                       T.C. Memo. 1998-394



                     UNITED STATES TAX COURT



GARY K. BIELFELDT AND CARLOTTA J. BIELFELDT, ET AL.,1 Petitioners
         v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 5936-96,   6080-96,    Filed November 6, 1998.
                 6154-96,   6155-96,
                 6156-96,   7264-96,
                 7265-96,   7346-96.

     Timothy C. Frautschi, Maureen A. McGinnity, Elizabeth Staton

Idleman, Lloyd J. Dickinson, and Wayman C. Lawrence, IV, for

petitioners.

     Alan M. Jacobson, Joseph T. Ferrick, and David D. Choi,

for respondent.



     1
      Cases of the following petitioners have been consolidated
for purposes of trial, briefing, and opinion: docket No.
6080-96, Bielfeldt & Company Profit Sharing Plan and Trust, Bank
One, Peoria, Trustee, and Bielfeldt & Company, a general
partnership, by Gary K. Bielfeldt; docket No. 6154-96, Linda S.
Bielfeldt; docket No. 6155-96, David L. & Julie K. Bielfeldt;
docket No. 6156-96, Karen J. Bielfeldt Gray; docket No. 7264-96,
Gary K. & Carlotta J. Bielfeldt; docket No. 7265-96, Gary K.
Bielfeldt; docket No. 7346-96, David L. & Julie K. Bielfeldt.
After trial, however, the parties notified the Court that the
issue addressed herein applies only to docket No. 5936-96.
Accordingly, the issue addressed herein applies only to
docket No. 5936-96.
                                  - 2 -


                MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:     Gary K. Bielfeldt and Carlotta J. Bielfeldt

petitioned the Court to redetermine respondent's determination of

deficiencies in, and additions to, their 1984 through 1988

Federal income taxes.    Respondent determined the following

deficiencies and additions thereto:

                                     Additions to Tax
     Year       Deficiency     Sec. 6653(a)(1)     Sec. 6661
     1984          ---             $32,514            ---
     1985       $5,013,651       1,280,929        $1,253,413
     1986       19,342,834         967,142         4,835,709
     1987        6,871,323         343,566         1,717,831
     1988        2,523,008         126,150           630,752

Respondent also determined that petitioners are liable for the

time-sensitive addition to tax under section 6653(a)(2) for each

of the taxable years from 1984 through 1987.

     Following the trial of one of the issues arising in this

case, we must decide whether gains and losses realized by Gary K.

Bielfeldt (petitioner) on the disposition of U.S. Treasury

securities (Treasury securities) are ordinary or capital.

We hold they are capital.      Unless otherwise stated,

section references are to the Internal Revenue Code in effect for

the relevant years.

                             FINDINGS OF FACT

I.   Overview

     Some facts have been stipulated and are so found.      The

stipulated facts and exhibits submitted therewith are

incorporated herein by this reference.      Petitioner and Ms.
                                 - 3 -


Bielfeldt are husband and wife, and they resided in Peoria

Heights, Illinois, when they petitioned the Court.   They are cash

method taxpayers, and they filed joint Federal income tax returns

for the subject years.   Their 1984 through 1988 tax returns were

prepared by Peat, Marwick, Mitchell & Co., or a successor thereto

(collectively, Peat, Marwick).    Their 1989 return was prepared by

Coopers & Lybrand.   Petitioner holds a bachelor's degree and a

master's degree.

     During the subject years, petitioner bought and sold

Treasury securities, and his tax returns for those years reported

his sales as capital gains or capital losses.   Petitioner's 1984

return reported that he was an "investor" in Treasury securities.

Petitioner's 1985 through 1989 returns reported that he was a

"trader" in Treasury securities.    Petitioner notified respondent

of his claimed change in status by attaching a statement to his

1985 tax return that read in relevant part as follows:

     During 1985 the above-named taxpayer had a very extreme
     change in the volume of trading activities conducted on
     his own behalf. The magnitude of trading activities
     now qualify the taxpayer as "trader" for tax purposes
     rather than an "investor".

     Respondent audited petitioner's 1984 through 1989 taxable

years, and, at or about the same time, respondent audited the

related years of Bielfeldt & Co. (B&C) and its predecessor

Bielfeldt, Lauritsen & Hagemeyer (BL&H), general partnerships in
                                 - 4 -


which petitioner was the controlling partner.2     Respondent's

audit of petitioner ended on April 22, 1991, with the issuance to

him of a 30-day letter.

      On July 17, 1991, petitioner amended his 1985 through 1988

tax returns to assert therein that he was a dealer in Treasury

securities, and that he was entitled to income tax refunds

resulting from reclassifying his gains and losses as ordinary.

On January 11, 1996, respondent issued to petitioner a notice of

deficiency that, in relevant part, disallowed the refund claims

on the amended returns on the basis of respondent's determination

that petitioner was not a dealer in Treasury securities.     In this

proceeding, petitioner claims the following income tax refunds on

the basis of his assertion that he was a dealer:

                     Year               Refund
                     1984             $3,202,380
                     1985             19,781,480
                     1986             39,160,798
                     1987             16,232,812
                     1988              6,658,075


II.   Treasury Securities Cash Market

      The Treasury securities cash market consists of bills,

notes, and bonds issued by the Department of the Treasury

(Treasury).   Treasury bills (T-bills) are issued in 3-month,

6-month, or 1-year maturities.    T-bills are non-interest-bearing



      2
       BL&H's partnership agreement was amended on Dec. 7, 1985,
to change BL&H's name to B&C as of Jan. 1, 1986. Both BL&H and
B&C filed Forms 1065, U.S. Partnership Return of Income.
Hereinafter, we refer to BL&H as B&C.
                               - 5 -


obligations that are issued below face value and redeemed at

maturity at face value.   Treasury notes (T-notes) are issued in

2-, 3-, 4-, 5-, 7-, or 10-year maturities.    T-notes are issued at

or near face value, and they are redeemed at maturity at face

value.   T-notes bear a fixed rate of interest, which is payable

semiannually, and most T-notes are noncertificated; i.e., they do

not exist in physical form but trade through an electronic system

known as the Federal Reserve Bank book entry system.   Treasury

bonds (T-bonds) mature 10 or more years after issuance.   T-bonds

are issued at or near face value, and they are redeemed at

maturity at face value.   T-bonds bear interest, which is payable

semiannually, and most new T-bonds are noncertificated.   The

interest rate on new T-bonds is set at auctions held by the

Federal Reserve Bank of New York (the Fed).

