                      107 T.C. No. 3



                UNITED STATES TAX COURT



   IVAN A. JASKO AND JUDITH L. JASKO, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent


Docket No. 5553-95.                    Filed August 20, 1996.



     Ps' principal residence was destroyed by fire.
They recovered insurance proceeds based on replacement
cost, resulting in a gain. Ps incurred legal fees in
obtaining recovery of those proceeds and claimed a
deduction for the amount of those fees paid during the
taxable year. Ps assert that the insurance policy was
held for the production of income so that the deduction
is allowable under sec. 212(1), I.R.C. Held, under the
origin of claim doctrine, Ps' residence was the source
of their gain and the legal fees represented capital
expenditures constituting a reduction in their gain and
not currently deductible under sec. 212(1), I.R.C.



L. Randolph Harris, for petitioners.

Allan D. Hill, for respondent.
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                                OPINION

     TANNENWALD, Judge:     Respondent determined a deficiency in

petitioners' 1992 Federal income tax in the amount of $6,225.

The issue is whether petitioners may deduct legal fees paid

during 1992 and incurred as a result of a dispute with their

insurance carrier over the replacement cost of their residence,

which had been destroyed by fire.

     All section references are to the Internal Revenue Code in

effect for the year in issue.

     All the facts have been stipulated.    The stipulation of

facts and attached exhibits are incorporated herein by this

reference.

     At the time their petition was filed, petitioners resided in

Piedmont, California.

     On October 20, 1991, petitioners' then principal residence

in Oakland, California, (the Oakland Hills residence) was

destroyed by a firestorm.    Petitioners had lived in that

residence continuously from the time they purchased it in 1967

until its destruction.    The residence was not held either for

rental or sale during 1991.

     At the time of its destruction, the residence and its

contents were insured against fire loss by Republic Insurance

Company (Republic).   The insurance policy provided that, in the

event of a loss, petitioners were to receive the replacement cost

of the residence.
                                - 3 -

     On November 20, 1991, Republic made an interim payment to

petitioners in an amount based on its adjuster's determination

that the actual cash value of the home was $110 per square foot.

     During 1991, petitioners engaged the services of McInerney &

Dillon, P.C., Attorneys at Law (McInerney & Dillon), to resolve a

conflict with Republic as to replacement cost.   During 1991,

petitioners also hired a firm to draw plans for their home and to

estimate the replacement cost of the Oakland Hills residence.

Such replacement cost was estimated to be $921,994.

     On September 16, 1992, Republic increased its estimate of

replacement cost to $200 per square foot and made a further

payment to petitioners based on this estimate.

     The terms of the Republic policy provided for a form of

arbitration in the event of a dispute over the replacement cost

of insured property.   Pursuant to that procedure, petitioners and

Republic each chose an appraiser, and the two appraisers chose an

umpire.   An appraisal hearing ensued over replacement cost, and a

decision was reached that the replacement cost of the home was

$825,000.   During September 1993, Republic issued its check in

full satisfaction of the remaining balance due upon petitioners'

insurance claim.

     In pursuing their claim with Republic, petitioners incurred

legal fees with McInerney & Dillon of $71,044.61 during 1991,

1992, and 1993.    Petitioners paid $25,000 of that amount during
                              - 4 -

1992, which they claimed as a miscellaneous deduction on their

1992 return.

     At the outset, we note that we have no direct evidence that

petitioners realized taxable gain, i.e., an excess of the

insurance proceeds over cost, from their receipt of replacement

cost under the insurance policy.   Sec. 1033(a)(2); see Central

Tablet Manufacturing Co. v. United States, 417 U.S. 673, 676

(1974); Tobias v. Commissioner, 40 T.C. 84, 95 (1963).     However,

neither party has suggested that a gain is not involved herein,

and we think that the existence of a gain is a permissible

premise upon which to base our analysis and decision herein.1

     The issue before us is whether petitioners are entitled to

deduct the $25,000 legal fees under section 212(1) which provides

in pertinent part:

          In the case of an individual, there shall be
     allowed as a deduction all the ordinary and necessary
     expenses paid or incurred during the taxable year--

               (1) for the production or collection of
          income;

     Respondent contends that petitioners' home was not held for

the production of income and, thus, the legal fees incurred by

petitioners were incurred to recover a loss, not for the

production of income, and are therefore not deductible.

1
   No gain was reported on petitioners' 1992 return based on the
payment received in that year. It appears that petitioners were
waiting until the expiration of the applicable period in which to
replace the residence without current recognition of gain. See
sec. 1033(a)(2).
                              - 5 -

Petitioners concede that their residence was not held for the

production of income but contend that the insurance policy should

be separated from the ownership of the residence and that, in

this context, their expenses to recover full replacement cost of

their residence fall within the purview of section 212(1).

