                          T.C. Memo. 2011-225



                      UNITED STATES TAX COURT



        ROVAKAT, LLC, A PARTNERSHIP, SHANT S. HOVNANIAN,
                TAX MATTERS PARTNER, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3251-09.              Filed September 20, 2011.



     William R. Rankin, for petitioner.

     Laurie A. Nasky and Justin D. Scheid, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:   This case is a partnership-level proceeding

subject to the unified audit and litigation procedures of the Tax

Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248,

sec. 402, 96 Stat. 648.    Shant S. Hovnanian (Mr. Hovnanian), as

the tax matters partner of Rovakat, LLC (Rovakat), petitioned the
                                 -2-

Court to readjust partnership items that respondent adjusted for

Rovakat’s 2002 through 2004 taxable years.     See sec. 6226(a).1

Respondent’s principal adjustment was to disallow Rovakat’s claim

to section 988 ordinary losses of $130,766 for 2002, $890,485 for

2003, and $2,479,991 for 2004.   These losses stem from Rovakat’s

receipt of $34,185 in Swiss francs (francs) that, Mr. Hovnanian

claimed, carried with them a $5,805,000 tax basis.     Respondent

determined that the claimed losses are not allowed because Mr.

Hovnanian failed to establish Rovakat’s basis in the francs.

Respondent determined alternatively that the claimed losses are

not allowed because the transaction underlying Rovakat’s receipt

of the francs (francs transaction) lacked economic substance.       We

agree with respondent on both points.2

     We also decide the following secondary issues:     (1) Whether

Rovakat omitted income of $650,000 and $90,443 for 2002 and 2003,

respectively.   We hold it omitted income of $593,125 for 2002;

(2) whether the period of limitations for assessment has expired

as to Rovakat’s 2002 taxable year.     We hold it has not;

(3) whether $593,125 and $943,192 of Rovakat’s income for 2002

and 2003, respectively, is self-employment income.     We hold it


     1
      Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code (Code), and Rule
references are to the Tax Court Rules of Practice and Procedure.
Some dollar amounts are rounded.
     2
      Respondent also determined that the losses were not allowed
for other reasons. We do not address any of those reasons.
                                  -3-

is; (4) whether Rovakat may deduct “other expenses” of $63,964

and $352,663 for 2003 and 2004, respectively.    We hold it may

not; (5) whether the 40-percent accuracy-related penalty under

section 6662(a) and (h) for gross valuation misstatement applies

to any underpayment of tax attributable to the reporting of the

losses of $130,766 for 2002, $890,485 for 2003, and $2,479,991

for 2004.   We hold it does; and (6) whether a 20-percent

accuracy-related penalty under section 6662(a) and (b)(1), (2),

or (3) for negligence or disregard of rules or regulations,

substantial understatement of income tax, or substantial

valuation misstatement, respectively, applies to any underpayment

of tax attributable to the omitted income for 2002 and the

disallowed deductions for 2003 and 2004.    We hold it does.

                         FINDINGS OF FACT

I.   Preliminaries

      The parties filed with the Court numerous stipulations of

fact and accompanying exhibits.    The Court also deemed some facts

and accompanying exhibits stipulated pursuant to Rule 91(f).3

The stipulated facts, including those deemed established, and the

accompanying exhibits are incorporated herein by this reference.

We find the stipulated facts accordingly.




      3
      We concluded that the deemed facts and documents were
relevant to this case, and Mr. Hovnanian failed to show why the
matters therein should not be deemed admitted. See Rule 91(f).
                                   -4-

II.   Mr. Valdez

      A.   Background

      Lance O. Valdez (Mr. Valdez) is a tax attorney who practiced

law through his wholly owned professional corporation, Lance O.

Valdez & Associates, P.C. (LOVA).        He also is a financial adviser

who provided investment advisory services primarily through two

other entities that he controlled, LVCM, Ltd. (Limited), and

Lance Valdez Tax Management.

      As part of his investment advisory services, Mr. Valdez

structured and marketed tax-shelter transactions which generated

for U.S. taxpayers superficial Federal income tax losses greatly

disproportionate to economic outlay in the activities underlying

those losses.      For the most part, Mr. Valdez designed and

implemented these transactions, and he created the transaction

documents effecting their implementation.       The documents were

generally the same as to each transaction, except for the names

of the parties to the transaction and the amounts involved.

      B.   Transactions Promoted

      Mr. Valdez promoted his transactions as “investments”.

While the transactions varied according to the entities,

taxpayers, and assets involved, the transactions generally

involved foreign property with significant built-in losses

incurred by a foreign person not subject to U.S. tax, and used

the same three steps.
                                 -5-

     As the first step in the transaction, a foreign entity,

pursuant to an agreement with Mr. Valdez in which he agreed to

pay the foreign entity a fee, transferred the built-in loss

property with its purportedly high basis and a low fair market

value (distressed assets) to a domestic partnership in exchange

for an interest in the partnership.     Second, the foreign entity

sold a significant portion of its interest in the partnership to

a U.S. taxpayer who was one of Mr. Valdez’s “investors”.    Third,

the partnership disposed of the distressed assets to formally

trigger the built-in losses claimed to continue to inhere in the

distressed assets, with those “losses” allocated to the U.S.

taxpayer to offset the taxpayer’s unrelated income otherwise

subject to Federal income tax.

     In total, Mr. Valdez’s transactions caused over $147 million

in “losses” to be allocated among his “investors” who did not

actually realize economic losses of anywhere near the amounts

allocated and who had minimal economic outlays in relation to the

allocated “losses”.

     C.   IRS Investigates Mr. Valdez

     The Internal Revenue Service (IRS) investigated Mr. Valdez,

LOVA, and Lance Valdez Tax Management as organizers, sellers, or

promoters of potentially abusive tax shelters.    That

investigation led the IRS to examine Rovakat’s 2002 through 2004
                                     -6-

Forms 1065, U.S. Return of Partnership Income (2002 return, 2003

return, and 2004 return, respectively).

III.       Rovakat

       A.     Formation of Rovakat

       International Capital Partners, LP (ICP), and International

Strategic Partners, LLC (ISP), formed Rovakat on June 6, 2002, as

a Delaware limited liability company.4       Rovakat uses the cash

receipts and disbursements method of accounting for Federal tax

purposes, and Rovakat reports its income and expenses on the

basis of the calendar year.       Rovakat’s mailing address and

registered office were in the third judicial circuit of the

United States when the petition was filed.

       B.     ICP

               1.    Overview

       Mosafa, Ltd. (Mosafa), and Credicom N.V. (CNV) formed ICP as

a Cayman Islands limited partnership on May 7, 2001.       ICP

conducted its activities and maintained its books and records in

U.S. dollars.        Mr. Valdez controlled ICP at all relevant times.

               2.    Mosafa

       Mosafa is a Cayman Islands company.     As part of ICP’s

formation, Mosafa transferred $1,000 to ICP in exchange for a 2-

percent general partnership interest.


       4
      Rovakat was originally named Radio & Wireless Software
Development, LLC (Radio & Wireless). We henceforth refer to
Radio & Wireless as Rovakat.
                                 -7-

           3.   CNV

     CNV is a Belgian company that is a subsidiary of Immobilière

Hôtelière, S.A. (Immobiliere), a French real estate and hotel

conglomerate.   CNV conducted its activities and maintained its

books and records on the basis of the Belgian franc (Belgian

franc).   CNV’s managing director was Henri Van Zeveren (Mr. Van

Zeveren), a Belgian citizen and resident.   As part of ICP’s

formation, CNV contributed $49,000 to ICP in exchange for a

98-percent limited partnership interest.

           4.   Investment Advisory Agreement

     LVCM, LLC (LVCM), is a Delaware limited liability company

whose managing member was Mr. Valdez.    LVCM and ICP entered into

an investment advisory agreement under which LVCM agreed to

provide investment advisory and management services to ICP from

May 10, 2001, through December 31, 2015, in exchange for a

management fee and an allocation of ICP’s profits.   The agreement

appointed LVCM as ICP’s manager, agent, and attorney-in-fact, and

the agreement authorized LVCM to bind ICP with respect to, among

other things, asset transfers, bank accounts, and transactions.

     C.   ISP

     Limited formed ISP on January 23, 2001, as a Delaware

limited liability company.   During March 2002, Mr. Hovnanian

purchased a 93.9-percent interest in ISP; he did not conduct any

due diligence regarding that purchase.   ISP’s remaining 6.1-
                                  -8-

percent interest was owned by ICP and by Mr. Valdez’s wholly

owned corporation Horizon Capital Holdings Corp.     Mr. Valdez

controlled ISP at all relevant times.

IV.   Mr. Hovnanian and Related Entities

      A.   Mr. Hovnanian

      Mr. Hovnanian is the managing member of Rovakat and its tax

matters partner.     He earned a bachelor of science degree in

economics from the University of Pennsylvania, and he has over 20

years of experience in the computer, software, and wireless

telecommunications industries.     He has invested in real estate,

startup companies, and financial instruments such as foreign

currency contracts, hedging contracts, and the buying and selling

of stock (including short selling).     He is a wealthy individual,

and he is a high-income taxpayer.

      B.   VSHG

      Mr. Hovnanian was the executive vice president of V.S.

Hovnanian Group (VSHG) from June 1980 until January 1991.     VSHG

was a holding company, and its subsidiaries engaged in

construction, development, and utilities.     At all relevant times,

Mr. Hovnanian owned 25 percent of VSHG, and three members of his

family equally owned the remaining 75 percent.

      Hovbilt, Inc. (Hovbilt), a C corporation, was one of VSHG’s

subsidiaries.     VSHG owned 99 percent of Hovbilt, and Mr.

Hovnanian owned the other 1 percent.
                                    -9-

       C.     Speedus

       Speedus Corp. (Speedus) is a publicly traded company that

specializes in information technology and medical devices.5

Since 1991, Mr. Hovnanian has been its president, chief executive

officer, and chairman of its board of directors.       Mr. Hovnanian

also was an employee of Speedus at all relevant times.

V.     Jacques Vabre Transactions

       Immobiliere and its subsidiaries (collectively, Immobiliere

group) owned various assets which had lost much of their value by

February 2001.       Mr. Valdez and the Immobiliere group discussed

Immobiliere’s transferring of these distressed assets to entities

controlled by Mr. Valdez.       Mr. Valdez and the Immobiliere group

referred to these transactions as Jacques Vabre transactions,

with an understanding that “Jacques Vabre” was Mr. Valdez’s

nickname.

       The Immobiliere group participated in four Jacques Vabre

transactions.       Each transaction involved the equity interests of

a single entity; namely, Credicom Asia, Limited (Credicom Asia),

Kislev Partners, L.P. (Kislev Partners), Silvecom S.A., or Todor,

S.A.       The Immobiliere group earned between $7 million and $10

million in fees by participating in these transactions.       The fee

for each transaction was set at a percent (ranging from 2 to 2.5


       5
      Speedus was formerly known as Suite 12 Group, Highcrest
Management, and Cellular Vision. We refer to the precursors of
Speedus as Speedus.
                                  -10-

percent of 90 percent) of the distressed assets’ Federal income

tax basis that was claimed to be obtained from the Immobiliere

group as part of the transaction.

VI.   Transaction Involving Credicom Asia

      A.   Overview

      The Jacques Vabre transaction at issue was essentially a

four-step transaction involving Credicom Asia.     First, Credicom

Asia redeemed its worthless class A common stock (class A stock)

from CNV for 1,718,116 francs and $303,375.     Second, CNV

transferred the francs to ICP in exchange for an increased

interest in ICP.      Third, ICP transferred to Rovakat 50,000 of the

francs with an aggregate fair market value of $34,185.     Fourth,

ICP sold 90 percent of its interest in Rovakat to Mr. Hovnanian.