     Treasury securities are rarely listed on an organized

exchange, and the volume of trading of Treasury securities on

organized exchanges is minimal.   Virtually all trading of

Treasury securities occurs over the counter or at auctions which

the Treasury holds to sell the securities initially.   Auction

bidders tender competitive or noncompetitive bids.   Competitive

bids generally represent the price that bidders offer to buy the

securities, and noncompetitive bids generally represent the

bidders' offers to buy the securities at the average of the

successful competitive bids.   Bidders, other than primary dealers

(as defined below), must deposit 10 percent of any competitive
                               - 6 -


bid tendered, and these deposits are held without interest for

days or weeks until the auction purchase settles.   In practice,

only primary dealers submit competitive bids directly to the

Treasury; they do so for their own accounts as well as on behalf

of others.

     After Treasury securities are issued through the auction

process, they are generally traded over the counter in direct

transactions between the buyer and the seller or through

interdealer brokers (as defined below).3   Prices are quoted as

bids (the price that a buyer is willing to pay) and offers or

asks (the price at which a seller is willing to sell).   A

transaction is effectuated when a buyer or seller accepts a bid

or offer, respectively, or when they negotiate a different price.

Over-the-counter trading of Treasury securities is usually

effectuated over the telephone on the basis of established

business relationships.

     "Primary dealers" are the 35 to 40 firms which have been

recognized as such by the Fed to deal with it directly in the

Treasury securities market.4   In designating primary dealers, the


     3
       Between the announcement of an upcoming auction and the
issuance of the securities following the auction, new issues of
Treasury securities also are traded over the counter on a
"when-issued" (WI) basis for a period that may last from several
days to approximately 2 weeks. The purchaser of WI securities
must pay for the securities on or before the date that the
securities are issued.
     4
       Dealers in the Treasury securities market who are not
primary dealers are known informally as "secondary dealers".
                                                   (continued...)
                               - 7 -


Fed applies the following criteria:    (1) The firm must have

adequate capital relative to the positions it assumes; (2) the

firm must participate consistently and meaningfully in Treasury

auctions of new securities and must submit bids in every auction;

(3) the firm must file periodic reports with the Fed setting

forth certain market information; and (4) the firm must be an

effective market maker.

     Primary dealers trade Treasury securities for their own

accounts (proprietary trading) or for the accounts of customers

pursuant to customer directives (customer trading).    These two

types of trading are not mutually exclusive.    A primary dealer

may accept a customer's bid or offer for a particular security as

part of the dealer's proprietary trading strategy, or it may

initiate trades to improve its proprietary position.    Primary

dealers frequently trade Treasury securities with other primary

dealers either directly (trader to trader) or indirectly through

interdealer brokers.   Primary dealers frequently sell to other

primary dealers the Treasury securities that they purchase at

auction.   When a primary dealer and a counterparty agree on a

transaction, a trade ticket is prepared which states the terms of

the transaction.   The primary dealer uses the information on the

trade ticket to prepare a confirmation slip that is sent to the

counterparty.



     4
      (...continued)
The Treasury securities market has many secondary dealers.
                                 - 8 -


     Interdealer brokers are brokerage firms that facilitate

trades between counterparties who are mainly primary dealers;

interdealer brokers do not hold positions in Government

securities themselves.    The principal interdealer brokers are

RMJ, Fundamental Brokers, Inc., Garban, Liberty, and Cantor

Fitzgerald (CF).    CF is the only interdealer broker that trades

for customers other than primary dealers.    CF's customers include

banks, fund managers, and investment funds.    Approximately 30

percent of CF's volume of trading in Treasury securities is for

customers who are not primary dealers.

     Interdealer brokers provide their customers with CRT

terminals (screens) on which the customers may view in their

offices the best bids and offers made by the broker's

subscribers.    The customers telephone bids and offers to their

broker, and the broker electronically posts these bids and offers

on its screens without identifying the customers who are

tendering the bids or offers.5    When a person accepts a bid or an

offer listed with the broker, the broker effectuates the

transaction and indicates on its screens that the bid or offer

was accepted.    The broker sends confirmation to the buyer and

seller showing the broker itself as the counterparty; neither the

person quoting the price nor the person accepting the price knows




     5
       Bids and offers are also quoted directly (verbally or
otherwise) between potential counterparties.
                                   - 9 -


the identity of the counterparty.6         The broker earns a

commission, which is paid by the person who accepted the bid or

offer.

III.       Financing Positions in Treasury Securities

       Treasury securities are excellent collateral for loans

because they are highly liquid.       Loans secured by Treasury

securities usually take the form of a simultaneous "sale" of the

security by the borrower to the lender and a binding obligation

of the borrower to "repurchase" the security from the lender in

the future at a somewhat higher price than the original sale

price.7      The difference between the purchase and sale prices is

the functional equivalent of interest.         A borrower calls these

transactions "repurchase agreements" or "repos", and a lender

calls these transactions "reverse repurchase agreements" or

"reverse repos".       A reverse repo allows a person with idle cash

to earn interest on the idle funds, and it allows a seller of

unencumbered Treasury securities to finance a counterparty's

purchase of securities.       A reverse repo also lets a short seller

of Treasury securities borrow the securities to cover a short

sale; cash is transferred to the security lender as collateral to

guarantee return of the borrowed security, and the short seller


       6
       For this reason, interdealer brokers are known as "blind
brokers".
       7
       Although the "loans" are actually independent purchase and
sale transactions, the terms "borrower" and "lender" are used
figuratively to simplify the explanation of these financing
arrangements.
                                - 10 -


earns interest on the cash collateral.    The lender under a repo

typically buys and resells the Treasury security at a small

discount from its current value.

      Repos can mature overnight, they can have fixed, longer

terms, or they can have indefinite terms that continue until

terminated by either party.   The interest rate charged by a repo

lender can be fixed for the term of the repo, or it can be reset

daily.

      Repurchase and reverse repurchase transactions are primarily

transacted over the telephone, and primary dealers, secondary

dealers, interdealer brokers, and other market participants

engage in repos and reverse repos as principals.    The Treasury

securities cash market is characterized by highly leveraged

transactions, and virtually all participants in the Treasury

securities market engage in leveraged trading to a large extent.

