                  T.C. Memo. 1996-78



                UNITED STATES TAX COURT



       MASCHMEYER’S NURSERY, INC., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 22315-94.            Filed February 26, 1996.



     R determined that deductions claimed by P for
annual rental payments made to P’s sole shareholder
under a real property lease exceeded the fair rental
value of the property, and disallowed depreciation
deductions claimed by P for improvements made to a
residence used by P’s sole shareholder. Held: Rental
payments were not deductible to the extent that they
exceeded the amount allowed by R. Held, further, the
residence occupied by P’s sole shareholder was used in
P’s business for purposes of sec. 167, I.R.C., and
hence, depreciation may be deducted by P.


F. Pen Cosby, for petitioner.

Ronald T. Jordan, for respondent.
                                  - 2 -




             MEMORANDUM FINDINGS OF FACT AND OPINION

     LARO, Judge:   This case is before the Court on the petition

of Maschmeyer’s Nursery, Inc., to redetermine deficiencies and

accuracy-related penalties determined by respondent as follows:

                                                Penalty
     Year            Deficiency              Sec. 6662(a)

     1989             $47,284                   $9,457
     1990              47,762                    9,552
     1991              43,777                    8,755

     The issues for decision are:     (1) Whether annual payments

made by petitioner to its sole shareholder and his wife under a

lease of undeveloped land are deductible by petitioner as rent to

the extent that they exceed $65,000; (2) whether improvements to

a residence located on petitioner’s premises and used by its sole

shareholder qualify as property used in a trade or business for

which depreciation deductions claimed by petitioner are

allowable; and (3) whether petitioner is liable for accuracy-

related penalties under sections 6662(a) and (b)(1).1

                         FINDINGS OF FACT

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

The stipulations and attached exhibits are incorporated herein by

this reference.   Petitioner is an Indiana corporation with its


     1
       All section references are to the Internal Revenue Code in
effect for the years at issue and all Rule references are to the
Tax Court Rules of Practice and Procedures.
                                - 3 -

principal office located in Whiteland, Indiana.   Petitioner grows

nursery stock for sale at wholesale and provides landscaping

services.   During the taxable years at issue petitioner’s sole

shareholder was James R. Maschmeyer (Maschmeyer).   He became sole

shareholder in 1986 after petitioner redeemed the stock held by

his parents.

Rent Deductions

     Petitioner owns a parcel of 265 acres.   The scale of

petitioner’s operations is approximately twice this area,

however, because petitioner leases additional contiguous land

from Maschmeyer and his wife.   The Maschmeyers acquired the land

for petitioner’s use as it became available over several years.

This arrangement was designed to avoid increasing the

corporation’s long-term debt, which would have jeopardized its

ability to borrow for working capital at favorable rates.    Tract

B, comprising 126.5 acres situated on the southern border of

petitioner’s own land, was acquired by the Maschmeyers in two

parts:   37-1/2 acres in August 1984 at a price of $52,500 ($1,400

per acre) and 89 acres in December 1986 at a price of $180,000

($2,022.50 per acre).   Tract A, comprising 123.5 acres situated

on the northern border of petitioner’s own land, was acquired in

January 1989 through an estate sale for $228,449 ($1,850 per

acre).   Thus, the total investment by the Maschmeyers amounted to

approximately $461,000.   In January 1989 they entered into a

5-year lease with petitioner for both tracts at an annual rental
                               - 4 -

of $140,000 ($560 per acre).   On its corporate tax returns, Form

1120, for the years at issue petitioner claimed a deduction for

this amount as an ordinary and necessary business expense.     On

their individual tax returns for these years, the Maschmeyers

claimed mortgage interest deductions in connection with the lease

in the amounts of $25,031, $19,170, and $17,550.

     The two tracts are essentially identical in soil quality,

grade, and drainage and have no improvements besides drainage

tile.   About 30 percent of tract A is covered in woods and

consequently not used for cultivation.   During the years at

issue, the tracts had access to some utilities.    Sewer,

electricity, and telephone service were available to tract A.

Only electricity and telephone service were available to tract B.