One day after the fourth step, Rovakat sold its 50,000 francs to

a third party at their fair market value of $35,268.

      B.   History of Credicom Asia

      Credicom Asia is a subsidiary of CNV and a member of the

Immobiliere group.     Credicom Asia was formed as a British Virgin

Islands company on June 18, 1992, under the name Pacific Eagle

Corporation Limited, and subsequently changed its name to

Credicom Asia.    On or about September 13, 1996, Credicom Asia was

registered to do business in the Cayman Islands.     Credicom Asia

primarily conducted its activities and maintained its books and

records in U.S. dollars.
                                -11-

     Credicom Asia had two classes of common stock outstanding as

of December 2, 1996.   The first class, class A stock, was

initially owned entirely by CNV and represented 70 percent of the

equity interests in Credicom Asia.     The second class, class B

common stock (class B stock), was initially owned entirely by

Colony Credicom, L.P., and Colorado Credicom, LLC (collectively,

C&C), and represented the remaining 30 percent equity interests

in Credicom Asia.

     C.    Liquidation Preference of Credicom Asia

     In a Restated Memorandum of Association dated September 13,

1996, Credicom Asia provided that holders of its common stock

were entitled to apportion any assets that remained after the

preference rights of the preferred shareholders were satisfied as

follows:

     First, to the holders of the * * * [class B stock], an
     amount that would cause [them] to receive an 18% per
     annum (compounded annually and computed from the date
     of the issuance thereof) internal rate of return on
     [their] original principal investment after taking into
     account * * * all dividends and distributions from
     [Credicom Asia] in respect of the * * * [class B stock]
     * * *;

     * * * Second, to the holders of the * * * [class A
     stock], an amount that would cause [them] to receive an
     18% per annum (compounded annually and computed from
     the date of issuance) internal rate of return on
     [their] original principal investment after taking into
     account * * * all dividends and distributions from
     * * * [Credicom Asia] in respect of the * * * [class A
     stock] * * *;

     * * * Third, to the holders of the * * * [class B
     stock], an amount equal to the product of (A) that
                                   -12-

       percentage which the * * * [class B stock] represents
       of all the outstanding common stock, times (B) the
       ratio of 25/35 times (C) the remaining amount of
       proceeds to be distributed in respect of a liquidation;
       and * * *

       * * * [Fourth,] * * * the remaining amount to the
       holders of the * * * [class A stock] * * *.

       C&C paid $55 million for the class B stock and as of

December 2, 1996, was entitled upon the liquidation of Credicom

Asia to a priority distribution of $55 million plus an 18-percent

cumulative annual return before any distributions were made to

CNV.       CNV, the holder of the class A stock, was entitled to

receive a portion of the liquidated assets after payment of the

priority distribution.6

       D.     Credicom Asia’s Holdings

               1.   Overview

       As of January 1, 1997, Credicom Asia’s assets consisted of:

(1) 100 percent of the stock of Golf de Ramatuelle, S.A. (Golf de

Ramatuelle), a French société anonyme; (2) 100 percent of the

stock of Lahotel Corporation (Lahotel), a British Virgin Islands

company; (3) 91.3 percent of the stock of Argent Holdings, Ltd.

(Argent), a British Virgin Islands company; and (4) an

unspecified interest in Kislev Partners, a Cayman Islands

partnership.



       6
      On Mar. 26, 2001, Credicom Asia executed a Restated
Memorandum of Association, which sought to eliminate the
liquidation preference retroactively.
                                 -13-

           2.   Golf de Ramatuelle

     As of January 1, 1997, Golf de Ramatuelle was engaged in the

attempted development of land (Golf property) in the Commune of

Ramatuelle in the Canton of Saint-Tropez, France.     Golf de

Ramatuelle’s principal assets were direct and indirect ownership

interests in the Golf property.      Golf de Ramatuelle’s liabilities

totaled $10,524,301 as of December 2, 1996, and approximately $7

million on June 7, 2001.

     The Golf property consists of approximately 321 acres of

land.   The land is principally forest land, with a portion that

may be used for agriculture, and is in an area subject to a high

risk of fire.   The land lacks adequate water, sewer, and power

supply to support extensive development.     The Golf property was

not zoned for commercial development, and Golf de Ramatuelle’s

attempts to develop the property for nonagricultural uses were

unsuccessful throughout the years.

           3.   Lahotel

     As of January 1, 1997, Lahotel owned L’Ermitage Hotel

(L’Ermitage), a luxury hotel in Beverly Hills, California.      Built

in 1976, L’Ermitage was closed for renovations from September

1993 until June 1998.     L’Ermitage’s liabilities were $9,347,765

as of December 31, 1996.    In 1998, L’Ermitage was assessed at

$13,185,232 for property tax purposes.
                                   -14-

            4.   Argent

     As of January 1, 1997, Argent owned an interest in the

Amanresorts hotel chain, through a 60.97-percent interest in

Silverlink Holdings, Ltd. (Silverlink).         Amanresorts and the nine

Aman operating assets, partially or wholly owned by Silverlink,

are widely viewed as an innovative upscale hotel group.         Aman was

recapitalized in 1993 with Immobiliere, through Argent, acquiring

control of the company.    Silverlink’s current liabilities

exceeded its current assets on December 31, 1995 and 1996.

            5.   Kislev Partners

     As of January 1, 1997, Kislev Partners, through a wholly

owned subsidiary, owned approximately 60 percent of Financiere

Saresco (Saresco).    Saresco was founded in 1976 by Air France

Group and Aeroports de Paris to operate duty-free stores in Paris

airports.    Saresco, through its various subsidiaries, operated

duty-free retail stores which sold perfumes, cosmetics, spirits,

tobacco, and fashion accessories.         Substantially all of these

retail stores sold goods free of duty and of tax.         Over 80

percent of the sales in the duty-free division were from

Saresco’s stores in two terminals in Paris Charles de Gaulle

Airport at Roissy.
                                -15-

     E.   Buyout of the Class B Stock

     By 1998, C&C had become increasingly unhappy with their

investment in the class B stock.    On February 15, 1999, C&C

petitioned the High Court of Justice, British Virgin Islands, to

order the winding up of Credicom Asia.    At that time, Credicom

Asia was unable to pay its debts, and C&C owned 36.62 percent of

Credicom Asia through ownership of the class B stock and a

partial interest in Kislev Partners.    Credicom Asia also owed C&C

approximately $22 million.

     During August 2000, Immobiliere disposed of substantially

all of Saresco’s assets in exchange for the cancellation of debt.

Shortly thereafter, on September 1, 2000, Credicom Asia, CNV, and

C&C entered into a settlement agreement in lieu of the winding up

of Credicom Asia.    Under that agreement, C&C granted CNV an

option to pay $118 million to acquire the following assets

(optioned assets):    (1) 45,834 shares of class B stock owned by

C&C; (2) the Kislev partnership interest owned by C&C; (3) debts

which Credicom Asia owed to C&C; and (4) a mortgage on Lahotel’s

assets.   In return, C&C agreed to dismiss the winding up petition

upon CNV’s exercise of the option.     Mr. Valdez received a copy of

this settlement agreement.

     CNV exercised its option and purchased the optioned assets

on September 18, 2000.    By October 5, 2000, Credicom Asia’s
                                -16-

remaining assets were its interests in Golf de Ramatuelle and in

Saresco.

     Credidev, Ltd. (Credidev), a British Virgin Islands entity,

was formed as a wholly owned subsidiary of CNV to receive C&C’s

class B stock.   The class B stock was transferred to Credidev on

October 5, 2000.    CNV retained its interest in the class A stock.

     F.    March 14, 2001, Meeting of the Board of Directors

     CNV had no source of revenue other than fees generated from

the Jacques Vabre transactions.   During a meeting of CNV’s board

of directors on March 14, 2001, the board of directors “ordered”

that CNV reduce its interest in Credicom Asia.

     Mr. Van Zeveren, in his capacity as CNV’s managing director,

worried that CNV’s directors could be faulted for failing to call

for the cessation of CNV’s activities.   Specifically, he was

concerned that CNV’s directors might be reproached because CNV

had consistently generated losses since 1991 and all of its fixed

assets, with the exception of Golf de Ramatuelle and shares in

shell companies, were sold.   Mr. Van Zeveren reasoned that CNV’s

interests in the shell companies had “residual value” in that the

companies could generate fees from Mr. Valdez by participating in

his transactions.   Immobiliere, in its capacity as CNV’s majority

shareholder, contemplated using any such fees to pay CNV’s

arrears, to cover its operating expenses for 1 to 2 years, and if

necessary, to pay for an amicable liquidation of CNV.
                                -17-

     G.   ICM’s Purchase of Class A Stock

     International Capital Management, LLC (ICM), is a Delaware

limited liability company that Mr. Valdez controlled as its

managing member.    On March 26, 2001, ICM purchased (1) 1,586.5

shares of class A stock from CNV for $26,503; and (2) 2,291.7

shares of class B stock from Credidev for $38,913.    The purchased

class A stock represented a 2-percent interest in Credicom Asia,

and the purchased class B stock represented a 5-percent interest

in Credicom Asia.

     H.   Redemption of Class A Stock

     Mr. Valdez was named Credicom Asia’s president sometime

before June 7, 2001.    On April 25 and May 8, 2001, Mr. Valdez

transferred a total of $1,325,126 to a UBS AG (UBS) bank account

held by Credicom Asia.    On May 14, 2001, Credicom Asia purchased

1,718,116 francs through its UBS bank account for $1,021,751.

These francs were transferred to a UBS bank account held by CNV.

     On June 7, 2001, Credicom Asia redeemed from CNV all of its

class A stock for 1,718,116 francs and $303,375.    The redemption

was entered into by Mr. Van Zeveren in his capacity as CNV’s

managing director and by Mr. Valdez in his capacity as Credicom

Asia’s president.    Also on June 7, 2001, CNV transferred the

1,718,116 francs to ICP in return for an increased limited

partnership interest in ICP.
                                 -18-

     Mr. Valdez wired the $303,375 to CNV from Credicom Asia’s

UBS bank account.    CNV then wired the $303,375 to ICP’s UBS bank

account.    No further activity in Credicom Asia’s UBS account

occurred until August 24, 2005, when Mr. Valdez closed both the

Credicom Asia and ICP UBS bank accounts.

     I.     Participation Fees

     CNV’s claimed basis in the class A stock was approximately

$184 million, and CNV expected to receive approximately

$4,140,000 from Mr. Valdez in exchange for its participation in

the Credicom Asia transaction.    These fees were payable in two

tranches.    The first tranche related to $100 million of CNV’s

claimed basis in the class A stock and generated $2.2 million in

fees for CNV.7    The second tranche related to $84 million of

CNV’s claimed basis in the class A stock and generated $1,940,000

in fees for CNV.    CNV used the fees from the first tranche to

purchase bonds issued by Immobiliere in 2001.    CNV (or

Immobiliere) intended to use the fees generated from the second

tranche to pay its arrears, to continue its operations long

enough to allow for the sale of CNV’s remaining assets, and “to

pick the bones clean”.




