Owen v. U.S.

• Citation: 34 F.Supp.2d 1071
• Decision Date: 17 December 1998
• Docket Number: No. 97-2564-TUBRE.,97-2564-TUBRE.
• Parties: John W. OWEN and Glenda F. McCormick, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Western District of Tennessee

34 F.Supp.2d 1071

John W. OWEN and Glenda F. McCormick, Plaintiffs, v. UNITED STATES of America, Defendant.

No. 97-2564-TUBRE.

United States District Court, W.D. Tennessee, Western Division.

December 17, 1998.

Order Denying Reconsideration, February 23, 1999.

James T. Bland, Law Offices of James T. Bland, Memphis, TN, for John W. Owen, Glenda F. McCormick.

David M. Katinsky, Department of Justice, Tax Division, Washington, DC, for United States of America.

ORDER ON CROSS-MOTIONS FOR PARTIAL SUMMARY JUDGMENT

TURNER, District Judge.

Plaintiffs John Owen and Glenda McCormick brought this action to recover $74,107 of federal income tax paid for the 1987 tax year plus statutory additions. Presently before the court are plaintiffs' and defendant United States' cross-motions for partial summary judgment.

I. Standard of Review

The moving party is entitled to summary judgment where there is no genuine issue of material fact and the party is entitled to judgment as a matter of law. Fed.R.Civ.P. 56(c). When considering a motion for summary judgment, the court's function is not to weigh the evidence or judge its truth; rather, the court must determine whether there is a genuine issue for trial. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 254, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986). The substantive law governing the case will determine what issues of fact are material. Street v. J.C. Bradford & Co., 886 F.2d 1472, 1479 (6th Cir.1989).

A summary judgment movant "bears the burden of clearly and convincingly establishing the nonexistence of any genuine issue of material fact and the evidence as well as all inferences drawn therefrom must be read in a light most favorable to the party opposing the motion." Kochins v. Linden-Alimak, Inc., 799 F.2d 1128, 1133 (6th Cir.1986).

If the movant carries its burden of demonstrating that the non-moving party has not established an essential element of that party's case, the burden shifts to the non-moving party to set forth specific facts showing a genuine issue of triable fact. Fed.R.Civ.P. 56(e). To meet this burden, the non-movant must present sufficient countervailing evidence such that a jury could return a verdict favorable to the non-moving party. Anderson, 477 U.S. at 249-50, 106 S.Ct. 2505. The non-moving party "may not rest upon the mere allegations or denials of [its] ... pleading, but ... must set forth specific facts showing that there is a genuine issue for trial." Fed.R.Civ.P. 56(e).

II. Burden of Proof

"In a refund suit the taxpayer bears the burden of proving the amount he is entitled to recover." United States v. Janis, 428 U.S. 433, 440, 96 S.Ct. 3021, 49 L.Ed.2d 1046 (1976) (citing Lewis v. Reynolds, 284 U.S. 281, 52 S.Ct. 145, 76 L.Ed. 293 (1932)). The Commissioner's determination is entitled to a presumption of correctness, and the plaintiff bears the burden of proving that the Commissioner's determination is wrong. Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 78 L.Ed. 212 (1933). Under this burden, the taxpayer must substantiate the deductions he claims he is entitled to. Blackburn v. Commissioner, 681 F.2d 461, 462 (6th Cir.1982) (affirming Tax Court's disallowance of deductions where taxpayer failed to offer documentation to substantiate his claims); Davis v. Commissioner, 674 F.2d 553, 553-54 (6th Cir.1982) (same).

III. Background

In March of 1993 plaintiffs, who are cash basis taxpayers, filed a claim with the Internal Revenue Service for a refund of $74,107 in taxes paid in 1987 plus statutory additions. The IRS disallowed the refund claim and sent plaintiffs a Notice of Disallowance on June 21, 1995. Plaintiffs then initiated this action on June 23, 1997.

Plaintiffs' refund claim is based on several distinct factors, the following of which are at issue in the cross-motions for partial summary judgment. The majority of the alleged overpayment stems from $240,405 in improvements allegedly made to office condominiums that the plaintiffs sold during 1987. Plaintiffs claim the cost of these improvements should be added to the basis of the condominiums, thus affecting the gain/loss computation on their sale. The $240,405 is made up of four smaller amounts, including $156,000, $48,225, and $20,792 allegedly paid for physical improvements to the property, and $15,388 paid out of the sale proceeds to a bank at closing.

The refund claim also sets forth operating costs allegedly paid by plaintiffs on the condominiums not previously deducted. Specifically, plaintiffs claim they are entitled to an additional $3,377 deduction for real estate taxes and an additional $655 deduction for mortgage interest expense. Plaintiffs' original tax return claimed $33,014 in rental expenses on the condominiums, including $27,758 in mortgage interest expense and $2,015 in property taxes. Plaintiffs' refund claim alleges these amounts should have been $28,413 and $5,392, respectively, reflecting increases of $655 and $3,377, respectively.

