                        T.C. Memo. 1996-392



                      UNITED STATES TAX COURT



      PAUL A. RENDINA AND JANET MAE RENDINA, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 19223-93.                     Filed August 21, 1996.



     Joseph P. Alexander, J. Timothy Bender, and David G.

Lambert, for petitioners.

     Jeffrey J. Erney, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     BEGHE, Judge:   Respondent determined a deficiency of $35,934

in petitioners’ 1988 Federal income tax, and additions to tax of

$1,797 and $8,984, under sections 6653(a)(1) and 6661(a),
                                - 2 -


respectively.1   The deficiency arose from respondent’s

determination that the distribution to petitioner2 of two

condominium units by Wood Street Apartments, Inc. (WSAI) was a

dividend.

     We hold that petitioner received the condominium units as a

distribution in de facto liquidation of his shares of WSAI,

thereby reducing his realized gain by the amount of his basis in

the shares and by the amount of certain liabilities to third

parties that he assumed, resulting in a lesser deficiency than

respondent determined.    We also hold petitioner liable for the

additions to tax for negligence under section 6653 and

substantial understatement under section 6661, computed on the

reduced deficiency.

                          FINDINGS OF FACT

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

The stipulation of facts and attached exhibits are incorporated

herein.

     When petitioners filed their petition, they resided in

Willoughby Hills, Ohio.


     1
      Unless otherwise identified, section references are to the
Internal Revenue Code in effect for 1988, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
     2
      Janet Mae Rendina has an interest in this case solely by
virtue of having filed a joint 1988 Federal income tax return
with her husband. Accordingly, all references to “petitioner”
in the singular are to Paul A. Rendina.
                               - 3 -


     Petitioner is a certified public accountant.    During the

year at issue, he was an owner-shareholder in a certified public

accounting firm, Rendina & Vitantonio, Inc.

Wood Street Apartments, Inc.

     In 1986, petitioner and Thomas J. Ackerman (Ackerman), a

construction contractor, formed WSAI as a general business

corporation under Ohio law, for the purposes of constructing and

selling 18 condominium units in Willoughby, Ohio.    WSAI was

operated as a C corporation.   Petitioner and Ackerman each paid

WSAI approximately $250 for an equal number of common shares of

WSAI.

     In 1987 and 1988, WSAI constructed the 18 condominium units,

known as “South Wood Condominiums” (South Wood).    South Wood

consists of two-story townhouses, built in clusters of six units

in each of three buildings.

     WSAI financed the construction of South Wood primarily with

borrowed funds.   The funds used by WSAI consisted of a loan from

Security Federal Savings and Loan of approximately $740,000,

petitioner’s deposits in WSAI’s checking account of approximately

$41,200,3 and approximately $68,000 in loans from three of


     3
      Petitioner made three deposits into the account. On
Apr. 11, 1987, petitioner deposited $20,200 into the account. On
Sept. 22, 1987, petitioner deposited $20,000 into the account,
with a notation on the deposit ticket indicating that the deposit
was a “loan”. On Oct. 6, 1987, petitioner deposited $1,000 into
the account.
                                - 4 -


petitioner’s accounting clients:    William and Mary Foss (the

Fosses), Vito and Adella Navar (the Navars), and Frank and

Benette Posa (the Posas).    The principal amounts of the loans

from the Fosses, Navars, and Posas were $53,000, $10,000, and

$5,000, respectively.   The loan checks were made to WSAI, and

deposited in WSAI’s checking account at National City Bank.      WSAI

issued promissory notes to    the lenders, providing that interest

would be paid at a rate of 12 percent per year.    The maturity

date of each of the notes was approximately 1 year after

issuance.

     On March 9, 1987, the Posas lent $5,000 to WSAI, and

received notes as follows:

     Entity         Date                Amount
     WSAI           2/17/87             $5,000
     WSAI           3/01/88              5,000
     WSAI4          3/01/89              5,000

     On May 5, 1987, June 8, 1987, and June 29, 1987, the Fosses

lent $18,000, $10,000, and $25,000, respectively, to WSAI, and

received notes as follows:


     Entity         Date                Amount
     WSAI           4/06/87             $28,000
     WSAI           6/29/87              25,000



     4
      In 1989, petitioner replaced the prior note with a note
issued in the name of WSAI, which was by then no longer an active
corporation. When the 1989 notes were typed, petitioner’s office
inadvertently transcribed the information from the client’s old
notes.
                                - 5 -


     WSAI5          4/06/89              53,000

     On February 27, 1987, the Navars lent $10,000 to WSAI, and

received the following note:


     Entity         Date                Amount
     WSAI           2/26/87             $10,000