     7
      Mr. Valdez initially agreed to pay CNV a $2,250,000 fee
related to the first tranche. That fee was reduced, however,
following Mr. Valdez’s agreement to accelerate payments due under
the first tranche.
                                 -19-

VII.    Francs Transaction

       During November 2002, ICP transferred to Rovakat 50,000

francs with a fair market value of $34,185.     Immediately

thereafter, Rovakat’s owners were ISP (approximately 75-percent

owner) and ICP (approximately 25-percent owner).     On December 26,

2002, Mr. Hovnanian purchased 90 percent of ICP’s interest in

Rovakat for $30,776.     Immediately after, Rovakat’s owners (with

their approximate ownership interests) were ISP (approximately

75-percent owner), ICP (approximately 2-percent owner), and Mr.

Hovnanian (approximately 23-percent owner).

       On December 27, 2002, Rovakat sold the 50,000 francs to a

third party for $35,468.     Rovakat reported on its 2002 return

that its tax basis in the francs was $5,805,000 and that it

realized a $5,769,532 loss on the sale ($35,468 - $5,805,000).

Rovakat lacked sufficient income to apply all of the reported

loss to 2002, and it reported that it was suspending the unused

portion of the reported loss.

VIII.    Payment of Fees to Mr. Valdez

       A.   Overview

       From 2002 through 2004, Rovakat directly or indirectly paid

fees of at least $147,318 to Mr. Valdez.     Rovakat paid these fees

through an intermediary entity, Wireless Audience Survey, Inc.

(WASI).     Manuel Asensio, a close personal friend and business

acquaintance of Mr. Hovnanian, controlled WASI and authorized the
                                -20-

fee payments.    WASI, in turn, paid the fees to Mr. Valdez through

Limited.    Additional fees of $234,835 were paid to another entity

controlled by Mr. Valdez.

     B.    2002 Payments

     Limited issued WASI an October 30, 2002, invoice in the

amount of $650,000 for “advisory services in connection with

software licensing and code development”.     Limited received

$650,000 from WASI on November 22, 2002.

     Rovakat issued Limited a December 26, 2002, invoice in the

amount of $593,125 for “consulting” services.     One day later,

Rovakat issued Limited an invoice in the amount of $593,125 as a

“refundable prepaid deposit” for “consulting” services.     Limited

transferred $593,125 to Rovakat on December 31, 2002.

     Rovakat did not report on its 2002 return that any portion

of either the $650,000 or the $593,125 was includable in income.

     C.    2003 Payments

     Limited issued WASI a February 27, 2003, invoice for

$1,033,635 of “advisory services in connection with software

licensing and code development rendered in 2002”.     Limited

received $1,033,635 from WASI on March 24, 2003.

     Rovakat issued Limited a March 25, 2003, invoice for

$943,192 of “consulting” services.     On March 25, 2003, Limited

transferred $943,192 to Rovakat.
                                 -21-

      Rovakat did not report on its 2003 return that any portion

of either the $1,033,635 or the $943,192 was includable in

income.

IX.   WIC Lawsuit and Mr. Hovnanian’s Bonus

      A.   Overview

      Speedus filed a lawsuit (WIC lawsuit) against Western

International Communications (WIC) on or before April 25, 2002.

Speedus agreed in an employment agreement with Mr. Hovnanian to

pay him a bonus (bonus) of 20 percent of any net proceeds

received by Speedus from the WIC lawsuit.     When that agreement

was executed, Mr. Hovnanian was Speedus’ chief executive officer,

and he was paid in that capacity an annual salary of at least

$250,000.    He also was entitled to receive reimbursement for

“reasonable business related expenses” incurred as Speedus’ chief

executive officer.

      B.   Mr. Hovnanian Assigns Bonus to Rovakat

      On July 10, 2002, Mr. Hovnanian assigned his rights to the

bonus to Rovakat.     Mr. Hovnanian did so without receiving a

membership interest in Rovakat commensurate with the value of the

rights.    The assignment agreement stated that Mr. Hovnanian

assigned his rights to the bonus to Rovakat because Rovakat “has

members who can confidentially assist and advise the pursuit of

the interest in the [WIC lawsuit].”     Under the assignment

agreement, Mr. Hovnanian permitted Rovakat to assign the bonus to
                                    -22-

subsidiaries or partnerships in which Rovakat held a majority

interest.

        C.   Settlement of WIC Lawsuit

     In late 2003 or early 2004, Speedus and WIC settled the WIC

lawsuit for $15 million.      Of that amount, Speedus was entitled to

receive $14,232,280 in net proceeds.       Speedus was amenable to

paying the $2,846,456 bonus (20 percent x $14,232,280) to Mr.

Hovnanian as he directed.

     D.      Sunshower

     Mr. Hovnanian, on behalf of Rovakat, formed Sunshower LLC

(Sunshower) as a Delaware limited liability company on February

4, 2004.      Sunshower is a disregarded entity for Federal income

tax purposes.      On February 20, 2004, Speedus transferred

$2,846,456 to Sunshower’s bank account.       In correspondence with

Rovakat’s accountant, Mr. Hovnanian designated these proceeds as

“consulting income”.

     On February 27, 2004, Mr. Hovnanian caused $234,835 to be

transferred from Sunshower to Sterling Capital Management,

Ltd. (Sterling), an entity controlled by Mr. Valdez.       Mr.

Hovnanian noted that this payment represented "fees paid to

* * *     [Mr. Valdez’s] entity”.    Speedus did not reimburse Mr.

Hovnanian for the $234,835 paid to Mr. Valdez.
                                -23-

X.    Similar Transactions in Which Mr. Hovnanian Participated

      Mr. Hovnanian participated in two additional transactions

involving purportedly high-basis francs and the reporting of

ordinary losses.    The first transaction involved the transfer of

francs with a fair market value of approximately $60,000 and a

purported basis of $11,698,313.      Hovbilt used the resulting

claimed loss to offset income that VSHG earned.      The second

transaction involved the transfer of francs with a fair market

value of approximately $59,920 and a purported basis of

$11,847,499.    ISP used the resulting claimed loss to offset

income that Mr. Hovnanian earned from unrelated sources.

XI.   Rovakat’s Federal Partnership Tax Returns

      A.   Preparer of the Returns

      Harvey Weinreb (Mr. Weinreb) prepared Rovakat’s 2002, 2003,

and 2004 returns.    Mr. Hovnanian retained Mr. Weinreb for that

purpose at the suggestion of Mr. Valdez.

      B.   2002 Return

      Rovakat filed its 2002 return on October 23, 2003.     The 2002

return reported no gross receipts and no income.      Rovakat

reported that it was entitled to recognize $130,766 as a loss on

the francs transaction and that another $5,638,765 from the

transaction was a “suspended loss”.
                                 -24-

     C.     2003 Return

     Rovakat filed its 2003 return on April 7, 2005.     The 2003

return reported no gross receipts, no ordinary business income or

loss, and “other fees income” of $943,192.     Rovakat recognized

$890,485 of the suspended loss and reported that $4,335,154

remained “suspended”.8    Rovakat also reported a charitable

contribution deduction of $6,224.

     D.     2004 Return

     Rovakat filed the 2004 return on February 13, 2006.       The

2004 return reported total income of $2,846,456, which apparently

was the bonus from Speedus.     Rovakat recognized $2,479,991 of the

suspended loss as a “prior year suspended loss” and reported that

$1,855,163 remained “suspended”.     Rovakat also reported a

charitable contribution deduction of $60,350.

     E.     Expenses Reported on 2003 and 2004 Returns

     Rovakat reported the following expenses as deductions on its

2003 and 2004 returns:

         Expense                  2003           2004

   Bank fee                        $332            -0-
   Consulting                    22,000        $56,154
   Filing fees                      546          2,418
   Finance charge                    58            -0-
   Office                           861            -0-
   Postage and delivery              14            -0-


     8
      The amount of the remaining “suspended loss” appears to
have been reported incorrectly ($5,769,532 claimed loss -
$130,766 loss reported on the 2002 return - $890,485 loss
reported on the 2003 return = $4,748,281).
                                    -25-

   Professional fees                13,000         -0-
   Legal and accounting fees           -0-     250,410
   Miscellaneous                       -0-          65
   Auto                              7,659       1,408
   Computer                            198         -0-
   Meal and entertainment           19,296      42,208
     Total                          63,964     352,663

XII.    Tax Advice and Opinions

       A.   KPMG Facsimile

       On March 1, 2001, KPMG sent to Mr. Van Zeveren a one-page

facsimile which stated that the “evolution of the purchase value”

of the class A stock as recorded in CNV’s books was $184,955,349.

KPMG apparently did not attach the source documents for this

conclusion to its facsimile, and the memorandum does not define

“purchase value”.

       B.   Sidley Austin Opinion

       Before July 31, 2001, Mr. Valdez hired Sidley, Austin,

Brown, and Wood LLP (Sidley Austin) to render an opinion (Sidley

Austin opinion) for Federal tax purposes on the bases of various

assets transferred in connection with Credicom Asia’s redemption

of its class A stock.     In rendering its opinion, Sidley Austin

reportedly “relied on audited financial statements, accounting

records, third party appraisals, and certain other factual,

financial, and numerical information that * * * [it] deemed

relevant.”     In addition, the Sidley Austin opinion noted that

Sidley Austin relied on at least 25 assumptions and 13 factual

representations.
                                -26-

     The Sidley Austin opinion concluded that (1) the basis of

CNV’s interest in the class A stock as of June 7, 2001, was

$207,093,834; (2) CNV’s basis in the 1,718,116 francs and the

$303,375 received from the redemption of the class A stock

totaled $207,093,834; (3) the basis of CNV’s interest in ICP as

of June 8, 2001, was $207,093,834; and (4) ICP’s basis in the

1,718,116 francs which ICP received from CNV was $206,790,459.

Mr. Hovnanian first received a copy of the Sidley Austin opinion

in 2008.

     C.    De Castro Opinions

     Mr. Hovnanian, at the suggestion of Mr. Valdez, hired the

law firm of De Castro, West, Chodorow, Glickfield & Nass, Inc.

(De Castro), to render a tax opinion regarding the tax

consequences of the francs transactions (Rovakat opinion).    The

cost of the Rovakat opinion was $13,000.   Mr. Hovnanian relied on

Mr. Valdez to serve as an intermediary between Mr. Hovnanian and

De Castro.   The Rovakat opinion concluded that “there is a

greater than 50% likelihood that the tax treatment of the * * *

[francs transaction] would be upheld if challenged by the IRS.”

In rendering that opinion, De Castro “assumed * * * the accuracy

of the factual matters” represented in the Sidley Austin opinion,

including ICP’s basis in the francs, and did not review “any

transactional documents”.
                                   -27-

       Mr. Hovnanian also procured an opinion from De Castro on the

tax consequences associated with ISP’s investment in francs (ISP

opinion).       The Rovakat and ISP opinions are identical in most

material regards.

       In total, De Castro wrote nine opinions for Mr. Valdez and

for individuals who invested in his transactions.       De Castro made

thousands of dollars on referrals from Mr. Valdez and at least $2

million from writing opinions on other similar transactions.

Menasche Nass, a partner of De Castro, invested in a “distressed

debt transaction”.

XIII.       FPAAs

       On November 13, 2008, respondent issued to Rovakat a

separate notice of final partnership administrative adjustment

(FPAA) for each of Rovakat’s 2002, 2003, and 2004 taxable years.

The FPAAs determined that Rovakat had not established its basis

in the francs.       The FPAAs determined alternatively that the

francs transaction lacked economic substance.

XIV.    Trial of This Case

       A.     Overview

       A trial was held in New York, New York, from December 14

through December 17, 2010.       The evidence consists of the

uncontested pleadings, the trial testimony of 7 lay and 3 expert

witnesses, over 700 stipulated facts, and over 600 exhibits.
                                   -28-

     B.     Expert Witnesses

            1.   Dr. LaRue

     Respondent offered, and the Court recognized, David W.

