                        T.C. Memo. 2009-210



                      UNITED STATES TAX COURT



             ESTATE OF TERENCE P. MELCHER, DECEASED,
  TERESE MELCHER, EXECUTRIX, AND TERESE MELCHER, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 8941-07.              Filed September 15, 2009.



     Philip Garrett Panitz, for petitioners.

     Michael W. Berwind, for respondent.



                        MEMORANDUM OPINION


     KROUPA, Judge:   Respondent determined a $74,001 deficiency

in petitioners’ Federal income tax for 2004 and a $14,800.20

accuracy-related penalty under section 6662(a).1   Petitioners are


     1
      All section references are to the Internal Revenue Code in
effect for the year at issue, and all Rule references are to the
                                                   (continued...)
                                  -2-

Terese Melcher, as executrix of the Terence Melcher estate, and

separately as petitioner wife.

     We are asked to decide three issues.    The first issue is

whether petitioners may deduct legal expenses incurred in

defending appeals of a judgment and orders related to Terence

Melcher’s (Mr. Melcher’s) divorce from Jacqueline Melcher (first

wife).   We hold that the legal expenses attributable to the

divorce are not deductible.    The second issue is whether

petitioners may deduct legal expenses incurred in defending their

interest in, and in collecting rent from, property held in the

first wife’s bankruptcy estate.    We hold that a portion of the

expenses is deductible as ordinary and necessary expenses for the

production of income and a portion is not deductible and must be

capitalized.   The third issue is whether petitioners are liable

for the accuracy-related penalty under section 6662(a).      We hold

that they are not liable.

                              Background

     This case was submitted fully stipulated under Rule 122.

The stipulation of facts and the accompanying exhibits are

incorporated by this reference, and the facts are so found.

Petitioner wife was Mr. Melcher’s second wife.    She also serves




     1
      (...continued)
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
                                 -3-

as executrix of his estate.    She resided in California when she

filed the petition.

Mr. Melcher’s First Marriage

     Mr. Melcher was the son of the singer, actress, and animal

welfare advocate Doris Day.     He served as the executive producer

of her television series, the Doris Day Show, and earned most of

his income from the series and her films.    He also wrote and

produced music, including songs performed by the Beach Boys, and

owned interests in land and oil.

     Mr. Melcher married his first wife in 1983.    During their

marriage he worked for Arwin Production Inc. and earned

approximately $336,000 per year.    His first wife did not work

outside the home.   They each brought substantial separate

property into their marriage.    Mr. Melcher owned a 40-percent

interest in Arwin Production Inc. stock.    In addition, he

received entertainment and oil royalties.    His first wife owned

three real properties before the marriage.    She owned a home in

Los Angeles and two properties in Martha’s Vineyard,

Massachusetts, including an ocean-front property (Stonewall

Beach).   During the marriage Mr. Melcher’s first wife purchased

two properties in Carmel, California.    In addition, the couple

owned another Carmel property, which became the family residence

in 1985 (family residence).
                                 -4-

       Stonewall Beach is a 3.75-acre parcel of ocean-front

property that remained mostly vacant until 1989 when Mr. Melcher

secured a $900,000 loan in his name to build a house on the

property.    The lender required that the first wife convert her

separate title in Stonewall Beach into joint title with Mr.

Melcher.    She was reluctant to change the title but ultimately

relented to speed construction of the house.

Mr. Melcher’s Divorce

       Mr. Melcher’s first marriage lasted 15 years and ended in

1998 after Mr. Melcher filed for divorce in California.    The

Monterey County Superior Court (family court) granted a status-

only judgment of dissolution of marriage in 1998.    The divorce

proceeding was bifurcated to sever marital status in advance of

sorting the respective interests in a multi-million dollar

marital estate.    Mr. Melcher and his first wife sought to protect

their respective separate property interests and claimed

community interests in property transactions that took place

during the marriage.    Mr. Melcher argued that the conversion of

title to Stonewall Beach transmuted the property from his first

wife’s separate property into community property under California

law.    The family court agreed and found that Stonewall Beach, the

family residence, and certain entertainment rights that were

created during the marriage were community property.    The family

court also found the Arwin Production Inc. stock to be Mr.
                                  -5-

Melcher’s separate property and certain real properties to be his

first wife’s.

