Pesarik v. Commissioner: Tax Court Rejects Principal Residence Exclusion and Adjusts Basis for Property Sales

The $255K Tax Bill: How Poor Recordkeeping Cost a Taxpayer

The stakes couldn’t have been higher for Jeffrey Pesarik. The IRS hit him with a $255,281 deficiency for unreported gains from two property sales in 2020, along with a $54,355 accuracy-related penalty. At the heart of the dispute was Pesarik’s claim that both properties qualified for the § 121 exclusion; the $250,000 tax-free gain exclusion for principal residences. The Tax Court ultimately sided with the IRS, rejecting his exclusion claims and adjusting the basis for one property, leaving Pesarik with a crushing tax bill. The case serves as a stark warning: when records vanish and claims go unsubstantiated, the Tax Court shows little mercy.

From Chicken Coop to Cash: The Story of Two Property Sales

Jeffrey Pesarik’s return to New Hampshire in fall 2016 marked more than just a personal homecoming; it set the stage for a high-stakes real estate gamble that would later land him in Tax Court. A property management veteran with a finance degree under his belt, Pesarik had spent years honing his skills in Seattle, Dallas, and Washington, D.C. But his move back to the Granite State was driven by family duty: settling the affairs of his late mother. That responsibility soon expanded into a full-blown renovation project on her Portsmouth home, a venture that would net him $157,000; and a lesson in the importance of meticulous recordkeeping.

Pesarik’s property ambitions didn’t stop there. Just weeks after his mother’s house sold in March 2017, he set his sights on a far more modest investment: the Wakefield Property. Purchased for $30,000 on November 17, 2016, the place was, in his own words, “basically a chicken coop”; a dilapidated structure in an “extremely rural” corner of New Hampshire, 45 minutes north of Portsmouth. Undeterred, Pesarik dove into a gut renovation, claiming he “pretty much built a new house” from the ground up. The scope of work was staggering: underground utilities, a new septic system, foundation repairs, and structural reinforcements. By the time he was done, the property had been transformed from a derelict shack into a habitable home.

The transformation came at a cost, and Pesarik financed it creatively. He leaned heavily on credit cards and his property management business accounts, shuffling expenses between accounts without clear allocation. The lack of separation between personal and business funds would later become a critical vulnerability in his tax filings. Still, the gamble paid off when he sold the Wakefield Property for $187,000 on March 30, 2020, netting a tidy profit after $17,843 in closing costs.

Pesarik’s next move was bolder; and far pricier. On July 6, 2018, he purchased the Hull Property in Hull, Massachusetts, for $394,750. A two-hour drive from Portsmouth and just two blocks from the beach, the waterfront home was a stark contrast to the rural Wakefield Property. Pesarik never established residency in Massachusetts: no state income tax returns were filed, no Massachusetts driver’s license was obtained. Yet he claimed the property as his own, using an Arizona driver’s license as proof of identity at the October 7, 2020 closing, where he sold the Hull Property for $556,800; after $24,967 in closing costs.

By the time the dust settled on both sales, Pesarik had cashed out over $743,000 in gross proceeds. But the Tax Court would later scrutinize every dollar, every renovation receipt, and every mile between Portsmouth, Wakefield, and Hull. The question wasn’t just how much he’d earned; it was whether he’d played by the rules.

The Tax Dispute: Basis Adjustments vs. Principal Residence Exclusion

The IRS had a clear message for Pesarik: Show your work. When the agency issued its deficiency notice for the 2020 tax year, it challenged two core claims; one rooted in the arcane mechanics of basis calculation, the other in the very definition of home.

Pesarik’s first contention centered on the Wakefield Property, where he claimed that renovation expenditures and closing costs had increased his basis, thereby reducing the taxable gain from its sale. Under Internal Revenue Code § 1016(a), the basis of property is adjusted upward for capital improvements; permanent enhancements that add value or extend the property’s useful life. Pesarik argued that expenditures like kitchen renovations, bathroom upgrades, and new flooring qualified as capital improvements, while closing costs tied to the sale further bolstered his basis. His position hinged on the idea that these adjustments limited his taxable gain to just $55,799.

