                         T.C. Memo. 1999-11



                       UNITED STATES TAX COURT



   WILLIAM BARRY BLYTHE AND CHERYL LYNN BLYTHE, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 13949-97.                     Filed January 22, 1999.



     William Barry and Cheryl Lynn Blythe, pro sese.

     Karen Nicholson Sommers, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     CHIECHI, Judge:    Respondent determined a deficiency in

petitioners' Federal income tax (tax) and an accuracy-related

penalty under section 6662(a)1 for taxable year 1994 in the

amounts of $15,404 and $3,081, respectively.

     The issues remaining for decision are:


     1
        All section references are to the Internal Revenue Code
(Code) in effect for the year at issue. All Rule references are
to the Tax Court Rules of Practice and Procedure.
                                 - 2 -


       (1)   Are petitioners liable for 1994 for self-employment

tax?    We hold that they are not.

       (2)   Are petitioners entitled for 1994 to the deductions

that they are claiming?     We hold that they are not.

       (3)   Are petitioners liable for 1994 for the accuracy-

related penalty under section 6662(a)?     We hold that they are to

the extent stated herein.

                           FINDINGS OF FACT

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

       Petitioners resided in Murrieta, California, at the time the

petition was filed.

       At various times during the last four months of 1993 and the

first six months of 1994, petitioner William Barry Blythe (Mr.

Blythe) acquired title to ten parcels of residential real prop-

erty (parcels), each of which was subject to an outstanding

mortgage loan at the time he acquired title.     He acquired such

title without having paid any cash or having assumed any such

loan.    With respect to six of the ten parcels, Mr. Blythe ac-

quired title within one-to-several months after a notice of

default had been recorded on each such parcel by the holder of

the outstanding mortgage loan thereon (lender).     With respect to

the remaining four parcels, the lender recorded a notice of

default on each such parcel within two-to-several months after

Mr. Blythe acquired title to each parcel.

       Mr. Blythe held title (1) to three of the ten parcels until

the lenders foreclosed on them during 1994 and (2) to the remain-
                                - 3 -


ing seven parcels until the lenders foreclosed on them during

1995.    Mr. Blythe acquired and held title to the ten parcels in

question for the purpose of producing rental income from such

parcels.    He did not acquire and hold title to those parcels for

the purpose of selling them with a view to the gains and profits

that might be derived from such sales.

     Throughout the various periods during which Mr. Blythe held

title to the ten parcels, the respective occupants of those

parcels made rental payments to petitioners.   Throughout those

periods, petitioners did not pay any property taxes or make any

mortgage loan payments with respect to any of those parcels.    Nor

did Mr. Blythe offer or advertise any of them for sale.

     In Schedule C of their return for 1994 (1994 Schedule C),

petitioners reported the rental payments that they received

during that year from the ten parcels in question as gross

receipts from a business which they described as "Property Mgmt".

Petitioners reported no other gross receipts or income in their

1994 return.    Petitioners claimed in their 1994 Schedule C total

expenses of $54,372.2   Those expenses did not include any claimed

depreciation.   Petitioners reported in their 1994 Schedule C a

net profit of $5,229.   Each of them reported in a separate

Schedule SE, Self-Employment Tax, of their 1994 return (1994

Schedule SE) about one-half (viz. $2,615) of that claimed 1994

Schedule C net profit and "Net earnings from self-employment" of

     2
        In fact, the various expenses that petitioners claimed in
their 1994 Schedule C total $54,880, not $54,372.
                                - 4 -


$2,414.    Petitioners did not report any gain or loss with respect

to the foreclosures on the ten parcels in their 1994 and 1995 tax

returns.

     On January 11, 1994, Franz Huber and Nancy Huber (the

Hubers) and petitioners entered into a "Lease with Option to

Purchase" (lease).    Pursuant to the lease, throughout the term of

the lease which began on March 1, 1994, and ended on February 28,

1997, the Hubers agreed to lease to petitioners, and petitioners

agreed to pay the Hubers monthly rent of $2,200 for, certain real

property located in Temecula, California, which petitioners used

as their personal residence (personal residence).    The Hubers

also granted to petitioners in the lease the option to purchase

for $389,000 the personal residence, which petitioners could

exercise at any time during the period March 1, 1994, through

February 28, 1997, by giving 60 days' written notice to the

Hubers.    Petitioners did not claim any mortgage loan interest

deductions with respect to the personal residence in their 1994

return.