IV.   Background of Petitioner and B&C

      Petitioner has worked in the commodities and securities

industries his entire career.    From 1960 to 1970, he worked as a

securities broker registered with the National Association of

Securities Dealers (NASD), the New York Stock Exchange, and the

American Stock Exchange.   From 1970 to 1972, he worked with J.W.

Dickson, a Futures Commission Merchant (FCM) and a member of the

Chicago Board of Trade (CBT).8    In 1972, he began working for


      8
       An FCM is a designation given by the Commodity Futures
Trading Commission (CFTC) to a person who it has licensed to do
                                                   (continued...)
                                - 11 -


B&C, a commodities clearing firm that he formed in partnership

with three former coworkers.    Petitioner was B&C's managing

partner, and he initially owned 54 percent of its equity.     B&C

traded commodity futures for its own account and for the accounts

of its customers, and it cleared trades for customers with

accounts which it managed on a nondiscretionary basis

(nondiscretionary accounts).9    B&C was a member of the CBT and

the Board of Trade Clearing Corporation.    B&C was registered with

the CFTC as an FCM.

     At the end of 1982, petitioner purchased his partners'

interests in B&C, and he installed his three children as partners

as of January 1, 1983.   As relevant herein, petitioner owned 95.5

percent of B&C, and each of his children owned 1.5 percent.     B&C

traded Treasury securities in both the cash and futures markets

for customer accounts and for its own accounts, and it had

established trading relationships and credit lines with a number

of primary and secondary dealers.    B&C facilitated retail

customers' submittal of noncompetitive bids in Treasury auctions

by forwarding their bids to a primary dealer named Harris Bank &

Trust.   B&C acted on behalf of the retail customers in reselling

the securities purchased at auction at the highest available


     8
      (...continued)
business in the futures market.
     9
       Alternatively, an account could be managed on a
discretionary basis. In the case of discretionary accounts,
customers give their broker a set amount of money to manage in
the manner which the broker believes is wise.
                              - 12 -


price.   B&C's retail customers in Treasury securities were long-

term clients, personal friends, employees, and friends of

personal friends.   The only account holders at B&C, other than

petitioner, who traded Government securities were customers of

B&C, not of petitioner.

     B&C's offices are in Peoria and Chicago, Illinois, and

employees in both offices engage in proprietary trading.    The

Peoria office is primarily responsible for customer relations,

including identifying and soliciting customer prospects,

preparing customer account agreements, responding to customer

inquiries, and administering the managed account program.     The

Chicago office serves "back office" functions, clearing all

Treasury securities, futures, and other trades and handling

accounting, customer credit, and regulatory compliance.

Petitioner works out of the Peoria office, and B&C pays the rent

on the space that he uses.   Petitioner used this space to engage

in his personal trading, which included the trading of futures

contracts, stocks, corporate bonds, and all three types of

Treasury securities.   Petitioner transacted his personal trades

through B&C, and B&C cleared these trades and performed the

required bookkeeping for them.   Petitioner used B&C's video

screens and other market information services to assist him with

his Treasury securities cash trading, and he used B&C's

telephones and direct lines to primary dealers.   An employee in
                              - 13 -


the Peoria office arranged financing for petitioner's Treasury

securities trades.

     Petitioner's personal trading was transacted through B&C's

House Account 2900 (Account 2900).     B&C maintained this account

as a "partner's account", and the securities purchased and sold

in Account 2900 were petitioner's property.    Petitioner did not

share with his partners the gains and losses from trading these

securities, and he made his own trading decisions in trading in

this account.   The typical holding period for the Treasury

securities held in Account 2900 was less than 1 month.

     Petitioner's trading records were maintained primarily in

the Peoria office by B&C employees; B&C's records were maintained

in the Chicago office.   B&C employees in Peoria forwarded

clearing instructions to the Chicago office for all of

petitioner's Account 2900 trades, and B&C employees in the

Chicago office cleared all these trades and made appropriate

entries in B&C's records.

     The Government Securities Act of 1986 (the 1986 Act),

Pub. L. 99-571, sec. 102(e) and (f), 100 Stat. 3218, 15 U.S.C.

sec. 78o, became effective in July 1987.    Before that time, most

dealers in Treasury securities were not required to register with

the Securities and Exchange Commission (SEC) or the NASD.     The

1986 Act required Government securities brokers and dealers to

register with the SEC and the NASD unless an exemption applied.

Initially, there was uncertainty as to whether the 1986 Act
                               - 14 -


required firms like B&C, already registered with and regulated by

the CFTC as an FCM, to register with the SEC and the NASD.   B&C

initially applied for registration but later withdrew its

application on the basis of its understanding that it was not

required to register because it was an FCM.    Petitioner, who was

not personally registered as an FCM, never registered with the

SEC as a Government securities dealer for a trade or business

separate from B&C's, and he never registered with the NASD as a

dealer for a trade or business separate from B&C's.

      Generally, any person acting as a dealer in securities and

maintaining a place of business in Illinois must register with

the Illinois secretary of state.    B&C did not register with the

Illinois secretary of state because of its understanding that it

was exempt from registration requirements as an FCM.   Petitioner

never registered with the Illinois secretary of state as a dealer

for a trade or business separate from B&C's.

