                        T.C. Memo. 2010-141



                      UNITED STATES TAX COURT



          D.L. WHITE CONSTRUCTION, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 8523-08.               Filed June 28, 2010.



     David L. White (an officer), for petitioner.

     Aimee R. Lobo-Berg, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     MARVEL, Judge:   Respondent determined a deficiency in

petitioner’s Federal income tax of $79,982 for the taxable year

ending on September 30, 2002 (2002 taxable year).   After
                              - 2 -

concessions,1 the issue for decision is whether petitioner was

entitled to claim $220,000 of the cost of acquiring unimproved

real estate in December 2001 as cost of goods sold or,

alternatively, to deduct the amount as a business loss under

section 165(a)2 for the 2002 taxable year.

                        FINDINGS OF FACT

     Some of the facts have been stipulated.   The stipulation of

facts is incorporated herein by this reference.   Petitioner’s

principal place of business was in Idaho when its petition was

filed.

     Petitioner, a C corporation that uses a fiscal year3 ending

on September 30 and a cash receipts and disbursements

(cash basis) method of accounting,4 is in the business of

residential real estate construction.   During its 2002 taxable



     1
      In the notice of deficiency respondent disallowed $9,931
that petitioner claimed as a bad debt deduction and $4,722 that
petitioner deducted as the cost of employee benefit programs.
Although petitioner has not expressly conceded these adjustments,
petitioner failed to contest the adjustments in its petition or
at any time during this proceeding. Accordingly, we deem these
issues conceded. See Rule 34(b)(4), Tax Court Rules of Practice
and Procedure.
     2
      Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended.
     3
      Sec. 441(e) defines a fiscal year for a taxpayer that has
not made an election under sec. 441(f) as a period of 12 months
ending on the last day of any month other than December.
     4
      Sec. 448(a) provides that, except as otherwise provided in
sec. 448, a C corporation’s taxable income shall not be computed
under the cash receipts and disbursements method of accounting.
                                - 3 -

year and at all relevant times petitioner had two corporate

officers, David L. White (Mr. White) and Michelle White (Mrs.

White).   Mr. and Mrs. White are husband and wife.

     On or about December 20, 2001, petitioner purchased four

parcels of adjoining land in northern Idaho (the Blossom Mountain

property), totaling approximately 80 acres, from Vernon J.

Mortensen (Mr. Mortensen) for $290,000.   Petitioner paid $10,000

to Mr. Mortensen’s company, Timberland Ag L.L.C., on November 1,

2001, and $190,000, $1,669.34, and $28 to North Idaho Title Co.

on December 21, 2001, April 1, 2002, and July 17, 2002,

respectively.   The balance of the purchase price, approximately

$90,000, was financed through a promissory note.5    Petitioner

planned to build four homes on the Blossom Mountain property and

sell the homes at a profit.

     To reach the Blossom Mountain property, petitioner used an

access road that crossed an adjoining property owned by Dennis

and Sherrie Akers (Mr. and Mrs. Akers).   On January 10, 2002, Mr.

and Mrs. Akers filed suit against petitioner and Mr. and Mrs.

White in the District Court for the First Judicial District of

Idaho (Idaho district court) for negligence and trespass and to

quiet title.    Mr. Mortensen and his wife, Martie Mortensen, were

later added as defendants.



     5
      The details regarding the promissory note are unclear but
ultimately are not necessary to resolve the issue in this case.
                                - 4 -

     On December 20, 2002, petitioner filed its Form 1120, U.S.

Corporation Income Tax Return, for the 2002 taxable year.    On the

Form 1120 petitioner included the $220,000 it allegedly spent6

with respect to the Blossom Mountain property in petitioner’s

cost of goods sold.7   Although the Akerses’ lawsuit was still

ongoing when petitioner filed its Form 1120 for the 2002 taxable

year, petitioner claimed the $220,000 amount on its 2002 taxable

year return because petitioner did not have legal access to the

Blossom Mountain property and contended that the property was

worthless.