     In the notice of deficiency (notice) issued to petitioners

for 1994, respondent disallowed the expenses that they claimed in

their 1994 Schedule C because they did not establish that those

expenses were paid or incurred during 1994 and/or that they were

ordinary and necessary expenses within the meaning of section

162(a).    Respondent further determined in the notice that the net

profit that petitioners reported in their 1994 Schedule C should

be increased by the amount of those disallowed expenses and that,
                               - 5 -


because of that increase in net profit, the self-employment tax

due from each petitioner should be increased from that reported

in the 1994 Schedules SE.   Respondent also determined in the

notice that petitioners are liable for 1994 for the accuracy-

related penalty under section 6662(a) because of negligence or

disregard of rules or regulations under section 6662(b)(1).

                              OPINION

     Petitioners bear the burden of proving that the determina-

tions in the notice are erroneous and that their position regard-

ing the new issues that they raised in the petition and at trial

should be sustained.   Rule 142(a); Welch v. Helvering, 290 U.S.

111, 115 (1933).

Self-Employment Tax

     Petitioners reported in their 1994 Schedule C the rental

payments that they received and the expenses that they claimed

from the activity in which they engaged during 1994 involving the

ten parcels in question and which they described in that schedule

as a property management business.     Petitioners now contend that

they should have reported those payments and those expenses for

1994 in Schedule E, Supplemental Income and Loss (Schedule E),

and not in their 1994 Schedule C, because they were not engaged

during 1994 in a trade or business involving the ten parcels as

real estate dealers.   According to petitioners, they had no net

profit from a business as real estate dealers, and therefore had

no net earnings from self-employment, for 1994.    They maintain

that, therefore, they are not liable for self-employment tax for
                                - 6 -


that year.   Respondent disagrees.   According to respondent,

petitioners were engaged during 1994 in a business as real estate

dealers with respect to the ten parcels in question and received

the rental payments from those parcels in the course of that

business.    Respondent maintains that, therefore, those payments

are required to be included in calculating petitioners' net

earnings from self-employment and self-employment tax for 1994.

     Section 1401 imposes a tax on an individual's "self-employ-

ment income".   As applicable here, the term "self-employment

income" means the net earnings from self-employment derived by an

individual during any taxable year, sec. 1402(b), and the term

"net earnings from self-employment" means

     the gross income derived by an individual from any
     trade or business carried on by such individual, less
     the deductions allowed by this subtitle which are
     attributable to such trade or business * * * except
     that in computing such gross income and deductions
     * * * --

                 (1) there shall be excluded rentals
            from real estate * * * together with the
            deductions attributable thereto, unless
            such rentals are received in the course
            of a trade or business as a real estate
            dealer * * * [Sec. 1402(a)(1).]

     Section 1.1402(a)-4(a), Income Tax Regs., elaborates on the

foregoing exception from the definition of the term "net earnings

from self-employment", as follows:

     (a) In general. Rentals from real estate * * * and the
     deductions attributable thereto, unless such rentals
     are received by an individual in the course of a trade
     or business as a real-estate dealer, are excluded.
     Whether or not an individual is engaged in the trade or
     business of a real-estate dealer is determined by the
     application of the principles followed in respect of
                               - 7 -


     the taxes imposed by sections 1 and 3. In general, an
     individual who is engaged in the business of selling
     real estate to customers with a view to the gains and
     profits that may be derived from such sales is a real-
     estate dealer. On the other hand, an individual who
     merely holds real estate for investment or speculation
     and receives rentals therefrom is not considered a
     real-estate dealer.

