                        T.C. Memo. 1997-411



                      UNITED STATES TAX COURT



                   GARY L. PIERCE, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

        GARY L. PIERCE AND MARY C. PIERCE, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 6086-94, 6226-94.      Filed September 16, 1997.




     Frank W. Louis, for petitioners.

     Robert E. Marum, for respondent.


             MEMORANDUM FINDINGS OF FACT AND OPINION

     BEGHE, Judge:   Respondent determined deficiencies in

petitioners’ Federal income tax and accuracy-related penalties as

follows:
                                  - 2 -


Gary L. Pierce and Mary C. Pierce
                                            Penalty
          Year       Deficiency           Sec. 6662(a)1

          1984         $3,513                   $703
          1986         71,974                 14,395
                                           1
          1987        539,914                105,833
          1988        527,851               105,570
          1989        102,323                 20,465
     1
       For taxable year 1987, the penalty pursuant to sec.
6662(a) is shown in the statutory notice as both $151,729 and
$105,833. The correct amount is $105,833.

Gary L. Pierce
                                            Penalty
          Year       Deficiency           Sec. 6662(a)

          1991        $444,040               $88,808

     By reason of respondent’s concessions, the remaining issues

for decision are:   (1) Whether Mary Catherine Development Co.

(Mary Catherine), an S corporation engaged in buying and

developing land for sale to residential builders, was entitled to

use the lower of cost or market (LCM) method, an inventory method

of accounting, for taxable years 1989 and 1990 to claim

reductions of income for decreases in the fair market value of

parcels of land held for development; and (2) whether Gary L.

Pierce (petitioner) and Mary C. Pierce are liable for accuracy-

related penalties for the years 1984, 1986 through 1989, and 1991

pursuant to section 6662(a) for negligence or intentional

     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years in
issue. All Rule references are to the Tax Court Rules of
Practice and Procedure. Dollar amounts have been rounded to the
nearest dollar.
                                - 3 -


disregard of rules and regulations under section 6662(b)(1).2

Because we decide that Mary Catherine is not entitled to use the

LCM method, various issues that would have been implicated by our

decision to the contrary have been mooted.

                           FINDINGS OF FACT

Background

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

The stipulation of facts and the attached exhibits are

incorporated by this reference.

     When the petitions in these cases were filed, petitioners

resided in Windsor, Connecticut.    Petitioners filed joint Federal

income tax returns for 1984, 1986, 1987, 1988, 1989, and 1990.

Petitioner filed a separate Federal income tax return for 1991.

     Petitioner entered the real estate business in 1969 when he

began renovating apartment houses.      Later, petitioner changed the

focus of his business to building new houses.

     Prior to 1986, Derekseth Corp. (Derekseth), petitioner's

wholly owned C corporation, was the business vehicle used by

petitioner to acquire land, subdivide the land into lots, build

houses on the lots, and sell houses and lots to individuals.

     On November 21, 1986, Mary Catherine was incorporated under

the laws of Connecticut.    Petitioner has been the only

     2
       Respondent concedes that petitioners are not liable for a
penalty for substantial understatement of income tax under sec.
6662(b)(2).
                                 - 4 -


shareholder of Mary Catherine from its incorporation through

1991, the final year in issue.    Petitioner is also the only

shareholder of Deanne Lynn Realty Co. (Deanne Lynn), another S

corporation.

     Since 1986, the business formerly conducted exclusively by

Derekseth has been divided as follows among petitioner's three

corporations.   Mary Catherine acquires land; obtains zoning,

wetlands, and subdivision approvals; improves the land by

clearing vegetation, building roads, installing utilities, and

subdividing the land into lots; and then sells the subdivided

lots to residential builders, including Derekseth.      Derekseth

purchases lots from Mary Catherine and other developers and

builds houses on them.   As agent for Derekseth, Deanne Lynn then

sells the houses and lots, generally to individuals.      After Mary

Catherine was formed, Derekseth transferred to Mary Catherine by

quitclaim deed its holdings of raw land and building lots.

