
Further, petitioners did not substantiate the B&B expenses.
They produced no books or records substantiating, among other
things, the amount of rent collected, the number of days that
guests stayed, or the rates that guests paid. We are left with
little more than petitioners’ Schedule C, on which they listed
marginal gross income for the B&B and substantial expenses. A
schedule of expenses is not sufficient to meet petitioners’
burden, however. See Cluck v. Commissioner, 105 T.C. 324, 338
(1995) (summary schedules insufficient to entitle taxpayer to
claimed deductions). Accordingly, based upon a lack of
substantiation, a general dearth of evidence, and the personal
use of the B&B, petitioners are not entitled to deduct any of the
disputed expenses for any portion of their residence in 1997. We
therefore sustain respondent’s disallowance of the B&B expenses.
C. Writing Activity Expense
Finally, we must determine whether petitioners may deduct
expenses in 1997 and 1998 related to Mr. Lofstrom’s writing
activities. The evidence includes manuscripts that Mr. Lofstrom
allegedly drafted, including a science fiction novel called “Out
of the Mando Galaxy by Nnak Kamon” and a health and fitness book
12 (...continued) expenses not deductible where taxpayer did not rent residence at least 15 days and personal use exceeded 14 days). - 13 -
called “A Common Sense Approach to Weight Loss, Nutrition,
Physical Fitness, and Exercise for the Non-Fanatic of All Ages.”
We accord little weight to these submissions, however, because
respondent did not have the opportunity to cross-examine
Mr. Lofstrom at trial. Respondent argues nonetheless that, even
considering these manuscripts, petitioners have not shown that
Mr. Lofstrom engaged in his writing activities for profit. We
agree.
Taxpayers may deduct ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or
business. See sec. 162. To do so, taxpayers must demonstrate
that they were involved in the activity on a continuous and
regular basis and that their purpose for engaging in the activity
was for income or profit. See Commissioner v. Groetzinger, 480
U.S. 23, 35 (1987); Wittstruck v. Commissioner, 645 F.2d 618, 619
(8th Cir. 1981), affg. T.C. Memo. 1980-62; Jasionowski v.
Commissioner, 66 T.C. 312, 320-322 (1976); Gentile v.
Commissioner, 65 T.C. 1, 4 (1975); sec. 1.183-2(a), Income Tax
Regs. Whether the required profit objective exists is determined
on the basis of all the facts and circumstances of each case.
See Hirsch v. Commissioner, 315 F.2d 731, 737 (9th Cir. 1963),
affg. T.C. Memo. 1961-256; Golanty v. Commissioner, 72 T.C. 411,
426 (1979), affd. without published opinion 647 F.2d 170 (9th
Cir. 1981); sec. 1.183-2(a), Income Tax Regs. While a reasonable - 14 -
expectation of profit is not required, the taxpayer’s objective
of making a profit must be bona fide. See Wittstruck v.
Commissioner, supra at 619; Elliott v. Commissioner, 84 T.C. 227,
236 (1985), affd. without published opinion 782 F.2d 1027 (3d
Cir. 1986). The Court gives greater weight to objective factors
in making the factual determination than to a taxpayer’s mere
statement of intent. See Indep. Elec. Supply, Inc. v.
Commissioner, 781 F.2d 724 (9th Cir. 1986), affg. Lahr v.
Commissioner, T.C. Memo. 1984-472; Dreicer v. Commissioner, 78
T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205 (D.C.
Cir. 1983); sec. 1.183-2(a), Income Tax Regs.
We consider several factors13 in determining whether
Mr. Lofstrom was engaged in the writing activity for profit,
including the manner in which he carried on the activity, the
time and effort he expended on the activity, the history of
income or loss with respect to the activity, and the amount of
13 The Court generally considers nine nonexclusive factors for determining whether taxpayers engaged in an activity for profit. Sec. 1.183-2(b), Income Tax Regs. Petitioners here failed to produce relevant evidence regarding many of the factors, and we consequently confine our analysis to four of the nine factors. The nine factors are: (1) The manner in which the taxpayer carried on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that the assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other activities for profit; (6) the taxpayer’s history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) elements of personal pleasure or recreation. Id. - 15 -
any profits that he earned. Sec. 1.183-2(b)(1)-(9), Income Tax
Regs. The individual facts and circumstances of each case are
the primary test, and no factor or set of factors is necessarily
controlling. See Hendricks v. Commissioner, 32 F.3d 94, 98 (4th
Cir. 1994), affg. T.C. Memo. 1993-396; Brannen v. Commissioner,
722 F.2d 695, 704 (11th Cir. 1984), affg. 78 T.C. 471 (1982);
Keanini v. Commissioner, 94 T.C. 41, 46 (1990); Allen v.
Commissioner, 72 T.C. 28, 34 (1979); sec. 1.183-2(b), Income Tax
Regs.
Petitioners failed to identify the amount of time that
Mr. Lofstrom spent writing during the years at issue or whether
he had anything published.14 Nor did petitioners report any
gross or net income on their returns for Mr. Lofstrom’s writing
activities. Rather, petitioners reported a string of losses, in
the years at issue and in 3 prior years (from 1994 to 1998).
These factors, taken together, indicate that Mr. Lofstrom was not
involved in the writing activity for profit.15 See Zuckerman v.
Commissioner, T.C. Memo. 1984-192 (substantial income from other
14 Petitioners claimed, in their answers to interrogatories, that Mr. Lofstrom writes “many nights and weekends” and once had “100 copies” of something “distributed free of charge.” 15 The only information petitioners offered to prove Mr. Lofstrom’s profit motive was a day-of-trial deluge of miscellaneous handwritten notes, correspondence with publishers, a typewritten “novel”, and hundreds of handwritten notes on health, fitness, and dieting. We accord little weight to these documents because Mr. Lofstrom did not testify. - 16 -
sources, losses over a number of years, and tax benefits are
features characteristic of an activity not operated for profit).
Accordingly, we find that petitioners failed to meet their burden
to establish that Mr. Lofstrom engaged in his writing activities
with a bona fide profit objective.
Conclusion
We sustain respondent’s determinations in the deficiency
notice for 1997 and 1998. In reaching our holding, we have
considered all arguments made, and, to the extent not mentioned,
we conclude that they are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
for respondent.