                        T.C. Memo. 2004-236



                      UNITED STATES TAX COURT



           STEWART AND SHIRLEY OATMAN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 5378-03.            Filed October 14, 2004.


     Stewart and Shirley Oatman, pro se.

     Elaine T. Fuller, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     COLVIN, Judge:   Respondent determined a deficiency in

petitioners’ Federal income tax of $1,285 for 1999 and an

accuracy-related penalty of $257.
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     After concessions,1 the issues for decision, all relating to

petitioners’ tax year 1999, are:

     1.     Whether respondent bears the burden of proof under

section 7491(a)2 as to respondent’s deficiency determination.      We

hold that petitioners bear the burden of proof.

     2.     Whether petitioners may deduct depreciation of their

Crenshaw Blvd. and W. 66th Street rental properties in an amount

greater than respondent allowed.    We hold that they may not with

respect to the W. 66th Street property, and that depreciation

with respect to the Crenshaw Blvd. property is calculated as

discussed below.

     3.     Whether petitioners may deduct a deposit of $30,087.57

they paid toward the purchase of the Crenshaw Blvd. rental

property.    We hold that petitioners must capitalize that payment

and include it in their basis in the Crenshaw Blvd. property, and

recover that cost through their depreciation deduction discussed

in issue 2.




     1
        Petitioners concede that they are not entitled to deduct
$1,466 for charitable contributions, $4,725 for employee business
expenses, $699 for miscellaneous expenses, and $1,601 for
Schedule C (Profit or Loss From Business) losses.
     2
        Section references are to the Internal Revenue Code as
amended and in effect in 1999. Rule references are to the Tax
Court Rules of Practice and Procedure.
                                - 3 -

     4.   Whether petitioners may deduct $1,304.14 they claim

they paid to refinance their W. 66th Street rental property.        We

hold that they may not.

     5.   Whether petitioners may deduct as a bad debt the amount

of a late rent penalty ($2,219) to which petitioners contend they

were entitled but did not receive.      We hold that they may not.

     6.   Whether petitioners are liable for the accuracy-related

penalty for negligence for 1999.   We hold that they are.

                          FINDINGS OF FACT

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

A.   Petitioners

     Petitioners are married and lived in Los Angeles,

California, when they filed their petition in this case.

B.   Petitioners’ Rental Properties

     Petitioners bought a four-unit residential rental property

at 8200, 8202, 8204, 8206 Crenshaw Blvd. (Crenshaw Blvd.

property) for $222,305.91 on May 3, 1999.      Petitioners paid a

deposit of $30,087.57 as part of the purchase price.

     The monthly rental rate for each Crenshaw Blvd. property

unit was $550 in 1999.    Three of those units were occupied for 8

months and the fourth was occupied 6 or 7 months in 1999.

Petitioners received rent of $14,700 in 1999 from the Crenshaw

Blvd. property tenants.
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     In 1999, petitioners also owned rental real estate at 1112 -

1114 W. 66th Street (W. 66th Street property) and 10.85 acres of

rental real estate in San Luis Obispo, California (San Luis

Obispo property).   In 1999, petitioners received rent of $8,100

from their W. 66th Street property tenants, and $0 from the San

Luis Obispo property.

C.   Petitioners’ Tax Return and Respondent’s Notice of
     Deficiency

     Petitioners timely filed their Federal income tax return for

1999.   In it, they claimed depreciation deductions for 1999 of

$8,000 for the Crenshaw Blvd. property and $3,600 for the W. 66th

Street property.    Petitioners also deducted the amount of a late

rent penalty ($2,219) to which petitioners contend they were

entitled but did not receive.

