United States

Brown case provides insight on substantiation requirement for repairs

TAX ALERT  | 

On Monday, Feb. 5, 2018, the Tax Court released Brown, Brandon et ux. v. Commissioner; No. 2809-16S; T.C. Summ Op. 2018-6. From a substantive tax law perspective, Brown involves a fairly unexceptional scenario: taxpayers argue that repairs to their commercial rental property are deductible business expenses, the Service claims the items are capital expenditures, and the court applies settled tax law that delineates one category from the other and assigns the burden of proof. What is interesting in Brown, however, is the procedural perspective and how it underscores the need to substantiate deductions for property repairs.

While the Browns lost their case, it was on the lack of corroborating documentation not the position the Browns took that caused the Court to rule against them. The Browns asserted the following positions in support of their case:

  1. The disallowed expenses to repair or replace carpeting involved only items that were damaged or worn. Expenditures were limited to only the flooring portion that needed to be repaired or replaced, rather than a replacement of the entire flooring.   
  2. Certain remodeling expenses, painting damaged walls and replacing worn ceiling tiles, were remedial repairs made pursuant to their lease agreements.
  3. Finally, the taxpayers made these and any other expenditures to keep their rental property in operating condition over its useful life: the items neither prolonged the property's life nor increased its value.

The Service responded to these claims with “aside from their self-serving declarations, [the taxpayers] failed to provide any information about the expenditures other than that they were incurred.” 

The Service countered each of the taxpayers’ substantive arguments with an evidentiary rebuttal:

  1. If the expenditures were to replace worn or damaged items, where was the evidence documenting the older item’s age or condition upon replacement?
  2. If the expenditures were required to maintain the properties as set out in the taxpayers’ lease agreements, shouldn’t the taxpayer be able to provide the relevant lease agreement provisions or be able to show that such work was performed on a recurring basis?
  3. If the expenditures did not add value to the rental properties, where was the evidence concerning the property’s value before and after renovation that allowed the taxpayers to make that determination?

The Service also pointed out that the taxpayers failed to provide any evidence showing that useful life of the repairs was less than a year or that they were done not as part of a general plan of improvement.  

To clarify, the Service did not assert that each of these evidentiary items is necessary to support the current deductibility of repairs. What the Service did argue was that the taxpayers’ failure to produce this evidence, considering that such items are within the taxpayers’ control, would not support the taxpayers’ testimony.

In finding for the Service, the court made special note of the fact that had the taxpayers offered further evidence, the court would have been able to consider whether such evidence supported petitioners' contentions. The court was left with little more than “an itemized list of the work performed and the costs therefor [with] no evidence about the context in which that work was performed, nor its effect on the value or the useful life of either property.” Given the scarcity of the record, the court had little choice to but uphold the Service’s notice of deficiency.

Takeaways

Cases like these remind taxpayers of a fundamental, but easily overlooked or underestimated, tenet of tax law: deductions are a matter of legislative grace, and taxpayers must prove their entitlement to them. Even routine items can be challenged for a lack of substantiation, and the Brown case provides useful insights into the Service’s documentation expectations for property repairs. 

For information on how to satisfy this substantiation requirement as it applies to your particular property repairs or to other deductions, contact your tax adviser. 

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