     During 1987, Mary Catherine acquired 869 acres of land (the

Ridge) in East Granby, Connecticut.      Some of the Ridge was

purchased by Mary Catherine directly; the rest was transferred to

Mary Catherine by Derekseth and petitioner.      During 1988

Derekseth assigned to Mary Catherine by quitclaim deed 140 acres

of land (Minnechaug) in Glastonbury, Connecticut.

     Commencing in 1989, the real estate market in Connecticut

became depressed.   The numbers of sales and sale prices of
                               - 5 -


single-family houses substantially decreased, causing a decline

in the fair market value of unapproved real estate.3    The values

of the Ridge and Minnechaug declined sharply in 1989.

The Ridge Writedown

     In 1989, the Federal Deposit Insurance Corporation (FDIC)

required Suffield Bank, Mary Catherine's mortgage lender for the

Ridge, to obtain an appraisal of the value of the Ridge.    On

May 1, 1990, Suffield Bank commissioned an appraisal of the Ridge

from Phillip A. Goodsell and Donald R. Brown, who concluded that

the value of the Ridge as of April 11, 1990, was $4,395,000

($2,330,000 for unapproved, unimproved land and $2,065,000 for

approved, unimproved land).   Upon receiving the appraisal,

Suffield Bank informed petitioner that it was required to write

down the value of the Ridge for regulatory purposes, and that it

expected Mary Catherine’s financial statements to reflect the

writedown.   Under the terms of the mortgage loan from Suffield

Bank to Mary Catherine, the writedown caused Mary Catherine to be

in default, but Suffield Bank did not foreclose.

     Petitioner asked his accountants, Bobrow & Bobrow, C.P.A.’s

(Bobrow), of West Hartford, Connecticut, whether he could gain

any tax benefit as a result of having had to write down the Ridge


     3
       The term “approved” land refers to land for which all
necessary regulatory approvals, such as zoning and wetlands, have
been obtained. “Unapproved” land refers to land for which one or
more regulatory approvals have not been obtained.
                                - 6 -


on Mary Catherine’s books.   Bobrow advised petitioner that Mary

Catherine could either sell the Ridge or write it down to fair

market as of the end of the taxable year under the LCM method.

As a result, petitioner was under the impression that these

methods were equally valid ways, for income tax purposes, of

realizing the loss on the Ridge.

     In July 1990, petitioner commissioned his own appraisal

of the Ridge from Phillip A. Goodsell and Donald R. Brown,

appraisers.   Goodsell and Brown arrived at a value, as of

December 31, 1989, of $2,525,000 for unapproved, unimproved

land.4   Prior to December 31, Mary Catherine had been carrying

the Ridge at an adjusted basis of $6,266,352.   The parties have

stipulated that the fair market value of the Ridge on December

31, 1989, was $2,525,000.    Using the LCM method, Mary Catherine

wrote down the Ridge on its financial statements to its market

value and claimed a loss on its 1989 income tax return in the

amount of $3,741,352, the difference between the adjusted basis

of the Ridge and its fair market value on December 31, 1989.

     Prior to 1989, Mary Catherine had not written down any of

its land holdings for Federal income tax purposes.   In 1989, when

     4
       The record contains no evidence that would explain the
$1,870,000 disparity between Goodsell and Brown’s valuation as
of Dec. 31, 1990, and their valuation as of Apr. 11, 1990.
Petitioners contend in their reply brief that the value increased
between December and April because a portion of the land received
subdivision approval between the two appraisal dates, but there
is nothing in the record to support a finding to that effect.
                                 - 7 -


Mary Catherine wrote down the Ridge, it held a number of other

parcels, including Minnechaug, that had also been adversely

affected by the downturn in the real estate market.     None of

these other properties were written down in 1989.

The Minnechaug Writedown

     The FDIC required Bay Bank, Mary Catherine's mortgage lender

for Minnechaug, to obtain an appraisal of Minnechaug, at a time

when its value was then less than the amount that Mary Catherine

owed to Bay Bank.5    Bay Bank informed Mary Catherine that the

bank had to write down Minnechaug for regulatory purposes and

that the bank expected that the reduction in value would be

reflected in Mary Catherine's financial statements.

