Murphy v. Commissioner

• Decision Date: 07 July 1993
• Docket Number: Docket No. 4857-91.
• Citation: 66 T.C.M. 32
• Parties: Michael E. Murphy and Katherine L. Murphy v. Commissioner.
• Court: U.S. Tax Court

66 T.C.M. 32

T.C. Memo. 1993-292

Michael E. Murphy and Katherine L. Murphy v. Commissioner.

Docket No. 4857-91.

United States Tax Court.

Filed July 7, 1993.

Thomas I. Hara, 6200 Shingle Pkwy., Minneapolis, Minn., for the petitioners. Robert F. Cunningham and Thomas E. Ritter, for the respondent.

Memorandum Opinion

RAUM, Judge:

The Commissioner determined an income tax deficiency of $26,207 for 1986 against petitioners, husband and wife. After certain concessions by petitioners, the remaining issues are: (1) Whether petitioners effectively converted their former residence in Minnesota to an income-producing property prior to sale, thereby enabling them to deduct loss on sale of that residence as well as rental expenses; (2) whether petitioners were entitled to deduct certain expenses claimed as business travel expenses; and (3) whether petitioners were required to include certain reimbursements of travel expenses in income as excess per diem. The facts have been stipulated. All references to petitioner in the singular are to petitioner-husband, who will also be referred to at times as Mr. Murphy. Petitioners resided in Hopkins, Minnesota, at the time they filed their petition herein.

1. Conversion of Residence to Income-Producing Property. For several years prior to and during the taxable year 1986, petitioner was employed by Warrington Associates, Inc. (Warrington), a Minnesota corporation. His post of duty was Birmingham, Alabama, where petitioners resided for several years prior to 1985. In 1985, Warrington advised Mr. Murphy that a sale of the business was contemplated and reassigned him to its Minneapolis headquarters.

For various reasons, including uncertainties surrounding the sale of the Warrington business, petitioners did not sell their Alabama residence upon relocation to Minnesota. Although they retained ownership of their Alabama home, they did not offer it or hold it out for rental. They retained their major Alabama banking affiliation and never changed their voting registration or drivers' licenses from Alabama to Minnesota. At some point, petitioners contracted with a builder and built a home in Excelsior, Minnesota. The cost of the new Minnesota property was $322,691. As with all such investments, one aspect of petitioners' acquisition of their new Minnesota home was a view to its appreciation for resale purposes. Petitioners occupied their new home in September 1985.

Warrington was subsequently sold in early 1986. After several months, Mr. Murphy became pessimistic about his future with the company under its new management and asked for and received a transfer back to Birmingham, Alabama. Petitioners returned to Birmingham in June 1986. Prior to moving back to Birmingham, they listed their Minnesota residence with a realtor. The asking price was $319,900.

A few days after the listing agreement was signed, petitioners leased their Minnesota property on a month-to-month basis to the contractor who had built the house. He was building another house in the same subdivision and leased petitioners' house "during the construction phase of his next project."¹ The lease agreement called for the lessee to pay rent in the amount of $650 per month, maintain the property, and allow for showing of the house by the realtor with whom it was listed. Petitioners considered the contractor an excellent tenant because he had built the house, was constructing another house in the same subdivision, and was known to be reliable. They were therefore willing to lease the property to him for less than its fair rental value.

During the late part of the summer of 1986, Mr. Murphy found his employment under the new management to be unsatisfactory, and decided to leave the company. At that point the sale of petitioners' Minnesota property "became essential." They thereafter entered into an agreement to sell the property, which they had already placed in the hands of a broke at least as far back as June 1986. The gross sale price was $278,070. The sale was closed in late November 1986, and the lease was then terminated.

On their 1986 joint return, petitioners took the position that the lease to the builder converted their former residence in Minnesota from personal use (as a home) to an income-producing property. Accordingly, they deducted not only the $38,402 claimed ordinary loss² on the sale of the property, but also rental expenses (in excess of rental income) relating to the period that the property was under lease to the builder.³

The Commissioner determined that the property had not been "converted to income producing property", that the $38,402 deduction of the loss on sale was not allowable, and that although the $11,292 mortgage interest component of the $15,430 rental loss was deductible, the remaining portion of the rental loss was not deductible. We sustain the Commissioner.