Neither had access to municipal water.   Both tracts were zoned

for residential use.   The tracts are located about 15 to 20 miles

from downtown Indianapolis in a neighborhood consisting primarily

of agricultural land intermixed with single-family homes.     During

the years at issue demand for undeveloped land in the

neighborhood was stable.   But the neighborhood lies within a

narrow corridor formed by two major arteries to the Indianapolis

metropolitan area, I-65 and U.S. Highway 31, along which

considerable residential and commercial development was

occurring.   The residential growth extending southward and

northward from the nearby cities of Greenwood and Franklin made

it likely that vacant land in this neighborhood would be subject
                                - 5 -

to increasing demand from speculators and developers in the near

future.

     In determining a rental rate for the tracts of $140,000,

Maschmeyer did not consult a real estate appraiser.   He relied

instead upon the expertise that he had developed over nearly

20 years of full-time work in the nursery business and upon the

advice of a certified public accountant (C.P.A.), Daniel H.

Wagner (Wagner).    Wagner had at least 10 years of experience in

tax accounting prior to the years at issue and personally

prepared petitioner’s tax returns for each year beginning in

1985.   Maschmeyer and Wagner were not aware of any comparable

leases in the Indianapolis area, so they constructed what they

believed to be a fair and reasonable rent from, inter alia,

information they had as to prevailing cash rents for lower value

crops, productivity of nursery operations, petitioner’s projected

cash-flow, the Maschmeyers’ borrowing costs for purchase of the

tracts, loss of topsoil through harvesting practices, the

economies expected to result from the use of contiguous acreage,

and the prevailing yield on financial assets.   In her notice of

deficiency respondent determined that only $23,000 of the annual

rental payments was deductible as an ordinary and necessary

business expense.   Subsequently respondent revised her

determination to $65,000 on the basis of a professional real

estate appraisal.
                                 - 6 -

Depreciation Deductions

     A house is located on petitioner’s property.   The

Maschmeyers moved into this house in 1977 to replace the previous

tenant, who had lived there since about 1965 while employed as

petitioner’s foreman.   Maschmeyer continued to occupy the house

throughout the years at issue.    For the convenience of his wife

and children, however, in 1989 he purchased a home in

Indianapolis, where his wife and children lived during the week.

Maschmeyer assumed the foreman’s duties, securing the premises

and equipment, overseeing the gang of migrant workers housed in

mobile homes on the premises, and supervising pickup of trees

outside business hours during harvest seasons.

     After Maschmeyer became sole shareholder, petitioner made

certain improvements to the house that Maschmeyer occupied.   In

1986 a swimming pool was installed at a cost of $35,011.    In 1987

a pool house and other amenities were added to the house at a

cost of $32,684.   In 1988 and 1989 improvements were made to the

garage and a master bedroom was added to the house at a cost of

$94,295.   Additional redecorating and wallpapering were done at a

cost of $4,482 in 1990.   Petitioner claimed depreciation

deductions for the aforesaid improvements in 1989, 1990, and 1991

in the amounts of $4,212, $5,038, and $5,038, respectively.

Respondent disallowed these deductions in her notice of

deficiency.
                               - 7 -

                              OPINION

1. Rent Deductions

     Section 162 provides for the deduction of all ordinary and

necessary business expenses, including rentals required to be

paid as a condition for the use of property.   Sec. 162(a)(3).

Although the statutory standard does not expressly limit the

deduction to a reasonable amount, where the lessor and lessee are

closely related and there is no arm’s-length dealing between

them, an inquiry into what constitutes a reasonable rental is

necessary to determine whether the sums paid exceed what the

lessee would have been required to pay in an arm’s-length

transaction with an unrelated party.    Potter Elec. Signal &

Manufacturing. Co. v. Commissioner, 286 F.2d 200, 202-203 (8th

Cir. 1961), affg. T.C. Memo. 1960-030; Feldman v. Commissioner,

84 T.C. 1, 6-8 (1985); Davis v. Commissioner, 26 T.C. 49, 56

(1956); Place v. Commissioner, 17 T.C. 199, 203 (1951), affd. 199

F.2d 373 (6th Cir. 1952).   Since Maschmeyer is petitioner’s sole

owner and it is undisputed that he played a major role in

determining the rental, we look beyond the agreement for evidence

of the fair rental value of the subject property.

