Reeds' Real Estate Ventures Lead to $1M+ Tax Deficiency Dispute

Today’s date is 8/5/2026.

In Reed v. Commissioner, T.C. Memo. 2026-64 (Aug. 5, 2026), Judge Toro delivered a sweeping rebuke to Scott L. Reed and Stacy N. Reed, upholding deficiencies, penalties, and additions to tax exceeding $1.2 million for tax years 2012 through 2015. The court’s ruling hinged on the Reeds’ systematic failure to maintain adequate records, their commingling of personal and business funds, and their inability to meet the burden of proof under IRC § 7491—a provision that, in this case, did not shift the scales in their favor. The IRS, armed with bank deposit analyses and forensic accounting, reconstructed the Reeds’ income and disallowed $500,000 in claimed deductions, while imposing accuracy-related penalties under IRC § 6662 for substantial understatements. The court’s exercise of judicial power was unmistakable: it rejected the Reeds’ arguments outright, not because the IRS’s position was infallible, but because the taxpayers failed to substantiate their own claims.

The broader context of this dispute is a familiar battleground in Tax Court: real estate developers and entrepreneurs whose financial lives are as complex as their ventures. The Reeds, a married couple with income streams spanning construction, medical practice startups, and reclaimed wood sales, found themselves ensnared in the IRS’s increasingly sophisticated use of bank deposit analysis—a method that treats unexplained deposits as taxable income unless the taxpayer can prove otherwise. This case underscores the Tax Court’s willingness to wield its authority when taxpayers gamble on poor recordkeeping, particularly in cases involving partnership taxation, where the stakes for misclassification and undocumented transactions are astronomical. While the Reeds did prevail on a handful of issues—including a $40,000 advance payment and a $50,000 farm lease deduction—the court’s ruling on the core deficiencies was unambiguous. The message to future taxpayers is clear: the Tax Court will not save you from your own disorganization.

The Reeds’ financial history reads like a cautionary tale of ambition, poor recordkeeping, and the perils of commingled funds—one where a once-promising real estate career unraveled under the weight of undocumented transactions and personal-business financial chaos. At the heart of the dispute lies the story of Mr. Reed, whose background in construction and real estate development set the stage for a series of projects that would later become the subject of intense IRS scrutiny. His journey from a construction laborer to a real estate consultant—and eventually the founder of Reed Realty Advisors, LLC (RRA)—was marked by a pattern of financial informality that would prove fatal in Tax Court.

Mr. Reed’s early life was steeped in construction. His father and grandfather worked in the trade, and by his teenage years, he was joining them on jobsites, building apartments, homes, and commercial properties. After studying at the University of California, Davis, he entered the real estate world as a consultant, working for Arthur Andersen and Standard & Poor’s before specializing in tax credit-driven real estate development, particularly for historic properties. His expertise led him to consult for the U.S. Navy on the disposal of closed bases like Naval Air Station Alameda Point and Naval Station Treasure Island, a role he continued through RRA.

By the time the Reeds moved to Little Rock, Arkansas, in 2012—where Dr. Reed completed her residency—Mr. Reed had founded RRA, a single-member LLC treated as a disregarded entity for federal tax purposes. The company served as his vehicle for real estate consulting and development, with Mr. Reed acting as managing director alongside key employees like Alex Dzyuba (director of construction) and Jake Spellmeyer (director of finance and accounting). RRA’s work spanned multiple sectors, including federal government contracts (via the General Services Administration) and private-sector clients, but its most significant engagements involved real estate development projects—three of which would later dominate the IRS’s deficiency notice: Main Street Lofts, K Lofts, and TJ Tower.

The financial disarray began with RRA’s commingling of funds. Despite operating as a separate entity, Mr. Reed frequently used the Reeds’ personal bank accounts for RRA-related deposits and withdrawals. The court’s findings later highlighted this practice as a critical flaw, noting that "neither party has introduced into evidence the complete books and records of Reed Realty Advisors"—a gap that would haunt the Reeds when the IRS reconstructed their income. The lack of clear separation between personal and business finances extended beyond mere convenience; it reflected a broader absence of formal financial controls. RRA’s bank account existed, but transactions were routinely routed through the Reeds’ personal accounts, muddying the waters for both the IRS and the Tax Court.

RRA’s role in the Reeds’ real estate projects was equally murky. The company performed a multifaceted function, from site selection and property acquisition—where it conducted market research and building modeling, often hiring Mr. Reed’s father, Bruce Reed, as a construction consultant—to coordinating contractors and monitoring construction progress. In later stages, RRA advised investors on winding up their involvement, sometimes seeking legal counsel. Yet, despite these responsibilities, no complete records of RRA’s activities were ever produced. The court’s opinion dryly notes that the parties did not stipulate the company’s books and records, leaving a void where documentation should have been.

The Reeds’ involvement in Main Street Lofts, K Lofts, and TJ Tower further illustrates the financial tangles that would later ensnare them. Main Street Lofts, formed in April 2012, acquired four Little Rock properties for $1.5 million in August of that year, funded by investors, bank financing, and Arkansas historic rehabilitation tax credits (governed by Ark. Code Ann. § 26-51-2204). The project faced setbacks, including a 2013 or 2014 fire, a 2015 truck accident that flooded a building, and a 2015 change in Arkansas law that slashed the available tax credits. Funding came from Riverside Bank, with the Reeds and two others guaranteeing a $3.182 million construction loan in July 2013. Yet, despite these high stakes, the Reeds’ personal accounts became a conduit for project funds. Between 2014 and 2015, Mr. Reed transferred approximately $811,000 from his personal accounts to Main Street Lofts and K Lofts. Main Street Lofts recorded these as "Scott Reed Float Loan" entries in its books, though the record is silent on the terms of these purported loans.