     With the exception of one of the Foss notes, each new note

reflected a rollover of the obligation on the prior note.    For

the months of January, February, March, and April 1989, all

interest payments due on the notes to the Fosses, Navars, and

Posas were made in the name of WSAI.6

     In 1988, 16 of the 18 units were sold, two of which were

purchased by Ackerman.    The stated purchase prices and dates of

purchase for the 16 units were as follows:

                                             Purchase    Purchase
     Purchaser                  Condo        Date        Price

     Thomas J. &                Unit A,      9-16-88     $65,9007
     Michelle L. Ackerman       Bldg. A

     5
      See supra note 4.
     6
      The record does not indicate the source of the funds used
to make the first 4 months’ interest payments in 1989.
     7
      Ackerman borrowed $100,000 to purchase the two condominium
units, and testified that he performed approximately $15,000
worth of work on each of them. While the statutory conveyance
fee for each of the units was $65.90, representing 1 percent of
the purchase price, the way we decide this case does not require
a factual determination of how much Ackerman actually paid for
each of the units. We do find that the stated purchase prices
for the 14 units purchased by the unrelated parties were the
actual purchase prices.
                              - 6 -


     Thomas J. &              Unit B,    9-16-88        $65,900
     Michelle L. Ackerman     Bldg. A

     Geza Bihari              Unit C,    8-12-88        $66,900
                              Bldg. A

     Larry & Ruth Entis       Unit D,    8-19-88        $67,375
                              Bldg. A

     Donald C. &              Unit E,    8-04-88        $69,622
     Janet T. Matz            Bldg. A

     Debra J. Stewart         Unit F,    8-07-88        $65,900
                              Bldg. A

     Karen Ann Helsel         Unit A,    2-03-88        $65,900
                              Bldg. B

     Donald L. Smith          Unit C,    6-29-88        $66,900
                              Bldg. B

     Edward N. &              Unit D,   10-14-88        $67,900
     Barbara J. Snyder        Bldg. B

     Gia M. Perrico           Unit E,   12-08-88        $67,900
                              Bldg. B

     Lauren B. &              Unit F,    9-12-88        $65,900
     Joseph Wolf              Bldg. B

     Ronald S. &              Unit A,    9-30-88        $65,900
     Denise A. Rychel         Bldg. C

     Gary Ackerman            Unit B,   10-18-88        $67,900
                              Bldg. C

     Maria L. Podmore         Unit C,   11-21-88        $66,900
                              Bldg. C

     Sharon L. Spei           Unit D,   11-30-88        $66,900
                              Bldg. C

     John Viviani &           Unit F,    9-26-88        $64,900
     Kimberly M. Ficke        Bldg. C

     Ackerman and petitioner expected a net profit of

approximately $5,000 to $10,000 on each condominium unit sold,
                                - 7 -


based on a cost estimate of approximately $50,100 per unit.

However, WSAI incurred approximately $3,500 to $4,000 in

commissions and settlement costs for each condominium.    In

addition, rebates or building allowances were given to

prospective buyers in amounts ranging from $1,500 to $3,500.

WSAI also incurred financing costs, unanticipated zoning costs,

development fees, $25,000 paid in settlement of a lawsuit by

South Wood Condominium Association related to alleged

construction defects in South Wood and various

misrepresentations, nondisclosures, and failures to perform, and

WSAI’s actual construction costs.

       Toward the end of 1988, two of the 18 units remained unsold.

Petitioner and Ackerman orally agreed that WSAI would transfer

title to the two remaining condominium units to petitioner in

consideration of petitioner’s assumption of the Foss, Navar, and

Posa notes, and petitioner’s discharge of WSAI’s “debt” owed to

him.

       In December 1988, WSAI transferred South Wood’s two

remaining condominium units to petitioner.    Petitioner did not

report any income or gain from the receipt of the two condominium

units on his 1988 Federal income tax return, but did report a

taxable dividend from WSAI in the amount of $90.    Although WSAI

had filed U.S. corporation income tax returns for the tax years

1986 and 1987, employing the completed contract method of
                                - 8 -


accounting, and showing no gross receipts, sales, or other

income, WSAI filed no U.S. corporation income tax return for

1988, the tax year in which all the condominium units were sold

or transferred.

      With the transfer of the last two condominium units to

petitioner in 1988, WSAI no longer held business assets, and

ceased to be a going concern.   Upon transfer of all 18

condominium units in 1988, WSAI ceased doing business, but did

not formally dissolve.   Its charter was revoked in 1990 for

nonpayment and nonfiling of Ohio franchise tax returns.

     In April 1989, petitioner sold one of the units for $67,900.

Transfer of notes from WSAI to Canterbury Construction Co.