V.   Petitioner/B&C Trading in Treasury Securities Cash Market

       Petitioner traded Treasury securities through Account 2900

with the following known counterparties:

       Aubrey G. Lanston & Co., Chicago
       Barclays de Zoete Wedd, New York
       Chemical Bank, New York
       Chicago Research & Trading Co., New York
       Citibank, N.A./Citicorp, New York
       Continental Illinois National Bank and Trust Co., Chicago
       Daiwa Securities America, Inc., New York
       Discount Corp. of New York
       Drexel Burnham Lambert Government Securities, Inc., New York
     * Fidelity Investments Brokerage Services, Boston
       First Boston Corporation, New York
       First Interstate Bank of California, Chicago
                               - 15 -


     Goldman, Sachs & Co., New York
     Greenwich Capital Markets, Inc., Greenwich, CT
     Harris Trust & Savings Bank, Chicago
     Kidder Peabody & Co., Incorporated, Chicago
     Kleinwort Benson Government Securities, Chicago
     Lehman Government Securities, Inc., New York
     Lloyds Government Securities, Inc., New York
     Manufacturers Hanover Trust Co., New York
     Merrill Lynch Government Securities, New York
     Morgan Stanley & Co., Inc., New York
     Nomura Securities International Inc., New York
     Salomon Brothers Inc., New York
     Smith Barney Government Securities, Inc., Chicago
   * Staley Financial Services Inc., New York
     Yamaichi International American Inc., New York

All of these counterparties, other than the two denoted with an

asterisk, were or became primary dealers during the subject

years.   Petitioner regularly purchased securities from and sold

securities to, and engaged in repos and reverse repo transactions

with, these counterparties.    These transactions were effectuated

through Account 2900.    Petitioner traded Treasury securities in

Account 2900 directly with these counterparties on a principal-

to-principal basis.    He also traded Treasury securities in

Account 2900 with other, unknown counterparties (i.e., on a blind

basis) through CF.    He regularly dealt with many different

counterparties to improve his access to market information.    He

traded mainly with large primary dealers because they were among

the most active participants in the Treasury securities cash

market, and they traded the largest volumes.

     Before 1985, B&C opened an account with CF.   CF provided B&C

with its Speed System electronic screen; B&C already had two

screens.   Through CF, petitioner posted bids and asks on these
                                                   - 16 -


      screens and executed blind trades with counterparties who were

      either primary dealers or other market participants.                               Petitioner

      could not place orders to buy or sell securities on any other

      interdealer broker screen because those screens were restricted

      for use by primary dealers only.                     CF gave petitioner the same

      favorable commission rate extended to primary dealers on account

      of the volume of his trading.                  The advantageous commission rate

      offered to petitioner, based on volume, was generally available

      to all CF customers.

               Petitioner worked an average of 12 hours per day, spending

      60-80 percent of his time trading in Account 2900.                              His trading

      assistant, a B&C employee named Cindy James, verbally confirmed

      all of his Account 2900 trades with his counterparties on the day

      of the trade, and, during the next day, she verified principal

      and accrued interest and prepared the necessary cash and security

      delivery instructions.                Although it was customary for dealers to

      send their customers confirmation, petitioner did not send

      confirmation to his counterparties.

               Petitioner traded the following dollar volumes in the

      Treasury securities cash market during 1985 through 1989:
COUNTERPARTY                     1985               1986             1987             1988            1989

Aubrey Lanston                    -0-                -0-              -0-              -0-         $50,000,000
Barclays Bank                     -0-                -0-              -0-              -0-         150,000,000
CF1                        $6,668,145,000    $15,757,000,000   $1,427,000,000   $1,828,000,000   9,547,000,000
Chemical Bank                     -0-                -0-           50,000,000       55,000,000     200,000,000
Chicago Research & Trading        -0-          1,808,000,000          -0-              -0-         535,000,000
Citibank                          -0-                -0-          294,000,000          -0-       4,348,000,000
Continental Bank                  -0-                -0-              -0-              -0-         636,000,000
Daiwa                             -0-            150,000,000          -0-              -0-         139,000,000
Discount Corp.                 50,000,000      1,415,000,000      200,000,000       70,000,000     485,000,000
Drexel Burnham              1,872,600,000      4,348,000,000      934,500,000          -0-         550,000,000
Fidelity                          -0-                -0-              -0-              -0-         200,000,000
First Boston                3,686,550,000      3,298,000,000      105,000,000          -0-         150,000,000
First Interstate            2,330,000,000      2,712,800,000      400,000,000          -0-             -0-
                                                   - 17 -

Goldman Sachs               12,761,645,000    12,134,750,000     7,777,000,000   12,291,000,000 2,368,000,000
Greenwich Capital                  -0-               -0-               -0-              -0-      2,010,000,000
Harris Bank                  1,357,000,000       108,000,000        10,000,000      907,000,000 2,482,000,000
Kidder Peabody                     -0-           410,000,000       575,000,000          -0-         50,000,000
Kleinwort Benson               494,000,000           -0-               -0-              -0-        100,000,000
Lehman Brothers                912,000,000     2,167,800,000       480,000,000       55,000,000 3,126,000,000
Lloyds                             -0-           468,000,000           -0-              -0-            -0-
Manufacturers                      -0-           630,000,000           -0-              -0-            -0-
Merrill Lynch                4,853,250,000     3,073,000,000       305,800,000      125,000,000 1,057,000,000
Morgan Stanley                     -0-           150,000,000           -0-              -0-            -0-
Nomura                             -0-           615,000,000       100,000,000          -0-            -0-
Salomon Bros.               10,073,000,000    69,169,750,000     8,869,500,000    3,107,000,000 9,829,000,000
Smith Barney                       -0-               -0-               -0-              -0-        250,000,000
Staley                          50,000,000           -0-               -0-              -0-            -0-
Yamaichi                           -0-           215,000,000           -0-              -0-            -0-
     Total                 l45,108,190,000   118,630,100,000   21,527,800,000    18,438,000,000 38,262,000,000
1
  These volumes refer to trades brokered by CF on a blind basis.


             Dealers try to be available regularly to satisfy customer

      requests, and the normal function of a Government securities

      trading desk at a primary dealer is to try to buy and sell

      securities all the time.                Primary dealers typically engage in

      Government securities trading daily, and they seldom fail to

      respond to a customer request to do a transaction or to make a

      market.10      No person ever asked petitioner to make a market, and

      petitioner did not always accept requests to buy or sell a

      security.        Petitioner was more interested in buying an initial

      position rather than selling.                  He had no Government securities

      transactions during extended periods during the subject years;

      his trading gaps exceeded 100 days in 1987, 150 days in 1988, and

      200 days in 1989.            He did not trade on a regular daily basis

      during 1987, 1988, and 1989, and he suffered increasing losses in

      those years.

             The Treasury holds 157 Treasury securities auctions each

      year, most of which are weekly auctions of Treasury bills.


             10
             Making a market means providing a simultaneous bid and
      offer on the same security pursuant to a customer request.
                               - 18 -


Petitioner was awarded Treasury securities in 23 auctions in

1985, 19 in 1986, 14 in 1987, 9 in 1988, and 9 in 1989.