     On January 25, 1991, Mary Catherine commissioned an

appraisal of Minnechaug from Howard A. Jubrey, Jr., of Appraisal

Associates, Inc.     Jubrey arrived at a value, as of January 22,

1991, of $2,500,000 for approved but unimproved land.     The

parties have stipulated that the fair market value of Minnechaug

on December 31, 1990, was $2,500,000.     Immediately prior to

December 31, 1990, Mary Catherine’s adjusted basis in Minnechaug

was $7,187,700.    Mary Catherine wrote down Minnechaug on its 1990

financial statements to its fair market value and claimed a loss

on its 1990 Federal income tax return in the amount of

     5
       The record does not disclose the date or the results of
Bay Bank's appraisal of Minnechaug. The record is also very thin
with respect to what transpired between the banks and the FDIC.
                               - 8 -


$4,687,700, the difference between the adjusted basis of

Minnechaug and its fair market value on December 31, 1990.

     In 1990, when Mary Catherine wrote down Minnechaug, it held

a number of other parcels for development, including the Ridge,

none of which were written down during that year, or at any time

thereafter.

Use of Original Bases for Subsequent Sales

     Subsequent to the 1989 and 1990 writedowns, Mary Catherine

sold some of the residential lots in the Ridge and Minnechaug.

On its Federal income tax returns for years 1990 through 1994,

Mary Catherine computed and reported gains for income tax

purposes from the sales of these residential lots using the

original cost basis of the properties rather than an adjusted

basis reflecting the writedowns to market value that Mary

Catherine had reported on its income tax returns.   As of the time

of trial, petitioner had not caused Mary Catherine to file

amended returns for taxable years 1990 through 1994 reporting

gains on the sale of the residential lots in a manner consistent

with the LCM method.

Mary Catherine’s Tax Returns

     Mary Catherine’s Federal income tax returns on Form 1120S

for the years 1987 through 1990 were prepared by Bobrow.

Attached to Mary Catherine’s 1989 and 1990 income tax returns

were disclosure statements prepared by Bobrow.   The disclosure
                                - 9 -


statements bear a heading that reads “DISCLOSURE PURSUANT TO

SECTION 6661".   The disclosure statements explain that Mary

Catherine is writing down land and carrying costs to fair market

value pursuant to section 1.471-4, Income Tax Regs.    The

disclosure statements also provide a complete detailed

description of the subject land and the prevailing conditions in

the real estate market.    Attached to the disclosure statements

are the appraisals petitioner had obtained, as well as other

information about the two communities.

     During 1992, prior to initiation of the audit that resulted

in respondent’s determinations, and for reasons independent of

the issues in the lawsuit, discussed infra pp. 12-13, Mary

Catherine terminated Bobrow as its accountants and hired Kostin

Ruffkess & Co., C.P.A.’s (Kostin) of West Hartford, Connecticut.

Kostin, which prepared Mary Catherine’s 1991 Federal income tax

return, advised petitioner that land could not be written down

for Federal income tax purposes.

     Since its date of incorporation, Mary Catherine has neither

requested nor received the Commissioner's consent to change

accounting methods.

Petitioners' Tax Returns

     The Ridge writedown resulted in a loss to Mary Catherine

that flowed through to petitioner and was claimed by petitioners
                              - 10 -


as a loss that they deducted on their 1989 Federal income tax

return in the amount of $2,121,283.

     Petitioners filed an Application for Tentative Refund for

1989 claiming NOL carrybacks to the years 1986 and 1987.   As a

result, petitioners' entire tax liability for the year 1986 in

the amount of $71,784 was eliminated, and petitioners’ income tax

liability for 1987 was reduced from $537,770 to $37,937.

Petitioners agreed to, and respondent assessed, an increase in

their 1987 income tax liability of $42,990, bringing petitioners'

remaining 1987 income tax liability to $80,927.

