                        T.C. Memo. 1997-205



                      UNITED STATES TAX COURT



         LEE D. AND MARJORIE L. HUSTEAD, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 4905-95.                 Filed May 5, 1997.



     Lee D. Hustead, pro se.

     George Curran, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     TANNENWALD, Judge:    Respondent determined the following

deficiencies in petitioners' Federal income tax:

               Year                   Amount

               1991                   $7,532
               1992                    6,226
                               - 2 -

     After concessions by respondent,1 the issue for decision is

whether petitioners' Schedule C expenses are deductible as

current business expenses or must be treated as capital

expenditures.

                          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.    Petitioners resided in

Norristown, Pennsylvania, at the time they filed their petition

in this case.

Petitioners' Activities

     During the taxable years 1991 and 1992, petitioners were

engaged in an unincorporated business entitled LM Development.

Petitioners started LM Development in 1987.    Petitioners'

business is to purchase undeveloped land with low density zoning

and challenge unconstitutional and unlawful land practices by

government entities, thereby achieving appreciation in the value

of land assets owned or under contract.

     Prior to March 1, 1992, petitioner Lee D. Hustead (Mr.

Hustead) was employed as an engineer at General Electric.     Mr.

Hustead retired from General Electric on March 1, 1992, and


     1
       Respondent concedes that mortgage interest expenses of
$9,504.89 and $7,366.99 are deductible by petitioners on their
Schedules A for the taxable years 1991 and 1992, respectively.
Respondent also concedes $141 of insurance expenses for each year
as a Schedule A deduction.
                               - 3 -

continues to work in the operation of LM Development.     Petitioner

Marjorie L. Hustead was employed as a registered nurse.

     Petitioners purchased undeveloped land located in Skippack

Township, Pennsylvania (two lots in 1977 and one lot in 1987).

At the times of purchase, the land was zoned "R1", which allowed

only one residential dwelling per acre.

     Petitioners' selected the land because:

     a.    Petitioners believed Skippack Township was
           practicing zoning (a delegated police power)
           that was unconstitutional.

     b.    Petitioners believed the land's situation and
           characteristics were ideal to sustain a
           constitutional challenge.

     c.    Petitioners found this land significantly
           undervalued with respect to its worth with
           even partial recovery of what the petitioners
           believed to be its full value under
           constitutional zoning.

     d.    Petitioners determined that this land was a
           superior buy with respect to all other land
           opportunities (townships and land), analyzed
           for all of their criteria.

Petitioners intended to retain the land in its undeveloped state

and to challenge the constitutionality of Skippack Township's

zoning ordinance and obtain a change in zoning which would allow

more residential dwellings per acre.   After obtaining such a

change, petitioners intended to sell the land to builders at a

profit.   The receipt of capital gains from its sale is the only

means by which petitioners intend to earn income on the

undeveloped land.
                               - 4 -

     From 1987 to 1993, petitioners engaged in various activities

to obtain a zoning change.   Petitioners' efforts were first

reflected in litigation challenging the constitutionality of the

Skippack Township zoning provisions.   These efforts were

initially unsuccessful, but petitioners filed an appeal.    In

1991, by reason of a settlement offer and stipulation,

petitioners' efforts were thereafter directed to achieving an

amicable disposition of their claims which would result in an

acceptable change in the zoning.

     On October 23, 1991, Skippack Township adopted a new

comprehensive land use plan.   The new plan increased, from 80 to

337, the number of acres of land in Skippack Township designated

for housing at four dwellings per acre (Village Residential).

During 1991 and 1992, petitioners worked with Skippack Township

with respect to the development, review, and enactment of a new

zoning ordinance which included petitioners' land.

     On May 23, 1993, the Board of Supervisors voted to change

the zoning ordinance as applied to petitioners' undeveloped land

and approximately 217 more acres.   This change allowed

petitioners' undeveloped land to be developed as Village

Residential, i.e., four residential units per acre.

Petitioners' Expenses and Federal Income Tax Returns

     Petitioners capitalized the startup costs for LM Development

including the cost of acquiring the undeveloped land in 1977 and

1987.
                               - 5 -

     During the years at issue, petitioners paid professional

fees to a land use planning firm and engineers for services such

as review of the land use plan, a wetlands survey, and evaluation

of sewerability.   Petitioners also paid for legal assistance in

their zoning appeal and in negotiating the stipulation.   Other

expenditures included payment for repair of a broken floppy disk

drive on petitioners' computer and for typing services.