     Following his receipt of the last two South Wood condominium

units, petitioner gave the Fosses, Navars, and Posas the option

of either having their loans repaid, or of having the loan

obligations taken over by Canterbury Construction Co.

(Canterbury), an S corporation wholly owned by petitioner that is

in the business of real estate construction and development.   The

note holders chose to have Canterbury take over the loan

obligations and to continue receiving interest payments.   While

petitioner did not, in his individual capacity, issue promissory

notes to any of the note holders, Canterbury issued new notes to

the Fosses, Navars, and Posas sometime after April 1989, and

began making interest payments on the notes.
                                - 9 -


     The loans to the Posas and Navars, in the principal amounts

of $15,000 and $10,000, respectively, have been paid.     As of the

date of filing of the petition, the Fosses still held a note

issued by Canterbury on which they were receiving interest

payments.

     As a result of the earlier lawsuit, WSAI turned its books

and records over to the South Wood Estates Condominium

Association.   Petitioner has not recovered the books and records

of WSAI from the Association.

Corporation tax and transferee issues

     On or around March 1, 1994, respondent sent petitioner, as

transferee of WSAI, a 30-day letter, with a report of income tax

examination and explanation of items, asserting for the taxable

year 1988 that WSAI had taxable income of $272,320, resulting

from gross receipts of $1,068,000 from the sale of the South Wood

condominium units,8 based on the retail sales prices as

determined by the transfer taxes paid, less costs and expenses of

$795,680.9   The report took the position that WSAI owed 1988 U.S.

     8
      Respondent excluded the two units transferred to petitioner
from the calculation of gross receipts.
     9
      Respondent relied on the Cohan rule to provide what
respondent regarded as a reasonable allowance for costs and other
expenses in lieu of substantiating documents. See Cohan v.
Commissioner, 39 F.2d 540 (2d Cir. 1930). Respondent arrived at
the $795,680 figure for costs and expenses by allowing $715,000
of construction loan proceeds (cf. our findings supra p. 3),
$70,000 as the cost of the land, and $10,680 as expenses of the
                                                   (continued...)
                                 - 10 -


corporation income tax of $89,455, and an addition of $22,364 for

failure to file its corporation income tax return.       WSAI’s

liability for 1988 U.S. corporation income tax and the failure to

file addition remains unresolved; respondent had issued no

statutory notice of deficiency to WSAI (or to petitioner as

transferee) as of the date of issuance of this report.

                                OPINION

     Because WSAI has never filed a 1988 U.S. corporation income

tax return, the periods of limitation on assessment of WSAI’s

1988 corporation income tax liability and petitioner’s transferee

liability remain open indefinitely.       In the course of our

unsuccessful efforts to lead the parties to a comprehensive

settlement or to postpone the submission of this case in order to

allow the related corporation tax and transferee liability cases

to be perfected and consolidated with this case, we observed to

the parties that it would have been preferable, in the interests

of efficient case management and sound judicial administration,

to bring the cases on together, so that the interrelated

questions of corporate taxable income and earnings and profits,

which bear on the transferee liability and dividend questions,

could have been tried together.10     Be that as it may, we decide

     9
      (...continued)
sale of the condominium units.
     10
          For an example of a consolidated proceeding dealing with
                                                       (continued...)
                              - 11 -


this case, on its somewhat unsatisfactory record, in a way that

enables us to avoid making the earnings and profits/dividend

determination, and leave the related corporate taxable income

question for another day, if respondent should decide to pursue

it.

      The substantive tax question before us is whether

petitioner’s receipt of two condominium units, during the taxable

year 1988, was a taxable distribution from WSAI.   Respondent

determined that petitioner’s receipt of the last two units was a

dividend in the amount of $135,800 during the taxable year 1988.

Petitioner contended that his receipt of the units was not

taxable to him because it was offset by discharge of WSAI’s debt

to him, and his assumption of the Foss, Navar, and Posa notes.

Petitioner also maintained that his receipt of the two units

could not be a dividend because WSAI had no earnings and profits.

      Petitioner, in his reply brief, raised the alternative

argument that he received the condominium units in de facto

liquidation of WSAI, which would entitle him to use the basis of

his WSAI stock to compute his gain on the distribution, if we

should determine that his payments into WSAI represented equity

rather than debt.   Because it appeared to us that this position


      10
      (...continued)
related questions of corporation tax and transferee liability,
and shareholder gain on liquidation, see Schneider v.
Commissioner, 65 T.C. 18 (1975).
                              - 12 -


might have greater merit than the primary position of either of

the parties, we had them address this newly raised issue in

supplemental briefs.