     The family court awarded the family residence, valued at

$1.24 million, to the first wife after giving Mr. Melcher a

community property interest.    In addition, the family court

ordered that the Stonewall Beach property be sold and the

proceeds be divided between the couple after assigning an

$800,000 separate interest to the first wife.    The family court

also found that Mr. Melcher would not be required to provide

spousal support after the sale.

     In 2001 the family court accepted a third party’s offer to

buy Stonewall Beach for $12 million.    The first wife vehemently

resisted the sale.    She filed motions for a new trial and to

vacate the judgment, which were denied.    She subsequently

initiated numerous lawsuits to prevent the sale of Stonewall

Beach.   These lawsuits were in Massachusetts and California and

included an appeal of the judgment and orders of the family

court.   She also filed for personal bankruptcy to stay the sale

of Stonewall Beach.

Divorce Appeals

     The first wife brought at least four separate appeals to the

California State Court of Appeal (appellate court) from the

judgment and orders of the family court.    She argued, among other

things, that the family court erred in its determination that
                                -6-

Stonewall Beach was transmuted into community property.     She also

argued that the family court erred in concluding that she was not

entitled to spousal support.2

     The appellate proceedings lasted for approximately five

years and the ownership of Stonewall Beach remained unresolved

until 2006.   In January 2006 the appellate court affirmed in toto

the challenged judgment and orders of the family court.     The

Supreme Court of California denied the first wife’s petition for

further review in March 2006.

     Petitioners hired C. Michael McClure and Joel Franklin to

dispute the first wife’s arguments raised in the appeal.

Petitioners incurred $127,499.71 in legal expenses to Mr.

Franklin and $74,473.57 to Mr. McClure in 2004.

Bankruptcy Proceeding

     The first wife filed for bankruptcy shortly after filing the

appeals and a day before the close of escrow on the court-ordered

sale of Stonewall Beach in June 2001.   The United States

Bankruptcy Court (bankruptcy court) found that the first wife

supported herself in large part through rental income from

Stonewall Beach and that its sale would eliminate her source of

income.   An automatic stay was triggered on the sale of Stonewall

Beach.



     2
      The parties made no arguments concerning the deductibility
of costs associated with the other issues in the appeals.
                                  -7-

     The first wife and the creditors’ committee filed several

plans of reorganization between 2001 and 2004.    A plan (the plan)

was finally confirmed by the bankruptcy court in 2005 over

petitioners’ objections.   The plan provided that Stonewall Beach

and the family residence remain property of the first wife’s

bankruptcy estate until all issues in the divorce proceedings

were determined by final and non-appealable orders.

     Petitioners’ main objective in the bankruptcy litigation was

to collect rental income from Stonewall Beach and the family

residence.   Petitioners sought to collect $1 million in rental

income from the two properties.    Petitioners also attempted to

persuade the first wife’s bankruptcy estate to sell Stonewall

Beach so that they could collect their share of the proceeds.

Petitioners argued that they are entitled to one-half of the

projected $12 million sale price of Stonewall Beach after

allowing for the first wife’s separate interest of $800,000.    The

record is unclear as to what other issues petitioners’ lawyers

raised in the bankruptcy proceeding.    Petitioners hired the Loeb

& Loeb law firm to defend their interests in the bankruptcy

proceeding and incurred $72,886.63 in legal expenses in 2004.