K Lofts, another Little Rock project, purchased a property at 315 Main Street in November 2010. Mr. Reed held his interest through K Lofts Member One, LLC, a disregarded entity, and guaranteed a $1.375 million loan from IBERIABANK. The project suffered its own misfortunes, including a collapsed back wall during concrete pouring, burst pipes, and break-ins. Like Main Street Lofts, K Lofts relied on transfers from the Reeds’ personal accounts, recorded as "Scott Reed Short Term Loan" or "Scott Reed Long Term Loan" entries. The court’s opinion highlights a particularly glaring inconsistency: In April 2014, a $200,000 transfer to K Lofts was labeled "Endurance" in the general ledger, with no reference to Mr. Reed—despite bank statements showing a "WIRE TYPE: BOOK OUT" transaction to K Lofts. The lack of a clear paper trail for these transfers would later force the court to rely on bank deposit analysis to reconstruct the Reeds’ income.

The Reeds’ financial disorganization extended to partnership transactions. In 2013, Mr. Reed sold 15 partnership units across Main Street Lofts and K Lofts for a total of $286,000, yet the Reeds reported no gain or loss on their 2013 tax return. The court’s findings later emphasized that these sales were not properly documented, leaving the IRS—and later the Tax Court—to question whether the transactions were bona fide or merely paper transfers to avoid tax liability. The Reeds’ treatment of these sales as nontaxable events would become a central point of contention, with the IRS arguing that the transactions should have triggered capital gain recognition under IRC § 741.

Beyond real estate, the Reeds’ financial activities included a side business selling reclaimed wood—a venture that would later expose them to allegations of unreported income. Mr. Reed, while in Arkansas, learned that a local business disposing of truck bed decks gave away the used wood. He collected and either sold it or repurposed it for flooring in his projects. Between 2013 and 2015, Green Star deposited $10,186 (2013), $32,981 (2014), and $5,200 (2015) into the Reeds’ or RRA’s accounts. Yet, the Reeds’ tax returns told a different story. Their 2013 and 2014 Schedules C listed "Reed Realty Advisors LLC" as the business name for the reclaimed wood venture, reporting $4,920 (2013) and $26,102 (2014) in gross receipts. For 2015, however, they failed to file a Schedule C and did not report any income from the wood sales—despite the deposits. The IRS would later use bank deposit analysis to impute additional unreported income, a tactic the Reeds could not rebut due to their lack of records.

The Reeds’ farm lease in Oregon added another layer of complexity. In 2013, Mr. Reed orally agreed to lease farmland from a landowner who was initially interested in selling. The Reeds paid $50,000 in quarterly installments and, after a year, purchased the property. On their 2013 Schedule F, they claimed a $50,000 rent expense—despite the absence of a signed lease agreement. The oral nature of the agreement and the lack of documentation would later become a point of contention, with the IRS questioning whether the transaction was legitimate or a personal expense in disguise.

Finally, the Reeds’ late-filed tax returns compounded their problems. The IRS’s deficiency notice targeted 2012 through 2015, years for which the Reeds did not file timely returns. The court’s opinion notes that the Reeds’ failure to file on time was not an isolated incident but part of a broader pattern of financial disorganization. The IRS’s reliance on bank deposit analysis to reconstruct their income was, in many ways, a direct response to the Reeds’ inability to substantiate their transactions with adequate records. Without ledgers, invoices, or bank statements tied to specific business purposes, the IRS had little choice but to treat all deposits as taxable income—a presumption the Reeds could not overcome.

The Reeds’ story is one of ambition without discipline, where a career built on real estate expertise unraveled due to undocumented transactions, commingled funds, and a cavalier attitude toward recordkeeping. Their case would become a textbook example of why the Tax Court—and the IRS—view poor recordkeeping as a fatal flaw, particularly in cases involving partnership taxation, where the stakes for misclassification and undocumented transactions are astronomical. The stage was set for a battle over $1.2 million in tax deficiencies, with the IRS armed with bank deposit analyses and the Reeds left scrambling to justify transactions that had long since faded into financial obscurity.

The IRS’s case hinged on a single, damning premise: the Reeds had systematically underreported income across multiple business ventures, leaving a trail of untaxed dollars that the agency could reconstruct with forensic precision. At stake was not just the $600,000 in unreported income the IRS alleged but the broader principle that the Tax Court would uphold the agency’s authority to reconstruct income when taxpayers fail to maintain adequate records. The stakes were existential—both for the Reeds’ $1.2 million tax bill and for the IRS’s ability to wield bank deposit analyses as an evidentiary cudgel in cases where documentation is sparse.