I.   Lack of Prejudice to Respondent in Addressing Liquidation

      Respondent maintains that petitioner’s delay in raising the

de facto liquidation issue precludes us from addressing it.

Respondent relies on Brown v. Commissioner, T.C. Memo. 1979-443,

to argue that our consideration of the new issue raised on brief

would severely prejudice her case and violate fundamental

fairness.

      We have allowed petitioner to raise the de facto liquidation

issue for two reasons.   First, just as respondent is not bound by

the theory upon which she relied in determining the deficiency,

Blansett v. United States, 283 F.2d 474 (8th Cir. 1960), so

petitioner is not precluded from raising a new theory on post-

trial brief.   Ware v. Commissioner, 906 F.2d 62 (2d Cir. 1990),

affg. 92 T.C. 1267 (1989) and T.C. Memo. 1989-165 (declining to

adopt an ironclad rule that the Tax Court may not consider a

legal theory surfacing in posttrial briefs).   Our duty is to

consider all the evidence, and in light thereof, decide whether

or not petitioner has a deficiency.    We are therefore entitled to

adopt a new theory of decision, especially where we give both

parties the opportunity to argue its merits.   See Brooks v.

Commissioner, 424 F.2d 116 (5th Cir. 1970), revg. 50 T.C. 927
                              - 13 -


(1968); Gulf Oil Corp. v. Commissioner, 89 T.C. 1010 (1987),

affd. 914 F.2d 396 (3d Cir. 1990).

     Where the record contains sufficient facts to permit us to

decide a case on an issue that would dispose of it, we shall do

so, whether or not the parties have pleaded the issue.    Barnette

v. Commissioner, T.C. Memo. 1992-595, affd. without published

opinion sub nom. Allied Management Corp. v. Commissioner, 41 F.3d

677 (11th Cir. 1994); see Concord Consumers Housing Coop. v.

Commissioner, 89 T.C. 105, 126 (1987) (Körner, J., concurring);

Park Place, Inc. v. Commissioner, 57 T.C. 767, 768-769 (1972).

In Ohio Clover Leaf Dairy Co. v. Commissioner, 8 B.T.A. 1249

(1927), affd. 34 F.2d 1022 (6th Cir. 1929), the Board decided the

case on the record presented, as we do here.   The parties’

failure to plead correctly does not prevent us from deciding this

case on what we consider to be the correct application of the law

to the facts in the record presented.    Barnette v. Commissioner,

supra.

     Our second reason for allowing petitioner to raise the de

facto liquidation issue is that respondent has not been surprised

or prejudiced by our addressing it.    See Riss v. Commissioner, 56

T.C. 388, 400 (1971), affd. 478 F.2d 1160, affd. sub nom.

Commissioner v. Transport Manufacturing & Equip. Co., 478 F.2d

731 (8th Cir. 1973).   The rule that a party may not raise a new

issue on brief is not absolute; it is founded upon the exercise
                              - 14 -


of judicial discretion in determining whether considerations of

surprise and prejudice require that a party be protected from a

belated confrontation that precludes or limits his opportunity to

present pertinent evidence.   Ware v. Commissioner, 92 T.C. 1267

(1989), affg. 906 F.2d 62 (2d Cir. 1990).

     Respondent’s reliance on Brown v. Commissioner, T.C. Memo.

1979-443, is misplaced.   In Brown, the taxpayer was not given

notice of the Commissioner's change in theory, and was thus

denied the opportunity to prepare an adequate case on the new

issue.   Brown is distinguishable from the case at hand.   We have

given both petitioner and respondent the same opportunity to make

their arguments on the de facto liquidation issue by way of

supplemental reply brief.   Thus, neither party is advantaged or

disadvantaged.

     Respondent maintains that, if petitioner had raised the de

facto liquidation issue earlier, respondent would have had the

opportunity to provide evidence on: (1) Whether WSAI was formally

dissolved; (2) whether the corporate records established a plan

by the shareholders to dissolve WSAI; (3) whether WSAI continued

to hold title to the land underlying the condominiums, or any

other property; (4) whether WSAI continued to manage the common

areas of the condominium complex; (5) whether WSAI continued to

file tax returns; (6) whether WSAI continued to comply with
                                - 15 -


statutory corporate formalities; and (7) whether WSAI maintained

its corporate identity.

     The record adequately addresses these issues, and additional

evidence is not needed to enable us to make a fair determination

of whether de facto liquidation treatment of WSAI is appropriate.

