                          T.C. Memo. 1996-141



                        UNITED STATES TAX COURT



               JOSEPH FRANCIS CUNNINGHAM, Petitioner v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 22176-93.               Filed March 20, 1996.



        Kathleen A. Chapman, for petitioner.

        Aretha Jones, for respondent.



                MEMORANDUM FINDINGS OF FACT AND OPINION

        CARLUZZO, Special Trial Judge:   This case was heard pursuant

to the provisions of section 7443A(b)(3) and Rules 180, 181, and

182.1


        1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code for the years in issue. All Rule
references are to the Tax Court Rules of Practice and Procedure.
                               - 2 -

     Respondent determined deficiencies in petitioner's 1987,

1988, and 1989 Federal income taxes in the amounts of $3,437,

$1,093, and $4,634, respectively.   The issue for decision is

whether the limitations imposed by section 280A(c)(5) are

applicable to business expense deductions claimed by petitioner's

wholly owned S corporation in connection with the operation of a

commercial art gallery located in the building where petitioner

resided.   The resolution of this issue turns upon whether the

portions of the building in which the art gallery was situated

are part of, or appurtenant to, the dwelling unit in which

petitioner resided.

                         FINDINGS OF FACT

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

The stipulation of facts and the exhibits attached thereto are

incorporated herein by this reference.   At the time the petition

was filed, petitioner resided in Alexandria, Virginia.

     During the years in issue, petitioner was employed on a

full-time basis as an attorney.   On December 4, 1986, petitioner

purchased a building located at 229 North Royal Street (the

building) in the Old Town section of Alexandria, Virginia.    The

building is located on the northeast corner at the intersection

of North Royal and Queen Streets in a predominantly residential

neighborhood composed mostly of townhouses.   It is attached to

townhouses on North Royal and Queen Streets, although

architecturally distinct in appearance from the other townhouses
                                - 3 -

in the area.   Petitioner purchased the building with the intent

of establishing a commercial art gallery there.      Although there

is conflicting evidence on the point, it appears that at the time

of purchase, petitioner, who was engaged to be married and was

living in a rented apartment, also intended to use a portion of

the building as a residence for himself and his future spouse.

     The building was zoned residential.      However, the previous

owners obtained special use permits allowing them to operate

various businesses, including an antique furniture shop, at that

location.   Petitioner was required to obtain a special use permit

so that the art gallery could be located and operated in the

building.

     The building consists of three levels, including a basement

(below street level), ground floor (street level), and upper

floor.   Petitioner anticipated that the basement and ground floor

would provide sufficient space to locate and operate the art

gallery.    The upper level was large enough to use as a residence

and contained two full bathrooms, although it had not been

finished or equipped for residential use at the time that

petitioner purchased the building.      Petitioner began using the

upper level as his residence in August of 1987 after adding new

flooring, a complete kitchen, and walls and doors that defined

separate living and bedroom areas.

     Because of its prior use as an antique shop, the street

level was already well suited for use as an art gallery when the
                               - 4 -

building was acquired by petitioner and required no renovations.

It was composed of three areas, including one large room in front

(the North Royal Street side), a foyer with a staircase in the

back (with an exit to Queen Street), and a half bathroom.      The

large room in the front was used to display the art work.

     The basement consisted of a landing for the staircase, a

laundry room, a half bath, and two separate rooms that at times

were used as additional display areas.    There was also a

kitchenette located in the basement that included a refrigerator,

sink, and hot plate.

     The building has two street level entrances.    One is on

North Royal Street and leads to the large room used as the

primary exhibition area.   The other entrance is on Queen Street

and leads to the foyer behind the large room.    The U.S. Postal

Service recognizes separate addresses for the building, one on

North Royal Street and one on Queen Street, and delivers mail to

mailboxes at each location.   Customers of the art gallery were

expected to use the North Royal Street entrance and, when viewed

from that street, this was the entrance a potential customer

would assume leads to the art gallery.    This entrance remained

unlocked during gallery business hours.    The Queen Street

entrance leads to the foyer where the staircase is located.      This

door remained locked and from the street did not appear

necessarily to be connected to the gallery.    Each entrance
                                 - 5 -

provides access to all areas of the building including the areas

used for the art gallery as well as for petitioner's residence.