LaRue, Ph.D. (Dr. LaRue), as an expert in financial and tax

accounting, finance, and economics.       Dr. LaRue is a professor

emeritus at the University of Virginia, and he holds a Ph.D. in

accounting, taxation, and economics and a master’s degree in

accounting and taxation.       From 2000 through 2005 he was the

director of the graduate accounting program at the University of

Virginia.    He has over 30 years of teaching experience in the

fields of taxation, accounting, and finance.       He has testified

before this and other Courts on many previous occasions as an

expert in financial and tax accounting, finance, and/or

economics.

            2.   Dr. Friedman

     Respondent offered, and the Court recognized, Jack P.

Friedman, Ph.D. (Dr. Friedman), as an expert on fair market value

as it relates to real estate and business valuation.       Dr.

Friedman holds a Ph.D. in business administration with a focus in

real estate and urban affairs, a master’s degree in business

administration, and a bachelor’s degree in business

administration.    Dr. Friedman is published and holds the

following professional certifications:       Certified public

accountant (C.P.A.), member of the Appraisal Institute, senior
                                    -29-

real estate analyst, senior member of the American Society of

Appraisers, and fellow of the Royal Institute of Chartered

Surveyors.     Dr. Friedman has taught real estate appraisal courses

for 19 years, and he has developed courses for various

professional associations.

             3.   Mr. Bernatowicz

     Mr. Hovnanian called Frank A. Bernatowicz (Mr. Bernatowicz)

as his expert, and the Court recognized Mr. Bernatowicz as an

expert in financial accounting.       Mr. Bernatowicz is a C.P.A. and

a member of the American Institute of C.P.A.s, the Illinois

C.P.A. Society, and the National Society of Professional

Engineers.    He holds a bachelor of science degree in electrical

engineering and a master’s degree in business administration in

finance.    He was a partner with Ernst and Whinney (now Ernst and

Young), and he directed the firm’s Midwest Region Litigation

Services and Real Estate Advisory Services practices.      He was a

managing principal of Alix & Associate’s Chicago office, a

managing partner of the Midwest Region Intellectual Property

Practice of PricewaterhouseCoopers LLP, and a managing partner of

BDO Seidman’s Specialized Services practice.

     C.    Special Procedure as to Expert Testimony

     With the agreement of the parties, we directed the experts

to testify concurrently.     To implement the concurrent testimony,

the Court sat at a large table in the middle of the courtroom
                                 -30-

with all three experts, each of whom was under oath.      The

parties’ counsel sat a few feet away.     The Court then engaged the

experts in a three-way conversation about ultimate issues of

fact.     Counsel could, but did not, object to any of the experts’

testimony.    When necessary, the Court directed the discussion and

focused on matters that the Court considered important to

resolve.     By engaging in this conversational testimony, the

experts were able and allowed to speak to each other, to ask

questions, and to probe weaknesses in any other expert’s

testimony.    The discussion that followed was highly focused,

highly structured, and directed by the Court.9

                                OPINION

I.   Burden of Proof

      Taxpayers generally bear the burden of proof in a

partnership-level proceeding such as this, see Rule 142(a), and

Mr. Hovnanian concedes that this general rule applies with

respect to the adjustments in the FPAAs.    Respondent bears the

burden of proving the allegation in his amendment to answer that

Rovakat earned unreported income of $650,000 in 2002.     See id.




      9
      The U.S. District Court for the District of Massachusetts
has apparently used concurrent witness testimony in a number of
nonjury cases in recent years. See Wood, “Experts in the Tub”,
21 Antitrust 95, 97 (2007).
                                -31-

II.   Rovakat’s Claimed Loss

      A.   Overview

      We first decide whether Rovakat may recognize its claimed

losses of $130,766 for 2002, $890,485 for 2003, and $2,479,991

for 2004.    Mr. Hovnanian contends that these losses are allowed

on account of Rovakat’s sale of the francs.    As Mr. Hovnanian

sees it, CNV was a partnership that had a $182,068,631 basis in

its class A stock (which Mr. Hovnanian considers to be a

partnership interest), and that basis was transferred to the

1,781,116 francs that CNV received upon the redemption of the

class A stock.    Then, Mr. Hovnanian reasons, ICP received that

basis upon its receipt of the francs, and Rovakat received a pro

rata share of the basis upon Rovakat’s receipt of 50,000 of the

francs.    Mr. Hovnanian concludes that Rovakat’s sale of the

50,000 francs on December 27, 2002, triggered the basis, which in

turn resulted in an approximately $5 million loss allocable to

its partners (principally, Mr. Hovnanian).

      Respondent argues that Rovakat may not recognize its claimed

losses because Mr. Hovnanian has failed to establish Rovakat’s

basis in the francs.    In addition, respondent argues, Rovakat may

not recognize its claimed losses because the transfers of the

francs lacked economic substance in that the francs transaction

was effected solely to generate an artificial loss.
                                -32-

     We agree with respondent that Rovakat may not recognize its

claimed losses.   As we find, Mr. Valdez orchestrated a series of

transactions through which CNV, a corporation, sold its built-in

loss in its class A stock to either Mr. Valdez or to ICP, and the

transactions resulting in that sale were intended solely to

disguise the sale as a tax loss that could ultimately shelter Mr.

Hovnanian’s ordinary income from U.S. taxes.

     B.   Basis in the Francs

     Mr. Hovnanian bears the burden of establishing Rovakat’s

basis in the francs, and that burden includes establishing ICP’s

basis in the francs upon their transfer.    Mr. Hovnanian strives

to meet this burden by focusing on the general rules of

partnership taxation.   Under those rules, which apply even where

the contributor is a foreign entity, see Gutwirth v.

Commissioner, 40 T.C. 666, 678-679 (1963), a partner’s

contribution of property to a partnership in exchange for a

partnership interest is generally a tax-free transaction, see

sec. 721(a).   In addition, the partner’s basis in the partnership

interest received generally equals the partner’s adjusted basis

in the contributed property plus, where applicable, the amount of

any money the partner also contributed.    Sec. 722.   In addition,

the partnership’s basis in the contributed property generally is

a substitute basis that equals the partner’s adjusted basis in

that property at the time of contribution.    Sec. 723.
                               -33-

     These general rules do not apply, however, where, as here,

the facts establish that one or more of the relevant transactions

is not in substance a contribution to a partnership as it

purports to be.   The substance of the transactions at hand, as we

find on the basis of the credible evidence in the record, is that

Mr. Valdez, in his individual capacity or on behalf of ICP,

bought the class A stock from CNV, a corporation, at an amount

drastically in excess of the stock’s fair market value, and he

did so with an understanding that CNV would cooperate in

structuring the sale to appear to be a nontaxable transfer.     For

obvious reasons, the parties to the agreement could not

memorialize in the transaction documents the true terms of the

transaction as a sale because a sale would negate any claims of a

substitute basis in the francs under the partnership rules

applicable to contributions of property.   When viewed in total,

however, the record leads us to conclude that either Mr. Valdez

engaged in an actual purchase of the class A stock or ICP engaged

in a disguised purchase of the class A stock, which in either

case sets the basis in the francs at their cost.   See sec. 1012;

see also sec. 1.707-3(a)(2), Income Tax Regs.

     To be sure, Mr. Valdez structured the transactions using

entities he controlled, aiming to manipulate the rules applicable

to partnership taxation so that he could sell to his U.S.

“investors” foreign built-in losses that they could personally
                               -34-

apply as ordinary losses.   He provided the money for the class A

stock to be “redeemed”.   He converted the stock to francs so he

could use a currency which was CNV’s nonfunctional currency.     He

caused CNV to transfer the francs to ICP, an entity he controlled

and which he claimed was a partnership, so he could claim a

substitute basis in the francs.   The fact that Mr. Valdez wanted

directly or indirectly to purchase the class A stock with its

built-in loss retained for use by Mr. Hovnanian cannot reasonably

be denied.

     Nor has Mr. Hovnanian established (as he asserts) that ICP

was a partnership entitled to a substitute basis in the francs.

A partnership exists for Federal income tax purposes only when

“persons join together their money, goods, labor, or skill for

the purpose of carrying on a trade, profession, or business and

when there is community of interest in the profits and losses.”

Commissioner v. Tower, 327 U.S. 280, 286 (1946).   Facts relevant

to this determination include the conduct of the parties,

particularly their due diligence (or lack thereof) and

negotiations (or lack thereof), the relationship of the parties,

and the control of income and the purposes for which it is used.

See Commissioner v. Culbertson, 337 U.S. 733, 742 (1949).     The

absence of a nontax business purpose is fatal to the validity of

a partnership.   See ASA Investerings Pship. v. Commissioner, 201

F.3d 505, 512-513 (D.C. Cir. 2000), affg. T.C. Memo. 1998-305.
                                -35-

     The record does not suggest, and we do not find, that ICP’s

listed partners intended to join together to carry on a trade or

business.   The record does not establish the intent of each of

ICP’s “partners”, but we find as to Mr. Valdez and CNV, ICP’s

primary “partners”, that they had their own agendas.   CNV was in

financial trouble, and it and Immobiliere desired to obtain

liquidity primarily by selling alleged tax basis in what was

otherwise a worthless shell entity, Credicom Asia.   CNV’s and

Immobiliere’s due diligence was focused on how many Jacques Vabre

transactions could be put together with Mr. Valdez and how fast

payment could be made.   CNV and Immobiliere expected to be paid

approximately $4 million for their part, far in excess of the

approximately $1.3 million actually exchanged for the redemption

of the class A stock.    Because Mr. Hovnanian has failed to prove

that ICP was a partnership for Federal income tax purposes (and

the record establishes that it was not), ICP had a cost basis in

the francs, see sec. 1012, rather than the substitute basis that

Rovakat reported.10


     10
      Nor does the record establish, as Mr. Hovnanian asserts,
that Credicom Asia was a partnership. Credicom Asia had two
classes of common stock, and its ownership was represented by
“shares” owned by “shareholders”. The record also lacks a
partnership agreement entered into between the purported partners
of Credicom Asia. While the Sidley Austin opinion states that
Credicom Asia amended its articles to reflect the characteristics
of a partnership on Dec. 2, 1996, that statement is unsupported
by the record. In addition to our discussion set forth above in
this footnote, Credicom Asia did not file a Form 1065 until 2001,
                                                   (continued...)
                                 -36-

     C.   Economic Substance

          1.   Guiding Legal Principles

     Mr. Hovnanian stated at trial that an appeal in this case

would lie in the Court of Appeals for the Third Circuit, and

respondent agreed.    In ACM Pship. v. Commissioner, 157 F.3d 231,

247-248 (3d Cir. 1998), affg. in part and revg. in part on an

issue not relevant here T.C. Memo. 1997-115, the Court of Appeals

for the Third Circuit articulated a two-factor inquiry to decide

whether a transaction or series of transactions had sufficient

economic substance to be respected for Federal tax purposes.11

The first factor requires an objective inquiry as to whether the

transaction had practical economic effect apart from tax savings.

