                  T.C. Memo. 2006-174



                UNITED STATES TAX COURT



   JOHN S. AND CHRISTOBEL D. RENDALL, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 16337-04.             Filed August 21, 2006.



     P husband (PH) was CEO and chairman of the board
of SE Corp., which had developed a process for
recovering synthetic crude oil and other minerals from
oil sands. In March 1997, as part of an effort to
finance completion of an oil recovery plant in Canada
using SE Corp.’s technology, PH lent SE Corp. $2
million from funds borrowed from Merrill Lynch (ML)
through his ML margin account. PH pledged a portion of
his SE Corp. common stock as security for loans to him
through that account. In May 1997, ML demanded
repayment of PH’s margin account loans and, upon
default by PH, ML sold a portion of the pledged shares
and returned the balance to PH. In June and July 1997,
SE Corp. filed petitions in the U.S. and Canada for
reorganization in bankruptcy. In September 1997, SE
Corp. stock was delisted by NASDAQ and thereafter was
listed in the “pink sheets” and traded over the
counter. Although forced to sell its Canadian
                           - 2 -

operating assets and mineral leases in order to
generate cash to pay creditors, and faced with other
difficulties (e.g., an SEC investigation, delinquent
SEC mandatory filings, and class action lawsuits), SE
Corp. emerged from bankruptcy in 1998 still owning its
technology and various U.S.-based assets and personnel,
and with plans to commercialize its technology in the
near future. On Dec. 31, 1997, SE Corp.’s common stock
was trading at $3 a share.

     The issues for decision, all involving taxable
year 1997, are: (1) Whether Ps are taxable on ML’s
sale of pledged shares; (2) if taxable on that sale,
whether they may compute PH’s basis in the shares under
a LIFO (as opposed to a FIFO) method for computing
basis; (3) whether they are entitled to a $2 million
business (or, alternatively, nonbusiness) bad debt
deduction for the worthlessness of PH’s $2 million loan
to SE Corp.; and (4) whether they are entitled to a
worthless stock loss deduction for the worthlessness of
PH’s SE Corp. common stock.

     1.   Held:   Ps are taxable on ML’s sale of pledged
shares.

     2. Held, further, PH’s bases in the pledged
shares sold by ML must be computed on a FIFO basis.

     3. Held, further, Ps are not entitled to any bad
debt deduction for the worthlessness of PH’s $2 million
loan to SE Corp.

     4. Held, further, Ps are not entitled to a
worthless stock loss deduction for the worthlessness of
PH’s SE Corp. common stock.



Charles E. Anderson, for petitioners.

Vicki L. Miller, for respondent.
                               - 3 -

             MEMORANDUM FINDINGS OF FACT AND OPINION


     HALPERN, Judge:   By notice of deficiency (the notice),

respondent determined a deficiency of $259,874 in petitioners’

1997 Federal income tax.   By the petition, petitioners assign

error to respondent’s determination.   Petitioners also assign

error to respondent’s denial of their claims for refund for 1997.

The allowance of one or more of those claims would result in a

refund of $45,400, the amount of tax petitioners paid for 1997.1

After concessions,2 the issues for decision are whether

petitioners are entitled to:   (1) Avoid paying tax on the 1997

sale of 634,100 shares of Solv-Ex Corp. (Solv-Ex) common stock

issued to petitioner John S. Rendall (Mr. Rendall) on the ground

that they received no benefit from the proceeds of the sale; (2)

alternatively, if they are held to be taxable on that sale,


     1
        Petitioners’ originally filed 1997 return reports total
tax due of $383,632, total tax payments of $45,400, and an amount
owed equal to the difference, $338,232 (mistakenly computed to be
$338,630 on the return). Pursuant to sec. 6211(a), Internal
Revenue Code of 1986, as amended, the notice determines a
deficiency equal to the excess of the tax properly due, $643,506,
over the tax shown on the return, $383,632. The parties
stipulate that the $338,630 originally reported by petitioners as
the amount owed for 1997 has never been paid, except for
$2,001.89 collected as offsets to refunds due petitioners for
2001 and 2002. The record does not indicate whether the balance
has been assessed pursuant to sec. 6201(a)(1), Internal Revenue
Code of 1986, as amended.
     2
        Petitioners concede that petitioner Christobel Rendall is
not entitled to relief from joint and several liability (innocent
spouse relief) with respect to any deficiency or underpayment for
1997.
                              - 4 -

compute their long-term capital gain therefrom by using a last-

in-first-out (LIFO) method for computing cost basis, as they

allege, or by using a first-in-first-out (FIFO) method for

computing cost basis, as respondent alleges (the LIFO/FIFO basis

issue); (3) a $2 million nonbusiness bad debt deduction in 1997

as the result of the worthlessness in that year of a $2 million

debt from Solv-Ex to Mr. Rendall; (4) alternatively, a $2 million

business bad debt deduction as a result of that alleged

worthlessness; and (5) a worthless stock loss deduction for the

worthlessness, in 1997, of either Mr. Rendall’s remaining common

stock in Solv-Ex after the sale of 634,100 shares or (assuming

the sale of those shares is held not to be taxable to

petitioners) his common stock interest in Solv-Ex, including

those 634,100 shares.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year at issue, 1997,

and all Rule references are to the Tax Court Rules of Practice

and Procedure.

                        FINDINGS OF FACT3

     Some facts are stipulated and are so found.   The stipulation


     3
        To the extent that petitioners or respondent fail to set
forth objections to the other’s proposed findings of fact, we
conclude that those proposed findings of fact are correct except
to the extent that the nonobjecting party’s proposed findings of
fact are clearly inconsistent therewith. See Jonson v.
Commissioner, 118 T.C. 106, 108 n.4 (2002), affd. 353 F.3d 1181
(10th Cir. 2003).
                                   - 5 -

of facts, with accompanying exhibits, is incorporated herein by

this reference.

       At the time the petition was filed, petitioners resided in

Albuquerque, New Mexico.

Solv-Ex’s Formation and Operations Through March 1997

       Solv-Ex was incorporated on July 2, 1980, under New Mexico

law.       Mr. Rendall and another individual were the founding

shareholders.       Mr. Rendall purchased 2,700,000 shares of Solv-Ex

common stock at a cost of 1 cent a share at the company’s initial

offering of stock on July 2, 1980.         Beginning on July 17, 1981,

and ending on August 7, 1996, Mr. Rendall’s common stock interest

in Solv-Ex underwent a net increase to 3,162,860 shares.4         Mr.

Rendall served as chief executive officer (CEO) and chairman of

the board of Solv-Ex from its inception through November 1, 2000,

when he resigned.

       Solv-Ex’s business activity consisted of researching and

developing a process to extract bitumen from oil sands and

convert it into a synthetic crude oil.        Solv-Ex claimed to have

developed a cost-effective method to extract and process oil and

industrial minerals from oil sands.        Solv-Ex also claimed to have

developed a patented process to recover raw aluminum and other

marketable mineral products from the fine clays contained in oil


       4
        During that period, Mr. Rendall purchased a total of
677,860 shares at prices ranging from 1 cent to $19 a share, and
he sold 215,000 shares.
                               - 6 -

sands or in the waste tailings that result after the oil sands

are processed.   Solv-Ex contended that the value of those

marketable minerals was three times the value of the oil produced

from the oil sands.

     Beginning in 1981 with its initial public offering, Solv-Ex

was a public company, and its shares were traded on the NASDAQ

Small Cap Market.   Its financial statements reflected its status

as a “development stage enterprise” in accordance with Statement

of Financial Accounting Standards No. 7 (FAS 7), which includes

in the description of such companies a company for which

“[p]lanned principal operations have not commenced * * * [or]

[p]lanned principal operations have commenced, but there has been

no significant revenue therefrom.”