     Based on our examination of the entire record before us, we

find that Mr. Blythe acquired and held title to the ten parcels

in question for the purpose of producing rental income from such

parcels.   That is exactly what he did, and it is that rental

income which petitioners reported in their 1994 Schedule C.     We

also find on that record that Mr. Blythe did not acquire and did

not hold title to the ten parcels in question for the purpose of

selling them to customers with a view to the gains and profits

that might be derived from such sales.   Petitioners did not offer

or advertise any of the parcels for sale during 1994 or at any

other time.   The lenders who foreclosed upon the ten parcels

during 1994 and 1995 were not customers of petitioners.

     On the instant record, we find that petitioners were not

engaged in a business as real estate dealers during 1994, that

the rental payments which they received during that year were not

received by them in the course of such a business, and that such

rental payments are not includible in the computation of net

earnings from self-employment under section 1402.   Sec.
                               - 8 -


1402(a)(1).   Accordingly, we hold that petitioners are not liable

for self-employment tax for 1994.3

Claimed Deductions

     Claimed Deductions Relating to the Ten Parcels

     Petitioners claimed in their 1994 Schedule C various ex-

penses with respect to the activity in which they engaged involv-

ing the ten parcels.   They did not, however, claim any deprecia-

tion with respect to those parcels.    In the notice, respondent

disallowed the expenses that petitioners claimed in their 1994

Schedule C because they did not establish that those expenses

were paid or incurred during 1994 and/or that they were ordinary

and necessary expenses within the meaning of section 162(a).

     Petitioners contend that they are entitled to all of the

expenses that they claimed in their 1994 Schedule C except for

certain expenses which they have conceded.     In addition, they now

claim that they are entitled to depreciation for each of the ten

parcels in question.   Respondent disagrees.

     Deductions are strictly a matter of legislative grace, and

petitioners bear the burden of proving that they are entitled to

any deductions claimed.   INDOPCO, Inc. v. Commissioner, 503 U.S.

     3
        In order to resolve the self-employment tax issue
presented, we need not decide whether petitioners correctly
included the rental payments from the ten parcels in question in
their 1994 Schedule C or whether they should have included those
payments in Schedule E for that year. That is because,
regardless whether petitioners were engaged in an activity during
1994 involving the ten parcels in question that constituted a
trade or business, we have found that petitioners were not
engaged during that year in a trade or business as real estate
dealers.
                               - 9 -


79, 84 (1992).   Petitioners attempted to satisfy that burden

through Mr. Blythe's testimony as well as certain limited docu-

mentary evidence which related only to the vehicle expense and

depreciation deductions that they are seeking.   We found Mr.

Blythe's testimony about the deductions at issue to be general,

conclusory, vague, and/or questionable.   We found the limited

documentary evidence to suffer from inadequacies that are similar

to those that we found in Mr. Blythe's testimony.   Suffice it to

say that we consider the document which petitioners claim is a

log of the miles that they drove during 1994 in their activity

involving the ten parcels in question and which is the foundation

for petitioners' claim to the vehicle expense deductions at issue

to be suspect.   The one-page document in the record relating to

the depreciation deductions claimed with respect to seven of the

ten parcels merely sets forth petitioners' position as to, inter

alia, the date on which each such parcel was placed in service,

the basis that petitioners claim they had in each such parcel for

purposes of computing a depreciation deduction for 1994, and the

amount of depreciation to which they contend they are entitled

for each of those seven parcels.   However, there is no evidence

in the record establishing the correctness of petitioners'

position as to each of those matters.   For example, petitioners

have not established that they had a basis in any of the parcels

in question on which a depreciation deduction could be calcu-

lated, let alone how any such basis should be allocated between

nondepreciable land and depreciable buildings.
                              - 10 -


     Evidently realizing that they have serious evidentiary

problems regarding their position on the deductions that they are

claiming with respect to the ten parcels, petitioners assert:

"It is unreasonable to expect to manage and maintain 10 proper-

ties for 12 months * * * without incurring any expenses.   Reason-

able expenses should be allowed."   In support of that position,

petitioners cite Cohan v. Commissioner, 39 F.2d 540 (2d Cir.