The second factor requires a subjective inquiry into whether the

taxpayer participated in the transaction for a valid nontax

business purpose.    See id.   These factors are interrelated and


     10
      (...continued)
and we do not find that any of Credicom Asia’s shareholders as of
the time of the stated conversion reported the deemed liquidation
and distribution that would have occurred on such a conversion.
See sec. 301.7701-3(g)(1)(ii), Proced. & Admin. Regs.; see also
Rev. Rul. 63-107, 1963-1 C.B. 71.
     11
      Congress codified the economic substance doctrine mostly
as articulated by the Court of Appeals for the Third Circuit in
ACM Pship. v. Commissioner, 157 F.3d 231, 247-248 (3d Cir. 1998),
affg. in part and revg. in part on an issue not relevant here
T.C. Memo. 1997-115. See sec. 7701(o), as added to the Code by
the Health Care and Education Reconciliation Act of 2010, Pub. L.
111-152, sec. 1409, 124 Stat. 1067; see also H. Rept. 111-443
(I), at 291-299 (2010) (discussing the reasons for codification
of the economic substance doctrine). This codified doctrine does
not apply to this case pursuant to its effective date.
                                 -37-

are not simply “discrete prongs of a ‘rigid two-step analysis.’”

Id. at 247 (quoting Casebeer v. Commissioner, 909 F.2d 1360, 1363

(9th Cir. 1990), affg. Sturm v. Commissioner, T.C. Memo. 1987-

625).   In applying these factors, all stages of the transaction

must be scrutinized to determine whether the taxpayer’s

beneficial interest was affected in a meaningful nontax way.

Knetsch v. United States, 364 U.S. 361, 366 (1960).

           2.   Objective Inquiry

                 a.   Overview

     We first examine whether the francs transaction had

practical economic effect other than the creation of a tax loss.

We conclude it did not.     When viewed according to their objective

economic effect, Credicom Asia’s redemption of the class A stock

from CNV partially for francs, CNV’s transfer of the francs to

ICP, ICP’s transfer of a portion of the francs to Rovakat, CNV’s

sale of 90 percent of its interest in Rovakat to Mr. Hovnanian,

and Rovakat’s sale of the francs were, economically speaking,

negligible events.    The francs transaction as a whole, when

viewed in the light of its individual steps, had no economic

significance other than to serve as a means for Mr. Hovnanian’s

attempt to purchase and use CNV’s built-in loss.     The following

factors further support our conclusion that the objective

economic effect of the francs transaction is not consistent with

Rovakat’s reporting of that transaction.
                                -38-

               b.   Lack of Pretax Profit Potential

     In general, a transaction has economic substance and will be

respected for Federal tax purposes where the transaction offers a

reasonable opportunity for profit independent of tax savings.

Gefen v. Commissioner, 87 T.C. 1471, 1490 (1986).     A reasonable

opportunity for profit will ordinarily be found only if there was

a legitimate expectation that the nontax benefits would be at

least commensurate with the associated transaction costs.     ACM

Pship. v. Commissioner, T.C. Memo. 1997-115; see also Salina

Pship. L.P. v. Commissioner, T.C. Memo. 2000-352.     Deliberately

incurring expenses in excess of appreciable gain is “the

antithesis of profit-motivated behavior”.   Yosha v. Commissioner,

861 F.2d 494, 498 (7th Cir. 1988), affg. Glass v. Commissioner,

87 T.C. 1087 (1986).

     The francs transaction did not present Rovakat with a

reasonable opportunity for profit independent of tax savings.

Rovakat incurred at least $395,153 in transaction costs related

to the francs transaction.   These costs included at least

$382,153 in fees paid to Mr. Valdez and $13,000 paid to De Castro

for the Rovakat opinion.12   The sole economic gain that Rovakat

could realize on the francs transaction was attributable to

exchange rate fluctuations between the franc and the U.S. dollar.


     12
      The $382,153 consists of the $56,875 and $90,443 that
Rovakat paid in 2002 and 2003, respectively, and the $234,835
that Sunshower paid to Mr. Valdez.
                                -39-

     Dr. LaRue reviewed the franc to U.S. dollar exchange rates

from January 1, 1990, to December 30, 2006.   During that time,

the relationship between the franc and the U.S. dollar was

relatively stable, and the buy-side market for francs was highly

liquid with minimal transaction costs.   Dr. LaRue concluded that

the franc to U.S. dollar exchange rates were not sufficient to

yield a positive pretax return and that the value of the U.S.

dollar against a franc would have had to increase by more than

157 percent before Mr. Hovnanian realized his first nominal

dollar of pretax profit.13   Dr. LaRue concluded that even if the

franc became worthless, Mr. Hovnanian would have experienced a

positive aftertax return in excess of 9,380 percent,

notwithstanding the corresponding loss of his initial investment

in francs.   When Credicom Asia redeemed its class A stock, the

claimed tax basis in the francs ultimately transferred to ICP was

over 200 times greater than their fair market value.   If the

value of the francs doubled during Mr. Hovnanian’s holding

period, the potential Federal income tax savings, assuming a tax

rate of 39.1 percent, would exceed the pretax economic gain by

approximately 80 times.

     We credit Dr. LaRue’s testimony and conclude that a rational

investor would have recognized the nonexistence of a realistic


     13
      A nominal dollar is the value of a dollar in the future
that is not discounted to take into account the time-value-of-
money, risk, or other similar costs of capital.
                               -40-

probability that the francs which Rovakat held would have

sufficiently appreciated to produce a pretax profit.     This lack

of pretax profit potential weighs heavily against a finding that

the francs transaction was economically significant.14    Accord

Gilman v. Commissioner, T.C. Memo. 1989-684 (sale-leaseback

transaction lacked economic substance where, when the transaction

was entered into, a prudent investor would have concluded that

there was no chance to earn a nontax profit in excess of

transaction costs), affd. 933 F.2d 143 (2d Cir. 1991).

               c.   Actual Economic Effect

     Tax losses which fail to “correspond to any actual economic

losses, do not constitute the type of bona fide losses that are

deductible” for Federal tax purposes.   ACM Pship. v.

Commissioner, 157 F.3d at 252 (internal citations omitted).    The

economics of the francs transaction do not support Rovakat’s

claim to the losses reported on its 2002 through 2004 returns.

Upon the sale of the francs, Rovakat did not realize a $5,769,532




     14
      Mr. Hovnanian presented no expert testimony on the pretax
profit potential associated with Rovakat’s investment in the
francs transaction. Rather, he contends that the fees which
Rovakat paid to Mr. Valdez were “collection fees” unrelated to
the structuring of the francs transaction. We find to the
contrary. Even if they were collection fees, however, Rovakat
still could not have reasonably expected a pretax profit on the
francs transaction. The $13,000 fee paid to De Castro for the
Rovakat opinion alone consumed any profit to be realized on the
francs transaction.
                                -41-

economic loss; it realized a $1,283 economic gain.15   While

realization of an economic gain may suggest that a transaction

has economic substance, the prospect of a nominal, incidental

pretax profit does not necessarily establish that a transaction

was designed to serve a nontax profit motive.   Id. at 258;

Sheldon v. Commissioner, 94 T.C. 738, 768 (1990).   Moreover, as

to the francs transaction, any profitability on the transaction

was subsumed by the costs of entering into the transaction.16

               d.   Francs Paid in Redemption

     We are similarly not persuaded that Credicom Asia’s partial

redemption of its class A stock with francs had practical

economic effect apart from tax savings.   The functional currency

of Credicom Asia was the U.S. dollar, and the functional currency

of CNV was the Belgian franc.   One might reasonably expect that

the redemption would have been effected with the functional

currency of one of the parties to the redemption and not the

nonfunctional franc.   While the form of consideration might, at

first blush, appear to be insignificant, the tax benefit to


     15
      Rovakat’s $1,283 economic gain equals $35,468 (amount
Rovakat realized when it sold the francs) minus $34,185 (fair
market value of francs when Rovakat received them).
     16
      Equally compelling is our finding that the event giving
rise to Rovakat’s claimed high basis in the francs was CNV’s
failed investment in Credicom Asia, as opposed to an economic
outlay made by Rovakat. Dr. Friedman opined that the class A
stock was worthless at and before the time of its redemption.    We
consider that opinion to be reasonable and reliable, and we
accept it.
                               -42-

Rovakat’s members by structuring the transaction with francs was

potentially tremendous.

     Gains or losses attributable to a section 988 transaction

are generally treated as ordinary income or ordinary losses.

Sec. 988(a)(1).   A disposition of property is usually considered

to be a section 988 transaction where the property is a

nonfunctional currency; i.e., a currency other than (1) the U.S.

dollar or (2) in certain cases, the currency of the economic

environment in which a significant part of an activity is

conducted and which is used in the books and records of that

activity.   See sec. 1.988-1, Income Tax Regs.; see also secs.

985(b)(1), 989(a).

     If, as Mr. Hovnanian asserts, Rovakat acquired the francs as

part of an investment activity entered into for the production of

income, the francs would be a nonfunctional currency to Rovakat,

and Rovakat’s disposition of the francs would result in ordinary

income or ordinary loss.   See sec. 988(a)(1), (c)(1).   If,

however, Credicom Asia had redeemed its class A stock in U.S.

dollars and the contributions from CNV to ICP to Rovakat were

denominated in U.S. dollars, any gain or loss on Rovakat’s

disposition of the U.S. dollars would be taxed as a capital gain

or a capital loss.   See Ark. Best Corp. v. Commissioner, 485 U.S.

212, 213 (1988); see also sec. 1221(a).   Thus, by using francs in

partial satisfaction of the redemption, Mr. Valdez aimed to
                                -43-

convert capital losses into ordinary losses that could offset

ordinary income such as salaries and wages.   For a high-income

taxpayer such as Mr. Hovnanian expecting to receive a significant

amount of ordinary income for his role in the WIC lawsuit, these

tax savings were substantial.   Mr. Hovnanian has offered no valid

business reason why Credicom Asia would partially redeem its

class A stock with francs but for the prospect of converting the

character of the purported resulting loss from capital to

ordinary.

               e.   Rovakat’s Sale of the Francs

     Nor do we find that there was a valid business reason for

Rovakat’s sale of the francs just 1 day after Mr. Hovnanian

purchased 90 percent of ICP’s interest in Rovakat.   Mr. Hovnanian

asserts that the sale of the francs was necessary for Rovakat to

generate working capital.   We are not persuaded.   As of December

27, 2002, Rovakat had $100,000 in its checking account and had

invoiced Limited for $593,125 from “consulting” services.   Mr.

Hovnanian fails to adequately explain why its proffered need for

Rovakat to have working capital was not met by these funds.

Rovakat’s decision to exit the francs transaction literally

overnight is especially telling because Rovakat’s sale of the

francs served as the triggering mechanism by which Mr. Hovnanian

would purportedly be able to personally claim his portion of that
                                -44-

loss for Federal income tax purposes.     See Santa Monica Pictures,

LLC v. Commissioner, T.C. Memo. 2005-104.

                f.   Fees Paid to the Immobiliere Group

     Mr. Valdez’s payment of over $4 million in fees to the

Immobiliere group in exchange for CNV’s participation in the

francs transaction also suggests that the francs transaction

lacked economic substance.   These fees were not standard

financing fees but were based upon the amount of tax basis which

ICP expected to receive.   Mr. Hovnanian has not explained why a

fee due to a foreign company would depend upon the basis of

property for Federal tax purposes.     The payment of fees

contingent upon the tax basis which could be realized for Federal

tax purposes suggests that tax-motivated considerations were the

principal reason for the francs transaction.     See Kerman v.

Commissioner, T.C. Memo. 2011-54.

                g.   Summary of Objective Economic Effect

     We conclude that the first factor of the economic substance

inquiry weighs heavily against a finding that the francs

transaction was “compelled or encouraged by business or

regulatory realities, * * * imbued with tax-independent

considerations, and * * * not shaped solely by tax-avoidance

features”.    Frank Lyon Co. v. United States, 435 U.S. 561, 583-

584 (1978).   Rovakat effectively spent over $382,000 to produce

an economic gain of less than $1,300 and a reportable tax loss in
                               -45-

excess of $5 million.   Rovakat’s reporting of the losses reflects

neither the economic realities of the gain which Rovakat

realized, nor that the actual economic loss was borne by CNV.