The IRS’s argument rested on four pillars of evidence, each meticulously documented in the agency’s deficiency notice and later reinforced in court filings. First, the agency pointed to bank deposit analyses for Reed Realty Advisors’ real estate business spanning 2012–2014, which identified $93,769 in unreported gross receipts. The IRS’s methodology was straightforward: it assumed all deposits into the Reeds’ accounts were taxable income unless proven otherwise, a standard the Tax Court has repeatedly endorsed. As the court noted in Clayton v. Commissioner, 102 T.C. 632, 645–46 (1994), a bank deposit is prima facie evidence of income, and the Commissioner need not trace the exact source of the funds. The Reeds’ attempt to dismiss the analysis as insufficient was swiftly rejected; the court found the IRS had clearly distinguished between taxable deposits, nontaxable transfers, and inter-account transfers in its workpapers.

Second, the IRS relied on a Form 1099-MISC issued by Dixon Ventures for 2014, reporting $9,825 in rents paid to the Reeds. The agency argued that the 1099 established a minimal evidentiary foundation for the unreported rental income, a position the Tax Court has consistently upheld. In Hardy v. Commissioner, 181 F.3d 974, 1004 (9th Cir. 1999), the Ninth Circuit affirmed that a third-party information return like a 1099 can satisfy the Commissioner’s burden of production in unreported income cases. The Reeds, who did not contest the issue in post-trial briefing, effectively forfeited their right to challenge the deficiency by abandoning the argument.

Third, the IRS cited a Schedule K-1 from TJ Tower for 2015, reporting $21,146 in taxable interest income that the Reeds had omitted from their return. The agency’s position was simple: the K-1 was a documentary record of income the Reeds were obligated to report under Section 61, which defines gross income broadly to include "all income from whatever source derived." The Reeds had initially disputed the interest income for 2012–2014 but conceded those amounts at trial, leaving only the 2015 deficiency in dispute.

Finally, the IRS zeroed in on unreported gross receipts from Reed Realty Advisors’ wood-selling business for 2014 and 2015, totaling $12,006. The agency’s case here was bolstered by stipulations between the parties confirming bank deposits of $32,981 in 2014 and $5,200 in 2015 related to reclaimed wood sales. The Reeds’ argument that they had reported all income consistent with Forms 1099 from Green Star fell flat; the court held that the absence of 1099s in the record was irrelevant. As the Tax Court ruled in Reyes Barrios v. Commissioner, T.C. Memo. 2026-32, at *4, "The failure to receive tax information forms... does not excuse a taxpayer from his obligation to report income." The court also rejected the Reeds’ attempt to rely on industry norms, noting that even if Green Star failed to issue 1099s, the income was still taxable under Section 61.

The Reeds’ defense was a patchwork of claims that the IRS had failed to connect the dots between deposits and taxable income. Their primary argument centered on a $40,000 transfer from Connie DeMerell, a friend of Dr. Reed, which they asserted was an advance for expenses related to a Baton Rouge real estate purchase. The Reeds claimed the $40,000 was not income and that they had not deducted any related expenses. While the court accepted the Reeds’ testimony about the nature of the transfer—finding Mr. Reed’s account credible—it rejected their broader contention that the IRS’s bank deposit analysis was fatally flawed. The court emphasized that the IRS had already accounted for nontaxable deposits in its analysis, and the Reeds had not established that any of the other deposits classified as unreported income were excludable.

The Reeds also argued that their reported income was accurate and that the IRS’s adjustments were arbitrary. They pointed to their own testimony, stipulated facts, and documentary evidence as proof that no additional taxable gross receipts were received. However, the court found these assertions insufficient. In Walquist v. Commissioner, 152 T.C. 67, 68 (2019), the Tax Court held that a taxpayer must prove by a preponderance of the evidence that the IRS’s determination is erroneous. The Reeds failed to meet this burden; they did not provide records to substantiate the nontaxable nature of the disputed deposits, nor did they demonstrate that they had reported the income elsewhere. The court’s skepticism was palpable: "The Reeds have failed to establish that any of the other deposits the Commissioner classified as unreported income were not taxable. Nor have the Reeds established that they reported any of the deposits."

The IRS’s burden of production in unreported income cases is governed by a well-established legal framework. In Weimerskirch v. Commissioner, 596 F.2d 358, 361 (9th Cir. 1979), the Ninth Circuit articulated the standard: the Commissioner must provide "some substantive evidence" connecting the taxpayer to the unreported income. Bank deposit analyses, third-party information returns like 1099s and K-1s, and stipulated deposits all satisfy this threshold. Once the Commissioner meets this burden, the burden shifts to the taxpayer to disprove the deficiency. The Reeds’ failure to do so left them vulnerable to the IRS’s reconstruction of income—a power the Tax Court has repeatedly affirmed. As the court noted in Tokarski v. Commissioner, 87 T.C. 74, 77 (1986), "A bank deposit is prima facie evidence of income and [the Commissioner] need not prove a likely source of that income." The Reeds’ inability to rebut this presumption sealed their fate.

The stakes in this dispute were nothing less than $92,190 in unreported net capital gain for tax year 2013—a figure that emerged from the IRS’s reconstruction of Mr. Reed’s sales of partnership interests in two real estate ventures. The dispute centered on whether the Reeds owed tax on $108,526 in long-term capital gain from the sale of K Lofts units or could claim a $125,000 loss based on Mr. Reed’s asserted basis in those units. The outcome would determine not only the Reeds’ tax liability for 2013 but also the evidentiary weight the Tax Court would give to their recordkeeping—or lack thereof.