     The bankruptcy proceeding is still pending.3

     3
      The United States Bankruptcy Appellate Panel of the Ninth
Circuit concluded in 2006 that the first wife’s bankruptcy
proceeding was an abuse of process and merely functioned to
frustrate the implementation of the family court orders. The
United States Court of Appeals for the Ninth Circuit affirmed the
                                                   (continued...)
                                 -8-

Petitioners’ Return and Deficiency Notice

      Petitioners hired John Woodford, a certified public

accountant at Robertson, Woodford & Summers LLP to prepare their

tax return for 2004.    Petitioners claimed $165,627 of legal

expenses as unreimbursed employee expenses on Schedule A,

Itemized Deductions, and $191,372 of legal expenses on Schedule

C, Profit or Loss From Business, in 2004.     Respondent issued a

deficiency notice to petitioners disallowing these legal expense

deductions, and petitioners timely filed the petition.

                             Discussion

I.    Introduction

      We are asked to decide whether petitioners may deduct

various legal expenses incurred in the divorce appeals and

bankruptcy litigation involving Mr. Melcher’s first wife.     The

answer depends on whether the legal expenses were ordinary and

necessary expenses for the production of income.     We must also

determine whether petitioners are liable for the accuracy-related

penalty.

      We first address the burden of proof.

II.   Burden of Proof

      The Commissioner’s determinations are generally presumed

correct, and the taxpayer bears the burden of proving that the

Commissioner’s determinations are erroneous.     Rule 142(a); Welch


      3
      (...continued)
judgment in 2008.
                                  -9-

v. Helvering, 290 U.S. 111, 115 (1933).       Petitioners do not argue

that the burden of proof shifted to respondent under section

7491(a).   Petitioners also did not establish that they satisfy

the requirements of section 7491(a)(2).    We therefore find that

the burden of proof remains with petitioners.

III. Legal Expenses and Origin of the Claim Test

     We now turn to whether petitioners’ legal expenses are

deductible as ordinary and necessary expenses for the production

of income under section 212.    Taxpayers may generally deduct all

ordinary and necessary expenses paid for the production or

collection of income, or for the management, conservation, or

maintenance of property held for the production of income.      Sec.

212(1) and (2).   Taxpayers may not deduct, however, personal,

living, or family expenses.    Sec. 262(a).    Legal expenses and

other costs paid in connection with a divorce are generally not

deductible because they are considered personal expenses.      Sec.

1.262-1(b)(7), Income Tax Regs.    In addition, taxpayers may not

deduct expenses for acquiring or defending title to a capital

asset.   See sec. 263; Woodward v. Commissioner, 397 U.S. 572, 576

(1970); sec. 1.263(a)-2(a), (c), Income Tax Regs.

     We apply the origin of the claim test to determine whether a

taxpayer’s legal expenses are personal or necessary for the

production of income.   Under this test, the characterization of

legal expenses incurred to defend against a lawsuit depends on
                                -10-

whether the suit arose in connection with the taxpayer’s personal

or profit-seeking activities.     See United States v. Gilmore, 372

U.S. 39, 48 (1963).   It does not depend on whether the taxpayer

successfully defended the suit.    See id.

      The ascertainment of a claim’s origin and character must be

made on the basis of the facts and circumstances of the

litigation.    Guill v. Commissioner, 112 T.C. 325, 329 (1999).

The origin of the claim test is not a mechanical search for the

first in the chain of events that led to the litigation but

rather requires an examination of all the facts.    See Boagni v.

Commissioner, 59 T.C. 708, 713 (1973).

IV.   Legal Expenses Related to the Divorce Appellate Proceeding

      We now turn to the origin and character of petitioners’

$201,973.28 legal expenses in the divorce appellate proceedings.