Petitioner's auction purchases as a percentage of his total

purchases of Treasury securities ranged from 25 to 50 percent

during 1985 through 1989.   Overall, petitioner acquired more than

one-third of his Treasury securities through auctions during that

period.    Petitioner participated actively in the auctions because

they allowed him to acquire a large position in a short time at

one price.   Petitioner then traded from the core positions

acquired at auction, adding to his holdings through purchases and

selling the securities to primary dealers in smaller blocks.

Petitioner frequently submitted multiple bids in the same auction

through different primary dealers.      Petitioner never acquired a

Treasury security on the auction in response to a prospective

buyer's request to repurchase that security from him.

     Petitioner had ongoing contacts with CF and numerous primary

dealers.   There was no difference in the way CF treated

petitioner and the way it treated any other CF customer.     When a

customer of CF would call to place a bid or offer on the CF

system, it was solely the customer's choice to decide the

security on which he would make a bid or offer.     When petitioner

called CF to post a bid or offer on the CF system, it was solely

his choice whether to do so, and solely his choice as to the

specific security he wanted to bid or offer.     When petitioner

called CF to post a bid or offer on the CF system, it was not
                              - 19 -


pursuant to a request by a customer of petitioner to do a trade.

Many times petitioner would submit a bid to CF and ask that it be

continuously re-input into the CF system until petitioner was

successful in buying the desired security.    Petitioner on

occasion gave discretion to primary dealers as to price for both

auction and nonauction transactions.   On other occasions,

petitioner would give the primary dealers "orders".11   Petitioner

never received a customer order in Government securities.

     Petitioner typically financed his purchases of Treasury

securities through repurchase agreements.    Ms. James contacted

primary dealers and CF to locate the best rates.   Petitioner had

credit lines with 20 different primary and secondary dealers, and

he could finance his purchases through any of these firms.

Petitioner sometimes financed Treasury securities through a

dealer other than the dealer from whom he purchased the

securities.   Petitioner typically dealt with a variety of

counterparties in the course of acquiring, financing, and selling

particular positions.

     Government securities dealers usually orally confirm a trade

and mail written confirmation on it.   When petitioner executed

trades of Treasury securities with primary dealers, the primary

dealers always mailed the confirmation to B&C, sometimes to the


     11
       An "order" is a customer's request to a dealer to
purchase or sell a specified quantity of securities on the
customer's behalf either at a specified price or at the best
available price in the market.
                               - 20 -


attention of petitioner, sometimes with a reference to Account

2900, and sometimes with no reference to either petitioner or

Account 2900.    Petitioner almost always received repo trade

confirmation from the primary or secondary dealers with whom he

dealt.   Petitioner never sent trade or repo confirmation to the

primary dealers with whom he dealt and he never sent trade or

repo confirmation to any of the counterparties with whom he

dealt.   When B&C executed a trade for a retail customer, B&C

usually phoned the customer acknowledging that the trade had been

executed and sent the customer a written confirmation.

     Petitioner received monthly statements from the primary

dealers with whom he dealt regularly, and he received monthly

statements from other primary dealers irregularly.    He never sent

monthly statements to any of his primary dealer counterparties,

and he never sent monthly statements to any of his secondary

dealer counterparties.    B&C routinely sent monthly statements to

its customers.

     The Government securities dealers with whom petitioner dealt

kept various records on their customers' accounts, including

petitioner's.    These records included customer account

agreements.   B&C regularly used a customer agreement for its

retail customers during the subject years.    Petitioner did not

receive a customer account agreement from any of the

counterparties with whom he dealt.
                               - 21 -


                              OPINION

      We must decide whether petitioner's gains and losses from

his dealings in Treasury securities were ordinary or capital.

Whereas an individual may generally deduct from current income

all ordinary losses, sec. 165(a), an individual's deduction for

capital losses is limited, secs. 165(f), 1211.   See Moravec v.

Commissioner, 500 F.2d 1298 (7th Cir. 1974), affg. per curiam

T.C. Memo. 1973-83.   An individual may currently deduct capital

losses only up to the amount of his or her capital gains plus

$3,000 (or $1,500 for married individuals filing separately).

He or she must carry forward any excess loss to a future taxable

year.    Secs. 1211(b) and 1212(b); see Moravec v. Commissioner,

supra.

      A capital loss is any loss realized on the sale or exchange

of a capital asset.   See sec. 1222; Arkansas Best Corp. v.

Commissioner, 485 U.S. 212, 223 (1988).   A "capital asset"

includes any "property held by the taxpayer (whether or not

connected with his trade or business)" that is not within one of

five categories.   Sec. 1221; Arkansas Best Corp. v. Commissioner,

supra at 215.   Section 1221(1), the only category that could

apply here, provides that property is not a capital asset if it

is:

      stock in trade of the taxpayer or other property of a
      kind which would properly be included in the inventory
      of the taxpayer if on hand at the close of the taxable
      year, or property held by the taxpayer primarily for
                                - 22 -


     sale to customers in the ordinary course of his trade
     or business * * *

     Petitioner focuses on this text and argues that his Treasury

securities were not capital assets.      According to petitioner,

even if he did not hold the Treasury securities for sale to

customers, the securities were "stock in trade" or "other

property of a kind which would properly be included in * * *

[his] inventory * * * if on hand at the close of the taxable

year".   Petitioner asserts that he bought the Treasury securities

for resale, which, he concludes, means that the securities were

stock in trade or inventory.    Petitioner asserts that an ordinary

loss arises from the sale of property in an everyday activity,

such as his security trading, in which there are short holding

periods, a frequency and volume of sales, and regular interaction

with buyers.   Alternatively, petitioner argues, he held the

Treasury securities "primarily for sale to customers in the

ordinary course of his trade or business".      Petitioner asserts

that his customers were his primary dealer counterparts;

according to petitioner, the meaning of the word "customer"

includes any person with whom he had established business

relationships and with whom he dealt regularly on a

principal-to-principal basis.    Petitioner asserts that the fact

that he held his Treasury securities primarily for sale to

customers is evidenced by the fact that B&C bought and held

securities primarily for sale to its customers.      Petitioner
                               - 23 -


asserts that the mere fact that he traded on his own account,

rather than on behalf of third parties, does not take him outside

the definition of a dealer.