The use of francs to partially redeem Credicom Asia’s shares

served the seemingly limited purpose of converting the character

of the loss from capital to ordinary.     Rovakat joined ICP so as

to effect a disposition of the francs and have those losses

allocated to Mr. Hovnanian.

          3.   Subjective Business Purpose

               a.   Overview

     The second factor of the economic substance inquiry requires

that we examine the taxpayer’s subjective nontax reasons for

entering into a transaction and whether the taxpayer held a

legitimate profit motive for doing so.     Rice’s Toyota World, Inc.

v. Commissioner, 752 F.2d 89, 92 (4th Cir. 1985)), affg. in part

and revg. in part 81 T.C. 184 (1983).    Whether a transaction is

conducted with a subjective business purpose depends on a number

of subfactors, including whether:     (1) The taxpayer had a valid

nontax business purpose for entering into the transaction, see

Casebeer v. Commissioner, 909 F.2d at 1363-1364; (2) the

transaction was negotiated and entered into at arm’s length, see

Helba v. Commissioner, 87 T.C. 983, 1004-1007 (1986), affd.

without published opinion 860 F.2d 1075 (3d Cir. 1988); (3) the

taxpayer performed due diligence regarding the commercial
                                -46-

viability and market risks of the transaction, see Rose v.

Commissioner, 868 F.2d 851, 854 (6th Cir. 1989), affg. 88 T.C.

386 (1987); (4) in the case of a partnership, the partners

intended to join together for the present conduct of an

undertaking or enterprise, see Culbertson v. Commissioner, 337

U.S. at 742; and (5) the transaction was marketed as a tax

shelter in which the purported tax benefit significantly exceeded

the taxpayer’s actual investment, see Booker v. Commissioner,

T.C. Memo. 1996-261.   These subfactors are not exclusive, and no

one subfactor is dispositive.   We analyze the subfactors

seriatim.

               b.    Rovakat’s Business Purpose

     Mr. Hovnanian has failed to establish that the francs

transaction served any legitimate business purpose, and we

conclude that none existed.   He asserts that the contribution of

francs to Rovakat and Rovakat’s subsequent sale of the francs

were intended to serve as seed money to fund Rovakat’s

development of a competitor to the Nielsen television rating

service (Nielsen).   We are unpersuaded.

     Early in 2001, Mr. Hovnanian introduced Dish and EchoStar

(collectively, EchoStar) to the concept of establishing EchoStar

as a competitor to Nielsen.   EchoStar committed support of up to

$15 million to a project to carry out this concept, though the

record is not clear whether Mr. Hovnanian or Rovakat actually
                                -47-

received these funds.   Mr. Hovnanian testified that he engaged

Mr. Valdez to form Rovakat as part of the project because, among

other things, Mr. Valdez had access to investors with the capital

to fund such a venture.   The Nielsen-competitor project

ultimately failed.

     Mr. Hovnanian’s testimony misses the point.    We focus on the

business purpose of the francs transaction and not any business

venture which Mr. Hovnanian may have pursued before Rovakat’s

formation.    The record does not establish that Rovakat had an

ongoing business after the Nielsen-competitor project failed, nor

when that project failed.    Mr. Hovnanian could have called

witnesses from EchoStar to testify on this point, but he declined

to do so.17

     Mr. Hovnanian also asserts that the francs transaction

enabled him to establish and cultivate ties with Mr. Valdez and

with the Belgian entities, apart from any possible tax

considerations.   We are not persuaded.   The Credicom Asia

redemption, CNV’s contribution of the francs to ICP, and the

payment of fees from ICP to Immobiliere occurred between Mr.



     17
      At trial, Mr. Hovnanian attempted to introduce, and the
Court declined to admit, an affidavit from an EchoStar executive
in lieu of that executive’s direct testimony. We found the
affidavit to be inadmissible hearsay not excepted by Fed. R.
Evid. 807. See Saavedra v. Commissioner, T.C. Memo. 1988-587
(declining to admit an affidavit where the taxpayer did not
demonstrate “reasonable efforts to obtain the witness’ personal
testimony”); see also Rule 143(b).
                                 -48-

Valdez and members of the Immobiliere group.      Any goodwill which

may have been gained from these transactions was to the benefit

of Mr. Valdez and not Mr. Hovnanian.

                c.    Lack of Arm’s-Length Dealing

     In determining whether a transaction possesses objective

indicia of economic substance, we examine whether the transaction

was conducted at arm’s length.     Helba v. Commissioner, supra at

1005.   Where a transaction occurs between related parties, the

transaction is carefully scrutinized “‘because the control

element suggests the opportunity to contrive a fictional * * *

[transaction].’”     Geftman v. Commissioner, 154 F.3d 61, 68 (3d

Cir. 1998) (quoting United States v. Uneco, Inc., 532 F.2d 1204,

1207 (8th Cir. 1976)), revg. in part and vacating in part T.C.

Memo. 1996-447; see also Schering-Plough Corp. v. United States,

651 F. Supp. 2d 219, 244 (D.N.J. 2009), affd. sub nom. Merck &

Co. v. United States, __ F.3d __ (3d Cir., June 20, 2011).

     We find a lack of arm’s-length dealing with respect to the

francs transaction.    Mr. Valdez controlled each aspect of that

transaction up until the sale of ICP’s interest in Rovakat to Mr.

Hovnanian.   By June 7, 2001, Mr. Valdez was Credicom Asia’s

president, and he caused the redemption of the class A shares

with francs and with U.S. dollars.      He controlled the bank

accounts of Credicom Asia and of ICP.      He effected the transfer
                                 -49-

of funds between Credicom Asia, CNV, and ICP.       He controlled ICP,

and he managed LVCM.

     In addition, Mr. Valdez continued to influence the outcome

of the francs transaction even after ICP sold 90 percent of its

interest in Rovakat to Mr. Hovnanian.       Mr. Valdez suggested that

Mr. Hovnanian engage Mr. Weinreb to prepare Rovakat’s 2002

through 2004 returns.    Mr. Valdez recommended that Mr. Hovnanian

engage De Castro to provide tax advice regarding the francs

transaction.   Rovakat’s procurement of tax advice was more

reflective of a symbiotic relationship between De Castro and Mr.

Valdez rather than of independent counseling on the merits of the

francs transaction.

                d.    Lack of Due Diligence

     Mr. Hovnanian presented no documentary evidence to suggest

that he undertook a critical nontax economic analysis of the

risks associated with investing in francs.18      The De Castro

opinion focuses only on the tax effect of the francs transaction

without regard to the commercial viability or market risk

associated with that transaction.       Such a lack of due diligence

on the part of Mr. Hovnanian suggests that he was not concerned

with the economic realities of the francs transaction or with


     18
      The absence of such evidence creates a presumption that no
such documents existed or that they were not favorable to Mr.
Hovnanian’s position. See Wichita Terminal Elevator Co. v.
Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th
Cir. 1947).
                                 -50-

elements of risk.     Cf. Salina Pship. L.P. v. Commissioner, T.C.

Memo. 2000-352 (finding indicia of economic substance where a

partnership held two meetings with the investment banker who

structured a transaction in which the partnership invested and

was presented with several analyses of the financial risks and

rewards associated with such an investment).    Mr. Hovnanian’s

lack of concern for the underlying economics of the francs

transaction is not consistent with a genuine nontax profit

motive.

                 e.   Lack of Mutuality of Profit Objective

     We also examine the surrounding facts and circumstances to

determine whether any of the relevant persons, in good faith,

intended to join together for the present conduct of an

undertaking or enterprise.     TFID III-E, Inc. v. United States,

459 F.3d 220, 231-232 (2d Cir. 2006); see also Commissioner v.

Culbertson, 337 U.S. at 742.    We find that the francs transaction

lacks mutuality of profit objective.

     CNV was motivated to enter into the francs transaction to

realize whatever fees it could from its failed investment in

Credicom Asia.   The payment of these fees allowed CNV to pay its

arrears and to continue its operations long enough to allow for

the sale of CNV’s remaining asset, an interest in Golf de

Ramatuelle.   While these goals might be valid business reasons

for CNV’s redemption of its class A stock, they bear no apparent
                                -51-

relation to CNV’s, ICP’s, or Rovakat’s business purpose for

entering into the francs transaction.     The fees due to CNV were

contingent on the tax basis in the francs for Federal tax

purposes.   Such a framework suggests that ICP was motivated by

CNV’s tax attributes and not by an independent economic

significance of the francs.

     Mutuality of profit objective also is lacking between ICP

and Rovakat.   ICP’s transfer of 50,000 francs and ISP’s transfer

of $100,000 served the seemingly limited purpose of enabling ICP

to become a temporary partner of Rovakat and to transfer the

purportedly high-basis francs to Rovakat to trigger the intended

tax loss.   Mr. Hovnanian did not desire to invest in francs, and

those francs were sold just 1 day after Mr. Hovnanian acquired

ICP’s 90-percent interest in Rovakat.     The occurrence of these

steps within such a short time suggests that the disposition of

the francs was predetermined.

                f.   Other Distressed Asset Transactions

     Mr. Hovnanian, acting in a capacity as other than Rovakat’s

tax matters partner, invested in at least two other transactions

similar to the francs transaction.     The resulting claimed losses

from those transactions were used to offset unrelated income of

Mr. Hovnanian and an entity that he and his family owned.    Mr.

Hovnanian’s investment in those similar transactions supports a

finding that the francs transaction lacked economic substance.
                                 -52-

                 g.   Other Considerations

     Mr. Hovnanian asserts that because Rovakat was not sure it

would earn income, any loss from the francs transaction was not

certain to be used.    We disagree.     Mr. Hovnanian purchased ICP’s

interest in Rovakat during the last week of 2002, by which time

he most likely knew whether some or all of the loss could be used

for that year.   In addition, we doubt that Mr. Hovnanian would

have paid $13,000 to De Castro for its tax opinion if he did not

expect that the loss could be used.      Further, notwithstanding

whether Rovakat realized any income, the loss passed through to

Mr. Hovnanian who in turn was entitled to carry forward and to

apply any unapplied portion of the loss against his future income

(e.g., his salary and any bonus he received as to the WIC

lawsuit).19

                 h.   Summary of Subjective Business Purpose

     We conclude that Rovakat’s reasons for entering into the

francs transaction do not demonstrate a legitimate profit motive.

The lack of arm’s-length dealing at almost every stage of the

francs transaction, coupled with the lack of mutuality of profit


     19
      Mr. Hovnanian fails to explain why Rovakat did not pass
through the entire loss in 2002, the year in which it was
reportedly incurred. Instead, Rovakat suspended some of the loss
at the partnership level and in later years recognized at the
partnership level portions of the suspended loss as needed to
offset its partners’ income. Respondent asserts, and we agree,
that such a suspension of the loss was improper. We consider
Rovakat’s improper reporting of its claimed loss as another
attempt to hide the illegitimacy of the francs transaction.
                                  -53-

objective by all parties, suggests that a nontax profit was a

primary driver for entering into the francs transaction.    Mr.

Hovnanian’s investment in two similar transactions also suggests

that Rovakat was motivated mostly by tax considerations when

entering into the francs transaction.     On balance, we conclude

that the economic reality of the francs transaction is not

consistent with a bona fide profit objective.