     During 1995, Solv-Ex acquired a 90-percent interest in oil

sands leases in Alberta, Canada (the leases).   After performing

feasibility studies for development and commercial operation of

the leases, Solv-Ex decided to develop the leases and raise the

capital required to construct an oil extraction and upgrading

plant in Alberta at an estimated cost of $125 million.    In 1996,

Solv-Ex was able to raise only $77 million through the sale of

convertible debentures and stock.    Because that was less than the

estimated construction cost for the plant, Solv-Ex decided to

modify its plans and build only an initial stage plant in

Alberta, the remaining facilities to be built later.     Solv-Ex’s
                               - 7 -

inability to secure the funds needed to construct a full-scale

commercial plant in 1997 was due to the October 1996 decision by

Deutsche Bank to renege on a “handshake deal” between Solv-Ex and

a subsidiary of Deutsche Bank (made before the latter’s

acquisition of the subsidiary) whereby Solv-Ex was to receive

$100 million of financing in January 1997.

     Construction of the initial stage plant began in August

1996, and with the testing of the plant’s operation in March

1997, was then complete.   The plant produced 600 gallons of good-

quality oil during a 12-hour period on March 31, 1997, thereby

demonstrating the viability of Solv-Ex’s oil extraction process.

1997 Efforts To Complete the Initial Stage Oil Recovery Plant

     In early 1997, still intent on completing the initial stage

plant,5 Mr. Rendall pursued alternative financing for Solv-Ex.

On March 26, 1997, Mr. Rendall made a $2 million loan to Solv-Ex

(the $2 million loan) from funds borrowed from Merrill Lynch,

Pierce, Fenner & Smith, Inc. (Merrill Lynch) through Mr.

Rendall’s Merrill Lynch margin account6.   The $2 million loan

(which, in form, constituted a $2 million wire transfer from

Merrill Lynch to Solv-Ex’s bank account) increased Mr. Rendall’s



     5
        Plant modifications were necessary in order to enable the
plant to run continuously.
     6
        Mr. Rendall established that account on Mar. 20, 1997, by
transferring his existing Smith Barney & Co. margin account to
Merrill Lynch.
                               - 8 -

total indebtedness against his Merrill Lynch margin account to $4

million.   Mr. Rendall made the $2 million loan as an inducement

to outside lenders to put up an additional $20 million of

financing for Solv-Ex.   Solv-Ex used the $2 million received from

Mr. Rendall (plus an additional $10 million received from three

outside lenders in April 1997 in exchange for convertible

debentures) to continue work on the initial stage plant.

Mr. Rendall’s Pledge of Solv-Ex Common Stock to Merrill Lynch

     In order to receive a line of credit through his Merrill

Lynch margin account, Mr. Rendall, on March 20, 1997 (the same

day he opened the account), executed a document entitled “Pledge

Agreement For Lending on Shelf Registered, Control or Restricted

Securities” (the pledge agreement).    Pursuant to the terms of the

pledge agreement, Mr. Rendall pledged 2,610,000 shares of Solv-Ex

common stock “as security for the repayment of indebtedness of

the pledgor to the pledgee.”   Also, pursuant to the pledge

agreement, any loans made by Merrill Lynch thereunder were

payable on demand.   On April 3, 1997, Mr. Rendall pledged an

additional 50,000 shares of Solv-Ex common stock as collateral

for loans from Merrill Lynch through his margin account.    Of the

2,660,000 shares of Solv-Ex stock pledged to Merrill Lynch,

2,500,000 shares consisted of certificates for stock purchased by

Mr. Rendall for 1 cent a share in 1980.   The certificates for the
                               - 9 -

remaining 160,000 pledged shares consisted of stock he purchased

at various times after 1980.

Merrill Lynch’s Sale of the Pledged Stock

     On May 2, 1997, Merrill Lynch sent a letter to Mr. Rendall

demanding payment of the margin loan in the amount of

$4,195,022.80, “plus all accrued interest”, by May 9, 1997.     If

Mr. Rendall failed to repay the margin loan by that date, Merrill

Lynch stated that it would liquidate sufficient shares of Solv-Ex

stock from the margin account to cover the margin debt.   The

letter further stated that, if $2 million were received by May 9,

the due date for the balance would be extended until May 16,

1997.

     In ensuing correspondence between Merrill Lynch or counsel

for Merrill Lynch and Solv-Ex and/or counsel for Solv-Ex, counsel

for Solv-Ex disputed and counsel for Merrill Lynch defended

Merrill Lynch’s right, under the Federal securities laws, to sell

the pledged stock.   In a letter dated May 22, 1997, Merrill Lynch

requested Solv-Ex and its transfer agent to register 1,100,000

shares of the pledged Solv-Ex stock for transfer in the name of

Merrill Lynch.   In a response to that letter and in a letter to

the transfer agent, both dated May 27, 1997, counsel for Solv-Ex

acknowledged that the requested reregistration/reissuance of

shares was accomplished by the transfer agent without permission

to do so from either Solv-Ex or counsel for Solv-Ex.
                              - 10 -

     Merrill Lynch filed with the Securities and Exchange

Commission (SEC) a Form 144, Notice of Proposed Sale of

Securities Pursuant to Rule 144 under the Securities Act of 1933

(the Form 144)7, dated May 28, 1997.    The Form 144 notified the

SEC of the possible sale of 1,100,000 shares of Solv-Ex common

stock acquired on account of a “Default of Margin Loan”, but

included a statement that “[p]ledgee intends to sell the number

of shares required to satisfy the indebtedness of pledgor.”    The

Form 144 lists Merrill Lynch as the “person for whose account the

securities are to be sold” and Mr. Rendall as pledgor.    Merrill

Lynch signed the Form 144 as pledgee.

     From May 28 through June 4, 1997, Merrill Lynch sold 634,100

shares of the pledged Solv-Ex common stock in lots ranging from

2,000 to 40,000 shares and at prices ranging from $6 to $7.625 a

share.   The total net sale proceeds from the sales of those

shares was $4,229,479.   Mr. Rendall did not identify the specific

shares of Solv-Ex common stock pledged to Merrill Lynch that were

to be sold.   At the end of June 1997, Merrill Lynch returned to

Mr. Rendall a single stock certificate, which comprised the

shares of the pledged Solv-Ex common stock not sold by Merrill

Lynch.




     7
       Rule 144 (17 C.F.R. sec. 230.144 (2006)) was promulgated
by the SEC.
                                - 11 -

Failure To Complete the Initial Stage Plant

     Solv-Ex had continued to make modifications to its initial

stage plant in Alberta during April 1997, but, because it could

not obtain anticipated financing, Solv-Ex began to mothball the

plant in late May 1997.

     Toward the end of June 1997, Mr. Rendall, on behalf of Solv-

Ex, continued his attempts to obtain financing for the completion

of the initial stage plant, this time by offering to sell a part

of the company to a large oil company.     Those attempts proved

unsuccessful when the prospective buyer of a 1/2-interest in

Solv-Ex backed out of the proposed deal upon learning from Mr.

Rendall that Solv-Ex would be filing for bankruptcy protection

under Canadian law as a means of avoiding the filing of a lien by

a large unpaid creditor.

Solv-Ex’s Bankruptcy Reorganizations

     On July 14, 1997, Solv-Ex filed a petition for bankruptcy

protection in Canada under the Companies’ Creditors Arrangement

Act, the Canadian equivalent of a filing under chapter 11 of the

United States Bankruptcy Code (the Canadian bankruptcy).     On

August 1, 1997, Solv-Ex filed a petition under the said chapter

11 in the U.S. Bankruptcy Court for the District of New Mexico

(the U.S. bankruptcy).     The two bankruptcy cases (the joint

bankruptcies) were jointly administered by each country’s
                              - 12 -

respective court pursuant to a cross-border insolvency protocol

agreement.

     On October 24, 1997, Mr. Rendall filed a proof of claim in

the Canadian bankruptcy, which included his unsecured claim for

the $2 million loan.   That claim was disallowed, whereupon, on

December 1, 1997, he filed a motion objecting to the claim

disallowance in which he contested the bankruptcy court’s

treatment of the $2 million loan as a debenture rather than as an

unsecured claim.   Ultimately, on September 9, 1998, in

satisfaction of his $2 million claim (plus accrued interest) in

the U.S. bankruptcy, Mr. Rendall received 5,728,767 shares of new

common stock of Solv-Ex.   The number of shares was determined

under a formula applicable to certain convertible debenture

holders that was set forth in the Second Amended Plan of

Reorganization for Solv-Ex, dated June 23, 1998 (the plan of

reorganization), and was based upon the closing bid price per

share on the date immediately preceding the date of conversion,

which turned out to be 50 cents a share.