Petitioners argue that the disputes regarding the ownership and

sale of Stonewall Beach were not part of the divorce proceedings

but rather a fight over income-producing property that was

reserved after a legal divorce was granted.    Petitioners further

argue that the legal expenses were incurred for the production

and collection of income and therefore are deductible under

section 212.   Respondent counters that petitioners’ legal

expenses stemmed from Mr. Melcher’s determination to end his

marriage to his first wife and therefore are nondeductible

personal expenses.
                                -11-

     Petitioners defended against two main arguments the first

wife asserted in the appellate proceedings.   The first wife

argued that the family court erred in finding that the title to

Stonewall Beach was transmuted from her separate property into

community property.    She also argued that the family court erred

in finding that she was not entitled to spousal support.4

     The determination regarding the origin and character of

divorce-related legal fees revolves around whether the spouse’s

claims toward a property would have existed but for the marriage

relationship.   See United States v. Gilmore, supra at 52.       “If

the claim could not have existed but for the marriage

relationship, the expense of defending it is a personal expense

and not deductible.”    Fleischman v. Commissioner, 45 T.C. 439,

446 (1966); see United States v. Gilmore, supra at 52.     The

record establishes that the first wife’s ownership argument

towards Stonewall Beach did not stem from the marriage.     She held

title to Stonewall Beach before she married Mr. Melcher.     The

transfer of title from the first wife’s separate property to

joint ownership with Mr. Melcher also did not stem entirely from

the marriage but was due to Mr. Melcher’s financial investment in

constructing a residence on the property.   We therefore conclude

that the origin of the legal expenses incurred to establish Mr.

Melcher’s ownership of Stonewall Beach was not personal.


     4
      Petitioners produced no evidence that the issue of rents
was raised in the divorce appellate proceeding.
                               -12-

     Concluding that the expenses were not personal does not

necessarily mean that petitioners’ legal expenses relating to the

ownership of Stonewall Beach are deductible, however.    Expenses

incurred in connection with the defense or perfection of title to

a capital asset are nondeductible capital expenditures.    See

Woodward v. Commissioner, supra at 576; Spangler v. Commissioner,

323 F.2d 913, 919 (9th Cir. 1963), affg. T.C. Memo. 1961-341;

Boagni v. Commissioner, supra at 713.   The record establishes

that the first wife appealed the judgment of the family court

regarding transmutation of the title to Stonewall Beach.   Mr.

Melcher’s title to Stonewall Beach was therefore called into

question by the first wife’s appeals and the issue was not

resolved until 2006 when the appellate court confirmed the family

court’s judgment.   Accordingly, to the extent that petitioners

incurred legal expenses to defend their title to Stonewall Beach,

the legal expenses are not deductible and must be capitalized.

In addition, we find that legal expenses associated with

defending against the first wife’s claims regarding spousal

support stemmed entirely from the marriage.   These expenses are

therefore personal and are not deductible.    In sum, we conclude

that none of the legal expenses petitioners incurred in the

divorce appeals were deductible.
                                 -13-

V.   Legal Expenses Related to the Bankruptcy Proceeding

     We now examine the origin and character of petitioners’

$72,886.63 legal expenses incurred in the bankruptcy proceeding.

Petitioners sought to collect rental income from Stonewall Beach

and the family residence in the bankruptcy proceeding.    They also

sought to sell Stonewall Beach and collect their share of the

proceeds.

     Expenses incurred in connection with the acquisition or

disposition of a capital asset are nondeductible capital

expenditures.    See Woodward v. Commissioner, 397 U.S. at 575-576;

Spangler v. Commissioner, supra at 921; Boagni v. Commissioner,

supra at 713.    Moreover, legal expenses relating to sale of a

property are capital expenditures and must be offset against the

sale price.     See Gunn v. Commissioner, 49 T.C. 38, 57 (1967); see

also Clay v. Commissioner, T.C. Memo. 1981-375.    Taxpayers may

deduct, however, the portion of legal expenses allocated to

recover income derived from a capital asset.    See Kelly v.

Commissioner, 23 T.C. 682 (1955), affd. 228 F.2d 512 (7th Cir.

1956); see also Boagni v. Commissioner, supra at 715; Estate of

Arnett v. Commissioner, 31 T.C. 320, 335 (1958); Hahn v.

Commissioner, T.C. Memo. 1976-113.