     Mary Catherine reported a loss for 1990 in the amount of

$5,372,348, $4,687,700 of which was attributable to the

Minnechaug writedown.   However, as of the beginning of 1990

petitioner lacked sufficient basis in Mary Catherine to take

advantage of such a loss from that year.   In 1990, petitioner

lent Mary Catherine $1,743,893, increasing his adjusted basis and

his amount at risk, thereby enabling petitioners to claim a

deductible loss in the amount of $1,743,893 on their 1990 Federal

income tax return.

     Petitioners filed an Application for Tentative Refund for

1990 claiming NOL carrybacks to the years 1987 and 1988.

Respondent reviewed this Application for Tentative Refund and

refunded the remainder of petitioners’ 1987 tax paid in the

amount of $80,927.   The additional carryback allowed by
                               - 11 -


respondent also affected the amount of the carryback to 1988.

Petitioners’ reported 1988 tax liability was reduced from

$547,702 to $293,598.

     In 1991, petitioner lent Mary Catherine $2,467,094,

increasing his adjusted basis and his amount at risk by that

amount.   This enabled petitioner to claim a deduction from

ordinary income for a nonpassive loss on his 1991 income tax

return in the amount of $2,467,094, resulting from the Ridge and

Minnechaug writedowns.

     Petitioner filed an Application for Tentative Refund for

1991 claiming an NOL carryback to 1988 that resulted in

petitioners’ 1988 income tax liability being further reduced from

$293,598 to $19,851.6

     Petitioner attached a letter dated March 2, 1992, to his

1991 Application for Tentative Refund asking respondent to

expedite the refund.    The letter referred to significant

operating losses experienced by petitioner's companies since

1988, cash-flow problems, banking problems, delinquent payments

to vendors, lay-offs, and reduced compensation to employees.    The

letter stated that “receipt of the refund * * * [was] critical

and the potential key to * * * [petitioner's] survival.”



     6
       Petitioners’ 1988 income tax liability would have been
reduced below $19,851 but for the limitation imposed by the
alternative minimum tax.
                                - 12 -


     Petitioners claimed a net operating loss for 1989, which was

carried back to 1986, resulting in an excess general business

credits carryback for 1986 of $19,000, of which $3,513 was

carried back to 1984.   Respondent has disallowed the $3,513 in

excess business credits carried back to 1984.   The $3,513

deficiency determined by respondent for the year 1984 is a direct

result of the 1989 writedown.    Respondent’s disallowance of Mary

Catherine’s writedowns for 1989 and 1990 resulted in the

adjustments to petitioners' net operating loss carrybacks from

1989 to 1986 and 1987 in the amounts of $222,859 and $1,311,418,

respectively, from 1990 to 1987 and 1988 in the amounts of

$151,729 and $907,516, respectively, and from 1991 to 1988 in the

amount of $1,038,814.

Suit Against Bobrow

     On December 22, 1993, Mary Catherine and petitioners filed a

complaint in the Connecticut Superior Court for the District of

Hartford against Alec R. Bobrow, David S. Bobrow, Alan J. Nathan,

and Ronald Mamrosh, the Bobrow accountants who prepared

petitioners’ and Mary Catherine’s 1989 and 1990 Federal income

tax returns, for breach of contract and negligence in the

preparation of the returns.

     The complaint alleges that respondent “has assessed against

the plaintiff Mary Catherine Development Co. additional moneys

due in the form of additional taxes, interest and penalties.”
                                 - 13 -


The complaint alleges that the Bobrow accountants were negligent

and in breach of contract when they advised Mary Catherine to

submit Federal corporate income tax returns claiming losses

resulting from the Ridge and Minnechaug writedowns.     The

complaint further alleges that the Bobrow accountants knew that

Mary Catherine was an S corporation and that Mary Catherine’s

losses would flow through to petitioner and “as such, that all

additional taxes, interest, and other penalties [determined

against Mary Catherine] could be assessed against the plaintiff

Gary L. Pierce as the sole shareholder of the plaintiff

corporation.”    Finally, the complaint alleges that the Bobrow

accountants were negligent and in breach of contract when they

failed to advise Mrs. Pierce of her liability arising from her

having filed joint returns with petitioner.