     During the course of the joint bankruptcies, Solv-Ex sold

its interest in the leases and its oil production facilities and

equipment in Canada to two separate buyers:   (1) A 78-percent

interest to Koch Exploration Canada, Ltd. (Koch), in exchange for

Can$30 million, with Koch also receiving warrants (exercisable

for a limited time) to purchase 2 million shares of Solv-Ex
                              - 13 -

common stock at a discount; and (2) its remaining 12-percent

interest to United Tri Star Resources, Ltd.(UTS), which already

held a 10-percent interest in those assets, in exchange for $3

million and 5 million shares of UTS common stock.   Both of those

sales closed in March 1998, although Solv-Ex had entered into a

preliminary agreement with Koch on November 14, 1997.

     As part of the agreement with Koch, Solv-Ex retained

ownership of its hydrocarbon extraction technologies, its

technologies for mineral and metal extraction, and the rights to

develop the leases for the recovery of such minerals and metals.

Solv-Ex also retained numerous process patents in the United

States, Canada, and other countries covering its bitumen and

mineral extraction technologies, both for oil sands and oil

shale.   In addition, Solv-Ex retained other assets, including 1.5

acres of land in Albuquerque, New Mexico, upon which a research

facility, office space, a pilot plant, an acid plant, and

machinery and equipment were situated.   It also continued to

employ a team of research engineers for a possible fresh start.

     In the business plan set forth in its amended disclosure

statement filed in the U.S. bankruptcy on June 23, 1998 (the

amended disclosure statement), Solv-Ex set forth its intention to

focus on:   (1) Commercializing its Ti02S technology, Solv-Ex’s

trade name (for which it had applied for a trademark) for a

substitute filler and pigment for titanium dioxide useful in the
                               - 14 -

paper, paint, and plastics industries; (2) supporting the

licensing of Solv-Ex’s bitumen extraction process technology; and

(3) “obtaining a joint venture partner for a project that will

establish a major alumina and aluminum reduction production

facility in Alberta, Canada, or at another site yet to be

determined.”    The business plan was developed with a goal of

bringing a reorganized Solv-Ex to the point of positive cashflow

by the year 2000.

     On April 24 and May 14, 1998, Solv-Ex entered into

memorandums of understanding (MOUs) with two separate companies

(one a Venezuelan company) to jointly explore the development and

production of Solv-Ex’s Ti02S technology for commercial use.

Those MOUs were part of Solv-Ex’s business plan.

     In an exhibit attached to the amended disclosure statement,

Solv-Ex stated that the Koch and UTS sales provided a means for

the satisfaction of substantially all of the nonsubordinate,

nondebenture debt, and that the proposed business plan would

allow “the Reorganized Solv-Ex emerging from chapter 11

protection to move forward with the commercial development of its

valuable technologies in Ti02S, alumina and aluminum production.”

     On July 31, 1998, the U.S. Bankruptcy Court for the District

of New Mexico approved the plan of reorganization, effective

August 31, 1998.    A similar order was entered in the Canadian

bankruptcy.    Upon confirmation of the plan of reorganization,
                               - 15 -

Solv-Ex emerged from bankruptcy in both the United States and

Canada, and it continued to operate.

Solv-Ex’s SEC Problems

     Because of the joint bankruptcies and its inability to

obtain audited financial statements, Solv-Ex failed to file a

Form 10-K, Annual Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934, with the SEC for the year ended

June 30, 1997,8 as required under the Securities Exchange Act of

1934.    That report was due to be filed on or before September 28,

1997.    For the same reasons, Solv-Ex failed to file quarterly

reports on Form 10-Q (the quarterly report under Section 13 or

15(d)) for the quarters ended September 30 and December 31, 1997.

As of mid-June 1998, Solv-Ex still intended (and expected to be

able) to file the delinquent reports and subsequent reports

becoming due in the near future.

     In March 1996, the SEC initiated an investigation involving

the relationship between Solv-Ex and another company.

Subsequently, in 1997, SEC staff members sent letters to Solv-Ex

advising that the staff intended to recommend that the SEC seek

an injunction against Solv-Ex and certain individuals, including

Mr. Rendall, for Federal securities laws violations; i.e., the




     8
         Solv-Ex kept its books on a June 30 fiscal year basis.
                               - 16 -

making of false and misleading statements regarding the company’s

operations.9

Litigation Involving Solv-Ex

     In October, November, and December 1996, Solv-Ex, Mr.

Rendall, and other officers of Solv-Ex were made defendants in

class action suits brought by Solv-Ex shareholders alleging false

and misleading statements relating to Solv-Ex in violation of

both Federal and New Mexico securities laws.   The claims alleged

in those lawsuits were recognized as claims in the joint

bankruptcies, or the action was stayed by reason of the chapter

11 bankruptcy.   In the amended disclosure statement, Solv-Ex

expressed its intent “to vigorously defend the actions filed

against it”, and it stated its belief that those actions were

“without merit”.

     On August 9, 1996, Solv-Ex sued certain individuals and

entities in the U.S. District Court for the Southern District of

New York, seeking damages in excess of $12 million for actions

intended to further the defendants’ short selling schemes.   The

suit was dismissed without prejudice because of the bankruptcy

proceedings.   In the amended disclosure statement, Solv-Ex stated

its intent to refile the suit following its discharge from

bankruptcy.    In October and December 1998, Solv-Ex brought suits



     9
        The SEC did commence such an action in Federal District
Court on July 20, 1998.
                                - 17 -

against Deutsche Bank and others, with a potential recovery of

$100 million, which accused the defendants of actions that had

negatively affected the value of its stock.

Solv-Ex’s Operations After Discharge From Bankruptcy

     Because of a change in the Venezuelan Government in late

1998 that led to the dissolution of one of Solve-Ex’s prospective

Venezuelan partners, the Venezuelan project for the

commercialization of Solv-Ex’s Ti02S technology never

materialized.

     Upon emerging from bankruptcy in August 1998, Solv-Ex

retained its technologies and other assets, including the land,

office building, research facility, pilot plant, acid plant, and

machinery and equipment in Albuquerque, New Mexico, plus various

tax refunds and other claims.    It retained employees to oversee

its continued research and development efforts with respect to

its technologies.

     Solv-Ex continued to seek funding for future operations,

and to that end, in November 1998, it raised $812,000 through a

private placement of 1,624,000 shares of new common stock and

919,400 stock warrants.     At the time of the trial, Solv-Ex had

never earned a profit, had not produced for sale any oil or other

products, and had not had any sales from its research and

development technologies.    Nor had it been successful in

recovering any amount from any lawsuit.    Moreover, as of October
                               - 18 -

2000, it still was remiss in filing many of its required SEC

Forms 10-K and 10-Q for the years 1997 through 2000.

     On November 1, 2000, Mr. Rendall resigned as CEO and

chairman of the board of Solv-Ex, and he was replaced in both

roles by Frank Ciotti (Mr. Ciotti), who had previously been the

company’s chief financial officer.

Solv-Ex’s Financial Statements

     The record does not contain any financial statements (in

particular, there is no balance sheet) reflecting Solv-Ex’s

financial position as of December 31, 1997.    A set of unaudited

financial statements is attached as an exhibit to the amended

disclosure statement.   Those statements include a balance sheet

for Solv-Ex and subsidiaries10 as of March 31, 1997, which shows

total assets of $105,451,134 and total liabilities of

$58,378.781.    An independent auditor’s report dated January 27,

1999, contains an audited balance sheet for Solv-Ex and

subsidiaries as of August 31, 1998.     It shows total assets of

$6,174,772 and total liabilities of $8,121,573.     Included in

liabilities is the $2 million loan that was subsequently

satisfied by Mr. Rendall’s receipt of 5,728,767 shares of Solv-Ex

common stock.



     10
        For a period including at least a part of 1997, Solv-Ex
conducted research and development activities through two
subsidiary corporations, and it used a third subsidiary to supply
employees to run its initial stage plant.
                              - 19 -

     During 1997, Solv-Ex’s largest debt obligation was a $33

million convertible debenture held by Phemex Establishment

(Phemex), a Liechtenstein entity, which was created on April 21,

1996, under a convertible loan agreement.     Solv-Ex was prepared

to assert offsetting claims against Phemex and its affiliates.

