Kofmehl v. C.I.R., 110678 FEDTAX, 8845-74

Docket Nº:8845-74.
Opinion Judge:IRWIN, Judge:
Attorney:Robert E. Kovacevich and Richard P. Algeo, for the petitioners. Matthew W. Stanley, for the respondent.
Case Date:November 06, 1978
Court:United States Tax Court

37 T.C.M. (CCH) 1831




No. 8845-74.

United States Tax Court

November 6, 1978

Held: On these facts, where books and records maintained by taxpayer were inadequate, respondent was justified in reconstructing petitioner's income using cash basis net worth method notwithstanding the existence of inventories of petitioner. Thus, deficiencies were properly determined. Held further: The additions to tax under sec. 6653(b), I.R.C. 1954, denied for 1967, and upheld for 1968 and 1969.

Robert E. Kovacevich and Richard P. Algeo, for the petitioners.

Matthew W. Stanley, for the respondent.


IRWIN, Judge:

Respondent determined deficiencies in petitioners' Federal income tax and additions to tax pursuant to section 6653(b)[1] as follows:

Year Deficiency Addition to tax Section 6653(b)
1967 $ 2,268.10 $ 1,134.05
1968 15,898.78 7,949.39
1969 21,162.05 10,581.02
1970 926.00 ..........
The 1970 adjustment is dependent upon the amount of unreported income ultimately determined for the three preceding years. At the close of his case at trial, respondent requested the Court to grant leave to amend his pleadings. That request was granted and in an amended answer respondent increased his proposed deficiency for the taxable year 1967 to $3,141.01. The issues for our decision are: (1) Whether petitioners failed to report gross income during the taxable years 1967, 1968 and 1969; and (2) Whether, pursuant to the provisions of section 6653(b), petitioners' underpayment of tax, if any, was due to fraud. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts along with attached exhibits are incorporated herein by this reference. Petitioners, husband and wife, were residents of Spokane, Washington at the time of filing their petition herein. They filed their joint Federal income tax returns for the taxable years 1967 through 1970 with the Western Regional Service Center, Ogden, Utah. For the taxable years 1967 through 1969, petitioners filed their returns utilizing the cash method of accounting. Since Linda M. Kofmehl is a party hereto solely by reason of having filed a joint return with her husband for the years in issue, references to petitioner will hereafter be considered as references to Patrick only. From 1965 until December 1966, petitioners resided in a duplex at 903-905 Mountain View, Spokane, Washington. During the first part of 1967, they rented a house located at 8011 Hughes Drive, also in Spokane. From the middle of 1967 until November 1968 they resided at West 109 Westview, Spokane, and in November 1968, they moved to North 4517 Center Road, Spokane, where they resided at the time of trial. After serving four years, petitioner was discharged from the Air Force in 1965. Using $10,000 he had saved, he purchased some land in the Spokane area, land which he subsequently sold. Then, with the aid of his father-in-law, Joe Miller, petitioner built a duplex at 903-905 Mountain View, part of which served as his personal residence until December of 1966. Simultaneously therewith, petitioner began an apprenticeship under Joe Miller, learning the trade of residential home construction. Joe Miller was regarded as one of the foremost residential home builders in Spokane, and an apprenticeship under him was regarded favorably by those in the construction and related businesses with whom petitioner would eventually deal. Petitioner began contracting the construction of residential homes on his own in 1967. He personally constructed each house which he sold, utilizing only subcontractors. It also appears that he continued to receive advice from Joe Miller. In March 1966, petitioner purchased property known as the ‘ Indian Trail’ property for $12,000. As of December 31, 1966, he still owed a balance on this purchase of $4,083. In May 1967, he sold that property for $20,000, receiving $8,000 down with the remaining $12,000 to be paid through an escrow account established at the Old National Bank of Washington in Spokane. As of the end of 1967, 1968 and 1969, the balances due petitioner on this sale were $12,000, $8,816 and $6,683, respectively. During 1967, petitioner sold four houses ranging in price from $13,950 to $22,900. Additionally, he sold the Mountain View duplex for $28,500. In 1968, the number of houses sold by petitioner increased to six, ranging in price from $17,500 to.$23,500. He did not report one of these sales (University Road) and also underreported the sale of his personal residence by $6,000 (Westview). As part of the consideration for the sale of 8310 East Maringo in Spokane, to John and Dawn Eacho, petitioner took a residence located at East 3933 Euclid in trade and on which the parties to the transaction placed a value of $11,500. The details of the transaction were as follows:
Sale price
Mortgage reserves
Maringo taxes: $10.78, prorated as of 10/68
Excise tax $ 215.00
Title Insurance 67.93
Interest adjustment 12/1 to 12/10 32.59
Revenue stamps 5.50
Recording fee 2.00
Attorney fee 72.00
Deed of Trust assumed 16,185.18
Transfer of Euclid property (trade in) 11,500.00
Sewer Assessment:
$1,291.53 (one-half to each) 645.76
Euclid taxes: $192.45, prorated as of 12/10 11.07
Due from Sellers 7,055.90
$28,737.03 $28,737.03
On their 1968 return, petitioners deducted the $7,055.90 which they paid the Eachos. Although owned by petitioner, the residence was used by Gerald Kofmehl, petitioner's brother, a rent free basis. Petitioner also deducted a driver's fee, a traffic fine and the cost of a horseshoeing in 1968. In 1969, petitioner sold or traded seven houses which he had constructed, with sale prices ranging from $22,950 to $30,500. One of these transactions was entered into with Herbert Thompson whereby petitioners acquired a motel located at East 1704 Sprague in Spokane at a stated price of $58,000. In exchange for the motel, petitioners conveyed free and clear a house and lot located at North 4522 Center Road and assumed a $28,000 mortgage on the motel. The house conveyed was valued by the parties at $30,000 (petitioners paid an excise tax to the state of Washington based upon the $30,000 value) and a construction loan in the amount of $22,800 had been approved for the property. Petitioner did not report either the house-motel exchange or the sale of the house at North 4510 Center Road on his 1969 return. Also, during 1969, petitioners sold their former personal residence at West 109 Westview for $24,950. In partial payment of the sales price, they accepted a house in trade located at North 5216 Stevens. This house was also sold in 1969 for $14,500. Finally, during both 1968 and 1969, petitioner deducted as business expenses the costs of constructing his residence at North 4517 Center Road. A schedule of petitioners' real estate sales transactions for 1967, 1968 and 1969 is set forth below:
Contract Actual Amount Business Sale of
Date of Sale Purchaser Location of Property Sold Price Realized Sale Capital Asset
2/10/67 Leroy H. Risdon 903-905 Mt. View Avenue $28,500.00 $28,500.00 $14,250.00- Duplex, one
& Kathleen Spokane, Wash. unit personal
5/ 3/67 Edward E. Midgley E. 1108 Pinetree Drive 18,900.00 18,900.00 $18,900.00
& Afton Spokane, Wash.
8/13/67 Dorothy R. Zack N. 5008 Ash 13,950.00 13,950.00 13,950.00
Spokane, Wash.
10/18/67 George Martgluo 2013 W. Providence 22,900.00 22,900.00 22,900.00
Spokane, Wash.
8/15/67 Murray A. Nash & W. 2011 Providence 20,890.72 20,890.72 20,890.72
Effie Jean Spokane, Wash.
5/17/67 Joan E. Paisley S.W. 1/4 Sec. 10 Tws. 26 20,000.00 20,000.00 20,000.00- Land held for
Known as Indian Trail investment
1/24/68 Robert E. Dixon, S. 2704 University Rd. 21,900.00 18,400.00 18,400.00
Jr. and wife Spokane, Wash.
5/21/68 Gary D. Smith E. 14010 Mallon 18,045.00 18,045.00 18,045.00
Spokane, Wash.
5/27/68 James C. Wilkerson E. 8302 Maringo 21,500.00 21,500.00 21,500.00
Spokane, Wash.
6/ 5/68 David Neal E. 14006 Mallon 17,500.00 17,500.00 17,500.00
11/21/68 Arthur N. Evans E. 14022 Mallon 23,500.00 23,500.00 23,500.00
& Jean Rea Spokane, Wash.
12/10/68 John Eacho and 8310 E. Maringo 21,500.00 21,500.00 21,500.00
Dawnelda Spokane, Wash.
12/ /68 Guy A. Melberg W. 109 Westview 24,950.00 24,950.00 24,950.00- Personal
or & Laura M. Spokane, Wash. residence
1/15/69 Norman P. Hill N. 5816 Stevens 14,500.00 14,500.00 14,500.00- Received in
Spokane, Wash. trade on sale
of W. 109
2/12/69 Walter W. Madden E. 14016 Mallon 22,950.00 22,950.00 22,950.00
& LaLanie Spokane, Wash.
4/ 1/69 Richard L. Price N. 4707 Ella 31,500.00 29,500.00 29,500.00
Spokane, Wash.
5/ 1/69 Harold H. Thompson N. 4421 Ely 28,700.00 28,700.00 28,700.00
Spokane, Wash.
6/ 6/69 Herbert E. Thompson N. 4522 Center Rd. 30,000.00 30,000.00
Spokane, Wash.
6/ 9/69 Donald D. Rohrer 4510 N. Center Rd. 31,500.00 30,500.00 30,500.00
Spokane, Wash.
8/15/69 Donald T. Meier 4512 N. Ely Rd., 30,000.00 30,000.00 30,000.00
Spokane, Wash.

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