Court allows partial basis increase under Cohan but denies §121 exclusion
Pesarik v. Commissioner, T.C. Memo. No. 23859-22. Court Opinion.
Poor records will cost you precision, and claiming the §121 principal residence exclusion without objective proof will fail.
Holding
The Tax Court allowed a limited increase to the basis for renovation costs on one property using an estimate under Cohan, but denied the §121 exclusion for a second property and sustained the §6662 substantial understatement penalty.
Why It Matters
The case shows the practical limits of Cohan. The Court will estimate the basis, but it will heavily discount unsupported allocations.
The §121 principal residence exclusion requires objective, contemporaneous evidence. Mailing addresses, licenses, and tax filings matter.
Owning multiple properties increases the substantiation burden when allocating renovation expenses.
A belief that a property sale produced a loss, without calculation or documentation, will not support reasonable cause under §6664(c).
Key Facts
Jeffrey Pesarik sold:
Wakefield, NH, property for $187,000 in March 2020.
Hull, MA property for $556,800 in October 2020.
He did not report a gain from either sale on his 2020 return.
IRS issued a notice of deficiency asserting:
$271,774 deficiency.
$54,355 accuracy-related penalty under §6662.
He claimed:
Increased basis in Wakefield for renovations and closing costs.
Full exclusion of gain on Hull under §121 as his principal residence.
During the relevant years, he owned multiple properties and used several credit cards and a business bank account to fund renovations.
He did not file Massachusetts returns and held an Arizona driver’s license during the Hull ownership period.
Statutory and Regulatory Framework
§1001: Gain equals amount realized minus adjusted basis.
§1012 and §1016: Basis starts with cost and increases for capital improvements.
Treas. Reg. §1.263(a)-1 through -3: Capital expenditures include improvements and selling costs.
§121: Up to $250,000 exclusion if the taxpayer owned and used the property as a principal residence for at least two of the five years before the sale.
Treas. Reg. §1.121-1(b)(2): Principal residence determined by all facts and circumstances, including address on returns, license, mailing address, and employment location.
§6662: 20 percent penalty for substantial understatement.
§6664(c): No penalty if reasonable cause and good faith.
Cohan v. Commissioner: Court may estimate expenses if some evidentiary basis exists.
Arguments
Taxpayer argued:
Wakefield gain was only $55,799 after adding:
$82,358 of renovation costs.
$17,843 of closing costs.
Hull gain was fully excludable under §121 because it was his principal residence for more than two years.
He acted with reasonable cause, believing Wakefield was sold at a loss and citing medical conditions.
Government argued:
Renovation costs were not sufficiently substantiated or allocable to Wakefield.
Hull was not proven to be the taxpayer’s principal residence.
Substantial understatement penalty applied.
Court’s Reasoning
Wakefield Property
Purchase price was $30,000, not $31,000. The deed controlled.
Closing costs of $17,843 were capitalizable selling expenses.
Credit card statements and spreadsheets did not clearly connect most expenses to Wakefield.
The taxpayer owned four properties and renovated multiple homes, making allocation uncertain.
Spreadsheet allocations were inconsistent with ownership dates and did not reconcile purchases and returns.
The Court found credible evidence of:
$6,156 in checks tied to the property or a specific painting company.
Total spending at Home Depot and Lowe’s during ownership was $59,213.
Applying Cohan, the Court allowed 25 percent of that amount, or $14,803, to be treated as Wakefield capital improvements.
Total allowed capital improvements: $20,959.
Final Wakefield gain: $118,198.
The Court emphasized that it would “bear heavily” against the taxpayer because the inexactitude was self-created.
Hull Property and §121
Hull was purchased in July 2018 and sold in October 2020.
To qualify, it needed to be his principal residence for essentially the entire ownership period.
Factors weighed against him:
Arizona driver’s license.
No Massachusetts returns.
Federal return listed Portsmouth address.
Credit card statements addressed to Portsmouth until early 2020.
Credit card transaction locations were inconclusive and geographically inconsistent.
A summary of electric bills lacked provenance and did not prove residence.
No corroborating evidence of relocation, such as moving expenses or furniture purchases.
Legal difficulties allegedly requiring Massachusetts residence were unsupported by documentation.
The Court held he failed to meet his burden under §121.
Penalty
Understatement exceeded statutory thresholds under §6662(d).
Penalty was automatically calculated by electronic means, so supervisory approval under §6751(b) was not required.
Claiming a loss on a sale at more than six times the purchase price was objectively unreasonable.
No evidence showed that his medical conditions impaired his ability to comply.
No reasonable cause under §6664(c).
Result
Decision to be entered under Rule 155, reflecting adjusted gain on Wakefield, full gain on Hull, and imposition of the §6662 penalty.
The Takeaway
Cohan can rescue a poorly documented renovation project, but it will not rescue a loosely asserted principal residence claim.
If you want §121, align the paperwork, the license, the tax returns, and the mailing address before you sell.
List of Citations
Cohan v. Commissioner, 39 F.2d 540: Allows estimation of expenses when some evidentiary basis exists.
§121: Principal residence exclusion requirements.
Treas. Reg. §1.121-1(b)(2): Multi-factor test for principal residence.
§6662: Substantial understatement penalty.
§6664(c): Reasonable cause exception.
Walquist v. Commissioner, 152 T.C. 61: No supervisory approval required for automatically calculated penalties.