                        T.C. Memo. 1997-382



                      UNITED STATES TAX COURT



              THOMAS LOUIS MITCHELL, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10147-95.                     Filed August 20, 1997.



     Thomas Louis Mitchell, pro se.

     Thomas L. Fenner, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GALE, Judge:   Respondent determined the following

deficiencies in, and additions to, petitioner's Federal income

taxes:
                                    - 2 -

                                       Additions to Tax
     Year      Deficiency       Sec. 6651(a)(1)   Sec. 6654(a)
     1985      $9,696               $2,424            $556
     1986       5,077                1,117             236
     1987       5,974                1,296             344
     1988       8,206                1,952             514
     1989       2,195                  148                56
     1990      10,448                2,144                71
     1991       9,984                2,496             574
     1992       6,556                1,639             286
     1993       6,786                1,697             296

     Unless otherwise noted, all section references are to the

Internal Revenue Code in effect for the years in issue, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.

     The parties filed a stipulation of settled issues, which was

amended by agreement of the parties at trial.     The sole issue

remaining after concessions is the amount and character of losses

sustained by petitioner on the foreclosure of various partnership

interests in 1987.

                            FINDINGS OF FACT

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

incorporate by this reference the stipulation of facts, the

supplemental stipulation of facts, and the attached exhibits.      At

the time of filing the petition, petitioner resided in Round

Rock, Texas.
                                - 3 -

Ownership and Foreclosure

     In 1982, petitioner acquired limited partnership interests

in a partnership named 66 Farmout, both individually and under

the name M & A Interest.    In 1983, petitioner acquired limited

partnership interests in three partnerships:     Dime Box No. II,

Dime Box No. III, and CAG Farmout.      Petitioner owned interests in

Dime Box No. III individually and under the name M & A Interest.

We will refer to 66 Farmout, Dime Box No. II, Dime Box No. III,

and CAG Farmout collectively as the partnerships.     The

partnerships were engaged in the activity of drilling oil and gas

wells.   Prior to the year in issue, petitioner used portions of

his interests in the partnerships as collateral for loans.

Petitioner used his interests in 66 Farmout as collateral for one

loan in an amount not in the record1 and used his interests in

the remaining partnerships as collateral for another loan in the

amount of $100,000.   Petitioner owned the partnerships, and used

the partnership interests as collateral, in the following

percentage amounts:




     1
       In his trial memorandum, petitioner asserts that the loan
for which the 66 Farmout interests served as collateral was equal
to $15,000. We have no sworn testimony or other evidence to
support this claim, and in any event the amount of the loan is
unimportant to the resolution of the issue in this case.
                                  - 4 -



                66        66              DB III     DB III
Partnership    (Pet.)    (M&A)   DB II    (Pet.)     (M&A)    CAG
% Owned         3%         2%      4%      4%          1%      2%
                1          1                           1
% Used as        3%         2%     4%      3.75%        .5%    1.5%
 collateral
     1
       Respondent has conceded that petitioner used as collateral
his entire interest in 66 Farmout (both the interest held in his
name and the interest held in the name of M & A Interest), and 50
percent of his interest in Dime Box No. III held in the name of M
& A Interest. See infra note 6.

Thus, petitioner pledged 100 percent of 66 Farmout held in

petitioner's name, 100 percent of 66 Farmout held in the name of

M & A Interest, 100 percent of Dime Box No. II, 93.75 percent of

Dime Box No. III held in petitioner's name, 50 percent of Dime

Box No. III held in the name of M & A Interest, and 75 percent of

CAG Farmout.   In 1987, the holders of the loans foreclosed on the

portions of petitioner's interests in the partnerships that

secured the loans.      At the time of foreclosure, the fair market

value of petitioner's foreclosed interests in the Dime Box No.

II, Dime Box No. III, and CAG Farmout partnerships, collectively,

was $60,000.

Basis and Capital Account

     Prior to the foreclosures, the only property petitioner

contributed to the partnerships was cash.          Similarly, the only

property the partnerships distributed to petitioner was cash.