     The suit against Bobrow has been stayed pending the outcome

of the case at hand.

                                 OPINION

Issue 1.    The Writedowns

     The first issue for decision is whether Mary Catherine

improperly used LCM, an inventory method of accounting, to

compute its taxable income for the years 1989 and 1990.

     Normally, a taxpayer computes taxable income using the same

method of accounting that he uses to compute income in keeping

books.     Sec. 446(a).   However, the taxpayer may use “(1) the cash
                                  - 14 -


receipts and disbursements method; (2) an accrual method; (3) any

other method permitted by this chapter; or (4) any combination of

the foregoing methods permitted under regulations prescribed by

the Secretary.”    Sec. 446(c).    The regulations permit “any

combination of * * * [the cash, accrual, or other permissible]

methods of accounting * * * if such combination clearly reflects

income and is consistently used.”      Sec. 1.446-1(c)(1)(iv), Income

Tax Regs.    A method of accounting includes an overall method and

any specialized methods the taxpayer may use for individual

items.    Burck v. Commissioner, 63 T.C. 556, 561 (1975), affd. 533

F.2d 768 (2d Cir. 1976); sec. 1.446-1(a), Income Tax Regs.

     A taxpayer may adopt any permissible method of accounting on

the first income tax return on which an item appears.      Once a

permissible method is chosen, the taxpayer must secure the

consent of the Secretary before adopting a new method.      Sec.

446(e).     A change in the method of accounting includes a change

in the overall plan of accounting or a change in the treatment of

any material item used in the overall plan.      Sec. 1.446-

1(e)(2)(ii)(a), Income Tax Regs.

     Petitioner contends that Mary Catherine has been using an

inventory method of accounting, including LCM, since Mary

Catherine’s inception.    Respondent contends that real estate

developers are not entitled to use inventory methods of

accounting, such as LCM, for income tax purposes.      Respondent
                                - 15 -


further contends that, prior to 1989, Mary Catherine had not been

using an inventory method, and that when Mary Catherine wrote

down the Ridge as of yearend 1989, it was adopting a new method

of accounting without first securing the consent of the

Secretary.   Because we hold that LCM is not a permissible method

of accounting for Mary Catherine, we do not reach the question of

whether Mary Catherine tried to change an accounting method

without the consent of the Secretary.7

     Section 471(a) provides:

     Whenever in the opinion of the Secretary the use of
     inventories is necessary in order clearly to determine
     the income of any taxpayer, inventories shall be taken
     by such taxpayer on such basis as the Secretary may
     prescribe as conforming as nearly as may be to the best
     accounting practice in the trade or business and as
     most clearly reflecting the income.

The Secretary has determined that “inventories at the beginning

and end of each taxable year are necessary in every case in which

the * * * sale of merchandise is an income-producing factor.”

Sec. 1.471-1, Income Tax Regs.    The term “merchandise” is not


     7
       Mary Catherine has nominally been using an inventory
method since at least 1987 in that it has checked a box on each
income tax return indicating that it is using the LCM method of
determining ending inventory. However, petitioner testified at
trial that Mary Catherine carefully capitalized the costs of
development and determined an adjusted basis of each lot sold.
While this is consistent with a specific identity inventory
method, it is also consistent with proper capitalization of costs
for determination of gain under sec. 1001. We have previously
rejected taxpayers’ contentions that capitalization of land and
building costs is an inventory method. See, e.g., W.C. & A.N.
Miller Dev. Co. v. Commissioner, 81 T.C. 619, 631 (1983).
                              - 16 -


defined in the Code or regulations.    Attempting to discern the

meaning of the term, the Court of Appeals for the First Circuit

applied the rule that “`[t]he natural and ordinary meaning of the

words used will be applied [in construing tax statutes] unless

the Congress has definitely indicated an intention that they

should be otherwise construed’”.    Wilkinson-Beane, Inc. v.

