Cuthbertson v. Comm'r

• Decision Date: 14 January 2020
• Docket Number: Docket No. 19871-15.,T.C. Memo. 2020-9
• Parties: GLENN DAVID CUTHBERTSON a.k.a. DAVID CUTHBERTSON AND PAMELA CUTHBERTSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

GLENN DAVID CUTHBERTSON a.k.a. DAVID CUTHBERTSON
AND PAMELA CUTHBERTSON, Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

T.C. Memo. 2020-9
Docket No. 19871-15.

UNITED STATES TAX COURT

January 14, 2020

Ps were engaged in the development of a golf course and surrounding residential housing through several wholly owned entities. In 2009 and 2010, Ps' wholly owned entities engaged in a series of real estate and financial transactions, involving a golf course, that purported to generate losses on the alleged transfer of the golf course property, on the alleged abandonment of the golf course's improvements, and on a sale of promissory notes. In 2009 and 2010, Ps also transferred parcels of real estate from a limited liability company (LLC), which was wholly owned by P-H and P-W and was treated as a non-TEFRA partnership for U.S. income tax purposes, to another LLC that was wholly owned by P-H, via direct and indirect ownership, and that was also treated as a non-TEFRA partnership for income tax purposes. Ps caused the seller LLC to use the installment method of accounting, under I.R.C. sec. 453, so as to defer the recognition of gain on these transfers.

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These losses flowed through to Ps, and Ps claimed deductions for these losses on their 2009 and 2010 Forms 1040. In 2009 Ps also filed a Form 1045, "Application for Tentative Refund", in an attempt to carry back some of these losses to their 2004, 2005, 2006, 2007, and 2008 tax years. R issued a statutory notice of deficiency that, among other things, determined that Ps were not entitled to certain loss deductions Ps claimed under I.R.C. sec. 165 and determined that Ps incorrectly accounted for the income from the transfers of the real estate lots by causing the LLC to improperly use the installment method.

Held: Ps are not entitled to deduct the losses arising out of the golf course transfer, property abandonment, and financial transactions.

Held, further, the seller LLC adopted an impermissible method of accounting for the transfers of real estate parcels between the LLCs; therefore, Ps are not allowed to defer the gain from the transferred property to future tax years.

Held, further, Ps did not have reasonable cause for their underpayments of income tax and therefore are liable for I.R.C. sec. 6662 accuracy-related penalties.

William C. Elliott, Jr., and John J. Nail, for petitioners.

Kimberly B. Tyson and James D. Hill, for respondent.

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MEMORANDUM FINDINGS OF FACT AND OPINION

GUSTAFSON, Judge: By statutory notice of deficiency ("SNOD") dated May 27, 2015, the Internal Revenue Service ("IRS") determined deficiencies in income tax for petitioners Glenn David Cuthbertson and Pamela Cuthbertson for the years 2004, 2005, 2006, 2009, 2010, and 2011,¹ arising from passthrough

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entities owned by them,² and section 6662(a)³ accuracy-related penalties in the following amounts:

Year	Deficiency	Penalty; sec. 6662(a)
2004	$175,884	$35,177
2005	308,175	61,635
2006	484	-0-
2009	1,427,186	435,863
2010	517,898	103,579
2011	-0-	-0-

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The Cuthbertsons timely filed a petition in this Court pursuant to section 6213(a) for redetermination of the deficiencies and the penalties in the SNOD. After concessions by the parties, the issues for decision are:

(1) whether for 2009 the Cuthbertsons are entitled to a loss deduction of $100,137 from their wholly owned partnership, Craft Holdings, LLC, from the purported sale of a golf course (we hold that they are not);

(2) whether for 2009 the Cuthbertsons are entitled to a loss deduction of $5,278,404 for the purported sale or abandonment of golf course improvements by their other wholly owned partnership, Craft Development, LLC (we hold that they are not);

(3) whether for 2010 the Cuthbertsons are entitled to loss deductions under section 165(a) in the amounts of $397,575 from Craft Development, LLC, and $1,568,925 from Craft Holdings, LLC, on the purported sale of promissory notes (we hold that they are not);

(4) whether the installment method of accounting was improperly used to report the 2008 and 2009 transfers of real estate parcels from Craft Development, LLC, which was wholly owned by Mr. and Mrs. Cuthbertson, to True Homes, LLC, an entity wholly owned by Mr. Cuthbertson (via his direct ownership and

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indirect ownership via his 100% ownership of Craft Builders, Inc.) (we hold that it was); and

(5) whether the Cuthbertsons are liable for section 6662(a) accuracy-related penalties (we hold that they are).