             4.   Summary of Economic Substance

     We conclude that the francs transaction lacked economic

substance.    Because a transaction that lacks economic substance

is not recognized for Federal tax purposes, and “‘cannot be the

basis for a deductible loss’”, see ACM Pship. v. Commissioner,

157 F.3d at 247 (quoting Lerman v. Commissioner, 939 F.2d 44, 45

(3d Cir. 1991), affg. Fox v. Commissioner, T.C. Memo. 1988-570),

we hold that Rovakat is not entitled to the losses claimed on its

2002 through 2004 returns.20




     20
      We are not unmindful that Rovakat realized an economic
gain of $1,283 from the francs transaction. Because respondent
does not contend that this gain is taxable to Rovakat or to Mr.
Hovnanian, we hold it is not. Cf. Lerman v. Commissioner, 939
F.2d 44, 45 (3d Cir. 1991) (“If a transaction is devoid of
economic substance * * * it simply is not recognized for federal
taxation purposes, for better or for worse”), affg. Fox v.
Commissioner, T.C. Memo. 1988-570.
                                 -54-

III.    Omitted Income

       A.   Overview

       Respondent determined that Rovakat’s 2003 gross income

includes $90,443 which was paid to Limited through WASI on March

24, 2003.     In addition, respondent amended his answer to assert

that Rovakat omitted $650,000 in income from its 2002 gross

income.     As to the latter, respondent asserts that Rovakat failed

to recognize the (1) $593,125 received from Limited on December

31, 2002, and (2) $56,875 paid to Limited, through WASI, on or

about November 22, 2002.    We agree with respondent that Rovakat

omitted income for 2002 but only to the extent of the $593,125.

       Gross income includes “all income from whatever source

derived, including (but not limited to) * * * gross income

derived from business”.    Sec. 61(a)(2).    Under section 451(a),

items of gross income generally must be included in the gross

income of a cash method taxpayer in the taxable year in which the

taxpayer actually or constructively received that income.      See

sec. 1.451-1(a), Income Tax Regs.       Income not actually reduced to

a taxpayer’s possession is constructively received by a taxpayer

in the year during which the income is credited to an account,

set apart, or otherwise made available so that the taxpayer may

draw upon it at any time.    See sec. 1.451-2(a), Income Tax Regs.

Income is not constructively received if the taxpayer’s control
                                   -55-

 of its receipt is subject to substantial limitations or to

restrictions.    See id.

     B.    Payments From Limited

     Limited deposited $593,125 in Rovakat’s bank account on

December 31, 2002.     Mr. Hovnanian concedes that Rovakat was

required to recognize the $593,125 as income but maintains that

the amount was a “refundable prepaid deposit” includable in

Rovakat’s 2003 gross income.     The $593,125 is not includable in

Rovakat’s 2002 income if it is a deposit.     See Commissioner v.

Indianapolis Power & Light Co., 493 U.S. 203, 213 (1990).        The

$593,125 is includable in Rovakat’s 2002 income if it is an

advance.    See Schlude v. Commissioner, 372 U.S. 128, 134 (1963).

     Respondent seeks to prevail on this issue by relying on the

record as a whole, the 2002 return, and the invoices between

Rovakat, Limited, and WASI.     On the basis of these documents, we

are satisfied that respondent has met his burden of proof.

Limited deposited the $593,125 payment into Rovakat’s bank

account during 2002.    Neither of the two invoices submitted by

Rovakat to Limited in connection with the $593,125 payment states

that the payment was subject to a contingency.     Nor does the

record contain any document that establishes the existence of a

contingency that would negate inclusion of the payment in 2002

under sections 61 and 451.     See Commissioner v. Indianapolis

Power & Light Co., supra at 211 (“Whether these payments
                                 -56-

constitute income when received * * * depends upon the parties’

rights and obligations at the time the payments are made.”).

     Moreover, Rovakat reported as income on its 2003 return a

$943,192 payment received from Limited for “consulting” services

on March 25, 2003.     Rovakat did not report any portion of the

$593,125 payment as income on its 2003 return even though Mr.

Hovnanian asserts that the income was taxable to Rovakat in that

year.     Nor did Rovakat file an amended 2003 return to include

that payment in its gross income for that year.     See sec. 1.451-

1(a), Income Tax Regs. (“If a taxpayer ascertains that an item

should have been included in gross income in a prior taxable

year, he should, if within the period of limitation, file an

amended return and pay any additional tax due.”).     We hold that

Rovakat was required to report the $593,125 payment received from

Limited in 2002.

     C.     Payments to WASI

     Respondent also determined that Rovakat was required to

report as income (1) $56,875 of the $650,000 which Limited

received from WASI on November 22, 2002, and (2) $90,443 of the

$1,033,635 which Limited received from WASI on March 24, 2003.

According to respondent, these amounts represent “implicit

deductions” claimed by Rovakat.    We disagree.

     The definition of gross income encompasses all undeniable

accessions to wealth, clearly realized, and over which a taxpayer
                               -57-

has complete dominion and control.     Commissioner v. Glenshaw

Glass Co., 348 U.S. 426, 431 (1955).    While broad, the definition

of gross income does not contemplate income that does not result

in a realizable economic benefit to the taxpayer.     United States

v. Goldberg, 330 F.2d 30, 39 (1964) (citing Burnet v. Wells, 289

U.S. 670 (1933), and Corliss v. Bowers, 281 U.S. 376 (1930)).

Rovakat realized no apparent economic benefit from the fees of

$56,875 and $90,443.   Respondent’s contention that Mr. Hovnanian

seeks an implicit deduction from these fees is without merit

because Rovakat did not report these fees as deductions on its

2002, 2003, or 2004 returns.   We hold that Rovakat need not

recognize as income the fees of $56,875 and $90,443.

IV.   Effect of Omitted Income on 2002 Period of Limitations

      Mr. Hovnanian asserts that the period of limitations as to

Rovakat’s 2002 taxable year is closed.    Respondent counters that

the period remains open because Rovakat omitted from its 2002

return an amount in excess of 25 percent of the amount of gross

income required to be stated on that return.    We agree with

respondent.

      The Commissioner generally must assess tax within 3 years

after a return is filed.   See sec. 6501(a).   Section 6501(e)(1)

provides an exception, however, where the taxpayer fails to

report gross income in excess of 25 percent of the amount of

gross income stated on its return.    Section 6229 sets forth
                                -58-

special rules to extend the period of limitations described by

section 6501 with respect to partnership items or affected items.

Section 6229(a) generally provides that the period for assessing

against a person any income tax attributable to a partnership

item or to an affected item shall not expire before the date that

is 3 years after the later of the date that the partnership

return is filed or the last day for filing the return.   Section

6229(c)(2) provides that if any partnership omits from gross

income an amount properly includable therein that is in excess of

25 percent of the amount of gross income stated on its return,

the 3-year period described in section 6229(a) is extended to 6

years.   Highwood Partners v. Commissioner, 133 T.C. 1, 10 (2009).

      Mr. Hovnanian filed Rovakat’s 2002 return on October 23,

2003, and the return reported no gross income.   The $593,125

omitted from Rovakat’s 2002 return was in excess of 25 percent of

the amount of gross income stated on the return.   Respondent

issued Mr. Hovnanian the FPAA for 2002 on November 13, 2008,

within the 6-year period for assessment provided by sections

6229(c)(2) and 6501(e)(1)(A).   Accordingly, respondent timely

issued the FPAA for 2002, and the adjustments set forth in that

FPAA are not barred by any limitations period.

V.   Liability for Self-Employment Tax

      Respondent determined that the $593,125 and $943,192 paid to

Rovakat in 2002 and 2003, respectively, were self-employment
                                  -59-

income.21   Section 1401 imposes a tax on self-employment income.

Sec. 1401(a) and (b); Schelble v. Commissioner, 130 F.3d 1388,

1391 (10th Cir. 1997), affg. T.C. Memo. 1996-269.      Self-

employment income includes an individual’s distributive share of

income from a partnership.      Sec. 1402(a); sec. 1.1402(a)-2(d),

(f), Income Tax Regs.

     Rovakat received $593,125 and $943,192 in 2002 and 2003,

respectively.    Limited paid these amounts through WASI as fees.

Neither the 2002 nor the 2003 return reported these amounts as

self-employment income.    They were and should have been reported

as such.    See sec. 1402(a).




     21
      The FPAA for 2003 determined that Rovakat’s self-
employment income was $1,536,317, which apparently is the sum of
the $593,125 and $943,192 Rovakat received in 2002 and 2003,
respectively. On brief, respondent asserts that Rovakat’s self-
employment income was $650,000 and $1,033,635 for 2002 and 2003,
respectively. We attribute the increased amounts to respondent’s
determination that Rovakat’s gross income includes the $56,875
and the $90,443. We have held supra that those amounts are not
includable in Rovakat’s income.
                                    -60-

VI.     Entitlement to Deductions

       Respondent determined that Rovakat was not entitled to

deduct “other expenses” of $63,964 and $352,663 for 2003 and

2004, respectively.22      We agree.

       Deductions are strictly a matter of legislative grace, and a

taxpayer bears the burden of producing sufficient evidence to

substantiate any deduction that would otherwise be allowed by the

Code.       Sec. 6001; Rule 142(a); INDOPCO, Inc. v. Commissioner, 503

U.S. 79, 84 (1992).       Rovakat did not present any evidence to

substantiate the actual payment of the “other expenses” claimed

on its 2003 and 2004 returns or that these payments were ordinary

and necessary to Rovakat’s activity.       See secs. 162(a), 212.   We

conclude that Rovakat may not deduct any portion of those claimed

expenses.

VII.        Accuracy-Related Penalties

       A.     Overview

       Section 6662(a) and (b)(1), (2), and (3) provides that a

taxpayer may be liable for a 20-percent accuracy-related penalty

on the portion of an underpayment of income tax attributable to,

among other things, negligence or disregard of rules or



       22
      We conclude that respondent has conceded his determination
that Rovakat may not deduct charitable contributions of $6,224
for 2003 and $60,350 for 2004, by virtue of the fact that
respondent did not address that issue at trial or in his
posttrial brief. Cf. Harbor Cove Marina Partners Pship. v.
Commissioner, 123 T.C. 64, 66 (2004).
                                 -61-

regulations, a substantial understatement of income tax, or a

substantial valuation misstatement.     Section 6662(h)(1) increases

the 20-percent rate to a 40-percent rate to the extent that the

underpayment is attributable to a gross valuation misstatement.

Sec. 6662(h)(1).    An accuracy-related penalty under section 6662

does not apply to any portion of an underpayment of tax for which

a taxpayer had reasonable cause and acted in good faith.     Sec.

6664(c)(1).

     Respondent determined that one or more of the referenced

accuracy-related penalties apply with respect to the partnership

adjustments for Rovakat’s 2002 through 2004 taxable years.

Respondent determined that the 40-percent accuracy-related

penalty applies to the portion of any underpayment of tax

attributable to the ordinary losses reported for 2002, 2003, and

2004.     Respondent determined that a 20-percent accuracy-related

penalty applies to any underpayment of tax attributable to the

omitted income and to the disallowed deductions.     Mr. Hovnanian

does not deny that the accuracy-related penalties apply in

accordance with their terms.     His sole defense against the

imposition of the accuracy-related penalties is that Rovakat

meets the reasonable cause exception of section 6664.23


     23
      The Commissioner bears the burden of production on whether
an accuracy-related penalty applies “with respect to the
liability of any individual”. See sec. 7491; Higbee v.
Commissioner, 116 T.C. 438, 446-447 (2001). We have previously
                                                   (continued...)
                                  -62-

        B.   Gross Valuation Misstatement

     Respondent determined that it was appropriate to impose an

accuracy-related penalty of 40 percent under section 6662(h) for

a gross valuation misstatement with respect to the basis reported

on the francs transaction.     Section 6662(h) provides that a

taxpayer may be liable for a 40-percent penalty on that portion

of an underpayment of tax that is attributable to one or more

gross valuation misstatements.     A gross valuation misstatement

exists if the value or adjusted basis of any property claimed on

a tax return is 400 percent or more of the amount determined to

be the correct amount of such value or adjusted basis.     Sec.