With respect to the observation of corporate and tax formalities,

WSAI was not formally dissolved--its charter was revoked for

nonfiling of Ohio franchise tax returns and nonpayment of Ohio

taxes, and it neither adopted a written plan of liquidation nor

filed the notice of corporate dissolution or liquidation required

by section 6043(a).    The record also shows that WSAI filed no

U.S. corporation income tax returns for 1988 or any year

thereafter.   The record further shows that WSAI no longer held

business assets after the sale and distribution of the South Wood

units, and that thereafter South Wood was managed by the South

Wood Condominium Association.    Finally, the record shows that

WSAI did maintain its corporate identity at least until its

charter was revoked.

     Having made findings on the foregoing factual issues, the

majority of which facially would tend to favor respondent’s

position that WSAI was not liquidated in 1988, we see no

prejudice to respondent.
                               - 16 -


II.    De Facto Liquidation

       Applying the three-pronged test of Estate of Maguire v.

Commissioner, 50 T.C. 130, 140 (1968): (1) Whether there is a

manifest intention to liquidate; (2) whether there is a

continuing purpose to terminate corporate affairs; and (3)

whether the activities of the corporation and its shareholders

are directed toward that objective, we are convinced that WSAI

and its shareholders displayed a manifest intention to liquidate

and continuing purpose to terminate corporate affairs, and that

the activities of WSAI and its shareholders were directed to that

end.    See Olmsted v. Commissioner, T.C. Memo. 1984-381.

       Neither the Code nor the regulations to section 331 define

the term “complete liquidation.”    However, as we noted in Olmsted

v. Commissioner, T.C. Memo. 1984-381, the regulations under

section 332 (governing subsidiary liquidations) contain a

definition of “complete liquidation” under section 332 that

applies equally to section 331:

       A status of liquidation exists when the corporation
       ceases to be a going concern and its activities are
       merely for the purpose of winding up its affairs,
       paying its debts and distributing any remaining balance
       to its shareholders. A liquidation may be completed
       prior to the actual dissolution of the liquidating
       corporation. However, legal dissolution of the
       corporation is not required. Nor will the mere
       retention of a nominal amount of assets for the sole
       purpose of preserving the corporation’s legal existence
       disqualify the transaction. [Sec. 1.332-2(c), Income
       Tax Regs.]
                               - 17 -


     Respondent maintains that petitioner never liquidated WSAI.

In support of her position, respondent relies on Haley Bros.

Constr. Corp. v. Commissioner, 87 T.C. 498, 515-516 (1986).       In

Haley Bros. Construction Corp., the corporation at issue,

Marywood Corp., was not dissolved formally in accordance with

State law, and continued to maintain a checking account.    We held

that there was no liquidation because there was a business

purpose for the continued existence of Marywood, which continued

to be operated in accordance with that business purpose, holding

and selling real property, maintaining a checking account, paying

expenses, and filing tax returns.    Moreover, the continued

corporate existence of Marywood served the purpose of insulating

its parent corporation from liabilities on a mortgage and in

pending litigation.

     In the case at hand, there was no business purpose for WSAI

to continue operating.    WSAI did not file a corporate tax return

for 1988, and, with the sale or distribution of all of the

condominium units, WSAI had no further assets of any consequence.

     We are unpersuaded by respondent’s assertion that, because

WSAI continued some activities through the beginning of 1989, it

did not liquidate.    Complete liquidation can occur despite an

extended liquidation process, and several earlier opinions of

this court have upheld liquidations despite protracted time

frames.   See, e.g., Estate of Maguire v. Commissioner, supra;
                              - 18 -


T.T. Word Supply Co. v. Commissioner, 41 B.T.A. 965 (1940);

Olmsted v. Commissioner, supra.   In order for complete

liquidation treatment to apply, it is not essential that a formal

plan of liquidation be adopted or that the corporation dissolve,

as long as there is a manifest intention to liquidate that is

carried out.   Genecov v. United States, 412 F.2d 556 (5th Cir.

1969); Stamler v. Commissioner, 145 F.2d 37 (3d Cir. 1944), affg.

45 B.T.A. 37 (1941); Kennemer v. Commissioner, 96 F.2d 177, 178

(5th Cir. 1938), affg. 35 B.T.A. 415 (1937); Olmsted v.

Commissioner, supra; Silverman v. Commissioner, T.C. Memo. 1971-

143; see Bittker & Eustice, Federal Income Taxation of

Corporations & Shareholders, par. 10.02, at 10-9 (6th ed. 1994);

11 Mertens, Law of Federal Income Taxation, sec. 42.06, at 53

(1992 rev.).