     In the notice of deficiency, respondent determined that

petitioners incorrectly calculated depreciation of the Crenshaw

Blvd. property for 1999.   Respondent determined that petitioners’

depreciable basis was $182,290.85 by subtracting $40,015.06 (to

account for basis allocated to land) from the $222,305.91

purchase price.    Respondent then applied the straight-line method

of depreciation over 27.5 years which resulted in $6,628.75

allowable depreciation for the year.    Respondent reduced that

amount to $3,867 to account for the fact that petitioners owned

the Crenshaw Blvd. property for 7 months in 1999.    Respondent

disallowed petitioners’ $2,219 bad debt deduction.
                                - 5 -

                               OPINION

A.     Whether Respondent Bears the Burden of Proof Under Section
       7491(a)

       Petitioners contend that respondent bears the burden of

proof under section 7491(a).    We disagree.

       Under section 7491(a), the Commissioner bears the burden of

proof with respect to factual issues if, inter alia, the taxpayer

has: (1) Complied with substantiation requirements under the

Internal Revenue Code, sec. 7491(a)(2)(A); (2) maintained all

records required by the Internal Revenue Code, sec.

7491(a)(2)(B); and (3) cooperated with reasonable requests by the

Secretary for information, documents, and meetings, id.

Taxpayers bear the burden of proving that these requirements are

met.    See H. Conf. Rept. 105-599, at 239 (1998), 1998-3 C.B. 747,

993; S. Rept. 105-174, at 45 (1998), 1998-3 C.B. 537, 581.      The

record does not show whether petitioners substantiated their

bases, kept records of their expenses, or cooperated with

respondent’s agents.    Thus, section 7491(a) does not apply.

Respondent’s determination is presumed to be correct, and

petitioners bear the burden of proof.    Rule 142(a)(1); Welch v.

Helvering, 290 U.S. 111, 115 (1933).

B.     Whether Petitioners May Deduct More Depreciation on the
       Crenshaw Blvd. Property Than Respondent Allowed for 1999

       Petitioners contend that they may deduct depreciation of

$11,059 with respect to the Crenshaw Blvd. property for 1999.
                               - 6 -

Petitioners contend that they may calculate the depreciation

deduction for their Crenshaw Blvd. property based on the total

amount of their payments of principal and interest over 30 years,

rather than the purchase price.   Petitioners contend that their

method of calculating depreciation is allowable under sections

167(c), 1011, and 1012 and the underlying regulations, Crane v.

Commissioner, 331 U.S. 1 (1947), and Commissioner v. Oxford Paper

Co., 194 F.2d 190 (2d Cir. 1952).   We disagree.   Depreciation

deductions are allowed on the basis of property, sec. 167(c), and

the basis of property does not include interest paid on the

mortgage used to acquire the property, see secs. 1012, 1016.

     Residential rental property placed in service after December

31, 1986, has a recovery period of 27.5 years and is depreciable

using the straight-line method.   Sec. 168(c), (b)(3)(B).   The

applicable convention for residential rental property is the

midmonth convention.   Sec. 168(d)(2).   Petitioners improperly

calculated depreciation by using a useful life of 17.5 years,

based on a full year of ownership for 1999.

     We conclude that petitioners may deduct depreciation with

respect to the Crenshaw Blvd. property for 1999 calculated by

first subtracting the amount allocable to land from the purchase

price and then, for the remaining amount, applying the straight-

line method of depreciation over 27.5 years using the midmonth

convention based on purchase on May 3, 1999.    The parties shall
                                - 7 -

calculate depreciation with respect to the Crenshaw Blvd.

property for 1999 under Rule 155.

C.   Whether Petitioners May Deduct More Depreciation on the W.
     66th Street Property Than Respondent Allowed for 1999

     Petitioners contend that they may deduct depreciation of

$16,714 with respect to the W. 66th Street property.     We

disagree.   Petitioners make the same argument relating to the W.

66th Street property as discussed in paragraph B, above.      We

disagree for the reasons stated in paragraph B, above.

D.   Whether Petitioners Must Capitalize the Deposit They Paid To
     Acquire the Crenshaw Blvd. Property

     Petitioners contend that they may deduct an earnest money

deposit of $30,087.57 they paid in 1999 for the Crenshaw Blvd.

property.   We disagree.