1930).   On the record before us, we disagree with petitioners'

position that "Reasonable expenses should be allowed" in the

present case.   The so-called Cohan rule permits us to estimate

and allow expenses that have not been adequately substantiated

only if we are convinced from the record that such expenses were

incurred by the taxpayer and that they otherwise satisfy the

requirements of the Code as to their deductibility, and we have a

basis on which to make an estimate of such expenses.   The circum-

stances under which the so-called Cohan rule is to be applied are

not present in the instant case.

     Based on our examination of the entire record in this case,

we find that petitioners have failed to establish that they are

entitled (1) under either section 162 or section 212 to the

expense deductions4 or (2) under section 167 to the depreciation

deductions that they are claiming for 1994 with respect to the

ten parcels in question.

     4
        We need not decide whether the claimed expense deductions
are subject to sec. 162 or sec. 212 because petitioners have
failed to show that they have met the requirements of either
section.
                               - 11 -


     Claimed Mortgage Loan Interest Deductions
     Relating to the Personal Residence

     Although petitioners did not claim any mortgage loan inter-

est deductions with respect to the personal residence in their

1994 return, they contend here that they are entitled to such

deductions.   That is because, according to petitioners, petition-

ers purchased, and did not lease, the personal residence, and the

payments that they made during the first nine months of 1994 to

the Hubers were mortgage loan payments consisting entirely of

interest.   Respondent counters that petitioners were leasing the

personal residence during 1994 and that the payments which they

made to the Hubers during that year constitute rental income.    On

the record before us, we agree with respondent.   We find the

agreement entitled "Lease with Option to Purchase" into which the

Hubers as lessors and petitioners as lessees entered to be an

agreement under which the Hubers agreed to lease to petitioners,

and petitioners agreed to pay the Hubers monthly rent of $2,200

for, the personal residence.   Although that agreement also

granted petitioners the option to purchase the leased personal

residence, there is no reliable evidence in the record establish-

ing that petitioners exercised that option.

     Based on our examination of the entire record in this case,

we find that petitioners have failed to show that they are

entitled to the mortgage loan interest deductions that they are

claiming for 1994 with respect to the personal residence.
                                - 12 -


Accuracy-Related Penalty

     Respondent determined that petitioners are liable for 1994

for the accuracy-related penalty under section 6662(a) because

their underpayment of tax for that year was due to negligence or

disregard of rules or regulations under section 6662(b)(1).       For

purposes of section 6662(a), the term "negligence" includes any

failure to make a reasonable attempt to comply with the provi-

sions of the Code.     Sec. 6662(c).    Negligence also includes any

failure by the taxpayer to keep adequate books and records or to

substantiate items properly.     Sec. 1.6662-3(b), Income Tax Regs.

The term "disregard" includes any careless, reckless, or inten-

tional disregard.     Sec. 6662(c).

     The accuracy-related penalty under section 6662(a) does not

apply to any portion of an underpayment if it is shown that there

was reasonable cause for such portion and that the taxpayer acted

in good faith.     Sec. 6664(c)(1).    The determination of whether

the taxpayer acted with reasonable cause and in good faith

depends upon the pertinent facts and circumstances.       Sec. 1.6664-

4(b)(1), Income Tax Regs.     The most important factor is the

extent of the taxpayer's efforts to assess his or her proper tax

liability.   Id.

     In support of petitioners' position that they are not liable

for 1994 for the accuracy-related penalty, Mr. Blythe testified

that he "did the best that * * * [he] could" in preparing peti-

tioners' 1994 return.     On the record before us, we find that

petitioners failed to show that they acted with reasonable cause
                              - 13 -


and in good faith in claiming deductions for the expenses listed

in their 1994 Schedule C.   Consequently, we sustain respondent's

determination imposing the accuracy-related penalty under section

6662(a) for 1994 to the extent that those claimed deductions

resulted in an underpayment of tax required to be shown in

petitioners' return for that year.

     To reflect the foregoing and the concessions of petitioners,



                                     Decision will be entered

                               under Rule 155.