     The initial element in determining deductibility is the

application of the "origin of the claim" doctrine articulated by

the Supreme Court in United States v. Gilmore, 372 U.S. 39

(1963), and applied in Woodward v. Commissioner, 397 U.S. 572

(1970), and United States v. Hilton Hotels Corp., 397 U.S. 580

(1970).

     We are not prepared to accept petitioners' argument that we

separate the insurance policy and the dispute thereunder from

petitioners' ownership of the residence, which was concededly a

capital asset not held for the production of income.   The policy

was designed to reimburse petitioners against economic loss

arising from the occurrence of defined contingencies, represented

by the amount necessary to replace the residence.   See, e.g.,

Allied Fidelity Corp. v. Commissioner, 66 T.C. 1068, 1074 (1976),

affd. 572 F.2d 1190 (7th Cir. 1978).   But for the residence and

the fire, the insurance policy would be meaningless.   Under such

circumstances, the residence is the origin of the situation that

caused petitioners to incur the legal fees.   Compare Wagner v.

Commissioner, 78 T.C. 910 (1982), where we refused to separate a

lawsuit seeking adjustment of the purchase price of stock from
                                 - 6 -

the earlier sale of the stock.    See also Mosby v. Commissioner,

86 T.C. 190, 198 (1986); cf. Neely v. Commissioner, 85 T.C. 934,

954-955 (1985).2   That the insurance proceeds produced a gain in

and of itself is insufficient to require a different conclusion.

The existence of that gain, however, raises the question of how

the legal fees should be treated.

      It is well established that expenses that are incurred in

either the acquisition or disposition of a capital asset are

nondeductible capital expenditures.      Sec. 263; see Wagner v.

Commissioner, supra at 915-916.     The destruction of petitioners'

residence by the firestorm in effect constituted a disposition of

the residence in return for payment of the proceeds of the

insurance.   In this context, the treatment of the legal fees in

condemnation cases provides a useful analogy.     A property owner's

expenses incurred to increase a condemnation award are

nondeductible capital expenditures under section 263 that serve

to reduce the amount of the taxable gain.      Mosby v. Commissioner,

supra at 196-197; Casalina Corp. v. Commissioner, 60 T.C. 694,

703 (1973), affd. per curiam 511 F.2d 1162 (4th Cir. 1975).        We

think that petitioners' legal expenses should be accorded the

same treatment since destruction is in a very real sense the

equivalent of an involuntary conversion; in either case, the

taxpayer loses the property.   We note that our treatment of the

2
    See also Myers v. Commissioner, T.C. Memo. 1988-160.
                               - 7 -

destruction of petitioners' residence as a disposition finds

support in the involuntary conversion provisions of section 1033,

which treat casualties in the same manner as condemnations, and

in the provisions dealing with the limitation of the deduction

for casualty losses under section 165(h), which specify that

personal casualty gains in excess of losses shall be treated as

gains from the sale of the property.

     We also note that no part of the gain from such disposition

of petitioners' residence appears on their 1992 return and indeed

may never be includable in income if petitioners take advantage

of the replacement provisions of section 1033, e.g., if

petitioners die before disposing of the replacement home.    See

supra note 1.   This being the case, the disallowance of the

deduction of the legal fees herein is comparable to the situation

involved in Towanda Textiles, Inc. v. United States, 149 Ct. Cl.

123, 180 F. Supp. 373 (1960), where legal expenses of collecting

insurance proceeds on a building, destroyed by fire during a

section 337 liquidation, were denied.

     Petitioners rely heavily on Ticket Office Equipment Co. v.

Commissioner, 20 T.C. 272 (1953), affd. per curiam 213 F.2d 318

(2d Cir. 1954).   In that case, the taxpayer was allowed to deduct

legal and adjusters' fees expended to collect insurance when the

taxpayer's building was partially destroyed by fire.   The

building was used in the taxpayer's business, and the Court

observed that the expenditures arose in the ordinary course of
                                - 8 -

that business.    Furthermore, a loss was involved, a point which

the Court emphasized by observing that the expenses reduced the

amount of the loss and consequently the deduction.      Indeed, the

Court suggested that a gain might involve different treatment.

See Ticket Office Equipment Co. v. Commissioner, 20 T.C. at 280

n.6.    Finally, it is not without significance that Ticket Office

Equipment long antedated the articulation by the Supreme Court of

the "origin of the claim" doctrine, see supra p. 5.       Thus, Ticket

Office Equipment is clearly distinguishable, as is United States

v. Pate, 254 F.2d 480 (10th Cir. 1958), which also involved

business property.

       We hold that the legal expenses represent capital

expenditures nondeductible under section 263 and an offset

against the gain represented by the insurance proceeds, none of

which petitioners recognized in the taxable year before us.

                                        Decision will be entered

                                for respondent.