Plaintiffs also claim they are entitled to an additional depreciation deduction of $1,269 on a warehouse based on a recomputation made in accordance with their claim for refund. Plaintiffs' original return claimed $3,780 in depreciation on the warehouse, and their claim for refund alleges the appropriate amount is $5,049. The increase results from $26,612 in improvements allegedly made to the warehouse that increased its depreciable basis.

IV. Analysis

1. Improvements to the Condominiums

Plaintiffs claim $240,425 worth of improvements were made to the condominiums before they were sold but that this amount was never incorporated into the condominiums' basis. To substantiate that the improvements were made, plaintiffs have submitted copies of three promissory notes in the amounts of $156,000, $20,792 and $84,225, respectively, issued to Section Seven Contractors, Inc., allegedly in payment for the improvements. Plaintiffs have offered no evidence to support their claim that the remaining $15,388 ($240,425 less the sum of $156,000, $20,792 and $84,225) was related to improvements made on the condominiums.

Defendant has moved for partial summary judgment on this issue only with respect to the $15,388 paid by plaintiffs to the bank out of the proceeds from the sale of the condominiums. Plaintiffs have since conceded that the $15,388 should not be added to the basis of the sold condominiums. Thus, only $225,017 ($240,405 - $15,388) remains at issue pertaining to physical improvements allegedly made to the condominiums. Plaintiffs have moved for partial summary judgment on the remaining $225,017 at issue.

Cash basis taxpayers may only deduct expenses in the year they pay cash for the expense. Eckert v. Burnet, 283 U.S. 140, 141-42, 51 S.Ct. 373, 75 L.Ed. 911 (1931). Delivering a promissory note to a creditor in payment of the expense does not entitle a taxpayer to a deduction until the taxpayer pays the note. See Helvering v. Price, 309 U.S. 409, 413, 60 S.Ct. 673, 84 L.Ed. 836 (1940); Patmon, Young & Kirk, Professional Corp. v. Commissioner, 536 F.2d 142, 143-44 (6th Cir.1976). The same reasoning holds true where a taxpayer sells property. Although a taxpayer is entitled to increase his basis for expenditures properly chargeable to capital, I.R.C. § 1016, a cash basis taxpayer has not made an expenditure that will increase his basis where he only issues a secured promissory note. Jenkins v. Bitgood, 101 F.2d 17, 19 (2d Cir.1939). It is not until the note is actually paid that a cash basis taxpayer can increase his basis. Id.

Defendant asserts that there is a genuine issue of material fact as to whether Owen ever paid the promissory notes issued to Section Seven. Owen owned and controlled Section Seven, and Owen decided to accept the notes on behalf of Section Seven as payment. There is no evidence that Owen paid the notes in 1987, and in fact, Owen testifies that he never paid Section Seven.¹ The only payments Owen claims he made were a $50,000 and $126,000 payment to G.F. Walter in 1990 which claimed at that time to be the holder in due course on the notes.² This creates at least two issues of material fact sufficient to preclude partial summary judgment on this issue. First, plaintiffs may not increase their basis in the condominiums in 1987 if the notes issued for the improvements were not paid until 1990. Second, plaintiffs only offer evidence of having paid $176,000 towards the $225,017 in notes. As the notes bore interest at 10 percent, a large portion of the $176,000 in payments would appear to be allocable to interest. Thus, plaintiffs have offered no evidence of having ever paid the full principal amount of the notes. Therefore, the court finds plaintiffs have not satisfied their burden of showing they are entitled to increase the basis of the condominiums in 1987 by $225,017.³

Accordingly, plaintiffs' motion for partial summary judgment is denied with respect to the $225,017 in physical improvements allegedly made to the condominiums. Defendant's motion for partial summary judgment is granted and plaintiffs' motion for partial summary judgment is denied with respect to the $15,388 paid to the bank out of the condominium sale proceeds.

2. Mortgage Interest and Property Tax Expense on the Condominiums

Plaintiffs claim they paid an additional $655 of mortgage interest expense and $3,377 in property taxes not deducted on their original 1987 return.

As substantiation of these amounts plaintiffs have produced a copy of a Seller's Settlement Sheet which reflects the condominium sale proceeds and costs associated with the sale. Listed as the "Net to Retire Loan" is $264,572.73. Next to this amount is a handwritten plus sign and then the amount of $638.61. Immediately below the net to retire loan amount is $15,338.06 listed as the "Union Planters National Bank payoff." Next to this amount is a handwritten plus sign and then the amount of $16.31. The handwritten amounts of $638.61 and $16.31 are in a single hand drawn...