     Respondent maintains that petitioner has failed to provide

the necessary books and records to support his position regarding

the liquidation of WSAI.   Although we agree with respondent that

there are gaps in the record, we believe that it contains

sufficient evidence to sustain our conclusion that WSAI was

liquidated in 1988.   The intentions of petitioner and Ackerman to

liquidate WSAI at the end of 1988 were apparent from the sales of

WSAI’s assets, its cessation of business, and the agreement of

petitioner and Ackerman that WSAI would distribute the last two

condominium units to petitioner, in consideration of petitioner's
                              - 19 -


assumption of the corporation's liabilities to its lenders and

his recovery of his investment out of the balance.    With that

final distribution, WSAI held title to no further assets of any

substantial consequence.   With the exception of interest payments

made through the beginning of 1989,11 WSAI engaged in no further

activities.

     Finally, respondent argues that petitioners made no

disclosure of any kind on their 1988 individual income tax return

regarding the receipt of the two condominium units as a

liquidating distribution, as required by section 1.331-1(d),

Income Tax Regs, which states:

     In every case in which a shareholder transfers
     stock in exchange for property to the corporation which
     issued such stock, the facts and circumstances shall be
     reported on his return unless the property is part of a
     distribution made pursuant to a corporate resolution
     reciting that the distribution is made in liquidation
     of the corporation and the corporation is completely
     liquidated and dissolved within one year after the
     distribution. See section 6043 for requirements
     relating to returns by corporations.

     Section 1.331-1(d), Income Tax Regs., does not impair

our ultimate conclusion that a de facto liquidation did occur

during the taxable year 1988 in the case at hand.    Although

section 1.331-1(d), Income Tax Regs., appears to complement

section 6043 and section 1.6043-1, Income Tax Regs., thereunder,


     11
      The record contains no evidence of the source of the funds
that were apparently used to make interest payments in the name
of WSAI.
                                - 20 -


providing for the filing of Form 966 (Corporate Dissolution or

Liquidation) by a corporation that adopts any resolution or plan

of liquidation, the filing of Form 966 is not a condition of

liquidation treatment under any provision of the Internal Revenue

Code.     Maguire v. Commissioner, 222 F.2d 472, 478 (7th Cir.

1955), revg. 21 T.C. 853 (1954); Murphy v. Commissioner, T.C.

Memo. 1996-59; see also Fowler Hosiery Co. v. Commissioner, 36

T.C. 201 (1961), affd. 301 F.2d 394 (7th Cir. 1962).    We are

satisfied that section 1.331-1(d), Income Tax Regs., like the

regulation under section 6043, is directory only.    While

compliance with these regulations serves the evidentiary function

of supporting the conclusion that a distribution was received in

a corporate liquidation, and helps to avoid controversies of the

sort we now deal with, we regard them as playing only a

facilitating role.    Petitioner's compliance with section 1.331-

1(d), Income Tax Regs., is not a condition precedent to our

treating the distribution of the condominium units to petitioner

as a liquidating distribution.12

     We are convinced that the agreement of the WSAI

shareholders, petitioner and Ackerman, for the distribution of

the last two condominium units to petitioner, in consideration of


     12
      For an example of a mandatory requirement for filing a
form in order to obtain specified tax treatment in a "one month"
liquidation, see former sec. 333, repealed by sec. 631(e)(3) of
the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2273.
                                - 21 -


his taking care of the corporate liabilities and recovering his

own investment, manifested WSAI’s intention to liquidate, and

that that intention was carried out in the informal winding-up of

WSAI's affairs that followed.

III.   Computation of Gain

       Having found that WSAI was liquidated in 1988, we turn to

the tax treatment of petitioner’s receipt of the condominium

units.    Section 331(a) provides that amounts received by a

shareholder in complete liquidation of a corporation shall be

treated as “full payment in exchange for the stock”, considering

a liquidating distribution, in effect, as a sale by the

shareholder of his stock to the corporation.    Bittker & Eustice,

Federal Income Taxation of Corporations & Shareholders, at 10-4,

10-5 (6th ed. 1994); S. Rept. 398, 68th Cong., 1st Sess. 11

(1924), 1939-1 C.B. (pt. 2) 266, 274.    As a result, the

shareholder computes gain or loss under section 1001(a) by

subtracting the adjusted basis of his stock from the amount

realized (the fair market value of the distribution), and reports

the difference as capital gain or loss if the stock is a capital

asset in his hands.

       To compute petitioner’s gain, we first look at the value of

the condominium units distributed to determine the amount

realized.    We then look at whether petitioner’s deposits into the

WSAI checking account were loans or equity investments;
                               - 22 -


concluding that they are equity rather than debt, we add them to

petitioner’s basis in his WSAI stock, rather than treating them

as liability offsets to the amount realized.   We also look at

whether petitioner assumed, or took subject to, WSAI liabilities,

because the amount realized under section 1001 on the liquidation

exchange is the net value of the distribution, and that amount

must be reduced by the amount of liabilities assumed or taken

subject to.   See Ford v. United States, 160 Ct. Cl. 417, 311 F.2d

951 (1963).   We then subtract the basis of petitioner’s shares

from the amount realized on the distribution to compute his gain.