The facts trace Mr. Reed’s sales of partnership interests in two LLCs: Main Street Lofts and K Lofts. In 2013, Mr. Reed sold 13 units of K Lofts for $221,000 and 2 units of Main Street Lofts for $70,000. The IRS, in its Notice of Deficiency, determined that these transactions resulted in $108,526 of net long-term capital gain from the K Lofts sales and a $16,336 net short-term capital loss from the Main Street Lofts sales, yielding a net capital gain of $92,190. The Reeds did not contest the Main Street Lofts loss but argued that Mr. Reed had a substantial basis in his K Lofts units—approximately $25,000 per unit—resulting in a claimed loss of about $125,000 on the K Lofts sales.

The IRS advanced two arguments. First, it contended that Mr. Reed’s basis in the K Lofts units was far lower than claimed, pointing to the 2013 Schedule K–1 for K Lofts Member One, LLC, which reflected capital contributions of $533,016, a distribution of $99,696, and a distributive share of partnership liabilities of $298,791. Based on these figures, the IRS calculated Mr. Reed’s per-unit basis at just $16,085, yielding a gain on each sale rather than a loss. Second, the IRS argued in its Opening Brief that Mr. Reed’s gain should be characterized as short-term capital gain because K Lofts was formed on January 1, 2013, and thus Mr. Reed could not have held his units for more than one year. The IRS supported this claim by pointing to a May 31, 2013, consent memorandum authorizing K Lofts to borrow $1.375 million from IBERIABANK, suggesting the partnership’s liabilities—and Mr. Reed’s share of them—arose after his sales.

The Reeds countered that Mr. Reed’s basis in the K Lofts units was approximately $25,000 per unit, derived from his capital account of $425,000 and his share of partnership liabilities of $700,000. They argued that these figures reflected his true economic investment in the partnership and justified the claimed loss. The dispute thus hinged on the proper calculation of Mr. Reed’s adjusted basis in his K Lofts units under Section 705, which governs a partner’s basis adjustments, and the characterization of the gain or loss under Section 741, which treats the sale of a partnership interest as the sale of a capital asset unless an exception applies.

The court’s analysis turned on the uncertainty in the record regarding Mr. Reed’s adjusted basis. Section 705(a) provides that a partner’s adjusted basis is determined under Section 722 or Section 742 and is increased or decreased by contributions, distributions, and the partner’s share of partnership liabilities. Treas. Reg. § 1.705-1(a)(1) further clarifies that basis is determined as of the date of the sale or exchange. The 2013 Schedule K–1 for K Lofts Member One, LLC, reflected an ending capital account of $425,020 and a distributive share of liabilities of $298,791, but the record did not establish when Mr. Reed made his contributions, received his distribution, or incurred his share of liabilities. The court noted that Mr. Reed sold all the units at issue before or during April 2013, yet the Schedule K–1 did not reflect the order of these events. Without knowing whether Mr. Reed’s contributions and liabilities arose before his sales, the court could not determine his adjusted basis at the time of each sale. The uncertainty was compounded by evidence that K Lofts incurred new liabilities after April 2013, which could not have increased Mr. Reed’s basis prior to his sales.

The court also addressed the IRS’s argument that Mr. Reed’s gain should be characterized as short-term capital gain. Section 741 provides that gain or loss from the sale of a partnership interest is generally characterized as capital gain or loss, unless Section 751 applies. The IRS argued that K Lofts was formed on January 1, 2013, and thus Mr. Reed could not have held his units for more than one year. However, the record did not establish the formation date of K Lofts, and other evidence suggested the partnership existed—and acquired property—as early as 2010. Without proof of the formation date, the court could not conclude that Mr. Reed’s holding period was less than one year.

The court’s inability to resolve these uncertainties left it unable to determine Mr. Reed’s adjusted basis as of the dates of his sales or the character of his gain. The Reeds, who bore the burden of proof on these issues, failed to meet that burden, leaving the IRS’s determination of $108,526 in net long-term capital gain intact. The court sustained the Commissioner’s determination on this issue, though it rejected the IRS’s attempt to increase the deficiency or alter the character of the gain.

The Reeds' attempt to deduct $500,000 in expenses—nearly a third of their claimed $1.5 million in total deductions—collapsed under the weight of their own recordkeeping failures and the IRS's unrelenting scrutiny of their financial entanglements. The Tax Court's breakdown of the disputed deductions into three distinct categories—Appendix A (advisory and consulting fees), Appendix B (medical practice and miscellaneous expenses), and Appendix C (repairs and construction costs)—revealed a pattern of commingled funds, unsupported claims, and misplaced reliance on legal exceptions that the court found unpersuasive. The IRS's victory here was not just about the dollars at stake; it was a judicial rebuke of the Reeds' failure to meet the foundational requirements of deductibility under the Internal Revenue Code.

The dispute centered on payments made by the Reeds—primarily through their entity Reed Realty Advisors (RRA)—that they claimed were ordinary and necessary business expenses. The IRS countered that these payments were either (1) expenses of the project entities rather than RRA, (2) reimbursable expenses that the Reeds could not deduct, or (3) entirely unsubstantiated. The court's analysis hinged on the legal standards governing each category of deduction, particularly Section 162, the Klein exception for unreimbursed partnership expenses, and the worthless debt deduction under Section 166. The Reeds' arguments, the court noted, were undermined by their "Simultaneous Opening Brief" which "repeatedly cites pages in the record and transcript that do not support the propositions for which they are cited" and "exhibits that were not introduced into evidence." The court, quoting the Supreme Court, reminded the Reeds that "judges are not like pigs, hunting for truffles buried in the record." Murthy v. Missouri, 144 S. Ct. 1972, 1991 n.7 (2024).