But the IRS saw no proof. The agency dismissed Pesarik’s basis claims outright, arguing he had failed to substantiate the claimed expenditures. Without receipts, invoices, or bank records, the IRS contended, the court had no choice but to disallow the adjustments; a position reinforced by third-party reporting that showed no corresponding deductions on Pesarik’s tax filings.

Pesarik’s second claim was even more consequential: he insisted the Hull Property sale qualified for the § 121 exclusion, which allows taxpayers to exclude up to $250,000 of gain from the sale of their principal residence. To meet the exclusion’s requirements, a taxpayer must pass two tests: the ownership test (owning the home for at least two of the last five years) and the use test (using it as a principal residence for at least two of the last five years). Pesarik maintained he had lived in the Hull Property long enough to satisfy both.

The IRS disagreed. The agency argued that Pesarik had failed to establish the Hull Property as his principal residence, pointing to his Arizona driver’s license, his tax filings, and his mailing address; all of which suggested Portsmouth, not Hull, was his true home. The IRS also relied on third-party records, including utility bills and voter registration, to challenge Pesarik’s residency claims. The burden, the agency stressed, was on Pesarik to prove his eligibility; and in their view, he had not met it.

The stage was set for a clash over proof, presumption, and the Tax Court’s authority to weigh evidence when the IRS’s own records suggested a taxpayer’s claims were unsupported. The question was no longer just about dollars and cents; it was about who gets to decide what counts as a home, and how much a taxpayer must prove to call it their own.

Cohan to the Rescue: How the Court Estimated Basis for the Wakefield Property

The Tax Court’s willingness to wield the Cohan rule; a judicial power that allows it to fill evidentiary gaps with reasonable estimates; proved decisive in salvaging Jeffrey Pesarik’s basis claims for the Wakefield Property. The stakes were high: Without a credible way to substantiate his renovation expenses, Pesarik risked owing tax on the full $187,000 sale price instead of the $55,799 gain he claimed. The IRS, ever skeptical of unsupported deductions, argued that his scattered records and vague testimony left no room for estimation. But the court, invoking its authority to weigh evidence flexibly, stepped in to bridge the gap; calculating a $20,959 basis adjustment and slashing the taxable gain to $118,198.

The legal framework governing basis adjustments is rooted in Section 1001, which defines gain as the difference between the sale price and the property’s adjusted basis. Section 1012(a) sets the default basis as the property’s purchase price, while Section 1016(a)(1) permits adjustments for capital improvements; expenditures that materially enhance the property’s value or extend its useful life. But these statutes are only as good as the evidence taxpayers can produce. When records are incomplete, the Cohan rule (derived from Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930)) empowers the court to estimate deductible amounts if the taxpayer demonstrates a good-faith effort to substantiate the expense. The rule is a judicial corrective to the IRS’s rigid substantiation requirements, allowing the court to exercise its discretion when exact proof is impossible.

Pesarik’s evidence for the Wakefield Property’s basis adjustment was, at best, haphazard. His primary support consisted of credit card statements and bank checks, but the connections to the property were tenuous. Most transactions lacked specificity; Home Depot receipts were lumped into broad categories like “seasonal/garden electrical and lighting,” while Lowe’s statements offered only slightly more detail, such as “gate hardware” or “spray foam insulation.” The court found that these records, alone, were insufficient to tie the expenses directly to the Wakefield Property. Pesarik’s testimony didn’t help: He admitted owning multiple properties during the relevant years, including the Hull Property and his late mother’s home in Portsmouth, making it impossible to allocate expenses with precision.

The spreadsheet he later produced; a desperate attempt to retroactively assign costs; only deepened the confusion. The court noted that the allocations were arbitrary, with entries that conflicted with the underlying statements and failed to reconcile returns or reconcile purchases with property timelines. The IRS seized on these flaws, arguing that Pesarik’s inexactitude barred any estimation under Cohan.