     Petitioners paid the $30,087.57 deposit to acquire the

Crenshaw Blvd. property.   No deduction is allowed for capital

expenditures.   Sec. 263(a).   Amounts paid to acquire property

having a useful life substantially beyond the taxable year must

be capitalized.   Sec. 1.263(a)-2(a), Income Tax Regs.    Thus,

petitioners must capitalize the $30,087.57 deposit, include it in

their basis in the Crenshaw Blvd. property, and recover that cost

as part of their depreciation deduction discussed at paragraph B,

above.
                                   - 8 -

E.   Whether Petitioners May Deduct $1,304.14 That They Claim
     They Paid To Refinance the W. 66th Street Property

     Petitioners contend that, on August 5, 1999, they paid

$1,304.14 to refinance the W. 66th Street property, and that they

may deduct this amount for 1999.      We disagree for several

reasons.    First, petitioners raised this issue for the first time

on brief.   Generally, we do not consider an issue raised for the

first time on brief and do not do so here.      DiLeo v.

Commissioner, 96 T.C. 858, 891 (1991), affd. 959 F.2d 16 (2d Cir.

1992); Torres v. Commissioner, 88 T.C. 702, 718 (1987).         Second,

even if we considered this argument, there is no evidence that

petitioners paid any amount to refinance the W. 66th Street

property in 1999.    Third, deduction of this amount for 1999 is

not appropriate because a taxpayer generally must capitalize the

cost of refinancing property that is not a principal residence.

Sec. 461(g)(1).

F.   Whether Petitioners May Deduct $2,219 as a Bad Debt

     Petitioners contend that they may deduct as a bad debt in

1999 a 1-percent penalty for late rent, totaling $2,219, that

they claim their Crenshaw Blvd. property tenants owe them but

have not paid.    We disagree.

     A taxpayer may deduct a debt that becomes worthless in the

taxable year.    Sec. 166(a)(1).    However, an unpaid amount is not

deductible as a bad debt unless the taxpayer has included the

amount in income for the year for which the bad debt is deducted
                                 - 9 -

or for a prior tax year.     Gertz v. Commissioner, 64 T.C. 598, 600

(1975).3

     Petitioners contend that they included $2,219 in income in

1999.    We disagree.   Petitioners reported on their 1999 return

that they received rent of $14,700 from the Crenshaw Blvd.

property in 1999; they did not report any other income related to

the Crenshaw Blvd. property on that return.     We conclude that

petitioners may not deduct $2,219 as a bad debt for 1999.

G.   Whether Petitioners Are Liable for the Accuracy-Related
     Penalty

     Respondent met the burden of production under section

7491(c) with respect to the accuracy-related penalty under

section 6662 because petitioners conceded that they are not

entitled to deduct certain charitable contributions, employee

business expenses, miscellaneous expenses, and Schedule C losses,

and they figured their tax liability for 1999 by computing

depreciation using clearly improper methods.4


     3
        See also sec. 1.166-1(e), Income Tax Regs., which
provides:

     Worthless debts arising from unpaid wages, salaries,
     fees, rents, and similar items of taxable income shall
     not be allowed as a deduction under section 166 unless
     the income such items represent has been included in
     the return of income for the year for which the
     deduction as a bad debt is claimed or for a prior
     taxable year.
     4
       We could also conclude that respondent has no burden of
production under sec. 7491(c) where, as here, petitioners failed
                                                   (continued...)
                             - 10 -

     We conclude that petitioners are liable for the accuracy-

related penalty under section 6662 because they have neither

contended nor offered evidence to show that they are not so

liable.   Rule 34(b)(4).

     To reflect the foregoing,



                                             Decision will be

                                        entered under Rule 155.




     4
      (...continued)
to challenge (and we deem them to have conceded) the accuracy-
related penalty. See Funk v. Commissioner, 123 T.C. __, __
(2004) (slip op. p. 9); Swain v. Commissioner, 118 T.C. 358, 364-
365 (2002); Jarvis v. Commissioner, 78 T.C. 646, 658 n.19 (1982).