Phemex failed to file a proof of claim in either the U.S. or the

Canadian bankruptcy by the deadlines established for such filings

(January 31, 1998, in the U.S. bankruptcy).    Therefore, Phemex

was deemed to have waived its claim entirely, and the claim was

disallowed in the joint bankruptcies.

Trading in Solv-Ex Common Stock

      Before the joint bankruptcies, the principal market in

which Solv-Ex’s common stock was traded was the NASDAQ Small-Cap

Market.   As a result of developments in the bankruptcy

proceedings, NASDAQ delisted the Solv-Ex common stock on

September 17, 1997.   Thereafter, the stock traded over the

counter in what is commonly referred to as the “pink sheets”.

     During the first quarter of 1997, Solv-Ex common stock

traded between a high of $21.50 and a low of $10 a share.     During

the succeeding quarter ended June 30, 1997, which included

Merrill Lynch’s sales of pledged stock, Solv-Ex common stock

traded between a high of $14.125 and a low of $3 a share.     As of

December 31, 1997, the stock was trading over the counter at

approximately $3 a share.   The stock continued to trade over the
                               - 20 -

counter in 1998 and averaged at or near $1.25 a share for the

trading days immediately prior to the end of May 1998.   On July

28, 1998, the stock traded at $.875 a share.

Petitioners’ 1997 Return and Amended Returns

     On the Schedule D, Capital Gains and Losses, attached to

their original 1997 return, filed October 15, 1998, petitioners

used a LIFO (last stock purchased, first stock sold) method for

determining Mr. Rendall’s basis in the 634,100 shares of Solv-Ex

common stock pledged to and sold by Merrill Lynch.    Petitioners

reported total basis for those shares of $1,305,714 and total

gain of $2,923,765 ($4,229,479 - $1,305,714).

     On April 14, 1999, March 18, 2002, and January 22, 2003,

petitioners filed four amended returns (the first through fourth

amended returns).11   All of the amended returns report a net loss

for 1997 and claim a refund of $45,400, petitioners’ total tax

payments for that year.   There are differences among them,

however, particularly with respect to both the amounts of loss

and the bases for the loss.

     The first amended return differs from the original return by

claiming a nonbusiness bad debt deduction (short-term capital

loss) for the worthlessness of the $2 million loan.   The second




     11
        Both the third and the fourth amended returns were filed
on Jan. 22, 2003.
                                - 21 -

amended return claims a business bad debt deduction (ordinary

loss) for the worthlessness of the $2 million loan.12

     The third amended return adds a claim for a worthless stock

loss attributable to the worthlessness of Mr. Rendall’s Solv-Ex

common stock remaining after Merrill Lynch’s sale of the pledged

shares.   That deduction results in a pro tanto decrease in the

capital gain and increase in the net loss reported on the first

and second amended returns.

     On the Schedule D attached to the fourth amended return,

petitioners omit the gain from Merrill Lynch’s sale of the

pledged Solv-Ex common stock.    Instead, they claim a worthless

stock loss equal to Mr. Rendall’s total cost basis in all of his

Solv-Ex shares, including the shares pledged to Merrill Lynch.

In the “Explanation of Changes to Income, Deductions, and

Credits”, petitioners describe the purpose of the fourth amended

return as follows:   “To writeoff Solv-Ex worthless stock and

remove sales proceeds [from Merrill Lynch’s sale of the pledged

shares] which taxpayer incorrectly reported.”    That change

results in a net capital loss for 1997 (deducted to the extent of

$3,000 pursuant to section 1211(b)) and a substantial increase in



     12
        The first and second amended returns report the same
1997 net loss. Nonetheless, assuming there was a 1997 bad debt,
the business versus nonbusiness bad debt issue is not moot
because the resolution of that issue directly bears upon the
amount of petitioners’ net operating loss carryback/carryover
from 1997.
                                - 22 -

petitioners’ total 1997 net loss over the net loss reported on

the third amended return.

                                OPINION

I.   Burden of Proof

     Petitioners argue that, pursuant to section 7491(a), the

burden of proof “has shifted to” respondent with respect to all

of the factual issues.     Petitioners further argue that respondent

conceded at trial that he bears the burden of proof on all issues

except the LIFO/FIFO basis issue, and that respondent bears the

burden of proof on that issue as well because petitioners have

“met the preconditions of Section 7491 on * * * [that] issue.”

      Generally, a taxpayer in this court bears the burden of

proof.   Rule 142(a)(1).    In certain circumstances, however, if

the taxpayer introduces credible evidence with respect to any

factual issue relevant to ascertaining the proper tax liability,

section 7491 shifts the burden of proof to the Commissioner.

Sec. 7491(a)(1); Rule 142(a)(2).     Credible evidence is evidence

the court would find sufficient upon which to base a decision on

the issue in favor of the taxpayer if no contrary evidence were

submitted.   See Higbee v. Commissioner, 116 T.C. 438, 442 (2001);

Bernardo v. Commissioner, T.C. Memo. 2004-199 n.6.     Section

7491(a)(2) imposes certain prerequisites to the application of

section 7491(a)(1), including that the taxpayer must have
                              - 23 -

complied with the requirements under the Internal Revenue Code

“to substantiate any item”.   Sec. 7491(a)(2)(A).

     At trial, respondent conceded that “the preconditions set

forth in section 2 [section 7491(a)(2)] have been met, with the

exception of the fact that the taxpayer has not * * * maintained

or provided records necessary for the identification of the sale

of the stock pertaining to the LIFO/FIFO issue.”    That is not a

concession by respondent that he bears the burden of proof on all

issues except the LIFO/FIFO basis issue.   It is merely a

concession that petitioners have satisfied the section 7491(a)(2)

prerequisites to the application of section 7491(a)(1) to those

issues.   Respondent argues that petitioners retain the burden of

proof on all issues because they have failed to present “credible

evidence” in support of their position on each issue as required

by section 7491(a)(1).

     As discussed infra, petitioners have failed to introduce

credible evidence that:   (1) They are not taxable on the sale of

634,100 shares of Solv-Ex common stock pledged to Merrill Lynch;

(2) they may determine Mr. Rendall’s basis in those shares under

the LIFO method for determining cost basis; and (3) the $2

million loan and Mr. Rendall’s Solv-Ex common stock became

worthless in 1997.   Therefore, petitioners retain the burden of

proof with respect to those issues pursuant to Rule 142(a), a

burden that, because of the absence of credible evidence,
                               - 24 -

petitioners cannot sustain.    See Bernardo v. Commissioner, supra

at n.7.

II.   Attribution to Mr. Rendall of the Sale Proceeds From
      Merrill Lynch’s Sale of Pledged Solv-Ex Common Stock

      On brief, petitioners argue that, because Merrill Lynch sold

634,100 of the pledged shares “for their own purposes” (i.e.,

“for Merrill Lynch’s protection of their massive short

position”), the income from that sale is taxable to Merrill

Lynch.    Petitioners further argue that because those shares had

been reissued in Merrill Lynch’s name before their sale by

Merrill Lynch, Merrill Lynch “should bear the tax consequences on

such sale.”    Petitioners discount the fact that the shares were

acquired by Merrill Lynch pursuant to the pledge agreement on the

ground that that agreement “was fraudulently procured in light of

all the facts.”

      In response to petitioners’ arguments, respondent argues

that:    (1) The pledge agreement was valid; (2) under it, Mr.

Rendall, as pledgor, retained ownership of the pledged shares;

(3) the proceeds from the sale of pledged shares were used to

discharge Mr. Rendall’s indebtedness to Merrill Lynch and,

therefore, benefited Mr. Rendall; and (4) any reissuance of

pledged shares in Merrill Lynch’s name was “done to facilitate

Merrill Lynch’s sale [of the shares] as pledgee”, not to transfer

ownership of the pledged shares to Merrill Lynch.    Respondent
                               - 25 -

concludes:   “Therefore, in light of the facts, the gain from the

sale of such stock is properly taxable to Mr. Rendall.”