     Each party presented the opinion of a professional real

estate appraiser to establish fair rental value.    Both appraisers

were highly qualified by education and experience to render an

expert opinion.   Since neither expert was able to identify

comparable lease transactions within the Indianapolis region,
                                - 8 -

each resorted to an alternate method.    Respondent’s expert,

Michael C. Lady (Lady), arrived at a figure of $65,000 ($260 per

acre) by comparing the subject property with certain nursery

properties under long-term lease in the vicinity of the Chicago

metropolitan area.   Petitioner’s expert, Stephen L. Cobb (Cobb),

used financial theory to calculate a market rate of return on the

appraised value of the subject property.    He conservatively

estimated this return at $111,500 ($446 per acre), but values of

$139,000 to $156,000 would have provided the lessor with a more

reasonable return in his opinion.    Petitioner bears the burden of

proof.   Rule 142(a).   Accordingly, the question for the Court to

decide is whether petitioner, through its expert, has justified

rental payments in excess of the amount of $65,000 adopted by

respondent in her revised determination.

     The first step in Cobb’s analysis was to determine the fair

market value of the subject property as of June 1990, assuming

based on neighborhood growth trends that its current agricultural

use was an interim use and that residential development was

likely in the near future.    For each tract Cobb identified six

sale transactions in the neighborhood involving vacant land with

comparable characteristics.    After making certain adjustments to

correct for significant differences, such as size, utilities, and

zoning, he appraised tract at $593,000 ($4,800 per acre) and

tract B at $278,000 ($2,200 per acre).    The aggregate value of

the subject property in Cobb’s opinion was therefore $871,000
                                - 9 -

(about $3,500 per acre).   Respondent challenges the reliability

of Cobb’s appraisal on several grounds.    Respondent argues that

three of the sale transactions used to support the valuation of

tract A are unrepresentative because two of the properties are

located within the city limits of Greenwood, where residential

development is more advanced than in the immediate environs of

the subject property, and the third is known to have been sold to

a developer for residential subdivision.   The weakness in this

argument is that respondent concedes that the other sales

comparables used by Cobb to value tract A and tract B are

unbiased and consistent with the fair market value determined by

her own expert, and yet all of these properties were also located

in Greenwood and some were intended for immediate residential

development, like the comparables which respondent believes to be

unrepresentative.

     Respondent also points out the large discrepancy between the

$593,000 value Cobb assigns to tract as of 1990 and the $228,500

price at which it was acquired by the Maschmeyers in 1989.    Cobb

explained this discrepancy by the fact that the Maschmeyers

acquired tract A in the settlement of an estate; hence in his

view the price of that acquisition had not reflected the

property’s fair market value.   A more serious problem in Cobb’s

appraisal is the discrepancy between his values for tract A

($4,800 per acre) and tract B ($2,200 per acre).   The only

important difference between the tracts is that one has access to
                               - 10 -

a sewer and the other does not.    This difference is important:

in reconciling the sales comparables to the subject property,

Cobb used an adjustment factor of plus 60 percent or minus 30

percent to correct for inferior or superior utility service

relative to the subject property.    Yet, if tract B were correctly

valued at $2,200 per acre, application of Cobb’s adjustment

factor would yield a value for tract A of $3,520 per acre.    On

the other hand, if tract A were correctly valued at $4,800 per

acre, application of Cobb’s adjustment factor would yield a value

for tract B of $3,360 per acre.    Either way there is a sizable

residual discrepancy that Cobb has not explained.    That only 70

percent of tract A is currently tillable makes the discrepancy

all the more puzzling.    Respondent reasons that Cobb has grossly

overstated the value of tract A.    An alternative interpretation,

however, is that Cobb understated the value of tract B.    The

inconsistency calls into question the reliability of Cobb’s

appraisal.

     The next step in Cobb’s analysis was to calculate the amount

of rental income that a hypothetical investor in the subject

property would require.   This was accomplished by multiplying the

estimated fair market value of each tract by a “built-up” rate.