     On January 3, 2003, the Idaho district court issued its

findings of fact and conclusions of law and order (decision) in

favor of Mr. and Mrs. Akers, finding that the defendants,

including petitioner, did not have a complete easement over Mr.

and Mrs. Akers’ property, had trespassed, were negligent, and had

engaged in malicious conduct.   On August 21, 2003, the defendants

filed a motion for a new trial.   The Idaho district court



     6
      The record does not explain how petitioner calculated the
$220,000 amount.
     7
      On its 2002 Form 1120 petitioner claimed that it was a cash
basis taxpayer, but it reported gross receipts or sales of
$1,312,157, cost of goods sold of $1,139,540, and opening and
closing inventory amounts of $5,000 each. In the notice of
deficiency respondent reduced the cost of goods sold by $220,000
because “there is not a closed and complete transaction which
occurred during * * * [the 2002 taxable year]”. The record does
not explain why petitioner, a cash basis taxpayer, was allowed to
claim any cost of goods sold adjustment.
                                - 5 -

characterized the defendants’ motion for a new trial as a motion

to reopen the previous trial on the basis of new evidence and

granted the motion.   On April 1, 2004, the Idaho district court

issued a second decision in which it again found in favor of Mr.

and Mrs. Akers.   The Idaho district court imposed willful

trespass damages against the defendants in the trebled amount of

$51,008.55 and imposed punitive damages of $30,000 against Mr.

White.

     After the Idaho district court issued its April 1, 2004,

decision, North Idaho Title Co.’s insurer issued a $200,000 check

to petitioner.    Petitioner gave the check to its attorney, Robert

Covington (Mr. Covington), who deposited the check into his

client trust account on August 17, 2004.

     On May 28, 2004, petitioner filed a notice of appeal with

the Idaho supreme court.   On October 14, 2004, Mr. Covington used

$154,049 of the $200,000 he had received from North Idaho Title

Co.’s insurer to secure a bond with the Idaho supreme court with

respect to petitioner’s appeal.   On December 30, 2005, the Idaho

supreme court remanded the case to the Idaho district court.    On

October 6, 2006, the Idaho district court issued its decision on

remand, once again finding that the defendants, including

petitioner, did not have a complete easement to the Blossom

Mountain property, that Mr. and Mrs. Akers were entitled to costs

and attorney’s fees, and that the defendants were liable for
                                 - 6 -

damages.    The defendants appealed the Idaho district court’s

order on remand, and on June 4, 2008, the Idaho supreme court

issued an unpublished opinion remanding the case to the Idaho

district court.8

     On January 11, 2008, respondent issued a notice of

deficiency to petitioner with respect to petitioner’s 2002

taxable year that reduced petitioner’s cost of goods sold by

$220,000.    Petitioner timely filed a petition in this Court.9

                                OPINION

I.   Cost of Goods Sold

     In a manufacturing, merchandising, or mining business, gross

income means the total sales of the business less the cost of

goods sold plus any income from investments and from incidental

or outside operations or sources.        Sec. 1.61-3(a), Income Tax

Regs.    A taxpayer’s cost of goods sold is determined in

accordance with the method of accounting consistently used by the

taxpayer.    Id.   The amount a taxpayer claims as cost of goods


     8
      We take judicial notice that on Jan. 22, 2009, the Supreme
Court of Idaho withdrew its unpublished opinion issued on Jun. 4,
2008, and issued a new opinion affirming the Idaho district
court’s judgment that the defendants did not have an implied
easement and that the defendants’ prescriptive easement is 12.2
feet wide, vacating the Idaho district court’s judgment as to the
location of the prescriptive easement and the award of damages,
attorney’s fees and costs, and remanding the case for further
proceedings. Akers v. Mortensen, 205 P.3d 1175, 1185 (Idaho
2009).
     9
      On Oct. 6, 2009, we ordered the parties to file posttrial
briefs. Only respondent filed a posttrial brief.
                                - 7 -

sold is not subject to the limitations on deductions found in

sections 162 and 274 but rather is treated as a subtraction from

gross sales to arrive at a qualifying business’ gross income.