     There is no door at the bottom or top of the stairs leading

to petitioner's residence preventing access to the residence from

the rest of the building.   Although petitioner placed a "private"

sign on the stairway leading up to his residence, there are no

permanent dividing walls or partitions separating the residence

from the art gallery.

     The property upon which the building is located is subject

to a single deed.   Similarly, there is a single real estate tax

assessment for the property and one sewage and water bill.    There

were separate telephone lines for the art gallery and

petitioner's residence.   Electricity and natural gas usage were

also metered and billed separately.

     Petitioner incorporated FOTA Gallery, Inc. (FOTA) in 1986.

FOTA's purpose was to own and operate the art gallery, which it

did during the years in issue.    Without a lease, or any other

formalities, it appears that petitioner allowed FOTA to use the

street and basement levels of the building for the operation of

the art gallery.2   FOTA held its first art show in 1987.

     2
      A real estate settlement statement introduced into evidence
as one of respondent's exhibits indicates that FOTA, rather than
petitioner, was the purchaser of the building. Petitioner signed
this settlement statement on behalf of FOTA as president of the
corporation. Contrary to the settlement statement, the
stipulation of facts included the following paragraph: "The
petitioner purchased a three level structure. * * * The
structure was purchased by petitioner on December 4, 1986."
                                - 6 -

     For the years 1987, 1988, and 1989, FOTA filed its Federal

income tax returns in accordance with an election made pursuant

to section 1362(a), commonly referred to as an S election.     For

the years in issue, petitioner's individual Federal income tax

returns reflected petitioner's distributive share of the losses

incurred by FOTA in the amounts of $45,035, $23,180, and $63,512,

respectively.    Although the record is incomplete as to the

circumstances surrounding the filing of FOTA's Federal income tax

returns for the years in issue and respondent's examination of

those returns, it appears that respondent made adjustments to the

amount of losses reported by FOTA for the years 1987, 1988, and

1989.    In a portion of FOTA's examination report included with

the notice of deficiency issued to petitioner, respondent

provided the following explanation for certain of the

adjustments:3

     The deductions for business use of your dwelling unit
     are limited to the gross income from the business
     activity after subtracting the business part of your
     real estate taxes, mortgage interest, and expenditures
     required for the activity but not allocable to the use
     of the unit itself.


[emphasis added]. The Court was invited to ignore the exhibit
when this inconsistency was called to the attention of the
parties in a posttrial conference. Because the technical
ownership of the building has no impact on the outcome of the
issue under consideration, we honor the stipulation and proceed
as though petitioner was, in fact, the owner of the building.
     3
      Certain allocations and other adjustments were made by
respondent in connection with her examinations of FOTA and
petitioner. Petitioner only contests the adjustments that depend
upon the resolution of the issue disputed in this proceeding.
                                - 7 -

Consistent with her examinations of FOTA, respondent reduced the

losses claimed by petitioner from FOTA by $17,101 and $21,891 for

the years 1987 and 1989, respectively, and increased the losses

claimed by $24,070 for the year 1988.

                               OPINION

     Section 162(a) generally allows a deduction for all ordinary

and necessary expenses paid or incurred during the taxable yearin

carrying on a trade or business.   Section 280A(a) provides that

in the case of a taxpayer who is an individual or an S

corporation, no deduction otherwise allowable under chapter 1

(Normal Taxes and Surtaxes) shall be allowed with respect to the

use of a dwelling unit which is used by the taxpayer during the

taxable year as a residence.   The term "dwelling unit" includes a

house, apartment, condominium, or similar property, and all

structures or other property appurtenant to such dwelling unit.

Sec. 280A(f)(1).

