                        T.C. Memo. 2004-134



                      UNITED STATES TAX COURT



         MICHAEL R. AND HELEN G. JOSEPH, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10840-02.           Filed June 8, 2004.



     Joe Alfred Izen, Jr., for petitioners.

     David Lau, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     SWIFT, Judge:   Respondent determined deficiencies in

petitioners’ Federal income taxes as follows:


                       Year       Deficiency
                       1998        $   801
                       1999         32,509
                                - 2 -
     The issue for decision is whether petitioners are entitled

to claimed capital loss carryover deductions relating to a 1995

purported sale of residential property located in Honolulu,

Hawaii.

     Unless otherwise specified, references to petitioner in the

singular are to petitioner Michael R. Joseph, and all section

references are to the Internal Revenue Code in effect for the

years in issue.


                           FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

     At the time the petition was filed, petitioners resided in

Honolulu, Hawaii.

     From 1987 to 1992, petitioner practiced as a chiropractor in

California but once a month commuted to Hawaii as a consultant

for insurance companies.    In 1992, petitioners sold their

California residence, and petitioner moved his family and his

chiropractic practice to Hawaii.

     On December 21, 1992, with proceeds from the sale of their

California residence, petitioners purchased a residential lot

located at 595 Kahiau Loop, Honolulu, Hawaii (the property), for

a purchase price of $662,608.

     At the time of purchase, petitioners intended to construct

on the property their personal residence.     The property has

unobstructed views of Diamond Head and the Pacific Ocean, with
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views of the sunrise, sunset, city of Honolulu, and the

mountains.

     Shortly after purchasing the property, petitioners hired an

engineer to complete a soil report.   Petitioners then hired a

prestigious architect in Hawaii to draw up the plans for

petitioners’ residence on the property.   Thereafter, petitioners

solicited from contractors bids to prepare the foundation for the

residence on the property.

     In August of 1994, petitioners hired a contractor to

construct petitioners’ residence on the property.

     By October of 1994, however, petitioners’ relationship with

the contractor had deteriorated to the point where petitioners

terminated the contract with the contractor.   The contractor then

threatened to sue petitioners and to “steal” the property from

them.

     Petitioners were advised by a business consultant to

transfer the property to a trust that the consultant had

established (the Trust) in order to make it more difficult for

petitioners’ former contractor to carry through with his threat

to “steal” the property from petitioners.
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     On March 7, 1995, petitioners transferred1 the property to

the Trust for a stated sale price of $300,000.     Petitioners

received the $300,000, the ultimate source of which, however, is

not established in the record.    Petitioners deposited the

$300,000 into their personal bank account.

     Prior to transferring the property to the Trust, petitioners

did not attempt to list the property for sale with a realtor or

otherwise attempt to market or to sell the property.

     With the transfer of the property to the Trust, petitioners

retained an option to repurchase the property for an unstated

amount, which option they recorded.      Petitioners purportedly paid

the Trust $100 for the option.

     Petitioners also transferred to the Trust two building

permits that had been issued to petitioners on October 18, 1993,

and February 1, 1995, by the city and county of Honolulu,

authorizing construction of petitioners’ residence on the

property.   Architectural plans and drawings for the residence,

soil reports, and other reports also were transferred to the

Trust.

     Between March of 1995 and April of 1996, approximately

$600,000 was spent on the construction of a residence on the


     1
       The use in our Findings of Fact of the words “transfer”
and “repurchase” (and other forms thereof) is not intended to
constitute findings as to the true nature of the transactions
between petitioners and the Trust.
                                 - 5 -
property.    The ultimate source of the $600,000 spent on the

residence, however, is not established in the record.    The

residence was completed sometime in 1996.    Shortly after

completion, petitioners moved into the residence.

     On April 22, 1996, when the contractor was no longer viewed

as a threat, for a stated price of $500,000, petitioners

exercised the option to repurchase the property and the completed

residence.    Petitioners, however, paid no money to the Trust at

the closing of this repurchase, nor in later years through the

time of trial.

     Prior to transferring the property back to petitioners, the

Trust did not attempt to list the property for sale with a

realtor or otherwise attempt to market or to sell the property.

     From 1996 to the time of trial, petitioners have lived in

the residence on the property.

     From 1992 to 1996, petitioners employed a certified public

accountant to prepare petitioners’ Federal income tax returns and

to give petitioners tax advice.

     On Schedule D, Capital Gains and Losses, attached to their

1995 joint Federal income tax return, petitioners reported a

capital loss of $598,059 relating to the purported 1995 sale of

the property by petitioners to the Trust, $3,000 of which was

applied to offset petitioners’ ordinary income and $4,033 of

which was applied to offset petitioners’ capital gain for 1995,
                               - 6 -
and $5,854 of which was applied as a carryover loss deduction to

offset petitioners’ ordinary income and/or capital gain for 1996

and/or for 1997.

     On their 1998 and 1999 joint Federal income tax returns,

petitioners claimed a capital loss carryover of $585,172 relating

to the purported 1995 sale of the property by petitioners to the

Trust, $3,000 of which was applied to offset petitioners’

ordinary income for each of 1998 and 1999 and $137,544 of which

was applied to offset petitioners’ capital gain for 1999.