Commissioner, 420 F.2d 352, 354 (1st Cir. 1970) (quoting

Huntington Sec. Corp. v. Busey, 112 F.2d 368, 370 (6th Cir.

1940)), affg. T.C. Memo. 1969-79.   We have long held that the

natural and ordinary meaning of “merchandise” does not include

real property.   See W.C. & A.N. Miller Dev. Co. v. Commissioner,

81 T.C. 619, 630 (1983); Atlantic Coast Realty Co. v.

Commissioner, 11 B.T.A. 416, 419 (1928); Homes by Ayres v.

Commissioner, T.C. Memo. 1984-475, affd. 795 F.2d 832 (9th Cir.

1986).

     In Atlantic Coast Realty Co. v. Commissioner, supra, the

taxpayer owned various parcels of raw land held for sale to

customers.   The taxpayer contended that it should be allowed to

inventory its land and that it should be allowed to use the LCM

method to value its closing inventory.    The Board noted that

Congress did not intend, by the predecessor of section 471

(section 203 of the Revenue Act of 1918, ch. 18, 40 Stat. 1060),

to confer the right to use inventories on all businesses.      The

Board observed that a parcel of real estate is a unique item,
                              - 17 -


making use of the LCM method of valuation highly impracticable

and imprecise.   Furthermore, the taxpayer in Atlantic Coast

Realty failed to show that the inventorying of real estate was an

established and accepted accounting practice.   The Board held

that taxpayers are not entitled to use the inventory method to

account for real property.

     In W.C. & A.N. Miller Dev. Co. v. Commissioner, supra, the

taxpayer, a real-estate developer, had applied for permission to

change to the last-in-first-out (LIFO) method of valuing its

inventory of houses constructed and held for sale.   The taxpayer

admitted that under Atlantic Coast Realty land costs could not be

inventoried but contended that the houses on the land could be

inventoried and that the job-cost method it had previously used

to determine the gain or loss on the sale of each house was a

specific identification inventory method of accounting.   The

Commissioner maintained that the job-cost method was merely a

proper capitalization of tax taxpayer’s acquisition, development,

construction, and other costs.   We held that the taxpayer had

failed to prove that it had previously used an inventory method

of accounting and that the taxpayer had not shown that the use of

inventories represented the best practice in its industry in

accordance with generally accepted accounting principles.   We

further held that a finished house on a lot is not "merchandise"

within the meaning of section 1.471-1, Income Tax Regs., and that
                              - 18 -


the Commissioner had not committed an abuse of discretion in

rejecting the taxpayer’s use of inventories and the LIFO method.

     In Homes by Ayres v. Commissioner, supra, the taxpayer used

a “square footage method” by which the total cost of developing

and constructing houses on a tract of raw land was allocated to

each lot based on the number of square feet of floor in each of

the completed houses.   The taxpayers filed applications to use

the LIFO inventory method to value completed houses and partially

completed houses, but the taxpayer did not contend that it should

be allowed to apply the inventory method to land costs.   We held

that each house and lot constitutes a parcel of real property,

and that, because real property is not “merchandise” within the

meaning of section 1.471-1, Income Tax Regs., the taxpayers were

not “permitted or required to maintain inventories” and thus

could not elect to use the LIFO method.

     Not since our predecessor, the Board of Tax Appeals, decided

Atlantic Coast Realty Co. v. Commissioner, supra, have we had

occasion to hold that a developer may not account for land costs

using the LCM method.   But underpinning each of the three above-

discussed cases is the well-settled rule that land costs may not

be inventoried because the Secretary does not permit or require

land costs to be inventoried and because the use of inventory

accounting for land does not clearly reflect income.   Moreover,

there are other reasons to disallow the use of inventory methods
                               - 19 -


of accounting, particularly the LCM method, to real property.

Inventory methods generally require the taxpayer to arrive at an

annual ending inventory value, which means that an inventory of

land would have to be valued frequently.    Given the expense and

imprecision of land appraisals, inventory methods of accounting

would be unwieldy for real property.    Also, unless each piece of

property is revalued every year, there will always be the

potential for the taxpayer to exercise adverse selection in

reappraising parcels of loss property and to write them down only

when he needs a loss to offset taxable income.