Petitioners used their computer for word processing, to keep

business records, and to prepare their tax returns.   In 1992,

petitioners used the services of a tax accountant and a tax

lawyer to review their records.2

     Petitioners timely filed U.S. Individual Income Tax Returns

for the taxable years 1991 and 1992.   They claimed deductions for

LM Development's 1991 and 1992 business activities on Schedules C

as follows:




     2
        Petitioner Lee Hustead so testified without specifying
the amount paid, which on brief petitioners listed as $650.
                                - 6 -

     Schedule C Expense                    1991             1992

     Commissions1                       $3,239.75        $1,231.90
     Legal & professional service        4,800.00         4,111.59
     Office                              3,759.65         3,798.43
     Repairs                               295.74           - 0 -
     Supplies                              630.88           - 0 -
     Taxes                               1,793.94         2,008.31
     Travel                                315.00           310.35
     Utilities                             253.93           302.70
     Other expenses                        957.93           389.31
     Depreciation                        1,735.18         2,776.28
     Insurance                             141.00           141.00
     Interest                            9,504.89         7,366.99

            TOTAL                       27,428.54        22,436.86
     1
         These represent fees paid to Skippack Township as costs
         for the public hearings.

     All of the above expenses were incurred attendant to

petitioners' business as LM Development and, with one exception,

see infra pp. 11-12, were directly related to petitioners'

attempt to improve the value of the land.

Respondent's Determinations

     Respondent issued the notices of deficiency for the taxable

years 1991 and 1992 on January 6, 1995.       The adjustments to

income were as follows:

            Item                                  1991             1992

     All Schedule C expenses                 $27,428          $22,437
     Self-employment Tax deductions               (8)             (42)
     Itemized deductions                      (1,309)            (870)

Previous Litigation

     Hustead v. Commissioner, T.C. Memo. 1994-374, concerned the

deductibility of petitioners' Schedule C expenses for LM
                               - 7 -

Development for the taxable years 1989 and 1990.   The petition

therein was filed with the Court on September 11, 1992.   The

Court in its opinion, filed August 8, 1994, agreed with

respondent that the disputed expenses were to be capitalized.

The Court of Appeals for the Third Circuit, without published

opinion, affirmed this Court's decision on June 28, 1995.

Hustead v. Commissioner, 61 F.3d 895 (3d Cir. 1995).



                              OPINION

     The issue in this case is whether petitioners' 1991 and 1992

Schedule C expenses can be deducted as current business expenses

or whether they constitute capital expenditures.   The amounts or

business purpose of the claimed expenses are not in dispute.

     Although the parties have stipulated that the above is the

only issue for decision, petitioners on brief continue to assert

that "respondent's failure to cite any basis in law (reference to

an IRC section) acts to deprive taxpayers of a fair trial and due

process of law."   Petitioners request that the burden of proof be

upon respondent as a sanction for such failure.

     The notices of deficiency indicated that respondent had

disallowed all Schedule C expenses for both 1991 and 1992.   This

clearly advised petitioners of the basis for the deficiencies.

The Court's opinion in the earlier case, which addressed the same

issue, was issued prior to the mailing of the notices involved
                               - 8 -

herein.   Petitioners cannot claim surprise or ignorance as to

the basis for the determinations.

     Under the circumstances herein, we reject petitioners'

request noting that, in any event, we can dispose of the case on

the merits based on the undisputed facts with the result that the

location of the burden of proof becomes irrelevant.

     Section 162(a)3 allows the deduction of "all the ordinary

and necessary expenses paid or incurred during the taxable year

in carrying on any trade or business".   However, section

263(a)(1) provides that "No deduction shall be allowed for * * *

any amount paid out for new buildings or for permanent

improvements or betterments made to increase the value of any

property or estate."

     The parties have stipulated that the activities of LM

Development constituted a "business", but that is not

determinative of deductibility.   As the Court of Appeals for the

Ninth Circuit stated in Madden v. Commissioner, 514 F.2d 1149,

1150 (9th Cir. 1975), revg. and remanding 57 T.C. 513 (1972)4:

          The statutes involved in this appeal are
     relatively clear. Sections 162 and 212 allow a
     taxpayer to deduct many current expenses from ordinary

     3
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years before
the Court, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
     4
        Madden and its rationale were specifically accepted by
this Court in Soelling v. Commissioner, 70 T.C. 1052, 1055-1056
(1978).
                               - 9 -

     income if they are related to business or profit-
     seeking activity. Once that nexus is established,
     however, the taxpayer still cannot be sure of deducting
     the expenses. Rather, an additional question must be
     answered: Are the expenses "capital" in nature under §
     263? If they are capital, they cannot be deducted as
     business expense. [Citations omitted.]

     Whether an expenditure may be deducted or must be

capitalized is a question of fact.     INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 86 (1992); A. E. Staley Manufacturing

Co. v. Commissioner, 105 T.C. 166, 193 (1995).