The following table shows adjustments to petitioner's capital
                                                       - 5 -

accounts in the partnerships during the year in issue as

reflected on the Schedules K-1:



                                                                          DB III         DB III
     Name                 66 (Pet.)       66 (M & A)         DB II        (Pet.)        (M&A)            CAG

 Cap. acct.               ($761.00)        ($508.00)        $373.00      $3,051.00       $763.00      $2,109.00
  beginning 1987

 Ord. income             $1,634.68        $1,089.79         $683.32        $679.90       $110.26        $688.60

 Distributions          ($1,539.09)      ($1,026.03)     ($1,056.32)    ($3,891.52)     ($169.04)    ($2,383.06)

 Cap. acct. ending        ($665.41)        ($444.24)           0.00       ($160.62)      $704.22        $414.54
  1987

 % Cap. ownership            3%               2%               4%            4%            1%             2%
  beginning 1987

                             1                1                                            1
 % Cap. ownership             3%              2%               0%            .25%           1%           .5%
  ending 1987

     1
       The Schedules K-1 are inconsistent with the findings as to the amount pledged as collateral and foreclosed
on, as shown in the previous table. See infra note 6.



For each partnership interest, the beginning capital account

balance reflects the intangible drilling costs (IDC) incurred and

deducted by the partnership.

                                                      OPINION

Amount of Loss

        We must first decide the amount of the loss that petitioner

incurred as a result of the foreclosure of his partnership

interests.2           In the notice of deficiency, respondent took the


        2
       Respondent concedes that petitioner had a loss equal to
his basis rather than a gain, even though respondent also
concedes that the fair market value of petitioner's interests in
Dime Box No. II, Dime Box No. III, and CAG Farmout exceeded his
bases in those interests. Cf. Correra v. Commissioner, T.C.
Memo. 1997-356. The finding of fact as to the fair market value
of petitioner's foreclosed interests in the Dime Box No. II, Dime
Box No. III, and CAG Farmout partnerships, collectively, is based
                                                   (continued...)
                                 - 6 -

position that petitioner's loss deduction was limited to his

basis in the partnership interests, which respondent computed

using the Schedules K-1.     We accept the approach taken by

respondent.

     Section 165(a) permits a deduction for "any loss sustained

during the taxable year and not compensated for by insurance or

otherwise."   Sec. 165(a).    The amount of the deduction is limited

to the amount of the basis of the property prescribed by section

1011 for determining the loss from the sale or other disposition

of the property.   Sec. 1.165-1(c), Income Tax Regs.    Thus, the

key question concerns the bases of the properties involved.

     Petitioner agrees that his loss deduction is limited to

basis, but disputes respondent's method for computing basis.

Petitioner first argues that for each partnership interest he is

entitled to a basis equal to the fair market value of that

partnership interest.   Petitioner argues that when he pledged the

partnership interests as collateral, he relinquished total

control over those interests for the duration of the loan.     This,

in petitioner's view, caused the basis to be equal to fair market

value.   Since the fair market value of the partnership interests

was equal to $60,000 at the time of the foreclosure, petitioner




     2
      (...continued)
on a stipulation of the parties. The parties did not stipulate,
or present any other evidence, as to the fair market value of
petitioner's interests in the 66 Farmout partnership.
                               - 7 -

believes he is entitled to a $60,000 loss deduction.3

     All of the properties with respect to which petitioner

sustained losses were partnership interests.    In general, the

adjusted basis of a partner's interest in a partnership equals

the amount of money and the adjusted basis of property

contributed by the partner to the partnership, increased by the

partner's distributive share of partnership income and certain

other amounts, and decreased by distributions and the sum of the

partner's distributive share of partnership losses and certain

other expenditures.   Sec. 705(a).   Petitioner's contentions

notwithstanding, there is no provision in the Code allowing a

partner a stepped-up basis in his partnership interest as a

result of its being pledged as collateral.    Thus, we reject

petitioner's argument that the basis of each partnership interest

was equal to its fair market value.4

     Petitioner next argues, in the alternative, that

respondent's computation of basis is wrong in any event.    First,

petitioner argues that respondent improperly relied on the

Schedules K-1 in computing basis.    Second, petitioner argues that

respondent double counted IDC in making that computation.