     The record establishes that petitioners incurred legal

expenses to facilitate the sale of Stonewall Beach.    We conclude

that the expenses associated with petitioners’ attempts to sell
                                 -14-

Stonewall Beach originated in the disposition of a capital asset

and therefore are nondeductible capital expenditures.     To the

extent that petitioners incurred legal expenses to collect

accumulated rents from Stonewall Beach and the family residence,

however, we find the origin of those expenses to be in the

production of income, and therefore they are deductible.

      The record fails to allocate the legal expenses between the

time spent on the Stonewall Beach sale and the time spent to

collect rent.   It is therefore impossible to determine with

exactness what portion of the legal expenses was paid for the

sale of Stonewall Beach and what portion is allocable to

collecting rental income.    We have held under similar

circumstances that we may approximate the allocation and

apportionment under the principle of Cohan v. Commissioner, 39

F.2d 540 (2d Cir. 1930).    See Estate of Arnett v. Commissioner,

supra at 335.   Petitioners sought to collect $1 million in rent,

and the record establishes that they sought approximately $5

million in sale proceeds from Stonewall Beach.   Thus, we conclude

that one-sixth of the $72,886.63 legal expenses (or $12,147) was

expended to collect rent and is deductible.

VI.   Accuracy-Related Penalty

      We now address whether petitioners are liable for the

accuracy-related penalty for a substantial understatement of

income tax in 2004.   A taxpayer may be liable for a penalty of 20
                               -15-

percent on the portion of an underpayment of tax attributable to,

among other things, a substantial understatement of income tax.

Sec. 6662(a) and (b)(2).   There is a substantial understatement

of income tax if the amount of the understatement exceeds the

greater of 10 percent of the tax required to be shown on the

return, or $5,000.   Sec. 6662(d)(1)(A); sec. 1.6662-4(b)(1),

Income Tax Regs.

     Respondent has met his burden of production with respect to

petitioners’ substantial understatement of income tax.    See

Higbee v. Commissioner, 116 T.C. 438, 446 (2001).     Petitioners

reported their income tax liability for 2004 to be $39,210.

Respondent adjusted their tax liability to $133,211 and

determined a deficiency of $74,001.   Although we have determined

that petitioners are entitled to deduct $12,147 of the legal

expenses incurred in the bankruptcy proceeding, the

understatement remains greater than $5,000 or 10-percent of their

correct tax liability.

     A taxpayer is not liable for an accuracy-related penalty,

however, if the taxpayer acted with reasonable cause and in good

faith with respect to any portion of the underpayment.    Sec.

6664(c)(1).   The determination of whether a taxpayer acted with

reasonable cause and in good faith depends on the pertinent facts

and circumstances, including the taxpayer’s efforts to assess his

or her proper tax liability, the knowledge and experience of the
                                 -16-

taxpayer, and the taxpayer’s reliance on the advice of a

professional.     Sec. 1.6664-4(b)(1), Income Tax Regs.    Reliance on

the opinion of a tax adviser will constitute good faith and

reasonable cause where the reliance is reasonable.        United States

v. Boyle, 469 U.S. 241, 250 (1985).

     Petitioners relied upon the advice of a certified public

accountant who prepared the tax return and determined that

petitioners’ legal expenses were deductible expenses.       Taking

into consideration the number of the issues that were raised in

the divorce appellate and the bankruptcy proceedings and the

complexity involved with determining the tax consequences of each

issue, we find that petitioners acted with reasonable cause and

in good faith when they relied on the advice of a certified

public accountant.    We accordingly do not sustain respondent’s

determination regarding the accuracy-related penalty for 2004.

VII. Conclusion

     Petitioners’ legal expenses relating to the divorce appeals

are nondeductible because they were either capital expenditures

or personal expenses.    Further, petitioners’ legal expenses

relating to the bankruptcy proceeding must be allocated between

deductible expenses for the production of income and

nondeductible capital expenditures.     In addition, petitioners are

not liable for the accuracy-related penalty.
                                 -17-

     In reaching our holdings, we have considered all arguments

made, and to the extent not mentioned, we consider them

irrelevant, moot, or without merit.

     To reflect the foregoing,



                                             Decision will be entered

                                        under Rule 155.