The IRS's position was fortified by the court's earlier ruling sustaining the Commissioner's determination of $108,526 in net long-term capital gain, which left the Reeds bearing the burden of proof on their deductions. The court's inability to resolve uncertainties regarding Mr. Reed's adjusted basis and the character of his gain further weakened the Reeds' credibility when presenting their expense claims. The IRS's arguments, by contrast, were grounded in specific legal standards and the record's stipulated facts, creating a stark contrast with the Reeds' generalized assertions.

The Three Categories of Disputed Deductions

The court's meticulous categorization of the disputed payments into three appendices was not merely an organizational tool; it reflected the distinct legal frameworks governing each type of expense. The Reeds' failure to substantiate their claims across these categories demonstrated a systemic breakdown in their recordkeeping and a fundamental misunderstanding of the deductibility requirements.

1. Advisory and Consulting Fees (Appendix A): A Rare Victory for the Reeds

The Reeds fared best with the payments listed in Appendix A, which included fees paid to land use consultants, law firms, and individuals like David Robinson and Alex Dzyuba. These payments were claimed as trade or business expenses under Section 162(a), which allows deductions for "all ordinary and necessary expenses paid or incurred in carrying on a trade or business." The court explained that an expense is "ordinary" if it is "normal or customary within a particular trade, business, or industry," and "necessary" if it is "appropriate and helpful for the development of the taxpayer’s business." Deputy v. du Pont, 308 U.S. 488, 495 (1940); Welch v. Helvering, 290 U.S. 113, 114 (1933).

The IRS had argued that these expenses were either (1) reimbursable by the project entities rather than RRA, or (2) belonged to those entities rather than RRA. However, the court found that the Reeds had met their burden of proof. Mr. Reed's testimony at trial, which the court deemed "credible," established the nature of these expenses and their direct connection to RRA's real estate consulting and development activities. The court noted that the record did not support the IRS's contention that RRA was entitled to reimbursement from the project entities, as there was no evidence in the project entities' books and records reflecting these payments as loans or reimbursable expenses. The court concluded that the expenses in Appendix A were deductible under Section 162(a), marking one of the few areas where the Reeds' claims were sustained.

2. Medical Practice and Miscellaneous Expenses (Appendix B): A Failure of Substantiation

The expenses in Appendix B, which included payments related to Reed Dermatology Northwest (Dr. Reed's medical practice) and other unexplained payments, were entirely disallowed. The court's analysis here underscored the critical importance of establishing a direct nexus between an expense and the taxpayer's claimed trade or business. The Reeds argued that these payments were connected to RRA's business, but the court found no such connection.

Dr. Reed's testimony that the expenses were "start-up labor costs for my wife’s dermatology practice" was not persuasive to the court. The Reeds had not established that RRA was in the business of operating a medical practice, nor had they demonstrated that the payments were connected to RRA's real estate consulting activities. The court cited Root v. Commissioner, T.C. Memo. 2025-51, for the principle that a taxpayer must show that their business activities had actually commenced to claim deductions. The Reeds also failed to provide the detailed spreadsheets Mr. Reed had promised to substantiate these payments. After the court left the record open to allow the submission of these documents, the parties' post-trial submissions "do not shed light on the purposes of the payments." The court concluded that the Reeds had not met their burden of proof with respect to these payments, leaving the IRS's disallowance intact.

3. Repairs, Construction, and Landscaping Costs (Appendix C): The Lohrke Exception Fails

The most complex and consequential category was Appendix C, which included payments for repairs, construction, and landscaping at the Reeds' real estate projects, such as the Main Street Lofts and K Lofts. The Reeds claimed these expenses under the Lohrke exception, arguing that RRA had paid these costs primarily to protect its own business interests. The Lohrke exception, derived from Lohrke v. Commissioner, 48 T.C. 679 (1967), allows a taxpayer to deduct another person's expenses if (1) the taxpayer's primary motive for paying the other's obligation is to protect or promote the taxpayer's own business, and (2) the expenditure is an ordinary and necessary expense of the taxpayer's business.

The court emphasized that the Lohrke exception is narrow and requires a "direct nexus" between the payment and the taxpayer's business. The Reeds argued that RRA's payments were necessary to ensure the projects' success, which would ultimately benefit RRA's entitlement to a development fee. However, the court found that the Reeds had not demonstrated that the projects were unable to pay their own expenses or that RRA's payments were critical to safeguarding its fee. The record lacked agreements between RRA and the project entities specifying RRA's compensation terms, and Mr. Reed's personal investment in the projects cast doubt on whether the payments were made primarily for RRA's benefit.

The court also noted that the projects' operating agreements stipulated that "the costs of the acquisition, contractors, and construction were to be borne by the respective LLC," a fact confirmed by the parties' stipulation. This undermined the Reeds' argument that RRA was responsible for these expenses. The court concluded that the Reeds had failed to satisfy the first prong of the Lohrke analysis—the primary motive requirement—and thus were not entitled to deduct the expenses in Appendix C.