But the court, exercising its authority to parse the record, carved out a middle path. It credited Pesarik for $6,156 in checks that bore the Wakefield Property’s address or were made out to Finishing Touches, a painting company he testified worked on the property. For the credit card transactions, the court applied a 25% allocation to Home Depot and Lowe’s spending; $59,213 in total; reasoning that a quarter of these expenses were plausibly tied to the Wakefield Property’s renovations. The court justified this fraction by invoking Cohan’s admonition to “bear[] heavily upon the taxpayer whose inexactitude is of his own making,” given Pesarik’s failure to maintain property-specific records.

The result was a calculated gain of $118,198; a far cry from the IRS’s initial deficiency of $271,774, but still a victory for the taxpayer. The decision underscores the Tax Court’s power to reconstruct tax liabilities when the IRS’s rigid substantiation demands would otherwise overwhelm taxpayers with imperfect records. It also serves as a cautionary tale: While Cohan can rescue taxpayers from the void of lost receipts, it demands more than vague assertions or hastily assembled spreadsheets. The court’s willingness to estimate is not boundless; it requires a foundation of credible evidence, however fragmentary. For Pesarik, that foundation was just enough to avoid a crushing tax bill. For others, it’s a reminder that meticulous recordkeeping remains the best defense against the IRS’s skepticism; and the Tax Court’s discretion.

No Home Sweet Home: Why the Hull Property Failed the § 121 Test

The Tax Court’s rejection of Mr. Pesarik’s § 121 exclusion claim for the Hull Property underscores the narrow construction of exclusions and the taxpayer’s heavy burden of proof. Section 121(a) allows an exclusion of up to $250,000 in gain from the sale of a principal residence, but only if the taxpayer owned and used the property as their primary home for at least two of the five years before the sale. Treasury Regulation § 1.121-1(b)(2) further clarifies that determining a principal residence hinges on a range of objective factors; such as employment location, family ties, and official documentation; rather than subjective intent.

The court found no evidence that the Hull Property met these requirements. Pesarik purchased the property in July 2018, yet the record contained no proof of a move-in; no moving expenses, no furniture purchases, and no explanation for why such basic indicators of residency were absent. His credit card statements, often cited as evidence of occupancy, were inconclusive: they showed activity in Massachusetts before, during, and after his purchase of the Hull Property, with no consistent pattern of use. The court noted that statements addressed to his Portsmouth address persisted until early 2020, suggesting he did not consider Hull his primary residence until much later.

The court also dismissed Pesarik’s claim that legal troubles forced him to reside at the Hull Property for extended periods. Despite his testimony, he provided no corroborating evidence; no court filings, no utility bills in his name, and no third-party verification of his presence. His failure to file Massachusetts tax returns for 2018–2020, his use of a Portsmouth mailing address on his 2020 federal return, and his Arizona driver’s license further undermined his assertion.

Ultimately, the court calculated Pesarik’s gain on the Hull Property at $137,083; $556,800 in sale proceeds minus $394,750 in basis and $24,967 in closing costs. Because he could not prove the property was his principal residence for the required two-year period, the § 121 exclusion was denied. The decision serves as a stark reminder: when claiming a principal residence exclusion, the burden of proof is absolute, and the Tax Court will not accept vague assertions in place of credible evidence.

The Price of Inexactitude: Accuracy-Related Penalty Upheld

The Tax Court’s ruling in Pesarik serves as a blunt reminder: when the IRS assesses an accuracy-related penalty under § 6662, the taxpayer bears the burden of proving that the underpayment was not due to negligence or disregard of rules. The court’s decision to uphold the penalty; despite Pesarik’s arguments of reasonable cause; highlights the Tax Court’s willingness to exercise its authority over both taxpayers and the IRS when assessing penalties for sloppy recordkeeping.

§ 6662 imposes a 20% penalty on underpayments of tax attributable to negligence, disregard of rules, or substantial understatements. The IRS’s burden of production is straightforward: it must show that the taxpayer’s return position lacked a reasonable basis or that the taxpayer failed to maintain adequate records. The taxpayer, in turn, must prove reasonable cause and good faith under § 6664(c) to avoid the penalty. This is a high bar; one that Pesarik failed to clear.