     A.   Value of Condominium Units Distributed

     Respondent maintains that petitioner received a taxable

distribution of $135,800, or the value of the two condominium

units received.13   Petitioner maintains that he gave value

equivalent to that of the condominium units.   Petitioner’s

position throughout this proceeding has been that the value of

the condominium units was no more than $109,200--the sum of what

he argues were the amount of the WSAI liabilities that he assumed

and his deposits into the WSAI account.

     We disagree with petitioner’s estimate of the value of the

condominium units received.   The average selling price of the


     13
      Respondent makes her determination of the value of the
condominiums based on the $66,787 average price of the other 16
units sold, as well as the price petitioner received from the
sale of one of the units transferred to petitioner.
                                - 23 -


other 14 condominium units was $66,915.14     Four months after the

distribution, petitioner sold one of his condominium units for

$67,900.

       Petitioner has not convinced us that the fair market value

of his condominium units should be less than the average selling

price of the other units sold, or $66,915.      Thus, we find the

fair market value of the condominiums transferred to petitioner

to be $133,830.

       B.   Basis of WSAI Shares:   Debt v. Equity

       Respondent maintains that no loan or other value was given

by petitioner to WSAI.     However, the deposit records of National

City Bank, where WSAI maintained a checking account, indicate

that petitioner deposited $41,200 into WSAI’s account.      Because

the books and records of WSAI were not made available, we must

look to such documentary evidence as bank statements, as well as

the testimony of witnesses, in considering whether petitioner

gave value to WSAI.     Hagaman v. Commissioner, T.C. Memo. 1987-

549.    We are satisfied that petitioner’s deposits into the WSAI

account constitute value that resulted in cost to be taken into

account in determining petitioner’s gain on the receipt of the

condominium units.




       14
      We exclude from this calculation the purchase price of
Ackerman’s condominium units. See supra note 7.
                              - 24 -


     While the analysis would vary, depending on whether the

investment in the corporation were debt or equity, the net tax

effect to petitioner would be the same.   If petitioner's

investment in the corporation were a loan, WSAI's transfer of

property to petitioner in satisfaction of the loan would not be

governed by section 331 to that extent.   This is because the

transfer would not be “in payment for” petitioner's stock.     In

such a case, the corporation merely would be repaying the loan,

receiving equal value in exchange for the transfer, resulting in

no taxable event for the transferee.   See Citizens Bank & Trust

Co. v. United States, 217 Ct. Cl. 606, 580 F.2d 442 (1978); J.

Hofert Co. v. United States, 23 AFTR 2d 69-845, 69-1 USTC par.

9220 (C.D. Cal. 1969).

     If petitioner's investment were equity, petitioner would be

entitled to increase his basis in his WSAI shares by the amount

of the investment.   Under this scenario, petitioner would

subtract his basis from the amount of the distribution; if the

distribution should exceed petitioner's basis, the excess would

be treated as capital gain from sale of the stock.

     In Donisi v. Commissioner, 405 F.2d 481, 483 (6th Cir.

1968), affg. T.C. Memo. 1967-62, the court noted that, although

the intention of the parties weighs heavily in determining

whether advances are loans, proof of such intent is to be found

in “the arrangements concerning the normal security, interest and
                               - 25 -


repayment or efforts to secure the same.”    In Austin Village,

Inc. v. United States, 432 F.2d 741, 745 (6th Cir. 1970), the

court relied on the fact that there was no unconditional promise

to repay the loans, no fixed schedule of payments, and no

security given for issuance of the loans.

     In the case at hand, none of the factors are present that

would tend to show that petitioner reasonably expected WSAI to

repay the “loan” in accordance with terms in line with those

generally prevailing in the business community.     See Nassau Lens

Co. v. Commissioner, 308 F.2d 39 (2d Cir. 1962), remanding 35

T.C. 268 (1960).    Moreover, no interest payments to petitioner

were made or provided for.    See Texas Farm Bureau v. United

States, 725 F.2d 307, 313-314 (5th Cir. 1984).      If petitioner had

been a true lender, he would have provided for interest payments.

Curry v. United States, 396 F.2d 630, 634 (5th Cir. 1968).

     We find that petitioner’s $41,200 of deposits into the WSAI

checking account was a contribution to the capital of WSAI.