See B.C. Cook & Sons, Inc. v. Commissioner, 65 T.C. 422, 428

(1975), affd. 584 F.2d 53 (5th Cir. 1978); see also Metra Chem

Corp. v. Commissioner, 88 T.C. 654, 661 (1987).     A taxpayer must

substantiate the amount it reports as cost of goods sold and must

maintain adequate records for this purpose.    Sec. 6001; Nunn v.

Commissioner, T.C. Memo. 2002-250; Wright v. Commissioner, T.C.

Memo. 1993-27; sec. 1.6001-1(a), Income Tax Regs.

     As a general rule, in all cases in which the production,

purchase, or sale of merchandise of any kind (inventory) is an

income-producing factor, inventory on hand at the beginning and

end of the year shall be taken into account in computing the

taxable income for the year.    Secs. 1.446-1(a)(4)(i), 1.471-1,

Income Tax Regs.    If a taxpayer must use an inventory, the

taxpayer ordinarily is required to use the accrual method of

accounting with regard to purchases and sales unless otherwise

authorized.   Sec. 1.446-1(c)(2)(i), Income Tax Regs.

     Section 471 generally prohibits the use of inventory

accounting for property other than merchandise.     Homes by Ayres

v. Commissioner, 795 F.2d 832, 836 (9th Cir. 1986), affg. T.C.

Memo. 1984-475.    Property other than merchandise may be

inventoried only if the regulations under section 471 expressly
                               - 8 -

provide for inventory accounting or the Commissioner has

consented to the use of inventories for such property.     Id.    As a

general rule, real property is not merchandise for purposes of

inventory accounting.   See W.C. & A.N. Miller Dev. Co. v.

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

Commissioner, 11 B.T.A. 416, 419 (1928).

     Petitioner apparently uses an inventory in its business even

though it claims to be a cash basis taxpayer.    The record does

not explain this oddity.   Assuming for the sake of argument,

however, that merchandise is an income-producing factor in

petitioner’s business and that petitioner is required to use an

inventory, petitioner has failed to prove that the Blossom

Mountain property is merchandise properly includable in

calculating petitioner’s cost of goods sold.    Petitioner also

failed to prove that the Blossom Mountain property, even if

properly classified as merchandise includable in inventory,

should not have been included in closing inventory for purposes

of calculating petitioner’s cost of goods sold.    Finally,

petitioner failed to prove that any amount in excess of

$201,697.34 was the cost associated with acquiring the Blossom

Mountain property.10


     10
      Even if the Blossom Mountain property were properly
classified as inventory, petitioner would not be entitled to
include the cost of the property in its cost of goods sold
expense for the taxable year 2002 because it continued to own the
                                                   (continued...)
                               - 9 -

II.   Business Loss

      We turn then to the real issue as we see it--whether

petitioner is entitled to deduct a loss on its 2002 taxable year

return for its cost in acquiring the Blossom Mountain property

because the property became worthless in that year.   Petitioner

acknowledges that its Form 1120 may have been prepared

incorrectly with respect to the $220,000 deduction for cost of

goods sold but argues that it may nonetheless deduct a loss

attributable to the Blossom Mountain property.   Although

petitioner’s argument is not entirely clear, petitioner appears

to suggest that the $220,000 it deducted with respect to the

Blossom Mountain property qualifies as a business loss under

section 165.11

      Section 165(a) allows a taxpayer to deduct any loss

sustained during the taxable year and not compensated for by

insurance or otherwise.   To be allowable under section 165(a),

the loss must be evidenced by a closed and completed transaction,

fixed by identifiable events, and actually sustained during the



      10
      (...continued)
property on Sept. 30, 2002, and did not prove that the property
was worthless as of that date.
      11
      Petitioner stated in its petition: “At the time of our
tax preparation, we were unable to use, access, sell, build, or
borrow money against this property because of legal litigation.
Since this was a useless investment at the time, and we were led
to believe that this purchase was a complete loss to our company,
we believed that taxes were prepared properly.”
                              - 10 -

taxable year.   Natl. Home Prods., Inc. v. Commissioner, 71 T.C.