This rate is the sum of (1) the risk-free rate of return for a

term of years equal to that of the lease, represented by the

yield of 8.77 percent on 5-year U.S. Treasury bonds as of April

1990; (2) a minimum risk premium of 2 percent, reflecting the
                              - 11 -

riskiness associated with investment in real estate; and (3) a

minimum soil depletion factor of 2 percent, reflecting a

conservative forecast of the loss of topsoil through nursery

cultivation.   Cobb’s conservative estimate of the required rate

of return is thus 12.77 percent.    Although Cobb believes that

more reasonable estimates of each component would imply a rate of

return in the range of 16 to 18 percent, Cobb adopted the

conservative figure in his conclusions:

     Required rent = ($871,000) (12.77%)
                   = $111,2272

     Respondent contends that “Cobb committed a fundamental error

in financial analysis” by computing the hypothetical investor’s

rate of return on investment in terms of the fair market value of

the subject property instead of the original investment cost.

The Maschmeyers purchased the tracts for a total of $461,000.     If

Cobb had multiplied his estimate of the required rate of return

by this amount, his conclusion would have been an annual rent of

less than $59,000, an amount which does not exceed the deduction

respondent has allowed.

     We believe respondent misconstrues what Cobb’s required

return attempts to measure.   As we understand it, his calculation

is based on the opportunity cost as of mid-1990 of holding the

subject property.   The opportunity cost of an investment is the


     2
       Cobb’s figure is $111,562.   This discrepancy is due to
rounding.
                              - 12 -

highest alternative return from assets of equivalent risk which

the investor forgoes as a result of his investment.3    Where, as

here, the fair market value of an asset substantially exceeds the

cost of acquisition, it would make little sense to measure the

opportunity cost of holding the asset by the return that the

investor could otherwise earn on the cost of the investment,

since he could sell the asset at its higher fair market value and

reinvest the proceeds.   Thus, the amount that Cobb’s hypothetical

investor forgoes by holding the subject property as of mid-1990,

and which the land must yield in order to induce him to continue

holding it, is the amount that the current cash value of the land

would yield if this sum were invested in financial assets of

equivalent risk.4

     In other respects, however, Cobb’s methodology seems to us

unsound.   First, we are not convinced that a 2-percent allowance

should be made for soil depletion.     Respondent’s expert testified

that information he received from other nursery operators whom he

interviewed suggests that topsoil loss over the limited period


     3
       See generally Brealey & Myers, Principles of Corporate
Finance 87-88, 248-249 (2d ed. 1984).
     4
       The capital gains tax that would be incurred in this
alternative reinvestment strategy represents a cost that would
reduce the return from the alternative investment relative to the
return from holding the land. Ideally this should be taken into
account. However, the size of this cost would depend upon the
hypothetical investor’s effective tax rate and whether the tax
was spread out over multiple years by use of an installment sale,
matters as to which we have no information.
                                - 13 -

over which agricultural use of the land is expected to continue

would probably be much less than Cobb estimates.    Moreover, the

value of the land for residential use would not decline with

moderate amounts of topsoil loss, because less topsoil is needed

for this purpose.   Maschmeyer himself, through careful and

well-informed calculations submitted for the record, estimated

that $9,125 per year would compensate him for soil depletion.

This represents only 1.05 percent of the fair market value

determined by Cobb.

     More importantly, Cobb’s analysis fails to take into account

changes in land value.    If one measured the return from corporate

stock solely in terms of dividend yield, one would not be able to

explain why so many investors hold stock as an alternative to

corporate bonds offering much higher coupon yields.    The

investor’s total return from land is the sum of the periodic

income plus capital appreciation minus any depreciation in the

land owing to soil depletion.    By omitting an appreciation

factor, Cobb’s equation overstates the amount of rent that an

investor would require.

     Omission of an appreciation factor is also inconsistent with

characterization of agriculture as only an interim use, a major

premise of Cobb’s fair-market value appraisal.    If the return

from the agricultural use in the form of annual rent were

sufficient to satisfy the investor, then agriculture would be the

highest and best use of the land.    The phenomenon of speculative
                              - 14 -

appreciation in and around the neighborhood of the subject

property due to the expectation of, and opportunities for,

residential development is one empirical fact on which both

experts agreed, and it plays a central role in their assessment

of the market.   As Cobb in his report observes:

          This vacant land is in the likely path of
     development and would be appealing to a potential
     developer as demand is increased. This investor would
     be interested in holding the property in anticipation
     of a future reward for the investment as utilities are
     extended toward the subject.