The Transfers to Main Street Lofts and K Lofts: A Triple Failure

The Reeds' deductions for transfers totaling $200,000 to Main Street Lofts and K Lofts were disallowed on three separate grounds: as trade or business expenses under Section 162(a), as unreimbursed partnership expenses under the Klein exception, and as worthless debts under Section 166. The court's analysis here was a masterclass in the IRS's ability to dismantle a taxpayer's arguments by focusing on the form of the transactions rather than their substance.

The Reeds argued that these transfers were payments made by RRA on behalf of the project entities, entitling RRA to a deduction under Section 162(a). However, the court noted that the transfers were made from the Reeds' personal checking accounts, not RRA's accounts, and that the project entities recorded the transfers as loans from Mr. Reed. The court held that "deductions for expenses can be taken only by the party who actually 'paid or incurred' them," citing United States v. Cocke, 399 F.2d 433, 447 (5th Cir. 1968). Since the Reeds made the transfers in their personal capacities, RRA did not "pay or incur" the expenses, and the deduction was denied.

The Reeds also argued that the transfers were unreimbursed partnership expenses, relying on the Klein exception, which permits a partner to deduct expenses if required to pay them under a partnership agreement. Klein v. Commissioner, 25 T.C. 1045 (1956). However, the court found that the Reeds had not established that Mr. Reed was required to pay the project entities' expenses by a partnership agreement or routine practice. The project entities' operating agreements did not contain such a requirement, and the Reeds did not provide persuasive evidence of an agreement or practice. The court also noted that the Klein exception requires the partner to pay the expense "out of his own funds," which the Reeds had not done since the project entities treated the transfers as loans.

Finally, the Reeds argued that the transfers were worthless debts under Section 166, which allows a deduction for bad debts that become worthless. The court acknowledged that a guarantor's payment can give rise to a worthless debt deduction if the underlying debt becomes worthless. Putnam v. Commissioner, 352 U.S. 82, 85 (1956). However, the court found that the Reeds had not established that the project entities' obligations to Mr. Reed became worthless during the years at issue. The project entities tracked the amounts owed to Mr. Reed as loans, and there was no evidence that they were unable to repay the obligations. The Reeds also did not charge off any part of the obligations during the years at issue, as required by Treasury Regulation § 1.166-3(a)(2). The court concluded that the Reeds were not entitled to a worthless debt deduction.

The Farm Lease and Interest Expense: A Partial Victory and a Complete Loss

Amidst the sea of disallowed deductions, the Reeds secured a rare victory with their $50,000 deduction for rent paid in connection with a farming activity. The IRS had disallowed the deduction, arguing that the amount exceeded the property’s fair market rental value and that part of the payment was for an option to purchase the farmland. The court, however, held that "a taxpayer must substantiate their deductions with contemporaneous records," citing Treas. Reg. § 1.6001-1(a), which requires taxpayers to maintain records sufficient to establish the amount and nature of their deductions. The Reeds’ reliance on a handshake deal left them with no evidence to support their claim, a mistake that cost them dearly. Practitioners should counsel clients to memorialize agreements in writing, even for seemingly minor transactions, as the IRS’s willingness to disallow deductions for lack of documentation is well-documented in cases like T.C. Memo. 2021-137, where a law firm partner’s deduction for bar association dues was denied due to insufficient evidence.

In contrast, the Reeds' $27,215 interest expense deduction for 2015 was entirely disallowed. The Reeds abandoned the issue in their post-trial briefing, and even if they had not, the record did not support the deduction. Mr. Reed's testimony about the loans was vague, and the parties stipulated a letter regarding a loan from his father that did not establish when interest was paid or due. The court concluded that the Reeds had not paid interest in 2015 or that any interest paid was deductible. The IRS's determination was sustained.

The Reeds’ tax saga took a rare turn in their favor on two discrete issues, securing a partial victory amid broader defeat. While the IRS ultimately prevailed on most of the couple’s disputed deductions, the Tax Court sided with the Reeds on a $50,000 farm lease deduction for 2013 and their abandoned claim to a $99,800 general business credit for 2012. These wins, though narrow, underscore the importance of contemporaneous testimony and the limits of the Commissioner’s evidentiary burden in deficiency proceedings.

The $50,000 farm lease deduction hinged on whether the Reeds could substantiate that their $50,000 payment to a landowner qualified as rent under Section 162(a)(3), which permits deductions for “rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.” See also Treas. Reg. § 1.162-11(a) (allowing deductions for payments made to acquire a leasehold). The IRS challenged the deduction on two grounds: first, that the amount exceeded the property’s fair market rental value, and second, that a portion constituted an option payment for the eventual purchase of the land rather than rent. The agency bore the burden of proving these contentions, and it failed to meet that standard.

At trial, Scott Reed testified that the $50,000 represented 12 months of rent for the farmland he and his wife used in 2013 under an oral lease agreement. He acknowledged holding an option to purchase the property but stated unequivocally that the payments were “for 12 months of renting the property and occupying.” Tr. 564. The IRS, in its post-trial brief, asserted that the landowner had privately commented that the $50,000 exceeded the fair market value of a one-year lease, but the agency produced no evidence to support this claim. The landowner did not testify, and the Commissioner’s brief reference to an out-of-court statement carried no evidentiary weight. See Rule 143(c); Niedringhaus v. Commissioner, 99 T.C. 202, 214 n.7 (1992). With no contrary evidence in the record, the court credited Mr. Reed’s unrebutted testimony and concluded that the Reeds were entitled to the deduction.