     Respondent replies that petitioner's gains and losses were

capital because he was not a dealer.     Respondent asserts that

petitioner traded for his own account and that he had no

customers.   Respondent asserts that petitioner had no separate

place of business to conduct his trading and that he used B&C's

resources to effectuate his trades.     Respondent asserts that

petitioner did not register as a dealer with the SEC, NASD, or

Illinois secretary of state.   Respondent asserts that petitioner

did not treat himself as a dealer on his tax returns as

originally filed.

     We agree with respondent that petitioner was not a dealer in

Treasury securities during the subject years.     To start with,

petitioner is incorrect in asserting that his Treasury securities

were his stock in trade or inventory, even if he did not hold the

securities for sale to customers.   As courts have consistently

held, securities may be classified as stock in trade or inventory

only when they are held primarily for sale to customers in the

ordinary course of business.   Marrin v. Commissioner, 147 F.3d

147, 152 (2d Cir. 1998), affg. T.C. Memo. 1997-24; United States

v. Wood, 943 F.2d 1048, 1051 (9th Cir. 1991); Swartz v.

Commissioner, 876 F.2d 657, 659 (8th Cir. 1989), affg. per curiam

T.C. Memo. 1987-582; United States v. Diamond, 788 F.2d 1025,
                              - 24 -


1029 (4th Cir. 1986); Van Suetendael v. Commissioner, 152 F.2d

654, 654 (2d Cir. 1945), affg. per curiam a Memorandum Opinion of

this Court dated Sept. 25, 1944; King v. Commissioner, 89 T.C.

445, 458 (1987); see Wood v. Commissioner, 16 T.C. 213, 225-226

(1951) ("It is well settled that property cannot be classified as

stock in trade or property subject to inventory unless it is held

by the taxpayer primarily for sale to customers in the ordinary

course of his trade or business."); see also Kelly v.

Commissioner, T.C. Memo. 1996-529; Tybus v. Commissioner,

T.C. Memo. 1989-309.   The mere fact that petitioner may have sold

the Treasury securities in the ordinary course of his trade or

business, an assertion that petitioner vigorously makes but which

we decline to decide, does not mean, as petitioner asks us to

hold, that the securities are outside the meaning of the term

"capital asset" as used in section 1221.   In order to escape the

broad reach of that term, and the resulting classification as a

capital gain or capital loss, petitioner's sales not only must

have been "in the ordinary course of his trade or business", but

must have been "to customers" as well.12   In fact, the phrase "to

customers" was expressly added to the predecessor of section


     12
       Petitioner, citing Corn Prods. Ref. Co. v. Commissioner,
350 U.S. 46 (1955), argues on brief that the term "capital asset"
is narrowly defined for purposes of sec. 1221. We disagree. In
Arkansas Best Corp. v. Commissioner, 485 U.S. 212, 222 (1988),
the Supreme Court clarified that the term "capital asset" is
construed broadly, and that "Corn Products * * * [stands] for the
narrow proposition that hedging transactions that are an integral
part of a business' inventory-purchase system fall within the
inventory exclusion of § 1221."
                                - 25 -


1221(1) in the Revenue Act of 1934, ch. 277, 48 Stat. 680, to

make it "impossible to contend that a stock speculator trading on

his own account is not subject to the [capital loss limitation]

provisions".    H. Conf. Rept. 1385, 73d Cong., 2d Sess. 22 (1934),

1939-1 C.B. (Part 2) 627, 632; see also United States v. Diamond,

supra at 1028; Mirro-Dynamics Corp. v. United States, 374 F.2d

14, 16 (9th Cir. 1967); Kemon v. Commissioner, 16 T.C. 1026, 1032

(1951).   For a detailed discussion of the legislative history of

the "to customers" amendment, see King v. Commissioner, supra at

457-458; Kemon v. Commissioner, supra at 1032; Wood v.

Commissioner, supra at 219-220.

     As to petitioner's alternative argument, namely, that he

sold the Treasury securities to customers, whether an individual

sells securities to customers is a question of fact that hinges

on his or her classification as a dealer, trader, or investor.

Kemon v. Commissioner, supra at 1032.     All purchasers of

securities are within one of these three categories, and only a

dealer is eligible for the section 1221(1) exception because only

a dealer has customers.     United States v. Wood, supra at

1051-1052.     As the Court of Appeals for the Ninth Circuit has

stated, in distinguishing these three types of purchasers:

          A dealer is a person who purchases the securities
     or commodities with the expectation of realizing a
     profit

          not because of a rise in value during the interval of
          time between purchase and resale, but merely because
                             - 26 -


          they have or hope to find a market of buyers who will
          purchase from them at a price in excess of their cost.
          This excess or mark-up represents remuneration for
          their labors as a middleman bringing together buyer and
          seller, and performing the usual services of retailer
          or wholesaler of goods.

     Kemon v. Commissioner, 16 T.C. 1026, 1032-33 (1951).
     Dealers have customers for purposes of section 1221.
     See United States v. Diamond, 788 F.2d 1025, 1029 (4th
     Cir. 1986).

          Traders, on the other hand, are sellers of
     securities or commodities who "depend upon such
     circumstances as a rise in value or an advantageous
     purchase to enable them to sell at a price in excess of
     cost." Id. at 1033. A trader performs no
     merchandising functions nor any other service which
     warrants compensation by a price mark-up of the
     securities he or she sells. Id. at 1032-33. "[A]
     trader will be deemed to be engaged in a trade or
     business if his or her trading is frequent and
     substantial. King, 89 T.C. at 458. Generally, both
     dealers and traders will be engaged in a trade or
     business; only a dealer, however, has customers.

          An investor is very similar to a trader. Like a
     trader, an investor "makes purchases for capital
     appreciation and income." King, 89 T.C. at 459.
     Unlike a trader, however, an investor makes such
     purchases "usually without regard to short-term
     developments that would influence prices on the daily
     market." Id. An investor, on the other hand, will
     never be considered to be engaged in a trade or
     business with respect to his or her investment
     activities, no matter how extensive his or her
     activities might be. Id. at 459. [Id.]

See also sec. 1.471-5, Income Tax Regs. (regulatory definition of

a dealer in securities).