Pesarik’s primary argument for reasonable cause was his belief that he incurred a loss on the Wakefield Property, which he claimed justified his failure to report the gains from either sale. The court swiftly rejected this contention, noting that his belief was unsubstantiated by any credible evidence. The record showed no basis for his assertion of a loss, and his testimony lacked specificity about the alleged loss or its connection to the tax underpayment. The court emphasized that mere assertion, without proof, is insufficient to establish reasonable cause.

Pesarik also pointed to his disabilities as a mitigating factor, but the court found this argument unpersuasive. While the court acknowledged that disabilities can sometimes contribute to a reasonable cause defense, it stressed that Pesarik made no effort to assess his tax liability accurately. His failure to maintain records, reconcile his expenditures, or even attempt to calculate his taxable gain demonstrated a lack of diligence that the court could not overlook. The court’s opinion underscored that inexactitude is of the taxpayer’s own making; a refrain echoing the Cohan rule but with far harsher consequences.

The court’s decision to uphold the penalty was not a stretch of judicial power but a straightforward application of the law. It reinforced the Tax Court’s role as a gatekeeper against careless tax reporting, even when the taxpayer’s errors stemmed from poor recordkeeping rather than outright fraud. For future taxpayers, the lesson is clear: the IRS and the Tax Court will not accept vague assertions or unproven beliefs in place of diligent recordkeeping and accurate tax reporting. The price of inexactitude is steep; and in Pesarik’s case, it came with a $54,355 penalty.

What This Means for Taxpayers: Lessons from Pesarik

The Pesarik case serves as a cautionary tale for taxpayers navigating the treacherous waters of basis adjustments and principal residence exclusions. The court’s strict interpretation of § 121; the provision allowing exclusion of up to $250,000 in gain from the sale of a principal residence; demonstrates that the Tax Court will not tolerate vague assertions or incomplete records when taxpayers seek to claim this valuable tax benefit. The IRS and the court require irrefutable evidence that the property met the ownership and use tests within the five-year lookback period, and any gaps in documentation will be met with skepticism.

The court’s willingness to apply the Cohan rule; allowing estimation of basis when exact records are unavailable; was a rare concession, but it came with strict conditions. The Tax Court emphasized that Cohan is not a blanket invitation to guesswork; estimates must be reasonable, supported by credible evidence, and based on a good-faith effort to reconstruct records. Taxpayers who rely on Cohan to justify missing receipts or incomplete documentation do so at their peril, as the IRS and the court will closely scrutinize such claims. The lesson is clear: the Cohan rule is a lifeline, not a crutch.

For those seeking to claim the § 121 exclusion, the Pesarik decision underscores the importance of meticulous recordkeeping. Taxpayers must maintain concrete proof of their principal residence status, including utility bills, tax returns, voter registration, and other documentation that ties them to the property. The court’s narrow construction of § 121; requiring strict adherence to the two-out-of-five-year rule; leaves little room for interpretation. Even minor deviations, such as renting out the property for a period or failing to update official records, can disqualify a taxpayer from the exclusion.

The case also highlights the high bar for reasonable cause defenses to the § 6662 accuracy-related penalty. Taxpayers who argue that their errors stemmed from poor recordkeeping rather than intentional disregard will find little sympathy from the Tax Court. The court’s decision to uphold the penalty reinforces that negligence, even if unintentional, carries a steep price. Taxpayers must demonstrate extraordinary diligence in their recordkeeping and reporting to avoid penalties, and even then, the IRS and the court may not be persuaded.

For future taxpayers, the Pesarik case is a stark reminder that the Tax Court will exercise its authority as a gatekeeper against careless tax reporting. The court’s willingness to apply Cohan in limited circumstances, while simultaneously rejecting vague assertions and unproven beliefs, sends a clear message: the burden of proof lies with the taxpayer. Those who fail to meet this burden will face not only the tax liability they sought to avoid but also the 54,355 penalty that accompanies it.

As the Tax Court continues to refine its interpretation of these provisions, taxpayers and practitioners must adapt. The days of relying on loose estimates or incomplete records are over. The future belongs to those who document every detail, comply with every requirement, and leave nothing to chance. For those who do, the rewards; whether in the form of a $250,000 exclusion or the avoidance of a crushing penalty; are well worth the effort.