6662(h)(2)(A).     The value or adjusted basis of any property

claimed on a tax return that is determined to have a correct

value or adjusted basis of zero is considered to be 400 percent

or more of the correct amount.     Sec. 1.6662-5(g), Income Tax

Regs.     Whether there is a gross valuation misstatement in the

partnership context is determined at the partnership level.       Sec.

1.6662-5(h)(1), Income Tax Regs.



     23
      (...continued)
questioned whether sec. 7491 applies in the partnership context,
given that the section applies only to the liability of “any
individual”. See, e.g., Palm Canyon X Invs., LLC v.
Commissioner, T.C. Memo. 2009-288; Santa Monica Pictures, LLC v.
Commissioner, T.C. Memo. 2005-104. We need not decide that
question here because we find that the record establishes that
the criteria for the imposition of the sec. 6662(a) accuracy-
related penalties is met without regard to the burden of
production.
                                 -63-

     In Merino v. Commissioner, 196 F.3d 147, 158–159 (3d Cir.

1999), affg. T.C. Memo. 1997–385, the Court of Appeals for the

Third Circuit held that imposition of a valuation misstatement

penalty is generally appropriate where a claimed tax benefit is

disallowed because it is an integral part of a transaction

determined to lack economic substance.    We found that the francs

transaction was a sale or, alternatively, that it lacked economic

substance.    Rovakat’s basis in the francs as reported on its

returns exceeds 400 percent of the basis that Rovakat actually

had.24    Consequently, an accuracy-related penalty under section

6662(a) on account of a gross valuation misstatement under

section 6662(h) applies through its terms to that portion of any

underpayment of tax attributable to the reported loss.25

     C.    Other Accuracy-Related Penalties Determined

     Respondent determined that Rovakat is liable for the 20-

percent accuracy-related penalty under section 6662(a) as to the

portion of any underpayment of tax attributable to the remaining

adjustments on account of negligence or disregard of rules or

regulations, substantial understatement of income tax, and/or



     24
      We conclude from the record that Rovakat’s basis in the
francs was $34,185 because the francs transaction was a sale, see
sec. 1012, or, alternatively, that the basis was zero because the
francs transaction lacked economic substance.
     25
      Given that holding, we do not consider the applicability
of a 20-percent accuracy-related penalty on that portion of the
underpayment of tax attributable to the reported losses.
                                -64-

substantial valuation misstatement under section 6662(b)(1), (2),

and (3).    Only one accuracy-related penalty may be applied with

respect to any portion of an underpayment, even if that portion

resulted from more than one of the types of misconduct described

in section 6662.    Sec. 1.6662-2, Income Tax Regs.   The record

establishes (and Mr. Hovnanian does not contest) that the

determined accuracy-related penalties apply absent a mitigating

reason.

     D.    Reasonable Cause

     Mr. Hovnanian argues that the accuracy-related penalties may

not be imposed because Rovakat meets the reasonable cause defense

of section 6664(c)(1).   Pursuant to that section, an accuracy-

related penalty under section 6662(a) may not be imposed with

respect to any portion of an underpayment of tax for which Mr.

Hovnanian establishes that Rovakat, through his actions, had

reasonable cause and acted in good faith.26    Whether a taxpayer

acted with reasonable cause and in good faith is a factual

determination, in which the taxpayer’s effort to assess the

proper level of tax is of utmost importance.    See sec. 1.6664-

4(b)(1), Income Tax Regs.


     26
      We determine the application of the reasonable cause
defense in this partnership-level proceeding because Mr.
Hovnanian claims that the defense applies on account of his
actions as Rovakat’s managing member and tax matters partner.
See Am. Boat Co., LLC v. United States, 583 F.3d 471, 480 (7th
Cir. 2009); 106 Ltd. v. Commissioner, 136 T.C. 67, 75-77 (2011);
Fears v. Commissioner, 129 T.C. 8, 10 (2007).
                                 -65-

        Mr. Hovnanian argues that Rovakat reasonably relied on the

Rovakat opinion and on the Sidley Austin opinion when filing

Rovakat’s 2002 through 2004 returns.     A taxpayer’s reliance on

the advice of a professional, such as an attorney, may constitute

reasonable cause and good faith where the taxpayer proves by a

preponderance of the evidence that:     (1) The taxpayer reasonably

believed that the professional upon whom the reliance is placed

is a competent tax adviser with sufficient expertise to justify

reliance; (2) the taxpayer provided necessary and accurate

information to the adviser; and (3) the taxpayer actually relied

in good faith on the adviser’s judgment.     Neonatology Associates,

P.A. v. Commissioner, 115 T.C. 43, 98-99 (2000), affd. 299 F.3d

221 (3d Cir. 2002); see also sec. 1.6664-4(c)(1), Income Tax

Regs.     On the basis of the record as a whole, we conclude that

Mr. Hovnanian has not satisfied all of these requirements.

     As to the Rovakat opinion, Mr. Hovnanian had no personal

contact with the attorneys who rendered that opinion.     Instead,

he relied solely on the recommendation of Mr. Valdez, the person

who promoted the transaction to be opined upon.     See Tigers Eye

Trading, LLC v. Commissioner, T.C. Memo. 2009-121 (defining a

promoter as “an adviser who participated in structuring the

transaction or is otherwise related to, has an interest in, or

profits from the transaction”).     Mr. Hovnanian knew that Mr.

Valdez structured and promoted the francs transaction, and we
                              -66-

find in the record that the Rovakat opinion was simply a product

that Mr. Valdez essentially included as part of his “investments”

to attempt to insulate his clients from the imposition of an

accuracy-related penalty as to his transactions.

     Nor did Mr. Hovnanian reasonably rely on the Rovakat opinion

in that the opinion contained material misstatements of fact or

otherwise did not properly explain the facts.   Cf. Long Term

Capital Holdings v. United States, 330 F. Supp. 2d 122, 209 (D.

Conn. 2004), affd. 150 Fed. Appx. 40 (2d Cir. 2005).   First, the

Rovakat opinion stated that Mr. Hovnanian was not affiliated with

any member of Rovakat or of ICP; Mr. Hovnanian owned an interest

in Rovakat, and he managed ICP.   Second, the Rovakat opinion

stated that Rovakat’s principal business activity was “trading

personal property for the account of owners of interest in the

activity”; Mr. Hovnanian admitted during his testimony that

Rovakat never intended to invest in francs.   Third, the Rovakat

opinion stated that the parties to the “transaction” entered into

the francs transaction for “business reasons independent of the

tax consequences for tax purposes, with a view toward making a

profit on the activities contemplated in the Transaction”; the

opinion never elaborates on this purported “business purpose”.

Fourth, the Rovakat opinion stated that the parties to the

“transaction” dealt with each other at arm’s length; the francs
                               -67-

transaction was not conducted at arm’s length but orchestrated

exclusively by Mr. Valdez.27

     Nor do we find that Mr. Hovnanian relied in good faith on

the Rovakat opinion’s conclusion that Rovakat realized a

$5,769,532 loss as to a transaction that resulted in a $1,283

economic gain.   In determining whether a taxpayer relied in good

faith on the advice of a professional, we consider (1) the

taxpayer’s business sophistication and experience, (2) the

reasonableness of the advice solicited, and (3) whether the

advice was obtained as part of a tax shelter.   See 106, Ltd. v.

Commissioner, 136 T.C. 67, 77-78 (2011); see also sec.

1.6664-4(b)(1), Income Tax Regs.   Each factor weighs against a

finding that Mr. Hovnanian relied in good faith on the Rovakat

opinion.   As a business executive with more than 20 years of

experience and an economics degree from the University of

Pennsylvania, Mr. Hovnanian obviously recognized the incongruity

of reporting a loss in excess of $5 million on a transaction that



     27
      In addition, the Rovakat opinion contained numerous
disclaimers that served as notice to Mr. Hovnanian that the legal
opinion was tenuous. The opinion states, for example, that
“Congress has actively pursued legislation to curb abusive tax
shelters and the media has publicized many of the tax
transactions of now large bankrupt entities and high profile
individuals. * * * The legislative and political climate and
publicity may influence a court to accept the IRS arguments
notwithstanding the merits of our analysis.” The opinion states
likewise that “We have * * * considered certain judicial
doctrines which, if applicable, could affect our view of the
facts described and our analysis”.
                               -68-

yielded an economic gain.   We have stated that where an

investment has such obviously suspect tax claims as to put a

reasonable taxpayer under a duty of inquiry, a good faith

investigation of the underlying viability, financial structure,

and economics of the investment is required.     Roberson v.

Commissioner, T.C. Memo. 1996-335 (citing LaVerne v.

Commissioner, 94 T.C. 637, 652-653 (1990), affd. without

published opinion 956 F.2d 274 (9th Cir. 1992), affd. without

published opinion sub nom. Cowles v. Commissioner, 949 F.2d 401

(10th Cir. 1991), and Horn v. Commissioner, 90 T.C. 908, 942

(1988)), affd. without published opinion 142 F.3d 435 (6th Cir.

1998).   If Mr. Hovnanian’s business prowess did not allow him to

make such a determination, then certainly the fact that the

Rovakat and ISP opinions were virtually identical in all material

respects should have prompted inquiry from an independent

adviser.   We conclude that any reliance which Mr. Hovnanian

placed on the Rovakat opinion was not reasonable.

     We similarly reject Mr. Hovnanian’s claimed reliance on the

Sidley Austin opinion.   Mr. Valdez procured the Sidley Austin

opinion for the benefit of ICP and of himself.    That opinion

makes no specific mention of Rovakat or of Mr. Hovnanian, and it

was not given to Mr. Hovnanian until 2008.   The Sidley Austin

opinion also turned the seemingly simple prospect of purchasing

francs and contributing them to a partnership into a 74-page
                                -69-

guide on shifting losses from foreign entities to U.S. taxpayers.

Any reliance that Mr. Hovnanian claims to have placed on the

Sidley Austin opinion is not reasonable or is otherwise not

supported by the record.

     The Supreme Court observed long ago that an expert opinion

may be had as to any amount.   Winans v. N.Y. & Erie R.R. Co., 62

U.S. 88, 101 (1958).   Legal and tax opinions are no different.

The mere fact that a taxpayer purchases an “opinion” from a

self-professed expert does not necessarily mean that the taxpayer

relied on the “expert” in good faith.    An individual who blindly

relies on a professional opinion to support a facially too good

to be true transaction such as we have here does so at his or her

own peril.    Cf. Neonatology Associates, P.A. v. Commissioner, 115

T.C. at 99.   Never has this been more true than in today’s

environment where taxpayers seek to reduce their tax liabilities

by engineering artificial tax losses in complex and/or foreign

transactions which leave little to no paperwork that the

Commissioner may access to examine the transaction.    We conclude

that Rovakat, through Mr. Hovnanian, does not meet the reasonable

cause defense of section 6664(c)(1).    It follows that the

accuracy-related penalties determined by respondent are

applicable to the extent stated herein.
                              -70-

VIII.   Epilogue

     We have considered and rejected as without merit all

arguments that Mr. Hovnanian made which are not addressed herein.

To reflect the foregoing,


                                          Decision will be entered

                                     under Rule 155.