     Petitioner was not a dealer.   First, he did not conduct his

trading activity in the manner in which a dealer would have.   He

personally owned all of the Treasury securities that he traded,
                                - 27 -


he traded those securities only for his own account, and he

reported on his personal income tax returns the gains and losses

on his trades.   He did not make a market in Treasury securities,

and he did not earn a commission on any of his trades because the

counterparties thereto were not required to pay him a commission.

He did not maintain a place of business for trading his

securities separate from B&C's, and he did not effectuate trades

pursuant to a directive.     He did not treat his counterparties as

customers; e.g., he did not send them confirmation, he did not

have them sign customer account agreements, and he did not send

them monthly statements.13    Although he was a part owner of B&C,

the business of which included trading securities to customers,

he did not trade his Treasury securities in the course of that

business.   He merely used B&C's resources to assist him in his

independent activity of trading Treasury securities.    Although he

asks the Court to consider his trading activity part of B&C's

business activity, we decline to do so.    Petitioner and B&C are

separate, and, under the facts herein, we will not disregard

their separateness or otherwise treat them as one.    To the extent

that petitioner asks the Court to conclude that he used B&C as



     13
       Petitioner asks the Court to find that sending written
confirmation was not the practice in the industry, especially in
cases where, like his, all trades were confirmed orally.
Petitioner also asks the Court to find that the industry practice
was not to send monthly statements to, or obtain customer
agreements from, institutional investors. We decline to make
either finding. Neither finding is supported by reliable
evidence in the record.
                                - 28 -


his agent and instrumentality for purposes of trading the

Treasury securities in Account 2900, the facts at hand do not

support such a conclusion.   The fact that petitioner personally

owned his Treasury securities, that he traded them for his own

account, that he did not have a separate place of business to

conduct his trading, and that his only source of income from his

trading depended on an increase in value all militate against

categorizing him as a dealer.    See Marrin v. Commissioner,

147 F.3d at 151; Kemon v. Commissioner, supra at 1032.

     Second, petitioner's primary intent in trading Treasury

securities was inconsistent with that of a dealer.    A dealer

purchases securities intending to profit primarily from selling

the securities at an increased price that represents remuneration

for working as a middleman and performing the usual services of

retailer or wholesaler of goods.    Kemon v. Commissioner, 16 T.C.

at 1032-1033; see Estate of Hall v. Commissioner, 29 B.T.A. 1255,

1259-1260 (1934), affd. sub nom. Commissioner v. Stevens, 78 F.2d

713 (2d Cir. 1935); see also MacAdam v. Commissioner, T.C. Memo.

1991-410.   Petitioner, by contrast, aimed to reap a profit from

an increase in value caused by a favorable fluctuation in

interest rates, and, but for such a favorable fluctuation, he

would not have reaped any meaningful profit at all.    Interest

rates change daily, and petitioner speculated that the short-term

course of those rates would be consistent with the course that he

predicted, which, in turn, would increase the value of his
                                - 29 -


securities.   The mere fact that petitioner may have traded

Treasury securities regularly and extensively does not

necessarily mean, as petitioner would have us hold, that any

purchaser of those securities was a customer of his.     A profit

motive that hinges on a hope or expectation of prospering from a

rise in the value of a security is not indicative of a dealer.

See United States v. Wood, 943 F.2d at 1051-1052; see also Marrin

v. Commissioner, supra at 151.

     Third, petitioner's pool of purchasers was not indicative of

that of a dealer.   His pool was almost exclusively primary

dealers, and most of his trades were effectuated through two of

those dealers; namely, Salomon Brothers, Inc., and Goldman, Sachs

& Co.   He sold many of his securities to the same primary dealer

from whom he had bought them.    See Van Suetendael v.

Commissioner, 152 F.2d at 654; MacAdam v. Commissioner, supra.

Such a pool of purchasers as that maintained by petitioner is not

indicative of a dealer.   Accord Marrin v. Commissioner, 147 F.3d

147 (2d Cir. 1998) (taxpayer who bought stock from a broker and

sold it to the same or another broker was not entitled to

ordinary loss treatment); Faroll v. Jarecki, 231 F.2d 281 (7th

Cir. 1956) (taxpayer who traded futures contracts on the floor of

the CBT on his own behalf, and not for the account of the

partnership of which he was a member or for any customer of the

partnership, did not hold the contracts primarily for sale to

customers in the ordinary course of his trade or business); cf.
                               - 30 -


Estate of Hall v. Commissioner, supra (partnership was a dealer

of securities even though its sales were made primarily to

brokers on the New York Stock Exchange; partnership had

established place of business, held itself out as a dealer, and,

most importantly, did not buy the securities for investment or

speculation).

     Fourth, the fact that petitioner did not perform any

merchandising functions or any other services which would have

warranted a markup in the price of his Treasury securities is

indicative of a trader.   See Kelly v. Commissioner, T.C. Memo.

1996-529; Furer v. Commissioner, T.C. Memo. 1993-165, affd.

without published opinion 33 F.3d 58 (9th Cir. 1994).   Petitioner

used B&C's facilities and personnel to trade the securities, and

he never received any remuneration for working as a middleman

because he never brought a buyer and seller together.   His

securities were as easily accessible to one as to the other;

thus, he profited only when his securities rose in value between

the time that he bought them and the time that he sold them.    See

Kemon v. Commissioner, supra at 1033.    The inability to mark up a

security for reasons other than value appreciation is not

indicative of a dealer.    See Frankel v. Commissioner, T.C. Memo.

1989-39.

     Fifth, the fact that petitioner did not consider himself a

dealer during the relevant time militates against classifying him

as a dealer.    If petitioner had in fact been a dealer, he would
                                - 31 -


have been required to register as such with the SEC, the NASD,

and the Illinois secretary of state.     Yet, he did not register

with any of these agencies.14    Nor did he advertise himself as a

dealer.   One need only examine his tax returns as originally

filed to understand that he did not consider himself a dealer at

the time of their filings.   None of these returns reported that

he was a dealer in Treasury securities.     They reported that his

gains and losses were capital.    Although he testified that he did

not know when he originally filed his returns that the Federal

tax laws differentiated between gains and losses that were

capital as opposed to ordinary, we find this testimony illogical

when considered in the light of the record as a whole.