     On audit of petitioners for 1998 and 1999, respondent

determined that the transfer of the property by petitioners to

the Trust constituted a sham transaction and that no actual loss

was realized by petitioners.   Alternatively, respondent

determined that even if petitioners transferred the property to

the Trust, the property constituted a personal asset of

petitioners with respect to which no capital loss carryover

deductions for 1998 and 1999 were allowable.2




     2
       The record herein does not indicate whether respondent
disallowed the capital loss deductions claimed by petitioners for
1995, 1996, and 1997 and whether respondent determined a
deficiency against petitioners for those years relating to the
purported 1995 sale of the property by petitioners to the Trust.
                                 - 7 -
                              OPINION

     We address only respondent’s alternative ground for

disallowing petitioners’ claimed capital loss carryover

deductions for 1998 and 1999.3

     Under section 165(c)(2) an individual taxpayer is allowed a

loss deduction where a loss is incurred in a transaction entered

into for profit.   The purchase of a personal residence generally

is not considered a transaction entered into for profit.

     The regulations under section 165 provide:   “A loss

sustained on the sale of residential property purchased or

constructed by the taxpayer for use as his personal residence and

so used by him up to the time of the sale is not deductible under

section 165(a).”   Sec. 1.165-9(a), Income Tax Regs.

     The regulations also provide that in order to be allowed a

loss on the sale of property, which at an earlier time was used

as a personal residence, a taxpayer must show that the taxpayer’s

purpose for owning the residence changed and that the new purpose

was for the production of income.


     If property purchased or constructed by the taxpayer for use
     as his personal residence is, prior to its sale, rented or
     otherwise appropriated to income-producing purposes and is
     used for such purposes up to the time of its sale, a loss
     sustained on the sale of the property shall be allowed as a
     deduction under section 165(a). [Sec. 1.165-9(b)(1), Income
     Tax Regs.]

     3
       Petitioners do not assert that the burden of proof in this
case should shift to respondent under sec. 7491.
                                 - 8 -

     Although inconsistent with previous statements, including

their testimony at trial, petitioners now argue that in 1992 they

purchased the property with the intent to build a residence

thereon not for them to live in but for them to resell for a

profit.

     Respondent argues that the property at all relevant times

constituted a personal asset of petitioners and was not held for

resale and, therefore, that the purported sale of the property to

the Trust does not give rise to an allowable capital loss and

that the claimed capital loss carryover deductions for 1998 and

1999 were properly disallowed.

     In Jones v. Commissioner, 152 F.2d 392, 393 (9th Cir. 1945),

a capital loss deduction was disallowed relating to the sale of

property on which the taxpayers intended to build their personal

residence.   The taxpayers in Jones never lived on the property.

Instead, they built their residence elsewhere and, after making

extensive improvements to the property, they sold it at a loss.

See also Guffey v. United States, 339 F.2d 759 (9th Cir. 1964).

     Petitioners attempt to distinguish Jones.   Petitioners argue

that Jones does not apply to losses claimed under section 165

because Jones was decided prior to enactment of section 165 and

the regulations thereunder.   Jones however involved section 23 of

the Internal Revenue Code of 1939, the predecessor to section

165, which limited the deductibility of losses of individuals to
                                 - 9 -
the same circumstances outlined in current section 165.     See

secs. 23(e), I.R.C. 1939, 165(c).

     The regulations promulgated under section 23 of the Internal

Revenue Code of 1939 are virtually identical to the current

regulations.   They provided:   “A loss on the sale of residential

property purchased or constructed by the taxpayer for use as his

personal residence and so used by him up to the time of the sale

is not deductible.”   Sec. 29.23(e)-1, Regs. 111 (1943).

     Petitioners argue that because they did not live in the

residence on the property before the purported sale to the Trust,

the claimed loss should be allowed.      The taxpayers in Jones v.

Commissioner, supra, never lived on the property, and the Court

of Appeals for the Ninth Circuit ruled that no loss was

allowable.

     Petitioners also argue that Jones is distinguishable because

the taxpayers in Jones did not purchase the property with the

intent to sell it at a profit.    As stated, petitioners herein

stipulated that they intended to construct on the property “their

personal residence”, and petitioner testified that petitioners

were attracted to the property because they were “looking for a

house in Hawaii to live in.”    Clearly, petitioners purchased the

property with the intent to build thereon their personal

residence.
                              - 10 -
     In effect, petitioners are arguing that between the time

they purchased the property and the time they purportedly

transferred the property to the Trust, their intent for holding

the property changed.   The evidence does not establish any such

change in petitioners’ intent.   The property was never rented nor

otherwise changed by petitioners to income-producing property.

See, e.g., Newbre v. Commissioner, T.C. Memo. 1971-165.

     The stated purpose for the purported 1995 sale of the

property by petitioners to the Trust was to prevent petitioners’

former contractor from obtaining the property on which

petitioners still intended to build their personal residence.

     Petitioners’ intent to build their personal residence on the

property did not change at any time between petitioners’ 1992

purchase of the property and petitioners’ purported 1995 sale to

the Trust, or thereafter.

     Petitioners are not entitled to the capital loss carryover

deductions claimed for 1998 and 1999.

     To reflect the foregoing,

                                        Decision will be entered

                                 for respondent.
