Lofstrom v. Comm'r of Internal Revenue, No. 4667–03.

• Decision Date: 22 November 2005
• Docket Number: No. 4667–03.
• Citation: 125 T.C. No. 13,125 T.C. 271
• Parties: Dennis E. and Paula W. LOFSTROM, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

125 T.C. 271

125 T.C. No. 13

Dennis E. and Paula W. LOFSTROM, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 4667–03.

United States Tax Court.

Nov. 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), and 215(a) and (b).

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, J.

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.

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, 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 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.

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 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, 112 S.Ct. 1039, 117 L.Ed.2d 226 (1992); Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 78 L.Ed. 212 (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 Company, Inc. v. Helvering, 292 U.S. 435, 54 S.Ct. 788, 78 L.Ed. 1348 (1934); Hradesky v. Commissioner, 65 T.C. 87, 90, 1975 WL 3047 (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 v. Commissioner, 6 T.C. 1158, 1165, 1946 WL 298 (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).

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 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...