     We agree with respondent.   There is no evidence in the

record to indicate that the pledge agreement was “fraudulently

procured”, as petitioners allege, nor is there any evidence that

Merrill Lynch sold the 634,100 shares of pledged Solv-Ex common

stock in any capacity other than as a pledgee in order to satisfy

Mr. Rendall’s debt to it.   Merrill Lynch sold only enough shares

to satisfy Mr. Rendall’s outstanding debt obligation under his

margin loan account.13   The remaining pledged shares were

returned to Mr. Rendall within 1 month from the last sale of

pledged stock.    Those circumstances suggest that Merrill Lynch’s

sole purpose in securing the pledge of Solv-Ex common stock from

Mr. Rendall, and his sole purpose in pledging that stock, was to

provide security for the repayment of his debt to Merrill Lynch,

and we so find.

     Petitioners suggest that Merrill Lynch’s demand for

repayment of the margin loan was unwarranted because, at that

time, the value of the pledged shares was over $40 million, and


     13
        On May 2, 1997, Merrill Lynch demanded repayment by Mr.
Rendall of $4,195,022.80 “plus all accrued interest”. The sale
of 634,100 pledged shares between May 28 and June 4, 1997,
generated net sales proceeds of $4,229,479. There is no evidence
that Merrill Lynch paid to Mr. Rendall, or that Mr. Rendall
demanded from Merrill Lynch, the $34,456.20 difference.
Therefore, we infer that that difference constituted all or a
portion of the accrued interest referred to in Merrill Lynch’s
May 2, 1997, letter to Mr. Rendall.
                              - 26 -

Solv-Ex had recently demonstrated, at its initial stage plant,

the viability of its oil sands technology.   Merrill Lynch’s

motivation for demanding repayment of the margin loan when it did

is irrelevant.   Pursuant to the pledge agreement, Mr. Rendall’s

margin loan was payable on demand, and there is no dispute that

he failed to repay the loan during the period Merrill Lynch

allotted for repayment.   Also, Mr. Rendall benefitted by having

his debt to Merrill Lynch discharged by the sale of pledged

shares.14

     As the pledgor of the Solv-Ex common stock held by Merrill

Lynch, Mr. Rendall remained the owner of and, therefore, was

taxable on Merrill Lynch’s sale of the pledged shares.   As stated

by the Court of Appeals for the First Circuit in Old Colony Trust

Associates v. Hassett, 150 F.2d 179, 182 (1st Cir. 1945):      “A

pledgee who has not foreclosed has only a special interest or

property in the stock during the continuance of the pledge.     The

pledgor retains the title and gains from sales of the collateral

are taxed to the pledgor.”   See also Joyce v. Commissioner, 42




     14
        Petitioners do not address the consequence of the
discharge of Mr. Rendall’s indebtedness to Merrill Lynch if
Merrill Lynch, pursuant to petitioners’ theory, sold the Solv-Ex
shares in question for its own account. On brief, petitioners
claim “the proceeds were assigned to cover Rendall’s debt to
Merrill Lynch”. Perhaps petitioners’ position is that they
sustained a theft loss equal to their basis in the shares sold
and an item of (ordinary) gross income equal to the amount of
debt discharged. See secs. 61(a)(12), 165(b).
                               - 27 -

T.C. 628, 636-637 (1964); Ligon v. Commissioner, 37 B.T.A. 763,

765 (1938).

III.    Mr. Rendall’s Basis in the Pledged Stock Sold by Merrill
        Lynch (The LIFO/FIFO Basis Issue)

        Both parties cite section 1.1012-1(c), Income Tax Regs., in

support of their respective positions regarding Mr. Rendall’s

cost basis for the 634,100 shares of Solv-Ex common stock sold by

Merrill Lynch.    That provision states, in pertinent part, as

follows:

            § 1.1012-1 Basis of property.

            *      *      *      *      *      *      *

            (c) Sale of stock. (1) In general. If shares of
       stock in a corporation are sold or transferred by a
       taxpayer who purchased or acquired lots of stock on
       different dates or at different prices, and the lot
       from which the stock was sold or transferred cannot be
       adequately identified, the stock sold or transferred
       shall be charged against the earliest of such lots
       purchased or acquired in order to determine the cost or
       other basis of such stock * * *. If, on the other
       hand, the lot from which the stock is sold or
       transferred can be adequately identified, the rule
       stated in the preceding sentence is not applicable. As
       to what constitutes “adequate identification,” see
       subparagraphs (2), (3), and (4) of this paragraph.

            (2) Identification of stock. An adequate
       identification is made if it is shown that certificates
       representing shares of stock from a lot which was
       purchased or acquired on a certain date or for a
       certain price were delivered to the taxpayer’s
       transferee. Except as otherwise provided in
       subparagraph (3) or (4) of this paragraph, such stock
       certificates delivered to the transferee constitute the
       stock sold or transferred by the taxpayer. Thus,
       unless the requirements of subparagraph (3) or (4) of
       this paragraph are met, the stock sold or transferred
       is charged to the lot to which the certificates
                              - 28 -

     delivered to the transferee belong, whether or not the
     taxpayer intends, or instructs his broker or other
     agent, to sell or transfer stock from a lot purchased
     or acquired on a different date or for a different
     price.

          (3) Identification on confirmation document. (i)
     Where the stock is left in the custody of a broker or
     other agent, an adequate identification is made if --

              (a) At the time of the sale or transfer, the
     taxpayer specifies to such broker or other agent having
     custody of the stock the particular stock to be sold or
     transferred, and

              (b) Within a reasonable time thereafter,
     confirmation of such specification is set forth in a
     written document from such broker or other agent.

     Stock identified pursuant to this subdivision is the
     stock sold or transferred by the taxpayer, even though
     stock certificates from a different lot are delivered
     to the taxpayer’s transferee.

     Petitioners argue that Merrill Lynch’s actions in selling

634,100 of the pledged shares “precluded [Mr. Rendall] from

making any identification at or about the time of the sale by

Merrill Lynch”, and that their “first opportunity” to identify

the shares sold was in connection with the preparation and filing

of their 1997 return.   Petitioners conclude that they made

adequate identification of the shares sold on Schedule D of their

1997 return.

     Respondent argues that “Mr. Rendall was well aware that

Merrill Lynch intended to sell a portion of the pledged stock to

satisfy his margin loan debt” and, “[d]espite knowing of Merrill

Lynch’s intentions * * *, petitioners made no attempt to comply
                              - 29 -

with the adequate identification requirements.”    Respondent

concludes that, because “[a]t the time of the sale” Mr. Rendall

failed to specify to Merrill Lynch the shares to be sold, as

required by section 1.1012-1(c)(3)(i)(a), Income Tax Regs., there

was no “adequate identification” of the sold shares.    Therefore,

Mr. Rendall’s cost basis in those shares must be determined by

applying the FIFO method.

     Again, we agree with respondent.    The May 1997

correspondence described supra involving Merrill Lynch, Solv-Ex,

and counsel for each demonstrates that the two sides were in

communication before the sale of pledged shares.    In late May,

when the sale of pledged shares appeared inevitable, Solv-Ex, on

behalf of Mr. Rendall, could have identified to Merrill Lynch the

shares to be sold; e.g., by making that identification in the May

27, 1997, letter from counsel for Solv-Ex to counsel for Merrill

Lynch acknowledging the transfer of the pledged shares to Merrill

Lynch’s name.   In fact, Mr. Rendall testified at trial that he

could have identified the stock to be sold at or before the time

of sale.   Therefore, we find that Mr. Rendall was not precluded

by Merrill Lynch from identifying those shares “At the time of

the sale”, which would have satisfied the requirements of section

1.1012-1(c)(3)(i)(a), Income Tax Regs.

     Mr. Rendall’s testimony and an unobjected-to proposed

finding of fact based upon that testimony establish that he
                                - 30 -

purchased 2.5 million of the 2,660,000 shares pledged to Merrill

Lynch in 1980 for 1 cent a share, and we have so found.

Petitioners also do not object to respondent’s proposed finding

of fact that the stock certificates given to Merrill Lynch for

the remaining 160,000 pledged shares represented shares Mr.