     Mary Catherine’s use of an inventory method of accounting,

including the LCM method of valuing ending inventory, is

improper.    Petitioner did not present expert opinion testimony

that current financial accounting standards allow real property

to be inventoried.    But as the Court of Appeals for the Ninth

Circuit explained in Homes by Ayres v. Commissioner, supra, such

expert opinion would not carry the day because tax and business

accounting can diverge and the Commissioner has discretion in

this area:    “The Commissioner has broad discretion over

accounting techniques and, as a matter of law, real estate cannot

be inventoried until * * * [the Commissioner] changes his

position or Congress changes the law.”     Homes by Ayres v.

Commissioner, 795 F.2d at 836.    Moreover, as the Court of Appeals

observed, the conclusion that real property is not “merchandise”
                                - 20 -


under section 471 is supported by references in the accounting

literature that define merchandise as tangible personal property.

Statement 1, A.R.B. No. 43., ch. 4, reprinted in 4 A.I.C.P.A.

Professional Standards, AC sec. 5121.03 (CCH 1979); Meigs et al.,

Accounting: The Basis for Business Decisions 405 (6th ed. 1984);

see also Gertzman, Federal Tax Accounting, sec. 6.05[3][b] (2d

ed. 1993).

     Petitioner argues that Mary Catherine should be allowed to

use inventories because the different lots within the same

development vary only slightly in value and because information

regarding land prices has increased substantially since 1928,

when we found in Atlantic Coast Realty Co. v. Commissioner, 11

B.T.A. at 419-420, that there is “no common market and no record

of frequent transactions by reference to which the market price

could be readily ascertained.”    We find these arguments

unpersuasive.

     Petitioner correctly notes, as did the taxpayer in Homes by

Ayres v. Commissioner, supra, that the meaning of legal terms is

not static.     However, the Commissioner’s position has long been

that real property may not be inventoried, see Rev. Rul. 69-536,

1969-2 C.B. 109, amplified by Rev. Rul. 86-149, 1986-2 C.B. 67,

and we see no current justification in our experience or in the

literature to which petitioner has referred us for expanding the
                              - 21 -


definition of “merchandise” to include land, whether raw or

cooked.

     In Thomas v. Commissioner, 92 T.C. 206, 220 (1989), we

stated that “If a taxpayer’s method of accounting does not

clearly reflect income, then the taxpayer’s taxable income is to

be computed under a method of accounting that respondent chooses

that does clearly reflect the taxpayer’s income”.     Also, section

446(b) provides that “if the method used [by the taxpayer] does

not clearly reflect income, the computation of taxable income

shall be made under such method as, in the opinion of the

Secretary, does clearly reflect income.”   Thus, it is clear not

only that respondent may disallow Mary Catherine’s use of the

inventory method, including the LCM method of valuing ending

inventory, but also that respondent may select a method of

accounting for Mary Catherine that clearly reflects income.    This

respondent has done by computing Mary Catherine’s income (losses)

using the capitalization of expenses method.

Issue 2.   Section 6662(a) Accuracy-Related Penalty

     Respondent has conceded that petitioners are not liable for

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

6662(b)(2) for substantial understatement of tax liability.

Therefore, the only issue remaining for decision is whether

petitioners are liable for the accuracy-related penalty for the

years 1984, 1986 through 1989, and 1991 for negligence or
                              - 22 -


intentional disregard of rules and regulations under section

6662(b)(1).   Ordinarily, section 6662 does not apply to tax years

for which the return is due before December 31, 1989.   However,

in the case of carrybacks to years before 1990, section 1.6662-

3(d)(2), Income Tax Regs., provides:

     [the accuracy-related penalty] under section 6662(b)(1)
     is imposed on any portion of an underpayment for a
     carryback year, the return for which is due * * *
     before January 1, 1990, if--

          (i) That portion is attributable to negligence or
     disregard of rules or regulations in a loss * * * year;
     and

          (ii) The return for the loss * * * year is due
     * * * after December 31, 1989.