     3
       At trial, petitioner also argued that he was entitled to a
loss deduction of $40,000 -- the difference between the $100,000
loan secured by the Dime Box No. II, Dime Box No. III, and CAG
Farmout partnership interests and the $60,000 fair market value
of those interests at foreclosure. On brief, petitioner merely
maintains that the loss is equal to $60,000.
     4
       For the same reason, we reject petitioner's argument at
trial, identified supra note 3, that his loss was equal to
$40,000.
                                 - 8 -

     Petitioner argues that it was arbitrary for respondent to

rely on the Schedules K-1 to compute basis, especially in light

of the instructions to Form 1065, which indicate that the capital

account information provided on the Schedule K-1 may not be

determinative of basis.    The instructions to Form 1065 merely

reflect that basis and capital account are frequently not equal,

as, for example, where property (as distinguished from cash) is

contributed to or distributed from a partnership.    In such

circumstances, taxpayers may not rely on capital account as a

substitute for basis.    However, these instructions do not

foreclose the use of Schedules K-1 in appropriate circumstances

to compute basis.     Most importantly for petitioner, if we did not

rely on the Schedules K-1, there would be insufficient evidence

of basis on this record, and petitioner would not be entitled to

any loss deduction.    See Blocker v. Commissioner, T.C. Memo.

1992-725, affd. without published opinion 25 F.3d 1043 (5th Cir.

1994).

     In the circumstances of this case, the Schedules K-1 provide

an accurate measure of basis.    Although contributions and

distributions of property (as distinguished from cash) can cause

the capital account and basis in a partnership interest to

diverge,5 no such divergence occurred in this case because


     5
       In general, to determine a partner's capital account
balance, the fair market value of property that is contributed by
or distributed to the partner is added to or subtracted from his
existing capital account balance. See, e.g., secs. 1.705-
1(a)(1), 1.704-1(b)(2)(iv)(b), Income Tax Regs. By contrast, to
                                                   (continued...)
                                - 9 -

petitioner contributed only cash to the partnerships and received

only cash as distributions.    Moreover, petitioner agrees that the

Schedules K-1 accurately reflect the amount of the beginning

capital account balances, income, distributions, and ending

capital account balances for the year in issue.     Therefore, each

capital account balance accurately reflects petitioner's basis in

the respective partnership.

     Petitioner also argues that his adjusted basis should not be

reduced by his distributive share of IDC.      Petitioner agrees that

all of the partnerships took deductions for IDC and that the

capital account balances on the Schedules K-1 reflect a downward

adjustment due to IDC.    The following table sets out the

beginning capital account balances for the year in issue for each

of the partnership interests with and without the effects of IDC:

         Name            Cap. Acct. With IDC    Cap. Acct. W/Out IDC
Dime Box II                     $373                $7,183.74
Dime Box III (Pet.)            3,051                20,547.59
Dime Box III (M&A)               763                 5,136.67
CAG Farmout                    2,109                15,460.28
66 Farmout (Pet.)               (761)               11,675.89
66 Farmout (M&A)                (508)              not available

In petitioner's view, however, because IDC is counted in

calculating each partnership's income, it is not proper to count


     5
      (...continued)
determine a partner's adjusted basis in the partnership interest,
the adjusted basis of contributed or distributed property is
added to or subtracted from his adjusted basis in the partnership
interest. See, e.g., secs. 722, 733.
                              - 10 -

IDC in calculating petitioner's basis in each partnership.     Thus,

petitioner argues that respondent's reliance on the Schedules K-1

results in a double counting of IDC, improperly reducing

petitioner's basis.   This view is incorrect.

     In general, deductible items reduce both the partnership's

taxable income and each partner's basis in the partnership.

Pursuant to section 703, a partnership computes its taxable

income in the same manner as an individual, except that certain

items must be stated separately and certain deductions are not

allowed.   IDC is an item that must be stated separately.    Sec.