FINDINGS OF FACT

I. Petitioners and their entities

Mr. Cuthbertson is in the real estate development business, and he is married to petitioner Mrs. Cuthbertson. Mr. Cuthbertson incorporated Craft Builders ("Builders") under North Carolina law in December 1991; and he has always been its sole equity owner. During all relevant periods, Builders was an S corporation for Federal tax purposes.

The Cuthbertsons organized the following LLCs under North Carolina law in the following years: Craft Development ("Development") in 2003; Craft Holdings ("Holdings") in 2006; Edgewater Golf Club ("EGC") in 2007; and Carolina Development Services ("CDS") in 2008. As a land development company, Development accounted for land purchases as inventory.

Since at least as early as 2008, Mr. Cuthbertson has held 99% of the equity in Development, Holdings, CDS, and EGC, and Mrs. Cuthbertson has held the remaining 1%. As relevant to these proceedings, Development and Holdings were

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taxed as partnerships for Federal income tax purposes during the 2008, 2009, and 2010 tax years. Mr. Cuthbertson's intended purpose for Holdings was to hold property which was not intended for developments, while Development was the entity through which he conducted real estate development activities and sold developed properties.

In January 2008 Mr. Cuthbertson organized True Homes as an LLC under Delaware law; and since its formation, he has held 100% of True Homes--59.7% directly and 40.3% indirectly through Craft Builders (of which he is the sole owner).

II. Petitioners' relatives and their entities

Petitioners have two adult daughters: Crystal Kiker and Sandra ("Sandy") Russell. Sandy is married to Ben Russell, who is therefore petitioners' son-in-law.

Mrs. Kiker and her brother-in-law Mr. Russell formed the following LLCs under North Carolina law: B&C⁴ Land Holdings ("B&C I") in December 2008, B&C Land Holdings II ("B&C II") in November 2009, and B&C Land Holdings III ("B&C III") in November 2009. Since its formation, B&C III has had no employees; Mr. Russell and Mrs. Kiker are managers of the entity. All three B&C entities were formed for the purpose of investing in real estate.

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III. Golf course property transactions

A. The acquisition, development, and use of Edgewater golf course through 2009

Sometime in the late 1990s, Development purchased 309 acres of property in Lancaster, South Carolina, sometimes referred to as "Edgewater Phase 1". In November 2003 Development purchased 1,032 acres of land in Lancaster for $4.2 million, sometimes referred to as "Edgewater Phase 2". In January 2005 Development purchased another 561 acres of land in Lancaster for $3.9 million, sometimes referred to as "Edgewater Phase 3". The borders of these three properties met across much of their acreage.

Approximately 154 acres of raw land within Phase 2 and Phase 3 of the Edgewater properties was chosen to be the site of what is now the Edgewater golf course. The golf course was intended to enhance the value of residential real estate in the Edgewater community. The golf course and the residential properties were developed accordingly, but in that process the intended purposes of Mr. Cuthbertson's entities, their actual roles, and important details of their agreements became confused, as we show here.

For the three years 2006 through 2008, it was Development that created the Edgewater golf course. However, in November 2006 Development signed a deed

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transferring all 1,032 acres of Edgewater Phase 2 real estate to Holdings; the deed was recorded in June 2007. In March 2007 Development signed a deed transferring all 561 acres of Edgewater Phase 3 real estate to Holdings. Together, these two transfers included the 154 acres that underlay the Edgewater golf course. Development's transfer of the Edgewater Phase 2 parcel to Holdings was recorded in the public records of Lancaster County, South Carolina, in June 2007, and in March 2007 the transfer of the Edgewater Phase 3 parcel was recorded in the public records of Lancaster County, South Carolina. With respect to the 154 acres of land that would become the golf course, Holdings recorded on its books the basis of the portion (107 acres) of Edgewater Phase 2 as $432,740 and the basis of the portion (47 acres) of Edgewater Phase 3 as $327,397, totaling $760,137. Thus, for much of this three-year period (starting in November 2006), Development was building a golf course on land to which it no longer held title, and to which no contemporaneous agreements suggest that Development owned the improvements it was building.

During those same three years, Development also constructed a building that was used as a clubhouse for the golf course, and this clubhouse was constructed on part of the land, outside the 154 acres that made up the golf course, that Development had transferred to Holdings.

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In April 2008 EGC executed a lease agreement to become the tenant of the Edgewater golf course premises. Although it was Holdings that held legal title to the 154 acres underlying the golf course (and the rest of Phase 2 and Phase 3), the lease agreement purported to name Development as the lessor.⁵ That is, Development was ostensibly the landlord of property that in fact it did not own. This lease charged EGC a one-time rental fee of $1 and stated that the landlord is responsible for paying the real estate taxes associated with the leased property and that the lessee is...