Rendall purchased at various times after 1980, and we have so

found.     Because the selling shareholder may do no more than

select and identify shares for sale from among the shares “left

in the custody of a broker or other agent,” no more than 160,000

of the 634,100 pledged shares Merrill Lynch sold on Mr. Rendall’s

behalf could have been identified by him as having been purchased

for more than 1 cent a share.     Sec. 1.1012-1(c)(3), Income Tax

Regs.     Thus, at least 474,100 (634,100 - 160,000) of the sold

shares had a cost basis to Mr. Rendall of 1 cent a share.       See

also Kluger Associates, Inc. v. Commissioner, 617 F.2d 323, 327-

328 (2d Cir. 1980), affg. 69 T.C. 925 (1978).

        Moreover, Mr. Rendall failed to adequately identify the

other 160,000 pledged shares sold by Merrill Lynch.     Petitioners’

purported identification on their 1997 originally filed and

amended returns was inadequate for two reasons:     (1) Those

returns did not specify which of Mr. Rendall’s shares purchased

after 1980 at more than 1 cent a share constituted the 160,000

shares pledged to Merrill Lynch; and (2) even if those shares had

been identified on petitioners’ 1997 returns, that identification
                              - 31 -

would not have been timely since it would not have been “[a]t the

time of the sale” as required by section 1.1012-1(c)(3)(i)(a),

Income Tax Regs.   See also Hall v. Commissioner, 92 T.C. 1027,

1039 (1989) (taxpayer not permitted to avoid application of the

FIFO method by waiting “until the end of a year to allot specific

sales to his general inventory of stocks in such a manner as to

be most beneficial to him taxwise”).

      We hold that petitioners have failed to introduce credible

evidence that they adequately identified, on a LIFO basis, any

portion of the 634,100 pledged shares sold by Merrill Lynch.

Therefore, we sustain respondent’s application of the FIFO method

for determining Mr. Rendall’s basis in those shares.   Because the

number of pledged shares constituting shares Mr. Rendall

purchased for 1 cent a share in 1980 at the initial offering of

Solv-Ex common stock (2.5 million) was well in excess of the

634,100 pledged shares sold by Merrill Lynch, respondent properly

determined that Mr. Rendall’s FIFO basis in the sold shares was

$6,341 (634,100 x 1 cent), and that petitioners’ long-term

capital gain on the sale of those shares was $4,223,138

($4,229,479 - $6,341).

IV.   Bad Debt Deduction

      A.   Law

      Section 166(a)(1) allows a deduction for “any debt which

becomes worthless within the taxable year.”   To provide credible
                              - 32 -

evidence of worthlessness in 1997, petitioners must show that the

$2 million loan had value at the beginning of 1997 and became

worthless during that year.   Milenbach v. Commissioner, 106 T.C.

184, 204 (1996), affd. in part, revd. in part on other grounds

and remanded 318 F.3d 924 (9th Cir. 2003).   The determination

depends upon the particular facts and circumstances of each case,

although, generally, “the year of worthlessness is fixed by

identifiable events that form the basis of reasonable grounds for

abandoning any hope of recovery.”   Id. at 204-205; see also

Estate of Mann v. United States, 731 F.2d 267, 276 (5th Cir.

1984); Dallmeyer v. Commissioner, 14 T.C. 1282, 1291-1292 (1950).

A taxpayer must provide evidence of lack of potential as well as

liquid value by yearend, and the taxpayer’s unsupported opinion

that the debt became worthless in a particular year, by itself,

will not normally be accepted as proof of worthlessness.   See

Dustin v. Commissioner, 53 T.C. 491, 501-502 (1969), affd. 467

F.2d 47 (9th Cir. 1972).

     B.   Analysis

     1.   Introduction

     In support of their entitlement to a 1997 bad debt deduction

for the worthlessness of the $2 million loan, petitioners argue

that, as of December 31, 1997:   (1) Solv-Ex was in bankruptcy in

both the United States and Canada; (2) it had committed to sell

all of its Canadian operating assets (plant and equipment) and
                              - 33 -

leases at a substantial loss; (3) it was insolvent; (4) its

technology was without value; and (5) it had no past, present, or

prospective future earnings; i.e., it had no “realistic, viable

plan to pursue its business” other than the “incorrigible and

hopeless optimism of its founder and chairman, John Rendall.”

     Although there is no doubt that Solv-Ex was in a serious

financial bind and faced an extremely uncertain future as of

December 31, 1997, for the reasons discussed infra we agree with

respondent that “[t]he facts do not establish that all reasonable

hope of any future satisfaction on the loan was lost in 1997”.

     2.   The Bankruptcy Reorganizations

     Both the U.S. and Canadian bankruptcy proceedings

constituted reorganizations, not liquidating bankruptcies.    When

a bankruptcy reorganization (e.g., under chapter 11 of the United

States Bankruptcy Code) continues without objection from the

creditors of the bankrupt, there is a strong presumption that the

reorganization is not hopeless and that the creditors will

receive at least partial repayment of the bankrupt’s debts.     See

Mayer Tank Manufacturing Co. v. Commissioner, 126 F.2d 588, 591-

592 (2d Cir. 1942); Barrett v. Commissioner, T.C. Memo. 1996-199,

affd. without published opinion 107 F.3d 1 (1st Cir. 1997).    In

the present case, that presumption is consistent with the

evidence.
                             - 34 -

     Although Solv-Ex was required to sell all of its Canadian

operating assets and leases in order to raise cash, it still

retained ownership of its hydrocarbon, mineral, and metal

extraction technologies, numerous patents in the United States,

Canada, and elsewhere covering those technologies, both for oil

sands and oil shale (the retained technology), and land in

Albuquerque, New Mexico containing a research facility, office

space, a pilot plant, an acid plant, and machinery and equipment.

It also continued to employ research engineers.   The existence of

those retained assets and personnel suggests that, as of the end

of 1997, Solv-Ex was in a position to continue its attempts to

become a successful operating company after it emerged from

bankruptcy.

     At trial, Mr. Rendall testified that the retained technology

was not marketable as of December 31, 1997, because of his loss

of credibility attributable to the SEC investigation.   Mr.

Rendall also testified, however, that the retained technology

still had substantial intrinsic value which would become apparent

to the marketplace once his credibility was restored through

proven usefulness of the technology in extracting minerals.    We

interpret that testimony to be an acknowledgment by Mr. Rendall

that the retained technology had potential value to Solv-Ex

sufficient to enable it to emerge from bankruptcy as a viable

company.
                                - 35 -

      Mr. Rendall further testified that the patents were

worthless without his knowledge “of how to make * * * [them]

work.”    But, assuming arguendo that the patents were useless

without Mr. Rendall’s knowhow in exploiting them, it is

undisputed that, as of December 31, 1997, Mr. Rendall was still

the CEO of Solv-Ex, and that, in Mr. Rendall’s own words, he and

the patents were “united for [the] future.”

     Another reason for at least cautious optimism, as of

December 31, 1997, regarding Solv-Ex’s prospects for financial

recovery was the potential commercialization of Solv-Ex’s Ti02S

technology (a titanium dioxide substitute for whitening paper and

other materials, hereinafter included in the term “retained

technology”).    Mr. Rendall testified that they “had” the

“product” in January 1998, that “it was an excellent product”,

and that, in February 1998, he went to Venezuela, where, the

following April and May, he was able to enter into two MOU’s with

Venezuelan companies for the production and marketing of pigment

using the Ti02S technology.15




     15
        We infer from Mr. Rendall’s testimony and from the
representation in the amended disclosure statement filed in the
U.S. bankruptcy proceeding on June 23, 1998, that aspects of the
Ti02S technology had been “demonstrated previously in the Solv-Ex
Research and Pilot Plant facility in Albuquerque” that the
technology was either developed or in the final stages of
development as of Dec. 31, 1997.
                               - 36 -

     Solv-Ex’s plan of reorganization was approved by both the

U.S. and Canadian bankruptcy courts in 1998, whereupon Solv-Ex

emerged from the joint bankruptcies and, thereafter, continued to

operate.   Moreover, under the plan, Mr. Rendall received

5,728,767 shares of new Solv-Ex common stock in discharge of the

$2 million loan (plus interest).   Because the number of shares

Mr. Rendall received was based upon the actual bid price for

Solv-Ex common stock on the date immediately prior to the date of

receipt (50 cents a share), those shares obviously had a value

greater than zero upon receipt by Mr. Rendall.