          The subject’s proximity to employment centers,
     surrounding land development and extended utility
     development supports the speculative attitude toward
     the subject tracts, especially tract A. It is obvious
     that the subject has the potential for becoming
     speculative land.

     It is clear that an analysis of an investor’s total return

from the land should take into account the rent plus actual or,

more appropriately, expected appreciation.     The difficulty is to

estimate the rate of appreciation.     Lady used a figure of 4

percent per year to correct for time differences in the four

comparable sales transactions that he identified in the

neighborhood of the subject property between 1990 and 1992 as the

basis of his fair market value appraisal.     If we used 4 percent

as a measure of the return received by an investor in the form of

land appreciation, and limited the soil depletion factor to

1.05 percent, we would adjust Cobb’s equation as follows:

     Required rent + 4% = ($871,000) (8.77% + 2% + 1.05%)
          Required rent =   $68,112
                              - 15 -

     The basis for Lady’s 4-percent figure is not evident from

his report, but as an estimate of the expected rate of

appreciation during the years at issue it seems very

conservative.   The consumer price index for the 2 years prior to

April 1990 was increasing at 4-1/2 to 5 percent.     An investor

holding land for interim agricultural use in the vicinity of

substantial residential development could presumably have

expected it to appreciate significantly in excess of the general

inflation rate.   Information in the record is not sufficient for

the Court to estimate what rate of appreciation an investor could

reasonably have expected.   Suffice it to say, however, that if we

selected a rate even one-half percentage point higher than

4 percent, the required rent implied by Cobb’s equation would no

longer exceed the amount determined by respondent.

     Required rent = ($871,000) (7.32%)
                   =   $63,760

Accordingly, Cobb’s analysis does not persuade us that

respondent’s determination is incorrect.

     Our result would not be materially different if we

constructed an arm’s-length rent in a manner similar to that used

by Maschmeyer and petitioner’s accountant.     The rental amount

determined by respondent would cover the Maschmeyers’ actual

costs and provide a reasonable return for ownership risk.

     In his computation Maschmeyer allowed $26,004 for the

Maschmeyers’ average borrowing costs.     Why this amount exceeds
                              - 16 -

the mortgage interest deductions claimed on the Maschmeyers’

individual tax returns for the years at issue was not

satisfactorily explained.   The average of the amounts claimed on

the returns is $20,584.   To this we add the annual allowance for

soil depletion that Maschmeyer carefully calculated and used in

his computation; viz., $9,125.   These are the lessors’ costs.    We

can also include in the arm’s-length price the $25,000 location

premium that Maschmeyer calculated based on the savings to the

corporation in labor and fuel costs.   It is an elementary fact of

real estate markets that land is not fungible, and locational

differences can account for significant price differences within

a competitive market.   Because contiguous acreage is more

valuable to petitioner than otherwise identical property situated

at a distance, even if the land owner were an unrelated party

negotiating at arm’s length he would be in a position to capture

at least some of the premium value that the land would generate

in petitioner’s operations.

     Maschmeyer included in the rent an additional amount

representing a 10-percent return on investment ($46,592).    In

support of this item he noted that the return per acre for a

nursery operation is approximately 25 times that from typical

farming operations.   We think this item is unwarranted for three

reasons.   First, the return per acre is a function not only of

land but also of labor and capital inputs.   Maschmeyer apparently

made no attempt to quantify the relative contribution of each of
                                - 17 -

these three factors of production in nursery operations.

Consequently, this comparison is of little, if any, probative

value.   Second, the location premium itself represents pure

profit, which ought to be included in the landowner’s return.

Third, a rate of return as high as 10 percent has not been

justified.    Petitioner’s own expert estimated that a 2-percent

premium would adequately compensate an investor for the risks of

ownership.    The $25,000 location premium alone provides more than

that, measured either in relation to the Maschmeyers’ original

investment cost or the current value of their investment.

Finally, Maschmeyer included in his calculation a base rental

amount equal to the market rent for land used to grow corn and

beans ($37,500 or $150 per acre).    We fail to see the relevance

of this item and accordingly exclude it.    The total of the

justifiable items enumerated above does not exceed $65,000.