Section 165(c)(2)⁴ allows individual taxpayers to take a deduction for losses incurred in "any transaction entered into for profit". Section 212(2) similarly allows individual taxpayers to deduct ordinary and necessary expenses "for the management, conservation, or maintenance of property held for the production of income". Accordingly, once it has been established that a taxpayer held property for the production of income and that his or her motives were thus profit-driven, that individual may — subject to certain limitations not at issue here⁵ — deduct not only the expenses of managing and maintaining the property but also any subsequent loss incurred on the disposition of the property, as hereinafter shown.

However, as the applicable Treasury regulations relating to sections 165(c)(2) and 212(2) make clear, if property has been acquired or used as the taxpayer's personal residence, it must be converted to a use related to the production of income in order for the taxpayer to become entitled to deduct such losses and/or expenses. Secs. 1.165-9, 1.212-1, Income Tax Regs.⁶ It is clear from the record that petitioners used their home in Minnesota as their personal residence. Accordingly, they may not deduct either the loss on the sale of their Minnesota home or the expenses incurred in leasing the home (other than mortgage interest) unless the property was converted from personal use to use as an income-producing property. Such purpose may be based on rental activity involving the property or on the taxpayer's attempts "to realize a profit representing postconversion appreciation in the market value of the property." Newcombe v. Commissioner [Dec. 30,178], 54 T.C. 1298, 1302 (1970)⁷; see also Quinn v. Commissioner [Dec. 33,537], 65 T.C. 523, 526 (1975).

In either event, however, it is the taxpayer who bears the burden of establishing that conversion to the requisite profit-motivated purpose has occurred. Grant v. Commissioner [Dec. 42,067], 84 T.C. 809, 825 (1985), affd. without opinion 800 F.2d 260 (4th Cir. 1986); MaDan v. Commissioner [Dec. 42,808(M)], T.C. Memo. 1986-7. And the taxpayer cannot carry that burden merely by showing that there was a purpose of making a profit if that purpose was secondary to a primary nonqualifying purpose. See Austin v. Commissioner [62-1 USTC ¶ 9215], 298 F.2d 583, 584 (2d Cir. 1962), affg. [Dec. 24,435] 35 T.C. 221 (1960), where the Court of Appeals accepted this Court's finding that the property involved "was purchased by petitioners primarily for a residence and secondarily to make a profit." (Quoting Austin v. Commissioner [Dec. 24,435], 35 T.C. at 224.)

To be sure, the record does show that "one aspect of the petitioners [sic] acquisition of the Minnesota house was a view to its appreciation in value for resale purposes". But the stipulation of the parties weakens that view by describing it generally "As with all such investments." Plainly, petitioners' view to realizing a profit on resale was secondary to their primary purpose of acquiring a residence upon Mr. Murphy's transfer to Minnesota. Although he had misgivings about his future in Minnesota, as evidenced by the fact that certain ties to Alabama were retained as a sort of safety net, the acquisition of the house in which to reside was nevertheless obviously a matter of immediate and first importance. But as the Court noted in Austin v. Commissioner, supra at 584, it is petitioner's "primary motive [that] must be ascertained and given effect." See also Arata v. Commissioner [60-1 USTC ¶ 9454], 277 F.2d 576, 578-579 (2d Cir. 1960), affg. in part, revg. in part [Dec. 23,240] 31 T.C. 346 (1958); Meurer v. Commissioner [55-1 USTC ¶ 9343], 221 F.2d 223, 224 (2d Cir. 1955).⁸ And petitioners have not proved that their primary objective was to make a profit.

We turn now to the question whether petitioners' primary intention with respect to their Minnesota residence shifted from personal use to the production of income when they subsequently left that property as their home and returned to Alabama. The answer here as in every other case must be arrived at "in light of all of the facts and circumstances" surrounding the particular case. Quinn v. Commissioner [Dec. 33,537], 65 T.C. 523, 526 (1975); see also Newcombe v. Commissioner [Dec. 30,178], 54 T.C. 1298, 1299-1300 (1970). The decided cases have enumerated a number of factors that may be considered to assist in arriving at a final conclusion. See Grant v. Commissioner [Dec. 42,067], 84 T.C. 809, 825 (1985), affd. without opinion 800 F.2d 260 (4th Cir. 1986); Quinn v. Commissioner, supra at 526; Newcombe v. Commissioner, supra at 1299-1300. However, some factors bear more directly than others on the situation at hand. There is no magic formula for weighing these factors to arrive at the final answer, which in the last analysis must depend upon "all the facts and circumstances" surrounding the particular case. We have considered all of the suggested factors, and in our judgment, the bottom line is that at the time of conversion, petitioners' motive was neither to hold the property...