     Petitioners characterize some phases of their land

development activities as lobbying, citing section 162(e), or

marketing.   In this context, they seek to distinguish the

situation involved in the earlier years and disposed of in

Hustead v. Commissioner, T.C. Memo. 1994-374, on the basis that

those years involved litigation activities whereas negotiating

activities were the focus in the years involved herein.      We think

this is a distinction without a difference.    In any event,

petitioners' characterizations are not determinative of

deductibility.   The question remains what is the origin or nature

of the transaction out of which the expenses arose.       Petitioners

refer to some expenses as those of being in business, e.g.,

office supplies, alleging that respondent has disallowed these

expenses on a theory of guilt by association.    Again, the same

analysis governs these expenses.   It is not the nature of the

item paid for, but the nature of the transaction giving rise to
                              - 10 -

that expense.   A. E. Staley Manufacturing Co. v. Commissioner,

supra at 195.

     Petitioners contend that their land development activities

did not change the physical characteristics of the land itself

nor did they affect title and that, therefore, there were no

"improvements or betterments" to the land.   Petitioners also

maintain that they did not have a vested interest in the zoning

change during the years at issue and would not acquire such an

interest until a land-use permit was granted; consequently, they

argue, their activities did not lead to a "permanent" change

during the years at issue, which, as petitioners interpret

section 263(a)(1), is required for capitalization.

     While physical alterations, e.g., construction, or actions

affecting title, may be sufficient conditions to classify an

expense as capital, they are not necessary conditions.      INDOPCO,

Inc. v. Commissioner, supra at 86-87; Commissioner v. Lincoln

Savings & Loan Association, 403 U.S. 345, 358 (1971) ("§ 263 does

not provide a complete list of nondeductible expenditures").     Nor

does section 263(a)(1) require that the change for which the

funds were expended be completed or vested within a specific tax

year for that change to be permanent within the meaning of that

section.

     The foregoing principles have been applied in a number of

cases where expenditures in efforts to obtain changes in land

zoning have been required to be capitalized.   Godfrey v.
                               - 11 -

Commissioner, 335 F.2d 82, 84-85 (6th Cir. 1964) (where the

efforts were unsuccessful but the expenditures were held not to

be deductible, the court stating:   "The purpose of the

expenditure was to create a permanent benefit.   The fact that it

created neither a permanent nor exhaustible benefit does not

change its character."); Soelling v. Commissioner, 70 T.C. 1052,

1055-1056 (1978); Galt v. Commissioner, 19 T.C. 892, 910 (1953),

affd. in part and modified on other issues 216 F.2d 41 (7th Cir.

1954).5

     Most of petitioners' disputed Schedule C expenses, including

office supplies and depreciation of their computer, arose out of

their activities to change the zoning and enhance the value of

their undeveloped land.   The very purpose of their business was

to conduct these activities.   Indeed, petitioners stipulated

without qualification that "The expenses [Schedule C] were

directly related to petitioners' attempts to improve the value of

the land."   The benefit to petitioners' land from rezoning is one

which inures beyond the year of the expenditures.   Income will be

realized from petitioners' activities when, and not until, the

property is sold.   Capitalization of petitioners' Schedule C

expenses leads to a closer matching of expenses with income.    See

INDOPCO, Inc. v. Commissioner, supra at 84, where the Supreme

Court emphasized the importance of such matching principle.

     5
        See also Davis v. Commissioner, T.C. Memo. 1983-160;
Ackerman Buick, Inc. v. Commissioner, T.C. Memo. 1973-224.
                             - 12 -

     In sum, we are satisfied, as we were in the earlier case,

that petitioners' Schedule C expenses, with one exception, are

not currently deductible and must be capitalized.

     The exception relates to State and local real property taxes

of $1,793.94 and $2,008.31 which petitioners paid in the taxable

years 1991 and 1992, respectively.    The obligation to pay these

taxes arose out of mere ownership of the undeveloped land, not

out of petitioners' rezoning activities.    We hold that these

taxes are deductible under section 164(a).6

     To implement our holdings and respondent's concessions,

                                           Decision will be entered

                                     under Rule 155.




     6
        Respondent has made no claim that these taxes should be
capitalized under sec. 263A, an issue that was involved in the
earlier case. Since it is undisputed that they relate to
petitioners' "business", they constitute a Schedule C deduction
and will be taken into account in computing "adjusted gross
income" for purposes of the 2-percent limitation on itemized
deductions. See Brown v. United States, 434 F.2d 1065 (5th Cir.
1970); sec. 1.62-1T, Temporary Income Tax Regs., 53 Fed. Reg.
9870 (March 28, 1988).