                 $20,584   average borrowing cost
                   9,125   depletion cost
                  25,000   location premium/profit
                  54,709

     We need not make our own determination of fair rental value.

Petitioner has justified no more than the amount allowed by

respondent.

2. Depreciation Deductions

     Respondent disallowed depreciation deductions claimed by

petitioner for improvements to a residence occupied by Maschmeyer

during the years at issue.    Section 167 authorizes a depreciation
                               - 18 -

deduction equal to a reasonable allowance for the exhaustion and

wear and tear of property used in a trade or business.    In

determing whether living accommodations provided to a corporate

employee constitute property used in a trade or business for

purposes of section 167, this Court has taken into account the

requirements of section 119:   (1) The living accommodations are

furnished on the business premises of the employer; (2) they are

furnished for the convenience of the employer; and (3) the

employee is required to accept such living accommodations as a

condition of his employment.   The third requirement can be

satisfied by a showing that acceptance of the accommodations was

necessary in order for the employee properly to perform his

duties, as for instance, where he must be available for duty at

all times on the premises of the employer.   Johnson v.

Commissioner, T.C. Memo. 1985-175; J. Grant Farms v.

Commissioner, T.C. Memo. 1985-174; sec. 1.119-1(b), Income Tax

Regs.   Thus, in the companion cases of Johnson and J. Grant Farms

we held that a corporation in the business of farming was

entitled to deduct depreciation on a residence used by its sole

owner/farm operator because he was required to live on site in

order to be available for duty at all times in connection with

his managerial responsibilities.   Petitioner bears the burden of

proving that its deductions are allowable.   Rule 142(a).
                              - 19 -

     The dispute between the parties focuses on the third

requirement.5   Respondent argues that because Maschmeyer was

employed as petitioner’s president, in order to satisfy the third

requirement petitioner must demonstrate that Maschmeyer was

required to use the residence in order to perform his executive

duties.   In respondent’s view, petitioner has not satisfied its

burden.

     We are not persuaded by respondent’s logic, which reflects

an unduly narrow understanding of the scope of Maschmeyer’s

executive duties.   Maschmeyer testified that petitioner needed

someone on the premises at all times for the security of its

500-acre nursery and valuable equipment, for supervision of

resident migrant workers, and for shipment of trees after

business hours during the busy harvest season.   He testified that

for more than a decade the residence was occupied by the foreman

who performed these duties.   He testified that he assumed these

duties when the foreman secured employment elsewhere.

Maschmeyer’s testimony was credible and uncontroverted.   It is

clear from the nature of these duties that they required presence

on-site at all times during the work week.   If Maschmeyer had not

been required by his responsibilities to reside on-site, there

would be no explanation for the fact that he continued to live

     5
       Both parties seem to have taken it for granted that
improvements to a residence should be treated no differently from
the residence for purposes of this analysis. We shall therefore
do likewise.
                               - 20 -

there after his family moved to a different home in 1989.    No

evidence was offered from which we can properly infer any other

reason for this separation.6   That Maschmeyer served as

petitioner’s president is beside the point.   His use of the

residence was necessary to petitioner’s business as described

above.   We are satisfied that the residence was used in

petitioner’s business for purposes of section 167.

     Respondent attaches great importance to the fact that the

improvements commenced immediately after Maschmeyer became sole

shareholder.   From this respondent infers that the improvements

were made to benefit Maschmeyer as a shareholder rather than as

an employee.   There is no support in the analogous cases,

J. Grant Farms v. Commissioner, supra, and Johnson v.

Commissioner, supra, for the proposition that because the farm

operators who lived on site were also sole owners of the

corporation, the accommodations were being furnished to them in

their capacity as shareholders.   Inasmuch as Maschmeyer continued

throughout the taxable years at issue to perform the employment

duties for which the corporate residence was made available to

him, we find that any distinction between benefits he received as

an employee and benefits he received as a shareholder is not


     6
       We are not persuaded otherwise by the evidence that he is
currently in the process of obtaining a divorce. We find that he
was required to live on petitioner’s property in order to
discharge his responsibilities as manager of petitioner’s
business.
                                - 21 -

dispositive.7    Petitioner has satisfied its burden of proving

that disallowance of the depreciation deductions on the grounds

adduced therefor by respondent was improper.8

3.   Accuracy-Related Penalty

     Section 6662 provides for a penalty equal to 20 percent of

any portion of the underpayment that is attributable to

negligence or disregard of rules or regulations.       Sec. 6662(a)

and (b)(1).     Negligence generally is defined as lack of due care

or failure to do what a reasonable and ordinarily prudent person

would do under the circumstances.     Neely v. Commissioner, 85 T.C.