     Section 280A(c)(1) provides an exception to section 280A(a)

stating that subsection (a) shall not apply to any item to the

extent such item is allocable to a portion of the dwelling unit

which is exclusively used on a regular basis as the principal

place of business for any trade or business of the taxpayer.

Sec. 280A(c)(1)(A).4   Section 280A(c)(5) provides a limitation on

     4
      In her brief, respondent raised an argument that petitioner
failed to satisfy the "exclusive use" test with respect to the
basement level of the building. The argument is inconsistent
with allocations expressly and implicitly made in respondent's
                               - 8 -

the deductions that may be allowed under section 280A(c)(1)(A).

Specifically, section 280A(c)(5) provides that the deductions

allowed shall not exceed the excess of the gross income derived

from the trade or business use for the taxable year, over the sum

of certain deductions allocable to such income.5

     The parties agree that at least the top floor of the

building which petitioner used as a residence constitutes a

dwelling unit as defined in section 280A(f)(1)(A) and that

petitioner used such dwelling unit as his residence during the

relevant periods.   Petitioner argues, however, that section 280A,

and particularly the limitations on deductions imposed by section

280(c)(5), are not applicable because only the upper level of the

building constitutes a dwelling unit.   According to petitioner,

the basement and street levels, which were used for art gallery

business purposes, should not be considered part of the dwelling

unit, or appurtenant to it.   Respondent argues the entire

building constitutes the dwelling unit.   In support of her

argument respondent relies heavily upon the fact that physically

there is unrestricted access to all parts of the building from

any location within the building.


examination of FOTA and reflected in certain adjustments made to
FOTA's income for the years in issue. Because the argument was
first made in her brief, it will not be considered. See
Markwardt v. Commissioner, 64 T.C. 989 (1975).
     5
      Petitioner agrees that if the provisions of sec. 280A(c)(5)
are applicable, respondent's adjustments to the losses reported
by FOTA for the years in issue are correct.
                                 - 9 -

     We agree with respondent that all floors of the building

constitute petitioner's "dwelling unit".    Clearly, the upper

level of the building, which petitioner utilized as his

residence, is a dwelling unit.    The building contains no

permanent partitions or walls that physically or functionally

separate the area used by the art gallery from the areas used as

petitioner's residence.   Various photographs introduced into

evidence depicting different interior areas of the building

reveal nothing that suggests that the three levels of the

building were anything other than one integrated unit.    Customers

who entered the art gallery had free access to the foyer where

the stairway to the basement was located.    Allowing customers to

have access to the foyer area also gave them access to the

building's upper level, or petitioner's residence.    Petitioner

had to pass through the foyer in order to gain access to his

residence.   He had to use the same stairway that customers used

when he descended to the laundry room in the basement.

     We see no meaningful distinction between the facts of this

case and those involved in Burkhart v. Commissioner, T.C. Memo.

1989-417.    In that case the taxpayer used the basement portion of

his residence exclusively for business purposes.    In deciding

that the entire structure constituted the dwelling unit the Court

stated:

     The basement became both a physical and functional part
     of the building. * * * The costs of maintaining the
     basement in terms of taxes, interest, utilities and
                               - 10 -

     insurance were integrated with the costs of maintaining
     the rest of the building. The basement became part and
     parcel--a "portion," in the language of section
     280A(c)(1) and (5)--of petitioners' dwelling unit.
     * * * [Burkhart v. Commissioner, supra.]

In the instant case, the basement and street levels were

certainly physical parts of the building, and, even if we only

take into account the necessary usage of the stairway, those

levels were functional parts as well.    Accordingly, consistent

with our reasoning in the Burkhart case, we find that the entire

building constitutes petitioner's dwelling unit as that term is

used in section 280A.

     Because we find that the entire building constitutes the

petitioner's dwelling unit, we need not address the question of

whether the basement and street levels were appurtenant to the

upper level.

     Because the areas used as an art gallery were part of

petitioner's dwelling unit, the deductions attributable to the

business use of the building are subject to the limitations set

forth in section 280A(c)(5).   Accordingly, respondent's

determination in this regard is sustained.

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