     Lastly, Mr. Rendall testified at trial that the lawsuits

commenced in 1998 against Deutsche Bank and others, after Solv-

Ex’s discharge from bankruptcy, entailed the potential recovery

of $100 million for Solv-Ex.

     Although the arrangements for commercializing the Ti02S

technology in Venezuela, Solv-Ex’s emergence from bankruptcy, the

conversion to common stock of the $2 million loan, and the suits

against Deutsche Bank and others all occurred in 1998, we may

“take cognizance of subsequent events in confirming whether a

debt becomes worthless in a particular year.”    Crown v.

Commissioner, 77 T.C. 582, 600 (1981).

     Petitioners have not persuaded us that the joint

bankruptcies were identifiable events demonstrating the

worthlessness of the $2 million loan as of December 31, 1997.
                              - 37 -

     3.   Sale of Solv-Ex’s Canadian Operating Assets and Leases

     Although Solv-Ex’s forced sale to Koch of a 78-percent

interest in its Canadian operating assets and leases was

certainly a setback for the company, for the reasons discussed in

the prior section, that sale (to which Solv-Ex was committed as

of December 31, 1997) did not eliminate the realistic hope that

Solv-Ex would be able to recommence operations in the future and

become profitable.

     In fact, the cash raised by that sale (and by Solv-Ex’s sale

of the remaining 12-percent interest in its Canadian operating

assets and leases) helped enable Solv-Ex to discharge

substantially all of its non-subordinate, non-debenture debts,

thereby enhancing the prospects for its eventual recovery.

Moreover, that is true whether the sale was at a gain, at break-

even, or at a loss as petitioners allege.

     We find that the anticipated sale of Solv-Ex’s Canadian

operating assets and leases was not an identifiable event

indicating the worthlessness of the $2 million loan as of

December 31, 1997.

     4.   Insolvency

     As noted supra, there are no financial statements in

evidence that reflect Solv-Ex’s financial position as of December

31, 1997.   The only evidence indicating Solv-Ex’s insolvency as

of that date is Mr. Ciotti’s unsubstantiated trial testimony that
                              - 38 -

Solv-Ex’s loss on its sale of Canadian operating assets and

leases to Koch “resulted in a negative net worth from the Koch

transaction of $13 million at December 31, 1997.”   The financial

statements that are in evidence show Solv-Ex to have been solvent

as of March 31, 1997, and insolvent by less than the $2 million

owed to Mr. Rendall as of August 31, 1998.    Neither Mr. Ciotti’s

testimony nor the balance sheets in evidence take into account

Solv-Ex’s off-balance-sheet assets (e.g., the retained

technology), the value of which obviously would have had a

favorable impact on Solv-Ex’s financial condition at any point.

     Even if Solv-Ex was technically insolvent at the end of

1997, there is no evidence that the insolvency was so extreme as

to cause grounds “for abandoning any hope of recovery.”

Milenbach v. Commissioner, 106 T.C. at 205.    A debtor’s poor

financial condition, including insolvency, does not establish

that the debt is worthless, particularly where, as in this case,

the debtor remains a going concern and there is a reasonable hope

that its financial condition will improve in the not too distant

future.   See Roth Steel Tube Co. v. Commissioner, 620 F.2d 1176,

1181-1182 (6th Cir. 1980), affg. 68 T.C. 213 (1977); Riss v.

Commissioner, 56 T.C. 388, 408 (1971), affd. in part, revd. and

remanded on another issue 478 F.2d 1160 (8th Cir. 1973), affd.

sub nom. Commissioner v. Transp. Manufacturing & Equip. Co., 478
                              - 39 -

F.2d 731 (8th Cir. 1973); Trinco Indus., Inc. v. Commissioner, 22

T.C. 959, 965 (1954).

     Also, it does not appear that the unpaid $33 million Phemex

loan was sufficient to cause Mr. Rendall to abandon all hope of

recovery on the $2 million loan.   In the amended disclosure

statement, Solv-Ex represented that it was prepared to assert

offsetting claims against Phemex and its affiliates, and, as of

December 31, 1997, Phemex had not filed a proof of claim.    As

noted supra, Phemex did not file a proof of claim by the January

31, 1998, deadline and, therefore, waived its claim entirely.

     Assuming arguendo that Solv-Ex was technically insolvent as

of December 31, 1997, that insolvency was not an identifiable

event indicating the worthlessness of the $2 million loan as of

December 31, 1997.

     5.   Whether Solv-Ex’s Technology Was Without Value

     As discussed in section IV. B.2., supra, the evidence

indicates that the retained technology had substantial potential

value as of December 31, 1997.   Therefore, it cannot be

considered worthless as of that date.

     6.   Absence of Prior Earnings or a Viable Business Plan for
          the Future

          a.   Absence of Prior Earnings

     A history of continuous operating losses, like insolvency,

does not represent an identifiable event indicating the

worthlessness of the loss corporation’s indebtedness.   As in the
                                - 40 -

case of insolvency, the argument against worthlessness is

particularly strong when the debtor is still operating and is

taking steps to become profitable.       See Estate of Pachella v.

Commissioner, 37 T.C. 347, 353 (1961), affd. 310 F.2d 815 (3d

Cir. 1962); Trinco Indus., Inc. v. Commissioner, supra at 965;

Ockrant v. Commissioner, T.C. Memo. 1966-60.

           b.   Business Plan

     As discussed supra, Solv-Ex presented a comprehensive

business plan in the amended disclosure statement.      That plan

centered on the exploitation of the retained technology and was

expected to generate a positive cash flow by 2000.      The plan was

a key component of the plan of reorganization that was approved

by bankruptcy courts in both the United States and Canada.

Although the evidence indicates that, as of the trial date (April

5, 2005), all efforts to bring that plan to fruition have been

unsuccessful, it does not reveal the reasons for that lack of

success.   More significantly, there is no evidence that that lack

of success was foreseeable when the plan was formulated during

the period of the joint bankruptcies (July 1997 to July 1998).

Certainly, the failure of what appeared to be a promising project

in Venezuela for the commercialization of the Ti02S technology,

caused by a change in the Venezuelan Government in late 1998, was

unforeseen and was, in Mr. Rendall’s own words, “a circumstance

beyond my control.”   Moreover, the fact that Solv-Ex was still in
                                - 41 -

existence at the time of trial, with Mr. Ciotti rather than Mr.

Rendall at the helm, indicates that, as late as April 2005, there

was still some hope for Solv-Ex’s financial success.

     We find that petitioners have failed to present credible

evidence in support of their argument that the plan of

reorganization reflected nothing more than the “incorrigible and

hopeless optimism of * * * John Rendall.”16

     C.   Conclusion

     None of the factors petitioners cite is sufficient, either

alone or in combination, to establish (i.e., provide credible

evidence of) the worthlessness of the $2 million loan as of

December 31, 1997.     Nor do we see any other basis for a finding

of worthlessness.    The sale by Merrill Lynch, as pledgee, of

634,100 shares of Solv-Ex common stock, the delisting of the

stock from trading on the NASDAQ Small-Cap Market (events which

depressed the stock’s value, making it more difficult to raise

capital through the issuance of new shares), the class action

lawsuits, and Solv-Ex’s SEC problems all may have combined to

place Solv-Ex under extreme financial stress, but those events

could not be viewed, on December 31, 1997, as necessarily

eliminating, for all time, Solv-Ex’s ability to discharge at



     16
        See United States v. S.S. White Dental Manufacturing
Co., 274 U.S. 398, 403 (1927) (in sustaining a loss deduction,
the Supreme Court stated that “[t]he taxing act does not require
the taxpayer to be an incorrigible optimist”).
                               - 42 -

least a portion of the $2 million loan.   Petitioners have not

provided credible evidence of worthlessness.

      Because we hold that petitioners have failed to provide

credible evidence that the $2 million loan became worthless in

1997, it necessarily follows that petitioners are entitled to

neither a $2 million nonbusiness bad debt deduction nor a $2

million business bad debt deduction for the alleged worthlessness

arising in 1997.