934, 942 (1985); cf. sec. 6662(c).       The penalty can be avoided by

good faith reliance on the expertise of a professional adviser

after full disclosure of relevant information.       United States v.

Boyle, 469 U.S. 241, 250-251 (1985); Patin v. Commissioner,

88 T.C. 1086, 1129-1131 (1987), affd. sub nom. Gomberg v.

Commissioner, 868 F.2d 865 (6th Cir. 1989), affd. without

published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186


     7
       Cf., e.g., Gill v. Commissioner, T.C. Memo. 1994-92, affd.
___ F.3d ___ (6th Cir. Jan. 23, 1996), where we disallowed
depreciation deductions claimed by a corporation with respect to
a residence furnished to its shareholder-employee, because the
primary purpose for the corporation’s acquisition and maintenance
of the residence was to serve the shareholder’s personal benefit.
     8
       The deduction provided by sec. 167 is limited to a
reasonable allowance. Respondent has not challenged the
depreciation deductions on the ground that the expenditures for a
pool, pool house, master bedroom, interior redecorations, and the
like were extravagant or extraneous to the business purpose of
the residence.
                              - 22 -

(4th Cir. 1988), affd. sub nom. Skeen v. Commissioner, 864 F.2d

93 (9th Cir. 1989), affd. without published opinion 865 F.2d 1264

(5th Cir. 1989); Pessin v. Commissioner, 59 T.C. 473, 489 (1972);

sec. 6664(c)(1); sec. 1.6664-4(b)(1) and (2), Example (1), Income

Tax Regs.   Reliance on an adviser will not immunize the taxpayer

from liability, however, where the taxpayer knew or should have

known that its adviser lacked sufficient knowledge regarding the

subject matter of the consultation.    Patin v. Commissioner,

supra; Ellwest Stereo Theaters v. Commissioner, T.C. Memo.

1995-610; sec. 1.6664-4(b)(1) and (2), Example (1), Income Tax

Regs.

     It is undisputed that Maschmeyer relied on the advice of

petitioner’s accountant, Wagner, in determining a rental for the

lease of tracts A and B, and in preparing the corporate tax

returns reflecting these rental payments.   Respondent argues that

the penalty is nevertheless appropriate because Maschmeyer did

not rely on the advice of a real estate appraiser.   Respondent’s

argument is unwarranted on the particular facts of this case.

Maschmeyer is highly knowledgeable about a business he has been

engaged in for 20 years.   Wagner is a C.P.A. with many years’

experience in tax return preparation and thorough familiarity

with petitioner’s tax and financial situation.   It was not

unreasonable for Maschmeyer to believe that together they could

determine an arm’s-length rent that accounted for all relevant

business and financial factors.   Their testimony and the exhibits
                              - 23 -

they prepared explaining how the rental was derived display a

conscientious, if not wholly convincing, effort to arrive at an

accurate appraisal.   As the wide discrepancy between the

appraisals presented to the Court by the parties’ experts, Lady

and Cobb, illustrates, the making of an appraisal is not an exact

science.   We are satisfied that Maschmeyer’s conduct on

petitioner’s behalf was consistent with ordinary business care

and prudence.

     Indeed the $140,000 rental deduction claimed by petitioner

on its tax returns falls squarely within the range that Cobb, in

his expert opinion, considered reasonable ($871,000 x 16% =

$139,360; $871,000 x 18% = $156,780).   Thus, petitioner’s

valuation was in fact consistent with that of a professional real

estate appraiser.

     The accuracy-related penalty does not apply.     To reflect the

foregoing,

                                         Decision will be entered

                                    under Rule 155.