Because petitioner was a shareholder of WSAI, his $41,200 of

contributions to capital is reflected in an increased basis for

his WSAI stock.    Sec. 1.118-1, Income Tax Regs.   Thus,

petitioner’s basis in his WSAI stock was $41,450.15

     15
      At trial, respondent produced copies of WSAI checks to
petitioner and to Camelot Court Development, Inc., and Camelot
Court Development, Inc. II, in the amounts of $5,000, $3,697, and
$57,703, respectively (Petitioner has a 45-percent interest in
                                                   (continued...)
                               - 26 -




      Petitioner’s amount realized from the distribution of the

condominium units should be reduced by the amount of the

corporation's liabilities to the Posas, Fosses, and Navars that

petitioner agreed to assume, and for whose discharge he made the

necessary arrangements.    Thus, after subtracting the assumed

liabilities of $68,000 from the $92,380 gain ($133,830 amount

realized minus $41,450 adjusted basis), petitioner’s realized

capital gain is $24,380.



IV.   Additions

      A.   Section 6653(a) negligence addition

      Respondent determined that petitioner is liable for an

addition to tax for negligence pursuant to section 6653(a).

Section 6653(a)(1) imposes an addition to tax of 5 percent of the

portion of the underpayment to which section 6653 applies.


      15
      (...continued)
Camelot Court Development, Inc., and a 50-percent interest in
Camelot Court Development, Inc. II). Petitioner objected to
their introduction into evidence, because they had not been
submitted to petitioner prior to trial, contrary to our Standing
Pretrial Order, for incorporation in the stipulation of facts
under Rule 91. Respondent did not request leave to amend her
answer to assert an additional deficiency for these amounts, and
did not make any argument on brief that we should treat them as
taxable distributions or as reductions in the basis of
petitioner's stock. Respondent maintained at trial that the
documents were offered for impeachment purposes only, under Fed.
R. Evid. 607, as an exception to Rule 91 and the Standing
Pretrial Order, and we so regard them.
                                - 27 -


Section 6653(a)(3) defines “negligence” as including any failure

to make a reasonable attempt to comply with the provisions of the

Code.     Petitioner has the burden of proving that respondent’s

determination of the addition to tax for negligence is erroneous.

Rule 142(a); Luman v. Commissioner, 79 T.C. 846, 860-861 (1982).

        Negligence is defined as the lack of due care or the failure

to do what a reasonable and ordinarily prudent person would do

under similar circumstances.     Anderson v. Commissioner, 62 F.3d

1266, 1271 (10th Cir. 1995), affg. T.C. Memo. 1993-607; Norgaard

v. Commissioner, 939 F.2d 874, 880 (9th Cir. 1991), affg. in part

and revg. in part on other grounds T.C. Memo. 1989-390.     A

taxpayer’s failure to maintain adequate books and records is

sufficient to establish negligence.      Sec. 6001; Zafiratos v.

Commissioner, T.C. Memo. 1992-135, affd. without published

opinion 993 F.2d 880 (3d Cir. 1993); Moran v. Commissioner, T.C.

Memo. 1981-352.

        Petitioner has been a certified public accountant for many

years and was aware of the requirement that complete and accurate

books and records be maintained with respect to WSAI’s activities

and any distributions from WSAI to petitioner.     As an accountant,

petitioner was also aware of his requirement to verify and

document the value of the condominium units distributed to him.

See Henry Schwartz Corp. v. Commissioner, 60 T.C. 728, 740

(1973); D’Arcangelo v. Commissioner, T.C. Memo. 1994-572.       A
                                 - 28 -


careful consideration of the evidence, including the selling

price of the other South Wood condominiums and petitioner’s sale

price of his own South Wood Condominium around the time for

filing his 1988 return, should have alerted him, as an

accountant, to the appropriate values for the condominium units

distributed.    See deRochemont v. Commissioner, T.C. Memo. 1991-

600.

       We sustain respondent’s determination that petitioner was

negligent with respect to the underpayment.

       B.   Section 6661 substantial understatement addition

       Respondent determined that petitioner is liable for an

addition to tax under section 6661 for substantial

understatement.     This addition applies when the understatement of

income tax exceeds the greater of (1) 10 percent of the tax

required to be shown on the return for the taxable year, or (2)

$5,000.     Sec. 6661(b)(1).   The understatement for purposes of

this addition is reduced where there is substantial authority for

the tax treatment of any item or if there was adequate

disclosure, in or attached to the return, of the relevant facts

affecting any item.     Sec. 6661(b)(2)(B).

       Petitioner made no disclosure of the distribution on his

individual return for 1988 and made no argument against

imposition of this addition.      Since the amount of petitioner’s
                             - 29 -


understatement for the 1988 taxable year is substantial, we

sustain respondent’s determination on this issue.


                                       Decision will be entered

                                   under Rule 155.