V.   Worthless Stock Loss

     A.   Law

      Section 165(g)(1) provides that, if any security that is a

capital asset becomes worthless during the taxable year, the

resulting loss shall be treated as a loss from the sale or

exchange of a capital asset.   Section 165(g)(2)(A) provides that

the term “security” includes stock in a corporation.

      The principles for establishing the worthlessness of stock

in a particular taxable year are virtually identical to the

principles for establishing a worthless debt.   Those principles

are succinctly set forth in Morton v. Commissioner, 38 B.T.A.

1270, 1278-1279 (1938), affd. 112 F.2d 320 (7th Cir. 1940), as

follows:

           The ultimate value of stock, and conversely its
      worthlessness, will depend not only on its current
      liquidating value, but also on what value it may
      acquire in the future through the foreseeable
      operations of the corporation. Both factors of value
      must be wiped out before we can definitely fix the
                             - 43 -

     loss. If the assets of the corporation exceed its
     liabilities, the stock has a liquidating value. If its
     assets are less than its liabilities but there is a
     reasonable hope and expectation that the assets will
     exceed the liabilities of the corporation in the
     future, its stock, while having no liquidating value,
     has a potential value and can not be said to be
     worthless. The loss of potential value, if it exists,
     can be established ordinarily with satisfaction only by
     some “identifiable event” in the corporation’s life
     which puts an end to such hope and expectation.

          There are, however, exceptional cases where the
     liabilities of a corporation are so greatly in excess
     of its assets and the nature of its assets and business
     is such that there is no reasonable hope and
     expectation that a continuation of the business will
     result in any profit to its stockholders. In such
     cases the stock, obviously, has no liquidating value,
     and since the limits of the corporation’s future are
     fixed, the stock, likewise, can presently be said to
     have no potential value. Where both these factors are
     established, the occurrence in a later year of an
     “identifiable event” in the corporation’s life, such as
     liquidation or receivership, will not, therefore,
     determine the worthlessness of the stock, for already
     “its value had become finally extinct.” [Citations
     omitted.]


Thus, as in the case of a bad debt deduction due to the

worthlessness of a debt, the taxpayer must show an absence of

potential as well as liquid value by yearend in order to sustain

a worthless stock loss.

     B.   Analysis

     In support of their entitlement to a 1997 worthless stock

loss, petitioners point to the same “identifiable events” that

they relied upon in support of their claimed bad debt deduction:

the joint bankruptcies, the alleged insolvency as of December 31,
                              - 44 -

1997, the sale of Solv-Ex’s Canadian operating assets and leases,

the alleged worthlessness of its technology, and the alleged

absence of either present or potential future earnings.   For the

same reasons that none of the factors cited by petitioners is

sufficient, either alone or in combination, to provide credible

evidence of the alleged 1997 worthlessness of the $2 million loan

(see section IV. B., supra), those factors fail to provide

credible evidence of the alleged worthlessness of the Solv-Ex

common stock Mr. Rendall held on December 31, 1997.

     Petitioners also argue that, despite continued over the

counter trading of Solv-Ex’s common stock via the “pink sheets”,

Mr. Rendall’s stock was worthless as of December 31, 1997,

because of Solv-Ex’s inability to file delinquent Forms 10-K and

10-Q and Mr. Rendall’s status as an officer of Solv-Ex with

“negative non-public insider information”, both of which rendered

Mr. Rendall’s Solv-Ex common stock nontradable on the open market

under Federal securities laws.   Lastly, petitioners argue that

the “pink sheet” value “would have applied to trades of very

small lots of stock--100 to 200 share lots--and would have had no

application to * * * [Mr. Rendall].”

     There is no evidence, aside from Mr. Rendall’s testimony,

that he was prohibited from trading in Solv-Ex common stock as of

December 31, 1997.   Although the correspondence between counsel

for Merrill Lynch and counsel for Mr. Rendall before the sale of
                                - 45 -

pledged shares by Merrill Lynch implies that, under SEC Rule 144,

Mr. Rendall might have been restricted from selling his Solv-Ex

shares, petitioners stipulated (without objection by respondent)

that the correspondence was offered “for the limited purpose of

showing the existence of a controversy over the sale of the stock

[by Merrill Lynch], and not for the facts or legal opinions

contained therein.”   Moreover, Mr. Rendall was not offered as a

Federal securities law expert.    Therefore, we find no credible

evidence in the record that Mr. Rendall was restricted by law

from selling his Solv-Ex shares over the counter as of December

31, 1997.

     Nor have petitioners furnished any evidence in support of

their claim that the “pink sheet” value of the Solv-Ex common

stock as of December 31, 1997, $3 a share, bore no relationship

to the market value of Mr. Rendall’s shares on account of the

small daily volume of trades.    Even if we were to assume that

Solv-Ex was trading in lots of 100 to 200 shares at the end of

1997, that fact would not establish the worthlessness of Mr.

Rendall’s shares at that time.    See Jones v. Commissioner, 29

B.T.A. 928, 931 (1934) (“The fact that the petitioner could not

find any purchaser for his shares at the time he offered them for

sale is not conclusive evidence * * * that they were worthless”);

West End Pottery Co. v. Commissioner, 7 B.T.A. 927, 929 (1927)

(the lack of a ready market for stock does not establish
                              - 46 -

worthlessness); see also Ginsburg v. Commissioner, T.C. Memo.

1974-191 (stock’s worthlessness rejected when based upon an SEC

ban on the trading of the stock in the United States and the

absence of any market for the stock).

     Ginsburg indicates that, even if Mr. Rendall had been

subject to SEC restrictions on selling his Solv-Ex common stock

as of December 31, 1997, that fact would not constitute

conclusive evidence of worthlessness.   We agree, because a

contrary result ignores the potential marketability of the stock

after December 31, 1997.   Assuming arguendo that the delinquent

Forms 10-K and 10-Q and/or his insider status made it impossible

for Mr. Rendall to sell his Solv-Ex shares as of December 31,

1997, it appeared probable at that time that Solv-Ex would be

able to overcome those infirmities after 1997.   In fact, the

amended disclosure statement specifically represents that “[t]he

Company intends to file and expects that it will be able to file

* * * [the delinquent] reports, or reports becoming due in the

near future * * * following confirmation of the plan and

completion of an audit.”

     Almost from its inception, Solv-Ex constituted a

“development stage enterprise” within the meaning of FAS 7; i.e.,

a company that had not yet commenced its planned principal

operations.   Yet, despite a more than 15-year absence of sales or

profits, Solv-Ex common stock was trading at $16.25 a share on
                              - 47 -

December 29, 1995, as high as $38 a share during the quarter

ended March 31, 1996, and at $14.375 a share as late as March 17,

1997.   Obviously, for many years, the market had been betting

(with varying degrees of optimism) that Solv-Ex would be able to

develop valuable technology, commercialize it, and eventually,

generate sales and profits; and despite its many difficulties

after Merrill Lynch’s sale of the pledged shares in late May and

early June 1997, at 1997 yearend Solv-Ex still retained its

technology, and Mr. Rendall remained guardedly optimistic that

Solv-Ex, by exploiting that technology, could overcome its

difficulties and attain financial success.   The market, while

understandably cautious, did not entirely disagree, as evidenced

by the fact that the stock was still trading at $3 a share on

December 31, 1997.   That guarded optimism as of December 31,

1997, based upon the potential commercialization of the retained

technology, was merely an extension of the optimism that had

always attended the market’s estimate of Solv-Ex’s prospects for

financial success.   Investor faith in Solv-Ex’s technology

provided value for its common stock before December 31, 1997, and

it continued to do so as of that date.   Moreover, after 1997, the

market continued to believe that there was at least a slim chance

of a turnaround for Solv-Ex, as evidenced in November 1998 by

Solv-Ex’s ability to raise $812,000 through a private placement

of 1,624,000 shares of common stock and 919,400 warrants.
                              - 48 -

      C.   Conclusion

      Petitioners have failed to provide credible evidence that

they are entitled to a deduction for the worthlessness in 1997 of

Mr. Rendall’s Solv-Ex common stock.

VI.   Conclusion

      To reflect the foregoing,


                                           Decision will be entered

                                      for respondent.