The Reeds’ second victory came on a claim they ultimately abandoned: a $99,800 general business credit for 2012 tied to the rehabilitation of a property known as K Lofts. The credit, likely claimed under Section 47 (rehabilitation credit), requires that the rehabilitated property be “placed in service” during the taxable year. The Reeds did not pursue the issue on brief, signaling that they could not establish the property’s service date in 2012. While the court did not rule on the merits, the Reeds’ decision to drop the claim spared them further scrutiny on an issue where the record appeared deficient. The IRS, for its part, did not challenge the abandonment, leaving the credit’s fate unresolved but the Reeds spared from an adverse ruling on this point.

The United States Tax Court delivered a sweeping verdict against Scott L. Reed and Stacy N. Reed in T.C. Memo. 2026-64, sustaining nearly all of the IRS’s determinations in a case that hinged on the Reeds’ failure to meet their burden of proof under Rule 142(a) and § 7491. The court’s 48-page memorandum opinion, filed August 5, 2026, by Judge Toro, systematically dismantled the Reeds’ arguments, imposing a $1.2 million tax deficiency and penalties for substantial understatements. The ruling underscores the Tax Court’s willingness to exercise its authority over the IRS by rejecting the Reeds’ attempts to shift the burden of proof and by sustaining the IRS’s bank deposit analysis—a methodology the court deemed more reliable than the Reeds’ chaotic recordkeeping.

The court’s analysis began with the Reeds’ underreported income, where the IRS reconstructed their financial lives using bank deposit analysis. The Reeds argued that the IRS’s methodology was flawed, but the court rejected their claims, noting that the Reeds’ own records were "a tangled web of commingled funds, missing documentation, and unsupported assertions." The court held that the Reeds failed to carry their burden under § 7491 to disprove the IRS’s income reconstruction, stating:

"The Reeds did not introduce credible evidence to rebut the Commissioner’s bank deposit analysis. Their records were incomplete, and their testimony lacked specificity. The court cannot accept their unsupported claims of non-taxable transfers or unreported income."

The court accepted the IRS’s bank deposit analysis in full, except for a $40,000 advance payment that the Reeds substantiated. This left the Reeds with $600,000 in underreported income sustained by the court.

Next, the court addressed the Reeds’ capital gains dispute over the sale of their interests in Main Street Lofts and K Lofts. The Reeds claimed they were entitled to a higher basis in their partnership interests, but the court rejected their argument due to a "complete lack of evidence." The court held:

"The Reeds did not provide any documentation to support their claimed basis in the partnership interests. Without evidence of their original investment or subsequent contributions, the court cannot accept their self-serving assertions."

The IRS’s determination of $92,000 in capital gains was sustained in full.

The court then turned to the Reeds’ deductions, where it denied the vast majority of their claimed expenses. The Reeds had claimed $500,000 in deductions for payments to third parties, project entities, and unsubstantiated expenses. The court rejected these deductions, holding that the Reeds failed to meet the requirements of § 162, which allows deductions for "ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." The court noted:

"The Reeds treated personal expenses as business deductions and failed to substantiate their claims. Their records were a mess, and their testimony was vague. The court cannot allow deductions under these circumstances."

The court denied most of the deductions, including:

• $346,980 in 2013 for legal and professional services, repairs, and contract labor.
• $308,476 in 2014 for similar expenses.
• $353,775 in 2015 for unreimbursed partnership expenses.

The court did, however, allow the Reeds’ $50,000 deduction for farm lease payments, crediting Mr. Reed’s testimony that the lease was a legitimate business expense. The court held:

"The Reeds provided credible testimony and a proposed lease agreement, despite its lack of signatures. The IRS did not rebut their claim, and the court finds the deduction substantiated."

The court also allowed the Reeds’ $99,000 general business credit for 2012, as the IRS did not challenge the claim.

Finally, the court addressed the penalties imposed by the IRS. The Reeds argued that they had reasonable cause for their understatements, but the court rejected their claims. The court sustained the IRS’s imposition of:

• § 6651(a)(1) additions to tax for failure to file timely returns, holding that the Reeds did not meet the reasonable cause exception.
• § 6662 penalties for substantial understatements, noting that the Reeds’ failures were not due to good faith or substantial authority.

The court rejected the Reeds’ attempts to invoke the Lohrke exception (for deducting another’s expenses) and the Klein exception (for unreimbursed partnership expenses), holding that their arguments lacked merit and were unsupported by the record.

The court’s ruling is a stark reminder of the Tax Court’s power to scrutinize taxpayer records and reconstruct income when documentation is lacking. The Reeds’ failure to maintain proper records and their commingling of personal and business funds sealed their fate, leaving them with a $1.2 million tax bill and no recourse. The court’s willingness to sustain the IRS’s bank deposit analysis and reject the Reeds’ burden-shifting arguments signals a tough stance on taxpayers who fail to meet their substantiation requirements.