501, 521 (1979); sec. 1.165-1(b), Income Tax Regs.     Section

1.165-1(d)(2)(i), Income Tax Regs., provides in part:

     If a casualty or other event occurs which may result in
     a loss and, in the year of such casualty or event,
     there exists a claim for reimbursement * * * no portion
     of the loss * * * is sustained, for purposes of section
     165, until it can be ascertained with reasonable
     certainty whether or not such reimbursement will be
     received. Whether a reasonable prospect of recovery
     exists with respect to a claim for reimbursement of a
     loss is a question of fact to be determined upon an
     examination of all facts and circumstances. * * *

A reasonable prospect of recovery exists where the taxpayer has

bona fide claims for recoupment and there is a substantial

possibility that such claims will be decided in the taxpayer’s

favor.   Ramsay Scarlett & Co. v. Commissioner, 61 T.C. 795, 811

(1974), affd. 521 F.2d 786 (4th Cir. 1975).

     As with most other deductions, a taxpayer ordinarily has the

burden of proving each of the elements of a deductible loss.

Accordingly, the deductibility of petitioner’s alleged loss

attributable to its investment in the Blossom Mountain property

depends upon whether at the close of petitioner’s 2002 taxable

year, petitioner’s alleged loss was evidenced by a closed and

completed transaction, fixed by identifiable events, and actually

sustained during the taxable year.     Moreover, petitioner must

prove that as of September 30, 2002, there was no reasonable

prospect of recovery with respect to its investment in the
                                - 11 -

Blossom Mountain property.    See Natl. Home Prods., Inc. v.

Commissioner, supra at 522.

     Petitioner has failed to prove any of these elements.

Petitioner’s claimed loss with respect to the Blossom Mountain

property was not evidenced by a closed and completed transaction,

fixed by identifiable events.    On the contrary, at the close of

petitioner’s 2002 taxable year the Idaho district court had not

yet issued its first opinion in Mr. and Mrs. Akers’ lawsuit.      The

lawsuit remains unresolved to this day.      Mr. White’s belief that

the lawsuit would be resolved against petitioner, however

sincere, does not qualify as either a completed transaction or an

identifiable event.   In addition, petitioner failed to show that

the claimed loss was actually sustained during petitioner’s 2002

taxable year or in any other year.       Mr. White testified that he

considered the Blossom Mountain property worthless as of the end

of the 2002 taxable year because petitioner did not have any

access to the property.   However, petitioner continued to own the

property, and there is no credible evidence that petitioner could

not acquire access to the property in some other way or that the

property had become worthless as of September 30, 2002.

     Finally, even if petitioner had established that it

sustained a $220,000 loss with respect to the Blossom Mountain

property during the taxable year 2002, it still could not deduct

the loss because it had a reasonable prospect of recovery as of
                               - 12 -

the end of the year since it had a claim under its title

insurance policy.   Indeed, petitioner actually received

reimbursement of $200,000 for its loss from North Idaho Title

Co.’s insurer after the Idaho district court issued its April 1,

2004, opinion.    Accordingly, petitioner has failed to prove that

it is entitled to a business loss deduction under section 165(a)

with respect to its investment in the Blossom Mountain property.

III. Conclusion

     For the foregoing reasons, we hold that petitioner is not

entitled to include in its cost of goods sold for the taxable

year 2002 the sum of $220,000 or any other amount attributable to

its acquisition of the Blossom Mountain property.    Alternatively,

we hold that petitioner has not met its burden of proving that it

is entitled to deduct the $220,000 amount as a business loss

under section 165(a).

     We have considered the parties’ arguments and, to the extent

not discussed herein, we conclude the arguments are irrelevant,

moot, or without merit.

     To reflect the foregoing,


                                      Decision will be entered

                                 for respondent.