Petitioner is an intelligent man who, when he filed his 1984 tax

return, had been working for more than 25 years.     During each

year in issue, he had experienced the benefits of capital gains

and the burdens of capital losses; he reported that he was unable

to deduct currently $29,457,311, $48,900,546, and $93,752,481 of

capital losses that he realized (exclusive of any prior year




     14
       Petitioner and B&C's chief financial officer testified
that they believed that petitioner did not have to register
individually because he and B&C were one and the same. We do not
find this testimony persuasive. Even if petitioner did believe
that he and B&C were one and the same when it came to partnership
business, a finding that petitioner asks the Court to make but
which we are unable to make because of a lack of substantiation,
the subject trading of Treasury securities was not partnership
business. It was an activity that petitioner conducted
independently of B&C. Moreover, petitioner reported the gains
and losses therefrom on his personal income tax return.
                              - 32 -


carryovers) in 1987, 1988, and 1989, respectively,15 and he

reported net long-term capital gains of $4,729,387, $42,213,314,

and $53,119,895 on his 1984, 1985, and 1986 returns,

respectively, for which he took into account 60-percent

deductions under section 1202.   We also believe that he was

familiar with the classifications of dealer, trader, or investor.

We discussed the difference between a dealer and a trader almost

10 years before petitioner first entered the securities industry,

see Kemon v. Commissioner, 16 T.C. at 1032-1033, and this

distinction was almost 35 years old at the time that he filed his

1984 return.   We also take into account that all of the subject

returns were prepared by large, multinational accounting firms,

and that the 1985 return noted specifically that petitioner was a

"trader", and not an "investor".16   The fact that petitioner did

not have himself licensed as a dealer, that he did not consider



     15
       In other words, notwithstanding the multi-million-dollar
capital losses that petitioner reportedly incurred during these
years, he limited his capital loss deduction for 1987, 1988, and
1989 to $3,000 each. We also note that petitioner reported
"total income" of $44,122,440, $24,267,722, and $58,882 for these
respective years, and that he reported that his related tax
liability was $16,243,036, $6,661,226, and $605, respectively.
     16
       Petitioner testified that he retained Coopers & Lybrand
to prepare his tax returns because it was more familiar than
Peat, Marwick with the securities area. Petitioner implied
during his testimony that Coopers & Lybrand saw that Peat,
Marwick had incorrectly classified him as a "dealer", and that
Coopers & Lybrand amended his 1985 through 1989 returns to
correct Peat, Marwick's mistake. We are unpersuaded by this
testimony. As a point of fact, petitioner's 1989 tax return
classified petitioner as a trader, and this return was prepared
by Coopers & Lybrand.
                              - 33 -


himself a dealer, and that he did not hold himself out as a

dealer undercuts his argument that he was one.    See Mirro-

Dynamics Corp. v. United States, 374 F.2d 14 (9th Cir. 1967); see

also Furer v. Commissioner, supra; Michelson v. Commissioner,

T.C. Memo. 1990-27, affd. 951 F.2d 288 (10th Cir. 1991); Tybus v.

Commissioner, T.C. Memo. 1989-309; Huebschman v. Commissioner,

T.C. Memo. 1980-537.

     Petitioner argues vigorously that his customers were the

primary dealers to whom he sold the securities.   We do not agree.

Petitioner's proffered definition of the word "customer", to wit,

any person with whom he had established business relationships

and with whom he dealt regularly on a principal-to-principal

basis, misses the mark.   As we stated in Frankel v. Commissioner,

supra, in refusing to adopt a similar definition that was

proffered by the taxpayer there,17 a "seller of securities who

does not perform a merchandising function--who does not act as a

middleman bringing buyer and seller together--is considered a

trader, and as such, not even the broadest array of vendees will

be his 'customers'".

     Although not identical, the instant case is analogous to

Frankel v. Commissioner, supra.   There, the taxpayer was an

associate of an investment firm who began trading GNMA's for his



     17
       The taxpayer in Frankel v. Commissioner, T.C. Memo.
1989-39, asked the Court to adopt a definition under which a
"customer" is "any person who buys an asset from another person".
                              - 34 -


own account in 1977.   With one exception, he sold the GNMA's back

to the same primary dealer from whom he had purchased them.    In

1980, he stopped trading GNMA's and began trading Treasury

securities through accounts which he maintained with primary

dealers.   We rejected his argument that he was a dealer and that

the primary dealers were his "customers".   We stated:

     The fact that petitioner did not trade on an organized
     exchange, but rather dealt directly with the primary
     traders, is of no consequence due to the fact that
     there existed no GNMA exchange. * * * Petitioner was
     a trader, not a dealer, and the primary dealers with
     whom petitioner traded were not his "customers,"
     rather, he was theirs.

          Petitioners would have us look to a myriad of
     other factors in defining a trader and a dealer.
     However, we point out that, unlike a dealer, a trader
     has no 'customers' and trades only on his own account.
     However, the trading activity in which traders engage
     may resemble the activity of a dealer in every other
     respect. It is possible that the trading activity of a
     trader may rise to the level of a trade or business of
     selling securities, but, nevertheless, such sales still
     produce capital gains and losses. King v.
     Commissioner, supra, at 457. The distinguishing
     characteristic between a trader and a dealer is the
     presence of "customers." [Id.]

     Petitioner argues that Frankel v. Commissioner, supra, is

distinguishable because petitioner's trading activity was more

extensive than that of the taxpayer in Frankel.   We disagree that

this fact is a meaningful distinction.   As in Frankel, the

primary dealers with whom petitioner traded Treasury securities

through his personal account were not his "customers", and,

consistent with Frankel, the absence of "customers" properly
                              - 35 -


characterizes petitioner as a trader even though his trading

activity may have resembled the activities of a dealer in some

respects.   See Marrin v. Commissioner, 147 F.3d 147

(2d Cir. 1998) (taxpayer who bought stock from a broker and sold

it to the same or another broker did not sell the stock to

customers); Faroll v. Jarecki, 231 F.2d 281 (7th Cir. 1956)

(taxpayer who traded futures contracts on the floor of the CBT on

his own behalf did not sell the contracts to customers).

     We sustain respondent's determination on this issue.    In so

doing, we have considered all arguments made by petitioner for a

contrary holding, and, to the extent not addressed above, find

them to be irrelevant or without merit.

     Because other issues remain to be tried,

                                                An appropriate order

                                          will be issued.