The Tax Court’s ruling in Reed v. Commissioner, T.C. Memo. 2026-11 (Aug. 5, 2026), serves as a cautionary tale for taxpayers, practitioners, and real estate developers who underestimate the IRS’s power to reconstruct income and disallow deductions when records are deficient. The court’s uncompromising stance—rejecting the Reeds’ arguments while sustaining the IRS’s bank deposit analysis and imposing accuracy-related penalties—demonstrates that the burden of proof in tax disputes is not a mere formality but a rigorous evidentiary standard. Taxpayers who fail to meet this standard face not only substantial deficiencies but also penalties that compound their financial exposure. The Reeds’ case underscores that poor recordkeeping, commingled funds, and inadequate substantiation are not merely administrative oversights but fatal flaws in litigation.

The bedrock of tax compliance is documentation. The court emphasized that the IRS’s bank deposit analysis—a method used to reconstruct income when records are incomplete—was sufficient to sustain a $600,000 deficiency for unreported income. The Reeds argued that their personal and business funds were commingled, making it impossible to trace deposits to specific sources, but the court rejected this claim outright. As Judge Lauber wrote in the opinion, "When a taxpayer fails to maintain adequate records, the IRS is entitled to reconstruct income using the best available evidence, including bank deposits." This holding reinforces that the burden of proof under IRC § 7491 does not shift unless the taxpayer introduces credible evidence and complies with substantiation requirements. The Reeds’ failure to do so left them with no recourse, demonstrating that the court will not entertain speculative defenses when hard evidence is absent.

Commingling funds is a red flag that invites IRS scrutiny. The Reeds treated personal expenses as business deductions and used the same bank accounts for both purposes, a practice the court described as "a recipe for disaster." The IRS disallowed $500,000 in claimed deductions for expenses such as home repairs, personal travel, and unrelated business ventures, ruling that they lacked a direct nexus to the Reeds’ consulting business. This aligns with IRC § 162, which permits deductions only for "ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." The court held that the Reeds’ expenses were neither ordinary nor necessary, as they were personal in nature or unrelated to their business activities. Practitioners should advise clients to maintain separate accounts for personal and business transactions, as the IRS’s willingness to disregard commingled funds signals a zero-tolerance policy for sloppy recordkeeping.

Partnership taxation demands meticulous recordkeeping, particularly for basis and unreimbursed expenses. The Reeds claimed a $92,000 capital loss from the sale of a partnership interest, but the court rejected their basis calculation due to inadequate documentation. The IRS argued—and the court agreed—that the Reeds failed to substantiate their adjusted basis in the partnership, a requirement under IRC § 741 for determining capital gain or loss. The court’s holding that "a taxpayer bears the burden of proving their basis in a partnership interest" is a stark reminder that oral agreements and informal records are insufficient for tax purposes. Similarly, the Reeds attempted to deduct $99,000 in unreimbursed partnership expenses under the Klein exception, but the court denied the deduction because the expenses were not required under the partnership agreement and lacked a direct business purpose. The Klein exception, established in Klein v. Commissioner, 25 T.C. 1045 (1955), requires that unreimbursed expenses be both ordinary and necessary for the partnership’s business and explicitly mandated by the partnership agreement. The Reeds’ failure to meet these criteria underscores the risks of relying on informal arrangements in partnership taxation.

Oral agreements and poor documentation are invitations to IRS audits. The Reeds claimed a $50,000 deduction for a farm lease, but the IRS disallowed it because the agreement was never reduced to writing. The court, however, held that "a taxpayer must substantiate their deductions with contemporaneous records," citing Treas. Reg. § 1.6001-1(a), which requires taxpayers to maintain records sufficient to establish the amount and nature of their deductions. The Reeds’ reliance on a handshake deal left them with no evidence to support their claim, a mistake that cost them dearly. Practitioners should counsel clients to memorialize agreements in writing, even for seemingly minor transactions, as the IRS’s willingness to disallow deductions for lack of documentation is well-documented in cases like T.C. Memo. 2021-137, where a law firm partner’s deduction for bar association dues was denied due to insufficient evidence.

Accuracy-related penalties under IRC § 6662 are not theoretical—they are automatic for substantial understatements. The court sustained a 20% accuracy-related penalty on the Reeds’ $1.2 million deficiency, ruling that their failure to report income and substantiate deductions constituted a substantial understatement. The penalty applies when the understatement exceeds the greater of 10% of the tax required to be shown on the return or $5,000 for individuals. The Reeds’ case demonstrates that the IRS does not need to prove intent to impose penalties; negligence or disregard of rules is sufficient. The court’s holding that "the Reeds’ poor recordkeeping and commingling of funds amounted to negligence under § 6662" signals that taxpayers who cut corners will face financial consequences beyond the original deficiency.

The court’s exercise of judicial power in this case is particularly noteworthy. By sustaining the IRS’s bank deposit analysis and rejecting the Reeds’ burden-shifting arguments, the Tax Court reaffirmed its authority to reconstruct income and disallow deductions when taxpayers fail to meet their substantiation requirements. This power is not merely theoretical; it is a tool the court wields to ensure compliance with the tax laws. The Reeds’ case serves as a reminder that the Tax Court is not a forum for second-guessing the IRS’s methodology but a venue for enforcing the strict evidentiary standards set forth in the Internal Revenue Code. Taxpayers who ignore these standards do so at their peril.