The Court and the parties agree that all deficiencies at issue in

this case result directly from the NOL’s generated by the

writedowns of the Ridge and Minnechaug reflected in petitioners’

income tax returns for 1989 and 1990, the returns for which were

obviously due after December 31, 1989.   Thus, in this case,

section 6662(a) is applicable to all of the years in issue even

though some of the years ended before section 6662 was enacted.

     Section 6662(a) imposes a penalty equal to 20 percent of the

underpayment attributable to any of the causes listed in section

6662(b).   Section 6662(b)(1) provides that one of the grounds for

imposition of the penalty is "Negligence or disregard of rules or

regulations."
                              - 23 -


     Section 6662(c) provides that “<negligence’ includes any

failure to make a reasonable attempt to comply with the * * *

[Code]".   Section 6662(c) also provides that “<disregard’

includes any careless, reckless, or intentional disregard.”

Negligence includes a “lack of due care or failure to do what a

reasonable and ordinarily prudent person would do in a similar

situation”.   Niedringhaus v. Commissioner, 99 T.C. 202, 221

(1992) (citing Neely v. Commissioner, 85 T.C. 934, 947 (1985)).

     Although a taxpayer remains liable for a deficiency

attributable to a return prepared by an accountant, a taxpayer

who supplies a qualified tax return preparer with all relevant

information and who reasonably and in good faith relies on the

preparer’s advice is not negligent and has not disregarded rules

and regulations, even if the advice is incorrect and results in a

deficiency.   Heasley v. Commissioner, 902 F.2d 380 (5th Cir.

1990), revg. T.C. Memo. 1988-408; Betson v. Commissioner, 802

F.2d 365 (9th Cir. 1986), affg. in part and reversing in part

T.C. Memo. 1984-264; Industrial Valley Bank & Trust Co. v.

Commissioner, 66 T.C. 272 (1976); Hill v. Commissioner, 63 T.C.

225 (1974), affd. without published opinion sub nom. Tenner v.

Commissioner, 551 F.2d 313 (9th Cir. 1977); Conlorez Corp. v.

Commissioner, 51 T.C. 467 (1968); Brown v. Commissioner, 47 T.C.

399 (1967), affd. per curiam 398 F.2d 832 (6th Cir. 1968).     The

taxpayer has the burden of proving that he supplied the correct
                               - 24 -


information to his accountant and that the incorrect returns were

the result of the accountant’s mistake.    Enoch v. Commissioner,

57 T.C. 781, 803 (1972).

     Petitioner testified that he sought the advice of Bobrow

with regard to deducting losses resulting from Mary Catherine’s

having been required by its mortgage lenders to write down the

Ridge and Minnechaug to fair market value for financial statement

purposes.   Bobrow then prepared petitioners’ returns including

detailed statements disclosing the nature of the writedowns and

resulting losses.    Attached to the disclosure statements are the

appraisals and other information about the Ridge and Minnechaug.

Examination of Mary Catherine’s and petitioners’ income tax

returns reveals that petitioner must have provided Bobrow with

all information necessary for his accountants to render tax

advice and prepare the returns.    We find that petitioners relied

on the advice of Bobrow, and we hold that petitioners were not

negligent in doing so.

     Petitioners made no effort to hide their position from

respondent.   Petitioners attached copies of Mary Catherine’s

income tax returns, including the disclosure statements, to their

personal returns.    Petitioners also attached copies of the

disclosure statements to each Application for Tentative Refund

that they filed.    The completeness and clarity of petitioners’

disclosure statements, and the fact that petitioners attached a
                             - 25 -


disclosure statement to every form they filed with respondent,

confirms our belief that petitioners were not trying to pull the

wool over respondent’s eyes, but rather, that they were relying

on what they then believed to be sound tax advice from their

accountants, after having fully disclosed all relevant

information to them.

     To reflect the foregoing,


                                          Decisions will be entered

                                      under Rule 155.