1.702-1(a)(8)(i), Income Tax Regs.     Thus, in determining his

income tax, petitioner must take into account his distributive

share of loss due to IDC.   Sec. 702(a).    Pursuant to section

705(a), a partner's adjusted basis in his partnership interest is

increased by the partner's distributive share of taxable income

of the partnership and decreased by the partner's distributive

share of losses of the partnership.     Thus, petitioner's adjusted

basis in each partnership interest was properly increased by

petitioner's distributive share of taxable income of the

partnership, net of petitioner's distributive share of IDC.       The

deduction for IDC affects both petitioner's ultimate distributive

share of partnership income and petitioner's basis in the

partnership interest.   Thus, reliance on the Schedules K-1 does

not result in an improper double counting.

     On brief respondent relied on the Schedules K-1 in computing

petitioner's basis by taking the capital account balance at the
                                   - 11 -

beginning of the year and adding partnership income received

during the year.       Respondent's computation represents a

concession of sorts, because it produces the largest possible

basis to which petitioner may be entitled, since it does not

account for any distributions that may have occurred during the

year.     We will accept respondent's computation of basis in this

case.     Petitioner's challenges are unavailing, and petitioner has

offered no other evidence from which we might compute basis.

Thus, we accept respondent's approach, and petitioner's basis in

each of the partnership interests is set out in the following

table:

                                            Basis (Beginning Cap.
                   Name                        Acct. + Income)

         Dime Box No. II                         $1,056.32
         Dime Box No. III (Petitioner)            3,730.90
         Dime Box No. III (M & A)                   873.26
         CAG Farmout                              2,797.60
         66 Farmout (Petitioner)                    873.68
         66 Farmout (M & A)                         581.79

Further, in some cases only portions of petitioner's interests

were actually pledged as collateral and foreclosed on, so that

petitioner's loss deduction is limited to the following amounts:6


     6
       Respondent uses the Schedules K-1 stipulated into evidence
to compute basis, and petitioner agrees as to the accuracy of the
Schedules K-1. However, in three instances the Schedules K-1
fail to reflect the effect of the foreclosures upon petitioner's
ownership of certain partnership interests; namely, the 66
Farmout interest held in petitioner's name, the 66 Farmout
                                                   (continued...)
                               - 12 -

                                          % of P's
                                          Interest
         Name                  Basis     Foreclosed On      Loss


Dime Box No. II              $1,056.32      100%         $1,056.32
Dime Box No. III (Pet.)       3,730.90      93.75         3,497.72
Dime Box No. III (M & A)        873.26      50              436.63
CAG Farmout                   2,797.60      75            2,098.20
66 Farmout (Pet.)               873.68      100             873.68
66 Farmout (M & A)              581.79      100             581.79



Character of Loss

     Finally, we must decide the character of the loss.     Gain or

loss on the sale or exchange of a partnership interest is capital

gain, except in certain circumstances involving unrealized

receivables and inventory.   Secs. 741, 751.     Respondent concedes

that the foreclosure of each partnership interest was a sale or

exchange under which loss was realized and hence recognized.



     6
      (...continued)
interest held in the name of M & A Interest, and the Dime Box No.
III interest held in the name of M & A Interest. According to
the Schedules K-1, petitioner owned the same percentage of each
of these three partnerships at the end of 1987 as he did at the
beginning, which suggests that no foreclosures occurred with
respect to these partnership interests during the year. However,
the parties agree, and we have found, that foreclosures occurred
during 1987 with respect to these interests. The Schedules K-1
are, in this respect, inconsistent. The Schedules K-1
notwithstanding, respondent clearly concedes, and we have found,
that petitioner suffered losses premised on the foreclosure of
the following: His entire interest in 66 Farmout held in his
name, his entire interest in 66 Farmout held in the name of M & A
Interest, and half of his interest in Dime Box No. III held in
the name of M & A Interest.
                              - 13 -

Sec. 1001(a)-(c); Helvering v. Hammel, 311 U.S. 504 (1941).

Petitioner argues that the IRS regulations and publications state

that the sale or exchange of an interest in oil or gas produces

ordinary, not capital, gain or loss.   However, the interests

foreclosed herein were not interests in oil or gas, but

partnership interests.   Petitioner has presented no evidence of

unrealized receivables or inventory held by the partnerships, and

thus the losses in issue in this case are capital losses.

     To reflect the foregoing,



                                       Decision will be entered

                                 under Rule 155.
